Washington Tax Insight July 2019
Politics and Congressional Activity
H0use and Senate leadership continue to meet with White House officials in an effort to work out a two-year budget deal that would also address the issue of the debt ceiling limit. If they can successfully agree on a two-year deal rather than just a one-year measure, the path to writing spending bills and avoiding another government shutdown becomes clearer.
Congress passed a $19 billion disaster relief bill, which was signed by the President. The House passed an immigration bill, but it is unlikely to advance in the Senate, following the similar fate of other Democratic agenda items, including health care, gun control, climate change, and elections security. The House and Senate passed different versions of legislation to provide funding for the purpose of addressing the humanitarian crisis at the southern border after which the House passed the $4.6 billion Senate version of the bill sending it to the President for signature.
Some Senate Republicans are interested in trying to get movement on issues beyond just the confirmation of judges on the Senate Floor, and reports are that the Committee chairs have been instructed to prepare bills for Floor action. The Senate “wish list” includes legislation to lower health care costs, a defense policy bill, the new Mexico-Canada trade deal, and bipartisan legislation to lift the budget caps. There is concern that the lack of legislative accomplishments is embarrassing for the GOP heading into the elections in 2020.
Ways & Means Committee: The Ways & Means Committee held a hearing on the state and local tax deduction (SALT) entitled “How Recent Limitations to the SALT Deduction Harm Communities, Schools, First Responders, and Housing Values” with a Joint Tax Committee pamphlet issued as a background report on the issue. At the hearing, some witnesses noted that the impact on high-tax states and their residents had not been significant, while others noted that this provision is set to expire in 2025 along with certain other individual income tax changes in the TCJA. Although Chair Neal (D-MA) has been critical of the cap, he has not announced plans to deal with the issue legislatively. Earlier this year, Committee Democrats established an informal working group to consider solutions to the limitation recognizing that full repeal of the cap would be expensive and likely opposed by the Republican-controlled Senate. The Committee held a “Members Day” hearing intended to allow House Members to testify on legislation within the panel’s jurisdiction. Thirty-five Members testified on a range of bills covering the deduction for state and local taxes (SALT), student debt, empowerment zones, cryptocurrencies, and renewable energy.
Senate Finance Committee: Ranking Democrat Wyden (D-OR) introduced legislation that would close the perceived loophole in the tax treatment of carried interest. Under the bill, a fund manager would be required to recognize annually as ordinary income a deemed compensation amount that is computed by applying an interest factor to the capital he or she manages on behalf of others, and the deemed compensation would be subject to self-employment tax. Senator Wyden has explained that his bill would prevent fund managers from converting wage income into lower-taxed, long-term capital gain and would prevent deferral of carried interest income taxation until the underlying investment producing the carry is sold, which is a gap that he argues exists in current law. President Trump has said publicly that he too would like to close the carried interest loophole, but this proposal is unlikely to be considered by the Republican-controlled Senate in the near future.
Retirement Savings Legislation: The Senate has not yet considered the House-passed version of retirement legislation due to the opposition of Senator Cruz (R-TX) because the House stripped out a proposed expansion of the tax advantaged 529 programs for education savings prior to House Floor considerations. In an effort to move the bill, Senate Republicans have offered to allow Cruz to attach the 529 provision to other legislation this year, such as the education bill or an appropriations package. Senators Toomey (R-PA), Lee (R-UT), and Rubio (R-FL) reportedly also have objections to the bill. The Senate will be unable to consider the bill under unanimous consent if these objections continue, which would lead to a decision by Senator Majority Leader McConnell as to whether he can find Senate Floor time for the bill’s consideration. The primary revenue offset in the House version of the bill has been gaining attention of late as it would change the distribution rules for “stretch IRAs”, which is a planning strategy that extends the tax-deferred status of an IRA account to a non-spouse who receives the money when the IRA holder dies.
IRS Reform Legislation: Congress approved and the President signed a revised version of the bipartisan IRS reform bill, which is designed to reorganize the IRS, make taxpayer-friendly changes in the areas of enforcement, appeals and customer service, and modernize the IRS’s technology and cybersecurity infrastructure. Congress dropped the controversial provision that would have codified the Free File program.
Tax Treaties: The Senate Foreign Relations Committee approved several tax treaties that have been waiting for ratification for several years including treaties with Japan, Luxembourg, Spain, and Switzerland. Senate Majority Leader McConnell has signaled that he plans to bring the treaties to the Senate Floor for a vote the week of July 15th. The pending treaties with Chile, Poland, and Hungary were not marked up as the Treasury Department seeks to clarify how provisions in those agreements interact with the base erosion and anti-abuse tax (BEAT) enacted in the TCJA. Senator Rand Paul (R-KY) has objected to these treaties in the past because of objections about privacy protections in the documents, and he has stated that he will not allow the treaties to be cleared by the Senate through unanimous consent, so the vote is likely to be a regular order roll call vote
Tax Court: With a 2-1 majority opinion, the US Court of Appeals for the Ninth Circuit has reversed the Tax Court’s decision in Altera (now a subsidiary of Intel), and upheld tax regulations on certain cross-border cost-sharing agreements within corporations, giving a victory to the IRS. The case involved what is known as share-based compensation and the issue of where it should be deducted as a business expense. The Court found that IRS regulation § 1.482-7A(d)(2) was not arbitrary and capricious under the Administration Procedure Act, disagreeing with the Tax Court, which had overturned the 2003 regulation upon finding that the IRS had not complied with procedural requirements in promulgating the rule. The court had issued a similar ruling in 2018 but heard the case again because one of the judges died before the ruling was issued. Other tech companies had been watching the case closely with some of them citing the pending case as a risk in their financial statements. Intel did not comment on whether an appeal will be pursued.
Treasury and the IRS
Treasury and the IRS have released a significant amount of guidance on the TCJA to date. Treasury had until June 22, 2018 (18 months after the TCJA was enacted) to issue final rules that would operate retroactively back to the enactment date.
Global Intangible Low-Taxed Income (GILTI) & Foreign-Derived Intangible Income (FDII): The IRS issued final regulations on Code section 951A and foreign tax credits and proposed regulations on GILTI and Code section 958 (rules for determining stock ownership). The final regulations cover: (1) determining the amount of GILTI included in the gross income of certain US shareholders of foreign corporations, including members of a consolidated group; (2) determining a US shareholder’s pro rata share of a CFC’s subpart F income included in the shareholder’s gross income and reporting requirements on inclusions of subpart F income and GILTI; and (3) application of certain foreign tax credit provisions to persons that directly or indirectly own stock in foreign corporations. The proposed regulations cover the treatment of domestic partnerships for determining amounts included in the gross income of their partners with respect to foreign corporations and the issue of gross income that is subject to a high rate of foreign tax.
The IRS issued a notice of public hearing on proposed regulations regarding the amount of the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) for July 10, 2019. The Joint Committee on Taxation released a presentation that provides an overview of the GILTI and FDII regimes including background details on prior law for taxing multinationals, an explanation of the formulas for calculating GILTI and FDII, and specific examples.
DRD and the Look-Through Exception/Section 954: The IRS issued proposed and temporary final regulations under Code section 245A on limiting the dividend received deduction (DRD) for amounts from certain foreign corporations and amounts eligible for a look-through exception under Code section 954. The temporary final regulations limit the DRD for certain dividends received from current or former CFCs, and they also include rules to “limit the applicability of the exception to foreign personal holding company income for certain dividends received by upper-tier controlled foreign corporations from lower-tier controlled foreign corporations and temporary regulations under Code section 6038 to facilitate administration of certain rules in the temporary regulations.” The text of the temporary regulations also serves as the text of the proposed regulations.
Base Erosion and Anti-Abuse Tax (BEAT): The IRS plans to issue final regulations on the base erosion and anti-abuse tax (BEAT) sometime this summer, according to IRS officials at a recent Washington tax conference. The IRS received over 60 comment letters about the December 2018 proposed regulations with a significant number of comments dealing with reinsurance.
SALT regulations: The IRS issued final regulations under Code section 170 on the deduction for state and local taxes (SALT) and the $10,000 cap enacted by the TCJA. The final rules effectively shut down a tax-planning strategy that had been utilized by residents of high-tax states, such as New York, New Jersey, California, and Connecticut, which attempted to convert nondeductible state tax payments into deductible charitable contributions. They follow the proposal that Treasury released in August of 2018 with one change that allows people who itemize deductions to make limited use of credit-for-donation programs as long as the total of their state and local tax payments and those donations are below $10,000. The final regulations are effective August 11, 2019 but apply to contributions made after August 27, 2018.
Opportunity Zone regulations: A Treasury official has stated that Treasury is not working on a third set of proposed regulations for the opportunity zone program but instead is focused on finalizing the two sets that have been released. Investment in opportunity zones has been lower than expected, and a deadline is looming as investments must be made by December 31, 2019, in order to take advantage of the full 15% step up in basis, which is gained after holding the investment for seven years.
New Draft W-4 Tax Withholding Form: The IRS released a new draft Form W-4 to be used in determining federal income tax withholding on the wages of employees hired after 2019 with a final form expected to be released by the end of 2019. The IRS expects to release another near-final form with employer instructions by the beginning of August so that employers and payroll processors have time to update their systems before the final form is released. In the interim for 2019, taxpayers should continue to use the current version of Form W-4, and taxpayers will not be required to update their forms once the final form is released. The new form uses a new five-step process that moves away from the allowances system currently being used, because it is based on personal exemptions that were eliminated by the TCJA.
Other Issues and Guidance
Health Reimbursement Arrangements: The IRS with the Departments of Labor (DOL) and Health and Human Services (HHS) issued final regulations that expand and simplify the rules for health reimbursement arrangements (HRAs). The IRS explained, “Specifically, the final rules allow integrating HRAs and other account-based group health plans with individual health insurance coverage or Medicare, if certain conditions are satisfied (an individual coverage HRAs).” The final rules also set forth conditions under which certain HRAs and other account-based group health plans will be recognized as limited excepted benefits as well as rules on premium tax credit (PTC) eligibility for individuals offered an individual coverage HRA.
Property Transfers to RICs and REITs: The IRS issued final regulations under Code section 337(d) regarding certain property transfers to Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs). The rules are intended to further implement the repeal of the General Utilities doctrine by the Tax Reform Act of 1986 and to prevent abuse of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The IRS explained that the “final regulations impose corporate-level tax on certain transactions in which property of a C corporation becomes the property of a REIT.”
Cryptocurrency Guidance: In response to a bipartisan letter from several members of Congress and in other public comments, IRS Commissioner Rettig has stated that guidance on cryptocurrencies, such as bitcoin, will be released soon with comments that he believes that taxpayers deserve clarity on basic issues related to the taxation of virtual currency transactions, so he made this issue a priority. The last guidance issued was in 2014 with the Treasury Inspector General for Tax Administration finding in 2016 that the IRS needed to issue more guidance. The IRS basic position on taxing virtual currencies is to treat any gain as a capital gain, but guidance is needed to address issues of cost basis and hard forks.
Brexit: Following the resignation of UK Prime Minister Theresa May, attention in the UK is on the elections to replace her as the head of the Conservative Party, and after several rounds of voting, the contest is between Boris Johnson and Jeremy Hunt with a new prime minister expected to be determined the week of July 22nd. The UK was required to hold elections to the European Parliament, and the “Brexit Party,” which ran a no-deal platform gained more votes than any other party. This result has pushed leading contenders for the Conservative Party leadership to include the possibility of a no-deal exit as an option, but that option is unlikely to be approved by Parliament and could result in a vote of no-confidence in the new Government. On October 31st, the UK will leave the EU without a deal unless one of three steps is taken: agreement to a deal, a request for a further delay, or a decision to cancel Brexit. Under the agreement with the EU, the UK may reconsider their entire Brexit strategy, but the extension agreement precludes reopening the withdrawal agreement. Johnson has said that a no-deal exit is not his preferred way of exiting the EU, but he would accept it to ensure that the UK does in fact leave the EU. He believes that the UK has some leverage over the EU on this issue with the position that the EU has more to lose politically and economically in the case of a no-deal exit, but EU officials disagree with this assessment. In the period prior to the original Brexit date of March 29, the Government worked on plans for dealing with a no-deal exit, but this work is ongoing and individual bills would need to be approved by Parliament.
Digital Services Taxes: The OECD continues working on a plan to tax digital commerce as part of the BEPS initiative, but the debate has broadened to a general discussion of global tax rules including addressing which countries are allowed to tax certain profits of multinationals and ensuring that multinationals pay their fair share of taxes. The group of 129 countries known as the Inclusive Framework on BEPS agreed to a Programme of Work on May 28th, which was approved by the G20 Finance Ministers on June 9th. In approving the work plan, the ministers said in a communique: “We welcome the recent progress on addressing the tax challenges arising from digitalization and endorse the ambitious work program that consists of a two-pillar approach, developed by the inclusive Framework on BEPS.” They agreed that they would continue to work toward a final report by the end of 2020. The work plan was approved by the G20 leaders l at their June 28-29 meeting.
US Activity: At the G20 meeting of Finance Ministers, Secretary Mnuchin continued to express US concerns about the unilateral actions of countries like the UK and France stating “It sounds like we have a strong consensus about the goals of tax reform” but noting the need to take the consensus and deal with the technicalities of producing an agreement. At the OECD conference, Chip Harter, Deputy Assistant Treasury Secretary for International Tax Policy, stated that there would need to be three principles developed as part of this plan. He said that the profit allocation rules would need to be fairly simple and formulaic. He said that the second principle should be to focus on above-normal returns rather than allocating some portion of the entire return to the market jurisdiction. Finally, he said that market jurisdictions need to be willing to provide certainty to companies about their tax treatment in exchange for additional taxing rights.
The OECD announced at the recent conference in Washington sponsored by the OECD, BIAC, and the USCIB that a working group of the Committee on Fiscal Affairs has finished technical work on its transfer pricing guidelines for financial transactions with agreement on nearly all of the 25 areas of disagreement identified in a July 2018 non-consensus discussion draft. The work has not been published because work continues on commentary to the OECD Model Tax Convention’s Article 9 concerning whether the arm’s length standard applies to companies’ capital structures—how much is financed with debt vs. equity. A key question is whether Article 9 would override approaches in countries’ domestic laws. Once agreement on this issue has been reached, the work will be made public as a final report hopefully by the end of 2019 according to an OECD official. Christopher Bello, the US IRS Branch Chief, Office of Associate Chief Counsel (International), Branch 6, commented at the conference that the OECD guidance in this area might be a good model for the IRS should the US decide to issue transfer pricing regulations on financial transactions.
The OECD also reported at the conference that work on a 2020 review of country-by-country reporting is underway. Agreement on the issues to be included in a consultation document for public feedback is to be agreed upon by January of 2020 with the consultation during 1Q of 2020, and approval of a final document by the Inclusive Framework by the end of 2020.
European Union: The EU Council adopted a revised EU list of non-cooperative tax jurisdictions, removing Aruba, Barbados, and Bermuda from the list. The Council also announced that while it will continue to regularly review and update the tax blacklist in 2019, starting in 2020, updates to the EU list will be done no more than twice per year to give Member States adequate time to amend their domestic legislation. Currently, 12 jurisdictions remain on the EU list of non-cooperative jurisdictions. The aim of the EU list is to contribute to ongoing efforts to prevent tax avoidance and promote good governance principles, such as tax transparency, fair taxation, and international standards combatting tax base erosion and profit shifting.
The recent EU elections produced a higher than normal turnout with result being a broadly pro-EU body but a more fragmented majority with both business-friendly and environmental factions. This result along with the uncertainty of the exit of the UK from the EU creates a complex decision-making process going forward, with the formation of complicated coalitions necessary.
The new Brexit Party led by Nigel Farage came in first for the UK with 31% of the vote and the ruling Conservative Party in 5th place in the voting. The EU will have to deal with the complication of having the UK continue to be a player in the EU Parliament until the planned exit in the fall of 2019.
United Nations: The United Nations released its report on the 18th session of the Committee of Experts on International Cooperation in Tax Matters, including chapters on the discussions and conclusions on substantive issues related to international cooperation in tax matters and matters calling for action by the Economic and Social Council.
Swiss Corporate Tax Reform: Swiss corporate tax reform, which was approved by a popular referendum on May 19th, includes a new corporate tax structure that preserves the country’s traditional reputation for being friendly to business and competitive globally in attracting business. Certain tax breaks that Switzerland had allowed for multinationals were in violation of OECD guidelines including the BEPS project. Included in the new rules is the introduction of a new tax-related special arrangement to promote R&D — the patent box — which will allow a portion of the profits from inventions to be taxed at a reduced level in the Swiss cantons in the future. After this positive vote, cantons have to abolish their special regimes and then rewrite their tax systems on the basis of the reform provided by the federal government. The new tax reform rules will be effective January 1, 2020.
The Tax-Writing Committees: Tax Extenders & Technical Corrections
On June 20th, the House Ways & Means Committee approved legislation on a party-line vote that would extend several temporary tax provisions, provide tax relief and assistance to taxpayers affected by natural disasters, and address some Democratic priorities including the Child Tax Credit, the Earned Income Tax Credit, and the Child Care and Dependent Car Tax Credit. Prior to the markup, the Joint Tax Committee issued a set of background documents related to all of the issues considered during the Committee meeting. Chair Neal intends to package some of these other proposals with the tax extenders prior to House Floor consideration, but he will need to find revenue offsets for them.
The Taxpayer Certainty and Disaster Relief Act would extend through 2020 most of the nearly two dozen temporary tax deductions, credits, and incentives that expired in 2017 and 2018, as well as those scheduled to expire in 2019. The provisions that have already expired would be extended retroactively to the beginning of 2018. Some of the significant provisions that are included are:
- Lookthrough treatment of payments between related controlled foreign corporations under the foreign personal holding companies rules (section 954(c)(6));
- The New Markets Tax Credit (section 45D(f))
- The Work Opportunity Credit (section 51(c)(4)); and
- Credits for electricity produced from wind and nonwind renewable resources (section 45, 45(d) , and 48(a)(5))
The cost of the bill was offset by a provision that would raise $37.5 billion over 10 years by reducing the unified credit against the estate tax through language that would accelerate the expiration of the increased estate tax exemption levels, currently set to expire at the end of 2025, to the end of 2022.
During the markup, a number of amendments offered by Republican Committee members were rejected including an amendment to make permanent certain individual tax provisions of the TCJA. The bill will now be considered on the House Floor although a date for that activity has not been announced, and there are some reports that House Floor action may not be critical to entering into negotiations with the Senate on a final bill.
Advancement of a technical corrections bill continues to be a low priority for tax-writers in Congress in part because Democrats continue to take the position that they do not want to help Republicans correct errors in legislation that passed without Democratic input. During the markup on the tax extenders legislation, Republican Committee Members attempted to offer amendments that would have corrected some of the technical errors in the TCJA, but they were rejected. Chair Neal had stated prior to the markup that TCJA technical corrections would be considered separately from the tax extenders. A handful of technical corrections have been considered including the “grain glitch,” which was corrected in budget legislation in 2018 and the Kiddie Tax changes, which are being considered as part of the bipartisan retirement legislation moving in Congress.