Washington Tax Insight February 2018
Politics and Congressional Activity
Congressional Agenda/Schedule for 2018
Following an eventful December that saw enactment of major tax legislation, Congress returned in January to face a full agenda of issues that must be addressed in 2018 but which will certainly be affected by the politics of the year with mid-term elections in the fall providing an opportunity for Democrats to take control of either the House or Senate – or both. The successful completion of tax reform legislation with the enactment of The Tax Jobs and Cuts Act (TJCA) will be the key element of Republican messaging this year with a focus on the economy.
Congress must deal with reaching agreement on funding the federal government for the remainder of FY 2018. Another short term Continuing Resolution (CR) was approved on January 22nd with an expiration date of February 8th. The agreement was reached after a 3-day government shutdown when Republicans and Democrats could not agree on a resolution of the Deferred Action for Childhood Arrivals (DACA) program, which has an expiration of March 5th. As part of the latest CR, Senator Majority Leader McConnell has committed to bringing an immigration bill to the Senate Floor by February 8th. Should a bipartisan bill be approved by the Senate, this could prove to be challenging for House Speaker Ryan who may face opposition to it from conservatives but will be pressured to bring the bill to the House Floor for a vote.
The latest CR reauthorized the Children’s Health Insurance Program (CHIP), which was extended for 6 years. Congress, however, has yet to deal with an $81 billion disaster relief bill that passed the House but not the Senate and the flood insurance program.
Congress is also working on budget issues for FY19 including the Republican plan to increase defense spending which is currently limited by discretionary spending caps in the Budget Control Act with the Democrats taking the position that there should be equivalent increases in domestic spending. The lack of agreement on this issue has slowed down the work of the Appropriations committees. If and when agreement is reached, there will likely be an omnibus bill that incorporates multiple spending packages.
Congress must then decide whether to advance a budget for FY 2019, and there has reportedly been consideration about not doing so. Failure to do a budget, however, means that Republicans would not have available to them the process of budget reconciliation to move issues without the threat of filibuster as was done with tax reform in 2017.
Congress must address the issue of increasing the debt limit soon as Treasury will likely not be able to use “extraordinary measures” to avoid exceeding the current limit beyond mid-March. With the latest CR expiring in early February, it is possible that the debt limit issue could be part of those negotiations with Congressional Democrats using that issue as leverage to resolve the DACA issue.
Other issues that have been discussed for this year’s agenda include infrastructure and entitlement reform. Some details on a plan from the White House on infrastructure have been reported, although the Administration has not released a formal proposal. Reportedly the spending breakdown includes infrastructure incentives initiative (50%); transformative projects (10%); rural infrastructure (25%); federal credit programs (7%); and federal capital financing fund (5%) with the federal government contribution still expected to be in the $200 billion range designed to draw in state, local and private investment in major public work projects that could total $1 trillion. An interesting issue in the plan is the dependence on the use of private activity bonds including allowing advance refunding bonds that help localities refinance existing debt in light of the fact that the TJCA repealed the tax advantage for advance refunding bonds.
House Speaker Ryan and the President have both suggested they are interested in working on entitlement reform, but Senate Majority Leader McConnell is doubtful of the ability to work on this in the Senate with the slim majority control, and the President now appears to have less interest in tackling this issue in 2018.
Health Care Reform and Health Care-Related Taxes
Congressional Republicans have been working to enact the suspension of several health-care related taxes enacted as part of the Affordable Care Act (ACA), and those provisions were included in the latest CR. The taxes included are the medical device tax (2-year moratorium for 2018 and 2019), the excise tax on high-cost employer health coverage (“Cadillac tax”) which will go into effect in 2022 rather than 2020, and a 1-year moratorium for the annual excise tax imposed on health insurers for calendar year 2019. The IRS issued Notice 2018-10, which provides guidance on the 2.3% medical device excise tax and specifically provides temporary relief to medical device manufacturers from the failure to deposit penalties imposed by Code section 6656.
Senate Republican leaders have agreed to bring two bills to the Senate Floor for a vote in an effort to stabilize the health insurance market – one cosponsored by Senators Collins (R-ME) and Nelson (D-FL) and the other sponsored by Senators Alexander (R-TN) and Murray (D-WA). Both bills will need significant Democratic support and may need to be attached to “must-pass” legislation to advance.
The Mid-Term Elections
The mid-term elections will play a key role in all legislative work that is done in Congress in 2018 with the possibility that control of either the House or Senate or both could change. The current ratio in the Senate is 51-49 but the Democrats will have a challenging path to control since there are 24 Democratic seats in play and 2 Independents but only 8 Republican seats in play. In addition, Senator Tina Smith (D-MN) who replaced Senator Franken must also run to complete the term to 2020.
In the House, the current ratio is 239 Republicans to 193 Democrats and 3 vacancies. The Democrats must pick up 25 seats for control, which is a heavy lift, but it has been done in the past in mid-term election cycles.
Senate Majority Leader McConnell has said he wants to pursue issues in 2018 that have bipartisan support, but it is questionable whether Democrats will want to work with Republicans on any issues if to do so would give the party in control additional “wins.’ Republicans will want to send a message to swing voters and independents that they can work across party lines in governing.
Senate Finance Committee
SFC Chair Hatch (R-UT) announced that he will retire when his current term expires at the end of 2018, which opens up the chairmanship Hatch has held since 2015. Senator Grassley (R-IA) could reclaim the SFC chair but he would have to give up his position as chair of the Senate Judiciary Committee. Next in seniority are Senator Crapo (R-ID), who chairs the Banking Committee, and Senator Roberts (R-KS), who chairs the Agriculture Committee. Senator Hatch also holds the position of president pro tempore and is third in the line of succession to the presidency due to him being the Senate majority’s longest-serving member. The selection of the person who holds this position, however, is not a law but a practice in the Senate, so any member of that body regardless of age or politics could be selected to fill the position.
Senator Sheldon Whitehouse (D-RI) was named by Senate Democratic Leader Schumer (D-NY) to the Senate Finance Committee, which resulted from the election of Senator Doug Jones (D-AL) to the Senate causing a changed party ratio in that body which necessitates similar ratios in committee assignments. He released a statement in which he outlined his priorities for serving on the committee, including “making our tax code fairer for middle-class families.”
The Joint Tax Committee (JCT) released its annual list of expired and expiring tax provisions which prompted speculation on whether and when Congress might address these issues in 2018. SFC Chair Hatch introduced legislation in December 2017 that generally would retroactively extend most of the 2016 expired provisions through the end of 2018, but Republican leadership in Congress has yet to announce their plan for addressing these issues. The JCT list now includes 82 provisions (up from 58 in 2017) in part because of the addition of several individual tax provisions that expire in 2025 as a result of the TJCA including lower rates for individuals and owners of pass-through entities, the expanded child tax credit, the increased standard deduction, and increased exemptions for the estate tax. W&M Committee Chair Brady has commented that he would like to make many of these provisions permanent as Congress did in 2015 when they last approved a major extenders bill, but that will be difficult to do unless they have Democratic support for the legislation.
House Ways & Means Committee
W&M Committee Chair Brady (R-TX) announced the subcommittee chairs and assignments with Congress Buchanan (R-FL) taking over as chair of the Tax Policy Subcommittee. Congressman LaHood (R-IL) joined the Committee.
The US Supreme Court granted certiorari in South Dakota v. Wayfair, Inc. et al, No. 17-494, which is a case challenging South Dakota’s “economic nexus” law requiring remote sellers without a physical presence in the state to collect use tax on sales to South Dakota customers. South Dakota’s law is one of several state legislative initiatives designed to directly challenge the physical presence standard for remote sales and use tax collection established in Quill Corp. v. North Dakota, 504 U.S. 298 (1992). If Quill is overturned, online businesses could be required to collect and remit taxes regardless of their physical location. Several members of Congress have called on Congress to pass legislation that would address this issue, and bills in both the House and Senate have been introduced including S.976, the Marketplace Fairness Act of 2017, introduced by Senators Durbin (D-IL), Alexander (R-TN), Heitkamp (D-ND) and Enzi (R-WY).
Treasury and the IRS
President Trump is reportedly planning to nominate Charles Rettig to be the next IRS Commissioner. He is a tax controversy lawyer from California, and his nomination requires Senate confirmation.
The Treasury and IRS issued final regulations for electing out of the centralized partnership audit regime enacted as part of the Bipartisan Budget Act of 2015 that assesses and collects tax at the partnership level. The rules finalize, with minor changes, the portion of the rules proposed on June 14, 2017 relating to Code section 6221(b). The final regulations reflect, despite commenters’ suggestions, Treasury’s decision not to expand the definition of eligible partners for qualification to elect out, to continue to require foreign eligible partners to provide TINs for valid elections out, and to continue not to permit unilateral revocations of elections out. The AICPA sent a letter to members of the SFC and W&M Committee asking that Congress enact legislation to delay the effective date of the new centralized partnership audit regime for one year until December 31, 2018. Although Treasury and the IRS have issued several sets of regulations implementing the new regime, the AICPA notes that many of these regulations have not been finalized and contain significant gaps.
The IRS also issued proposed regulations that further implement statutory changes to the audit regime for partnerships and partners. The proposed regulations provide rules addressing how pass-through partners should take into account adjustments under the alternative to payment of the imputed underpayment described in Code section 6226 (the “push-out” election). Under the proposed rules, each pass-through partner in an ownership chain is given a choice to either (1) push the adjustments to its partners, shareholders or beneficiaries, or (2) pay tax with respect to the adjustments. The proposed regulations provide similar rules for pass-through partners to take into account adjustments requested in an administrative adjustment request under Code section 6227, if the partnership elects to have its partners take into account the adjustments (or if the partnership is required to have its partners take into account the adjustments). The proposed rules would also amend the prior regulations issued under these sections. In addition to instructing on assessment and collection, penalties and interest, and period of limitations, the regulations also address the rules for seeking judicial review of partnership adjustments.
Treasury and the IRS issued Notice 2018-08, which suspends, until such time as future guidance is issued, all withholding on the sale or disposition of publicly traded partnership (PTP) interests as defined under Code section 7704(b) – as imposed under newly enacted subsection 1446(f) in the TCJA. Withholding on PTPs will be prospective from the date of the new guidance. A revised timeline for implementing withholding on the disposition of PTP interests is also provided, but is subject to dates that must be provided in future guidance. The notice does not suspend substantive treatment of foreign partner gains or losses as effectively connected income under subsection 864(c)(8), also enacted in the TCJA, effective for sales or dispositions occurring on or after November 27, 2017. The notice also announces that the IRS continues to observe its position in Rev. Rul. 91-32 for non-PTP dispositions that occurred prior to November 27, 2017.
Treasury and the IRS issued proposed regulations on the tax treatment of foreign currency gains and losses of a controlled foreign corporation (CFC) under the business needs exclusion from foreign personal holding company income. The proposed rules would allow taxpayers to elect to use a mark-to-market method of accounting for certain foreign currency gain or loss attributable to Code section 988 transactions. They also would permit the controlling US shareholders of a CFC to automatically revoke certain elections concerning the treatment of foreign currency gain or loss. Comments on the proposed rules are due by March 19th.
The OECD released the second round of analyses of individual country efforts to improve dispute resolution mechanisms. The seven peer review reports represent the second round of stage 1 evaluations of how countries are implementing new minimum standards agreed in the OECD/G20 BEPS Project. The reports relate to implementation by Austria, France, Germany, Italy, Liechtenstein, Luxembourg, and Sweden.
The OECD released an updated model tax treaty that incorporates policy changes reflecting its BEPS project. They explained that the newly updated Model Tax Convention reflects “a consolidation of the treaty-related measures resulting from the work on the OECD/G20 BEPS project under Action 2 (Neutralising the Effects of Hybrid Mismatch Arrangements), Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances), Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status), and Action 14 (Making Dispute Resolution More Effective).” The Model Tax Convention serves as a model for negotiation and application of bilateral tax treaties between countries designed to assist business while helping to prevent tax evasion and avoidance. It also provides a means for settling on a uniform basis the most common problems that arise in the field of international double taxation.
The OECD announced that in accordance with the BEPS Action 13 minimum standard (country-by-country reporting), additional automatic exchange relationships were activated under the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country (CbC) Reports. The automatic exchange of CbC reports, set to start in June 2018, will give tax administrations around the world access to key information on the annual income and profits, as well as the capital, employees, and activities of multinational groups that are active within their jurisdictions. There are now over 1400 automatic exchange relationships in place among jurisdictions committed to exchanging CbC Report as of mid-2018, including those under EU Council Directive 2016/881/EU and bilateral competent authority agreements (including 31 with the United States).
The OECD released additional CbC reporting guidance for multinational groups and tax administrators. The guidance addresses a number of specific issues, including how to report amounts taken from fair-value financial statements; how to treat mergers, acquisitions, and de-mergers; how to treat short accounting periods; and the definition of total consolidated group revenue.
The European Commission released a report titled “Tax Policies in the European Union: 2017 Survey.” The report presents the most recent tax reforms in EU member states and presents further reform options intended to improve efficiency and fairness in tax systems. The report also examines how EU member states’ tax systems help to promote investment and employment, how they are working to reduce tax fraud, evasion and avoidance, and how tax systems help to address income inequalities and ensure social fairness.
Tax Reform Update
Treasury Secretary Mnuchin has commented on the process by which he believes most of the issues and questions about the TJCA will be addressed. He noted that nearly 80 sections of the law require the promulgation of regulations, and he expects there to be a significant amount of guidance issued by Treasury and the IRS throughout 2018 and beyond. He has acknowledged that there may be some issues that could require a legislative correction and that technical corrections legislation would need Democratic support to advance in Congress, because such legislation cannot move as part of the budget reconciliation process, which requires only a simple majority vote for approval. Under the Byrd Rule, the Senate cannot advance budget reconciliation legislation with any provisions that have either no budget effect or only a minimal impact. Technical corrections by definition are not scored by the JCT to have an impact on revenue because they are written to clarify Congressional intent.
The IRS issued Notice 1036, which provides updated income tax withholding tables for 2018 in light of statutory changes made by the TCJA. The IRS says that employers should begin using the 2018 withholding tables as soon as possible, but not later than February 15, 2018. The tables are “designed to work with the Forms W-4 that workers have already filed with their employers to claim withholding allowances. This will minimize burden on taxpayers and employers.” Employers should continue to use the 2017 withholding tables until they can implement the 2018 withholding tables. More guidance is coming from the IRS “to help improve the accuracy of withholding following major changes made by the new tax law.” The IRS is still working on a revised Form W-4 to reflect additional changes in the new law, such as changes in available itemized deductions, increases in the child tax credit, the new dependent credit and repeal of dependent exemptions, which employees may be required to file by 2019. Current withholding rules are largely based on the personal exemption, which has now been repealed by the TCJA, which also limits state and local-tax deductions, increases the child tax credit and changes the tax brackets and income thresholds.
Senator Wyden (D-OR) and Congressman Neal (D-MA), who are the Ranking Members of the SFC and W&M Committee, sent a letter to the Government Accountability Organization (GAO) asking that the GAO review 2018 withholding tax tables to ensure that “there is no political influence in the formulation” of the tables. The letter expressed concern that the tables could cause taxpayers to under withhold taxes in 2018 – and thereafter find that they owe additional taxes in April 2019 – as a result of the repeal of the personal and dependent exemptions and the repeal or limitation of many itemized deductions.
Taxing Repatriated Earnings
The IRS has issued additional guidance on the taxation of repatriated earnings of foreign subsidiaries of US companies with Notice 2018-13, which states that the Treasury and IRS intend to issue regulations for determining amounts included in gross income by a US shareholder by reason of Code section 965 as amended by the TCJA. The Notice includes a modification intended to be made regarding regulations described in section 3.03 of Notice 2018-07. It also considers issues in connection with the repeal of Code section 958(b)(4), announces the IRS’s intention to update the Instructions for Form 5471 as a result of such repeal, and describes the effective dates of the regulations and other guidance described. The Notice also asks for suggestions on what issues subsequent guidance should cover. “In addition, comments are requested as to whether, in light of the repeal of section 958(b)(4), it would be appropriate for the Treasury Department and the IRS to reconsider the provisions of any form, publication, regulations, or other guidance that reference CFCs, and if so, what revisions may be appropriate.”
W&M Committee Chair Brady (R-TX) has already commented that technical corrections legislation will likely be necessary in 2018, but he has also said that it will not be done quickly. House Speaker Ryan (R-WI) has also suggested that technical corrections will likely be needed to the new tax law, although he said he expects them to be minor. Some Congressional Democrats, however, have suggested that they may not be willing to work with Republicans to fix problems with the new law since they did not support it, and should there be a shift in party control in either the House or Senate or both, Democrats may believe there will be an opportunity in 2019 to make substantive changes to the tax law. Comparisons have been made to the process of fixing the ACA, which was approved in 2010 with only Democratic support, with Republicans since that time unwilling to fix issues with the health care bill.
Because of the perceived difficulty of moving technical corrections legislation through Congress in an election year, it is likely that the primary focus in 2018 will be on providing guidance to taxpayers through the regulatory process. There are limits, however, on the authority of Treasury to issue interpretive guidance in order to make sure that the intent of Congress is followed.
Areas that most likely will see the need for technical corrections include the international law changes and the new pass-through rules. The new international provisions introduce complex formulas as backstops to the territorial system, e.g. the base erosion and anti-abuse rules, the repatriation tax, and the tax on intangible low-taxed income (GILTI). The new pass-through rules and the changes to the partnership rules will result in many taxpayers and their advisors considering whether they should restructure their businesses, creating inevitable questions and issues about the new rules.
Businesses who have questions or concerns about technical issues with the bill would be well-advised to contact both the Treasury/IRS and the tax-writing committees of Congress along with the Joint Tax Committee in order to request guidance and to alert government officials to the issues. It is also possible that with further understanding of the way the new law works, government staff will find unintended consequences or loopholes that must be addressed. Unlike with a true technical correction, these fixes may require revenue offsets.
State Tax Issues
Many of the changes in the TJCA will have major impacts on state governments across the country. Some states use the calculation of federal taxable income as the starting point for the calculation of state taxable income while others use federal adjusted gross income, and each state will have to make decisions about whether to conform to the changes in the TJCA or decouple from some or all of the new provisions. Most state legislatures convene their legislative sessions in January, and this year, they are facing decisions about how to react to federal tax reform.
States can conform to the federal tax code in one of two ways. Rolling or current conformity states tie the state tax to the federal tax code so that they adopt all changes as passed by Congress unless the state passes legislation to decouple from specific provisions. Static or fixed-date conformity states tie to the federal tax code as of a specific date so that the state legislature must act to incorporate subsequent federal tax code changes into the state tax code. Regardless of which approach a state uses, most will pick and choose federal items to which they will conform, sometimes based on the revenue consequences to the state budget. In this case with such broad changes to the federal tax code, some states may decide to delay their decisions until they are able to fully assess the impacts to the state budgets and state taxpayers.
In general, state governments need to balance their budgets and cannot borrow to fund current operating expenditures. Thus, each state will have to assess whether it can afford to conform to the federal changes or if conformity will be too costly for their budget. States have varying timetables for determining whether to conform to or decouple from certain TJCA provisions, but as of the date of enactment, some states will automatically conform to many if not most of the provisions based on each state’s rolling conformity provisions. Every business will have to evaluate the financial results of state conformity on their own current and prospective tax planning.
State governments will also have to consider the fact that under the terms of the TJCA, some provisions will sunset in 2025, which was necessary in order to ensure that the tax act met budget requirements. This will primarily relate to individual rules as many of the business changes are permanent, but they will be factored into the uncertainty faced by both state governments and taxpayers.
For the business community, this means uncertainty about the level of taxes that will be due on the state level as companies wait to see what changes state governments make. It also means that the importance of state tax planning will likely increase for many companies.
There are a number of issues that could have an impact on states including the new deduction for pass-through income, the treatment of repatriation income, full-expensing, limits on business interest, changes to the subpart F regime, the participation exemption for foreign dividends, and the loss of tax credit bonds and tax-exempt advance refunding of government debt.
Some issues in the TJCA have already provoked reactions from some states including the limit on the deductibility of state and local income taxes. In many cases, the result of the federal law changes will result in increased revenue to the state, but state officials will have to decide whether to use that increased revenue or make changes in their laws to lower taxes for state taxpayers who would see increased tax bills. Some of the states who are considering ideas that either return revenue to taxpayers or provide a process to work around new rules include New York, California, Illinois, Pennsylvania, Connecticut, Michigan, Maryland, New Jersey, and Maine. Treasury Secretary Mnuchin is skeptical of the proposal being considered by California, New York and New Jersey to work around the state and local income tax deduction by allowing taxpayers to make charitable contributions to state funds, but says he would like to see the legislative language before commenting on the merits of it.