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November 2021 IRSAC Report

In case you missed it, the Internal Revenue Service Advisory Council (IRSAC) published its November 2021 report. In it, there are a number of issues relevant to the U.S. federal tax information reporting community. Here are some of the key updates by both the Information Reporting Subgroup and the Large Business and International Subgroup.

Information Reporting Subgroup Issues

1. Digital assets. The industry has a number of open items that require guidance for the IRS including, but not limited to:

  • Existing disparities in information reporting by exchanges and custodians.
  • Whether exchanges, brokers, and other payors will be required to submit Forms 1099-K or Forms 1099-B, or another information return, during the transition period before the new Section 6045 regulations become effective.
  • Which digital assets are in scope and which are excluded from these reporting requirements?
  • Identification of who is a “broker” for purposes of Section 6045, specifically noting those that may not have control, receipt or custody of the income that gives rise to information reporting and withholding requirements under Section 6045 (e.g., node operators of decentralized protocols do not have access to payee tax profiles required to report information returns).
  • Clarifications about the source of income that gives rise to reportable transactions for Section 6041 reporting purposes. Because blockchain technology does not have a physical location, brokers will need clarity as to when new unites are treated as being derived from U.S. sources, for purposes of information reporting and withholding.
  • Certain terms, such as “covered” security need clarification in terms of digital asset, because transactions may occur without conversion to cash.
  • Whether wash sale rules apply to digital asset transactions. Generally, wash sales of securities are required to be reported only if the transactions take place in the same account and involve the same CUSIP number. Digital assets do not have a standard CUSIP number or central clearing agency to standardize the transaction details for purposes of applying the wash sale rules.
  • What is fair market value (FMV) when determining the value of a digital asset for Section 6045 reporting? There are thousands of digital assets that are traded daily with high price volatility across the same digital asset. These markets operate twenty-four hours a day and seven days a week, which complicates the pricing fluctuations categorically with no actual “closing price” on any day.
  • How should a broker measure the trading period for purposes of information reporting and withholding and how should a broker determine the FMV of digital assets for purposes of reporting?
  • Is there a de minimis rule applicable to digital asset transactions for purposes of Section 6045 reporting?

Internal Revenue Service Advisory Council recommends that the IRS:

  • Expedite the release of the modifications under Section 6045 in order to minimize ongoing taxpayer issues with digital asset transactions. However, the new reporting requirements should include sufficient time for the industry to prepare for and implement the proposed changes, and should contemplate fundamental information reporting issues, including who is a broker, what digital assets are in scope for reporting, and how to account for details related to the transactions for purposes of basis reporting.
  • Develop a strategic plan for analyzing and providing the industry with applicable withholding and information reporting guidance for other digital asset related transactions including income from staking, lending activities and NFT marketplaces.
  • Update existing publications and Form 1099 Instructions with examples of digital asset transactions subject to the requirements. Leverage traditional communications like Internal Revenue Bulletins to articulate guidance for more specific application of details.

2. Non-U.S. student and scholar Social Security and Medicare exemptions. Non-U.S. students and scholars are eligible to work under certain VISAs and conditions related to their presence in the United States. They are eligible for Social Security and Medicare tax exemptions in the first years in which they are present in the United States. Sometimes the employer and employee work out the exemptions and sometimes the employee bypasses the employer, which causes discrepancies between the employer and IRS records.

Internal Revenue Service Advisory Council recommends that the IRS:

  • Eliminate the requirement for employers to refund and adjust information returns that would be impacted by NRA Student employee exemption requests for a given tax year once the Form W-2 has been issued by employers.
  • Require employees to submit all required exemption substantiation documentation and Form 843 to the IRS for a refund of taxes withheld if the request for exemption review occurs after the issuance of Form W-2 for impacted tax year.
  • Create a grid on the current IRS notice requiring employers to provide quarterly wage and tax information related to the adjustment and refund issued to the employee by the IRS. This would be completed in lieu of a Form 941-X, if the employer chooses not to seek a refund of the employer portion of exempted wages.
  • Not require but permit the option for employers to submit Forms 941-X if they are seeking a refund of the employer portion of the taxes withheld.

3. Section 1446(f) regulations, specifically with respect to consistent withholding practices on transfers of interests in publicly traded partnerships. A number of issues need IRS guidance, including, but not limited to:

  • Whether a retroactive Form W-8 and accompanying withholding statement, where required, applicable with respect to Section 1446(f) withholding tax. In order for a withholding agent to reduce withholding tax based on the modified amount realized provisions, a non-U.S. partnership must allocate gain, not just income, on a withholding statement. Current withholding certificates do not include this information and are allowed to use retroactive forms; however, these will not be applicable for purposes of payments subject to Section 1446(f) withholding.

Internal Revenue Service Advisory Council recommends that the IRS:

  • Publish guidance regarding the treatment of PTP Loan Transactions under Section 1446(f).
  • Publish guidance regarding the treatment of short sales of PTP interests under Section 1446(f).
  • Publish guidance regarding the applicability of Section 1446(f) withholding tax to a distribution by a PTP if the PTP does not publish a qualified notice, or if the PTP publishes a qualified notice that does not specify the amount of the distribution attributable to amounts in excess of CNI.
  • Publish guidance regarding the rules applicable to withholding agent reliance on retroactive Forms W-8 and accompanying withholding statements under Section 1446(f).

4. Sourcing of negative interest rate payments. Currently there is no authority as to the characterization and source of a negative rate payment for U.S. tax purposes.

Internal Revenue Service Advisory Council requests that the IRS:

  • Publish guidance with respect to the source of a negative rate payment that is broad enough to cover payments on routine financial transactions such as deposits, collateral on derivatives, margin loans, and repos.
  • Where published guidance treats a negative rate payment as U.S. source fixed or determinable annual or periodical (FDAP) income, the guidance should be effective only after an adequate transition period for withholding agents to modify systems to account for this guidance, and the IRS should not challenge taxpayers who have taken a reasonable position with respect to the tax characterization and source of a negative tax rate payment prior to the effective date of the guidance.

Large Business and International Subgroup Issues

1. Consider Reasonable Cause prior to assessing penalties on international information reporting forms. IRS assesses automatic penalties for late or incomplete information reporting returns specifically on the following forms:

  • Form Forms 5471, Information Return of U.S. Persons Wirth Respect to Certain Foreign Corporations.
  • Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. trade or Business.
  • Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.
  • Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. Failure to file these forms does not result in underpayment of income or other tax liabilities.
  • Currently, the IRS does not consider the inability to obtain information due to secrecy laws or incorrect tax advice to constitute reasonable cause for failure to file or incomplete non-U.S. information returns.

IRSAC recommends that the IRS:

  • Consider the reasonable cause statement submitted by the taxpayer before penalties are automatically assessed and provide taxpayers a ninety-day grace period with a temporary hold on collection activity to remedy information reporting deficiencies after initial filing.
  • Consider developing a uniform reasonable cause statement and information template that provides taxpayers and their advisors with valuable guidance on best to submit information useful for IRS review and consideration and avoid follow-up requests that day resolution.

2. Continuation of Rev. Proc. 94-69. This allows Large Corporate Compliance taxpayers to avoid certain accuracy related penalties under Section 6662(b) by providing IRS with a written statement showing the additional tax due or making a disclosure within 15 days from the written information request form IRS personnel, instead of having to submit a Qualified Amended Return. IRS has proposed to eliminate the availability of this Rev. Proc.

IRSAC recommends that the IRS:

  • Maintain Rev. Proc 94-60, or an equivalent process, for large business taxpayers to inform the IRS of adjustments to an original filed income tax return while obtaining penalty protection.
  • Change the scope of taxpayers that may use the protection of this Rev. Proc.
  • Consider a standard submission protocol to ensure that the protections of this Rev. Proc. are available only for disclosures of complete and specific adjustments to the original return.

3. Protecting the Personal Identifiable Information (PII) of Responsible Parties. This is related to the Form SS-4 application to be assigned an employer identification number (EIN), which requires an individual to be designated as a “responsible party” and provide PII.

IRSAC recommends that the IRS:

  • Identify an existing proxy identification number that a responsible party could use in lieu of PII.

4. Ensuring timely issuance of Certificate of Residency Forms. Recently, taxpayers have been experiencing delays in receiving IRS Form 6166, Certification of U.S. Tax Residency, which harm the ability of U.S. investors to obtain treaty benefits to which they are entitled.

IRSAC recommends that the IRS:

  • Permit electronic filing of Form 8802, Application for United States Residency Certification.
  • Accelerate the submission date of Form 8802 prior to December 1st and begin processing applications on a rolling basis once received, so that they are ready to be issued as soon as possible after January 1st.
  • Continue to proactively engage and educate other non-U.S. competent tax authorities, so that they are aware of the IRS timeline and potential administrative delays for issuing Certifications of U.S. Tax Residency and advocate for grace periods for U.S. resident taxpayers to provide these Certifications to claim treaty benefits.

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November 2021 IRSAC Report

This document contains general information only and is not a substitute for accounting, tax, or any other professional advice or services. The information provided is considered accurate at the time of publishing and will not be updated with new regulation requirements.

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