Washington Tax Insight August 2018
Politics and Congressional Activity
The House has adjourned for the summer and will return to work on September 4th. The Senate will work for most of the month of August, with only a one-week break August 6-10th.
In July, work continued in both the House and Senate on appropriations bills for FY 2019, which starts October 1, 2018. Congressional leadership would like to avoid an omnibus spending bill at the end of the year, and President Trump said earlier this year after signing the Bipartisan Budget Act of 2018, that he would not sign an omnibus bill this year.
Senate Finance Committee: The SFC favorably voted the nomination of Charles Rettig to be IRS Commissioner out of the committee, and now he must be confirmed by the full Senate. If confirmed, he would serve a term that expires November 12, 2022. Rettig was generally supported by both Republicans and Democrats on the Committee, but his nomination was held up after Committee Democrats opposed new IRS guidance in Rev. Proc. 2018-38, which generally provides that tax-exempt organizations, other than 501(c)(3) groups, are no longer required to disclose names and addresses of donors on their Forms 990 or Forms 990-EZ.
SFC Chair Hatch (R-UT) and Ranking Member Wyden (D-OR) introduced The Taxpayer First Act, which is a bipartisan bill that would increase taxpayer protections and electronic filing, enhance whistleblower protections, reform policies concerning IRS employees, increase scrutiny of IRS audit criteria, and support prevention of identity theft and tax refund fraud. The legislation follows HR 5444, which unanimously passed the House earlier this year.
House: The House adopted a non-binding resolution opposing carbon taxes with the text of the resolution listing a summary of the potential harm that a tax on fossil fuels could have on the economy, including higher prices for food, fuel, and electricity. In contrast, Congressman Curbelo (R-FL), who is a member of the W&M Committee and co-chair of the bipartisan Climate Solutions Caucus, is reportedly planning to introduce legislation that would enact a $23 per-metric ton carbon tax to replace the federal gas tax.
The House approved several health care related bills, including legislation that would permanently repeal the 2.3 percent excise tax on medical devices, which was enacted as part of the Affordable Care Act. Implementation of this provision had been delayed twice since enactment so that the tax is currently scheduled to take effect on January 1, 2020. No Senate action is currently scheduled. The House also approved two bills to expand various health care accounts for individuals, consolidating several bills approved by the Ways & Means Committee that aim to expand Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs). The White House issued a statement in support of the bills, which now go to the Senate for consideration.
The White House: Shahira Knight will replace Marc Short as the Director of the Office of Legislative Affairs. She has extensive tax experience from employment on Capitol Hill and was a key person in ensuring that the TCJA was enacted; she most recently served as Deputy Director of the White House National Economic Council.
South Dakota v. Wayfair – Online Sales Taxation
The House Judiciary Committee, which has jurisdiction over state tax issues in the House, held a hearing on the Supreme Court’s recent decision in South Dakota v. Wayfair with lawmakers and witnesses disagreeing over whether the case was correctly decided and on what action, if any, Congress should take in response. Committee Chair Goodlatte (R-VA) stated his opinion that the Wayfair decision overturned a stable precedent and would lead to states overreaching in the collection of taxes. He commented that the physical presence test provided a bright line rule for when a state could force a business to collect and remit sales taxes and that the Court’s decision would increase complexity for remote sellers, who will have to deal with thousands of different taxing jurisdictions.
Chair Goodlatte called for Congress to address the issue legislatively and to consider a moratorium on collection while states and stakeholders decide how best to proceed. Since some states have already had online sales tax collection rules in place, however, a moratorium could impact those established revenue streams. Other Committee members argued that no legislative action was necessary, commenting that the decision would equalize the tax treatment of online retailers and brick-and-mortar stores.
One concern addressed was the possibility that states would attempt to collect sales and use taxes from online transactions retroactively. Some states that already have laws in place or ready to enact have rules about retroactive collection and some do not.
There was also discussion of the questions not answered by the Wayfair decision. The decision states that a lack of physical presence in a state is not enough to create an undue burden under the Commerce Clause, but the Court did not discuss what would create an undue burden. The Committee discussed whether the threshold used by South Dakota for small businesses ($100,000 in sales or 200 transactions into the state) should apply in every state or whether larger states such as California and New York should use higher thresholds. The Committee discussed the issue of the availability of software to help businesses navigate the complexity of the tax rules in different jurisdictions with some witnesses saying that the software would cost millions, while the representative of the National Retail Federation stated that the software would cost much less.
There was some testimony about what states are currently doing in response to the decision. Utah is an example of a state that has enacted a remote sales tax collection law since the decision, while New Hampshire—which does not impose sales tax—has taken precautionary measures and is considering legislation to protect their citizens from taxation in other states.
There are certain issues that companies can begin to consider with respect to complying with the remote sales collection laws in any state. First, it may be difficult to determine where to source a particular sale, especially in cases where the purchaser is an organization with many locations, such as the sale of a software license to a company with several office locations. Second, most states limit the imposition of a sales tax primarily to sales of tangible property, which means that many services are not subject to sales and use tax. However, an increasing number of states tax different kinds of business services, including those involving data processing, software, and online or other cloud-based information technology services. Also, some states do not tax software except where it is delivered in tangible form, while others tax electronically downloaded software and “software as a service” subscriptions. There are exemptions that may be available including (1) sales of goods or services for use in manufacturing or industrial processing; (2) sales made for resale; and (3) sales to non-profit, government, or other tax-exempt entities.
Treasury and the IRS
- Transition tax rules: The Treasury released proposed regulations related to the Code section 965 transition tax on August 1. The regulations, which exceed 250 pages, provide guidance for taxpayers to include the tax on their 2017 tax returns.
- Passthrough Deduction rules: Treasury and the IRS sent the proposed regulations to implement the 20 percent deduction for the qualified business income of pass through businesses to the Office of Management and Budget for review on July 23, 2018, and they could be released in early August. OMB explained that the forthcoming rules will provide “guidance on computations necessary in computing the deduction for qualified business income” of pass through entities under new Code section 199A.
- Treasury and the IRS posted a new draft Form 1040 for next year’s tax filing season. The draft Form is only two pages long, although most of the information contained on the old Form 1040 has been moved to separate schedules. The Form will be finalized later this summer and then replace the current Form 1040 as well as Forms 1040A and 1040 EZ.
- Other areas that could see guidance during the next few months include entertainment expenses and the SALT deduction. Other issues included on the Priority Guidance list are: (1) hybrid dividends and payment under Code section 267A; (2) rules regarding the business interest limitation under Code section 163(j); (3) the carried interest earnings “loophole”; and (4) bonus depreciation.
- A new coalition has formed called the Working Group on Competitive International Taxation aimed at working with Treasury on international tax regulations related to the TCJA changes. The group includes over 20 major companies such as Microsoft, Walgreens, American Express, and Exxon Mobil. The coalition will focus on the global intangible low taxed income (GILTI) provision with the aim of ensuring that regulations are drafted in a way that is fair and equitable.
Other Issues and Guidance
Treasury and the IRS issued final regulations to take effect on July 12, 2018, to address transactions that are structured to avoid Code sections 7874 and 367 and certain post-inversion tax avoidance transactions. The final rules modify and clarify parts of the 2016 proposed regulations. Although the IRS concedes that the TCJA includes provisions that “may increase incentives to invert, including the tax imposed on Global Intangible Low Tax Income (GILTI) of foreign subsidiaries,” it believes that overall the TCJA reduced overall tax-motivate incentives to invert. The regulations address certain transactions structured to avoid the purposes of Code section 7874, providing rules for (1) identifying domestic entity acquisitions and foreign acquiring corporations in certain multiple-step transactions; (2) calculating the ownership percentage and, more specifically, disregarding certain stock of the foreign acquiring corporation for purposes of computing the denominator of the ownership fraction; (3) determining when certain stock of a foreign acquiring corporation is treated as held by a member of the expanded affiliated group (EAG); and (4) determining when an EAG has substantial business activities in a relevant foreign country.
The IRS has published new guidance and resources on the Country-by-Country (CbC) Reporting Guidance webpage. The IRS has also updated the Jurisdiction Status Table with recently signed Competent Authority Arrangements for the exchange of CbC reports.
Treasury and the IRS issued final regulations regarding the definition of qualified matching contributions and qualified nonelective contributions made by employers to certain retirement plans under Code section 401(k) and 401(m).
The IRS launched a new awareness campaign for tax practitioners to protect client data by issuing a revised Publication 4557, Safeguarding Taxpayer Data, and a new document, Publication 5293, Data Security Resource Guide for Tax Professionals. The campaign encourages tax professionals to take stronger security steps to protect client data following continued security threats to tax and financial data held by tax professionals.
The Treasury Inspector General for Tax Administration (TIGTA) released a report finding that the IRS has taken limited or no action on a majority of the planned activities outlined in the Foreign Account Tax Compliance Act (FATCA) Compliance Roadmap. As a result, the IRS has been unable to monitor compliance with reporting requirements by foreign financial institutions (FFIs) sufficiently and match data provided by FFIs to enforce FATCA requirements for individual taxpayers. FATCA requires US taxpayers to report certain offshore accounts and sets up a withholding regime for FFIs with certain US account holders. TIGTA made a number of recommendations to the IRS in the report.
The IRS Large Business and International Division announced five new compliance campaigns for large businesses and international taxpayers, including compliance with Code section 965. The five campaigns include: (1) Section 965 transition tax; (2) Repatriation via foreign triangular reorganizations; (3) Restoration of sequestered AMT credit carryforward; (4) Corporation distributions; and (5) Virtual currency.
The IRS recently issued new audit guidance to the field on the conduct of transfer pricing audits with the Transfer Pricing Examination Process (TPEP), announced in Publication 5300, replacing the now retired Transfer Pricing Audit Roadmap. The updated guidance includes recent changes to the IRS’s Large Business and International procedures and other changes implemented since 2014, when the Roadmap was released. The TPEP provides guidelines for the three major phases of the transfer pricing examination process: planning, execution, and resolution and includes both a two-year and three-year timeline for a transfer pricing audit.
The OECD Secretary-General issued a report to the G20 Finance Ministers covering progress in implementing the BEPS project, the tax challenges from the digitalization of the economy, and proposals to increase tax transparency. Also included is an IMF/OECD Report on Tax Certainty for the G20 that identifies the sources of uncertainty in tax matters and provides approaches to improve certainty, which range from improving the clarity of legislation and increasing predictability and consistency of tax administration practices to effective dispute prevention and resolution.
The OECD issued a discussion draft on the application of transfer pricing principles to financial transactions under Actions 8-10 the Base Erosion and Profit Shifting (BEPS) Action Plan. This guidance is a follow up to the 2015 report and although it does not represent a consensus position, but is intended to “clarify the application of the principles included in the 2017 OECD Transfer Pricing Guidelines” specifically to financial transactions. The draft also addresses specific issues relating to the pricing of financial transactions, including treasury function, intra-group loans, cash pooling, hedging, guarantees, and captive insurance. Public comments are due by September 7, 2018.
Following the European Commission’s (EC) 2016 adoption of an Action Plan on VAT designed to provide for a single VAT area in the European Union (EU), the EC has issued a series of proposals intended to work toward its completion including a recently released working document that includes all adopted amendments on the definitive VAT system proposal. Also, the EU’s VAT Committee released updated guidelines on the VAT. The guidelines reflect the views of the advisory committee, but do not constitute an official interpretation of EU law and are not binding on member states.
The Platform for Collaboration on Tax, which is a joint initiative of the IMF, OECD, UN, and World Bank Group, issued an invitation for public comments on a revised version of its report on the “Taxation of Offshore Indirect Transfers of Assets.” This new draft incorporated some of the many comments on a previous draft of the report, and raised some additional questions for consideration. Comments are due by September 24, 2018.
The OECD published a new set of bilateral exchange relationships established under the Common Reporting Standard Multilateral Competent Authority Agreement (CRS MCAA). The international legal network for the automatic exchange of offshore financial account information under the CRS now covers over 90 jurisdictions (not including the U.S.) with an additional dozen scheduled to be covered by fall. This network will allow these jurisdictions to exchange CRS information in September 2018 under more than 3200 bilateral relationships that currently exist.
Tax Reform Update
Tax Cuts 2.0
House Ways & Means Committee Chair Brady (R-TX) briefed his Committee colleagues on his Tax Cuts 2.0 proposal and released an outline, which he plans to revise over the coming weeks for consideration by the House in September, although it is unlikely that such legislation would move in the Senate prior to the mid-term elections. Approval in the Senate would require 60 votes to overcome procedural hurdles, because Republicans have not passed a joint FY 2019 budget resolution with reconciliation instructions that would allow for passage of tax legislation with a simple majority.
Chair Brady’s plan covers three areas including (1) Protecting middle-class and small business tax cuts (including income tax rates, the standard deduction, and the 20 percent deduction for certain pass through income) by making them permanent (rather than expiring after 2025); (2) Promoting family savings; and (3) Spurring new business innovation. Some details were provided for the “Promoting family saving” section which covers (1) the creation of a new Universal Savings Account to “offer a fully flexible savings tool for families”; (2) expanded 529 education accounts to allow the use of funds to pay for apprenticeship fees to learn a trade, cover the cost of home schooling, and help pay off student debt; and (3) “new baby savings” which would allow families to access their own retirement accounts penalty-free for expenses when welcoming a new child into the family, whether by birth or adoption.
The innovation section is less specific but includes the comment that Tax Reform 2.0 will “help brand-new businesses write off more of their initial start-up costs and remove barriers to growth.” The President has made public comments about lowering the corporate rate to 20 percent (from the current level of 21 percent), but this idea has not drawn public comments from Chair Brady.
Chair Brady plans to spend the next month conducting “listening sessions” to get feedback from House members and constituents on his proposal. Committee Democrats have reportedly not been included in discussions about possible proposals. It is possible that the Tax Cuts 2.0 will be packaged as separate bills rather than one piece of legislation in an effort to facilitate timely movement in the Senate. The retirement savings bill would appear to have the best chance of moving in the Senate as SFC Chair Hatch (R-UT) and Ranking Member Wyden (D-OR) have cosponsored legislation called the Retirement Enhancement and Savings Act, and there is bipartisan support of this issue.
The outline does not identify any significant revenue provisions that would offset the cost of the proposed tax cuts. The Congressional Budget Office has estimated that making the tax cuts permanent would cost $650 billion from 2019 to 2028 and the Joint Committee on Taxation has estimated a revenue cost of $405 billion from 2018-2027. In recent public comments, Chair Brady appeared to indicate that there would not be a major revenue offset title in any of the Tax Cuts 2.0 bills, although there may be minor provisions that have the effect of providing revenue offsets.
There have been reports that a proposal to index capital gains to inflation may also be included, but it was not part of this outline. Congressman Nunes (R-CA) has introduced legislation with a proposal for capital gains indexing – The Capital Gains Inflation Act. Ordinary individual tax brackets are indexed to inflation each year by means of updated tax tables released by the IRS. (Reportedly, Treasury is exploring whether capital gains can be indexed by means of regulations rather than through a statutory change.)
Chair Brady has also said that the House will need to address the foreign provisions of the TCJA but this issue was also not addressed in this outline. “We didn’t have as much time to model and analyze it,” Brady said. “Now that we’re getting that feedback, we’re going to be making those changes, fine-tuning the international side to make sure it hits the mark,” he said adding that changes may be included in “tax reform phase two and beyond.”
The outline that Chair Brady released on the Tax Cuts 2.0 is silent on the status of technical corrections legislation even though he recently indicated that he would provide more details on the timeline for this legislation. Based on comments from House Speaker Ryan (R-WI), the technical corrections legislation will likely not be considered until a lame duck session after the elections and would move separately from the Tax Cuts 2.0 bills. Acknowledging that the major changes in the TCJA inevitably resulted in “glitches,” he indicated that deferring the vote on technical corrections legislation until the lame duck session would be necessary in order to pick up Democratic support for the bill as it is unlikely Democrats would cooperate on moving the bill before the elections. Reports are that Democrats feel the process has been rushed and secretive, and they have not been involved.
The states of New York, Connecticut, Maryland, and New Jersey filed a lawsuit in the Southern District of New York arguing that the $10,000 cap on the state and local tax (SALT) deduction passed as part of the TCJA is unconstitutional. The complaint argues that the SALT cap was enacted to target Democratic-leaning states and interferes with the sovereign authority of the states.