Impact of Tax Cuts and Jobs Act: Part IV – Changes to the Section 162(m) Deduction Limitation for Executive Compensation

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November 3, 2017

Yesterday, the House Ways and Means Committee released the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), a bill that, if enacted, would represent the most substantial overhaul of the U.S. tax code in decades.  We are releasing a series of posts to highlight the provisions of the Bill affecting the topics pertinent to our readers, where each post will cover a different area of importance.  In Part I of this series, we covered potential changes to employer-provided benefits, and in Part II, we addressed entertainment expenses and other fringe benefits.  In Part III, we discussed the Bill’s potential impact on various retirement provisions.  In this Part IV of the series, we address proposed changes to the deduction limitation for executive compensation under Code section 162(m).

Currently, Code section 162 allows as a deduction all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.   This includes a deduction for reasonable compensation for personal services actually rendered.   However, Code section 162(m) limits the deduction of any publicly held corporation with respect to compensation paid to a “covered employee” to $1 million.   However, certain types of compensation—such as qualified performance-based compensation and commissions—are not subject to the deduction limitation.  Covered employees are defined to include the chief executive officer (“CEO”), as of the close of the taxable year and the officers whose compensation is required to be reported to shareholders by reason of being among the three most highly compensated officers for the taxable year (other than the CEO).

Section 3802 of the Bill would amend section 162(m) in three key ways: (1) it would eliminate the exceptions for qualified performance-based pay and commissions; (2) it would extend the deduction disallowance to a broader array of companies; and (3) it would amend the definition of covered employee to more closely align with current SEC disclosure requirements and make covered employee status permanent.

Repeal of Exceptions to Deduction Limitation.  Many public companies pay covered employees primarily in the form of performance-based compensation to avoid the effect of the deduction limitation.  This exception applies to many forms of equity-based compensation— most stock options, stock appreciation rights, restricted stock, and restricted stock units—and many annual and long-term cash incentive compensation plans.  The Bill would repeal Code sections 162(m)(4)(B) and (C), removing the exceptions for performance-based compensation and commissions.  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.

Expansion of Deduction Limitation to Additional Corporations.  Currently, the deduction limitation applies only to corporations that issue a class of common equity securities required to be registered under section 12 of the Securities Exchange Act of 1934 (the “’34 Act”).  The Bill would amend Code section 162(m)(2) to apply the limitation to any corporation that is an issuer under section 3 of the ’34 Act that (1) has a class of securities registered under section 12 of the ’34 Act or (2) is required to file reports under section 15(d) of the ’34 Act.  This would extend the deduction limitation to corporations beyond those with publicly traded equity securities to include those are required to file reports solely because they issue public debt.

Change to the Definition of Covered Employee.  Code section 162(m)(3) defines covered employee to include the CEO (or the individual acting in such capacity) as of the last day of the tax year and the four officers whose compensation is required to be disclosed to shareholders because the officer is one of the four most highly compensated officers for the tax year.  However, because of a change to the cross-referenced section of the ’34 Act, the IRS interpreted the limitation as applying to only the principal executive officer (generally, the CEO) and the three most highly compensated officers other than the CEO and CFO in Notice 2007-49.  Compensation paid to the CFO was not subject to the deduction limitation regardless of how much he or she was paid.

The Bill would amend the definition of covered employee to align it more closely with current SEC disclosure rules.  Under the Bill, covered employees would include employees who, at any time during the tax year, were the principal executive officer or principal financial officer, and the three officers whose compensation is required to be disclosed to shareholders because they are the three most highly compensated officers during the tax year (other than the principal executive officer).  As a result, the deduction limitation could apply to a variable number officers for any given tax year depending upon whether more than one individual serves as either the principal executive officer or principal financial officer during the tax year and whether the principal financial officer is among the three most highly compensated officers during the tax year.

The Bill would also add a third category of covered employee: individuals who were covered employees of the employer (or any predecessor) for any preceding tax year beginning after December 31, 2016.  Accordingly, the Bill has the effect of making covered-employee status permanent.  Under current law, employees (and former employees) who are no longer officers of the employer as of the last day of the tax year are not covered employees.  As such, the deduction for compensation that is deferred until a date after the employee is no longer a covered employee is not subject to the limitation under Code section 162(m).  The Bill would eliminate this strategy for avoiding the deduction limitation.  Moreover, the Bill specifies that covered-employee remuneration that is includible in the income of, or paid to, someone other than a covered employee, such as a beneficiary of a covered employee after the covered employee’s death, remains subject to the deduction limitation.  Given the changes to the taxation of nonqualified deferred compensation in the Bill (and discussed in Part III of our series), the utility of this strategy for avoiding the deduction limitation would have been greatly reduced even without this amendment.

The amendments to Code section 162(m) would be effective for tax years beginning after December 31, 2017.

Impact of Tax Cuts and Jobs Act: Part II – Deduction Disallowances for Entertainment Expenses and Certain Fringe Benefits

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November 3, 2017

Yesterday, the House Ways and Means Committee released the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), a bill that, if enacted, would represent the most substantial overhaul of the U.S. tax code in decades.  This is the second in a series of posts discussing the effect of the Bill on topics of interest to our readers.  (See our first post discussing the effect of the Bill on various exclusions for employer-provided benefits here.)  Section 3307 of the Bill makes several changes to the deduction limitations under section 274 related to meals and entertainment expenses.  The Bill also expands the reach of the deduction limitations to disallow deductions for de minimis fringe benefits excluded from income under Code section 132(e), unless the employer includes such amounts in the employee’s taxable income. With respect to tax-exempt entities, section 3308 of the Bill would treat funds used to provide employees transportation fringe benefits and on-premises gyms and other athletic facilities as unrelated business taxable income.

Total Disallowance of Deductions for Entertainment Expenses.  Under Code section 274(a), a taxpayer may not deduct expenses for entertainment, amusement, or recreation (“entertainment expenses”), unless the taxpayer establishes that the item was directly related to the active conduct of the taxpayer’s business, subject to a number of exceptions in Code section 274(e) (e.g., reimbursed expenses; expenses treated as compensation to (or included in the gross income of) the recipient; recreational, social, and similar activities primarily for the benefit of employees other than highly compensated employees; entertainment sold to customers).  If the taxpayer establishes that the entertainment expenses were directly related to the active conduct of its trade or business, section 274(n) limits the deduction to 50 percent of expenses relating to entertainment, subject to a number of exceptions, many of which are the same exceptions that apply to the 100 percent disallowance under Code section 274(a) (e.g., reimbursed expenses; expenses treated as compensation to (or included in the gross income of) the recipient; recreational, social, and similar activities primarily for the benefit of employees other than highly compensated employees; entertainment sold to customer).

The Bill would amend section 274(a) to eliminate the exception for entertainment expenses directly related to the active conduct of the taxpayer’s business.  Accordingly, deductions for entertainment expenses would be fully disallowed unless one of the exceptions under Code section 274(e) applies.  The Bill would also make changes to some of the exceptions under Code section 274(e), described below.

Disallowance of Deductions for On-Site Athletic Facilities.  Similarly, the Bill would fully disallow a deduction for on-site gyms or athletic facilities as defined in Code section 132(j)(4)(B).  Such facilities are gyms and athletic facilities that are located on the premises of the employer, operated by the employer, and substantially all the use of which is by employees of the employer, their spouses, and their dependent children.  Although the Bill would add such expenses to the list of disallowed deductions under Code section 274(a), the Bill does not eliminate the exclusion from employee’s income under Code section 132.  Accordingly, employers will be left to choose between (1) losing the deduction for the cost of such facility or (2) retaining the deduction by imputing the fair market value of the use of the facility to employees. The Bill includes instructions to the Treasury Department to issue regulations providing appropriate rules for allocation of depreciation and other costs associated with an on-site athletic facility.

Disallowance of Deductions for Qualified Transportation Fringes and Parking Facilities.  The Bill would also fully disallow a deduction for qualified transportation fringes as defined in Code section 132(f) and parking facilities used in connection with qualified parking as defined in Code section 132(f)(5)(C).  These fringe benefits are popular with employees and permit employees 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.  Like with athletic facility expenses, the Bill would add such expenses to the list of disallowed deductions under Code section 274(a), but retain the exclusion from employee’s income under Code section 132.  As a result, employers will be left to choose between (1) losing the deduction for the cost of providing these benefits or (2) discontinuing the benefits.  The Bill includes instructions to the Treasury Department to issue regulations providing appropriate rules for allocation of depreciation and other costs associated with a parking facility.

Disallowance of Deductions for Certain De Minimis Fringe Benefits.  The Bill would likewise disallow deductions for what it refers to as “amenities.”  Amenity is defined as a de minimis fringe benefit that is primarily personal in nature and involving property or services that are not directly related to the taxpayer’s business.  This would seemingly subject expenses related to the provision of most de minimis fringe benefits to a full deduction disallowance unless the expense qualified for one of the exceptions under Code section 274(e) (e.g., expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of an employer primarily for its employees; reimbursed expenses; expenses treated as compensation to (or included in the gross income of) the recipient; recreational, social, and similar activities primarily for the benefit of employees other than highly compensated employees; items available to the public; entertainment sold to customers).  It would perhaps leave unaffected some de minimis fringe benefits such as personal use of a copy machine.  Even with respect to de minimis fringe benefits that would likely qualify as amenities, it is unclear how much of an impact this would have, because many de minimis fringe benefits would likely qualify for one of the exceptions (for example, coffee, doughnuts, soft drinks, and occasional cocktail parties would likely remain fully deductible under Code sections 274(e)(1) and 274(n)(2)(B), provided they are provided to employees on the business premises of the employer).  Others, however, such as occasional sporting or theater tickets, gifts given on account of illness, and traditional holiday or birthday gifts, may well be affected by the disallowance.  The Bill includes instructions to the Treasury Department to define amenity in regulations.

Deduction Limited to Amounts Actually Included in Income.Code section 274(e)(2) contains an exception to the disallowance under Code section 274(a) to the extent an expense is treated as compensation to an employee.  Code section 274(e)(9) includes a similar provision for expenses treated as includible in the gross income of the recipient that is not an employee of the taxpayer as compensation or as a prize or award.  The Bill would limit the exception for entertainment expenses treated as compensation to (or included in the gross income of) the recipient to the amount actually treated as compensation (or included in gross income of) the recipient as it is with employees that are “specified individuals” under current law.  Code section 274(e)(2)(B) was adopted to impose this limitation with respect to certain senior executives following the decision in Sutherland Lumber-Southwest, Inc. v. Commissioner.  The Bill would extend the effect of Code section 274(e)(2)(B) to all recipients.  The limitation prevents a taxpayer from deducting a cost in excess of the amount required to be included in the recipients income, such as in the case of vacation travel on board corporate aircraft, where the cost of operating the flight often far exceeds the amount required to be included in the employee’s income under Treasury Regulations.

Deduction Disallowance Applies with Respect to Expenses Reimbursed by a Tax-Exempt Entity.  Under section 274(e)(3), a taxpayer that incurs an expense subject to the deduction disallowance in section 274(a) or 274(n) may fully deduct the expense if the expense is reimbursed by another party, provided that certain requirements are met.  The rule allows two parties as part of a reimbursement arrangement to effectively shift the burden of the deduction disallowance to the party between them.   Section 3307 of the Bill amends section 274(e)(3) to prevent the use of tax-exempt entity (that is not affected by the deduction disallowance under current law) to avoid the effect of the disallowance.

Full Deduction for Meals Excluded from Employee’s Income under Code Section 119.  Under Code section 119, the value of meals provided to employees for the convenience of the employer are excludable from the employee’s income.  Such meals, however, are currently subject to the 50% deduction disallowance under Code section 274(n) unless the meals are treated as being provided at an employer-operated eating facility that is a de minimis fringe benefit under Treasury Regulation § 1.132-7.  (This was the issue in the Boston Bruins decision (earlier coverage).)  Running counter to the general approach of the legislation—which seeks to eliminate corporate deductions for amounts not included in employee income—the Bill would amend Code section 274(n)(2)(B) include meals excludable from an employee’s income under section 119 in addition to amounts being excludable under section 132(e).  This change would appear to expand the ability of employer’s to fully deduct more meals provided to their employees.

With the exception of the last change, the Bill would seek to limit the ability of taxpayers to deduct entertainment expenses and expenses related to the provision of various excludable fringe benefits.  The provisions would be effective for amounts paid or incurred after December 31, 2017.

New CAAs on Exchange of CbC Reports Pushes Total to 20

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August 24, 2017

The IRS has concluded competent authority arrangements (“CAAs”) for the exchange of country-by-country (“CbC”) reports with Australia and the United Kingdom.  The CAA with Australia was signed in Australia on July 14 and by the United States on August 1.  The CAA with the United Kingdom was signed on August 16.  The new arrangements bring the number of CAAs for the exchange of CbC reports to 20. The CAAs for the exchange of CbC reports generally require 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.

In the United States, CbC reporting is required for U.S. persons that are the ultimate parent entity of a multinational enterprise (“MNE”) with revenue of $850 million or more in the preceding accounting year, for reporting 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 (“Country by Country Report”) and Schedule A to Form 8975 (“Tax Jurisdiction and Constituent Entity Information”).  In Revenue Procedure 2017-23, the IRS announced that U.S. MNEs may voluntarily file Form 8975 with the IRS for taxable years beginning on or after January 1, 2016, and before June 30, 2016.  U.S. MNEs that do not voluntarily file with the IRS may be subject to CbC reporting in foreign jurisdictions in which they have constituent entities.

A CAA generally must be in force with a foreign jurisdiction for CbC reports filed with the IRS by a U.S. MNE to satisfy the CbC reporting requirements under foreign law.  This has raised concerns about the pace at which the IRS has concluded CAA negotiations with foreign jurisdictions.  Many foreign jurisdictions that have adopted CbC reporting requirements under the OECD’s Base Erosion and Profit Shifting Action 13 have done so with respect to reporting years beginning on or after January 1, 2016.  Most of those countries have signed a multilateral CAA, but the United States has chosen instead to pursue bilateral CAAs with each foreign jurisdiction—likely due to U.S. concerns regarding the use of the information contained in the CbC reports and potential public disclosure of the information.  The U.S. CAAs are substantially similar to the multilateral CAA, but numerous foreign jurisdictions have not yet signed a bilateral CAA with the IRS, including China, France, Germany, Mexico, and Japan.

The IRS maintains a status table of foreign jurisdictions on its CbC Reporting page.  With voluntary reporting for early reporting periods set to begin on September 1, U.S. MNEs should monitor continuing developments to determine whether delays in the U.S. CAA process may necessitate the filing of CbC reports in foreign jurisdictions.

IRS Extends Deadline for FFI Agreement Renewal

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August 2, 2017

Following the July 31, 2017, deadline for renewing an FFI agreement (prior coverage), the IRS announced in a new FAQ that a participating FFI (including a reporting model 2 FFI) that renews its FFI agreement by October 24, 2017, will continue to be treated as a participating FFI.  Rev. Proc. 2017-16, which includes the current FFI agreement, provides that a participating FFI that fails to renew its FFI agreement by July 31, 2017, will be treated as having terminated its FFI agreement as of January 1, 2017, and will be treated as a nonparticipating FFI and removed from the IRS FFI list.  Registration FAQ #10, added only a few weeks ago, reiterated that result (prior coverage).

On August 1, the IRS added Registration FAQ #12 providing that a participating FFI that has otherwise complied with the terms of its FFI agreement (including the current FFI agreement since January 1, 2017), will not be removed from the IRS FFI list provided that it renews its FFI agreement by October 24, 2017.  Participating FFIs that fail to renew their FFI agreements by October 24, 2017, will be removed from the IRS FFI list in November.  The reprieve will be welcome news for participating FFIs that were unable to renew their FFI agreement before the July 31 deadline.  Those participating FFIs that still need to renew their FFI agreements should ensure they are complying with the new FFI agreement (prior coverage) and take steps to renew their agreements sooner rather than later to avoid inadvertently missing the extended deadline.

New FATCA FAQs Address Date of Birth and Foreign TIN Requirements for Withholding Certificates

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April 7, 2017

Yesterday, the IRS added three new FAQs to its list of frequently asked questions on compliance with the Foreign Account Tax Compliance Act (“FATCA”).  The questions address the need for withholding agents to obtain foreign TINs or dates of birth for nonresident alien or foreign entity on beneficial owner withholding certificates, e.g., Forms W-8BEN and W-8BEN-E.  The FAQs address the requirement under temporary regulations published in the Federal Register on January 6, 2017, that a beneficial owner withholding certificate contains a foreign TIN and, in the case of an individual, a date of birth in order to be considered valid.

FAQ #20 clarifies when a withholding agent must collect a foreign TIN or date of birth on a beneficial owner withholding certificate.  In general, withholding agents must obtain a foreign TIN if either (1) the foreign person is claiming a reduced rate of withholding under an income tax treaty and the foreign person does not provide a U.S. TIN and a TIN is required to make a treaty claim or (2) the foreign person is an account holder of a financial account maintained at a U.S. office or branch of the withholding agent and the withholding agent is a financial institution.  However, a withholding certificate that does not contain a foreign TIN may still be treated as valid with respect to payments made in 2017 in the absence of actual knowledge on the part of the withholding agent that the individual has a foreign TIN.  For payments made on or after January 1, 2018, a beneficial owner withholding certificate that does not contain a foreign TIN will be invalid unless the beneficial owner provides a reasonable explanation for its absence, such as that the country of residence does not issue TINs.

Consistent with the language of the temporary regulations, FAQ #21 clarifies that a withholding agent may treat a beneficial owner withholding certificate provided by an individual after January 1, 2017, as valid even if it does not contain a date of birth if the withholding agent otherwise has the individual’s date of birth in its records.

Finally, FAQ #22 clarifies that if a beneficial owner provides an otherwise valid withholding certificate that fails to include its foreign TIN, the beneficial owner may provide the foreign TIN to the withholding agent in a written statement (that may be an email) from the beneficial owner that includes the foreign TIN and a statement indicating that the foreign TIN is to be associated with the beneficial owner withholding certificate previously provided.  If the beneficial owner does not have a foreign TIN, the beneficial owner may provide the reasonable explanation required after January 1, 2018, in a similar written statement.

While helpful, the FAQs continue a growing trend toward subregulatory guidance from the IRS.  Because the guidance does not require the same level of review as more formal guidance, it can be issued more quickly.  However, informal guidance, such as FAQs, can be difficult to rely on because it may disappear or change without notice and typically is not binding on the IRS.

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.

Revised House ACA Repeal Will Delay Repeal of AMT until 2023

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March 24, 2017

Last night, Republican leadership released a manager’s amendment to the American Health Care Act (AHCA) that would delay the repeal of the additional Medicare tax (AMT) of 0.9% imposed on certain high-income individuals from 2017 until 2023.  The move is an effort to shore up Republican support for the bill in advance of an expected vote late this afternoon or this evening.  The delay comes three days after an earlier manager’s amendment moved up the repeal of the AMT from 2018 to 2017, and added a transition rule related to employer withholding of the tax.  That change was also made in an effort to shore-up Republican support ahead of the House vote, which was originally expected to happen yesterday.  Our earlier analysis of the information reporting and employment tax provisions of the AHCA is available here.

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.

Singapore Seeks Reciprocal IGA to replace Nonreciprocal IGA Currently In Effect

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August 3, 2016

During a state visit by Singapore Prime Minister Lee Hsien Loong, Singapore and the United States announced they were negotiating a reciprocal Model 1 IGA.  The countries had previously entered into a nonreciprocal Model 1 IGA in 2014 that went into effect on March 28, 2015.  Unless Congress enacts legislation providing for greater collection of information from U.S. financial institutions, the reciprocal agreement will provide for limited exchange of information regarding Singapore residents who maintain accounts with U.S. financial institutions.  The obligations of Singapore financial institutions would be unchanged.  As part of the effort, the countries are negotiating the terms of a Tax Information Exchange Agreement (TIEA), and continue to discuss whether an income tax treaty should be negotiated.  According to the statement, the countries hope to complete negotiations on the TIEA and reciprocal IGA by the end of 2017.

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

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July 25, 2016

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

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

IRS 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.

Regulations Limiting Refunds and Credits for Chapter 3 and Chapter 4 Withholding Due Soon

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June 3, 2016

John Sweeney, Branch 8 Chief in the IRS Office of Associate Chief Counsel International, said on June 2 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 of the Code will be released soon.  According to Sweeney, who was speaking at the Federal Bar Association Insurance Tax Seminar, most of the work on the regulations is complete.

The IRS announced its intent to amend the regulations under Chapter 3 and Chapter 4 last year in Notice 2015-10.  According to the notice, the temporary regulations will amend Treas. Reg. §§ 1.1464-1(a) and 1.1474-5(a)(1) to provide that, subject to section 6401(b), a refund or credit is allowable with respect to an overpayment only to the extent the relevant withholding agent has deposited (or otherwise paid to the Treasury Department) the amount withheld and such amount is in excess of the claimant’s tax liability.  The IRS said the regulation is needed because allowing a credit or refund based on the amount reported as withheld on Form 1042-S represents a risk to the Treasury if a foreign withholding agent fails to deposit the withheld tax with the U.S. Treasury.  The IRS has limited ability to pursue foreign withholding agents for such failures making it difficult to recover the amounts allowed to be claimed as credits or refunds.

According to Sweeney, the regulations will adopt the pro rata method described in Notice 2015-10 for allocating the amount available for refund or credit with respect to each claimant. Under this method, a withholding agent’s deposits made to its Form 1042 account will be divided by the amount reported as withheld on all Forms 1042-S filed by the withholding agent to arrive at a “deposit percentage.”  Each claimant will then be allowed to claim as a credit or refund the amount reported on its Form 1042-S multiplied by the deposit percentage for the withholding agent.  The pro rata approach is necessary because of the inability for the IRS to trace deposits back to specific payments made to a claimant based on the information reported on Form 1042 and Form 1042-S.

IRS Updates IDES Technical FAQs for FATCA

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May 31, 2016

On May 27, the IRS updated the technical FAQs for the International Data Exchange Service (IDES) used by foreign financial institutions (FFIs) and other organizations to file information returns required by the Foreign Account Tax Compliance Act.  Among other changes, the IRS provided a work-around for direct-reporting non-financial foreign entities (direct reporting NFFEs) that must register with the IRS and file annual FATCA reports disclosing certain information regarding their substantial U.S. owners.

In general, passive NFFEs provide information on their substantial U.S. owners to withholding agents on Form W-8BEN-E.  However, a passive NFFE may register as a direct reporting NFFE and receive a global intermediary identification number (GIIN)  from the IRS.  A direct reporting NFFE provides information on its substantial U.S. owners to the IRS and provides its GIIN on Form W-8BEN-E rather than providing the information on its substantial U.S. owners to withholding agents.

Because FFIs in Model 1 IGA jurisdictions report information on their U.S. account holders to local tax authorities who then exchange the information with the IRS via IDES, the IDES system does not accept registrations from entities in Model 1 IGA jurisdictions.  This is a problem for direct-reporting NFFEs in Model 1 IGA jurisdictions that must use IDES to file Form 8966 (FATCA Report).  As a workaround, FAQ A17 instructs such direct-reporting NFFEs to register using “Other” as their country of tax residence in Question 3A, provide its country of jurisdiction/tax residence tax identification number in question 3B, and select “None of the Above” for the entity’s FATCA Classification in its country of jurisdiction/tax residence.

Other updates included the addition of FAQ B11 regarding which issues were corrected in an April 2016 maintenance release, an update to FAQ E21 regarding the exchange of the initialization vector as part of CBC cipher mode, and the addition of FAQ E22 regarding the effect on recently uploaded files of updating the public key certificate.

IRS Error Leads to Erroneous Penalty Notices

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May 9, 2016

The IRS announced that some taxpayers may have been erroneously assessed failure to deposit penalties after an IRS system error failed to account for the April 15, 2016, holiday in Washington, D.C.  The holiday moved the deadline for payroll tax deposit to April 18, 2016.  However, some taxpayers who timely deposited payroll taxes by the later date were assessed failure to deposit penalties.  The notice is titled “Your Federal Tax Deposit Wasn’t Submitted Correctly.” At the bottom, the date due is shown as April 15, 2016, and the date received is shown as April 18, 2016.  The IRS will contact affected taxpayers and no taxpayer action is required.

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 Issues Regulations Relating to Employees of Disregarded Entities

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May 5, 2016

Yesterday, Treasury and the IRS released final and temporary regulations under Section 7701 meant to clarify issues related to the employment of owners of disregarded entities.  In 2009, the IRS issues regulations that required disregarded entities be treated as a corporation for purposes of employment taxes including federal income tax withholding and Federal Insurance Contribution Act (FICA) taxes for Social Security and Medicare.  The regulations provided that a disregarded entity was disregarded, however, for purposes of self-employment taxes and included an example that demonstrated the application of the rule to an individual who was the single owner of a disregarded entity.  In the example, the disregarded entity is treated as the employee of its employees but the owner remains subject to self-employment tax on the disregarded entity’s activities.  In other words, the owner is not treated as an employee.

Rev. Rul. 69-184 provides that partners are not employees of the partnership for purposes of FICA taxes, Federal Unemployment Tax Act (FUTA) tax, and federal income tax withholding.  This is true even if the partner would qualify as an employee under the common law test.  This made it difficult—if not impossible—for partnerships to allow employees to participate in the business with equity ownership such as options even if the employee owned only a very small portion of the partnership.  The 2009 regulations raised questions, however, provided some hope that a disregarded entity whose sole owner was a partnership could be used to as the employer of the partnership’s partners. Doing so would have allowed partners in the partnership to be treated as employees of the disregarded entity and participate in tax-favored employee benefit plans, such as cafeteria plans.  The final and temporary regulations clarify that that an individual who owns and portion of a partnership may not be treated as an employee of the partnership or of a disregarded entity owned by the partnership.

As a result, payments made to partners should not be reported on Form W-2, but should be reported on Schedule K-1.  Such payments are not subject to federal income tax withholding or FICA taxes, but will be subject to self-employment taxes when the partner files his or her individual income tax return.  In addition, if partners are currently participating in a disregarded entity’s employee benefit plans, such as a health plan or cafeteria plan, the plan has until the later of August 1, 2016, or the first day of the latest-starting plan year following May 4, 2016.