On December 20, President Donald Trump signed the bipartisan, year-end government spending and tax package, just hours before federal funding was set to expire. Trump's signature on the over 2,000-page spending package avoided a government shutdown.

On December 20, President Donald Trump signed the bipartisan, year-end government spending and tax package, just hours before federal funding was set to expire. Trump's signature on the over 2,000-page spending package avoided a government shutdown.

Year-End Tax Package
The Further Consolidated Appropriations Act, 2020, (HR 1865), logs just over 700 pages and serves as only half of the government spending package for fiscal year 2020, which runs through September 30. Most notably, HR 1865 serves as the legislative vehicle for a year-end tax package, which carries a costly $426 billion price tag over a 10-year budget window, according to the nonpartisan Joint Committee on Taxation (JCT), JCX-54R-19.

Some of the tax-related provisions in the year-end package include, among other items:

• Retroactive and current renewal of over two dozen temporary tax breaks known as tax extenders, which have expired or would soon be expired, spanning from 2017 to 2019. Generally, the renewed tax breaks are extended through 2020, and the biodiesel and short-line railroad maintenance tax credits are extended until 2022;
• The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) (HR 1994), which makes sweeping changes to retirement savings and employer retirement contributions provisions;
• Certain fixes to the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97); and
• Full repeal of three tax-related provisions of the Affordable Care Act (ACA) ( P.L. 111-148), two of which include the 2.3 percent excise tax on medical devices and the 40 percent excise "Cadillac" tax on high-dollar employer-sponsored health insurance plans.

The House approved HR 1865 on December 17 by a 297-to-120 vote. The Senate cleared the measure on December 19 by a 71-to-23 vote.

"So in the end, with more than $400 billion in tax cuts, there were lots of winners and the usual loser – the budget."

"There were numerous fits and starts, but this result is a reminder that Congressional muscle memory on extenders is very strong, so ultimately the members did what they always do – extend them," John Gimigliano, principal-in-charge of the federal legislative and regulatory services group in the Washington National Tax practice of KPMG LLP told Wolters Kluwer. "Some might be surprised to see the ACA taxes rolled back, but it has always felt like those items were on borrowed time; it was really just a question of when and how they were repealed, not whether. So in the end, with more than $400 billion in tax cuts, there were lots of winners and the usual loser – the budget."

SECURE ACT
The bipartisan SECURE Act, which cleared the House in May but remained stalled in the Senate most of the year, makes a number of major as well as administrative changes for retirement savings affecting both individuals and employers.

Some of those changes are noted as follows:

IRA Changes

• Moving the start date for requirement required minimum distributions (RMDs) to the year the owner turns 72;
• Ending the 70 1/2 age limit for contribute contributions to an IRA; and
• Shortening the distribution period for nonspouse inherited IRAs to a 10-year maximum.
  The 10-year window for distributions to a nonspouse beneficiary applies regardless of when the IRA owner dies. Thus, the change will severely limit the use of "stretch IRAs" as an effective planning tool. Limited exceptions are available.

401(k) Changes

• Requiring plans to offer participation to long-term, part-time employees;
• Encouraging auto-enrollment by increasing the cap; and
• Streamlining the safe harbor for non-elective contributions.

Employers with 401(k) plans must offer employees who work between 500 and 1000 hours year an additional means to participate in the plan. The rule change would only affect 401(k) cash or deferral arrangements, and no other qualified plans.

Retirement Plans for Small Employers

Several changes are made to encourage more small employers to offer retirement benefits to their employees, such as:

• Adding a new tax credit for small employers using auto-enrollment plans;
• Increasing the credit for small employer pension plan start-up costs; and
• Allow small employers of two or more to band together to participate in a new class of pooled multiple employer plans (MEPs).

Congress Adjourns Until 2020
After an eventful two-week sprint to the finish line, Congress adjourned for the year on December 20. Lawmakers are expected to return to Washington, D.C. during the week of January 6, 2020.

The Fifth Circuit U.S. Court of Appeals ruled that the Patient Protection and Affordable Care Act’s (ACA) ( P.L. 111-148) individual mandate is unconstitutional because it can no longer be read as a tax, and there is no other constitutional provision that justifies this exercise of congressional power. However, the central question of whether the rest of the ACA remains valid after Congress removed the penalty for not having health insurance remained unanswered. Instead, the case was sent back to the district court to reconsider how much of the ACA could survive without the individual mandate penalty.

The Fifth Circuit U.S. Court of Appeals ruled that the Patient Protection and Affordable Care Act’s (ACA) ( P.L. 111-148) individual mandate is unconstitutional because it can no longer be read as a tax, and there is no other constitutional provision that justifies this exercise of congressional power. However, the central question of whether the rest of the ACA remains valid after Congress removed the penalty for not having health insurance remained unanswered. Instead, the case was sent back to the district court to reconsider how much of the ACA could survive without the individual mandate penalty.

District Court
According to the opinion, "the rule of law demands a careful, precise explanation of whether the provisions of the ACA are affected by the unconstitutionality of the individual mandate as it exists today." Therefore, the opinion directs the district court to carefully consider whether the mandate can be legally distinct from the rest of the law. The opinion instructs the district court to answer two questions: Which parts of the ACA "are indeed inseverable" now that the mandate is no longer enforced and whether a ruling in the case should apply only to the Republican-led states that sued to overturn the law, an issue raised by Trump administration lawyers.

Dissenting Opinion
A dissenting opinion discussed that Congress made it clear that it wanted the rest of the ACA to stand and sending the case back to the lower court was criticized. The opinion also highlighted that sending the case back to the lower court merely identifies serious flaws in the district court’s analysis and remands for a do-over, which will unnecessarily prolong this litigation and the concomitant uncertainty over the future of the health care sector.

Proposed qualified opportunity zone regulations issued on October 29, 2018 ( REG-115420-18) and May 1, 2019 ( REG-120186-18) under Code Sec. 1400Z-2 have been finalized with modifications. The regulations. which were issued in a 550 page document, are comprehensive.

Proposed qualified opportunity zone regulations issued on October 29, 2018 ( REG-115420-18) and May 1, 2019 ( REG-120186-18) under Code Sec. 1400Z-2 have been finalized with modifications. The regulations. which were issued in a 550 page document, are comprehensive.

The regulations address issued related to all aspects of the gain deferral rules and also various requirements that must be met for an entity to qualify as a qualified opportunity fund (QOF) or as a qualified opportunity zone business. Duplicative rules regarding QOFs and qualified opportunity zone businesses have been combined and definitions of key terms added. The regulations detail which taxpayers are eligible to make the election, the types of capital gains eligible for deferral, and the method of making deferral elections. Revisions are made to the rules applying the statutory 180-period and other requirements with regard to the making of a qualifying investment in a QOF.

The IRS will reflect these regulations in updated forms, instructions, and other guidance in January 2020.

Benefits of QOF Investments
Taxpayers may elect to temporarily defer capital gain in income if the gain is invested within 180 days in a QOF. The gain is recognized on Dec. 31, 2026, or if earlier, upon the occurrence of an inclusion event such as the sale of the QOF investment. However, 10 percent of the deferred gain is not recognized if the investment is held five years and 15 percent is not recognized after seven years. In addition, taxpayers may exclude recognition of gain on appreciation in the investment if the investment in the qualified opportunity fund is held for at least 10 years.

Section 1231 gains
The final regulations provide that eligible gains include the gross amount of eligible section 1231 gains unreduced by section 1231 losses regardless of character. The proposed regulations took a "netting" approach. The 180-day period for an eligible taxpayer to invest an amount with respect to an eligible section 1231 gain begins on the date of the sale of the section 1231 asset rather than at the end of the tax year.

RICS and REITS
The 180-day period for RIC or REIT capital gain dividends generally begins at the close of the shareholder’s tax year in which the capital gain dividend would otherwise be recognized by the shareholder. To ensure that RIC and REIT shareholders do not have to wait until the close of their tax year to invest capital gain dividends received during the tax year, the final regulations also provide that shareholders may elect to begin the 180-day period on the day each capital gain dividend is paid. The 180-day period for undistributed capital gain dividends, however, begins on either the last day of the shareholder’s tax year in which the dividend would otherwise be recognized or the last day of the RIC or REIT’s tax year, at the shareholder’s election.

The aggregate amount of a shareholder’s eligible gain with respect to capital gain dividends received from a RIC or a REIT cannot exceed the aggregate amount of capital gain dividends that the shareholder receives as reported or designated by that RIC or that REIT for the shareholder’s tax year.

Installment Sales
The final regulations allow an eligible taxpayer to elect to choose the 180- day period to begin on either (i) the date a payment under an installment sale is received for that tax year, or (ii) the last day of the tax year the eligible gain under the installment method would be recognized. Therefore, if the taxpayer defers gain from multiple payments under an installment sale, there might be multiple 180-day periods, or a single 180-day period at the end of the taxpayer’s tax year, depending upon taxpayer’s election.

Partners, S Corporation Shareholders, and Trust Beneficiaries
The final regulations provide partners, S shareholders, and beneficiaries of decedents’ estates and non-grantor trusts with the option to treat the 180-day period as commencing upon the due date of the related entity’s tax return, not including any extensions. This rule does not apply to grantor trusts.

Gain from Disposal of Partial Interest in QOF Investment
Gain arising from an inclusion event is eligible for deferral even though the taxpayer retains a portion of its qualifying investment after the inclusion event. If an inclusion event relates only to a portion of a taxpayer’s qualifying investment in the QOF, (i) the deferred gain that otherwise would be required to be included in income (inclusion gain amount) may be invested in a different QOF, and (ii) the taxpayer may make a deferral election with respect to the inclusion gain amount, so long as the taxpayer satisfies all requirements for a deferral election on the inclusion gain amount.

Post-December 31, 2026 Gain Ineligible
Gain arising after December 31, 2026 (including gain mandatorily recognized on that date) is not eligible for deferral.

Death Related Transfers of QOF Investments
A qualifying investment received by a beneficiary in a transfer by reason of death remains a qualifying investment in the hands of the beneficiary.

Acquisition of Eligible Interest from Person Other than a QOF
A taxpayer may make a deferral election for an eligible interest acquired from a person other than a QOF. The final regulations do not require the transferor to have made a prior deferral election for the acquirer of an eligible interest to make the election.

Further, for interests in entities that existed before the enactment of the deferral provision, if such entities become QOFs, then the interests in those entities, even though not qualifying investments in the hands of a transferor, are eligible interests that may (i) be acquired by an investor and (ii) result in a qualifying investment of the acquirer if the acquirer has eligible gain and the acquisition was during the 180-day period with respect to that gain.

Built in Gains
Built-in gain of a REIT, a RIC, or an S corporation potentially subject to corporate-level tax is eligible for deferral. If the deferral election is made, the amount of gain is not included in the calculation of the entity’s net recognized built-in gain.

Identification of Disposed Interests in a QOF
The final regulations permit taxpayers to specifically identify QOF stock that is sold or otherwise disposed. If a taxpayer fails to adequately identify which QOF shares are disposed of, then the FIFO identification method applies. If, after application of the FIFO method, a taxpayer is treated as having disposed of less than all of its investment interests that the taxpayer acquired on one day and the investments vary in its characteristics, then a pro-rata method applies to the remainder.

The specific identification method does not apply to the disposition of interests in a QOF partnership.

Deferred Gain Retains Tax Attributes
The final regulations make it clear that if a taxpayer is required to include in income some or all of a previously deferred gain, the gain so included has the same attributes that the gain would have had if the recognition of gain had not been deferred. If a deferred gain cannot be clearly associated with an investment in a particular QOF, an ordering rule applies to make this determination.

Effective Date
The final regulations are generally applicable to tax years beginning after 60 days after publication in the Federal Register.

With respect to the portion of a taxpayer’s first tax year ending after December 21, 2017, that began on December 22, 2017, and for tax years beginning after December 21, 2017, and on or before 60 days after publication in the Federal Register taxpayers may rely on either the proposed regulations or the final regulations but not both.

The IRS has issued final regulations that provide guidance on transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Specifically, the regulations override the general nonrecognition rule under Code Sec. 721(a) unless the partnership adopts the remedial allocation method and certain other requirements are satisfied. The regulations affect U.S. partners in domestic or foreign partnerships.

The IRS has issued final regulations that provide guidance on transfers of appreciated property by U.S. persons to partnerships with foreign partners related to the transferor. Specifically, the regulations override the general nonrecognition rule under Code Sec. 721(a) unless the partnership adopts the remedial allocation method and certain other requirements are satisfied. The regulations affect U.S. partners in domestic or foreign partnerships.

Background
Code Sec. 721(a) generally provides that no gain or loss is recognized by either a partnership or any of its partners upon a contribution of property to the partnership in exchange for a partnership interest. In Code Sec. 721(c), the Treasury Secretary has regulatory authority to override this nonrecognition provision for gain realized on the transfer of property to a domestic or foreign partnership if the gain, when recognized, would be includible in the gross income of a person other than a U.S. person.

Under temporary regulations issued in 2017, if a U.S. person contributes certain property with built-in gain to a partnership that has foreign partners related to the transferor, then gain will be recognized unless the gain deferral method is applied with respect to the property ( Temporary Reg. §§1.721(c)-2T; 1.721(c)-3T). Under a de minimis exception, nonrecognition continues to apply if the sum of all built-in gain property contributed to the partnership during the tax year does not exceed $1 million.

The final regulations adopt the temporary regulations with certain modifications.

Related Person Definition
The final regulations modify the definition of related person in certain situations. This modification provides relief when certain foreign individual partners of a partnership would be treated as a related person with respect to a domestic corporation by reason of Code Sec. 267(c)(3).

Consistent Allocation Method
The final regulations add a new sentence in Reg. §1.721(c)-3(c)(1). Upon a variation (as described in Reg. §1.706-4(a)(1)) of a U.S. transferor’s interest in a Code Sec. 721(c) partnership, book items with respect to section 721(c) property that are allocated under the interim closing method (as described in Reg. §1.706-4) will be treated as allocated in the same percentage for applying the consistent allocation method in a single tax year, unless the variation results from a transaction undertaken with a principal purpose of avoiding the tax consequences of the gain deferral method.

Reporting Requirements
The 2017 regulations required much of the reporting to be on statements attached to returns. Since the 2017 regulations were issued, however, the IRS has updated and added new schedules to Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, to facilitate compliance with these reporting requirements. The IRS has also issued new Form 8838-P, Consent To Extend the Time To Assess Tax Pursuant to the Gain Deferral Method (Section 721(c)). The final regulations generally require taxpayers to use these forms and schedules.

The final regulations also clarify the duration for which the U.S. transferor must extend the period of limitations on the assessment of tax under Reg. §1.721(c)-6(b).

Technical Termination Rules
The Tax Cuts and Jobs Act, ( P.L. 115-97) (the "TCJA") eliminated technical terminations. However, the applicability date for these final regulations relates back to the applicability date provided in the 2017 regulations, which is before the effective date provided in the TCJA. Accordingly, the final regulations retain technical termination rules, but their application will be limited. The rules will only apply to technical terminations occurring on or after the applicability date provided in the 2017 regulations but before the effective date for the repeal of Code Sec. 708(b)(1)(B) provided in the TCJA.

Effective Date
The regulations are effective on the date of filing with the Federal Register. For dates of applicability, see Reg. §§1.197-2(l)(5)(i), 1.704-1(f), 1.704-3(g)(1), 1.721(c)-1(e), 1.721(c)-2(e), 1.721(c)-3(e), 1.721(c)-4(d), 1.721(c)-5(g), 1.721(c)-6(g), and 1.6038B-2(j)(4).

The IRS has released Publication 5382, "Internal Revenue Service Progress Update / Fiscal Year 2019—Putting Taxpayers First." This new annual report describes accomplishments across the agency, and highlights the work of IRS employees during the past year. It covers a variety of taxpayer service efforts, including development of the new Taxpayer Withholding Estimator, as well as operations support efforts on areas involving information technology modernization, human capital office initiatives, and others.

The IRS has released Publication 5382, "Internal Revenue Service Progress Update / Fiscal Year 2019—Putting Taxpayers First." This new annual report describes accomplishments across the agency, and highlights the work of IRS employees during the past year. It covers a variety of taxpayer service efforts, including development of the new Taxpayer Withholding Estimator, as well as operations support efforts on areas involving information technology modernization, human capital office initiatives, and others.

"This report is about more than what happened during the past year," IRS Commissioner Chuck Rettig wrote in the report’s opening message to taxpayers. "It’s also designed to provide insight into the people serving this country on behalf of the IRS, and provide a glimpse into the future," he added.

IRS Pub. 5382 also focuses criminal investigation results and efforts involving civil enforcement. Also discussed are ongoing compliance areas, including micro-captives, syndicated conservation easements, and virtual currency. The report further covers the IRS’s implementation of new tax laws, and the IRS’s ongoing work on the new Taxpayer First Act of 2019.

Individual Audits Down
Taxpayers are now half as likely to be audited by the IRS for their individual income tax returns as they were a decade ago. As described in IRS Pub. 5382, the IRS audited 0.45 percent of individual (1040) income tax returns during fiscal year (FY) 2019. This number is down from 1.1 percent of tax returns audited in 2010. The IRS’s ongoing loss to its total workforce is largely to blame for the consistent decline in IRS audits, according to the report.

"The IRS lost more than 29,618 full time positions between FY 2010 and FY 2019, which includes Information Technology, Operations Support, Taxpayer Service and Enforcement personnel. These losses directly correlate with a steady decline in the number of individual audits during the past nine years," the report notes.

Hill Reaction
Although individual audits have significantly decreased, Democratic lawmakers on Capitol Hill are criticizing the fact that the IRS continues to conduct more examinations on lower-income individual taxpayers than it does on higher-income taxpayers or corporations. However, the IRS has said previously that audits on higher-income individuals and businesses are significantly more complex and require more resources.

"IRS audit rates are at their lowest levels in 40 years, allowing the wealthy and well-connected to steal from taxpayers with no consequences," Senate Finance Committee ranking member Ron Wyden, D-Ore., said in a January 7 statement. "The bulk of tax avoidance and fraud comes from corporations, pass-through business and those at the top. Ensuring the wealthy and corporations pay what they owe takes the most resources and manpower, and I’m working with the IRS to get a clear picture on funding and staffing levels needed to audit top earners at 2010 levels," Wyden added.

Currently, the IRS anticipates that up to 31 percent of its workforce (nearly 19,719 full-time employees) will retire within the next five years. The IRS’s workforce decline is expected to create a "significant risk of a large knowledge and experience gap for the nation’s tax agency," according to the IRS report.

Bridget Roberts, the Acting National Taxpayer Advocate, released her 2019 Annual Report to Congress. The report discusses the key challenges facing the IRS regarding the implementation of the Taxpayer First Act, inadequate taxpayer service and limited funding of the agency. Further, Roberts released the third edition of the National Taxpayer Advocate’s "Purple Book," which presents 58 legislative recommendations designed to strengthen taxpayer rights and improve tax administration.

Bridget Roberts, the Acting National Taxpayer Advocate, released her 2019 Annual Report to Congress. The report discusses the key challenges facing the IRS regarding the implementation of the Taxpayer First Act, inadequate taxpayer service and limited funding of the agency. Further, Roberts released the third edition of the National Taxpayer Advocate’s "Purple Book," which presents 58 legislative recommendations designed to strengthen taxpayer rights and improve tax administration.

Taxpayer First Act
The report highlighted that the Taxpayer First Act ( P.L. 116-25) had made the most comprehensive revisions to IRS procedures since the IRS Restructuring and Reform Act of 1998, including some 23 provisions previously recommended by the National Taxpayer Advocate. Further, the Taxpayer First Act also required the IRS to develop four strategic plans:

• a comprehensive taxpayer service strategy (due to Congress by July 1, 2020);
• a comprehensive plan to redesign the IRS’s organizational structure (due to Congress by Sept. 30, 2020);
• a comprehensive employee training strategy that includes taxpayer rights training (due to Congress by July 1, 2020); and
• a multi-year plan to meet IRS information technology (IT) needs.

Key IRS Challenges
The biggest challenge facing the IRS is its struggle to complete its mission. The IRS aims to "provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." The report emphasizes that the IRS is struggling to meet both of those goals, and attributes the IRS’s shortcomings mostly to budget constraints but also to a culture in which the agency focuses on its own priorities without adequately factoring in the needs of taxpayers.

The report states that the IRS is among the lowest-performing federal agencies in providing a positive customer experience. During fiscal year (FY) 2019, the report said that the IRS received approximately 100 million telephone calls, and customer service representatives answered only 29 percent. The report further states that the IRS has also struggled to enforce the law with "fairness to all". The report urges the IRS to prioritize phone service for taxpayers against whom it takes collection action.

Low Budget
Since 2010, the IRS budget has been reduced by about 20 percent after adjusting for inflation, and the number of full-time equivalent employees has declined by about 22 percent. The report points out that answering 100 million telephone calls, conducting audits, and taking enforcement actions require adequate staffing, and the IRS cannot substantially improve its performance without additional resources. The report urges Congress to increase IRS funding and particularly for taxpayer service and IT modernization, and to change the budget rules to account for the revenue additional IRS appropriations are likely to generate.

Identifying Taxpayer Needs and Preferences
Despite the IRS’s significant funding limitations, the report urges the IRS to utilize the Taxpayer First Act requirements – to develop plans to revamp its taxpayer service strategy, organizational structure, employee training strategy, and technology priorities – as a roadmap for a once-in-a-generation reassessment of its objectives and operations.

While noting that the IRS has developed strategies in a vacuum without soliciting taxpayer feedback and taking into account taxpayer needs and preferences, the report suggests a full-scale cultural shift. The report also expressed concern that the IRS has declined to include the National Taxpayer Advocate or a Taxpayer Advocate Service (TAS) representative as part of a core team created to coordinate its Taxpayer First Act implementation activities.

The report also makes numerous recommendations to improve the customer experience, including that the IRS take the following actions:

• Conduct multi-disciplined, comprehensive research into taxpayer needs and preferences.
• Require that all IRS business units, including those charged primarily with enforcement, develop a detailed customer service strategy.
• Appoint a Chief Customer Experience Officer to coordinate service initiatives across IRS business units.
• Ensure that taxpayers who cannot work with the IRS digitally, or whose issues are not resolved online, can reach and work with an IRS employee.
• Address the needs of practitioners who interact with the IRS on behalf of large numbers of taxpayers.
• For each proposal included in its customer service strategy, include cost estimates, milestones, and taxpayer-focused performance measures so the effectiveness of the strategy in improving customer service can be measured over time.

Other Matters
The report also:

• identified 10 "most serious problems";
• provided status updates on two problems identified in previous reports;
• made dozens of recommendations for administrative change;
• made 58 recommendations for legislative change;
• analyzed the 10 tax issues most frequently litigated in the federal courts; and
• presented four research studies.

The IRS has modified the applicability dates for proposed regulations under Code Sec. 382 that were issued with NPRM REG-125710-18, September 10, 2019 (2019 proposed regulations). The IRS is withdrawing the text of the proposed applicability dates, and proposing revised applicability dates. The newly issued proposed rules would also provide transition relief.

The IRS has modified the applicability dates for proposed regulations under Code Sec. 382 that were issued with NPRM REG-125710-18, September 10, 2019 (2019 proposed regulations). The IRS is withdrawing the text of the proposed applicability dates, and proposing revised applicability dates. The newly issued proposed rules would also provide transition relief.

Proposed Regulations and Notice 2003-65
The 2019 proposed regulations would provide guidance on the inclusion of items of income and deductions in the calculation of built-in gains and losses under Code Sec. 382(h). The proposed regulations would apply to ownership changes that occur after the date the proposed regulations are published as final regulations in the Federal Register.

Notice 2003-65, 2003-2 CB 747, provides interim guidance for identifying built-in gains and losses under Code Sec. 382(h). This notice permits taxpayers to rely on safe harbor approaches for applying Code Sec. 382(h) to an ownership change prior to the effective date of temporary or final regulations issued under that provision.

Delay of Applicability Date
To address concerns raised by taxpayers and practitioners, the IRS has withdrawn the text of Proposed Reg. §1.382-2(b)(4) and Proposed Reg. §1.382-7(g) contained in the 2019 proposed regulations, and replaced it with a revised proposed applicability date text. To avoid any gap between the date on which taxpayers can no longer rely on Notice 2003-65 and the date on which the final regulations are applicable, the applicability date of the final regulations would be 30 days after the date such regulations are published in the Federal Register (delayed applicability date). Exceptions exist for two situations discussed below.

Notice 2003-65 will remain applicable to ownership changes to which the final regulations do not apply.

Limiting Duplicative Application
The first exception to the delayed applicability date relates to the rule in Proposed Reg. §1.382-7(d)(5), which provides that certain carryforwards of business interest expense disallowed under Code Sec. 163(j) would not be treated as recognized built-in losses under Code Sec. 382(h)(6)(B), if such amounts were allowable as deductions during the five-year recognition period set forth in Code Sec. 382(h)(7)(A). This rule eliminates the possible duplicative application of Code Sec. 382 to certain disallowed business interest expense carryforwards.

The IRS has determined that Proposed Reg. §1.382-7(d)(5) should be finalized before the remainder of the rules in the 2019 proposed regulations, and that taxpayers should be allowed to retroactively apply this rule. To that end, the IRS expects that Proposed Reg. §1.382-7(d)(5) will be finalized as part of the Treasury decision that finalizes the proposed Code Sec. 163(j) regulations (see 83 FR 67490), and that taxpayers will be permitted to apply the rule to prior periods. The IRS continues to study the remainder of the rules in the 2019 proposed regulations.

Transition Relief
Under the proposed transition relief provisions, the final regulations would not apply to certain ownership changes that occur after the delayed applicability date. To qualify for the transition relief, the ownership change must occur immediately after an owner shift or equity structure shift that occurs pursuant to:

• a binding agreement in effect on or before the delayed applicability date and at all times thereafter;
• a specific transaction described in a public announcement made on or before the delayed applicability date;
• a specific transaction described in a filing with the Securities and Exchange Commission submitted on or before the delayed applicability date;
• a transaction described in a private letter ruling request submitted to the IRS on or before the delayed applicability date; or
• a court order (or a plan confirmed, or a sale approved, by court order) in a title 11 or similar case, provided that the taxpayer was a debtor in a case before such court on or before the delayed applicability date.

The relevant owner shift or equity structure shift must be a specific, identifiable transaction.

Taxpayers may continue to rely on Notice 2003-65 for to any ownership change qualifying for transition relief, even though the notice will be obsoleted on the delayed applicability date. However, a taxpayer may choose to apply the final regulations to such an ownership change.

The Treasury and IRS have issued final regulations on the due diligence and reporting rules for persons making certain U.S. source payments to foreign persons. Guidance is also provided on reporting by foreign financial institutions on U.S. accounts. The regulations are effective on the date the regulations are published in the Federal Register.

The Treasury and IRS have issued final regulations on the due diligence and reporting rules for persons making certain U.S. source payments to foreign persons. Guidance is also provided on reporting by foreign financial institutions on U.S. accounts. The regulations are effective on the date the regulations are published in the Federal Register.

Obtaining a Foreign TIN and Date of Birth
Temporary regulations provided that beginning January 1, 2017, a beneficial withholding certificate provided to document an account maintained at a U.S. branch or office of a financial institution was required to include a foreign taxpayer identification number (TIN) and the date of birth for an individual, in order to treat the certificate as valid. In response to comments regarding the difficulty of the requirements, the Treasury and IRS issued Notice 2017-46.

The notice provided a one-year delay in the implementation of the requirements for payments made on or after January 1, 2018, and a transitional rules to phase in the foreign TIN requirement for certificates provided before January 1, 2018. The transitional rules allow an otherwise valid certificate to remain valid until January 1, 2020. For payments made after January 1, 2020, a withholding agent may treat a pre-2018 as valid if the foreign TIN is obtained on a written statement or is in the withholding agent’s files. In Notice 2018-20, the IRS stated that it intended to expand its list of jurisdictions that do not issue foreign TINs to their residents to include jurisdictions that requested to be on the list, even if they issue foreign TINs.

The final regulations incorporate the temporary regulations and Notices with minor changes, by:

• providing, with respect to withholding certificates signed on or after January 1, 2018, that a separate written statement is an acceptable way to collect a foreign TIN, if the written statement contains an acknowledgment that the statement is part of the withholding certificate;
• clarifying the exception to the foreign TIN requirement for an account holder that is a government, international organization, foreign central bank or resident of a U.S. territory; and
• clarifying that a withholding agent may rely on the date of birth on a withholding certificate, unless it knows or has reason to know that the date of birth is incorrect.

Nonqualified Intermediaries
A nonqualified intermediary is generally required to provide a withholding agent a Form W-8IMY, a withholding statement, and documentation for each payee for which the intermediary receives a payment. The final regulations clarify that the general standards of knowledge that apply to withholding agents apply to a nonqualified intermediary for reliance on payee documentation, for making the representation that the information on the certificate is not inconsistent with other account information that the nonqualified intermediary has.

A nonqualified intermediary may provide a withholding statement that does not include a chapter 4 recipient code for one or more payees if the withholding agent can determine the appropriate code based on other information included on or associated with the withholding statement, or contained in the withholding agent’s records.

Electronic Signatures
A withholding agent can accept an electronically signed withholding certificate if the certificate reasonably demonstrates to the withholding agent that it has been electronically signed by the recipient identified on the form or authorized by the recipient to sign the form.

The final regulations allow the withholding agent to also consider documentation or other information that the withholding agent has that supports that the withholding certificate was electronically signed, absent actual knowledge that the information or documentation is incorrect.

Additional Changes
The final regulations also make clarifications with respect to withholding certificates and statements furnished through a third party repository.

Regarding the claim of a reduced rate of withholding under a treaty, the final regulations modify the general standard of knowledge by providing that:

• the withholding agent has reason to know that a claim of reduced rate under a treaty is unreliable or incorrect when it can check a list on the IRS website regarding the existence of the treaty, and
• a withholding agent can rely on a beneficial owner’s claim regarding a limitation of benefits (LOB) provision, absent actual knowledge that the claim is unreliable or incorrect.

The final regulation also extend the time for withholding agents to obtain treaty statements, with respect to specific LOB provisions for preexisting accounts, to January 1, 2020.

Taxpayers have been provided with additional guidance for complying with the Code Sec. 871(m) regulations on dividend equivalent payments for 2021, 2022, and 2023. The Treasury Department and the IRS intend to amend the regulations to delay the effective/applicability date of certain rules. Further, the phase-in period provided in Notice 2018-762, I.R.B. 2018-40, 522, has been extended.

Taxpayers have been provided with additional guidance for complying with the Code Sec. 871(m) regulations on dividend equivalent payments for 2021, 2022, and 2023. The Treasury Department and the IRS intend to amend the regulations to delay the effective/applicability date of certain rules. Further, the phase-in period provided in Notice 2018-762, I.R.B. 2018-40, 522, has been extended.

Dividend Equivalent Payments
A dividend equivalent amount is essentially an amount directly or indirectly determined by reference to a U.S. dividend. Code Sec. 871(m) treats dividend equivalent payments as U.S. source dividends. These payments are subject to 30-percent withholding (or a lower treaty rate) if received by a nonresident alien or foreign corporation.

The Code Sec. 871(m) regulations include final and temporary regulations under Code Secs. 871(m), 1441, 1461, and 1473.

Phase-in Year Extended
The effective/applicability date for the specified notional principal contract (NPC) rules under Reg. §1.871-15(d)(2) and the specified equity-linked instrument (ELI) rules under Reg. §1.871-15(e) will be revised. These rules will not apply to any payment made with respect to any non-delta-one transaction issued before January 1, 2023.

The IRS will take into account the extent to which the taxpayer or withholding agent made a good faith effort to comply with the Code Sec. 871(m) regulations in enforcing those regulations—

• for any delta-one transaction in 2017 through 2022; and
• for any non-delta-one transaction that is a Code Sec. 871(m) transaction under Reg. §1.871-15(d)(2) or Reg. §1.871-15(e) in 2023.

Further, the period when the IRS will take into account the extent to which a qualified derivatives dealer made a good faith effort to comply with the Code Sec. 871(m) regulations and the relevant provisions of the 2017 Qualified Intermediary (QI) Agreement is extended through 2022.

The 2017 QI Agreement will be revised so that a QDD will be treated as satisfying the obligations that specifically apply to a QDD under that agreement for 2017 through 2022.

Simplified Standard Extended
The period when the simplified standard applies for withholding agents to determine whether transactions entered into were combined transactions is extended to include 2021 and 2022. Transactions entered into in 2017 through 2022 that are combined under the simplified standard will continue to be treated as combined for future years. They will not stop being combined transactions by applying Reg. §1.871-15(n) (the combined transactions rule in the regulations), or by disposing of less than all of the potential Code Sec. 871(m) transactions that are combined under this rule.

Transactions entered into in 2017 through 2022 that are not combined under the simplified standard will not become combined transactions by applying Reg. §1.871-15(n) to them in future years, unless a reissuance or other event causes the transactions to be retested to determine whether they are Code Sec. 871(m) transactions.

Phase-In Relief for Qualified Derivatives Dealers Extended
Regarding qualified derivatives dealers (QDDs), Reg. §1.871-15(q)(1), Reg. §1.871-15(r)(3), and Reg. §1.1441-1(b)(4)(xxii)(C) will be amended so that a QDD will not be subject to tax on dividends and dividend equivalents received in 2021 and 2022 in its equity derivatives dealer capacity or withholding on those dividends (including deemed dividends). A QDD will have to compute its Code Sec. 871(m) amount using the net delta approach beginning in 2023.

A QDD will remain liable under Code Sec. 881(a)(1) for tax on dividends and dividend equivalents that it receives in any other capacity, and on any other U.S. source FDAP payments that it receives (whether or not in its equity derivatives dealer capacity). A QDD is also responsible for withholding on dividend equivalents it pays to a foreign person on a Code Sec. 871(m) transaction.

Transition Rules Extended
Withholding agents may apply the qualified securities lender (QSL) transition rules described in Notice 2010-46, I.R.B. 2010-24, 757, for payments made in calendar years 2021 and 2022.

Anti-Abuse Rule
The anti-abuse rule in Reg. §1.871-15(o) will continue to apply during the phase-in years. This means that a transaction that would not otherwise be treated as a Code Sec. 871(m) transaction (including as a result of the new guidance) might still be a Code Sec. 871(m) transaction under the anti-abuse rule.

Taxpayer Reliance
Taxpayers and withholding agents can rely on the new guidance before the Treasury and IRS amend the Code Sec. 871(m) regulations and the 2017 QI Agreement.

You have just been notified that your tax return is going to be audited ... what now? While the best defense is always a good offense (translation: take steps to avoid an audit in the first place), in the event the IRS does come knocking on your door, here are some basic guidelines you can follow to increase the chances that you will come out of your audit unscathed.

You have just been notified that your tax return is going to be audited ... what now? While the best defense is always a good offense (translation: take steps to avoid an audit in the first place), in the event the IRS does come knocking on your door, here are some basic guidelines you can follow to increase the chances that you will come out of your audit unscathed.

Relax. It is a normal reaction upon receiving notice of an audit to panic and feel particularly singled out, however, as in most situations, panic can be counterproductive. A better course of action is to contact an experienced professional to get additional guidance as to how best to proceed to prepare for the audit as well as to get reassurance that everything will be fine.

Be professional. In the event that you have any type of communication with the IRS prior to your audit -- written or verbal, it's important that you act in a professional, business-like manner. Verbally abusing the auditor or becoming defensive is not a good way to start off your relationship with him or her.

Organization is very important. Before the audit, take the time to gather all of your documents together and consider how they will be presented. While throwing them all into a box in a haphazard fashion is certainly one way to present your documents to your auditor, this method will also be sure to raise at least one eyebrow ... and encourage him or her to dig deeper.

As you gather your data, you may need to re-create records if no longer available. This may involve calls to charities, medical offices, the DMV, etc., to obtain the written documentation required for verification of deductions claimed. Once you are confident that you have all of the necessary documentation, organize it in a binder, separated by category as shown on your return. This will allow quick and easy access to these records during the actual audit, something that the auditor will appreciate and will give him/her the impression that you are organized and thorough.

Leave the face to face to a professional. Make sure that you retain the services of a tax professional, most likely the person who prepared your return. Having a tax professional appear on your behalf for your audit is beneficial in a number of ways.

• A tax professional is emotionally detached from the return and less likely to become angry or defensive if questioned.
• A tax professional can serve as a "buffer" between you and the IRS -- indicating that he/she will need to get back to the auditor on certain issues, can buy you extra time to prepare for an issue raised you didn't consider.
• A tax professional can keep an auditor on track, making sure all inquiries are relevant to the return areas being audited.

If you disagree, appeal. If you disagree with the outcome of the audit, you still have the right to send your case to the IRS Appeals division for review. Appeals officers are usually more experienced than auditors and are more likely to negotiate with you, if necessary.

As for the "best defense is a good offense" comment? In this case, this old adage applies to how you approach the tax return preparation process throughout the year, year-in and year-out.

• Good recordkeeping is key. Maintaining complete and accurate records throughout the year reduces the chance that you will forget to provide important information to your tax preparer, which can increase your chances of audit. Good recordkeeping will also result in a more relaxed reaction to notification of an audit as most of your upfront audit work will be complete -- this is especially true if you audit pertains to a tax year several years in the past! Tax records should be retained for at least 3 years after the filing date.
• Provide ALL relevant information to your tax preparer. When your tax preparer is fully informed of all tax-related events that occurring during the year, the chances for errors or omissions on your return dramatically decrease.
• Keep a low profile. Error-free, complete tax returns that are filed in a timely manner don't have the tendency to raise any of those infamous "red flags" with the IRS. During the year, if the IRS does send you correspondence, it should be responded to immediately and fully. Don't hesitate to retain professional assistance to help you "fly under the radar".

While the odds of your tax return being audited remain very low, it does happen to even the most diligent taxpayers. If you are contacted about an examination by the IRS, take a deep breath, relax and contact the office as soon as possible for additional assistance and guidance.

Employers are required by the Internal Revenue Code to calculate, withhold, and deposit with the IRS all federal employment taxes related to wages paid to employees. Failure to comply with these requirements can find certain "responsible persons" held personally liable. Who is a responsible person for purposes of employment tax obligations? The broad interpretation defined by the courts and the IRS may surprise you.

Employers are required by the Internal Revenue Code to calculate, withhold, and deposit with the IRS all federal employment taxes related to wages paid to employees. Failure to comply with these requirements can find certain "responsible persons" held personally liable. Who is a responsible person for purposes of employment tax obligations? The broad interpretation defined by the courts and the IRS may surprise you.

Employment taxes such as federal income tax, social security (FICA) tax, unemployment (FUTA) tax and various state taxes (note that state issues are not addressed in this article) are all required to be withheld from an employee's wages. Wages are defined in the Code and the accompanying IRS regulations as all remuneration for services performed by an employee for an employer, including the value of remuneration, such as benefits, paid in any form other than cash. The employer is responsible for depositing withheld taxes (along with related employer taxes) with the IRS in a timely manner.

Although the employer entity is required by law to withhold and pay over employment taxes, the penalty provisions of the Code are enforceable against any responsible person who willfully fails to withhold, account for, or pay over withholding tax to the government. The trust fund recovery penalty -- equal to 100% of the tax not withheld and/or paid over -- is a collection device that is normally assessed only if the tax can't be collected from the employer entity itself. Once assessed, however, this steep penalty becomes a personal liability of the responsible person(s) that can wreak havoc on their personal financial situation -- even personal bankruptcy is not an "out" as this penalty is not dischargeable in bankruptcy.

A corporation, partnership, limited liability or other form of doing business won't insulate a "responsible person" from this obligation. But who is a responsible person for purposes of withholding and paying over employment taxes, and ultimately the possible resulting penalty for noncompliance? Also, what constitutes "willful failure to pay and/or withhold"? To give you a better understanding of your potential liability as an employer or employee, these questions are addressed below.

Typically, the types of individuals who are deemed "responsible persons" for purposes of the employment tax withholding and payment are corporate officers or employees whose job description includes managing and paying employment taxes on behalf of the employer entity.

However, the type of responsibility targeted by the Code and regulations includes familiarity with and/or control over functions that are involved in the collection and deposit of employment taxes. Unfortunately for potential targets, Internal Revenue Code Section 6672 doesn't define the term, and the courts and the IRS have not formulated a specific rule that can be applied to determine who is or is not a "responsible person." Recent cases have found the courts ruling both ways, with the IRS generally applying a broad, comprehensive standard.

A Texas district court, for example, looked at the duties performed by an executive -- and rejected her argument that responsibility should only be assigned to the person with the greatest control over the taxes. Responsibility was not limited to the person with the most authority -- it could be assigned to any number of people so long as they all had sufficient knowledge and capability.

The Fifth Circuit Court of Appeals has delineated six nonexclusive factors to determine responsibility for purposes of the penalty: whether the person: (1) is an officer or member of the board of directors; (2) owns a substantial amount of stock in the company; (3) manages the day-to-day operations of the business; (4) has the authority to hire or fire employees; (5) makes decisions as to the disbursement of funds and payment of creditors; and (6) possesses the authority to sign company checks. No one factor is dispositive, according to the court, but it is clear that the court looks to the individual's authority; what he or she could do, not what he or she actually did -- or knew.

The Ninth Circuit recently cited similar factors, holding that whether an individual had knowledge that the taxes were unpaid was irrelevant; instead, said the court, responsibility is a matter of status, duty, and authority, not knowledge. Agreeing with the Texas district court, above, the court held that the penalty provision of Code section 6672 doesn't confine liability for unpaid taxes to the single officer with the greatest control or authority over corporate affairs.

Suffice it to say that, under the various courts' interpretations -- or that of the IRS -- many corporate managers and officers who are neither assigned nor assume any actual responsibility for the regular withholding, collection or deposit of federal employment taxes would be surprised to find that they could be responsible for taxes that should have been paid over by the employer entity but weren't.

Once it has been established that an individual qualifies as a responsible person, he must also be found to have acted willfully in failing to withhold and pay the taxes. Although it may be easier to establish the ingredients for "responsibility," some courts have focused on the requirement that the individual's failure be willful, relying on various means to divine his or her intent.

An Arizona district court, for example, found that a retired company owner who had turned over the operation of his business to his children while maintaining only consultant status was indeed a responsible person -- but concluded that his past actions indicated that he did not willfully cause the nonpayment of the company's employment taxes. Since he had loaned money to the company in the past when necessary, his inaction with respect to the taxes suggested that he believed the company was meeting its obligations and the taxes were being paid.

A Texas district court found willfulness where an officer of a bankrupt company knew that the taxes were due but paid other creditors instead.

The Fifth Circuit has determined that the willfulness inquiry is the critical factor in most penalty cases, and that it requires only a voluntary, conscious, and intentional act, not a bad motive or evil intent. "A responsible person acts willfully if [s]he knows the taxes are due but uses corporate funds to pay other creditors, or if [s]he recklessly disregards the risk that the taxes may not be remitted to the government, or if, learning of the underpayment of taxes fails to use later-acquired available funds to pay the obligation.

Is there any way for those with access to the inner workings of an employer's finances or tax responsibilities -- but without actual responsibility or knowledge of employment tax matters -- to protect themselves from the "responsible person" penalty? It may depend on which jurisdiction you're in -- although a survey of the courts suggests most are more willing than not to find liability. Otherwise, the wisest course may be to enter into an employment contract that carefully delineates and separates the duties and responsibilities -- and the expected scope of knowledge -- of an individual who might find himself with the dubious distinction of being responsible for a distinctly unexpected and undesirable drain on his finances.

The laws and requirements related to employment taxes can be complex and confusing with steep penalties for non-compliance. For additional assistance with your employment related tax issues, please contact the office for additional guidance.

Q. I have a professional services firm and am considering hiring my wife to help out with some of the administrative tasks in the office. I don't think we'll have a problem working together but I would like to have more information about the tax aspects of such an arrangement before I make the leap. What are some of the tax advantages of hiring my spouse?

Q. I have a professional services firm and am considering hiring my wife to help out with some of the administrative tasks in the office. I don't think we'll have a problem working together but I would like to have more information about the tax aspects of such an arrangement before I make the leap. What are some of the tax advantages of hiring my spouse?

A. Small business owners have long adhered to the practice of hiring family members to help them run their businesses -- results have ranged from very rewarding to absolutely disastrous. From a purely financial aspect, however, it is very important for you as a business owner to consider the tax advantages and potential pitfalls of hiring -- or continuing to employ -- family members in your small business.

Pay your family -- not Uncle Sam. Hiring family members can be a way of keeping more of your business income available for you and your family. The business gets a deduction for the wages paid -- as long as the family members are performing actual services in exchange for the compensation that they are receiving. This is true even though the family member will have to include the compensation received in income.

Some of the major tax advantages that often can be achieved through hiring a family member -- in this case, your spouse -- include:

Health insurance deduction. If you are self-employed and hire your spouse as a bona fide employee, your spouse -- as one of your employees -- can be given full health insurance coverage for all family members, including you as the business owner. This will convert the family health insurance premiums into a 100% deductible expense.

Company retirement plan participation. You may be able to deduct contributions made on behalf of your spouse to a company sponsored retirement plan if they are employees. The tax rules involved to put family members into your businesses retirement plan are quite complex, however, and generally require you to give equal treatment to all employees, whether or not related.

Travel expenses. If your spouse is an employee, you may be able to deduct the costs attributable to her or him accompanying you on business travel if both of you perform a legitimate business function while travelling.

IRA contributions. Paying your spouse a salary may enable them to make deductible IRA contributions based on the earned income that they receive, or Roth contributions that will accumulate tax-free for eventual tax-free distribution.

In order for a business owner to realize any of the advantages connected with the hiring family members as discussed above, it is imperative for the family member to have engaged in bona fide work that merits the compensation being paid. Because this area has such a high potential for abuse, it's definitely a hot issue with the IRS. If compensation paid to a family member is deemed excessive, payments may be reclassified as gifts or as a means of equalizing payments to shareholders.

As you decide on how much to pay your spouse working in your business, keep in mind the reasonable compensation issue. Consider the going market rate for the work that is being done and pay accordingly. This conservative approach could save you money and headaches in the event of an audit by the IRS.

Hiring your spouse can be a rewarding and cost effective solution for your small business. However, in order to get the maximum benefit from such an arrangement, proper planning should be done. For additional guidance, please feel free to contact the office.

Q. Each year when it comes time to prepare my return, I realize how little I think about my tax situation during the rest of the year. I seem to lack any sort of common sense when it comes to dealing with my taxes. Do you have any general advice for people like me trying to "do the right thing" in any tax situation that may arise during the year?

Q. Each year when it comes time to prepare my return, I realize how little I think about my tax situation during the rest of the year. I seem to lack any sort of common sense when it comes to dealing with my taxes. Do you have any general advice for people like me trying to "do the right thing" in any tax situation that may arise during the year?

A. Unfortunately, you're not alone in your "seasonal" approach to considering your tax situation. Many people have a once-a-year relationship with their tax professional, which can result in the improper handling of important tax documents and sometimes-costly financial decisions. When it comes to handling your tax situation during the year, you will find that a little common sense will go a long way.

Here are some general common sense tips to handling all things tax-related pre- tax season and during the "off-season":

Don't assume all your tax paperwork is correct. Check Forms W-2s and 1099s for accuracy. Many W-2s and 1099s are prepared by data processing companies that merely process your tax information as raw data. Mistakes have been known to occur. Although your employer or financial institution should be checking these forms for accuracy, it's a good idea to double-check these forms against payroll stubs and monthly statements from the payer. If you find a discrepancy, notify your employer as soon as possible to the error corrected and reported to the appropriate taxing authorities.

Gather possible ALL relevant tax documents for your tax preparation. Don't avoid taking legitimate deductions out of fear of "raising red flags" that may cause your return to be audited. Filing a complete and accurate return is required and is your best defense against an audit.

Don't make decisions solely on potential "tax breaks". All good investment or business decisions should be able to stand on their own before tax breaks are considered. A change in the tax law can be disastrous (and costly) when you are stuck in an affected investment (can you say "abusive tax shelter"?).

Seek planning advice from a tax professional. Probably the best investment decision you can make is to seek out the services of your tax professional. In most cases, the amount you are charged for good tax advice is a fraction of the resulting tax savings.

Consult with a tax professional before responding to IRS notices. If you receive a notice from the IRS (or any taxing authority) do not automatically assume that it is accurate and mail them a check. Many notices are inaccurate or merely require additional explanation. Tax professionals have the knowledge and experience to recognize areas where additional explanation or documentation may reduce or eliminate the assessment stated on the notice.

If audited, consider your appeal rights. Although the IRS auditor may not bring it to your attention, the end of an audit is be no means the end of the road for your tax case. Appealing an audit decision can many times put your case in front of a more experienced agent who may better understand the issues and your position on them.

Taking a little time during the year to consider your tax situation and invoke a little common sense can pay off with substantial tax savings and the avoidance of unnecessary expenditures. If you need any additional assistance throughout the year, please do not hesitate to contact the office for guidance.

All of us will, at one time or another, incur financial losses - whether insubstantial or quite significant -- in our business and personal lives. When business fortunes head South -- either temporarily or in a more prolonged slide, it is important to be aware of how the tax law can limit the actual amount of your losses and your ability to deduct them. Here are some of the types of losses your business may experience and the related tax considerations to keep in mind in the event of a business downturn.

All of us will, at one time or another, incur financial losses - whether insubstantial or quite significant -- in our business and personal lives. When business fortunes head South -- either temporarily or in a more prolonged slide, it is important to be aware of how the tax law can limit the actual amount of your losses and your ability to deduct them. Here are some of the types of losses your business may experience and the related tax considerations to keep in mind in the event of a business downturn.

Bad debts

One loss that occurs frequently when business slows down is bad debt. A bad debt is simply a technical term used to describe a debt that has become totally or partially worthless. Different strategies apply depending upon whether you are the borrower or the lender.

As borrower. If you are the borrower, the "forgiveness" of all or part of the debt by the lender will generally trigger taxable income on that amount, unless the business is insolvent (debts exceed liabilities).

Note. The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) allows some business to elect to recognize cancellation of indebtedness income over five years, beginning in 2014. The temporary benefit applies to specific types of business debt repurchased by the business after December 31, 2008 and before January 1, 2011. Under this provision, an applicable debt instrument includes a bond, note, certificate, debenture, or other instrument that constitutes indebtedness issued by a C corporation or any other "person" in connection with the conduct of trade or business by that person. This election is irrevocable. Moreover, the liquidation or sale of substantially all the taxpayer's assets can result in acceleration of deferred items.

Although recognizing income may not be an immediate problem for a business that has plenty of losses to net against current income, additional income may wash out a net operating loss carryover that can either provide an immediate refund for a past tax year or shelter from income in the future. As a result, some businesses re-define debt "forgiveness" into a non-taxable event, such as a refinancing or a business-generated settlement.

As lender. If you are the lender, your major tax concern will be proving that a real debt exists, and then determining how fast you can deduct the bad debt and whether the deduction can offset ordinary income, as opposed to just capital gains.

Loans between corporations and their shareholders are scrutinized to make sure that they are really debts rather than disguised dividends or contributions to the corporation's capital. You can protect yourself by taking the steps that an arm's-length lender would take, such as putting it in writing and charging a reasonable rate of interest.

The IRS sometimes requires taxpayers to play a guessing game about which tax year a debt becomes sufficiently worthless to support the deduction. Because of potential statute of limitations problems, tax experts generally recommend that you claim the loss in the earliest possible year that it can reasonably be argued to be worthless.

Finally, you must determine whether a business or nonbusiness bad debt exists. A business bad debt must be created or acquired, or become worthless, in the course of your trade or business. If you conduct a business in the form of a corporation, generally any debt held by the corporation is a business debt. Any debt not falling into the business category is a nonbusiness debt.

As guarantor. If you take out a loan on behalf of your corporation or you personally guarantee the loan and then must make good on it, you are usually considered to have either made a contribution to capital or created a nonbusiness bad debt to protect your position as an investor. A nonbusiness debt must be completely worthless before a loss can be taken. Furthermore, nonbusiness bad debts are subject to limits on capital losses. Business bad debts, on the other hand, are deductible as ordinary losses in full against your other income.

Net operating losses

If you show a net operating loss for the year, it normally may be carried back two years or carried forward up to 20 years until it can be netted against current taxable income. A net operating loss (NOL) for this purpose has some complexity built in to strip it of most personal tax characteristics. An individual's NOL, for example, does not include any offset for personal or dependency exemptions, for net nonbusiness capital losses, or for nonbusiness itemized deductions that exceed nonbusiness income. Another choice in dealing with an NOL is to elect to immediately carryforward the loss. This can be advantageous when high rate-bracket income is anticipated in the following year.

Note. The 2009 Recovery Act provides a five-year carryback of 2008 NOLs for qualified small businesses only. These are small businesses with average gross receipts of $15 million or less. Businesses can choose to carryback NOLs three, four or five years. This treatment applies only to NOLs for any tax year beginning or ending in 2008. The normal NOL carryback period returns in for NOLs incurred in 2009.

Pass-through losses

One of the advantages of investing in a business as a partner or a subchapter S shareholder is that losses on the business level get passed-through to your individual tax return. Regular corporations, on the other hand, file separate returns and the shareholder cannot "realize" a tax loss until he or she actually sells stock.

For both partners and S shareholders, however, the ability to deduct pass-through losses is determined by the amount of tax basis the partner has in his partnership interest or the S shareholder has in his shares. This, in turn, depends upon a variety of factors, including the original price paid, the amount of losses already passed through, cash or property distributed, and any later contributions.

If you have such a stake in a business, a tax strategy for both adding to basis and preventing its diminution is critical to your ability to be able to deduct business losses as a partner or S shareholder.

Section 1244 Stock

If you sell stock at a loss and that stock had been designated on its issuance to be "Section 1244 stock," you are more fortunate than most investors who bail out during a business downturn. Reason: you are entitled to an ordinary loss deduction rather than a capital loss. This special loss treatment is limited to $50,000 for any one year ($100,000 for joint returns). Other requirements are that the stock was issued for no more than $1 million, less than 50% of corporate receipts were from passive sources for the first five years of operation, and the shareholder claiming the treatment must be an individual.

Dealing with and making the most of losses related to a business downturn can get complicated. Because the preceding discussion is meant to be general, is limited in nature and does not cover all the tax rules involved, you are encourage to contact the office for additional guidance with this issue.

Fringe benefits to employees often provide the "sizzle" to keep them aboard during times of high employment. One increasingly popular benefit -- from the perspective of both employees and employers alike -- comes in the form of "qualified transportation fringe benefits." Set up properly, this fringe benefit arrangement can fund a substantial portion of an employee's commuting expenses with either pre-tax dollars or tax-free employer-provided benefits.

The recently enacted American Recovery and Reinvestment Tax Act of 2009 (2009 Recovery Act) increases certain qualified transportation fringe benefits. Fringe benefits to employees often provide the "sizzle" to keep them aboard during times of high employment. One increasingly popular benefit -- from the perspective of both employees and employers alike -- comes in the form of "qualified transportation fringe benefits." Set up properly, this fringe benefit arrangement can fund a substantial portion of an employee's commuting expenses with either pre-tax dollars or tax-free employer-provided benefits.

Commuting expenses to and from a place of business and home are generally considered nondeductible, personal expenses. The magic of "transportation fringe benefits," however, is that they can turn some commuting expenses into tax-favored benefits. They do so by defraying some of an employee's commuting expenses with either pre-tax dollars that reduce otherwise taxable compensation, or with direct, employer-subsidized amounts that are considered tax free.

Qualified transportation fringe benefits include transit passes, van pooling and qualified parking. These benefits are not included in an employee's gross income up to an inflation-adjusted monthly cap. The 2009 Recovery Act increases for March 2009 through 2010 the current $120 per month income exclusion amount for transit passes and van pooling to $230 per month. For qualified parking expenses, the limit is $230 per month. Additionally, employees can exclude $20 per month for qualified bicycle commuting. Benefits that exceed the limitation are included in an employee's income.

Transit passes. A transit pass --which is now tax-free up to $230 per month-- includes a pass, token, fare card, voucher or similar item entitling a person to ride at a reduced price on mass transit facilities or in a highway vehicle with a seating capacity of at least six adult passengers. Transit passes also include cash reimbursements only if a voucher is not readily available for direct distribution by the employer to employees.

Van pooling. Transportation in a vanpool may be valued at its fair market value, or under the automobile lease valuation rule, the vehicle cents-per-mile rule, or the commuting valuation rule. Cash reimbursement for this transportation is allowed. Car pooling arrangements can obtain pre-tax benefits only if organized and administered by the employer. Private arrangements among employees won't work.

The van that is used must carry a seating capacity of at least six adults, not including the driver. At least 80 percent of its mileage use must be reasonably expected to be for purposes of transporting employees.

Parking. Some employers assume -- incorrectly -- that transportation fringe benefits are available only in circumstances that are "environmentally correct." Parking subsidies, which may persuade some employees not to use mass transportation, nevertheless can amount to a tax-free fringe benefit.

The exclusion is available only for the value of parking provided to an employee at the business premises of the employer or at a staging area from which the employee commutes to work by car pool, commuter highway vehicle, or mass transit facilities. Parking provided by an employer includes parking for which the employer pays, either directly to a parking lot operator or by reimbursement to the employee, or provides on premises it owns or leases.

In compensation-reduction arrangements (where the employee foots the bill "pre-tax"), the employee's election must be in writing or in another form, such as electronic, that includes, in a permanent and verifiable form, the required information. The election must contain the date of the election, the amount of the compensation to be reduced, and the period for which the benefit will be provided. The employer may provide as a default that employees will be provided with the fringe unless they elect to receive cash, provided that employees receive adequate notice that a reduction will be made and are given adequate opportunity to make a contrary election.

The portion of a qualified transportation fringe benefit that is included in income is subject to withholding and reporting rules. Such amount is treated as wages for federal income and employment tax withholding purposes, and must be reported on an employee's Form W-2, Wage and Tax Statement. Qualified transportation fringes not exceeding the applicable monthly limit are not wages for purposes of withholding and employment taxes.

If you are self-employed, qualified transportation fringe benefits are not available to you. For this purpose, self-employed persons include independent contractors, partners and 2-percent shareholders of S corporations. However, a de minimis fringe rule for transit passes continues to apply: tokens or farecards worth $21 a month or less, provided by a partnership to a partner that enable the partner to commute on a public transit system, are excludable from the partner's gross income. In addition, if a partner performing services for a partnership or a director of a corporation would be able to deduct the cost of parking as a trade or business expense, the value of free or reduced-cost parking is entirely excludable as a working condition fringe.

Providing some assistance to your employees to offset their commuting costs in the form of transportation fringe benefits can prove to be an effective employee recruitment and retention tool. If you are interested in finding out more about this type of fringe and how it could benefit your business, please contact the office for a consultation.