Treasury report details next steps for controversial guidance projects

The Treasury Department on Oct. 4 released a report to President Donald Trump on the future of eight controversial tax regulations promulgated by the government since Jan. 1, 2016.

The report, “Identifying and Reducing Tax Regulatory Burdens,” follows up on an initial Treasury report, Notice 2017-38, which identified the eight regulations as either imposing an undue burden on U.S. taxpayers or adding undue complexity to federal tax laws. Treasury determined that none of the eight regulations exceeded the statutory authority of the IRS.

The report, which was submitted to the President on Oct. 2 by Treasury Secretary Steven Mnuchin, as required under Executive Order 13789, states that the government will entirely withdraw the following regulations identified in Notice 2017-38:

  • Proposed regulations (REG-129067-15) under Section 103 on the definition of a political subdivision: The proposed regulations require a political subdivision to possess (i) sovereign powers, (ii) a governmental purpose and (iii) governmental control. The notice indicates that the government believes that some enhanced standards for qualifying as a political subdivision are appropriate, but that these specific proposed regulations are not justified. Treasury and the IRS may propose more targeted guidance in the future, however, the report states.

  • Proposed regulations (REG-163113-02) under Section 2704 related to restrictions on liquidation of an interest for estate, gift or generation-skipping transfer (GST) taxes: The regulations would restrict certain discounts from applying to the fair market value of certain interests related to family-controlled entities for estate, gift or GST tax purposes, which many commenters and taxpayers found concerning. Treasury and the IRS agree with commenters that valuation would be difficult and burdensome.

The report also considers revoking parts of the following three regulations:

  • Temporary regulations (T.D. 9788) under Sections 707 and 752 related to partnership liabilities: The regulations generally provide rules for how certain liabilities are allocated solely for purposes of disguised sale rules, and whether “bottom-dollar payment obligations” provide for the necessary economic risk of loss to be taken into account as a recourse liability for a partnership under Section 752. Regarding the rules pertaining to disguised sales, the report states that the Treasury and IRS are considering whether to reinstate the prior regulations and revoke the proposed and temporary regulations at issue. However, the report recommends that the rules regarding bottom-dollar guarantees be retained to prevent abuses and that the rules do not meaningfully increase regulatory burdens for affected taxpayers.

  • Final and temporary regulations (T.D. 9790) under Section 385 related to treatment of interests in corporations as equity or debt: Arguably the most prominent of the regulations issued during the time period specified by the EO, the regulations under Section 385 provide for minimum documentation standards related to purported debt instruments between related parties and for reclassification of debt as stock in certain situations. Taxpayers have long criticized the regulations’ imposition of significant compliance burdens and have asked for a delay in the effective date of the documentation rules, among other simplifications. With regard to the documentation requirements, the report notes that while Notice 2017-36 delayed application of those rules until 2019, Treasury and IRS are considering revoking the documentation requirements as issued in the regulations. The report states that the government is considering a revised documentation rule that would be “substantially simplified and streamlined.” In the place of any revoked regulations, the streamlined rules would be prospective and would allow time for comments and compliance. In particular, the new rules would significantly modify the requirement of a reasonable expectation of an ability to pay indebtedness, which, the report notes, has proved “problematic.” The treatment of ordinary trade payables under the documentation rules is also being re-examined, according to the report.

    Regarding the earnings stripping rules contained in the regulations, the report concludes that these distribution rules are a “blunt instrument for accomplishing their tax policy objectives,” and while the government continues to consider how the rules may be more targeted and less burdensome, the government also believes in “maintaining safeguards against earnings-stripping.” The report notes that legislation is the best way to address these issues and cites Congress’s impending tax reform efforts to “obviate the need for the distribution regulations.” In the meanwhile, revoking the earnings stripping rules before the enactment of tax reform could make existing problems worse. If legislation does not eliminate the need for the distribution rules, then Treasury and the IRS may then propose more streamlined rules, the report states.

  • Final regulations (T.D. 9778) under Section 7602 on the participation of certain independent contractors in a summons interview: While the IRS has long relied on certain outside experts in tax litigation, the regulations allow attorneys as contractors to participate in certain litigation activities, including conducting depositions, which certain commenters objected to. The report states that the IRS and Treasury are considering a prospectively effective amendment to the regulations to narrow their scope by prohibiting the IRS from enlisting outside counsel to participate in an examination of a taxpayer, including a summons interview. Nonetheless, the regulations would continue to allow outside subject-matter experts to participate in a summons proceeding as well as in examinations.

The report also considers substantially revising three regulations:

  • Final regulations (T.D. 9794) under Section 987 related to income and currency gain or loss with respect to certain qualified business units: The final regulations generally contain guidance relating to foreign currency translations, the determination of taxable income or loss (or earnings and profits) of a taxpayer with respect to a qualified business unit (QBU) subject to Section 987 (a Section 987 QBU), as well as timing, character and the source of any Section 987 gain or loss. The report states that the government intends to propose modifications to the final regulations to permit taxpayers to elect or adopt a simplified method of calculating Section 987 gain and loss and translating Section 987 income and loss. The report provides, however, that the simplified method would be subject to certain limitations with respect to the timing of recognition of Section 987 losses. One variation of this simplified methodology would allow taxpayers to treat all assets and liabilities of a Section 987 QBU as marked items and translate all items of income and expense at an average exchange rate for the year, putting such determinations more in line with certain financial accounting rules and the proposed regulations from 1991.

    The report also states that in connection with the simplified methodology, the government is considering alternative loss recognition timing limitations for certain electing taxpayers. This is consistent with concern that the government previously expressed in a notice issued in 2000 regarding the 1991 proposed regulations, which stated that taxpayers may have been using a similar method to trigger noneconomic gains or losses when the dollar was strong against other currencies. Under the base limitation in consideration, the electing taxpayer would be permitted to recognize net Section 987 losses only to the extent of net Section 987 gains recognized in prior or subsequent years. In addition, the government is also considering the administrability of a limitation under which the electing taxpayer would defer recognition of Section 987 gains and losses until the earlier of (i) the year that the trade or business conducted by the QBU ceases to be performed by any member of its controlled group or (ii) the year substantially all the assets and activities of the QBU are transferred outside the controlled group. The report also states that the government is considering alternatives to the transition rules in the final regulations.

    The report states that Treasury and IRS are contemplating guidance that would permit taxpayers to elect to defer the application of Treas. Reg. Secs. 1.987-1 through 1.987-10 until at least 2019, depending on the taxpayer’s taxable year. The IRS has already taken steps to implement this portion of the report. On Oct. 2, 2017, the IRS and Treasury announced (Notice 2017-57) that the recently issued final regulations under Section 987, as well as certain provisions of the temporary regulations under Section 987, will be delayed by one year. For example, a taxpayer whose first tax year after Dec. 7, 2016, begins on Jan. 1, 2017, the final regulations and the related temporary regulations will apply for the tax year beginning on Jan. 1, 2019. The notice provides that taxpayers may still apply the final regulations and the related temporary regulations to taxable years beginning after Dec. 7, 2016, provided the taxpayer consistently applies the regulations with respect to all Section 987 QBUs directly or indirectly owned by the taxpayer, a members of the taxpayer’s consolidated group, or certain related controlled foreign corporations on the transition date.

  • Final regulations (T.D. 9803) under Section 367 on the treatment of transfers of property to foreign corporations: The regulations eliminate the so-called “foreign goodwill exception” and limit the scope of the active trade or business exception related to certain transfers of property by U.S. persons to foreign corporations. The report states that the government will expand the active trade or business exception to include relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch under circumstances with limited potential for abuse and administrative difficulties. The government will propose regulations in the “near term” on this issue, the report states.

  • Temporary regulations (T.D. 9770) under Section 337(d) on certain transfers of property to regulated investment companies and REITs: The final regulations provided additional guidance on newly enacted provisions of the Protecting Americans from Tax Hikes (PATH) Act of 2015, and commenters expressed concern that the REIT spinoff rules could result in over-inclusion of gain in some cases, on which the report states, the government agrees. As a result, Treasury and the IRS are considering revisions to these rules that would limit the potential taxable gain recognized in certain situations. For example, where a smaller corporation that is a party to a spin-off merges into a larger corporation in a tax-free reorganization, and then larger corporation makes a REIT election after the spin-off, the proposed regulations being considered by Treasury and the IRS would limit gain recognition to the assets of the smaller corporation.

In addition to providing guidance under EO 13789, the report also provides a brief update as to the furtherance of policies contained in EO 13771, which generally requires the identification of two regulations for repeal for every new regulation that is proposed, and EO 13777, which sets forth procedures for implementing and enforcing regulatory reform. The report states that Treasury, along with the IRS Office of Chief Counsel, have identified more than 200 regulations for potential revocation, most of which have been “outstanding” for many years. While those regulations remain in the Code of Federal Regulations, they are, to varying degrees, “unnecessary, duplicative, or obsolete,” according to the report. Treasury and the IRS are expected to begin the rulemaking process for revoking these regulations later this year, and are also expected to attempt to streamline rules wherever possible.

Contacts David Auclair
National Managing Principal
Washington National Tax Office
T +1 202 521 1515

Grace Kim

Partnership Tax Technical Leader
Washington National Tax Office
T +1 202 521 1590

Andy Cordonnier
Corporate Tax Technical Leader
Washington National Tax Office
T +1 202 521 1502

David Sites
International Tax Technical Leader
Washington National Tax Office
T +1 202 861 4104

Liz Askey
Managing Director
Tax Practice Policy & Quality
T +1 202 521 1513

Dustin Stamper
Washington National Tax Office
T +1 202 861 4144

Shamik Trivedi
Senior Manager
Washington National Tax Office
T +1 202 521 1511

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