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On July 4, President Donald Trump signed into law a Paycheck Protection Program (PPP) application extension bill that Congress had quickly passed just before the Independence Day holiday. According to several senators, the measure was "surprisingly" introduced and approved by unanimous consent in the Senate late on June 30. It cleared the House the evening of July 1.

Most notably, the bill pushes out the PPP application window deadline five weeks from June 30 to August 8. "The resources are there. The need is there. We just need to change the date," Sen. Ben Cardin, D-Md., said. Prior to the extension, the small business loan program was set to expire at midnight on July 1 with over $130 billion left in funding.

Mnuchin, Rettig Testify
Treasury Secretary Steven Mnuchin and IRS Commissioner Charles "Chuck" Rettig testified before House and Senate committees on June 30, just hours before the PPP application period was set to close.

"There appears to be bipartisan support to repurpose the [remaining] $134 billion for PPP," Mnuchin told lawmakers during a House Financial Services Committee hearing on June 30. Mnuchin stated that "it should be done," and that the administration is looking toward targeted industry-specific relief.

Additionally, Mnuchin told lawmakers that he has been having discussions about more PPP-related relief with the House and Senate Small Business Committees. Reportedly, lawmakers are currently considering an extension or a second round of the PPP.

As for "phase four" of Congress’s next economic relief package, Mnuchin again alluded to a narrower approach. "We would anticipate that any additional relief would be targeted to certain industries that have been especially hard-hit by the pandemic, with a focus on jobs and putting all American workers who lost their jobs, through no fault of their own, back to work."

Meanwhile, several PPP-related bills have been introduced in the Senate over the last few weeks, and most recently a bipartisan PPP Forgiveness bill introduced on June 30. The Paycheck Protection Small Business Forgiveness Bill, authored by bipartisan members of the Senate Banking Committee, would streamline the forgiveness of certain PPP loans.

Senate Minority Leader Chuck Schumer, D-NY, also called for an extension of the small business loan program. "It is the last day small business can apply for PPP, but the economic crisis is not over. Senators Cardin, Shaheen, Coons and I will take to the Senate floor and demand we pass a bill to extend it," Schumer said in a June 30 tweet.

IRS 2020 Filing Season, Agency Redesign
In other news, Rettig testified on June 30 before the Senate Finance Committee (SFC) on IRS operations during the 2020 tax filing season. Notably, Rettig told senators that the decision not to further extend the 2019 tax year filing and payment deadline beyond July 15 was made in consultation with professional services organizations, adding that too many due dates can be confusing for taxpayers.

To that end, Treasury first signaled in a June 29 press release that it would not further extend the 2020 filing season. "Treasury and IRS encourage taxpayers to file their taxes by July 15, or file for an automatic extension of time to file to October 15," the press release stated.

"The IRS understands that those affected by the coronavirus may not be able to pay their balances in full by July 15, but we have many payment options to help taxpayers," Rettig said in the press release. "These easy-to-use payment options are available on IRS.gov, and most can be done automatically without reaching out to an IRS representative."

Additionally, Rettig told SFC members that the IRS is well underway in its redesign of the agency for the first time in over 20 years. As noted in Rettig’s testimony, the foundational components of a new holistic taxpayer experience will include the following:

Expanded Digital Services. An improved experience through self-service digital channels by building upon existing online accounts and introducing online accounts for tax professionals and business taxpayers.
Seamless Experience. Taxpayers should be guided to the resources and communication channels that will resolve their issues most effectively and efficiently.
Proactive Outreach and Education. Educate the taxpayer community by proactively providing information in the language, timing, and method taxpayers need or prefer.
Focused Strategies for Reaching Underserved Communities. Establish a consolidated program to engage with historically underserved communities to address issues of communication, education, transparency and trust, as well as access to quality products and services.
Ecosystem of Partnerships. Establish, shepherd, and facilitate a collaborative and interactive network of partnerships across the entire tax ecosystem and bring together existing efforts.
Enterprise Data Management and Advanced Analytics. An enterprise data management strategy that includes a cross-enterprise understanding of the customer experience, emerging needs and expectations, and operational data.

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"If you can look into the seeds of time, and say which grain will grow and which will not, speak then unto me." — William Shakespeare

The Paycheck Protection Program (PPP) was enacted under the bipartisan Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136) on March 27, 2020. The PPP, a seemingly ever-evolving small business loan program, was derived from an unprecedented partnership between certain private lending institutions and the U.S. Small Business Administration (SBA). After its enactment in late March, the program quickly went from concept to implementation when it launched on April 3, 2020.

Fast forward to a somewhat rocky roll-out with several speed bumps and shake-ups, akin to a Shakespearean plotline, President Donald Trump on June 5, 2020, signed into law the bipartisan Paycheck Protection Program Flexibility Act (PPPFA) of 2020 ( P.L. 116-142). The PPPFA makes several enhancements to the swiftly implemented loan program, including providing for an extension of the expense forgiveness period from 8-to-24 weeks. The legislation also reduces the 75 percent payroll ratio requirement to 60 percent, extends the two-year loan repayment requirement to five years for future borrowers (existing PPP loans can be extended up to five years if lender/borrower agree), allows payroll tax deferment for PPP recipients, and extends the June 30, 2020, rehiring deadline to December 31, 2020.

Accordingly, the SBA, in consultation with Treasury, officially published in the Federal Register updated interim final rules (effective immediately upon publication, as opposed to the "regular order" of first issuing a proposed rule with a preliminary comment period) on June 16 and June 18, and issued new and revised forgiveness applications forms on June 17. Additional guidance is expected. The SBA is accepting comments through the Federal eRulemaking Portal at www.regulations.gov.

Wolters Kluwer recently spoke with Daniel G. Strickland, an associate with Eversheds Sutherland, about some of the underlying tax policy issues and lingering complexities with the PPP, and subsequent legislation and guidance. Strickland, who regularly works with the IRS on behalf of taxpayers to obtain benefits offered by the IRS, and with taxpayers to resolve tax controversy disputes with the IRS, currently serves as co-chair of the Federal Bar Association’s Tax Practice and Procedure Committee, as well as chair of the D.C. Bar Association’s New Tax Practitioner Subcommittee. Prior to tax practice, Strickland clerked for several years at the U.S. Tax Court.

To Double-Dip, or not to Double-Dip: That is the Question…(Well, One of Them)
Wolters Kluwer: Can you expand upon the preventive double-benefit tax policy position behind the IRS’s controversial Notice 2020-32, I.R.B. 2020-21, 837, which states that business expenses paid with tax-exempt income, i.e. a forgivable PPP loan, are not deductible under Code Sec. 265? Treasury Secretary Steven Mnuchin said recently, "if the money that is coming is not taxable, you can't double dip."

Daniel Strickland: Good question. As you correctly state, the IRS published Notice 2020-32 to address the tax treatment of expenses that would otherwise be deductible but that were paid using PPP loan proceeds that are forgiven.

From the IRS’s perspective, Congress only exempted the amount of forgiveness from taxation; it did not allow deductions for the expenses paid with forgiven proceeds. Notice 2020-32 points to section 265 as providing legal support for the proposition that otherwise-deductible expenses are not allowable for deduction to the extent that the income is wholly exempt from taxation.

My take is that the IRS is drawing a line at government-sponsored business expenses. In other words, for the taxpayers to receive forgiveness, the loan proceeds must be spent in a certain way. If they are, then it is as if the government paid those expenses directly in a valiant effort to prop up the COVID-affected small businesses. But there is an issue with the IRS’s position: a borrower cannot know the extent to which it will even be eligible for forgiveness—let alone whether its substantiation will be sufficient. And given the deadline for application for forgiveness, borrowers might not even know in the same tax year.

Wolters Kluwer: Sen. John Cornyn, R-Tex., recently introduced the bipartisan Small Business Expense Protection Act ( S. 3612), which moves to essentially nullify Notice 2020-32, clarifying congressional intent that the receipt and forgiveness of a PPP loan would not affect the deductibility of ordinary business expenses. What is your take on the underlying policy of this bill, and do you see the IRS reversing Notice 2020-32 before the measure moves through Congress?

Daniel Strickland: Senator Cornyn has the right idea. In my mind, a few simple examples show the logic: If I borrowed money from a bank and spent the proceeds on deductible expenses, I could deduct those expenses from my income when I file my taxes. If the bank forgave my debt, I would need to recognize the forgiven amount as income. If, on the other hand, I received a gift, I could also use that gift to pay for deductible expenses and then deduct those expenses from my income. I would not generally include the gift in my income – setting aside the differences between corporate taxes and individual taxes—since many small businesses are sole proprietorships or disregarded entities. When the CARES Act provided that the forgiven PPP loan amounts were not subject to tax, conceptually, the loans are turned into gifts. The deductibility should be no different. And the tax treatment should be the same irrespective of the type of corporate entity involved.

That is where the Senator is coming from. Unfortunately, the existence of a bill in Congress isn’t going to be enough to convince the IRS to about-face. The fact that there are still holds on Senator Cornyn’s bill is concerning to me.

"Know You of This Taxation?"
Wolters Kluwer: Are there other tax-related implications taxpayers and practitioners should keep in mind specific to PPP loan forgiveness?

Daniel Strickland: There are always tax implications. In the absence of congressional action on the deductibility question, another arises regarding timing. As detailed in the SBA’s interim final rule, SBA-2020-0035:

If you do not submit to your lender a loan forgiveness application within 10 months after the end of your loan forgiveness covered period, you must begin paying principal and interest after that period. For example, if a borrower’s PPP loan is disbursed on June 25, 2020, the 24-week period ends on December 10, 2020. If the borrower does not submit a loan forgiveness application to its lender by October 10, 2021, the borrower must begin making payments on or after October 10, 2021.

Taxpayers may not know whether—or to what extent—their PPP loans are forgiven until 2021, and some may not know until after they file their 2020 income tax returns. How should the deductions be reported?

In addition, we don’t know how the state and local taxing authorities will react.

Wolters Kluwer: Although the SBA, in consultation with Treasury, has addressed the PPPFA’s 60 percent "cliff" to allow for partial forgiveness if the 60 percent threshold is not reached, an added variable to the equation now exists. According to a June 8 joint Treasury/SBA statement and now updated guidance, partial forgiveness will be subject to at least 60 percent of the loan forgiveness amount having been used for payroll costs. What is your interpretation of this new variable, and is the solution to the 60 percent "cliff," as termed by Sen. Susan Collins, R-Me., who was recently drafting a bill to address the issue, correctly addressed through regulatory guidance? Do you foresee any pushback?

Daniel Strickland: If I am honest, this one took me a couple times to read to understand that it isn’t internally inconsistent:

If a borrower uses less than 60 percent of the loan amount for payroll costs during the forgiveness covered period, the borrower will continue to be eligible for partial loan forgiveness, subject to at least 60 percent of the loan forgiveness amount having been used for payroll costs.

I certainly understand what the SBA is trying to do here, but I think the better explanation is in the SBA’s updated interim final rule, Docket No. SBA-2020-0035. The SBA does a great job explaining the math behind the partial forgiveness.

But to your question, I am not sure that this falls within the realm of regulatory guidance. The hurdle is going to be with the language of the PPPFA:

LIMITATION ON FORGIVENESS.—To receive loan forgiveness under this section, an eligible recipient shall use at least 60 percent of the covered loan amount for payroll costs, and may use up to 40 percent of such amount for any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation), any payment on any covered rent obligation, or any covered utility payment.

That being said, the SBA is creating a taxpayer-favorable solution to the PPPFA’s 60 percent "cliff." I am not sure who in their right mind will object, but given the pressure put onto the SBA’s rules in courts across the country, it will be interesting to see what happens next and how the agencies show reasoned decision-making in their rules that diverge from the statutory text.

"All’s Well That Ends Well?"
Wolters Kluwer: The PPP application process is scheduled to expire on June 30, 2020. Notably, prior to Senate approval of the PPPFA, the congressional record was updated with a letter from the bipartisan, bicameral PPPFA authors and policy architects to state that the PPPFA’s "extension of the covered period does not authorize the [SBA] to issue any new PPP loans after June 30, 2020, as this date remains fixed by section 1102(b) of the CARES Act." Furthermore, Treasury and the SBA, too, recently reaffirmed the June 30 cutoff date.

However, Mnuchin told lawmakers recently that another round of loans is on the discussion table, following Sen. Tim Scott’s, R-S.C., inquiry as to whether there is an appetite for further enhancing and extending the PPP. Moreover, fellow Senate Small Business Committee members Chris Coons, D-Del., and Ben Cardin, D-Md., have introduced the Prioritized Paycheck Protection Program (P4) Bill, which would authorize new lending under the PPP to borrowers with 100 employees or less who have or will soon exhaust the original PPP loan. A Democratic companion bill was introduced in the House on June 18.

Are you aware of any calls among taxpayers or practitioners to extend PPP loan applications beyond June?

Daniel Strickland: The SBA has been processing loans fast, processing more than 14 years’ worth of loans in 14 days in the initial round of funding. Since then, however, things have slowed down. I haven’t heard any calls for extension recently. But at the same time, the most recent numbers I saw suggested that there is still more than $125 billion available. The next round of published data will give us some indication of what happens. If there is still a significant amount of money left over, and if there is a need, I can certainly see Congress extending the loan application deadline without expanding the available funds. It would be additional taxpayer relief at no additional cost to the government. But with the PPPFA’s changes, we might see the remaining funds mostly or completely extended. In that case, I think we wouldn’t see an extension without another tranche of available funding.

"Confusion Now Hath Made His Masterpiece"
Wolters Kluwer: As for when pension expenses are paid and incurred, current guidance does not indicate whether the amount that is "paid by Borrower" can include retirement contributions attributable to all of 2019, 2020, or even the two years combined. Absent any further guidance, how would you advise taxpayers and practitioners on the matter?

Daniel Strickland: That is a tough question. The short answer is that there are a lot of unanswered questions like this one. The SBA and IRS are publishing guidance as quickly as they can, but it isn’t possible to give the requisite considered decision-making and answer all of the outstanding questions at the same time. What that means for taxpayers and practitioners is that each situation needs to be carefully considered. Without specific guidance, there is a risk that certain expenses don’t qualify for forgiveness or that a portion of the loan could be called for repayment.

The first thing that I advise is to work with an attorney to evaluate the specific facts of each situation and to look at the tax and business consequences of each option. In general, where there is no clear answer, having advice in writing from your attorney that the answer you choose is the right answer can help protect businesses from some of the negative consequences of being wrong.

Wolters Kluwer: Outside the most recently published interim final rules, are there other unanswered questions for which you think Treasury and the SBA could issue additional PPP guidance?

Daniel Strickland: There are a number of unanswered questions with respect to definitions. As you reference above, the one that makes most practitioners’ lists is this issue of paid versus incurred. The loan amount is determined using "monthly payments by the applicant for payroll costs incurred." And forgiveness is determined based on "the sum of the following costs incurred and payments made during the covered period." Another outstanding question is how the forgiveness reduction exemptions will work with the cure date being shifted to December 31 and how the "option to use an eight-week covered period" for those taxpayers who have already received their loan proceeds will work if the June 30 cure date falls within the 8-week covered period.

These are just the tip of the iceberg of unanswered questions.

Wolters Kluwer: Executive agencies, including the IRS and SBA, have been increasingly reliant on sub-regulatory FAQs as a means for issuing guidance lately. What are some potential consequences or drawbacks to this method?

Daniel Strickland: Receiving guidance by FAQ is certainly an efficient way to push information out to taxpayers and practitioners. But as you allude, there are some potential issues—both legal and practical. The first for me is in the second introductory paragraph:

Borrowers and lenders may rely on the guidance provided in this document as SBA’s interpretation of the Paycheck Protection Program Interim Final Rules . . . . The U.S. government will not challenge lender PPP actions that conform to this guidance 1[.]

Footnote 1 provides:

This document does not carry the force and effect of law independent of the statute and regulations on which it is based.

Although "borrowers . . . may rely on the guidance," it is only the SBA’s interpretation of its own interim final rules. There is certainly an open question as to the level of deference to which the FAQs are entitled.

Second to that is the issue of whether the government will challenge taxpayer actions that conform to the guidance. Although the guidance provides some comfort to lenders, and the lenders will be the ones approving loan forgiveness applications, there are still a slew of potential consequences in the fine print that could be asserted against borrowers.

Third is the complexity in advising clients. If you are paying daily attention to the guidance, the tempo of guidance isn’t a big deal, but what I am noticing is that the guidance is changing—think about the initial PPP interest rate of 0.50 percent fixed rate announced by Treasury that was later changed to 1.00 percent fixed rate—and few of the published thought guidance pieces are being updated. For practitioners who are trying to play catchup after receiving a client question, this can be complicated and a great deal of time can be lost spinning their wheels trying to figure out why two seemingly well-reasoned articles have divergent facts or conclusions.

Last, but not least, for taxpayers who are looking for answers online, this could be devastating when it comes to applications for forgiveness. If practitioners are having to sift through the outdated legal analysis by comparison to the newest FAQ iteration, how can taxpayers be confident that they are only relying on the correct version. And when the next round of guidance comes out, those taxpayers must rinse and repeat.

"Tomorrow, and Tomorrow, and Tomorrow…"
Wolters Kluwer: Looking ahead, any closing thoughts or advice for practitioners related to the PPP moving forward?

Daniel Strickland: We all want to get to the right answer. For taxpayers and practitioners alike, it is important to ask questions. The SBA, for example, is receptive to discussing concerns and comments. And given the frequency of guidance, it is more important than ever to be involved in the process. For taxpayers specifically, asking questions of their advisers can protect small businesses against the "penny-wise, pound-foolish" adage. I know I want to protect my clients from missteps and help them take fullest advantage of these benefits.

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The U.S. Supreme Court upheld the Trump Administration’s rule under the Affordable Care Act (P.L. 111-148) that any nongovernment, nonpublicly traded employer can refuse to offer contraceptive coverage for moral or religious reasons, and that publicly traded employers can refuse to do so for religious reasons. Application of this rule had been halted by litigation, but the Administration is now free to apply it.

The issues in the case were: (1) whether the ACA actually requires contraceptive coverage or was that just a creature of regulations that any administration may change, and (2) whether the administration complied with Administrative Procedures Act (APA) in light of the surprising breadth of the regulation going well beyond religious objections to include any moral objection.

Contraceptive Regulation
The prior version of this regulation included an exception for religious employers and small businesses with a religious objection. They had to self-certify that they qualified. Some objected. Shortly after the Administration changed hands, it issued a new version as an interim final regulation.

The Treasury, Health and Human Services (HHS), and Labor Departments have nearly identical versions of these rules. The Treasury version is Reg. §54.9815-2713(a)(1)(iv), but it references HHS regulations (45 CFR 147.131–147.133), and that is where much of the change was made.

The new rule provides that a nongovernment employer that has religious or moral objections to providing coverage for some or all forms of birth control can simply not provide the coverage. These rules also apply to colleges and universities providing student health insurance coverage. The religious exemption is open to any nongovernment employer, including both nonprofit and for-profit entities. The same holds true for the moral exemption, except only the religious exemption is available for publicly traded employers. An objecting employer need not file anything with the government, though affected plan participants need to be notified of mid-plan year coverage changes. Employers are free to pick and choose among contraceptives if they do decide to offer contraceptive coverage.

These regulations extend the exemption for objecting employers to objecting health insurance issuers, and to objecting individuals under which a health insurance issuer may offer a separate benefit package option to any individual who objects to coverage or payments for some or all contraceptive services based on the individual’s sincerely held religious beliefs or moral convictions.

Authority Under ACA
The majority opinion by Justice Thomas viewed the ACA as blank slate on what it required for women’s preventive health. The relevant ACA provision provides that, with respect to women, a group health plan and a health insurance issuer shall, at a minimum provide additional preventive care and screenings "as provided for" in comprehensive guidelines supported by the Health Resources and Services Administration (HRSA), an agency of the Department of Health and Human Services (HHS). At the time of the ACA’s enactment, these guidelines were not yet written.

The HRSA Guidelines were based on recommendations compiled by the Institute of Medicine (now called the National Academy of Medicine). The Guidelines included the contraceptive mandate, which required health plans to provide coverage for all contraceptive methods and sterilization procedures approved by the Food and Drug Administration, as well as related education and counseling.

The same day the Guidelines were issued in 2011, the Departments of Labor, Health and Human Services, and the Treasury (the Departments) issued interim final regulations requiring contraceptive coverage, with exceptions for churches. The Departments determined that it was appropriate that HRSA take into account the mandate’s effect on certain religious employers, and concluded that HRSA had the discretion to do so through the creation of an exemption. Ever since, the HRSA has been tasked (according to the majority opinion) with devising religious exemptions. The majority opinion concluded that ACA granted the HRSA broad authority to define preventive care and screenings, which implies that the HRSA also has broad power to create any religious and moral exemptions. Thus, if the HRSA changes its mind, there is nothing in the ACA to prevent it.

Justice Ginsburg’s dissent (joined by Justice Sotomayor) argued the legislative language HRSA in fact only delegates to the HRSA the task of compiling a list of services that should be provided. The ACA did not delegate the authority to determine who must provide the coverage for these services. Justice Kagan’s concurrence (joined by Justice Breyer) disagreed with the majority and dissent about the clarity of the ACA’s language on this, but from the beginning the Departments acted as if it were up to the HRSA to make this call. Under the Chevron doctrine, the interpretation of unclear legislation by the agency tasked with enforcement is owed due deference by the courts.

No “Open-Mindedness” Test
The majority opinion found no violation of the Administrative Procedures Act. The fact that the final rules made only minor alterations to the interim final regulations did not render the final rules procedurally invalid, because nothing in the record suggested that the Departments maintained an open mind during the post-promulgation process. The “open-mindedness” test has no basis in the APA, according to Justice Thomas.

The majority opinion also addressed the issue of calling the document containing the interim final rules "Interim Final Rules with Request for Comments" instead of "General Notice of Proposed Rulemaking." The request for comments readily satisfied the APA notice requirements, Justice Thomas ruled. Even assuming that the APA requires an agency to publish a document entitled "notice of proposed rulemaking," there was no prejudicial error here.

Justice Kagan’s opinion questioned whether the rule was not arbitrary and capricious. The rule went beyond what the Departments’ justification supported, raising doubts about whether the solution lacks a "rational connection" to the problem described. Few employers have expressed reservations about self-certification, and in any case the new exemption includes any employer (except publicly traded employers) with a moral objection whether it is religious or not.

Where’s RFRA?
The majority opinion stopped its authority analysis at holding that the ACA authorized the regulation, and stated that it did not need go into the requirements of the Religious Freedom Restoration Act of 1993 (RFRA). Justice Alito (joined by Justice Gorsuch) filed a concurrence taking the position that RFRA compels an exemption for the Little Sisters and any other employer with a similar objection to what has been called the accommodation to the contraceptive mandate.

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The IRS has issued guidance to employers on the requirement to report the amount of qualified sick and family leave wages paid to employees under the Families First Coronavirus Response Act (Families First Act) ( P.L. 116-127). This reporting provides employees who are also self-employed with information necessary for properly claiming qualified sick leave equivalent or qualified family leave equivalent credits under the Families First Act.

Background
Under the Families First Act, many employers with fewer than 500 employees must provide paid leave to employees due to circumstances related to the Coronavirus Disease 2019 (COVID-19). Certain employers must provide an employee with up to 80 hours of paid sick leave if the employee cannot work or telework because he or she:

is subject to a federal, state or local quarantine or isolation order related to COVID-19;
has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;
is experiencing symptoms of COVID-19 and seeking a medical diagnosis;
is caring for an individual who is subject to a federal, state, or local quarantine or isolation order related to COVID-19, or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;
is caring for a son or daughter if the child’s school or place of care has been closed, or the child’s care provider is unavailable, due to COVID-19 precautions; or
is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services in consultation with the Secretaries of the Treasury and Labor.

The employee is entitled to paid sick leave at his or her regular pay rate (or if higher, the applicable federal, state, or local minimum wage), up to:

$511 per day ($5,110 in the aggregate) if the employee cannot work for reasons listed in (1), (2), or (3), above;
$200 per day ($2,000 in the aggregate) if the employee cannot work for reasons listed in (4), (5), or (6) above.

The Families First Act also amends the Family and Medical Leave Act of 1993 to require employers to provide expanded paid family and medical leave to employees who cannot work or telework for reasons related to COVID-19. An employee can receive up to 10 weeks of paid family and medical leave at two-thirds the employee’s regular rate of pay, up to $200 per day ($10,000 in the aggregate) if the employee cannot work because he or she is caring for a son or daughter whose school or place of care is closed, or whose child care provider is unavailable, for reasons related to COVID-19.

Eligible employers may receive a refundable payroll credit for required qualified sick leave wages or qualified family leave wages paid to an employee, plus allocable qualified health plan expenses. An equivalent credit is available to self-employed individuals carrying on a trade or business, if the self-employed individual would be entitled to receive paid leave if he or she were an employee of an employer (other than himself or herself). The refundable credits apply to qualified leave wages paid with respect to the period beginning on April 1, 2020, and ending on December 31, 2020.

Reporting Qualified Leave Wages
In addition to reporting qualified sick leave wages paid and qualified family leave wages paid in Boxes 1, 3 (up to the social security wage base), and 5 of Form W-2 (or, in the case of compensation subject to the Railroad Retirement Tax Act (RRTA), in Boxes 1 and 14 of Form W-2), employers must report to the employee the following types and amounts of the wages that were paid, with each amount separately reported either in Box 14 of Form W-2 or on a separate statement:

the total amount of qualified sick leave wages paid for reasons (1), (2), or (3) above, labelled as "sick leave wages subject to the $511 per day limit" or in similar language;
the total amount of qualified sick leave wages paid for reasons (4), (5), or (6) above, labelled as "sick leave wages subject to the $200 per day limit" or in similar language; and
the total amount of qualified family leave wages paid, labelled as "emergency family leave wages" or in similar language.

If a separate statement is provided and the employee receives a paper Form W-2, the statement must be included with the Form W-2 provided to the employee. If the employee receives an electronic Form W-2, the statement must be provided in the same manner and at the same time as the Form W-2.

Self-Employed Individuals
Self-employed individuals who are claiming qualified sick leave equivalent or qualified family leave equivalent credits, and who are also eligible for qualified sick leave and qualified family leave wages as employees, must report the qualified leave wage amounts described above on Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals, included with their income tax returns. They also must reduce (but not below zero) any qualified sick leave or qualified family leave equivalent credits by the amount of these qualified leave wages.

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The IRS has issued guidance and temporary relief for required minimum distribution (RMD) changes in 2020. Distributions that would have been RMDs under old law are treated as eligible rollover distributions. The 60-day rollover period deadline for any 2020 RMDs already taken has been extended to August 31, 2020. Notice 2007-7, I.R.B. 2007-5, 395 is modified.

SECURE and CARES Acts
The new guidance addresses RMD issues arising from recent unexpected changes in the rules. The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) ( P.L. 116-94), enacted at the end of 2019, changed the required beginning date for RMDs for individuals turning age 70-1/2 in 2020. The Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136), enacted in March 2020, waived the RMD requirements for 2020.

Plans, administrators, and individuals were taken by surprise. Some plans and participants treated distributions as RMDs even though they were not under new rules then in effect. The SECURE Act provided no relief. However, the CARES Act allowed plans and participants to treat would-be RMDs as eligible rollover distributions. Still, under the rules, individuals have 60 days to recontribute distributions, and can only do that once in a 12-month period. That left individuals who took early distributions twisting in the wind, not to mention people taking monthly RMD installments.

60-Day Deadline Extended
Under the new relief, any distribution already taken in 2020 that would have been an RMD under the old rules has a 60-day recontribution deadline of no earlier than August 31. For example, if someone took a distribution in January 2020 that would have been an RMD under the old rules (either sets of old rules), they have until August 31 to recontribute it to an eligible plan or IRA.

For an IRA owner or beneficiary who has already received a distribution that would have been an RMD in 2020 but for the 2020 RMD waiver under the CARES Act or the change in the required beginning date under the SECURE Act, the recipient may repay the distribution to the distributing IRA, even if the repayment is made more than 60 days after the distribution, provided the repayment is made no later than August 31, 2020. The repayment will be treated as a rollover, but will be subject to the one rollover per 12-month period limitation or the restriction on nonspousal beneficiary rollovers.

SECURE Act Relief
Distributions that were intended as RMDs but in fact are not due to the SECURE Act change in required beginning date are treated as eligible rollover distributions. RMDs do not have to satisfy rules regarding mandatory withholding, the option of a direct rollover, and notice of that right. Under this relief, individuals and plans can still treat these as eligible rollover distributions.

2020 Waiver Guidance
The IRS has clarified that the CARES Act relief applies for 2020 distributions that would have been RMDs, had it not been for the 2020 RMD waiver. These include distributions to a plan participant paid in 2020 (or paid in 2021 for the 2020 calendar year in the case of an employee who has a required beginning date of April 1, 2021) if the payments equal the amounts that would have been RMDs in (or for) 2020 had it not been for 2020 RMD waiver. They also include distributions that are one or more payments (that include the 2020 RMDs) in a series of substantially equal periodic payments made at least annually and expected to last for the participant’s life or life expectancy, the joint lives (or joint life expectancies) of the participant and the participant’s designated beneficiary, or for a period of at least 10 years.

For a plan participant with a required beginning date of April 1, 2021, distributions paid in 2021 that would have been an RMD for 2021 had it not been for the CARES Act are treated as eligible rollover distributions. However, a plan participant with a required beginning date of April 1, 2021, must still receive RMD for the 2021 calendar year by December 31, 2021. If the employee receives a distribution during 2021, that distribution is an RMD for the 2021 calendar year to the extent the total RMD for 2021 has not been satisfied even if the distribution is made on or before April 1, 2021, and accordingly, is not an eligible rollover distribution. However, to the extent the RMD for 2021 has been satisfied, subsequent amounts distributed in 2021 that would otherwise not be eligible rollover distributions may be rolled over.

Extended Deadlines Due to 2020 Waiver
If a plan permits an employee or beneficiary to elect whether the 5-year rule or the life expectancy rule applies in determining RMDs, then the deadline for making that election typically would be the end of calendar year following the calendar year of the employee’s death. For example, if a 50-year-old employee in a plan providing the election died in 2019 with his sister as his designated beneficiary, the plan provision would require the election by the end of 2020. However, that type of plan may be amended to permit the extension of the election deadline to the end of 2021.

The RMD waiver extends the time for making a direct rollover for a nonspouse designated beneficiary if the participant died in 2019. A special rule provides that if the 5-year rule applies to a benefit under a plan, the nonspouse designated beneficiary may determine the amount that is not eligible for rollover because it is an RMD using the life expectancy rule in the case of a distribution made prior to the end of the year following the year of death. This special rule is modified so that if the employee’s death occurred in 2019, the nonspouse designated beneficiary has until the end of 2021 to make the direct rollover and use the life expectancy rule.

Plan Amendments
The guidance provides a sample plan amendment for defined contribution plans that plan sponsors may adopt to implement waiver rules. Any plan amendment must be adopted no later than the last day of the first plan year beginning on or after January 1, 2022 (January 1, 2024, for governmental plans), and must reflect operation of the plan beginning with the effective date of the plan amendment. Timely adoption of the amendment must be shown by a written document signed and dated by the employer (including an adopting employer of a pre-approved plan). IRAs do not need to be amended.

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The IRS has clarified and provided relief for mid-year amendments reducing safe harbor contributions. An updated safe harbor notice and an election opportunity must be provided even if the change is only for highly compensated employees. Coronavirus (COVID-19) relief applies if a plan amendment is adopted between March 13, 2020, and August 31, 2020. For nonelective contribution plans, the supplemental notice requirement is satisfied if provided no later than August 31, 2020, and the amendment that reduces or suspends contributions is adopted no later than the effective date of the reduction or suspension. Notice 2016-16, I.R.B., 2016-7, 318, is clarified.

Mid-Year Amendments
Safe harbor contributions for a plan year may be amended during the plan year to reduce or suspend future matching or nonelective contributions only under certain conditions. Among them are that the employer must either (1) be operating at an economic loss for the plan year, or (2) have included in the plan’s safe harbor notice for the plan year a statement that the plan may be amended during the plan year to reduce or suspend safe harbor contributions, and that the reduction or suspension will not apply earlier than 30 days after all eligible employees are provided notice of the reduction or suspension.

The reduction or suspension of safe harbor contributions may be effective no earlier than the later of the date the amendment is adopted or 30 days after eligible employees are provided in a supplemental notice. Eligible employees must be given a reasonable opportunity (including a reasonable period after receipt of the supplemental notice) prior to the reduction or suspension of safe harbor contributions to change their cash or deferred elections and, if applicable, their employee contribution elections.

Safe Harbor Contributions
Reductions or suspensions of contributions. If a plan amendment that reduces or suspends safe harbor matching or nonelective contributions during a plan year is adopted between March 13, 2020, and August 31, 2020, then the plan will not be treated as failing to satisfy the requirement that the employer either (1) is operating at an economic loss; or (2) has included in the plan’s safe harbor notice for the plan year a statement that (a) the plan may be amended during the plan year to reduce or suspend the safe harbor contributions and (b) the reduction or suspension will not apply until at least 30 days after all eligible employees are provided notice of the reduction or suspension.

Supplemental notice requirement. If a plan amendment that reduces or suspends safe harbor nonelective contributions during a plan year is adopted between March 13, 2020, and August 31, 2020, then the plan will not be treated as failing to satisfy the supplemental notice requirements merely because it is not provided to eligible employees at least 30 days before the reduction or suspension of safe harbor nonelective contributions is effective, provided that (1) the supplemental notice is provided to eligible employees no later than August 31, 2020, and (2) the plan amendment that reduces or suspends safe harbor nonelective contributions is adopted no later than the effective date of the reduction or suspension of safe harbor nonelective contributions.

There is no relief with respect to the timing of supplemental notices for a mid-year reduction or suspension of safe harbor matching contributions because matching contribution levels communicated to employees directly affect employee decisions regarding elective contributions (and, if applicable, employee contributions).

HCE Contributions
The new notice clarifies that an updated safe harbor notice and an election opportunity (as required by Notice 2016-16, I.R.B. 2016-7, 318) must be provided to highly compensated employees (HCEs) to whom the mid-year change applies, determined as of the date of issuance of the updated safe harbor notice. This rule applies even if the change only applies to HCEs.

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The IRS amended final regulations with guidance on the Code Sec. 199A deduction for suspended losses and shareholders of regulated investment companies (RICs). The amendments address the treatment of suspended losses included in qualified business income (QBI), the deduction allowed to a shareholder in a regulated investment company (RIC), and additional rules related to trusts and estates. The IRS had previously issued final and proposed regulations addressing these issues (NPRM REG-134652-18)

The IRS amended final regulations with guidance on the Code Sec. 199A deduction for suspended losses and shareholders of regulated investment companies (RICs). The amendments address the treatment of suspended losses included in qualified business income (QBI), the deduction allowed to a shareholder in a regulated investment company (RIC), and additional rules related to trusts and estates. The IRS had previously issued final and proposed regulations addressing these issues ( NPRM REG-134652-18)

Background
Code Sec. 199A provides a deduction of up to 20 percent of qualified business income (QBI) from a U.S. trade or business operated as a sole proprietorship, or through a partnership, S corporation, trust, or estate. If the taxpayer’s taxable income exceeds the threshold amount in Code Sec. 199A(e)(2), the deduction may be limited. Statutory limitations are subject to phase-in rules. Code Sec. 199A also provides individuals and some trusts and estates a deduction of up to 20 percent of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.

461(l) Losses
Under Reg. §1.199A-3(b)(1)(iv), previously disallowed losses or deductions allowed in the tax year are generally taken into account for computing QBI, except to the extent the losses or deductions were disallowed, suspended, limited, or carried over from tax years ending before January 1, 2018. The final regulations amend Reg. §1.199A-3(b)(1)(iv)(A) to specifically reference excess business losses disallowed by Code Sec. 461(l) and treated as a net operating loss (NOL) carryover for the tax year for purposes of determining any NOL carryover in subsequent tax years. The IRS notes that the list of statutes in the regulation is not exhaustive

Phase-in Rules for SSTB Losses
The amendments also clarify how the phase-in rules apply when a taxpayer has a suspended or disallowed loss or deduction from a specified service trade or business (SSTB). If the individual’s taxable income is at or below the threshold amount in the year the loss or deduction is incurred, the entire disallowed loss or deduction is treated as QBI from a separate trade or business in the later tax year in which the loss is allowed. If the individual’s taxable income is within the phase-in range, only a percentage of the disallowed loss or deduction is taken into account in the later tax year. If the individual’s taxable income exceeds the phase-in range, the loss or deduction is not included in QBI.

Conduit Treatment
The final regulations provide conduit treatment for qualified REIT dividends earned by a RIC. Conduit treatment happens when a RIC treats dividends paid to a shareholder in the same or similar manner as the shareholder would treat the underlying item of income or gain if the shareholder realized it directly. The Treasury Department and IRS continue to consider comments on whether to provide conduit treatment for qualified PTP income, and for RIC income from an activity that would generate QBI if conducted by a partnership or an S corporation.

Separate Share Rule
The separate share applies for a trust or estate described in Code Sec. 663(c) with substantially separate and independent shares for multiple beneficiaries. Under the final regulations, the trust or estate will be treated as a single trust or estate for determining taxable income, net capital gain, net QBI, W-2 wages, unadjusted basis immediately after acquisition (UBIA) of qualified property, qualified REIT dividends, and qualified PTP income for each trade or business of the trust or estate, and for computing the W-2 wage and UBIA of qualified property limitations.

Applicability
The amended regulations apply to tax years beginning 60 days after publication in the Federal Register. However, taxpayers may choose to apply the amendments before that date. Taxpayers who chose to rely on the proposed regulations issued in February 2019 may continue to do so until the date these amendments are published.

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The Treasury Department and the IRS have released drafts of proposed partnership forms for tax year 2021 (the 2022 filing season). The proposed forms are intended to provide greater clarity for partners on how to compute their U.S. income tax liability for relevant international tax items, including claiming deductions and credits. The redesigned forms and instructions will also give useful guidance to partnerships on how to provide international tax information to their partners in a standardized format.

The draft forms are:

Schedule K-2 (Form 1065), Partners’ Distributive Share Items—International, and Instructions for Schedule K-2.
Schedule K-3 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc.—International ; and Instructions for Schedule K-3.

These proposed forms would apply to a partnership required to file Form 1065 only if it has "items of international tax relevance" (i.e., generally, foreign activities or foreign partners). The changes would not affect domestic partnerships with no international tax items to report.

Partner Reporting of International Items
Partners must report international tax information on their tax returns on several tax forms and schedules. They generally obtain this information from their partnerships, usually through narrative statements attached to one or more Schedules K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc. Since partnerships compile these statements in a variety of formats, partners might have difficulties translating the statements onto their own returns.

To ease this burden, the Treasury and IRS state that the proposed changes would provide a standard format that offers greater clarity to both partnerships and their partners. This standard format is designed to better align the information that partnerships provide on the schedules with the tax forms used by partners, so that partners can more easily prepare their tax returns, and the IRS can more efficiently verify taxpayer compliance. It is intended that all information to be reported on the new schedules is already necessary for the partnership to provide to partners or is available to the partnership.

Draft Schedules K-2 and K-3
Any partnership that is required to file Form 1065, U.S. Return of Partnership Income, and has items relevant to the determination of the U.S. tax or certain withholding tax or reporting obligations of its partners under the international provisions of the Code, will be required to complete the relevant parts of Schedule K-2 and Schedule K-3.

The proposed parts included in new Schedule K-2 (Form 1065) replace portions of existing Form 1065, Schedule K, lines 16(a) through 16(r). The proposed schedule provides for international tax information to be reported in a standardized manner. The partnership will attach Schedule K-2 to its Form 1065.

The proposed parts included in new Schedule K-3 (Form 1065) replace portions of Schedule K-1 (Form 1065), Part III, Boxes 16 and 20. The proposed schedule provides information to the partner generally in the format of the following forms that the partner might need to complete:

Form 1040, U.S. Individual Income Tax Return;
Form 1040-NR, U.S. Nonresident Alien Income Tax Return;
Form 1116, Foreign Tax Credit (Individual, Estate, or Trust;
Form 1118, Foreign Tax Credit—Corporations;
Form 1120, U.S. Corporation Income Tax Return;
Form 1120-F, U.S. Income Tax Return of a Foreign Corporation;
Form 4797, Sales of Business Property;
Form 8949, Sales and Other Dispositions of Capital Assets;
Form 8991, Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts;
Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI); and
Form 8993, Section 250 Deduction for Foreign Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI).

The partnership will provide Schedule K-3 to its partners according to the timeline for providing Schedule K-1.

Comments Requested
The draft schedules and instructions have been released to allow partnerships and other stakeholders time to consider the proposed changes and provide comments that can be taken into account in finalizing the schedules and instructions. The Treasury and IRS will be actively engaged with stakeholders to solicit input on these proposed changes before the forms are finalized later in 2020.

Affected stakeholders can submit comments through September 14, 2020. Written comments should be sent to the following email address: lbi.passthrough.international.form.changes@irs.gov with the subject line: "International Form Changes."

For additional information and updates, see https://www.irs.gov/businesses/1065-form-changes.

Other Revisions
The Treasury and IRS plan similar revisions, as applicable, to Form 1120-S, U.S. Income Tax Return for an S Corporation, and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. They welcome comments on similar changes to be made to these forms for the 2021 tax year.

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The Treasury and IRS have issued final regulations covering the Code Sec. 250 deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI). Proposed regulations were issued on March 6, 2019 (NPRM REG-104464-18). The final regulations maintain the basic approach and structure of the proposed regulations and provide guidance on computation of the deduction and the determination of FDII, including in the consolidated return context. Additionally, rules requiring the filing of Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income, are finalized.

Section 250 Deduction
The Code Sec. 250 deduction is available to domestic corporations for:

a portion of profits attributable U.S. activities that serve foreign markets, and
a portion of profits of controlled foreign corporations (CFCs).

The deduction is available with respect to a domestic corporation’s "excess return" or return in excess of fixed return on tangible assets, derived from serving foreign markets. FDII is the portion of the excess return derived from serving foreign markets directly from the United States. GILTI is the portion of the excess return derived through foreign affiliates. The deduction results in a lower effective U.S. tax rate on a U.S. corporation’s FDII and GILTI.

Documentation Requirements
The proposed regulations defined terms and provide specific documents that were required to establish that income was derived from serving foreign markets. Commentators found that the proposed regulations could present compliance burdens. Accordingly, the final regulations provide a more flexible approach than the specific documentation requirements.

For many types of sales and services, eligibility for the Code Sec. 250 deduction is subject to the general requirement under the Code that deductions must be supported by sufficient substantiation, including the use of available business records.

More specific substantiation requirements are required for:

intangible property;
sales of general property to resellers and manufacturers; and
the provision of general services to recipients.

The requirements include either:

a specific document;
information from the recipient obtained or created in the ordinary course of a trade or business; or
a taxpayer statement with corroborating evidence.

Taxpayers may choose a method of substantiation among the methods. The specific substantiation requirements do not apply to businesses with less than $25 million in gross receipts. The final regulations also eliminate references to the use of market research to establish foreign use.

The final regulations clarify how to establish foreign use for sales of digital content and how to establish a recipient’s location outside of the United States with respect to electronically supplied services and advertising services. The final regulations:

evaluate the sale of a copyrighted article under the general property rules, rather than under the rules for foreign use of intangible property;
provide new rules for establishing whether a sale of digital content is for foreign use;
define "digital content" as a computer program or any other content in digital format; and
provide that a sale of general property that primarily includes digital content is a foreign-derived deduction eligible income (FDDEI) sale if the end user downloads or accesses the content on a device located outside of the United States.

The final regulations add two subcategories of general services:

a subcategory of general services for electronically supplied services; and
a subcategory for advertising services.

In these cases, the location of the recipient is where the content is accessed or viewed.

Foreign Military Sales and Services
The proposed regulations provided special rules to cover U.S. Defense Contractors’ military sales of equipment and provision of services to the U.S. government that are subsequently sold or provided to a foreign government.

The final regulations adopt the proposed regulations, which treat sales and services provided to the U.S. government under the Arms Export Control Act as a sale or provision of services to the foreign government that is eligible for the deduction. The final regulations relax the substantiation requirements, so that the general substantiation requirements apply.

Ratio of FDDEI to DEI
A corporation’s FDII is defined as its deemed intangible income (DII) multiplied by the corporation’s foreign-derived ratio. This is the ratio of the corporation’s foreign-derived deduction eligible income (FDDEI) to its deduction eligible income (DEI).

The final regulations retain the rule that the domestic corporation must allocate expenses to its gross FDDEI to determine the numerator of the foreign-derived ratio.

Deduction for Individuals
The final regulations extend the Code Sec. 250 deduction with respect to GILTI, to individuals—including individual partners and individual S corporation shareholders—making the Code Sec. 962 election to be treated as a domestic corporation.

Additional Changes
Additional changes in the final regulations generally expand situations in which a transaction will be an FDDEI transaction, including:

a property service may be a FDDEI service if it is provided with respect to property temporarily located in the United States;
the definition of transportation services is revised to include freight forwarding services;
the sale of a manufacturing method or process intangible to a foreign unrelated party is for foreign use based on the location of the manufacture rather that the end user;
elimination of the rule that allowed the deduction for sales of international property only if certain time and use thresholds were met and the replacement of foreign use based on place of registration;
clarification that general property includes physical commodities sold pursuant to derivative contracts, and that hedging sales impact a taxpayer’s income; and
removal of the rule that the sale of an interest in a foreign branch is treated as giving rise to foreign branch income preventing the deduction.

Taxpayers can also use any reasonable method to determine the ordering of rules that limit deductions based on taxable income until additional rules are issued.

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The IRS is calling on any taxpayers involved in syndicated conservation easement transactions who receives a settlement offer from the agency to accept it soon. The Service made this request in the wake of the Tax Court’s recent strike down of four additional abusive syndicated conservation easement transactions.

Settlement Offers
Time-limited settlement offers, which the IRS announced on June 25 ( IR-2020-130), are only being made to certain taxpayers with pending docketed Tax Court cases involving this type of abusive transaction. The IRS declared that these and other recent Tax Court decisions support the abusive nature of the underlying syndicated conservation easement deduction.

The four recent Tax Court decisions in question disallowed conservation easement deductions totaling nearly $21 million ( Village at Effingham, LLC, TC Memo. 2020-102, Dec. 61,715(M); Riverside Place, LLC, TC Memo. 2020-103, Dec. 61,716(M); Maple Landing, LLC, TC Memo. 2020-104, Dec. 61,717(M); Englewood Place, LLC, TC Memo. 2020-105, Dec. 61,718(M)).

Abusive Transactions
While recognizing the important role of legitimate conservation easement deductions in incentivizing land preservation for future generations, the IRS pointed out that abusive syndicated conservation easement transactions have been of concern for several years.

In listed syndicated conservation easement structures, promoters syndicate ownership interests in real property through partnerships, using promotional materials to suggest that prospective investors may be entitled to a share of a conservation easement contribution deduction that equals or exceeds two and one-half times the investment amount. The promoters obtain an appraisal that greatly inflates the value of the conservation easement, based on a fictional and unrealistic highest and best use of the property before it was encumbered with the easement. After the investors invest in the partnership, the partnership donates a conservation easement to a land trust. Investors in the partnership then claim a deduction based on an inflated value. According to the IRS, the investors typically claim charitable contribution deductions that grossly multiply their actual investment in the transaction and defy common sense.

The IRS is aware that some promoters of these abusive transactions have downplayed the significance of the string of recent court decisions holding in the government’s favor, arguing that their cases are somehow different or that those decisions might be reversed on appeal. These promoters ignore common sense and argue that the real dispute is about value, neglecting to explain how the reporting of short-term appreciation, often exceeding many multiples of reality, could possibly withstand judicial scrutiny. "Taxpayers should ignore this nonsense, take an objective look at their cases, and cut their losses," said IRS Chief Counsel Mike Desmond; "abusive transactions, like settlement offers, do not get better with time, and this is a good opportunity to get out," he added.

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The IRS remains focused on an issue that doesn’t seem to be going away: the misclassification of workers as independent contractors rather than employees. Recently, the IRS issued still another fact sheet “reminding” employers about the importance of correctly classifying workers for purposes of federal employment taxes (FS-2017-9). Generally, employers must withhold income taxes, withhold and pay social security and Medicare taxes, and pay unemployment tax on wages paid to employees. They are lifted of these obligations entirely for independent contractors, with usually the only IRS-related responsibility being information reporting on amounts of $600 or more paid to a contractor.

Weighing the factors

Whether a worker is an employee or an independent contractor depends on a number of considerations that fall into three categories: behavioral control, financial control and the type of relationship between the worker and the service recipient. Within these categories, the IRS has identified 20 factors that can be used to determine whether an individual is an independent contractor or effectively an "employee."

The determination of independent contractor versus employee status is based on all of the facts and circumstances surrounding the relationship. None of the identified factors is determinative. In addition, not all factors are present in all employee or independent contractor relationships. Frequently, the relationship of a worker is clear cut using these factors; but sometimes a worker can fall into a gray area.

The Form SS-8 route

An employer who is unsure of how to classify its workers can file a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. There is no fee for requesting a worker classification determination. Because worker classification has become such a “hot” audit trigger, many employers opt for the Form SS-8 route, particularly because penalties on top of back employment taxes can result from a classification misstep.

Other relief

After emphasizing in its latest Fact Sheet that employee misclassification as independent contractors exposes the employer to employment tax liability, the IRS also highlighted two ways to escape or ameliorate liability, even for an after-the-fact classification: “Section 530 relief” and relief under the Voluntary Classification Settlement Program.

Section 530 relief: An employer that has a reasonable basis for classifying its workers as independent contractors may be entitled to special relief under section 530 of the Revenue Act of 1978. "Section 530 relief" protects taxpayers who have consistently treated workers as independent contractors and have a reasonable basis for doing so. The rule covers workers who are common law employees, but it does not cover certain third-party-arranged technical service workers.

A reasonable basis for classification for purposes of Section 530 relief generally includes an employer's treatment of the individual based on any of the following:

judicial precedent, published rulings, technical advice to the employer or a letter ruling to the employer;
a past examination of the taxpayer by the IRS in which there was no assessment attributable to the treatment for employment tax purposes of individuals holding positions substantially similar to the position held by this individual; or
long-standing recognized practice of a significant segment of the industry in which the individual was engaged.

Voluntary Classification Settlement Program. Entry into the Voluntary Classification Settlement Program (VSCP) can provide an opportunity to reclassify workers as employees for future tax periods, with partial relief from federal employment taxes. Under the program, the employer:

Agrees to prospectively treat the class of workers as employees for future tax periods;
Will pay 10 percent of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under reduced rates;
Will not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified under the VCSP for prior years; and
Will not be liable for any interest or penalties on the liability.

Under the VCSP, an employer may reclassify some or all of their workers. Once reclassified, all workers in the same class must be treated as employees for employment tax purposes.

Worker initiative

The IRS also makes it clear in its latest Fact Sheet on employee misclassification that action on its part may take place not only based on an employer-based initiative; workers can also have indirect input on whether an audit will take place. “Workers who believe an employer improperly classified them as independent contractors may use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee’s share of uncollected social security and Medicare taxes,” the IRS Fact Sheet concludes.

If you have any concerns surrounding possible worker misclassification within your business, please feel free to contact this office for a more targeted discussion.

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A recent Tax Court decision and pending tax reform proposals have intersected in highlighting how stock sales can be timed for maximum tax advantage. The taxpayer in the recent case (Turan, TC Memo. 2017-141) failed to convince the Tax Court that he timely made an election with his broker to use the last-in-first-out (LIFO) method to set his cost-per-share cost basis for determining capital gains and losses on his stock trades on shares of the same company. As a result, he was required to calculate the capital gain or loss on his stock trades using the firm’s first-in-first-out (FIFO) “default” method, which, in his case, yielded a significant increase in tax liability for the year.

Timing stock trades to maximize the tax advantage of long- and short-term capital gains and losses has always made sense, particularly as a year-end planning technique. This year, tax reform may make such strategies considerably more lucrative. If tax rates are suddenly set lower, either retroactively for this year or, more probably, starting January 1, 2018, managing stock basis becomes more significant. As a result, investors should consider carefully whether they may be better off tax-wise to give their brokers specific instructions in certain cases not to use the default FIFO method when selling certain holdings of the same company purchased at different times.

General FIFO rule

If a taxpayer purchases identical shares of stock at different prices or on different dates and then sells only part of the stock, the basis and holding period of the shares sold are determined on a FIFO basis unless the specific shares sold are adequately identified. The date of acquisition for purposes of the FIFO rule is determined by reference to the holding period of the securities for capital gain or loss purposes, including any prior holding period that has been tacked on.

Comment. Securities in a margin or other account with a broker are considered sold in the order in which they were purchased, not the order in which they were placed in the account. The FIFO rule is applied by allocating the earliest lots acquired to the securities sold rather than to the securities removed from the brokerage account but still owned.

Alternate identification

When the securities to be sold are specifically identifiable, FIFO does not apply for purposes of allocating basis. The identity of securities sold or otherwise transferred generally is determined by the certificates actually delivered to the transferee.

Planning Tip: Thus, taxpayers who have records showing the cost and holding period of securities represented by separate certificates can control the amount of gain or loss realized by selecting the certificates to be transferred.

A standing order or instruction to a broker is treated as adequate identification. The instructions need not be in writing. Sufficient instruction to a broker or other agent of the particular securities to be sold or transferred does not require designation by certificate number; any designation that specifically identifies the securities to be transferred is adequate. Orders to sell the highest priced shares, shares with the highest cost basis, or the shares purchased at a certain price or on a specific date have been ruled acceptable.

Broker reporting

A broker is required to report the customer’s basis in securities sold, classifying the gain as short or long term. Identification of the securities is made at the time of sale, transfer, delivery, or distribution. Clarifying instructions before the sale takes place, or immediately thereafter, is important since a broker is obligated to report to the IRS on Form 1099-B. Once the report is sent to the IRS, changing basis is more likely to raise a red flag with the IRS.

Please contact this office if you need to discuss a strategy of tax selling that is more specific to your portfolio and Congress’s plans for tax reform.

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The much-anticipated regulations (REG-136118-15) implementing the new centralized partnership audit regime under the Bipartisan Budget Act of 2015 (BBA) have finally been released. The BBA regime replaces the current TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) procedures beginning for 2018 tax year audits, with an earlier "opt-in" for electing partnerships. Originally issued on January 19, 2017 but delayed by a January 20, 2017 White House regulatory freeze, these re-proposed regulations carry with them much of the same criticism leveled against them back in January, as well as several modifications. Most importantly, their reach will impact virtually all partnerships.

Scope

Under the proposed regulations, to which Congress left many details to be filled in, the new audit regime covers any adjustment to items of income, gain, loss, deduction, or credit of a partnership and any partner’s distributive share of those adjusted items. Further, any income tax resulting from an adjustment to items under the centralized partnership audit regime is assessed and collected at the partnership level. The applicability of any penalty, addition to tax, or additional amount that relates to an adjustment to any such item or share is also determined at the partnership level.

Immediate Impact

Although perhaps streamlined and eventually destined to simplify partnership audits for the IRS, the new centralized audit regime may prove more complicated in several respects for many partnerships. Of immediate concern for most partnerships, whether benefiting or not, is how to reflect this new centralized audit regime within partnership agreements, especially when some of the procedural issues within the new regime are yet to be ironed out.

Issues for many partnerships that have either been generated or heightened by the new regulations include:

Selecting a method of satisfying an imputed underpayment;
Designation of a partnership representative;
Allocating economic responsibility for an imputed underpayment among partners including situations in which partners’ interests change between a reviewed year and the adjustment year; and
Indemnifications between partnerships and partnership representatives, as well as among current partners and those who were partners during the tax year under audit.

Election out

Starting for tax year 2018, virtually all partnerships will be subject to the new partnership audit regime …unless an “election out” option is affirmatively elected. Only an eligible partnership may elect out of the centralized partnership audit regime. A partnership is an eligible partnership if it has 100 or fewer partners during the year and, if at all times during the tax year, all partners are eligible partners. A special rule applies to partnerships that have S corporation partners.

Consistent returns

A partner’s treatment of each item of income, gain, loss, deduction, or credit attributable to a partnership must be consistent with the treatment of those items on the partnership return, including treatment with respect to the amount, timing, and characterization of those items. Under the new rules, the IRS may assess and collect any underpayment of tax that results from adjusting a partner’s inconsistently reported item to conform that item with the treatment on the partnership return as if the resulting underpayment of tax were on account of a mathematical or clerical error appearing on the partner’s return. A partner may not request an abatement of that assessment.

Partnership representative

The new regulations require a partnership to designate a partnership representative, as well as provide rules describing the eligibility requirements for a partnership representative, the designation of the partnership representative, and the representative’s authority. Actions by the partnership representative bind all the partners as far as the IRS is concerned. Indemnification agreements among partners may ameliorate some, but not all, of the liability triggered by this rule.

Imputed underpayment, alternatives and "push-outs"

Generally, if a partnership adjustment results in an imputed underpayment, the partnership must pay the imputed underpayment in the adjustment year. The partnership may request modification with respect to an imputed underpayment only under the procedures described in the new rules.

In multi-tiered partnership arrangements, the new rules provide that a partnership may elect to "push out" adjustments to its reviewed year partners. If a partnership makes a valid election, the partnership is no longer liable for the imputed underpayment. Rather, the reviewed year partners of the partnership are liable for tax, penalties, additions to tax, and additional amounts plus interest, after taking into account their share of the partnership adjustments determined in the final partnership adjustment (FPA). The new regulations provide rules for making the election, the requirements for partners to file statements with the IRS and furnish statements to reviewed year partners, and the computation of tax resulting from taking adjustments into account.

Retiring, disappearing partners

Partnership agreements that reflect the new partnership audit regime must especially consider the problems that may be created by partners that have withdrawn, and partnerships that have since dissolved, between the tax year being audited and the year in which a deficiency involving that tax year is to be resolved. Collection of prior-year taxes due from a former partner, especially as time lapses, becomes more difficult as a practical matter unless specific remedies are set forth in the partnership agreement. The partnership agreement might specify that if any partner withdraws and disposes of their interest, they must keep the partnership advised of their contact information until released by the partnership in writing.

If you have any questions about how your partnership may be impacted by these new rules, please feel free to call our office.

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The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, requires certain U.S. taxpayers to report their interests in specified foreign financial assets. The reporting requirement may apply if the assets have an aggregate value exceeding certain thresholds. The IRS has released Form 8938, Statement of Specified Foreign Financial Assets, for this reporting requirement under FATCA.

Reporting

For now, only specified individuals are required to file Form 8938, but specified U.S. entities will eventually also have to file the form. Taxpayers who do not file a federal income tax return for the year do not have to File Form 8938, even if the value of their foreign assets exceeds the normal reporting threshold.

Individuals who have to file Form 8938 include U.S. citizens, resident aliens for any part of the year, and nonresident aliens living in Puerto Rico or American Samoa.

Reporting applies to specified foreign financial assets. Specified foreign financial assets include:

A financial account maintained by a foreign financial institution;
Other foreign financial assets, such as stock or securities issued by a non-U.S. person, or an interest in a foreign entity.

The aggregate value of the individual’s specified foreign financial assets must exceed specified reporting thresholds, as follows:

Unmarried U.S. taxpayers, and married U.S. taxpayers filing a separate return – more than $50,000 on the last day of the year, or more than $75,000 at any time during the year;
U.S. married taxpayers filing a joint return – more than $100,000 on the last day of the year, or more than $150,000 at any time during the year; or
Taxpayers living abroad: if filing a joint return, more than $400,000 on the last day of the year, or more than $600,000 during the year; other taxpayers, more than $200,000 on the last day of the year, or more than $300,000 at any time during the year.

Taxpayers who report assets on other forms, such as Form 3520, do not have to report the asset on Form 8938, but must use Form 8938 to identify other forms on which they report.

Filing

Reporting applies for tax years beginning after March 18, 2010, the date that FATCA was enacted. Most taxpayers, such as those who report their taxes for the calendar year, must start filing Form 8938 with their 2011 income tax return.

If you have any questions about Form 8938, please contact our office.

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When an individual dies, certain family members may be eligible for Social Security benefits. In certain cases, the recipient of Social Security survivor benefits may incur a tax liability.

Family members

Family members who can collect benefits include children if they are unmarried and are younger than 18 years old; or between 18 and 19 years old, but in an elementary or secondary school as full-time students; or age 18 or older and severely disabled (the disability must have started before age 22). If the individual has enough credits, Social Security pays a one-time death benefit of $255 to the decedent’s spouse or minor children if they meet certain requirements.

Benefit amount

The benefit amount is based on the earnings of the decedent. The more the decedent paid into Social Security, the larger the benefit amount. Social Security uses the decedent’s basic benefit amount and calculates what percentage survivors may receive. That percentage depends on the age of the survivors and their relationship to the decedent. Children, for example, receive 75 percent of the decedent’s benefit amount.

Taxation

The person who has the legal right to receive Social Security benefits must determine whether the benefits are taxable. For example, if a taxpayer receives checks that include benefits paid to the taxpayer and the taxpayer's child, the child's benefits are not considered in determining whether the taxpayer's benefits are taxable. Instead, one half of the portion of the benefits that belongs to the child must be added to the child's other income to see whether any of those benefits are taxable to the child.

Social security benefits are included in gross income only if the recipient's "provisional income" exceeds a specified amount, called the "base amount" or "adjusted base amount." There are two tiers of benefit inclusion. A 50-percent rate is used to figure the taxable part of income that exceeds the base amount but does not exceed the higher adjusted base amount. An 85-percent rate is used to figure the taxable part of income that exceeds the adjusted base amount.

Up to 50 percent of Social Security benefits could be included in taxable income if a recipient's provisional income is more than the following base amounts:

--$25,000 for single individuals, qualifying surviving spouses, heads of household, and married individuals who live apart from their spouse for the entire tax year and file a separate return; and

--$32,000 for married individuals filing a joint return;

--zero for married individuals who do not file a joint return and do not live apart from their spouse during the entire tax year

Up to 85 percent of benefits could be included in taxable income if a recipient's provisional income is more than the following adjusted base amounts:

--$34,000 for single individuals, qualifying surviving spouses, heads of household, and married individuals who live apart from their spouse for the entire tax year and file a separate return; and

--$44,000 for married individuals filing a joint return;

--zero for married individuals who do not file a joint return and do not live apart from their spouse during the entire tax year.

If the taxpayer's provisional income does not exceed the base amount, no part of Social Security benefits will be taxed. For taxpayers whose income exceeds the base amount, but not the higher adjusted base amount, the amount of benefits that must be included in income is the lesser of:

--One-half of the annual benefits received; or

--One-half of the amount that remains after subtracting the appropriate base amount from the taxpayer's provisional income.

Taxpayers whose provisional income exceeds the adjusted base amount must include in income the lesser of:

--85 percent of the annual benefits received; or

--85 percent of the excess of the taxpayer's provisional income over the applicable adjusted base amount plus the smaller of: (a) the amount calculated under the 50-percent rules above, or (b) one-half of the difference between the taxpayer's applicable adjusted base amount and the applicable base amount. One-half of the difference between the base amount and the adjusted base amount is $6,000 for married taxpayers filing jointly and $4,500 for other taxpayers. For taxpayers who are married, not living apart from their spouse, and filing separately, the amount will always be zero.

If you have any questions about the taxation of Social Security benefits, please contact our office.

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A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

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The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

-- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

-- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

-- The child receives more than one-half of his or her support from you; and

-- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

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The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the investment income of higher-income individuals. Although the tax does not take effect until 2013, it is not too soon to examine methods to lessen the impact of the tax.

Net investment income

"Net investment income" includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual's capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

The tax applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

However, the tax will not apply to nontaxable income, such as tax-exempt interest or veterans' benefits.

Deductions

Net investment income is gross income or net gain, reduced by deductions that are "properly allocable" to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property's basis. It also focuses on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers' fees, may increase basis or reduce the amount realized from an investment. As such, taxpayers may want to consider avoiding installment sales with net capital gains (and interest) running past 2012.

Thresholds

The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is your AGI increased by any foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

Example. Jim, a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760. In this case, the tax is not applied to the entire $40,000 of investment income.

Exceptions to the tax

Certain items and taxpayers are not subject to the 3.8 percent Medicare tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. There is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A. However, distributions from these plans (including amounts deemed as interest) are generally treated as compensation, not as investment income.

The exception for distributions from retirement plans suggests that potentially taxable investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Another exception is provided for income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Investment income from an active trade or business is also excluded. However, SECA (Self-Employment Contributions Act) tax will still apply to proprietors and partners. Income from trading in financial instruments and commodities is also subject to the tax.

The additional 3.8 percent Medicare tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity's property would be from an active trade or business. The tax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable under Code Sec. 664.

Income tax rates

In addition to the tax on investment income, certain other tax increases proposed by the Obama administration may take effect in 2011. The top two marginal income tax rates on individuals would rise from 33 and 35 percent to 36 and 39.6 percent, respectively. The maximum tax rate on long-term capital gains would increase from 15 percent to 20 percent. Moreover, dividends, which are currently capped at the 15 percent long-term capital gain rate, would be taxed as ordinary income. Thus, the cumulative rate on capital gains would increase to 23.8 percent in 2013, and the rate on dividends would jump to as much as 43.4 percent. Moreover, the thresholds are not indexed for inflation, so more taxpayers may be affected as time elapses.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

Regardless of the type of record keeper you consider yourself to be, there are numerous ways to simplify the burden of logging your automobile expenses for tax purposes. This article explains the types of expenses you need to track and the methods you can use to properly and accurately track your car expenses, thereby maximizing your deduction and saving taxes.

Expense methods

The two general methods allowed by the IRS to calculate expenses associated with the business use of a car include the standard mileage rate method or the actual expense method. The standard mileage rate for 2017 is 53.5 cents per mile. In addition, you can deduct parking expenses and tolls paid for business. Personal property taxes are also deductible, either as a personal or a business expense. While you are not required to substantiate expense amounts under the standard mileage rate method, you must still substantiate the amount, time, place and business purpose of the travel.

The actual expense method requires the tracking of all your vehicle-related expenses. Actual car expenses that may be deducted under this method include: oil, gas, depreciation, principal lease payments (but not interest), tolls, parking fees, garage rent, registration fees, licenses, insurance, maintenance and repairs, supplies and equipment, and tires. These are the operating costs that the IRS permits you to write-off. For newly-purchased vehicles in years in which bonus depreciation is available, opting for the actual expense method may make particularly good sense since the standard mileage rate only builds in a modest amount of depreciation each year. For example, for 2017, when 50 percent bonus depreciation is allowed, maximum first year depreciation is capped at $11,160 (as compared to $3,160 for vehicles that do not qualify). In general, the actual expense method usually results in a greater deduction amount than the standard mileage rate. However, this must be balanced against the increased substantiation burden associated with tracking actual expenses. If you qualify for both methods, estimate your deductions under each to determine which method provides you with a larger deduction.

Substantiation requirements

Taxpayers who deduct automobile expenses associated with the business use of their car should keep an account book, diary, statement of expenses, or similar record. This is not only recommended by the IRS, but essential to accurate expense tracking. Moreover, if you use your car for both business and personal errands, allocations must be made between the personal and business use of the automobile. In general, adequate substantiation for deduction purposes requires that you record the following:

The amount of the expense;
The amount of use (i.e. the number of miles driven for business purposes);
The date of the expenditure or use; and
The business purpose of the expenditure or use.

Suggested recordkeeping: Actual expense method

An expense log is a necessity for taxpayers who choose to use the actual expense method for deducting their car expenses. First and foremost, always keep your receipts, copies of cancelled checks and bills paid. Maintaining receipts, bills paid and copies of cancelled checks is imperative (even receipts from toll booths). These receipts and documents show the date and amount of the purchase and can support your expenditures if the IRS comes knocking. Moreover, if you fail to log these expenses on the day you incurred them, you can look back at the receipt for all the essentials (i.e. time, date, and amount of the expense).

Types of Logs. Where you decide to record your expenses depends in large part on your personal preferences. While an expense log is a necessity, there are a variety of options available to track your car expenditures - from a simple notebook, expense log or diary for those less technologically inclined (and which can be easily stored in your glove compartment) - to the use of a smartphone or computer. Apps specifically designed to help track your car expenses can be easily downloaded onto your iPhone or Android device.

Timeliness. Although maintaining a daily log of your expenses is ideal - since it cuts down on the time you may later have to spend sorting through your receipts and organizing your expenses - this may not always be the case for many taxpayers. According to the IRS, however, you do not need to record your expenses on the very day they are incurred. If you maintain a log on a weekly basis and it accounts for your use of the automobile and expenses during the week, the log is considered a timely-kept record. Moreover, the IRS also allows taxpayers to maintain records of expenses for only a portion of the tax year, and then use those records to substantiate expenses for the entire year if he or she can show that the records are representative of the entire year. This is referred to as the sampling method of substantiation. For example, if you keep a record of your expenses over a 90-day period, this is considered an adequate representation of the entire year.

Suggested Recordkeeping: Standard mileage rate method

If you loathe recordkeeping and cannot see yourself adequately maintaining records and tracking your expenses (even on a weekly basis), strongly consider using the standard mileage rate method. However, taking the standard mileage rate does not mean that you are given a pass by the IRS to maintaining any sort of records. To claim the standard mileage rate, appropriate records would include a daily log showing miles traveled, destination and business purpose. If you incur mileage on one day that includes both personal and business, allocate the miles between the two uses. A mileage record log, whether recorded in a notebook, log or handheld device, is a necessity if you choose to use the standard mileage rate.

If you have any questions about how to properly track your automobile expenses for tax purposes, please call our office. We would be happy to explain your responsibilities and the tax consequences and benefits of adequately logging your car expenses.

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In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

The salary history of the individual employee
Compensation paid by comparable employers to comparable employees
The salary history of other employees of the company
Special employee expertise or efforts
Year-end payments
Independent inactive investor analysis
Deferred compensation plan contributions
Independence of the board of directors
Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

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If someone told you that you could exchange an apartment house for a store building without recognizing a taxable gain or loss, you might not believe him or her. You might already know about a very valuable business planning and tax tool: a like-kind exchange. In some cases, if you trade business property for other business property of the same asset class, you do not need to recognize a taxable gain or loss.

Not a sale

An exchange is a transfer that is not a sale. Essentially, it is a trade of like property.

In an exchange, property is relinquished and property is received. If the transaction includes money or property that is not of a like kind (referred to as "boot"), the transaction does not automatically become a sale. Any gain realized in the transaction, however, is recognized in that tax year to the extent of boot received.

In a like-kind exchange, the basis in the property received is the same as the basis in the property relinquished, with some adjustments. Any unrecognized gain or loss on the relinquished property is carried over to the replacement property. At a future time, the gain or loss will be recognized. If there is boot in the exchange and the gain is recognized, basis is increased by the amount of recognized gain.

The like-kind rules also require that property must be business or investment property. The taxpayer must hold both the property traded and the property received for productive use in its trade or business or for investment. Additionally, most stocks, bonds and other securities are not eligible.

Example

Jesse owns an office supply company and wants to expand his business. Carmen owns a restaurant and also wants to expand her business. Both individuals own parcels of land for investment that would benefit their respective expansion plans. The adjusted basis of both properties is $250,000. The fair market value of both properties is $400,000. Jesse and Carmen engage in a like-kind exchange. Neither Jesse nor Carmen would report any gain or loss.

More than two properties

Like-kind exchanges can involve more than two properties. While the rules are complicated, the basic approach is to combine properties into groups consisting of the same kind or class. If you are interested in a like-kind exchange involving more than two properties, we can help you.

Timing

The exchange does not have to take place at a given moment. If property is relinquished, the replacement property can be identified and received anytime within a specific period. Replacement property must be identified within 45 days after property is relinquished. The replacement property has to be received within 180 days after the transfer but sooner if the tax return is due before the 180 days are over (although the due date takes into account any extension that is permitted).

Reporting

A like-kind exchange must be reported to the IRS. The report must be made even if no gain is recognized in the transaction. Again, our office can help you make sure that everything that needs to be reported to the IRS is reported.

This is just a brief overview of like-kind exchanges. The rules are complicated and could trip you up without help from a tax professional. If you think a like-kind exchange is in your future, give our office a call. We'll sit down, review your plans and make sure your like-kind exchange meets all the complex IRS requirements.

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For U.S. taxpayers, owning assets held in foreign countries may have a variety of benefits, from ease of use for frequent travelers or those employed abroad to diversification of an investment portfolio. There are, however, additional rules and requirements to follow in connection with the payment of taxes. Some of these rules are very different from those for similar types of domestic income, and more than a few are quite complex.

Two documents do not apply directly to federal income taxation, but are nevertheless highly important. The first of these is a Treasury form, Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts. Any individual or organization that owns or has control over a bank or brokerage account must complete this form if the aggregate value of all such accounts under that taxpayer's ownership or control exceeds $10,000. The second such form is not a requirement per se, but taxpayers who have income in a foreign country with which the United States has a treaty would be seriously remiss in failing to complete it. IRS Form 8802, Application for United States Residency Certification, helps to speed and simplify the application process for eligible taxpayers claiming the benefits of tax treaties in connection with foreign taxes paid. Requirements for organizations that may have dual or layered status offer complications that depend on the type of entity, so these instructions must be parsed carefully.

Taxes on real and personal property held overseas are treated quite differently for purposes of federal income taxation, as opposed to the treatment of domestic property. Individuals may claim foreign real property taxes as itemized deductions on Schedule A of Form 1040, just as they would with U.S. real estate. However, taxes on personal property may only be deductible if used in connection with a trade or business or in the production of income.

U.S. taxpayers who own homes in foreign countries are eligible for the capital gains exclusion on the sale of a principal residence subject to the same requirements as domestic homeowners. Likewise, if a taxpayer derives rental income from a home, the rules for reporting income and deductions are the same. However, claiming depreciation expenses in connection with rental income subjects taxpayers to a different set of rules. Code Sec. 168(g) indicates that tangible property used predominantly outside the United States must be depreciated using the alternative depreciation system (ADS), rather than the modified accelerated cost recovery system (MACRS), and involves longer recovery periods. This is true whether the tangible property in question is the residence itself or household appliances contained therein, as well as any other tangible property.

Intangible property such as patents, licenses, trademarks, copyrights and securities produce a variety of types of income, and the taxation of such income may be subject to different rules than similar domestic income. The provisions for taxation of foreign income are often subject to modification by treaty, and the United States has negotiated treaties with over sixty nations.

Income from all sources must be reported in U.S. dollars, regardless of how it is paid. One exception to this rule is that if income is received in a currency that is not convertible to U.S. dollars because of prohibitions placed on conversion by the issuing country, then the taxpayer may choose when to report the income. The income may be reported either in the year earned, according to the most accurate valuation means available, with the taxes paid from other income, or the taxpayer may choose to wait until the currency becomes convertible again.

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