Tax Strategy: A Top 10 list of 2016 developments ready for 2017
Tax practitioners never really “start fresh” as a new calendar year rolls around. For 2017, carryover from 2016 not only includes the usual reporting and compliance issues related to the 2016 tax year just ending, but also those tax changes and issues begun in 2016 that are by no means finished at year’s end. Our column this month focuses on identifying these latter changes that carry over into 2017. We have chosen a “Top 10” format for presentation for our 2016 picks, aware of the dangers of missing one or debatably prioritizing one over another. (A slideshow version version of this story is available here.)
No. 1: The Trump Administration
The election of Donald Trump as president, and Republican control of both the House and Senate, create a political environment that makes the probability of individual and business tax cuts high for 2017.
The extent to which overall taxes are reduced depends upon a variety of variables, including a desire for comprehensive tax reform, concern over budget costs, and a willingness to include Democrats at the negotiating table in order to provide a change more durable than beyond the next election cycle. Prior work in Congress on tax reform in 2016 has formed a foundation of data that will be drawn upon as bill language is now negotiated and drafted.
No. 2: Debt versus equity
Final debt-equity Code Section 385 regulations issued in October not only make our Top 10 list because of the counterpoint they represent against the scope of the considerably more aggressive proposed version released last May. Although these final regulations represent substantial modifications from proposed regulations that would have impacted many more transactions, they remain controversial in their broad potential for debt/equity reclassification. These final regulations may get another look under the new administration, especially with Republican tax reform proposals that would limit business interest deductions.
No. 3: Partnerships strategies
Partnerships continued to increase, with more than 3.6 million partnership returns filed, representing more than 27 million partners, based on the latest data, according to the Internal Revenue Service Fall SOI Bulletin. With greater use apparently also comes greater scrutiny, as the IRS issued guidance during 2016 that makes certain strategies more restricted.
Leveraged partnerships. Particularly notably, final and temporary regulations under Sections 707 and 752 issued this past October severely limit use of partnership leveraged transactions. For example, by treating all partnership liabilities as nonrecourse liabilities solely for disguised sale purposes, as well as changing the treatment of bottom-dollar payment obligations, most structured leveraged partnership transactions built to eliminate the tax on distributions to partners that would follow contributions of appreciated property, will no longer work.
Partners as employees. Also significant to partnerships going forward, the IRS issued final, temporary and proposed regulations in May intended to preserve a partner’s status as a partner, and not an employee, where the partner works for a disregarded entity owned by the partnership. The IRS described the rules as clarifying the employment tax treatment of partners in a partnership that owns a disregarded entity. In what may be an indication of things to come, however, the preamble to these regulations invited comments on when a partner should be allowed to be treated as an employee, not just in the disregarded entity context, but in the partnership context in general.
No. 4: New partnership audit regime
The IRS issued temporary and proposed regulations in August that provide the time, form and manner of election for a partnership to opt in to the new partnership audit regime under the Bipartisan Budget Act of 2015. The election is available for partnerships that want the new audit regime to apply to a return filed for a partnership tax year that begins before Jan. 1, 2018. Starting in 2018, the new audit regime is mandatory. Although partnerships as a whole did not like the old TEFRA audit regime, most partnerships are holding back on using the new opt-in procedure until more detailed guidance on the new rules is provided, either by Congress or the IRS.
No. 5: Section 355 spins
Practice under Code Sec. 355 changed starting in 2016 based on several developments from the IRS. In July, the IRS issued proposed regulations under Code Sec. 355 that tighten the requirements for corporations to spin off controlled corporations tax-free to their shareholders.
The regulations would impose new bright-line standards for triggering the device test and for satisfying the “active trade or business” test. They also would modify the nature and use of assets device factor, modify the corporate business purpose nondevice factor, and would add a per se device test. Although “proposed,” the preamble to the regulations included a long list of issues on which the IRS is seeking comments. Clearly, changes will continue to evolve.
In the following month, some good news: After more than 13 years on the no-rule list, the IRS reinstated two areas relating to distributions of stock of controlled corporations under Code Section 355. Effective Aug. 26, 2016, Rev. Proc. 2016-45 announced that the IRS is once again issuing rulings relating to tax-free spin-offs that a distribution be carried out for a corporate business purpose, and that a transaction not be used principally as a device for the distribution of earnings and profits of the distributing corporation, the controlled corporation, or both.
No. 6: BEPS
The Organization for Economic Cooperation and Development made final recommendations in early 2016 on its Base Erosion and Profit Shifting Project. The proposals would align tax laws in all 28 European Union countries to fight aggressive tax practices by multinational enterprises. In response, House Ways and Means Committee Chair Kevin Brady, R-Texas, commented that the documents prove that Washington must move forward on international tax reform.
“If Washington continues to sit by idly in the face of these punitive policy changes, American workers will continue to be the victims of our irresponsible inaction,” Brady said in a statement.
Country-by-country reporting. Meanwhile, the Treasury and the IRS did what they could to coordinate international oversight where possible. The OECD, in its BEPS project, recommended that countries require county-by-country, or CbC reporting by multinational groups to report their business activity for each country where they operate. In response, the IRS issued final regs in June that require CbC reporting by multinational enterprises. The Treasury is working to ensure that foreign jurisdictions implementing CbC reporting requirements will not require constituent entities of U.S. MNE groups to file a CbC report with the foreign jurisdiction if the U.S. MNE group files a report with the IRS pursuant to this procedure and that report is exchanged with such foreign jurisdiction pursuant to a competent authority arrangement.
Earnings stripping/inversions. Part of the Treasury and the IRS’s focus on international tax consideration in 2016 also included attempts to stem the tide of corporate inversions. In April, the IRS issued temporary regulations that addressed corporate inversion transactions structured to avoid the purposes of Code Sec. 367 and 7874 as well as certain post-inversion tax avoidance transactions. Proposed regulations, now finalized, were also issued to target earnings-stripping transactions by recharacterizing debt between related parties as stock under the debt-equity rules of Code Sec. 385.
No. 7: Estate tax valuation/basis reporting
Estate valuation discounts. To say that controversy surrounds the estate tax valuation regulations under Code Sec. 2704 is an understatement. The proposed regulations deal with the valuation of interests with respect to corporations and partnerships for estate, gift and generation-skipping transfer tax purposes in conjunction with the treatment of lapsing rights and restrictions on liquidation when determining value in intra-family transfers. A hearing on those regulations in early December highlighted the harmful impact that literal enforcement of the proposed regulations would have on transfers of family-owned entities. As we go to press, concern grows, alternatively, that relief through final regulations will not arrive soon enough for planning purposes; or that it will arrive too soon, with some eleventh-hour planning, as stated in the proposed regulations, generally only available until the final regulations are published.
Consistent basis reporting guidance. The IRS issued regulations in 2016 on the requirement that a beneficiary’s basis in certain property acquired from a decedent be consistent with the value of the property as finally determined for estate tax purposes. Because many executors were unprepared for this requirement, first introduced by the Surface Transportation and Veterans Health Care Act of 2015, the IRS extended the due date for filing initial Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, and distributing Schedule(s) A, first to Feb. 29, then to March 31, and finally to June 30, 2016. Final regulations in December confirmed that no further extension beyond June 30, 2016, would apply to initial reporting and that the rule going forward generally requires reporting within 30 days of filing Form 706.
No. 8: The Sharing Economy
As the sharing economy grows, the IRS has responded with new resources for taxpayers and closer scrutiny on taxpayers who, intentionally or unintentionally, are paying more or less than they should. The IRS launched a Sharing Economy Tax Center on its Web site, highlighting tax issues for individuals and companies performing services in the sharing economy.
Earlier in the year, National Taxpayer Advocate Nina Olson told lawmakers that more than 40 percent of service providers in the sharing economy were unaware of possible estimated tax requirements. At present, third-party payment networks are only required to issue Form 1099-K when service providers have at least 200 transactions in a year and earn at least $20,000. Expect those rules to change.
No. 9: Passive activity losses
The intricacies of the passive activity loss rules under Code Sec. 469, and recently their use in determining the net investment income tax, have bedeviled taxpayers for years.
In August, the IRS gave some taxpayers some breathing room by announcing that it would not regroup a taxpayer’s interests in multiple activities as a single activity under the passive loss rules of Code Sec. 469, or otherwise challenge the taxpayer’s grouping of activities.
The IRS determined in TAM 201634022 that there was more than one reasonable method for grouping a taxpayer’s activities and that the taxpayer’s choice among them would not show a tax avoidance purpose. Code Sec. 469 disallows losses from a passive activity, defined in part as a trade or business in which the taxpayer does not materially participate.
No. 10: Legislation and the lack thereof
2016 was not a banner year for tax legislation, but with the floodgates likely to be released in 2017 as a result of the election. Over 30 extenders provisions expired at the end of 2016, but with the hope that the tax reform that is coming in 2017 will either renew most of them retroactively or provide even greater tax benefits in other forms.
Nevertheless, 2015 legislation provided many changes effective in 2016 that will carry over into 2017. Some minor 2016 tax bills include the tax part of the 21st Century Cures Act that allows certain small businesses to offer health reimbursement accounts without running afoul of the Affordable Care Act; the Olympians and Paralympians Act that excludes from gross income of any individual with adjusted gross income of $1 million or less the value of medals and any prize money received; and the Trade Facilitation and Trade Enforcement Act that increases the penalty for failure to file a return effective for returns required to be filed in calendar years after 2015.
There you have it — our “Top Ten” list, along with best wishes to all for a Happy and Prosperous New Year!