Washington Tax Insight December 2018
Politics and Congressional Activity
As a result of the mid-term elections, the Democrats regained control of the House of Representatives, while the Republicans retained and increased their majority in the Senate. The current ratio in the House is 234 Democrats and 200 Republicans (with 1 race not yet decided) and the current ratio in the Senate is 53 Republicans and 47 Democrats.
In the House, Rep. Nancy Pelosi (D-CA) was elected as party leader by the Democratic Caucus in a written vote of reportedly 203 supporting her with a handful of members absent or abstaining. A formal vote to choose the Speaker of the House will take place in the full House in January, and she will need 218 votes to be elected. She and her supporters have expressed confidence in her election as Speaker, but it is uncertain as to whether she can get the 218 votes needed on the first ballot, with the assumption that no Republican members of the House will support her.
House Republicans elected Kevin McCarthy (R-CA) as Minority Leader with current Speaker Paul Ryan (R-WI) retiring at the end of the year. Rep. Steve Scalise (R-LA) was elected Minority Whip.
In the Senate, Senator Mitch McConnell (R-KY) retained his position as Majority Leader, while Senator John Thune (R-SD) was elected Majority Whip replacing Senator John Cornyn (R-TX), who was required to step down due to GOP term limits. Senator Chuck Schumer (D-NY) retained his position as Minority Leader and Senator Dick Durbin (D-IL) will stay on as Minority Whip.
Because of the split control between Republicans, who hold the White House and the Senate, and the Democrats, who hold the House, it is unlikely that major changes to the tax code will advance in the 116th Congress, which convenes in January 2019. It is possible, however, that some tax initiatives will be considered if they are targeted and are able to win bipartisan support, such as infrastructure legislation.
Lame Duck Session – Spending Bills & Government Shutdown Update
The President has threatened to veto an omnibus bill that would keep the government running into the new year over the issue of funding for a border wall between the US and Mexico. A GOP proposal to provide $5 billion in funding over a 2-year period is opposed by Democrats. If a shutdown occurs, it would be limited in scope as 75% of the government, including the Pentagon, has already been funded through next September, but it would still have a significant effect on those functions that have not been funded including the Department of Homeland Security. Congress is working this week on a 2-week extension of the current funding deadline due to the death of President George H.W. Bush so that the new expiration date would be December 21st.
A compromise has been reached on a major farm bill, but it must pass the Senate, possibly being added to a government funding bill. Senate Majority Leader McConnell has stated that his plans for the lame duck include funding the government, passing a farm bill, and approving judicial nominees. With Democrats poised to take control of the House in January, they may have little incentive to make any deals in a lame duck session.
House Ways & Means Committee: Rep. Richard Neal (D-MA) will assume the Chair of the House Ways & Means Committee, since the Democrats regained control of the House. Current Chair Brady (R-TX) will become the Ranking Member on the Committee.
Rep. Neal’s priorities include reexamining the TCJA, retirement security, and supporting the Affordable Care Act, and he will play a key role in the tax component of any infrastructure bill that advances. There will be several new members on the W&M Committee due to retirements, election defeats, and decisions to run for a different office.
Senate Finance Committee: Senator Chuck Grassley (R-IA) has announced that he will serve as Chair of the Senate Finance Committee (SFC) during the 116th Congress starting in January 2019. He previously served as Chair in 2001 and from 2003-2007. He opted to give up the Chair of the Senate Judiciary Committee, which will be assumed by Senator Lindsay Graham (R-SC), in order to assume the Chair of the SFC. Senator Grassley voted for the TCJA, has a record of supporting renewable fuels, including ethanol, and he supports strengthening protections for whistleblowers. The Republicans now hold a 53-47 majority in the Senate, which could cause changes in the ratio of members on the SFC, which is currently 14 Republicans and 12 Democrats. In any event, there will be several new members on the Committee due to retirements and election defeats.
Treasury and the IRS
Foreign Tax Credit Rules/GILTI: The IRS issued proposed regulations on the foreign tax credit (FTC) reflecting major changes made by the TCJA, including new limitation categories for the FTC and the global intangible low-taxed income (GILTI) regime. The Treasury press release explains that the proposed regulations provide “rules on the allocation and apportionment of deductions, including a rule treating certain assets as partially exempt for expense allocation purposes.” They also establish rules on applying the new foreign tax credit limitation categories and include a taxpayer favorable elective transition rule for carryovers of foreign tax credits. Comments are due within 60 days after the regulations are published in the Federal Register. A public hearing has not been scheduled.
The regulations cover six major areas:
- The allocation and apportionment of deductions under Code sections 861 through 865 and adjustments to the foreign tax credit limitation under Code section 904(b)(4);
- Transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under Code section 904(f) and (g), and for the carryover and carryback of unused foreign taxes under Code section 904(c);
- The addition of separate categories under Code section 904(d) and other necessary updates to the regulations under Code section 904, including revisions to the look-through rules and other updates to reflect pre-Act statutory amendments;
- The calculation of the exception from subpart F income for high-taxed income under Code section 954(b)(4);
- The determination of deemed paid credits under Code section 960 and the gross up under Code section 79; and
- The application of the election under Code section 965(n).
163(j) Business Interest Expense: The IRS issued proposed regulations under Code section 163(j) on limiting the deduction for business interest expense. The regulations reflect changes made by the TCJA, which generally limits the deduction for business interest expense to the sum of a taxpayer’s business interest income, 30 percent of adjusted taxable income, and certain floor plan financing interest. The proposed regulations provide general rules and definitions and rules for calculating the limitation in the context of consolidated groups, partnerships, and international cases. They also deal with issues related to the carryforward of interest expense that cannot be deducted currently. The IRS organized the regulations into eleven sections and has requested comments on them within 60 days of the publication in the Federal Register. A public hearing will be held on February 25, 2019.
The IRS also issued Revenue Procedure 2018-59, which provides a safe harbor for taxpayers to “treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under section 163(j)(7)(B) of the Internal Revenue Code.” Taxpayers that make an election for an infrastructure trade or business to be an electing real property trade or business under Code section 163(j)(7)(B) are not subject to the limitation on business interest expense under Code section 163(j) but must use the alternative depreciation system of Code section 168(g) to depreciate the property described in Code section 168(g)(8). The IRS also recently released a new draft Form 8990, Limitation on Business Interest Expense Under Section 163(j).
Code section 956 Recognition of Income from CFCs: The IRS issued proposed regulations that would reduce the amount determined under Code section 956 for certain domestic corporations, which is designed to reduce complexity and costs for US shareholders of controlled foreign corporations (CFCs). The IRS determined that following the enactment of the participation exemption system set out in Code section 245A, a broad application of Code section 956 to corporate US shareholders would be inconsistent with the purposes of Code section 956 and the scope of transactions it is intended to address. The proposed regulations would exclude corporate US shareholders from the application of Code section 956 to the extent necessary to maintain symmetry between the taxation of actual repatriations and the taxation of effective repatriations. The IRS commented that “Absent the proposed regulations, corporate US shareholders would need to continue to carefully monitor the application of section 956 to their operations, including provisions related to loans, guarantees, and pledges, to ensure that earnings were repatriated only through actual dividends, and therefore allowed a participation exemption, rather than through a deemed repatriation under section 956 subject to additional US tax.” The IRS has requested comments on the proposed rules and specifically on the following: (1) the appropriate application of the proposed regulations to US shareholders that are domestic partnerships, which may have partners that are a combination of domestic corporations, US individuals, or other persons; (2) maintenance of previously taxed earnings and profits accounts under Code section 959 and basis adjustments under Code section 961; and (3) the interaction between the proposed regulations and Code section 245A(e).
Interim Withholding Guidance: The IRS issued Notice 2018-92, which provides interim guidance for the 2019 calendar year on income tax withholding from wages and from retirement and annuity distributions. It also extends the guidance issued by the IRS in Notice 2018-14 and Notice 2018-7 reflecting changes made by the TCJA. The Notice states that the IRS is developing regulations under Code sections 3401 and 3402. The IRS explains, “These withholding regulations will reflect changes made by the TCJA, other changes in the Code since the regulations were last amended, and certain miscellaneous changes consistent with current procedures. Comments on the interim guidance in the Notice and the forthcoming guidance on withholding are due by January 25, 2019.
Other Issues and Guidance
The Office of Information and Regulatory Affairs (OIRA) received Treasury’s proposed regulations addressing certain related party amounts paid or accrued in hybrid transactions or with hybrid entities under Code section 267A(e).
The IRS and Treasury issued their Priority Guidance Plan for the 2018-2019 plan year, which runs from July 1, 2018 through June 30, 2019, with a list of the tax policy regulations, notices, revenue rulings, revenue procedures, and other guidance the IRS expects to work on during the 12-month period. The key projects focus on implementing the TCJA with more than 60 regulatory/guidance projects included.
The IRS announced the addition of five new compliance campaigns, focusing on foreign income and the Work Opportunity Tax Credit. The issue-based compliance campaign initiative focuses on areas of risk that the IRS says require a response “in the form of one or multiple treatment streams” to improve tax compliance. The five new campaigns are: (1) Individual foreign tax credit Phase II; (2) Offshore service providers; (3) FATCA filing accuracy; (4) 1120-F delinquent returns campaign; and (5) Work Opportunity Tax Credit.
The IRS issued final regulations on the tax return preparer penalty under Code section 6695(g). The regulations implement changes from the PATH Act that expand the scope of the tax return preparer due diligence penalty so that it applies to the child tax credit, the American opportunity tax credit, and the eligibility to file as head of household.
The IRS issued Revenue Procedure 2018-57 providing inflation adjustments and changes for tax rate schedules and more than 60 other tax provisions. There are key changes to the following: (1) standard deduction; (2) individual top tax rate; (3) itemized deductions limits; (4) AMT; (5) flexible spending accounts; (6) Medical Savings Accounts; (7) foreign earned income exclusion; (8) estate and gift tax; and (9) adoption credit.
The IRS issued Notice 2018-83 with updated guidance on contributions to retirement plans with cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2019. The changes increase the limits for contributions to certain plans and allow taxpayers to deduct contributions to a traditional IRA if they meet certain conditions.
The IRS Advisory Council released its 2018 annual report, which includes recommendations to the IRS regarding new and continuing tax administration issues. The report covers topics and concerns including the IRS budget, electronic third-party authentication, transfer pricing documentation, and the update of Circular 230.
The European Council released a Council Directive amending Directive 2006/112/EC, regarding the harmonization and simplification of certain rules in the value added tax (VAT) system for the taxation of trade between member states of the European Union. The European Parliament released a study on VAT fraud in the EU that describes current weaknesses in the VAT system and recommendations for improvement.
The OECD released Guidance for the Development of Synthesised Texts, which presents an overview of the modifications to tax treaties resulting from the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, which entered into force on July 1, 2018. They also released a Secretariat Note that clarifies the rules regarding the effective date for tax treaties of jurisdictions that ratified the Convention last September. It is intended that the Guidance be used by governments to provide insight into the impact of the Convention on existing treaties.
The OECD has requested taxpayer input by December 13th on the 7th round of Dispute Resolution peer reviews (BEPS Action 14), covering Brazil, Bulgaria, China (People’s Republic of), Hong Kong (China), Indonesia, Papua New Guinea, Russian Federation, and Saudi Arabia. Taxpayers are invited to submit input on specific issues relating to access to MAP, clarity and availability of MAP guidance and the timely implementation of MAP agreements for each of these jurisdictions using the taxpayer input questionnaire.
The UK has announced that it will introduce a Digital Services Tax (DST) to be effective in April 2020. The DST would impose a 2% tax on the revenues of specific digital businesses where revenues are linked to the participation of UK users. The tax will apply to search engines, social media platforms, and online marketplaces. There is a final draft of the EU’s digital tax proposal that calls for a 3 percent levy and states that EU governments “shall adopt” the levy by December 31, 2021 and “Apply” it from January 1, 2022. The tax would expire if the OECD reaches a global deal for digital taxation, but if no global deal is reached, the draft says that the EU levy would automatically come into force and self-terminate by a date yet to be determined. Support for an EU-wide digital tax may be problematic, but the result may be that individual countries, including France and Spain, will advance their own tax proposals, similar to the UK action.
Tax Reform Update
Lame Duck Session – Tax Issues?
Republican Tax Reform 2.0
Ways & Means Chair Brady (R-TX) released the text of an omnibus tax bill that would include extensions of nearly 30 temporary tax provisions, technical corrections to the TCJA, reform of the IRS, and several retirement savings changes. A manager’s amendment with changes to several provisions of the bill was added during consideration in the House Rules Committee, and the bill was sent to the House Floor for a vote. The bill includes a modified version of the Family Savings Act and the American Innovation Act, both of which had previously been approved by the House. A House floor vote had been scheduled for November 30th, but it was postponed reportedly because Republicans did not have enough votes for approval. This legislation is unlikely to be considered in the Senate, where 60 votes would be needed for approval. Senate Minority Whip Durbin (D-IL) has said that he does not expect any tax legislation to be approved in the lame duck session.
Separate sections of the bill may make it through Congress in the lame duck session, however, if they have bipartisan support, such as the IRS reform changes, which are aimed at improving customer service, enforcement changes, combating identity theft, and upgrading the agency’s technology. Retirement changes and some of the tax extenders also enjoy some bipartisan support and may be able to advance before the end of the year.
Sales Tax Legislation
Several Senate Democrats, including Senators Shaheen, Merkley, Wyden, Hassan are making an effort to block states from requiring online merchants and other remote sellers to collect sales tax from their customers. In a letter to Senate leadership, they state “We believe that Congress should act immediately in the lame duck session to enact a moratorium on collection requirements and a prohibition on retroactive collection authority.” However, Senate and House members are split on the issue, and the leadership of both chambers has shown little interest in dealing with this issue this year.
Democratic Tax Agenda
In anticipation of regaining control of the House and the agenda for the Ways & Means Committee, Democrats have been making plans for the new Congress which will convene in January. Undoubtedly, they will hold hearings and take actions to reverse and change some of the provisions that were enacted into law as part of the TCJA. These changes may be used to generate revenues for infrastructure legislation and middle-class tax cut plans.
Democrats did not offer an alternative comprehensive plan during the consideration of the TCJA, but they have clearly stated their opposition to many of the provisions of the TCJA including the individual and corporate tax rate cuts. In March of 2018, Senate Democrats released the Jobs & Infrastructure Plan for America’s Workers, which is a $1 trillion infrastructure plan designed to repair and modernize the country’s roads, bridges, waterways, broadband network, and transit systems. To fund this plan, the bill would have made changes to the corporate tax rate cut, the individual tax rate cut, the AMT, the estate tax, and the treatment of carried interest. Other provisions that may be targeted are the pass-through deduction for business income and the $10,000 cap on state and local deductions.
Without control of the Senate, however, any legislation put forward by House Democrats is unlikely to go anywhere, as 60 votes would be needed.