Casey, Menden, Faust & Nelson, P.A.

The IRS has released new proposed rules related to charitable contributions made to get around the $10,000/$5,000 cap on state and local tax (SALT) deductions. The proposed regulations:

incorporate the safe harbor in Notice 2019-12 for individuals who have any portion of a charitable deduction disallowed to the receipt of SALT benefits;
incorporate the safe harbor in Rev. Proc. 2019-12 for business entities to deduct certain payments made to a charitable organization in exchange for SALT benefits; and
clarify the application of the quid pro quo principle under Code Sec. 170 to benefits received or expected to be received by the donor from a third party.

SALT Limit

An individual’s itemized deduction of SALT taxes is limited to $10,000 ($5,000 if married filing separately) for tax years beginning after 2017. Some states and local governments have adopted laws that allowed individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes.

The IRS issued final regulations in June 2019 that provide that the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). Thus, the taxpayer must reduce any contribution deduction by the amount of any SALT credit received or expected to receive in return. The regulations contain a de minimis exception if the SALT credit does not exceed 15 percent of the taxpayer’s charitable payment.

A taxpayer is not required to reduce the charitable contribution deduction because of the receipt of SALT deductions. However, the taxpayer must reduce the charitable deduction if it receives or expects to receive SALT deductions in excess of the taxpayer’s payment or the fair market value of property transferred.

Payments by Individuals

A safe harbor was provided in Notice 2019-12 for individuals who have a portion of a charitable deduction disallowed due to the receipt of a SALT credit. Under the safe harbor, any disallowed portion of the charitable contribution deduction may be treated as the payment of SALT taxes for the purposes of deducting taxes under Code Sec. 164.

The new proposed regulations incorporate the safe harbor in Notice 2019-12. The safe harbor is allowed in the tax year the charitable payment is made, but only to the extent that the SALT credit is applied as provided under state or local law to offset the individual’s SALT liability for the current or preceding tax year. Any unused credit may be carried forward as provided under state and local law.

Payments by Business Entities

The IRS also provided a safe harbor in Rev. Proc. 2019-12 that business entities may continue to deduct charitable contributions in exchange a SALT credit. A business entity may deduct the payments as ordinary and necessary business expenses under Code Sec. 162 if made for a business purpose.

The new proposed regulations incorporate the safe harbor in Rev. Proc. 2019-12. If a C corporation or specified pass-through entity makes the charitable payment in exchange for a SALT credit, it may deduct the payment as a business expense to the extent of any SALT credit received or expected to be received. In addition, the new proposal provides that if the charitable payment bears a direct relationship to the taxpayer’s business then it may be deducted as a business expense rather than a charitable contribution regardless of whether the taxpayer receives or expects to receive a SALT credit.

Benefits Received from Third Party

If a taxpayer receives any goods, services, or other benefits from a charitable organization in consideration for a contribution, then the charitable deduction must be reduced by the value of those benefits. If the contribution exceeds the fair market value of the benefits received, then only the excess is a deductible as a charitable contribution.

The new proposed regulations clarify that this quid pro quo principal applies regardless of whether the party providing the goods, services, or other benefits is the charitable organization or not. A taxpayer will be treated under the proposal as receiving goods and services in consideration for the taxpayer’s charitable contribution if, at the time the taxpayer makes the payment or transfer, the taxpayer receives or expects to receive goods or services in return.

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Final regulations provide rules on the attribution of ownership of stock or other interests, for determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under the foreign base company sales income rules. The regulations also provide rules to determine whether a CFC receives rents in the active conduct of a trade or business, for determining the exception from foreign personal holding company income.

The regulations adopt without change, proposed regulations published on May 20, 2019 ( NPRM REG-125135-15).

Attribution of Ownership

The regulations provide specific rules for applying principles similar to those in the Code Sec. 958(b) constructive ownership rules when determining related person status under the foreign base company sales income rules. The determination of related person status is relevant for many purposes, including whether certain types of income can be characterized as subpart F foreign base company sales or service income.

A person is a related person with respect to a CFC if the person is:

an individual who controls the CFC,
an entity that controls or is controlled by the CFC, or
an entity that is controlled by the same person that controls the CFC.

Rules similar to those for determining stock ownership in Code Sec. 958 apply for purposes of determining whether a person is a related person. The regulations limit the application of the downward attribution rules in Code Sec. 318(a)(3), which apply by reference to the Code Sec. 958 stock ownership rules, and which attribute ownership downward from the owner of an entity to an entity. The downward attribution rules are applied regardless of the size of the ownership interest in a partnership, estate, or trust, but are applied to corporations based on a 50-percent or more ownership interest.

The regulations address concern that application of the downward attribution rules could inappropriately treat entities (including CFCs) that do not have significant relationships with each other as related persons. Accordingly, the regulations provide that the downward attribution rules of Code Sec. 318(a)(3) and Reg. §1.958-2(d) will not apply for purposes of determining related person status under the foreign base company sales income rules.

The change does not preclude a corporation, partnership, trust, or estate from being treated as controlled by the same person or persons that control the CFC under other rules that remain applicable for the related person rules.

Additionally, an anti-abuse rule is provided with respect to the option attribution rule in Code Sec. 318(a)(4). The option attribution rule in Code Sec. 318(a)(4) and Reg. §1.958-2(e) will not be applied to treat a person with an option as owning the stock or an equity interest for purposes of the related person rule if the principal purpose of using the option was to cause a person to be treated as a related person.

The regulations also incorporate a similar rule issued in section 7(d) of Notice 2007-9, 2007-1 CB 401. The rule applies if the principal purpose for the use of an option is to qualify dividends, interest, rents or royalties paid by a foreign corporation for the Code Sec. 954(c)(6) CFC look-through exception from foreign personal holding company income. The rule applies to tax years of CFCs beginning after December 31, 2006, and ending before November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end.

Personal Holding Company Income

The regulations modify the foreign personal holding company rules for amounts paid or incurred by a CFC in connection with the CFC’s rental income and the active rents exception. Rents are excluded from foreign personal holding company income if the rents are:

received from a person other than a related person, and
from the active conduct of a trade or business.

If rents are from leasing property as a result of marketing activities, there must be a substantial marketing organization in order to meet the active trade or business test. Under a safe harbor, an organization is substantial if active leasing expenses equal or exceed 25 percent of adjusted leasing profit. If the CFC receives rents from property it does not own, the substantiality of the organization is determined net of those rent payments.

The regulations extend the rule to apply to royalties in addition to rents. As a result, the substantiality of the organization is determined under the safe harbor net of the rents or royalties paid or incurred by the lessor CFC, for the right to use the property (or a component part of the property) that generated the rental income.

Applicability Date

The regulations generally apply to tax years of CFCs ending on or after November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end. The regulations on the downward attribution rule, and the option anti-abuse rule for use of the option to treat a person as a related person with respect to a CFC, apply to tax years of CFCs ending on or after May 17, 2019, and to tax years of U.S. shareholders in which or with which such tax years end, with respect to amounts received or accrued by a CFC on or after May 17, 2019, to the extent the amounts are received or accrued in advance of the period to which such amounts are attributable with a principal purpose of avoiding application of the rules.

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The IRS has issued final and proposed regulations implementing the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A. The BEAT is a minimum tax that certain large corporations must pay on certain payments made to foreign related parties, and was added by the Tax Cuts and Jobs Act ( P.L. 115-97).

The final regulations adopt proposed rules ( REG-104259-18) published on December 21, 2018 (2018 proposed regulations), with certain modifications. The proposed regulations ( REG-112607-19) (2019 proposed regulations) provide rules under Code Secs. 59A and 6031 regarding certain aspects of the BEAT.

Final Regulations

The 2018 proposed regulations provided guidance related to the mechanics of determining a taxpayer’s BEAT liability, and addressed application of the BEAT to partnerships, banks, registered security dealers, and consolidated groups. The final BEAT regulations retain the basic approach and structure of the 2018 proposed regulations, with certain revisions.

The final regulations continue to be exclude from the denominator of the base erosion percentage Code Sec. 988 losses with respect to transactions with foreign related parties that are excluded from the numerator of the percentage. The final regulations also retain the add-back method for computing modified taxable income and the computation of base erosion minimum tax amount (BEMTA) on a taxpayer-by-taxpayer basis.

Among some of the more significant changes to the proposed rules, the final regulations:

adopt the "with-or-within" method to determine the gross receipts and the base erosion percentage of an aggregate group;
disregard transactions between parties if both parties were members of the aggregate group at the time of the transaction;
exclude the base erosion tax benefits and deductions attributable to the tax year of a member of an aggregate group that begins before January 1, 2018;
clarify that payments resulting in a reduction to determine gross income are not treated as base erosion payments;
require that the determination of whether a payment or accrual is a base erosion payment be made under general U.S. federal income tax law;
clarify the definition of a "base erosion payment," and generally exclude amounts transferred to, or exchanged with, a foreign related party in certain corporate nonrecognition transactions from that definition;
clarify the rules for determining the portion of U.S. branch interest paid to foreign related parties;
provide rules for the treatment of an interest expense determined under a U.S. tax treaty;
include additional detail on the documentation required to satisfy the service cost method (SCM) exception;
modify the total loss-absorbing capacity (TLAC) exception;
provide that the additional one percent add-on to the BEAT rate will not apply to a taxpayer that is part of an affiliated group with de minimis banking and securities dealer activities;
provide that Code Sec. 15 applies only to the change in tax rate set forth in Code Sec. 59A(b)(2) and should not apply to the change in tax rate included in Code Sec. 59A(b)(1)(A) for tax years beginning in calendar year 2018;
change the Qualified Derivative Payments (QDP) exception;
clarify the rules regarding how partnerships and their partners are treated for purposes of the BEAT; and
clarify the anti-abuse rule and certain rules applicable to insurance companies and consolidated groups.

Applicability Dates

The final regulations (other than the reporting requirements for QDPs) apply to tax years ending on or after December 17, 2018. However, taxpayers may apply these final regulations in their entirety for tax years ending before December 17, 2018. Taxpayers may also apply provisions matching Reg. §§1.59A-1 through 1.59A-9 in their entirety for all tax years ending on or before December 6, 2019. Taxpayers choosing to apply the proposed regulations must apply them consistently and cannot selectively choose which particular provisions to apply.

The related Code Sec. 6038A regulations apply to tax years beginning Monday, June 7, 2021. The related consolidated return regulations generally apply to tax years for which the original consolidated return is due (without extensions) after December 6, 2019.

2019 Proposed Regulations

The 2019 proposed regulations provide rules regarding relating to (1) how a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage; (2) an election to waive deductions; and (3) application of the BEAT to partnerships.

The 2019 proposed regulations generally apply to tax years beginning on or after the date that the final regulations are filed with the Federal Register. Certain rules, however, have specific applicability dates. In addition, taxpayers may rely on the rules in the proposed regulations in their entirety for tax years beginning after December 31, 2017, and before the final regulations are applicable.

Practitioner’s Observations

Arlene Fitzpatrick, a Principal in the National Tax Department of Ernst & Young LLP, told Wolters Kluwer that "there are changes and new proposed rules in the package of final and proposed regulations that are helpful, though not all changes requested through the comment process were made. For example, the rules in the final regulations to exclude, in certain circumstances, from the definition of a base erosion payment amounts transferred to, or exchanged with, a foreign related party pursuant to a specified nonrecognition transaction are welcome. Furthermore, clarifying that a built-in loss recognized on a sale or transfer of property to a foreign related party is not in itself a deduction that causes the payment to be treated as a base erosion payment is helpful. The final regulations however, retain the internal dealings rule whereby a notional payment for purposes of attribution of profits under certain tax treaties may be taken into account for purposes of determining BEAT. Thus, although deductions from internal dealings would not be allowed under the Code or regulations, and only relevant under certain treaties (the regulations do not specify the treaties), the regulations provide such amounts are relevant for purposes of determining BEAT."

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The IRS has issued highly anticipated final regulations on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The final regulations retain the basic approach and structure of the 2018 proposed regulations ( NPRM REG-105600-18). The final regulations also eliminate deadwood, reflect statutory amendments made prior to TCJA, and update expense allocation rules not updated since 1988.

Also adopted are proposed regulations on overall foreign losses, published on June 25, 2012 ( NPRM REG-134935-11), and a U.S. taxpayer’s obligation to notify the IRS of a foreign tax redetermination, published on November 7, 2007 ( NPRM REG-209020-86).

A separate set of 2019 proposed regulations were also issued ( NPRM REG-105495-19).

Final Regulations

The final regulations make extensive changes to the rules on the determination of the foreign tax credit. Many of these changes were required to implement the TCJA, including the items discussed, below.

The final regulations provide details on how income is assigned and expenses are apportioned to the Code Sec. 951A global intangible low-taxed income (GILTI) and foreign branch foreign tax credit separate limitation categories added by TCJA.

The regulations provide that, for purposes of applying the expense allocation and apportionment rules, the portion of gross income related to foreign derived intangible income (FDII) or a GILTI inclusion that is offset by a Code Sec. 250 deduction is treated as exempt income. This means that fewer expenses will be allocated to the GILTI category, resulting in a higher foreign source taxable income, a higher foreign tax credit limitation, and a larger foreign tax credit offset with respect to GILTI income.

The regulations also address how the balance of foreign tax credit carryovers prior to the TCJA are allocated across new and existing separate categories. Under a default rule, foreign tax credit carryovers remain in the general category going forward. A taxpayer can elect to reconstruct the carryover regarding a foreign branch. The final regulations provide a simplified rule under which taxpayers can assign foreign tax credits to the foreign branch category proportionately, according to the ratio of foreign taxes paid or accrued by the taxpayer’s branches to total foreign taxes paid or accrued by the taxpayer in that year.

The regulations modify the proposed rule for determining foreign branch income based on the U.S. tax-adjusted books and records of the foreign branch. The proposed regulations disregarded transfers of intellectual property (IP) between a foreign branch and its owner if the transfer would result in a deemed payment that reallocates income between the foreign branch category and the general branch category. The final regulations limit the rule to transactions that occurred after the date of the proposed regulations and include an exception for transitory ownership.

The regulations provide rules for the treatment of GILTI for purposes of the interest allocation rules. In general, a controlled foreign corporation (CFC) must allocate and apportion its interest expense among groups of income for purposes of determining tested income, subpart F income and other types of net foreign source income. A U.S. taxpayer must characterize the value of its CFC for allocating and apportioning its own interest expense. A CFC allocates and apportions its interest expense using either the modified gross income (MGI) method or the asset method. The U.S. taxpayer uses the same method to characterize the stock of its CFC. The regulations take into account gross tested income from a lower-tier CFC with respect to an upper-tier CFC for allocating the upper-tier CFC’s interest expense when applying the MGI method.

Dividends, interest, rents and royalties (look-through payments) paid to a U.S. shareholder by a CFC were generally allocated to general category income to the extent that they were not treated as passive category income. Because this type of payment made directly by a U.S. shareholder is not included in the GILTI category, the regulations provide that the look-through payments are assigned either to the general category or the foreign branch category. The payments cannot be assigned to the GILTI category.

The final regulations also address certain potentially abusive borrowing arrangements involving loans by U.S. persons to foreign partnerships that artificially increase foreign source income and the foreign tax credit limitation without affecting U.S. taxable income. Under the regulations, the interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate limitation categories in the same manner as the associated interest expense.

Applicability of Final Regs

The final regulations related to statutory amendments made by the TCJA apply to tax years beginning after December 31, 2017. Regulations that contain both rules that relate to the TCJA and rules that do not relate to the TCJA generally apply to tax years that both (1) begin after December 31, 2017, and (2) end on or after December 4, 2018.

The regulations on the deemed paid credit under Code Sec. 960 apply to tax years that both begin after December 31, 2017, and end on or after December 4, 2018. The final OFL regulations apply to tax years on or after the date the regulations are filed in the Federal Register. The final foreign tax redetermination regulations apply to foreign tax redeterminations occurring in tax years ending on or after the date the regulations are filed in the Federal Register.

Proposed Regulations

Proposed foreign tax credit regulations address changes made by the TCJA, and also respond to issues raised in the 2018 proposed regulations on the foreign tax credit ( NPRM REG-105600-18). The proposed regulations address:

the allocation and apportionment of deductions under Code Sec. 861 through Code Sec. 865;
the definition of "financial services income" under Code Sec. 904(d)(2)(D);
the allocation and apportionment of creditable foreign taxes;
the interaction of branch loss and dual consolidated loss recapture rules under Code Sec. 904(f) and Code Sec. 904(g);
the effect of Code Sec. 905(c) foreign tax redeterminations of foreign corporations on the high-tax exception in Code Sec. 954(b)(4) and the required notification and penalty provisions;
the definition of "personal holding company income" under Code Sec. 954; and
the application of the foreign tax credit limitation rule to consolidated groups.

Allocation and Apportionment

Under the general rule, a taxpayer may allocate research and experimentation (R&E) expenses to the foreign tax credit separate limitation categories under the sales method or the gross income method. The proposed regulations revise the sales method to provide that R&E expenses are only allocated to income that represents return on intellectual property. When applying these rules, gross intangible income does not include dividends or amounts included under subpart F, GILTI or Code Sec. 1293. As a result, none of a U.S. taxpayer’s R&E expenses are allocated to the GILTI category. The proposed regulations eliminate the gross income method for purposes of allocating R&E expenses.

Stewardship expenses are related and allocable to dividends received or to be received from related corporations. The proposed regulations provide that stewardship expenses are allocated to subpart F and GILTI inclusions, to Code Sec. 78 dividends and all amounts included under the passive foreign investment company (PFIC) provisions.

Under the Code Sec. 818(f) allocation rules that apply to life insurance companies, expenses are generally apportioned ratably across all gross income. Under a new rule, the proposed regulations allocate expenses in a life-nonlife consolidated group solely among items of the insurance company that has reserves (separate entity method).

The final foreign tax credit limitations provide a matching rule for a U.S. partner that makes loans to a foreign partnership. Under the rule, the partner’s gross interest income is apportioned between U.S. and foreign sources in each separate foreign tax credit limitation category based on the partner’s interest expense apportionment ratios. The proposed regulations provide the same rule for loans from partnerships to U.S. partners (upstream partnership loans).

Redeterminations

Portions of the 2007 temporary regulations on foreign tax redeterminations ( T.D. 9362) are reproposed so that taxpayers can provide comments on the rules in light of the changes made by the TCJA. The proposed regulations address foreign tax redeterminations that affect the deemed paid credit under Code Sec. 960; procedural notification rules; and penalties for failure to notify the IRS of a foreign tax redetermination.

The proposed regulations require taxpayers to account for foreign tax redeterminations of foreign subsidiaries on an amended return that reflects the revised foreign taxes deemed paid under Code Sec. 960 and any changes to the taxpayer’s U.S. tax liability. This reflects the repeal of the pooling mechanism to account for redeterminations of foreign taxes.

A transition rule provides that post-2017 redeterminations of pre-2018 foreign income taxes must be made by adjusting the foreign corporation’s taxable income and earnings and profits and post-1986 undistributed earnings and income taxes in the pre-2018 year to which the redetermined foreign taxes relate. The proposed regulations also provide that the foreign tax redetermination rules cover situations in which the foreign tax redetermination affects whether or not the CFC qualifies for the high-tax exceptions under GILTI and subpart F.

Additional Rules

Additional provisions in the proposed regulations:

modify the definition of a "financial services entity" by adopting a definition of "predominately engaged in the active conduct of a banking, insurance, finance, or similar business" and "income derived in the active conduct of a banking, insurance, finance, or similar business" that is generally consistent with Code Secs. 954(h), 1297(b)(2)(B), and 953(e);
provide more detailed guidance on the allocation and apportionment of foreign income taxes, and generalize the rules to apply to statutory and residual groupings;
provide a new ordering rule for overall foreign loss recapture that addresses additional income recognition under the branch loss recapture and dual consolidated loss recapture rules: the amounts are not taken into account for purposes of the ordering rules until Code Sec. 904(f)(3) amounts are determined;
clarify the rules that apply to jurisdictions that do not impose corporate income tax on CFCs until earnings are distributed. or where foreign tax is contingent on a future distributions, for purposes of the high-tax exception in Code Sec. 954(b)(4);
apply the principles for allocating and apportioning foreign income taxes for purposes of Code Sec. 965(g); and
update the Code Sec. 1502 regulations relating to the computation of the consolidated foreign tax credit to reflect changes in the law, and add new rules for the determining the source and separate category of the a consolidated NOL, as well as the portion of a consolidated net operating loss (CNOL) that is apportioned to a separate return year of a member.

Applicability of Proposed Regs

The proposed regulations are generally proposed to apply to tax years that end on or after the date the proposed regulations are filed in the Federal Register, with exceptions. For example, the rules for R&E expenses are proposed to apply to tax years beginning after December 31, 2019. However taxpayers on the sales method for tax years beginning after December 31, 2017, and before January 1, 2020, may rely on the proposed regulations if the rules are applied consistently. Thus, a taxpayer on the sales method for its tax year beginning in 2018 may rely on the proposed regulation, but must also apply the sales method (relying on the proposed regulation) for its tax year beginning in 2019.

Practitioner’s Observations

WK: Were you surprised by anything in the final regs?

Martin Milner: The final regulations are generally consistent with the proposed regulations and do not include any major surprises. The changes and clarifications that are in the final regulations are largely helpful. As would be expected, most of the new provisions are in the proposed portion of the package.

WK: With the proposed regs are there areas that you can see may result in pushback? If so why?

Martin Milner: The business community is likely to comment on the proposal to apportion stewardship expenses to dividends, subpart F income and GILTI (including IRC Section 78 gross-ups) because many had hoped that stewardship expenses would not be apportioned to GILTI.

WK: How did you feel about the R&E Expense Apportionment changes?

Martin Milner: The mandatory sales-based apportionment of R&E expenses to all gross intangible income related to the relevant product SIC code will be complicated in practice. However, it is helpful that the proposed rules specifically exclude dividends, subpart F income and GILTI.

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The IRS has released guidance that provides that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 partnership tax years, but will first apply to 2020 partnership tax years.

2019 Reporting

For 2019, partnerships and other persons must report partner capital accounts consistent with the reporting requirements in the 2018 forms and instructions, including the requirement to report negative tax basis capital accounts on a partner-by-partner basis.

Section 704(c) Gain or Loss

As a clarification, the notice also defines the term "partner’s share of net unrecognized Code Sec. 704(c) gain or loss," which must be reported by partnerships and other persons in 2019. Further, the notice exempts publicly traded partnerships from the requirement to report their partners’ shares of net unrecognized Code Sec. 704(c) gain or loss until further notice. Solely for purposes of completing the 2019 Forms 1065, Schedule K-1, Item N, and 8865, Schedule K-1, Item G, the notice defines a partner’s share of "net unrecognized Code Sec. 704(c) gain or loss" as the partner’s share of the net (meaning aggregate or sum) of all unrecognized gains or losses under Code Sec. 704(c) in partnership property, including Code Sec. 704(c) gains and losses arising from revaluations of partnership property.

Section 465 At-Risk Activities

The notice provides that the requirement added by the draft instructions for 2019 for partnerships to report to partners information about separate Code Sec. 465 at-risk activities will not be effective until 2020. The draft of the instructions for the 2019 Form 1065, Schedule K-1, released October 29, 2019, included a new paragraph at page 12, At-Risk Limitations, At-Risk Activity Reporting Requirements, that would expressly require partnerships or other persons that have items of income, loss, or deduction reported on the Schedule K-1 from more than one activity that may be subject to limitation under Code Sec. 465 at the partner level to report certain additional information separately for each activity on an attachment to a partner’s Schedule K-1. The new paragraph would require the partnership to identify the at-risk activity, the items of income, loss, or deduction for the activity, other items of income, loss, or deduction, partnership liabilities, and any other information that relates to the activity, such as distributions and partner loans. This requirement in the draft instructions for the 2019 Form 1065 is in addition to long-standing at-risk reporting requirements included in the instructions to the Form 1065.

Penalty Relief

Taxpayers who follow the provisions of the notice will not be subject to any penalty, including a penalty under Code Sec. 6722 for failure to furnish correct payee statements, under Code Sec. 6698 for failure to file a partnership return that shows required information, and under Code Sec. 6038 for failure to furnish information required on a Schedule K-1 (Form 8865).

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The IRS has released final regulations that present guidance on how certain organizations that provide employee benefits must calculate unrelated business taxable income (UBTI) under Code Sec. 512(a).

Background

Organizations that are otherwise exempt from tax under Code Sec. 501(a) are subject to tax on their unrelated business taxable income (UBTI) under Code Sec. 511(a). Code Sec. 512(a) defines UBTI of exempt organizations and provides special rules for calculating UBTI for organizations described in Code Sec. 501(c)(7) (social and recreational clubs), voluntary employees’ beneficiary associations (VEBAs) described in Code Sec. 501(c)(9) and supplemental unemployment benefit trusts (SUBs) described in Code Sec. 501(c)(17).

Covered Entity

"Covered entity" describes VEBAs and SUBs subject to the UBTI computation rules under Code Sec. 512(a)(3). A corporation is treated as having exempt function income for a taxable year only if it files a consolidated return with the organization described in Code Sec. 501(c)(7), (9), or (17). These final regulations add a clause to clarify that the term "covered entity" includes a corporation described in Code Sec. 501(c)(2) to the extent provided in Code Sec. 512(a)(3)(C).

Nonrecognition of Gain

If a property used directly in the performance of the exempt function of a covered entity is sold by that covered entity, and other property is subsequently purchased and used by the covered entity directly in the performance of its exempt function—at any point within a four-year period beginning one year before the date of the sale and ending three years after the date of sale—gain, if any, from the sale is recognized only to the extent that the sales price of the old property exceeds the covered entity’s cost of purchasing the other property.

Limitation on Amounts Set Aside for Exempt Purposes

The total amount of investment income earned during the year should be considered when calculating whether an excess exists at the end of the year. Any investment income a covered entity earns during the taxable year is subject to unrelated business income tax (UBIT) to the extent the covered entity’s year-end assets exceed the account limit.

Effective Date

The final regulations apply to tax years beginning on or after December 10, 2019.

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The IRS has issued Reg. §20.2010-1(c) to address the effect of the temporary increase in the basic exclusion amount (BEA) used in computing estate and gift taxes. In addition, Reg. §20.2010-1(e)(3) is amended to reflect the increased BEA for years 2018-2025 ($10 million, as adjusted for inflation). Further, the IRS has confirmed that taxpayers taking advantage of the increased BEA in effect from 2018 to 2025 will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels.

The regulations apply to estates of decedents dying on and after November 26, 2019.

Special Rule for Post-2025 Decedents

Reg. §20.2010-1(c) provides a special rule in cases where the portion of the credit against the estate tax that is based on the BEA is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable within the meaning of Code Sec. 2001(b)(2). In that situation, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based upon the greater of those two credit amounts.

Inflation-Adjusted Amounts and DSUE Amount

Because the term "BEA" includes the exclusion amount, as adjusted for inflation, the examples in the regulations reflect hypothetical inflated adjusted BEAs. Reg. §20.2010-1(c)(2)(ii), Example 2, illustrates the application of the special rule based on gifts actually made, and would be inapplicable to a decedent who did not make gifts in excess of the date of death BEA, as adjusted for inflation.

Reg. §20.2010-1(c)(2)(iii) and (iv), Examples 3 and 4, illustrate that if a spouse dies during the increased BEA period, and the deceased spouse’s executor makes the portability election, the surviving spouse’s applicable exclusion amount includes the full amount of the deceased spousal unused exclusion (DSUE) amount based on the deceased spouse’s increased BEA. The DSUE amount is available to reduce the surviving spouse’s transfer tax liability regardless of when transfers are made.

BEA Calculations

The final rules explain how to determine the extent to which a credit allowable in computing gift tax payable is based solely on the BEA. Reg. §20.2010-1(c)(2)(iv), Example 4, addresses the application of the DSUE ordering rule, as well as the computation of the credit based solely on the BEA in a calendar period in which the transfer exhausts the remaining DSUE amount with the result that the BEA is also allowable.

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The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.

TIGTA Final Audit Report

The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.

Suitability Checks

The IRS’s suitability checks for applicants to the Acceptance Agent, Enrolled Agent, and e-File Provider Programs generally ensured that only reputable individuals were accepted in the programs during fiscal year 2018. Further, the IRS’s continuous suitability checks also ensured that individuals accepted in the programs prior to the initial suitability checks had not engaged in criminal activity warranting removal from the program. TIGTA also identified that when the Federal Bureau of Investigation reported a criminal history for an applicant, the adjudication process was inconsistent depending on the program to which the individual was applying. Finally, the IRS did not take sufficient actions to address the fraudulent submission of fingerprint cards by some applicants to pass their background investigations.

TIGTA Recommendations

TIGTA recommended that the IRS:

assess the risk to tax administration of performing inconsistent initial and continuous suitability checks on individuals seeking to participate or enrolled in the e-File Provider, Acceptance Agent, and Enrolled Agent Programs;
assess the risk of the e-File Provider Program’s use of decision matrices to adjudicate an applicant’s criminal history that are inconsistent with the matrices used by the Acceptance Agent and Enrolled Agent Programs; and
work with the Federal Bureau of Investigation to identify additional individuals who may have submitted fingerprint cards that match the fingerprints of another individual.

The IRS agreed with all the recommendations.

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As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important federal tax reporting and filing data for individuals, businesses and other taxpayers for the month of October 2017.

October 4

Employers. Semi-weekly depositors must deposit employment taxes for Sept 27–Sept 29.

October 6

Employers. Semi-weekly depositors must deposit employment taxes for Sept 30, Oct 1–Oct 3.

October 10

Employees who work for tips. Employees who received $20 or more in tips during September must report them to their employer using Form 4070.

October 12

Employers. Semi-weekly depositors must deposit employment taxes for Oct 4–Oct 6.

October 13

Employers. Semi-weekly depositors must deposit employment taxes for Oct 7–Oct 10.

October 16

Individuals. Individuals with automatic 6-month extensions file Form 1040, 1040A, or 1040EZ, and pay any tax, interest, and penalties due.

Corporations. Corporations who had timely requested an automatic six-month extension file calendar year income tax return (Form 1120) and pay any tax, interest and penalties due.

Employers. For those to whom the monthly deposit rule applies, deposit employment taxes and nonpayroll withholding for payments in September.

October 18

Employers. Semi-weekly depositors must deposit employment taxes for Oct 11–Oct 13.

October 20

Employers. Semi-weekly depositors must deposit employment taxes for Oct 14–Oct 17.

October 25

Employers. Semi-weekly depositors must deposit employment taxes for Oct 18–Oct 20.

October 27

Employers. Semi-weekly depositors must deposit employment taxes for Oct 21–Oct 24.

October 31

Employers. File Form 941 for third quarter of 2017 and deposit or pay any undeposited tax. Pay tax liability in full with timely filed return if less than $2,500. If the tax for the quarter was deposited timely, properly, and in full, deadline to file Form 941 is November 13.

Employers. Deposit federal unemployment tax owed through September if more than $500.

Certain Small Employers. Deposit any undeposited tax if tax liability is $2,500 or more for 2017 but less than $2,500 for the third quarter.

November 1

Employers. Semi-weekly depositors must deposit employment taxes for Oct 25–Oct 27.

November 3

Employers. Semi-weekly depositors must deposit employment taxes for Oct 28–Oct 31.

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There are two important energy tax credits that can benefit homeowners in 2010: (1) the nonbusiness energy property credit and (2) the residential energy efficient property credit. Collectively, they are known as the "home energy tax credits." With the home energy tax credits, you can not only lower your utility bill by making energy-saving improvements to your home, but you can lower your tax bill in 2010 as well. Eligible taxpayers can claim the credits regardless of whether or not they itemize their deductions on Schedule A. Your costs for making these energy improvements are treated as paid when the installation of the item is completed.

Nonbusiness energy property credit

The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) extended the nonbusiness energy credit for 2009 and 2010. The nonbusiness property credit equals 30 percent of a homeowner's expenses on eligible energy-saving improvements, up to $1,500 for both the 2009 and 2010 tax years. Qualifying expenses include costs of certain high-efficiency heating and air conditioning systems, water heaters and stoves that burn biomass, asphalt roofs, as well as costs associated with the installation of these items. The costs of energy-efficient windows, skylights, and doors, and qualifying insulation also qualify for the credit. However, the costs of installing these items do not qualify. Since the credit amounts are combined for both 2009 and 2010, if you made energy improvements in 2009 to which you claimed part of the expenses, you must take that into consideration when claiming the credit in 2010 for qualified expenses. The credit applies only to your principal residence, and special rules apply to condo owners.

Residential energy efficient property credit

The credit rate for the residential energy property credit equals 30 percent of the cost of all qualifying improvements. The residential energy efficient property credit can be claimed for solar electric systems, solar hot water heaters, geothermal heat pumps, wind turbines, and fuel cell property. Generally, labor costs are included when calculating this credit. No cap exists on the amount of the credit available, except in the case of fuel cell property.

Caution. As in the case of the nonbusiness energy property credit, not all energy-efficient improvements qualify for this tax credit. As such, you should check the manufacturer's tax credit certification statement before purchasing or installing any energy-efficient property. We can help you determine your eligibility based on a certification statement.

Reporting

Both energy credits are claimed by eligible homeowners when they file their 2010 federal income tax return. While you do not get an immediate check from Uncle Sam since you claim it on your 2010 return filed in 2011, you might be able to lower your estimated tax payments or withholding immediately to enjoy the benefits of the credit earlier.

Both the nonbusiness energy property credit and the residential energy property credit are claimed and figured on Form 5695, Residential Energy Credits. Since these are credits, not deductions, they increase a taxpayer's refund or reduce the tax he or she owes. An eligible taxpayer can claim these credits, regardless of whether he or she itemizes deductions on Schedule A. Use Form 5695, Residential Energy Credits, to figure and claim these credits. Certain other credits you claim for the 2010 tax year, if any, will affect your computation of the home energy credits.

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Health care reform is now law and many employers are asking how does it affect my business and my employees? The first thing to keep in mind is that reform is gradual. The health care reforms and tax provisions in the new health care reform package play out over time, with some taking effect this year or next year but others not until 2014 and beyond. However, the health care package imposes significant new responsibilities and taxes on employers and individuals so it is not too early to start preparing.

Two new laws

Health care reform is actually made up of two new laws. The first is the Patient Protection and Affordable Care Act of 2010, signed by President Obama on March 23. The second is the Health Care and Education Reconciliation Act of 2010, signed by the president on March 26. The Patient Protection Act, which reflects the Senate's original health care reform bill, provides the overall framework for reform. The Reconciliation Act was drafted in the House to make changes to the Patient Protection Act, especially in the area of cost-sharing and in some of the revenue raisers.

Employer responsibility

The final health care package, unlike earlier versions, does not include an employer mandate. However, any employer with more than 50 full-time employees that does not offer health insurance and has at least one full-time employee receiving a premium assistance tax credit or cost-sharing will pay a per-employee penalty. An employer with more than 50 full-time employees that offers coverage that the government deems unaffordable or fails to meet minimum standards and has at least one full-time employee receiving a premium assistance tax credit or cost-sharing also will pay a per-employee penalty. Small employers with less than 50 employees will not be penalized in any case. The penalty rules apply starting in 2014.

Small employers that provide health insurance coverage are eligible for a new tax credit. A sliding scale tax credit is available immediately in 2010 for qualified small employers. The IRS is expected to make guidance for the new credit a priority. If your small business offers or is thinking of offering health insurance to your workers, the credit could generate significant cost-savings. Please contact our office and we can discuss the details of the credit in depth.

Individual responsibility

Unlike employers, individuals have a mandate under the health care reform package. Beginning in 2014, most individuals will be responsible for maintaining health insurance coverage for themselves and their dependents. If they do not have minimum essential coverage, they will be liable for a penalty.

The health care package excludes many individuals from the mandatory coverage requirement. Any individual or family who currently has coverage can retain that coverage under a "grandfather" provision. Individuals with incomes below the federal filing threshold, religious objectors, individuals covered by Medicaid and Medicare and others are also exempt.

The health care package provides a premium assistance tax credit and cost-sharing to help make coverage more affordable. The premium assistance tax credit is calculated on a sliding scale based on the individual's income in relation to the federal poverty level. Cost-sharing reduces the cost of coverage for qualified individuals. The premium assistance tax credit and cost-sharing generally will be available after 2013.

High-dollar plans

One of the principal revenue raisers to fund health care reform is a new excise tax on high-dollar health insurance plans. The health care reform package imposes an excise tax of 40 percent on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of $10,200 for individuals and $27,500 for families. The excise tax applies to the amount in excess of the $10,200/$27,500 levels. The thresholds are higher for individuals in high-risk occupations and individuals over age 55. The excise tax will not kick in until 2018.

Medicare additional tax and surtax

Changes to the hospital insurance (HI)(Medicare) tax also fund health care reform. These changes impact higher-income individuals and families.

The health care reform package increases the Medicare tax by 0.9 percent for individuals who receive wages in excess of $200,000 (the threshold increases to $250,000 for married couples who file a joint federal income tax return). Additionally, the new law imposes a 3.8 percent surtax (called the Unearned Income Medicare Contribution) on investment income for individuals with adjusted gross incomes above $200,000 ($250,000 for married couples filing jointly). Investment income includes income from interest and dividends.

The additional Medicare tax on wages and the additional Medicare contribution on investment income take effect in 2013, so taxpayers have some time to prepare. Please contact our office for more details about how these tax changes may impact you.

Flexible spending arrangements

Flexible spending arrangements (FSAs) are a very popular way to save and pay for health care expenses. One of the most attractive features is the ability to use FSA dollars for over-the-counter medications. The health care reform package ends that feature after 2010.

In 2011 and subsequent years, FSA dollars can only be used to pay for prescription medications (with some limited exceptions). In 2013, the health care reform package limits the amount of contributions to health FSAs to $2,500 per year. The $2,500 amount will be indexed for inflation after 2013.

More provisions

The health care reform package als

Increases the AGI threshold for claiming the itemized deduction for medical expenses for regular tax purposes to 10 percent after 2012 with a delayed effective date for seniors;
Extends dependent coverage up to age 26;
Expands Medicaid eligibility;
Requires states to establish insurance exchanges to help individuals and small employers obtain coverage;
Increases the additional tax on distributions from health savings accounts (HSAs) not used for qualified medical expenses;
Eliminates the employer deduction for Medicare Part D;
Imposes annual fees on pharmaceutical manufacturers and health insurance providers;
Imposes an excise tax on medical device manufacturers;
Requires more corporate information reporting;
Imposes new requirements on non-profit hospitals;
Accelerates some corporate estimated income taxes in 2014;
Imposes an excise tax on indoor tanning services;
Codifies the economic substance doctrine; and
Modifies the biofuel credit.

In the coming months and years, the IRS and other federal agencies will issue many new rules and regulations to implement health care reform. Our office will keep you posted of developments, and, as always, please contact us if you have any questions.

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