Federal Tax Update – December 2017
Public Law 115-97, the Tax Cuts and Jobs Act:
- Reduces all cost of living adjustments throughout the Internal Revenue Code effective 2018 for years thereafter by converting indexing to chained CPI-U (C-CPI-U) which assumes consumers look for substitute items rather than absorb rising prices.
- Eliminates like-kind exchanges other than for real property effective 2018 (with protection for forward or reverse exchanges in progress as of December 31, 2017).
- Excludes vacations, meals, lodging, tickets and gift certificates from employee achievement and length of service awards, essentially limiting this tax free benefit to tangible personal property or a limited array of tangible choices effective 2018.
- Repeals the exclusion for qualified bicycle commuting reimbursement for 2018-2025.
- Excludes discharges of student loans (including private loans) from income where the discharge is on account of death or total and permanent disability for 2018-2025.
- Removes self-created patents, inventions, models, designs, secret formulas or processes, copyrights, literary, musical or artistic compositions from the definition of capital assets effective 2018 (though certain transfers of patents continue to get capital gain treatment under Code Section 1235).
- Changes the treatment of alimony to make it nondeductible to the payer and taxfree to the recipient for divorce or separation instruments after 2018; existing agreements which were modified follow old law unless new law is expressly made applicable.
- Ends the deduction for moving expenses and the exclusion on employer-paid moving expenses for 2018-2025 except for active duty military who move by order to a permanent change installation.
- Increases the standard deduction for 2018 to $24,000, $18,000 and $12,000 for married filing jointly, head of household and unmarried with indexing for 2019-2025 before the increase expires.
- Ends the income phaseout on total itemized deductions from 2018-2025.
- Lowers the floor to 7½ percent of adjusted gross income for all individuals to deduct medical expenses in 2017 and 2018.
- Caps the deduction for personal taxes at $10,000 ($5,000 married filing separate) for years 2018-2025, considering property taxes and either state, local and foreign income taxes or sales taxes.
- Reduces the maximum interest deduction on residences to the cost of acquisition financing including improvements on $750,000 effective December 16, 2017 and through 2025 except in the case of binding contracts scheduled to close in 2017 that actually close by March 31, 2018; existing acquisition debt including refinancing remains under prior law but no deduction is available after the expiration of the term of the original indebtedness (if not amortized, then the earlier of the term of the first refi or 30 years).
- Eliminates the deduction for interest on home equity indebtedness 2018-2025.
- Increases the maximum deduction for cash donations to public charities to 60 percent of adjusted gross income, disallows deductions for donations coupled with preferred seating at college sports events and ends direct donee reporting as a possible alternative to the donor obtaining contemporaneous written acknowledgement; all changes are effective 2018 except the last provision is effective 2017.
- Eliminates the deduction for personal theft losses as well as for casualty losses for 2018-2025 except for those in disaster areas as declared by the President; however, these losses may be used to reduce casualty and theft gains in the same year.
- Offers relief in 2016 and 2017 for casualty losses to residents in Presidentially declared disasters in 2016 by waiving the 10 percent of adjusted gross income floor (though raising the minimum loss to $500) and permitting casualty deductions by non-itemizers.
- Terminates the deduction for all miscellaneous itemized deductions subject to the 2 percent of adjusted gross income floor for 2018-2025.
- Includes the expenses of gamblers as part of their losses for 2018-2025, for purpose of denying a deduction when losses exceed winnings.
- Discontinues personal exemptions for 2018-2025.
- Creates seven new rate brackets for 2018-2025 (10%, 12%, 22%, 24%, 32%, 35% and 37%); in 2018 the 37% bracket starts at $600,000 of taxable income for married couples filing jointly, $500,000 for singles and $300,000 for married individuals filing separately (the 35% bracket for singles starts at $200,000 as opposed to $416,700 in 2017); indexing for cost of living begins in 2019.
- Revises “Kiddie Tax” rates for 2018-2025 to disregard the income of parents and to apply trust and estate income tax rates to the unearned income of applicable children.
- Raises the individual alternative minimum tax exemption for 2018-2025 to $109,400 for married couples filing jointly, $70,300 for singles and $54,700 for married individuals filing separately with the phaseouts computed at 25 percent of excess alternative minimum taxable income over $1 million for married couples filing jointly and $500,000 for others; exemptions and phaseout levels are increased for cost of living in 2019 and subsequent years.
- Doubles the child tax credit to $2,000 for each qualifying child from 2018-2025 with the refundable portion (15 percent of earned income greater than $2,500) up to $1,400 per child subject to cost of living increases in 2019 and subsequent years with the phaseout at $50 per $1,000 or fraction over the thresholds of $400,000 for married couples filing jointly and $200,000 for others (the child’s social security number must be issued by the due date of the return and provided); a $500 nonrefundable credit applies for qualifying defendants other than children who are U.S. citizens or residents (or in the case of a child where the social security number rules are not met).
- Repeals the individual mandate for health insurance coverage effective 2018.
In Okonkwo v. Commissioner, 120 AFTR2d 2017-6758, the Ninth Circuit Court of Appeals agreed with the Tax Court that a couple could not utilize over $300,000 in losses over three years from renting a residence to their daughter at $2,000 per month when the prior tenant had paid $6,000 per month.
In Salt Point Timber, LLC v. Commissioner, TC Memo 2017-245, the Tax Court denied a deduction for a charitable easement because under certain circumstances the easement could pass to a non-charitable group.
In Colliver v. Commissioner, TC Summary Opinion 2017-93, the Tax Court denied a deduction for education courses leading to a masters degree for a school speech pathologist who had been allowed to work temporarily pending her degree, the Court finding that the education qualified her for a new profession.
In News Release 2017-210, IRS advised that prepayments of real property taxes in 2017 for a subsequent period will only be deductible if the taxes have actually been assessed as determined by state or local law.
Public Law 115-97, the Tax Cuts and Jobs Act:
- Lengthens the time limitation to the extended due date of the return plus timely extensions for rolling over outstanding loan balances in employer plans where the plan is terminated or the employee severs employment effective for 2018 deemed distributions.
- Eliminates the 10 percent penalty on early withdrawal on distributions from qualified retirement plans, governmental plans and IRAs in 2016 and 2017 for victims of Presidentially declared disasters in 2016 who resided in the affected area, permitting this income to be reported ratably over three years and allowing recontributions in the form of rollovers within three years of distribution.
- Doubles to $6,000 in 2018 the maximum annual accrual in a Section 457 defined contribution plan (using actuarial equivalents for defined benefit plans) for volunteer firefighters with cost of living adjustments beginning in 2019.
- Prohibits a reconversion from a Roth IRA to a traditional IRA if previously moved from a traditional to a Roth effective 2018.
Public Law 115-97, the Tax Cuts and Jobs Act:
- Doubles the applicable exemption for the estate, gift and generation-skipping tax to $11.2 million in 2018 as indexed for cost of living beginning in 2019 and reverting to half the adjusted amount in 2026.
- Cuts the number of income tax brackets for trusts and estates to four from 2018-2025 with the 37 percent bracket commencing at over $12,500 in taxable income.
- Permits distributions of up to $10,000 per year from one or more Section 529 plans to a child for public or private (secular or religious) elementary or secondary education effective 2018.
- Increases the aggregate annual ABLE contribution limit of $15,000 for 2018-2025 as indexed after 2018 for cost of living by allowing the disabled beneficiary to contribute an added amount equal to the lesser of the beneficiary’s compensation for the current year or the poverty level for a one-person household for the preceding year ($12,060 for 2016); the provision also creates a credit only for the disabled individual of 10-50 percent of contributions depending on filing status and adjusted gross income with a maximum credit of $1,000.
- Allows rollovers from Section 529 plans to ABLE accounts, either for the disabled transferor or for a disabled family member effective after December 22, 2017 and before 2026; such rollovers count toward the annual ABLE contribution limit of $15,000 as indexed after 2018 for cost of living.
Public Law 115-97, the Tax Cuts and Jobs Act:
- Allows cash basis accounting effective 2018 tax years for all businesses (except “tax shelters”) provided average gross receipts of the three preceding years are less than $25 million in average revenue as indexed for cost of living beginning in 2019, C corporations except personal service businesses and partnerships with a corporate partner must then change to accrual and others must use a method that clearly reflects income (all changes in accounting method consistent with the statute will be deemed to have IRS consent and a 4-year adjustment period will be allowed if a change in method increases taxable income).
- Exempts businesses with less than $25 million indexed in average gross receipts effective 2018 tax years from the uniform capitalization rule otherwise requiring certain costs of self-produced property to be included in inventory or be part of basis (a change in handling will be a change in accounting method).
- Allows businesses with long term contracts and less than $25 million indexed in average gross receipts to use the completed contract method for contracts entered into after December 31, 2017 in tax years ending after that date.
- Permits accrual basis businesses to generally defer the reporting of advance payments to the next year but prohibits income deferrals effective 2018 tax years in any event beyond the year when income is shown on applicable financial statements.
- Repeals effective 2018 the election to rollover realized capital gain within 60 days on the sale of publicly listed securities into common stock or partnership interests in specialized small business companies.
- Requires the inclusion in income of contributions to capital by governmental entities, customers or prospects after December 22, 2017 unless under an existing developmental plan.
- Allows state governors as of December 22, 2017 to designate certain low income areas as “qualified opportunity zones” allowing deferral of capital gains through reinvestments in corporations and partnerships (90 percent of assets must be in the zone) and gains on sales of such investments are made taxfree after ten years.
- Denies a deduction for costs of local lobbying after December 22, 2017 (other lobbying and political expenditures were previously nondeductible).
- Expands the denial of a deduction for payment of penalties on or after December 22, 2017 to include amounts paid at the direction of governmental entities or certain nongovernmental entities related to a violation or potential violation of any law but other than as restitution.
- Disallows a deduction for any settlement, payout or attorney fees after December 22, 2017 related to sexual harassment or abuse if payments are subject to a nondisclosure agreement.
- Denies any deduction for business entertainment paid or incurred after 2017 (business meals remain 50 percent deductible).
- Makes meals provided by employers to employees at or near an employer-operated eating facility subject to the 50 percent disallowance rule from 2018-2025 and nondeductible thereafter.
- Disallows a deduction for transportation expenses of employees after 2017 including commuter highway vehicles, transit passes and parking excepting expenditures related to employee safety and from 2018-2025 bicycle commuting reimbursements.
- Repeals the 9 percent deduction for income attributable to domestic production activities for tax years after 2017.
- Requires research and development expenses including software that are incurred in post-2021 tax years to be amortized over five years (15 years if outside the United States) with continuing amortization in the event of abandonment.
- Removes computer equipment as “listed property” effective with 2018 acquisitions.
- Limits the business interest deduction (excluding floor planning interest) beginning with 2018 tax years for businesses with a prior three-year average gross receipts of greater than $25 million (indexed) to an amount equal to the sum of business interest income plus 30 percent of adjusted taxable income from the business (without deductions for interest, net operating loss and for 2018-2021 depreciation, amortization and depletion) with an indefinite carry forward; the test is at the entity level but partners and S corporation shareholders can adjust to pick up added business interest paid personally (real property businesses can irrevocably opt out of the limitation by using ADS to depreciate real property with its new recovery period of 30 years for residential property and farming businesses can irrevocably opt out by using ADS to depreciate property with a recovery period of ten years or more).
- Expands Section 179 expensing effective 2018 tax years to $1 million of qualifying capital expenditures with a dollar for dollar reduction at $2.5 million of capital expenditures indexed beginning in 2019; eligible property is expanded to include tangible personal property in connection with the providing of lodging and to include replacement roofs, HVAC, alarm systems and security systems in nonresidential real property.
- Indexes for cost of living the $25,000 Section 179 deduction for SUVs 6001-14,000 pounds beginning in 2019.
- Expands bonus depreciation to include used property effective September 28, 2017 and raises the deduction to 100 percent for property placed in service September 28, 2017 through 2022 and 80, 60, 40 and 20 percent respectively for 2023-2026 before expiration.
- Increases allowable depreciation on luxury cars in 2018 to $10,000 for first year, $16,000 for second year, $9,600 for third year and $5,560 thereafter with future year acquisitions indexed for cost of living.
- Shortens the cost recovery period for original use farm machinery and equipment from seven to five years and permits double declining balance for 10-year or less property effective 2018 acquisitions.
- Creates a 15-year writeoff period for “qualified improvement property” placed in service after 2017 encompassing nonstructural improvements generally placed in service at least three years after the building itself.
- Eliminates the two-year net operating loss carryback except for farmers effective for 2018 tax years, creating an indefinite carryforward but allowing the NOL to be used only against 80 percent of subsequent year tentative taxable income.
- Adds a credit to the general business credit for wages paid in 2018 and 2019 for employers who have a written family and medical leave policy for full and part time employees and who pay employees on such leave who have at least one year of service and earn no more than $72,000 in 2018 (indexed in 2019) at least 50 percent of normal wages (the written policy of employers not covered by FMLA must include anti-interference and anti-discrimination provisions); the credit is equal to 12½ percent of wages and will rise to 25 percent in .25 percent increments for each added percent in excess of 50 percent that is employer-paid (the deduction for wages is reduced by the amount of the credit).
- Eliminates the 10 percent rehabilitation credit after 2017 for renovations to pre-1936 buildings after a transition period of 24 or 60 months (phased rehabilitation) for work in progress, retaining the 20 percent credit for qualifying work on historical structures but requiring that the credit be claimed ratably over five years.
- Permits after 2017 an election to be made under Code Section 83(i) by an eligible employee (excluding most shareholders and officers) recipient of stock from settled restricted stock units or exercised options (any ISO would thereby convert to a NQ) from a qualified employer (one which offers the benefit to at least 80 percent of employees working at least 30 hours per week) which defers for income tax (not payroll tax) the recognition of income as determined at the time of the election for a period up to five years (with forced recognition earlier if the corporation goes public or the individual becomes an “excluded employee”); the election is made within 30 days of the earlier of when the stock is substantially vested or first transferable and is not available if a Section 83(b) election was made.
- Reduces the dividends received deduction from 70 percent to 50 percent (for 20 percent owned corporations from 80 percent to 65 percent) beginning 2018 tax years.
- Includes incentive bonuses, nonqualified options and commissions as compensation for the $1 million limit on deducting compensation paid to the CEO, CFO and three other highest paid officers of public corporations for tax years 2018 and subsequent; agreements in effect on November 2, 2017 are protected until material modification or extension.
- Creates a single tax rate for all C corporations, including personal service corporations, of 21 percent effective with 2018 years.
- Abolishes the corporate alternative minimum tax effective 2018 tax years with unused credits available to offset regular tax liability in part for 2018-2020 and the balance in 2021.
- Imposes a one-time tax where a U.S. corporation owns a foreign subsidiary, requiring each 10 percent shareholder to include in income a pro rata share of the subsidiary’s accumulated post-1986 earnings and profits using the higher E&P of November 2, 2017 or December 31, 2017; the tax is computed at 15½ percent to the extent of the shareholder’s share of cash and cash equivalents and 8 percent on the balance with installments equal to 8 percent of the liability for 2017-2021 tax years followed by 15 percent, 20 percent and 25 percent respectively in each of the three succeeding years (S corporations may defer until cessation of business, conversion to C status or sale of stock by the electing shareholder).
- Requires U.S. shareholders owning 10 percent or more of a foreign “controlled foreign corporation” to include a pro rata portion of that corporation’s global intangible low-taxed income (“GILTI”) unless otherwise already subject to U.S. taxation; GILTI is the net income of the CFC in excess of an assumed 10 percent base return on the adjusted basis of depreciable assets.
- Creates a new deduction (“Qualified Business Income Deduction”) for unincorporated businesses from 2018-2025 under which a non-corporate business owner can deduct against taxable income an amount equal to the lesser of 20 percent of business income earned in the U.S. (which excludes capital gains/losses, dividends and nonbusiness interest) determined by distributive shares excluding owner wages or guaranteed payments in the case of a flow through entity or 20 percent of tentative taxable income less net capital gain with joint filers phased out between $315,000 and $415,000 of taxable income and others phased out between $157,500 and $207,500 as to qualified business income from personal service activities (the phaseout start is indexed in 2019 and subsequent years for COLA); an additional limitation tied to employee wages (including elective deferrals) and qualified property at year-end applies when this range is reached (combined qualified business losses carryforward and reduce combined qualified business income in subsequent years).
- Requires that individuals with business losses greater than $250,000 ($500,000 on a joint return) for 2018-2025 after application of the passive loss rule add the excess to a net operating loss carryforward; the thresholds are indexed for cost of living in 2019 and subsequent years.
- Creates a 3-year holding period to obtain long term capital gain for partnership interests acquired after 2017 that are disproportionate to capital and are received for services from a business involved in raising capital for investing in specified assets.
- Repeals for 2018 and subsequent tax years the provision which terminated a partnership for tax purposes upon certain 50 percent changes in ownership.
- Expands for 2018 and subsequent years the existing rule effectively forcing a one-time application of Section 754 on admission of a partner where the partnership’s adjusted basis in property exceeds its fair market value by more than $250,000 to include situations where the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition of assets.
- Treats gains or losses on sales of partnership interests after November 26, 2017 as effectively connected with a U.S. business to the extent an asset sale would have been connected; the transferee of a partnership interest must withhold 10 percent on the sale unless the transferor certifies that it is not a foreign corporation or nonresident alien.
- Allows nonresident aliens to be current beneficiaries of an electing small business trust (ESBT) effective 2018.
- Creates favored treatment for S corporations converting to C status within two years of December 21, 2017 by permitting a 6-year spread of any income caused by being forced to use an accrual method of accounting and by allowing the accumulated adjustments account to be returned taxfree based on the ratio of AAA to accumulated earnings and profits.
- Imposes a 21 percent tax on tax-exempt organizations effective 2018 tax years on compensation over $1 million paid to anyone who was among its five highest compensated employees for any year after 2016 (this includes payments by many universities to football and basketball coaches).
- Requires the separate computation of unrelated business taxable income effective for 2018 years when an exempt organization has multiple businesses and prohibits losses from one business to offset profits from another (grandfathering pre-2018 net operating losses).
Proposed Regulations under Code Section 6227 set forth that adjustments under the centralized partnership audit regime can be “pushed out” to the ultimate owners in the case of a multi-tier partnership; absent an affirmative election to continue the push out, tax liability will fall on such tier at its entity level.
In Lender Management, LLC v. Comissioner, TC Memo 2017-246, the Tax Court found that a management company was engaged in carrying on a business where it provided direct management services to three other family companies, each of which held investments in a different class of assets.
In Barnhart Ranch Company v. Commissioner, 120 AFTR2d 2017-5614, the Fifth Circuit Court of Appeals agreed with the Tax Court that a cattle business was owned by a corporation and was not an agent for the underlying individuals.
In In Re: Health Diagnostic Laboratory, Inc., 120 AFTR2d 2017-6736, a Virginia Bankruptcy Court went against the weight of authority and determined that S status is not an asset of a corporation and, as such, the conversion to C status could not be challenged by the bankruptcy trustee as a fraudulent conveyance.
In Spizz v. United States, 120 AFTR2d 2017-6719, a New York Federal District Court found two shareholder-officers in a law firm to be personally liable for unpaid payroll taxes where the third shareholder-employee had embezzled from the Firm; the two individuals found liable had been aware of the unpaid taxes for several years before they discovered the theft but allowed other bills to be paid.
In Chief Counsel Advice 201748008, IRS set forth its position that amounts paid to the Government as disgorgement for violating a federal securities law are penalties and are therefore nondeductible.
Public Law 115-97, the Tax Cuts and Jobs Act:
- Expands the $500 preparer penalty per return to include failure to exercise due diligence in claiming head of household status effective 2018 tax years.
- Extends the time period to two years for third party claims to recover wrongful levies by IRS effective for seizures after March 22, 2017.
In United States v. Coinbase, Inc., 120 AFTR2d 2017-5538, a California Federal District Court allowed enforcement of a summons which sought to obtain information on “virtual currency” trading; the Court noted that IRS showed that it may obtain information not in its possession and relevant to a legitimate purpose through enforcement and that it had satisfied all required administrative steps.
In Banister v. United States, 120 AFTR2d 2017-5546, the Ninth Circuit Court of Appeals agreed with a Nevada Federal District Court that a taxpayer representative can be liable for the civil penalty of aiding and abetting an understatement of tax liability through the preparation of documents in connection with a CDP hearing.
In Lessard v. Commissioner, TC Summary Opinion 2017-95, the Tax Court denied innocent spouse relief through separation of liability to a wife married and divorced in one year who was aware of retirement plan income but claimed she did not review the return to see that it was unreported; she also failed to get equitable relief in the absence of hardship.
In Auto Pride Collision East, Inc. v. United States, 120 AFTR2d 2017-5578, a Michigan Federal District Court determined that it had no jurisdiction to hear a challenge to an IRS penalty without payment of the penalty amount even if the principal liability, which was unchallenged, was paid; the Court indicated a different result would be reached where a penalty does not constitute an independent issue and the amount of principal itself is being challenged.
In Ivy v. Commissioner, 120 AFTR2d 2017-________, the DC Circuit Court of Appeals agreed with the District Court for DC that IRS has the right to offset tax refunds for delinquent student debt.