In the last issue of the Funeral Business Advisor, we talked about stuff. Specifically, we acknowledged that as the owner of a funeral home, you’re constantly buying stuff for various reasons and among your considerations in choosing what stuff to buy are the tax implications. Will buying this stuff lower my taxes? The answer was (surprise!) “It depends”. In our previous article, we dealt with the small stuff; i.e. inventory, supplies, furniture, equipment and vehicles. In this issue, we’re going to focus on the big stuff: real estate.

Buying real estate will be one of the largest investments you’ll make as a business owner. Even with bank financing, you’ll likely need to make a substantial down payment to acquire a desired property. You would think that, having drained your bank account to make that big investment, there has to be some large tax write-off that goes with it, right? “WRONG!” Despite the big investment required to buy real estate, the annual write-off you get from real estate under the tax code is small in comparison. It all has to do with depreciation. Let me explain.

Generally under the tax code, property that you use over a number of years is not expensed immediately when it is purchased. Rather, you deduct the property’s cost over its depreciable life. The property’s depreciable life is determined under the tax code, and the annual deduction is called depreciation expense. For example, if you purchase a hearse (which has a depreciable life of 5 years) for $60,000, the annual deductible depreciation expense is $12,000 ($60,000 ÷ 5 years). As explained in our previous article, there are provisions in the tax code that allow you to immediately expense personal property rather than having to depreciate it over several years, but those exceptions rarely apply to real estate. As you’ve probably guessed by now, your depreciation deduction depends heavily on the depreciable life of the asset and therein lies the problem. Under the tax code, the depreciable life of a funeral home building is 39 years! Furthermore, if you make substantial capital improvements to your property, those improvements also need to be depreciated over 39 years. Considering you probably have a 15 or 20 year mortgage, you can see that your building will be paid off long before you will have completely written it off for your taxes. So what can you do to accelerate the deductible cost of your property? Here are some options.

Consider a Cost Segregation Study
One of the key strategies in maximizing and accelerating the depreciation deduction for your property is in the allocation of its cost. The cost of a property must first be allocated between land and building. Allocation here is important because land cannot be depreciated, so you will receive no tax benefit from the land cost until later when the property is sold. So it’s important to be aggressively reasonable when allocating a portion of your purchase price to land.

Once you’ve carved out the cost of the land, what remains is the building which, as previously mentioned, must be depreciated over 39 years. However, the tax regulations allow you to break out your property into various components which can be depreciated over shorter lives, thereby increasing and accelerating your depreciation deduction. To do this, you need to have a cost segregation study (CSS) performed on your property. The CSS is performed by engineers who will examine your property and provide you with a report which breaks out the cost of your property into several “asset classes” of varying depreciable lives. The result is that rather than having to depreciate the cost of your entire building over 39 years, portions of it will be depreciated over 5, 7 or 15 years thereby increasing and accelerating your depreciation deductions in the earlier years of ownership. By way of example, a client of mine purchased a property for $2.5M. By having a CSS performed on the property, my client was able to claim additional depreciation expense of approximately $330,000 over the first five years the property was owned thereby significantly reducing his tax liability during that time.

Although performing a CSS on your property sounds like a great idea, there are a few considerations to keep in mind. First, a properly done CSS will set you back $5,000 to $7,000 depending on the property. As such, it doesn’t make economic sense to do a CSS if the cost allocated to your building is less than $800,000. Second, a CSS only allows you to depreciate portions of your building faster. Once your building has reached the end of its depreciable life, the total depreciation you will have taken on that property will be no different regardless of how it was written off. If you paid $750,000 for your building, that’s all you’ll get to depreciate. The CSS just allows you to write off that $750,000 at a faster rate, and because a deduction today is worth more than a deduction five years from now, the CSS could be worth doing. Third, work closely with your tax advisor to ensure the accelerated depreciation will provide you the intended tax benefits. There are various other provisions within our complicated tax code that can lessen the tax benefits coming out of a CSS, so best to know those before you spend the money on a CSS.

Repairs vs Capital Improvements
So you are now the proud owner of a beautiful funeral home. For obvious reasons, funeral home owners are well known for meticulously maintaining their stuff, especially their properties. But that gets expensive. Whether all those costs are tax deductible depends on what you’re doing to the property and as you would expect, the IRS doesn’t make that easy. There are hundreds of pages of regulations which deal with this (known as “the repair regs”), but we’ll stick to the basics.

First, a repair is deductible immediately while a capital improvement needs to be depreciated. That makes a repair more tax advantageous than a capital improvement. So what’s the difference between a repair and a capital improvement? It really depends on nature of the “improvement” and here’s how it works.

The tax regulations require you to look at your building as a structure with a collection of “systems.” Examples of these systems are HVAC, electrical, plumbing, elevator, etc. If you restore or improve a substantial portion of the building structure or any of these systems, that will be a capital improvement which will need to be depreciated. If it’s not a substantial improvement, then it’s a repair that can be expensed immediately. I know what you’re asking; what does “substantial” mean? The IRS provides no clear definition of what substantial means, but the rule of thumb appears to be 30% of the repaired property. For example, your funeral home has thirty windows. You replace four windows. Since four windows comprise less than 30% of all your windows, you would treat the window replacement as a repair. But suppose you replace 20 windows. You’ve now replaced 66% of your windows, so the replacement cost would be a capital improvement which would need to be depreciated over 39 years.

What do we learn from this? For one thing, proper planning and timing of your building repairs can significantly affect your ability to expense the repair, so plan ahead. Spread projects out over time so you fall below the 30% repair threshold. Secondly, talk to your tax advisor when contemplating large repair or improvement projects. They can work with you to maximize possible write-offs associated with such projects. Finally, ensure your contractor will provide you detailed billing statements for your repair project so as to maximize possible write-offs.

Partial Asset Dispositions
So you’ve concluded that your project is indeed a capital improvement and you are now stuck depreciating it over the next 39 years. However, all hope may not be lost. There is another opportunity to possibly get a substantial write-off associated with a large improvement project. However, it applies only to a refurbishment or improvement of a currently existing property; it does not apply to a building addition or expansion. In tax jargon it’s called a “partial asset disposition” and it’s a relatively new option under the tax code. Here’s how it works.

Suppose you decide to renovate the inside of your funeral home to expand viewing rooms, add bathrooms, etc. You are not expanding your facility, you are simply renovating the current structure. Obviously, such a large project is a capital improvement that must be depreciated. However, what about the structures and systems that you have removed from the building? When you purchased the building, you paid for all those former walls, flooring, electrical systems and other portions of the building. Granted you were depreciating them along with the rest of your building, but they no longer exist. Seems unfair that you would be forced to continue depreciating something that no longer exists, doesn’t it? Furthermore, you should be able to write off the remaining undepreciated portion of the building that has been replaced by the renovation. That’s exactly what you can do through a partial asset disposition (PAD).

A PAD allows you to write off the undepreciated portion of property that has been replaced through a renovation or refurbishment. The amount of the write off will depend on the age and cost of your property. It is unlikely that the write-off will equal the cost of the renovation, but it could be substantial nonetheless and is certainly worth investigating. Finally, demolition costs can be expensed immediately, so be sure your contractor bills you separately for demolition.

Section 179 Election
In our previous article on the tax treatment of stuff (see July/August edition of Funeral Business Advisor) we talked about the Section 179 election. This provision of the tax code allows you to immediately expense the entire cost of property that would otherwise need to be depreciated. It normally doesn’t apply to real estate. However, the recent tax law changes expanded Sec 179 to allow the immediate write-off of certain real estate improvements such as roofs, HVAC property, security systems, etc. It’s important to remember that Sec 179 cannot be used for rental activities. So if you own your building in a separate entity and rent it to your funeral home business, you may not be able to claim an immediate write-off using Sec 179. It’s worth discussing this with your tax advisor.

Of all the stuff you will ever buy, it’s likely that real estate will be your biggest investment. How profitable it may be depends on many factors including the tax benefits or ramifications of owning real estate. As with all investment decisions, knowledge is power so be smart and always speak with your tax advisor before you invest in real estate. FBA

This article is meant to provide general information and should not be construed as legal or tax advice or opinion and is not a substitute advice of counsel, CPAs or other professionals.

A company’s strategic plan can look good on paper but never really work out in real life. Here’s how to ensure your business accomplishes its goals.

In the broadest sense, strategic planning comprises two primary tasks: establishing goals and achieving them. Many business owners would probably say the first part, coming up with objectives, is relatively easy. It’s that second part — accomplishing those goals — that can really challenge a company. The key to turning your strategic objectives into a reality is a solid implementation plan.

Start with people

After clearly identifying short- and long-range goals under a viable strategic planning process, you need to establish a formal plan for carrying it out. The most important aspect of this plan is getting the right people involved.

First, appoint an implementation leader and give him or her the authority, responsibility and accountability to communicate and champion your stated objectives. (If yours is a smaller business, you could oversee implementation yourself.)

Next, establish teams of carefully selected employees with specific duties and timelines under which to complete goal-related projects. Choose employees with the experience, will and energy to implement the plan. These teams should deliver regular progress reports to you and the implementation leader.

Watch out for roadblocks

On the surface, these steps may seem logical and foolproof. But let’s delve into what could go wrong with such a clearly defined process.

One typical problem arises when an implementation team is composed of employees wholly or largely from one department. Often, they’ll (inadvertently or intentionally) execute an objective in such a way that mostly benefits their department but ultimately hinders the company from meeting the intended goal.

To avoid this, create teams with a diversity of employees from across various departments. For example, an objective related to expanding your company’s customer base will naturally need to include members of the sales and marketing departments. But also invite administrative, production and IT staff to ensure the team’s actions are operationally practical and sustainable.

Another common roadblock is running into money problems. Ensure your implementation plan is feasible based on your company’s budget, revenue projections, and local and national economic forecasts. Ask teams to include expense reports and financial projections in their regular reports. If you determine that you can’t (or shouldn’t) implement the plan as written, don’t hesitate to revise or eliminate some goals.

Succeed at the important part

Strategic planning may seem to be “all about the ideas,” but implementing the specific goals related to your strategic plan is really the most important part of the process. Of course, it’s also the most difficult and most affected by outside forces. We can help you assess the financial feasibility of your objectives and design an implementation plan with the highest odds of success.

Did you make large gifts to your heirs in 2018? If so, it’s important to determine whether you’re required to file a gift tax return by April 15 (Oct. 15 if you file for an extension). Generally, you’ll need to file one if you made 2018 gifts that exceeded the $15,000-per-recipient gift tax annual exclusion (unless to your U.S. citizen spouse) and in certain other situations. But sometimes it’s desirable to file a gift tax return even if you aren’t required to. If you’re not sure whether you must (or should) file a 2018 gift tax return, contact us.

Did you make large gifts to your children, grandchildren or other heirs last year? If so, it’s important to determine whether you’re required to file a 2018 gift tax return — or whether filing one would be beneficial even if it isn’t required.

Filing requirements

Generally, you must file a gift tax return for 2018 if, during the tax year, you made gifts:

• That exceeded the $15,000-per-recipient gift tax annual exclusion (other than to your U.S. citizen spouse),
• That you wish to split with your spouse to take advantage of your combined $30,000 annual exclusion,
• That exceeded the $152,000 annual exclusion for gifts to a noncitizen spouse,
• To a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($75,000) into 2018,
• Of future interests — such as remainder interests in a trust — regardless of the amount, or
• Of jointly held or community property.

Keep in mind that you’ll owe gift tax only to the extent an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($11.18 million for 2018). As you can see, some transfers require a return even if you don’t owe tax.

No return required

No gift tax return is required if your gifts for the year consist solely of gifts that are tax-free because they qualify as:

• Annual exclusion gifts,
• Present interest gifts to a U.S. citizen spouse,
• Educational or medical expenses paid directly to a school or health care provider, or
• Political or charitable contributions.

But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

Be ready for April 15

The gift tax return deadline is the same as the income tax filing deadline. For 2018 returns, it’s April 15, 2019 — or October 15, 2019, if you file for an extension. But keep in mind that, if you owe gift tax, the payment deadline is April 15, regardless of whether you file for an extension. If you’re not sure whether you must (or should) file a 2018 gift tax return, contact us.

Albert Einstein allegedly once said, “Creativity is intelligence having fun.” So it should go with your company’s marketing budget. Be creative in smart ways like these and you can maximize your ROI.

A strong economy leads some company owners to cut back on marketing. Why spend the money if business is so good? Others see it differently — a robust economy means more sales opportunities, so pouring dollars into marketing is the way to go.

The right approach for your company depends on many factors, but one thing is for sure: Few businesses can afford to cut back drastically on marketing or stop altogether, no matter how well the economy is doing. Yet spending recklessly may be dangerous as well. Here are three ways to creatively get more from your marketing dollars so you can cut back or ramp up as prudent:

1. Do more digitally. There are good reasons to remind yourself of digital marketing’s potential value: the affordable cost, the ability to communicate with customers directly, faster results and better tracking capabilities. Consider or re-evaluate strategies such as:

• Regularly updating your search engine optimization approaches so your website ranks higher in online searches and more prospective customers can find you,
• Refining your use of email, text message and social media to communicate with customers (for instance, using more dynamic messages to introduce new products or announce special offers), and
• Offering “flash sales” and Internet-only deals to test and tweak offers before making them via more expansive (and expensive) media.

1. Search for media deals. During boom times, you may feel at the mercy of high advertising rates. The good news is that there are many more marketing/advertising channels than there used to be and, therefore, much more competition among them. Finding a better deal is often a matter of knowing where to look.

Track your marketing efforts carefully and dedicate time to exploring new options. For example, podcasts remain enormously popular. Could a marketing initiative that exploits their reach pay dividends? Another possibility is shifting to smaller, less expensive ads posted in a wider variety of outlets over one massive campaign.

1. Don’t forget public relations (PR). These days, business owners tend to fear the news. When a company makes headlines, it’s all too often because of an accident, scandal or oversight. But you can turn this scenario on its head by using PR to your advantage.

Specifically, ask your marketing department to craft clear, concise but exciting press releases regarding your newest products or services. Then distribute these press releases via both traditional and online channels to complement your marketing efforts. In this manner, you can make the news, get information out to more people and even improve your search engine rankings — all typically at only the cost of your marketing team’s time.

These are just a few ideas to help ensure your marketing dollars play a winning role in your company’s investment in itself. We can provide further assistance in evaluating your spending in this area, as well as in developing a feasible budget for next year.

As we approach the end of 2018, it’s a good idea to review the mutual fund holdings in your taxable accounts and take steps to avoid potential tax traps. Here are some tips.

Avoid surprise capital gains

Unlike with stocks, you can’t avoid capital gains on mutual funds simply by holding on to the shares. Near the end of the year, funds typically distribute all or most of their net realized capital gains to investors. If you hold mutual funds in taxable accounts, these gains will be taxable to you regardless of whether you receive them in cash or reinvest them in the fund.

For each fund, find out how large these distributions will be and get a breakdown of long-term vs. short-term gains. If the tax impact will be significant, consider strategies to offset the gain. For example, you could sell other investments at a loss.

Buyer beware

Avoid buying into a mutual fund shortly before it distributes capital gains and dividends for the year. There’s a common misconception that investing in a mutual fund just before the ex-dividend date (the date by which you must own shares to qualify for a distribution) is like getting free money.

In reality, the value of your shares is immediately reduced by the amount of the distribution. So you’ll owe taxes on the gain without actually making a profit.

Seller beware

If you plan to sell mutual fund shares that have appreciated in value, consider waiting until just after year end so you can defer the gain until 2019 — unless you expect to be subject to a higher rate next year. In that scenario, you’d likely be better off recognizing the gain and paying the tax this year.

When you do sell shares, keep in mind that, if you bought them over time, each block will have a different holding period and cost basis. To reduce your tax liability, it’s possible to select shares for sale that have higher cost bases and longer holding periods, thereby minimizing your gain (or maximizing your loss) and avoiding higher-taxed short-term gains.

Think beyond just taxes

Investment decisions shouldn’t be driven by tax considerations alone. For example, you need to keep in mind your overall financial goals and your risk tolerance.

But taxes are still an important factor to consider. Contact us to discuss these and other year-end strategies for minimizing the tax impact of your mutual fund holdings.

With the April 17 individual income tax filing deadline behind you (or with your 2017 tax return on the back burner if you filed for an extension), you may be hoping to not think about taxes for the next several months. But for maximum tax savings, now is the time to start tax planning for 2018. It’s especially critical to get an early start this year because the Tax Cuts and Jobs Act (TCJA) has substantially changed the tax environment.

With the April 17 individual income tax filing deadline behind you (or with your 2017 tax return on the back burner if you filed for an extension), you may be hoping to not think about taxes for the next several months. But for maximum tax savings, now is the time to start tax planning for 2018. It’s especially critical to get an early start this year because the Tax Cuts and Jobs Act (TCJA) has substantially changed the tax environment.

Many variables

A tremendous number of variables affect your overall tax liability for the year. Looking at these variables early in the year can give you more opportunities to reduce your 2018 tax bill.

For example, the timing of income and deductible expenses can affect both the rate you pay and when you pay. By regularly reviewing your year-to-date income, expenses and potential tax, you may be able to time income and expenses in a way that reduces, or at least defers, your tax liability.

In other words, tax planning shouldn’t be just a year-end activity.

Certainty vs. uncertainty

Last year, planning early was a challenge because it was uncertain whether tax reform legislation would be signed into law, when it would go into effect and what it would include. This year, the TCJA tax reform legislation is in place, with most of the provisions affecting individuals in effect for 2018–2025. And additional major tax law changes aren’t expected in 2018. So there’s no need to hold off on tax planning.

But while there’s more certainty about the tax law that will be in effect this year and next, there’s still much uncertainty on exactly what the impact of the TCJA changes will be on each taxpayer. The new law generally reduces individual tax rates, and it expands some tax breaks. However, it reduces or eliminates many other breaks.

The total impact of these changes is what will ultimately determine which tax strategies will make sense for you this year, such as the best way to time income and expenses. You may need to deviate from strategies that worked for you in previous years and implement some new strategies.

Getting started sooner will help ensure you don’t take actions that you think will save taxes but that actually will be costly under the new tax regime. It will also allow you to take full advantage of new tax-saving opportunities.

Now and throughout the year

To get started on your 2018 tax planning, contact us. We can help you determine how the TCJA affects you and what strategies you should implement now and throughout the year to minimize your tax liability.

While April 15 (April 17 this year) is the main tax deadline on most individual taxpayers’ minds, there are others through the rest of the year that you also need to be aware of. To help you make sure you don’t miss any important 2018 deadlines, here’s a look at when some key tax-related forms, payments and other actions are due. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you.

While April 15 (April 17 this year) is the main tax deadline on most individual taxpayers’ minds, there are others through the rest of the year that you also need to be aware of. To help you make sure you don’t miss any important 2018 deadlines, here’s a look at when some key tax-related forms, payments and other actions are due. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you.

Please review the calendar and let us know if you have any questions about the deadlines or would like assistance in meeting them.

June 15

• File a 2017 individual income tax return (Form 1040) or file for a four-month extension (Form 4868), and pay any tax and interest due, if you live outside the United States.
• Pay the second installment of 2018 estimated taxes, if not paying income tax through withholding (Form 1040-ES).

September 17

• Pay the third installment of 2018 estimated taxes, if not paying income tax through withholding (Form 1040-ES).

October 1

• If you’re the trustee of a trust or the executor of an estate, file an income tax return for the 2017 calendar year (Form 1041) and pay any tax, interest and penalties due, if an automatic five-and-a-half month extension was filed.

October 15

• File a 2017 income tax return (Form 1040, Form 1040A or Form 1040EZ) and pay any tax, interest and penalties due, if an automatic six-month extension was filed (or if an automatic four-month extension was filed by a taxpayer living outside the United States).
• Make contributions for 2017 to certain retirement plans or establish a SEP for 2017, if an automatic six-month extension was filed.
• File a 2017 gift tax return (Form 709) and pay any tax, interest and penalties due, if an automatic six-month extension was filed.

December 31

• Make 2018 contributions to certain employer-sponsored retirement plans.
• Make 2018 annual exclusion gifts (up to $15,000 per recipient).
• Incur various expenses that potentially can be claimed as itemized deductions on your 2018 tax return. Examples include charitable donations, medical expenses and property tax payments.

But remember that some types of expenses that were deductible on 2017 returns won’t be deductible on 2018 returns under the Tax Cuts and Jobs Act, such as unreimbursed work-related expenses, certain professional fees, and investment expenses. In addition, some deductions will be subject to new limits. Finally, with the nearly doubled standard deduction, you may no longer benefit from itemizing deductions.

The federal income tax filing deadline is slightly later than usual this year — April 17 — but it’s now nearly upon us. So, if you haven’t filed your individual return yet, you may be thinking about an extension. Or you may just be concerned about meeting the deadline in the eyes of the IRS. Whatever you do, don’t get tripped up by one of these potential pitfalls.

The federal income tax filing deadline is slightly later than usual this year — April 17 — but it’s now nearly upon us. So, if you haven’t filed your individual return yet, you may be thinking about an extension. Or you may just be concerned about meeting the deadline in the eyes of the IRS. Whatever you do, don’t get tripped up by one of these potential pitfalls.

Filing for an extension

Filing for an extension allows you to delay filing your return until the applicable extension deadline, which for 2017 individual tax returns is October 15, 2018.

While filing for an extension can provide relief from April 17 deadline stress and avoid failure-to-file penalties, there are some possible pitfalls:

• If you expect to owe tax, to avoid potential interest and penalties you still must (with a few exceptions) pay any tax due by April 17.
• If you expect a refund, remember that you’re simply extending the amount of time your money is in the government’s pockets rather than your own. (If you’re owed a refund and file late, you won’t be charged a failure-to-file penalty. However, filing for an extension may still be a good idea.)

Meeting the April 17 deadline

The IRS considers a paper return that’s due April 17 to be timely filed if it’s postmarked by midnight. Sounds straightforward, but here’s a potential pitfall: Let’s say you mail your return with a payment on April 17, but the envelope gets lost. You don’t figure this out until a couple of months later when you notice that the check still hasn’t cleared. You then refile and send a new check. Despite your efforts to timely file and pay, you can still be hit with both failure-to-file and failure-to-pay penalties.

To avoid this risk, use certified or registered mail or one of the private delivery services designated by the IRS to comply with the timely filing rule, such as:

• DHL Express 9:00, Express 10:30, Express 12:00 or Express Envelope,
• FedEx First Overnight, Priority Overnight, Standard Overnight or 2Day, or
• UPS Next Day Air Early A.M., Next Day Air, Next Day Air Saver, 2nd Day Air A.M. or 2nd Day Air.

Beware: If you use an unauthorized delivery service, your return isn’t “filed” until the IRS receives it. See IRS.gov for a complete list of authorized services.

Avoiding interest and penalties

Despite the potential pitfalls, filing for an extension can be tax-smart if you’re missing critical documents or you face unexpected life events that prevent you from devoting sufficient time to your return right now. We can help you estimate whether you owe tax and how much you should pay by April 17. Please contact us if you need help or have questions about avoiding interest and penalties.

Home ownership is a key element of the American dream for many, and the U.S. tax code includes many tax breaks that help support this dream. If you own a home, you may be eligible for several valuable breaks when you file your 2017 return. But under the Tax Cuts and Jobs Act, your home-related breaks may not be as valuable when you file your 2018 return next year.

Home ownership is a key element of the American dream for many, and the U.S. tax code includes many tax breaks that help support this dream. If you own a home, you may be eligible for several valuable breaks when you file your 2017 return. But under the Tax Cuts and Jobs Act, your home-related breaks may not be as valuable when you file your 2018 return next year.

2017 vs. 2018

Here’s a look at various home-related tax breaks for 2017 vs. 2018:

Property tax deduction. For 2017, property tax is generally fully deductible — unless you’re subject to the alternative minimum tax (AMT). For 2018, your total deduction for all state and local taxes, including both property taxes and either income taxes or sales taxes, is capped at $10,000.

Mortgage interest deduction. For 2017, you generally can deduct interest on up to a combined total of $1 million of mortgage debt incurred to purchase, build or improve your principal residence and a second residence. However, for 2018, if the mortgage debt was incurred on or after December 15, 2017, the debt limit generally is $750,000.

Home equity debt interest deduction. For 2017, interest on home equity debt used for any purpose (debt limit of $100,000) may be deductible. (If home equity debt isn’t used for home improvements, the interest isn’t deductible for AMT purposes). For 2018, the TCJA suspends the home equity interest deduction. But the IRS has clarified that such interest generally still will be deductible if used for home improvements.

Mortgage insurance premium deduction. This break expired December 31, 2017, but Congress might extend it.

Home office deduction. For 2017, if your home office use meets certain tests, you may be able to deduct associated expenses or use a simplified method for claiming the deduction. Employees claim this as a miscellaneous itemized deduction, which means there will be tax savings only to the extent that the home office deduction plus other miscellaneous itemized deductions exceeds 2% of adjusted gross income. The self-employed can deduct home office expenses from self-employment income. For 2018, miscellaneous itemized deductions subject to the 2% floor are suspended, so only the self-employed can deduct home office expenses.

Home sale gain exclusion. When you sell your principal residence, you can exclude up to $250,000 ($500,000 for married couples filing jointly) of gain if you meet certain tests. Changes to this break had been proposed, but they weren’t included in the final TCJA that was signed into law.

Debt forgiveness exclusion. This break for homeowners who received debt forgiveness in a foreclosure, short sale or mortgage workout for a principal residence expired December 31, 2017, but Congress might extend it.

Additional rules and limits apply to these breaks. To learn more, contact us. We can help you determine which home-related breaks you’re eligible to claim on your 2017 return and how your 2018 tax situation may be affected by the TCJA.

Making your financial statements gleam with success in the eyes of lenders or other stakeholders may require cutting back on poor-selling, unprofitable inventory or services.

Your business financials — where they stand currently and where they might be going next year — are incredibly important. Obviously, sales and expenses play enormous roles in the strength of your position. But a fundamental and often-overlooked way of making your cash flow statement shine is to minimize inventory or services so you have just enough to fulfill demand.

Sprucing up

Carrying too much inventory can devastate a budget as the value of the surplus items drops throughout the year. In turn, your financial statements simply won’t look as good as they could. Taking stock and perhaps cutting back on excess inventory:

• Reduces interest and storage costs,
• Improves your ability to prevent fraud and theft, and
• Increases your capacity to track what’s in stock.

One item to perhaps budget for here: upgraded inventory tracking and ordering software. Newer applications can help you better forecast demand, minimize overstocking, and even share data with suppliers to improve accuracy and efficiency.

Serving wisely

If yours is a more service-oriented business, you can apply a similar approach. Check into whether you’re “overstocking” on services that just aren’t adding enough revenue to the bottom line. Keeping infrastructure and, yes, even employees in place that aren’t improving profitability is much like leaving items on the shelves that aren’t selling.

Making improvements may require some tough calls. You might have long-time customers to whom you provide certain services that just aren’t substantially profitable anymore. If it’s getting to the point where your company might start losing money on these customers, you may have to discontinue the services and sacrifice their business.

You can ease difficult transitions like this by referring customers to another, reputable service provider. Meanwhile, of course, your business should be looking to either find new service areas to generate revenue or expand existing services.

Brightening the future

A variety of threats can cast a dark shadow on your company’s financial statements. Keeping your inventory or service selection in tip-top shape can help ensure that the numbers — and your business’s future — look bright. Contact our firm for help specific to your situation.

A $100 donation may not provide a $100 charitable deduction. What you give and how the charity uses the gift are just two of the factors that may also affect your deduction. Here’s what you need to know.

As you file your 2016 income tax return and plan your charitable giving for 2017, it’s important to keep in mind the available deduction. It can vary significantly depending on a variety of factors.

What you give

Other than the actual amount you donate, one of the biggest factors that can affect your deduction is what you give:

Cash. This includes not just actual cash but gifts made by check, credit card or payroll deduction. You may deduct 100%.

Ordinary-income property. Examples include stocks and bonds held one year or less, inventory, and property subject to depreciation recapture. You generally may deduct only the lesser of fair market value or your tax basis.

Long-term capital gains property. You may deduct the current fair market value of appreciated stocks and bonds held for more than one year.

Tangible personal property. Your deduction depends on the situation:

• If the property isn’t related to the charity’s tax-exempt function (such as an antique donated for a charity auction), your deduction is limited to your basis.
• If the property is related to the charity’s tax-exempt function (such as an antique donated to a museum for its collection), you can deduct the fair market value.

Vehicle. Unless the vehicle is being used by the charity, you generally may deduct only the amount the charity receives when it sells the vehicle.

Use of property. Examples include use of a vacation home and a loan of artwork. Generally, you receive no deduction because it isn’t considered a completed gift.

Services. You may deduct only your out-of-pocket expenses, not the fair market value of your services. You can deduct 14 cents per charitable mile driven.

Other factors

Your annual charitable donation deductions may be reduced if they exceed certain income-based limits. And if you receive some benefit from the charity, your deduction generally must be reduced by the benefit’s value.

In addition, various substantiation requirements apply. And the charity must be eligible to receive tax-deductible contributions. Finally, keep in mind that tax law changes could be passed later this year that might affect your 2017 charitable deductions.

If you have questions about how much you can deduct on your 2016 return, let us know. We also can keep you apprised of the latest information on any tax law changes.

"A thumb goes up, a car goes by…" Tax extenders remain a top contender for "hitching a ride" on November’s must-pass government funding bill.

"A thumb goes up, a car goes by…" Tax extenders remain a top contender for "hitching a ride" on November’s must-pass government funding bill.

Wolters Kluwer recently sat down with Jennifer Acuña, Principal, Federal Legislative and Regulatory Services, KPMG LLP, in Washington, D.C. to discuss over 30 temporary tax provisions known as "tax extenders," which have expired or will soon expire spanning from 2017 to 2019. Before joining KPMG, Acuña served as chief tax counsel for the Senate Finance Committee (SFC), and was previously tax counsel for the House Ways and Means Committee.

New Tax Extenders Climate on Capitol Hill
"There is an interesting dynamic going on with tax extenders on Capitol Hill. In the past, extenders were viewed as a priority item, and that has changed," Acuña said.

Generally, tax extenders have been viewed on Capitol Hill as a consistently bipartisan annual or biannual year-end legislative initiative. However, the fate of tax extenders is more uncertain than it has been in the past – in part because it is not clear yet whether there will be an opportunity for any further tax legislation to become law this year, Acuña observed.

Funding Bill Likely Driver for Tax Package
Lawmakers are revving up negotiations as Congress races against this year’s dwindling legislative calendar to reach an agreement on fiscal year (FY) 2020 appropriations. Government funding is scheduled to expire on November 21.

Given the political climate on Capitol Hill and Congress’s limited time left on the legislative calendar, a stand-alone tax package is considered unlikely to make its way through both chambers successfully. That said, November’s "must-pass" government funding bill could be the legislative vehicle for dozens of expired or soon-to-be expired tax extenders, as well as for any other tax provisions that may crop up during lawmakers’ negotiations.

SFC Chair Chuck Grassley, R-Iowa, and ranking member Ron Wyden, D-Ore., introduced their bipartisan Tax Extenders and Disaster Relief bill (Sen. 617) earlier this year. Subsequently, House Ways and Means Committee Chairman Richard Neal, D-Mass., introduced his version of a similarly named tax extenders bill (HR 3301). However, Neal’s bill—which proposes undoing certain provisions related to estate taxes under 2017 tax reform as a "pay for"—was immediately deemed a nonstarter by Senate Republicans.

Notably, Acuña observed that House Democrats may be viewing their tax extenders bill as an opening offer, providing leverage for a larger tax policy negotiation. "In today’s climate it seems that some of the signaling that’s taking place is that House Democrats are trying to position tax extenders as a Republican priority to build up leverage for a larger tax policy negotiation," Acuña said. "Once you have a tax title on a big bill, there is no limit as to which tax provisions could actually be included in the bill," she added.

Larger Tax Package Could Emerge
In that vein, there has been talk among lawmakers that a larger, catch-all tax package could emerge from these negotiations. Any tax package that is unveiled in the coming weeks must have significant bipartisan support to make it to the president’s desk. That said, amidst the new climate surrounding tax extenders on Capitol Hill. several lawmakers have alluded that bipartisan negotiations could result in any number of tax provisions being added to the anticipated tax package, including technical corrections to the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Staking Ground on Extenders
"Right now, what is happening is that parties are staking their ground," Acuña said. While Neal’s bill was largely seen on Capitol Hill as an opening bid to these negotiations, "no one opens with their best offer," Acuña said. However, "there is common ground with respect to tax extenders," she added.

Additionally, Acuña noted that these temporary tax provisions benefit a broad range of constituents. "They have been extended historically without fail for a reason. And it is because there has typically been general bipartisan support for extenders; there is a little bit of something for everyone" she said.

However, as for which tax extenders will be renewed this year, as well as retroactively or all together forgotten, Grassley recently indicated that all eligible provisions will likely make the cut. "I would expect that as of right now, if there is an extenders package there won’t be anything left out," Grassley told reporters.

When asked if Grassley was likely referring to all expired or soon-to-be expired tax incentives spanning from 2017 to 2019, Acuña told Wolters Kluwer "that would seem to be the case." While discussing the possibility of yet another temporary extension, Acuña noted that it is hard to make policy calls on a temporary tax extenders package.

"If you want a drama free negotiation on temporary extensions, it’s a clean date change. It is easier – you do not have a policy debate," she said. "If there is an opportunity for a tax title to be attached to a larger bill this year, it is infinitely harder to include changes that some Members of Congress will not like than it is to just do what has been done in the past and kick the can down the road by temporarily extending everything."

In looking ahead, deciding which temporary tax provisions get the axe is a policy call that is unlikely to be made this year and will not easily be done on a bipartisan basis, according to Acuña.

To Pay For or Not to Pay For
As for tax extenders’ cost, the issue of pay-fors has not generally been a longwinded discussion among lawmakers. "In the past, there have been very short-lived debates on whether to pay for them," Acuña said, adding that extenders generally have not been paid for. "It is hard to find a way to raise the kind of money needed to pay for a tax extenders bill that would be politically palatable for both sides of the aisle."

However, cost can be a leading issue when Congress creates these tax breaks on a temporary rather than permanent basis, Acuña explained. "In theory, everyone might agree that a tax incentive is excellent tax policy, but because of revenue constraints, Congress will not or cannot pay for it on a permanent basis—and that is usually where Congress lands in this temporary tax policy pickle."

Additionally, Acuna highlighted that many of the individual tax cuts under the TCJA were enacted temporarily through 2025 due to budgetary reasons. "A lot of the TCJA provisions gave life to new expiring provisions," Acuña noted. Likening the TCJA’s individual provisions to the long list of tax extenders currently awaiting possible renewal, Acuña noted that tax policy is not usually made temporary "because the members viewed the underlying tax policy as unsound but because of other constraints."

The End for Tax Extenders?
Many Republican and Democratic lawmakers’ have called for an end to tax extenders, citing to the annual year-end dash to renew temporary tax provisions as bad tax policy overall. Indeed, five taskforces comprised of bipartisan SFC members recently reviewed these tax extenders and largely agreed that temporary tax policy in general is less than ideal. While many House lawmakers on both sides of the aisle, in this Congress and those before it, have agreed that enacting permanent tax invectives is better policy than doing so temporarily, actually getting there remains a challenge, even if just procedurally.

The IRS has issued a revenue procedure with a safe harbor that allows certain interests in rental real estate to be treated as a trade or business for purposes of the Code Sec. 199A qualified business income (QBI) deduction. The safe harbor is intended to lessen taxpayer uncertainty on whether a rental real estate interest qualifies as a trade or business for the QBI deduction, including the application of the aggregation rules in Reg. §1.199A-4.

The IRS has issued a revenue procedure with a safe harbor that allows certain interests in rental real estate to be treated as a trade or business for purposes of the Code Sec. 199A qualified business income (QBI) deduction. The safe harbor is intended to lessen taxpayer uncertainty on whether a rental real estate interest qualifies as a trade or business for the QBI deduction, including the application of the aggregation rules in Reg. §1.199A-4.

QBI Deduction and Rental Real Estate
Under Code Sec. 199A, certain noncorporate taxpayers can deduct up to 20 percent of the taxpayer’s QBI from each of the taxpayer's qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship. Certain relevant passthrough entities (RPEs) (partnerships, S corporations, trust funds) calculate the deduction and pass it along to their owners or beneficiaries. A qualified trade or business is generally any trade or business under Code Sec. 162, but not a specified service trade or business (SSTB) or a trade or business of performing services as an employee.

Rental or licensing of tangible or intangible property (i.e., rental activity) that is not a Code Sec. 162 trade or business is still treated as a trade or business for the QBI deduction if the property is rented or licensed to a trade or business conducted by the individual or a RPE which is commonly controlled under Reg. §1.199A-4 ( Reg. §1.199A-1(b)(14)).

Earlier this year, the IRS released a proposed revenue procedure with a safe harbor for treating a rental real estate enterprise as a trade or business under Code Sec. 199A ( Notice 2019-7, I.R.B. 2019-9, 740). The IRS has issued the new revenue procedure after considering public comments on Notice 2019-7.

Rental Real Estate Enterprise
The new safe harbor applies to a "rental real estate enterprise." This is an interest in real property held for the production of rents, and may consist of an interest in a single property or interests in multiple properties. The taxpayer or RPE must hold each interest directly or through a disregarded entity, and may either:

• treat each interest in similar property held for the production of rents as a separate rental real estate enterprise; or
• treat interests in all similar properties held for the production of rents as a single rental real estate enterprise.

Properties are similar if they are part of the same rental real estate category: either residential or commercial. Commercial real estate held for the production of rents can only be part of the same enterprise with other commercial real estate. Residential properties can only be part of the same enterprise with other residential properties.

A taxpayer or RPE that treats interests in similar properties as a single rental real estate enterprise must continue to treat interests in all similar properties, including newly acquired properties, as a single rental real estate enterprise if it continues to rely on the safe harbor. However, a taxpayer or RPE that chooses to treat its interest in each residential or commercial property as a separate rental real estate enterprise can choose to treat its interests in all similar commercial or all similar residential properties as a single rental real estate enterprise in a future year.

An interest in mixed-use property—a single building that combines residential and commercial units—can be treated as a single rental real estate enterprise, or bifurcated into separate residential and commercial interests. A mixed-use property interest that is treated as a single rental real estate enterprise cannot be treated as part of the same enterprise as other residential, commercial, or mixed-use property.

Safe Harbor Requirements
The safe harbor determination must be made annually. For a rental real estate enterprise to qualify for the safe harbor, all of the following requirements must be met during the tax year:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise. If an enterprise has more than one property, the requirement can be met if income and expense information statements for each property are maintained and then consolidated.
• For rental real estate enterprises in existence for less than four years, 250 or more hours of rental services are performed per year. For rental real estate enterprises in existence for at least four years, 250 or more hours of rental services are performed per year in any three of the five consecutive tax years that end with the tax year.
• The taxpayer maintains contemporaneous records (including time reports, logs, or similar documents) on the hours of all services performed, a description of all services performed, the dates when the services were performed, and who performed the services. For services performed by employees or independent contractors, the taxpayer may provide a description of the rental services, the amount of time generally spent performing the services, and the time, wage, or payment records for the employee or independent contractor. Records must be made available for inspection at the IRS's request. (The contemporaneous records requirement does not apply to tax years that begin before January 1, 2020.)
• For each tax year for which it relies on the safe harbor, the taxpayer or RPE must attach a statement to a timely filed original return (or an amended return for the 2018 tax year only) that includes: (i) a description (including the address and rental category) of all rental real estate properties in each rental real estate enterprise; (ii) a description (including the address and rental category) of rental real estate properties acquired and disposed of during the tax year; and (iii) a representation that the requirements of Rev. Proc. 2019-38 have been satisfied.

"Rental services" include, but are not limited to:

• advertising to rent or lease the real estate;
• negotiating and executing leases;
• verifying information contained in prospective tenant applications;
• collecting rent;
• daily operation, maintenance, and repair of the property, including purchasing materials and
• supplies;
• managing the real estate; and
• supervising employees and independent contractors.

Rental services does not include:

• financial or investment management activities, such as arranging financing;
• procuring property;
• studying and reviewing financial statements or reports on operations;
• improving property under Reg. §1.263(a)-3(d); or
• time spent traveling to and from the real estate.

If an enterprise fails to satisfy the safe harbor requirements, it can still be treated as a trade or business for the QBI deduction if it otherwise meets the trade or business definition in Reg. §1.199A-1(b)(14).

Property Excluded From Safe Harbor
The safe harbor does not apply to:

• real estate used by the taxpayer (including an owner or beneficiary of an RPE) as a residence under Code Sec. 280A(d);
• real estate rented or leased under a triple net lease, which includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for a property in addition to rent and utilities;
• real estate rented to a trade or business conducted by a taxpayer or an RPE that is commonly controlled under Reg. §1.199A-4(b)(1)(i); or
• the entire rental real estate interest, if any portion of it is treated as an SSTB under Reg. §1.199A-5(c)(2).

Effective Date
The safe harbor applies to tax years ending after December 31, 2017. However, taxpayers and RPEs can rely on the prior safe harbor in Notice 2019-7 for the 2018 tax year.

The IRS has released cryptocurrency guidance and frequently asked questions (FAQs) on virtual currency.

The IRS has released cryptocurrency guidance and frequently asked questions (FAQs) on virtual currency. Under the cryptocurrency guidance:

• a taxpayer does not have gross income from a "hard fork" of the taxpayer's cryptocurrency if the taxpayer does not receive units of a new cryptocurrency; and
• a taxpayer has ordinary income as a result of an "airdrop" of a new cryptocurrency following a hard fork if the taxpayer receives units of the new cryptocurrency.

The IRS has posted the FAQs on its website ( https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions).

Virtual Currency and Cryptocurrency
Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and a store of value other than a representation of the U.S. dollar or a foreign currency.

Cryptocurrency is a type of virtual currency that uses cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality.

Hard Forks and Air Drops
A hard fork occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger, and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger.

An airdrop is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency. Note, however, that a hard fork is not always followed by an airdrop.

Cryptocurrency from an airdrop generally is received on the date and at the time it is recorded on the distributed ledger. However, a taxpayer may constructively receive cryptocurrency prior to the airdrop being recorded on the distributed ledger. A taxpayer does not have receipt of cryptocurrency when the airdrop is recorded on the distributed ledger if the taxpayer is not able to exercise dominion and control over the cryptocurrency.

Gross Income
If the taxpayer did not receive units of new cryptocurrency from a hard fork, the taxpayer does not have an accession to wealth and does not have gross income as a result of the hard fork.

If the taxpayer receives units of new cryptocurrency from an airdrop following a hard fork, the taxpayer received a new asset. Therefore, the taxpayer has an accession to wealth and has ordinary income in the year in which the taxpayer receives the new cryptocurrency. The taxpayer includes in gross income the fair market value of the cryptocurrency received. The taxpayer’s basis in the new cryptocurrency is the amount of income recognized.

Schedule 1, Form 1040 for 2019
A draft of the 2019 Form 1040, Schedule 1, "Additional Income and Adjustments to Income," includes a question which asks: "At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?" If an individual has engaged in any virtual currency transaction in 2019, he or she must check the “Yes” box next to the question.

If the taxpayer has disposed of any virtual currency that was held as a capital asset, he or she must use Form 8949 to figure the capital gain or loss and report it on Schedule D (Form 1040 or Form 1040-SR). If the taxpayer has received any virtual currency as compensation for services, or disposed of any virtual currency that he or she held for sale to customers in a trade or business, the taxpayer must report the income as he or she would report other income of the same type.

A district court has dismissed a lawsuit filed by four states’ against the federal government, ruling that the $10,000 state and local taxes (SALT) federal deduction cap is not unconstitutionally coercive.

A district court has dismissed a lawsuit filed by four states’ against the federal government, ruling that the $10,000 state and local taxes (SALT) federal deduction cap is not unconstitutionally coercive.

In 2018, New York, Connecticut, Maryland, and New Jersey filed suit against the IRS and Treasury alleging that the SALT cap violates the federalism principles that undergird the U.S. Constitution. Judge J. Paul Oetken of the U.S. District Court for the Southern District of New York ruled on September 30 that the SALT cap is not an unconstitutional infringement of state power.

The states’ primary concern stemmed from the claim that the introduction of the SALT cap could impair each of the states’ ability to pursue its own preferred tax policies. However, the court noted that Congress lawfully enacted the SALT cap pursuant to its broad tax powers under Article I, section 8 and the Sixteenth Amendment, and that the cap, like any federal tax provision, will affect some taxpayers more than others and, by extension, will affect some states more than others. However, the cap, like every other feature of the federal tax code, is a part of the landscape of federal law with which states make their decisions as to how they will exercise their own sovereign tax powers, according to Oetken. Because the states failed to plausibly allege that the cap, more so than any other major federal initiative, meaningfully constrains this decision-making process, the district court had no basis for concluding that the SALT cap is unconstitutionally coercive.

Background
In 2017, President Trump signed into law sweeping tax reform legislation informally known as the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), which made several substantial amendments to the federal tax code. Among other things, the TCJA placed an upper limit of $10,000 on the amount a taxpayer may deduct from their federal tax income to offset those sums they have paid toward certain state and local taxes (the "SALT cap"). As enacted, the SALT cap is scheduled to expire at the end of 2025.

Democrats on Capitol Hill Prepare to Move SALT Cap Repeal Bill
Meanwhile, Democratic lawmakers on Capitol Hill are preparing to move a SALT cap repeal bill when Congress returns from its two-week recess. Specifically, Rep. Bill Pascrell, D-N.J. has proposed repealing the SALT cap and raising the top income tax rate from 37 percent to 39.6 percent, where it previously sat. Additionally, Pascrell recently told reporters that House Democrats will likely propose a temporary repeal of the SALT cap as a "compromise."

At this time, however, any Democratic-backed measure to repeal or scale back the SALT cap is expected to fail in the Republican-controlled Senate.

New final regulations that address the allocation of partnership liabilities for disguised sale purposes revert back to prior regulations. Under the final regulations:

New final regulations that address the allocation of partnership liabilities for disguised sale purposes revert back to prior regulations. Under the final regulations:

• a partner’s share of a recourse liability of the partnership equals the partner’s share of the liability under the rules of Code Sec. 752 and the related regulations; and
• a partner’s share of a nonrecourse liability of the partnership is determined by applying the same percentage used to determine the partner’s share of the excess nonrecourse liability under Reg. §1.752-3(a)(3) ( Reg. §1.707-5(a)(2)).

Executive Order Triggers Reversion Back to Prior Disguised Sale Rules
In October 2016, the IRS issued final and temporary regulations (707 Temporary Regulations) under which a partnership would determine all partnership liabilities for disguised sales purposes—both recourse and nonrecourse—by applying the same percentage used to determine a partner’s share of excess nonrecourse liability under Reg. §1.752-3(a)(3) ( T.D. 9788).

In April 2017, the President issued Executive Order 13789 (E.O. 13789) on reducing tax regulatory burdens. In response, the IRS identified the final and temporary regulations in T.D. 9788 as implicating some of those regulatory burdens. In turn, in 2018 Proposed Regulations, the IRS proposed to withdraw the 707 Temporary Regulations and reinstate the regulations under Reg. §1.707-5(a)(2) described above. Now, the IRS has adopted the 2018 Proposed Regulations, thereby reinstating the Prior 707 rules.

Treasury and the IRS will continue to study the merits of the approach in the 707 Temporary Regulations and other approaches, including the final regulations, to determine which results in the most appropriate treatment of liabilities in the context of disguised sales.

Effective Dates
The final regulations apply to any transaction with respect to which all transfers occur on or after October 4, 2019, the date that the 707 Temporary Regulations expire. However, partnerships and their partners may apply the final regulations to any transaction where all transfers occur on or after January 3, 2017, the applicable date of the 707 Temporary Regulations.

The IRS has released final regulation on the election to take a loss resulting from a federally declared disaster in the year preceding the disaster. The final regulations adopt proposed regulations substantially without change.

The IRS has released final regulation on the election to take a loss resulting from a federally declared disaster in the year preceding the disaster. The final regulations adopt proposed regulations substantially without change.

Disaster Defined
The regulations provide definitions of:

• federally declared disaster;
• federally declared disaster area;
• disaster loss;
• disaster year; and
• preceding year.

Scope and Effect of Election
The election for a disaster loss attributable to a particular disaster applies to the entire loss sustained by the taxpayer from that disaster during the disaster year.

Making or Revoking Election
A taxpayer elects to deduct a disaster loss for the preceding year on:

• an original federal income tax return for the preceding year; or
• an amended federal income tax return for the preceding year.

The election is made in the manner specified by guidance issued pursuant to the regulations.

A taxpayer may not to take a disaster loss in the preceding year if the taxpayer claims a deduction (as a loss, as cost of goods sold, or otherwise) for the same loss for the disaster year.

If a taxpayer has claimed a deduction for a disaster loss for the disaster year and wants to elect the loss for the preceding year, the taxpayer must file an amended federal income tax return to remove the previously deducted loss on or before the date that the taxpayer makes the election for the preceding year loss.

If a taxpayer has claimed a deduction for a disaster loss for the preceding year and wants to revoke that election, the taxpayer must file an amended federal income tax return to remove the loss for the preceding year on or before the date the taxpayer files the federal income tax return or the amended federal income tax return for the disaster year that includes the loss.

Due Dates
The due date for making the election to deduct a disaster loss in the preceding year is six months after the due date for filing the taxpayer's federal income tax return for the disaster year (determined without regard to any extension of time to file).

Subject to the final regulation requirements, a taxpayer may revoke the election on or before the date that is 90 days after the due date for making the election.

Applicability Date
The final regulations apply to elections and revocations that are made on or after the date they are published in the Federal Register.

Proposed regulations provide guidance on the potential tax consequences of replacing the London interbank offered rates (LIBORs) with a new reference rate in contracts and agreements.

Proposed regulations provide guidance on the potential tax consequences of replacing the London interbank offered rates (LIBORs) with a new reference rate in contracts and agreements.

On July 27, 2017, the U.K. Financial Conduct Authority announced that all currency and term variants of the LIBORs may be phased out after 2021. On March 5, 2018, the Alternative Reference Rates Committee (ARRC) established that the Secured Overnight Financing Rate (SOFR) would replace the LIBOR within the United States.

Tax Implications
Because the LIBORs are being phased out, existing debt instruments and derivatives must be amended. Parties will either amend debt instruments or contracts to replace references to the LIBOR with the SOFR (if in the United States). Alternatively, parties may alter debt instruments or contracts to replace the LIBOR-referencing fallback rate with another fallback rate upon the cessation of the LIBOR.

The ARRC has expressed several concerns to the IRS about the potential tax consequences associated with these contract amendments:

• Modification of Terms of Debt and Non-Debt Instruments. Currently, there are no regulations under Code Sec. 1001 that address when a modification of a debt instrument, derivative, or other non-debt contract creates a realization event.
• Transactions and Hedges. Amending the LIBOR-referencing debt instrument or hedge may cause a deemed termination of the hedge, which could lead to undesirable tax consequences.
  
• Character of a One-Time Payment. Parties may need to agree to a one-time payment to address any differences between the LIBOR and the new rate, and it is unclear what the character of this payment would be.
• Grandfathered Agreements. Certain debt and non-debt instruments that are exempt from specific laws due to their grandfathered status may lose that status if they are modified to reflect the elimination of the LIBOR.
  
• OID and Qualified Floating Rates. The transition from the LIBOR to the SOFR (or other alternative rates) raises potential issues under the original issue discount (OID) rules.
• REMICs. The modification of the terms of the regular interest rate in a real estate mortgage investment conduit (REMIC) to deal with the elimination of the LIBOR could preclude the interest from being a regular interest.
• Interest in Foreign Corporations. The elimination of the LIBOR could prevent a foreign bank from taking advantage of the election under Reg. §1.882-5(d)(5)(ii)(B).

Modification of Debt Instruments, Non-Debt Contracts
Under Proposed Reg. §1.1001-6(a), if the terms of a debt instrument or non-debt contract are modified to replace, or to provide a fallback to, an LIBOR-referencing rate and the modification does not change the fair market value, there is no gain or loss under Code Sec. 1001. These rules apply regardless of whether the modification occurs by an amendment to the terms of the instrument or agreement or by replacing the existing debt instrument or contract with a new one.

Furthermore, altering the debt instrument’s terms to replace the LIBOR with a qualified rate is not treated as a modification and does not result in a deemed exchange of the debt instrument under Reg. §1001-3. Likewise, an alteration to a debt instrument’s terms to include a qualified rate (see below) as a fallback to an LIBOR referencing rate is not treated as a modification and therefore does not result in an exchange of the debt instrument for purposes of Reg. §1.1001-3.

Qualified Rate
Proposed Reg. §1.1001-6(b) provides the rules for determining whether a rate is a qualified rate. To be a qualified rate, Proposed Reg. §1.1001-6(b)(2)(i) requires that the fair market value of the debt instrument or non-debt contract after the modifications must be substantially equivalent to the fair market value before that alteration or modification. The proposed regulations provide that the fair market value of a debt instrument or derivative may be determined by any reasonable valuation method, as long as that method is applied consistently and takes into account any one-time payment made in lieu of a spread adjustment.

The proposed regulations provide two safe harbors to address the fair market value requirements. The debt instrument or non-debt contract are considered equivalent in value after the modification if:

• at the time of the modification, the historic average of the LIBOR-referencing rate is within 25 basis points of the historic average of the rate that replaces it; or
• the parties to the debt instrument or non-debt contract are not related and, through bona fide, arm’s length negotiations, determine that the fair market value of modified instrument or contract is substantially equivalent to the fair market value prior to the modification.

Transactions and Hedges
Proposed Reg. §1.1001-6(c) clarifies that a taxpayer can alter the terms of a debt instrument or modify one or more of the other components of an integrated or hedged transaction to replace a rate referencing an IBOR with a qualified rate without affecting the tax treatment of either the underlying transaction or the hedge. However, the integrated or hedged transaction as modified must continue to qualify for integration.

One-Time Payment
Under Proposed Reg. §1.1001-6(d), the source and character of a one-time payment that is made in connection with a modification described above will be the same as the source and character that would otherwise apply to a payment made by a payor with respect to the debt instrument or non-debt contract that is altered or modified.

Grandfathered Agreements
Because Proposed Reg. §1.1001-6(a) prevents debt instruments and non-debt contracts from being treated as reissued following a deemed exchange under Code Sec. 1001, the debt instrument or contract would not lose its grandfathered status as a result of any modifications made in connection with the elimination of an LIBOR.

OID and Qualified Floating Rate
Proposed Reg. §1.1275-2(m) stipulates three special rules for determining the amount and accrual of OID in the case of a variable rate debt instrument that provides both for interest at an LIBOR-referencing qualified floating rate and for a fallback rate that is triggered when the LIBOR becomes unavailable or unreliable.

• The LIBOR-referencing qualified floating rate and the fallback rate are treated as a single qualified floating rate for purposes of Reg. §1.1275-5.
• The possibility that the relevant LIBOR will become unavailable or unreliable is treated as a remote contingency for purposes of Reg. §1.1275-2(h).
• Occurrence of the event that triggers activation of the fallback rate is not treated as a change in circumstances.

REMIC Interests
Proposed Reg. §1.860G-1(e) permits an interest in a REMIC to retain its status as a regular interest despite certain alterations and contingencies.

Foreign Corporation Interests
The proposed regulations amend the election in Reg. §1.882-5(d)(5)(ii)(B) to allow a foreign corporation that is a bank to compute interest expense attributable to excess U.S.-connected liabilities using a yearly average SOFR in addition to the 30-day LIBOR. This amendment would allow the foreign corporation bank to make the election even after the LIBOR is phased out.

Applicability Date
The proposed regulations will apply to an alteration of the terms of a debt instrument or a modification to the terms of a non-debt contract that occurs on or after the date of publication of a Treasury Decision adopting those rules as final regulations in the Federal Register. A taxpayer may choose to apply the proposed regulations to alterations and modifications that occur before the regulations are finalized.

Health flexible spending arrangements (health FSAs) are popular savings vehicles for medical expenses, but their use has been held back by a strict use-or-lose rule. The IRS recently announced a significant change to encourage more employers to offer health FSAs and boost enrollment. At the plan sponsor's option, employees participating in health FSAs will be able to carry over, instead of forfeiting, up to $500 of unused funds remaining at year-end.

Health flexible spending arrangements (health FSAs) are popular savings vehicles for medical expenses, but their use has been held back by a strict use-or-lose rule. The IRS recently announced a significant change to encourage more employers to offer health FSAs and boost enrollment. At the plan sponsor's option, employees participating in health FSAs will be able to carry over, instead of forfeiting, up to $500 of unused funds remaining at year-end.

Health expenses

Health FSAs are designed to reimburse participants for certain health care expenditures, typically expenses that qualify for the medical and dental expense deduction. Medical supplies, such as eye glasses and bandages, are usually treated as qualified expenses. However, nonprescription medicines (other than insulin) are not considered qualified medical expenses.

Health FSAs are often funded through voluntary salary reduction agreements with the participant's employer under a cafeteria plan. In that case, they are very taxpayer-friendly because no federal employment or federal income taxes are deducted from the employee's contribution. The employer may also contribute to a health FSA. However, there are special rules which govern employer contributions.

Typically, participants designate at the beginning of the year the amount they want to contribute to their health FSA and these amounts are deducted from their pay. For 2014, an employee's salary reduction contributions cannot exceed $2,500. The $2,500 cap is very important because cafeteria plans that do not limit health FSA contributions to $2,500 are not treated as cafeteria plans, and all benefits offered under the plan are included in the participants' gross income.

Use-or-lose rule

As mentioned, the use-or-lose rule is a drawback to health FSAs. Unused amounts remaining in the health FSA at year-end are forfeited. Employers are not allowed to refund any unused funds in a health FSA. Critics of the use-or-lose rule argue that it has discouraged participation in health FSAs because many employees do not want to risk forfeiting unused funds. Often, participants have to scramble at year-end to use their health FSA dollars

Grace period option

A few years ago, the IRS modified the use-or-lose rule. The IRS allowed cafeteria plans to adopt a grace period. Participants can use amounts remaining in a health FSA at year-end for up to an additional two months and 15 days. This grace period is optional. Employers are not required to offer the grace period, although many do.

Carryover option

At its option, an employer may now amend its cafeteria plan to provide for the carryover to the immediately following year of up to $500 of any amount remaining unused as of the end of the year in a health FSA. The carryover of up to $500 may be used to pay or reimburse qualified expenses under the health FSA incurred during the entire plan year to which it is carried over. Additionally, the carryover does not count against or otherwise affect the salary reduction limit ($2,500 for 2014) for health FSAs. However, the new rules do not allow participants to cash out unused health FSA amounts or convert them to other types of benefits.

The maximum carryover amount is $500. An employer can choose to offer a $0 carryover, a $500 carryover or any amount in between. As we discussed, the carryover is optional. Employers can choose not to offer any carryover.

Employers cannot offer both the grace period and the carryover. It is a choice of either the grace period or the carryover....or neither. The employer and not the participant decides. In regulations, the IRS described how employers can amend their cafeteria plans to provide for the carryover and how they can, if they choose, replace the grace period with the carryover.

Let's take a look at an example: Jacob participates in a health FSA under his employer's cafeteria plan. At year-end, Jacob has $255 remaining in his health FSA. Jacob's employer never offered a grace period but opted to allow participants to carry over up to $300 of unused health FSA dollars. Jacob can carry over all of his $255 in unused health FSA dollars.

If you have any questions about the new carryover option or health FSAs, please contact our office.

Notice 2013-71

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.

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.