June 2017 Tax Snacks
Tax Snacks: Bite-size tax news and information on the fly
June 30: Canadian Form T2 (Corporation Income Tax Return) is due
July 31: Form 5500 (Annual Return of Employee Benefit Plan) is due
Nothing much has materialized since our last update, but a lot has taken place. Here is a status report on the tax-related activity (or lack thereof) in Congress.
Health care – related tax provisions
The Affordable Care Act (ACA, often referred to as “Obamacare”) is strongly linked to taxes, and Republicans hoped to dismantle or replace that before tackling more comprehensive tax reform.
In March, proposed ACA replacement known as the American Health Care Act of 2017 (AHCA) won approval by committees, but was pulled prior to voting by the full House of Representatives when it became clear it would fail due to opposition by both Democrats and Republicans.
In May, a revised version was passed by the House, but it interestingly was done so prior to “scoring.” Scoring is a detailed determination of the cost and other effects of proposed law changes, undertaken by the Congressional Budget Office (CBO), a nonpartisan agency that works for congress. Scoring later determined the bill would result in 14 million fewer insured next year (climbing to 26 million fewer insured by 2026) but reduce the deficit by $119 billion over that same 10 year period.
The AHCA bill is now in the hands of the Senate. Although it, like the lower chamber, is in control by Republicans, the Senate Republicans have indicated publicly that they will not rubber-stamp the House version, and instead are creating their own version. Many would argue that the process in both March and in May appeared to be rushed. By contrast, the Senate is acting more deliberately and with less fanfare, and is accused of moving too slowly and being too secretive. A draft of the Senate’s plans should be released this week.
The House and the Senate, in the end, will have to agree on one version, so there clearly is a lot more to come on this front.
General tax reform
As noted above, overall tax reform is somewhat in limbo pending the outcome of the health care overhaul that is so strongly tethered to taxes.
In May, President Trump provided an outline of an updated tax package. In terms of both level of detail (sparse – more like a rough set of goals and basic changes to accomplish them) and content, it is very similar to the plans provided during his campaign. Treasury Secretary Steven Mnuchin noted last month that the White House has no changes planned for the Earned Income Credit, the Child Tax Credit, or the deduction for charitable contributions, but he did not provide details regarding plans for other deductions and credits. The alternative House “blueprint” (which contains significantly more detail than the Trump plans) was crafted a year ago and has remained unchanged. The Trump plan may be viewed here and is explained here. The House blueprint may be found here.
It is likely appropriate that little movement takes place on general tax reform until the landscape resulting from ongoing health care changes is clear. They simply are too strongly linked to separate them or reverse the order without creating more problems. What this will do to timing of any resulting law changes is anyone’s guess. If asked 5 or 6 months ago, many would speculate that law changes would be known by now, or even implemented. Now it appears to be months from fruition, and whether or not a change will be retroactive to the beginning of this year becomes hazier by the minute.
The information below will be very applicable to S corporations that are owned in whole or in part by an ESOP. It will prove irrelevant, somewhat technical, and incredibly boring for anyone else. (Consider yourself warned.)
In a case of first impression, the Tax Court this month determined that the Internal Revenue Code Section 267 rules that delay accrued payroll deductions payable to S corporation owners also applies to employees who are not shareholders, but are ESOP participants that have S corporation shares allocated to their accounts. The material below describes the impact of Steven M. Petersen and Pauline Petersen v. Commissioner; John E. Johnstun and Larue A. Johnstun v. Commissioner, U.S. Tax Court, 148 T.C. No. 22 (June 13, 2017).
The text of the case explains this in more detail, but basically the ESOP participants and the sponsoring S corporation are treated as related parties due to the ESOP’s technical status as a trust established for its participants, and any indirect “ownership” at all taints them, forcing the company into deducting those expenses (accrued vacation pay, accrued other payroll) on the cash basis. (In spite of using the accrual method of accounting, the company cannot deduct those costs until the following year, when the recipient includes the remuneration in his or her income.)
This deduction delay has long been imposed on accruals to direct shareholders, and the relevance of this court case is that it will now apply to non-shareholders, as long as the intended payroll recipient is a participant in the company’s ESOP, and that participant’s account within the ESOP holds shares of the company that accrued the pay.
This treatment does not apply to C corporation ESOPs, because their related party/constructive ownership rules are governed by Sec. 318 rather than 267, and an exception exists in 318 for benefit plans like ESOPs. (Sec. 267 was written prior to 1998, when S corps were first allowed to participate in ESOPs, and no comparable exception exists in 267.)
The court noted that this issue apparently has never been raised in the past, and it is likely that few, if any, have interpreted the rules in a way consistent with the court’s new determination. (The court refused to allow penalties for this reason.)
This will not be much of a problem for 100% owned ESOPs, because their shareholders (the ESOPs) are not taxed. But it is a meaningful concern for the direct, individual shareholders of partially-owned ESOPs, because this will accelerate some K-1 income by delaying a corporate deduction. Even for 100% ESOP- owned entities, the change creates some busy work, as a year-end accrual that we are used to breaking out into shareholder vs. non-shareholder pieces (which is relatively easy) will now need to include more variables. The only immediately deductible piece will consist of payroll accruals to non-owners whose ESOP accounts do not yet have shares allocated to them.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.