12/12/2018 SC TAX TEAM 2018 FEDERAL TAX UPDATE

Transcription

1 SC TAX TEAM 2018 FEDERAL TAX UPDATE 1 2 1

2 QUALIFIED BUSINESS INCOME ( 199A) 3 Category 1 Category 2 Category 3 Taxable Income < $157,500 $157,500 - $207,500 > $207,500 < $315,000 $315,000 - $415,000 > $415,000 Wage Limitation DOES NOT APPLY PHASE-IN APPLIES Specified Service Trade or Business Discrimination DOES NOT APPLY PHASE-IN 4 2

3 Who gets it? (Pass-through owners) - Sole Proprietors - S Corporation Shareholders - Partners - Members of a Limited Liability Company not taxed as a C Corporation - Estate and Trust Beneficiaries - Members of Qualified Cooperatives - REIT / Publicly-Traded Partnership ( PTP ) Owners 5 Lesser of: Basic Deduction = Basic Deduction = 20% of Combined Qualified Business Income ( CQBI ) -OR- 20% x (taxable income net capital gain) 6 3

4 Example #1 Basic Deduction Samantha owns and operates S Corp, with $200,000 in revenue after expenses (other than Sam s salary) S Corp pays Samantha a reasonable salary of $100,000 Samantha s taxable income (after deductions) is $150,000 Samantha s QBI deduction is 20% of $100,000 ($20,000) and she will pay income tax on $130,000 7 Coverage What income qualifies? - Qualified Business Income ( QBI ) - Combined QBI - Qualified REIT Dividends / Publicly Traded Partnership ( PTP ) Income What businesses qualify? - Qualified Trade or Business ( QTB ) - Business of Being an Employee 8 4

5 Coverage Aggregation - when is a business separate? Businesses operated through another pass-through entity ( PTE ) Limitations: - Income thresholds - Specified Service Trade or Business ( SSTB ) limitation - Wage limitation - Unadjusted Basis Immediately After Acquisition ( UBIA ) 9 Coverage Tax Penalties and Administrative - QBI must be effectively connected with the U.S. - Sunset (d) exception 10 5

6 Qualified Business Income ( QBI ) QBI = net amount of qualified items of income, gain, deduction, and loss with respect to each Qualified Trade or Business ( QTB ) of the taxpayer QBI is determined separately for each QTB Tax items taken into account only to extent included or allowed in the determination of taxable income 11 Qualified Business Income ( QBI ) Includes: - REIT dividends - Publicly-traded partnership ( PTP ) income - Qualified cooperative dividends Deduction treated below-the-line Deduction is allowed in full for AMT purposes 12 6

7 What is not QBI? Reasonable compensation paid to taxpayer Guaranteed payments ( 707(c)) paid to a partner for services rendered 707(a) payments to a partner for services rendered 13 What is not QBI? Investment income (dividends, interest, capital gains, etc.) QBI deduction does not: - Reduce net earnings from self-employment - Reduce the 3.8% net investment tax 14 7

8 Combined QBI Sum of QBI for each QTB + 20% of taxpayer s: (1) Qualified dividends from real estate investment trusts, and (2)Qualified income from publicly traded partnerships ( PTPs ) 15 Example #2 Combined QBI QTB #1 QTB #2 Aggregated Income $200,000 $100,000 $300,000 Wages (50,000) (120,000) (170,000) QBI 150,000 (20,000) 130,000 a20% of QBI 30,000 (4,000) 26,000 bwage Limit (50%) 25,000 60,000 85,000 Lesser of a or b 25,000 (4,000) 26,000 Combined QBI $21,000 $26,

9 Qualified Trade or Business ( QTB ) Any trade or business other than: Specified service trade or business ( SSTB )* The trade or business of being an employee * Unless the taxpayer s income is under the threshold 17 Trade or Business - Not defined by the Code or Proposed Regulations - Prop. Treas. Reg A-1(b)(13) - a Section 162 trade or business other than the trade or business of performing services as an employee - Must look to common law for definition 18 9

10 Groetzinger v. Commissioner, 480 U.S. 23 (1987) Two things: - Continuous and regular involvement - Primary purpose for income or profit But...resolution of this issue requires an examination of the facts in each case. (quoting Higgins v. Commissioner, 312 U.S. 212 (1941)). 19 Trade or Business - Includes the rental or licensing of tangible or intangible property that does not rise to the level of a trade or business where the property is rented/licensed to a commonly controlled entity (Prop. Treas. Reg A-1(b)(13)) 20 10

11 Rental Real Property - Facts and circumstances - Tax law regarding trade or business - Case law 21 Rental Real Property - Yes Facts Trade or Bus? Venue/comments Murtaugh v. Comm r. 2 timeshares; mgt. co.; had subst. activity Yes Tax Ct: mgrs. activity counts (post- Groetzinger case) LaGreide v. Comm r. Inherited, singlefamily residence Yes Tax Ct. - single prop. rental = business Hazard v. Comm r. Single-family, taxpayer lived in different city Yes Tax Ct. single prop. rental = business Reiner v. U.S. Single-family; mgt. co. Yes 7 th Cir./cited LaGreide 22 11

12 Rental Real Property - No Facts Trade or Bus? Venue/comments Grier v. U.S. Single-family; only one tenant; made repairs Balsamo v. Comm r. Inherited (sold after 3 mos.); no repairs Union Bank of Troy Triple net lease; tenant maintained building No No No 2 nd Cir. - has least favorable position Tax Ct. - used 2 nd Cir. law, bound by Golsen U.S. Dist. Ct. (N.Y.) PLR Triple net lease; tenant maintained building No Admin. guidance only - no precedential value 23 Business of Being an Employee Excluded from QBI Prop. Treas. Reg A-5(d) former employee now treated as other than an employee with regard to substantially the same services will be presumed to still be an employee Presumption may be rebutted upon a showing that the individual is performing services in a capacity other than as an employee Presumption applies even if individual forms an S corp or other entity through which individual performs services 24 12

13 Business of Being an Employee Example: - Law firm associates leave Law Firm 1 to form Law Firm 2 - Law Firm 2 performs substantially all its legal services for Law Firm 1 - Law firm associate income will be treated as income from the business of being an employee and excluded from QBI (deduction unavailable on the income) 25 Business of Being an Employee Example: - Engineering Firm is a partnership - Firm has structure in place to promote senior engineers to partner after 10 years if certain milestones are met - Engineer meets milestones and is admitted as a partner - Engineer is able to rebut presumption by showing partnership rules and Engineer s sharing of partnership net profits

14 Taxpayer s with Multiple QTBs QBI items must be allocated among QTBs using a reasonable method based on all the facts and circumstances Method must: - Be applied consistently from one tax year to the next - Clearly reflect the income and expenses of each trade/business Overall combination of methods among QTBs must be reasonable 27 Aggregation Proposed Regulations allow aggregation of separate businesses into one (combines QBI, W-2 wages and qualified property Aggregation is at option of taxpayer (each business owner may chose whether to aggregate) Consistency once you aggregate you must continue unless: - Adding newly created/acquired business to group - Facts have changed such that you no longer qualify 28 14

15 Aggregation 5 Requirements 1. Same person/group owns 50% or more of each business (directly or indirectly); 2. Ownership exists for majority of tax year; 3. All items attributable to each business are reported on returns having same taxable year; 4. None of the businesses are SSTBs; and 5. Businesses satisfy at least 2 aggregation factors. 29 Aggregation 3 Factors A. Businesses provide products/services that are the same or customarily offered together B. Businesses share facilities or significant centralized business elements C. Businesses are operated in coordination with or reliance upon one or more businesses in the aggregated group 30 15

16 What about tiered entities? Deduction available for income allocated through another passthrough entity, trust or estate (Relevant Passthrough Entity ( RPE )) Prop. Treas. Reg A-6 31 Relevant Passthrough Entity Rules Four Rules: 1. Determine if 1 or more QTBs and whether any are SSTBs 2. Determine QBI for each QTB 3. Determine wage and UBIA limitations 4. Determine qualified REIT dividends and PTP income 32 16

17 Relevant Passthrough Entity Rules RPEs must report to owners on Schedule K-1 or attachment: - Owner s share of QBI, wages, UBIA and SSTB info - QBI, wages, UBIA and SSTB info from other RPEs (tiered entity structures) - Owner s share of qual. REIT dividends / PTP income 33 Trusts and Estates (Prop. Treas. Reg A-6(d)) QBI, wages, UBIA, qual. REIT dividends and PTP income to be allocated by distributable net income ( DNI ) Treated as an RPE to the extent it allocated items to beneficiaries Treated as an individual to extent items are not allocated Grantor trusts will be treated like a sole proprietorship 34 17

18 Analyzing the Deduction 1. Overall Limitation 2. Wage limitation (or modified wage limit for capital intensive businesses Unadjusted Basis Immediately After Acquisition ( UBIA )) 3. SSTB discrimination 4. Lower income taxpayer (threshold) 5. Phase-in range 35 Overall Limitation Lesser of 20% of: Combined Qualified Business Income ( QBI ) Deduction = Taxable Income Net Capital Gain Qual. Cooperative Dividends PLUS -OR- Lesser of: 20% of Qual. Cooperative Dividends -OR- Taxable Income Net Capital Gain 36 18

19 Specified Service Trade or Business - Health - Law - Accounting - Actuarial science - Performing arts - Consulting - Athletics - Financial services - Brokerage services 37 SSTB Accounting (Prop. Treas. Reg A-5(b)(2)(iv) Provision of services by accountants, enrolled agents, return preparers, financial auditors, and similar professionals in their capacity as such. Not limited to services requiring CPA license Aim of proposed regulation is to capture common understanding of accounting including tax return and bookkeeping services Does not include payment processing / billing analysis 38 19

20 Specified Service Trade or Business Principal asset is the reputation or skill of one or more employees Involves services of investing and investment management, trading, or dealing in securities, partnership interests, or commodities 39 Category 1 Category 2 Category 3 Taxable Income < $157,500 $157,500 - $207,500 > $207,500 < $315,000 $315,000 - $415,000 > $415,000 Wage Limitation DOES NOT APPLY PHASE-IN APPLIES Specified Service Trade or Business Discrimination DOES NOT APPLY PHASE-IN 40 20

21 Category 1 Category 2 Category 3 Taxable Income < $157,500 $157,500 - $207,500 > $207,500 < $315,000 $315,000 - $415,000 > $415,000 Wage Limitation DOES NOT APPLY PHASE-IN APPLIES Specified Service Trade or Business Discrimination DOES NOT APPLY PHASE-IN 41 Taxable Income Category 3 Category 1 Category 2 < $157,500 $157,500 - $207,500 > $207,500 < $315,000 $315,000 - $415,000 > $415,000 Wage Limitation DOES NOT APPLY PHASE-IN APPLIES Specified Service Trade or Business Discrimination DOES NOT APPLY PHASE-IN 42 21

22 Category 3 & SSTB Taxable Income > Upper Thresholds = No Deduction ($207,500 / $415,000) 43 Wage Limitation Otherwise available QBI deduction limited to greater of: - 50% of W-2 wages with respect to the qualified trade or business -OR- - 25% of W-2 wages + 2.5% of the unadjusted basis of all qualified property immediately after acquisition 44 22

23 Example 2a Wage Limit QBI $2,000,000 x 20% Potential QBI Deduction $400,000 Taxpayer's Wages $200,000 x 50% Wage Limited Deduction $100,000 x 37% Savings from Deduction $37, Example 2b Increase Wages QBI $2,000,000 x 20% Potential QBI Deduction $400,000 Taxpayer's Wages $500,000 x 50% Wage Limited Deduction $250,000 x 37% Savings from Deduction $92,500 Less: Addit'l Empl. Tax (2.9%) ($8,700) Net Savings $83,

24 Qualified Property Tangible, depreciable property: 1. Held by and available for use in the qualified trade or business at the close of the tax year, 2. Used at any point during the tax year in the production of QBI, and 3. Depreciable period for property has not ended before the close of the tax year 47 Example 2c Capital Intensive QBI $2,000,000 x 20% Potential QBI Deduction $400,000 Wages Qual. Property Total Taxpayer's Wages $200,000 $2,500,000 x 25% x 2.5% Wage Limited Deduction $50,000 $62,500 $112,500 x 37% Tax Savings $41,

25 Wage Limitation Must be reported timely to the Social Security Administration - If > 60 days late the wages won t count Guaranteed payments from partnerships are not wages - Not included in QBI (so not deduction permitted for such amounts) - Also not included in wages (so the wage limit will be lower) 49 Category 2 Category 1 Category 3 Taxable Income < $157,500 $157,500 - $207,500 > $207,500 < $315,000 $315,000 - $415,000 > $415,000 Wage Limitation DOES NOT APPLY PHASE-IN APPLIES Specified Service Trade or Business Discrimination DOES NOT APPLY PHASE-IN 50 25

26 Non-SSTB SSTB Wage Limitation (1b) > Un-Limited Deduction (1a) Phase-In Inapplicable Simple Phase-In Un-Limited Deduction (1a) > Wage Limitation (1b) Complicated Phase-In 51 Phase-In Step #1 1a. Calculate (un-limited) QBI deduction 1b. Calculate wage limitation 52 26

27 Phase-In Step #2 2a. Compare 1a and 1b 2b. If 1b > 1a and business is not a specified service T/B analysis stops (wage limit is too low and the phase-in won t apply) 53 Example 3a (Phase-In) 1b > 1a & Not SSTB 1a. QBI $182,500 x 20% Un-Limited QBI Deduction $36,500 1b. Taxpayer's Wages $80,000 x 50% Wage Limitation $40,000 1b > 1a: Deduction = 1a 54 27

28 Non-SSTB SSTB Wage Limitation (1b) > Un-Limited Deduction (1a) Phase-In Inapplicable (Example 3a) Simple Phase-In Un-Limited Deduction (1a) > Wage Limitation (1b) Complicated Phase-In 55 Phase-In Step #2 2c. If 1b > 1a and business is a specified service T/B: Applicable % = 100% minus ratio of taxable income in excess of $157,500 / $315,000 divided by $50,000 / $100,000 Phase-in limitation = 1a x Applicable % 56 28

29 Example 3b (Phase-In) 1a > 1b & SSTB 1a. QBI $182,500 x 20% Un-Limited QBI Deduction $36,500 1b. Taxpayer's Wages $80,000 x 50% Wage Limitation $40,000 2c. Taxable Income ($182,500) > $157,500 $25,000 $50, % 50% -50% Applicable % 50% Un-Limited QBI Deduction $36,500 Applicable % x 50% Phase-In Limitation $18, Non-SSTB SSTB Wage Limitation (1b) > Un-Limited Deduction (1a) Phase-In Inapplicable (Example 3a) Simple Phase-In (Example 3b) Un-Limited Deduction (1a) > Wage Limitation (1b) Complicated Phase-In 58 29

30 Phase-In Step #2 2d. If 1a > 1b: Excess amount = 1a 1b Reduction = Excess amount x ratio of taxable income in excess of $157,500 / $315,000 divided by $50,000 / $100,000 Phase-in limitation = 1a - reduction 59 Example 3c Phase-In & 1b > 1a 1a. QBI $182,500 2d. Un-Limited QBI Deduction $36,500 x 20% Less: Wage Limitation ($15,000) Un-Limited QBI Deduction $36,500 Excess Amount $21,500 1b. Taxpayer's Wages $30,000 Taxable Income $182,500 x 50% ($157,500) Wage Limitation $15,000 $25,000 $50,000 50% Excess Amount x $21,500 Reduction $10,750 1a. Un-Limited QBI Deduction $36,500 Less: Reduction ($10,750) Phase-In Deduction $25,

31 Non-SSTB SSTB Wage Limitation (1b) > Un-Limited Deduction (1a) Phase-In Inapplicable (Example 3a) Simple Phase-In (Example 3b) Un-Limited Deduction (1a) > Wage Limitation (1b) Complicated Phase-In (Example 3c) (d)(1)(C) Penalty Threshold for substantial understatement of tax reduced from 10% to 5% Applies to taxpayers claiming a 199A deduction 5% reduction threshold applies to all items (so a 6% understatement unrelated to the QBI deduction will cause application of the penalty) 62 31

32 199A Final Thoughts If net QBI loss from all qualified T/B, the loss is carried forward to the next tax year Carryforward will apply to reduce any QBI deduction in a subsequent year Sunset - 199A is inapplicable for tax years beginning after 12/31/ Depreciation and Expense Deductions After Tax Cuts & Jobs Act 64 32

33 Depreciation changes made by Bonus Depreciation - Written Binding Contract vs. Substantial Construction (see Depreciation Accelerator) Qualified Improvement Property (QIP) under the Interest Deduction Limitation (see ADS vs. MACRS decision tree) Section 179 Expensing State and Local Deductions Like-Kind Exchanges Bipartisan Budget Act of 2018 (179D and 45L) 65 Bonus Depreciation Under the increases bonus to 100% for properties placed-in-service between 9/28/ /31/2022 Applicable to new Construction/Renovation Acquisitions now eligible qualifying assets no longer have to be new, just new to you After 2022, bonus rates will gradually decline 66 33

34 Bonus Depreciation Rates Under the Year Bonus Value 9/28/ /31/ % (50% election) 1/1/ % 12/31/ % % % % 67 Bonus Depreciation Under the Crucial Date Established a Mid-Year Bonus Rate Split 9/27/2017 is the crucial day that will determine bonus rates The IRS has not yet issued further guidance for Note: If the law applies according to guidance issued in 2010 when a mid-year rate split last occurred (Reg (k)-1(b)(4) and Revenue Procedure ) As such, the following content is subject to change as the IRS issues new guidance 68 34

35 Bonus Under the -- Written Binding Contract Bonus eligibility in 2017 is contingent on a written binding contract signed after 9/27/17: If a written binding contract for the acquisition of property is in effect prior to 9/28/17, the property is not considered acquired after the date the contract is entered into (Act Sec (h)(1) of the ). Consequently, property subject to a binding written contract entered into before 9/28/17 is not eligible for the 100-percent rate and is subject to a 40-percent rate if placed in service in 2018 and a 30-percent rate if placed in service in The 50- percent rate applies if such property is placed in service in Bonus Under the Acquisitions of Real Estate WBC for Purchase of Property Signed BEFORE 9/28/17 Considered to have been acquired before came into play Therefore, PATH Act Rules must apply and acquired assets would not be eligible for Bonus Controlled by Date of the Written Binding Contract (WBC) WBC for Purchase of Property Signed ON or AFTER 9/28/17 Acquired under, therefore Bonus rules apply 100% Bonus Assets must have MACRS class lives of 20-years or less 70 35

36 Bonus Under the New Construction/Renovation Driven by date substantial construction begun -- but how do we define substantial? No bright line definition in the code but In general, manufacture, construction, or production of property begins when physical work of a significant nature begins. Physical work does not include preliminary activities such as planning or designing, securing financing, exploring, or researching. PLUS -- IRS Safe Harbor Option: Physical work of a significant nature will not be considered to begin before the taxpayer incurs (in the case of an accrual basis taxpayer) or pays (in the case of a cash basis taxpayer) more than 10 percent of the total cost of the property. 71 Bonus Under New Construction/Renovation Driven by Date Substantial Construction Began 72 Construction Begun Before 9/28/17 PATH Act Rules Apply Pre-existing phase-down rules Placed-in-Service by 12/31/17: 50% Bonus Placed-in-Service by 12/31/18: 40% Bonus Placed-in-Service by 12/31/19: 30% Bonus Also applies to new spend on renovations postacquisition Construction Begun On or After 9/27/17* Rules Apply 100% Bonus Acquired assets are eligible Regardless of when contract was initially signed (Reg 1.168(k)- 1(b)(4)(iii)(A)) 36

37 Bonus Depreciation Under the Summary Great time to reconsider cost segregation studies on acquired properties Original use of property need not have commenced with the current taxpayer Bonus boosted to 100% Be clear on relevant dates If elect-out of interest deduction limitation, must use ADS depreciation which is generally NOT bonus-eligible 73 Qualified Improvement Property THEN: QIP-PATH Established as a new property category under the PATH Act Defined as any improvement to an interior portion of a building which is nonresidential real property if the improvement is placed-in-service after the date the building was placed-in-service Restrictions associated with QLI, QRI, and QRIP did not apply No Three-Year Rule Did not have to be made pursuant to a lease QIP classified as 39-year after Bonus (other three categories classified as 15-year SL, not Bonus-eligible) 74 37

38 Qualified Improvement Property after Any improvement to an interior portion of a building which is nonresidential real property if the improvement is placed-inservice after the date the building was first placed-in-service by any taxpayer. Replaces the separate categories of QLI, QRI, QRIP Classification based on assumption that QIP placed-in-service after 12/31/2017 supposed to have a 15-year SL recovery period as intended by Congress (P.L ). Requires a technical correction 75 QIP Under the Summary Under PATH Act, easy to meet definition of QIP, but QIP was long-lived 39-year after Bonus To depreciate using shorter 15-year life, asset had to meet additional qualifications to be considered QLI/QRI/QRIP However, the new QIP- has the shorter 15-year class life, without the associated restrictions This is another big plus further enhances the value of a traditional cost segregation study 76 38

39 Interest Deduction Limitation Effective 1/1/18, limited the amount of business interest a taxpayer may deduct in any tax year The limitation is an amount of business interest equal to the sum of - The business interest income of the taxpayer for the tax year; - 30% of adjusted taxable income of the taxpayer for the tax year (which cannot be a negative amount), and; - The floor plan financing interest of the taxpayer for the tax year. 77 Interest Deduction Limitation The 30% limit applies only to net business interest expense (i.e., the excess of business interest expense over business interest income) and is based on the taxpayer s adjusted taxable income. For tax years beginning after 12/31/17 and before 1/1/22, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, depletion, or business interest expense (similar to EBITDA). For tax years beginning after 12/31/21, adjusted taxable income will include deductions for depreciation and amortization, but not business interest expense

40 Interest Deduction Limitation The exempted certain small businesses from the business interest limitation in the event that they meet the $25 million gross receipts test This test is satisfied if the taxpayer has average annual gross receipts of less than $25 million for the three previous taxable years (or such shorter period in which the taxpayer was in existence) Hopefully, the IRS will provide guidance with respect to the impact of related parties on the gross receipts test 79 Interest Deduction Limitation If annual gross receipts average MORE than $25M, taxpayers operating a real property trade or business may irrevocably elect to opt out of the business interest limitation. The consequence of such an election is that all of the taxpayer s residential rental property, nonresidential real property and QIP used in such real property trade or business must be depreciated using the alternative depreciation system (ADS)

41 Interest Deduction Limitation A real property trade or business is any real property development, redevelopment, construction, reconstruction,, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business. If the taxpayer elects out, the taxpayer MUST depreciate real property using ADS (Alternative Depreciation System) 81 Interest Deduction Limitation ADS ADS recovery periods are - 40 years for nonresidential property, - 30 years for residential rental property, and - 20 years for qualified QIP As compared to MACRS recovery periods of - 39 years for nonresidential property, years for residential rental property, and - 15 years for QIP 82 41

42 Interest Deduction Limitation ADS ADS classes are longer-lived, and properties depreciated with ADS are generally not bonus-eligible Taxpayer should consider ramifications of electing out 83 Section 179 Expensing Pre- Entity-level election Permits the full purchase price of a qualifying asset to be written off completely in the year of purchase Qualifying assets included: business equipment computers business related vehicles, etc. Section 179 election encourages businesses to invest in their own growth 84 42

43 Section 179 Expensing Under the Effective 1/1/2018, the expanded the eligible assets to include the following improvements to nonresidential building systems placed-in-service after the building was placed-inservice: - Qualified Improvement Property (QIP) - Roofs - HVAC - Fire protection and alarm systems - Security systems 85 Section 179 Expensing Under the Increased the dollar limitation of the election from $510,000 to $1 million Eliminated the exclusion of tangible personal property used in connection with lodging facilities (i.e. hotels) Assets may be new or used 86 43

44 Section 179 Expensing Under the Summary Demonstrates advantage of cost segregation study - The newly included improvements can be carved out during a cost segregation study adds even more value - Limitation on the election is increased by almost 50% - For the first time, assets used in hotels, motels, and dormitories are eligible for expensing under Section No authority to take Sec. 179 on a Schedule E! 87 Like-Kind Exchanges Under the Section 1031 real estate like-kind exchanges are preserved and will continue to be eligible for tax deferral Effective 1/1/2018, like-kind personal property exchanges are no longer permitted 88 44

45 Bipartisan Budget Act of 2018: Section 179D Reinstated for 2017 only Extended the most recent rules for application Up to $1.80/ square foot of deduction benefit For new construction and renovation work Three areas of construction: - Interior lighting - HVAC - Building envelope 89 Bipartisan Budget Act of 2018: Section 45L Reinstated for 2017 only Extended the most recent rules for application $2,000 tax credit per dwelling unit For new and renovation work to: - Single family homes - Multifamily three up to three stories 90 45

46 Bonus, Section 179 and the repair regulations The same property may be depreciable under both bonus and Section 179 and expensed under the repair regulations Repair regulations require a more complex analysis of expenditures, including requiring determination of unit of property and whether an expenditure can be expensed or must be capitalized 91 Bonus, Section 179 and the repair regulations Unlike section 179 expensing, taxpayers do not need net income to take bonus depreciation deductions But taxpayers must take the new net operating loss (NOL) limitations as well as the new limitation on losses of noncorporate taxpayers into account Bonus depreciation is not limited to smaller businesses or capped at a certain dollar level as under section

47 Impact of the new depreciation rules on the repair regulations The current depreciation rules are very generous % bonus and Section 179 s application to nonresidential real property such as roofs, heating, ventilation, and airconditioning property, fire protection and alarm systems, and security systems Determination whether an expenditure is a repair and maintenance expense as opposed to an expenditure that must be a capitalized under the repair regulations may be a less crucial determination for many taxpayers in Impact of the new depreciation rules on the repair regulations Identifying a unit of property as required under the repair regulations will still be important Ability to fully depreciate an expenditure by utilizing the 100% bonus depreciation or Section 179 reduces the risk of taking an invalid position by expensing the activity as a repair and maintenance item 94 47

48 De minimis safe harbor election? Making a de minimis safe harbor election remains a viable option for many taxpayers Under the repair regulations, a taxpayer may elect to apply a de minimis safe harbor to amounts paid to acquire or produce tangible property to the extent such amounts are deducted for financial accounting purposes or in keeping books and records. If the taxpayer has an applicable financial statement (AFS), the taxpayer may use this safe harbor to deduct amounts paid for tangible property up to $5,000 per invoice or item (as substantiated by invoice) If the taxpayer does not have an AFS, the taxpayer may use the safe harbor to deduct amounts up to $2,500 per invoice or item (as substantiated by invoice). 95 De minimis safe harbor election? The de minimis safe harbor election eliminates the burden of determining whether every small-dollar expenditure for the acquisition or production of property is properly deductible or capitalizable If a taxpayer elects to use the de minimis safe harbor, the taxpayer does not have to capitalize the cost of qualifying de minimis acquisitions or improvements

49 Deduction versus capitalization The final tangibles regulations synthesize existing case law and prior administrative rules into a framework to help taxpayers determine whether a cost is deductible as a repair and maintenance expense or must be capitalized because it is an improvement If the amounts are not paid or incurred for an improvement to tangible property as determined under the final tangibles regulations, then the amounts generally are deductible as repairs and maintenance 97 Improvements that must be capitalized A unit of tangible property is improved only if the amounts paid are: - For a betterment to the unit of property; or - To restore the unit of property; or - To adapt the unit of property to a new or different use

50 Impact of depreciation expense on the Section 199A deduction One potential limit on the Section 199A deduction is the taxable income limitation. The 199A deduction is the lower of 20% of qualified business income (QBI) or taxable income, if taxable income is less than QBI If a taxpayer s taxable income is less than his or her QBI, then the deduction is the lesser of 20% of either QBI or taxable income. Thus when a taxpayer is eligible for the Section 199A deduction, maximizing depreciation expense could result in a reduction, or elimination altogether, of the Section 199A deduction because taxable income might be negative due to the very large depreciation expense deduction 99 Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) Generally, assets are placed in service when the asset is in a condition or state of readiness and available for a specifically assigned function The taxpayer in Stine ran a retail operation that sold home building material and supplies

51 Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) In 2008, the taxpayer built two new buildings that were inside the Gulf Opportunity Zone (GO Zone). Stine involved incentive depreciation for assets utilized in GO Zones, the placed in service test is employed in a variety of code sections, including 167 and Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) In 2008, the taxpayer built two new buildings in LA that were inside the Gulf Opportunity Zone The taxpayer obtained certificates of occupancy before year end for two newly completed retail store buildings Taxpayer allowed to receive equipment, shelving, racks, and merchandise and have such installed Stores had not been issued certificates of occupancy allowing customers to enter the buildings

52 Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) Taxpayer argued that the properties were placed in service because they were ready and available for their intended use e.g., to store and house equipment, racks, shelving, and merchandise. The IRS argued that, as of GO Zone allowance deadline, the buildings were not open for business and thus not yet placed in service 103 Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) A building is considered placed in service when the building is substantially complete and the building is in a condition or state of readiness and availability The Tax Court held the two buildings were substantially complete, fully functional, and that placed in service does not require the business be "open for business" for purposes of a depreciation deduction

53 Determining when to depreciate an asset Stine 115 AFTR 2d 2015-XXXX (DC LA) There is no open for business rule. The taxpayer s retail building had been placed in service despite the fact that the retail stores had not yet open for business. As a result, the taxpayer s buildings were judged to be placed in service prior to 12/31/2008 and the taxpayer could therefore claim a deduction for 50% Go Zone incentive depreciation 105 S CORP VS C CORP AFTER TAX CUTS AND JOBS ACT

54 Together we will focus on the following. Opportunity Knocks S Corp vs. C Corp Rate differences factoring in: Participation in business Earnings distributed vs. reinvested Eligibility for 20% QBI deduction End game - sell the business?

55 Choosing the Optimal Structure Single-member LLCs (disregarded entity, S corp or C corp) Multi-member LLCs (partnership, S corp or C corp) Partnerships S Corporations 109 Tax Reform Changes for C Corps Old Law Prior maximum tax rate 35% Personal service corporations (PSCs) were taxed at flat 35% Corporate AMT - 20% New Law Flat tax rate 21% No separate rate for PSCs No Corporate AMT

56 Tax Rate Differences in S Tax Corp Reform Changes for S Corps Old Law Top Individual Rate 39.6% No 199A deduction New Law Top Individual Rate 37% 20% 199A deduction possible 111 Considerations for Switch Section 481(a) adjustment will be spread over 6 years Two tax returns required if S election revoked mid-year After revocation, AAA cash distributions can be made tax free during the post-termination transition period (PTTP) Suspended losses can be used on the last day of the PTTP assuming the shareholder has basis in the S Corp stock

57 Comparison of 2017 and 2018 Tax Rates Entity Change S Corp (active; no 199A) 39.6% 37.0% -2.6% S Corp (passive; no 199A) 43.4% 40.8% -2.6% S Corp (active; w/ 199A) 39.6% 29.6% -10.0% S Corp (passive; w/199a) 43.4% 33.4% -10.0% C Corporation 35.0% 21.0% -14.0% Scenarios & Choice of Entity Implications Business generating tax losses Business distributing all profits Business retaining all profits to finance growth

58 Business Distributing all Profits to Owners C Corp S Corp 21 % Flat Tax Rate Dividends to individuals at 15% Net Investment Income Tax (NIIT) 3.8% Total rate % Top Individual Rate 37% Full QBI deduction of 20% Assume no Investment Income Tax (NIIT) Total rate % 115 Business Distributing all Profits to Owners C Corporation S Corporation Earnings $300,000 $300,000 Less: corporate tax - 63,000 0 Available for distribution $237,000 $300,000 Less: tax at owner level - 56,406-88,800 Available after-tax earnings $180,594 $211,

59 Business Distributing all Profits to Owners Earnings $100,000 $200,000 $300,000 Salary $40,000 $80,000 $120,000 Payroll tax (15.3%) $6,120 $12,240 $18,360 Income tax 6,980 24,150 44,266 Total S Corp Taxes $13,100 $36,390 $62, Business Distributing all Profits to Owners Earnings $100,000 $200,000 $300,000 Less: corp. tax (21%) - 21,000-42,000-63,000 Dividends $79,000 $158,000 $237,000 Dividend tax $0 $23,700 $44,556 Total C Corp Taxes $21,100 $65,700 $107,

60 Business Distributing all Profits to Owners Earnings $100,000 $200,000 $300,000 C Corp Taxes $21,000 $65,700 $107,556 S Corp Taxes -13,100-36,390-62,626 S Corp Savings $7,900 $29,310 $44, Business Retaining Profits to Finance Growth C Corp 21 % Flat Tax Rate Dividends to individuals at 15% 3.8% NIIT Total 39.8% Rate S Corp Top Individual Rate 37% Full QBI deduction of 20% Assume no NIIT Total 29.6% Rate

61 C Corp - Advantages and Disadvantages Advantages Deductibility of fringe benefits Corporate AMT is eliminated Distributions for 1 year receives special tax treatment Ability to choose any fiscal year Shareholders do not have to be natural persons Disadvantages Electing to C Corp may require use of accrual method of accounting Double taxation No 199A Deduction Penalty taxes such as PHC Taxes and accumulated earnings taxes 121 S Corp - Advantages & Disadvantages Advantages 199A Deduction Ability to pass losses to shareholders More flexibility to respond to future tax rate changes South Carolina - reduced individual tax rate for S Corps Disadvantages No deductibility of fringe benefits Disallowance of 199A deduction for high income service business owners or wage limited businesses Cannot reelect S status for 5 years if revoked Built in gains

62 Selling the Business C Corp Company can sell assets or stock Sale of assets will trigger 21% corporate tax as well as capital gains tax if corp liquidated Company will generate more cash flow for debt repayment C Corp may be more attractive if a sale is much farther down the road 21% rate is permanent S Corp Owners basis is increased by undistributed earnings Owners can give the buyer a step up in basis ( 338(h)(10) election) Owners receive capital gain treatment on sales proceeds 199A deduction expires in 2026 along with the reduced individual rate

63 LUNCH! RECONVENE AT 1:00 PM 125 CASES AND RULINGS

64 The World Around Us 127 Emotional Distress Hunsaker; CA 9; 2018 Taxpayers entitled to emotional distress damages after IRS willfully violated bankruptcy stay by sending levy notices

65 Third Party Settlement Organization TPSO PLR Taxpayer is a sharing economy mobile and online platform connecting Service Providers with Service Recipients and facilitating payments (including a fee to the taxpayer!) A TPSO is not required to report 3 rd party network transactions for a participating payee until the amount to be reported exceeds $20,000 AND the number of transactions with that payee exceeds 200. Taxpayer is NOT the common law employer of the Service Providers Each service provided is a single transaction 129 High Deductible Health Plan Notice Three states, Oregon, Illinois, and Maryland have enacted laws that require insurers to cover male sterilization or contraceptives without a deductible - Those procedures are not preventive care that can be covered before a deductible, so... A plan that complies with state law is not eligible to make or receive tax favored HSA contributions... so... - Notice allows for transition relief... At any time before 2020, a taxpayer will not fail to be HSA eligible solely because he is covered under a plan that covers male sterilization or contraception

66 Student Loan Benefit With 401(k) Plan PLR Employer s plan to make non-elective contributions to an employee s 401(k) plan equal to the employee s student loan repayment will not violate contingent benefit rule - Employer contributions would be based on student loan repayments, not on employee s elective contributions to the plan, AND - Employee could still make non-elective payments to the plan and receive employer nonelective matching contributions 131 Taxes Will Not End at Death!!! Rev. Rul When an IRA trustee makes a payment to a State unclaimed property fund, the payment is subject to federal withholding... REALLY??? - Who can file a return to claim the economic benefit of the tax payment??? - How will the $$$$ be accounted for??? TEO Division Memo Missing Participants and Beneficiaries and Required Minimum Distributions (10/19/2017) instructs auditors not to challenge a plan that has taken listed actions to locate missing participants. Some $$$ will go to Mephistopheles!!!

67 Constitutional Issues 133 Physical Presence Standard South Dakota v. Wayfair; US SC; 2018 Physical presence is not required to meet a substantial nexus standard That standard is more appropriate when marketplace conditions favor remote sellers to the extent that States lose enormous amounts of revenue Remote sellers have established an extensive virtual presence that is sufficient to trigger substantial nexus

68 Executive Authority Public Citizen v. Donald J. Trump; D DC; 2018 Dismissed challenge to Presidential Executive Order (EO) that mandated for every new regulation, two existing regulations must be cut - Plaintiffs could not establish that they had associational standing because they failed to identify particular members who might be harmed by the policy 135 Disclosure of Donors Americans for Prosperity Foundation v. Becarra; Ca 9; 2018 See also...center for Competitive Politics v. Harris; CA 9; 2015, AND Citizens United Foundation v. Schneiderman; CA 2; 2018 All of the above decisions, favored disclosure of donors to 501(c)(4) organizations - However... In July, 2018, the IRS announced it would no longer require certain tax exempt organizations to report the names and addresses of their contributors on Schedule B... Press release Treasury Department and IRS Announce Significant Reform to Protect Personal Donor Information to Certain Tax-Exempt Organizations (July 16, 2018)

69 Constitutional Issues Who (or What) is the Taxpayer S Corporation as an Entity CCA IRS will NOT follow Morton v. US; Ct FedClms; 2011 In Morton, Court accepted taxpayer s argument to disregard his S corporation in which he held a majority interest and which carried on a unified business enterprise thereby allowing Morton to avoid the limitation of IRC Sec. 183 The authority here, according to the CCA, should continue to be Moline Properties, Inc v. US; US SC; A corporation is generally respected... there is no justification for doing otherwise S status does not alter the separate identification of a corporation as an entity for federal tax purposes

70 Husband and Wife LLC Members Argosy Technologies, LLC; T.C. Memo Husband and wife were members of an LLC in a non-community property state LLC could not be a single-member entity - No 761(f) election had been made - LLC had filed Forms 1065 (LATE) that included a TEFRA statement 139 Corporation as Mere Accounting Arrangement Barnhart Ranch Company; CA 5; 2017 Corporation owned cattle ranch s business assets and deposited receipts in its bank accounts is the taxpayer Court rejected the notion that the corporation only served as the business manager... To divide income and expenses among the shareholders

71 Constitutional Issues What is Real??? 141 Shareholders Liable as Transferees??? Slone v. Comm; CA 9; 2018 Slone sold assets to Citadel Corporation Immediately after the sale, those shareholders sold their stock to a third corporation (B), which paid using borrowed funds Slone and B then merged and the debt was repaid, But no one paid the $15.3 million federal income tax due on the sale After winning twice in the Tax Court, the Slone shareholders were finally held to account as transferees - The transaction lacked economic substance

72 Substance Over Form Mazzei; 150 TC No. 7 (2018) Substance-over-form principles applied to impose excise tax on excess contributions to Roth IRAs associated with pre-packaged program involving foreign sales corporations Benenson v. Comm.; CA 1; reversed Tax Court to allow taxpayers use of a DISC to transfer amounts from a C corporation to Roth IRAs for the taxpayers children Summa Holdings Inc.; CA 6; Reversed Tax Court in similar facts. While the purpose of the transaction was clearly tax avoidance, the taxpayers actions were congressionally sanctioned making IRS application of substance over form inappropriate. 143 Economic Substance Hahn; T.C. Memo Custom Adjustable Rate Structure (CARDS) transaction lacked economic substance Transaction failed both the objective and subjective tests for economic substance No opportunity for profit and taxpayer had no non-tax purpose for the transaction

73 Gross Income and Exclusions 145 Payment From Qualified Settlement Fund Ritter; T.C. memo $30,000 payment from QSF established to remedy bank s deficient mortgage servicing and foreclosure practices must be included in income Taxpayer was not required to show financial harm or request a review Terms of settlement did not in any manner reflect specific financial injury or harm that may have been suffered by borrowers receiving payments

74 State Grants Uniquest Delaware LLC; D NY; 2018 Partnership must include $11 million of State grants in income Grants were received to help restore and develop a property the partnership had purchased from the State They were NOT a discount or rebate on the purchase of the property. NOT a gift, NOT a non-taxable contribution to capital, and NOT otherwise excludable under any common law doctrine 147 Recovery of Capital McKenny; D FL; CPA firm instructed taxpayer to set up business as an S corporation owned by an ESOP, but the firm did not file the proper documents necessary to make the plan work Taxpayer sued and recovered money damages District Court ruled settlement was not taxable because it simply restored taxpayer to position he was in before the loss

75 Recovery of Capital PLR Payment received by bankruptcy estate as successor to insured driver s settlement of malpractice claim against insurance company and its law firm for failing to settle wrongful death suit against driver within policy limits Excludable from taxpayer s gross income as return of capital... compensating him for loss or destruction of capital (payment of death claim!) 149 Information Reporting Requirements PLR State is subject to information reporting requirements (under Sections 6041(a) and 6041(d)) for grants to homeowners to help improve their property against earthquakes Grants were accessions to wealth Not general welfare payments More than an incidental benefit Not qualified under welfare exclusion because not based on family need

76 Can t Refuse Income Ramsay; CA 5; 2018 Taxpayer did not want employer provided life insurance but was taxed on the benefit anyway!!! 151 Section Exclusion for Injury Smith; T.C. Memo Payment received from VA for employment discrimination was not excludable. Court rejected claim that employment discrimination led to physical injury French; T.C. Summ No part of a couple s payment from a bank, to settle a contentious mortgage dispute, qualified for the physical injury exclusion because none of their claims against the bank sought compensation for physical injury or illness

77 Section Discharge of Debt Sun; CA 5; Distinguishing between receiving a loan and misappropriating funds, the 5 th Circuit has held the fact that there is an obligation to repay such funds does not prevent their inclusion in taxable income. See also James; 366 U.S. 213 (1961) for the proposition that embezzled funds are includable in income. 153 Section Discharge of Debt Bullock; T.C. Memo Taxpayer who mistakenly cosigned a loan for her son, rather than guarantee as she had intended, did not have Section 108, cancellation or discharge of debt income when the unpaid loan balance was forgiven. Lender issued a Form 1099-C even though it never looked to her for payment Tax Court found there was no accession to wealth when loan was forgiven, and therefore no COD income

78 Section Discharge of Debt CCA Cash award payments made pursuant to a State s student loan repayment program to encourage physicians to practice in underserved areas were excludable from recipients gross income under Section 108(f)(4), but were not forgiveness or discharge of debt so information returns were not required 155 Fringe Benefits Notice ; Provides guidance on application of Section 132(g)(2) to employer reimbursements for qualified moving expenses received in 2018 for expenses incurred in Reimbursement is excludable if expense would have been deductible if paid by employee in 2017 CCA Value of tax preparation services provided by US company for benefit of its employees working in foreign countries is includable in employee s gross income and subject to employment taxes

79 Deductions Ordinary and Necessary Trade or Business Expense 157 Quarterly Commitment Fees Field Attorney Advice F... Quarterly commitment fees paid to keep a revolving line of credit in force not required to be capitalized, ut deductible in year incurred. No intangible asset was acquired or created, nor was such a transaction facilitated

80 Disgorgement Payments CCA Refer to Kokesh; US SC; IRC Section 162(f) bars a deduction under Section 162 for an amount paid as discouragement for violating a federal securities law. Such a payment bears all the hallmarks of a penalty: it is imposed as a consequence of violating a public law and it is intended to deter, not to compensate 159 Business Meals Notice Provides transitional guidance (pending proposed regulations) on deductibility of expenses for business meals purchased in an entertainment context. The following requirements must be met; - Expense must be ordinary and necessary under 162(a) paid or incurred during the tax year in carrying on a trade or business - Expense must not be lavish or extravagant under the circumstances - Taxpayer, or an employee of the taxpayer must be present when the food or beverages are furnished - Food and beverages must be provided to a current or potential business customer, client, consultant or similar business contact -... Continued

81 Business Meals (continued) Continued - If food and beverages are provided during or at an entertainment activity, they must be purchased separately from the entertainment, or the cost of each must be separately stated on one or more bills, invoices, or receipts - The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages 161 Tax Home Barrett; T.C. Memo Self-employed taxpayer s tax home is in Las Vegas because he did most of his work from his Las Vegas home and had rental property in the Las Vegas area Did not matter that he traveled regularly to Washington DC nor that he rented an apartment there

82 Taxes IR Prepayment of real property taxes is deductible in the year of prepayment ONLY if the property tax is assessed in the year of prepayment Check State, County and City laws for assessment date 163 Multiple Employers CCA $500,000 limitation [see IRC Section 162(m)(6)] on deductible wages must be pro rated between multiple employers including one or more employers that are exempt from federal income tax Applies to compensation paid by covered health insurance providers so pro-ration may result in reduced tax benefit to taxable insurers

83 Bad Debts... IRC Sec. 166 Sensenig; CA 3; affirming Tax Court Transfers from taxpayer to companies in which he had an equity interest were equity investments, not loans No due diligence No documentation Claimed deductions for wholly worthless loans were disallowed 165 Deductions Charitable Contributions

84 Guidance to Contributors Rev. Proc Modifies, supersedes and clarifies previously issued guidance to grantors and contributors to tax exempt organizations on various deductibility and reliance issues May be helpful when you need to answer that hard question 167 Nature of the Gift Platts; T.C. Memo Deduction for appraised value of a house was denied House was donated with understanding that it would be disassembled and moved to the organization s property Value of donation was building parts, not an intact structure

85 Conservation Easements IRC Section 170(h)(1) and Treas. Reg. Section 1.170A-14(a) A contribution of property can be a qualified conservation contribution if: - The property is a qualified real property Interest - The property is contributed to a qualified organization AND - The contribution is exclusively for conservation purposes Each of those conditions is further explained in the regulations and the tax advisor should become familiar with the fine points that apply here as well as other contributions of property 169 Conservation Easement Harbor Lofts Associated, LP; 151 T.C. No. 3 (2018) Partnership leased property for period of 60 years and assumed most responsibilities of a owner Donated façade easement on the historic property and claimed a conservation easement deduction NOT SO FAST! In Massachusetts leasehold interest is not real property, so no donation of a real property interest Could not donate in perpetuity since lease was for 60 years

86 Conservation Easements PBBM-Rose Hill, Limited; CA 5; Grant of easement did not meet perpetuity requirement because provision in deed would not allow for extinguishment [as required by Treas. Reg. Section 1.170A-14(g)(6)] That allows termination of the easement in the situation of impossibility IF... the requisite amount of proceeds are given to the nonprofit holder of the easement to be used for similar purposes 171 Conservation Easements Champions Retreat Golf Founders, LLC; T.C. Memo Golf club development LLC not entitled to a charitable deduction for donation to land trust of easement across operating golf course No conservation purpose because not enough natural habitat Insufficient presence of rare, endangered, or threatened species Not enough open space to provide scenic enjoyment for general public

87 Deductions Hobby Losses 173 Performance Venue (Theater) Ford; T.C. Memo Taxpayer not entitled to claim losses from operation of theater - Did not change anything despite years of losses - Clearly derived personal pleasure from the activity - No expertise in operating a theater - Inadequate records - Made no attempt to reduce expenses

88 Cattle Ranch Robison; T.C. Memo High income tax payers really had a profit motive for running their cattle ranch, and could claim more than $9 million in losses BUT WAIT!!! the story isn t over... Taxpayers were not able to support material participation and their loss was limited by the Passive Activity loss rules (IRC Section 469) 175 Another One! Welch; T.C. memo Taxpayer s 8,700 acre ranch engaged in cattle, hay, and horse breeding and training activities as a single activity for purposes of IRC Section 183 Court found a profit motive was present in spite of persistent and substantial losses Although only a weekend rancher, taxpayer Welch ran the ranch in a businesslike manner, had considerable expertise himself, hired professionals, and made business changes where feasible Court warned that decision was close and he might not win next time

89 IRC Sec. 280E Limits on Deductions in Marijuana Business 177 Drug Paraphernalia CCA Certain equipment used by taxpayers in the marijuana business could be seized and sold because it was not drug paraphernalia. - any equipment, product, or material of any kind which is primarily intended or designed for use in manufacturing, compounding, converting, concealing, producing, processing, preparing, injecting, ingesting, inhaling, or otherwise introducing a controlled substance into the human body - Equipment in question was Spectrometers used to measure strength of cannabis products - Nothing to do with using them!

90 Business Deductions Alpenglow Botanicals LLC; CA 10; Court followed IRC Section 280E to disallow all business deductions other than cost of goods sold and depreciation 179 Wages to Owners Loughman; T.C. Memo S corporation that grew and sold marijuana not permitted to claim a deduction for wages paid to owners Stop and think about this one... without payment of wages, all profits reported to shareholder employees on Schedule K-1... with disallowed deduction for wages paid, shareholder employees have same amount of income, but have paid payroll taxes

91 Sales, Exchanges, and Basis 181 IRC Section 1001 Simonsen; 150 T.C. No. 8; 2018 California taxpayer owed more on the mortgage on their principal residence than it was worth Converted to rental (DANGER!!!) Negotiated short sale Reported (1) loss on sale and (2) COD income that was excluded under Sec. 108 Wrong... For several reasons. A short sale will usually be two transactions, but not in this circumstance... Different facts!

92 IRC Section 1001 (continued) Because the debt was nonrecourse by operation of California law, the sale and debt forgiveness are combined in one transaction that yielded a gain... Amount realized included BOTH the cash received and the debt discharged... $556,000 in this case Basis for determining loss was $495,000 (FMV when converted to rental) Basis for determining gain was $695,000 (purchase price of home) complicated subject area that lacks clear guidance 183 IRC Section 1060 Alta Wind Owner Lessor C, et al; Fed. Cir On appeal, the Federal Circuit ordered the Court of Federal Claims to apply the residual allocation method to determine the basis of windfarm property eligible for federal grants - Allocate FMV to all tangible and intangible property, with any remaining unallocated amount then allocated to goodwill - Stands for the proposition that goodwill can be present even if a property is not yet operational

93 IRC Section 1031 PLR Where avoidance of federal income tax is not a principal purpose of an early disposition (within two years) of property received in an otherwise tax-free exchange with a related party, the transaction qualifies for non-tax avoidance exception provided by IRC Section 1031(f)(2)(C) 185 IRC Sections 1400Z-1 and 1400Z-2 Notice IRS lists population census tracts the are qualified opportunity zones for purposes of the special tax deferral rules of IRC Sections 1400Z-1 and 1400Z-2 allows taxpayers to take advantage of a new investment vehicle called a Qualified Opportunity Fund (QOF) QOF directs resources to low-income communities called Qualified Opportunity Zones

94 IRC Sections 1400Z-1 and 2 (continued) A QOF provides 3 tax incentives to an investor: - (1) deferral of capital gain, - (2) possible reduction of the amount of gain realized through a basis adjustment, and - (3) possible permanent exclusion of gain on the appreciation for the interest in a QOF There is no cap on the amount of money that can be invested in a QOF 187 IRC Sections 1400Z-1 and 2 (continued) An investor with a realized gain from the sale or exchange of a capital asset to an unrelated party has 180 days from the date of disposition to reinvest the gain amount with a cash investment into a QOF A QOF must hold at least 90% of its assets in "Qualified Opportunity Zone Property," Investor receives either stock or an interest in the QOF and the QOF must invest in Qualified Opportunity Zone Property If an investor holds the interest in the QOF for at least 5 years, he or she receives a basis increase in the investment that equals 10% of the deferred gain invested in the QOF

95 IRC Sections 1400Z-1 and 2 (continued) If an investor holds their an interest in the fund for an additional 2 years (or 7 years total), he or she will receive an additional increase in basis that equals 5% of the deferred gain invested in the QOF If an investor is still holding the interest in the fund on 12/31/26 then, regardless if he or she continues to hold the interest in the fund, he or she is required to recognize and pay taxes on the deferred gain on that day, subject to any increases in basis he or she may have received for holding the property for 5 years or more 189 Timing Issues

96 Accrual Method R J Channels, Inc.; T.C. Memo Accrual method C corporation engaged in business of providing tax advice received retainers Obligated to return the fee if client s issue was not resolved favorably Must include fees received in income No adjustment for unfunded promise to return fee How might the all events test apply here? 191 All Events Test Charles Schwab; CA 9; 1998 When applying the all events test, there is a difference between conditions precedent, that must occur before the right to income arises, and conditions subsequent, that will terminate an existing right to income, but their presence does not preclude accrual of income. In R.J Channels, the promise to return the fees was a condition subsequent that did not prevent accrual of income Also consider that Channels had unrestricted right to use the funds

97 Qualified Settlement Funds PLR Explains how a creative plan for establishing settlement funds could qualify for deduction when contributions were made to the funds, but still allow for the return of excess earnings to the taxpayer Use of a qualified settlement fund allows immediate tax deduction for funding a trust that is obligated to pay claims over a term of years 193 Accounting Method Change FA F... Taxpayer erroneously recognized income in a merger and asset assumption transaction Correction of that recognition was not an accounting method change In disallowing the Section 481(a) adjustment the IRS focused on the difference between a permanent difference and a timing difference Accounting method changes deal with timing differences

98 Passive Activity Losses and Credits Robison; supra... Taxpayers could not rely on after-the-fact estimates of how much time they spent participating in their ranching venture Reliance on ranch manager caused them to appear more as investors Losses suspended as passive losses under IRC Section At Risk Limitation CCA Taxpayer could not treat business activities conducted through three S corporations and an LLC in which he was a minority owner, as a single activity for purposes of Section 465 at risk rule Personal guarantee of LLC s line of credit did not create at risk basis allowing deduction of losses from all four entities

99 Character of Income 197 Section 1222 Capital Assets Sugar Land Ranch Development, LLC; T.C. Memo Formed for purpose of land development in 1998 Partnership was not engaged in real estate development after 2008 Held subject properties as investments Gains from sales of large tracts beginning in 2012 were capital gains

100 Section 1234A Certain Terminations CRI-Leslie, LLC.; CA 11; Treatment of forfeited deposits... Taxpayer not entitled to capital gain treatment under IRC Section 1234A on retained deposits from canceled sale of real property used in its trade or business... The property was not a capital asset Taxpayer entered into agreement to sell a hotel, but buyer defaulted leaving deposit of $9.7 million Hotel was not a capital asset... It was real property used in the taxpayer s trade or business 199 Retirement and Other Saving Plans

101 529 and ABLE Plans Notice IRS announced intent to issue regulations clarifying recent amendments to Section 529 and to special rules for ABLE accounts Among other things, Regulations will address - Special rules for 529 plan beneficiaries who receive tuition refunds - Allowing 529 plan funds to be rolled into ABLE accounts - Treating certain elementary and secondary school expenses as qualified higher education expenses 201 Group Health Plan: Small Employer Notice ; employer with fewer than 50 full time equivalent employees that does not offer a group health plan to any of its employees may provide a qualified small employer health reimbursement arrangement (QSEHRA) to its eligible employees IRC Section 9831(d)(1) is the statutory authority, this Notice provides information to implement such a plan

102 IRAs PLR IRS waived 60-day rollover period for taxpayer who relied on advice of her spouse. Funds were dormant in same credit union account from deposit until rollover PLR IRS waived 60-day rollover requirement where failre was due to spouse s failure to fulfill legal requirements under State law during contentious divorce proceedings Shank; T.C. Memo In unusual, but valid, application of the Cohan rule, the Court ruled that some of taxpayer s deposits into a regular IRA made years ago were non-deductible contributions, thereby providing basis for current distributions 203 Exempt Organizations

103 Obtaining Tax Exempt Status Abovo Foundation Inc.; T.C. Memo Denied tax exempt status to doctor s medical consulting business Benefits of entity s operation would inure entirely to the doctor Abovo would develop the doctor s business relationships, further his consulting career as a board-certified expert in patient safety, and potentially pay him annual compensation in excess of $300,000 Abovo was merely a façade for the doctor s consulting activities 205 Obtaining Tax Exempt Status Rev. Proc Modifies Rev. Proc to provide rules for obtaining determination letters... - Organizations desiring recognition of 501(c)(4) status may now file the simpler Form 1024-A instead of Form 1024 to apply - Each 501(c)(4) organization established after 12/18/2015 must, within 60 days after the organization is established, provide IRS with notification that it is operating as a 501(c)(4) organization. Form 1024A does not fulfill that obligation

104 Keeping Tax Exempt Status Rev. Proc Effective for tax years beginning on or after 1/1/2018, IRS will not require new exemption application from a domestic 501(c) organization that undergoes an F reorg This applies to organizations classified as corporations as the result of an election under Treas. Regs (b)(1) or 2(b)(2) and are recognized as exempt under 501(a) as organizations described in 501(c). 207 Donor Advised Funds Notice IRS addresses several issues related to donor advised funds, including when a distribution from a DAF results in a more than incidental benefit to the donor or a donor advisor (DA) - Proposed Section 4967 regs will likely provide that a distribution from a DAF pursuant to the advice of a DA that subsidizes the DA s attendance or participation in a charitysponsored event will confer more than an incidental benefit on the DA - IRS is considering proposed regs to provide that distributions from a DAF to a charity will not be considered to result in a more than incidental benefit to a DA just because the DA has made a pledge to the same charity if certain requirements are met

105 Scholarships PLR Good roadmap for exempt private foundation procedures for awarding scholarships to high school seniors graduating from stated schools to comply with Section 4945(g)(1) requirements so that expenditures will not be taxable 209 Unrelated Business Income Tax Notice Interim and transition rules under Section 512(a)(6) with respect to aggregating gross income and directly connected deductions of certain investment activities 512(a)(6), part of the, requires an organization subject to the UBIT with more than one unrelated trade or business to calculate UBTI separately for each trade or business

106 Unrelated Business Income Tax New Jersey Council of Teaching Hospitals; 149 T.C. No Hospital trade association received fees for endorsing certain vendors and claimed these were royalties exempt from UBIT Court ruled the payments were fees, not royalties - Association did not license any intangible property - Service provided was presentation of vendors on association webpage 211 Corporate Tax

107 S Corporations 213 S Corporations & Carried Interest Rules Notice S corporations are subject to the extended three-year holding period applicable to carried interests

108 L B & I Practice Unit In Practice Unit (essentially a PowerPoint slide show with commentary) the IRS explains S corporation stock basis rules, specifically addressing the regulations that coordinate pass-through of income and timing of distributions under Treas. Reg Stock Basis Ordering Rules are illustrated with several helpful examples 215 Loans to Establish S Corporation Basis Messina; T.C. Memo S corporation shareholders did not have sufficient basis in their stock to claim losses from S corporation Made loans to a subsidiary of the corporation Court found the subsidiary was NOT a conduit so that loans to the subsidiary should be considered loans to the parent Shareholders did NOT increase basis with loans to an S subsidiary

109 Changing Methods of Accounting Rev. Proc Rev. Proc is amended to reflect the new rule contained in the providing that Section 481 adjustments which are attributable to revocation of S status by certain S corporations are to be taken into account ratably over a six-year period 217 Permissible Shareholders PLR Stock in S corporation was held by Electing Small Business Trust That meant S corporation income allocated to the Trust was taxed at maximum individual rate IRS honored Fiduciary s request to transfer all S stock to a Voting Trust with beneficiaries continuing to be treated as owners of the shares, subject to the power of the Trustee to vote all shares

110 Permissible Shareholders PLR Stock of S corporation was held in grantor trust of which the beneficiary was husband (H). Stock was collateral for loans that were less than H s basis in the stock. H and W are divorcing and transferring stock to two new grantor trusts with complex distribution arrangements related to marital settlement IRS rules that 1041(a) will apply to make any transfer tax-free, and The transfer would be treated as a gift under 1041(b) so any rights acquired by W would not be treated as a purchase disqualifying trust from being an ESBT 219 Corporate Tax Rate Notice Guidance on how a corporation with a 2017/2018 fiscal year will calculate and pay federal income tax Corporation will use a blended rate (See IRC Section 15) including the Alternative Minimum Tax for a part of the year

111 Transfers Between Controlled Corporations Povolny Group; T.C. Memo Payments made by one of taxpayer s controlled corporations to other financially troubled entities owned by the taxpayer were dividends to the taxpayer, not loans to those entities Further taxpayer could not claim a bad debt deduction for any of those transfers due to lack of documentation. 221 Loss Limitations Notice IRS modifies both the 338 approach and the 1374 approach for determining recognized built-in gains or losses owned by a loss corporation at the time of an ownership change under IRC Section 382(h) Hypothetical cost recovery deductions that would have been allowable are determined without regard to the additional first-year depreciation in Section 168(k), effective for any ownership change that occurs after 5/8/

112 Employment Tax Issues 223 Rent & Wages for Work on Farm Martin; 149 T.C. No. 12; Tax Court will follow McNamara [CA 8, 2000] to find where a corporation pays its shareholders both rent for farmland, and wages for work the shareholders perform on the farmland... AND the rent is not in excess of FMV, the rent will not be subject to SE tax Regardless of a taxpayer s material participation, if the rental income is shown to be less than or equal to market value for rent, the income is presumed to be unrelated to any employment agreement

113 Civil Damages for Fraudulent W-2 Guerra v. Teixeira; D MD; IRC Section 7434 provides a civil damages if any person willfully files a fraudulent information return with respect to payments purported to be made to any other person. The law was not intended to apply to worker classification issues 225 Partnership Taxation

114 LLC to LP PLR Conversion of LLC classified as a partnership for federal tax purposes, to a limited partnership was not a partnership termination and did not cause the entity to be treated as an association taxable as a corporation Follows logic of Rev. Rul which also stated that the same result would apply if conversion had been from LLC to general partnership 227 Economic Effect CCA Joint venture s method of allocating losses to foreign partners lacked economic effect Foreign equity partners did not bear the economic burden of the losses because they had no obligation to restore any shortfall if the venture liquidated when their capital accounts were negative

115 Estate and Gift Taxation 229 Decedent s Notes for Remainder Interest CCA Decedent purchased remainder interest from children with his promissory notes He died the next day Transaction was a gift... Value of notes was not adequate and full consideration for children s remainder interest in Trust assets Notes did not reduce Decedent s estate... Deduction limited to the extent that an obligation was not contracted bona fide, and for adequate and full consideration

116 Transfer of Property Between Heirs PLR Transfer of property between grandson and daughter did not trigger 2032A special use valuation estate tax because they were both qualified heirs of decedent Daughter was required to execute consent to personal liability for any additional estate tax under 2032A(c) reflecting changed ownership of the property 231 International Taxation

117 Repatriation Tax IR (Q & A About Reporting Related to Section 965 on 2017 Tax Returns)... IRS will waive late payment penalties relating to 965 transition tax and provided additional information for individuals subject to the tax Also see FAQs posted to Failure to File Form 5471 IRS has published procedures for staff to apply in determining penalties under IRC Section 6679 Examiner must determine whether failure was due to reasonable cause Only the initial $10,000 penalty can be considered for reasonable cause Examiner should consider - Taxpayer s compliance with reporting and recordkeeping requirements - Whether taxpayer exercised ordinary care and prudence, but was unable to provide information required under IRC Section Possibility of erroneous advice, death or serious illness

118 Taxpayer s Residency Practice Unit... Determining Individual s Residency for Treaty Purposes... To help examiners determine an individuals right to claim tax treaty benefits 235 Tax Home IR BBA 2018 amended IRC Section 911(d)(3) regarding an individual s tax home Individual living and working in designated combat zone will not fail to qualify for Section 911 benefits because they maintain an abode in the U.S. Contractors who support armed forces in combat zones should now be able to claim the foreign earned income exclusion

119 FBAR Update Bussell; CA 9; Supreme Court declined to review decision finding taxpayer willfully failed to file FBAR and assessing over $ one million in penalties Program Manager s Tech Advice Definition of willfulness and the standard of proof for the penalty for willful violation of the rules for reporting foreign financial accounts Garrity; D CN; IRS may prove willfulness by showing reckless conduct... Expert not allowed to testify because standard was not negligence, it was willfulness 237 Tax Procedure

120 Transcripts IRS Fact Sheet Outlines upcoming changes in format of tax transcripts and procedures to be implemented to protect taxpayers from identity theft - New Format effective September 2018 will redact much identifying information - 3 rd party requestors, including tax professionals, will assign a new identifying number to requests since SSN will no longer be fully visible - After 2018, IRS will no longer fax transcripts to 3 rd parties or the taxpayer. Will mail to taxpayer s address - Later in 2019, tax professionals will have a different process than traditional one, including form of E-verification. 239 Joint v Separate Returns Camara; 149 T.C. No. 13; IRC Section 6013 does not permit filing a joint return if taxpayer has filed a separate return. Where a married person files a return as single, he has not filed a separate return. A separate return means a return on which a married person claims the permissible status of married filing separately. Filing a return as a single person is not available to a married person

121 Joint Returns - -Knowledge Coggin; D NC; Joint returns prepared by husband with wife s implied consent will be honored as such Wife may not claim they were not valid and file separate returns after his death 241 Value of Taxpayer s Affidavit Stein; CA 11; With all judges participating... Vacates prior decision in this case AND overrules precedent in Mays A taxpayer s affidavit, in good form, may create an issue of material fact, and preclude summary judgment EVEN IF IT IS SELF-SERVING AND UNCORROBORATED!!!

122 Timely Mailing Pearson; 149 T.C. No. 20; Lawyer s staff applied Stamps.com certified mail label, dated April 21, to Tax Court petition to meet April 22 nd deadline and member of staff testified she delivered the envelope to the USPS on that date Postal Service entered envelope in its tracking system on April 23 rd Tax Court received petition on April 29 th... Within normal delivery time Petition was timely filed Date of entry into USPS tracking system is not a postmark, so the only postmark is the Stamps.com one 243 Tax Penalties

123 Supervisory Approval Graev; 149 T.C. No Chai; T.C. Memo Written approval requirement is an essential element of the penalty that must be satisfied at the initial determination of a penalty assessment 245 Preparer Penalties Lowery; D NC; He and his staff prepared 19 very sketchy individual income tax returns IRS imposed IRC Section 6694 penalties on Lowery % for returns he signed - 50% for returns signed by staff persons Court ruled Lowery could only be penalized for returns he prepared and/or signed Liability cannot be imposed solely on the basis that Lowery employed the signing preparers

124 Fraud Ankerberg; T.C. Memo Self-employed CPA/taxpayer had, for years, failed to report income and claimed bogus deductions IRS clearly proved he had underpayments each year attributable to fraud which could be proven by entire course of conduct 247 Preparer Risks, Etc

125 Permanent Injunction Stinson; CA 11; District Court decision to permanently enjoin Stinson from preparing returns affirmed - Acted willfully and recklessly by claiming inflated and false unreimbursed employee business expenses - Falsified deductions on low income clients - Did not conduct required due diligence - Such conduct was likely to be repeated 249 And Now to Anthony

126 TAX CUTS AND JOBS ACT OF 2017 UPDATE 251 STATUS ISSUES

127 Head of Household Due Diligence Added by Included on Form 8867 Creates another potential $520 penalty Adds a single new line: o Unmarried or considered unmarried at year end? o Provide over ½ the cost of keeping up the home for a qualified person? 253 Dependency Release Exemption deduction suspended still needed for custodial parent release o Child tax credit o State dependent benefits

128 Exemptions Deduction suspended 2018 thru 2025 Still used for other tax issues o Gross income test for other dependents o $4,150 for Alimony For divorces before 1/1/2019: No Change o Alimony paid still deductible o Alimony received still taxable o Alimony received treated as earned income for purposes of making IRA contributions. Conflict of interest

129 Alimony For divorces after 12/31/2018*: o Alimony paid no longer deductible o Alimony received not taxable o Alimony received no longer treated as earned income for purposes of making IRA contributions. *Also prior agreements modified after 12/31/18 and -change language included 257 Clergy SE Tax Housing Allowance o Subject to SE tax o Can no longer reduce SE income by prorated employee business expenses o They are suspended 2018 through

130 Kiddie Tax New rules ( simplified ) o Changes the computation. o Cuts connection to parent s return. o Unearned Income taxed at fiduciary rates. 259 INCOME PROVISIONS

131 Coins and Precious Metals Section 1031 Treatment o Used to be allowed Narrow definition o Numismatic for numismatic o Bullion for bullion o But not, for example silver for gold o After 2017 Sec 1031 treatment no longer allowed. 261 Fringe Benefits MONTHLY TRANSPORTATION FRINGE BENEFITS Year Qualified Parking Transit Passes Bicycle Commuting 2018 $260 $260 Repealed 2017 $255 $255 $

132 Fringe Benefits Bicycle commuting no longer excludable after 2017 Parking and transit passes still excludable by employees through 2025 Employers get no deduction for parking and transit passes after 2017 Employers can deduct reimbursement for commuting where there is a safety issue 263 Capital Gains Rates Retained The CG rates are no longer tied to the tax brackets. Instead they are the pre-2018 rates at specified breakpoints adjusted for inflation. Level I: 0% tax rate Level II: 15% tax rate Level III: 20% tax rate

133 CG & Tax Rate Comparison 2018 Regular Tax Threshold CG Tax Threshold Tax Rate 0 0% 0 10% 9,525 12% 38,601 15% 38,700 22% 85,500 24% 157,500 32% 200,000 35% 425,801 20% 500,000 37% 265 Patents After 2017 patents no longer a capital asset, so gains from sales of patents not eligible for lower capital gains rates

134 Incentive Stock Options AMT is now less likely to be triggered Therefore with planning, more ISOs up to the AMT threshold, can be exercised and avoid the AMT preference 267 Wrongful Incarceration Claims Exclusion for wrongful incarceration payments Unlimited waiver of the statute of limitations Extended to Dec 17,

135 Qualified Dividends CG YEAR MFJ MFS HH SINGLE RATE Still eligible for CG rates ZERO to 77,200 0 to 38,600 0 to 51,700 0 to 38, to 75,900 0 to 37,950 0 to 50,800 0 to 37,950 15% ,201 to 38,601 to 51,701 to 38,601 to 479, , , , ,901 to 37,951 to 50,801 to 37,951 to 470, , , ,400 20% ,001 & Up 239,501 & Up 452,401 & Up 425,801 & Up ,701 & Up 235,351 & Up 444,551 & Up 418,401 & Up 269 Insurance Information Reporting Reportable policy sales o Acquisition of a life policy o If the buyer has no family, business, or financial relationship with the insured Reportable death benefits o Where the insurance contract was acquired in a reportable policy sale Issuer of the insurance files 1099-SB

136 Insurance Information Reporting Form 1099-SB o Name, Address and TIN o Date of sale o Issuer of life insurance contract and the contract number o Amount of consideration transferred in the sale 271 DEDUCTION ISSUES

137 Standard Deductions Plus add-ons for elderly and blind 273 Standard Deductions Dependent standard deduction is the greater of: o The base amount of $1,050, or o Earned income plus $350 (but not exceeding single std. ded. of $12,000 + age/blind addition(s) if applicable) Roth IRA for earned income? o Parent or grandparent gift

138 Standard Deduction Phase out o Prior to 2018 Reduced by 3% of AGI in excess of threshold 275 Filing Requirement Filing Status Age End of 2018 If gross income is at least Single Under or older $12,000 $13,600 Married Filing Jointly Under 65 (both spouses) 65 or older (one spouse) 65 or older (both spouses) $24,000 $25,300 $26,600 Married Filing Separate Any age $5 Head of Household Under or older $18,000 $19,600 Qualifying Widow Under or older $24,000 $25,

139 Moving Deduction Employee For years 2018 through 2025 The moving deduction is suspended Exception Active duty armed forces pursuant to military orders Transitional relief Reimbursement in 2018 for move expenses in Moving Reimbursement Employer o For Years 2018 through 2025 o Cannot deduct employee reimbursement

140 Itemized Deductions Managing deductions o Bunch charitable donations o IRA to charity transfers even small amounts save tax o Max one year to a donor-advised fund 279 Medical Deductions Medical Retained 7.5% AGI threshold (2017 & 2018) 10% 2019 and after Also 7.5% for AMT (2017, 2018)

141 Taxes Taxes Retained but state & local taxes limited to $10K Includes same taxes as before - Exception: Foreign real property taxes not allowed Those related to business still allowed 281 Taxes Commentary $10K Limit made up for 37% top rate Elect sales tax - avoid taxable refund Home office Takes part of property tax off Schedule A. Capitalize taxes

142 Taxes State SALT Workarounds Supreme Court quid pro quo IRS Proposed Regs. Apply to post- 8/27/18 payments Contribution deduction is difference between donation and benefit 283 Taxes Business Taxpayers Contribute to state funds/charities Deductible on all business schedules Assumed IRS rationale: Since they are getting state tax credits, treat it as tax payment not a charitable contribution

143 Taxes Capitalize taxes Annual election Unimproved & unproductive real estate Adds to basis When to consider Hit with the AMT SALT deduction exceeds $10,000 Taxpayer taking the standard deduction. 285 Home Mortgage Interest Home Mortgage Acquisition Interest Grandfathered Acquisition Debt o $1 Million acquisition debt limit (first and second homes) o $500,000 for MFS o Continues to Apply to loans secured before 12/16/

144 Home Mortgage Interest IMPORTANT Just because the bank calls a loan an equity loan (e.g., HELOC) does not mean it is an equity loan for tax purposes. 287 Home Mortgage Interest Acquisition Debt Interest Mortgages Acquired after 12/15/17 o $750K acquisition debt limit (first and second homes) o $375K MFS

145 Home Mortgage Interest Commentary equity debt interest o Home used as a piggy bank problems o $100K home equity limit Only suspended not repealed Does that mean can t trace first 100K? NO! Tracing is allowed. Unsecured election 289 Home Mortgage Interest Refinancing Acquisition Debt o Prior to 2018 Refinance existing balance For an unlimited future term o After 2017 Refinance existing balance For the remaining term of the existing loan

146 Interest Tracing Home Equity Debt Interest Deduction Suspended 2018 through 2025 Can trace it to its actual use Bails out those who have been illegally tracing the first $100K equity debt secured by home without using the unsecured election. Excess debt could always be traced. 291 Investment Interest Still Deductible (Up to NII) NII computation changed Tier 2 Itemized Suspended o 3.8% Tax on NII - Hurts o Investment Interest - Helps

147 Charitable Contributions Deduction retained o 50% AGI limit increased to 60% But only for cash contributions o Mileage rate remains at 14 cents Purchase of athletic seating rights tickets o College or university donations o No longer deductible 293 Charitable Contributions Blank pledge cards o Not acceptable documentation Appraisal Fees o Before 2018 were a Tier 2 deduction o Tier 2 expenses not deductible

148 Gambling Gambling Losses (Tier 1) Retained Now includes traveling to and from the casino However, the travel can only offset the gains for that particular trip Was aimed primarily at professionals 295 Gambling Gambling Losses (Tier 1) Tax Issues SS income Premium tax credit Medicare rates AGI limitations Might even impact new 199A deduction

149 Tier 1 Itemized Deductions Not Subject To The 2% of AGI Floor Retained o Amortizable bond premium o Estate tax on IRD income o Impairment related work expenses o Repayments > $3K under claim of right o Unrecovered investments in pensions o Gambling losses 297 Tier 2 Deductions Suspended 2018 through 2025 o Employee business expenses o Tax preparation fees o Investment expenses o Safe deposit box o Legal Fees Discrimination suits, suits against the federal government and whistleblower are above-theline

150 Tier 2 Deductions Tier 2 Itemized Deductions (Continued) o Claim of right deduction (credit ok) o Credit card convenience fees to pay tax o Excess deductions on trust termination o IRA Losses o Hobby loss expenses 299 Tier 2 Deductions Commentary Impacts: o Long-haul truckers o Firefighters & police o Outside sales o Entertainment Industry o Union members o Educators

151 Tier 2 Deductions Commentary Impacts: o 1041 excess deductions on termination o Minister expenses o Legal expenses o Investment expenses o Union members o Educators o Tier 2 suspension also applies to Legal Expenses Legal expenses are a tier 2 misc. deduction Tier 2 misc. suspended 2018 through 2025 On the bright side: o Related to business o Related to capital items o Those allowed above-the-line

152 Legal Expenses Those allowed above-the-line o Unlawful discrimination actions o Claims against the federal government o Cause of action under Medicare secondary payer statute These are limited to taxable award 303 Casualty Losses Personal casualty losses No Longer Allowed, Except... To the extent of gains, or In Federally Declared Disaster Areas Clients may want to increase insurance coverage

153 ALTERNATIVE MINIMUM TAX 305 AMT Promised To Repeal But Reneged Increased Exemptions (Approx. 30%) Increased Exemption Phase Out (Huge)

154 AMT Exemption Amounts: 307 AMT Phase Out Thresholds:

155 AMT Major AMT Contributors & o State and Local Income Tax $10,000 Limit o Tier 2 Itemized Deductions o Equity Debt Interest Gone! o Medical AMT Adjustment No longer a difference Significantly Less Chance For AMT 309 AMT AMT Credit Carryover o More opportunity to utilize carryover o Credit is the lesser of: AMT credit carryover The amount the regular tax is in excess of the tentative AMT

156 AMT Corporate AMT is repealed effective in TAX CREDITS

157 Child & Dependent Credits Qualifying Child Under 17 at the end of the year Meets relationship test Not self-supporting Lived with TP over ½ of the year Claimed as a dependent SSN before return due date 313 Child & Dependent Credits Child Tax Credit Increases credit to $2,000 per qualifying child $1,400 of the credit is refundable Income threshold reduced from $3,000 to $2,

158 Child & Dependent Credits Dependent (Non-Qualifying Child & Others) Tax Credit o Must be a dependent o Non-refundable o Credit is $500 each o SSN before due date requirement does not apply 315 Child & Dependent Credits Credit Phase Out Thresholds o $400K (up from $110K) MFJ o $200K (up from $55K MFS, $75,000 Single/HH/SS) Others Huge increase, a lot more clients will qualify

159 Residential Energy Credit 25D (30%) Credit o Was limited to solar (Path Act) o After 2017 includes Geothermal Wind, Fuel cell o Phase out: 2020 = 26%, 2021 = 22%, 2022 = 0% 317 MISCELLANEOUS ISSUES

160 Fraudulent Preparers Reporting Issues o IRS Form Preparer Complaint Form A Fraud Or Misconduct 319 Estate & Gift Taxes Annual Gift Exclusion Retained Lifetime (Estate) Exclusion Increased

161 ACA Insurance Penalty Penalty For Not Being Insured No longer applies after 2018 SHARED RESPONSIBITY PAYMENT Years & Later Flat Dollar Amounts Adult... Individual Under 18 Maximum.. $ $ $2, ZERO Percentage of Income Rate 2.5% ZERO 321 Churches & Non-profits May not be aware of this change o Employee fringe benefits (examples) Parking Travel Shuttles o Subject to the 21% UBI tax o Alternative treat as employee wages o Form 990-T

162 Tax Deferred Exchanges Exchanges after 2017 Limited to real estate U.S. real property exchanged for foreign real property: not like kind & not qualified. Transition rule: If property was disposed of by 12/31/17 then property received in exchange during 2018 still qualifies as a delayed exchange. 323 Tax Deferred Exchanges Business-Use Vehicles after 2017 Trade-ins are no longer exchanges Trade or sale, gain or loss all are reportable in year of the transaction. Virtual Currency Every transaction is now reportable

163 IRA, QUALIFIED PLAN, AND EDUCATION PROVISIONS 325 IRA Contributions Contribution limit increased o Effective for 2019 o First time since 2013 o Under age 50: $6,000 o Age 50 and over: $7,

164 IRA Recharacterizations Recharacterizations are repealed o Can t undo a traditional to Roth conversion once made o Effective for years after 2017 o Applies to conversions from: Traditional IRA, SEP or SIMPLE 327 IRA Recharacterizations Some recharacterizations still ok o Traditional or Roth contributions o Character can be switched o If done so by the unextended due date of the return

165 Qualified Tuition Plans Modified to pay tuition only annual max. $10,000 per student for: o Kindergarten through o High school At: o Public o Private, and o Religious schools 329 Qualified Tuition Plans Tends to benefit the wealthy Most beneficial if plan is established at child s birth. Needs big upfront contributions to gain any benefit in the short term

166 ABLE Accounts Savings plan for the disabled Disabled before turning age 26 Maximum annual contribution o Before 2018: $14,000 o After 2017: $15,000 plus the lesser of the Disabled s taxable compensation or Single person s poverty level for the year 331 ABLE Accounts One person poverty level for 2018 is $12,060 Thus the max could be $27,060 Don t overlook that direct payment for medical and education is exempt from gift tax

167 529 to ABLE Rollovers 2018 through Plan distributions of the beneficiary or family members (see text) Within 60 days Up to $15,000 (reduced by other contributions) 333 Paid Family & Med Leave For 2 years only 2018 and 2019 General business credit Leave pay must be at least 50% of normal pay Basic credit is 12.5% x leave pay Increase by.25% for each add l 1% of pay above the 50% Maximum credit percentage 25%

168 Paid Family & Med Leave Example o Leave pay equals 70% of regular wage o 70% is 20 points above the 50% threshold o Credit Increase is 5% (.25 x 20%) o Base Credit (12.5%) plus extra (5%) = 17.5% o Leave pay = $15,000 o Credit will be $2,625 (17.5% of $15,000) 335 Paid Family & Med Leave Other Issues o Not allowed where required by state o Employer must have a written policy* All FT employees at least 2 weeks All PT employees a prorated amount o Employee qualifications Employed for one year Prior year compensation < 60% of highly compensated employee amount ($72,000) o Deduction or credit for employer *IRS Notice allows retroactive policy if in place by 12/31/

169 Business Tax Provisions 337 FARM LOSS PROVISIONS

170 Non-C Corp Farm Losses Limited Prior to 2018 Farm losses limited when certain subsidies received to greater of: o $300,000 ($150K MFS), or o Total of prior 5 years net income o o Excess carried over Losses attributable to disease or drought are not subject to the limitation. 339 Non-C Corp Farm Losses Limited The farm loss limitation no longer applies Instead the general business loss limitation applies

171 HOBBY LOSS PROVISIONS 341 Hobby Loss Prior to 2018 o Income was reported on 1040 line 21 o Expenses were deducted as tier 2 deductions subject to a specific pecking order o Expenses were limited to income o No SE tax

172 Hobby Loss SE Tax Does not apply to: o Sporadic activities o One shot deals o Hobbies 343 Hobby Loss Bottom Line through 2025 o Sec 183 unaltered by o Activities not for profit o Income reported on 1040, Sch. 1, line 21 o No expenses - can t deduct Tier 2 expenses o No SE tax

173 OTHER DEPRECIATION PROVISIONS 345 RE Recovery Periods ADS depreciable life o Residential rental property o Placed in service: Prior to 2018 was 40 years After 2017 it is 30 years o What is affected: o Election to use ADS life o Foreign real estate depreciation o Some AMT adjustments

174 Sec 179 Sports Utility Vehicle o Gross Weight more than 6,000 pounds o Gross Weight 14,000 pounds or less o Sec 179 limit remains at $25,000 BUT WAIT! A luxury vehicle is 6,000 pounds or less o So you can use bonus depreciation on SUVs 347 Farm Equipment In service after 2017 o Other than: o Grain bin o Cotton ginning asset o Fence or land improvement o Life shortened from 7 to 5 years o Use 200% declining balance (was 150%) o 150% continues to apply to 15 & 20 Year

175 Rental Activities 5-year (1245) property o Appliances o Carpets o Furniture Subjective determination o Example: Kitchen Cabinets 349 Rental Activities Purchased as whole o Depreciate as whole, or o Perform a cost segregation study Depreciation recapture 1245 Ordinary income 1250 Capital gains

176 Rental Activities Other considerations o 199A deduction 1245 property shorter lives increase depreciation, thus reduce QBI and TI But 1245 property is qualified property for a shorter period of time o Sec 1031 exchanges 1245 property no longer qualifies 351 Computers After 2017 o No longer listed property and no longer: Subject to special substantiation Special depreciation rules As if you have been following the listed property rules all along anyway

177 INDEPENDENT CONTRACTOR PROVISIONS 353 A big Issue going forward o o Independent Contractor Worker perspective Pro Loss of employee business expenses Pro Advent of the Sec 199A deduction Neg Loss of employer provided benefits Employer perspective cost of Payroll taxes Insurance and fringe benefits Paid time off Not a choice Facts & Circumstances

178 BUSINESS DEDUCTION PROVISIONS 355 Meals & Entertainment Say goodbye to: Golf outings Fishing trips Spa visits Sporting events Concerts And the like

179 Meals & Entertainment Business Meals Still allowed at 50% if: 1. Ordinary & necessary 2. Not lavish or extravagant 3. Taxpayer or employee present 4. Provided to potential business client, consultant or similar business contact 357 Meals & Entertainment Business Meals 5. If meals and beverage provided with entertainment, then they are deductible if separately paid for or separately stated Notice example: Take customer to ball game Cost of tickets is non-deductible entertainment However the cost of hot dogs and beer, if paid for separately, would be a deductible meal expense

180 Meals & Entertainment Employer Provided Meals In-house cafeteria meals Still allowed 2018 through 2025 Limited to a 50% deduction (was 100%) After 2025, meals for the convenience of the employer and cafeteria meals sunset 359 Meals & Entertainment Away From Home Meals Reimbursement still deductible by employer o Accountable plan not income to employee o Otherwise included in W-2 income, and not deductible by employee Still limited to 50% Includes self-employed individuals

181 Luxury Autos 361 Luxury Autos Luxury Auto Limits (GVW 6,000 pounds or less) Automobiles Year 1 st 1 st (bonus) 2 nd 3 rd Thereafter ,160 11,160 5,100 3,050 1, ,000 18,000* 16,000 9,600 5,760 Qualified Trucks and Vans ,560 11,560 5,700 3,450 2, ,000 18,000 16,000 9,600 5,760 * Can elect 50% bonus 1 st year - $14,000. If acquired 1/1/17-9/27/17 but not placed in service until 2018, 1 st year limit with bonus = $16,400. Note: Autos and trucks are the same for 2018 could vary in future due to inflation adj

182 Hind Sight Retroactive Law Luxury Autos Used Vehicles placed in service before 9/28/17 do not qualify for bonus depreciation. (Prior to 9/28/17 bonus only applied to new property.) After 9/27/17 bonus applies to both new and used property 363 Luxury Autos Vehicles in Excess of 6,000# GVW Not bound by the luxury auto rules If placed in service after 9/27/17, qualify for 100% bonus depreciation. May not need or want 100%, can elect to step down to 50% bonus

183 Unreimbursed Employee Travel Expenses 2018 through 2025 Employee business expenses suspended Thus no deduction Employees should negotiate accountable plans Still deductible for certain states including California 365 Home Office 2018 through 2025 Employee business expenses suspended Thus no deduction Still available for self-employed

184 BUSINESS LOSS PROVISIONS 367 NOL Farming Carryback Exception Repeal does not apply to farming losses. Farming NOL is the lesser of: o The portion of the NOL attributable to farming, or o The NOL for the year

185 NOL Pre-2018 Carryovers Unaffected by Not subject to the 80% rule But only carry forward for 20 years Potential technical correction o Applies to years ending after 12/31/2017 Congress s intent was: o Applies to years beginning after 12/31/ NOL Excess Business Losses New provisions Discussed later If there are excess losses they are added to the post-2017 NOL carryover Two Types of Carryovers Pre-2018, the 80% limit does not apply Post-2017, the 80% limit does apply

186 Excess Business Loss Non-Corporate Taxpayers: o Excess business loss equals: o Aggregate deductions in excess of business income plus $250K ($500K MFJ) The excess business loss is not allowed in the current year and is carried forward as part of the NOL. 371 Excess Business Losses Included in business income o Wages o Sch C, E, F profit or loss o 1041, 1065, 1120-S K-1s profit or loss o 4797 gain or loss o Unemployment income o At-risk and passive loss limits apply before business loss limitations are applied

187 Excess Business Losses Computation (new) Form 461 o Step 1 Add up Wages Schedule C, E and F profit or loss 1041, 1065, 1120-S profit or loss (K-1s) CG or loss 4797 gain or loss Unemployment comp 373 Excess Business Losses Computation Form 461 o Step 2 o Determine the amounts in step 1 that are not business related

188 Excess Business Losses Computation Form 461 o Step 3 1. Adjust amount from step 1 by step If the result is negative add $250K ($500 if MFJ) to the amount of line If the result is still negative a. Treat amount from 3 as income on line 21 b. Also add the amount to NOL carryover 375 Excess Business Losses Notes: o Income from activities is adjusted by passive losses before this computation o After 2017, NOLs only carry forward and can only offset 80% of income

189 Limited Business Interest Disallowance of Business Interest o Applies to all business forms o Interest is limited to 30% of the business s adjusted taxable income (ATI). o ATI is figured without depreciation, amortization or depletion 377 Limited Business Interest Exceptions o Small Business (Aver. gross receipts prior 3 years $25M or less) o RE Property Trades or Businesses using ADS depreciation o Farming using ADS for property with useful life of 10 years or more o Inventory interest for auto, boat, and machinery dealers

190 Bipartisan Budget Act of Individual Income Tax Provisions Extended o o o o o o o o o Exclusion from gross income of discharge of indebtedness on qualified principal residence indebtedness; Above-the-line deduction for qualified tuition and related expenses; Mortgage insurance premiums treated as qualified residence interest; Credit for section 25C non-business energy property; Credit for residential energy-efficient property; Alternative motor vehicle credit for qualified fuel cell motor vehicles; Credit for alternative fuel vehicle refueling property; Two-wheeled plug-in electric vehicles; and Credit for construction of energy-efficient new homes

191 Other Tax Measures Additionally, the Act contains a number of other tax-related provisions that had originally been included in various versions of the recently enacted tax reform legislation, 2 but had been removed prior to passage of the final bill, which was signed into law into December Among these provisions are as follows: o Tax relief related to the California wildfires and Hurricanes Harvey, Irma, and Maria; o Individuals held harmless on improper levy on retirement plans; o Modification of user fee requirements for installment agreements; o Simplified filing requirements for individuals over age 65 years; o Provisions related to whistleblower awards; o Simplification of rules regarding records, statements, and returns (through December 31, 2019); o Modification of rules relating to certain hardship withdrawals; and o Treatment of foreign persons for returns relating to payments made in settlement of payment card and third-party network transactions