Washington Tax Insight May 2017
Politics and Congressional Activity
The White House and Congress continue to face a full legislative agenda including budget deadlines, tax reform, health care reform, and House and Senate intelligence committee hearings on Russian involvement in the 2016 election. April 29th marked the end of the first 100 days of the Trump Administration. Other issues which Congress will need to address this year include the debt limit, which will likely need to be raised by September, an infrastructure bill, veterans’ legislation, defense policy legislation and reauthorizing the children’s health insurance program, the Federal Aviation Administration and the government flood insurance program. It is expected that there will be a need for all of these issues to gain some bipartisan support to advance.
The Continuing Resolution and Funding the Government
The current Continuing Resolution funding the government expired on April 28th so Congress approved a one-week extension and has now reportedly agreed to a bipartisan deal to fund the government through September. The $1 trillion budget deal increases defense spending to fight terrorism by up to $15 billion (with $2.5 billion contingent on the White House presenting a strategy to defeat the Islamic State to Congress) and provides $1.5 billion in new border security spending but does not include funding for a wall between Mexico and the US to which Democrats objected. The bill also includes $2 billion in increased spending for the National Institutes of Health, the extension of expiring health benefits to retiring coal miners, and continues to fund Planned Parenthood. This bill is expected to pass both the House and Senate.
Democrats have also said that the spending bill must include a commitment to continuing the ACA’s subsidies for low-income taxpayers. Although originally Office of Management and Budget Director Mick Mulvaney said that the President would not sign a bill that includes those subsidies, the latest reports are that the Administration will agree to that funding.
Health Care Reform
House Republicans have continued to work to draft health care reform legislation that could garner enough votes for passage, but the urgency of dealing with the expiration of the Continuing Resolution has delayed consideration of this issue. Working from the legislation which was pulled from the House Floor prior to a vote last month, House leaders have focused on an amendment that would allow states to remove some insurance requirements established by the Affordable Care Act (ACA) if the states could prove that it would enable them to lower the cost of premiums or insure more people. Under the proposal, states could relax requirements that set which benefits health plans must cover (such as maternity services and mental health services), as well as allow insurers to charge higher premiums to people with pre-existing conditions and older enrollees under certain conditions. Although the revisions have been endorsed by the conservative Freedom Caucus, there is a risk of losing support from Republican moderates. President Trump has urged Congress to move on health care reform as quickly as possible.
Ways & Means Committee/House
The House Energy & Commerce Committee held a hearing titled “Federal Energy Related Tax Policy and its Effects on Markets, Prices, and Consumers,” which was scheduled in conjunction with Congressional work on comprehensive tax reform.
Fifteen Republican members of the Ways & Means Committee including Chair Brady (R-TX) sent a letter to President Trump requesting the removal of John Koskinen as IRS Commissioner prior to the expiration of his term on November 12, 2017, and the appointment of a new leader as soon as possible.
Treasury and the IRS
President Trump signed an Executive Order (EO) instructing Treasury Secretary Mnuchin to review all significant tax regulations since the beginning of 2016. He commented that “this regulatory reduction is the first step toward a tax reform that reduces rates, provides relief to our middle class, and lowers our business tax, which is one of the highest in the world and has stopped us from so much wealth and productivity.” The EO directs the Treasury Secretary to send an interim report to the President by June 20th (with a final report due September 18th) of all regulations that: (1) impose an undue financial burden on US taxpayers; (2) add undue complexity to the Federal tax laws; or (3) exceed the statutory authority of the IRS. The report is to also include recommendations on specific actions to ease the regulatory burden by causing “the effective date of such regulations to be delayed or suspended, to the extent permitted by law, and to modify or rescind such regulations as appropriate and consistent with law, including, if necessary, through notice and comment rule making.” Regulations that may be affected by this EO include: (1) Code section 385 final regulations on earnings stripping; (2) Code section 7874 regulations on corporate inversions; (3) Code section 367(a) and (d) final regulations on outbound intangibles; (4) Code section 707 and 752 regulations on partnership allocation of liabilities; (5) Code section 721(c) regulations on the outbound transfer of appreciated property to a partnership; and (6) Code section 956 CFC-foreign partnership regulations.
The IRS issued Revenue Procedure 2017-25, which establishes the Small Business/Self Employed (SB/SE) Fast Track Settlement program to provide an expedited format for resolving disputes between examination and SB/SE taxpayers. This Fast Track Settlement program can be used by SB/SE taxpayers who have at least one fully developed issue under examination that can be referred to IRS Appeals for resolution.
The IRS issued Revenue Procedure 2017-29, which updates for 2017 tax years the annually published depreciation and inclusion tables for owners and lessees, respectively, of passenger vehicles, trucks and vans.
The IRS issued an annual report on its 2016 work on the structure, composition, and operation of its Advance Pricing and Mutual Agreement Program (APMA Program). The report also includes descriptions of various elements of the APAs executed in 2016, including types of transactions covered, transfer pricing methods used, and completion time. The current model APA agreement, which is included in the report, is currently under review for future revisions.
The IRS issued Revenue Procedure 2017-31, related to Code section 6049 which updated its list of jurisdictions that have an automatic information exchange relationship for certain deposit interest paid to nonresident alien individuals, adding Belgium, Colombia and Portugal.
The IRS issued its 2016 Data Book, which includes statistics on its activities from October 1, 2015 to September 30, 2016 covering returns filed, revenue collection, and enforcement, showing that there were fewer enforcement actions in FY 2016 and several collection activities decreased.
The IRS issued Notice 2017-17, which seeks comments on a new approval process for taxpayers to change a method of accounting for recognizing income to comply with new revenue recognition standards. New standards were issued in May 2015 as Financial Accounting Standards Board (FASB) Update No. 2014-09 and by the International Accounting Standards Board (IASB) in International Financial Reporting Standard (IFRS) 15. The IRS wants to clarify whether these new standards are permissible methods of accounting that may be used for federal income tax purposes. The Notice includes a new draft Revenue Procedure for obtaining IRS consent to a qualifying same-year accounting change and requests comments on all aspects of the proposed procedures and on the specific method change issues identified in Notice 2015-40.
The fourth meeting of the OECD Global Forum on VAT took place on April 12-14, during which the OECD Deputy Secretary-General announced the release of the Recommendation of the Council on the Application of Value Added Tax/Goods and Services Tax to the International Trade in Services and Intangibles. This Recommendation is the first OECD Act in the area of VAT, and it is open to “adherence” by non-OECD members. It incorporates the International VAT/GST Guidelines, which were developed with the active involvement of a wide range of countries beyond the OECD and the global business community, and outlines a set of internationally agreed standards and recommended approaches to address the issues that arise from the uncoordinated application of national VAT systems in the context of international trade.
Following the G20 Finance Ministers and Central Bank Governors meeting, the OECD Secretary-General issued the Report to G20 Finance Ministers including the latest developments in the international tax agenda and a progress report on the Global Forum on Transparency and Exchange of Information for Tax Purposes. The report states, “We will continue our work for a globally fair and modern international tax system. We remain committed to a timely, consistent and widespread implementation of the Base Erosion and Profit Shifting (BEPS) package, welcome the growing membership of the Inclusive Framework on BEPS, and encourage all relevant and interested countries and jurisdictions to join. We ask the OECD to report back on the progress of BEPS implementation, including on all the four minimum standards, by the Leaders Summit in July 2017.”
The Inclusive Framework on BEPS released additional guidance to provide essential information that will give certainty to tax administration and multinational enterprises (MNEs) on implementation of Country-by-Country (CbC) reporting (BEPS Action 13). The additional guidance clarifies several interpretation issues related to the data to be included in the CbC report as well as to the application of the model legislation contained in the Action 13 Report, to assist jurisdictions with the introduction of consistent domestic rules. Five specific issues are addressed in this guidance: the definition of revenues; the accounting principles/standards for determining the existence of and membership in a group; the definition of total consolidated group revenue; the treatment of major shareholdings; and the definition of related party for purposes of completing Table 1 of the CbC report.
Tax Reform Update
One of the President’s key legislative initiatives is to enact comprehensive tax reform, and the White House has now moved on to this issue in order to try and achieve a major legislative success in 2017. Tax reform will likely prove to be even more challenging to achieve than health care reform, and it remains to be seen whether Republicans will choose to proceed with plans for comprehensive tax reform or scale back their plans and advance a tax cut bill.
Secretary Mnuchin stated that the plan is to complete tax reform by the end of 2017. The White House released its tax reform plan to “get the conversation started” with a package of principles and proposals designed to set the stage for Congressional debate. Speaker Ryan has also stated that tax reform could take all year noting “We can clearly get this done by the end of summer but if it needs to go a little longer, we’ll do that.”
The plan does not include an infrastructure package, although there were reports that this was being discussed as a way to gain interest from Democrats. Congressional leadership continues to discuss using the budget reconciliation process to advance tax reform indicating that they do not expect to get Democratic support, and they are not working currently to explore ways in which to make tax reform a bipartisan initiative.
President Trump’s Tax Plan
Treasury Secretary Mnuchin released the Administration’s tax reform plan on April 26th with proposals that are similar to those he proposed during his campaign. Comments from the White House indicate that they plan to take the lead on tax reform in light of the problems that health care reform encountered, but tax reform legislation must be written and approved by Congress, so a partnership between the two branches will be necessary.
There are key differences between this plan and the House Republican Blueprint on tax reform, although comments from key Republicans have focused on the ways in which the goals of the two plans are similar. Senate Finance Committee Chair Hatch (R-UT) has commented that he believes a 15% corporate tax rate is unattainable, but he has stated clearly that he wants to work with the Administration and consider all their ideas.
Business Tax proposals: The plan proposes cutting the tax rate on corporations and pass-through businesses to 15% and to levy a one-time tax on corporate earnings currently held offshore. It proposes broad support for shifting to a territorial tax system (from the current worldwide system).
Individual Tax proposals: The plan proposes three tax brackets of 10 percent, 25 percent and 35 percent and doubles the standard deduction, which is designed to simplify the process of filing tax returns for many taxpayers. The plan calls for the elimination of most itemized deductions except for the deductions for mortgage interest and charitable donations. The plan repeals the estate tax and the Alternative Minimum Tax and includes an expansion of the Child and Dependent Care Credit. It also repeals the 3.8 percent tax on investment income from the ACA.
Issues to Note:
- In contrast to the Administration plan, the House GOP Blueprint proposes a 20% corporate tax rate and a 25% top rate on pass-through businesses. The Blueprint also includes a “repatriation tax” of 8.75% on earnings held offshore as cash or cash equivalents and a 3.5 % rate on earnings that have been invested otherwise.
- The disparity in the tax rate for pass-through businesses and the individual tax rate in the Administration plan could create opportunities for tax planning that inappropriately takes advantage of the 15% rate for individuals who form S corporations, partnership, and limited liability companies. Staff of the W&M Committee have stated that they are working on a set of rules to be administered by the IRS that would address how the rules would operate for pass-through businesses.
- An increased standard deduction would result in fewer taxpayers itemizing their deductions, thereby putting at risk itemized deductions such as mortgage interest and charitable deductions.
- The Administration plan is not revenue neutral and thus will add to the deficit over time, unlike the Republican Blueprint and the commitment of Speaker Ryan and Chair Brady that tax reform be deficit neutral. It will be challenging to find enough business tax incentives to repeal to cover the estimated $5 trillion cost of lowering the rate to 15%. The cost of lowering the rate 20 percentage points would be $2 trillion over a decade. Secretary Mnuchin has stated that faster economic growth from the tax cuts would increase revenue and avoid the risk of increased deficits, but some economists have questioned whether such economic growth could be sustained. He has also made it clear that the Administration will use dynamic scoring for its proposals, which takes into account the impact of new tax proposals on the economy.
- The Administration plan does not include the border adjustment proposal, which is the key revenue raiser in the House Republican Blueprint and which has drawn significant opposition from several Senators and businesses groups. Secretary Mnuchin has not opposed it altogether but has said “We don’t think it works in its current form.” W&M Committee Chair Brady’s position on this issue has not changed stating “I’ll continue to make the case that with changes, modifications and transition rules that address the issues that have been raised since we first put the blueprint in place that we can come up with a good solution.” Speaker Ryan has said “We all agree that in its present form it needs to be modified.” Although Chair Brady has not been specific about modifications he is considering, one idea that has been suggested is a 5-year phase-in which would be similar to the new passive loss rule that was included in the Tax Reform Act of 1986.
- One issue that remains with the failure of health care reform to advance is whether repeal of the ACA taxes is included in tax reform. House leadership thus far has indicated they do not want to include these issues in tax reform preferring to keep them in the health care reform package, but SFC Chair Hatch has said he would consider repealing those taxes as part of tax reform, which would create a significant increase in the cost of the legislation.
- The White House issued a statement in response to a media report that a Value Added Tax and a carbon tax are not in play with respect to tax reform. The statement said “As we have said many times, the President’s team is hearing input from experts on all sides of the tax reform debate as we formulate what will ultimately be the President’s plan to enact the first significant tax reform since 1986. As of now, neither a carbon tax nor a VAT are under consideration.”
Tax Reform or Tax Cuts?
House Republican leadership has considered moving legislation that would include significant tax cuts for a 2-3-year period but not comprehensive tax reform as part of the budget reconciliation process. Mick Mulvaney, the President’s budget director, stated “It’s the same discussion they had about the Bush tax cuts in the previous administration: Are you better off having a smaller cut that is permanent, or a larger cut that is temporary?”
The Joint Tax Committee has informed Speaker Ryan that a 3-year tax cut would add to the deficit outside the 10-year budget window with a loss of $5.9 billion in year 2027. That result would trigger a challenge to the use of the budget reconciliation process by the violation of the Byrd rule which prevents the inclusion of proposals in a reconciliation bill if they increase the deficit beyond the 10-year budget window. The JCT analysis is that corporations would repatriate offshore earnings to take advantage of the tax cut and delay the use of tax credits to later years. The inclusion of revenue offsets in the budget reconciliation legislation, however, could take care of the revenue shortfall.
Some Washington commentators feel that the substitution of short term tax cuts in place of comprehensive tax reform would not be viewed favorably by the business community, which has waited years for Congress to reform the tax code.
Ways & Means Activity
The Ways & Means Committee is expected to begin holding hearings in the near future on the Administration’s tax reform proposal. W&M Committee Chair Brady has commented that a markup in the Committee on tax reform may not take place prior to the August recess, but that his goal is to complete tax reform prior to the end of the year.
Based on W&M leadership comments, it was expected that hearings on the GOP Blueprint and the border adjustment tax proposal would have been scheduled at this point, but there is no official timing yet on those hearings.
Robert M. Gordon