Tax Law Developments in the First Quarter of 2012

Here are some of the more important tax developments that have come out during the first three months of 2012. Most are documents from the Internal Revenue Service, but some are important cases and legislative changes you might want to be aware of for you or your business.

Payroll Tax Cut Full-Year Extension: On February 22, President Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, extending the payroll tax cut for the remainder of 2012. The legislation maintains the FICA payroll tax rate for employees at the 4.2% rate that has been in place since January 2011, rather than the historical rate of 6.2%. Note that unless Congress decides to extend the lower rate again, the 4.2% rate expires December 31, 2012. The extension does not affect the 10.4% SECA rate, as that was already in place through 2012.
Business Automobile Depreciation Limits: In Rev. Proc. 2012-23, the IRS provided inflation-adjusted automobile (including trucks and vans) depreciation deduction limitations and automobile (including trucks and vans) lessee inclusion amounts for 2012, including automobiles, cars and trucks eligible for first-year additional depreciation.
Deduction for Mortgage Interest: In an IRS Chief Counsel Memorandum, CCA 201201017, the IRS advised that any reasonable method, including the exact and simplified methods described in temporary regulations to §163, the method provided in Publication 936, Home Mortgage Interest Deduction, or a reasonable approximation of those methods, may be used until final regulations are issued specifically addressing allocations of interest on part of acquisition and/or home equity indebtedness that exceeds qualified residence interest limitations. In Sophy v. Comr., the U.S. Tax Court held that unmarried taxpayers who owned homes in California as joint tenants may not deduct more than a proportionate share of interest on $1 million of acquisition indebtedness and $100,000 in home equity indebtedness. The Tax Court determined that the debt must be determined per residence rather than per taxpayer. In the case, two unmarried taxpayers owned two homes with mortgages totalling more than $2.2 million. The each attempted to take an interest deduction on $1.1 million of debt per person.
Electronic Filing of Schedules K-1: Certain entities, such as partnerships, are required to annually file a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., with the IRS and provide a copy to their partners. In Rev. Proc. 2012-17, the IRS set forth procedures under which a partnership (including an electing large partnership, as defined in §775) that furnishes Schedules K-1 (Form 1065) to its partners electronically will be treated as satisfying the requirements of §6031(b). Prior to the issuance of the new revenue procedure, there was no specific guidance as to whether the furnishing of Schedules K-1 electronically met these requirements. Partnerships must receive the partner’s consent before providing the K-1 electronically, rather than on paper.
S Corporation Dividends: In David E. Watson PC v. U.S., the Eighth Circuit Court of Appeals, in an issue of first impression, held that some of the purported dividend payments that an S corporation made to its sole shareholder constituted wages subject to FICA. The court determined that the characterization of funds distributed by an S corporation to its shareholder-employees turns on an analysis of whether the payments were made as compensation for service, not on the intent of the corporation in making the payments. The court explained that while the concept of “reasonable compensation” is generally applied to the realm of income taxes, the concept is equally applicable to FICA tax cases.
Extension of Deadline to Make Portability Election: Section 2010(c) allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death. The portability election may be made only by the estates of decedents dying after December 31, 2010. Section 6075(a) makes the due date for filing an estate tax return nine months after the date of the decedent’s death. Section 6081(a) provides that IRS may grant a reasonable extension of time for filing any return and that, except in the case of taxpayers who are abroad, no such extension may be for more than six months. In Notice 2011-82, the IRS provided procedures to make the portability election. For estates of decedents dying in early 2011 that had missed the due date for filing Form 706 and Form 4768, the IRS granted, for the purpose of make a portability election pursuant to §2010(c)(5)(A), a six-month extension of time for filing Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. In Notice 2012-21, the IRS stated that the extension applies when the executor of a qualifying estate did not file a Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, within nine months after the decedent’s date of death, and therefore the estate did not receive the benefit of the automatic six-month extension. A qualifying estate is an estate: (1) the decedent is survived by a spouse; (2) the decedent’s date of death is after December 31, 2010, and before July 1, 2011; and (3) the fair market value of the decedent’s gross estate does not exceed $5,000,000.
Repeal of Special Corporate Estimated Tax Payment Rules: The Middle Class Tax Relief and Job Creation Act of 2012, enacted Feb. 22, repealed the special estimated tax payment rules for corporations with assets of at least $1 billion (determined as of the end of the preceding taxable year) that would have impacted payments due in July, August or September 2012, 2014, 2015, 2016 and 2019, respectively. The changes were made over numerous pieces of legislation that increased the required payments. Thus, such corporations should determine their estimated tax payment as if the special rules had never been enacted.
Splitter Regulations: On February 14, the IRS published in the Federal Register foreign tax credit regulations concerning who is the taxpayer who may claim the credit when the foreign law differs from the U.S. law in viewing the entity with the right to the income as fiscally transparent (i.e., merely a representative of its owners or members) or as a required member of a combined income regime (such as in the case of a disregarded entity or a consolidated income group). The new rules generally retain the long-standing legal liability standard, but provide that the credit is to follow the income in many of these situations regardless of who pays the tax or has the tax obligation. On the same day, the IRS published temporary regulations under a statutory change in 2010 designed to prevent taxpayers from splitting the foreign income from the creditable foreign taxes so as to claim the latter and defer the former. The rules for these cases generally suspend the credit until the income is recognized for U.S. purposes.
FATCA Proposed Regulations: FATCA, which was part of the 2010 HIRE Act, enacted chapter 4 (§§1471- 1474), which in turn imposes 30% withholding on “withholdable payments” to foreign financial entities (FFIs) and certain nonfinancial foreign entities (NFFEs) unless they report U.S. account owner information to the IRS. Withholdable payments are basically fixed or determinable annual or periodic (FDAP) gains and the gross proceeds of the sale or disposition of FDAP income-producing assets. With the issuance of the proposed regulations on February 8, there is no longer any doubt that the objective of FATCA is information reporting, not withholding — withholding is simply the “incentive” to report.
In general, the proposed regulations, which build on earlier preliminary guidance aim to reduce FATCA’s compliance burden and to provide (through transitional rules) ample time for affected entities to comply with chapter 4. The proposed regulations establish a timetable for implementation (including grandfathered treatment for pre-existing obligations), exempt many classes of entities that would otherwise be subject to FATCA, set out payee/beneficial owner identification and documentation procedures, and provide FFI due diligence procedures. The proposed regulations also signal the IRS’s intention to coordinate chapter 3 (§§1441-1446) and chapter 4 so as to avoid duplicate reporting.
The same day that the proposed regulations were issued, Treasury issued a joint statement with five countries (the UK, France, Italy, Spain, and Germany). The joint statement would introduce a framework that would let banks send information on their U.S. accounts to their own governments, which then would share the information with the IRS. The framework would not provide country-by-country blanket exemptions; rather, it would provide an alternative mode of FATCA compliance by adjusting local (i.e., foreign) law restrictions to allow for the automatic exchange of information between and/or among participating governments. (It’s not yet clear if the framework would be implemented multilaterally or bilaterally.)
Offshore Voluntary Disclosure Initiative: On January 16, the IRS announced that it is reopening its special program to allow taxpayers to disclose their offshore assets to the government for a third time. According to the IRS, the program will be open for an indefinite period until otherwise announced. A few key differences in this program from 2011, include its open-ended structure and a slightly higher top penalty of 27.5%, up from 25%. But the program does retain a feature that allows some smaller taxpayers to be eligible for a 5% penalty or a 12.5% penalty. To participate, taxpayers must file all original and amended tax returns and include payment for back taxes and interest for up to eight years, as well as paying accuracy-related and/or delinquency penalties.
Foreign Financial Accounts Reporting: Beginning in 2012, virtually every U.S. individual (including residents, certain nonresident aliens, among others) who files a federal return for the year and had an interest in an applicable account/asset valued over $50,000 on the last day of the year or $75,000 at any point during the year, must file Form 8938, Statement of Specified Foreign Financial Assets. Reporting thresholds vary based on filing status. The form must be filed annually.
Proposed Withdrawal of 2007 Coordinated Issue Paper on Cost Sharing: On January 19, IRS Transfer Pricing Director Sam Maruca, who has said in the past that coordinated issue papers are not the best way to disseminate guidance to the field, announced the proposed withdrawal of a 2007 coordinated issue paper (CIP) on cost sharing. Maruca said the CIP illustrates the hazards of trying to develop a blueprint for transfer pricing cases. “It has been very risky—indeed, has backfired on us—to think we can issue blanket advice in this area,” he said. Following the release of the paper in September 2007, practitioners complained that it was an attempt to retroactively apply the income method, which was not introduced until 2005, when the IRS issued its proposed cost sharing regulations. The issue paper warned auditors to be skeptical of taxpayer attempts to apply the comparable uncontrolled price and residual profit split methods to cost sharing transactions, saying the “discounted cash flow”—an unspecified method in the 1996 regulations, renamed the income method in the proposed regulations—likely was more appropriate.
Merger of the IRS’s Advance Pricing Agreement and Competent Authority Functions. Maruca said the new Advance Pricing and Mutual Agreement Program was up and running February 27. The new structure puts an end to the handoff between the APA Program and the U.S. Competent Authority in bilateral cases, which represent the majority of APAs. Under the old structure, the APA Program, working with the taxpayer, developed a negotiating position in a case and submitted it to Competent Authority, which then undertook the negotiations with the foreign authorities. Now, the same individual will be responsible for both developing and negotiating the position. This is the structure employed by most U.S. trading partners.
Final Rules, Sample Language for Health Plan Summary Benefit Disclosures: Under the Public Health Service Act (PHSA) §2715, group health plans and health insurance issuers that offer group or individual health insurance coverage must provide a summary of benefits and coverage (SBC), as well as a uniform glossary of insurance-related and medical terms, to the individuals they cover. The IRS, HHS and EBSA, who all share rule-making authority under PHSA, issued final regulations that change some of the content requirements that were included in the proposed regulations issued in August 2011. Specifically, the IRS eliminated provisions that would have required premiums (or cost of coverage information for self-insured plans) to be included in SBCs. The IRS indicated that premium information may be too complex to be conveyed in an SBC and is not required by statute. The IRS also modified the final regulations to require SBCs to include an internet address where an individual may review the uniform glossary, a contact phone number to obtain a paper copy of the uniform glossary, and a disclosure that paper copies of the uniform glossary are available. The final regulations apply for disclosures to participants and beneficiaries who enroll or re-enroll in group health coverage through an open enrollment period (including re-enrollees and late enrollees) beginning on the first day of the first open enrollment period that begins on or after September 23, 2012. For disclosures to participants and beneficiaries who enroll other than through an open enrollment period (including individuals who are newly eligible for coverage and special enrollees), the final regulations apply beginning on the first day of the first plan year that begins on or after September 23, 2012. For disclosures to plans, and to individuals and dependents in the individual market, the regulations apply to health insurance issuers beginning on September 23, 2012.
Final Rules on ERISA 408(b)(2) Service-Provider Disclosure: Under final rules issued by the Department of Labor’s Employment Benefits Security Administration February 3, covered service providers to ERISA-covered defined benefit and defined contribution plans must provide to plan fiduciaries the information required to: (1) assess reasonableness of the total compensation, both direct and indirect, that a covered service provider receives from the contract; (2) identify potential conflicts of interest; and (3) satisfy reporting and disclosure requirements under Title I of ERISA. “Covered service providers” include ERISA fiduciary service providers, investment advisers registered under federal or state law, brokers, and recordkeepers. The rule only applies to service providers that reasonably expect to earn $1,000 or more in total compensation under a service contract. The rule does not apply to simplified employee pension plans, savings investment match plans for employees of small employers, individual retirement accounts, certain §403(b) annuity contracts and custodial accounts, or employee welfare plans.
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