Federal Tax Update – November 2020

INDIVIDUALS

Proposed Regulations under Section 1031 adopt a broad definition of “real property” so that structural components of permanent structures as well as licenses and permits related thereto will qualify for like-kind exchange. 

In Cutting v. Commissioner, TC Memo 2020-158, the Tax Court determined that an international pilot made a fatal error when he advised the airline that he selected United States as his “home base” and was unable to claim the income earned abroad exclusion despite his residence in Thailand in a home leased by his wife.

In Kissling v. Commissioner, TC Memo 2020-153, the Tax Court recognized that the decline in value from a façade easement for federal tax purposes may be greater than that given by a local government where based on its historic preservation code.

In Glade Creek Partners v. Commissioner, TC Memo 2020-148, the Tax Court denied a deduction for a $17.5 million conservation easement because extinguishment would have subtracted any value attributable to subsequent improvements from the proceeds before determining the charitable entitlement.

In Castaneda v. Commissioner, 126 AFTR2d 2020-6760, the Ninth Circuit Court of Appeals agreed with the Tax Court that a gambler who kept no records of his losses was taxable on the gross winnings off of information returns.

In Bruno v. Commissioner, TC Memo 2020-156, the Tax Court determined that a former husband’s failure to pay over the wife’s share of marital property following a divorce is not a theft loss under state law and, in any event, the wife had a reasonable prospect of recovery in a succeeding year.

In Notice 2020-75, IRS indicated that future regulations will allow flowthrough entities to deduct state and local income taxes paid at the entity level in lieu of including all or a portion of that income at the individual level where a deduction would not be allowed.

BUSINESS

In Moore v. United States, 126 AFTR2d 2020-________, a Washington Federal District Court determined that the repatriation tax on accumulated income did not violate the Apportionment Clause or the Due Process Clause of the Constitution despite its retroactivity.

In Berry v. Commissioner, 126 AFTR2d 2020-6743, the Ninth Circuit Court of Appeals agreed with the Tax Court that a couple failed to prove that a cash deposit was a loan from a relative as opposed to income, producing only an unsigned note at trial.

In Lakew v. Commissioner, TC Summary Opinion 2020-27, the Tax Court declined to accept testimony that the owner gave cash refunds to unhappy customers at his driving school, producing evidence solely in the form of bad YELP reviews.

In Revenue Ruling 2020-27, IRS stated that expenses expected to be reimbursed through loan forgiveness pursuant to the PPP program should not be deducted on the 2020 tax return; in Revenue Procedure 2020-51, IRS stated that, on denial of forgiveness or a withdrawal of the forgiveness application, applicable expenses can be claimed in 2020 or in the year of denial (presumably 2021). 

In Chief Counsel Advice 202045012, IRS noted that the failure of a closely held corporation to pay more than a de minimis portion of its earnings as dividends is a “very significant factor” in determining the deductibility of compensation paid to owners.

PROCEDURE

In United States v. Wunder, 126 AFTR2d 2020-________, the Third Circuit Court of Appeals agreed with a Pennsylvania Federal District Court that an individual who cited the Declaration of Independence, Constitution, several inapplicable 19th Century Supreme Court cases and the long defunct Articles of Confederation, could not avoid the payment of taxes.

In Fakiris v. Commissioner, TC Memo 2020-157, the Tax Court found that the gross valuation misstatement penalty applies where the alleged charitable contribution is nonexistent and of zero value.

In Lashua v. Commissioner, TC Memo 2020-151, the Tax Court stated that a Notice of Deficiency is not invalidated by the lack of signature by an authorized IRS official.

In Sedlmayr v. United States, 126 AFTR2d 2020-________, a Missouri Federal District Court allowed IRS to show computer entries to “prove” that a taxpayer extended the statute of limitations on collections notwithstanding that it could not produce the signed extension.

In Alexander v. Internal Revenue Service, 126 AFTR2d 2020-________, a Connecticut Bankruptcy Court determined that the usual three-year rule for discharge of income tax measured from the extended due date of the return does not run during the pendency of a CDP appeal.

In United States v. Allahyari, 126 AFTR2d 2020-________, the Ninth Circuit Court of Appeals reversed a Washington Federal District Court and stated that a father’s security interest in property owned by his son and placed on the property upon paying off a bank loan prior to an IRS lien gave the father priority over IRS despite the allegation that the father knew of his son’s nonpayment of taxes.

In Leith v. Commissioner, TC Memo 2020-149, the Tax Court awarded innocent spouse status to a wife who agreed in the marital settlement agreement to be responsible for one-half of the debt as the factors supporting relief including the presence of abuse were substantially in her favor.

In Landers v. United States, 126 AFTR2d 2020-6744, a Texas Federal District Court determined that the exception to the Tax Anti-Injunction Act only applies to prospective levies and not prior pending levies when an innocent spouse claim is filed.

In News Release 2020-248, IRS expanded consideration of when a balance is temporarily uncollectible and will permit installment agreements without financial statements and substantiation and (for 2019 liabilities only) without the filing of a lien for more balances of up to $250,000 if the monthly payment proposal is sufficient; the short term ability to delay payment was increased from 120 day to 180 days.

In SBSE Memorandum 05-1120-0085, IRS indicated that the trust fund recovery penalty cannot be imposed prematurely for tax periods where the employee portion of social security is deferred through April 30, 2021.

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Year-end 2020 Planning: Georgia on My Mind

Year-end planning for Americans will be more challenging than ever in 2020, as we are forced to make year-end financial decisions based on events that will not happen until 2021. Two Georgia Senate runoff elections will be held on January 5, 2021, which will determine whether Republicans retain control of the Senate or whether Democrats will have control of the White House and both Houses of Congress.

Legislation is always unpredictable, and so are the effective dates that new legislation takes effect. However, we do know what both parties have been championing with respect to taxes and have historical precedent for guidance.

Should Democrats win both Senate seats, they would be able to act unilaterally for the first time since 2010, setting the stage for major tax increases on businesses and high-income, high-net worth households. Should this occur and increases are enacted retroactive to January 1, 2021, numerous income acceleration and estate planning gifting strategies should be deployed before 2020 year-end. 

However, if the Republicans win one of the two runoffs and retain control of the Senate, legislative gridlock will likely prevail for another two years, lessening the need for planning in 2020. Regardless, some bipartisan policy agreement is expected in a number of areas such as whether to extend certain CARES Act relief provisions that expire at the end of 2020. 

PLANNING FOR A DEMOCRAT-CONTROLLED CONGRESS

Higher Income Tax Rates

During the 2020 election campaign, Democrats proposed to raise taxes on earners with more than $400,000 of annual income, cut them for others, and raise benefits for the lowest earners. Those affected would want to deploy basic tax bracket management strategies for times of rising tax rates, such as to accelerate income into 2020 by converting traditional IRAs to Roth IRAs, exercising stock options and taking bonuses early if possible. 

From a corporate rate perspective, Biden’s proposal is to increase the corporate tax rate, bumping it from 21 percent to 28 percent. Biden would also create a new alternative minimum tax of 15 percent on corporations with over $100 million in book net income. Biden’s plan would increase the tax on foreign profits, doubling the tax rate on global intangible low-taxed income from 10.5 percent to 21 percent for companies operating in the U.S. and abroad. Facing potentially rising tax rates and a new corporate alternative minimum tax, corporations should consider income acceleration techniques as well.

Limits on Itemized Deductions

A Biden administration would also limit the value of itemized deductions. Under the Biden proposal, a tax deduction would save a taxpayer with more than $400,000 of income no more than 28 cents on the dollar, even if that person’s top tax bracket is higher. In addition, itemized deductions for those with income over $400,000 would be further limited by restoring the pre-2018 Pease Limitation. This would reduce itemized deductions by 3 percent of AGI over the threshold – up to 80 percent of itemized deductions. Restoring the Pease Limitation would cause many current itemizers to fall below the standard itemized deduction limit of $24,800 for a married couple in 2020, impacting their charitable contribution, mortgage interest and state and local tax (SALT) decisions.

Affected taxpayers should consider accelerated deductions into 2020, especially large charitable donations, to take advantage of increased limits currently in place as part of the CARES Act. However, if Biden restores the SALT deduction for amounts above the current $10,000 cap, itemizers should plan to defer payments of these taxes until after the law change. Taxpayers should be cautioned that the potential benefit of this SALT deduction deferral could be reduced or offset by the 28 percent top rate benefit ceiling and a restoration of the 3 percent Pease Limitation.

Increased Payroll Taxes

The Biden payroll tax proposal would subject wage and self-employment income in excess of $400,000 to the Social Security payroll tax.  Currently, the 6.2% tax is on the first $137,700 of wage income, so wages and earnings between $137,700 and $400,000 would not be taxed, creating a donut-hole structure. Should this Social Security tax be expanded, business owners can consider converting to an S corporation structure, as S corporation dividends are not subject to employment taxes. Assuming that reasonable compensation rules are met, this would be a viable solution to this potential payroll tax increase. As for executive compensation, incentive stock options would likely become more popular because there is no Social Security tax on the option spread.

Higher Capital Gains and Investment Income Taxes

Under a Biden capital gains and investment income plan, individuals earning over $1 million would be subject to ordinary income tax rates on their long-term capital gains and qualified dividends. Should both Georgia Senate seats be won by Democrats, investors with incomes over $1 million should seriously consider selling appreciated assets in 2020 as the the 20 percent preferential rate for long-term capital gains and qualified dividends would very likely be eliminated. Conversely, any capital loss harvesting – a year-end ritual in any other year – should be delayed until 2021 as capital gains rates would be expected to go up.

Other effective capital gains tax mitigation strategies to contemplate before 2020 year-end under this scenario include gifting appreciated assets to utilize the current estate and gift tax exemption, and charitable contributions of appreciated assets to qualified charities, including donor-advised funds and private foundations.

Limit on the 199A Pass-Through Deduction

The Biden platform would retain the 199A qualified business income deduction for pass-through business income, however he proposes modifications to rules utilized by real estate investors and a phase-out of the deduction for taxpayers with income exceeding $400,000. Again, affected business owners are encouraged to consider accelerating income into 2020 should Democratic Senate control appear likely.

Estate and Gift Tax Changes

Biden’s estate tax proposals are his most dramatic proposed changes. The current estate tax exemption threshold is $11.58 million per individual (indexed for inflation) with a top tax rate of 40 percent. After 2025, this amount is scheduled to revert to the pre-Tax Cuts and Jobs Act (TCJA) exemption, which is an indexed amount that would equate to approximately $5.8 million. The Biden plan would accelerate the reduction of the lifetime exemption threshold either to the pre-TCJA level of $5 million (indexed for inflation), or as low as the 2009 level of $3.5 million per individual as proposed by the Obama administration. The tax on estates above this threshold would increase as well to 45 percent.

Another significant Biden proposed change is with regard to the “basis step-up” at death. Currently, a future capital gains tax upon disposition of an inherited asset is based on its value at the time it is inherited, rather than the time of purchase – referred to as the “basis step-up”. The Biden plan is unclear as to how this would be implemented, but there are two options. The first is to tax unrealized gains of the decedent, whereby the decedent’s estate would pay the tax at death, and presumably the heirs would take the assets at a basis stepped-up to fair market value. Alternatively, the heirs would receive carryover basis at death, and would pay capital gains tax on the sale of the asset based on the value at the time the original investment. Either option would lead to a significantly higher income tax liability for appreciated assets.  

Regardless of the option chosen for this proposal, it would create significant practical problems with establishing the tax basis of long-held assets such as appreciated investments or a family business. Combined with the possibility that the estate tax exemption could be cut in half or more, taxpayers with estates worth in excess of several million dollars and with significantly appreciated assets should seriously consider a wealth-transfer plan prior to year-end.

Retirement Plan Contributions

Democratic Senate control would also likely change how retirement contributions are treated for tax purposes.  Biden proposes to convert currently deductible retirement plan contributions into a refundable 26 percent tax credit for each $1 contributed.  Roth tax treatment would be unaffected and therefore, higher income taxpayers would likely benefit from a shift to more Roth-style accounts.

PLANNING FOR A REPUBLICAN-CONTROLLED SENATE

A continued split of government control would prevent President-elect Biden from getting many of his tax proposals enacted into law. That said, as the pandemic continues to impact businesses and taxpayers across the country, it is likely that additional legislation will be enacted to provide economic relief.

Among the more likely developments are an infrastructure bill and further relief packages such as have been enacted under the CARES Act. Prior packages included direct tax rebate payments to individual taxpayers, the acceleration of depreciation deductions for qualified improvement property, increased business interest expense deductions, increased charitable contribution deductions, and restoration of net operating loss carrybacks. New payroll tax programs were also created, including the employee retention credit, additional credits for paid sick leave and paid family leave, and the deferral of the employer portion of payroll taxes.

Extender provisions are also likely to get bipartisan support. Provisions in the TCJA, which generally are set to expire at the end of 2025, could be extended such as the middle-class tax cuts, and research and development expensing which is currently set to sunset in January 2022. With over 30 provisions expiring at the end of 2020, it is reasonable to expect that bipartisan support exists to extend provisions of the CARES Act which provided relief for taxpayers, including retirement income provisions. 

Should a Republican-controlled Senate in 2021 appear likely, there are several year-end planning strategies to consider.

Income Tax Planning

Traditional year-end tax planning in a normal year would include postponing income into the following year combined with accelerating deductions into the current year.  With the current TCJA higher itemized standard deduction amounts, a bunching strategy for itemized deductions may be effective. A taxpayer would take the standard deduction every other year and bunch itemized deductions such as charitable contributions or perhaps medical deductions into the itemized off year. This year may be a good year to bunch itemized deductions with higher limits on charitable contributions and a lower 7.5 percent threshold for medical expenses only available for 2020. 

Capital Gains and Losses

Investors with less concern about a capital gain rate increase in 2021 may be able to focus on the usual year-end strategy of looking over their investment portfolio for holdings they might wish to sell and see how their capital gains and losses for the year match up in deciding whether to do the sale in 2020 or 2021. Recognizing capital losses to offset recognized capital gains, referred to as “loss harvesting,” is important to consider at year-end. However, as noted above, for investors that believe capital gains tax rates may be higher in 2021 than they are now, the recognition of losses should be deferred until January, while long-term capital gains should be recognized this year. The 30-day wash sales rule for losses must be taken into account if sold securities are to be repurchased within a short timeframe.

Charitable Giving

Charitable giving remains a key strategy to reduce income tax for taxpayers electing to itemize their deductions. For those that do not itemize, under the CARES Act for 2020, a $300 charitable cash contribution can be made directly to a charity to receive an “above-the-line” deduction. In addition, those over age 70½, can make qualified charitable contributions (QCD) from traditional IRAs of up to $100,000 despite the waiver of a required minimum distribution (RMD) for 2020 under the CARES Act. Making a QCD before year-end, reduces the value of an IRA, which in turn reduces the amount of the 2021 RMD. Note that QCDs cannot be made to donor-advised funds or most private foundations.

Another strategy for the charitably inclined to consider is donation of appreciated securities held for more than one year. While this has long been a tax-advantaged way to make charitable gifts, the CARES Act enhances the tax benefit by allowing up to 100% of AGI to be deducted. Note that this enhanced deduction limit is not available for gifts to donor-advised funds or supporting organizations, which are still limited to 60% of AGI for cash gifts and 30% of AGI for appreciated securities.

Finally, taxpayers that are itemizing this year but may not be in future years, should consider “gift bunching” by accelerating potential charitable gifts in 2021 or later years to 2020. If the amounts to be gifted are not ready to pass to charities immediately, consider contributing to a donor-advised fund, which may allow you to receive the current-year tax deduction while retaining the ability to request that the donated funds be distributed to qualified charities during future years.

Retirement Planning and Roth Conversions

In the event of a Republican-controlled Senate in 2021, any increases in tax rates that are passed are much less likely to be made retroactive. As a result, there would be reduced benefit in Roth IRA conversions this year. Of course each taxpayer’s situation is different, and a taxpayer in a 24% or lower tax bracket should definitely consider whether a Roth conversion makes sense. Retirement planning should continue to focus on changes to the new distribution rules for IRA beneficiaries and the ability to continue to make IRA contributions after age 70 ½ if there is enough earned income to support them. 

Health and Education Savings

Year-end planning for those with a high-deductible health plan should always include consideration for contributions to a health savings account (HSA). Taxpayers with self-only coverage can deduct up to $3,550 ($7,100 with family coverage) for 2020. An additional $1,000 contribution is permitted if the eligible taxpayer is at least age 55. Some call this a turbo-charged IRA because it offers three tax savings benefits: first, contributions are currently tax deductible; second, the earnings compound tax-free; and third, withdrawals are tax-free when the money is withdrawn for medical expenses. After age 65, withdrawals can be used for non-medical expenses as well. Consider HSAs as a form of long-term care insurance, which grow tax free for use during retirement.

A 529 plan or Coverdell education savings account should also be considered to help ease the burden of future qualified higher education expenses. Any investment growth is federally income tax-free to the extent distributions do not exceed qualified expenses, and many states offer income tax benefits for qualifying contributions. Keep in mind, taxpayers also can use 529 plan distributions to pay up to $10,000 of elementary or secondary school expenses per student per year. 

Annual Gift Giving

An individual can give up to $15,000 to as many individuals as he or she chooses without utilizing any of his or her lifetime gift and estate tax exemption amount (currently $11.58 million.) That $15,000 combines to $30,000 for married couples who either make separate gifts or choose to “gift split.”

Contributions to a family member’s Section 529 Plan for education can be made with annual exclusion gifts. In fact, a 529 Plan can be front loaded with the gift spread ratably over a five-year period when the gift tax return is filed.  This enables a married couple choosing to “gift split”, is able to gift up to $150,000 tax-free to a 529 Plan.

In addition to the annual exclusion gifts noted above, an individual can also pay tuition expenses and qualified medical expenses directly to the provider without creating a taxable gift. Tuition includes the cost of education from preschool through graduate school, but does not include non-tuition charges such as room and board or books. Qualified medical expenses include health insurance premiums.

Wealth Transfer Planning

Finally, under a Republican-controlled Senate, estate and gift planning may be less a 2020 year-end priority given the reduced risk of a reduction in the unified credit or an increase in estate and gift tax rates in 2021.  However, the increased estate tax lifetime exemption which sunsets in five years presents an extraordinary opportunity to effectively transfer wealth tax-free. The current $11.58 million lifetime gift and estate tax exemption is scheduled to sunset on December 31, 2025, at which time it will likely be reduced by at least by half, indexed for inflation. Given this reduction is almost certain to occur, a wealth-transfer plan should be developed now, so that you can permanently take advantage of this higher exemption amount. 

SUMMARY

2020’s year-end tax and financial planning is unique.  It will require consideration of the taxpayer’s facts and circumstances, existing rules, predicted election results in Georgia, and the potential of resulting retroactive tax legislation advancing in 2021. Based on analysis of these factors, each taxpayer will have to decide whether to complete any special planning actions before the end of 2020. Not to be forgotten however, are normal year-end planning strategies that should be deployed regardless of the outcome of the Georgia runoffs.

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AAA-CPA member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained.

Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management

Investment products such as stocks, bonds, and mutual funds are:

NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

Federal Tax Update – October 2020

INDIVIDUALS

In Lucero v. United States, 126 AFTR2d 2020-________, a New Mexico Federal District Court allowed a discharged employee to challenge the “agreed” value of privately owned stock received in a settlement for wrongful termination and accepted a significantly lower value after allowing a 38 ½ percent combined discount.

In Langston v. Commissioner, 126 AFTR2d 2020-6330, the Tenth Circuit Court of Appeals agreed with the Tax Court that an individual who held vacant property for over ten years and then rented it for one year at a below market price could not deduct a loss as it was acquired for personal use and was only rented in order to keep insurance costs down through occupancy. 

In Pine Mountain Preserve v. Commissioner, 126 AFTR2d 2020-________, the Eleventh Circuit Court of Appeals reversed the Tax Court citing conservation easements as the “intersection of obscure common-law property concepts and the often byzantine Internal Revenue Code”, stating that a clause in an easement permitting parties to bilaterally amend the grant to modify location of reserve rights to put up structures has no material adverse effect on the purposes of the easement and, accordingly, should be treated as being granted in perpetuity.

In Coleman v. Commissioner, TC Memo 2020-146, the Tax Court found that a compulsive slot machine gambler netted losses despite over $350,000 of gambling winnings reported to him on 160 separate forms W-2G from three Maryland casinos and one Delaware casino; his diary of wins and losses was incomplete but he was able to show 210 withdrawals from credit cards and accounts in a single year and no accretion to wealth assisted by his expert witness who testified that, based on gambling 193 full days during the year, there was a 99 percent level of certainty that he had gambling losses of at least $151,000 for the year.

In Scholl v. Mnuchin, 126 AFTR2d 2020-________, a California Federal District Court permanently enjoined IRS from following its FAQ which declines to send advanced refunds under the CARES Act to incarcerated individuals. 

In Chief Counsel Advice 202042015, IRS stated that participation in fantasy sports constitutes wagering transactions for purpose of using such losses to offset gambling winnings. 

RETIREMENT AND ESTATE PLANNING

In Revenue Ruling 2020-24, IRS stated that employers must withhold federal income taxes on paying out employee retirement benefits into state unclaimed property funds; in Revenue Procedure 2020-46, IRS added that account holders can claim a waiver of the 60-day rollover period when the transfer is accomplished within 30 days of being able to access funds.

BUSINESS

In Watts v. Commissioner, TC Memo 2020-144, the Tax Court refused to allow an individual to bring in evidence of intention of the parties in a tax allocation when the language of the document was clear.

In Notice 2020-43, IRS announced its intention to require partner capital accounts to reflect basis information in 2002 rather than interrelationships among the partners with penalties to apply effective in 2021.

In Letter Ruling 202042001, IRS ruled that the creation of a second class of stock in the Operating Agreement of an LLC electing to be taxed as an S Corporation was inadvertent and S status was not lost if the improper language was corrected.

PROCEDURE

In Gaetano v. United States, 126 AFTR2d 2020-________, a Michigan Federal District Court concluded that IRS may have a valid purpose for seeking documents beyond the tax periods under investigation. 

In Oropeza v. Commissioner, 155 TC No. 9, the Tax Court rejected the IRS imposition of the 40 percent accuracy penalty as a separate addition to liability where it did not obtain timely supervisory approval for the lesser 20 percent penalty.

In United States v. Horowitz, 126 AFTR2d 2020-________, the Fourth Circuit Court of Appeals agreed with a Maryland Federal District Court that a couple who claimed that they were unaware of the FBAR filing requirement and placed earnings from Saudi Arabian sources into a Swiss bank account acted willfully through their recklessness. 

In United States v. Wolin, 126 AFTR2d 2020-________, a New York Federal District Court agreed with earlier caselaw that the FBAR penalty survives the death of a taxpayer and, as such, the decedent’s estate is liable for payment.

In Shire Hampton Drive Trust v. United States Department of Treasury, 126 AFTR2d 2020-________, a Nevada Federal District Court stated that an earlier IRS lien has priority over a subsequent homeowners association assessment.

FinCEN extended the filing date for the 2019 FBAR from October 15, 2020 until October 31, 2020 because of a misleading notice that the deadline had been extended to yearend where that was only to apply only to victims of a natural disaster. 

In Chief Counsel Advice 202038010, IRS stated that state and local governments may take advantage of Section 530 which prohibits IRS from reclassifying workers as employees when they have been consistently treated as independent contractors and received a Form 1099 as long as there was a rational basis for treating them as independent contractors (including industry norms).

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Federal Tax Update – September 2020

INDIVIDUALS

In McKenny v. United States, 126 AFTR2d 2020-5943, the Eleventh Circuit Court of Appeals reversed a Florida Federal District Court and found a settlement payment from a CPA firm for bad tax advice to be taxable (in contrast to a payment for error in tax preparation), allowing a deduction for legal expenses and other costs only as a miscellaneous itemized deduction under pre-2018 law inasmuch as a loss related to advice on how to handle business arrangements is personal in nature.

In Lucero v. Commissioner, TC Memo 2020-136, the Tax Court declined to accept non-contemporaneous records purportedly showing material participation related to a rental property, the Court also striking driving time as personal and time dealing with the property manager and preparing tax return schedules as “investor activities.”

In Armstrong v. Commissioner, TC Summary Opinion 2020-26, the Tax Court once again disallowed employee business expenses under pre-2018 law where the employee did not seek reimbursement from the employer as she thought it might not be approved.

RETIREMENT AND ESTATE PLANNING

Final Regulations under Code Section 642 amend Proposed Regulations to permit a beneficiary to carryover excess deductions on termination of an estate or trust to succeeding years if not usable by the beneficiary in the tax year to which the estate or trust terminates.

In Fridman v. United States, 126 AFTR2d 2020-________, the Second Circuit Court of Appeals agreed with a New York Federal District Court that a trustee cannot invoke Fifth Amendment privilege with regards to the trust itself as the trustee is holding documents in a representative capacity and the trust is an independent entity apart from its individual beneficiaries.

In Notice 2020-68, IRS gave guidance on the CARES Act and indicated that the $10,000 amount that can be taken from certain retirement plans on the birth or adoption of a child is to be applied on a per person basis in the case of multiple births or adoptions. 

BUSINESS

In Duncan v. Commissioner, 126 AFTR2d 2020-________, the Ninth Circuit Court of Appeals agreed with the Tax Court that an attorney who received gratuitous money beyond the agreed fee from his client for a favorable result had to report the income where the client did not treat the payment as a gift.

In Franklin v. Commissioner, TC Memo 2020-127, the Tax Court disallowed numerous business expenses of an investment banker with an MBA including business bad debts for lack of substantiation; he created a travel log after receiving an audit notice and sought to deduct cross country flights to visit his son who was living with the taxpayer’s former wife. 

In Lothringer v. United States, 126 AFTR2d 2020-5663, a Texas Federal District Court determined that the owner of a corporation was, in essence, its alter ego and personally liable for corporate tax debt based, among other things, on failure to observe corporate formalities including filing income tax returns and annual reports as well as paying personal expenses out of the business.

PROCEDURE

In Patel v. Commissioner, TC Memo 2020-133, the Tax Court threw out accuracy related penalties that did not have supervisory approval at the time of issuance of the Revenue Agent Report and accompanying letter 5153.

In United States v. Toth, 126 AFTR2d 2020-________, a Massachusetts Federal District Court found not only that the FBAR penalty for willful failure to report foreign assets did not violate the due process clause or constitute cruel and unusual punishment but also that it was appropriate due to the individual’s conscious effort to be unaware of her responsibilities (she left a blank where asked on Schedule B whether she had an interest in any foreign account).

In United State v. Cantliffe, 126 AFTR2d 2020-________, a Colorado Federal District Court stated that an IRS lien attached to real property of a taxpayer transferred to a trust where there was not adequate consideration, no recordation and the taxpayer continued to reside in the property taking mortgage interest and home office deductions as a “beneficiary” of the trust.

In In Re:  Feshbach, 126 AFTR2d 2020-________, the Eleventh Circuit Court of Appeals agreed with a Florida Federal District Court that a couple could not discharge over $5 million in tax liability where they earned as much as $8.5 million a year but who spent the substantial portion; IRS had previously rejected multiple Offers in Compromise.

In United States v. Webb, 126 AFTR2d 2020-________, an Indiana Federal District Court allowed IRS to reverse, reinstate and enforce collection of liability improperly written off following bankruptcy but where prior liens remained collectible against assets.

In Robinson v. Commissioner, TC Memo 2020-134, the Tax Court granted innocent spouse status to a divorcee whose husband put her name on the business though she did not actually perform services and did not control the business funds (and only had restricted access to personal funds).

The IRS Manual was revised to reflect that nonautomatic/discretionary penalties must be approved by the immediate supervisor before any written communication of proposed penalties wherein the taxpayer may be asked to consent.

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Federal Tax Update – August 2020

INDIVIDUALS

In Brzyski v. Commissioner, TC Summary Opinion 2020-25, the Tax Court denied dependency allowances under pre-2018 law for an individual claiming a common law marriage to the mother of the children, noting that one night together in a state recognizing common law marriages is insufficient particularly when he referred to the children’s mother as his fiancee. 

In Perkins v. Commissioner, 126 AFTR2d 2020-_______, the Second Circuit Court of Appeals agreed with the Tax Court that an enrolled member of the Seneca Nation of Indians was properly subject to income tax on a gravel business on land belonging to the Nation; the Court looked at 1794 and 1842 treaties and found no individual exemption from income derived from the land.

In Connell v. Commissioner, 126 AFTR2d 2020-5574, the Third Circuit Court of Appeals agreed with the Tax Court that cancellation of a broker’s debt to his company was taxable as ordinary income and not capital gain for transferring his book of business.

In Matzkin v. Commissioner, TC Memo 2020-117, the Tax Court determined that a dentist got no added basis through a buyout of his wife’s marital interest in assets or by his payment of attorney fees.

In Johnson v. United States, 126 AFTR2d 2020-________, a Nevada Federal District Court found that a couple with four rental properties, two of which were not rented during the years in issue and two that were rented by property management companies, did not take the wife to 750 hours in a real estate activity for purpose of utilizing the losses as a real estate professional

In Eger v. United States, 126 AFTR2d 2020-________, the Ninth Circuit Court of Appeals agreed with a California Federal District Court that properties with average use under seven days are not rental properties under the Regulations such that owners cannot argue that they are real estate professionals potentially able to use losses against nonpassive income; the Court noted that only “creative tax lawyers” could argue that the customer was not the user of the property but instead was the rental management company.

In Winslow v. Commissioner, TC Summary Opinion 2020-22, the Tax Court disagreed with the IRS and found under pre-2018 law that an exchange of emails setting support payments for the wife and showing her acceptance constitutes a written agreement between the spouses. 

In Emanouil v. Commissioner, TC Memo 2020-120, the Tax Court allowed a deduction for a developer donating three parcels of land to the town where the donation was not contingent on approval of the development; the Court also found that the income tax statement, despite some missing information, was in substantial compliance such as not to disqualify the donation.

In Cottonwood Place LLC v. Commissioner, TC Memo 2020-115, and in Red Oak Estates LLC v. Commissioner, TC Memo 2020-116, the Tax Court again denied charitable deductions for conservation easements where a possible future extinguishment would not pay a proportionate share of the proceeds on any increase in value attributable to improvements.

In Notice 2020-65, IRS provided limited guidance on the prior Presidential Memorandum permitting deferral of the employee portion of social security taxes from September-December 2020 to January-April 2021 on a ratable basis; the deferral is available only in the case of an employee grossing $4,000 or less for a biweekly pay period or equivalent and is not employer mandated.

The IRS website, citing Notice 2006-59, sets forth that an employee who donates leave under an employer leave-sharing plan to assist other employees adversely affected by COVID-19 does not create taxable income to employees who donate.

In Chief Counsel Advice 202035011, IRS advised that the receipt of virtual currency for services generates ordinary income and may be subject to self-employment tax depending on circumstances. 

RETIREMENT AND ESTATE PLANNING

In an FAQ on the IRS website, IRS stated that a taxpayer cannot rollover an outstanding loan balance from a retirement plan into an IRA inasmuch as IRAs cannot make loans and a rollover would disqualify the IRA. 

In Letter Ruling 202033008, IRS declined to waive the 60-day rollover rule where a taxpayer’s real estate agent suggested that the taxpayer pay cash for a home and put the funds back in his IRA upon sale of the current residence and did not mention the 60-day rule.

BUSINESS

Final Regulations under Code Section 162 allow a deduction for promotional rather than charitable expense for payments to charitable organizations bearing a direct relationship to a taxpayer’s business made with a reasonable expectation of financial return commensurate with the amount of the payment. 

In VHC Inc. v. Commissioner, 126 AFTR2d 2020-5578, the Seventh Circuit Court of Appeals agreed with the Tax Court that purported loans in excess of $132 million over a 16-year period with only $39 million repaid did not give a bad debt deduction to the lender entity, owned by the father, as the Court agreed that there was no likelihood of repayment from the borrower which was owned by the son of the owner of the lender entity.

In Brashear v. Commissioner, TC Memo 2020-122, the Tax Court stated that involvement in “projects” is not necessarily a trade or business, disallowing losses claimed from a “development project” and a “waste management” project.

In Sham v. Commissioner, TC Memo 2020-119, the Tax Court in a detailed 94 page opinion denied most business expenses as well as additional personal expenses due to lack of substantiation; the Court also disallowed other expenses for developing “soft skills” and “general self-help guidance” including hypnosis and travel to India and Europe for lack of relevance.

In Preimesberger v. United States, 126 AFTR2d 2020-5552, a California Federal District Court refused to give summary judgment in favor of the Government on the willfulness of a 10 percent owner of a nursing home facility who did not pay the payroll taxes due to slow payments by medicare as well as a bank loan compelling the payment of other bills including net payroll.

PROCEDURE

In Babu v. Commissioner, TC Memo 2020-121, the Tax Court agreed with the failure of IRS to abate an accuracy penalty in the case of an attorney who had taken tax courses and owned a business supplying owners with software for return preparation and did not report over $2.9 million of flowthrough income from the entity over a two-year period.

In Thompson v. Commissioner, 155 TC No. 5, the Tax Court determined that supervisory approval is not required of discretionary penalties when a resolution is reached at the agent level inasmuch as the examination is not considered complete. 

In Hidy v. United States, 126 AFTR2d 2020-5545, a Nebraska Federal District Court found no reasonable cause for abating the non-willful FBAR penalties for five years where the taxpayer had ten different accounts at eight different foreign banks of up to $1 million in the aggregate; although the taxpayer prepared his own return, the Court said that he should have looked into the question on Schedule B of the tax return.

In Gregory v. United States, 126 AFTR2d 2020-________, the Court of Federal Claims agreed with the IRS denial of a refund based on an amended return where the return was not signed; the Court noted that the requirement of a signature was statutory and could not be waived. 

In Porporato v. Commissioner, TC Summary Opinion 2020-24, the Tax Court stated that, where a taxpayer’s refund from an overpayment is barred due to the statute of limitations, any offset of another year is also barred. 

In Yiu v. Commissioner, TC Summary Opinion 2020-23, the Tax Court determined that Congress intentionally denied claimants of innocent spouse status a refund if proceeding under Section 6015(c) as opposed to Subsections (b) or (f). 

In News Release 2020-182, IRS announced that Form 1040-X, amending individual income tax returns, can now be filed electronically. 

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Tax Planning for a Possible Joe Biden Presidency

With Election Day just over two months away and the end of 2020 following two months later, it’s not too soon to consider the landscape of the tax law in the event of a Joe Biden Presidency.  Back to 1969, a major tax bill has been enacted in the first year following a shift in political control.  Change will be facilitated, of course, if the Democrats take control of the Senate, requiring a net gain of three seats, while holding their existing majority in the House.

            What would 2021 tax law revisions look like under a Biden administration?  As a starting point, look to the Democratic party platform and the prior specific proposals of candidate Biden.

            1.         Individual tax rates – Expect the highest individual marginal bracket to return to the 39.6 percent rate of the Obama administration beginning as low as $400,000 of taxable income.

            2.         Dividend and capital gain rates – Both dividends and capital gains may be taxed at ordinary income rates for the highest earners – perhaps those with taxable income in excess of $ 1 million.

            3.         Like-Kind exchanges – Joe Biden has suggested the elimination of real estate swaps for those with incomes over $400,000.  Exchanges of personal property have been disallowed since 2018.

            4.         Basis of inherited assets – Candidate Biden has suggested the elimination of the stepped-up basis of most assets on death.  This may apply only to heirs of larger estates.  As was the case with a 1976 law terminating carryover basis which was repealed retroactively a year later, appreciation prior to enactment may still enjoy the step-up.

            5.         Student loans – Joe Biden supports any forgiveness of student loans to be excludable from income.

            6.         Qualified business income deduction – The QBID, scheduled to expire after 2025, may be phased out for all higher income individuals and not just those with income from specified service businesses.

            7.         Itemized deductions – The $10,000 cap on deducting state and local taxes, also scheduled to expire after 2025, may be repealed but the benefit of this restoration could be offset by a proposal to limit the tax benefit of all itemized deductions to 28 percent.  In other words, an individual in a higher tax bracket with $50,000 of itemized deductions could save no more than $14,000 in taxes by the itemized deductions.

            8.         Tax credits – Candidate Biden would significantly raise the child tax credit to $8,000 for one child and $16,000 for two or more, phasing out at adjusted gross income between $125,000 and $400,000.  He favors expanding the earned income credit for lower income individuals without dependents to include those over age 65.  He supports an advanced and refundable tax credit of up to $15,000 for first-time homebuyers as well as a renters’ tax credit of up to 30 percent of income for low-income individuals.

            9.         Estate taxes – Expect the current estate and gift tax exemption of $11,580,000, already scheduled to be cut in half in 2026, to be reduced to an amount as low as $3.5 million or, perhaps more likely, to about $5.8 million (one-half of the current amount as indexed in 2021).

            The next question is whether planning steps can await the results of the election and a 2021 tax bill?  Examining “tax history”, some new provisions may be effective on enactment or even a date thereafter but others may be retroactive to the start of the year or even to an earlier date to prevent tax saving maneuvers.  Courts have generally found retroactive tax legislation to be constitutional.

            Following are steps to be considered by affected individuals.  Most may be accomplished after November 3 in the event of a Democratic sweep but wealthiest individuals wishing to take advantage of the current enhanced applicable estate and gift tax exemption should complete gifting prior to Election Day as a hedge on retroactivity.

            The Internal Revenue Service has previously indicated that the scheduled halving of the applicable exemption in 2026 will not cause a “clawback” meaning that the entire reduced exemption will remain available to individuals who fully utilized the expired enhanced amount.  Accordingly, wealthiest individuals who are comfortable passing considerable assets to next generations may wish to consider, subject to prior gifting, transfers of up to $5,790,000 prior to Election Day.  Married couples may consider transfers of twice this amount. 

            Actions for higher income individuals to consider prior to year-end in the event of a Democratic sweep include:

                        ●          Accelerating income and capital gain into 2020.

●          Closing by year-end on the disposition of real property to be exchanged (given the likely ability to close on replacement property into 2021).

●          Accelerating large planned charitable lifetime giving into 2020.

Actions that should be considered by additional individuals as well include:

●          Delaying payment of property taxes, 2020 estimated state income taxes and delinquent state income taxes until 2021.

●          If a first-time homebuyer, holding up the purchase of a property until after enactment.

●          If eligible for discharge of student debt and discharge would be taxable under current law, delaying forgiveness until after enactment.

Financial Planning Now In Anticipation of the Upcoming Election

With inauguration day less than six months away, taxpayers are still adjusting their organizational structures and transactions to address the ongoing COVID-19 pandemic and an economy still reeling from the resulting recession. With the increasing political polarization and economic uncertainty in mind, tax policy will be critical point of differentiation in the 2020 presidential race and have important ramifications on your financial wellbeing.

Of course, even if Democrats control both the White House and Congress, there is no guarantee that any of these proposals presented to date will be adopted. But most experts can agree that current tax rates for both individuals and corporations are at a historically low point, and some low rates are already scheduled to sunset after 2025.  Higher taxes therefore appear inevitable, due to fiscal pressure to generate revenue to pay for the over $3 trillion in current COVID-19 relief measures with a fourth stimulus package currently being negotiated.

This alert sets out to highlight some of the election’s potential tax implications should President Trump win, or if former Vice President Biden should win and Democrats should acquire control of Congress. A Biden administration would rollback many of the 2017 tax cuts and would increase capital gains and payroll taxes on high-earners. A Trump administration would look to make the 2017 tax cuts permanent and would propose to reduce the long-term capital gains tax rates through indexing.  We have developed a summary of the more significant income tax changes Biden has proposed and how it compares to Trump’s plan.

Corporations

From a corporate perspective, the largest source of new business revenue from the Biden proposal is an increase in the corporate tax rate from 21% to 28%. (Vice presidential candidate Senator Kamala Harris went further during her presidential campaign, proposing a 35% corporate tax rate.)  Biden’s plan would also raise an additional $470 billion from an increase in tax on foreign profits and create a new alternative minimum tax of 15% on global book income, while still allowing net operating losses and foreign tax credits, for corporations with more than $100 million in book net income. For companies operating in the United States and abroad, Biden has also proposed doubling the tax rate on global intangible low-taxed income to 21% (currently 10.5%). 

The proposed Biden 15% alternative minimum tax could adversely impact start-up companies and other corporations whose taxable income is likely to be materially lower than their book income, such as taxpayers with capital intensive projects, which would lose the benefits of tax bonus depreciation. 

President Trump has been campaigning on making certain expiring provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) permanent, including the 20% tax deduction for pass-through entities.  (Biden would phase out the 20% pass-through deduction for income over $400,000.)  Expect additional proposals to be put forth closer to the election. 

Planning:  With both potential rising tax rates and a new corporate alternative minimum tax, income acceleration techniques and capital improvement projects should be considered.  Rising corporate rates will also prompt many businesses to revisit their business entity structure to determine whether a partnership or LLC is more advantageous than a C corporation.

Individuals

For most individuals, the most impactful proposed Biden changes are to the tax rates, which would return the current 37% top rate to the 39.6% pre-TCJA level for taxpayers with incomes above $400,000.  In addition, Biden would limit total itemized deductions to where the reduction in tax liability per dollar of deduction does not exceed 28%, meaning taxpayers in tax brackets higher than 28% will face limited itemized deductions.

Trump proposes a 10% middle-class tax cut, which reportedly could include lowering the 22% marginal tax rate to 15%. For 2020, the 22% marginal tax rate applies to income over $40,125 for individuals and $80,250 for married couples filing jointly.  He also proposes to permanently extend the current lower individual rates and the higher basic standard deduction enacted by the TCJA that is scheduled to expire after 2025.

Planning:   A lower-income-tax-rate environment is generally favorable for Roth IRA conversions to lock in lower tax rates on pretax retirement savings.  Income acceleration strategies, such as capital gain harvesting, and deduction deferrals would be recommended options should tax rates be expected to rise in the future.  While uncertain at this point, should the Biden plan restore the state and local tax deduction for amounts above the current $10,000 cap, itemizers should also plan to defer payments of these taxes to after the law change. 

Investment Income and Capital Gains

Under the Biden plan, the tax rate on long-term capital gains and dividends would be increased from 20% to 39.6% for taxpayers with income above $1 million. This income would continue to be subject to the 3.8% net investment income tax as it was enacted as part of the Affordable Care Act. The impact of this would be significant for high-income investors as well as founders and entrepreneurs who may experience a liquidity event.  Individuals with highly appreciated assets may consider hedging the tax rate by selling some of those assets now, before any rate increase comes into effect.

Biden supports a financial transaction tax on trades of stocks, bonds and other financial instruments but has not released the details of this plan.  Vice presidential candidate Senator Kamal Harris has proposed imposing a financial transactions tax on stock trades at 0.2 percent, bond trades at 0.1 percent, and derivative transactions at 0.002 percent.  

President Trump said on August 10th that he’s “very seriously” considering a capital gains tax cut through indexing capital gains for inflation. He has also proposed a capital gains tax holiday that eliminates capital gains taxes for a yet-to-be-identified period.

Planning:  Expect many people with incomes over $1 million to sell appreciated assets prior to the elimination of the 20% preferential rate for long-term capital gains and qualified dividends.  Another effective capital gains tax mitigation strategy is the gifting of appreciated assets to utilize the current increased estate and gift tax exemption.  Similarly, charitable contributions of appreciated assets to qualified charities, including donor advised funds and private foundations, is an effective way to sidestep the capital gains tax on disposition.  Another strategy, the reinvestment of realized capital gains in to qualified opportunity zone funds, should be considered but also carries some risk.  The benefits include the ability to defer a current capital gain to 2026, avoid 10% of that current capital gain if it is held for 5 years, and permanently avoid all future capital gains after the contribution if held for 10 years or more.  The risk however is that the current deferred to 2026 capital gain is subject to whatever capital tax rate is in effect in 2026, which could be a substantially higher rate than today. 

Payroll Taxes

Biden seeks to eliminate the Social Security tax exemption for wages and self-employment earnings above $400,000, and therefore, wages and earnings between $137,700 and $400,000 would not be taxed, creating a donut-hole structure. Because the 12.4% Social Security tax is split evenly between the employer and the employee, this proposal would increase payroll taxes for both high-income wage earners and their employers.

Trump, facing an impasse on Capitol Hill over coronavirus relief, issued an executive directive on August 8th that would delay the deadline to submit payroll taxes for millions of workers until the end of the year. He said he hopes Congress will forgive those tax debts, but absent legislation, those payments will still be required by the extended due date.

Planning:  One possible solution for business owners should the Social Security tax be expanded is to convert to an S-corporation structure.  S-corporation dividends are not subject to employment taxes.  In the executive compensation area, incentive stock options would become more popular because there is no Social Security tax on the option spread. 

Estate & Gift Taxes

The current estate tax exemption threshold is $11.58 million per individual (indexed for inflation) with a top tax rate of 40%.   This amount is scheduled to revert to the pre-TCJA indexed amount of approximately $5.8 million after 2025.   The Biden-Sanders Unity Task Force has recommended returning the estate tax regime to the “historical norm”.  This could mean restoring the exemption threshold to the 2009 level of $3.5 million per individual, and it could portend an estate tax rate increase back to the 45% rate in effect in 2009, or even higher.

The Trump plan would extend the higher estate and gift tax exemption enacted by the TCJA that is scheduled to expire after 2025.  Assuming the Trump plan is not enacted and/or in anticipation of enactment of a Biden-Sanders plan, taxpayers with more than the full $11.58 exclusion amount should be planning gifts of their full exclusion amount NOW, before the exclusion amount might revert to a lower threshold. 

Planning:  In 2019, the Treasury finalized taxpayer friendly regulations confirming that this temporary increased estate and gift tax exemption will not be clawed back for taxpayers who die after 2025.  However, the Treasury rejected so-called “off the top” use of exemption, meaning that the benefit of the increased exclusion amount is a use-it-or-lose-it proposition, encouraging taxpayers to act now to use the current increased exemption before the law changes under a new administration or reverts back in 2026 as planned.  For example, an individual with a 2020 exemption of $11.58 million who only utilizes $9 or $10 million of that exemption through 2025 will lose the unused exemption amount above the $9 or $10 million in 2026 when the law reverts to pre-TCJA law, or earlier if a new Biden lower exemption limit is passed. 

Likely the most significant Biden proposal is a proposed change to the estate tax regime.  Currently, a future capital gains tax upon disposition of an asset is based on its value at the time it’s inherited, referred to as the basis “step-up”.  Biden’s plan would eliminate the step-up in basis for inherited assets.  The Biden plan is not entirely clear whether the proposal would provide the heirs with a carryover basis or impose capital gains tax on the decedent for unrealized appreciation at the time of death, which was one of President Obama’s budget proposals. If heirs receive carryover basis, capital gains tax would be imposed on the heir based on the value of the asset from the time the original investment was made. The result would often lead to a significantly higher income tax liability for the heir should the inherited asset be sold. If the proposal is to tax unrealized gains of the decedent, the decedent’s estate would pay the tax, and presumably the heirs would take the assets at a basis stepped-up to fair market value. 

Planning:  With either a capital gains tax on assets held upon death or upon the later sale of inherited assets by the heirs who obtained a carryover basis, the Biden proposal would create significant practical problems in establishing the tax basis of long-held assets such as family businesses or farms, or investment assets for which the historical tax basis is no longer available.  Taxpayers with significant appreciated assets should carefully consider a wealth-transfer plan prior to enactment of such proposals. 

Elimination of Tax Benefit for Real Estate Like-Kind Exchanges

The TCJA repealed like-kind exchange treatment (Internal Revenue Code Section 1031) for personal property. However, the new like-kind provision allows investors to defer tax on gains from sales of real property by rolling the sales proceeds over into a subsequent real property purchase. Biden’s plan would repeal like-kind exchange treatment for real property for taxpayers with income over $400,000.

Planning:  Taxpayers with real estate contemplating a Section 1031 like-kind exchange should complete their transactions to defer their tax gains prior to enactment of such a provision. 

Biden vs. Trump Comparison Chart

Summary

The results of an election are impossible to predict, as 2016 has shown.  Which of these proposals become law depends not just on the Presidential election, but on which party controls the Senate.  Should Democrats win the White House as well as the House and Senate, the enactment of tax changes in 2021 is highly likely.  Sweeping tax changes such as those proposed are not typically retroactive and therefore might not be effective until January 1, 2022 once passes.  However, it is possible these tax increases could be retroactive to as soon as January 1, 2021.   

It is critical for investors to consider these proposed law changes in their current investment and estate planning.  If you have any questions on how this may impact you, please do not hesitate to contact your Wintrust Wealth Services advisor. 

Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained. Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management Investment products such as stocks, bonds, and mutual funds are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

Strategies for Maximizing Cash Flow with the CARES Act

Provisions in the Act allow taxpayers to potentially generate cash flow in 2021 and beyond

At this point, most of us are familiar with the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed earlier this year, which provided $2.2 trillion in economic impact payments, assistance to small businesses, and more amidst the ravages of COVID-19. Now, months later, economic output and employment remain far below their pre-pandemic levels and many of our clients are desperately seeking ways to generate liquidity.

Those who only see the CARES Act as a way to access immediate liquidity from loans may be overlooking significant tax provisions that can generate cash flow in 2021 and beyond. The Act contains several temporary changes to the Tax Cuts and Jobs Act of 2017 (TCJA) of which CPAs can take advantage. Following are three strategies to take advantage of CARES Act provisions to maximize cash flow long after the loans have been disbursed and stimulus payments have been spent.

Strategy 1: Maximize Tax Value of Net Operating Losses and Carrybacks

Under the CARES Act, net operating losses (NOLs) arising in tax years beginning after December 31, 2017, and before January 1, 2021 may be carried back to each of the five tax years preceding the tax year of such loss. Under the TCJA, NOLs generally could not be carried back; they could only be carried forward indefinitely, and NOLs could only be used to offset 80 percent of taxable income. The CARES Act temporarily removes the 80 percent limitation, reinstating it for tax years beginning after 2020. Special carryback rules are provided for some businesses such as real estate investment trusts (REITs) and life insurance companies.

In addition, organizations are allowed to use an NOL from a tax year with a lower corporate tax rate such as 2020, where the federal corporate tax rate is 21 percent, to offset taxable income that was subject to a higher corporate tax rate in an earlier tax year, such as 2015, where the corporate tax rate was 35 percent. This provides a unique opportunity to use deductions generated in the lower tax bracket years of 2018 to 2020 to offset income in the higher tax bracket years of 2013 to 2017.

Organizations can still waive the carryback and elect to carry NOLs forward to subsequent tax years in certain situations where that may be more beneficial. Taxpayers such as international corporations will want to consider how other tax attributes such as foreign tax credits or the transition tax on repatriated income will be impacted by an NOL carryback and plan accordingly. Organizations participating in an M&A transaction will also want to consider contractual limitations affecting their ability to carry back, or carry over, an NOL.

The tax returns for 2019 and 2020 must be filed before a refund may be requested. Therefore, in early 2021, expect a significant boost to cash flow for calendar year 2020 taxpayers who incur significant losses because of the COVID-19 crisis. These taxpayers should file their returns as soon as possible after their year-end so that a refund claim may be filed. A refund may be requested by filing either Form 1120X or Form 1139 for corporations, or either Form 1040X or Form 1045 for individuals. Forms 1139 and 1045 are a much faster process, as the IRS is required to issue a tentative refund by the later of 90 days after filing the form, or 90 days from the last day of the month of the due date of the taxpayer’s return for the NOL year, including extensions. Taxpayers who file their 2020 tax returns by April 15, 2021 should therefore begin receiving their refunds by the summer of 2021.

Strategy 2 – Accelerate Excess Business Loss Tax Benefits

Under the TCJA, for tax years beginning after December 31, 2017 and ending before January 1, 2026, taxpayers other than C corporations are not allowed to deduct excess business losses. For this purpose, and with some exceptions, “excess business loss” essentially means taxpayers’ otherwise deductible trade or business losses in excess of $250,000 for single filing taxpayers, or $500,000 for married taxpayers filing jointly, adjusted for inflation. Disallowed excess business losses were carried forward and treated as a net operating loss in subsequent tax years. Under the CARES Act, the excess business loss limitation for non-C corporations is retroactively eliminated for tax years beginning before 2021, potentially increasing the amounts available for loss carryback.

Strategy 3 – Capitalize on Increased Deduction Allowances

Qualified Improvement Property Deductions

The CARES Act qualified improvement property (QIP) provision enables businesses to use bonus depreciation to immediately write off costs associated with improving facilities instead of having to depreciate those improvements over the 39-year life of a commercial building. QIP is defined as any improvement made by a taxpayer to an interior portion of a nonresidential building after the building was placed in service. The QIP provision, which corrects an error in the TCJA often referred to as the “retail glitch,” not only increases companies’ access to cash flow by allowing them to claim the benefit retroactively, but also incents them to continue to invest in improvements as the country recovers from the COVID-19 economic fallout. Either amending 2019 tax returns for this law change if already filed or claiming bonus depreciation now as 2019 tax returns are filed, can produce significant cash flow benefit.

The CARES Act changes to depreciation are further enhanced by the bonus depreciation rules and cost segregation studies. Bonus depreciation allows individuals and businesses to immediately deduct a certain percentage of their asset costs the first year they are placed in service. The TCJA made used property eligible for bonus treatment for the very first time, and it also increased the bonus percentage to 100 percent through tax year 2022. Prior to this, only new property was eligible, and bonus depreciation was expected to be only 50 percent in 2019. Any assets that are removed from the “real property” category and placed in the “personal property” category may now be eligible for bonus depreciation and can be immediately expensed in the first year.

A cost segregation study is an established technique used to further enhance cash flow, reduce tax liability, and uncover missed deductions. The study assesses an entity’s real property assets to identify the portion of those costs that can be treated as personal property. By segregating personal property from the building itself, the study will allow for costs that would have otherwise been depreciated over a 39-year period to be reassigned to asset groups that will be depreciated at a much quicker pace, or perhaps even expensed immediately as bonus depreciation.

Business Interest Deductions

Under the TCJA, business interest expense deductions are generally limited to 30 percent of a company’s adjusted taxable income. The CARES Act increases that to 50 percent for taxable years 2019 and 2020. In addition, a company can elect to use their 2019 adjusted taxable income (which is likely higher than their 2020 adjusted taxable income) to compute the business interest expense deduction for the 2020 taxable year. It should be noted that special rules apply to businesses taxed as partnerships.

Increased Charitable Deduction Limits

One significant consequence of the TCJA is the dramatic reduction in the number of taxpayers that itemize deductions. Many donors now opt for an increased standard deduction (and do not itemize their deductions) and therefore get no tax benefit for their charitable contributions.

This changes under the CARES Act. An individual can now claim an above-the-line deduction of up to $300 for donations made to qualified charitable organizations. As a result, donors may be entitled to a charitable deduction whether or not they itemize. One caveat: The deduction is not available for contributions to private foundations or donor-advised funds. The first $300 donated in 2020 goes toward this deduction. Therefore, itemizers will benefit from the deduction before claiming any other donations on Schedule A. Any excess is carried forward for up to five years.

Prior to the CARES Act, an individual’s annual deduction for cash contributions was limited to 60 percent of adjusted gross income (AGI). This limit was raised from 50 percent of AGI for 2018 through 2025 by the TCJA. The CARES Act increases this deduction limit to 100 percent of AGI for 2020. Therefore, a taxpayer who itemizes can generally write off the full amount of his or her charitable contributions of cash or cash-equivalents in 2020. Any excess above 100 percent of AGI is carried forward for up to five years. As is the case with the new $300 deduction, this provision does not apply to private foundations or donor-advised funds.

The TCJA also imposes limits on deductions for charitable contributions made by corporations: the annual deduction for contributions by a corporation cannot exceed 10 percent of its taxable income, with any excess carried forward for up to five years. Under the CARES Act, the annual threshold for corporate deductions is increased to 25 percent of taxable income for 2020, with any excess carried forward for up to five years.

The CARES Act offers a unique opportunity to help businesses and individuals impacted by COVID-19 maximize cash flow long after 2020 tax returns are filed. By exploring these options and implementing the best available strategies, organizations and individuals alike can generate liquidity during this economically challenging time.

About the Author

Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Services. He is also a former chair of the Illinois CPA Society Board of Directors.

This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained.

Securities, insurance products, financial planning, and investment management services are offered through Wintrust Investments, LLC (Member FINRA/SIPC), founded in 1931. Trust and asset management services offered by The Chicago Trust Company, N.A. and Great Lakes Advisors, LLC, respectively. © 2020 Wintrust Wealth Management

Investment products such as stocks, bonds, and mutual funds are:

NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE | NOT A DEPOSIT | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY

Federal Tax Update – July 2020

INDIVIDUALS

In Beckett v. Commissioner, TC Summary Opinion 2020-19, the Tax Court found that, although the source of a claim for seizures at work from epilepsy was failure of an employer to make a reasonable accommodation constituting discrimination, the physical distress cited in the complaint and in the settlement agreement caused the Court to state that one-third of the settlement award was nontaxable based on the intent of the payor to pay in part for physical injury.

In Weiderman v. Commissioner, TC Memo 2020-109, the Tax Court denied an exclusion on cancellation of debt incurred to purchase a primary residence inasmuch as the property did not secure the loan. 

In Duffy v. Commissioner, TC Memo 2020-108, the Tax Court decided against the taxpayer on a number of issues, finding that a loss on one property was not allowable inasmuch as it was not rental property despite possible occasional rental income and on a second property where the adjusted basis could not be proven.

In Keefe v. Commissioner, 126 AFTR2d 2020-________, the Second Circuit Court of Appeals agreed with the Tax Court that a couple who took six years to renovate an historic mansion and then sold the property could not claim an ordinary loss where they spent more time trying to sell the property than rent it, the Court noting that a property never rented can still give rise to an ordinary loss under more favorable facts.

In Villages at Effingham LLC v. Commissioner, TC Memo 2020-102, Riverside Place LLC v. Commissioner, TC Memo 2020-103, Maple Landing LLC v. Commissioner, TC Memo 2020-104, Anglewood Place LLC v. Commissioner, TC Memo 2020-105, Smith’s Lake LLC v. Commissioner, TC Memo 2020-107, and Belair Woods LLC v. Commissioner, TC Memo 2020-112, the Tax Court rejected a deduction for a conservation easement, finding that it was not perpetually donated due to excluding any increase in value after the date of the easement attributable to improvements from any proceeds in the event of extinguishment. 

In Johnson v. Commissioner, TC Memo 2020-79, the Tax Court allowed about 60 percent of the $610,000 charitable contribution claimed for donation of a conservation easement although the amount allowed was almost twice the purchase price of the property five years earlier and excluded five acres with a residence. 

RETIREMENT AND ESTATE PLANNING

In Letter Ruling 202029006, IRS waived the 60-day rollover period in the case of a recent divorcee who was unaware that funds placed in her bank account by her spouse were from an IRA. 

BUSINESS

In Pilyavsky v. Commissioner, TC Summary Opinion 2020-20, the Tax Court found that a database engineer fabricated about $47,000 in expenses and $10,000 in income to create a Schedule C reflecting alleged self-employment; the Court allowed $3,500 in expenses but did not adjust out the $10,000 of alleged self-employment income. 

In Yapp v. Commissioner, 126 AFTR2d 2020-________, the Ninth Circuit Court of Appeals agreed with the Tax Court that expenses incurred in developing a product line and in soliciting pre-orders prior to the official launching of products were start-up expenses and not eligible for an immediate deduction. 

In United States v. Beskrone, 126 AFTR2d 2020-________, a Delaware Federal District Court reversed a bankruptcy court and held that a C corporation’s tax liability accrues only on the last day of the year which makes the tax obligation solely that of the estate and gives the Government priority over other creditors. 

In Fact Sheet 2020-11, IRS provided examples of situations in which Form 8300, reporting cash payments over $10,000 received in a trade or business, will be required including any two or more related payments within 24 hours or payments as part of a single transaction or related transactions within a 12-month period; recipients would need to file when $10,000 in cash is received cumulatively during the 12-month period and then with each $10,000 in additional payments. 

PROCEDURE

In Trump v. Vance, 126 AFTR2d 2020-5082, the US Supreme Court by a 7 to 2 margin agreed with the Second Circuit Court of Appeals that a sitting President does not enjoy absolute immunity from state criminal process and, accordingly, a prosecutor can obtain the President’s tax returns as part of an investigation upon showing of need and relevance.

In United States v. Blake, 126 AFTR2d 2020-5258, the Seventh Circuit Court of Appeals agreed with an Indiana Federal District Court that it was proper to base the sentencing of an individual with an MBA who filed false tax returns including one alleging his own death on the amount of the attempted fraud and not just the actual fraud.

In Minemyer v. Commissioner, TC Memo 2020-99, the Tax Court found that an individual was not liable for the civil fraud penalty due to lack of supervisory approval before communication to the taxpayer. 

In Barnhill v. Commissioner, 155 TC No. 1, the Tax Court allowed a company director pursued for unpaid trust funds taxes to argue merits at a CDP hearing when he asserted that he failed to get notice of an Appeals conference and IRS closed the matter and assessed two days later without follow-up.

In Dodson v. Commissioner, TC Memo 2020-106, the Tax Court agreed that IRS did not abuse its discretion in denying an installment agreement where a couple had sufficient equity in their primary residence against which they could borrow to pay the liability in full.

In Sadjadi v. Commissioner, 126 AFTR2d 2020-5188, the Fifth Circuit Court of Appeals agreed with the Tax Court that the terms of acceptance of an Offer in Compromise were clear and that it was voided by noncompliance during the five succeeding years.

In In Re:  Gabbidori, 126 AFTR2d 2020-5080, and in In In Re:  Szczyporski, 126 AFTR2d 2020-5048, Bankruptcy Courts in Florida and Pennsylvania respectively found the shared responsibility payment to be a tax rather than a penalty.

In SBSE-05-0720-0049, IRS recognized that CDP notices currently have two response addresses, one at the top of the first page and another on a voucher for submitting payment at the bottom of the first page, and will consider a timely appeal sent to either address as valid notwithstanding that the intended address is the one at the top of the page.

In Chief Counsel Advice 202026002, IRS determined that a “superseding” return, one refiled before the due date and not as an amended return, does not change the statute of limitations which is measured based on the date of the original return; this applies both to an IRS assessment and to a taxpayer claim for refund.

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After the Loan Programs – CARES Act Cash Flow Generating Strategies

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was passed, providing $3.3 trillion in tax, grant, and loan provisions designed to provide financial aid to individuals, businesses, nonprofits, and state and local governments which have been severely impacted by COVID-19.  The Paycheck Protection Program loans and other measures have helped stabilize the economy, but economic output and employment remain far below their pre-pandemic levels. 

Beyond these loan programs and other financial measures, which primarily supported employers, there are a number of significant cash flow benefits directed to businesses and individuals which to date have been greatly overlooked because most of their impact won’t be realized until the 2021 tax season.  These provisions contained in the CARES Act have the potential to greatly impact cash flow for taxpayers if planned for properly.

These tax provisions can be categorized into three buckets, (1) the carryback of losses to generate tax refunds and hence, liquidity, (2) relaxed limitations on deductibility of losses, and (3) increased deductions.  These categories are all interrelated:  increased deductions can generate greater losses, the limitations on those losses are relaxed to potentially produce even larger losses, and a greater amount losses can be carried back five years, producing significant new cash flow to taxpayers in the form of tax refunds.

This article provides an overview of those provisions contained in the Act.

Bucket 1 – Net Operating Losses and Carrybacks

Under the CARES Act, net operating losses (NOLs) arising in tax years beginning after December 31, 2017, and before January 1, 2021 (for example, NOLs incurred in 2018, 2019, or 2020 by a calendar-year taxpayer) may be carried back to each of the five tax years preceding the tax year of such loss. Previously, since the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA), NOLs generally could not be carried back; they could only be carried forward indefinitely. Further, under the TCJA, NOLs could only be used to offset 80% of taxable income. The CARES Act temporarily removes the 80% limitation, reinstating it for tax years beginning after 2020. Special carryback rules are provided for taxpayers such as real estate investment trusts (REITs) and life insurance companies.

In addition, taxpayers are allowed to use an NOL from a tax year with a lower corporate tax rate such as 2020, where the federal corporate tax rate is 21%, to offset taxable income that was subject to a higher corporate tax rate in an earlier tax year, such as 2015, where the corporate tax rate is 35%.  This provides taxpayers with the unique opportunity to use deductions that are generated in the lower 21% tax bracket years of 2018, 2019 or 2020, and to use them to offset income in the higher 35% tax bracket years of 2013 to 2017.

A taxpayer can still waive the carryback and elect to carry NOLs forward to subsequent tax years in certain situations where that may be more beneficial.  Taxpayers such as international corporations will want to consider how other tax attributes such as foreign tax credits or the TJCA transition tax on repatriated income will be impacted by an NOL carryback and plan accordingly.  Taxpayers that were a party to an M&A transaction may also need to consider contractual limitations affecting their ability to carry back, or carry over, an NOL.

Loss Carryback Example

Facts: A calendar year corporate taxpayer has taxable income in years 2014 through 2018 of $100,000, and an NOL of 150,000 in 2019.  It also expects a $1 million NOL in 2020 because of COVID-19 related business disruption.  Assume no election to forego the NOL carryback.

2019 NOL carryback benefit:  the $150,000 2019 NOL can be carried back 5 years to offset all of 2014’s $100,000 of income, as well as $50,000 of 2015’s income.  Because 2014 and 2015 had a corporate tax rate of 35%, the business work receive a $52,500 tax refund. 

2020 NOL carryback benefit: $350,000 of the $1 million 2020 NOL can then be carried back, first to 2015, and then to years 2016 – 2019, in that order.  $50,000 of the 2015 income has already been offset by the 2019 NOL carryback, so $50,000 remains to be offset.  The business can also offset taxable income of $100,000 in 2016, 2017, and 2018. The unused NOL will carryforward.  This 2020 carryback will result in the following tax refund: 

YEARINCOMETAX RATEREFUND
201550,00035%17,500
2016100,00035%35,000
2017100,00035%35,000
2018100,00021%21,000
TOTAL TAX REFUND108,500

The tax returns for 2019 and 2020 must be filed before a refund may be requested.  Therefore, in early 2021, expect a significant boost to cash flow for calendar year 2020 taxpayers who incur significant losses because of the COVID-19 crisis.  These taxpayers should file their tax returns as soon as possible after their year-end so that a refund claim may be filed.  A refund may be requested by filing either a Form 1120X or Form 1139 for corporations, or Form 1040X or a Form 1045 for individuals.  Forms 1139 and 1045 are the much faster method to obtain refunds; the IRS is required to issue a tentative refund by the later of 90 days after filing form 1139 or 1045, or 90 days from the last day of the month of the due date of the taxpayer’s return for the NOL year, including extensions.  Taxpayers who file their 2020 tax returns by April 15, 2021 should therefore begin receiving their refunds by the summer of 2021. 

Bucket 2 – Relaxed Limitations on Loss Deductibility

Net Operating Loss 80% Limitation

The TCJA enacted two rules that imposed significant limitations on a taxpayer’s ability to deduct losses—one applicable to net operating losses and the other applicable to active business losses. For tax years beginning after December 31, 2017, a taxpayer became limited in its ability to deduct net operating loss carryovers by reference to 80 percent of taxable income.  Under the CARES Act, the 80 percent limitation is eliminated for net operating losses deducted in a tax year beginning before 2021   Therefore a 2020 NOL would not be subject to the 80% limitation if it is carried back; it only applies if it is carried forward.   This potentially increases the cash flow benefit of such a loss carryback. 

Excess Business Losses

Also a part of the TCJA, for tax years beginning after December 31, 2017 and ending before January 1, 2026, taxpayers other than C corporations were not allowed to deduct excess business losses.  For this purpose and with some exceptions, “excess business loss” essentially means taxpayers’ otherwise deductible trade or business losses in excess of $250,000 for single filing taxpayers, or $500,000 for married taxpayers filing jointly, adjusted for inflation. Disallowed excess business losses were carried forward and treated as a net operating loss in subsequent tax years.  

Under the CARES Act, the excess business loss limitation for non-C corporation taxpayers is retroactively eliminated for tax years beginning before 2021, potentially increasing the amounts available for loss carryback.

Bucket 3 – Increased Deductions

There are three provisions in the CARES Act that increase available deductions: the tax treatment of Qualified Improvement Property (QIP) deductions, the relaxation of the limitation on deductibility of business interest, and increased limitations on charitable deductions for both corporations and individuals.  The CARES Act changes to depreciation for qualified improvement property are further enhance by the bonus depreciation rules and cost segregation studies as discuss below. 

Qualified Improvement Property, Bonus Depreciation, and Cost Segregation

The CARES Act QIP provision enables businesses to use bonus depreciation to immediately write off costs associated with improving facilities instead of having to depreciate those improvements over the 39-year life of a commercial building. The QIP provision, which corrects an error in the TCJA often referred to as the “retail glitch,” not only increases companies’ access to cash flow by allowing them to claim the benefit retroactively to the enactment of TCJA, but also incentivizes them to continue to invest in improvements as the country recovers from the COVID-19 emergency.  Either amending 2019 tax returns for this law change if already filed, or claiming bonus depreciation now as 2019 tax returns are filed, can result in significant cash flow benefits.

QIP is defined as any improvement made by a taxpayer to an interior portion of a nonresidential building placed in service after the building was placed in service. It excludes expenditures for the enlargement of the building, elevators and escalators, or the building’s internal structural framework. QIP can include roofs, heating and air conditioning equipment, and fire protection and security equipment. In order to qualify for bonus depreciation, the QIP must be new property in the hands of the taxpayer, not used property. 

Bonus depreciation allows individuals and businesses to immediately deduct a certain percentage of their asset costs the first year they are placed in service. The TCJA made used property eligible for bonus treatment for the very first time, and it also increased the bonus percentage to 100 percent through tax year 2022. Prior to this law change, only new property was qualifying, and bonus depreciation was expected to be only 50 percent in 2019.  Any assets that are removed from the “real property” bucket and placed in the “personal property” bucket may now be eligible for bonus depreciation and can be immediately expensed in the first year.

To further enhance cash flow, a cost segregation study is an established tax technique used to increase cash flows, reduce tax liability, and uncover missed deductions, should be considered.  The study assess an entity’s real property assets to identify the portion of those costs that can be treated as personal property. By segregating personal property from the building itself, the study will be able to reassign costs that would have been depreciated over a 39-year period to asset groups that will be depreciated at a much quicker pace, or perhaps expensed immediately as bonus depreciation.

An example: A taxpayer purchases a building worth $10 million. After performing a cost segregation study, they can reclassify 10 percent of those costs to be personal property. By assigning these assets a shorter depreciable life, they can apply bonus depreciation and write off $1 million of that $10 million purchase price in Year 1. A taxpayer with a 21 percent federal corporate tax rate would save $210,000 in taxes that first year.  If this transaction occurs in 2019 or 2020, and the taxpayer is in an NOL position, this incremental deduction may be carried back 5 years to recover taxes at an even higher 35% tax rate. 

Business Interest Deductions

Under the TCJA, business interest expense deductions are generally limited to 30% of a company’s adjusted taxable income. The CARES Act provides that the 30% limitation on business interest expense deductions is generally increased to 50% for any taxable year beginning in 2019 or 2020.  In addition, a company can generally elect to use their 2019 adjusted taxable income (which is likely higher than their 2020 adjusted taxable income) for purposes of computing the business interest expense deduction for the 2020 taxable year.  It should be noted that special rules apply to businesses taxed as partnerships.

New Charitable Above-the-Line Deduction

One significant impact of the TCJA is that fewer taxpayers are itemizing deductions than they did previously.  Many donors now opt for an increased standard deduction (and do not itemize their deductions) and therefore get zero no tax benefit for their charitable contributions

This changes under the CARES Act.  An individual can now claim an above-the-line deduction of up to $300 for donations made to qualified charitable organizations. As a result, donors may be entitled to a charitable deduction whether or not they itemize.  One caveat, the deduction isn’t available for contributions to private foundations or donor-advised funds. 

The first $300 donated in 2020 goes toward this deduction.   Therefore, itemizers will benefit from the deduction before claiming any other donations on Schedule A. Any excess is carried forward for five years.

Increased Individual Charitable Deduction Limit

Prior to the CARES Act, an individual’s annual deduction for cash contributions was limited to 60 percent of adjusted gross income (AGI).  This limit was raised from 50 percent of AGI for 2018 through 2025 by the TCJA.

The CARES Act increases this deduction limit to 100 percent of AGI for 2020.  Therefore, a taxpayer who itemizes can generally write off the full amount of his or her charitable contributions of cash or cash-equivalents in 2020. Any excess above 100 percent of AGI is carried forward for up to five years. As noted with the new $300 deduction for non-itemizers, this provision does not apply to private foundations or DAFs.

Increased Corporate Charitable Deduction Limit

The tax law also imposes limits on deductions for charitable contributions made by corporations: the annual deduction for contributions by a corporation cannot exceed 10 percent of its taxable income. Therefore, a corporation with taxable income of $10 million is limited to a deduction of $1 million. Any excess is carried forward for up to five years.

Under the CARES Act, the annual threshold for corporate deductions is increased to 25 percent of taxable income for 2020. Going back to our previous example, a corporation with taxable income of $10 million could write off up to $2.5 million.  Any excess is carried forward for up to five years.

The CARES Act contains many cash flow planning opportunities, mostly overlooked because their benefits will not be realized until mid-2021, months after 2020 tax returns are filed.  Businesses and individuals impacted by the COVID-19 should review their options with their advisors as soon as possible to achieve the optimal tax result that also gets much needed cash into their hands. 

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This information may answer some questions, but is not intended to be a comprehensive analysis of the topic. In addition, such information should not be relied upon as the only source of information; professional tax and legal advice should always be obtained.

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