Washington Tax Insight December 2017
Congress faces a full agenda in December before the planned adjournment for the holidays including completion of comprehensive tax reform legislation, funding the government beyond the current Continuing Resolution expiration date, renewal of a children’s health program, and work on the Deferred Action for Childhood Arrivals (DACA) program.
FY 2018 Budget and Debt Ceiling
The short term continuing resolution that was passed in September to fund the federal government expires on December 8th, and Congressional leadership has been working to reach agreement on avoiding a government shutdown at that time. The current plan is reportedly to pass two additional short term continuing resolutions with the first to run from December 8th to December 22nd, allowing them time to finish the tax reform bill. The second would run from that date until sometime in January after Congress returns from the holiday recess thereby allowing leadership to reach a longer-term deal which addresses key issues.
It is not clear that rank and file Republicans are on board with this strategy, however, which would envision the second CR including increased spending caps and miscellaneous programs such as the children’s health program. One of the key issues involved in the funding debate is dealing with the DACA program, which Democrats have stated must be dealt with in any spending deal. The continuing resolutions governing spending agreements will need Democratic support to pass in the Senate where the legislation can be filibustered and possibly also in the House where some Republican opposition from the rank and file remains. Democrats are also insisting that any increase in the spending caps for defense spending must be matched by increased caps for domestic spending.
More than two dozen Republicans have sent a letter to House Speaker Paul Ryan urging him to include a DACA fix in the year-end spending bill in order to successfully reach a deal with Democrats on long-term funding for the federal government. House Majority Leader McCarthy (R-CA), however, has commented that he does not see a solution for DACA coming until closer to the expiration of the program in March of 2018.
In addition, there is now discussion about including an increase in the debt ceiling in any end-of-the-year spending legislation, although that action will likely not be necessary until January 2018. Dealing with this issue in an election year is always problematic, but it also is not must-pass legislation, so it could be left until January as Republican leadership do not want this issue to be viewed as leverage by the Democrats in their effort to deal with DACA.
Health Care Reform Legislation
The Senate version of tax reform legislation (discussed below) includes a repeal of the Affordable Care Act’s individual mandate. This provision will generate $318.4 billion over 10 years, according to the Joint Committee on Taxation (JCT), which will be used to help offset the cost of the tax reform bill. Both the Congressional Budget Office and the JCT has projected that the result of repeal of the individual mandate will be 13 million fewer people with insurance by 2027. This move has been uniformly criticized by Democrats and by several medical groups who have suggested this move will also result in increased premiums.
Treasury and the IRS
The IRS issued new rules under the revised audit regime for partnerships enacted in 2015. The proposed regulations address “how certain international rules operate in the context of the centralized partnership audit regime, including rules relating to the withholding of tax on foreign persons, withholding of tax to enforce reporting on certain foreign accounts, and the treatment of creditable foreign tax expenditures of a partnership.”
The IRS issued Revenue Procedure 2017-59 which provides guidance on obtaining consent of the Commissioner of the IRS to change a method of accounting for federal income tax purposes. This revenue procedure also specifies the Code section 481 adjustment period for elections under Code section 404A that are treated as changes in method of accounting for purposes of Code section 481.
The IRS announced that its Large Business and International (LB&I) Division has identified 11 new issue areas that will get focused compliance efforts in the next several months. The announcement relates to the set of 13 issue areas for compliance that were announced earlier in 2017 by LB&I. The areas covered in the Withholding and International Individual Compliance include the following: (1) Form 1120-F, Chapter 3 and 4 Withholding Campaign; (2) Swiss Bank Program Campaign; (3) Foreign Earned Income Exclusion Campaign; and (4) Verification of Form 1042-S Credit Claimed on Form 1040NR. Two issues were targeted in the Cross-Border Practice Area: (1) Corporate Direct (Section 901) Foreign Tax Credit and (2) Section 956 Avoidance. Other issues included are: (1) Energy Efficient Commercial Building Property Campaign; (2) Deferral of Cancellation of Indebtedness Income Campaign; (3) Economic Development Incentives Campaign; (4) Individual Foreign Tax Credit (Form 1116); and (5) Agricultural Chemicals Security Credit Campaign.
The OECD released new value added tax (VAT) guidance related to the levying of consumption taxes on cross-border sales titled “Mechanisms for the Effective Collection of VAT/GST Where the Supplier Is Not Located in the Jurisdiction of Taxation.” This guidance is part of the OECD BEPS project designed to strengthen tax compliance among multinational enterprises, developing the recommendations on BEPS Action 1, “Addressing the Tax Challenges of the Digital Economy.” The OECD explained, “This guidance will support the consistent implementation of internationally agreed standards for the VAT treatment of cross-border trade and is of particular relevance given the rapid and ongoing digitalization of the economy.” The OECD further commented that the guidance builds on the best practices of jurisdictions “when they require foreign suppliers to register and collect VAT on cross-border B2C (business to customer) sales.” The guidance discusses the collection of VAT on suppliers of services and intangibles by foreign suppliers, implementation of registration-based collection regimes, and simplification of registration and reporting regimes that are intended to improve the compliance of foreign suppliers.
On November 21, 2017, the OECD Council approved the contents of the 2017 Update to the OECD Model Tax Convention. The 2017 Update, which was previously approved by the Committee on Fiscal Affairs on September 28, 2017, will be incorporated in a revised version of the OECD Model Treaty that will be published in the next few months. The 2017 Update consists primarily of changes to the OECD Model Treaty that were developed through the OECD/G20 BEPS Project.
The OECD published updated versions of the transfer pricing country profiles (TPCP). According to the OECD press release, the “information contained in the TPCP is intended to clearly reflect the current state of countries’ transfer pricing legislation and to indicate to what extent their rules follow the OECD Transfer Pricing Guidelines.”
The 10th meeting of the Global Forum on Transparency and Exchange of Information for Tax Purposes took place November 15-17, 2017 with 200 delegates from more than 90 delegations out of a total of 147 country and jurisdiction members. The Global Forum adopted the first report on the status of implementation of the Automatic Exchange of Information Standard a few weeks after nearly 50 countries started exchanges of information under the new standard on automatic exchange of information with another 53 countries scheduled to start in September of 2018. The principle of annual implementation reports and peer reviews were agreed to at the meeting to ensure effective implementation and a level playing field.
Public comments on the tax challenges of digitalization were requested by the OECD in September of 2017, and those comments have now been published by the OECD. Also, a public consultation on the tax challenges of digitalization was held at the University of California, Berkeley, on November 1st.
The Netherlands government has begun a review of 4000 tax deals it has previously completed with multinationals since 2012 to ensure that proper procedures were followed. This could affect future tax arrangements for some companies operating there and potentially challenge the Netherlands’ reputation as a tax-friendly jurisdiction for business. This initiative comes at the same time the European Union is pushing for new rules to target tax avoidance by companies, and it follows the Paradise Papers leaks from a law firm that showed that proper procedures were not followed in one case of an arrangement with a US company.
Tax Reform Update
Both the House and Senate have approved comprehensive tax reform bills, which now will be reconciled with a target of completion by the end of the year. The House passed the “Tax Cuts and Jobs Act” (H.R. 1) on November 16th by a vote of 227-205. The Senate passed their version of the bill by a vote of 51-49 on December 1st. The legislation in both chambers is advancing with the protections of the budget reconciliation process, which allows for passage in the Senate by a simple majority vote rather than the three-fifths supermajority vote normally required to avoid procedural issues such as the filibuster. The legislation garnered no Democratic support in the House with a handful of Republican defections. In the Senate, no Democrats voted for the bill, with one Republican Senator, Bob Corker (R-TN) voting against the bill.
During the debate of the bill in the Senate, Senate leadership faced a number of concerns from Republican Senators, which resulted in some significant changes to the bill before the final vote as detailed below. Some of the last-minute changes were added to the legislation by handwritten changes on the Senate Floor, evidence of which was posted on Twitter by Senate Minority Whip Dick Durbin (D-IL).
After Senate passage, House Republican leadership immediately announced that there will be a vote on December 4th to initiate a formal conference on the legislation, which will be needed to reconcile differences between the two bills before the legislation can be sent to the President to be signed. Senate leadership, however, has not yet publicly committed to a formal conference procedure.
On November 9th, the Senate Finance Committee revealed its version of the tax reform plan as detailed in the True Alert dated November 15th. The SFC approved its version of the bill by a strictly party-line vote on November 16th after several days of Committee markup and a series of modifications to the Chairman’s Mark. The SFC bill generally followed the House version of the bill, but included some key differences including repeal of the ACA individual mandate and sunsets for several of the changes on the individual side (as opposed to permanent changes in the House bill).
The SFC bill was then scheduled for Senate Floor action, which took nearly a week and resulted in passage by a very narrow margin with significant changes made to the SFC version in order to secure enough Republican votes for approval. Notably, however, the opposition from Senator Corker was not addressed in the final version of the bill resulting in him being the lone Republican to vote no on final passage.
Senator Corker and other deficit hawks were concerned about the long-term deficit effects of the legislation, and they wanted a “trigger” provision added to the bill that would have cut back on certain tax cuts if economic growth failed to hit certain targets. White House officials and Congressional Republicans had argued that economic growth from tax reform would largely offset the cost of rate reductions and other tax relief over a period of time. On November 30th, the JCT staff released a “dynamic” revenue score which estimated that the growth effects of tax reform would increase tax revenue by only $407.5 billion between 2018 and 2027, resulting in an increase to the federal deficit of $1 trillion (as compared to $1.4 trillion using a “static” scoring model).
The Senate parliamentarian, however, ruled that this type of “trigger” mechanism would violate the Byrd rule prohibitions against reconciliation bill provisions that have no revenue impact or whose revenue impact is incidental. When Senate leadership was able to modify the bill in other ways and pick up support from other Republican holdouts, the effort to deal with the deficit issue was dropped.
Key Changes to the Senate Bill Prior to Senate Floor Approval
Although there was discussion of modifying the corporate rate reduction to a rate higher than 20% and a Senate Floor amendment attempted to raise the rate slightly in order to pay for a larger refundable child tax credit, the final bill includes a corporate tax rate of 20% beginning in 2019.
A number of Senate Floor amendments were offered, but nearly all were defeated or ruled out of order. One amendment was approved as offered by Senator Ted Cruz (R-TX) by a vote of 51-50 (with Vice President Pence casting the tie-breaking vote). It would allow funds from tax-preferred section 529 accounts, which are currently used to promote savings for college, to be used for costs associated with elementary and secondary education, including homeschooling.
Changes that were agreed to include:
- An increase in the deduction for pass-through business income to 23 percent from the 17 percent included in the SFC bill. Significant concern had been expressed about the perceived inequitable treatment between the treatment of pass-throughs and corporations.
- The 100 percent expensing provision was scheduled to sunset but was rewritten to phase down after 2022.
- The bill now includes the House provision allowing taxpayers to deduct up to $10,000 in state and local property taxes but continues to repeal the deduction for state and local income taxes. The SFC bill had included a repeal for all state and local taxes with this change included in order to gain the support of Senator Susan Collins (R-ME).
- The bill will permit a deduction in 2017 and 2018 for medical expenses exceeding 7.5 percent of adjusted gross income (AGI), again at the urging of Senator Collins. This would be more generous than current law which allows for unreimbursed medical expenses in excess of 10 percent of AGI (with 7.5 percent for those age 65 and older).
- The final bill drops the repeal of the alternative minimum tax (AMT) for corporations that was in the SFC bill, and it includes a modified version of the individual AMT, which would have also been repealed by the SFC bill.
- The bill increases the deemed repatriation tax rates to 7.49 percent for noncash assets and 14.49 percent for cash and cash-equivalents. These are slightly higher than the 7 percent and 14 percent rates included in the House version of the bill, and increased from the 5 and 10 percent rates in the SFC bill.
- The final bill sunsets the suspension of the overall limitation on itemized deductions after 2024 instead of 2025.
The last three changes were included to help raise the additional revenue needed to offset the cost of the more generous provision on pass-through rates, expensing and state and local tax changes.
House-Senate Conference Action
Conference negotiations are expected to start immediately in order to meet the intended target of completion prior to the end of the year. A list of key issues that will need to be addressed include:
- The treatment of mortgage interest: House bill caps the deduction for future mortgages at loan amounts of $500,000 while the Senate bill retains the current cap of $1 million
- Treatment of the estate tax: House bill repeals the estate tax while the Senate bill includes a larger exemption
- The proposed treatment of pass-through business income
- The individual rate structure: House bill includes four brackets plus a bubble rate while the Senate bill includes seven brackets
- The base erosion prevention provisions applicable to international business activity
- The taxation of certain life insurance company income: House bill includes an eight percent surtax
- The corporate rate reduction: Senate bill has a delayed effective date of 2019
- The treatment of individual tax deductions for medical expenses and student loan interest
- The sunsets for the individual changes included in the Senate bill
- The repeal of the ACA individual mandate