Avoid the Surprise!  In the world of Income tax, 2018 saw many changes as a result of the Tax Cuts and Jobs Act (TCJA) that was passed in 2017.  To that end, what follows in this memo is a highlight of the most relevant changes and some recurring “standard” advice around which meaningful year-end planning can occur.

December 2018 Tax Planning   -   Avoid The Surprise!

Clients & Friends:

While the end of the year involves a lot of hustle and bustle, it also presents an opportunity to reflect on all that has unfolded over the past several months. We hope that among the many things you take the time to reflect on, tax reform and planning is atop that list.

In the world of Income tax, 2018 saw many changes as a result of the Tax Cuts and Jobs Act (TCJA) that was passed in 2017. We have been busy working hard to stay current on the new regulations so that we can provide effective tax planning as we wind down the year. To that end, what follows in this memo is a highlight of the most relevant changes and some recurring “standard” advice around which meaningful year-end planning can occur.

The new tax law resulted in changes/decreases to the tax tables for withholding on your paychecks. We have found that this decrease in federal tax withholding may result in the tax withheld being significantly too low and could result in a balance due on the 2018 tax return. This situation can be particularly problematic when both spouses are wage earners. It is important that you check your withholding rates now. We are happy to help with this so that you avoid any surprises come April. Simply send us over a copy of your YTD pay advice(s) and we can take a look.

Individuals are also impacted by the removal of personal exemptions and limitations on itemized deductions.

• Beginning in 2018, the itemized deduction for all state and local taxes (income and real estate) is limited to $10,000.

• Miscellaneous Itemized deductions subject to the 2% floor are suspended. The most common examples include unreimbursed business expenses, safe deposit boxes, investment advisory fees, and tax preparation fees.

Many filers who previously took itemized deductions on their return will now likely take the standard deduction as a result of these changes. The 2018 standard deduction amounts are $24,000 for joint filers and $12,000 for single filers. The standard deduction amounts above are increased for persons over 65 by $1,600 for single or Head of household filers and by $1,300 each or $2,600 for joint returns.

Beginning in 2019, the deduction for medical expenses is limited by an even higher threshold of 10%. If you expect to qualify for medical deductions in 2018 consider, to the extent possible, accelerating the payment of any discretionary medical expenses to 2018 while the threshold still remains at 7.5%. 

With the standard deduction under the new TCJA increased to $24,000, another strategy for taking advantage of itemized deductions is to consider bunching the payment of any charitable contributions. Consider making two years’ worth of contributions in 2018 or in 2019 if it will help to push your itemized deductions above the amount of the new standard deduction. In this strategy you might itemize your deductions every other year and take the higher standard deduction in the off years.

One method for achieving this strategy is through the use of a Donor Advised Fund. These allow for efficient bunching of contributions because they allow you to donate cash or appreciated securities into the fund and take the tax deduction in 2018 all while deferring payment to your selected charities until 2019.

Another very tax efficient way to make charitable contributions, for those over 70 ½, is to earmark up to $100,000 of you annual Required Minimum Distribution (RMD) from your IRA account to be paid to a qualified charity. You do not get a tax deduction BUT the amount designated is excluded from your taxable income. This can be more beneficial than a deduction, as it satisfies both your annual RMD and charitable inclinations.

On the topic of securities, we advise that the donation of appreciated securities is a highly tax effective means of making contributions. You get a deduction for the full market value of the stock and do not pay the tax on any gain! If you happen to hold stocks that are losers do NOT donate those. Sell them and take the loss on your tax return. Be careful when considering the purchase of mutual funds at this time in the year. You may essentially be “buying a capital gain”, as most all mutual funds pay out gains come year end.

There are several other areas of the new tax law that provide individuals with opportunities to make the law “work for them”:

• The annual gift tax exclusion has been increased for 2018. Up from $14,000 in 2017, individuals may now gift up to $15,000 ($30,000 per beneficiary from a married couple filing jointly).We usually suggest that these gifts be given as early in the year as possible. Even with the new higher Estate tax exemption amounts this gifting routine still can result in decreased “death” taxes. 
• Federal tax law now allows for 529 Plan withdrawals up to $10,000 a year to be used for qualified education expenses for each child from Kindergarten through the 12^th grade.
  • No longer only applicable to higher education costs, you may want to consider making these payments through a 529 plan to secure the PA tax deduction for these contributions and expenses. For example if you are making these payments anyway for your children or grandchildren and there are three of them, the $30,000 PA deduction will save you $921 in PA taxes!

TCJA also made notable changes to the following areas of tax law affecting Individuals:

• The Kiddie Tax has been modified, resulting in the net unearned income of children under the age of 19 (or full-time students under 24) being taxed according to the brackets applicable to trusts and estates.
• The Child Tax Credit has increased in 2018 to $2,000 per qualified child. The income thresholds for taking the credit have also substantially increased. More filers will qualify for this credit. 
• The deduction for home mortgage interest is limited to underlying indebtedness of up to $750,000 beginning with purchases made on or after December 15, 2017. The interest deduction related to home equity indebtedness is suspended in 2018 unless used to make improvements to the home.
• Alimony is not deductible by the Payor spouse and is not included in the income of the Payee spouse for any divorce or separation agreement executed after December 31, 2018.
• Business/client meals are still limited by 50%. There is no longer an entertainment expense deduction, though employee Holiday parties are 100% deductible.

Though the focus of our memo thus far has been on year-end planning for Individual Income Tax, the TCJA has also resulted in substantial changes to tax law for business income and pass through income that is taxed on the individual return.

• Corporate tax rates have been drastically cut to 21% and corporate AMT is no longer applicable. (AMT will apply to substantially less individuals than it has in the past.) 
• New tax law allows for enhanced bonus depreciation and Section 179 deductions.
  • Bonus depreciation now currently allows for 100% expensing of both new and used acquisitions.
  • Maximum deductions for Section 179 property has been increased to $1 million.
  • The phase-out threshold has increased, and the definition of 179 property has expanded to include certain nonresidential real property improvements. 
• The Section 199A deduction is a new and complex deduction intended for individuals and for pass-through entity income on the individual return. It could result in up to a 20% deduction on qualified business income.
  • One consideration related to this deduction is the establishment of a retirement plan on your business income. Doing so will reduce your taxable income for the purposes of qualifying for the deduction while simultaneously helping you save for retirement.
  • If you think this deduction may be applicable to you, we urge you to give us a call. 
• Speaking of retirement plans, if you are eligible to fund one strongly consider that option AND be reminded that some plans, especially those with a 401( k) feature (like a Solo 401(k)) need to be established before December 31st.

We would be remiss if we did not remind you to revisit your estate plan. Some advisors are suggesting, if you are financially situated, you make significant gifts to your heirs before there is a change in Congress that might result in a decrease to the current estate tax exemption amount which is now at $11,180,000 each. If your will is over 5 years old it may need a review.

Please also look at the beneficiary designations on your life insurance policies and your retirement plans. If a prior beneficiary has left us and a new one is not named, the asset may be administered through your estate which is NOT usually the best tax or economic answer.

That’s it for now. These are challenging tax times. PLEASE contact us if you want to discuss or implement any of the items in this memo or if you have any questions that we can help with. 

As always, we hope you find plentiful reasons to give thanks and that the happiness and peace of this season is abundant in your heart and home. Have a great Holiday Season and a happy and healthy 2019!

Thank you for being our friends and clients and allowing our firm to provide your tax and accounting needs. 

Siana Carr O’Connor & Lynam, LLP

Please read about the various changes in payroll withholding and related tax filing requirments for 2019.

The following is a summary of the various changes in payroll withholding and related filing requirements for 2019.  As always, contact us if you have any questions on these matters.

On December 22, 2017, the most significant overhaul of the tax code in over three decades was signed into law. The Tax Cuts and Jobs Act (TCJA) impacts individuals through the introduction of new tax rates and brackets, increased standard deduction, changes to allowable itemized deductions, elimination of personal exemptions, plus many other changes. 

Under the new law, various deductions and certain tax-favored fringe benefits have been eliminated or modified. These changes include the suspension of the deductions for moving expenses and certain qualified transportation expenses. The tax-free reimbursement of employment-related moving expenses has been suspended. The Act also suspends an employee's deduction for unreimbursed business expenses (previously deductible as a miscellaneous itemized deduction). For tax years 2018 and 2019, a credit for Paid Family and Medical Leave may apply to some larger employers who are subject to the Family Medical Leave Act (FMLA). 

The Act reduces the federal corporate (C-Corp) tax rate to 21%, while also providing a new deduction from pass-through income generated by most S-Corps, Partnerships, Sole Proprietors, etc. These provisions have many business owners reconsidering their current entity structure and evaluating the methods for paying themselves and their employees. Please note that the issues of reasonable compensation to owners, and the classification of workers as employees vs. independent contractors remain the focus of Internal Revenue Service scrutiny. Numerous other provisions exist which may impact your employees, you and/or your business, but a more in-depth analysis of the complete Act is beyond the scope of this newsletter focusing on employment taxes. Please contact our office should you desire a more in-depth explanation of this legislation.

 A.         FEDERAL TAX DEPOSITS

Most taxpayers are required to make federal tax deposits for payroll taxes, corporate income tax, and backup withhlding electronically through use of the electronic federal tax payment system.  Paper coupons are discontinued as the paper coupon system is no longer maintained by the Treasury Department.  The primary exemption is for employers that have $2,500 or less in quarterly payroll tax liability, who may pay this liability when filing the quarterly employment tax return.

Officers and/or employees of a corporation or partnership can become personally liable for failure to withhold and remit federal employment taxes.  If you are using a payroll service to make your deposits, you should ensure that the payments are timely made.  Penalties can equal the amount of the tax due (100% penalty).  If you are having difficulty paying your employment taxes timely, please call us.

 The net FUTA rate for most Pennsylvania and New Jersey employers is 0.6% for 2018.  The 2019 net FUTA tax rates are likely to approximate the same.  FUTA tax continues to be assessed on the first $7,000 of wages paid to each worker during a calendar year.

The Internal Revenue Service deadline for submitting government copies of 2018 Form W-2 to the Social Security Administration is January 31, 2019.  This is the same as the deadline to furnish employees with their forms.

B.         SOCIAL SECURITY & MEDICARE TAXES

For 2019, the taxable social security wage base limit is $132,900. The employee and employer tax rate for social security is 6.2%. In 2019, all wages are taxable for the Medicare portion of the tax which is 1.45% for both employees and employers. The self-employment tax rate will be 15.3% on the first $132,900 of net earnings.   

The Patient Protection and Affordable Care Act (ACA) imposes an additional 0.9% Medicare tax on wages, compensation, or self-employment income exceeding the threshold amount $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for other taxpayers. There is no corresponding amount owed by the employer. Employers must withhold Additional Medicare tax from wages it pays to an individual in excess of $200,000 in a calendar year. If individuals anticipate owing more Additional Medicare tax than the amount withheld, they should request additional income tax withholding using Form W-4 and/or should make estimated tax payments. Taxpayers will calculate Additional Medicare tax liabilities on their individual income tax returns (Form 1040), and will apply any Additional Medicare tax withheld against all taxes shown on this return.

 C.         PENNSYLVANIA PERSONAL INCOME TAXES

The withholding rate remains at 3.07%. The PA Dept. of Revenue no longer provides paper coupon booklets. Instead, employer returns and payments should be filed using three electronic options: Internet, Tele file or third-party software. If you have not yet registered under one of these methods, we encourage you to do so. If you want our help in using these filing methods, please call us. More information can be obtained via the internet at www.revenue.state.pa.us and www.etides.state.pa.us. Employers may still file using paper returns and checks, however, we recommend that you switch to the D.O.R. mandated methods.

 D.         PENNSYLVANIA UNEMPLOYMENT COMPENSATION

The first $10,000 of wages paid to each worker in calendar year 2019 is taxed at the employer’s standard rate, as provided by the State. In addition, employers are required to withhold unemployment taxes from employees’ gross wages at a rate of 0.06%. The amount of compensation subject to employee withholding is not limited. Pennsylvania employers are required to electronically file quarterly UC tax and wage reports through the Unemployment Compensation Management System (UCMS). The Department of Labor is no longer mailing paper UC-2 forms to employers. Additional information is available at www.dli.state.pa.us.

E.          PENNSYLVANIA NEW ELECTRONIC FILING REQUIREMENT

The Pennsylvania Department of Revenue recently changed the electronic filing requirement threshold for W-2 forms. Employers who file 10 or more W-2 forms with the Department are now required to file those forms electronically. The change is in effect for tax year 2018 filings. Employers should visit e-TIDES, the Department’s online system for business taxes, at www.etides.state.pa.us to file their Annual Withholding Reconciliation Statement (REV-1667). The REV-1667 must be filed by January 31. Copies of the Individual Wage Statement (W-2) must also be filed electronically with the form REV-1667. 

            Employers should know that the Department will grant a waiver for the 2018 tax filing season with regard to the electronic filing requirement. Additional information regarding the electronic filing requirement is available through the Department’s Business Taxes e-Services Center by accessing its website www.revenue.pa.gov or calling 717-787-7635.

 F.         PHILADELPHIA CITY WAGE TAX

Employers must withhold city wage taxes for residents at the rate of 3.8809% (.038809) and nonresidents who work in the city at the rate of 3.4567% (.034567). Every Pennsylvania employer who employs a Philadelphia resident must register with the Philadelphia City Revenue Commissioner and withhold the city wage tax.  Please note that Philadelphia commonly changes these rates in July each year.

G.         LOCAL PAYROLL TAXES

PA Act 32 - Local Earned Income Tax Law

The Pennsylvania law known as “Act 32” requires every business that employs individuals who work within Pennsylvania, either at a worksite or from their homes to withhold the applicable local earned income tax amount from employees’ wages and to remit this timely to the appropriate tax collection agency. The employer must withhold the greater of the employee’s resident tax rate for where they live or nonresident tax rate for where they work. Each employee must complete a Residency Certification Form, to identify the proper subdivision where they live and work. Additional information regarding Act 32 is available through the PA Department of Community and Economic Development by accessing its website www.newPA.com or calling 1-866-466-3972.

 Philadelphia is not regulated by Act 32, so the present system administered by the Philadelphia Department of Revenue remains in effect.

 Local Services Tax (LST)

 The Local Services Tax (LST) allows local governments to levy a tax of $10 to $52 per employee per year.  If the locality levies a tax of $10, then the employer should withhold the tax from the first paycheck of the employee unless the employee qualifies for an exemption.  The LST exempts employees who make less than $12,000 annually from the tax.  The LST also exempts disabled veterans and reservists who are called to active duty at any time during the year from the tax.  The employer must obtain and retain exemption certificates from such employees to document the non-withholding exemption.  The LST (if more than $10) is not collected at one time, but must be withheld pro rata during the year with each payroll.

 H.        NEW HIRE REPORTING

 Federal regulation mandates all employers to report information about any new employee within 20 DAYS of their hire date.  Penalties for noncompliance can be up to $500 per employee.  Mandatory information to report for all Pennsylvania employers includes: employee’s name, address, social security number, date of birth and hire date, also employer’s name, address, federal identification number, contact and phone number.  Employers may report their new hire information by either manual or electronic means.  Multi state employers must report employees either by magnetic tape or electronically.  Additional information can be obtained at www.cwds.pa.gov or call 1-888-PAHIRES.

I.          RETIREMENT PLANS

• The limitation on the exclusion for elective deferrals under 401(k) and other plans is increased from $18,500 in 2018 to $19,000 in 2019. Taxpayers who are age 50 and older (during 2019) can make an additional catch-up contribution in the amount of $6,000 in 2019.
• 401(k) and 403(b) plans may offer qualified Roth contributions that allow employees to elect to make all or a portion of their 401(k) contributions on an after-tax basis. Similar to Roth IRA’s, earnings grow tax free and, in most circumstances, distributions are free from tax when withdrawn. Your plan documents must explicitly allow designated Roth contributions.
• The annual compensation limit taken into account for qualified plan purposes is increased from $275,000 in 2018 to $280,000 in 2019. 
• The maximum annual amount of salary reduction contributions to a SIMPLE retirement plan is increased from $12,500 in 2018 to $13,000 in 2019. Taxpayers who are age 50 and older (during 2019) can make an additional contribution of $3,000 in 2019.
• The limitation on the annual benefit under a defined benefit plan is increased from $220,000 in 2018 to $225,000 in 2019. The limitation for defined contribution plans is increased from $55,000 in 2018 to $56,000 in 2019.
• The amount used to identify highly compensated employees for non-discrimination testing purposes is increased from $120,000 in 2018 to $125,000 in 2019.

J.         MINIMUM WAGE RATE

 The minimum wage rate for Pennsylvania remains at $7.25 per hour in 2019.

K.         STANDARD MILEAGE RATES

 The standard mileage rate for business automobile usage is 58 cents per mile in 2019.  The optional mileage allowance deduction may be used for both leased and purchased autos.  If you elect the standard mileage rate for a leased auto, that method must be used for the entire lease period of that auto.

L.        NON-CASH FRINGE BENEFITS

As noted above, the Tax Cuts and Jobs Act modifies or eliminates the tax-favored treatment of certain fringe benefits such as moving expenses. The rules regarding the taxation and reporting of other fringe benefits still apply. Taxable fringe benefits include the following: the cost of nondiscriminatory group-term life insurance provided to employees in excess of $50,000; personal use of an employer provided vehicle; the cost of life insurance (other than group-term) provided to employees where the employee may determine the beneficiary; and discriminatory payments to key employees under educational assistance plans, self-insured medical reimbursement plans, dependent care assistance programs and group legal service plans.

 M.         1099 REQUIREMENTS

Form 1099-MISC must be issued to persons and unincorporated entities (including partnerships and LLCs not taxed as corporations) receiving at least $600 for: 1) services rendered other than as an employee; 2) rent; 3) prizes; 4) medical and health care payments; or 5) other payments. Form 1099-MISC is not required to be filed for payments for merchandise, payments made via credit card, nor most payments to corporations, subject to some exceptions. You must also file Form 1099-MISC for each person from whom you have withheld any federal income tax under the backup withholding rules regardless of the amount of payment. Form 1099-INT should be filed to report interest payments of at least $10. 

The filing deadline for Form 1099-MISC to report non-employee compensation in Box 7 and the related Form 1096 is January 31, 2019. For all other reported payments, file Form 1099 by February 28, 2019. The forms generally should be provided to recipients by January 31, 2019. Penalties for late filing, non-filing, or filing incorrect information range from $50 per information return to the greater of $540 or 10% of the aggregate dollar amount of the items required to be reported correctly. In certain instances, these penalties may be higher. Should you require our assistance in preparing these forms, please submit all information to us as soon as possible to allow for timely filing and to avoid the assessment of significant penalties. We recommend that you collect names, addresses and taxpayer identification numbers for every payee and vendor with whom you transact business. Forms W-9 should be used for this purpose and may be obtained via the internet at www.irs.gov or from our website.

Companies paying non-employee compensation for Pennsylvania based work must submit copies of federal forms 1099-MISC to the Pennsylvania Department of Revenue at the same time they are due to the Internal Revenue Service. Beginning January 1, 2018, payors of $5,000 or more for Pennsylvania-sourced work to nonresident individuals or to disregarded entities owned by nonresident individuals are required to withhold Pennsylvania personal income tax from such payments at a rate of 3.07%. Similarly, a business making rent or royalty payments exceeding $5,000 to nonresidents with regard to Pennsylvania property is required to withhold Pennsylvania personal income tax on such payments. These new withholding rules require electronically filed copies of IRS Form 1099-MISC with the Pennsylvania Department of Revenue, as well as quarterly withholding returns and annual reconciliations.

The issue of whether workers should be classified as employees or as independent contractors remains the focus of Internal Revenue Service scrutiny. In determining appropriate worker classification, businesses must weigh a variety of factors. Some will dictate in favor of employee status while others will be indicative of independent contractor status. No single factor establishes the outcome, and all must be carefully considered within the context of the relationship. Improper reporting of workers can result in a requirement to pay back taxes plus interest and punitive penalties. Additional guidance with regard to this complex and important determination may be found at www.irs.gov (search “worker classification”). Should you have any questions, please call us. 

 N.        HEALTH FLEXIBLE SPENDING ARRANGEMENT

 The maximum salary reduction contribution to a health flexible spending arrangement (health FSA) is $2,700 for 2019.  Any salary reductions in excess of this amount will be subject to tax on distributions from the health FSA.

 O.         THE PATIENT PROTECTION AND AFFORDABLE CARE ACT (ACA)

Beginning in 2019, the TCJA eliminates the individual mandate imposing a penalty on those individuals failing to have health insurance coverage required under ACA; however, other provisions of the ACA are still in effect. Generally, ACA requires employers with at least 100 full-time equivalent employees (FTE) to provide health coverage, or risk paying a penalty. ACA also requires employers and insurers to report certain information to the Internal Revenue Service. 

In addition, ACA requires certain employers to report on Form W-2 the aggregate cost of applicable employer sponsored health coverage paid during the calendar year. The aggregate reportable cost is reported on Form W-2 in Box 12, using Code DD. Pending further guidance from the IRS, transition relief of this disclosure requirement may apply to certain small employers who issue less than 250 W-2 Forms each year. A detailed analysis for implementing these provisions is beyond the scope of this newsletter, but please contact us if further guidance is needed in regard to the Affordable Care Act.

 P.         EMPLOYEE BUSINESS EXPENSE REIMBURSEMENTS

If an employee is reimbursed for business expenses under an “accountable plan”, the reimbursements are not treated as taxable income to the employee. An accountable plan must require the employee to: 1) substantiate the nature and amount of the expenses, and 2) repay to the employer any reimbursements in excess of the business expenses incurred. Please contact us if you need assistance in designing an accountable plan.

 Q.        ANNUAL LEASE VALUE AMOUNTS FOR PERSONAL USE OF COMPANY CARS

The “Annual Lease Value” (ALV) table, as issued by the Internal Revenue Service (www.irs.gov), shows the annual value to employees for the personal use of a company car.  This ALV amount of the auto is includible in the employee’s income, unless the car is used exclusively for business purposes.  If the car is used partly for personal driving, a percentage of the ALV (based on the percentage of personal use) is reported on the employee’s W-2.  Note that the ALV does not change each year.  Instead, it is treated as constant for each of the first four years of use.  If the company car is still in use after four years, it is revalued at the beginning of the fifth year, and the ALV based on this new fair market value is used for the next four years of employee use.  The ALV includes the value of auto insurance, registration fees and repairs paid by the company.  It does not include the cost of fuel.  If the company pays for fuel, the cost consumed in personal driving is additional W-2 income to the employee.  A standard rate of 5½ cents per mile may be used in computing income attributable to personal fuel costs paid by the employer.

 R.       PROPOSED OVERTIME REGULATIONS HALTED BY FEDERAL DISTRICT COURT

In 2016, the Department of Labor issued revised overtime rules under the Fair Labor Standards Act. These changes were scheduled to go into effect on December 1, 2016 but have since been halted by subsequent litigation. We recommend that employers remain informed as to the status of this matter.

DISCLOSURE

 The above synopses are brief reviews of general payroll tax issues.  They are not intended to be complete explanations or to provide tax advice for specific fact patterns.  Please discuss any decision concerning specific situations with a tax advisor qualified on such issues.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11 was issued concurrently to provide further guidance on the definition of wages. Also, a proposed revenue procedure, Notice 2019-7, was issued concurrently to provide a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: What is your general overview of the revised, final regulations for the Section 199A Qualified Business Income (QBI) or "pass-through" deduction?

Tom West: I think it is admirable that Treasury and IRS were able to publish these final regulations so quickly and address so many of the comments and questions that the proposed regulations generated. I think they realized how important this particular package was to so many taxpayers for the 2018 filing season and, while questions obviously remain, having these rules out in time to inform decisions for this year’s tax returns is helpful. In particular, the liberalized aggregation rules and the additional examples regarding certain specified service trades or businesses (SSTBs) are the most consequential in my mind.

Wolters Kluwer: What should taxpayers and practitioners keep in mind in consideration of relying on either the proposed or final regulations for the 2018 tax year?

Tom West: I have to imagine that when choosing between the two, for most taxpayers the final regulations will ultimately provide the better result. The ability to aggregate at the entity level, which was only provided in the final regulations, may be a key consideration for those taxpayers with more complicated or tiered structures. That said, I do think taxpayers need to be careful in their aggregation modeling because you are going to be stuck with your aggregation once you’ve filed. It may be that some taxpayers wait on getting locked into a particular aggregation and continue to study the new rules—and even wait on additional guidance that may be coming. However, it may be important to note that the final regulations provide that if an individual fails to aggregate, the individual may not aggregate trades or businesses on an amended return—other than for the 2018 tax year.

Wolters Kluwer: How is the removal of the proposed 80 percent rule regarding specified service trades or businesses (SSTBs) from the final regulations likely to impact certain taxpayers?

Tom West: First of all, I think the removal of this rule is a demonstration of two important dynamics. One, the critical importance of the engagement of taxpayers in the comment process, and, two, the government’s willingness to listen and adapt in their rule-making. I don’t know if there are particular industries or taxpayers who will be impacted, but I do know that the change is a very logical and appropriate one, and logic doesn’t always prevail in these processes, so I’m happy to give the regulators credit when it does.

Wolters Kluwer: Which industries may have been helped or hindered by the final regulations with respect to SSTB rules?

Tom West: I’m not sure specific industries were helped, but the biggest positive in terms of the SSTB final rules is the carryover from the proposed regulations of the treatment of the skill or reputation provision. Had Treasury and the IRS gone in a different direction, there was a risk of that provision swallowing the rest of the 199A regime—not to mention how much more subjective the already sometimes difficult SSTB determinations would have become.

Wolters Kluwer: Are there any lingering, unanswered questions among taxpayers or practitioners that particularly stand out when determining what constitutes SSTB income?

Tom West: I think many taxpayers who have both SSTB and non-SSTB activities were hoping for more clarity, either in rules or examples, on how to acceptably segregate business lines or on when (or if) certain activities are inextricably tied together. There are also still lingering questions regarding when a trade or business is an SSTB—particularly in the field of health.

Wolters Kluwer: Were there any surprises in the final regulations?

Tom West: I don’t know if I’m surprised, knowing the concerns that led them to the decisions they made, but the fact that Treasury and IRS held the line on some of the SSTB-related rules is notable. I’m thinking specifically of the so-called "cliff" effect of the de minimis rule and the fact that owners of certain kinds of SSTB businesses, e.g., sports teams, are not allowed to benefit from the Section 199A deduction.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11, I.R.B. 2019-9, 742, was issued concurrently to provide further guidance on the definition of wages. Also, a proposed Revenue Procedure, Notice 2019-7, I.R.B. 2019-9, 740, was issued, concurrently providing a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: Neither the proposed nor final regulations for Section 199A give guidance as to when rental real estate activity constitutes a Section 162 trade or business. How might the application of the safe harbor provided for in IRS Notice 2019-7 offer taxpayers clarity? And how might failure to qualify for the safe harbor impact the determination of whether the rental activity is a trade or business under Section 199A?

Tom West: The safe harbor is helpful but it appears to be intended for relatively smaller taxpayers who may have had questions about their activities rising to the level of a trade or business. I don’t think falling outside of the safe harbor is dispositive—especially in light of the recent policy statement from Treasury regarding sub-regulatory guidance.

Wolters Kluwer: Can you speak to the some of the complexity that may be involved in tax planning with respect to achieving the right balance between adequate W-2 wages and QBI?

Tom West: Other than for small taxpayers, there is only a benefit under Section 199A if the limitations are met. It does not do any good to have QBI but then have insufficient W-2 wages and qualified property to meet the limitations. So when taxpayers are evaluating what constitutes a qualified trade or business (or whether to aggregate qualified trades or businesses) they will need to determine the amount of W-2 wages with respect to each QTB. Aligning the W-2 wages with the QTB will be important—but the salary expense will also result in a reduction in the amount of QBI and therefore the amount of any Section 199A benefit—so modeling becomes critical. Consideration should also be given to any collateral consequences—for instance the impact of the alignment on allocation and apportionment for state taxes.

Wolters Kluwer: According to a March 18, 2019, Treasury Inspector General for Tax Administration (TIGTA) report, Reference Number: 2019-44-022, IRS management indicated that the timeline related to the issuance of Section 199A guidance did not provide enough time for the IRS to develop a QBI deduction tax form. Although the IRS did create a worksheet, do you have a prediction on what key elements may be included on the new form once released?

Tom West: I do think that worksheets could be developed that would facilitate the reporting of Section 199A information—particularly through tiered structures—so as to ease the reporting burden and enhance compliance.

Wolters Kluwer: The IRS has estimated that nearly 23.7 million taxpayers may be eligible to claim the Section 199A deduction and that more than 22.2 million (94 percent) of those eligible taxpayers will not require a complex calculation for the deduction. What notable differences do you expect there are between "complex" and the majority of calculations?

Tom West: For taxpayers under the Section 199A income thresholds ($157.5K single, $315K joint), the deduction is very easy to calculate and claim. Those taxpayers don’t need to worry about being in an SSTB, how much wages they paid, or the basis of their property. Once those taxpayers hit those income thresholds though, even in the phase-out range, things very quickly get complex—and that’s as a consequence of the statute; it is not something that the regulators can change.

Wolters Kluwer: Do you anticipate the IRS will issue further guidance on the Section 199A deduction?

Tom West: I do. As I said at the top, I think part of the government’s motivation in finalizing these regulations so quickly was providing guidance to taxpayers ahead of the tax-filing season. And while for the majority of taxpayers who are below the 199A cap there is probably now sufficient guidance, I think there are still a lot of questions for those with more complex situations. Given the number of taxpayers who are eligible for this deduction, and the importance of Section 199A as the big benefit to non-corporate businesses in what the Administration views as a signature legislative achievement, I have to believe that the government will be responsive to taxpayers’ requests for additional help on this provision. However, given that the provision is due to sunset, it will be important that any guidance is forthcoming in fairly short order to be of any usefulness to taxpayers.

Wolters Kluwer: At this time, do you have any recommendations for taxpayers and practitioners moving forward?

Tom West: As people are going through their tax filings this year, I’d keep a list of issues, questions, and areas where additional guidance would be helpful. It often happens that problems with new legislation or regulations don’t reveal themselves until taxpayers have to put pencil to paper and track their real-world numbers through returns. We’ll all have that experience this year and, with those lists of issues and questions in hand, there may be an opportunity to approach the IRS and Treasury in the hopes of getting resolution going forward. Keeping that list could also help identify areas for tax planning and perhaps ease the complexity of filing for 2019.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

Immediate Expensing

The Restoring Investment in Improvements Act (HR 1869), sponsored by House tax writers Reps. Jimmy Panetta, D-Calif., and Jackie Walorski, R-Ind., would allow restaurants, retailers, and other leaseholders to immediately write off the cost of certain improvements. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, inadvertently excludes qualified improvement property (QIP) from the new 100 percent bonus depreciation provision.

The measure is a "small but critical fix for our job creators, and technical corrections like this are a normal part of the process when Congress enacts major reforms," Walorski said in a recent press release. "This bipartisan, commonsense bill will allow restaurants, retailers, and other small businesses to unlock the full benefits of tax reform and continue driving our nation’s economic growth."

Similarly, Panetta highlighted the negative impact that the loss of immediate expensing has caused many small businesses. "Our bill will allow restaurants, retailers, and other businesses to make the improvements they need to keep their stores competitive and safe and plan for the future," he said.

Although the "retail glitch" measure has solid bipartisan support, Democrats in general have seemed hesitant to fix any errors in the GOP tax law. To that end, House Ways and Means Committee Chairman Richard Neal, D-Mass., has said he would like to hold a hearing on technical corrections for the TCJA. The committee’s March 27 hearing on the TCJA did not specifically address technical corrections.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

IRS Reform

The Taxpayer First Act of 2019 (HR 1957), as amended, cleared the House Ways and Means Committee by voice on April 2. The House and Senate both introduced the bicameral, bipartisan measure on March 28. If enacted, the bill would make numerous reforms to the IRS, some of which include modernizing antiquated information technology systems and enhancing taxpayer services and identity protections.

"With a new tax code, it is time for a new tax administrator," House Ways and Means Committee ranking member Kevin Brady, R-Tex., said in an April 9 statement. "I applaud the House for passing the Taxpayer First Act—a bold step to redesign the IRS to be an agency with one singular mission: putting taxpayers first."

The IRS Reform bill has been "years in the making," Brady said on April 9, echoing a joint statement that he and Ways and Means Chairman Richard Neal, D-Mass., along with other bipartisan tax writers recently issued. "The House Ways and Means Committee and the Senate Finance Committee have carefully and thoughtfully developed this legislation over several years, after numerous hearings and roundtables, in a bipartisan, bicameral manner," the lawmakers said.

AICPA Applauds Taxpayer First Act

The American Institute of CPAs (AICPA) issued an April 9 statement commending the House for passing HR 1957. "The AICPA appreciates the bipartisan recognition by members of the U.S. House of Representatives for bringing the Internal Revenue Service into the 21st Century," Edward S. Karl, vice president of taxation, said in a statement on behalf of the AICPA. "The AICPA has long been interested in and active in working to find ways to modernize the IRS so that it can better serve the needs of taxpayers and tax practitioners."

Free File Alliance

However, the bipartisan, bicameral bill has not advanced without its share of criticism. Several Democratic lawmakers have criticized a provision within the bill that would codify the Free File Alliance, which is an agreement between the IRS and certain tax preparation companies that includes the IRS being unable to directly assist in tax return preparation.

"Again and again in my service in the Senate I have battled the tax-preparation software industry to simplify filing taxes for the typical American," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said in an April 9 statement. "During the debate on the tax administration bill, my staff pushed back on a prohibition on the agency competing with private tax preparation services, and I will continue to push for my proposal for the pre-filed ‘simple’ return and the principle that a taxpayer should not have to use a private company to pay their taxes online," he added.

Looking Ahead

It remains unclear when the Senate will take up the Taxpayer First Act bill. However, the bill is presently expected on Capitol Hill to easily be approved in the Senate.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

The proposed regulations also withdraw and replace placeholder provisions in an earlier set of proposed regulations ( REG-115420-18). These concern:

• the definition of "substantially all"regulations
• transactions that can trigger includible gain;
• the timing and amount of deferred gain that is included;
• treatment of leased property used in the qualified opportunity zone (QOZ) business;
• use of QOZ business property in the QOZ;
• sourcing of income to the QOZ business; and
• the reasonable period for a QOF to reinvest proceeds from the sale of qualifying assets.

In addition, within a few months the IRS expects to address administrative rules for a QOF that fails to maintain the required 90-percent investment standard, as well as information reporting requirements.

Finally, the IRS expects to revise Form 8996, Qualified Opportunity Fund, for 2019 and subsequent tax years. These revisions may require additional information, including the employer identification number (EIN) for the QOF business, and the amounts invested by QOFs and QOZ businesses located in particular QOZs.

"Substantially All" for QOZ Business

The 2018 regulations provided that a trade or business satisfies the "substantially all" test for a QOZ business if at least 70 percent of its tangible property is qualified opportunity zone business property. The new proposed regulations generally extend this 70-percent threshold to the "substantially all" tests for use. However, in the holding period context, the "substantially all" threshold is 90 percent.

Original Use of Purchased Tangible Property

The proposed regulations generally provide that the "original use" of tangible property acquired by purchase by any person starts on the date when that person or a prior person:

• first places the property in service in the qualified opportunity zone for purposes of depreciation or amortization; or
• first uses the property in the qualified opportunity zone in a manner that would allow depreciation or amortization if that person were the property’s owner.

Used tangible property will satisfy the original use requirement with respect to a QOZ so long as the property has not been previously used (that is, has not previously been used within that QOZ in a manner that would have allowed it to depreciated or amortized) by any taxpayer

In addition, a building or other structure that has been vacant for at least five years before being purchased by a QOF or QOZ business satisfies the original use requirement. Improvements made by a lessee to leased property satisfy the original use requirement and are considered purchased property for the amount of the unadjusted cost basis of the improvements.

Land can be treated as QOZ business property only if it is used in a trade or business of a QOF or QOZ business. The holding of land for investment does not give rise to a trade or business, and the land cannot be QOZ business property. Anti-abuse rules determine whether unimproved land can be qualifying property. However, other purchased real property generally must be substantially improved, determined on an asset-by-asset basis.

Leased Tangible Property in QOZ

Leased tangible property may be QOZ property if:

• the lease is entered into after 2017; and
• substantially all of the property’s use is in a QOZ during substantially all of the lease period.

However, the first-use requirement does not apply to leased tangible property. The leased property can generally also be acquired from a related person, though several conditions apply. The proposed regulations also provide methods for valuing the leased property.

QOZ Businesses

The proposed regulations:

• provide that in determining whether a substantial portion of intangible property of a QOZ is used in the active conduct of a trade or business, a substantial portion is at least 40 percent;
• address real property that straddles a QOZ;
• provide three safe harbors and a facts-and-circumstances test for determining whether a corporation or partnership derives at least 50 percent of its gross income from the active conduct of a qualified business;
• define "trade or business" by reference to Code Sec. 162, except that the ownership and operation (including leasing) of real property used in a trade or business can also be the active conduct of a trade or business; and
• provide a safe harbor for working capital.

Other Business Rules

The proposed regulations also address:

• Section 1231 gains;
• relief regarding the 90 percent asset test, including relief for newly contributed assets and QOF reinvestments;
• the amount of an investment for purposes of the deferral election;
• inclusion events, the timing on basis adjustments, includible amounts, and special rules for partnerships and S corporations;
• gifts and bequests;
• exceptions for disregarded transfers and some nonrecognition transactions;
• distributions and contributions;
• consolidated return provisions;
• holding periods and tacking rules;
• anti-abuse rules;
• special rules for Indian tribes and tribally leased property.

Comments Requested; Public Hearing Scheduled

A public hearing on the proposed regulations is scheduled for 10 am on July 9, 2019, at the New Carrollton Federal Building in Latnham, MD. Public comments may be mailed or hand-delivered to the IRS, or submitted via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-120186-18).

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

Value of Professional Sports Contracts

Professional sports teams enter into contracts with their personnel (e.g., managers, coaches, players, etc.). Typical personnel contracts provide an agreed-upon amount of compensation for a certain duration of service. The value of such a contract may fluctuate based on a variety of factors, including:

• player performance;
• the changing needs of the team and of other teams;
• a player’s effect on fan attendance; and
• the number of years until a player becomes a free agent and is able to sign a contract to play for any team in a league.

Other considerations affecting the value of a player contract include:

• the size of the team’s market (i.e., whether a smaller city or a major urban population);
• the cost of player development; and
• the impact of injuries and slumps on player performance.

In most cases, teams do not trade personnel contracts or draft picks unless the team thinks that it is receiving contracts of an equal or greater value. Because each party believes that they are receiving personnel contracts or draft picks of an equal or greater value, it is difficult to assign a monetary value to them. Accordingly, the IRS developed a safe harbor whereby each team is able to treat the traded contracts or draft picks as having a basis of zero, thus avoiding the recognition of gain or loss on the trade.

Safe Harbor Requirements

In order to use the safe harbor, professional sports teams must meet the following requirements:

• all teams involved in the trade must use the safe harbor;
• teams may only trade personnel contracts, draft picks, and/or cash;
• personnel contracts and/or draft picks cannot be Code Sec. 197 intangibles; and
• the financial statements of all teams involved in the trade must not reflect assets or liabilities resulting from the trade other than cash.

Application

Sports teams using the safe harbor will not recognize any gain or loss if they only trade personnel contracts or draft picks. However, teams that receive cash in a trade will recognize the amount of cash received as gain. In addition, the team providing cash to another team in the trade will receive basis in the personnel contract or draft pick equal to the amount of cash that it provided. A team providing cash to another team in a trade for two or more draft picks or personnel contracts must allocate its basis to each personnel contract or draft pick received from the other team by dividing the basis by the number of personnel contracts or draft picks received.

In certain cases, a team may have unrecovered basis in a draft pick or personnel contract under Code Sec. 167(c). In those instances, the team may recognize gain or loss based on the difference between the unrecovered basis and any cash received.

Effective Date

Teams may use the safe harbor for any trades involving personnel contracts or draft picks entered into after April 10, 2019. However, teams may choose to apply these rules in any open tax year.