Implementation of Financial Accounting Standards Board Accounting Standards Update No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”) is required for fiscal years beginning after December 15, 2019

Client letter FASB ASU 2016-2

FASB lease template

Implementation of Governmental Accounting Standards Board Statement No. 87, “Leases” (“GASB 87") is required for fiscal years beginning after December 15, 2019.

Client letter GASB 87

GASB lease template

Financial Reporting for Pension Plans - an amendment of GASB 25 

Click here for GASB 67

Accounting and Financial Reporting for Pensions - an amendment of GASB 27

Click here for GASB 68

The Regional CPA Firm: Your Trusted Business Adviser

Regional CPA firms are great business advisers to the companies in their communities.  CPAs have long been the trusted business advisers for their clients, providing services to meet a wide range of business needs. Their services might include not only audit, accounting and tax, but also information technology, strategic planning and business valuation, as well as personal financial planning, estate planning and general business consulting. For those reasons, companies have long turned to CPA firms to help them understand and address their most pressing business questions.  And regional CPA firms don't simply deliver services, they provide the kinds of customized, hands-on advice and insights that their clients need to achieve their business goals.

Would you would like to learn more about all a regional CPA firm has to offer?  If so, please contact:

McMahan and Associates, LLC

Committed A committed component of fund balance would have most likely been previously reported within unreserved, designated fund balance. They are resources whose use is constrained by a limitation that a government imposes upon itself at its highest decision making level (i.e., council/commissioners) and remains binding unless the constraint is removed in the same manner in which it was placed.  For these items, please have the ordinance/ resolution/ approval available during fieldwork to determine the proper amount.   As an example, previous unreserved designated fund balances that we feel would meet this category are “designated for housing loan programs”, “designated for encumbrances” (if governing approval required).

Assigned An assigned component of fund balance would have most likely been previously reported within unreserved, undesignated fund balance.  This amount would reflect a government’s “intended use of the resource”.  Therefore, remaining fund balances for capital projects and special revenue funds not constrained by the previous fund balance components would be reported here.

Unassigned If an amount does not fit any other component listed above, these amounts would be reported within this category but, usually only for the General Fund. This component may be reported in another governmental fund only if the fund is in a deficit situation.

We are asking each of our clients to review their current chart of accounts in order to update accounts used to currently track this information. Certain accounts may not be currently maintained within the chart of accounts (non-spendable); if this is the case, this data may only be captured within the drafted financial statements. For those instances, we will discuss during fieldwork whether it is necessary to add to the current chart of accounts or not.

As information, if any, arises that affects implementation, we will notify you as soon as possible.  Please feel free to contact us with any questions or concerns. During fieldwork, we will be spending some time to go over the specific needs of each of our clients.

Condominium associations, which may include property owner associations, and time-share or interval ownership associations, are responsible for maintaining and preserving the association’s common property.

Condominium associations, which may include property owner associations, and time-share or interval ownership associations, are responsible for maintaining and preserving the association’s common property.

Typically, associations are incorporated under state non-profit statutes, since these entities do not issue capital stock or have shareholders.  That is, the net income or losses of the association do not flow to the owner/members.  However, incorporation as a non-profit does not equate to exemption from income taxes, and all associations must file annual tax returns.  Most associations will be required to file either Form 1120 (U.S. Corporation Income Tax Return) or Form 1120-H (U.S. Income Tax Return for Homeowner Associations).

An association filing Form 1120 would be subject to regular graduated corporate tax rates (beginning at 15% of the first $50,000 of taxable income) on its net taxable income.  Taxable income is comprised of revenues earned from sources other than common assessments or from the provision of services for members/owners of the association (e.g., investment income, rentals, vending, or fees earned from parties other than the owner/members) reduced by expenses incurred in generating these revenues (e.g., investment account fees, management fees, professional fees, rental expenses, vending supplies, etc.).

Generally, time-share associations and associations which are considered “substantially residential” (based on IRS criteria) would file Form 1120-H.  Note that the IRS’ definition of “substantially residential” incorporates an evaluation of the percentage of units participating in short-term rentals.  Form 1120-H imposes a flat tax rate of 30% (32% for time-shares) on the association’s net taxable income, which is largely similar to the concept of taxable income discussed above.

Common misconceptions frequently encountered when discussing association income taxes include the following:

• “Our association reported a net income (loss) on our financial statements; therefore we will report the same amount as taxable income (loss) for the year.”  Taxable income for an association is calculated differently than net income for financial statement purposes.
• “Income earned from investments held in the Replacement Fund isn’t taxable”.  All interest income is considered taxable regardless of the fund in which it is reported.
• “Transferring Operating Fund net income to the Replacement Fund will minimize our association’s taxable liability.”  Transfers between funds do not have a direct impact on the amount of income taxes paid by the association.

Recent IRS scrutiny of association income tax returns has resulted in numerous court rulings, revenue procedures, and amendments to the Internal Revenue Code.  The tax professionals at McMahan and Associates work to ensure that your association’s tax return complies with applicable tax guidance, while minimizing your tax liability.  If you have questions regarding your association’s specific tax situation, please don’t hesitate to contact us.

The IRS has released new proposed rules related to charitable contributions made to get around the $10,000/$5,000 cap on state and local tax (SALT) deductions. The proposed regulations:

The IRS has released new proposed rules related to charitable contributions made to get around the $10,000/$5,000 cap on state and local tax (SALT) deductions. The proposed regulations:

• incorporate the safe harbor in Notice 2019-12 for individuals who have any portion of a charitable deduction disallowed to the receipt of SALT benefits;
• incorporate the safe harbor in Rev. Proc. 2019-12 for business entities to deduct certain payments made to a charitable organization in exchange for SALT benefits; and
• clarify the application of the quid pro quo principle under Code Sec. 170 to benefits received or expected to be received by the donor from a third party.

SALT Limit

An individual’s itemized deduction of SALT taxes is limited to $10,000 ($5,000 if married filing separately) for tax years beginning after 2017. Some states and local governments have adopted laws that allowed individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes.

The IRS issued final regulations in June 2019 that provide that the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). Thus, the taxpayer must reduce any contribution deduction by the amount of any SALT credit received or expected to receive in return. The regulations contain a de minimis exception if the SALT credit does not exceed 15 percent of the taxpayer’s charitable payment.

A taxpayer is not required to reduce the charitable contribution deduction because of the receipt of SALT deductions. However, the taxpayer must reduce the charitable deduction if it receives or expects to receive SALT deductions in excess of the taxpayer’s payment or the fair market value of property transferred.

Payments by Individuals

A safe harbor was provided in Notice 2019-12 for individuals who have a portion of a charitable deduction disallowed due to the receipt of a SALT credit. Under the safe harbor, any disallowed portion of the charitable contribution deduction may be treated as the payment of SALT taxes for the purposes of deducting taxes under Code Sec. 164.

The new proposed regulations incorporate the safe harbor in Notice 2019-12. The safe harbor is allowed in the tax year the charitable payment is made, but only to the extent that the SALT credit is applied as provided under state or local law to offset the individual’s SALT liability for the current or preceding tax year. Any unused credit may be carried forward as provided under state and local law.

Payments by Business Entities

The IRS also provided a safe harbor in Rev. Proc. 2019-12 that business entities may continue to deduct charitable contributions in exchange a SALT credit. A business entity may deduct the payments as ordinary and necessary business expenses under Code Sec. 162 if made for a business purpose.

The new proposed regulations incorporate the safe harbor in Rev. Proc. 2019-12. If a C corporation or specified pass-through entity makes the charitable payment in exchange for a SALT credit, it may deduct the payment as a business expense to the extent of any SALT credit received or expected to be received. In addition, the new proposal provides that if the charitable payment bears a direct relationship to the taxpayer’s business then it may be deducted as a business expense rather than a charitable contribution regardless of whether the taxpayer receives or expects to receive a SALT credit.

Benefits Received from Third Party

If a taxpayer receives any goods, services, or other benefits from a charitable organization in consideration for a contribution, then the charitable deduction must be reduced by the value of those benefits. If the contribution exceeds the fair market value of the benefits received, then only the excess is a deductible as a charitable contribution.

The new proposed regulations clarify that this quid pro quo principal applies regardless of whether the party providing the goods, services, or other benefits is the charitable organization or not. A taxpayer will be treated under the proposal as receiving goods and services in consideration for the taxpayer’s charitable contribution if, at the time the taxpayer makes the payment or transfer, the taxpayer receives or expects to receive goods or services in return.

Final regulations provide rules on the attribution of ownership of stock or other interests, for determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under the foreign base company sales income rules. The regulations also provide rules to determine whether a CFC receives rents in the active conduct of a trade or business, for determining the exception from foreign personal holding company income.

Final regulations provide rules on the attribution of ownership of stock or other interests, for determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under the foreign base company sales income rules. The regulations also provide rules to determine whether a CFC receives rents in the active conduct of a trade or business, for determining the exception from foreign personal holding company income.

The regulations adopt without change, proposed regulations published on May 20, 2019 ( NPRM REG-125135-15).

Attribution of Ownership

The regulations provide specific rules for applying principles similar to those in the Code Sec. 958(b) constructive ownership rules when determining related person status under the foreign base company sales income rules. The determination of related person status is relevant for many purposes, including whether certain types of income can be characterized as subpart F foreign base company sales or service income.

A person is a related person with respect to a CFC if the person is:

• an individual who controls the CFC,
• an entity that controls or is controlled by the CFC, or
• an entity that is controlled by the same person that controls the CFC.

Rules similar to those for determining stock ownership in Code Sec. 958 apply for purposes of determining whether a person is a related person. The regulations limit the application of the downward attribution rules in Code Sec. 318(a)(3), which apply by reference to the Code Sec. 958 stock ownership rules, and which attribute ownership downward from the owner of an entity to an entity. The downward attribution rules are applied regardless of the size of the ownership interest in a partnership, estate, or trust, but are applied to corporations based on a 50-percent or more ownership interest.

The regulations address concern that application of the downward attribution rules could inappropriately treat entities (including CFCs) that do not have significant relationships with each other as related persons. Accordingly, the regulations provide that the downward attribution rules of Code Sec. 318(a)(3) and Reg. §1.958-2(d) will not apply for purposes of determining related person status under the foreign base company sales income rules.

The change does not preclude a corporation, partnership, trust, or estate from being treated as controlled by the same person or persons that control the CFC under other rules that remain applicable for the related person rules.

Additionally, an anti-abuse rule is provided with respect to the option attribution rule in Code Sec. 318(a)(4). The option attribution rule in Code Sec. 318(a)(4) and Reg. §1.958-2(e) will not be applied to treat a person with an option as owning the stock or an equity interest for purposes of the related person rule if the principal purpose of using the option was to cause a person to be treated as a related person.

The regulations also incorporate a similar rule issued in section 7(d) of Notice 2007-9, 2007-1 CB 401. The rule applies if the principal purpose for the use of an option is to qualify dividends, interest, rents or royalties paid by a foreign corporation for the Code Sec. 954(c)(6) CFC look-through exception from foreign personal holding company income. The rule applies to tax years of CFCs beginning after December 31, 2006, and ending before November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end.

Personal Holding Company Income

The regulations modify the foreign personal holding company rules for amounts paid or incurred by a CFC in connection with the CFC’s rental income and the active rents exception. Rents are excluded from foreign personal holding company income if the rents are:

• received from a person other than a related person, and
• from the active conduct of a trade or business.

If rents are from leasing property as a result of marketing activities, there must be a substantial marketing organization in order to meet the active trade or business test. Under a safe harbor, an organization is substantial if active leasing expenses equal or exceed 25 percent of adjusted leasing profit. If the CFC receives rents from property it does not own, the substantiality of the organization is determined net of those rent payments.

The regulations extend the rule to apply to royalties in addition to rents. As a result, the substantiality of the organization is determined under the safe harbor net of the rents or royalties paid or incurred by the lessor CFC, for the right to use the property (or a component part of the property) that generated the rental income.

Applicability Date

The regulations generally apply to tax years of CFCs ending on or after November 19, 2019, and to tax years of U.S. shareholders in which or with which such tax years end. The regulations on the downward attribution rule, and the option anti-abuse rule for use of the option to treat a person as a related person with respect to a CFC, apply to tax years of CFCs ending on or after May 17, 2019, and to tax years of U.S. shareholders in which or with which such tax years end, with respect to amounts received or accrued by a CFC on or after May 17, 2019, to the extent the amounts are received or accrued in advance of the period to which such amounts are attributable with a principal purpose of avoiding application of the rules.

The IRS has issued final and proposed regulations implementing the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A. The BEAT is a minimum tax that certain large corporations must pay on certain payments made to foreign related parties, and was added by the Tax Cuts and Jobs Act ( P.L. 115-97).

The IRS has issued final and proposed regulations implementing the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A. The BEAT is a minimum tax that certain large corporations must pay on certain payments made to foreign related parties, and was added by the Tax Cuts and Jobs Act ( P.L. 115-97).

The final regulations adopt proposed rules ( REG-104259-18) published on December 21, 2018 (2018 proposed regulations), with certain modifications. The proposed regulations ( REG-112607-19) (2019 proposed regulations) provide rules under Code Secs. 59A and 6031 regarding certain aspects of the BEAT.

Final Regulations

The 2018 proposed regulations provided guidance related to the mechanics of determining a taxpayer’s BEAT liability, and addressed application of the BEAT to partnerships, banks, registered security dealers, and consolidated groups. The final BEAT regulations retain the basic approach and structure of the 2018 proposed regulations, with certain revisions.

The final regulations continue to be exclude from the denominator of the base erosion percentage Code Sec. 988 losses with respect to transactions with foreign related parties that are excluded from the numerator of the percentage. The final regulations also retain the add-back method for computing modified taxable income and the computation of base erosion minimum tax amount (BEMTA) on a taxpayer-by-taxpayer basis.

Among some of the more significant changes to the proposed rules, the final regulations:

• adopt the "with-or-within" method to determine the gross receipts and the base erosion percentage of an aggregate group;
• disregard transactions between parties if both parties were members of the aggregate group at the time of the transaction;
• exclude the base erosion tax benefits and deductions attributable to the tax year of a member of an aggregate group that begins before January 1, 2018;
• clarify that payments resulting in a reduction to determine gross income are not treated as base erosion payments;
• require that the determination of whether a payment or accrual is a base erosion payment be made under general U.S. federal income tax law;
• clarify the definition of a "base erosion payment," and generally exclude amounts transferred to, or exchanged with, a foreign related party in certain corporate nonrecognition transactions from that definition;
• clarify the rules for determining the portion of U.S. branch interest paid to foreign related parties;
• provide rules for the treatment of an interest expense determined under a U.S. tax treaty;
  include additional detail on the documentation required to satisfy the service cost method (SCM) exception;
• modify the total loss-absorbing capacity (TLAC) exception;
• provide that the additional one percent add-on to the BEAT rate will not apply to a taxpayer that is part of an affiliated group with de minimis banking and securities dealer activities;
• provide that Code Sec. 15 applies only to the change in tax rate set forth in Code Sec. 59A(b)(2) and should not apply to the change in tax rate included in Code Sec. 59A(b)(1)(A) for tax years beginning in calendar year 2018;
• change the Qualified Derivative Payments (QDP) exception;
• clarify the rules regarding how partnerships and their partners are treated for purposes of the BEAT; and
• clarify the anti-abuse rule and certain rules applicable to insurance companies and consolidated groups.

Applicability Dates

The final regulations (other than the reporting requirements for QDPs) apply to tax years ending on or after December 17, 2018. However, taxpayers may apply these final regulations in their entirety for tax years ending before December 17, 2018. Taxpayers may also apply provisions matching Reg. §§1.59A-1 through 1.59A-9 in their entirety for all tax years ending on or before December 6, 2019. Taxpayers choosing to apply the proposed regulations must apply them consistently and cannot selectively choose which particular provisions to apply.

The related Code Sec. 6038A regulations apply to tax years beginning Monday, June 7, 2021. The related consolidated return regulations generally apply to tax years for which the original consolidated return is due (without extensions) after December 6, 2019.

2019 Proposed Regulations

The 2019 proposed regulations provide rules regarding relating to (1) how a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage; (2) an election to waive deductions; and (3) application of the BEAT to partnerships.

The 2019 proposed regulations generally apply to tax years beginning on or after the date that the final regulations are filed with the Federal Register. Certain rules, however, have specific applicability dates. In addition, taxpayers may rely on the rules in the proposed regulations in their entirety for tax years beginning after December 31, 2017, and before the final regulations are applicable.

Practitioner’s Observations

Arlene Fitzpatrick, a Principal in the National Tax Department of Ernst & Young LLP, told Wolters Kluwer that "there are changes and new proposed rules in the package of final and proposed regulations that are helpful, though not all changes requested through the comment process were made. For example, the rules in the final regulations to exclude, in certain circumstances, from the definition of a base erosion payment amounts transferred to, or exchanged with, a foreign related party pursuant to a specified nonrecognition transaction are welcome. Furthermore, clarifying that a built-in loss recognized on a sale or transfer of property to a foreign related party is not in itself a deduction that causes the payment to be treated as a base erosion payment is helpful. The final regulations however, retain the internal dealings rule whereby a notional payment for purposes of attribution of profits under certain tax treaties may be taken into account for purposes of determining BEAT. Thus, although deductions from internal dealings would not be allowed under the Code or regulations, and only relevant under certain treaties (the regulations do not specify the treaties), the regulations provide such amounts are relevant for purposes of determining BEAT."

The IRS has issued highly anticipated final regulations on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The final regulations retain the basic approach and structure of the 2018 proposed regulations ( NPRM REG-105600-18). The final regulations also eliminate deadwood, reflect statutory amendments made prior to TCJA, and update expense allocation rules not updated since 1988.

The IRS has issued highly anticipated final regulations on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The final regulations retain the basic approach and structure of the 2018 proposed regulations ( NPRM REG-105600-18). The final regulations also eliminate deadwood, reflect statutory amendments made prior to TCJA, and update expense allocation rules not updated since 1988.

Also adopted are proposed regulations on overall foreign losses, published on June 25, 2012 ( NPRM REG-134935-11), and a U.S. taxpayer’s obligation to notify the IRS of a foreign tax redetermination, published on November 7, 2007 ( NPRM REG-209020-86).

A separate set of 2019 proposed regulations were also issued ( NPRM REG-105495-19).

Final Regulations

The final regulations make extensive changes to the rules on the determination of the foreign tax credit. Many of these changes were required to implement the TCJA, including the items discussed, below.

The final regulations provide details on how income is assigned and expenses are apportioned to the Code Sec. 951A global intangible low-taxed income (GILTI) and foreign branch foreign tax credit separate limitation categories added by TCJA.

The regulations provide that, for purposes of applying the expense allocation and apportionment rules, the portion of gross income related to foreign derived intangible income (FDII) or a GILTI inclusion that is offset by a Code Sec. 250 deduction is treated as exempt income. This means that fewer expenses will be allocated to the GILTI category, resulting in a higher foreign source taxable income, a higher foreign tax credit limitation, and a larger foreign tax credit offset with respect to GILTI income.

The regulations also address how the balance of foreign tax credit carryovers prior to the TCJA are allocated across new and existing separate categories. Under a default rule, foreign tax credit carryovers remain in the general category going forward. A taxpayer can elect to reconstruct the carryover regarding a foreign branch. The final regulations provide a simplified rule under which taxpayers can assign foreign tax credits to the foreign branch category proportionately, according to the ratio of foreign taxes paid or accrued by the taxpayer’s branches to total foreign taxes paid or accrued by the taxpayer in that year.

The regulations modify the proposed rule for determining foreign branch income based on the U.S. tax-adjusted books and records of the foreign branch. The proposed regulations disregarded transfers of intellectual property (IP) between a foreign branch and its owner if the transfer would result in a deemed payment that reallocates income between the foreign branch category and the general branch category. The final regulations limit the rule to transactions that occurred after the date of the proposed regulations and include an exception for transitory ownership.

The regulations provide rules for the treatment of GILTI for purposes of the interest allocation rules. In general, a controlled foreign corporation (CFC) must allocate and apportion its interest expense among groups of income for purposes of determining tested income, subpart F income and other types of net foreign source income. A U.S. taxpayer must characterize the value of its CFC for allocating and apportioning its own interest expense. A CFC allocates and apportions its interest expense using either the modified gross income (MGI) method or the asset method. The U.S. taxpayer uses the same method to characterize the stock of its CFC. The regulations take into account gross tested income from a lower-tier CFC with respect to an upper-tier CFC for allocating the upper-tier CFC’s interest expense when applying the MGI method.

Dividends, interest, rents and royalties (look-through payments) paid to a U.S. shareholder by a CFC were generally allocated to general category income to the extent that they were not treated as passive category income. Because this type of payment made directly by a U.S. shareholder is not included in the GILTI category, the regulations provide that the look-through payments are assigned either to the general category or the foreign branch category. The payments cannot be assigned to the GILTI category.

The final regulations also address certain potentially abusive borrowing arrangements involving loans by U.S. persons to foreign partnerships that artificially increase foreign source income and the foreign tax credit limitation without affecting U.S. taxable income. Under the regulations, the interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate limitation categories in the same manner as the associated interest expense.

Applicability of Final Regs

The final regulations related to statutory amendments made by the TCJA apply to tax years beginning after December 31, 2017. Regulations that contain both rules that relate to the TCJA and rules that do not relate to the TCJA generally apply to tax years that both (1) begin after December 31, 2017, and (2) end on or after December 4, 2018.

The regulations on the deemed paid credit under Code Sec. 960 apply to tax years that both begin after December 31, 2017, and end on or after December 4, 2018. The final OFL regulations apply to tax years on or after the date the regulations are filed in the Federal Register. The final foreign tax redetermination regulations apply to foreign tax redeterminations occurring in tax years ending on or after the date the regulations are filed in the Federal Register.

Proposed Regulations

Proposed foreign tax credit regulations address changes made by the TCJA, and also respond to issues raised in the 2018 proposed regulations on the foreign tax credit ( NPRM REG-105600-18). The proposed regulations address:

• the allocation and apportionment of deductions under Code Sec. 861 through Code Sec. 865;
• the definition of "financial services income" under Code Sec. 904(d)(2)(D);
• the allocation and apportionment of creditable foreign taxes;
• the interaction of branch loss and dual consolidated loss recapture rules under Code Sec. 904(f) and Code Sec. 904(g);
• the effect of Code Sec. 905(c) foreign tax redeterminations of foreign corporations on the high-tax exception in Code Sec. 954(b)(4) and the required notification and penalty provisions;
• the definition of "personal holding company income" under Code Sec. 954; and
• the application of the foreign tax credit limitation rule to consolidated groups.

Allocation and Apportionment

Under the general rule, a taxpayer may allocate research and experimentation (R&E) expenses to the foreign tax credit separate limitation categories under the sales method or the gross income method. The proposed regulations revise the sales method to provide that R&E expenses are only allocated to income that represents return on intellectual property. When applying these rules, gross intangible income does not include dividends or amounts included under subpart F, GILTI or Code Sec. 1293. As a result, none of a U.S. taxpayer’s R&E expenses are allocated to the GILTI category. The proposed regulations eliminate the gross income method for purposes of allocating R&E expenses.

Stewardship expenses are related and allocable to dividends received or to be received from related corporations. The proposed regulations provide that stewardship expenses are allocated to subpart F and GILTI inclusions, to Code Sec. 78 dividends and all amounts included under the passive foreign investment company (PFIC) provisions.

Under the Code Sec. 818(f) allocation rules that apply to life insurance companies, expenses are generally apportioned ratably across all gross income. Under a new rule, the proposed regulations allocate expenses in a life-nonlife consolidated group solely among items of the insurance company that has reserves (separate entity method).

The final foreign tax credit limitations provide a matching rule for a U.S. partner that makes loans to a foreign partnership. Under the rule, the partner’s gross interest income is apportioned between U.S. and foreign sources in each separate foreign tax credit limitation category based on the partner’s interest expense apportionment ratios. The proposed regulations provide the same rule for loans from partnerships to U.S. partners (upstream partnership loans).

Redeterminations

Portions of the 2007 temporary regulations on foreign tax redeterminations ( T.D. 9362) are reproposed so that taxpayers can provide comments on the rules in light of the changes made by the TCJA. The proposed regulations address foreign tax redeterminations that affect the deemed paid credit under Code Sec. 960; procedural notification rules; and penalties for failure to notify the IRS of a foreign tax redetermination.

The proposed regulations require taxpayers to account for foreign tax redeterminations of foreign subsidiaries on an amended return that reflects the revised foreign taxes deemed paid under Code Sec. 960 and any changes to the taxpayer’s U.S. tax liability. This reflects the repeal of the pooling mechanism to account for redeterminations of foreign taxes.

A transition rule provides that post-2017 redeterminations of pre-2018 foreign income taxes must be made by adjusting the foreign corporation’s taxable income and earnings and profits and post-1986 undistributed earnings and income taxes in the pre-2018 year to which the redetermined foreign taxes relate. The proposed regulations also provide that the foreign tax redetermination rules cover situations in which the foreign tax redetermination affects whether or not the CFC qualifies for the high-tax exceptions under GILTI and subpart F.

Additional Rules

Additional provisions in the proposed regulations:

• modify the definition of a "financial services entity" by adopting a definition of "predominately engaged in the active conduct of a banking, insurance, finance, or similar business" and "income derived in the active conduct of a banking, insurance, finance, or similar business" that is generally consistent with Code Secs. 954(h), 1297(b)(2)(B), and 953(e);
• provide more detailed guidance on the allocation and apportionment of foreign income taxes, and generalize the rules to apply to statutory and residual groupings;
• provide a new ordering rule for overall foreign loss recapture that addresses additional income recognition under the branch loss recapture and dual consolidated loss recapture rules: the amounts are not taken into account for purposes of the ordering rules until Code Sec. 904(f)(3) amounts are determined;
• clarify the rules that apply to jurisdictions that do not impose corporate income tax on CFCs until earnings are distributed. or where foreign tax is contingent on a future distributions, for purposes of the high-tax exception in Code Sec. 954(b)(4);
• apply the principles for allocating and apportioning foreign income taxes for purposes of Code Sec. 965(g); and
• update the Code Sec. 1502 regulations relating to the computation of the consolidated foreign tax credit to reflect changes in the law, and add new rules for the determining the source and separate category of the a consolidated NOL, as well as the portion of a consolidated net operating loss (CNOL) that is apportioned to a separate return year of a member.

Applicability of Proposed Regs

The proposed regulations are generally proposed to apply to tax years that end on or after the date the proposed regulations are filed in the Federal Register, with exceptions. For example, the rules for R&E expenses are proposed to apply to tax years beginning after December 31, 2019. However taxpayers on the sales method for tax years beginning after December 31, 2017, and before January 1, 2020, may rely on the proposed regulations if the rules are applied consistently. Thus, a taxpayer on the sales method for its tax year beginning in 2018 may rely on the proposed regulation, but must also apply the sales method (relying on the proposed regulation) for its tax year beginning in 2019.

Practitioner’s Observations

WK: Were you surprised by anything in the final regs?

Martin Milner: The final regulations are generally consistent with the proposed regulations and do not include any major surprises. The changes and clarifications that are in the final regulations are largely helpful. As would be expected, most of the new provisions are in the proposed portion of the package.

WK: With the proposed regs are there areas that you can see may result in pushback? If so why?

Martin Milner: The business community is likely to comment on the proposal to apportion stewardship expenses to dividends, subpart F income and GILTI (including IRC Section 78 gross-ups) because many had hoped that stewardship expenses would not be apportioned to GILTI.

WK: How did you feel about the R&E Expense Apportionment changes?

Martin Milner: The mandatory sales-based apportionment of R&E expenses to all gross intangible income related to the relevant product SIC code will be complicated in practice. However, it is helpful that the proposed rules specifically exclude dividends, subpart F income and GILTI.

The IRS has released guidance that provides that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 partnership tax years, but will first apply to 2020 partnership tax years.

The IRS has released guidance that provides that the requirement to report partners’ shares of partnership capital on the tax basis method will not be effective for 2019 partnership tax years, but will first apply to 2020 partnership tax years.

2019 Reporting

For 2019, partnerships and other persons must report partner capital accounts consistent with the reporting requirements in the 2018 forms and instructions, including the requirement to report negative tax basis capital accounts on a partner-by-partner basis.

Section 704(c) Gain or Loss

As a clarification, the notice also defines the term "partner’s share of net unrecognized Code Sec. 704(c) gain or loss," which must be reported by partnerships and other persons in 2019. Further, the notice exempts publicly traded partnerships from the requirement to report their partners’ shares of net unrecognized Code Sec. 704(c) gain or loss until further notice. Solely for purposes of completing the 2019 Forms 1065, Schedule K-1, Item N, and 8865, Schedule K-1, Item G, the notice defines a partner’s share of "net unrecognized Code Sec. 704(c) gain or loss" as the partner’s share of the net (meaning aggregate or sum) of all unrecognized gains or losses under Code Sec. 704(c) in partnership property, including Code Sec. 704(c) gains and losses arising from revaluations of partnership property.

Section 465 At-Risk Activities

The notice provides that the requirement added by the draft instructions for 2019 for partnerships to report to partners information about separate Code Sec. 465 at-risk activities will not be effective until 2020. The draft of the instructions for the 2019 Form 1065, Schedule K-1, released October 29, 2019, included a new paragraph at page 12, At-Risk Limitations, At-Risk Activity Reporting Requirements, that would expressly require partnerships or other persons that have items of income, loss, or deduction reported on the Schedule K-1 from more than one activity that may be subject to limitation under Code Sec. 465 at the partner level to report certain additional information separately for each activity on an attachment to a partner’s Schedule K-1. The new paragraph would require the partnership to identify the at-risk activity, the items of income, loss, or deduction for the activity, other items of income, loss, or deduction, partnership liabilities, and any other information that relates to the activity, such as distributions and partner loans. This requirement in the draft instructions for the 2019 Form 1065 is in addition to long-standing at-risk reporting requirements included in the instructions to the Form 1065.

Penalty Relief

Taxpayers who follow the provisions of the notice will not be subject to any penalty, including a penalty under Code Sec. 6722 for failure to furnish correct payee statements, under Code Sec. 6698 for failure to file a partnership return that shows required information, and under Code Sec. 6038 for failure to furnish information required on a Schedule K-1 (Form 8865).

The IRS has released final regulations that present guidance on how certain organizations that provide employee benefits must calculate unrelated business taxable income (UBTI) under Code Sec. 512(a).

The IRS has released final regulations that present guidance on how certain organizations that provide employee benefits must calculate unrelated business taxable income (UBTI) under Code Sec. 512(a).

Background

Organizations that are otherwise exempt from tax under Code Sec. 501(a) are subject to tax on their unrelated business taxable income (UBTI) under Code Sec. 511(a). Code Sec. 512(a) defines UBTI of exempt organizations and provides special rules for calculating UBTI for organizations described in Code Sec. 501(c)(7) (social and recreational clubs), voluntary employees’ beneficiary associations (VEBAs) described in Code Sec. 501(c)(9) and supplemental unemployment benefit trusts (SUBs) described in Code Sec. 501(c)(17).

Covered Entity

"Covered entity" describes VEBAs and SUBs subject to the UBTI computation rules under Code Sec. 512(a)(3). A corporation is treated as having exempt function income for a taxable year only if it files a consolidated return with the organization described in Code Sec. 501(c)(7), (9), or (17). These final regulations add a clause to clarify that the term "covered entity" includes a corporation described in Code Sec. 501(c)(2) to the extent provided in Code Sec. 512(a)(3)(C).

Nonrecognition of Gain

If a property used directly in the performance of the exempt function of a covered entity is sold by that covered entity, and other property is subsequently purchased and used by the covered entity directly in the performance of its exempt function—at any point within a four-year period beginning one year before the date of the sale and ending three years after the date of sale—gain, if any, from the sale is recognized only to the extent that the sales price of the old property exceeds the covered entity’s cost of purchasing the other property.

Limitation on Amounts Set Aside for Exempt Purposes

The total amount of investment income earned during the year should be considered when calculating whether an excess exists at the end of the year. Any investment income a covered entity earns during the taxable year is subject to unrelated business income tax (UBIT) to the extent the covered entity’s year-end assets exceed the account limit.

Effective Date

The final regulations apply to tax years beginning on or after December 10, 2019.

The IRS has issued Reg. §20.2010-1(c) to address the effect of the temporary increase in the basic exclusion amount (BEA) used in computing estate and gift taxes. In addition, Reg. §20.2010-1(e)(3) is amended to reflect the increased BEA for years 2018-2025 ($10 million, as adjusted for inflation). Further, the IRS has confirmed that taxpayers taking advantage of the increased BEA in effect from 2018 to 2025 will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels.

The IRS has issued Reg. §20.2010-1(c) to address the effect of the temporary increase in the basic exclusion amount (BEA) used in computing estate and gift taxes. In addition, Reg. §20.2010-1(e)(3) is amended to reflect the increased BEA for years 2018-2025 ($10 million, as adjusted for inflation). Further, the IRS has confirmed that taxpayers taking advantage of the increased BEA in effect from 2018 to 2025 will not be adversely affected after 2025 when the exclusion amount is set to decrease to pre-2018 levels.

The regulations apply to estates of decedents dying on and after November 26, 2019.

Special Rule for Post-2025 Decedents

Reg. §20.2010-1(c) provides a special rule in cases where the portion of the credit against the estate tax that is based on the BEA is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable within the meaning of Code Sec. 2001(b)(2). In that situation, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based upon the greater of those two credit amounts.

Inflation-Adjusted Amounts and DSUE Amount

Because the term "BEA" includes the exclusion amount, as adjusted for inflation, the examples in the regulations reflect hypothetical inflated adjusted BEAs. Reg. §20.2010-1(c)(2)(ii), Example 2, illustrates the application of the special rule based on gifts actually made, and would be inapplicable to a decedent who did not make gifts in excess of the date of death BEA, as adjusted for inflation.

Reg. §20.2010-1(c)(2)(iii) and (iv), Examples 3 and 4, illustrate that if a spouse dies during the increased BEA period, and the deceased spouse’s executor makes the portability election, the surviving spouse’s applicable exclusion amount includes the full amount of the deceased spousal unused exclusion (DSUE) amount based on the deceased spouse’s increased BEA. The DSUE amount is available to reduce the surviving spouse’s transfer tax liability regardless of when transfers are made.

BEA Calculations

The final rules explain how to determine the extent to which a credit allowable in computing gift tax payable is based solely on the BEA. Reg. §20.2010-1(c)(2)(iv), Example 4, addresses the application of the DSUE ordering rule, as well as the computation of the credit based solely on the BEA in a calendar period in which the transfer exhausts the remaining DSUE amount with the result that the BEA is also allowable.

The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.

TIGTA Final Audit Report

The Treasury Inspector General for Tax Administration (TIGTA) has released a report on suitability checks for participation in IRS programs. TIGTA initiated this audit to assess the effectiveness of IRS processes to ensure the suitability of applicants seeking to participate in IRS programs and to follow up on IRS planned corrective actions to address prior TIGTA recommendations.

Suitability Checks

The IRS’s suitability checks for applicants to the Acceptance Agent, Enrolled Agent, and e-File Provider Programs generally ensured that only reputable individuals were accepted in the programs during fiscal year 2018. Further, the IRS’s continuous suitability checks also ensured that individuals accepted in the programs prior to the initial suitability checks had not engaged in criminal activity warranting removal from the program. TIGTA also identified that when the Federal Bureau of Investigation reported a criminal history for an applicant, the adjudication process was inconsistent depending on the program to which the individual was applying. Finally, the IRS did not take sufficient actions to address the fraudulent submission of fingerprint cards by some applicants to pass their background investigations.

TIGTA Recommendations

TIGTA recommended that the IRS:

• assess the risk to tax administration of performing inconsistent initial and continuous suitability checks on individuals seeking to participate or enrolled in the e-File Provider, Acceptance Agent, and Enrolled Agent Programs;
• assess the risk of the e-File Provider Program’s use of decision matrices to adjudicate an applicant’s criminal history that are inconsistent with the matrices used by the Acceptance Agent and Enrolled Agent Programs; and
• work with the Federal Bureau of Investigation to identify additional individuals who may have submitted fingerprint cards that match the fingerprints of another individual.

The IRS agreed with all the recommendations.

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

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

SHOP

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

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

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

Code Sec. 36B tax credit

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

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

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

Employer mandate

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

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

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

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

HealthCare.gov

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

Enrollment

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

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

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

No, taxpayers may destroy the original hardcopy of books and records and the original computerized records detailing the expenses of a business if they use an electronic storage system.

Business often maintain their books and records by scanning hardcopies of their documents onto a computer hard drive, burning them onto compact disc, or saving them to a portable storage device. The IRS classifies records stored in this manner as an "electronic storage system." Businesses using an electronic storage system are considered to have fulfilled IRS records requirements for all taxpayers, should they meet certain requirements. And, they have the freedom to reduce the amount of paperwork their enterprise must manage.

Record-keeping requirements

Code Sec. 6001 requires all persons liable for tax to keep records as the IRS requires. In addition to persons liable for tax, those who file informational returns must file such returns and make use of their records to prove their gross income, deductions, credits, and other matters. For example, businesses must substantiate deductions for business expenses with appropriate records and they must file informational returns showing salaries and benefits paid to employees.

It is possible for businesses using an electronic storage system to satisfy these requirements under Code Sec. 6001. However, they must fulfill certain obligations.

Paperwork reduction

In addition, using an electronic storage system may allow businesses to destroy the original hardcopy of their books and records, as well as the original computerized records used to fulfill the record-keeping requirements of code Sec. 6001. To take advantage of this option, taxpayers must:

(1) Test their electronic storage system to establish that hardcopy and computerized books and records are being reproduced according to certain requirements, and

(2) Implement procedures to assure that its electronic storage system is compliant with IRS requirements into the future.

Our firm would be glad to work with you to meet the IRS's specifications, should you want to establish a computerized recordkeeping system for your business. The time spent now can be worth considerable time and money saved by a streamlined and organized system of receipts and records.

Q. I use my computer for both business and pleasure and I am confused about how much I can deduct. Also, how are PDAs such as Palm Pilots, etc. deducted for tax purposes?

A. Because computers and peripheral equipment are viewed as more susceptible than other business property to unwarranted deductions for personal use, they are subject to special scrutiny under the tax law. This scrutiny comes from their classification as "listed property," which limits the amount that may be deducted each year.

A computer as listed property only becomes an issue if it is not used exclusively in business. If a computer is used exclusively at the taxpayer's regular business establishment or in the taxpayer's principal trade or business, the listed property limitations don't apply at all.

Any computer that you use predominately for pleasure may not be written-off over its life nearly as quickly as exclusive-use computers. If your business usage does not meet the predominant use test, you are relegated to using a much slower depreciation method (the ADS, straight-line method) over the longer-ADS recovery period.

Your computer will meet the predominant use test for any tax year if its qualified business use is more than 50% of its total use. You must review your computer's usage and determine the percentage usage for each of its various uses (business, investment, and personal). When computing the predominant use test, any investment use of your computer cannot be considered as part of the percentage of qualified business use. However, you do use the combined total of business and investment use to figure your depreciation deduction for the property. It's up to you to prove business use to the IRS; the IRS does not need to prove personal use to reject your deductions.

In order to claim your computer expenses, you must meet the adequate records requirements by maintaining a "log" or other documentary evidence that sufficiently establishes the business/investment percentage claimed. The log should be similar to a log you would keep to track your auto expenses, indicating date, time of usage, business or nonbusiness, and business reason. Good documentation is always the key to success if your return is ever audited.

Finally, what about application of these rules to PDA's? The shorter the designated "life" of the property, the faster you can write-off its cost. Cell phones are generally considered 7-year property (the cost is depreciated over seven years). Computers are generally considered 5-year property, and computer-software normally is 3-year property. PDA's are generally classified as 5-year property, being considered wireless computers. If a PDA includes a cell phone feature, as long as that feature is not predominant and removable, it continues to fall under the 5-year property rule. Software that you may download to your PDA is 3-year property. Software that you buy already loaded into the PDA, however, is 5-year property. Monthly charges for a wireless service provider are deductible as paid each month, just as your business would deduct any phone or internet service bill.