IRS Releases Five CbC Reporting Agreements

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June 9, 2017

The IRS has released the first set of competent authority arrangements (CAAs) for the automatic exchange of country-by-country (CbC) reports, with Iceland, Norway, the Netherlands, New Zealand, and South Africa.  These CAAs are implemented under Action 13 of the Organization for Economic Co-Operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project, requiring jurisdictions to exchange standardized CbC reports beginning in 2018.  Specifically, under the OECD’s Guidance (see prior coverage regarding recent updates), multinational enterprise (MNE) groups with $750 million Euros or a near equivalent amount in domestic currency must report revenue, profit or loss, capital and accumulated earnings, and number of employees for each country in which they operate.  These CbC reports will assist each jurisdiction’s tax authorities to identify the bases of economic activity for each of these companies, in order to combat tax base erosion and profit shifting.

The CAAs are substantially similar, and each requires the competent authorities of the foreign country and the United States to exchange annually, on an automatic basis, CbC reports received from each reporting entity that is a tax resident in its jurisdiction, provided that one or more constituent entities of the reporting entity’s group is a tax resident in the other jurisdiction, or is subject to tax with respect to the business carried out through a permanent establishment in the other jurisdiction.  Each competent authority is to notify the other competent authority when it has reason to believe that CbC reporting is incorrect or incomplete or the reporting entity did not comply with its CbC reporting obligations under domestic law.

The CAAs provide an aggressive implementation schedule.  Generally, a CbC report is intended to be first exchanged with respect to fiscal years of MNEs commencing on or after January 1, 2016 (or January 1, 2017 in the case of Iceland).  This CbC report is intended to be exchanged as soon as possible and no later than 18 months after the last day of the MNE’s fiscal year to which the report relates.  For fiscal years of MNEs commencing on or after January 1, 2017 (or January 1, 2018 in the case of Iceland), the CbC reports are intended to be exchanged as soon as possible and no later than 15 months after the last day of the fiscal year.

In the United States, CbC reporting is required for U.S. persons that are the ultimate parent entity of a MNE with revenue of $850 million or more in the preceding accounting year, for taxable years beginning on or after June 30, 2016, under the IRS’s final regulations issued last summer (see prior coverage).  Reporting entities must file a new Form 8975, the “Country by Country Report,” which the IRS is currently developing.

We will provide updates upon the release of additional CAAs, the Form 8975, and OECD guidance on CbC reporting.

IRS FATCA Portal Now Accepting FFI Agreement Renewals

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June 6, 2017

Today, the IRS announced that it has updated the FATCA registration system to allow foreign financial institutions (FFIs) to renew their FFI agreements.  A new link, “Renew FFI Agreement” appears on the registration portal’s home page allowing a financial institution (FI) to determine whether it must renew its FFI agreement (see prior coverage).  The FI can review and edit its registration form and information, and renew its FFI agreement.

All FIs whose prior FFI agreement expired on December 31, 2016, and that wish to retain their Global Intermediary Identification Number (GIIN) must do so by July 31, 2017, to be treated as having in effect an FFI agreement as of January 1, 2017.  FFIs that are required to update their FFI agreement and that do not do so by July 31, 2017, will be treated as having terminated their FFI agreement as of January 1, 2017, and may be removed from the IRS’s FFI list, potentially subjecting them to withholding under FATCA.

IRS Approves First Group of Certified PEOs under Voluntary Certification Program

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June 5, 2017

Last week, the IRS announced that it issued notices of certification to 84 organizations that applied for voluntary certification as a certified professional employer organization (CPEO), nearly a year after the IRS finished implementing this program (see prior coverage).  The IRS will publish the CPEO’s name, address, and effective date of certification, once it has received the surety bond.  Applicants that have yet to receive a notice of certification will receive a decision from the IRS in the coming weeks and months.

Congress enacted Code sections 3511 and 7705 in late 2014 to establish a voluntary certification program for professional employer organizations (PEOs), which generally provide employers (customers) with payroll and employment services.  Unlike a PEO, a CPEO is treated as the employer of any individual performing services for a customer with respect to wages and other compensation paid to the individual by the CPEO.  Thus, a CPEO is solely responsible for its customers’ payroll tax—i.e., FICA, FUTA, and RRTA taxes, and Federal income tax withholding—liabilities, and is a “successor employer” who may tack onto the wages it pays to the employees to those already paid by the customers earlier in the year.  The customers remain eligible for certain wage-related credits as if they were still the common law employers of the employees.  To become and remain certified, CPEOs must meet certain tax compliance, background, experience, business location, financial reporting, bonding, and other requirements.

The impact of the CPEO program outside the payroll-tax world has been limited thus far.  For instance, certification does not provide greater flexibility for PEO sponsorship of qualified employee benefit plans.  In the employer-provided health insurance context, the certification program leaves unresolved issues for how PEOs and their customers comply with the Affordable Care Act’s employer mandate (see prior coverage).  While the ACA’s employer mandate may become effectively repealed should the Senate pass the new American Health Care Act (AHCA) after the House of Representatives did so last month (see prior coverage here and here), the AHCA would impose its own information reporting requirements on employers with respect to offers of healthcare coverage or lack of eligible healthcare coverage for their employees.  It remains to be seen if the AHCA becomes law, what information reporting requirements will remain, and how PEOs and CPEOs can alleviate these obligations for their customers.

First Friday FATCA Update

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June 2, 2017

Since our last FATCA Update, the IRS has published a reminder that foreign financial institutions (FFIs) required by FATCA to renew their FFI agreements must do so by July 31, 2017.  The IRS released an updated FFI agreement on December 30, 2016, that is effective on or after January 1, 2017 (see prior coverage).  All financial institutions (FIs) whose prior FFI agreement expired on December 31, 2016, and that wish to retain their Global Intermediary Identification Number (GIIN) must do so by July 31, 2017 to be treated as having in effect an FFI agreement as of January 1, 2017.  According to the IRS, a new “Renew FFI Agreement” link will become available on the FFI’s account homepage in a future update to the FATCA registration portal.

Generally, FATCA requires the following types of FIs to renew their FFI agreements: participating FFIs not covered by an intergovernmental agreement (IGA); reporting Model 2 FFIs; reporting Model 1 FFIs operating branches outside of Model 1 jurisdictions.  By contrast, renewal is not required for reporting Model 1 FFIs that are not operating branches outside of Model 1 jurisdictions; registered deemed-compliant FFIs (regardless of location); sponsoring entities; direct reporting non-financial foreign entities (NFFEs); and trustees of trustee-documented trust.

Since our last update, Treasury has not published any new intergovernmental agreements (IGAs), and the IRS has not published any new competent authority agreements (CAAs).  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.

Information Reporting Provisions of AHCA Unchanged from Earlier Bill

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May 5, 2017

Yesterday, the House of Representatives narrowly passed the American Health Care Act (AHCA) on a near party-line vote, 217-213.  The legislation would repeal many provisions of the Affordable Care Act (ACA) but would retain and expand many of the ACA’s information reporting requirements.  After the House failed to pass the AHCA in late March, Republicans have worked to secure additional support for the legislation.

Although Republicans made changes to the legislation to enable it to pass the House, those changes do not substantively effect the information reporting provisions, including the new health insurance coverage credit reporting under section 6050X beginning in 2020, Form W-2 reporting of employer offers of coverage beginning in 2020, and the additional reporting required by providers of minimal essential coverage under Code section 6055.  (See earlier coverage here.)

The legislation faces an uncertain future in the Senate, where budget reconciliation rules and tepid support from some Republicans may make it difficult to secure passage.

First Friday FATCA Update

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May 5, 2017

Since our last monthly FATCA update, the OECD issued an array of guidance on country-by-country (CbC) reporting and automatic exchange of tax information (see prior coverage). In addition, the IRS released the Competent Authority Agreement (CAA) implementing the Model 1B Intergovernmental Agreement (IGA) between the United States and Algeria entered into on October 13, 2015.

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.

IRS Provides Interim Guidance for Claiming Payroll Tax Credit for Research Activities

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April 19, 2017

The Treasury and the IRS recently released Notice 2017-23 providing interim guidance related to  the payroll tax credit for research expenditures by qualified small businesses under Code § 3111(f).  (See prior coverage.)  Specifically, the notice provides interim guidance on the time and manner of making the payroll tax credit election and claiming the credit, and on the definitions of “qualified small business” and “gross receipts.”  Comments are requested by July 17, 2017.

Code § 41(a) provides a research tax credit against federal income taxes.  Effective for tax years beginning after December 31, 2015, Code §§ 41(h) and 3111(f) allow a “qualified small business” to elect to apply a portion of the § 41(a) research credit against the employer portion of the social security tax under the Federal Insurance Contributions Act.  Generally, a corporation, partnership, or individual is a qualified small business if its “gross receipts” are less than $5 million and the entity did not have gross receipts more than 5 years ago.  The election must be made on or before the due date of the tax return for the taxable year (e.g., Form 1065 for a partnership, or Form 1120-S for an S corporation).  The amount elected shall not exceed $250,000, and each quarter, the amount that the employer may claim is capped by the employer portion of the social security tax imposed for that calendar quarter.

The notice provides that, to make a payroll tax credit election, a qualified small business must attach a completed Form 6765 to its timely filed (including extensions) return for the taxable year to which the election applies.  The notice provides interim relief for qualified small businesses that timely filed returns for taxable years on or after December 31, 2015, but failed to make the payroll tax credit election.  In this case, the entity may make the election on an amended return filed on or before December 31, 2017.  To do so, the business must either: (1) indicate on the top of its Form 6765 that the form is “FILED PURSUANT TO NOTICE 2017-23”; or (2) attach a statement to this effect to the Form 6765.

A qualified small business can claim the payroll tax credit on its Form 941 for the first calendar quarter beginning after it makes the election by filing the Form 6765.  Similarly, if the qualified small business files annual employment tax returns, it may claim the credit for the return that includes the first quarter beginning after the date on which the business files the election.  A qualified small business claiming the credit must attach a completed Form 8974 to the employment tax return.  On the Form 8974, the taxpayer filing the employment tax return claiming the credit provides the Employer Identification Number (EIN) used on the Form 6765.

For qualified small businesses filing quarterly employment tax returns, they must use the Form 8974 to apply the social security tax limit to the amount of the payroll tax credit it elected on Form 6765 and to determine the amount of the credit allowed on its quarterly employment tax return.  If the payroll tax credit elected exceeds the employer portion of the social security tax for that quarter, then the excess determined on the Form 8974 is carried over to the succeeding calendar quarter(s), subject to applicable social security tax limitation(s).

The notice also provides guidance for purposes of defining a “qualified small business.”  Specifically, the notice provides that the term “gross receipts” is determined under Code § 448(c)(3) (without regard to Code § 448(c)(3)(A)) and Treas. Reg. § 1.448-1T(f)(2)(iii) and (iv)), rather than Code § 41(c)(7) and Treas. Reg. § 1.41-3(c).  Therefore, gross receipts for purposes of the notice do not, as Treas. Reg. § 1.41- 3(c) does, exclude amounts representing returns or allowances, receipts from the sale or exchange of capital assets under Code § 1221, repayments of loans or similar instruments, returns from a sale or exchange not in the ordinary course of business, and certain other amounts.

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.

First Friday FATCA Update

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April 7, 2017

Since our last monthly FATCA update, we have addressed the following recent FATCA developments:

  • The IRS updated the list of countries subject to bank interest reporting requirements (see prior coverage).
  • The IRS released new FATCA FAQs addressing date of birth and foreign TIN requirements for withholding certificates (see prior coverage).
  • The IRS extended the deadline for submitting qualified intermediary agreements and certain other withholding agreements from March 31, 2017 to May 31, 2017 (see prior coverage).

Recently, the IRS released the Competent Authority Agreement (CAA) implementing the Model 1B Intergovernmental Agreement (IGA) between the United States and the Bahamas entered into on November 3, 2014.

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.

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.

IRS Guidance on Reporting W-2/SSN Data Breaches

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April 6, 2017

The IRS recently laid out reporting procedures for employers and payroll service providers that have fallen victim to various Form W-2 phishing scams.  In many of these scams, the perpetrator poses as an executive in the company and requests Form W-2 and Social Security Number (SSN) information from an employee in the company’s payroll or human resources departments (see prior coverage).  If successful, the perpetrator will immediately try to monetize the stolen information by filing fraudulent tax returns claiming a refund, selling the information on the black market, or using the names and SSNs to commit other crimes.  Thus, time is of the essence when responding to these data breaches.

According to the IRS’s instructions, an employer or payroll service provider that suffers a Form W-2 data loss should immediately notify the following parties:

  1. IRS. The entity should email dataloss@irs.gov, with “W2 Data Loss” in the subject line, and provide the following information: (a) business name; (b) business employer identification number (EIN) associated with the data loss; (c) contact name; (d) contact phone number; (e) summary of how the data loss occurred; and (f) volume of employees impacted.  This notification should not include any employee personally identifiable information data.  Moreover, the IRS does not initiate contact with taxpayers by email, text messages, or social media channels to request personal or financial information.  Thus, these types of requests should not be taken as IRS requests.
  2. State tax agencies. Since any data loss could affect the victim’s tax accounts with the states, the affected entity should email the Federal Tax Administrators at StateAlert@taxadmin.org for information on how to report the victim’s information to the applicable states.
  3. Other law enforcement officials. The entity should file a complaint with the FBI’s Internet Crime Complaint Center (IC3), and may be asked to file a report with their local law enforcement agency.
  4. Employees. The entity should ask its employees to review the IRS’s Taxpayer Guide to Identity Theft and IRS Publication 5027 (Identity Theft Information for Taxpayers).  The Federal Trade Commission (FTC) suggests that victims of identity theft take various immediately actions, including: (a) filing a complaint with the FTC at identitytheft.gov; (b) contacting one of the three major credit bureaus to place a “fraud alert” on the victim’s credit card records; and (c) closing any financial or credit accounts opened by identity thieves.

The IRS has also established technical reporting requirements for employers and payroll service providers that only received the phishing email without falling victim.  Tax professionals who experience a data loss also should promptly report the loss pursuant to the IRS’s procedures.

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.

Poor Design and Poor Defense Sink Employee Discount Plan

A recent IRS Field Attorney Advice (FAA) memorandum highlights the risk of poorly designed employee discount plans.  In FAA 20171202F, the IRS Office of Chief Counsel determined that an employer was liable for failing to pay and withhold employment taxes on employee discounts provided under an employee discount plan that failed to satisfy the requirements for qualified employee discounts under Code section 132(c).  The FAA also suggests that had the employer either kept or provided better records of the prices at which it provided services to select groups of customers, the result may have been different.  In the FAA, the IRS applied the fringe benefit exclusion for qualified employee discounts to an employer whose business information was largely redacted.  Under the employee discount program considered, an employee and a set number of participants designated by each employee (including the employee’s family members and friends) were eligible for discounts on certain services provided by the employer.  The Treasury Regulations under section 132(c) permit employers to offer employees and their spouses and dependent children non-taxable discounts of 20 percent on services sold to customers.

The employer argued that, although the discounts provided under the program exceeded the 20 percent limit applicable to discounted services when compared to published rates, they were in most cases less than the discount rates the employer offered to its corporate customers and members of certain programs.   The Treasury Regulations provide that an employee discount is measured against the price at which goods or services are sold to the employer’s customers.  However, if a company sells a significant portion of its goods or services at a discount to discrete customers or consumer groups—at least 35 percent—the discounted price is used to determine the amount of the employee discount.  Despite the employer’s argument that the determination of the amount of the employee discounts should not be based on the published rates, the IRS refused to apply this special discount rule for lack of adequate substantiation.  Although the employer provided the IRS with bar graphs showing the discounts it gave to various customers, the employer did not substantiate the information on the graphs or provide the IRS with evidence showing what percentage of its total sales were made from each of the customers allegedly receiving discounted rates.  Had the employer shown that it sold at least 35 percent of its services at a discount, then at least some, if not most of the employee discounts in excess of the published rates less 20 percent, may not have been taxable.

Having determined that the discounts offered exceeded the 20 percent limit applicable to services, the IRS ruled that the employer must withhold and remit employment taxes on any employee discount to the extent it exceeded 20 percent of the published rate.  Correspondingly, the employer must report the taxable amount as additional wages on the employee’s Form W-2.  Perhaps even more costly for the employer, the IRS determined that the entire value of the discount (and not just the amount in excess of 20 percent) provided to someone designated by an employee constitutes taxable wages paid to the employee unless the person is the employee’s spouse or dependent child.  Accordingly, if an employee designates a friend under the program who uses the discount, the entire discount must be included in the employee’s wages and subjected to appropriate payroll taxation.

Offering employee discounts on property and services sold to customers can make for a valuable employee reward program, but the technical requirements to avoid tax consequences for these programs can be overlooked.  The FAA’s analysis is consistent with the regulations under Code sections 61 and 132, and should not be surprising to anyone familiar with the rules.  Given the recent interest in employee discount programs by IRS examiners conducting employment tax examinations, it would be prudent for employers to review their employee discount programs and consider whether the programs are properly designed to avoid the potentially expensive payroll tax consequences that could be triggered by discounts that do not qualify for the income exclusion under section 132(c).

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.

House Republicans Pull ACA Replacement Bill

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March 24, 2017

Facing likely defeat, Republicans have pulled the American Health Care Act, which would have made numerous changes to the information reporting provisions and employment tax provisions of the Affordable Care Act (ACA) (earlier coverage).   The legislation would have also created a new information reporting requirement by adding Section 6050X to the Code.  The House was scheduled to vote on the legislation this afternoon, but Republicans have struggled to appease both conservative Republicans, who wanted a more completed repeal of the ACA, and moderate Republicans, who were concerned about the potential loss of coverage that could result from the legislation. The decision to pull the bill increases the likelihood that the ACA’s information reporting regime under Sections 6055 and 6056 will remain in place, along with the additional Medicare tax and other provisions of the ACA.

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).

House Republicans’ ACA Repeal-and-Replace Bill Would Change Health Coverage Reporting Requirements

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March 7, 2017

A House Republican bill, entitled the American Health Care Act, would repeal many provisions of the Affordable Care Act (ACA) but retain and expand the information reporting rules.  Released on March 6, the proposal consists of two parts: (1) a bill drafted by the House Ways and Means Committee, to eliminate the ACA’s taxes and income-based subsidies, zero out penalties for the individual and employer mandates, and establish a new individual tax credit; and (2) a bill drafted by the House Energy and Commerce Committee, to freeze and reform Medicaid.

The Ways & Means bill would help taxpayers pay for health insurance by expanding health savings accounts, and by providing an advanceable, refundable tax credit—the “health insurance coverage” credit—for purchasing state-approved, major medical health insurance and unsubsidized COBRA coverage.  Unlike the leaked bill obtained by Politico on February 24, the bills do not cap the tax exclusion for employer-provided health insurance.  Although the legislation is unlikely to pass in its current form, as it is headed for markup by the two Committees later this week, it does provide insight into the thinking of House Republicans.

Those hoping for a full repeal of the ACA’s reporting provisions will be disappointed as the ACA’s reporting regime would largely survive, at least temporarily.  Applicable large employers (ALEs), for instance, would still be required to file Forms 1094-C and 1095-C pursuant to Code section 6056, even though the bill would reduce penalties for failure to comply with the employer mandate to zero beginning in 2016.  Similarly, the Ways & Means bill does not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) despite eliminating the penalty on individuals for failing to maintain coverage.

However, the Ways & Means bill would alter health insurance reporting in three ways.  First, the bill would establish new information reporting rules under Code section 6050X for the health insurance coverage credit beginning in 2020.  Second, the bill would expand information reporting under Code section 6055 regarding the ACA’s premium tax credits used for qualifying off-Exchange coverage in 2018 and 2019.  Third, the bill would repeal the additional Medicare tax and thereby eliminate employers’ corresponding reporting and withholding obligations beginning in 2020.

New Reporting Rules for Health Insurance Coverage Credits Beginning in 2020

The bill would replace the ACA’s premium tax credit with the health insurance coverage credit for purchasing eligible health insurance—state-approved, major medical health insurance and unsubsidized COBRA coverage—starting in 2020.  Generally, an individual is eligible for this credit only if he or she lacks access to government health insurance programs or offer of employer coverage.  The credit amount varies from $2,000 to $4,000 annually per person based on age, and phases out for those earning over $75,000 per year ($150,000 for joint filers).  The credit maxes out at $14,000 per family, and is capped by the actual amount paid for eligible health insurance.  Treasury would be required to establish a program for making advance payments of the credit, on behalf of eligible taxpayers, to providers of eligible health insurance or designated health savings accounts no later than 2020.

Reporting for Health Insurance Coverage Credit.  To administer the health insurance coverage credit, the bill would create Code section 6050X that would require providers of eligible health insurance to file information returns with the IRS and furnish taxpayer statements, starting in 2020.  The return must contain the following information: (a) the name, address, and taxpayer identification number (TIN) of each covered individual; (b) the premiums paid under the policy; (c) the amount of advance payments made on behalf of the individual; (d) the months during which the individual is covered under the policy; (e) whether the policy constitutes a high deductible health plan; and (f) any other information as Treasury may prescribe.  The bill does not specify how often providers would be required to file returns reporting this information with the IRS, but it would authorize Treasury to require a provider to report on a monthly basis if the provider receives advance payments.  A provider would also be required to furnish taxpayers, by January 31 of the year after the year of coverage, written statements containing the following information: (a) the name, address, and basic contact information of the covered entity required to file the return; and (b) the information required to be shown on the return with respect to the individual.

Employer Statement for Advance Payment Application.  The advance payment program would require an applicant—if he or she (or any qualifing family member taken into account to determine the credit amount) is employed—to submit a written statement from the applicable employer stating whether the applicant or the qualifying family member is eligible for “other specified coverage” in connection with the employment.  Other specified coverage generally includes coverage under an employer-provided group health plan (other than unsubsidized COBRA continuation coverage or plan providing excepted benefits), Medicare Part A, Medicaid, the Children’s Health Insurance Program, and certain other government sponsored health insurance programs.  An employer shall provide this written statement at the request of any employee once the advance payment program is established.  This statement is not required if the taxpayer simply seeks the credit without advance payment.

Employer Coverage Reporting on Form W-2.  The bill would require reporting of offers of coverage by employers on the Form W-2 beginning with the 2020 tax year.  Employers would be required to report each month in which the employee is eligible for other specified coverage in connection with employment.  This requirement would likely demand a substantial revision to the current Form W-2, which is already crowded with information.  The Form W-2 reporting requirement appears to be intended to replace the reporting rules under Section 6056 based on a statement in the Ways and Means Committee summary.

Although the budget reconciliation rules limit Congress’s ability to repeal the current coverage reporting rules, the Ways and Means Committee states that Treasury can stop enforcing any reporting not required for tax purposes.  Given the elimination of penalties for individuals who fail to maintain minimum essential coverage and ALEs that fail to offer coverage, this statement may serve as a green light to undo many of the Form 1095-B and 1095-C reporting requirements once the ACA’s premium tax credits are eliminated and Form W-2 reporting is in place in 2020.

Reasonable Cause Waiver.  The bill would make these new information returns and written statements subject to the standard information reporting penalties under Code section 6721 (penalties for late, incomplete, or incorrect filing with IRS) and Code section 6722 (penalties for late, incomplete, or incorrect statements furnished to payees).  The bill also extends the reasonable cause waiver under Code section 6724 to information reporting penalties with respect to the new health insurance coverage credit returns, so that the IRS may waive such penalties if the failure is “due to reasonable cause and not to willful neglect.”

Transitional Reporting Rules for Premium Tax Credits in 2018 and 2019

The Ways & Means bill would allow the ACA’s premium tax credits to be used for off-Exchange qualified health plans in 2018 and 2019 before eliminating the credits in 2020.  The premium tax credit is a refundable, income-based credit that helps eligible individuals and families pay premiums for coverage under a “qualified health plan,” which, under current law, only includes plans sold on ACA Exchanges, and does not include catastrophic-only health plans.  The bill, however, would expand the definition of qualified health plan to include off-Exchange and catastrophic-only health insurance plans that otherwise meet the requirements for a qualified health plan, so that these types of plans would also be eligible for the premium tax credit.  Advance payment of the credit is only available for coverage enrolled in through an Exchange.

To aid in the administration of the expanded credit, the bill would amend Code section 6055(b) to require providers of minimum essential coverage to report certain information related to premium tax credits for off-Exchange qualified health plans.  Because employer-sponsored coverage does not qualify for the credit, employers sponsoring self-insured plans generally would not be required to report additional information on the Form 1095-C beyond that already required under Code sections 6055 and 6056.  Health insurance issuers who provide coverage eligible for the credit would be required to report annually to the IRS: (a) a statement that the plan is a qualified health plan (determined without regard to whether the plan is offered on an Exchange); (b) the premiums paid for the coverage; (c) the months during which this coverage was provided to the individual; (d) the adjusted monthly premium for the applicable second lowest cost silver plan for each month of coverage; and (e) any other information as Treasury may prescribe.  These new reporting requirements would apply only in 2018 and 2019, before the premium tax credit is scrapped and replaced by the health insurance coverage credit in 2020.

Repeal of Additional Medicare Tax

The bill would also repeal the additional Medicare tax under Code section 3101(b)(2), beginning in 2018.  This 0.9% tax is imposed on an employee’s wages in excess of a certain threshold (e.g., $200,000 for single filers and $250,000 for joint filers).  Under current law, employers are required to withhold and remit additional Medicare taxes when it pays wages to an employee over $200,000.  The additional Medicare tax has complicated the process for correcting employment tax errors because unlike other FICA taxes (and more like income tax withholding) the additional Medicare tax is paid on the employee’s individual income tax return.  As a result, the employer cannot make changes to the amount of additional Medicare tax reported after the end of the calendar year.  The elimination of the additional Medicare tax will likely be welcomed by employers and employees affected by it.  In addition, the bill would also repeal the net investment income tax that expanded the Medicare portion of FICA taxes to non-wage income for individuals with incomes in excess of certain thresholds.

What to Expect Next

The fate of the legislation is uncertain, and it will likely undergo substantive changes before House Republicans move the bill to the floor.  A key issue that House Republicans are reportedly debating is how to structure the health insurance coverage tax credit.  Additionally, the decision to eliminate the cap on tax breaks for employer-provided health insurance that was included in the draft language leaked in late February may mean that the legislative proposal will need to be amended to include another funding source.  However these issues are resolved, the legislation makes it clear that a health insurance reporting regime is likely to survive Republicans’ ACA repeal-and-replace efforts.  We will continue to monitor further developments on the proposal and its impact on the information reporting regime for health insurance coverage.

First Friday FATCA Update

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March 3, 2017

Recently, the Treasury released the Model 1B Intergovernmental Agreement (IGA) entered into between the United States and Ukraine. The IRS released the Competent Authority Agreements (CAAs) implementing the IGAs between the United States and the following treaty partners:

  • Antigua and Barbuda (Model 1B IGA signed on August 31, 2016);
  • Vietnam (Model 1B IGA signed on April 1, 2016).

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.

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.”

First Friday FATCA Update

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February 3, 2017

Recently, the Treasury released the Intergovernmental Agreements (IGAs) entered into between the United States and the following treaty partners, in these respective forms:

  • Anguilla, Model 1B;
  • Bahrain, Model 1B;
  • Greece, Model 1A; and
  • Greenland, Model 1B.

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.

Discharge of Federal Student Loans Not Income to Defrauded Students; Creditors Relieved From Information Reporting Regarding Discharge

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January 23, 2017

The IRS announced in Rev. Proc. 2017-24 that creditors of federal student loans made to former students of American Career Institutes, Inc. (ACI) that were discharged under the Department of Education’s “Defense to Repayment” or “Closed School” discharge processes need not file or furnish a Form 1099-C reporting the loan discharge.  Former ACI students whose loans were discharged do not need include in income the amount of the loans discharged.  Only the federal loans discharged under one of the two named processes are subject to the relief.

Two years ago, in Rev. Proc. 2015-57, the IRS provided the same income exclusion under the same conditions to former students defrauded by Corinthian Colleges, Inc.  However, unlike Rev. Proc. 2017-24, Rev. Proc. 2015-57 did not alleviate the information reporting obligations under Code section 6050P for the creditors of those loans.  Rev. Proc. 2017-24 amends the earlier revenue procedure to eliminate the reporting requirement for loans made to former Corinthian College students whose loans were discharged.  Thus, these creditors need not file Forms 1099-C with the IRS or furnish payee statements regarding the loan discharges.

Under the Higher Education Act of 1965 (HEA), the Closed School discharge process allows DOE to discharge a Federal student loan obtained by a student, or by a parent on behalf of a student, who was attending a school at the time it closed or who withdrew from the school within a certain period before the closing date.  Federal student loans for this purpose include Federal Family Education Loans, Federal Perkins Loans, and Federal Director Loans.  The HEA excludes from income the amount of these loans discharged under the Closed School discharge process.

Under the Defense to Repayment discharge process, DOE must discharge a Federal Direct Loan if the borrower establishes, as a defense against repayment, that a school’s actions would give rise to a cause of action against the school under applicable state law.  Federal Family Education Loans can also be discharged under this process if certain other requirements are met.  Although the HEA does not exclude from income the amount of loans discharged under this process, two other authorities are relevant.  First, a common law tax principle is that a debt that is reduced due to a legal infirmity relating back to the original sale transaction (e.g., fraud) is not income to the extent of the debt reduction.  Second, under Code section 108(a)(1)(B), a taxpayer may exclude from income a discharge of indebtedness to the extent the taxpayer is insolvent.  The Treasury and IRS concluded that all or most borrowers who took out Federal student loans to attend ACI-owned schools are eligible for one or both of these exclusions.

IRS Begins Requesting Missing ACA Returns from Employers

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January 19, 2017

Despite an uncertain future for the Affordable Care Act (ACA), the IRS is moving forward with enforcement efforts for 2015.  Employers have recently begun receiving IRS Letter 5699 requesting Forms 1094-C and 1095-C for 2015.  The letter notifies the recipient that it may have been an applicable large employer (ALE) in 2015 with ACA reporting obligations and that the IRS has not yet received Forms 1095-C for 2015.  The returns were due on June 30, 2016, for electronic filings through the ACA Information Reporting (AIR) system, or May 31, 2016, for paper filing (see prior coverage).

The letter requires that, within 30 days from the date of the letter, the recipient must provide one of the following responses: (1) the recipient was an ALE for 2015 and has already filed the returns; (2) the recipient was an ALE for 2015 and is now enclosing the returns with the response; (3) the recipient was an ALE for 2015 and will file the returns by a certain date; (4) the recipient was not an ALE in 2015; or (5) an explanation of why the recipient has not filed the returns and any actions the recipient intends to take.

Code section 6056 requires ALEs to file ACA information returns with the IRS, and furnish statements to full-time employees relating to any health insurance coverage the employer offered the employee.  Failure to file returns may result in penalties under Section 6721 (penalties for late, incomplete, or incorrect filing with IRS) and Section 6722 (penalties for late, incomplete, or incorrect statements furnished to payees, in this case, employees).  Importantly, the “good faith” penalty relief previously announced by the IRS applies only to incorrect or incomplete ACA returns—not to late filing of returns (see prior coverage).  Accordingly, ALEs who failed to file the required returns by the deadline may be subject to penalties of up to $520 for each return they failed to file with the IRS and furnish to employees, in addition to any employer shared responsibility penalties that may apply if the ALE failed to offer the required coverage.

While the change in political administration casts uncertainty on the future of the ACA and its penalties, the IRS’s actions indicate that its enforcement efforts are moving forward.  The request for missing ACA returns may mean that the IRS will begin assessing ACA reporting penalties and employer shared responsibility penalties in the near future.  Accordingly, ALEs that have not yet filed the 2015 ACA returns should do so as soon as possible and timely respond to Letter 5699 if they receive one.

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 Releases Four FATCA-Related Regulation Packages

Late Friday, December 30, 2016, the IRS and Treasury Department released four regulation packages related to its implementation of the Foreign Account Tax Compliance Act (FATCA).  Two of the packages include final and temporary regulations and two contain proposed regulations.  The packages are:

  • Final and Temporary Regulations under Chapter 4 that largely finalize the temporary regulations issued in 2014 and update those temporary regulations to reflect the guidance provided in Notices 2014-33, 2015-66, and 2016-08 and in response to comments received by the IRS.
  • Final and Temporary FATCA Coordinating Regulations under Chapter 3 and Chapter 61 that largely finalize the temporary coordination regulations issued under Chapter 3 and Chapter 61 in 2014 and update those temporary regulations to reflect the guidance provided in Notices 2014-33, 2014-59, and 2016-42 and in response to comments received by the IRS.
  • Proposed Regulations under Chapter 4 that describe the verification and certification requirements applicable to sponsoring entities; the certification requirements and IRS review procedures applicable to trustee-documented trusts; the IRS review procedures applicable to periodic certifications of compliance by registered deemed-compliant FFIs; and the certification of compliance requirements applicable to participating FFIs in consolidated compliance groups. The proposed regulations also reflect the language of the temporary Chapter 4 regulations described above.
  • Proposed Coordinating Regulations under Chapter 3 and Chapter 61 that reflect the language of the temporary coordination regulations described above.

We are reviewing the regulations and preparing a series of articles discussing various provisions in the regulations.  We will post the articles over the next several days.

IRS Provides Guidance on De Minimis Safe Harbor for Errors in Amounts on Information Returns

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January 4, 2017

The IRS today released Notice 2017-09 providing guidance on the de minimis safe harbor for errors in amounts reported on information returns.  The safe harbor was added to Sections 6721 and 6722 by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act).

Under the statute, filers are not subject to penalties under either Section 6721 and 6722 if an amount reported on the return is within $100 of correct amount or within $25 if the amount is an amount of tax withheld.  However, if the payee requests a corrected return, the filer must file and furnish one or the payee is liable for potential penalties.  Prior to the enactment of the PATH Act, any error in an amount was considered consequential and could result in a penalty—even if the error was only one cent.  With this change, de minimis errors no longer necessitate corrected information returns or payee statements.  The safe harbor is effective for information returns and payee statements required to be filed after December 31, 2016.

Notice 2017-09 specifies that the safe harbor will not apply in the event of an intentional error or if a payor fails to file a required information return or furnish a required payee statement.  In other words, a filer cannot use the safe harbor to increase the filing threshold for reporting by arguing that the amount that should have been reported was within $25 of a threshold.  Accordingly, if a filer determines that a Form 1099-MISC was not required because the amount paid to the payee was $550 and later determines the amount paid was actually $650, the safe harbor would not apply.  Similarly, filers cannot apply the safe harbor to avoid penalties for payees of interest of less than $100 for whom they did not file a Form 1099-INT because the filer incorrectly believed the interest paid was less than $10.

The notice also clarifies the process by which a payee may request a corrected information return by electing that the safe harbor not apply.  If the payee makes such an election and the payor furnishes a corrected payee statement and files a corrected information return within 30 days of the election, the error will be deemed to be due to reasonable cause and neither Section 6721 or 6722 penalties shall apply unless specific rules specify a time in which to provide the corrected payee statements, such as for Forms W-2.  The notice leaves unanswered, however, how this rule will apply when a payee has an ongoing election not to apply the safe harbor in effect as described below.

The notice permits payors to prescribe any reasonable manner for making the election, including in writing, on-line, or by telephone, provided that the payor provide written notification of the manner prescribed before the date the payee makes an election.  If on-line elections are prescribed by the payor, the payor must also provide another means for making an election.  If the payor has prescribed a manner for making such an election, the payee must make the election using the prescribed manner and elections made otherwise are not valid.  If the payor has not prescribed a manner for making the election, the payor may make an election in writing to the payor’s address on the payee statement or by a manner directed by payor after making an inquiry.  The payor may not otherwise limit the payee’s ability to make the election.

Payees are permitted to make an election with respect to information returns and payee statements that were required to be furnished in the calendar year of the election.  Alternatively, a payee may make an election for such returns and payee statements and all succeeding calendar years.  The statute did not clearly envision an ongoing election as prescribed in the notice.  The decision to allow for an ongoing election as opposed to an annual election requirement raises compliance concerns with respect to small payors who do not have electronic vendor management systems and with respect to payees who only receive intermittent payments that may have been inactivated in the payor’s systems.

The payee may subsequently revoke an election at any time after the election is made by providing written notice to the payor.  The revocation applies to all information returns and payee statements of the type specified in the revocation that are required to be filed and furnished, respectively, after the date on which the payor receives the revocation.

A valid election must: (1) clearly state that the payee is making the election; (2) provide the payee’s name, address, and taxpayer identification number (TIN); (3) identify the type of payee statement(s) and account number(s), if applicable, to which the election applies if the payee wants the election to apply only to specific statements; and (4) if the payee wants the election to apply only to the year for which the payee makes the election, state that the election applies only to payee statements required to be furnished in that calendar year.  If the payee does not identify the type of payee statement and account number or (ii) the calendar year to which the election relates, the payor must treat the election as applying to all types of payee statements that the payor is required to furnish to the payee and as applying to payee statements that are required to be furnished in the calendar year in which the payee makes the election and all succeeding calendar years.

The notice indicates that it does not prohibit a payee from making a request with respect to payee statements required to be furnished in an earlier calendar year.  It is not clear, however, whether such a request must be honored by the payor.

With respect to Forms W-2, Notice 2017-09 encourages employers to correct any errors on Forms W-2c even though the safe harbor may apply.  The notice expresses concern that failure to correct de minimis errors on Forms W-2 will result in combined annual wage reporting (CAWR) errors.  Under the CAWR program, the IRS compares amounts reported on Forms 941 with those reported on Forms W-3 and the processed totals from Forms W-2.  When the amounts do not match, an intentional disregard penalty is automatically assessed under Section 6721.  Although the notice does not specify as much, these penalties would presumably be abated if the employer demonstrated that the mismatch resulted from de minimis errors that were not required to be corrected under the safe harbor.

The notice states that the Treasury Department and IRS intend to issue regulations incorporating the rules contained in the notice.  The regulations are also expected to require payors to notify payees of the safe harbor and the option to make an election to have the safe harbor not apply.  The notice also indicates that the regulations may provide that the safe harbor does not apply to certain information returns and payee statements to prevent abuse as permitted by the statute, but does not indicate which, if any, information returns the IRS believes raise such concerns.  Comments are requested on the rules in the notice and are due by April 24, 2017.

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.

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.

IRS Guidance Provides Transition Relief for Withholding Agents and Qualified Derivative Dealers under Section 871(m)

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December 7, 2016

Last week, the IRS issued Notice 2016-76 providing phased-in application of certain section 871(m) withholding rules applicable to dividend equivalents.  In addition to providing good-faith relief to certain transactions in 2017 and 2018, the Notice eases several reporting and withholding requirements for withholding agents and qualified derivatives dealers (QDDs).

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.  Thus, when a foreign financial institution issues derivatives based on U.S. equities to non-U.S. investors, it must withhold on the dividend payments it makes to the non-U.S. investors.  In 2015, the IRS issued final and temporary regulations (T.D. 9734) specifying certain withholding and reporting requirements under section 871(m).  Earlier this summer, the IRS proposed a qualified intermediary (QI) agreement (Notice 2016-42) that spells out a new QDD regime, which was developed to mitigate cascading withholding that would occur as a result of the withholding requirements imposed on dividend equivalents (see prior coverage).

Good-Faith Relief

Notice 2016-76 provides good-faith transition relief during 2017 for delta-one transactions and during 2018 for non-delta-one transactions.  (Delta means the “ratio of a change in the fair market value of a contract to a small change in the fair market value of the property referenced by the contract.”  A delta-one transaction is a transaction in which changes in the fair market value of the derivative precisely mirror changes in the fair market value of the underlying property.)  The IRS will take into account the extent to which a taxpayer or withholding agent made “a good faith effort” to comply with the section 871(m) regulations.  Relevant factors include a withholding agent’s efforts to build or update documentation and withholding systems and comply with the transition rules under Notice 2016-76.

Quarterly Deposit of Withholdings in 2017

During 2017, a withholding agent will be considered to have satisfied the deposit requirements for section 871(m) dividend equivalent payments if it deposits amounts withheld during any calendar quarter by the last day of that quarter.  The agent should write “Notice 2016-76” on the center, top portion of the 2017 Form 1042.

Qualified Derivative Dealers

The Notice also eased, in four ways, the reporting obligations of intermediaries applying for QDD status.  First, the IRS’s enforcement of the QDD rules and the 871(m) regulations in 2017 will take into account good-faith efforts by intermediaries to comply with the regulations and the QI agreement.

Second, the Notice allows an intermediary to certify its QDD status during interim periods.  Generally, a QDD must provide a valid Form W-8IMY certifying QDD status to a withholding agent, and the agent is not required to withhold on its payments regarding a potential or actual section 871(m) transaction to a QDD in its QDD capacity.  An intermediary that has submitted a QI application by March 31, 2017 may claim QDD status on Form W-8IMY for six months after submitting the application, pending approval of its QI agreement and QDD status.  If an intermediary has not yet submitted a QI application but intends to do so by March 31, 2017, it may claim QDD status on Form W-8IMY until the end of the sixth full month after the month in which it actually submits the QI application (provided the application is submitted by March 31, 2017).  An intermediary may not represent QDD status if it no longer intends to submit an application by March 31, 2017, or if its application has been denied.

Third, the Notice allows an intermediary to provide a Form W-8IMY certifying its QDD status to a withholding agent before it has received a QI-EIN from the IRS.  The intermediary must write “awaiting QI-EIN” on line 8 of Part I of the Form W-8IMY.  While the intermediary must provide its QI-EIN to the withholding agent as soon as practicable after receiving it, the intermediary need not provide a newly executed form, provided the original form remains accurate and valid.  If QDD status is denied, however, an intermediary must notify the withholding agent immediately, and the agent must notify the IRS such notification when it files its Form 1042, listing the name and EIN (if available) of any intermediary whose QDD status was withdrawn for any of these reasons.

A withholding agent may rely on the “awaiting QI-EIN” statement unless it knows or has reason to know that the intermediary cannot validly represent that it is a QDD.  Thus, a withholding agent is not required to determine when a QDD has applied for or actually possesses a QI agreement.  Nor is it required to verify whether a QDD’s EIN is a QI-EIN.  A withholding agent may only rely on an “awaiting QI-EIN” statement for up to six months after receiving the form, unless a QI-EIN is provided within that time.

Fourth, the Notice provides that failure-to-deposit penalties will not be assessed against a QDD before it actually receives its QI-EIN (which the IRS issues upon approving a QI application).  This relief from penalty is available only if the QDD deposits the amounts withheld within 3 days of receiving its QI-EIN.  Extended relief is available to a QDD that applies to enroll in the Electronic Federal Tax Payment Systems (EFTPS) within 30 days of receiving a QI-EIN, provided that the QDD deposits the amounts withheld within 3 days of enrolling in EFTPS.

Other Rules

The Notice also addressed other issues under the section 871(m) regulations.  Specifically, the Notice provided: (a) a simplified standard that withholding agents may use to determine whether transactions are combined transactions under Treas. Reg. §1.871-15(n); (b) a net-delta exposure test for a QDD’s section 871(m) amount; and (c) transition relief for certain existing exchange-traded notes listed in section V.d of the Notice until January 1, 2020.

First Friday FATCA Update

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December 2, 2016

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

  • Qatar (Model 1B IGA signed on January 7, 2015);
  • Kosovo (Model 1B IGA signed on February 26, 2015).

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.

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.

IRS Extends Deadline for Furnishing ACA Statements to Individuals And Good-Faith Transition Relief

Today, the IRS in Notice 2016-70 extended the deadline for certain 2016 information reporting requirements under the Affordable Care Act (ACA), as employers and other coverage providers prepare for their second year of ACA reporting.   Specifically, providers of minimum essential coverage under Code section 6055 and applicable large employers under Code section 6056 will have until March 2, 2017—not January 31, 2017—to furnish to individuals the 2016 Form 1095-B (Health Coverage) and the 2016 Form 1095-C (Employer-Provided Health Insurance Offer and Coverage).  Because this extended deadline is available, the normal automatic and permissive 30-day extensions of time for furnishing ACA forms will not apply on top of the extended deadline.  Additionally, the Notice extended good-faith transition relief from penalties under Code sections 6721 and 6722 to 2016 ACA information reporting.

Filers should note that, unlike Notice 2016-4, which extended the deadlines for both furnishing to individual taxpayers and filing with the IRS the 2015 ACA forms, Notice 2016-70 did not extend the deadline for filing with the IRS the 2016 Forms 1094-B, 1095-B, 1094-C, and 1095-C—and this deadline remains to be February 28, 2017 (or March 31, 2017, if filing electronically).  Filers may apply for automatic extensions for filing ACA forms by submitting a Form 8809 and seek additional permissive extensions.  Late filers should still furnish and file ACA forms as soon as possible because the IRS will take into account this timing when determining whether to abate penalties for reasonable cause.

The extended furnishing deadline means that some individual taxpayers will not have received a Form 1095-B or Form 1095-C by the time they are ready to file their 2016 tax return.  The Notice provides that these taxpayers need not wait to receive these forms before filing their returns.  Instead, taxpayers may rely on other information received from their employer or other coverage provider for filing purposes, including determining the taxpayers’ eligibility for the premium tax credit and confirming that they received minimum essential coverage.

Notice 2016-70 also extended the good-faith transition relief for 2016 returns.  Specifically, filers that can show that they made good-faith efforts to comply with the ACA reporting requirements for 2016 are not subject to penalties under Code sections 6721 (penalties for late, incomplete, or incorrect filing with IRS) and 6722 (penalties for late, incomplete, or incorrect furnishing of statement to individual taxpayers).  This relief would apply to missing and inaccurate TINs and dates of birth, and other information required on the ACA form.  It does not apply where a filer does not make a good-faith effort to comply with the regulations or where the filer failed to file or furnish by the applicable deadlines.

IRS Extends Transitional Relief for PATH Act’s Changes to Form 1098-T Reporting for Colleges and Universities

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November 17, 2016

In Announcement 2016-42, the IRS recently provided transitional penalty relief to certain colleges and universities with respect to new Form 1098-T reporting requirements under the Protecting Americans from Tax Hikes (PATH) Act of 2015.  Specifically, the IRS will not impose penalties under Code section 6721 or 6722 on an eligible educational institution with respect to Forms 1098-T required to be filed and furnished for the 2017 calendar year, if the institution reports the total amount billed for qualified tuition and related expenses instead of the total payments received, as required by section 212 of the PATH Act.  This transitional relief for 2017 reporting effectively extends the same transitional relief for 2016 reporting in Announcement 2016-17, released this spring (see prior coverage).  In both instances, the IRS provided transitional relief because numerous eligible educational institutions indicated that, despite their diligent efforts, they have not fully implemented accounting systems, software, and business practices necessary to satisfy the new reporting requirement.

Earlier this year, the IRS issued proposed regulations to reflect other changes made to the Form 1098-T reporting requirements by Congress as part of the Trade Preferences Extension Act of 2015 (TPEA) and the PATH Act (see prior coverage).

Earlier Deadline for Filing Forms W-2 and 1099-MISC Looms

The earlier filing deadline for the Form W-2 and a Form 1099-MISC that reports nonemployee compensation (Box 7) is fast approaching.  In prior years, electronic filers had until as late as March 31 to file copies of such forms with the IRS (or the Social Security Administration (SSA), in the case of Forms W-2).  Additionally, filers could request an automatic extension to push the deadline back another 30 days.  Many large filers requested automatic extensions in the normal course to provide extra time to clean up their filings and avoid penalties.  For 2016, however, Forms W-2 and Forms 1099-MISC reporting nonemployee compensation in Box 7 are required to be filed by January 31, 2017–the deadline for furnishing copies to recipients–regardless of whether they are filed electronically or on paper.

Section 201 of the Protecting Americans from Tax Hikes (PATH) Act, enacted last December, accelerated the filing deadlines to combat identity theft and fraudulent claims for refund.  In past years, the IRS often issued refunds to taxpayers well before filers were required to file copies of the Form W-2 with the SSA and copies of the Form 1099-MISC reporting nonemployee compensation with the IRS.  Because the IRS had to process certain tax returns and refund claims without having all of the third-party payor information, the process was susceptible to fraudulent returns claiming refunds.  The new January 31 deadline makes the payor information available to the IRS sooner, thus reducing the potential for fraud.  This change comes on top of temporary Treasury Regulations issued last year that eliminated the automatic 30-day extension for Forms W-2 and proposed Treasury Regulations that would eliminate the same extension for other information returns, including Forms 1099-MISC, when effective.  Because the proposed regulations are intended to take effect sometime after the filing of 2016 information returns, they will not affect the availability of the automatic 30-day extension for 2016 information returns.

Although the earlier deadline and elimination of automatic extensions address valid concerns, the new rules inevitably increase the risk of penalties for erroneous information returns under section 6721 of the Code.  Combined with the increased penalty rates adopted as part of the Trade Preferences Extension Act of 2015 (see prior coverage) and subsequent inflation adjustment, the new deadlines increase the risk of large penalties, particularly for large filers.  For example, many employers with large expatriate workforces use the first quarter of the year to perform tax equalization calculations and prepare tax returns for their overseas workers.  That process often results in adjustments to the Form W-2 that could previously be made before filing the forms with the SSA.  Now, those same adjustments may well result in penalties.  Although the filing of corrected Forms W-2 have not consistently attracted the automatic information reporting penalties that corrections of other information returns have historically attracted, the changes to the filing deadlines and the statutory penalty rates create cause for concern.

Given the earlier deadlines, filers should take steps now to prepare for the 2017 filing season.  For example, lining up outside vendors to prepare and print recipient copies of returns earlier in January will provide recipients with some time before the January 31 filing deadline to identify potential errors and request corrections.  Many filers have traditionally waited until late January to print and send recipient copies knowing that they had time to make corrections before the filing deadline.  That strategy is no longer prudent in the face of simultaneous IRS/SSA filing and recipient copy deadlines.  To that end, large filers should notify the departments making the payments of the earlier deadline, and instruct them to provide required information with sufficient lead time to allow for processing of the data to prepare information returns for review and timely filing.  Filers should consider setting deadlines for transmitting payment data internally early in January to allow for the earlier distribution of recipient copies.

In addition, filers of Forms 1099-MISC reporting nonemployee compensation in Box 7 should submit a Form 8809 requesting an automatic 30-day extension in January 2017 to extend the filing deadline until March 2.  This extension will provide some additional time to identify errors and make corrections before the returns are filed.  Filers who believe that a non-automatic 30-day extension is warranted for Forms W-2 should be forewarned that the IRS will only grant such an extension in extraordinary circumstances, such as a natural disaster or a fire that destroys the filer’s books and records.

 

Final Regulations Amend Section 6050P Regulations to Remove 36-Month Nonpayment Testing Period

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November 15, 2016

Last week, the IRS issued final regulations removing the 36-month nonpayment testing period from the regulations issued under section 6050P of the Code.  The final regulations adopted the proposed regulations issued in 2014 without significant changes.

Code section 6050P requires certain financial entities to file a Form 1099-C when it cancels (in whole or in part) debt of a debtor in the amount of $600 or more.  This obligation is generally triggered when an identifiable event, as defined in the regulations, occurs.  Unlike all of the other identifiable events, the expiration of the 36-month nonpayment period, which creates a rebuttable presumption that an “identifiable event” occurred that would trigger the obligation to report the cancellation of debt on Form 1099-C, does not necessarily reflect a discharge of the underlying debt.  The presumption of discharge could be rebutted if the creditor showed that it had undertaken significant bona fide collection activity in the calendar year during which the 36-month period expired or if the facts and circumstances existing as of the January 31 following such calendar year indicated the debt had not been discharged.

As a result of the final regulations, entities required to report under Section 6050P will no longer need to file Form 1099-C reporting cancellation of debt because of the expiration of the 36-month nonpayment period and the lack of bona fide collection activity.  The IRS removed the rule because it often caused significant confusion.  Although a creditor could be obligated to file a Form 1099-C as a result of the rule, the creditor may not have actually discharged the debt.  Nonetheless, the rule may lead a debtor to conclude that the debt has actually been discharged because he or she received a Form 1099-C and the rule may create confusion among creditors regarding whether they may legally continue to pursue the debt following issuance of the Form 1099-C.  (For examples, see FDIC v. Cashion (holding that the issuance of Form 1099-C does not discharge the underlying debt) and Franklin Credit Mgmt. Corp. v. Nicholas (holding that Form 1099-C is a writing that serves as prima facie evidence that a debt has been discharged).)  Furthermore, issuing a Form 1099-C may cause the IRS to initiate collection action against the debtor for failing to report income from the cancellation of debt reported on Form 1099-C even though the creditor has not actually discharged the debt.  To alleviate confusion and simplify tax administration, the IRS eliminated the 36-month nonpayment testing period, thus limiting identifiable events to the defined events that coincide with an actual cancellation of debt.

First Friday FATCA Update

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November 4, 2016

Recently, the Treasury released the Model 1A Intergovernmental Agreement (IGA) entered into between the United States and Guyana.  The IRS also released the Competent Authority Agreement (CAA) implementing the Model 1B IGA between the United States and Kuwait entered into on April 29, 2015.

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

  • Rep. Edward R. Royce (R-Calif.) recently introduced in the House of Representatives a bill that would exempt premiums paid on non-cash-value property and casualty insurance from coverage under FATCA (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.

New Bill Would Exempt Premiums Paid on Non-Cash-Value Property Insurance From FATCA Withholding

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October 13, 2016

Rep. Edward R. Royce (R-Calif.) recently introduced in the House of Representatives a bill that would exempt premiums paid on non-cash-value property and casualty insurance from coverage under the Foreign Account Tax Compliance Act (FATCA).  Specifically, H.R. 6159 would amend the definition of “withholdable payment,” to which FATCA reporting and withholding rules apply, under Code Section 1473(1) to exempt premiums paid for any insurance contract that has an aggregate cash value of zero or less, and that is not considered for purposes of determining whether the insurance company is a life insurance company under Code Section 816.  Cash value generally means the amount that is payable to the policyholder upon policy surrender or termination, or that can be borrowed, except that cash value does not include any death, sickness, or casualty loss benefit, refund of and dividends not exceeding premiums paid (less cost of insurance charges), and certain advance premium or deposit.  In other words, the proposed bill would exclude from FATCA coverage premiums paid on property and casualty insurance that does not have an investment or earnings component.

Currently, FATCA withholding potentially applies to all insurance premiums, regardless of whether the premiums are for life insurance, annuities, or property and casualty coverage, if the payments are made to a nonparticipating FFI or passive NFFE.  However, many non-U.S. property and casualty insurers are excepted NFFEs that are not subject to withholding.  The proposed legislation would streamline the documentation process required for withholding agents making property and casualty insurance premium payments for U.S. risks as the withholding agents would no longer be required to document the FATCA status of the insurance company they are paying.  Because such premiums are generally not subject to Chapter 3 withholding, the premium payments could in many cases be made without the need for a Form W-8BEN-E from the insurer.  Some insurance buyers currently pay premiums to foreign insurance companies through a U.S. insurance broker to avoid the requirement to collect documentation from non-U.S. insurers because the FATCA rules treat such payments as a payment to a U.S. person, provided that the buyer does not know or have reason to know that the broker will not comply with its withholding obligations under FATCA.

First Friday FATCA Update

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October 7, 2016

Recently, the Treasury released the Model 1A Intergovernmental Agreement (IGA) entered into between the United States and the Dominican Republic.  The IRS also released the Competent Authority Agreement (CAA) implementing the Model 1B IGA between the United States and the Vatican City State entered into on June 10, 2015.

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

  • New legislation, H.R. 5935, has been introduced in Congress to repeal FATCA, on the basis that FATCA violates Americans’ Fourth Amendment privacy rights (see previous coverage).
  • On September 1, Justice Hanan Meltzer of Israel’s High Court of Justice issued a temporary injunction preventing exchange of tax information under FATCA with the United States (see previous coverage).  After a hearing on September 12, however, a three-judge panel lifted the injunction, rejecting the plaintiffs’ arguments that this exchange of tax information under FATCA violates human rights and privacy laws.

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.

Beware of Errors in Limitations on Benefits Table on IRS Website When Vetting Treaty Claims on Forms W-8BEN-E

Earlier this year, the IRS changed the Form W-8BEN-E to require beneficial owners to identify the applicable limitation on benefits (“LOB”) test under the LOB article (if an LOB exists under the treaty) to claim tax treaty benefits. Income tax treaties often contain LOB articles to prevent treaty shopping by residents of a third country by limiting treaty benefits to residents of the treaty country that satisfy one of the tests specified in the LOB article. The form change requires additional complexity on the part of beneficial owners and additional due diligence on the part of withholding agents when vetting treaty claims. In the revised Instructions to the Form W-8BEN-E, the IRS includes a URL to an IRS table that summarizes the major tests within the LOB articles of U.S. tax treaties (“IRS LOB Table”) to document an entity’s claim for treaty benefits. The table can be found here.  After reviewing a recent treaty claim on Form W-8BEN-E, we discovered that the table contains some errors and misleading information with respect to several countries.

The new requirement to report the LOB provision on Form W-8BEN-E is onerous because it essentially requires withholding agents to pull the income tax treaty and protocols for each treaty claim submitted on a Form W-8BEN-E to validate that the appropriate LOB test is accurately reflected by the box checked on the form. There are two potential pitfalls for withholding agents reviewing these claims using information found on the IRS website. First, withholding agents must carefully review the U.S. income tax treaties and protocols made available to the public on the IRS website, which is a challenge for many Form W-8BEN-E reviewers who may be untrained or inexperienced regarding these documents. Many withholding agents are sure to either skip or struggle with this validation approach. Second, the table provided by the IRS is essentially incomplete and contains errors, so in certain cases it cannot be relied upon. This is particularly concerning in light of the “reason to know” standard as it applies to treaty claims set forth under Temp. Treas. Reg. §1.1441-6T(b) and the Instructions for the Requester of Forms W-8, which require diligence on the part of withholding agents with respect to treaty claims.

The IRS should be more careful before it releases informal guidance to the public, but it has repeatedly warned taxpayers over the years that the public relies upon informal guidance at its own peril. In fact, courts have upheld penalties assessed against taxpayers for relying on such guidance, holding that administrative guidance contained in IRS publications is not binding on the government. Accordingly, prudent withholding agents are best served to “trust but verify” when relying on the IRS LOB Table.

The errors we discovered in the IRS LOB Table are described below.

U.S. – Australia Treaty

The Australia entry should cite to Section 16(2)(h) (rather than Section 16(1)(h)) as the provision that permits a recognized company headquarters to claim treaty benefits.

U.S. – Bulgaria Treaty

The IRS LOB Table also fails to reflect a 2008 protocol modifying the 2007 U.S. – Bulgaria income tax treaty, which added a triangular provision that provides a safe harbor for certain companies resident in a partner state that derive income from the other partner state attributable to a permanent establishment located in a third jurisdiction. This triangular provision is set forth in new Section 21(5) of the treaty. The Bulgaria entry in the IRS LOB Table also contains the wrong citation for the provision permitting discretionary determinations of treaty eligibility. Because the 2008 protocol set forth a new Section 21(5), the discretionary provision was relocated to Section 21(6).

U.S. – China Treaty

The China entry does not specify the correct protocol in which certain LOB tests are located. The United States and China entered into protocols in 1984 and 1986, both of which are still in effect and neither of which actually supplement or modify the text of the U.S. – China income tax treaty—in other words, the text of the original treaty is left as-is and the protocols simply layer on top of it. This is a unique scenario, since protocols generally supplement or modify the original text of the treaty. In fact, we are only aware of one other country (Italy) with which the United States has entered into protocols that did not supplement or modify the original treaty text. The two China protocols, which do not contain provisions titled “Limitations on Benefits” and instead require a careful reading to identify the presence of LOB provisions, must therefore be read in tandem with the underlying treaty. The existence of multiple protocols, the second of which was solely created to modify a provision in the first protocol, serves as the cause of the errors in the IRS LOB Table. Specifically, the citations for the publicly traded company and stock ownership and base erosion test provisions should read “P2(1)(b)” and “P2(1)(a),” respectively.

U.S. – France Treaty

The IRS LOB Table makes several mistakes with respect to the 1994 U.S. – France income tax treaty, one of which relates to a 2009 protocol to the treaty. The 2009 protocol added new Section 30(3) to the treaty, which sets forth a provision on derivative benefits that allows a company to claim treaty benefits if a percentage of its shares is owned by persons who would be entitled to treaty benefits had they received the income directly. However, the IRS LOB Table currently states that Section 30(3) permits a recognized headquarters company to claim treaty benefits—the 2009 protocol eliminated the company headquarters safe harbor. In addition to this error, the U.S. – France treaty entry in the IRS LOB Table mistakenly points to Section 30(1)(c)–(f) as the location for three safe harbors (safe harbors for publicly traded companies or their subsidiaries, tax exempt organizations and pension funds, and persons satisfying the stock ownership and base erosion test), all of which are actually set forth in Section 30(2)(c)–(f).

U.S. – New Zealand Treaty

Yet another protocol not reflected in the IRS LOB Table is New Zealand’s 2008 protocol, which replaced the entire LOB article in the 1982 U.S. – New Zealand income tax treaty. The new LOB article still contains safe harbors for publicly traded companies and companies that satisfy the stock ownership and base erosion test, but the section references should be Section 16(2)(c) and 16(2)(e), respectively. The safe harbor categorized as “Other” in the IRS LOB Table, which required New Zealand and the United States to consult each other before denying benefits under the LOB article, no longer exists, so it should be removed from the table. However, the 2008 protocol added safe harbors for: (i) tax exempt organizations and pension funds, set forth in new Section 16(2)(d); (ii) certain active trades or businesses in new Section 16(3); (iii) persons that qualify under a triangular provision in new Section 16(5); and (iv) persons deemed to qualify under a discretionary determination made by the appropriate partner country in new Section 16(4).

U.S. – Tunisia Treaty

The provision in the Tunisia treaty permitting discretionary determinations is Article 25(7), not Article 25(5)(7).

Miscellaneous Issues with IRS LOB Table

The IRS LOB Table includes various non-substantive issues that signal that the document has not been subject to a final, careful review by the IRS. The footnotes set forth in the document are incomplete and, in certain cases, incorrect. The column headings for each LOB test refer to a footnote, but the footnotes at the end of the table seem to either merely restate the name of the LOB test or, in many cases, do not even align with the linked column headings. For example, the “Derivative Benefits” heading cites to footnote 8, which only states “Derivative benefits test –,”and the “Active Business” heading cites to footnote 9, which actually states “triangular provisions” (curiously, the “Triangular Provision” heading does not cite to a footnote). Most perplexing, however, are the blank footnotes. For example, the title of the chart, “Limitation on Benefits Tests (Safe Harbors)” cites to footnote 2, yet footnote 2 contains no text. A taxpayer might then turn to the “LOB Test Category Codes” to ease this confusion, which are located directly above the IRS LOB Table on the first page and appear to possibly correlate with the column headings. However, these Codes provide no detail beyond merely restating the headings themselves, or in the case of “01” and “02,” do not seem to correlate to anything in the Table.

Another non-substantive oversight relates to a lack of citations in the entry describing the LOB provisions for the U.S. – U.S.S.R. treaty (listed as “Comm. of Independent States”). Though the U.S. – U.S.S.R. treaty is no longer in effect, the LOB provisions are likely still relevant to many beneficial owners and withholding agents, as the IRS LOB Chart states that the U.S. – U.S.S.R. treaty still applies to nine former members of the Soviet Union.

Conclusion

The IRS LOB Table has the potential to be a helpful resource for withholding agents to use when reviewing new Forms W-8BEN-E submitted with treaty claims, but withholding agents should verify the information set forth in the table with the related treaties and protocols that are also available on the IRS website.

September 28 Deadline Approaches For Work Opportunity Tax Credit Certification

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September 27, 2016

The IRS recently reminded employers to certify certain new hires by September 28 to qualify for the newly expanded Work Opportunity Tax Credit (WOTC).  The WOTC is a federal tax credit available to employers who hire eligible workers—e.g., certain veterans, public assistance recipients—who have consistently faced significant barriers to employment.  Congress enacted the Protecting Americans from Tax Hikes (PATH) Act last December, which retroactively extended the WOTC for nine categories of eligible workers hired on or after January 1, 2015, and adding a tenth category for certain long-term unemployment recipients hired on or after January 1, 2016.  Accordingly, the ten categories of eligible workers include:

  • Qualified IV-A Temporary Assistance for Needy Families (TANF) recipients;
  • Unemployed veterans, including disabled veterans;
  • Ex-felons;
  • Designated community residents living in Empowerment Zones or Rural Renewal Counties;
  • Vocational rehabilitation referrals;
  • Summer youth employees living in Empowerment Zones;
  • Food stamp (SNAP) recipients;
  • Supplemental Security Income (SSI) recipients;
  • Long-term family assistance recipients;
  • Qualified long-term unemployment recipients (who begin work after 2015).

To qualify for the WOTC, an employer normally must first request certification by filing the IRS’s Form 8850 with the applicable state workforce agency within 28 days after the eligible worker begins to work.  Under the transition relief, however, the certification deadline is extended to September 28, 2016, for eligible workers hired between January 1, 2015, and August 31, 2016.  To claim the WOTC when filing its income tax returns, an employer calculates the WOTC on Form 5884, and claims it as a general business credit on Form 3800.

Additional requirements for claiming the WOTC credit can be found in the instructions to Form 8850, Notice 2016-22, and Notice 2016-40.

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.

First Friday FATCA Update

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September 2, 2016

Recently, the Treasury released the Model 1A Intergovernmental Agreement (IGA) entered into between the United States and Trinidad and Tobago.

The IRS also released the Competent Authority Agreements (CAAs) implementing the IGAs between the United States and the following treaty partners:

  • Cambodia (Model 1B IGA signed on September 14, 2015);
  • United Arab Emirates (Model 1B IGA signed on June 17, 2015);
  • Turks and Caicos Islands (Model 1B IGA signed on December 1, 2014).

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.

IRS Provides Guidance on Calculating Intentional Disregard Penalties for Paper Filings

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August 26, 2016

Earlier this month, the IRS announced in interim guidance that it would amend Section 20.1.7 of the Internal Revenue Manual to provide a methodology for the calculation of intentional disregard penalties under Section 6721 for filers who fail to file information returns electronically when required.  In general, filers of more than 250 information returns are required to file such returns electronically with the IRS.  For this purpose, each type of information return is considered separately, so that a filer who files 200 Forms 1099-DIV and 200 Forms 1042-S is not required to file electronically.  In contrast, if the filer was required to file 300 Forms 1099-DIV and 200 Forms 1042-S, it must file the Forms 1099-DIV electronically, but may file Forms 1042-S on paper.

Section 6721 imposes a penalty of $250 for failures that are not due to intentional disregard.  Section 6721(e) provides an increased penalty for cases of intentional disregard.  In general, the increased penalty is equal to $500 or, if greater, a percentage of the aggregate amount of the items required to be reported correctly on the returns.  Information returns required under Section 6045(a) (Form 1099-B and Form 1099-MISC, Box 14), Section 6050K (Form 8308), and Section 6050L (returns by donees relating to dispositions of donated property within two years of the donor’s contribution of such property) are subject to a penalty of 5% of the amount required to be reported.  Returns required to be filed under Section 6041A(b) (Form 1099-MISC, Box 9), Section 6050H (Form 1098), and Section 6050J (Form 1099-A) are subject only to the flat $500 per return penalty.  Information returns required under other sections are subject to a penalty of 10% of the amount required to be reported.  (Different penalties apply for failures to file correct Forms 8300, but such forms are not subject to the mandatory electronic filing requirements of Section 6011.)

According to the IRS, the amount of the penalty for intentional disregard with respect to a failure to file electronically is determined by calculating the simple average reported on all such returns, multiplying by the number of returns in excess of 250, and then multiplying by the applicable percentage penalty.  For example, if a filer was required to file 1,000 Forms 1099-INT reporting total payments of $5,000,000, the penalty would be calculated by determining the average amount reported on each form $5,000,000 / 1,000 = $5,000), multiplying by the number of returns in excess of 250 ($5,000 x 750 = $3,750,000), and multiplying by the applicable percentage ($3,750,000 x 10% = $375,000).

As the example shows, the penalty for intentional disregard can be harsh.  Fortunately, intentional disregard penalties can often be avoided as the standard is high and it is difficult for the government to meet its burden of proof.  It is far more common for filers to fail to comply with information reporting requirements due to error or mistake.  If the IRS proposes intentional disregard penalties, filers should seek assistance from experienced counsel not only because the penalties can be large but because the imposition of intentional disregard penalties can make it more difficult to obtain relief from other penalties in the future.  One step in seeking penalty relief is to show that the taxpayer has a history of compliance.  The past assessment of intentional disregard penalties can make this more difficult.

IRS Certified PEO Program Leaves Unresolved Qualified Plan and ACA Issues

The IRS recently implemented the voluntary certification program for professional employer organizations (PEOs) (discussed in a separate blog post).  Earlier this summer, the IRS released temporary and proposed Treasury regulations and Revenue Procedure 2016-33 pursuant to Code Sections 3511 and 7705, which created a new statutory employer for payroll-tax purposes: an IRS-certified PEO (CPEO).  Last week, the IRS released Notice 2016-49, which relaxed some of the certification requirements set forth in the regulations and Revenue Procedure 2016-33.

Although a significant change in the payroll tax world, the new CPEO program does not clarify the issue of whether a PEO or its customer, the worksite employer, is the common law employer for other purposes.  Thus, even when properly assisted by CPEOs, customers may still be common law employers and must plan for potential liability accordingly.  Two key areas of potential liability are PEO sponsorship of qualified employee benefit plans and the Affordable Care Act’s employer mandate.

PEO Sponsorship of Qualified Plans

Before the new CPEO program became available, the PEO industry was already expanding, with customers pushing for PEOs to act as the common law employers for all purposes, not just payroll tax administration.  Customers particularly sought PEOs to sponsor qualified benefit plans for the customers’ workers.  This arrangement, however, clashed with a fundamental rule of qualified plans under ERISA and the Code:  Under the exclusive benefit rule, employers can sponsor qualified plans only for their common law employees and not independent contractors.  Many PEOs set up single employer plans, even though customers – not PEOs – usually had the core characteristics of a common law employer:  Exercising control over the worker’s schedule and manner and means of performing services.

In Revenue Procedures 2002-21 and 2003-86, the IRS reiterated its hardline stance on enforcing the exclusive benefit rule against PEO plans, stating that after 2003, PEOs can no longer rely on any determination letter issued to their single employer plans, even if the letter was issued after 2003.  The guidance provided two forms of transition relief available until 2003: (1) a PEO could terminate the plan, or (2) convert the plan into a multiple employer plan (MEP), which is an employee benefit plan maintained and administered as a single plan in which two or more unrelated employers can participate.  This MEP option, however, still treated customers as the common law employers, who are subject to nondiscrimination, funding, and other qualified-plan rules under ERISA and the Code.

The new CPEO program does not affect the exclusive benefit rule or the determination of common law employer status for qualified plan purposes.  Certified or not, a PEO can sponsor MEPs, but properly sponsoring any single-employer plan rests on the argument that the PEO is the common law employer.  Thus, the law still significantly limits a customer from outsourcing its qualified plan to a PEO.

ACA Employer Mandate & PEO-Sponsored Health Plan

The Affordable Care Act (ACA) imposes on employers with 50 or more full-time equivalent (FTE) employees the “employer mandate,” which, in turn, applies a tax penalty if the employer chooses not to provide health care insurance for its workers.  In general, the common law employer is required to offer coverage to its employees.  Under some circumstances, however, the common law employer can take credit for coverage offered by another entity—such as another company within the same controlled group.

The problem for PEO customers stems from a provision in the final regulations on Section 4980H.  The provision allows the PEO’s customer to take credit for the PEO’s offer of coverage to the customer’s workers only if the customer pays an extra fee:

[I]n cases in which the staffing firm is not the common law employer of the individual and the staffing firm makes an offer of coverage to the employee on behalf of the client employer under a plan established or maintained by the staffing firm, the offer is treated as made by the client employer for purposes of section 4980H only if the fee the client employer would pay to the staffing firm for an employee enrolled in health coverage under the plan is higher than the fee the client employer would pay the staffing firm for the same employee if that employee did not enroll in health coverage under the plan.

The preamble to the regulations doubles down by describing a situation in which the staffing firm is not the common law employer as the “usual case.”

This extra-fee rule puts the PEO’s customer in a difficult position.  If it does not pay the extra fee, then the PEO’s offer of health coverage cannot be credited to the customer.  Thus, the customer risks being subject to the tax penalty, if upon audit the customer is determined to be the common law employer (assuming the PEO’s customer is an applicable large employer).  Alternatively, if the customer pays the extra fee to hedge against the risk of the tax penalty, the payment could be taken as an admission that the customer—not the PEO—is the common law employer.  Being the common law employer could expose the PEO’s customer to a host of legal liabilities, including, for example, rules pertaining to qualified plans (e.g., funding, nondiscrimination), workers compensation, and respondeat superior.  This result is unacceptable for many customers, who take the position that they are not the common law employers for any purpose.  Unfortunately, the new CPEO program only allows the customer to shift its payroll tax liabilities, and does not affect whether the customer or the CPEO is the common law employer for other purposes.

Finally, there is also a reporting wrinkle for customers outsourcing their health coverage obligations to PEOs.  The ACA requires the common law employer to report the offer of coverage on Form 1095-C.  If the PEO’s customer is the common law employer, there is no rule allowing it to shift this reporting obligation to the PEO.  Thus, if the PEO, rather than the customer, files the Form 1095-C, the customer may be subject to reporting penalties for failure to file a return.

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.

IRS Clarifies Several Issues Related to Section 6055 Reporting in Proposed Regulations

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August 1, 2016

On July 29, the IRS issued proposed regulations under Section 6055 that seek to clarify a number of issues raised by commenters in response to the original proposed regulations under Section 6055 and Notice 2015-68.  Filers may rely on the proposed regulations for calendar years ending after December 31, 2013, making them applicable at the option of filers for all years during which Forms 1095-B and Forms 1095-C were required to be filed.  In addition to the clarifications contained in the regulations themselves, the IRS’s comments in the preamble to the regulations provide additional helpful guidance to filers.  Ultimately, the proposed regulations are helpful but continue to overlook some areas where further binding guidance in regulations would be helpful.  Specific changes are discussed below:

Catastrophic Coverage.  Unlike other coverage purchased through an exchange, the proposed regulations implement the change announced in Notice 2015-68, requiring that insurers providing the coverage report it.  This change is effective for catastrophic coverage provided in 2017 and required to be reported in 2018.  Insurers are not required to report catastrophic coverage provided in 2016 (and otherwise required to be reported in 2017), although they are encouraged to do so on a voluntary basis.  A filer who voluntarily reports catastrophic coverage provided in 2016 is not subject to penalties on those returns.

Supplemental or Duplicative Coverage.  Consistent with Notice 2015-68, the proposed regulations simplify the rule contained in the final regulations relating to supplemental coverage. Under the proposed regulations, a reporting entity that during a month provides minimum essential coverage under more than one plan that it provides (such as an HRA and a high-deductible health plan) need only report coverage under one plan.

Truncated TINs.  Consistent with Notice 2015-68, the proposed regulations clarify that a filer may use a truncated TIN in place of the TIN of each covered individual, the responsible individual, and if applicable, the sponsoring employer’s EIN.

TIN Solicitation.  Responding to comments from Section 6055 filers, the proposed regulations clarify how the reasonable cause rules relating to TIN solicitation under Section 6724 apply to Section 6055.  The IRS acknowledged in the preamble, that the existing rules were difficult to apply outside of the financial context for which they were written.  The clarifications include:

  • Under Section 6724, a filer is required to make an initial TIN solicitation at the time an account is opened. Commenters had requested clarification regarding when an account is opened for purposes of applying the TIN solicitation rules to Section 6055.  The proposed regulations specify that the account is “opened” when the filer receives a substantially completed application for coverage, including an application to add an individual to existing coverage.  The application may be submitted either by the individual or on the individual’s behalf (for example, by an employer).  As a result, providers of minimum essential coverage who are required to report under Section 6055 should strongly consider changing their applications forms to include a request for TINs, if they have not already done so. (See the discussion of transition relief below for the treatment of coverage in effect before July 29, 2016.)
  • If the initial solicitation does not result in the receipt of a TIN for each covered individual and the responsible individual, the filer must make the first annual TIN solicitation within 75 days of such date, or in the case of retroactive coverage, within 75 days after the determination of retroactive coverage is made. The second annual solicitation must be made by December 31 of the following year.  (See the discussion of transition relief below for the treatment of coverage in effect before July 29, 2016.)
  • Under Section 6724, initial and first annual solicitations relate to failures on returns for the year in which the account is opened. In other words, to demonstrate reasonable cause for the year in which the account was opened, a filer must generally show that it made the initial and first annual solicitations.  In contrast, the second annual solicitation relates to failures on returns for all succeeding years.  Because the first return required under Section 6055 will often be required for a year after the year in which the account is “opened” (as described above), the proposed regulations provide that the initial and first annual solicitations relate to the first effective date of coverage for an individual.  The second annual solicitation relates to subsequent years.  The IRS did not discuss how these rules related to an individual who has been covered continuously since a date prior to the requirement to solicit a TIN from an individual.  Presumably, the initial and first annual solicitations will relate to the first year for which a Form 1095-B or Form 1095-C would have been required to be filed by the filer.  These changes generally relate only to the solicitation process for missing TINs and not the process for erroneous TINs.
  • An open question was whether a separate TIN solicitation was required to each covered individual on Form 1095-B or Form 1095-C. The proposed regulations provide that a filer may satisfy the TIN solicitation rules with respect to all covered individuals by sending a single TIN solicitation to the responsible individual.  This is welcome news and alleviates the concern about sending separate solicitations to children and other covered individuals.  However, the proposed regulations do not adopt commenters’ suggestion that if an individual is later added to existing coverage that prior annual TIN solicitations, if those solicitations were unsuccessful, made to the same responsible individual would satisfy the annual TIN solicitation requirement with respect to the new covered individual.  Instead, even though a filer may have made an initial and two annual solicitations to the responsible person, the addition of a new covered individual will require the filer to make a new series of solicitations with respect to the new individual’s TIN.
  • Although not addressed in the regulations, the preamble indicates that a filer may solicit TINs electronically consistent with the requirements in Publication 1586. The guidelines for electronic solicitations generally require an electronic system to (1) ensure the information received is the information sent, and document all occasions of user access that result in submission; (2) make it reasonably certain the person accessing the system and submitting the form is the person identified on the Form W-9; (3) provide the same information as the paper Form W-9; (4) require as the final entry in the submission, an electronic signature by the payee whose name is on the Form W-9 that authenticates and verifies the submission; and (5) be able to provide a hard copy of the electronic Form W-9 to the IRS if requested.  Although it is helpful to know that the IRS believes filers may make use of an electronic system for TIN solicitations like filers under other provisions of the Code, it would have been helpful for the IRS to update its outdated regulations under Section 6724 to specifically permit electronic TIN solicitations.  Ultimately, because Forms 1095-B and 1095-C do not report income that an individual may seek to avoid having reported by using an erroneous name/TIN combination, a less complicated means of electronic solicitation would have been appropriate in this case.

The preamble declines to make four changes requested by commenters:

  • First, the preamble declines to amend the regulations to clarify that a renewal application satisfies the requirements for annual solicitation. Instead, the preamble states that the provision of a renewal application that requests TINs for all covered individuals “satisfies the annual solicitation provisions” if it is sent by the deadline for those annual solicitations.  Although the rule stated in the preamble would be helpful, it is not the rule contained in the regulations.  The regulations under Section 6724 include detailed requirements for annual solicitations including that they include certain statements, a return envelope, and a Form W-9.  Accordingly, a renewal application is unlikely, on its own, to satisfy the annual solicitation requirements as stated in the preamble.  Commenters had requested some changes to these rules, but as discussed below, the IRS declined to adopt such changes in the proposed regulations.
  • Second, the proposed regulations do not remove the requirement to include a Form W-9 or substitute form in a mailed annual solicitation. The preamble indicates that this change was not needed because filers are already permitted to include a substitute Form W-9 with a TIN solicitation.  Although this is true, it sidesteps the concerns raised by commenters relating to the inappropriateness of a Form W-9.  The preamble indicates that an application or renewal application would be an acceptable substitute.  However, the IRS drafters do not seem to understand what constitutes a substitute Form W-9  because an application under the new proposed rule would have to meet several requirements that such documents are unlikely to meet.  For example, a substitute Form W-9 must include a statement under penalties of perjury that the payee is not subject to backup withholding due to a failure to report interest and dividend income and the FATCA code entered on the form indicating that the payee is exempt from FATCA reporting is correct.  Neither of these certifications is relevant to Section 6055 reporting.  Moreover, the references to a “payee” is confusing in the context of Section 6055 reporting, which does not involve a payee (and to the extent there is a payee at all, it would be the filer).  The reference to FATCA exemptions is also not relevant, especially given that only individuals would be completing the form and no U.S. person is exempt from FATCA reporting even if it were relevant.  Moreover, because an application would likely require the applicant to agree to provisions unrelated to these required certifications (such as their age being correct, gender being correct, and other information on the application being correct), a separate signature block or conspicuous statement that the IRS requires only that they consent to the certifications required to avoid backup withholding would have to be included on the form.  It seems doubtful that any applications would satisfy these requirements currently.  Given the misleading nature of the statements and the simple fact that the discussion of backup withholding is completely irrelevant to Section 6055 reporting, it even seems doubtful that many filers will redesign their application forms to satisfy the substitute form requirements even though the drafters of the proposed regulations seem to believe that such forms would be acceptable substitutes.
  • Third, the proposed regulations do not remove the requirement that a mailed TIN solicitation include a return envelope. While retaining the rule in the existing Section 6724 regulations, the preamble does, however, clarify that only a single envelope is required to be sent consistent with the decision to allow a single TIN solicitation to the responsible individual to satisfy the TIN solicitation requirement for all covered individuals.
  • Fourth, commenters had requested that the IRS adopt rules specifically permitting filers to rely on the sponsors of insured group health plans to solicit TINs from their employees on the filer’s behalf. Although the IRS indicated that a filer may use an employer as an agent for TIN solicitation, it declined to provide a distinct ground for reasonable cause when the filer contracted with the employer-sponsor to perform the TIN solicitations.  As a result, the employer’s failure to satisfy the TIN solicitation requirements will leave a filer subject to potential penalties.

Transition Relief. The preamble provides that if an individual was enrolled in coverage on any day before July 29, 2016, the account is considered opened on July 29, 2016. Accordingly, reporting entities have satisfied the requirement for the initial solicitation with respect to already enrolled individuals so long as they requested enrollee TINs at any time before July 29, 2016.

As discussed above, the deadlines for the first and second annual solicitations are set by reference to the date the account is opened.  Accordingly, the first annual solicitation with respect to an individual enrolled in coverage before July 29, 2016, should be made at a reasonable time after that date (the date on which such account is considered open) consistent with Notice 2015-68. Accordingly, a filer that makes the first annual solicitation within 75 days of July 29, 2016 (by October 12, 2016), will be treated as having made such solicitation within a reasonable time.

The preamble states that filers that have not made the initial solicitation before July 29, 2016, should comply with the first annual solicitation requirement by making a solicitation within a reasonable time of July 29, 2016. The preamble reiterates that as provided in Notice 2015-68, a filer is deemed to have satisfied the initial, first annual, and second annual solicitations for an individual whose coverage was terminated prior to September 17, 2015, and taxpayers may continue to rely on this rule as well.  Because a filer is not required to make an annual solicitation under Section 6724 during a year for which it is not required to report coverage, presumably, a filer need not make any solicitations with respect to an individual for whom coverage was terminated at any time in 2015.

AIR System Messages.  The preamble to the proposed regulations formalizes the position of the IRS with respect to TIN mismatch messages generated by the ACA Information Returns (AIR) filing system.  In a footnote, the preamble states that such error messages are “neither a Notice 972CG, Notice of Proposed Civil Penalty, nor a requirement that the filer must solicit a TIN in response to the error message.”  However, given the IRS’s stated position that error correction is a necessary part of demonstrating “good faith” required for penalty relief, it is unclear what, if anything, a filer should do in response to these error messages.  In any event, filers may wish to demonstrate good faith by making an effort to obtain correct TINs from responsible individuals and head-off future errors by working to do so now, rather than later, when such efforts will likely be required.

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.

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.

IRS Releases Final Regulations Imposing Country-by-Country Reporting

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June 30, 2016

As part of its effort to combat tax base erosion and international profit shifting, the IRS finalized regulations requiring country-by-country (CbC) reporting by U.S. persons that are the ultimate parent entity of a multinational enterprise (MNE) group with revenue of $850 million or more in the preceding accounting year. The final regulations, set forth in Treasury Regulation § 1.6038-4, require these U.S. persons to file annual reports containing information on a CbC basis of a MNE group’s income, taxes paid, and certain indicators of the location of economic activity. The preamble to the final regulations notes that comments expressed general support for implementing CbC reporting in the United States. The new reporting requirements are imposed on all parent entities with taxable years beginning on or after June 30, 2016. The final regulations will require reporting on new Form 8975, the “Country by Country Report,” which the IRS is currently developing.

In a prior post, we addressed ABA comments on the proposed regulations, and the final regulations address several of those comments.

  • The ABA noted the hardships that would arise from a mid-2016 effective date due to the need to submit reports to foreign tax authorities for 2016 and problems for calendar year-end U.S. MNEs with an accounting year that begins before the publication date of the final regulations and extends into 2017. In the preamble to the final regulations, the IRS notes that it will work to avoid duplicate reporting in 2016 and will release separate, forthcoming guidance to address accounting years beginning before the final regulations’ publication date and extending into 2017.
  • The ABA noted a need for clarification of the “tax jurisdiction of residency” for purposes of determining territorial income, so the final regulations state that a country with a purely territorial tax regime can be a tax jurisdiction of residence and clarify the meaning of “fiscal autonomy” for purposes of determining whether a non-country jurisdiction is a tax jurisdiction.
  • The ABA requested clarification on the treatment of partnerships under the $850,000 reporting threshold, and the final regulations provide that distributions from a partnership to a partner are not included in the partner’s revenue.
  • The ABA requested tie-breaker rules for residency determinations, and the proposed regulations declined to issue such a rule but noted that Form 8975 may provide guidance.
  • The ABA requested greater flexibility with respect to the time and manner of filing CbC reports, but the IRS rejected this request (though the preamble to the final regulations states that Form 8975 may prescribe an alternative time and manner for filing).

We will provide an update upon the release of Form 8975 that discusses the form itself and any important additions it makes to the final regulations.

IRS Provides Guidance on ACA Reporting in Working Group Meeting

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June 16, 2016

In its Affordable Care Act (ACA) Information Returns (AIR) Working Group Meeting on June 14, the IRS discussed several outstanding issues related to ACA reporting under Sections 6055 and 6056 of the Internal Revenue Code.  Section 6055 generally requires providers of minimum essential coverage to report health coverage.  Section 6056 generally requires applicable large employers to report offers of coverage to full-time employees.  The telephonic meeting touched on a number of topics:

  • Correction of 2015 Returns. The IRS confirmed that filers are required to correct erroneous returns filed for 2015.  Moreover, the IRS stated that error correction is part of the good faith effort to file accurate and complete returns.  As a result, filers who fail to make timely corrections risk being ineligible for the good faith penalty relief that has been provided with respect to 2015 Forms 1095-B and 1095-C filed in 2016.
  • Correction Timing. Corrections to Forms 1095-B and 1095-C must be made “as soon as possible after [a filer] discover[s] that inaccurate information was submitted and [it] gets the correct information.”  Filers may furnish a “corrected” information return to the responsible individual or employee before filing with the IRS by writing “corrected” on the Form 1095-B or 1095-C.  The copy filed with the IRS should not be marked corrected in that circumstance.
  • TIN Validation Failures. The IRS reiterated that the system will only identify the return that contained an incorrect name/TIN combination.  It will not identify which name/TIN combination on the return is incorrect, a source of frustration for filers because they are not permitted from using the TIN Matching Program to validate name/TIN combinations before filing the returns.  Accordingly, a filer will need to verify the name and TIN for each person for whom coverage is reported on the Form 1095-B or Form 1095-C.
  • TIN Mismatch Penalties. The IRS confirmed that error messages generated by the AIR filing system are not proposed penalty notices (Notice 972CG).
  • TIN Solicitation. The IRS reiterated the TIN solicitation rules first published in Notice 2015-68.  In the notice, the IRS provided that the initial solicitation should be made at an individual’s first enrollment or, if already enrolled on September 17, 2015, the next open season, (2) the second solicitation should be made at a reasonable time thereafter, and (3) the third solicitation should be made by December 31 of the year following the initial solicitation.
  • Lowest Cost Employee Share. Applicable large employers must report the lowest cost employee share for self-only coverage providing minimum value on Line 15 of Form 1095-C.  The IRS clarified that coverage must be available to the employee to whom the Form 1095-C relates at the cost reported.  In other words, if the employee cost share varies based on age, salary, or other factors, the share reported must be the one applicable to the employee for whom the Form 1095-C is being filed.

Reporting Self-Insured Coverage to Non-employees.  An employer that provides self-insured health coverage to non-employees may elect to report coverage on either Form 1095-B or Form 1095-C.  In response to a question, the IRS noted that Form 1095-C may only be used if the individual reported on Line 1 has a social security number.  Accordingly, coverage provided to a non-employee that does not have a social security number must be reported on Form 1095-B.

First Friday FATCA Update

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June 3, 2016

Since our last monthly FATCA update, the Treasury Department has not released any new Intergovernmental Agreements nor has the IRS released any new Competent Authority Agreements under the Foreign Account Tax Compliance Act (FATCA). There have been, however, two recent FATCA developments:

  • On June 2, 2016, an IRS official stated that proposed and temporary regulations limiting refunds and credits claimed by nonresident alien individuals and foreign corporations for taxes withheld under Chapter 3 and Chapter 4 (FATCA) of the Code will soon be released (see previous coverage).
  • On May 27, 2016, the IRS updated the technical FAQs (see previous coverage) for the International Data Exchange Service (IDES) used by foreign financial institutions (FFIs) and other organizations to file information returns required by FATCA.

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 Webinar Answers ACA Information Reporting Questions

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May 16, 2016

Last week, the IRS released a webinar on identifying and correcting errors on information returns related to the Affordable Care Act (ACA).  The ACA requires health insurers and some employers to file information returns with the IRS and furnish a copy to the recipient.  The 2015 returns are due by May 31, 2016, if filing on paper, or June 30, 2016, if filing electronically through the ACA Information Reporting (AIR) System.  The IRS webinar addressed frequently asked questions on four topics: correcting specific forms; TIN solicitation and correcting TIN errors; correcting AIR filing; and penalties, exceptions, and penalty relief.

Form-Specific Corrections

To correct errors on Forms 1095-B, 1094-C, and 1095-C, an entity must complete the proper form with the corrected information and mark it as a corrected return.  An entity should not file a return that includes only the corrected information.  Employers used to filing Forms W-2c to correct Forms W-2 will find this approach different from the process with which they are familiar.

To correct a Form 1095-B previously filed with the IRS, an entity should file a complete and corrected Form 1095-B that is marked as corrected, with a Form 1094-B Transmittal (which cannot and should not be marked as corrected).  To correct a Form 1095-C previously filed with the IRS, an entity must file a complete and corrected Form 1095-C that is marked as corrected, with a Form 1094-C Transmittal that is not marked as corrected.  Next, the entity must furnish the employee with a copy of the corrected Form 1095-C.  Employers using the qualifying offer method or the qualifying offer method transition relief for 2015, however, are not required to furnish the copy to the employee in certain cases.

To correct a Form 1094-C that is the authoritative transmittal previously filed with the IRS, an entity should file a standalone Form 1094-C.  An entity need not correct a Form 1094-C that is not the authoritative transmittal.

Some filers have expressed confusion as to why they must file corrected returns given that the IRS has indicated that a recipient of a Form 1095-B or Form 1095-C need not correct their tax return to reflect information reflected on a corrected form.  The webinar makes clear that regardless of that approach, filers must correct returns timely.  In terms of timing, an entity should file a correction as soon as the error is discovered if the filing deadline has already passed.  If an entity has already furnished Forms 1095-B or 1095-C to recipients but finds an error before filing with the IRS, the entity needs to file with the IRS a regular return, i.e., not marked as corrected, containing the accurate information. A new original, i.e., not marked as corrected, form should be provided to the responsible individual or employee as soon as possible.

TIN Solicitation and Error Corrections

In an effort to assuage a key concern of many filing entities, the IRS stated that an error message for missing and/or incorrect information is not a proposed penalty notice.  However, when an entity receives an error message regarding a name/TIN mismatch, the entity should file a correction if it has correct information.  If the entity lacks the TIN, it may use the date of birth and avoid penalties for failure to report a TIN, provided that the entity followed the three-step TIN solicitation process under Notice 2015-68: “(1) the initial solicitation is made at an individual’s first enrollment or, if already enrolled on September 17, 2015, the next open season, (2) the second solicitation is made at a reasonable time thereafter, and (3) the third solicitation is made by December 31 of the year following the initial solicitation.” The webinar is unclear whether the receipt of an error message triggers an obligation for filers to engage in a new round of TIN solicitation.

If an entity has not solicited a TIN, e.g., the individual was already enrolled on September 17, 2015, and the next open season is not until July 2016, the entity may be unable to correct the error before the return filing deadline.  In this case, the entity should still file a correction when it obtains the TIN or the date of birth if the TIN is not provided.  If a Penalty Notice 972CG is issued, the entity will have the opportunity to show whether good-faith relief or a reasonable-cause waiver applies.

AIR Filing Corrections

The IRS also clarified AIR’s transmission responses, which are defined under IRS Publication 5165.  An AIR filing will generate one of five responses: accepted, accepted with errors, partially accepted, rejected, or not found by AIR.  “Accepted with errors” means that AIR found at least one of the submissions had errors, but did not find fatal errors – i.e., the submission had unusable data – which would prompt a “rejected” response.  “Partially accepted” means AIR accepted some of the submissions and rejected others.  If AIR rejected any attempted filings, the entity must cure the problem and transmit the return again rather than use the correction process.

If AIR identifies errors, an entity will receive an acknowledgement in XML with an attached Error Data File.  Again, this error message is not a proposed penalty notice.  Rather, to assist the entity, the Error Date File includes unique IDs to identify the erroneous returns, and error codes and descriptions to identify the specific errors.  After locating and identifying the error, the entity must prepare corrected returns, which must reference the unique IDs of the returns being corrected.  AIR will assign unique IDs to the corrected returns, which the entity can then transmit through AIR.

Penalties and Penalty Relief

ACA-related information reporting is subject to the general penalties under Sections 6721 and 6722 of the Code for failure to (1) furnish correct copies to employees and insured individuals or (2) file complete and accurate information returns with the IRS.  The penalty for each incorrect information return is $260 and up to $3,178,500 for each type of failure, for entities with over $5 million in average annual gross receipts over the last three taxable years.  Only one penalty applies per record, even if the record has multiple errors, such as incorrect TIN and incorrect months of coverage.  For late returns, penalty amounts per return start at $50 and increase to $520, depending when the correction is filed and whether the failure was due to intentional disregard.  Further, a penalty may apply if an entity is required to file electronically because it has 250 or more returns but the entity files on paper and fails to apply for a waiver using Form 8508.

The IRS has provided good-faith relief to entities that file or furnish incorrect or incomplete – but not late – information, including TINs or dates of birth, if the entity can show that it made a good-faith effort to comply with the requirements.  Good-faith relief does not apply to egregious mistakes, e.g., where an entity transmits returns with just names and addresses and no health coverage information.  Further, good-faith relief does not excuse an entity from the continuing obligations to identify and correct errors in returns previously filed with the IRS.  An entity must correct errors within a reasonable period of time after discovering them (corrections must be filed within 30 days).  Importantly, if subsequent events, such as a retroactive enrollment or change in coverage make the information reported on a Form 1095-B or Form 1095-C incorrect, the entity has an affirmative obligation to correct the return even though it was correct when initially filed.

In addition to the good-faith relief, inconsequential errors and omissions are not subject to these penalties.  An error or omission is inconsequential if it does not stop the IRS from correlating the required information with the affected person’s tax return, or otherwise using the return. Errors and omissions are not inconsequential, however, if they pertain to the TIN and/or surnames of the recipient or other covered individuals, or if the return furnished to a recipient is not the appropriate form or substitute form.  Many errors relating to addresses or to an individual’s first name may be inconsequential, and are not required to be corrected.

Another exception is available for a de minimis number of failures to provide correct information if the filing entity corrects that information by August 1 of the calendar year to which the information relates, or November 1 for 2016.  For a calendar year, penalties do not apply to the greater of 10 returns or half a percent of the total number of returns the entity is required to file or furnish.

Finally, a filer may qualify for a reasonable cause waiver under Section 6724 of the Code for a failure that is due to a reasonable cause and not willful neglect.  To establish “reasonable cause,” an entity must show that it acted responsibly before and after the failure occurred and that the entity had significant mitigating factors or the failure was due to events beyond its control.  Significant mitigating factors include, for instance, that an entity was not previously required to file or furnish the particular type of form, and that an entity has an established history of filing complete and accurate information returns.  Events beyond an entity’s control include fire or other casualty that make relevant business records unavailable and prevent the entity from timely filing.

Proposed Regulations Impose Reporting Obligations on Foreign-Owned U.S. Entities

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May 10, 2016

Today, the IRS published proposed regulations that would impose reporting obligations upon a domestic disregarded entity wholly owned by a foreign person (foreign-owned DDE).  Specifically, the proposed regulations would amend Treasury Regulation § 301.7701-2(c) to treat a foreign-owned DDE as a domestic corporation separate from its owner for the limited purposes of the reporting, recordkeeping, and other compliance requirements that apply to 25 percent foreign-owned domestic corporations under Section 6038A of the Internal Revenue Code.  These changes broaden the IRS’s access to information that would help the IRS enforce tax laws under the Code and international treaties and agreements.

The proposed regulations would render foreign-owned DDEs reporting corporations under Section 6038A.  Accordingly, 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 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 Section 482).  Thus, a foreign-owned DDE would 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.

This rulemaking project is still in its infancy, and it remains to be seen if and how the IRS harmonizes the proposed regulations with existing rules.  For example, the proposed regulations impose a filing obligation on a foreign-owned DDE for reportable transactions even if its foreign owner already has an obligation to report the income resulting from those transactions (e.g., transactions resulting in income effectively connected with the conduct of a U.S. trade or business).  The Treasury Department and the IRS sought comments on possible alternative methods for reporting the disregarded entity’s transactions in these cases.  In the preambles, the IRS also stated that it is considering changing corporate, partnership, and other tax or information returns (or their instructions) to require foreign-owned DDEs to identify all the foreign and domestic disregarded entities it owns, consistent with the proposed regulations.

These proposed regulations will apply for tax years ending on or after May 10, 2017.  Comments and public hearing requests are due by August 8, 2016.

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.

First Friday FATCA Update

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May 6, 2016

Recently, the IRS released the Intergovernmental Agreements (IGAs) entered into between the United States and the following foreign treaty partners, in these respective forms:

  • Vietnam, Model 1B;
  • Panama, Model 1A.

The IRS also released the Competent Authority Agreements (CAAs) implementing the IGAs between the United States and the following treaty partners:

  • Bulgaria (Model 1B IGA signed on December 5, 2014);
  • Curacao (Model 1A IGA signed on December 16, 2014);
  • Cyprus (Model 1A IGA signed on December 12, 2014);
  • France (Model 1A IGA signed on November 14, 2013);
  • Israel (Model 1A IGA signed on June 30, 2014);
  • Philippines (Model 1A IGA signed on July 13, 2015);
  • Saint Lucia (Model 1A IGA signed on November 19, 2015);
  • Slovak Republic (Model 1A IGA signed on July 31, 2015).

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

  • The U.S. government filed its brief in opposition to a petition for certiorari seeking Supreme Court review of FATCA reporting requirements for foreign account holders (see previous coverage).
  • The U.S. District Court for the Southern District of Ohio, in Crawford v. United States Department of the Treasury, dismissed a challenge to FATCA brought by Senator Rand Paul and several current and former U.S. citizens living abroad on standing grounds (see previous coverage).
  • The IRS released a new Form W-8BEN-E – which is used by foreign entities to report their U.S. tax status and identity to withholding agents – along with updated instructions (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.

IRS Modifies 2015 6050W Letter Ruling

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May 6, 2016

The IRS released a modified private letter ruling superseding a ruling issued in late 2015 under Section 6050W.  That ruling had determined that the party requesting the ruling was a third-party settlement organization.  The new ruling does not change the conclusion, but removes one rationale upon which the earlier ruling had based its determination.

In PLR 201604003, the IRS indicated that the party requesting the ruling was a third-party settlement organization, in part because it was the only party that had all the information necessary to report on Form 1099-K accurately.  This is because it was the only party who was aware of the gross amount of the reportable payment transactions.  PLR 201619006 removed this paragraph from the ruling.  The rationale in the original ruling raised questions for practitioners because it is a factor that is not present in the 6050W statute or regulations.  It was unclear whether the IRS would consider a party that might not otherwise be a third-party settlement organization to be a third-party settlement organization if it was the only party with the required information.  Similarly, if a party that otherwise would have been a third-party settlement organization lacked the required information, would it not be required to file Forms 1099-K?  It is unclear whether the IRS removed the language because it was an invalid basis for its determination or if the IRS learned that the facts differed from those in the original ruling.

IRS Provides Transitional Relief for PATH Act’s Changes to Form 1098-T Reporting for Colleges and Universities

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April 28, 2016

On April 27, 2016, the IRS issued transitional penalty relief to colleges and universities under Announcement 2016-17 with respect to new reporting requirements implemented as part of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). Prior to the PATH Act, eligible educational institutions were required to report annually on Form 1098-T either (i) the aggregate amount of payments received for qualified tuition and related expenses, or (ii) the aggregate amount billed for such tuition and expenses. Section 212 of the PATH Act eliminates the option to report payments billed, meaning that colleges and universities must report the amount of payments received each year on a prospective basis.

If a college or university fails to properly file correct or timely tuition information with the IRS or furnish a proper written statement to the recipient, reporting penalties will apply under sections 6721 and 6722. Numerous eligible educational institutions notified the IRS that the law change would require computer software reprogramming that could not be completed prior to the 2016 deadlines for furnishing Forms 1098-T, which would trigger widespread penalties. Accordingly, Announcement 2016-17 permits eligible educational institutions to report the aggregate amount billed on all 2016 Forms 1098-T, effectively providing one year of transitional relief.

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.

First Friday FATCA Update

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April 1, 2016

Recently, the Internal Revenue Service released the Competent Authority Agreement (CAA) between the United States and Turkey.  This CAA implements the Model 1A Intergovernmental Agreement (IGA) the parties entered into on July 29, 2015.

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

  • The Canadian government expressed support for FATCA despite concerns about how FATCA impacts Canadian citizens’ privacy rights (see previous coverage).
  • New Zealand released guidance explaining how FATCA applies to New Zealand trusts that maintain or hold financial accounts (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.

IRS Updates Guidelines for Substitute Wage Forms

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March 29, 2016

The IRS released Revenue Procedure 2016-20 to update IRS and Social Security Administration guidelines for employers issuing substitute Forms W-2c, Corrected Wage and Tax Statements, and W-3c, Transmittal of Corrected Wage and Tax Statements. These guidelines assist employers with filing electronically; filing “red-ink” and “black-and-white” versions of Copy A of Form W-2c; and furnishing substitute privately printed versions of Copies B, C, and 2 of Form W-2c to employees. The guidance also provides rules regarding retention of both information and copies.

Revenue Procedure 2016-20 supersedes Revenue Procedure 2014-56, and several changes have been made. Although most of these changes are minor, one important change is the updated address for SSA inquiries about substitute black-and-white Forms W-2c Copy A and W-3c Copy A, which is now:

Social Security Administration Direction Operations Center
Attn: Substitute Black-and-White Copy A Forms, Room 341
1150 E. Mountain Drive
Wilkes-Barre, PA 18702-7997

IRS Tax Study Intended to Guide Future Audits Nears Completion

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March 25, 2016

The IRS expects to soon conclude its study of 6,000 audits that was aimed at identifying problem industries that show a history of noncompliance with certain tax and reporting rules, including worker classification, the accountable plan rules, and the fringe benefit rules. At an American Payroll Association conference on March 21, John Tuzynski, the IRS’s director of Technical Services in Exam, said that the results will likely be published in early 2017.

The results should help the IRS focus its increasingly limited resources on industries and issues that produce the most violations, as the IRS plans to use them to inform examination decisions. Currently, the IRS is relying on the results of a study conducted in the mid-1980s, so the new data provides a much-needed update and, depending on the results, could result in a significant shift in decision-making with respect to examinations and compliance programs. Although decisions are currently made based largely on anecdotal evidence, the IRS seeks to become more calculated going forward and target the industries proven to produce significant rates of noncompliance.

It is no secret that the IRS expends a disproportionate amount of its enforcement resources auditing the same large businesses year after year while largely ignoring small and mid-size businesses on the theory that audits of larger taxpayers result in larger assessments. The practical problem with this approach is the development of a lack of evenness with respect to compliance, which suggests unfairness in the enforcement process. Perhaps the research program undertaken by the Service with respect to these 6,000 audits, which began approximately seven years ago, will result in a more even distribution of enforcement resources and a more broad-based focus on compliance from all taxpayers rather than pursuing past practices in a wooden fashion.

Proposed Regulations on Country-by-Country Reporting Raises Concerns for ABA

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March 24, 2016

On March 23, 2016, the American Bar Association (ABA) Section of Taxation commented on proposed Treasury regulations requiring country-by-country (CbC) reporting by U.S. persons that are the ultimate parent entity of a multinational enterprise (MNE) group with annual revenue of $850 million or more in the preceding accounting year.  Issued in December 2015, Proposed Regulation § 1.6038-4 would require these U.S. persons to file annual reports containing information on a CbC basis of a MNE group’s income, taxes paid, and certain indicators of the location of economic activity.

The United States, through bilateral agreements with other tax jurisdictions, may exchange U.S. CbC reports with those tax jurisdictions in which the U.S. MNE group operates. Every information exchange agreement to which the United States is a party requires both parties to treat the information as confidential, implement data safeguards, and use the information only for tax administration purposes. The United States will stop automatic exchange with tax jurisdictions violating those requirements until the violations are cured.

Aimed at combating tax base erosion and international profit shifting, the proposed regulation will give the IRS greater transparency into the operations and tax positions taken by U.S. MNE groups. While the information in a CbC report will not itself constitute conclusive evidence of federal income tax or transfer pricing violations, they may form the basis for the IRS’s further inquiries into transfer pricing practices or other tax matters.

Members of the ABA Taxation Section, while generally supportive of the proposed regulations, urged the IRS to implement changes and provide clarification. Section members expressed concern that the delay of the U.S. effective date to mid-2016 “will cause hardships for U.S. companies because they will be required to submit CbC reports directly to foreign tax authorities for fiscal year 2016 with the concomitant problems of multiple filings and potentially weaker data confidentiality protections.” Further, a mid-year effective date would cause reporting issues for calendar year-end U.S. MNEs with foreign constituents having a 2016 accounting year that begins before the publication date of the final regulations and carries over into 2017.

Regarding the timing and manner of filing reports, section members urged the IRS to allow MNEs (a) to file within a 12-month period after the end of the accounting period to which the report relates, rather than impose an accelerated deadline; and (b) to use mix-source data to generate their CbC reports. Section members also asked the IRS to issue tie-breaker rules for residency determinations, clarify the meaning of “tax jurisdiction of residence” for purposes of determining territorial income, and clarify how partnerships are treated under the $850 million threshold.

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.

New Zealand Releases Guidance Explaining Application of FATCA to Trusts

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March 10, 2016

The New Zealand Inland Revenue issued guidance notes explaining the application of FATCA to New Zealand trusts that maintain or hold financial accounts.  The nearly 40-page document explains cases where trusts should be treated as financial institutions, as well as the due diligence and reporting obligations of Reporting New Zealand Financial Institution “investment entity” trusts.  The guidance notes address four different types of trusts: unit trusts, family trusts, trading trusts, and charitable trusts.  Solicitors’ trust accounts will be addressed separately in upcoming guidance.  If the trust is deemed a Reporting New Zealand Financial Institution, then it must register with the IRS and will have FATCA reporting and due diligence obligations.