Category: Tax

Eleventh Hour Fiscal Cliff Deal – What Does it Mean for Canadians?

Altro Levy LogoJust hours before midnight on New Years Eve, the US Senate hammered out a tentative deal to avoid sending the country over the Fiscal Cliff. Yesterday, a reluctant, Republican-controlled House of Representatives has also blessed the plan, which deals with many of the major tax issues at stake, while pushing back the spending issues to later into the new year.

The “Fiscal Cliff”, a term coined by Ben Bernanke, the Chairman of the Federal Reserve, refers to the cumulative effect of spending cuts and tax increases, which were scheduled to occur January 1, 2013 as a result of the expiry of several pieces of legislation. The issue has received a great amount of press in recent months, as commentators continued to hope that Congress would agree on compromise legislation to soften the economic blow. In this post, we will outline the primary cross border tax impacts on Canadians.

Federal Estate Tax

For Canadians with interests in the US, the primary consequence of going over the Fiscal Cliff would relate to the federal estate tax. The Canada – US Tax Treaty allows Canadian residents to piggy-back onto some estate tax exemptions that are available to US citizens and residents. In particular, in 2012, there was a $5.12 million exemption from estate tax, such that only estates worth greater than that amount would end up paying taxes, and the maximum rate was capped at 35%. The looming Fiscal Cliff threatened to bring us back to the $1 million exemption amount at maximum rate of 55%, which was in effect when President Bush took office in 2001. Note that this is not a capital gains tax on death, as we have in Canada. This tax applies to the fair market value of assets at the time of death.

The good news for Canadians is that the deal will extend the $5.12 million exemption amount, which will increase with inflation. The maximum rate will increase to 40% on a permanent basis. As a consequence, if a Canadian owns US assets (such as real estate or US securities) worth more than $60,000, and passes away with a worldwide estate valued in excess of $5.25 million, some US estate tax is likely going to be payable. It is important to note that the worldwide estate value includes everything: real estate, investment accounts, RRSPs, business interest, even the proceeds of life insurance. However, the tax is only applied against the value of the US situated assets, and some tax credits ought to be available under the Tax Treaty thanks to the extension of the high exemption amount.

Nonetheless, it remains worthwhile for high-net worth Canadians to evaluate their estate tax exposure and hold US assets in Cross Border structures that minimize or eliminate the potential for US estate tax liability.

Income and Capital Gains Tax

Most of the press on the Fiscal Cliff has centered on the increases in income tax rates. This issue is very unlikely to cause Canadian residents much concern, even though US income tax may be payable. Since Canadian residents pay Canadian tax on their world wide income, any US source income earned by a Canadian will be added on the top of their Canadian income, such that it will be taxed at a relatively high marginal rate. In contrast, that same US sourced income will be taxed in the US at the lower marginal rates, and Canada will give a credit for US tax paid. As such, as long as the marginal rate in the US is lower than the marginal rate in Canada on the same income (which it clearly will), increases in US income tax rates will not be noticed by Canadians when the dust settles at the end of a tax year.

One expiring tax cut that was not renewed under the Eleventh Hour Deal relates to the long-term capital gains tax rate on the disposition of capital assets. This is one tax increase that will be felt by some Canadians. In Canada, we pay regular income tax on half of the capital gain. As such, if the gain pushes a taxpayer into the top marginal rate in Canada, the effective capital gains tax rate ranges from approximately 19.5% in Alberta to almost 25% in Quebec. In 2012, the US federal capital gains tax for individuals who had held an asset for longer than one year was capped at 15% on the gain. That rate has increased to 20% with the Fiscal Cliff Deal (high income earners will pay 23.8% including an “Obamacare” surcharge). Where state-level tax also applies, the US capital gains tax may well exceed that owed in Canada, resulting in a higher overall tax burden. For example, California has a state capital gains tax rate of 9.3%. Therefore, any Canadian selling a California property will owe more tax to the US (combined rate of 29.3%) than to Canadian jurisdictions. Other states have a lower rate of tax, such that the effective US rate may not exceed the Canadian rates. For example, Florida does not impose a capital gains tax on individuals, trusts, or limited partnerships.

Market Volatility

The other aspect of the Fiscal Cliff that may affect Canadians is the most difficult to anticipate. Many economics were predicting that the overall effect of the Fiscal Cliff would send the US back into recession. This was the concern that prompted Bernanke and others to characterize the issue as a ‘cliff’ connoting catastrophic economic consequences. While the economy should respond favorably to the agreement that Congress passed, there are many pressing issues that were simply deferred in this week’s deal. Many of the spending cuts, which are thought to jeopardize the economic recovery, were pushed back two months for Congress to resolve later on. If worst fears are realized, the value of many US assets may decline as economic conditions generally erode.

As cross border tax and estate planners, we often advise Canadian clients to consider repositioning their investment portfolios to exclude directly held US securities because of the US estate tax exposure they represent. If you believe that the fiscal transition will negatively impact the value of US securities, it may be a good time to discuss repositioning with your investment advisor.

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Employers Have Until October 1st to Comply with Affordable Care Act’s Notice Requirements

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The Patient Protection and Affordable Care Act (the “Affordable Care Act”) represents the most substantial overhaul of the nation’s healthcare system in decades.  Much of the Affordable Care Act is meant to expand access to affordable health insurance coverage, including provisions for coverage to be offered through a Health Insurance Marketplace (the “Marketplace”) beginning in 2014.  As part of the overhaul, the Affordable Care Act requires most employers to provide written notice to their employees of coverage options available through the Marketplace and to give employees information regarding the coverage, if any, offered by the employer.

The United States Department of Labor (“DOL”) recently issued a Technical Release, which provides temporary guidance regarding the notice requirement and announces the availability of the Model Notice to Employees of Coverage Options.  The Technical Release can be obtained from the following link to the DOL’s website:  www.dol.gov/ebsa/newsroom/tr13-02.html.

Notice to Employees Under the Affordable Care Act

Beginning October 1, 2013, most employers must give a written notice to each employee,[1] regardless of plan enrollment status or the employee’s status as a part-time or full-time employee, with the following information:

  • The notice must include information regarding the existence of the new Marketplace as well as contact information and a description of the services provided by the Marketplace
  • The notice must inform the employee that the employee may be eligible for a premium tax credit under section 36B of the Internal Revenue Code if the employee purchases a qualified health plan through the Marketplace
  • The notice must include a statement informing the employee that if the employee purchases a qualified health plan through the Marketplace, the employee may lose the employer contribution (if any) to any health benefits plan offered by the employer and that all or a portion of such contribution may be excludable from income for federal income tax purposes

Employers must provide the notice to current employees no later than October 1, 2013 when “open enrollment” begins for coverage through the Marketplace.  For new employees, employers must provide the notice at the time of hiring beginning October 1, 2013.  For 2014, if the notice is provided within 14 days of an employee’s start date, the DOL will consider the notice to be provided at the time of hiring.

The notice must be provided to employees in writing.  The notice may be sent via first class mail or it may be provided electronically as long as the requirements of the DOL’s electronic disclosure safe harbor are met.  Employers may not charge their current employees or new hires a fee for providing the notice.

To assist employers with complying with the notice requirement, the DOL has drafted two model notices that meet the notice content requirements discussed above.  The model notice for employers who do not offer a health plan is available at the following link:  www.dol.gov/ebsa/pdf/FLSAwithoutplans.pdf.  The model for employers who do offer a health plan to some or all of their employees is available at the following link:  www.dol.gov/ebsa/pdf/FLSAwithplans.pdf.

Updated Model Election Notice Under COBRA

Under COBRA, a group health plan administrator must provide qualified beneficiaries with an election notice describing their rights to continuation of health insurance coverage and how to make an election.  A “qualified beneficiary” is an individual who was covered by a group health plan on the day before the occurrence of a qualifying event, such as termination of employment or reduction in hours that causes loss of health insurance coverage under the group health plan.

The DOL’s Technical Release includes a revised COBRA model election notice to help make qualified beneficiaries aware of other coverage options available in the Marketplace.  Upon the group health plan administrator filling in the blanks in the model election notice with the appropriate plan information and using the notice, the DOL will consider the use of the model notice to be good faith compliance with the election notice content requirements of COBRA.  Employers should begin using the model election notice immediately.

The COBRA model election notice can be obtained from the following link to the DOL’s website:  www.dol.gov/ebsa/cobra.html.

[1] Employers are not required to provide a separate notice to employees’ dependents or other individuals who are or may become eligible for coverage under the plan but who are not employees of the employer.

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Compensation & Benefits Law Update

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Department of Labor Guidance on Required Notice to Employees Regarding Health Insurance Exchanges

Under the Patient Protection and Affordable Care Act (the “ACA“), individuals will be allowed to purchase health insurance coverage on exchanges, referred to as the Health Insurance Marketplace (the “Marketplace”). Certain lower income individuals may also qualify for premium tax credits if they do not have affordable, minimum value health coverage available through their employers. The Marketplace and the low income tax credits will be available beginning January 1, 2014.

Under the ACA, employers subject to the Fair Labor Standards Act (the “FLSA”) must provide a notice to their employees regarding the coverage available on the Marketplace. Although this notice was originally required to be distributed by March 1, 2013, the Department of Labor (“DOL“) postponed the notice requirement.

The DOL recently issued Technical Release 2013-02, which provides guidance regarding the Marketplace notice requirement as well as a model Marketplace notice. In addition, the DOL revised its model COBRA notice to address the availability of the Marketplace. The following are some key points from the Technical Release:

  • No later than October 1, 2013, an employer subject to the FLSA is required to provide the Marketplace notice to each current employee who was hired before that date.
  • Beginning October 1, 2013, an employer subject to the FLSA is required to provide the Marketplace notice to each new employee at the time of hiring. For 2014, the DOL will consider a notice to be provided at the time of hiring if the notice is provided within 14 days of an employee’s start date.
  • An employer must provide the Marketplace notice to employees even if the employer does not provide health plan coverage.
  • An employer must provide a Marketplace notice to each employee, regardless of whether the employee is eligible to enroll in the employer’s health plan and regardless of whether the employee is part-time or full-time.
  • An employer is not required to provide a separate Marketplace notice to dependents or other individuals who are eligible for coverage under the employer’s health plan but who are not employees.
  • The Marketplace notice must inform the employee regarding the existence of the Marketplace, provide the employee Marketplace contact information to request assistance, and provide a description of the services provided by the Marketplace. The notice must also inform the employee that the employee may be eligible for a premium tax credit if the employee purchases a qualified health plan through the Marketplace. The notice must include a statement informing the employee that, if the employee purchases a qualified health plan through the Marketplace, the employee may lose the employer contribution (if any) to any health plan offered by the employer and that all or a portion of that employer contribution may be excludable from income for Federal income tax purposes.
  • The notice must be provided in writing in a manner calculated to be understood by the average employee. It may be provided by first-class mail. Alternatively, it may be provided electronically if the requirements of the DOL’s electronic disclosure safe harbor are met.

A model Marketplace notice is available on the DOL’s website www.dol.gov/ebsa/healthreform. There is one model for employers who do not offer a health plan and another model for employers who offer a health plan to some or all employees. Employers may use one of these models, as applicable, or a modified version, provided the notice meets the content requirements. The model Marketplace notice includes sections to be completed by an employer offering health coverage to its employees related to whether the coverage is affordable and provides minimum value (as defined under the ACA).

Each employer should review the model Marketplace notice in view of the provisions of its group health plan. The notice may need to be tailored to particular groups of employees if the employer’s plan has differing design features for various employee groups (e.g., eligibility, waiting period, employer contribution, etc.).

In addition, an employer should update its COBRA notice in view of the changes to the DOL model COBRA notice.

Our Compensation & Benefits attorneys are available to assist you in preparing your Marketplace notice and your updated COBRA notice and to assist with all of your ACA compliance efforts.

IRS Announces 2014 Inflation Adjustments for Health Savings Accounts and High Deductible Health Plans

The IRS announced the 2014 inflation adjusted amounts for Health Savings Accounts (“HSAs”) and for High Deductible Health Plans (“HDHPs”).

  • For calendar year 2014, the annual limit on deductions for contributions to an HSA for an individual with self-only coverage under an HDHP will be $3,300 and the annual limit on deductions for contributions to an HSA for an individual with family coverage under an HDHP will be $6,550.
  • For calendar year 2014, an HDHP is defined as a health plan under which:
    • the annual deductible is not less than $1,250 for self-only coverage and not less than $2,500 for family coverage; and
    • annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,350 for self-only coverage and $12,700 for family coverage.

IRS to Review 457(b) Plans

The IRS will be instituting a compliance check program for nongovernmental 457(b) plans. The IRS will be sending questionnaires to approximately 200 nongovernmental, tax-exempt employers that have indicated on their Form 990s that they have 457(b) plans.

A 457(b) plan (or “eligible deferred compensation plan”) is a popular form of nonqualified deferred compensation plan available to tax-exempt organizations and government employers. Amounts contributed to a 457(b) plan for the benefit of an eligible employee are not subject to income tax until distributed from that plan. 457(b) plans are subject to annual contribution limits. Under a 457(b) plan of a nongovernmental tax-exempt employer, total contributions (i.e., employee salary reduction contributions and employer contributions) of up to $17,500 can be made for 2013. This annual limit is periodically adjusted by the IRS to reflect increases in the cost of living.

Although 457(b) plans are not subject to the often complex tax rules of Internal Revenue Code (“Code”) section 409A or 457(f), a 457(b) plan must satisfy certain plan document requirements and be operated in accordance with the terms of the plan and Code section 457(b). With respect to salary reduction contributions, 457(b) plans are subject to special rules regarding the timing of salary reduction elections. 457(b) plans are also subject to rules that can be complex with respect to the required timing of distributions. In addition, the fact that the rules applicable to the 457(b) plans of government and nongovernmental entities differ (e.g., age 50 catch-up contributions are not permitted under the 457(b) plan of a nongovernmental entity) can create confusion. Finally, for employers who are subject to ERISA, participation in a Code section 457(b) plan must be limited to a select group of management or highly compensated employees.

The IRS anticipates that it will find problems with funding arrangements, improper loans, improper catch-up contributions, and employer eligibility. In reviewing 457(b) plans in recent months, we have also found plan documents in need of revision.

If your organization has a 457(b) plan, it would be a good time to review the plan document, salary reduction contribution election forms, and the plan’s operation generally.

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U.S. Supreme Court Unanimously Upholds Creditability of UK Windfall Tax

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In a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under IRC Section 901.

On May 20, 2013, in a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under Internal Revenue Code (IRC) Section 901.  This decision definitively establishes the principles to be applied when determining whether a foreign tax is creditable under Section 901, expressly favoring a “substance-over-form” evaluation of a foreign tax’s economic impact.

The UK windfall tax was enacted in 1997 as a means to recoup excess profits earned by 32 UK utility and transportation companies once owned by the government.  During the 1980s and 1990s, the UK sold several government-owned utility companies to private parties.  After privatization, the UK Government prohibited these companies from raising rates for an initial period of time.  Because only rates and not profits were regulated, many of these companies were able to greatly increase their profits by becoming more efficient.  The increased profitability of these companies drew public attention and became a hot political issue in the United Kingdom, which ultimately resulted in Parliament enacting a windfall tax designed to capture the excess or “windfall” profits earned by these companies during the years they were prohibited from raising rates.  The tax was 23 percent of any “windfall” earned by such companies, which was calculated by subtracting the price for which the company was sold by the United Kingdom from an imputed value based on the company’s average annual profits.  Both PPL Corporation and Entergy Corporation owned interests in two of these 32 privatized companies and took a U.S. tax credit for the windfall taxes paid to the United Kingdom.

IRC Section 901 grants U.S. citizens and corporations an income tax credit for “the amount of any income, war profits and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.”  Whether a foreign tax is creditable for U.S. income tax purposes is based upon the “predominant standard for creditability” laid out in Treasury Regulation §1.901-2.  Under that approach, a foreign tax is an income tax “if and only if the tax, judged on the basis of its predominant character,” satisfies three tests.  The foreign tax must be imposed on realized income (i.e., income that has already been earned), the basis of gross receipts (i.e., revenue) and net income (i.e., gross receipts less significant costs and expenditures).  See Treas. Reg. §1.901-2(a)(3).

The Supreme Court’s decision resolved a split between the U.S. Courts of Appeals for the Third and Fifth Circuits on how to apply the predominant standard for the creditability test set forth in the regulations.  The Third and Fifth Circuits took opposite views of two U.S. Tax Court decisions, PPL Corp.  v. Commissioner, 135 T.C. 304 (2010), and Entergy Corp.  v. Commissioner, T.C. Memo. 2010-197, which both held in favor of the taxpayers that the practical effect of the UK windfall tax, the circumstances of its adoption and the intent of the members of Parliament who enacted it evidenced that the substance of the tax was to tax excess profits, and therefore was creditable.

In PPL Corp. v. Commissioner, 665 F.3d 60 (3d Cir. 2011), the Third Circuit reversed the Tax Court, refusing to consider the practical effect of the UK windfall tax and the intent of its drafters.  Instead, the court focused solely on the text of the UK statute, which in its estimation was a tax on excess value and not on profits.  In contrast, in Entergy Corp. v. Commissioner, 683 F.2d 233 (5th Cir. 2012), the Fifth Circuit affirmed the Tax Court, finding that the tax’s practical effect on the taxpayer demonstrated that the purpose of the tax was to tax excess profits.  The court explained that Parliament’s decision to label an “entirely profit-driven figure a ‘profit-making value’ must not obscure the history and actual effect of the tax.”

In its decision, the Supreme Court agreed with both the Fifth Circuit and the Tax Court.  In applying the rules of the Treasury Regulations, the Supreme Court reinforced the three basic principles to determine whether a tax is creditable.  First, a tax that functions as an income tax in most instances will be creditable even if a “handful of taxpayers” may be affected differently.  This means that the controlling factor is the tax’s predominant character.  Second, the economic effect of the tax, and not the characterization or structure of the tax by the foreign government, is controlling on whether the tax is an income tax.  This extends the principle of “substance over form” to the characterization of a foreign tax.  Third, a tax will be an income tax if it reaches net gain or profits.  Applying these principles to the PPL case, the Supreme Court found that the predominant character of the windfall tax was that of an excess profit tax and was therefore creditable.

The PPL decision will likely have far-reaching effects on courts that wrestle with whether certain taxes paid overseas are creditable for U.S. income tax purposes.

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IRS, Treasury Department Issue Proposed Rules Governing Minimum Value, Affordability, and Wellness Programs

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A key policy goal of the Patient Protection and Affordable Care Act (the “Act”) is the expansion of health insurance coverage to all Americans. The concepts of “minimum value” and its correlate “actuarial value” speak to the generosity of that coverage. What constitutes minimum value is important both for employers that sponsor group health plans and for low-income individuals seeking government subsidies to help pay for coverage through newly established public insurance exchanges. Recently issued proposed regulations provide important clarifications on how employers determine minimum value, and how those determinations impact their compliance with the Act. The proposed rule also clarifies the relationships among minimum value and affordability, on the one hand, and wellness programs, Health Reimbursement Accounts and Health Savings Accounts, on the other. This advisory explains these and other features of the proposed regulations.

Overview

Beginning in 2014, the Act requires most U.S. citizens and green card holders to maintain health insurance coverage, which the Act refers to as “minimum essential coverage.” The phrase minimum essential coverage refers not to the content but to the source of coverage, which can include Medicare, Medicaid, or an “eligible employer-sponsored plan,” among others. Low income individuals may qualify for premium tax credits and cost sharing reductions (collectively, “premium assistance”) to assist with the purchase of coverage through public insurance exchanges. Where an individual is eligible for coverage under an eligible employer-sponsored group health plan that is both affordable and provides minimum value, however, that individual is ineligible for premium assistance.

Beginning in 2014, the Act also imposes certain obligations on “applicable large employers” — i.e., employers with 50 or more full-time and full-time equivalent employees — under which these employers must either offer group health plan coverage or face the prospect of a penalty. These “employer shared responsibility” (or “pay-or-play”) rules include two options:

  • The “no-coverage” prong:
    The employer fails to offer to at least 95% of its full-time employees (and their dependents) the opportunity to enroll in a group health plan of the employer, and any full-time employee qualifies for premium assistance, or

  • The “coverage” prong
    The employer offers to at least 95% of its full-time employees (and their dependents) the opportunity to enroll in a group health plan of the employer that is either unaffordable or fails to provideminimum value, and one or more full-time employees qualifies for premium assistance.

These rules are set out in new Internal Revenue Code section 4980H. The no-coverage prong is referred to more formally in proposed regulations as the “4980H(a) penalty,” and the coverage prong, the “4908H(b) penalty.” Both penalties are determined monthly, but they are easiest to understand when expressed as an annual amount. The no-coverage penalty is determined by multiplying the number of the employer’s full-time employees (excluding the first 30) by $2,000. In contrast, the coverage penalty (i.e., the penalty for offering coverage that is either unaffordable or fails to provide minimum value) is determined by multiplying the number of the employer’s full-time employees who qualify for premium assistance by $3,000. This latter penalty can never exceed the 4980H(a) penalty. Where an employer makes an offer of coverage that is both affordable and provides minimum value, there is no penalty.

Coverage is affordable if the employee premium for self-only coverage does not exceed 9.5% of an employee’s household income. Recognizing the difficulty with obtaining household income data, proposed regulations under Code section 4980H provide three proxies or safe harbors for determining affordability: W-2 income, rate-of-pay, and (lowest) Federal Poverty Limit.

Minimum value

A plan fails to provide minimum value if the plan’s “share of the total allowed costs of benefits provided under the plan is less than 60 percent of the costs.” A plan with a minimum value of 100% would cover all benefit costs with no cost-sharing. Anything below 100% simply means that the covered employee or family member will pay a portion of the costs for covered services. The lower the value, the more the employee will need to pay by way of co-pays, deductibles, co-insurance and other cost sharing requirements.

The terms “minimum value” and “actuarial value” both describe the percentage of expected health care costs a health plan will cover for a “standard population.” In the case of minimum value, it’s a population that reflects typical self-insured group health plans. In the case of actuarial value, the standard population is a population that reflects the average health risk of the individual and/or small group health markets.

When determining actuarial value for individual and small group coverage, the services that must be covered include “essential health benefits.”1 For minimum value determinations involving large and self-funded groups, the standards are less clear. Should minimum value be based on the plan’s share of the cost of coverage for all essential health benefits? Or should it be based on the plan’s share of the costs of only those benefits that the plan actually covers? Both prior guidance (i.e., IRS Notice 2012-31) and the proposed regulations concede that there is no support under the Act for the former approach, and both reject the latter. In Notice 2012-31, the Treasury Department and the IRS charted a middle path, noting that the Act directs that the statutory phrase “percentage of the total allowed costs of benefits provided under a group health plan” is determined under rules contained in the regulations to be promulgated by HHS relating to actuarial value, and that the determination of whether an employer-sponsored plan provides minimum value “will be based on the actuarial value rules with appropriate modifications.” Notice 2012-31 proposed that, for an employer-sponsored plan to provide minimum value, it would be required to cover four core categories of benefits: physician and mid-level practitioner care, hospital and emergency room services, pharmacy benefits, and laboratory and imaging services.

HHS has since published a final rule defining the “percentage of the total allowed costs of benefits provided under a group health plan” as

  1. The anticipated covered medical spending for essential health benefits (EHB) coverage … paid by a health plan for a standard population,

  2. Computed in accordance with the plan’s cost-sharing, and

  3. Divided by the total anticipated allowed charges for EHB coverage provided to a standard population.

HHS provided employers with three ways to determine actuarial and minimum value:

  • AV and MV calculators. Employer-sponsored plans may determine their actuarial or minimum value by entering information about the cost-sharing features of the plan for different categories of benefits into an online calculator made available by HHS.

  • Design-based safe harbor checklists. Employers will be able to use safe harbor checklists. If the employer-sponsored plan’s terms are consistent with or more generous than any one of the safe harbor checklists, the plan would be treated as providing minimum value.

  • Actuarial certification. For plans with nonstandard features that preclude the use of the AV calculator, or the MV calculator, actuarial value or minimum value is determined based on the AV or MV calculator with adjustments as certified to an actuary.

The proposed regulations include a fourth option: For small groups, plans that satisfy any of the metal tiers (platinum, gold, silver, and bronze) specified for coverage under a public insurance exchange are deemed to provide minimum value.

The minimum value proposed regulation coordinates with and builds on the HHS final regulation. The proposed regulations refer to the proportion of the total allowed costs of benefits provided to an employee that are paid by the plan as the plan’s “MV percentage.” According to the proposed regulation,

“The MV percentage is determined by dividing the cost of certain benefits the plan would pay for a standard population by the total cost of certain benefits for the standard population, including amounts the plan pays and amounts the employee pays through cost-sharing, and then converting the result to a percentage.” (Emphasis added).

A plan with an MV percentage of 60% or more is deemed to provide minimum value. Anything less, and a plan fails to provide minimum value.

The proposed regulations do not require an employer to provide coverage for all EHB categories. Instead, minimum value is measured with reference to “benefits covered by the employer that also are covered in any one of the EHB benchmark plans.” Or, put another way, a plan’s anticipated spending for benefits provided under any particular EHB-benchmark plan for any state “counts towards” that plan’s MV. Thus, while large groups are not required to offer EHBs, their minimum value percentage is tested against an EHB benchmark plan. The categories of EHB provided in the IRS/HHS calculator include:

  • Emergency Room Services

  • All Inpatient Hospital Services (including mental health and substance use disorder services)

  • Primary Care Visit to Treat an Injury or Illness (except Preventive Well Baby, Preventive, and X-rays) Specialist Visit

  • Mental/Behavioral Health and Substance Abuse Disorder Outpatient Services

  • Imaging (CT/PET Scans, MRIs)

  • Rehabilitative Speech Therapy

  • Rehabilitative Occupational and Rehabilitative Physical Therapy

  • Preventive Care/Screening/Immunization

  • Laboratory Outpatient and Professional Services

  • X-rays and Diagnostic Imaging

  • Skilled Nursing Facility

  • Outpatient Facility Fee (e.g., Ambulatory Surgery Center)

  • Outpatient Surgery Physician/Surgical Services

  • Drug Categories

    • Generics

    • Preferred Brand Drugs

    • Non-Preferred Brand Drugs

    • Specialty Drugs

Safe harbor minimum value plans

The proposed regulations establish the following safe harbor plan designs for plans that cover all of the benefits included in the minimum value calculator:

  • A plan with a $3,500 integrated medical and drug deductible, 80% plan cost sharing, and a $6,000 maximum out-of-pocket limit for employee cost-sharing;

  • A plan with a $4,500 integrated medical and drug deductible, 70% plan cost sharing, a $6,400 maximum out-of-pocket limit, and a $500 employer contribution to an HSA; and

  • A plan with a $3,500 medical deductible, $0 drug deductible, 60% plan medical expense cost-sharing, 75% plan drug cost-sharing, a $6,400 maximum out-of-pocket limit, and drug co-pays of $10/$20/$50 for the first, second and third prescription drug tiers, with 75% coinsurance for specialty drugs.

HSAs, HRAs, and wellness programs — Impact on minimum value

The proposed regulations provide that current year employer contributions to a health savings account (HSA) and amounts newly made available under a health reimbursement arrangement (HRA) that is integrated with an eligible employer-sponsored plan and that are limited to the payment or reimbursement of medical expenses count toward the plan’s share of costs included in calculating minimum value. But if the HRA can be applied toward both the reimbursement of medical expenses and the payment of premiums, employer HRA credits may not be used in the minimum value determination. An integrated HRA is an HRA that coordinates with an employer’s group health plan.

The proposed regulations also provide that a plan’s share of costs for minimum value purposes is generally determined without regard to reduced cost-sharing available under a nondiscriminatory wellness program. But in the case of nondiscriminatory wellness programs designed to prevent or reduce tobacco use, minimum value may be calculated assuming that every eligible individual satisfies the terms of the program. These rules apply to wellness program incentives that affect deductibles, co-payments, or other cost-sharing.

HSAs, HRAs, and wellness programs — Impact on affordability

Because HSAs cannot be used to pay premiums, they don’t affect affordability.

Amounts newly made available under an integrated HRA for the current plan year are taken into account in determining affordability if the employee may use the amounts only for premiums or if he or she may choose to use the amounts for either premiums or cost-sharing. According to the preamble to the proposed regulation, treating amounts that may be used either for premiums or cost-sharing towards affordability prevents double counting the HRA amounts when assessing minimum value.

Tracking the rules for determining minimum value, after 2014, wellness incentives may not be included as either additions to, or deletions from, an individual’s plan premium for purposes of calculating affordability unless the incentive is related to a tobacco cessation program. Thus, the affordability of a plan that charges a higher initial premium for tobacco users will be determined based on the premium that is charged to non-tobacco users, or tobacco users who complete the related wellness program, such as attending smoking cessation classes.

2014 Transition Rule

For purposes of applying the employer shared responsibility rules, for plan years beginning before January 1, 2015, an employer will not incur a penalty under the coverage prong where an employee qualifies for premium assistance if the offer of coverage would have been affordable or would have satisfied minimum value based on the required employee premium and cost-sharing determined as if the employee satisfied the requirements of any such wellness program (including a wellness program relating to tobacco use). This rule applies only to wellness plan terms and incentives in effect as of May 3, 2013, and only to employees who are in a category of employees eligible for the program as of that date.

The following table summarizes the rules governing wellness programs, HSAs and HRAs:

Health Savings Accounts, Health Reimbursement Accounts, and Non-discriminatory Wellness Programs: Summary of Impact on Affordability and Minimum Value

 

Affordability

Minimum Value

Current-year contributions to Heath Savings Accounts

Does not apply, since HSAs can’t be used to pay premiums

Amounts contributed by an employer for the current plan year to an HSA are taken into account in determining the plan’s share of costs for MV purposes.

Current-year contributions to integrated Heath Reimbursement Accounts—premiums and payment/reimbursement of medical expenses

Applies for purposes of the affordability determinations

Amounts newly made available under an integrated HRA for the current plan year are not taken into account for MV purposes.

Current-year contributions to integrated Heath Reimbursement Accounts—Limited to payment/reimbursement of medical expenses

Applies for purposes of the affordability determinations

Amounts newly made available under an integrated HRA for the current plan year are taken into account for MV purposes.

Non-discriminatory wellness programs for 2014

For purposes of applying the employer shared responsibility rules (i.e., Code § 4980H), affordability is determined by assuming that each employee satisfies the requirements of a wellness program (including a wellness program relating to tobacco use).

For purposes of applying the employer shared responsibility rules (i.e., Code § 4980H), MV is determined by assuming that each employee satisfies the requirements of a wellness program (including a wellness program relating to tobacco use).

Non-discriminatory wellness programs—other than tobacco cessation for 2015 and later years

Affordability is determined by assuming that each employee fails to satisfy the requirements of a wellness program.

A plan’s share of costs is determined without regard to reduced cost-sharing available under a nondiscriminatory wellness program.

Non-discriminatory wellness programs—tobacco cessation for 2015 and later

Affordability is based on the premium charged to non-tobacco users (or tobacco users who complete the alternative standard).

A plan’s share of costs is determined assuming every eligible individual satisfies the terms of a nondiscriminatory wellness program.

Modified Rule for Retirees

The proposed regulations provide that a pre-Medicare retiree who declines to enroll in available retiree coverage may qualify for premium assistance. This is similar to the rule adopted in final regulations under Code section 36B, under which an individual who may enroll in continuation coverage required under federal law or a state law is eligible for minimum essential coverage only for months that the individual is enrolled in the coverage. Under this proposed rule, a low-income retiree who declines to enroll in an employer’s retiree health plan may still qualify for premium assistance despite that employer’s coverage is both affordable and provides minimum value.

Top Five Traps for the Unwary in Spin-Offs

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A wave of corporate breakups has swept through the United States over the last few years as investors have taken notice of the fact that smaller companies focused on a single business tend to outperform their more diversified peers.  A primary vehicle for these breakups has been the spin-off transaction, in which a publicly traded parent company distributes the shares of the spin-off company (spinco) to its own shareholders, creating a new, independent publicly traded entity.  The New York Times, citing Dealogic, reported that there were 93 spin-off transactions worth $128 billion in 2011, and that 2012 kept pace with 85 spin-off transactions worth $109 billion.  The rationale for a spin-off often is to unlock the value in a business or division that is trapped in a larger corporate bureaucracy.  Conglomerates tend to spread capital across all of their divisions rather than focusing on the individual opportunities within each business that are the most promising.  Holding company structures also can make decision-making more cumbersome and equity incentives less incentivizing for division management who feel as though their hard work is being diluted by the underperformance of other divisions or businesses.

Spin-offs, however, are complicated transactions that require a great deal of advance planning.  In many cases, an announcement that a parent company is considering the spin-off of one of its businesses is actually the start of a “dual-track” process wherein the parent company considers and plans for a spin-off while also remaining open to potential bids from third parties to acquire the business.  In even more complicated cases, a parent company agrees to sell a business to an acquirer in connection with a spin-off transaction.

The vast majority of spin-off transactions are designed to qualify under the rules of the Internal Revenue Code as “tax free” to the parent company and the shareholders who receive the spinco stock.

With this in mind, any company considering spinning off a division or business should keep in mind the following five potential traps.

1.  Tax-Free Qualification – Legitimate Business Purpose 

The spin-off must satisfy a legitimate business purpose in order to qualify under both the tax-free rules of the Internal Revenue Code and the Securities Act of 1933.  The tax authorities require that the spin-off be motivated in whole or in substantial part by one or more legitimate corporate business purposes in order to ensure that the purpose of the transaction is not simply “tax avoidance.”  The business purpose requirement is one of many requirements under the tax laws to qualify for a tax-free spin-off.  Because the costs of triggering tax in a spin-off transaction often are very high, most parent companies obtain a legal opinion from outside counsel and obtain a ruling from the Internal Revenue Service as a condition to completing a spin-off transaction.  As discussed in relation to trap number five below, a legitimate business purpose for the spin-off also is required under the securities laws in order for the distribution of the spinco stock to not be treated as a “sale” of securities by the parent company or the spinco requiring Securities Act of 1933 registration and the strict liability standard of care that comes with such a registration.  See the article entitled, “Five Key Tax Considerations for Spin-Off Transactions” for a more in depth discussion of tax issues raised in spin-offs.

2.  Separation of Assets and Liabilities

Before a business or a division can be spun off, both its assets and its liabilities must be separated.  Large companies with long operating histories often find that the process of separating out the spinco business is not straightforward, because the legal entities that house the business might also house other businesses and divisions that share assets, services, products, employees, vendors and customers with the spinco business.  The pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial agreements, financing agreements, intellectual property licensing agreements, collective bargaining agreements, employment contracts, benefit plans, etc.  Often the spinco and the parent company or another legacy business must enter into complex sharing or licensing agreements or joint ventures relating to valuable intellectual property, such as trade names, trademarks or patents, as well as employee matters.  See the article entitled “Trademark, Domain Name and Other IP Considerations for Spin-Offs” for a more in depth discussion of IP issues raised in spin-offs and see the article entitled, “Employee Benefit Issues in a Spin-Off” for a more in depth discussion of employee benefit issues raised in spin-offs.

The sharing of liabilities is often the most complicated endeavour because of the slew of legal obligations that are triggered.  In allocating liabilities to the spinco, the parent company must evaluate the impact such allocation will have on the solvency of the parent and the spinco.  Parent company directors can face personal liability under state corporate law for making an unlawful dividend because the company lacked sufficient capital to make such a dividend or for rendering the parent company insolvent by distributing out the spinco business, and the parent company itself can face claims of constructive fraudulent conveyance—i.e., the parent company received less than equivalent value, and either the parent or spinco was rendered insolvent (assets do not exceed liabilities), the parent and/or spinco was left with unreasonably small capital to run its respective business, or the parent or spinco was left with debts that exceed its respective ability to pay those debts as they become due.  Parent company directors can rely on legal experts and financial advisors to assist them in satisfying their duty of care.  A solvency opinion from a nationally recognized provider of such opinions is often a condition to the consummation of a spin-off transaction.  Such an opinion may be helpful to the directors of the parent company and spinco for a variety of reasons: (i) it can help to show that the directors properly exercised their duty of care in determining to enter into the spin-off transaction; (ii) it can assist in rebutting a fraudulent conveyance claim; and (iii) it can assist in rebutting a claim that the company had insufficient capital to make such a dividend.

3.  Transition Services

While one of the key rationales for spinning off a business or division is to allow the enterprise to operate independently, the reality in most cases is that, at least during the first year or so post-spin, a spinco must rely on its former parent company to provide many key administrative and operational services during the spinco’s transition period to a self-sufficient, independent public company.  During the pre-spin planning period, companies should consider, among other things, which transition services will be required, how they will be provided, for how long and under what pricing terms.  Typical transition services include legal, internal auditing, logistics, procurement, quality assurance, distribution and marketing.  These arrangements often have durations that last between six and 24 months.  Many parent companies agree to provide such transition services purely on a cost basis, while others will use a “cost plus” or “market” rate.

4.  Spinco Management and Board of Directors

Again, while independence from the former parent company is a key benefit for most spincos, having corporate managers with institutional knowledge and history with the enterprise is an important factor in assisting the spinco to successfully transition to independence.  Many spinco management teams include members who have served as executives at the former parent company.  In many cases, these are managers who served as division leaders who reported to the parent company CEO or CFO and are now ready to step into executive roles on their own.  It is also common for between one and three members of the parent company board to agree to take seats on the spinco board to provide the new public company board with a source of the company’s history and culture to ensure a smooth transition.  However, because of the competing fiduciary duties that these directors will face if they hold seats on both the parent and spinco boards, it is important for the spinco board to also have a majority of truly independent directors.  Spinco directors who are former executive officers of the parent also must be aware that the stock exchanges and influential shareholder services firms such as Institutional Shareholder Services will not view them as being truly independent from a corporate governance standpoint for some time after the completion of the spin-off.  This will inhibit their ability to serve on key board committees of the spinco.

5.  Preparation of the Disclosure 

Under the U.S. Securities and Exchange Commission’s rules, a spin-off of the shares of a subsidiary to a parent company’s shareholders does not involve the sale of securities by either the parent company or the subsidiary as long as the following conditions are met: (i) the parent company does not provide consideration for the spun-off shares; (ii) the spin-off is pro rata to the parent company shareholders; (iii) the parent company provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; and (iv) the parent has a valid business purpose for the spin-off.

To meet the adequate public information requirement, parent companies are required to prepare and disseminate detailed “information statements” that effectively look like initial public offering registration statements for the spinco.  These information statements are filed with the spinco’s Form 10 registration statement, which is required in order to register the spinco’s shares under the Securities Exchange Act of 1934 and to permit listing of such shares on a national securities exchange.  The preparation of the spinco information statement can take up to three or four months and requires a great deal of effort and cooperation among the lawyers, the business leaders, the finance department, the human resources/employee benefits department and the auditors.  In addition, under New York law, a spin-off of all or substantially all of a company’s assets may require a vote of such company’s shareholders, while under Delaware law, such a requirement is much less likely.

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Obama Administration Aims to Restrict Physician Self-Referrals for Certain In-Office Services in Proposed Budget

Barnes & Thornburg

In its recently unveiled budget proposal for fiscal year 2014, the Obama administration has proposed saving billions in federal expenditures by tightening restrictions on certain services for which physicians can self-refer patients and receive government payment.

Under current federal law, a physician cannot make a referral to an entity for the furnishing of “designated health services” payable by government-funded health programs, such as Medicare, if the physician has a financial relationship with the entity. Correspondingly, this law—the “Stark Law”—also prohibits the entity receiving the referral from submitting a claim for payment for such services. Several exceptions, however, punctuate these prohibitions, including the “in-office ancillary services” exception, which shields referrals within physician practice groups for designated health services that meet specified criteria regarding the individual who furnishes the services, the location where the individual furnishes the services, and the party that bills for the services.

In an overview of the President’s 2014 budget plan for health care spending, the U.S. Department of Health and Human Services (HHS) notes that there are “many appropriate uses” for the in-office ancillary services exception, which the agency describes as designed to allow physicians to “self-refer quick turnaround services.” But, the agency cautions, some physicians have relied on the exception for certain services, such as advanced imaging and outpatient therapy that “are rarely performed on the same day as the related office visit.” Additionally, HHS claims, evidence suggests that the exception may have spurred “overutilization and rapid growth” of these services.

In light of these findings, the Obama administration has recommended excluding radiation therapy, therapy services (such as physical therapy and occupational therapy), and advanced imaging (such as CT scans and MRIs) from the in-office ancillary exception to encourage “more appropriate use of select services,” as HHS explains in the health spending overview. Notably, however, the administration would not extend this exclusion to “cases where a practice meets certain accountability standards,” which the HHS Secretary would have the authority to define, presumably before the exclusion would take effect in calendar year 2015 as the administration intends. Amending the Stark Law exception in this fashion would yield $6.1 billion in federal savings over 10 years, according to the administration.

Providers of the in-office services identified by the Obama administration should follow closely to see if the administration’s suggested change to the Stark Law makes it into the final budget and, if so, how the HHS Secretary ultimately defines the “accountability standards” that could make the difference between staying within the boundaries of the law and falling outside of them.

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Far From Perfection: Individual Alternative Minimum Tax Is Still Alive

Southern Methodist University, SMU Dedman School of Law

Spring 2013 Law Student Legal Writing Contest Winner

 

Introduction

On January 2, 2013, President Barack Obama signed the American Taxpayer Relief Act of 2012 (“ATRA”).[1] ATRA § 104 provides for annual inflation adjustments for purposes of the alternative minimum tax (“AMT”).[2] The law also makes Bush tax cuts permanent.[3] This paper focuses on the influences of the AMT on the individual tax liability with the proposals on a more rational AMT or a progressive replacement for the AMT. After a historical and academic overview of the AMT in Part I, the paper introduces the reasons of changing the AMT in Part II as failure of its intended purposes and the general tax policies. By elaborating in Part III the evaluation of ATRA and addressing the possible future reforms including a more rational AMT or a repeal of the AMT, the paper concludes that ATRA solution for the AMT is not the end but another start for the future tax reform.

I. Overview Of The AMT

The individual income tax has consisted of two parallel tax systems: a regular tax and an alternative tax.[4] The current version of the alternative tax is the AMT that operates parallel to the regular tax and sets a floor on total tax liability.[5] Taxpayers whose income exceeds the AMT exemption must calculate both regular tax and AMT liabilities and pay the larger amount of the two.[6]

1.          The History Of The AMT

The original minimum tax in 1969 was to guarantee that high-income individuals paid at least a minimal amount of tax.[7] Prior to ATRA, the AMT required annual congressional actions to prevent it from expansion on more taxpayers because of its design flaws.[8] 20 historical legislations on individual minimum taxes preceded ATRA.[9] Those changes before ATRA included the rates, the exemption amounts, and the credits allowed against the tax, but the basic structure had remained unchanged.[10] Over time, the AMT has become more influential on middle-class taxpayers.[11] Before 2000, the AMT was less than 2 percent of individual income tax revenue and 1 percent of total revenue, and affected less than 1 percent of taxpayers, so it played a minor role in the tax system.[12] Since 2000, the AMT is exploding.[13] The number of taxpayers owing the AMT grew from about 20,000 in 1970 to roughly 4 million in 2011.[14]

2.          The Definition And Operation Of The AMT

The Black Law Dictionary defines the AMT as “A tax, often a flat rate, potentially imposed on corporations and higher-income individuals to ensure that those taxpayers do not avoid too much (or all) income-tax liability by legitimately using exclusions, deductions, and credits.”[15] The AMT is the addition to regular income taxes,[16] and its amount equals to the excess of the AMT liability over the regular tax liability after appropriate credits.[17] Taxpayers calculate their taxes under the tentative AMT and the regular tax, and pay the higher of the two.[18] The following table shows the general formula of calculating the tentative AMT.

Taxable Income For Regular Tax Purposes[19]
− Certain Exclusions, Deductions, And Credits Allowed In The Regular Tax[20]
− The AMT Exemption Amount[21]
× The AMT Rate[22]
− The AMT Foreign Tax Credit[23]
= The Tentative AMT

The Tentative AMT Calculation

3.          The Intended Purposes And Policies Of The AMT

Underlying goals of the AMT are requiring high-income taxpayer to pay some tax, deterring the aggressive use of tax shelters, and ensuring progressivity.[24] Being originally motivated by a simplified version of vertical equity,[25] the AMT’s simple mission was making all Americans pay tax regardless of their tax shelters and avoidance efforts.[26] Additionally, the AMT is a second-best backstop for a porous regular income tax system by reducing distortions and avoiding tax sheltering because Legislature cannot address directly some unwarranted tax shelters in the regular income tax system.[27] Moreover, the AMT should increase the tax system progressivity, which means average tax burdens increase with income-size classes in all years and ensure the vertical equity of the tax system.[28]

II. Why To Change

The AMT failed its purposes and had explosive expand to the middle-class taxpayers because it was not indexed for inflation and Bush tax cuts reduced regular income tax without a permanent AMT fix. Moreover, the AMT thwarted generally accepted tax polices such as equity and efficiency bymodifying regular income tax incentives, altering marginal tax rates, increasing complexity, and reducing transparency.

1.          Failure of Intended Purposes Of The AMT

The AMT fails its intended purposes because of its expansion. Before ATRA, two main factors were responsible for the explosive growth in the AMT since 2000: it was not indexed for inflation and Bush tax cuts reduced regular income tax without a permanent AMT fix.[29] Inflation is an important factor of the long-term AMT receipts, but the exemption amounts and the tax rate brackets in AMT were not indexed to automatically adjust and keep pace with inflation as the regular tax before ATRA.[30] Because taxpayers pay the higher of the tentative AMT and the regular tax, the different treatments between the two tax systems would push more taxpayers to the AMT. Additionally, Bush tax cuts reduced regular tax rates without changing the AMT, which would have resulted a dramatic increase in the projected future number of AMT taxpayers.[31] If Legislature had not made the temporary adjustments (“patches”) to the AMT, more returns would be subject to the AMT after Bush tax cuts.[32] However, the patches have only served to mask the underlying problems rather than a permanent solution.[33] ATRA makes Bush tax cuts permanent.[34]

Because of its expansion, the AMT failed its purposes of requiring high-income taxpayer to pay some tax, deterring the aggressive use of tax shelters, and ensuring progressivity for the following ways.[35]

Although Congress originally enacted the AMT to prevent high-income individuals from sheltering all of their income and paying no tax, its expansion gradually moves the types of the AMT taxpayers from higher-income to lower-income by encroaching on the middle class.[36] Because taxpayers would pay higher of the tentative AMT and the regular tax, the top statutory rate for regular income tax higher than the top statutory rate for the AMT would move high-income individuals without substantial sheltering to the regular tax system.[37]

Additionally, the AMT fails to impede some tax shelters. For example, the current AMT cannot stop the tax shelters by reporting capital gains, which could be deferred for years and faced a low statutory rate after recognition.[38] Under the different tax rate treatments between ordinary income and capital gain in the regular tax, an investment that would be a loss before tax when the income including capital gains was less than the expense, but the same investment could be profitable after tax because expenses were overstated for tax purposes and capital gains had lower tax rates.[39] The post-1987 AMT does not have different rate treatment between long-term capital gains and ordinary income as the regular tax, which leads high-income taxpayers report large amounts of capital gains and generally receive the same tax break under the AMT as under the regular income tax.[40]

Furthermore, progressivity of the tax system means average tax burdens increase with income-size classes in all years.[41] The contribution to the AMT from middle-class families was increasing significantly while the contribution to the AMT from high-income families was decreasing, so the AMT becomes less progressive over time,[42] which causes less vertical equity in the tax system.

2.          The AMT Thwarting Generally Accepted Tax Policies

The AMT thwarted generally accepted tax polices such as equity and efficiency bymodifying regular income tax incentives, altering marginal tax rates, increasing complexity, and reducing transparency

A.         Modifying Or Limiting Regular Income Tax Incentives[43]

For the horizontal equity, the AMT should reduce the variance of average effective tax rates among taxpayers with similar incomes.[44] However, the AMT differently affects taxpayers with similar incomes but different family circumstances or different state of residence.[45] The AMT disallows the deduction for state and local taxes, so it affects more taxpayers who live in the places with high state and local taxes.[46] Moreover, the AMT replaces the personal exemptions based on filing status and number of dependents in the regular tax with one single exemption solely based on filing status, so the AMT will not benefit larger families and marriage.[47] Additionally, the AMT has the exemption for married couples less than twice of that for singles[48] and has the same brackets regardless of filing status, so the AMT has more impact on married than unmarried.[49] Furthermore, the AMT requires higher percent of AGI as the threshold (10 percent) to deduct medical expenses than the regular tax (7.5 percent), and disallows the deduction for mortgage interest paid on secondary residences and interest paid on certain other mortgage debt,[50] which discourage the incentives to get medical treatments and purchase real property.

B.         Altering Marginal Tax Rates

Because Legislature cannot address directly some unwarranted tax shelters in the regular income tax system, the most plausible economic rationale for the AMT is that it is a second-best backstop for a porous regular income tax system by reducing distortions and avoiding tax sheltering.[51] However, because the AMT exempts a large share of income for many middle-class taxpayers and has the phase-out of the AMT exemption,[52] the AMT fails on the efficiency policy by taxing narrower base of income and imposing higher marginal rates than the regular income tax for the most AMT taxpayers.[53] Narrower base and higher marginal tax rates in AMT can decrease after-tax income, discourage work, and reduce economic efficiency.[54]

C.         Increasing Complexity And Reducing Transparency

The AMT can increase the complexity of the tax calculations and reduce the transparency of the tax system because it can affect people’s behavior, alter the distribution of taxes, and complicate the tax planning decisions.[55] Taxpayers need to complete AMT forms in addition to their regular income tax returns,[56] and keep two separate sets of books because of the different deferral preferences between the AMT and the regular income tax.[57] Most people filling out the AMT forms end up owing no additional taxes.[58] Using computer software[59] may lower the complexity of filings, but it will increase the out-of-pocket costs and decrease taxpayer’s intended incentives in the tax code.[60]

III. ATRA Solution: Not The End But Another Start

The increasing number of taxpayers in the AMT placed pressure to permanently restructure of the AMT.[61] In 2013, President Obama signed ATRA, § 104 of which provides for annual inflation adjustments for purposes of the AMT and makes Bush tax cuts permanent.[62] This part lays out the evaluation of ATRA and addresses the possible future reforms including a more rational AMT or the AMT abolishment.

1.          Evaluation Of ATRA Solution

This section assesses ATRA solution in the context of possible legislative options before its enactment, the insufficiency of the current solution, and the potential barriers for the future AMT reform.

A.         Legislative Options Before ATRA

The problems in the AMT placed pressure to permanently restructure of the AMT. Before the enactment of ATRA, the alternative options to repeal the AMT included repealing regular tax, indexing the AMT’s parameters for inflation, and allowing additional exemptions and deductions under the AMT.

(1)  The AMT Or The Regular Income Tax[63]

A debate exists on the elimination of the AMT or the regular income tax. Because ATRA indexes the AMT for inflation and makes Bush tax cuts permanent,[64] the AMT will affect 8 million households by 2020.[65] After the permanent extension of Bush tax cuts by the ATRA, repealing the AMT would reduce revenues by over $2.7 trillion between 2011 and 2022.[66] On the contrary, the advocates of regular tax state that the single AMT system would lead undesirable policy changes from current law.[67] By eliminating the regular tax, the differences between the AMT and the regular tax would alter the current distribution of the income tax, which would be especially detrimental against middle class.[68]

This paper would respectfully join the pro-regular-tax alignment. The statistical indicators of immense scope of the AMT are mostly based on the legislations before ATRA, so it must be subject to change after ATRA. Even assuring that the statistical changes after ATRA are small, it would be against the legislative logic to remove the regular tax and preserve the AMT because the regular tax is the foundation of the AMT calculation.[69] The approach of eliminating the regular tax is analogous to remove the tree trunk (the AMT) from the root (the regular tax) and expect the tree trunk to grow bigger and stronger. Additionally, simply eliminating the regular tax would sacrifice substantial revenues, impose marriage penalties, produce higher marginal tax rates, etc.[70] Admittedly, neither the AMT nor the regular tax is a perfect tax system. However, the regular tax has fewer defects than the AMT.[71] As the discussion in Part II, Section 2A, the AMT rejects the deduction of the state and local taxes; disallows exemptions for dependents; requires higher percent of AGI as the threshold to deduct medical expenses than the regular tax; and disallows the deduction for mortgage interest paid on secondary residences and interest paid on certain other mortgage debt. These defects do not exist in the regular tax. Moreover, Legislature would consider the cost-benefit to eliminate the regular tax. The cost of eliminating the regular tax would be the lost revenue from the regular tax and the cost of correcting the defects of the AMT. Assuming that the lost revenue from eliminating either the regular tax or the AMT would be close in number, the cost of improving the AMT will probably be higher than improving the regular tax because the regular tax has fewer defects than the AMT.[72]

(2) Rationale Of Congress On Choosing Inflation Index

Before the enactment of ATRA, Legislature could permanently limit the expansion of the AMT’s impact in a number of ways, such as indexing the AMT’s parameters for inflation; allowing additional exemptions and deductions under the AMT; and eliminating the AMT.[73] This part will not discuss the elimination of the regular tax as a legislative option for the reasons in the preceding section (1).

Permanently indexing the AMT’s parameters for inflation was a compelling candidate for AMT reform before ATRA. Even though the patches to the AMT exemptions can have similar effects as the inflation indexing, they create uncertainty for taxpayers and their financial decisions.[74] Additionally, allowing additional exemptions and deductions under the AMT would offset the erosion of the un-indexed AMT exemptions caused by inflation and would provide similar relief as indexing the AMT for inflation.[75] To provide some reliefs for AMT taxpayers, Legislature could allow state and local taxes deductions and dependent exemptions, lower the threshold of medical expense deduction, and loose the rules on interest deductions.Moreover, because the AMT did not fulfill its purposes or policies but became a de facto ATM machine for generating additional tax revenue from middle-class taxpayers,[76] the most comprehensive approach would simply eliminate the individual AMT, which will relief all taxpayers from the complexity and opacity of two parallel tax systems.[77] The following table gives the brief comparisons and contrasts for the three options.

                Consequences

 

 

Legislative Options

 Decreased Number Of AMT Taxpayer In 2010 After Adopting The Optional Reform 2010-2019 Lost Tax Revenue By Adopting The Optional Reform
Option 1: Indexing The AMT’s Parameters For Inflation 22 million[78] $450 billion[79]
Option 2: Allowing Additional Preferences Under The AMT 25 million[80] $530 billion[81]
Option 3: Eliminating The AMT 27 million[82] $620 billion[83]

Legislative Options And Their Consequences Before ATRA

The table above can show that indexing the AMT’s parameters for inflation was the cheapest option before ATRA among the three options. Moreover, either allowing additional preferences under the AMT or eliminating the AMT is more difficult and complex legislation procedures than indexing the AMT for inflation. Allowing additional preferences will have a lot of detailed changes for the current regular tax system. Additionally, the following Section 3 of the paper can show that eliminating the AMT will be a progressive procedure with the AMT indexing as the initial step. Furthermore, indexing the AMT for inflation will be the prerequisite of allowing additional preferences under the AMT because the preferences should be indexed for inflation.[84] So Congress made a right choice to have the AMT indexing for inflation in ATRA.

B.         Insufficiency Of ATRA Solution

The AMT actually affects taxpayers with similar incomes but different family circumstances or different state of residence differently, raising the variance of after-tax income.[85] After ATRA, the AMT still rejects the deduction of the state and local taxes; disallows exemptions for dependents; requires higher percent of AGI as the threshold to deduct medical expenses than the regular tax; and disallows the deduction for mortgage interest paid on secondary residences and interest paid on certain other mortgage debt. Moreover, ATRA does not eliminate the phase-out of the AMT exemption that leads additional marginal tax rates,[86] so most taxpayers still have higher marginal tax rates under the AMT than under the regular income tax.[87] Additionally, ATRA does not reduce complexity and increase transparency of the AMT. Taxpayers still need to complete AMT forms in addition to their regular income tax returns,[88] and keep two separate sets of books.[89] Furthermore, the AMT after ATRA still fails to impede some shelters, such as the ones involved with capital gains.[90] The future legislations after ATRA should change these defects or abolish the whole AMT.

C.         Barrier To AMT Reform After ATRA

A significant barrier to AMT reform has been the challenge of what to do about the lost revenues.[91] If the AMT reform would have no offsets, federal budget deficits would rise and the cost would be shifted to the future taxpayers.[92] Methods of offsetting the revenue loss from the AMT reform include broadening the base for the regular income tax or raising its rates, increasing revenues from other tax sources, and reducing spending.[93] Regular tax system would have to rise by a similar magnitude to offset the revenue loss, may eliminate various tax preferences, and could raise all or some of rates on capital gains, dividend income, etc.[94] However, if other tax increases or spending reductions would offset the resulting revenue losses, the AMT reform would benefit some taxpayers and disadvantage others.[95]

2.          Possibility Of Creating A More Rational AMT

The more rational AMT should “keep the baby but throw out the bathwater.”[96] If the AMT will remain, a more rational system should allow additional exemptions and deductions as the regular tax[97], and neutralize the potential federal deficit by increasing the AMT tax bracket[98] and eliminating the preferential rates for capital gains in regular tax.[99]

3.          Feasibility Of Repealing The AMT

If Legislature will repeal the AMT, it can be a progressive elimination.[100] The following flowchart illustrates the progressive procedure of the AMT elimination.

à

Indexing The AMT For Inflation

Step 1

(Completed)

à

Allowing Dependent Personal Exemptions

Step 2

à

Repealing The Phase-out And Allowing Same Deductions As Regular Tax

Step 3

à

Deleting Deferral Preferences

Step 4

à

 NO AMT

AMT

The Flowchart On The AMT Progressive Elimination

ATRA has already finished Step 1.[101]  Step 2 can remove almost the entire middle class from the AMT.[102] Step 3 will eliminate the major different tax preferences between the AMT and the regular tax and end the AMT except for high-income taxpayers.[103] Step 4 will significantly increase the number of high-income taxpayers who pay no income tax because deferral preferences have a greater tendency to affect high-income taxpayers.[104]

Two reasonable methods can offset the revenue loss after the AMT progressive elimination. First, after the AMT deletion, Legislature can impose an add-on tax.[105] However, this option is actually back to the origin of the AMT,[106] and will have the possibility to repeat some AMT mistakes in future. Second, changing the regular income tax can reduce some federal deficits.[107] Some AMT provisions, which are preventing investment activities to avoid the regular income tax,[108] should be incorporated into the regular income tax after repealing the AMT.[109] But the legislation of such incorporations may not be easy because the AMT was created to backstop the unwarranted tax shelters that Legislature could not address directly for some reasons in the first place.[110] Additionally, Legislature can raise some or all of the regular income tax rates, including tax rates on capital gains and dividend income,to compensate the lost revenue after the termination of the AMT.[111] Moreover, the AMT elimination can pair with the abolishment of various regular tax preference, such as state and local tax deduction to reduce the federal deficits.[112]

Conclusion

The individual AMT operates parallel to the regular income tax by defining income differently, imposing different tax rates, and allowing different tax preferences. Ideally, the most comprehensive approach should be reforming the income tax to eliminate the AMT. But considering the reality under the huge pressure of potential federal revenue loss, Legislature chose the AMT indexing for inflation in ATRA. As Republican Senator Orrin Hatch of Utah told ABC News, “Far from perfect, this legislation does include a permanent fix to the ever-growing the AMT, giving millions of hard-working, middle-class families certainty that the nightmare of this tax has finally come to an end.”[113] As long as the individual AMT exists, the future tax reform is still foreseeable.

[1]126 Stat 2313 (2013).

[2]Id.

[3]Luke Landes, Fiscal Cliff Bill Passes: American Taxpayer Relief Act of 2012 (H.R. 8), http://www.consumerismcommentary.com/fiscal-cliff-bill-american-taxpayer… (last visited April 1, 2013).

[4]Congressional Budget Office, Economic and Budget Issue Brief: The Individual Alternative Minimum Tax, 1 (2010); Katherine Lim & Jeff Rohaly, The Individual Alternative Minimum Tax: Historical Data and Projections, Urban-Brookings Tax Policy Center, 1, 3 (2009).

[5]Id.

[6]Congressional Budget Office, supra note 4, at 2; I.R.S., supra note 7 (“Thus, the AMT is owed only if the tentative minimum tax is greater than the regular tax.”);Burman et al., supra note 7, at 1.

[7]I.R.S. Topic 556 – Alternative Minimum Tax, http://www.irs.gov/taxtopics/tc556.html (last visited April 1, 2013); Lim & Rohaly, supra note 4, at3; Leonard E. Burman et al., The Individual Alternative Minimum Tax (AMT): 12 Facts and Projections, Urban-Brookings Tax Policy Center, 1 (2008).

[8]Lim & Rohaly, supra note 4, at3.

[9]Leonard E. Burman et al., Historical Features of Individual Minimum Taxes, Urban-Brookings Tax Policy Center, 1, 2 (2011).

[10]Greg Leiserson & Jeff Rohaly, What Is Responsible for the Growth of the AMT?, Urban-Brookings Tax Policy Center, 1 (2007).

[11]Burman et al., supra note 9, at 1.

[12]The Joint Committee on Taxation, Present Law and Background Relating to the Individual Alternative Minimum Tax, JCX-10-07 (2007); Lim & Rohaly, supra note 4, at5-7.

[13]Burman et al., supra note 7, at 1.

[14]Aggregate AMT Projections 2011-2022, Urban-Brookings Tax Policy Center (2011).

[15]Black’s Law Dictionary, 1, 1594 (9th ed. 2009) (under the definition of “Tax”).

[16]1 MertensLaw of Fed.Income Tax’n§ 4:39 (“The alternative minimum tax is a tax upon income.”).

[17]Congressional Budget Office, supra note 4, at 2.

[18]Id. at 2; I.R.S., supra note 7;Burman et al., supra note 7, at 1.

[19]Lim & Rohaly, supra note 4, at3.

[20]I.R.S., supra note 7.

[21]I.R.S., supra note 7 (stating that the AMT exemption amount is set by law).

[22]Id. (stating that AMT rate is set by law and the rates in effect for the regular tax are used for capital gains and certain dividends).

[23]I.R.C. § 59; Leonard E. Burman & David Weiner, Suppose They Took the AM Out of the AMT?,Urban-Brookings Tax Policy Center, 1, 6 (2007) (“After determining pre-credit tentative AMT liability above, taxpayers subtract foreign tax credits (FTC) to calculate tentative AMT liability.”).

[24]Lim & Rohaly, supra note 4, at6.

[25]Leonard E. Burman et al., The Expanding Reach of the Individual Alternative Minimum Tax, Urban-Brookings Tax Policy Center, 1, 7 (2005).

[26]2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 86.

[27]Burman et al., supra note 25, at 8 (“For example, by taxing interest income from bonds that state and local governments issue to support private activities like shopping centers or stadiums, income that is exempt from the regular income tax, the AMT reduces the subsidy afforded such investments.”).

[28]Tom Petska & Mike Strudler, Income, Taxes, And Tax Progressivity: An Examination Of Recent Trends In The Distribution Of Individual Income And Taxes, Statistics of Income Division, I.R.S., http://www.irs.gov/pub/irs-soi/indincdi.pdf (last visited April 1, 2013).

[29]Lim & Rohaly, supra note 4, at3; Burman et al., supra note 7, at 2; Leiserson & Rohaly, supra note 10, at 1.

[30]Congressional Budget Office, supra note 4, at 1.

[31]Leiserson & Rohaly, supra note 10, at 3; Gabriel Aitsebaomo, The Individual Alternative Minimum Tax and the Intersection of the Bush Tax Cuts: A Proposal for Permanent Reform, 23 Akron Tax J. 109, 134 (2008).

[32]Congressional Budget Office, supra note 4, at 1.

[33]Leiserson & Rohaly, supra note 10, at 3.

[34]Landes, supranote 3.

[35]Burman et al., supra note 25, at 11.

[36]Congressional Budget Office, supra note 4, at 5-7; Lim & Rohaly, supra note 4, at6; Burman et al., supra note 7, at 2.

[37]Lim & Rohaly, supra note 4, at6.

[38]Burman et al., supra note 25, at 9.

[39]Burman et al., supra note 25, at 9 (2005).

[40]Lim & Rohaly, supra note 4, at6, n.10.

[41]Petska & Strudler, supra note 28.

[42]Burman et al., supra note 25, at 7.

[43]Congressional Budget Office, supra note 4, at 7.

[44]Burman et al., supra note 25, at 7.

[45]Id. at 7-8.

[46]Burman et al., supra note 7, at 2.

[47]I.R.C. §§ 55, 56, 151; Burman et al., supra note 7, at 2.

[48]I.R.C. §§ 55(d)(1), 56; Rev. Proc. 2013-15, 2013-5 I.R.B. 444.

[49]Lim & Rohaly, supra note 4, at7.

[50]I.R.C. §§ 55, 56, 163, 213; Congressional Budget Office, supra note 4, at 8.

[51]Burman et al., supra note 25, at 8.

[52]Lim & Rohaly, supra note 4, at8-9.

[53]Lim & Rohaly, supra note 4, at10.

[54]Burman et al., supra note 7, at 2 (“Marginal tax rates affect the incentive to work, save, and comply with the tax system.”); Congressional Budget Office, supra note 4, at 7-8 (“The AMT can subject taxpayers to higher marginal tax rates—which, in turn, influence decisions about how much to work and save, potentially reducing economic efficiency.”).

[55]Congressional Budget Office, supra note 4, at 7.

[56]Id. at 8.

[57]Burman et al., supra note 25, at 11.

[58]Burman et al., supra note 7, at 2; Burman et al., supra note 25, at 11.

[59]See, e.g.,I.R.S., supra note 7 (“If you are filing the Form 1040, you may use the AMT Assistant for Individuals, which is an electronic version of the AMT worksheet available on the IRS website.”).

[60]Congressional Budget Office, supra note 4, at 9.

[61]Congressional Budget Office, supra note 4, at 3.

[62]126 Stat 2313 (2013); Landes, supranote 3.

[63]Burman & Weiner, supra note 23, at Table 2 (listing the regular tax and the AMT provisions for comparison and contrast).

[64]126 Stat 2313 (2013); Landes, supranote 3.

[65]Lim & Rohaly, supra note 4, at6.

[66]Urban-Brookings Tax Policy Center, supra note 14.

[67]2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 87.

[68]Burman et al., supra note 7, at 2 (“The AMT is encroaching on the middle class.”);2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 87 (“Relative to the current system, many middle-income taxpayers would face higher marginal tax rates, while lower- and very high-income taxpayers would face lower marginal tax rates.”).

[69]I.R.S., supra note 7 (“The AMT is the excess of the tentative minimum tax over the regular tax.”); Congressional Budget Office, supra note 4, at 2 (stating that the AMT is the addition to regular income taxes, and its amount equals to the excess of the AMT liability over the regular tax liability after appropriate credits).

[70]Burman & Weiner, supra note 23, at 17.

[71]2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 87.

[72]Id.

[73]Congressional Budget Office, supra note 4, at 9.

[74]Id. at 10.

[75]Congressional Budget Office, supra note 4, at 10.

[76]Aitsebaomo, supra note 31, at 141.

[77]2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 85-87.

[78]Congressional Budget Office, supra note 4, at 10 (“If the exemption amounts in effect for 2009 were made permanent and indexed for inflation after 2009, along with the AMT’s brackets and the threshold at which the exemption phased out, 5 million taxpayers would pay the AMT in 2010—rather than the 27 million projected to pay under current law—and revenues would be about $450 billion lower from 2010 to 2019 than they would be otherwise.”).

[79]Id.

[80]Id. (In January of 2010, The CBO estimates that this option would decrease the number of people affected by the AMT from 27 million to 2 million in 2010).

[81]Id.

[82]Lim & Rohaly, supra note 4, at3 (“Absent another temporary fix or other change in law, the tax cuts and lack of indexation will combine to push more than 27 million taxpayers onto the AMT in 2010.”).

[83]Congressional Budget Office, supra note 4, at 10 (The CBO estimating a revenue cost of more than $620 billion from 2010 to 2019 for the AMT elimination). See also Urban-Brookings Tax Policy Center, supra note 14(showing that the cost of repealing the AMT would be over $2.7 trillion between 2011 and 2022 after the permanent extension of Bush tax cuts by the ATRA).

[84]Id. (“To provide some relief to taxpayers, lawmakers could allow them to use the standard deduction, personal exemptions, and deductions for state and local taxes (as they are used under the regular tax) when computing their tax liability under the AMT. The standard deduction and personal exemptions are both indexed for inflation, and state and local taxes also generally rise with prices.”).

[85]Burman et al., supra note 25, at 7-8.

[86]I.R.C. §§ 55(d)(1), 56; Rev. Proc. 2013-15, 2013-5 I.R.B. 444; 2005 Report of the President’s Advisory Panel on Federal Tax Reform, Chapter Five-Seven, supra note 26, at 87 (“The phase-out of the AMT exemption at higher income levels actually creates two additional marginal tax rates – and a resulting tax rate schedule of 26, 32.5, 35, and 28 percent.”).

[87]Congressional Budget Office, supra note 4, at 8.

[88]Id.

[89]Burman et al., supra note 25, at 11.

[90]Lim & Rohaly, supra note 4, at6, n.10.

[91]Burman et al., supra note 7, at 3 (“Paying for reform or repeal is a key issue”).

[92]Congressional Budget Office, supra note 4, at 1.

[93]Id. at 9.

[94]Id.

[95]Id. at 1.

[96]Burman et al., supra note 25, at 11.

[97]Aitsebaomo, supra note 31, at 139 (“Given that the major pitfall of the AMT is its increasing proliferation into the unintended returns of middle and upper middle class taxpayers, a permanent remedy to this unintended spread should be to exempt taxpayers with AGI of $250,000 or less from the AMT altogether. The implementation of such exemption would help align the AMT closer to its original purpose and policy objective of ensuring that wealthy individuals (not middle and upper middle class taxpayers) would be subject to the AMT.”); Burman et al., supra note 25, at 13.

[98]Burman et al., supra note 25, at 13 (proposing increasing the 28 percent AMT bracket to 33.5 percent to offset the revenue loss because it would only increase taxes for those with incomes above the AMT exemption phase-out).

[99]Burman et al., supra note 25, at 13; Burman & Weiner, supra note 23, at 15 (“If capital gains are taxed at the same 37 percent rate as other income, the option could raise $67 billion that could be applied to deficit reduction.”).

[100]Burman et al., supra note 25, at 11-13.

[101]Id.at 11.

[102]Id. at 12.

[103]Id.

[104]Id. at 12-13.

[105]Leonard E. Burman & Greg Leiserson, A Simple, Progressive Replacement for the AMT, Tax Analysts Viewpoints, 945 (2007) (proposing the 4 percent add-on tax of AGI above certain amount that will be indexed for inflation.).

[106]Burman et al., supra note 9, at 1(illustrating 4 add-on tax related legislations in the early stage of the AMT as 1969 TRA, 1976 TRA, 1978 Revenue Act, and 1982 TEFRA).

[107]Burman et al., supra note 25, at 14.

[108]Id. at 8 (“For example, by taxing interest income from bonds that state and local governments issue to support private activities like shopping centers or stadiums, income that is exempt from the regular income tax, the AMT reduces the subsidy afforded such investments.”).

[109]Congressional Budget Office, supra note 4, at 10.

[110]Burman et al., supra note 25, at 8.

[111]Congressional Budget Office, supra note 4, at 10.

[112]Id.; Burman et al., supra note 25, at 14, n.13 (stating that eliminating the regular income tax deduction for state and local taxes would more than pay for repealing the AMT).

[113]Dan Kadlec, At Long Last, a Permanent Patch for a Dreaded Tax Read, Time Business & Money (Jan. 03, 2013), http://www.consumerismcommentary.com/fiscal-cliff-bill-american-taxpayer-relief/.

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Considerations For International Clients Who Intend to Buy A Home In the U.S.

Sheppard Mullin 2012

International buyers invested $82.5 billion in U.S. residential real estate (4.8% of total U.S. sales) according to the most recent survey conducted by the National Association of Realtors for the 12 month period ending with March 2012. According to that survey, the top states in the U.S. for international buyers were Florida, California, Arizona and Texas. That survey also finds that the top-five international buyers were from Canada, China, Mexico, India, and the United Kingdom and that Brazil also remains a major source of purchasers. Homes are bought in the U.S. for investment, vacation-use, temporary use for professional, educational (which could include providing a home to a child who is pursuing his or her education in the U.S.), and a myriad of other reasons.

U.S. home buying and ownership, without proper planning, can have unexpected and unintended consequences. Many international clients are not aware that ownership of a U.S. home triggers U.S. estate tax on death and a gift of the property during lifetime triggers U.S. gift tax. U.S. estate and gift tax is imposed at a rate of 40%. An individual who is neither a U.S. citizen nor domiciled in the U.S. can shelter only $60,000 of U.S. situs assets on death (i.e. assets located or deemed to be located within the U.S.). In terms of gifting, an individual who is neither a U.S. citizen nor domiciled in the U.S. can make annual exclusion gifts of $14,000 per year to anyone and can currently pass $143,000 per year to a spouse who is not a U.S. citizen free of gift tax. That is in contrast to the $5,250,000 that a U.S. citizen or domiciliary can pass free of estate tax on death or by gift during lifetime as well as unlimited transfers to a U.S. citizen spouse.

To avoid triggering U.S. estate tax on death, many international clients are counseled to take title to the home in a foreign “blocker” corporation which, if respected, is not subject to U.S. estate tax on death. This form of title has the added advantage of providing anonymity and liability protector to the shareholder . Owning a home in a foreign corporation triggers other more immediate tax concerns such as application of the corporate tax rate (up to 35%) in lieu of the preferential long-term capital gains rates on sale (up to 20%), possible imputed rental income for use of corporate property by the shareholder, loss of step-up in the income basis of the home on the death of the owner (the basis of the stock in the corporation would be adjusted but the inside basis—the home itself would not be entitled to a basis adjustment), and loss of the ability to avoid the home being reassessed for California real property tax purposes on transfer from parent to a child. In addition, a U.S. person who will inherit shares in a corporation that will either become a Controlled Foreign Corporation (CFC) or a passive foreign investment company (PFIC) faces numerous special compliance obligations and substantive tax issues as a result of the ownership of those shares. There are many other ways to take title, such as through a LLC or a trust and each option should be explored in depth to achieve the client’s objectives to the maximum extent possible. Consideration should also be given to planning aimed at avoiding a public court proceeding that would be necessary to convey title to the beneficiaries of an international client who dies holding title directly to a U.S. home.

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Investment Regulation Update – April 2013

GT Law

The Investment Regulation Update is a periodic publication providing key regulatory and compliance information relevant to broker-dealers, investment advisers, private funds, registered investment companies and their independent boards, commodity trading advisers, commodity pool operators, futures commission merchants, major swap participants, structured product sponsors and financial institutions.

This Update includes the following topics:

  • SEC Adopts Rules to Help Protect Investors from Identity Theft
  • Increased Attention to Broker-Dealer Registration in the Private Fund World
  • SEC Issues Guidance Update on Social Media Filings By Investment Companies
  • AIFMD — Effect on U.S. Fund Managers
  • SEC Announces 2013 Examination Priorities
  • Reminder — Upcoming Form PF Filing Deadline
  • Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline
  • Are you a Lobbyist?
  • Recent Events

SEC Adopts Rules to Help Protect Investors from Identity Theft

On April 10, 2013, SEC Chairman Mary Jo White’s official first day on the job, the SEC, jointly with the CFTC, adopted rules and guidelines requiring broker-dealers, mutual funds, investment advisers and certain other regulated entities that meet the definition of “financial institution” or “creditor” under the Fair Credit Reporting Act (FCRA) to adopt and implement written identity theft prevention programs designed to detect, prevent and mitigate identify theft in connection with certain accounts. Rather than prescribing specific policies and procedures, the rules require entities to determine which red flags are relevant to their business and the covered accounts that they manage to allow the entities to respond and adapt to new forms of identity theft and the attendant risks as they arise. The rules also include guidelines to assist entities subject to the rules in the formulation and maintenance of the required programs, including guidelines on identifying and detecting red flags and methods for administering the program. The rules also establish special requirements for any credit and debit card issuers subject to the SEC or CFTC’s enforcement authority to assess the validity of notifications of changes of address under certain circumstances. Chairman White stated, “These rules are a common-sense response to the growing threat of identity theft to all Americans who invest, save or borrow money.” The final rules will become effective 30 days after date of publication in the Federal Register and the compliance date will be six months thereafter.

Increased Attention to Broker-Dealer Registration in the Private Fund World

The role of unregistered persons in the sale of interests in privately placed investment funds is an area of great interest for the SEC and the subject of recent enforcement actions. On March 8, 2013, the SEC filed and settled charges against a private fund manager, Ranieri Partners, LLC, one of the manager’s senior executives and an external marketing consultant regarding the consultant’s failure to register as a broker-dealer. The Ranieri Partners enforcement actions are especially interesting for two reasons: (i) there were no allegations of fraud and (ii) the private fund manager and former senior executive, in addition to the consultant, were charged.

On April 5, 2013, David Blass, the Chief Counsel to the SEC’s Division of Trading and Markets, addressed a subcommittee of the American Bar Association. His remarks have been posted on the SEC website. Mr. Blass referenced a speech by the former Director of the Division of Investment Management, who expressed concern that some participants in the private fund industry may be inappropriately claiming to rely on exemptions or interpretive guidance to avoid broker-dealer registration.

In addition, Mr. Blass noted Securities Exchange Act Rule 3a4-1’s safe harbor for certain associated persons of an issuer generally is not or cannot be used by private fund advisers. He suggested that private fund managers should consider how they raise capital and whether they are soliciting securities transactions, but he did acknowledge that a key factor in determining whether someone must register as a broker-dealer is the presence of transaction-based compensation. The Chief Counsel also raised the question of whether receiving transaction-based fees in connection with the sale of portfolio companies’ required broker-dealer registration. He suggested that private fund managers may receive fees additional to advisory fees that could require broker-dealer registration, e.g., fees for investment banking activity.

On a related note, in two recent “no-action” letters, the SEC has established fairly clear rules regarding how Internet funding network sponsors may operate without being required to register as broker-dealers. On March 26 and 28, 2013, the SEC’s Division of Trading and Markets addressed this narrow, fact-specific issue in response to requests from FundersClub Inc. and AngelList LLC seeking assurances that their online investment matchmaking activities would not result in enforcement action by the SEC. The April 10, 2013 GT Alert—SEC Clarifies Position on Unregistered Broker-Dealer Sponsors of Internet Funding Networks is availablehere.

SEC Issues Guidance Update on Social Media Filings by Investment Companies

On March 15, 2013, the SEC published guidance from the Division of Investment Management (IM Guidance) to clarify the obligations of mutual funds and other investment companies to seek review of materials posted on their social media sites. This report stems from the SEC’s awareness of many mutual funds and other investment companies unnecessarily including real-time electronic materials posted on their social media sites (interactive content) with their Financial Industry Regulatory Authority filings (FINRA). In determining whether a communication needs to be filed, the content, context, and presentation of the communication and the underlying substantive information transmitted to the social media user and consideration of any other facts and circumstances are all taken into account, such as whether the communication is merely a response to a request or inquiry from the social media user or is forwarding previously-filed content. The IM Guidance offers examples of interactive content that should or should not be filed with FINRA. The IM Guidance is the first in a series of updates to offer the SEC’s views on emerging legal issues and to provide transparency and enhance compliance with federal securities laws and regulations. You may find a link to the SEC Press Release and IM Guidance here.

On a related note, on April 2, 2013, the SEC released a report of an investigation regarding whether the use of social media to disclose nonpublic material information violates Regulation FD. The SEC has indicated that, in light of evolving communication technologies and habits, the use of social media to announce corporate developments may be acceptable; however, public companies must exercise caution and undertake careful preparation if they wish to disseminate information through non-traditional means. The April 5, 2013 GT Alert—Social Media May Satisfy Regulation FD But Not Without Risk and Preparation by Ira Rosner is available here.

AIFMD – Effect on U.S. Fund Managers

New European Union legislation that regulates alternative asset managers who manage or market funds within the EU comes into force on July 22, 2013. The Alternative Investment Fund Managers Directive (AIFMD) will have a significant impact on U.S. fund managers if they actively fundraise in Europe after July 21, 2013 (or if they manage EU-domiciled fund vehicles). Historically, U.S. private equity firms raising capital in Europe have relied on private placement regimes that essentially allowed marketing to institutions and high net worth investors. Beginning July 22, 2013, U.S. fund managers may continue to rely on private placement regimes in those EU jurisdictions that continue to operate them; however, they will now be under an obligation to meet certain reporting requirements and rules set out in the AIFMD relating to:

  • transparency and disclosure, and
  • rules in relation to the acquisition of EU portfolio companies.

The transparency and disclosure rules require, for the most part, the disclosure of information typically found in a PPM; however, additional items are likely to be required such as the disclosure of preferential terms to particular investors and level of professional indemnity cover. The rules also require reports to be made to the regulator in each jurisdiction in which the fund has been marketed. The reports will need to include audited financials, a description of the fund’s activities, details of remuneration and carried interest paid, and details of changes to material disclosures. Acquisitions of EU portfolio companies also lead to reporting obligations on purchase – an annual report – and a rule against “asset stripping” for 24 months after the acquisition of control. Firms with less than €500 million in assets under management are exempt from the reporting requirements and reverse solicitation is potentially an option, as the directive does not prevent an EU institution from contacting the U.S. fund manager, but in practice it may be difficult to apply systematically.  Fund managers may choose to register in the EU on a voluntary basis from late 2015. This will allow marketing across all EU member states on the basis of a single registration. However, registration will come with a significant compliance burden. If you plan to market in the EU after July 23, 2013, ensure that you review your marketing materials, evaluate your likely reporting obligations and consider how the portfolio company acquisition rules are likely to impact your transactions.

SEC Announces 2013 Examination Priorities

On February 21, 2013 the SEC’s National Examination Program (NEP) published its examination priorities for 2013. The examination priorities address issues market-wide, as well as issues relating to particular business models and organizations. Market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and technology controls.  Priorities in specific program areas include: (i) for investment advisers and investment companies, presence exams for newly registered private fund advisers, and payments by advisers and funds to entities that distribute mutual funds; (ii) for broker-dealers, sales practices and fraud, and compliance with the new market access rule; (iii)for market oversight, risk-based examinations of securities exchanges and FINRA, and order-type assessment; and (iv) for clearing and settlement, transfer agent exams, timely turnaround of items and transfers, accurate recordkeeping, and safeguarding of assets, and; (iv) for clearing agencies, designated as systemically important, conduct annual examinations as required by the Dodd-Frank Act. The priority list is not exhaustive. Importantly, priorities may be adjusted throughout the year and the NEP will conduct additional examinations focused on risks, issues, and policy matters that are not addressed by the release.

Reminder—Upcoming Form PF Filing Deadline

SEC registered investment advisers who manage at least $150 million in private fund assets with a December 31st fiscal year end should be well underway in preparing their submissions for the approaching April 30, 2013 deadline. Filings must be made through the Private Fund Reporting Depository (PFRD) filing system managed by the Financial Industry Regulatory Authority (FINRA). As a reminder, advisers to three types of funds must file on Form PF: hedge funds, liquidity funds and private equity funds. Hedge funds are generally defined as a private fund that has the ability to pay a performance fee to its adviser, borrow in excess of a certain amount or sell assets short. Liquidity funds are defined as a private fund seeking to generate income by investing in short-term securities while maintaining a stable net asset value for investors. Private equity funds are defined in the negative as not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not generally provide investors with redemption rights. When classifying its funds, advisers should carefully read the fund’s offering documents and definitions on Form PF and should seek assistance of counsel. Particularly, we have seen the broad definition of hedge fund cause a fund considered a private equity fund by industry-standards to be a hedge fund for purposes of Form PF, thus subjecting the fund to more expansive reporting requirements. As is the case with filing Form ADV through IARD, the $150 Form PF filing fee is paid through the same IARD Daily Account and must be funded in advance of the filing. FINRA recently updated their PFRD System FAQs. The SEC has also posted new Form PF FAQs, which should be referred to for upcoming filings.

Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline

All entities, including private funds, engaged in swap transactions must adhere to the ISDA Dodd-Frank Protocol no later than May 1, 2013 in order to engage in new swap transactions on or after May 1. Adherence to the Dodd-Frank Protocol will result in an entity’s ISDA swap documentation being amended to incorporate the business conduct rules that are applicable to swap dealers under Dodd-Frank.  Adherence to the Protocol involves filling out a questionnaire to ascertain an entity’s status under Dodd-Frank (e.g., pension plan, hedge fund and corporate end-user).  Further information on adherence to the Protocol can be obtained at ISDA’s website by clicking here.

Are you a lobbyist?

Over the last decade, many state and municipal governments have enacted new laws regarding how businesses may interact with government officials. These laws often establish new rules expanding the activities that are deemed to be “lobbying,” who is required to be registered as a lobbyist and what information must be publicly disclosed. Approximately half of the states, and countless municipalities, now define lobbying to include attempts to influence government decisions regarding procurement contracts – including contracts for investment advisors and placement agents – and impose steep penalties for companies that fail to register and disclose their “lobbying” activities and expenditures. Although some lobbying laws include exceptions for communications that occur as part of a competitive bidding process, the rules are inconsistent and not always clear. For example, although New York City’s lobbying law long included procurement lobbying, in 2010 the City’s Corporation Counsel and the City Clerk issued letters warning businesses that “activities by placement agents and other persons who attempt to influence determinations of the boards of trustees by the City’s . . . pension funds” are likely to be considered lobbying activity that requires registration and disclosure. Similarly, California’s lobbying law was expanded in 2011 to expressly include persons acting as “placement agents” in connection with investments made by California retirement systems, or otherwise seek to influence investment by local public retirement plans. Greenberg Traurig’s Investment Regulation Group, in conjunction with our Political Law Compliance team, is available to assist clients with questions regarding how to navigate increasingly complex lobby compliance laws and rules across the country and beyond. GT has a broad range of experience in advising to some of the world’s leading corporations, lobbying firms, public officials and others who seek to navigate lobbying and campaign finance laws.

Recent Events

On April 18, 2013, GT hosted the seminar, “The Far Reaching Impact of FATCA Across Borders and Across Industries” as both a webinar and live program in NY and Miami. The seminar explored the latest FATCA regulations and key intergovernmental agreements as well as their applications to a variety of industries. Click here to view the presentation.

On April 10, 2013, GT sponsored Artisan Business Group’s EB-5 Finance seminar at our NYC office. The program exposed participants to a unique alternative financing opportunity for projects that lend themselves to the EB-5 immigrant investor program and featured several GT speakers, including Steve Anapoell and Genna Garver, Co-Chair of the Investment Regulation Group, who provided a securities law update and considerations in the EB-5 area. Guest speakers included Jeff Carr from EPR, Phil Cohen from the EB-5 Resource Center, and Reid Thomas from NES Financial.

On April 2, 2013, GT co-hosted a Global Compliance seminar with Dun & Bradstreet on Foreign Corrupt Practices Act (FCPA) issues. The program included an overview of the FCPA, with a specific emphasis on the Department of Justice’s recently released Resource Guide to the FCPAand recent enforcement activities. A link to the Resource Guide can be found here.

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