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Friday, January 11, 2019

Tax reform reminders

The Tax Cuts and Jobs Act enacted on December 22, 2017 was mostly effective starting in 2018. That was not enough time for anyone to get a good understanding of all of its over 100 changes and the effect and relevance.  The IRS has issued a lot of guidance, but there wasn't enough time to even get all of this finalized by the time any estimated tax payments for 2018 returns were due. 

If any practitioners have ever used Reg. 1.163-8T, 1.163-10T or temporary regulations under section 469, that's a reminder that guidance for some areas changed or added by the Tax Reform Act of 1986 are not yet final!  And there are areas of many Code sections without sufficient guidance, such as Section 1202 added in 1993, but now widely used due to its now 100% gain exclusion (rather than the original 50%) and its reference in new Section 199A on the qualified business income deduction.

So, a few reminders to consider for yourself and if you're a practitioner, your clients:
  • Regulations and other IRS guidance are likely to continue through the extended due date of 2018 returns (and likely beyond).
  • Some issues might not get addressed! Look at the legislative history; read the Bluebook from the Joint Committee on Taxation (JCT), although there are a few places it conflicts with IRS guidance.
  • IRS Notices, such as Notice 2018-76 on deductibility of client meals, are often transitional or interim guidance. So, the rule might be different for 2019 than what the IRS told us for 2018.
  • Non-binding guidance is also being issued by the IRS: forms, instructions, publications, websites, FAQs, information letters, and news releases. But look at them still; they might just be clarifying the statute. If you rely on an FAQ, be sure to make a copy of it. The IRS can change an FAQ and has no archival responsibilities for this informal, non-binding guidance.
  • There are areas where what the JCT Bluebook says and IRS guidance are not the same. For example, page 189 of the Bluebook says that a meal connected with an entertainment event is non-deductible entertainment. In contrast, Notice 2018-76 says if separately charged, the food (client meal for example) is still 50% deductible.
  • There are several areas where the TCJA had errors where the change that Congress said it intended in the committee reports did not make it into the statute. The statute controls what the law is. Congress needs to enact a technical corrections bill to make any of these changes. It was unable to do so in the 115th Congress (in 2018) other than the grain glitch fix. Will any of these corrections be made in the 116th Congress?  Certainly there will be a challenge to doing so in the House now controlled by Democrats although all members have constituents who want some of these taxpayer favorable corrections made (not all of the corrections are taxpayer favorable thought). The real problem to enactment and why we didn't see technical corrections enacted in the 115th Congress is that 60 votes are needed in the Senate. [See former Ways & Means Committee Chair Brady's technical corrections bill introduced on the last day of the 115th Congress and the JCT explanation of it (JCX-1-19).]
  • State treatment of the TCJA provisions might not be clear or complete. For example, California does not (yet?) conform to most of the TCJA provisions. Will it even conform to some? If yes, will that be retroactive to 1/1/18?

What do you think?

Practitioners will want to be sure clients are aware of these issues so they are not caught by surprise or think the practitioner told them something in error where, for example, the rule works one way for 2018, but under updated guidance, works differently for 2019; or is changed for 2018 due to a technical correction being enacted.

Saturday, December 22, 2018

One Year Anniversary of TCJA

On December 22, 2017, President Trump signed an Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018, commonly referred to as the Tax Cuts and Jobs Act (Public Law 115-97). While there were over 100 hearings on tax reform starting in 2011, and a "unified framework for tax reform" released in September 2017, the final legislation moved quickly over about five weeks. There were no public hearings to analyze proposals or look at the big picture to be sure it was the type of reform needed.  The law has a long name because it was created via the budget reconciliation process so that the Senate could pass it with 51 votes rather than the usual 60. The TCJA was a partisan process.

On its anniversary, I'll offer just a few observations on the TCJA:
  1. It's major goal was to lower the corporate rate and move the corporate system to more of a territorial system. This was accomplished with a flat rate of 21% rather than the prior top rate of 35%.
  2. There are several new areas of complexity including an interest expense limitation of Section 163(j), excess business loss limit of Section 461(l), extra calculations for high income individual business owners under Section 199A (it is simpler if the individual has taxable income below $157,500 ($315,000 if MFJ); and most people are below these levels), and a new international regime with many new rules and complexities.
  3. Most of the individual changes, including the rate reductions are temporary for 2018 through 2025.
  4. With over 100 changes and the need for lots of guidance from the IRS, we continue to find surprises. One that dawned on my a few weeks ago is that while Congress explicitly expanded the preparer due diligence penalty of Section 6695(g) to cover returns where the client claims head-of-household status, it sneakily also causes this penalty to apply when the client claims the $500 dependent credit because Congress put that credit in Section 24 where the Child Tax Credit is which was already subject to the penalty. For more, see my 12/13/18 post.
  5. This legislation is not the end-all of tax reform. There were many areas in need of attention that were not included in the bill for various reasons. Missing items include efforts to reduce the annual $400 billion tax gap (taxes owed but not collected), recognize today's economy that involves intangible assets (most of the TCJA favors tangible assets) and a growing gig workforce (no effort to clarify worker classification or provide a simpler/better retirement system for these workers), address the growing deficit-debt-interest expense which will harm future economic growth and be a big burden for our children and grandchildren, improve IRS operations and the tax compliance process, or address problems with Social Security, Medicare and the Highway Trust Fund. In addition, more work is needed to help our tax system meet principles of good tax policy better, such as improved equity and simplification.
btw - here is my post from 12/22/17.

What do you think?

Friday, December 21, 2018

California to follow South Dakota nexus threshold of the Wayfair decision!

On December 11, the California Department of Tax and Fee Administration (CDTFA) announced that effective April 1, 2019, the South Dakota sales/use tax nexus thresholds will apply in California. I think we'll see the California legislature offer a law change to increase these thresholds, at least the one for 200 transactions in a year, to be something more realistic for California that also recognizes the burden on the CDTFA to seek out non-compliance vendors around the world that have 200 or more transactions in California during a calendar year, and to service the compliance ones. After all, customers not charged sales tax still need to report and pay their use tax.

I have more at my policy post at - here.  Please take a look and post a comment!  Thank you!

Thursday, December 13, 2018

TCJA Expanded Preparer Due Diligence Beyond What Congress and IRS Highlight

The Tax Cuts and Jobs Act enacted December 22, 2017, included over 100 tax changes. In the discussion of tax reform, there was a possibility that the head-of-household filing status would be repealed for simplification purposes. But, it was kept. To try to reduce the errors in claiming this status, Congress expanded the Section 6695(g) preparer penalty to include application of the penalty to a paid preparer who does not exercise the appropriate due diligence in preparing a return where the client claims that status. The penalty is $530 per failure.

The Section 6695(g) penalty has gradually expanded since it was first enacted in 1997 to reduce errors in claiming and calculating the Earned Income Tax Credit by paid preparers. In 2015, Congress expanded the penalty to also possibly apply to a preparer who prepares a return where the client claims the Child Tax Credit (CTC) or American Opportunity Tax Credit (AOTC).

Congress and IRS have highlighted that the TCJA expanded the penalty to cover returns where the client claims head-of-household filing status. See for example, this November 7 news release (IR-2018-216). Well, the TCJA actually made this penalty potentially apply even more broadly! The TCJA temporarily repealed the personal and dependency exemptions. The dependency exemption was partly replaced with a $500 per dependent credit. Generally, this credit is available for your children over age 16 and under 19 (under age 24 is a full-time college student). It is also available to a qualifying relative. If a child is under age 17, the parent most likely gets a $2,000 credit for that child instead of $500.

The $500 credit is new and Congress put it in IRC Section 24 where the CTC is located. The Section 6695(g) penalty applies to "the credit allowable by section 24." So, the $500 dependent credit requires paid preparers to do extra due diligence to be sure the client is entitled to any such credit claimed. This basically means asking appropriate questions and documenting the questions and answers and maintaining this information and any documents received for at least three years after filing the return. Form 8867 must also be attached to the return.


What do you think?

Additional resources for Form 8867 and the Section 6695(g) preparer penalty:

  • Section 6695
  • Final regulations released in November 2018 (TD 9842 (11/7/18)
  • Draft instructions for Form 8867
  • Information from the California Franchise Tax Board on head-of-household status (California requires additional information on a return claiming this status due to potential for mistake)
  • Due diligence for the EITC, CTC and AOTC (IRS Pub 4687) (let's see if this gets updated to address all items under Section 6695(g))
  • AOTC - Pub 970 includes some helpful flowchart a preparer might want to have a client use to determine if they might be eligible for the AOTC

Friday, December 7, 2018

Revenues and customers can still be a hobby

For a few years, I have noted in update presentations and elsewhere that some gig drivers who only drive occasionally, do it for cash generation or to pass the time, or have other income sources, might really have an activity not engaged in for profit ("hobby"), rather than a business. The tax consequences of the hobby designation are tremendous in that no deductions are allowed starting in 2018. No self-employment tax is owed either, but loss of tax deductions for a gig driver is costly.  Following is an example of a taxpayer with revenues, customers and a business premises who was found not to be engaged in a business.

Revenues Not Enough to Indicate Business – Ford, TC Memo 2018-8 (1/25/18), aff’d No. 18-1524 (6th Cir., 11/5/18, not for publication) – F used to be recording artist and spend most of her life promoting and performing country music. For the years under exam -  2012 through 2014, she owned and operated the Bell Cove Club in Tennessee on her own. Earlier, she and her husband operated this club (starting in 1986) and wanted it to be a place where artists could perform for talent scouts and producers. It closed when her husband died in 1999 but Joy reopened it in 2008. Customers only had to pay $5 for admission and a small amount for food. F paid performers. Losses were generated. F had some plans she pursued to convert the club into a restaurant or televise the performances, but these changes did not materialize. The IRS disallowed the losses finding the club not operated for profit. The court agreed finding the club was operated mostly for personal pleasure rather than profit with the losses offsetting investment income of F.
F appealed to the 6th Circuit which upheld the Tax Court decision as it did not find any error in that court’s analysis. At the start, the 6th Circuit notes:
“’Find a job doing something you love.’ Perhaps that is sound advice.  But deducting business losses from your taxes when you are not trying to profit from the business you love is not a sound strategy.  Here, the Tax Court found that the appellant did just that: ran a business doing something she loved, accumulated substantial losses, and deducted those losses from her income. Because the court below did not commit clear error in making this determination, we AFFIRM.” The court re-examined the factors under Reg. 1.183-2 that help distinguish a business from an activity not engaged in for profit and concluded that the club wasn’t operated in a for-profit manner. For example, the court noted that Ford did nothing to reduce costs, leaving empty refrigerators and stage lights running even when the club wasn’t open for business. Also, she did not adjust the cover charge to help make a profit. In addition, she did not want to serve alcohol, but let patrons bring in their own. Per the court: “The record paints a picture of a business operated without regard to cost or profit. There is nothing indicating Ford operated in a “business-like manner.””
Observations: The Tax Court generally applied Reg. 1.183-2 without going through a detailed analysis of each of the nine factors. In contrast, the 6th Circuit analyzed each of the nine factors. But both courts concluded that the club was an activity not engaged in for profit (a hobby). Often, we think that an activity with customers and revenues is automatically a business. But more is needed under IRC sections 162 and 183 and the regulations and court cases. Today, this issue can arise with some occasional, part-time gig workers. They generate income from, for example, using the Uber or Lyft platform, but do not set prices, have no business plan, do not regularly engage in the activity, do not have separate financial records, may be doing the activity to generate cash for bills and/or pass the time. These individuals may fall into the same situation as Joy Ford. A tax adviser can help these individuals to convert their hobby or activity at risk of being a hobby into a business by following the Reg. 1.183-2 factors to make the activity a business. After the TCJA, a hobby means all of the revenue is reported, but no deductions are allowed.
What do you think?