IRS Releases Guidance for Section 199A Pass-Through Deduction

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the “pass-through deduction” or the “qualified business income deduction.” Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final. Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97). In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity. Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

  • each trade or business is itself a trade or business;
  • the same person or group owns a majority interest in each business to be aggregated;
  • none of the aggregated trades or businesses can be a specified service trade or business; and
  • the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers. A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

  • gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
  • gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

  • endorsing products or services;
  • licensing the use of an individual’s image, name, trademark, etc.; or
  • receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

  • W-2 wages that are allocable to QBI; and
  • unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction. The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, “immediately after acquisition” is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

  • definitions;
  • basic computations;
  • loss carryovers;
  • Puerto Rico businesses;
  • coordination with other Code Sections;
  • penalties;
  • special basis rules;
  • previously suspended losses and net operating losses;
  • other exclusions from qualified business income;
  • allocations of items that are not attributable to a single trade or business;
  • anti-abuse rules;
  • application to trusts and estates; and
  • special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

  • several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
  • anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
  • if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018. The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.

Proposed Regs on Pass-Through Deduction Generate Mixed Reviews

The IRS’s proposed pass-through deduction regulations are generating mixed reactions on Capitol Hill. The 184-page proposed regulations, REG-107892-18, aim to clarify certain complexities of the new, yet temporary, Code Sec. 199A deduction of up to 20 percent of income for pass-through entities. The new deduction was enacted through 2025 under the Tax Cuts and Jobs Act (TCJA), ( P.L. 115-97). The pass-through deduction has remained one of the most controversial provisions of last year’s tax reform. A legislative package that would make permanent the pass-through deduction, as well as other individual tax cuts, is expected to move though the House this fall. However, the House’s legislative efforts are not expected, at this time, to pass muster in the more narrowly GOP-controlled Senate.

Criticism

Several Democratic lawmakers and tax policy experts have already started to weigh in on the proposed regulations, which were released on August 8 while Congress remained in its annual August recess. Democrats have criticized the new deduction for primarily benefiting the wealthy. Meanwhile, several tax policy experts have taken to Twitter to note that the deduction is overly complex and administratively burdensome. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has reportedly said that the proposed regulations “confirm that the fortunate few win,” under the new tax law. “Tax planners are already scouring through the nearly 200 pages of regulations in search of new ways to keep wealthy clients from paying their fair share.”

Compliance Burdens

The pass-through deduction could add 25 million hours to taxpayers’ annual reporting burden, according to the proposed regulations. Additionally, the IRS has estimated that gross reporting annualized costs to taxpayers will total approximately $1.3 billion over 10 years. Furthermore, the IRS has estimated that the compliance burden will vary between taxpayers, averaging between 30 minutes and 20 hours. The administrative burden on smaller pass-through entities is anticipated to be on the lower end of the estimate, according to the IRS. Comment. Ryan Kelly, partner at Alston & Bird LLP, told Wolters Kluwer on August 13 that the IRS’s 25 million-hour estimate, whether accurate or not, suggests that there will be a significant increase in administrative compliance costs. “There is a real cost to tax compliance in lost time and productivity for taxpayers,” Kelly said. However, Kelly predicted that taxpayers’ Code Sec. 199A compliance burden will eventually decrease. “Time will reveal the extent of taxpayers’ administrative burden to comply; however, it is likely that as time goes on the taxpayers’ compliance burden will fall as taxpayers, tax practitioners, and the Service all become more familiar with section 199A and how it is intended to operate.” Meanwhile, the chairs of the House and Senate tax writing committees have both praised Treasury and the IRS for quickly releasing the much anticipated regulations. Additionally, several tax policy experts have also praised the proposed regulations for alleviating confusion, as well as taxpayer anxiety, about ambiguous provisions of the law. “This first-ever 20 percent deduction for small businesses allows our local job creators to keep more of their money so they can hire, invest, and grow in their communities,” House Ways and Means Committee Chairman Kevin Brady, R-Tex., said in a statement. “These proposed regulations are intended to provide certainty and flexibility for Main Street businesses in this historic new small business deduction.” Improvements to the proposed regulations are expected in the coming months as stakeholders submit comments. A public hearing at IRS headquarters in Washington, D.C., has been scheduled for October 16. “Evolution of tax regulations is generally never a pretty process, but it is a necessary process that in this case will hopefully happen sooner rather than later,” Kelly told Wolters Kluwer.

Brady Unveils Tax Reform 2.0 Framework

The House’s top tax writer has unveiled Republicans’ “Tax Reform 2.0” framework. The framework outlines three key focus areas:

  • making permanent the individual and small business tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97);
  • promoting family savings by streamlining retirement savings accounts and creating a new Universal Savings Account; and
  • spurring business innovation by allowing new businesses to write off more initial start-up costs.

Tax Reform 2.0

The GOP’s tax reform “phase two” framework—otherwise known as “Tax Cuts 2.0″—was released by House Ways and Means Committee Chairman Kevin Brady, R-Tex. on July 24. The outline is expected to be used for GOP “listening sessions” to be held among lawmakers. Brady has said that making permanent the TCJA’s individual and small business tax cuts, enacted last December temporarily through 2025, will be the “centerpiece” of the next tax reform package. Further, Brady told reporters on July 24 that he anticipates Tax Reform 2.0 to move forward as three separate tax bills. A House vote on the package is expected sometime in September.

Preliminary Analysis

Republicans’ Tax Reform 2.0 framework is a “good start,” according to a July 24 report released by the independent, yet widely-considered conservative-leaning, think tank Tax Foundation. The report praised the framework’s proposal to streamline retirement savings accounts and make permanent the TCJA’s individual tax cuts. Additionally, the Tax Foundation estimates that making permanent the individual tax cuts set to expire in 2026 would grow the U.S. economy by 2.2 percent while reducing federal revenue by $165 billion annually on a static basis.

Democrats Disagree

However, several Democratic lawmakers began issuing statements criticizing the Tax Reform 2.0 framework shortly after its release. Democrats have remained united in their disapproval of the TCJA, criticizing last year’s tax code overhaul for primarily benefiting the wealthy and corporations. “Republicans’ first tax bill exposed the party’s real priorities: big corporations and people at the top,” House Ways and Means Committee ranking member Richard Neal, D-Mass., said in a July 24 statement. “This new framework is more of the same – it rewards the well-off and well-connected, fails to reinstate the state and local tax deduction, and leaves the middle class behind.”

Corporate Tax Cuts

The Tax Reform 2.0 framework did not include a proposal to further reduce the corporate tax rate. President Trump has called for lowering the corporate tax rate to 20 percent. The corporate tax rate was lowered from 35 to 21 percent last December under the TCJA. Brady previously told reporters that House Republicans and the White House are continuing discussions on the idea.

Tax Reform 3.0, 4.0

“Tax Reform 2.0 is a new commitment to improve the tax code each and every year for American families and local businesses,” the framework says. Congress will examine the tax code each year to identify areas of needed improvement, according to the outline. Additionally, Brady has said he hopes to see a Tax Reform 3.0, 4.0, and so on.

Senate

At this time, the Tax Reform 2.0 package is not expected to clear the Senate in its entirety. It is thought on Capitol Hill that Democrats may support measures that focus on retirement and education savings and business innovation. However, several lawmakers view it as unlikely that Democrats would support a bill that makes permanent the individual tax cuts under the TCJA. Brady has reportedly said that extending TCJA’s individual provisions would increase the deficit by $600 billion over 10 years but would be offset, at least in part, by beneficial economic factors. Several Senate Democrats and Republicans have said they would not vote for extending or creating tax cuts that increase the federal deficit.

Senate Panel Examines IRS Administration; Congress Works Toward Bipartisan IRS Reform

The IRS faces numerous challenges, most of which are attributable to funding cuts, the National Taxpayer Advocate Nina Olson told a Senate panel on July 26. “The IRS needs adequate funding to do its job effectively,” Olson told lawmakers.

IRS Funding

Olson, while testifying at a Senate Finance Committee (SFC) Taxation and IRS Oversight Subcommittee hearing, placed blame on both congressional appropriations and IRS management for the Service’s challenges. “While some of the IRS’s struggles can be addressed by better management, much of the IRS’s challenges are attributable to funding cuts,” Olson said. The IRS has simultaneously seen an increased workload and budget reduction of 20 percent when accounting for inflation between fiscal years 2010 and 2018, according to Olson. “Because of these reductions, the IRS does not have enough employees to answer the phones, to conduct outreach and education, or to provide basic taxpayer service,” she added. Further, Olson noted that the IRS answered only 29 percent of telephone calls received on the Accounts Management lines during this year’s filing season. Additionally, IRS compliance and enforcement efforts have also struggled, Olson said, adding that the audit rate is at its lowest level in “memory.” Likewise, Phyllis Jo Kubey, testifying on behalf of the National Association of Enrolled Agents, IRS Advisory Council, remarked on decreased IRS funding. “The agency is handicapped by budgeting that is not only insufficient to meet its large and growing portfolio, but also inefficiently structured,” Kubey told lawmakers.

IRS Reform

The SFC subcommittee hearing came just days after the 20-year anniversary of the IRS Restructuring and Reform Act of 1998. The House and Senate are currently working toward approving bipartisan legislation that would significantly reform the IRS for the first time in 20 years. SFC Taxation and IRS Oversight Subcommittee Chairman Rob Portman, R-Ohio, and Sen. Ben Cardin, D-Md., unveiled on July 26 the bipartisan Protecting Taxpayers Bill. The measure aims to reform a number of IRS functions and administrative practices, according to a joint press release issued the same day. “It has been 20 years since the last significant IRS reform, and it is time to update the agency once again,” Portman said in the press release. Similarly, Cardin praised the bill for including needed updates to modernize the IRS. “Americans of all income levels deserve a responsive, effective IRS, and the updates contained in this bipartisan bill will help keep the IRS on that path,” Cardin said. Additionally, SFC Chairman Orrin G. Hatch, R-Utah, and ranking member Ron Wyden, D-Ore., recently introduced the bipartisan Taxpayer First Bill ( Sen. 3246). The measure would also reform certain administrative practices at the IRS. To that end, the House approved its bipartisan IRS reform package, the Taxpayer First Bill ( HR 5444) last April. The House package contains several proposals, which would, among other things:

  • establish a single point of contact for tax-related identity theft victims;
  • expand the use of Low-Income Taxpayer Clinics (LITCs); and
  • require electronic filing for certain tax-exempt organizations

Path Forward

Hatch previously told Wolters Kluwer that the House’s IRS reform proposals are a “welcomed step forward.” Additionally, Hatch told Wolters Kluwer that he will work with his “colleagues in Congress to find a path forward that reflects both the House and Senate views.”

Senate GOP Tax Writers Clarify Intent on Certain Tax Reform Provisions

Senate Finance Committee (SFC) Republicans are clarifying congressional intent of certain tax reform provisions. In an August 16 letter, GOP Senate tax writers called on Treasury and the IRS to issue tax reform guidance consistent with the clarifications. The letter, addressed to Treasury Secretary Steven Mnuchin and Acting IRS Commissioner David Kautter, identifies three sections of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) needing clarification:

  • Section 13204 – qualified improvement property expensing;
  • Section 13302 – net operating losses (NOLs) deduction; and
  • Section 13307 – sexual misconduct settlement deduction.

Real Property Depreciation

Congressional intent for Section 13204 under the TCJA was to provide a 15-year modified accelerated cost recovery system (MACRS) recovery period for qualified improvement property, the lawmakers wrote. Additionally, the letter states that the new law should also provide a 20-year alternative deprecation system (ADS) recovery period for qualified improvement property.

NOLs

The TCJA contains a typographical error in Section 13302. The law should state that the NOL carryforward and carryback modifications are effective for NOLs arising in tax years beginning after December 31, 2017, the lawmakers noted. Currently, the legislative text states the effective date is for tax years ending after December 31, 2017.

Attorney’s Fees

Generally, section 13307 of the TCJA denies a deduction for attorney’s fees related to a settlement or payment stemming from a sexual harassment/abuse nondisclosure agreement (NDA). Congressional intent was that attorney’s fees would not be subject to the rule prohibiting the deduction, the letter states.

Technical Corrections

SFC Republicans intend to introduce a technical corrections bill addressing other needed clarifications of the TCJA, the letter notes. The intended technical corrections bill is not expected to be a part of Republican “Tax Reform 2.0” efforts. “While this letter focuses on these three important provisions, we are continuing a thorough review…to identify other instances in which the language as enacted may require regulatory guidance or technical corrections to reflect the intent of the Congress. After this review, we intend to introduce technical corrections legislation to address any items identified in the on-going review.”

AICPA: Immediate Guidance Needed on S Corporation Issues

Taxpayers and practitioners need clarity on certain S corporation issues by next tax filing season, the American Institute of CPAs (AICPA) has said. In an August 13 letter sent to Treasury and the IRS, the AICPA requested immediate guidance on certain S corporation provisions under the Tax Cuts and Jobs Act (TCJA) (P.L. 115-97).

S Corporations

S corporations elect to pass corporate income, losses, deductions, and credits through to shareholders for federal tax purposes. Thus, S corporations are considered a pass-through entity. This election allows S corporations to avoid double taxation on the corporate income, according to the IRS. “Taxpayers and practitioners need clarity on S corporation issues in order to comply with their 2018 tax obligations and to make informed decisions regarding cash-flow, entity structure, and tax planning issues,” Annette Nellen wrote in the letter on behalf of the AICPA. Generally, the letter noted the following three areas for which guidance is needed:

  • application of the new laws on loss carryforwards;
  • clarification of certain provisions relating to the post-termination transition period (PTTP) and the eligible terminated S corporation period (ETSC Period); and
  • treatment of deferred foreign income upon transition to participation exemption system of taxation for S corporation trust shareholders.

Earlier this year, the AICPA also called for guidance on the Code Sec. 199A new pass-through deduction.

IRS Releases Guidance for Section 199A Pass-Through Deduction

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the “pass-through deduction” or the “qualified business income deduction.” Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final. Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97). In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity. Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

  • each trade or business is itself a trade or business;
  • the same person or group owns a majority interest in each business to be aggregated;
  • none of the aggregated trades or businesses can be a specified service trade or business; and
  • the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers. A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

  • gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
  • gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

  • endorsing products or services;
  • licensing the use of an individual’s image, name, trademark, etc.; or
  • receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

  • W-2 wages that are allocable to QBI; and
  • unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction. The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, “immediately after acquisition” is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

  • definitions;
  • basic computations;
  • loss carryovers;
  • Puerto Rico businesses;
  • coordination with other Code Sections;
  • penalties;
  • special basis rules;
  • previously suspended losses and net operating losses;
  • other exclusions from qualified business income;
  • allocations of items that are not attributable to a single trade or business;
  • anti-abuse rules;
  • application to trusts and estates; and
  • special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

  • several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
  • anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
  • if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018. The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.

Regulations Issued on Partnership Representative Under Centralized Partnership Audit Regime

The IRS has issued final regulations regarding the designation and authority of the partnership representative under the centralized partnership audit regime. The final regulations make a number of changes to prior proposed regulations.

Eligibility to Serve as Representative

The final regulations clarify that:

  • a disregarded entity can serve as a partnership representative; and
  • a partnership may designate itself as its own partnership representative.

In either case, the entity must have substantial presence in the United States, and must appoint a designated individual that has a substantial presence in the United States to act on the entity’s behalf as partnership representative. In addition, the final regulations remove the capacity-to-act requirement contained in the proposed regulations. This is because the partnership should have as much flexibility as possible in determining a partnership representative so long as the person meets the substantial presence in the United States requirements.

Time for Changing the Representative

The final regulations allow the partnership to change the partnership representative through revocation when the partnership is notified that the partnership return is selected for examination as part of an administrative proceeding, in addition to when the notice of administrative proceeding (NAP) is mailed. Under the proposed regulations, the partnership was not able to change the partnership representative until it received the NAP.

Resigning Representative

The final regulations remove the ability of a resigning partnership representative or designated individual to designate a successor. Because it is unfair to the partnership to allow a resigning partnership representative to request adjustments to items of a partnership, the final regulations also have been revised to prohibit a resignation at the time of the filing of an administrative adjustment request.

Other Changes

Among the additional changes contained in the final regulations are changes to:

  • the ability to revoke partnership representative status;
  • the effective date of a revocation or resignation of a partnership representative;
  • notification requirements for resigning partnership representation or revocation of partnership representation designation; and
  • IRS designation of a partnership representative.

Temporary Regulations Removed

The final regulations remove temporary regulations regarding the election to apply the centralized partnership audit regime to partnership tax years beginning after November 2, 2015, and before January 1, 2018.

Effective Date

The final regulations are effective on August 9, 2018, the date when published in the Federal Register.

Proposed Rules Address 100-Percent Depreciation Deduction

Proposed regulations address the new 100-percent depreciation deduction that allows businesses to write off most depreciable business assets in the year they are placed in service.

Background

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) amended Code Sec. 168(k) to increase the percentage of the additional first year depreciation deduction from 50 percent to 100 percent for property acquired after September 27, 2017. It also expanded the property eligible for the additional first year depreciation to include certain used depreciable property and certain film, television, or live theatrical productions. Generally, the 100-percent depreciation deduction generally applies to depreciable business assets with a recovery period of 20 years or less and certain other property. Such assets include in part machinery, equipment, computers, appliances, and furniture. The proposed regulations provide guidance on what property qualifies for the deduction, and rules for qualified film, television, live theatrical productions and certain plants.

Property of a Specified Type

In order to be considered qualified property, the proposed regulations require that property must be:

  • MACRS property that has a recovery period of 20 years or less;
  • computer software as defined in, and depreciated under, Code Sec. 167(f)(1);
  • water utility property as defined in Code Sec. 168(e)(5);
  • a qualified film or television production as defined in Code Sec. 181(d);
  • a qualified live theatrical production as defined in Code Sec. 181(e); or
  • a specified plant as defined in Code Sec. 168(k)(5)(B) and for which the taxpayer has made an election to apply Code Sec. 168(k)(5)(B).

Qualified improvement property acquired after September 27, 2017, and placed in service after September 27, 2017, and before January 1, 2018, also is qualified property.

Placed-in-Service Date

The proposed regulations provide that qualified property must be placed in service by the taxpayer after September 27, 2017, and before January 1, 2027, or before January 1, 2028, in the case of certain aircraft property described in Code Sec. 168(k)(2)(B) or (C). For specified plants, if the taxpayer has made an election to apply Code Sec. 168(k)(5), the proposed regulations provide that the specified plant must be planted before January 1, 2027, or grafted before January 1, 2027. The proposed regulations also provide that a qualified film or television production is treated as placed in service at the time of initial release or broadcast as defined under Reg. §1.181-1(a)(7). Further, a qualified live theatrical production is treated as placed in service at the time of the initial live staged performance.

Acquisition Date

The proposed regulations provide the date of acquisition rules for different types of property, including self-constructed qualified film, television, or live theatrical productions, and specified plants. Under the proposed regulations, the property must be acquired by the taxpayer after September 27, 2017, or acquired by the taxpayer pursuant to a written binding contract after September 27, 2017. The proposed regulations also provide that property that is manufactured, constructed, or produced for the taxpayer by another person under a written binding contract that is entered into before the manufacture, construction, or production of the property for use by the taxpayer in its trade or business or for its production of income is acquired pursuant to a written binding contract. For self-constructed property, the proposed regulations provide that the acquisition rules are met if the taxpayer begins manufacturing, constructing, or producing the property after September 27, 2017. The proposed regulations provide that a qualified film or television production is treated as acquired on the date principal photography commences. Qualified live theatrical production is treated as acquired on the date when all of the necessary elements for producing the live theatrical production are secured. These elements may include a script, financing, actors, set, scenic and costume designs, advertising agents, music, and lighting. For a specified plant, the proposed regulations provide that the specified plant must be planted after September 27, 2017, or grafted after September 27, 2017, to a plant that has already been planted, by the taxpayer in the ordinary course of the taxpayer’s farming business.

Elections

The proposed regulations provide rules for making the election out of the additional first year depreciation deduction. Taxpayers who elect out of the 100-percent depreciation deduction must do so on a timely-filed return. Those who have already filed their 2017 return and either did not claim the mandatory deduction on qualifying property, or did not elect out but still wish to do so, will need to file an amended return.

Applicable Date

These regulations apply to qualified property placed in service or planted or grafted, as applicable, by the taxpayer during or after the taxpayer’s tax year that includes the date that the regulations are adopted as final. Pending the issuance of the final regulations, a taxpayer may choose to apply the proposed regulations to qualified property acquired and placed in service or planted or grafted, as applicable, after September 27, 2017, by the taxpayer during tax years ending on or after September 28, 2017.

Regulations Proposed on Code Sec. 965 Transition Tax

Proposed regulations provide rules for determining the Code Sec. 965 inclusion amount of a U.S. shareholder of a foreign corporation with deferred foreign income. The tax imposed on the inclusion is referred to as the transition tax. The proposed regulations address open questions regarding the application of the transition tax, and reflect previously issued guidance, with some modifications. The proposed regulations apply beginning with the last tax year of a foreign corporation that begins before January 1, 2018, and with respect to a U.S. person, beginning with the tax year in which or with which the tax year of the foreign corporation ends.

Background

Generally, a foreign corporation’s earnings are not taxed to its U.S. shareholders until the earnings are repatriated as a dividend to its U.S. shareholders. If the foreign corporation earns certain types of income or invests in U.S. property, the U.S. shareholder may be taxed currently under the provisions of Code Sec. 951 and Subpart F. To combat the incentive for U.S. shareholders to keep their earnings and profits overseas, the Tax Cuts and Jobs Act ( P.L. 115-97) enacted a one-time mandatory tax on the untaxed post-1986 earnings and profits of foreign subsidiaries of U.S. shareholders. Earnings held in the form of cash and cash equivalents are taxed at a 15.5 percent rate and remaining earnings are taxed at an 8 percent rate. The transition tax may be paid in installments over eight years. Specifically, the transition tax is imposed on U.S. shareholders who own 10 percent or more, by vote, of a deferred foreign income corporation (DFIC). A DFIC is any specified foreign corporation that has a positive amount of accumulated post-1986 deferred foreign income on one of two measurement dates: November 2, 2017, or December 31, 2017. U.S. shareholders include the domestic pass-through owners of a domestic pass-through U.S. shareholder. A specified foreign corporation is either:

  • a controlled foreign corporation (CFC); or
  • any foreign corporation in which a domestic corporation is a U.S. shareholder.

For the last tax year of the DFIC beginning before January 1, 2018 (the inclusion year), the U.S. shareholder includes as subpart F income its pro rata share of accumulated post-1986 foreign earnings of the foreign corporation determined on November 2, 2017, or on December 31, 2017, whichever is greater. Beginning in December 2017, the IRS released the following pieces of guidance that taxpayers could rely on when applying the transition tax:

  • Notice 2018-7, 2018-4 IRB 317;
  • Notice 2018-13, 2018-6 IRB 341; and
  • Notice 2018-26, 2018-16 IRB 480.

What Do the Proposed Regulations Cover?

The proposed regulations provide:

  • general rules and definitions, including general rules for determining the Code Sec. 965(a) inclusion amount, the Code Sec. 965(c) deduction, and rules for the treatment of certain specified foreign corporations as CFCs and certain domestic partnerships as foreign partnerships;
  • rules for adjustments to E&P and basis;
  • specific rules for Code Sec. 965(c) deductions;
  • rules that disregard certain transactions when applying the transition tax;
  • rules related to foreign tax credits that coordinate the transition tax rules and foreign tax provisions prior to repeal by P.L. 115-97;
  • rules regarding elections and payments; and
  • rules for applying the transition tax to affiliated groups and that treat all U.S. shareholders of a specified foreign corporation in a consolidated group as a single shareholder.

Many of the rules in the proposed regulation are consistent with the guidance previously provided in the Notices. For example, consistent with the Notice 2018-26, the proposed regulations address the application of the constructive ownership rules that provide for downward attribution of stock from a partner to a partnership. Because the rules make it difficult to determine if a foreign corporation is a specified foreign corporation, stock owned, directly or indirectly, by or for a partner will not be considered owned by the partnership if the partner owns less than five percent of the partnership’s capital and profits interests. Other rules in the proposed regulations that are consistent with the Notices include:

  • rules that require that the status of a specified foreign corporation as a DFIC be determined before its status as an E&P deficit corporation;
  • rules for determining cash measurement dates and pro rata share;
  • rules that address the treatment of derivative financial instruments for purposes of measuring the cash position of a specified foreign corporation;
  • definitions of accounts payable and accounts receivable, and loans treated as short-term, for determining the cash position of a specified foreign corporation;
  • foreign currency rules, including that the accumulated post-1986 deferred foreign income of the specified foreign corporation as of each of the measurement dates must be compared in the functional currency of the specified foreign corporation, and use of the spot rate for translating amounts taken into account;
  • rules for preventing double counting the aggregate foreign cash position, and preventing double counting and non-counting in computing deferred earnings for amounts paid between related parties and measurement dates;
  • anti-avoidance rules disregarding certain transactions, and rules disregarding certain changes in accounting methods and entity classification elections;
  • rules on the Code Sec. 962 election for an individual to be taxed as a corporation; and
  • clarification of the interaction between the transition tax and the previously taxed income rules.

Elections

The proposed regulations also provide the mechanics for making the following transition tax elections:

  • the election to pay net tax liability in eight installments ( Code Sec. 965(h));
  • the election by an S corporation shareholder to defer a portion of net tax liability ( Code Sec. 965(i));
  • the election of a real estate investment trust (REIT) to defer the inclusion in gross income ( Code Sec. 965(m)); and
  • the election not to apply the net operating loss deduction ( Code Sec. 965(n)).

The proposed regulations provide that because a domestic pass-through owner will take its inclusion into account, whether or not it is a U.S. shareholder, the owner may make the elections under Code Sec. 965(h), Code Sec. 965(m), and Code Sec. 965(n). The proposed regulations define a new term “total net tax liability”. The term reflects the definition of net tax liability with respect to a person, as if the person were a U.S. shareholder of all DFICs with respect to which it has inclusions. Dividends excluded, however, include dividends received directly or through a chain of ownership. The proposed regulations clarify when an underpayment of an installment constitutes an acceleration event or a proration of a deficiency to installments. A deficiency or additional amount will be prorated among installments if:

  • the person is assessed a deficiency with respect to the Code Sec. 965(h) net tax liability;
  • the person timely files a return increasing the amount of the Code Sec. 965(h) net tax liability above the amount taken into account in the payment of the first installment; or
  • the person files an amended return increasing the amount of its Code Sec. 965(h) net tax liability.

Circumstances in which an installment payment will be accelerated are identified, including any exchange or other disposition of substantially all of the assets of a taxpayer and an event that results in a person no longer being a U.S. person. Additionally, an “eligible section 965(h) transferee exception” is provided if the acceleration event is eligible for the exception and the terms of the transfer agreement are met. Taxpayers may choose to apply the election and payment rules to all tax years as if they were final rules.

IRS Replaces Proposed Rules on Partnership Audit Regime

The IRS has released proposed regulations governing the centralized partnership audit regime. These regulations replace some existing proposed rules to reflect changes made by the Tax Technical Corrections Act of 2018 (TTCA, P.L. 115-141). The new proposed regulations also provide some additional clarifications.

Partnership Items and Partnership-Related Items

The TTCA generally used “partnership-related items” instead of “items of income, gain, loss, deduction, or credit of a partnership.” This clarified that the centralized partnership audit regime is not intended to be narrower than the TEFRA partnership audit procedures. The new proposed regulations reflect these changes. They apply to:

  • the scope of the centralized partnership audit regime; and
  • the requirement for a partner’s return to be consistent with the partnership’s return.

Imputed Underpayments

The new proposed rules incorporate several changes TTCA made to the rules for imputed underpayments. These include:

  • adjustments arising from partnership-related items;
  • how to net adjustments;
  • determining the amount of an imputed underpayment;
  • adjustments that reallocate distributive shares among partners;
  • modifications to adjustments rather than to underpayments;
  • amended returns to reflect adjustments;
  • assessment, collection and payment of imputed underpayments;
  • related interest and penalties; and
  • required jurisdiction deposit for judicial review of the final partnership adjustment (FPA).

In addition, the new proposed regulations make technical changes that are unrelated to TTCA to clarify the Code Sec. 6226 election for the partners to take the adjustment into account.

Administrative Adjustment Requests

The new proposed regulations reflect several changes in the procedures for a partnership to file an administrative adjustment request (AAR). These changes relate to:

  • partnership-related items;
  • when the partnership takes the adjustment into account; and
  • coordination of the adjustment rules and the imputed underpayment rules.

The new proposed regulations also make changes unrelated to TTCA, including:

  • coordination of the AAR rules with revoking the designation of a partnership representative;
  • a withdrawn notice of administrative proceeding (NAP);
  • rules for pass-through partners.

Other Changes

The new proposed regulations reflect TTCA changes on the timing of a notice of any proposed partnership adjustment (NOPPA) resulting from an administrative proceeding, and a notice of any final partnership adjustment (FPA).

In addition, the new proposed regulations clarify the limitations period for making adjustments.

Finally, the new proposed regulations incorporate technical TTCA changes in:

  • several definitions and special rules;
  • coordination of the centralized partnership audit regime with other provisions of the Code;
  • special enforcement considerations; and
  • shareholders in controlled foreign corporations.

Comments Requested

A public hearing is scheduled at the IRS Building at 10 a.m. on October 9, 2018. The IRS must receive any written or electronic comments, as well as an outline of topics for discussion at the hearing, by September 27, 2018. Comments may be mailed or hand-delivered to the IRS, or submitted electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-136118-15).

Short-Term Health Insurance Exemption from ACA Consumer Protections Broadened

The Departments of Health and Human Services, Labor, and Treasury have amended the definition of short-term, limited-duration individual health insurance coverage, by allowing such coverage to last up to 364 days rather than up to three months. The amendments apply 60 days after August 3, 2018, the date the new regulations were published in the Federal Register.

Short-Term Coverage and the ACA

Short-term, limited-duration insurance is a type of health insurance coverage designed to fill temporary gaps in coverage that may occur when an individual is transitioning from one plan or coverage to another. Short-term coverage is exempt from the minimum essential coverage requirements under the Affordable Care Act (ACA) ( P.L. 111-148) because it is not considered individual health insurance. Although short-term coverage does not satisfy the requirements for avoiding individual mandate liability, the individual mandate does not apply after 2018.

In 2016, the Obama Administration changed the maximum term from less than one year to less than three months. They wanted to make it more difficult for insurers to offer stripped down, short-term coverage to the young and healthy in competition with Affordable Care Act individual market coverage that has to be available to any applicant.

Making Short-Term Coverage More Viable

The Trump Administration has made it a priority to make short-term insurance more viable as a means of getting around the Affordable Care Act’s prohibition against pre-existing condition exclusions. The amended rule—

  • changes the maximum period back up to less than one year (i.e., 364 days); and
  • provides that short-term contracts may be renewed for a maximum period of less than 36 months.

Because issuers of short-term contracts can pick and choose whom and what they will cover, the costs of coverage will be far less, and the expectation is that these savings will be passed along in lower premiums. Younger and healthier individuals should benefit, but older individuals and individuals with pre-existing conditions will still need to obtain more expensive Affordable Care Act-compliant coverage in order to have their pre-existing conditions covered. Affordable Care Act-compliant coverage might become more expensive as younger and healthier individuals leave these plans, leaving behind an older and sicker risk pool.

Because the individual mandate is eliminated after 2018, insurers have no reason not to offer short-term plans starting in 2019.

Group Health Plans

Although these changes are primarily aimed at the individual insurance markets rather than group plans, the definition of short-term, limited-duration insurance is relevant to group health plans and group health insurance issuers. For example, an individual who loses coverage due to moving out of an HMO service area in the individual market triggers a special enrollment right into a group health plan ( Reg. §54.9801-6(a)(3)(i)(B)). Also, a group health plan that wraps around individual health insurance coverage is an excepted benefit if certain conditions are satisfied ( Reg. §54.9831-1(c)(3)(vii)).

Amendments of Reg. §§54.9801–2 and 54.9833–1, amending the definition of short-term, limited-duration insurance for purposes of its exclusion from the definition of individual health insurance coverage, are adopted.

Hardest Hit Fund Safe Harbor Modified

The IRS has modified the safe harbor for computing deductible mortgage interest under Code Sec. 163 and real property taxes under Code Sec. 164(a)(1) by homeowners participating in the Housing Finance Agency Innovation Fund for the Hardest-Hit Housing Markets (HFA Hardest Hit Fund).

Previous guidance provided that the safe harbor is available for tax years 2010 through 2021 to homeowners who, for the tax year, (1) meet the requirements to deduct all of the mortgage interest and real property taxes relating to the principal residence; and (2) participate in a state program in which program payments can be used to pay interest on the home mortgage. However, for tax years beginning in 2018 through 2025, Code Sec. 164(b)(6) limits an individual’s itemized deduction for certain state and local taxes—including state and local real property taxes—to only $10,000 ($5,000 if married filing separately).

The modified guidance makes the safe harbor available even if the Code Sec. 164(b)(6) limitation precludes a homeowner from deducting all of the real property taxes imposed on the principal residence. Thus, for tax years 2010 through 2021, a homeowner may deduct the lesser of:

  • the sum of all mortgage payments the homeowner actually makes during the tax year; or
  • the amounts shown on Form 1098, Mortgage Interest Statement, plus real property taxes and deductible mortgage insurance premiums.

If the deduction is the sum of all payments made during a tax year, the homeowner may first allocate amounts paid to mortgage interest up to the amount shown on form 1098, and then use any reasonable method to allocate the remaining balance of the payments to real property taxes, mortgage insurance premiums, home insurance premiums, and principal. Any part allocated to state or local property taxes is subject to the Code Sec. 164(b)(6) limitation.

IRS Extends Filing, Payment Deadlines for California Wildfire Victims

The IRS has extended filing and payment deadlines for certain California taxpayers affected by wildfires. Taxpayers in Shasta County may qualify for tax relief.

Extended Deadlines

Individuals and businesses have until November 30, 2018, to file returns and pay any taxes that were originally due on or after July 23, 2017. This includes:

  • estimated tax payments due on September 17, 2018;
  • payroll and excise tax returns due on July 31, 2018, and October 31, 2018.

Individuals with filing extensions for 2017 now have until November 30, 2018, to file their returns. However, the payment extension does not apply to related tax payments that were originally due on April 18, 2018.

Calendar-year businesses with filing extensions also have additional time to file returns, including:

  • partnerships whose 2017 extensions run out on September 15, 2018; and
  • tax-exempt organizations whose 2017 extensions run out on November 15, 2018.

Waiver of Late Deposit Penalties

The IRS will also waive late-deposit penalties for federal payroll and excise tax deposits that are normally due during the first 15 days of the disaster period. Taxpayers can find information about these extended due dates at https://www.irs.gov/newsroom/tax-relief-for-victims-of-wildfires-and-high-winds-in-north-california.

Automatic Extensions

The extended filing and payment deadlines are automatic for any taxpayer with an IRS address of record in the disaster area. These taxpayers do not have to contact the IRS to qualify for the extended deadlines. An affected taxpayer who receives a late filing or late payment notice should contact the IRS at 866-562-5227.

Taxpayers Outside Disaster Area

Finally, the IRS will work with other taxpayers who are affected by the disaster even if they live or work outside the disaster area. Taxpayers should contact the IRS if they:

  • have tax or business records in the affected area; or
  • are assisting relief activities and are affiliated with a recognized government or philanthropic organization.
Discharge Relief Available for Private Student Loan Debtors

The IRS has provided relief to taxpayers who took out private student loans to finance attendance at a school owned by Corinthian College, Inc. (CCI) or American Career Institutes, Inc. (ACI). Under this guidance, a taxpayer will be able to exclude from gross income the discharged amount of a private student loan taken out to finance attendance at ACI or CCI. In addition, taxpayers also will not be required to increase taxes owed in the year of discharge for prior claimed credits or deductions attributable to payments made on these private student loans. Further, the IRS will not require a creditor to file returns and furnish payee statements for the discharged indebtedness.

The relief is effective for tax years beginning on or after January 1, 2015, for private student loans taken out to finance attendance at schools owned by CCI. Further, it is effective for tax years beginning on or after January 1, 2016, for private student loans taken out to finance attendance at schools owned by ACI. Taxpayers may apply this guidance in tax years for which the limitations period on claims for a credit or refund under Code Sec. 6511 has not expired.

Small Businesses Get Automatic Consent for Accounting Method Changes

The IRS will provide automatic consent to a small business taxpayer’s application to change to the cash method of accounting. Eligible small business taxpayers, as defined by the Tax Cuts and Jobs Act (P.L. 115-97), are generally those with average annual gross earnings of $25 million or less in the prior three-year period. The automatic consent changes include:

  • a switch to the cash method of accounting;
  • exemption from UNICAP for certain costs, including self-constructed assets;
  • certain changes to inventory items;
  • a change from the percentage-of-completion method for long-term construction contracts; and
  • exemption from UNICAP for home construction contracts.
Exempt Organizations May Not Need to Include Donor Information on Returns

Tax-exempt organizations, other than charities exempt under Code Sec. 501(c)(3), will soon be able to stop reporting the names and addresses of contributors on Schedule B when filing their information returns. Organizations exempt from tax under Code Sec. 501(a) that are required to file Form 990, Return of Organization Exempt from Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax, will still be required to collect and record this donor information, and make it available to the IRS upon request.

Background

Tax-exempt organizations are required to keep records and accounts of gross income, receipts, and disbursements under Reg. §1.6001-1(c). Code Sec. 6033(a) requires certain tax-exempt organizations to report such information, and other information required by forms or regulations, on the applicable forms, which include Form 990, Form 990-EZ, Form 990-PF, Return of Private Foundation, and Form 990-BL, Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons. Code Sec. 6033(b) requires that 501(c)(3) organizations also furnish information on additional items, including total contributions and gifts received during the year, and the names and addresses of all substantial contributors.

However, the implementing regulations under Code Sec. 6033 generally require:

  • all exempt organizations to report the names and addresses of all persons who contribute $5,000 or more in a year; and
  • exempt social clubs, fraternal beneficiary societies, and domestic fraternal societies (organizations exempt under Code Secs. 501(c)(7), 501(c)(8), and 501(c)(10), respectively) to also report the names of each person who contributes more than $1,000 during the tax year to be used exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.

To comply, exempt organizations provide the names and addresses of donors on Schedule B, Schedule of Contributors, filed with Forms 990, 990-EZ, and 990-PF. Black lung benefit trusts report this information in Part IV of Form 990-BL.

Public Inspection Requirement

Code Sec. 6104(b) requires the IRS to make these information returns available to public. Code Sec. 6104(d) similarly requires most exempt organizations to provide their annual information returns upon request to members of the public. However, both the IRS and the exempt organizations are restricted from disclosing any donor names or addresses except when the contribution is to a private foundation or a Code Sec. 527 political organization.

Donor Information Reporting Not Required

Under the revised reporting requirements:

  • Tax-exempt organizations required to file Form 990 or Form 990-EZ, other than those described in Code Sec. 501(c)(3), will no longer be required to provide contributors’ names and addresses on Forms 990 or Forms 990-EZ. Accordingly, these organizations will not be required to complete these portions of their Schedules B (or the similar portions of Part IV of the Form 990-BL).
  • Exempt social clubs, fraternal beneficiary societies, and domestic fraternal societies will no longer be required to provide on Forms 990 or Forms 990-EZ the names and addresses of persons who contributed more than $1,000 during the tax year to be used for exclusively charitable purposes.

These reporting changes do not affect:

  • the information required to be reported on Forms 990, 990-EZ, or 990-PF by Code Sec. 501(c)(3) (including for these purposes nonexempt charitable trusts under Code Sec. 4947(a)(1) and nonexempt private foundations under Code Sec. 6033(d)) or political organizations under Code Sec. 527;
  • the reporting of contribution information (other than contributors’ names and addresses) required to be reported on Schedule B of Forms 990 and 990-EZ and Part IV of the Form 990-BL; or
  • the disclosure requirements under Code Sec. 6104(b) or (d) of any information reported on Schedule B of Forms 990 and 990-EZ and Part IV of the Form 990-BL.

The reporting changes will have no effect on the reporting of Schedule B information that is currently open to public inspection.

Organizations relieved of the obligation to report contributors’ names and addresses must continue to keep this information in their books and records. This is needed to allow the IRS to efficiently administer the tax laws through examinations of specific taxpayers.

Effective Date

The revised reporting requirements will apply to information returns for tax years ending on or after December 31, 2018. Thus, the revised reporting requirements generally will apply to returns that become due on or after May 15, 2019.

IRS Unveils Draft Form 1040

Taxpayers will be able to file federal income taxes starting next filing season on a new postcard-sized Form 1040. The IRS officially released the draft 2018 Form 1040 on June 29.

Draft Form 1040

The new base Form 1040 will be finalized this summer, an IRS spokesperson told Wolters Kluwer on June 29. The IRS plans to work with the tax community to finalize the form. “This early release is part of our standard process to invite stakeholder input into draft forms before finalizing them,” the IRS spokesperson told Wolters Kluwer.

However, Treasury Secretary Steven Mnuchin has reportedly said the new Form 1040 is “mostly” finalized. “The new, postcard-size Form 1040 is designed to simplify and expedite filing tax returns, providing much-needed relief to hardworking taxpayers,” Mnuchin said in a June 29 statement.

Consolidated Approach

The new, two-sided Form 1040 is intended to replace and consolidate current Forms 1040, 1040A and 1040EZ. “This new approach will simplify the 1040 so that all 150 million taxpayers can use the same form,” the IRS said.

The shortened form reflects many of the changes to the tax code under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), such as the higher standard deduction and the elimination of certain deductions and personal exemptions. The new form now has 23 lines, decreased from 79. However, there are now six separate schedules that taxpayers with less straightforward tax situations may need to complete and include with their return.

The new, smaller form was promised by Republicans in advance of the TCJA becoming law last December. Republican lawmakers continue to tout the new form for its simplicity.

However, several Democrats have already criticized the new form and schedules, challenging Republicans’ claims that it is simpler. “Trump’s new postcard is a smokescreen designed to conceal paperwork, additional calculations and [Trump’s] broken promise to simply the tax code,” Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said in a June 29 tweet. “The postcard isn’t simple – it’s simply complicated.”

Preparer Due Diligence Rules Include Head of Household Eligibility

The IRS has proposed amendments to the tax preparer due diligence regulations to reflect a recent law change. The Tax Cuts and Jobs Act ( P.L. 115-97) expanded the scope of the due diligence penalty to apply to tax preparers who fail to use due diligence when determining a client’s head of household status.

Preparer Due Diligence

Under Code Sec. 6695(g), tax return preparers must meet due diligence requirements in ensuring that their clients meet the eligibility requirements for:

  • the earned income credit;
  • the child tax credit /additional child tax credit;
  • the American opportunity tax credit; and
  • for tax years beginning after December 31, 2017, head of household filing status.

Tax return preparers comply with this due diligence requirement by completing a Form 8867, Paid Preparer’s Due Diligence Checklist, and attaching it to a return or refund claim. Among other things, the preparer must not know or have reason to know that the client does not qualify. A tax preparer who fails to exercise due diligence must pay a $500 penalty for each failure.

Amendments to Proposed Regulations

The IRS has proposed amendments that update 2016 proposed regulations, to reflect the expansion of the preparer due diligence requirements to determining head of household status. An example in the proposed regulations is being updated to demonstrate how the head of household due diligence requirements are intertwined with the rules for determining a taxpayer’s eligibility for the child tax credit. Also, a new example illustrates how the penalty applies when there is a failure to meet the due diligence requirements for determining head of household eligibility as well as for determining eligibility for one of the applicable credits.

The IRS anticipates that it will revise Form 8867 to include head of household filing status in time for the 2019 filing season.

Comments Requested

The IRS must receive written or electronic comments on the proposed regulations and requests for a public hearing by August 17, 2018.

IRS Clarifies Estate and Trust Expenses Not Subject to Miscellaneous Itemized Deduction Suspension

The Treasury Department and the IRS plan to issue regulations clarifying that certain estate and nongrantor trust expenses remain deductible and are not subject to the miscellaneous itemized deductions suspension. As added by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), Code Sec. 67(g) generally provides that miscellaneous itemized deductions subject to the 2-percent-of-adjusted-gross-income floor are suspended and may not be deducted for tax years beginning after 2017 and before 2026.

Under Code Sec. 67(e), the adjusted gross income of an estate or trust is generally computed in the same manner as that of an individual, except that the following are treated as allowable in arriving at adjusted gross income:

  • deductions for costs that are paid or incurred in connection with estate or trust administration that would not have been incurred if the property were not held in the estate or trust; and
  • deductions allowable under Code Sec. 642(b) (personal exemption deduction for estate and trusts), Code Sec. 651 (deduction for trusts distributing current income only), and Code Sec. 661 (deduction for estate and trusts accumulating income or distributing corpus).

Code Sec. 67(e) removes estate or trust administration expenses described above from the category of itemized deductions, and instead treats them as above-the-line deductions allowable in determining adjusted gross income. As a result, the suspension of the deductibility of miscellaneous itemized deductions does not affect the deductibility of such payments.

Caution. Note, however, that an expense that an individual would commonly or customarily incur does fall under the Code Sec. 67(g) suspension, and cannot be deducted by an estate or trust during the suspension period.

The Treasury Department and IRS intend to issue regulations clarifying that:

  • estates and nongrantor trusts can continue to deduct expenses described in Code Sec. 67(e), including the appropriate portion of a bundled fee, in determining the estate or nongrantor trust’s adjusted gross income during the suspension period; and
  • deductions classified in Code Sec. 67(b) as not being “miscellaneous itemized deductions,” and the deductions in Code Sec. 67(e), continue to remain outside the definition of “miscellaneous itemized deductions” and are unaffected by Code Sec. 67(g).

Further, the Treasury Department and the IRS intend to issue regulations and request comments regarding the effect of Code Sec. 67(g) on the ability of a beneficiary to deduct amounts comprising Code Sec. 642(h)(2) excess deduction upon the termination of a trust or estate, in light of Code Sec. 642(h) and its corresponding regulation.

Veterans Urged to Claim Refund for Tax Overpayments on Disability Severance Payments

The IRS has urged certain veterans who received disability severance payments after January 17, 1991, and included that payment as income that they should file Form 1040X, Amended U.S. Individual Income Tax Return, to claim a credit or refund of the overpayment attributable to the payment. Most veterans who received a one-time lump-sum disability severance payment when they separated from military service will receive a letter from the Department of Defense (DoD) with information explaining how to claim tax refunds they are entitled to.

Limitations Period

Taxpayers can usually only claim tax refunds within three years from the due date of the return. Under the Combat-Injured Veterans Tax Fairness Act passed in 2016, veterans making these refund claims have until the later of the normal refund limitations period or one year from the date of their letter from the DoD to make the claim. The alternative time frame is important because some veterans’ claims may be for refunds of taxes paid as far back as 1991.

Refund Claim Amount

Veterans can either submit a refund claim based on either:

  • the actual amount of their disability severance payment; or
  • a standard refund amount based on the calendar year (an individual’s tax year) in which they received the severance payment.

Veterans claiming the standard refund amount must write “Disability Severance Payment” on line 15 of Form 1040X, and enter on lines 15 and 22 the standard refund amount that applies to them.

Other Instructions

Veterans claiming these refunds should write either “Veteran Disability Severance” or “St. Clair Claim” across the top of the front page of the Form 1040X, and mail it with a copy of the DoD letter to: Internal Revenue Service, 333 W. Pershing Street, Stop 6503, P5, Kansas City, MO 64108.

If a veteran is eligible for the refund but did not receive the DoD letter, he or she must include with the Form 1040X both of the following:

  • A copy of documentation showing the exact amount of and reason for the disability severance payment, such as a letter from the Defense Finance and Accounting Services (DFAS) explaining the severance payment at the time of the payment or a Form DD-214; and
  • A copy of either the Department of Veteran Affairs determination letter confirming the veteran’s disability or a determination that the veteran’s injury or sickness was either incurred as a direct result of armed conflict, while in extra-hazardous service, or in simulated war exercises, or was caused by an instrumentality of war.

Veterans who did not receive the DoD letter and who do not have the required documentation will need to obtain the necessary proof by contacting the DFAS.

IRS Highlights “Security Six” Safeguards

The IRS, along with Security Summit partners, offered important tips dubbed “Security Six”protections to help tax professionals protect their computers and email as well as safeguard sensitive taxpayer data. The “Security Six” protections is the second in a series called “Protect Your Clients; Protect Yourself: Tax Security 101.” All tax professionals, whether part of a large firm or a one-person shop, must enact security safeguards.

The “Security Six” are:

  • antivirus software, to automatically or manually scan computers for protection against malware, spyware and phishing;
  • firewalls, to protect unnecessary network traffic and malicious software from accessing the network;
  • two-factor authentication, to access emails by adding an extra layer of protection;
  • backup software and services, to back up critical files routinely;
  • drive encryption, to transform data on the computer into unreadable files for the unauthorized person accessing the computer; and
  • a written data security plan as required by the Federal Trade Commission and its Safeguards Rule.

Further, tax practitioners were urged to review the recently revised IRS Publication 4557, Safeguarding Taxpayer Data, and Small Business Information Security: the Fundamentals by the National Institute of Standards and Technology. In addition, tax practitioners were advised to review Publication 5293, Data Security Resource Guide for Tax Professionals, which provides a compilation data theft information available on IRS.gov. Tax professionals can stay connected to the IRS by subscribing to e-News for Tax Professionals, QuickAlerts and Social Media.

CT - Connecticut provides pass-through entity tax credit guidance

Connecticut provided guidance on the pass-through entity tax credit. Pass-through entity owners can claim the credit against Connecticut:

  • corporation business tax liability; or
  • personal income tax liability.

Pass-through entity owners include:

  • S corporation shareholders;
  • individual and corporate partners; and
  • individual and corporate members of limited liability companies (LLCs) taxed as partnerships.

What Is the Pass-Through Entity Tax?

Effective for tax years beginning after 2017, Connecticut imposes a tax on pass-through entities doing business in the state. Pass-through entities pay the tax at the highest Connecticut personal income tax rate.

What Is the Pass-Through Entity Tax Credit?

Pass-through entity owners can claim a credit for the tax paid by the entity. The credit equals 93.01% of the owner’s direct and indirect share of the entity’s tax liability. An owner cannot claim a credit before the entity pays the tax.

What Information Does the Guidance Provide?

The guidance contains answers to questions about:

  • how a pass-through entity distributes and reports the credit to owners;
  • what year an owner can claim the credit;
  • what happens if the credit exceeds an owner’s tax liability;
  • how to determine an owner’s credit under the standard or alternative tax calculation;
  • how tiered pass-through entities report and distribute the credit;
  • how combined groups distribute the credit;
  • how trusts report and distribute the credit; and
  • whether nonresident individuals who receive a credit must otherwise file a Connecticut return.

Office of the Commissioner Guidance OCG-7, Connecticut Department of Revenue Services, August 21, 2018

ME - Certification for home accessibility credit revised

The certification process for Maine’s “AccessAble Home” personal income tax credit was revised. The credit is for certain costs to make a home accessible to a disabled person who lives there.

Due Date of Certification Request

The timing of credit certification requests is changed. Previously, certification requests were due March 1 of the year after the year payments for home accessibility costs were made. The March 1 deadline no longer applies.

Claiming the Credit

A taxpayer now must claim the credit in the same year that certification is issued. Rule 33 (99-346 CMR 33), Maine State Housing Authority, effective September 1, 2018

MA - Massachusetts creates apprenticeship credit

Massachusetts legislation creates a credit program for taxpayers who hire and train apprentices. Taxpayers who qualify for the credit can apply it against:

  • corporate excise tax liability; and
  • personal income tax liability.

When Can Taxpayers Claim the Credit?

Taxpayers can claim the credit in tax years beginning after 2018.

How Do Taxpayers Qualify for the Credit?

To qualify for the credit, taxpayers must:

  • employ the apprentice in Massachusetts for at least 180 days in the tax year in which they claim the credit;
  • register as an apprenticeship program sponsor; and
  • enter an apprenticeship agreement.

They also must hire and train the apprentice in:

  • computer occupations;
  • health technologist and technician occupations;
  • healthcare support occupations; or
  • product manufacturing occupations.

How Much Is the Credit?

The credit equals the lesser of:

  • $4,800; or
  • 50% of the wages paid to the apprentice.

Taxpayers can claim a second credit if they continue to employ the apprentice in the next tax year. The taxpayer must receive certification of the continued employment.

Massachusetts caps credits for all taxpayers at $2.5 million each calendar year.

Can Pass-Throughs Claim the Credit?

A pass-through entity can claim the credit. But it must distribute the credit to its owners, partners, and members based on their share of its income. The owners, partners, or members can apply the credit against their Massachusetts tax liability.

Does the Credit Program Sunset?

The legislation contained provisions that sunset the credit for tax years after 2021. Gov. Charlie Baker vetoed the sunset provisions and sent them back to the legislature. He proposed a 5-year period for examining the program’s effectiveness. Ch. 228 (H.B. 4732), Laws 2018, effective August 10, 2018 and as noted; Veto Message, Massachusetts Gov. Charlie Baker, August 10, 2018

NY - Taxpayer’s protest partially denied

A New York state taxpayer’s petition for redetermination or for refund of personal income taxes was partially denied. In this matter, the notice of intent at issue indicated that the notice of deficiency was issued on September 21, 2016, but that the protest was not filed until July 28, 2017, or 310 days later. Moreover, the notice of intent indicated that the notice and demand was issued on February 22, 2017, and the protest was filed 156 days later. The taxpayer conceded the untimeliness but argued that he did not receive the notices because they were sent to a previous address. It was noted that a notice and demand does not provide for a right to a hearing prior to payment of the assessment and because the taxpayer did not pay the tax due, the Division of Tax Appeals could not adjudicate that part of the protest. However, the division failed to submit regarding the mailing of the notice of the deficiency, and thus the taxpayer was entitled to a hearing. Accordingly, the taxpayer’s protest was partially denied. Kalinsky, New York Division of Tax Appeals, Administrative Law Judge Unit, DTA No. 828296, August 23, 2018.