Capitol Hill

On Oct. 13, the IRS issued a 518-page final rule under Section 385 of the U.S. tax code aimed at curtailing corporate inversions. Inversions occur when domestic companies move their headquarters overseas to take advantage of lower corporate tax rates.

Partisan gridlock between the Obama administration and Congress has made tax reform impossible given Democrats favor tax increases and Republicans strongly oppose them. So instead of working with Congress to make the tax code more competitive for domestic and multinational companies so they can invest and grow, the Department of Treasury took it upon itself to try to inhibit businesses headquartered in the U.S. from leaving.

The proposal

Under the proposed regulations, the IRS would have been authorized to reclassify certain related-party debt as equity (stock), in whole or in part, for federal income tax purposes to stop earnings-stripping transactions. After analyzing the proposed regulations earlier this year, NRCA found U.S. businesses structured as S corporations would have been negatively affected.

With 75 percent of NRCA members structured as pass-through businesses and a vast majority as S corporations, NRCA aggressively opposed the proposed regulations. NRCA's Washington, D.C., office undertook numerous efforts to have its members' concerns addressed in the final rule.

NRCA's efforts included working with allied organizations to file detailed comments outlining how the proposed regulations would harm employers; sending a grassroots action alert to all members; and meeting with numerous members of Congress to develop bipartisan opposition to the proposed regulations.

There was meaningful dialogue during the comment period between Congress and the Department of Treasury. The tax-writing committees sent letters outlining their concerns, which NRCA shared, and held roundtables with treasury officials to stress the need to protect common business practices.

The wins

NRCA is pleased to report the final rule included nearly all the changes requested and virtually no NRCA members will be affected by the final rule. This is a major victory at a time when regulations have come crashing down on businesses. NRCA is thankful the Department of Treasury listened to its concerns, narrowed the final rule to target bad actors and shielded small businesses.

NRCA's major concern was that by reclassifying certain debt as equity, a second class of stock would be created. S corporations only are allowed to have one class of stock and, therefore, would lose their S status and be forced to be taxed as C corporations. Given that S corporations can only be owned by U.S. citizens, it is unlikely they will engage in earnings-stripping activities or invert their companies. Therefore, the Department of Treasury exempted transactions made by S corporations in the final rule.

The proposed rule also included restrictions on businesses that use cash-pooling arrangements and short-term intercompany loans. Many NRCA members use these common, widely accepted business practices to finance their businesses. The final rule provides a broad exemption for cash pools and short-term loans.

In addition, the Department of Treasury expanded the exceptions for distributions (payments made to affiliated companies) to generally include future earnings and allow corporations to net distributions against capital contributions. The agency also included exceptions for ordinary course transactions, such as acquisitions of stock associated with employee compensation plans.

NRCA was concerned about the paperwork burden associated with disclosing loans to the IRS within 30 days as was required by the proposed rule. If a roofing contractor were subject to the final rule, there would not be relief provided when it came to filing IRS reports. Thankfully, the 30-day window was removed, and companies have until they file their yearly tax returns to report any qualifying transaction. Also, the documentation rules don't take effect until Jan. 1, 2018.

The final rule's effective date is April 4, 2016, which means it is retroactive and could punish business owners for transactions that were deemed acceptable at the time.

NRCA is watching the administration's actions closely to prepare for any other regulations that may become final in the coming months.

Andrew Felz is NRCA's manager of federal affairs.