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July 15, 2016
In This Issue of NSAlert:
Proposed Section 385 Regulations: Sub S Could Be Impacted
In two Notices issues in 2014 and 2015, the Treasury Department served notice that it would issue guidance that would "address strategies that avoid U.S. Tax on U.S. operations by shifting or stripping U.S.-source earnings to lower-tax jurisdictions, including through intercompany debt." Fair enough – address the avoidance of U.S. taxes through earnings stripping and corporate inversions.
Enter the proposed section 385 regulations, which were issued on April 4. However, instead of focusing on shifting earning overseas, the regulations would give the IRS the authority to re-characterize debt as equity in a number of situations involving related entities, whether or not there is any tax avoidance motive and whether or not there is any foreign aspect to the intercompany debt. Furthermore, the proposed regs would require any company to company debt to be documented within thirty days.
The proposed regulations apply only to expanded corporate groups with total assets greater than $100 million or revenues greater than $50 million.
Because the proposed regulations apply to any corporation, they would also apply to Sub S corporations that exceed the asset/revenue threshold above. One common example: a family-owned company owning a number of shopping centers and other real estate in the U.S. Each property is operated through an S corporation. Every time a new shopping center or office building is constructed, a new S corporation is formed and money is borrowed from the existing companies for the start-up. If the combined assets of all the companies is greater than $100 million or the revenues exceed $50 million, the borrowed funds could be deemed "preferred equity" rather than debt. In that event, the S corporation election could be invalidated - even though the company has no overseas components and the S corporation election has no tax avoidance purpose – because a S corporation can have only one class of stock.
Comments on the proposed regulations have asked that the proposed regulations be amended to, among other things:
- Ensure that S corporations, a critical component of America's small business community, do not lose their S corporation tax status by virtue of having their debt re-characterized as equity and are not penalized for their domestic-to-domestic transactions;
- Ensure that non-tax motivated cash management techniques, such as cash pooling or revolving credit arrangements, are exempted;
- Address the "cascading effect" of the currently drafted regulations, where a single tainted transaction funded with intercompany debt can create a multitude of additional tainted transactions;
- Extend the 30-day deadline for meeting the documentation requirements;
- Expand the $50 million intercompany debt threshold so that more small businesses will be exempt from these rules;
NSA has received informal word that Treasury is willing to amend the proposed regulations to ensure that S corporations would not be forced to be recast as C corpoations.
House Bill Reduces IRS Budget Again
The House passed legislation cutting the IRS budget by $236 million for fiscal year 2017.
The budget funds were included in the appropriations bill for the next fiscal year (H.R. 5485). The bill, which allocated $10.9 billion to the IRS, includes several restrictions, including one barring the agency from implementing the individual insurance mandate under the Affordable Care Act. It also stipulates that $290 million must be spent on improving customer service, fraud prevention and cybersecurity. An amendment, offered by Rep. Paul Gosar (R-Ariz.) to prohibit the use of funds to pay bonuses to senior IRS employees, passed by voice vote.
The Senate Appropriations Committee on June 16 unanimously advanced its appropriations bill, which would hold IRS funding steady at $11.2 billion. A floor vote on that bill hasn't yet been announced.
The House and Senate versions of the appropriations bill will have to be reconciled after the Senate passes its version of the bill after Labor Day. The Administration has already announced it opposes the House version of the bill
Reminder: New 501(c)(4) Groups Must Notify IRS
The IRS on July 8 issues new IRS rules requiring new social welfare organizations to notify the agency of their intent to operate as a Section 501(c)(4) entity. The final and temporary rules (T.D. 9775, RIN:1545-BN26) and proposed rules (REG-101689-16, RIN:1545-BN25) essentially codify the requirement added by the Protecting Americans from Tax Hikes Act of 2015 that groups intending to operate as tax code Section 501(c)(4) social welfare groups notify the tax agency no later than 60 days after the date the organization is established.
When submitting the notification, groups must file a new electronic form, Form 8976, Notice of Intent to Operate Under Section 501(c)(4), the IRS said.
While the new guidance provides important information on deadlines and forms, "it still leaves open the big questions about (c)(4)—how much political work they can do, what's political work? It takes care of this one tiny little issue but it leaves open the huge questions that are still out there," said James Joseph, a partner at Arnold & Porter LLP.
Douglas Varley, an attorney at Caplin & Drysdale, said the rules don't provide any new details on what it takes to actually be exempt under 501(c)(4). "That's the 800-pound gorilla of a question," he said.
The IRS also issued Revenue Procedure 2016-41 July 8, which elaborated and provided examples for the requirements under the final, temporary and proposed regulations. The revenue procedure will be in Internal Revenue Bulletin 2016-30, dated July 25.
IRS Warns Tax Preparers Of New Data, Identity Theft Risks
Tax preparers increasingly are the targets of cybercriminals and are being encouraged to take appropriate steps to safeguard their clients' data.
"We have more than 700,000 tax preparers in this country, with many of those taking good security precautions. But cybercriminals are continuing to evolve, using new technology, ruses and scams," IRS Commissioner John Koskinen said in a news release, IR-2016-96, issued July 6 by the Security Summit. "The tax community handles large volumes of sensitive personal and financial information. We need every tax professional to stay on top of their security to protect taxpayers as well as their businesses," he said. IR-2016-96 is available here.
The Security Summit, essentially a partnership between the IRS, state tax agencies and the tax preparation community formed to combat identity theft, also issued a fact sheet (FS-2016-23), the first in a series of tips on security, scams and identity theft prevention measures aimed at tax professionals as part of the "Protect Your Clients; Protect Yourself" campaign, which will run through the 2017 filing season.
IRS Commissioner Outlines New Initiatives For 2017 Filing Season
IRS Commissioner John Koskinen reviewed a number of new initiatives his agency is planning in preparation for the 2017 tax filing season. Speaking to attendees at the IRS Tax Forum in Chicago, Koskinene reviewed the following:
- An earlier filing schedule for Forms W-2. Koskinen said July 12 that the IRS is anxious to implement legislation Congress passed in 2015 changing the deadline for filing Form W-2, Wage and Tax Statement, and other information returns to the end of January, beginning in 2017. The previous deadline was the end of February for paper filers and the end of March for electronic filers. Koskinen said the change would enhance IRS efforts aimed at detecting errors and patterns of fraud. "Having W-2s earlier will make it easier for the IRS to verify the legitimacy of tax returns at the point of filing and to spot fraudulent returns," Koskinen said.
- W-2 verification codes. Koskinen said the IRS would substantially expand its previous pilot program assigning verification codes to the form as a safeguard against fraudulent W-2s. The codes are transferred to electronically filed returns to verify authenticity. Koskinen said the codes would be expanded to 50 million W-2s in 2017, up from the 2 million W-2s involved in the 2016 pilot program. "This will be an extra layer of protection that will help taxpayers and the tax system," he said.
- EITC, Child Credit Verification. Koskinen said that, beginning with the 2017 filing season, 2015 legislation will required the IRS to hold tax returns claiming either credit until Feb. 15. "This change is designed to give us time to verify the income claimed on these returns and prevent fraud related to fabricated wages and withholdings," he said. Koskinen said the agency is aware this will be a major change for some taxpayers and the IRS will have an extensive communications campaign later in the year to highlight the changes and raise awareness.
- Sharing economy tax guidance. Koskinen said the IRS is aware of significant confusion for taxpayers participating in the sharing economy—Uber and Lyft drivers, for example, and homeowners selling housing services through venues such as Airbnb Inc. He said the IRS would launch an initiative to provide guidance to taxpayers about these economic trends and the resulting tax obligations. "Many of them are unaware of what taxes they might owe or records they need to keep," Koskinen said. "They need our help to make sure they are tax compliant. So IRS will be working to raise public awareness about the sharing economy in the coming months.
IRS Releases Drafts of ACA Reporting Forms 1095-C, 1094-C
The IRS has released drafts of two forms for reporting 2016 health-coverage information under the Affordable Care Act.
Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, and Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, are to be filed in early 2017. The draft forms are for employer planning purposes and may change before their final release later in 2016, the Internal Revenue Service said July 7.
The instructions on the draft of Form 1095-C were revised to reduce confusion on how data entered on Line 14 affects Line 15, which now says "Employee Required Contribution." On the 2015 form, Line 15 was listed as "Employee Share of Lowest Cost Monthly Premium, for Self-Only Minimum."
The revised instructions for Line 15: "This line reports the employee required contribution, which is the monthly cost to you for the lowest-cost self-only minimum essential coverage providing minimum value that your employer offered you. The amount reported on line 15 may not be the amount you paid for coverage if, for example, you chose to enroll in more expensive coverage such as family coverage. Line 15 will show an amount only if code 1B, 1C, 1D, 1E, 1J, or 1K is entered on line 14. If you were offered coverage but there is no cost to you for the coverage, this line will report a "0.00" for the amount."
The draft of Form 1095-C is available here.
The draft of Form 1094-C is available here.
House Conservatives Launch Bid to Impeach Koskinen
Rep. John Fleming (R-La.) and Rep. Tim Huelskamp (R-Kan.) have introduced a privileged resolution to impeach IRS Commissioner John Koskinen. Both are members of the House Freedom Caucus, whose members consist of the most conservative members of the House of Reopresentatives.
"If the leadership were to allow a vote today, the impeachment would pass," Fleming said. "So it's not a matter of getting people willing to vote for it. It is a matter of getting the opportunity to vote."
Speaker Paul Ryan (R-Wis.) is not supportive of the impeachment proposal, saying at his July 14 weekly news conference that a lot of members haven't focused on the issue. "They're not even, you know, familiar with all of the facts and the circumstances. So, we're going to have a good conversation when we get back," he said. The House will be back in session Sept. 6.
Democrats noted that any privileged resolution must be considered within two days of being introduced. Because the House holds brief pro-forma sessions while it is away, the resolution's the two-day legislative clock would expire during the summer recess. Furthermore, given the lack of time before the elections and the start of a new Congress, there is no apparent scenario for the effort to have any chance of success.
The Treasury Department, which oversees the IRS, issued a statement calling the effort baseless and a distraction, adding that Treasury Secretary Jacob Lew continues to have full confidence in Koskinen. It also noted it is highly unusual for Congress to impeach an appointed administration official. The last time it happened was 140 years ago. Senate leaders have also indicated that they don't favor an effort to impeach Koskinen.
Koskinen's lawyer, Reginald Brown of Wilmer Cutler Pickering Hale & Dorr LLP, said in an e-mail that Fleming's resolution "unfortunately repeated a conspiracy theory that was long ago discredited by the Republican-appointed inspector general who comprehensively investigated these issues."
The resolution requires a simple majority of the House. It would then go to the Senate, which would try the case.
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