Employer Withholding Guidance Delayed Pending Tax Reform

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December 8, 2017

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

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

Fate of Employer Tuition Assistance Programs Hangs in the Balance

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December 8, 2017

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

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

Educational Benefits that Qualify for Exclusion as Working Condition Fringe Benefits

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Fringe Benefits

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

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

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

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

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

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

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

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

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

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

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

Private Employer Retirement Benefits

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

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

Employer Tax Credits

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

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

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

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

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

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

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

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

Health Reform

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

Equity and Executive Compensation

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

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

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

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

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

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

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

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

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

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

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

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

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

Tax Reform Proposals Advance in the House and Senate

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November 17, 2017

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

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

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

Modified Senate Tax Proposal Would Repeal ACA Individual Mandate and Certain Employer Meal Deductions, and Establish Five-Year Deferral Election for Stock Options and RSUs of Privately-Held Corporations

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November 16, 2017

On November 14, the Senate Finance Committee released modifications to its tax reform proposal (discussed here).  The Senate modification contains key changes in the following areas:

  • Health Reform – Repeal the individual mandate under the Affordable Care Act (“ACA”).
  • Fringe Benefits – (1) Disallow deductions for meals provided for the employer’s convenience that are not occasional overtime meals, and meals provided at an employer-operated eating facility; and (2) expand the income exclusion for length of service awards for public safety volunteers.
  • Private Retirement Benefits – (1) Strike the proposed elimination of catch-up contributions for high-wage employees; (2) extend the rollover time period of certain outstanding plan loans; (3) allow re-contribution of retirement plan distributions due to incorrect IRS levies; and (4) allow qualified distributions for victims of Mississippi River Delta flooding.
  • NQDC and Executive Compensation – (1) Eliminate the repeal of Code section 409A and the new rules for non-qualified deferred compensation (“NQDC”) included in the original tax reform proposal; (2) allow deferral for up to five years for stocks pursuant to exercise of stock options and settlement of restricted stock units (“RSUs”) issued under broad-based plans of privately-held corporations; and (3) provide transition relief for the expanded application of Code section 162(m).
  • Worker Classification and Information Reporting – (1) Eliminate the proposed worker classification safe harbor that would have applied for all purposes of the Code; and (2) eliminate the proposed changes to the reporting thresholds for filing Forms 1099-MISC and Forms 1099-K under Code sections 6041(a), 6041A(a), and 6050W.
  • Employer Tax Credits – Provide employer tax credits in 2018 and 2019 for wages paid to employees on leave under the Family and Medical Leave Act (“FMLA”).

We have summarized the key changes in the Senate modification, which generally would be effective after 2017, except as otherwise noted below.

Health Reform

Elimination of Individual Mandate Penalties.  After multiple attempts to repeal and replace the ACA, including the individual and employer mandates (see discussions here), Senate Republicans are proposing to zero out penalties for failure to comply with the ACA’s individual mandate, effective starting in 2019, as part of the tax reform bill.  Incorporating this repeal into the tax reform proposal carries risks and rewards.  Although the Congressional Budget Office (CBO) and Joint Tax Committee estimated that the repeal would raise $338 million over the next ten years (reducing the budget impact of the reform proposal), the CBO also estimates that the repeal would increase the number of uninsured people by 4 million in 2019 and 13 million in 2027.  This may complicate efforts to pass the tax reform package given the difficulty Republicans had in maintaining a majority during earlier efforts to repeal the ACA.

Information Reporting Implications.  As we have discussed in a previous post, zeroing out the individual mandate penalty would not directly affect the ACA’s information reporting requirements under Code sections 6055 and 6056.  As with earlier ACA repeal efforts, the Senate modification does not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) or offers of minimum essential coverage on Form 1095-C despite eliminating the penalty imposed on individuals for failing to maintain coverage.  These forms would still be necessary for the IRS to administer the premium tax credit, which GOP tax reform bills have thus far left intact.

Fringe Benefits

Disallowance of Deduction for Meals Provided for Employer’s Convenience (that are not Occasional Overtime Meals) and Meals Provided at Employer-Operated Eating Facilities.  Under existing law, taxpayers may generally deduct 50 percent of food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work-related travel and meals provided for the employer’s convenience under Code section 119), and fully deduct expenses for meals provided through an employer-operated eating facility that constitute de minimis fringe benefits under Treasury Regulation § 1.132‑7.  The initial Senate proposal would expand this 50-percent limitation to expenses of employer-operated eating facilities as defined under Code section 132(e)(6).  The Senate modification, however, would completely disallow deductions for meals provided for the employer’s convenience under Code section 119 or at an employer-operated eating facility.  Importantly, these changes would not affect the employer’s full deduction (and the employee’s full income exclusion) for occasional overtime meals that constitute de minimis fringe benefits under Treasury Regulation § 1.132‑6(d)(2).  This approach under the Senate modification differs from the House bill, which would not only maintain the full deduction for meals provided at an employer-operated eating facility that is a de minimis fringe benefit, but also remove the 50-percent deduction limitation on meals provided to employees for the employer’s convenience under Code section 119.

Expansion of Exclusion for Length of Service Awards for Public Safety Volunteers.  Under Code section 139B, bona fide volunteers (or their beneficiaries) may exclude “qualified payments,” which include reimbursement of reasonable expenses or other payment, including length of service awards, on account of performing qualified volunteer emergency response services.  The annual exclusion is limited to $30 multiplied by the number of months that the volunteer performs the services during the year.  The Senate modification would increase the exclusion for the aggregate amount of length of service awards to $6,000 in each service year, adjusted for cost of living.  Additionally, length of service awards structured as defined benefit plans would not have to comply with Code section 457, but the annual dollar limit would apply to the actuarial present value of the aggregate amount awards that have accrued under the plan.  This increased exclusion would not apply to other forms of qualified payments, such as reimbursements, which would still be subject to the $30 per service month limitation.

Private Employer Retirement Benefits

Repeal of Proposed Elimination of Catch-up Contributions for High-Wage Employees.  The Senate proposal would have repealed catch-up contributions for employees who receive wages of $500,000 or more for the preceding year.  The Senate modification would eliminate this change.

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

Re‑Contribution of Incorrect IRS Levies.  Under existing law, amounts withdrawn from a qualified retirement plan on account of an IRS levy is includible in income in the same manner as other distributions, but the 10-percent early withdrawal penalty would not apply.  While the IRS may return these amounts pursuant to Code section 6343 if the levy was wrongful or not compliant with IRS administrative procedures, existing law does not allow an individual to re‑contribute these amounts.  The Senate modification would allow an individual to re‑contribute such amounts and any applicable interest (in the case of wrongful levies, but not levies in violation of IRS administrative procedures), without regard to the normally applicable limits on plan contributions and rollovers.  The amounts (and applicable interest) may also be contributed to a different IRA or plan to which a rollover would be permitted.

Qualified Mississippi River Delta Flooding Distribution.  Under the Senate modification, the early withdrawal tax would not apply to a distribution of up to $100,000 to an individual whose place of abode on August 11, 2016, was located in the Mississippi River Delta area, and who suffered economic loss due to the storm and flooding that occurred in the area during August 2016.  The distribution must be made on or after August 11, 2016, and before January 1, 2018, to be exempt from the early withdrawal tax.  Additionally, any distribution required to be included in income as a result of this special distribution rule is included in income ratably over a three-year period, beginning with the year of distribution.  During this three-year period, amounts received may be re‑contributed to the plan and treated as a rollover, thus allowing the individual to file an amended return.  (For more information regarding special tax relief for victims of natural disasters, see our discussions of: (1) leave-based donation programs, leave-sharing programs, and relaxed plan loans and hardship withdrawal rules for victims of Hurricane Harvey and Irma; and (2) qualified disaster relief payments under Code section 139.)

NQDC and Executive Compensation

Repeal of Provisions Changing Taxation of Non-qualified Deferred Compensation.  As we discussed in our prior post, the Senate proposal would have enacted a new Code section 409B and repealed the current section 409A, and significantly restricted the conditions that qualify as a substantial risk of forfeiture.  As a result, NQDC would have become taxable at the time that it was no longer subject to future performance of substantial services.  The Senate modification announced on November 13 would eliminate that change, meaning that current section 409A would continue to apply going forward.

Five-Year Stock Deferral for Stock Options and RSUs Issued under Broad-Based Plans of Privately-Held Corporations.  Currently, under Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Additionally, they are exempt from taxation under section 409A because they are generally not considered deferred compensation when the exercise price equals or exceeds the fair market value of the underlying stock at the time of grant.  Like the House bill, the Senate modification would allow “qualified employees” to elect to defer for up to five years federal income taxation related to qualified stock.  “Qualified stock” means the stock of a privately-held corporation received upon exercise of a stock option or settlement of a RSU that was transferred in connection with the performance of services.  To be effective, an inclusion deferral election must be made no later than 30 days after the first time the employee’s rights in the stock are substantially vested or transferrable.  The inclusion deferral election would also be subject to the following rules:

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

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

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

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

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

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

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

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

Transition Relief for Modified Limitation on Excessive Employee Remuneration.  The Senate proposal would expand the $1 million deduction limitation under Code section 162(m) on compensation a publicly-traded corporation pays to a covered employee, by expanding the definition of a covered employee, eliminating the exceptions for performance-based compensation and commissions, and covering additional types of corporations.  The Senate modification would add a transition rule, such that the proposed changes would not apply to any remuneration under a written binding contract in effect on (and not materially modified after) November 2, 2017, and to which the right of the covered employee was no longer subject to a substantial risk of forfeiture before 2017.

Repeal of Proposed Worker Classification Safe Harbor and Changes to 1099-MISC/1099-K Reporting

The Senate proposal would have added a worker classification safe harbor for all purposes under the Code, to provide more certainty to independent contractors and “gig economy” workers regarding their worker classification.  It also would have changed the reporting thresholds for filing Forms 1099-MISC and Forms 1099-K under Code sections 6041(a), 6041A(a), and 6050W.  The Senate modification would eliminate these changes.

Employer Tax Credits

Employer Tax Credit for Paid FMLA Leave in 2018 and 2019.  To increase access to and promote paid FMLA leave, the Senate modification would allow “eligible employers” to claim a general business credit equal to 12.5 percent of wages paid to a “qualifying employee” while on FMLA leave, plus 0.25 percent of wages (capped at 25 percent) for each percentage point by which the FMLA pay exceeds 50 percent of the employee’s normal pay.  An eligible employer is one that allows all qualifying full-time employees not less than two weeks of annual paid FMLA leave (not counting leave paid by State or local government), and that allows less-than-full-time employees a commensurate amount of leave on a pro rata basis.  A qualifying employee is an employee under the Fair Labor Standards Act who has been employed by the employer for at least one year, and whose preceding‑year compensation did not exceed 60 percent of the compensation threshold for highly compensated employees ($120,000 for 2017).  The Senate modification would establish the credit as a pilot program in 2018 and 2019, and instruct the Government Accountability Office (GAO) to study the credit’s effectiveness for increasing access to and promoting paid FMLA leave.

Impact of Senate Tax Reform Proposal – Changes to Fringe Benefits, Retirement Plans, NQDC and Executive Compensation, Workers Classification, and 1099-MISC/1099-K Reporting

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November 14, 2017

UPDATE 11/16/2017

On November 14, the Senate Finance Committee released modifications to its tax reform proposal.  The Senate modification contains key changes in the following areas (and we have summarized these changes here):

  • Health Reform – Repeal the individual mandate under the Affordable Care Act (“ACA”).
  • Fringe Benefits – (1) Disallow deductions for meals provided for the employer’s convenience that are not occasional overtime meals, and meals provided at an employer-operated eating facility; and (2) expand the income exclusion for length of service awards for public safety volunteers.
  • Private Retirement Benefits – (1) Strike the proposed elimination of catch-up contributions for high-wage employees; (2) extend the rollover time period of certain outstanding plan loans; (3) allow re-contribution of retirement plan distributions due to incorrect IRS levies; and (4) allow qualified distributions for victims of Mississippi River Delta flooding.
  • NQDC and Executive Compensation – (1) Eliminate the repeal of Code section 409A and the new rules for non-qualified deferred compensation (“NQDC”) included in the original tax reform proposal; (2) allow deferral for up to five years for stocks pursuant to exercise of stock options and settlement of restricted stock units (“RSUs”) issued under broad-based plans of privately-held corporations; and (3) provide transition relief for the expanded application of Code section 162(m).
  • Worker Classification and Information Reporting – (1) Eliminate the proposed worker classification safe harbor that would have applied for all purposes of the Code; and (2) eliminate the proposed changes to the reporting thresholds for filing Forms 1099-MISC and Forms 1099-K under Code sections 6041(a), 6041A(a), and 6050W.
  • Employer Tax Credits – Provide employer tax credits in 2018 and 2019 for wages paid to employees on leave under the Family and Medical Leave Act (“FMLA”).

ORIGINAL POST

Last Thursday, the Senate Finance committee released its tax reform proposal, a day before the House Ways and Means Committee approved the House tax reform bill after adopting two amendments (see unified House bill discussed in our five-part series).  Written in “concept language” as opposed to legislative text, the Senate proposal contains various changes affecting employer‑provided fringe benefits, qualified retirement benefits, nonqualified deferred compensation (“NQDC”) and executive compensation, worker classification, and thresholds for filing Forms 1099-MISC and Forms 1099-K under Code sections 6041, 6041A, and 6050W.  Some of these changes are similar to those proposed under the House bill, but there are key divergences.

We have summarized these changes, which generally would be effective after 2017, except as otherwise noted below.

Fringe Benefits

With respect to fringe benefits, the Senate proposal is generally more employee-friendly than the House bill, in that the Senate proposal would not repeal or limit the fringe benefit exclusions for employer-provided lodging, dependent care assistance programs, educational assistance programs and qualified tuition reductions, and adoption assistance programs (see discussion of the House bill’s changes to employer-provided fringe benefits in Part I and entertainment expenses and other fringe benefit deductions in Part II of our series).  But the Senate proposal would more aggressively limit deductions for meal expenses provided at an employer-operated eating facility, as well as make the following changes:

  • Total Disallowance of Deductions for Entertainment Expenses.  Similar to the House bill, the Senate proposal would disallow employer deductions for (1) entertainment, amusement, or recreation (“entertainment expenses”); (2) membership dues for clubs organized for business, pleasure, recreation or other social purposes; and (3) facilities used in connection with any of these items. Thus, the Senate proposal would replace the existing 50-percent limitation for entertainment expenses directly related to the active conduct of the employer’s trade or business with a full disallowance.  Unlike the House bill, however, the Senate bill would not impose a separate deduction limitation on “amenities,” which the House bill defined as a de minimis fringe benefit that is primarily personal in nature and involving property or services that are not directly related to the taxpayer’s business.  The House bill’s amenities provision would seemingly deny deductions for most de minimis fringe benefits unless the expense qualified for one of the exceptions under Code section 274(e)—e.g., expenses for food and beverages (and facilities used in connection therewith) furnished on the business premises of an employer primarily for its employees; reimbursed expenses; expenses treated as compensation to (or included in the gross income of) the recipient; recreational, social, and similar activities primarily for the benefit of employees other than highly compensated employees; items available to the public; entertainment sold to customers.  The Senate proposal would continue to permit deductions for such expenses to the extent currently permitted by law.
  • 50-Percent Deduction Limitation Applied to Eating Facilities. While taxpayers may still generally deduct 50 percent of food and beverage expenses associated with operating their trade or business (g., meals consumed by employees on work-related travel), the Senate proposal would expand this 50-percent limitation to expenses of employer-operated eating facilities as defined under Code section 132(e)(6), expenses which currently are fully deductible provided they satisfy the requirements for de minimis fringe benefits.  This approach differs from the House bill, which would not only maintain the full deduction for meals that are treated as being provided at an employer-operated eating facility that is a de minimis fringe benefit, but also remove the 50-percent deduction limitation on meals provided to employees for the employer’s convenience under Code section 119.
  • Disallowance of Deductions for Qualified Transportation Fringes. Like the House bill, the Senate proposal would disallow the deduction for providing any qualified transportation fringe benefits.  Under Code section 132(f), these fringe benefits permit employees to either pay for an employee’s public transportation, van pool, bicycle, or parking expenses related to commuting on a pre-tax basis or allow employees to elect to receive a portion of their compensation in the form of non-taxable commuting benefits.  The Senate bill would also repeal the exclusion under Code section 132(f) for bicycle commuting expenses, making such benefits taxable to employees.
  • Disallowance of Deductions for Commuting Expenses. Unlike the House bill, the Senate proposal would further disallow deductions for providing transportation (or any payment or reimbursement for related expense) for commuting between an employee’s residence and place of employment, except as necessary to ensure the employee’s safety.  This deduction disallowance would appear to apply even to commuting benefits that are treated as taxable compensation to the employee, but it is difficult to tell for certain given the Committee’s use of conceptual language.  Although the proposal does not change the existing exclusion for occasional overtime taxi fare that constitutes de minimis fringe benefits, it would discourage employers from providing commuting benefits.
  • Elimination of Exclusion for Employer-Paid Moving Expenses. The Senate proposal would repeal the exclusion from income and wages for a qualified moving expense reimbursement, which is an employer-provided benefit capped at the amount deductible by the individual if he or she directly paid or incurred the cost.  The House bill, by contrast, would retain a narrow exclusion for members of U.S. Armed Forces on active duty who move pursuant to military orders (discussed here).

Private Employer Retirement Benefits

In the area of retirement plans sponsored by private employers, the House bill loosened the hardship withdrawal rules, reduced the minimum age for in-service distributions, extended the time period for rollover of certain plan loans, and provided additional nondiscrimination testing options for closed defined benefit plans (see Part III).  By contrast, the Senate proposal does not contain any of these changes, but would make the following change:

  • Elimination of Catch-up Contributions for High-Wage Employees. Under existing law, contributions to account-based qualified retirement plans—including defined contribution plans, 403(b) plans, and 457(b) plans—are subject to an annual limit of the lesser of a specific dollar amount and the employee’s compensation.  For employees age 50 or older, the specific dollar amount is increased (generally $6,000 for 2017), allowing the employee to make “catch-up” contributions for the year.  The Senate proposal would eliminate catch-up contributions for employees who receive wages of $500,000 or more for the preceding year.

NQDC and Executive Compensation

Regarding NQDC and executive compensation, the Senate proposal is similar to the House bill insofar as it would expand the deduction limitation on excessive employee remuneration pursuant to Code section 162(m), and create an excise tax on excess tax-exempt organization executive compensation (see Part IV).  But the Senate proposal would adopt a new regime that subjects NQDC to taxation upon vesting, a regime that was included in the originally introduced House bill but was removed by the second amendment adopted by the Ways and Means Committee in favor of retaining the existing regime under Code section 409A (discussed here).

  • Non-qualified Deferred Compensation. Currently, NQDC that complies with Code section 409A is not included in an employee’s income until the year received, and the employer’s deduction is postponed until that date. Like the initial House bill (prior to the second amendment), the Senate proposal would impose a new regime with respect to NQDC for services performed after 2017.  Under the new regime, NQDC would become taxable upon becoming no longer subject to a “substantial risk of forfeiture,” a term narrowly defined as including only the future performance of substantial services.  For these purposes, NQDC would include stock options and stock appreciation rights, even if not yet exercised.  Amounts deferred for services performed before 2018 would remain subject to the current regime and section 409A until the later of 2025 or the taxable year in which the substantial risk of forfeiture lapses, at which point all pre-2018 deferrals would be includible in income.  The Senate proposal would direct the IRS to establish transition rules allowing early payment without violating section 409A.  Finally, the Senate proposal would also eliminate Code sections 457A and 457(f), since all post-2017 deferrals would be governed by section 409B.
  • Modification of Limitation on Excessive Employee Remuneration.  Code section 162(m) currently limits a publicly-traded company’s deduction for compensation paid to a “covered employee” to $1 million with exceptions for performance-based compensation and commissions.  Like the House bill, the Senate proposal would eliminate the exceptions for performance-based compensation and commissions paid after 2017, as well as modify the definition of a “covered employee.” Under the proposal, a covered employee would include any individual who is the principal executive officer or principal financial officer at any time during the tax year and the three highest paid officers for the tax year (as disclosed to shareholders).  Further, if an individual is a covered employee after 2016, the individual would retain the covered‑employee status for all future years.  Finally, the Senate proposal would also expand section 162(m) to apply to corporations beyond those with publicly traded securities.  The House bill would extend section 162(m) to any corporation that is required to file reports under section 15(d) of the Securities Exchange Act of 1934.  In contrast, the Senate proposal would extend section 162(m) to all domestic publicly‑traded corporations and all foreign companies publicly traded through American Depository Receipts, and contemplates covering “certain additional corporations that are not publicly traded, such as large private C or S corporations.”
  • Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Like the House bill, the Senate proposal would impose a 20‑percent excise tax on the employer with respect to compensation paid post‑2017 by a tax-exempt organization (or a related entity) to a covered employee: (1) to the extent the compensation exceeds $1 million for the tax year; or (2) if the compensation constitutes an “excess parachute payment” (based on a measure of separation pay).  For these purposes, a “covered employee” means an employee who is among the tax-exempt organization’s five highest paid employees, or who was a covered employee for a preceding tax year beginning after 2016.

Worker Classification Safe Harbor

In a significant departure from the House bill and existing law, the Senate proposal wades bravely into worker classification disputes by creating a worker classification safe harbor.  This proposed change reflects legislation introduced in July by Senator John Thune (R‑SD) to provide more certainty to independent contractors and “gig economy” workers regarding their worker classification.  If the safe harbor requirements are met, a service provider would be treated as an independent contractor and the service recipient as a non-employer customer for all purposes under the Code.  If the safe harbor requirements are not met, workers classification would still be governed by the applicable existing common law or statutory rules.   The proposal instructs Treasury to issue regulations necessary for implementing the new safe harbor.

Safe Harbor Requirements.  The safe harbor imposes three groups of objective criteria to ensure the independence of the service provider from the service recipient:

  1. Parties’ Relationship – The service provider generally must incur his or her own business expenses, agree to specific tasks or projects, and not be tied to a single service recipient. The service provider may not own any interest—other than publicly traded stock—in the service recipient. In addition, the service provider cannot have provided substantially the same services to the service recipient as an employee during the one-year period ending on the date of the commencement of services under the contract.  (Accordingly, the safe harbor may be unavailable for former executives who transition to consultant status as part of a phased retirement plan.)  The service provider also may not be compensated primarily on the basis of hours worked (and in the case of an independent sales agent, must be compensated primarily on a commission basis).
  2. Location and Means – The service provider must provide his own tools and supplies, have his or her own place of business and not work primarily at the service provider’s location, or the service provider must provide a fair market rent for the use of the service recipient’s place of business.
  3. Written Contract – The parties must have a signed written contract stating the independent-contractor relationship, acknowledging that the service provider is responsible for the payment of his or her own taxes (including self-employment taxes) and that the service recipient (or the payor) has certain reporting and withholding obligations (discussed below). Additionally, the term of the contract must not exceed two years, though it may be renewed for successive two-year periods by a signed written agreement.

Reporting and Withholding.  As under current law, amounts paid by a service recipient to the service provider under the safe harbor would be reported to the IRS under Code sections 6041(a) or 6041A(a) (or section 6050W, if paid via a payment card or third-party network transaction), subject to the increased reporting thresholds described below.  However, under current law, amounts paid to independent contractors are not typically subject to federal income tax withholding unless backup withholding is required (for example, because the contractor did not provide a TIN before payment).  The Senate proposal would create a new withholding obligation that requires the service recipient or payor to withhold 5 percent of the first $20,000 in compensation paid pursuant to contract.   It is unclear whether the withholding requirement would apply over the life of the contract or to the first $20,000 paid annually under the contract.

Reasonable Cause Relief.  The Senate proposal also addresses cases where service providers and service recipients (or payors) mistakenly believe that they have satisfied the safe harbor requirements.  In these cases, as long as the mistake was due to reasonable cause and not willful neglect, the IRS would be permitted to reclassify the relationship as an employee-employer relationship—but only prospectively.

Effective Date.  The safe harbor would be available for services performed—and compensation for these services paid—after 2017.  Service recipients, payors, and required written contracts would not be treated as failing to meet the safe harbor requirements with respect to compensation paid to a service provider within 180 days after the Senate proposal’s enactment.

Information Reporting Thresholds Under Section 6041, 6041A, and 6050W 

The Senate proposal would change the reporting thresholds for filing Forms 1099-MISC and Forms 1099-K under Code sections 6041(a), 6041A(a), and 6050W.  The reporting threshold for Forms 1099-MISC would be increased from $600 to $1,000 with respect to payments reportable under sections 6041(a) and 6041A(a).  These changes would affect, for instances, reporting of non-employee compensation on Forms 1099-MISC.

In contrast, the threshold under section 6050W for reporting third-party network transactions by third-party settlement organizations (“TPSOs”) would be decreased to $1,000 from the current “de minimis” threshold of $20,000 in aggregate transactions and more than 200 transactions.  Certain TPSOs that qualify as “marketplace platforms” may instead elect to report once the transactions with a participating payee either exceed $5,000 or 50 transactions provided that substantially all of the participating payees for whom it settles transactions are engaged in the sale of goods.  TPSOs that do not qualify as “marketplace platforms” may apply the new de minimis threshold with respect to participating payees that are primarily engaged in the sale of goods.  These changes would be effective for payments made after December 31, 2018.

House Ways and Means Committee Approves Second Amendment to Tax Cuts and Jobs Act

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November 9, 2017

Today, the House Ways and Means Committee approved a new amendment to the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”) offered by Chairman Brady as part of the on-going markup (the “Second Amendment”).  The Committee reported the Bill, as modified by the Brady amendment, on a partisan vote of 24-16.  This marks the second major revision to the Bill and makes changes on top of those contained in the first of which affected provisions related to dependent care assistance programs and deferred compensation (the “First Amendment,” discussed here).  For further information on the Bill, please see our series of posts highlighting provisions of the Bill affecting topics pertinent to our readers, all of which are linked in the final post in this series.

Repeal of Provisions Changing Taxation of Non-qualified Deferred Compensation.  As we discussed in our prior post, Section 3801 of the original Bill text enacted a new Code section 409B and repealed current section 409A, which would have significantly restricted the conditions that qualify as a substantial risk of forfeiture, such that non-qualified deferred compensation would have become taxable immediately unless it was subject to future performance of substantial services.  This restriction was not popular, and Chairman Brady’s amendment would eliminate Section 3801 in its entirety, meaning that current section 409A would continue to apply going forward.

In addition, Chairman Brady’s First Amendment added a new Section 3804 to the Bill that would, through the addition of a new subsection 83(i) to the Code, allow certain employees of privately-held companies the ability to defer income on shares of stock covered by options and restricted stock units (RSUs).  The Second Amendment would clarify that no provision of section 83 applies to RSUs other than section 83(i), meaning that employees cannot make section 83(b) elections with respect to RSUs.

Limited Retention of Exclusion for Employer-Paid Moving Expenses.  As discussed previously, Section 1405 of the Bill would eliminate the exclusion from income and wages available under Code section 132(a)(6) for a qualified moving expense reimbursement.  The Second Amendment would retain this exclusion for members of the U.S. Armed Forces on active duty who move pursuant to military orders.

Ways and Means Committee Approves Amendment to Tax Cuts and Jobs Act

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November 8, 2017

As part of the on-going markup of the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), Chairman Brady of the House Ways and Means Committee introduced a sizeable amendment to the Bill that was approved on Monday evening, affecting the changes made to the exclusion for dependent care assistance programs (DCAP) and introducing a new rule affecting income deferral on privately-held stock options and restricted stock units (RSUs).  We have been releasing a series of posts to highlight the provisions of the Bill affecting the topics pertinent to our readers, all of which are linked in the most recent post in this series.

Elimination of Exclusion for Dependent Care Assistance Programs.  As we explained in Part I of our series on the Bill, under Code section 129, the value of employer-provided DCAP is generally excluded from an employee’s income and wages up to $5,000 per year, and employees frequently take advantage of this exclusion through a dependent care flexible spending account that is part of a cafeteria plan under Code section 125.  Previously, Section 1404 of the Bill would have repealed this exclusion in its entirety, effective for tax years beginning after 2017.  The amendment to Section 1404 of the Bill delays the effective date of this repeal, eliminating the exclusion for tax years beginning after 2022.

New Rules Regarding Income Deferral for Stock Options and Restricted Stock Units Issued by a Privately-Held Corporation.  The amendment added a new Section 3804 to the Bill, which would allow certain employees of privately-held companies the ability to defer income on shares of stock covered by options and RSUs.  Currently, pursuant to Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Additionally, they are exempt from taxation under Code section 409A because they are generally not considered deferred compensation when the exercise price equals the fair market value at the time of grant.

Section 3804 of the Bill would add a new subsection 83(i) to the Code, which would allow “qualified” employees to elect to defer income related to stock of a privately-held corporation received upon stock option exercise or RSU settlement by making an election no later than 30 days after the first time the employee’s rights in such stock are transferrable or no longer subject to a substantial risk of forfeiture.  Following such an election, the stock would be includable in income on: (i) the first date the stock becomes transferrable; (ii) the date the recipient first becomes an excluded employee (generally, a 1% owner, an officer, or a highly-compensated employee); (iii) the first date any stock of the corporation becomes readily tradeable on an established securities market; (iv) five years after the earlier of the date the recipient’s rights are not transferable or are not subject to a substantial risk of forfeiture; or (v) the date on which the employee revokes his or her election.  This change to section 83, in conjunction with the fact that the Bill would specifically include stock options within the definition of deferred compensation for purposes of what would be new section 409B (previously discussed here), suggests that Congress may intend to make stock options taxable upon vesting, even if the options do not yet have a readily-ascertainable fair market value.  Another issue raised by this new subsection 83(i) relates to whether section 83(b) elections, which currently permit unvested property to be includable in income in the year of transfer, should be expanded to allow such elections for stock options.  Indeed, section 83(i) seems to envision such a change: the new election provided for under section 83(i) is explicitly barred for any stock options with respect to which an employee has already made a section 83(b) election.

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 IV – Changes to the Section 162(m) Deduction Limitation for Executive Compensation

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November 3, 2017

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

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

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

Repeal of Exceptions to Deduction Limitation.  Many public companies pay covered employees primarily in the form of performance-based compensation to avoid the effect of the deduction limitation.  This exception applies to many forms of equity-based compensation— most stock options, stock appreciation rights, restricted stock, and restricted stock units—and many annual and long-term cash incentive compensation plans.  The Bill would repeal Code sections 162(m)(4)(B) and (C), removing the exceptions for performance-based compensation and commissions.  It is unclear whether the repeal of the performance-based pay exception will reverse the trend toward performance-based compensation, given that many shareholders and shareholder advocates believe that performance-based compensation can align shareholder and executive interests.

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

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

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

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

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

Impact of Tax Cuts and Jobs Act: Part 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).

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

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November 3, 2017

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

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

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

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

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

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

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

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

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

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

First Friday FATCA Update

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November 3, 2017

Since our last monthly FATCA update, no new intergovernmental agreements (IGA) or competent authority agreements (CAA) have been released.  The Treasury Department website publishes IGAs, and the IRS publishes their implementing CAAs.

On October 24, 2017, the United States and Singapore released a joint statement following the meeting between President Donald Trump and Prime Minister Lee Hsien Loong the previous day.  The statement indicated that the two countries have substantially completed negotiations on a Tax Information Exchange Agreement and a reciprocal Model 1A IGA.  The countries plan to sign the agreements before the end of the year.

Impact of Tax Cuts and Jobs Act: Part I – Exclusions for Certain Employer-Provided Benefits

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November 2, 2017

Today, 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 will release 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 the first of this series of posts, we will discuss the Bill’s potential impact on the exclusions for several popular employer-provided benefits.

Limitation on Exclusion for Employer-Provided Meals and Lodging. Under Code section 119 as currently written, the value of employer-provided housing is excludable from an employee’s gross income and is not considered to be wages for purposes of employer withholding.  Section 1401 of the Bill would add a new subsection (e) to Code section 119 to limit the income exclusion for employer-provided housing to $50,000 ($25,000 for a married individual filing a joint return), and that amount would phase out for highly compensated individuals.  Presumably, this change would obligate employers to report the fair market value of employer-provided housing on an employee’s Form W-2 even if excludable under Code section 119, and the employee would take the exclusion on his or her individual income tax return.  In addition, the exclusion would be limited to a single residence for all employees, and the exclusion would be altogether eliminated for 5 percent owners of the employer.

Elimination of Exclusion for Dependent Care Assistance Programs. Under Code section 129, the value of employer-provided dependent care assistance programs (“DCAP”) is generally excluded from an employee’s income and wages up to $5,000 per year.  Employees typically take advantage of this exclusion through a dependent care flexible spending account that is part of a cafeteria plan under Code section 125.  Section 1404 of the Bill would repeal this exclusion in its entirety. Note: This provision was eliminated from the bill by an amendment adopted by the Ways and Means Committee (discussed here).

Educational Assistance Programs and Qualified Tuition Reductions. Two benefits primarily focused on assisting employees with educational expenses would be eliminated by the Bill.  First, under Code section 127, amounts paid to or on behalf of an employee under a qualified educational assistance program are excluded from an employee’s income and wages up to $5,250 per year.  Section 1204 of the Bill would repeal this exclusion in its entirety.  Second, the exclusion from income and wages for qualified tuition reductions provided by educational institutions would also be repealed by Section 1204.  Though this change would affect fewer employers, it would eliminate an often-significant benefit for employees who work for educational institutions, as they would be taxed on the full amount of tuition waived for them or their spouses or dependents to attend the educational institution.

Elimination of Exclusion for Adoption Assistance Programs. Currently, Code section 137 provides an exclusion from an employee’s income and wages for amounts provided by an employer to an employee for amounts paid or expenses incurred for the adoption of a child up a certain amount that is indexed for inflation ($13,570 in 2017).  Section 1406 of the Bill would repeal the exclusion.

Elimination of Exclusion for Employer-Paid Moving Expenses. Code section 132(a)(6) provides an exclusion from income and wages for a qualified moving expense reimbursement, which is an employer-provided benefit capped at the amount deductible by the individual if he or she directly paid or incurred the cost.  Section 1405 of the Bill would repeal this exclusion.

Exclusion for Employee Achievement Awards. Code section 74(c) excludes the value of certain employee achievement awards given in recognition of an employee’s length of service or safety achievement from the employee’s income. Section 274(j) limits an employer’s deduction for employee achievement awards for any employee in any year to $1,600 for qualified plan awards and $400 otherwise. A qualified plan award is an employee achievement award that is part of an established written program of the employer, which does not discriminate in favor of highly compensated employees, and under which the average award (not counting those of nominal value) does not exceed $400.  The exclusion under Code section 74(c) is limited to the amount that the employer is permitted to deduct for the award.  Section 1403 of the Bill would repeal this exclusion and the corresponding deduction limitation.

All of these changes would be effective for tax years beginning after 2017.  In addition to the employer-provided benefits discussed in this post, the Bill would affect a number of other topics covered by this Blog, so stay tuned for Part II in the series.

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.

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.

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 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.

Mobile Workforce Bill Passes House Again, Senate Fate Uncertain

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July 7, 2017

On June 20, 2017, the House of Representatives passed legislation to simplify state income tax rules for employees who temporarily work outside their home state.  Under the Mobile Workforce State Income Tax Simplification Act of 2017 (H.R. 1393), a state generally could tax a nonresident’s wages earned in the state only if he or she is working in the state for more than 30 days during the year.  Likewise, employers would have no corresponding duty to withhold and report the tax unless the 30-workday threshold is met.  Propelled by bipartisan support, similar measures have twice passed in the House in 2012 and 2015 but failed to gain traction in the Senate.  Currently, legislation similar to the House bill is awaiting Senate consideration, and once again, faces an uphill battle amidst concerns that the bill would cause significant revenue losses to certain states—including New York—with large employment centers close to state borders.

The bill is intended to reduce confusion and compliance costs stemming from inconsistent state income tax laws on nonresident employees and their employers.  Currently, forty-three states impose personal income tax on wages, including nonresidents’ wages earned in the state.  Thus, a traveling employee working on temporary projects in multiple states may be obligated to file and pay taxes in each of those states, and the employer would have corresponding withholding and reporting obligations.  Although states have three main measures that reduce compliance costs, the measures are largely piecemeal and inconsistent.  First, states generally provide an income tax credit for income taxes paid to other states, but the credit system does not eliminate the travelling employee’s obligation to file a nonresident return and the employer’s obligation to withhold and report the tax.  Second, some states waive the income tax obligations of nonresident employees and employers based on de minimis earnings and/or time spent in the state, but the waiver thresholds vary, and not all states have them.  Third, some bordering states have entered into reciprocity agreements under which each state agrees not to tax each other’s residents’ wages (see prior coverage of NY-NJ reciprocity agreement).  But these agreements only cover one-third of the states, and are geared toward regular commuters living near state borders, rather than employees traveling to multiple states for temporary work.

The bill would impose a 30-workday threshold on state income taxation of nonresidents, but would not prevent states from adopting higher or other types of thresholds.  Reciprocity agreements of bordering states, for instance, would still be effective.  Moreover, the bill allows an employer to avoid withholding and reporting penalties if they simply rely on their employees’ annual determination of days to be spent working in the nonresident state (barring actual knowledge of fraud, collusion, or use of a daily time and attendance system).  The bill also defines what constitutes a workday to minimize double counting.  The bill would not cover the wages of professional athletes, professional entertainers, certain production employees, and prominent public figures paid on a per-event basis.  Additionally, the bill does not specifically address equity or trailing compensation and employees who work for more than one related employer.

The bill likely faces an uphill battle in the Senate because the bill would cause significant revenue losses to certain states.  Generally, states that have large employment centers close to a state border (e.g., Illinois, Massachusetts, California, and New York) would lose the most revenue, while their neighboring states (e.g., New Jersey) from which employees travel would gain revenue.  Notably, New York would likely lose between $55 million and $120 million per year—an amount greater than the estimated revenue impact on all the other states combined (a $55 million to $100 million loss).  For these reasons, three members of the House Committee on the Judiciary opposed the bill and proposed to replace the 30-workday threshold with a 14‑workday threshold.  This is, not coincidentally, the threshold New York currently has in place for employer withholding obligations (but not for employee income tax liability or employer reporting obligations).  Although rejected, the effort to reduce the threshold may ultimately reshape the bill in the Senate or signal its continued lack of action.

With the Senate preoccupied with other legislative matters such as health reform (see prior coverage of health insurance reporting under the American Health Care Act) and opposition from some powerful Senators, it is unclear whether the Senate will consider the mobile workforce bill despite bipartisan interest.  In the meantime, employers with employees temporarily working in multiple states must continue to meet their nonresident state income tax withholding and reporting obligations.  We will continue to monitor further developments on the mobile workforce bill and its impact on state income tax filing, withholding, and reporting rules.

Senate GOP Health Care Bill Would Retain Most Existing Health Coverage Reporting Rules

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June 23, 2017

Yesterday morning, Senate Majority Leader Mitch McConnell released a draft version of the Better Care Reconciliation Act, which would retain much of the existing health coverage reporting rules enacted as part of the Affordable Care Act.  Unlike the House bill passed on May 4, 2017 (discussed here and here), which would introduce an age-based health insurance coverage credit and corresponding information reporting requirements, the Senate bill would keep the current premium tax credit (with new restrictions effective in 2020), and leave untouched the information reporting regime under Code sections 6055 and 6056.  Thus, Applicable large employers (ALEs) 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 Senate bill does not eliminate the requirement for providers of minimum essential coverage under section 6055 to report coverage on Form 1095-B (or Form 1095-C) despite eliminating the penalty on individuals for failing to maintain coverage. The Senate bill would, however, repeal the additional Medicare tax and thereby eliminate employers’ corresponding reporting and withholding obligations beginning in 2023.

The fate of this draft bill remains uncertain, as several Republican Senators have already expressed unwillingness to support the bill, which is not expected to find any support among Senate Democrats.  We will continue to monitor further developments on the Senate bill and its impact on the information reporting regime for health insurance coverage.

Recent FAA Serves as Warning to Employers Using PEOs

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

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

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

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

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

House Republicans’ 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.

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.

D.C. Council Passes Mandatory Paid Leave Bill

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December 22, 2016

The District of Columbia Council passed a generous paid family leave bill on Tuesday by a 9-4 margin.  The bill will provide eight weeks of paid leave to new mothers and fathers, six weeks for employees caring for sick family members, and two weeks for personal sick leave.  As we explained in a prior post, the District will fund the new benefit with a new 0.62 percent payroll tax on employers.  Large employers, some of whom already provide similar benefits to employees, have been increasingly outspoken against the bill, taking issue with what it views as a bill requiring them to fund paid leave for small employers who do not currently offer such benefits.  Despite large employers’ strong lobbying effort, which were joined by Mayor Muriel Bowser, the bill still passed by a comfortable margin.  Mayor Bowser has not indicated whether she will sign the bill, but the 9-4 vote is sufficient to override a veto.  Regardless of Mayor Bowser’s decision, the program will likely not get off the ground until 2019 due to the administrative hurdles required to implement the new system.

D.C. Council Moves Closer to Enacting Employer Payroll Tax to Create Nation’s Most Generous Family Leave Law

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December 7, 2016

On December 6, the District of Columbia Council advanced a bill known as the Universal Paid Leave Act of 2016.  The bill would impose an estimated $250 million in employer payroll taxes on local businesses to fund a paid leave benefit created by the bill.  The bill would raise the funds by creating a new employer payroll tax of 0.62%.  Self-employed individuals may also opt-in to the program by paying the tax.  Federal government employees and District residents who work outside of the District would not be covered by the bill.  However, Maryland and Virginia residents who work within the district would be covered and entitled to benefits from the government fund created by the bill.

If ultimately passed, the bill would require businesses to provide eight weeks of paid time-off for both full and part-time workers to care for newborn or adopted children.  The bill, which advanced on an 11-2 vote, will also guarantee six weeks of paid leave for workers to care for sick relatives, as well as two weeks of annual personal sick leave.  (Many employees would already qualify for unpaid leave under the Federal and District family and medical leave laws.)

A government insurance fund funded with the new employer payroll taxes would pay workers during their leaves. The bill provides for progressive payment rates, such that lower-income individuals receive a greater percentage of their normal salary during periods of time off covered by the program.  The fund created with the tax revenue would pay a base amount equal to 90% of a worker’s average weekly wage up to 150% of the District’s minimum wage.  (Based on the District’s current minimum wage laws, the base amount is expected to be calculated on up to $900 in weekly salary by the time the program would take effect based on a $15 per hour minimum wage rate that is currently being phased in.)  An employee whose average weekly wage exceeds 150% of the District’s minimum wage would receive the base amount plus 50% of the worker’s weekly wage above the District’s minimum wage.  Payments would be capped at $1,000 a week, with the cap being subject to increases for inflation beginning in 2021.

The bill must pass a final D.C. Council vote on December 20 and approval by District Mayor Muriel E. Bowser. A Bowser spokesman reported that the mayor was still undecided on the bill.  If the bill ultimately passes, benefits would likely not be available before 2019, as the District would need time to prepare and fund the program.

New Jersey and Pennsylvania Will Maintain Tax Reciprocal Agreement

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November 23, 2016

New Jersey Governor Chris Christie, who promised in September to revoke New Jersey’s 40-year-old tax reciprocal agreement with Pennsylvania, announced through a November 22 statement that he would continue the agreement.  Governor Christie had said he would eliminate the State of New Jersey and the Commonwealth of Pennsylvania Reciprocal Personal Income Tax Agreement unless the New Jersey legislature took steps to reduce public employee health insurance costs.

The stated impetus for scrapping the agreement was to make up for a budget deficit: cancelling the agreement was estimated to produce $180 million in revenue for New Jersey. Under the agreement, New Jersey and Pennsylvania residents who work in the other state are only required to file a tax return in their state of residence.  Pennsylvania residents working in New Jersey must file Form NJ-165, Employee’s Certificate of Nonresidence in New Jersey, and New Jersey residents working in Pennsylvania must file Form REV-419EX, Employee’s Nonwithholding Application Certificate, with their employers to avoid having New Jersey taxes withheld from compensation.

Without the agreement, residents of Pennsylvania and New Jersey who work in the other state would need to file two tax returns and claim a credit against taxes owed in their state of residence for taxes paid in their state of employment. Because Pennsylvania imposes a 3.07% flat tax and New Jersey imposes a graduated tax that is capped at 8.97%, New Jersey would greatly benefit from taxing the income of Pennsylvania residents working in New Jersey.  However, cancelling the agreement would have hurt many lower-income New Jersey residents who work in Pennsylvania (Philadelphia, in particular), as they would be forced to pay Pennsylvania’s 3.07% flat tax, instead of the lower New Jersey graduated rate.

However, Governor Christie stated that the agreement could continue due to the $200 million in savings caused by a public worker union-backed health care bill that was signed into law on November 21 (S2749).  The new legislation saves money by adjusting the process through which public workers receive their prescriptions.  Several major corporations that operate in New Jersey, including Subaru of America and Campbell Soup Co., have already praised the decision to maintain the agreement.

Another Attempt to Repeal FATCA Is Introduced to Congress

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September 12, 2016

New legislation, H.R. 5935, has been introduced in Congress to repeal the Foreign Account Tax Compliance Act (FATCA), on the basis that FATCA violates Americans’ Fourth Amendment privacy rights.  Rep. Mark Meadows (R-NC) introduced the bill to the House on September 7, along with two original cosponsors.  The alleged privacy violations stem from requirements in FATCA that force foreign financial institutions to report all account holdings and assets of U.S. taxpayers to the IRS, or else face potential penalties in the form of 30% withholding on all U.S. source income.  According to Rep. Meadows’s press release, FATCA “requires a level” of disclosure that violates the Fourth Amendment, though Rep. Meadows offers no specific support for this claim.

If history is any indication, this latest repeal effort will fall flat. Prior attempts have been made to repeal FATCA, such as Senate Amendment 621 and Senate Bill 663, but none have succeeded.  Though S. 663 has not yet been officially defeated, its sponsor, Sen. Rand Paul, has pursued a lawsuit making similar claims without success, as we discussed in a prior post.

Israeli Court Threatens to Undermine FATCA Agreement

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September 8, 2016

Israel was nearing completion of the steps required to comply with the Foreign Account Tax Compliance Act (FATCA), but its attempt to comply may be in sudden jeopardy thanks to a recent Israeli court decision.  FATCA exchanges were to begin on September 1, but Justice Hanan Meltzer issued a temporary injunction that day that prevents FATCA-related regulations that would have permitted the exchange of information with the United States from going into effect.  The injunction was issued in response to a request filed August 8 by a group named Republicans Overseas Israel.  An emergency hearing is scheduled for September 12.

In July 2014, Israel signed an intergovernmental agreement with the United States to implement FATCA, under which it agreed to pass regulations to bring Israel into compliance with the agreement.  The Israeli parliament (Knesset) approved such regulations on August 2, which would have required Israeli financial institutions to report on certain accounts held by U.S. citizens to the Israel tax authority by September 20.  Financial institutions that failed to comply would face monetary penalties, in addition to the penalties that are required under FATCA, including 30% withholding on payments from the United States.

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.

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

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July 25, 2016

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

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