Impact of Tax Cuts and Jobs Act: Part V – Certain Changes Affecting Cross-Border Withholding and Sourcing

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November 6, 2017

Thursday, November 2, 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.  Part I of this series covered potential changes to employer-provided benefits, Part II addressed entertainment expenses and other fringe benefits, Part III discussed changes to employee retirement plans, and Part IV covered changes to the Code section 162(m) deduction limitation for executive compensation.  In this Part V, we will discuss the Bill’s potential impact on two cross-border tax issues.

Reduced FIRPTA Withholding Rates.  Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), gain or loss on the disposition of U.S. real property interests by a nonresident alien individual or foreign corporation is subject to U.S. income tax as though the taxpayer were engaged in a trade or business in the United State and such gain or loss were effectively connected with such trade or business.  Section 1445 applies a withholding mechanism to ensure the payment of any tax due.  When a domestic partnership, trust, or estate disposes of a U.S. real property interest, section 1445 requires that it (or the trustee or executor, in the case of a trust or estate, respectively) withhold 35 percent of the gain realized that is allocable to a foreign person (or allocable to a portion of a trust treated as owned by a foreign person).  Similarly, when a foreign corporation distributes a U.S. real property interest to its shareholders, it must withhold at a rate of 35 percent.  The same withholding rate applies to distributions that are treated as gains or losses from the disposition of a U.S. real property interest allocable to foreign persons from certain domestic entities (such as real estate investment trusts and registered investment companies that would be considered U.S. real property holding corporations if their shares were not publicly traded).  Section 3001 of the Bill, which reduces corporate tax rates in general, includes a corresponding reduction of the FIRPTA tax withholding rate, modifying paragraphs 1445(e)(1), 1445(e)(2), and 1445(e)(6) to require withholding at a 20 percent rate.  The reductions would take effect for tax years beginning after 2017.

Modification to Sourcing Rule for Sales of Inventory Property.  Currently, up to 50 percent of income from the sale of inventory property produced entirely within the United States and sold outside the United States (or vice-versa) can be treated as foreign-source income for purposes of calculating foreign tax credits.  Section 4102 of the Bill would require sales of inventory property to be sourced solely based on the location of production activity with respect to the inventory.  This change would be effective for tax years beginning after 2017.

Impact of Tax Cuts and Jobs Act: Part III – Changes to Employee Retirement Plans

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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 this Part III, we will discuss the Bill’s potential impact on various retirement provisions.

Loosening of Hardship Withdrawal Rules.  Currently, participants in 401(k) plans may only receive hardship withdrawals under certain circumstances, and those withdrawals are limited to the amount of the participants’ elective deferrals.  In addition, participants are prohibited from making elective deferrals to their 401(k) plan for six months following receipt of a hardship distribution.  First, Section 1503 of the Bill would eliminate the six-month prohibition on making elective deferrals after receiving a hardship distribution contained in the current Treasury Regulations.  The provision would require Treasury to revise its regulations within one year of the Bill’s date of enactment to allow participants to continue contributing to their retirement accounts without interruption. Section 1504 of the Bill would add a new subsection 401(k)(14) to the Code expand the funds eligible for hardship withdrawal by permitting participants to make such withdrawals from account earnings and from employer contributions.   This provision, as well as the requisite revised regulations, would apply to tax years beginning after 2017.

Reduction in Minimum Age for In-Service Distributions.  Participants in profit-sharing (including 401(k) plans) and stock purchase plans currently may not take an in-service distribution before age 59½, and participants in other retirement plans (including defined benefit pension plans) are generally barred from taking in-service distributions until age 62.  Section 1502 of the Bill would lower the limit for in-service distributions from plans currently subject to the age 62 limit to age 59½ limit.  This provision would apply to tax years beginning after 2017.

Extension of Time Period for Rollover of Certain Outstanding Plan Loan.  Currently, under Code section 402(c)(3), a participant whose plan or employment terminates while he or she has an outstanding plan loan balance must contribute the loan balance to an individual retirement account (IRA) within 60 days of the termination, otherwise the loan is treated as an impermissible early withdrawal and is subject to a 10% penalty.  Section 1505 of the Bill would add a new subsection 402(c)(3)(C) to the Code to relax these rules by giving such employees until the due date for their individual tax return to contribute the outstanding loan balance to an IRA.  The 10% penalty would only apply after that date.  This provision would apply to tax years beginning after 2017.

Changes to Taxation of Non-qualified Deferred Compensation.  Currently, non-qualified deferred compensation that is subject to a substantial risk of forfeiture is not included in an employee’s income until the year received, and the employer’s deduction is postponed until that date.  By repealing Code section 409A and introducing a new section 409B, Section 3901 of the Bill would significantly restrict the conditions that qualify as a substantial risk of forfeiture, such that non-qualified deferred compensation would become taxable immediately unless it is subject to future performance of substantial services.  This provision would simplify the taxation of non-qualified deferred compensation to align it with the FICA tax timing rules that already applied under Code section 3121(v)(2).  This provision would be effective for amounts attributable to services performed after 2017, though the current rules would apply to existing non-qualified deferred compensation arrangements beginning with the last tax year before 2026.  Notably, the change is substantially identical to one introduced by former Ways & Means Chairman Camp in the past.  It is unclear how the provision in the Bill would apply to some forms of equity-based compensation, such as stock options, which the Bill includes within the definition of non-qualified deferred compensation.  If enacted, the change is likely to trigger a substantial reduction in the use of non-qualified deferred compensation because the resulting accelerated taxation would erode one of the primary purposes of deferring compensation.  Note: This provision was eliminated by the second amendment adopted by the Ways & Means Committee (discussed here).

Proposed Bill Would Streamline Employer Reporting Under ACA

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October 16, 2017

On October 3, bipartisan legislation was introduced in the House and the Senate to streamline the employer health-coverage reporting requirements under the Affordable Care Act (ACA).  In contrast to the ACA repeal-and-replace bills proposed in the past several months, which do not directly affect ACA information reporting provisions (see prior coverage), the Commonsense Reporting Act would direct the Treasury Department to implement a more streamlined, prospective reporting system less burdensome than the current requirements.  Specifically, the legislation would create a voluntary prospective reporting system for employer-provided health coverage and permit employers who use this system to provide employee statements under section 6056 only to employees who have purchased coverage through an exchange, rather than to the entire workforce.  The Commonsense Reporting Act has bipartisan support, and may gain more traction if Congress seeks to improve the ACA and its exchanges rather than repeal and replace the ACA entirely.

The ACA requires employers and insurance carriers to gather monthly data and report them to the IRS and their employees annually under sections 6055 and 6056.  This reporting is intended to verify compliance with the individual and employer mandates, and to administer premium tax credits and cost sharing subsidies under the state and federally-facilitated insurance exchanges.  Section 6056 requires applicable large employers (ALEs) to file a return with the IRS and provide a statement to each full-time employee with information regarding the offer of employer-sponsored health care coverage.

At its core, the Commonsense Reporting Act would create a voluntary prospective reporting system.  This system would allow employers to make available data regarding their health plans not later than 45 days before the first day of open enrollment, rather than at the end of a tax year.  The data required includes the employer’s name and EIN, as well as certifications regarding:

  • whether minimum essential coverage under section 5000A(f) is offered to the following groups: full-time employees, part-time employees, dependents, or spouses;
  • whether the coverage meets the minimum value requirement of section 36B;
  • whether the coverage satisfies one of the affordability safe harbors under section 4980H; and
  • whether the employer reasonably expects to be liable for any shared responsibility payments under section 4980H for the year.

The employer would also need to provide the months during the prospective reporting period that this coverage is available, and the applicable waiting periods.

The proposed legislation would also ease an employer’s obligation to furnish employee statements (Forms 1095-C) regarding employer-provided coverage pursuant to section 6056.  Specifically, employers who use the voluntary prospective reporting system must provide employee statements only to those who have purchased coverage through an Exchange (based on information provided by the Exchange to the employer), rather than to the entire workforce.  Presumably, the rationale is that an employee covered through an Exchange can use information provided in Part II of the Form 1095-C—regarding whether, in each month, the employer offered minimum essential coverage (MEC) that is affordable and that provides minimum value—to apply for the premium tax credit.  This credit is available only for employees covered through an Exchange and only for the months in which the employee was not eligible for affordable employer-provided MEC that provides minimum value and any other MEC outside the individual market.

In addition to these changes to employer health-coverage reporting, the proposed legislation would also: (a) direct the IRS to accept full names and dates of birth in lieu of dependents’ and spouses’ Social Security numbers and require the Social Security Administration to assist in the data-matching process; (b) allow for electronic transmission of employee and enrollee statements without requiring recipients to affirmatively opt-in to electronic receipt; and (c) require the Government Accountability Office to study the functionality of the voluntary prospective reporting system.

Although the legislation has attracted the support of a large number of business groups, it remains unclear whether it can overcome the current reluctance among Republican Representatives and Senators to take any action that may further entrench the ACA.  Given the White House’s recent actions that appear designed to weaken the ACA, White House support may also be difficult to garner.  We will monitor the legislation for further developments.

Five New CAAs on Exchange of CbC Reports Pushes Total to 27

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October 9, 2017

The IRS has concluded competent authority arrangements (“CAAs”) for the exchange of country-by-country (“CbC”) reports with the Czech Republic, Finland, Greece, Italy, and Sweden.  The new arrangements bring the number of CAAs for the exchange of CbC reports to 27.  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.

As we have previously reported, 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.  Although the new agreements are welcome, the pace at which the IRS has concluded CAA negotiations with foreign jurisdictions continues to raise concerns that U.S. MNEs may be subject to foreign filing requirements, as 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.  The United States’ decision to pursue bilateral CAAs with each foreign jurisdiction rather than sign a multilateral CAA has made the implementation process longer than that in other jurisdictions.  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, although a number of these jurisdictions are in negotiations with the United States.

The IRS maintains a status table of foreign jurisdictions on its CbC Reporting web site.  The table identifies foreign countries with which the U.S. is in negotiations for a CAA and that have satisfied the United States’ data safeguards and infrastructure review.  Although the foreign jurisdictions listed have consented to being listed, the web site warns that taxpayers cannot rely on the table for assurances that the CAAs will be adopted by the end of 2017.  Although U.S. voluntary reporting for early reporting periods began 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 in addition to the United States.

First Friday FATCA Update

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October 6, 2017

Since our last monthly FATCA update, the IRS has issued Notice 2017-46, providing welcomed reprieve for U.S. financial institutions with respect to the collection of foreign taxpayer identification numbers (FTINs) required of them by FATCA to avoid Chapter 3 withholding.  The notice delays the date on which U.S. financial institutions must begin collecting FTINs to January 1, 2018, provides a phase-in period for obtaining FTINs from account holders documented before January 1, 2018, that will end on December 31, 2019, and limits the circumstances in which FTINs are required (see prior coverage).  This week, an IRS official reiterated that a change in an accountholder’s address to another jurisdiction is a change in circumstances that will invalidate the Form W-8 for payments made after the change provided an FTIN is otherwise required, necessitating the collection of an FTIN if an FTIN is otherwise required with respect to the payment(s).

Additionally, the Treasury Department has also released the Model 1A intergovernmental agreement (IGA) between the United States and Kazakhstan.

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 competent authority agreement (CAA) is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

IRS Updates List of Countries Subject to Bank Interest Reporting Requirements

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October 2, 2017

Last week, the IRS issued Revenue Procedure 2017-46 to supplement the list of countries subject to the reporting requirements of Code section 6049, which generally relate to reporting on bank interest paid to nonresident alien individuals.  The expansion is not unexpected, as this list of countries, originally set forth in Revenue Procedure 2014-64 and modified a handful of times since, will likely continue to expand as more countries enter into tax information exchange agreements with the U.S. in order to implement the Foreign Account Tax Compliance Act (FATCA).  Specifically, the Revenue Procedure adds the Faroe Islands and Greenland to the list of countries with which the U.S. has a bilateral tax information exchange agreement, and adds Croatia and Panama to the list of countries with which Treasury and IRS have determined the automatic exchange of information to be appropriate.  Coverage of previous updates to these lists can be found here and here.

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

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

IRS Approves Final Regulations on Gambling Withholding

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September 28, 2017

The IRS has finalized regulations under section 3402(q) simplifying the withholding regime applicable to certain gambling winnings, which were issued in proposed form in December 2016 (prior coverage here).  The IRS issued the regulations in response to complaints about the withholding system previously applicable to horse races, dog races, and jai alai.  Commenters explained that newer methods of gambling on such events often caused the amount withheld to exceed the actual tax liability.  The key change made by the regulations relates to the method of calculating the amount of the wager in the case of parimutuel wagers, a type of bet that differs from the typical straight wager.  Under the new rules, all wagers placed in a single parimutuel pool and represented on a single ticket are permitted to be aggregated and treated as a single wager.  One point clarified in the preamble to the final regulations is that electronic bettors may aggregate wagers made at different times, so long as the wagers are represented on a single electronic record.  To allow industry participants time to update their systems to accommodate the new rules and seek any necessary state regulatory approval, the final regulations will take effect 45 days from the date of publication.

IRS Makes Good on Promise to Issue Guidance Loosening Certain FATCA Reporting Requirements

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September 26, 2017

Yesterday, the IRS issued Notice 2017-46, representing a welcome reprieve for U.S. financial institutions with respect to the collection of foreign taxpayer identification numbers (FTINs) required of them by the Foreign Account Tax Compliance Act (FATCA) to avoid Chapter 3 withholding.  As we discussed in a prior post, an official with the IRS Office of Chief Counsel previewed this forthcoming guidance earlier this month and communicated that it was intended as a response to comments received by the IRS from withholding agents.  The new guidance delays the date on which U.S. financial institutions must begin collecting FTINs to January 1, 2018, provides a phase-in period for obtaining FTINs from account holders documented before January 1, 2018 that will end on December 31, 2019, and limits the circumstances in which FTINs are required.  For example, withholding agents will not be required to obtain FTINs on Forms W-8 that the withholding agent would otherwise obtain solely to avoid Form 1099 reporting or backup withholding, or in situations where a payment is not otherwise subject to reporting on Form 1042-S.  Additionally, withholding agents will not be required to obtain FTINs from an account holder in a jurisdiction that has not entered a reciprocal tax information exchange treaty with the United States or in a jurisdiction that does not issue FTINs to its residents.  Finally, withholding agents need not acquire FTINs for governments, international organizations, foreign central banks of issue, or residents of a U.S. territory.  The IRS will revise the Instructions for Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” to reflect the amended FTIN requirements.

In addition, Notice 2017-46 also provides a reprieve for certain Model 1 FFIs with respect to their reporting requirements, extending the time by which they must obtain and report U.S TINs for preexisting accounts that are U.S. reportable accounts.  For such accounts, the U.S. Competent Authority will not determine that there is “significant non-compliance” with obligations under a Model 1 intergovernmental agreement solely because of a failure to obtain and report a U.S. TIN, provided that the Model 1 FFI follows certain alternative procedures specified in Notice 2017-46.

The IRS intends to amend the regulations to reflect the rules announced in Notice 2017-46, but taxpayers may rely on the Notice until it issues such regulations.

Graham-Cassidy Bill Eliminates Premium Tax Credit But Retains ACA Information Reporting Requirements

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September 21, 2017

With the September 30 budget reconciliation deadline looming, Senate Republican leaders recently released the Graham-Cassidy proposal, which would repeal and replace the Affordable Care Act, but retain most of its information reporting requirements.  A departure from previous GOP proposals (see discussions here and here), the Graham-Cassidy proposal would completely eliminate federal premium tax credits by January 2020, and not provide any other health insurance tax credits.  The legislation would instead put in place a system of block grants to the states which states could use to increase health coverage, but would not be required to use for that purpose.  The proposal would also zero out penalties for the individual and employer mandates beginning in 2016.

The information reporting rules under Code sections 6055 and 6056 would be retained under the proposal, but it is unclear what purpose the Form 1095-B would serve after 2019 when there is no penalty for failing to comply with the individual mandate and no premium tax credit or other health insurance tax credit.  The bill likely does not repeal the provisions because of limitations on the budget reconciliation process, which requires that changes have a budgetary impact.  The proposal would also keep in place the 3.8% net investment income tax, as well as the 0.9% additional Medicare tax on wages above a certain threshold that varies based on filing status and that employers are required to withhold and remit when paying wages to an employee over $250,000.

The Senate has until the end of this month to pass a bill with 51 Senate votes under the budget reconciliation process, before rules preventing a Democratic filibuster expire.  A vote is expected next week.

Proposed Regulations Would Allow Truncated SSN on Forms W-2 Furnished to Employees

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September 20, 2017

The IRS recently issued proposed regulations that would allow employers to truncate employees’ social security numbers (SSNs) on copies of Forms W-2 furnished to employees, to help protect employees from identity theft.  The truncated SSNs must appear in the form of IRS truncated taxpayer identification numbers (TTINs): the first five digits of the nine-digit SSN are replaced with Xs or asterisks.  For example, a TTIN replacing an SSN appears in the form XXX‑XX‑1234 or ***‑**‑1234.  Employers may also use TTINs on Forms W-2 furnished to employees for payment of wages in the form of group-term life insurance.  But as with information returns filed with the IRS, employers cannot use TTINs on copies of the Forms W-2 filed with the Social Security Administration.   If finalized, these regulations would be applicable to Forms W-2 required to be furnished after December 31, 2018, due to concerns with providing state tax administrators sufficient time to accommodate TTIN usage on Forms W-2.  Comments on the proposed regulations are due by December 18, 2017.

The proposed regulations reflect statutory changes made in late 2015 by section 409 of the Protecting Americans from Tax Hikes (PATH) Act.  Section 409 of the PATH Act amended Code section 6051(a)(2) by striking “his social security account number” from the list of information required on Form W-2 and inserting “an identifying number for the employee” instead.  The IRS already permitted the usage of TTINs on a number of information returns furnished to payees including Forms 1095, 1099, 1098, and others.  The use of TTINs is intended to help reduce identity theft by reducing the number of documents that include both an individual’s name and TIN.

Tax Relief for Leave-Based Donation Programs and Qualified Plan Distribution Extended to Hurricane Irma Victims

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September 18, 2017

The IRS recently announced favorable tax relief for “leave-based donation programs” designed to aid victims of Hurricane Irma, as well as easier access to funds in qualified retirement plans for these victims.  These forms of relief were provided to victims of Hurricane Harvey last month (see prior coverage), and as expected, were promptly extended to victims of Hurricane Irma.

Specifically, under Notice 2017-52, employees may forgo paid vacation, sick, or personal leave in exchange for cash donation the employer makes, before January 1, 2019, to charitable organization providing relief for the Hurricane Irma victims.  The IRS will not treat the donated leave as income or wages to the employee, and will permit employers to deduct the donations as business expenses.  Similarly, in Announcement 2017-13, the IRS extended to employees affected by Hurricane Irma the relaxed distribution rules announced following Hurricane Harvey for plan loans and hardship distributions from qualified retirement plans.  The relief generally permits plan sponsors to adopt amendments permitting plan loans and hardship withdrawals later than would otherwise be required to provide such options, waives the six-month suspension of contributions for hardship withdrawals, and allows the disbursement of hardship withdrawals and plan loans before certain procedural requirements are satisfied.

As we discussed with respect to Hurricane Harvey, employers looking to provide further relief to their employees have other long-standing options, as well.  For example, Notice 2006-59 provides favorable tax treatment similar to that provided under Notice 2017-52 for “leave-sharing plans” that permit employees to deposit leave in an employer-sponsored leave bank for use by other employees who have been harmed by a major disaster.  Additionally, section 139 permits individuals to exclude from gross income and wages any “qualified disaster relief payment” for reasonable and necessary personal, family, living, or funeral expenses, among others; and the payments may be made through company-sponsored private foundations (see our recent Client Alert on section 139 disaster relief payments).

Hurricane Harvey Prompts IRS to Provide Tax Relief for Leave-Based Donation Programs

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September 7, 2017

The IRS recently released Notice 2017-48, providing favorable tax relief for “leave-based donation programs” designed to aid victims of Hurricane Harvey.  Under these programs, employees may elect to forgo vacation, sick, or personal leave in exchange for payments that the employer makes to charitable organizations described under section 170(c).  Under this notice, payments employees elect to forgo do not constitute income or wages of the employees for federal income and employment tax purposes if the employer makes the payments, before January 1, 2019, to charitable organizations for the relief of victims of Hurricane Harvey.  The IRS will not assert that an opportunity to make this election results in employees’ constructive receipt of the payments.  Thus, the employer would not need to include the payments in Box 1, 3 (if applicable), or 5 of the Forms W-2 for employees electing to forgo their vacation, sick, or personal leave.

With respect to employer deductions, the IRS will not assert that an employer is permitted to deduct these cash payments exclusively under the rules of section 170, applicable to deductions for charitable contributions, rather than the rules of section 162.  Accordingly, the deduction will not be limited by the percentage limitation under section 170(b)(2)(A) or subject to the procedural requirements of section 170(a).  Thus, payments made to charitable organizations pursuant to leave-based donation programs are deductible to the extent the payments would be deductible under section 162 if paid to the employees (i.e., the payments would have constituted reasonable compensation and met certain other requirements).

The requirements of Notice 2017-48 are straightforward, but if an employer fails to comply, the general tax doctrines of assignment of income and constructive receipt would apply.  Under these doctrines, if an employee can choose between receiving compensation or assigning the right to that compensation to someone else, the employee has constructive receipt of the compensation even though he or she never actually receives it.  (These concepts also create difficulties for paid-time off programs under which employees can choose to use PTO or receive cash.)  Thus, without special tax relief, an employee who assigns the right to compensation to a charitable organization would be taxed on that compensation, and the employer would have corresponding income and employment tax withholding and reporting obligations.  Although the employee would be entitled to take an itemized deduction for charitable contributions in that amount, this below-the-line deduction only affects income taxes (and not FICA taxes), and would not fully offset the amount of the income for non-itemizers who claim the standard deduction ($6,300 for single filers in 2016).

The devastation caused by Hurricane Harvey and the impending threat of Hurricane Irma, which is currently affecting islands in the Eastern Caribbean islands, have renewed interest in favorable charitable contribution tax rules that extend beyond the parameters of section 170.  Apart from Notice 2017-48, the IRS has also previously provided certain special tax treatment for disaster relief payments employers provide to their employees.  On August 30, the IRS provided for easier access to funds in qualified retirement plans in IRS Announcement 2017-11.  The rules generally permit plan sponsors to adopt amendments permitting plan loans and hardship withdrawals later than would otherwise be required to provide such options, waive the six-month suspension of contributions for hardship withdrawals, and allow the disbursement of hardship withdrawals and plan loans before certain procedural requirements are satisfied.  Although the relief provided in Announcement 2017-11 applies only to those affected by Hurricane Harvey (and Notice 2017-48 applies only to charitable contributions designed to aid such individuals), it is likely the IRS will provide similar relief to those affected by Hurricane Irma if it makes landfall in the United States, as appears likely at this time.

Employers looking to provide further relief to their employees have other long-standing options, as well.  For example, Notice 2006-59 provides favorable tax treatment similar to that provided under Notice 2017-48 for “leave-sharing plans” that permits employees to deposit leave in an employer-sponsored leave bank for use by other employees who have been harmed by a major disaster.  Additionally, section 139 permits individuals to exclude from gross income and wages any “qualified disaster relief payment” for reasonable and necessary personal, family, living, or funeral expenses, among others; and the payments may be made through company-sponsored private foundations (see our recent Client Alert on section 139 disaster relief payments).

First Friday FATCA Update

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September 1, 2017

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

  • The Sixth Circuit issued an opinion on August 18, 2017 upholding the dismissal of a challenge to FATCA brought by Senator Rand Paul and several current and former U.S. citizens living abroad who hold foreign accounts (see prior coverage).
  • The IRS posted draft instructions to the Form 8966 (FATCA Report) dated August 9, 2017, with some changes pertaining to participating foreign financial institutions (PFFIs) and other changes reflecting the final and temporary Chapter 4 regulations released in January of this year (see prior coverage).

Additionally, an official with the IRS Office of Chief Counsel recently stated that the IRS will delay the date on which U.S. financial institutions must start treating an otherwise valid Form W‑8 as invalid merely because it does not include a foreign taxpayer identification number (FTIN) or a reasonable explanation for its absence, to avoid Chapter 3 withholding.  Specifically, a valid Form W-8 obtained before January 1, 2018, will not be treated as invalid on that date if the form simply lacks the FTIN or a reasonable explanation for its absence (e.g., the account holder’s country of residence does not provide TINs).  It is unclear what form the relief will take, but it is possible the IRS will continue to allow a U.S. financial institution to treat a Form W-8 as valid if the financial institution does not have actual knowledge that the beneficial owner has an FTIN for some period of time.

This informal relief from the new FTIN requirement (issued in final and temporary regulations in late 2016) is welcomed by banks and withholding agents that report income for foreign account holders.  The relief is still reflected in FAQs on the IRS website (see prior coverage).  But since Form W-8s expire on three-year cycles, banks and agents still have to update their withholding policies and annual re-solicitation processes to comply with the new FTIN requirements.  Additionally, banks and agents are still waiting for further guidance on how they can update Form W‑8s issued before 2018 with the newly‑required FTIN or reasonable explanation.  An IRS FAQ posted in April 2017 specifies that the information can be provided in a written statement, including an email, but it is unclear what other requirements might apply to such a statement.

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

  • Anguilla (Model 1B IGA signed on January 15, 2017);
  • Italy (Model 1A IGA signed on January 10, 2014).

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

New 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 Delays Mandatory Reporting for Issuers of Catastrophic Health Plans

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August 18, 2017

On August 3, the IRS issued Notice 2017-41 to extend the period of voluntary reporting by insurance issuers regarding “catastrophic plans” for 2017 coverage and to provide that information reporting penalties will not apply to such voluntary reporting.  “Catastrophic plans” provide essential health benefits as defined under the Affordable Care Act (ACA), but only to the extent they exceed the annual limit on cost-sharing under the ACA, and a limited number of primary care visits.  Catastrophic plans can generally only be sold to low-income individuals and those determined by HHS to have suffered undue hardship and satisfy the coverage requirement under Section 5000A when purchased by such individuals.  Such plans may be enrolled in through an Exchange, but purchasers are ineligible for a premium tax credit for such coverage.  Section 6055 requires all persons, including issuers, providing minimum essential coverage to file annual information returns with the IRS and the responsible individual, but the timing of the reporting is subject to IRS regulations.  Section 36B(f)(3) includes a similar reporting requirement for any health plan provided by an Exchange.

Under current IRS regulations, the IRS has interpreted “any health plan,” to exclude catastrophic plans.  Additionally, IRS regulations do not require issuers to report coverage enrolled in through an exchange, including coverage under a catastrophic plan.  The result is that no reporting is currently required on catastrophic plans by issuers or the exchanges.

As a result, the IRS has issued several stop-gap measures over the past couple of years.  In September 2015, the IRS issued Notice 2015-68, which provided for voluntary reporting by issuers regarding catastrophic plans and stated that it intended to require reporting for 2016 coverage, which would be done on Form 1095-B, “Health Coverage.”  In August 2016, the IRS published proposed regulations under Section 6055 that would be effective for 2017 coverage and require reporting by issuers of catastrophic plans purchased through an exchange.  Since the IRS has still not finalized these proposed regulations, it issued Notice 2017-41 to extend the period of voluntary reporting and communicate that information reporting penalties will not apply to such voluntary reporting in 2017.

There is debate over whether issuers are the appropriate avenue for reporting this information, as the statute suggests that Congress intended to assign this duty to the exchanges.  As discussed above, Section 36B(f)(3) requires that exchanges report on “any health plan,” but the IRS has interpreted that term to exclude catastrophic health plans.  This interpretation effectively reads “any health plan” to mean a “qualified health plan.”  Congress used the term “qualified health plan” repeatedly and consistently throughout Section 36B, so its use of the term “any health plan” in this instance suggests that Congress intended to encompass plans other than “qualified health plans” when creating the reporting requirement applicable to exchanges, including catastrophic health plans.  Placing the reporting obligation on the exchanges also makes sense from a policy perspective, as the exchanges already collect the information needed to comply with this reporting obligation directly from customers enrolling through them, so they are better positioned to meet this reporting obligation than the health insurance issuers, which must rely upon the exchanges to provide timely and accurate information to enable them to report.

Draft Instructions for Form 8966 (FATCA Report)

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August 14, 2017

The IRS recently posted draft instructions to the Form 8966 (FATCA Report) dated August 9, 2017, with some changes pertaining to participating foreign financial institutions (PFFIs) and others reflecting the final and temporary Chapter 4 regulations released in January of this year.  The Form 8966 reports information with respect to certain U.S. accounts, substantial U.S. owners of passive non-financial foreign entities (NFFEs), specified U.S. persons that own certain debt or equity interests in owner-documented FFIs, and certain other accounts as applicable based on the filer’s status under Chapter 4 of the Internal Revenue Code.  A Model 1 FFI files the Form 8966 (or its equivalent) with its host country’s tax authority which, pursuant to the Model 1 IGA, shares the information with the IRS.  A Model 2 FFI directly files a Form 8966 with the IRS pursuant to its FFI agreement (see prior coverage regarding deadline for renewal of FFI agreement).

The changes reflected in the draft instructions are summarized below.  The draft instructions are before the official release.

  • Reporting on accounts held by nonparticipating FFIs. For 2017, a PFFI (including a Reporting Model 2 FFI) does not need to report on accounts held by nonparticipating FFIs in Parts II and V of the Form 8966.  Specifically, PFFIs should not check the box for “nonparticipating FFI” on line 5 of Part II, should not check the pooled reporting type “nonparticipating FFI” on line 1 of Part V, and should not complete line 3 of Part V.  This reporting obligation only applied for 2015 and 2016.
  • Limited FFIs and limited branches. The statuses for limited FFIs and limited branches expired on December 31, 2016.  Accordingly, the references to limited FFI and limited branch statuses are removed for the 2017 Form 8966.
  • Reporting Model 2 FFI related entities or branches. The instructions for limited FFIs and limited branches are revised to apply to Reporting Model 2 FFIs with related entities and branches that are required by the applicable Model 2 IGA to report U.S. accounts to the IRS to the extent permitted.  Thus, a related entity or branch of a Reporting Model 2 FFI filing Form 8966 should select the filer category code for limited branch or limited FFI (code 03) on line 1b of Part I.
  • Reporting Model 2 FFIs reporting on non-consenting U.S. accounts. For a preexisting account that is a non-consenting U.S. account, the Reporting Model 2 FFI should use the pooled reporting category for either recalcitrant account holders that are U.S. persons or recalcitrant account holders that have U.S. indicia.  For a new individual account that has a change in circumstances that causes the Reporting Model 2 FFI to know or have reason to know that the original self-certification is incorrect or unreliable, and the Reporting Model 2 FFI is unable to obtain a valid self-certification establishing whether the account holder is a U.S. citizen or resident, the Reporting Model 2 FFI should use the pooled reporting category for recalcitrant account holders with U.S. indicia.
  • U.S. branches. The draft instructions under Special Rules for Certain Form 8966 Filers reflect the updated reporting requirements for U.S. branches in the final Chapter 4 regulations published in January 2017.  On line 1b of Part I, all U.S. branches of a FFI not treated as U.S. persons should select the filer category code for PFFIs (code 01), and U.S. branches that are treated as U.S. persons should select the code for withholding agents (code 10).
  • PFFIs (including Reporting Model 2 FFIs) that are partnerships. The draft instructions for line 4d of Part IV for PFFIs (including Reporting Model 2 FFIs) are updated to conform to temporary Chapter 4 regulations published in January 2017 with respect to the amounts required to be reported by a partnership-PFFI reporting a partner’s interest in the partnership.
  • Mergers and bulk acquisitions of accounts.  New instructions under Special Rules for Certain Form 8966 Filers are added for combined reporting after a merger or bulk acquisition of accounts.

First Friday FATCA Update

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August 4, 2017

Since our last monthly FATCA update, the IRS has updated its FATCA frequently asked questions to include four new FAQs addressing the renewal of foreign financial institution (FFI) agreements and extending the deadline for renewing FFI agreements to October 24, 2017 (discussed here and here).

Recently, the Treasury released the Model 1B Intergovermental Agreement (IGA) between the United States and Turkmenistan.

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 Competent Authority Agreement (CAA) is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

IRS 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.

Version III of Senate GOP Health Care Bill Retains Same Health Coverage Reporting Rules

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July 20, 2017

Senate Republicans have just released another update to the Better Care Reconciliation Act, which would repeal and replace the Affordable Care Act.  This updated bill preserves the same health coverage reporting rules under the prior version that was released a week ago on July 13 (discussed here).  Senate Republican leader Mitch McConnell stated that he expects a vote early next week on a motion to start the debate on either a repeal-and-replace bill or a standalone ACA-repeal bill.

Updated FAQs on FFI Agreement Renewal

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July 19, 2017

Recently, the IRS updated its FATCA frequently asked questions to include four new FAQs addressing the renewal of foreign financial institution (FFI) agreements.  The new FAQs address the requirement that financial institutions (FIs) must renew their FFI agreements by July 31, 2017, pursuant to Revenue Procedure 2017-16, to be treated as having in effect an FFI agreement as of January 1, 2017.

FAQ#8 clarifies that, generally, FATCA requires the following types of FIs to renew their FFI agreements: participating FFIs not covered by an intergovernmental agreement (IGA); reporting Model 2 FFIs; reporting Model 1 FFIs operating branches outside of Model 1 jurisdictions (other than branches treated as nonparticipating FFIs under Article 4(5) of the Model 1 IGA).  By contrast, renewal is not required for the following types of entities: reporting Model 1 FFIs that are not operating branches outside of Model 1 jurisdictions; registered deemed-compliant FFIs (regardless of location); sponsoring entities; direct reporting non-financial foreign entities (NFFEs); and trustees of trustee-documented trust.

FAQ#9 provides that entities that do not need to renew their FFI agreements do not need to take any action—and do not even need to select “No” on the “Renew FFI Agreement” link—to remain on the FFI list and retain their Global Intermediary Identification Number (GIIN).

FAQ#10 clarifies that an entity that, before January 1, 2017, entered into the FFI agreement under Rev. Proc. 2014-38 (which terminated on December 31, 2016), and that failed to renew its FFI agreement by July 31, 2017, will be considered a nonparticipating FFI as of January 1, 2017, and will be removed from the FFI List.

If an entity that is required to renew its FFI agreement incorrectly selected “No” when asked if renewal is required, FAQ#11 provides that the entity can simply return to the FATCA FFI Registration system home page, click on the “Renew FFI Agreement” link, and select “Yes” to complete the renewal application before the deadline on July 31, 2017.

Updated Senate GOP Health Care Bill Retains Additional Medicare Tax and Most Health Coverage Reporting Rules

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July 13, 2017

This morning, Senate Republican leaders released an updated Better Care Reconciliation Act that would largely retain the existing health coverage reporting regime enacted as part of the Affordable Care Act (ACA). In contrast to the prior Senate bill (see prior coverage), the updated bill would keep in place the 3.8% net investment income tax, as well as the 0.9% additional Medicare tax, which employers are required to withhold and remit when paying wages to an employee over a certain threshold (e.g., $200,000 for single filers and $250,000 for joint filers). The updated bill is otherwise similar to the prior bill from a health reporting standpoint, as it would keep the current premium tax credit (with new restrictions effective in 2020) and retain the information reporting rules under Code sections 6055 and 6056. (The House bill passed on May 4, 2017 (discussed here and here), by contrast, would introduce an age-based health insurance coverage credit along with new information reporting requirements.) The updated bill would also zero out penalties for the individual and employer mandates beginning in 2016.

In addition to the ACA repeal-and-replace efforts in the Senate bill, the House Committee on Appropriations included in its appropriation bill a provision that would stop the IRS from using its funding to enforce the individual mandate or the related information reporting rule under Code section 6055 for minimum essential coverage (on Form 1095-B or 1095-C). This provision would be effective on October 1 this year. Apart from significantly cutting IRS funding, however, the appropriation bill would not otherwise affect IRS enforcement of information reporting by applicable large employers regarding employer-provided health insurance coverage. Thus, even if both the Senate health care bill and the House appropriation bill were to become law as currently proposed, applicable large employers would still be required to file Forms 1094-C and 1095-C pursuant to Code section 6056 in the coming years.

Late Form W-2s Doubled, Penalties to Come

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July 12, 2017

The earlier filing deadline on January 31 for Forms W-2 resulted in more than double the number of late-filed returns, according to Tim McGarvey, Social Security Administration branch chief, who was speaking on an IRS payroll industry conference call.  He said that, to date, the SSA has received close to 50,000 late Form W-2 submissions, compared to an average of 25,000 late submissions annually in the past few years.  In response to an inquiry from the Tax Withholding & Reporting Blog, Mr. McGarvey indicated that the 50,000 submissions represent approximately 4 million late-filed 2016 Forms W-2.

In addition to the jump in the number of late-filed returns, Mr. McGarvey said that the number of Forms W-2c filed has also increased dramatically—up 30 percent from last year.  In response to an inquiry, Mr. McGarvey reported that the SSA has received approximately 2.7 million Forms W-2c in 2017, with some 2.2 million of those correcting 2016 returns.  That compares to a total of approximately 2 million Forms W-2c processed in 2015.

The January 31 deadline for filing and furnishing recipients with the Form W-2 and a Form 1099-MISC that reports nonemployee compensation (Box 7) became required under the Protecting Americans from Tax Hikes (PATH) Act to combat identity theft and fraudulent claims for refund (see prior coverage).

Late filers and those that struggled to provide accurate filings by the January 31 deadline should take steps now to prepare for the 2017 filing season.  Employers who provide taxable non-cash fringe benefits (such as the personal use of company cars) may want to consider imputing income for those benefits using the special accounting rule and flexibility in Announcement 85-113, if they are not already doing so.  Announcement 85-113 permits employers to treat non-cash fringe benefits as received on certain dates throughout the year (such as on the first of each month, each quarter, semi-annually, or annually).  It also allows employers to treat the value of non-cash fringe benefits actually received in the last two months of the calendar year as received in the following calendar year.  Making use of these rules can ease the year-end payroll crunch.  The earlier employers can provide copies of Forms W-2 to employees, the greater the chance there is for employees to identify errors and request corrections before the January 31 filing deadline.

First Friday FATCA Update

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July 7, 2017

Since our last monthly FATCA update, the IRS has updated its online FATCA portal to allow foreign financial institutions to renew their FFI agreements (see prior coverage).

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

  • Bahrain (Model 1B IGA signed on January 18, 2017);
  • Croatia (Model 1A IGA signed on March 20, 2015);
  • Greenland (Model 1A IGA signed on January 17, 2017); and
  • Panama (Model 1A IGA signed on April 27, 2016).

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions 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.

Tax Court Expands Section 119 Exclusion in Boston Bruins Decision

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June 27, 2017

In a much anticipated decision, the U.S. Tax Court ruled yesterday that “the business premises of the employer” can include an off-premises facility leased by the employer when its employees are on the road.  The decision in Jacobs v. Commissioner addressed whether the employer (in this case, the professional hockey team, the Boston Bruins) was entitled to a full deduction for the meals provided to the team and staff while on the road for away games.  The debate arose after the IRS challenged the full deduction and asserted that the employer should have applied the 50% deduction disallowance applicable to meals by section 274(n) of the Code.

Under section 162 of the Code, an employer may deduct all ordinary and necessary business expenses.  However, in recognition that the cost of meals is inherently personal, the Code limits the deductions for most business meal expenses to 50% of the actual expense under section 274(n), subject to certain exceptions.  The exception at issue in Jacobs allows an employer to deduct the full cost of meals that qualify as de minimis fringe benefits under section 132(e) of the Code.  In general, this includes occasional group meals, but would not typically include frequently scheduled meals for employees travelling away from home.  (For this purpose, home is the employee’s tax home, which is typically the general area around the employee’s principal place of employment.)  However, under Treasury Regulation § 1.132-7, an employer-operated eating facility may qualify as a de minimis fringe benefit if, on an annual basis, the revenue from the facility is at least as much as the direct operating cost of the facility.  In other words, an employer may subsidize the cost of food provided in a company cafeteria, provided the cafeteria covers its own direct costs on an annual basis and meets other criteria (owned or leased by the employer, operated by the employer, located on or near the business premises of the employer, and provides meals immediately before, during, or immediately after an employee’s workday).

The Bruins’ owners argued that they were entitled to a full deduction because the banquet rooms in which employees were provided free meals qualified as an employer-operated eating facility.  That may leave some of our readers wondering, “How can a facility that is free have revenue that covers its direct operating cost?”  The key to answering that question lies in the magic found in the interface of sections 132(e)(2)(B) and section 119(b)(4) of the Code.  Under section 132(e)(2)(B), an employee is deemed to have paid an amount for the meal equal to the direct operating cost attributable to the meal if the value of the meal is excludable from the employee’s income under section 119 (meals furnished for the “convenience of the employer”) for purposes of determining whether an employer-operated eating facility covers its direct operating cost.  In turn, section 119(b)(4) provides that if more than half of the employees who are furnished meals for the convenience of the employer, all of the employees are treated as having been provided for the convenience of the employer.  Working together, if more than half the employees are provided meals for the convenience of the employer at an employer-operated eating facility, the employer may treat the eating facility as a de minimis fringe benefit, and deduct the full cost of such facility.

The IRS objected to the owners’ treatment of the banquet rooms as their employer-operated eating facilities and disallowed 50% of the meal costs.  The Tax Court succinctly explained that the Bruins’ banquet contracts constituted a lease of the rooms provided for meals and that the contracts also meant that the Bruins operated the facilities under Treasury Regulation § 1.132-7(a)(3).  In doing so, the Tax Court summarily dismissed the IRS’s argument that the payment of sales taxes meant that the contracts were not contracts for the operation of an eating facility but instead the purchase of meals served in a private setting.

Having determined that the first two criteria were satisfied, the Tax Court turned to the question of whether the hotel banquet rooms constituted the “business premises of the employer.”  The court looked to a series of cases indicating that the question was one of function rather than space.  Relying on those cases, the court determined that the hotels were the business premises of the employer because the team’s employees conducted substantial business activities there.   The court seemed to put significant weight on the fact that the team was required to participate in away games, necessitating it travel and operation of its business away from Boston.  The Tax Court was unpersuaded by the IRS’s quantitative argument that the team spent more time working at its facility in Boston than at any individual hotel and its qualitative argument that the playing of the away game was more important than the preparation for the game that took place at the hotel.

Having determined that the hotel banquet rooms were an employer-operated eating facility, the Tax Court next addressed whether it qualified as a de minimis fringe benefit because more than half of the employees who were furnished meals in the banquet rooms were able to exclude the value of such meals from income under section 119 of the Code.  The court determined that this requirement was satisfied because the meals were provided to the team and staff for substantial noncompensatory business reasons.  The business reasons included: ensuring the employees’ nutritional needs were met so that they could perform at peak levels; ensuring that consistent meals were provided to avoid gastric issues during the game; and the limited time to prepare for a game in each city given the “hectic” hockey season schedule.  Relying on the Ninth Circuit’s decision in Boyd Gaming v. Commissioner from the late 1990s, the court declined, once again, to second guess the team’s business judgment by substituting the government’s own determination.

Although the decision focuses on the specific facts and the exigencies of a traveling hockey team, the decision is of interest for other taxpayers as well.  This is especially true given the IRS’s recent increased interest in both meal deductions and the imposition of payroll tax liabilities with respect to free or discounted meals provided to employees, particularly in company cafeteria settings.  The decision expands the scope of the section 119 exclusion to meals further than the IRS’s current limited view that it applies only to remote work sites, such as oil rigs, schooners,  and camps in Alaska.   To date, the most expansive application of the exclusion in the company cafeteria setting occurred in Boyd Gaming, where a casino successfully established that its policy requiring employees to eat lunch on-site was based on security concerns and the attendant screening procedures made it necessary to provide employees with meals during their shifts.

Jacobs seems to take the analysis one step further, because many of the business reasons for providing meals to Bruins employees could be echoed by other taxpayers.  No doubt, all employers are concerned with the performance of their employees.  To that end, it could be argued that ensuring that they eat well-balanced nutritionally appropriate meals can increase performance even if the employer is more concerned with brains rather than brawn.  Indeed, given the large health insurance costs borne by many employers, employers have a legitimate interest in providing healthy meals that may reduce the incidence of obesity, diabetes, heart disease, and other chronic ailments that raise their costs.  Moreover, many employees have hectic schedules during the work day with frequent appointments, meetings, and other activities that make it necessary to maximize the time available for work during the day.   Given the Tax Court’s implicit admonition of the IRS’s attempt to substitute its own judgment regarding the employer’s business reasoning in Jacobs and the court’s refusal to substitutes its own judgment as well, the IRS likely has a more difficult road ahead if it attempts to challenge the purported business reasons that an employer provides for furnishing meals to its employees.  It remains to be seen how the IRS will react to the decision and whether it will appeal the case, which seems likely.  For now, however, the case is a positive development for employers who have made a business decision to provide meals on a free or discounted basis to their employees to increase productivity and improve their health.

IRS Releases Five CbC Reporting Agreements

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June 9, 2017

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

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

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

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

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

IRS FATCA Portal Now Accepting FFI Agreement Renewals

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June 6, 2017

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

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

IRS Approves First Group of Certified PEOs under Voluntary Certification Program

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June 5, 2017

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

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

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

First Friday FATCA Update

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June 2, 2017

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

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

Since our last update, Treasury has not published any new intergovernmental agreements (IGAs), and the IRS has not published any new competent authority agreements (CAAs).  Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

First Friday FATCA Update

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May 5, 2017

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

Under FATCA, IGAs come in two forms: Model 1 or Model 2. Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS. Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements. By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions. A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable. Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation. Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

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

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April 19, 2017

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

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

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

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

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

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

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

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

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

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

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

First Friday FATCA Update

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April 7, 2017

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

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

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

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

IRS Updates List of Countries Subject to Bank Interest Reporting Requirements

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

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

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

IRS Guidance on Reporting W-2/SSN Data Breaches

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April 6, 2017

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

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

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

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

Entities Allowed Additional Time to Renew QI Agreements

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

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

Poor Design and Poor Defense Sink Employee Discount Plan

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

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

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

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

Recent FAA Serves as Warning to Employers Using PEOs

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

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

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

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

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

Employers Likely Need to Update Their Processes Based on New Requirements for Employer Refund Claims of FICA and RRTA Taxes

On March 20, the IRS released Rev. Proc. 2017-28, providing guidance to employers on employee consents used to support a claim for credit or refund of overpaid taxes under the Federal Insurance Contributions Act (FICA) and the Railroad Retirement Tax Act (RRTA). The revenue procedure requires the employee consent to contain, among other information, the basis for the refund claim and a penalties of perjury statement. In addition, it permits employers to request, receive, and retain employee consent electronically, and clarifies the “reasonable efforts” an employer must make, if it fails to secure employee consent, to claim a refund of the employer’s share of overpaid FICA or RRTA taxes. Many of the requirements in the revenue procedure were included in a proposed revenue procedure contained in Notice 2015-15. Rev. Proc. 2017-28 also provides the circumstances under which an employee consent may use a truncated taxpayer identification number (TTIN).  Employers will need to review the new requirements and update their existing FICA refund process to ensure that process satisfies the new requirements.

Background

Treasury Regulation section 31.6402(a)-2 provides general rules for employers to claim refunds of overpaid FICA and RRTA taxes. An employer must file the refund claim on the form prescribed by the IRS (e.g., Form 941-X) and designate the return period to which the claim relates, explain the grounds and facts supporting the claim, and meet other requirements under the regulations and the form’s instructions. An employer that is granted a tax refund of FICA or RRTA taxes (including any applicable interest) must give the employee his or her share.

To protect an employee’s interests, the regulations prohibit the refund of the employer share unless the employer (a) has first repaid or reimbursed the employee, or (b) has included a claim for refund of the employee share of FICA or RRTA taxes, along with the employee’s consent. Similarly, to claim refund of the employee share, the employer must certify that the employer has repaid or reimbursed the employee share or has secured the employee’s written consent for the refund claim, except to the extent taxes were not withheld from the employee. But these requirements do not apply, and the employer may claim refund for the employer share, to the extent that either (a) the taxes were not withheld from the employee’s compensation; or (b) the employer cannot locate the employee or the employee will not provide consent after the employer has made reasonable efforts to either secure the employee’s consent or to repay or reimburse the employee.

New Rules on Requesting and Retaining Employee Consent

45-day consent period. A request for consent must give employees a reasonable period of time to respond, not less than 45 days. The request must clearly state: (a) the purpose of the employee consent; (b) that the employer will repay or reimburse the employee share (including allocable interest) to the extent refunded by the IRS; and (c) that an employee cannot authorize the employer to claim a refund on the employee’s behalf for any overpaid Additional Medicare Tax. A request for consent may include an express presumption that if an employee’s response has not been received by the employer during the specified time period, the employee will be considered as having refused to provide the employee consent. However, a failure to respond may not be deemed consent. A request for consent also may include a request that the employee keep the employer informed about any change in the employee’s mailing address or email address.

Electronic Consent. An employer may establish a system to request, furnish, and retain employee consent in an electronic format that ensures the authenticity and integrity of the electronic signature and record. Although an employer may use electronic consent, the employer must provide an employee, upon request, the option to review the consent request and to provide the consent in paper format.

Reasonable Efforts. An employer may claim a refund of the employer share of FICA and RRTA tax without obtaining employee consent only if the employer makes “reasonable efforts” to repay or reimburse the employee or secure the employee’s consent and the employer cannot locate the employee or the employee will not provide consent. The reasonable efforts rule is satisfied if an employer fulfills the following requirements.

  • Request for consent. The employer properly requests the employee’s consent.
  • Email receipt acknowledgement. Any electronic request for consent asks the employee to affirmatively acknowledge the request (e.g., by clicking on a voting button (YES) or by sending a reply message). A read-receipt message is not sufficient.
  • Record retention. The employer retains a record of sending the request for consent, including the mailing or personal delivery record, the email record (including any receipt acknowledgement), or the employee’s reply declining the request.
  • Second delivery attempt. If the employer’s initial request fails to be delivered, the employer must attempt to secure consent a second time, with a 21-day response period from the date of the second request. In particular, if a mailing is undeliverable, the employer must make a good faith attempt to determine the employee’s current address and if a new address is discovered, send the request again by mail or personal delivery. Alternatively, the employer can email the request to the employee. If an email is undeliverable (e.g., due to problems with the employee’s email address) or if the employee does not acknowledge receipt of the email, the employer must send a request in paper to the employee’s last known address by mail or personal delivery.

New Rules on Employee Consent

Required Items. Employee consents are subject to a list of requirements, two of which are noteworthy. First, the employee must identify the specific basis of the refund claim. The revenue procedure provides a detailed example: “request for refund of the social security and Medicare taxes withheld with regard to excess transit benefits provided in 2014 due to a retroactive legislative change.” It is unclear how detailed the basis provided must be to satisfy this requirement. Second, the consent must contain the employee’s signature under a penalties of perjury statement. The penalties of perjury requirement will complicate efforts to obtain employee consents and written statements as employees are often reluctant to sign documents under threat of perjury even when they are certifying true statements. This is particularly true with regard to former employees.

In addition to the two requirements described above, an employee consent must:

  • contain the employee’s name, address, and taxpayer identification number (TIN);
  • contain the employer’s name, address, and employer identification number (EIN);
  • contain the tax period(s), type of tax (e.g., social security and Medicare taxes), and the amount of tax for which the employee consent is provided;
  • state that the employee authorizes the employer to claim a refund for the overpayment of the employee share; and
  • with regard to refund claims for employee tax overcollected in prior years, include the employee’s written statement certifying that the employee has not made previous claims (or that the claims were rejected) and will not make any future claims for refund of the overcollected amount.

Use of TTIN. To address concerns regarding identity theft, the revenue procedure allows the use of a TTIN in place of the employee’s complete social security number (SSN) if the employer prepares the employee consent and prepopulates the TIN field with the TTIN. A TTIN may not be used, however, if the employer requests the SSN as the employee’s TIN or if the employee furnishes the TIN as part of the consent.

As a result of the new guidance, many employers will need to update their employee consent procedures to comply with the new rules, most of which are not specified in the Code or the implementing Treasury regulations. FICA tax overpayments frequently occur, and failure to obtain the proper employee consent, or failure to follow the procedures for requesting consent, can delay the employer’s refund claim. The new requirements apply to employee consents requested on or after June 5, 2017.

IRS Negotiating CbC Information Exchange Agreements

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

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

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

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

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March 7, 2017

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

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

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

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

New Reporting Rules for Health Insurance Coverage Credits Beginning in 2020

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

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

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

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

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

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

Transitional Reporting Rules for Premium Tax Credits in 2018 and 2019

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

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

Repeal of Additional Medicare Tax

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

What to Expect Next

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

First Friday FATCA Update

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March 3, 2017

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

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

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

IRS Issues Guidance for Early Country-by-Country Reporting

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February 7, 2017

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

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

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

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

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

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February 3, 2017

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

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

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

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

First Friday FATCA Update

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February 3, 2017

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

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

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

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

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January 23, 2017

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

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

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

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

IRS Begins Requesting Missing ACA Returns from Employers

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January 19, 2017

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

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

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

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

Refusal to Allow Closing Agreements on FICA Timing May Lead to Challenge

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January 17, 2017

In an IRS Chief Counsel Advice Memorandum released on January 13, the IRS concluded that it should not enter into closing agreements with employers who failed to subject amounts of nonqualified deferred compensation to FICA taxes under the special timing rule in Section 3121(v)(2)(A).  In the past, some employers have been able to obtain a closing agreement in such circumstances.  In the CCA, the IRS concludes that, because the regulations apply the general timing rule in such situations, closing agreements that would allow the avoidance of the harsh result prescribed by the regulations are inappropriate.

The unwillingness of the IRS to issue closing agreements on the issue going forward may bring to a head arguments that the IRS’s regulations under Section 3121(v)(2) are not well supported by the language of the statute.  Under the statute, an amount deferred under a “nonqualified deferred compensation plan” is required to be “taken into account” as wages for FICA tax purposes when the services creating the right to that amount are performed, or, if later, the date on which the right to that amount is no longer subject to a substantial risk of forfeiture.  Under the “nonduplication rule,” an amount taken into account as wages under this mandatory timing rule (and any income attributable to such amount) are not treated as wages at any later time.  In other words, deferrals under a nonqualified deferred compensation plan and the related earnings are subjected to FICA taxation only once—at the time mandated by Section 3121(v)(2)(A).

Under the Treasury Regulations, the IRS goes a step further and creates out of whole cloth a second time for including in wages amounts deferred under a nonqualified deferred compensation plan—the time that the deferred amount and earnings would have been taken into account as wages under Section 3121(a) but for the application of Section 3121(v)(2).  The IRS’s regulatory approach is arguably contrary to the statutory language, which does not include a “backup” timing rule but instead provides the sole and exclusive rule regarding the time at which such amounts are wages as a matter of statutory law. There is no other Code provision that would override the clear and unambiguous mandate of Section 3121(v)(2)(A) to require, or event permit, amounts deferred under nonqualified deferred compensation plans to be treated as FICA wages in a later year.

In the absence of an explicit statutory command that would require the later inclusion in wages of deferred amounts that were not properly subjected to FICA taxation, the approach taken by Treasury and the IRS in the regulations may be vulnerable to attack.  With the IRS now refusing to enter into closing agreements on the issue, a cornered taxpayer might seek to do just that.

First Friday FATCA Update

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January 6, 2017

Since our last monthly FATCA update, we have addressed several other recent FATCA developments, including a flurry of FATCA-related regulations released by the IRS and Treasury Department:

  • Late Friday, December 30, 2016, the IRS and Treasury Department released four regulation packages related to its implementation of FATCA (see previous coverage).   These regulations largely finalized the 2014 temporary FATCA regulations and 2014 temporary FATCA coordination regulations with the changes that the IRS had previously announced in a series of notices.
  • The final regulations released by the IRS under FATCA on December 30, 2016, finalized the temporary presumption rules promulgated on March 6, 2014 with no substantive changes, but several changes were made to the final coordinating regulations under Chapter 3 and Chapter 61, also released on the same date (see previous coverage).
  • In the preamble to the final FATCA regulations released on December 30, 2016, the IRS rejected a request from a commenter that the regulations be modified to permit a non-financial foreign entity (NFFE) operating in an IGA jurisdiction to determine its Chapter 4 status using the criteria specified in the IGA (see previous coverage).
  • The IRS released final agreements for foreign financial institutions (FFIs) and qualified intermediaries (QIs) to enter into with the IRS, set forth in Revenue Procedure 2017-16 and Revenue Procedure 2017-15, respectively (see previous coverage).
  • Two FATCA transition rules expired on January 1, 2017:  One related to limited branches and limited FFIs, and one related to the deadline for sponsoring entities to register their sponsored entities with the IRS (see previous coverage).
  • The IRS issued Revenue Procedure 2016-56 to add to the list of countries subject to the reporting requirements of Code section 6049, which generally relate to reporting on bank interest paid to nonresident alien individuals (see previous coverage).
  • The IRS issued Notice 2016-76 providing phased-in application of certain section 871(m) withholding rules applicable to dividend equivalents, and easing several reporting and withholding requirements for withholding agents and qualified derivatives dealers (QDDs) (see previous coverage).

In addition, the Treasury Department recently released the Intergovernmental Agreements (IGA) entered into between the United States and the following treaty partners, in these respective forms:

  • Grenada, Model 1B;
  • Macau, Model 2;
  • Taiwan, Model 2.

Further, the IRS released the Competent Authority Agreement (CAA) implementing the Model 1A IGA between the United States and Guyana entered into on October 17, 2016.

Under FATCA, IGAs come in two forms: Model 1 or Model 2.  Under a Model 1 IGA, the foreign treaty partner agrees to collect information of U.S. accountholders in foreign financial institutions (FFIs) operating within its jurisdiction and transmit the information to the IRS.  Model 1 IGAs are drafted as either reciprocal (Model 1A) agreements or nonreciprocal (Model 1B) agreements.  By contrast, Model 2 IGAs are issued in only a nonreciprocal format and require FFIs to report information directly to the IRS.

A CAA is a bilateral agreement between the United States and the treaty partner to clarify or interpret treaty provisions.  A CAA implementing an IGA typically establishes and prescribes the rules and procedures necessary to implement certain provisions in the IGA and the Tax Information Exchange Agreement, if applicable.  Specific topics include registration of the treaty partner’s financial institutions, time and manner of exchange of information, remediation and enforcement, confidentiality and data safeguards, and cost allocation.  Generally, a CAA becomes operative on the later of (1) the date the IGA enters into force, or (2) the date the CAA is signed by the competent authorities of the United States and the treaty partner.

The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

 

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

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January 5, 2017

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

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

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

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

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

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

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

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

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

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January 5, 2017

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

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

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

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

IRS Releases Four FATCA-Related Regulation Packages

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

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

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

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

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January 4, 2017

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

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

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

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

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

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

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

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

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

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

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

IRS Releases Final Qualified Intermediary and Foreign Financial Institution Agreements

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December 30, 2016

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

FFI Agreement

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

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

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

QI Agreement

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

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

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

IRS Issues Final and Proposed Regulations on Treatment of Gambling Winnings

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December 30, 2016

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

Final Regulations on Bingo, Slot Machine, and Keno Winnings

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

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

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

The final regulations are effective today.

Proposed Regulations

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

Comments on the proposed regulations are due by March 30.

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

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December 29, 2016

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

Limited Branches and Limited FFIs

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

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

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

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

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

Sponsored Entity Registration

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

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

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December 13, 2016

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

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

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

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

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

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December 9, 2016

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

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

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

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

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

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

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

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

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

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

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November 17, 2016

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

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

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

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

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

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

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

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

 

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

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

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

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

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

U.S. – Australia Treaty

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

U.S. – Bulgaria Treaty

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

U.S. – China Treaty

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

U.S. – France Treaty

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

U.S. – New Zealand Treaty

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

U.S. – Tunisia Treaty

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

Miscellaneous Issues with IRS LOB Table

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

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

Conclusion

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

September 28 Deadline Approaches For Work Opportunity Tax Credit Certification

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September 27, 2016

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

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

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

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

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.

Court Decision Underscores Need for Due Diligence When Using Payroll Service Providers

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August 24, 2016

A recent decision of the U.S. District Court for the Central District of California should remind employers to regularly verify the actions of payroll service providers regardless of the provider’s reputation and the longevity of the relationship.  In particular, employers should open an e-Services account with the IRS and verify that all deposits are in fact hitting their payroll accounts timely.  This check should be performed weekly.  If deposits are not timely reflected on accounts, it is incumbent on employers to promptly determine the nature of the problem.  The IRS does not police payroll service companies, and the Department of Justice has prosecuted a number of people for embezzlement of payroll taxes over the years.

In Kimdun Inc. et al. v. United States, four McDonald’s franchises (the “Employer”) under common ownership used an outside payroll company for 30 years to process all aspects of their payroll, including the remittance of payroll taxes to the U.S. Treasury and the California Employment Development Department.  However, during the last several years of the relationship (2008-2011), the payroll company or its related bank embezzled the Employer’s payroll taxes.  To make matters worse, the Employer learned of the failure to deposit its taxes in 2009 but neglected to take any action until mid-2011 and continued to use the payroll company through 2012.  The IRS subsequently assessed approximately $425,000 in failure-to-pay penalties under Section 6651(a), failure-to-deposit penalties under Section 6656, and related interest.  Note that the penalties and interest were in addition to the payroll taxes that the Employer had to pay to the U.S. Treasury above and beyond the funds that were embezzled.

The Employer filed refund claims with respect to the penalties and related interest, which were denied by the IRS.  The Employer then sued for a refund in U.S. District Court arguing that the penalties should be abated on the grounds that the failures occurred due to reasonable cause and not due to willful neglect.  The District Court granted the government’s motion to dismiss, holding that the Employer failed to show that it had acted with ordinary business care and prudence.  In its analysis, the court considered the typical authorities that arise in reasonable cause determinations and concluded that the Employer’s reliance on the payroll company, an agent, did not establish reasonable cause.  The fact that the Employer seemed to wait passively for such a protracted period of time was a particularly bad fact.  The result may well have been different if the Employer had identified the theft within a matter of weeks, made good on the late taxes, and pursued legal action against the payroll company.

The key takeaway from this case, however, is that employers will not simply be absolved of their tax obligations based upon illegal acts committed by third-party agents.  With the tools available from the IRS through e-Services, employers should independently verify that their payroll service providers perform the tasks they agree to perform.

IRS Pushes Bad Position in Penalty Case and Loses on Reasonable Cause Grounds

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August 17, 2016

The U.S. Tax Court recently held that an individual taxpayer was not liable for failure-to-file and failure-to-pay penalties under Code Sections 6651(a)(1) and 6651(a)(2), respectively, due to reasonable cause.  In Rogers v. Commissioner, a 2007 fire nearly destroyed Rogers’ home, resulting in losses exceeding $150,000 and essentially leaving her homeless.  Rogers did not deduct the losses on her 2007 or 2008 return, believing that she could claim the deduction only in the year the insurance company resolved her claim.  In 2009, the insurance company paid her $43,964, and she did not file an income tax return or pay the related taxes because she believed that her casualty losses (to the extent not compensated by insurance) fully offset her 2009 income.

The IRS disagreed with the timing of this deduction because a casualty loss is generally deductible in the year of the casualty.  Only if and to the extent a taxpayer has a reasonable prospect of insurance recovery, the deduction is deferred until it can be ascertained whether such reimbursement will be received.  Thus, Rogers should have deducted the casualty losses in 2007 or 2008, not in 2009.  Rogers and the IRS settled the deduction issue and litigated the penalties under Sections 6651(a)(1) and 6651(a)(2).

The Tax Court ruled that the taxpayer’s error was due to reasonable cause and not willful neglect for three key reasons.  First, Rogers had a significant compliance history hallmarked by timely filing and paying her federal income taxes, and “significant efforts to correctly prepare her income tax returns” by consulting tax books and articles and even the IRS.  Second, following the casualty, Rogers suffered personal hardships.  From 2007 through 2009, she suffered bouts of depression, experienced living conditions she found dehumanizing, and in 2009, fractured her skull after falling from a subway platform.  Third, Rogers’ error—deducting a loss in a year later than the correct year—was an error made in good faith and not a blatant tax avoidance technique.  Although the court did not explicitly mention the difficulty of applying the law as a factor, the court did highlight the murkiness of the issue: determining the year in which there was “no prospect of recovery from insurance.”

The reasonable cause exception exists because Congress recognized that even the most compliant taxpayers are not perfect.  Notwithstanding case law on penalties that is often viewed as unfavorable, taxpayers often prevail in penalty cases before IRS Appeals.  Although the taxpayer in Rogers was an individual, the case sheds light on why the IRS concedes penalty cases when businesses demonstrate a history of compliance and identify rational and understandable reasons for the errors at issue.  Reasonable cause exists when a taxpayer exercises “ordinary business care and prudence.”  Ordinary business care and prudence is determined based upon all the relevant facts and circumstances, and the burden of proof rests on the taxpayer.

Consistent with Rogers, taxpayers can elevate their chances for abatement by establishing a history of tax compliance.  Further, when things go awry, taxpayers should promptly take responsibility and correct the mistake, and then take steps to identify the cause of the failure and establish procedures to prevent a recurrence of the failure.  By taking swift action, the taxpayer increases the odds of overcoming its burden to show reasonable cause.

IRS Implements New Voluntary Certification Program for PEOs

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August 15, 2016

Through a flurry of guidance this summer, the IRS has finally implemented the long-anticipated voluntary certification program for professional employer organizations (PEOs).  In 2014, Congress enacted Code Sections 3511 and 7705, which brought about a sea-change in the payroll tax world by creating a new statutory employer: An IRS‑certified PEO (CPEO).  This change is significant because a common law employer (customer) who is otherwise liable for payroll taxes on wages that its PEO pays its employees may shift this payroll tax liability to a CPEO.  In May 2016, the IRS released temporary and proposed Treasury Regulations and Revenue Procedure 2016-33, providing tax and CPEO-certification rules under Sections 3511 and 7705.  After launching the online CPEO application in early July, the IRS proposed to create a new CPEO records system and last week, loosened certain certification rules by issuing interim guidance (Notice 2016-49), on which taxpayers may rely pending final regulations.  Importantly, Notice 2016-49 extended the application deadline from August 31, 2016, to September 30, 2016, for PEOs seeking to have the earliest possible effective certification date of January 1, 2017.

Although the CPEO program is welcomed by PEOs and their customers, applicants and CPEOs must carefully comply with numerous certification rules established under the recent IRS guidance.  Moreover, customers should be aware of limitations on their ability to shift payroll tax liabilities to their CPEOs.  Further, CPEOs and their customers should keep in mind that the CPEO program primarily assists payroll tax administration, and leaves difficult questions regarding CPEO sponsorship of qualified employee benefit plans and compliance with the Affordable Care Act (discussed in a separate blog post).

Background

PEOs provide customer-employers with payroll and employment services.  Before Congress enacted Sections 3511 and 7705 in late 2014, however, customers had remained liable for payroll taxes on wages paid to their employees.  Because there was no rule allowing the tacking of wages, PEOs would have to restart the applicable wage base limitations (e.g., FICA and FUTA limitations) upon moving the customers’ employees to the PEOs’ payrolls.  Under Section 3511, a CPEO is solely responsible for its customers’ payroll tax—i.e., FICA, FUTA, and RRTA taxes, and Federal income tax withholding—liabilities, and is a “successor employer” who may tack onto the wages it pays to the employees to those already paid by the customers earlier in the year.  The customers, on the other hand, remain eligible for certain wage-related credits as if they were still the common law employers of the employees.  Section 7705 called for the IRS to establish certification requirements.  It also provided a critical enforcement tool:  The IRS will publish every quarter a list of all CPEOs.

On May 5, 2016, the IRS released temporary Treasury regulations establishing certification rules under Section 7705 (temporary regulations).  These temporary regulations became effective on July 1, 2016 and will remain effective for three years thereafter.  Simultaneously, the IRS released proposed Treasury regulations under Section 3511 (proposed regulations) that establish rules on the payroll tax liabilities of CPEOs and their customers.  These rules are likely in proposed form because the IRS intends to revisit numerous issues, such as the treatment of specified tax credits.  Shortly after releasing these regulations, the IRS published Revenue Procedure 2016-33, which provides additional certification and application rules.  Although these rules do not affect an existing PEO’s established practices, a PEO must satisfy the requirements to become certified and thereby attract customers wishing to shift their payroll tax liabilities.

New Certification Requirements

The new IRS guidance establishes a robust set of certification requirements—e.g., proof of suitability, annual financial reporting and positive working capital, bonding requirements, etc.—aimed at ensuring the IRS’s collection of payroll taxes from CPEOs.

Suitability.  The temporary regulations add “suitability” requirements designed to ensure that the PEO has the capability, experience, and integrity to properly withhold and remit payroll taxes.  Showing that it has mulled over the PEO industry and its potential tax pitfalls, the IRS decided to apply many of these suitability requirements not only to the PEOs themselves, but also to certain “responsible individuals,” “related entities,” and “precursor entities” of the PEO.  Thus, for example, the IRS will not certify a PEO solely because its responsible individuals (e.g., certain owners, the CEO, or CFO) have failed to pay applicable Federal or state income taxes or have been professionally sanctioned for misconducts.  Nor can a PEO that is otherwise unsuitable for certification cleanse the taint of prior tax wrongdoings by transferring its assets to a new PEO that applies for certification.

Positive Working Capital & Transition Relief.  The temporary regulations add a positive-working capital rule—tweaked by Notice 2016-49—to ensure that the PEO is financially capable of fulfilling its tax obligations.  Under the temporary regulations, applicants and CPEOs must file annual audited financial statements accompanied by an independent CPA’s opinion that the financial statements (1) are fairly presented under GAAP, (2) reflect positive working capital, and (3) show that the PEO uses an accrual method of accounting.  Addressing comments that CPAs may be professionally prevented from including the last two items in a CPA opinion, Notice 2016-49 provides that, in lieu of doing so, a PEO must include in its annual filing a Note to the Financial Statements stating that the financial statements reflect positive working capital and providing detailed calculations.  Further, Notice 2016-49 provides transition relief for applicants required to submit a copy of its annual audited financial statements and CPA opinion for a fiscal year ending before September 30, 2016.

To allow reasonable fluctuation in working capital, an exception to the positive-working capital rule is available if: (1) the working capital of two consecutive fiscal quarters that year were positive; (2) the PEO explains the reason for the negative working capital; and (3) the negative working capital does not present a material risk to the IRS’s collection of payroll taxes.  The third element hinges on whether the PEO has identified facts and circumstances that will result in positive working capital in the near future.  A similar positive working-capital rule and a similar exception apply to quarterly financial statements.

Bond and Surety.  Under Section 7705(c)(2), an applicant or CPEO must post a bond (ranging from $50,000 to $1 million) with respect to its employment tax liabilities.  The temporary regulations clarified that the bond cannot be substituted with collateral, and that the bond must be issued by a qualified surety, i.e., one that holds a certificate of authority from the IRS.  Accordingly, a CPEO application must include a signed surety letter confirming that the surety agrees to issue a bond pursuant to terms set forth in Form 14751 and in the required amount to the applicant, if and when the applicant is certified.

Business Entity.  The temporary regulations provide that a CPEO must be a “business entity” organized in the United States, but may not be a disregarded entity.  Addressing concerns that PEOs may choose to be disregarded entities for legitimate business reasons, Notice 2016-49 provides that a CPEO may be a wholly domestic disregarded entity.  The Treasury and the IRS sought comments on whether they should allow partly or fully foreign disregarded entity to apply for certification.  Additionally, Notice 2016-49 provides that a sole proprietorship, which is not included in the definition of “business entity,” may apply for certification.

Consent to Disclosure.  Consistent with Section 7705(f), which requires the IRS to publish the names and addresses of all CPEOs, the temporary regulations add that the IRS will also publish the fact of the suspension or revocation of a PEO’s certification and may notify the PEO’s customers of this fact.  Accordingly, the temporary regulations also require an applicant or CPEO to provide the consents for the IRS to disclose confidential tax information to the customers and to other persons as necessary to carry out the purposes of the CPEO rules.

Functional Application of Rule.  The IRS will likely take a functional rather than a mechanical approach to applying the certification rules.  The temporary regulations permit the IRS to suspend or revoke a PEO’s certification if the PEO violates a certification requirement, but require the IRS to do so only if the violation presents a material risk to the IRS’s collection of Federal payroll taxes.  If the IRS suspends or revokes a PEO’s certification, the benefits—e.g., shifting of payroll tax liability and tacking of wages—under Section 3511 will not apply and the PEO must notify its customers of its suspension or revocation.

Employment Tax Treatment of CPEOs and Their Customers

The proposed regulations implement rules under Section 3511 pertaining to the employment tax treatment of CPEOs and their customers.

Work Site Employee.  Section 3511 shifts a customer’s payroll tax liability with respect to wages paid to a “work site employee,” and the proposed regulations apply a quarterly test.  Specifically, a covered employee is a work site employee for a calendar quarter, if at any time during that quarter, at least 85 percent of the service providers at the same work site are subject to one or more CPEO contracts between the CPEO and the customer.

Specified Tax Credits.  The proposed regulations also indicate that the IRS may change its treatment of specified tax credits under Section 3511(d)(1), for which the customer—not the CPEO—is eligible, provided that the wages at issue are paid to a work site employee.  In the preambles to the proposed regulations, the Treasury and the IRS sought comments as to whether they should expand the list of specified tax credits, and how the tax credits should apply with respect to non-work site covered employees.

Continuing Reporting Obligations.  Most significantly, the proposed regulations add three categories of reporting requirements that a CPEO must meet in order to remain certified: (1) reporting to the IRS by CPEOs, including any Form 940 (Employer’s Annual FUTA Tax Return) or Form 941 (Employer’s Quarterly Federal Tax Return) and their applicable schedules, periodic verification of compliance, notice of material changes to information provided, and independent financial review documents, such as the annual audited financial statements along with the CPA opinion; (2) reporting to customers by CPEOs, including notification of suspension or revocation of certification and notification regarding transfer of CPEO contract; and (3) inclusion of certain information in the CPEO contract.

CPEO System of Records

To ensure that an applicant or CPEO complies with the new certification rules, the Treasury and the IRS proposed to establish a records system that covers a myriad of groups of individuals involved in the certification process or administration of the applicant or CPEO.  The proposed records system keeps administrative, investigative, and tax records, which the IRS will only use and disclose consistent with the confidentiality rules under Code Section 6103.  Like the detailed certification rules, the proposed records system signals the IRS’s commitment to enforce the CPEO suitability requirements by weeding out PEOs managed by individuals with a history of tax wrongdoings.  The proposed system became effective on August 10, 2016.

Other Issues

Groundbreaking in the payroll tax world, the CPEO rulemaking project is still in its infancy, and the IRS will continue to issue new rules and clarifications as to a CPEO’s certification and reporting obligations, as well as the new CPEO records system.  Additionally, the IRS will likely address whether to expand the list of specified tax credits applicable to a customer with respect to its work site employees, and how these credits may apply in the case of non-work site covered employees.

One crucial issue the IRS has yet to address is the scope of the liability of CPEOs’ customers.  Although the new rules are intended to shift payroll tax liability to the CPEO, the customer, as the common law employer, may be liable if the IRS retroactively revokes or suspends a CPEO’s certification.  This liability may be significant, as it includes the payroll taxes that should have been but were not properly withheld and/or remitted, and may also include Trust Fund Recovery Penalties.  It is unclear if a customer can avoid this liability when its CPEO failed to withhold or remit payroll taxes properly, solely by showing that it relied on the IRS’s quarterly CPEO list.  Thus, it remains to be seen if the IRS clarifies whether customers must verify their CPEOs’ ongoing compliance with certification requirements.

IRS Certified PEO Program Leaves Unresolved Qualified Plan and ACA Issues

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

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

PEO Sponsorship of Qualified Plans

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

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

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

ACA Employer Mandate & PEO-Sponsored Health Plan

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Treasury to Remove Jurisdictions from List of Countries Treated as Having IGAs in Effect

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August 1, 2016

Last week, the IRS announced that on January 1, 2017, the U.S. Treasury will remove some jurisdictions from the list of foreign jurisdictions that are treated as having intergovernmental agreements (IGAs) in effect.  To remain on the list after December 31, 2016, each jurisdiction that seeks to continue to be treated as having an IGA in effect must provide to the Treasury a detailed explanation of its failure to bring an IGA into force and a step-by-step plan and timeline for signing the IGA, or if the IGA has already been signed, to bring the IGA into force.  Since 2013, the Treasury has provided a list of jurisdictions that are as having an IGA in force as long as the jurisdiction is taking “reasonable steps” or showing “firm resolve” to sign the IGA (if no IGA has been signed) or to bring the IGA into force.

As of today, the United States has signed IGAs with 83 jurisdictions and 61 of those IGAs are in effect.  Another 30 jurisdictions are considered to have an agreement in substance, but have not yet signed an IGA.  The jurisdictions who are treated as having an IGA in effect that have not yet signed an agreement or who have signed an agreement but not yet brought it into effect are: Anguilla, Antigua and Barbuda, Armenia, Bahrain, Belgium, Cabo Verde, Cambodia, Chile, Costa Rica, Croatia, Curaçao, Dominica, Dominican Republic, Georgia, Greece, Greenland, Grenada, Guyana, Haiti, Hong Kong, Indonesia, Iraq, Israel, Kazakhstan, Macao, Malaysia, Montenegro, Montserrat, Nicaragua, Paraguay, Peru, Philippines, Portugal, San Marino, Saudi Arabia, Serbia, Seychelles, South Korea, St. Lucia, Taiwan, Thailand, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Ukraine, United Arab Emirates, and Uzbekistan.

Under FATCA, an IGA is a bilateral agreement between the United States and a foreign jurisdiction to collect information related to U.S. accountholders at foreign financial institutions (FFIs) in the foreign jurisdiction and transmit the information to the IRS.  If a foreign jurisdiction lacks an IGA in force, then FFIs in that jurisdiction face greater FATCA compliance burdens.  First, they must register with the IRS as participating FFIs (rather than registered deemed compliant FFIs) to avoid the mandatory 30% withholding on payments of U.S. source FDAP income that they receive.  This subjects them to the full requirements of the Treasury Regulations governing FATCA rather than the streamlined procedures in the IGAs.  Further, they are often subject to conflicting obligations, because the foreign jurisdiction may have privacy or bank laws that conflict with the disclosure requirements of FATCA.

In the announcement, the IRS stressed that a jurisdiction initially determined to have shown firm resolve to bring an IGA into force will not retain that status indefinitely (e.g., if the jurisdiction fails to follow its proposed plan and timeline for bringing an IGA into force).  If the IRS determines that a jurisdiction ceases to be treated as having an IGA effect, an FFI in the jurisdiction generally will have to enter into a FFI Agreement to comply with the FFI’s FATCA reporting obligations within 60 days.

IRS Simplifies Filing Requirements for Section 83(b) Elections

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July 27, 2016

On July 25, the IRS released final regulations eliminating the requirement that taxpayers making a Section 83(b) election file a copy of the election notice with their federal income tax return.  Under Section 83, the fair market value of property received (less any basis in the property) for the performance of services is generally included in income when the property is no longer subject to a substantial risk of forfeiture or when the taxpayer’s interest in the property is transferable.  However, taxpayers may elect under Section 83(b) to include the property’s fair market value (less any basis in it) as of the date of transfer in income in the year of transfer.  Despite the upfront tax liability, this election may actually defer taxation on the appreciated value of the property and subject the appreciation to capital gains rates rather than ordinary income rates.  Under the prior regulations, taxpayers who make an 83(b) election must submit to the IRS a copy of the election notice not only within 30 days after the date of the transfer, but also with their federal income tax return for the year of the transfer.  Last summer, the Treasury and the IRS proposed to eliminate the latter filing requirement, and after receiving no comments, adopted the final regulations without modification.

The requirement to file an election notice with the annual return was duplicative and easy to miss because taxpayers making an 83(b) election were already required to submit to the IRS the election notice within 30 days after the date of the transfer.  Further, as the IRS explained in the preambles to the proposed regulations, this requirement had become an obstacle to electronic filing of returns for certain taxpayers, since commercial e-filing software does not consistently allow for submitting an 83(b) election notice with the return.  The final regulations apply to transfers on or after January 1, 2016, and taxpayers can also rely on these regulations for transfers in 2015.  As a result, taxpayers are not required to file a copy of any 83(b) election made in 2015 with their 2015 tax returns.

Significantly, the final regulations ease compliance for non-resident alien employees of multinational companies.  Although foreign tax consequences can make transfers of restricted stock to such employees undesirable from the employee’s perspective, it may be desirable for the employee to make a section 83(b) election when restricted stock is transferred.  This is particularly true for start-ups and other companies where the value of the shares is small when granted and is likely to increase.  (It is often undesirable to make an 83(b) election for a mature company where the value of the stock is high at transfer and may decline.)

When nonresident alien employees working outside of the United States receive non-vested equity compensation, they may have no obligation to file a U.S. tax return, and could easily neglect to file a return for purposes of filing the election notice.  (Because the employees are nonresident aliens working outside the United States, the income from their 83(b) elections would presumably be foreign source income resulting in no U.S. income tax due in the year of transfer.)  But if these employees become U.S. residents between the grant and vesting dates, their failure to file nonresident returns and attach the 83(b) election notices would invalidate their 83(b) elections, thereby subjecting the value of the property to U.S. income tax upon vesting based on their U.S. resident status at the time of vesting.  Under the final regulations, these employees – and any other service providers – must simply file an election notice with the IRS within 30 days after the date of the transfer.

Although the final regulations simplified filing obligations under Section 83(b), the IRS emphasized taxpayers’ recordkeeping responsibilities under Section 6001, especially to show the basis of property reported on taxpayers’ returns.  Thus, to protect themselves from tax-return audit liability, executives and other service providers who receive restricted property under an 83(b) election must be careful to keep records of the original cost of the property received, and retain the records until at least the period of the limitations for the returns expires.

Print Out IRS FAQs and Other Informal Guidance While You Have the Chance

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July 26, 2016

When you find favorable informal guidance posted on the IRS website, print it out and save it.  A few years ago, a Treasury official from the Office of Tax Policy rebuked someone who proposed addressing a technical issue through IRS FAQs, conveying that the Treasury frowns on issuing such informal guidance.  At the time, we wondered whether the official had recently visited the IRS website and understood how much informal guidance the IRS provides to taxpayers and practitioners in this manner.

The U.S. tax system is complicated, and significant guidance is necessary to foster compliance.  Yet, the IRS and Treasury does not publish adequate formal guidance (e.g., regulations, revenue rulings, notices, etc.) each year to keep up, so the IRS fills the gaps through FAQs and other informal guidance on its website.  The problem is multifaceted, from the IRS brain drain due to the loss of retiring seasoned technicians, to difficulty recruiting qualified personnel at IRS Chief Counsel related to inadequate Congressional funding and compensation that is no longer reasonably competitive with the private sector, to a logjam of draft guidance at the Treasury Office of Tax Policy.  The IRS seems to feel that the issuance of informal guidance on its website is better than nothing, and it is probably right.

The knock on FAQs and its ilk is twofold.  First, taxpayers probably cannot rely on it because it is informal, unreviewed, and occasionally wrong.  Second, it has a way of disappearing from the website without a trace.  This happened recently with respect to slides made public by the LB&I International Practice Service Concept Unit, which were issued last month and revised this month.  We wrote about how the original slides addressed “transportation income” in an earlier post.

The original slides included a reference to “transportation income” with a parenthetical indicating that such income was “not FDAP.”  FDAP stands for fixed or determinable annual or periodical income.  This struck us as odd, because we felt that transportation income likely was FDAP income, but practitioners have been asking the IRS to issue formal guidance to clarify withholding rules regarding transportation income for years, without success.  (If you are interested, see the IRPAC briefing books on the IRS website to see a discussion of the requests for guidance from 2010 through 2013.)  Thus, any discussion from the IRS to address Chapter 3 withholding related to U.S. source gross transportation income is of great interest to those of us who have been requesting it. Publication 515, for the record, indicates Chapter 3 withholding is not required on U.S. source gross transportation income.  Taxpayers paradoxically should not really rely on statements of law included in IRS publications either.

Alas, someone must have told the responsible LB&I unit that transportation income is FDAP, so when the slides were updated, the statement about transportation income not being FDAP income was removed.  The older version of the practice unit has been replaced with the updated version, so the statement can no longer be found on the IRS website.  Unfortunately, the latest hope for a trump card on U.S. source transportation income disappeared like so many FAQs on other issues before it – into the ether.  The before and after slides are shown below.

Original Practice Unit [Click Image to Enlarge]

OldPracticeUnitPage8

Updated Practice Unit [Click Image to Enlarge]

UpdatedPracticeUnitSlide8

IRS Audit Guidelines Provide Insights for Withholding Agents

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July 21, 2016

In audit guidelines contained in a recent International Practice Unit, the IRS advised its agents that when a U.S. business buys intangibles, such as patents, copyrights, formulas, good will, brands, or franchises, from a foreign seller and agrees to pay for them contingent on their productivity, the contingent payments should be treated as royalties.  As such, the payments are potentially subject to withholding under Chapter 3 of the Internal Revenue Code.

Generally, Chapter 3 withholding is required on payments to foreign persons of fixed, determinable, annual, or periodical (FDAP) income from sources within the U.S. that are not ECI.  Royalties, such as those from an intangible or a patent, are U.S. source FDAP income if the intangible or patent is used in the U.S.  In contrast, payments for the purchase of an intangible or patent are treated as non-FDAP sales proceeds, and hence are not subject to Chapter 3 withholding.  The IRS’s Practice Unit reminds agents that when a U.S. business buys intangibles, such as patents, from a foreign seller and agrees to pay for them contingent on their productivity, the contingent payments are treated as royalties, not sales proceeds.

Withholding agents should carefully consider whether any payments for intangibles should be treated as royalties and are thus subject to withholding.  The audit guidelines also provide an important reminder to withholding agents about the importance of understanding the source of payments it makes to foreign persons.  The Practice Unit emphasizes that if the source of a payment cannot be determined or is not known, the IRS examiner should treat the amount as U.S. source.  Accordingly, withholding agents should document the source of its payments to foreign persons and ensure that they know whether amounts are U.S. source before making payment to avoid secondary liability for withholding failures.

Testing Period Scheduled for Form 8966 Electronic Submission Process

The IRS announced that it will conduct a test of the International Data Exchange Services (IDES) system beginning on July 18, 2016.  The IDES system allows financial institutions and foreign tax authorities to securely transmit data directly to the IRS.  One of the forms that financial institutions must submit through the IDES system is Form 8966, “FATCA Report,” which is used by foreign financial institutions to report certain U.S. accounts, substantial U.S. owners of passive non-financial foreign entities, and other required information.

Any foreign financial institution that will submit a Form 8966 through the IDES system once the system goes into effect may want to participate in this testing period.  Participation in the testing period is open to any financial institution that has completed IDES Enrollment before 5:00pm EST on July 14, 2016, which can be done online.  The testing period is scheduled to close on July 29, 2016.

IRS Releases Final Regulations Imposing Country-by-Country Reporting

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June 30, 2016

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

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

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

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

IRS Provides Guidance on ACA Reporting in Working Group Meeting

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June 16, 2016

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

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

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

IRS Guides for the Field Summarize U.S. Withholding Agent Responsibilities and Confuse Issue Related to U.S. Source Gross Transportation Income

[UPDATE: LB&I revised the practice unit “FDAP Payments – Source of Income” on July 15.  The link below now accesses the updated version, which removes the statement regarding transportation income described in this article.  For our discussion of the change and images of the original and updated language, see this article.]

The Large Business and International division of the IRS released two new practice units (slide presentations) that can serve as a guide to U.S. withholding agents with respect to several key compliance issues.  The first practice unit, “FDAP Withholding Under Chapter 3,” serves as a quick summary of U.S. withholding agents’ obligations under Chapter 3 and the risks of noncompliance (i.e., penalties), while the second practice unit, “FDAP Payments – Source of Income,” can help U.S. withholding agents determine the source of income for purposes of deciding whether Chapter 3 applies.

One issue that U.S. withholding agents have struggled with relates to whether withholding is required  for payments of U.S. source transportation income to foreign persons.  Generally, Sections 1441 and 1442 require withholding agents to withhold 30% on payments subject to the 30% gross tax under 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.  To this end, IRS Publication 515 provides that such amounts are not subject to Chapter 3 withholding under Section 1441 or 1442.  Nonetheless, various large taxpayers have had examiners raise the issue on audit asserting that such amounts are subject to Chapter 3 withholding notwithstanding the inapplicability of the underlying tax that Chapter 3 is intended to collect although the examiners have ultimately retreated with respect to the issue.  As a result, U.S. withholding agents have struggled to determine their withholding obligations with respect to such payments, and the IRS has ignored repeated requests from the IRS Information Reporting Program Advisory Committee (IRPAC) (for example, see the 2013 IRPAC report) and others to provide formal guidance in this area.

The “FDAP Payments – Source of Income” practice unit confuses the issue further by definitively stating that transportation income is not FDAP income.  Because Chapter 3 applies only to payments of FDAP income, the 30% withholding for payments subject to Chapter 3 would not apply to payments of transportation income.  Although this might seem like welcome news, the conclusion is puzzling given that FDAP income is generally defined very broadly to include all income, except gains derived from the sale of real or personal property and items of income excluded from gross income.  This broad definition would seemingly include U.S. source gross transportation income, which is a payment for a service paid in an amount known ahead of time or calculable.  Moreover, this is not the basis given in Publication 515 for excluding such amounts from withholding.  Thus the conclusion in the practice unit would seem incorrect and suggests that the document was not reviewed for accuracy by the Chief Counsel attorneys in Branch 8, the international withholding branch.

The pronouncement of law contained in the practice unit continues a worrying trend toward informal guidance in frequently asked questions, publications, comments at conferences, and on the IRS website.  Taxpayers are not permitted to rely on informal guidance, but have often been left without any formal guidance upon which to rely.  Until the IRS issues formal guidance, taxpayers are left to navigate an issue that could arise on audit but truly should not be an issue in most cases.  It would be preferable if the IRS issued a notice announcing the IRS and Treasury intend to amend the Section 1441 regulations to preclude withholding on U.S. source gross transportation income that is subject to the 4% excise tax under Section 887.

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

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

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

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

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

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.

Wellness Program Cash Rewards and Salary-Reduction Premium Reimbursements Taxable

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May 27, 2016

Recently, the IRS clarified whether employees are taxed for receiving cash rewards and reimbursements from their employers for participating in wellness programs.  In CCA 201622031, the IRS ruled that an employee must include in gross income (1) employer-provided cash rewards and non-medical care benefits for participating in a wellness program and (2) reimbursements of premiums for participating in a wellness program if the premiums were originally made by salary reduction through a Section 125 cafeteria plan.

In CCA 201622031, the taxpayer inquired whether an employee’s income includes (a) employer-provided cash rewards or non-medical care benefits, such as gym membership fees, for participating in a wellness program; and (b) reimbursements of premiums for participating in a wellness program if the premiums were originally made by salary reduction through a cafeteria plan.  The IRS ruled that Sections 105 and 106 do not apply to these rewards and reimbursements, which are includible in the employee’s gross income and are also subject to employment taxation.

NGOs Argue For Public CbC Reporting and Clearer Definition of Employee

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May 23, 2016

At an IRS hearing (transcript) on May 13, NGOs that advocate for tax transparency and financial fairness argued that the Treasury and the IRS should publish country-by-country (CbC) reports.  In December 2015, the Treasury and the IRS issued proposed regulations  (see previous coverage) requiring CbC reporting by a U.S. parent entity of a multinational enterprise (MNE) group with annual revenue of $850 million or more.  These reports contain information on a CbC basis of a MNE group’s income and taxes paid, and certain indicators of economic activity (e.g., the number of employees, the size of investments in the subsidiaries, the profits and losses), to help the tax authorities combat tax base erosion and profit shifting.

The reports would be protected from disclosure and could be only used by the IRS, other U.S. governmental agencies in specific circumstances, and competent authorities of treaty partners who also adhere to strict confidentiality rules.  However, representatives from several NGOs requested the CbC reports be made public.  The groups argued that base erosion and profit shifting are problems too complex and burdensome for U.S. tax authorities to handle on their own, and that publishing the reports would “crowd source” the work.  These NGOs suggested that even if the Treasury and the IRS do not publish CbC reports, they should at least (a) deem the CbC reports Treasury reports that other federal law enforcement and senior policy makers can use and not tax returns subject to the confidentiality rules under Section 6103 or (b) provide aggregate data on CbC reporting if the reports are considered tax returns.

Heather Lowe, representing Global Financial Integrity, pointed out that the proposed regulations treat employees and independent contractors ambiguously.  The proposed regulations would require a reporting entity to count the number of full-time equivalent (FTE) employees, which are determined by reference to “employees that perform their activities for the U.S. MNE group within [the] tax jurisdiction of residence.”  For this purpose, a reporting entity “may” count as employees “independent contractors that participate in the ordinary operating activities of a constituent entity.”  But the proposed regulations do not further define “independent contractors” and “ordinary operating activities.”   Lowe suggested that employees should include (a) people for whom the subsidiary pays payroll, Social Security, and other employment taxes, and (b) people for whom those taxes would be paid were they employed by the parent entity in the U.S.

Some NGOs also argued for expanding the scope of CbC reports to include information on deferred taxes and uncertain tax positions—two potential indicators of profit shifting and tax avoidance.  Currently, the IRS requires corporations with $10 million or more in assets to report uncertain tax, but the proposed regulations do not require CbC reporting of this information.

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

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

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

 

IRS Webinar Answers ACA Information Reporting Questions

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May 16, 2016

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

Form-Specific Corrections

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

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

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

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

TIN Solicitation and Error Corrections

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

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

AIR Filing Corrections

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

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

Penalties and Penalty Relief

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

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

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

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

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

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.

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

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

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

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

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 To Implement Certification Program For Professional Employer Organizations

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May 5, 2016

Today, the IRS released temporary and proposed regulations implementing a new voluntary certification program for professional employer organizations (PEOs).  These regulations set forth the application process and the tax status, background, experience, business location, financial reporting, bonding, and other requirements PEOs must meet to become and remain certified.  The IRS will begin accepting applications for CPEO certification on July 1, 2016, and will release a revenue procedure further detailing the application process in the coming weeks.  We will provide more details on the regulations when we have had the opportunity to review them.

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

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April 28, 2016

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

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

IRS Corrects FIRPTA Final Regulations

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April 27, 2016

Income tax withholding under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) applies to a foreign person’s disposition of a U.S. real property interest. On April 26, 2016, the IRS published a correcting amendment to the final regulations (T.D. 9751) addressing the taxation of and withholding on payments to foreign persons on certain dispositions of U.S. real property interests, under Internal Revenue Code Sections 897 and 1445. This correcting amendment is effective on April 26, 2016, and applicable on or after February 19, 2016 – the effective date of the final regulations.

In general, under Code Section 1445(e) and its regulations, certain entities must withhold tax upon certain dispositions and distributions of U.S. real property interests to “foreign persons.” The existing Treasury Regulation § 1445-5(b)(3)(ii)(A) states that “[i]n general, a foreign person is a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, or foreign estate, but not a resident alien individual.” The final regulations affected certain holders of U.S. property interests and withholding agents that are required to withhold tax on certain disposition of, and with respect to, these property interests. While the final regulations initially did not impact the definition of a “foreign person,” the correcting amendment revised the “but not” clause to state that a foreign person is “not a qualified foreign pension fund (as defined in section 897(l)) or an entity all of the interests of which are held by a qualified foreign pension fund.” Code Section 897(l) – recently added by the Protecting Americans from Tax Hikes Act of 2015 – provides that federal income taxation does not apply to distributions received from a real estate investment trust by a qualified foreign pension fund or an entity wholly owned by a qualified foreign pension fund.

IRS Releases New W-8BEN-E and Instructions

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

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

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

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

Tax Court Lacks Jurisdiction to Review IRS Employment Classification Determination

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April 5, 2016

Today, the U.S. Tax Court held that it lacked jurisdiction to review a Form SS-8 determination that a father was an employee, not an independent contractor, of his son. In B G Painting, Inc. v. Commissioner, the son, a painting contractor, issued Forms 1099-MISC to his workers, including the father. The father filed a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding), requesting that the IRS determine his employment status. In response, the IRS SS-8 Unit notified the parties that the father is the son’s “employee.” The son petitioned the court to review this determination.

The Tax Court held that it lacked statutory jurisdiction to review this determination because the Form SS-8 process is not an “examination.” Section 7436(a) of the Internal Revenue Code grants the Tax Court jurisdiction over employment status if “in connection with an audit of any person, there is an actual controversy involving a determination by the Secretary as part of an examination.” But the Form SS-8 process is not an “audit” or “examination”; rather, it is a voluntary compliance process involving no specific tax liabilities or assessments. Therefore, the Tax Court dismissed the case for lack of jurisdiction.

Once the IRS rules that an individual is an employee on the basis of a Form SS-8 submission, the employer has no right to appeal the determination. The IRS will send a follow-up letter to the employer asking whether the employer has filed Forms 941-x to pay the applicable FICA taxes based on the determination, whether the employer is eligible for Section 530 relief, and whether the employer has reasons for believing the IRS determination is incorrect. Given the obligation to provide health insurance to employees or face a potential tax penalty, the employer should expect an increased number of Form SS-8 submissions by independent contractors and increased focus on worker classification issues by the government.

If the employer fails to treat the individual as an employee following a Form SS-8 determination, the individual may file Form 8919 to report his or her share of FICA taxes. The same form can be used while a Form SS-8 is pending for the individual or if the individual was provided both a Form 1099-MISC and a Form W-2 and believes the income reported on the Form 1099 should have been included on Form W-2.

IRS Updates Guidelines for Substitute Wage Forms

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March 29, 2016

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

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

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

IRS Tax Study Intended to Guide Future Audits Nears Completion

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March 25, 2016

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

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

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

IRS Signals Intent to Scrutinize Foreign Payments

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March 10, 2016

The IRS intends to more closely scrutinize payments made to foreign corporations, as indicated by its creation of a new international LB&I “practice unit,” which will provide guidance for IRS auditors.  With respect to foreign corporations, auditors are instructed to focus significantly on whether FDAP income is paid to foreign corporations, and if it is, whether 30% withholding should apply under Chapter 3. Though the practice unit does not issue official pronouncements of law, its guidance to the field can provide taxpayers with valuable insights into issues of importance to the IRS.  Further, guidance issued by the new unit can help to educate taxpayers on the process auditors will use to analyze transactions.  The development of this new practice unit highlights the IRS’s focus on compliance with respect to outbound payments of U.S.-source income.  Taxpayers should ensure that they carefully consider the character and source of payments to determine whether withholding might apply under either Chapter 3 or Chapter 4 (FATCA) of the Code.  Failure to withhold as required subjects withholding agents to secondary liability for amounts that should have been withheld.

11th Circuit Decision Highlights the Disparity Between Regular IRS Appeals and Collection Appeals

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March 8, 2016

Although IRS Appeals personnel handle both traditional cases and collection due process (CDP) hearings, the two proceedings have vast practical differences for taxpayers. First, regular Appeals cases are conducted by Appeals Officers, who are well-versed in the law and legal authorities, whereas CDP hearings are conducted by Settlement Officers, who typically are former collection personnel that often lack the technical background of Appeals Officers. Although this difference is not critical in a case focusing solely on establishing a payment plan, it can be a significant issue if the case involves a dispute over substantive legal questions relating to the underlying tax dispute.

A recent opinion from the U.S. Court of Appeals for the Eleventh Circuit highlights the distinction between the two proceedings in a case of first impression in that circuit. In its opinion, the panel reversed the Tax Court on the issue of whether a preassessment hearing is required when a taxpayer timely protests a case involving trust fund recovery penalties but is subsequently afforded a CDP hearing. In Romano-Murphy v. Commissioner, the 11th Circuit reviewed the statute and regulations governing trust fund taxes, other applicable regulations, and the Internal Revenue Manual, and concluded that taxpayers who properly request preassessment hearings must be granted such hearings. This holding highlights the disparate opportunities available to a taxpayer in a traditional IRS Appeals hearing as compared to a CDP hearing.

Although the critical issue in Romano-Murphy is procedural in nature, the issue arose in the context of trust fund taxes. When an employer withholds federal income tax, Social Security tax, and Medicare tax on that income (known as “trust fund taxes”) but fails to deposit the withheld taxes, the Commissioner has several alternatives to collect those taxes. Section 6672(a) makes the responsible officers or employees personally liable for a penalty equal to the amount of the delinquent taxes, allowing the Commissioner to seek the tax from the individuals responsible for the collection and payment of withholding taxes on behalf of the organization, so long as the individuals willfully failed to properly pay.

The taxpayer in Romano-Murphy, Chief Operating Officer of a healthcare staffing company, was assessed nearly $350,000 in trust fund recovery penalties for her company’s failure to remit withheld taxes. The taxpayer timely and properly protested the assessment, providing all required information and identifying disputed issues, but the IRS failed to send her protest to IRS Appeals (no explanation for this failure was offered in the court’s opinion). Subsequently, the IRS served the taxpayer with a notice of intent to levy to collect the trust fund taxes, as well as a notice of federal tax lien filing. In response, the taxpayer challenged the levy and the lien in a request for a CDP hearing. At the CDP hearing, the Settlement Officer considered the taxpayer’s challenges and upheld the assessment in full. The taxpayer then challenged the CDP determination, including the legitimacy of the assessment in the Tax Court. In its decision, the Tax Court addressed the underlying liability and found the taxpayer liable for the taxes and essentially dismissed the taxpayer’s argument that she was entitled to a preassessment hearing before IRS Appeals before the assessment itself could be made.

The taxpayer’s sole argument in its appeal to the 11th Circuit was that the IRS denied her a preassessment hearing, which therefore invalidates the assessment. The IRS asserted that the absence of an explicit statutory requirement negated the need for a preassessment hearing, but the 11th Circuit panel looked to other statutory references, the regulations, the Internal Revenue Manual, and other relevant authorities to conclude that a regular IRS Appeals conference is indeed required on a preassessment basis when timely requested by the taxpayer. The court rejected the IRS’s argument that it may “simply ignore, disregard, or discard a taxpayer’s timely protest . . . if it so chooses” without establishing any rational criterion for doing so. The court went on to point out that were the IRS’s position correct, “the IRS could arbitrarily decide to shred one of every three . . . protests that arrive in the mail, or throw out all such protests received on Fridays, without any consequences whatsoever.”

In the alternative, and perhaps more importantly, the IRS argued harmless error on the grounds that the taxpayer’s challenges to the underlying tax were considered and rejected, just in the setting of a CDP hearing. Essentially, the IRS equated the opportunity afforded the taxpayer to present her case at the CDP hearing to the opportunity that she would have received at a preassessment Appeals hearing. The taxpayer argued that the denial of a preassessment conference prejudiced her because, for example, interest began accruing from the date of the assessment, the delay in hearing her claim kept her from being able to access for 18 months information that was only maintained on the IRS’s system, and the lien placed on her property harmed her credit. The court refused to rule on the issue of actual harm to the taxpayer but acknowledged that arguments exist on both sides. On one hand, it stated that the taxpayer was “not completely denied a right to be heard,” and thus her due process rights were not violated. But, the court also acknowledged the importance of enforcing procedures required by law that an agency failed to follow. The court vacated the judgment but remanded the case to the Tax Court to address whether the taxpayer was harmed by the error.

Although the 11th Circuit did not expressly address the vast differences between a taxpayer presenting its case in a preassessment Appeals hearing versus a CDP hearing, the differences in the qualifications between Appeals Officers and Settlement Officers cast a troubling shadow over the case due to the existence of substantive tax issues that require a higher degree of training, knowledge, and experience. As a result, whether a taxpayer presents its case at a preassessment Appeals hearing or a CDP hearing can significantly affect the outcome.

The court’s remand to the Tax Court will require the Tax Court to determine whether the IRS’s denial of a preassessment Appeals hearing that was ultimately held in a CDP hearing before a Settlement Officer years later caused sufficient harm to the taxpayer to warrant the invalidation of the assessment. If the taxpayer prevails, it appears that the statute of limitations may bar a reassessment by the IRS.

IRS to Receive Automatic Notice of Missed Employment Tax Payments

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March 7, 2016

As of September 2015, unpaid employment tax reported on voluntary returns amounted to $59 billion, a number the IRS hopes to decrease by preventing employers from accruing the substantial employment tax deficits currently plaguing the system. Darren Guillot, a director in the IRS Small Business/Self-Employed Division, announced that the IRS intends to take a more “proactive” approach to employment tax situations, part of which will involve an update to the Electronic Federal Tax Payment System (EFTPS) that will enable the system to alert the IRS within 2-3 days after an employer misses an employment tax deposit. This change serves as an improvement to the current system, which can take over three months to notify the IRS of missed employment tax. By that time, a business has often fallen into significant arrears.

Employers who fall behind on employment tax payments and are identified by the new alert system can expect outreach to begin December 2016. The outreach will at first come in various forms, as the IRS plans to examine which forms of outreach are most effective and which employers will react more favorably. From a practical perspective, this represents a much needed and proactive compliance move. Taxpayers that fall into a pattern of nonpayment for trust fund taxes (e.g., payroll taxes, backup withholding, withholding under Chapter 3 and Chapter 4 of the Code) often are using the withholdings to pay other creditors. When this happens, personnel known as “responsible persons” under the law may become personally liable for the nonpayment of tax. By delaying contact with taxpayers regarding the nature of severity of the situation, taxpayers and those responsible persons who make these decisions often create financial burdens from which they may never recover.

Tax Court Case Highlights Growing Problem of IRS Collection Activity before Taxes are Properly Assessed and Administrative Appeal Rights Exhausted

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March 5, 2016

A growing problem with the IRS’s administration of tax disputes involves the IRS initiating collection activity before it has either properly assessed the tax or before taxpayers have exhausted their administrative remedies. Generally, the IRS must observe certain procedural requirements before a tax or addition to tax is assessed against a taxpayer. Increasingly, however, the IRS has initiated collections against taxpayers before completing the assessment procedures or before the taxpayer has had the opportunity to exhaust its administrative remedies. This is particularly true with respect to certain employment tax liabilities and penalty assessments. It is important for taxpayers to avail themselves of their appeal rights timely to prevent erroneous and unsupportable assessments, which happen far more often than one would expect including against large employers.

The Tax Court recently addressed this issue in Hampton Software Development, LLC v. Commissioner. The Tax Court denied the Commissioner’s motion for summary judgment holding that a preassessment IRS Appeals conference held after the IRS issued a 30-day letter at the end of an employment tax audit did not constitute a “prior opportunity” for the taxpayer to dispute its underlying tax liability with respect to a Notice of Determination of Worker Classification (NDWC) that the taxpayer did not receive. Instead, the court held that a taxpayer will only be considered to have had a prior opportunity to dispute the underlying liability when the taxpayer actually receives the NWDC. Though this case arose in the context of worker classification, the procedures for challenging an NDWC apply in the same manner as if the NDWC were a notice of deficiency. Similar to a standard notice of deficiency in an income tax audit (as opposed to an employment tax audit, which are not within the jurisdiction of the Tax Court), section 7436 also provides for a 90-day period to file a petition in Tax Court challenging the IRS’s determination of worker classification during an IRS audit.

In this case, the taxpayer treated a maintenance worker as an independent contractor and issued Forms 1099-MISC. The IRS concluded on audit that the taxpayer should have treated the worker as an employee, thus underpaying its employment taxes for two tax years. The IRS issued a 30-day letter to the taxpayer advising the taxpayer of its right to request an IRS Appeals conference, and the taxpayer timely protested the audit findings and requested a conference with IRS Appeals. The taxpayer and the IRS Appeals Officer did not resolve the worker classification dispute, and the IRS subsequently sent an NWDC to the taxpayer by certified mail that the Postal Service was unable to deliver and returned to the IRS. Because the taxpayer was unaware of the NWDC, the taxpayer did not petition the Tax Court for redetermination of the worker classification dispute, and the IRS subsequently assessed the employment taxes and initiated collection activity by issuing a notice of levy.

Upon receiving the notice of levy, the taxpayer timely requested a collection due process (CDP) hearing before IRS Appeals. Although CDP hearings are conducted under the direction of IRS Appeals, they are not conducted by regular IRS Appeals Officers. Rather, Settlement Officers conduct CDP hearings. Generally, Settlement Officers are promoted from the ranks of Revenue Officers working for IRS Collections. Consequently, taxpayers seeking to make substantive legal challenges to an assessment in a CDP hearing can face an uphill battle. However, a taxpayer may seek judicial review of the Settlement Officer’s determination in the Tax Court if the taxpayer timely requests the CDP hearing within 30 days of the issuance of the CDP notice.

When the Settlement Officer conducted the CDP hearing in Hampton Software, the taxpayer disputed the underlying employment tax liabilities arising from the asserted misclassification of the worker, but the Settlement Officer refused to allow the taxpayer to dispute the underlying liabilities because it had previously disputed the same liabilities in a preassessment IRS Appeals conference. Soon thereafter, the Settlement Officer issued a notice of determination permitting collection activity to continue, and the taxpayer filed a Tax Court petition seeking review of the underlying employment tax liabilities.

In its motion for summary judgment, the Commissioner asserted that the taxpayer was precluded from disputing the underlying tax liabilities in the CDP hearing because it previously had an “opportunity to dispute” the underlying tax liabilities with IRS Appeals and because the IRS had issued an NWDC to the taxpayer. The Tax Court denied the Commissioner’s motion for summary judgment on both theories. With respect to the former, the court identified that the Commissioner’s argument deviated from its own regulations. In particular, the Section 6330 regulations regarding CDP hearings draw a distinction between taxes subject to the deficiency procedures and taxes not subject to the deficiency procedures. Taxes not subject to the deficiency procedures may not be challenged in a CDP hearing if the taxpayer had an opportunity to dispute the underlying liability either before or after the assessment of the tax. Conversely, the regulations provide that taxes subject to the deficiency procedures may be challenged in a CDP hearing if the taxpayer had an opportunity for a conference with IRS Appeals prior to assessment (but not a postassessment Appeals conference), meaning that in Hampton Software Development, the preassessment conference with IRS Appeals was not a “prior opportunity” for the taxpayer to be heard so the underlying liability could be raised in the Appeals conference.

Consequently, the court found that an NDWC is generally subject to the deficiency procedures, so the taxpayer was not precluded from later challenging the underlying liability in a CDP hearing, provided it did not have “actual receipt” of the NDWC. Had the taxpayer actually received the NDWC, it would have been able to petition the Tax Court within 90 days, so it would have been barred in any subsequent CDP hearing from contesting the substantive basis for the underlying liability. Because the taxpayer did not receive the NDWC and its Appeals conference was a preassessment conference, the taxpayer was not barred from raising substantive issues in its CDP hearing. The importance of actual receipt of the notice of deficiency is underscored by the requirement that the IRS send the notice by certified or registered mail. Absent evidence that the taxpayer deliberately refused delivery of the NDWC, the taxpayer’s claim that it did not receive the NDWC was sufficient to overcome the IRS’s motion for summary judgment. The Tax Court did not remand the case to the IRS Settlement Officer for further consideration. At this time, the taxpayer’s challenge has survived the Commissioner’s motion for summary judgment and presumably the Tax Court will review and rule upon the underlying worker classification dispute.

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

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

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

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

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

Limitations on Cash Reimbursements for Transit Benefits Apply to Retroactive Increase in Transit Limits

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March 2, 2016

In a technical advice memorandum (PMTA 2016-01), the IRS Office of Chief Counsel stated that a retroactive increase in transit benefits paid in a cash lump sum is only excludable to the extent a transit pass or voucher is unavailable.  This ruling clarifies that these retroactive increases are subject to the same rules as other transit benefits.  This issue arises from Congress’s decision to increase the amount of transit benefits excludable from income in 2012, 2014, and 2015 (e.g., the limit in 2015 was increased from $130/month to $250/month), which has led employers to inquire about the tax treatment of lump sum payments made to compensate employees for transit payments made by the employees in those years that exceeded the limits in place at the time.  The IRS states that it will deem such lump sum payments income and subject to withholding and reporting if transit passes or vouchers are “readily available.”

If transit passes or vouchers are not “readily available,” employers may provide cash reimbursements, so long as employees incur and substantiate their expenses pursuant to an accountable plan.  Accordingly, most employers are unable to allow employees to take advantage of the retroactive increase.  If an employer allowed employees to exceed the pre-tax limit and purchase transit passes with after-tax dollars (or provided the employees with transit passes and imputed taxable income for amounts in excess of the pre-tax limit), it could provide amended Forms W-2 and file Forms 941-X removing the after-tax amounts from wages (for both FITW and FICA purposes).  However, given that the difference for each employee is only $1450 per year, some employees may not wish to file amended income tax returns to recover any excess tax paid.  In addition, the cost savings for employers may not be sufficient to justify the expense of preparing the amended returns.