In addition to family gatherings and pumpkin pie, my thoughts for November drift toward scintillating information reporting conversations happening around the tax water cooler.
What’s going on with IRS backup withholding enforcement? Anything of interest in the new IRSAC report? What has been the reaction to the new IRS crypto tax guidance? Did you hear about upcoming guidance for FATCA certifications defaults? And what are the prospects for more tax treaty ratifications?
Well, here is a short round-up of some of tax chit-chat that spiced up our November.
1. IRS is Getting More Serious about Backup Withholding Enforcement
We’ve heard reports over the past year that the IRS has been concerned about loss of tax revenue due to failures by withholding agents to backup withhold on payments. Backup withholding may be required when U.S. payees fail to provide or certify their taxpayer identification number prior to a reportable payment and are not otherwise exempt recipients. In such cases, a withholding agent is generally required to withhold on the payment at the backup withholding rate of 24%. The withholding is reported to the IRS (and payee) on a Form 1099, and the backup withholding amount on the Forms 1099 needs to reconcile with the annual Form 945 filed by the withholding agent.
Apparently, reconciliation is not happening as well as the IRS believes it should be. The withheld amounts may not tally. There may be mismatched EINs on the 1099s vs the 945. The IRS notified industry in November that a new backup withholding unit has been formed in Covington, Kentucky that is now in the process of reaching out to withholding agents on backup withholding errors and inconsistencies.
It may not be a bad time to review internal procedures for handling backup withholding scenarios and associated reporting since the IRS appears to be getting serious about backup withholding enforcement.
2. New IRSAC Report is Out
In the past, we would tell you that the IRPAC report is out, but since IRPAC is no more (as it has been folded into the broader Internal Revenue Service Advisory Council (IRSAC)) the announcement is that the IRSAC report is out. Because of the broader mandate of IRSAC, the information reporting parts appear to be contained in the section of the report (IRS Pub. 5316 Rev. 11-2019) for the Large Business and International Subgroup.
Among the issues discussed: downward attribution under section 958(b)(4) (in particular, inadvertent CFCs that may be treated as US payors for Form 1099 reporting due to section 958(b)(4) repeal – though the IRS has since provided relief for this issue), a recommendation that the IRS allow withholding agents to file Form 1042 electronically, the need for additional IRS assistance and educational efforts relating to the FATCA and QI portals, a request to have the IRS allow more time for overseas withholding agents to respond in Form 1042-S audit campaigns, and several issues that are relevant for financial institutions that are Qualified Intermediaries – including flexibility in allowing QIs to opt in or out of withholding responsibility with respect to section 1446(f) withholding on dispositions of publicly traded partnerships.
Speaking of section 1446(f), final regulations (and changes to the QI Agreement) are expected within the next year. The topic is of great relevance to brokers since under the proposed section 1446(f) regulations, brokers are tasked with the obligation to withhold on sales of PTP interests by non-US persons and the proposed regulations had indicated that there may be as little as 60 days for withholding agents to prepare once the regulations are finalized. Word from recent industry conferences, however, suggests that the IRS is aware that 60 days may not be sufficient for brokers to implement new withholding systems to account for PTP gross proceeds withholding.
3. Crypto Taxation
As we have reported, the IRS issued new FAQs and a revenue ruling in October, providing its first bit of new guidance on crypto taxation in 5 years. While there is some excitement that there is now additional tax guidance to follow in dealing with crypto transactions, there’s also a level of concern about the actual guidance that was issued.
Among practitioners, for example, there is concern that the revenue ruling (Rev. Rul. 2019-24) that was issued, in which the IRS takes the position that a crypto hard fork can be a taxable event, misstates the mechanics of a hard fork and may reflect a lack of understanding by the IRS of what is involved in such events. Some suggest that the ruling conflates two different crypto events: a hard fork in which a crypto coin may be split into two coins and an air drop where a person may receive a crypto coin as an incentive that could be unrelated to the recipient’s existing holdings. Practitioners reading the facts of the examples in the ruling have been left a little confused, and some are wondering if a misunderstanding of the nature of hard forks is creating also an incorrect result. Interestingly, in several other jurisdictions outside the U.S. such as the U.K. and Australia, crypto hard forks are generally not taxable events. They are treated more in the manner of a stock split.
Another point of discussion surrounds the idea of “block rewards” – whether this be crypto coins “earned” by a miner of bitcoin or coin rewards received by a coin holder in “staking” as part of an alternative consensus protocol known as “proof of stake.” The IRS had stated that coins received by bitcoin miners as part of their role as validators in the bitcoin blockchain are taxable as ordinary income earned. Some tax practitioners are debating whether that should be the correct result or whether the these “validators” are creating the coins as part of maintaining the network, much as a business might manufacture a shoe. Under that theory, the taxable event doesn’t occur until you sell the shoe.
At this point though, as much as we can read it, the IRS’s position is that both hard forks and mining (and possibly be extension staking) rewards are taxable when new coins are received.
4. FATCA Certification Issues
In a conference in November, the IRS noted that additional guidance on FATCA certification failures/notices of default may be issued by year-end. So financial institutions with operations outside the U.S. may wish to monitor this.
Under FATCA, certain categories of financial institutions must make periodic certifications to the IRS of effective internal controls with respect to the their FATCA compliance. The IRS noted that missives are being sent to certain FFIs regarding certification failures, and the upcoming guidance should provide some more clarity on the processes that are involved in such cases, with the indication that the process may differ between financial institutions subject to FATCA Intergovernmental Agreements and those that are not.
5. Status of Tax Treaty Ratifications
We discussed ratification of several new tax treaties in a prior note, and the withholding tax provisions in the Spain tax treaty are effective as of November 27. News is that several other pending treaties (with Chile, Hungary and Poland) are still being held up. There appears to be a concern that the provisions of these treaty may conflict with the base erosion and anti-abuse tax (BEAT) rules enacted as part of the 2017 tax act. So while we had lift-off for Japan, Spain, Switzerland and Luxembourg this past summer with the Senate ratification of those treaties, not so with the remainder. So more to come.