Casino Enterprise Management

With the books closed on 2009—certainly to the delight of the many gaming businesses that encountered a challenging year—gaming businesses can begin to examine the federal tax landscape for 2010. On the horizon in 2010 is the potential for significant tax law changes. Faced with a federal budget deficit that reached a record high $1.42 trillion at the end of the 2009 fiscal year, revenue-raising measures will become a focal point for the Obama administration and Congress. As Congress continues to debate expanding federal programs, most notably those involving health care, the likelihood of further tax law changes remains possible. Surveying the landscape for 2010, there are two influences that may impact federal tax law and should garner the attention of the gaming industry: the effect of health care proposals on federal tax law and an increased interest in taxation of the international activities of U.S. taxpayers.

The Health Care Debate
At the time this article was written, the House had already passed its version of health care legislation—the Affordable Health Care for America Act (HR 3962)—and Senate Majority Leader Harry Reid’s (D–Nev.) health care legislation had moved to the Senate floor for debate. While the health care debate in itself is not a debate centered on tax policy, the legislative proposals contain a number of provisions that will impact federal tax law. The tax law changes are primarily intended to serve as revenue-raising measures to finance the health care policies embodied in the House and Senate legislation.

Whether health care legislation will ultimately be passed is still uncertain. As of early December 2009, the prognosis from Capitol Hill appeared to be that health care legislation would not be enacted prior to the Christmas recess. Even assuming some form of health care legislation is passed by early 2010, the tax law changes that may ultimately be included in any final legislation remains in a fluid state. Thus, the tax law provisions that have been proposed in the House and Senate legislation, as well as by the administration, serve as a barometer for the types of tax provisions that may end up in a final legislative product.

The Affordable Health Care for America Act
There is a litany of tax law-related provisions in the House’s Affordable Health Care for America Act that are directed at raising revenue. The bulk of the tax provisions impact individual income tax liability. The centerpiece of the House legislation provides for a 5.4 percent surtax on individuals with adjusted gross income exceeding $500,000, or $1 million for joint returns. While individual taxpayers are the primary targets of the tax law changes contained in the House health care legislation, there are also several business tax-related provisions. Tax law provisions contained in the Affordable Health Care for America Act include:

• Impose a 5.4 percent surtax on individuals with adjusted gross income in excess of $500,000, or $1 million for joint returns.
• Require greater information reporting of payments made by corporate taxpayers.
• Delay implementing worldwide interest allocation until 2020.
• Limit foreign tax treaty benefits for certain payments, such as provisions relating to interest and dividend withholding.
• Limit contributions to Health Flexible Spending Arrangements (FSA) in cafeteria plans to $2,500.
• Increase penalties for non-qualified distributions from Health Savings Accounts (HSA) to 20 percent.
• Impose fees on insured and self-insured health plans.
• Make certain large or publicly traded businesses subject to a “more likely than not” standard for the purposes of defenses to imposing civil tax penalties on underpayments of tax.
• Conform the definitions of qualifying medical expenses for employer provided health coverage in FSA, HSA, Health Reimbursement Arrangements (HRA) and Archer MSA to the definition of medical expenses used for itemized deductions.
• Codify the Economic Substance Doctrine.

The above list of tax law provisions set forth in the House legislation reveals that the legislation will force substantial changes to existing operating procedures of businesses, including those in the gaming industry. What is not factored in the tax provisions of the House legislation are the consequences businesses will incur due to their increased compliance obligations.

Specific provisions worth highlighting include the proposal to impose more stringent information reporting obligations on corporate taxpayers. Under current law, only certain payments in excess of $600 are subject to information reporting. The House legislation would substantially broaden these information reporting obligations for corporate taxpayers.

Another provision in the House legislation that will be particularly noteworthy for gaming businesses with foreign activities is the repeal of the rule allowing for worldwide interest allocation for purposes of the foreign tax credit. The Internal Revenue Code of 1986, as amended, provisions addressing the taxation of U.S. taxpayers’ foreign activities grants a credit against U.S. taxes for foreign taxes paid. In certain circumstances, U.S. taxpayers are allowed to increase the amount of their income allocated to foreign activities. As an example, when a business incurs more foreign taxes than available U.S. foreign tax credits, the business can increase the amount of income allocated to overseas activities. The effect is to correspondingly increase the foreign tax credit available under the code, which in return reduces U.S. tax liability. A 2004 change in the code allowed for interest on foreign borrowings and debt-financed investment income to be included in the allocation computation. The consequence of the 2004 provision was to allocate more U.S. interest to U.S.-sourced income and reduce interest allocated to foreign income, with the ultimate effect of increasing the foreign tax credit limit. The House legislation would repeal the 2004 provision and, thus, reduce the amount of foreign tax credits.

The Senate Health Care Legislation
The Senate health care legislation includes many of the same provisions contained in the House legislation, but there are several additional tax law provisions included in the Senate health care legislation. These provisions include:

• Impose an excise tax on health care coverage in excess of $8,500 for singles and $23,000 for families, indexed for inflation.
• Require employers to report on W-2 statements the value of health benefits.
• Raise the 7.5 percent adjusted gross income floor on medical expense deductions to 10 percent.
• Impose an additional 0.5 percent hospital insurance tax on wages in excess of $200,000 ($250,000 joint).
• Impose a 5 percent excise tax on cosmetic surgery.

Like the House health care legislation, the Senate proposal would limit existing tax-favored programs, such as imposing a $2,500 contribution limit on FSAs and increase reporting and compliance by businesses.

Finance Health Care Proposals
Policymakers have suggested several other tax initiatives as a means to raise revenue to finance the cost of health care legislation. The Obama administration has also identified numerous tax expenditures to finance its health care proposals in addition to the specific provisions contained in the current House and Senate bills. While the legislation remains fluid, any final legislation may adopt administration proposals when reconciling the existing legislative proposals. The tax proposals offered by policymakers and the Obama administration include:

• Eliminating or capping the exclusion from income and payroll taxes amounts paid by employers for health insurance.
• Limiting the amount that individuals can contribute to HSAs for high deductible health plans and increasing the penalty for using HSA funds for non-qualifying medical expenses.
• Increasing the excise tax on alcohol and imposing an excise tax on non-diet sweetened beverages.
• Limiting itemized deductions for the top two tax rates to 28 percent.
• Modifying certain tax accounting methods.
• Increasing capital gains tax rates.
• Taxing carried interests in private equity and hedge funds.
• Reforming international tax enforcement.
• Increasing payroll taxes through either higher rates or raising the earnings ceiling.

Increasing Scrutiny of Foreign Activities
One initiative that has already been a considerable focal point of the Obama administration and congressional Democrats—and will likely continue to receive considerable attention in 2010—is the taxation of foreign activities of U.S. taxpayers. The focus on offshore activities will have a significant impact on gaming businesses, particularly because many casino operating companies and equipment suppliers operate both domestically and overseas. Activity in the international tax arena during 2010 may arise in two fashions: (1) legislative initiatives; and (2) increased enforcement activity by the Internal Revenue Service.

Legislative Initiatives
On May 4, 2009, the Obama administration introduced a proposal, which included strong anti-business aspects, to ostensibly “reform” the U.S. taxation of international activities of businesses. President’s Obama’s international tax “reform” proposal has two themes. First, the proposal would eliminate existing code Subpart F recognition of the principle of a single layer of corporate tax for the offshore activities of U.S. taxpayers. The Obama international tax proposal would seek to effectuate eliminating the principle of a single layer of corporate tax by repealing existing U.S. income tax deferral rules and narrowing the scope of the foreign tax credit. Second, the president’s proposal attacks the use of so-called offshore “tax havens.” While the president’s proposals have not been acted on legislatively during 2009, in light of the $1.4 trillion (and growing) budget deficit, Congress may be pressed to take up aspects of the president’s international tax proposal.

In addition to the prospect that some, or all, of President Obama’s international tax reform proposals may be taken up by Congress, there is a significant possibility that other legislation impacting the taxation of the foreign activities of U.S. taxpayers will be introduced. On Oct. 27, 2009, legislation was unveiled by a group of Senate and House Democrats to require greater disclosure of foreign investments and substantially increase penalties for non-disclosure. The legislation, titled the Foreign Account Tax Compliance Act of 2009, would, among other things, impose a 30 percent withholding tax on financial institutions unless the financial institutions agreed to disclose the identity of and information about any U.S. account holder; increase underpayment penalties; and extend the statute of limitations to six years for certain underreporting of foreign assets. To the extent that gaming businesses are engaged in foreign activities, the Foreign Account Tax Compliance Act could impose new obligations and substantially increase compliance costs.

Increased Enforcement Activity
During 2009, the IRS introduced a major initiative offering taxpayers with undisclosed offshore bank accounts the opportunity to voluntarily disclose accounts and avoid potential criminal prosecution. In connection with the voluntary disclosure program, three IRS officials voiced the position that an equity interest in an offshore private equity or hedge fund constituted a foreign bank account for purposes of triggering the obligation to file a Report of Foreign Bank and Financial Account (FBAR). Failure to file an FBAR can expose a responsible party to not only draconian civil tax penalties but also criminal sanctions. The consequence of the position articulated by the IRS is that almost any equity interest in an offshore business entity could conceivably be construed to be a “foreign account” and, hence, subject to disclosure on an FBAR.

In 2010, U.S. businesses with foreign activities can expect the IRS to continue with initiatives directed at offshore activities. Gaming businesses involved in i-gaming should remain acutely sensitive to IRS international enforcement activities. In 2009, the U.S. Department of Justice commenced legal proceedings to seize tens of millions of dollars of funds held by i-poker players. With the Obama administration’s focus on international activities of U.S. taxpayers, it is no coincidence that enforcement activity has increased, particularly for businesses within the i-gaming industry.

Enforcement activities may run the gamut from the IRS adopting expansive views of the types of business interests that may be subject to disclosure to increased scrutiny of foreign tax credits and income deferral under Subpart F. It is also anticipated that the IRS will issue guidance with respect to FBAR disclosure obligations and the extent to which equity interests in offshore entities can qualify as a foreign financial account. Another enforcement area that is likely to continue to be a hot area is suspicious activity reporting and efforts to combat third parties’ use of gambling as a mechanism for money laundering.

Final Thoughts
As the nation moves into the mid-term election year in 2010, there will be several hot topics in tax law that will gain the attention of the gaming industry. Like the rest of the business community, the health care proposals, if enacted, will have a significant impact on gaming businesses. Not only will new tax provisions likely be adopted as part of any health care legislation, but the initiatives will also likely expand compliance and reporting obligations of businesses. International taxation of U.S. businesses should also continue to be a focal point, both legislatively and through administrative initiatives. Increased enforcement activity by the IRS may reach the gaming industry, because many gaming businesses not only operate domestically but also have offshore activities.

Peter J. Kulick is a tax and gaming attorney with Dickinson Wright PLLC, which has an international gaming law practice with offices in Michigan, Nashville,  Washington, D.C., Toronto and Phoenix. He received his LL.M in tax law from New York University. Kulick may be reached at pkulick[at]dickinsonwright.com.