15 November 2017 Senate Finance Committee tax reform proposal includes provisions affecting banking and capital markets The tax reform proposal description released by the Senate Finance Committee on November 9, 2017, includes many general tax provisions that would affect banking and capital markets, such as rate reduction, as well as several provisions specifically concerning banking and capital markets. A cash-basis taxpayer includes an amount in income when the amount is actually or constructively received. A taxpayer generally is in constructive receipt of an amount if the taxpayer has an unrestricted right to demand payment. An accrual-basis taxpayer includes an amount in income when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy, unless an exception allows deferral or exclusion. For example, several exceptions allow tax deferral for advance payments of income. The provision would modify the income recognition rules by requiring a taxpayer to recognize income no later than the tax year in which the amount is taken into income on the taxpayer's financial statements. In addition, the plan would apply this rule before applying the original issue discount (OID) rules, so that items such as late-payment fees, cash-advance fees, and interchange fees would be included in taxable income when received if these items are treated as income when received on the taxpayer's financial statements. An exception would apply for long-term contract income to which Section 460 applies. Additionally, the provision would codify the deferral method of accounting for advance payments for goods and services contained in Revenue Procedure 2004-34. Under that method, taxpayers could defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if the income were deferred for financial statement purposes. The provision would apply to tax years beginning after December 31, 2017. Application of these rules would be a change in the taxpayer's accounting method for Section 481 purposes. The provision would accelerate certain taxable income that previously would have been recognized in a period following that for book purposes. Given that the proposal would apply to income only, it would leave in place book/tax differences that treat expenses as recognized for financial statement purposes, but not for tax. Applying Section 451 first would accelerate receipts such as late payment fees, cash advance fees and over-limit fees that the industry currently defers as original issue discount. Outside of original issue discount, this provision could require acceleration of income on other financial products to the extent income on those transactions is recognized for book purposes earlier than tax. For example, if the taxpayer must mark securities for book purposes but is not on mark-to-market accounting for tax purposes (e.g., for derivatives used to hedge a taxpayer's borrowings), this could have the effect of placing a taxpayer on the higher of cost or market for federal income tax purposes. Insured depository institutions paying an assessment by the Federal Deposit Insurance Corporation (FDIC) to support the Deposit Insurance Fund (DIF) may deduct the amount paid as a trade or business expense. The provision would make a percentage of such assessments non-deductible for institutions with total consolidated assets over $10 billion. The percentage of nondeductible assessments would equal the ratio that total consolidated assets in over $10 billion bears to $40 billion. Assessments would be completely non-deductible for institutions with total consolidated assets over $50 billion. Limitation or elimination of this deduction would increase effective tax rates for those larger banks that are subject to the provision. Section 103 excludes from gross income the interest on any state or local bond. State and local bonds are classified generally as either governmental bonds or private activity bonds. Governmental bonds are bonds whose proceeds are primarily used to finance governmental facilities or that are repaid with governmental funds. Private activity bonds are bonds for which the state or local government serves as a conduit providing financing to nongovernmental persons (e.g., private businesses or individuals). Bonds issued to finance the activities of charitable organizations described in Section 501(c)(3) (qualified 501(c)(3) bonds) are one type of private activity bond. The exclusion from income for interest on state and local bonds only applies if certain Code requirements are met. The Section 103 exclusion applies to refunding bonds (i.e., bonds used to pay principal, interest or redemption price on a prior bond issue), but there are limits on "advance refunding" bonds. An advance refunding occurs when organizations refinance their outstanding debt but cannot call the outstanding debt for at least 90 days after the issuance of the new debt. The Code limits the number of times that a bond can be advance refunded. Generally, governmental bonds and qualified 501(c)(3) bonds may be advance refunded one time. Private activity bonds, other than qualified 501(c)(3) bonds, may not be advance refunded at all. Furthermore, for an advance refunding bond that results in interest savings, the refunded bond must be redeemed on the first call date 90 days after the issuance of the refunding bond that results in debt-service savings. The provision would repeal the exclusion from gross income for interest on a bond issued to advance refund another bond. Advance refunding bonds are common in periods of declining interest rates, allowing governmental agencies and tax-exempt organizations to benefit from refinancing at lower rates even though the outstanding debt is not currently callable. Ending that ability could raise costs for those entities and have the corollary effect of decreasing the supply of tax-exempt bonds. Gain or loss generally is recognized for tax purposes when realized, by computing the difference between the amount realized on the sale and the taxpayer's adjusted basis in the property. Various basis computation rules apply to taxpayers that acquire stock in a corporation on different dates or at different prices and subsequently sell or transfer some of the shares of that stock. If the lot from which the stock is sold or transferred is not adequately identified, the shares sold are deemed to be those acquired earliest (the first in, first out rule). If a taxpayer makes a "specific identification" of shares that it sells, however, the identified shares are treated as sold. In addition, a taxpayer that owns shares in a regulated investment company (RIC) may elect — in lieu of either the first in, first out rule or specific identification — to determine the basis of RIC shares sold under one of two average-cost-basis methods described in Treasury regulations (together, the "average basis method"). A broker must report to the IRS a customer's adjusted basis in a "covered security" (i.e., generally any specified security acquired after an applicable date specified in the basis-reporting rules) that the customer has sold and whether any gain or loss from the sale is long-term or short-term. The provision would require determination of the cost of any specified security sold, exchanged or otherwise disposed of to be based on the first-in, first-out rule — except to the extent the average basis method is otherwise allowed (as in the case of stock of a RIC). The provision would also make several conforming amendments, including a rule restricting a broker's basis-reporting method to the first-in, first-out rule for the sale of any stock for which the average basis method is not permitted. Mandating first-in, first-out lot relief decreases planning opportunities and, in a rising market, generally will result in larger gains being recognized earlier than smaller gains or losses. Current law allows business interest as a deduction in the tax year in which the interest is paid or accrued, subject to certain limits. Section 163(j) limits a corporation's ability to deduct disqualified interest (i.e., interest paid or accrued to a related party when no federal income tax is imposed on the interest) if: (1) the payor's debt-to-equity ratio exceeds 1.5 to 1.0 (safe harbor ratio); and (2) the payor's net interest expense exceeds 50% of its adjusted taxable income. In general, adjusted taxable income is the corporation's taxable income calculated without taking into account deductions for net interest expense, net operating losses (NOLs), domestic production activities under Section 199, depreciation, amortization and depletion. Disallowed interest amounts may be carried forward indefinitely and any excess limitation may be carried forward for three years. The provision would limit the net interest expense deduction for every business, regardless of form, to 30% of adjusted taxable income. The provision would require the interest expense disallowance to be determined at the tax-filer level (e.g., at the partnership rather than partner level). Adjusted taxable income for purposes of this provision would be a business's taxable income calculated without taking into account: (i) any item of income, gain, deduction, or loss that is not properly allocable to a trade or business, (ii), business interest expense, (iii) business interest income, (iv) the 17.4% deduction for certain pass-through income, and (v) NOLs. The provision would allow businesses to carry forward interest amounts disallowed under the provision to succeeding tax years indefinitely. Any carryforward of disallowed interest would be an item taken into account in the case of certain corporate acquisitions described in Section 381 and treated as a "pre-change loss" subject to limitation under Section 382. The provision would include special rules to allow a pass-through entity's owners to use unused interest limitation for the tax year and to ensure that net income from pass-through entities would not be double-counted at the partner level. The provision would exempt businesses with average annual gross receipts of $15 million or less from these rules. The provision also would not apply to certain regulated public utilities and, at the taxpayer's election, any real property trades or businesses. Businesses sometimes prefer debt financing to equity financing, because interest expense is normally deductible, while dividends paid are not. The provision would expand the ambit of Section 163(j), further limiting the ability to deduct interest expense, thus lessening the attractiveness of debt financing. Document ID: 2017-1936 |
