IRS Simplifies Filing Requirements for Section 83(b) Elections

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July 27, 2016

On July 25, the IRS released final regulations eliminating the requirement that taxpayers making a Section 83(b) election file a copy of the election notice with their federal income tax return.  Under Section 83, the fair market value of property received (less any basis in the property) for the performance of services is generally included in income when the property is no longer subject to a substantial risk of forfeiture or when the taxpayer’s interest in the property is transferable.  However, taxpayers may elect under Section 83(b) to include the property’s fair market value (less any basis in it) as of the date of transfer in income in the year of transfer.  Despite the upfront tax liability, this election may actually defer taxation on the appreciated value of the property and subject the appreciation to capital gains rates rather than ordinary income rates.  Under the prior regulations, taxpayers who make an 83(b) election must submit to the IRS a copy of the election notice not only within 30 days after the date of the transfer, but also with their federal income tax return for the year of the transfer.  Last summer, the Treasury and the IRS proposed to eliminate the latter filing requirement, and after receiving no comments, adopted the final regulations without modification.

The requirement to file an election notice with the annual return was duplicative and easy to miss because taxpayers making an 83(b) election were already required to submit to the IRS the election notice within 30 days after the date of the transfer.  Further, as the IRS explained in the preambles to the proposed regulations, this requirement had become an obstacle to electronic filing of returns for certain taxpayers, since commercial e-filing software does not consistently allow for submitting an 83(b) election notice with the return.  The final regulations apply to transfers on or after January 1, 2016, and taxpayers can also rely on these regulations for transfers in 2015.  As a result, taxpayers are not required to file a copy of any 83(b) election made in 2015 with their 2015 tax returns.

Significantly, the final regulations ease compliance for non-resident alien employees of multinational companies.  Although foreign tax consequences can make transfers of restricted stock to such employees undesirable from the employee’s perspective, it may be desirable for the employee to make a section 83(b) election when restricted stock is transferred.  This is particularly true for start-ups and other companies where the value of the shares is small when granted and is likely to increase.  (It is often undesirable to make an 83(b) election for a mature company where the value of the stock is high at transfer and may decline.)

When nonresident alien employees working outside of the United States receive non-vested equity compensation, they may have no obligation to file a U.S. tax return, and could easily neglect to file a return for purposes of filing the election notice.  (Because the employees are nonresident aliens working outside the United States, the income from their 83(b) elections would presumably be foreign source income resulting in no U.S. income tax due in the year of transfer.)  But if these employees become U.S. residents between the grant and vesting dates, their failure to file nonresident returns and attach the 83(b) election notices would invalidate their 83(b) elections, thereby subjecting the value of the property to U.S. income tax upon vesting based on their U.S. resident status at the time of vesting.  Under the final regulations, these employees – and any other service providers – must simply file an election notice with the IRS within 30 days after the date of the transfer.

Although the final regulations simplified filing obligations under Section 83(b), the IRS emphasized taxpayers’ recordkeeping responsibilities under Section 6001, especially to show the basis of property reported on taxpayers’ returns.  Thus, to protect themselves from tax-return audit liability, executives and other service providers who receive restricted property under an 83(b) election must be careful to keep records of the original cost of the property received, and retain the records until at least the period of the limitations for the returns expires.

Print Out IRS FAQs and Other Informal Guidance While You Have the Chance

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July 26, 2016

When you find favorable informal guidance posted on the IRS website, print it out and save it.  A few years ago, a Treasury official from the Office of Tax Policy rebuked someone who proposed addressing a technical issue through IRS FAQs, conveying that the Treasury frowns on issuing such informal guidance.  At the time, we wondered whether the official had recently visited the IRS website and understood how much informal guidance the IRS provides to taxpayers and practitioners in this manner.

The U.S. tax system is complicated, and significant guidance is necessary to foster compliance.  Yet, the IRS and Treasury does not publish adequate formal guidance (e.g., regulations, revenue rulings, notices, etc.) each year to keep up, so the IRS fills the gaps through FAQs and other informal guidance on its website.  The problem is multifaceted, from the IRS brain drain due to the loss of retiring seasoned technicians, to difficulty recruiting qualified personnel at IRS Chief Counsel related to inadequate Congressional funding and compensation that is no longer reasonably competitive with the private sector, to a logjam of draft guidance at the Treasury Office of Tax Policy.  The IRS seems to feel that the issuance of informal guidance on its website is better than nothing, and it is probably right.

The knock on FAQs and its ilk is twofold.  First, taxpayers probably cannot rely on it because it is informal, unreviewed, and occasionally wrong.  Second, it has a way of disappearing from the website without a trace.  This happened recently with respect to slides made public by the LB&I International Practice Service Concept Unit, which were issued last month and revised this month.  We wrote about how the original slides addressed “transportation income” in an earlier post.

The original slides included a reference to “transportation income” with a parenthetical indicating that such income was “not FDAP.”  FDAP stands for fixed or determinable annual or periodical income.  This struck us as odd, because we felt that transportation income likely was FDAP income, but practitioners have been asking the IRS to issue formal guidance to clarify withholding rules regarding transportation income for years, without success.  (If you are interested, see the IRPAC briefing books on the IRS website to see a discussion of the requests for guidance from 2010 through 2013.)  Thus, any discussion from the IRS to address Chapter 3 withholding related to U.S. source gross transportation income is of great interest to those of us who have been requesting it. Publication 515, for the record, indicates Chapter 3 withholding is not required on U.S. source gross transportation income.  Taxpayers paradoxically should not really rely on statements of law included in IRS publications either.

Alas, someone must have told the responsible LB&I unit that transportation income is FDAP, so when the slides were updated, the statement about transportation income not being FDAP income was removed.  The older version of the practice unit has been replaced with the updated version, so the statement can no longer be found on the IRS website.  Unfortunately, the latest hope for a trump card on U.S. source transportation income disappeared like so many FAQs on other issues before it – into the ether.  The before and after slides are shown below.

Original Practice Unit [Click Image to Enlarge]

OldPracticeUnitPage8

Updated Practice Unit [Click Image to Enlarge]

UpdatedPracticeUnitSlide8

Bipartisan Support for Legislation Codifying Tax-Free Student Loan Repayment Benefits, But Does the Code Already Allow for It?

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July 25, 2016

As college graduates struggle under the weight of larger student loan burdens, some employers have begun to offer student loan repayment benefits intended to help employees repay their loans.  In May, House Ways and Means Committee member Robert Dold (R-IL) introduced legislation that would, among other changes, amend Section 127 of the Internal Revenue Code to explicitly allow employers to make payments on their employees’ student loans on a tax-free basis.  That provision excludes from gross income up to $5,250 paid by an employer per year for expenses incurred by or on behalf of an employee for education of the employee (including, but not limited to, tuition, fees, and similar payments, books, supplies, and equipment).   Other proposed bills have also been introduced to provide the same benefit.  Although the legislation has bipartisan support, it is unclear whether Congress has the appetite for passing legislation that would appear to reduce revenues, or the fortitude to pass anything nonessential in an election year.

For employers interested in providing tax-free student loan repayment benefits, existing law may already allow for such a result.  The Internal Revenue Service issued a private letter ruling in 2003 that suggests that such payments may already be excludable under Section 127.  In the ruling, a law firm established an educational assistance plan for its non-lawyer employees.  The firm’s employees borrowed funds to pay for law school.  The firm then provided the employees with additional salary to pay the principal and interest due on the loans during each year of employment, essentially forgiving the debt.  The IRS ruled that the first $5,250 of loan payments each year were excludable from the employee’s income under Section 127.  Although the private letter ruling applies only to the taxpayer and does not fully describe the terms of the law firm’s program, it offers a strategy for employers to consider when evaluating how to help their employees with student loan payments.

IRS Audit Guidelines Provide Insights for Withholding Agents

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July 21, 2016

In audit guidelines contained in a recent International Practice Unit, the IRS advised its agents that when a U.S. business buys intangibles, such as patents, copyrights, formulas, good will, brands, or franchises, from a foreign seller and agrees to pay for them contingent on their productivity, the contingent payments should be treated as royalties.  As such, the payments are potentially subject to withholding under Chapter 3 of the Internal Revenue Code.

Generally, Chapter 3 withholding is required on payments to foreign persons of fixed, determinable, annual, or periodical (FDAP) income from sources within the U.S. that are not ECI.  Royalties, such as those from an intangible or a patent, are U.S. source FDAP income if the intangible or patent is used in the U.S.  In contrast, payments for the purchase of an intangible or patent are treated as non-FDAP sales proceeds, and hence are not subject to Chapter 3 withholding.  The IRS’s Practice Unit reminds agents that when a U.S. business buys intangibles, such as patents, from a foreign seller and agrees to pay for them contingent on their productivity, the contingent payments are treated as royalties, not sales proceeds.

Withholding agents should carefully consider whether any payments for intangibles should be treated as royalties and are thus subject to withholding.  The audit guidelines also provide an important reminder to withholding agents about the importance of understanding the source of payments it makes to foreign persons.  The Practice Unit emphasizes that if the source of a payment cannot be determined or is not known, the IRS examiner should treat the amount as U.S. source.  Accordingly, withholding agents should document the source of its payments to foreign persons and ensure that they know whether amounts are U.S. source before making payment to avoid secondary liability for withholding failures.

Two District Courts Rule Stock Option Income Subject to RRTA Tax

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July 14, 2016

Two more railroad companies have failed in their efforts to obtain Railroad Retirement Tax Act (RRTA) tax refunds based on the application of RRTA’s definition of “compensation” as it relates to nonqualified stock option exercises by employees.  Just a week apart, the U.S. District Courts for Nebraska in Union Pac. R.R. Co. v. United States  and for the Northern District of Illinois in Wis. Central Ltd. v. United States, agreed with the government that the term “any form of money remuneration,” as compensation is defined by RRTA, is susceptible to a broad reading analogous to that of “wages” in the Federal Insurance Contributions Act (FICA).  Both courts, in detailed memorandum opinions, concluded that the income arising from the NQSO exercises had been properly subjected to Tier 1 RRTA taxes and, consequently, the refund claims were denied.  In so doing, both courts accepted the government’s position that the Treasury regulations defining RRTA compensation by reference to the definition of FICA wages in Section 3121(a) was a reasonable one.

In the first case on this issue, the U.S. Court of Appeals for the Fifth Circuit rejected BNSF Railway Company’s claims for refund of Tier 1 RRTA taxes that had been paid in conjunction with the exercise of nonqualified stock options.  In its refund claim, BNSF had argued that the term “any form of money remuneration” meant payment in cash or other medium of government authorized exchange and, consequently, NQSOs could not qualify as money.  Therefore, according to BNSF, income arising from the exercise of NQSOs did not constitute “compensation” subject to RRTA taxes.   In analyzing the definition of “compensation” under RRTA, the Fifth Circuit applied the two step framework set out in Chevron v. Natural Res. Def. Council, Inc. and concluded that Treasury was reasonable in interpreting RRTA coextensively with the FICA tax provisions, so that it was consistent with the broad reading of the term “wages” in FICA provisions.

FATCA Update*

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July 12, 2016

Recently, the IRS released the Competent Authority Agreements (CAAs) implementing the Intergovernmental Agreements (IGAs) between the United States and the following treaty partners:

  • Portugal (Model 1A IGA signed on August 6, 2015);
  • St. Vincent and the Grenadines (Model 1B IGA signed on August 18, 2015).

Since our last monthly FATCA update, we have also addressed other recent FATCA developments:

  • The IRS announced that it will conduct a test of the International Data Exchange Services (IDES) system beginning on July 18, 2016 (see previous coverage).
  • The IRS issued a proposed qualified intermediary (QI) agreement (Notice 2016-42) that spells out the new qualified derivatives dealer (QDD) regime (see previous coverage).
  • Argentina’s Federal Administration of Public Revenue (AFIP) was reported to begin negotiating an IGA with the U.S. Treasury Department to ease compliance with FATCA (see previous coverage).
  • The Supreme Court denied the petition for certiorari filed by two bankers associations that sought to challenge the validity of FATCA regulations that impose a penalty on banks that fail to report interest income earned by nonresident aliens on accounts in U.S. banks (see previous coverage).

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

* This post should have been published on Friday, July 1, but was delayed.  We typically publish the First Friday FATCA updates on the first Friday of each month.

Testing Period Scheduled for Form 8966 Electronic Submission Process

The IRS announced that it will conduct a test of the International Data Exchange Services (IDES) system beginning on July 18, 2016.  The IDES system allows financial institutions and foreign tax authorities to securely transmit data directly to the IRS.  One of the forms that financial institutions must submit through the IDES system is Form 8966, “FATCA Report,” which is used by foreign financial institutions to report certain U.S. accounts, substantial U.S. owners of passive non-financial foreign entities, and other required information.

Any foreign financial institution that will submit a Form 8966 through the IDES system once the system goes into effect may want to participate in this testing period.  Participation in the testing period is open to any financial institution that has completed IDES Enrollment before 5:00pm EST on July 14, 2016, which can be done online.  The testing period is scheduled to close on July 29, 2016.

Proposed QI Agreement Includes Rules for Qualified Derivatives Dealers

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July 7, 2016

The IRS recently issued a proposed qualified intermediary (QI) agreement (Notice 2016-42) that spells out the new qualified derivatives dealer (QDD) regime.  The final QI agreement will be issued later in 2016 and will apply to agreements in starting January 1, 2017, replacing the 2014 QI agreement that will expire on December 31, 2016.  The QDD regime replaces the qualified securities lender (QSL) regime in Notice 2010-46.  The QSL rules will continue to apply for substitute dividend payments made under sale-repurchase or securities lending transactions.

The QDD regime was developed to mitigate cascading withholding that would occur as a result of the withholding requirements imposed on “dividend equivalents.”  Section 871(m) of the Code imposes withholding on certain payments that are determined by reference to or contingent upon the payment of a U.S. source dividend.  As a result, when a foreign financial institution holds U.S. equities and issues derivatives to non-U.S. investors that are based on the stock, it may be subject to withholding on dividend payments made with respect to the underlying equities and have to withhold on the payments it makes to the holders of the derivatives.

Under the proposed QI agreement, only a subset of QIs called “eligible entities” will be permitted to act as QDDs.  Eligible entities are: (1) regulated securities dealers; (2) regulated banks; and (3) certain entities wholly-owned by regulated banks.  Under the QDD regime, a dividend payment to a QDD is not subject to withholding if the QDD provides the withholding agent with a Form W-8IMY indicating the QDD’s status.  The QDD certification is made on Form W-8IMY even though the QDD is acting as a principal with respect to the transaction.

If a QI acts as a QDD, it must act as a QDD for all payments made as a principal with respect to potential Section 871(m) transactions, including any sale-repurchases or securities lending transactions that qualify as such, and all payments received as a principal with respect to potential Section 871(m) transactions and underlying securities, excluding payments effectively connected with a U.S. trade or business. All securities lending and sale-repurchase transactions the QI enters into that are Section 871(m) transactions will be deemed to be entered into by the QI as a principal.

When a QI is acting as a QDD, it must assume primary withholding responsibilities under Chapters 3 and 4 and primary Form 1099 reporting and Section 3406 backup withholding responsibility for all payments related to potential Section 871(m) transactions that it receives as a principal—even if such payments are not dividend equivalent payments.  As a consequence, a QDD will be required to withhold to the extent required for the applicable dividend on the dividend payment date.  In contrast, when a QI is acting as intermediary, i.e., not as a principal, with respect to such a payment, it may choose to act as a QI (and choose whether or not to assume primary withholding and reporting responsibility with respect to the payment) or a nonqualified intermediary (NQI).

A QDD is liable for any tax on any dividends and dividend equivalents it receives in its dealer capacity to the extent the QDD is not contractually required to make offsetting payments that reference the same dividend or dividend equivalent that it received as a dealer.  For purposes of determining the QDD tax liability, payments received by a QDD acting as a proprietary trader are treated as payments received in a non-dealer capacity, while transactions properly reflected in a QDD’s dealer book are presumed to be held in its dealer capacity.  A QDD will reports its QDD tax liability on Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons.  When a foreign branch of a U.S. financial institution acts as a QDD, the branch is not required to report the QDD tax liability for income related to potential Section 871(m) transactions and underlying securities; instead, the U.S. financial institution will file the appropriate tax return to report and pay its tax liability.

The proposed QI agreement also updated requirements relating to periodic review and certification of compliance, substitute interest, limitation of benefits for treaty claims, and other items.

ACA E-Filing Deadline Passed

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July 1, 2016

June 30, 2016 was the deadline to file ACA information returns for the year 2015 with the IRS through the ACA Information Reporting (AIR) system. In a QuickAlerts Bulletin, the IRS reiterated that:

• The AIR system will continue to accept information returns filed after June 30, 2016.

• If transmissions or submissions were rejected by the AIR system, the filer has 60 days from the date of rejection to submit a replacement and have the rejected submission treated as timely filed.

• If the filer submitted and received “Accepted with Errors” messages, the entity may continue to submit corrections after June 30, 2016.

The IRS has publicly stated in recent months that a filer of Forms 1094-B, 1095-B, 1094-C and 1095-C that miss the AIR filing due date will avoid the late filing penalties under section 6721 if the filer has made legitimate efforts to register with the AIR system and to file its information returns, and it continues to make such efforts and completes the process as soon as possible.