Bates Income Tax - Newsletters

The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

penalties for participants (40 percent accuracy-related penalty);
penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

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Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

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Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

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Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

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The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

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Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
the census tract location of the tangible property of the business;
the value of the QOF’s investment; and
the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

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A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
Does the Eighth Amendment apply to corporation taxpayers?

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The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;
provide AAA and AE&P ratios used to the implement the proration; and
describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

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An eligible taxpayer can deduct qualified interest on a qualified student loan for an eligible student's qualified educational expenses at an eligible institution. The amount of the deduction is limited, and it is phased out for taxpayers whose modified adjusted gross income (AGI) exceeds certain thresholds.

The maximum deduction allowed for educational loan interest is $2,500. This amount is not adjusted for inflation. For tax years beginning in 2017, the $2,500 maximum deduction for interest paid on qualified education loans is reduced when modified adjusted gross income (AGI) exceeds $65,000 ($135,000 for joint returns), and is completely eliminated when modified AGI reaches $80,000 ($165,000 for joint returns).

Planning tip: Some taxpayers may choose to take out a home equity loan to pay off their student debt. Use of a home-equity loan of up to $100,000 principal is allowed for purposes other than home improvement or purchase. Interest up to that amount is fully deduction, as an itemized mortgage interest deduction.

Student loan interest is an “above-the-line” deduction; the taxpayer need not itemize.

Eligible student. An eligible student for purposes of eligible debt is a student enrolled in a college degree, certificate or other program, including a program of study abroad approved for credit at an institution of higher learning where the student is enrolled, and leading to a recognized educational credential at an eligible educational institution. The student must also carry at least one half of the normal full-time workload for the course of study being pursued during at least one academic period beginning during the tax year.

Student loan interest is not deductible if a dependency exemption is allowed for the taxpayer on someone else's return. Thus, if parents take a dependency exemption for a student who is the only person legally obligated to pay interest on a qualified loan, neither the parents nor the student is entitled to deduct any interest paid by the student during the time he is claimed as a dependent. A student may deduct interest paid in years after the student has ceased to be a dependent.

Legal obligation. The taxpayer claiming the deduction must be legally obligated to make the interest payments. Thus, a parent who had signed for the student loan and is liable personally for its payment may deduct interest paid on the loan.

If a third party who is not legally obligated makes an interest payment on behalf of a taxpayer who is legally obligated, the taxpayer is treated as receiving the payment from the third party and using it to pay the interest. For instance, if an employer makes an interest payment on behalf of the employee, and the payment is included in the employee's income as compensation, the employee can deduct the payment. Similarly, if a parent pays interest on behalf of a non-dependent borrower, the borrower may deduct the interest.

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Lawmakers from both parties spent much of June debating and discussing tax reform, but without giving many details of what a comprehensive tax reform package could look like before year-end. At the same time, several bipartisan tax bills have been introduced in Congress, which could see their way to passage.

Tax reform

House Speaker Paul Ryan, R-Wisc., predicted that tax reform would be accomplished in 2017. “Transformational tax reform can be done, and we are moving forward," Ryan said in June. We need to get this done in 2017. We cannot let this once-in-a-generation moment slip by.” Last year, House Republicans unveiled their “Better Way Blueprint,” which sets principles for tax reform, including lower individual tax rates, a reduced corporate tax rate, and a border adjustment tax, among other measures.

“Republicans have been afraid to expose their Blueprint to scrutiny,” Rep. Lloyd Doggett, D-Texas, a senior member of the House Ways and Means Committee, said. “The Republican Blueprint is both the wrong way for tax policy and the wrong way to legislate tax reform,” Doggett said.

In the Senate, the chair of the Senate Finance Committee (SFC), Orrin Hatch, R-Utah, asked stakeholders for input on tax reform. Hatch requested recommendations on individual, business and international tax reform. "After years of committee hearings, public statements, working groups, and conceptual exercises, Congress is poised to make significant steps toward comprehensive tax reform," Hatch said. “As we work to achieve those goals, it is essential that Congress has the best possible advice and insight from experts and stakeholders," he added.

Sen. Ron Wyden, D-Oregon, is ranking member of the SFC and urged lawmakers to take a bipartisan approach to tax reform. "The only way to pass lasting, job-creating tax reform that’s more than an economic sugar-high is for it to be bipartisan," Wyden said. "Tax reform takes a lot of careful consideration to write a bipartisan tax reform bill, and I know because I’ve written two of them."

Small business

The Senate Small Business Committee explored tax reform at a hearing in June. “Tax compliance costs are 67 percent higher for small businesses," Committee Chair James Risch, R-Idaho, said. Ranking member Jeanne Shaheen, D-N.H., said that “small businesses spend 2.5-billion hours complying with IRS rules.”

Mark Mazur, former Treasury assistant secretary for tax policy, was one of the experts who testified before the committee. Mazur said that small businesses generally have a larger per-unit cost of tax compliance than larger businesses. “One particular area that adds to the complexity of complying with the tax code is accrual accounting,” he said.

Other tax legislation

In June, the House passed HR 1551, a bipartisan bill. The legislation generally modifies the tax credit for advanced nuclear power facilities.

A number of bipartisan stand-alone tax bills have been introduced in Congress recently. They include:

The Invent and Manufacture in America Bill, a bipartisan bill that would enhance the research tax credit. Generally, the bill would increase the value of the credit by up to 25 percent for qualified research activities.
The Graduate Student Savings Bill, introduced by a group of Senate Democrats and Republicans. The bill would generally allow funds from a graduate student’s stipend or fellowship to be deposited into an individual retirement account (IRA).
The Adoption Tax Credit Refundability Act is another bipartisan bill. The measure generally would enhance the adoption tax credit.
Another bipartisan proposal would treat bicycle sharing systems as mass transit facilities for purposes of qualified transportation fringe benefits.

Additionally, a group of House Democrats and Republicans wrote to Treasury Secretary Steven Mnuchin in June. The bipartisan group of lawmakers asked Mnuchin to preserve the state and local sales tax deduction in any tax reform plan.

If you have any questions about tax reform, please contact our office.

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Shortly after resuming operations post-government shutdown, the IRS told taxpayers that the start of the 2014 filing season will be delayed by one to two weeks. The delay will largely impact taxpayers who want to file their 2013 returns early in the filing season. At the same time, the White House clarified on social media that no penalty under the Affordable Care Act's (ACA) individual mandate would be imposed during the enrollment period for obtaining coverage through an ACA Marketplace.

IRS shutdown

On October 1, many IRS employees in Washington, D.C. and nationwide were furloughed after Congress failed to approve funding for the government's fiscal year (FY 2014). During the shutdown, only 10 percent of the IRS' approximately 90,000 employees remained on the job, most engaged in criminal investigations and infrastructure support. Employees on furlough, including revenue agents assigned to exams and hearing officers assigned to collection due process cases, were expressly prohibited from doing any work, including checking email and voice messages.

Employees return to work

The IRS reopened on October 17. The previous day, Congress had passed legislation to fund the government through mid-January 2014. The IRS immediately cautioned taxpayers to expect longer wait times and limited service as it would take time for employees to resume work and process backlogged inventory. Upon their return to work, IRS employees began reviewing email, voice messages and their files as well as completing administrative tasks to reopen operations. The IRS reported that it received 400,000 pieces of correspondence during the furlough period in addition to nearly one million items already being processed before the shutdown.

Returns and refunds

The 16-day furlough overlapped with the October 15 deadline for taxpayers on extension to file 2012 returns. The IRS reported that during the shutdown it continued as many automated processes as possible, including accepting returns and processing payments. The Free File system also was open during the furlough period. However, refunds were not issued while the IRS was closed. Refunds are now being processed. If you have any questions about a refund or payment, please contact our office.

Filing season

The start of the 2014 filing season will be delayed approximately one to two weeks so the IRS can program and test tax processing systems following the 16-day federal government closure. The IRS had anticipated opening the 2014 filing season on January 21. With a one- to two-week delay, the IRS would start accepting and processing 2013 individual tax returns no earlier than January 28, 2014 and no later than February 4, 2014. The IRS reported it will make a final determination on the start of the 2014 filing season in mid-December.

The IRS explained that the government shutdown took place during the peak period for preparing its return processing systems for the 2014 filing season. The IRS must program, test and deploy more than 50 systems to handle processing of nearly 150 million tax returns.

"Readying our systems to handle the tax season is an intricate, detailed process, and we must take the time to get it right," Acting Commissioner Daniel Werfel said in a statement. "The adjustment to the start of the filing season provides us the necessary time to program, test and validate our systems so that we can provide a smooth filing and refund process for the nation's taxpayers. We want the public and tax professionals to know about the delay well in advance so they can prepare for a later start of the filing season."

Affordable Care Act

Beginning January 1, 2014, the Affordable Care Act generally requires individuals - unless exempt - to carry health insurance or make a shared responsibility payment (also known as a penalty). Individuals exempt from the payment include individuals covered by most employer-sponsored health plans, Medicare, Medicaid, and other government programs. The penalty is $95 in 2014 or the flat fee of one percent of taxable income, $325 in 2015 or the flat fee of two percent of taxable income, $695 in 2016 or 2.5 percent of taxable income (the $695 amount is indexed for inflation after 2016).

The Obama administration launched individual Marketplaces (formerly known as Exchanges) on October 1 in all 50 states and the District of Columbia. The enrollment period for coverage for 2014 began on October 1 and is scheduled to end March 31, 2014, which is after the January 1 effective date of the individual mandate. In late October, the Obama administration clarified on social media that individuals who enroll in coverage through a Marketplace at anytime during the enrollment period will not be responsible for a penalty.

Because of technical problems, some applications on HealthCare.gov have not been running at 100 percent, the U.S. Department of Health and Human Services (HHS) reported. Individuals can, however, enroll and obtain insurance at in-person assistance centers. Marketplace customer call centers are also open, HHS explained.

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Despite the 16-day government shutdown in October, a number of important developments took place impacting the Patient Protection and Affordable Care Act, especially for individuals and businesses. The Small Business Health Option Program (SHOP) was temporarily delayed, Congress took a closer look at income verification for the Code Sec. 36B premium assistance tax credit, and held a hearing on the Affordable Care Act's employer mandate. Individuals trying to enroll in coverage through HealthCare.gov also experienced some technical problems in October.

SHOP

The Affordable Care Act created two vehicles to deliver health insurance: Marketplaces for individuals and the SHOP for small businesses. Marketplaces launched as scheduled on October 1 in every state and the District of Columbia. Qualified individuals can enroll in a Marketplace to obtain health insurance. Coverage through a Marketplace will begin January 1, 2014.

The October 1 start of SHOP, however, was delayed. Small employers may start the application process on October 1, 2013 but all functions of SHOP will not be available until November, the U.S. Department of Health and Human Services (HHS) reported. If employers and employees enroll by December 15, 2013, coverage will begin January 1, 2014, HHS explained.

SHOP is closely related to the Code Sec. 45R small employer health insurance tax credit. This tax credit is designed to help small employers offset the cost of providing health insurance to their employees. After 2013, small employers must participate in SHOP to take advantage of the Code Sec. 45R tax credit. For tax years beginning during or after 2014, the maximum Code Sec. 45R credit for an eligible small employer (other than a tax-exempt employer) is 50 percent of the employer's premium payments made on behalf of its employees under a qualifying arrangement for QHPs offered through a SHOP Marketplace. The maximum credit for tax-exempt employers for those years is 35 percent. Maximum and minimum credits are based upon the level of employee wages. If you have any questions about SHOP and the Code Sec. 45R credit, please contact our office.

Code Sec. 36B tax credit

Effective January 1, 2014, qualified individuals may be eligible for the Code Sec. 36B premium assistance tax credit to help pay for health coverage through a Marketplace. The credit is linked to household income in relation to the federal poverty line (FPL). Generally, taxpayers whose household income for the year is between 100 percent and 400 percent of the federal poverty line for their family size may be eligible for the credit.

When taxpayers apply for coverage in a Marketplace, the Marketplace will estimate the amount of the Code Sec. 36B credit that the taxpayer may be able to claim for the tax year. Based upon the estimate made by the Marketplace, the individual can decide if he or she wants to have all, some, or none of the estimated credit paid in advance directly to the insurance company to be applied to monthly premiums. Taxpayers who do not opt for advance payment may claim the credit when they file their federal income tax return for the year.

The October 16 agreement to reopen the federal government directed HHS to certify to Congress that Marketplaces verify eligibility for the Code Sec. 36B credit. HHS must submit a report to Congress by January 1, 2014 on the procedures for verifying eligibility for the credit and follow-up with a report by July 1, 2014 on the effectiveness of its income verification procedures.

Employer mandate

The Affordable Care Act generally requires an applicable large employer to make an assessable payment (a penalty) if the employer fails to offer minimum essential health coverage and a number of other requirements are not met. The employer mandate was scheduled to take effect January 1, 2014. However, the Obama administration delayed it for an additional year, to 2015.

In October, the House Small Business Committee heard testimony on the definition of full-time employee status for purposes of the employer mandate. An applicable large employer for purposes of the employer mandate is an employer that employs at least 50 full-time employees or a combination of full-time and part-time employees that equals at least 50. A full-time employee with respect to any month is an employee who is employed on average at least 30 hours of service per week.

Employers testifying before the GOP-chaired committee urged an increase in the 30-hour threshold. "Many small businesses simply cannot afford to provide coverage to employees who average 30 hours per week," the owner of a supermarket told the committee. "Business owners will have to make tough choices and many part-time employees will face reduced hours," he added. "Many franchise businesses are being turned upside down by the new costs, complexities and requirements of the law," another business owner told the committee.

Legislation (HR 2575) has been introduced in the House to repeal the 30-hour threshold for classification as a full-time equivalent employee for purposes of the employer mandate and to replace it with 40 hours. The bill has been referred to the House Ways and Means Committee.

HealthCare.gov

As has been widely reported, the individuals seeking to enroll in Marketplace coverage through HealthCare.gov experienced some online problems in October. The U.S. Department of Health and Human Services (HHS) has undertaken a comprehensive review of HealthCare.gov. In the meantime, HHS reminded individuals that in-person assistance centers are open as are customer call centers.

Enrollment

The Affordable Care Act generally requires individuals to carry health insurance after 2013 or make a shared responsibility payment (also known as a penalty). For 2014, the penalty is $95 or the flat fee of one percent of taxable income, $325 in 2015 or the flat fee of two percent of taxable income, $695 in 2016 or 2.5 percent of taxable income (the $695 amount is indexed for inflation after 2016).

Open enrollment in the Affordable Care Act's Marketplaces began October 1, 2013 and runs through March 31, 2014. The enrollment period overlaps with the January 1, 2014 requirement to carry health insurance or make a shared responsibility payment. On social media, the Obama administration clarified that individuals who enroll in coverage through a Marketplace at anytime during the enrollment period will not be responsible for a penalty.

If you have any questions about these developments or the Affordable Care Act in general, please contact our office.

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The arrival of year end presents special opportunities for most taxpayers to take steps in lowering their tax liability. The tax law imposes tax liability based upon a "tax year." For most individuals and small business, their tax year is the same as the calendar year. As 2013 year end gets closer, most taxpayers have a more accurate picture of what their tax liability will be in 2013 than at any other time during the current year. However, if you don't like what you see, you have until year end to make improvements before your tax liability for 2013 is permanently set in stone.

A good part of year-end tax planning involves techniques to accelerate or postpone income or deductions, as your tax situation dictates. Efforts are generally focused on keeping projected tax liability for 2013 slightly lower than that anticipated for 2014, not overweighing projected tax liability for any one year. Having spikes in taxable income in any one tax year puts you in a higher average tax bracket than you would be in if you had evened out the amount of taxable income between the current and subsequent year.

Right to income versus cash receipt

Generally, a cash-basis taxpayer (which includes most individuals) recognizes income when it is received and takes deductions when expenses are paid. There is a subtle but important difference between the two:

Income is generally taxable in the year that it is received, by cash or check or direct deposit. You cannot postpone tax on income by refusing payment until the following year once you have the right to that payment in the current year. However, if you make deferred payments a part of the overall transaction, you may legitimately postpone both the income and the tax on it into the year or years in which payment is made. Postponement in this context usually takes place in a business setting. Examples include: installment sales, on which gain is prorated and taxed based upon the years over which installment payments are made; like-kind exchanges through which no gain is realized except to the extent other non-like-kind property (including cash) may change hands; and, on a higher level, tax-free corporate reorganizations pursuant to special tax code provisions.
Deductions, on the other hand, are generally not allowed until you pay for the item or service for which you want to take the deduction. Merely accepting the liability to pay for a deductible item does not make it deduction. Therefore, a doctor's bill does not become a medical expense deduction necessarily in the year that services are rendered or the bill is sent for payment. Rather, it is only considered deductible in the year in which you pay the bill. Determining when you pay your bills for tax purposes also has its nuances. A bill may be paid when cash is tendered; when a credit card is charged; or when a check is put in the mail (even if it is delivered in due course a few days into a new calendar year).

Compensation arrangements

Compensation arrangements carry their own special set of tax rules. The timing of the inclusion and deduction of compensation is largely governed by the employee's and the employer's normal methods of accounting. Under the cash method of accounting, amounts are includible in income when they are actually or constructively received and deductible when they are paid. Most employees are on the cash method.

Cash-basis employers can only deduct the cost of compensation the employee actually or constructively received. Constructive receipt comes into play when an employee attempts to decline offered compensation in order to defer its receipt and thereby postpone tax. Under the constructive receipt rule, the employee is currently taxed in this situation. However, there is no analogous constructive payment rule. Thus, a cash-basis employer may not take a deduction for amounts that it is willing to pay, and that it may have debited on its corporate books, but that it has not actually paid.

Deferred compensation plans, however, may be used to modify these general rules. There are basically two kinds of deferred compensation plans: qualified plans (such as 401(k) plans) and nonqualified plans or arrangements (common in executive compensation packages). Qualified plans are tax favored in that an employer can take an immediate deduction even though the employee might not recognize the income for years. With a nonqualified plan, the employer cannot take its deduction until the employee recognizes the income.

Particularly relevant to employers at year end is an annual bonus rule. Bonuses paid within a brief period of time after the end of the employer's tax year may be deducted in that tax year. Compensation is generally considered to be paid within a brief period of time if it is paid within two and one-half months of the end of the employer's tax year.

For a customized examination of what deferral or acceleration planning at year end may work best for you, please contact this office.

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