Washington Tax Insight January 2019 – Happy New Year!
Politics and Congressional Activity
Congress returns to work on January 3rd, when the Democrats take over control of the House with Nancy Pelosi (D-CA) as the likely Speaker of the House. She appears to have garnered enough support among Democrats in the House to win confirmation, in part by agreeing to relinquish her leadership post in 2020 (after the 116th Congress) unless she receives the support of two-thirds of the Democratic Caucus to continue as Speaker. This procedure will also apply to the other two senior leaders of the Democratic party in the House, Congressman Hoyer (D-MD), who will likely become House Majority Leader, and Congressman Clyburn (D-SC), who will likely become House Majority Whip.
The outcome of the mid-term elections played out to a large extent the way many Washington experts expected with the Republicans retaining control of the Senate and the Democrats retaking control of the house – with a margin of control in the latter case that was larger than expected. Due to the fact that 2019 will bring a divided government to Washington, the expectation is that there will be more investigating than legislating.
House Democrats will make one important change to House rules with respect to tax legislation by dropping the GOP rule that requires a three-fifths supermajority vote to pass legislation that would increase tax rates. The new rules package will be approved by Democrats when they return in January. It is not clear yet whether House Democrats will retain the PAYGO rule, although indications are that it will be included in the new rules package. In general, PAYGO rules require that any new spending increase or tax cut legislation be offset by accompanying spending cuts or tax increases. Current House rules also included a CUTGO rule which prohibits legislation that includes a net increase in direct spending, but it is expected that this rule will be dropped by the Democrats. It is also not clear whether the new rules will continue using dynamic scoring to measure the budget impact of tax legislation or will revert to the use of static scoring models. Dynamic scoring incorporates macroeconomic effects of tax changes while static scoring does not. House rules can be waived by a simple majority vote during the consideration of legislation.
Lame Duck Session – Spending Bills & Government Shutdown Update
Congress failed to approve a continuing resolution to fund the government into January of 2019, so the government shut down on December 22nd due to the fact that the President would not agree to sign a funding bill that did not include money for a border wall. Although Congress is continuing to negotiate, it is unclear whether this issue can be resolved before the new Congress convenes.
House Ways & Means Committee: Congressman Richard Neal (D-MA), who has been in Congress for 30 years and is a close ally of Pelosi, was approved to be Chair of the House Ways & Means Committee by the House Democratic Steering and Policy Committee. His appointment must be confirmed by the full House Democratic caucus, but a vote has not yet been scheduled. Neal has historically been viewed as a business-friendly Democrat with the ability to work in a bipartisan fashion should his party be inclined to let him do so. Republicans lost 10 members of the Committee to retirements and defeat, but they may lose seats due to the shift in ratios of control in the House.
Senate Finance Committee: Senator Chuck Grassley (R-IA), who will become the Chair of the Senate Finance Committee in the next Congress, outlined his tax legislative priorities in a speech on the Senate Floor. With respect to the Tax Cuts & Jobs Act (TCJA), he said that he would support “legitimate efforts to perfect” it, but that efforts to “undermine the strength of the American economy for the sake of ideology,” but he would oppose proposed tax hikes. Other items he noted as important include: (1) a permanent extension of the 2017 tax cuts for individuals and small businesses; (2) overhauling the retirement savings rules; (3) modernizing the IRS and protecting taxpayer rights; (4) increasing the competitiveness of US businesses; and (5) identifying and cracking down on improper tax shelters. He expressed interest in bipartisan activity on tax issues involving education, renewable and alternative energy, and health care. Two new Democrats were appointed to the SFC – Senator Cortez-Masto of Nevada and Senator Hassan of New Hampshire. There will also be two new Republican members of the panel, but they have not yet been named.
Joint Committee on Taxation: The Joint Committee on Taxation (JCT) issued its general explanation of the TCJA, commonly known as the Blue Book, with a summary of all the changes made to the tax code by the TCJA and an explanation of prior law. The Blue Book identifies over 70 provisions of the TCJA that require a technical correction in order to achieve the intent of Congress, covering issues such as the effective date of new rules governing the treatment of net operating losses, the depreciation period for qualified improvement property, and the treatment of installment overpayments under the new repatriation tax. The Blue Book was prepared by the JCT in consultation with the staffs of the House Ways & Means Committee and the Senate Finance Committee.
Sales & Use Taxation – Wayfair case update
The California Department of Tax and Fee Administration released a special notice providing that beginning April 1, 2019, a retailer located outside of California is required to collect tax if, during the preceding or current calendar year: (1) the retailer’s sales into California exceed $100,000; or (2) the retailer made sales into California in two hundred (200) or more separate transactions. The notice states that an out-of-state retailer reaching either of these sales thresholds is engaged in business in California pursuant to California law and the US Supreme Court’s decision in South Dakota v. Wayfair, Inc.
Treasury and the IRS
Treasury and the IRS have released a significant amount of guidance on the TCJA to date. Rules need to be finalized by June of 2019 in order to allow for guidance to be applied retroactively. Businesses should not delay in submitting comments on proposed rules.
Base Erosion and Anti-Abuse Tax (BEAT): On December 13, 2018, the IRS issued proposed regulations on the base erosion and anti-abuse tax (BEAT) under Code section 59A, which was enacted as part of the TCJA. Code section 59A imposes a tax equal to the base erosion minimum tax amount for certain taxpayers starting in 2018. These regulations provide guidance on how to determine if a taxpayer has income taxed by the BEAT and provides the rules for computing a taxpayer’s BEAT liability. The regulations cover a number of different issues including: (1) determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed; (2) determining the amount of base erosion payments; (3) the rules for computing the base erosion minimum tax amount; (4) application of the rules to partnerships; (5) rules that are specific to banks, registered securities dealers, and insurance companies; (6) anti-abuse rules; and (7) reporting and record keeping requirements.
The TCJA also added reporting obligations regarding the BEAT for 25-percent foreign-owned corporations subject to Code section 6038A and foreign corporations subject to Code section 6038C and addressed other issues related to information reporting under those code sections. The preamble of the proposed regulations addresses Notice 2018-28 related to the treatment of business interest carried forward and whether it is a base erosion payment stating that the regulations do not follow the approach in the Notice.
The IRS invited comments on all aspects of the regulations but did not provide a specific deadline for submission of them or the date of public hearing. The IRS stated that if any part of the rule is finalized after June 22, 2019, that provision will apply only to taxable years ending on or after the date it is published in the Federal Register.
Previously Taxed Earnings & Profits: The IRS issued Notice 2019-1 announcing that Treasury and the IRS intend to issue regulations addressing issues arising from the enactment of the TCJA with respect to foreign corporations with previously taxed earnings and profits (PTEP). These regulations are expected to cover: (1) rules relating to the maintenance of PTEP in annual accounts and within certain groups; (2) rules relating to the ordering of PTEP upon distribution and reclassification; and (3) rules relating to the adjustment required when an income inclusion exceeds the earnings and profits of a foreign corporation. These regulations will be effective for taxable years of US shareholders ending after December 14, 2018 (the date of the Notice). Comments are due by February 12, 2019, and the IRS has noted several issues on which it is specifically requesting feedback.
Deferral on Income attributable to qualified stock: The IRS issued Notice 2018-97, providing early guidance under Code section 83(i) and the tax treatment of property transferred in connection with the performance of services. The TCJA added Code section 83(i), which allows certain employees to defer tax on income attributable to the receipt or vesting of qualified stock. The Notice focused on three areas including: (1) the application of the requirement in Code section 83(i)(2)(C)(i)(II) that grants be made to not less than 80% of all employees who provide services to the corporation in the United States; (2) the application of federal income tax withholding to the deferred income related to the qualified stock; and (3) the ability of an employer to opt out of permitting employees to elect the deferred tax treatment even if the requirements under Code section 83(i) are otherwise met. The IRS indicated that it intends to propose regulations that will incorporate this guidance. Comments are due by February 5th with specific interest in comments on “additional or alternative mechanisms that could be established to ensure the collection of the required income tax withholding in accordance with section 83(i)(3)(A)(ii).”
Hybrid Dividends: The IRS issued proposed regulations on hybrid dividends and certain amounts paid or accrued in hybrid transactions or with hybrid entities under Code sections 245A(e) and section 267A, which were both added by the TCJA. The guidance also includes proposed regulations under Code sections 1503(d) and 7701 to prevent the same deduction from being claimed under the tax laws of both the United States and a foreign country. The rules also contain proposed regulations under sections 6038, 6038A, and 6038C to facilitate administration of the new rules. The proposed regulations affect taxpayers that would otherwise claim a deduction related to hybrid dividends and certain shareholders of foreign corporations that pay or receive hybrid dividends.
The IRS issued proposed regulations on the tax implications for foreign persons from the sale or exchange of certain partnership interests under Code section 864(c)(8) covering the following areas: (1) gain or loss on the transfer of a partnership interest; (2) coordination with Code section 897; (3) tiered partnerships; (4) treaties; (5) anti-stuffing rule; and (6) Code section 1446(f) guidance. Code section 864(c)(8) generally overturned the Tax Court’s ruling in Grecian Magnesite Mining v. Comm’r., by providing that gain or loss of a nonresident alien individual or foreign corporation from the sale, exchange, or other disposition of a partnership interest is treated as effectively connected with the conduct of a trade or business within the United States to the extent that the transferor would have had effectively connected gain or loss if the partnership had sold all of its assets at fair market value as of the date of the sale or exchange.
Other Issues and Guidance
The Senate voted 55-44 to confirm Justin Muzinich to serve as Deputy Treasury Secretary. His nomination had been approved in August in the SFC but was held up in the Senate based on Democratic opposition tied to Treasury policy that no longer requires 501(c) organizations (except 501(c)(3)s) to disclose names and addresses of donors.
The Senate approved a resolution by a 50-49 vote that would block guidance issued by the IRS earlier in 2018 to no longer require certain tax-exempt organizations to report the names and addresses of their contributors. The House did not take up the Senate-passed resolution prior to the end of the year so it expired with the end of the 115th Congress. In July, the IRS issued Revenue Procedure 2018-38, which provided that 501(c) tax-exempt organizations (other than 501(c)(3) entities) no longer were required to report the names and addresses of their contributors with their Forms 990 or 990-EZ with the Assistant Treasury Secretary for Tax Policy telling Congress that the collection of this donor information was not needed to enforce the tax laws or collect revenue. Democrats, led by SFC Ranking Member Wyden (D-OR), opposed the move, citing a reduction in transparency. The resolution was considered under the Congressional Review Act, which allowed for an expedited process for overturning a major regulation by a simple majority vote in each chamber.
Treasury and the IRS issued proposed Foreign Account Tax Compliance Act (FATCA) regulations, which are intended to reduce taxpayer burdens with respect to FATCA requirements by eliminating withholding on payments of gross proceeds, deferring withholding on foreign passthru payments, clarifying the definition of investment entity, and eliminating withholding on certain insurance premiums. The IRS requested comments on the regulations but did not set a deadline for submission.
The IRS Criminal Investigation Division issued a memorandum providing significant guidance on voluntary disclosures (both domestic and offshore) for willful noncompliance in the future. The updated practice described in the memorandum follows the IRS announcement in March of 2018 that it would discontinue the 2014 Offshore Voluntary Disclosure Program effective September 28, 2018 and represents a major change to the way the IRS will deal with disclosures that involve willful conduct. Prior to this, taxpayers with willful tax violations were given an opportunity to avoid criminal prosecution and utilize a reduced civil penalty structure. Other disclosure programs will continue to be available for now for taxpayers who are not willfully noncompliant and who do not have criminal exposure.
The IRS issued Revenue Procedure 2018-60, which provides procedures for certain accounting changes relating to the timing of the recognition of income for taxable years beginning after December 31, 2017. The guidance “provides the procedures by which a taxpayer may obtain the automatic consent of the Commissioner of Internal Revenue under section 446 and section 1.446-1(e) of the Income Tax Regulations to change a method of accounting to comply with section 451(b).” The revenue procedure also provides procedures for certain qualifying taxpayers to make a method change to comply with Code section 451(b) without filing a Form 3115, Application for Change in Accounting Method.
The IRS issued Revenue Ruling 2018-32, which sets certain interest rate increases for the first quarter of 2019. Starting on January 1, 2019, interest rates will be: (1) six (6) percent for overpayments [five (5) percent in the case of a corporation]; (2) three and one-half (3.5) percent for the portion of a corporate overpayment exceeding $10,000; (3) six (6) percent for underpayments; and (4) eight (8) percent for large corporate underpayments.
The IRS issued Notice 2019-2, which sets the standard mileage rates used for deducting the costs of operating an automobile for business (58 cents), charitable (14 cents), medical (20 cents), or moving purposes (20 cents) in 2019.
The IRS issued final regulations on the allocation of costs to certain property produced or acquired for resale under Code section 263A. The regulations (1) provide rules for the treatment of negative adjustments related to certain costs required to be capitalized to property produced or acquired for resale; (2) provide a new simplified method of accounting for determining the additional costs allocable to property produced or acquired for resale; and (3) redefine how certain types of costs are categorized for purposes of the simplified methods. The IRS also issued Revenue Procedure 2018-56, providing procedures by which a taxpayer may obtain automatic consent to change to the methods of accounting described in these regulations.
The Council of the European Union (EU) released a proposal for a Council Directive on the common system of a digital services tax on revenues resulting from the provision of certain digital services. The European Parliament of the EU released a report on this proposal.
The European Commission released a report titled Tax Policies in the European Union, 2018 Survey. The survey summarizes 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.
The Council of the European Union (EU) released the latest compromise text for the proposal for a Council Directive on a Common Corporate Tax Base proposal.
The European Union’s Economic and Financial Affairs Council (ECOFIN) released a report to the European Council on tax issues. The report provides an overview of the progress achieved in ECOFIN during the past six months, as well as an overview of the state of play of the most important dossiers under negotiations in the area of taxation.
The OECD released a report titled “Harmful Tax Practices – 2017 Peer Review Reports on the Exchange of Information on Tax Rulings” as part of the BEPS project. The report assesses 92 individual jurisdictions’ progress in exchanging information on tax rulings in accordance with Action 5 of the BEPS Action Plan.
The OECD announced that Malta and Singapore have deposited their instruments of ratification for the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. The convention will enter into force with respect to Malta and Singapore on January 4, 2019.
Tax Reform Update
Republican Tax Reform 2.0
Ways & Means Committee Chair Brady (R-TX) successfully gained approval of a tax bill before the end of the year that included IRS reform, some technical corrections to the TCJA, new retirement incentives for businesses and individuals, and a couple of tax extenders. As expected, however, the Senate took no action on the bill prior to the end of the 115th Congress.
House and Senate Democrats have opposed this effort including the TCJA corrections by Chair Brady from the beginning in part because House Democrats were not included in the drafting process for the 2017 tax act or the technical corrections. They will also have greater leverage in the next Congress when they take control of the House with incoming W&M Committee Chair Neal stating that he will hold hearings on technical corrections before moving any legislation.
Although Senate Majority Leader McConnell (R-KY) had never made this tax bill a Senate priority, there was some speculation that some of its provisions might be added to other legislation, but incoming SFC Chair Grassley (R-IA) has not publicly supported that approach.
Democratic Tax Agenda
Chair Brady’s bill expired at the end of the 115th Congress, and incoming Chair Neal is not expected to reintroduce it, but he may look for areas of bipartisan agreement for legislation in the 116th Congress including IRS reform and retirement savings incentives. Neal is also expected to advance technical corrections legislation after Committee hearings including consideration of some of the technical corrections suggested in the JCT Blue Book on the TCJA, but this process may prove to be challenging if Democrats also pursue substantive changes to the TCJA.
House Democrats are expected to consider increasing tax cuts for middle- and lower-income families and individuals, which could be paid for by increasing corporate tax rates to a rate in the range of 25-27 percent. Some Democrats favor revisiting the cap on state and local tax deductions while other issues that could be revisited by the Democrats include the deduction for income from pass-through entities. It is unlikely that Neal will lead an effort to repeal the TCJA, but it is equally unlikely that he will support any expansion of it. Targeted efforts to modify parts of the TCJA are likely as part of a Democratic plan to begin their messaging for the 2020 elections.
Infrastructure legislation has consistently been a priority for Democrats and many Republicans, but the challenge will be how to fund the legislation. Neal is reportedly considering the formation of an infrastructure subcommittee.
Neal has also said that the Committee will consider the expired tax extenders, but it is unclear what approach he will favor moving forward. In the past, House Republicans have preferred an approach of making favored extenders permanent rather than a continuing process of approving short-term extensions. There is also an expectation that Neal will undertake some oversight with respect to the TCJA. He led the Democratic opposition to the TCJA and has consistently been in favor of closing tax “loopholes” that allow taxpayers to shelter income abroad.
Neal will have the ability to request copies of the President’s tax returns under a 1924 law that allows tax-writing committee chairs to request the tax return of any taxpayer. Treasury Secretary Mnuchin has the responsibility of overseeing such a request.
The Congressional Budget Office released a report summarizing over 100 options for reducing the federal deficit between 2019 and 2028. The report is released annually by the non-partisan CBO to offer legislators ideas for legislation that will contribute to a decrease in the budget deficit through cuts in mandatory or discretionary spending or raising revenues. The revenue section included 40 proposals including raising tax rates on individuals and corporations. This report will likely be used by the Democrats once they take control of the Ways & Means Committee to provide ideas for tax legislation in the 116th Congress.