Category: Tax Services

Posted on Feb 13, 2017

Several significant tax developments happened last year that may affect federal income tax returns that individual and business taxpayers file in 2017. Here’s a quick look at 10 key changes that you should be aware of during this tax season.

Uncertain Fate of Tax Extenders

In 2016, Congress adjourned without addressing numerous temporary tax provisions that were set to expire at the end of the year. Congress generally renews these “tax extenders” when they expire, but there aren’t any guarantees.

For example, Congress extended all 52 provisions that had expired after 2014 in the Protecting Americans from Tax Hikes (PATH) Act of 2015. Unlike previous tax extenders legislation, however, the PATH Act made a number of these provisions permanent. Several others were extended through 2019, while many provisions were temporarily extended for two years, through 2016.

Stay tuned for additional information on the fate of the tax extenders currently in limbo, as well as details of tax reform measures under the Trump administration and the Republican majority in Congress.

1. Stand-Alone HRAs

On December 13, 2016 — just over a month before leaving office — President Obama signed the 21st Century Cures Act into law. In addition to funding cutting-edge medical research, this new legislation allows an employer with fewer than 50 employees and no other group health insurance plan to establish Health Reimbursement Arrangements (HRAs) for its employees.

These standalone HRAs aren’t subject to certain penalties and restrictions imposed by the IRS under the Affordable Care Act (ACA). Plan ahead: The 21st Century Cures Act applies to plan years beginning after 2016.

2. ACA Reporting

Although the ACA might be repealed or modified in 2017, it’s still in effect for 2016. Under the ACA, employers must file information returns with the IRS and provide information to employees and other responsible individuals.

Recently, the IRS offered some consolation: It extended to March 2, 2017, the due date for furnishing to individuals 2016 Form 1095-B, “Health Coverage,” and 2016 Form 1095-C, “Employer-Provided Health Insurance Offer and Coverage.” This gives employers an extra 30 days to get their paperwork in order.

3. Premium Tax Credits

Taxpayers required to acquire health insurance under the ACA may qualify for premium tax credits to offset part of the cost. Although existing regulations include several favorable safe-harbor rules for determining eligibility, those rules don’t apply where an individual, with reckless disregard of the facts, provides incorrect information to a health insurance exchange.

New final regulations clarify that this provision for “reckless disregard of the facts” applies only to the conduct of the individual — not to information provided by any third parties.

4. Standard Mileage Rates

Each year, the IRS adjusts the standard mileage rates that taxpayers may use in lieu of tracking actual driving expenses. Due to lower gas prices, the rates have been reduced for 2017. The IRS recently announced that the flat rate for business driving is 53.5 cents per mile in 2017 (down from 54 cents per mile in 2016). Also, the rates for driving attributable to medical and moving purposes dropped to 17 cents per mile in 2017 (down from 19 cents per mile in 2016). Finally, the rate for charitable driving, which is set statutorily, remains at 14 cents per mile in 2017. In all cases, related tolls and parking fees can be added to the flat rate.

5. Valuations for Vehicles

Employees are taxed on the fair market value (FMV) of their personal use of company-provided vehicles. For convenience, the IRS permits FMV accounting methods based on the cents-per-mile rule (see “Standard Mileage Rates” above), as well as a fleet average value for employers with 20 or more vehicles, with the maximums updated annually.

Under a recent IRS Notice, the cents-per-mile thresholds in 2017 are $15,900 for automobiles (the same as in 2016) and $17,800 for trucks and vans (up from $17,700 for 2016). The thresholds for the fleet average rule in 2017 are $21,100 for a passenger auto (down from $21,200 for 2016) and $23,300 for a truck or van (up from $23,100 for 2016).

6. CPEOs

The IRS has now provided detailed requirements for certified professional employer organizations (CPEOs) — often called leasing companies — to remain certified. The IRS also has established procedures for suspending and revoking certification. Small businesses often contract with CPEOs to ensure compliance with workplace laws and regulations.

Under the Tax Increase Prevention Act of 2014, a CPEO may be treated as the sole employer of employees for purposes of paying and withholding employment taxes. Professional employer organizations can be certified as CPEOs effective as of January 1, 2017.

7. Delayed Refunds

A new tax law change requires the IRS to hold refunds for tax returns claiming the Earned Income tax credit or the additional child credit until at least February 15, 2017. As a result, many early filers still won’t have access to their refunds until the week of February 27 or even later.

Under the new rules, the IRS must delay the entire refund, even the portion that isn’t associated with the Earned Income tax credit or additional child credit. The IRS is advising taxpayers that the fastest way to get a refund is to file electronically and choose the direct deposit method.

8. ABLE Accounts

The Achieving a Better Life Experience (ABLE) Act of 2014 authorized special tax-favored savings accounts for individuals who are disabled before age 26. After the IRS issued regulations on this issue, individual states began rolling out ABLE accounts in 2016.

With an ABLE account, contributions aren’t tax deductible. But the amounts set aside in ABLE accounts are distributed tax-free to recipients if they’re used to pay for qualified disability expenses. Contributions to ABLE accounts may be sheltered by the annual gift tax exclusion of $14,000 for 2017 (the same as in 2016). Note, however, that if the account balance exceeds $100,000 it will impact SSI (Supplemental Security Income) eligibility.

9. Self-Certified Rollover Waivers

In general, an individual has 60 days to complete a tax-free rollover of a distribution from an Individual Retirement Account (IRA) or workplace retirement plan to another eligible retirement program. If you inadvertently miss this deadline, the distribution is usually taxable unless you obtain a waiver from the IRS. Thanks to a new ruling from the IRS in 2016, a taxpayer can self-certify that mitigating circumstances caused the failure.

For this purpose, a waiver may be allowed due to:

  • A distribution check being misplaced and never cashed,
  • Severe damage to the taxpayer’s home,
  • Death of a family member,
  • A serious illness of the taxpayer or a relative,
  • The taxpayer’s incarceration, or
  • Restrictions imposed by a foreign country.

The new rules went into effect on August 24, 2016.

Important note: Don’t forget that qualifying taxpayers may still make contributions, whether deductible or nondeductible, to a traditional IRA until the day taxes are due, without extension. They also have until Tax Day to make a nondeductible contribution to a Roth IRA for 2016. Put simply, the deadline for individuals to contribute to traditional or Roth IRAs for 2016 is April 18, 2017.

10. FBAR Reporting

Generally, a taxpayer who has over $10,000 in foreign bank accounts at any time during the year must file a Report of Financial Bank and Financial Accounts (FBAR). In the past, the filing deadline was June 30 of the following year. Now the FBAR due date has been moved to coincide with federal income tax filings.

Accordingly, 2016 FBARs must be filed electronically with the Financial Crimes Enforcement Network (FinCEN) by April 18, 2017. Also, FinCEN will grant filers missing the April 18, 2017, deadline an automatic extension until October 16, 2017.

Just a Sampling

This brief article covered just a few noteworthy tax developments in 2016. The IRS made many other changes that could affect your tax obligations, depending on your personal situation. Contact your CJ tax advisor if you have any questions.

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Posted on Jan 27, 2017

When you retire, you may consider moving to another state — say, for the weather or to be closer to loved ones. State taxes also may factor into the equation. Here’s what you need to know about establishing residency for state tax purposes — and why the process may be more complicated than it initially appears to be.

Identify and Quantify All Applicable Taxes

It may seem like a no-brainer to simply move to a state that has no personal income tax, such as Nevada, Texas or Florida. But, to make a good decision, you must consider all of the taxes that can potentially apply to a state resident, including:

  • Income taxes,
  • Property taxes,
  • Sales taxes, and
  • Estate taxes.

For example, suppose you’ve narrowed your decision down to two states: Texas and Colorado. Texas currently has no individual income tax, and Colorado has a flat 4.63% individual income tax rate. At first glance, Texas might appear to be much less expensive from a state tax perspective. Not necessarily. The average property tax rate in Texas is 1.93% of assessed value, while in Colorado it’s only 0.62%.

Within the city limits of Dallas, the property tax rate is a whopping 5.44%. So, a home that’s assessed at $500,000 would incur an annual property tax bill of $27,200 if it’s located in Dallas, compared to only $3,100 in Colorado. That difference could potentially cancel out any savings in state income taxes between those two states, depending on your income level.

If the states you’re considering have an income tax, also look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.

Watch Out for State Estate Tax

Not all states have estate tax, but they can be expensive in states that do. Every dollar you pay in state estate tax is in addition to any federal estate tax owed, except for the federal estate tax savings from the state estate tax deduction. Currently, estate taxes are levied in:

  • Connecticut,
  • Delaware,
  • Hawaii,
  • Illinois,
  • Maine,
  • Maryland,
  • Massachusetts,
  • Minnesota,
  • New York,
  • Oregon,
  • Rhode Island,
  • Tennessee,
  • Vermont,
  • Washington, and
  • Washington, D.C.

Beware — the federal estate tax exemption is $5.49 million in 2017. But some states haven’t kept pace with the federal level and, instead, levy estate tax with a much lower exemption. Also note that some states may levy an inheritance tax in addition to (or in lieu of) an estate tax.

Establish Domicile

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new state. The exact definition of legal domicile varies from state to state. In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Because each state has its own rules regarding domicile, you could wind up in the worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old state. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax.

How do you establish domicile in your new state? The more time that elapses after you change states and the more steps you take to establish domicile in the new state, the harder it will be for your old state to claim that you’re still domiciled there for tax purposes. Some ways to help lock in domicile in the new state:

  • Buy or lease a home in the new state.
  • Sell your home in the old state or rent it out at market rates to an unrelated party.
  • Change your mailing address with the U.S. Postal Service.
  • Change your address on passports, insurance policies, will or living trust documents, and other important documents.
  • Get a driver’s license and register your vehicle in the new state.
  • Register to vote in the new state. (This can probably be done in conjunction with getting a driver’s license.)
  • Open and use bank accounts in the new state.
  • Close bank accounts in the old state.

If an income tax return is required in the new state, file a resident return. File a nonresident return or no return (whichever is appropriate) in the old state. Your tax advisor can help with these returns.

Make an Informed Choice

Before deciding where you want to live in retirement, do some research and contact a tax professional in the new state that you’re considering. Taking these steps could avoid making a bad relocation decision when taxes are considered — one that could be difficult and expensive to unwind.

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Posted on Jan 26, 2017

The following table provides some important federal tax information for 2017, as compared with 2016. Many of the dollar amounts are unchanged or have changed only slightly due to low inflation. Other amounts are changing due to legislation.

Social Security/ Medicare 2017 2016
Social Security Tax Wage Base $127,200 $118,500
Medicare Tax Wage Base No limit No limit
Employee portion of Social Security 6.2% 6.2%
Individual Retirement Accounts 2017 2016
Roth IRA Individual, up to 100% of earned income $5,500 $5,500
Traditional IRA Individual, up to 100% of earned Income $5,500 $5,500
Roth and traditional IRA additional annual “catch-up” contributions for account owners age 50 and older $1,000 $1,000
Qualified Plan Limits 2017 2016
Defined Contribution Plan limit on additions on Sections 415(c)(1)(A) $ 54,000 $ 53,000
Defined Benefit Plan limit on benefits (Section 415(b)(1)(A)) $215,000 $210,000
Maximum compensation used to determine contributions $270,000 $265,000
401(k), SARSEP, 403(b) Deferrals (Section 402(g)), & 457 deferrals (Section 457(b)(2)) $ 18,000 $ 18,000
401(k), 403(b), 457 & SARSEP additional “catch-up” contributions for employees age 50 and older $ 6,000 $ 6,000
SIMPLE deferrals (Section 408(p)(2)(A)) $ 12,500 $ 12,500
SIMPLE additional “catch-up” contributions for employees age 50 and older $ 3,000 $ 3,000
Compensation defining highly compensated employee (Section 414(q)(1)(B)) $120,000 $120,000
Compensation defining key employee (officer) $175,000 $170,000
Compensation triggering Simplified Employee Pension contribution requirement (Section 408(k)(2)(c)) $600 $600
Driving Deductions 2017 2016
Business mileage, per mile 53.5 cents 54 cents
Charitable mileage, per mile 14 cents 14 cents
Medical and moving, per mile 17 cents 19 cents
Business Equipment 2017 2016
Maximum Section 179 deduction $510,000 $500,000
Phase out for Section 179 $2.03 million $2.01 million
Transportation Fringe Benefit Exclusion 2017 2016
Monthly commuter highway vehicle and transit pass $255 $255
Monthly qualified parking $255 $255
Standard Deduction 2017 2016
Married filing jointly $12,700 $12,600
Single (and married filing separately) $6,350 $6,300
Heads of Household $9,350 $9,300
Personal Exemption 2017 2016
Amount $4,050 $4,050
Personal Exemption Phaseout 2017 2016
Married filing jointly and surviving spouses Begins at $313,800 Begins at $311,300
Heads of Household Begins at $287,650 Begins at $285,350
Unmarried individuals Begins at $261,500 Begins at $259,400
Married filing separately Begins at $156,900 Begins at $155,650
Domestic Employees 2017 2016
Threshold when a domestic employer must withhold and pay FICA for babysitters, house cleaners, etc. $ 2,000 $ 2,000
Kiddie Tax 2017 2016
Net unearned income not subject to the “Kiddie Tax” $ 2,100 $ 2,100
Estate Tax 2017 2016
Federal estate tax exemption $5.49 million $5.45 million
Maximum estate tax rate 40% 40%
Annual Gift Exclusion 2017 2016
Amount you can give each recipient $14,000 $14,000

If you have a question for a tax expert, contact the CJ Tax Advisor team today. We’re here to help.

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Posted on Jan 4, 2017

The Joint Committee on Taxation (JCT) is a nonpartisan Congressional committee that, among other things, assists in the analysis and drafting of proposed federal tax legislation and prepares reports that interpret newly enacted federal tax legislation. The JCT recently issued the Overview of the Federal Tax System as in Effect for 2016. Here are the details of that report, including some interesting trends about business taxes.

Background on Business Taxes

The federal income tax treatment of a domestic business operation — one that’s domiciled in the United States — depends on how it’s set up. A business’s “choice of entity” has broad implications, including:

  • Whether there’s an entity-level federal income tax,
  • How much flexibility (if any) the entity has to allocate its taxable income among its owners,
  • Whether individual owners are subject to the self-employment tax, and
  • Whether the owners are liable for the entity’s debts and the entity’s access to capital.

When deciding how to set up a business, you have five basic options:

1. Sole proprietorship. This is the most basic way to operate a business. For tax and legal purposes, a sole proprietorship is one and the same as its owner. So, a sole proprietorship’s tax results are reported on the owner’s personal return. A major downside with operating a sole proprietorship is that the owner’s personal assets are generally exposed without limitation to any liabilities related to the business. Sole proprietors also owe self-employment tax on net income from a nonrental business.

2. C corporation. Businesses that incorporate are treated as separate legal and taxable entities apart from their owners. So, a C corporation owes corporate-level federal income tax on its taxable income (and possibly state income tax, too). If after-tax amounts are distributed to shareholders, the distributions may constitute dividends that are taxed again at the shareholder level, resulting in double taxation.

A major advantage of C corporation status is that the shareholders’ personal assets are generally protected from liabilities related to the corporation’s activities. In addition, C corporations face no tax-law restrictions on the type and number of shareholders it can have, the citizenship of its shareholders or the classes of stock it can issue.

3. S corporation. This refers to a closely held corporation that elects to be treated as a pass-through entity for federal income tax purposes. While an S corporation is still a separate taxable entity from its owners and must file a corporate return (on Form 1120-S), pass-through status means the S corporation’s income, gains, losses, deductions and credits are passed through to its shareholders and reported on their returns. In general, there is no entity-level federal income tax on an S corporation’s earnings.

Several requirements must be met to qualify for S corporation status: The corporation must be a U.S. entity, it can have only one class of stock, and there are limitations on the type and number of shareholders it can have. As with a C corporation, the personal assets of an S corporation’s shareholders are generally protected from liabilities related to the S corporation’s activities.

4. Partnership. This is a joint venture between at least two partners. Partnerships enjoy the benefits of pass-through tax status, including substantial flexibility to arrange transactions to reduce taxes. A partnership’s income, gains, losses, deductions and credits are passed through to its partners and reported on their returns. However, a partnership can (within limits) make disproportionate allocations of tax items (so-called special allocations).

For example, a 25% partner can be allocated 50% of partnership tax losses during the start-up period when losses are expected and then 50% of partnership income when the partnership goes into the black. After making up for the earlier special allocation of losses, the partner’s share of income can go back to 25%.

There’s no partnership-level income tax. In addition, there aren’t any tax-law restrictions on who can be a partner. In many cases, partnerships and partners can find ways to swap cash and other assets back and forth without triggering taxable gains or other adverse tax consequences.

The extent of a partner’s liability for debts of the business, if any, depends on the type and structure of the partnership. With a general partnership, all partners are exposed to partnership liabilities without limitation. But with a limited partnership, limited partners aren’t exposed to partnership liabilities (unless they guarantee them). General partners are exposed without limitation to partnership liabilities unless another partner guarantees them.

5. Limited liability company (LLC). Single-member LLCs (SMLLCs) have only one member (owner) and are generally disregarded for federal income tax purposes. The tax items of a disregarded SMLLC owned by an individual taxpayer are reported on the owner’s personal return (same as with a sole proprietorship). The tax items of a disregarded SMLLC owned by a corporation are reported on the corporation’s return (same as with an unincorporated branch or division).

Multimember LLCs have more than one member (owner) and are generally treated as partnerships for federal income tax purposes. As such, they have the same tax advantages as partnerships.

LLC members (owners) generally aren’t personally liable for the LLC’s debts, unless they guarantee them.

Important note: LLCs can elect to be treated as corporations for federal income tax purposes, but that’s rarely done unless it’s followed by an election to be treated as an S corporation.

JCT Findings

The JCT report includes statistics on the number of federal income tax returns filed by the different types of business entities and the share of federal income taxes they pay. The statistics cover 1978 through 2013 in five-year increments.

Here’s a summary of the returns filed for each of the five types of business entities:

Year

Sole proprietorships*

C corporations

S corporations

Partnerships*
1978 8.9 million 1.9 million 479,000 1.2 million
1983 10.7 million 2.4 million 648,000 1.5 million
1988 13.7 million 2.3 million 1.3 million 1.6 million
1993 15.8 million 2.1 million 1.9 million 1.5 million
1998 17.4 million 2.3 million 2.6 million 1.9 million
2003 19.7 million 2.1 million 3.3 million 2.4 million
2008 22.6 million 1.8 million 4.0 million 3.1 million
2013 24 million 1.7 million 4.3 million 3.5 million

* The statistics for sole proprietorships include SMLLCs taxed as sole proprietorships but exclude farms. The statistics for partnerships include LLCs taxed as partnerships.

The following trends have been observed from the JCT report:

  • The number of businesses operating as sole proprietorships (or as SMLLCs treated as sole proprietorships for tax purposes) has increased by 270% over the last 35 years.
  • The number of businesses operating as C corporations has actually declined over the last 35 years. This is a reaction to the 35% federal income tax rate that profitable C corporations have to pay and the dreaded double taxation threat that they face.
  • The number of businesses operating as S corporations has increased by almost 900% over the last 35 years. This may be because S corporations currently receive much more favorable treatment than C corporations under the Internal Revenue Code.
  • The number of businesses operating as partnerships and as LLCs taxed as partnerships has almost tripled over the last 35 years. This reflects the fact that partnerships get favorable treatment under the Internal Revenue Code.

The JCT report also includes statistics showing federal income tax receipts by type of entity as a percentage of total receipts. Corporate receipts over the 35-year period dropped from 15% to 10.6%, which is nearly a 30% drop. The drop is even more dramatic looking back to 1952, when the corporate income tax generated 32.1% of federal income tax revenue.

Implications for Business Tax Reform

The rise of sole proprietorships and pass-through entities (S corporations, partnerships and LLCs) shows that an increasing share of economic activity is being conducted by these forms of businesses. It also shows that an increasing share of business income is being reported on individual tax returns rather than on corporate returns where it’s potentially subject to high rates and double taxation. Some commentators have speculated that this makes tax reform even more challenging because there’s not a clear separation between business and individual taxation. In other words, it’s difficult to reform business taxes without also reforming personal taxes (and vice versa).

Business tax reform proposals often focus on the corporate federal income tax and the fact that the U.S. statutory rate (35% for a highly profitable corporation) is significantly higher than the rates in most other developed countries. Reform proposals tend to call for lower corporate tax rates and a broader tax base. However, some business groups assert that lowering the corporate rate without a corresponding decrease in the individual rates on pass-through business income would be unfair.

Tax Reform Proposals

Several business tax reform proposals have been floated as attempts to deal with the friction between corporate income tax rates and individual income tax rates on pass-through business income. These proposals include:

Taxing pass-through entities with gross revenues in excess of $50 million as C corporations.

Eliminating the double taxation threat by taxing C corporation income only at the corporate level. As a result, corporate dividends would be tax-free to recipients.

Establishing a “Growth and Investment Tax” that would tax all business income (regardless of the type of entity used by the business) at 30% and taxing dividends and capital gains at a flat 15% rate.

Providing pass-through entities with more generous tax breaks while leaving the rate system unchanged.

Establishing a deduction equal to 20% of active business income for certain small businesses, and/or allowing this deduction for pass-through entities in conjunction with lowering the corporate rate.
As a result of the election, we’re likely to see major tax changes in 2017. Congressional Republicans are eager to implement tax reforms within the first 100 days after President-elect Trump’s inauguration. At this point, however, it’s uncertain exactly which changes will make it through Congressional negotiations — or when the changes will go into effect.

Uncertainty Ahead

From high corporate tax rates to double taxation, today’s existing tax laws generally treat C corporations unfavorably. Over the last 35 years, this situation has led many businesses to rethink how they’re operated and switch to alternative pass-through structures, including S corporations, partnerships and LLCs. Additionally, many sole proprietorships have shied away from incorporating to avoid unfavorable tax treatment.

However, corporate tax reform could change the trends reported by the JCT in the future. As you plan for next year, discuss the latest tax reform proposals with your CJ tax advisor. It’s important to be nimble and knowledgeable in today’s evolving tax environment.

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Posted on Jan 2, 2017

Corporations can generally deduct interest on debts for federal tax purposes. A valid obligation exists if the parties intended to create a debt, and the debt is enforceable and unconditional. In contrast, a capital contribution is a direct or indirect contribution of cash or other property to the capital of a business entity. Generally, a contribution to the capital of a corporation isn’t treated as taxable income to the corporation, and the contributor can’t deduct the payment for tax purposes.

8 Factors to Consider

If the American Metallurgical Coal decision is appealed, that taxpayer’s fate will be in the hands of the U.S. Court of Appeals for the Fifth Circuit. That court has identified the following factors to consider when distinguishing bona fide debt from a capital contribution:

  1. The names given to the documents purporting to establish the debt,
  2. The presence (or absence) of a fixed maturity date,
  3. The right to enforce the payment of purported debt principal and interest,
  4. The failure of the purported borrower to pay amounts due on time or seek a postponement,
  5. The status of the purported debt in relation to debt owed to other corporate creditors (if the purported debt is last in line, it indicates an equity interest),
  6. The intent of the parties,
  7. The purported borrower’s ability to obtain loans from outside lending institutions, and
  8. The extent of the purported creditor’s participation in management of the purported borrower.

The issue of whether certain corporate instruments should be classified as debt owed by the corporation or as an equity interest in the corporation (the equivalent of stock) has been around for many decades. Internal Revenue Code Section 385, which was put in place in 1969, authorizes the IRS to issue regulations to address this question. However, no final regulations have ever been issued. So the debt vs. equity issue has evolved based on court decisions issued over the years.

There are two recent developments on this issue: 1) a recent U.S. Tax Court decision, and 2) long-awaited Sec. 385 regulations that will generally take effect for tax years ending on or after Jan. 19, 2017. Here are the details.

Court Decision

In a recent decision, a corporate subsidiary of a U.S. corporation purchased a partnership interest from a Liberian corporation in exchange for a 10-year note. The note had a fixed interest rate of 12%. It also provided for additional interest based on cash flow from the partnership interest.

At the time of the purported purchase, the taxpayer’s corporate subsidiary had no assets and required an advance of the entire purchase price from the seller (seller financing). In reality, the purported fixed interest payments were solely dependent on cash flow from the partnership interest (the asset that was purportedly purchased with the seller financing). The terms of the note were later amended to provide for a reduced interest rate.

The IRS denied the taxpayer’s interest expense deductions, claiming that the purchase of the partnership interest by the subsidiary was financed with equity rather than debt. In other words, the partnership interest was contributed by the Liberian corporation to the capital of the subsidiary.

The court agreed, holding that the parties created the transaction to reduce their respective tax liabilities and didn’t create a bona fide debtor-creditor relationship. (American Metallurgical Coal Co., TC Memo 2016-139.)

New IRS Regulations

The IRS has never issued final regulations under Internal Revenue Code Sec. 385 even though it has been around since 1969. However, in corporate inversion transactions (which have become popular amid heavy criticism from some quarters), multinational corporations often use a technique called “earnings stripping” to minimize U.S. taxes. Specifically, the taxable income of the domestic corporation is stripped away by payments of deductible interest to the new foreign parent or one of its foreign affiliates domiciled in a country with lower tax rates. Needless to say, the IRS doesn’t like this strategy.

In April 2016, the IRS issued proposed regs to clarify when to treat an instrument as corporate debt or corporate equity in certain transactions between related corporations. After receiving numerous comments, the IRS issued final and temporary regulations in October 2016.

The new regulations are included in a Treasury Decision, which is a daunting 518 pages long. But, in a nutshell, they essentially restrict the ability of corporations to engage in earnings stripping by treating financial instruments that are purported to be corporate debt as corporate equity in certain circumstances involving loans between related corporations. In addition, the new regulations require borrowing corporations that claim interest expense deductions for certain loans from related corporations to provide documentation of the loans.

Because the ability to minimize income tax liabilities through the issuance of related-party financial instruments isn’t limited to cross-border scenarios, the new regulations also apply to related U.S. affiliates of a corporate group. The updated rules generally go into effect for tax years ending on or after Jan. 19, 2017, subject to certain transition rules.

Limited Scope

The debt vs. equity issue has heated up. But most of the heat focuses on purported debt transactions between related corporations, especially when the purported lender is a foreign corporation. Therefore, many corporations won’t be affected by the new regulations. If you have questions or want more information on this important issue, contact your tax advisor.

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Posted on Dec 22, 2016

Are you an employee, a partner, a partner who doesn’t know it — or a combination of these classifications? The answer can have serious tax implications. If you participate in a business that’s operated as a partnership or a limited liability company, here are some recent developments that you need to know.

Tax Court Rules on Unknown, Undistributed Partnership Income

A gossip blogger was involved in a recent Tax Court decision. The man was approached by an investor who recommended the formation of a partnership called “Dirty World.” The taxpayer agreed and received a 41% limited partnership interest. He functioned as the editor and received wages from a related entity.

For the tax year in question, the taxpayer failed to include his share of undistributed partnership income from Dirty World. He claimed he’d never received distributions or a Schedule K-1 from the partnership. After an audit, the IRS assessed a tax deficiency, and the taxpayer took his case to the Tax Court.

But the Tax Court agreed with the IRS that the taxpayer owed tax on his share of undistributed partnership income from Dirty World, regardless of whether he was aware of it or not. (Nik Lamas-Richie, TC Memo 2016-63.)

IRS Position on Dual Status

Longstanding IRS guidance in Revenue Ruling 69-184 states that a partner can’t also be an employee of the same partnership. However, this policy has recently come into question. Some tax experts have been prodding the IRS to allow dual employee/partner status in certain circumstances.

For example, it can be argued that dual status is appropriate when an employee of a partnership receives a small interest in the partnership as equity-oriented compensation. Continued status as an employee would allow the individual to continue to participate in tax-favored employee benefit programs sponsored by the partnership.

In a recently issued temporary regulation, the IRS stated that, until further notice, there’s no exception to the Revenue Ruling 69-184 stipulation that a partner in a partnership can’t also be an employee of the same partnership. So, for now, once an employee of a partnership receives an ownership interest in the partnership, that individual is treated as a partner — regardless of how small the partnership interest may be.

However, the IRS says it might consider changing this stance if it can be shown that allowing dual employee/partner status in certain cases is desirable and wouldn’t lead to abuse of tax rules.

Important note: These considerations apply equally to multimember LLCs that are treated as partnerships for tax purposes and their employees and members.

IRS Position on Partners in Partnerships that Own Disregarded SMLLCs

In a recently issued temporary regulation, the IRS clarified the federal employment tax treatment of partners in a partnership that also owns a disregarded single-member (one-owner) LLC (SMLLC). A disregarded SMLLC is generally ignored for federal tax purposes. So, a disregarded SMLLC that’s owned by a partnership is simply treated as an unincorporated branch or division of the partnership, and all of the SMLLC’s tax items are included in the partnership’s tax return.

The new temporary regulation says that partners in the parent partnership can’t also be treated as employees of the disregarded SMLLC. Therefore, these individuals may be subject to self-employment tax on income passed through from the disregarded entity and they’re prohibited from participating in certain tax-favored employee benefit programs sponsored by the disregarded SMLLC. The new temporary regulation is effective as of the later of:

  • August 1, 2016, or
  • The first day of the latest-starting plan year following May 4, 2016, of an affected employee benefit plan.

An affected plan would include any employee benefit plan sponsored by the disregarded SMLLC that was adopted before and in effect as of May 4, 2016.

Important note: These considerations apply equally when a disregarded SMLLC is owned by a multimember LLC that is treated as a partnership for tax purposes.

Appeals Court Ruling on Oil and Gas Working Interest Income

The self employment (SE) tax is the government’s way of collecting Social Security and Medicare taxes on net income from self employment. What you may not know is that profits from passive investments in oil and gas working interests are subject to SE tax, according to a Tax Court decision that was recently affirmed by the 10th Circuit Court of Appeals. (Methvin v. Commissioner, 117 AFTR 2d 2016-2231, June 24, 2016.)

The taxpayer in this case owned small percentage working interests in several oil and gas properties. Owning a working interest entitles you to a percentage share of the net profits, if any, from an oil and gas property. The taxpayer had an agreement with the operator of the properties that allocated the taxpayer a share of the revenue and expenses from the properties. He had no right to be involved in the management or operation of the properties, and he had no expertise in oil and gas drilling or extraction. (His background was as a computer company executive.)

The taxpayer’s working interests represented no more than about a 2% to 3% interest in any single property, and they weren’t part of any formal business organization — such as a partnership, limited partnership, LLC or corporation — that was registered under applicable state law. Instead, the working interests were governed by a purchase and operation agreement entered into by the taxpayer, other working interest owners and the operator/manager of the properties.

Despite these informal arrangements, the oil and gas ventures that the taxpayer was involved in constituted partnerships for federal income tax purposes. However, the parties involved in the ventures exercised their right to be excluded from the partnership tax rules found in the section of the Internal Revenue Code that applies specifically to partnerships.

Consequently, there wasn’t a requirement to file annual partnership returns for the ventures. Instead, the operator provided the taxpayer with annual accounting summaries that showed the revenues and expenses allocated to the taxpayer’s working interests. The operator also issued an annual Form 1099-MISC to the taxpayer that showed his share of the net revenues from his working interests.

While the taxpayer reported the net revenue on his federal income tax returns, he didn’t pay any SE tax on the net revenue. After auditing his 2011 return, the IRS claimed that the taxpayer’s net profits from the oil and gas working interests were subject to SE tax because they constituted income from a business carried on by a partnership.

The taxpayer contended that he wasn’t engaged in the oil and gas business and wasn’t a partner in any oil and gas partnership. He argued that his minority working interests were merely investments in which he had no active involvement. Therefore, the taxpayer believed he didn’t owe SE tax on his working interest income, and he took his case to the U.S. Tax Court.

Court Decisions

The Tax Court noted that taxpayers who aren’t personally active in the management or operation of a business may nevertheless be liable for SE tax on their share of net SE income from the business if the business is carried on by a partnership in which the taxpayer is a member. In this case, the taxpayer and other parties involved in the oil and gas ventures elected out of the partnership federal income tax provisions. However, the election out applied only to tax provisions that are included in Subchapter K of the Internal Revenue Code (such as the requirement to file an annual partnership return on Form 1065). The SE tax provisions are not found in Subchapter K.

Therefore, the Tax Court ruled that the oil and gas ventures were still considered partnerships for SE tax purposes and that the taxpayer owed SE tax on his net income from his working interests.

On appeal, the 10th Circuit agreed, affirming that those working interests should be treated as partnership interests and that the profits from the investments were subject to SE tax.

Bottom Line

Business arrangements, including employment and compensation arrangements, can have surprising (and sometimes costly) tax consequences. For that reason, seeking advice from a tax professional before entering into arrangements is a smart idea. That way, there won’t be unpleasant surprises, and better tax results can often be achieved with some advance planning.

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Posted on Dec 20, 2016

If you’re looking for a way to lower your tax bill and your dealership owns real estate, a cost segregation study may be the answer. Read on to see if you qualify.

What Is a Cost Segregation Study?

You may be eligible to retroactively save taxes through accelerated depreciation if you purchased real estate, built a new showroom, renovated your facilities or expanded your property anytime since 1987.

Traditionally, dealers depreciate nonresidential buildings and improvements over 39 years using the straight-line depreciation method. A cost segregation study, however, works differently. It identifies, segregates and reclassifies qualifying property into asset groups with shorter depreciable lives of five, seven or 15 years. These shorter lived personal assets are eligible for MACRS accelerated depreciation schedules, rather than straight-line depreciation.

Cost segregation studies are used for tax purposes only. Your GAAP financial statements won’t be affected by the study, unless your dealership uses tax depreciation methods for book purpose, too.

Which Assets Qualify?Take a look at what’s included in the value of your real estate. Chances are the gross amount will include such things as carpeting, window treatments, wiring, cabinetry, lighting, driveways, wall coverings and cubicles, landscaping and drainage. Soft costs such as architectural and engineering fees might also be lumped into the total. All of these items potentially can be carved out as personal property and depreciated more quickly than standard real estate.

For example, suppose a dealership purchased a new showroom for $5 million in 2003. In 2013, the dealership’s CPA conducts a cost segregation study and determines that the following assets can be reclassified:

  • Parking lot ($500,000);
  • Carpeting, blinds and wallpaper ($20,000);
  • Cabinetry ($25,000);
  • Lighting ($5,000);
  • Service equipment ($200,000); and
  • Landscaping and drainage ($50,000).

This study enables the dealer to reclassify and accelerate depreciation on $800,000 of its fixed assets. In 2013, the dealership can deduct all the depreciation it could have taken since the building was acquired 10 years before.

Auto retailers tend to achieve some of the highest savings from cost segregation studies compared to other businesses. That’s because dealerships own significant fixed assets — including display areas, lift and repair equipment, showrooms, and other specialized mechanical systems — that can be mistakenly classified as real property.

When Will Tax Savings Happen?By reclassifying assets, dealers can maximize their depreciation deductions in the early years, improving cash flow sooner rather than later. Cost segregation studies adjust the timing of deductions, not the total deductions taken over an asset’s life.

Since 1996, dealers have been able to capture immediate retroactive savings from cost segregation studies. Before then, taxpayers had to spread depreciation savings over four years. Today, you can deduct the full amount as soon as your study is complete, thereby dramatically lowering your current tax bill. Of course, if you’re buying, building or renovating a dealership currently, this also is an ideal time to perform a study.

By lowering the value assigned to real property, a cost segregation study also can help you save on real estate, sales and use taxes.

Why Do I Need a Formal Study?

Formal cost segregation studies are required to support the deductions on your tax return in accordance with IRS guidelines. An experienced professional can analyze a dealership’s blueprints, engineering drawings and electrical plans to determine exactly which assets qualify as personal property. Bottom line: A formal cost segregation study will prove its worth if IRS auditors come knocking.

Savings Varies

Tax savings will vary depending on the value of your property, its age and your effective tax rates. But, it’s not uncommon to convert 20 to 40 percent of total building costs from real to personal property. Contact your Cornwell Jackson CPA to discuss how much you can expect to save from a cost segregation study.

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Posted on Dec 12, 2016

advisory services, business tax, business services, tax services, CPA in DallasBusiness tax credits are particularly beneficial for planning because they reduce tax liability dollar-for-dollar. The Protecting Americans from Tax Hikes (PATH) Act of 2015 has made permanent the research credit and extended but not made permanent other credits, including the Work Opportunity credit (through 2019). Let’s explore a few details of these business tax credits.

Research credit

Also known as the Research & Development (R&D) credit, it gives businesses an incentive to step up their investments in research and innovation. The PATH Act permanently extends the credit, allowing businesses to earn a credit for pursuing critical research into new products and technologies. Plus, in 2016 businesses with $50 million or less in gross receipts can claim the credit against AMT liability. Certain start-ups (in general, those with less than $5 million in gross receipts) that haven’t yet incurred any income tax liability can use the credit against their payroll tax. While the credit is complicated to compute, the tax savings can be worth the effort.

Work Opportunity credit

This credit is for employers that hire from a “target group.” It has been extended through 2019. Starting this year, target groups are extended to include individuals who’ve been unemployed for 27 weeks or more. The size of the tax credit depends on the hired person’s target group, the wages paid to that person and the number of hours that person worked during the first year of employment. The maximum tax credit that can be earned for each member of a target group is generally $2,400 per adult employee. But the credit can be higher for members of certain target groups, up to as much as $9,600 for certain veterans. Employers aren’t subject to a limit on the number of eligible individuals they can hire. That is, if there are 10 individuals that qualify, the credit can be 10 times the listed amount. Bear in mind that you must obtain certification that an employee is a target group member from the appropriate State Workforce Agency before you can claim the credit. The certification generally must be requested within 28 days after the employee begins work.

New Markets credit

This credit has been extended through 2019. It gives investors who make “qualified equity investments” in certain low-income communities a 39% tax credit over a seven-year period. Certified Community Development Entities (CDEs) determine which projects get funded — often construction or rehabilitation real estate projects in “distressed” communities, using data from the 2006–2010 American Community Survey. Flexible financing is provided to the developers and business owners.

Empowerment Zones

Empowerment Zones are certain urban and rural areas where employers and other taxpayers qualify for special tax incentives, including a 20% credit for “qualified zone wages” up to $15,000, for a maximum credit of $3,000. The tax incentive expired December 31, 2014, but it has been extended through December 31, 2016.

If you have questions about any of these potential deductions, employee benefits incentives or tax credits for the current or coming tax year, talk to the Tax Services Group at Cornwell Jackson. You may also download our newest Tax Planning Guide.

Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax advisory services to individuals and business leaders in the Dallas/Fort Worth area and across North Texas. 

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Posted on Dec 6, 2016

With Donald Trump as the president elect and Republicans holding a majority in the U.S. House and Senate, GOP tax reform appears likely in 2017. While campaigning, Mr. Trump promised big tax changes. Here’s a digest of his proposals, according to his website.

Individual Tax Rates and Capital Gains Taxes

For individuals, President-elect Trump proposes fewer tax brackets and lower top rates: 12%, 25% and 33% — versus the current rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The tax rates on long-term capital gains would be kept at the current 0%, 15% and 20%.

Proposed Rate Brackets for Married-Joint Filing Couples

Taxable Income Rate Bracket
Less than $75,000 12%
More than $75,000 but less than $225,000 25%
More than $225,000 33%

 

Proposed Rate Brackets for Unmarried Individuals

  Taxable Income
Rate Bracket
$0 to $37,500 12%
More than $37,500 but less than $112,500 25%
More than $112,500 33%

The proposed plan would eliminate the head of household filing status, which could prove to be a controversial idea.

President-elect Trump would abolish the alternative minimum tax (AMT) on individual taxpayers.

Itemized/ Standard Deductions and Personal/ Dependent Exemptions

The president-elect’s plan would cap itemized deductions at $200,000 for married joint-filing couples and $100,000 for unmarried individuals.

The standard deduction for joint filers would be increased to $30,000 (up from $12,700 for 2017 under current law). For unmarried individuals, the standard deduction would be increased to $15,000 (up from $6,350).

The personal and dependent exemption deductions would be eliminated.

Child and Dependent Care

Proposed new deduction: The Trump plan would create a new “above-the-line” deduction (meaning you don’t have to itemize to benefit) for expenses on up to four children under age 13. In addition, it would cover eldercare expenses for dependents. The deduction wouldn’t be allowed to a married couple with total income above $500,000 or a single taxpayer with income above $250,000. The childcare deduction would be available to paid caregivers and families who use stay-at-home parents or grandparents to provide care. The deduction for eldercare would be capped at $5,000 annually, with inflation adjustments.

Rebates for child care expenses: The proposed Trump Plan would offer new rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit. The rebate would equal 7.65% of eligible childcare expenses, subject to a cap equal to half of the federal employment taxes withheld from a taxpayer’s paychecks. The rebate would be available to married joint filers earning $62,400 or less and singles earning $31,200 or less. These ceilings would be adjusted for inflation annually.

Dependent care savings accounts: Under the proposed plan, taxpayers could establish new Dependent Care Savings Accounts for the benefit of specific individuals, including unborn children. Annual contributions to one of these accounts would be limited to $2,000. When established for a child, funds remaining in the account when the child reaches age 18 could be used for education expenses, but additional contributions couldn’t be made. To encourage lower-income families to establish these accounts for their children, the government would provide a 50% match for parental contributions of up to $1,000 per year. Dependent Care Savings Account earnings would be exempt from federal income tax.

Affordable Care Act Taxes

President-elect Trump wants to repeal the Affordable Care Act and the tax increases and employer penalties that it imposes — including the 3.8% Medicare surtax on net investment income and the 0.9% Medicare surtax on wages and self-employment income.

Estate Tax

His plan would also abolish the federal estate tax. But it would hit accrued capital gains that are outstanding at death with a capital gains tax, subject to a $10 million exemption.

Business Tax Changes

The president-elect proposes major changes to the taxes paid by businesses. Trump would cut the corporate tax rate from the current 35% to 15%, but eliminate tax deferral on overseas profits.

Under the proposed plan, a one-time 10% tax rate would be allowed for repatriated corporate cash that has been held overseas where it’s not subject to U.S. income tax under current rules.

The plan would also allow the same 15% tax rate for business income from sole proprietorships and business income passed through to individuals from S corporations, LLCs, and partnerships, which could cause a significant decrease in tax revenues.

Without getting very specific, the proposed plan proposes the elimination of “most” corporate tax breaks other than the Research and Development (R&D) credit. At-risk tax breaks could include unlimited deductions for interest expense and a bevy of other write-offs and credits.

On the other hand, the proposed Trump plan would allow manufacturing firms to immediately write off their capital investments in lieu of deducting interest expense.

What about Congress?

In addition to President-elect Trump’s proposed plan, House Republicans released the “Better Way Tax Reform Blueprint” earlier this year and Republicans in the Senate proposed their own tax plans. These proposals — which in some cases, differ from Trump’s — would make numerous changes to cut taxes and simplify filing. Despite some differences, members of Congress have expressed support for Trump’s plans and have vowed to act quickly.

When Might Changes Happen?

Democrats in Washington are likely to oppose any meaningful tax cuts, and they can attempt to stall things in the Senate where the Republicans won’t have a filibuster-proof majority. However, the Republicans can use the same procedural tactics that the Democrats used in 2010 to enact the Affordable Care Act. It’s possible that Trump’s tax plan (or parts of it) may pass in the first 100 days of his new presidency. If that happens, we could see major tax changes taking effect as early as next year.

Stay tuned.

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Posted on Dec 6, 2016

In 2017, the amount you can give to one person without triggering a gift tax return is $14,000 per donor, per recipient. It is unchanged from 2016.

You might be able to give someone more than this amount for certain expenses. For example, tuition or medical expenses that you pay on behalf of another person do not count.

Don’t expect the annual gift exclusion amount to rise every year, since it only increases in increments of $1,000 and is indexed to inflation.

Here’s a little history on the gift tax exemption: In 1932, the gift tax was made lower than the estate tax in order to encourage people to transfer their wealth during their lifetimes. A lifetime exemption was established, and the first annual gift exclusion was set at $5,000 per recipient.

But in the decades that followed, numerous changes came in quick succession, most of which resulted in higher gift and estate taxes. The incentive to transfer wealth through gifts was greatly diminished. It wasn’t until 1982 that the annual gift exclusion amount was raised to $10,000 (accompanied by other changes). The per donee amount remained at $10,000 for two decades.

The Taxpayer Relief Act of 1997 stipulated that the exclusion become indexed to inflation and increase in increments of $1,000. Even so, it took until 2002 for inflation to push the value of a dollar far enough to justify raising the exclusion to $11,000. On January 1, 2006, the amount rose to $12,000, then rose to $13,000 on January 1, 2009 and $14,000 on January 1, 2013 (where it remains).

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