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

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

SALT Limit

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

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

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

Payments by Individuals

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

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

Payments by Business Entities

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

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

Benefits Received from Third Party

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

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

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

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

Attribution of Ownership

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

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

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

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

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

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

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

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

Personal Holding Company Income

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

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

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

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

Applicability Date

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

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

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

Final Regulations

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

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

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

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

Applicability Dates

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

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

2019 Proposed Regulations

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

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

Practitioner’s Observations

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

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

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

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

Final Regulations

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

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

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

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

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

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

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

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

Applicability of Final Regs

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

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

Proposed Regulations

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

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

Allocation and Apportionment

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

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

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

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

Redeterminations

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

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

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

Additional Rules

Additional provisions in the proposed regulations:

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

Applicability of Proposed Regs

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

Practitioner’s Observations

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

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

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

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

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

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

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

2019 Reporting

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

Section 704(c) Gain or Loss

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

Section 465 At-Risk Activities

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

Penalty Relief

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

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

Background

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

Covered Entity

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

Nonrecognition of Gain

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

Limitation on Amounts Set Aside for Exempt Purposes

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

Effective Date

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

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

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

Special Rule for Post-2025 Decedents

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

Inflation-Adjusted Amounts and DSUE Amount

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

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

BEA Calculations

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

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

TIGTA Final Audit Report

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

Suitability Checks

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

TIGTA Recommendations

TIGTA recommended that the IRS:

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

The IRS agreed with all the recommendations.

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The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS and the Treasury Department intend to develop income tax withholding regulations to reflect changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), as well as other changes in the Code since the regulations were last amended, and certain miscellaneous changes consistent with current procedures.

Withholding Allowances
The IRS delayed the release of the 2018 Form W-4, Employee’s Withholding Allowance Certificate, in order to reflect changes made by the TCJA, such as changes in itemized deductions available, increases in the child tax credit, the new credit for other dependents, and the suspension of personal exemption deductions. Notice 2018-14 provided relief for employers and employees affected by the delay.

In June, the IRS released a draft 2019 Form W-4 and instructions, which incorporated changes that were meant to improve the accuracy of income tax withholding and make the withholding system more transparent. However, in response to stakeholders’ comments, the IRS later announced that the redesigned Form W-4 would be postponed until 2020. The IRS intends to release a 2019 Form W-4 before the end of 2018 that makes minimal changes to the 2018 Form W-4.

The 2019 Form W-4 and the computational procedures in IRS Publication 15 (Circular E), Employer’s Tax Guide, will continue to use the term "withholding allowances" and related terminology to incorporate the withholding allowance factors specified in Code Sec. 3402(f) and the additional allowance items in Code Sec. 3402(m). Until further guidance is issued, references to a "withholding exemption" in the Code Sec. 3402 regulations and guidance will be applied as if they were referring to a withholding allowance.

Changes in Status
The guidance provides that if an employee experiences a change of status on or before April 30, 2019, that reduces the number of withholding allowances to which he or she is entitled, and if that change is solely due to the changes made by the TCJA, the employee generally must furnish a new Form W-4 to the employer by May 10, 2019. However, if an employee no longer reasonably expects to be entitled to a claimed number of allowances due to a change in personal circumstances that is not solely related to TCJA changes, the employee must furnish his or her employer a new Form W-4 within 10 days after the change. Similarly, if an employee claims married filing status on Form W-4 but divorces his or her spouse, the employee must furnish the employer a new Form W-4 within 10 days after the change.

Failure to Furnish
The IRS and the Treasury Department intend to withdraw the regulations under Code Sec. 3401(e), and modify other regulations, so that an employee who fails to furnish a Form W-4 will be treated as "single" but entitled to the number of withholding allowances determined under computational procedures provided in IRS Publication 15. Until further guidance is issued, however, employees who fail to furnish a Form W-4 will be treated as single with zero withholding allowances.

Additional Allowances
Until further guidance is issued, a taxpayer may include his or her estimated Code Sec. 199A passthrough deduction in determining whether he or she can claim the additional withholding allowance under Code Sec. 3402(m) on Form W-4.

Alternative Procedure
The IRS and the Treasury Department intend to update the withholding regulations to explicitly allow employees to determine their Form W-4 entries by using the IRS withholding calculator ( www.irs.gov/W4App) or IRS Publication 505, Tax Withholding and Estimated Tax, instead of having to complete certain schedules included with the Form W-4. However, the regulations are expected to provide that an employee cannot use the withholding calculator if the calculator’s instructions state that it should not be used due to his or her individual tax situation. The employee will need to use Publication 505 instead.

Alternative Methods
The IRS and the Treasury Department intend to eliminate the combined income tax withholding and employee FICA tax withholding tables under Reg. §31.3402(h)(4)-1(b), due to this alternative procedure’s unintended complexity and burden.

Lock-In Letters
The IRS may issue a "lock-in letter" to an employer, which sets the maximum number of withholding allowances an employee may claim. If the employer no longer employs the employee, the employer must send a written response to the IRS office designated in the lock-in letter that the employee is not employed by the employer. The IRS and the Treasury Department intend to eliminate the written response requirement. Pending further guidance, employers should not send a written response to the IRS under Reg. §31.3402(f)(2)-1(g)(2)(iv).

Pension, Annuity Payments
The payor of certain periodic payments for pensions, annuities, and other deferred income generally must withhold tax from the payments as if they were wages, unless the individual payee elects not to have withholding apply. Before 2018, if a withholding certificate was not furnished to the payor, the withholding rate was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended this rule so that the rate "shall be determined under rules prescribed by the Secretary." The IRS has determined that, for 2019, withholding on periodic payments when no withholding certificate is in effect continues to be based on treating the payee as a married individual claiming three withholding allowances.

Comments Requested
The IRS and the Treasury Department request comments on both the interim guidance and the guidance that should be provided in regulations. Comments must be received by January 25, 2019. Comments should be submitted to: CC:PA:LPD:PR (Notice 2018-92), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2018-92), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., 20224. Alternatively, taxpayers may submit comments electronically to Notice.comments@irscounsel.treas.gov (include "Notice 2018-92" in the subject line of any electronic submission).

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

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

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

I. Qualified Business Income and Activities

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

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

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

Qualified Business Income

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

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

Unadjusted Basis Immediately after Acquisition

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

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

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

De Minimis Exception

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

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

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

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

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

II. Aggregation, Winners & Losers

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

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

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

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

Crack & Pack

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

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

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

Winners & Losers

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

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

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

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

III. Looking Ahead

Questions Remain

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

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

Possible Changes to Proposed Regulations

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

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

Tax Reform 2.0

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

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

Key Takeways

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

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

Wolters Kluwer: Any closing thoughts or comments?

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

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

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

Individual Tax Brackets

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

For married taxpayers filing jointly:

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

For heads of households:

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

For unmarried taxpayers:

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

For married taxpayers filing separately:

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

For estates and trusts:

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

Standard Deduction

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

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

AMT Exemptions

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

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

Estate and Gift Tax

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

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

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

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

Other Amounts

The following other amounts are also projected for 2019:

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

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

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

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

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

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

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A new year may find a number of individuals with the pressing urge to take stock, clean house and become a bit more organized. With such a desire to declutter, a taxpayer may want to undergo a housecleaning of documents, receipts and papers that he or she may have stored over the years in the event of an IRS audit. Year to year, fears of an audit for claims for tax deductions, allowances and credits may have led to the accumulation of a number of tax related documents—many of which may no longer need to be kept.

However, it is of extreme importance for tax records to support the income, deductions and credits claimed on returns. Therefore, taxpayers must keep such records in the event the IRS inquires about a return or amended return.

Return-related documents

Generally, the IRS recommended that a taxpayer keep copies of tax returns and supporting documents at least three years. However, the IRS noted, there are some documents that should be kept for up to seven years, for those instances where a taxpayer needs to file an amended return or if questions may arise. As a rule of thumb, taxpayers should keep real estate related records for up to seven years following the disposition of property.

Health care related documents

Although health care information statements should be kept with other tax records, taxpayers are to remember that such statements do not need to be sent to the IRS as proof of health coverage. Records that taxpayers are strongly encouraged to keep include records of employer-provided coverage, premiums paid, advance payments of the premium tax credit received and the type of coverage held. As with other tax records, the IRS recommended that taxpayers keep such information for three years from the time of filing the associated tax return.

Last year’s return

Taxpayers are encouraged to keep a copy of last year’s return. The IRS, in efforts to thwart tax related identity theft and refund fraud, continues to make changes to authenticate and protect taxpayer identity in online return-related interactions. Beginning in 2017, some taxpayers who e-file will need to enter either the prior-year adjusted gross income or the prior-year self-select PIN and date of birth—information associated with the prior year’s return—to authenticate their identity.

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