R.E. Scott Co - Newsletters

Tax Extenders Remain Top Contender for Hitching a Ride on Must-Pass Government Funding Bill

"A thumb goes up, a car goes by…" Tax extenders remain a top contender for "hitching a ride" on November’s must-pass government funding bill.

Wolters Kluwer recently sat down with Jennifer Acuña, Principal, Federal Legislative and Regulatory Services, KPMG LLP, in Washington, D.C. to discuss over 30 temporary tax provisions known as "tax extenders," which have expired or will soon expire spanning from 2017 to 2019. Before joining KPMG, Acuña served as chief tax counsel for the Senate Finance Committee (SFC), and was previously tax counsel for the House Ways and Means Committee.

New Tax Extenders Climate on Capitol Hill
"There is an interesting dynamic going on with tax extenders on Capitol Hill. In the past, extenders were viewed as a priority item, and that has changed," Acuña said.

Generally, tax extenders have been viewed on Capitol Hill as a consistently bipartisan annual or biannual year-end legislative initiative. However, the fate of tax extenders is more uncertain than it has been in the past – in part because it is not clear yet whether there will be an opportunity for any further tax legislation to become law this year, Acuña observed.

Funding Bill Likely Driver for Tax Package
Lawmakers are revving up negotiations as Congress races against this year’s dwindling legislative calendar to reach an agreement on fiscal year (FY) 2020 appropriations. Government funding is scheduled to expire on November 21.

Given the political climate on Capitol Hill and Congress’s limited time left on the legislative calendar, a stand-alone tax package is considered unlikely to make its way through both chambers successfully. That said, November’s "must-pass" government funding bill could be the legislative vehicle for dozens of expired or soon-to-be expired tax extenders, as well as for any other tax provisions that may crop up during lawmakers’ negotiations.

SFC Chair Chuck Grassley, R-Iowa, and ranking member Ron Wyden, D-Ore., introduced their bipartisan Tax Extenders and Disaster Relief bill (Sen. 617) earlier this year. Subsequently, House Ways and Means Committee Chairman Richard Neal, D-Mass., introduced his version of a similarly named tax extenders bill (HR 3301). However, Neal’s bill—which proposes undoing certain provisions related to estate taxes under 2017 tax reform as a "pay for"—was immediately deemed a nonstarter by Senate Republicans.

Notably, Acuña observed that House Democrats may be viewing their tax extenders bill as an opening offer, providing leverage for a larger tax policy negotiation. "In today’s climate it seems that some of the signaling that’s taking place is that House Democrats are trying to position tax extenders as a Republican priority to build up leverage for a larger tax policy negotiation," Acuña said. "Once you have a tax title on a big bill, there is no limit as to which tax provisions could actually be included in the bill," she added.

Larger Tax Package Could Emerge
In that vein, there has been talk among lawmakers that a larger, catch-all tax package could emerge from these negotiations. Any tax package that is unveiled in the coming weeks must have significant bipartisan support to make it to the president’s desk. That said, amidst the new climate surrounding tax extenders on Capitol Hill. several lawmakers have alluded that bipartisan negotiations could result in any number of tax provisions being added to the anticipated tax package, including technical corrections to the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Staking Ground on Extenders
"Right now, what is happening is that parties are staking their ground," Acuña said. While Neal’s bill was largely seen on Capitol Hill as an opening bid to these negotiations, "no one opens with their best offer," Acuña said. However, "there is common ground with respect to tax extenders," she added.

Additionally, Acuña noted that these temporary tax provisions benefit a broad range of constituents. "They have been extended historically without fail for a reason. And it is because there has typically been general bipartisan support for extenders; there is a little bit of something for everyone" she said.

However, as for which tax extenders will be renewed this year, as well as retroactively or all together forgotten, Grassley recently indicated that all eligible provisions will likely make the cut. "I would expect that as of right now, if there is an extenders package there won’t be anything left out," Grassley told reporters.

When asked if Grassley was likely referring to all expired or soon-to-be expired tax incentives spanning from 2017 to 2019, Acuña told Wolters Kluwer "that would seem to be the case." While discussing the possibility of yet another temporary extension, Acuña noted that it is hard to make policy calls on a temporary tax extenders package.

"If you want a drama free negotiation on temporary extensions, it’s a clean date change. It is easier – you do not have a policy debate," she said. "If there is an opportunity for a tax title to be attached to a larger bill this year, it is infinitely harder to include changes that some Members of Congress will not like than it is to just do what has been done in the past and kick the can down the road by temporarily extending everything."

In looking ahead, deciding which temporary tax provisions get the axe is a policy call that is unlikely to be made this year and will not easily be done on a bipartisan basis, according to Acuña.

To Pay For or Not to Pay For
As for tax extenders’ cost, the issue of pay-fors has not generally been a longwinded discussion among lawmakers. "In the past, there have been very short-lived debates on whether to pay for them," Acuña said, adding that extenders generally have not been paid for. "It is hard to find a way to raise the kind of money needed to pay for a tax extenders bill that would be politically palatable for both sides of the aisle."

However, cost can be a leading issue when Congress creates these tax breaks on a temporary rather than permanent basis, Acuña explained. "In theory, everyone might agree that a tax incentive is excellent tax policy, but because of revenue constraints, Congress will not or cannot pay for it on a permanent basis—and that is usually where Congress lands in this temporary tax policy pickle."

Additionally, Acuna highlighted that many of the individual tax cuts under the TCJA were enacted temporarily through 2025 due to budgetary reasons. "A lot of the TCJA provisions gave life to new expiring provisions," Acuña noted. Likening the TCJA’s individual provisions to the long list of tax extenders currently awaiting possible renewal, Acuña noted that tax policy is not usually made temporary "because the members viewed the underlying tax policy as unsound but because of other constraints."

The End for Tax Extenders?
Many Republican and Democratic lawmakers’ have called for an end to tax extenders, citing to the annual year-end dash to renew temporary tax provisions as bad tax policy overall. Indeed, five taskforces comprised of bipartisan SFC members recently reviewed these tax extenders and largely agreed that temporary tax policy in general is less than ideal. While many House lawmakers on both sides of the aisle, in this Congress and those before it, have agreed that enacting permanent tax invectives is better policy than doing so temporarily, actually getting there remains a challenge, even if just procedurally.

IRS Provides Section 199A Safe Harbor for Rental Real Estate

The IRS has issued a revenue procedure with a safe harbor that allows certain interests in rental real estate to be treated as a trade or business for purposes of the Code Sec. 199A qualified business income (QBI) deduction. The safe harbor is intended to lessen taxpayer uncertainty on whether a rental real estate interest qualifies as a trade or business for the QBI deduction, including the application of the aggregation rules in Reg. §1.199A-4.

QBI Deduction and Rental Real Estate
Under Code Sec. 199A, certain noncorporate taxpayers can deduct up to 20 percent of the taxpayer’s QBI from each of the taxpayer's qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship. Certain relevant passthrough entities (RPEs) (partnerships, S corporations, trust funds) calculate the deduction and pass it along to their owners or beneficiaries. A qualified trade or business is generally any trade or business under Code Sec. 162, but not a specified service trade or business (SSTB) or a trade or business of performing services as an employee.

Rental or licensing of tangible or intangible property (i.e., rental activity) that is not a Code Sec. 162 trade or business is still treated as a trade or business for the QBI deduction if the property is rented or licensed to a trade or business conducted by the individual or a RPE which is commonly controlled under Reg. §1.199A-4 ( Reg. §1.199A-1(b)(14)).

Earlier this year, the IRS released a proposed revenue procedure with a safe harbor for treating a rental real estate enterprise as a trade or business under Code Sec. 199A ( Notice 2019-7, I.R.B. 2019-9, 740). The IRS has issued the new revenue procedure after considering public comments on Notice 2019-7.

Rental Real Estate Enterprise
The new safe harbor applies to a "rental real estate enterprise." This is an interest in real property held for the production of rents, and may consist of an interest in a single property or interests in multiple properties. The taxpayer or RPE must hold each interest directly or through a disregarded entity, and may either:

treat each interest in similar property held for the production of rents as a separate rental real estate enterprise; or
treat interests in all similar properties held for the production of rents as a single rental real estate enterprise.

Properties are similar if they are part of the same rental real estate category: either residential or commercial. Commercial real estate held for the production of rents can only be part of the same enterprise with other commercial real estate. Residential properties can only be part of the same enterprise with other residential properties.

A taxpayer or RPE that treats interests in similar properties as a single rental real estate enterprise must continue to treat interests in all similar properties, including newly acquired properties, as a single rental real estate enterprise if it continues to rely on the safe harbor. However, a taxpayer or RPE that chooses to treat its interest in each residential or commercial property as a separate rental real estate enterprise can choose to treat its interests in all similar commercial or all similar residential properties as a single rental real estate enterprise in a future year.

An interest in mixed-use property—a single building that combines residential and commercial units—can be treated as a single rental real estate enterprise, or bifurcated into separate residential and commercial interests. A mixed-use property interest that is treated as a single rental real estate enterprise cannot be treated as part of the same enterprise as other residential, commercial, or mixed-use property.

Safe Harbor Requirements
The safe harbor determination must be made annually. For a rental real estate enterprise to qualify for the safe harbor, all of the following requirements must be met during the tax year:

Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise. If an enterprise has more than one property, the requirement can be met if income and expense information statements for each property are maintained and then consolidated.
For rental real estate enterprises in existence for less than four years, 250 or more hours of rental services are performed per year. For rental real estate enterprises in existence for at least four years, 250 or more hours of rental services are performed per year in any three of the five consecutive tax years that end with the tax year.
The taxpayer maintains contemporaneous records (including time reports, logs, or similar documents) on the hours of all services performed, a description of all services performed, the dates when the services were performed, and who performed the services. For services performed by employees or independent contractors, the taxpayer may provide a description of the rental services, the amount of time generally spent performing the services, and the time, wage, or payment records for the employee or independent contractor. Records must be made available for inspection at the IRS's request. (The contemporaneous records requirement does not apply to tax years that begin before January 1, 2020.)
For each tax year for which it relies on the safe harbor, the taxpayer or RPE must attach a statement to a timely filed original return (or an amended return for the 2018 tax year only) that includes: (i) a description (including the address and rental category) of all rental real estate properties in each rental real estate enterprise; (ii) a description (including the address and rental category) of rental real estate properties acquired and disposed of during the tax year; and (iii) a representation that the requirements of Rev. Proc. 2019-38 have been satisfied.

"Rental services" include, but are not limited to:

advertising to rent or lease the real estate;
negotiating and executing leases;
verifying information contained in prospective tenant applications;
collecting rent;
daily operation, maintenance, and repair of the property, including purchasing materials and
supplies;
managing the real estate; and
supervising employees and independent contractors.

Rental services does not include:

financial or investment management activities, such as arranging financing;
procuring property;
studying and reviewing financial statements or reports on operations;
improving property under Reg. §1.263(a)-3(d); or
time spent traveling to and from the real estate.

If an enterprise fails to satisfy the safe harbor requirements, it can still be treated as a trade or business for the QBI deduction if it otherwise meets the trade or business definition in Reg. §1.199A-1(b)(14).

Property Excluded From Safe Harbor
The safe harbor does not apply to:

real estate used by the taxpayer (including an owner or beneficiary of an RPE) as a residence under Code Sec. 280A(d);
real estate rented or leased under a triple net lease, which includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for a property in addition to rent and utilities;
real estate rented to a trade or business conducted by a taxpayer or an RPE that is commonly controlled under Reg. §1.199A-4(b)(1)(i); or
the entire rental real estate interest, if any portion of it is treated as an SSTB under Reg. §1.199A-5(c)(2).

Effective Date
The safe harbor applies to tax years ending after December 31, 2017. However, taxpayers and RPEs can rely on the prior safe harbor in Notice 2019-7 for the 2018 tax year.

Cryptocurrency Guidance, Virtual Currency FAQs Released

The IRS has released cryptocurrency guidance and frequently asked questions (FAQs) on virtual currency.

The IRS has released cryptocurrency guidance and frequently asked questions (FAQs) on virtual currency. Under the cryptocurrency guidance:

a taxpayer does not have gross income from a "hard fork" of the taxpayer's cryptocurrency if the taxpayer does not receive units of a new cryptocurrency; and
a taxpayer has ordinary income as a result of an "airdrop" of a new cryptocurrency following a hard fork if the taxpayer receives units of the new cryptocurrency.

The IRS has posted the FAQs on its website ( https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions).

Virtual Currency and Cryptocurrency
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the U.S. dollar or a foreign currency.

Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality.

Hard Forks and Air Drops
A hard fork occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger, and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger.

An airdrop is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency. Note, however, that a hard fork is not always followed by an airdrop.

Cryptocurrency from an airdrop generally is received on the date and at the time it is recorded on the distributed ledger. However, a taxpayer may constructively receive cryptocurrency prior to the airdrop being recorded on the distributed ledger. A taxpayer does not have receipt of cryptocurrency when the airdrop is recorded on the distributed ledger if the taxpayer is not able to exercise dominion and control over the cryptocurrency.

Gross Income
If the taxpayer did not receive units of new cryptocurrency from a hard fork, the taxpayer does not have an accession to wealth and does not have gross income as a result of the hard fork.

If the taxpayer receives units of new cryptocurrency from an airdrop following a hard fork, the taxpayer received a new asset. Therefore, the taxpayer has an accession to wealth and has ordinary income in the year in which the taxpayer receives the new cryptocurrency. The taxpayer includes in gross income the fair market value of the cryptocurrency received. The taxpayer’s basis in the new cryptocurrency is the amount of income recognized.

Schedule 1, Form 1040 for 2019
A draft of the 2019 Form 1040, Schedule 1, "Additional Income and Adjustments to Income," includes a question which asks: "At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?" If an individual has engaged in any virtual currency transaction in 2019, he or she must check the “Yes” box next to the question.

If the taxpayer has disposed of any virtual currency that was held as a capital asset, he or she must use Form 8949 to figure the capital gain or loss and report it on Schedule D (Form 1040 or Form 1040-SR). If the taxpayer has received any virtual currency as compensation for services, or disposed of any virtual currency that he or she held for sale to customers in a trade or business, the taxpayer must report the income as he or she would report other income of the same type.

SALT Cap Not Unconstitutionally Coercive

A district court has dismissed a lawsuit filed by four states’ against the federal government, ruling that the $10,000 state and local taxes (SALT) federal deduction cap is not unconstitutionally coercive.

In 2018, New York, Connecticut, Maryland, and New Jersey filed suit against the IRS and Treasury alleging that the SALT cap violates the federalism principles that undergird the U.S. Constitution. Judge J. Paul Oetken of the U.S. District Court for the Southern District of New York ruled on September 30 that the SALT cap is not an unconstitutional infringement of state power.

The states’ primary concern stemmed from the claim that the introduction of the SALT cap could impair each of the states’ ability to pursue its own preferred tax policies. However, the court noted that Congress lawfully enacted the SALT cap pursuant to its broad tax powers under Article I, section 8 and the Sixteenth Amendment, and that the cap, like any federal tax provision, will affect some taxpayers more than others and, by extension, will affect some states more than others. However, the cap, like every other feature of the federal tax code, is a part of the landscape of federal law with which states make their decisions as to how they will exercise their own sovereign tax powers, according to Oetken. Because the states failed to plausibly allege that the cap, more so than any other major federal initiative, meaningfully constrains this decision-making process, the district court had no basis for concluding that the SALT cap is unconstitutionally coercive.

Background
In 2017, President Trump signed into law sweeping tax reform legislation informally known as the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), which made several substantial amendments to the federal tax code. Among other things, the TCJA placed an upper limit of $10,000 on the amount a taxpayer may deduct from their federal tax income to offset those sums they have paid toward certain state and local taxes (the "SALT cap"). As enacted, the SALT cap is scheduled to expire at the end of 2025.

Democrats on Capitol Hill Prepare to Move SALT Cap Repeal Bill
Meanwhile, Democratic lawmakers on Capitol Hill are preparing to move a SALT cap repeal bill when Congress returns from its two-week recess. Specifically, Rep. Bill Pascrell, D-N.J. has proposed repealing the SALT cap and raising the top income tax rate from 37 percent to 39.6 percent, where it previously sat. Additionally, Pascrell recently told reporters that House Democrats will likely propose a temporary repeal of the SALT cap as a "compromise."

At this time, however, any Democratic-backed measure to repeal or scale back the SALT cap is expected to fail in the Republican-controlled Senate.

Final Regs Revert Back to Prior Partnership Disguised Sale Rules

New final regulations that address the allocation of partnership liabilities for disguised sale purposes revert back to prior regulations. Under the final regulations:

a partner’s share of a recourse liability of the partnership equals the partner’s share of the liability under the rules of Code Sec. 752 and the related regulations; and
a partner’s share of a nonrecourse liability of the partnership is determined by applying the same percentage used to determine the partner’s share of the excess nonrecourse liability under Reg. §1.752-3(a)(3) ( Reg. §1.707-5(a)(2)).

Executive Order Triggers Reversion Back to Prior Disguised Sale Rules
In October 2016, the IRS issued final and temporary regulations (707 Temporary Regulations) under which a partnership would determine all partnership liabilities for disguised sales purposes—both recourse and nonrecourse—by applying the same percentage used to determine a partner’s share of excess nonrecourse liability under Reg. §1.752-3(a)(3) ( T.D. 9788).

In April 2017, the President issued Executive Order 13789 (E.O. 13789) on reducing tax regulatory burdens. In response, the IRS identified the final and temporary regulations in T.D. 9788 as implicating some of those regulatory burdens. In turn, in 2018 Proposed Regulations, the IRS proposed to withdraw the 707 Temporary Regulations and reinstate the regulations under Reg. §1.707-5(a)(2) described above. Now, the IRS has adopted the 2018 Proposed Regulations, thereby reinstating the Prior 707 rules.

Treasury and the IRS will continue to study the merits of the approach in the 707 Temporary Regulations and other approaches, including the final regulations, to determine which results in the most appropriate treatment of liabilities in the context of disguised sales.

Effective Dates
The final regulations apply to any transaction with respect to which all transfers occur on or after October 4, 2019, the date that the 707 Temporary Regulations expire. However, partnerships and their partners may apply the final regulations to any transaction where all transfers occur on or after January 3, 2017, the applicable date of the 707 Temporary Regulations.

Preceding Year Disaster Loss Election Final Regulations

The IRS has released final regulation on the election to take a loss resulting from a federally declared disaster in the year preceding the disaster. The final regulations adopt proposed regulations substantially without change.

Disaster Defined
The regulations provide definitions of:

federally declared disaster;
federally declared disaster area;
disaster loss;
disaster year; and
preceding year.

Scope and Effect of Election
The election for a disaster loss attributable to a particular disaster applies to the entire loss sustained by the taxpayer from that disaster during the disaster year.

Making or Revoking Election
A taxpayer elects to deduct a disaster loss for the preceding year on:

an original federal income tax return for the preceding year; or
an amended federal income tax return for the preceding year.

The election is made in the manner specified by guidance issued pursuant to the regulations.

A taxpayer may not to take a disaster loss in the preceding year if the taxpayer claims a deduction (as a loss, as cost of goods sold, or otherwise) for the same loss for the disaster year.

If a taxpayer has claimed a deduction for a disaster loss for the disaster year and wants to elect the loss for the preceding year, the taxpayer must file an amended federal income tax return to remove the previously deducted loss on or before the date that the taxpayer makes the election for the preceding year loss.

If a taxpayer has claimed a deduction for a disaster loss for the preceding year and wants to revoke that election, the taxpayer must file an amended federal income tax return to remove the loss for the preceding year on or before the date the taxpayer files the federal income tax return or the amended federal income tax return for the disaster year that includes the loss.

Due Dates
The due date for making the election to deduct a disaster loss in the preceding year is six months after the due date for filing the taxpayer's federal income tax return for the disaster year (determined without regard to any extension of time to file).

Subject to the final regulation requirements, a taxpayer may revoke the election on or before the date that is 90 days after the due date for making the election.

Applicability Date
The final regulations apply to elections and revocations that are made on or after the date they are published in the Federal Register.

Proposed Regs Address Tax Implications of LIBOR Elimination

Proposed regulations provide guidance on the potential tax consequences of replacing the London interbank offered rates (LIBORs) with a new reference rate in contracts and agreements.

On July 27, 2017, the U.K. Financial Conduct Authority announced that all currency and term variants of the LIBORs may be phased out after 2021. On March 5, 2018, the Alternative Reference Rates Committee (ARRC) established that the Secured Overnight Financing Rate (SOFR) would replace the LIBOR within the United States.

Tax Implications
Because the LIBORs are being phased out, existing debt instruments and derivatives must be amended. Parties will either amend debt instruments or contracts to replace references to the LIBOR with the SOFR (if in the United States). Alternatively, parties may alter debt instruments or contracts to replace the LIBOR-referencing fallback rate with another fallback rate upon the cessation of the LIBOR.

The ARRC has expressed several concerns to the IRS about the potential tax consequences associated with these contract amendments:

Modification of Terms of Debt and Non-Debt Instruments. Currently, there are no regulations under Code Sec. 1001 that address when a modification of a debt instrument, derivative, or other non-debt contract creates a realization event.
Transactions and Hedges. Amending the LIBOR-referencing debt instrument or hedge may cause a deemed termination of the hedge, which could lead to undesirable tax consequences.
Character of a One-Time Payment. Parties may need to agree to a one-time payment to address any differences between the LIBOR and the new rate, and it is unclear what the character of this payment would be.
Grandfathered Agreements. Certain debt and non-debt instruments that are exempt from specific laws due to their grandfathered status may lose that status if they are modified to reflect the elimination of the LIBOR.
OID and Qualified Floating Rates. The transition from the LIBOR to the SOFR (or other alternative rates) raises potential issues under the original issue discount (OID) rules.
REMICs. The modification of the terms of the regular interest rate in a real estate mortgage investment conduit (REMIC) to deal with the elimination of the LIBOR could preclude the interest from being a regular interest.
Interest in Foreign Corporations. The elimination of the LIBOR could prevent a foreign bank from taking advantage of the election under Reg. §1.882-5(d)(5)(ii)(B).

Modification of Debt Instruments, Non-Debt Contracts
Under Proposed Reg. §1.1001-6(a), if the terms of a debt instrument or non-debt contract are modified to replace, or to provide a fallback to, an LIBOR-referencing rate and the modification does not change the fair market value, there is no gain or loss under Code Sec. 1001. These rules apply regardless of whether the modification occurs by an amendment to the terms of the instrument or agreement or by replacing the existing debt instrument or contract with a new one.

Furthermore, altering the debt instrument’s terms to replace the LIBOR with a qualified rate is not treated as a modification and does not result in a deemed exchange of the debt instrument under Reg. §1001-3. Likewise, an alteration to a debt instrument’s terms to include a qualified rate (see below) as a fallback to an LIBOR referencing rate is not treated as a modification and therefore does not result in an exchange of the debt instrument for purposes of Reg. §1.1001-3.

Qualified Rate
Proposed Reg. §1.1001-6(b) provides the rules for determining whether a rate is a qualified rate. To be a qualified rate, Proposed Reg. §1.1001-6(b)(2)(i) requires that the fair market value of the debt instrument or non-debt contract after the modifications must be substantially equivalent to the fair market value before that alteration or modification. The proposed regulations provide that the fair market value of a debt instrument or derivative may be determined by any reasonable valuation method, as long as that method is applied consistently and takes into account any one-time payment made in lieu of a spread adjustment.

The proposed regulations provide two safe harbors to address the fair market value requirements. The debt instrument or non-debt contract are considered equivalent in value after the modification if:

at the time of the modification, the historic average of the LIBOR-referencing rate is within 25 basis points of the historic average of the rate that replaces it; or
the parties to the debt instrument or non-debt contract are not related and, through bona fide, arm’s length negotiations, determine that the fair market value of modified instrument or contract is substantially equivalent to the fair market value prior to the modification.

Transactions and Hedges
Proposed Reg. §1.1001-6(c) clarifies that a taxpayer can alter the terms of a debt instrument or modify one or more of the other components of an integrated or hedged transaction to replace a rate referencing an IBOR with a qualified rate without affecting the tax treatment of either the underlying transaction or the hedge. However, the integrated or hedged transaction as modified must continue to qualify for integration.

One-Time Payment
Under Proposed Reg. §1.1001-6(d), the source and character of a one-time payment that is made in connection with a modification described above will be the same as the source and character that would otherwise apply to a payment made by a payor with respect to the debt instrument or non-debt contract that is altered or modified.

Grandfathered Agreements
Because Proposed Reg. §1.1001-6(a) prevents debt instruments and non-debt contracts from being treated as reissued following a deemed exchange under Code Sec. 1001, the debt instrument or contract would not lose its grandfathered status as a result of any modifications made in connection with the elimination of an LIBOR.

OID and Qualified Floating Rate
Proposed Reg. §1.1275-2(m) stipulates three special rules for determining the amount and accrual of OID in the case of a variable rate debt instrument that provides both for interest at an LIBOR-referencing qualified floating rate and for a fallback rate that is triggered when the LIBOR becomes unavailable or unreliable.

The LIBOR-referencing qualified floating rate and the fallback rate are treated as a single qualified floating rate for purposes of Reg. §1.1275-5.
The possibility that the relevant LIBOR will become unavailable or unreliable is treated as a remote contingency for purposes of Reg. §1.1275-2(h).
Occurrence of the event that triggers activation of the fallback rate is not treated as a change in circumstances.

REMIC Interests
Proposed Reg. §1.860G-1(e) permits an interest in a REMIC to retain its status as a regular interest despite certain alterations and contingencies.

Foreign Corporation Interests
The proposed regulations amend the election in Reg. §1.882-5(d)(5)(ii)(B) to allow a foreign corporation that is a bank to compute interest expense attributable to excess U.S.-connected liabilities using a yearly average SOFR in addition to the 30-day LIBOR. This amendment would allow the foreign corporation bank to make the election even after the LIBOR is phased out.

Applicability Date
The proposed regulations will apply to an alteration of the terms of a debt instrument or a modification to the terms of a non-debt contract that occurs on or after the date of publication of a Treasury Decision adopting those rules as final regulations in the Federal Register. A taxpayer may choose to apply the proposed regulations to alterations and modifications that occur before the regulations are finalized.

Careful planning required for new ACA requirements on 2014 returns

The Affordable Care Act—enacted nearly five years ago—phased in many new requirements affecting individuals and employers. One of the most far-reaching requirements, the individual mandate, took effect this year and will be reported on 2014 income tax returns filed in 2015. The IRS is bracing for an avalanche of questions about taxpayer reporting on 2014 returns and, if liable, any shared responsibility payment. For many taxpayers, the best approach is to be familiar with the basics before beginning to prepare and file their returns.

Individual mandate

Beginning January 1, 2014, the Affordable Care Act requires individuals (and their dependents) to have minimum essential health care coverage or make a shared responsibility payment, unless exempt. This is commonly called the "individual mandate."

Employer reporting

Nearly all employer-provided health coverage is treated as minimum essential coverage. This includes self-insured plans, COBRA coverage, and retiree coverage. Large employers will provide employees with new Form 1095-C, Employer-Provided Health Insurance Coverage and Offer, which will report the type of coverage provided. The IRS has encouraged employers to voluntarily report starting in 2015 for the 2014 plan year. Mandatory reporting begins in 2016 for the 2015 plan year.

Marketplace coverage

Coverage obtained through the Affordable Care Act Marketplace is also treated as minimum essential coverage. Marketplace enrollees should expect to receive new Form 1095-A, Health Insurance Marketplace Statement, from the Marketplace. Individuals with Marketplace coverage will indicate on their returns that they have minimum essential coverage. Because so many individuals with Marketplace coverage also qualify for a special tax credit, they will also likely need to complete new Form 8962, Premium Tax Credit (discussed below).

Medicare, Medicaid and other government coverage

Medicare, TRICARE, CHIP, Medicaid, and other government health programs are treated as minimum essential coverage. There are some very narrow exceptions but overall, most government-sponsored coverage is minimum essential coverage.

Exemptions

Some individuals are expressly exempt under the Affordable Care Act from making a shared responsibility payment. There are multiple categories of exemptions. They include:

Short coverage gap
Religious conscience
Federally-recognized Native American nation
Income below income tax return filing requirement

The short coverage gap applies to individuals who lacked minimum essential coverage for less than three consecutive months during 2014. They will not be responsible for making a shared responsibility payment. Individuals who are members of a religious organization recognized as conscientiously opposed to accepting insurance benefits also are exempt from the individual mandate. Similarly, members of a federally-recognized Native American nation are exempt. If a taxpayer’s income is below the minimum threshold for filing a return, he or she is exempt from making a shared responsibility payment.

The IRS has developed new Form 8965, Health Coverage Exemptions. Taxpayers exempt from the individual mandate will file Form 8965 with their federal income tax return.

Shared responsibility payment

All other individuals - individuals without minimum essential coverage and who are not exempt - must make a shared responsibility payment when they file their 2014 return. For 2014, the payment amount is the greater of: One percent of the person’s household income that is above the tax return threshold for their filing status; or a flat dollar amount, which is $95 per adult and $47.50 per child, limited to a maximum of $285. The individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014. Taxpayers will report the amount of their individual shared responsibility payment on their 2014 Form 1040.

The IRS has cautioned that it will offset a taxpayer’s refund if he or she fails to make a shared responsibility payment if required. However, the Affordable Care Act prevents the IRS from using its lien and levy authority to collect an unpaid shared responsibility payment.

Code Sec. 36B credit

Only individuals who obtain coverage through the Marketplace are eligible for the Code Sec. 36B premium assistance tax credit. The U.S. Department of Health and Human Services (HHS) has reported that more than two-thirds of Marketplace enrollees are eligible for the credit and many enrollees have received advance payment of the credit.

All advance payments of the credit must be reconciled on new Form 8962, which will be filed with the taxpayer’s income tax return. Taxpayers will calculate the actual credit they qualified for based on their actual 2014 income. If the actual premium tax credit is larger than the sum of advance payments made during the year, the individual will be entitled to an additional credit amount. If the actual credit is smaller than the sum of the advance payments, the individual’s refund will be reduced or the amount of tax owed will be increased, subject to a sliding scale of income-based repayment caps.

A change in circumstance, such as marriage or the birth/adoption of a child, could increase or decrease the amount of the credit. Individuals who are receiving an advance payment of the credit should notify the Marketplace of any life changes so the amount of the advance payment can be adjusted if necessary. Please contact our office if you have any questions about the Code Sec. 36B credit.

IRS officials have told Congress that the agency is ready for the new filings and reporting requirements. Our office will keep you posted of developments.

FAQ: Are individuals now required to purchase health insurance?

The answer is no for 2010, but yes, in practical terms, for 2014 and beyond. The health care reform package (the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010) does not require individuals to carry health insurance in 2010. However, after 2013, individuals without minimum essential health insurance coverage will be liable for a penalty unless otherwise exempt.

Shared responsibility

The health care reform package describes health insurance coverage as "shared responsibility." Individuals, employers, the federal government, and the states all have roles to play in guaranteeing that individuals do not lack minimum essential health insurance coverage.

The health care reform package assumes that employer-provided health insurance will continue to be the primary means of delivering coverage after 2013. The health care reform package includes measures that lawmakers hope will keep premium costs down along with tax incentives, so employers continue to offer health insurance. For larger employers (those with 50 or more employees), that "encouragement" is also combined with penalties if alternate health insurance is not offered.

Millions of Americans are also currently covered by Medicaid, Medicare and other government programs. They will continue to be covered by these programs after 2013. Indeed, some of these government programs will be expanded between now and 2013, covering more individuals.

Individual responsibility

Beginning in 2014, the health care reform package imposes a penalty on individuals for each month they fail to have minimum essential health insurance coverage for themselves and their dependents. Another name for the penalty is "shared responsibility payment."

As a baseline, all individuals without minimum essential health insurance coverage will be liable for the penalty. However, the health care reform package expressly excludes certain individuals from liability for the penalty. They include:

Individuals whose household income is below their income thresholds for filing a federal income tax return;
Individuals who are exempt on religious conscience grounds;
Individuals whose contribution to employer-provided coverage exceeds a threshold percentage;
Hardship cases;
Native Americans;
Undocumented aliens;
Incarcerated individuals;
Individuals with short lapses of minimum essential coverage;
Individuals covered by Medicare, Medicaid and other government programs; and
Certain individuals outside the U.S.

Amount of penalty

The monthly penalty after 2013 is 1/12 of the flat dollar amount or a percentage of income, whichever is greater. For 2014, the flat dollar amount is $95 and the percentage of income is one percent. The flat dollar amount rises to $695 in 2016 (indexed for inflation thereafter) and the percentage of income increases to 2.5 percent.

For individuals under age 18, the flat dollar amount is 50 percent of the amount for adults. Generally, a family's total penalty cannot exceed $285 for 2014 (rising to $2,085 by 2016) or the national average annual premium for the "bronze" level of coverage through a state insurance exchange. By 2014, each state must establish an insurance exchange where individuals can shop for health insurance coverage. The exchanges will have four levels of coverage: bronze, silver, gold, and platinum.

Example. Ana, age 38, is self-employed with a modified adjusted gross income (AGI) of $68,500 for 2014. Ana does not have minimum essential coverage for all 12 months of 2014 and is not exempt from carrying minimum essential coverage because of income or other qualifying reasons. Ana will be liable for a penalty of the greater of $95 or one percent of her modified AGI.

Example. Ana's mother, Barbara, is enrolled in Medicare. Barbara has minimum essential coverage because she is enrolled in Medicare and is not liable for a penalty.

Health insurance tax credits

At the same time the individual responsibility requirement kicks in, the health care reform package provides a refundable health insurance premium assistance tax credit to qualified persons. The premium assistance credit will operate on a sliding scale based on an individual's relationship to the federal poverty level (between 100 and 400 percent).

The healthcare reform package makes the premium assistance tax credit refundable and also provides for advance payment of the credit. Advance payment will be made to the health plan in which the individual is enrolled.

Adult children

There is one important change regarding individual coverage for 2010. Effective September 23, 2010, the health care reform package enables more young adults to remain on their parents' health insurance policies. Generally, employer-sponsored group health plans will be required to provide coverage for adult children up to age 26 if the adult child is ineligible to enroll in another employer-sponsored plan. The health care reform package also extends the employer-provided health coverage gross income exclusion to coverage for adult children under age 27 as of the end of the tax year.

Guidance

The IRS, the U.S. Department of Health and Human Services and other federal agencies are expected to issue extensive guidance on the individual responsibility mandate. Our office will keep you posted on developments.