Washington Tax Insight September 2020
Politics and Congressional Activity
President Trump accepted the Republican nomination for President with Mike Pence as the Vice Presidential nominee at the Republican National Convention. Former Vice President Joe Biden accepted the Democratic nomination for President with Kamala Harris selected as the Vice Presidential nominee at the Democratic National Convention. Election Day is November 3rd, and the expected increase in absentee and mail-in voting has focused attention on the USPS.
The House passed legislation to give the USPS $25 billion in additional funding and to mandate priority processing for election mail with all Democrats voting in support along with 26 Republicans. President Trump announced his opposition to the bill, and Senate leadership is not expected to schedule the bill for consideration on the Senate Floor. Both the House and Senate held hearings on the current status of the USPS with Postmaster General DeJoy as a hearing witness.
Congress is scheduled to return from their recess mid-September. A number of issues remain on the agenda for Congress this year, but the legislative calendar has very few workdays remaining due to the elections. Long-term government funding bills and another COVID-19 package are the key issues, and there has been speculation that the issues could be joined in one package. Uncertainty continues, however, as to whether a deal on the latter can be reached by the end of September in time to meet the government spending deadline, which means that a short-term funding deal may become necessary.
Negotiations on the 4th phase of pandemic relief have stalled since early in August with Democrats offering to come down from their proposed package of $3.4 trillion of relief to $2.4 trillion, but Republicans and the White House refusing to agree to more than the $1 trillion of relief they have proposed. Some taxpayer benefits that were included in earlier bills such as the additional unemployment compensation payments, have now expired, leading to a handful of Presidential directives on certain issues (discussed below).
House and Ways & Means Committee
The House approved legislation by a vote of 250-161 that includes permanent enhancements to the child and dependent care tax credit and a new payroll tax credit for employer-paid dependent care expenses. The legislation also includes provisions for employers that are designed to make child care more affordable and more widely available in light of the economic impact of the pandemic. The legislation is not expected to be considered this year by the Senate, but it will serve as a messaging document for the fall elections and policy debates in 2021.
Senate and Senate Finance Committee
The Senate Finance Committee approved two nominees to the US Tax Court, Alina Marshall and Christian Weiler. Marshall would replace Judge L. Paige Marvel and Weiler would replace Judge Albert Lauber. These nominations will now go to the full Senate for approval. The US Tax Court is conducting proceedings remotely during its fall trial calendar session because of the pandemic.
Government Response to the Coronavirus Pandemic
In response to the COVID-19 pandemic, government officials in Washington DC have taken a number of actions related to the economic effects of the crisis including legislation, regulatory action, and government agency action. As summarized in past True Alerts (Tax Issues Addressed by COVID-19 Emergency Legislation; Congressional Action on the COVID-19 Pandemic: The CARES Act), Congress has passed several major pieces of legislation to provide economic relief to the US economy and US taxpayers.
In May, the Democratic-controlled House approved the Health and Economic Recovery Omnibus Emergency Solutions Act (“HEROES Act”), which was intended to lay down markers on the issues the House Democrats believe should be addressed in the 4th Phase Bill.
On July 27th, Senate Republicans issued their proposals for a 4th Phase Relief bill. The proposals were released in sections, although they are viewed as a single bill called the “Health, Economic Assistance, Liability Protection and Schools (HEALS) Act.” Subsequently, Senate Republicans introduced a “skinny” coronavirus relief bill that includes a proposal for an additional $300 per week in unemployment benefits, another round of funding for the Paycheck Protection Program, an additional $10 billion for the USPS, and additional money for education and testing.
Treasury and the IRS
COVID-19 Crisis Guidance & Related Issues
Presidential Directives: The President issued 4 unilateral directives to address issues related to the COVID-19 crisis including:
- Directive to the Treasury Secretary to defer the withholding, deposit, and payment of the employee portion of the Social Security payroll tax at certain income levels;
- Providing supplemental payments for lost wages;
- Extending the federal moratorium on evictions; and
- Extending the deferment of federal student loan payments.
Guidance on Deferring Payroll Taxes: The IRS issued Notice 2020-65, which provides guidance on the President’s August 8th Memorandum to defer withholding of certain payroll taxes on wages paid from September 1, 2020 through December 31, 2020 below a specified amount. The employee Social Security tax deferral is available (and is elective for the employee) for payments of taxable wages to an employee that are less than $4000 during a bi-weekly pay period, with each pay period considered separately. An employee may be eligible for the deferral in one pay period even if they are ineligible in another pay period. The Notice provides that an Affected Taxpayer must withhold and pay the total taxes deferred “ratably from wages and compensation paid between January 1, 2021 and April 30, 2021, or interest, penalties, and additions to tax will begin to accrue on May 1, 2021, with respect to any unpaid Applicable Taxes. If necessary, the Affected Taxpayer may make arrangements to otherwise collect the total Applicable Taxes from the employee.” The “Affected Taxpayer” is the employer who has the obligation to collect the payroll taxes, so they will be liable for the penalties and interest if the deferred taxes are not paid by April 30, 2021.
SBA FAQs on Paycheck Protection Program: The Small Business Administration (SBA) published a new FAQ page on issues related to the loan forgiveness rules under the Paycheck Protection Program (PPP). The FAQs discuss general issues regarding the PPP loan forgiveness rules, as well as specific questions related to the eligibility of certain payroll and nonpayroll expenses for loan forgiveness.
E-Signature Allowed on Certain Paper-Only Filings
The IRS announced that it will accept digital signatures on certain forms not set up for electronic filing if they are mailed by or on December 31, 2020. The IRS stated that “After the expiration of this temporary deviation, we will evaluate the full impact of this change to inform the future path for handwritten signatures, balancing flexibility for taxpayers and their representatives with ensuring that we do not introduce downstream risks for tax administration.” Forms covered by this policy include Form 3115, Application for Change in Accounting Method, and Form 8832, Entity Classification Election.
Leave Sharing Guidance: A new FAQ page discusses tax considerations for employers and employees when an employer establishes a leave-sharing plan that permits employees to deposit leave in an employer-sponsored leave bank for use by other employees who have been adversely affected by a major disaster such as the coronavirus pandemic.
Form 3115/Accounting Method change: An IRS news release outlines a new temporary procedure for tax transmission of the duplicate copy of Form 3115, Application for Change in Accounting Method. This change applies only to taxpayers requesting consent to make a change in accounting method under the automatic change procedure.
Defined benefit plan funding rules: The IRS issued Notice 2020-61, which addresses changes to the special rules for the funding of single-employer defined benefit pension plans, and related benefit limitations that were enacted in the CARES Act. The CARES Act delays minimum required contributions (including quarterly contributions) that would otherwise be due this year until January 1, 2021, though interest must be added to any delayed contributions. The Notice includes 18 Q&A’s on several related issues. To the extent the instructions for Schedule SB, “Single-Employer Defined Benefit Plan Actuarial Information” of Form 5500 are inconsistent with this new guidance, Notice 2020-61 will supersede those instructions.
- 402(f) Notice for eligible rollover distributions: The IRS issued Notice 2020-62, which updates the “Section 402(f)” safe harbor notices provided to recipients of eligible rollover distributions from qualified retirement plans. The updated notices reflect changes made by the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) and the CARES Act.
Rehabilitation Tax Credit: The IRS issued Notice 2020-58, which provides temporary relief to taxpayers in satisfying the substantial rehabilitation test for claiming the rehabilitation tax credit under §47. The notice allows taxpayers that have a measuring period under the substantial rehabilitation test ending on or after April 1, 2020, and before March 31, 2021, to now have until March 31, 2021 to satisfy the test. This relief applies to the substantial rehabilitation test for claiming the credit or qualifying under the TCJA transition rule.
Home Office Deduction Eligibility: With many people working from home currently, the IRS decided to issue IRS Tax Tip 2020-98 in which the IRS summarizes the rules for claiming home office deductions. The Tax Tip reminds taxpayers that the home office deduction is no longer available to employees because unreimbursed employee business expenses are considered miscellaneous deductions, which are no longer deductible in 2018-2025. The Tax Tip also reminds taxpayers of the two basic requirements for the home office deduction and summarizes the rules for calculating the deduction.
Tax Cuts & Jobs Act (TCJA) Guidance
Final Regulations on Foreign Dividends under §245A: The IRS issued final regulations on foreign dividends under §245A and §954, addressing the deduction limitation for dividends received from certain foreign corporations and amounts eligible for the §954 look through exception with the inclusion of new reporting rules. They also issued proposed regulations coordinating the application of §245A and the global intangible low-taxed income (GILTI) rules under §951A. A True Alert on the final and proposed regulations will be issued in the near future.
Treasury and the IRS issued final regulations regarding the base erosion and anti-abuse tax (BEAT) under §59A that was enacted as part of the TCJA. The BEAT is intended to impose a minimum tax on large multinational corporate taxpayers with respect to certain payments made to foreign related parties. The final regulations address computational issues for groups of related taxpayers, clarify rules for waiving deductions for purposes of BEAT, and provide guidance for partnerships and anti-abuse rules. The final regulations are effective 60 days after publication in the federal register and generally apply to tax years beginning after the effective date (i.e. tax year 2021 for calendar-year taxpayers). A True Alert on the final BEAT regulations is forthcoming.
Treasury and the IRS issued final regulations addressing the treatment of certain payments made by a business or by an individual taxpayer that itemizes deductions to an organization described in §170(c) if the taxpayer receives or expects to receive a state or local tax credit in return for the payment. These regulations are intended to respond to efforts to avoid the impact of the cap on state and local taxes (SALT) enacted as part of the TCJA. The final regulations are effective August 11, 2020.
Prior to the TCJA, §164 authorized taxpayers to deduct the full amount of their state and local taxes, which are primarily property taxes and income taxes, subject to the limitation on itemized deductions. The TCJA enacted the rule in §164(b)(6) that limits the aggregate deduction of these taxes to $10,000 ($5000 if using married filing separately status). The new law was controversial, especially in states with high tax rates, and several states enacted a workaround designed to convert SALT into charitable deductions. The workaround programs provided a mechanism by which taxpayers would donate to state and local government-run entities that qualified as charitable entities under federal law and used the funds to pay for government services that otherwise would be funded through taxes. The taxpayer would get tax credits to apply against their SALT liabilities. The taxpayers would claim a §170 deduction on their federal income tax returns.
Treasury and the IRS were opposed to this type of workaround program, and the final regulations reflect that opposition. The IRS takes the position that charitable deductions are not available when there is a quid pro quo, and they view the receipt of state tax credits in exchange for a donation to be a quid pro quo. The regulations apply the quid pro quo principle irrespective of whether a donee or a third party provides the benefit received in return for the donated amount.
Importantly for taxpayers, however, the IRS did confirm that for individual taxpayers who made contributions to government-funded §170(c) organizations, to the extent that the payment reduces state and local taxes, the taxpayer may treat the donations as taxes paid and deduct them under §164. The final regulations also provide that any excess that cannot be deducted under that section may be eligible for a §170 charitable deduction. Unused tax credits may be carried forward in accordance with state or local law.
The final regulations also provide safe harbors for certain entities. C corporations that made workaround payments expecting to receive state or local tax credits are generally able to treat such payments as ordinary and necessary business expenses under §162. These regulations will shut down the workaround approach, but some members of Congress are still interested in changing this law, which is set to expire in 2025.
Accounting changes for small businesses: The IRS issued proposed regulations to implement statutory amendments to §§263A, 448, 460, and 471 by the TCJA in order to simplify certain accounting method rules for small businesses. This guidance addresses the usage of, and exemptions from using, certain accounting methods including the overall cash method of accounting, inventory maintenance, and the uniform capitalization rules under §263A. In order to qualify as a small business under these rules, and for other provisions such as §163(j), taxpayers must have average annual gross receipts of $25 million or less ($26 million in 2019 and 2020 after adjustments for inflation) for the three preceding taxable years, including the receipts of their affiliates under the aggregation rules of § 448(c)(2).
This guidance also includes proposed amendments to existing regulations under §460 regarding the special accounting rules for long-term contracts to implement legislative changes applicable to corporate taxpayers that repeal the corporate alternative minimum tax and add the BEAT. The IRS also is asking for taxpayer input on “the application of section 60 (or other special methods of accounting) to a contract with income that is accounted for in part under section 460 (or other special method) and in part under section 451.”
IRS Audit and Investigation Priorities: During the last several months because of the pandemic, the IRS put on hold new examinations of tax returns and enforced collection activity under its People First Initiative. The IRS is now “reopening” and is expected to resume its normal activities with a focus on issues and areas of noncompliance that it has identified for priority treatment. In the near future, the IRS plans to focus on: (1) high-net-worth taxpayer audits; (2) fraud enforcement with a focus on the areas of employment tax, non-filers, virtual currency and offshore compliance; (3) promoter and abusive tax preparers investigations; (4) syndicated conservation easements; (5) micro-captive insurance companies; and (6) the §965 transition tax.
Transition Tax under §965 – IRS Enforcement: IRS officials have stated during public webcasts that taxpayers should expect increased enforcement related to the §965 transition tax that was enacted in the TCJA. Utilizing a two-pronged approach, officials will begin distributing letters and placing people into its audit pipeline in October. The IRS recently announced that it would initiate a “soft letter” compliance campaign to put taxpayers on notice which is targeted at taxpayers who may not have understood their reporting requirements or failed to obtain information necessary to compute their tax liability. The IRS is also conducting a §965 compliance campaign targeting the 2017 and 2018 tax returns of US-based multinational corporations by putting taxpayers into the audit pipeline in cases where the risk requires an enforcement intervention. The audits will likely focus on computational and definitional issues, but the IRS has also said that transition tax audits will not necessarily be limited to §965.
Other Issues and Guidance
Chief of IRS Criminal Investigation: The IRS published a news release announcing that James Lee will become the new chief of IRS Criminal Investigation on October 1, 2020.
Tax Tips Release: The IRS published a news release on after-tax-day tips for taxpayers who missed the July 15, 2020 tax deadline and did not request an extension. The tips include advice on obtaining a refund and on reducing penalties and interest.
Sharing information obtained in exams with contractors: The IRS issued proposed regulations under §7602(f) regarding those who can be provided books, papers, and other data for the sole purpose of providing expert evaluation and assistance to the IRS. The rules would also continue limits on the types of non-governmental attorneys to whom, under the authority of §6103(n), any books, papers, records, or other data obtained pursuant to §7602 may be provided. The IRS states that “non-government attorneys may not be hired by the IRS to assist in an examination under section 7602 unless the attorney is hired by the IRS as a specialist in foreign, state, or local law (including foreign, state, or local tax law), or in non-tax substantive law that is relevant to an issue in the examination, or is hired for knowledge, skills, or abilities other than providing legal services as an attorney.”
Enterprise Digitalization and Case Management office: The IRS announced the creation of the new Enterprise Digitalization and Case Management office, which will spearhead IRS efforts to empower taxpayers and IRS employees to rapidly resolve issues in a simplified digital environment. The office’s efforts will support overall IRS modernization and implementation of long-term changes stemming from the Taxpayer First Act.
OECD – Adoption of a Global Minimum Tax & Digital Taxation
Multilateral tax negotiations, which have been ongoing at the Organization for Economic Cooperation and Development (OECD) with the goal of producing a global agreement on the taxation of multinational corporations, including those that provide digital services, have been impacted by the COVID-19 pandemic. The 2020 timeline has been modified, but the deadline for producing an agreement continues to be the end of 2020, and the OECD is expected to submit a blueprint to the G20 meeting in October.
The US has taken the position that the Pillar One approach should be optional, which is in conflict with several EU countries. The two Pillars operate independently, however, so agreement could be reached on Pillar Two, since there appears to be more consensus on that issue.
A draft report outlining technical details for Pillar One has been distributed to members of the Inclusive Framework, and the OECD has committed to releasing this kind of a report to the public including addressing the issue of whether Pillar One will be implemented as a safe harbor. The draft report also raises the issues of whether to remove prescription drugs from the scope of taxation, as well as consideration of an expanded list of exemptions including fishing and agriculture, financial technology, and shipping.
Reportedly, a draft of the report on Pillar 2 discusses the possibility of certain exemptions from the global minimum tax, including depreciable property and payroll expenses. Several key issues including whether the effective tax rates would be calculated by country or globally, have yet to be resolved.