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House Republican tax writers have advanced a "Tax Reform 2.0" legislative package. The measure is expected to reach the House floor for a full chamber vote by the end of September.

The House Ways and Means Committee debated the GOP Tax Reform 2.0 three-bill package in a September 13 markup that ran almost seven hours. The package focuses on making permanent individual and small business tax cuts, and creating incentives for retirement savings and business innovation. The following three bills were approved along party lines:

Protecting Family and Small Business Tax Cuts Act of 2018 ( HR 6760);
Family Savings Act of 2018 ( HR 6757); and
American Innovation Act of 2018 ( HR 6756).

Individual, Small Business Tax Cuts

HR 6757 would make permanent the individual and small business tax cuts that were enacted temporarily through 2025 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). These provisions were made temporary to comply with certain Senate budget rules applicable to the reconciliation process Republicans used to pass tax reform with only a simple GOP majority. Notable TCJA provisions that would be made permanent under HR 6750 include, among others:

lowered individual income tax rates;
20-percent deduction of income for qualifying passthrough entities;
$12,000 (individual) and $24,000 (married filing jointly) standard deduction; and
$10,000 annual cap on the state and local tax (SALT) deduction.

Family Savings and Business Innovation

HR 6757 aims to simplify certain rules for employer retirement plans, and eliminates the age limit on IRA contributions, among other things. Additionally, it would create a Universal Savings Account (USA), while also allowing tax-advantaged 529 Plans to be used for expenses related to trade schools, home schooling, and up to $10,000 in total distributions for repayment of student loans.

HR 6756 would improve the tax treatment of certain start-up businesses. The bill would allow new businesses to write off up to $20,000 of start-up and organization expenditures. Additionally, HR 6756 would allow for a change in start-up ownership without triggering limits on certain tax benefits.

JCT

The Joint Committee on Taxation (JCT), a nonpartisan congressional scorekeeper, has estimated that all three bills will cost the federal government revenue. As noted in JCX-71-18, the JCT estimates that making permanent the individual and small business tax cuts under the TCJA, as proposed by HR 6750, would cost the federal government $631 billion in lost revenue over the next 10 years. Additionally, the JCT has estimated that HR 6756 and HR 6757, collectively, would cost approximately $26 billion in lost federal revenue over the next 10 years ( JCX-75-18, JCX-78-18).

Tax Reform 2.0’s Fate Uncertain

Tax Reform 2.0’s fate remains largely uncertain as it makes its way through the legislative process. While the measure is expected to garner enough Republican support in the House, despite certain GOP criticisms of the SALT deduction cap, it is not expected as a whole to fare well in the Senate. There is talk on Capitol Hill that Democrats could potentially support the retirement savings and business innovation bills in some form. However, it is considered unlikely that Democrats will support making permanent certain provisions of a law (the TCJA) for which not a single Democrat voted.

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Charles P. "Chuck" Rettig was confirmed as the new IRS Commissioner on September 12. The Senate confirmed the nomination by a 64-to-33 vote. Rettig received both Democratic and Republican support.

Senate Finance Committee (SFC) Chairman Orrin G. Hatch, R-Utah, praised Rettig, saying that he is both "qualified and ready" to lead the IRS. Although SFC ranking member Ron Wyden, D-Ore., previously said that Rettig is a "qualified nominee," he urged colleagues to oppose Rettig’s nomination. Wyden previously said he would only support Rettig’s nomination if he promised to reverse recent IRS guidance which limits Schedule B donor reporting for certain tax-exempt organizations ( Rev. Proc. 2018-38).

Rettig will oversee implementation of tax reform enacted last December under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). His term as IRS Commissioner will expire on November 12, 2022.

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New IRS guidance aiming to curb certain state and local tax (SALT) deduction cap "workarounds" is the latest "hot topic" tax debate on Capitol Hill. The IRS released proposed amendments to regulations, REG-112176-18, on August 23. The proposed rules would prevent taxpayers, effective August 27, 2018, from using certain charitable contributions to work around the new cap on SALT deductions.

SALT Deduction

The SALT deduction limit is one of the most controversial temporarily enacted provisions of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) signed into law last December. Under the TCJA, beginning in 2018 and running through 2025, taxpayers may not claim more than $10,000 ($5,000 if married filing separately) for all state and local sales, income and property taxes.

After the tax code overhaul, New York, New Jersey, and Connecticut (considered high-tax states) passed legislation that essentially allows taxpayers to circumvent the SALT deduction cap by making charitable contributions to state-run charitable organizations. Indeed, similar workarounds for private-school tuition already exists in other states.

"Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,"Treasury Secretary Steven Mnuchin said in a statement. "The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions."

Congressional Republicans and Democrats, as with the TCJA, are mostly divided on the topic. House Ways and Means Committee Chair Kevin Brady, R-Tex., praised the IRS proposal for aiming to prevent tax evasion. "These Treasury regulations rightly close the door on improper tax evasion schemes conjured up by state and local politicians who insist on brutally taxing local families and businesses," Brady said in a statement.

Meanwhile, Democratic lawmakers are criticizing the regulations. "The Trump administration doubled down on its attack on the middle class," Ways and Means ranking member Richard Neal, D-Mass., said in a statement. "The administration’s new regulations block affected states’ attempts to cope with this significant change and protect residents."

Tax Policy Experts Weigh-In

Several tax policy experts have criticized states’ efforts to circumvent the SALT deduction cap. Carl Davis, research director at the Democratic-leaning Institute on Taxation and Economic Policy, has called the workarounds an "abuse" of the charitable giving deduction. "Anyone who wants a fair and transparent tax system should be cautiously optimistic that these rules will put an end…to the workaround provisions enacted by states more recently," Davis wrote in a recent op-ed about the proposed IRS guidance.

Jared Walczak, senior policy analyst at the conservative-leaning Tax Foundation, has said that states’ strategies to re-characterize SALT payments were pursued to primarily help high-income taxpayers. Additionally, the top one percent of the wealthiest households would reap more than half of the benefit if the SALT cap were eliminated, according to an estimate from the Democratic-leaning Tax Policy Center.

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The IRS has proposed to remove the Code Sec. 385 documentation regulations provided in Reg. §1.385-2. Although the proposed removal of the documentation rules will apply as of the date the proposed regulations are published as final in the Federal Register, taxpayers can rely on the proposed regulations until the final regulations are published.

The documentation regulations provide minimum documentation requirements that must be satisfied in order for certain related-party instruments to be treated as debt for federal tax purposes. They are part of final and temporary Section 385 regulations adopted with T.D. 9790, I.R.B. 2016-45, 540. In addition to the documentation requirements, the Section 385 regulations also include rules that recharacterize as equity certain debt issued in connection with distributions and acquisitions that do not result in new investment in the operations of the issuer. The Section 385 regulations apply generally to debt instruments issued by a domestic corporations (or its disregarded entity) and held by members of the domestic corporation’s expanded group.

Documentation Regulations

The documentation rules generally require large corporations to document related-party loans just as all businesses do when they borrow from unrelated lenders. Reg. §1.385-2 prescribes the nature of the documentation necessary to substantiate the tax treatment of related-party instruments as debt. Taxpayers must be able to provide written evidence of four indebtedness factors analogous to those found in third-party loans.

Compliance with the documentation rules does not establish that an interest is debt. Instead, it serves only to satisfy the minimum documentation for making the determination under general federal tax principles. If a debt instrument is reclassified as stock due to a failure to meet the documentation requirements, it is treated as stock for all federal tax purposes.

Corporations must document relevant transactions under these rules if they are part of expanded affiliated groups and:

stock of any member of the group is publicly traded;
one or more members have total assets that exceed $100 million on any applicable financial statement or combination of statements; or
one or more members have annual total revenue that exceeds $50 million on any applicable financial statement or combination of statements.

The documentation regulations apply to relevant intercompany debt issued beginning in 2019, and require that the taxpayer’s documentation for a given tax year be prepared by the time the borrower’s return is filed.

Executive Order 13789

Executive Order 13789, issued on April 21, 2017 (E.O. 13789), instructs the Treasury Secretary to identify significant tax regulations issued on or after January 1, 2016, that impose an undue financial burden on U.S. taxpayers, add undue complexity to the federal tax laws, or exceed the statutory authority of the IRS. The Treasury Secretary is instructed to take concrete actions to alleviate these burdens.

Based on E.O. 13789, the Treasury Department identified, among others, the Section 385 regulations adopted with T.D. 9790 as significant tax regulations that impose an undue financial burden on U.S. taxpayers and/or add undue complexity to the federal tax laws ( Notice 2017-38, I.R.B. 2017-30, 147).

In light of further actions in connection with the required review of the Section 385 regulations, and in response to continued taxpayer concern, the IRS has delayed the applicability date of the documentation regulations for 12 months. As a result, the documentation requirements apply to interests issued or deemed issued on or after January 1, 2019. As originally adopted, the final regulations applied to interests issued or deemed issued on or after January 1, 2018 ( Notice 2017-36, I.R.B. 2017-33, 208).

In a later report, the Treasury has proposed to revoke the current documentation rules and replace them with substantially simplified and streamlined documentation rules ( TDNR SM-0172, October 4, 2017; U.S. Department of the Treasury, Second Report to the President on Executive Order 13789, October 2, 2017).

Proposed Removal of Documentation Rules

The IRS has proposed to remove the documentation regulations after considering the comments received in connection with E.O. 13789, including with respect to Notice 2017-36 and Notice 2017-38. However, the IRS will continue to study the issues addressed by the documentation regulations, When the study is complete, the IRS may propose a modified version of the documentation regulations. The revised documentation rules:

would be substantially simplified and streamlined to reduce the burden on U.S. corporations;
would still require sufficient documentation and other information for tax administration purposes; and
would be proposed with a prospective effective date to allow sufficient lead time for taxpayers to design and implement systems to comply with the revised requirements.

Comments

Written or electronic comments and requests for a public hearing must be received by December 23, 2018. Send submissions to: CC:PA:LPD:PR (REG-130244-17), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-130244-17), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20224 or sent electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-130244-17).

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Last year’s Tax Reform created a new 20-percent deduction of qualified business income for passthrough entities, subject to certain limitations. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) created the new Code Sec. 199A passthrough deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, the provision was enacted only temporarily through 2025. The controversial deduction has remained a buzzing topic of debate among lawmakers, tax policy experts, and stakeholders. In addition to its impermanence, the new passthrough deduction’s ambiguous statutory language has created many questions for taxpayers and practitioners.

The IRS released the much-anticipated proposed regulations on the new passthrough deduction, REG-107892-18, on August 8. The guidance has generated a mixed reaction on Capitol Hill, and while significant questions may have been answered, it appears that many remain. Indeed, an IRS spokesperson told Wolters Kluwer Tax & Accounting before the regulations were released that the IRS’s goal was to issue complete regulations but that the guidance "would not cover every question that taxpayers have."

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new passthrough deduction and proposed regulations. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

I. Qualified Business Income and Activities

Wolters Kluwer: What is the effect of the proposed regulations requiring that qualified business activities meet the Code Sec. 162 trade or business standard? And for what industries might this be problematic?

Joshua Wu: The positive aspect of incorporating the Section 162 trade or business standard is that there is an established body of case law and administrative guidance with respect to what activities qualify as a trade or business. However, the test under Section 162 is factually-specific and requires an analysis of each situation. Sometimes courts reach different results with respect to activities constituting a trade or business. For example, gamblers have been denied trade or business status in numerous cases. In Groetzinger, 87-1 ustc ¶9191, 480 U.S. 23 (1987), the Court held that whether professional gambling is a trade or business depends on whether the taxpayer can show he pursued gambling full-time, in good faith, regularly and continuously, and possessed a sincere profit motive. Some courts have held that the gambling activity must be full-time, from 60 to 80 hours per week, while others have questioned whether the full-time inquiry is a mandatory prerequisite or permissive factor to determine whether the taxpayer’s gambling activity is a trade or business. See e.g., Tschetschot , 93 TCM 914, Dec. 56,840(M)(2007). Although Section 162 provides a built-in body of law, plenty of questions remain.

Aside from the gambling industry, the real estate industry will continue to face some uncertainty over what constitutes a trade or business under Code Secs. 162 and 199A. The proposed regulations provide a helpful rule, where the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business if the rental or licensing and the other trade or business are commonly controlled. But, that rule does not help taxpayers in the rental industry with no ties to another trade or business. The question remains whether a taxpayer renting out a single-family home or a small group of apartments is engaged in a trade or business for purposes of Code Secs. 162 and 199A. Some case law indicates that just receiving rent with nothing more may not constitute a trade or business. On the other hand, numerous cases have found that managing property and collecting rent can constitute a trade or business. Given the potential tax savings at issue, I suspect there will be additional cases in the real estate industry regarding the level of activity required for the leasing of property to be considered a trade or business.

Qualified Business Income

Wolters Kluwer: How does the IRS define qualified business income (QBI)?

Joshua Wu: QBI is the net amount of effectively connected qualified items of income, gain, deduction, and loss from any qualified trade or business. Certain items are excluded from QBI, such as capital gains/losses, certain dividends, and interest income. Proposed Reg. §1.199A-3(b) provides further clarity on QBI. Most importantly, they provide that a passthrough with multiple trades or businesses must allocate items of QBI to such trades or businesses based on a reasonable and consistent method that clearly reflects income and expenses. The passthrough may use a different reasonable method for different items of income, gain, deduction, and loss, but the overall combination of methods must also be reasonable based on all facts and circumstances. Further, the books and records must be consistent with allocations under the method chosen. The proposed regulations provide no specific guidance or examples of what a reasonable allocation looks like. Thus, taxpayers are left to determine what constitutes a reasonable allocation.

Unadjusted Basis Immediately after Acquisition

Wolters Kluwer: What effect does the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to a trade or business have on determining QBI?

Joshua Wu: For taxpayers above the taxable income threshold amounts, $157,500 (single or married filing separate) or $315,000 (married filing jointly), the Code limits the taxpayer’s 199A deduction based on (i) the amount of W-2 wages paid with respect to the trade or business, and/or (ii) the unadjusted basis immediately after acquisition (UBIA) of qualified property held for use in the trade or business.

Where a business pays little or no wages, and the taxpayer is above the income thresholds, the best way to maximize the deduction is to look to the UBIA of qualified property. Rather than the 50 percent of W-2 wages limitation, Section 199A provides an alternative limit based on 25 percent of W-2 wages and 2.5 percent of UBIA qualified property. The Code and proposed regulations define UBIA qualified property as tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year. The proposed regulations helpfully clarify that UBIA is not reduced for taxpayers who take advantage of the expanded bonus depreciation allowance or any Section 179expensing.

De Minimis Exception

Wolters Kluwer: How is the specified service trade or business (SSTB) limitation clarified under the proposed regulations? And how does the de minimis exception apply?

Joshua Wu: The proposed regulations provide helpful guidance on the definition of a SSTB and avoid what some practitioners feared would be an expansive and amorphous area of section 199A. Under the statute, if a trade or business is an SSTB, its items are not taken into account for the 199A computation. Thus, the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial and brokerage services, investment management, trading, dealing in securities, and any trade or business where the principal asset of such is the reputation or skill of one or more of its employees or owners, do not result in a 199A deduction.

There is a de minimis exception to the general rule for taxpayers with taxable income of less than $157,500 (single or married filing separate) or $315,000 (married filing jointly). Once those thresholds are hit, the 199A deduction phases-out until it is fully eliminated at $207,500 (single) or $415,000 (joint).

The proposed regulations provide guidance for each of the SSTB fields. Importantly, they also limit the "reputation or skill" category. The proposed regulations state that the "reputation or skill" clause was intended to describe a "narrow set of trades or businesses, not otherwise covered by the enumerated specified services." Thus, the proposed regulations limit this definition to cases where the business receives income from endorsing products or services, licensing or receiving income for use of an individual’s image, likeness, name, signature, voice, trademark, etc., or receiving appearance fees. This narrow definition is unlikely to impact most taxpayers.

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Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new Code Sec. 199A passthrough deduction and its recently-released proposed regulations, REG-107892-18. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

II. Aggregation, Winners & Losers

Wolters Kluwer: How do the proposed regulations provide both limitations and flexibility regarding the available election to aggregate trades or businesses?

Joshua Wu: Treasury agreed with various comments that some level of aggregation should be permitted to account for the legal, economic and other non-tax reasons that taxpayers operate a single business across multiple entities. Permissive aggregation allows taxpayers the benefit of combining trades or businesses for applying the W-2 wage limitation, potentially resulting in a higher limit. Under Proposed Reg. §1.199A-4, aggregation is allowed but not required. To use this method, the business must (1) qualify as a trade or business, (2) have common ownership, (3) not be a SSTB, and (4) demonstrate that the businesses are part of a larger, integrated trade or business (for individuals and trusts). The proposed regulations give businesses the benefits of electing aggregation without having to restructure the businesses from a legal standpoint. Businesses failing to qualify under the above test will have to consider whether a legal restructuring would be possible.

Wolters Kluwer: How does Notice 2018-64 Methods for Calculating W-2 Wages for Purposes of Section 199A, which accompanied the release of the proposed regulations, coordinate with aggregation?

Joshua Wu: Notice 2018-64 contains a proposed revenue procedure with guidance on three methods for calculating W-2 wages for purposes of section 199A. The Unmodified Box method uses the lesser of totals in Box 1 of Forms W-2 or Box 5 (Medicare wages). The Modified Box 1 method takes the total amounts in Box 1 of Forms W-2 minus amounts not wages for income withholding purposes, and adding total amounts in Box 12 (deferrals). The Tracking wages method is the most complex and tracks total wages subject to income tax withholding. The calculation method is dependent on the group of Forms W-2 included in the computation and, thus, will vary depending upon whether businesses are aggregated under §1.199A-4 or not. Taxpayers with businesses generating little or no Medicare wages may consider aggregating with businesses that report significant wages in Box 1 that are still subject to income tax withholding. Under the Modified Box 1 method, that may result in a higher wage limitation.

Crack & Pack

Wolters Kluwer: What noteworthy anti-abuse safeguards did the proposed regulations seek to establish? How do the rules address "cracking" or "crack and pack" strategies?

Joshua Wu: Treasury included some anti-abuse provisions in the proposed regulations. One area that Treasury noted was the use of multiple non-grantor trusts to avoid the income threshold limitations on the 199A deduction. Taxpayers could theoretically use multiple non-grantor trusts to increase the 199A deduction by taking advantage of each trust’s separate threshold amount. The proposed regulations, under the authority of 643(f), provide that two or more trusts will be aggregated and treated as a single trust if such trusts have substantially the same grantor(s) and substantially the same primary beneficiary or beneficiaries, and if a principal purpose is to avoid tax. The proposed regulations have a presumption of a principal purpose of avoiding tax if the structure results in a significant tax benefit, unless there is a significant non-tax purpose that could not have been achieved without the creation of the trusts.

Another anti-abuse issue relates to the "crack and pack" strategies. These strategies involve a business that is limited in its 199A deduction because it is an SSTB spinning off some of its business or assets to an entity that is not an SSTB and could claim the 199A deduction. For example, a law firm that owns its building could transfer the building to a separate entity and lease it back. The law firm is an SSTB and, thus, is subject to the 199A limitations. However, the real estate entity is not an SSTB and can generate a 199A deduction (based on the rental income) for the law partners. The proposed regulations provide that a SSTB includes any business with 50 percent common ownership (direct or indirect) that provides 80 percent or more of its property or services to an excluded trade or business. Also, if a trade or business shares 50 percent or more common ownership with an SSTB, to the extent that trade or business provides property or services to the commonly-owned SSTB, the portion of the property or services provided to the SSTB will be treated as an SSTB. The proposed regulations provide an example of a dentist who owns a dental practice and also owns an office building. The dentist rents half the building to the dental practice and half to unrelated persons. Under [Proposed Reg.] §1.199A-5(c)(2), the renting of half of the building to the dental practice will be treated as an SSTB.

Winners & Losers

Wolters Kluwer: Generally, what industries can be seen as "winners" and "losers" in light of the proposed regulations?

Joshua Wu: The most obvious "losers" in the proposed regulations are the specified services businesses (e.g., lawyers, accountants, doctors, etc.) who are further limited by the anti-abuse provisions in arranging their affairs to try and benefit from 199A. On the other hand, certain specific service providers benefit from the proposed regulations. For example, health clubs or spas are exempt from the SSTB limitation. Additionally, broadcasters of performing arts, real estate agents, real estate brokers, loan officers, ticket brokers, and art brokers are all exempt from the SSTB limitation.

Wolters Kluwer: What areas of the Code Sec. 199A provision stand out as most complex when calculating the deduction, and how does this complexity vary among taxpayers?

Joshua Wu: With respect to calculating the deduction, one complex area is planning to maximize the W-2 wages limitation. Because compensation as W-2 wages can reduce QBI, and potentially the 199A deduction, determining the efficient equilibrium point between having enough W-2 wages to limit the impact of the wage limitation, while preserving QBI, will be a fact-driven complex planning issue that must be determined by each taxpayer. Another area of complexity will be how taxpayers track losses which may reduce future QBI and, thus, the 199A deduction. The proposed regulations provide that losses disallowed for taxable years beginning before January 1, 2018, are not taken into account for purposes of computing QBI in a later taxable year. Taxpayers will be left to track pre-2018 and post-2018 losses and determine if a loss in a particular tax year reduces QBI or not.

III. Looking Ahead

Questions Remain

Wolters Kluwer: An IRS spokesperson told Wolters Kluwer that the IRS did not expect the proposed regulations to answer all questions surrounding the deduction. Indeed, Acting IRS Commissioner David Kautter has said that stakeholder feedback would help finalize the regulations. What significant questions remain unanswered for taxpayers and tax practitioners, and has additional uncertainty been created with the release of the IRS guidance?

Joshua Wu: On the whole, the proposed regulations did a good job addressing the most important areas of Section 199A. However, there are many areas where additional guidance would be helpful. Such guidance may be in the form of additional regulations or other administrative pathways. For example, the proposed regulations did not address the differing treatment between a taxpayer operating as a sole proprietor versus an S corporation. Wages paid to an S corporation shareholder boosts the W-2 limitation but are not considered QBI. Thus, with the same underlying facts, the 199Adeduction may vary between taxpayers operating as a sole proprietor versus those operating as an S corporation.

Possible Changes to Proposed Regulations

Wolters Kluwer: In what ways do you see the passthrough deduction rules changing when the final regulations are released?

Joshua Wu: I suspect that the core components of the proposed regulations will not change significantly. However, I would not be surprised if Treasury were to include more specific examples with respect to real estate and whether certain types of activity constitute a trade or business. Additionally, the proposed regulations will likely generate comments and questions from various industry groups related to the SSTB definitions and specific types of services (e.g., do trustees and executors fall under the legal services definition). Treasury may change the definitions of SSTBs in response to comments and clarify definitions for industry groups.

Tax Reform 2.0

Wolters Kluwer: The White House and congressional Republicans are currently moving forward on legislative efforts known as "Tax Reform 2.0." The legislative package proposes making permanent the passthrough deduction. How does the impermanence of this deduction currently impact taxpayers? (Note: On September 13, the House Ways and Means Committee marked up a three-bill Tax Reform 2.0 package. The measure is expected to reach the House floor for a full chamber vote by the end of September.)

Joshua Wu: The 199A deduction has a significant impact on the choice of entity question for businesses. With the 21 percent corporate rate, we have seen many taxpayers considering restructuring away from passthrough entities to a C corporation structure. The 199A deduction is a large consideration in whether to restructure or not, but its limited effective time does raise questions about the cost effectiveness of planning to obtain the 199A deduction where the benefit will sunset in eight years.

Key Takeways

Wolters Kluwer: Aside from advice on specific taxpayer situations, what key takeaways should tax practitioners generally alert clients to ahead of the 2019 tax filing season?

Joshua Wu: Practitioners should remind clients who may benefit from the 199A deduction to keep detailed records of any losses for each line of business, as this may impact the calculation of QBI in the future. Practitioners should also help clients examine the whole of their activity to define their "trades or businesses." This will be essential to calculating the 199A deduction and planning to maximize any such deduction. Finally, practitioners should remember that some of the information that may be necessary to determine a 199A deduction may not be in their client’s possession. Practitioners need to plan in advance with their clients regarding how information about each trade or business will be obtained (e.g., how will a limited partner in a partnership obtain information regarding the partnership’s W-2 wages and/or UBIA of qualified property).

Wolters Kluwer: Any closing thoughts or comments?

Joshua Wu: Practitioners and taxpayers should remember that the regulations are only proposed and may change before they become final. Any planning undertaken this year should carefully weigh the economic costs and be rooted in the statutory language of 199A. It will be some time before case law helps clarify the nuances of Section 199A, and claiming the deduction allows the IRS to more easily impose the substantial understatement penalty if a taxpayer gets it wrong.

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Wolters Kluwer has projected annual inflation-adjusted amounts for tax year 2019. The projected amounts include 2019 tax brackets, the standard deduction, and alternative minimum tax amounts, among others. The projected amounts are based on Consumer Price Index figures released by the U.S. Department of Labor on September 12, 2018.

The Tax Cuts and Jobs Act of 2017 (TCJA) ( P.L. 115-97) mandated a change from the Consumer Price Index for All Urban Consumers (CPI-U) to the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). Official amounts for 2019 should be released by the IRS later in 2018.

Individual Tax Brackets

The projected bracket ranges for individuals in 2019 are as follows.

For married taxpayers filing jointly:

The 10 percent bracket applies to taxable incomes up to $19,400
The 12 percent bracket applies to taxable incomes over $19,400 and up to $78,900
The 22 percent bracket applies to taxable incomes over $78,900 and up to $168,400
The 24 percent bracket applies to taxable incomes over $168,400 and up to $321,450
The 32 percent bracket applies to taxable incomes over $321,450 and up to $408,200
The 35 percent bracket applies to taxable incomes over $408,200 and up to $612,350
The 37 percent bracket applies to taxable incomes over $612,350

For heads of households:

The 10 percent bracket applies to taxable incomes up to $13,850
The 12 percent bracket applies to taxable incomes over $13,850 and up to $52,850
The 22 percent bracket applies to taxable incomes over $52,850 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,700
The 32 percent bracket applies to taxable incomes over $160,700 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $510,300
The 37 percent bracket applies to taxable incomes over $510,300

For unmarried taxpayers:

The 10 percent bracket applies to taxable incomes up to $9,700
The 12 percent bracket applies to taxable incomes over $9,700 and up to $39,450
The 22 percent bracket applies to taxable incomes over $39,450 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,700
The 32 percent bracket applies to taxable incomes over $160,700 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $510,300
The 37 percent bracket applies to taxable incomes over $510,300

For married taxpayers filing separately:

The 10 percent bracket applies to taxable incomes up to $9,700
The 12 percent bracket applies to taxable incomes over $9,700 and up to $39,450
The 22 percent bracket applies to taxable incomes over $39,450 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,725
The 32 percent bracket applies to taxable incomes over $160,725 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $306,175
The 37 percent bracket applies to taxable incomes over $306,175

For estates and trusts:

The 10 percent bracket applies to taxable incomes up to $2,600
The 24 percent bracket applies to taxable incomes over $2,600 and up to $9,300
The 35 percent bracket applies to taxable incomes over $9,300 and up to $12,750
The 37 percent bracket applies to taxable incomes over $12,750

Standard Deduction

TCJA also roughly doubled the amount of the standard deduction. For 2019, the following standard deduction amounts are projected:

For married taxpayers filing jointly, $24,400
For heads of households, $18,350
For unmarried taxpayers and well as married taxpayers filing separately, $12,200

AMT Exemptions

TCJA eliminated the AMT for corporations, and increased the exemption amounts, and the exemption phaseouts, for individuals. For 2019, the AMT exemption amounts are projected to be:

For married taxpayers filing jointly, $111,700
For unmarried individuals and heads of households, $71,700
For married taxpayers filing separately, $55,850

Estate and Gift Tax

The following amounts related to transfer taxes (estate, generation-skipping, and gift taxes) are projected for 2019:

The gift tax annual exemption is projected to be $15,000 in 2019

The estate and gift tax applicable exclusion (increased under TCJA) is projected to be $11,400,000 for decedents dying in 2019

The exclusion for gifts made in 2019 to a spouse who is not a U.S. citizen is projected to be $155,000 for 2019

Other Amounts

The following other amounts are also projected for 2019:

The adoption credit for 2019 is projected to be $14,080 for 2019.

For 2019, the allowed Roth IRA contribution amount is projected to phase out for married taxpayers filing jointly with income between $193,000 and $203,000 For heads of household and unmarried filers, the projected phaseout range is between $122,000 to $137,000.

The maximum amount of deductible contributions that can be made to an IRA is projected to be $6,000 for 2019. The increased contribution amount for taxpayers age 50 and over will, therefore, be $7,000.

The deduction for traditional IRA contributions is projected to begin to phase out for married joint filers whose income is greater than $103,000 if both spouses are covered by a retirement plan at work. If only one spouse is covered by a retirement plan at work, the phaseout is projected to begin when modified adjusted gross income reaches $193,000. For heads of household and unmarried filers who are covered by a retirement plan at work, the 2019 income phaseout range for deductible IRA contributions is projected to begin at $64,000.

For 2019, the $2,500 student loan interest deduction is projected to begin to phase out for married joint filers with modified adjusted gross income (MAGI) above $140,000. For single taxpayers, the 2019 deduction is projected to begin to phase out at a MAGI level of over $70,000.

The amount of the 2019 foreign earned income exclusion under Code Sec. 911 is projected to be $105,900.

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Tax season is scheduled to begin shortly and, as in past years, there are some possible glitches to be mindful of. Already, the IRS has alerted taxpayers that the start of filing season will be delayed. Late tax legislation, although unlikely, could result in a further delay. Some new requirements under the Patient Protection and Affordable Care Act have been waived for 2014, but others have not. The IRS also is facing the prospect of another government shutdown in January.

Filing season

In recent years, the IRS has had to delay the start of the filing season to reprogram its return processing systems for changes in the tax laws. The 2014 filing season will also be delayed but not, as of today, because of new tax laws. The IRS operated with minimal staffing during the 16-day government shutdown in October and fell behind in its scheduled maintenance and programming of its return processing systems because employees were furloughed. At this time, the IRS expects the 2014 filing season to be delayed for possibly two weeks.

Before the shutdown, the IRS had anticipated opening the 2014 filing season on January 21, 2014. With a one- to two-week delay, the IRS would start accepting and processing returns no earlier than January 28, 2014 and no later than February 4, 2014. Individuals who file early in anticipation of receiving a refund will likely see their refunds delayed. The IRS is expected to make a final determination on the start date of the 2014 filing season in mid-December. Our office will keep you posted of developments.

Taxpayers are also waiting on some important final forms for the 2014 filing season, including Form 8960, Net Investment Income Tax. The Affordable Care Act created the new 3.8 tax on qualified net investment income, effective January 1, 2013. Additionally, the IRS has indicated that more guidance will be available for married same-sex couples. Since publication of the IRS's initial guidance, questions have surfaced concerning employee benefits, return filing and other issues affecting married same-sex couples and domestic partners (whom the IRS does not treat as married). Late-year guidance on either the 3.8 percent net investment income tax or same-sex tax issues may require last-minute changes in year-end tax strategies.

Another shutdown possible

The IRS is currently operating under a stop-gap funding measure, which ended the government shutdown in October. Funding under the stop-gap measure is scheduled to lapse after January 15, 2014. A House-Senate budget conference committee is attempting to reconcile competing fiscal year (FY) 2014 budget bills. So far, lawmakers appear to have made little progress.

A mid-January shutdown could further delay the start of the filing season. In a November 18 letter to IRS Acting Commissioner Daniel Werfel, the American Institute of Certified Public Accountants (AICPA) expressed concern that another government shutdown would result in a huge strain on taxpayers and tax professionals trying to timely file and report their income taxes by April 15. "The IRS keeping more essential positions working during January would help make the already delayed filing season operate as smoothly as possible," the AICPA told Werfel. The AICPA also recommended that the Taxpayer Advocate Service, which closed during the October shutdown, remain open in the event of another lapse in appropriations.

Tax legislation

Although many tax bills have been introduced in Congress, 2013 is likely to end without lawmakers tackling comprehensive tax reform. The House Ways and Means Committee and the Senate Finance Committee have both prepared discussion drafts on tax reform, covering a host of tax issues. One possible reason for the lack of movement of tax reform appears to be lukewarm interest, at best, from the House and Senate leaders. This could change in 2014 but it is too early to make any predictions.

One path for tax reform could be the House-Senate budget conference committee. However, as mentioned, the committee has not yet produced any concrete proposals. Several lawmakers have recommended that the committee strike a deal to lower corporate tax rates in exchange for businesses giving up unspecified tax breaks. Many Republicans want to keep scheduled across-the-board spending cuts in place for 2014 and beyond; many Democrats want to replace the spending cuts with new revenue raisers. The conference committee has a mid-December deadline to reach an agreement.

A package of so-called tax extenders-popular but temporary tax incentives-could move before year-end but more likely will be taken up by Congress early next year. Unlike last year, the expiring incentives do not affect 2013 returns filed in 2014. Eligible taxpayers will be able to claim the state and local sales tax deduction, the higher education tuition deduction, the teachers' classroom expense deduction, home energy tax breaks, and many others on their 2013 returns. If you have any questions about the expiring incentives, please contact our office.

Affordable Care Act

Starting January 1, 2014, the Affordable Care Act requires individuals to carry minimum essential health insurance (unless they are exempt) or make a shared responsibility payment. Tax credits and cost-sharing also kick-in next year. At this time, it appears unlikely that the Obama administration will delay the individual mandate. The employer mandate, however, is delayed. Employer reporting (and reporting by some insurers) will not apply until 2015, but is optional for 2014. Generally, employer reporting applies to employers with at least 50 full-time employees on business days during the preceding calendar year.

November was dominated by news of technical troubles for the online Affordable Care Act Marketplaces and the cancellation of some individual insurance policies that did not meet new standards. The White House has made getting the online Marketplaces running at 100 percent a priority and also gave states the option of allowing individuals to re-enroll in coverage that would otherwise be terminated. The fix is temporary and individuals will need to find alternative coverage for 2015 and beyond. Small businesses also may have received cancellation notices and should be exploring alternative coverage.

If you have any questions about year-end tax developments, please contact our office.

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The IRS has made several changes to its examination (aka, "audit") functions that are designed to expedite the process and relieve some burden on business taxpayers. These include the expansion of the Fast Track Settlement (FTS) program for small business, self-employed (SB/SE) taxpayers and a new process for issuing information document requests (IDRs) in large case audits.

Fast Track Settlement

The IRS launched the FTS program in 2005 to help small business taxpayers expedite case resolution. Small business FTS is modeled on a similar program for taxpayers in the IRS Large Business and International (LB&I) Division.

The goal of small business FTS is to complete cases within 60 days of their acceptance into the program. Under FTS, taxpayers under examination with issues in dispute work directly with IRS representatives from SB/SE's Examination Division and Appeals to resolve those issues. An Appeals Officer, trained in mediation, serves as a neutral party and employs dispute resolution techniques to facilitate settlement between the parties.

Application. To request to participate in small business FTS, the taxpayer and the SB/SE Group Manager submit Form 14017, Application for Fast Track Settlement. The taxpayer or the IRS examination representative may initiate Fast Track for eligible cases, usually before a 30-day letter is issued.

If the case is accepted and an agreement is reached, the IRS will use established issue or case closing procedures and applicable agreement forms, including preparation of a Form 906 specific matters closing agreement, if appropriate. If the case is not accepted the IRS explained that SB/SE or Appeals will inform the taxpayer of the basis for this decision and discuss other dispute resolution opportunities.

Qualifying issues. Small business FTS is generally available if:

Issues are fully developed;
The taxpayer has stated a position in writing or filed a small case request for cases in which the total amount for any tax period is less than $25,000; and
There are a limited number of unagreed issues.

Small business FTS is unavailable for Collection Appeals Program, Collection Due Process, Offer-In-Compromise and Trust Fund Recovery cases, except as provided in any guidance issued by the IRS; correspondence examination cases worked solely in a Campus/Service Center site; and cases in which the taxpayer has failed to respond to IRS communications.

Information Document Requests

The IRS Large Business & International (LB&I) Division has issued a new directive (LB&I-04-1113-009) that expands on an earlier directive from in June (LB&I-04-0613-004) by itemizing the requirements for IRS agents preparing information document requests (IDRs). The new directive also outlines the mandatory three-part enforcement process for taxpayers that do not timely respond to an IDR. While IDRs are common for large business taxpayers, the IRS also uses them in auditing certain small business issues.

June directive. The original June 2013 directive set forth general principles and several mandatory actions that examiners must take while issuing IDRs. These principles are reiterated in the November directive.

The June directive also provided that IDRs issued after June 30, 2013 must comply with these principles. In particular, the IRS reported that the mandatory training emphasized that employees must focus their IDRs on specific issues relevant to the exam. IRS employees are required to discuss the IDRs and issues with the taxpayer, as well as what would be an appropriate deadline for the response to the request. The deadline must fall within a "reasonable timeframe" and be "mutually agreed upon." If the examiner does not receive a response by this date, and the IDR otherwise met the requirements listed under the directive, the case will proceed into the enforcement process outlined in the new directive from November 2013.

November directive. If a taxpayer does not respond to the IRS by the date indicated in the IDR, the case must proceed to the graduated, three-step enforcement process outlined in Attachment 2 of the November directive. This process, assuming the taxpayer could not respond to the IDRs by the dates specified at each step, would involve first a delinquency notice, then a pre-summons letter, and finally a summons.

The IRS has recently promoted the revised IDR enforcement process as a "win-win" for both the IRS and taxpayers. However, some practitioners have expressed concerns that the rigid deadlines in the new enforcement process will have the opposite effect and result in more summonses being issued. Practitioners recommend that taxpayers proactively involve themselves in the initial IDR process to ensure that the IDR, once issued, provides them with enough time to supply the requested information.

If you have questions relating to the IRS's new FTS or IDR programs, please contact our offices.

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As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of December 2013.

December 2
Employers. Semi-weekly depositors must deposit employment taxes for payroll date November 23-26.

December 4
Employers. Semi-weekly depositors must deposit employment taxes for payroll date November 27-29.

December 6
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 30-December 3.

December 10
Employees who work for tips. Employees who received $20 or more in tips during November must report them to their employer using Form 4070.

December 11
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 4-6.

December 13
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 7-10.

December 16
Corporations. Deposit the fourth installment of estimated income tax for 2013, using Form 1120W.

December 18
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 11-13.

December 20
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 14-17.

December 26
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 18-20.

December 30
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 21-24.

January 2
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 25-27.

January 3
Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 28-31.

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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.

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A child with earned income above a certain level is generally required to file a separate tax return as a single taxpayer. However, a child with a certain amount of unearned income (from investments, including dividends, interest, and capital gains) may find that this income becomes subject to tax at his or her parent's highest marginal tax rate. This is referred to as the "kiddie tax," and it is designed to prevent parents from transferring income-producing investments to their children, who would generally be taxed at a lower rate.

Does the kiddie tax apply to my situation?

The kiddie tax applies if:

The child has investment income greater than the annual inflation-adjusted amount ($1,900 for 2013; $2,000 for 2014);
At least one of the child's parents was alive at the end of the tax year;
The child is required to file a tax return for the tax year;
The child does not file a joint return for the tax year; and
The child meets one of the following requirements relating to age and income:

The child was under age 18 at the end of the tax year; or
The child was age 18 at the end of the tax year and the child's earned income does not exceed one-half of the child's own support for the year; or
The child was a full-time student who was under age 24 at the end of the tax year and the child's earned income does not exceed one half of the child's own support for the year (This does not include scholarships.)

Computing the kiddie tax

If the kiddie tax applies to a child, the child's tax is calculated as the greater of one of two items:

The tax on all of the child's income, calculated at the rates applicable to single individuals; or
The sum of two things:

The tax that would be imposed on a single individual if the child's taxable income were reduced by net unearned income, plus
The child's share of the allocable parental tax.

The allocable parent tax is the amount of the increase in the parent's tax liability that results from adding to the parent's taxable income the net unearned income of the parent's children who are subject to the kiddie tax. If a parent has more than one child with unearned income subject to the kiddie tax, then each child's share of the allocable parental tax would be assigned pro rata according to the ratio that its net unearned income bears to the aggregate net unearned income subject to the kiddie tax.

Which tax form should I use?

A parent with a child or children whose unearned income is subject to the kiddie tax must generally complete and file Form 8615, Tax for Certain Children Who Have Investment Income of More Than $1,900, along with his or her tax return. However, if the child's interest and dividend income (including capital gain distributions) total less than $9,500 for 2013 ($10,000 for 2014), the parent may be able to elect to include that income on the parent's return rather than file a separate return for the child. In this case, the parents should complete Form 8814, Parents Election To Report Child's Interest and Dividends. However, the IRS cautions that the federal income tax owed on a child's income may be lower if the parent files a separate tax return for the child, which would enable him or her to take certain tax benefits that cannot be taken on the parents' return.

Divorced, separated, or unmarried parents

The kiddie tax is based on a parent's tax return, but what happens when parents do not file joint returns? Several special rules determine what should happen. If the parents are married, but file separate returns, then the child should use the return of the parent with the largest taxable income to figure the kiddie tax.

If the parents are married, but do not live together, and the custodial parent is considered unmarried then generally the custodial parent's return would be used. However, if the custodial parent is not considered unmarried, the child should use the return of the parent with the largest amount of taxable income.

If the child's parents are divorced or legally separated, and the custodial parent has not remarried, the child should use the custodial parent's return. If the custodial parent has remarried, the child's stepparent, rather than the noncustodial parent, is treated as the child's other parent. Similarly, if the child's parent is a widow or widower who has remarried, the new spouse is treated as the child's other parent.

If the child's parents never married each other, but lived together all year, the child should use the return of the parent with the greater taxable income. If the parents were never married and did not live together all year, the rules are the same as the rules for parents who are divorced.

Calculating the kiddie tax can become confusing as a taxpayer attempts to sort through the numerous rules governing who is subject to the tax, which income is subject to the tax, and how to report it properly. Please do not hesitate to contact our offices with any questions.

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The IRS has issued much-anticipated final "repair" regulations that provide guidance on the treatment of costs to acquire, produce or improve tangible property. These regulations take effect January 1, 2014. They affect virtually any business with tangible assets. The IRS has estimated that about 4 million businesses must comply.

At a length of over 200 pages, the regulations remain complex. Taxpayers will need to devote significant time and effort to study these regulations and to address their impact on their tax accounting. Taxpayers must decide whether they can deduct costs as repairs and maintenance or must capitalize the costs and recover their costs over a period of years. Every business, especially those with significant fixed assets, must develop an understanding of the regulations and their requirements.

Effective dates, decisions and opportunities

The final regulations retain the basic structure of the temporary and proposed regulations issued in December 2011 (the 2011 regulations). The IRS is not expected to delay these effective dates, since taxpayers were informed of the impending changes in many of the rules almost two years ago. Moreover, taxpayers will have the decision of whether to apply the regulations (either the temporary or the final) to the 2012 or 2013 tax years.

The IRS must provide additional guidance for taxpayers to change their methods of accounting to elect to apply either set of regulations retroactively and to comply with the 2014 effective date. Some accounting method changes will require taxpayers to make adjustments under Code Sec. 481(a), in effect, applying the regulations to past years and calculating the impact on income.

The final regulations make significant changes that can benefit most taxpayers if applied correctly. The changes include new and revised safe harbors, as well as new relief provisions for small business. The regulations will provide simplification and reduce controversy by allowing taxpayers to follow their financial accounting ("book") policies in some areas.

The IRS did not finalize every portion of the 2011 regulations. To address some problems with the temporary regulations on the disposition of depreciable property, the IRS issued new proposed regulations that ease the requirements for taxpayers to deduct the cost of building components that they replace.

Significant provisions in the final regulations include the following:

Materials and supplies - The threshold for deducting materials and supplies was increased from $100 to $200 and generally applies to items expected to be consumed in 12 months or less, or that have an economically useful life of 12 months or less.

De minimis safe harbor - The final regulations eliminate a controversial ceiling on the use of this safe harbor. Taxpayers with applicable financial statements can apply the safe harbor to an item that is $5,000 or less. The regulations extend the safe harbor to taxpayers without a financial statement, but only for property that costs $500 or less. Taxpayers must have written book policies in place at the beginning of the year to apply the safe harbor.

Routine maintenance and improvements - The final regulations retain controversial unit of property rules that apply the rules for real property to eight separate building systems. However, the rules do extend the routine maintenance safe harbor to real property and provide a new safe harbor for small taxpayers. The safe harbor for real property limits the period for recurring maintenance to 10 years, which many practitioners believe is too short.

Capitalization election - The final regulations allow taxpayers to capitalize repair and maintenance costs if these costs are capitalized for financial accounting purposes. This provides significant simplification over the temporary regulations, although the tax impact is contrary to what taxpayers normally want.

If you have any questions regarding the compliance obligations that your business now must face, and the opportunities that many of these new rules present, please do not hesitate to call this office.

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The U.S. Supreme Court's decision in June to strike down Section 3 of the Defense of Marriage Act (DOMA) (E.S. Windsor, 2013-2 ustc ¶50,400) generated many questions about federal taxes and same-sex couples. The IRS has responded with a general rule recognizing same-sex marriages nationwide. The agency also promised that more guidance will be released before the start of the 2014 filing season.

Place of celebration approach

Section 3 of DOMA prevented the IRS (and all federal agencies) from recognizing same-sex married couples as married. After the Supreme Court struck down Section 3 of DOMA, the IRS had an important decision to make. The IRS could recognize all same-sex marriages regardless of where the couple resided. Alternatively, the IRS could only recognize the marriages of couples who reside in states that recognize same-sex marriage.

The IRS chose the first approach, which is known as "place of celebration" approach. All legally married same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes, regardless of whether a couple resides in a jurisdiction that recognizes same-sex marriage or in a jurisdiction that does not recognize same-sex marriage. This means that a couple who marry in a state (or other jurisdiction) that recognizes same-sex marriage and subsequently move to a state that does not recognize same-sex marriage will continue to be treated as married for all federal tax purposes.

The IRS had an important historical precedent that lead to its choosing place of celebration over place of residence. The IRS has taken a place of celebration approach to common law marriages for over 50 years.

Tax returns

For 2013 returns filed in 2014, legally married same-sex couples must file as married filing jointly or married filing separately. The rules for 2012 and prior years are not as simple.

The IRS imposed a deadline of September 16, 2013 for married same-sex couples, who had yet to file an original return for 2012, to file as single or as married. For 2011 and earlier, same-sex spouses who filed their tax returns timely may choose (but are not required) to amend their federal tax return filing status. They may amend their prior-year returns using either married filing separately or jointly filing status, provided the period of limitations for amending the return has not expired. If you have any questions about filing an amended return, please contact our office.

Employee benefits

Because of DOMA, taxpayers may have paid taxes on the fair market value of employer-provided health care coverage for their same-sex spouse. The IRS will allow the employee to file an amended return for open tax years reflecting his or her status as a married individual to recover federal income tax paid on the value of health coverage of the employee's spouse. The IRS also instructed certain sponsors of some employee benefit plans to treat same-sex spouses as spouses.

Employment taxes

The IRS has provided two optional alternative special administrative procedures for employers to use to correct overpayments of employment taxes. Under the first alternative, employers may use the fourth quarter 2013 Form 941, Employer's Quarterly Federal Tax Return, to correct these overpayments of employment taxes for the first three quarters of 2013. Under the second alternative, employers may file one Form 941-X, Adjusted Employer's Quarterly Federal Tax Return or Claim for Refund, for the fourth quarter of 2013 to correct these overpayments of FICA taxes for all quarters of 2013. Please contact our office for more details about these optional procedures.

Domestic partners

There is one very important distinction that the IRS has made in its guidance for same-sex couples. The IRS is not recognizing registered domestic partners, individuals in a civil union, or similar relationships as married. Registered domestic partners may not file as married filing jointly or married filing separately because the individuals are not married or spouses for federal tax purposes

Looking ahead

The IRS will likely begin accepting 2013 returns for processing in mid- to late January 2014. Some same-sex couples may find their filing more complicated despite the demise of DOMA. States that do not recognize same-sex marriage will presumably not allow these couples to file their state returns (if required) as married. The IRS is also expected to issue more guidance on particular areas of the tax law, such as estate and gift taxes, retirement plans and more. Our office will keep you posted of developments.

Please contact our office if you have any questions about the IRS's guidance for same-sex couples.

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The end of the 2009 year will also spell the end of many tax breaks for both individuals and businesses. Some of these tax breaks are "temporary" credits and deductions that Congress typically extends for another year or two at the last moment. Other sunsetting provisions are relatively new, with no previous track record on their being extended. In either case, however, the unfamiliar economic climate in which our nation finds itself makes predicting whether Congress will find the funding necessary to extend any particular tax break this time around, beyond 2009, a matter of guesswork. The following is a list of important tax breaks expiring at the end of 2009.

A word to the wise: if you can take advantage of any tax break on this list before 2009 closes, do so. At this point, you cannot -and should not-- count on having any of them available in 2010.

Homebuyer tax credit. The first-time homebuyer tax credit expires sooner rather than later in 2009. That is, the credit expires November 30 - the credit provision requires that the residence be "purchased" by November 30, with "purchase" defined as taking place when title passes and the full purchase price is paid (that is, at the "closing") and not earlier when the contract of sale is executed and a down payment is escrowed. The credit is equal to 10 percent of the purchase price of a principal residence, up to $8,000. It applies to homes purchased after December 31, 2008, and before December 1, 2009.

Itemized state and local sales tax deduction. The ability to deduct state and local sales taxes in lieu of state and local income taxes is available until December 31, 2009, when the itemized state and local sales tax deduction expires.

Higher education tuition deduction. The higher education tuition deduction, permitting taxpayers to take an above-the-line deduction for qualified tuition and related expenses, will expire this year. The maximum deductible amount is $4,000 for taxpayers with adjusted gross income not exceeding $65,000 ($130,000 for joint filers). Taxpayers whose income exceeds that limit but does not exceed $80,000 ($160,000 for joint filers) may deduct up to $2,000 in qualified expenses.

Additional standard deduction for real property taxes. If you claim the standard deduction and also have real estate taxes, you can take an increased deduction ($500 for individuals and $1,000 for married couples filing jointly) for your real estate taxes. This tax break is scheduled to expire at the end of 2009.

Teachers' classroom expense deduction. The $250 above-the-line deduction for qualified classroom expenses will expire at the end of 2009. The deduction benefits teachers and other educators, from teachers' aides to school principals, who used their own out-of-pocket money to purchase qualified classroom supplies, such as notebooks, scissors, paper, pens, markers and books. As an above-the-line deduction, the $250 tax break is available to non-itemizers as well.

Bonus depreciation. For businesses, bonus depreciation and enhanced "section 179 expensing," both designed to - temporarily - encourage business to make capital investments, are set to expire at the end of 2009. Bonus depreciation can be claimed for both regular tax and alternative minimum tax (AMT) liability unless the taxpayer makes an election out.

Enhanced Code Sec. 179 expensing. Enhanced "section 179 expensing," is set to expire at the end of 2009 in addition to bonus depreciation, as mentioned above. Qualified taxpayers may deduct up to $250,000 of the cost of machinery, equipment, vehicles, furniture, and other qualifying property placed in service during 2009. The $250,000 amount is reduced if the cost of all Code Sec. 179 property placed in service by the taxpayer during the tax year exceeds $800,000.

Research and development credit. The research and development, or R&D credit, is set to expire at the end of 2009. The credit is available for businesses that increase their research expenses. The credit is 14 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding tax years.

COBRA subsidy. The COBRA premium assistance provided as part of the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) will not benefit individual involuntarily terminated from employment after December 31, 2009. The COBRA subsidy is only available to individuals involuntarily terminated from work between September 1, 2008 and December 31, 2009 The COBRA subsidy under the 2009 Recovery Act provides for individuals to pay only 35 percent of their COBRA premiums with employers paying the remaining 65 percent, for nine months.

Unemployment compensation. Although unemployment compensation is typically taxable income, the 2009 tax year provides a respite from taxability for up to $2,400 of unemployment income. However, the exclusion from taxable income for unemployment compensation is only available for 2009, and will expire at the end of the year unless Congress acts to extend this benefit.

Motor vehicle sales tax deduction. The deduction for sales tax paid on the purchase a new motor vehicle is available for vehicles purchased between February 17, 2009 and December 31, 2009. Taxpayers can deduct state and local sales and use taxes paid on the first $49,500 of the purchase price of the vehicle. The deduction can be taken whether or not the taxpayer itemizes deductions. However, if you deduct state and local general sales taxes as an itemized deduction, you cannot "double dip" and take the deduction for new car sales taxes.

AMT exemption amounts. For 2009, the AMT exemption amounts increased to $46,700 for individuals and $70,950 for married taxpayers filing jointly. However, these exemption amounts will decrease in 2010 to $33,750 for single taxpayers and $45,000 married taxpayers filing jointly.

Our office will continue to monitor the situation in Washington to be ready to advise you if any of the provisions set to expire at the end of 2009 are extended. With Congress busy with health care reform, the likelihood is that the fate of most if not all of the expiring provisions will remain uncertain for some time. In fact, some in Congress have been quietly discussing the possibility of not passing any extension until next year, and then making it retroactive to January 1. Stay tuned.

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