Washington's Effect on Global Mobility in 2013 Houston Relocation Professionals - March 20, 2013

1. Washington's Effect on Global Mobility in 2013 Houston Relocation Professionals - March 20, 2013 Peter K. Scott Worldwide ERC® Tax Counsel Peter Scott Associates Tristan North Government Affairs Adviser Worldwide ERC®

2. Washington's Effect on Global Mobility in 2013 Policy Issues Debt Ceiling Sequestration FY 2013 Federal Budget Consumer Financial Protection Bureau Immigration Reform Accountable Care Act Questions and Answers Tax Issues American Taxpayer Relief Act New Medicare Taxes Home Purchase Program Audits Short Sales

3. Tax Issues

4. Tax Issues • American Taxpayer Relief Act • New Medicare Taxes • Home Sale Program Audits • Short Sales

5. American Taxpayer Relief Act • “American tax laws are constantly changing as our elected representatives seek new ways to ensure that whatever tax advice we receive is incorrect.” Dave Barry

6. American Taxpayer Relief Act • Most Americans dodged a bullet on January 1 • Tax cuts from 2001 and 2003 were set to expire • A number of other provisions of value to mobility industry would also have expired

7. American Taxpayer Relief Act • New law Jan 1: • Reduced tax rates made permanent, except for taxpayers with taxable income of $400,000 ($450,000 married filing jointly) • 10%, 15%, 25%, 28%, 33%, 35% • Brackets are adjusted for inflation after 2013

8. American Taxpayer Relief Act • Top rate returns to 39.6% for taxable income above “high income” thresholds • $400,000/$450,000 also indexed for inflation • Note these taxpayers only paying top rate on income above the thresholds

9. American Taxpayer Relief Act • Capital Gains • Had Congress not acted, reduced capital gain tax rate would have disappeared • Capital gains will still be taxed at 15%, except 20% rate returns for those in high income brackets above • Dividends • Would have returned to tax at regular income tax rates • 15% rate made permanent • 20% for high income

10. American Taxpayer Relief Act • Personal exemptions, itemized deductions • Old law phaseouts would have returned had Congress not acted • New law limits phaseouts, but makes permanent • Phaseouts now begin at $250K of adjusted gross income ($300K married filing jointly) • Old phaseouts started at $178K • However, still will raise taxes for fair number of taxpayers (note AGI is larger than taxable income) • This is where Dave Barry comes in!

11. American Taxpayer Relief Act • Effects on Mobility • Gross-up calculations largely unaffected; would have changed considerably if all rates rose • Saves companies lots of money • Supplemental withholding rate also stays at 25% • Withholding tables provided by IRS, to be used ASAP but no later than February 15 • Reinstatement of personal exemption and itemized deduction phaseouts may prompt a few more gross-up challenges • No more uncertainty about rates

12. American Taxpayer Relief Act • A casualty: No more reduced FICA tax • Employee portion returns to 6.2% from 4.2% • Employers told to implement increased withholding by February 15, adjust for under-witholding by March 31 • Wage Base $113,500 for 2013

13. American Taxpayer Relief Act • Big Deal: AMT permanently fixed • Exemption levels rise, are indexed for inflation • No more annual fixes • Saves some 30 million taxpayers from owing several thousand more • Reduces gross-ups

14. American Taxpayer Relief Act • Other good news • Exclusion for up to $2 million forgiven mortgage debt on principal residence extended through 2013 • Private mortgage insurance deduction reinstated for 2012 and 2013 • Same for deduction for state and local sales taxes

15. American Taxpayer Relief Act • Many other credits/breaks extended • Child tax credit • Student loan interest deduction • Child and dependent care credit • Adoption credit • These may be welcome to transferees, but can complicate gross-up when taxable relocation puts transferee above levels when credits phase out

16. Tax Reform • “A tax loophole is something that benefits the other guy. If it benefits you, it is tax reform.” Russell B. Long • “I was working on a flat tax proposal, and I accidentally proved there’s no God.” Homer Simpson • “This idea that you start with a clean slate and end up with a beautiful, logical tax system just isn’t democracy.” John L. Knapp

17. Tax Reform • Possibly could happen as part of “grand bargain” to address the deficit • Most popular notion is to reduce/eliminate tax breaks that cost money, reduce/flatten rates somewhat • Tax breaks we care a lot about might be included • Mortgage interest deduction • State/local income tax deduction • Foreign income exclusion • Home sale capital gain exclusion • Moving expense deduction • Not likely this year, but Boy Scout motto applies

18. New Medicare Taxes • Two new taxes on high income individuals begin January 1, 2013 • .9% increase, to 2.35%, in employee share of Medicare • Applies to those whose wages exceed $200,000 ($250,000 married filing jointly) • Employer not required to withhold unless the wages of the spouse working for the employer exceed $200k, even if joint wages exceed $250k • Will require adjustment of withholding for high income employees, and consideration of gross-up if taxable relocation puts employee over $200k and if company grosses up for Medicare

19. New Medicare Taxes • Second new tax is a 3.8% tax on unearned income (for example, interest, dividends, annuities, rents, capital gains) • Applies to those whose Adjusted Gross Income exceeds $200,000 ($250,000 married filing jointly). Note different standard for threshold • Applies to the lesser of unearned income or the amount AGI exceeds the threshold • Example: UI is $15,000, AGI is $210,000. Tax applies to $10,000. • No withholding required, but companies will have to consider gross up if taxable relocation puts employee over the AGI threshold. This is NOT a Medicare tax, but an additional INCOME tax to enhance Medicare funding

20. New Medicare Taxes • UI tax could apply to gain from home sale • However, applies after the home sale capital gain exclusion ($250,000, or $500,000 married filing jointly), and after basis is subtracted. That is, applies to net capital gain after the exclusion • Example: Sale price $800,000, basis $600,000, capital gain exclusion $250,000, amount subject to 3.8% tax is zero • Very few relocating employees have reportable capital gain beyond the home sale exclusion • Reports circulating on internet that this is a tax on real estate sales are erroneous • However, would apply to gain from sales of second homes if seller income is high enough

21. New Medicare Taxes • May cause estimated tax issues for those affected • Some may owe both the 0.9% Medicare tax and the 3.8% UI tax, although applied to different parts of the income base • Gross-up issues will require reference to actual tax returns

22. Home Sale Program Audits • “The Opera reminds me of my tax audit. It was in a language I didn’t understand, and it ended in tragedy.” Jeff McNelly’s “Shoe”

23. Home Sale Program Audits • IRS agents still sometimes contend BVO with no appraisal, guaranteed buyout, not within Rev. Rul. 2005-74 • Good case they are wrong, but ERC continues to recommend addition of delayed AV process • Position of IRS lawyers who wrote Rev. Rul. 2005-74 unclear • Have expressed some skepticism that BVO works, but no definite position • No indication yet that issue has resurfaced as part of the IRS’s ongoing special employment tax audits, but caution advised

24. Home Sale Program Audits • Generally, audits less frequent than in past, but still a number every year • Audits focus not only on basic BVO, but procedures used (also in AV) • Poor audit results are almost always the result of questionable risk reduction procedures used by company

25. Home Sale Program Audits • In both AV and BVO, companies often have waited to enter contract with transferee until inspections are complete, all contingencies are removed from outside contract • Transferee is usually involved in negotiating inspection results • Sometimes, company intentionally waits to sign contract with transferee until very shortly before outside closing, resulting in a “holding period” of no more than 1-3 days

26. Home Sale Program Audits • IRS consistently maintains that this practice falls within “situation 3” of Rev. Rul. 2005-74 and that the program fails. Company has simply not assumed any significant ownership risk for any significant period of time • Recent audit: IRS disqualified all transactions in which contract with outside buyer signed first • Cost company millions, will also cost more millions for the next few years until company can clean up its practice

27. Home Sale Program Audits • Companies should NOT engage in practices that artificially create short holding periods. They should also NOTwait for inspections to be completed before contracting with employee. Better practice is to do own inspections up front, do not rely on buyer inspections to set price for purchase from employee

28. Home Sale Audit Results • “We try to cooperate fully with the IRS, because, as citizens, we feel a strong patriotic duty not to go to jail.” Dave Barry • Tax Lawyer’s Golden Rule: If somebody has to go to jail, make sure it’s the client

29. Home Sale Audit Results • In audits, IRS invariably asks for complete list of purchase and sale dates • IRS invariably concludes that all purchases/sales within a few days of each other fail • Some success for taxpayer when it can be shown that nothing other than transferee vacate date causes some to be close together • However, if procedures force short periods, IRS always sticks to disallowance • Settlements usually involve company conceding all transactions where purchase/sale within some agreed number of days of one another

30. Home Sale Audit Results • Other issues: • Reverse contracts • Can be explained if occasional delays on one side or the other the cause • IRS always questions if delay intentional • Regular delays in payments of equity until outside sale closes • Repayment agreement including home sale expenses

31. Home Sale Audit Results • IRS sometimes notes company is not treating houses as capital assets for income tax deduction purposes, takes that to mean it is contending it doesn’t actually own them • But company does agree it owns houses • They are not capital assets because section 1221 excludes from that category property held for sale in the ordinary course of a trade or business • Interestingly, incidence of income tax audits raising capital loss issue has greatly declined

32. Relocation Short Sales • Old Country Song: “How can I miss you if you won’t go away”? • Another: “I’m so miserable without you, its just like you’re still here” • Short sales can involve both of these principles

33. Relocation Short Sales • It is possible to take these homes into a relocation home sale program (some companies will do so, others won’t), but some issues must be addressed

34. Relocation Short Sales • In a relocation short sale, still must have two separate, independent sales for tax purposes • In a homesale program, companies must be extremely careful that the amount of negotiation and finalization of the outside sale between transferee and buyer does not violate the “two transaction” requirement for favorable tax treatment • Lender ordinarily willing to base acceptance of short sale on offer from employer, provided it can be satisfied amount is FMV • In an AV or GBO, there will be appraisals • In a BVO, need contract with outside buyer to establish value.

35. Relocation Short Sales • But company must protect itself in event lender approval to reduce debt is not obtained • If company buys house without reduced debt, will become liable for entire debt • Excess debt over FMV of house will be wage income to employee, subject to withholding, FICA • Same result as if employer had paid negative equity on employee’s behalf

36. Relocation Short Sales • How to protect company: • DO NOT include clause in sale contract with outside buyer making that contract contingent on employee obtaining debt reduction • DO include clause in purchase contract with employee making that transaction dependent upon employee obtaining debt reduction • This is no different than standard clause in such contracts requiring that employee pay negative equity • DO include clause in Addendum with buyer making entire contract contingent upon company ability to obtain ownership of the home • This is a standard clause in all relocation sales

37. Relocation Short Sales • Other factors: • Lenders should actually prefer relocation short sales over not only foreclosures, but over other short sales • Unlike other short sales, company is paying sale costs, they don’t come out of proceeds and reduce lender share • Sometimes lenders don’t understand this, have to be reminded • Some lenders continue to have issues with corporate purchasers, or with fact there will be a “flip” within a short period • Lenders sometimes include various representations in affidavits that purchaser must sign that are problematic because company doesn’t know all the facts relating to outside buyer

38. Policy Issues

39. Policy Issues • Debt Ceiling • Sequestration • FY 2013 Federal Budget • Consumer Financial Protection Bureau • Immigration Reform • Accountable Care Act

40. Fiscal Cliffs and Deficit Reduction • American Taxpayer Relief Act of 2012 (H.R. 8) • Averted first fiscal cliff by extending Bush era tax cuts • Delayed Sequestration until March 1 • Failed to address deficit reduction • Debt Ceiling Extended until May 18 • Second Fiscal Cliff Looming on March 1 • Sequestration • Expiration of Continuing Resolution for FY 2013 Budget • Republicans looking to address deficit reduction

41. Debt Ceiling • Department of U.S. Treasury estimated that federal government had reach debt ceiling in December and would run out of money in late February • H.R. 325 – Temporary Increase of Debt Ceiling • Allows the U.S. Treasury to issue new debt through May 18 • Withholds pay from Members of Congress starting on April 15, until whichever the respective body in which they serve passes a budget or the end of the Congress • House passed bill on January 23 followed by Senate on January 31 and signed into law on February 4

42. Sequestration • “Super Committee” failed to reach agreement on long-term deficit reduction plan • $1.2 trillion cut over 10 years to federal spending if Congress does not prevent implementation • Starting on March 1, 2013: • 10% cut in nonexempt mandatory defense funding • 9.4% cut in nonexempt discretionary defense funding • 7.6% cut in nonexempt nondefense mandatory funding • 8.2% cut in nonexempt nondefense discretionary funding • 2.0% cut in Medicare provider payments • $80 billion needed to prevent cuts for remainder of FY 2013

43. Sequestration • Social Security benefits, Medicaid, military personnel pay, veteran benefits and certain other popular programs exempt • Consumer Financial Protection Bureau would see reduction of 7.6% or 34 million of their $448 million budget • U.S. Customs and Border Protection and Citizenship and Immigration Services are subject to sequestration but exact dollar figure or percentage not determined yet • Impact on funds for relocating federal employees would be determined by Agency heads who would overall have less administrative funding • President wants spending cuts and revenue raises to delay Sequestration and congressional Republicans want just cuts

44. FY 2013 Federal Budget • Continuing resolution extended FY 2012 funding levels through February 28 • All federal departments, agencies and most programs impacted if there is a shutdown • House Appropriations Committee Chairman Hal Rogers (R-KY) states he is developing measure to continue funding through end of fiscal year and also address parts of Sequestration

45. Consumer Financial Protection Bureau • Established under Dodd-Frank Act • CFPB has authority over various fair lending and consumer protection laws including the Real Estate Settlement Procedures Act (RESPA) • FY 2013 Budget request of $448 million • $108 million increase from FY 2012 budget estimated to be $340 million and a $286 million increase from the actual budget of $162 million for FY 2011 • Estimated number of employees would increase to 1,359 in 2013 from 942 in 2012 and actual number of 178 employees in 2011

46. Consumer Financial Protection Bureau • On January 4, 2012, President Obama tapped Richard Cordray through recess appointment to head agency • Much of the authority of the CPPB and ability to function rests with its Director • Recent federal appeals court decision invalidated three recess appointments to the National Labor Relations Board made the same day as Cordray • State National Bank of Big Spring, TX has asked court to invalidate Cordray appointment as well • President plans to formally nominate Cordray

47. Consumer Financial Protection Bureau • New Mortgage Disclosure Forms Rule • “Loan Estimate” form provided to borrower within three days of submitting loan application • Replaces Good Faith Estimate and “early” Truth in Lending forms • “Closing Disclosure” form provided three days before closing • Replaces HUD-1 and Truth in Lending forms • How APR is calculated would change to reflect up front costs • Comments were due November 6 and final rule expected this summer

48. Consumer Financial Protection Bureau • Qualified Mortgage (QM) Final Rule • Final rule issued on January 10 with January 2014 start date • Key Provisions • Loan originator must verify that borrower has ability to repay mortgage with no more than 43% debt ratio • Several loan types including those with balloon payment, interest-only and longer than 30 years do not qualify • Cap of 3% on fees that lenders can charge excluding loans under $100k • Safe haven for those loans with interest rate of 1.5% or less about prime rate • Qualified residential mortgage (QRM) final rule expected shortly

49. Immigration Reform Senate Activity - Hearings • On February 13, Senate Committee on the Judiciary held hearing on comprehensive immigration reform • AOL Co-founder Steve Case testified and urged the Committee to address high-skilled worker immigration as part of comprehensive immigration reform • Chairman Leahy hopes for the Committee to consider reform legislation “soon”

50. Immigration Reform Senate Activity - Legislation • Bipartisan Comprehensive Immigration Reform Framework • Being developed by Senators Chuck Schumer (D-NY), John McCain (R-AZ), Dick Durbin (D-IL), Lindsey Graham (R-SC), Robert Menendez (D-NJ), Marco Rubio (R-FL), Michael Bennett (D-CO), Jeff Flake (R-AZ) • Path to citizenship for unauthorized immigrants currently in U.S. • Reduce backlog of workers trying to obtain visas and provide green cards to foreign students who receive PhD or Masters degrees in science, technology, engineering, math (STEM) at U.S. universities • Strengthen worker verification system • Allow businesses to hire lower-skilled workers if jobs can’t be filled