Tax Reform Proposals Advance in the House and Senate

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November 17, 2017

Yesterday, the full House passed its tax reform proposal, the Tax Cuts and Jobs Act (H.R. 1), on a party-line vote, 227-205.  In addition to the headline changes to the corporate and individual tax systems, the bill would make numerous changes to various fringe benefit exclusions, employer deductions for fringe benefits and executive compensation, cross-border withholding and sourcing, and employee retirement plans  (discussed here, here, here, herehere, here, and here).  Meanwhile, the Senate Finance Committee advanced its tax reform proposal, also on a party-line vote (14-12), with similar changes (discussed here and here).

Before advancing the proposal to the floor, the Senate Finance Committee adopted additional modifications to its existing proposal.  The new modifications included a change to the transition rule for the modified deduction limitation for executive compensation, a delay in the effective date of the new deduction disallowance for meals provided at the convenience of the employer and excluded from employee’s income under Code section 119 or 132(e)(6), and a definition of Mississippi River Delta flood disaster area and Mississippi River Delta flooding distribution for purposes of the retirement plan relief provided in the existing proposal:

  • The new transition relief for the deduction limitation under Code section 162(m) would apply the changes made in the proposal only to contracts entered into after November 2, 2017, and contracts materially modified after that date. The relief provided in the first modification to the chairman’s mark would have applied only if the compensation was no longer subject to a substantial risk of forfeiture before 2017.
  • The modification would delay the effective date for the deduction disallowance for meals provided for the employer’s convenience and meals provided at employer-operated eating facilities until 2026.
  • The modification defines “Mississippi River Delta flood disaster area” as an area subject to a Presidential major disaster declaration before March 31, 2016, by reason of severe storms and flooding occurring in Louisiana, Texas, and Mississippi during March 2016. A “Mississippi River Delta flooding distribution” is a distribution from an eligible retirement plan made on or after March 1, 2016, and before January 1, 2018, to an individual whose principal residence on March 1, 2016, was located in the Mississippi River Delta flood disaster area and who sustained an economic loss by reason of the severe storms and flooding that resulted in the Presidential disaster declarations.  (The modification also provides for an enhanced ability to claim a casualty loss deduction as a result of such storms and flooding.)

Temporary FATCA Coordination Regulations Bring U.S. Source Gross Transportation Income Saga to a Close

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January 4, 2017

On Friday, December 30, 2016, the IRS and Treasury Department released over 600 pages of new final, temporary and proposed regulations under Chapter 4 (FATCA), Chapter 3, and Chapter 61 (see earlier coverage).  The four packages finalize the temporary regulations issued in 2014 and make additional changes based on comments received by the IRS.  One issue addressed by the temporary FATCA coordination regulations issues under Chapter 3 addresses the outstanding question of whether withholding agents must document the foreign payees of U.S. source gross transportation income (USSGTI) and withhold under Chapter 3.  The temporary regulations amend the regulations under Section 1441 to specifically exempt USSGTI from amounts subject to withholding.

Although it informally suggested that withholding agents were not required to document or withhold 30% on payments of USSGTI, the IRS has been reluctant to issue formal guidance.  To this end, IRS Publication 515 provides that such amounts are not subject to Chapter 3 withholding under Section 1441 or 1442.  However, Sections 1441 and 1442 generally require withholding agents to withhold 30% on payments subject to the tax imposed by Sections 871 and 881 (i.e., FDAP income).  However, payments of gross transportation income that is U.S. source because the transportation begin or ends (not both) in the United States are subject to a 4% excise tax under Section 887 that is self-imposed by the payee, unless an exception applies.  Section 887(c) provides that the 30% gross tax applicable to most U.S. source income of foreign persons (other than income effectively connected with a U.S. trade or business) does not apply to transportation income.

The issue that has arisen is that neither Section 1441 or 1442 explicitly reference Sections 871 and 881 as a basis for the withholding.  However, it seems illogical to require 30% withholding on U.S. source gross transportation income given that such income is only subject to the 4% excise tax.  Despite the guidance in Publication 515, examiners have asserted on audit that such payments are subject to withholding under Chapter 3.  Nevertheless, withholding agents have generally been successful in rebutting such assertions and avoiding audit assessments.

The IRS created confusion regarding this issue earlier in 2016 when it asserted in a practice unit that USSGTI did not constitute FDAP income and was therefore not subject to withholding under Chapter 3 (see earlier coverage).  The IRS later revised the practice unit to remove the reference to USSGTI (see earlier coverage) after taxpayers questioned whether such payments are FDAP income.  The preamble to the temporary regulations now clarify that although USSGTI is FDAP income, it is nonetheless not subject to Chapter 3 withholding because the tax imposed under Section 871 or 881 does not apply.  The temporary regulations now thankfully bring this saga to a close six years after the IRS Information Reporting Program Advisory Committee made its original request for the IRS to clarify this problem for withholding agents in 2010.  A discussion of this issue can be found in IRPAC’s 2013 annual report.

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 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.