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.

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.

"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

"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.

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 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.

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.

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:

1. is subject to a federal, state or local quarantine or isolation order related to COVID-19;
2. has been advised by a health care provider to self-quarantine due to concerns related to COVID-19;
3. is experiencing symptoms of COVID-19 and seeking a medical diagnosis;
4. 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;
5. 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
6. 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.

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.

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.

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.

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.

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.

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 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.

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.

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.

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.

Under Code Sec. 469, passive losses can only be used to offset passive income. Taxpayers who have losses from a passive activity cannot use losses from a passive activity to offset nonpassive income, such as wages. A passive activity generally is an activity in which a taxpayer does not “materially participate.” Passive losses that cannot be deducted must be carried over to a future year, where they can offset newly generated passive income.

Under Code Sec. 469, passive losses can only be used to offset passive income. Taxpayers who have losses from a passive activity cannot use losses from a passive activity to offset nonpassive income, such as wages. A passive activity generally is an activity in which a taxpayer does not “materially participate.” Passive losses that cannot be deducted must be carried over to a future year, where they can offset newly generated passive income.

Taxpayers with excess passive losses may seek to generate additional passive income by converting nonpassive income into passive income. The regulations under Code Sec. 469 (Reg. §1.469-2(f)(6)) include a “self-rental rule” to prevent taxpayers from creating artificial passive activity income that they could use to offset their passive losses.

Ordinarily, rental income is treated as passive income. However, the self-rental rule provides that income from a taxpayer’s rental activity from an item of property, is treated as not being from a passive activity if the property is rented for use in a trade or business activity in which the taxpayer materially participates. Income that is recharacterized as nonpassive income cannot offset passive losses.

For example

An example of the self-rental rule was addressed in Williams, CA-5, 2016-1 USTC ¶50,173. In Williams, the taxpayer owned a C corporation and materially participated in the corporation’s trade or business. The taxpayer also owned an S corporation that rented real estate to the C corporation. The taxpayer did not materially participate in the rental activity. The rental activity generated income, which the taxpayer treated as passive income and used to offset passive losses from other entities.

The court concluded that the self-rental rule applied to the S corporation’s rental of the real property. The taxpayer, the owner of the S corporation, materially participated in the business of the C corporation that rented the property. As a result, the income generated by the rental activity had to be recharacterized as nonpassive income under the self-rental rule, and could not be used to offset the taxpayer’s passive losses from other activities.

Everyone in business must keep records. Among other things, good records will help a business prepare the business tax returns, and will support items reported on tax returns. Taxpayers also must keep their business records available for inspection by the IRS.

Everyone in business must keep records. Among other things, good records will help a business prepare the business tax returns, and will support items reported on tax returns. Taxpayers also must keep their business records available for inspection by the IRS.

In order to claim any deduction, a business owner, like any taxpayer, must prove two things: what expenses were for and that the expense was in fact paid or incurred. Supporting documents may include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. The documents should show the amount paid and the reason for the expense. Businesses must keep their records as long as needed to qualify under the Tax Code. Generally, this means until the period of limitations for auditing the return expires.

Special expenses

There are special recordkeeping requirements and strict documentation rules for certain expenses. These expenses include:

• expenses for travel away from home (including meals and lodging while traveling),
• meal and entertainment expenses,
• business gifts, and
• cars and other means of transportation.

For these expenses, taxpayers must keep receipts and must also substantiate each individual expense as to (1) the amount, (2) time and place, and (3) business purpose. For entertainment and gift expenses, taxpayers must also provide the business relationship of the person(s) being entertained or receiving a gift. For vehicle expenses, taxpayers must keep a mileage log.

Reimbursed Expenses

Businesses that give reimbursements and allowances to their employees for employment-related travel and entertainment expenses must generally treat these amounts as income to the employees. However, there is no income inclusion if: (1) the employee is required to account for the expenses to the employer; (2) the employee does not deduct the expenses; and (3) the total expenses equal the total reimbursements and allowances.

Accounting for expenses means giving the employer documentary evidence and an account book or statement to verify each expense’s amount, time, place and business purpose. An employee is treated as having accounted for expenses if the employer provided a fixed allowance, and the employee verifies the time, place, and business purpose of each expense. A fixed allowance includes the standard mileage rate for cars and the federal per diem rate for travel away from home.

Accountable Plan

A reimbursement arrangement is considered an accountable plan if it meets the following three requirements:

1. It provides advances, allowances or reimbursements for business expenses paid or incurred by an employee;
2. Each business expense must be substantiated to the employer within a reasonable period of time; and
3. The employee must return any excess reimbursement within a reasonable period of time.

If the arrangement is an accountable plan, the reimbursements are excluded from the employee's wages and exempt from employment taxes. Any excess reimbursement that is not returned within a reasonable period is treated as paid under a nonaccountable plan.

The IRS requires that taxpayers substantiate their donations to charity. Whatever the donation is, whether money or a household item or clothing, the substantiation rules must be followed. The rules are complex and frequently tripped up taxpayers who had good intentions but failed to satisfy the IRS's requirements.

The IRS requires that taxpayers substantiate their donations to charity. Whatever the donation is, whether money or a household item or clothing, the substantiation rules must be followed. The rules are complex and frequently tripped up taxpayers who had good intentions but failed to satisfy the IRS's requirements.

Substantiation

One way to understand the IRS's requirements is to break them down by monetary amount and the type of donation, money and/or household items or clothing.

• To deduct a contribution of cash, check, or other monetary gift (of less than $250), a taxpayer must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution.
• To claim a deduction for contributions of cash or property equaling $250 or more, the taxpayer must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.
• If the total deduction for all noncash contributions for the year is over $500, the taxpayer must file Form 8283, Noncash Charitable Contributions, with the IRS.
• Donations valued at more than $5,000 generally require an appraisal by a qualified appraiser.

The IRS also requires that donations of clothing and household items be in good used condition or better to be deductible. Special rules apply to donations of motor vehicles, boats and aircraft.

Tax Court sheds light

In April, the U.S. Tax Court issued an instructive decision (Kunkel, TC Memo. 2015-71) on the steps taxpayers must take to deduct a contribution to a charitable organization. The taxpayers in Kunkel made a number of donations, some by cash and others of household items and clothing, but the court disallowed nearly all of the claimed deductions because the taxpayers failed to follow the rules.

In this case, the taxpayers reported $42,000 in charitable contributions, comprising $5,000 in cash and $37,000 in noncash donations. The noncash contributions were donations of books, clothing, furniture, and household items. The taxpayers told the IRS that they took the household items, clothing and books to charities in batches, which they claimed were worth less than $250 because they believed this eliminated the need to get receipts. Other times, one or more charities came to the taxpayers' residence and picked up the household items (however, the taxpayers were not home at the time of the pickup and the charities left undated doorknob hangers as receipts).

The Tax Court reminded the taxpayers that for all contributions of $250 or more, a taxpayer generally must obtain a contemporaneous written acknowledgment from the charity. The court found it implausible that the taxpayers had made their donations in batches worth less than $250. The court calculated that this would mean they had made these donations on 97 different occasions in one year. The court also found that the doorknob hangers were inadequate substantiation of their claimed donations. The doorknob hangers not specific to taxpayer, did not describe the property contributed, and were not contemporaneous written acknowledgments, the court found.

This article is a very high level overview of the IRS's substantiation requirements for donations to charity. If you have any questions about the substantiation or other requirements for a gift you are making to a charity, please contact our office for more details.

In Rev. Proc. 2015-20, the IRS substantially simplified the requirements for small businesses to adopt the tangible property regulations (the "repair regulations") for 2014. The relief allows small businesses to change their accounting methods, to comply with the regulations, without having to apply Code Sec. 481 and without having to file Form 3115, Application for Change in Accounting Method.

In Rev. Proc. 2015-20, the IRS substantially simplified the requirements for small businesses to adopt the tangible property regulations (the "repair regulations") for 2014. The relief allows small businesses to change their accounting methods, to comply with the regulations, without having to apply Code Sec. 481 and without having to file Form 3115, Application for Change in Accounting Method.

The repair regulations are broad and comprehensive, applying to any business that uses tangible property. The regulations totally redo the rules for deducting and capitalizing expenses associated with fixed assets. IRS adopted final regulations in September 2013, effective for tax years beginning on or after January 1, 2014. Taxpayers also have the option of applying the final regulations in 2012 and/or 2013.

Change of accounting method

Taxpayers ordinarily have to file Form 3115 to request IRS consent to change a method of accounting. The IRS provided automatic consent for taxpayers to change their accounting methods to comply with the repair regulations, but this did not relieve taxpayers of the requirement to file Form 3115. Furthermore, taxpayers changing their accounting method must apply Code Sec. 481(a), which requires them to calculate an adjustment to their accounting treatment of the same items for prior years, as if the new method were used in the prior years.  Code Sec. 481 is designed to prevent any duplication of deductions or omission of income upon a change in accounting method.

Small businesses in particular had complained to the IRS about the burden of implementing the regulations with a full Code Sec. 481 adjustment. Taxpayers would be required to go back in time (as far back as their books allow) and redo their analysis of prior year tangible property costs.

Relief

The IRS has now responded by providing relief from the requirements for changing an accounting method. Small business taxpayers can make the change without filing Form 3115 and without having to make a 481 adjustment. Instead, taxpayers can make the change on a "cutoff" basis, by taking into account only amounts paid or incurred, and dispositions of property, in their 2014 tax year. In effect, small business taxpayers can make the change prospectively.

The relief applies to a taxpayer that has one or more separate and distinct trade(s) or business(es) with either total assets under $10 million at the start of the 2014 tax year, or that has average annual gross receipts of $10 million or less for the prior three years.

Claiming relief

Because the IRS provided automatic consent, taxpayers making the change for 2014 would not have to file Form 3115 until the deadline for their 2014 income tax return, either March 15 or, with an extension, September 15. So taxpayers (and their tax representatives) are right in the middle of the process to comply with the regulations for 2014. The timing of the IRS's relief, in February 2015, is opportune, and gives small businesses plenty of time to comply with the regulations for 2014.

The relief is elective. Small businesses can follow normal change of accounting procedures, or can use the relief provided in Rev. Proc. 2015-20. There are trade-offs to claiming the relief. For some taxpayers, there may be tax savings from applying Code Sec. 481 to prior years, regardless of the burden involved to make the calculations. Furthermore, taxpayers that do not file Form 3115 will not get audit protection for tax years before 2014.

Rev. Proc. 2015-20, IR-2015-29

The required minimum distribution (RMD) rules require participants to start taking distributions when they turn age 70½. Treasury and the IRS have developed a new concept to enable retirees to preserve some of their retirement assets and to protect them from outliving their assets – the qualified longevity annuity contract or QLAC. At the same time, QLACS will help retirees to avoid limiting their retirement spending unnecessarily.

The required minimum distribution (RMD) rules require participants to start taking distributions when they turn age 70½. Treasury and the IRS have developed a new concept to enable retirees to preserve some of their retirement assets and to protect them from outliving their assets – the qualified longevity annuity contract or QLAC. At the same time, QLACS will help retirees to avoid limiting their retirement spending unnecessarily.

QLAC-eligible plans

A QLAC is a deferred annuity that will start paying benefits for life at an advanced age (up to 85 under IRS rules). Participants in defined contribution (DC) retirement plans, as well as owners of IRAs, can use a portion of their DC or IRA account to purchase a QLAC. DC retirement plans include a plan, annuity or account described in Code Secs. 401(a), 403(a), 403(b), 408 (other than a Roth IRA), and 457(b).

RMD relief

In calculating their RMD, which is based on their account balance, participants can deduct the price of the QLAC from their account. Without this relief, the RMD would be inflated to include the funds used to purchase the QLAC.

QLAC reporting

QLACs became available in 2014. The IRS has issued new Form 1098-Q, Qualifying Longevity Annuity Contract Information, for issuers of QLACs to report the contracts to the IRS and to the contract purchaser. Issuers must provide the form to the purchaser for the first year in which QLAC premiums are paid, and continue to provide the form until the earlier of the participant’s death or attaining age 85.

Form 1098-Q requires issuers to identify themselves, the participant, the plan, and the plan sponsor. Issuers also must provide the QLAC’s starting date, the annuity amount if payments have not begun, the total premiums, the premiums paid in 2014, the QLAC’s fair market value at the end of the year, and indicate whether the starting date may be accelerated. The IRS also encouraged issuers to assign an account number to each QLAC, and requires an account number if the participant has more than one QLAC.

As January 1, 2015 draws closer, many employers are gearing up for the “employer mandate” under the Affordable Care Act. For 2015, there is special transition relief for mid-size employers. Small employers (employers with fewer than 50 full-time employees, including full-time equivalent employees) are always exempt from the employer mandate and related employer reporting.

As January 1, 2015 draws closer, many employers are gearing up for the “employer mandate” under the Affordable Care Act. For 2015, there is special transition relief for mid-size employers. Small employers (employers with fewer than 50 full-time employees, including full-time equivalent employees) are always exempt from the employer mandate and related employer reporting.

Employer mandate

Under Code Sec. 4980H, an applicable large employer must make a shared responsibility payment if either:

• The employer does not offer or offers coverage to less than 95 percent (70 percent in 2015) of its full-time employees and their dependents the opportunity to enroll in minimum essential coverage and one or more full-time employee is certified to the employer as having received a Code Sec. 36B premium assistance tax credit or cost-sharing reduction (“Section 4980H(a) liability”); or
• The employer offers to all or at least 95 percent of its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan and one or more full-time employees is certified to the employer as having received a Code Sec. 36B premium assistance tax credit or cost-sharing reduction (“Section 4980H(b) liability”).

For purposes of the employer mandate shared responsibility provisions, an employee is a full-time employee for a calendar month if he or she averages at least 30 hours of service per week. Under final regulations issued by the IRS earlier this year, for purposes of determining full-time employee status, 130 hours of service in a calendar month is treated as the monthly equivalent of at least 30 hours of service per week.

The IRS has provided two methods for determining whether a worker is a full-time employee: the monthly measurement method and the look-back measurement method. The monthly measurement method allows an employer to determine each employee’s status by counting the employee’s hours of service for each month. The look-back measurement method allows employers to determine the status of an employee as a full-time employee during a future period, based upon the hours of service of the employee in a prior period.

In September 2014, the IRS clarified the look-back method in certain circumstances. The IRS described application of the look-back method where an employee moves from one measurement period to another (for example, an employee moves from an hourly position to which a 12-month measurement period applies to a salaried position to which a 6-month measurement period applies). The IRS also described situations where an employer changes the measurement method applicable to employees within a permissible category (for example, an employer changes the measurement period for all hourly employees for the next calendar year from a 6-month to a 12-month measurement period).

Transition relief for mid-size employers

Mid-size employers are exempt from the Code Sec. 4980H employer mandate for 2015 under special transition relief. Employers qualify as mid-size if they employ on average at least 50 full-time employees, including full-time equivalents, but fewer than 100 full-time employees, including full-time equivalents.

The IRS has placed some restrictions on this transition relief for mid-size employers. During the period beginning on February 9, 2014, and ending on December 31, 2014, the employer that reduces the size of its workforce or the overall hours of service of its employees in order to satisfy the workforce size condition is ineligible for the transition relief. A reduction in workforce size or overall hours of service for bona fide business reasons will not be considered to have been made in order to satisfy the workforce size condition, the IRS explained.

Information reporting

Code Sec. 6056 requires certain employers to report to the IRS information about the health insurance, if any, they offer to employees. The IRS has posted draft forms and instructions about Code Sec. 6056 reporting on its website: Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and Form 1095-C, Employer-Provided Health Insurance Offer and Coverage.

Information reporting encompasses (among other things):

• The employer’s name, address, and employer identification number;
• The calendar year for which information is being reported;
• A certification as to whether the employer offered to its full-time employees and their dependents the opportunity to enroll in minimum essential coverage under an employer-sponsored plan;
• The number, address and Social Security/taxpayer identification number of all full-time employees;
• The number of full-time employees eligible for coverage under the employer’s plan; and
• The employee’s share of the lowest cost monthly premium for self-only coverage providing minimum value offered to that full-time employee.

Code Sec. 6056 reporting for 2015 is mandatory. Although mid-size employers may be exempt from the employer mandate, they are not exempt from Code Sec. 6056 reporting for 2015. The IRS is requiring all Code Sec. 6056 information returns to be filed no later than February 28 (March 31 if filed electronically) of the year immediately following the calendar year to which the return relates.

Please contact our office if you have any questions about preparing for the employer mandate and Code Sec. 6056 reporting.

Life expectancies for many Americans have increased to such an extent that most taxpayers who retire at age 65 expect to live for another 20 years or more. Several years ago, a number of insurance companies began to offer a new financial product, often called the longevity annuity or deferred income annuity, which requires upfront payment of a premium in exchange for a guarantee of a certain amount of fixed income starting after the purchaser reaches age 80 or 85. Despite the wisdom behind the longevity annuity, this new type of product did not sell especially well, principally for tax reasons. These roadblocks, however, have largely been removed by new regulations.

Life expectancies for many Americans have increased to such an extent that most taxpayers who retire at age 65 expect to live for another 20 years or more. Several years ago, a number of insurance companies began to offer a new financial product, often called the longevity annuity or deferred income annuity, which requires upfront payment of a premium in exchange for a guarantee of a certain amount of fixed income starting after the purchaser reaches age 80 or 85. Despite the wisdom behind the longevity annuity, this new type of product did not sell especially well, principally for tax reasons. These roadblocks, however, have largely been removed by new regulations.

Treasury and the IRS recently released final regulations (TD 9673) to encourage taxpayers to purchase "qualified longevity annuity contracts" (QLACs) with a portion of their retirement savings held in IRAs or in retirement accounts held under a 401(k), 403(b) or other defined contribution plans that are subject to the rules for required minimum distributions (RMDs). The final regulations are meant to remove or mitigate some of the tax concerns new retirees may face when deciding whether or not to purchase a deferred income annuity.

Longevity Annuities—Generally

Purchase of a longevity annuity provides for a deferred income stream. Although the terms of specific longevity annuity contracts differ from plan to plan, the arrangement generally requires the purchaser to pay the premium as a lump sum to the insurer. The purchaser could be 65 years of age, 55, 50 or some other age, and the insurer would not begin to make payments under the longevity annuity contract until the purchaser had reached the specified age (of no more than 85 years for the tax benefits contained in the final regulations). The amount of the annuity depends on a number of factors, among them: the age at which the contract is purchased; the amount of the premium paid; the contractual interest rate; and the age at which payments begin.

RMDs

Not every individual who reaches retirement age possesses enough spare cash outside of his or her IRAs or other retirement accounts to purchase an income annuity, let alone a longevity annuity that does not begin to pay out for many years. In such cases individuals can purchase an annuity from within an IRA or defined contribution plan account. Prior to the final regulations, however, the RMD rules requiring taxpayers who reach age 70 ½ to begin taking distributions from these accounts would have forced taxpayers to factor the premium amounts into the calculation of their annual taxable distribution. This would have depleted the account funds more quickly than the actual balance, without premium payment, warranted.

QLACs

The final regulations provide that only qualified longevity annuity contracts (QLACs) are eligible for account balance exclusion from the RMD calculation. The regulations define a QLAC as:

• A longevity annuity whose premium payment does not exceed the lesser of $125,000 or 25 percent of the employee’s account balance;
• A contract that provides for payouts to begin no later than the first day of the month following the purchaser’s 85th birthday;
• A contract that does not provide any commutation benefit, cash surrender right, or other similar feature;
• A contract under which any death benefit offered meets the requirements of paragraph A-17(c) of Reg. §1.401(a)(9)-6 (see below for more details);
• A contract that states when issued that it is intended to be a QLAC; and
• A contract that is not a variable contract under Code Sec. 817, an indexed contract, or a similar contract.

The total value of all QLACs held by one person cannot exceed the lesser of $125,000 (indexed for inflation) or 25 percent of all qualified retirement accounts put together. This limitation does not extend to funds held in non-retirement accounts or to funds held in Roth IRAs.

In addition, the amount used to pay the QLAC premium is not taxable when the QLAC is purchased. This means the account holder has a zero basis in the QLAC. Distributions from the QLAC are fully taxable.

Death Benefit

Most longevity annuities do not provide any death benefit for the purchaser's beneficiaries. While some longevity annuity plans do offer a death benefit for the beneficiaries of annuity purchasers who die prematurely, plans that maximize the annuity payment generally provide that the insurer keeps the entire premium amount, plus interest, if the purchaser dies before payouts begin or the contract basis is exhausted.

Return of premium. The final regulations attempt to mitigate some of the risk retirees face when deciding to purchase a QLAC by allowing a QLAC to provide certain death benefits in limited circumstances. Notably, the final regulations add a feature missing from the proposed regulations: return of premium. Under the final rules, a QLAC is authorized to guarantee the return of a purchaser's premium if the purchaser dies before receiving benefits equal to the premium paid.

Surviving spouse. The final regulations provide that, where the purchaser's sole beneficiary under the QLAC is his or her surviving spouse, generally the only benefit permitted to be paid after the purchaser's death is a life annuity that does not exceed 100 percent of the annuity that would have been paid to the employee. The final regulations also allow QLACs to provide the return of premium feature if a surviving spouse who receives a life annuity under the contract dies before the payments equal the premium.

Non-spouse beneficiary/beneficiaries. QLACs may also provide a lifetime annuity to designated non-spouse beneficiaries, but the annuity would likely be reduced. Calculation of an annuity payable to a non-spouse beneficiary would be calculated based on the applicable percentage provided in one of the tables in the final regulations. However, if the QLAC provides a return of premium feature, the applicable percentage that the beneficiary would receive is zero.

Please contact this office if you have any questions on how a qualified longevity annuity might fit into your retirement plans now that the IRS has relaxed some of the rules.

One of the most complex, if not the most complex, provisions of the Patient Protection and Affordable Care Act is the employer shared responsibility requirement (the so-called "employer mandate") and related reporting of health insurance coverage. Since passage of the Affordable Care Act in 2010, the Obama administration has twice delayed the employer mandate and reporting. The employer mandate and reporting will generally apply to applicable large employers (ALE) starting in 2015 and to mid-size employers starting in 2016. Employers with fewer than 50 employees, have never been required, and continue to be exempt, from the employer mandate and reporting.

Employer mandate

The employer mandate under Code Sec. 4980H and employer reporting under Code Sec. 6056 are very connected. Code Sec. 4980H generally provides that an ALE is required to pay a penalty if it fails to offer minimum essential coverage and any full-time employee receives cost-sharing or the Code Sec. 36B premium assistance tax credit. An ALE would also pay a penalty if it offers coverage and any full-time employee receives cost-sharing or the Code Sec. 36B credit.

To receive the Code Sec. 36B credit, an individual must have obtained coverage through an Affordable Care Act Marketplace. The Marketplaces will report the names of individuals who receive the credit to the IRS. ALEs must report the terms and conditions of health care coverage provided to employees (This is known as Code Sec. 6056 reporting). The IRS will use all of this information to determine if the ALE must pay a penalty.

ALEs

Only ALEs are subject to the employer mandate and must report health insurance coverage under Code Sec. 6056. Employers with fewer than 50 employees are never subject to the employer mandate and do not have to report coverage under Code Sec. 6056.

In February, the Obama administration announced important transition rules for the employer mandate that affects Code Sec. 6056 reporting. The Obama administration limited the employer mandate in 2015 to employers with 100 or more full-time employees. ALEs with fewer than 100 full-time employees will be subject to the employer mandate starting in 2016. At all times, employers with fewer than 50 full-time employees are exempt from the employer mandate and Code Sec. 6056 reporting.

Reporting

The IRS has issued regulations describing how ALEs will report health insurance coverage. The IRS has not yet issued any of the forms that ALEs will use but has advised that ALEs generally will report the requisite information to the agency electronically.

ALEs also must provide statements to employees. The statements will describe, among other things, the coverage provided to the employee.

30-Hour Threshold

A fundamental question for the employer mandate and Code Sec. 6056 reporting is who is a full-time employee. Since passage of the Affordable Care Act, the IRS and other federal agencies have issued much guidance to answer this question. The answer is extremely technical and there are many exceptions but generally a full-time employee means, with respect to any month, an employee who is employed on average at least 30 hours of service per week. The IRS has designed two methods for determining full-time employee status: the monthly measurement method and the look-back measurement method. However, special rules apply to seasonal workers, student employees, volunteers, individuals who work on-call, and many more. If you have any questions about who is a full-time employee, please contact our office.

Form W-2 reporting

The Affordable Care Act also requires employers to disclose the aggregate cost of employer-provided health coverage on an employee's Form W-2. This requirement is separate from the employer mandate and Code Sec. 6056 reporting. The reporting of health insurance costs on Form W-2 is for informational purposes only. It does not affect an employee's tax liability or an employer's liability for the employer mandate.

Shortly after the Affordable Care Act was passed, the IRS provided transition relief to small employers that remains in effect today. An employer is not subject the reporting requirement for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year. Special rules apply to multiemployer plans, health reimbursement arrangements, and many more.

Please contact our office if you have any questions about ALEs, the employer mandate or Code Sec. 6056 reporting.

When an IRS is conducting a detailed audit of a taxpayer, it may want to see documents and records retained by the taxpayer. The examiner will ask the taxpayer what type of documents are maintained, and will request that the taxpayer produce particular documents for inspection.

The IRS uses Form 4564, Information Document Request, to request information from a taxpayer for an audit. There are several versions of Form 4564, such as those for income tax audits, tax-exempt organizations, and tax-exempt bonds. Form 4564 will list documents needed to support taxpayer items that the IRS wants to verify. Taxpayers may want to consult with legal counsel to ensure that they do not provide too much information and do not provide privileged documents.

IDR enforcement

The IRS has put into effect a new IDR enforcement process for IRS examiners to obtain information. In particular, the IRS's Large Business and International Division (LB&I) issued several memos in 2013 and 2014 to provide guidance on the use of IDRs and to explain the new IDR enforcement process. Other divisions follow, or will be following, similar procedures.

Under the guidelines, examiners are instructed to prepare one IDR for each issue being examined; the IDR should describe the issue for which the documents are being requested. IDRs should be clear and concise, and customized to the taxpayer under audit. There is an exception to the requirement that the IDR state the issue. An initial IDR that requests basic books and records and general information about a taxpayer's business does not have to meet this requirement.

Examiners are further instructed to discuss the proposed IDR with the taxpayer and to agree on a reasonable time for the taxpayer to respond. LB&I instituted a three-step process for enforcing the IDR, with strict deadlines: a delinquency notice; a pre-summons letter; and a summons. The process is mandatory. IRS Chief Counsel will enforce IDRs through summons issuance when necessary. The IRS may also apply this stricter process if it believes that the taxpayer's response is incomplete.

Mid-size employers may be eligible for recently announced transition relief from the Patient Protection and Affordable Care Act's employer shared responsibility requirements. Final regulations issued by the IRS in late January include transition relief for mid-size employers for 2015. Mid-size employers for this relief are defined generally as businesses employing at least 50 but fewer than 100 full-time employees. Exceptions and complicated measurement rules continue to apply. The final regulations also describe the treatment of seasonal employees, volunteer workers, student employees, the calculation of the employer shared responsibility payment, and much more.

Mid-size employers may be eligible for recently announced transition relief from the Patient Protection and Affordable Care Act's employer shared responsibility requirements. Final regulations issued by the IRS in late January include transition relief for mid-size employers for 2015. Mid-size employers for this relief are defined generally as businesses employing at least 50 but fewer than 100 full-time employees. Exceptions and complicated measurement rules continue to apply. The final regulations also describe the treatment of seasonal employees, volunteer workers, student employees, the calculation of the employer shared responsibility payment, and much more.

Delayed implementation

As enacted in 2010, the Affordable Care Act required applicable large employers (ALEs) to make an assessable payment if any full-time employee is certified to receive a health insurance premium tax credit or cost-sharing reduction, and either:

• The employer does not offer to its full-time employees and their dependents the opportunity to enroll in minimum essential coverage (MEC) under an eligible employer-sponsored plan; or
• The employer offers its full-time employees and their dependents the opportunity to enroll in MEC under an employer-sponsored plan, but the coverage is either unaffordable or does not provide minimum value.

The employer shared responsibility requirement was scheduled to apply January 1, 2014, the same effective date for the individual mandate and the health insurance premium assistance tax credit. In July 2013, the Obama administration announced that employer shared responsibility requirements would not apply for 2014.

The final regulations make further changes. Under the final regulations, the employer mandate will generally apply to large employers (employers with 100 or more employees) starting in 2015 and to qualified mid-size employers (employers with 50 to 99 employees) starting in 2016. Employers that employ fewer than 50 full-time employees (including full-time equivalents (FTEs)) are not subject to the employer mandate.

Caution. Determining the number of employees for purposes of the employer shared responsibility requirement is a complex calculation for many employers that is beyond the scope of this article. The Affordable Care Act and the final regulations describe how to calculate full-time employees (including FTEs) and also which employees are excluded from that calculation. Please contact our office for details about the Affordable Care Act and your business.

Transition relief for mid-size employers

Qualified employers are not subject to the employer mandate until 2016 if they satisfy certain conditions. Among other requirements, the employer must employ on average at least 50 full-time employees (including FTEs) but fewer than 100 full-time employees (including FTEs) on business days during 2014. Additionally, the final regulations impose a broad maintenance of previously offered heath coverage requirement.

The final regulations do not allow an employer to reduce the size of its workforce or the overall hours of service of its employees in order to satisfy the workforce size condition and thus be eligible for the transition relief. A reduction in workforce size or overall hours of service for bona fide business reasons, however, will not be considered to have been made in order to satisfy the workforce size condition. This provision is certainly one that is expected to generate many questions. The IRS may provide additional guidance and/or clarification in 2014 and our office will keep you posted of developments.

Additionally, the final regulations also modify the extent of required coverage. Proposed regulations required that the employer provide coverage to 95 percent of its full-time employees. The final regulations delay the 95 percent requirement until 2016 for larger employers. For 2015, larger employers need only provide coverage to 70 percent of their full-time employees.

Special types of employees

Since passage of the Affordable Care Act, questions have arisen about the treatment of certain types of employees. These include seasonal employees, short-term employees, volunteer workers, and student employees. The final regulations clarify some of the issues surrounding these employees.

Many industries employ seasonal workers. The final regulations describe who may qualify as a seasonal worker. The retail industry, which employs many workers for the holiday season, asked the IRS to specify which events or periods of time that would be treated as holiday seasons. The final regulations, however, do not indicate specific holidays or the length of any holiday season as these will differ for different employers, the IRS explained.

For volunteer workers, such as volunteer fire fighters and first responders, the final regulations provide that an individual's hours of service do not include hours worked as a "bona fide volunteer." This definition, the IRS explained, encompasses any volunteer who is an employee of a government entity or a Code Sec. 501(c)(3) organization whose compensation is limited to reimbursement of certain expenses or other forms of compensation.

Many college, university and vocational students are engaged in federal and state work-study programs. The final regulations provide that hours of service for purposes of the employer mandate do not include hours of service performed by students in federal or other governmental work-study programs. The IRS noted the potential for abuse by labeling individuals who receive compensation as "interns" to avoid the employer mandate. Therefore, the IRS did not adopt a special rule for student employees working as interns for an outside employer, and the general rules apply.

The final regulations also describe how the employer mandate may or may not apply to adjunct faculty, members of religious orders, airline industry employees, employees who must work “on-call” hours, short-term employees and others. Special rules may apply to these employees in some cases.

Waiting period limitation

The Affordable Care Act generally requires that an employee (or dependent) cannot wait more than 90 days before employer-provided coverage becomes effective. The IRS issued final regulations in February on the 90-day waiting period limitation. The IRS also issued proposed regulations generally allowing employers to require new employees to complete a reasonable orientation period. The proposed regulations set forth one month as the maximum length of any orientation period.

If you have any questions about the final regulations for the employer mandate, the transition relief, the 90-day waiting period, or any aspects of the Affordable Care Act, please contact our office.

TD 9655, TD 9656, NPRM REG-122706-12

In his January 2014 State of the Union address, President Obama instructed the Treasury Department to develop a new savings vehicle called "myRA." The new savings arrangements share many similarities with Roth IRAs but also have some unique features. At press time, the Treasury Department is expected to roll out myRAs before year-end 2014. Certain details on how they will operate continue to unfold.

In his January 2014 State of the Union address, President Obama instructed the Treasury Department to develop a new savings vehicle called "myRA." The new savings arrangements share many similarities with Roth IRAs but also have some unique features. At press time, the Treasury Department is expected to roll out myRAs before year-end 2014. Certain details on how they will operate continue to unfold.

Saving for retirement

In his address, President Obama cautioned that Social Security, by itself, is often not enough to meet the financial needs of retirement. Many Americans participate in retirement savings arrangements, such as 401(k) plans, but many do not. President Obama subsequently issued an executive order directing the Treasury department to create a new retirement savings arrangement-myRA-that would protect the principal contributed while earning interest at a rate based on yields on outstanding Treasury securities. The President also instructed Treasury to develop and launch myRAs before 2015.

Key features

myRAs will be offered by automatic payroll deduction and will be portable. That means the accounts will not be tied to a single employer. However, employers must choose to offer myRAs to their employees. The White House is hoping that the ease of setting up these accounts will encourage employers, especially small employers, to offer myRAs to their employees.

After Treasury launches myRAs, employees of participating employers will be able to sign up to participate in the accounts. Employees will be able to enroll in the program with a minimum contribution of $25. An employee can then elect to have a portion of each paycheck (as little as $5) directly deposited into a myRA automatically. Employers will not contribute to myRAs.

The Treasury Department has posted some basic information about myRAs. Account holders will be able to build savings for 30 years or until their myRA reaches $15,000, whichever comes first. After that, myRA balances will roll over to private-sector retirement accounts. Contributions to myRAs can be withdrawn tax-free at any time. Earnings will be tax-free unless withdrawn before the saver is age 59 ½.

Funds in a myRA will earn interest at the same variable rate as the Government Securities Investment Fund in the Thrift Savings Plan (TSP) available to employees of the federal government. TSP has explained that this fund invests exclusively in U.S. Treasury securities. The earnings consist entirely of interest income on the securities. TSP has acknowledged that this fund is subject to inflation risk, or the possibility that the investment will not grow enough to offset the reduction in purchasing power that results from inflation. This is one concern that some financial advisors have raised about myRAs.

More details expected

The Treasury Department is expected to issue rules and regulations for myRAs just as it has for IRAs, Roth IRAs and other retirement savings vehicles. Several questions are expected to be answered in the guidance, such as how rollover of funds in myRAs will work. The Treasury Department also is expected to describe in greater detail the income qualifications. At this time, Obama administration officials have indicated that myRAs will be available to individuals with annual incomes of less than $129,000 a year and $191,000 for couples. These amounts are expected to be adjusted annually for inflation.

As discussed above, more details about myRAs will be available as 2014 unfolds. Obama administration officials have described myRAs as "starter savings accounts" and in many respects, myRAs may be most attractive to individuals just starting out in the workforce. However, myRAs also could be part of the retirement savings portfolio of individuals who have been in the workforce longer.

If you have any questions about myRAs, please contact our office. We will keep you posted of developments.

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

First, the law actually requires taxpayers to retain certain records for a specified number of years, for example tax returns or employment tax records (for employers).

Second, good recordkeeping is essential for taxpayers while preparing their tax returns. The Tax Code frequently requires taxpayers to substantiate their income and claims for deductions and credits by providing records of various profits, expenses and transactions.

Third, if a taxpayer is ever audited by the IRS, good recordkeeping can facilitate what could be a long and invasive process, and it can often mean the difference between a no change and a hefty adjustment.

Finally, business taxpayers should maintain good records that will enable them to track the trajectory of their success over the years.

Here you will find a sample list of various types of records it would be wise to retain for tax and other purposes (not an exhaustive list; see this office for further customization to your particular situation):

Individuals

Filing status:

Marriage licenses or divorce decrees – Among other things, such records are important for determining filing status.

Determining/Substantiating income:

State and federal income tax returns – Tax records should be retained for at least three years, the length of the statute of limitations for audits and amending returns. However, in cases where the IRS determines a substantial understatement of tax or fraud, the statute of limitations is longer or can remain open indefinitely.

Paystubs, Forms W-2 and 1099, Pension Statements, Social Security Statements – These statements are essential for taxpayers determining their earned income on their tax returns. Taxpayers should also cross reference their wage and income reports with their final pay stubs to verify that their employer has reported the correct amount of income to the IRS.

Tip diary or other daily tip record – Taxpayers that receive some of their income from tips should keep a daily record of their tip income. Under the best circumstances, taxpayers would have already accurately reported their tip income to their employers, who would then report that amount to the IRS. However, mistakes can occur, and good recordkeeping can eliminate confusion when tax season arrives.

Military records – Some members of the military are exempt from state and/or federal tax; combat pay is exempt from taxation, as are veteran’s benefits. (In many cases, a record of military service is necessary to obtain veteran’s benefits in the first place.)

Copies of real estate purchase documents – Up to $500,000 of gain from the sale of a personal residence may be excludable from income (generally up to $250,000 if you are single). But if you own a home that sold for an amount that produces a greater amount of gain, or if you own real estate that is not used as your personal residence, you will need these records to prove your tax basis in your home; the greater your basis, the lower the amount of gain that must be recognized.

Individual Retirement Account (IRA) records – Funds contributed to Roth IRAs and traditional IRAs and the earnings thereon receive different tax treatments upon distribution, depending in part on when the distribution was made, what amount of the contributions were tax deferred when made, and other factors that make good recordkeeping desirable.

Investment purchase confirmation records – Long-term capital gains receive more favorable tax treatment than short-term capital gains. In addition, basis (generally the cost of certain investments when purchased) can be subtracted from gain from any sale. For these reasons, taxpayers should keep records of their investment purchase confirmations.

Substantiating deductions:

Acknowledgments of charitable donations – Cash contributions to charity cannot be deducted without a bank record, receipt, or other means. Charitable contributions of $250 or more must be substantiated by a contemporaneous written acknowledgment from the qualified organization that also meets the IRS requirements.

Cash payments of alimony – Payments of alimony may be deductible from the gross income of the paying spouse . . . if the spouse can substantiate the payments and certain other criteria are met.

Medical records – Disabled taxpayers under the age of 65 should keep a written statement from a qualified physician certifying they were totally disabled on the date of retirement.

Records of medical expenses – Certain unreimbursed medical expenses in excess of 10 percent of adjusted gross income may be deductible. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Mortgage statements and mortgage insurance – Mortgage interest and real estate taxes have generally deductible for taxpayers who itemize rather than claim the standard deduction. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Receipts for any improvements to real estate – Part or all of the expense of certain energy efficient real estate improvements can qualify taxpayers for one or more tax credits.

Keeping so many records can be tedious, but come tax-filing season it can result in large tax savings. And in the case of an audit, evidence of good recordkeeping can get you off to a good start with the IRS examiner handling the case, can save time, and can also save money. For more information on recordkeeping for individuals, please contact our offices.

Businesses

Taxpayers are required by law to keep permanent books of account or records that sufficiently substantiate the amount of gross income, deductions, credits and other amounts reported and claimed on any their tax returns and information returns.

Although, neither the Tax Code nor its regulations specify exactly what kinds of records satisfy the record-keeping requirements, here are a few suggestions:

State and federal income tax returns – These and any supporting documents should be kept for at least the period of limitations for each return. As with individual taxpayers, the limitations period for business tax returns may be extended in the event of a substantial understatement or fraud.

Employment taxes – The Tax Code requires employers to keep all records of employment taxes for at least four years after filing for the 4th quarter for the year. Generally these records would include wage payments and other payroll-related records, the amount of employment taxes withheld, reported tip income, identification information for employees and other payees; employees’ dates of employment; income tax withholding allowance certificates (Forms W-4, for example), fringe benefit payments, and more.

Business income – These would go toward substantiating income, and could include cash register tapes, bank deposit slips, a cash receipts journal, annual financial statements, Forms 1099, and more.

Inventory costs – Businesses should keep records of inventory purchases. For example, if an electronics company purchases a certain number of widgets for resale or a manufacturer purchases a certain number of ball bearings for use in the production of industrial equipment that it manufactures and sells. The costs of these goods, parts, or other materials can be deducted from sales income to significantly reduce tax liability.

Business expenses – Ordinary and necessary expenses for carrying on business, such as the cost of rental office space, are also generally deductible from business income. Such expenses can be substantiated through bank statements, canceled checks, credit card receipts or other such records. The cost of making certain improvements to a business, such as through buying equipment or renovating property, can also be deductible.

Electronic back-up

Paper records can take up a great deal of storage space, and they are also vulnerable to destruction in fires, floods, earthquakes, or other natural phenomena. Because records are required to substantiate most income, deductions, property values and more—even when they no longer exist—taxpayers (and especially business taxpayers) should digitize their records on an electronic storage system and keep a back-up copy in a secure location.

Business taxation can be extremely complicated, and the requirements for recordkeeping vary greatly depending on the size of the business, the form of organization chosen, and the type of industry in which the business operates. For more details on your specific situation, please call our offices.

Despite the passage of the American Tax Relief Act of 2012 - which its supporters argued would bring greater certainty to tax planning - many taxpayers have questions about the tax rates on qualified dividends and capital gains.

Despite the passage of the American Tax Relief Act of 2012 - which its supporters argued would bring greater certainty to tax planning - many taxpayers have questions about the tax rates on qualified dividends and capital gains.

Background

Before ATRA, the maximum tax rate on net capital gains and qualified dividends was 15 percent for taxpayers in the 25, 28, 33, or 35 percent individual income tax brackets (the 35 percent rate was the highest individual tax bracket before ATRA). For 2008 through 2012, taxpayers in the 10 and 15 percent individual income tax brackets enjoyed a zero percent tax rate on net capital gains and qualified dividends. Generally, the 15 and zero percent rates applied to long-term capital gains (resulting from the sale of an asset held for longer than one year) and qualified dividends (such as dividends received from a domestic corporation and certain foreign corporations).

ATRA's rates

Under ATRA, the 15 percent rate on net capital gains and qualified dividends is made permanent for taxpayers in the 25, 28, 33, or 35 percent individual income tax brackets. This treatment applies for 2013 and all subsequent years unless modified by Congress in the future. ATRA also made permanent the zero percent tax rate on net capital gains and qualified dividends for taxpayers in the 10 and 15 percent income tax brackets. This treatment applies for 2013 and all subsequent years unless modified by Congress.

Additionally, ATRA created a 20 percent tax rate on net capital gains and qualified dividends intended to apply to higher income taxpayers. The 20 percent tax rate applies to qualified capital gains and dividends of taxpayers subject to the revived 39.6 percent income tax bracket. Taxpayers are subject to the 39.6 percent income tax bracket to the extent their taxable income exceeds certain thresholds: $450,000 for married couples filing joint returns and surviving spouses, $425,000 for heads of households, $400,000 for single filers, and $225,000 for married couples filing separate returns. These threshold amounts are projected to be slightly higher in 2014 as indexed for inflation.

Collectibles and unrecaptured Code Sec. 1250 gain

The Tax Code has special tax rates for collectibles and unrecaptured Code. Sec. 1250 gain. These tax rates were not changed by ATRA or other legislation. A 28 percent tax rate applies to collectibles, and a 25 percent tax rate applies to unrecaptured Code Sec. 1250 gain.

Short-term capital gains

The tax rates are significantly different for short-term capital gains than for long-term capital gains. Short-term capital gains are taxed at ordinary income tax rates. This means that the tax rate on short-term capital gains can range from 10 percent to 39.6 percent, depending on the taxpayer's situation. Income generated from non-capital assets are also subject to these rates.

Net investment income surtax

Unrelated to ATRA's changes is a new 3.8 percent surtax imposed by the Patient Protection and Affordable Care Act (PPACA) on individuals, estates and trusts that have certain investment income above threshold amounts including $250,000 for married couples filing jointly and $200,000 for single filers. These amounts are not subject to an annual adjustment for inflation. The 3.8 percent surtax took effect January 1, 2013 and therefore will be reflected on 2013 returns filed in 2014.

Timing the recognition of capital gain and offsetting losses when possible can frequently lower overall tax liability. Year-end tax planning can be a particularly advantageous in this regard. If you have any questions about the capital gains and dividends tax rates, please contact our office.

A business can deduct only ordinary and necessary expenses. Further, the amount allowable as a deduction for business meal and entertainment expenses, whether incurred in-town or out-of-town is generally limited to 50 percent of the expenses. (A special exception that raises the level to 80 percent applies to workers who are away from home while working under Department of Transportation regulations.)

A business can deduct only ordinary and necessary expenses. Further, the amount allowable as a deduction for business meal and entertainment expenses, whether incurred in-town or out-of-town is generally limited to 50 percent of the expenses. (A special exception that raises the level to 80 percent applies to workers who are away from home while working under Department of Transportation regulations.)

Related expenses, such as taxes, tips, and parking fees must be included in the total expenses before applying the 50-percent reduction. The 50-percent reduction is made only after determining the amount of the otherwise allowable deductions. However, allowable deductions for transportation costs to and from a business meal are not reduced.

The 50-percent deduction limitation also applies to meals and entertainment expenses that are reimbursed under an accountable plan to a taxpayer's employees. In that case, it doesn't matter if the taxpayer reimburses the employees for 100 percent of the expenses.

Employee-only meals.  If the value of any property or service provided to an employee is so minimal that accounting for the property or service would be unreasonable or administratively impracticable, it is a de minimis fringe benefit that is excluded for income and employment tax purposes.  Such benefits that are food-related may include occasional parties or picnics, occasional supper money due to overtime work, and employer-furnished coffee and doughnuts.

A subsidized eating facility can be a de minimis fringe if it is located on or near the business premises and the revenue derived from it normally equals or exceeds direct operating costs. Further, if more than one-half of the employees are furnished meals for the convenience of the employer, all meals provided on the premises are treated as furnished for the convenience of the employer. Therefore, the meals are fully deductible by the employer, instead of possibly being subject to the 50-percent limit on business meal deductions, and excludable by the employees.

Whether or not the IRS will allow a deduction for year-end bonuses for services performed during that year depends not only on the timing of the payment, but also the events surrounding the payment. If your business is planning to provide year-end bonuses to employees, you may find the following tax tips useful in your planning.

Whether or not the IRS will allow a deduction for year-end bonuses for services performed during that year depends not only on the timing of the payment, but also the events surrounding the payment. If your business is planning to provide year-end bonuses to employees, you may find the following tax tips useful in your planning.

The "All Events" test

Code Sec. 461(a) provides that the amount of any deduction for employee bonuses must be taken for the proper tax year as determined under the method of accounting the taxpayer uses to compute taxable income. (The two most common methods are the cash method and the accrual method, the latter of which allows taxpayers to include income items when earned and claim deductions when expenses are incurred.)

Under the accrual method of accounting, the three-prong "All events" test is used to determine the tax year in which a liability-in this case the year-end employee bonuses—is incurred. The prongs are:

• Have all the events have occurred that establish the fact of the liability?
• Can the amount of the liability be determined with reasonable accuracy?
• Has economic performance occurred for the liability?

Approval and retention provisions

Some year-end bonus plans are structured with certain conditions attached to payment. For example, some bonus plans provide that payment cannot occur until formally approved. In such cases, the fact of the liability may not be established, and the employer may need to wait a year before being able to deduct the bonus amount.

Other plans specify that bonus payments cannot be made if an employee has left employment at year-end. In this case as well, questions arise as to whether liability for the bonuses has been fixed at the end of the year in which the employee's services were performed.

Deferred compensation

Generally, Code Sec. 404 states that, an employer may not deduct deferred compensation paid to an employee until the employee includes it in income. However, a bonus received within a 2 1/2-month period after the end of the tax year in which the employee has rendered its services is not considered deferred compensation. The employer should be able to claim a tax deduction for the bonus in the tax year during which the services were rendered provided that the liability meets the all events test. If the employee receives the deferred amount more than 2 1/2 months after the close of the employer's taxable year, the payment is presumed to have been made under a deferred compensation plan.

If you think you might be interested in structuring a year-end bonus plan specific to your business, please feel free to contact this office for an appointment.

Retired employees often start taking benefits by age 65 and, under the minimum distribution rules, must begin taking distributions from their retirement plans when they reach age 70 ½. According to Treasury, a 65-year old female has an even chance of living past age 86, while a 65-year old male has an even chance of living past age 84. The government has become concerned that taxpayers who normally retire at age 65 or even age 70 will outlive their retirement benefits.

The government has found that most employees want at least a partial lump sum payment at retirement, so that some cash is currently available for living expenses. However, under current rules, most employer plans do not offer a partial lump sum coupled with a partial annuity. Employees often are faced with an “all or nothing” decision, where they would have to take their entire retirement benefit either as a lump sum payment when they retire, or as an annuity that does not make available any immediate lump-sum cash cushion. For retirees who live longer, it becomes difficult to stretch their lump sum benefits.

Longevity solution

To address this dilemma, the government is proposing new retirement plan rules to allow plans to make available a partial lump sum payment while allowing participants to take an annuity with the other portion of their benefits. Furthermore, to address the problem of employees outliving their benefits, the government would also encourage plans to offer “longevity” annuities. These annuities would not begin paying benefits until ages 80 or 85. They would provide you a larger annual payment for the same funds than would an annuity starting at age 70 ½. Of course, one reason for the better buy-in price is that you or your heirs would receive nothing if you die before the age 80 or 85 starting date. But many experts believe that it is worth the cost to have the security of knowing that this will help prevent you from “outliving your money.”

To streamline the calculation of partial annuities, the government would allow employees receiving lump-sum payouts from their 401(k) plans to transfer assets into the employer’s existing defined benefit (DB) plan and to purchase an annuity through the DB plan. This would give employees access to the DB plans low-cost annuity purchase rates.

According to the government, the required minimum distribution (RMD) rules are a deterrent to longevity annuities. Because of the minimum distribution rules, plan benefits that could otherwise be deferred until ages 80 or 85 have to start being distributed to a retired employee at age 70 ½. These rules can affect distributions from 401(k) plans, 403(b) tax-sheltered annuities, individual retirement accounts under Code Sec. 408, and eligible governmental deferred compensation plans under Code Sec. 457.

Tentative limitations

The IRS proposes to modify the RMD rules to allow a portion of a participant’s retirement account to be set aside to fund the purchase of a deferred annuity. Participants would be able to exclude the value of this qualified longevity annuity contract (QLAC) from the account balance used to calculate RMDs. Under this approach, up to 25 percent of the account balance could be excluded. The amount is limited to 25 percent to deter the use of longevity annuities as an estate planning device to pass on assets to descendants.

Coming soon

Many of these changes are in proposed regulations and would not take effect until the government issues final regulations. The changes would apply to distributions with annuity starting dates in plan years beginning after final regulations are published, which could be before the end of 2012. Our office will continue to monitor the progress of this important development.

The number of tax return-related identity theft incidents has almost doubled in the past three years to well over half a million reported during 2011, according to a recent report by the Treasury Inspector General for Tax Administration (TIGTA). Identity theft in the context of tax administration generally involves the fraudulent use of someone else’s identity in order to claim a tax refund. In other cases an identity thief might steal a person’s information to obtain a job, and the thief’s employer may report income to the IRS using the legitimate taxpayer’s Social Security Number, thus making it appear that the taxpayer did not report all of his or her income.

In light of these dangers, the IRS has taken numerous steps to combat identity theft and protect taxpayers. There are also measures that you can take to safeguard yourself against identity theft in the future and assist the IRS in the process.  

IRS does not solicit financial information via email or social media

The IRS will never request a taxpayer’s personal or financial information by email or social media such as Facebook or Twitter. Likewise, the IRS will not alert taxpayers to an audit or tax refund by email or any other form of electronic communication, such as text messages and social media channels.

If you receive a scam email claiming to be from the IRS, forward it to the IRS at phishing@irs.gov. If you discover a website that claims to be the IRS but does not begin with 'www.irs.gov', forward that link to the IRS at phishing@irs.gov.

How identity thieves operate

Identity theft scams are not limited to users of email and social media tools. Scammers may also use a phone or fax to reach their victims to solicit personal information. Other means include:

-Stealing your wallet or purse
-Looking through your trash
-Accessing information you provide to an unsecured Internet site.

How do I know if I am a victim?

Your identity may have been stolen if a letter from the IRS indicates more than one tax return was filed for you or the letter states you received wages from an employer you don't know. If you receive such a letter from the IRS, leading you to believe your identity has been stolen, respond immediately to the name, address or phone number on the IRS notice. If you believe the notice is not from the IRS, contact the IRS to determine if the letter is a legitimate IRS notice.

If your tax records are not currently affected by identity theft, but you believe you may be at risk due to a lost wallet, questionable credit card activity, or credit report, you need to provide the IRS with proof of your identity. You should submit a copy of your valid government-issued identification, such as a Social Security card, driver's license or passport, along with a copy of a police report and/or a completed IRS Form 14039, Identity Theft Affidavit, which should be faxed to the IRS at 1-978-684-4542.

What should I do if someone has stolen my identity?

If you discover that someone has filed a tax return using your SSN you should contact the IRS to show the income is not yours. After the IRS authenticates who you are, your tax record will be updated to reflect only your information. The IRS will use this information to minimize future occurrences.

What other precautions can I take?

There are many things you can do to protect your identity. One is to be careful while distributing your personal information. You should show employers your Social Security card to your employer at the start of a job, but otherwise do not routinely carry your card or other documents that display your SSN.

Only use secure websites while making online financial transactions, including online shopping. Generally a secure website will have an icon, such as a lock, located in the lower right-hand corner of your web browser or the address bar of the website with read “https://…” rather than simply “http://.”

Never open suspicious attachments or links, even just to see what they say. Never respond to emails from unknown senders. Install anti-virus software, keep it updated, and run it regularly.

For taxpayers planning to e-file their tax returns, the IRS recommends use of a strong password. Afterwards, save the file to a CD or flash drive and keep it in a secure location. Then delete the personal return information from the computer hard drive.

Finally, if working with an accountant, query him or her on what measures they take to protect your information.

The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

These so-called “repair regulations” are broad and comprehensive. They apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. They are intended to clarify and expand existing regulations, set out some bright-line tests, and provide some safe harbors for deducting payments.

The regulations are an ambitious effort to address capitalization of specific expenses associated with tangible property. The regulations affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased. The rules provide a more defined framework for determining capital expenditures.

Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again.

The IRS has promised to issue two revenue procedures that will provide transition rules for taxpayers changing their method of accounting, including the granting of automatic consent to make the change. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.

The new regulations provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.

Costs to acquire, produce or improve tangible property must be capitalized. The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.

To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.

The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, with both mandatory and optional adjustments made to past treatment as appropriate.

Please feel free to call this office for a more targeted explanation of how these new regulations impact your business operations.

In light of the IRS’s new Voluntary Worker Classification Settlement Program (VCSP), which it announced this fall, the distinction between independent contractors and employees has become a “hot issue” for many businesses. The IRS has devoted considerable effort to rectifying worker misclassification in the past, and continues the trend with this new program.  It is available to employers that have misclassified employees as independent contractors and wish to voluntarily rectify the situation before the IRS or Department of Labor initiates an examination.

The distinction between independent contractors and employees is significant for employers, especially when they file their federal tax returns. While employers owe only the payment to independent contractors, employers owe employees a series of federal payroll taxes, including Social Security, Medicare, Unemployment, and federal tax withholding. Thus, it is often tempting for employers to avoid these taxes by classifying their workers as independent contractors rather than employees.

If, however, the IRS discovers this misclassification, the consequences might include not only the requirement that the employer pay all owed payroll taxes, but also hefty penalties. It is important that employers be aware of the risk they take by classifying a worker who should or could be an employee as an independent contractor.

“All the facts and circumstances”

The IRS considers all the facts and circumstances of the parties in determining whether a worker is an employee or an independent contractor. These are numerous and sometimes confusing, but in short summary, the IRS traditionally considers 20 factors, which can be categorized according to three aspects: (1) behavioral control; (2) financial control; (3) and the relationship of the parties.

Examples of behavioral and financial factors that tend to indicate a worker is an employee include:

• The worker is required to comply with instructions about when, where, and how to work;
• The worker is trained by an experienced employee, indicating the employer wants services performed in a particular manner;
• The worker’s hours are set by the employer;
• The worker must submit regular oral or written reports to the employer;
• The worker is paid by the hour, week, or month;
• The worker receives payment or reimbursement from the employer for his or her business and traveling expenses; and
• The worker has the right to end the employment relationship at any time without incurring liability.

In other words, any existing facts or circumstances that point to an employer’s having more behavioral and/or financial control over the worker tip the balance towards classifying that worker as an employee rather than a contractor. The IRS’s factors do not always apply, however; and if one or several factors indicate independent contractor status, but more indicate the worker is an employee, the IRS may still determine the worker is an employee.

Finally, in examining the relationship of the parties, benefits, permanency of the employment term, and issuance of a Form W-2 rather than a Form 1099 are some indicators that the relationship is that of an employer–employee.

Conclusion

Worker classification is fact-sensitive, and the IRS may see a worker you may label an independent contractor in a very different light. One key point to remember is that the IRS generally frowns on independent contractors and actively looks for factors that indicate employee status.

Please do not hesitate to call our offices if you would like a reassessment of how you are currently classifying workers in your business, as well as an evaluation of whether IRS’s new Voluntary Classification Program may be worth investigating.

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.

Individual retirement accounts (IRAs) -- both traditional and Roth IRAs -- are among the most popular retirement savings vehicles today. Protecting the value of your IRA (and other retirement accounts) is incredibly important. While some factors affecting the value of your retirement savings may be out of your control, there are many things within your control that can help you safeguard the wealth of those accounts and further their growth. This article addresses common mistakes regarding IRA distributions and contributions, and how to avoid them.

 A recent report by the Treasury Inspector General for Tax Administration, which oversees IRS activities through investigative programs, reports that an increasing number of taxpayers are not complying with IRA contribution and distribution requirements. Mistakes include, among other things, making excess contributions that are left uncorrected or failing to take required minimum distributions from their IRAs.

 Making excess contributions

 Knowing the maximum amount that you can contribute to your IRA is imperative to avoid negative tax consequences. A 6-percent excise tax applies to any excess contribution made to a traditional or Roth IRA. In 2010, individuals can contribute up to $5,000 to both traditional and Roth IRAs. Individuals age 50 or older can also make “catch-up” contributions of up to $1,000 to their IRA in 2010 as well.

 If you withdraw the excess contribution amount on or before the due date (including extensions) for filing your federal tax return for the year, you will not be treated as having made an excess contribution and the 6-percent excise tax will not be imposed. You must also withdraw any earnings on the contributions as well.

 Not contributing enough

 On the opposite end of the spectrum, you may be contributing too little to your IRA. Although your financial and personal situation will dictate how much you contribute to your IRA each year, and whether you are able to contribute the maximum amount, there are benefits to making the maximum contribution. Contributing the maximum amount means larger tax-free or tax-deferred growth opportunity for your dollars, and a higher – expectedly – account value upon retirement. Moreover, contributing more to your traditional IRA means a larger tax deduction come April 15. Thus, failing to contribute the maximum allowable amount means you may be missing out on tax deductions in addition to tax-deferred, or tax-free earnings.

 Not taking your RMDs

 Required minimum distributions (RMDs) are minimum amounts that a traditional IRA account owner must withdraw annually beginning with the year that he or she reaches age 70 ½. The RMD rules also apply to 401(k) plans, Roth 401(k)s, 403(b) plans, 457(b) plans, SIMPLE IRAs, and SEP IRAs. However, Roth IRAs are not subject to RMD rules (beneficiaries of Roth IRAs must take RMDs, however).

If you fail to take a RMD, or fail to take the correct amount for the year, the IRS imposes a 50 percent penalty tax on the difference between the actual amount you withdrew and the amount that was required. This is a stiff penalty to pay. A specific formula is used to compute annual RMDs, based on your current age, the amount in your IRA as of a certain date, and your life expectancy. Generally, RMDs are calculated for each account (if more than one) by dividing the prior December 31st balance of the IRA (or other retirement account) by a life expectancy factor that the IRS publishes in Tables in IRS Publication 590, which can be found on the agency’s website.

Note. RMDs were suspended for the 2009 tax year, in order to help retirement plans hit by the economic downturn. However, individuals must begin taking RMDs again in 2010 and thereafter.

Failing to rollover IRA funds within 60-days

If you receive funds from an IRA and want to roll over the money to another, you have only 60 days to complete the rollover in order to escape paying taxes on transaction. In general, failing to complete a rollover from one IRA to another within the 60-day window has significant tax ramifications. If the funds are not rolled over within this timeframe, the amount is considered taxable income, subject to ordinary income tax rates. And, if you are younger than age 59 ½, you will pay an additional 10 percent tax. The distribution may also have state income tax consequences as well. (Note: Rollovers from traditional IRAs to Roth IRAs are taxable, regardless of whether they are completed within 60 days). If you have the option, make a direct rollover or transfer. A direct, trustee-to-trustee transfer involves your funds being directly rolled over from one financial institution to the other, avoiding the 60-day requirement since you never directly receive the money.

Also, you can generally only make a tax-free rollover of amounts distributed to you from IRAs only once in 12-month period. As such, you can not make another rollover from the same IRA to another IRA (or from a different IRA to the same IRA) for one year without the amount being subject to tax.

And, individuals age 70 ½ or older cannot rollover any RMD amounts. Make sure that if you must take an RMD for the year, you withdraw the amount prior to rolling over the IRA.

Make Roth IRA contributions after age 70 ½

 If you continue earning income after reaching age 70 ½, you can continue contributing to your Roth IRA, on top of not having any RMD requirement. Therefore, you continue to accumulate tax-free savings. If you have earned income, and your financial and personal situation allow, consider continuing contributions to your Roth, building up tax-free money when you withdraw the funds.

 Failing to name an IRA beneficiary

 Don’t make the mistake of neglecting to name a beneficiary for your IRA. IRAs do not pass by will, but rather pass under the terms of an IRA Beneficiary Designation Form. If you have not named a beneficiary of your IRA, such as your spouse or child(ren), the “default” beneficiary usually is the account holder’s estate. Where there is no named beneficiary, distributions from the IRA must then generally be made as a lump sum or within five years after the owner’s death.

 When you designate your child(ren) as the IRA beneficiary, the rules regarding distributions differ from those that govern IRAs held by a surviving spouse beneficiary. Non-spouse IRA beneficiaries must generally begin taking required distributions over their life expectancy or within five years after the IRA owner's death. Although taking required distributions, the undistributed IRA assets continue to grow in a tax-deferred manner. On the other hand, a surviving spouse beneficiary may elect to treat the IRA as his or her own, or take minimum distributions as a non-spouse beneficiary would.

 Distributions from inherited IRAs are taxable to the recipient as ordinary income. Generally, the income tax rate tends to be higher when an IRA is paid to the estate instead of an individual beneficiary.

 Roth IRA conversions

 This year may be the first time you are eligible to convert your traditional IRA to a Roth. Beginning in 2010, any individual regardless of adjusted gross income (AGI) or filing status can take advantage of a Roth IRA conversion. Prior to 2010, the ability to convert a traditional IRA to a Roth was limited to individuals with AGIs of less than $100,000. Also, married individuals filing a separate return could not convert to a Roth IRA either. If you convert in 2010, you can elect to split (and defer) the tax you will owe on the conversion and pay half in 2011 and half in 2012.

 The decision to convert to a Roth IRA depends on many factors, including the financial and tax consequences of the transaction. Sometimes, it may be wiser depending on your situation to stick with your traditional IRA, especially if you will pay more tax on the conversion than in the account, or you don’t have outside funds to pay for the conversion tax. Do the math carefully and talk with your tax advisor beforehand.