IRS Adds Five New FATCA FAQs Addressing QDD, QI, and WP Concerns

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December 13, 2017

The IRS updated its FATCA frequently asked questions to include five new FAQs.  The new FAQs address issues involving qualified intermediaries (QIs) that are or are seeking to become qualified derivatives dealers (QDDs), non-financial foreign entities (NFFEs) seeking to become withholding foreign partnerships (WPs), the period review requirements applicable to QIs that are QDDs, and the independence standard applicable to external reviewers of a QI, WP, or withholding foreign trust (WT).

Three FAQs were added to the “New Applications/Renewals” section, the first two of which address QIs.  In FAQ#17, the IRS clarifies that a QI that is not currently a QDD does not have to wait for its QI agreement to expire before applying for QDD status.  It also reiterates that branches of QIs wishing to become QDDs must complete their own separate QDD application.  FAQ#18 addresses the effective date (i.e., the date on which the QI can represent itself as a QDD on Form W-8IMY) of a newly-granted QDD status.  If a QI is granted QDD status prior to March 31 of a calendar year, or after March 31 for QIs that have not received any reportable payments before being granted QDD status, that status will become effective as of January 1 of that year.  Otherwise, QDD status will become effective the first day of the month in which the QDD application is approved.  FAQ#19 addresses the circumstances in which an NFFE that is a foreign reverse hybrid entity (a foreign entity that is fiscally transparent for foreign tax purposes but not transparent for U.S. tax purposes) can become a WP (a status reserved for foreign reverse hybrid entities that are FFIs under section 6.03(C) of the WP agreement).  The FAQ clarifies that a foreign reverse hybrid entity that is an NFFE may apply to be a WP but only with respect to payments of personal services income effectively connected with a U.S. trade or business.

The IRS also added a new section titled “Certifications and Periodic Reviews,” consisting of two review-related FAQs.  FAQ#1 addresses the circumstances in which QIs that are QDDs can avoid periodic review for certification periods ending in 2017 and 2018.  Section 10.07 of the QI agreement permits waivers of periodic review requirements for QIs not acting as QDDs, but Notice 2017-42 extended this waiver to QIs that are QDDs for its QDD activities with respect to certification periods ending in 2017 and 2018.  This left open the question of whether such QIs could seek a waiver of periodic review for their non-QDD activities.  FAQ#1 answers this question in the affirmative and provides instructions on the process of applying for a waiver.  In FAQ#2, the IRS expands on the requirement in section 10.04 of the QI agreement and section 8.04 of the WP and WT agreements that an external reviewer of a QI, WP, or WT not review the work of others in the same “firm,” a standard that has raised questions.  Accordingly, the IRS clarifies that for years before 2018, external reviewers may apply the standards otherwise applicable to their engagement to conduct the review (e.g., procedures for a certified public accountant).  The IRS intends to provide further guidance for calendar years 2018 and later.

Employer Withholding Guidance Delayed Pending Tax Reform

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December 8, 2017

The increasingly likely prospect of a tax reform bill being enacted by the end of the year has prompted the IRS to delay annual withholding guidance, according to Scott Mezistrano of the IRS Wage and Investment Division’s Industry Stakeholder Engagement and Strategy Office.  It is expected that any tax reform bill would change tax rates, increase the standard deduction, and eliminate personal exemptions.  These changes will necessitate changes in withholding rates and withholding tables to ensure that employers withhold the appropriate amount of tax from employees’ wages.  Speaking on an IRS payroll industry monthly conference call on December 7, Mezistrano said that the guidance that will be delayed includes Form W‑4 (Employee’s Withholding Allowance Certificate), the withholding tables, Publication 15‑A (Employer’s Supplemental Tax Guide), and Publication 15‑B (Employer’s Tax Guide to Fringe Benefits).  Employers will likely be required to continue using the 2017 withholding tables and guidance into 2018, even if the tax reform legislation were to be signed into law before year end and the new tax rates were to take effect on January 1, 2018.  Employers would also be provided a transition period to implement the new IRS withholding guidance, according to Mezistrano.

Currently, a conference committee with selected lawmakers from both chambers is negotiating a final bill to reconcile the two versions of the GOP tax reform bill passed in the Senate (discussed here, here, and here) and in the House (discussed in an earlier series of posts).  A final negotiated bill would need to pass both chambers before the President can sign it into law.  We will continue to monitor tax reform legislation and related IRS guidance for further developments.

Fate of Employer Tuition Assistance Programs Hangs in the Balance

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December 8, 2017

On December 2, the Senate passed a version of the Tax Cuts and Jobs Act that differed in key respects from the House bill passed several weeks prior.  Notably, the House bill would eliminate the exclusion of up to $5,250 from an employee’s wages for qualified educational assistance under Code section 127 (discussed here), but the Senate bill would leave the exclusion in place.  While headlines address the more high-profile differences between the bills (e.g., the new corporate tax rate and the repeal of the ACA’s individual mandate), a number of large employers, including a number of our clients, have expressed concern about the fate of tuition assistance programs, as they view it as an important benefit for their employees.  This backlash is unsurprising, given that the Society for Human Resource Management (SHRM) estimates that over 60% of employers offer some form of tuition assistance.

The fate of the tuition assistance exclusion, as well as all other areas in which the House and Senate bills disagree, now rests with the conference committee.  The Senate bill also retains the exclusion for qualified tuition reductions provided by educational institutions that the House bill would eliminate, representing another education benefit that the conference committee will need to address.  The conference committee is tasked with reconciling the differences between the two bills, and it is expected that the process will conclude within the next one to two weeks.  Conference committees are notoriously unpredictable, making it difficult to anticipate the fate of the tuition assistance provision, particularly with many of the details of the final legislation in flux.  Though several major employers, as well as SHRM, have vocalized objections to the House bill’s proposed repeal, public criticism of a possible repeal has not been as strong as some had anticipated, a fact that could influence policymakers.

Educational Benefits that Qualify for Exclusion as Working Condition Fringe Benefits

Notably, neither version of the Bill would affect the ability of employees to exclude education benefits that qualify as working condition fringe benefits from taxable wages under Code section 132(d).  Working condition fringe benefits include any property or services that would have been deductible by an employee as a business expense had the employee paid for it his or herself.  Some employers have questioned whether the suspension of miscellaneous itemized deductions under Code section 67 under the Senate bill and the new Code section 262A that would be added by the House bill disallowing deductions for unreimbursed business expenses would eliminate the exclusion for working condition fringes because the expenses would no longer be deductible under Code section 162 by the employee if the employee had paid them directly.  The House bill directly addresses this by amending Code section 132(d) to specify that it is determined without regard to Code section 262A.  Although the Senate bill is silent, the change to section 67 would not seem to affect working condition fringes as the exclusion is currently applied without regard to the 2% of adjusted gross income floor that section 67 applies under current law.

Many employers offer educational benefits that qualify for exclusion as a working condition fringe benefit because the benefits are limited to education that maintains or improves job skills or meets requirements for the employee to remain in his or her current position.  One example would be a program under which the employer pays for continuing education courses for medical professional, lawyers, and accountants.  Education benefits that qualify as working condition fringes are more flexible than under Code section 127 because there is no dollar limit and a written plan is not required.  Travel and lodging expenses incurred as part of attending courses can also qualify for exclusion.

IRS Proposed Coordination of Partnership Audit Rules with Withholding and Reporting Rules under Chapters 3 and 4

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December 5, 2017

Recently, the IRS proposed regulations addressing how certain international tax rules would operate under the centralized partnership audit regime (“CPAR”), including rules relating to the withholding of tax on foreign persons and withholding of tax to enforce reporting on certain foreign accounts. CPAR was introduced in 2015 to allow for the assessment and collection of tax on audit at the partnership level rather than at the level of the individual partners.  The proposed regulations are designed to coordinate CPAR and the international tax regime, so that tax is collected only once from partnerships that have tax withholding obligations on payments to foreign partners.

Coordination of CPAR with Chapters 3 and 4 of the Code

Under the proposed regulations, CPAR would not apply to any adjustments that the IRS makes when a partnership fails to withhold tax at the correct rate (e.g., under section 1441 on payments made to an unrelated foreign person, or under section 1445 on receiving transfers of U.S. real property interest).  By contrast, CPAR would apply if a partnership fails to report income and withhold tax on that additional income allocable to a foreign partner.  The IRS may, however, make an adjustment to the same item under chapter 3 or 4 outside of CPAR.

Where an item subject to CPAR is also subject to chapter 3 or 4, the proposed regulations would coordinate these tax regimes to prevent double taxation on the same adjustment. For example, if an audit of chapter 3 or 4 compliance is conducted before the CPAR proceedings and the IRS collects withholding tax under chapter 3 or 4 attributable to the adjustment, that adjustment would be disregarded to the extent the IRS collected the tax for purposes of calculating the total netted partnership adjustment (upon which the imputed underpayment amount is determined) under CPAR. In contrast, if the IRS has not collected withholding taxes under chapter 3 or 4 on an amount subject to withholding and the partnership is subject to a CPAR examination; the partnership pays the imputed underpayment pursuant to sections 6225 or 6227; and the total netted partnership adjustment includes an adjustment to an amount subject to withholding under chapter 3 or 4, then the partnership would be treated as having paid the amount required to be withheld with respect to that adjustment for purposes of applying Treasury Regulations §§ 1.1463-1 or 1.1474-4.  Accordingly, the partnership would be considered to have satisfied its withholding tax liability associated with the adjustment.  However, the partnership would not be relieved from any interest, penalties, or additions to tax under chapter 3 and 4 that may otherwise apply for the failure to withhold.

Coordination of Chapters 3 and 4 with Section 6226 Elections

Under section 6226, a partnership may elect to “push out” adjustments to its partners during the year to which an adjustment relates (i.e., reviewed‑year partners are taxed) rather than pay an imputed underpayment (i.e., current-year partners are effectively taxed).  The proposed regulations provide rules that would apply withholding and reporting requirements under chapters 3 and 4 to a partnership that makes a section 6226 election with respect to a reviewed‑year partner that would have been subject to withholding in the reviewed year.  The regulations would also provide rules that apply to the reviewed‑year partner when taking these adjustments into account.

The preamble states that the Treasury and IRS are considering ways to alleviate the need for a reviewed‑year partner that is subject to chapter 3 or 4 withholding to file an income tax return reporting its additional reporting‑year tax (and its share of any penalties, additions to tax, additional amounts and interest) when a partnership pushes out its adjustments and does not make a specific imputed underpayment for adjustments subject to withholding. Specifically, comments are sought on an approach that would allow a partnership that pays the withholding tax to also pay their share of penalties, interest and additional taxes attributable to a partner that would have been subject to withholding in the reviewed year.  Comments are also sought on the application of chapters 3 and 4 to section 6226 in the case of partners that are foreign flow-through entities, including partners that assume primary withholding responsibility as withholding foreign partnerships or withholding foreign trusts.  Comments are due by January 29, 2018.

Analysis of the Senate Tax Reform Bill – Part III: New Source Rules and Tax Reporting and Withholding Requirements

Early Saturday morning, the Senate voted 51-49 to approve a modified version of the Tax Cuts and Jobs Act (the “Senate Bill”). The Senate Bill differs from the House bill (discussed in an earlier series of posts here) passed last month in several respects, and a final negotiated bill will need to pass both chambers before the President can sign it into law. Given the difficulty of moving legislation through the Senate, it seems likely that any enacted legislation would likely be similar to the version passed by the House.

This post is the third in a series of three posts analyzing provisions of the Senate Bill. (Part I analyzes the elimination of the penalty for failing to maintain minimum essential coverage under the ACA and changes to equity and executive compensation.   Part II analyzes changes to deductions and exclusions for employee meals and other fringe benefits, changes to private retirement plan benefits, and a new paid leave credit.)

This post analyzes the new reporting and withholding requirements and source rules. Specifically, the Senate Bill would: (a) eliminate personal exemptions for income tax purposes but retain them for income tax withholding purposes; (b) require reporting for deductible amounts paid with respect to fines and penalties; (c) require reporting for certain life insurance transactions; (d) modify the reporting rules for Alaska Native Corporations; (e) modify the sourcing rule for sale of inventory items; (f) modify the sourcing rule for U.S. possessions; and (g) impose withholding under section 1446 for sale of an interest in a U.S. partnership by a foreign person that is treated as effectively connected income under new Code section 864(c)(8).

These changes generally would be effective after 2017, except as otherwise noted below.

Withholding Exemptions. The Senate Bill would raise the standard deduction and eliminate personal exemptions, which currently allow individuals to reduce their taxable income.  However, section 11041(c) of the Senate Bill would keep the value of the personal allowance in place for purposes of determining the correct amount of federal income tax withholding.

Reporting of Deductible Amounts Paid with Respect to Fines and Penalties. As we previously covered, section 13306(b) of the Senate Bill would adopt a new Code section 6050X requiring government agencies (or entities treated as government agencies) to report to the IRS and taxpayer on a new information return the amount of each settlement agreement or order entered into, where the aggregate amount required or directed to be paid or incurred exceeds a threshold ($600 in the statute, but subject to adjustment by Treasury).  The return must identify any amounts for restitution or remediation of property or correction of noncompliance, which are deductible, unlike fines and penalties paid under the agreement. These changes would generally apply to amounts paid or incurred on or after the date of enactment, except that the changes would not apply to binding orders or agreements entered into or subject to court approval before that date. The House bill did not include any similar provision.

Reporting of Certain Life Insurance Transactions. As we previously covered, section 13520 of the Senate Bill would also adopt a new Code section 6050Y that would create a new information reporting requirement for certain life insurance contract transactions. This includes: (a) a return filed and furnished by every person who acquires a life insurance contract or any interest in a life insurance contract in a “reportable policy sale”; (b) a return filed and furnished by each issuer of a life insurance contract upon notice of a transaction reported under (a); and (c) a return filed and furnished by every payor of “reportable death benefits.”  A “reportable policy sale” is generally the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship to the insured.  A “reportable death benefit” is an amount paid by reason of death of the insured under a life insurance contract that was transferred in a reportable policy sale.  The buyer must file the return required under (a) with the IRS and furnish copies of the return to the insurance company that issued the contract and the seller.  The insurance company that bears the risk with respect to a life insurance contract that receives a copy of a return required under (a) must file the return required under (b) with the IRS and furnish a copy of the return to the seller.  The payor insurance company must file the return required under (c) with the IRS and furnish a copy of the return to the payee.  The reporting requirements would apply for reportable death benefits paid and reportable policy sales after 2017. The House bill did not include any similar proposal.

Reporting Requirements of Alaska Native Corporations. Under current law, Alaska Native Corporations may deduct donations of cash or assets to “settlement trusts,” which are entities that manage Native lands. Section 13821(c) of the Senate Bill would modify the reporting requirements imposed on Native Corporations with respect to such deductions. Specifically, Native Corporations that have made contributions to a settlement trust and elected to deduct those contributions would be required to provide the settlement trust a statement regarding the election not later than January 31 of the calendar year after the calendar year in which the contribution was made. The statement would be required to include: (i) the amount of the contribution to which the election applies; (ii) whether the contribution was made in cash; (iii) for contributions of property other than cash, certain details about the property; (iv) the date of the contribution; and (v) any other information required by Treasury.

Sourcing Rule for Sale of Inventory Property. Under Code section 863(b), sales of inventory property produced in one jurisdiction and sold in another are currently sourced by allocating 50% of the sales income to one jurisdiction and 50% to the other.  Section 14304 of the Senate Bill would change this sourcing rule so that the entire amount would be sourced to the jurisdiction of production.

Sourcing Rule for U.S. Possessions. Section 14503 of the Senate Bill would change two provisions affecting the sourcing rules related to U.S. possessions.  First, Code section 937(b), which controls whether income of U.S. citizens and residents is treated as possession source income, generally provides that income treated as U.S. source or effectively connected with a U.S. trade or business is not treated as income from sources within a possession or effectively connected with a trade or business in that possession.  The Senate Bill would amend Code section 937(b)(2) so that only U.S. source or effectively connected income attributable to a U.S. office or fixed place of business is excluded from possession source income.  Second, the Senate Bill would amend Code section 865, which sets forth the sourcing rules for personal property sales, so that capital gains earned by a U.S. Virgin Islands resident would always be U.S. Virgin Islands source income.

Withholding on Gain from the Sale by Foreign Persons of Interests in Certain Partnerships. Section 13501 of the Senate bill would add a new Code section 864(c)(8) that treats a portion of the gain or loss on the sale or exchange of a partnership interest by a foreign person as effectively connected income if that partnership is engaged in a U.S. trade or business. Under the provision, if a foreign corporation or nonresident alien individual owns, directly or indirectly, an interest in a partnership engaged in a U.S. trade or business, a portion of the gain or loss on the sale or exchange of such interest is treated as effectively connected with the conduct of a U.S. trade or business to the extent such gain or loss does not exceed: (1) in the case of a gain, the portion of the partner’s distributive share of the amount of gain which would have been treated as effectively connected if the partnership had sold all of its assets at fair market value as of the date of the sale or exchange of the partnership interest (or zero, if no such deemed sale would have been effectively connected) or (2) in the case of a loss, the portion of the partner’s distributive share of the amount of loss on the deemed sale described in (1) which would have been effectively connected (or zero, if no such deemed sale would have been effectively connected).  The gain or loss treated as effectively connected under the provision is reduced by the amount so treated with respect to United States real property interests under section 897.

The Senate Bill would also amend Code section 1446 to impose a 10% withholding requirement on the amount of gain treated as effectively connected income under Code section 864(c)(8), similar to the existing rules under section 1445. Upon request by the transferor (generally, the seller) or the transferee (generally, the buyer), the Treasury may prescribe a reduce rate of withholding if the Secretary determines it is appropriate.  In addition, no withholding is required if a transferor furnish to the transferee an affidavit signed under penalty of perjury stating that the transferor is not a foreign person and providing the transferor’s U.S. TIN.  In the absence of such an affidavit (or if the transferee has actual knowledge that a provided affidavit is false or receives a notice from the transferor’s agent or transferee’s agent that such affidavit is false, similar to agent’s notice obligations under section 1445(d)), the transferee of the partnership interest is liable for satisfying the withholding obligation, but in the event that the transferee fails to withhold the required tax, the partnership must withhold an amount equal to the amount the transferee failed to withhold (plus interest) from distributions to the transferee.

The changes would generally be effective for sales and exchanges on or after November 27, 2017.

Analysis of the Senate Tax Reform Bill – Part II: Changes to Deductions and Exclusions for Employee Meals and Other Fringe Benefits, Changes to Private Retirement Plan Benefits, and New Paid Leave Credit

Early Saturday morning, the Senate voted 51-49 to approve a modified version of the Tax Cuts and Jobs Act (the “Senate Bill”). The Senate Bill differs from the House bill (discussed in an earlier series of posts here) passed last month in several respects, and a final negotiated bill will need to pass both chambers before the President can sign it into law. Given the difficulty of moving legislation through the Senate, it seems likely that any enacted legislation would likely be similar to the version passed by the House.

This post is the second in a series of three posts analyzing provisions of the Senate Bill. (Part I analyzes the elimination of the penalty for failing to maintain minimum essential coverage under the ACA and changes to equity and executive compensation. Part III analyzes new reporting and withholding requirements and source rules.)  This post analyzes the following changes:

  • Fringe Benefits – (a) eliminate the deduction for entertainment expenses; (b) eliminate the deduction (after 2025) for meals provided for the employer’s convenience (that are not occasional overtime meals) and meals provided at employer-operated eating facilities; (c) impose a 50-percent limitation on deductions for occasional overtime meals and other de minimis meals; (d) eliminate the deduction for qualified transportation fringes; (e) eliminate the deduction for commuting expenses (except for the employee’s safety); (f) suspend the exclusion for qualified bicycle commuting reimbursement; (g) suspend the exclusion for qualified moving expense reimbursement; and (h) prohibit the use of cash or gift cards and other non-tangible personal property as employee achievement awards.
  • Private Retirement Benefits – (a) extend the rollover time period of certain outstanding plan loans; and (b) allow qualified distributions for victims of major disasters in 2016.
  • Employer Tax Credits – provide employer tax credits in 2018 and 2019 for paid family and medical leave.

These changes generally would be effective after 2017, except as otherwise noted below.

Fringe Benefits

Elimination of Deduction for Entertainment Expenses. Similar to the House bill, section 13304(a) of the Senate Bill would completely disallow employer deductions for (1) entertainment, amusement, or recreation (“entertainment expenses”); (2) membership dues for clubs organized for business, pleasure, recreation or other social purposes; and (3) facilities used in connection with any of these items.  This full disallowance would replace the existing 50‑percent limit for entertainment expenses directly related to the active conduct of the employer’s trade or business.

Unlike the House bill, however, the Senate Bill would not impose a separate deduction limitation on “amenities,” which the House bill defined as de minimis fringe benefits that are primarily personal in nature and that involve property or services not directly related to the taxpayer’s business. (See earlier coverage.) The Senate Bill would continue to permit deductions for such expenses to the extent currently permitted by law (as modified by the provisions relating to employer meals discussed below).

Elimination of Deduction for Meals Provided for Employer’s Convenience (that are not Occasional Overtime Meals) and Employer-Operated Eating Facilities After 2025. Under existing law, employers may generally deduct (1) 50 percent of expenses for meals provided for the employer’s convenience under Code section 119; and (2) all expenses for the operation of and meals provided through an employer-operated eating facility that constitute de minimis fringe benefits under Treasury Regulation § 1.132-7 (but as described below, a 50‑percent limitation would apply starting in 2018). These deductions would be repealed under section 13304(d) of the Senate Bill, effective after 2025. After the repeal, if an employer chooses to provide meals to employees under section 119 or through an employer‑operated eating facility, these meals would remain excludable from employees’ income and wages to the extent currently excludable under section 132, but the cost of providing them would not be deductible by the employer (except to the extent employees pay for the meals). The Senate Bill would not change the existing 50‑percent deduction for other meal expenses associated with operating the employer’s trade or business (e.g., meals consumed by employees on work-related travel).

The Senate Bill’s restrictive approach to meal deductions differs from the House bill’s approach of allowing full deductions for meals provide at employer‑operated eating facilities, meals provided for the employer’s convenience under section 119, and meals that otherwise qualify as de minimis fringe benefits, such as occasional overtime meals. Moreover, the Senate Bill’s deferred repeal at the end of the 10‑year budget window suggests that the repeal may have been part of an effort to ensure compliance with Senate reconciliation rules requiring that the Bill not increase the deficit outside of the budget window.

50-Percent Limitation on Deductions for Occasional Overtime Meals and Other De Minimis Meals. Currently, employers may generally deduct and employees may exclude from income meals that constitute de minimis fringe benefits under Code section 132(e). De minimis meals may include occasional overtime meals, cocktail parties, group meals, and picnics for employees and their guests, and year-end holiday parties, in addition to meals provided at employer‑operated eating facilities. Section 13304(b) of the Senate Bill would generally impose a 50‑percent limitation on deductions for de minimis meals starting in 2018. As described above, starting in 2026, employers would not be permitted to deduct any expenses for operating and providing meals through employer‑operated eating facilities (except to the extent the employees pay for the meals). But the other types of de minimis meals would continue to be deductible subject to the 50‑percent limitation.

Elimination of Deduction for Qualified Transportation Fringes. Like the House bill, section 13304(c) of the Senate Bill would disallow the deduction for providing any qualified transportation fringe benefits.  Under Code section 132(f), these fringe benefits permit employers to either pay for an employee’s public transportation, van pool, bicycle, or parking expenses related to commuting on a pre-tax basis or allow employees to elect to receive a portion of their compensation in the form of non-taxable commuting benefits. Although the Senate Bill does not change the existing income exclusion for commuting expenses (other than bicycle commuting expenses, discussed below) that constitutes de minimis fringe benefits, it would likely discourage employers from providing qualified transportation benefits to employees.

Elimination of Deduction for other Commuting Expenses (Except for Employee’s Safety). Unlike the House bill, section 13304(c) of the Senate Bill would further disallow deductions for providing transportation (or any payment or reimbursement for related expense) for commuting between an employee’s residence and the place of employment, except as necessary to ensure the employee’s safety. This deduction disallowance would appear to apply even to commuting benefits that are treated as taxable compensation to the employee. Although it is unclear how the IRS would interpret the provision, the Senate Bill could be read to disallow a deduction for transportation between an employee’s home and a temporary place of employment, which are currently fully deductible and excludable by the employee. Ultimately, the effect of this change will depend upon how broadly the IRS interprets “place of employment,” which could be interpreted to include even temporary work locations away from an employee’s tax home.

Suspension of Exclusion for Qualified Bicycle Commuting Reimbursement. Unlike the House bill, section 11048 of the Senate Bill would repeal the exclusion under Code section 132(f) for bicycle commuting expenses, making such benefits taxable to employees from 2018 through 2025.

Suspension of Exclusion for Qualified Moving Expense Reimbursement. Similar to the House bill, section 11049 of the Senate Bill would partially suspend the exclusion from income and wages for a qualified moving expense reimbursement, which is an employer-provided benefit capped at the amount deductible by the individual if he or she directly paid or incurred the cost.  The Bill would retain a narrow exclusion for members of U.S. Armed Forces on active duty who move pursuant to military orders. These changes would be effective from 2018 through 2025.

Prohibition on Use of Cash or Gift Cards and Other Non-Tangible Personal Property as Employee Achievement Awards.  Whereas the House bill would eliminate the exclusion and deduction limitation for employee achievement awards, section 13311 of the Senate Bill would retain the exclusion and deduction limitation but codify proposed regulations defining “tangible personal property” for purposes of employee achievement awards.  Under Code sections 74(c)(1) and 274(j), employee achievement awards are excludable from income and deductible by the employer.  Section 274(j)(3)(A) defines an “employee achievement award” as an item of “tangible personal property” that meets certain other requirements without defining this term.  Under Treasury Regulation § 1.274-3(b), tangible personal property does not include cash or any gift certificate other than a nonnegotiable gift certificate conferring only the right to receive tangible personal property.  Under Proposed Regulation § 1.274-8(c)(2), the IRS provided a more comprehensive list of items that do not constitute tangible personal property, but these regulations were never issued in final form.

The Senate Bill would basically codify the list in the proposed regulations, to make clear that the following items do not constitute tangible personal property: (a) cash, cash equivalents, gift cards, gift coupons, or gift certificates (other than certificates conferring only the right to select and receive tangible personal property from a limited array of pre-selected items); (b) vacations, meals, lodging, tickets to theater or sporting events; and (c) stocks, bonds, other securities, and other similar items.  The restriction on gift certificates is more restrictive than the current language of Treasury Regulation § 1.274-3(b) and the proposed regulations, which would permit employee achievement awards that are nonnegotiable gift certificates that provide only the right to receive tangible personal property.  The requirement that the employee be permitted to choose from a limited array of pre-selected items would appear to bless many common employee achievement programs, but is still more restrictive than existing law and the proposed regulations.

Private Employer Retirement Benefits

Extension of Time Period for Rollover of Certain Outstanding Plan Loans.  Under Code section 402(c)(3), a participant whose plan or employment terminates while he or she has an outstanding plan loan balance generally must contribute the loan balance to an individual retirement account (IRA) within 60 days of receiving an offset distribution.  Otherwise, the loan is treated as an impermissible early withdrawal and is subject to the 10‑percent early withdrawal penalty.  Like the House bill, section 13613 of the Senate Bill would relax these rules by adding a new section 402(c)(3)(B) to give these employees until the due date for their individual tax return to contribute the outstanding loan balance to an IRA.  The 10‑percent penalty would only apply after that date.

Qualified 2016 Disaster Distribution (for 2016 and 2017). Unlike the House bill, the Senate Bill would provide additional disaster relief.  Section 11029 of the Senate Bill, would waive the 10‑percent early withdrawal tax on distributions of up to $100,000 to an individual whose principal place of abode at any time during 2016 or 2017 was located in a “2016 disaster area” as declared by the President, and who suffered economic loss due to the storm, flooding, or other disaster that occurred in the area during 2016.  This relief is broader than that contained in the Senate Finance Committee language, which provided relief only to flooding and storm victims in the “Mississippi River Delta flood disaster area” during March 2016 (earlier coverage). The distribution must be made during 2016 or 2017 to be exempt from the early withdrawal tax.  Additionally, any distribution required to be included in income as a result of this special distribution rule is included in income ratably over a three-year period, beginning with the year of distribution.  During this three-year period, amounts received may be re‑contributed to the plan and treated as a rollover, thus allowing the individual to file an amended return.  (For more information regarding special tax relief for victims of natural disasters, see our discussions of: (1) leave-based donation programs, leave-sharing programs, and relaxed plan loans and hardship withdrawal rules for victims of Hurricane Harvey and Irma; and (2) qualified disaster relief payments under Code section 139.)

Employer Tax Credits

Employer Tax Credit for Paid FMLA Leave for 2018 and 2019.  Section 13403 of the Senate Bill would allow eligible employers to claim a general business credit equal to 12.5 percent of wages paid to a qualifying employee while on FMLA leave, plus 0.25 percent of wages (capped at 25 percent) for each percentage point by which the FMLA pay exceeds 50 percent of the employee’s normal pay.   An “eligible employer” is one that institutes a FMLA‑leave policy that: (a) allows all qualifying full-time employees not less than two weeks of annual paid family and medical leave (not counting leave paid by State or local government); (b) allows less-than-full-time employees a commensurate amount of leave on a pro rata basis; and (c) provide leave pay at a rate that is at least 50 percent of the employee’s normal pay. A “qualifying employee” is an employee under the Fair Labor Standards Act who has been employed by the employer for at least one year, and whose preceding‑year compensation did not exceed 60 percent of the compensation threshold for highly compensated employees ($120,000 for 2017).

The Senate Bill would also allow eligible employers to take this credit for paid family and medical leave provided to qualifying employees that are not covered by Title I of the FMLA, provided the employer will not interfere with rights provided under the policy and will not discharge or discriminate against any individual for opposing practices prohibited by the policy. This is a change from the credit as proposed in the Senate Finance Committee language (earlier coverage).

For each employee, the credit that the employer may claim is limited to 12 weeks of paid FMLA leave. Moreover, the employer may not deduct any portion of wages for which the employer claims the credit, but the employer can elect not to have the credit apply and deduct the paid leave instead. Finally, as the credit is part of a pilot program, the credit would only be available in 2018 and 2019.

Analysis of the Senate Tax Reform Bill – Part I: Elimination of ACA Individual Mandate and Changes to Equity and Executive Compensation Rules

Early Saturday morning, the Senate voted 51-49 to approve a modified version of the Tax Cuts and Jobs Act (the “Senate Bill”). The Senate Bill differs from the House bill (discussed in an earlier series of posts here) passed last month in several respects, and a final negotiated bill will need to pass both chambers before the President can sign it into law. Given the difficulty of moving legislation through the Senate, it seems likely that any enacted legislation would likely be similar to the version passed by the House.

This post is the first in a series of three posts analyzing provisions of the Senate Bill. (Part II analyzes changes to deductions and exclusions for employee meals and other fringe benefits, changes to private retirement plan benefits, and a new paid leave credit.  Part III analyzes new reporting and withholding requirements and source rules.)  This post analyzes the following provisions:

  • Health Reform – eliminate the individual mandate penalties under the Affordable Care Act (“ACA”) after 2019.
  • Equity and Executive Compensation – (a) expand application of the limitation on excessive remuneration to covered employees of publicly‑traded corporations under Code section 162(m); (b) impose an excise tax on excess tax-exempt organization executive compensation; and (c) permit a deferral for up to five years for stocks pursuant to exercise of stock options and settlement of restricted stock units (“RSUs”) issued under broad‑based plans of privately-held corporations.

These changes generally would be effective after 2017, except as otherwise noted below.

Health Reform

Elimination of Individual Mandate Penalties after 2019.  Following multiple attempts to repeal and replace the ACA, including the individual and employer mandates (see discussions here), section 11081 of the Senate Bill would zero out penalties for failing to comply with the ACA’s individual mandate, effective starting in 2019.  As we have discussed in a previous post, zeroing out the individual mandate penalty would not directly affect the ACA’s information reporting requirements under Code sections 6055 and 6056.  Like earlier ACA repeal efforts, the Senate Bill does not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) or offers of minimum essential coverage on Form 1095-C despite eliminating the penalty imposed on individuals for failing to maintain coverage.  Some of the information reported on these forms would still be necessary for the IRS to administer the premium tax credit, which both the House bill and Senate bill have thus far left intact.

Equity and Executive Compensation

Modification of Limitation on Excessive Employee Remuneration.  Code section 162(m) currently limits a publicly-traded company’s deduction for compensation paid to a “covered employee” to $1 million, with exceptions for performance-based compensation and commissions.  Like the House bill, section 13601 of the Senate Bill would make the following three changes.

  1. Repeal of Exceptions to Deduction Limitations. The Senate Bill would eliminate the exceptions for performance-based compensation and commissions under Code section 162(m)(4)(B) and (C). It is unclear whether the repeal of the performance-based pay exception will reverse the trend toward performance-based compensation, given that many shareholders and shareholder advocates believe that performance-based compensation can align shareholder and executive interests.
  2. Changes to the Definition of Covered Employee. Under the Senate Bill, a “covered employee” would include any individual who is the principal executive officer or principal financial officer at any time during the tax year and the three highest paid officers for the tax year (as disclosed to shareholders).  Further, if an individual is a covered employee after 2016, the individual would retain the covered‑employee status for all future years.
  3. Expansion of Deduction Limitation to Additional Corporations. The Senate Bill would also amend Code section 162(m)(2) to apply the limitation to any corporation that is an issuer under section 3 of the Securities Exchange Act of 1934 that (1) has a class of securities registered under section 12 of the Act or (2) is required to file reports under section 15(d) of the Act.  This change would extend the deduction limitation to corporations beyond those with publicly traded equity securities to include those that are required to file reports solely because they issue public debt.

Transition Relief. Unlike the House bill, the Senate Bill would provide that these changes would only apply to contracts that are entered into—or that are materially modified—after November 2, 2017 (see earlier coverage).  The House bill does not have a similar transition rule.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Like the House bill, section 13602 of the Senate Bill would impose a new 20‑percent employer excise tax with respect to compensation paid post‑2017 by a tax-exempt organization (or a related entity) to a covered employee: (1) to the extent the compensation exceeds $1 million for the tax year; or (2) if the compensation constitutes an “excess parachute payment” (based on a measure of separation pay).  For these purposes, a “covered employee” means an employee who is among the tax-exempt organization’s five highest paid employees, or who was a covered employee for any preceding tax year beginning after 2016.

Five-Year Deferral for Stock Option and RSU Income under Broad-Based Plans of Privately-Held Corporations.  Currently, under Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Like the House bill, section 13603 of the Senate Bill would allow “qualified employees” (excluding the CEO, CFO, and certain other top-compensated employees) to elect to defer for up to five years federal income taxation related to qualified stock.  Qualified stock means the stock of a privately-held corporation received upon exercise of a stock option or settlement of a RSU that was transferred in connection with the performance of services.  To be effective, an inclusion deferral election must be made no later than 30 days after the first time the employee’s rights in the stock are substantially vested or transferrable.  The inclusion deferral election would also be subject to the following rules:

Broad-Based Plans.  The election would only apply to a privately-held corporation that offers a written plan under which, in the calendar year, not less than 80 percent of all employees who provide services to the corporation in the United States “are granted” (and not merely be eligible for) stock options or RSUs with the “same rights and privileges” to receive the corporation’s stock. The determination of rights and privileges would be made under rules similar to existing rules under Code section 423(b)(5) (employee stock purchase plans).  This cross reference implies that the amount of the stock which may be purchased by the employee under the stock option or RSU may bear a uniform relationship to the employee’s total or regular compensation, provided that the number of shares available to each employee is more than a de minimis amount.

Stock Repurchase Limitations and Reporting.  An inclusion deferral election is not available if, in the preceding year, the corporation purchased any of its outstanding stock, unless at least 25 percent of the total dollar amount of the stock purchased is qualified stock subject to the election (“deferral stock”).  Generally, in applying this rule, an individual’s deferral stock to which the proposed election has been in effect for the longest period must be counted first.  A corporation that has deferral stock outstanding in the beginning of any calendar year and that purchases any of its outstanding stock during the year must report on its income tax return for that year the total value of the outstanding stock purchased during that year and other information as the IRS may require.

Deferral Period and Income Inclusion.  A stock to which an inclusion deferral election applies would be includable in income on the earliest of: (i) the first date the stock becomes transferrable; (ii) the date the recipient first becomes an excluded employee (generally, a 1% owner, an officer, or a highly-compensated employee); (iii) the first date any stock of the corporation becomes readily tradeable on an established securities market; (iv) five years after the earlier of the first date the recipient’s rights in the stock are transferable or are not subject to a substantial risk of forfeiture; or (v) the date on which the employee revokes his or her election (the “deferral period”).  The amount to be included in income following the deferral period, however, would be determined based on the value of the stock upon substantial vesting, regardless of whether the stock value has declined during the deferral period.

Coordination with Statutory Stock Option Rules.  An inclusion deferral election would be available with respect to statutory stock options.  If an election is made, these options would no longer be treated as statutory stock options or subject to Code sections 422 or 423.

Coordination with NQDC Regime and 83(b).  The inclusion deferral election would not apply to income with respect to unvested stock that is includible in income as a result of an election under Code section 83(b), which permits unvested property to be includable in income in the year of transfer.  The Senate Bill also clarifies that, apart from the new section 83(i), section 83 (including section 83(b)) shall not apply to RSUs.

Employee Notice.  A corporation that transfers qualified stock to a qualified employee must provide notice to the employee at the time (or a reasonable period before) that the employee’s right to the stock is substantially vested.  The notice must certify that the stock is qualified stock and notify the employee that: (1) if eligible, the employee may make an inclusion deferral election; (2) the amount includible in income is determined based on the value of the stock when it substantially vests, and not when the deferral period ends; (3) the taxable amount will be subject to withholding at the end of the deferral period; and (4) the employee has certain responsibilities with respect to required withholding.  The penalty for failing to provide the notice is $100 per failure, capped at $50,000 for all failures during any calendar year.

Withholding and Form W-2 Reporting.  Following the deferral period, the corporation must withhold federal income taxes on the amount required to be included in income at a rate not less than the highest income tax bracket applicable to the individual taxpayer.  The corporation must report on a Form W-2 the amount of income covered by an inclusion deferral election: (1) for the year of deferral; and (2) for the year the income is required to be included in the employee’s income.  In addition, for any calendar year, the corporation must report on Form W-2 the aggregate amount of income covered by inclusion deferral elections, determined as of the close of the calendar year.

Effective Date.  These changes would generally apply to stock attributable to options exercised or RSUs settled after 2017.  Until the IRS issues regulations on the 80-percent and employer notice requirements, a corporation will be treated as complying with these requirements if it complies with a reasonable good faith interpretation of them.  The penalty for failure to provide the employee notice would apply after 2017.

First Friday FATCA Update

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December 1, 2017

Since our last monthly FATCA update, the IRS has released the Competent Authority Agreements (CAAs) implementing Intergovernmental Agreements (IGAs) between the United States and the following treaty partners:

  • Greece (Model 1A IGA signed on January 19, 2017); and
  • Saint Kitts and Nevis (Model 1B IGA signed on August 31, 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 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.