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2018 Year-End Tax Planning Tax Reform 2.0 2018 Post-Filing Season Update

Final Regulations on 100 Percent Bonus Depreciation Issued, Along With New Proposals

Final regulations dealing with the 100 percent bonus depreciation allowance for qualified property acquired and placed in service after September 27, 2017, allow property which is constructed under a pre-September 28, 2017 binding contract to qualify for the 100 percent rate. The final regulations adopt proposed regulations ( REG-104397-18) with certain modifications, including a revised constructed property rule. In addition, the IRS has issued a new set of proposed regulations dealing with issues it is not ready to finalize.

FINAL REGULATIONS: Written Binding Contract Rules
Constructed property. The proposed regulations provided that property manufactured, constructed, or produced for the taxpayer by another person under a written binding contract entered into prior to the manufacture, etc., of the property is acquired pursuant to a written binding contract. Thus, if the contract was entered into before September 28, 2017, the 100 bonus rate did not apply.

That rule was scrapped in response to negative feedback. Instead the final regulations provide that such property is treated as self-constructed property, and the contract is ignored for purposes of determining when the property is deemed acquired. The acquisition date is now the date that the taxpayer begins manufacturing, constructing, or producing the property as determined under rules similar to those that apply to 50 percent bonus property.

Acquisition date. The final regulations provide that the acquisition date of property acquired pursuant to a written binding contract is the later of:

the date on which the contract is entered into;
the date on which the contract is enforceable under state law;
if the contract has one or more cancellation periods, the date on which all cancellation periods end; or
if the contract has one or more contingency clauses, the date on which all conditions subject to such clauses are satisfied.

Liquidated damage clause. When a contract has multiple damage provisions, the final regulations clarify that only the provision with the highest damages is taken into account in determining whether the contract limits damages.

Qualified Improvement Property
The IRS once again declined to make qualified improvement property placed in service after 2017 eligible for bonus depreciation. A legislative change is required to give this property its intended 15-year recovery period. With a 15-year recovery period, qualified improvement property will qualify for bonus depreciation under the general rule that allows bonus depreciation on property with an MACRS recovery period of 20 years or less.

Used Property
Predecessor defined. Property previously used by the taxpayer or a predecessor of a taxpayer does not qualify for bonus depreciation if the taxpayer or predecessor had a depreciable interest in the property. The final regulations define "predecessor" as:

a transferor of an asset to a transferee in a transaction to which Code Sec. 381(a) applies;
a transferor of an asset to a transferee in a transaction in which the transferee’s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the transferor’s hands;
a partnership that is considered as continuing under Code Sec. 708(b)(2);
the decedent in the case of an asset acquired by an estate; or
a transferor of an asset to a trust.

Depreciable interest look back rule. The final regulations do not define a "depreciable interest" because this is a facts and circumstances issue. However, a five-year look back period is provided for determining whether a taxpayer or predecessor held a depreciable interest in property.

Substantially renovated property. If a taxpayer places substantially renovated property in service and the taxpayer or a predecessor previously had a depreciable interest in the property before it was substantially renovated, the taxpayer’s or predecessor’s prior depreciable interest does not prevent the taxpayer from claiming bonus depreciation. Property is substantially renovated if the cost of the used parts is not more than 20 percent of the total cost of the substantially renovated property, whether acquired or self-constructed.

Syndication transactions. A lessor who reacquires property in a syndication transaction is not treated as having a prior depreciable interest in the property.

Partnerships
The final regulations permit a partnership to claim bonus depreciation on the portion of a Code Sec. 743(b) basis increase that is attributable to built-in gain under Code Sec. 704(c), even if the partnership is using the remedial allocation method. An exception is provided for publicly traded partnerships that need to maintain fungibility for publicly traded partnership units.

If a partnership interest is acquired and disposed of during the same tax year, the bonus deduction is not allowed for any Code Sec. 743(b) adjustment arising from the initial acquisition. However, if a partnership interest is purchased and disposed of in a "step-in-the shoes" Code Sec. 168(i)(7) transaction in the same tax year, bonus on the section 743(b) adjustment is allowed. The section 743(b) adjustment is apportioned between the purchaser/transferor and the transferee.

The final regulations also clarify the treatment of qualified property transferred in a Code Sec. 721(a) transaction to a partnership in the same tax year that the qualified property is acquired by the transferor if the partnership has another partner who previously had a depreciable interest in the qualified property. In this situation, the qualified property is deemed placed in service by the transferor during that tax year, and the bonus deduction is allocated entirely to the transferor and not to the partnership. Thus, the contributing partner has contributed property with a zero basis to the partnership, and the contributed property is Code Sec. 704(c) property in the hands of the partnership.

Film, Television, and Theatrical Productions
The final regulations clarify that a used qualified film, television, or live theatrical production does not qualify for bonus depreciation. Also, the basis of a qualified film, television, or live theatrical production is reduced by the deduction claimed under Code Sec. 181 before computing the bonus deduction.

Using ADS
Using the alternative depreciation system (ADS) to determine the adjusted basis of a taxpayer’s qualified business investment (under Code Sec. 250(b)(2)(B) or Code Sec. 951A(d)(3)) or the adjusted basis of a taxpayer’s tangible assets for allocating business interests expense between excepted and non-excepted trades or businesses (under Code Sec. 163(j)) does not cause a taxpayer’s tangible property to be ineligible for bonus depreciation.

Public Utility Property
An example is added to clarify that the 100 percent bonus rate does not apply to self-constructed property of a regulated public utility if construction begins after September 27, 2017, and the property is placed in service in a tax year beginning after 2017.

Effective Date
The final regulations apply to qualified property placed in service during or after the tax year that includes the date of publication in the Federal Register. However, a taxpayer may choose to apply the final regulations in their entirety to qualified property acquired and placed in service after September 27, 2017, provided the taxpayer consistently applies all rules in the final regulations. Additionally, a taxpayer may rely on the proposed regulations issued on August 8, 2018, to qualified property acquired and placed in service after September 27, 2017, in tax years ending before the date of publication of the final regulations.

PROPOSED REGULATIONS: Acquired and Self-Constructed Components
A taxpayer may elect to treat components of a larger self-constructed property that are acquired or self constructed after September 27, 2017, as eligible for the 100 percent bonus rate, even though manufacture, construction, or production of the larger self-constructed began before September 28, 2017. The larger property must be eligible for bonus depreciation at the 50 percent rate.

Businesses With Floor Plan Financing
Property used in a trade or business that has had floor plan financing indebtedness does not qualify for bonus depreciation if the floor plan financing interest related to the indebtedness is taken into account under Code Sec. 163(j)(1)(C) in determining the allowable business interest deduction.

The proposals provide rules for determining whether interest in floor plan financing indebtedness has been taken into account during a tax year. In general, floor plan interest is not considered taken into account for a tax year if the sum of interest business income for the tax year and 30 percent of the adjusted taxable income for the tax year equals or exceeds business interest as defined in Code Sec. 163(j)(5). The proposals clarify that the determination of whether a trade or business that has had floor plan financing indebtedness has taken floor plan financing interest into account is made annually.

Leased Property
The proposals clarify that taxpayers leasing property to a trade or business with floor plan financing indebtedness or a rate-regulated utility may claim bonus depreciation. The taxpayer, however, may not be a trade or business with floor plan financing indebtedness that prevents it from claiming bonus depreciation or a rate-regulated utility.

Used Property
Five-year lookback. A safe harbor provides that a taxpayer who disposes of property within 90 days after placing it in service did not hold a prior depreciable interest in the property. Consequently, the property is eligible for bonus depreciation if subsequently reacquired.

Partnerships. A taxpayer has a prior depreciable interest in a portion of property if the taxpayer was a partner in a partnership at any time the partnership owned the property. The amount of the prior depreciable interest is based on the partner’s total share of depreciation deductions with respect to the property.

Series of related transactions. Special rules in the original proposed regulations governing the treatment of a series of related transactions for purposes of the used property acquisition requirements are modified and expanded.

Consolidated groups. Significant clarifications to the rules governing the used property acquisition requirements for consolidated groups are also made.

Written Binding Contract Rules
Property not acquired pursuant to a contract. The acquisition date of property that is not acquired pursuant to a written binding contract is the date on which the taxpayer paid or incurred more than 10 percent of the total cost of the property. The cost of land and preliminary activities are excluded from cost for this purpose.

Purchase of entities. Binding contract rules that apply to the purchase of an entity are proposed. The current binding contract rules only deal with purchases of assets.

A contract to acquire all or substantially all of the assets of a trade or business, or to acquire an entity such as a corporation, a partnership, or a limited liability company, is binding if it is enforceable under state law against the parties to the contract. The presence of a condition outside the parties’ control (including, for example, regulatory agency approval) will not prevent the contract from being a binding contract. Further, the fact that insubstantial terms remain to be negotiated by the parties to the contract, or that customary conditions remain to be satisfied, does not prevent the contract from being a binding contract. This proposed rule also applies to a contract for the sale of the stock of a corporation that is treated as an asset sale as a result of a deemed asset acquisition election under Code Sec. 338.

Long Production Property
The proposals provide rules for determining qualifying basis attributable to the manufacture, construction, or production of long production property and certain aircraft eligible for an extended placed in service deadline.

Mid-Quarter Convention
The mid-quarter convention applies to property placed in service during the tax year if 40 percent or more of the basis of the property was placed in service in the last three months of the tax year. The proposals clarify that the basis of property is not reduced by the 100 percent bonus allowance. This rule has always applied to 50 percent bonus property.

Effective Date of Proposals
In general, the proposed regulations apply to qualified property placed in service during or after the tax year that includes the date the proposals are finalized. A taxpayer may rely on the proposals in their entirety to qualified property acquired and placed in service after September 27, 2017.

Proposed Regulations Provide Guidance on Section 382(h) Built-in Gain and Loss Computation

Proposed regulations would provide guidance on the inclusion of income and deduction items in the calculation of built-in gains and losses under Code Sec. 382(h). The proposed regulations would:

simplify the application of Code Sec. 382;
provide more certainty to taxpayers in determining built-in gains and losses for Code Sec. 382(h) purposes; and
ensure that the application of certain law changes made by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA) does not further complicate the application of Code Sec. 382(h).

Taxpayers may rely on these proposed regulations until final regulations are issued. When these proposed regulations are adopted as final regulations, it is expected that Notice 87-79, 1987-2 CB 387, Notice 90-27, 1990-1 CB 336, Notice 2003-65, 2003-2 CB 747, and Notice 2018-30, 2018-21 I.R.B. 610, will be withdrawn and declared obsolete.

Built-in Gains and Losses
Generally, Code Sec. 382 imposes a value-based limitation (section 382 limitation) on the ability of a loss corporation to offset its taxable income in periods subsequent to an ownership change with losses attributable to periods prior to that ownership change.

Code Sec. 382(h) provides rules relating to the determination of a loss corporation’s built-in gains and losses as of the date of the ownership change (change date). In general, built-in gains recognized during the five-year period beginning on the change date (recognition period) allow a loss corporation to increase its section 382 limitation. Built-in losses recognized during the recognition period are subject to the loss corporation’s section 382 limitation.

Specifically, if a loss corporation has a net unrealized built-in gain (NUBIG), the section 382 limitation for any tax year ending during the recognition period is increased by the recognized built-in gain (RBIG) for the year, with cumulative increases limited to the amount of the NUBIG. If a loss corporation has a net unrealized built-in loss (NUBIL), the use of any recognized built-in loss (RBIL) during the recognition period is subject to the section 382 limitation.

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

Notice 2003-65 provides (i) a single safe harbor for computing the NUBIG or NUBIL of a loss corporation, based on principles underlying the calculation of net recognized built-in gain under Code Sec. 1374, and (ii) two safe harbors for the computation of a loss corporation’s RBIG or RBIL: the 1374 approach and the 338 approach.

The 1374 approach identifies RBIG and RBIL at the time of the disposition of a loss corporation’s assets during the recognition period. Generally, this approach relies on accrual method of accounting principles to identify built-in income and deduction items at the time of the ownership change, with certain exceptions.

In contrast, the 338 approach identifies items of RBIG and RBIL generally by comparing the loss corporation’s actual items of income, gain, deduction, and loss recognized during the recognition period with those that would have been recognized had an election under Code Sec. 338 (section 338 election) been made with respect to a hypothetical purchase of all of the outstanding stock of the loss corporation on the change date.

Taxpayers may rely on either the 338 approach or the 1374 approach until the IRS issues temporary or final regulations under Code Sec. 382(h). Compared to the 338 approach, the accrual-based 1374 approach is simpler to apply and administer and provides greater certainty for taxpayers.

Prior to the issuance of Notice 2003-65, the IRS had issued Notice 87-79 and Notice 90-27, which provided much more limited guidance regarding the determination of built-in gains and losses. After the TCJA, the IRS issued Notice 2018-30, which makes the 338 approach unavailable when computing items arising from bonus depreciation under Code Sec. 168(k).

The law changes made by the TCJA created additional uncertainty regarding the application of Code Sec. 382 in general, and Notice 2003-65 in particular. Specifically, certain important changes under the TCJA could potentially compromise the mechanics of the 338 approach and further complicate its application.

1374 Approach
For purposes of computing NUBIG and NUBIL, the proposed regulations would adopt as mandatory the NUBIG/NUBIL safe harbor and the 1374 approach described in Notice 2003-65, with certain modifications. These modifications would include technical fixes to calculations involving cancellation of indebtedness (COD) income, deductions for contingent liabilities, and cost recovery deductions. Additionally, the proposed regulations would clarify that carryovers of Code Sec. 163(j) disallowed business interest are counted only once for purposes of Code Sec. 382.

The modifications to the existing NUBIG/NUBIL safe harbor and the 1374 approach would ensure greater consistency between:

amounts that are included in the NUBIG/NUBIL computation; and
items that could become RBIG or RBIL during the recognition period.

Comment
According to the IRS, the proposed regulations would modestly restrict net operating loss usage by reducing the amount that would qualify as RBIG, reducing the incentive to engage in inefficient, tax-motivated mergers and acquisitions.

NUBIG or NUBIL Computation
The proposed rules for the computation of NUBIG/NUBIL would capture a range of items that closely tracks the NUBIG/NUBIL safe harbor computation in Notice 2003-65. However, the component steps of the proposed NUBIG/NUBIL computation would be more explicit, as follows:

The proposed NUBIG/NUBIL computation would first take into account the aggregate amount that would be realized in a hypothetical disposition of all of the loss corporation’s assets in two steps treated as taking place immediately before the ownership change:
- —Step 1: the loss corporation would be treated as satisfying any inadequately secured nonrecourse liability by surrendering to each creditor the assets securing such debt.
- —Step 2 : the loss corporation would be treated as selling all remaining assets pertinent to the NUBIG/NUBIL computation in a sale to an unrelated third party, with the hypothetical buyer assuming no amount of the seller’s liabilities.
- That total hypothetical amount realized by the loss corporation pursuant to Steps 1 and 2, above, would be then decreased by (i) the sum of the loss corporation’s deductible liabilities (both fixed and contingent), and (ii) the loss corporation’s basis in its assets.
- Finally, the decreased hypothetical total would be then increased or decreased, as applicable, by the following:
- —(i) the net amount of the total RBIG and RBIL income and deduction items that could be recognized during the recognition period (excluding COD income); and
- —(ii) the net amount of positive and negative section 481 adjustments that would be required to be included on the previously-described hypothetical disposal of all of the loss corporation’s assets.

The proposed regulations generally would not allow COD income to be included in the calculation of NUBIG/NUBIL, but would provide certain exceptions.

RBIG and RBIL Items
As mentioned above, the proposed regulations would apply a methodology for identifying RBIG or RBIL that closely tracks the accrual based 1374 approach described in Notice 2003-65. However, the proposed regulations would significantly modify the 1374 approach to include as RBIL the amount of any deductible contingent liabilities paid or accrued during the recognition period, to the extent of the estimated value of those liabilities on the change date.

The proposed regulations also would add a rule clarifying that certain items do not constitute RBIG (such as dividends paid during the recognition period). In addition, limitations would be provided on the extent to which excluded COD income is treated as RBIG. Further, the proposed regulations would provide two different RBIG ceilings with regard to COD on recourse debt, and would provide special rules for COD income on nonrecourse debt.

Finally, rules would be provided for the interaction between Code Sec. 163(j) and Code Sec. 382. To eliminate the possibility of duplication of RBIL items, the proposed regulations would provide that Code Sec. 382 disallowed business interest carryforwards would not be treated as RBIL if such amounts were allowable as a deduction during the recognition period. The proposed regulations also would clarify the treatment of certain items allocated from a partnership.

Applicability Date
The regulations are proposed to be effective for ownership changes occurring after the date the proposed regulations are published as final regulations in the Federal Register. However, taxpayers and their related parties may apply these proposed regulations to any ownership change occurring during a tax year with respect to which the period described in Code Sec. 6511(a) has not expired, so long as the taxpayers and all of their related parties consistently apply the rules of these proposed regulations to such ownership change and all subsequent ownership changes that occur before the applicability date of the final regulations.

Comments and Requests for Hearing
Written or electronic comments must be received by November 9, 2019. Written or electronic requests for a public hearing and outlines of topics to be discussed at the public hearing must be received by November 9, 2019. Electronic submissions must be sent via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-125710-18) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Treasury and the IRS will publish for public availability any comment received to its public docket, whether submitted electronically or in hard copy.

Hard copy submissions must be sent to: Internal Revenue Service, CC:PA:LPD:PR (REG-125710-18), Room 5203, Post Office Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (indicate REG-125710-18), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224.

Final Regulations Amend Hardship Distribution Rules from Section 401(k) Plans

The IRS has issued final regulations that amend the rules relating to hardship distributions from Code Sec. 401(k) plans. The final regulations are substantially similar to the proposed regulations. Further, plans that complied with the proposed regulations satisfy the final regulations as well. The regulations are effective on September 23, 2019.

The final regulations:

reflect statutory changes affecting Code Sec. 401(k) plans, including changes made by the Bipartisan Budget Act of 2018 ( P.L. 115-123); and
affect participants in, beneficiaries of, employers maintaining, and administrators of plans that include cash or deferred arrangements or provide for employee or matching contributions.

Deemed Immediate and Heavy Financial Need
The final regulations modify the safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need. The final regulations:

add "primary beneficiary under the plan" as an individual for whom qualifying medical, educational, and funeral expenses may be incurred;
modify the expense listed in existing Reg. §1.401(k)-1(d)(3)(iii)(B)(6) to provide that the limitations in Code Sec. 165(h)(5) do not apply for this purpose; and
add to the list a new type of expense, relating to expenses incurred as a result of certain disasters.

Distribution Necessary to Satisfy Financial Need
The final regulations modify the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need, by:

eliminating any requirement that an employee be prohibited from making elective contributions and employee contributions after receipt of a hardship distribution; and
eliminating any requirement to take plan loans prior to obtaining a hardship distribution.

In particular, the final regulations, like the proposed regulations, eliminate the safe harbor in existing Reg. §1.401(k)-1(d)(3)(iv)(E), under which a distribution is deemed necessary to satisfy the financial need only if elective contributions and employee contributions are suspended for at least six months after a hardship distribution is made and, if available, nontaxable plan loans are taken before the hardship distribution is made.

Expanded Sources for Hardship Distributions
The final regulations modify existing Reg. §1.401(k)-1(d)(3) to permit hardship distributions from Code Sec. 401(k) plans of elective contributions, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on these amounts, regardless of when contributed or earned.

Section 403(b) Plans
A hardship distribution of Code Sec. 403(b) elective deferrals is subject to the rules and restrictions set forth in Reg. §1.401(k)-1(d)(3). Accordingly, the preamble to the proposed regulations had stated that the new rules relating to a hardship distribution of elective contributions from a Code Sec. 401(k) plan generally apply to Code Sec. 403(b) plans. Because this requirement is retained in the final regulations, at Reg. §1.401(k)-1(d)(3)(iii)(B), it applies to Code Sec. 403(b) plans.

Applicability Dates
The changes to the hardship distribution rules made by the Bipartisan Budget Act of 2018 are effective for plan years beginning after December 31, 2018.

Plan Amendments
The Treasury Department and IRS expect that plan sponsors will need to amend their plans’ hardship distribution provisions to reflect the final regulations, and any such amendment must be effective for distributions beginning no later than January 1, 2020. The deadline for amending a disqualifying provision is set forth in Rev. Proc. 2016-37, I.R.B. 2016-29,136.

Proposed Regulations Released on Applicable Financial Statement for All-Events Test

For a taxpayer using an accrual method of accounting, the all events test is not met for item of gross income any later than when is included in revenue on an applicable financial statement (AFS) or other financial statement specified by the Treasury Secretary. How the AFS income inclusion rule applies to accrual method taxpayers with an AFS is described and clarified by Proposed Reg. §1.451-3.

Year-by-Year Application
The proposed regulations provide that the AFS income inclusion rule generally applies to accrual method taxpayers with an AFS when the timing of income inclusion for one or more items of income is determined using the all events test. They further clarify that the AFS income inclusion rule applies only to taxpayers that have one or more AFS covering the entire tax year.

The AFS income inclusion rule applies on a year-by-year basis and, therefore, an accrual taxpayer with an AFS in one tax year that does not have an AFS in another tax year must apply the AFS income inclusion rule in the tax year that it has an AFS, and does not apply the rule in the tax year in which it does not have an AFS.

No Change to Income Tax Treatment
The proposed regulations also clarify that AFS income inclusion rule does not change the treatment of a transaction for federal income tax purposes:

The treatment of a transaction or event in a tax year may be different for federal income tax and AFS purposes.
The applicability of any exclusion provision, or the treatment of nonrecognition transactions, in the Code, the Income Tax Regulations, or other guidance does not change.

Partial Payment
The proposed regulations provide that an amount included in the transaction price for AFS purposes may not be treated as contingent on the occurrence or nonoccurrence of a future event if the taxpayer has been paid or has an equitable, contractual, or other right to partial payment for performance completed to date. Additionally, that transaction price may not be reduced for amounts subject to Code Sec. 461, including reward amounts in credit card transactions.

Special Methods and Multi-Year Contracts
The proposed regulations clarify that when a taxpayer uses a special method of accounting, the special method of accounting determines the timing of the income inclusion.

Proposed regulations also provide guidance for taxpayers with a financial reporting period that is different than the taxpayer’s tax year. The taxpayer must use one of three permissible methods in order to determine whether an item of income has been included in revenue on an AFS.

For a contract with multiple performance obligations, the allocation of the transaction price to each performance obligation equals the amount allocated to each performance obligation for purposes of including the item in revenue in the taxpayer's AFS. The proposed regulations clarify that a transaction price does not include amounts collected on behalf of third parties, or amounts that are contingent on the occurrence or nonoccurrence of a future event.

A taxpayer with a multi-year contract applies the all events test by applying a cumulative approach reflecting amounts previously included under Code Sec. 451 rather than an annualized approach.

Fees
Under the proposed regulations if the taxpayer does not treat a fee as discount or as an adjustment to the yield of a debt instrument over the life of the instrument (such as points) in its AFS, and the fee otherwise would be treated as creating or increasing original issue discount (OID) for federal income tax purposes (specified fee), then the rules in the proposed regulations under Code Sec. 451(b) apply before the rules in Code Secs. 1271 through Code Sec. 1275. Removing specified fees and specified credit card fees from the calculation of OID will permit taxpayers to apply only the rules of Code Sec. 451(b) to these fees, without also having to apply the rules relevant to OID.

The proposed section regulations would not apply to determine the time at which OID generally is includible in income.

Effective Date
The regulations are proposed generally to apply to tax years beginning on or after the date the final regulations are published in the Federal Register. However, in the case of a specified fee, Proposed Reg. §1.451-3(i)(2) is proposed to apply for a taxpayer’s first tax year beginning one year after the date the Treasury Decision adopting these regulations as final is published in the Federal Register.

A taxpayer may rely on the proposed regulations (other than the proposed regulations relating to specified fees) for tax years beginning after December 31, 2017 (after December 31, 2018, for specified credit card fees), as long as the taxpayer: (1) applies all the applicable rules contained in the proposed regulations for specified credit card fees; and (2) consistently applies the proposed regulations to all items of income during the tax year (other than specified fees).

Advance Payment Proposed Regulations Released

Automatic Accounting Change Procedures for All Events Test and Advance Payment Deferral

Taxpayers may use the automatic consent procedures to change accounting methods to comply with the recent proposed regulations described above. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

The proposed regulations provide rules for:

inclusion in gross income under the all events test for taxpayers with an applicable financial statement (AFS) ( NPRM REG-104870-18); and
use of the deferral method for advance payments for taxpayers with or without an AFS ( NPRM REG-104554-18).

Certain qualifying taxpayers may apply for a change to comply with the proposed regulations without filing a Form 3115, Application for Change in Accounting Method.

Taxpayers Affected
The accounting change procedures for inclusion in gross income for taxpayers with an AFS generally apply to taxpayers with an AFS that want to:

change to a method of accounting that treats an item of gross income as meeting the all events test no later than when the item is taken into account as revenue in its AFS under Code Sec. 451(b)(1)(A);
in certain cases, allocate the transaction price to performance obligations under Code Sec. 451(b)(4);
change to a method of accounting that complies with Proposed Reg. §1.451-3; or
change to a method of accounting that complies with Proposed Reg. §1.451-8(c).

The procedures also apply to taxpayers that do not have an AFS and that want to change to a method of accounting that complies with Proposed Reg. §1.451-8(d).

In addition, the procedures apply to a change in AFS in order to apply certain revenue recognition methods of accounting.

Pending Nonautomatic Applications
The IRS will return any Form 3115 requesting a change in method of accounting available under this revenue procedure that:

was filed on or before September 9, 2019, under the non-automatic procedures for a tax year beginning after December 31, 2017; and
is pending with the National Office on September 9, 2019.

The National Office will send a letter to the taxpayer acknowledging the return of the Form 3115, and will return the user fee submitted with the form. A timely resubmitted Form 3115 will be considered filed as of the date the taxpayer originally filed the Form 3115 under the nonautomatic change procedures.

Effective Date
This revenue procedure is generally effective for tax years beginning after December 31, 2017. For specified credit card fees, it is effective for tax years beginning after December 31, 2018.

Proposed Regulations Update Exempt Organization Reporting Requirements; Penalty Relief Provided

Amendments to have been proposed to update the information reporting regulations under Code Sec. 6033, which generally apply to organizations exempt from tax under Code Sec. 501(a). The proposed regulations reflect statutory amendments and certain grants of reporting relief announced through guidance that has been made since the current regulations were adopted. The amendments and grants of relief apply particularly with respect to tax-exempt organizations required to file an annual Form 990, Return of Organization Exempt from Income Tax, or a Form 990-EZ information return.

Annual Return and Reporting Requirements
Code Sec. 6033 outlines various requirements for an annual information return to be filed by organizations that are exempt from tax under Code Sec. 501(a) or are described in Code Sec. 527, including exceptions to the filing requirement. The reporting requirements under Code Sec. 6033(h) mandate controlling organizations to include on their returns:

interest, annuities, royalties, or rents received from each controlled entity under Code Sec. 512(b)(13);
any loans made to each such controlled entity; and
any transfers of funds between such controlling organization and each such controlled entity.

Penalty Relief
Under Code Sec. 6104(b), the IRS must make the filed annual returns available to the public. Under Rev. Proc. 2018-38, I.R.B. 2018-31, 280, tax-exempt organizations (other than charities exempt under Code Sec. 501(c)(3) and Code Sec. 527 political organizations) were no longer required to report the names and addresses of contributors on Schedule B when filing their information returns. This change applied to information reporting for tax years ending on or after December 31, 2018, for donations above certain applicable thresholds.

However, Rev. Proc. 2018-38 has been overturned by a federal district court ( S.C. Bullock, DC Mont., 2019-2 ustc ¶50,245), which held that the IRS failed to follow the notice and comment procedures required by the Administrative Procedure Act (APA).

Code Sec. 6652(c)(1)(A) imposes penalties for a failure to file a return required under Code Sec. 6033, failure to include any required information, or failure to provide correct information. Under Code Sec. 6652(c)(5), the penalty is not imposed if it is shown that the failure was due to reasonable cause. Notice 2019-47 provides that the IRS will consider there to be a reasonable cause based on reliance on Rev. Proc. 2018-38 for any organizations that file Form 990 or 990-EZ and did not include on their 2018 information return such donor information as Rev. Proc. 2018-38 indicated was not required.

Proposed Amendments
The proposed amendments to the regulations would restore relief from the requirement to report contributor names and addresses on the annual returns filed by certain tax-exempt organizations that was previously provided in Rev. Proc. 2018-38 before the federal district court overturned that rule. Therefore, only organizations exempt under Code Secs. 501(c)(3) and 527 would need to continue reporting their donor information on their Forms 990, 990-EZ, or 990-PF.

In addition, the proposed amendments would incorporate into the regulations the existing exception from having to file an annual return for certain organizations that normally have gross receipts of $50,000 or less, found in Rev. Proc. 2011-15, I.R.B. 2011-3, 322.

Donation of Appreciated Securites and Donor-Advised Funds

On December 22, the President signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). Personal Exemptions have been eliminated and replaced with higher standard deductions for individuals and married couples. State and Local Taxes (SALT) for state income tax, property taxes have been limited to $10,000 for 2018. The Standard Deduction will increase from $6,350 per person in 2017 to $12,000 per person in 2018. All persons over age 65 will also be permitted an additional $1,300 increase in their Standard Deduction.

In 2018, married couple without a mortgage and regular medical expenses, that makes less than $14,000 in charitable contributions will not get any tax benefit for their donations, ($24,000 standard deduction, less $10,000 for state and local income taxes equal $14,000 maximum charitable contributions without tax benefit).

One planning thought if your do not get the full impact of your Charitable donations is to setup a Donor-Advised Fund. A donor-advised fund is like a charitable investment account, for the sole purpose of supporting charitable organizations you care about. When you contribute cash, securities or other assets to a donor-advised fund, you are generally eligible to take an immediate tax deduction. Then those funds can be invested for tax-free growth and you can recommend grants to virtually any IRS-qualified public charity.

Various brokerage firms sponsor donor-advised funds, such as Fidelity Investments, Charles Schwab and Merrill Lynch. Each firm have different requirements for minimum contributions, fees and minimum grants amounts to charities.

Let’s say you typically donate $5,000 per year. You could fund the next four years by donating $20,000 of appreciated stock to the fund. You are best to donate the stock with the largest gain. You pay no tax on the gain but get full deduction of the $20,000 fair market value in the year of donation. The fund will sell your stock but provide you an opportunity to invest that amount within the fund to grow tax deferred. You can than direct the fund to send money to charities of your choice with no minimum grant requirement. You can designate an heir to continue to send donations from your fund should you not complete all your donations. Once contributed to the fund, you can never get the funds returned.

Donation of appreciated securities usually makes the most sense. Let’s say you donate $20,000 stock with a cost of $10,000. If you sold those stock to make the donation you could owe $3,380 (Federal Capital Gain rate of 23.8% and California of 10%) in taxes leaving a net of $16,620 to charities. If you donated appreciated securities, you could grant the full $20,000 to charities. Keep in mind that in both cases, you would get a tax deduction up to 47% of the donation, (Federal maximum tax rate of 37% and California of 10%).

One further advantage of a donor-advised fund is that the record keeping requirement for individual donations is eliminated, since the fund will keep track of the donations.

If this is too complicated, many charities will also accept the direct donation of securities providing the same tax benefits.

QBI – Qualified Business Income

Congress passed the most significant tax reform bill in thirty years, “The Tax Cuts and Jobs Act”. One of the more complex areas is the new deduction for “qualified business income” – often referred to as QBI. You may hear this talked about as the “New 20% Pass-Through Tax Deduction” or the “Section 199A Deduction”.

In December 2017, Congress passed the most significant tax reform bill in thirty years, “The Tax Cuts and Jobs Act”. One of the more complex areas is the new deduction for “qualified business income” – often referred to as QBI. You may hear this talked about as the “New 20% Pass-Through Tax Deduction” or the “Section 199A Deduction”. Regular “C” corporations do not qualify for this deduction; however, starting in 2018 they do qualify for a low 21% corporate tax rate.

The pass-through deduction is a deduction you may take on your Form 1040 even if you do not itemize. There will be a line to list it on the second page of our Form 1040. It is not an “above the line” deduction on the first page of Form 1040 that reduces your adjusted gross income (AGI). Moreover, the deduction only reduces income taxes, not Social Security or Medicare taxes

This new provision should provide a substantial tax benefit to individuals with qualified business income from a partnership, S corporation, LLC, or sole proprietorship. For tax purposes, what distinguishes these types of businesses is that the business pays no income taxes themselves. Instead, the profits (or losses) from such businesses are passed through the business to the owners whom pay tax on the money on their individual tax returns at their individual tax rates.

QBI is the net income (profit) your pass-through business earns during the year. You determine this by subtracting all your regular business deductions from your total business income. QBI includes rental income so long as your rental activity qualifies as a business. It also includes income from publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives. QBI does not include:

short-term or long-term capital gain or loss—for example, a landlord would not include capital gain earned from selling a rental property
dividend income
interest income
wages paid to S corporation shareholders
guaranteed payments to partners in partnerships or LLC members, or
business income earned outside the United States.

QBI is determined separately for each separate business you own. If one or more of your businesses lose money, you deduct (net) the loss from the QBI from your profitable businesses. If you have a qualified business loss—that is, your net QBI is zero or less--you get no pass-through deduction for the year. Any loss is carried forward to the next year and is deducted against your QBI for that year. This serves as a penalty for having a money-losing business.

To determine your pass-through deduction, you must first figure your total taxable income for the year (not counting the pass-through deduction). This is your total taxable income from all sources (business, investment, and job income) minus deductions, including the standard deduction ($12,000 for singles and $24,000 for marrieds filing jointly in 2018). You must have positive taxable income to take the pass-through deduction.

Moreover, the deduction can never exceed 20% of your taxable income.

Rules are in place to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction. These rules involve “thresholds.” This means that you might be ineligible for the deduction if you have a business that is classified as a specified service trade or business, SSTB. What is a specified service trade or business? These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services. There is a final catchall category that includes any business where the principal asset is the reputation or skill of one or more of its owners or employees. This likely includes many individuals who provide services not listed above. However, all the details have yet to be worked out by the IRS. Architecture and engineering services are expressly not included in the list of personal services. So, spas and health clubs are in, medical services provided by high income physicians, nurses, dentists etc. are out. High income attorneys, accountants, actuaries, financial advisors, mortgage brokers, realtors, actors, musicians etc. are out, but promoters, broadcasters, engineers and architects are in.

Starting in 2018, taxpayers with qualified business income (including rental income), may be eligible to take a tax deduction up to 20% of their QBI. Determining whether you will be eligible to capture the full 20% deduction will be based on your total taxable income for year. The taxable income thresholds are as follows:

Single filers: $157,500 (SSBT with phase-outs at $207,500)

Married filing joint: $315,000 (SSBT with phase-outs at $415,000)

If your business is one of the Specified Service Trade or Services above these thresholds, you may not qualify for the deduction. The SSBT phased-out is 2% for every $1,000 your income exceeds the $157,500, or 1% for every $1,000 your income exceeds the $315,000 threshold.

If you exceed the income thresholds, your deduction is the lesser of:

20% of QBI
The greater of:

50% of W-2 wages paid to employees

25% of W-2 wages paid to employees PLUS 2.5% of the unadjusted asset basis

The business property must be depreciable long-term property used in the production of income—for example, the real property or equipment used in the business (not inventory). The cost is its unadjusted basis—the original acquisition cost, minus cost of land, if any. The 2.5% deduction can be taken during the entire deprecation period for the property. For use in this property calculation, the period of use starts on the date the property is places in service and ends on the LATER 10 years or the last day of the asset regular depreciation period.

If you have neither employees nor depreciable property, you get no deduction if your income is over the thresholds. This is intended to encourage pass-through owners to hire employees and/or buy property for their business.

Fancy footwork may seem the way to go when dealing with the new tax rules, but the old reliable methods of reducing income have a better chance having stood the test of time. Lowering your income if you are already below the phaseout has less benefit than in the past as business deductions are technically only worth 80 cents on the dollar. (You get a 20% deduction anyway if you don’t invest in the expense.) The phase out is where things really get interesting. If you’re reasonably close to the phase out threshold, a modest amount of planning could make the difference between the full QBI deduction and no deduction at all.

Some Simple Examples:

Mark is married and files jointly. He earned $345,000 in taxable income this year. His sole proprietorship consulting business earned $345,000 and paid $100,000 to employees. Consulting is one of service provider categories SSTB, so his pass-through deduction is subject to the phase-out. His $345,000 taxable income is $30,000, or 30% ($30,000/$1,000,000), over the $315,000 threshold. Before the phase-out, his deduction is limited to 50% of the W2 wages he paid, which was $50,000 (50% x $100,000 W2 wages = $50,000). Since, his phase-out percentage is 30%, he gets 70% of the full deduction, or $35,000 (70% x $50,000 = $35,000). If his taxable income was over $415,000, there would be no QBI deduction.

Jim and Sue are married and file jointly. Their taxable income this year is $500,000, including $400,000 in QBI they earned from their bar business they own through an LLC. They employed four bartenders during the year to whom they paid $150,000 in W2 wages. They own their bar building. They bought it four years ago for $600,000 and the land is worth $100,000, so its unadjusted acquisition basis is $500,000. Their maximum possible pass-through deduction is 20% of their $400,000 QBI, which equals $80,000. However, since their taxable income was over $415,000, their pass-through deduction is limited to the greater of (1) 50% of the W2 wages they paid their employees, or (2) 25% of W2 wages plus 2.5% of their bar building’s $500,000 basis. (1) is $75,000 (50% x $150,000 = $75,000; (2) is $50,000 (2.5% x $500,000) + (25% x $150,000) = $50,000. (1) is greater so their pass-through deduction is $75,000.

Alice, a single taxpayer, owns a 5-unit apartment building. She earned $250,000 in QBI income and total taxable income during 2018, well over the $207,500 threshold for singles. She has no employees in her rental business. Thus, her pass-through deduction is limited to 2.5% of the unadjusted basis of the long-term property she uses in her rental business. This consists of her building, which she purchased five years ago. Her unadjusted basis in the building (purchase price minus value of the land) is $500,000. Her pass-through deduction is 2.5% x $500,000 = $12,500.

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