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The IRS has announced penalty relief for the 2025 tax year relating to new information reporting obligations introduced under the One, Big, Beautiful Bill Act (OBBBA). The relief applies to penalties imposed under Code Secs. 6721 and 6722 for failing to file or furnish complete and correct information returns and payee statements.

The OBBBA introduced new deductions for qualified tips and qualified overtime compensation, applicable to tax years beginning after December 31, 2024. These provisions require employers and payors to separately report amounts designated as cash tips or overtime, and in some cases, the occupation of the recipient. However, recognizing that employers and payors may not yet have adequate systems, forms, or procedures to comply with the new rules, the IRS has designated 2025 as a transition period.

For 2025, the Service will not impose penalties if payors or employers fail to separately report these new data points, provided all other information on the return or payee statement is complete and accurate. This relief applies to information returns filed under Code Sec. 6041 and to Forms W-2 furnished to employees under Code Sec. 6051. The IRS emphasized that this transition relief is limited to the 2025 tax year only and that full compliance will be required beginning in 2026 when revised forms and updated electronic reporting systems are available.

Although not mandatory, the IRS encourages employers to voluntarily provide separate statements or digital records showing total tips, overtime pay, and occupation codes to help employees determine eligibility for new deductions under the OBBBA. Employers may use online portals, additional written statements, or Form W-2 box 14 for this purpose.

Notice 2025-62

IR-2025-110

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The 2026 cost-of-living adjustments (COLAs) that affect pension plan dollar limitations and other retirement-related provisions have been released by the IRS. In general, many of the pension plan limitations will change for 2026 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. However, other limitations will remain unchanged.

The SECURE 2.0 Act (P.L. 117-328) made some retirement-related amounts adjustable for inflation. These amounts, as adjusted for 2026, include:

The catch-up contribution amount for IRA owners who are 50 or older is increased from $1,000 to $1,100.
The amount of qualified charitable distributions from IRAs that are not includible in gross income is increased from $108,000 to $111,000.
The limit on one-time qualified charitable distributions made directly to a split-interest entity is increased from $54,000 to $55,000.
The dollar limit on premiums paid for a qualifying longevity annuity contract (QLAC) remains $210,000.

Highlights of Changes for 2026

The contribution limit has increased from $23,500 to $24,500 for employees who take part in:

401 (k)
403 (b)
most 457 plans, and
the federal government’s Thrift Savings Plan

The annual limit on contributions to an IRA increased from $7,000 to $7,500.

The catch-up contribution limit for individuals aged 50 and over for employer retirement plans (such as 401(k), 403(b), and most 457 plans) has increased from $7,500 to $8,000.

The income ranges increased for determining eligibility to make deductible contributions to:

IRAs,
Roth IRAs, and
to claim the Saver’s Credit.

Phase-Out Ranges

Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. The deduction phases out if the taxpayer or their spouse takes part in a retirement plan at work. The phase-out depends on the taxpayer’s filing status and income.

For single taxpayers covered by a workplace retirement plan, the phase-out range is $81,000 to $91,000, up from $79,000 to $89,000.
For joint filers, when the spouse making the contribution takes part in a workplace retirement plan, the phase-out range is $129,000 to $149,000, up from $126,000 to $146,000.
For an IRA contributor who is not covered by a workplace retirement plan but their spouse is, the phase-out range is $242,000 to $252,000, up from $236,000 to $246,000.
For a married individual filing separately who is covered by a workplace plan, the phase-out range remains $0 to $10,000.

The phase-out ranges for Roth IRA contributions are:

$153,000 to $168,000 for singles and heads of household,
$242,000 to $252,000 for joint filers,
$0 to $10,000 for married separate filers.

Finally, the income limits for the Saver’s Credit are:

$80,500 for joint filers,
$60,375 for heads of household,
$40,250 for singles and married separate filers.

Notice 2025-67

IR-2025-111

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The IRS released interim guidance and announced its intent to publish proposed regulations regarding the exclusion of interest on loans secured by rural or agricultural real property under Code Sec. 139L. Taxpayers may rely on the interim guidance in section 3 of the notice for loans made after July 4, 2025, and on or before the date that is 30 days after the publication of the forthcoming proposed regulations.

Partial Exclusion of Interest

Code Sec 139L, as added by the One Big Beautiful Bill Act (P.L. 119-21), provides for a partial exclusion of interest for certain loans secured by rural or agricultural real property. The amount excluded is 25 percent of the interest received by a qualified lender on a qualified real estate loan. A qualified lender will include 75 percent of the interest received on a qualified real estate loan in gross income. A qualified lender is not required to be the original holder of the loan on the issue date of the loan in order to exclude the interest under Code Sec 139L.

Qualified Real Estate Loan

A qualified real estate loan is secured by qualified rural or agricultural property only if, at the time that the interest accrues, the qualified lender holds a valid and enforceable security interest with respect to the property under applicable law. Subject to a safe harbor provision, the amount of a loan that is a qualified real estate loan is limited to the fair market value of the qualified rural or agricultural property securing the loan, as of the issue date of the loan. If the amount of the loan is greater than the fair market value of the property securing the loan, determined as of the issue date of the loan, only the portion of the loan that does not exceed the fair market value is a qualified real estate loan.

The safe harbor allows a qualified lender to treat a loan as fully secured by qualified rural or agricultural property if the qualified lender holds a valid and enforceable security interest with respect to the qualified rural or agricultural property under applicable law and the fair market value of the property security the loan is at least 80 percent of the issue price of the loan on the issue date.

Fair market value can be determined using any commercially reasonable valuation method. Subject to certain limitations, the fair market value of any personal property used in the course of the activities conducted on the qualified rural or agricultural property (such as farm equipment or livestock) can be added to the fair market value of the rural or agricultural real estate. The addition to fair market value may be made if a qualified lender holds a valid and enforceable security interest with respect to such personal property under applicable law and the relevant loan must be secured to a substantial extent by rural or agricultural real estate.

Use of the Property

The presence of a residence on qualified rural or agricultural property or intermittent periods of nonuse for reasons described in Code Sec. 139L(c)(3) does not prevent the property from being qualified rural or agricultural property so long as the the property satisfies the substantial use requirement.

Request for Comments

The Treasury Department and the IRS are seeking comments on the notice in general and on the following specific issues:

The extent to which the forthcoming proposed regulations address the meaning of certain terms;
The extent to which the forthcoming proposed regulations address whether property is substantially used for the production of one or more agricultural products or in the trade or business of fishing or seafood processing;
The extent to which the forthcoming proposed regulations address how the substantial use requirement applies to properties with mixed uses;
The manner in which the forthcoming proposed regulations address changes involving qualified rural or agricultural property following the issuance of a qualified real estate loan;
The manner in which the forthcoming proposed regulations address how a qualified lender determines whether the loan remains secured by qualified rural or agricultural property;
The extent to which the forthcoming proposed regulations address how Code Sec. 139L applies in securitization structures; and
The extent to which the forthcoming proposed regulations address Code Sec. 139L(d), regarding the application of Code Sec. 265 to any qualified real estate loan.

Written comments should be submitted, either electronically or by mail, by January 20, 2026.

Notice 2025-71

IR-2025-113

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The IRShas provided a safe harbor for trusts that otherwise qualify as investment trusts under Reg. §301.7701-4(c) and as grantor trusts to stake their digital assets without jeopardizing their tax status as investment trusts and grantor trusts. The Service also provided a limited time period for an existing trust to amend its governing instrument (trust agreement) to adopt the requirements of the safe harbor.

Background

Under “custodial staking,” a third party (custodian) takes custody of an owner’s digital assets and facilitates the staking of such digital assets on behalf of the owner. The arrangement between the custodian and the staking provider generally provides that an agreed-on portion of the staking rewards are allocated to the owner of the digital assets.

Business or commercial trusts are created by beneficiaries simply as a device to carry on a profit-making business that normally would have been carried on through a business organization classified as a corporation or partnership. An investment trust with a single class of ownership interests, representing undivided beneficial interests in the assets of the trust, is classified as a trust if there is no power under the trust agreement to vary the investments of the certificate holders.

Trust Arrangement

The revenue procedure applies to an arrangement formed as a trust that (i) would be treated as an investment trust, and as a grantor trust, if the trust agreement did not authorize staking and the trust’s digital assets were not staked, and (ii) with respect to a trust in existence before the date on which the trust agreement first authorizes staking and related activities in a manner that satisfies certain listed requirements, qualified as an investment trust, and as a grantor trust, immediately before that date. If the listed requirements (described below) are met, a trust's authorization in the trust agreement to stake its digital assets and the resulting staking of the trust's digital assets will, under the safe harbor, not prevent the trust from qualifying as an investment trust and as a grantor turst.

Requirements for Trust

The requirements for the safe harbor to apply are as follows:

Interests in the trust must be traded on a national securities exchange and must comply with the SEC’s regulations and rules on staking activities.
The trust must own only cash and units of a single type of digital asset under Code Sec. 6045(g)(3)(D).
Transactions for the cash and units of digital asset must be carried out on a permissionless network that uses a proof-of-stake consensus mechanism to validate transactions.
Trust’s digital assets must be held by a custodian acting on behalf of the trust at digital asset addresses controlled by the custodian.
Only the custodian can effect a sale, transfer, or exercise the rights of ownership over said digital assets, including while those assets are staked.
Staking of the trust's digital assets must protect and conserve trust property and mitigate the risk that another party could control a majority of the assets of that type and engage in transactions reducing the value of the trust’s digital assets.
The trust’s activities relating to digital assets must be limited to (1) accepting deposits of the digital assets or cash in exchange for newly issued interests in the trust; (2) holding the digital assets and cash; (3) paying trust expenses and selling digital assets to pay trust expenses or redeem trust interests; (4) purchasing additional digital assets with cash contributed to the trust; (5) distributing digital assets or cash in redemption of trust interests; (6) selling digital assets for cash in connection with the trust's liquidation; and (7) directing the staking of the digital assets in a way that is consistent with national securities exchange requirements.
The trust must direct the staking of its digital assets through custodians who facilitate the staking on the trust's behalf with one or more staking providers.
The trust or its custodian must have no legal right to participate in or direct the activities of the staking provider.
The trust's digital assets must generally be available to the staking provider to be staked.
The trust's liquidity risk policies must be based solely on factors relating to national securities exchange requirements regarding redemption requests.
The trust's digital assets must be indemnified from slashing due to the activities of staking providers.
The only new assets the trust can receive as a result of staking are additional units of the single type of digital asset the trust holds.

Amendment to Trust

A trust may amend its trust agreement to authorize staking at any time during the nine-month period beginning on November 10, 2025. Such an amendment will not prevent a trust from being treated as a trust that qualifies as an investment trust under Reg. §301.7701-4(c) or as a grantor trust if the aforementioned requirements were satisfied.

Effective Date

This guidance is effective for tax years ending on or after November 10, 2025.

Rev. Proc. 2025-31

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WASHINGTON – National Taxpayer Advocate Erin Collins told attendees at a recent conference that she wants to see the Taxpayer Advocate Service improve its communications with taxpayers and tax professionals.

“What I would like to do is improve our responsiveness and communication with fill-in-the-blank, whether it be taxpayer or practitioner, because I think that is huge,” Collins told attendees November 18, 2025, at the American Institute of CPA’s National Tax Conference.

“I think a lot of my folks are working really hard to fix things, but they’re not necessarily communicating as fast and often as they should,” she continued. “So, I would like to see by year-end we’re in a position that that is a routine and not the exception.”

In tandem with that, Collins also told attendees she would like to see the IRS be quicker in terms of how it fixes issues. She pointed to the example of first-time abatement, something she called an “an amazing administrative relief for taxpayers” but one that is only available to those who know to ask for it.

She estimated that there are about one million taxpayers every year that are eligible to receive it and among those, most are lower income taxpayers.

The IRS, Collins noted, agreed a couple of years ago that this was a problem. “The challenge they had was how do they implement it through their systems?”

Collins was happy to report that those who qualify for first-time abatement will automatically be notified starting with the coming tax filing season, although she did not have any insight as to how the process would be implemented.

Patience

Collins also asked for patience from the taxpayer community in the wake of the recently-ended government shutdown, which has increased the TAS workload as TAS employees were not deemed essential and were furloughed during the shutdown.

She noted that TAS historically receives about 5,000 new cases a week and the shutdown meant the rank-and-file at TAS were not working. She said that the service did work to get some cases closed that didn’t require employee help.

“So, any of you who are coming in or have cases, please be patient,” Collins said. “Our guys are doing the best they can, but they do have, unfortunately, a backlog now coming in.”

By Gregory Twachtman, Washington News Editor

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The IRS and Treasury have issued final regulations that implement the excise tax on stock repurchases by publicly traded corporations under Code Sec. 4501, introduced in the Inflation Reduction Act of 2022. Proposed regulations on the computation of the tax were previously issued on April 12, 2024 (NPRM REG-115710-22) and final regulations covering the procedural aspects of the tax were issued on July 3, 2024 (T.D. 10002). Following public comments and hearings, the proposed computation regulations were modified and are now issued as final, along with additional changes to the final procedural regulations. The rules apply to repurchases made after December 31, 2022.

Overview of Code Sec. 4501

Code Sec. 4501 imposes a one percent excise tax on the fair market value of any stock repurchased by a “covered corporation”—defined as any domestic corporation whose stock is traded on an established securities market. The statute also covers acquisitions by “specified affiliates,” including majority-owned subsidiaries and partnerships. A “repurchase” includes redemptions under Code Sec. 317(b) and any transaction the Secretary determines to be economically similar. The amount subject to tax is reduced under a netting rule for stock issued by the corporation during the same tax year.

Scope and Definitions

The final regulations clarify the definition of stock, covering both common and preferred stock, with several exclusions. They exclude:

Additional tier 1 capital not qualifying as common equity tier 1,
Preferred stock under Code Sec. 1504(a)(4),
Mandatorily redeemable stock or stock with enforceable put rights if issued prior to August 16, 2022,
Certain instruments issued by Farm Credit System entities and savings and loan holding companies.

The IRS rejected requests to exclude all preferred stock or foreign regulatory capital instruments, limiting exceptions to U.S.-regulated issuers only.

Exempt Transactions and Carveouts

Several categories of transactions are excluded from the excise tax base. These include:

Repurchases in connection with complete liquidations (under Code Secs. 331 and 332),
Acquisitive reorganizations and mergers where the corporation ceases to be a covered corporation,
Certain E and F reorganizations where no gain or loss is recognized and only qualifying property is exchanged,
Split-offs under Code Sec. 355 are included unless the exchange is treated as a dividend,
Reorganizations are excluded if shareholders receive only qualifying property under Code Sec. 354 or 355.

The IRS adopted a consideration-based test to determine whether the reorganization exception applies, disregarding whether shareholders actually recognized gain.

Application to Take-Private Transactions and M&A

The final rules clarify that leveraged buyouts, take-private deals, and restructurings that result in loss of public listing status are not considered repurchases for tax purposes. This reverses prior treatment under proposed rules, aligning with policy concerns that such deals are not akin to value-distribution schemes.

Similarly, cash-funded acquisitions and upstream mergers into parent companies are excluded where the repurchase is part of a broader ownership change plan.

Netting Rule and Timing Considerations

Under the netting rule, the amount subject to tax is reduced by the value of new stock issued during the tax year. This includes equity compensation to employees, even if unrelated to a repurchase program. The rule does not apply where a corporation is no longer a covered corporation at the time of issuance.

Stock is treated as repurchased on the trade date, and issuances are counted on the date the rights to stock are transferred. The IRS clarified that netting applies only to stock of the covered corporation and not to instruments issued by affiliates.

Foreign Corporations and Surrogates

The excise tax also applies to certain acquisitions by specified affiliates of:

Applicable foreign corporations, i.e., foreign entities with publicly traded stock,
Covered surrogate foreign corporations, as defined under Code Sec. 7874.

Where such affiliates acquire stock from third parties, the tax is applied as if the affiliate were a covered corporation, but limited only to shares issued by the affiliate to its own employees. These provisions prevent U.S.-parented multinational groups from circumventing the tax through offshore affiliates.

Exceptions Under Code Sec. 4501(e)

The six statutory exceptions remain intact:

Reorganizations with no gain/loss under Code Sec. 368(a);
Contributions to employer-sponsored retirement or ESOP plans;
De minimis repurchases under $1 million per tax year;
Dealer transactions in the ordinary course of business;
Repurchases by RICs and REITs;
Repurchases treated as dividends under the Code.

The IRS expanded the RIC/REIT exception to cover certain non-RIC mutual funds regulated under the Investment Company Act of 1940 if structured as open-end or interval funds.

Reporting and Administrative Requirements

Taxpayers must report repurchases on Form 720, Quarterly Federal Excise Tax Return. Recordkeeping, filing, and payment obligations are governed by Part 58, Subpart B of the regulations. The procedural rules also address:

Applicable filing deadlines;
Corrections for adjustments and refunds;
Return preparer obligations under Code Secs. 6694 and 6695.

These provisions codify prior guidance issued in Notice 2023-2 and reflect technical feedback from tax professionals and stakeholders.

Applicability Dates

The final rules apply to:

Stock repurchases occurring after December 31, 2022;
Stock issuances during tax years ending after December 31, 2022;
Procedural compliance starting with returns due after publication in the Federal Register.

Corporations may rely on Notice 2023-2 for transactions before April 12, 2024, and either the proposed or final regulations thereafter, provided consistency is maintained.

Takeaways

The final regulations narrow the excise tax’s reach to align with Congressional intent: discouraging opportunistic buybacks that return capital to shareholders outside traditional dividend mechanisms. By excluding structurally transformative M&A transactions, debt-like preferred stock, and regulated financial instruments, the IRS attempts to strike a balance between tax enforcement and market practice.

T.D. 10037

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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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