Category: Tax Services

Posted on Dec 3, 2016

Year end is rapidly approaching. It’s now time to consider making some moves that will lower your 2016 tax bill and get you into position for tax savings in future years. This article offers some year-end planning tips for individuals — while keeping the results of the recent election in mind.

Tax Reform Plans for Individuals

Both proposals set forth by President-elect Trump and the House Ways and Means Committee would reduce the number of tax brackets and lower top rates. In particular, the President-elect’s proposal calls for the following federal income tax rates for married-joint filers:

12% on taxable income below $75,000,
25% on taxable income of at least $75,000 but less than $225,000, and
33% on taxable income of $225,000 or higher.
The bracket thresholds for unmarried individuals would be half these amounts, and the head of household filing status would be eliminated. The tax rates on long-term capital gains would be kept at the current 0%, 15% and 20%.

Under the President-elect’s plan, the alternative minimum tax (AMT) would be eliminated for individual taxpayers. And he has proposed capping itemized deductions at $200,000 for married joint-filing couples ($100,000 for unmarried individuals).

In addition, 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). But personal and dependent exemption deductions would be eliminated.

There’s no way to tell what will happen in 2017. These proposed changes are significant and controversial to some, so it’s uncertain what will actually change — or when. The President-elect’s proposal differs somewhat from the House’s Tax Reform Blueprint, and some concessions may eventually be made to appease congressional Democrats.

Current Federal Tax Scene

The 2016 federal income tax rate picture for individuals is the same as last year, except the rate brackets have been adjusted slightly for inflation. Specifically, the tax rates remain 10%, 15%, 25%, 28%, 33% and 35%. The highest-income individuals face a top rate of 39.6%, but that rate only affects singles with 2016 taxable income above $415,050, married joint-filing couples with income above $466,950, and heads of households with income above $441,000.

For most individuals, the 2016 federal income tax rate on long-term capital gains and dividends will be either 0% or 15%. The 0% rate applies to gains and dividends that would otherwise fall within the 10% or 15% brackets. However, the maximum rate on long-term capital gains and dividends rises to 20% for singles with taxable income above $415,050, married joint-filing couples with income above $466,950, and heads of households with income above $441,000. (These are the same thresholds as for the 39.6% maximum rate on ordinary income.)

Note: President-elect Donald Trump’s current tax plan is similar to the proposal published by the House Ways and Means Committee earlier this year. Both call for reducing the number of brackets, lowering the top individual and business tax rates, eliminating the estate tax and making various other changes. (See “Tax Reform Plans for Individuals” at right.)

It’s unknown when (or if) these tax reform proposals will be enacted. With the Republicans in control of Congress and the White House, it wouldn’t be unreasonable to expect some of the proposals to pass and go into effect next year, however.

ACA Surtaxes

Under current tax law, high-income individuals may be subject to an additional 0.9% Medicare tax on wages and self-employment (SE) income. The 0.9% tax is charged on salary and/or net SE income above $200,000 for an unmarried individual and salary and/or net SE income above $250,000 for a married joint-filing couple.

Net investment income, including long-term capital gains and dividends, may also be hit with the 3.8% Medicare surtax, also known as the net investment income tax (NIIT). However, the NIIT doesn’t apply unless your modified adjusted gross income (MAGI) exceeds $200,000 if you are unmarried or $250,000 if you are married and file jointly with your spouse. The NIIT applies to the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold.

Note: The President-elect’s proposed 100-day plan would repeal the Affordable Care Act (ACA). If his plan succeeds, the ACA-related surtaxes may be repealed in 2017. 

Itemized Deduction Phaseouts

Under the phaseout rule for itemized deductions, you can potentially lose up to 80% of your write-offs for mortgage interest, state and local taxes, charitable donations and miscellaneous itemized deductions. However, the phaseout rule applies only if your adjusted gross income (AGI) exceeds the applicable threshold.

For 2016, the AGI thresholds for the itemized deduction phaseout are $259,400 for singles, $311,300 for married joint-filing couples and $285,350 for heads of households. The total amount of your affected itemized deductions is reduced by 3% of the amount by which your AGI exceeds the applicable threshold. However, the reduction can’t exceed 80% of the affected deductions that you started off with.

Personal and Dependent Exemption Phaseouts

Under the phaseout rule for personal and dependent exemptions, your write-offs can be reduced or even completely eliminated. However, the phaseout rule applies only if your AGI exceeds the applicable threshold. The thresholds are the same as for the itemized deduction phaseouts listed above.

Note: The President-elect’s tax plan would eliminate personal and dependent exemptions.

Expiring Tax Breaks

These popular federal income tax breaks for individuals are scheduled to expire at the end of 2016, unless they’re reinstated by Congress:

1. Higher education tuition deduction. This write-off can be as much as $4,000, or $2,000 for higher-income individuals.

2. Tax-free treatment for forgiven principal residence mortgage debt. Forgiven debts generally count as taxable cancellation of debt (COD) income. However, a temporary exception applies to COD income from canceled mortgage debt used to acquire a principal residence. Under the temporary rule, up to $2 million of COD income from principal residence acquisition debt that’s canceled from 2007 to 2016 can be treated as a tax-free item.

3. $500 credit for energy-efficient home improvements. Homeowners can claim a tax credit of up to $500 for certain energy-saving improvements to a principal residence. The $500 cap must be reduced by any credits claimed in earlier years.

Year-End Planning Tips

Now that we’ve covered the basics, here are eight tax-saving strategies to consider between now and year end:

1. Exceed the standard deduction allowance. If your total itemized deductions for 2016 would be close to the standard deduction amount, consider making enough additional expenditures for itemized deduction items to exceed this year’s standard deduction. That will lower this year’s tax bill.

For 2016, the standard deduction is $12,600 for married joint-filing couples, $6,300 for singles and $9,300 for heads of households. For 2017, the standard deduction amounts will be $12,700, $6,350 and $9,350 under current law.

Note: The standard deduction amounts for 2017 could be significantly higher if tax reform legislation is approved. If you expect an increase, plan to itemize this year, and then claim the more generous standard deduction next year. Your taxes will be lower in both years.

2. Consider prepaying deductible expenditures. If you itemize deductions, accelerating some deductible expenditures into this year to produce higher 2016 write-offs makes sense if you expect to be in the same or lower tax bracket next year. That’s more likely with Republican tax reform proposals now on the table.

Perhaps the easiest deductible expense to prepay is included in the house payment due on January 1. Accelerating that payment into this year will give you 13 months of deductible home mortgage interest in 2016. You can use the same prepayment drill with a vacation home. However, if you prepay this year, you’ll have to continue the policy in future years. Otherwise, you’ll have only 11 months of interest in the first year you stop using this strategy.

Another option is to prepay state and local income and property taxes that are due early next year. Prepaying those bills before year end can decrease your 2016 federal income tax bill, because your itemized deductions will be that much higher.

In addition, you may prepay expenses that are subject to deduction limits based on your AGI, such as medical expenses and miscellaneous itemized deductions. Medical costs are deductible only to the extent they exceed 10% of AGI for most people. However, if you or your spouse will be age 65 or older as of year end, the deduction threshold for this year is a more-manageable 7.5% of AGI. (In 2017, this threshold will increase to 10% of AGI for people age 65 or older.)

Miscellaneous deductions — for investment expenses, job-hunting expenses, fees for tax preparation and advice, and unreimbursed employee business expenses — count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a greater chance of clearing the 2%-of-AGI hurdle and receiving some tax savings.

Note: The prepayment drill can be a bad idea if you owe the alternative minimum tax (AMT). That’s because write-offs for state and local income and property taxes, as well as for miscellaneous itemized deductions, are completely disallowed under the AMT rules. Therefore, prepaying these expenses may not save much tax for people who owe AMT.

3. Prepay tuition bills. If your 2016 AGI qualifies you for the American Opportunity credit (maximum of $2,500 per eligible student) or the Lifetime Learning credit (maximum of $2,000 per family), consider prepaying tuition bills that aren’t due until early 2017 if it generates a bigger credit on this year’s tax return. Specifically, you can claim a 2016 credit based on prepaying tuition for academic periods that begin in January through March of next year.

The American Opportunity credit can be reduced or completely eliminated if your MAGI is too high. Here are the current MAGI phaseout ranges:

  • $80,000 to $90,000 for unmarried individuals, and
  • $160,000 to $180,000 for married joint filers.

The Lifetime Learning credit is subject to lower phaseout ranges. The 2016 MAGI phaseout ranges for this credit are only:

  • $55,000 to $65,000 for unmarried individuals, and
  • $111,000 to $131,000 for married joint filers.

If your MAGI is too high to be eligible for these higher education credits, you might still qualify to deduct up to $2,000 or $4,000 of tuition costs. If so, consider prepaying tuition bills that aren’t due until early 2017 if that would result in a bigger deduction this year. As with the credits, your 2016 deduction can be based on prepaying tuition for academic periods that begin in the first three months of 2017.

4. Defer income recognition. It may also be beneficial to defer some taxable income from this year into next year if you expect to be in the same or lower tax bracket in 2017 (which, again, is more likely with Republican tax reform proposals on the table). For example, if you’re in business for yourself and a cash-method taxpayer, you can postpone taxable income by waiting until late in the year to send out some client invoices. That way, you won’t receive payment for them until early 2017.

You can also defer taxable income by accelerating some deductible business expenditures into this year. Both moves will postpone taxable income from this year until next year, when it might be taxed at lower rates. Deferring income can also be helpful if you’re affected by unfavorable phaseout rules that reduce or eliminate various tax breaks, such as the child tax credit or the higher education tax credits.

5. Sell loser underperforming stocks held in taxable accounts. By selling off loser investments (currently worth less than what you paid for them) held in taxable brokerage accounts, you may be able to lower your 2016 tax bill, because you can offset the resulting capital losses against capital gains from earlier in the year.

If losses exceed gains, you’ll have a net capital loss for the year. You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) on this year’s return against ordinary income from salary, self-employment activities, alimony, interest, and other types of income. Any excess net capital loss is carried forward to future years and puts you in position for tax savings in 2017 and beyond.

6. Consider postponing Roth IRA conversions until next year. The best scenario for converting a traditional IRA into a Roth account is when you expect to be in the same or higher tax bracket during retirement. Even if the tax laws are reformed in 2017, you might eventually wind up in a higher tax bracket during retirement, so conversions can still be a smart tax-planning move.

But there’s a current tax cost for converting, because the conversion is treated as a taxable liquidation of your traditional IRA followed by a nondeductible contribution to the new Roth account. If you don’t convert until next year, the tax cost could be much lower if tax rates are cut by tax reform legislation.

After the conversion, qualified withdrawals (including income and gains that accumulate in the Roth account) will be federal-income-tax-free. In general, qualified withdrawals are those taken after:

  • You’ve had at least one Roth account open for more than five years, and
  • You’ve reached age 59-1/2 or become disabled or died.

With qualified withdrawals, you (or your heirs if you pass on) avoid having to pay higher tax rates that might otherwise apply in future years. While the current tax hit from a Roth conversion is unwelcome, it could be a relatively small price to pay for future tax savings.

7. Donate appreciated stock to charity. If you own appreciated stock or mutual fund shares that you’ve held for over a year, consider donating them to IRS-approved charities. If you itemize deductions, you can generally claim a deduction for the market value at the time of the donation and avoid any capital gains tax hit.

On the other hand, don’t donate stocks or mutual fund shares that have decreased in value while you’ve owned them. Sell the underperforming investments, book the resulting capital losses and then donate the cash proceeds from the sales. That way, you can generally claim an itemized deduction for the cash donation while keeping the tax-saving capital loss for yourself.

8. Make charitable donations from IRAs. IRA owners and beneficiaries who have reached age 70-1/2 are permitted to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. These so-called qualified charitable distributions (QCDs) are federal-income-tax-free, but you can’t claim an itemized deduction for the charitable donation. That’s okay, because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can delay itemized charitable write-offs.

QCDs have other tax advantages, too. If you’re interested in taking advantage of the QCD strategy for 2016, you’ll need to arrange with your IRA trustee for money to be paid out to one or more qualifying charities before year end.

Need Assistance?

These are just some of the tax-planning strategies available to help individuals lower their taxes. Before implementing any of these strategies, consult your Cornwell Jackson tax advisor to discuss the details and limitations, as well as other creative tax-saving alternatives. Your tax advisor is closely monitoring any tax law changes and will let you know when (and if) circumstances change.

 

Related Posts

Posted on Dec 1, 2016

It’s not too late to take steps to significantly reduce your 2016 business income tax bill and lay the groundwork for tax savings in future years. Here’s a summary of some of the most effective year-end tax-saving moves for small businesses under the existing Internal Revenue Code. After President Obama hands over the baton to President-elect Trump and new members of Congress are sworn into office in January, the tax laws could change. But here’s what we know now.

Take Advantage of Net Operating Losses (NOLs)

NOLs received some bad press during the 2016 election season. But they can be an effective — and perfectly legal — way for small business owners to lower taxes in the future. NOLs happen when a business’s deductible expenses exceed its income for the year.

With the exception of the Section 179 depreciation deduction, the business tax breaks and strategies discussed in the main article can be used to create or increase a 2016 NOL. You can then choose to carry a 2016 NOL back for up to two years in order to recover taxes paid in those earlier years. Or you can choose to carry the NOL forward for up to 20 years if you think your business tax rates will go up.

Juggle Pass-Through Income and Deductible Expenditures

If your business operates as a sole proprietorship, S corporation, limited liability company (LLC) or partnership, your share of the net income generated by the business will be reported on your Form 1040 and taxed at your personal rates. If the new Congress maintains the status quo, individual federal income tax rate brackets for 2017 will be about the same as this year’s brackets (with modest increases for inflation).

Under that assumption, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2016 until 2017.

On the other hand, if your business is healthy, and you expect to be in a significantly higher tax bracket in 2017 (say, 35% vs. 28%), take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2017. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate.

Important note: The results of the election could affect tax rates and regulations in the future. Individual tax rates in 2017 and beyond could be higher or lower than under current law.

Defer Corporate Income and Accelerate Deductible Expenditures (or Vice Versa)

If your business operates as a regular C corporation, corporate tax rates for 2017 are scheduled to be the same — again, assuming the new Congress makes no tax law changes. So, if you expect your corporation to pay the same or lower rate in 2017, you should plan to defer income into next year and accelerate deductible expenditures into this year. If you expect the opposite, accelerate income into this year, while postponing deductible expenditures until next year.

Looking for easy ways to defer income and accelerate deductible expenditures? If your small business uses cash-method accounting for tax purposes, it can provide flexibility to manage your 2016 and 2017 taxable income to minimize taxes over the two-year period. Here are four specific cash-method moves if you expect business income to be taxed at the same or lower rates next year:

  1. Before year end, charge on your credit cards recurring expenses that you would otherwise pay early next year. You can claim 2016 deductions even though the credit card bills won’t be paid until next year. However, this favorable treatment doesn’t apply to store revolving charge accounts. For example, you can’t deduct business expenses charged to your Sears or Home Depot account until you actually pay the bill.
  2. Pay expenses with checks and mail them a few days before year end. The tax rules say you can deduct the expenses in the year you mail the checks, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail. That way, you can prove they were mailed this year.
  3. Prepay some expenses for next year, as long as the economic benefit from the prepayment doesn’t extend beyond the earlier of: 1) 12 months after the first date on which your business realizes the benefit, or 2) the end of 2017 (the tax year following the year in which the payment is made). For example, this rule allows you to claim 2016 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.
  4. On the income side, the general rule for cash-basis taxpayers is that you don’t have to report income until the year you receive cash or checks in hand or through the mail. To take advantage of this rule, hold off sending out some invoices at year end. That way, you won’t get paid until early next year. Of course, you should never do this if it raises the risk of not collecting the cash.

When should you take the opposite approach? If you expect to pay a significantly higher tax rate on next year’s business income, try to use the opposite strategies to raise this year’s taxable income and lower next year’s. Be sure to factor into the equation your expectations about how the election results will affect taxes in future years.

Buy Heavy Vehicles

Purchasing a gas-guzzling SUV, pickup or van for your business may be seen by some as bad for the environment. But these vehicles can be useful if you need to haul people, equipment and other things around as part of your day-to-day business operations. They also have major tax advantages.

Under the Section 179 election, you can elect to immediately write off up to $25,000 of the cost of a new or used heavy SUV that’s: 1) placed in service by the end of your business tax year that begins in 2016, and 2) used over 50% for business during that year.

If the vehicle is new, 50% first-year bonus depreciation allows you to write off half of the remaining business-use portion of the cost of a heavy SUV, pickup or van that’s: 1) placed in service in calendar year 2016, and 2) used over 50% for business during the year.

After taking advantage of the preceding two breaks, you can follow the “regular” tax depreciation rules to write off whatever is left of the business portion of the heavy SUV’s, pickup’s or van’s cost over six years, starting with 2016.

To cash in on this favorable tax treatment, you must buy a “heavy” vehicle, which means one with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. First-year depreciation deductions for lighter SUVs, light trucks, light vans and passenger cars are much skimpier. You can usually find a vehicle’s GVWR specification on a label on the inside edge of the driver’s side door where the hinges meet the frame.

Example 1: New Heavy Vehicle

Your business uses the calendar year for tax purposes. You buy a new $65,000 Cadillac Escalade and use it 100% for business between now and December 31. On your 2016 business tax return or form, you can elect to write off $25,000 under Sec. 179.

Then you can use the 50% first-year bonus depreciation break to write off another $20,000 (half the remaining cost of $40,000 after subtracting the $25,000 Sec. 179 deduction).

Finally, you can follow the regular depreciation rules to depreciate the remaining cost of $20,000. (That’s the amount left after subtracting the Sec. 179 deduction and the 50% bonus depreciation deduction.) For this asset, regular depreciation will generally result in a $4,000 deduction (20% x $20,000) in the first year.

When all is said and done, your first-year depreciation write-offs amount to $49,000 ($25,000 + $20,000 + $4,000). That represents a whopping 75.4% of the vehicle’s total cost.

In contrast, if you spend the same $65,000 on a new sedan that you use 100% for business between now and year end, your 2016 depreciation write-off will be only $11,160.

Example 2: Used Heavy Vehicle

Your business uses the calendar year for tax purposes. You buy a used $40,000 Cadillac Escalade and use it 100% for business between now and December 31. On your 2016 business tax return or form, you can elect to write off $25,000 under Sec. 179. Bonus depreciation isn’t allowed on used vehicles.

But you can generally write off another $3,000 under the normal depreciation rules. That’s equal to 20% of the remaining cost of $15,000 ($40,000 – $25,000).

Your first-year depreciation deductions add up to $28,000 ($25,000 + $3,000).

In contrast, if you spend the same $40,000 on a used passenger car and use it 100% for business, your 2016 depreciation write-off will be only $3,160.

You may not be eligible to claim Sec. 179 deductions if you have a tax loss for the year (or close to it). Sec. 179 can’t be used to create an overall business tax loss. This is the so-called business taxable income limitation.

Elect Sec. 179 on Other Fixed Asset Purchases

Sec. 179 is even more generous for other types of fixed assets, such as equipment, software and leasehold improvements. For tax years that begin in 2016, the maximum Sec. 179 first-year depreciation deduction is $500,000. This amount will be adjusted for inflation in future years.

Thanks to this tax break, many small and medium-size businesses can immediately deduct most (or all) of their new and used fixed asset purchases in the current tax year. This can be especially beneficial if you buy a new or used heavy long-bed pickup and/or heavy van to be used over 50% in your business. Unlike heavy SUVs, these heavy vehicles aren’t subject to the $25,000 Sec. 179 deduction limitation. That means you can probably deduct the full business percentage of the cost on this year’s federal income tax return.

Real property improvements have traditionally been ineligible for the Sec. 179 deduction. However, an exception that started in 2010 has been made permanent for tax years beginning in 2016. Under the exception, you can claim a first-year Sec. 179 deduction of up to $500,000 (adjusted for inflation in future years) for the following qualified real property improvement costs:

    • Certain improvements to interiors of leased nonresidential buildings,
    • Certain restaurant buildings or improvements to such buildings, and
  • Certain improvements to interiors of retail buildings.

Important note: Deductions claimed for qualified real property costs count against the overall $500,000 maximum for Sec. 179 deductions.

Take Advantage of 50% First-Year Bonus Depreciation

For qualified new assets (including software) that your business places in service in calendar year 2016, you can claim 50% first-year bonus depreciation. (Used assets don’t qualify.) This break is available for the cost of new computer systems, purchased software, machinery and equipment, and office furniture.

Additionally, 50% bonus depreciation can be claimed for qualified improvement property, which means any qualified improvement to the interior portion of a nonresidential building if the improvement is placed in service after the date the building was first placed in service. However, qualified improvement costs don’t include expenditures for the enlargement of a building, any elevator or escalator, or the internal structural framework of a building.

Important note: Under the current rules, 50% bonus depreciation will also be available for qualified assets that are placed in service in 2017. In 2018 and 2019, bonus depreciation rates will fall to 40% and 30%, respectively. The bonus depreciation program is set to expire in 2020, unless Congress revives it.

Sell Qualified Small Business Corporation (QSBC) Stock

For QSBC stock that was acquired after September 27, 2010, a 100% federal gain exclusion break is potentially available when the stock is eventually sold. That equates to a 0% federal income tax rate if you sell the shares for a gain.

To qualify for this break, you must hold the shares for more than five years. In addition, this deal isn’t available to C corporations that own QSBC stock. Finally, many companies won’t meet the definition of a QSBC in the first place, and the gain exclusion break could be on the chopping block when the new Congress convenes early next year.

Consult a Tax Pro

These are just some of the tax-planning strategies available to help small business owners lower their taxes. Before implementing any of these strategies, consult your tax advisor to discuss the details and limitations, as well as other creative tax-saving alternatives. Your tax advisor is closely monitoring any tax law changes and will let you know when (and if) circumstances change.

Related Posts

Posted on Dec 1, 2016

Thanks to recent legislation, the due dates have been changed for some information returns and related statements and for some business tax returns. Here’s what you need to know.

Two Laws Are Responsible for the Changes

1. The Protecting Americans from Tax Hikes (PATH) Act.Enacted on December 18, 2015, the PATH Act extended or made permanent a number of “tax extenders” (provisions with expiration dates that had been routinely extended by Congress on a one- or two-year basis). It also contained a number of other provisions, including the changed due dates for W-2s and some 1099s.

2. The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. This new law was primarily designed as a three-month stopgap extension of the Highway Trust Fund and related measures. But it includes a number of important tax provisions, including the revised due dates for partnership and corporation tax returns. President Obama signed it into law on July 31, 2015.

Earlier Due Dates for Forms 1099-MISC and W-2

When a business pays non-employee compensation aggregating to $600 or more to a single payee in a tax year, the business must file a Form 1099-MISC to report the payments to the IRS. Similarly, employers must report wages paid to employees on Forms W-2. Copies of these forms (called payee statements) must also be supplied to payment recipients.

Before a law passed last year, Forms 1099-MISC and W-2 were required to be filed with the IRS and the Social Security Administration (SSA) by the last day of February or by March 31 if filed electronically. (See “Two Laws Are Responsible for the Changes” at right.) Now, the due dates have been accelerated.

Starting with returns for the 2016 calendar year (which must be filed in early 2017), the due date for IRS and SSA filings is advanced to January 31 of the following year. The March 31 due date for electronic filings is no longer available. So the deadline for filing 2016 Forms 1099-MISC and W-2 with the IRS and the SSA is January 31, 2017.

Note: For filing 2016 Forms 1099-MISC and W-2 with the IRS and the SSA, one 30-day extension is allowed. To obtain an extension, you must file Form 8809, “Application for Extension of Time to File Information Returns,” by no later than January 31.

The deadline to supply payee statements to recipients remains January 31 with no extensions allowed.

Reason for the New W-2 and 1099 Deadline

The goal of the new earlier deadline is to:

  • Give the IRS more time to spot errors on tax returns.
  • Make it easier for the tax agency to verify the legitimacy of returns and properly issue refunds to taxpayers eligible to receive them.

Reducing tax refund fraud has been a priority of the federal government in recent years.

Later Due Dates for 2016 Corporate Federal Income Tax Returns

For many years, C corporation federal income tax returns on Form 1120 were due two and a half months after the end of the corporation’s taxable year (March 15, adjusted for weekends and holidays, for a calendar-year corporation). Form 1120 could be automatically extended for six months (through September 15, adjusted for weekends and holidays, for a calendar-year corporation).

However, a law passed last year established new due dates for Form 1120. For tax years beginning after December 31, 2015, the due date is generally moved back one month to three and a half months after the close of the corporation’s tax year (to April 15, adjusted for weekends and holidays, for a calendar-year corporation).

Automatic five-month extensions are allowed (to September 15, adjusted for weekends and holidays, for a calendar-year corporation). You must file Form 7004, “Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns,” to obtain an automatic extension.

The Form 1120S due date for S corporations is unchanged.

Note: Under a special transition rule for C corporations with fiscal years ending on June 30, the due date change won’t kick in until tax years beginning after 2025. Until then, the traditional due date of September 15 (adjusted for weekends and holidays) for these corporations will continue to apply, with automatic seven-month extensions allowed.

Earlier Due Dates for 2016 Partnership and LLC Returns

For many years, partnership federal income tax returns on Form 1065 have been due three and a half months after the end of the partnership tax year. So for a calendar-year partnership, the filing deadline was April 15 of the following year (adjusted for weekends and holidays).

The Form 1065 due dates have also now been changed. For partnership tax years beginning after December 31, 2015, the Form 1065 due date is accelerated by one month, to two and a half months after the close of the partnership’s tax year (March 15 for calendar-year partnerships). The same deadline applies to limited liability companies (LLCs) that are treated as partnerships for federal tax purposes.

Automatic six-month extensions are allowed (to September 15, adjusted for weekends and holidays, for a calendar-year partnership or LLC). File Form 7004 to obtain an automatic extension.

Need Help with Compliance?

If you have questions about the new filing deadlines for tax returns or information returns, or you want to file an extension, contact your Cornwell Jackson tax advisor.

Related Posts

Posted on Nov 29, 2016

As we wrap up our end-of-year to-do lists, it’s time to look ahead to the New Year’s to-do list. That new list should include changes to the due date for wage (W-2) and non-employee (1099) compensation returns. Today, The Tax Warriors® explain the changes and what businesses can do to avoid the increased penalties.
As in previous years, employees and independent contractors must receive W-2 and 1099 statements by January 31st, but now so must the IRS and Social Security. E-filers no longer get the extended time to file. This means you must review, mail employees’ forms, and have your authorization back to the accountant before January 31st. This change is an IRS effort to reduce fraud. While admirable, it adds to an already busy time of the year for businesses and accountants.

What can you do now to meet this shorter deadline? Ensure you have W-9s for all contractors and vendors paid more than $600 in 2016. Then, as soon as you print that last check for 2016, print those vendor ledgers and employee year-to-date registers, or copy the check register pages and get them to your accountant ASAP.

The due dates for Form 1099 MISC still have the same due dates of February 28th to the IRS if paper filed, and March 31st if electronically filed. However, since your accountant will need the materials for independent contractors, you should consider sending all the information at once. There are only 20 working days in January 2017, so this proactive measure will save time for both you and your accountant.
The penalties for late filings and non-filing have increased. Here is a list of the new penalties, which are PER FORM so they can add up quickly:

  • Filing only 30 days late is now $50 (previously $30)
  • Filing 31 days until August 1st is now $100 (previously $50)
  • Filing with missing or incorrect TIN or filing after August 1st is now $260 (previously $100)
  • Intentional disregard of filing requirements is now $530 (previously $250)

These fines double if you do not send the form to the payee, and if it is not submitted to the IRS. The IRS is looking for all sources of revenue and the best defense is likely a good offense. So, plan now to meet the new deadlines!

Related Posts

Posted on Nov 28, 2016

advisory services, business tax, business services, tax services, CPA in Dallas

Finding skilled talent is a high priority for almost any industry you read about in the US. Employee benefits like health insurance and paid time off are mainly done to attract and retain the best employees, but there are some tax savings incentives associated with this practice. Consider the following tax savings options through employee benefits:

Qualified deferred compensation plans

These plans include pension, profit-sharing and 401(k) plans, as well as SIMPLEs. You take a tax deduction for your contributions to employees’ accounts. Certain small employers may also be eligible for a credit when setting up a plan.

Retirement plan credit

Small employers (generally those with 100 or fewer employees) that create a new retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of the first $1,000 in qualified plan startup costs. Employers must file IRS Form 8881 – Credit for Small Employer Pension Plan Startup Costs.

HSAs and FSAs

If your business provides employees with a qualified high deductible health plan (HDHP), you can offer them Health Savings Accounts to contribute dollars pre-tax for certain medical expenses. Regardless of the type of health insurance you provide, you can also offer Flexible Spending Accounts for health care. If you have employees who incur day care expenses, consider offering FSAs for child and dependent care.

Employees can also contribute to an FSA for unreimbursed business expenses such as parking. The money for HSAs and FSAs can be contributed pre-tax, helping employees reduce their taxable income for expenses they would pay for anyway. A certain amount of money from FSAs can be carried forward for non-health care related expenses.  HSAs can be a long-term investment vehicle if employees don’t need to use the funds for medical care.

HRAs

A Health Reimbursement Account reimburses an employee for medical expenses up to a maximum dollar amount. Unlike an HSA, no high deductible health plan (HDHP) is required. Unlike an FSA, any unused portion can be carried forward to the next year. But only the employer can contribute to an HRA. The employer sets the parameters for the HRA, and unused dollars remain with the employer rather than following the employee to new employment. Because the reimbursements occur pre-tax, employees and employers often save up to 50% in combined taxes on the cost of medical expenses.

Small-business health care credit

The maximum credit is 50% of group health coverage premiums paid by the employer, provided it contributes at least 50% of the total premium or of a benchmark premium. For 2016, the full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of less than $25,900 per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $51,800. To qualify, employers must generally be enrolled online in the Small Business Health Options Program (SHOP). The credit can be taken for only two years, and the years must be consecutive.

Fringe benefits

Some fringe benefits — such as employee discounts, group term-life insurance (up to $50,000 annually per person), parking (up to $255 per month), mass transit / van pooling (also up to $255 per month for 2016, because Congress has made parity permanent) and health insurance — aren’t included in employee income. Yet the employer can still receive a deduction for the portion, if any, of the benefit it pays and typically avoid payroll tax as well.

Play-or-pay penalty risk

Not all employee benefits are created equal in terms of tax advantage. The play-or-pay provision of the Affordable Care Act (ACA) does impose a penalty on “large” employers if just one full-time employee receives a premium tax credit. Premium tax credits are available to employees who enroll in a qualified health plan through a government-run Health Insurance Marketplace (e.g. exchanges) and meet certain income requirements — but only if: they don’t have access to “minimum essential coverage” from their employer, or the employer coverage offered is “unaffordable” or doesn’t provide “minimum value.” The IRS has issued detailed guidance on what these terms mean and how employers can determine whether they’re a “large” employer and, if so, whether they’re offering sufficient coverage to avoid the risk of penalties.

Review your company’s employee benefits with your tax advisor to determine which benefits may provide additional business tax savings. If you are planning to add new benefits, explore the advantages and tax implications first.

Continue Reading: Which tax credits apply to my business in 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. 

Related Posts

Posted on Nov 14, 2016

advisory services, business tax, business services, tax services, CPA in Dallas

Running a profitable business these days isn’t easy. You have to operate efficiently, market aggressively and respond swiftly to competitive and financial challenges. Even when you do all of that, taxes may drag down your bottom line more than they should.

Projecting your business’s income for this year and next can allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider:

Deferring income to next year

If your business uses the cash method of accounting, you can defer billing for products or services at year-end. If you use the accrual method, you can delay shipping products or delivering services.

Accelerating deductible expenses into the current year

If you’re a cash-basis taxpayer, you may pay business expenses by December 31 so you can deduct them this year rather than next. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid. You may also choose to take the opposite approach. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax over the two-year period.

Don’t forget about depreciation of larger assets as a way to reduce taxable income. For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases, the Modified Accelerated Cost Recovery System (MACRS) will be preferable to other methods because you’ll get larger deductions in the early years of an asset’s life. But if you made more than 40% of the year’s asset purchases in the last quarter of 2016, you could be subject to the typically less favorable midquarter convention. Careful planning can help you maximize depreciation deductions in 2017. Other depreciation-related breaks and strategies may still be available for 2016:

Section 179 expensing election

This election allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment and furniture. The expensing limit for 2015 had been $25,000 — and the break was to begin to phase out dollar-for-dollar when total asset acquisitions for the tax year exceeded $200,000 — but Congress revived the 2014 levels of $500,000 and $2 million, respectively, for 2015. These amounts are annually adjusted for inflation, with the election at $2.01 million and  $500,000 for 2016.

The new expensing election permanently includes off-the-shelf computer software as qualified property. Beginning in 2016, it adds air conditioning and heating units to the list. You can claim the election only to offset net income from a “trade or business,” not to reduce it below zero to create a loss.

The break allowing Section 179 expensing for qualified leasehold improvement, restaurant and retail-improvement property has also been made permanent. For 2015, a $250,000 limit applied, but for 2016 the full Sec. 179 expensing limit applies.

50% bonus depreciation

This additional first-year depreciation for qualified assets expired December 31, 2014, but it has now been extended through 2019. However, it will drop to 40% for 2018 and 30% for 2019. Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold improvement property. Beginning in 2016, the qualified improvement property doesn’t have to be leased.

Accelerated depreciation

The break allowing a shortened recovery period of 15 years — rather than 39 years — for qualified leasehold improvement, restaurant and retail-improvement property expired December 31, 2014. However, it has now been made permanent.

Tangible property repairs

A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Final IRS regulations released in late 2013 distinguish between repairs and improvements and include safe harbors for qualified businesses and routine maintenance. The final regulations are complex and are still being interpreted, so check with your CPA or tax services advisor on how it may apply to you.

Cost segregation study

If you’ve recently purchased or built a building or are remodeling existing business space, consider a cost segregation study. It identifies property components that can be depreciated much faster, increasing your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots and landscaping.

Hire Your Children

If your children don’t have earned income and you own a business, consider hiring them. As the business owner, you can deduct their pay. Other tax benefits may also apply. The children must be paid in line with what you would pay non-family employees for the same work.

Vehicle-related deductions

Business-related vehicle expenses can be deducted using the mileage-rate method (54 cents per mile driven in 2016) or the actual-cost method (total out-of-pocket expenses for fuel, insurance, repairs and other vehicle expenses, plus depreciation). Purchases of new or used vehicles may be eligible for Sec. 179 expensing. However, many rules and limits apply.

For autos placed in service in 2016, the first-year depreciation limit is $3,160. The amount that may be deducted under the combination of MACRS depreciation and Sec. 179 for the first year is limited under the luxury auto rules to $11,160. In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use.

NOLs

A net operating loss occurs when a C corporation’s operating expenses and other deductions for the year exceed its revenues. Generally, an NOL may be carried back two years to generate a refund. Any loss not absorbed is carried forward up to 20 years to offset income. Carrying back an NOL may provide a needed influx of cash. But you can elect to forgo the carryback if carrying the entire loss forward may be more

beneficial. This might be the case if you expect your income to increase substantially compared to the prior two years…or for tax rates to go up in future years.

Section 199 deduction

The Section 199 deduction, also called the “manufacturers’ deduction” or “domestic production activities deduction,” (DPAD) is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts. The deduction is available to traditional manufacturers and to businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing. It isn’t allowed in determining net self-employment earnings and generally can’t reduce net income below zero. But it can be used against the Alternative Minimum Tax calculation.

Not all of these deductions will apply to your particular business, but knowing about them supports better business tax planning in 2017.

Continue Reading: Which employee benefits offer 2016 tax savings?

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. 

Related Posts

Posted on Nov 7, 2016

On October 5, 2016, the IRS released new temporary and final Section 752 regulations. Sec. 752 of the Internal Revenue Code and related regulations explain how to allocate partnership debt among partners for purposes of calculating the basis of their partnership interests. This calculation determines what’s often referred to as the partners’ “outside basis” in the partnership (their basis for deducting losses and receiving tax-free distributions). In some situations, the new regulations make it more difficult for partnerships to manipulate the rules to increase the outside basis of certain partners for tax planning purposes. In most situations, however, the effects of the new regulations are neutral.

Here are the most important changes included in the new Sec. 752 regulations — and how they may affect your investments in partnerships and limited liability companies (LLCs).

Why Sec. 752 Matters

A partner’s share of partnership liabilities, as determined under the Sec. 752 rules, is added to the partner’s outside basis. That gives the partner more room to deduct partnership losses and/or receive tax-free partnership distributions.

However, a reduction in a partner’s share of partnership liabilities, as determined under the Sec. 752 rules, is treated as a deemed cash distribution that reduces the partner’s outside basis. A reduction can trigger a taxable gain to the extent the deemed distribution — along with actual cash distributions and actual distributions of certain marketable securities — exceeds the partner’s outside basis.

For these reasons, the Sec. 752 rules are important. In general, these rules apply equally to LLCs that are treated as partnerships for federal tax purposes. For simplicity, this article uses the terms 1) “partnership” to refer more generally to both partnerships and LLCs that are treated as partnerships for tax purposes, and 2) “partner” to refer more generally to the owners of those entities (partners and LLC members).

How to Define a “Payment Obligation”

IRS temporary regulations typically have the same authority as final regulations. As such, they are in force as of the specified effective date. However, temporary regulations may be amended before being reissued as final regulations, with a new effective date for any changes.

A new temporary regulation issued in October clarifies when a partner is considered to have a payment obligation with respect to a partnership recourse debt for purposes of allocating that debt among the partners under the Sec. 752 rules. (Recourse debt is debt for which the borrower is personally liable — the lender can collect what is owed beyond any collateral.)

Without having a payment obligation with respect to a recourse liability, a partner generally can’t be allocated any basis from that liability under the Sec. 752 rules. However, in some cases, a partner can be allocated basis from a recourse liability when a taxpayer related to the partner has a payment obligation with respect to that liability.

The new guidance stipulates that the determination of the extent to which a partner or related person has a payment obligation with respect to a recourse liability is based on the facts and circumstances at the time of the determination. It also lists some specific factors that should be considered.

To the extent that the obligation of a partner or related person to make a payment with respect to a partnership recourse liability is not recognized under this rule, the payment obligation is ignored for purposes of allocating that debt to that partner under the Sec. 752 rules. All statutory and contractual obligations relating to the payment obligation are considered in applying this rule.

Example 1: Payment Obligations

If a partner guarantees a partnership recourse debt, but the guarantee isn’t legally binding under applicable state law, the purported guarantee won’t be recognized as a payment obligation. Therefore, the guarantee will have no impact on how that debt was allocated to that partner under the Sec. 752 rules.

 

The new clarification of payment obligations with respect to partnership recourse debts generally applies to liabilities incurred or assumed by a partnership on or after October 5, 2016. It also applies to payment obligations imposed or undertaken with respect to a partnership liability, other than liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken pursuant to a written binding contract in effect prior to that date.

A partnership can, however, elect to apply all the new rules to all of its liabilities as of the beginning of the first taxable year of the partnership that ends on or after October 5, 2016 (calendar year 2016 for a calendar year partnership). A special transitional rule allows the impact of the new rules to be postponed for up to seven years in some situations when the new rules would be harmful to a partner.

Important note: This temporary regulation is basically neutral in its effect on partners.

How to Handle Guarantees of Recourse Debt and Exculpatory Liabilities

Another new temporary regulation creates a new term called “bottom-dollar payment obligation.” For purposes of allocating recourse liabilities among partners under the Sec. 752 rules, a bottom-dollar payment obligation isn’t recognized. That means it’s ignored for purposes of allocating the entity’s recourse liabilities under the Sec. 752 rules.

In this context, so-called exculpatory liabilities are treated as recourse debts. Exculpatory liabilities are debts that are secured by all partnership property. Therefore, they’re effectively recourse to the partnership, even though no partner is personally liable.

The new guidance also requires partnerships to disclose to the IRS all bottom-dollar payment obligations for the tax year in which the bottom-dollar payment obligation is undertaken or modified.

Important note: The new rules for bottom-dollar payment obligations are primarily aimed at LLCs treated as partnerships for tax purposes that use member guarantees of exculpatory liabilities. Guarantees of LLC exculpatory liabilities have been used “creatively” to increase the basis of certain LLC members in their membership interests (outside basis). The IRS doesn’t look kindly on these types of arrangements, and the new rules make it more difficult to use them for tax planning purposes. As such, the new rules are unfavorable to taxpayers.

Limited liability partnerships (LLPs) can also have exculpatory liabilities. But LLPs are unlikely to have bottom-dollar payment obligation arrangements, because LLPs are most often used simply to operate professional practices. In contrast, some LLCs have been used as “creative” tax-planning vehicles.

Exculpatory liabilities aren’t relevant in the context of garden-variety general or limited partnerships, because one or more of their general partners will always be personally liable for partnership recourse debts.

Example 2: Guarantee of First and Last Dollars of LLC Exculpatory Liability

Individual taxpayers A, B and C are equal members (owners) of ABC LLC, which is treated as a partnership for federal tax purposes. ABC borrows $1 million from the bank. The $1 million liability is an exculpatory liability of ABC, because all of ABC’s assets are potentially exposed to the debt, but none of the three members have any personal liability for the debt.

Member A guarantees payment of up to $300,000 of the debt if any part of the $1 million isn’t recovered by the bank. Member B guarantees payment of up to $200,000, but only if the bank otherwise recovers less than $200,000.

Member A is obligated to pay up to $300,000 if, and to the extent that, any part of the $1 million liability isn’t recovered by the bank. So, Member A’s guarantee is not a bottom-dollar payment obligation, and his or her payment obligation is recognized for Sec. 752 purposes. Therefore, Member A is allocated $300,000 of basis from the $1 million debt, because he or she has an economic risk of loss to that extent.

On the flip side, Member B is obligated to pay up to $200,000 only if, and to the extent that, the bank otherwise recovers less than $200,000 of the $1 million loan. So, Member B’s guarantee is a bottom-dollar payment obligation, which is not recognized under the new guidance, because Member B isn’t considered to bear any economic risk of loss for the $1 million liability.

In summary, the first $300,000 of ABC’s $1 million liability is allocated to Member A. The remaining $700,000 is allocated to Members A, B and C under the rules for nonrecourse liabilities, because none of ABC’s members have any personal liability for the $700,000.

The same effective date and transitional relief rules that apply to the updated definition of payment obligations with respect to recourse debts also apply to the new rules regarding bottom-dollar payment obligations.

How to Allocate Excess Nonrecourse Liabilities

Under the Sec. 752 rules, partnerships must allocate nonrecourse liabilities among the partners using a three-tiered procedure. The last tier applies to so-called excess nonrecourse liabilities, which are allocated according to the partners’ percentage shares of partnership profits.

Effective for partnership liabilities incurred or assumed on or after October 5, 2016 — subject to an exception for pre-existing binding contracts — a new final regulation stipulates that the partnership agreement can specify the partners’ percentage interests in partnership profits for purposes of allocating excess nonrecourse liabilities.

But the specified percentages must be reasonably consistent with valid allocations of some other significant item of partnership income or gain. This is often referred to as the “significant item method” of allocating excess nonrecourse liabilities.

The new regulation also allows two other alternative methods of allocating excess nonrecourse liabilities. Moreover, excess nonrecourse liabilities aren’t required to be allocated under the same method each year.

Important note: This new final regulation is basically neutral in its effect on determining the outside basis of partners.

Where to Find Additional Information

This is only a brief summary of the key changes under the new temporary and final Sec. 752 regulations. Consult your Cornwell Jackson tax professional for full details on how the new rules might affect your partnership (or LLC) and its partners (or members).

Related Posts

Posted on Nov 4, 2016

In October, the IRS issued new guidance targeting strategies that are used to exploit the tax benefits associated with partnerships and limited liability companies (LLCs) that are treated as partnerships for tax purposes. In a nutshell, under the new guidance, property transactions between partners and partnerships are more likely to be classified as disguised sales and, therefore, subject to taxes. Here’s a summary of the most important aspects of the new temporary and final regulations on disguised sales that apply to these entities.

IRS temporary regulations typically have the same authority as final regulations. As such, they are in force as of the specified effective date. However, temporary regulations may be amended before being reissued as final regulations, with a new effective date for any changes.

Contributing Appreciated Property

In general, partners who contribute appreciated property (with a fair market value that exceeds its basis) to their partnerships don’t recognize any taxable gains under federal income tax rules. But there are exceptions to this general rule.

The most common exception occurs when the partnership assumes debt that encumbers the contributed property, and the assumed debt is large enough to cause the partner’s basis in the partnership interest — his or her “outside basis” — immediately after the contribution to be negative.

In that case, a taxable gain — equal to the negative outside basis amount — is triggered. The gain increases the contributing partner’s outside basis to zero. It’s fairly uncommon for such gains to occur, because the contributing partner’s outside basis is increased by the partner’s share of all partnership liabilities, including liabilities that encumber the contributed property.

Triggering the Disguised Sale Rules

However, when the dreaded “disguised sale rules” apply, contributions of appreciated property can trigger taxable gains that contributing partners may not have anticipated. That’s mainly because the partnership’s assumption of liabilities encumbering contributed appreciated property can be treated as disguised sale proceeds.

Disguised sale gains can also be triggered when a partner contributes appreciated property and receives distributions of cash or other assets from the partnership that are deemed to be related to the property contribution. Distributions that occur within two years (before or after) of the date the property was contributed are automatically assumed to be disguised sale proceeds, unless the facts and circumstances indicate to the contrary.

From a tax perspective, the disguised sale rules are bad news for partners that contribute appreciated property to their partnerships. So, it’s important to understand these rules and avoid triggering them whenever possible. But planning around the disguised sale rules has been made more difficult thanks to final and temporary IRS regulations that were issued in October.

Important note. The disguised sale rules, including the new regulations, apply equally to LLCs that are treated as partnerships for federal tax purposes. For simplicity, this article uses the terms 1) “partnership” to refer more generally to both partnerships and LLCs that are treated as partnerships for tax purposes, and 2) “partner” to refer more generally to the owners of those entities (partners and LLC members).

Identifying Exceptions to the Disguised Sale Rules

Fortunately, partners can avoid the disguised sale rules with certain favorable exceptions that have been updated under the new IRS guidance, including:

Exception for reimbursements of preformation expenditures. Certain reimbursements by a partnership to a contributing partner for capital expenditures related to contributed property that were incurred before the contribution — so-called preformation expenditures — aren’t included in disguised sale proceeds. In other words, such reimbursements can’t trigger or increase a disguised sale gain.

The new final regulations include several taxpayer-friendly changes to the preformation expenditure exception that are effective for transfers that occur on or after October 5, 2016.

Exception for qualified liabilities. For years, IRS regulations have provided special rules for the treatment of liabilities incurred or transferred in connection with certain contributions of property to partnerships. These rules were designed to trigger taxable disguised sale gains in certain circumstances, including situations where a partner encumbers a property with debt in anticipation of contributing the property to a partnership.

The treatment of liabilities under the disguised sale rules hinges on whether they’re qualified liabilities. A qualified liability that the partnership assumes (or takes property subject to) is treated as consideration for disguised sale purposes only if the property contribution would have been treated as a disguised sale without considering the qualified liability — in other words, when the contributing partner is deemed to receive other consideration, such as cash, in exchange for the property contribution.

On the other hand, liabilities that are not qualified liabilities are always treated as consideration in determining if a property contribution and a liability assumption together constitute a disguised sale. Therefore, nonqualified liabilities that encumber appreciated property and that are assumed by a partnership can easily trigger disguised sale gains.

Distinguishing between Qualified and Nonqualified Liabilities

According to the final regulations, qualified liabilities include the following:

  1. Debt incurred more than two years before the property contribution.
  2. Debt incurred less than two years before the property contribution but not incurred in anticipation of the contribution.
  3. A liability the proceeds of which can be traced to capital expenditures made in connection with the contributed property (such as acquisition or improvement costs).
  4. A liability that was incurred in the ordinary course of the business in which property transferred to the partnership was used or held (such as trade payables), but only if all the assets related to that business are transferred (other than assets that aren’t material to the continuation of the business).
  5. For transactions where all transfers occur on or after October 5, 2016, a liability that wasn’t incurred in anticipation of the transfer of the property to a partnership, but that was incurred in connection with a trade or business in which property transferred to the partnership was used or held but only if all the assets related to that trade or business are transferred other than assets that are not material to a continuation of the trade or business.

Debts (other than acquisition debt, improvement debt and trade payables) incurred within two years of the property contribution are presumed to have been incurred in anticipation of the property contribution unless the facts and circumstances clearly indicate otherwise.

If property subject to liabilities that aren’t qualified liabilities is contributed to a partnership, the liabilities are treated as disguised sale consideration to the extent that the contributing partner is relieved of the liability.

Here’s an example of how the disguised sale rules can work under the final regulations, which apply to transactions for which all transfers occur on or after October 5, 2016.

Example 1: Partnership’s Assumption of Nonrecourse Liability Encumbering Transferred Property

Partners A and B form the AB Partnership (a 50/50 deal) to rent office space. Partner A transfers $500,000 in cash to the partnership. Partner B transfers an office building with a fair market value (FMV) of $1 million and an adjusted basis of $400,000.

The office is also encumbered by a $500,000 nonrecourse liability that the partnership assumes. Partner B incurred the liability 12 months earlier to finance the acquisition of other property. No facts rebut the presumption that the liability was incurred in anticipation of transferring the property to the partnership. The partnership agreement provides that all partnership items are allocated equally between Partners A and B.

The $500,000 nonrecourse liability isn’t a qualified liability. Under IRS regulations, Partner B must be allocated 50% of the liability ($250,000) for disguised sale purposes.

Therefore, the partnership’s assumption of the liability is treated as a transfer of $250,000 of disguised sale consideration to Partner B. That’s the amount by which the $500,000 liability exceeds Partner B’s $250,000 share of the liability under the disguised sale rules immediately after the partnership’s assumption of the liability.

In summary, Partner B is treated as having sold $250,000 of the FMV of the office building to the partnership in exchange for the partnership’s assumption of a $250,000 liability. Therefore, Partner B must recognize a disguised sale gain of $150,000. The gain is calculated by taking $250,000 of disguised sale proceeds and subtracting the basis of $100,000 for the part of the property that is deemed to be sold in the disguised sale ($250,000/$1,000,000 x $400,000).

Partner A is unaffected by the disguised sale rules.

Discouraging Contributions of Leveraged Assets to Partnerships and LLCs

For disguised sale purposes only, a new temporary IRS regulation forces partnerships to determine a partner’s percentage share of any liabilities assumed by a partnership when encumbered property is contributed to the partnership — whether the liability is recourse or nonrecourse and whether it’s guaranteed by the contributing partner — using the contributing partner’s percentage share of partnership profits. A partner’s percentage shares of partnership profits must be determined based on all facts and circumstances at the time of the property contribution.

Important note: The new rule can result in adverse tax consequences for taxpayers that contribute leveraged assets to partnerships, as illustrated by the following example.

Example 2: Partnership’s Assumption of Recourse Liability Encumbering Transferred Property

Partner C transfers Property Y to a partnership in which Partner C has a 50% interest in partnership profits. Property Y has a FMV of $10 million, and it’s subject to an $8 million liability that Partner C incurred and guaranteed immediately before transferring the property. Partner C used the $8 million of debt proceeds to finance other expenditures unrelated to the partnership.

Upon the transfer of the property, the partnership assumed the $8 million liability, which is a recourse debt. Under federal tax law, the entire $8 million liability is allocated to Partner C for purposes of determining his basis in his partnership interest (outside basis), because he guaranteed the debt.

Under the facts in this example, however, the $8 million liability is not a qualified liability for disguised sale purposes. Therefore, the partnership’s assumption of the liability results in a deemed transfer of consideration to Partner C in connection with his transfer of Property Y to the partnership. Even though Partner C is allocated the entire amount of the $8 million liability for outside basis purposes, he’s allocated only 50% of the liability ($4 million) for disguised sale purposes. This is pursuant to the rule stating that his share of the liability for disguised sale purposes equals his 50% interest in partnership profits.

In summary, Partner C is deemed to receive disguised sale proceeds of $4 million upon transferring Property Y to the partnership. That amount equals the excess of the $8 million liability assumed by the partnership over Partner C’s share of the liability for disguised sale purposes ($4 million). This is the outcome even though Partner C remains personally liable for the entire $8 million liability because he guaranteed it.

This example illustrates only one of many unfavorable changes included in the new temporary IRS regulation. Be especially cautious when contributing leveraged assets to partnerships for any transfers that occur on or after January 2, 2017. The tax results under the disguised sale rules can be surprisingly unfavorable.

Finding Additional Information

This is only a brief summary of the new temporary and final disguised sale regulations. Consult your tax professional for full details on how the new rules might affect your partnership (or LLC) and its partners (or members).

Related Posts

Posted on Sep 23, 2016

Employee Cell Phone Use

It’s hard to imagine life without cell phones.

These devices have become essential for just about everyone, and in particular many businesses, whose employees are often required to use one.

But in the cases of companies, there are tax ramifications that depend on whether the firm or the employee owns the phone. Strict substantiation requirements have been removed, so it’s easier for employer-provided cell phones to qualify for tax-free treatment. Otherwise, your firm’s payroll professionals will report amounts as taxable income to employees.

In some cases, employees occasionally will use a personal cell phone for business purposes, mainly for their convenience. There’s nothing wrong with that, but this article is devoted to times when employees are required to use cell phones for their jobs. (Employees paying their own costs may be eligible for miscellaneous expense deductions on their personal tax returns.)

2 Ways to Go

Assuming that cell phone use is part and parcel of the job, the starting point is to decide who owns the phones, employer or employee. Generally there are advantages to your company to furnishing cell phones for business use. It helps to keep a lid on costs, protect confidential information and it offers legal advantages. But this route may still be full of problems. With that in mind, here are the two most common ways to approach the issue:

1. Employer-owned cell phones. You call the shots on the plan being used. In other words, you pay only what you think the company needs based on the job. This includes voice, text and data services. Typically, but not always, business rates are lower than those for personal cell phone plans.

What’s more, you will own the phone numbers, so you are less likely to miss important calls if an employee leaves the company.

Also, remember that you are often responsible for client data. This is a critical legal issue. By owning the cell phones, you can set passwords and use applications for greater protection. Conversely, if employees own their cell phones, it’s more likely that problems will occur, especially when they control decisions on carriers and services.

Finally, if you purchase phones for employees, tech support will be simplified. It’s recommended that you use a single platform for a small-to-midsized business. This will further improve security and reduce exposure to outside hackers.

2. Employee-owned cell phones. Despite the advantages outlined above, owning cell phones is not always a slam-dunk for employers. Consider the following:

  • Cost. Employee-owned phones may be less costly for employers, particularly if the employee has a family plan, or a spouse’s employer covers the entire cost. When analyzing the costs, be sure to take all the relevant factors into account.
  • Personal use. Face it — the phones belong to the employees and they will be using them for personal reasons. If you’re uncomfortable with that, you might choose to reimburse employees for business use. Besides, do you really expect employees to carry two phones?
  • Data use. Personal use may push employees over the allotment. That means a line-by-line examination of the bills will be necessary.
  • Deactivation. If a departing employee refuses to give up a company-provided phone, you’ll have to take steps to deactivate it and re-route the number to another person. This hassle won’t exist with employee-owned phones.
    Usually, employers reimburse employees for substantiated business use, but not for personal use. As an alternative, you could use another form of reimbursement, such as a flat monthly amount of $50 or $100. If an employee doesn’t have a cell phone and can’t afford to buy one, you could arrange to pay for the phone initially and have the employee take over the payments at a later time.

Tax Consequences of Reimbursements

The Small Business Jobs Act made it easier to qualify for tax-free treatment. The IRS explained the basic guidelines in Notice IR-2011-93. As long as certain requirements are met, the value of employer-provided cell phones or reimbursements may be treated as a “working condition fringe benefit.”

But this tax break isn’t automatic. To qualify, the cell phones must be provided to employees for “noncompensatory business reasons.” In other words, there must a bona fide business purpose. The tax exclusion is extended to employer-paid cell phone plans.

The IRS provides three common examples of noncompensatory business reasons.

1. The employer must be able to contact the employee at all times for work-related emergencies,

2. The employer requires the employee to be available to speak with clients or customers at all times when away from the office, or

3. Employees must speak with clients located in other time zones at times outside the regular work time.
If the employer reimburses employees with personal cell phones for business use, it can count as a noncompensatory business reason. However, the amounts must be limited to the cell phone charges. Any excess should be returned to the employer or it will be treated as taxable compensation. Rely on your payroll providers to determine the taxable value.

Also, the value of personal use of an employer-provided cell phone used primarily for noncompensatory business reasons is a tax-free de minimis fringe benefit, provided such use is minimal.

In a memorandum to examiners, the IRS outlined an administrative approach for small businesses that provide cash allowances and reimbursements. Employers that require employees to use personal cell phones primarily for noncompensatory business reasons may treat reimbursements as being tax-free.

If there isn’t a noncompensatory business reason for cell phone use, the value is reported to the IRS as taxable income. Employees may owe tax, which is relatively small, but otherwise they get the phone for free. You may want to set up this arrangement when you want to:

  • Boost morale among employees,
  • Encourage new-hires,
  • Add to the compensation of employees, or
  • Reimburse or pay international coverage for a service technician with only local clients or customers.

IRS examiners have been instructed to ferret out reimbursement arrangements that appear out of the norm. For example, reimbursements that are substantially back-loaded to the end of the year could be disguised compensation. Consult with your Cornwell Jackson payroll provider to determine which route your company should take to avoid any problems.

Related Posts

Posted on Sep 19, 2016

Hand writing the text: IRS Scam

In a new alert, the IRS warned taxpayers to be on guard against bogus emails telling recipients that they owe money for taxes related to the Affordable Care Act (ACA). The IRS has received numerous reports from around the country about scammers sending a fraudulent version of CP2000 notices for tax year 2015. The scam usually includes a fake CP2000 as an attachment to the email.

What Is a CP2000?

A CP2000 notice is mailed by the IRS to a taxpayer if income reported from third-party sources (such as an employer) doesn’t match the income reported on the person’s tax return. It is sent through the United States Postal Service and is never sent as an email.

Importantly, a CP2000 notice isn’t a bill. It informs a taxpayer about an issue and how it affects an individual’s tax situation. The notice contains instructions on what a taxpayer should do if he or she disagrees with the information. It also requests that a check be made out to “United States Treasury” if the taxpayer agrees additional tax is owed. Or, if an individual is unable to pay, the notice provides instructions for payment options, such as installment payments.

What Does the Fake CP2000 Notice Email Say?

Here are some other aspects of the fake emailed CP2000s:

  • The fraudulent CP2000 notice included a payment request that taxpayers mail a check made out to “I.R.S.” to the “Austin Processing Center” at a Post Office Box address. This is in addition to a “payment” link within the email itself.
  • They appear to be issued from an Austin, Texas, address.
  • The underreported issue is said to be related to the ACA requesting information regarding 2014 coverage.
  • The payment voucher lists the letter number as 105C.

Scams Take Many Forms

This scam is just the latest in a long series of IRS impersonation schemes. They can involve threatening telephone calls, phishing emails and demanding letters. If you receive this scam email (or others), you should forward it to phishing@irs.gov and then delete it from your email account.

You should beware of any unsolicited emails, phone calls and other communications purported to be from the IRS or any unknown source. Never open an attachment or click on an email link sent by sources you don’t know. Contact the tax team at Cornwell Jackson if you have questions.

Related Posts