On December 20, President Donald Trump signed the bipartisan, year-end government spending and tax package, just hours before federal funding was set to expire. Trump's signature on the over 2,000-page spending package avoided a government shutdown.

On December 20, President Donald Trump signed the bipartisan, year-end government spending and tax package, just hours before federal funding was set to expire. Trump's signature on the over 2,000-page spending package avoided a government shutdown.

Year-End Tax Package
The Further Consolidated Appropriations Act, 2020, (HR 1865), logs just over 700 pages and serves as only half of the government spending package for fiscal year 2020, which runs through September 30. Most notably, HR 1865 serves as the legislative vehicle for a year-end tax package, which carries a costly $426 billion price tag over a 10-year budget window, according to the nonpartisan Joint Committee on Taxation (JCT), JCX-54R-19.

Some of the tax-related provisions in the year-end package include, among other items:

• Retroactive and current renewal of over two dozen temporary tax breaks known as tax extenders, which have expired or would soon be expired, spanning from 2017 to 2019. Generally, the renewed tax breaks are extended through 2020, and the biodiesel and short-line railroad maintenance tax credits are extended until 2022;
• The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) (HR 1994), which makes sweeping changes to retirement savings and employer retirement contributions provisions;
• Certain fixes to the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97); and
• Full repeal of three tax-related provisions of the Affordable Care Act (ACA) ( P.L. 111-148), two of which include the 2.3 percent excise tax on medical devices and the 40 percent excise "Cadillac" tax on high-dollar employer-sponsored health insurance plans.

The House approved HR 1865 on December 17 by a 297-to-120 vote. The Senate cleared the measure on December 19 by a 71-to-23 vote.

"So in the end, with more than $400 billion in tax cuts, there were lots of winners and the usual loser – the budget."

"There were numerous fits and starts, but this result is a reminder that Congressional muscle memory on extenders is very strong, so ultimately the members did what they always do – extend them," John Gimigliano, principal-in-charge of the federal legislative and regulatory services group in the Washington National Tax practice of KPMG LLP told Wolters Kluwer. "Some might be surprised to see the ACA taxes rolled back, but it has always felt like those items were on borrowed time; it was really just a question of when and how they were repealed, not whether. So in the end, with more than $400 billion in tax cuts, there were lots of winners and the usual loser – the budget."

SECURE ACT
The bipartisan SECURE Act, which cleared the House in May but remained stalled in the Senate most of the year, makes a number of major as well as administrative changes for retirement savings affecting both individuals and employers.

Some of those changes are noted as follows:

IRA Changes

• Moving the start date for requirement required minimum distributions (RMDs) to the year the owner turns 72;
• Ending the 70 1/2 age limit for contribute contributions to an IRA; and
• Shortening the distribution period for nonspouse inherited IRAs to a 10-year maximum.
  The 10-year window for distributions to a nonspouse beneficiary applies regardless of when the IRA owner dies. Thus, the change will severely limit the use of "stretch IRAs" as an effective planning tool. Limited exceptions are available.

401(k) Changes

• Requiring plans to offer participation to long-term, part-time employees;
• Encouraging auto-enrollment by increasing the cap; and
• Streamlining the safe harbor for non-elective contributions.

Employers with 401(k) plans must offer employees who work between 500 and 1000 hours year an additional means to participate in the plan. The rule change would only affect 401(k) cash or deferral arrangements, and no other qualified plans.

Retirement Plans for Small Employers

Several changes are made to encourage more small employers to offer retirement benefits to their employees, such as:

• Adding a new tax credit for small employers using auto-enrollment plans;
• Increasing the credit for small employer pension plan start-up costs; and
• Allow small employers of two or more to band together to participate in a new class of pooled multiple employer plans (MEPs).

Congress Adjourns Until 2020
After an eventful two-week sprint to the finish line, Congress adjourned for the year on December 20. Lawmakers are expected to return to Washington, D.C. during the week of January 6, 2020.

The Fifth Circuit U.S. Court of Appeals ruled that the Patient Protection and Affordable Care Act’s (ACA) ( P.L. 111-148) individual mandate is unconstitutional because it can no longer be read as a tax, and there is no other constitutional provision that justifies this exercise of congressional power. However, the central question of whether the rest of the ACA remains valid after Congress removed the penalty for not having health insurance remained unanswered. Instead, the case was sent back to the district court to reconsider how much of the ACA could survive without the individual mandate penalty.

The Fifth Circuit U.S. Court of Appeals ruled that the Patient Protection and Affordable Care Act’s (ACA) ( P.L. 111-148) individual mandate is unconstitutional because it can no longer be read as a tax, and there is no other constitutional provision that justifies this exercise of congressional power. However, the central question of whether the rest of the ACA remains valid after Congress removed the penalty for not having health insurance remained unanswered. Instead, the case was sent back to the district court to reconsider how much of the ACA could survive without the individual mandate penalty.

District Court
According to the opinion, "the rule of law demands a careful, precise explanation of whether the provisions of the ACA are affected by the unconstitutionality of the individual mandate as it exists today." Therefore, the opinion directs the district court to carefully consider whether the mandate can be legally distinct from the rest of the law. The opinion instructs the district court to answer two questions: Which parts of the ACA "are indeed inseverable" now that the mandate is no longer enforced and whether a ruling in the case should apply only to the Republican-led states that sued to overturn the law, an issue raised by Trump administration lawyers.

Dissenting Opinion
A dissenting opinion discussed that Congress made it clear that it wanted the rest of the ACA to stand and sending the case back to the lower court was criticized. The opinion also highlighted that sending the case back to the lower court merely identifies serious flaws in the district court’s analysis and remands for a do-over, which will unnecessarily prolong this litigation and the concomitant uncertainty over the future of the health care sector.

Proposed qualified opportunity zone regulations issued on October 29, 2018 ( REG-115420-18) and May 1, 2019 ( REG-120186-18) under Code Sec. 1400Z-2 have been finalized with modifications. The regulations. which were issued in a 550 page document, are comprehensive.

Proposed qualified opportunity zone regulations issued on October 29, 2018 ( REG-115420-18) and May 1, 2019 ( REG-120186-18) under Code Sec. 1400Z-2 have been finalized with modifications. The regulations. which were issued in a 550 page document, are comprehensive.

The regulations address issued related to all aspects of the gain deferral rules and also various requirements that must be met for an entity to qualify as a qualified opportunity fund (QOF) or as a qualified opportunity zone business. Duplicative rules regarding QOFs and qualified opportunity zone businesses have been combined and definitions of key terms added. The regulations detail which taxpayers are eligible to make the election, the types of capital gains eligible for deferral, and the method of making deferral elections. Revisions are made to the rules applying the statutory 180-period and other requirements with regard to the making of a qualifying investment in a QOF.

The IRS will reflect these regulations in updated forms, instructions, and other guidance in January 2020.

Benefits of QOF Investments
Taxpayers may elect to temporarily defer capital gain in income if the gain is invested within 180 days in a QOF. The gain is recognized on Dec. 31, 2026, or if earlier, upon the occurrence of an inclusion event such as the sale of the QOF investment. However, 10 percent of the deferred gain is not recognized if the investment is held five years and 15 percent is not recognized after seven years. In addition, taxpayers may exclude recognition of gain on appreciation in the investment if the investment in the qualified opportunity fund is held for at least 10 years.

Section 1231 gains
The final regulations provide that eligible gains include the gross amount of eligible section 1231 gains unreduced by section 1231 losses regardless of character. The proposed regulations took a "netting" approach. The 180-day period for an eligible taxpayer to invest an amount with respect to an eligible section 1231 gain begins on the date of the sale of the section 1231 asset rather than at the end of the tax year.

RICS and REITS
The 180-day period for RIC or REIT capital gain dividends generally begins at the close of the shareholder’s tax year in which the capital gain dividend would otherwise be recognized by the shareholder. To ensure that RIC and REIT shareholders do not have to wait until the close of their tax year to invest capital gain dividends received during the tax year, the final regulations also provide that shareholders may elect to begin the 180-day period on the day each capital gain dividend is paid. The 180-day period for undistributed capital gain dividends, however, begins on either the last day of the shareholder’s tax year in which the dividend would otherwise be recognized or the last day of the RIC or REIT’s tax year, at the shareholder’s election.

The aggregate amount of a shareholder’s eligible gain with respect to capital gain dividends received from a RIC or a REIT cannot exceed the aggregate amount of capital gain dividends that the shareholder receives as reported or designated by that RIC or that REIT for the shareholder’s tax year.

Installment Sales
The final regulations allow an eligible taxpayer to elect to choose the 180- day period to begin on either (i) the date a payment under an installment sale is received for that tax year, or (ii) the last day of the tax year the eligible gain under the installment method would be recognized. Therefore, if the taxpayer defers gain from multiple payments under an installment sale, there might be multiple 180-day periods, or a single 180-day period at the end of the taxpayer’s tax year, depending upon taxpayer’s election.

Partners, S Corporation Shareholders, and Trust Beneficiaries
The final regulations provide partners, S shareholders, and beneficiaries of decedents’ estates and non-grantor trusts with the option to treat the 180-day period as commencing upon the due date of the related entity’s tax return, not including any extensions. This rule does not apply to grantor trusts.

Gain from Disposal of Partial Interest in QOF Investment
Gain arising from an inclusion event is eligible for deferral even though the taxpayer retains a portion of its qualifying investment after the inclusion event. If an inclusion event relates only to a portion of a taxpayer’s qualifying investment in the QOF, (i) the deferred gain that otherwise would be required to be included in income (inclusion gain amount) may be invested in a different QOF, and (ii) the taxpayer may make a deferral election with respect to the inclusion gain amount, so long as the taxpayer satisfies all requirements for a deferral election on the inclusion gain amount.

Post-December 31, 2026 Gain Ineligible
Gain arising after December 31, 2026 (including gain mandatorily recognized on that date) is not eligible for deferral.

Death Related Transfers of QOF Investments
A qualifying investment received by a beneficiary in a transfer by reason of death remains a qualifying investment in the hands of the beneficiary.

Acquisition of Eligible Interest from Person Other than a QOF
A taxpayer may make a deferral election for an eligible interest acquired from a person other than a QOF. The final regulations do not require the transferor to have made a prior deferral election for the acquirer of an eligible interest to make the election.

Further, for interests in entities that existed before the enactment of the deferral provision, if such entities become QOFs, then the interests in those entities, even though not qualifying investments in the hands of a transferor, are eligible interests that may (i) be acquired by an investor and (ii) result in a qualifying investment of the acquirer if the acquirer has eligible gain and the acquisition was during the 180-day period with respect to that gain.

Built in Gains
Built-in gain of a REIT, a RIC, or an S corporation potentially subject to corporate-level tax is eligible for deferral. If the deferral election is made, the amount of gain is not included in the calculation of the entity’s net recognized built-in gain.

Identification of Disposed Interests in a QOF
The final regulations permit taxpayers to specifically identify QOF stock that is sold or otherwise disposed. If a taxpayer fails to adequately identify which QOF shares are disposed of, then the FIFO identification method applies. If, after application of the FIFO method, a taxpayer is treated as having disposed of less than all of its investment interests that the taxpayer acquired on one day and the investments vary in its characteristics, then a pro-rata method applies to the remainder.

The specific identification method does not apply to the disposition of interests in a QOF partnership.

Deferred Gain Retains Tax Attributes
The final regulations make it clear that if a taxpayer is required to include in income some or all of a previously deferred gain, the gain so included has the same attributes that the gain would have had if the recognition of gain had not been deferred. If a deferred gain cannot be clearly associated with an investment in a particular QOF, an ordering rule applies to make this determination.

Effective Date
The final regulations are generally applicable to tax years beginning after 60 days after publication in the Federal Register.

With respect to the portion of a taxpayer’s first tax year ending after December 21, 2017, that began on December 22, 2017, and for tax years beginning after December 21, 2017, and on or before 60 days after publication in the Federal Register taxpayers may rely on either the proposed regulations or the final regulations but not both.

The IRS has issued final regulations that provide guidance on transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Specifically, the regulations override the general nonrecognition rule under Code Sec. 721(a) unless the partnership adopts the remedial allocation method and certain other requirements are satisfied. The regulations affect U.S. partners in domestic or foreign partnerships.

The IRS has issued final regulations that provide guidance on transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Specifically, the regulations override the general nonrecognition rule under Code Sec. 721(a) unless the partnership adopts the remedial allocation method and certain other requirements are satisfied. The regulations affect U.S. partners in domestic or foreign partnerships.

Background
Code Sec. 721(a) generally provides that no gain or loss is recognized by either a partnership or any of its partners upon a contribution of property to the partnership in exchange for a partnership interest. In Code Sec. 721(c), the Treasury Secretary has regulatory authority to override this nonrecognition provision for gain realized on the transfer of property to a domestic or foreign partnership if the gain, when recognized, would be includible in the gross income of a person other than a U.S. person.

Under temporary regulations issued in 2017, if a U.S. person contributes certain property with built-in gain to a partnership that has foreign partners related to the transferor, then gain will be recognized unless the gain deferral method is applied with respect to the property ( Temporary Reg. §§1.721(c)-2T; 1.721(c)-3T). Under a de minimis exception, nonrecognition continues to apply if the sum of all built-in gain property contributed to the partnership during the tax year does not exceed $1 million.

The final regulations adopt the temporary regulations with certain modifications.

Related Person Definition
The final regulations modify the definition of related person in certain situations. This modification provides relief when certain foreign individual partners of a partnership would be treated as a related person with respect to a domestic corporation by reason of Code Sec. 267(c)(3).

Consistent Allocation Method
The final regulations add a new sentence in Reg. §1.721(c)-3(c)(1). Upon a variation (as described in Reg. §1.706-4(a)(1)) of a U.S. transferor’s interest in a Code Sec. 721(c) partnership, book items with respect to section 721(c) property that are allocated under the interim closing method (as described in Reg. §1.706-4) will be treated as allocated in the same percentage for applying the consistent allocation method in a single tax year, unless the variation results from a transaction undertaken with a principal purpose of avoiding the tax consequences of the gain deferral method.

Reporting Requirements
The 2017 regulations required much of the reporting to be on statements attached to returns. Since the 2017 regulations were issued, however, the IRS has updated and added new schedules to Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, to facilitate compliance with these reporting requirements. The IRS has also issued new Form 8838-P, Consent To Extend the Time To Assess Tax Pursuant to the Gain Deferral Method (Section 721(c)). The final regulations generally require taxpayers to use these forms and schedules.

The final regulations also clarify the duration for which the U.S. transferor must extend the period of limitations on the assessment of tax under Reg. §1.721(c)-6(b).

Technical Termination Rules
The Tax Cuts and Jobs Act, ( P.L. 115-97) (the "TCJA") eliminated technical terminations. However, the applicability date for these final regulations relates back to the applicability date provided in the 2017 regulations, which is before the effective date provided in the TCJA. Accordingly, the final regulations retain technical termination rules, but their application will be limited. The rules will only apply to technical terminations occurring on or after the applicability date provided in the 2017 regulations but before the effective date for the repeal of Code Sec. 708(b)(1)(B) provided in the TCJA.

Effective Date
The regulations are effective on the date of filing with the Federal Register. For dates of applicability, see Reg. §§1.197-2(l)(5)(i), 1.704-1(f), 1.704-3(g)(1), 1.721(c)-1(e), 1.721(c)-2(e), 1.721(c)-3(e), 1.721(c)-4(d), 1.721(c)-5(g), 1.721(c)-6(g), and 1.6038B-2(j)(4).

The IRS has released Publication 5382, "Internal Revenue Service Progress Update / Fiscal Year 2019—Putting Taxpayers First." This new annual report describes accomplishments across the agency, and highlights the work of IRS employees during the past year. It covers a variety of taxpayer service efforts, including development of the new Taxpayer Withholding Estimator, as well as operations support efforts on areas involving information technology modernization, human capital office initiatives, and others.

The IRS has released Publication 5382, "Internal Revenue Service Progress Update / Fiscal Year 2019—Putting Taxpayers First." This new annual report describes accomplishments across the agency, and highlights the work of IRS employees during the past year. It covers a variety of taxpayer service efforts, including development of the new Taxpayer Withholding Estimator, as well as operations support efforts on areas involving information technology modernization, human capital office initiatives, and others.

"This report is about more than what happened during the past year," IRS Commissioner Chuck Rettig wrote in the report’s opening message to taxpayers. "It’s also designed to provide insight into the people serving this country on behalf of the IRS, and provide a glimpse into the future," he added.

IRS Pub. 5382 also focuses criminal investigation results and efforts involving civil enforcement. Also discussed are ongoing compliance areas, including micro-captives, syndicated conservation easements, and virtual currency. The report further covers the IRS’s implementation of new tax laws, and the IRS’s ongoing work on the new Taxpayer First Act of 2019.

Individual Audits Down
Taxpayers are now half as likely to be audited by the IRS for their individual income tax returns as they were a decade ago. As described in IRS Pub. 5382, the IRS audited 0.45 percent of individual (1040) income tax returns during fiscal year (FY) 2019. This number is down from 1.1 percent of tax returns audited in 2010. The IRS’s ongoing loss to its total workforce is largely to blame for the consistent decline in IRS audits, according to the report.

"The IRS lost more than 29,618 full time positions between FY 2010 and FY 2019, which includes Information Technology, Operations Support, Taxpayer Service and Enforcement personnel. These losses directly correlate with a steady decline in the number of individual audits during the past nine years," the report notes.

Hill Reaction
Although individual audits have significantly decreased, Democratic lawmakers on Capitol Hill are criticizing the fact that the IRS continues to conduct more examinations on lower-income individual taxpayers than it does on higher-income taxpayers or corporations. However, the IRS has said previously that audits on higher-income individuals and businesses are significantly more complex and require more resources.

"IRS audit rates are at their lowest levels in 40 years, allowing the wealthy and well-connected to steal from taxpayers with no consequences," Senate Finance Committee ranking member Ron Wyden, D-Ore., said in a January 7 statement. "The bulk of tax avoidance and fraud comes from corporations, pass-through business and those at the top. Ensuring the wealthy and corporations pay what they owe takes the most resources and manpower, and I’m working with the IRS to get a clear picture on funding and staffing levels needed to audit top earners at 2010 levels," Wyden added.

Currently, the IRS anticipates that up to 31 percent of its workforce (nearly 19,719 full-time employees) will retire within the next five years. The IRS’s workforce decline is expected to create a "significant risk of a large knowledge and experience gap for the nation’s tax agency," according to the IRS report.

Bridget Roberts, the Acting National Taxpayer Advocate, released her 2019 Annual Report to Congress. The report discusses the key challenges facing the IRS regarding the implementation of the Taxpayer First Act, inadequate taxpayer service and limited funding of the agency. Further, Roberts released the third edition of the National Taxpayer Advocate’s "Purple Book," which presents 58 legislative recommendations designed to strengthen taxpayer rights and improve tax administration.

Bridget Roberts, the Acting National Taxpayer Advocate, released her 2019 Annual Report to Congress. The report discusses the key challenges facing the IRS regarding the implementation of the Taxpayer First Act, inadequate taxpayer service and limited funding of the agency. Further, Roberts released the third edition of the National Taxpayer Advocate’s "Purple Book," which presents 58 legislative recommendations designed to strengthen taxpayer rights and improve tax administration.

Taxpayer First Act
The report highlighted that the Taxpayer First Act ( P.L. 116-25) had made the most comprehensive revisions to IRS procedures since the IRS Restructuring and Reform Act of 1998, including some 23 provisions previously recommended by the National Taxpayer Advocate. Further, the Taxpayer First Act also required the IRS to develop four strategic plans:

• a comprehensive taxpayer service strategy (due to Congress by July 1, 2020);
• a comprehensive plan to redesign the IRS’s organizational structure (due to Congress by Sept. 30, 2020);
• a comprehensive employee training strategy that includes taxpayer rights training (due to Congress by July 1, 2020); and
• a multi-year plan to meet IRS information technology (IT) needs.

Key IRS Challenges
The biggest challenge facing the IRS is its struggle to complete its mission. The IRS aims to "provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." The report emphasizes that the IRS is struggling to meet both of those goals, and attributes the IRS’s shortcomings mostly to budget constraints but also to a culture in which the agency focuses on its own priorities without adequately factoring in the needs of taxpayers.

The report states that the IRS is among the lowest-performing federal agencies in providing a positive customer experience. During fiscal year (FY) 2019, the report said that the IRS received approximately 100 million telephone calls, and customer service representatives answered only 29 percent. The report further states that the IRS has also struggled to enforce the law with "fairness to all". The report urges the IRS to prioritize phone service for taxpayers against whom it takes collection action.

Low Budget
Since 2010, the IRS budget has been reduced by about 20 percent after adjusting for inflation, and the number of full-time equivalent employees has declined by about 22 percent. The report points out that answering 100 million telephone calls, conducting audits, and taking enforcement actions require adequate staffing, and the IRS cannot substantially improve its performance without additional resources. The report urges Congress to increase IRS funding and particularly for taxpayer service and IT modernization, and to change the budget rules to account for the revenue additional IRS appropriations are likely to generate.

Identifying Taxpayer Needs and Preferences
Despite the IRS’s significant funding limitations, the report urges the IRS to utilize the Taxpayer First Act requirements – to develop plans to revamp its taxpayer service strategy, organizational structure, employee training strategy, and technology priorities – as a roadmap for a once-in-a-generation reassessment of its objectives and operations.

While noting that the IRS has developed strategies in a vacuum without soliciting taxpayer feedback and taking into account taxpayer needs and preferences, the report suggests a full-scale cultural shift. The report also expressed concern that the IRS has declined to include the National Taxpayer Advocate or a Taxpayer Advocate Service (TAS) representative as part of a core team created to coordinate its Taxpayer First Act implementation activities.

The report also makes numerous recommendations to improve the customer experience, including that the IRS take the following actions:

• Conduct multi-disciplined, comprehensive research into taxpayer needs and preferences.
• Require that all IRS business units, including those charged primarily with enforcement, develop a detailed customer service strategy.
• Appoint a Chief Customer Experience Officer to coordinate service initiatives across IRS business units.
• Ensure that taxpayers who cannot work with the IRS digitally, or whose issues are not resolved online, can reach and work with an IRS employee.
• Address the needs of practitioners who interact with the IRS on behalf of large numbers of taxpayers.
• For each proposal included in its customer service strategy, include cost estimates, milestones, and taxpayer-focused performance measures so the effectiveness of the strategy in improving customer service can be measured over time.

Other Matters
The report also:

• identified 10 "most serious problems";
• provided status updates on two problems identified in previous reports;
• made dozens of recommendations for administrative change;
• made 58 recommendations for legislative change;
• analyzed the 10 tax issues most frequently litigated in the federal courts; and
• presented four research studies.

The IRS has modified the applicability dates for proposed regulations under Code Sec. 382 that were issued with NPRM REG-125710-18, September 10, 2019 (2019 proposed regulations). The IRS is withdrawing the text of the proposed applicability dates, and proposing revised applicability dates. The newly issued proposed rules would also provide transition relief.

The IRS has modified the applicability dates for proposed regulations under Code Sec. 382 that were issued with NPRM REG-125710-18, September 10, 2019 (2019 proposed regulations). The IRS is withdrawing the text of the proposed applicability dates, and proposing revised applicability dates. The newly issued proposed rules would also provide transition relief.

Proposed Regulations and Notice 2003-65
The 2019 proposed regulations would provide guidance on the inclusion of items of income and deductions in the calculation of built-in gains and losses under Code Sec. 382(h). The proposed regulations would apply to ownership changes that occur after the date the proposed regulations are published as final regulations in the Federal Register.

Notice 2003-65, 2003-2 CB 747, provides interim guidance for identifying built-in gains and losses under Code Sec. 382(h). This notice permits taxpayers to rely on safe harbor approaches for applying Code Sec. 382(h) to an ownership change prior to the effective date of temporary or final regulations issued under that provision.

Delay of Applicability Date
To address concerns raised by taxpayers and practitioners, the IRS has withdrawn the text of Proposed Reg. §1.382-2(b)(4) and Proposed Reg. §1.382-7(g) contained in the 2019 proposed regulations, and replaced it with a revised proposed applicability date text. To avoid any gap between the date on which taxpayers can no longer rely on Notice 2003-65 and the date on which the final regulations are applicable, the applicability date of the final regulations would be 30 days after the date such regulations are published in the Federal Register (delayed applicability date). Exceptions exist for two situations discussed below.

Notice 2003-65 will remain applicable to ownership changes to which the final regulations do not apply.

Limiting Duplicative Application
The first exception to the delayed applicability date relates to the rule in Proposed Reg. §1.382-7(d)(5), which provides that certain carryforwards of business interest expense disallowed under Code Sec. 163(j) would not be treated as recognized built-in losses under Code Sec. 382(h)(6)(B), if such amounts were allowable as deductions during the five-year recognition period set forth in Code Sec. 382(h)(7)(A). This rule eliminates the possible duplicative application of Code Sec. 382 to certain disallowed business interest expense carryforwards.

The IRS has determined that Proposed Reg. §1.382-7(d)(5) should be finalized before the remainder of the rules in the 2019 proposed regulations, and that taxpayers should be allowed to retroactively apply this rule. To that end, the IRS expects that Proposed Reg. §1.382-7(d)(5) will be finalized as part of the Treasury decision that finalizes the proposed Code Sec. 163(j) regulations (see 83 FR 67490), and that taxpayers will be permitted to apply the rule to prior periods. The IRS continues to study the remainder of the rules in the 2019 proposed regulations.

Transition Relief
Under the proposed transition relief provisions, the final regulations would not apply to certain ownership changes that occur after the delayed applicability date. To qualify for the transition relief, the ownership change must occur immediately after an owner shift or equity structure shift that occurs pursuant to:

• a binding agreement in effect on or before the delayed applicability date and at all times thereafter;
• a specific transaction described in a public announcement made on or before the delayed applicability date;
• a specific transaction described in a filing with the Securities and Exchange Commission submitted on or before the delayed applicability date;
• a transaction described in a private letter ruling request submitted to the IRS on or before the delayed applicability date; or
• a court order (or a plan confirmed, or a sale approved, by court order) in a title 11 or similar case, provided that the taxpayer was a debtor in a case before such court on or before the delayed applicability date.

The relevant owner shift or equity structure shift must be a specific, identifiable transaction.

Taxpayers may continue to rely on Notice 2003-65 for to any ownership change qualifying for transition relief, even though the notice will be obsoleted on the delayed applicability date. However, a taxpayer may choose to apply the final regulations to such an ownership change.

The Treasury and IRS have issued final regulations on the due diligence and reporting rules for persons making certain U.S. source payments to foreign persons. Guidance is also provided on reporting by foreign financial institutions on U.S. accounts. The regulations are effective on the date the regulations are published in the Federal Register.

The Treasury and IRS have issued final regulations on the due diligence and reporting rules for persons making certain U.S. source payments to foreign persons. Guidance is also provided on reporting by foreign financial institutions on U.S. accounts. The regulations are effective on the date the regulations are published in the Federal Register.

Obtaining a Foreign TIN and Date of Birth
Temporary regulations provided that beginning January 1, 2017, a beneficial withholding certificate provided to document an account maintained at a U.S. branch or office of a financial institution was required to include a foreign taxpayer identification number (TIN) and the date of birth for an individual, in order to treat the certificate as valid. In response to comments regarding the difficulty of the requirements, the Treasury and IRS issued Notice 2017-46.

The notice provided a one-year delay in the implementation of the requirements for payments made on or after January 1, 2018, and a transitional rules to phase in the foreign TIN requirement for certificates provided before January 1, 2018. The transitional rules allow an otherwise valid certificate to remain valid until January 1, 2020. For payments made after January 1, 2020, a withholding agent may treat a pre-2018 as valid if the foreign TIN is obtained on a written statement or is in the withholding agent’s files. In Notice 2018-20, the IRS stated that it intended to expand its list of jurisdictions that do not issue foreign TINs to their residents to include jurisdictions that requested to be on the list, even if they issue foreign TINs.

The final regulations incorporate the temporary regulations and Notices with minor changes, by:

• providing, with respect to withholding certificates signed on or after January 1, 2018, that a separate written statement is an acceptable way to collect a foreign TIN, if the written statement contains an acknowledgment that the statement is part of the withholding certificate;
• clarifying the exception to the foreign TIN requirement for an account holder that is a government, international organization, foreign central bank or resident of a U.S. territory; and
• clarifying that a withholding agent may rely on the date of birth on a withholding certificate, unless it knows or has reason to know that the date of birth is incorrect.

Nonqualified Intermediaries
A nonqualified intermediary is generally required to provide a withholding agent a Form W-8IMY, a withholding statement, and documentation for each payee for which the intermediary receives a payment. The final regulations clarify that the general standards of knowledge that apply to withholding agents apply to a nonqualified intermediary for reliance on payee documentation, for making the representation that the information on the certificate is not inconsistent with other account information that the nonqualified intermediary has.

A nonqualified intermediary may provide a withholding statement that does not include a chapter 4 recipient code for one or more payees if the withholding agent can determine the appropriate code based on other information included on or associated with the withholding statement, or contained in the withholding agent’s records.

Electronic Signatures
A withholding agent can accept an electronically signed withholding certificate if the certificate reasonably demonstrates to the withholding agent that it has been electronically signed by the recipient identified on the form or authorized by the recipient to sign the form.

The final regulations allow the withholding agent to also consider documentation or other information that the withholding agent has that supports that the withholding certificate was electronically signed, absent actual knowledge that the information or documentation is incorrect.

Additional Changes
The final regulations also make clarifications with respect to withholding certificates and statements furnished through a third party repository.

Regarding the claim of a reduced rate of withholding under a treaty, the final regulations modify the general standard of knowledge by providing that:

• the withholding agent has reason to know that a claim of reduced rate under a treaty is unreliable or incorrect when it can check a list on the IRS website regarding the existence of the treaty, and
• a withholding agent can rely on a beneficial owner’s claim regarding a limitation of benefits (LOB) provision, absent actual knowledge that the claim is unreliable or incorrect.

The final regulation also extend the time for withholding agents to obtain treaty statements, with respect to specific LOB provisions for preexisting accounts, to January 1, 2020.

Taxpayers have been provided with additional guidance for complying with the Code Sec. 871(m) regulations on dividend equivalent payments for 2021, 2022, and 2023. The Treasury Department and the IRS intend to amend the regulations to delay the effective/applicability date of certain rules. Further, the phase-in period provided in Notice 2018-762, I.R.B. 2018-40, 522, has been extended.

Taxpayers have been provided with additional guidance for complying with the Code Sec. 871(m) regulations on dividend equivalent payments for 2021, 2022, and 2023. The Treasury Department and the IRS intend to amend the regulations to delay the effective/applicability date of certain rules. Further, the phase-in period provided in Notice 2018-762, I.R.B. 2018-40, 522, has been extended.

Dividend Equivalent Payments
A dividend equivalent amount is essentially an amount directly or indirectly determined by reference to a U.S. dividend. Code Sec. 871(m) treats dividend equivalent payments as U.S. source dividends. These payments are subject to 30-percent withholding (or a lower treaty rate) if received by a nonresident alien or foreign corporation.

The Code Sec. 871(m) regulations include final and temporary regulations under Code Secs. 871(m), 1441, 1461, and 1473.

Phase-in Year Extended
The effective/applicability date for the specified notional principal contract (NPC) rules under Reg. §1.871-15(d)(2) and the specified equity-linked instrument (ELI) rules under Reg. §1.871-15(e) will be revised. These rules will not apply to any payment made with respect to any non-delta-one transaction issued before January 1, 2023.

The IRS will take into account the extent to which the taxpayer or withholding agent made a good faith effort to comply with the Code Sec. 871(m) regulations in enforcing those regulations—

• for any delta-one transaction in 2017 through 2022; and
• for any non-delta-one transaction that is a Code Sec. 871(m) transaction under Reg. §1.871-15(d)(2) or Reg. §1.871-15(e) in 2023.

Further, the period when the IRS will take into account the extent to which a qualified derivatives dealer made a good faith effort to comply with the Code Sec. 871(m) regulations and the relevant provisions of the 2017 Qualified Intermediary (QI) Agreement is extended through 2022.

The 2017 QI Agreement will be revised so that a QDD will be treated as satisfying the obligations that specifically apply to a QDD under that agreement for 2017 through 2022.

Simplified Standard Extended
The period when the simplified standard applies for withholding agents to determine whether transactions entered into were combined transactions is extended to include 2021 and 2022. Transactions entered into in 2017 through 2022 that are combined under the simplified standard will continue to be treated as combined for future years. They will not stop being combined transactions by applying Reg. §1.871-15(n) (the combined transactions rule in the regulations), or by disposing of less than all of the potential Code Sec. 871(m) transactions that are combined under this rule.

Transactions entered into in 2017 through 2022 that are not combined under the simplified standard will not become combined transactions by applying Reg. §1.871-15(n) to them in future years, unless a reissuance or other event causes the transactions to be retested to determine whether they are Code Sec. 871(m) transactions.

Phase-In Relief for Qualified Derivatives Dealers Extended
Regarding qualified derivatives dealers (QDDs), Reg. §1.871-15(q)(1), Reg. §1.871-15(r)(3), and Reg. §1.1441-1(b)(4)(xxii)(C) will be amended so that a QDD will not be subject to tax on dividends and dividend equivalents received in 2021 and 2022 in its equity derivatives dealer capacity or withholding on those dividends (including deemed dividends). A QDD will have to compute its Code Sec. 871(m) amount using the net delta approach beginning in 2023.

A QDD will remain liable under Code Sec. 881(a)(1) for tax on dividends and dividend equivalents that it receives in any other capacity, and on any other U.S. source FDAP payments that it receives (whether or not in its equity derivatives dealer capacity). A QDD is also responsible for withholding on dividend equivalents it pays to a foreign person on a Code Sec. 871(m) transaction.

Transition Rules Extended
Withholding agents may apply the qualified securities lender (QSL) transition rules described in Notice 2010-46, I.R.B. 2010-24, 757, for payments made in calendar years 2021 and 2022.

Anti-Abuse Rule
The anti-abuse rule in Reg. §1.871-15(o) will continue to apply during the phase-in years. This means that a transaction that would not otherwise be treated as a Code Sec. 871(m) transaction (including as a result of the new guidance) might still be a Code Sec. 871(m) transaction under the anti-abuse rule.

Taxpayer Reliance
Taxpayers and withholding agents can rely on the new guidance before the Treasury and IRS amend the Code Sec. 871(m) regulations and the 2017 QI Agreement.

Every year the IRS publishes a list of projects that are currently on its agenda. For example, the IRS may indicate through this list that it is working on a new set of procedures relating to claiming business expenses. The new 2014–2015 IRS Priority Guidance Plan, just released this September, has indicated that IRS is working on guidance relating to whether employer-provided meals offered on company premises are taxable as income to the employee. In the Priority Guidance Plan’s Employee Benefits Section B.3, the IRS listed: "Guidance under §§119 and 132 regarding employer-provided meals" in its list of projects for the upcoming year.

Every year the IRS publishes a list of projects that are currently on its agenda. For example, the IRS may indicate through this list that it is working on a new set of procedures relating to claiming business expenses. The new 2014–2015 IRS Priority Guidance Plan, just released this September, has indicated that IRS is working on guidance relating to whether employer-provided meals offered on company premises are taxable as income to the employee. In the Priority Guidance Plan’s Employee Benefits Section B.3, the IRS listed: "Guidance under §§119 and 132 regarding employer-provided meals" in its list of projects for the upcoming year.

This could be significant for many employees who could potentially have to report as taxable income what they formerly thought were free meals provided by their employer. Currently, an employer may offer meals to employees on the work premises as a tax-free perk, if the meals are provided for the employer’s convenience. The question of whether the meals are provided for the convenience of the employer is determined, however, on the basis of all the facts and circumstances. Clearer guidance from the IRS may signal that in the future, examiners will pay closer attention to meals provided by employers.

Background

A growing trend among employers is to provide free gourmet meals to their employees. Employers argue this is for their convenience, which if true would make the meals non-taxable. But in some instances the IRS and others have posited that such meals more closely resemble income.

The Tax Code currently sets forth some basic guidelines for how to determine whether meals are being provided “for the convenience of the employer.” First of all, an employment contract or state statute are not determinative of whether the meals are intended as compensation. Secondly, the meals must be provided for a substantial noncompensatory business reason.

Factors indicating that meals are furnished for the convenience of the employer include:

• A short time available for lunch due to legitimate business reasons and not just to shorten the work day;
• The need for availability of employees for emergencies;
• Insufficient other eating facilities nearby; and
• A standard charge for meals regardless of whether they are eaten.

The IRS has also noted in its existing regulations that meals provided simply to promote morale or goodwill of employees, to attract new employees or as a means of providing additional compensation are not considered to be furnished for the convenience of the employer.

Examples

The IRS’s current regulations contain examples of meals that the IRS has considered to be legitimately provided to employees, tax-free, because they are provided for the employer’s conveniences. These include:

• Meals provided by a bank to its bank tellers to retain them on the premises during the lunch hour because the bank's peak workload occurs during the normal lunch period; and
• Meals provided to casino workers, who are required to eat their meals on the premises in order to minimize the security searches they undergo as they come and go, and to ensure that staff does not succumb to the temptations of nearby casinos rather than promptly returning to work.

Conversely, meals provided by a restaurant to a waitress on her days off are not tax-free because they are perks and not for the employer’s convenience.

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

The self-employment tax is levied and collected as part of the income tax. The tax must be taken into account in determining an individual's estimated taxes. The self-employed taxpayer is responsible for the self-employment tax, in effect paying both the employer's and the employee's share of the tax. The tax is calculated on Schedule SE, filed with the individual's income tax return, and is then reported on the Form 1040.

Self-Employment Tax Rate

The self-employment tax rate is 15.3 percent of self-employment income. This is the same overall percentage that applies to an employee's compensation. The rate combines the 12.4 percent Social Security tax and the 2.9 percent Medicare tax. Self-employed individuals can deduct one-half of the self-employment tax. (For 2011 and 2012, the Social Security tax rate was reduced from 12.4 to 10.4 percent.) If the individual's net earnings from self-employment are less than $400 (or $100 for a church employee), the individual does not owe self-employment tax.

Like FICA taxes, the 12.4 percent Social Security tax only applies to earning up to a specified threshold. For 2013, this threshold was $113,700; for 2014, the threshold is $117,000. There is no ceiling for applying the 2.9 percent Medicare tax.

Self-Employment

The tax applies to net earnings from self-employment. This is the taxpayer's gross income for the year from operating a trade or business, minus the deductions allowable to the trade or business, plus the taxpayer's distributive share of income or loss from a partnership.

A person is self-employed if he or she carries on a trade or business as a sole proprietor or independent contractor. A general partner of a partnership that carries on a trade or business is also considered to be self-employed. Self-employment does not include the performance of services by an employee. However, an employee who also carries on a separate business part-time can be self-employed with respect to the business.

Additional Medicare Tax

Effective for 2013 and subsequent years, both employees and self-employed individuals must pay an additional 0.9 percent Medicare tax if their FICA wages or self-employment income exceeds specified thresholds $250,000 for joint filers; $125,000 for married filing separately; and $200,000 for all other taxpayers. This tax is determined on Form 8959.

The current likelihood that your business will become involved in an employment tax audit or an employment-related income tax audit has increased: the IRS is aggressively attempting to reduce the "tax gap" of uncollected revenues in a time of increasing budget austerity. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue. Add to that total amount over $50 billion in estimated employment-associated income tax lost that is the result of missteps in withholding obligations, tip reporting, and proper fringe benefit classification . . . and employers are forewarned. The IRS is stepping up its auditing in these areas and has been conducting studies to maximize the best use of its agents' time to do so.

Latest audit survey

The IRS is conducting an intensive audit of 6,000 employment tax returns to obtain an up-to-date picture of taxpayers' employment tax practices. This will enable the IRS to better devote its compliance resources to the most important areas of noncompliance and to the taxpayers most likely not to be in compliance.

Based on these audits, the IRS's Chief of Employment Tax Policy has spotlighted several areas of concern that the IRS will focus on. These areas include backup withholding, tip reporting, worker classification, and fringe benefit reporting.

Backup withholding. Backup withholding is the number one problem uncovered in the audits. The IRS can impose backup withholding on income reported on Forms 1099 that is not ordinarily subject to withholding, such as interest, dividends, and nonemployee compensation. Failure to provide a taxpayer identification number (TIN) on the Form 1099, an incorrect TIN, or a TIN that does not match the name on the form can trigger backup withholding. A taxpayer's failure to report the income can also trigger backup withholding.

Tip reporting. Tip reporting is a major concern of the IRS. The IRS considers noncompliance a widespread problem, especially for small businesses that are not aware of the issues. The IRS has been focusing on educating employers, and is not auditing employment tax returns filed before 2014. An important issue is the failure to differentiate between service charges and tips. A payment that is automatically added to a bill may be a service charge. A service charge is characterized as Social Security wages, rather than Social Security tips. The distinction is important, because employers can claim a Social Security credit for FICA obligations attributable to tips that exceed the minimum wage, but cannot claim a credit for taxes paid on service charges.

Worker misclassification. To avoid FICA and FUTA taxes and income tax withholding, some employers intentionally classify employees as independent contractors. This has been a longstanding concern for the IRS, and the recent audits have shown that the problem continues. The agency regularly conducts employment tax audits to reclassify workers as employees. To facilitate reclassification to employee status, the IRS has two settlement programs for employers: the Classification Settlement Program (CSP) for taxpayers under audit, and the Voluntary Classification Settlement Program (VCSP) for companies that are not under an employment tax audit and meet other requirements. The IRS has received 1,550 applications under the VCSP and has reclassified approximately 25,000 workers. Companies that agree to prospectively treat workers as employees generally pay reduced taxes and may get audit protection for past years.

Fringe benefit reporting. Fringe benefits can be cash or noncash benefits provided in addition to regular wages. As a compliance matter, fringe benefits are taxable and must be included in the recipient's income, unless the Tax Code specifically excludes the benefit from taxable income. Moreover, if the recipient is an employee, the value of the benefit is additional compensation subject to employment taxes. Fringe benefits can be a particular problem for small companies, where owners seek to reduce their taxable income by taking noncash benefits, such as the use of company vehicles. A bargain sale of a house to an employee could also generate taxable income subject to employment taxes.

Conclusions

Employment taxes present an increasing risk to employers as the IRS steps up focuses on what it suspects is a heretofore largely untapped source of revenue. The IRS is certain to use the data now being harvested through its latest audit surveys. Many employers may do well to review how their employment tax compliance now measures up to this new degree of scrutiny.

In January, the U.S. Tax Court threw a curve ball in many retirement planning strategies. The court held that a taxpayer could make only one nontaxable rollover contribution within each one-year period regardless of how many IRAs the taxpayer has. The court found that the one-year limitation under Code Sec. 408(d)(3)(B) is not specific to any single IRA owned by an individual but instead applies to all IRAs owned by a taxpayer. The court's decision was a departure from a long-time understanding of IRS rules and publications and, for several weeks after, it was unclear what approach the IRS would take. Now, the IRS has announced that it will follow the court's decision and revise its rules and publications. Everyone contemplating an IRA rollover needs to be aware of this important development.

Rollovers

Individuals have traditionally enjoyed flexibility in moving their retirement savings from one type of retirement plan to another type of plan. A rollover is a transfer of a distribution received from an IRA or other retirement plan by the recipient to another IRA or type of retirement plan owned by the same recipient. A rollover has important tax considerations. The amount distributed is not included in the recipient's income if the distribution is transferred to an eligible arrangement within 60 days after it is received. In certain cases, the 60-day period may be extended by the IRS.

Generally, only the owner of the IRA may roll over an amount. A surviving spouse who receives a distribution after the death of the account owner can make rollovers to the same extent as the account owner could have. There are also special rules for Roth IRAs and other retirement arrangements.

Tax Court case

In Bobrow, TC Memo. 2014-21, a married couple received distributions from more than one IRA in 2008. The couple claimed that they could make more than one tax-free rollover. The Tax Court disagreed.

The court found that Code Sec. 408(d)(3)(B) limits the frequency with which a taxpayer may make a nontaxable rollover contribution. The one-year limitation is not specific to any single IRA a taxpayer has but instead applies to all of the taxpayer's IRAs. If Congress had intended to allow individuals to take nontaxable distributions from multiple IRAs per year, the court found that Code Sec. 408(d)(3)(B) would have been worded differently.

Immediately after the decision, many benefits professionals pointed out that the IRS's rules and publications appeared to be contrary to the court's decision. In particular, many taxpayers noted that IRS Publication 590, Individual Retirement Plans, seemed to say that multiple rollovers were permissible if taken from different accounts.

IRS action

The IRS intends to amend the existing rules and revise Publication 590 to clarify that it will adopt the court's decision. Additionally, many IRA trustees, the IRS explained, may need time to make changes to reflect Bobrow. Therefore, in a relief measure, the IRS will not apply the Tax Court's decision to any rollover that involves an IRA distribution occurring before January 1, 2015.

Trustee-to-trustee transfers

A rollover must be distinguished from a trustee-to-trustee transfer. The Tax Court explained in its opinion that individuals who maintain more than one IRA may make multiple direct rollovers from the trustee of one IRA to the trustee of another IRA without triggering the one-year limit under Code Sec. 408(d)(3)(B). Transferring funds directly between trustees, the court found, does not result in a distribution within the meaning of Code Sec. 408(d)(3)(A). Since the funds are not within the direct control and use of the participant, they are not considered to be rollovers.

Planning

The court's decision and the IRS's action may impact your retirement planning. Keep in mind also that trustee-to-trustee transfers are not affected by the court's decision, which leaves some flexibility intact for planning. If you have any questions about IRA rollovers, please contact our office.

The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the investment income of higher-income individuals. Although the tax does not take effect until 2013, it is not too soon to examine methods to lessen the impact of the tax.

Net investment income

"Net investment income" includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual's capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

The tax applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

However, the tax will not apply to nontaxable income, such as tax-exempt interest or veterans' benefits.

Deductions

Net investment income is gross income or net gain, reduced by deductions that are "properly allocable" to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property's basis. It also focuses on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers' fees, may increase basis or reduce the amount realized from an investment. As such, taxpayers may want to consider avoiding installment sales with net capital gains (and interest) running past 2012.

Thresholds

The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is your AGI increased by any foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

Example. Jim, a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760. In this case, the tax is not applied to the entire $40,000 of investment income.

Exceptions to the tax

Certain items and taxpayers are not subject to the 3.8 percent Medicare tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. There is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A. However, distributions from these plans (including amounts deemed as interest) are generally treated as compensation, not as investment income.

The exception for distributions from retirement plans suggests that potentially taxable investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Another exception is provided for income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Investment income from an active trade or business is also excluded. However, SECA (Self-Employment Contributions Act) tax will still apply to proprietors and partners. Income from trading in financial instruments and commodities is also subject to the tax.

The additional 3.8 percent Medicare tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity's property would be from an active trade or business. The tax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable under Code Sec. 664.

Income tax rates

In addition to the tax on investment income, certain other tax increases proposed by the Obama administration may take effect in 2011. The top two marginal income tax rates on individuals would rise from 33 and 35 percent to 36 and 39.6 percent, respectively. The maximum tax rate on long-term capital gains would increase from 15 percent to 20 percent. Moreover, dividends, which are currently capped at the 15 percent long-term capital gain rate, would be taxed as ordinary income. Thus, the cumulative rate on capital gains would increase to 23.8 percent in 2013, and the rate on dividends would jump to as much as 43.4 percent. Moreover, the thresholds are not indexed for inflation, so more taxpayers may be affected as time elapses.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.

Keeping the family business in the family upon the death or retirement of the business owner is not as easy as one would think. In fact, almost 30% of all family businesses never successfully pass to the next generation. What many business owners do not know is that many problems can be avoided by developing a sound business succession plan in advance.

Keeping the family business in the family upon the death or retirement of the business owner is not as easy as one would think. In fact, almost 30% of all family businesses never successfully pass to the next generation. What many business owners do not know is that many problems can be avoided by developing a sound business succession plan in advance.

In the event of a business owner's demise or retirement, the absence of a good business succession plan can endanger the financial stability of his business as well as the financial security of his family. With no plan to follow, many families are forced to scramble to outsiders to provide capital and acquire management expertise.

Here are some ideas to consider when you decided to begin the process of developing your business' succession plan:

Start today. Succession planning for the family-owned business is particularly difficult because not only does the founder have to address his own mortality, but he must also address issues that are specific to the family-owned business such as sibling rivalry, marital situations, and other family interactions. For these and other reasons, succession planning is easy to put off. But do you and your family a favor by starting the process as soon as possible to ensure a smooth, stress-free transition from one generation to the next.

Look at succession as a process. In the ideal situation, management succession would not take place at any one time in response to an event such as the death, disability or retirement of the founder, but would be a gradual process implemented over several years. Successful succession planning should include the planning, selection and preparation of the next generation of managers; a transition in management responsibility; gradual decrease in the role of the previous managers; and finally discontinuation of any input by the previous managers.

Choose needs over desires. Your foremost consideration should be the needs of the business rather than the desires of family members. Determine what the goals of the business are and what individual has the leadership skills and drive to reach them. Consider bringing in competent outside advisors and/or mediators to resolve any conflicts that may arise as a result of the business decisions you must make.

Be honest. Be honest in your appraisal of each family member's strengths and weaknesses. Whomever you choose as your successor (or part of the next management team), it is critical that a plan is developed early enough so these individuals can benefit from your (and the existing management team's) experience and knowledge.

A business succession plan should not only address management succession, but transfer of ownership and estate planning issues as well. Buy-sell agreements, stock gifting, trusts, and wills all have their place in the succession process and should be discussed with your professional advisors for integration into the plan.

Developing a sound business succession plan is a big step towards ensuring that your successful family-owned business doesn't become just another statistic. Please contact the office for more information and a consultation regarding how you should proceed with your business' succession plan.

If you are considering selling business property that has substantially appreciated in value, you owe it to your business to explore the possibility of a like-kind exchange. Done properly, a like-kind exchange will allow you to transfer your appreciated business property without incurring a current tax liability. However, since the related tax rules can be complex, careful planning is needed to properly structure the transaction.

If you are considering selling business property that has substantially appreciated in value, you owe it to your business to explore the possibility of a like-kind exchange. Done properly, a like-kind exchange will allow you to transfer your appreciated business property without incurring a current tax liability. However, since the related tax rules can be complex, careful planning is needed to properly structure the transaction.

Like-kind exchanges: The basics

The tax law permits you to exchange property that you use in your business or property that you hold for investment purposes with the same type of property held by another business or investor. These transactions are referred to as "like-kind" exchanges and, if done properly, can save your business from paying the taxes that normally would be due in the year of sale of the appreciated property.

Instead of an immediate tax on any appreciation in the year of sale, a like-kind exchange allows the appreciated value of the property you're transferring to be rolled into the working asset that you'll be receiving in the exchange. Mixed cash and property sales, multi-party exchanges, and time-delayed exchanges are all possible under this tax break.

What property qualifies?

In order to qualify as a tax-free like-kind exchange, the following conditions must be met:

• The property must be business or investment property. You must hold both the property you trade and the property you receive for productive use in your trade or business or for investment. Neither property may be property used for personal purposes, such as your home or family car.
• The property must not be held primarily for sale. The property you trade and the property you receive must not be property you sell to customers, such as merchandise.
• Most securities and instruments of indebtedness or interest are not eligible. The property must not be stocks, bonds, notes, chooses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest, including partnership interests. However, you can have a nontaxable exchange of corporate stocks in certain circumstances.
• There must be a trade of like property. The trade of real estate for real estate, or personal property for similar personal property is a trade of like property.

Examples:

Like property:

• An apartment house for a store building
• A panel truck for a pickup truck

Not like property:

• A piece of machinery for a store building
• Real estate in the U.S. for real estate outside the U.S.

• The property being received must be identified by a specified date. The property to be received must be identified within 45 days after the date you transfer the property given up in trade.
• The property being received must be received by a specified date.The property to be received must be received by the earlier of:
  1. The 180th day after the date on which you transfer the property given up in trade, or
  2. The due date, including extensions, for your tax return for the year in which the transfer of the property given up occurs.

Dealing with "boot" received

If you successfully make a straight asset-for-asset exchange, as discussed earlier, you will not pay any immediate tax with respect to the transaction. The property you acquire gets the same tax "basis" (your cost for tax purposes) as the property you gave up. In some circumstances, when you are attempting to make a like-kind exchange, the properties are not always going to be of precisely the same value. Many times, cash or other property is included in the deal. This cash or other property is referred to as "boot." If boot is present in an exchange, you will be required to recognize some of your taxable gain, but only up to the amount of boot you receive in the transaction.

Example:

XYZ Office Supply Co. exchanges its business real estate with a basis of $200,000 and valued at $240,000 for the ABC Restaurant's business real estate valued at $220,000. ABC also gives XYZ $35,000 in cash. XYZ receives property with a total value of $255,000 for an asset with a basis of $200,000. XYZ's gain on the exchange is $55,000, but it only has to report $35,000 on its tax return - the amount of cash or "boot" XYZ received. Note: If no cash changed hands, XYZ would not report any gain or loss on its tax return.

Using like-kind exchanges in your business

There are several different ways that like-kind exchanges can be used in your business and there are, likewise, a number of different ways these exchanges can be structured. Here are a couple of examples:

Multi-party exchanges. If you know another business owner or investor that has a piece of property that you would like to acquire, and he or she only wants to dispose of the property in a like-kind exchange, you can still make a deal even if you do not own a suitable property to exchange. The tax rules permit you to enter into a contract with another business owner that provides that you are going to receive the property that he or she has available in exchange for a property to be identified in the future. This type of multi-party transaction can also be arranged through a qualified intermediary with unknown third (or even fourth) parties.

Multiple property exchanges. Under the like-kind exchange rules, you are not limited in the number of properties that can be involved in an exchange. However, the recognized gain and basis of property is computed differently for multiple property exchanges than for single property-for-property exchanges.

Trade-ins. You could also structure a business to business trade-in of machinery, equipment, or vehicles as a like-kind exchange.

There are many ways that you can advantageously use the like-kind exchange rules when considering disposing of appreciated business assets. However, since the rules are complicated and careful planning is critical, please contact the office for assistance with structuring this type of transaction.

Starting your own small business can be hectic - yet fun and personally fulfilling. As you work towards opening the doors, don't let the onerous task of keeping the books rain on your parade. With a little planning upfront and a promise to "keep it simple", you can get an effective system up and running in no time.

Starting your own small business can be hectic - but also personally fulfilling. As you work towards opening the doors, don't let the onerous task of keeping the books rain on your parade. With a little planning upfront, you can get an effective system up and running quickly.

The IRS requires all businesses to keep adequate books and records but accurate financial records can be used by the small business owner in many other ways. Good records can help you monitor the progress of your business, prepare financial statements, prepare your tax returns, and support items on your tax returns. The key to accurate and useful records is to implement a good bookkeeping system.

The most important thing that you as a busy business owner should remember when planning your bookkeeping system is that simple is better. Bookkeeping should not interfere with the daily operations of your business or impede the progress of your business' goals in any way.

Decisions, decisions....

Probably the hardest part about bookkeeping for any small business is getting started. There are so many decisions to make that the business owner may seem overwhelmed. Single or double entry? Manual or computerized system? Should I try to do it myself or hire a bookkeeper?

Here are some good questions to ask yourself as you are making some very important upfront decisions:

• Single or double entry (manual bookkeeping systems). While a single entry system can be simple and straightforward (especially when you are just starting out a small business), a double entry system has built-in checks and balances that can help assure accuracy and control.

• Manual or computerized. Will a manual system quickly become overwhelmed with the expected volume of transactions from your business? Will your efforts be less if a certain element of your transactions were automated? If you plan on doing your books yourself, do you have the time/patience to learn a new software program?

• Self-prepare or outsource. How much time will you or your employees have to allocate to recordkeeping activities each day? Do you have any accounting experience or at least a good head for numbers? Does your budget allow for the additional expense of an outside bookkeeper? If outsourcing was an option, would it make sense to outsource some of it and do some yourself (e.g. use a payroll processing service but do your own daily transaction input and bank reconciliation)?

As you sit down to make these fundamental decisions regarding your bookkeeping system, here are a few things to keep in mind:

Be realistic. Be honest with yourself and realistic about the amount of time and energy you will be able to devote to the bookkeeping task. As a new small business owner, you will be pulled in a hundred different directions - make sure that you take on only as much of the bookkeeping task as you feel you can do without making yourself crazy.

Do your homework. Before you commit to any bookkeeping decision, it makes sense to find out what resources are available and at what cost. For example, you may find out that having your payroll processed by an outside company costs much less than you imagined or that a bookkeeping software package you thought was difficult is actually very straightforward. An informed decision is a good decision.

Ask for references and recommendations. Other successful small business owners have a wealth of knowledge surrounding all aspects of running a business, including bookkeeping. Ask them about their experiences with recordkeeping and find out what has (and what has not) worked for their companies. If they know of a good, reasonably priced bookkeeper or they've had a good experience with a software package, take notes.

See the forest for the trees. Translation: Give the minutia only as much attention as it needs and concentrate on the big picture of your business' finances. Implementing a bookkeeping system - on your own or with outside help - that is simple and reliable will give you the opportunity to step back and evaluate how effectively your business is operating.

There are many important decisions to make when you start your own business, including ones that seem mundane - such as recordkeeping - but that can have a significant impact on your ability to successfully operate your business. Before you make any of these decisions, we encourage you to contact the office for a consultation.

Once you have decided on the type of bookkeeping system to use for your new business, you will also be faced with several other accounting and tax related decisions. Whether to use the cash or accrual method of accounting, for example, although not always a matter of choice, is an important decision that must be carefully considered by the new business owner.

Generally, there are two methods of accounting used by small businesses - cash and accrual. The basic difference between the two methods is the timing of how income and expenses are recorded. Your method of accounting is chosen when you file your first tax return. If you ever wish to change your accounting method after that, you'll need to file for IRS approval, which can be a time-consuming process.

While no single accounting method is required of all taxpayers, you must use a system that clearly shows your income and expenses, and maintain records that will enable you to file a correct return. If you do not consistently use an accounting method that clearly shows your income, your income will be figured under the method that, in the opinion of the IRS, clearly shows your income.

Cash method

Most small businesses use the cash basis method of accounting, which is based on real time cash flow. Under the cash method, income is recorded when it is received, and expenses are reported when they are paid. For example, if you receive a check in the mail, it becomes a cash receipt (and is recorded as income). Likewise, when you pay a bill, you record the payment as an expense. The word "cash" is not meant literally - it also covers payments by check, credit card, etc.

Accrual method

Under the accrual method, you record income when it is earned, not necessarily when it is received. Likewise, you record your expenses when the obligation arises, not necessarily when you pay the bills. In short, the accrual method of accounting matches revenue and expenses when they occur whether or not any cash changes hands. For example, suppose you're hired as a consultant and complete a job on December 29^th, but you haven't been paid for it. You would still recognize all expenses you incurred in relation to that engagement regardless of whether you've been paid yet or not. Both the income and the expenses are recorded for that year, even if payment is received and bills are paid the following January.

Businesses are required to use the accrual method of accounting in several instances, including:

• If the business has inventory.
• If the business is a C corporation with gross annual sales exceeding $5 million (with certain exceptions for personal service companies, sole proprietorships, farming businesses, and a few others).

If you operate two or more separate and distinct businesses, you can use a different accounting method for each if the method clearly reflects the income of each business. The businesses are considered separate and distinct if books and records are maintained for each business. If you use the accounting methods to create or shift profits or losses between the businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct.

Other methods of accounting

In addition to the cash and accrual methods of accounting, there are other ways that your business can account for your income and expenses (e.g., hybrid, long-term contract). These methods are beyond the scope of this article but may be available for your business.

As stated previously, you choose your method of accounting when you file your first tax return. Because there are advantages and disadvantages to each of the accounting methods, it is important that you make the right decision. If you need assistance in determining the best accounting method for your business, please contact the office.

As you open the doors of your new business, the last thing on your mind may be the potential for loss of profits through employee oversight or theft - especially if you are the only employee. However, setting up some basic internal controls to guard against future loss before you hire others can save you headaches in the future.

As you open the doors of your new business, the last thing on your mind may be the potential for loss of profits through employee oversight or theft - especially if you are the only employee. However, setting up some basic internal controls to guard against future loss before you hire others can save you headaches in the future.

Soon after you start making money and the world realizes that they cannot live without your goods or service, you will probably need to hire employees. Although necessary for your growing company, hiring employees increases your risk of loss through errors, oversights and theft.

Implementing internal controls to help you monitor your business can decrease the need for constant supervision of your employees. Internal controls are checks and balances to prevent fraud, limit financial losses and reduce errors or oversights by employees. For example, the most basic internal control concept requires that certain tasks be handled by different people. This process, called "separation of duties", can greatly decrease the probability of loss.

The following basic internal control checklist includes suggestions that, once implemented, can help you and your employees avoid concerns about fraud or theft in the workplace:

• Have one person open the mail and list all the checks on the deposit slip while another enters cash receipts in your financial records.

• Make sure someone who does not handle the checkbook or purchasing is in charge of payments to suppliers and vendors.

• Have your bank reconciliation done by someone who does not have access to daily checkbook transactions.

• Make sure that you approve all vendors and that you count all goods received. Check all orders to make sure they are correct and of the quality you intended. Sign each check and review the invoice, delivery receipt and purchase order.

As your company grows, you may want to become less and less involved with the day-to-day operations of the business. The internal controls you put into place now will help keep the profits up, the losses down, and help you sleep better at night. If you need any assistance with setting up internal controls for you business, please feel free to contact our office.

The rise of paperless processing and remote access to computer systems has made increased computer security imperative. Establishing an effective password system can help keep your data secure while allowing you greater control over the access to your company's vital information.

The rise of paperless processing and remote access to computer systems has made increased computer security imperative. Establishing an effective password system can help keep your data secure while allowing you greater control over the access to your company's vital information.

Your best weapon to combat illegal access is a password system. Once it is installed, take the following steps to support it and ensure its effectiveness:

Create password guidelines. Clearly worded and easily accessible password guidelines can nip a computer security problem in the bud. Keep in mind that an outside hacker does only 15 percent of computer break-ins - 85% of such security breaches comes from inside, usually from disgruntled employees.

• Make and enforce rules about not using easy-to-guess passwords. Experts suggest passwords be a minimum length of six characters, using numbers (or symbols) as well as letters to make guessing nearly impossible. Try to avoid easily obtainable information such as birthdays, anniversaries, initials or mother's maiden name.
• In the office, don't allow passwords to be written down. Instead, have your employees memorize them or use a special computerized password program to keep track of them.
• Suggest that employees change passwords regularly - many businesses do this every 90 days.
• Erase default passwords and carefully monitor guest passwords or stations. Remember to promptly delete former employees' passwords.

Create a clear access rights policy and be sure everyone knows what it is. Certain levels and certain positions will have rights to specified parts of the system. Review log-in registers to see if a change in pattern pops up. Investigate anything suspicious immediately.

Control remote access. An off-the-shelf program, such as a firewall or encryption program, will add the security you need. A firewall system will allow access only to specific programs from the outside. Unfortunately, it's often the protected information your workers need. Encryption programs use codes to "scramble" data. Although persistent hackers can crack codes, these programs can make your information relatively safe.

If you take these steps to better your company's data security, you can be certain that the investment will pay off in the end. If you have any further questions, please feel free to contact our office.