Legislative update: Preliminary observations regarding year-end tax legislation

KPMG’s preliminary observations

The House today passed the “Protecting Americans from Tax Hikes Act of 2015”—the PATH Act. This is the first part of the year-end legislative package that includes tax provisions. The second part is the omnibus spending bill (Omnibus Bill) which is scheduled for a vote in the House tomorrow.

Related content

The following discussion provides KPMG’s preliminary observations regarding the tax provisions in the PATH Act and the Omnibus Bill.  

Congressional schedule

Both the PATH Act and the Omnibus Bill are being considered in the House via a parliamentary procedure that aims to combine the two bills by attaching them both as amendments to H.R. 2029, the Military Construction and Veterans Affairs and Related Agencies Appropriations Act, 2016. The House voted today to attach the PATH Act to H.R. 2029 and is expected to vote tomorrow (December 18) on the question of whether to also approve the Omnibus Bill by adding it as a separate amendment to H.R. 2029.  

Assuming that both amendments pass the House, H.R. 2029 (then renamed the ‘‘Consolidated Appropriations Act, 2016’’ and containing both the Omnibus Bill and the PATH Act in one bill) will be sent to the Senate for consideration. Senate action on H.R. 2029 is expected to follow shortly thereafter, perhaps as early as late Friday evening or over the weekend.


The PATH Act would:

  • Make permanent some provisions in the Code that recently expired or that are scheduled to expire, including the research credit and the exception under Subpart F for active financing income
  • Extend certain other expired provisions through 2019
  • Extend other expired provisions through 2016
  • Extend and phase out certain energy provisions over a defined schedule

Extensions of provisions that already have expired generally would be retroactive to the beginning of 2015.  

In addition, both the PATH Act and “Division P” of the Omnibus Bill include other significant tax policy changes, including provisions relating to real estate, the medical device excise tax, the so-called “Cadillac tax” on certain health care plans, loss deferral under section 267, modifications to the section 199 rules as applied to independent oil refiners, certain procedural matters, and a host of other issues.  

The Omnibus Bill also includes a temporary extension of the ban on states and localities taxing internet access.


Revenue estimates

The Joint Committee on Taxation (JCT) has estimated that the PATH Act would lose approximately $622 billion over the 10-year scoring window.  The costs of extending items does not appear to have been offset. However, the PATH Act includes revenue raisers to offset the costs of other measures. 

The JCT has estimated that the tax provisions of the Omnibus Bill would lose approximately $58 billion over the 10-year scoring window. 

Read the JCT revenue estimates:

Permanent extensions (with some modifications)

The PATH Act would make permanent the research credit, 34 years after its original, temporary enactment.  The credit would be reinstated for qualified research expenses (QRE) paid or incurred on or after January 1, 2015.  The current methods of computing the research credit would not be changed: i.e., a “traditional” regular credit at a nominal rate of 20%, or the Alternative Simplified Credit (ASC) at a nominal rate of 14%.

Effective for research credits determined for tax years beginning after 2015, certain businesses with average annual gross receipts of $50 million or less would be allowed to offset their alternative minimum tax (AMT) liability with the credits.  Also, for tax years beginning after 2015, certain start-up companies with gross receipts for the year of less than $5 million would be allowed to elect to apply up to $250,000 of their research credit against their payroll tax liability, instead of their income tax liability.

KPMG observation:  There have been proposals in Congress to raise the rate of the ASC to 20%, and to eliminate the traditional credit.  Those changes are not included in this legislation.  Tax professionals expect efforts to make those changes will continue.

The PATH Act also would make permanent the following other provisions:

  • Exception under subpart F for active financing and insurance income
  • The $500,000 higher limitation on the amount of depreciable property that may be expensed under section 179 in the year placed in service, which has generally been in effect since 2010.  This limitation is reduced when the taxpayer’s total investment in eligible property for the year exceeds $2 million. This would be effective for property placed in service on or after January 1, 2015; the dollar amounts would be indexed for inflation in tax years beginning after 2015.  Rules allowing a section 179 election for computer software and for up to $250,000 of qualified leasehold improvement property, qualified retail improvements, and qualified restaurant property would also be made permanent, and the $250,000 limitation would be removed for tax years beginning after 2015.  A long-standing exclusion for air conditioning and heating units would be repealed for tax years beginning after 2015. 
  • Reduction in section 1374 built-in gains (BIG) tax recognition period to five years (with a special rule for distributions to shareholders pursuant to section 593(e))
  • Basis adjustment to stock of S corporations making charitable contributions of property
  • 100% exclusion of gain on qualified small business stock (and elimination of the AMT preference item for such excluded gain)
  • The 15-year depreciation recovery period for portions of a building that are qualified leasehold improvements, qualified retail improvements, or qualified restaurant property for property placed in service on or after January 1, 2015.  The legislation separately would extend bonus depreciation through 2019, with a newly defined category of qualified property called qualified improvement property; some of this 15-year property may meet the definition of qualified improvement property and would be eligible for bonus depreciation while it is in effect. However, qualified improvement property would not necessarily be eligible for 15-year depreciation.
  • Definition of regulated investment company (RIC) as qualified investment entity under the “Foreign Investment in Real Property Tax Act” (FIRPTA)
  • Treatment of certain dividends by RICs to foreign investors
  • The minimum 9% low-income housing credit rate for investments in new buildings that are not federally subsidized.  A rule that excludes military housing allowances for purposes of determining whether certain tenants are low-income also would be made permanent.
  • Tax-free distributions from individual retirement accounts (IRAs) for charitable purposes.  This provision would apply to distributions after the IRA owner attains age 70½ years and would be limited to $100,000 per taxpayer per tax year.
  • Enhanced charitable deduction for contributions of food inventory (modified to increase the limit on deductible contributions of food inventory and by providing special rules for valuing food inventory)
  • Modification of tax treatment of certain payments to controlling exempt organizations
  • Special rules for contributions of capital gain real property made for conservation purposes (modified to permit Alaska Native Corporations to deduct certain donations of conservation easements up to 100% of taxable income)
  • Parity for exclusion from income for employer-provided mass transit and parking benefits. For 2015 and 2016, $130 per month could be excluded in combined transit pass and vanpool benefits.  For 2016, the monthly exclusion limit for qualified parking would be $255.
  • Deduction for state and local general sales taxes
  • The general business credit allowed to certain small employers (generally, with fewer than 50 employees) that provide differential wage payments to employees while they are on active duty in the uniformed services.  The credit would be made available to all employers in tax years beginning after 2015.
  • Deduction for certain expenses of elementary and secondary school teachers (modified to index the $250 cap on expenses for inflation and to include expenses for certain professional development courses for tax years beginning after December 31, 2015)
  • Enhanced child credit
  • American opportunity tax credit
  • Enhanced earned income tax credit 

Temporary extensions through 2019

The PATH Act generally would extend the following expired provisions retroactively from the beginning of 2015 through 2019.

First, it would extend look-through treatment of payments between related controlled foreign corporations (CFCs) under foreign personal holding company rules.

Second, the PATH Act would extend authority for the Treasury Department to allocate new markets tax credits to qualified community development entities (which then award the credits to investors who make qualified equity investments in the entity), and $3.5 billion of credits would be authorized for each year from 2015 through 2019, the same amount that has been authorized for 2010 through 2014.

Third, the PATH Act would extend the work opportunity credit, effective for the wages an employer pays in the first year to targeted employees who begin work after 2014 and before 2020.  Beginning in 2016, there would be a new category of targeted employees: individuals who have been unemployed at the time they begin work for at least 27 consecutive weeks, who have received federal or state unemployment compensation for some portion of that period.

Finally, it would extend the 50% “bonus depreciation” deduction. However, the deduction percentage would be reduced to 40% for property placed in service in 2018, and to 30% for 2019. Current-law rules that allow certain extended production period property and certain corporate aircraft an extra year to be placed in service would continue, so the 30% rate would apply to that through 2020. 

Beginning in 2016, the allowance of the bonus for qualified leasehold improvement (QLI) property would be modified.  The modified category is called “qualified improvement property.”  Under the new rules, improvements to an interior portion of a commercial building that meet the requirements to be QLI would be bonus-eligible whether or not the improvement is to a leasehold in the building, and improvements would qualify even if they are made before the building has been in service for three years.  Another provision in the legislation would make permanent the 15-year depreciation treatment of QLI property; not all qualified improvement property would be eligible for a 15-year recovery period.

The election allowing a corporation to forego bonus depreciation (and to use straight-line depreciation) on its qualified property, and instead to accelerate the ability to use additional alternative minimum tax (AMT) credits, would also continue through 2019 (through 2020, if a taxpayer has qualified long-production period property in that year).  The additional credits would continue to be refundable.  For qualified property placed in service in 2015, the amount of accelerated AMT credits would, as in the past, be based in part on the amount of AMT credits generated before 2006 that were available in the first tax year ending after March 31, 2008 (also limited by reference to the amount of foregone bonus depreciation that would be foregone, and in all cases limited to $30 million).  For tax years ending after 2015, the annual limitation would be 50% of the AMT credits generated in tax years ending before January 1, 2016, but not more than the total amount of such pre-2016 credit that has not been previously used as a credit (and also limited by reference to the amount of foregone bonus depreciation).  A corporation that owns more than 50% of the capital and profits interests of a partnership could apply the provision to its distributive share of the partnership’s qualified property.

Also, a taxpayer could elect to apply the bonus depreciation rules to the basis of certain plants bearing fruits or nuts that are planted or grafted, in the United States, in the 2016 through 2019 period. 

Long-term extension of energy credits with phase-outs

The Omnibus Bill includes long-term extensions to wind and solar tax credits along with a phase-out schedule for each. 

With respect to wind facilities, the “begin construction deadline” for the production tax credit would be extended five years from the current deadline of December 31, 2014, to December 31, 2019. In addition, the “begin construction deadline” with respect to the election to claim the investment tax credit in lieu of the production tax credit also would be extended to December 31, 2019. 

The amount of the credit would be determined by the year in which construction begins.

Period in which construction begins Reduction to credit
Before January 1, 2017 No reduction
After December 31, 2016, and before January 1, 2018 20% reduction
After December 31, 2017, and before January 1, 2019 40% reduction
After December 31, 2018, and before January 1, 2020 60% reduction

The effective date for these amendments relating to wind facilities under sections 45 and 48 would be January 1, 2015.

With respect to the 30% investment tax credit for solar energy facilities under section 48, such facilities would now be required only to have begun construction by a certain deadline—rather than being placed in service (i.e., a “begin construction deadline” approach). 

The deadline for solar energy property would be extended five years from the current deadline of December 31, 2016, to property whose construction begins on or before December 31, 2021.

Similar to the amendments for wind facilities, the investment tax credit for solar would be reduced the later construction begins:

Period in which construction begins Credit rate
Before January 1, 2020 30%
After December 31, 2019, and before January 1, 2021 26%
After December 31, 2020, and before January 1, 2022 22%

In addition—unique to the proposed amendments for solar energy property—for any project for which the construction begins before January 1, 2022, but is not placed in service before January 1, 2024, the credit rate would be 10%.

The effective date for these amendments relating to solar energy property under section 48 would be the date of enactment of the legislation.

Read more at TaxNewsFlash-Legislative Updates

KPMG observation: The “begin construction approach” for solar energy property would appear to “level the playing field” between wind and solar with respect to the tax credit eligibility deadlines. (However, solar energy property still would not be eligible for the production tax credit.)

Temporary extensions through 2016

The PATH Act would temporarily extend (generally from January 1, 2014, through December 31, 2016) the following provisions that expired at the end of 2014:

  • Exclusion of income from discharge of qualified principal residence indebtedness (with a modification for discharges pursuant to a binding written agreement entered into before January 1, 2017)
  • Shorter depreciation recovery periods for tangible property used predominantly in the active conduct of a trade or business (other than gaming) within an Indian reservation.  For tax years beginning after 2015, a taxpayer would be permitted to elect out of the special recovery period for any class of property it places in service during the year.
  • The general business credit for certain wages paid to a member of an Indian tribe (or the member’s spouse) for services within an Indian reservation, while the employee lives on or near the reservation
  • Nonbusiness energy property credit (with modifications relating to energy efficiency for property placed in service after December 31, 2015)
  • Credit for alternative fuel vehicle refueling property
  • Second generation biofuel producer credit
  • Incentives for biodiesel and renewable diesel
  • Production credit for Indian coal facilities (with modifications removing the placed-in-service date limit, removing the nine-year limit, and allowing the credit to be claimed against AMT beginning in 2016)
  • Production tax credit for certain renewable sources of electricity (for facilities for which construction has commenced by the end of 2016)
  • Credit for construction of new energy efficient homes
  • Cellulosic biofuels bonus depreciation
  • Energy efficient commercial buildings deduction
  • Special rule for sales or dispositions relating to FERC or state electric restructuring policy for qualified electric utilities
  • Credits relating to alternative fuels
  • Credit for fuel cell motor vehicles
  • Deduction for mortgage interest premiums
  • Above-the-line deduction for qualified tuition
  • The general business credit for amounts paid for the maintenance of certain railroad track owned or leased by a Class II or Class III railroad in the United States.  For tax years beginning after 2015, the credit would be determined for railroad track owned or leased on January 1, 2015, rather than on January 1, 2005.
  • The general business credit allowed for certain training costs of a mine rescue team worker
  • Authorization for credits for state or local qualified zone academy bonds used to support a school in an empowerment zone or enterprise zone.  The Treasury Department would be authorized to allow tax credits for up to $400 million of such bonds issued each year in 2014 and 2015, the same level that has applied since 2011.
  • The three-year depreciation recovery period for any race horse, regardless of its age when it is placed in service.
  • The seven-year depreciation recovery period for motorsports entertainment complexes, including land improvements, support facilities, and certain buildings used by the public in attending racing events.
  • The election to expense 50% of the cost of advanced mine safety training equipment in the year it is placed in service.
  • The election to expense up to $15 million of the production costs of a film or television production, when at least 75% of the compensation of the production is for services performed in the United States by actors, production personnel, directors, and producers.  For productions the first performance of which is after 2015, the costs of staging live theatrical productions also would be eligible, generally limited to shows in venues with an audience capacity of 3,000 or less.  As is the rule for film and television productions, theatrical performances showing actual sexually explicit conduct would not be eligible.
  • Deduction with respect to income attributable to domestic production activity in Puerto Rico
  • Temporary increase in rum cover over limit
  • American Samoa economic development credit

In addition, the PATH Act would reinstate a 10% credit for the purchase of electric motorcycles in 2015 and 2016. The credit, which is capped at $2,500 per qualifying vehicle, was in place prior to 2014, but was allowed to expire on December 31, 2013. The provision would apply only to two-wheel, not three-wheel, electric vehicles.

Refer to the statutory language of the PATH Act for more details and for the complete list of provisions that would be extended by the legislation.

Procedural and compliance “program integrity” provisions

The PATH Act includes a “program integrity” title that includes a host of procedural and compliance changes (most of which are scored as raising revenue). 

One of the provisions in this title relates to modification of filing dates of certain returns and statements relating to employee wage information and nonemployee compensation.

KPMG observation: The bill would accelerate the filing date of Form W-2 with the IRS to January 31, the same date for furnishing W-2 forms to employees.  The ability to make corrections before submission to the IRS, possible with the March 31 due date, for electronically filed Forms W-2 (and the February 28 due date for paper-filed forms) would essentially no longer be available. This change would be effective for calendar year 2016 Forms W-2 required to be filed in 2017.

The PATH Act also contains a safe harbor for certain penalties for de minimis errors on information returns and payee statements.

KPMG observation:  The bill would provide much-welcomed relief to information return filers that discover errors of $100 or less (or withholding tax errors of $25 or less).  This provision would remove the administrative burden of filing corrected information returns without exposure to information reporting penalties.  This relief would apply to information returns and statements required to be filed after December 31, 2016 (i.e., calendar year 2016 information returns filed in 2017).

Other provisions in the bill generally relate to the following:

  • New requirements relating to taxpayer identification numbers (TINs) issued by the IRS
  • Expansion of certain penalties and due diligence requirements relating to the earned income tax credit, the child credit, and the American Opportunity tax credit
  • Changing penalty rules applicable to erroneous claims with respect to refundable credits
  • Reforms to reporting requirements for Form 1098-T so that educational institutions are required to report only qualified tuition and expenses actually paid

Real estate provisions

The PATH Act would make a number of changes to the real estate investment trust (REIT) rules.  Some of these provisions previously were included in former Ways and Means Chairman Camp’s Tax Reform Act of 2014 (and the "Real Estate and Investment Jobs Act of 2015").


REIT spin-off transactions  

Section 311 of the PATH Act would restrict tax-free spinoffs involving REITs, effective for distributions on or after December 7, 2015, subject to a “grandfather rule” for certain distributions pursuant to transactions described in ruling requests submitted to the IRS on or before such date.  A spin-off involving a REIT generally would qualify for tax-free treatment only if “Distributing” and “Controlled” both were REITs immediately following the spin (or if Controlled had been a taxable REIT subsidiary of the REIT, provided certain other conditions are satisfied).  Further, neither Distributing nor Controlled would be permitted to elect to be treated as a REIT for 10 years following a tax-free spin-off transaction (other than an election for Controlled when both Distributing and Controlled would be REITs immediately following the spin).

KPMG observation: In Rev. Rul. 2001-29, 2001-1 C.B. 1348, the IRS concluded that a REIT could satisfy the active trade or business requirement in section 355 for tax-free spin-off transactions. In recent years, a few publicly traded companies have spun off entities that elected REIT status in tax-free transactions.  This provision would prevent these transactions in the future (except for those grandfathered under the Act).


Alternative three-year averaging prohibited transaction safe harbor

Section 313 of the PATH Act would modify the current safe harbor for certain sales not to constitute prohibited transactions by permitting a REIT to sell a maximum of 20% of its property in a tax year (determined by reference either to tax basis or to value), provided that the average of its total sales over a three year period does not exceed 10% (determined by reference either to tax basis or to value). This provision would apply to tax years beginning after the date of the enactment of the Act.

Section 313 would also make clear that the safe harbor applies, irrespective of the property’s classification as dealer property under section 1221(a)(1). This provision would apply with respect to sales made after July 30, 2008.

KPMG observation: To prevent a REIT from retaining any profit from dealer activities, a REIT is subject to a 100% tax on any net gain realized from the sale of “dealer property.” Under currently available safe harbor provisions, a REIT may engage in up to seven sales or, alternatively, sell up to 10% of its portfolio (determined by reference either to tax basis or to value) in a given year. The new three-year “averaging option” would be helpful to a REIT that has historically fewer, or smaller, sales but is expecting more, or larger sales in connection with, for instance, exiting certain markets or property classes or otherwise rebalancing its portfolio.

Also, section 313 would clarify that the safe harbor is solely an exception to the imposition of the 100% prohibited transaction tax and that it does not mean (or imply) that a transaction results in ordinary income. Thus, while a REIT may be assured it is not subject to the prohibited transaction tax by satisfying the terms of the safe harbor, the gain on the transaction nevertheless may be treated as ordinary (dealer) income rather than capital gain, if the transaction is in substance an ordinary income transaction under section 1221. 


Repeal of preferential dividend rules for publicly offered REITs

Under section 314 of the PATH Act, the preferential dividend rule (under Code section 562(c)) would not apply to distributions by a publicly offered REIT in tax years beginning after December 31, 2014. For this purpose, a publicly offered REIT is a REIT that is required to file annual and periodic reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934.

KPMG observation: The "Regulated Investment Company Modernization Act of 2010" repealed the preferential dividend rule for publicly offered RICs. A similar repeal proposal was included recently in both the administration’s FY 2016 revenue proposals  and the "Update and Streamline REIT Act of 2012" (H.R. 5746). This repeal would have negligible revenue effect. However, it would eliminate a significant source of potential REIT qualification “foot faults” for public REITs. Public REITs include all REITs that file reports with the SEC.  Thus, both listed and non-listed REITs may be entitled to rely on this rule, so long as they are SEC filers.


Distribution failures by private REITs 

Under section 315 of the PATH Act, with respect to distributions in tax years beginning after December 31, 2015, the Treasury Secretary would have the authority to provide an appropriate alternative remedy to cure a preferential distribution in lieu of disallowing the dividends paid deduction if the Secretary determines that the preferential distribution is inadvertent or is due to reasonable cause and not due to willful neglect or the failure is a type of failure identified by the Secretary as being of so described.

KPMG observation: Even though repealed for public REITs, the preferential dividend rule would remain relevant to private REITs. The new rule would permit the IRS to restore a REIT's dividend paid deduction after a REIT violated the preferential dividend rule, provided the REIT could demonstrate the error was inadvertent or due to reasonable cause and not wilful neglect. 


Dividend designations by REITs

Under section 316 of the PATH Act, the aggregate amount of capital gain dividend and qualified dividend income designated by a REIT with respect to distributions in a tax year beginning after December 31, 2015, would be limited to the aggregate amount of dividends paid by the REIT with respect to such year. Further, the Secretary could prescribe regulations or other guidance requiring the proportionality of the designation of particular types of dividends among shares or beneficial interests of a REIT.

KPMG observation: In Rev. Rul. 2005-31, 2005-1 C.B. 1084, the IRS ruled that, in making the dividend designations permitted by Code section 852(b)(3)(C) and (b)(5)(A), section 854(b)(1) and (2), and section 871(k)(1)(C) and (2)(C), a RIC may designate the maximum amount permitted under each provision even if the aggregate of all of the amounts so designated exceeds the total amount of the RIC's dividend distributions. Rev. Rul. 2005-31 was referenced in JCT’s Description of Revenue Provisions Contained in the President’s Fiscal Year 2012 Budget Proposal with respect to discussions concerning both RICs and REITs. Thus, presumably, Rev. Rul. 2005-31 was the source of the concern prompting the proposed limitation on a REIT’s overall designation of special character dividends.


Debt of publicly offered REITs and certain secured debt

Section 317 of the PATH Act would treat debt instruments (that do not otherwise qualify as real estate assets) issued by publicly offered REITs as qualified real estate assets, subject to an overall cap of 25% of the REIT’s total assets. In addition, this proposal would expand the definition of real estate assets to include mortgages on “interests in real property,” as well as mortgages on real property. The provisions would apply to tax years beginning after December 31, 2015.

KPMG observation: It is worth noting that although the proposal would treat debt instruments issued by publicly offered REITs as real estate assets, it would not change the current law that income from such instruments (if not secured with a mortgage) is not qualifying income for the REIT 75% gross income test (which generally relates real estate-sourced gross income). Further, unlike other qualified real estate assets, the proposal provides that these REIT debt instruments would not be permitted to account for more than 25% of a REIT’s total assets. Under current law, a REIT is generally permitted to hold non-mortgage debt securities of another REIT, provided they do not exceed 25% of the REIT’s assets when aggregated with other non-real estate securities held by the REIT, and provided the securities of a single issuer do not represent more than 5% of the REIT’s assets. Thus, the practical effect of the proposal to treat public REIT debt securities as real estate assets is that such instruments would no longer be subject to the single-issuer 5% limitation and would become subject to the 25% limitation without aggregation with other nonqualifying assets of the REIT.

Expanding the definition of real estate assets to include mortgages on interests in real property (in addition to mortgages on real property) conforms the definition of mortgage assets with that of real property assets. 


Treatment of ancillary personal property

Under section 318 of the PATH Act, ancillary personal property leased with real property (applying the 15% personal property test applicable to characterizing rental income) would be treated as a real estate asset for purposes of the REIT asset tests. 

Further, for purposes of characterizing as a real estate asset an obligation secured by a mortgage on both real property and personal property, the personal property-collateral is treated as real estate provided the value of the personal property does not exceed 15% of the total collateral.  These amendments would be effective for tax years beginning after December 31, 2015.

KPMG observation: Under current section 856(d)(1)(C), rents attributable to personal property, which is leased under or in connection with a lease of real property, is generally treated as qualifying real estate rents provided the average value(s) of the personal property does not exceed 15% of the value of the personal and real property combined. There is no analogous provision for personal property under the REIT qualifying asset tests.  In the case of mortgages that are secured by both real and personal property, the rules in Reg. section 1.856-5(c) generally require that interest income from such a mortgage be apportioned between a qualifying amount (attributable to the portion of the loan secured by real property) and a non-qualifying amount attributable to the personal property.  Rev. Proc. 2014-51 provides rules for applying principles similar to those in Reg. section 1.856-5(c) to determine the portion of a loan treated as secured by real property and the portion treated as secured by personal property for purposes of the REIT asset tests.

Under the proposed provision, personal property that is leased under or in connection with a lease of real property may itself be treated as a real estate asset, so long as the 15% test is satisfied.  Similarly, if both real property and personal property are used to secure a loan, and the fair market value of the personal property does not exceed 15% of the real and personal property combined, then all the interest income from the loan is treated as qualifying income under the REIT’s 95% and 75% gross income tests, and the loan itself is treated as a qualified mortgage under the REIT asset tests. 


Hedging provisions

Under current law, income from qualifying hedging is excluded from the REIT income tests. Under section 319 of the PATH Act, effective for tax years beginning after December 31, 2015, income from counteracting hedges would be similarly excluded for purposes of the income tests. 

Specifically, if (1) a REIT enters into qualifying liability hedges or qualifying currency hedges with respect to qualifying property, (2) any portion of the liabilities is extinguished or any portion of the property is disposed of, and (3) in connection with such extinguishment or disposition, the REIT enters into hedging transactions (i.e., counteracting hedges) with respect to the original hedges, any income from the original and counteracting hedges would not constitute gross income for purposes of the income tests. 

Further, a conforming amendment would be made to reference the identification provision (including a reference to curative regulations dealing with inadvertent failures to identify).

KPMG observation: A REIT may use a counteracting hedge to effect, economically, either a partial or complete termination of an original hedge at potentially reduced costs. In PLR 201406009, the IRS ruled that (1) pursuant to section 856(c)(5)(G), a REIT’s gross income from the original hedges would not constitute gross income for purposes of the income tests; and (2) pursuant to section 856(c)(5)(J)(i), a REIT’s gross income from the counteracting hedges would not constitute gross income for purposes of the income tests. 

PATH Act section 319 should, then, allow a REIT to manage its interest rate and currency risks more effectively without the need to secure letter rulings.


Modification of REIT E&P to avoid double taxation

Section 320 of the PATH Act would make technical modifications to Code sections 857(d) and 562(e)—provisions of the Code primarily intended to provide that the REIT has sufficient E&P to support its required dividend distribution. 

Because E&P and taxable income may be computed differently, REITs can be deemed under these Code sections to have higher E&P than their actual cumulative earnings. In some situations in which section 857(d) creates additional earnings to support a dividend paid deduction, the additional earnings may be reflected in the amount of dividend income reported to shareholders, resulting in double reporting by the shareholders of the same earnings over time.  PATH Act section 320 preserves the ability to create enough earnings to support the REIT’s dividend paid deduction, while eliminating the potential for double taxation.

KPMG observation: The disparate earnings and profits treatment that section 320 addresses generally is that attributable to accelerated or bonus depreciation, where the deductions for earnings and profits purposes are different than the amount allowed for taxable income purposes. The provision would apply to tax years beginning after December 31, 2015.


Taxable REIT subsidiary (TRS) provisions

Limitation on TRSs. Section 312 of the PATH Act would limit the value of taxable REIT subsidiary securities that a REIT may own to no more than 20% of the REIT’s total assets. This provision would apply for tax years beginning after 2017.

KPMG observation: When originally enacted, the taxable subsidiary limitation was 20% of a REIT’s assets. This limit was increased to 25% in 2008. The proposal would reduce the limit to its pre-2008 level.

Certain services by TRSs. Under section 321 of the PATH Act, a REIT would be permitted to use its TRS (in addition to an independent contractor) with respect to the marketing and development expenditures under the prohibited transaction safe harbor (Code section 857(b)(6)(C)(v)) and the foreclosure property provisions (Code section 856(e)(4)(C)). 

Furthermore, a new category of transactions between a REIT and its TRS would be subject to the 100% excise tax: redetermined TRS service income, which means the TRS’s gross income attributable to services provided to, or on behalf of, its REIT (less deductions properly allocable thereto) to the extent the amount of such income (less such deductions) would be increased on distribution, apportionment, or allocation under section 482.  The provision generally does not apply to income and expenses associated with services provided to a REIT’s tenants, which are already subject to the 100% excise tax as redetermined rents.

These provisions would be effective for tax years beginning after December 31, 2015.

KPMG observation: For purposes of the prohibited transaction safe harbor, if a REIT has more than seven sales of property during a year, the statute requires the use of independent contractors for substantially all of the marketing and development expenditures with respect to the property. Similarly, an independent contractor is required if a foreclosure property is used by a REIT in a trade or business after 90 days following the acquisition of the property. If enacted, a REIT with internal expertise would not be forced to outsource these functions and incur additional costs. Instead, the REIT could use a taxable REIT subsidiary to perform these activities (through the TRS would need to be compensated at an arm’s length rate, enforced by the new 100% excise tax).

Changes to the FIRPTA Regime

The PATH Act would make several taxpayer favorable amendments to the FIRPTA rules that are designed to encourage foreign investment in U.S. real property. The PATH Act also includes several revenue-raising provisions to offset the cost of the new favorable amendments. 


Exemption from FIRPTA for foreign pension funds

The PATH Act would add new subsection 897(l), which would provide that section 897 shall not apply to any United States real property interest (“USRPI”) held directly (or indirectly through one or more partnerships) by, or to any distribution received from a REIT by, a qualified foreign pension fund or any entity all of the interests of which are held by a qualified foreign pension fund. The PATH Act also would exempt “qualified foreign pension funds” from FIRPTA withholding under section 1445 by amending the definition of “foreign person” in section 1445(f)(3) to exclude an entity described in new section 897(l). 

A “qualified foreign pension fund” means any trust, corporation, or other organization or arrangement (A) which is created or organized under the law of a country other than the United States, (B) which is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by such employees) of one or more employers in consideration for services rendered, (C) which does not have a single participant or beneficiary with a right to more than 5% of its assets or income, (D) which is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates, and (E) with respect to which, under the laws of the country in which itis established or operates, (i) contributions to such organization or arrangement that would otherwise be subject to tax under such laws are deductible or excluded from the gross income of such entity or taxed at a reduced rate, or (ii) taxation of any investment income of such organization or arrangement is deferred or such income is taxed at a reduced rate.

The PATH Act directs the Treasury to prescribe such regulations as may be necessary or appropriate to carry out the purposes of this provision. The provision is effective for dispositions and distributions after the date of enactment. 


Exception from FIRPTA for certain REIT stock

The FIRPTA regime contains an exemption for dispositions of minority interests (5% or less) in publicly traded corporations, and a similar rule for distributions from publicly traded RICs or REITs that are subject to section 897(h)(1). The PATH Act would increase the ownership threshold for the exemption from 5% to 10% for dispositions of sock of, or distributions from, publicly traded REITs. 

The bill also would exempt from the definition of a USRPI, stock of a REIT that is held by a “qualified shareholder,” except to the extent that an investor in the qualified shareholder (other than an investor that itself is a qualified shareholder) actually or constructively holds more than 10% of the REIT stock (the “10% investor rule”). If the 10% investor rule applies, a portion of the qualified shareholder’s REIT stock would constitute a USRPI. The PATH Act also would turn off section 897(h)(1) on a distribution from a REIT to a qualified shareholder, except to the extent of the 10% investor rule. A qualified shareholder includes certain foreign entities that are publicly traded, are eligible for the benefits of a comprehensive U.S. tax treaty, are treated as partnerships for U.S. federal income tax purposes, would be treated as United States real property holding corporations if they were domestic corporations, and satisfy certain additional requirements. The PATH Act also would provide the Secretary with authority to expand the class of eligible qualified shareholders to include certain other types of entities. 

These provisions would apply to any disposition of REIT stock on or after the date of enactment, and to any distribution by a REIT on or after the date of enactment that is treated as a deduction for a tax year of the REIT ending after such date. 


Determination of domestically controlled RIC or REIT status 

A USRPI does not include any interest in a domestically controlled RIC or REIT (collectively, “qualified investment entities” or “QIEs.” A QIE is domestically controlled if foreign persons directly or indirectly own less than 50% of the value of the entity’s stock. It often is difficult, however, for QIEs to determine with certainty the U.S. or foreign status of all of their direct and indirect investors, particularly in the context of publicly traded entities. 

The PATH Act would provide three new rules and presumptions for purposes of determining whether a QIE is domestically controlled. First, a publicly traded QIE would be permitted to presume (absent actual knowledge to the contrary) that a person that holds less than 5% of a class of publicly traded stock is a U.S. person. Second, any stock in a QIE that is held by a publicly traded QIE (or a RIC that issues redeemable securities) would be treated as held by a foreign person,  unless the other QIE is domestically controlled, in which case the stock is treated as held by a U.S. person. Lastly, stock in a QIE that is held by any other QIE not described above would be treated as held by a U.S. person only to the extent the stock of the other QIE is (or is treated as) held by a U.S. person. 

This provision would be effective on the date of enactment.

KPMG observation: Apart from these new rules and presumptions, the PATH Act does not address the larger uncertainty regarding the meaning of “indirect” ownership for this purpose (i.e., whether “indirect” ownership includes constructive ownership principles). 


Increased withholding on dispositions of USRPIs

The PATH Act generally would increase the rate of withholding tax under section 1445(a) on dispositions of USRPIs by foreign persons from 10% to 15%. The PATH Act also would increase the rate of withholding under sections 1445(e)(3), (e)(4), and (e)(5) from 10% to 15% with respect to certain distributions from current or former USRPHCs to foreign shareholders, certain distributions of USRPIs by partnerships, and dispositions of interests in partnerships by foreign persons. 

This provision would be effective for dispositions occurring more than 60 days after the date of enactment. 


Denial of “cleansing” exception to shareholders in RICs and REITs

Section 897(c)(1)(B) currently excludes from the definition of a USRPI an interest in a domestic corporation that has sold all of its USRPIs in taxable transactions. Thus, if a domestic corporation that is or was a USRPHC sells all of its USRPIs in taxable transactions (and pays any U.S. tax due), the stock will cease to be a USRPI, and a foreign shareholder therefore may sell the stock without triggering FIRPTA.  

The PATH Act would preclude a RIC or REIT (or a predecessor of the RIC or REIT) from qualifying for this exception. This rule would be effective for dispositions on or after the date of enactment. 


Denial of dividends received deduction for certain RIC and REIT dividends 

The PATH Act would amend section 245 to provide that RICs and REITs are not treated as domestic corporations for purposes of section 245(a)(5)(B). As a result, a U.S. shareholder that receives a dividend distribution from a foreign corporation could not claim a dividends received deduction with respect to any portion of the distribution attributable to dividends received by the foreign corporation from RICs or REITs. 

Temporary suspension of medical device excise tax

The PATH Act would impose a two-year moratorium on application of the medical device excise tax. Under the legislation, the tax would not apply to sales of taxable medical devices made between January 1, 2016, and December 31, 2017.  

KPMG observation: If enacted, manufacturers and importers of devices that are sold during this time period would not need to make semi-monthly deposits of tax or file the quarterly federal excise tax returns relating to these sales. However, the semi-monthly deposit for sales made between December 16 and December 31, 2015, is to be made by January 14, 2016, and the return for the fourth quarter of 2015 is due by February 1, 2016.

Unlike other proposed legislation related to the repeal of this tax, the moratorium does not provide for a refund of tax for sales before January 1, 2015.  

Note the moratorium does not suspend the statute of limitations for claims for refund; accordingly, taxpayers may consider whether other opportunities exist to claim refunds of previously paid tax. The statute of limitations for sales during the first quarter of 2013 expires on May 2, 2016.

“Cadillac tax”

The Omnibus Bill would delay for two years the so-called “Cadillac tax”—an excise tax on certain high-cost health insurance plans. Under the bill, the tax would not be in effect until January 1, 2020.

A separate provision would also provide a one-year moratorium (for 2017) on application of the fee applicable to health insurance providers. 

Temporary rule for oil refiners

The Omnibus Bill would temporarily create a special rule for independent oil refiners that enhances the section 199 domestic manufacturing deduction. Specifically, the legislation would allow an independent refiner to reduce transportation costs allocable to “qualified production activities income” (QPAI) by 75%, thus increasing the amount of deduction. The rule would be applicable for tax years beginning between 2016 and 2021.

Partnership audit provisions

The PATH Act proposes a few amendments to the partnership audit reform measures that were recently enacted as part of the “Bipartisan Budget Act of 2015” (Pub. L. 114-74). These changes include modifications to the general rules for determining the amount of an “imputed underpayment” to take into account: (1) capital gains rates in the case of C corporation partners, and (2) passive activity losses in the case of publicly traded partnerships (PTPs).  The bill also includes a clarification to the period of limitations on making adjustments and other technical changes.

KPMG observation: Under the bill, in the case of an audit of a publicly traded partnership (PTP) that results in an adjustment, if the PTP does not elect to push the adjustment to its partners within 45 days under section 6226, the PTP could take its partners’ suspended passive losses under section 469(k) into account in calculating its imputed underpayment.  Partnerships other than PTPs would not be entitled to a similar reduction of the partnership’s imputed underpayment.

The PATH Act does not address a number of other significant issues that have been raised about the new partnership audit regime. Read KPMG’s description of the partnership audit reform provisions in TaxNewsFlash-United States [PDF 155 KB]

Internet access moratorium

Section 633 of the Omnibus Bill includes an extension through October 1, 2016, of the ban on states and localities taxing internet access or placing multiple and discriminatory taxes on internet commerce.

Other provisions

The PATH Act also includes other significant tax law changes. Some of these changes are revenue raisers that may have been included to offset the costs of provisions not related to extending provisions that expired or that are scheduled to expire.  These include the following:

  • Amendments to section 267(d) intended to prevent the transfer of certain losses from tax indifferent parties (estimated to raise approximately $1.24 billion over the 10-year scoring window)
  • Updated standards for the energy efficient commercial buildings deduction (estimated to raise approximately $8 million over the 10-year scoring window)
  • Excise tax credit equivalency for liquefied petroleum gas (LPG) and liquefied natural gas (LNG) (estimated to raise approximately $63 million over the 10-year scoring window)
  • Exclusion from gross income of certain clean coal power grants to non-corporate taxpayers (estimated to raise approximately $6 million over the 10-year scoring window)
  • Clarification of value rule for early termination of certain charitable remainder unitrusts (estimated to raise approximately $113 million over the 10-year scoring window)
  • Treatment of certain persons as employers for motion picture projects (estimated to raise approximately $45 million over the 10-year scoring window)
  • Special tax rate for timber gains of C corporations
  • An amendment to the section 831(b) election for small nonlife insurance companies to: (1) increase the annual premium limitation from $1.2 million to $2.2 million; and (2) add a “diversification” rule under which no single policyholder may be responsible for more than 20% of net written premium (or direct written premium, if greater)
  • Deductibility of charitable contributions to agricultural research organizations
  • Rollovers permitted from other retirement plans into simple retirement accounts
  • Tax administration provisions affecting the IRS, including a provision treating transfers to certain organizations that are exempt from tax under section 501(c)(4), 501(c)(5), or 501(c)(6) as exempt from gift tax
  • Provisions relating to taxpayer access to, and the administration of, the U.S. Tax Court
  • Other provisions


For more information, contact a member of KPMG’s Washington National Tax (WNT) Federal Legislative and Regulatory Services group:

John Gimigliano | +1 202-533-4022 | jgimigliano@kpmg.com

Carol Kulish | +1 202-533-5829 | ckulish@kpmg.com

Tom Stout | +1 202-533-4148 | tstoutjr@kpmg.com

Jennifer Bonar Gray | +1 202-533-3489 | jennifergray@kpmg.com

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