William L. Stark and Company
Certified Public Accountants and Business Consultants
The IRS has released new proposed rules related to charitable contributions made to get around the $10,000/$5,000 cap on state and local tax (SALT) deductions. The proposed regulations:
The IRS has released new proposed rules related to charitable contributions made to get around the $10,000/$5,000 cap on state and local tax (SALT) deductions. The proposed regulations:
SALT Limit
An individual’s itemized deduction of SALT taxes is limited to $10,000 ($5,000 if married filing separately) for tax years beginning after 2017. Some states and local governments have adopted laws that allowed individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes.
The IRS issued final regulations in June 2019 that provide that the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). Thus, the taxpayer must reduce any contribution deduction by the amount of any SALT credit received or expected to receive in return. The regulations contain a de minimis exception if the SALT credit does not exceed 15 percent of the taxpayer’s charitable payment.
A taxpayer is not required to reduce the charitable contribution deduction because of the receipt of SALT deductions. However, the taxpayer must reduce the charitable deduction if it receives or expects to receive SALT deductions in excess of the taxpayer’s payment or the fair market value of property transferred.
Payments by Individuals
A safe harbor was provided in Notice 2019-12 for individuals who have a portion of a charitable deduction disallowed due to the receipt of a SALT credit. Under the safe harbor, any disallowed portion of the charitable contribution deduction may be treated as the payment of SALT taxes for the purposes of deducting taxes under Code Sec. 164.
The new proposed regulations incorporate the safe harbor in Notice 2019-12. The safe harbor is allowed in the tax year the charitable payment is made, but only to the extent that the SALT credit is applied as provided under state or local law to offset the individual’s SALT liability for the current or preceding tax year. Any unused credit may be carried forward as provided under state and local law.
Payments by Business Entities
The IRS also provided a safe harbor in Rev. Proc. 2019-12 that business entities may continue to deduct charitable contributions in exchange a SALT credit. A business entity may deduct the payments as ordinary and necessary business expenses under Code Sec. 162 if made for a business purpose.
The new proposed regulations incorporate the safe harbor in Rev. Proc. 2019-12. If a C corporation or specified pass-through entity makes the charitable payment in exchange for a SALT credit, it may deduct the payment as a business expense to the extent of any SALT credit received or expected to be received. In addition, the new proposal provides that if the charitable payment bears a direct relationship to the taxpayer’s business then it may be deducted as a business expense rather than a charitable contribution regardless of whether the taxpayer receives or expects to receive a SALT credit.
Benefits Received from Third Party
If a taxpayer receives any goods, services, or other benefits from a charitable organization in consideration for a contribution, then the charitable deduction must be reduced by the value of those benefits. If the contribution exceeds the fair market value of the benefits received, then only the excess is a deductible as a charitable contribution.
The new proposed regulations clarify that this quid pro quo principal applies regardless of whether the party providing the goods, services, or other benefits is the charitable organization or not. A taxpayer will be treated under the proposal as receiving goods and services in consideration for the taxpayer’s charitable contribution if, at the time the taxpayer makes the payment or transfer, the taxpayer receives or expects to receive goods or services in return.
Final regulations provide rules on the attribution of ownership of stock or other interests, for determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under the foreign base company sales income rules. The regulations also provide rules to determine whether a CFC receives rents in the active conduct of a trade or business, for determining the exception from foreign personal holding company income.
Final regulations provide rules on the attribution of ownership of stock or other interests, for determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under the foreign base company sales income rules. The regulations also provide rules to determine whether a CFC receives rents in the active conduct of a trade or business, for determining the exception from foreign personal holding company income.
The regulations adopt without change, proposed regulations published on May 20, 2019 ( NPRM REG-125135-15).
Attribution of Ownership
The regulations provide specific rules for applying principles similar to those in the Code Sec. 958(b) constructive ownership rules when determining related person status under the foreign base company sales income rules. The determination of related person status is relevant for many purposes, including whether certain types of income can be characterized as subpart F foreign base company sales or service income.
A person is a related person with respect to a CFC if the person is:
Rules similar to those for determining stock ownership in Code Sec. 958 apply for purposes of determining whether a person is a related person. The regulations limit the application of the downward attribution rules in Code Sec. 318(a)(3), which apply by reference to the Code Sec. 958 stock ownership rules, and which attribute ownership downward from the owner of an entity to an entity. The downward attribution rules are applied regardless of the size of the ownership interest in a partnership, estate, or trust, but are applied to corporations based on a 50-percent or more ownership interest.
The regulations address concern that application of the downward attribution rules could inappropriately treat entities (including CFCs) that do not have significant relationships with each other as related persons. Accordingly, the regulations provide that the downward attribution rules of Code Sec. 318(a)(3) and Reg. §1.958-2(d) will not apply for purposes of determining related person status under the foreign base company sales income rules.
The change does not preclude a corporation, partnership, trust, or estate from being treated as controlled by the same person or persons that control the CFC under other rules that remain applicable for the related person rules.
Additionally, an anti-abuse rule is provided with respect to the option attribution rule in Code Sec. 318(a)(4). The option attribution rule in Code Sec. 318(a)(4) and Reg. §1.958-2(e) will not be applied to treat a person with an option as owning the stock or an equity interest for purposes of the related person rule if the principal purpose of using the option was to cause a person to be treated as a related person.
The regulations also incorporate a similar rule issued in section 7(d) of Notice 2007-9, 2007-1 CB 401. The rule applies if the principal purpose for the use of an option is to qualify dividends, interest, rents or royalties paid by a foreign corporation for the Code Sec. 954(c)(6) CFC look-through exception from foreign personal holding company income. The rule applies to tax years of CFCs beginning after December 31, 2006, and ending before November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end.
Personal Holding Company Income
The regulations modify the foreign personal holding company rules for amounts paid or incurred by a CFC in connection with the CFC’s rental income and the active rents exception. Rents are excluded from foreign personal holding company income if the rents are:
If rents are from leasing property as a result of marketing activities, there must be a substantial marketing organization in order to meet the active trade or business test. Under a safe harbor, an organization is substantial if active leasing expenses equal or exceed 25 percent of adjusted leasing profit. If the CFC receives rents from property it does not own, the substantiality of the organization is determined net of those rent payments.
The regulations extend the rule to apply to royalties in addition to rents. As a result, the substantiality of the organization is determined under the safe harbor net of the rents or royalties paid or incurred by the lessor CFC, for the right to use the property (or a component part of the property) that generated the rental income.
Applicability Date
The regulations generally apply to tax years of CFCs ending on or after November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end. The regulations on the downward attribution rule, and the option anti-abuse rule for use of the option to treat a person as a related person with respect to a CFC, apply to tax years of CFCs ending on or after May 17, 2019, and to tax years of U.S. shareholders in which or with which such tax years end, with respect to amounts received or accrued by a CFC on or after May 17, 2019, to the extent the amounts are received or accrued in advance of the period to which such amounts are attributable with a principal purpose of avoiding application of the rules.
The IRS has issued final and proposed regulations implementing the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A. The BEAT is a minimum tax that certain large corporations must pay on certain payments made to foreign related parties, and was added by the Tax Cuts and Jobs Act ( P.L. 115-97).
The IRS has issued final and proposed regulations implementing the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A. The BEAT is a minimum tax that certain large corporations must pay on certain payments made to foreign related parties, and was added by the Tax Cuts and Jobs Act ( P.L. 115-97).
The final regulations adopt proposed rules ( REG-104259-18) published on December 21, 2018 (2018 proposed regulations), with certain modifications. The proposed regulations ( REG-112607-19) (2019 proposed regulations) provide rules under Code Secs. 59A and 6031 regarding certain aspects of the BEAT.
Final Regulations
The 2018 proposed regulations provided guidance related to the mechanics of determining a taxpayer’s BEAT liability, and addressed application of the BEAT to partnerships, banks, registered security dealers, and consolidated groups. The final BEAT regulations retain the basic approach and structure of the 2018 proposed regulations, with certain revisions.
The final regulations continue to be exclude from the denominator of the base erosion percentage Code Sec. 988 losses with respect to transactions with foreign related parties that are excluded from the numerator of the percentage. The final regulations also retain the add-back method for computing modified taxable income and the computation of base erosion minimum tax amount (BEMTA) on a taxpayer-by-taxpayer basis.
Among some of the more significant changes to the proposed rules, the final regulations:
Applicability Dates
The final regulations (other than the reporting requirements for QDPs) apply to tax years ending on or after December 17, 2018. However, taxpayers may apply these final regulations in their entirety for tax years ending before December 17, 2018. Taxpayers may also apply provisions matching Reg. §§1.59A-1 through 1.59A-9 in their entirety for all tax years ending on or before December 6, 2019. Taxpayers choosing to apply the proposed regulations must apply them consistently and cannot selectively choose which particular provisions to apply.
The related Code Sec. 6038A regulations apply to tax years beginning Monday, June 7, 2021. The related consolidated return regulations generally apply to tax years for which the original consolidated return is due (without extensions) after December 6, 2019.
2019 Proposed Regulations
The 2019 proposed regulations provide rules regarding relating to (1) how a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage; (2) an election to waive deductions; and (3) application of the BEAT to partnerships.
The 2019 proposed regulations generally apply to tax years beginning on or after the date that the final regulations are filed with the Federal Register. Certain rules, however, have specific applicability dates. In addition, taxpayers may rely on the rules in the proposed regulations in their entirety for tax years beginning after December 31, 2017, and before the final regulations are applicable.
Practitioner’s Observations
Arlene Fitzpatrick, a Principal in the National Tax Department of Ernst & Young LLP, told Wolters Kluwer that "there are changes and new proposed rules in the package of final and proposed regulations that are helpful, though not all changes requested through the comment process were made. For example, the rules in the final regulations to exclude, in certain circumstances, from the definition of a base erosion payment amounts transferred to, or exchanged with, a foreign related party pursuant to a specified nonrecognition transaction are welcome. Furthermore, clarifying that a built-in loss recognized on a sale or transfer of property to a foreign related party is not in itself a deduction that causes the payment to be treated as a base erosion payment is helpful. The final regulations however, retain the internal dealings rule whereby a notional payment for purposes of attribution of profits under certain tax treaties may be taken into account for purposes of determining BEAT. Thus, although deductions from internal dealings would not be allowed under the Code or regulations, and only relevant under certain treaties (the regulations do not specify the treaties), the regulations provide such amounts are relevant for purposes of determining BEAT."
The IRS has issued highly anticipated final regulations on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The final regulations retain the basic approach and structure of the 2018 proposed regulations ( NPRM REG-105600-18). The final regulations also eliminate deadwood, reflect statutory amendments made prior to TCJA, and update expense allocation rules not updated since 1988.
The IRS has issued highly anticipated final regulations on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The final regulations retain the basic approach and structure of the 2018 proposed regulations ( NPRM REG-105600-18). The final regulations also eliminate deadwood, reflect statutory amendments made prior to TCJA, and update expense allocation rules not updated since 1988.
Also adopted are proposed regulations on overall foreign losses, published on June 25, 2012 ( NPRM REG-134935-11), and a U.S. taxpayer’s obligation to notify the IRS of a foreign tax redetermination, published on November 7, 2007 ( NPRM REG-209020-86).
A separate set of 2019 proposed regulations were also issued ( NPRM REG-105495-19).
Final Regulations
The final regulations make extensive changes to the rules on the determination of the foreign tax credit. Many of these changes were required to implement the TCJA, including the items discussed, below.
The final regulations provide details on how income is assigned and expenses are apportioned to the Code Sec. 951A global intangible low-taxed income (GILTI) and foreign branch foreign tax credit separate limitation categories added by TCJA.
The regulations provide that, for purposes of applying the expense allocation and apportionment rules, the portion of gross income related to foreign derived intangible income (FDII) or a GILTI inclusion that is offset by a Code Sec. 250 deduction is treated as exempt income. This means that fewer expenses will be allocated to the GILTI category, resulting in a higher foreign source taxable income, a higher foreign tax credit limitation, and a larger foreign tax credit offset with respect to GILTI income.
The regulations also address how the balance of foreign tax credit carryovers prior to the TCJA are allocated across new and existing separate categories. Under a default rule, foreign tax credit carryovers remain in the general category going forward. A taxpayer can elect to reconstruct the carryover regarding a foreign branch. The final regulations provide a simplified rule under which taxpayers can assign foreign tax credits to the foreign branch category proportionately, according to the ratio of foreign taxes paid or accrued by the taxpayer’s branches to total foreign taxes paid or accrued by the taxpayer in that year.
The regulations modify the proposed rule for determining foreign branch income based on the U.S. tax-adjusted books and records of the foreign branch. The proposed regulations disregarded transfers of intellectual property (IP) between a foreign branch and its owner if the transfer would result in a deemed payment that reallocates income between the foreign branch category and the general branch category. The final regulations limit the rule to transactions that occurred after the date of the proposed regulations and include an exception for transitory ownership.
The regulations provide rules for the treatment of GILTI for purposes of the interest allocation rules. In general, a controlled foreign corporation (CFC) must allocate and apportion its interest expense among groups of income for purposes of determining tested income, subpart F income and other types of net foreign source income. A U.S. taxpayer must characterize the value of its CFC for allocating and apportioning its own interest expense. A CFC allocates and apportions its interest expense using either the modified gross income (MGI) method or the asset method. The U.S. taxpayer uses the same method to characterize the stock of its CFC. The regulations take into account gross tested income from a lower-tier CFC with respect to an upper-tier CFC for allocating the upper-tier CFC’s interest expense when applying the MGI method.
Dividends, interest, rents and royalties (look-through payments) paid to a U.S. shareholder by a CFC were generally allocated to general category income to the extent that they were not treated as passive category income. Because this type of payment made directly by a U.S. shareholder is not included in the GILTI category, the regulations provide that the look-through payments are assigned either to the general category or the foreign branch category. The payments cannot be assigned to the GILTI category.
The final regulations also address certain potentially abusive borrowing arrangements involving loans by U.S. persons to foreign partnerships that artificially increase foreign source income and the foreign tax credit limitation without affecting U.S. taxable income. Under the regulations, the interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate limitation categories in the same manner as the associated interest expense.
Applicability of Final Regs
The final regulations related to statutory amendments made by the TCJA apply to tax years beginning after December 31, 2017. Regulations that contain both rules that relate to the TCJA and rules that do not relate to the TCJA generally apply to tax years that both (1) begin after December 31, 2017, and (2) end on or after December 4, 2018.
The regulations on the deemed paid credit under Code Sec. 960 apply to tax years that both begin after December 31, 2017, and end on or after December 4, 2018. The final OFL regulations apply to tax years on or after the date the regulations are filed in the Federal Register. The final foreign tax redetermination regulations apply to foreign tax redeterminations occurring in tax years ending on or after the date the regulations are filed in the Federal Register.
Proposed Regulations
Proposed foreign tax credit regulations address changes made by the TCJA, and also respond to issues raised in the 2018 proposed regulations on the foreign tax credit ( NPRM REG-105600-18). The proposed regulations address:
Allocation and Apportionment
Under the general rule, a taxpayer may allocate research and experimentation (R&E) expenses to the foreign tax credit separate limitation categories under the sales method or the gross income method. The proposed regulations revise the sales method to provide that R&E expenses are only allocated to income that represents return on intellectual property. When applying these rules, gross intangible income does not include dividends or amounts included under subpart F, GILTI or Code Sec. 1293. As a result, none of a U.S. taxpayer’s R&E expenses are allocated to the GILTI category. The proposed regulations eliminate the gross income method for purposes of allocating R&E expenses.
Stewardship expenses are related and allocable to dividends received or to be received from related corporations. The proposed regulations provide that stewardship expenses are allocated to subpart F and GILTI inclusions, to Code Sec. 78 dividends and all amounts included under the passive foreign investment company (PFIC) provisions.
Under the Code Sec. 818(f) allocation rules that apply to life insurance companies, expenses are generally apportioned ratably across all gross income. Under a new rule, the proposed regulations allocate expenses in a life-nonlife consolidated group solely among items of the insurance company that has reserves (separate entity method).
The final foreign tax credit limitations provide a matching rule for a U.S. partner that makes loans to a foreign partnership. Under the rule, the partner’s gross interest income is apportioned between U.S. and foreign sources in each separate foreign tax credit limitation category based on the partner’s interest expense apportionment ratios. The proposed regulations provide the same rule for loans from partnerships to U.S. partners (upstream partnership loans).
Redeterminations
Portions of the 2007 temporary regulations on foreign tax redeterminations ( T.D. 9362) are reproposed so that taxpayers can provide comments on the rules in light of the changes made by the TCJA. The proposed regulations address foreign tax redeterminations that affect the deemed paid credit under Code Sec. 960; procedural notification rules; and penalties for failure to notify the IRS of a foreign tax redetermination.
The proposed regulations require taxpayers to account for foreign tax redeterminations of foreign subsidiaries on an amended return that reflects the revised foreign taxes deemed paid under Code Sec. 960 and any changes to the taxpayer’s U.S. tax liability. This reflects the repeal of the pooling mechanism to account for redeterminations of foreign taxes.
A transition rule provides that post-2017 redeterminations of pre-2018 foreign income taxes must be made by adjusting the foreign corporation’s taxable income and earnings and profits and post-1986 undistributed earnings and income taxes in the pre-2018 year to which the redetermined foreign taxes relate. The proposed regulations also provide that the foreign tax redetermination rules cover situations in which the foreign tax redetermination affects whether or not the CFC qualifies for the high-tax exceptions under GILTI and subpart F.
Additional Rules
Additional provisions in the proposed regulations:
Applicability of Proposed Regs
The proposed regulations are generally proposed to apply to tax years that end on or after the date the proposed regulations are filed in the Federal Register, with exceptions. For example, the rules for R&E expenses are proposed to apply to tax years beginning after December 31, 2019. However taxpayers on the sales method for tax years beginning after December 31, 2017, and before January 1, 2020, may rely on the proposed regulations if the rules are applied consistently. Thus, a taxpayer on the sales method for its tax year beginning in 2018 may rely on the proposed regulation, but must also apply the sales method (relying on the proposed regulation) for its tax year beginning in 2019.
Practitioner’s Observations
WK: Were you surprised by anything in the final regs?
Martin Milner: The final regulations are generally consistent with the proposed regulations and do not include any major surprises. The changes and clarifications that are in the final regulations are largely helpful. As would be expected, most of the new provisions are in the proposed portion of the package.
WK: With the proposed regs are there areas that you can see may result in pushback? If so why?
Martin Milner: The business community is likely to comment on the proposal to apportion stewardship expenses to dividends, subpart F income and GILTI (including IRC Section 78 gross-ups) because many had hoped that stewardship expenses would not be apportioned to GILTI.
WK: How did you feel about the R&E Expense Apportionment changes?
Martin Milner: The mandatory sales-based apportionment of R&E expenses to all gross intangible income related to the relevant product SIC code will be complicated in practice. However, it is helpful that the proposed rules specifically exclude dividends, subpart F income and GILTI.
The IRS has released guidance that provides that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 partnership tax years, but will first apply to 2020 partnership tax years.
The IRS has released guidance that provides that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 partnership tax years, but will first apply to 2020 partnership tax years.
2019 Reporting
For 2019, partnerships and other persons must report partner capital accounts consistent with the reporting requirements in the 2018 forms and instructions, including the requirement to report negative tax basis capital accounts on a partner-by-partner basis.
Section 704(c) Gain or Loss
As a clarification, the notice also defines the term "partner’s share of net unrecognized Code Sec. 704(c) gain or loss," which must be reported by partnerships and other persons in 2019. Further, the notice exempts publicly traded partnerships from the requirement to report their partners’ shares of net unrecognized Code Sec. 704(c) gain or loss until further notice. Solely for purposes of completing the 2019 Forms 1065, Schedule K-1, Item N, and 8865, Schedule K-1, Item G, the notice defines a partner’s share of "net unrecognized Code Sec. 704(c) gain or loss" as the partner’s share of the net (meaning aggregate or sum) of all unrecognized gains or losses under Code Sec. 704(c) in partnership property, including Code Sec. 704(c) gains and losses arising from revaluations of partnership property.
Section 465 At-Risk Activities
The notice provides that the requirement added by the draft instructions for 2019 for partnerships to report to partners information about separate Code Sec. 465 at-risk activities will not be effective until 2020. The draft of the instructions for the 2019 Form 1065, Schedule K-1, released October 29, 2019, included a new paragraph at page 12, At-Risk Limitations, At-Risk Activity Reporting Requirements, that would expressly require partnerships or other persons that have items of income, loss, or deduction reported on the Schedule K-1 from more than one activity that may be subject to limitation under Code Sec. 465 at the partner level to report certain additional information separately for each activity on an attachment to a partner’s Schedule K-1. The new paragraph would require the partnership to identify the at-risk activity, the items of income, loss, or deduction for the activity, other items of income, loss, or deduction, partnership liabilities, and any other information that relates to the activity, such as distributions and partner loans. This requirement in the draft instructions for the 2019 Form 1065 is in addition to long-standing at-risk reporting requirements included in the instructions to the Form 1065.
Penalty Relief
Taxpayers who follow the provisions of the notice will not be subject to any penalty, including a penalty under Code Sec. 6722 for failure to furnish correct payee statements, under Code Sec. 6698 for failure to file a partnership return that shows required information, and under Code Sec. 6038 for failure to furnish information required on a Schedule K-1 (Form 8865).
The IRS has released final regulations that present guidance on how certain organizations that provide employee benefits must calculate unrelated business taxable income (UBTI) under Code Sec. 512(a).
The IRS has released final regulations that present guidance on how certain organizations that provide employee benefits must calculate unrelated business taxable income (UBTI) under Code Sec. 512(a).
Background
Organizations that are otherwise exempt from tax under Code Sec. 501(a) are subject to tax on their unrelated business taxable income (UBTI) under Code Sec. 511(a). Code Sec. 512(a) defines UBTI of exempt organizations and provides special rules for calculating UBTI for organizations described in Code Sec. 501(c)(7) (social and recreational clubs), voluntary employees’ beneficiary associations (VEBAs) described in Code Sec. 501(c)(9) and supplemental unemployment benefit trusts (SUBs) described in Code Sec. 501(c)(17).
Covered Entity
"Covered entity" describes VEBAs and SUBs subject to the UBTI computation rules under Code Sec. 512(a)(3). A corporation is treated as having exempt function income for a taxable year only if it files a consolidated return with the organization described in Code Sec. 501(c)(7), (9), or (17). These final regulations add a clause to clarify that the term "covered entity" includes a corporation described in Code Sec. 501(c)(2) to the extent provided in Code Sec. 512(a)(3)(C).
Nonrecognition of Gain
If a property used directly in the performance of the exempt function of a covered entity is sold by that covered entity, and other property is subsequently purchased and used by the covered entity directly in the performance of its exempt function—at any point within a four-year period beginning one year before the date of the sale and ending three years after the date of sale—gain, if any, from the sale is recognized only to the extent that the sales price of the old property exceeds the covered entity’s cost of purchasing the other property.
Limitation on Amounts Set Aside for Exempt Purposes
The total amount of investment income earned during the year should be considered when calculating whether an excess exists at the end of the year. Any investment income a covered entity earns during the taxable year is subject to unrelated business income tax (UBIT) to the extent the covered entity’s year-end assets exceed the account limit.
Effective Date
The final regulations apply to tax years beginning on or after December 10, 2019.
The IRS has issued Reg. §20.2010-1(c) to address the effect of the temporary increase in the basic exclusion amount (BEA) used in computing estate and gift taxes. In addition, Reg. §20.2010-1(e)(3) is amended to reflect the increased BEA for years 2018-2025 ($10 million, as adjusted for inflation). Further, the IRS has confirmed that taxpayers taking advantage of the increased BEA in effect from 2018 to 2025 will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels.
The IRS has issued Reg. §20.2010-1(c) to address the effect of the temporary increase in the basic exclusion amount (BEA) used in computing estate and gift taxes. In addition, Reg. §20.2010-1(e)(3) is amended to reflect the increased BEA for years 2018-2025 ($10 million, as adjusted for inflation). Further, the IRS has confirmed that taxpayers taking advantage of the increased BEA in effect from 2018 to 2025 will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels.
The regulations apply to estates of decedents dying on and after November 26, 2019.
Special Rule for Post-2025 Decedents
Reg. §20.2010-1(c) provides a special rule in cases where the portion of the credit against the estate tax that is based on the BEA is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable within the meaning of Code Sec. 2001(b)(2). In that situation, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based upon the greater of those two credit amounts.
Inflation-Adjusted Amounts and DSUE Amount
Because the term "BEA" includes the exclusion amount, as adjusted for inflation, the examples in the regulations reflect hypothetical inflated adjusted BEAs. Reg. §20.2010-1(c)(2)(ii), Example 2, illustrates the application of the special rule based on gifts actually made, and would be inapplicable to a decedent who did not make gifts in excess of the date of death BEA, as adjusted for inflation.
Reg. §20.2010-1(c)(2)(iii) and (iv), Examples 3 and 4, illustrate that if a spouse dies during the increased BEA period, and the deceased spouse’s executor makes the portability election, the surviving spouse’s applicable exclusion amount includes the full amount of the deceased spousal unused exclusion (DSUE) amount based on the deceased spouse’s increased BEA. The DSUE amount is available to reduce the surviving spouse’s transfer tax liability regardless of when transfers are made.
BEA Calculations
The final rules explain how to determine the extent to which a credit allowable in computing gift tax payable is based solely on the BEA. Reg. §20.2010-1(c)(2)(iv), Example 4, addresses the application of the DSUE ordering rule, as well as the computation of the credit based solely on the BEA in a calendar period in which the transfer exhausts the remaining DSUE amount with the result that the BEA is also allowable.
The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.
The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.
Suitability Checks
The IRS’s suitability checks for applicants to the Acceptance Agent, Enrolled Agent, and e-File Provider Programs generally ensured that only reputable individuals were accepted in the programs during fiscal year 2018. Further, the IRS’s continuous suitability checks also ensured that individuals accepted in the programs prior to the initial suitability checks had not engaged in criminal activity warranting removal from the program. TIGTA also identified that when the Federal Bureau of Investigation reported a criminal history for an applicant, the adjudication process was inconsistent depending on the program to which the individual was applying. Finally, the IRS did not take sufficient actions to address the fraudulent submission of fingerprint cards by some applicants to pass their background investigations.
TIGTA Recommendations
TIGTA recommended that the IRS:
The IRS agreed with all the recommendations.
An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.
An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn't mind the IRS default entity classification does not necessarily need to file Form 8832.
"Check-the-Box" Election
An LLC with more than one member can elect tax status as:
An LLC with only one member can elect tax status as:
The IRS will assign the following classifications if no entity election is filed for an LLC (the default rules):
Typically, an LLC with more than one member will elect to be taxed as a partnership, whereas a single-member LLC will elect to be disregarded and taxed as a sole proprietorship.
If you have any questions relating to LLCs, their benefits, drawbacks, or their treatment under the Tax Code, please contact our offices.
The IRS has issued proposed reliance regulations on the 3.8 percent surtax on net investment income (NII), enacted in the 2010 Health Care and Education Reconciliation Act. The regulations are proposed to be effective January 1, 2014. However, since the tax applies beginning January 1, 2013, the IRS stated that taxpayers may rely on the proposed regulations for 2013. The IRS expects to issue final regulations sometime later this year.
The IRS has issued proposed reliance regulations on the 3.8 percent surtax on net investment income (NII), enacted in the 2010 Health Care and Education Reconciliation Act. The regulations are proposed to be effective January 1, 2014. However, since the tax applies beginning January 1, 2013, the IRS stated that taxpayers may rely on the proposed regulations for 2013. The IRS expects to issue final regulations sometime later this year.
The surtax applies to individuals, estates, and trusts. The surtax applies if the taxpayer has NII and his or her "modified" adjusted gross income exceeds certain statutory thresholds: $250,000 for married taxpayers and surviving spouses; $125,000 for married filing separately; and $200,000 for individuals and other taxpayers. The tax is broad and can raise tax bills by hundreds, if not thousands, of dollars.
Complex provisions
The regulations are extensive and complex. They address a number of issues that were not answered in the statute, such as the interaction of Code Sec. 1411 (the surtax provisions) and Code Sec. 469 (passive activity loss rules). Significant areas addressed in the proposed regulations include:
Some issues, however, are not yet addressed, such as the application of the Code Sec. 469 material participation rules to trusts and estates. Further guidance from the IRS is expected.
Borrowed definitions and principles
Net investment income that is subject to the new 3.8 percent tax generally includes interest and dividend income as well as capital gains from investments. But Code Sec. 1411 doesn't stop there, seeking to tax "passive activities" and contrasting those activities with a "trade or business" in often complex ways.
Because Code Sec. 1411 does not define many important terms, the regulations use definitions from several other Tax Code provisions. For example, the definition of a trade or business is determined under Code Sec. 162, regarding trade or business expenses. This definition is essential to Code Sec. 1411, since the application of each of the three categories of net investment income depends on determining whether the income is from a trade or business. The regulations also borrow the definition of a disposition, which applies to category (iii) income, from other provisions, such as Code Section 731 (partnership distributions) and Code Sec. 1001 (dispositions of property).
New elections available
The regulations provide certain elections that may be beneficial to many taxpayers. Taxpayers that engage in multiple activities under Code Sec. are allowed to make another election to regroup their activities. Taxpayers married to a nonresident alien can elect to treat their spouse as a U.S. resident, which allow more income to escape the 3.8 percent surtax.
Net investment income generally includes interest and dividend income as well as capital gains from investments. To prevent avoidance of the tax, the regulations include substitute payments of interest and dividends in the definition. The IRS also warned in the preamble to the proposed regulations that it will scrutinize activities designed to circumvent the surtax and will challenge questionable transactions using applicable statutes and judicial doctrines. The IRS further warned that taxpayers should figure their exposure to the 3.8 percent tax quickly since liability for this additional tax must be included in quarterly estimated tax computations and payments starting with first quarter 2013.
Please feel free to contact this office for a personalized review of how the 3.8 percent tax may impact you, and what compliance and planning steps should be considered as a consequence.
Effective January 1, 2013, a new Medicare tax takes effect. The Additional Medicare Tax imposes a 0.9 percent tax on compensation and self-employment income above a threshold amount. Unlike regular Medicare tax, the Additional Medicare Tax has no employer match but employers have withholding obligations. The IRS issued proposed reliance regulations about the Additional Medicare Tax in December 2012.
Effective January 1, 2013, a new Medicare tax takes effect. The Additional Medicare Tax imposes a 0.9 percent tax on compensation and self-employment income above a threshold amount. Unlike regular Medicare tax, the Additional Medicare Tax has no employer match but employers have withholding obligations. The IRS issued proposed reliance regulations about the Additional Medicare Tax in December 2012.
Medicare
Medicare is funded through payroll taxes. Employees and employers (and self-employed individuals) all pay into Medicare. Employees and employers each pay Medicare tax at a rate of 1.45 percent (self-employed individuals pay at a combined rate but are allowed to deduct half of the Medicare tax as an adjustment to income). The Additional Medicare Tax is a new tax that may apply to certain taxpayers in addition to regular Medicare tax. The new tax was part of the Patient Protection and Affordable Care Act (Affordable Care Act), which was passed by Congress in 2010. However, Congress delayed the start date of the new tax until 2013.
Liability
Generally, an individual is liable for Additional Medicare Tax if the individual's wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceed the threshold amount for the individual's filing status. Only individuals with incomes above the threshold amount will be liable for the new tax and if their employer does not withhold it, they will have to pay it when then they file their returns.
The threshold amounts are: $250,000 for married couples filing jointly; $200,000 for single individuals, head of household (with qualifying person) and qualifying widow(er) with dependent child; and $125,000 for married couples filing separately.
Withholding
An employer must withhold Additional Medicare Tax from wages it pays to an individual in excess of $200,000 in a calendar year, without regard to the individual's filing status or wages paid by another employer. The IRS explained in its proposed reliance regulations that the employer has this withholding obligation even though an employee may not be liable for Additional Medicare Tax because, for example, the employee's wages together with that of his or her spouse do not exceed the $250,000 threshold for married couples filing jointly.
Let's look at an example from the IRS proposed reliance regulations:
Elena, who is married and files a joint return, receives $100,000 in wages from her employer for the calendar year. Caleb, Elena's spouse, receives $300,000 in wages from his employer for the same calendar year. Elena's wages are not in excess of $200,000, so her employer does not withhold Additional Medicare Tax. Caleb's employer is required to collect Additional Medicare Tax only with respect to wages it pays which are in excess of the $200,000 threshold (that is, $100,000) for the calendar year.
Planning considerations
Taxpayers who believe they may be liable for the Additional Medicare Tax in 2013 and beyond should carefully plan ahead. The IRS has cautioned that an individual may owe more than the amount withheld by the employer, depending on the individual's filing status, wages, compensation, and self-employment income. All these factors come into play in planning for the Additional Medicare Tax.
One strategy may be to make estimated tax payments and/or request additional income tax withholding. Our office can help you determine which strategy would work best for you.
Employers
There is no employer match for the Additional Medicare Tax. However, the Affordable Care Act and the IRS proposed reliance regulations require employers to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year, beginning January 1, 2013. If an employer fails to withhold, the IRS may impose penalties on the employer and the employee would be liable for the tax.
Reliance regulations
The regulations issued by the IRS in December 2012 are proposed reliance regulations. The IRS explained that it intends to finalize the proposed regulations in 2013. Taxpayers may rely on the proposed regulations for tax period beginning before the date that the regulations are finalized.
If you have any questions about the Additional Medicare Tax, please contact our office.
Beginning with 2012 Forms W-2, large employers must report the aggregate cost of employer-sponsored health insurance provided to employees. 2012 Form W-2s must be furnished to employees by January 31, 2013.
Beginning with 2012 Forms W-2, large employers must report the aggregate cost of employer-sponsored health insurance provided to employees. 2012 Form W-2s must be furnished to employees by January 31, 2013.
For tax years beginning on or after January 1, 2011, the Patient Protection and Affordable Care Act (PPACA) required that employers report the aggregate cost of employer-sponsored health insurance provided on Form W-2, Wage and Tax Statement. The IRS then exempted all employers from the requirement for 2011, making 2011 reporting optional.
Reporting took effect in early 2012, but only for large employers filing 250 or more Forms W-2 for the preceding calendar year (2011). Small employers are exempt from reporting for 2012 and beyond, until the IRS issues further guidance. An employer does not have to report the cost if it is not required to issue a Form W-2. This would be the case for a retiree or other former employee who does not receive compensation.
The aggregate reportable cost should be shown on Form W-2, Box 12, using Code DD. The IRS has reiterated that reporting is for informational purposes only, and that the cost of health insurance generally remains excludable from income.
Reporting applies to applicable coverage under any group health plan provided by an employer or employee organization, if the coverage is excludable from the employee's income or would have been excludable if provided by the employer. Costs for self-insured plans and plans of self-employed persons are covered, unless the only coverage provided by the employer is a self-insured plan that is not subject to COBRA continuation coverage requirements (e.g. a self-insured church plan). Coverage does not include long-term care; accident or disability coverage; coverage for treatment of the mouth; and coverage only for a specified illness or disease.
Reportable costs include both employer costs and employee costs for the health insurance, even if the employee paid his or her share through pre-tax or salary reduction contributions. The aggregate cost includes the cost of coverage included in the employee's income, such as the cost of coverage for a person who is not a dependent or a child under age 27.
However, costs do not include amounts contributed to an Archer Medical Savings Account, health savings account, or health reimbursement arrangement, and salary reduction contributions made to a flexible spending arrangement.
Reporting is required of most employers, including federal, state, and local governments, and churches and other religious organizations.
Please contact this office if you would like further information on how these new reporting obligations may apply to your business.