Washington Tax Insight March 2018
Politics and Congressional Activity
Congressional Agenda/Schedule for 2018
The Bipartisan Budget Act of 2018 (“Budget Act”), which was approved by Congress and signed into law by the President in early February, is a two-year budget agreement that sets defense and non-defense spending levels for two years, extends several expired temporary tax provisions (“extenders”), provides tax relief for victims of several 2017 natural disasters, and includes a handful of changes to the tax reform legislation enacted in late 2017, the Tax Cuts and Jobs Act (“TCJA”).
The bill was agreed to by Congressional leadership after a brief government shutdown with the key focus of the bill being to lift the statutory caps on defense and domestic appropriations for the remainder of fiscal year 2018 and for fiscal year 2019 which begins on October 1st. The deal allows for increased appropriations of nearly $300 billion with $165 billion allocated to defense and $131 billion for domestic spending.
This legislation also included a Continuing Resolution (“CR”) that extends government spending at current levels until March 23rd, giving Congressional appropriators additional time to pass appropriations legislation that allocates the spending totals to specific programs. Due to the scope of the Budget Act, there is speculation that it will be the last piece of significant legislation Congress advances prior to the 2018 mid-term elections apart from the appropriations legislation. It is possible that Congress will cover an extension of the so-called Dreamers program in the CR if a bipartisan solution can be found.
The Budget Act also extends the “mandatory sequester” mechanism for 2 years through fiscal year 2027. The mandatory sequester on discretionary spending, which is part of the Budget Control Act of 2011, operates to require mandatory cuts in certain non-exempt mandatory spending programs, and it was included as a means by which to offset part of the budgetary cost of the discretionary spending increases in the legislation.
As part of the deal, Senate leaders agreed to increase funding for infrastructure, child care programs, opioid abuse programs, and “adequate funding” for the IRS. Also included was suspension of the federal debt limit until March 1, 2019, taking a politically contentious issue out of the mix this year.
Finally, the Budget Act also included an extension of funding for the Children’s Health Insurance Program (“CHIP”) for four years through 2028, reauthorization of the Community Health Centers program, extension of several provisions known as the “health extenders,” and the establishment of two bipartisan, bicameral “Joint Select Committees” that will make legislative recommendations by November 30, 2018, to reform the budget and appropriations process and improve the solvency of multiemployer pension plans.
The Administration released a summary of its infrastructure plan stating that a more complete plan would be introduced in the future. Although the issue has generated bipartisan interest, it appears unlikely that this legislation will advance in the near future.
White House FY 2019 Budget and the State of the Union address
The President delivered his first State of the Union address on January 30th with his comments focusing on immigration reform and infrastructure spending. The White House released its FY 2019 budget proposal on February 12th with the Treasury releasing its annual Greenbook, which provides an explanation of the Administration’s revenue proposals. Tax proposals are included in the following areas: international, small business, job creation and manufacturing, infrastructure, the financial sector, individuals and families, retirement and health benefit plans, tax administration, and the imposition of an oil fee.
The Ways & Means Committee held a hearing on the Administration’s FY 2019 budget proposal and the implementation of the TCJA including testimony from Treasury Secretary Mnuchin. The Senate Finance Committee held two hearings on the FY 2019 budget proposal and TCJA implementation with testimony from both Treasury Secretary Mnuchin and Acting IRS Commissioner and Assistant Secretary for Tax Policy Kautter. In his opening statements, SFC Chair Hatch (R-UT) restated his position that it is Congress’ responsibility to clarify and, if needed, fix questions about the TCJA.
The Budget Act included the extension of a number of temporary tax deductions, credits, and incentives that expired at the end of 2016 generally through 2017 including: (1) commercial and residential investment tax credits for certain energy property; (2) several energy provisions including the Code section 45 production tax credit, the credit for new energy-efficient homes, credits for fuel cell and plug-in electric vehicles, and incentives for biodiesel and renewable diesel fuels; (3) business incentives including depreciation for race horses and motorsports entertainment complexes and expensing for certain film, television, and live theatrical productions; (4) several economic development incentives; and (5) individual incentives including the deduction for qualified tuition and related expenses and the gross income exclusion for discharge of indebtedness on a principal residence. The Senate Finance Committee released its Summary of the Tax Extenders Agreement.
The so-called “orphaned” renewable tax credits for fuel cells, combined heat and power, and small-scale wind were originally included in 2017 tax reform legislation but ultimately dropped as they had been in 2015 when large-scale wind and solar projects were extended. For projects covering biogas, biomass, and geothermal that relied on the PTC, the extension only covers projects that began construction by the end of 2017.
Following enactment of these extensions, Vern Buchanan (R-FL), the new Chair of the W&M Tax Policy Subcommittee, stated that he plans to hold a hearing to examine the provisions that are temporary and must be extended, and W&M Chair Kevin Brady also agreed, stating that the rationale of each expired provision must be re-evaluated “in a post-tax reform world.”
Joint Tax Committee
The Joint Tax Committee issued its annual report summarizing the federal tax system as currently in effect. The report provides a broad overview of the following four areas and reflects the significant changes that were enacted in 2017: (1) individual and corporate income taxes; (2) payroll taxes; (3) estate, gift, and generation-skipping transfer taxes; and (4) excise taxes.
Treasury and the IRS
The White House announced that the President plans to officially nominate Charles P. Rettig to become the next Commissioner of the IRS. Rettig’s nomination will be sent to the Senate, considered by the Senate Finance Committee, and then voted on by the full Senate. Mr. Rettig has practiced with a private law firm in California for more than 35 years and has represented several taxpayers in court against the IRS and the Tax Division of the US Department of Justice.
The IRS issued Revenue Procedure 2018-10, which applies the procedures for exempt organizations seeking a determination letter to Form 1024-A, Application for Recognition of Exemption Under Section 501(c)(4). This guidance modifies Revenue Procedure 2018-5, which included the agency’s annual explanation of IRS procedures for issuing determination letters on exempt status.
The IRS issued Revenue Procedure 2018-12, which provides a safe harbor for valuing certain stock received by a target corporation’s shareholders in a potential reorganization. The guidance outlines the valuation methods for such stock to determine whether the continuity of interest (COI) requirement is satisfied under section 1.368-1(e) of the Income Tax Regulations, and it takes effect for transactions with an effective date on or after January 23, 2018. The IRS also says it will consider requests for rulings and determination letters regarding transactions and legal issues to which the safe harbor does not apply and regarding the applicability of the safe harbor.
The IRS issued proposed regulations for partnerships that address tax attribute adjustments related to the implementation of the new centralized audit regime for partnerships that was enacted in late 2015. These rules address how and when partnerships and their partners adjust tax attributes to take into account partnership adjustments under both Code sections 6225 (relating to the calculation of the imputed underpayment) and 6226 (which provides for an alternative to payment of the imputed underpayment via the so-called “push-out” election). The regulations propose special allocation, inside basis adjustment, outside basis adjustment, and capital account adjustment rules for imputed underpayments (including adjustments thereto) and the results of push-out elections.
Treasury and the IRS issued a second quarter update to the 2017-2018 Priority Guidance Plan, which outlines the regulations, notices, revenue rulings and other guidance the IRS expects to issue during the period from July 1, 2017 – June 30, 2018. The second quarter update reflects 29 additional projects, including those that have become near term priorities as a result of the TCJA and other priorities that relate to Treasury’s agenda to minimize regulations perceived as being unnecessary, imposing excessive burdens, and creating undue complexity. Projects related to the new tax law include: (1) guidance under the new Code section 199A, which provides a 20 percent deduction for pass-through businesses that pass their income on to owners; (2) withholding; (3) the excise tax on excess remuneration paid by certain tax-exempt organizations under Code section 4960; (3) calculation of estate and gift taxes to reflect changes in the basic exclusion amount; (4) computation of unrelated business taxable income for separate trades or businesses; and (5) international provisions, including the deemed repatriation of offshore earnings in the new Code section 965.
Treasury released its Strategic Plan for Fiscal Years 2018-22. The plan is published every four years and outlines the goals and objectives for achieving the department’s mission.
The IRS issued a proposed regulation aimed at repealing 298 regulations and modifying another 79 that would be affected by the repeals. This regulation relates to Executive Orders 13777 and 13789, which were issued by the President directing agency heads to identify and reduce unnecessary, costly, and overly burdensome regulations. Last October, Treasury issued a report on its efforts to identify and reduce burdensome tax regulations. The tax regulations marked for repeal fall into one of three categories: (1) regulations interpreting provisions of the Code that have been repealed; (2) regulations interpreting Code provisions that, while not repealed, have been significantly revised, and (3) regulations that, by the terms of the relevant Code provisions of the regulations themselves, are no longer applicable.
The IRS issued Notice 2018-15, which states that the IRS will no longer be processing applications for, or issuing allocations of, new clean renewable energy bonds (New CREBs) under Code section 54C. This section authorized the issuance of up to $2.4 billion (volume cap) of New CREBs for qualified renewable energy facilities but was repealed by the TCJA effective for bonds issued after December 31, 2017.
The OECD released additional guidance and information on the implementation of country-by-country reporting. The additional guidance addresses two issues: the definition of total consolidated group revenue and whether non-compliance with the confidentiality, appropriate use, and consistency conditions constitutes systemic failure. Also released was a compilation of the approaches adopted by member jurisdictions regarding country-by-country reporting where alternative approaches are permitted under the BEP’s framework. These documents will continue to be updated with any further guidance that may be agreed.
In December 2017, interested parties were invited by the OECD to provide comments on a discussion draft on model mandatory disclosure rules. The public comments received were published by the OECD.
Eight members of the OECD Forum on Tax Administration (FTA), including Australia, Canada, Italy, Japan, the Netherlands, Spain, the United Kingdom, and the United States, launched a pilot for the voluntary International Compliance Assurance Programme (ICAP) for the multilateral risk assessment of large MNE groups. The ICAP pilot will use CbC reports and other information to facilitate open and co-operative multilateral engagements between MNE groups and tax administrations, with a view to providing early tax certainty and assurance. A handbook which provides more detail on ICAP and the procedure for the pilot was also launched at the event.
The European Commission Taxation and Customs Union has established a website providing information about the impact of the United Kingdom’s withdrawal from the European Union (EU) with respect to customs and tax matters. According to the website, preparing for the UK’s withdrawal in the area of customs and taxation is not just a matter for EU and national authorities but also for companies and individuals trading with the UK. The page will be updated regularly with new information.
The OECD released Taxing Energy Use in 2018, a report analyzing energy taxation in 42 OECD and G20 countries. The OECD urged governments to make better use of energy tax policy to address climate change.
Tax Reform Update
Limits on business interest: At a recent ABA meeting, an Attorney-Advisor in the Treasury Office of Tax Legislative Counsel, commented that an anti-abuse rule for the new limitations on business interest expense may be considered by Treasury despite the fact that it is not specifically listed on the Treasury’s Priority Guidance Plan. The Plan said that the IRS and Treasury were working on “computational, definitional, and other guidance” on the business interest deduction limitations under new Code section 163(j), and he stated that “other guidance” covers a possible anti-abuse rule. The TCJA amended Code section 163(j) to impose a 30 percent cap on net business interest expenses beginning in 2018. An exception to the limits is provide for the real estate and farming industries as well as for businesses with average annual gross receipts of $25 million or less.
Repatriation Tax: As part of its shift to a territorial system, the TCJA imposed a one-time tax on the deferred offshore earnings of US companies, applied either at 15.5 percent for cash or cash equivalent holdings or 8 percent for invested income. In an effort to head-off abuse of the new law, the IRS issued Revenue Procedure 2018-17 under Code section 965(o), which modifies IRS procedures for changing the accounting period of foreign corporations owned by US shareholders subject to the tax on deemed repatriated earnings. The guidance prevents changes to the annual accounting periods of certain foreign corporations in 2017 under either the existing automatic or general procedures if such change could result in the avoidance, reduction, or delay of the transition tax. It applies to any request to change an annual accounting period that ends on December 31, 2017, regardless of when the request was made.
A number of measurement and definitional issues have arisen, and the IRS has identified this area as a priority for guidance with two previous pieces of guidance issued thus far. In the first notice, the IRS noted the risk that earnings and profits could be double-counted in cases when specified foreign corporations have inclusion years that don’t align with the taxable years of a US shareholder. In the second notice, the IRS expanded on how debt is characterized when companies tally their offshore earnings.
Also, the US Chamber of Commerce has sent a letter to Treasury and the IRS asking for clarification of the prior guidance issued on this topic. Issues addressed include: (1) the November 2ndmeasurement date requirement for earnings and profits; (2) the definition of accounts payable; (3) the inclusion of current year 2017 taxable losses in the definition of “net operating loss”; and (4) the payment of tax liability in installments or deferral of inclusion of deemed repatriated income.
Withholding: The IRS issued Notice 2018-14, which provides additional guidance to employers on withholding changes in response to the enactment of the TCJA. This guidance (1) extends the effective period of Forms W-4 furnished to claim exemption from income tax withholding under Code section 3402(n) for 2017 until February 28, 2018, and temporarily permits employees to claim exemption from withholding under Code section 3402(n) for 2018 by using 2017 Form W-4; (2) temporarily suspends the requirement under Code section 3402(f)(2)(B) that employees must furnish their employers new Forms W-4 within 10 days of changes in status that reduce the withholding allowances they are entitled to claim; (3) provides that the optional withholding rate on supplemental wage payments under Treas. Reg. section 31.3402(g)-1 is 22 percent for 2018 through 2025; and (4) provides that, for 2018, withholding under Code section 3405(a)(4) on periodic payments when no withholding certificate is in effect is based on treating the payee as a married individual claiming 3 withholding allowances.
The Budget Act Modifications and Technical Corrections
The Budget Act Modifications
The Budget Act which was enacted early in February included several modifications or clarifications to the TCJA covering the following areas: (1) the excise tax on the net investment income of colleges and universities; (2) the exception for the excess business holding rules for independently operated philanthropic business holdings; and (3) certain rules for craft beverages.
It also repealed a provision enacted in trade legislation in 2015 that increased corporate estimated tax payments otherwise due in July, August, or September of 2020 by 8 percent and reduced the payment due in October, November, or December of 2020 by the same percentage. Thus, payment for the third and fourth quarters of 2020 will be 100 percent of the amount due. Also included were a number of miscellaneous targeted tax law changes.
Technical Corrections and Possible TCJA Modifications
Carried Interest Profits: During an SFC hearing, Treasury Secretary Mnuchin was asked about reports that taxpayers will be able to avoid the new requirement that carried interests be held for three years to be taxed as capital gain, and he responded that IRS guidance to shut down this technique will be issued in the near future. Under the TCJA, general fund managers are required to hold investments for at least three years for carried interests to be treated as capital gains instead of ordinary income. The three-year rule, however does not apply when payments are made to companies rather than individuals, and some hedge funds have set up limited liability companies in Delaware to use the exception. He has met with IRS and Treasury staff and believes they will be able to close the loophole with existing statutory authority.
Net Operating Loss Effective Date: The net operating loss effective date no longer allows tax filers to spread out financial losses over past years, while under prior law, taxpayers could do so for two years.
Repatriation Tax: Mnuchin also agreed to work on an issue with the new repatriation tax and the calculation for deducting net operating losses under Code section 965(n).
Activity from the State Governments
The new federal tax reform law has caused most states to reconsider what changes they need to make in response to the tax reform law enacted in 2017. While the new federal law affects every state with an income tax system, the states most affected are those who use federal taxable income as a starting point and those that use federal standard deductions or personal exemptions.
Vermont, for example, has followed the federal tax code and based state taxation on federal taxable income. Now, however, they will start with federal adjusted gross income and retain a state personal exemption with a lower standard deduction than the federal amount, while reducing marginal rates. Several states including Iowa, Maryland, Michigan and Nebraska have plans to retain a state personal exemption.
States with high state and local taxes including California and New York are working on ways to mitigate the cap on deduction for state and local taxes paid, while a growing number of other states are working on similar ideas including Connecticut, Illinois, Maryland, Nebraska, New Jersey, Virginia, Washington and the District of Columbia. Governors of New York, Connecticut, and New Jersey have also announced that they have launched a coalition to sue the federal government over the issue of state and local tax deductibility.
Most states are focusing on changes related to personal income tax rather than the changes to the corporate tax system and those affecting foreign source income, which may be more difficult for states to assess. Some states thus far have determined that they would see a revenue increase from the changes rather than a decrease with the latter appearing to be a result of the 20 percent deduction for pass-through income, which means many states may “de-couple” their systems from that pass-through deduction.
With respect to the repatriation tax, some commentators have raised some issues that will need to be considered with respect to whether and how a state taxes subpart F income and the extent of their conformity with the federal system. Another international issue that will have an impact on companies with respect to state taxation is the requirement that US shareholders of controlled foreign corporations must include in gross income the amount of its global intangible low-taxed income (“GILTI”) but is permitted a deduction equal to 50 percent of the GILTI. US corporations are also required to include foreign-derived intangible income (“FDII”) in gross income but are then allowed a deduction on the FDII. Companies will have to review each state’s tax system to determine how to compute these new rules.
Despite the fact that several states have proposed legislation to deal with conformity issues, the majority of states have not, because they have not had adequate time to review and assess the impact of the federal changes. Because the federal changes are effective for 2018, however, states need to consider changes to their state tax systems now so that they are prepared for the filing season in 2019.