“complete guide to tax cuts and jobs act”

ldquoComplete Guide toTax Cuts and Jobs Actrdquo

Tax Educatorsrsquo Network Inc

Prof John J Connors JD CPA LLM

Tax Educatorsrsquo Network (TEN) Inc

12403 North Hawks Glen Court

Mequon WI 53097-2140

TaxesProfmsncom


As an accounting graduate of La Salle University in Philadelphia ProfConnors went on for his law degree at the University of Notre Damegraduating in 1980 After serving as an instructor in the School of BusinessAdministration he obtained his Masters of Law in Taxation at the Universityof Miami Law School in Coral Gables Florida He then served on the graduatetax faculty at the University of Wisconsinrsquos School of Business in MilwaukeeWI

His professional background includes experience in income and estate taxplanning as well as individual partnership and corporate tax returnpreparation and research as a senior tax consultant for Price Waterhouse inthe Philadelphia and South Bend offices Prof Connors also worked onexpatriate and corporate tax matters as an international tax consultant for theChrysler Corporation in London England

Prof Connors currently conducts a national consulting practice designedespecially for tax professionals based out of Milwaukee WI He also publishesa tax newsletter devoted exclusively to practitioners entitled the Monthly TaxUpdate He has been the outside editor for CCHrsquos Federal Tax Course andhas spoken at numerous tax institutes workshops and conferences aroundthe country And his ldquoComplete Guide to Depreciation Amortization ampTransfers of Property - Issues Strategies amp Answersrdquo is sold to taxpractitioners throughout the US along with a brand new publication entitledldquoLLCs Taxed as Partnershipsrdquo

As a nationally known speaker on a variety of tax topics Prof Connors hasconsistently earned average overall ratings in excess of 47 (ie on a 50scale) for his knowledge and presentation skills as well as the quality of hismaterials He was chosen as a Distinguished Discussion Leader for the NewYork Society of CPAs Foundation for Accounting Education And in 2013 hereceived the AICPA prestigious Sidney Kess Award for ldquoExcellence inContinuing Educationrdquo

copy Tax Educatorrsquos Network (TEN) Inc - 2018


Table of Contents

Introduction 1LTax Policy Center Estimate of TCJA Effect 2LJCT ldquoBlue Bookrdquo on TCJA Might Not Be Available Until Yearend 2LCBO Report Provides Optimistic Outlook Due to TCJA (The Budget and Economic Outlook

2018-2028) 2LTIGTA Audit Evaluates IRS Handling of New Tax Cuts and Jobs Act (Audit Report No 2018-44-

027) 2LCBO States Recent Tax Cuts Will Cause Budget Deficit to Sharply Increase (Budget and

Economic Outlook 2018 to 2028) 3LConsolidated Appropriations Act Contains Technical Corrections to TCJA (PL 115-141) 3LIRS Outlines Initial Plan for Guidance on Implementing New Tax Act Provisions (Department

of the Treasury 2017-2018 Priority Guidance Plan (Feb 7 2018)) 4LIRS Releases Second Quarter Update to 2017-2018 Priority Guidance Plan 5LIRS Dedicates Special Website to Updates on New Tax Cuts and Jobs Act (e-News for Tax

Professionals 2018-6) 5LVarious State Approaches to Conformity with TCJA 5

Business Tax Provisions 621 Flat C Corporation Tax Rate 6LAlternatives for Handling C Corp Profits 7LImpact of Blended Rates for Fiscal Year C Corporations 8LPossible Windfall in Corporate Tax Revenues for States 921 Rate Also Available for PSCs 1021 C Corp Rate v 37 for S Corp Owners and Partners 10LC Corp Electing S Status Allowed Built-In Loss for Bonuses Pegged Against Cash Basis

Receivables (PLR 200925005) 11100 Bonus Depreciation 12LTechnical Correction Needed for ldquoQualified Improvement Propertyrdquo 14Increased Sec 179 Immediate Expensing Election 15LIRS Fact Sheet Highlights New Rules amp Limits for Depreciation and Expensing under TCJA (FS-

2018-9) 18LCRS Report Analyzes Impact of Sec 179 and Bonus Depreciation on Asset Acquisitions (CRS

Report RL31852) 2025-Year Classlife for Real Estate Rejected 21Recovery Period for Other Types of Real Property 21Luxury Car Caps Dramatically Increased 23LIRS Releases 2018 Vehicle Depreciation Limits (Rev Proc 2018-25) 24LDepreciation Limits Increased for Purposes of Computing FAVR Plan Allowance (Notice 2018-

42) 24MACRS 5-Year Recovery Period and 200 DB for Certain Farm Property 24Listed Property Substantiation Rules Dropped for Computers amp Peripheral Equipment 26Corporate Alternative Minimum Tax Repealed 26Like-Kind Exchanges Now Only Available for Real Estate 26

-i-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

Carried Interest Holding Period Extended to 3 Years 28LNew Carried Interest Rule Not Avoided by Having S Corporation Hold Interest (Notice 2018-18)

29Restricted Stock Now Ineligible for Sec 83(b) Elections 29Transportation amp On-Premise Gym Fringe Benefits Curtailed 29LIRS Releases Updated Version of Publication 15-B 30Entertainment and Meal Expenses Curtailed 30LTax Deduction Status for Various Types of Business Meals Under the New Tax Act 32Employer-Provided Housing 36Treatment of Certain Self-Created Property 36Non-Owner Capital Contributions 37Rollover of Publicly Traded Securities Gain 37Tax Incentives for Investment in Qualified Opportunity Zones 38LldquoOpportunity Zonesrdquo Might Provide Significant Tax Savings Under TCJA 39L Treasury amp IRS Announce Designated TCJA Opportunity Zones (Treasury Press Release

Treasury IRS Announce First Round Of Opportunity Zones Designations for 18 States) 39

Transfers of Patents 40Nonqualified Deferred Compensation 40Employee Achievement Awards 40Length of Service Award Programs for Public Safety Volunteers 41

Accounting Method Changes 41Taxable Year of Inclusion 41

Other Small Business Accounting Method Reforms 42Cash Method of Accounting 42Cash Method and Farms 43Businesses with Inventories 43Uniform Capitalization Rules 44Accounting for Long-Term Contracts 44

Capitalization Rules 45Costs of Replanting Citrus Plants Lost Due to Casualty 45

Deductions amp Exclusions 45Limits on Interest Expense Deduction 45LElecting Real Property Trades and Businesses Not Subject to Limitation on Deduction of

Business Interest 47LIRS Offers Guidance on New Business Interest Expense Limitations (IR 2018-82) 48Ordinary REIT Dividends Reduced by Sec 199A Deduction 52Modification of Net Operating Loss Deduction 52LTechnical Correction Needed for Effective Date of NOL Change 53Dividend Received Deduction 53Sec 199 QPAD Deduction 54Deduction of FDIC Premiums 54Research and Development Costs 54Limitation on Excessive Employee Compensation 55Litigation Costs Advanced by Attorneys in Contingency Cases 56LIRS Issues Transitional Guidance on Nondeductible Fines and Penalties (Notice 2018-23)

-ii-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

57No Deduction for Amounts Paid For Sexual Harassment Subject to Non-Disclosure Agreement

57Local Lobbying Expenses 57New Deferral Election for Qualified Equity Grants 57

Business Tax Credits 59Certain Unused Business Credits 59New Credit for Employer-Paid Family and Medical Leave 59LGuidance Provided on New Employer-paid Family and Medical Leave Credit (FAQs) 60Employer Tip Credit 61Employer-Provided Child Care Credit 61Rehabilitation Credit 61Work Opportunity Tax Credit 62New Market Tax Credit 62Disabled Access Credit 62Residential Energy Efficient Property Credit 62Orphan Drug Credit Modified 63

Partnership Tax Provisions 63Technical Terminations of Partnerships 63ldquoLook-Through Rulerdquo Applied to Gain on Sale of Partnership Interest 63Partnership ldquoSubstantial Built-In Lossrdquo Modified 64Charitable Contributions amp Foreign Taxes in Partnerrsquos Share Of Loss 65

S Corporation Tax Provisions 66Revocations of S Corp Elections 66LTechnical Correction Needed Re Revocation of S Corp Election 67LTax Professionals Asking for 6-Month Extension to Make 2018 S Corp Elections 67Qualifying Beneficiaries of an ESBT 68

New 20 Deduction for K-1 and Proprietorship Profits and Net Rental Income 68Various Approaches Congress Took w Sec 199A DeductionSpecial Tax Rate 69LJCT Estimates Distributional Effect of Sec 199A Deduction 69Highlights of New Sec 199A 20 Deduction of ldquoQualified Business Incomerdquo 69Final Sec 199A 20 Deduction Includes Net Rental Income As Well 71IRS Guidance Desperately Needed 72Sec 199A Deduction Cannot Exceed Taxable Income Without Net Capital Gain 72Taxpayers Receiving QBI From Fiscal Year Businesses 73Passive v Nonpassive K-1 Investors amp Rental Property Owners 73Sec 199A Deduction Not Allowed Against Gross or Adjusted Gross Income 75Sec 199A Deduction Not Allowed in Computing Self-Employment Tax 75Definition of Qualified Business Income 75Qualified Business Income Does Not Include Wages Paid to S Corp OwnerEmployee or

Guaranteed Payments Made to Partners 76Location of Qualified Business for Purposes of Sec 199A Deduction 76ldquoSpecified Service Businessrdquo Defined 76LSplitting Off of S Corporationrsquos Separate Businesses Qualified as Divisive Re-Org (PLR

201402002) 79LOnce Again Divisive D Re-Org Solves Problem of Family Disharmony (PLR 201411012)

-iii-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

7920 Deduction for K-1 Income and Net Profit from Proprietorships 81LCritical Steps to Implementing Sec 199A Deduction 81Critical 1st Step - Determine Projected Taxable Income for 2018 83Calculating Sec 199A 20 Deduction Where Taxable Income Thresholds Not Exceeded 83Critical 2nd Step - Determine Limited 20 Deduction If Projected Taxable Income Falls Within

Phaseout Range ($157500 to $207500 for Unmarried Taxpayers and $315000 to$415000 for MFJ) 85

Taxpayer Planning Steps to Keeping Taxable Income Before Sec 199A DeductionBelowThresholds 86

50 or 20 Wage Limitations 8625 Investment in Capital Limitation 89Dispositions of Sec 1231 Assets and 25 Capital Formula 91Do Sec 754 or Sec 338(h)(10) Elections Create ldquoUnadjusted Basisrdquo for Purposes of the 25

Capital Formula Limitation 91Impact of Purchase Price Allocations under Code Sec 1060 92Critical 3rd Step - Determine ldquoSpecified Service Businessrdquo Status If Taxable Income Exceeds End

of Taxable Income Phaseout Range of $207500 or $415000 94Critical 4th Step - Determine If 20 Sec 199A Deduction Exceeds 20 of Overall Taxable

Income Before Deduction Less Any Net Capital Gain (Defined as Excess If Any of LTCGover STCL) 97

LDoes Tax Benefit of Sec 199A Deduction Offset Additional Payroll Taxes Due If Wages AreIncreased for Purposes of 5025 ldquoWage Limitationsrdquo 98

Calculating QBI with Multiple Businesses 100Calculation of Sec 199A Deduction with Negative QBI 100Businesses Owned by Estates or Trusts 103Other Special Limitations for Sec 199A Deduction 103Lower Threshold for Imposition of IRS Penalty 103Specified Agricultural or Horticultural Cooperatives 104LRecent Budget Bill Includes Fix to Code Sec 199As Treatment of Sales to Cooperatives

104LTax Professionals Asking for 6-Month Extension to Make 2018 S Corp Elections 105

Individual Tax Calculations 105Tax Rates and Brackets 105LIRS to Issue New Form 1040-SR for 2019 108LIRS Issues 2018 Version of Employers Tax Guide (IRS Pub 15 Circular E) 108LIRS Issues Guidance on Withholding Rules (Notice 2018-14) 109LIRS Releases Updated 2018 Withholding Tables (IR 2018-5) 110LIRS Releases Updated Withholding Calculator and New Form W-4 (IR 2018-36) 110Capital Gains amp Dividends Preferential Rates Retained 111Standard Deductions Dramatically Increased 112Personal and Dependency Exemptions 114Phase-Out of Personal and Dependency Exemptions 115Kiddie Tax 115Alternative Minimum Tax 117AMT Exemption Amounts Increased 117AMT Exemption for Child Subject to Kiddie Tax 118AMT Exemption Phaseout Increased 118LTechnical Correction Needed for AMT Exemption Amount and Phaseout for Trusts and Estates

-iv-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

118AMT Tax Rates - 26 v 28 118Treatment of AMT Carryforwards 119

Individual Deductions 119Miscellaneous Itemized Deductions 119Phase-Out of Itemized Deductions 121Mortgage Interest Deduction 121LIRS Clarifies Interest on Home Equity Loans Often Still Deductible (IR 2018-32) 124State and Local Tax Deduction 128LImpact of $10000 SALT Deduction on Form 8960 Calculation of NII 129LNonresident State Income Tax on Law Partners K-1 Income Not Deductible on Schedule E

(Cutler TC Memo 2015-73 (492015)) 129LRecent Developments Regarding Various State Workarounds Challenges to SALT Deduction

Limitation 130LIRS to Propose Regulations on State and Local Tax Deduction (Notice 2018-54) 131Medical Expenses 131Medical Savings Accounts 132Charitable Contribution of Cash Now Allowed Up to 60 of AGI 132LTechnical Correction Needed for Cash Contributions Subject to New 60 AGI Limitation

133Personal Casualty Loss Deduction 134LIRS Offers New Safe Harbors for Calculating Personal Casualty Losses (Rev Proc 2018-08)

134Gambling Losses 134Alimony Deduction Eliminated After 2018 135Moving Expense Deductions 135Net Operating Losses 136Changes to ABLE Accounts 137Deduction for Living Expenses of Members of Congress Eliminated 138Deduction For Amounts Paid For College Athletic Seating Rights 139

Individual Credits and Exclusions 139Increased Child Tax Credit 139Dependent Care Assistance and Child Care Expenses 141Adoption Credit 141LAdoption Credit and Exclusion Amounts Set for 2018 (Rev Proc 2018-18) 141Credit for Plug-In Electric Vehicles 142Credit For The Elderly amp Permanent Disabled 142Moving Expenses and Reimbursements 142Qualified Bicycle Commuting Reimbursements 143Repeal of Exclusion for Advance Refunding Bonds 143Exlusion of Gain from Sale of Principal Residence Left Unchanged 144

Educational Tax Breaks for Individuals 144Education Tax Incentives 145Educational Savings Account 145Section 529 Plan Distributions 145Qualified Tuition Program (QTP) Distributions for Apprenticeships 145Treatment of Discharged Student Loan Indebtedness 146

-v-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

Educatorrsquos Deduction 146Qualified School Construction Bonds 146Student Loan Interest 146Tuition and Fees Deduction 147Exclusion for Savings Bond Interest 147Tuition Waivers 147Employer-Provided Education Assistance 147

Individual Health Insurance Mandate 147Individual Health Insurance Penalty Eliminated 148

Retirement Plans 148Qualified Retirement Plans 148L2018 Retirement Plan Limits Not Affected by New Tax Act (IR 2018-19) 148Roth IRA Recharacterization Rule Repealed 148LIRS Clarifies Effective Date of New Roth Conversion Recharacterization Prohibition 150Reduction in Minimum Age for Allowable In-Service Distributions 150Modified Rules on Hardship Distributions 150Extended Rollover Period for the Rollover of Plan Loan Offset Amounts in Certain Cases

150

Estate and Generation-Skipping Transfer Taxes 151Doubling of Unified Credit Equivalent 151

Income Tax Rates for Trusts and Estates 152

Tax-Exempt Entities 152Unrelated Business Taxable Income 152Streamlined Excise Tax on Private Foundation Income 153Excise Tax on Private Colleges and Universities 153Excise Tax on Excess Tax-Exempt Organization Executive Compensation 154Johnson Amendment Restricted 154New Reporting for Donor Advised Funds 155

IRS Practice and Procedural Changes 155Time To Contest IRS Levy Extended 155LTaxpayers Now Given More Time to Contest Erroneous IRS Levies 155Due Diligence Requirements for Claiming Head of Household 155

Foreign Tax Provisions 156Deduction for Foreign-Source Portion of Dividends 156Taxation of Foreign Profits 156Taxation of Payments Made to Foreign Businesses Operation in US 157Repatriation of Foreign Earnings 157LIRS Issues Guidance on New Deemed Repatriation Tax (Notice 2018-7) 157LIRS Provides Additional FAQ Guidance on Deemed Repatriation Tax 157LIRS Issues Additional Guidance on New Deemed Repatriation Tax (Notice 2018-13) 158LIRS Outlines Regs to Be Issued on ldquoDeemed Repatriation Transition Taxrdquo (IR 2018-79)

158

-vi-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

Possibility of 100+ Marginal Rate within Certain Phaseout Ranges 159

Case Study 1 - MFJ w $350000 Rental K-1 amp Schedule C Income 160

Impact of House Ways amp MeansTax Reform Proposals 11-2-17Using Client 2016 Tax Return 160

Impact of Senate Finance CommitteeTax Reform Proposals 12-1-17Using Client 2016 Tax Return 161

Impact of Revised Senate VersionTax Reform Proposals 12-2-17Using Client 2016 Tax Return 162

Impact of Congressional ConfereesFinal Tax Reform Proposals 12-15-17Using Client 2016 Tax Return 164

AMT Calculation Under FinalConference Bill 165

Case Study 2 - MFJ w $70000 W-2 Income and Three Dependents(Tax savings = 1640) 166


Case Study 4 - MFJ w $700000 W-2 Income and $500000 DividendsLTCGs(Tax savings = 30865) 168

Case Study 5 - MFJ w $1200000 W-2 Income and No DividendsLTCG(Tax savings = 5380) 170

Case Study 6 - MFJ w $700000 W-2 Income and $500000 AMT Adjustment(Tax savings = 22306) 172

-vii-copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

Summary of Tax Reform Proposals

Introduction In most cases the changes listed below would be effective for tax years beginning after2017 However a few of them will potentially impact 2017 tax returns for certain clients The TCJA makessignificant revisions to almost every area including changes affecting individuals real estate pensionand employee benefits insurance companies tax-exempt bonds exempt organizations and foreignincome and foreign persons And these changes would radically alter the taxation of all businesses Asa result clients should begin to evaluate how these changes will affect both their business and individualtax situations The choice-of-entity question will especially be a key component of their future taxplanning1

One of the major distinctions between the House and Senate bills was that the latter version providesfor a ldquosunsetrdquo of the most of the individual provisions after 2025 Of course Congress could certainly actin the interim to extend these provisions (or maybe drastically change the tax law yet again) On theother hand most of the business changes are permanent in nature

Because the new Tax Act was rushed through Congress without the needed debate or hearings thereare numerous provisions where we need significant clarification or maybe even some technicalcorrections But as to a technical corrections bill this new law would need the usual 60 votes in theSenate to pass If so it might be even harder to get needed changes made to the Tax Cuts and JobsAct2 As a result it is much more likely that the Treasury and the IRS will have to come out with thenecessary regulations and rulings to give us the guidance vital to the implementation of these newprovisions

Comment There were several tax provisions that expired at the end of 2016 as follows (1) PMIas additional mortgage interest (2) 10 residential energy credit (3) $20004000 tuition and feesdeduction and (4) $2 million COD exception for forgiven mortgage indebtedness on a principalresidence At this point it seems unlikely that these tax breaks will be resurrected in time for theupcoming tax return busy season

Comment Although the Congress was locked into the requirement that the new tax law not costmore than a projected $15 trillion over the next 10 years the Joint Committee on Taxation (JCT)on Dec 22 published a document titled Macroeconomic Analysis of the ConferenceAgreement for HR 1 the Tax Cuts and Jobs Act (JCX-69-17) which projected that there willonly be a net revenue loss of $107 trillion during that time frame On the other hand theCongressional Budget Office (CBO) and the Joint Committee on Taxation have determined thatprovisions in the new Tax Act would increase deficits over the 2018-2027 period by $15 trillion(not including any macroeconomic effects) in a recent letter to Sen Ron Wyden (D-OR) rankingmember of the Senate Finance Committee estimated additional debt service would increase thedeficit by $18 trillion over the 10-year period As a result of those higher deficits debt held by thepublic would increase from the 912 of gross domestic product in CBOs June 2017 baseline to

1 The final Conference bill is 1097 pages long and contains all of the details with regard to the provisions

summarized below and can be found at httpdocshousegovbillsthisweek20171218CRPT-115HRPT-466pdfThe language was finalized late Thursday night (1214) and GOP leaders had to make 100 sure they had the votesbecause after noon Friday (1215) there could no longer be any changes Furthermore the Joint Committee onTaxation estimates the bill will lower federal revenue by $1456 trillion over 10 years mdash a key finding as the bill couldnot add more than $15 trillion in debt and qualify for special Senate reconciliation rules

2 Another source of information on the Tax Cuts and Jobs Act is JOINT EXPLANATORY STATEMENT OF

THE COMMITTEE OF CONFERENCE

1copyTax Educatorsrsquo Network Inc - 2018 Current as of 6142018

975

LTax Policy Center Estimate of TCJA Effect The Tax Policy Center issue a report which concluded that

- 80 of taxpayers will receive a tax cut- 15 will see no change- 5 will see a tax increase- ldquoMiddle-class taxpayersrdquo will see an average tax savings of $930- Top 1 will supposedly save an average of $51140

LJCT ldquoBlue Bookrdquo on TCJA Might Not Be Available Until Yearend Tax professionals are eagerly awaiting a legislative publication explaining the new tax law Namely theso-called ldquoblue bookrdquo is published by the Joint Committee on Taxation a nonpartisan staff ofcongressional aides who work with Senate and House tax writers It comes out every two years and alsogenerally when key tax legislation is enacted Tax practitioners were hoping to see the blue book onTCJA law by summer but it now looks as if this publication will not be released until close to year-end (TCJA Blue Book)

LCBO Report Provides Optimistic Outlook Due to TCJA (The Budget and Economic Outlook2018-2028) The Tax Cuts and Jobs Act (TCJA) changes the incentives of businesses and individuals with a net result that thosechanges are expected to encourage saving investment and work according to a recent blog post on theCongressional Budget Offices (CBO) website CBO projects that the acts effects on the US economy over the2018-2028 period will include higher levels of investment employment and gross domestic product (GDP) it saidThe TCJA is projected to initially boost real GDP in relation to real potential GDP (ie the economys maximumsustainable level of production) This is due to the fact that the TCJA increases overall demand for goods andservices by raising households and businesses after-tax income In developing its baseline budget projections CBOincorporated the effects of the tax act taking into account economic feedback especially the ways in which the actis likely to affect the economy and in turn affect the budget The JCTA raised CBOs estimated cumulative primarydeficit (which excludes costs of debt servicing) by $13 trillion and increased projected debt service costs by some$600 billion The total projected deficit over the 2018-2028 period totals about $19 trillion Before taking economicfeedback into account CBO estimated that the tax act would increase the primary deficit by $18 trillion anddebt-service costs by roughly $450 billion the blog said The feedback is estimated to lower the cumulative primarydeficit by about $550 billion mostly because the act is projected to increase taxable income and thus push taxrevenues up it added The growth in debt service costs is attributed to higher interest rates The blog also addressedthe uncertainty surrounding CBO estimates stating CBOs estimates of the economic and budgetary effects of the2017 tax act are subject to a good deal of uncertainty But the agency was uncertain about various issues Forexample the way the act will be implemented by the Treasury how households and businesses will rearrange theirfinances in the face of the act and how households businesses and foreign investors will respond to changes inincentives to work save and invest in the United States That uncertainty implies that the actual outcomes may differsubstantially from the projected ones (Misc TCJA)

LTIGTA Audit Evaluates IRS Handling of New Tax Cuts and Jobs Act (Audit Report No2018-44-027)The Treasury Inspector General for Tax Administration (TIGTA) released an audit which evaluated theServicersquos efforts in implementing the Tax Cuts and Jobs Act (TCJA) of 2017 The law contains 119provisions that are administered by the agency and affect both domestic and international taxes TheIRSs Legislative Affairs function monitored the pending legislation to identify provisions that affectedthe agency and kept the various IRS operating divisions abreast of developments This allowed theoperating divisions to assess how to handle the implementation Once enacted the IRS immediatelybegan the task of implementing these provisions The agency also created a sophisticated oversightstructure to coordinate all the required implementation activities Working with the Treasury Department


the IRS estimated that implementation of the TCJA would cost approximately $397 million which includesthe hiring of an estimated 1734 full-time equivalent positions to implement tax reform over the next twocalendar years The IRS took adequate steps to create the required withholding tables The IRS inconjunction with the Department of the Treasury designed the Tax Year 2018 withholding tables to workwith an employees existing Form W-4 Employees Withholding Allowance Certificate to minimizepotential burden on employees and employers The audit also praised the manner in which the IRSupdated its online Withholding Calculator (Misc TCJA)

LCBO States Recent Tax Cuts Will Cause Budget Deficit to Sharply Increase (Budget andEconomic Outlook 2018 to 2028) An economic report by the Congressional Budget Office (CBO) The Budget and Economic Outlook2018 to 2028 indicates that the US budget deficit ldquowill increase markedlyrdquo over the next few yearsmainly because of deep tax cuts approved in the Tax Cuts and Jobs Act Despitestronger-than-predicted economic growth ahead the CBO said the deficit will grow to $804 billion in fiscalyear 2018 which ends on Sept 30 up from $665 billion in fiscal year 2017 The deficit that CBO nowestimates for 2018 is $242 billion larger than the one that it previously projected for that year in June2017 Accounting for most of that difference is a $194 billion reduction in projected revenues mainlybecause the TCJA is expected to reduce collections of individual and corporate income taxes In the nextfew years deficits will grow substantially before stabilizing in 2023 resulting in a projected cumulativedeficit of $117 trillion for 2018-2027 the CBO said

CBOs current economic projections differ from those that the agency made in June 2017 in a numberof ways The most significant is that potential and actual real gross domestic product (GDP) are projectedto grow more quickly over the next few years CBO forecasts 33 growth in 2018 in GDP and 24GDP growth in 2019 By way of comparison last year grew by 26

CBO expects corporations income tax payments net of refunds to decline by $54 billion in 2018 to$243 billion The projected decline in corporate income tax receipts mainly results from changes madeby the TCJA The largest part of the projected revenue decline stems from the corporate tax ratereduction itself from 35 to 21 In addition the prospective reduction in the corporate tax rate inJanuary 2018 provided an opportunity for some firms to accelerate expenses such as employeescompensation into the 2017 tax year in order to claim deductions at the 35 rate in effect for that yearthus lowering their tax liabilities in fiscal year 2018

Furthermore the TCJA allows businesses to fully expense (ie under either Sec 179 or bonusdepreciation) equipment they purchased and put into service beginning in the fourth quarter of calendaryear 2017 The ability to deduct the full value of such investments will also lower taxable income in fiscalyear 2018 The lower taxes resulting from those provisions are partly offset by new revenues stemmingfrom a one-time tax on previously untaxed foreign profits expected to be paid from 2018 through 2026 (Misc TCJA)

LConsolidated Appropriations Act Contains Technical Corrections to TCJA (PL 115-141) The Consolidated Appropriations Act 2018 was signed into law on 32318 The provisions of theAct include a $13 trillion spending bill that funds the federal government through 93018 and avoids afederal government shutdown The Act also contains provisions for several technical corrections Themost significant are (1) a fix to the so-called grain glitch to change a provision in the Tax Cuts andJobs Act that gave preference to farmer-owned cooperatives over other types of entities (2) provisionsto correct and clarify the partnership audit rules enacted under the Bipartisan Budget Act of 2015 and(3) provisions to increase the low-income state housing credit ceiling for calendar years 2018-2021 andthe creation of a new category of low-income housing project credit qualification (Misc Consolidated


Appropriations Act)

LIRS Outlines Initial Plan for Guidance on Implementing New Tax Act Provisions (Department ofthe Treasury 2017-2018 Priority Guidance Plan (Feb 7 2018)) The IRS has issued its second quarter update to the 2017-2018 Priority Guidance Plan describingthe guidance that the IRS intends to issue during by June 30 2018 as part of its initial implementationof the recently enacted Tax Cuts and Jobs Act (TCJA)

Comment One provision of particular interest to taxpayers and practitioners is the new Codesect199A 20 deduction with regard to ldquoqualified business incomerdquo The IRS has stated that it willissue computational definitional and anti-avoidance guidance on this new provision

The Guidance Plan lists the following 18 action items relating to the TCJA

- Guidance on certain issues related to the new business credit under Code sect45S with respect to wagespaid to qualifying employees during family and medical leave

- Guidance under Code sect101 Code sect1016 and new Code sect6050Y regarding ldquoreportable policy salesrdquoof life insurance contracts

- Guidance under Code sect162(m) regarding the application of the effective date provisions to theelimination of the exceptions for commissions and performance-based compensation from the definitionof compensation subject to the $1 million deduction limit for covered employees of publicly-tradedcorporations

- Guidance under Code sect162(f) (on the deductibility of certain fines and penalties) and new Codesect6050X (requiring government agencies or similar entities to report certain settlement payments to IRSand the taxpayer)

- ldquoComputational definitional and other guidancerdquo under new Code sect163(j) (which limits the deductionfor interest paid to 30 of adjusted taxable income for businesses with more than $25 million in grossreceipts)

- Guidance on new Code sect168(k) (100 bonus depreciation)

- ldquoComputational definitional and anti-avoidance guidancerdquo under new Code sect199A (the 20 qualifiedbusiness income deduction)

- Guidance adopting new small business accounting method changes under Code sect263A Code sect448Code sect460 and Code sect471

- ldquoDefinitional and other guidancerdquo under new Code sect451(b) (under which income inclusion for taxpurposes cannot be later than for certain financial reporting purposes) and Code sect451(c) (allowingdeferral of advance payments in certain circumstances)

- Guidance on computation of unrelated business taxable income (UBTI) for separate trades orbusinesses under new Code sect512(a)(6)

- Guidance implementing changes to Code sect529 (qualified tuition programs)


- Guidance implementing new Code sect965 (deemed repatriation rules) and other international sectionsof the TCJA (IRS notes that such guidance Notice 2018-7 was released on Dec 29 2017)

- Guidance implementing changes to Code sect1361 regarding electing small business trusts

- Guidance regarding Opportunity Zones under Code sect1400Z-1 and Code sect1400Z-2

- Guidance under new Code sect1446(f) for dispositions of certain partnership interests (IRS noted thatsuch guidance Notice 2018-8 was released on Dec 29 2017)

- Guidance on computation of estate and gift taxes to reflect changes in the basic exclusion amount

- Guidance regarding withholding under Code sect3402 and Code sect3405 and optional flat rate withholding

- Guidance on certain issues relating to the excise tax on excess remuneration paid by applicabletax-exempt organizations under Code sect4960

LIRS Releases Second Quarter Update to 2017-2018 Priority Guidance Plan The IRS has released the second quarter update to its 2017-2018 priority guidance plan The plancontains guidance projects the IRS hopes to complete during the period 7117 through 63018 Amongthe 29 new projects added to the plan 18 of them have been designated as near term priorities as aresult of the Tax Cuts and Jobs Act (TCJA) These include (1) computational definitional and anti-avoidance guidance on the new Section 199A deduction for qualified business income (2) rules relatingto the new Section 45S employer credit for paid family and medical leave (3) computational definitionaland other guidance on the business interest limitation under Code sect163(j) and (4) guidance on adoptingnew small business accounting method changes (Misc TCJA)

Comment The IRS may update this list during the year as it considers comments from taxpayersand tax practitioners

LIRS Dedicates Special Website to Updates on New Tax Cuts and Jobs Act (e-News for TaxProfessionals 2018-6) The IRS recently announced that it has created a special page on its website titled Resources for TaxLaw Changes According to the Service the page is designed to assist the tax community in trackinginformation related to the Tax Cuts and Jobs Act (TCJA) The frequently updated page will include aone-stop listing of new legal guidance news releases Frequently Asked Questions and otherinformation related to TCJA the IRS stated Therefore the Service recommended that tax professionalsregularly check the page for the latest updates (Misc TCJA)

LVarious State Approaches to Conformity with TCJA For companies operating in numerous states issues arise especially where the individual states choosenot to conform to the provisions contained in TCJA In other words the state income tax implications ofthe new Tax Act vary widely depending on statesrsquo automatic or fixed conformity to the Internal RevenueCode as well as the statesrsquo ldquoappetiterdquo for amending their own tax laws in the face of TCJA Generallyspeaking the Tax Act will have the effect of increasing most businessesrsquo effective state income tax ratesdue to the broadened federal income tax base without a corresponding reduction in the state income taxrate (Misc State Tax Conformity)


Business Tax Provisions

- 21 Flat C Corporation Tax Rate3

- Corporate tax rate would generally be taxed at a flat 21 rate for tax years beginning in2018 Therefore the current graduated rates4 of 15 (for taxable income of $0-$50000) 25 (fortaxable income of $50001-$75000) 34 (for taxable income of $75001-$10000000) and 35(for taxable income over $10000000) will be eliminated5

Comment There is the obvious ldquochoice-of-entityrdquo question now that C corps (includingPSCs) receive a flat 21 tax rate on all taxable income Some have argued that this isespecially true where a K-1 entity will not be entitled to the new Code sect199A 20 deductionfor ldquoqualified business incomerdquo But as discussed below if a C corp pays out its profits aswages this ordinary income would face a marginal tax rate of up to 37 on an employeeownerrsquospersonal tax return (let alone a minimum of 29 in employment taxes for a closely-held C corp)This would basically be the same result had an S corp paid out wages or for any SE income toa partnerLLC member Dividends on the other hand are nondeductible to the C corp but onlyface a 20 top rate with no employment taxes Yet when you factor in the 21 rate that the Ccorp has already paid on such profits the effective ldquodouble taxationrdquo rate approximates 37 aswell6

Comment For smaller regular C corps which held back up to $50000 of profits under current lawthis taxable income would have only faced a 15 marginal tax rate And if invested in a dividend-paying mutual fund for instance the C corp would have also received a Code sect243 dividendreceived deduction of 70 (resulting in an effective tax rate on such dividends of only 45)Under the new Tax Act these dividends would now be subject to a 105 effective tax rate(ie after a 50 DRD and the new 21 C corp tax rate)

Comment When preparing 2017 C corporation tax returns special attention should be paidto taking the maximum amount of deductions especially with Sec 179 and bonusdepreciation Using an extreme example for a smaller C corporation having taxable incomebetween $100000 and $335000 it would face a marginal tax rate of 39 Even a PSC wouldface a flat tax rate of 35 on any taxable income So deductions in 2017 have the benefit of thesehigher marginal tax rates while those delayed until 2018 (and later years) receive only a 21 taxbenefit

3 By increasing corporate rate to 21 instead of 20 the effective date will now remain for ldquotax years

beginning after 2017rdquo instead of being delayed for until 2019 Code Sec 11(b) as amended by Act Sec 13001

4 These graduated rates produced an effective corporate tax rate of 2225 on the first $100000 of Ccorporation taxable income But from $100000 to $335000 of C corporation taxable income under the ldquooldrdquo lawthere was an effective 39 tax rate Thus with a flat 21 flat tax rate on all C corp taxable income this is effectivelyan 18 decrease (and with TI gt $335000 a drop from 35 to only 21)

5 Given that the top C corp rate would be a flat 21 there should be a corresponding reduction of the Codesect1374 S corp built-in gains rate of 35 and the Code sect1375 35 penalty on ldquoexcess passive investment incomerdquo Onthe other hand both the Code sect531 accumulated earnings tax penalty and the Code sect541 personal holding companypenalty would remain at just 20 given this remains the top rate on dividend income

6 And this 37 combined rate is before any possible imposition of the Code sect1411 38 Medicare surtax


Comment A number of commentators7 are insisting that there will be a proration of taxrates for fiscal year C corporations based upon the days before January 1 2018 and thedays after that date [Sec 15(a)(2)] Therefore if you have a September 30 2018 year-end youwill calculate the taxable income from October 1 2017 to December 31 2017 at the old rates andafter that date at the new rates This will be based upon the number of days in each period

Comment As a consequence of having a 2017-2018 blended tax rate all fiscal year corporationswill be in a higher tax bracket in 2017-2018 then they will be in future years when they will betaxed at 21 As a result deductions in their 2017-2018 tax years will yield a greater tax benefitthan in later years while income will be taxed at a higher rate in their 2017-2018 tax years thenit will be in later years So fiscal year corporations can obviously benefit from taking steps thatmove deductions away from future years into the current year while moving income from thecurrent fiscal year to future years

LAlternatives for Handling C Corp Profits

Example ldquoPaying Out Nondeductible DividendrdquoOn $100 of C corporation profits $21 would be paid in federal income taxes Then of the $79remaining to pay a nondeductible dividend 208 or about $16 would be subject to tax at theshareholder level As a result this $100 of corporate profit would face a combined effective taxrate of 37 which is also the top marginal tax rate on ordinary income for individuals starting in2018

Example ldquoCorporate Profits Paid Out as Deductible WagesrdquoIf this $100 of C corporation profits had been paid out as wages there would have been acorresponding deduction to the corporation with the owneremployee picking up this ordinarywage income at marginal rates of up to 37 In addition even if the FICA cap (ie $128400in 2018) is exceeded there would still be the 29 in employments taxes to be considered (145for the employer and employee each) Finally the 9 Medicare surtax would also have to beconsidered if the taxpayerrsquos AGI exceeded the $200000250000 thresholds (depending on filingstatus)

Choice of Entity As far as the ldquochoice-of-entityrdquo question had this $100 of profit instead flowedthrough on an ownerrsquos K-1 from an S corporation or a partnership it could have possibly receiveda 20 deduction (given that the partnerS corp shareholders taxable income did not exceed$315000 on a MFJ return ($1575000 for an unmarried taxpayer) And even if it did exceed theseaforementioned ldquothreshold amountsrdquo then as long as this was not a ldquoserviced-based businessrdquothe 20 deduction would be allowed as long as it did not exceed 50 of any wages paid by thecompany (or an alternative formula for capital intensive businesses) The bottom line is given that

7 Some of the larger accounting firms such as EY KPMG and Deloitte are advising that fiscal year corporatefilers should prorate the tax rate for fiscal years which include days prior to and after 12312017 However thelanguage in the Conference Agreement does not seem to support this position It clearly states that the new flat 21C corporate rate is for ldquotax years beginning after 2017rdquo Nevertheless it seems the actual Conference Report underSubtitle C (page 115) - Business-related Provisions - is silent with regard to fiscal year corporations (ie it doesnot incorporate the language tax years beginning after 2017) So in the absence of this guidance some experts(apparently) are instead looking to Code sect15(c) Effective Date of Change for the rules applicable to corporate taxyears which include days before and after the laws effective date

8 This of course ignores the possible imposition of the Code sect1411 38 Medicare surtax


the 20 deduction was allowed this would leave $80 (of the original $100 of profit) which couldbe taxed at a marginal rate of up to 37 resulting in a effective tax rate of 2969

- Another option would be to just accumulate this $100 of profit as additional working capital whichcould be invested in a mutual fund for instance yielding a dividend each month First of all theC corporation would have $79 (of the original $100 of profit) to invest And Code sect243 wouldpermit 5010 of this dividend to be excluded from the C corporationrsquos taxable income whenreceived

Example ldquoRetaining C Corp Profits as Invested Working CapitalrdquoIf a C corp had a $100 of profit should it be paid out as additional wages which would face a topmarginal tax rate of 37 along with at least 29 of employment taxes Or should the C corpinstead accumulate this working capital and invest it in a mutual fund paying 7 The C corpshareholder would only have at best about $60 to invest after federal income and employmenttaxes on wages and would then face up to a 20 tax rate on any dividends or LTCGs leaving$80 after-tax per $100 On the other hand the C corporation would have $79 to invest after-taxand would only pay an effective tax rate of 105 of each $100 of return on investment (($100 x50 DRD) x 21) Of course the C corporation would have to watch out for both the AET taxpenalty under Code sect53l (where up to $150000 or $250000 of accumulated earnings could beretained without question) as well as the Code sect541 personal holding company penalty

Example ldquoC Corp Profits Used to Make Retirement Plan Pay-InrdquoA final option might be for the C corporation to contribute the $100 profit into a qualified retirementplan There would be no income taxes due on this amount although employment taxes of at least29 would be owed

LImpact of Blended Rates for Fiscal Year C Corporations

- Due to the fact that the Tax Cuts and Jobs Act reduced the corporate income tax rate from amaximum of 35 to a flat 21 and that changes interaction with Code sect15(a) which coverschanges in rates during a tax year fiscal year corporations will have a blended 2017-2018 taxrate More importantly the one-year existence of that blended rate has planning implications

- With regard to this ldquoblended tax raterdquo before enactment of TCJA corporations were taxed underCode sect11(b) at graduated rates that ranged from 15 to 35 The new flat 21 tax rate providesthat the lowered corporate income tax rate is effective for tax years that begin after Dec 31 2017However for fiscal years that ldquostraddlerdquo the 123117 date the blended procedure outlined belowmust be followed

- Code sect15(a) provides that when tax rates change during a taxpayers tax year (ie a ldquostraddleyearrdquo) the taxpayers tax for the straddle year is computed using a blended tax rate In otherwords the taxpayer is required to

9 Of course separately-stated dividends LTCGs or Sec 1231 gains would receive an even lower rateversus a C corporation which would face a flat 21 tax rate regardless of the source of income

10 The dividend received deduction had been 70 but will be reduced to just 50 under the Tax Actstarting in 2018


(1) Calculate two tentative taxes for the straddle year by applying each tax rate to thetaxpayers income for the year

(2) Multiply each tentative tax by the proportion of the straddle year to which each tax rateapplies and

(3) Adds the results of the two calculations

Example A C corporationrsquos tax year ends September 30 2018 and its taxable income is $10million To compute its tax the corporation first determines the tax on the taxable income of $10million based on the pre-2018 rates That tax $35 million is multiplied by the ratio of 92 days inJays 2017-2018 tax year (ie the number of days in the 2017 calendar year) over 365 to arriveat approximately $875000 Next the tax on the taxable income of $10 million based on the 2018rates is determined The tax of $21 million is multiplied by the ratio of 273 days in the companyrsquos2017-2018 tax year (ie the number of days in the 2018 calendar year) over 365 to arrive atapproximately $1575000 The corporation then adds $875000 and $1575000 to determine totaltax due of $2450000 Dividing the total tax of $2450000 by taxable income of $10 million yieldsa blended statutory rate of 245 for a fiscal year ending on Sept 30 2018

Comment The blended statutory rate drops by 117 per month ((35-21)12)) For examplea corporation with an October year end will have a blended rate roughly 117 lower than thecompany mentioned in the example above

Planning Point Because of this 2017-2018 blended tax rate all fiscal year corporations will bein a higher tax bracket in 2017-2018 then they will be in future years when they will be taxed at21 Therefore deductions in their 2017-2018 tax years will have greater value than in lateryears and income will be taxed at a higher rate in their 2017-2018 tax years then it will be in lateryears As a result fiscal year corporations would obviously benefit by taking steps that accelerateddeductions into the months in 2017 while deferring income from 2017 to future years

LPossible Windfall in Corporate Tax Revenues for States States may receive a major boost in their corporate tax revenues as a result of the Tax Cuts and JobsAct according to a new report The report prepared by EYrsquos Quantitative Economics and Statisticsunit on behalf of the Council On State Taxationrsquos State Tax Research Institute estimates thenationwide overall increase in state corporate income tax bases is 12 percent over the next 10 yearsalthough it predicts significant variations between the states by year The report estimates the averageexpansion in the state corporate tax base to be 8 percent from 2018 through 2022 increasing to 135percent for 2022 through 2027 The growing increase in later years is due mainly to the impact ofresearch and experimentation expense amortization starting in 2022 and the change in the interestlimitation that same year

Another important factor behind the projected increase in corporate tax revenue is because statesusually conform to federal provisions that broaden the corporate tax base but not to provisions thatreduce corporate tax rates The magnitude of increased corporate tax collections for each state willdepend on how it chooses to conform to the changes in the federal tax code from the new law thecomposition of its economy and the way in which specific provisions within the Tax Cuts and Jobs Actare implemented at the federal level

The states that are expected to get the greatest estimated percentage change in state corporate taxbase from the new tax law are mainly those that tax certain types of foreign income The impact will also


vary by industry based on the tax and financial profiles of companies in each industry sector The studyestimates the change in the state corporate tax base expansion by sector manufacturing (12 percent)capital intensive services (17 percent) labor intensive services (9 percent) finance and holdingcompanies (8 percent) and other industries (13 percent) (Misc TCJA)

- 21 Rate Also Available for PSCs

- Although the House version would have imposed a separate 25 flat tax rate on PSCs the finalConference version of the Tax Act declined to do so

- As a result personal service corporations would also be subject to a flat 21 corporatetax rate (ie the same as any other C corporation) rather than the current 35 rateeffective for tax years beginning after 2017 A personal service corporation is a corporation theprincipal activity of which is the performance of personal services in the fields of health lawengineering architecture accounting actuarial science performing arts or consulting and suchservices are ldquosubstantially performedrdquo by the employee-owners

Comment Cf Code sect448 for the definition of a PSC But since the same 21 rate appliesto all C corporations the specific classification of a company as a PSC is no longerimportant to ascertain On the other hand for purposes of the new 20 deduction on K-1profits covered below the definition of a service-based business appears to be muchbroader than this ldquooldrdquo definition of PSCs

- 21 C Corp Rate v 37 for S Corp Owners and Partners

- Should a PSC decide to convert to S corporation status it would still face the possible impositionof the Code sect1374 built-in gains tax for the first 5 years after the effective date of the S electionBut as mentioned above the BIG rate should be dropping to just 21 since it will be the highest(and only) C corporation tax rate for tax years beginning after 2017

- On the other hand if a S corp business is ldquoservice-basedrdquo with its owneremployees havingtaxable incomes significantly above the respective phaseout points for the Sec 199A ldquothresholdamountsrdquo (ie gt $207500 and $415000) they might want to instead revoke their S election andtake advantage of the 21 flat tax rate otherwise available for all types of regular C corporationsThis might be especially true if the owners can use the ldquopersonal goodwillrdquoargument to avoiddouble taxation if and when they decide to liquidate the C corporation (and a sale of stock is notavailable) while accumulating some earnings and taking advantage of the Code sect243 dividendreceived deduction

- ldquoService-basedrdquo partnerships might also want to consider converting their business to a regularC corporation if the Sec 199A is not otherwise available due to the partners high taxable incomeson their personal returns In addition the prospect of completely tax-free fringe benefits becomingonce again available with a C corporation could be an attractive side benefit as well

Choice of Entity Most ldquoservice-basedrdquo businesses such as law accounting medicine etc tendto take the profits generated out of the business annually leaving only what is needed for workingcapital purposes If that is the case it probably does not make sense to operate as a C corporationunless substantial sums were instead going to be reinvested back into the business (or within the


$150000 Code sect531 AET tax limit profits were retained and invested to take advantage of theCode sect243 50 ldquodividend received deductionrdquo) With the double taxation on dividends distributedout of C corporation profits you still face a maximum effective 40 tax rate (ie 21 x $100 ofC corp profits plus 238 x $80 dividend)

LC Corp Electing S Status Allowed Built-In Loss for Bonuses Pegged Against Cash BasisReceivables (PLR 200925005) A cash basis personal service corporation (PSC) that elected S status was permitted to offset thepotential built-in gain from the eventual collection of cash basis receivables with a built-in lossEssentially this took the form of a bonus for services rendered by its professional shareholder (as wellas its nonshareholder employees) that was recorded on the books of the former C corporation during itslast days of existence but which was paid within 2frac12 months after becoming an S corp

Comment Key to the favorable result in this ruling was the fact that the taxpayer would pay to itsshareholderemployees within the first two and one-half months of the recognition period all salaryand wage expenses that were related to the production of accounts receivable that wereoutstanding as of the effective date of the S election

Comment As to the payments made to any nonshareholder employees these could be madeat any point during the 10-year built-in gains period (ie the same time frame as that for any otheraccounts payable or other unpaid payroll expenses)

Background Code sect1374(d)(4) provides that any loss recognized on a disposition of an assetduring the recognition period is recognized built-in loss to the extent the S corporation establishes thatit held the asset on the first day of the recognition period and such loss does not exceed the excess of(i) the adjusted basis of such asset as of the beginning of such first taxable year over (ii) the fair marketvalue of such asset as of such time Code sect1374(d)(5)(B) provides that any item of deduction properlytaken into account during the recognition period but attributable to periods before the first day of therecognition period is recognized built-in loss for the taxable year for which it is allowable as a deductionCode sect1374(d)(5)(C) provides that an S corporations net unrealized built-in gain is properly adjusted foritems of income and deduction that would be recognized built-in gain or loss if taken into account duringthe recognition period Reg sect11374-4(b)(2) provides in relevant part that any item of deductionproperly taken into account during the recognition period is recognized built-in loss if the item would havebeen properly allowed as a deduction against gross income before the beginning of the recognition periodto an accrual method taxpayer Reg sect11374-4(c) limits the treatment under Reg sect11374-4(b)(2) ofitems of deduction properly taken into account during the recognition period as recognized built-in lossThe limitation of Reg sect11374-4(c) applies to items of deduction constituting payments to related partiesand any amount properly deducted during the recognition period under Code sect404(a)(5) (ie relatingto payments for deferred compensation) Reg sect11374-4(c)(1) (relating to regular compensation suchas bonuses paid out of receivables) provides that any payment to a related party properly deducted inthe recognition period under Code sect267(a)(2) will be deductible as recognized built-in loss only if (i) allevents have occurred that establish the fact of the liability to pay the amount and the exact amount ofthe liability can be determined as of the beginning of the recognition period and (ii) the amount is paid(A) within the first two and one-half months of the recognition period or (B) to a related party owning lessthan five percent by voting power and value of the corporationrsquos stock both as of the beginning of therecognition period and when the amount is paid Meanwhile Reg sect11374-4(c)(2) (relating to deferredcompensation payments) provides that any amount properly deducted in the recognition period underCode sect404(a)(5) will be deductible as recognized built-in loss to the extent (i) all events have occurredthat establish the fact of the liability to pay the amount and the exact amount of the liability can be


determined as of the beginning of the recognition period and (ii) the amount is not paid to a related partyto which Code sect267(a)(2) applies (Code sect1374 BIG Tax)

Comment This is one of the prime considerations when a PSC decides to elect S status Namelyif a cash basis accounts receivable is subject to the built-in gains tax the rate could effectively goas high as 575 (ie 35 x $100 of BIG + (35 x ($100 - 35 BIG tax)) Whereas if S electionhad never been made then the PSC would have simply paid out these receivables as collectedwith the only tax being that paid at the shareholderemployeersquos marginal tax rate (ie at most35) And the IRS has won at least two cases where the planning outlined above was notproperly consummated and the cash basis receivables subsequently collected by the S corp weresubject to the built-in gains tax

- 100 Bonus Depreciation

Comment Since many states must have balanced budgets they often ldquodecouplerdquo from thefederal tax law Therefore provisions such as 100 bonus depreciation and Sec 179 immediateexpensing may not be allowed in determining taxes due at the state or local level So in additionto the federal income tax law prohibitions such as the ldquoat-risk limitations (ie on Form6198) or the Code sect469 passive loss rules there will be the added complexity ofmaintaining distinct bases for depreciable (and perhaps amortizable) assets at the federalv state income tax levels (let alone for book or GAAP purposes)

- Under prior law an additional first-year bonus depreciation deduction was allowed equal to 50of the adjusted basis of qualified property the ldquooriginal userdquo of which began with the taxpayerplaced in service before Jan 1 2020 (Jan 1 2021 for certain property with a ldquolonger productionperiodrdquo) But the 50 allowance was to be phased down to 40 for property placed in servicein 2018 and to 30 for property placed in service in 2019 A first-year depreciation deduction wasalso electively available for certain plants bearing fruit or nuts planted or grafted after 2015 andbefore 2020 Film productions were not eligible for bonus depreciation

- Under the new Tax Act businesses will be able to fully and immediately expense 100 ofthe cost of qualified property acquired and placed in service after Sept 27 2017 and beforeJan 1 2023 (with an additional year for certain qualified property with a longer production period)

Comment Note that the ldquotestrdquo here is conjunctive meaning that the asset must have been bothldquoacquiredrdquo and ldquoplaced in servicerdquo after 92717 Thus assets acquired before 92817 but thenplaced in service after 92717 would result in the ldquooldrdquo 50 bonus depreciation rules applying

- For productions placed in service after Sept 27 2017 qualified property eligible for a 100first-year depreciation allowance now includes qualified film television and live theatricalproductions A production is considered ldquoplaced in servicerdquo at the time of initial release broadcastor live staged performance (ie at the time of the first commercial exhibition broadcast or livestaged performance of a production to an audience)

- For certain plants bearing fruit or nuts planted or grafted after Sept 27 2017 the 100first-year deduction is also available

- The ldquooriginal userdquo requirement has now been eliminated under the new Tax Act It wasproposed that that bonus depreciation would not be available for any property used in a ldquoreal


property trade or businessrdquo11 But the new Tax Act did not include the exclusion of ldquopropertyused in a real estate trade or businessrdquo (ie as proposed by the House)

Comment Under prior law ldquoqualified propertyrdquo included property acquired by purchase if anothertaxpayer had not previously used the property In other words the property did not have to benew as long as it was not acquired from a related party However under the new Tax Actldquoqualified propertyrdquo does not include property used in a business that is not subject to thenet business interest expense limitation (discussed below) but it does include propertyused in farm business The law also adds a new category for qualified film TV and livetheatrical production property

- Even though bonus depreciation will increase to 100 the effect on the Code sect280Fldquoluxury car capsrdquo is still only an $8000 increase to the first year cap (though the first yearcap will be increasing to $10000 from $3160 starting in 2018 so a total of $18000 mightbe available when bonus depreciation is included)

- The election to accelerate AMT credits in lieu of bonus depreciation is repealed12

Comment For perhaps the sake of simplicity a taxpayer can choose for the first tax yearending after Sept 27 2017 to instead elect to claim 50 bonus first-year depreciation(instead of claiming a 100 first-year depreciation allowance) So for a 2017 calendar-yeartaxpayer 50 bonus depreciation can continue to be used (instead of 100) for otherwisequalifying assets acquired and placed in service after 92717 through 123117

Comment The pre-Act law phase-down of bonus depreciation continues to apply toproperty acquired before Sept 28 2017 In other words otherwise qualifying ldquooriginal userdquoassets placed into service before that date would only be allowed 50 bonus depreciation13 Andif the asset was acquired before Sept 28 2017 but not placed into service until 2018 forexample then the asset would only be eligible for 40 bonus depreciation Furthermore it wouldappear that the ldquooriginal userdquo requirement would also have to be satisfied

Comment And of course unlike Sec 179 immediate expensing which is done on an asset-by-asset basis using Form 4562 bonus depreciation continues to be ldquoautomaticrdquo insomuchas the taxpayer must elect on a MACRS class-by-class basis to not be subject to bonusdepreciation (for each and every tax year that it otherwise applies) And you must elect outon a MACRS class-by-class basis by the extended due date of the return to not be automaticallysubject to this deduction (ie it cannot be done on an amended tax return)

Example ldquoBuying Out Assets at End of Lease - Pre-92817rdquoA taxpayer is leasing a car whose lease expires 92717 at which time he has the option of buyingthe vehicle If the car was new at the beginning of the lease the ldquooriginal userdquo of the vehicle would

11 Keep in mind though that the new Tax Act would now permit Sec 179 immediate expensing for assets

ldquoused in connection with lodgingrdquo even if the rental activity did not involve ldquotransient dwellersrdquo

12 Code Sec 168(k)(4) as amended by Act Sec 12001

13 This statement contained in the final Conference Agreement clarifies that assets purchased before Sept28 2017 but not placed into service until after Sept 27 would receive 50 bonus depreciation (or even be subject tothe 40 or 30 bonus depreciation rules if they were not placed into service until either 2018 and 2019)


have started with him And with the 50 bonus depreciation rules applying he would be eligible(unless he elected out of bonus depreciation for the MACRS 5-year class) a first-year luxury carcap of $11160 (ie the normal first-year cap of $3160 plus $8000 additional write-off due to the50 bonus depreciation)

Example ldquoBuying Out Assets at End of Lease - Post-92717rdquoSame facts as above except that the vehicle was used as of the beginning of the lease Nowhowever the lease expires one day later on 92817 at which time he decides to buy the car Eventhough the new 100 bonus depreciation rule would now be in effect the impact on the first-yearluxury car cap would be the same Namely it would still only be increased by $8000 (ie to anoverall cap of $11160) Nevertheless bonus depreciation is available even though a ldquousedrdquo assetis being purchased (and the ldquooriginal userdquo of this asset did not begin with this specific taxpayer)

Example ldquoAssets Acquired Before amp After 92717 Effective DaterdquoA taxpayer buys two pieces of equipment one on 92717 and the other on 92817 Although hecan claimed a Sec 179 immediate write-off of up to $510000 he would be limited to 50 bonusdepreciation for the first asset but would have 100 bonus depreciation for the second asset

Comment So for the assets mentioned in the above examples were purchased after 92717it would no longer matter if the ldquooriginal userdquo of them started with the taxpayer In other words theycan be new or used

Comment Obviously with 100 bonus depreciation for the next 5 years it essentially makesSec 179 immediate expensing superfluous along with the fact that there is no overall cap nophaseout rules or the need for ldquotrade or business taxable incomerdquo to claim the deduction Ineffect then bonus depreciation can be used to create or increase an NOL (as opposed to Sec179 write-offs) Nevertheless there will be some situations where Sec 179 should still be electedFor example where a state only allows $25000 for Sec 179 and nothing for bonus depreciationAt least $25000 under Sec 179 should be elected on the federal tax return so that it will also beavailable for the state return as well

LTechnical Correction Needed for ldquoQualified Improvement Propertyrdquo

- ldquoQualified improvement property (QIP)rdquo is any improvement to an interior portion of a buildingthat is nonresidential real property if the improvement is placed in service after the date thebuilding was first placed in service except for any improvement for which the expenditure isattributable to

1 Enlargement of the building

2 Any elevator or escalator or

3 The internal structural framework of the building (Code sect168(e)(6))

- Under the TCJA the statutory language for Code sect168(e)(3)(E) does not include QIP leavingit as nonresidential real property (ie MACRS 39-year commercial real estate) and therefore notsubject to bonus depreciation or some other class of property (eg a property with 15 yearsMACRS) However according to the conference committee QIP was intended to be 15-yearproperty qualifying for bonus depreciation


- A technical correction is therefore needed to the property class life for QIP so that it would clearlynow be classified as MACRS 15-year property and thus eligible for 100 bonus depreciation

Comment ldquoQualified improvement propertyrdquo was a new category added to the MACRSclassification system as 39-year commercial real property effective for the 2016 tax year (andcarried over for 2017) More importantly it was eligible for 50 bonus depreciation In otherwords tangible personal or real property no longer needed to have a MACRS class of 20 yearsor less to be eligible for bonus depreciation Now for otherwise qualifying assets acquired andplaced into service after 92717 (ie regardless of tax year) 100 bonus depreciation wouldapply even if the ldquooriginal userdquo of the asset did not commence with the taxpayer

Comment With ldquoimprovement propertyrdquo such as QIP this would normally involve assetsconnected with commercial real estate that the taxpayer did not feel comfortable in expensing asa ldquorepairrdquo and therefore ones which they would capitalize as part of the real property As a resultthe question as to whether the ldquooriginal userdquo commenced with the taxpayer would usually be amoot point

- Increased Sec 179 Immediate Expensing Election

- In general ldquoqualifying propertyrdquo is defined as depreciable tangible personal property that ispurchased for use in the active conduct of a trade or business14 and includes off-the-shelfcomputer software and ldquoqualified real propertyrdquo (ie qualified leasehold improvementproperty qualified restaurant property and qualified retail improvement property)

Comment As discussed below in greater detail the TCJA expanded the definition of qualifiedproperty to include ldquoqualified improvement propertyrdquo specified improvements (eg new roofsHVAC along with fire and security alarm systems) to nonresidential real property and assets usedin connection with lodging (eg rugs appliances and FampF)

Comment As explained below the term ldquoqualified real propertyrdquo (with its special ldquotestsrdquo such ashaving to be subject to a lease on a commercial building placed in service gt 3 years previouslyor made to a ldquoqualifying restaurant buildingrdquo under the ldquo50 of square footage testrdquo) has beeneliminated so that Sec 179 will be available regardless of these requirements being metHowever restaurant building property placed in service after December 31 2017 that does notmeet the definition of ldquoqualified improvement propertyrdquo is not eligible for section 179 expensingFurthermore without the special ldquo50 of square footage testrdquo such buildings (ie real property)would now be classified once again as MACRS 39-year commercial real estate

- ldquoQualified improvement propertyrdquo is any improvement to an interior portion of a buildingthat is nonresidential (ie commercial) real property if such improvement is placed inservice after the date such building was first placed in service But qualified improvementproperty does not include any improvement for which the expenditure is attributable to theenlargement of the building any elevator or escalator or the internal structural framework of thebuilding These latter types of fixed assets would be considered as part of the MACRS 39-year

14 Keep in mind that triple net lease situations might not qualify as assets being used in the ldquoactive conductof a trade or businessrdquo Also if a ldquononcorporate lessorrdquo is involved (eg SMLLC or multi-member LLC) then Codesect179(d)(5) will impose a special limitation test during the first 12 months that the asset is being leased


commercial real property

- Passenger automobiles subject to the Code sect280F limitation continue to be eligible for Codesect179 expensing only to the extent of the Code sect280F dollar limitations (which has now beenincreased to $10000 for the first year placed in service for tax years beginning after 2017) Butfor sport utility vehicles above the 6000 pound weight rating and not more than the 14000 poundweight rating (ie which are therefore not subject to the Code sect280Fcar caps) the maximumcost that may be expensed for any tax year under Code sect179 remains at just $2500015

- Under the House bill the Sec 179 cap would have been increased to $5 million (from the current$510000) and the phase-out amount would have increased to $20 million (from the current$2030000) effective for tax years beginning after 2017 through tax years beginning before 2023The Senate version would have allowed for $1 million in immediate expensing with a phaseoutof $25 million The final Conference bill adopted the Senate version

Comment As mentioned previously with bonus depreciation now 100 (for otherwise qualifyingnew or used assets placed into service after Sept 272017) along with the fact that this write-offis not subject to a cap does not have a phaseout mechanism or the need for ldquotrade or businesstaxable incomerdquo it now makes Sec 179 (at no matter what the overall cap is set at) basicallyredundant in most instances

Comment Once again keep in mind that unlike bonus depreciation (which is ldquoautomaticrdquo unlessthe taxpayer chooses to elect out of that particular MACRS class of assets by the extended duedate of that yearrsquos tax return) Sec 179 immediate expensing can always be revoked or electedon an amended tax return (ie assuming that the tax year in question is still open)

Example ldquoAmending Return to Elect Sec 179Upon being audited by the IRS the taxpayer is informed that they must capitalize certain assetimprovements which had originally been written off as ldquorepairsrdquo Despite the taxpayerrsquos protestsand in order to settle the IRS audit without additional expense the taxpayer capitalizes theldquorepairsrdquo but then chooses to amend the return in question taking Sec 179 immediate expensing(at least to the extent that it is still available to them for that particular tax year)

Example ldquoElecting Sec 179 After Cost Seg StudyrdquoAs a result of a cost segregation study numerous MACRS 5- and 7-year assets are uncoveredFurthermore the tax year in which they were placed into service is still open In this situation thetaxpayer can choose to amend their tax return for that year and immediate expense such newly-found assets (at least to the extent that the overall cap for Sec 179 has not yet been exceeded)Of course if those assets have been acquired and placed into service after Sept 27 2017 aForm 3115 could instead be filed to ldquocatch uprdquo on any depreciation along with 100 bonusdepreciation (even if it were a closed tax year assuming that the taxpayer had not elected out ofthat MACRS classlife for the year that the assets were first placed into service)16

15 For tax years after 2018 this $25000 limit will be indexed for inflation (something that was not done in thepast)

16 Keep in mind that if the taxpayer had merely misclassified an asset (or simply failed to claimed anydepreciation) and only one year had passed with the use of this erroneous method then a ldquomethod of accountingrdquowould not have been ldquoadopted for two or more consecutive yearsrdquo and therefore an amended return could be filed(and Form 3115 would not be necessary)


- The definition of section 179 property would now also include ldquoqualified energy efficientheating and air-conditioning propertyrdquo (ie HVAC assets) effective for property acquired andplaced in service after Nov 2 201717

Comment And now it would not matter for purposes of Sec 179 for instance if the air-conditioning equipment was located outside of the building (ie as is the current requirementfor ldquoqualified improvement propertyrdquo to be in the ldquointeriorrdquo of the building under the bonusdepreciation rules)

Comment Such property would be any depreciable Code sect1250 property that is (a) installed aspart of a buildings heating cooling ventilation or hot water system and (b) within the scope ofStandard 901-2007 of the American Society of Heating Refrigerating and Air-ConditioningEngineers and the Illuminating Engineering Society of North America

- The new Tax Act now allows for Sec 179 with regard to assets ldquoused in connection withlodgingrdquo (without regard to the current 30-day ldquotransient dwellerrdquo rule which normally applied tohotels motels and BampBs)

- Example ldquoAssets Used in Connection with Lodging - FampFrdquo In 2017 a taxpayer acquires a condo for rental purposes in FL and proceeds to fully furnish it withrugs furniture appliances etc Sec 179 would not be allowed for immediate write off of theseassets (although 50 bonus depreciation would be since these are MACRS 5-year assetsclassified as ADR 570 ldquoDistributive Trades or Businessesrdquo) Had the condo be acquired (orfurnished) in 2018 Sec 179 (let alone 100 bonus depreciation) could be used

- Example ldquoAssets Used in Connection with Lodging - Other AssetsrdquoA large 250-unit apartment complex has a maintenance shed in the rear of the property in whichare stored riding mowers snow blowers a pick-up truck and other equipment all of which areused to maintain the premises If this equipment and truck were placed in service in 2017 Sec179 would not be available since these assets ldquoare used in connection with lodgingrdquo (although 50bonus depreciation could be claimed) If the assets were instead placed into service after2017 Sec 179 could be used

Comment Of course either 50 or 100 bonus depreciation could be used on such MACRS5-year property depending on when they were acquired and placed into service (ie based onthe change for 92717 for bonus depreciation)

Example ldquoAssets Used in Connection with Lodging - HotelsMotelsrdquoIf these assets were instead being used in connection with a hotel motel or BampB etc then Sec179 would be available regardless of when the assets had been placed into service since theyinvolve real property being rented out to ldquotransient dwellersrdquo (ie whose average stay was 30days or less)

Comment Use of either Sec 179 immediate expensing or bonus depreciation avoids anydepreciation adjustment for AMT purposes since neither is a not a write-off ldquoexpressed in

17 Hopefully this change will clear up the confusion where the PATH Act (121815) stated that Sec 179

was available for HVAC assets but then the IRS came out with Rev Proc 2017-33 and insisted that it was only forldquoportable heaters and air conditioning unitsrdquo Code Sec 179 as amended by Act Sec 13101


terms of yearsrdquo Furthermore Sec 179 (but not bonus depreciation) can be used to avoid theimposition of the mid-quarter convention (which looks to any tangible personal or real property witha MACRS class life of 20 years or less where gt 40 of such property is placed into service duringthe last quarter of the tax year)

- The new Tax Act also modifies the definition of ldquoqualified real propertyrdquo and now uses theterm ldquoqualified improvement propertyrdquo eligible for Code sect179 expensing to include any ofthe following improvements to nonresidential (ie commercial) real property placed inservice after the date such property was first placed in service18 roofs heating ventilationand air-conditioning property fire protection and alarm systems and security systemseffective for tax years beginning after 2017

Comment The Conference Agreement still uses the term qualified real property instead of theterm qualified improvement property since the QIP improvements listed above (which were partof the MACRS 39-year QIP commercial real property classification in 2016) are now reclassifiedas MACRS 15-year QIP So even though some clarification would be welcome from the IRS orthe Treasury in the form of regulations 100 bonus depreciation would arguably be available forQIP improvements whether they are classified as MACRS 39-year or 15-year property

Example ldquoSec 179 - New Roof amp Alarm SystemsrdquoIn 2018 the taxpayer does major repairs to the roof of a commercial building along with fireprotection and alarm systems Determining that these expenditures should be capitalized as partof the basis of the real estate he does not take a current ldquorepairrdquo expense Nevertheless Sec 179could instead be used to immediate expense the cost of such assets

Comment As mentioned above with 100 bonus depreciation now available for ldquoqualifiedimprovement propertyrdquo19 100 bonus depreciation could be claimed (instead of Sec 179immediate expensing) on the cost of such assets

Comment Obviously if some of these improvements are instead treated as ldquorepairsrdquo20 youdo not even have to address the question as to whether Sec 179 can be taken on the costsinvolved But better to expense or use bonus depreciation You get an immediate write-off but still have the ldquounadjusted basisrdquo of the asset for Sec 199A purposes

LIRS Fact Sheet Highlights New Rules amp Limits for Depreciation and Expensing under TCJA(FS-2018-9)

18 Take note of the fact that the building does not have to be placed in service more than 3 years ago to takeadvantage of this immediate write-off Also it would appear that specific types of ldquoqualified improvement propertyrdquo thathad been in the MACRS 39-year class for commercial real estate in 2016 (and for whichrdquo 50 bonus depreciationwas allowed) have now been moved to this new QIP MACRS 15-year classification

19 The separate definition of ldquoqualified improvement propertyrdquo which had been classified as MACRS 39-yearcommercial property for 2016 (ie the first year that this new QIP definition came into the tax law) would now to beincluded in the expanded (and revised) definition of 15-year ldquoqualified real propertyrdquo (under which all of these types ofproperty improvements would be labeled as ldquoqualified improvement propertyrdquo (QIP) for MACRS classificationpurposes)

20 Over 75 years of case law have consistently reiterated that if the ldquorepairrdquo does not (1) ldquomaterially increaserdquothe current FMV of the asset or (2) ldquosignificantly prolongrdquo the assetrsquos useful life then a current Sec 162 ldquoordinary andnecessary business expenserdquo can be claimed for the underlying cost


The IRS has issued a fact sheet that highlights some of the new rules and limitations for depreciationand expensing under the Tax Cuts and Jobs Act

Increased Sec 179 Expensing Amounts A taxpayer may elect to expense the cost of any Codesect179 property (an expanded definition of which is discussed below) and deduct it in the year the propertyis placed in service The TCJA increased the maximum deduction from $500000 to $1 million andincreased the phase-out threshold from $2 million to $25 million effective for property placed inservice in tax years beginning after 2017 (ie unlike 100 bonus depreciation which changed forassets placed in service after 92717 regardless of tax year)

Expanded Definition of Sec 179 Property The TCJA also expanded the definition of Codesect179 property effective for property placed in service in tax years beginning after 2017 to allowtaxpayers to elect to include the following improvements made to nonresidential real property after thedate when the property was first placed in service (ie the property does not need to have been firstplaced into service gt 3 years previously)

- ldquoQualified improvement propertyrdquo which means any improvement to a buildings interior exceptimprovements attributable to the enlargement of the building any elevator or escalator or the internalstructural framework of the building

- Roofs HVAC fire protection systems alarm systems and security systems

First-Year Bonus Depreciation The TCJA increased the bonus depreciation percentage from50 to 100 for ldquoqualified propertyrdquo acquired and placed in service after Sept 27 2017 and before Jan1 2023 (Jan 1 2024 for certain aircraft and property with longer production periods) The bonusdepreciation percentage for qualified property that a taxpayer acquired before Sept 28 2017 and placedin service before Jan 1 2018 remains at 50 The definition of property eligible for 100 bonusdepreciation was expanded to include used (ie as opposed to only ldquooriginal userdquo) qualified propertyacquired and placed in service after Sept 27 2017 if

1) The taxpayer did not use the property at any time before acquiring it (eg used it first pursuant to alease and then decided to acquire it at the end of the lease) or acquire the property from a related partyor component member of a controlled group of corporations or

2) The taxpayers basis of the used property is not figured in whole or in part by reference to theadjusted basis of the property in the hands of the seller or transferor and is not figured under theprovision for deciding basis of property acquired from a decedent

Furthermore the cost of the ldquoused qualified propertyrdquo eligible for bonus depreciation does not includeany carryover basis of the property (eg in a like-kind exchange or involuntary conversation) The new law added qualified film television and live theatrical productions as types of qualified propertythat are eligible for 100 bonus depreciation effective for property acquired and placed in service afterSept 27 2017 But under the TCJA certain types of property are not qualified property eligible forbonus depreciation including most public utility property and any property used in a trade or businessthat has ldquofloor-plan financingrdquo (ie car and RV dealers)

Luxury Auto Limits The TCJA changed depreciation limits for passenger vehicles placed inservice after Dec 31 2017 If the taxpayer does not claim bonus depreciation the greatest allowabledepreciation deduction is $10000 for the first year $16000 for the second year $9600 for the third


year and $5760 for each later tax year in the recovery period On the other hand if a taxpayer does infact claim 100 bonus depreciation the greatest allowable depreciation deduction is $18000 for the firstyear $16000 for the second year $9600 for the third year and $5760 for each later tax year in therecovery period

Limits on Personal Use Property For property placed in service after 2017 the TCJA removedcomputer or peripheral equipment from the category of listed property subject to restrictive limits ondepreciation and expensing deductions

Farm Property The TCJA shortened the recovery period for machinery and equipment used ina farming business from being MACRS 7-year property to now being 5-year property (but excluding grainbins cotton ginning assets fences or other land improvements which remain in the MACRS 7-yearclass) However the ldquooriginal userdquo of such property must occur after 2017 (ie regardless of tax year)and the shortened recovery period is effective for property placed in service after 2017 Also propertyused in a farming business and placed in service after 2017 is not required to use the 150 decliningbalance method except for 15-year or 20-year property

Recovery Period - Real Property For property placed in service after 2017 the TCJA shortenedthe alternative depreciation system (ADS) recovery period for residential rental property from 40 yearsto 30 years Also under the TCJA ldquoqualified leasehold improvement propertyrdquo ldquoqualified restaurantpropertyrdquo and ldquoqualified retail improvement propertyrdquo are no longer separately defined (ie as ldquoqualifiedreal propertyrdquo) and given a special 15-year recovery period

Under the TCJA a real property trade or business electing out of the interest deduction limit under Codesect163(j) (ie if the business is otherwise under this constraint since their average gross receipts are notless than $25 million or they do not meet some other exception) must use the longer ADS class lives todepreciate any of its nonresidential real property residential rental property and qualified improvementproperty effective for tax years beginning after 2017

Use of ADS for Farm Businesses Farming businesses that elect out of the interest deductionlimit must use the alternate depreciation system (ADS) to depreciate any property with a recovery periodof 10 years or more such as single-purpose agricultural or horticultural structures trees or vines bearingfruit or nuts multi-purpose farm buildings and certain land improvements effective for tax years beginningafter 2017 (Misc Depreciation Methods)

LCRS Report Analyzes Impact of Sec 179 and Bonus Depreciation on Asset Acquisitions (CRSReport RL31852) The CRS report noted that many lawmakers treat the Code sect179 expensing and Code sect168(k) bonusdepreciation allowances as effective policy tools for promoting the growth of small firms and stimulatingthe economy during periods of slow or negative growth Meanwhile many business owners think of thetwo allowances as valuable and desirable instruments for increasing their cash flow and simplifying taxaccounting

Economists on the other hand have a more nuanced understanding of the effects of the allowancesand generally view their disadvantages as outweighing the advantages according to the CRS reportSpecifically economists maintain that the allowances have the potential to

i Promote an inefficient allocation of capital among domestic industries and investment opportunities(ie by distorting the allocation of resources based on whether the asset is tax-favored) and


ii Lessen the federal tax burden on upper-income business owners who are more likely to realize thebenefits associated with capital income

The report also noted that expensing arguably distorts a firms incentives to grow by limiting investmentin order to be able to continue to benefit from the allowance

The CRS report cited a number of reasons why the allowances likely had a modest impact on the USeconomy as a whole since the early 2000s including their design inherently limits their impact on thelevel of overall economic activity (ie by not applying to investments in inventory or land) spending onthe assets eligible for the allowances tends to account for a relatively small slice of US businessinvestment and expensing offers no immediate tax benefit to companies with net operating losses It alsonoted that the allowances ability to stimulate the economy was ldquomore limited during recessions becauseinvestment decision making during that time is likely more tied to economic vs tax considerationsrdquo Atthe same time the CRS observed that many economists acknowledge that expensing ldquocan reduce thecost of tax compliance especially for smaller firmsrdquo Nevertheless the allowances ldquogenerally simplify taxaccounting for depreciation and it takes less time and less paperwork to write off the entire cost of adepreciable asset in its first year of use than writing off that cost over a longer period using depreciationschedulesrdquo (Misc TCJA)

- 25-Year Classlife for Real Estate Rejected

- Under the final Conference bill the depreciable life for both residential and commercialreal estate will remain at 275 years for residential and 39 years for commercial propertyand would not be reduced to just 25 years (for property placed into service after 2017)

- Obviously cost segregation studies as well as an aggressive approach to taking ldquorepairrdquo write-offs (v capitalization) will continue to be important to avoid the normal MACRS classifications forreal property along with the $25005000 ldquode minimisrdquo asset exception

- Recovery Period for Other Types of Real Property

- Under current law the cost recovery periods for most real property are 39 years fornonresidential real property and 275 years for residential rental property The straight linedepreciation method and mid-month convention are required for such real property Howeverthere are a number of different recovery periods for other real property including separaterecovery periods for qualified real property improvements (whether or not made pursuantto a leasehold) which also includes premises used for a restaurant (whether or not theldquo50 of square footagerdquo test is met) and qualified retail improvement property All of theseimprovements (if not otherwise classified as ldquorepairsrdquo and written off as a current expense)are included in the MACRS 15-year recovery period as ldquoqualified real propertyrdquo

- The 6 other types of real property with ldquonontraditionalrdquo MACRS classification include (1) Single-purpose agricultural or horticultural structures as 10-year property (2) Car washbuildingsstructures gas stationconvenience stores billboards and land improvements as 15-yearproperty and (3) Multi-purpose agricultural or horticultural structures as 20-year property

Comment And since these 9 types of commercial real property have a MACRS classlifeof 20 years or less 100 bonus depreciation is also available


- Under prior law ldquoqualified leasehold improvement propertyrdquo was an interior building improvementto nonresidential real property by a landlord tenant or subtenant that was placed in service morethan three years after the building is and that meets other requirements (such as having aldquoqualified leaserdquo where there is not gt 80 relationship directly or indirectly between the landlordand tenant) ldquoQualified restaurant propertyrdquo was either (a) a building improvement in a building inwhich more than 50 of the buildingrsquos square footage was devoted to the preparation of andseating for on-premises consumption of prepared meals (the ldquomore-than-50 testrdquo) or (b) abuilding itself that passed the ldquomore-than-50 testrdquo21 ldquoQualified retail improvement propertyrdquo wasan interior improvement to retail space that was placed in service more than three years after thedate the building was first placed in service and that meets other requirements

- As mentioned above for property placed in service after Dec 31 2017 (ie regardless oftax year) the new Tax Act eliminates the separate definitions of ldquoqualified leaseholdimprovementrdquo ldquoqualified restaurant propertyrdquo and ldquoqualified retail improvement propertyrdquowhile retaining the MACRS 15-year recovery period for such ldquoqualified improvementpropertyrdquo (and a 20-year ADS recovery period for such property) Thus these types ofproperty would remain in the MACRS 15-year class although all three types of propertywould simply fall under the titled of ldquoqualified improvement propertyrdquo22

- As a result ldquoqualified improvement propertyrdquo placed in service after Dec 31 2017 (ieregardless of tax year) is generally depreciable over a MACRS 15-year recovery period using thestraight-line method and half-year convention regardless of whether the improvements areproperty subject to a lease placed in service more than three years after the date thebuilding was first placed in service or made to a restaurant building But restaurant buildingproperty placed in service after Dec 31 2017 that does not meet the definition of ldquoqualifiedimprovement propertyrdquo will continue to be depreciable as MACRS 39-year nonresidential (iecommercial) real property using the straight-line method and the mid-month convention

Comment So it would not matter any longer if a ldquoqualified leaserdquo was involved For that matterimprovements that otherwise qualified (ie interior of a commercial building) would not have tobe made to leased premises

Comment Take note that the ldquogt50 of square footage testrdquo for qualified restaurant real estatehas now been eliminated after 2017 As stated above the MACRS 15-year classification will onlyapply to such ldquoqualified improvementsrdquo As a result restaurant buildings placed into service after2017 will now be placed once again into the normal 39-year MACRS class for commercialbuildings (ie regardless of any ldquosquare footagerdquo test) In other words it will only be the ldquoqualifiedimprovementsrdquo made to restaurant buildings that will be eligible for MACRS 15-year classification(and thus Sec 179 and 100 bonus depreciation)

21 The ldquomore-than-3-yearrdquo test for qualified restaurant property was eliminated from the tax law severalyears ago even though it was retained for both ldquoqualified leasehold improvementsrdquo and ldquoqualified retailimprovementsrdquo through the 2017 tax year

22 What is not entirely clear with this new QIP label of former ldquoqualified real propertyrdquo is whether all types ofldquoqualified improvement propertyrdquo which was new for the 2016 tax year (and for which 50 bonus depreciation couldbe claimed given certain conditions were met) will now also be included under the new QRP category But with 100bonus depreciation this would essentially make this a moot point (ie whether QIPs were classified as either MACRS15-year or 39-year property)


- For tax years beginning after Dec 31 2017 an ldquoelecting farming businessrdquo (ie a farmingbusiness electing out of the limitation on the deduction for interest where they otherwise do notmeet the $25 million average gross receipts exception) must use ADS to depreciate any propertywith a recovery period of 10 years or more (eg a single-purpose agricultural or horticulturalstructures trees or vines bearing fruit or nuts multi-purpose farm buildings and certain landimprovements)

- Luxury Car Caps Dramatically Increased

- Code sect280F limits the Code sect179 expensing and cost recovery deduction with respect to certainpassenger autos (ie the luxury car caps) Under current law for passenger autos placed inservice in 2017 for which the additional first-year depreciation deduction under Code sect168(k) isnot (or could not be) claimed the maximum amount of allowable depreciation deduction is $3160for the year in which the vehicle is placed in service $5100 for the second year $3050 for thethird year and $1875 for the fourth and later years in the recovery period This limitation isindexed for inflation

- For passenger automobiles eligible for the additional first-year depreciation allowance in 2017the first-year limitation is increased by an additional $8000 This amount would have been phaseddown from $8000 by $1600 per calendar year beginning in 2018 As a result the Code sect280Fincrease amount for property placed in service during 2018 would have been $6400 and during2019 would have been $4800

- Special rules also apply to ldquolisted propertyrdquo such as any passenger auto any other property usedas a means of transportation any property of a type generally used for purposes of entertainmentrecreation or amusement and under pre-Act law any computer or peripheral equipment

- Under the new Tax Act for passenger automobiles placed in service after Dec 31 2017 (ieregardless of tax year) and for which bonus depreciation is not claimed the maximum amountof allowable depreciation would be $10000 for the year in which the vehicle is placed inservice $16000 for the second year $9600 for the third year and $5760 for the fourth andlater years in the recovery period

Comment These increased luxury car caps will be indexed for inflation for tax years after 2018

- If bonus depreciation is claimed then the first year cap would increase by $8000 (sameamount as in 2017) from $10000 to $1800023

- For passenger automobiles acquired before Sept 28 2017 and placed in service after Sept27 2017 the pre-Act phase-down of the Code sect280F increase amount in the limitation on thedepreciation deductions applies (ie the ldquooldrdquo $3160 luxury car cap will continue to apply) Andif the vehicle was not placed into service until 2018 then the first year $3160 car cap would onlybe increased by $6400 (ie instead of $8000) given bonus depreciation could be claimed

- These ldquoluxury car capsrdquo continue to apply to passenger vehicles with a ldquogross unloadedcurb weight ldquoof 6000 lbs or less

23 Code Sec 280F as amended by Act Sec 13202


- Even if this ldquoweight testrdquo was exceeded for instance with a ldquoheavy SUVrdquo then the$25000 limit on Sec 179 still continues to apply (ie the new Tax Act did not affect thisrestriction)

- But as with the current law if a ldquoqualified nonpersonal use vehiclerdquo (QNPUV) was involvedthen neither of these aforementioned limitations (ie luxury car caps or the $25000 capon Sec 179 expensing) would apply Such ldquoQNPUVsrdquo continue to include hotel or commutervans with seating for at least 9 passengers behind the driver seat pick-up trucks with at least a72 bed ldquonot readily accessible from the cabrdquo and any other vehicle not ldquosusceptible of significantpersonal userdquo (eg mini van used by a plumber carpenter electrician etc)

- Of course business owners can continue to lease (v own) their vehicles taking a leasededuction each year and only have to offset this write-off with a modest ldquoannual income inclusionrdquoamount

- Personal use of a business vehicle would continue to be imputed to the employee etc but thisldquorestoresrdquo the ldquobusinessinvestment userdquo back up to 100 for tax purposes24

LIRS Releases 2018 Vehicle Depreciation Limits (Rev Proc 2018-25) The IRS has released the Section 280F ldquoluxury car cap limitsrdquo for passenger autos (including trucks andvans) first placed in service during 2018 These amounts reflect changes made by the Tax Cuts andJobs Act (TCJA) which did not provide for an inflation adjustment for 2018 For passenger autosacquired before 92817 and placed in service during 2018 the depreciation limits are $10000 for thefirst year ($16400 with bonus depreciation) $16000 for the second year $9600 for the third year and$5760 for each succeeding year For passenger autos acquired after 92717 and placed in serviceduring 2018 the depreciation limits are $10000 for the first year ($18000 with bonus depreciation)$16000 for the second year $9600 for the third year and $5760 for each succeeding year Also theIRS has released the lease ldquoannual income inclusion amountsrdquo for lessees of passenger autos first leasedin 2018 (Code sect280F Luxury Car Caps)

LDepreciation Limits Increased for Purposes of Computing FAVR Plan Allowance (Notice 2018-42) TCJA also increased the depreciation limitations for passenger automobiles placed in service after 2017for purposes of computing the allowance under a FAVR plan The maximum standard automobile costmay not exceed $50000 for passenger automobiles trucks and vans placed in service after 2017 (upfrom $27300 for passenger automobiles and $31000 for trucks and vans as originally provided for inNotice 2018-3) (Code sect162 FAVR Plan)

- MACRS 5-Year Recovery Period and 200 DB for Certain Farm Property

- Under current law depreciable assets used in agriculture activities that are assigned arecovery period of seven years include machinery and equipment grain bins and fences(but no other land improvements which are assigned a MACRS 15-year classification) thatare used in the production of crops or plants vines and trees livestock the operation of farm

24 The only instance where this imputation of personal use does not work is with a sole proprietor who wouldnot have a W-2 where this amount could be listed As a result the write-off for business use v personal use has to bepro rated for tax purposes


dairies nurseries greenhouses sod farms mushrooms cellars cranberry bogs apiaries and furfarms and the performance of agriculture animal husbandry and horticultural services Cottonginning assets are also assigned a recovery period of seven years while land improvements suchas drainage facilities paved lots and water wells are assigned a recovery period of 15 years

- For new farm machinery or equipment (other than MACRS 7-year property such as grain binscotton ginning assets fences or other MACRS 15-year land improvements) used in a farmingbusiness the original use of which began with the taxpayer after Dec 31 2008 and was placedin service before Jan 1 2010 a MACRS 5-year recovery period had applied

- Under current law any property (other than nonresidential real property residential rentalproperty and trees or vines bearing fruits or nuts) used in a farming business was subject to the150 declining balance method However under a special accounting rule (ie which relievesthe farmer from having to comply with the Code sect263A ldquouniform capitalizationrdquo rules) certaintaxpayers engaged in the business of farming who elect to deduct pre-productive periodexpenditures are required to depreciate all farming assets using the alternative depreciationsystem (ADS ie using longer recovery periods and the straight-line method)

- Under the new Tax Act for property placed in service after Dec 31 2017 the recoveryperiod has been shortened from seven to five years for any machinery or equipment (againother than MACRS 7-year property such as grain bins cotton ginning assets fences or otherMACRS 15-year land improvements) used in a farming business the original use of whichcommences with the taxpayer and is placed in service after Dec 31 201725

Comment If you read the language in the new Tax Act closely the new MACRS 5-year recoveryperiod only applies to ldquooriginal userdquo property (ie new) As a result the purchase of used farmmachinery and equipment would continue to be assigned a MACRS 7-year recovery period

- The new Tax Act also repealed the required use of the 150 declining balance method forproperty used in a farming business (ie for 3- 5- 7- and 10-year property) The 150declining balance method would continue to apply to any 15-year or 20-year property used in thefarming business to which the straight line method does not apply or to property for which thetaxpayer elects the use of the 150 declining balance method As a result such assets may nowbe depreciated using the 200 declining balance method (though this would make themsusceptible to an AMT adjustment)

- The bottom line is that farming property will be depreciated under the 200 declining balancemethod except for (1) buildings and trees or vines bearing fruits or nuts (to which the straight-linemethod applies) (2) property for which the taxpayer elects either the straight-line method or 150declining balance method (3) 15- or 20-year MACRS property that has to be depreciated underthe 150 declining balance method and (4) property subject to the ADS Land improvementsother than buildings are 15-year property and fences and grain bins have a 7-year recoveryperiod and single-purpose agricultural or horticultural structures (eg greenhouses specializedhousing for livestock) have a 10-year recovery period

- Comment In other words the current MACRS recovery period for farm equipment is seven

25 Code Sec 168(e) as amended by Act Sec 13203


years But beginning with purchases of new assets26 in 2018 the recovery period for new farmequipment will now be five years27 and the use of the 200 declining balance method willbe allowed However grain bins fences and cotton ginning assets will continue to bedepreciated over 7 years

Comment In addition 100 bonus depreciation will now apply to all farm assets (other thanland) Unlike current rules that allow bonus depreciation on only ldquooriginal userdquo (ie new) assetsthis provision now applies to all assets acquired by a farmer This is due to all farm assets havinga MACRS recovery period of 20 years or less However for those farmers who have elected outof Section 263A (ie ldquouniform capitalization rulesrdquo) or will elect out of the new ldquobusiness interestdeduction rulesrdquo bonus depreciation is not allowed The question remains however that if thefarm business has average gross receipts of $25 million or less they do not have to ldquoelect outrdquo ofthese provisions since they are not otherwise applicable Therefore 100 bonus depreciationshould continue to apply (unless they have elected out of that MACRS class for bonusdepreciation)

- Listed Property Substantiation Rules Dropped for Computers amp Peripheral Equipment

- The new Tax Act removes computer or peripheral equipment from the definition of listedproperty Such property therefore would not be subject to the ldquoheightened substantiationrequirementsrdquo that otherwise apply to listed property

- Corporate Alternative Minimum Tax Repealed

- Under current law the corporate alternative minimum tax (AMT) is 20 with an exemptionamount of up to $40000 Corporations with average gross receipts of less than $75 million forthe preceding three tax years are exempt from the AMT The exemption amount phases outstarting at $150000 of alternative minimum taxable income

- The new Tax Act repeals the C corp AMT28

- For tax years beginning after 2017 the AMT credit is refundable and can offset regular taxliability in an amount equal to 50 (100 for tax years beginning in 2021) of the excess of theminimum tax credit for the tax year over the amount of the credit allowable for the year againstregular tax liability As a result the full amount of the minimum tax credit will be allowed in taxyears beginning before 2022

- Like-Kind Exchanges Now Only Available for Real Estate

26 It appears that used farm property will continue to have a MACRS 7-year recovery period This mayrequire a technical corrections bill if this was unintentional

27 Code Sec 168(e)(3)(B)

28 Code Sec 55 as amended by Act Sec 12001


- Under current law the like-kind exchange rule provided that no gain or loss was recognized tothe extent that property (ie which is defined very broadly to include a wide range of property fromreal estate to tangible personal property) ldquoheld for productive use in the taxpayerrsquos trade orbusinessrdquo29 or property ldquoheld for investment purposesrdquo is exchanged for property ldquoof a like-kindthat also is held for productive use in a trade or business or for investmentrdquo

- Under the new Tax Act LKEs would only be allowed for real property and not tangiblepersonal property (eg vehicles equipment etc) including any Sec 1245 property exchangedin connection with real estate To the extent of any trade-in value a taxable exchange wouldresult But this increased basis (ie not just any boot paid but the trade-in value of thenow taxable exchange) could be offset by either Sec 179 or bonus depreciation on thenewly-acquired property

- However under a transition rule the current like-kind exchange rules continue to apply toexchanges of personal property if the taxpayer has either disposed of the relinquished propertyor acquired the replacement property on or before Dec 31 201730

Example ldquoLKE of Tangible Personal PropertyrdquoA taxpayer purchases equipment for $500000 and depreciates it down to an adjust basis of zero(ie using either Sec 179 immediate expensing or 100 bonus depreciation) Four years laterhe trades in the equipment for a new like-kind asset and is allowed $100000 as the trade-in valueof this old equipment He also has to pay $400000 in boot (ie cash) to acquire the newequipment Under the new Tax Act this is now treated as a taxable exchange (ie so a Form4797 is filed for the disposition and not Form 8824) with a realized and recognized gain of$100000 (ie $100000 trade-in value - zero adjusted basis) And the basis of the newly-acquired equipment would have a cost basis31 of $500000 which in turn can be fully written offwith either Sec 179 or 100 bonus depreciation32

Example ldquoLKE of Real PropertyrdquoA taxpayer decides to do a like-kind exchange of a Schedule E rental property that has anadjusted basis of $100000 As part of the exchange for ldquoqualifying replacement propertyrdquo (ieresidential or commercial property or raw land) he also pays $400000 of boot (ie cash) andreceives no boot in return Assuming he uses a qualified intermediary and complies with theldquodeferred Starker exchange rulesrdquo he reports the exchange on Form 8824 realizing no gain onthe transaction and takes a $500000 basis in the new property (ie $100000 carryover basisplus boot paid of $400000) Furthermore assuming the exchange is not for raw land (ie anondepreciable property) he can choose to take either a ldquofresh startrdquo approach for depreciationpurposes (ie he list the acquisition date as the date on which the LKE occurred on Form 4562)

29 Here is one instance where even a Schedule E rental property is considered to be ldquoused in a trade orbusinessrdquo and can otherwise qualify as Sec 1231 property whose sale or exchange is reported on Form 4797 so longas the property has been held long-term This is important in determining whether the new Sec 199A 20 deductionapplies to net rental income (ie either on Schedule E or Form 8825 and Box 2 of the K-1)


31 Pursuant to Code Sec 1001

32 And for purposes of the 100 bonus depreciation rules for assets acquired after Sept 27 2017 it wouldnot matter if the newly-acquired equipment was new or used (ie the ldquooriginal userdquo requirement has been dropped)


and commences using a new MACRS recovery period along with ldquofreshrdquo depreciation (ie usingthe mid-month convention) Or instead he can choose to use ldquoshoesrdquo depreciation whereby hecontinues the same classlife and remaining MACRS recovery period on the carryover basis of$100000 and only ldquofresh startsrdquo the basis attributable to the $400000 in boot paid (ie therewould literally be two separate lines on Form 4562 pertaining to this one replacement asset)33

Comment The ldquogood newsrdquo is that the client does not need to list the sale of their business carwith a high adjusted basis (eg an expensive vehicle otherwise subject to the ldquoluxury car capsrdquo)and low FMV to get a Sec 1231 ordinary loss Now just the trade-in will produce this deemed sale(ie since the LKE rules will no longer apply)

Comment Like-kind exchanges might be a bit more complicated where there is a mixture ofboth Sec 1245 property along with Sec 1250 real estate (ie part salepart LKE) insomuchas you would need to split out each type of asset being exchanged treating the transaction aspartially a LKE (ie on Form 8824) and the remainder as a taxable exchange (ie on Form4797)

- Carried Interest Holding Period Extended to 3 Years

- In general the receipt of a capital interest for services provided to a partnership results in taxablecompensation for the recipient However under a safe harbor rule the receipt of a profits interestin exchange for services provided is not a taxable event to the recipient if the profits interestentitles the holder to share only in gains and profits generated after the date of issuance (andcertain other requirements are met)

- Normally hedge fund managers guide the investment strategy and act as general partners toan investment partnership while outside investors own their interests as limited partners Fundmanagers are compensated in two ways First to the extent that they invest their owncapital in the funds they share in the appreciation of fund assets Second they charge theoutside investors two kinds of annual ldquoperformancerdquo fees a percentage of total fundassets typically 2 and a percentage of the fundrsquos earnings typically 20 respectivelyThe 20 profits interest is often carried over from year to year until a cash payment is madeusually following the closing out of an investment It is this portion which is typically referred to asa ldquocarried interestrdquo

- Under the Tax Act a new three-year holding period will now have to be satisfied in orderfor a carried interest in certain investment entities (ie described as ldquoany applicablepartnership interest held by the taxpayerrdquo) to qualify as capital gain As a result it would treatas short-term capital gain taxed at ordinary income rates (but apparently not as income subjectto employment taxes) the amount of a taxpayerrsquos net long-term capital gain with respect to anapplicable partnership interest if the partnership interest has been held for less than three years34

33 Code Sec 168(i)(7) Under the ldquochange-in-userdquo regs the taxpayer can choose to use the ldquooldrdquo lives andmethod to the extent of the carryover basis in a LKE or instead choose to ldquofresh startrdquo the entire basis of thereplacement asset

34 Code Sec 1061 ldquoPartnership Interests Held in Connection with Performance of Servicesrdquo added by ActSec 13309(a)


LNew Carried Interest Rule Not Avoided by Having S Corporation Hold Interest (Notice 2018-18) The IRS has clarified that taxpayers will not be able to avoid the requirement contained in the new TaxAct that a carried interest must be held for a minimum of three years in order to obtain long-term capitalgain-by using an S corporation to hold the interest

Background As discussed above effective for tax years beginning after Dec 31 2017 the Actadded new Code sect1061 which imposes a 3-year holding period requirement in order for applicablepartnership interests (ie carried interests) received in connection with the performance of servicesto be taxed as long-term capital gain

Code sect1061(c)(1) generally defines the term applicable partnership interest as meaning any interestin a partnership which directly or indirectly is transferred to (or is held by) the taxpayer in connectionwith the performance of substantial services by the taxpayer or any other related person in anyapplicable trade or business But Code sect1061(c)(4)(A) provides that the term applicable partnershipinterest does not include any interest in a partnership directly or indirectly held by a corporation includingan S corporation

IRS Notice The IRS has announced that it will be issuing regs that prevent ldquoS corporationworkaroundsrdquo Specifically under these regulations the application of Code sect1061 will provide that theterm corporation for purposes of Code sect1061(c)(4)(A) does not include an S corporation As a resulttaxpayers will not be able to circumvent the three-year rule by using S corporations

- Restricted Stock Now Ineligible for Sec 83(b) Elections

- Restricted stock units would be explicitly ineligible for Code sect83(b) elections

- Transportation amp On-Premise Gym Fringe Benefits Curtailed

- Under current law a taxpayer may deduct up to 50 of expenses relating to meals andentertainment Housing and meals provided for the convenience of the employer on the businesspremises of the employer are excluded from the employeersquos gross income Various other fringebenefits provided by employers are not included in an employeersquos gross income such as qualifiedtransportation fringe benefits However under the new Tax Act a number of these fringe benefitsas discussed below would now be nondeductible by the business

- No deduction would be allowed for transportation fringe benefits (ie parking or transitpasses) benefits in the form of on-premises gyms and other athletic facilities or foramenities provided to an employee that are ldquoprimarily personal in nature and that involveproperty or services not directly related to the employers trade or businessrdquo except to theextent that such benefits are treated as taxable compensation to an employee (or includiblein gross income of a recipient who is not an employee)

Comment The reasoning behind the elimination of the deduction is that since the tax billsubstantially lowers the corporate tax rate smaller tax breaks that complicate the tax code are nolonger necessary Companies could still provide the parking and transit passes to employees butthey would no longer get the tax deduction (unless they treated such costs as additional wagesto the employee) But employees who pay for their own transportation costs can still use pre-tax


income35

Comment It should be noted that cities such as New York City San Francisco and WashingtonDC require employers of a certain size to offer workers pre-tax commuter benefits

Comment A deduction will still be allowed for expenses associated with providing any qualifiedtransportation fringe to employees ldquonecessary for ensuring the safety of an employeerdquo On theother hand the new Tax Act makes clear that any expense incurred for providing transportation(or any payment or reimbursement) for commuting between the employeersquos residence and placeof employment is a nondeductible expense of the employer (and would be as additional wagesto the employee if the employer continued to cover such costs)

Comment Note that the language used in the final Conference Agreement states for amenitiesprovided to an employee that are ldquoprimarily personal in nature and that involve propertyor services not directly related to the employers trade or businessrdquo So it would appear thata ldquono additional costrdquo fringe benefit such as a non-revenue seat for an airline employee (or theirfamily members) will continue to be excludible from the employees gross income since it wouldbe ldquodirectly related to the employerrsquos (ie airline) trade or businessrdquo

Example ldquoEmployer Provided Transportation for Employee SafetyrdquoStephanie sometimes has to work long hours at her mid-town Manhattan office When workingpast 9 PM she can (at her discretion) take a cab home to Brooklyn instead of the subway Underthe new Tax Act given this is done to ensure the safety of the employee reimbursement of suchcosts to Stephanie need not be treated as additional wages

- The provision generally applies to amounts paid or incurred after December 31 2017However for expenses of the employer associated with providing food and beverages toemployees through an eating facility that meets requirements for ldquode minimis fringes and for theconvenience of the employerrdquo (as discussed below) amounts paid or incurred after December31 2025 are not deductible

LIRS Releases Updated Version of Publication 15-B The IRS has released an updated version of Publication 15-B (Employers Tax Guide to FringeBenefits) for use in 2018 Among other things the updated guide reflects provisions of the Tax Cuts andJobs Act (TCJA) that suspended or eliminated the income exclusion or tax deduction for certain fringebenefits For example the section on moving expense reimbursements has been removed due to theTCJAs suspension of the exclusion for tax years beginning after 2017 and before 2026 (except for activeduty military) In addition the guide clarifies that the deduction for ldquoqualified transportationrdquo is unavailableregardless of whether the benefit is provided by the employer through a bona fide reimbursementarrangement or through a compensation reduction agreement (Misc IRS Pub 15-B)

Comment This 2018 version provides that a purported workaround with respect to the Tax Cutsand Jobs Act (TCJA) provision that eliminated the employer deduction for transit and parkingbenefits does not provide employers with the deduction that workaround proponents say it does

- Entertainment and Meal Expenses Curtailed

35 There is a good summary on the elimination of the exclusion for transit passes in US News


- Under the new Tax Act no deduction will now be allowed for entertainment amusementor recreation activities facilities or membership dues relating to such activities or othersocial purposes for such costs incurred after 2017

- In other words the 50 limitation under current law would now apply only to expenses forfood or beverages and to ldquoqualifying business mealsrdquo (as defined under the Tax Reformprovisions) with no deduction allowed for other entertainment expenses (eg golf outingswith clients tickets to sporting events etc)

- The final Conference bill does go after that ldquofree foodrdquo that many companies provide theirworkers The new Tax Act would prevent companies from fully deducting the cost of foodand beverages they provide to workers at for example a corporate snack bar Instead theywould be taxed like restaurant meals for employees which are only 50 deductible36

Comment As discussed below this reduction to only 50 deductibility would not have any impactChristmas office parties as well as summer picnics for employees Also unaffected would be thecost of meals provided ldquofor the convenience of the employerrdquo (ie pursuant to Code sect119) Nevertheless ldquosubsidized eating facilitiesrdquo such as hospital and company cafeterias would nowface a 50 deduction limit However a restaurant would still write off the entire cost of any foodprepared for customers as part of its cost of goods sold But meal allowances provided under theapproved IRS per diem amounts and subject to the ldquoaccountable planrdquo rules would continue toresult in a 50 disallowance to the employers (or to the party otherwise making thereimbursement such as in an independent contractor situation)

Example ldquoMeals Provided to Employees in Travel StatusrdquoA music group is currently touring the country performing concerts in numerous cities They aresupported by a number of employees that set up and break down the stage arrangements in eachcity An IRS-approved per diem amount for meals is provided to these employees while that arein travel status for tax purposes Or as an alternative a catered meal is provided on-site for theday of the performance Under both sets of circumstances the new Tax Act would limit theemployerrsquos deduction for such meals to only 50 (ie since they are the reimbursing party for thecost of the meals)

- For tax years beginning after Dec 31 2025 the new Tax Act will disallow an employerrsquosdeduction for expenses associated with meals provided ldquofor the convenience of the employer onthe employerrsquos business premises or provided on or near the employerrsquos business premisesthrough an employer-operated facility that meets certain requirementsrdquo37

- The elimination of deductions for entertainment expenses would do away with the subjectivedetermination of whether such expenses are ldquosufficiently business relatedrdquo And as mentionedabove the current 50 limit on the deductibility of business meals is expanded to meals providedthrough an in-house cafeteria or otherwise on the premises of the employer

LTax Deduction Status for Various Types of Business Meals Under the New Tax Act

36 This limit applies until 2025 and then after that the costs would not be deductible at all The changeswould not directly affect employees but it might make companies think twice about providing generous spreads



This summary outlines the changes made by the Tax Cuts and Jobs Act and its impact not only onentertainment expenses but more importantly going forward to what extent are business meals stilldeductible for tax purposes

Comment A number of commentators (Cf ldquoNew Tax Law Cans Business Meals IndigestionInevitablerdquo (McBride Tax Notes Vol 158 No 13 32618)) have insisted that under Codesect274 the term ldquoentertainmentrdquo would also include business meals leading to these costs also beingeliminated As a result tax professionals are looking for Congress to enact a technical correctionto fix this problem and thereby clearly keep at least the ldquomealrdquo portion of entertaining a clientdeductible for tax purposes

Background Before the Tax Cuts and Jobs Act (TCJA) taxpayers could generally deduct 50of business-related meal and entertainment expenses Furthermore limited exceptions allowed for evenlarger deductions in certain circumstances But after 2017 entertainment expenses are completelyeliminated Nevertheless there exists some confusion what if any impact will this have on business-related meals in varying circumstances Below is a summary of what the law was before the changesmade before the new Tax Act as well as the ground rules going forward

Prior Law - 50 Deduction for Business Meals Under prior law taxpayers were generally ableto deduct 50 of business-related meal and entertainment expenses incurred or paid before 1118 underformer Code sect274(n) But even under the former rules taxpayers still had to establish that the expenseswere ldquodirectly related to or associated with the active conduct of a trade or business or income-producingactivityldquo And this general 50 deductibility rule applied to all business-related meals and entertainmentexpenses unless a specific exception applied

Exceptions to 50 Deduction for MampE - Prior and Current Law Under the prior law thefollowing exceptions to the general 50 deductibility rule were available And as outlined below someof these exceptions are still available in the under the provisions of the new Tax Act

(1) An employer was permitted to deduct 100 of meal expenses that were excluded from the recipientemployees gross income as a ldquode minimis fringe benefitrdquo For example ldquooccasional mealsrdquo foremployees working overtime qualified for this exception under former Code sect274(n)(2)(B) Codesectsect132(e)(1) and 274(e)(1) and Reg sect1132-6(d)(2)

(2) An employer was permitted to deduct 100 of the cost (including facility and other overhead costs)of providing meals to employees at a ldquoqualifying employer-operated eating facilityrdquo For example underformer Code sect274(n)(2)(B) and Code sectsect132(e)(2) and 274(e)(1) this exception applied to a qualifyingcompany cafeteria such as in a hospital where doctors and nurses were required to be readily availableshould their patients need them

(3) An employer was permitted to deduct 100 of meal and entertainment expenses that were reportedas taxable compensation to the employees receiving these benefits

Comment This exception is still available under the new Tax Act pursuant to Code sect274(e)(2)and continues to even cover applicable entertainment expenses given that such costs are treatedas taxable wages to the employees involved

(4) An employer was permitted to deduct 100 of food beverage and entertainment expenses incurredfor recreational social or similar activities ldquoprimarily for the benefit of employees other than certainhighly-compensated employeesrdquo (eg a company picnic or holiday party)


Comment This exception is still available under the new Tax Act pursuant to Code sect274(e)(4)and continues to even cover such entertainment costs let alone the food and beverage expenses

(5) Taxpayers were allow to deduct 100 of the cost of food beverages and entertainment that weremade available to the general public (eg free snacks at a car dealership or free food and music at anevent open to the public)

Comment This exception is still available under the new Tax Act pursuant to Code sect274(e)(7)and covers any entertainment costs as well as any food or beverage expenses that suchbusinesses might incur

(6) Taxpayers were allowed to deduct 100 of the cost of food beverages and entertainment sold tocustomers for full value including the cost of related facilities (ie as part of their cost-of-goods-soldschedule)


(7) Taxpayers were allowed to deduct 100 of the cost of meals and entertainment that were reportedas taxable income to a non-employee recipient on a Form 1099 (eg when a potential customer winsa dinner cruise valued at $750 at a sales presentation and is issued a Form 1099

Comment This exception is still available under the new Tax Act pursuant to Code sect274(e)(9)and covers any entertainment costs as well as food and beverage costs

(8) An employer was allowed to deduct 80 of the cost of meals provided to employees whose workis subject to US Department of Transportation ldquohours-of-service limitationsrdquo (eg interstate truck driversand airline pilots)

Comment This exception is still available under the new Tax Act pursuant to Code sect274(n)(3)

(9) Taxpayers were allowed to deduct 100 of the cost of tickets (less the FMV of any benefit receivedby the donor such as a meal drinks prizes or greens fee and cart in the example below) to fund raisingcharitable sporting events if (1) the event was organized for the benefit of a qualifying charitableorganization (2) 100 of the net proceeds were contributed to the charity and (3) volunteers didsubstantially all the work in staging the event For example a golf tournament organized to benefit acharity when all of the net proceeds are donated to the charity

Comment This exception however was eliminated under the provisions of the new Tax Act

Comment Many inquiries were received about the potential effect of the new Tax Act on certainmeal and entertainment expenses such as company picnics and holiday parties The thought wasthat such employee events for instance were now only 50 deductible However the JointCommittee on Taxation recently commented that the new Tax Act did not eliminated the Section274(e) exceptions to the disallowance of certain entertainment expenses As a result suchexpenses continue to be deductible under these old rules Nevertheless the IRS is expected toissue further guidance on changes to meal and entertainment expenses under Code sect274particularly as to how the new Tax Act impacts the deduction for business related meals


Elimination of Deduction for Entertainment Expenses Under Code sect274(a)(1) effective foramounts paid or incurred after 123117 the new Tax Act disallows deductions for the most commonbusiness-related entertainment expenses including the cost of facilities used for most business-relatedentertainment activities This would include the cost of tickets to sporting events license fees for stadiumor arena seating rights private luxury box suites at sporting events theater tickets golf club greens feesfor customers and business clients (monthly dues were already nondeductible) hunting fishing andsailing outings and all other entertainment related business expenses (except for the few narrowexceptions noted above such as company picnics or holiday parties for employees)

Allowable Food and Beverage Expenses under New Tax Act Under the new Tax Act the mostcommon business-related meals are still 50 deductible and the long-standing requirement forsubstantiating that the meals are business-related still applies In addition food and beverage expensesthat fall under exceptions 3-7 (listed above) are still 100 deductible and are not affected by any of thechanges made by the new Tax Act Meals that fall under exception 8 are still 80 deductible as well

Comment Also an argument can still be made that businesses can deduct 50 of food andbeverage expenses (but not any costs associated with the associated entertainment) incurred atsuch events but only if business was conducted during the event or immediately before or afterHowever this position is not clear cut so we should exercise caution until the IRS hopefully issuesguidance on this issue

Hotel amp Meal Expenses for Employees in Travel Status If a hotel or other lodgingestablishment includes meals in its room charges (eg daily breakfast or happy hour snacks and drinksare provided) or a taxpayer gives employees per-diem allowances that are intended to cover meals thetaxpayer must use a reasonable method to determine the portion of expenditures that are allocable tomeals and therefore subject to the 50 disallowance rule

Comment Assuming that the employee is being reimbursed under an ldquoaccountable planrdquo thenit is the employer who is subject to the 50 disallowance for meal expenses

Suggested Approach for MampE Expenses under the New Tax Act Practitioners should advisetheir clients to evaluate their current expense allowance policies to determine if changes are necessarydue to the unfavorable provisions in the new Tax Act especially for entertainment expenses incurred byemployees which are now nondeductible (unless reported as taxable compensation) Separateaccounting system may be needed to track changes with regard to both employee entertainmentexpenses and employee business-related meal expenses which are still 50 deductible

Meals Treated as DeMinimis Fringe Benefits Under the previous version of Codesect274(n)(2)(B) employers were permitted to deduct 100 of the cost of food and beverages if theyqualified as a tax-free ldquode minimis fringe benefitrdquo to employees (ie defined as a benefit with a value andfrequency of occurrence that made accounting for it ldquoadministratively impracticalrdquo) (Cf Code sectsect132(e)(1)and 274(e)(1) and Reg sect1132-6(d)(2)) Examples of de minimis fringe benefits include

- Meals or meal money provided to employees on an occasional basis

- Meals or meal money provided to employees because overtime work is necessary and the meals ormeal money enables the employees to work overtime

Under the new Tax Act former Code sect274(n)(2)(B) was eliminated As a result ldquode minimis fringebenefit mealsrdquo are no longer 100 deductible for amounts paid or incurred after 2017 However


arguably the new Tax Act still permits a 50 deduction for de minimis meals or meal money assumingthese costs come within the exceptions provided by Code sect274(e)(1) (ie occasional meals foremployees working overtime) and Code sect274(n)(2)(A) (ie as defined under Codesectsect274(e)(2)(3)(4)(7)(8) and (9) which includes the cost of meals treated as compensation employeesreimbursed for the cost of meals recreational expenses of employees meals available to the generalpublic entertainment sold to customers and expenses includible in the income of persons other thanemployees)

Tax Treatment of Employer-Subsidized Eating Facilities Under the former version of Codesect274(n)(2)(B) employers were allowed to deduct 100 of the cost of operating a ldquoqualified eating facilityrdquofor employees (eg company cafeteria) (Cf Code sectsect132(e)(2) and 274(e)(1)) In order to qualify assuch the facility had to meet the following requirements

- Be owned or leased by the employer

- Be operated by the employer (directly or through a contract with a vendor)

- Be on or near the employers business premises

- Revenue from the facility equals or exceeds the cost of operating the facility

- Meals are served during or immediately before or after the employees workday and

- The facility is available to generally all employees

The new Tax Act eliminated this former version of Code sect274(n)(2)(B) As a result for amounts paidor incurred from 1118 through 123125 the new law allows employers to deduct only 50 of the costof operating a subsidized qualified eating facility for employees And after 2025 (given there is notanother law change in the interim) no deductions will be allowed [(Cf Code sectsect274(n)(1) and 274(o))

Comment Obviously if the deduction for such facilities is being reduced in half (and maybeeventually eliminated) then employers will either have to consider raising the prices charged toemployees or even perhaps doing away with this option Nevertheless operations such as ahospital will still want their employees to take quick lunches on-premise and otherwise beavailable for their patients

Tax Treatment of Meals Provided for the Convenience of Employer Under the former versionof the law the cost of meals furnished to an employee ldquofor the convenience of the employerrdquo could befully deducted by the employer and treated as tax-free to the recipient [(Cf Code sect119(a) and Regsect1119-1(a)(2)) However 100 deductibility for the employer only applied if a number of requirementswere met If not the general 50 deductibility rule for meals applied

Under the new Tax Act for costs incurred from 2018 to 2025 employers will now be allowed to deductonly 50 of the cost of meals provided ldquofor the convenience of the employerrdquo And after 2025 nodeductions for such meals will be allowed (Cf Code sect274(o)(2))

Comment This analysis is based on an understanding of the law as it exists after theimplementation of the new Tax Act Nevertheless future IRS guidance could alter thisinterpretation of the deduction for meals As a result it is probably best to identify and segregatethe various types of meal expenses that a business might incur so that if the law evolves further


appropriate adjustments for tax purposes can be applied

- Employer-Provided Housing

- Under the House bill the exclusion for housing provided for the convenience of the employer andfor employees of educational institutions under Code sect119 to would have been limited to $50000($25000 for a married individual filing a separate return) In addition the exclusion would havebeen phased out for higher-income individuals

- The Conference bill did not eliminate this housing exclusion or otherwise imposed anycaps on the exclusion amount

Example ldquoApartment Provided to Graduate Student Overseeing Landlordrsquos RentalPropertyrdquoThe taxpayer owns a 100-unit apartment complex for mostly student renters near a majoruniversity But to limit his involvement on a day-to-day basis he supplies a graduate student afree unit along with a small monthly stipend This student-employee to expected to show units toprospective renters assist in lock-out situations and other emergency type occurances Althoughthe monthly stipend would be treated as wages to this employee the FMV of the housing wouldcontinue to be excludible

Example ldquoHotel Rooms Provided to Employees for Inclement Weather Situationsrdquo Whenthe 3 to 11 PM shift is coming to an end the manager on duty for a local hotel requests thatseveral employees stay over just in case the following morning 7 AM to 3 PM shift workers areunable to make it in due to impending bad weather (eg a severe snow storm) These roomsbeing used by the employees were otherwise going to be vacant for the night More importantlythe value of the rooms being used ldquofor the convenience of the employerrdquo in this instance would notresult in additional wages to the employees involved

- Treatment of Certain Self-Created Property

- Under current law property held by a taxpayer (whether or not connected with the taxpayerrsquostrade or business) is generally considered a capital asset under Code sect1221(a) However certainassets are specifically excluded from the definition of a capital asset including inventory propertydepreciable property and certain self-created intangibles (eg copyrights musical compositions)

- Under the new Tax Act such assets would no longer be treated as capital assets As aresult gain or loss from the disposition of a self-created patent invention model or design(whether or not patented) or secret formula or process would be ordinary in character Inaddition the election to treat musical compositions and copyrights in musical works as a capitalasset would also be repealed38

Comment The question has come up that since the disposition of such assets would now be

38 This change is not meant to convert goodwill of a business (either self-created through the efforts of theowners or acquired from a third party) into an ordinary income asset Of course however any amortization wouldhave to be treated as Sec 1245 recapture to the extent of gain realized on a taxable sale or exchange


treated as ordinary income would it be subject to self-employment tax The answer is not clearespecially if one could argue that the asset in question was not created in the conduct of a tradeor business and therefore should not be subject to SE tax

Comment This change is limited to those specifically enumerated assets described in Codesect1221(a)(3) (eg self-created patent invention model or design (whether or not patented) orsecret formula or process) It is not intended to transformed self-created assets such as goodwill(eg patients clients or customers belonging to a well-established professional firm) from acapital asset into an ordinary income one (except to the extent any such goodwill has beenpreviously amortized)

- Non-Owner Capital Contributions

- Under current Code sect118(a) provides that the gross income of a corporation (but not anynoncorporate entity such as a partnershipLLC) generally does not include any contribution to itscapital by a non-owner For purposes of this rule Code sect118(b) excludes from a contribution tothe capital of a corporation any contribution made ldquoin aid of construction or any other contributionfrom a customer or potential customerrdquo

- But if property is acquired by a corporation as a contribution to capital and is not contributed bya shareholder as such the adjusted basis of the property is deemed to be zero under Codesect362(c)(1) If the contribution consists of money Code sect362(c)(2) provides that the corporationmust first reduce the basis of any property acquired with the contributed money within the following12-month period and then reduce the basis of other property held by the corporation

- Under the new Tax Act Code sect118 would effectively be repealed As a result allcontributions to capital by a non-owner (eg governmental entity) made after the date ofenactment (122217) would be taxable And it would not matter whether these contributionswere made to a corporate or non-corporate entity (eg partnerships SMLLCs)39

Example ldquoCapital Contributions by Non-OwnerrdquoIn order to have a company locate their new location within a certain municipality both the stateand local government has extended significant enticements including free land along with taxrebates If these enticements are made after 2017 the FMV of each must now be included in thegross income of the company

- There is however an exception for ldquoprior approvalsrdquo As a result the new provision does notapply to any contribution made after the date of enactment (ie 122217) by a governmentalentity ldquopursuant to a master development plan that had been approved prior to such date by agovernmental entityrdquo

- Rollover of Publicly Traded Securities Gain

- Under current law Code sect1044(a) provides that a corporation or individual may elect to roll over

39 This change would have a significant impact on businesses that receive incentives and concessions fromstate or local governments Code Sec 118 as amended by Act Sec 13312


tax-free any capital gain realized on the sale of publicly-traded securities to the extent of thetaxpayerrsquos cost of purchasing common stock or a partnership interest in a ldquospecialized smallbusiness investment companyrdquo (SBIC) within 60 days of the sale The amount of gain that anindividual may elect to roll over under this provision for a taxable year is limited to (1) $50000 or(2) $500000 reduced by the gain previously excluded under this provision for corporations theselimits are $250000 and $1 million respectively (Code sect1044(b))

- The rollover of publicly traded securities gain into specialized small business investmentcompanies under Code sect1044 would be repealed effective for sales after 201740

- Tax Incentives for Investment in Qualified Opportunity Zones

- The Code currently has several incentives aimed at ldquoencouraging economic growth andinvestment in distressed communitiesrdquo by providing Federal tax benefits to businesses locatedwithin designated boundaries For example there is a federal income tax credit that is allowed inthe aggregate amount of 39 of a taxpayerrsquos ldquoqualified equity investmentrdquo in a ldquoqualifiedcommunity development entityrdquo (CDE) which is defined as an entity which is required to makeinvestments in low-income communities

- Effective on the enactment date (122217) the new Tax Act provides temporary deferralof inclusion in gross income for capital gains reinvested in a ldquoqualified opportunity fundrdquoand the permanent exclusion of capital gains from the sale or exchange of an investmentin the qualified opportunity fund41

- The new Tax Act also allows for the designation of certain ldquolow-income community populationcensus tractsrdquo as ldquoqualified opportunity zonesrdquo The designation of a population census tract asa qualified opportunity zone remains in effect for the period beginning on the date of thedesignation and ending at the close of the tenth calendar year beginning on or after the date ofdesignation (Code sect1400Z-1)

- Temporary deferral applies for capital gains that are reinvested in a ldquoqualified opportunity fundrdquowhich is defined as ldquoan investment vehicle organized as a corporation or a partnership for thepurpose of investing in qualified opportunity zone propertyrdquo (other than another qualifiedopportunity fund) that holds at least 90 of its assets in ldquoqualified opportunity zone propertyrdquoQualified opportunity zone property includes any qualified opportunity zone stock any qualifiedopportunity zone partnership interest and any qualified opportunity zone business property

- The maximum amount of the deferred gain equals the amount invested in a ldquoqualified opportunityfundrdquo by the taxpayer during the 180-day period beginning on the date of sale of the asset to whichthe deferral pertains However for amounts of the capital gains that exceed the maximum deferralamount the capital gains are recognized and included in gross income

- ldquoPost-acquisition capital gainsrdquo apply for a sale or exchange of an investment in opportunity zonefunds that are held for at least 10 years At the election of the taxpayer the basis of such

40 Former Code Sec 1044 as stricken by Act Sec 13313(a)

41 Code Sec 1400Z-2 as amended by Act Sec 13823


investment in the hands of the taxpayer is the fair market value of the investment at the date ofsuch sale or exchange

- Taxpayers however will continue to be allowed to recognize losses associated with investmentsin ldquoqualified opportunity zone fundsrdquo42

LldquoOpportunity Zonesrdquo Might Provide Significant Tax Savings Under TCJA The ldquoopportunity zone programrdquo under the new Tax Cuts and Jobs Act is not getting much attentionNevertheless when it is fully operational it will allow taxpayers to defer capital gains from the sale orexchange of business or personal property by investing the proceeds in ldquoopportunity fundsrdquo which arethen used to help low-income communities Taxpayers may decide to defer all or only a portion of thegain from a particular sale Although the program is in its initial stages the IRS has issued guidance tostate officials that sets forth various requirements and due dates for nominating localities that are eligibleto qualify for targeted economic investment by the opportunity funds (Code sect1400Z-1 OpportunityZones)

Comment One concern is that it is set to expire after 2025 And another open issue is whethergain deferral would automatically end at that time

L Treasury amp IRS Announce Designated TCJA Opportunity Zones (Treasury Press ReleaseTreasury IRS Announce First Round Of Opportunity Zones Designations for 18 States) The Treasury Department and the IRS have announced the designation of Opportunity Zones in 18states Opportunity Zones investments in which can receive preferential tax treatment were createdunder the Tax Cuts and Jobs Act in order to spur investment in distressed communities throughout thecountry

Background Code sect1400Z-1 as recently added by the TCJA allows for the designation ofcertain low-income community population census tracts as ldquoqualified opportunity zonesrdquo eligible for anumber of favorable tax rules aimed at encouraging economic growth and investment to businesseswithin the zone In general a population census tract that is a low-income community is designated asa ldquoqualified opportunity zonerdquo if the chief executive officer of the State in which the tract is located timelynominates the tract for designation as such and notifies the IRS in writing of the nomination and the IRSin return certifies the nomination and designates the tract as a qualified opportunity zone beyond the endof the consideration period (Code sect1400Z-1(b))

Code sect1400Z-2 provides temporary deferral of inclusion in gross income for capital gains reinvestedin a qualified opportunity fund and the permanent exclusion of capital gains from the sale or exchangeof an investment in the qualified opportunity fund

A ldquoqualified opportunity fundrdquo is generally an investment vehicle organized as a corporation or apartnership for the purpose of investing in ldquoqualified opportunity zone propertyrdquo (other than anotherqualified opportunity fund) that holds at least 90 of its assets in qualified opportunity zone property

ldquoQualified opportunity zone propertyrdquo includes any qualified opportunity zone stock any qualifiedopportunity zone partnership interest and any qualified opportunity zone business property

States were required by March 21st to submit nominations or request a 30-day extension to submit



nominations and the Treasury has 30 days from the date of submission to designate the nominatedzones

Comment Code sect1400Z-1 was modified by the Bipartisan Budget Act of 2018 to a newsubsection Code sect1400Z-1(b)(3) which provides a special rule for Puerto Rico under which everypopulation census tract in Puerto Rico that is a low-income community is deemed to be certifiedand designated as a ldquoqualified opportunity zonerdquo effective as of Dec 22 2017 (ie the date thatthe TCJA was enacted)

Designations Announced The Treasury has now designated the nominations of all States thatsubmitted by the March 21st deadline And the Treasury will make future designations as submissionsby the states that have requested an extension are received and certified Submissions were approvedfor American Samoa Arizona California Colorado Georgia Idaho Kentucky Michigan MississippiNebraska New Jersey Oklahoma Puerto Rico South Carolina South Dakota Vermont Virgin Islandsand Wisconsin

Qualified opportunity zones retain this designation for 10 years And investors can defer tax on any priorgains until no later than Dec 31 2026 so long as the gain is reinvested in a Qualified Opportunity Fund(ie an investment vehicle organized to make investments in Qualified Opportunity Zones) In additionif the investor holds the investment in the Opportunity Fund for at least ten years the investor would beeligible for an increase in its basis equal to the fair market value of the investment on the date that it issold (ie so no gain would be recognized on the sale)

Comment The Treasury and the IRS plan to issue additional information on Qualified OpportunityFunds The additional guidance will address the certification of Opportunity Funds which arerequired to have at least 90 of fund assets invested in Opportunity Zones (Code sect1400Z-2Qualified Opportunity Zones)

- Transfers of Patents

- The special rule treating the transfer of a patent prior to its commercial exploitation aslong-term capital gain would be repealed effective for dispositions after 2017

- Nonqualified Deferred Compensation

- Originally an employee would be taxed on compensation as soon as there is no ldquosubstantial riskof forfeiturerdquo with regard to that compensation (ie receipt of the compensation is not ldquosubject tofuture performance of substantial servicesrdquo) But the new Tax Act preserves the current lawtreatment of such compensation

- Employee Achievement Awards

- Employee achievement awards are excludible to the extent the employer is permitted to deductthe cost of the award (generally limited to $400 for any one employee or $1600 for a ldquoqualifiedplan awardrdquo) An ldquoemployee achievement awardrdquo is an item of tangible personal property givento an employee ldquoin recognition of either length-of-service or safety achievement and presented aspart of a meaningful presentationrdquo


- For amounts paid or incurred after Dec 31 2017 a more specific definition of ldquotangiblepersonal propertyrdquo is provided What ldquotangible personal propertyrdquo does not include howeveris cash cash equivalents gifts cards gift coupons gift certificates (other than where from theemployer pre-selected or pre-approved a limited selection) vacations meals lodging tickets fortheater or sporting events stock bonds or similar items and other non-tangible personal property

Comment The language of the Conference Agreement emphasizes that ldquono inference is intendedthat this is a change from present law and guidancerdquo43

- Length of Service Award Programs for Public Safety Volunteers

- Under current law any plan that solely provides ldquolength-of-service awardsrdquo to bona fidevolunteers or their beneficiaries on account of ldquoqualified servicesrdquo performed by the volunteersis not treated as a plan of deferred compensation for purposes of the Code sect457 rules ldquoQualifiedservicesrdquo are fire fighting and prevention services emergency medical services and ambulanceservices including services performed by dispatchers mechanics ambulance drivers andcertified instructors The exception applies only if the aggregate amount of length of serviceawards accruing for a bona fide volunteer with respect to any year of service does not exceed$3000

- For tax years beginning after Dec 31 2017 the new Tax Act increases the aggregateamount of length-of-service awards that may accrue for a bona fide volunteer with respectto any year of service from $3000 to $6000 and adjusts that amount to reflect changes incost-of-living for years after the first year the proposal is effective Also if the plan is a definedbenefit plan the limit applies to the actuarial present value of the aggregate amount of length-of-service awards accruing with respect to any year of service Actuarial present value is calculatedusing ldquoreasonable actuarial assumptions and methodsrdquo assuming payment will be made underthe ldquomost valuable form of payment under the planrdquo with payment commencing at the later of theearliest age at which unreduced benefits are payable under the plan or the participantrsquos age at thetime of the calculation44

Accounting Method Changes

- Taxable Year of Inclusion

- Under current law generally speaking for a cash basis taxpayer an amount is included inincome ldquowhen actually or constructively receivedrdquo For an accrual basis taxpayer an amount isincluded in income when ldquoall the events have occurred that fix the right to receive such income andthe amount thereof can be determined with reasonable accuracyrdquo (ie when the ldquoall events testrdquois met) unless an exception permits deferral or exclusion

- A number of exceptions exist that permit deferral of income relate to advance payments Anadvance payment is when a taxpayer receives payment before the taxpayer provides goods or

43 Code Sec 274(j) as amended by Act Sec 13310



services to its customer The exceptions often allow tax deferral to mirror financial accountingdeferral (eg income is recognized as the goods are provided or the services are performed)

- Under the new Tax Act generally for tax years beginning after Dec 31 2017 a taxpayeris required to recognize income no later than the tax year in which such income is takeninto account as income on an applicable financial statement (AFS) or another financialstatement under rules specified by the IRS (subject to an exception for long-term contractincome under Code sect460)

- The new Tax Act also codifies the current deferral method of accounting for ldquoadvance paymentsfor goods and servicesrdquo provided by Rev Proc 2004-34 to allow taxpayers to defer the inclusionof income associated with certain advance payments to the end of the tax year following the taxyear of receipt if such income also is deferred for financial statement purposes In addition itdirects taxpayers to apply the ldquorevenue recognition rulesrdquo under Code sect452 before applying theoriginal issue discount (OID) rules under Code sect127245

Comment In the case of any taxpayer required by this provision to change its accounting methodfor its first tax year beginning after Dec 31 2017 the new Tax Act that such change ldquowill betreated as initiated by the taxpayer and made with the IRSrsquos consentrdquo

Comment And under a special effective date provision the ldquoAFS conformity rulerdquo applies for OIDfor tax years beginning after Dec 31 2018 and the adjustment period is six years

Other Small Business Accounting Method Reforms

- Cash Method of Accounting

- Under current law a corporation (or a partnership with a corporate partner) may generally onlyuse the cash method of accounting if for all earlier tax years beginning after Dec 31 rsquo85 thecorporation or partnership met a ldquogross receipts testrdquo (ie the average annual gross receipts theentity for the three-tax-year period ending with the earlier tax year does not exceed $5 million)

- Under current law farm corporations and farm partnerships with a corporate partner may onlyuse the cash method of accounting if their gross receipts do not exceed $1 million in any year Anexception allows certain ldquofamily farm corporationsrdquo to qualify if the corporationrsquos gross receipts donot exceed $25 million

- ldquoQualified personal service corporationsrdquo are allowed to use the cash method without regard towhether they meet the ldquogross receipts testrdquo

- Under the new Tax Act for tax years beginning after Dec 31 2017 the cash method maybe used by taxpayers (other than ldquotax sheltersrdquo) that satisfy a $25 million gross receiptstest regardless of whether the purchase production or sale of merchandise is anincome-producing factor Under the gross receipts test taxpayers with annual average grossreceipts that do not exceed $25 million (indexed for inflation for tax years beginning afterDec 31 2018) for the three prior tax years are allowed to use the cash method



Comment Commonly controlled entities (ie gt 50 ownership) would probably have to beaggregated to determine the $25 million average gross receipts test

- But the exceptions from the required use of the accrual method for ldquoqualified personalservice corporationsrdquo and taxpayers other than C corporations are retained As a resultqualified personal service corporations partnerships without C corporation partners Scorporations and other pass-through entities are allowed to use the cash method withoutregard to whether they meet the $25 million gross receipts test so long as the use of themethod ldquoclearly reflects incomerdquo46

Example ldquoGross Receipts Test Under Prior Lawrdquo A company surpasses the $10 million average gross receipts test (which is based on the threemost recent tax years) in 2017 As a result it would normally have to file Form 3115 for thefollowing tax year (ie 2018) under the ldquoautomatic consentrdquo procedures to switch from the cashmethod of accounting to the accrual method But since the average gross receipts test will beincreasing to $25 million in 2018 the company will be able to continue using the cash method

Example ldquoGoing Back to Cash Method Under New $25 Million Gross Receipts Testrdquo Abusiness has been in excess of $10 million of average gross receipts for a number of yearsTherefore they had previously switched over to the accrual method But starting for their 2018tax year they will once again be eligible to use the cash method (ie their average gross receiptswill now be less than $25 million) They will now be able to file Form 3115 under the ldquoautomaticconsentrdquo procedures to switch back to the cash method This comes at a time they will have a $5million balance in their accounts receivable at the end of 2018 while their accounts payablebalance is expected to be only about $2 million As a result they will have a net ldquonegativerdquo Sec481(a) adjustment of $3 million And based on Rev Proc 2002-19 all of this negative adjustmentwill be taken in just one tax year (ie 2018)

- Cash Method and Farms

- Under the new Tax Act the increased $25 million threshold (above) would be extendedto farm corporations and farm partnerships with a corporate partner as well as family farmcorporations

- Businesses with Inventories

- Under the new Tax Act businesses with average gross receipts of $25 million or lesswould be permitted to use the cash (ie hybrid) method of accounting even if the businesshas inventories Conversely under current law the cash method can be used for certain smallbusinesses with average gross receipts of not more than $1 million (and for businesses in certainindustries whose annual gross receipts do not exceed $10 million)

Comment These businesses can use the cash method for their receivables and payables butstill need to maintain a cost-of-goods-sold schedule for inventory assets So technically speakingthis is really a ldquohybrid methodrdquo of accounting

46 Code Sec 448 as amend by Act Sec 13102


- Specifically the new law states that for tax years beginning after Dec 31 2017 taxpayers thatmeet the $25 million gross receipts test are not required to account for inventories under Codesect471 ldquoGeneral Rule for Inventoriesrdquo Instead they may use an accounting method forinventories that either (1) treats inventories as ldquonon-incidental materials and suppliesrdquo or(2) conforms to the taxpayerrsquos financial accounting treatment of inventories

- Uniform Capitalization Rules

- The uniform capitalization (UNICAP) rules under Code sect263A generally require certain directand indirect costs associated with real or tangible personal property manufactured by a businessto be included in either inventory or capitalized into the basis of such property However undercurrent law a business with average annual gross receipts of $10 million or less in the precedingthree years is not subject to the UNICAP rules for personal property acquired for resale Howeverthe exemption does not apply to real property (eg buildings) or personal property that ismanufactured by the business

- Under the new Tax Act businesses with average gross receipts of $25 million or lesswould be fully exempt from the uniform capitalization (UNICAP) rules under Code sect263A(ie ldquosuper absorptionrdquo method)

Comment As a result of these changes accounting for inventory will also be easier for manysmall businesses Fewer firms will have to capitalize inventory production costs now that the newtax law upped the gross receipts level to apply the UNICAP rules from $10 million to $25 million

Comment It would seem that a business that now qualifies under this exception would be ableto charge off previously capitalized costs under the uniform capitalization rules by filing Form 3115(and taking a ldquonegative adjustmentrdquo pursuant to Rev Proc 2002-19)

- Accounting for Long-Term Contracts

- Currently an exception from the requirement to use the percentage-of-completion method (PCM)for long-term contracts was provided for construction companies with average annual grossreceipts of $10 million or less in the preceding three years (ie they are allowed to instead deductcosts associated with construction when they are paid and recognize income when the buildingis completed)

- Under the new Tax Act the $10 million average gross receipts exception to thepercentage-of-completion method would be increased to $25 million The provision to expandthe exception for small construction contracts from the requirement to use thepercentage-of-completion method applies to contracts entered into after December 31 2017in taxable years ending after such date

- In other words contracts within this expanded exception are those contracts for theconstruction or improvement of real property if the contract (1) is expected (at the timesuch contract is entered into) to be completed within two years of commencement of thecontract and (2) is performed by a taxpayer that (for the taxable year in which the contractwas entered into) meets the $25 million gross receipts test


Comment The Committee Report states that if a taxpayer did want to change its method ofaccounting to take advantage of one of the aforementioned changes it would need to file Form3115 although it would be an ldquoautomatic consentrdquo situation so the normal fee would not becharged

Capitalization Rules

- Costs of Replanting Citrus Plants Lost Due to Casualty

- Under a special rule the uniform capitalization rules of Code sect263A do not apply and as aresult agricultural producers and certain co-owners are permitted to deduct costs incurred inreplanting ldquoedible crops for human consumptionrdquo following loss or damage due to freezingtemperatures disease drought pests or casualty The rule generally requires the agriculturalproducer to own the plants at the time that the damage occurred and to replace them with thesame type of crop on property located in the US The rule also requires that co-owners materiallyparticipate (ie under the Code sect469 PAL rules) in the business to deduct their portion of thereplacement costs

- This exception also applies to costs incurred by persons other than the taxpayer who incurredthe loss or damage if (1) the taxpayer who incurred the loss or damage retained an equity interestof more than 50 in the property on which the loss or damage occurred at all times during the taxyear in which the replanting costs were paid or incurred and (2) the person holding a minorityequity interest and claiming the deduction materially participated in the planting maintenancecultivation or development of the property during the tax year in which the replanting costs arepaid or incurred

- Under the new Tax Act for replanting costs paid or incurred after the enactment date(122217) but no later than a date which is ten years after the date of enactment (122227) thecosts incurred for citrus plants lost or damaged due to casualty may be currently deducted Thisexception will also be available to a person other than the taxpayer if (1) the taxpayer has anequity interest of not less than 50 in the replanted citrus plants at all times during the tax yearin which the replanting costs are paid or incurred and such other person holds any part of theremaining equity interest or (2) such other person acquires all of the taxpayerrsquos equity interest inthe land on which the lost or damaged citrus plants were located at the time of such loss ordamage and the replanting is on such land47

Deductions amp Exclusions

- Limits on Interest Expense Deduction

- Under current law interest paid or accrued by a business generally is deductible in thecomputation of taxable income subject to a number of limitations For a taxpayer other than acorporation the deduction for interest on indebtedness that is allocable to property held forinvestment (ie investment interest) is limited to the taxpayerrsquos net investment income for the taxyear (ie on Form 4952)

47 Code Sec 263A(d) as amended by Act Sec 13207


- Code sect163(j) can result in a disallowance of a deduction for ldquodisqualified interestrdquo paid oraccrued by a corporation in a tax year if (1) the payorrsquos debt-to-equity ratio exceeds 15 to 10 (theldquosafe harbor ratiordquo) and (2) the payorrsquos net interest expense exceeds 50 of its ldquoadjusted taxableincomerdquo (generally taxable income computed without regard to deductions for net interestexpense net operating losses domestic production activities under Code sect199 depreciationamortization and depletion)

- Under the new Tax Act all businesses (ie regardless of its tax status) would be subjectto a disallowance of a deduction for net interest expense in excess of 30 of thebusinesss ldquoadjusted taxable incomerdquo48 The net interest expense disallowance would bedetermined at the entity (v owner) level ldquoAdjusted taxable incomerdquo is a businesss taxableincome computed without regard to business interest expense business interest incomenet operating losses (NOLs) and depreciation amortization and depletion Any interestamounts disallowed under this rule would be carried forward indefinitely as a tax attribute of thebusiness In other words the amount of any business interest not allowed as a deduction for anytaxable year is treated as business interest paid or recruited in the succeeding tax yearNevertheless businesses with average gross receipts of $25 million or less would beexempt from these interest limitation rules49

- The bottom line is that the net interest deduction will be capped at 30 percent of ldquoearningsbefore interest taxes depreciation and amortizationrdquo (EBITDA) for four years and 30percent of ldquoearnings before interest and taxes (EBIT)rdquo thereafter

- As mentioned above an exemption from these rules applies for taxpayers (other than ldquotaxsheltersrdquo) with average annual gross receipts for the three-tax year period ending with the priortaxable year that do not exceed $25 million Furthermore the business-interest-limit provisiondoes not apply to certain regulated public utilities and electric cooperatives

Comment Even though this provision does come with a ldquosmall-business exceptionrdquo and afive-year carryforward it is still likely to have a very negative tax impact on debt-heavy businessesor businesses that are already struggling to produce sufficient revenue

- Real property trades or businesses that are not otherwise eligible for the ldquo$25 millionaverage gross receiptsrdquo exception can nevertheless elect out of this interest expenselimitation if they instead use ADS to depreciate ldquoapplicable real propertyrdquo used in a tradeor business

- Farming businesses can also elect out if they use ADS to depreciate any property used in thefarming business with a recovery period of ten years or more

- An exception from the limitation on the business interest deduction is also provided forldquofloor plan financingrdquo (ie financing for the acquisition of motor vehicles including RVsboats or farm machinery for sale or lease and secured by such inventory)

48 The interest deduction limitations discussed in the preceding bullet would not apply to taxpayers that paidor accrued interest on ldquofloor plan financing indebtednessrdquo

49 As a result the ldquothin capitalizationrdquo limitation on interest deductions in Code sect163(j) would be repealed


Comment ADS recovery periods are 40 years for nonresidential property 30 years for residentialand 20 years for improvement property But if the ldquoreal property TBrdquo did not have average grossreceipts above $25 million annually they would not be subject to this ADS rule for depreciationpurposes since they would not otherwise be under this ldquo30 interest expenserdquo limitation

Example ldquoReal Estate TBs with gt $25 Gross ReceiptsrdquoIn order to not be subject to the new 30 limitation on the deductibility of interest expense a realestate trade or business with average gross receipts gt $25 million elects to depreciate both theirresidential and commercial real property over the ADS 40-year classlife (ie instead of the normalMACRS 275-year or 39-year recovery periods)

Comment As mentioned above farmers are allowed to elect to deduct 100 of business interestif their gross receipts exceed $25 million However in return they are required to use ADS forassets with a recovery life of 10 years or greater50

Comment This provision was primarily provided for feedlot operators since their business modelrequires a lot of operating loans with low profit margins Also it appears that most farm equipmentwith a MACRS recovery period of less than 10 years will be allowed to use 200 decliningbalance and bonus depreciation The farmer will also continue to be allowed to use Sec 179immediate expensing However this election is better than the election out of Section 263A dueto ADS only being required on assets having a recovery life of 10 years or longer

Comment There is no ldquograndfather provisionrdquo for loans made prior to the enactment of TCJA Asa result interest on these loans will be subject to the new rules as well This may result in lessborrowing by businesses with a corresponding push toward equity transactions since not only willthe interest deduction be limited but the deduction itself will not be as valuable from a tax write-offstandpoint with the institution of a flat 21 corporate tax rate In addition the law fails to addresswhether a consolidated group is treated as a single taxpayer in the calculation of this deduction

LElecting Real Property Trades and Businesses Not Subject to Limitation on Deduction ofBusiness Interest For larger companies (ie whose average gross receipts exceed $25 million) the new Tax Act limitsthe deduction for net business interest expense to 30 percent of the ldquoadjusted taxable incomerdquo for thetaxpayerrsquos taxable year For this purpose adjusted taxable income is roughly similar to EBITDA fortaxable years before January 1 2022 and roughly similar to EBIT for years thereafter

However in addition to ldquosmallerrdquo companies this limitation does not apply to an electing real propertytrade or business (as defined in the PAL regs for the ldquoreal estate professionalrdquo exception) which includethe businesses of ldquoreal property development redevelopment construction reconstruction acquisitionconversion rental operation management leasing or brokeragerdquo

Comment This election is required to be made ldquoat a time and in a manner prescribed by the IRSrdquowhich at this time is not known because the IRS has not yet provided guidance in this regard

As mentioned above if the ldquoreal property trade or business exemptionrdquo does not apply there is also anexemption provided for taxpayers that (together with certain related parties) have average annual grossreceipts of $25 million or less over the three-year period ending with the most recent taxable year

50 Code Sec 163(j)(7)(A)(iii)


But a real estate trade or business that elects to be excluded from the limitation on deductibility ofbusiness interest (ie because it does not otherwise meet the ldquogross receiptsrdquo exception) will be requiredto use the ldquoAlternative Depreciation Systemrdquo which requires that longer recovery periods (ie the mid-point v MACRS recovery period) be used for its commercial real property residential rental property andqualified improvement property

Comment Due to drafting errors in the Tax Act the intended 15-year MACRS depreciation period(with a 20-year ADS mid-point) for ldquoqualified improvement propertyrdquo is absent from the text of theCode As a result ldquoqualified improvement propertyrdquo appears to be stuck in the normal MACRS 39-year nonresidential real property recovery period that is not eligible for bonus depreciationNevertheless it is apparent from the Joint Explanatory Statement accompanying the Tax Actthat the intent of Congress was for qualified improvement property to be classified as 15-yearMACRS assets and therefore be eligible for bonus depreciation

Generally ldquoqualified improvement propertyrdquo means any improvement to an interior portion of a buildingwhich is nonresidential real property if such improvement is placed in service after the date such buildingwas first placed in service subject to certain exceptions such as the enlargement of a building anyelevator or escalator or the internal structural framework of the building

If ADS depreciation had to be used (ie because a election out of the new 30 interest expenselimitation was made by a real estate trade or business) deductions for real estate property would beclaimed over a mid-point recovery period of 40 years for commercial real property 30 years for residentialrental property and 20 years for qualified improvement property However an ldquoelecting real property tradeor businessrdquo will be able to immediately expense (ie using 100 bonus depreciation or Sec 179immediate expensing for ldquoqualified real propertyrdquo which now includes QIPs) its cost of acquiring certainqualified property under the Tax Act

In general ldquoqualifying propertyrdquo for purposes of Sec 179 is defined as depreciable tangible personalproperty that is purchased for use in the active conduct of a trade or business But qualifying propertyalso includes ldquoqualified real propertyrdquo (ie before 11317 specifically defined as ldquoqualified leaseholdimprovement propertyrdquo ldquoqualified restaurant propertyrdquo and ldquoqualified retail improvement propertyrdquo) Butthe Tax Act further expanded ldquoqualified real propertyrdquo to now also include ldquoqualified energy efficientheating and air-conditioning propertyrdquo acquired and placed in service after November 2 2017 (MiscTax Act)

LIRS Offers Guidance on New Business Interest Expense Limitations (IR 2018-82) The IRS has provided guidance for computing the business interest expense limitation under Codesect163(j) as amended by the Tax Cuts and Jobs Act which limits most large businesses interestdeduction to any business interest income plus 30 of the business ldquoadjusted taxable incomerdquo

Comment Among other things the Notice describes regs that the IRS intends to issue andclarifies the treatment of interest disallowed and carried forward under former Code sect163(j)

Background - Pre-TCJA Law Prior to its amendment pre-TCJA Code sect163(j) disallowed adeduction for disqualified interest paid or accrued by a corporation in a tax year if

- The payors debt-to-equity ratio exceeded 15 to 10 (safe harbor ratio) and

- The payors net interest expense exceeded 50 of its ldquoadjusted taxable incomerdquo (generally taxableincome computed without regard to deductions for net interest expense net operating losses domestic


production activities under former Code sect199 depreciation amortization and depletion)

ldquoDisqualified interestrdquo for this purpose included interest paid or accrued to

1 Related parties when no Federal income tax was imposed with respect to such interest

2 Unrelated parties in certain instances in which a related party guaranteed the debt or

3 A real estate investment trust (REIT) by a taxable REIT subsidiary of that REIT

Interest amounts disallowed for any tax year under former Code sect163(j) were treated as interest paidor accrued in the succeeding tax year and could be carried forward indefinitely In addition any excesslimitation (ie the excess if any of 50 of the adjusted taxable income of the payor over the payors netinterest expense) could be carried forward three years

Former Code sect163(j)(6)(C) provided that [a]ll members of the same affiliated group (within the meaningof Code sect1504(a)) shall be treated as one taxpayer In addition former Code sect163(j)(9)(B) provided theIRS with the authority to issue regs providing for adjustments in the case of corporations that aremembers of an affiliated group ldquoas may be appropriate for carrying out the purposes of former Codesect163(j)rdquo

The IRS issued proposed regs in 1991 that contained super affiliation rules under which all membersof an affiliated group would be treated as one taxpayer for former Code sect163(j) purposes without regardto whether the group had filed a consolidated return The proposed regs also provided a rule under whichfor purposes of former Code sect163(j) if at least 80 of the total voting power and total value of the stockof an includible corporation under Code sect1504(b) is owned directly or indirectly by another ldquoincludiblecorporationrdquo the first corporation would be treated as a member of the affiliated group that includes theother corporation and its affiliates

Background - Interest Limitation Under Current Law Code sect163(j) as amended by the TCJAprovides new rules limiting the deduction of business interest expense for tax years beginning after Dec31 2017 For any taxpayer to which Code sect163(j) applies Code sect163(j)(1) now limits the taxpayersannual deduction for business interest expense to the sum of

1 The taxpayers ldquobusiness interest incomerdquo (as defined in Code sect163(j)(6)) for the tax year

2 30 of the taxpayers ldquoadjusted taxable incomerdquo (as defined in Code sect163(j)(8)) for the tax year and

3 The taxpayers ldquofloor plan financing interestrdquo (as defined in Code sect163(j)(9)) which is generallyinterest paid or accrued on indebtedness to finance the acquisition of motor vehicles held for sale orlease or to secure the inventory so acquired for the tax year

The limitation in Code sect163(j) applies to all taxpayers except for certain taxpayers that meet the ldquogrossreceipts testrdquo (ie average gross receipts gt $25 million) in Code sect448(c) and to all trades or businessesexcept certain trades or businesses listed in Code sect163(j)(7)

Under Code sect163(j)(2) the amount of any business interest not allowed as a deduction for any tax yearas a result of the limitation in Code sect163(j)(1) is treated as business interest paid or accrued in the nexttax year and may be carried forward indefinitely However Code sect163(j) does not provide for the


carryforward of any ldquoexcess limitationrdquo And Code sect163(j)(6)(C) which treated an affiliated group as onetaxpayer and Code sect163(j)(9)(B) which authorized the ldquosuper-affiliation rulesrdquo were eliminated by theTCJA

The TCJA Conference Report states in a footnote describing the House Bill that

- A corporation has neither investment interest nor investment income within the meaning of Codesect163(d) As a result interest income and interest expense of a corporation is properly allocable to a tradeor business unless such trade or business is otherwise explicitly excluded from the application of theprovision

- The Conference Report also notes in the description of the House Bill that In the case of a group ofaffiliated corporations that file a consolidated return the limitation applies at the consolidated tax returnfiling level

- However there is no mention in the Conference Report of applying Code sect163(j) to affiliated groups(within the meaning of Code sect1504(a)) that do not file a consolidated return

IRS Guidance on Code sect163(j) Notice 2018-28 provides the following guidance to helptaxpayers comply with Code sect163(j) as amended by the TCJA and describes proposed regs that itintends to issue in the future However the rules described below may be relied upon pending issuanceof the proposed regs

- Treatment of carried over disallowed disqualified interest Prior to the TCJA C corporationtaxpayers that could not deduct all of their interest expense under former Code sect163(j)(1)(A) could carrytheir disallowed disqualified interest forward to the succeeding tax year and such interest was treatedas paid or accrued in that succeeding tax year Similarly under Code sect163(j)(2) taxpayers that cannotdeduct all of their business interest because of the limitation in Code sect163(j)(1) may carry theirdisallowed business interest forward to the succeeding tax year and such interest is treated as businessinterest paid or accrued in the succeeding tax year

Consistent with both the former and current law approaches described above the IRS intends to issueregs clarifying that taxpayers with disqualified interest disallowed under former Code sect163(j)(1)(A) forthe last tax year beginning before Jan 1 2018 may carry such interest forward as business interest tothe taxpayers first tax year beginning after Dec 31 2017 The regs will also clarify that business interestcarried forward will be subject to potential disallowance under Code sect163(j) in the same manner as anybusiness interest otherwise paid or accrued in a tax year beginning after Dec 31 2017 In other wordssuch carryovers from pre-2018 tax years will be treated as arising from a tax year beginning in 2018 andwill therefore be subject to the new rules under TCJA

The regs will also address the interaction of Code sect163(j) with Code sect59A the new ldquobase erosionminimum taxrdquo by providing that business interest carried forward from a tax year beginning before Jan1 2018 will be subject to Code sect59A in the same manner as interest paid or accrued in a tax yearbeginning after Dec 31 2017 and will clarify how Code sect59A applies to that interest

In addition the regs will provide rules for the allocation of business interest from a group treated asaffiliated under the pre-TCJA super-affiliation rules

Finally while former Code sect163(j)(2)(B)(ii) allowed a corporation subject to the former Code sect163(j)(1)


limitation to add to its annual limitation any excess limitation carryforward from the prior year Codesect163(j) as amended does not have a similar provision As a result the IRS intends to issue regsclarifying that no amount previously treated as an ldquoexcess limitation carryforwardrdquo may be carried to taxyears beginning after Dec 31 2017 (Notice 2018-28 Section 3)

- Business interest etc of C corporations Consistent with congressional intent as reflected in theConference Report the IRS intends to issue regs clarifying that solely for purposes of Code sect163(j) inthe case of a taxpayer that is a C corporation all interest paid or accrued by the C corporation onindebtedness of such C corporation will be ldquobusiness interestrdquo within the meaning of Code sect163(j)(5) andall interest income on indebtedness held by the C corporation that is includible in gross income of suchC corporation will be ldquobusiness interestrdquo income within the meaning of Code sect163(j)(6) However theregs described in the foregoing sentence will not apply to an S corporation The regs will also address whether and to what extent interest paid accrued or includible in grossincome by a non-corporate entity (eg a partnership) in which a C corporation holds an interest isproperly characterized to such C corporation as business interest expense within the meaning of Codesect163(j)(5) or business interest income within the meaning of Code sect163(j)(6) (Notice 2018-28 Section4)

- Application of new limit to consolidated groups Consistent with congressional intent as reflectedin the Conference Report the IRS intends to issue regs clarifying that the Code sect163(j)(1) limitation onthe amount allowed as a deduction for business interest applies at the level of the consolidated group(as defined in Reg sect11502-1(h))

The regs will also address other issues concerning the application of Code sect163(j) to consolidatedgroups including among others how to allocate the limitation among group members and what happenswhen a member leaves the group However the IRS anticipates that such regs will not include a generalrule treating an affiliated group that does not file a consolidated return as a single taxpayer for purposesof Code sect163(j) (Notice 2018-28 Section 5)

- Effect of new limit on EampP The IRS intends to issue regs clarifying that the disallowance andcarryforward of a deduction for a C corporations business interest expense under Code sect163(j) will notaffect whether or when such business interest expense reduces earnings and profits of the payor Ccorporation (Notice 2018-28 Section 6)

- Business interest income amp floor plan financing-partnerships and partners Code sect163(j)(4)requires that the annual limitation on the deduction for business interest expense be applied at thepartnership level and that any deduction for business interest be taken into account in determining thenon-separately stated taxable income or loss of the partnership However while Code sect163(j)(4) isapplied at the partnership level with respect to the partnerships indebtedness Code sect163(j) may alsobe applied at the partner level in certain circumstances

- Interest expense incurred by partnerships The IRS intends to issue regs providing that forpurposes of calculating a partners annual deduction for business interest under Code sect163(j)(1) apartner cannot include the partners share of the partnerships business interest income for the tax yearexcept to the extent of the partners share of the excess of

1) The partnerships business interest income over

2) The partnerships business interest expense (not including ldquofloor plan financingrdquo)


In addition in order to prevent the double counting of business interest income and ldquofloor planfinancing interestrdquo for purposes of the business interest deduction the IRS intends to issue regs providingthat a partner cannot include such partners share of the partnerships ldquofloor plan financing interestrdquo indetermining the partners annual business interest expense deduction limitation under Code sect163(j)Similar rules will also apply to any S corporation and its shareholders (Notice 2018-28 Section 7) (Code sect163 Interest Expense)

- Ordinary REIT Dividends Reduced by Sec 199A Deduction

- US taxpayers (other than corporations) will now be able to deduct 20 percent of theamount of ordinary REIT dividends (ie dividends that are not capital gain dividends) thatthey receive subject to the limitation that the combined deduction for QBI and ordinaryREIT dividends cannot exceed 20 percent of the taxpayerrsquos income along with gain for theyear that is taxable at ordinary income rates As a result the top marginal tax rate onordinary REIT dividends that qualify for the 20 percent deduction under the Tax Act is 296percent (or 334 percent including the 38 percent Medicare surtax on net investmentincome)

- The 20 percent deduction for ordinary REIT dividends is not subject to the Sec 199Aldquowagecapital limitationsrdquo normally applicable with regard to the 20 deduction for QBI

Comment As discussed below an investor that would otherwise be subject to the Sec 199Aldquowagecapital limitationsrdquo might be better off making the same investment through a REIT

In the case of an investment in real estate mortgage debt if the investment is held through apartnership and the partnership is an investor rather than being in the business of lending theinterest income will not be QBI and no deduction will be available Conversely if the investmentis held through a REIT ordinary dividends from the REIT will be eligible for the 20 percentdeduction under Sec 199A

Comment The bottom line is that the use of a REIT structure may significantly reduce the federalincome tax on certain investments in real estate mortgage debt But the Sec 199A 20 percentdeduction for ordinary REIT dividends currently does not apply if the interest in a REIT is heldthrough a regulated investment company (ie a mutual fund)

Comment The Sec 199A 20 deduction is also available for QBI generated by master limitedpartnerships

- Modification of Net Operating Loss Deduction

- Under current law a net operating loss (NOL) may generally be carried back two years andcarried over 20 years to offset taxable income in such years However different carryback periodsapply with respect to NOLs arising in different circumstances For example extended carrybackperiods are allowed for NOLs attributable to ldquospecified liability lossesrdquo and certain casualty anddisaster losses

- Under the new Tax Act for NOLs arising in tax years ending after Dec 31 2017 the


two-year carryback and the special carryback provisions are repealed but a two-yearcarryback continues to appy in the case of certain losses incurred in the trade or business offarming

- In addition for losses arising in tax years beginning after Dec 31 2017 the NOLdeduction is limited to 80 of taxable income (determined without regard to the deduction)Carryovers to other years are adjusted to take account of this limitation and except as providedbelow NOLs can be carried forward indefinitely (ie no longer would there by a 20-yearcarryover limit)

Comment ldquoOlderrdquo NOLs will still be subject to the ldquooldrdquo 90 of taxable income limit (along withthe 20-year carryover period) So records would have to be maintained if both types of NOLswere being tracked by a taxpayer Furthermore any ldquooldrdquo NOLs would be used up first since theywould still be subject to a maximum 20-year carryover period

- However NOLs of property and casualty insurance companies can be carried back two yearsand carried over 20 years to offset 100 of taxable income in such years51

Comment This new provision is likely to dramatically lower the value of NOLs For instance theelimination of the two-year carryback will prevent loss companies from obtaining quick refunds forprior-year taxes to help them through tough times And the elimination of the carryback and therestriction on carryovers is also likely to make it tougher for struggling businesses to survive andreduce their attractiveness to possible merger candidates

Comment The elimination of the carryback of net operating losses and restriction of the carryoverof NOLs to offsetting only 80 of future yearsrsquo profits is projected to raise $201 billion in revenue

LTechnical Correction Needed for Effective Date of NOL Change

- TCJA sect13302(e)(2) provides that this change is effective for NOLs arising in ldquotax years endingafter Dec 31 2017rdquo However the conference committee provided an effective date for tax yearsbeginning after Dec 31 2017 As a result a technical correction has been requested to makethis change in language in the committees report This change would clarify matters especiallyfor fiscal year taxpayers In other words the law as currently written allows calendar-year filers tocarry back 2017 losses but fiscal-year taxpayers with 2017 losses are prohibited from doing thesame

- Dividend Received Deduction

- Under current law corporations that receive dividends from other corporations were entitled toa deduction for dividends received If the corporation owned at least 20 of the stock of anothercorporation an 80 dividends received deduction was allowed Otherwise a 70 deduction wasallowed

- For tax years beginning after Dec 31 2017 the 80 dividends received deduction is



reduced to 65 and the 70 dividends received deduction is reduced to 5052

Comment As a possible planning strategy C corporation profits and excess working capital couldbe retained and invested for instance but both the Code sect531 ldquoaccumulated earnings taxrdquo andCode sect541 ldquopersonal holding companyrdquo penalties would still have to be considered

- Sec 199 QPAD Deduction

- Under current law taxpayers could claim a domestic production activities deduction (DPAD)under Code sect199 equal to 9 (6 in the case of certain oil and gas activities) of the lesser of thetaxpayerrsquos ldquoqualified production activities incomerdquo or the taxpayerrsquos taxable income for the taxyear The deduction was limited to 50 of the W-2 wages paid by the taxpayer during the calendaryear ldquoQualified production activities incomerdquo was equal to ldquodomestic production gross receiptsrdquoless the cost of goods sold and expenses properly allocable to such receipts ldquoQualifying receiptsrdquowere derived from property that was manufactured produced grown or extracted within the USqualified film productions production of electricity natural gas or potable water constructionactivities performed in the US and certain engineering or architectural services

- The deduction for income attributable to domestic production activities would berepealed for tax years beginning after 201753

- Deduction of FDIC Premiums

- New limitations would be imposed on deductions for FDIC premiums paid by insured depositoryinstitutions such as banks

- Research and Development Costs

- Under current law taxpayers may elect to deduct currently the amount of certain reasonableresearch or experimentation (RampE) expenses paid or incurred in connection with a trade orbusiness Alternatively taxpayers may forgo a current deduction capitalize their researchexpenses and recover them ratably over the useful life of the research but in no case over aperiod of less than 60 months Or they may elect to recover them over a period of 10 years

- ldquoSpecified RampE expensesrdquo paid or incurred during taxable years beginning after 2023would be required to be capitalized and amortized over a 5-year period (15 years in the caseof expenditures attributable to research conducted outside the US) beginning with the midpointof the tax year in which the specified RampE expenses were paid or incurred

- ldquoSpecified RampE expensesrdquo subject to capitalization include expenses for software developmentbut not expenses for land or for depreciable or depletable property used in connection with theresearch or experimentation (but do include the depreciation and depletion allowances of such




property) Also excluded are exploration expenses incurred for ore or other minerals (including oiland gas) In the case of retired abandoned or disposed property with respect to which specifiedRampE expenses are paid or incurred any remaining basis are not allowed to be recovered in theyear of retirement abandonment or disposal but instead must continue to be amortized over theremaining amortization period54

- Use of this provision is treated as a ldquochange in the taxpayerrsquos accounting methodrdquo under Codesect481 initiated by the taxpayer and made with IRSrsquos consent For RampE expenditures paid orincurred in tax years beginning after Dec 31 2025 the provision is applied on a ldquocutoff basisrdquo (ieso there is no adjustment under Code sect481(a) for RampE paid or incurred in tax years beginningbefore Jan 1 2026)

- Limitation on Excessive Employee Compensation

- Under current law a deduction for compensation paid or accrued with respect to a ldquocoveredemployeerdquo of a publicly-traded corporation is limited to no more than $1 million per year Howeverexceptions applied for (1) commissions (2) performance-based remuneration including stockoptions (3) payments to a tax-qualified retirement plan and (4) amounts that are excludible fromthe executiversquos gross income

- Under the new Tax Act for tax years beginning after Dec 31 2017 the exceptions to the$1 million deduction limitation for commissions and performance-based compensation arerepealed And the definition of ldquocovered employeerdquo is revised to include the principal executiveofficer the principal financial officer and the three other highest-paid officers If an individual isa ldquocovered employeerdquo with respect to a corporation for a tax year beginning after Dec 312016 the individual remains a covered employee for all future years55

- Under a transition rule these changes do not apply to any remuneration under a written bindingcontract which was in effect on Nov 2 2017 and which was not modified ldquoin any materialrespectrdquo after that date Compensation paid pursuant to a plan qualifies for this exception if theright to participate in the plan is part of a written binding contract with the covered employee ineffect on Nov 2 2017 The fact that a plan was in existence on Nov 2 2017 is not by itselfsufficient to qualify the plan for the exception The exception ceases to apply to amounts paid afterthere has been a ldquomaterial modification to the terms of the contractrdquo The exception does not applyto new contracts entered into or renewed after Nov 2 2017 A contract that is ldquoterminable orcancelable unconditionally at will by either party to the contractrdquo without the consent of the otheror by both parties to the contract is treated as a new contract entered into on the date any suchtermination or cancellation if made would be effective However a contract is not treated as soterminable or cancelable if it can be terminated or cancelled only by terminating the employmentrelationship of the covered employee

Comment Keep in mind that the withholding tax rate on bonuses paid this year will be lowerthanks to the new tax law Bonuses up to $1 million get a 22 rate And any excess is withheldat 37 These rates also apply to other supplemental wages such as commissions and back pay


55 Code Sec 163(m) as amended by Act Sec 13601


Backup withholding on interest and dividends is also down to 24 This generally applies topeople who fail to provide a proper taxpayer ID number

- Litigation Costs Advanced by Attorneys in Contingency Cases

- The new Tax Act declined to adopt a House provision that would have prevented animmediate deduction for litigation costs advanced by an attorney to a client incontingent-fee litigation would be allowed until the contingency is resolved56

- Nondeductible Penalties and Fines

- Under current law no deduction is allowed for fines or penalties paid to a government for theviolation of any law

- Under the new Tax Act for amounts generally paid or incurred on or after the date ofenactment (122217) no deduction is allowed for any otherwise deductible amount paidor incurred (whether by suit agreement or otherwise) to or at the direction of agovernment or specified non-governmental entity in relation to the violation of any law orthe investigation or inquiry by such government or entity into the potential violation of anylaw

- An exception applies to payments that the taxpayer establishes are ldquoeither restitution (includingremediation of property) or amounts required to come into compliance with any law that wasviolated or involved in the investigation or inquiry that are identified in the court order or settlementagreement as restitution remediation or required to come into compliancerdquo Nevertheless the IRSremains free to challenge the characterization of an amount so identified However no deductionis allowed unless the identification is made

- An exception also applies to any amount paid or incurred as taxes due

- Restitution for failure to pay any tax that is assessed as restitution under the Code is deductibleonly to the extent it would have been allowed as a deduction if it had been timely paid57

- Government agencies (or entities treated as such) will be required to report to the IRS and tothe taxpayer the amount of each settlement agreement or order entered into where the aggregateamount required to be paid or incurred to or at the direction of the government is at least $600 (orsuch other amount as may be specified by IRS) The report must separately identify any amountsthat are for restitution or remediation of property or correction of noncompliance The report mustbe made at the time the agreement is entered into as determined by the IRS58

56 This change is intended to repeal Boccardo v Commissioner 56 F3d 1016 (9th Cir 1995) whichcreated a split in the U S circuit courts of appeal with respect to such deductions

57 Code Sec 162(f) as amended by Act Sec 13306

58 Code Sec 6050X as amended by Act Sec 13306


LIRS Issues Transitional Guidance on Nondeductible Fines and Penalties (Notice 2018-23) Subject to an exception for restitution payments the Tax Cuts and Jobs Act (TCJA) expanded thescope of nondeductible fines and penalties under Code sect162(f) The TCJA also added Code sect6050X which generally requires government officials to report to the IRS and each party to a settlement theamount and nature of any payments made under an agreement (if at least $600) In a recent Notice theIRS announced that it intends to publish proposed regulations under IRC Secs 162(f) and 6050X In themeantime reporting will not be required under IRC Sec 6050X until the date specified in the proposedregulations (which will not be earlier than 1119) In addition an amount will meet the identificationrequirement of IRC Sec 162(f)(2)(A)(ii) if the settlement agreement or court order specifically states onits face that the amount is restitution remediation or for coming into compliance with the law

- No Deduction for Amounts Paid For Sexual Harassment Subject to Non-Disclosure Agreement

- A taxpayer generally is allowed a deduction for ordinary and necessary expenses paid orincurred in carrying on any trade or business However among other exceptions a businessdeduction is specifically not allowed for any illegal bribe illegal kickback or other illegal paymentcertain lobbying and political expenses any fine or similar penalty paid to a government for theviolation of any law and two-thirds of treble damage payments under the antitrust laws

- Under the new Tax Act effective for amounts paid or incurred after the enactment date(122217) no deduction is allowed for any settlement payout or attorney fees related tosexual harassment or sexual abuse if such payments are subject to a non-disclosureagreement59

- Local Lobbying Expenses

- Under current law businesses generally may deduct ordinary and necessary expenses paid orincurred in connection with carrying on any trade or business And prior to any changes made bythe new Tax Act an exception to the general rule which disallowed deductions for lobbying andpolitical expenditures with respect to legislation and candidates for office existed for lobbyingexpenses with respect to legislation before local government bodies (including Indian tribalgovernments)

- Now the deduction for even local lobbying expenses (including Indian tribalgovernments) would be repealed effective for amounts paid or incurred after the date ofenactment (122217)60

- New Deferral Election for Qualified Equity Grants

- Code sect83 governs the amount and timing of income inclusion for property including employerstock transferred to an employee in connection with the performance of services Under Code


60 There is already a limitation on the deduction for such expenses involving lobbying before the federalgovernment That is why a certain portion of professional due for example are not deductible


sect83(a) an employee must generally recognize income for the tax year in which the employeersquosright to the stock is transferable or is not ldquosubject to a substantial risk of forfeiturerdquo The amountincludible in income is the excess of the stockrsquos fair market value at the time of substantial vestingover the amount if any paid by the employee for the stock

- Generally effective with respect to stock attributable to options exercised or restricted stock units(RSUs) settled after Dec 31 2017 (subject to a transition rule discussed below) a ldquoqualifiedemployeerdquo can elect to defer for income (but not employment) tax purposes recognition of theamount of income attributable to ldquoqualified stockrdquo transferred to the employee by the employer

- The election must be made no later than 30 days after the first time the employeersquos right to thestock is substantially vested or is transferable whichever occurs earlier61 If the election is madethe income has to be included in the employeersquos income for the tax year that includes the earliestof

(1) The first date the qualified stock becomes transferable including solely for this purposetransferable to the employer

(2) The date the employee first becomes an ldquoexcluded employeerdquo (ie an individual (a) who isone-percent owner of the corporation at any time during the 10 preceding calendar years (b) whois or has been at any prior time the chief executive officer or chief financial officer of thecorporation or an individual acting in either capacity (c) who is a family member of an individualdescribed in (a) or (b) or (d) who has been one of the four highest compensated officers of thecorporation for any of the 10 preceding tax years

(3) the first date on which any stock of the employer becomes readily tradable on an establishedsecurities market

(4) the date five years after the first date the employeersquos right to the stock becomes substantiallyvested or

(5) the date on which the employee revokes his or her election62

- The election is available for ldquoqualified stockrdquo63 attributable to a ldquostatutory optionrdquo In such a casethe option is not treated as a statutory option and the rules relating to statutory options andrelated stock do not apply In addition an arrangement under which an employee may receivequalified stock is not treated as a ldquononqualified deferred compensation planrdquo solely because of anemployeersquos inclusion deferral election or ability to make the election

- Deferred income inclusion also applies for purposes of the employerrsquos deduction of the amountof income attributable to the qualified stock That is if an employee makes the election theemployerrsquos deduction is deferred until the employerrsquos tax year in which or with which ends the taxyear of the employee for which the amount is included in the employeersquos income as described in

61 Code Sec 83(i)(4)(A) as added by Act Sec 13603(a)

62 Code Sec 83(i)(1)(B) as amended by Act Sec 13603(a)

63 Defined in Code Sec 83(i)(2)(A) as amended by Act Sec 13603(a)


(1) ndash (5) above

- The new election applies for ldquoqualified stockrdquo of an ldquoeligible corporationrdquo A corporation is treatedas such for a tax year if (1) no stock of the employer corporation (or any predecessor) is ldquoreadilytradable on an established securities marketrdquo during any preceding calendar year and (2) thecorporation has a written plan under which in the calendar year not less than 80 of allemployees who provide services to the corporation in the US are granted stock options orrestricted stock units (RSUs) with the same rights and privileges to receive qualified stock64

- Certain employees who receive stock options or restricted stock units as compensation for theperformance of services and later exercise such options or units would be permitted to elect todefer recognition of income for up to 5 years if the corporationrsquos stock is not publicly traded

Business Tax Credits

- Certain Unused Business Credits

- The deduction for certain unused business credits will be repealed effective for tax yearsbeginning after 2017

- New Credit for Employer-Paid Family and Medical Leave

- Under current law no credit is provided to employers for compensation paid to employees whileon leave

- For wages paid in tax years beginning after Dec 31 2017 but not beginning after Dec 312019 (ie so for a 2-year period including 2018 and 2019) the new Tax Act ldquoallowsbusinesses to claimrdquo a general business credit equal to 125 of the amount of wages paidto ldquoqualifying employeesrdquo during any period in which such employees are on family andmedical leave (FMLA) if the rate of payment is 50 of the wages normally paid to anemployee The credit would be increased by 025 percentage points (but not above 25) for eachpercentage point by which the rate of payment exceeds 50

- All ldquoqualifying full-time employeesrdquo would have to be given at least two weeks of annual paidfamily and medical leave (all less-than-full-time qualifying employees would have to be given acommensurate amount of leave on a pro rata basis) in order for the employer to claim this credit65

However the credit does not apply to employees with total wages in excess of $72000 in 2017

Comment The question has been asked as to whether this is a new ldquomandatoryrdquo provision Butnothing in the Conference Agreement indicates that is the case Simply if the employer decidesthat they want to offer this new fringe benefit and they otherwise meet the requirements statedabove this credit will be available (and claimed as part of the general business credit on Form3800)

64 Code Sec 83(i)(2)(C) as amended by Act Sec 13603(a)

65 Code Sec 45S as amended by Act Sec 13403


LGuidance Provided on New Employer-paid Family and Medical Leave Credit (FAQs) The IRS has provided information on the Code sect45S family and medical leave credit as added by theTax Cuts and Jobs Act

Background Generally Code sect45S provides that for wages paid in tax years beginning in 2018and 2019 eligible employers can claim a general business credit equal to the applicable percentageof the amount of wages paid to qualifying employees during any period in which such employees areon family and medical leave if certain requirements are met However at this point the credit does notapply to wages paid in tax years beginning after Dec 31 2019

FAQs The FAQs provide that the Code sect45S family and medical leave credit is a generalbusiness credit employers may claim based on wages paid to ldquoqualifying employeesrdquo while they are onfamily and medical leave subject to certain conditions To claim the credit employers must have a writtenpolicy in place that provides at least two weeks of paid family and medical leave (annually) to allqualifying employees who work full-time (prorated for employees who work part-time) The paid leavecannot be less than 50 of the wages normally paid to the employee The credit is generally effectivefor wages paid in tax years of the employer beginning after Dec 31 2017 and it is not available forwages paid in tax years beginning after Dec 31 2019

The credit is a percentage of the amount of wages paid to a qualifying employee while on family andmedical leave for up to 12 weeks per tax year The minimum percentage is 125 and is increased by025 for each percentage point by which the amount paid to a qualifying employee exceeds 50 of theemployees wages with a maximum of 25 An additional limit may apply in certain cases

Comment So from a tax benefit standpoint if a corporate employer pays $100 in reduced wages(eg 50 of the normal wage level paid to this particular employee) it would get a 125 creditwhich in effect means that the company paid $8750 of the total Furthermore assuming that thecorporation faces a flat 21 marginal tax rate the after-tax cost of this $100 of pay to anemployee on family or medical leave would be $6913 (ie 79 x $8750 without anyconsideration as state or local tax benefits)

The FAQs note that for purposes of the credit a ldquoqualifying employeerdquo is any employee under the FairLabor Standards Act who has been employed by the employer for one year or more and who for thepreceding year had compensation of not more than a certain amount For an employer claiming a creditfor wages paid to an employee in 2018 the employee cannot have earned more than $72000 in 2017

For purpose of the credit family and medical leave is leave for one or more of the following reasons

1 Birth of an employees child and to care for the child

2 Placement of a child with the employee for adoption or foster care

3 To care for the employees spouse child or parent who has a serious health condition

4 A ldquoserious health conditionrdquo that makes the employee unable to perform the functions of his or herposition

5 Any ldquoqualifying exigencyrdquo due to an employees spouse child or parent being on covered active duty(or having been notified of an impending call or order to covered active duty) in the Armed Forces or


6 To care for a service member who is the employees spouse child parent or next of kin

If an employer provides paid vacation leave personal leave or medical or sick leave (other than leavespecifically for one or more of the purposes stated above) that paid leave is not considered ldquofamily andmedical leaverdquo for purposes of the credit Furthermore any leave paid by a State or local government orotherwise required by State or local law is not taken into account in determining the amount ofemployer-provided paid family and medical leave

An employer must reduce its deduction for wages or salaries paid or incurred by the amount determinedas a credit Also any wages taken into account in determining any other general business credit may notbe used in determining this credit

The FAQs state that the IRS expects that additional information will be provided that will address whenthe written policy must be in place how paid family and medical leave relates to an employers other paidleave how to determine whether an employee has been employed for one year or more the impact ofState and local leave requirements and whether members of a controlled group of corporations andbusinesses under common control are treated as a single taxpayer in determining the credit (Codesect45S FamilyMedical Leave Credit)

- Employer Tip Credit

- The credit for a portion of the employer social security taxes paid with respect to employee tipwould be modified to reflect the current minimum wage so that it is available with regard to tipsreported only above the current minimum wage (ie rather than tips above $515 per hour) Inaddition all restaurants claiming the credit would be required to report to the IRS tipallocations among tipped employees (ie allocations at no less than 10 of gross receiptsper tipped employee rather than 8) which is a reporting requirement now required onlyof restaurants with at least ten employees The provision would be effective for tipsreceived for services performed after 2017

- Employer-Provided Child Care Credit

- The employer-provided child care credit would be repealed effective for tax yearsbeginning after 2017

- Rehabilitation Credit

- Under current law a 20 credit is provided for ldquoqualified rehabilitation expendituresrdquo with respectto a ldquocertified historic structurerdquo (ie any building that is listed in the National Register or that islocated in a registered historic district and is certified by the Secretary of the Interior to theSecretary of the Treasury as being of historic significance to the district) Furthermore a 10credit is provided for qualified rehabilitation expenditures with respect to a ldquoqualified rehabilitatedbuildingrdquo which generally means a building that was first placed in service before 1936 A buildingis treated as having met the ldquosubstantial rehabilitation requirementrdquo under the 10 credit only ifthe rehabilitation expenditures during the 24-month period selected by the taxpayer and endingwithin the tax year exceed the greater of (1) the adjusted basis of the building (and its structuralcomponents) or (2) $5000


- However straight-line depreciation or the ADS method must be used in order for rehabilitationexpenditures to be treated as qualified for the credit

- Under the new Tax Act for amounts paid or incurred after Dec 31 2017 the 10 creditfor qualified rehabilitation expenditures with respect to a pre-rsquo36 building is repealed anda 20 credit is provided for qualified rehabilitation expenditures with respect to a certifiedhistoric structure which can be claimed ratably over a 5-year period beginning in the taxyear in which a qualified rehabilitated structure is placed in service

- A transition rule provides that for qualified rehabilitation expenditures (for either a certified historicstructure or a pre-rsquo36 building) for any building owned or leased (as provided under current law)by the taxpayer at all times on and after Jan 1 2018 the 24-month period selected by thetaxpayer (under Code sect47(c)(1)(C)(i)) or the 60-month period selected by the taxpayer under therule for phased rehabilitation (Code sect47(c)(1)(C)(ii)) is to begin no later than the end of the180-day period beginning on the date of the enactment and apply to such expenditures paid orincurred after the end of the tax year in which such 24- or 60-month period ends66

- Work Opportunity Tax Credit

- The work opportunity tax credit was not repealed under the new Tax Act

- New Market Tax Credit

- The new markets tax credit was not repealed under the new Tax Act

- Disabled Access Credit

- The credit for expenditures to provide access to disabled individuals was not repealedunder the new Tax Act

- Residential Energy Efficient Property Credit

- Under Code sect25C a taxpayer were allowed to claim a 30 credit for the purchase of qualifiedgeothermal heat pump property qualified small wind energy property and qualified solar electricproperty Effective for property placed in service after 2016 the new Tax Act wouldretroactively extend the credit for residential energy efficient property for all qualifiedproperty placed in service before 2022 subject to a reduced rate of 26 for property placedin service during 2020 and 22 for property placed in service during 2021

- As a result if you added solar panels to your home you would a tax break equal to a credit for30 of the total cost As mentioned above for solar energy systems installed in a residence thefull credit applies through 2019 and then phases out with 26 for 2020 and 22 for 2021 untilit ends after 2021 The same is true for the tax credits also available for geothermal heat pumps



residential wind turbines and fuel cell property But as far as energy-efficient windows or doorsor just plain insulating the exterior walls of onersquos home you are out of luck at least for now Thelimited 10 tax credit (with a lifetime limit of $500) for these residential energy-saving items lapsedafter 2017

- Orphan Drug Credit Modified

- Under current law a drug manufacturer is permitted to claim a credit equal to 50 of ldquoqualifiedclinical testing expensesrdquo

- Under the new Tax Act for amounts paid or incurred after Dec 31 2017 the Code sect45Corphan drug credit is limited to 25 (ie instead of current lawrsquos 50) of so much ofqualified clinical testing expenses for the tax year However taxpayers can elect a reducedcredit in lieu of reducing otherwise allowable deductions in a manner similar to the research creditunder Code sect280C67

Partnership Tax Provisions

- Technical Terminations of Partnerships

- Under a ldquotechnical terminationrdquo under Code sect708(b)(1)(B) a partnership is considered asterminated if within any 12-month period there is a sale or exchange of 50 or more of the totalinterest in partnership capital and profits A technical termination gives rise to a deemedcontribution of all the partnershiprsquos assets and liabilities to a new partnership in exchange for aninterest in the new partnership followed by a deemed distribution of interests in the newpartnership to the purchasing partners and the other remaining partners

- Another key to understanding the tax ramifications as a result of a technical termination is thatsome of the tax attributes of the old partnership terminate For instance the partnershiprsquos tax yearcloses partnership-level elections generally cease to apply and the partnership depreciationrecovery periods restart

- Under the new Tax Act for partnership tax years beginning after Dec 31 2017 the Codesect708(b)(1)(B) rule providing for the technical termination of a partnership is repealed Butthis repeal does not change the pre-Act law rule of Code sect708(b)(1)(A) that a partnership isconsidered as terminated if no part of any business financial operation or venture of thepartnership continues to be carried on by any of its partners in a partnership68

- ldquoLook-Through Rulerdquo Applied to Gain on Sale of Partnership Interest

- Under Code sect741 gain or loss from the sale or exchange of a partnership interest generally is

67 Code Sec 45C as amended by Act Sec 13401

68 As a result partnerships would not be required or permitted to make new tax elections following such asale or exchange but at least depreciation or amortization of assets would not have to begin anew on Form 4562Code Sec 708(b) as amended by Act Sec 13504


treated as gain or loss from the sale or exchange of a capital asset However to the extent thatthe amount of money and the fair market value of property received in the exchange that representthe partnerrsquos share of certain ordinary income-producing assets of the partnership give rise toordinary income rather than capital gain under Code sect751

- A foreign person that is engaged in a trade or business in the US is taxed on income that isldquoeffectively connectedrdquo with the conduct of that trade or business (ie effectively connected gainor loss) Partners in a partnership are treated as engaged in the conduct of a trade or businesswithin the US if the partnership is so engaged

- In guidance that the IRS has previously issued in the form of a revenue ruling in determining thesource of gain or loss from the sale or exchange of an interest in a foreign partnership the IRSapplied an ldquoasset-use test and business activities testrdquo at the partnership level to determine theextent to which income derived from the sale or exchange is ldquoeffectively connected with that USbusinessrdquo However a Tax Court case has instead held that generally gain or loss on sale orexchange by a foreign person of an interest in a partnership that is engaged in a US trade orbusiness is considered to be from a ldquoforeign-sourcerdquo

- Under the new Tax Act for sales and exchanges on or after Nov 27 2017 gain or loss fromthe sale or exchange of a partnership interest is ldquoeffectively connected with a US trade orbusinessrdquo to the extent that the transferor would have had effectively connected gain or loss hadthe partnership sold all of its assets at fair market value as of the date of the sale or exchangeAny gain or loss from this hypothetical asset sale by the partnership must be allocated to interestsin the partnership ldquoin the same manner as non-separately stated income and lossrdquo69

- For sales exchanges and dispositions after Dec 31 2017 the transferee of a partnershipinterest must withhold 10 of the amount realized on the sale or exchange of a partnershipinterest unless the transferor certifies that the transferor is not a nonresident alien individual orforeign corporation70

- Partnership ldquoSubstantial Built-In Lossrdquo Modified

- General speaking a partnership does not adjust the basis of partnership property following thetransfer of a partnership interest unless either the partnership has made a one-time electionpursuant to Code sect754 to make basis adjustments or the partnership has a ldquosubstantial built-inlossrdquo immediately after the transfer If an election is in effect or if the partnership has a substantialbuilt-in loss immediately after the transfer adjustments are made with respect to the transfereepartner These adjustments are to account for the difference between the transferee partnerrsquosproportionate share of the adjusted ldquoinside basisrdquo of the partnership property and the transfereersquosldquooutside basisrdquo in their partnership interest

- Under current law a ldquosubstantial built-in lossrdquo exists if the partnershiprsquos adjusted basis in itsproperty exceeds by more than $250000 the fair market value of the partnership propertyCertain ldquosecuritization partnershipsrdquo and ldquoelecting investment partnershipsrdquo are not treated as

69 Code Sec 864(c) as amended by Act Sec 13501



having a ldquosubstantial built-in lossrdquo in certain instances and thus are not required to make basisadjustments to partnership property For ldquoelecting investment partnershipsrdquo in lieu of thepartnership basis adjustments a partner-level ldquoloss limitationrdquo rule applies

- Under the new Tax Act for transfers of partnership interests after Dec 31 2017 thedefinition of a ldquosubstantial built-in lossrdquo is modified for purposes of Code sect743(d) affectingtransfers of partnership interests In addition to the present-law definition a substantialbuilt-in loss also exists if the specific transferee would be allocated a net loss in excessof $25000071 upon a hypothetical disposition by the partnership of all partnershiprsquos assets in afully taxable transaction for cash equal to the assetsrsquo fair market value immediately after thetransfer of the partnership interest72

Example ldquoSale of Partnership Interest with lsquoSubstantial Built-In Loss - Pre-2018rdquoThe taxpayer is a one-third partner in ABC LLC when he decides to sell his interest to D At thetime of the sale the partnership had an adjusted basis in its only asset a commercial building of$600000 while its FMV is only $300000 Also their were no liabilities with regard this building(ie a mortgage) From 112005 until this change in the law for sales occurring after 2017 thisbuilt-in $300000 loss would have been considered ldquosubstantialrdquo And regardless of whether aCode sect754 election was in effect the new partner D would have to adjust his inside basis inthis asset so that it was now equal to the $100000 he paid for the purchase of thepartnership interest In other words the inside basis of $200000 to this new partner wouldhave to be reduced down to the $100000 paid

Example ldquoSale of Partnership Interest with lsquoSubstantial Built-In Loss - Post-2017rdquoA partnership of three taxable partners (partners A B and C) has not made an election pursuantto section 754 The partnership has two assets one of which Asset X has a built-in gain of $1million while the other asset Asset Y has a built-in loss of $900000 Pursuant to the partnershipagreement any gain on sale or exchange of Asset X is specially allocated to partner A The threepartners share equally in all other partnership items including in the built-in loss in Asset Y In thiscase each of partner B and partner C has a net built-in loss of $300000 (one third of the lossattributable to asset Y) allocable to his partnership interest Nevertheless the partnership doesnot have an overall built-in loss but a net built-in gain of $100000 ($1 million minus$900000) Partner C sells his partnership interest to another person D for $33333 Under theprovision the test for a substantial built-in loss applies both at the partnership level and atthe transferee partner level If the partnership were to sell all its assets for cash at their fairmarket value immediately after the transfer to D D would be allocated a loss of $300000 (onethird of the built-in loss of $900000 in Asset Y) A substantial built-in loss exists under thepartner-level test added by the provision and the partnership adjusts the basis of its assetsaccordingly with respect to D

- Charitable Contributions amp Foreign Taxes in Partnerrsquos Share Of Loss

- Under current law a partner was allowed to deduct his or her distributive share of partnershiploss only to the extent of the adjusted at-risk basis of the partnerrsquos interest in the partnership at

71 This compares to a potential $250000 in total to the partnership entity if this hypothetical sale occurred

72 Code Sec 743(d) as amended by Act Sec 13502


the end of the partnership year in which such loss occurred Any excess of the loss over basis wasallowed as a deduction at the end of the partnership year in which the excess was repaid to thepartnership The IRS has taken the position in a private letter ruling that the Code sect704(d) losslimitation on partner losses does not apply to limit the partnerrsquos deduction for its share of thepartnershiprsquos charitable contributions While the regs relating to the Code sect704(d) loss limitationdo not mention the foreign tax credit a taxpayer may choose the foreign tax credit in lieu ofdeducting foreign taxes

- Under the new Tax Act for partnership tax years beginning after Dec 31 2017 in determiningthe amount of a partnerrsquos loss the partnerrsquos distributive shares under Code sect702(a) of partnershipcharitable contributions and taxes paid or accrued to foreign countries or US possessions will betaken into account Nevertheless in the case of a charitable contribution of property with a fairmarket value that exceeds its adjusted basis (ie appreciated property) the partnerrsquos distributiveshare of the excess is not taken into account73

S Corporation Tax Provisions

- Revocations of S Corp Elections

- Under current law in the case of an S corporation that converts to a C corporation distributionsof cash by the C corporation to its shareholders during the ldquopost-termination transition periodrdquo(PTTP) to the extent of the amount in the accumulated adjustment account) are tax-free to theshareholders and reduce the adjusted basis of the stock

- The ldquopost-termination transition periodrdquo (PTTP) is

(1) The period beginning on the day after the last day of the corporationrsquos last tax year as an Scorporation and ending on the later of (a) the day that is one year after that day or (b) the duedate for filing the return for the corporationrsquos last tax year as an S corporation (includingextensions)

(2) The 120-day period beginning on the date of any determination (as defined in Regsect11377-2(c)) with respect to an audit of the taxpayer that follows the termination of thecorporationrsquos election and that adjusts a Subchapter S income loss or deduction item that arisesduring the S corporation period (ie the ldquomost recent continuous periodrdquo during which thecorporation was an S corporation) and

(3) The 120-day period beginning on the date of a determination that the corporationrsquos S electionhad terminated for an earlier year

- Under the new Tax Act the rules on conversions of certain S corporations into C corporationswould be modified These rules would apply to entities that were S corporations prior to theenactment of the TCJA that revoke their S elections during the two-year period beginningon the enactment date (ie 122217) and that have the same owners on the enactmentdate as on the revocation date Distributions from such a corporation would be treated aspaid from its accumulated adjustments account and from its earnings and profits on a



pro-rata basis And any Sec 481(a) adjustment would be taken into account ratably over a6-year period74

- On the date of enactment (ie 122217) any Code sect481(a) adjustment of an ldquoeligibleterminated S corporationrdquo attributable to the revocation of its S corporation election (eg a changefrom the cash method to an accrual method) is taken into account ratably during 6-tax year periodbeginning with the year of change An ldquoeligible terminated S corporationrdquo is any C corporationwhich (1) is an S corporation the day before the date of enactment (2) during the 2-year periodbeginning on the date of enactment revokes its S corporation election and (3) all of the ownersof which on the date the S corporation election is revoked are the same owners (and in identicalproportions) as the owners on the date of such enactment

LTechnical Correction Needed Re Revocation of S Corp Election

- As stated above the 1-year period after which a corporations S election terminates is generallyreferred to as the ldquopost-termination transition period (PTTP)rdquo The TCJA provides that if an eligibleterminated S corporation makes a cash distribution after the PTTP the accumulated adjustmentsaccount is allocated to the distribution and the distribution is chargeable to accumulated earningsand profits in the same ratio as the amount that the accumulated adjustments account bears tothe amount of such accumulated earnings and profits (Code sect1371(f))

- A technical correction is needed to allow taxpayers to elect out of the Code sect1371(f) provision

LTax Professionals Asking for 6-Month Extension to Make 2018 S Corp Elections The National Society of Accountants (NSA) recently contacted Acting IRS Commissioner David Kautterrequesting a six-month extension of time (ie beyond the normal 15th of the third month or 3152018deadline) during which a corporation must elect to be an S corporation in order for it to be retroactive to112018 for the current calendar year The request is made due to the lack of clarity in Code Sec 199Aof the Tax Cuts and Jobs Act the NSA said Clearly Code Sec 199A is not only complex andconfusing but the effective tax rate can vary substantially depending on the definition of various termsused therein including qualified business income (QBI) qualified property and W-2 wages properlyapplicable to QBI the letter stated The NSA noted that the terms used in Code sect199A have yet to bedefined in any IRS guidance Consequently NSA and tax professionals are being asked by clients tomake our own interpretations of Code sect199A even as IRS and Treasury Department personnel havemade numerous speeches acknowledging that the scope of this Section could change markedlydepending on how official pronouncements choose to define some of the terms mentioned above Theupdate Priority Guidance Plan lists guidance under Code sect199A as a priority and has a target date ofJune 30 However any entity that wishes to be treated as a S corporation for tax purposes for thiscalendar year must do so by March 15 even in the absence of such guidance NSA protested It strikesus that making an election in March when the guidance on which such election may be based will beissued in June is unfair to taxpayers tax professionals and the tax system itself Even if the regulationsunder Code sect199A are issued by June 30 the deadline for making an S election should be extended untilSept 15 the letter said This extension would afford time for all affected parties as well as their taxadviser to read and understand any such regulations and how they may impact their tax liabilities (Code sect1361 S Elections)

Comment Rev Proc 2013-30 provides procedures whereby late S elections will be accepted

74 Code Sec 1371(f) and Code Sec 481(d) as amended by Act Sec 13543


by the IRS And for the most part clients have been successful in obtaining S corp status evenwhere the Form 2553 has been filed late There have even been cases reported where acorporation initially files a Form 1120 for its first tax year and then successfully asks the IRS if itcan withdraw this form of filing as a regular C corporation and instead file Form 1120S as an Scorporation accompanied by a late-filed Form 2553

- Qualifying Beneficiaries of an ESBT

- An electing small business trust (ESBT) may be a shareholder of an S corporation Generallythe eligible beneficiaries of an ESBT include individuals estates and certain charitableorganizations eligible to hold S corporation stock directly Under current law a nonresident alienindividual is not permitted to be a shareholder of an S corporation and may not be a potentialcurrent beneficiary of an ESBT

Under the new Tax Act effective on Jan 1 2018 a nonresident alien individual will beeligible as a potential current beneficiary of an ESBT75

Comment This a huge change insomuch as in an emerging global economy foreign investorsmay now be a source of capital as indirect owners of S corporations And as is the case withldquocomposite tax returnsrdquo there would no concern that a nonresident alien would not be paying theirfair share of taxes (just like any other nonresident shareholder residing in a state other than wherethe S corporation is located) if the federal government would implement back-up withholding onsuch ESBT K-1 income to foreign recipients

- Charitable Contribution Deduction for ESBTs

- Under current law the deduction for charitable contributions applicable to trusts rather than thededuction applicable to individuals applied to an ESBT Generally a trust is allowed a charitablecontribution deduction for amounts of gross income without limitation which pursuant to the termsof the governing instrument are paid for a charitable purpose No carryover of excess contributionsis allowed An individual is allowed a charitable contribution deduction limited to certainpercentages of adjusted gross income generally with a 5-year carryforward of amounts in excessof this limitation

- For tax years beginning after Dec 31 2017 the new Tax Act provides that the charitablecontribution deduction of an ESBT is not determined by the rules generally applicable to trusts butrather by the rules applicable to individuals As a result the percentage limitations andcarryforward provisions applicable to individuals apply to charitable contributions made by theportion of an ESBT holding S corporation stock76

New 20 Deduction for K-1 and Proprietorship Profits and Net Rental Income




- Various Approaches Congress Took w Sec 199A DeductionSpecial Tax Rate

- Although the House passed a special tax rate of just 25 for K-1 trade or business income itwould not have been available for service-based businesses Furthermore even for non-service-based businesses this special 25 rate could generally be used against 30 of such K-1 income(ie the ldquolaborrdquo v ldquocapitalrdquo portion) Only passive investors would receive the 25 rate on theirentire K-1 income plus any other passive income such as Box 2 K-1 rental income

- The Senate version was at first a 174 deduction (ie instead of a special tax rate of 25)Then Sen Ron Johnson - WI insisted that it be set at a higher 23 level And it applies toservice-based businesses77 as long as the K-1 ownerrsquos taxable income is below $157500 forsingle taxpayers and $300000 for MFJ filers

LJCT Estimates Distributional Effect of Sec 199A Deduction

- The Code sect199A pass-through deduction is estimated for 2018 to be claimed on 174 millionreturns for a total of $402 billion in deductions The income categories for showing thisdistribution and others throughout the report are based on AGI plus

1 Tax-exempt interest

2 Employer contributions for health plans and life insurance

3 Employer share of FICA tax

4 Workers compensation

5 Nontaxable Social Security benefits

6 Insurance value of Medicare benefits

7 Alternative minimum tax preference items

8 Individual share of business taxes and

9 Excluded income of US citizens living abroad

- Of the $402 billion in 2018 deductions $178 billion is estimated to go to returns showing incomeof $1 million and over $36 billion to those with $500000 to $1 million $94 billion to those with$200000 to $500000 and $63 billion to those with $100000 to $200000 The remaining amountis estimated to be distributed among taxpayers with incomes under $100000

- Highlights of New Sec 199A 20 Deduction of ldquoQualified Business Incomerdquo

77 Service businesses are permitted to get the full 20 deduction for pass-through businesses if theirowners do not have more than $157500 of individual income or $315000 for married couples However in the finalconference bill architects and engineers are exempt and will be treated more like manufacturers than like lawyersand consultants


- Sec 199A provides taxpayers other than C corporations a deduction of 20 of ldquoqualifiedbusiness incomerdquo subject to certain limitations (ie ldquowagerdquo and ldquocapital formulardquo limits)so as to afford owners of K-1 businesses some level of equality while the top C corp ratehas been dropped to just 21

- The deduction is limited to the greater of (1) 50 of the W-2 wages with respect to thequalified trade or business or (2) the sum of 25 of the W-2 wages plus 25 of theldquounadjusted basesrdquo immediately after the acquisition of all ldquoqualified propertyrdquo (generallyreal or personal tangible property for which a depreciation deduction is allowed underCode sect167) The Sec 199A deduction also may not exceed (1) taxable income for the yearover (2) net capital gain plus aggregate ldquoqualified cooperative dividendsrdquo

- Since the Sec 199A deduction is the last item accounted for in arriving at taxable incomeit does not matter whether the taxpayers takes the standard deduction or otherwiseitemizes their deductions However it is not claimed in calculating SE tax nor does it haveany affect on determining an NOL

- ldquoQualified trades or businessesrdquo include all trades or businesses except the trade orbusiness of performing services as an employee or ldquospecified servicerdquo trades orbusinesses such as those involved with the performance of services in law accountinghealth financial and brokerage services actuarial sciences athletics consulting investingor investment management performing arts or any trade or business where the principalasset of such trade or business is the reputation or skill of one or more of its owners oremployees

- Clarifications are needed with regard to the application of Sec 199A to rental activitiesthe netting of qualified income and losses for taxpayers with multiple qualified trades orbusinesses determining the deduction for tiered entities allocating wages amongbusinesses and whether guaranteed payments may be treated the same as the wages paidto S corporation owneremployees

- Income earned by a C corporation is subject to ldquodouble taxationrdquo first at the entity leveland then a second time at the shareholder level when the corporation distributes itsincome as a dividend The new flat rate of 21 for C corps (downed from 35) helps whilethe top dividend rate remained at 20 The bottom line is that C corp profits distributed asdividends saw a overall rate drop from 48 to 368

- On the other hand K-1 owners face only a single level of tax which has dropped from atop rate of 396 to 37 And with the Sec 199A deduction this top rate is further reduceddown to 296

- The deductible amount of ldquoqualified business incomerdquo for each of the taxpayerrsquos qualifiedtrades or businesses is determined separately multiplied by a 20 deduction rate possiblysubjected to ldquowagerdquo and ldquocapitalrdquo limitations and then added together for a preliminarySec 199A amount

- But then this aggregate Sec 199A amount is subject to a final cap equal to the excessof taxable income for the year over net capital gain plus qualified cooperative dividends


- Final Sec 199A 20 Deduction Includes Net Rental Income As Well

- Effective for tax years beginning after December 31 201778 the new Tax Act set thededuction amount at 20 against ldquoqualified business incomerdquo which at least initiallyappeared to only apply against K-1 Box 1 trade or business income However in a last-minuteinsertion the conference bill now appears to also apply to any net rental income in Box 2 of theK-179 However this deduction amount is calculated after any wages are paid to an S corpowneremployee or after any guaranteed payments are made to an LLC memberpartner80

The overall deduction is then limited to alternative ldquowage limitationsrdquo unless the taxable incomeof the K-1 recipient (before any Sec 199A deduction) is less than $157500 for single taxpayers(phased out over a $50000 range) and $315000 for MFJ filers (phased out over a $100000range) But the good news is that even owners of service-based businesses (eg lawaccounting medical etc) are also entitled to the deduction as long as their taxable incomeis below these same thresholds81

Comment Once again these taxable income thresholds of $157500 and $31500082 arecomputed before the allowance of the 20 Sec 199A deduction

Comment The initial Senate version of Sec 199A contained only the ldquo50 of wagerdquo limitationBut during the subsequent conference committee hearings an alternative limitation was addedto the law Namely ldquo25 of wages plus 25 of the unadjusted basis of ldquoqualified propertyrdquo

Comment The supposed motivation behind this late addition to Sec 199A was to permit ownersof rental properties this 20 deduction And since rental expenses (whether on Form 8825 or

78 So for a fiscal-year partnership for instance ending on a 930 yearend the Sec 199A deduction wouldnot be available until the 93018 K-1 flowing through to the partnerLLC memberrsquos 2018 tax return

79 The issue here though is whether rental income reported from Form 8825 onto the K-1 Box 2 (as wellas a rental activity on page 1 of Schedule E) would be considered associated with a ldquotrade or businessrdquo It certainlyisnrsquot for employment tax purposes and if a taxpayer is a ldquoreal estate professionalrdquo involved in a ldquoreal estate trade orbusinessrdquo under Code sect469 they nevertheless still report their rental income on Schedule E and not Schedule C Onthe other hand rental activities use Code sect162 for taking ldquoordinary and necessary business expensesrdquo such asinsurance utilities and repairs as well as using Form 4797 (ie as ldquoSec 1231 trade or business propertyrdquo) todetermine any gain or loss on disposition Real estate management firms or hotelsmotels that rent their real estate(ie rooms) on a ldquotransient basisrdquo and therefore report their businesses on page 1 of Form 1065 or Form 1120scould possibly get this 20 deductions But pure rental activities that are not businesses and report their activities oneither Schedule E or Form 8825 (ie as part of Form 1065) are normally not considered ldquotrades or businessesrdquo formost purposes of the Code

80 Partnerships that pay no guaranteed payments for services rendered will nevertheless be able to look toany wages paid to rank-and-file employees On the other hand suppose that there are no wages to non-partneremployees and all of the partnershiprsquos profits are allocated by means of guaranteed payments It would appear thatthere would be no ldquoqualified business incomerdquo and therefor no 20 deduction

81 The final Conference bill offered another alternative to the ldquo50 of W-2 wages or guaranteed paymentsrdquoInstead if greater the 20 deduction would be limited to ldquo25 percent of wage income plus 25 percent of the cost oftangible depreciable property for qualifying businesses including publicly traded partnerships but not including certainservice providersrdquo Compared to the Senate bill that represents a benefit for capital-intensive companies orproprietorships that do not pay a lot of wages or any wages at all (such as a Schedule C or F proprietorship whichhas no employees)

82 Up until the last minute Congress had set these ldquothreshold amountsrdquo at $250000 and $500000respectively for unmarried and MFJ filers


Schedule E) normally do not include any ldquowagesrdquo (and instead pays a management fee to anoutside third-party) this addition of the ldquo25 of unadjusted basisrdquo provides an alternative whichfrees up at least some of the original 20 deduction

Example Lisa and John who are MFJ filers own a commercial property through an LLC Theirshare of net rental income is $200000 and their share of ldquounadjusted basisrdquo of the rental propertyis $1 million Meanwhile their taxable income (before the Sec 199A deduction) is well in excessof $415000 Without this ldquo25 capital formulardquo they would have not been entitled to any of theinitial $40000 Sec 199A deduction But with this ldquocapital formulardquo they will be able to subtract$25000 (25 x $1 million unadjusted basis) as a final deduction in calculating their taxableincome

- IRS Guidance Desperately Needed

- Guidance is needed to help understand and apply this new Sec 199A deduction On Feb 212018 the AICPA submitted a letter to Treasury and the IRS requesting guidance on several topicsincluding the definition of ldquoqualified business incomerdquo Hopefully guidance will be issued before2018 returns are filed but estimated payments are due and fiscal-year taxpayers need guidanceas soon as possible

- The Internal Revenue Service has said it will provide guidance detailing exactly who will beallowed to take the Sec 199A deduction With billions of dollars at stake business groups arelobbying for the agency to open the doors to the deduction as widely as possible Somehigh-earning proprietors such as construction contractors massage therapists executiveheadhunters and restaurateurs could be excluded if the IRS writes the rules too narrowly Howabout vets who provide boarding for pets as well as drugs and pet food What about portraitartists v tattoo artists

- Sec 199A Deduction Cannot Exceed Taxable Income Without Net Capital Gain

- The 20 Sec 199A deduction cannot exceed 20 of overall taxable income excluding thededuction less any net capital gain (defined as the excess if any of LTCG over STCL) butincluding qualified cooperative dividends

- If it does then the 20 deduction is limited to the taxpayerrsquos taxable income

Example A taxpayer has $100000 of ldquoqualified business incomerdquo as his only source of grossincome And after taking $60000 of otherwise allowable itemized deductions he lowers histaxable income to just $40000 His initial Sec 199A deduction would be $20000 (ie 20 x$100000) But under this taxable income limitation it will now be capped at just $8000 (ie20 x $40000 of taxable income)

Example Same facts as in Example above except that the taxpayer also has $100000 of netcapital gain And after taking $60000 of otherwise allowable itemized deductions he lowers histaxable income to $140000 (ie $100000 QBI + $100000 net capital gains less $60000) Hisinitial Sec 199A deduction would be $20000 (ie 20 x $100000) But under this taxableincome limitation in excess of any net capital gain it will now be capped at just $8000 (ie20 x ($140000 of taxable income - $100000 net capital gains)) In other words the additional


$100000 of net capital gains had no effect on the Sec 199A deduction)

Example Same facts as in Example above except his ldquoqualified business incomerdquo is only$60000 (ie instead of $100000) and he continues to have $100000 of net capital gains withan offset of $60000 of itemized deductions So his taxable income would now be $100000 Hisinitial Sec 199A deduction would be $12000 (ie 20 x $60000 QBI) But with the 20 oftaxable income in excess of net capital gains cap the Sec 199A deduction is now reducedto zero (ie 20 x ($100000 taxable income - $100000 net capital gains)

Example ldquoSMLLC ProprietorrdquoA Schedule C or F proprietor has $100000 in net profit from her sole proprietorship but alsodeducts $5000 for self-employed health insurance $7065 for self-employment taxes and $10000for a SEP IRA But these are not ldquobusiness deductionsrdquo to be used in determining her ldquoqualifiedbusiness incomerdquo Instead they are adjustments on Form 1040 to calculate adjusted grossincome As a result her deduction is the lessor of 20 of $100000 (ldquoqualified business incomerdquo)or 20 of her taxable income whichever is less

Comment Where a taxpayer ldquoneedsrdquo additional non-capital gain taxable income and they areotherwise considering a conversion from a deductible IRA to a Roth IRA for example it mightmake such a decision more attractive if it means that more of the Sec 199A 20 deduction wouldbe freed up

- Taxpayers Receiving QBI From Fiscal Year Businesses

- What do you do for a partner in a partnership with a June 30th year end In other words whatinformation do they use to calculate the Sec 199A deduction on their 2018 personal return It isthe K-1 for the year ended June 30 2018 It does not matter that the K-1 includes months priorto the effective date of Sec 199A because this provision applies to individuals for their tax yearsbeginning after Dec 31 2017

- Since the Sec 199A is determined at the individual level and given that it applies to tax yearsbeginning after 2017 the fact that a 2018 calendar-year K-1 owner receives QBI from a fiscal yearentity should not affect the normal computation of the Sec 199A deduction

Example A calendar-year MFJ taxpayer with taxable income (before the Sec 199A deduction)of less than $315000 receives QBI from a partnership with a 63018 yearend equal to $100000Given that this taxpayer has ldquonon-capital gainrdquo taxable income of at least $20000 they will beentitled to a Sec 199A deduction of $20000 (ie 20 x $100000 QBI) In other words there isno need to pro rate the QBI of $100000 even though 6 months of the partnership occurred before2018

- Passive v Nonpassive K-1 Investors amp Rental Property Owners

- The final version of the Code sect199A deduction makes no distinction between a passive vnonpassive investor or owners of rental properties Furthermore rental income that is treatedas ldquononpassiverdquo (eg ldquoself-rental incomerdquo or rental income of a ldquoreal estate professionalrdquo who hasgrouped their rentals as one activity for purposes of the passive loss rules) appears to qualify forthe 20 deduction just the same as passive rental income


Comment There is a question as to whether ldquoself-rental incomerdquo (which is considered nonpassivefor the Code sect469 PAL rules and therefore not subject to the Code sect1411 38 Medicare surtaxwhether or not a grouping election is made) will be treated as ldquoqualified business incomerdquo forpurposes of the this new Code sect199A 20 deduction Once again we will need to look for IRSguidance (or Treasury regulations) to clarify this issue but the wording of the law itself makes nosuch distinction between passive and nonpassive net rental income

Comment The Code sect469 ldquorecharacterization regsrdquo convert what appears to be passive income(eg self-rental income) in ldquononpassiverdquo income But they also convert such income intoldquoportfoliordquo income (eg rental of ldquonondepreciablerdquo or ldquosubstantially appreciatedrdquo property)

- Reg sect1469-2T(f) - Recharacterization Rules The regulations recharacterize passive incomeunder six separate rules as either active or portfolio income An additional rule recharacterizesincome from substantially appreciated property In certain cases these rules are also used torecharacterize gain from the sale of an interest in a passthrough entity if the entity itself wouldhave been subject to the rules on a sale of its assets The recharacterization rules apply to thefollowing activities

1) An activity where the taxpayer participates at least 100 hours but not more than 500 hours peryear (net income recharacterized as active income)

2) A rental activity in which less than 30 of the unadjusted basis of the property used or held foruse by customers is depreciable (net income recharacterized as portfolio income)

3) Substantially appreciated property (net income recharacterized as portfolio income)

4) Equity financed lending activities

5) Certain property rented incident to development activity (net income recharacterized as activeincome)

6) Property rented to a nonpassive activity of the taxpayer (net income recharacterized as activeincome)

7) Royalties received by a passthrough entity where the taxpayer acquires an interest in thepassthrough entity after the passthrough entity created or incurred substantial costs with respectto the property

Comment Although rental activities are apparently treated as ldquotrades or businessesrdquo for purposesof the new Sec 199A deduction there is some doubt that ldquotriple net leaserdquo situations would alsoqualify since the landlordlessor has so little involvement in the underlying rental activity This isagain another area where the IRS will have to issue some clear cut guidance one way or theother Nevertheless if mere dividends from a REIT are eligible for the Sec 199A deduction(ie where there is absolutely no involvement on the part of the investor in the underlyingrental activities) how can the new law deny this deduction to the lessor in a triple net leasesituation where at least they involve themselves in negotiating the lease arranging as wellas insuring the property and taking other minimal steps involving the rental activity

Comment Especially with rental real estate it is important to hold title to it in any format (ie ina flowthrough entity such as an LLC or S corporation or directly as a Schedule E activity) except


a C corporation in order to secure this new Sec 199A 20 deduction (let alone having theldquodouble taxationrdquo issue of holding appreciating property of any type in a C corporation)

Example ldquoSec 199A Deduction for Net Rental IncomerdquoSam owns three rentals with net incomes of $20000 and $5000 with one losing $8000 annuallyThe net rental income or loss from these three properties are aggregated to be $17000 As aresult he would deduct 20 of $17000

Example ldquoImpact of Freed-Up Suspended Losses on Sec 199A DeductionrdquoSam in the example above has passive losses that were suspended (ie on form 8582) andcarried forward In 2018 they are ldquoreleasedrdquo because he now has net rental income For purposesof the Sec 199A deduction those passive losses are taken first With using the same exampleabove with $10000 in passive loss carried forward Samrsquos deduction would equal $17000 less$10000 or 20 of $7000

- Sec 199A Deduction Not Allowed Against Gross or Adjusted Gross Income

- The conference agreement clarifies that the 20-percent deduction is not allowed incomputing adjusted gross income and instead is allowed as a deduction reducing taxableincome83 Thus for example the provision does not affect limitations based on adjusted grossincome Similarly the conference agreement clarifies that the deduction is available to both non-itemizers and itemizers

- Sec 199A Deduction Not Allowed in Computing Self-Employment Tax

- The Sec 199A deduction is also not allowed in computing any self-employment tax

- Definition of Qualified Business Income

- ldquoQualified business incomerdquo is determined for each ldquoqualified trade or businessrdquo of the taxpayerFor any taxable year qualified business income means the net amount of ldquoqualified itemsrdquo ofincome gain deduction and loss with respect to the qualified trade or business of the taxpayer

- The determination of ldquoqualified itemsrdquo of income gain deduction and loss takes into accountthese items only to the extent included or allowed in the determination of taxable incomefor the year (eg capital loss at-risk and PAL rules applied first)

Example If in a taxable year a qualified business has $100000 of ordinary income frominventory sales and makes an expenditure of $25000 that is required to be capitalized anddepreciated over 5 years under applicable tax rules the ldquoqualified business incomerdquo is $100000minus $5000 (current-year ordinary depreciation) or $95000 The ldquoqualified business incomerdquois not reduced by the entire amount of the capital expenditure but only by the amount deductiblein determining taxable income for the year

83 Code Sec 62(a) as added by Act Sec 11011(b)


Comment Even though some items of income or deduction are separately stated (eg Sec 179expense or Sec 1231 gain or loss) they would still be taken into account in determining ldquoqualifiedbusiness incomerdquo

Example If in a taxable year a qualified business has $100000 of ordinary income frominventory sales and makes an expenditure of $25000 that is required to be capitalized anddepreciated over 5 years under applicable tax rules Normally the ldquoqualified business incomerdquo is$100000 minus $5000 (current-year ordinary depreciation) or $95000 But if the taxpayerdecides to either take a Sec 179 immediate expensing deduction or claim 100 bonusdepreciation on the $25000 cost of this asset then the ldquoqualified business incomerdquo will reducedby the entire $25000 amount of the capital expenditure resulting in net QBI of $75000

- Qualified Business Income Does Not Include Wages Paid to S Corp OwnerEmployee orGuaranteed Payments Made to Partners

- Qualified business income does not include any amount paid by an S corporation that is treatedas reasonable compensation (ie wages) of the taxpayer (ie the owneremployee) Similarlyqualified business income does not include any guaranteed payment for services rendered to thepartnership by the partnerLLC member

Choice of Entity But if the taxpayerrsquos taxable income is anticipated to stay below the applicableldquothreshold amountsrdquo (ie $157500 or $315000) a partner or proprietor would have theadvantage over an S corporation owneremployee since the latter would have to pay a ldquoreasonablesalaryrdquo which in turn would reduce QBI

- Location of Qualified Business for Purposes of Sec 199A Deduction

- The Conference Agreements states that a ldquoqualified businessrdquo must be effectively connected withthe conduct of a business in the US

- As a result it would appear that businesses or rental activities located outside of the USwould not generate ldquoqualified business incomerdquo for purposes of the Sec 199A deduction

- ldquoSpecified Service Businessrdquo Defined

- A ldquoqualified trade or businessrdquo means any trade or business other than a ldquospecified service tradeor businessrdquo and other than the trade or business of being an employee

- A ldquospecified service trade or businessrdquo includes any trade or business involving the performanceof services in the fields of health law engineering architecture84 (these two areas wereeliminated in the final Conference bill) accounting actuarial science performing arts consultingathletics financial services brokerage services including investing and investment managementtrading or dealing in securities partnership interests or commodities and any trade or businessldquowhere the principal asset of such trade or business is the reputation or skill of one or

84 The conference agreement modifies the definition of a specified service trade or business to excludeengineering and architecture services


more of its employeesrdquo

Comment Much broader definition of ldquopersonal service corporationrdquo under Code sect448

Comment In Owen the court found that the principal assets of a company selling insurance andfinancial products were its ldquotraining and organizational structurerdquo even though the companyrsquossuccess was attributable to some of their employees ldquoeffectively using those assetsrdquo

Comment Where you have a ldquoblended businessrdquo (ie part service-based and also the sale ofa product for instance) the taxpayer would apparently have to go with the predominant characterif their taxable income (before any Sec 199A deduction) will otherwise be above the$207500415000 phaseout points Separation of the businesses if possible might be necessaryIn such instances For instance the taxpayer might seek to do a ldquodivisive re-orgrdquo (ie under Codesect368(a)(1)(D) and Code sect355 as a ldquospin-offrdquo) to separate the two lines of their current businessOr a partnership might consider passing out the assets of one of the ldquolines of businessrdquo pro ratato all of its partners who then contribute them over to a new partnership entity

- In other words while some businesses are clearly ldquospecified service businessesrdquo (eg thepractice of law medicine or accounting) there may be situations as discussed below where thetaxpayer is engaged in more than one trade or business For example an optometrist who alsosells glasses and contact lenses may be able to segregate the income and expenses from thosebusinesses Income from the practice of optometry would be from a ldquospecified service businessrdquobut income from the retail operation would not and therefore would not be subject to exclusionfrom the definition of QBI

Comment There is currently no guidance on how to group activities to determine which make upa trade or business for purposes of the QBI deduction However based on Reg sect1446-1(d)which provides that separate and distinct trades or businesses can use different accountingmethods (provided they maintain complete and separable sets of books and records) there is atleast an argument that such separate and distinct businesses can be treated as separatebusinesses for the QBI deduction Perhaps establishing separate LLCs (or SMLLCs) for eachseparate and distinct business may be helpful in this regard

Comment There will be numerous examples however where it is not clear whether the taxpayerhas a ldquoservice-basedrdquo business or not For instance how would you classify a web-designedbusiness They provide an intangible product but their reputation might have a significant impacton their ability to attract new clients The key reason for not being a ldquospecified service businessrdquois that the $157500315000 taxable income ldquothreshold limitsrdquo would not come into play (ie forphaseout of the overall 20 deduction amount) Only the 50 or 20 ldquowage limitationsrdquo or theldquo25 x capital assetrdquo would be factored into the Sec 199A calculation

Comment Taxpayers in ldquospecified service businessesrdquo whose taxable income is too high (ie$157500 to 257500 for unmarried taxpayers or $315000 to 415000 for MFJ filers) to qualifyfully for this new 20 deduction should perhaps consider incorporating andor changingexpandingtheir business model so that they are not specified service trades or businesses (or at least it isnot the predominant part of the business)

Example A law firm decides to transfer real property that they rent to their practice into the sameForm 1065 as their business (eg using a SMLLC owned by the law firm LLC for liabilitypurposes) The goal is to arguably ldquodiluterdquo the total gross revenues so that the gross rental income


exceeds that derived from providing professional services Nevertheless if QBI is to bedetermined ldquoseparately for each trade or businessrdquo would they still have to consider both of thesesources of gross receipts as coming from separate TBs (ie page 1 of Form 1065 v Form 8825on the same tax return)

Comment Note that the term specified service trade or business is defined in terms ofalready-existing Code sect1202(e)(3)(A) (and not Code sect448 for ldquoPSCsrdquo and the cash method ofaccounting) so there is (at least indirectly) existing guidance on what is and what is not aldquospecified service trade or businessrdquo

Example A client has a company that provides pyrotechnics to shows They sell the product (iefireworks) to the show but also provide the service of designing and setting off the pyrotechnicdisplays If they billed separately could they consider the selling of the product not ldquoservice-basedrdquoand the setting of the fireworks as ldquoservice-basedrdquo Or do they have to look at it from thestandpoint of which provides the higher income In other words if the setting off the fireworks ismore than 50 of the total fees are they then considered service-based If your answer is thatthey are service-based would it then be okay for them to split the selling of the product into aseparate company

Example Another client is a company that are ldquohigh-riggersrdquo In other words they hang things upin the air to either lift other things or to fasten other things to They work in the constructionindustry predominately but occasionally do this for shows Are they considered ldquoservice-basedrdquoIt is their skill that provides a service Or would the industry that they are in make a differenceSince the services of either architects and engineers are excluded from the definition of aldquospecified service businessrdquo should these other businesses which provide services to theconstruction also be excluded

Example How would a business which authors a ldquostock research publicationrdquo be treated forpurposes of the Sec 199A deduction It would seem that the reputation and skills of the ownersand employees would play a key role in the final product

Example If engineers and architects are exempt from the ldquospecified service businessrdquoclassification it would seem that a building contractor would be as well

Example What about a funeral home which does sell coffins and other products but their mainactivity is the providing of services Again it would seem that the reputation and skills of theowners and employees would play a key role in the final product

Example Although artisans such as plumbers electricians carpenters etc certainly have a skillset is their companyrsquos ldquoprincipal assetrdquo one which is based on ldquothe reputation and skills of one ormore of the owners or rank-and-file employeesrdquo

Comment One tax professional has music entertainer clients who earn income ldquothat is based onthe reputation or skill like touring incomerdquo They also earn merchandise income as well as musicroyalties The argument is that if you can prove that the principal asset of the business incomeis not the ldquoreputation of skill of one or more of its employees or ownersrdquo then it can be eligible forthe Sec 199A deduction In addition the revenue derived from the sale of merchandise shouldqualify because the primary asset is the actual inventory And royalty and publishing income couldalso be eligible because the primary assets are the music copyrights


Comment There have been several articles (eg ldquoCrack and Pack How Companies AreMastering the New Tax Coderdquo WSJ 4318) suggesting that ldquoblended businessesrdquo (ie partservice-based and part QBI producing) can (should) be split up so as to carve out any ldquoqualifiedbusiness incomerdquo for purposes of the Code sect199A deduction As mentioned previously this isespecially true where the owners of the business will have taxable income on their personalreturns in excess of the ldquothreshold amountsrdquo (ie $157500 for unmarried taxpayers and $315000for MFJ filers because below these thresholds it does not matter what type of business isinvolved) For a partnership this process can be fairly straight-forward with a pro rata distributionof the needed QBI assets and the formation of a separate entity But with an S corporation therequirements of a Code sect355 ldquodivisive re-orgrdquo would have to be satisfied (as outlined in the articlesbelow) Usually these ldquosplit-offsrdquo are done where family disharmony in the business exists or todivide up corporate-level businesses in a divorce But now with the introduction of new Codesect199A there might be another reason for dividing up a business

Comment The other option suggested is maybe to revoke the S election where a service-basedbusiness is involved and the owners anticipated taxable income is well above the ldquothresholdamountsrdquo Then you would benefit from the 21 flat tax rate for C corporations as well as the50 ldquodividend received deductionrdquo (although the Code sect531 ldquoaccumulated earnings taxrdquo penaltyor the Code sect541 ldquopersonal holding companyrdquo penalty might come into play) Also if a ldquopersonalgoodwillrdquo argument can be made then there might not be ldquodouble taxationrdquo issue when and if theC corporation is liquidated (ie given that a simple sale of stock is not feasible)

Comment Another potential problem with voluntary revoking an S election is that if there arefuture ldquounfavorablerdquo changes to the taxation of C corporations that make flowthrough entities evenmore attractive the 5-year waiting period for re-electing S corporation status might be a problem

LSplitting Off of S Corporationrsquos Separate Businesses Qualified as Divisive Re-Org (PLR201402002) In this instance the S corporation had one class of voting common stock that is equally owned by fourshareholders The corporation wanted to form four new corporations (each to elect S corporationtreatment) divide the assets and liabilities of its business equally between the new corporations anddistribute the stock of each corporation to one of the shareholders In this ruling the IRS concluded thatthe contribution of assets to the new corporations followed by the distribution of stock of each newcorporation to one of the four shareholders qualified as a tax-free reorganization under Codesect368(a)(1)(D) (ie as a ldquodivisive re-org) The result in the ruling was based on the representation thatthe purpose for the reorganization was ldquoto allow each shareholder to independently own and manage aseparate business according to his or her own goals and prioritiesrdquo (Code sect355 Divisive Re-Org)

LOnce Again Divisive D Re-Org Solves Problem of Family Disharmony (PLR 201411012) Given that certain prerequisites were met no gain or loss will be recognized on a proposed transactionby two siblings to divide their existing corporation into two corporations Each corporation will operate oneof the two businesses currently being run by the existing company

Background The Code provides general nonrecognition treatment for reorganizations specificallydescribed in Code sect 368(a) Under Code sect 368(a)(1)(D) a type D reorganization includes a transferof all or part of the assets of one corporation to another corporation if (i) immediately after the transferthe transferor or one or more of its shareholders (including persons who were shareholders immediatelybefore the transfer) or any combination thereof is in control of the transferee corporation and (ii) stockor securities of the corporation to which the assets are transferred are under the plan distributed in a


transaction which qualifies under Code sect354 Code sect355 or Code sect356

A corporation (Distributing) that meets the requirements of Code sect355(a) may distribute the stock orsecurities of a controlled corporation (Controlled) to its shareholders or security holders (Distributees) withno gain or loss recognized to the Distributees Distributing also generally recognizes no gain unless Codesect 355(d) or Code sect 355(e) applies Code sect355 is ldquogenerally intended to permit a corporations historicshareholders to carry on their historic corporate businesses in separate corporations without triggeringincome taxrdquo

Facts Distributing is a corporation that is on the cash method of accounting It was founded bythe father and mother of the current shareholders They own equal amounts of the outstanding a sharesof Distributing voting common stock Distributing owns several acres of land which can be distinguishedinto various separable tracts and is directly engaged in two businesses its historic business and asecond business Distributing has been actively engaged in these businesses for each of the past fiveyears

Comment Keep in mind that merely holding real estate such as a building is not a ldquotrade orbusinessrdquo so that just this asset (even if held for five years or more) could be placed by itself in acontrolled corporation (ie a subsidiary) with the stock of the sub then being distributed to theshareholder(s) of the original corporation pursuant to a divisive re-org plan

One sibling is President of Distributing operating and managing the businesses with active input fromthe other sibling and their adult children In recent years however the two have disagreed significantlyabout the direction in which to take each of the businesses Therefore they propose the followingtransaction

- Distributing will form Controlled and transfer to it a percentage of its active trade or business assetsincluding some of the separable tracts of land in exchange for all of Controlleds outstanding stock (theContribution)

- Distributing will distribute to one of the siblings all of the Controlled shares in exchange for all of hisstock in Distributing (the Split-Off)

- After the Split-Off the other sibling will hold all of the outstanding stock of Distributing which willremain actively engaged in its historic businesses using the remaining percentage of its historic businessassets The other sibling will hold all of the outstanding stock of Controlled which will be actively engagedin the other business using the historic business assets received in the Contribution

- The parties made numerous representations in connection with the proposed transactions Therepresentations mostly pertained to specific requirements that must be met to qualify under Code sect355

IRS Ruling The IRS ruled that the split will qualify for tax-free treatment Specifically it issuedthese rulings

- The Contribution by Distributing to Controlled in exchange for all of the Controlled stock followed bythe Split-Off will constitute a reorganization within the meaning of Code sect368(a)(1)(D) Distributing andControlled each will be a party to a reorganization within the meaning of Code sect368(b)

- Distributing will not recognize any gain or loss on the Contribution under Code sect357(a) and Codesect361(a)


- Controlled will not recognize any gain or loss on the exchange of its stock for the assets received fromDistributing in the Contribution under Code sect1032(a)

- Controlleds basis in each asset received in the Contribution will equal the basis of such asset in thehands of Distributing immediately before the Contribution under Code sect362(b)

- Controlleds holding period in each asset received in the Contribution will include the holding periodduring which Distributing held that asset under Code sect1223(2)

- Distributing will not recognize any gain or loss on the Split-Off under Code sect361(c)

- One sibling will not recognize gain or loss (and will include no amount in income) upon receipt ofControlled stock from Distributing under Code sect355(a)(1)

- The adjusted basis of the Controlled stock in distributee hands will equal the adjusted basis in theDistributing stock to be surrendered in exchange therefor under Code sect358(a)(1)

- Under Code sect1223(1) the holding period of the Controlled stock received by the distributee will includethe holding period of the Distributing shares surrendered by the distributee provided such stock was heldas a capital asset on the date of the Split-Off

- Distributings earnings and profits if any will be allocated between Distributing and Controlled underCode sect312(h) and Reg sect1312-10(a) (Code sect355 Divisive Re-Org)

Comment Among other items the IRS expressed no opinion regarding whether the Split-Off (i)satisfied the ldquobusiness purpose requirementrdquo of Reg sect1355-2(b) (ii) was used principally as adevice for the distribution of the earnings and profits of Distributing or Controlled or (iii) was partof a plan (or a series of related transactions) pursuant to which one or more persons will acquiredirectly or indirectly stock representing a 50 or greater interest in Distributing or Controlled underCode sect355(e) and Reg sect1355-7 (Code sect355 Divisive D Re-Org)

- 20 Deduction for K-1 Income and Net Profit from Proprietorships85

Comment As a caveat this is one of the most complex provisions in the new law There are anumber of special rules and restrictions most of which apply to high earners as well as unsettledissues begging for IRS guidance Also at this point the Sec 199A deduction expires after 2025

LCritical Steps to Implementing Sec 199A Deduction This provision is definitely one of the most convoluted of the new Tax Act And there is no question thatadditional guidance in the form of Treasury regulations or IRS rulings is desperately needed It will bekey that as we prepare clientsrsquo 2017 tax returns we literally have a 3-column worksheet and identify if

85 Under the House bill it was proposed employment taxes at least for ldquoactiverdquo owners of flowthroughentities that they would automatically imposed for 70 of any allocable K-1 income This is a bit confusing since atleast for ldquoactiverdquo managing LLC memberspartners they already pay SE tax regardless of whether it is K-1 Box 1ldquotrade or business income or Box 4 guaranteed payments Both amounts go into Box 14 SE income But forldquoactiverdquo S corp owneremployees whether it is a service-based or non-service-based business 70 of their allocableprofits before any W-2 wages would have been subject to employment tax


their businesses are expected to produce ldquoqualified business incomerdquo in 2018 and whether they areeither (1) ldquospecified service-basedrdquo businesses (2) non-service-based business or (3) a blend betweenthe two types of businesses In addition activities producing net rental income will also be a possiblesource of ldquoqualified business incomerdquo for which a 20 deduction might be claimed Of course if thebusiness or rental activity will be a negative source of QBI then this will result in a offset against otherQBI income sources

Once it is established that the business or rental activity will indeed produce QBI the following questionsshould be asked up-front

Step 1 Will the taxpayerrsquos anticipated taxable income (before any Sec 199A deduction) bebelow the ldquothreshold amountrdquo (ie $157500 for unmarried taxpayers and $315000 for MFJ filers)before the Sec 199A deduction

- If this is the case it will not matter if a service-based or non-service-based business is involved orit is a rental activity producing the QBI In other words the 20 will apply without any need to imposeeither the 50or 20 of wage limitation or look to 25 of the unadjusted bases of assets used in theactivity which produced the QBI

Choice of Entity But if the taxpayerrsquos taxable income is anticipated to stay below the applicableldquothreshold amountsrdquo (ie $157500 or $315000) a partnership or proprietorship would have theadvantage over an S corporation owneremployee since the latter would have to pay a ldquoreasonablesalaryrdquo which in turn would reduce QBI while the latter types of entities do not any suchrequirement

Step 2 Will the taxpayerrsquos aniticpated taxable income (before any Sec 199A deduction) will bein the ldquophaseout rangerdquo (ie $157500 to $207500 for unmarried taxpayers or $315000 to$415000 for MFJ filers)

- If this is the case then once again it will not matter if a service-based or non-service-basedbusiness is involved or if the QBI is from a rental activity In all three cases the taxpayer will haveto compare the initial 20 Sec 199A deduction with the amount that would otherwise be allowedafter applying either the 50 of wage limitation or the 20 of wage limitation plus a 25 xunadjusted bases of depreciable assets factor

- The final Sec 199A deduction will then be a pro rata amount between these two extremes

Step 3 Will the taxpayerrsquos anticipated taxable income (before any Sec 199A deduction) willabove the end of the ldquophaseout rangerdquo (ie $207500 for unmarried taxpayers or $415000 forMFJ filers)

- If this is the case the Sec 199A simply will not be available for a service-based business If insteada non-service-based business is involved or the QBI flows from a rental activity then it will be potentiallylimited to 50 of the wages paid by the activity or if greater 20 of wages plus 25 x unadjustedbases of depreciable assets involved in the activity

Step 4 Will the 20 Sec 199A deduction exceed 20 of overall taxable income before thededuction less any net capital gain (defined as the excess if any of LTCG over STCL) aboveany net capital gain


- If it does then the 20 deduction is limited to the taxpayers taxable income

- Critical 1st Step - Determine Projected Taxable Income for 2018

- A key point to understanding this new Sec 199A 20 deduction is to first determine whether thetaxpayerrsquos projected taxable income for 2018 is expected to exceed the ldquothreshold amountsrdquo

- The taxable income ldquothreshold amountrdquo for unmarried taxpayers is $157500 and for marriedtaxpayers filing joint returns it is $415000

- If these respective taxable income ldquothreshold amountsrdquo (which are determined before thesubtraction of the Sec 199A 20 deduction) are not expected to be exceeded then it does notmatter whether or not a ldquospecified service businessrdquo is involved

- Furthermore since the respective taxable income ldquothreshold amountsrdquo are not expected to beexceeded it will not matter if the qualifying business has paid any wages (or guaranteedpayments in the case of a partnership) or otherwise has any investment in capital The Sec 199A20 deduction will be allowed in full based on the total amount of ldquoqualified businessincomerdquo that the taxpayer has on their return There will be no need to examine the alternativeldquowagerdquo limitations or capital investment of the business

Comment Obviously steps which can be taken to keep onersquos income below the ldquothresholdamountsrdquo (ie $315000 of taxable income for MFJ filers and $157500 for unmarried taxpayers)would make a lot of sense For instance if a taxpayer wanted to itemized their deductions v usingthe standard deduction in a given year they could give appreciated securities to a donor-advisedfund which in turn could free up some or all of the Sec 199A deduction

- Calculating Sec 199A 20 Deduction Where Taxable Income Thresholds Not Exceeded

Comment For all of the examples illustrating the new Sec 199A 20 deduction a MFJ tax returnsituation is used But the same principles would apply if instead an unmarried taxpayer wasbeing considered The only difference is that the taxable income threshold would have been$157500 with a $50000 phaseout range (ie instead of a $315000 taxable income ldquothresholdrdquowith a $100000 phaseout range)

- Example ldquoService-Based Business w Taxable Income lt $315000 Thresholdrdquo Assume X is the sole owner and employee of a service-based S corporation and files a jointreturn with his wife He provides significant services on behalf of his company which earns$315000 annually (which is also the couplersquos taxable income for the year)86 If X withdraws the$315000 as a salary to compensate him for his services the wages are taxed at ordinary ratesas high as 24 generating a tax of $64179 (under the final tax brackets for MFJ in the new TaxAct) But in turn with this wage deduction there would be zero taxable income on the Form

86 The example limits the additional K-1 income to $315000 and assumes that any other income of eitherthe taxpayer or his wife is offset by otherwise allowable deductions so that their overall taxable income does notexceed $315000 Otherwise this service-based business would start to lose the 20 deduction as it is phased outpro rata over the next $100000 of taxable income


1120S and therefore no ldquoqualified business incomerdquo87

Comment This is a perfect example of where a partnership or a proprietorship would not haveto pay any guaranteed payments and a proprietorship would never have to pay ldquowagesrdquo to itsowner

Example (contrsquod) Alternatively to take advantage of the 20 deduction offered by the Senateproposal X could instead simply leave the $315000 of income in the S corporation to be taxedto X as flow-through income Given the couplersquos taxable income is below the $315000threshold X is entitled to a 20 deduction against their taxable income reducing taxableincome to $252000 and their tax bill from $64179 to $49059 a $15120 savings (ie 24 x63000 less in taxable income due to the Sec 199A of 20 x $315000 deduction)

- Conclusions from Example

1 In the Example above if a ldquonon-service-based businessrdquo was instead involved the Sec199A deduction would be exactly the same (ie since the couplersquos anticipated taxableincome was below the $315000 ldquothresholdrdquo for MFJ filers)

2 In the Example above if the couplersquos taxable income was above the $415000 taxableincome threshold as explained more fully below the Sec 199A deduction would not haveapplied at all since this is a service-based business and the couple is outside of thephaseout range

3 In the Example above if the couplersquos taxable income was above the $415000 taxableincome threshold and even if a non-service-based business was involved (eg manufacturer)the Sec 199A deduction would not have applied at all since the couple is outside of thephaseout range and no wages were paid and assuming that there was investment incapital (ie for the ldquo25 capital formulardquo)

4 In the Example above if the couplersquos taxable income was between the $315000 to $415000taxable income threshold the Sec 199A deduction would have been partially phased out(as explained in the examples below) In other words despite the partial phaseout the couplewould have at least gotten some of the Sec 199A deduction This would be the case whether ornot a service-based or non-service-based business was involved and even if there wereno wages or investment in capital

5 To reiterate in Example above since the couplersquos taxable income before the Sec 199Adeduction is below the $315000 threshold there is no need to consider the ldquowagelimitationsrdquo which otherwise serve to limit the otherwise allowable Sec 199A deduction to thegreater of (1) 50 of the wages paid by the S corporation or (2) 25 of the S corprsquos total wages(ie as shown on Lines 7 and 8 of Form 1120S) plus 25 of capital investment if anyFurthermore there is no need to determine whether or not a service-based or non-service-based business was involved

6 So taxpayers staying below the respective $157500 or $315000 threshold amounts have an

87 This assumes that there are no separately-stated net Sec 1231 gains or Sec 179 immediate expensingboth of which also have an impact on the calculation of ldquoqualified business incomerdquo


added incentive especially with an S corporation to under compensate themselves with regardto ldquoreasonable wagesrdquo (ie not only to save employment taxes but also to maximize their Codesect199A deduction) On the other hand if a partnership or proprietorship was involved then theissue of compensation would be ignored for the Sec 199A ldquowage limitationsrdquo (as mentionedbelow)

7 Meanwhile partners who expect to stay below the respective $157500 or $315000threshold amounts also have no need to pay any ldquoguaranteed paymentsrdquo However there isobviously no self-employment tax savings since both ldquoTrade or Business Incomerdquo in Box 1 ofthe K-1 along with any ldquoGuaranteed Paymentsrdquo in Box 4 are added together in Box 14 and thetotal is subject to SE tax They will receive the Sec 199A deduction on their net profitregardless of the lack of wages or investment in capital

8 The same holds true for proprietors on either Schedule C or F If they expect to stay below therespective $157500 or $315000 threshold amounts it does not matter that they cannot payany wages to themselves (or even if they do not have any wages paid to other employees) or ifthey have any investment in capital They will receive the Sec 199A deduction on their netprofit regardless of the lack of wages or investment in capital

Comment The new Tax Act provides significant tax savings for the majority of businesses givenan overall reduction of tax rates and increased bonus and Section 179 deductions Real estateowners along with owners of all flowthrough entity businesses should seriously considerprojected revenue tax liability and the application of accelerated depreciation such as Sec 179and 100 bonus depreciation to take advantage of this new Sec 199A 20 deduction by keepingtheir projected taxable income below the threshold amounts

Comment The taking of immediate write-offs (eg ldquorepair expenses v capitalization ofimprovementsrdquo Sec 179 immediate expensing or 100 bonus depreciation generate several taxbenefits First of all it will help to keep taxable income (before any Sec 199A deduction) belowthe applicable $157500 and $315000 ldquothresholdsrdquo Second it gives an immediate tax benefitequal to the ownerrsquos marginal tax bracket (which can be higher than the Sec 199A 20 amount)And third despite the immediate write-off of the underlying assetrsquos cost its ldquounadjusted basisrdquo isstill available for the ldquo25 capital formulardquo limitation (so long as the asset is still on hand as of theclose of the taxable year)

- Critical 2nd Step - Determine Limited 20 Deduction If Projected Taxable Income Falls WithinPhaseout Range ($157500 to $207500 for Unmarried Taxpayers and $315000 to $415000 forMFJ)

- As mentioned in Step 1 above a key point to understanding this new Sec 199A 20 deductionis to determine whether you have a ldquospecified service businessrdquo or not If you do then nextdetermine in Step 2 whether the taxpayer will otherwise exceed either the $157500(unmarried filers) or $315000 (MFJ filers) respective thresholds (ie taxable income beforethe Sec 199A deduction) As stated previously if they stay under those thresholds then the20 deduction is allowed in full If instead their taxable income is over the respectivethreshold amounts but still under either the $207500 (for unmarried) and $415000 (MFJ)end of the phaseout ranges then they would receive a pro rated deduction (as shown inthe examples below) based on the partial application of the ldquowage limitationsrdquo


Comment Before we can go forward in calculating the Sec 199A deduction for taxpayers fallingwithin the respective phaseout ranges we need to examine the alternative ldquowage limitationsrdquo thatwill otherwise apply

- Taxpayer Planning Steps to Keeping Taxable Income Before Sec 199A DeductionBelowThresholds

- Taxpayers with taxable income near or slightly over the threshold amounts should considertraditional planning techniques to decrease their taxable income These would include

1) Bunching income into one tax year and deductions into the next so that QBI can beclaimed every other year

2) Claiming Sec 179 immediate expensing or 100 bonus depreciation where otherwiseavailable

3) Using cost segregation studies to increase the allocation to assets available for bonusor accelerated depreciation

4) Making deductible retirement plan contributions

5) Making deductible HSA plan contributions

6) Contributing to donor-advised funds or bunching charitable contributions into one year

7) Tracking capital gains and utilizing capital losses to minimize taxable income

8) Gifting income-producing assets to children (but beware of the ldquokiddie taxrdquo)

- If taxable income is sufficiently reduced some or all of any income from a ldquospecified servicebusinessrdquo could qualify as QBI In addition the ldquowageinvestment limitsrdquo can be avoided ormitigated by managing taxable income since those limits are phased in at the same incomethresholds

- 50 or 20 Wage Limitations

- The conference agreement modifies the wage limit applicable to taxpayers with taxableincome above the ldquothreshold amountsrdquo (ie gt $157500 for single taxpayers and $315000 forMFJ filers)88 to provide a limit on the otherwise allowable Sec 199A deduction based on either(1) wages paid or (2) on wages paid ldquoplus a capital elementrdquo

- Under the new Tax Act the ldquowage limitationsrdquo are the greater of either (a) 50 of the W-2

88 These respective ldquothreshold amountsrdquo were up until the very last minute going to be $250000 and$500000 in the final Conference Agreement


wages paid with respect to the qualified trade or business89 or (b) the sum of 25 of theW-2 wages with respect to the qualified trade or business plus 25 of the unadjustedbasis (ie normally this would be the original cost paid for the asset) immediately afteracquisition of all ldquoqualified propertyrdquo90

- For a flowthrough entity the owner would receive an allocable share of total wages that thebusiness has paid for the tax year And for this purpose ldquowagesrdquo would be before any electivedeferrals (eg IRA set-asides 401(k) 403(b) pay-ins) However wages will be excluded unlessproperly included in a payroll tax return timely filed with the Social Security Administrationincluding extensions or within 60 days thereafter In other words the proper number to use forldquoForm W-2 wagesrdquo should be taken from the payroll records and isolated as directly related to theparticular trade or business

Comment For S corporation owners this would be a straight proration since there is only oneclass of common stock But for partners Code sect704(c) might dictate that depreciation oramortization deductions be allocated to certain owners Likewise Code sect704(b)(2) might allowfor ldquospecial allocationsrdquo given that they have ldquosubstantial economic effectrdquo Finally a Code sect754election might result in special allocations of certain deductions

Example John owns a 30 interest in the JKL partnership which is a ldquoqualified trade orbusinessrdquo Pursuant to the terms of the operating agreement John is specially allocated 40 ofall ordinary income or loss of the partnership and 70 of any depreciation or amortizationdeductions The partnership pays $100000 of wages in 2018 And since the partnershiprsquosdeduction for W-2 wages is part of its ordinary income or loss John would be allocated 40 ofthe partnershiprsquos W-2 wages for purposes of the Sec 199A deduction

- The ldquounadjusted basisrdquo of otherwise qualifying property

(1) Is not reduced by Sec 179 bonus depreciation or regular depreciation

(2) Is used for the greater of the MACRS recovery period or 10 years and

(3) Is ignored if the asset is no longer used in a qualifying business (is disposed of or takenout of service as of yearend)

Comment For higher-income taxpayers the new law encourages hiring employees because thehigher the payroll of the trade or business the higher the permitted Sec 199A deduction Buttrades or businesses with depreciable assets used in the business have an alternative to usingjust Form W-2 wages

- As mentioned previously the Sec 199A deduction is generally available to owners of all types

89 This initial approach would have left out real estate firms which typically have relatively few employeesbut large capital investments For them the compromise bill offers an additional method deduct 25 percent of wagespaid plus 25 percent of the purchase price -- or ldquounadjusted basisrdquo of their tangible depreciable property

90 The last-minute change to the tax bill -- which combined a capital-investment approach that the Housefavored with the Senatersquos tax-cut mechanism -- would in effect free up a 20 percent deduction on pass-throughbusiness income that would have been off-limits to many real estate firms under the Senate bill The change wouldstill leave some investment partnerships out those that have few employees and invest in tangible property like landor artwork


of pass-through entities (ie service-based or not) as well as proprietors and owners of rentalproperties so long as their 2018 projected taxable income91 does not exceed the thresholdamounts

- If at the other end of the respective phaseout ranges (ie $207500 for unmarried taxpayersand $415000 for married couples) a ldquospecified service businessrdquo is involved then it simply willnot matter whether any wages (or guaranteed payments for a partnership) are paid Or ifthe business (or rental activity) has any investment in capital The bottom line is that afterthese aforementioned phaseout limits are exceeded it would prevent various kinds of ldquoserviceprovidersrdquo (eg doctors lawyers investment advisers and brokers and professional athletes)from receiving Sec 199A deduction

Comment What would be the effect on these ldquowages limitationsrdquo where a business otherwiseused a PEO (ie professional employee organization) Or would the use of a ldquocommonpaymasterrdquo have any impact as well In the former situation the argument would be that the PEOwas merely an ldquoagentrdquo of the business that utilized them Therefore any wages were in fact thoseof the business (and not the PEO) And a common paymaster should still permit each separatebusiness to take into account their respective wages for the calculation of these limitations

Comment From a choice-of-entity standpoint it seems obvious that a Schedule C or F proprietorwith little or no wages for their non-service-based business along with a minimal investmentin capital and they were otherwise above the end of the respective phaseout ranges (ie gt$2075000 or $415000) is at a distinct disadvantage when compared to an owner of an Scorporation If they were to make an S election for their proprietorship they could at leastpay some wages to themselves and possibly keep a portion of the Sec 199A 20deduction (ie where it was being severely limited or otherwise completely eliminated due tothe 50-of-wage limitation)

Comment Also from a choice-of-entity standpoint a ldquosmaller C corprdquo (ie either a regular C corpor a PSC whose ownerrsquos had taxable income below the threshold amounts) might considermaking an S election (if otherwise eligible) For example a married couple whose taxable income(without the Sec 199A deduction) is projected to be below $315000 would be in a maximummarginal tax bracket of 24 (or less) So for every $100 of ldquoqualified business incomerdquo less a20 deduction it would leave only $80 to be taxed at no more than 24 for effective tax rate notexceeding 192 (ie 24 x ($100 - 20 Sec 199A deduction) And along with the potentialldquodouble taxationrdquo on any appreciated assets when the C corporation was liquidated this wouldyield a better marginal tax rate than the flat 21 tax rate now accorded all C corporations

Comment Once of the most important but unanswered questions at this point regarding theSec 199A deduction is whether guaranteed payments in a partnership can be counted asadditional ldquowagesrdquo when calculating the 50 or 20 wage limitations If not then in those caseswhere a partnership (including proprietorships) has little or no wages being paid to any rank-and-file employees the choice-of-entity decision would weigh heavily in favor of an S corporation Andif a business client would like to have their company treated as an S corporation retroactively toJan 1 2018 this decision to file the Form 2553 election should be done by 3152018 (thougharguably ldquolate electionsrdquo have been approved by the IRS)

91 The Conference bill does not specifically use the term ldquotaxable incomerdquo but merely states them asldquothreshold amountsrdquo


Comment Another planning possibility might be to bring ldquoin-houserdquo outside management of rentalproperties (or even a trade or business such as where a medical professional for exampleutilizes an outside management company to handle day-to-day administrative functions) At leastthis would create additional ldquowagesrdquo for purposes of the 50 and 20 limitation tests

- 25 Investment in Capital Limitation

- Instead of the ldquo50 of wage limitationrdquo a taxpayer finding themselves above the start of thephaseout range (ie $157500 or $315000) could instead look to 25 of wages plus 25 ofany capital investment in their qualified trade or business (including mere rental activities)

- ldquoQualified propertyrdquo for purposes of this ldquocapital investment formulardquo means ldquotangible propertyof a character subject to depreciationrdquo92 that is held by and available for use in the ldquoqualified tradeor businessrdquo at the close of the taxable year and which is used in the production of ldquoqualifiedbusiness incomerdquo and for which the depreciable period has not ended before the close ofthe taxable year However the depreciable period is deemed to end no earlier than 10 yearsfrom the point at which such assets are first placed into service

- As mentioned above the ldquounadjusted basisrdquo of otherwise qualifying property is used forpurposes of the 25 calculation And this will normally be the original cost before any Sec179 bonus depreciation or regular depreciation deductions have been taken

Comment Capitalized improvements added to the basis of otherwise depreciable property shouldserve to increase the ldquo25 capital formulardquo So should a taxpayer take a ldquorepair expenserdquo oncertain types of improvements Or would it be better at least for purposes of maximizing thepotential Sec 199A deduction to instead capitalize the improvement and then take Sec 179 or100 bonus depreciation if otherwise available Then you would still get a write-off but theunadjusted basis of the asset could still be counted for this 25 capital formula limit

Example A taxpayer put a new furnace (or AC unit) into their building Using long-establishedcase law as support this asset did not serve to either 1) ldquoSignificantly prolongrdquo the overall usefullife of the building or 2) ldquoMaterially increaserdquo the current FMV of the building Thus there is atleast an argument to take these costs as a current expense But wouldnrsquot it be better from a taxstandpoint to capitalize these costs and then take Sec 179 or bonus depreciation You wouldthen still have the ldquounadjusted basisrdquo of this asset to use for purposes of the ldquo25 capital formulardquounder Sec 199A while still getting an immediate write-off

Example A taxpayer held title to a shopping mall in an LLC reporting the rental income andexpenses on Form 8825 each year When the mall sold for $95 million for a recognized gain of$20 million would any of this Sec 1231 gain qualified for the Sec 199A 20 deduction asldquoqualified business incomerdquo (whether or not it is treated as ldquounrecaptured Sec 1250 gain taxedat 25 or Sec 1231 gain)

Since the LLC normally paid no ldquowagesrdquo each year to any employees (management of theproperty was done by an outside company along with repairs and maintenance) the owners of

92 Depreciable property includes apartment buildings housing complexes office towers and shoppingcenters


the LLC were counting on the ldquo25 x unadjusted basis of depreciable assetsrdquo to provide somerelief in claiming the Sec 199A deduction (ie since the owners taxable income on their personalreturns was anticipated to exceed the $207500 and $415000 phaseout limits) But since theproperty was no longer on the balance sheet (ie Form 4562 depreciation schedule) of the LLCas of the last day of the tax year this ldquo25 textrdquo yielded a zero result and the Sec 199Adeduction was not available

As an alternative should a client holding multiple real estate parcels opt to put them all into oneLLC which in turn would hold title to multiple SMLLCs (ie one for each of the propertiesinvolved) Therefore should one of the properties be sold the LLC could still pass through ldquo25x unadjusted basesrdquo for the remaining properties that it still had on hand as of the last day of theyear

The law appears to consider each rental activity (even where multiple rental activities areheld by one LLC using separate SMLLCs for each one) as a separate ldquotrade or businessrdquoTherefore a separate potential Sec 199A deduction would be calculated for each rentalactivity (which would have to apply the ldquo5020 wagerdquo and ldquo25 capital formulardquolimitations separately) Thus it seems unlikely that this rental activityproperty being soldcould look to theldquounadjusted basesrdquo of the other rental property (each listed on a separateForm 4562 depreciation schedule for each Form 8825) to support a ldquo25 capital formulardquofor the Sec 199A deduction

And this result appears likely for a couple holding multiple rental properties in separateSchedule Ersquos on their Form 1040

Only where a ldquo TBrdquo on a Form 1065 or Form 1120s (ie as opposed to Form 8825rental activities) had multiple depreciable assets listed on its Form 4562 could one tradeor business asset be sold resulting in an overall gain (which would be treated as QBI) andthe overall ldquowagesrdquo of this trade or business let alone the ldquounadjusted basesrdquo ofdepreciable properties still held (and listed on Form 4562) be counted when applying thelimitation tests for the Sec 199A deduction

Comment If the above ldquoshopping mallrdquo example instead involved multi-million dollar equipmentthat was being sold but which had little or no basis (eg 100 bonus depreciation had beenclaimed) would any of the gain on sale (even if it was all Sec 1245 depreciation recapture) beeligible for the Sec 199A deduction

- Even if there is a minimum 10-year period that can be used when applying the ldquo25 xunadjusted basis testrdquo for MACRS 3- 5- or 7-year assets if the asset in question is not onhand as of the last day of the tax year93 its unadjusted basis cannot be counted for thistest As a result the taxpayer could only look to other tangible real or personal depreciableproperty that it might still have on hand when calculating this limitation

Example If MACRS 3- 5- or 7-7year property was purchased during 2018 and assuming that

93 The Conference Agreement states that ldquoqualified property means tangible property of a character subjectto depreciation held by and available for use in the qualified trade or business at the close of the taxable year andwhich is used in the production of qualified business income and for which the depreciable period has not endedbefore the close of the taxable yearrdquo (though this cannot be shorter than 10 years so long as the property as statedabove is still held for use by the taxpayer in a qualified TB)


the half-year convention applied the ldquounadjusted basisrdquo of these assets could be used forpurposes of the ldquo25 capital formulardquo for at least 2018 through 2027 This is also assuming thatthe asset in question is still available for use in the taxpayerrsquos qualified trade or business and hasnot been disposed of prior to the end of 2027 Furthermore the reason that 2028 is not consideredis because with the half-year convention this 10-year minimum period would run from the middleof 2018 to the middle of 2028 And the Conference Agreement states that we cannot consider theassetrsquos unadjusted basis as of the end of the 2028 tax year since its depreciable life has deemedto have ended as of the middle of the 2028 tax year for purposes of the Sec 199A deduction

Comment Regulations are to be issued which will offer guidance on the calculation of an assetrsquosldquounadjusted basisrdquo after a like-kind exchange or an involuntary conversion But arguably sinceldquoshoes depreciationrdquo is used to the extent of any carryover basis the taxpayer should at least beentitled to the continue use of this basis as well as the basis created by any additional boot orconsideration paid (which would be depreciated using a ldquofresh-startrdquo approach)

- Of course if the taxpayer had taxable income below the end of the phaseout range (ie$207500 or $415000) they might still get a partial Sec 199A deduction

- Dispositions of Sec 1231 Assets and 25 Capital Formula

- Even though 25 of the unadjusted basis of the property can support a Sec 199Adeduction for example based on net rental income (especially where there is little or noldquowagesrdquo on either Form 8825 or Schedule E) as mentioned above a problem can arisewhere a significant Sec 1231 gain is realized upon the sale of the property

Example In the example above a significant Sec 1231 gain was realized upon the sale of theshopping mall held by an LLC (ie acting as a lessor on a Form 8825) where all managementfunctions were otherwise handled by an outside management company As a result there werelittle or no ldquowagesrdquo on this Form 8825 More importantly since the property was no longer held bythe LLC as of the close of the taxable year there was no ldquounadjusted basisrdquo against which theldquo25 capital formulardquo could be applied The bottom line was that a potential Sec 199A could belost which would have been a lot larger then just the one afforded against net rental income on anannual basis

- Do Sec 754 or Sec 338(h)(10) Elections Create ldquoUnadjusted Basisrdquo for Purposes of the 25Capital Formula Limitation

- These elections where properly made certainly do create both depreciable and amortizableassets which are listed on the Form 4562 depreciation schedule in the same fashion as a taxableacquisition of an asset Nevertheless guidance is needed insomuch with regard to the step-up inthese assets and whether they should essentially be treated as if acquired (at least where a buyeroffered valuable consideration for the purchase) in the same fashion as a normal purchase ascash being paid directly to the seller Yet there has not been the actual acquisition of a new assetInstead these elections only reflect the increased value of the assets already held by thebusiness

- The same argument could be raised where (regardless of any estate tax being paid) abeneficiary inherits a partnership interest and a Sec 754 election is made by the entity thereby


creating new stepped-up inside bases equal to the FMV of the partnership interest inherited Heretoo there has been no new acquisition of any assets Instead it is merely a reflection of theinherent value of the assets already owned by the partnership

- Would it make any difference if the step-up from a Sec 754 election resulted from a partnerhaving their interest acquired by purchase by an outside third party or by receiving a liquidatingdistribution from the partnership Here at least ldquofresh considerationrdquo has been paid in theacquisition of the partnership interest (v simply inheriting a partnership interest with a stepped-upbasis equal to the FMV as of the date of the decedentrsquos partnerrsquos death)

- How about where a taxpayer avoids income recognition stemming from a cancellation of debtsituation but utilizes an exception on Form 982 and is required to reduced any remaining adjustedbases of depreciable assets held directly (or indirectly) It would seem that such a reduction inbasis would have a corresponding effect on the 25 capital formula should that limitation comeinto play for purposes of the overall Sec 199A deduction

- Impact of Purchase Price Allocations under Code Sec 1060

- Buyers generally prefer allocations to Class III assets (ie receivables) or Class IV (ieinventory) which are ldquofast payrdquo assets when doing the lump-sum allocation of a purchase pricepaid for trade or business assets on Form 8594

- Class V assets (not Sec 197 intangibles) are generally subject to depreciation

- Increased Sec 179 expensing and bonus depreciation may allow Class V assets to create thesame tax benefit to the buyer as Class III or Class IV assets

- But Class V assets can also simultaneously increase the capital base (ie for the 25 xunadjusted bases ldquocapital limitationrdquo) and perhaps the Sec 199A deduction

Comment It should be noted that this provision may impact Code sect1060 allocations Forinstance Class III or IV assets may not be ldquobetterrdquo than Class V assets especially now with theincreased Sec 179 expensing provision or 100 bonus depreciation In addition Class V assetscreate ldquounadjusted basisrdquo for Sec 199A purposes

Comment On the other hand the seller will generally try to insist on the majority of thecompanyrsquos FMV being sold is attributable to goodwill It gives them LTCG but for the buyer it hasto be amortized over 180 months pursuant to Code sect197 And now with the Sec 199Adeduction it will not lead to any ldquounadjusted basisrdquo which can be used for the ldquo25 capitalformulardquo

Example ldquoNon-Service-Based Businessrdquo - Taxpayer at End of Phaseout Range with CapitalInvestmentrdquoA taxpayer who is subject to the ldquowage limitationsrdquo (ie because they are above the $157500 or$315000 threshold amounts) does business as a sole proprietorship (ie Schedule C) conductinga widget-making business which has a $10000 profit for 2018 The business buys awidget-making machine for $100000 and places it in service in 2018 But the business has noemployees in 2018 (and obviously the proprietor cannot pay any wages to himself) The ldquowagelimitationrdquo is the greater of (a) 50 of W-2 wages or $0 or (b) the sum of 25 of W-2 wages ($0)


plus 25 percent of the unadjusted basis of the machine immediately after its acquisition $100000x 025 = $2500 The amount of the limitation on the taxpayerrsquos initial Sec 199A 20 deductionof $10000 (ie 20 x $100000 Schedule C profit) is $2500 (ie the lesser of $10000 or$2500)

Example ldquoService or Non-Service-Based Businessrdquo - Taxpayer Within Phaseout Rangewith Capital InvestmentrdquoIf the taxpayer in the Example above (in either a service- or non-service-based business) hadtaxable income somewhere within the phaseout range for example a MFJ filer with $365000then the Sec 199A deduction would be half-way between the $10000 initial calculation andthe $2500 limit based on capital investment That is $6250 (ie $10000 ndash 3750)

Example ldquoService or Non-Service-Based Business w Taxable Income of $365000 and NoWages or Capital Investmentrdquo Assume X is the sole owner and employee of an S corporation and files a joint return with hiswife He provides significant services on behalf of his company which earns $365000 annually(which is also their projected taxable income )94 If X withdraws the $365000 as a salary tocompensate him for his services the wages are taxed at ordinary rates as high as 32generating a tax of $80179 (ie under the final Conference bill tax brackets for MFJ filers) Andthere would be no Sec 199A deduction since ldquoqualified business incomerdquo would have beenreduced to zero (ie taxable income on Form 1120S would be zero as shown in the K-1 Box 1for ldquoTrade or Business Incomerdquo assuming that there were no other sources of QBI such as netSec 1231 gains)

Alternatively to take advantage of the 20 deduction offered by the Senate proposal X couldsimply leave the $365000 of profits in the S corporation to be taxed to X as flow-throughincome But since the couplersquos taxable income is exactly half way between $315000threshold and the $415000 end of the phaseout range the ldquowage limitationsrdquo have to beconsidered In this situation X is entitled to half of the normal 20 deduction (ie 50 x(20 x 315000 = 31500)) against their taxable income reducing taxable income to $333500(ie 365000 - 31500 deduction) and their tax bill from $80179 to $70099 a $10080 savings(ie 32 x 31500 less in taxable income)

This phaseout Sec 199A amount is calculated by taking what would have been allowed hadthe couplersquos taxable income been $315000 or below (ie 20 x 315000 = 63000) andcomparing to what the deduction would have been at $415000 of taxable income (ie zerosince no wages were paid out of the S corporation) Since the couplersquos taxable income wasexactly half way between the phaseout range (ie 365000 is 50 between 315000 and415000) they will be able to subtract a Sec 199A deduction equal to $31500 in arriving at theirtaxable income

- For K-1 business owners with taxable incomes above the threshold amounts (ie $157500 and$315000) they can take into account their allocable share of all wages paid by the business (ieto both the owners at least for an owneremployee of an S corp as well as rank-and-file



employees) into account to determine either the 50 or 25 ldquowage limitationsrdquo As a resultflowthrough owners with even higher taxable income limits above the end of the respectivephaseout ranges are assured of at least getting some of this new 20 deduction as long as theyare not a ldquospecified service-based businessrdquo and they have either paid some wages (orguaranteed payments) or have some capital investment (ie tangible real or personalproperty assets) in their business

Comment With these new ldquowagerdquo and ldquo25 x capital assetsrdquo limitations there will certainly bea need for more information on an ownerrsquos K-1 Both non-service-based businesses as wellas ldquospecified service businessesrdquo (at least below the threshold amounts or otherwisewithin the respective phaseout ranges) apply these ldquowage limitationsrdquo But if a ldquospecifiedservice businessrdquo is involved unless the taxpayer is under the end of the applicable phaseoutamount (ie $207500 or $415000) they otherwise are not entitled at all to the Sec 199Adeduction

- Critical 3rd Step - Determine ldquoSpecified Service Businessrdquo Status If Taxable Income Exceeds Endof Taxable Income Phaseout Range of $207500 or $415000

- If a service-based business is owned by a taxpayer (ie either as a proprietorship or as a K-1entity) then if the respective ends of the phaseout range (ie $207500 or $415000) areexceeded it will not matter what if any wages (or guaranteed payments) are paid by thecompany since they will simply not be allowed a Sec 199A deduction

- If a ldquospecified service businessrdquo is not involved but the taxpayer is above the respectivephaseout points of either $207500 or $415000 then the ldquowage limitationsrdquo will serve to puta cap on the initial 20 deduction amount As stated previously the ldquowage limitationrdquo is thegreater of either (1) 50 of wages paid or (2) 25 of wages paid + 25 of capital

Example ldquoService-Based Business w Taxable Income gt $415000rdquo Assume X is the sole owner and employee of a service-based S corporation and files a jointreturn with his wife He provides significant services on behalf of his company which earns$415000 annually (and this is also the couplersquos taxable income before any Sec 199A deduction)If X withdraws the $415000 as a salary to compensate him for his services the wages are taxedat ordinary rates as high as 35 generating a tax of $96629 (ie under the final Conference billtax brackets for MFJ filers) And there is no Sec 199A deduction since the S corporation has noldquoqualified business incomerdquo after the $415000 in wages is subtracted

Alternatively to take advantage of the 20 deduction offered by the Senate proposal X decidesto simply leave the $415000 of income in this ldquoservice-basedrdquo S corporation to be taxed to X asflow-through income But since the couplersquos taxable income is at or above the $415000end of the phaseout range before any Sec 199A deduction X is not entitled to any of theSec 199A 20 deduction against their taxable income And it would not matter if any wageswere paid or if there was any investment in capital since a ldquoservice-based businessrdquo isinvolved and the couplersquos taxable income is above the end of the phaseout range (ie$415000 for MFJ)

Example ldquoS Corporation - Non-Service-Based Business with Taxable Income Above$415000rdquo


John is the sole owner and employee of a non-service-based S corporation business whichotherwise has a $500000 profit before any ldquoLine 7 - Compensation of OfficersShareholdersrdquoFurthermore this couple expects their taxable income to also be $500000 (ie above the end ofthe MFJ $415000 end of the phaseout range) And assume that there is no significant capitalinvestment in the corporation

Consider the following three alternatives and the related impact on a potential Sec 199Adeduction

Alternative 1 John pays the entire $500000 profit out as wages to himself thereby reducingldquoqualified business incomerdquo to zero and also the Sec 199A deduction to zero

Alternative 2 John decides to pay nothing in wages to himself and instead shows this$500000 profit from the S corporation as K-1 Box 1 ldquoTrade or Business Incomerdquo His ldquoqualifiedbusiness incomerdquo is now $500000 (assuming that there is no Sec 179 deduction or net Sec 1231gains or losses) So his initial Sec 199A deduction would be $100000 (ie 20 x $500000)But since his taxable income before the Sec 199A deduction is expected to be above the end ofthe $415000 phaseout range the ldquowage limitationsrdquo have to be considered Here since no wageswere paid (either to himself or to any other employees) both the 50 and 25 limits on wageswould be zero And given no capital investment in the business (ie either real estate or tangiblepersonal property) the 25 x capital formula would also be zero As a result the initial$100000 Sec 199A deduction would also be zero

Alternative 3 Assume that John decides to take the ldquomiddle groundrdquo where he pays some butnot all of the S corporationrsquos profit out to himself as wages If he was to take out $150000 of the$500000 profit as wages his initial Sec 199A deduction would be $70000 (ie 20 x $350000of QBI) And this amount would not be impacted by the ldquowages limitationsrdquo because the greaterof (1) 50 x $150000 in wages would be $75000 or (2) 25 x $150000 would be $37500 +25 x capital would be zero As a result the Sec 199A deduction would be $70000

Example ldquoProprietorship - Non-Service-Based Business with Taxable Income Above$415000rdquoJohn is the sole owner with no employees of a non-service-based Schedule C or F businesswhich otherwise has a $500000 net profit Furthermore this couple expects their taxable incometo also be $500000 (ie above the end of the MFJ $415000 end of the phaseout range) Andassume that there is no significant capital investment in the corporation


Alternative 1 John cannot pay any wages to himself (and he has no other employees) As aresult his initial Sec 199A deduction of $100000 (ie 20 x $500000 net profit) would belimited based on wages and capital investment to zero

Alternative 2 Assume that Johnrsquos business does have one employee who is paid $50000 inwages but the business otherwise has no significant capital investment His initial Sec 199Adeduction would be $100000 (ie 20 x $500000 net profit) but under the ldquowagelimitationsrdquo it would be limited to just $25000 (ie 50 x $50000 in wages)

Alternative 3 Assume that Johnrsquos business does have one employee who is paid $50000 in


wages and the business otherwise has a significant capital investment of $500000 in machineryand equipment His initial Sec 199A deduction would be $100000 (ie 20 x $500000 netprofit) but under the ldquowage limitationsrdquo it would be limited to the greater of (1) 50 ofwages (ie $25000) or (2) 25 of wages (ie $12500) plus 25 of capital (ie 25 x$500000 in machinery and equipment = $12500) or $25000 As a result the Sec 199Adeduction after the ldquowage limitationrdquo would be $50000

Comment In Alternative 3 above would John have been better off especially from a ldquotime-value-of-moneyrdquo standpoint) to have simply taken a Sec 179 immediate expense deduction or100 bonus depreciation deduction on this $500000 in machinery and equipment when originallypurchased At just 25 the capital investment formula does not yield any significant help overthe otherwise 10-year period that it could be claimed The greater limiting factor especially for asole proprietor would be what wages if any were being paid Of course if John and his wifecould keep their anticipated taxable income (before any Sec 199A deduction) below the $315000threshold (eg with maximizing their retirement plan contributions along with HSA set-asides andother itemized deductions) then it would not matter And even if their taxable income wasbetween $315000 and $415000 (ie somewhere in the MFJ phaseout range) they would havegotten at least a partial Sec 199A deduction

Comment This is where John should maybe consider making an S election for his Schedule Cor F business There at least he could possibly pay some of the $500000 out as wages tohimself and it would not matter if he did not have any other employees or a significant capitalinvestment

Example ldquoPartnership - Non-Service-Based Business with Taxable Income Above$415000rdquoJohn and Lisa are the owners of a non-service-based business which is treated as a partnershipfor tax purposes and which otherwise has a $500000 net profit Furthermore this couple expectstheir taxable income to also be $500000 (ie above the end of the MFJ $415000 end of thephaseout range)

Consider the following alternatives and their related impact on the potential Sec 199A deduction

Alternative 1 The partnership has no employees and John and Lisa take no guaranteedpayments to themselves (ie being husband and wife they simply ldquosplit the bottom line profitrdquo)Their initial Sec 199A deduction would be $100000 (20 x $500000 of qualified businessincome) But under the ldquowage limitationsrdquo and assuming that they have no significantcapital investment in the business the Sec 199A deduction would be reduced to zero asfollows (1) 50 x wages = zero and (2) 25 x wages = zero plus 25 x capital investment= zero

Alternative 2 The partnership still has no employees but John and Lisa instead take the entire$500000 profit out as ldquoguaranteed paymentsrdquo (which would have no effect on the self-employmenttax that they would otherwise pay) The initial Sec 199A deduction would be zero sinceldquoqualified business incomerdquo has now been reduced to zero with the offsetting guaranteedpayment deduction

Alternative 3 Unlike the S corporation example above it would not matter if John and Lisainstead took some but not all of the$500000 profit out as ldquoguaranteed paymentsrdquo (which wouldhave no effect on the self-employment tax that they would otherwise pay) For example suppose


that they reclassify $150000 as guaranteed payments (ie $75000 to each of them) The initialSec 199A deduction would be $70000 (ie 20 x $350000) But if guaranteed paymentsare not added back as ldquowagesrdquo you get the same result as in ldquoAlternative 2 above

Choice of Entity The hope is that future IRS guidance will allow partners to treat some (or all)of the bottom line profit as ldquoguaranteed paymentsrdquo (here $150000) which will be treated the sameas ldquowagesrdquo for the wage limitation If that was the case John and Lisa now have generated a$70000 deduction on their tax return And it would not matter that the partnership had no otheremployees or a significant capital investment Furthermore it had no impact on the SE tax thatthey would otherwise pay Otherwise John and Lisa should seriously consider making anS election for their partnership

- Critical 4th Step - Determine If 20 Sec 199A Deduction Exceeds 20 of Overall Taxable IncomeBefore Deduction Less Any Net Capital Gain (Defined as Excess If Any of LTCG over STCL)

Example A taxpayer has $100000 of qualified business income as his only source of grossincome And after taking $60000 of otherwise allowable itemized deductions he lowers his taxableincome to just $40000 His initial Sec 199A deduction would be $20000 (ie 20 x $100000) Butunder this taxable income limitation it will now be capped at just $8000 (ie 20 x $40000 of taxableincome)

Example Same facts as in Example above except that the taxpayer also has $100000 of netcapital gain And after taking $60000 of otherwise allowable itemized deductions he lowers his taxableincome to $140000 (ie $100000 QBI + $100000 net capital gains) His initial Sec 199A deductionwould be $20000 (ie 20 x $100000) But under this taxable income limitation in excess of any netcapital gain it will now be capped at just $8000 (ie 20 x ($140000 of taxable income - $100000 netcapital gains)) In other words the additional $100000 of net capital gains had no effect on the Sec 199Adeduction)

Example Same facts as in Example except his qualified business income is only $60000 (ieinstead of $100000) and he continues to have $100000 of net capital gains with an offset of $60000of itemized deductions So his taxable income would now be $100000 His initial Sec 199A deductionwould be $12000 (ie 20 x $60000 QBI) But with the 20 of taxable income in excess of net capitalgains the Sec 199A deduction is now reduced to zero (ie 20 x ($100000 taxable income - $100000net capital gains)

Comment On one hand Sec 1231 gains (including ldquounrecaptured Sec 1250 gain taxed at25) flowing from Form 4797 to the Schedule D worksheet are included in the overall ldquonetcapital gainrdquo calculation which although included in the taxpayerrsquos taxable income will nothelp in this final ldquoStep 4 limitation Yet Sec 1245 and Sec 1250 ordinary depreciationrecapture income (as well as recharacterized Sec 1231 gains due to the claiming of Sec1231 ordinary losses in the prior 5 tax years) flowing from Form 4797 to ldquoOther Incomerdquo onthe front page of the taxpayerrsquos return is used as taxable income which can cover the Sec199A deduction

Comment Would it make sense to create additional taxable income from a ldquonon-net capital gainrdquosource so as to free up more of the Sec 199A deduction Certainly if the taxpayer was in amarginal tax bracket of 20 or below any additional tax would be offset by the 20 deduction


afforded under Sec 199A For instance if a taxpayer was considering converting a deductible IRAto a Roth IRA than some of the tax resulting from this conversion could be offset by the Sec 199Adeduction while also supplying additional taxable income for purposes of the ldquoCritical Step 4relating to the ldquotaxable incomerdquo limitation

LDoes Tax Benefit of Sec 199A Deduction Offset Additional Payroll Taxes Due If Wages AreIncreased for Purposes of 5025 ldquoWage Limitationsrdquo

- If a taxpayer exceeds the threshold amounts (ie $157500 or $315000) and the Section 199Adeduction is limited by 50 of wages does it pay to increase wages paid to S corporationshareholders to provide an additional Section 199A deduction Or does the increase in payrolltaxes exceed the value of the extra deduction The answer is that in almost all cases paying extrawages will create a net tax savings to the farmer and the savings can be substantial

- The threshold limitation for all individual taxpayers begins at the 32 tax bracket ($315000 MFJand $157500 for Singles and HOH) And the fully phased-in threshold begins in the 35 taxbracket

Comment The Section 199A deduction is also available to trusts and estates and once thethreshold kicks in the 37 bracket applies

- As a result the tax savings on the extra deduction allowed under Section 199A will likely be inthe 35 or 37 tax bracket (or could be partially in the 24 or 32 bracket but on a phase-inbasis)

However this tax savings is then reduced by the net cost of the extra payroll taxes incurred bypaying the wages This tax rate is either 153 29 or 38 Because most taxpayers subjectto this limitation are higher-income taxpayers it is likely that the social security wage base (ie$128400 for 2018) has already been exceeded but not in all situations The greatest tax savingsis at the point the taxpayer exceeds the wage base but has not reached the Medicare surtax (iewhich commences at either $200000 for unmarried taxpayers or $250000 of AGI for MFJ filers)The assumption is made that taxable income exceeds qualified business income (QBI) due to thewages paid to the shareholder If taxable income does not exceed QBI the maximum savings willbe reduced due to the 20 of taxable income limitation on Section 199A (Cf Codesect199A(a)(1)(B))

- And the employer portion of the payroll tax however will create an additional tax savings to thetaxpayer

- The steps in calculating the total savings are as follows

1 Determine the tentative Section 199A deduction allowed based upon the qualified businessincome without limitation

2 Determine the limit under Sec 199A(b)(2)(B) (ie the 50 wage or 25 wage plus 25qualified property limitation)

3 Determine the difference between the 1 and 2


4 If the taxpayer has received wages exceeding the wage base the taxpayer can pay wages upto about 143 of the amount in 3 to maximize the tax savings If the taxpayer is under the wagebase a series of ldquowhat-ifsrdquo are required to determine the maximum tax savings

5 Once the extra wage amount is determined calculate the amount of extra payroll tax for theemployer and employee

6 Determine the net change in taxable income based on the extra Section 199A deduction plusthe employer payroll tax deduction and multiply by the tax rate

7 Compare this to the amount of payroll taxes paid and this is the net savings

Example ldquoPaying Additional Wages v Increased Sec 199A Deductionrdquo

An S Corporation currently has taxable income of $500000 and has paid wages to its shareholderof $75000 The shareholderrsquos spouse received $125000 of wages from another company TheSection 199A calculated amount is $100000 (ie 20 x $500000) however the 50 of wagespaid limit is $37500 (ie 50 x $75000)

Below is a chart illustrating the calculation of net tax savings assuming the corporation pays anextra $50000 of wages to the shareholder In this example the maximum tax savings is 603of extra wages paid But if the taxpayer is over the FICA wage base amount (ie $128400 for2018) the net savings increases to 1524 or 1614 assuming either a 38 or 29 Medicaretax rate respectively The table outlines the maximum net savings assuming a taxpayer is alreadyover the $128400 FICA wage base

Payroll Tax Tax BracketRate 37 35 32

153 603 488 315

29 1614 1511 1356

38 1524 1421 1266

Table Showing Net Savings from Extra $50000 of Wages Paidto Shareholder Under 2018 $18400 FICA Wage Base

S Corporation Information Original Wage Amount Additional Wages

Gross Income 575000 575000Wages Paid (75000) (125000)Employer PR Deduction - (3825)Net S Corp Income 500000 446175Initial Sec 199A Deduction 100000 89235Wage Limitation 37500 62500Sec 199A Deduction Allowed 37500 62500

Calculation of Shareholderrsquos Taxable Income


Wages Paid to Shareholder 150000 200000Other Non-wage Income 125000 125000S Corp K-1 Income 1000000 949275Standard Deduction (24000) (24000)Sec 199A Deduction (75000) (100000)Taxable Income 1176000 1150275

Net Tax Savings 37 9518Less Extra PR Taxes 29 (1450)Net Savings 8068Percentage Saved onExtra $50000 of Wages 1614

(806850000)

- Calculating QBI with Multiple Businesses

- If the taxpayer is involved in multiple businesses you determine QBI of each one separatelyand you calculate the deduction subject to any limitations on each business Of course moreinformation will be needed for K-1s including the allocable share of any wages paid (both to theowners as well as rank-and-file employees for an S corporation) or the allocable share of anywages plus guaranteed payments (both to the partners as well as rank-and-file employees fora partnership) along with any capital investment (determined using the ldquounadjusted basesrdquo ofqualifying assets) of the business Also the K-1 recipient would need the necessary informationto determined whether a ldquospecified service businessrdquo was involved

Comment K-1 recipients from professional firms (law accounting medicine etc) will have noproblem with this determination But the characterization of other ldquoblended businessesrdquo will be farfrom clear Nevertheless the preparer of the entityrsquos tax return (partnership or S corp) is probablyin the best position to make this determination based on what is the predominant function of thecompany

- Calculation of Sec 199A Deduction with Negative QBI95

Example ldquoNo Excess QBI Among Various Businessesrdquo

Year 1 QBI 20 X QBI 50 x Wages Sec 199A(2) Amount

Business 1 300000 60000 50000 50000

Business 2 (300000) (60000) - (60000)

Net QBI -0- (10000)

95 Assumed that taxable income from other sources offset by deductions so that ldquothresholdsrdquo of with$157500 or $315000 do not come into play


Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -

Carryover - Yr 1 - - - -

Net QBI 600000 50000 Cumulative Sec 199A = 50000

CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 - - - -

Total QBIWages 600000 120000 100000 100000

Comment One of the points to be made in the Example above is that if each business were tobe consider separately Business 1 would have had $600000 of QBI over the 2-year period andafter the lsquowage limitationrdquo would have had a cumulative Sec 199A deduction of $100000 (ie$50000 each year) And Business 2 would just have had a net zero of QBI over the same 2-year period

Comment But since a taxpayer will need to combine the QBI from all ldquoqualified trades orbusinessesrdquo here the ($300000) loss from Year 1 serves to wipe out any of the initial $50000Sec 199A deduction from Business 1 And even where Business 2 turns around and has a$300000 profit in Year 2 the ldquowage limitationsrdquo prevent any Sec 199A deduction at all (whileBusiness 1 has a cumulative Sec 199A deduction over the 2-year period)

Example


Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)

Net QBI (100000) (30000) Combined QBI Sec 199A = -0-

Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Carryover - Yr 1 (100000) (20000) - (20000) -

Net QBI 500000 30000 Combined QBI Sec 199A = 30000

CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000

Comment The point to be made in the Example above is that the ($400000) loss from Business2 in Year1 not only serves to wipe out the $50000 Sec 199A deduction from Business 1 inYear 1 but also reduces the $50000 Sec 199A deduction from Business 1 in Year 2 from$50000 down to $30000 So over a 2-year period only $30000 in Sec 199A deductions arerealized even though on a net aggregate basis the two businesses had $500000 of QBI whichwould have yielded a $100000 Sec 199A deduction if each business could have beenconsidered separately

Example

Year 1 QBI 20 X QBI 50 x Wages Sec 199A Deduction

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Year 2

Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)



CumulativeDeduction

Business 1 600000 120000 100000 100000


Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000

Comment The point to be made in the Example above is that it did not matter ldquonet negative QBIrdquooccurred in either Year 1 or Year 2 The overall effect for this taxpayer is that the Sec 199Adeduction over a 2-year period will only be $50000

- Businesses Owned by Estates or Trusts

- Some family-owned businesses got a reprieve under the final Conference Agreement whichensures that businesses owned through trusts or estates would receive the same tax treatmentas other kinds of businesses to the extent of any ldquoqualified business incomerdquo that they mightotherwise have for a complex trust on Form 1041 fiduciary income tax return (as well as for theForm 1041 income tax return for an estate)

Comment At issue was a provision in a Senate-passed tax bill that excluded estates and trustsestablished to preserve an enterprise for succeeding generations by protecting against estatetaxes or claims from receiving a new tax deduction

- Other Special Limitations for Sec 199A Deduction

- In the case of property that is sold the property would no longer available for use in thetrade or business and is not taken into account in determining the 25 limitation

- Rules are to be provided for applying the limitation in cases of a short taxable year of wherethe taxpayer acquires or disposes of the major portion of a trade or business or the major portionof a separate unit of a trade or business during the year

- Similar to the rules of Code sect179(d)(2) to address acquisitions of property from a related partyas well as in a sale-leaseback or other transaction regulations are to be issued ldquoas needed tocarry out the purposes of the provision and to provide anti-abuse rules including under thelimitation based on W-2 wages and capitalrdquo

- Guidance shall also be provided which prescribes rules for determining the unadjusted basisimmediately after acquisition of qualified property acquired in like-kind exchanges or involuntaryconversions as needed to carry out the purposes of the provision and to provide anti-abuse rulesincluding under the limitation based on W-2 wages and capital

- Lower Threshold for Imposition of IRS Penalty

- TCJA reduces the threshold at which an understatement of tax is consideredldquosubstantialrdquo for purposes of the accuracy-related penalty under Code sect6662 for any returnclaiming the new Sec 199A deduction from the generally applicable lessor of 10 of taxrequired to be shown on the return or $5000 before the change made by the Tax Act to5of the tax required to be shown or $5000


Comment This lower threshold for the imposition of the understatement of tax penalty isparticularly unfair especially given the number of unanswered questions and lack of guidancesurrounding this new Sec 199A deduction Moreover this change to the Code sect6662 does notrequire the substantial understatement to be specifically attributable to miscalculation of the Sec199A deduction As a result any taxpayer who attempts to claim the deduction opens themselvesup to this lower threshold for the penalty even if the understatement has nothing to do with Sec199A

- Specified Agricultural or Horticultural Cooperatives

- The new deduction for pass-through income is also available to specified agricultural orhorticultural cooperatives in an amount equal to the lesser of (i) 20 of the co-oprsquos taxableincome for the tax year or (ii) the greater of (a) 50 of the W-2 wages of the co-op with respectto its trade or business or (b) or the sum of 25 of the W-2 wages of the cooperative with respectto its trade or business plus 25 of the unadjusted basis immediately after acquisition of qualifiedproperty of the cooperative

Comment Unlike the fairly straight-forward calculation of Qualified Business Income (QBI) underCode 199A(a) farmers who transact business with a cooperative as a patron are now subject toadditional requirements Basically the patron of the co-op (ie the farmer) will receive a Section199A(g) deduction from the cooperative similar to the old rules under old Section 199 (ie theDomestic Production Activities Deduction) plus a regular Code sect199A(b)(2)(A) (ie QualifiedBusiness Income Amount or QBIA) deduction that will be reduced by the lesser of (1) 9 of QBIor (2) 50 of wages paid attributable to the income received from the cooperative As a result thefinal Section 199A deduction for a patron may be less than 20 equal to 20 or in excess of 20of QBI

Comment Based on various commentatorsrsquo reports there appears to the a glitch in how the final Tax Act is worded Instead of being limited to 20 of taxable income some pundits suggest thatit is 20 of gross patronage dividends being received by the farmer As a result this is just oneof the many areas of the new tax law that either need clarification or an outright technicalcorrection In fact some tax advisers are considering this alternative by recasting a pass-throughas a ldquocooperativerdquo because the new law lets cooperatives apply the deduction to their grossincome Conversely pass-through entities can only apply the break to net taxable income whichis basically gross income minus expenses In other words the new law sets income limits on thededuction for high-earners in health law and service professions such as financial servicesconsulting and performing arts But those limits apply only to pass-through entities notcooperatives

Example ldquoService-Based Business Owners Paying Dividends to Co-opsrdquoA group of plastic surgeons making millions of dollars a year could set themselves up as acooperative and pay themselves via dividends on their gross income saving far more than if theycontinued to operate as an S corporation

Comment Adopting cooperative status could be as simple as changing a companyrsquos bylaws toreflect the ldquothree pillarsrdquo of being a cooperative Namely control of capital by the owners who arealso called members giving each owner one vote and distributing profits to owners

LRecent Budget Bill Includes Fix to Code Sec 199As Treatment of Sales to Cooperatives


Lawmakers reached an agreement to revise a portion of Code sect199A which was added by the TaxCuts and Jobs Act that gave farmers a massive tax break for selling crops to cooperatives and so putprivate grain firms at a severe disadvantage Under a provision in Code sect199A farmers were given a20 deduction on payments for sales of crops to farmer-owned cooperatives but not for sales to privateor investor-owned grain handlers The provision was added to the tax bill amid of a flurry of last-minutenegotiations and lawmakers have admitted that these changes were a mistake The new agreement nowrestores balanced competition within the marketplace according to a statement from Republicansenators including John Thune (R-SD) John Hoeven (R-ND) and Chuck Grassley (R-IA) (Code sect199AGrain Sales)


Individual Tax Calculations

- Tax Rates and Brackets96

- To determine regular tax liability an individual will continue to use the appropriate tax rateschedule (or IRS-issued income tax tables for taxable income of lt $100000) And going forwardthere will still be four distinct tax rate schedules for individuals based on filing status (iesinglemarried filing jointlysurviving spouse married filing separately and head of household) each ofwhich is divided into income ranges which are taxed at progressively higher marginal tax rates asincome increases

96 Based on 1213 press release it was thought that the marginal rate slated to be 37 which wouldpresumably apply to taxable incomes above $500000 for single taxpayers and $1million for MFJ filers But the finaltax rate schedules surprisingly have $500000 for single taxpayers but only $600000 for where the top rate of 37kicks in for both HofH and MFJ filers Again another ldquomarriage penaltyrdquo for two single taxpayers considering gettingmarried


- In 2017 individuals were subject to six tax rates 10 152528 33 35 and 396

- The House version had four tax brackets 1297 25 35 and 396 and the Senate versionhad seven tax brackets 10 12 225 25 325 35 385

Comment And the highest marginal tax bracket was supposed to have applied for taxableincome of $5000001000000 for single and MFJ filers)

- The Tax Conferees have now finalized the rates as follows 10 12 22 24 32 35and 37 So basically the Senatersquos tax rate schedule was adopted (but with the top marginalbracket set at just 37 instead of 385) However as shown below some of the tax bracketsare extremely large (eg MFJ 24 bracket extends from $165000 to $315000 of taxableincome)

- For tax years beginning after 2018 the tax bracket amounts standard deduction amountspersonal exemptions and various other tax figures would still be indexed for inflation Butbeginning in 2019 the measure of inflation would now be ldquochained CPIrdquo (Consumer Price Index)as opposed to CPI-U (CPI for all urban customers) under current law which would result in lowerannual inflation adjustments

Comment And of course the Code sect1411 9 (on earned income gt$200000 for unmarriedtaxpayers and gt $250000 for MFJ filers) and 38 (on the lesser of ldquonet investment incomerdquo orAGI gt$200000 for unmarried taxpayers and gt $250000 for MFJ filers) Medicare surtaxes remainin the law Furthermore there have been no inflation adjustments since they were first enactedin 2013

Federal Individual Income Tax Rates for 2018 Under the New Tax Act

Comment The same four filing status criteria were retained for individual taxpayers as outlinedbelow However for 2018 ldquoHead-of-householdrdquo filing status will now be added to the ldquoduediligencerdquo requirements on Form 8867 (ie in addition to the current checklist for EITC AOTCand child tax credit)

Comment Whether you needed to file a tax return (other than to just get a refund) was based in2017 on your applicable standard deduction plus any personal exemptions In 2018 this decisionwill be based solely on what your appropriate standard deduction will be (ie $12000 $18000or $24000) plus any additional standard deduction amount (ie for being 65 or older or bilnd)For instance you must file MFJ if your gross income is gt $24000 standard deduction amountprovided that 1) Both individuals have the same household 2) no MFS return was filed and 3)neither individual can be claimed as a dependent on another taxpayerrsquos return or has $500+ ingross income

97 The House bill was revised to provide a reduced rate for small businesses with ldquonet active businessincomerdquo The amendment had provided a 9 tax rate in lieu of the ordinary 12 tax rate for the first $75000 in netbusiness taxable income of an active owner or shareholder earning less than $150000 in taxable income through apass-through business For unmarried individuals the $75000 and $150000 amounts were $37500 and $75000and for heads of household those amounts were $56250 and $112500 As taxable income exceeded $150000 thebenefit of the 9 rate relative to the 12 rate was reduced and it was fully phased out at $225000 But businessesof all types were eligible for the preferential 9 rate


If taxable income is Then income tax equalsSingle IndividualsNot over $9525 10 of the taxable incomeOver $9525 but not over $38700 $95250 plus 12 of the excess over $9525Over $38700 but not over $82500 $445350 plus 22 of the excess over $38700Over $82500 but not over $157500 $1408950 plus 24 of the excess over $82500Over $157500 but not over $200000 $3208950 plus 32 of the excess over $157500Over $200000 but not over $500000 $4568950 plus 35 of the excess over $200000Over $500000 $15068950 plus 37 of the excess over $500000

Heads of HouseholdsNot over $13600 10 of the taxable incomeOver $13600 but not over $51800 $1360 plus 12 of the excess over $13600Over $51800 but not over $82500 $5944 plus 22 of the excess over $51800Over $82500 but not over $157500 $12698 plus 24 of the excess over $82500Over $157500 but not over $200000 $30698 plus 32 of the excess over $157500Over $200000 but not over $500000 $44298 plus 35 of the excess over $200000Over $500000 $149298 plus 37 of the excess over $500000

Married Individuals Filing Joint Returns and Surviving SpousesNot over $19050 10 of the taxable incomeOver $19050 but not over $77400 $1905 plus 12 of the excess over $19050Over $77400 but not over $165000 $8907 plus 22 of the excess over $77400Over $165000 but not over $315000 $28179 plus 24 of the excess over $165000Over $315000 but not over $400000 $64179 plus 32 of the excess over $315000Over $400000 but not over $600000 $91379 plus 35 of the excess over $400000Over $600000 $161379 plus 37 of the excess over $600000

Comment The threshold of only $600000 for where the top marginal bracket begins for MFJfilers is not a typo It was supposed to be $1 million (ie twice the $500000 threshold forsingle taxpayers) But at the last minute it was reduced to only $600000 for budgetaryreasons creating a significant ldquomarriage penaltyrdquo

Married Individuals Filing Separate ReturnsNot over $9525 10 of the taxable incomeOver $9525 but not over $38700 $95250 plus 12 of the excess over $9525Over $38700 but not over $82500 $445350 plus 22 of the excess over $38700Over $82500 but not over $157500 $1408950 plus 24 of the excess over $82500Over $157500 but not over $200000 $3208950 plus 32 of the excess over $157500Over $200000 but not over $300000 $4568950 plus 35 of the excess over $200000Over $300000 $8068950 plus 37 of the excess over $300000

Comment The provisionrsquos rate structure does not apply to taxable years beginning afterDecember 31 2025 But this is an ldquoeternityrdquo with discussing tax law changes For instance ifthere is a major shift in the control of Congress after the up-coming 2018 mid-term elections wecould see significant revisions in the Tax Cuts and Jobs Act

By way of comparison below are the tax rate schedules for 2018 had the tax law not be changed

Tax Rates Schedules for 2018


- FOR MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES If taxableincome is not over $19050 10 of taxable income over $19050 but not over $77400 $1905 plus 15of the excess over $19050 Over $77400 but not over $156150 $1065750 plus 25 of the excessover $77400 Over $156150 but not over $237950 $3034550 plus 28 of the excess over $156150Over $237950 but not over $424950 $5324950 plus 33 of the excess over $237950 Over $424950but not over $480050 $114959 plus 35 of the excess over $424950 Over $480050 $13424450plus 396 of the excess over $480050

- FOR SINGLE INDIVIDUALS (OTHER THAN HEADS OF HOUSEHOLDS AND SURVIVINGSPOUSES) If taxable income is not over $9525 10 of taxable income Over $9525 but not over$38700 $95250 plus 15 of the excess over $9525 Over $38700 but not over $93700 $532875plus 25 of the excess over $38700 Over $93700 but not over $195450 $1907875 plus 28 of theexcess over $93700 Over $195450 but not over $424950 $4756875 plus 33 of the excess over$195450 Over $424950 but not over $426700 $12330375 plus 35 of the excess over $426700Over $426700 $12391625 plus 396 of the excess over $426700

- FOR HEADS OF HOUSEHOLDS If taxable income is not over $13600 10 of taxable income Over$13600 but not over $51850 $1360 plus 15 of the excess over $13600 Over $51850 but not over$133850 $709750 plus 25 of the excess over $51850 Over $133850 but not over $216700$2759750 plus 28 of the excess over $133850 Over $216700 but not over $424950 $5079550plus 33 of the excess over $216700 Over $424950 but not over $453350 $119518 plus 35 of theexcess over $424950 Over $453350 $129458 plus 396 of the excess over $453350

Comment If you recall from 2013 when the new top rate of 396 was added to the Code itapplied when taxable income exceeded $400000 $425000 and $450000 respectively Thesefigures are now $426700 $453350 and $480050 respectively

- FOR MARRIED FILING SEPARATE RETURNS If taxable income is not over $9525 10 of taxableincome Over $9525 but not over $38700 $95250 plus 15 of the excess over $9525 Over $38700but not over $78075 $532875 plus 25 of the excess over $38700 Over $78075 but not over$118975 $1517250 plus 28 of the excess over $78075 Over $118975 but not over $212475$2662450 plus 33 of the excess over $118975 Over $212475 but not over $240025 $5747950plus 35 of the excess over $240025 Over $240025 $6712225 plus 396 of the excess over$240025

LIRS to Issue New Form 1040-SR for 2019 In 2019 for taxpayers 65 or older this will supposedly be a ldquopostcard returnrdquo with specific lines forpension distributions and Social Security benefits

LIRS Issues 2018 Version of Employers Tax Guide (IRS Pub 15 Circular E) The IRS has released the 2018 version of Publication 15 (Circular E) Employers Tax Guideupdated to reflect a number of important changes made by the Tax Cuts and Jobs Act

Background IRS Pub 15 provides guidance on the requirements for withholding depositingreporting paying and correcting employment taxes The publication also includes information on theforms that employers must give to employees and that employees must give to employers as well as theforms that must be sent to the IRS and the Social Security Administration (SSA)

Changes to 2018 Circular E The 2018 version of Publication 15 takes into account a number


of important changes affecting employers including a number of changes made by the new Tax Act

- Withholding tables The 2018 wage bracket withholding tables and the previously-releasedpercentage method withholding tables are included in Publication 15 The 2018 withholding tax tablesincorporate changes to the individual tax rates made by the TCJA Employers should implement the 2018withholding tables ldquoas soon as possible but no later than Feb 15 2018rdquo The 2017 withholding tablesshould continue to be used until the 2018 withholding tables are implemented

- Form W-4 exemption The new version of Publication 15 also takes into account recent guidance onemployees claiming exemption from federal tax withholding on Form W-4 The Pub provides that a newForm W-4 must be provided to the employer by Feb 28 2018 It also notes that because the 2018version of Form W-4 may not be available by that date employees can use a 2017 Form W-4 and followinstructions for how to modify it for limited 2018 use

- Increased withholding allowance The value of an annual withholding allowance has increased from$4050 to $4150

Comment Even though both personal and dependency exemptions have been eliminated by thenew Tax Act the updated 2018 version of Form W-4 still lists the optional number of extra ldquoallowancesrdquo(which are explained in the instructions) that can be claimed for withholding purposes These would stillbe used to take into account head-of-household status dependent and child care expenses theincreased child tax credit etc (as shown on lines ldquoArdquo through ldquoGrdquo in the instructions for Form W-4

- Lower supplemental wage withholding rate The TCJA lowered the withholding rates onsupplemental wages to 22

- Lower backup withholding rate The TCJA lowered the backup withholding rate to 24

- Moving expense reimbursement exclusion generally suspended For tax years beginning afterDec 31 2017 and before Jan 1 2026 exclusion for qualified moving expense reimbursements issuspended except in the case of a member of the US Armed Forces on active duty who movesbecause of a permanent change of station

Comment With the elimination of Form 3903 any reimbursement of moving expenses by a newemployer for instance will result in additional taxable wages for the employeersquos first paycheck

- Social security wage base The social security wage base limit for 2018 is $128400

- Disaster tax relief The 2018 version of Publication 15 reminds employers that disaster tax relief wasenacted for those impacted by Hurricane Harvey Irma or Maria and that IRS has provided special reliefdesigned to support employer leave-based donation programs to aid the victims of these hurricanes andto aid the victims of the California wildfires that began Oct 8 2017 (Misc Circular E)

LIRS Issues Guidance on Withholding Rules (Notice 2018-14) The IRS has issued guidance on withholding rules due to enactment of the Tax Cuts and Jobs Actwhich made significant changes to income tax rates deductions and credits and withholding Asmentioned above the effective period of Form W-4 furnished to claim exemption from income taxwithholding for 2017 was extended until 22818while temporarily allowing employees to use the 2017Form W-4 to claim exemption from withholding for 2018 The Notice temporarily suspends therequirement that employees must furnish new Form W-4 to their employers within 10 days after a changein status that results in reduced withholding It also provides that the optional withholding rate on


supplemental wages is 22 for tax years 2018 through 2025 The rules for 2018 withholding on certainperiodic payments for pensions annuities and other deferred income when a withholding certificate isnot in effect is based on treating the payee as a married individual claiming three withholding allowances (Code sect3401 Form W-4)

Comment The IRS is stressing that a ldquowithholding check-uprdquo should be done for- 2-income families- 2+ jobs in one year- Taxpayers claiming child tax credit- Older dependents- Those taxpayers who itemized in 2017- High-income taxpayers- Large refund or tax liability in 2017

LIRS Releases Updated 2018 Withholding Tables (IR 2018-5) The IRS has released updated withholding tables for 2018 The tables reflect major changes made bythe Tax Cuts and Jobs Act (TCJA) including an increase in the standard deduction elimination ofpersonal exemptions and modification of tax rates and brackets Again the IRS encouraged employersto begin using the updated tables ldquoas soon as possible but no later than 21518rdquo Employees are notrequired to do anything at this time (such as submitting updated W-4 withholding forms) In addition theIRS is revising the withholding tax calculator on IRSgov and hopes to have it available soon Taxpayersare encouraged to use the calculator to adjust their withholding once it is released by the end of FebruaryThe IRS also is working on revising Form W-4 which will reflect additional changes in the TCJA The IRSmay implement further changes involving withholding in 2019 as it works with the business and payrollcommunity to encourage employees to file new Form W-4 next year (Code sect3401 Withholding Taxes)

LIRS Releases Updated Withholding Calculator and New Form W-4 (IR 2018-36) The IRS has released an updated withholding calculator on its website as well as a new version ofForm W-4 to assist taxpayers in checking their 2018 withholding due to the changes made by the TaxCuts and Jobs Act The IRS has also issued a series of frequently asked questions (FAQs) on thewithholding calculator

Background The TCJA contained major tax law changes for individuals among them being anincreased standard deduction elimination of personal and dependency exemptions an increased thechild tax credit limited or discontinued deductions (eg Form 3903 and Form 2106) while also changingthe tax rates and brackets effective for tax years beginning after Dec 31 2017 and before Jan 1 2026

On Jan 11 2018 the IRS issued 2018 withholding tables that reflect the TCJA with employers beinginstructed to begin using the 2018 withholding tables ldquoas soon as possiblerdquo but not later than Feb 152018 These updated withholding tables are designed to work with existing W-4s that employers haveon file but many taxpayers (such as those with children or multiple jobs and those who itemizeddeductions under prior law) are affected by the new law in ways that cannot be accounted for in the newwithholding tables

New Withholding Calculator Released On Feb 28 the IRS released an updated withholdingcalculator on its website as well as a new version of Form W-4 ldquoto help taxpayers make sure that theirwithholding is appropriaterdquo The IRS is encouraging employees to use the withholding calculator and new form to perform a quickpaycheck checkup to help protect against having too little tax withheld and facing an unexpected taxbill or penalty at tax time in 2019 It can also prevent employees from having too much tax withheld


Specifically the IRS is encouraging taxpayers with more complicated financial situations to check theirwithholding including and consider the following factors which could impact their final tax liability for2018

- 2-income families

- People with two or more jobs at the same time or who only work for part of the year

- People with children who claim credits such as the Child Tax Credit

- People who itemized deductions in 2017

- People with high incomes and more complex tax returns

The IRS noted that those with particularly complex situations (eg those who might oweself-employment tax or alternative minimum tax) should consult Publication 505 Tax Withholding andEstimated Tax to determine whether their withholding is proper

Comment The IRS expects the updated version of Pub 505 to be ready in ldquoearly springrdquo

FAQ Guidance The IRS has provided additional information on the withholding calculator in aset of contemporaneously issued FAQs which provided guidance on issues including how employeeschange the amount of tax withheld from their paychecks and why it is especially important for taxpayersto check their withholding this year The FAQs also noted that the IRS anticipates making further changesinvolving withholding in 2019 and that it would work with businesses and the tax and payroll communitiesto explain and implement these additional changes (Code sect3401 Withholding Taxes)

- Capital Gains amp Dividends Preferential Rates Retained

- Under current law the 0 capital gain rate applied to adjusted net capital gain that otherwisewould be taxed at a regular tax rate below the 25 rate (ie at the 10 or 15 ordinary incometax rates) the 15 capital gain rate applied to adjusted net capital gain in excess of the amounttaxed at the 0 rate that otherwise would be taxed at a regular tax rate below the 396 (ie atthe 25 28 33 or 35 ordinary income tax rates) and the 20 capital gain rate applied toadjusted net capital gain that exceeded the amounts taxed at the 0 and 15 rates

- Under the final Conference Agreement the ldquoadjusted net capital gainrdquo of a noncorporatetaxpayer (eg an individual) will continue to be taxed at maximum rates of 0 15 or2098

- Initially a zero percent tax rate would have applied for those taxpayers in the lowest two taxbracket (eg up to $77400 of taxable income for MFJ filers and $38700 for single taxpayers)meanwhile the higher 20 rate would apply to those taxpayers finding themselves in the highestbracket (ie at $600000 of taxable income for MFJ and head-of-households filers and $500000

98 Code Sec 1(j)(5)(A) as amended by Act Sec 11001(a)


for single taxpayers)99

- Now the actual thresholds at which the 0 bracket would end are a bit lower as follows

(1) The 0 rate will continue to apply for taxpayers with taxable income under $38600 onsingle-filed returns and $77200 on joint returns

(2) The 20 rate starts at $425800 for singles and $479000 for joint filers

(3) The 15 rate applies for filers with incomes between those break points

Comment As mentioned previously the 38 surtax on ldquonet investment incomerdquo (ie asdetermined on Form 8960) remains beginning for unmarried taxpayers with modified AGI over$200000 and $250000 for MFJ filers (numbers which have not been adjusted for inflation sincethey first came into the law in 2013)

- The FIFO rule for stock sales would have been made mandatory100 but the conference billdropped this provision If it had become law taxpayers would have been deemed to have soldtheir oldest blocks of a companyrsquos stock (where they otherwise hold multiple blocks of the samecompany) first In other words ldquospecific identificationrdquo of the blocks to be sold would have beeneliminated The proposal however would have exempted regulated investment companies suchas mutual funds and exchange-traded funds

- Standard Deductions Dramatically Increased

- The basic standard deduction for 2018 would have been 1) Joint return or surviving spouse - $13000 (up from $12700 for 2017) 2) Single (other than head of household or surviving spouse)- $6500 (up from $6350 for 2017) 3) Head of household $9550 (up from $9350 for 2017) and4) Married filing separate returns $6500 (up from $6350 for 2017)

- For an individual who can be claimed as a dependent on anothers return the basicstandard deduction for 2018 would have been $1050 (same as 2017) or $350 (same as2017) plus the individuals earned income whichever was greater However the standarddeduction could not exceed the regular standard deduction otherwise allowed for thatindividual And these amounts were not changes by the new Tax Act

- For 2018 the additional standard deduction for married taxpayers 65 or over or blind would havebeen $1300 (up from $1250 in 2017) For a single taxpayer or head of household who is 65 orover or blind the additional standard deduction for 2018 would have been $1600 (up from $1550in 2017)

- The Senate plan would have increased the standard deduction to $24000 for joint returns and

99 This is not a typo the 37 brackets starts at over $500000 for a single taxpayer filers but on only$600000 for MFJ and head-of-household taxpayers

100 Tax firms were already studying ways to help clients preserve tax benefits if Congress had passed thisFIFO rule For instance investors may be able to avoid FIFO by dividing their holdings between multiple moneymanagers or brokers segregating low-basis and high-basis holdings into separate accounts


surviving spouses $18000 for single parents (ie HofH) and $12000 for individuals On theother hand under the House bill the standard deduction would have increased to $12200 forindividuals $18300 for HOH and $24400 for married couples filing jointly slightly higher thanthose under the Senate bill As mentioned above this is up from the $12700 $9300 and $6350figures under current law

- Under the final Conference Agreement the Senate version was adopted whereby thestandard deduction amounts will increase to $12000 for individuals $18000 for HOH and$24000 for married couples filing jointly

- No changes are made to the current-law additional standard deduction for the elderly andblind as well as for dependents101 For instance the standard deduction for dependents in 2018will be the greater of $1050 or $350 plus any earned income (but not more than the regularstandard deduction amount generally $12000 for 2018)

- As is the case under current law taxpayers are allowed to reduce their AGI by thestandard deduction or the sum of itemized deductions to determine their taxable incomeBut especially for those taxpayers who are have paid off their home mortgages (or are otherwiserenting their homes) and who are otherwise healthy (ie with no sizable medical expenses) theiritemized deductions would be capped at just $10000 for property taxes andor state and localincome taxes So if their total charitable contribution deduction does not exceed $14000 theotherwise available standard deduction of $24000 (ie for a MFJ filer) will definitely come intoplay102

Comment According to the White House Council of Economic Advisors because of the dramaticincreases being made to the standard deduction amounts it is estimated that the number oftaxpayers itemizing their deductions will drop from 26 to just 8 In other words 92 ofall taxpayers are expected to opt for using the standard deduction amounts

Example Consider the tax situation of John and Lil who both 68 years old They sold their 5-bedroom home in 2016 as all of their children are grown and are living on their own For 2017they decided to rent for a year or two as they decide on buying a smaller residence They areotherwise healthy (ie their total medical expenses for 2018 should not come close to exceeding75 of their anticipated AGI) So with no mortgage interest deduction or real estate taxes theonly other significant itemized deduction will be their state income taxes which will cap out at thenew $10000 limit With a standard deduction of $26600 (ie 24000 + (2 x 1300)) they wouldhave more than $16500 in charitable contributions to itemize their deductions

Comment They could consider using a ldquodonor-advised fundrdquo to ldquodouble uprdquo on their charitabledeductions thereby itemizing in one year and then using the standard deduction for other yearsAnd the best way to do this given that they do not have sufficient cash on hand would be to useappreciated securities such as stock However keep in mind that these securities could not comedirectly from an IRA to a charity where such a distribution would not even be listed on page one

101 Code Sec 63(c)(7) as added by Act Sec 11021(a) These are slated to be $1250 per spouse for MFJand $1550 for unmarried taxpayers

102 As discussed below the deduction for most casualty losses and all miscellaneous deductions subject to

the 2 of AGI threshold (eg management advisory or tax prep fees) have been eliminated The Form 4952investment interest expense deduction is still available though


of their Form 1040

Comment The other obvious planning suggestion for John and Lil in the example above wouldbe to ldquobunchrdquo their deductions in one year (ie and therefore itemize) and then take the standarddeduction in the next year Nevertheless with the lower tax rates and more generous bracketsdeductions are going to yield less of a tax benefit than in prior years

Comment Another possible benefit of this planning suggestion would be to keep their taxableincome below the the $315000 taxable income ldquothresholdrdquo for purposes of the Sec 199Adeduction given that they otherwise have ldquoqualified business incomerdquo (QBI) from either aninvestment in a trade or business or simply net rental income

- Personal and Dependency Exemptions

- For 2017 you can claim a $4050 personal exemption for yourself your spouse and each ofyour dependents

- For 2018 both personal and dependency exemptions are eliminated103

Comment Even though dependency exemptions have been eliminated the definition of adependent will still be important for claiming head-of-household status the child tax credit theearned income tax credit as well as for other tax provisions As a result Code sect151 will still beused for determining who is a ldquodependentrdquo for tax purposes

- Does the larger standard deductions along with the child credit make up for the loss of thepersonal and dependency exemptions For example consider a MFJ situation with 3 dependents

Example Assume a couple has $400000 of AGI (so they are not in the phaseout range for thechild credit) and is in the 32 marginal tax bracket Without the changes made by the new TaxAct the law for 2018 for MFJ with 3 dependents would have been a $13000 standard deductionplus (5 x 4150 personaldependency exemptions) = $33750 total deduction With a 32 marginalrate the tax savings would be $10800 (32 x $33750) But under the new Tax Act thestandard deduction would now be $24000 (ie an $11000 increase over the former $13000amount for MFJ) And assuming a 32 tax bracket the new $24000 standard deduction wouldyield a tax savings of $7680 In addition with the new $2000 per child tax credit (given all ofthe children are under age 17) this would yield an additional tax savings of $6000 (3 x $2000)As a result the total tax savings under the Tax Reform Act would be $13680 or an increasedtax savings of $2880 (ie $13680 - 10800)

- Under the new Tax Act the credit begins to phase out for taxpayers with adjusted grossincome in excess of $400000 (in the case of married taxpayers filing a joint return) and$200000 (for all other taxpayers) However these phaseout thresholds are not indexed forinflation Nevertheless for 2017 the phaseout started at $110000 of AGI for married couples filing

103 Code Sec 151(d) as modified by Act Sec 11041(a) Also a number of corresponding changes aremade throughout the Code where specific provisions contain references to the personal exemption amount in CodeSec 151(d) and in each of these instances the dollar amount to be used is $4150 as adjusted by inflation Theseinclude Code Sec 642(b)(2)(C) (exemption deduction for qualified disability trusts) Code Sec 3402 (wagewithholding subject to an exception below for 2018) and Code Sec 6334(d) (property exempt from levy)


jointly And for each $1000 of income above the threshold the available child tax credit wasreduced by $50

- However there would no longer be any need to add back any personal or dependencyexemptions as a preference for AMT purposes

- For individuals who are claimed as dependents104 the new Tax Act would limit the standarddeduction to the greater of $500105 or the sum of $250 and the individuals earned income

- Trusts on Form 1041 would also lose their exemption of either $300 for a simple trust or $100for a complex trust

- As a result the question of filing new W-4s by employees in early 2018 to take into account thatthere are no more personal or dependency exemptions should perhaps be considered (thoughthe new withholding tables might take into account the necessary changes) But employees would only have to now indicate whether they are married or single (ie head-of-household statusis not factored into the W-4 form)106

- Phase-Out of Personal and Dependency Exemptions

- With no more exemptions the phase-out mechanism107 will no longer be necessary andhas therefore been eliminated

- Kiddie Tax

- Under current law pursuant to the ldquokiddie taxrdquo provisions the net unearned income of a child wastaxed at the parentsrsquo marginal tax rates if the parentsrsquo tax rates were higher than the tax rates ofthe child The remainder of a childrsquos taxable income (ie earned income plus unearned incomeup to $2100 (for 2018) less the childrsquos standard deduction) was taxed at the childrsquos rates Thekiddie tax applied to a child if (1) the child was under the age of 19 by the close of the tax yearor the child was a full-time student108 under the age of 24 and either of the childrsquos parents was

104 Presumably the definition of a ldquodependentrdquo did not change and would still apply to those children underage 19 or a full-time student under age 24 both ages being determined as of the last day of the year

105 Take note of this new $500 deduction (where it had been $1050 for 2016 and 2017) As a result forpurposes of determining any ldquokiddie taxrdquo especially for a child having only unearned income only the first $500 ofsuch unearned income would be spared any tax After that the taxable income resulting from unearned incomesources would be taxed at the rates otherwise applicable for trusts and estates (where the top marginal rate of 37plus the 38 Medicare surtax on any dividends and LTCGs) would be used

106 Regarding the withholding rules the Conference Agreement specifies that IRS may administer thewithholding rules under Code Sec 3402 for tax years beginning before Jan 1 2019 without regard to the aboveamendments (ie wage withholding rules may remain the same as present law for 2018) (Act Sec 11041(f)(2))

107 For 2018 exemptions would have phased out for MFJ filers for example when AGI exceeded $320000at a rate of 2 for each $2500 (or portion thereof) over that threshold

108 With children being allowed to remain on their parentsrsquo health insurance at least until the last day of themonth in which they turn age 26 the obvious planning point for children subject to the ldquokiddie taxrdquo would be to stayone or two credits shy of what their educational institution defines as a ldquofull-time studentrdquo


alive at such time (2) the childrsquos unearned income exceeded $2100 (for 2018) and (3) the childdid not file a joint return

- Under the new Tax Act the ldquokiddie taxrdquo is ldquosimplifiedrdquo by effectively applying ordinaryand capital gains income tax rates applicable to trusts and estates to the net unearnedincome of a child Thus as under present law taxable income attributable to earned incomecontinues to be taxed according to an unmarried taxpayersrsquo brackets and marginal tax rates Onthe other hand taxable income attributable to net unearned income will now be taxedaccording to the brackets applicable to trusts and estates with respect to both ordinaryincome and income taxed at preferential rates (ie dividends and LTCGs) As result thechildrsquos tax is completely unaffected by the tax situation of the childrsquos parent (ie theirmarginal tax rates or whether they are subject to the Code sect1411 38 Medicare surtax or thehigher 20 marginal tax rate on LTCGs or dividends) or the unearned income of any siblingsBut the higher 20 marginal tax rate for LTCGs and dividends will now apply at just$12501 of taxable income (whereas previously the ldquokiddierdquo would have only beenimpacted where their parentrsquos taxable income placed the parents in the highest 396marginal tax bracket which was $470700 for MFJ filers in 2017)

Comment As was the case before the Code sect1411 38 Medicare surtax will continue to applyonly when the ldquokiddiersquosrdquo AGI exceeds $200000 (ie the normal threshold for an unmarriedindividual) In other words the fact that the ldquokiddiersquosrdquo parents might have had AGI in excess of$250000 and therefore would have potentially been subject to the 38 Medicare surtax had noimpact on the ldquokiddierdquo

- The bottom line at least for unearned income of a child subject to ldquokiddie taxrdquo is that if theirunearned income exceeds the $500 standard deduction any tax would be calculated using thetrust and estate income tax schedules

Comment Given that the parentsrsquo marginal income tax brackets no longer have any impact ona ldquokiddiersquosrdquo tax calculation the option to file Form 8615 and put the kiddiersquos unearned income ontheir parentsrsquo tax return has been eliminated

Example Had the changes in the new Tax Act not been made in 2018 a child subject to kiddietax would have to had parents whose taxable income exceeded $480050 (ie what would havebeen the starting point for the highest marginal tax bracket) to have been forced to use the higher20 tax bracket for dividends and LTCGs Now given that the tax rates and brackets for Form1041 have to instead be used the 20 rate on such income would commence at only $12500of taxable income But the 38 Medicare surtax would not apply until the ldquokiddiersquosrdquo AGI reachedthe $200000 threshold for unmarried individuals (ie for a total tax rate of 238 on LTCGs anddividends)

Example A child who is otherwise subject to ldquokiddie taxrdquo had only unearned income of $12500from interest on CDs Assuming that this is also their taxable income according to the new taxschedule for trusts and estates (and with no $300 or $100 personal exemption whether or not youhave a simple or complex trust) the total tax would be $301150

Example Same facts as in the Example above except that the child also has $1000 of qualifieddividends and LTCGs In addition to the $301150 tax on the ordinary interest income they wouldpay a marginal 37 tax rate on this last $1000 of taxable income or $370 for a total tax of


$338150 (ie $33815013500 for an effective tax rate of 2505)

Comment As had been the case previously this child will not have paid the 38 Medicaresurtax until they actually had AGI over $200000 And under the prior law with regard to the$12500 in ordinary interest income the 37 top marginal rate would not have applied to the childuntil the parentrsquos taxable income exceeded $600000 (ie v only $12500 of taxable incomeusing the trust and estate income tax rates)

- Alternative Minimum Tax

- AMT would have been repealed for tax years after 2017 but the final Tax Act retained the AMTprovisions although with higher exemption amounts and much higher phaseout amountsfor purposes of eliminating these AMT exemption amounts

Comment Far fewer taxpayers will pay the AMT An estimated 200000 or so filers will owethe tax when they submit their 2018 returns as compared with about 5 million taxpayersif the tax legislation had not been enacted As a result the IRS announced that it will retire itsldquoAMT Assistant online toolrdquo in expectation of dwindling users

Comment The main reasons why AMT will not be as prevalent are 1) the $10000 SALT cap forregular tax 2) elimination of personal and dependency exemptions 3) elimination of 2miscellaneous deductions 4) the increase of AMT exemption amount (eg $84500 to $109400for MFJ) and 5) the dramatic increase at which the AMT exemption will phase out (ie for MFJat 25cent$100 where ldquopreliminary AMTIrdquo exceeds $1 million instead of just $160900) But someof the AMT ldquotriggersrdquo will still be 1) the ldquobargain elementrdquo when ISOs are exercised 2) 200 DBfor regular tax where only 150 DB is allowed for AMT purposes and 3) residential real propertyplaced in service before 1999 would still have to use a 40-year ldquomidpointrdquo for AMT instead of the275-year MACRS ldquorecovery periodrdquo permitted for regular tax purposes (although the SL methodis used for both regular and AMT tax purposes)

Comment Review the ldquoCase Studiesrdquo in the rear of the manual which illustrate how AMT willnot come into play nearly as much as it did before the changes made by the new Tax Act to theAMT exemption amount as well as the higher thresholds at which the phaseout mechanismapplies (as discussed below)

- AMT Exemption Amounts Increased

- The new Tax Act dramatically increases the AMT exemption amounts for individuals asfollows (1) For joint returns and surviving spouses from $86200 for 2018 to $109400 asadjusted for inflation in tax years beginning after 2018 and (2) For unmarried taxpayers from$54300 for 2018 to $70300 as adjusted for inflation in tax years beginning after 2018109

Comment Cf Case Study 1 - AMT Calculation for illustrative purposes

- For trusts and estates for 2018 the AMT exemption amount was scheduled to be $24600 and

109 Code Sec 55(d)(4) as amended by Act Sec 12003(a)


the exemption was to be reduced by 25 of the amount by which its AMTI exceeded $82050(with the phaseout complete at $180450) But under the final Conference agreement the basefigure of $22500 and phase-out amount of $75000 remain unchanged but these amounts willas those listed above be adjusted under the new C-CPI-U inflation measure (as discussedpreviously for the tax rate schedules and standard deduction amounts) (Code Sec 55(d)(4) asamended by Act Sec 12003(a)

- AMT Exemption for Child Subject to Kiddie Tax

- The AMT exemption for 2018 for a child subject to the kiddie tax may not be higher than $7600(up from $7500 for 2017) plus the childs earned income (if any)

- AMT Exemption Phaseout Increased

- Under the Senate version the above exemption amounts would have been reduced (but notbelow zero) to an amount equal to 25 of the amount by which the alternative minimum taxableincome of the taxpayer exceeds the phase-out amounts increased as follows (1) For joint returnsand surviving spouses from $150000 under current law as adjusted for inflation ($164100 for2018) to $208400 as adjusted for inflation in tax years beginning after 2018 and (2) For singletaxpayers from $112500 under current law as adjusted for inflation ($123100 for 2018) to$156300 as adjusted for inflation in tax years beginning after 2018

- But under the final Conference Agreement the phaseout thresholds were dramaticallyincreased to $1 million for MFJ filers (up from $160900 for 2017) and $500000 forunmarried taxpayers (up from $120700 in 2017)110

Comment Because of the dramatic increases in the exemption amounts and phaseout rangesmany more upper-income taxpayers will now be able to get the benefit of these exemptionsAccording to the nonpartisan Joint Committee on Taxation the higher AMT exemptions andphaseout zones will reduce federal revenues by $637 billion over the next 10 years

LTechnical Correction Needed for AMT Exemption Amount and Phaseout for Trusts and Estates

- Under TCJA Sec 11001 with respect to individual taxpayers the new Tax Act dramaticallyincreases the statutory AMT exemption amounts while also increasing the statutory AMT incomethreshold amounts for purposes of phasing out the exemption amounts (Code sect55(d)(4)(A))However TCJA failed to also increase these amounts with respect to estates and trusts As aresult a technical correction is needed to increase these amounts for estates and trusts as well

- AMT Tax Rates - 26 v 28

110 If the thresholds are this high for preliminary AMTI then essentially the taxpayer involved had to be inthe highest tax bracket for regular tax purposes (ie 37) making it less likely that AMT even under the higher 28bracket would even apply to these wealthier taxpayers


- For 2018 the excess taxable income above which the 28 tax rate applies is (1) MarriedIndividuals Filing Separate Returns $95550 (up from $93900 for 2017) and (2) Joint ReturnsUnmarried Individuals (other than surviving spouses) and Estates and Trusts $191100 (up from$187800 for 2017)

Comment Some personal credits are allowed against the AMT including the child credit theadoption credit the American Opportunity credit and the dependent care credit Another way ofstating this is that regular tax before these personal credits is compared to ldquotentative minimumtaxrdquo (TMT) when seeing which is the higher amount that taxpayers will pay with their personal taxreturns

- Treatment of AMT Carryforwards

- If a taxpayer has AMT credit carryforwards the new Tax Act would allow the taxpayer to claima refund of 50 of the remaining credits (to the extent the credits exceed regular tax for theyear) in tax years beginning in 2019 2020 and 2021 with the remainder claimed in the taxyear beginning in 2022

Individual Deductions

- Miscellaneous Itemized Deductions

- Under current law taxpayers were allowed to deduct certain miscellaneous itemized deductionsto the extent they exceeded in the aggregate 2 of the taxpayerrsquos adjusted gross income

- Unreimbursed employee business expenses as previously shown on Form 2106 will beeliminated as an itemized deduction on Schedule A111

- Under the final Conference Agreement all 2 miscellaneous deductions have now beeneliminated112 This includes deductions for unreimbursed employee expenses home officeexpenses and tax preparation expenses113 In addition expenses such as management advisoryfees would now also be disallowed along with ldquohobbyrdquo expenses (even though the gross receiptsfrom a ldquohobby businessrdquo would still have to be included as ldquoOther Incomerdquo) Other nondeductibleldquomiscellaneous expensesrdquo would also include investment fees (other than interest expense onForm 4952) safe deposit box rental and custodianrsquos fees for IRAs

Comment This will especially put a burden on employees who incur substantial unreimbursedexpenses as part of their job For instance they will not be able to deduct the standard mileagerate (545centmile) along with any tolls or parking fees going forward As a result they would bewell-advised to seek reimbursement under an employer accountable plan v future pay raises Or

111 Employees with remaining adjusted bases in depreciable assets (eg vehicle) would now lose theremaining write-off on this asset

112 Code Sec 67(g) as added by Act Sec 11045

113 The itemized deduction for tax preparation fees would be eliminated (with no apparent distinction for anyportion allocation for Schedules C E or F)


perhaps it is possible to shift their position to that of being as an independent contractor and asa Schedule C proprietor they might also now be eligible for the Sec 199A 20 deduction alongwith their other business-related expenses

- A sales rep might earn $100000 of commissions but if they were not treated as a ldquostatutoryemployeerdquo (ie as indicated on their W-2 so as to be able take their deductions on Schedule C)any related expenses that were not reimbursed would now be treated as nondeductibleldquomiscellaneous deductionsrdquo

Comment Instead of ldquomanagement advisory feesrdquo consider having these investors now payldquotransaction feesrdquo on the buying and selling of various investment assets which could then beadded to their basis Of course the tax benefit would now only be to the extent of the 15 or 20marginal rate that they might otherwise pay on subsequent gains on disposition but at least itwould not be treated as a nondeductible ldquomiscellaneous deductionrdquo

- For a teacher going back to graduate school to obtain their masterrsquos degree any expenseincurred above the $250 AGI deduction otherwise allowed would also be treated as anondeductible ldquomiscellaneous deductionrdquo

- Other Form 2106 Unreimbursed Employee Business Expenses would include Professionallicense fees malpractice insurance trade journals and reference books tools and supplies uniondues etc

Example A taxpayer receives a $250000 legal settlement in a lawsuit with the attorneys takinga 40 contingency fee The entire $250000 would have to be included in the taxpayerrsquos ldquoOtherIncomerdquo (ie Line 21 of Form 1040) while the entire $100000 of legal fees would now benondeductible As a possible planning alternative the final court judgment could dictate that thelosing defendant pay the legal fees of the plaintiff And since this expense would no longer be alegal obligation of the plaintiff the payment of the legal fees should not be treated as aldquoconstructive receiptrdquo of the plaintiff (though they would still have to include any final judgmentamount in their ldquoOther Incomerdquo)

Comment Notice 2018-42 clarifies that deductions for expenses that are deductible indetermining AGI which include unreimbursed employee travel expenses that are claimed bycertain taxpayers (eg reservists and certain state or local government officials) may still beclaimed at the 545cent 2018 business standard mileage rate

Comment Since ldquotax preprdquo fees (regardless of allocation on the Form 1040) have beeneliminated are these costs going to be ldquoreclassifyrdquo as ldquoprofessional feesrdquo for instance on aSchedule C or F business

Comment Since the write-off for Schedule A miscellaneous deductions is gone beginning with2018 returns filed next year this would also include investment account managementadvisoryfees as well So the proposal by some tax professionals will be to allocate a portion of these feesonto Schedule D where transactional fees are not otherwise imposed on each buysell of aninvestment Thus they would either be treated as an additional cost of acquiring a security forinstance or as an additional cost against proceeds received on a sale

- On the other hand miscellaneous itemized deductions not subject to the 2 of AGIthreshold would be retained such as gambling losses (at least to the extent of any


gambling winnings)

- Since all miscellaneous deductions subject to the present 2 of AGI threshold would beeliminated there would no longer be a preference for these expenses when calculatingAMT

- Phase-Out of Itemized Deductions

- Under current law higher-income taxpayers who itemized their deductions were subject tohaving up to 80 of certain itemized deductions phased out For taxpayers who exceed theapplicable threshold (ie based on filing status) the otherwise allowable amount of itemizeddeductions was reduced by 3 of the amount of the taxpayersrsquo adjusted gross income whichexceeded the threshold

- The total amount of most otherwise allowable itemized deductions (other than the deductions formedical expenses investment interest and casualty theft or gambling losses) was limited forcertain upper-income taxpayers All other limitations applicable to such deductions (such as theseparate floors) were applied first and then the otherwise allowable total amount of itemizeddeductions was reduced by three percent of the amount by which the taxpayerrsquos adjusted grossincome exceeds a threshold amount For 2017 the threshold amounts were $261500 for singletaxpayers $287650 for heads of household $313800 for married couples filing jointly and$156900 for married taxpayers filing separately

- Under the new Tax Act this phaseout mechanism is eliminated for tax years beginningafter 2017

- Mortgage Interest Deduction

- Under current law taxpayer are permitted to deduct as an itemized deduction ldquoqualifiedresidence interestrdquo which included interest paid on a mortgage secured by a principal residenceor a second residence The underlying mortgage loans included ldquoqualified acquisitionindebtednessrdquo114 of up to $1 million ($500000 in the case of a married individual filing a separatereturn) plus ldquoqualified home equity indebtednessrdquo115 of up to $100000

- Under the House bill existing mortgages (but only for principal residences and not QSRs) wouldhave been grandfathered and new mortgages would have been capped at $500000 Meanwhileunder the Senate bill the deduction would have remained in place for mortgages up to $1000000(but again only for principal residences and not QSRs) but the deduction for equity debt wouldhave been eliminated

- Under the new Tax Act new mortgages (ie taken out after December 15 2017) would be

114 ldquoQualified acquisition indebtednessrdquo is debt incurred to either build buy or substantially improve a first orsecond residence of the taxpayer

115 ldquoQualified equity indebtednessrdquo is debt secured by the equity in either a principal or one other residenceof the taxpayer which does not exceed $100000 the interest thereon which is deductible regardless of the use towhich the funds are put (eg consumer debt)


capped at $750000 for purposes of the home mortgage interest deduction and would beon both a principal residence as well as a QSR (which would continue to include certainRVs and boats)

Comment For clients with the available cash you might want to consider paying down a highermortgage balance (above either the $1 million or new $750000 cap) given there is no tax benefitfor interest paid If excess cash is not available then consider having the client borrow againsttheir investment assets if such investment interest expense would be deductible on Form 4952(ie as opposed to nondeductible mortgage interest) Or borrowing can be done against businessassets while using otherwise available cash to pay down a mortgage (or simply take a distributionof cash out of a K-1 business against available basis that the owner has in their S corp stock orpartnership interest)

- For any interest on mortgages taken out before December 15 2017 to ldquobuild buy orsubstantially improve a first or second homerdquo (ie ldquoacquisition indebtednessrdquo) the limit willremain at $1000000 and would be available for both the principal residence as well as aldquoqualified second residencerdquo

Example Taxpayer has a ldquograndfatheredrdquo mortgage of $15 million (when the cap for pre-121517 mortgages is $1 million) He incurs interest expense of $60000 for 2018 His mortgageinterest deduction would be $40000 (ie $10 million$15 million x $60000)

- Under a binding contract exception a taxpayer who has entered into a binding written contractbefore Dec 15 2017 to close on the purchase of a principal residence before Jan 1 2018 andwho purchases such residence before Apr 1 2018 shall be considered to incur acquisitionindebtedness prior to Dec 15 2017

- With regard to the refinancing of a mortgage the $1 million$500000 limitations continueto apply to taxpayers who refinance existing qualified residence indebtedness that wasincurred before Dec 15 2017 so long as the indebtedness resulting from the refinancingdoes not exceed the amount of the refinanced indebtedness116

Comment However it appears that if additional monies are taken out upon refinancing (ie thepre-121517 outstanding balance increases at all) then the ldquograndfatheredrdquo exception is lost andthe ldquonewrdquo $750000 (ie post-121417) would apply

Example A taxpayer had an $850000 outstanding mortgage balance relating to the purchaseof either a principal or qualified second residence as of 121517 With the prospect of mortgageinterest rates continually increasing the taxpayer refinances this mortgage but also receives anadditional $50000 to important home repairs Because of the receipt of additional funds uponrefinancing the ldquograndfatheredrdquo exception (ie $1 million cap) is lost and the taxpayer would nowbe subject to the ldquonewrdquo (ie post-12-15-17) $750000 cap As a result a fraction of$750000$900000 would have to be applied against the annual interest expense incurred goingforward Finally with the funds over the ldquonewrdquo $750000 cap being used for ldquopersonal purposesrdquo(ie to ldquobuild buy or substantially improve a first or second residence) it would be treated asnondeductible ldquoconsumer interestrdquo

116 Code Sec 163(h)(3)(F) as amended by Act Sec 11043(a)


Comment If this refinancing occurred on 7118 (ie approximately the middle of the 2018 taxyear) the taxpayer would have the benefit of the $1 million ldquograndfatheredrdquo exception for half ofthe year with the ldquofractionrdquo mentioned above being applied to the interest expense incurred on thisnew mortgage amount for the last six months of 2018

Comment If the taxpayer in the example above discloses that 20 of his home is used for abusiness office (eg to conduct his partnership activities or Schedule C or F proprietorship) thenat least part of the allocated interest expense incurred after the 7118 refinancing could be ldquotakenabove the linerdquo (ie for purposes of determining AGI) on either Schedule E page 2 (ie againstany K-1 income from the partnership) or on Schedule C or F In other words it would not all betreated as nondeductible ldquoconsumer interestrdquo But if the home office was used for employee-related activities (eg the employeeowner of an S corporation conducted his business out of thishome office) then with the elimination of Form 2106 Unreimbursed Employee Expenses thiswould also be treated as nondeductible

- $100000 ldquoqualified equity indebtednessrdquo exception would be eliminated As a result allinterest would have to be ldquotracedrdquo to the use to which it was put (same rules as wecurrently have for AMT with ldquoqualified housing interestrdquo (QHI)117

Comment Under the Reg sect1163-10T the taxpayer has always been free to ldquotracerdquo how thefunds under a debt secured by the equity in a first or second residence are used (ie instead ofautomatically treating the interest on up to $100000 of this QEI as additional mortgage interestfor tax years before 2018) This ldquotracing approachrdquo made sense for instance where despiteotherwise qualifying as QEI the taxpayer used the monies either to buy into a flowthrough entity(ie partnershipLLC or S corporation) or make a capital contribution to them Such interestexpense could instead be taken on page 2 of Schedule E under Part IV of Notice 89-35 Nowregardless of the securitycollateral on the debt (eg equity in a first or second residence) allinterest will need to be traced to the use to which the funds are put

Comment The changes made here to the ldquoqualified residence interestrdquo rules (and specificallyto ldquoqualified equity indebtednessrdquo) under Code sect163(h)(3) in no way impacts the ability of ataxpayer to continue deducting ldquoinvestment interest expenserdquo (eg margin interest) on Form4952 Of course you still need sufficient ldquonet investment incomerdquo (which is defined more narrowlythan NII for purposes of Form 8960 and the Code sect1411 38 Medicare surtax) And therecontinues to be an indefinite carryover of any investment interest expense not able to be taken ina particular tax year (Cf Code sect163(d)3))

Comment Other investment expenses such as IRA custodial fees or account management feeswill no longer be deductible since miscellaneous deduction subject to the 2 of AGI thresholdhave been eliminated starting in 2018

117 The new law states that QEI is eliminated And that would certainly be true when the monies are usedfor consumer purposes However the fact the equity in either a first or second home is used for collateral for a loanshould not automatically mean the any interest on such a loan is nondeductible Instead taxpayers would be subjectto the rules that we currently have for AMT purposes Namely in a fashion similar to the QHI (ie ldquoqualified housinginterestrdquo) rules for AMT all interest would have to be traced Therefore if the monies were used for investmentpurposes the interest would be taken on Form 4952 and Schedule A Likewise if the monies were used for eitherSchedule C E or F purposes any interest expense would be claimed on those respective schedules And under IRSNotice 89-35 if the monies were used to either invest in a passthrough entity or to make a capital contribution tosuch entities then the interest expense would be claimed on Schedule E page 2


Example John and Lisa have a HELOC of $100000 with a 55 interest rate They hadpreviously used these funds to make substantial improvements to their home Meanwhile thebalance in their mortgage (used to purchase their home and taken out before Dec 16 2017) doesnot exceed $900000 Under the new Tax Act all of the interest on both homes is fullydeductible

Example Same facts as in the Example above except that the funds from the HELOC were usedfor consumer purposes Under the new Tax Act all of the interest on the HELOC would nolonger be deductible but the interest on their mortgage would not be affected

Example Same facts as in the Example above except that the new mortgage for the purchaseof their home was taken out after Dec 15 2017 (and there is no HELOC loan) Under the newTax Act the new mortgage cannot exceed $750000

Example John and Lisa have now been living in their home for several years and the balance ontheir mortgage is $650000 In 2018 they find a condo in FL that they would like to purchase andthey would like to use the equity in their principal residence to make a down payment on this newsecond residence Under the new Tax Act with the overall limit of $750000 they could tapthe equity in their current home up to $100000 (ie using a HELOC) and still be able tofully deduct the interest on both loans as mortgage interest on Schedule A

LIRS Clarifies Interest on Home Equity Loans Often Still Deductible (IR 2018-32) The IRS in this ldquoNews Releaserdquo is attempting to clarify that in many cases taxpayers will still be ableto deduct interest paid on home equity loans under the recently enacted Tax Cuts and Jobs ActNevertheless they ignore some basic rules with regard to interest expense in general and specificallythe ldquotracingrdquo rules when the ldquoqualified residence interestrdquo rules do not otherwise apply (or the taxpayerelects to have them not apply)

Comment In the ldquoattempt to clarifyrdquo the ldquoqualified acquisition indebtednessrdquo rules they fail toaddress the long-standing ldquotracing rulesrdquo contained in Reg sect1163-8T where the taxpayer isrequired to ldquotracerdquo how the funds secured by a loan are being used to determine how the relatedinterest expense should be treated for tax purposes on the clientrsquos personal return In fact theService fails to even recognize under the separate Reg sect1163-10T(o)(5) election that even debtsecured by a principal or second home and which can otherwise be considered equityindebtedness can instead be ldquotracedrdquo under the ldquo-8T Regsrdquo

Comment The Reg sect1163-10T(o)(5) election is not something that the taxpayer has tophysically ldquoelectrdquo when they file their personal return Instead by simply ldquotracingrdquo the interestexpense in the first year incurred on a loan (even though it is in fact secured by either a principalor second residence) to how the underlying funds were used it literally takes the taxpayer out ofthe QRI rules regarding both ldquoqualified acquisition indebtednessrdquo (QAI) as well as ldquoqualified equityindebtednessrdquo (QEI) (ie under Reg sect1163-10T and instead puts them under the Reg sect1163-8T ldquotracingrdquo rules)

Background - Tracing Rules The interest expense ldquotracing regsrdquo (Reg sect1163-8T) came outin July of 1987 while the ldquoqualified residence interest regsrdquo were released shortly before Christmas of1987 The ldquotracing regsrdquo were exactly what they are purported to be Namely it did not matter whatcollateral was used to secure the loan Instead they strictly looked to the use to which the borrowedfunds were put to determine how the underlying interest expense on the loan should be treated for taxpurposes For example borrowed funds used to either buy into or to make a capital contribution to a


flowthrough entity (ie partnership or S corporation) were treated as an offsetting deduction against theK-1 from that same entity as shown on page 2 of Schedule E (Cf IRS Notice 89-35 Part IV) Or if themonies were used in connection with a Schedule C or F proprietorship the related interest expense onsuch funds was also shown on the appropriate Schedule C or F If the borrowed funds were made to buyinto or make a capital contribution to a C corporation or to make a loan to either a C or S corporationor a partnership the related interest expense would be shown on Form 4952 as ldquoinvestment interestrdquoexpense (ie since interest income should always be received in return for a ldquoloanrdquo even if it has to beimputed pursuant to Code sect7872) And finally if the borrowed funds were used in relation to a ScheduleE page 1 rental activity then the related interest expense would be shown on Schedule E

Background - Qualified Residence Interest (QRI) Taxpayers are permitted deduct interest onmortgage debt that is qualified acquisition indebtedness (QAI) This is defined as debt that is

1 Secured by the taxpayers principal home andor a second home and

2 Incurred in building buying or substantially improving the home

Comment It is key to understand that this rule has not been changed by the newly-enacted TaxCuts and Jobs Act Instead the bottom line is that the ability to ldquohiderdquo consumer related interestexpense as additional mortgage interest on Schedule A (ie as interest on ldquoqualified equityindebtednessrdquo )has been ldquosuspendedrdquo by the new law So such interest on up to $100000 ofequity indebtedness must now be ldquotracedrdquo to the use to which the funds were put This can simplybe done by making the Reg sect1163-10T(o)(5) election (as discussed above) And as a result thatinterest expense would then be treated accordingly on the taxpayerrsquos personal return with anyinterest related to ldquoconsumerrdquo purchases being nondeductible Furthermore this in essence iswhat we have had to do for years with regard to ldquoqualified housing interestrdquo when preparing Form6251 for AMT purposes

Comment Some practitioners have inquired about ldquohome equity indebtednessrdquo (ie a HELOC)where the funds are used for example to make improvements to their principal or secondresidence and whether the interest thereon is still deductible The response is that these clientsdo not even have QEI to begin with Instead these funds represent ldquoqualified acquisitionindebtednessrdquo (QAI) since they were used to make ldquosubstantial improvementsrdquo to their home andthe debt is secured by the residence in question And this is highlighted in one of the IRSexamples below

Under pre-Tax Cuts and Jobs Act law the maximum amount that was treated as ldquoqualified acquisitionindebtednessrdquo for the purpose of deducting mortgage interest on Schedule A was $1 million ($500000for marrieds filing separately) As a result a taxpayer was permitted to deduct interest on no more than$1 million of such acquisition indebtedness

The ldquosecond piecerdquo of QRI was ldquoqualified equity indebtednessrdquo (QEI) whereby taxpayers could alsodeduct as additional mortgage interest on Schedule A Qualified equity indebtedness as defined forpurposes of the Code sect163(h) QRI mortgage interest deduction included debt that

1 Was secured by the taxpayers home and

2 Was not acquisition indebtedness (as defined above)

In other words this rule had allowed the deduction as additional mortgage interest on QEI and enabled


taxpayers to deduct interest on debt that was not incurred to ldquobuild buy or substantially improverdquo aprincipal or second home (ie interest on debt that could be used for any purpose with no requirementof ldquotracingrdquo on how the borrowed funds were used) And as was the case with ldquoqualified acquisitionindebtednessrdquo the pre-Tax Cuts and Jobs Act rules limited the maximum amount of qualified equityindebtedness on which interest could be deducted Specifically the limit was the lesser of $100000($50000 for a married taxpayer filing separately) or the taxpayers combined equity in their principal andsecond home (if they in fact had any other residences)

Now under the new Tax Act for tax years beginning after Dec 31 2017 the limit on acquisition debtis reduced to $750000 ($375000 for a married taxpayer filing separately) But the $1 million pre-TaxCuts and Jobs Act limit applies to acquisition debt incurred before Dec 15 2017 and to debt arising fromrefinancing pre-Dec 15 2017 acquisition debt to the extent the debt resulting from the refinancing doesnot exceed the original debt amount

Comment The language above follows word-for-word what the final Conference Agreementstates However it leaves open the question as to the limit for a new mortgage taken out fromDec 15 through Dec 31 2017 Since it is not for a ldquotax year beginning after 2017rdquo does the $1million cap apply or the new $750000 limit

Again the new law simply states that for tax years beginning after Dec 31 2017 the deduction forinterest on home equity debt is suspendedrdquo And this elimination of the deduction for interest on QEIapplies regardless of when the home equity debt was incurred (Code Sec 163(h)(3)(F))

Comment When the Conference Agreement states that the deduction for interest on QEI isldquosuspendedrdquo it should simply mean that taxpayers regardless of the type of collateral used tosecure the debt (even if it is the equity in a principal or second residence) will now have to ldquotracerdquothe use to which the borrowed funds are put and treat the interest expense thereon accordingly

New IRS Guidance In IR 2018-32 the IRS states that ldquodespite the newly-enacted restrictions onhome mortgages under the Tax Cuts and Jobs Act taxpayers an often still deduct interest on a homeequity loan home equity line of credit (HELOC) or second mortgage regardless of how the loan islabeledrdquo Again the IRS is simply clarifiing that the Tax Cuts and Jobs Act only ldquosuspendedrdquo thededuction for interest paid on home equity loans and lines of credit unless they are used ldquoto build buyor substantially improverdquo the taxpayers home that secures the loan

For example interest on a home equity loan used to build an addition to an existing home is typicallydeductible while interest on the same loan used to pay personal living expenses such as personal creditcard debts is not (ie it is now exposed as ldquoconsumer interestrdquo under the tracing rules) As under pre-TaxCuts and Jobs Act law for the interest to be deductible the loan must still be secured by the taxpayersmain home or second home (ie a ldquoqualified residencerdquo)

Comment A fairly common tax issue arises when parents step in and assist their childrenespecially when they are attempting to buy their first home and they have little credit or asufficient down payment for making the purchase So the parents ldquoloanrdquo (some might argue thatthis ends up being in realty a ldquogiftrdquo) the funds to the kids but they never take the trouble toldquosecurerdquo the loan by placing a lien against the childrsquos home (normally accomplished by paying anominal fee and recording it at the local courthouse in the county where the home is located) Ifthis is the case then the child will never be able to claim a mortgage interest deduction on theirSchedule A even if they are in fact interest income to their parents (ie since it is not a Form1098 reporting situation they simply list the parentsrsquo names and SSNs on their Schedule A)


The main impact of the new law is that for anyone considering taking out a mortgage the new Tax Actimposes a lower $750000 dollar limit on mortgages qualifying for the home mortgage interest deductionThe lower limits apply to the aggregate amount of loans used to buy build or substantially improve thetaxpayers principal residence and up to one other qualified second residence

IR 2018-32 provides the following examples

Example In January 2018 John takes out a $500000 mortgage to purchase a principal residence with a fair market value of $800000 In February 2018 he takes out a $250000 home equity loan to putan addition on this home Both loans are secured by the home and the total does not exceed the cost ofthe home Because the total amount of both loans does not exceed $750000 all of the interest paid onthe loans is deductible under the new Tax Act However if John used some of the home equity loanproceeds to instead pay for personal expenses such as paying off student loans and credit cards thenthe interest on the home equity loan would not be deductible (ie since it was used for ldquoconsumer debtrdquoitems)

Comment But if John used some of the $250000 in home equity debt for other purposes hecould make the Reg sect1163-10T(o)(5) election and as a result the interest expense would haveto be ldquotracedrdquo under the Reg sect1163-8T rules For instance he could have used the funds suchas to buy stocks (ie investment interest expense on Form 4952) or to fund the business needsof his Schedule C or F proprietorship (ie trade or business interest expense) or to makerepairs on Schedule E rental property (ie generally an additional passive deduction) or to buyinto or make a capital contribution to a partnership or S corporation (additional interest expensededuction on Schedule E page 2 against the K-1 income or loss otherwise being shown thereonpursuant to IRS Notice 89-35 Part IV)

Example In January 2018 Mary takes out a $500000 mortgage to purchase a principalresidence The loan is secured by this home In February 2018 she takes out a separate $250000 loanto purchase a vacation home The loan is secured by the vacation home Because the total amount ofboth mortgages does not exceed $750000 all of the interest paid on both mortgages is deductible underthe new Tax Act However if Mary took out a $250000 home equity loan on her principal residence topurchase the vacation home then the interest on the home equity loan would not be deductible

Comment The IRS is simply taking a very literal reading of the exact wording contained in theConference Agreement and repeating it here in this second example insomuch as the lawtechnically now reads that the interest on a ldquohome equity loanrdquo is now ldquosuspendedrdquo Apparentlyat least in the eyes of the IRS it would not matter what the funds were used for arguing that theywere used for ldquoconsumer purposesrdquo (ie buying a second home which is to be used for personalpurposes) and therefore the interest involved would be nondeductible To fix the problemhowever the taxpayer should simply take out a second separate mortgage on this additionalhome (ie instead of using the equity in a principal residence) as shown in Example 3 below Butsuppose the monies on a home equity loan were used instead for the taxpayerrsquos trade or business(or investment purposes) as described above Is the IRS in a position to simply declare that thelong-standing ldquotracing rulesrdquo are to be disregarded and that the regulations under Reg sect1163-8Tare null and void (ie especially where the taxpayer is making the Reg sect1163-10T(o)(5)election)

Example In January 2018 Bob takes out a $500000 mortgage to purchase a principal residenceThe loan is secured by this home In February 2018 he takes out a $500000 loan to purchase a vacationhome The loan is secured by the vacation home Because the total amount of both mortgages exceeds


$750000 not all of the interest paid on the mortgages is deductible Only a percentage (ie 75) of thetotal interest paid is deductible

- State and Local Tax Deduction

- Under current law taxpayers could deduct from their taxable income as an itemized deductionseveral types of taxes paid at the state and local level including real and personal property taxesincome taxes andor sales taxes

- Under both the House and Senate versions all state and local taxes (regardless of what type)would have been disallowed for tax years beginning after 2017 But the new Tax Act continuesto permit up to $10000 to be claimed on Schedule A Furthermore this $10000 cap wouldapply to any state or local taxes such as income or sales tax along with real estate andpersonal property taxes118 However foreign real property taxes may not be deducted119

Comment The $10000 limit on property taxes does not apply to farm operations or landrental properties (or to any other Schedule C E or F activity) It only applies to the propertytaxes owed on onersquos personal residence any second home or other personally owned realestate such as investment real estate120 All property taxes paid on a farm or farmland rentedto a farmer is 100 deductible (subject to any at-risk and passive activity limitations)

Comment If a taxpayer has both real property and state or local income taxes it might makesense to reach the annual $10000 limit on SALT with solely real estate or personal propertytaxes Then if a state income tax refund is received by the taxpayer an argument could be madethat since no such taxes were claimed on the prior yearrsquos tax return under the Code sect111ldquotax benefit rulerdquo none of the state income tax refund would be taxable (similar to what wecurrently have where a taxpayer is otherwise subject to AMT)

Comment Looking at the language of the Conference Agreement it appears that the cap on theSALT deduction also applies to trusts and estates It states ldquoThe conference agreement providesthat in the case of an individual (while simultaneously referring to Code sect641(b) regarding thecomputation of taxable income of an estate or trust in the same manner as an individual) as ageneral matter state local and foreign property taxes and state and local sales taxes are allowedas a deduction only when paid or accrued in carrying on a trade or business or an activitydescribed in section 212 (relating to expenses for the production of income)rdquo

- Nevertheless the final Conference Agreement precludes the pre-payment in 2017 for stateor local income tax which is imposed for the 2018 tax year Instead they will be treated aspaid in 2018 In other words you will not be permitted to pre-pay your 2018 state and local income

118 Obviously any taxes paid or accrued in carrying on a trade or business or for a rental activity would goon Schedules C F or E And the $10000 cap applies regardless of filing status except for MFS which only gets$5000

119 Code Sec 164(b)(6) as amended by Act Sec 11042

120 The question remains that if such property taxes are now nondeductible then you would not also beallowed to capitalize them to the basis of this land held for investment under Code sect266 as a ldquocarrying chargerdquo


taxes in 2017 to avoid the new $10000 SALT cap121

- Since AMT was retained (though with higher exemption and phaseout thresholds) state andlocal taxes (at least to the extent of the $10000 cap) will still be a preference for alternative taxpurposes

LImpact of $10000 SALT Deduction on Form 8960 Calculation of NII Under Code sect1411 the offset of possible deductions against ldquonet investment incomerdquo for purposes ofcalculating the 38 Medicare surtax must first be determined under other applicable sections of theCode For instance a taxpayer might have a sizable capital loss carryover but without sufficient capitalgains they are limited to only $3000 of any capital loss carryover being available to offset other typesof income such as interest rents and dividends Likewise if a K-1 loss is limited due to either the at-riskrules or the passive loss rules it would not factor into the Form 8960 calculation of ldquonet investmentincomerdquo

So with the new 2018 $10000 limit on the deduction of state and local taxes this would be themaximum amount of such taxes for example which could be offset against K-1 income otherwisereported on page two of Schedule E In other words even though there is clearly a larger amount of stateor local income tax attributable to K-1 Box 1 ldquoTrade or Business Incomerdquo or Box 2 ldquoNet Rental Incomerdquothe offset would be capped at the $10000 overall limit allowed for such taxes (and this is only when thetaxpayer otherwise chooses to itemize their deductions on Schedule A)

LNonresident State Income Tax on Law Partners K-1 Income Not Deductible on Schedule E(Cutler TC Memo 2015-73 (492015)) Nonresident state income taxes paid by a lawyer on his law firms income derived from business thatthe firm conducted in four other states were not allowed to be deducted ldquofor AGIrdquo (ie on Schedule Eagainst his K-1 income) Instead as with any state or local taxes these taxes are only permitted asitemized deductions on Schedule A

Background Under Code sect62(a)(2) deductions are allowed for AGI if they are attributable toa trade or business carried on by the taxpayer if such trade or business does not consist of theperformance of services by the taxpayer as an employee Reg sect162-1T(d) explains this rule to meanthat expenses are deductible above the line when they are directly and not merely remotely connectedwith the conduct of a trade or business For example taxes are deductible for AGI only if they constituteexpenses directly attributable to a trade or business or to property from which rents or royalties arederived As a result property taxes paid or incurred on real property used in a trade or business aredeductible but state taxes on net income are not deductible even though the taxpayers income is derivedfrom the conduct of a trade or business

Comment The result in this case calls into question the argument that state income taxes on anyK-1 income (ie not just that derived from out-of-state income sources) which has to be addedback as a ldquopreferencerdquo for AMT purposes can also be deducted on Schedule E page 2 againstthe K-1 income to which it relates If the Tax Court feels that state income taxes allocable to K-1income in general cannot be deducted on Schedule E how can those allocable to the AMT stateand local tax addback (ie preference) be taken on Schedule E



Comment From a choice-of-entity standpoint should a flowthrough entity such as an S corprevoke its election and switch over to being a C corp where state and local taxes can be fully offsetagainst it profits on Form 1120 Of course there is would now be the issue of possible ldquodoubletaxationrdquo upon liquidation (unless a ldquopersonal goodwillrdquo argument could be mounted especiallyfor a service-based business)

On the other hand certain other deductions including those for state and local income tax may besubtracted from AGI in computing taxable income (Code sect63(a) Code sect63(b) Code sect63(d) Codesect164(a)(3))

Comment ldquoFor AGIrdquo deductions generally may be claimed in addition to itemized deductions orthe standard deduction and offer the added benefit of reducing AGI which in turn is used as ameasure to limit other tax benefits By contrast below-the-line deductions are subject to incomelimitations (ie phaseout mechanisms) and in some instances can be deducted only to the extentthey exceed a specified threshold amount

Facts The taxpayer was a partner in a law firm which was organized in Michigan but which alsoderived income from sources in Missouri Virginia Illinois and Oregon And even though the taxpayerdid not perform any services for clients in those other states he was still require to paid nonresident stateincome taxes on firmrsquos income from those states All of the income was listed in both Box 1 and Box 14of his K-1 as ldquotrade or business incomerdquo subject to SE tax He then reported this income and claimeddeductions for all nonresident state income taxes as ldquounreimbursed partnership expensesrdquo on SchedulesE These deductions amounted to $11943 in 2007 $15104 in 2008 and $14832 in 2009 But the TaxCourt agreed with the IRS that state and local taxes (including those paid to another state) in this instancecould only be claimed as itemized deductions on his Schedule A (thereby increasing his AGI withassociated increases in self-employment tax and alternative minimum taxable income) (Code sect164State Income Taxes)

LRecent Developments Regarding Various State Workarounds Challenges to SALT DeductionLimitation Various high-state income tax jurisdictions have introduced ldquoworkaroundsrdquo intended to challenge the newTax Actrsquos $10000 cap on the deduction of state and local taxes (income personal or real property taxes)These include the recent introduction of bills in the Connecticut and New Jersey legislatures anagreement among the governors of New Jersey New York and Connecticut to sue the federalgovernment and tax planning ideas from practitioners as follows

- Connecticut bill SB11 An Act concerning Connecticuts response to federal tax reform

- New Jersey bill S1893 An Act concerning local government charitable fund management and propertytax credits and supplementing Title 54 of the Revised Statutes

- New York Governor Andrew Cuomo Summary of Proposed Tax Reforms (February 2018)

- Letter from Congressman John Faso (R-NY) to US Department of the Treasury (Feb 26 2018)

Comment One of the prevailing ldquoargumentsrdquo is that a certain portion of a statersquos budget forinstance goes to service the needs of its less fortunate citizens which the state is insisting couldbe characterized as a ldquocharitable deductionrdquo But given that a charitable donation is not anextraction of the donorrsquos funds for which a lien could be placed on their assets if not made it wouldbe hard to say that this would fit the definition In other words if this ldquocharitable deductionrdquo (ie


a portion of the taxpayerrsquos state or local income (or real property) taxes) was not forthcomingwould the state (or local municipality) simply ldquolet it gordquo Or would these needed funds beextracted involuntarily if not forked over to the state The bottom line is that this is thequintessential ldquoquid pro quordquo analogy not a charitable donation

LIRS to Propose Regulations on State and Local Tax Deduction (Notice 2018-54) For tax years 2018-2025 a taxpayers itemized deduction for state and local taxes is limited to $10000($5000 if married filing separately) per year In response to this some states are considering or haveadopted legislation that allows taxpayers to make transfers to state-established charitable funds inexchange for credits against their state and local taxes In this recent Notice the IRS has announced itwill propose regulations on the federal income tax treatment of these payments The proposedregulations will specify that federal tax law which includes ldquosubstance-over-form principlesrdquo governs theproper characterization of these payments for federal income tax purposes In other words ldquoa statesclassification of the payment is irrelevantrdquo Also the proposed regulations will assist taxpayers inunderstanding the relationship between the federal charitable contribution deduction and the new stateand local tax deduction limit

Comment ldquoSubstance over formrdquo is a judicial doctrine in which a court ldquolooks to the objectiveeconomic realities of a transaction rather than to the particular form the parties employedrdquo (FrankLyon Co v US 41 AFTR 2d 78-1142 (Sup Ct 1978)) In essence the formalisms of atransaction are disregarded and the substance is examined in order to determine its true nature

Comment The obvious implication of IRSs reference to the ldquosubstance over form doctrinerdquo islikely that the formal mechanisms for implementing the State workarounds (eg charitablecontributions to charitable gifts trust funds) will not dictate their federal income tax treatment Inother words the IRS will not recognize a charitable contribution deduction that is a disguised SALTdeduction The IRS could also look to the Supreme Courtrsquos decision in Duberstein to easily seethat such ldquodonationsrdquo are not motivated by ldquodetached and disinterested generosityrdquo Theseldquodonationsrdquo are clearly a quid quo pro where the taxpayer is receiving a tax benefit in exchangeAnd although the federal tax law will oftentimes look or defer to state or local law in decipheringthe appropriate tax treatment of a transaction it is no otherwise required to do so in every case

Comment While the Notice only mentions workarounds involving transfers to state-controlledfunds another type of workaround has been enacted and while others have been proposed Inaddition to the charitable gifts trust funds described above New York also created a newemployer compensation expense tax that essentially converts employee income taxes toemployer payroll taxes The IRS has already stated in IR 2018-122 that it is continuing to monitorother legislative proposals to ensure that federal law controls the characterization of deductionsfor federal income tax filings

- Medical Expenses

- A deduction is allowed for the expenses paid during the tax year for the medical care of thetaxpayer the taxpayerrsquos spouse and the taxpayerrsquos dependents to the extent the expensesexceeded 10 of AGI To be deductible the expenses may not be reimbursed by insurance orotherwise And if the medical expenses are reimbursed then they must be reduced by thereimbursement before the threshold is applied

- The House version would have eliminated these deductions but the final Tax Act retained the


medical expense deduction while also lowering the AGI threshold back to 75122 for alltaxpayers (ie regardless of age) for both 2017 and 2018 In 2019 the 10 of AGI thresholdwould be reinstated (unless Congress acts to modify this deduction even further)

- Even though the threshold for medical deductions on Schedule A is now lowered back to theformer 75 of AGI threshold (at least for 2017 and 2018) there will still be no preferenceaddback for AMT purposes (which had previously allowed a deduction for medicalexpenses to the extent that they exceed 10 of AGI) In other words the final Conferencebill temporarily eliminated this preference item

- Medical Savings Accounts

- Contributions to Medical Savings Accounts (MSAs) under Code sect220 we were to be eliminatedwith existing balances allowed to be rolled over on a tax-free basis into a Health Savings Account(HSA) However the Conference bill did not adopt this House bill provision So the current lawremains unchanged

- Charitable Contribution of Cash Now Allowed Up to 60 of AGI

- The deduction for an individualrsquos charitable contribution is limited to prescribed percentages ofthe taxpayerrsquos ldquocontribution baserdquo Under current law the applicable percentages were 50 30or 20 and depended on the type of organization to which the contribution was made whetherthe contribution was made ldquotordquo or merely ldquofor the use ofrdquo the donee organization and whether thecontribution consisted of capital gain property The 50 limitation applied to public charities andcertain private foundations

- No charitable deduction is allowed for contributions of $250 or more unless the donorsubstantiates the contribution by a ldquocontemporaneous written acknowledgmentrdquo (CWA) from thedonee organization Under Code sect170(f)(8)(D) the IRS was authorized to issue regs that exemptdonors from this substantiation requirement if the donee organization files a return that containsthe same required information However the IRS has decided not to issue such donee reportingregs

- Under the new Tax Act the 50 limitation under Code sect170(b) for cash contributions topublic charities and certain private foundations would be increased to 60123 Contributionsexceeding the 60 limitation are generally allowed to be carried forward and deducted for up tofive years subject to the later yearrsquos AGI threshold124

- The charitable deduction limit for ldquoqualified conservation easementsrdquo has been increasedstarting 2018 as follows 1) for farmersranchers it is increased from 30 to 100 of AGI

122 The 75 of AGI threshold would also apply for AMT purposes As a result there would no longer be aAMT preference for medical expenses for 2017 and 2018

123 Code Sec 170(b)(1)(G) as added by Act Sec 11023

124 Code Sec 170(l) as amended by Act Sec 13704


and 2) for other taxpayers from 30 to 50 of AGI

- The charitable mileage rate under Code sect170(i) would have been adjusted for inflation but theconference bill dropped this provision

- The exception under Code sect170(f)(8) under which a taxpayer that failed to provide acontemporaneous written acknowledgment by the donee organization for contributions of $250or more is relieved from doing so when the donee organization files a return with the requiredinformation has been eliminated

Comment Keep in mind that the 80 charitable donation allowance for amount paid colleges anduniversities for ldquoseating rightsrdquo at athletic events has been eliminated But schools will probablydo away with this type of ldquodonationrdquo and instead just up the amount that a donor would have togive annually to renew their season tickets (or otherwise be in the lottery for sporting eventtickets)

Comment The new Tax Act did not impact the ability to donate up to $100000 directly from anIRA to a qualified charity Moreover the value of this tax break has increased from a tax benefitstandpoint Beginning with 2018 returns many more taxpayers will take the larger standarddeduction instead of itemizing leading to fewer filers claiming charitable write-offs on ScheduleA And such transfers also continue to satisfy the required minimum distribution format forretirees

Comment As is the case for all deductions under the new Tax Act these write-offs are going tobe worth less given the overall deduction in tax rates as well as the more generous tax bracketsBut with so much focus on charitable deductions at the federal level there might nevertheless bean increased value for state charitable deductions For example consider a California residentwho is in the statersquos top tax rate of 133 Under the old tax law a $100 charitable donation couldreduce this taxpayerrsquos federal and state taxes owed by as much as $4763 Under the new lawthe same donation could reduce taxes owed by $5030 (Cf Russell James ldquoHow The 2018 TaxLaw Increases Charitable Giving Deductionsrdquo Financial Advisor Marcy 18 2018)

LTechnical Correction Needed for Cash Contributions Subject to New 60 AGI Limitation

- As stated above the TCJA increased the charitable-contribution-base-percentage limit fordeductions of cash (but not property) contributions by individuals to 50 charities from 50 to60 (ie the 60 limit) (Code sect170(b)(1)(G)(I))

- Cash contributions that are taken into account under the 60 limit are not also taken intoaccount for purposes of applying the 50 limit (Code sect170(b)(1)(G)(iii)(I)) But the 30 and 50limits are applied for a tax year by reducing the aggregate contribution limit allowed for that yearby the aggregate cash contributions allowed under the 60 limit for the year (Codesect170(b)(1)(G)(iii)(II))

- As a result a technical correction is needed with regard to the current statutory language in theTCJA which reduces the allowed charitable deduction to 50 rather than 60 if even $1 ofassets other than cash are donated This would serve to confirm Congresss intent to allow for theincreased 60 of AGI limitation assuming the additional amount is in cash (for example where30 appreciated securities and 30 cash are donated to a charity)


- Personal Casualty Loss Deduction

- Under current law individual taxpayers were generally allowed to claim an itemized deductionfor uncompensated personal casualty losses including those arising from fire storm shipwreckor other casualty or from theft subject to a 10 of AGI threshold and a $100 floor

- Under the new Tax Act the itemized deduction for theft and casualty losses would beeliminated except for PDDAs125 However where a taxpayer has personal casualty gains (theydo not fully reinvest any insurance proceeds) the loss suspension does not apply to the extentthat any personal losses do not exceed any such gains

- The provision is effective for losses incurred in taxable years beginning after December 312017

LIRS Offers New Safe Harbors for Calculating Personal Casualty Losses (Rev Proc 2018-08) For taxpayers who might have suffered casualty or theft losses to their home or personal belongingsthe IRS has now released multiple safe harbors when calculating such losses One approach allows ahomeowner with casualty losses of $20000 or less take the lesser of two repair estimates to determinethe decrease in the homersquos value (ie from its pre-casualty condition) Another approach utilizes an IRStable to compute the replacement cost of personal belongings destroyed in a presidentially declareddisaster area (PDDA) (Code sect165 Casualty Losses)

Comment For those victims of hurricanes Harvey Irma and Maria another safe harbor is beingprovided by the IRS These taxpayers are permitted to use ldquocost index tablesrdquo to determine theamount of loss to their residences There are separate tables for various categories of homedamage ranging from total loss to over one foot of interior flooding to a ruined deck Rev Proc2018-09 can be referenced for additional details

Comment Keep in mind that the new Tax Act repeals the write-off for personal casualty and theftlosses beginning in 2018 except for casualty losses in presidentially declared disaster areas

- Gambling Losses

- In general taxpayers are permitted to claim a deduction for wagering losses to the extent ofwagering winnings126 However under current law other deductions connected to wagering (egtransportation admission fees) could be claimed regardless of wagering winnings

- Under the new Tax Act gambling losses as well as other deductions connected withwagering would only be deductible on Schedule A (to the extent of any gamblingwinnings) but not subject to the 2 of AGI threshold (there would be no possibility of taking suchlosses on Schedule C as a ldquobusiness endeavorrdquo)127

125 Code Sec 165(h)(5) as amended by Act Sec 11044

126 Code sect165(d)



Comment This change is intended to clarify that the limitation on losses from wageringtransactions applies not only to the actual costs of wagers incurred by an individual but to otherexpenses incurred by the individual in connection with the conduct of that individualrsquos gamblingactivity The provision clarifies for instance an individualrsquos otherwise deductible expenses intraveling to or from a casino are subject to the limitation under Code sect165(d)

- Alimony Deduction Eliminated After 2018

- Under current law alimony and separate maintenance payments were deductible by the payorspouse under Code sect215(a) and includible in income by the recipient spouse under Code sect71(a)and Code sect61(a)(8)

- Under the new Tax Act effective for divorce or separation decrees finalized (or modifiedand which ldquoexpressly state that the new rule would applyrdquo) after 2018128 this deductionwould be eliminated (in essence this income will now be taxed to the higher-tax-bracket ex-spouse)129

Comment The Tax Inspector General of Tax Administration estimates that there is a $23 billiongap between alimony deductions taken and the amount of corresponding alimony income includedin the recipientrsquos gross income

Comment There may be some situations where ex-spouses want the Tax Cuts and Jobs Actrules to apply to their existing divorce or separation Under the special provision mentioned aboveif taxpayers have an existing (ie pre-2019) divorce or separation decree and they have thatagreement legally modified after Dec 31 2018 the new rules apply to that modified decree ldquoif themodification expressly so providesrdquo For instance there may be situations where applying thesenew rules voluntarily is beneficial for the taxpayers such as a change in the income levels of thealimony payer or the alimony recipient

- As mentioned above alimony payments under grandfathered agreements executed before thisDec 31 will continue to be taxed under the old law But these payments cannot be for childsupport or property settlements to maintain property partially owned by the ex-spouse making thepayment or for any voluntary maintenance payments

- Moving Expense Deductions

- Under current law taxpayers could claim a deduction under Code sect217 for moving expenseson Form 3903 incurred in connection with starting a new job if the new workplace was at least50 miles farther from a taxpayerrsquos former residence than the former place of work130

Comment Even under the ldquooldrdquo law only the direct costs of moving the taxpayerrsquos family and

128 Both the House and Senate bills would have made this change for any divorce decrees after 2017

129 Former Code Secs 215 61(a)(8) and 71 as stricken by Act Sec 11051

130 There was also a 39-out-of-52-week work requirement after moving to the new job location


possessions from their former residence to the new one could be covered tax-free Other costssuch as ldquotemporary living expensesrdquo (eg staying at a hotel until their new home was ready andavailable) as well as ldquohouse-hunting tripsrdquo (eg to find a new residence) were nondeductible Soif reimbursed they had to be treated as additional wages in the new employeersquos first W-2

- Under the new Tax Act for tax years beginning after Dec 31 2017 the deduction formoving expenses is suspended except for members of the Armed Forces on active dutywho move pursuant to a military order and incident to a permanent change of station131

Comment Unlike unreimbursed employee business expenses that have now been eliminated onForm 2106 and for which an employer can arguably step in and reimbursed as ldquoordinary andnecessary expenses of the businessrdquo (eg meals travel etc under an accountable plan) movingexpenses are strictly a personal expense of the new employee As a result if the new employerwere to still reimburse costs such as moving household goods to the new location temporaryhousing costs or house hunting expenses these would have to be included in the newemployeersquos wages

Comment The IRS originally came out with Notice 2018-3 which listed the standard mileagerates for unreimbursed employee travel (ie 545centmile) along with the 18centmile rate for movingexpenses on Form 3903 But since TCJA eliminated these deductions the IRS has now issuedNotice 2018-42 which correctly states that these deductions are no longer available

- Net Operating Losses

- In general the passive loss rules under Code sect469 limit deductions and credits from passivetrade or business activities The passive loss rules apply to individuals estates and trusts andclosely-held corporations A passive activity for this purpose is any trade or business activity inwhich the taxpayer owns an interest but does not ldquomaterially participaterdquo (under any of 7 separatebut equal standards) ldquoMaterial participationrdquo means that the taxpayer is involved in the operationof the activity on a basis that is ldquoregular continuous and substantialrdquo (Reg sect1469-5) Deductionsattributable to passive activities to the extent they exceed income from passive activitiesgenerally may not be deducted against other income and are carried forward and treated asdeductions and credits from passive activities in the next year

- Under current law Code sect469 provides a limitation on ldquoexcess farm lossesrdquo that applies totaxpayers other than C corporations If a taxpayer other than a C corporation receives anldquoapplicable subsidyrdquo for the tax year the amount of the ldquoexcess farm lossrdquo is not allowed for thetax year and is carried forward and treated as a deduction attributable to farming businesses inthe next tax year An ldquoexcess farm lossrdquo for a tax year means the excess of aggregate deductionsthat are attributable to farming businesses over the sum of aggregate gross income or gainattributable to farming businesses plus the ldquothreshold amountrdquo The threshold amount is thegreater of (1) $300000 ($150000 for married individuals filing separately) or (2) for the5-consecutive-year period preceding the tax year the excess of the aggregate gross income orgain attributable to the taxpayerrsquos farming businesses over the aggregate deductions attributableto the taxpayerrsquos farming businesses

131 Code Sec 217(k) as amended by Act Sec 11049(a)


Comment Keep in mind that the Code sect465 ldquoat-risk rulesrdquo also come into play (ie as shown onForm 6198) and have to be considered before seeking to take any losses under the Code sect469passive loss rules

- For tax years beginning after Dec 31 2017 the Conference bill provides that the ldquoexcessfarm loss limitationrdquo does not apply and instead a noncorporate taxpayerrsquos ldquoexcessbusiness lossrdquo will be disallowed as a current deduction Under the new rule excessbusiness losses are not allowed for the tax year but are instead carried forward and treatedas part of the taxpayerrsquos net operating loss (NOL) carryforward in subsequent tax years Thislimitation applies after the application of the at-risk and passive loss rules describedabove132

- An ldquoexcess business lossrdquo for the tax year is the excess of aggregate deductions of thetaxpayer attributable to the taxpayerrsquos trades and businesses over the sum of aggregategross income or gain of the taxpayer plus a threshold amount The threshold amount fora tax year is $500000 for married individuals filing jointly and $250000 for otherindividuals with both amounts indexed for inflation133

Example A taxpayer has a nonpassive business loss of $600000 for the tax year $100000would be treated as an ldquoexcess business lossrdquo which would have to be carried over Theremaining $500000 (of the overall $600000 loss) could be used to offset current yearrsquos grossincome In other words the excess $100000 loss will be carried forward and treated as part ofa taxpayerrsquos net operating loss in the subsequent year This limitation could apply for exampleto losses from sole-proprietorships and pass-through entities (including farm losses)

- In the case of a partnership or S corporation the provision applies at the partner orshareholder level Each partnerrsquos or S corporation shareholderrsquos share of items of income gaindeduction or loss of the partnership or S corporation is taken into account in applying the abovelimitation for the tax year of the partner or S corporation shareholder

- The new Tax Act eliminates net operating loss carrybacks134 while providing indefinite netoperating loss carryforwards limited to 80 percent of taxable income

Comment The bottom line is that the amount of trade or business losses that exceed a $500000threshold for couples and $250000 for other filers is nondeductible but any excess can be carriedforward Again this limitation applies after the application of the current Code sect465 at-risk andCode sect469 passive-activity loss rules

- Changes to ABLE Accounts

- ABLE Accounts under Code sect529A provide individuals with disabilities and their families the

132 Code Sec 461(l) as added by Act Sec 11012

133 Code Sec 461(l)(3) as added by Act Sec 11012

134 With no opportunity to carryback NOLs there would be no need to ldquoelect outrdquo of the carryback optionafter 2017


ability to fund a tax preferred savings account to pay for ldquoqualifiedrdquo disability related expensesContributions may be made by the person with a disability (the ldquodesignated beneficiaryrdquo) parentsfamily members or others Under current law the annual limitation on contributions is the amountof the annual gift-tax exemption (ie $15000 in 2018)

- Effective for tax years after 2017 the contribution limitation to ABLE accounts withrespect to contributions made by the designated beneficiary is increased along with otherchanges (as described below) After the overall limitation on contributions is reached (ie theannual gift tax exemption amount for 2018 $15000) an ABLE accountrsquos designated beneficiarycan contribute an additional amount up to the lesser of (a) the Federal poverty line for aone-person household or (b) the individualrsquos compensation for the tax year135

- Additionally the designated beneficiary of an ABLE account can claim the saverrsquos credit underCode sect25B for contributions made to his ABLE account136

- The final Conference Agreement also contains a requirement that a designated beneficiary (orperson acting on the beneficiaryrsquos behalf) maintain adequate records for ensuring compliance withthe above limitations137

- For distributions after the date of enactment (122217) amounts from qualified tuitionprograms (QTPs) (ie Sec 529 accounts) are allowed to be rolled over to an ABLE accountwithout penalty provided that the ABLE account is owned by the designated beneficiaryof that 529 account or a member of such designated beneficiaryrsquos family138 But suchrolled-over amounts will be counted towards the overall limitation on amounts that can becontributed to an ABLE account within a tax year and any amount rolled over in excess of thislimitation is includible in the gross income of the distributee

Comment ABLE savings programs for the disabled are quickly expanding 30 states have nowlaunched ABLE programs and individuals who live in a state without such a program canparticipate in another states plan

- Deduction for Living Expenses of Members of Congress Eliminated

- Individual taxpayers generally can subject to certain limitations deduct ordinary and necessarybusiness expenses paid or incurred during the tax year in carrying on a trade or businessincluding expenses for travel away from home Under current law members of Congress wereallowed to deduct up to $3000 of living expenses when they were away from home (such asexpenses connected with maintaining a residence in Washington DC) in any tax year

- For tax years beginning after the 122217 enactment date members of Congress will not be

135 Code Sec 529A(b) as amended by Act Sec 11024(a)

136 Code Sec 25B(d)(1) as amended by Act Sec 11024(b)

137 Code Sec 529A(b)(2) as amended by Act Sec 11024(a)

138 Code Sec 529(c)(3) as amended by Act Sec 11025


permitted to deduct living expenses when they are away from home139

- Deduction For Amounts Paid For College Athletic Seating Rights

- Under current law special rules applied to certain payments to institutions of higher educationin exchange for which the payor receives the right to purchase tickets or seating at an athleticevent The payor was permitted to treat 80 of a payment as a charitable contribution where (1)the amount was paid to or for the benefit of an institution of higher education (ie generally aschool with a regular faculty and curriculum and meeting certain other requirements) and (2) suchamount would be allowable as a charitable deduction but for the fact that the taxpayer receives(directly or indirectly) as a result of the payment the right to purchase tickets for seating at anathletic event in an athletic stadium of such institution

- Under the new Tax Act for contributions made in tax years beginning after Dec 31 2017no charitable deduction is allowed for any payment to an institution of higher education inexchange for which the payor receives the right to purchase tickets or seating at an athleticevent140

Individual Credits and Exclusions

- Increased Child Tax Credit

- Under current law a taxpayer could claim a child tax credit of up to $1000 per ldquoqualifying childrdquounder the age of 17 The aggregate amount of the credit that could be claimed phased out by $50for each $1000 of AGI over $75000 for single filers $110000 for married filers and $55000 formarried individuals filing separately To the extent that the credit exceeded a taxpayerrsquos liabilitya taxpayer was eligible for a portion of the credit being refundable (ie the ldquoadditional child taxcreditrdquo) equal to 15 of earned income in excess of $3000 (the ldquoearned income thresholdrdquo) Ataxpayer claiming the credit had to include a valid Taxpayer Identification Number (TIN) for eachqualifying child on their return In most cases the TIN is the childrsquos Social Security Number (SSN)although Individual Taxpayer Identification Numbers (ITINs) were also accepted

- Under the House bill the amount of the child tax credit would have increased from $1000 to$1600 ($2000 under the Senate version) But only the first $1000 of the credit would have beenrefundable It would have also replaced the term qualifying child with dependent and eliminatedthe phrase for which a the taxpayer is allowed a deduction under section 151 Alternatively theact would provide a $500 refundable credit for non-child dependents141

139 Code Sec 162(a) as amended by Act Sec 13311

140 As far as amounts paid for seating rights at a professional sports stadium or arena those amounts wouldalready be denied insomuch as ldquoentertainment expensesrdquo after 2017 are no longer permitted This deduction denialstems from the possible treatment of such amounts as ldquocharitable contributionsrdquo

141 Code Sec 24(h)(4) as added by Act Sec 11022(a)


- Under the new Tax Act the child tax credit will now be doubled to $2000 per child142 andwill be refundable up to $1400 (up from $1100 in the Senate version) subject tophaseouts The bill also includes a temporary $500 nonrefundable credit for otherqualifying dependents (for example older dependent children and parents under a ldquomultiplesupport agreementrdquo) Furthermore the ldquoearned income thresholdrdquo for the refundable portion of thecredit is decreased from $3000 to $2500 (ie the refundable portion will now be equal to 15of earned income in excess of $2500 instead of the former $3000 threshold)143

Comment In prior years the child tax credit was nonrefundable As a result if the otherwiseavailable tax credit exceeded your tax liability your tax bill was simply reduced to zero So evenif you were able to claim the entire $1000 per child (ie the maximum available credit for the 2016tax year) if you did not have any income tax liability you could not benefit from the credit Thebottom line was that credit could not be carried forward to any future years or back to any pastyears Instead it simply disappeared Under tax reform part of the child tax credit remainsnonrefundable but the old additional child tax credit which was refundable has essentially beenmerged into the new credit The refundable portion is equal to 15 of your earned income whichexceeds $2500 up to the $1400 refundable portion per qualifying child144

- The child credit also includes a $500 non-refundable credit for ldquoqualifying dependentsrdquo(eg dependents age 17 and 18 or ldquofull-time students under age 24) other thanldquoqualifying childrenrdquo (ie dependents under age 17 who also meet the requirements for theCTC) This has been referred to as a family credit and allows you to claim a credit for otherdependents in your household that do not meet the definition of ldquoqualifying childrdquo The credit isclearly intended to make up for the fact that you no longer have the ability to claim otherdependents like your older children (or parents) on your tax return as personal exemptions sincethose have been eliminated For purposes of the additional non-refundable family credit thedefinition of dependent such as ldquoage residency and relationshiprdquo) still generally applies but thereis no requirement to provide an SSN (ie on Schedule 8812 where the child credit is claimed)It is nonrefundable but phases out at the same AGI thresholds as the $2000 child tax credit

- As mentioned above the income levels at which the credit phases out would increase Undercurrent law the credit is phased out beginning at income levels of $75000 for single filers and$110000 for joint filers The House version would have raised these amounts to $115000 and$230000 respectively while the Senate version would have adjusted these amounts to $500000and $1 million respectively But again under the final Tax Act these provisions begin tophase out at $400000 ($200000 for single filers)145

Comment As mentioned above the amount of the credit that is refundable is increased to $1400per qualifying child and this amount is indexed for inflation up to the base $2000 base creditamount

142 The $1400 refundable portion would be indexed for inflation after 2018 and will be continually increasedfor the effect of inflation until it reaches the $2000 base


144 More detailed information on the formula used to determine the refundable credit can be found in

numerous articles such as the one written by Forbes



- It would still only be available for children under age 17 instead of age 18

- A ldquoqualifying childrdquo for this credit must meet all of the following criteria

(1) ldquoAge Testrdquo - The child must be under age 17 ndash age 16 or younger ndash as of the end of thetax year

(2) ldquoRelationship Testrdquo - The child must either be your son daughter stepchild fosterchild brother sister stepbrother stepsister or a descendant of any of these individualswhich includes your grandchild niece or nephew An adopted child is always consideredyour own child

(3) ldquoSupport Testrdquo - The child must not have provided more than half of their own support

(4) ldquoDependency Testrdquo - You must claim the child as a dependent on your federal taxreturn

(5) ldquoCitizenship Testrdquo - The child must be a US citizen US national or US resident alienand you must provide a valid Social Security number (SSN) for the child by the tax returndue date and

(6) ldquoResidency Testrdquo - The child must have lived with you for more than half of the tax year(some exceptions apply)

- Dependent Care Assistance and Child Care Expenses

- Originally the Code sect129 set-aside program of pre-tax monies (ie $2500 for one child and$5000 for two or more children) for dependent care assistance would have been eliminated underthe House version but was immediately reinstated after numerous protests to legislatorsFurthermore there is no change to the $3000 or $6000 of child care expenses eligible for crediton Form 2441

- The bottom line under the new Tax Act there is no change to the current law with regardto either (1) the Code sect129 set-aside amounts of pre-tax dollars for dependent careassistance or (2) the ability to claim the tax credit on Form 2441 for child and dependentcare expenses

- Adoption Credit

- The adoption credit would have been eliminated by the original House bill along with theexclusion for employee-provided reimbursement for such expenses However these provisionsare now preserved in new Tax Act

LAdoption Credit and Exclusion Amounts Set for 2018 (Rev Proc 2018-18) For 2018 the credit allowed for an adoption of a child with special needs is $13810 (up from $13570for 2017) The maximum credit allowed for other adoptions is the amount of qualified adoption expensesup to $13810 (up from $13570 for 2017) Meanwhile for 2018 the credit will begin to phase out for


taxpayers with MAGI in excess of $207140 (up from $203540 for 2017) The phaseout is complete ifMAGI is $247140 (up from $243540 for 2017) With regard to the adoption exclusion for 2018 theamount that can be excluded from an employees gross income for the adoption of a child with specialneeds as well as other adoptions is also $13810 (up from $13570 for 2017) For 2018 the AGIamounts at which the phaseout occurs are also the same as stated above (Code sect23 Adoptions)

- Credit for Plug-In Electric Vehicles

- The credit for plug-in electric drive motor vehicles under Code sect30D was retained under the newTax Act146

Comment Several practitioners have asked whether there is any kind of annual limit on thenumber of such credits that can be claimed in a given tax year But a close reading of the statuteonly mentions that there is a 200000 unit limit at the manufacturer level but none at the consumerlevel (as long as there are separate contracts for each purchase even where perhaps the originalvehicle bought is then traded in for a second car

- Credit For The Elderly amp Permanent Disabled

- Under current law certain taxpayers who are over the age of 65 or retired due to a permanentand total disability may claim a nonrefundable credit of up to $750 for a return with one qualifyingindividual and $1125 for a return with two qualifying individuals subject to certain limits

- Under the House bill the credit would have been eliminated while under the Senate bill thecredit would have remained in place

- Under the final Conference Agreement the credit will remain in place

- Moving Expenses and Reimbursements

- Under current law an employee could under Code sect3401(a)(15) Code sect3121(a)(11) and Codesect3306(b)(9) exclude ldquoqualified moving expense reimbursementsrdquo from his or her gross incomeand from their wages for employment tax purposes This included any amount received (directlyor indirectly) from an employer as payment for (or reimbursement of) expenses which would bedeductible as moving expenses under Code sect217 if directly paid or incurred by the employee

- Under the new Tax Act Form 3903 has been eliminated for moving expenses except for certainexclusions andor reimbursements for members of the Armed Forces (and their spouses anddependents) who move pursuant to a military order and incident to a permanent change of

146 A tax credit of up to $7500 for electric vehicles survived in the final bill and represents a win for TeslaInc General Motors Co Nissan Motor Co and other auto makers counting on the credit to drive consumer interestin still-pricey Evs Elimination of the credit would have cut off a built-in discount for EV buyers crimping demand justas auto makers steer more investment toward battery powered cars Sales of electrics help car companies meetfederal fuel-efficiency regulations but EVs remain a tough sell because of their relatively high cost amid continued lowgas prices


station147

- As a result the exclusion for employer reimbursed amounts has likewise been eliminatedTherefore if the new employer for example reimbursed for house hunting trips temporaryliving expenses or the actual costs of moving the employee to this new work locationsuch monies would all have to be included in the employee wages

- Qualified Bicycle Commuting Reimbursements

- Under current law ldquoqualified bicycle commuting reimbursementsrdquo of up to $20 per ldquoqualifyingbicycle commuting monthrdquo are excludible from an employeersquos gross income A qualifying bicyclecommuting month is any month during which the employee ldquoregularly uses the bicycle for asubstantial portion of travel to a place of employmentrdquo and during which the employee does notreceive transportation in a commuter highway vehicle a transit pass or qualified parking from anemployer

- The new Tax Act eliminates the exclusion from gross income and wages for qualifiedbicycle commuting reimbursements for tax years beginning after 2017148

- Repeal of Exclusion for Advance Refunding Bonds

- The exclusion for income for interest on State and local bonds applies to ldquorefunding bondsrdquo butthere are limits on ldquoadvance refunding bondsrdquo A refunding bond is defined as any bond used topay principal interest or redemption price on a prior bond issue (the ldquorefunded bondrdquo) A ldquocurrentrefundingrdquo occurs when the refunded bond is redeemed within 90 days of issuance of therefunding bonds Conversely a bond is classified as an ldquoadvance refundingrdquo if it is issued morethan 90 days before the redemption of the refunded bond Proceeds of advance refunding bondsare generally invested in an escrow account and held until a future date when the refunded bondmay be redeemed

- Under the new Tax Act for ldquoadvance refunding bondsrdquo issued after Dec 31 2017 theexclusion from gross income for interest on a bond issued to advance refund another bondis repealed149

- Credit Bonds Repealed

- ldquoTax-credit bondsrdquo provide tax credits to investors to replace a prescribed portion of the interestcost The ldquoborrowing subsidyrdquo generally is measured by reference to the credit rate set by theTreasury Department Current tax-credit bonds include ldquoqualified tax credit bondsrdquo which havecertain common general requirements and include new clean renewable energy bonds qualified

147 Code Sec 132(g) as amended by Act Sec 11048

148 Code Sec 132(f)(8) as added by Act Sec 11047



energy conservation bonds qualified zone academy bonds and qualified school constructionbonds

- Under the new Tax Act for bonds issued after Dec 31 2017 the authority to issuetax-credit bonds and direct-pay bonds is prospectively repealed150

- Exlusion of Gain from Sale of Principal Residence Left Unchanged

- Under both the House and Senate bills in order to exclude gain from the sale of a principalresidence under Code sect121 (up to $500000 for joint filers $250000 for others) a taxpayer wouldhave to own and use as a home the residence for five out of the previous eight years (as opposedto two out of five years under current law) effective for sales and exchanges after Dec 31 2017In addition the exclusion could only be used once every five years and it would be phased outat higher income levels (ie over $250000 or $500000 of taxable income)

- Under the final Conference Agreement there are no changes from current law mentionedabove

- Nevertheless ldquonon-qualified userdquo after 2008 (ie any use other than as a principal residencesuch as a vacationrental property) would still have to be factored into the gain exclusion ratio

Example Bob was an actuary with a major insurance company when he retired early at age 60Upon retirement he began receiving sizable payouts from a tax-deferred annuity Having owneda small condo in FL he decided to change his residency status to FL to avoid any state incometax on the annuity income Meanwhile his former principal residence in WI (which he had originallypurchased in 1990) continued to be used during the warmer 5 months of the year as a ldquoqualifiedsecond residencerdquo

Bobrsquos plan is to declare his residency as being in FL from 2009 through 2018 when the annuitywill be fully paid out Then with a potential gain of over $300000 on the WI home he plans to re-establish his residency there for the 24-month period consisting of 2019 and 2020 After that heplans to sell his WI home

Even though Bob would have had at least 24 months with the WI home being his principalresidence before an eventual sale in 2021 he would nevertheless have ldquononqualified userdquo of itfrom 2009 through 2018 (ie a 10-year period) Given that he has held the WI home from 1990to 2020 (ie a 30-year period) he would not be allowed to exclude one-third of his anticipated$300000 gain Assuming that he has never rented the WI residence this $100000 (ie of theoverall $300000 gain) would be reported on Schedule D as a LTCG As to the remainder of thegain (ie $200000) given that he has satisfied both the ownership and use tests this can beexcluded under Code sect121

Educational Tax Breaks for Individuals

150 Code Sec 54A Code Sec 54B Code Sec 54C Code Sec 54D Code Sec 54E Code Sec 54F andCode Sec 6431 as amended by Act Sec 13404


- Education Tax Incentives

- Under the new Tax Act the Hope credit has been eliminated but both the AOTC and LLC(at the current amounts) would be retained

- Under the House bill you would have been permitted to claim the AOTC for five (ie instead ofthe current four) years of post-secondary education But the credit for the fifth year would beavailable at half the rate as the first four years with up to $500 being refundable This provisionwas not included in the conference bill

- Educational Savings Account

- The new Tax Act would generally prohibit new contributions to Coverdell educationsavings accounts after 2017

- Section 529 Plan Distributions

- Under current law funds in a Code sect529 college savings account could only be used forldquoqualified higher education expensesrdquo If funds were withdrawn from the account for otherpurposes each withdrawal was treated as containing a pro-rata portion of earnings and principalThe earnings portion of a nonqualified withdrawal was taxable as ordinary income and subject toa 10 additional tax unless an exception applied

- The new Tax Act would treat up to $10000 per year per student (ie as opposed to a ldquoper-accountrdquo approach) for elementary and high school expenses (including private orreligious school tuition as well as home schooling) as qualified expenses151 from Section529 plans Also rollovers would be permitted from a Sec 529 plan to the new Sec 529A ABLEplans

Comment Some commentators have remarked that even kindergarten expenses would becovered with the tax-free earnings of a Sec 529 plan (which could be a less expensive option thanchild care)

- The new Tax Act also modifies the definition of ldquohigher education expensesrdquo to includecertain expenses incurred in connection with homeschooling Those expenses are (1)curriculum and curricular materials (2) books or other instructional materials (3) onlineeducational materials (4) tuition for tutoring or educational classes outside of the home (but onlyif the tutor or instructor is not related to the student) (5) dual enrollment in an institution of highereducation and (6) educational therapies for students with disabilities152

- Qualified Tuition Program (QTP) Distributions for Apprenticeships

151 Neither the earnings nor distributions in 529 plans are taxable for federal purposes so long as the plan isused for costs associated with tuition and room and board as well as fees books supplies and equipment

152 Code Sec 529(c)(7) as added by Act Sec 11032(a)


- The new Tax Act would add to the term qualified education expenses certain books andsupplies required for registered apprenticeship programs

- Treatment of Discharged Student Loan Indebtedness

- Gross income generally includes the discharge of indebtedness of the taxpayer Under anexception to this general rule gross income does not include any amount from the forgiveness (inwhole or in part) of certain student loans if the forgiveness is contingent on the studentrsquos workingfor a certain period of time in certain professions for any of a broad class of employers

- Under the new Tax Act any income resulting from the discharge of student debt onaccount of death or total disability of the student would be excluded from taxableincome153

- Loans eligible for the exclusion under the provision are loans made by (1) the United States (oran instrumentality or agency thereof) (2) a State (or any political subdivision thereof) (3) certaintax-exempt public benefit corporations that control a State county or municipal hospital andwhose employees have been deemed to be public employees under State law (4) an educationalorganization that originally received the funds from which the loan was made from the UnitedStates a State or a tax-exempt public benefit corporation or (5) private education loans (for thispurpose private education loan is defined in section 140(7) of the Consumer Protection Act)

- The provision applies to discharges of loans after and amounts received after December31 2017

- Educatorrsquos Deduction

- The Senate would have increased this deduction from the current $250 amount to $500 but thenew Tax Act makes no change and keeps it at the current $250 cap

- Qualified School Construction Bonds

- The legislation would eliminate qualified school construction bonds and Qualified Zone AcademyBonds154

- Student Loan Interest

- The for-AGI deduction for interest payments on qualified education loans for qualified higher

153 Code Sec 108(f) as amended by Act Sec 11031 At the present time there is no specific line item in

Part 1 of Form 982 for this type of debt discharge The reason is that this relief from debt is excluded from thetaxpayerrsquos gross income thus there is no need for an exception

154 The latter is important to the charter school community which says the zone academy bonds helpcharter schools find facilities and amenities The Conference bill would also preserve the ability to issue privateactivity bonds


education expenses was to be eliminated but the new Tax Act keeps this $2500 deduction (Code 221)

- But whether you file an unmarried or MFJ tax return the overall limit will still remain at $2500and the phaseout thresholds stay at $65000 to $80000 for single taxpayers and $130000to $160000 for MFJ

- Tuition and Fees Deduction

- Although the conference bill did not adopt the House provision that eliminated the for-AGI $2000and $4000 deduction for qualified tuition and related expenses for tax years beginning after 2017it is a moot point since this deduction otherwise expired as of 123116 and there has notbeen an extension enacted (Code sect222)

- Exclusion for Savings Bond Interest

- The exclusion from income of interest on US savings bonds used to pay qualified highereducation expenses would have been eliminated under the House bill but the new Tax Actretains this exclusion (Code sect135)

- Tuition Waivers

- The exclusion from gross income of qualified tuition reductions provided by educationalinstitutions (eg PhD candidates children of university workers) would have been eliminated Ifcontinued to be provided they would have been treated as additional wages (Code sect117) Thenew Tax Act retains this exclusion

- Employer-Provided Education Assistance

- The $5250 exclusion for employer-provided education assistance was retained in the newTax Act but the amount was not increased nor will it be indexed for inflation155 (Codesect127)

- For purposes of the exclusion ldquoeducational assistancerdquo means the payment by an employer ofexpenses incurred by or on behalf of the employee for education of the employee including butnot limited to tuition fees and similar payments books supplies and equipment Educationalassistance also includes the provision by the employer of courses of instruction for the employee(including books supplies and equipment) However ldquoeducational assistancerdquo does not include(1) tools or supplies that may be retained by the employee after completion of a course (2) mealslodging or transportation and (3) any education involving sports games or hobbies

Individual Health Insurance Mandate

155 This $5250 amount has been in the law since the mid-80s


- Individual Health Insurance Penalty Eliminated

- Under current law the Affordable Care Act required that individuals who were not covered by ahealth plan that provided at least ldquominimum essential coveragerdquo were required to pay a ldquosharedresponsibility paymentrdquo (ie a penalty) with their federal tax return Unless an exception appliedthe tax was imposed for any month that an individual did not have minimum essential coverage

- The Form 8965 penalty for not having health insurance would now be repealed under thefinal Conference Agreement but not until 2019 Although the IRS would lose some revenuefrom not receiving these penalty monies they estimate about $338 million in governmentsubsidies would now not have to be paid to insurance companies on the behalf ofapproximately 15 million taxpayers with incomes between 100 to 400 of the federalpoverty level who could have gone to healthcaregov to purchase health insurance

- There is no repeal however of either of the Code sect1411 9 or 38 Medicare surtaxes(or change in the AGI levels at which they otherwise apply)

Retirement Plans

- Qualified Retirement Plans

- Under the new Tax Act current limits would be retained with the option to set aside eitherpre-tax or after-tax contributions And this was confirmed by the IRS in IR-2018-19 Notice2017-64 complete details of the specific 2018 limits on various types of retirement plans

Comment Although Congress proposed a change to elective deferrals and a repeal of the ldquonon-spousal beneficiary spreadrdquo current law in its entirety has been retained

Comment Keep in mind that IRA custodian fees are no longer deductible as 2 miscellaneousdeductions Furthermore losses on Roth IRAs continue to be nondeductible personal losses

Comment Alimony will continue to be considered ldquoearned incomerdquo prior to 2019 but notthereafter when such payments in new decrees will be nondeductible As a result such moniescould be contributed to IRAs (but now not after 2018)

L2018 Retirement Plan Limits Not Affected by New Tax Act (IR 2018-19) Prior to enactment of the Tax Cuts and Jobs Act (TCJA) the IRS published cost-of-living adjustmentsto various qualified retirement plans and related amounts for 2018 (Cf IR 2017-177 and Notice 2017-64)According to the IRS the TCJA does not affect these adjustments because it made no changes to thesection of the Code that limits benefits and contributions for retirement plans However the TCJA will nowrequire the use of a slower methodology (known as C-CPI-U) to index contribution limits for IRAs as wellas the income thresholds for IRAs and the Section 25B savers credit Despite this the IRS hasdetermined that the amounts previously announced for these items remain unchanged after taking intoaccount applicable rounding rules (Misc Retirement Plans)

- Roth IRA Recharacterization Rule Repealed


- The current rules dictate that an amount transferred in a recharacterization must beaccompanied by any net income allocable to the contribution In general even if arecharacterization is accomplished by transferring a specific asset net income is calculated as apro rata portion of income on the entire account rather than income allocable to the specific assettransferred However when doing a Roth conversion of an amount for a year an individual mayestablish multiple Roth IRAs for example Roth IRAs with different investment strategies anddivide the amount being converted among the IRAs The individual can then choose whether torecharacterize any of the Roth IRAs as a traditional IRA by transferring the entire amount in theparticular Roth IRA to a traditional IRA156 For example if the value of the assets in a particularRoth IRA declines after the conversion the conversion can be reversed by recharacterizing thatIRA as a traditional IRA The individual may then later convert that traditional IRA to a Roth IRA(referred to as a reconversion) including only the lower value in income Treasury regulationsprevent the reconversion from taking place immediately after the recharcterization by requiringa minimum period to elapse before the reconversion Generally the reconversion cannot occursooner than the later of 30 days after the recharacterization or a date during the taxable yearfollowing the taxable year of the original conversion157

- The current-law provisions in Code sect408A under which an individual may re-characterizea contribution to a traditional IRA as a contribution to a Roth IRA and may alsorecharacterize a conversion of a traditional IRA to a Roth IRA are repealed under the newTax Act However recharacterizations involving a Roth IRA back to the deductible IRA would stillbe allowed

Comment As a result a recharacterization cannot be used for tax years beginning after2017 to unwind a Roth conversion158

Comment The IRS on its website (IRA FAQs - Recharacterization of Roth Rollovers andConversions (Jan 18 2018)) has clarified that a recharacterization of a conversion from adeductible IRA to a Roth IRA can still be done for such conversions occurring in 2017 where youwould have until the extended due date of the 2017 tax return (ie Oct 15 2018) toreconvert the funds originally transferred plus any earnings thereon Conversely the Service isconfirming that a Roth IRA conversion made on or after January 1 2018 cannot berecharacterized

Comment Supposedly this change was made to prevent certain taxpayers from ldquogaming thesystemrdquo as demonstrated in the example below

Example In 2017 a taxpayer had a balance of $500000 in a deductible IRA He then splits theIRA into 5 separate IRAs invests the $100000 balance in each account into a variety of venturesand then sits back to see which ones flourish (ie at least until the extended due date of thatyearrsquos return) And for the investments that turn out poorly he then re-converts them back intoa deductible IRA Of course for tax years before 2018 the process could be repeated again eachyear

156 Treas Reg sec 1408A-5 QampA-2(b)

157 Treas Reg sec 1408A-5 QampA-9



Example Conversely a taxpayer had a balance of $500000 in a deductible IRA in 2018 anddecides to convert the entire balance to a Roth IRA at a time when the stock held therein has avalue of $100share But by the extended due date of that yearrsquos tax return the stockrsquos value hasdropped to only $10share For conversions starting in 2018 he would be stuck paying tax on theconversion at the higher stock price and would not be able to undo the conversion

Comment There is apparently no provision in the Conference bill that would prevent a taxpayerwith an AGI above the phaseout limit for making a contribution to a Roth IRA (and who otherwisehas no other IRA accounts) from making an annual contribution to a nondeductible IRA (asdocumented on Form 8606) and then immediately transferring this amount to a Roth IRA

- Planning Reminders Keep in mind that you can still 1) Convert any amount from a deductibleIRA to a Roth IRA 2) Rollovers of nondeductible IRAs (as recorded on Form 8606) are stillallowed 3) Basis can be spread across all traditional IRAs and 4) Separate 5-year holding periodsapply

LIRS Clarifies Effective Date of New Roth Conversion Recharacterization Prohibition Prior to enactment of the Tax Cuts and Jobs Act (TCJA) a taxpayer could convert a traditional IRAinto a Roth IRA pay tax on the conversion and then later decide to reconvert the Roth IRA back into atraditional IRA Recharacterizations were permitted for trustee-to-trustee transfers through the extendeddue date including extensions of the taxpayers tax return among other requirements Under the TCJAthe reconversion of a Roth IRA back into a traditional IRA will no longer be permitted The IRS has nowclarified in a Frequently Asked Question (FAQ) posted to the IRS website that re-conversions back intoa traditional IRA will be permitted through October 15 2018 But Roth IRA conversion made on or afterJanuary 1 2018 cannot be recharacterized (Code sect408 IRA Conversions)

- Reduction in Minimum Age for Allowable In-Service Distributions

- The Conference bill would not permit State and local government defined contribution plans(Code sect457(d)(1)) to make in-service distributions beginning at age 59-12

- Modified Rules on Hardship Distributions

- The new Tax Act would require the IRS to within one year from the date of enactment changeits regs under Codesect401(k) to allow employees taking hardship distributions to continue makingcontributions to the plan

- Extended Rollover Period for the Rollover of Plan Loan Offset Amounts in Certain Cases

- If an employee stops making payments on a retirement plan loan before the loan is repaid adeemed distribution of the outstanding loan balance generally occurs Such a distribution isgenerally taxed as though an actual distribution occurred including being subject to Code sect72(t)10 early withdrawal penalty if applicable Furthermore this type of deemed distribution is noteligible for rollover to another eligible retirement plan

- Under current law a plan may also provide that in certain circumstances (eg if an employeeterminates employment) an employeersquos obligation to repay a loan is accelerated and if the loan


is not repaid the loan is cancelled and the amount in employeersquos account balance is offset by theamount of the unpaid loan balance referred to as a ldquoloan offsetrdquo A loan offset is treated as anactual distribution from the plan equal to the unpaid loan balance (rather than a ldquodeemeddistributionrdquo) and (unlike a ldquodeemed distributionrdquo) the amount of the distribution is eligible for a tax-free rollover to another eligible retirement plan within 60 days However the plan is not requiredto offer a ldquodirect rolloverrdquo option with respect to a plan loan offset amount that is an eligible rolloverdistribution and the plan loan offset amount is generally not subject to 20 income taxwithholding

- The new Tax Act would modify Code sect402(c) to provide that employees whose planterminates or who separate from employment while they have plan loans outstandingwould have until the extended due date for filing their tax return for that year to repay suchloans or to otherwise contribute the outstanding loan balance amount to an IRA in orderto avoid the loan being taxed as a distribution

Comment This provision is in response to the high rate of default with pension loans

Estate and Generation-Skipping Transfer Taxes

- Doubling of Unified Credit Equivalent

- The current unified credit equivalent of $5600000 in 2018 would instead be doubledto$112 million and it would continued to apply to gift tax as well159 As a result a couple willbe able to transfer assets either during life or at death exceeding $24 million

Comment The IRS has announced that contrary to their prior guidance when they applied themost recent Department of Labor tables to introduce a Consumer Price Index inflation factor tothe lifetime exemption for gift estate and generation-skipping transfer taxes the change broughton by the Tax Cut and Jobs Act brings this exemption to $11180000 per person not quite the$11200000 previously announced

Comment There is no change insomuch as a beneficiary will continue to take a ldquodate-of-deathFMVrdquo for any property inherited at death (and a carryover basis for lifetime gifts) As a sidecomment the annual gift tax exclusion will be increasing from $14000 in 2017 to $15000 in 2018

Comment One has to question whether with such an increase in the unified credit equivalentit continues to make sense to gift away appreciating property during onersquos lifetime especiallywhere the current FMV is substantially above the propertyrsquos adjusted basis This would be an evenmore important issue if the potential donor was older or in poor health For example would settingup a ldquofamily limited partnershiprdquo (FLP) and utilizing substantial discounts on the subsequent giftingof the limited partnership interests to other family members still make sense after TCJA

Comment Estate and gift tax planning is important among other things for 1) successionplanning 2) blended families and 3) spendthrift surviving spouses

159 As a result the combined estate of a couple would be able to pass over $22 million to the nextgeneration without any estate tax And even wealthier estates will continue to set up private foundations or otherwisemake sizable charitable contributions in order to avoid estate tax


Income Tax Rates for Trusts and Estates

- Under the new Tax Act the highest marginal tax rate of 37 will now start at just $12500 oftaxable income160

Comment And this means that the higher 20 (v 0 or 15) marginal tax rate for LTCGs anddividends would also commence at just $12500 of taxable income as well

Estates and TrustsNot over $2550 10 of the taxable incomeOver $2550 but not over $9150 $255 plus 24 of the excess over $2550Over $9150 but not over $12500 $1839 plus 35 of the excess over $9150Over $12500 $301150 plus 37 of the excess over $12500

By way of comparison here is what the tax rate schedule would have been had the new Tax Act notbeen passed

- FOR ESTATES AND TRUSTS If taxable income is not over $2600 15 of taxable income Over$2600 but not over $6100 $390 plus 25 of the excess over $2600 Over $6100 but not over $9300$1265 plus 28 of the excess over $6100 Over $9300 but not over $12700 $2161 plus 33 of theexcess over $9300 Over $12700 $3283 plus 396 of the excess over $12700

So the top tax bracket of 37 (which also means that the 38 Medicare surtax will also applystarting at this level of taxable income) now commences at $12500 instead of $12700 Againfiduciary filers are going to try avoiding being labeled as a ldquocomplexrdquo trust with the retention of some oftheir taxable income But especially with capital gains which are normally allocable to corpus accordingto most trust instruments it will be difficult to offset this type of income with a corresponding distributiondeduction

Tax-Exempt Entities

- Unrelated Business Taxable Income

- A tax-exempt organization determines its ldquounrelated business taxable incomerdquo (UBTI) bysubtracting from its gross unrelated business income deductions ldquodirectly connectedrdquo with theunrelated trade or business Under the regs in determining UBTI an organization that operatesmultiple unrelated trades or businesses aggregates income from all such activities and subtractsfrom the aggregate gross income the aggregate of deductions As a result an organization mayuse a deduction from one unrelated trade or business to offset income from another therebyreducing total unrelated business taxable income

- For tax years beginning after Dec 31 2017 (subject to an exception for net operating losses(NOLs) arising in a tax year beginning before Jan 1 2018 that are carried forward) losses from

160 Obviously this would mean that the Code sect1411 38 Medicare surtax would also begin to apply at thislevel of taxable income meaning that LTCGs would face an effective tax rate of 238 (20 + 38) and ordinaryincome 408 (37 + 38)


one unrelated trade or business may not be used to offset income derived from anotherunrelated trade or business Furthermore gains and losses have to be calculated andapplied separately161 However the losses can be carried forward to offset future incomefrom that business The rules do not apply to pre-2018 losses that are carried forward Sothey can reduce future income from any unrelated business

- Tax-exempt entities would now also be taxed on the values of providing their employeeswith transportation and parking fringe benefits and on-premises gyms and other athleticfacilities by treating the funds used to pay for such benefits as ldquounrelated business taxableincomerdquo (UBTI) As a result the value of these employee benefits would be subject to a tax equalto the corporate tax rate

Comment Congressrsquos intent for this rule was to create parity with for-profit employers which canno longer deduct these costs

- Streamlined Excise Tax on Private Foundation Income

- Private foundations are currently subject to a 2 excise tax on their net investment incomes butthey may reduce this excise tax rate to 1 by making distributions equal to the averages of theirdistributions from the previous five years plus 1 of the net investment income for the tax yearUnder the new Tax Act the excise tax rate on net investment income would be streamlinedto a single rate of 14 and the rules providing for a reduction in the excise tax rate from2 to 1 would be repealed

- Excise Tax on Private Colleges and Universities

- Private colleges and universities generally are treated as public charities rather than privatefoundations and thus are not subject to the private foundation excise tax on net investmentincome

- The excise tax on net investment income currently normally does not apply to public charitiesincluding colleges and universities even though some have substantial investment income similarto private foundations

- Under the new Tax Act a 14 excise tax on net investment income would now also applyto private colleges and universities that have at least 500 students more than 50 of thestudents of which are located in the US and assets (other than those used directly incarrying out the institutions educational purposes) valued at the close of the preceding taxyear of at least $500000 per full-time student State colleges and universities would not besubject to the change

Comment About 30 colleges will be affected according to a congressional research report Theyinclude Harvard Rice Duke Stanford Univ of Richmond Amherst Notre Dame MIT and Univof Pennsylvania



- The number of students is based on the daily average number of ldquofull-time equivalent studentsrdquo(full-time students and part-time students on an equivalent basis)

- ldquoNet investment incomerdquo is gross investment income minus expenses to produce the investment(but disallowing the use of accelerated depreciation methods or percentage depletion)162

- Excise Tax on Excess Tax-Exempt Organization Executive Compensation

- Under current law there were ldquoreasonableness requirementsrdquo and a prohibition against ldquoprivateinurementrdquo with respect to executive compensation for tax-exempt entities but no excise tax wastied to the amount of compensation paid

- For tax years beginning after Dec 31 2017 a tax-exempt organization is subject to a tax atthe C corporation tax rate (ie 21 under the new Tax Act) on the sum of (1) the remuneration(other than an ldquoexcess parachute paymentrdquo) in excess of $1 million paid to a ldquocovered employeerdquoby an ldquoapplicable tax-exempt organizationrdquo for a tax year and (2) any ldquoexcess parachute paymentrdquo(as newly defined under the Tax Act) paid by the ldquoapplicable tax-exempt organizationrdquo to aldquocovered employeerdquo

- A ldquocovered employeerdquo is an employee (including any former employee) of an ldquoapplicabletax-exempt organizationrdquo if the employee is one of the five highest compensated employees of theorganization for the tax year or was a covered employee of the organization (or a predecessor)for any preceding tax year beginning after Dec 31 2016 Remuneration is treated as paid whenthere is no substantial risk of forfeiture of the rights to such remuneration163

- Johnson Amendment Restricted

- Under current law the so-called Johnson Amendment (a provision in Code sect501(c)(3))prohibits tax-exempt organizations including religious and educational institutions from engagingin certain types of political activity if they want to retain their tax-exempt status Effective for taxyears ending after the date of enactment Tax Reform would provide that a church will not fail tobe treated ldquoas organized and operated exclusively for a religious purposerdquo nor will it be deemedto have participated in or intervened in any political campaign on behalf of (or in opposition to)any candidate for public office solely because of the content of any homily sermon etc madeduring religious services or gatherings The change would apply only if the preparation andpresentation of such content is in the ordinary course of the organizations regular and customaryactivities in carrying out its exempt purpose and results in the organization incurring ldquonot morethan de minimis incremental expensesrdquo

- The final Conference Agreement dropped the repeal of the Johnson Amendment whichwould have allowed tax-exempt entities to specifically endorse a political candidate




- New Reporting for Donor Advised Funds

- Effective for returns filed for tax years beginning after Dec 31 2017 Tax Reform would requiredonor advised funds to disclose the average amount of grants made during the tax year(expressed as a percentage of the value of assets held in the funds at the beginning of the taxyear) and to indicate whether the organization has a policy with respect to donor advised fundsfor frequency and minimum level of distributions (and if so to include with its return a copy of thepolicy)

IRS Practice and Procedural Changes

- Time To Contest IRS Levy Extended

- The IRS is authorized to return property that has been wrongfully levied upon Under current law monetary proceeds from the sale of levied property could generally be returned within ninemonths of the date of the levy

- Under the new Tax Act for levies made after the date of enactment (122217) as well as forlevies made on or before the date of enactment if the 9-month period (32217)has not expired asof the date of enactment the 9-month period during which the IRS may return the monetaryproceeds from the sale of property that has been wrongfully levied upon is extended to two yearsAnd the period for bringing a civil action for wrongful levy is similarly extended from nine monthsto two years164

LTaxpayers Now Given More Time to Contest Erroneous IRS Levies Taxpayers will now get two years to claim that the IRS wrongfully levied their assets Otherwise the IRSis barred from returning the money even if the tax levy was in fact erroneous The two-year period is achange enacted under the Tax Cuts and Jobs Act Prior law allowed a taxpayer only nine months fromthe date of the levy to seek return of the seized funds The two-year period applies to funds levied afterMarch 22 2017 (Code sect7403 IRS Liens)

- Due Diligence Requirements for Claiming Head of Household

- Any person who is a tax return preparer for any return or claim for refund who fails to complywith certain regulatory due diligence requirements imposed by regs with regard to determining theeligibility for or the amount of an earned income credit a child tax credit a additional child taxcredit or an American opportunity tax credit must pay a penalty165 The base amount of thepenalty is $500 but for 2018 as adjusted for inflation under Code sect6695(h) the penalty is $520

- Under the new Tax Act effective for tax years beginning after Dec 31 2017 the Actexpands the ldquodue diligence requirementsrdquo for paid preparers to cover determiningeligibility for a taxpayer to file as head of household A penalty of $500 (adjusted for inflation)

164 Code Sec 6343(b) as amended by Act Sec 11071

165 Code Sec 6695(g)


is imposed for each failure to meet these requirements166

Foreign Tax Provisions

- Deduction for Foreign-Source Portion of Dividends

- Under current law US citizens resident individuals and domestic corporations generally aretaxed on all income whether earned in the US or abroad On the other hand foreign incomeearned by a foreign subsidiary of a US corporation generally is not subject to US tax until theincome is actually distributed as a dividend to the US corporation

- Under the new Tax Act for tax years of foreign corporations that begin after Dec 31 2017and for tax years of US shareholders in which or with which such tax years of foreigncorporations end the current-law system of taxing US corporations on the foreign earnings oftheir foreign subsidiaries when these earnings are actually distributed is being replaced

- The Tax Act will now provide an exemption (ie a dividend received deduction) for certainforeign income This exemption is provided for by means of a 100 deduction for theldquoforeign-source portionrdquo of dividends received from ldquospecified 10 owned foreign corporationsrdquo(generally any foreign corporation other than a ldquopassive foreign investment companyrdquo that is notalso a controlled foreign corporation (CFC) with respect to which any domestic corporation is aUS shareholder) by domestic corporations that are US shareholders of those foreigncorporations within the meaning of Code sect951(b) The foreign-source portion of a dividend froma specified 10-owned foreign corporation is that amount which bears the ratio to the dividendas the undistributed foreign earnings of the specified 10-owned foreign corporation bears to thetotal undistributed earnings of such foreign corporation167

- No foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect toa dividend that qualifies for the DRD There is also a provision in the new Tax Act that disallowsthe DRD if the domestic corporation did not hold the stock in the foreign corporation for a longenough period of time

- The provision is meant to eliminate the ldquolock-outrdquo effect under current law which encouragesUS companies to avoid bringing their foreign earnings back into the US

- The DRD is available only to C corporations that are not regulated investment companies (RICs)or real estate investment trusts (REITs)

- Taxation of Foreign Profits

- Would replace the current-law system of taxing US corporations on the foreign earnings of theirforeign subsidiaries when these earnings are distributed with a ldquodividend-exemption systemrdquoUnder the exemption system 100 of the foreign-source portion of dividends paid by a foreign

166 Code Sec 6695(g) as amended by Act Sec 11001(b)

167 Code Sec 245A(c) as added by Act Sec 14101


corporation to a US corporate shareholder that owns 10 or more of the foreign corporationwould be exempt from US taxation However no foreign tax credit or deduction would be allowedfor any foreign taxes (including withholding taxes) paid or accrued with respect to any exemptdividend

- Taxation of Payments Made to Foreign Businesses Operation in US

- Foreign businesses operating in the United States would face a tax of up to 20 percent onpayments they make overseas from their American operations

- Repatriation of Foreign Earnings

- Under the final Conference Agreement US companies would be subject to a one-timedeemed repatriation tax on untaxed foreign profits Tax would be imposed on the deemedrepatriation at a rate of 155 on liquid assets and 8 on illiquid assets

Comment The IRS announced in Notice 2018-7 that it intends to issue regulations pursuant toCode sect965 on the deemed repatriation tax including rules for computing cash and ldquocashequivalentsrdquo as wll as the amount of earnings and profits (EampP) subject to the tax In addition thisIRS notice provides (1) guidance on multiple inclusion years and the treatment of related-partytransactions (2) rules on determining accumulated EampP and (3) guidance on amounts treated assubpart F income consolidated groups and adjustments to foreign currency gain or loss Thedeemed repatriation tax is effective for the last tax years of foreign corporations that begin before1118 and for US shareholders for the tax years in which the foreign corporations tax yearsend

LIRS Issues Guidance on New Deemed Repatriation Tax (Notice 2018-7) The Tax Cuts and Jobs Act imposes a ldquodeemed repatriation taxrdquo on US shareholders that own atleast 10 of a foreign subsidiary The IRS has now announced that it intends to issue regulations on thedeemed repatriation tax including rules for computing cash and ldquocash equivalentsrdquo as wll as the amountof earnings and profits (EampP) subject to the tax In addition this IRS notice provides (1) guidance onmultiple inclusion years and the treatment of related-party transactions (2) rules on determiningaccumulated EampP and (3) guidance on amounts treated as subpart F income consolidated groups andadjustments to foreign currency gain or loss The deemed repatriation tax is effective for the last tax yearsof foreign corporations that begin before 1118 and for US shareholders for the tax years in which theforeign corporations tax years end (Code sect965 Repatriation Tax)

Comment As mentioned above the IRS has now published Guidance on Tax Acts DeemedRepatriation Rules and Constructive Ownership Changes in Notice 2018-13

LIRS Provides Additional FAQ Guidance on Deemed Repatriation Tax Under Code sect965 which was added by the Tax Cuts and Jobs Act (TCJA) US shareholders of aldquospecified foreign corporationrdquo are subject to a deemed repatriation tax For many US shareholders thistax will be reflected on their 2017 returns Given the recent March 15 deadline and soon-to-come April17 Form 1040 filing deadline the IRS has released guidance in a Frequently Asked Questions (FAQ)format that instructs taxpayers how to report and pay the deemed repatriation tax Among other thingsthe FAQs provide that US shareholders must include with their returns a Section 965 Transition TaxStatement which is signed under penalties of perjury In addition the FAQs direct taxpayers to make


two separate payments with their 2017 returns one reflecting tax owed without regard to the deemedrepatriation tax and a second payment reflecting the deemed repatriation tax only (Code sect965Repatriation Tax)

LIRS Issues Additional Guidance on New Deemed Repatriation Tax (Notice 2018-13) The Tax Cuts and Jobs Act (TCJA) imposes a deemed repatriation tax on US shareholders that ownat least 10 of a foreign subsidiary In Notice 2018-7 the IRS has announced that it intends to issueregulations on the deemed repatriation tax including the determination of the status of a specified foreigncorporation as a Deferred Foreign Income Corporation (DFIC) or an EampP deficit foreign corporationwhich is required to determine the amount of the deemed repatriation The TCJA also repealed Codesect958(b)(4) which now provides for downward attribution to determine whether a foreign corporation isa CFC The Notice provides that taxpayers may determine whether a foreign corporation is a CFC withoutregard to the repeal of Code sect958(b)(4) pending further guidance for purposes of the application of Regsect1863-8 to determine the source of any ldquospace or ocean incomerdquo or Reg sect1863-9 to determine thesource of any ldquointernational communications incomerdquo

Comment The deemed repatriation tax is effective for the last tax years of foreign corporationsthat begin before 1118 and for US shareholders for the tax years in which the foreigncorporations tax years end Furthermore taxpayers are permitted to rely on the Notice beforeregulations are issued

LIRS Outlines Regs to Be Issued on ldquoDeemed Repatriation Transition Taxrdquo (IR 2018-79) The IRS has announced that it intends to issue regs on Code sect965 as amended by the Tax Cuts andJob Act which requires certain foreign corporations to increase their subpart F income for their last taxyear that begins before Jan 1 2018 by the amount of their ldquodeferred foreign incomerdquo The regs willinclude rules on anti-avoidance special elections and reporting and payment of the transition tax TheNotice also announced relief from estimated tax penalties in connection with Code sect965 and the repealof former Code sect958(b)(4) which before its repeal had limited the effect of a constructive ownershiprule (Code sect965 Deemed Repatriation Tax)

Comment Taxpayers may rely on the rules provided in the Notice pending the issuance of theregs

Comment As discussed above under Code sect965 US shareholders of a ldquospecified foreigncorporationrdquo are subject to a ldquodeemed repatriation taxrdquo This is accomplished by increasing theforeign corporations Subpart F income by the greater of (1) the accumulated post-1986 earningsand profits of the corporation determined as of 11217 or (2) the accumulated post-1986 earningsand profits determined as of 123117 Recently the IRS released Pub 5292 (How to CalculateSection 965 Amounts and Elections Available to Taxpayers) which provides a workbook andinstructions to assist taxpayers in calculating the deemed repatriation tax The Publication alsoincludes worksheets for taxpayers who may be eligible to make certain elections under IRC Sec965

Notes


Possibility of 100+ Marginal Rate within Certain Phaseout Ranges168

The possible marginal tax rate of more than 100 results from the combination of tax policies designedto provide benefits to businesses and families but then deny them to those taxpayers finding themselvesin the highest marginal brackets169 As income climbs and those breaks phase out each dollar of incomefaces regular tax rates and a hidden marginal rate on top of that in the form of vanishing tax breaks Thatstructure if maintained in a final law would create some of the disincentives to working and to earningbusiness profit that Republicans have long complained about while opening lucrative avenues for taxavoidance Conversely as a taxpayerrsquos income gets much higher and moves out of those phaseoutranges the marginal tax rates would go down

For example if a New Jersey lawyerrsquos stay-at-home spouse wanted a job the first $100 of the spousersquoswages would require $10779 in taxes And the tax rates for similarly situated residents of California andNew York City would be even higher the Tax Foundation found Analyses by the Tax Policy Centerwhich is run by a former Obama administration official find similar results with federal marginal rates ashigh as 85 and those do not include items such as state taxes self-employment taxes or the phase-outof child tax credits

168 Summarized from Wall Street Journal ldquoThe Taxman Cometh Senate Billrsquos Marginal Rates Could Top100 for Somerdquo

169 If the highest marginal tax rate now becomes 37 (instead of 396 in the House bill and 385 in theSenate bill) then the effective marginal tax rates mentioned in the article above would go down slightly


Client Case Studies

Comment This first case study takes you through each of the iterations of the Tax Reform process(ie House bill Senate bill revised Senate bill and then through the new Tax Act) It is intended to helpyou understand how the final version of Tax Cuts and Jobs Act was crafted especially where a clientis citing what they believe to be in the law but it was a provision for instance that did not ldquomake it to thefinal cutrdquo On the other hand the other case studies simply demonstrate how the final version of theTax Act impacts a variety of client situations The most important piece of advise is to ldquorun thenumbersrdquo You can not generalize or presume the law is going to work in a certain way because the endresult might indeed surprise you and your client However from an initial assessment of the Tax Act itseems that most taxpayers will find that they are going to save some taxes and in some casesa significant amount

Case Study 1 - MFJ w $350000 Rental K-1 amp Schedule C Income

Consider the following scenario where a couple is earning approximately $35000 per year between themThey have no dependents Using their most recent numbers for the 2016 tax year the following analysisillustrates on the new Tax Act will impact them And even though their taxable income might increasesignificantly in 2018 due to the elimination of certain itemized deductions (especially state andlocal taxes) they still end up saving a considerable amount of taxes (basically due to the new Sec199A deduction) But of course each clientrsquos tax situation is different and one thing is clear youcannot generalize and assume that their taxes are either going up or down Instead you have torun the numbers for each case and see how the various new changes impact them

In this Case Study 1 the husband is the sole owner and employee of his S corporation while his wifehas both a W-2 position as well as her own Schedule C business Both are service-based businessesand neither one has any significant investment in capital assets Nevertheless their taxable income isnot expected to exceed the $315000 MFJ applicable threshold for the new Sec 199A 20deduction on ldquoqualified business incomerdquo And they contribute to their retirement plans as well asa family HSA which resulted in their AGI for 2016 being approximately $317000 The husbandrsquos K-1 fromhis S corporation is $104980 while he is receiving a salary of $88175 Meanwhile his wife realizes aprofit of $104011 from her Schedule C proprietorship And they receive $5400 per year from rentingtheir home office to the S corporation

Impact of House Ways amp MeansTax Reform Proposals 11-2-17

Using Client 2016 Tax Return(Tax Savings = 2811)

Example Using2016 Form 1040 Adjustment +-

AGI 317072 No Sec 199A deduction only 25 special rate for non-servicebusinesses

LessRE taxes (10000) - 942 (real estate taxes now limited to 10000 cap)SALT -0- -21619 (no deduction for statelocal income taxes)


Mrtg interest (16414) NA (no impact since no QSR and mortgage lt $500000)Charitable (11911) NA (no impact on charitable contributions)

Itemized Deductions (38325) -22561 (total itemized deductions lost to tax reform)

Personal Exemptions -0- -7614 (after partial phaseout on 2016 tax return)

Taxable Income 278747 +30002 (taxable income had been 248745 in 2016)

Tax 59861 +2362 (Regular tax in 2016 was 57499)

12 x 90000 = 1080025 x 170000 = 42500 (260000 - 90000)35 x 18747 = 6561 (278747 - 260000)

AMT -0- -5173 (AMT that had been due on 2016 tax return)

Total tax savings 2811 Note Total tax in 2016 had been 62672 under tax

reform proposals = 59861 savings = 2811

Special note on K-1 income 104980 on K-1 income and 104011 in Schedule C net profit in 2016would not receive the special 25 rate since they were both service-based businesses Had theyinstead been manufacturing businesses (ie ldquonon-service-based activities) 30 (under the Housebill) of this K-1 income plus W-2 wages of $88175 along with 104011 of Schedule C net profit wouldhave enjoyed the new 25 rate for a savings of about 4559 (ie 30 x (104980 + 88175 +104011) = 89150 25 x 89150 = 22287 33 x 89150 = 29420 marginal tax savings 29420 -22887 = 7133)170 If instead a ldquopassiverdquo investor was receiving this $193155 of allocable K-1 profits(104980 + 88175) then they would receive the special 25 tax rate on the entire amount171

Impact of Senate Finance CommitteeTax Reform Proposals 12-1-17



AGI 317072 AGI not affected by new Sec 199A deduction offset in determiningTI

170 By way of comparison this couple would have faced a 33 marginal tax rate on this last $56994 oftaxable income in 2016

171 Note the Schedule C net profit of 104011 would not be affected since the proprietor is not a passiveinvestor


LessRE taxes -0- -10942 (real estate taxes would be eliminated as well as sales tax)SALT -0- -21619 (no deduction for statelocal income taxes)Mrtg interest (16414) NA (no impact since no QSR)Charitable (11911) NA (no impact on charitable contributions)

Itemized Deductions (28325) -32561 (total itemized deductions lost to SALT tax reform)


Sec 199A (37304) (104980 K-1 + 104011 Schedule C profit + $5400 net Schedule Erent) x

Deduction 174) deduction under new Sec 199A Not limited to 50 of W-2income since MFJ taxable income lt $315000


Tax 49013 -8486 (Regular tax in 2016 was 57499)

Tax Calculation ((251443 - 140000) x 24) + 22267 = 53582)




Special note on K-1 income 104980 in K-1 income 104011 in Schedule C net profit and 5400 inSchedule E net rental income in 2016 would now receive special 174 deduction equal to 37304(214391 x 174) even though service-based businesses are involved so long as taxable incomedoes not exceed the $500000 threshold on a MFJ return And there would also be no 50 limitbased on W-2 wage income for the same reason172 Finally given a marginal tax bracket of 24along with this new 174 deduction the top marginal tax rate for the income subject to the Sec199A deduction is only 19824 (($100 - 1740) x 24) which is even less than the 25 special rategiven to non-service-based K-1 businesses and all passive investors in the House version

Impact of Revised Senate VersionTax Reform Proposals 12-2-17


172 The Senate versions of the bill never included the alternative ldquo25 x W-2 wages + 25 x unadjustedbases of tangible assets this was added in the final Conference bill And the original ldquothresholdsrdquo for taxable incomewere $500000 for MFJ and $250000 for unmarried taxpayers (instead of the final $315000 and $157500 thresholdsin the final version of the Tax Act)




LessRE taxes (10000) -942 (real estate taxes would be eliminated as well as sales tax)SALT -0- -21619 (no deduction for statelocal income taxes)Mrtg interest (16414) NA (no impact since no QSR)Charitable (11911) NA (no impact on charitable contributions)



Sec 199A (49310) (104980 K-1 + 104011 Schedule C profit + $5400 net Schedule EDeduction rent) x 23) deduction under new Sec 199A Not limited to 50 of

W-2 income since MFJ taxable income lt $315000

Taxable Income 229437 -19308 (taxable income had been 248745 in 2016)






Special note on K-1 income 214391 in gross income would now receive the new Sec 199A 23deduction equal to 49310 (104980 + 104011 + 5400) x 23) even though service-basedbusinesses are involved so long as taxable income does not exceed the $500000 threshold on aMFJ return And there would also be no 50 limit based on W-2 wage income for the samereason173 Finally given a marginal tax bracket of 24 along with this new 23 deduction theeffective top marginal tax rate on the gross income now eligible for the new Sec 199A deduction isonly 1848 (($100 - 2300) x 24) which is even less than the 25 special rate given to non-service-based K-1 businesses and all passive investors in the House version



Impact of Congressional ConfereesFinal Tax Reform Proposals 12-15-17




LessRE taxes (10000)174 -942 (real estate taxes would be eliminated)SALT -0- -21619 (no deduction for statelocal income taxes)Mrtg interest (16414) NA (no impact since no QSR and mortgage lt $1 million750000)Charitable (11911) NA (no impact on charitable contributions)



Sec 199A (42878) -42878 (104980 K-1 income + 104011 Schedule C net profit +5400 Schedule E net rental income) x 20)175 Not limited to 50of W-2 income since taxable income lt 315000 on MFJ return



Tax Calculation ((235869 - 165000) x 24) + 28179) = 45188)

AMT -0- 176 -5173 (AMT that had been due on 2016 tax return)

Total tax savings 17484 Note Total tax in 2016 had been 62672 under tax it drops to

$45188 (ie $17484 decrease)

Special note on K-1 income 214391 in gross income would now receive the new Sec 199A 20deduction equal to 42878 (104980 + 104011 + 5400) x 20) even though it is a service-basedbusiness so long as taxable income does not exceed the $315000 threshold on a MFJ return And

174 Now this $10000 cap would be for either real estate personal property income or sales taxes (or acombination thereof)

175 This deduction went from 174 to 23 and now down to 20 in the final Conference bill

176 Given the ldquohigher AMT exemptionsrdquo in the final Conference bill this couple would not be subject to AMTAlso there was initially a mandatory imposition of employment tax on a certain percentage of allocable K-1 profitsbefore any wages especially where the majority of the business revenues are generated by owneremployees of theS corporation in the original House bill but this was subsequently repealed in the revised House bill


there would also be no 50 limit based on W-2 wage income for the same reason Finally given amarginal tax bracket of 24 along with this new 20 deduction the effective top marginal tax rateon the gross income now eligible for the new Sec 199A deduction is only 1920 (($100 - 2000) x24) which is even less than the 25 special rate given to non-service-based K-1 businesses and allpassive investors in the House version

AMT Calculation Under FinalConference Bill


Regular taxable income 235869 -12876 (taxable income had been 248745 in 2016)

Preferences

- Personal exemptions NA -7614 (after phaseout) eliminated in new Tax Act

- State amp local taxes 10000 -22561 (had been 21619 income taxes 10942 propertytaxes)

- HELOC interest NA Eliminated to extent used for consumer borrowing

Preliminary AMTI 245869 109400 AMT exemption amount phased out 25cent$100 forevery dollar of preliminary AMTI over $1 million177 thereforeno phaseout applies in this instance

AMT Exemption 109400

AMTI 136469 28 AMT rate would not commenced until $191500178

TMT 35482 Tentative minimum tax would be 35482 (136469 x 26)

AMT savings 5173 Regular tax is 45188 therefore AMT NA under the new TaxReform Act resulting in additional tax savings of 5173

Note By way of comparison here is what the AMT inflation-adjusted amounts would have been for 2018had the Tax Reform Act not been passed

- AMT exemption amounts For 2018 the AMT exemption amounts would have been Joint returnsor surviving spouses $86200 (up from $84500 for 2017) Unmarried individuals (other than survivingspouses) $55400 (up from $54300 for 2017) Married individuals filing separate returns $43100 (upfrom $42250 for 2017) Estates and trusts $24600 (up from $24100 for 2017)

177 Under the Senate version the ldquoexemption thresholdrdquo would have started to phase out $208400 ($104200 for unmarried taxpayers) However under the final Tax Act a phaseout threshold of $500000 was adopted forunmarried taxpayers and $1 million for MFJ filers

178 The $191400 threshold at which the 28 AMT rate would commenced represents the 2018 inflation-adjusted amount had the Tax Reform Act not been passed In fact the actual threshold might indeed turn out to behigher


- AMT tax rates For 2018 the excess taxable income above which the 28 tax rate applies wouldhave been $191500 for joint returns unmarried individuals and estates and trusts (up from $187800 for2017) and $95750 for married persons filing separately (up from $93900 for 2017)

- Phaseout of AMT exemption amounts For 2018 the amounts used under Code sect55(d)(3) todetermine the phaseout of the exemption amounts would have been Joint returns or surviving spouses$164100 (up from $160900 for 2017) Unmarried individuals (other than surviving spouses) $123100(up from $120700 for 2017) Married filing separately and estates and trusts $82050 (up from $80450for 2017)

Case Study 2 - MFJ w $70000 W-2 Income and Three Dependents(Tax savings = 1640)

Assume a married couple makes $35000 each in W-2 income They also have three children all ofwhom are under age 17 who they claim as dependents In 2017 they claimed the standard deductionand had no other sources of income (eg interest dividends capital gains etc) Comparing their latestnumbers from 2017 what would be the impact of the recently-passed Tax Cuts and Jobs Act

Impact of Tax Cut and Jobs ActUsing Client 2017 Tax Return

Example Using Impact of New2017 Form 1040 Tax Act Adjustment +-

Wages 70000 70000LessStandardDeduction (12600) (24000)Personal ampDependentExemptions (20250) NA - 20250 (5 x 4050) personaldependency

exemptions repealedTaxableIncome 37150 46000 +8850 increase in taxable income

Tax 4640179 5139180 +499 increase in tax before credits

LessChild credit (3000) (6000) Offsets the initial 499 increase in tax3 x 1000 3 X 2000

Net tax due 1640 -0- Tax savings = 1640

Comment Obviously once these three children turn 17 or older the credit would drop to just$500 for a total credit offset of only $1500 When applied against their tax liability of $5139their net tax due would be $3630 which is a TAX INCREASE of $1999 (3630 - 1640)

179 $1865 plus 15 x (37150 - 18650) = 4640

180 $1905 plus 12 x (46000 - 19050) = 5139



Assume a married couple makes $310000 total in W-2 income They also have three children all ofwhom are under age 17 who they claim as dependents In 2017 they had 80000 in total itemizeddeductions (including 15000 in real estate taxes and 25000 in state and local income taxes along with25000 of mortgage interest on a principal residence and 15000 of charitable contributions) and had noother sources of income (eg interest dividends capital gains etc) Comparing their latest numbersfrom 2017 what would be the impact of the recently-passed Tax Cuts and Jobs Act



Wages 310000 310000LessItemized (40000) Mortgage interest amp charitable contributionsDeductions (80000) (10000) Only 10000 of 40000 SALT allowedPersonal ampDependentExemptions (20250)181 NA - 20250 (5 x 4050) personaldependency

exemptions repealedTaxableIncome 209750 260000

Regular 45615182 50979183 +5364 regular tax increase in 2018Tax

AMT Calculation

Regular TI 209750 260000

Plus

Exemptions 20250 NA Since personaldependency exemptionsrepealed

ItemizedDeductions 40000 10000

Pre-AMTI 270000 270000

181 No phaseout of itemized deductions or personal and dependency exemptions since AGI not gt $313800

182 $2975250 plus 28 x (209750 - 153100) = 45615

183 $28179 plus 24 x (260000 - 165000) = 50979


Less

Exemption (57225)184 (109400) No phaseout since pre-AMTI lt $1 million

AMTI 212775 160600 28 AMT rate would not commenced until$191500 in 2018 26 x 160600 = 41756

TMT 55821185 41756 -14065 decrease in AMT

AMT 10206186 -0- AMT NA since regular tax = 50979

Less

Child credit (NA)187 (6000) Fully allowed since AGI not gt $4000003 X 2000

Tax due 55821 44979 Tax savings = 10842

Case Study 4 - MFJ w $700000 W-2 Income and $500000 DividendsLTCGs(Tax savings = 30865)

Assume a married couple makes $700000 in total W-2 income between them They have nodependents but do have a large investment portfolio which produces an additional $500000 individends and LTCGs which gives them an AGI of $12 million In 2017 they had 200000 in totalitemized deductions (including 35000 in real estate taxes and 85000 in state and local income taxesalong with 45000 of mortgage interest on a principal residence which they purchased before121517 and 35000 of charitable contributions) Comparing their latest numbers from 2017 whatwould be the impact of the recently-passed Tax Cuts and Jobs Act



Wages 700000 700000Dividends ampLTCGs 500000 500000

AGI 1200000 1200000

Less

184 ((270000 - 160900) x 25) = 27275 84500 - 27275 = 57225

185 ((212775 - 187800) X 28 = 6993) + (187800 X 26 = 48828)) = 55821

186 55821 TMT - 45615 regular tax = 10206 AMT

187 Phaseout of child tax credit starts at $110000 $310000 AGI credits fully phased out


Itemized (80000) Mortgage interest amp charitable contributions188

Deductions (173414)189 (10000) Only 10000 of 120000 SALT allowedPersonal ampDependentExemptions -0-190 NA Personaldependency exemptions repealed in

2018

TaxableIncome 1026586 1100000


AMT CalculationRegular TI 1026586 1110000PlusExemptions -0- NA Since personaldependency exemptions

repealedItemizedDeductions 173414193 10000

Pre-AMTI 1200000 1120000

Less

Exemption194 -0- (79400) AMT exemption phased out when pre-AMTI gt$1 million 120000 x 25 = 30000 109400 -30000

AMTI 1200000 1040600

188 Itemized deduction phaseout mechanism repealed for 2018

189 200000 itemized deductions subject to phaseout AGI (1200000 - 313800) x 3 = 26586 phaseout

190 (2 x 4050 = 8100) subject to phaseout (1200000 - 313800)2500 = (354 x 2 = 709) phaseout

191 (1026586 - 500000 = 526586 taxed as OI = 153759) + (500000 DivsLTCGs taxed at 20 =100000) Total regular tax = 253759

192 MFJ for 2018 = over $600000 tax is $161379 plus 37 of the excess over $600000 (tax on OI of600000 = 161379) + (tax on dividendsLTCGs = 500000 x 20 = 100000) total regular tax = 261379

193 200000 itemized deductions - 26586 phaseout = 173414

194 AMT exemption completely phased out


TMT 292244195 269770196

AMT 38485 -0- -38485 decrease in AMT


Case Study 5 - MFJ w $1200000 W-2 Income and No DividendsLTCG(Tax savings = 5380)

Assume a married couple makes $1200000 in total W-2 income between them They have nodependents and do not have any other investment or ordinary income Otherwise In 2017 they havethe same itemized deductions as in Case Study 3 above namely 200000 in total itemized deductions(including 35000 in real estate taxes and 85000 in state and local income taxes along with 45000 ofmortgage interest on a principal residence which they purchased before 121517 and 35000 ofcharitable contributions) Comparing their latest numbers from 2017 what would be the impact of therecently-passed Tax Cuts and Jobs Act



Wages 1200000 1200000

AGI 1200000 1200000

LessItemized (80000) Mortgage interest amp charitable contributions197

Deductions (173414)198 (10000) Only 10000 of 120000 SALT allowed

Personal ampDependentExemptions -0-199 NA Personaldependency exemptions repealed in

2018TaxableIncome 1026586 1100000

195 ((700000 - 187800) X 28 = 143416) + (187800 X 26 = 48828)) = 192244) + (500000 x 20 =100000) TMT = 192244 + 100000 = 292244 v 253759 regular tax AMT = 38485

196 ((540600 - 191500) x 28 = 97748) + (191500 x 26 = 49790)) = 147538) + (500000 x 20 =100000) TMT = 169770 + 100000 = 247538 v 261379 regular tax AMT = -0-





Regular 351759200 346379201 -5380 regular tax increase in 2018Tax

AMT Calculation

Regular TI 1026586 1110000

Plus

Exemptions -0- NA Since personaldependency exemptionsrepealed


Less

Schedule APhaseout 26586 NA No itemized deduction phaseout in 2018

Pre-AMTI 1120000 1120000

Less

AMT Exemption203 -0- (79400) AMT exemption phased out when pre-AMTI gt$1 million 120000 x 25 = 30000 109400 -30000

AMTI 1120000 1040600

TMT 309844204 287538205 -44706 AMT decrease but TMT lt regular taxin both 2017 and 2018

AMT -0- -0- -0- impact on AMT


Comment Taxpayers with even higher gross income (eg several million dollars) wereprobably not in AMT in prior years yet even with the 3 phaseout rule on itemized deductions

200 (1026586 - 470700) x 396) + 131628 = 351759

201 MFJ for 2018 = TI over $600000 tax is $161379 plus 37 of the excess over $600000 (1100000 -600000 = 500000 x 37 = 185000) + 161379 = 346379

202 SALT itemized deduction (85000 + 35000 = 120000)

203 84500 AMT exemption completely phased out

204 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax

205 ((1040600 - 191500) x 28 = 237748) + (191500 x 26 = 49790)) = 287538 v 346379 regular taxAMT = -0-


they got more then $10000 as a SALT deduction These individuals will probably find theirfederal income taxes have increased under TCJA

Case Study 6 - MFJ w $700000 W-2 Income and $500000 AMT Adjustment(Tax savings = 22306)

Assume a married couple makes $700000 in total W-2 income between them They have nodependents and do not have any other investment or ordinary income However the wife exercised anincentive stock option which resulted in a $500000 ldquobargain elementrdquo which must be added back as anadjustment for AMT purposes Otherwise In 2017 they have the same itemized deductions as in CaseStudy 3 above namely 200000 in total itemized deductions (including 35000 in real estate taxes and85000 in state and local income taxes along with 45000 of mortgage interest on a principal residencewhich they purchased before 121517 and 35000 of charitable contributions) Comparing their latestnumbers from 2017 what would be the impact of the recently-passed Tax Cuts and Jobs Act



Wages 700000 700000

AGI 700000 700000




2018






209 (511586 - 470700) x 396) + 131628 = 147819



AMT Calculation

Regular TI 511586 610000

Plus

Exemptions -0- NA Personaldependency exemptions repealed


ISO BargainElement 500000 500000

Less


Pre-AMTI 1120000 1120000

Less

AMT Exemption -0-212 (79400) AMT exemption phased out when pre-AMTI gt$1 million 120000 x 25 = 30000 109400 -30000

AMTI 1120000 1040600

TMT 309844213 287538214 -44706 AMT decrease

AMT 162025215 122459 39566 decrease in AMT


Notes



213 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax


215 309844 - 147819 = 162025



As an accounting graduate of La Salle University in Philadelphia ProfConnors went on for his law degree at the University of Notre Damegraduating in 1980 After serving as an instructor in the School of BusinessAdministration he obtained his Masters of Law in Taxation at the Universityof Miami Law School in Coral Gables Florida He then served on the graduatetax faculty at the University of Wisconsinrsquos School of Business in MilwaukeeWI

His professional background includes experience in income and estate taxplanning as well as individual partnership and corporate tax returnpreparation and research as a senior tax consultant for Price Waterhouse inthe Philadelphia and South Bend offices Prof Connors also worked onexpatriate and corporate tax matters as an international tax consultant for theChrysler Corporation in London England

Prof Connors currently conducts a national consulting practice designedespecially for tax professionals based out of Milwaukee WI He also publishesa tax newsletter devoted exclusively to practitioners entitled the Monthly TaxUpdate He has been the outside editor for CCHrsquos Federal Tax Course andhas spoken at numerous tax institutes workshops and conferences aroundthe country And his ldquoComplete Guide to Depreciation Amortization ampTransfers of Property - Issues Strategies amp Answersrdquo is sold to taxpractitioners throughout the US along with a brand new publication entitledldquoLLCs Taxed as Partnershipsrdquo

As a nationally known speaker on a variety of tax topics Prof Connors hasconsistently earned average overall ratings in excess of 47 (ie on a 50scale) for his knowledge and presentation skills as well as the quality of hismaterials He was chosen as a Distinguished Discussion Leader for the NewYork Society of CPAs Foundation for Accounting Education And in 2013 hereceived the AICPA prestigious Sidney Kess Award for ldquoExcellence inContinuing Educationrdquo

copy Tax Educatorrsquos Network (TEN) Inc - 2018


Table of Contents
























































150






158


























975














Appropriations Act)
























































































































































































































































27 Code Sec 168(e)(3)(B)


































income35




























































































































































































































































































































































(1) ndash (5) above




















































































































































































































































































































































































Only where a ldquoPage 1 TBrdquo on a Form 1065 or Form 1120s (ie as opposed to Form 8825rental activities) had multiple depreciable assets listed on its Form 4562 could one tradeor business asset be sold resulting in an overall gain (which would be treated as QBI) andthe overall ldquowagesrdquo of this trade or business let alone the ldquounadjusted basesrdquo ofdepreciable properties still held (and listed on Form 4562) be counted when applying thelimitation tests for the Sec 199A deduction































































































153 603 488 315

29 1614 1511 1356

38 1524 1421 1266








(806850000)







Business 1 300000 60000 50000 50000

Business 2 (300000) (60000) - (60000)

Net QBI -0- (10000)



Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -



CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 - - - -

Total QBIWages 600000 120000 100000 100000



Example


Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)


Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Carryover - Yr 1 (100000) (20000) - (20000) -


CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000


Example


Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Year 2

Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)



CumulativeDeduction

Business 1 600000 120000 100000 100000


Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000

















































































- 2-income families








































of their Form 1040



















- Kiddie Tax



































































gambling winnings)










































































































- Medical Expenses



































- Gambling Losses




126 Code sect165(d)























































































- Adoption Credit

















station147






























































- Tuition Waivers












Retirement Plans


















































Tax-Exempt Entities









































































Notes








Client Case Studies
















12 x 90000 = 1080025 x 170000 = 42500 (260000 - 90000)35 x 18747 = 6561 (278747 - 260000)

























































$45188 (ie $17484 decrease)










Preferences


























179 $1865 plus 15 x (37150 - 18650) = 4640

180 $1905 plus 12 x (46000 - 19050) = 5139









AMT Calculation

Regular TI 209750 260000

Plus



Pre-AMTI 270000 270000


182 $2975250 plus 28 x (209750 - 153100) = 45615

183 $28179 plus 24 x (260000 - 165000) = 50979


Less





Less








AGI 1200000 1200000

Less

184 ((270000 - 160900) x 25) = 27275 84500 - 27275 = 57225

185 ((212775 - 187800) X 28 = 6993) + (187800 X 26 = 48828)) = 55821






2018





Pre-AMTI 1200000 1120000

Less


AMTI 1200000 1040600









TMT 292244195 269770196







Wages 1200000 1200000

AGI 1200000 1200000




2018TaxableIncome 1026586 1100000








AMT Calculation

Regular TI 1026586 1110000

Plus



Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600





200 (1026586 - 470700) x 396) + 131628 = 351759




204 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax








Wages 700000 700000

AGI 700000 700000




2018






209 (511586 - 470700) x 396) + 131628 = 147819



AMT Calculation

Regular TI 511586 610000

Plus




Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600

TMT 309844213 287538214 -44706 AMT decrease



Notes



213 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax


215 309844 - 147819 = 162025



Table of Contents
























































150






158


























975














Appropriations Act)
























































































































































































































































27 Code Sec 168(e)(3)(B)


































income35




























































































































































































































































































































































(1) ndash (5) above



















































































































































































































































































































































































































































































153 603 488 315

29 1614 1511 1356

38 1524 1421 1266








(806850000)







Business 1 300000 60000 50000 50000

Business 2 (300000) (60000) - (60000)

Net QBI -0- (10000)



Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -



CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 - - - -

Total QBIWages 600000 120000 100000 100000



Example


Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)


Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Carryover - Yr 1 (100000) (20000) - (20000) -


CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000


Example


Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Year 2

Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)



CumulativeDeduction

Business 1 600000 120000 100000 100000


Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000

















































































- 2-income families








































of their Form 1040



















- Kiddie Tax



































































gambling winnings)










































































































- Medical Expenses



































- Gambling Losses




126 Code sect165(d)























































































- Adoption Credit

















station147






























































- Tuition Waivers












Retirement Plans


















































Tax-Exempt Entities









































































Notes








Client Case Studies
















12 x 90000 = 1080025 x 170000 = 42500 (260000 - 90000)35 x 18747 = 6561 (278747 - 260000)

























































$45188 (ie $17484 decrease)










Preferences


























179 $1865 plus 15 x (37150 - 18650) = 4640

180 $1905 plus 12 x (46000 - 19050) = 5139









AMT Calculation

Regular TI 209750 260000

Plus



Pre-AMTI 270000 270000


182 $2975250 plus 28 x (209750 - 153100) = 45615

183 $28179 plus 24 x (260000 - 165000) = 50979


Less





Less








AGI 1200000 1200000

Less

184 ((270000 - 160900) x 25) = 27275 84500 - 27275 = 57225

185 ((212775 - 187800) X 28 = 6993) + (187800 X 26 = 48828)) = 55821






2018





Pre-AMTI 1200000 1120000

Less


AMTI 1200000 1040600









TMT 292244195 269770196







Wages 1200000 1200000

AGI 1200000 1200000




2018TaxableIncome 1026586 1100000








AMT Calculation

Regular TI 1026586 1110000

Plus



Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600





200 (1026586 - 470700) x 396) + 131628 = 351759




204 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax








Wages 700000 700000

AGI 700000 700000




2018






209 (511586 - 470700) x 396) + 131628 = 147819



AMT Calculation

Regular TI 511586 610000

Plus




Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600

TMT 309844213 287538214 -44706 AMT decrease



Notes



213 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax


215 309844 - 147819 = 162025













































150






158


























975














Appropriations Act)
























































































































































































































































27 Code Sec 168(e)(3)(B)


































income35




























































































































































































































































































































































(1) ndash (5) above



















































































































































































































































































































































































































































































153 603 488 315

29 1614 1511 1356

38 1524 1421 1266








(806850000)







Business 1 300000 60000 50000 50000

Business 2 (300000) (60000) - (60000)

Net QBI -0- (10000)



Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -



CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 - - - -

Total QBIWages 600000 120000 100000 100000



Example


Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)


Year 2

Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Carryover - Yr 1 (100000) (20000) - (20000) -


CumulativeDeduction

Business 1 600000 120000 100000 100000

Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000


Example


Business 1 300000 60000 50000 50000

Business 2 300000 60000 - -


Year 2

Business 1 300000 60000 50000 50000

Business 2 (400000) (80000) - (80000)



CumulativeDeduction

Business 1 600000 120000 100000 100000


Business 2 (100000) (20000) - -

Total QBIWages 500000 100000 100000 100000

















































































- 2-income families








































of their Form 1040



















- Kiddie Tax



































































gambling winnings)










































































































- Medical Expenses



































- Gambling Losses




126 Code sect165(d)























































































- Adoption Credit

















station147






























































- Tuition Waivers












Retirement Plans


















































Tax-Exempt Entities









































































Notes








Client Case Studies
















12 x 90000 = 1080025 x 170000 = 42500 (260000 - 90000)35 x 18747 = 6561 (278747 - 260000)

























































$45188 (ie $17484 decrease)










Preferences


























179 $1865 plus 15 x (37150 - 18650) = 4640

180 $1905 plus 12 x (46000 - 19050) = 5139









AMT Calculation

Regular TI 209750 260000

Plus



Pre-AMTI 270000 270000


182 $2975250 plus 28 x (209750 - 153100) = 45615

183 $28179 plus 24 x (260000 - 165000) = 50979


Less





Less








AGI 1200000 1200000

Less

184 ((270000 - 160900) x 25) = 27275 84500 - 27275 = 57225

185 ((212775 - 187800) X 28 = 6993) + (187800 X 26 = 48828)) = 55821






2018





Pre-AMTI 1200000 1120000

Less


AMTI 1200000 1040600









TMT 292244195 269770196







Wages 1200000 1200000

AGI 1200000 1200000




2018TaxableIncome 1026586 1100000








AMT Calculation

Regular TI 1026586 1110000

Plus



Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600





200 (1026586 - 470700) x 396) + 131628 = 351759




204 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax








Wages 700000 700000

AGI 700000 700000




2018






209 (511586 - 470700) x 396) + 131628 = 147819



AMT Calculation

Regular TI 511586 610000

Plus




Less


Pre-AMTI 1120000 1120000

Less


AMTI 1120000 1040600

TMT 309844213 287538214 -44706 AMT decrease



Notes



213 (1120000 - 187800) X 28 = 261016) + (187800 X 26 = 48828)) = 309844 v 351759 regular tax


215 309844 - 147819 = 162025


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