Washington Tax Insight November 2018
Politics and Congressional Activity
With both the House and Senate adjourned in order to campaign ahead of the November 6th mid-term elections, no further legislation will be addressed until a lame duck session. Both chambers are scheduled to return to Washington on November 13th. The outcome of the elections will likely have an effect on what issues will be addressed in the lame duck including whether any tax legislation will advance. If Democrats retake control of the House, they may decide to consider making deals with Republicans on some issues, such as the new NAFTA agreement reached by the US, Canada, and Mexico, and drug pricing. Any legislation that adds to the deficit, such as the proposed infrastructure package, is likely a non-starter despite bipartisan support. Senate Majority Leader McConnell has commented that he does not expect the revised NAFTA agreement to be scheduled for Senate consideration this year, but he does view it as a priority for 2019.
Congress will have to deal with the seven outstanding FY 2019 spending bills that were not completed prior to adjournment or face the prospect of acting on another stopgap funding bill or a government shutdown in December. Prior to adjournment, both the House and Senate approved a five-year reauthorization of the Federal Aviation Administration bill, which is noteworthy because it was one of the few must-pass bills in 2018 that could have served as a vehicle for tax legislation because it had a tax title.
Courts – The Wayfair Decision – Online Sales Taxation HR 6824, the Online Sales Simplicity and Small Business Tax Relief Act is intended to provide some harmonization among states with respect to sales tax collection procedures. This legislation is not getting much support from those states that have already moved forward with their procedures even though some supporters of the legislation believe that states aggressively acting on their own will result in lawsuits and industry concerns about the burden on retailers. California is one of the states that has yet to put in place a new procedure, but the state’s taxing authority has said that the state is ready to act on this and expects to notify retailers by the end of the year about collection requirements, which would be prospective. One of the key issues in California will be the threshold and whether they adopt the South Dakota threshold of $100,000 in total sales or 200 separate transactions despite the fact that some have argued that the size of California argues for higher thresholds. The District of Columbia may move to adopt legislation on an emergency basis to establish their procedure by January 1, 2019, since permanent bills out of the DC Council are required to go to Congress for a 30-day review before they become law. The Multistate Tax Commission has a project called the Wayfair Implementation and Marketplace Facilitator Work Group that helps states design marketplace laws on this issue including what appropriate thresholds are and how to implement enforcement.The American Catalog Mailers Association recently wrote to Congress urging them to pass legislation before the end of the year specifically citing the issues of whether states can require collection retroactively and the establishment of orderly phase-in dates for the various state procedures.
The Administration – Budget Deficit Results
Treasury and the Office of Management and Budget released details of the FY 2018 final budget results. The deficit in FY 2018 was $779 billion, which was $113 billion more than the prior year and the highest deficit since 2012. The decline in corporate tax revenue due to the tax cuts in the TCJA contributed to the deficit increase, although the Administration stated that increased federal spending was the reason for the increase.
Joint Tax Committee
The Joint Committee on Taxation (JCT) issued its annual report and estimate of tax expenditures, which are defined as revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability. The JCT annual expenditure report is often viewed by Members of Congress as a potential list of revenue offset provisions for tax legislation that would result in a revenue loss.
Treasury and the IRS TCJA Guidance
Global Intangible Low-Taxed Income (GILTI): A Treasury representative said recently at an American Bar Association meeting that Treasury is likely to narrow the GILTI anti-abuse rule included in recently proposed regulations stating that they are aware that the language that would negate transactions with the “principal purpose” of reducing Subpart F income could be overly broad and potentially capture transactions that Treasury doesn’t see as abusive. One concern is that the language could negate decades-old restructurings in which US companies distributed their controlled foreign corporation holdings to get out from under the Subpart F regime. Treasury has said that it is looking to clarify and refine the proposed regulations prior to issuing final regulations.
Section 965 Transition Tax: The IRS held a public hearing on its proposed regulations on the repatriation tax under Code section 965 on October 22nd. The IRS issued Notice 2018-78, announcing that taxpayers will not be required to make a binding basis election before its proposed regulations under Code section 965 are finalized. Code section 965 imposes a transition tax on the tax-deferred foreign earnings of US corpo- rations since 1986. The IRS says that the delayed basis election “will apply with respect to returns due (determined with regard to any extension) before the date that is 90 days after the date that the final regulations are published and that in such cases the basis election must be made no later than 90 days after the publication.” The final regulations will also provide that “if a basis election was made on or before the date the final regulations are published, the basis election may be revoked no later than 90 days after the publication.” Relevant tax returns must be filed consistently with an election that has been made and not revoked.
Opportunity Zones: Treasury and the IRS released proposed regulations clarifying rules for investments in qualified opportunity zones (QOZs), which are an incentive created by the TCJA designed to encourage investment in distressed communities by offering capital gains relief in Code section 1400Z-2. The regulations state that all capital gains qualify for deferral, and corporations, pass-through entities, and individuals may make such investments. The rules also address the requirements for meeting the assets tests, and they allow taxpayers to make the basis step-up election after the expiration of the zone designations through 2047. The guidance states that taxpayers may rely on these rules if the taxpayer applies the rules for the respective subsection in their entirety and in a consistent manner. A public hearing is scheduled for January 10, 2019, and the IRS has noted that it intends to issue additional regulations on other issues including the meaning of “substantially all” and information reporting requirements. In conjunction with the proposed rules, the IRS has issued Revenue Ruling 2018-29, which addresses the application to real property of the “original use” and “substantial improvement” requirements. The new rules on this incentive program have been well received by the investment community, which sees significant advantages to the tax benefits available.
State and Local Tax Deductions: Officials in several states including New York, New Jersey, and Connecticut have asked the IRS to withdraw proposed regulations that would limit the ability of states to work around the $10,000 cap on state and local tax deductions through the use of charitable donation programs. The officials submitted comments and letters as part of the comment period for the proposed regulations.
The IRS proposed removing existing Section 1.451-5 regula- tions regarding advance payments for goods and long-term contracts under Code section 451, as a result of changes made by the TCJA affecting taxpayers that use the accrual accounting method and who receive advance payments for goods, including for inventoried goods. Under Code section 451, the amount of any item of gross income is included in gross income for the taxable year in which it is received by the taxpayer, unless, under the method of accounting used in computing taxable income, the amount is to be properly accounted for as of a different period. The IRS stated that “the rules of section 446 regarding changes in methods of accounting will apply to taxpayers changing a method of accounting for advance payments from a method described in Section 1.451-5 to another method.” The IRS requests comments on “whether any changes to existing procedural rules under section 446 for changes in methods of accounting are necessary or desirable as a result of removing Section 1.451-5.”
Treasury and the IRS issued Notice 2018-76 providing transi- tional guidance and announcing forthcoming regulations on the deductibility of expenses for certain business meals under Code section 274 as amended by the TCJA. The notice states that taxpayers may rely on it until regulations on this issue become effective, and it invites public input by December 2, 2018.
There was positive reaction to the new rules from the accounting community, which had urged the IRS to allow the deduction of business meals when they are billed separately from expenses that are not deductible, such as entertainment expenses. The notice provides that taxpayers may deduct 50 percent of an otherwise allowable business meal expense under Code section 274 if:
- The expense is an ordinary and necessary expense under Code section 162(a) paid or incurred during the taxable year in carrying on any trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one of more bills, invoices, or or receipts.
Other Issues and Guidance
Charles Rettig was sworn in as IRS Commissioner on October 1st after a confirmation process that took nearly eight months. His confirmation was held up due to opposition from Democrats over IRS guidance that was issued providing that tax-exempt organizations, other than Code section 501(c)(3) groups, are no longer required to disclose names and address of donors. Subsequently, the IRS issued proposed regulations in August that effectively shut down attempts in some states to allow taxpayers to characterize certain state and local tax payments as charitable contributions so as to avoid the $10,000 annual cap on deductibility of state and local income and property taxes that was enacted in the TCJA, which caused Senator Menendez (D-NJ) to put a hold on Rettig’s nomination. Ultimately, the Senate confirmed Rettig on September 12th with his term scheduled to run until November of 2022. IRS Acting Commissioner David Kautter will now hold only the position of Assistant Treasury Secretary for Tax Policy.
The IRS released a statement informing taxpayers of a study regarding the active trade or business (ATB) requirement under Code section 355(b) and the possibility of future guidance regarding tax-free spinoffs. The IRS will not issue industry specific guidance but will consider private letter ruling requests regarding the ATB qualification of corporations that have not collected income. Specifically, the IRS wants to address “whether a business can qualify as an ATB if entrepreneurial activities, as opposed to investment or other non-business activities, take place with the purpose of earning income in the future, but no income has yet been collected.” The statement asks for public comments on the requirement that an ATB ordinarily must include the collection of income, including: (1) the scope of the requirement under current law and administrative guidance; (2) whether any applicable administrative guidance should be withdrawn, revoked, modified, or declared obsolete; and (3) whether the requirement should be modified — for example, whether an exception should apply to any particular business model due to its unique characteristics.
Treasury released its 2019 regulatory plan, which includes a list of regulatory priorities for the IRS and the Treasury’s Office of Tax Policy, which is compiled from the Office of Management and Budget’s Fall 2018 Unified Agenda of Regulatory and Deregulatory Agenda. The plan identifies seventeen regulations projects regarding implementation of the 2017 tax legislation as first priority and also states that they will continue to work on eliminating or reducing the burdens imposed on taxpayers by eight regulations that the Treasury has identified for review under Executive Order 13789. Also listed as priorities are rules and guidance to further implement the centralized audit regime for partnerships enacted in 2015 and new rules to promote health reimbursement arrangements as directed by Executive Order 13813.
The IRS issued Revenue Procedure 2018-53, which provides procedures for taxpayers that request private letter rulings (PLRs) regarding certain issues pertaining to divisive reorganizations under Code section 368(a)(1) (D) and Code section 355 . The guidance provides procedures regarding the satisfaction under Code section 361(b)(3) or Code section 361(c)(3) or assumption under Code section 357 of debt of a distributing corporation. It outlines the information and representations that must be submitted with such PLR requests. Although the IRS says it continues to study the assumption and satisfaction of a distributing corporation’s obligations in Divisive Reorganizations, they have determined that taxpayers requesting rulings on certain of these issues should follow specified procedures and submit specified representations and related information and analysis.
The IRS issued Notice 2018-80, which announces forthcoming regulations that will clarify that “market discount” defined in Code section 1278(a)(2) is not includible income under Code section 451(b). The regulations are applicable as of January 1, 2018.
The IRS issued Notice 2018-71, which gives guidance on the employer credit for paid family and medical leave under Code section 455. For eligible employers, the credit for paid family and medical leave is equal to a percentage of wages paid to qualifying employees while on such leave. It is generally effective only for wages paid in taxable years beginning after December 31, 2017, and before January 1, 2020. This guidance covers “the requirements an employer must satisfy to be an eligible employer, the types of leave that are family and medical leave under section 455, the minimum paid leave requirements, the calculation of the credit, and the impact of state-mandated leave on the availability and calculation of the credit.” The notice states that the IRS intends to issue proposed regulations under Code section 455, and it includes 34 questions and answers on several elements of the credits.
The IRS issued Notice 2018-84, which clarifies the elimination of the personal exemption deduction in relation to the Affordable Care Act’s premium tax credit and the individual mandate.
Australia, France, Japan, and Slovak Republic have deposited their instrument of ratification or acceptance for the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting with the OECD’s Secretary General, and thereby have underlined their strong commitment to prevent the abuse of tax treaties and base erosion and profit shifting (BEPS) by multinational enterprises.
The OECD has identified a list of potentially abusive residence and citizenship by investment schemes (RBI/ CBI), which are referred to as golden passports or visas and can create the potential for misuse as tools to hide assets held abroad from reporting under the OECD/G20 Common Reporting Standard (CRS). As part of its work to pre- serve the integrity of the CRS, the OECD has published the results of its analysis of over 100 CBI/RBI schemes offered by CRS-committee jurisdictions, identifying those schemes that potentially pose a high-risk to the integrity of CRS. The OECD has also published guidance intended to enable financial institutions to identify and prevent cases of CRS avoidance through the use of such schemes.
The European Union (EU) Council agreed to adopt several proposals from the European Commission (EC) to reform the current EU VAT system. Part of the adopted proposals were released by the EC in October 2017 including some quick fixes to the current regime that would apply to improve the functioning of the current VAT system, pending the introduction of the “definitive” VAT system that is still the subject of ongoing discussion. Under the definitive VAT system, cross-border sales of goods within the EU would be taxed in the same way as sales within a single EU member state, i.e. VAT would be imposed on cross-border sales between businesses (which currently are exempt from VAT) under a destination-based system. The new system is expected to significantly reduce VAT fraud in the EU and reduce the number of administrative steps needed when businesses sell to companies in other EU member states.
The OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes published compliance ratings on tax transparency for seven jurisdictions with reports assessing jurisdictions against the updated standard which incorporates beneficial ownership information of all relevant legal entities and arrangements, in line with the definition used by the Financial Action Task Force Recommendations. Austria, Aruba, Brazil, Saint Kitts, and the United Kingdom were all rated “Largely Compliant”, while Bahrain and Singapore were rated as “Compliant.”
A new annual report was released with the conclusion that Tax Inspectors Without Borders, which is a joint initiative of the OECD and the UN Development Programme, is boosting developing countries’ tax compliance efforts and ability to effectively tax multinational enterprises (MNEs). Many developing countries experience major losses arising from their inability to tax the economic activities and value creation generated within their borders by MNEs. Tax administrations that lack the effective means to deal with the complexities of auditing MNEs are turning to the Tax Inspectors Without Borders program for help.
The OECD released 2017 global mutual agreement procedure statistics covering 85 jurisdictions and nearly all mutual agreement procedure (MAP) cases worldwide. They contain detailed information on each jurisdiction as well as aggregated global information. Under Action 14 of the BEPS Action Plan, the minimum standard requires jurisdictions to seek to resolve MAP cases within an average timeframe of 24 months. To monitor compliance, members of the Inclusive Framework on BEPS have committed to report their MAP statistics pursuant to an agreed reporting framework with the results published annually.
Tax Reform Update
Tax Reform 2.0
Prior to adjournment, the House passed the centerpiece of Tax Reform 2.0, which would permanently extend all the individual TCJA provisions including the lower individual tax rates and the 20 percent deduction for pass-through income (set to expire in 2025). The House also passed two additional bills that complete the Tax Reform 2.0 package – the Family Savings Act of 2018 and the American Innovation Act. Although supporters cite this as a good first step, the Senate is unlikely to take up any of this legislation in a lame duck session because there won’t be 60 votes for approval.
President Trump floated the idea of a 10 percent tax cut targeting the middle class, which he stated was being discussed by House Speaker Paul Ryan (R-WI) and Ways & Means Committee Chair Kevin Brady (R-TX). Although the President indicated that this proposal would be considered in November, it is unlikely to be reviewed until after the mid-term elections on November 6th since both the House and Senate are currently in recess.
Chair Brady has said that he will work with the Administration on this new tax proposal if Republicans maintain control of both the House and Senate. SFC Chair Hatch (R-UT) has not made the same commitment yet stating that he has not seen the details of the proposal and he has not spoken to Senate Majority Leader McConnell about scheduling a vote on it.
Technical Corrections & Tax Extenders Legislation – Lame Duck Session?
With Congress out of session until after the mid-term elections, no action is expected on either technical corrections or tax extenders until Members return for a lame duck session, and the outcome of the mid-term elections will likely affect what, if any, tax legislation advances. GOP leadership has indicated a willingness to talk about legislation that would cover both of these sets of issues in the lame duck, but in order to get the Democratic support that would be needed in the Senate, there would need to be some agreement to address issues of interest to Democrats. Senator Wyden (D-OR), who is the SFC Ranking Member, has not specifically said what issues his members would like addressed other than the retirement legislation that he has cosponsored with SFC Chair Hatch (R-UT).
Democratic Tax Agenda?
If Democrats regain control of the House, they may be reluctant to move on tax legislation in a lame duck session, preferring to wait until a new Congress when they could pursue some of their tax priorities including raising rates on wealthy individuals and increasing the estate tax.
Should they be in a position to control the tax agenda at least in the House in 2019, it is expected that their list will include middle class tax cuts and infrastructure legislation, both of which will create revenue losses. Thus, the expectation is that they would turn to the TCJA to revisit some of the cuts enacted in that law including, e.g., the corporate tax rate, individual tax rates for the wealthy, the alternative minimum tax, the estate tax, and the treatment of carried interest.