OECD Issues Array of Guidance on Country-by-Country Reporting and Automatic Exchange of Tax Information

In an effort to help jurisdictions implement consistent domestic rules that align with recent guidance issued by the Organization for Economic Co-operation and Development (OECD), the OECD issued a series of guidance to further explain its country-by-country (CbC) reporting, most importantly by clarifying certain terms and defining the accounting standards that apply under the regime.  Each of these efforts relate to Action 13 of the OECD’s Base Erosion and Profit Shifting (BEPS) project, which applies to tax information reporting of multinational enterprise (MNE) groups.  CbC reporting aims to eliminate tax avoidance by multinational companies by requiring MNE groups to report certain indicators of the MNE group’s economic activity in each country and allowing the tax authorities to share that information with one another.  For additional background on CbC reporting, please see our prior coverage.

The most substantial piece of the OECD’s new guidance is an update to the OECD’s “Guidance on the Implementation of Country-by-Country Reporting–BEPS Action 13.”  The update clarifies: (1) the definition of the term “revenues”; (2) the accounting principles and standards for determining the existence of and membership in a “group”; (3) the definition of “total consolidated group revenue”; (4); the treatment of major shareholdings; and (5) the definition of the term “related parties.”  Specifically with respect to accounting standards, if equity interests of the ultimate parent entity of the group are traded on a public securities exchange, domestic jurisdictions should require that the MNE group be determined using the consolidation rules of the accounting standards already used by the group.  However, if equity interests of the ultimate parent entity of the group are not traded on a public securities exchange, domestic jurisdictions may allow the group to choose to use either (i) local generally accepted accounting principles (GAAP) of the ultimate parent entity’s jurisdiction or (ii) international financial reporting standards (IFRS).

To further define its Common Reporting Standard (CRS) for exchanging tax information, the OECD also issued twelve new frequently asked questions on the application of the standard.

Finally, the OECD issued a second edition of its Standard for Automatic Exchange of Financial Account Information in Tax Matters, which contains an expanded XML Schema (see prior coverage for additional information), used to electronically report MNE group information in a standardized format.

IRS Updates List of Countries Subject to Bank Interest Reporting Requirements

The IRS has issued Revenue Procedure 2017-31 to supplement the list of countries to subject to the reporting requirements of Code section 6049, which generally relate to reporting on bank interest paid to nonresident alien individuals.  This was an expected move, as this list of countries, originally set forth in Revenue Procedure 2014-64 and modified a handful of times since, will likely continue to expand as more countries enter into tax information exchange agreements with the U.S. in order to implement the Foreign Account Tax Compliance Act (FATCA).  Specifically, Revenue Procedure 2017-31 adds Belgium, Colombia, and Portugal to the list of countries with which Treasury and the IRS have determined the automatic exchange of information to be appropriate.  Unlike the last set of additions to the list, set forth in Revenue Procedure 2016-56 (see prior coverage), no countries were added to the list of countries with which the U.S. has a bilateral tax information exchange agreement.

Prior to 2013, interest on bank deposits was generally not required to be reported if paid to a nonresident alien other than a Canadian.  In 2012, the IRS amended Treas. Reg. § 1.6049-8 in an effort to provide bilateral information exchanges under the intergovernmental agreements between the United States and partner jurisdictions that were being agreed to as part of the implementation of FATCA.  In many cases, those agreements require the United States to share information obtained from U.S. financial institutions with foreign tax authorities.  Under the amended regulation, certain bank deposit interest paid on accounts held by nonresident aliens who are residents of certain countries must be reported to the IRS so that the IRS can satisfy its obligations under the agreements to provide such information reciprocally.

The bank interest reportable under Treas. Reg. § 1.6049-8(a) includes interest: (i) paid to a nonresident alien individual; (ii) not effectively connected with a U.S. trade or business; (iii) relating to a deposit maintained at an office within the U.S., and (iv) paid to an individual who is a resident of a country properly identified as one with which the U.S. has a bilateral tax information exchange agreement.  Under Treas. Reg. § 1.6049-4(b)(5), for such bank interest payable to a nonresident alien individual that exceeds $10, the payor must file Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” for the year of payment.

Entities Allowed Additional Time to Renew QI Agreements

In a Q&A on its list of questions and answers for qualified intermediaries (QIs), foreign withholding partnerships (WPs), and foreign withholding trusts (WTs) (see Q&A-22), the IRS today extended the deadline for submitting QI, WP, and WT agreement renewal requests from March 31, 2017, to May 31, 2017.  Applications submitted by the deadline will be granted a QI, WP, or WT agreement (as applicable) with an effective date of January 1, 2017.  This delay gives entities additional time to comply with the new application system (discussed in a prior post) and gather the necessary information to submit renewal requests.

The deadline for applications submitted for new QI agreements with an effective date of January 1, 2017, however, is extended to May 31, 2017, only if the QI is seeking qualified derivative dealer (QDD) status. To be granted an agreement with an effective date of January 1, 2017, applications for new QI agreements that are not seeking QDD status, WP agreements, and WT agreements must be submitted today.

Recent FAA Serves as Warning to Employers Using PEOs

A recent Internal Revenue Service Office of Chief Counsel field attorney advice memorandum (FAA 20171201F) sounds a cautionary note for employers making use of a professional employer organization (PEO).  The FAA holds a common law employer ultimately liable for employment taxes owed for workers it leased from the PEO.  Under the terms of the employer’s agreement with the PEO, the PEO was required to deposit employee withholdings with the IRS and pay the employer share of payroll taxes to the IRS.  Alas, that was not what happened.

The taxpayer did not dispute that it had the right to direct and control all aspects of the employment relationship and was thus was the common law employer with respect to the employees, but asserted that it was not liable for the unpaid employment taxes. Under the terms of the contracts between the taxpayer and the PEO, the taxpayer would pay an amount equal to the wages and salaries of the leased employees to the PEO prior to the payroll date, and the PEO would then pay all required employment taxes and file all employment tax returns (Forms 940 and 941) and information returns (Forms W-2) with respect to the employees.

After the PEO failed to pay and deposit the required taxes, the Examination Division of the IRS found the taxpayer liable for the employment tax of those workers, plus interest. The taxpayer appealed, making several arguments against its liability: (i) the PEO was liable for paying over the employment taxes under a state statute; (ii) the PEO was the statutory employer, making it liable for the employment taxes; and (iii) the workers were not employees of the taxpayer under Section 530 of the Revenue Act of 1978.

The Office of Chief Counsel first explained that the state law cited by the taxpayer was not relevant because it was superseded by the Internal Revenue Code. The FAA rejects the taxpayer’s second argument because the PEO lacked control over the payment of wages, and thus it was not a statutory employer. The PEO lacked the requisite control because the taxpayer was obligated to make payment sufficient to cover the employees’ pay before the PEO paid the workers.  Finally, the Office of Chief Counsel denied the taxpayer relief under Section 530 of the Revenue Act of 1978 because that provision only applies to questions involving employment status or worker classification, neither of which was at issue.  Although the FAA makes clear that the common law employer will be on-the-hook for the unpaid employment taxes, the FAA did indicate that it would be open to allowing an interest-free adjustment because the taxpayer’s reliance on the PEO to fulfill its employment tax obligations constituted an “error” under the interest-free adjustment rules.

The FAA serves as a reminder that the common law employer cannot easily offload its liability for employment taxes by using a contract. Indeed, it remains liable for such taxes and related penalties in the event that the party it has relied on to deposit them fails to do so timely.  Employers who choose to make use of a PEO should carefully monitor the PEO’s compliance with the payroll tax rules to ensure that it does not end up in this taxpayer’s position.  Alternatively, employers should consider whether to use a certified PEO under the new regime established by Congress (earlier coverage  available here and here).  When using a certified PEO, the common law employer can successfully shift its liability to the PEO and is not liable if the PEO fails to comply with the payroll tax requirements of the Code.

IRS Negotiating CbC Information Exchange Agreements

The IRS is engaging in negotiations with individual countries to implement country-by-country (CbC) reporting according to Douglas O’Donnell, Commissioner of IRS’s Large Business and International Division.  In a March 10 speech at the Pacific Rim Tax Institute that, he clarified that the IRS is only negotiating with jurisdictions that have both an information exchange instrument and adequate information safeguards.  Mr. O’Donnell did not provide a definitive timeline for those negotiations, but he said that they would be completed in a timely manner.  The IRS’s approach to negotiating information exchange agreements is consistent with the United States’ existing approach to negotiating IGAs and related agreements under FATCA.

Companies are anxiously awaiting the agreements, as they could face reporting obligations in certain jurisdictions with which the United States does not have agreements in place, causing them to potentially prepare multiple CbC reports. Companies are also urging the IRS to release information on the expected scope of the U.S. information exchange network, as lack of knowledge on the scope could negatively impact companies’ ability to do business in certain countries if the companies do not comply with local filing requirements.

These information exchange agreements arise from recent recommendations provided by the Organization for Economic Co-Operation and Development (OECD) (additional information on OECD guidance on CbC reporting available here) on jurisdictions with respect to information on multinational corporations, requiring jurisdictions to exchange such information in a standardized format beginning in 2018 (please see prior post for additional background).  The IRS released final regulations in June 2016 imposing CbC reporting on U.S. persons that are the ultimate parent entity of a multinational enterprise group with revenue exceeding $850 million in the preceding accounting year (prior coverage).

IRS Issues Guidance for Early Country-by-Country Reporting

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February 7, 2017

Recently, the IRS issued guidance for multinational enterprises (MNEs) with at least $850 million in annual revenue based in the United States that may have constituent entities subject to country-by-country (CbC) reporting requirements in foreign jurisdictions because of the effective date of CbC reporting in the United States.  CbC reporting aims to eliminate tax avoidance by multinational companies by requiring MNEs to report certain indicators of the MNE’s economic activity in each country and allowing the tax authorities to share that information with one another.

In the U.S., MNEs make the CbC report on Form 8975, “Country-by-Country” report.  The report contains revenue, profit or loss, capital, and accumulated earnings data for each country of operation.  Last year, the IRS issued final regulations requiring these reports for reporting periods that begin on or after the first day of the first taxable year of the ultimate parent entity beginning after June 30, 2016.  (See prior coverage.)  However, several countries have implemented CbC reporting on constituent entities for periods beginning on or after January 1, 2016.  As a result, constituent entities of a U.S. MNE may be subject to local CbC filing in their jurisdictions for reporting periods before the effective date of the final regulations unless the ultimate parent files Form 8975 for the earlier period or reports CbC information to another jurisdiction that accepts a surrogate filing for the U.S. MNE.

Revenue Procedure 2017-23 provides that the ultimate parent of a U.S. MNE may choose to voluntarily file Form 8975 and the accompanying Schedule A for reporting periods beginning after January 1, 2016 and before June 30, 2016.  Beginning on September 1, 2017, a parent entity may file Form 8975 for an early reporting period that ends with or during the parent entity’s tax year by attaching it to its tax return for such year.  If the ultimate parent has already filed its tax return for such year, it must file an amended return and attach Form 8975 within 12 months of the end of such tax year to file the CbC report for the early reporting period.

The IRS encourages entities that file their tax returns electronically to also file Form 8975 electronically.  Form 8975 must be filed through the IRS Modernized e-File system in XML format.  Paper forms will be made available before the September 1, 2017, deadline for filers who cannot file the form in XML format.

W-2 Phishing Scam Targeting More Employers, Including Chain Restaurants and Staffing Companies

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February 3, 2017

Yesterday, the IRS and state tax agencies issued a joint warning to employers that the Form W-2 phishing scam that first affected large businesses last year has now expanded to other organizations, including chain restaurants, staffing companies, schools, tribal organizations, and nonprofits.  The scam involves emails sent to payroll or human resources employees that appear to be from organization executives and request a list of all employees and their Forms W-2.  Once the scammer receives the information, it can be used to file false tax returns and claim employee refunds.

According to IRS Commissioner John Koskinen, this is one of the most dangerous phishing scams the tax world has faced in a long time.  The IRS and its state and industry partners, known as the “Security Summit,” have enacted safeguards in 2016 and 2017 to identify and halt scams such as this, but cybercriminals simply evolve their methods to avoid those safeguards.  A 2016 Government Accountability Office report found that in 2014, the IRS paid an estimated $3.1 billion in fraudulent identify theft refunds.  The report also found that the IRS prevented the payment of or recovered another $22.5 billion in identify theft refunds in the same year.  Both numbers were down from the prior year, but it is somewhat unclear whether that is a result of a change in the methodology used to calculate the estimates.

To add insult to injury, some scammers are going back to the well, by following-up on the Form W-2 request with an email requesting a wire transfer.  As a result, some entities have not only exposed their employees’ personal information and made them vulnerable to potential identify theft but also lost thousands of dollars.  Employers should ensure that payroll, treasury, and accounts payable processes and procedures are in place to prevent the unauthorized sharing of Form W-2 information and unauthorized wire transfers.

Organizations that receive a scam email should forward the email to phishing@irs.gov, placing “W2 Scam” in the subject line.  In addition, organizations should file a complaint with the Internet Crime Complaint Center (IC3), which is operated by the FBI.  If an organization has already had Forms W-2 stolen, it should review the Federal Trade Commission and IRS’s recommended actions, available at www.identitytheft.gov and www.irs.gov/identitytheft, respectively.  Employees concerned about identity theft can consult Publication 4524 and Publication 5027 for information.  If an employee’s tax return gets rejected because of a duplicate social security number, he or she should file Form 14039, “Identity Theft Affidavit.”

Final Regulations Make Minor Changes to FATCA and Chapter 3 Presumption Rules

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January 5, 2017

The final regulations released by the IRS under the Foreign Account Tax Compliance Act (FATCA) on December 30, 2016 finalized the temporary presumption rules promulgated on March 6, 2014 with no substantive changes, but several changes were made to the final coordinating regulations under Chapter 3 and Chapter 61, also released on the same date.

Under FATCA, withholding agents must conduct certain due diligence to identify the Chapter 4 status of their payees.  In the absence of information sufficient to reliably identify a payee’s Chapter 4 status, withholding agents must apply specific presumption rules to determine that status.

According to the preamble to the final FATCA regulations, a commenter requested that a reporting Model 1 foreign financial institution (FFI) receiving a withholdable payment as an intermediary or making a withholdable payment to an account held by an undocumented entity be permitted to treat such an account as a U.S. reportable account.  The IRS rejected the commenter’s suggestion, explaining that a reporting Model 1 FFI that follows the due diligence procedures required under Annex I of the IGA should not maintain any undocumented accounts.  In the absence of information to determine the status of an entity account, a reporting Model 1 FFI must obtain a self-certification, and in the absence of both the required information and a self-certification, the reporting Model 1 FFI must apply the presumption rules contained in the Treasury Regulations by treating the payee as a nonparticipating FFI and withholding.

The discussion in the preamble is consistent with the rules set forth in the IGAs, which require reporting Model 1 or Model 2 FFIs to withhold on withholdable payments made to nonparticipating FFIs in certain circumstances.  The reasoning provided is also the same as provided with respect to reporting Model 2 FFIs in Revenue Procedure 2017-16, setting forth the updated FFI agreement.

Although the IRS declined to make the requested change to the final Chapter 4 regulations, it did make a number of changes to the presumption rules in the final FATCA coordination regulations.  It also rejected some changes that were requested by commenters.

Under the temporary coordination regulations, a withholding agent must presume that an undocumented entity payee that is an exempt recipient is a foreign person if the name of the payee indicates that it is a type of entity that is on the per se list of foreign corporations.   However, an entity name that contains the word “corporation” or “company” is not required to be presumed foreign because such information in itself it is not indicative of foreign status.  According to the preamble, a commenter requested that the IRS amend the presumption rules to allow a presumption of foreign status for an entity whose name contains “corporation” or “company,” if the withholding agent has a document that reasonably demonstrates that the entity is incorporated in the relevant foreign jurisdiction on the per se list.  The IRS adopted this change to the coordination regulations.

In contrast, the IRS rejected a commenter’s other suggested changes to the presumption rules.  One commenter requested that a withholding agent making a payment other than a withholdable payment to an exempt recipient be permitted to rely on documentary evidence to presume the payee is foreign.  The IRS reasoned that the documentary evidence rule was not worthwhile because it would be limited in scope because an existing rule, which requires a withholding agent to presume a payee that is a certain type of exempt recipient is foreign with respect to withholdable payments, may be applied by the withholding agent to all payments with respect to an obligation whether or not they are withholdable payments.  The IRS also expressed concern about how the proposed change would work in the context of payments made to foreign partnerships with partners who are non-exempt recipients and for which different presumption rules apply.

The IRS also declined to make a suggested change that would permit an undocumented entity to be presumed foreign if the withholding agent has a global intermediary identification number (GIIN) on file for the payee and the payee’s name appears on the IRS FFI list.  The IRS rejected the proposed change because U.S. entities can register and obtain a GIIN (for example, as a sponsoring entity), so the existence of a GIIN does not necessarily indicate the payee is foreign.

IRS Says NFFEs Must Determine their Chapter 4 Status Under Treasury Regulations

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January 5, 2017

In the preamble to the final FATCA regulations released on December 30, 2016, the IRS rejected a request from a commenter that the regulations be modified to permit a non-financial foreign entity (NFFE) operating in an IGA jurisdiction to determine its Chapter 4 status using the criteria specified in the IGA.

In the preamble, the IRS responded to the request by indicating that although an NFFE may use the IGA to determine whether it is a foreign financial institution (FFI) or a NFFE,  it must look to U.S. Treasury Regulations to determine its Chapter 4 status once it determines it is an NFFE.  As a result, different sets of rules apply to determine an entity’s specific Chapter 4 status depending upon whether the entity is determining its status for purposes of documenting its status to a withholding agent or documenting its status to an FFI in its own jurisdiction.  Similarly, the IRS said a passive NFFE will be required to report U.S. controlling persons to FFIs in IGA jurisdictions and report substantial U.S. owners to participating FFIs and U.S. withholding agents.  As a justification for its response, the IRS said that the rules in the IGAs are intended only for FFIs and not for NFFEs.

Many practitioners believe that it is illogical for a single entity to have different Chapter 4 statuses depending upon who is documenting its status or where its status is being documented.  As a result, many practitioners believed it was appropriate for an entity resident in an IGA jurisdiction to determine its Chapter 4 status under the terms of the applicable IGA.  Because different rules apply to determine the entity’s status in different jurisdictions, an NFFE could otherwise have one Chapter 4 status when receiving payments from a U.S. withholding agent and a different Chapter 4 status in an IGA jurisdiction.

From a policy perspective, the IRS’s decision appears somewhat irrational—it requires NFFEs to follow U.S. Treasury Regulations to identify their Chapter 4 status, rather than using the rules for determining their status that are in the IGA that was agreed to by Treasury and the tax authorities in their own jurisdictions.  The impact of this goes beyond mere nomenclature, as the specific type of NFFE determines an entity’s responsibilities under FATCA.  Fortunately, since the two sets of rules contain significant overlap, applying the different rules will lead to the same Chapter 4 status in many situations.  To the extent that the two sets of rules would arrive at different results, the entities affected will have additional compliance burdens, as they will have to be familiar with both the rules under the U.S. Treasury Regulations and under the applicable IGA.

IRS Releases Final Qualified Intermediary and Foreign Financial Institution Agreements

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December 30, 2016

With the end of the year upon them, the IRS has kicked into high gear with a flurry of new administrative guidance. On the heels of yesterday’s release of final reporting rules on slot machine, bingo, and keno winnings, proposed rules on horse track, dog track, and jai lai winnings, and a revenue procedure on Certified Professional Employer Organizations, the IRS released final agreements for foreign financial institutions (FFIs) and qualified intermediaries (QIs) to enter with the IRS, set forth in Revenue Procedure 2017-16 and Revenue Procedure 2017-15, respectively.

FFI Agreement

FFIs enter into an FFI agreement with the IRS to become participating FFIs for purposes of Foreign Account Tax Compliance Act (FATCA) withholding and reporting obligations. The final FFI agreement set forth in Revenue Procedure 2017-16, which was previously published in Revenue Procedure 2014-38, applies to FFIs seeking to become participating FFIs under FATCA, as well as FFIs and branches of FFIs treated as reporting financial institutions under a Model 2 intergovernmental agreement (IGA).  The update was necessary because Revenue Procedure 2014-38 was set to expire on December 31, 2016.  Accordingly, the FFI agreement contained in Revenue Procedure 2017-16 applies to FFIs with an FFI agreement effective beginning January 1, 2017.

Changes were made to the FFI agreement generally to align with subsequent changes to IRS regulations, such as the withholding and reporting rules applicable to U.S. branches that are not U.S. persons. Additionally, several changes reflect the expiration of certain transitional rules provided in the 2014 FATCA regulations including those related to limited branches and limited FFIs.  (For additional information on the expiration of the transition relief for limited branches and limited FFIs, please see our prior post).  The FFI agreement also clarifies the presumption rules applicable to Model 2 FFIs, and the ability of Model 2 FFIs to rely on certain documentation for purposes of the due diligence requirements.

The FFI agreement also contains new certification requirements applicable to FFIs attempting to terminate an FFI agreement and clarifies that the obligations imposed with respect to the period the agreement was in force survive the termination of the agreement.

QI Agreement

A QI serves as an intermediary for payments of U.S. source income made to non-U.S. persons, and it must collect a taxpayer identification number from the payee, or else it must withhold 30% on the payment. When an intermediary acts as a QI, it may agree to assume the primary withholding and reporting obligations with respect to payments made through it for purposes of Chapter 3, Chapter 4, and/or Chapter 61 and backup withholding under Section 3406 of the Code.  When a QI assumes such responsibility, it is not required to provide a withholding statement to the withholding agent/payor making payment to it.  FFIs, foreign clearing organizations, and foreign branches of U.S. financial institutions and clearing organizations are eligible to enter into QI agreements by completing Form 8957 through the IRS website, as well as Form 14345.

Notice 2016-42 set forth a proposed QI agreement (prior coverage), which made revisions to the previous final QI agreement published in Revenue Procedure 2014-39.  The proposed QI agreement created a new regime that allowed certain entities to act as qualified derivatives dealers and act as the primary withholding agent on all dividend equivalent payments they make.  Several changes in the final QI agreement were made in response to comments on the rules applicable to qualified derivatives dealers (QDDs), including provisions that reflect changes to the treatment of dividend equivalents from U.S. sources and provisions clarifying that entities acting as QIs and QDDs must file separate Forms 1042-S when acting in each distinct capacity.  Some of the changes in the final QI agreement were previously announced in Notice 2016-76 (prior coverage).  However, the final QI agreement makes further changes based on anticipated revisions to the regulations under Section 871(m), which are expected to be published in January.

Additionally, the final QI agreement provides greater detail on the internal compliance measures that are to replace the external audit procedures previously applicable to QIs. The final QI agreement also eliminates the ability of limited FFIs to enter into QI agreements, as limited FFI status will no longer be available beginning January 1, 2017.  Additionally, QIs seeking to use documentary evidence to document an entity claiming reduced withholding under a treaty must collect certain information regarding the applicable limitation on benefits provision, though the IRS has enabled a two-year transition period for QIs to gather this information.  The final agreement also eliminates the ability of an NFFE seeking to become an intermediary with respect to its shareholders to enter into a QI agreement.  The QI agreement also contains a modified standard of knowledge to align with the reason-to-know standard adopted in regulations, and modified documentation requirements and presumption rules to align with IGA requirements.  Finally, the term of validity for a QI agreement is six calendar years, extended from the three years provided in the proposed agreement.  The updated final QI agreement is effective beginning January 1, 2017.

IRS Issues Final and Proposed Regulations on Treatment of Gambling Winnings

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December 30, 2016

Earlier this week, the IRS issued final regulations and proposed regulations governing the reporting and withholding obligations, respectively, associated with gambling winnings. The regulations are being seen as a win for the gambling industry, who desired the changes made by the final rule and proposed rule.

Final Regulations on Bingo, Slot Machine, and Keno Winnings

The final regulations, issued under Code section 6041, only affect payers and payees of $1,200 or more in bingo and slot machine winnings or $1,500 or more in keno winnings. The final regulations add a new section, Treas. Reg. § 1.6041-10, addressing reporting of such winnings, which requires every payer of “reportable gambling winnings” (a term defined in the new regulations) that is engaged in a trade or business to generally make a separate information return with respect to each such payment.  The payer must report by filing Form W-2G, “Certain Gambling Winnings” with the IRS.  However, payers may choose to report under an aggregate method that allows payers to aggregate multiple payments made within an “information reporting period” (either a calendar day or a gaming day) to the same payee onto a single Form W-2G if certain requirements are satisfied.  If a gaming day is used, such as 6:00 am to 6:00 am, the final information reporting period of the year must end at midnight on December 31.

The final regulations generally track the proposed regulations issued in March 2015, with several changes. For example, the final regulations dropped proposed special reporting rules for electronically tracked slot machine play, a process that typically involves cumulative tracking of a player’s winnings and losses at a particular casino through the use of an electronic card.  Commenters had explained the challenges associated with implementing controls necessary to use the electronic data for tax purposes and had expressed concern with customer responses to the proposed automatic electronic tax reporting.  In addition, the final regulations maintain the threshold for required reporting after the IRS’s request for comments on lowering the threshold in the proposed regulations drew fierce opposition from gamblers and gaming companies alike.  The IRS declined, however, to raise the limits as requested by some commenters.

The final regulations also loosen the requirements related to payee identification. Consistent with the proposed regulations, payees will no longer need to present identification containing their social security number, but may instead provide a completed Form W-9.  The final regulations also permit the use of tribal identification guides issued by federally recognized Indian tribes.  If presented at a casino owned by the tribe that issued the card, it may be accepted even though it lacks a photograph.

The final regulations are effective today.

Proposed Regulations

The IRS also issued proposed regulations under Code section 3402(q) related to winnings from horse races, dog races, and jai alai. Changes to the regulations were requested by commenters who explained that changes in the type of bets made on those events have resulted in scenarios where the amount withheld greatly exceeds the actual tax liability.  In response, the proposed regulations would alter the method of calculating the amount of the wager in the case of parimutuel wagers, a type of bet that differs from the typical straight wager, made on horse races, dog races, and jai alai to produce more accurate withholding.  Under the proposed rules, all wagers placed in a single parimutuel pool and represented on a single ticket are permitted to be aggregated and treated as a single wager. In determining whether the winnings are subject to withholding and reporting, the total amount wagered in a particular pool reflected on a single ticket is considered by the payer.

Comments on the proposed regulations are due by March 30.

Two Notable FATCA Transition Rules Set to Expire January 1, 2017

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December 29, 2016

The Foreign Account Tax Compliance Act (FATCA) provided several transition rules that are set to expire on January 1, 2017, one related to limited branches and limited foreign financial institutions (FFIs), and one related to the deadline for sponsoring entities to register their sponsored entities with the IRS.

Limited Branches and Limited FFIs

FATCA included a transition rule to temporarily ease compliance burdens for certain FFI groups with members otherwise unable to comply with FATCA that will no longer be available beginning January 1, 2017. Under Treas. Reg. § 1.1471-4(a)(4), an FFI that is a member of an expanded affiliated group (EAG) can become a participating FFI or a registered deemed-compliant FFI, but only if all FFIs in its EAG are participating FFIs, registered deemed-compliant FFIs, or exempt beneficial owners.

However, certain FFIs in an EAG may be located in a country that prevents them from becoming participating FFIs or registered deemed-compliant FFIs. This can arise when the country does not have an intergovernmental agreement (IGA) with the United States to implement FATCA, and when domestic law in that country prevents FFIs located within its borders from complying with FATCA (e.g., preventing FFIs from entering into FFI agreements with the IRS).

The IRS included a transition rule for so-called “limited branches” and “limited FFIs” that eased the often harsh consequences of this rule by providing temporary relief for EAGs that included FFIs otherwise prevented from complying with FATCA, but the transition rule was only intended to ease the burden while the countries either negotiated IGAs with the United States or modified its local laws to permit compliance with FATCA, or while the EAGs decided whether to stop operating in that country. While the IRS announced in Notice 2015-66 its intent to extend the transition rule originally set to expire December 31, 2015 through December 31, 2016, no additional extension has been announced.  Accordingly, this transition rule will expire on January 1, 2017.

EAGs with limited branches or limited FFIs doing business in countries with local laws that prevent compliance with FATCA may be faced with a choice. If the EAG has FFIs located in non-IGA jurisdictions, the EAG will either need to stop doing business in those countries or the FFIs within the EAG that are resident in non-IGA jurisdictions will be treated as noncompliant with FATCA even if they could otherwise comply as participating FFIs.  FFIs resident in countries that have entered into IGAs will generally be unaffected by a “related entity” (generally, an entity within the same EAG) or branch that is prevented from complying with FATCA by local law, so long as each other FFI in the EAG treats the related entity as a nonparticipating financial institution, among other requirements.

This provision is contained in Article IV, Section 5 of all iterations of Treasury’s model IGA (e.g., Reciprocal Model 1A with a preexisting tax agreement, Nonreciprocal Model 1B and Model 2 with no preexisting tax agreements).  The primary effect of this IGA provision is that only the nonparticipating FFIs become subject to FATCA withholding while the EAG as a whole can remain untainted.

Sponsored Entity Registration

Another transition rule set to expire is the ability of sponsored entities to use the sponsoring entity’s global intermediary identification number (GIIN) on Forms W-8. Under FATCA, withholding is not required on payments to certain entities that are “sponsored” by entities that are properly registered with the IRS, under the theory that all FATCA requirements imposed on the sponsored entity (due diligence, reporting, withholding, etc.) will be completed by the sponsoring entity.  Under the transition rule, sponsored entities have been able to use the sponsoring entity’s GIIN on forms such as the W-8BEN-E, but beginning on January 1, 2017, certain sponsored entities will need to include their own GIIN.  This means that the sponsoring entity must register the sponsored entity with the IRS before that date.  If a sponsored entity required to include its own GIIN after December 31, 2016, on a withholding certificate furnishes a form containing only the sponsoring entity’s GIIN, a withholding agent may not rely on that withholding certificate under FATCA’s due diligence requirements.  In such instance, the withholding agent will be required to withhold 30% of any payment made to the sponsored entity.  Originally, sponsored entities were required to be registered with the IRS by December 31, 2015, but the deadline was extended by Notice 2015-66.  The IRS has not announced any additional extension and the FATCA registration portal began allowing sponsoring entities to register sponsored entities earlier this year.

D.C. Council Passes Mandatory Paid Leave Bill

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December 22, 2016

The District of Columbia Council passed a generous paid family leave bill on Tuesday by a 9-4 margin.  The bill will provide eight weeks of paid leave to new mothers and fathers, six weeks for employees caring for sick family members, and two weeks for personal sick leave.  As we explained in a prior post, the District will fund the new benefit with a new 0.62 percent payroll tax on employers.  Large employers, some of whom already provide similar benefits to employees, have been increasingly outspoken against the bill, taking issue with what it views as a bill requiring them to fund paid leave for small employers who do not currently offer such benefits.  Despite large employers’ strong lobbying effort, which were joined by Mayor Muriel Bowser, the bill still passed by a comfortable margin.  Mayor Bowser has not indicated whether she will sign the bill, but the 9-4 vote is sufficient to override a veto.  Regardless of Mayor Bowser’s decision, the program will likely not get off the ground until 2019 due to the administrative hurdles required to implement the new system.

IRS Finalizes Regulations Imposing Reporting Obligations on Foreign-Owned U.S. Entities

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December 13, 2016

Yesterday, the IRS issued final regulations that impose reporting obligations on a domestic disregarded entity wholly owned by a foreign person (foreign-owned DDE).  The final regulations amend Treasury Regulation § 301.7701-2(c) to treat a foreign-owned DDE as separate from its owner for purposes of reporting, recordkeeping, and other compliance requirements imposed under Code section 6038A.  The effect of these final regulations is to enhance the IRS’s access to information needed to enforce tax laws and international treaties and agreements.

We discussed the substance of these regulations in an earlier post, and the final regulations reflect the proposed regulations with only minor clarifying changes.  The primary clarification relates to the intent of the IRS to disallow the exceptions to the requirements of Code section 6038A for a foreign-owned DDE.  The proposed regulations explicitly disallowed two of these exceptions, but the application of two additional exceptions was left unclear.  In the final regulations, the IRS expressly prevents a foreign-owned DDE from utilizing either of the remaining two exceptions to the Code section 6038A reporting requirements.

Under the regulations, a transaction between a foreign-owned DDE and its foreign owner (or another disregarded entity of the same owner) would be considered a reportable transaction for purposes of the reporting and recordkeeping rules under Code section 6038A, even though the transaction involves a disregarded entity and generally would not be considered a transaction for other purposes (e.g., adjustment under Code section 482).  Thus, a foreign-owned DDE will be required to file Form 5472 for reportable transactions between the entity and its foreign owner or other foreign-related parties, and maintain supporting records.  Further, to file information returns, a foreign-owned DDE would have to obtain an Employer Identification Number by filing a Form SS-4 that includes responsible party information.

The final regulations reflect several other minor changes intended to ease the compliance burden for foreign-owned DDEs.  Specifically, a foreign-owned DDE has the same tax year as its foreign owner if the foreign owner has a U.S. tax return filing obligation, and if not, the foreign-owned DDE’s tax year is generally the calendar year.  The final regulations are applicable to tax years of entities beginning after December 31, 2016 and ending after December 12, 2017.

IRS Adds to Lists of Countries Subject to Bank Interest Reporting Requirements

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December 9, 2016

Earlier this week, the IRS issued Revenue Procedure 2016-56 to add to the list of countries subject to the reporting requirements of Code section 6049, which generally relate to reporting on bank interest paid to nonresident alien individuals.  Specifically, the Revenue Procedure adds Saint Lucia to the list of countries with which the U.S. has a bilateral tax information exchange agreement, and adds Saint Lucia, Israel, and the Republic of Korea to the list of countries with which Treasury and IRS have determined the automatic exchange of information to be appropriate.

Prior to 2013, interest on bank deposits was generally not required to be reported if paid to a nonresident alien other than a Canadian. In 2012, the IRS amended Treas. Reg. § 1.6049-8 in an effort to provide bilateral information exchanges under the intergovernmental agreements between the United States and partner jurisdictions that were being agreed to as part of the implementation of the Foreign Account Tax Compliance Act (FATCA).  In many cases, those agreements require the United States to share information obtained from U.S. financial institutions with foreign tax authorities.  Under the amended regulation, certain bank deposit interest paid on accounts held by nonresident aliens who are residents of certain countries must be reported to the IRS so that the IRS can satisfy its obligations under the agreements to provide such information reciprocally.

The bank interest reportable under Treas. Reg. § 1.6049-8(a) includes interest: (i) paid to a nonresident alien individual; (ii) not effectively connected with a U.S. trade or business; (iii) relating to a deposit maintained at an office within the U.S., and (iv) paid to an individual who is a resident of a country properly identified as one with which the U.S. has a bilateral tax information exchange agreement.  Under Treas. Reg. § 1.6049-4(b)(5), for such bank interest payable to a nonresident alien individual that exceeds $10, the payor must file Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” for the year of payment.

The list of countries will likely continue to expand as more countries enter into tax information exchange agreements with the U.S. in order to implement FATCA.

D.C. Council Moves Closer to Enacting Employer Payroll Tax to Create Nation’s Most Generous Family Leave Law

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December 7, 2016

On December 6, the District of Columbia Council advanced a bill known as the Universal Paid Leave Act of 2016.  The bill would impose an estimated $250 million in employer payroll taxes on local businesses to fund a paid leave benefit created by the bill.  The bill would raise the funds by creating a new employer payroll tax of 0.62%.  Self-employed individuals may also opt-in to the program by paying the tax.  Federal government employees and District residents who work outside of the District would not be covered by the bill.  However, Maryland and Virginia residents who work within the district would be covered and entitled to benefits from the government fund created by the bill.

If ultimately passed, the bill would require businesses to provide eight weeks of paid time-off for both full and part-time workers to care for newborn or adopted children.  The bill, which advanced on an 11-2 vote, will also guarantee six weeks of paid leave for workers to care for sick relatives, as well as two weeks of annual personal sick leave.  (Many employees would already qualify for unpaid leave under the Federal and District family and medical leave laws.)

A government insurance fund funded with the new employer payroll taxes would pay workers during their leaves. The bill provides for progressive payment rates, such that lower-income individuals receive a greater percentage of their normal salary during periods of time off covered by the program.  The fund created with the tax revenue would pay a base amount equal to 90% of a worker’s average weekly wage up to 150% of the District’s minimum wage.  (Based on the District’s current minimum wage laws, the base amount is expected to be calculated on up to $900 in weekly salary by the time the program would take effect based on a $15 per hour minimum wage rate that is currently being phased in.)  An employee whose average weekly wage exceeds 150% of the District’s minimum wage would receive the base amount plus 50% of the worker’s weekly wage above the District’s minimum wage.  Payments would be capped at $1,000 a week, with the cap being subject to increases for inflation beginning in 2021.

The bill must pass a final D.C. Council vote on December 20 and approval by District Mayor Muriel E. Bowser. A Bowser spokesman reported that the mayor was still undecided on the bill.  If the bill ultimately passes, benefits would likely not be available before 2019, as the District would need time to prepare and fund the program.

New Jersey and Pennsylvania Will Maintain Tax Reciprocal Agreement

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November 23, 2016

New Jersey Governor Chris Christie, who promised in September to revoke New Jersey’s 40-year-old tax reciprocal agreement with Pennsylvania, announced through a November 22 statement that he would continue the agreement.  Governor Christie had said he would eliminate the State of New Jersey and the Commonwealth of Pennsylvania Reciprocal Personal Income Tax Agreement unless the New Jersey legislature took steps to reduce public employee health insurance costs.

The stated impetus for scrapping the agreement was to make up for a budget deficit: cancelling the agreement was estimated to produce $180 million in revenue for New Jersey. Under the agreement, New Jersey and Pennsylvania residents who work in the other state are only required to file a tax return in their state of residence.  Pennsylvania residents working in New Jersey must file Form NJ-165, Employee’s Certificate of Nonresidence in New Jersey, and New Jersey residents working in Pennsylvania must file Form REV-419EX, Employee’s Nonwithholding Application Certificate, with their employers to avoid having New Jersey taxes withheld from compensation.

Without the agreement, residents of Pennsylvania and New Jersey who work in the other state would need to file two tax returns and claim a credit against taxes owed in their state of residence for taxes paid in their state of employment. Because Pennsylvania imposes a 3.07% flat tax and New Jersey imposes a graduated tax that is capped at 8.97%, New Jersey would greatly benefit from taxing the income of Pennsylvania residents working in New Jersey.  However, cancelling the agreement would have hurt many lower-income New Jersey residents who work in Pennsylvania (Philadelphia, in particular), as they would be forced to pay Pennsylvania’s 3.07% flat tax, instead of the lower New Jersey graduated rate.

However, Governor Christie stated that the agreement could continue due to the $200 million in savings caused by a public worker union-backed health care bill that was signed into law on November 21 (S2749).  The new legislation saves money by adjusting the process through which public workers receive their prescriptions.  Several major corporations that operate in New Jersey, including Subaru of America and Campbell Soup Co., have already praised the decision to maintain the agreement.

Change to Sentencing Guidelines Reflects DOJ’s Increased Employment Tax Enforcement Efforts

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November 21, 2016

Pursuant to amendments to the U.S. Sentencing Commission Guidelines Manual (Sentencing Guidelines), the background commentary to the Sentencing Guidelines no longer refers to violations of Code section 7202 as “infrequently prosecuted.” These amendments were passed by the Federal Sentencing Commission on May 5, 2016 and effective November 1, 2016.  Code section 7202 provides that any person who willfully fails to collect or truthfully account for and pay taxes when required shall be guilty of a felony and subject to a fine up to $10,000 and up to five years’ imprisonment. Defense attorneys had been using the “infrequently prosecuted” language to argue for more lenient sentences for Code section 7202 violations, and the Justice Department, citing the increase in prosecutions of Code section 7202 violations, had recommended that the language be removed because it is no longer true. For additional information on the change, please refer to our prior post.

According to Caroline Ciraolo, principal deputy assistant attorney general at the Justice Department’s Tax Division, the Tax Division was responsible for pushing the change through. Employment tax enforcement has been a top priority for the Tax Division in recent years, and Ciraolo noted that it should remain a priority even after she resigns when Obama leaves office.

Another Attempt to Repeal FATCA Is Introduced to Congress

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September 12, 2016

New legislation, H.R. 5935, has been introduced in Congress to repeal the Foreign Account Tax Compliance Act (FATCA), on the basis that FATCA violates Americans’ Fourth Amendment privacy rights.  Rep. Mark Meadows (R-NC) introduced the bill to the House on September 7, along with two original cosponsors.  The alleged privacy violations stem from requirements in FATCA that force foreign financial institutions to report all account holdings and assets of U.S. taxpayers to the IRS, or else face potential penalties in the form of 30% withholding on all U.S. source income.  According to Rep. Meadows’s press release, FATCA “requires a level” of disclosure that violates the Fourth Amendment, though Rep. Meadows offers no specific support for this claim.

If history is any indication, this latest repeal effort will fall flat. Prior attempts have been made to repeal FATCA, such as Senate Amendment 621 and Senate Bill 663, but none have succeeded.  Though S. 663 has not yet been officially defeated, its sponsor, Sen. Rand Paul, has pursued a lawsuit making similar claims without success, as we discussed in a prior post.

Israeli Court Threatens to Undermine FATCA Agreement

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September 8, 2016

Israel was nearing completion of the steps required to comply with the Foreign Account Tax Compliance Act (FATCA), but its attempt to comply may be in sudden jeopardy thanks to a recent Israeli court decision.  FATCA exchanges were to begin on September 1, but Justice Hanan Meltzer issued a temporary injunction that day that prevents FATCA-related regulations that would have permitted the exchange of information with the United States from going into effect.  The injunction was issued in response to a request filed August 8 by a group named Republicans Overseas Israel.  An emergency hearing is scheduled for September 12.

In July 2014, Israel signed an intergovernmental agreement with the United States to implement FATCA, under which it agreed to pass regulations to bring Israel into compliance with the agreement.  The Israeli parliament (Knesset) approved such regulations on August 2, which would have required Israeli financial institutions to report on certain accounts held by U.S. citizens to the Israel tax authority by September 20.  Financial institutions that failed to comply would face monetary penalties, in addition to the penalties that are required under FATCA, including 30% withholding on payments from the United States.

IRS Releases New Form on Which Small Businesses Should Claim Payroll Tax Credit for R&D Expenditures

The IRS released draft Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, which qualified small business (i.e., start-up businesses) will use to claim the new payroll tax credit available to start-up businesses for qualified research and development (R&D) expenses up to $250,000.  As we explained in a prior post, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) allowed start-up businesses to take advantage of the R&D tax credit by allowing them to offset the employer portion of the Social Security tax—the credit was previously only available to companies that could offset such expenditures against taxable income.  Also covered in that post were modifications to two existing forms to accommodate the reporting of the expanded R&D tax credit: Form 6765, Credit for Increasing Research Activities, and Form 941, Employer’s Quarterly Federal Tax Return.

The new form allows qualified small businesses to calculate the amount of the qualified small business payroll tax credit for the current quarter. Taxpayers will file Form 8974 quarterly by attaching it to Form 941.  Form 8974 calculates the amount of payroll tax credit available to the taxpayer based on Line 44 of the prior tax year’s Form 6765, and the amount of social security taxes reported for the quarter, which is pulled from Column 2 of Lines 5a and 5b of the Form 941 on which the credit is applied.  The amount reported on Line 12 of Form 8974 is the payroll tax credit that qualified small businesses should report on Line 11 of the Form 941 (generally, the amount of the total credit allowable based on the prior year’s Form 6765 or 50% of the reported Social Security tax reported on the Form 941 for the current quarter).

Notice 2016-48 Implements PATH Act’s ITIN Changes, Clarifies Application of New Rules to Information Returns

The IRS recently issued Notice 2016-48 to implement changes to the individual tax identification number (ITIN) program that had been adopted by Congress.  The notice explains the changes made to the ITIN program, as well as how the IRS plans to implement those changes, and the consequences to taxpayers who do not comply with the new rules.

ITINs are issued to taxpayers who are required to have a U.S. taxpayer identification number but who are not eligible to obtain a social security number.  As discussed in an earlier post, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), signed into law in December 2015, made it more difficult for nonresident aliens to maintain valid ITINs by amending Section 6109 of the Internal Revenue Code, the provision that permits the IRS to issue taxpayer identification numbers and request information to issue such numbers.  Specifically, under the PATH Act, Treasury must move toward an in-person ITIN application process, ITINs must be renewed to avoid expiration, and ITINs must be used to file a U.S. tax return to avoid expiration.

Application Procedures.  Under the current application procedures, taxpayers may apply for an ITIN by submitting Form W-7, Application for IRS Individual Taxpayer Identification Number by mail or in-person.  Notice 2016-48 does not execute Congress’s directive to establish an exclusively in-person application program, instead continuing the current application procedures, while the IRS takes additional time to determine how to implement the PATH Act’s mandate.  The IRS announced that further guidance will be issued.

ITIN Expiration.  The PATH Act made ITINs no longer indefinitely valid.  Any ITIN that is not used on a federal tax return for three consecutive years will expire on December 31 of the third year.  Taxpayers with an ITIN that has expired because they have not used it in three consecutive years may renew the ITIN any time after October 1, 2016 by submitting Form W-7 and the required accompanying documentation.

The PATH Act sets forth a schedule by which ITINs issued before 2013 will expire.  That schedule, which is based upon the issue date of the ITIN, was modified by Notice 2016-48 because many individuals do not know when their ITINs were issued, making the PATH Act’s schedule impractical.  Under Notice 2016-48, ITINs will expire under a multi-year schedule based upon the fourth and fifth digits of the ITIN.  Under this renewal system, ITINs with the middle digits 78 or 79 will expire on January 1, 2017, and future guidance will set forth the expiration schedule for other middle digit combinations.  The IRS will send Letter 5821 to individuals who used an ITIN with the middle digits 78 or 79 on a U.S. income tax return in any of the previous three years, notifying them of the upcoming expiration.

The IRS will accept returns with expired ITINs, but it warns taxpayers that processing delays may result and certain credits may not be allowed.  The processing delays and unavailability of certain credits could result in additional penalties and interest and a reduced refund.

Information Returns.  Expired ITINs are permitted to be used on information returns, meaning that holders of expired ITINs that are only used on returns filed by third parties, such as the Form 1099 or Form 1042 series, are not required to renew their ITINs.  Filers of information returns are not subject to penalties under Section 6721 or 6722 for the use of an expired ITIN on information returns. (However, many individuals who receive such information returns are required to file U.S. income tax returns necessitating that they renew their ITINs.)

IRS Releases Drafts of Forms 941 and 6765 to Enable R&D Payroll Tax Credit Under Section 3111(f)

The IRS released drafts of Form 941 and Form 6765 to facilitate a new payroll tax credit intended to allow start-up businesses to take advantage of the research and development (R&D) credit in Section 41 of the Internal Revenue Code.  In the past, start-up businesses took issue with the R&D tax credit because the credit was an income tax credit.  Because start-up businesses may not have taxable income for several years, they were not able to take advantage of the credit.

The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) expanded the R&D credit by adding new Sections 41(h) and 3111(f) to the Code.  Those sections allow “qualified small businesses” to elect to claim the credit (up to a maximum of $250,000) as a payroll tax credit. Those employers may elect to use the credit to offset the employer portion of Social Security tax.  It may not be used to reduce the amount of Social Security tax withheld from employees’ wages, nor may it be used to offset the employer or employee share of Medicare tax.  For purposes of the credit, a “qualified small business” is an employer with gross receipts of less than $5 million in the current taxable year and no more than five taxable years with gross receipts.  Qualified small businesses may claim the R&D payroll tax credit in tax years beginning after December 31, 2015.

The IRS added two lines to Form 941 (Employer’s Quarterly Federal Tax Return). Qualified small businesses will report the amount of the credit on Line 11 and report the total applicable taxes after adjustments and credits on Line 12.  In addition, qualified small businesses will elect to take a portion of the R&D credit as a payroll tax credit by completing new Section D on Form 6765 (Credit for Increasing Research Activities).  Comments on the forms can be submitted on the IRS web site.

The IRS subsequently released a draft Form 8974 that is used to calculate the payroll tax credit.

IRS Proposed Regulations Clarify College Tuition Reporting Requirements Following TPEA and PATH Act

The IRS released proposed regulations on July 29 to reflect changes made to the Form 1098-T reporting requirements by Congress as part of the Trade Preferences Extension Act of 2015 (TPEA) and the Protecting Americans from Tax Hikes Act of 2015 (PATH Act).  The proposed regulations were issued in response to requests for additional guidance made by college financial officers and industry analysts.  The proposed regulations were published in the Federal Register today, and they will become effective on the date that final regulations are published.

Penalty Relief.  The proposed regulations amend the regulations under Section 6050S of the Internal Revenue Code to reflect new Section 6724(f) of the Code.  That provision was added by the TPEA and prohibits the IRS from imposing information reporting penalties under Sections 6721 and 6722 on educational institutions for failing to include a correct TIN on Form 1098-T if the educational institution certifies under penalty of perjury that it complies with the IRS’s rules governing TIN solicitations.  The applicable TIN solicitation rules are the same as under the existing regulations.  In general, if the educational institution does not have a record of the individual’s correct TIN, it must solicit the TIN on or before December 31 of each year during which it receives payments of qualified tuition and related expenses or makes reimbursements, refunds, or reductions of such amounts with respect to the individual.  If the individual does not provide his or her TIN upon request, the institution must file Form 1098-T without the TIN but with all other required information.

Reporting Exceptions.  The TPEA amended Section 25A of the Code so that a taxpayer may only claim an education credit if it receives a Form 1098-T from the educational institution that includes all of the required information, including the taxpayer’s TIN.  The proposed regulations amend the existing regulations under Section 6050S of the Code to eliminate a number of exceptions to the Form 1098-T reporting requirement that the IRS determined would frustrate the purpose of TPEA by depriving students of the Form 1098-T required to claim an education credit for which they may otherwise be eligible.  The current regulations under Section 6050S provide four exceptions to the Form 1098-T reporting requirement: (i) nonresident aliens, except upon request by the nonresident alien; (ii) individuals whose qualified tuition and related expenses are paid entirely with scholarships; (iii) individuals whose qualified tuition and related expenses are paid under a formal billing arrangement; and (iv) information with respect to courses for which no academic credit is awarded.  The proposed regulations maintain the exception related to courses for which no academic credit is awarded but eliminate the other three reporting exceptions.

New Reporting Requirement.  Additionally, the proposed regulations require educational institutions to report the number of months that a student was a full-time student during the calendar year on Form 1098-T.  The change is intended to help the IRS determine whether a parent properly claimed the student as a dependent, and therefore, properly claimed the credit for the student’s educational expenses.  For this purpose, one day during a month is treated as an entire month.

Amounts Reported.  In addition, the PATH Act requires educational institutions to report the amount of payments actually received for qualified tuition and related expenses on Form 1098-T, rather than simply the amount of payments billed.  This requirement is carried through to the proposed regulations, subject to the transition relief announced in IRS Announcement 2016-17 that allows educational institutions to report the amount billed for 2016, as explained in our earlier article.

To determine the amount of payments received for qualified tuition and related expenses, the proposed regulations instruct educational institutions to treat payments received during a calendar year as payments received for qualified tuition and related expenses up to the amount billed for such expenses, and any amount in excess of the amount billed as payments for other expenses.

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.

U.S. Supreme Court Denies Cert Petition in Case Challenging Information Reporting Requirements

The Supreme Court denied the petition for certiorari filed by two bankers associations that sought to challenge the validity of IRS regulations issued under the Foreign Account Tax Compliance Act (FATCA) that impose a penalty on banks that fail to report interest income earned by nonresident aliens on accounts in U.S. banks.

The denial leaves in place a divided D.C. Circuit panel decision holding that the Anti-Injunction Act (AIA) bars the bankers associations from challenging the validity of the regulations.  The associations argued that a recent Supreme Court decision regarding the similar Tax Injunction Act, which relates to state taxation, allowed them to file suit under the Administrative Procedure Act to enjoin certain IRS information reporting requirements when the information is not subject to domestic taxation and the noncompliance penalty does not constitute a restraint on the “assessment or collection” of a tax.  The D.C. Circuit accepted the government’s contention that because the penalties for noncompliance under Sections 6721 and 6722 are treated as a tax, the AIA bars pre-assessment challenges to the reporting requirements of the regulations.

The decision leaves those required to file information returns without recourse to challenge an information reporting requirement unless they forego the required reporting and are assessed a penalty under Section 6721 or 6722.

Additional discussion of this case can be found in our April 27 and March 1 posts.

IRS PLR: No Reporting Obligation for Facilitator of Tax Refund Payments

In PLR 201622011, the IRS ruled that a company (the “Taxpayer”) whose primary business is to assist tax return software providers, transmitters, and tax professionals by helping their clients (individual taxpayers) obtain refunds has no reporting obligation under either Section 6050W or 6041 of the Code. The IRS’s analysis of the reporting obligations under both Sections 6041 and 6050W emphasizes that the Taxpayer’s lack of control of the funds, as well as the Taxpayer’s contractual relationship to the other parties in the transaction, is a critical element of each provision.

The Taxpayer enters into agreements with various commercial banks and issuers of prepaid/stored value cards, which allows the Taxpayer to offer the clients several ways to receive their tax refunds. Under the agreement, the banks set up a temporary deposit account for each client that holds each client’s tax refund. The client may elect to have the bank fees and fees for the bank’s and tax preparer’s services directly deducted from the refund once it is deposited into this account. The Taxpayer receives a processing fee for each transaction, which the bank remits to the Taxpayer on a monthly basis—this is the Taxpayer’s sole source of revenue. The Taxpayer’s connection to the funds in each account is essentially limited to instructing the banks on the proper amount to disburse to the clients.

Section 6050W

Section 6050W imposes information reporting requirements on “payment settlement entities,” including third party settlement organizations (TPSOs), aggregated payees, and electronic payment facilitators with respect to payments made in settlement of reportable payment transactions. The IRS ruled that the Taxpayer was not obligated to file an information return under Section 6050W because it was not a TPSO, aggregated payee, or electronic payment facilitator. According to the ruling, the taxpayer was not a TPSO because it did not guarantee the payments. The Taxpayer was also not an aggregated payee because it neither received payment from a payment settlement entity nor distributed payments to the clients. Finally, the Taxpayer was not an electronic payment facilitator because it facilitated payments on behalf of the clients (the individual taxpayers), and not on behalf of payment settlement entities.

Section 6041

The IRS analyzed the Taxpayer’s participation in the underlying payment transactions, and it concluded that the Taxpayer had no reporting obligation under Section 6041 because the Taxpayer “is not making a payment” but is instead merely “submitting instructions to the Bank on how a particular Client’s refund should be disbursed.”

IRS Reports Automatic Alerts for Missed Employment Tax Payments Already Improving Compliance

In a previous post, we discussed the improved automated system that the IRS implemented to issue more timely and accurate federal tax deposit (FTD) alerts to employers that may owe employment taxes at the end of a quarter.  FTD alerts are generated automatically by the Electronic Federal Tax Payment System (EFTPS) and notify employers of potential employment tax violations by comparing  employment tax deposits against those made during the same quarter in the previous year.  The IRS has improved the algorithm used to identify potential missed payments.   Previously, the system would not generate an FTD alert to the employer until the 13th week of the quarter.  The new algorithm allows the IRS to predict when an employer may owe employment taxes at quarter end, which will allow the agency to issue FTD three times during the quarter.  According to a director in the IRS Small Business/Self-Employed Division, Darren Gulliot, the IRS has been studying employers’ responses to certain types of IRS outreach, such as field visits, soft notices, and prerecorded messages, to determine the most effective types of outreach.  These combined efforts have resulted in a more than 50% decrease in the number of FTD alerts issued during the first three months of 2016 when compared to that same time period in 2015, and the alerts issued have become more accurate, meaning that fewer employers will receive FTD alerts, but the ones who do receive them will likely be liable for employment tax that quarter.

The IRS is modifying the system to notify the IRS of potential missed payments within 48-72 hours rather than 12-13 weeks under the current system.

 

New ITIN Requirements in PATH Act Pose Challenges for Taxpayers and IRS

The PATH Act, signed into law in December 2015, may cause trouble for nonresident aliens who use individual tax identification numbers (ITINs) to file U.S. tax returns, as it creates additional hurdles to maintain a valid ITIN.  First, ITINs granted before 2013 must be renewed between 2017 and 2020 pursuant to a staggered schedule or they will expire.  Second, if an individual fails to file a U.S. tax return for three years, their ITIN will expire.  Third, the Treasury must adopt a system that will require in-person ITIN applications.

The new requirements are part of Congress’s attempts to reform certain IRS programs in order to improve their reliability, but it will likely inconvenience many taxpayers seeking to acquire ITINs.  Nonresident alien individuals need to obtain an ITIN to complete a Form 8233 asserting treaty relief from withholding on personal services income.  The process is already a difficult one for many nonresident alien taxpayers due to various procedural hurdles—such as obtaining a written denial letter from the Social Security Administration—that already existed.  Moreover, many nonresident aliens whose income is exempt from U.S. tax under a treaty do not file a Form 1040-NR and attach Form 8833 as required.  The changes in the PATH Act may force them to meet this filing requirement.

The result of the changes will increase the volume of applicants, since many will need to be renewed in the coming years.  Speaking at the recent American Bar Association Section of Taxation meeting in Washington, D.C., Julie Hanlon-Bolton, a representative from the IRS Wage and Investment Division, stated that the IRS is currently debating whether the ITIN offices will require additional staffing, and whether new or expanded offices may be needed in Austin, Texas.  This would require employing additional certified acceptance agents.  A certified acceptance agent is someone who has been trained to verify the authenticity of identification documents and trained in the process for a person to apply for an ITIN.

Government Files Brief Opposing Supreme Court Review of Bankers Associations’ Challenge to FATCA Reporting Requirements

The government filed its brief in opposition to a petition for certiorari seeking Supreme Court review of a decision holding that the Anti-Injunction Act prevents two banking associations from challenging a Treasury regulation requiring banks to report the amount of interest earned by nonresident alien account holders.  The banks are concerned with the substantial numbers of nonresident customers that have closed their accounts out of fear that the banks will disclose their information to the customers’ home governments.  As discussed in greater detail in a previous post, the bankers associations have gained support in the form of three amicus briefs, which generally highlight the tendency of the IRS to overstep its statutory authority and the unfairness that would result if banks are required to violate the rule and expose themselves to possible civil and criminal penalties in order to legally challenge the substance of the rule.

The government’s brief in opposition argues that the Court of Appeals for the D.C. Circuit was correct to deny the challenge on the grounds that the Anti-Injunction Act prevents the suit, stating that the holding does not conflict with any existing court of appeals decision.  However, the government had to address a new argument raised by the bankers associations in its petition for certiorari—that the Anti-Injunction Act does not apply because the alternative method of judicial review, to pay the penalty and then sue for a refund, is inadequate.  The government argued that this position was not raised until the petition for rehearing, and thus the position is time-barred.

Court Dismisses Sen. Rand Paul’s Challenge to FATCA

The U.S. District Court for the Southern District of Ohio dismissed a challenge to the Foreign Account Tax Compliance Act (FATCA) brought by Senator Rand Paul and several current and former U.S. citizens living abroad on standing grounds (Crawford v. United States Department of the Treasury).  The plaintiffs had argued that FATCA’s withholding and reporting requirements imposed on individuals and foreign financial institutions (FFIs), certain intergovernmental agreements (IGAs) negotiated by the Treasury, and the requirement to file a foreign bank account report (FBAR) by U.S. persons with financial accounts that exceed $10,000 in a foreign country were unconstitutional.

The court evaluated the requirements necessary for Article III standing and concluded that none of the individuals named in the suit had suffered or was about to suffer injury under the FATCA withholding tax, and, since all were individuals, none of the named plaintiffs could be FFIs subject to the requirements imposed on such entities.  Instead of asserting concrete particularized injuries, such as penalties brought for failure to comply with FATCA or FBAR requirements, the plaintiffs argued general “discomfort” with the disclosure requirements (Senator Paul also asserted a loss of political power), which the court deemed too abstract and thus insufficient to confer Article III standing.

IRS Releases New W-8BEN-E and Instructions

On April 13, the IRS released a revised version of Form W-8BEN-E, which is used by foreign entities to report their U.S. tax status and identity to withholding agents. Accompanying updated instructions were also released. The new Form W-8BEN-E, which had not been updated since 2014, includes several notable new items. First, 10 check boxes have been added to Part III, Item 14b, “Claim of Tax Treaty Benefits,” to require the foreign entity to identify which limitations on benefits provision it satisfies. The updated instructions include substantial information on these limitations on benefits provisions.

The second significant change relates to the requirement that certain disregarded entities complete Part II. Disregarded entities generally do not complete Form W-8BEN-E, but disregarded entities that receive withholdable payments and either (i) have a Global Intermediary Identification Number (GIIN) or (ii) is a branch of a foreign financial institution (FFI) in a country other than the FFI’s country of residence. Part II previously did not state that a disregarded entity with a GIIN must complete Part II.

The third notable change is in Part IV and Part XII, which now contains a place for sponsored entities and sponsoring entities to provide their GIINs. In Notice 2016-66, the IRS extended the deadline for sponsored entities to obtain their own GIINs to December 31, 2016, from December 31, 2015. In October 2015, the IRS updated the FATCA registration portal to allow sponsoring entities to register their sponsored entities and obtain GIINs for them. The change to the Form W-8BEN-E reflects the increase in sponsored entities receiving their own GIINs as the deadline approaches.

The FATCA regulations permit withholding agents to accept prior versions of Form W-8BEN-E for up to six months following the revision date shown on the new form, and withholding agents may continue to rely on prior versions of the form for the validity period provided under the FATCA regulations. Accordingly, withholding agents may accept the February 2014 version of the Form W-8BEN-E through October 2016. For Form W-8BEN-E, the validity period generally starts on the signature date and ends on the last day of the third subsequent calendar year, absent a change in circumstances.

Need for Increased Understanding of Multinational Corporate Structures Leads to Electronic Country-by-Country Reporting

In order to increase understanding of the ways in which multinational corporations structure their operations, the Organization for Economic Co-Operation and Development (OECD) will require jurisdictions to exchange such information in a standardized format beginning in 2018.  Specifically, multinational corporations must report revenue, profit or loss, capital and accumulated earnings, and number of employees for each country in which they operate.  Each jurisdiction’s tax administration uses these reports to identify the bases of economic activity for each of these companies, with the goal being to limit tax base erosion and profit shifting.  The tax administrations then exchange the reports, a process that the OECD hopes to streamline through use of this standardized format.

The new reporting template, named the “CbC XML Schema,” applies to corporations with annual consolidated revenue of at least €750 million (US$842 million) in the immediately preceding fiscal year.  The template will apply to all countries that have adopted the multilateral competent authority agreement (MCAA) on the exchange of country-by-country reports, which currently includes thirty-two countries.  Notably, the United States has not signed the agreement, but it intends to implement country-by-country reporting through bilateral agreements.  Although the primary purpose of the reports will be inter-jurisdictional, corporations may also rely on the report for domestic reporting purposes, so long as the report is mandated domestically.

IRS Clarifies Notice 2016-8 to Reduce Reporting Burden on FFIs

The IRS recently corrected Notice 2016-8, previously released on January 19, 2016.  The notice announced that the IRS intended to modify several portions of the FATCA regulations to ease burdens on foreign financial institutions (FFIs), largely in response to practitioner comments and provided that taxpayers may rely on the notice until the regulations are amended.  The Notice was amended to clarify that the time allowed for a participating FFI or reporting Model 2 FFI to provide the preexisting account certification also requires a certification that the FFI did not maintain practices and procedures to assist account holders in the avoidance of Chapter 4 of the Code.  Second, the Notice was amended to remove a requirement in the regulations that obligated registered deemed-compliant FFIs that manage accounts of nonparticipating FFIs to provide transitional reporting to the IRS of all “foreign reportable amounts” paid to or with respect to the account.  The changes made to the FATCA regulations in Notice 2016-8 can now be summarized as follows:

1. Certain financial institutions will have more time to certify accounts, as the timing requirements are eased for certain reporting of participating FFIs, reporting Model 2 FFIs, and local FFIs or restricted funds.  Under current rules, participating FFIs and reporting Model 2 FFIs must certify that they did not have practices and procedures to assist account holders in the avoidance of Chapter 4 (“preexisting account certification”).  The preexisting account certification must be made no later than 60 days following the date that is two years after the effective date of the FFI agreement.  Additionally, financial institutions are required to periodically certify to the IRS that they have complied with the terms of the FFI agreement.  Notice 2016-8 delays the date by which such FFIs must furnish the preexisting account certification, stating that they need not furnish it until the date on which the first periodic certification is due.  Notice 2016-8 also delays the date on which the first periodic certification is due, making it due on or before the July 1 of the calendar year following the certification period.  These same changes are made with respect to reporting for registered deemed-compliant FFIs that are local FFIs or restricted funds, but the certification period date is also delayed to the later of the date the FFI registered as a certified deemed-compliant FFI or June 30, 2014.

2. Reporting of accounts of nonparticipating FFIs maintained by participating FFIs has been delayed, with the IRS stating that it did not intend for the regulations to require such reporting prior to the date by which participating FFIs are required to report financial information of U.S. accounts.  Accordingly, Notice 2016-8 eliminates 2015 reporting of “foreign reportable amounts” with respect to nonparticipating FFI accounts maintained by a participating FFI.  Such reporting is now not needed until 2016.

3. Withholding agents will be able to rely on electronic Forms W-8 and W-9 collected by intermediaries and flow-through entities.  In general, electronic Forms W-8 and W-9 must be collected through an electronic system that meets certain requirements, including that the form be signed electronically under penalties of perjury by the person whose name appears on the form. Withholding agents have been reluctant to accept electronic Forms W-8 and W-9 collected by nonqualified intermediaries, nonwithholding partnerships, and nonwithholding trusts because they could not confirm the electronic signature.  Notice 2016-8 makes clear that withholding agents may rely on electronic Forms W-8 and W-9 provided by NQIs, NWPs and NWTs collected through an electronic system provided that the NQI, NWP or NWP provides a written statement verifying that the system meets the requirements of Treas. Reg. § 1.1441-1(e)(4)(iv), § 1.1471-3(c)(6)(iv), or Announcement 98-27, as applicable, and the withholding agent does not have actual knowledge that the statement is false.

Banking Associations Challenge IRS Reporting Requirements for Foreign Account Holders

On January 29, two bankers associations filed a petition for certiorari seeking U.S. Supreme Court review of a decision from the United States Court of Appeals for the District of Columbia Circuit that the Anti-Injunction Act prevents them from challenging a Treasury regulation requiring banks to report the amount of interest earned by nonresident alien account holders.  The regulations, contained in Treas. Reg. §§ 1.6049-4 and -8, were issued pursuant to Treasury’s authority granted to it by Congress in the Foreign Account Tax Compliance Act (FATCA).  The regulations are intended to help the U.S. comply with its obligation to turn over certain information about foreign assets held in U.S. banks in exchange for other countries providing information to Treasury about U.S. assets held overseas.

The bankers associations argue that the IRS requirements will cause far more harm to banks than anticipated, asserting that the IRS violated laws mandating a cost benefit analysis of certain regulations.  Though the focus of the litigation has been a procedural hurdle preventing the lawsuit, the case could have significant implications if the bankers associations are able to challenge the regulations.  Currently, the banks claim that the regulations have caused substantial numbers of nonresident customers to close their accounts out of fear that the banks will disclose their information to the customers’ home governments.  The banks are concerned that the outflow of these deposits will outweigh the revenue benefits of the FATCA regulations, which are supposed to arise from a clampdown on U.S. tax evaders.  As a result, the bankers associations seek to overturn the appeals court decision preventing them from challenging the rule without first violating it, since violation could result in institutional fines and criminal imprisonment of their officers.  The Court of Appeals rules that the Anti-Injunction Act prevents the court from enjoining the reporting requirement because the penalty for noncompliance with the reporting obligation is the imposition of penalties under section 6721, and such penalties are treated as taxes.

In late February, the bankers associations’ request  gained support in the form of three amicus briefs.  The first, written by Minnesota Law School professor Kristin E. Hickman, argues that the IRS has a history of overstepping its statutory authority and has done so again with the regulations at issue.  The second, filed by the Cause of Action Institute, argues that more robust judicial review of IRS rulemaking is required and that a taxpayer should not be required to violate the law before having the ability to challenge the legality of the rule.  The final amicus brief, filed by the National Federation of Independent Business Legal Center and the Cato Institute, similarly argues that Treasury has strayed from the requirements of the Administrative Procedure Act and that the Supreme Court should resolve the interpretative split between the Anti-Injunction Act and the Tax Injunction Act to allow lower courts to properly adjudicate challenges to tax regulations.