Richard J. Harrison, Jr., P.C.

On April 28, 2021, the White House released details on President Biden’s new $1.8 trillion American Families Plan. The proposal follows the already passed $1.9 trillion American Rescue Plan Act and the recently proposed $2.3 trillion infrastructure-focused American Jobs Plan. The details were released in advance of President Biden’s address to a joint session of Congress.

The plan includes many provisions that would make good on the President’s campaign promises. The proposal would provide universal preschool to three and four year-olds, two free years of community college, and free tuition for certain universities specializing in serving underrepresented students. The plan would also invest in teacher and child care education, provide free or lower cost child care to lower income families, expand paid leave programs, and improve the quality of student lunch programs. It would also establish automatic adjustments to unemployment insurance, depending upon economic conditions.

Personal Tax Breaks Extended

The proposal would also extend tax benefits already signed into law under the American Rescue Plan Act. This includes:

extending enhanced premium tax credits and making premium reductions permanent;
extending the enhanced child tax credit through 2025 (currently a fully refundable $3,000 per child ($3,600 for a child under age six) for 2021 only);
permanently extending the enhancements of the child and dependent care tax credit, which increase the amount of the credit as well as the incomes at which the credit is phased out;
permanently extending the increased earned income tax credit for taxpayers without children.

Tax Changes, TCJA Rollback

On the campaign trail, President Biden promised to increase taxes on both corporations and higher-income individuals. While the provisions of the American Jobs Plan are largely funded through a proposed increase in the corporate tax rate from 21% to 28%, the provisions of his American Families Plan are funded by the promised increases to individual taxes.

The proposal would increase the top tax rate on individuals to 39.6 percent from the current rate of 37 percent. This would return the tax rate on the highest bracket of income to where it was before the Tax Cuts and Jobs Act took effect in 2018.

The proposal would also increase the tax rate on capital gains and dividends for households making over $1 million, to match the 39.6 percent rate on income. For 2021, capital gains and certain qualified dividends are taxed at 20 percent for joint filers with taxable income of $496,000 or more.

The plan proposes to eliminate the tax-free step-up in basis on inherited property where the gain would be in excess of $1 million (up to $2.5 million in the case of a couple using existing real estate exemptions. The plan also eliminates the carried interest loophole that allows hedge fund partners to pay tax on income at capital gains rates. The plan would also limit a provision allowing for tax deferral on property exchanges, permanently extend the limitation on excess business losses, and ensure that higher income taxpayers cannot avoid the 3.8 percent Medicare tax.

The plan also provides increased funding for the IRS to improve enforcement, specifically to ensure that higher income taxpayers are unable to avoid proper payment of taxes. While the White House estimates that this will produce an additional $700 billion in revenue over 10 years, many believe this to be a vast overestimate.

Notably absent from the plan is an increase to the cap on the deduction of state and local taxes. The Tax Cuts and Jobs Act set a $10,000 limit for the deduction, but many lawmakers, particularly those representing higher tax states like New York and California, have been pressing to increase the limit or completely eliminate it

Next Steps?

It is uncertain when Congress may take up the process of proposing legislation carrying out the American Families Plan. President Biden has indicated his willingness to negotiate on any proposals he makes. However, the chilly reception to his American Jobs Plan does not indicate a smooth process to get a vote on a legislative package for the infrastructure proposal, let alone passage with razor-thin majorities in both chambers of Congress. With many lawmakers indicated that they want to work on infrastructure before moving on to other proposals, the process from proposal to law could stretch out for months.

Close

The IRS announced that it had started issuing refunds to eligible taxpayers who paid taxes on 2020 unemployment compensation that was excluded from taxable income by the recently enacted American Rescue Plan (ARP) (P.L. 117-2).

The IRS announced that it had started issuing refunds to eligible taxpayers who paid taxes on 2020 unemployment compensation that was excluded from taxable income by the recently enacted American Rescue Plan (ARP) ( P.L. 117-2).

Unemployment compensation is taxable income, but the ARP excludes $10,200 in unemployment compensation from the income used to calculate the amount of taxes owed. The $10,200 per person exclusion applies to taxpayers who are single or married filing jointly, with modified adjusted gross income of less than $150,000. The $10,200 is the amount of income exclusion, not the amount of the refund itself.

The IRS has identified over 10 million taxpayers who filed their tax returns prior to the ARP becoming law in March, and is reviewing past returns to determine the correct taxable amount of unemployment compensation and tax. This could potentially result in a refund, reduced balance due, or with no refund being owed.

The first phase of adjustments is being made for single taxpayers who had the simplest tax returns, such as those filed by taxpayers who did not claim children or any refundable tax credits. Notices explaining the corrections will be sent to taxpayers, and are expected to reach them within 30 days of the correction being made.

The IRS stated that it will issue refunds by direct deposit to taxpayers who provided their bank account information on their returns. Alternatively, refunds will be mailed as a paper check to the taxpayer’s address of record.

These refunds will be subject to normal offset rules, such as past-due federal tax, state income tax, state unemployment compensation debts, child support, spousal support or certain federal nontax debts, such as student loans. The IRS will send separate notices to those taxpayers whose refunds could be offset to settle unpaid debts.

Further, corrections to any Earned Income Tax Credit (EITC) without qualifying children and the recovery rebate credit are being made automatically as part of this process. However, some taxpayers may be eligible for certain income-based tax credits that were not claimed on their original return. The IRS also reminded taxpayers to file an amended tax return if the revised adjusted gross income amount makes them eligible for additional benefits.

Close

A safe harbor is available for certain Paycheck Protection Program (PPP) loan recipients who relied on prior IRS guidance and did not deduct eligible business expenses. These taxpayers may elect to deduct the expenses for their first tax year following their 2020 tax year, rather than filing an amended return or administrative adjustment request for 2020.

The IRS had initially determined that businesses whose PPP loans were forgiven or expected to be forgiven could not deduct business expenses paid for by the loan. However, the Consolidated Appropriations Act of 2021 ( P.L. 116-260), enacted on December 27, 2020, subsequently permitted taxpayers to deduct these expenses.

Safe Harbor Eligibility

To be eligible for the safe harbor, the taxpayer must have received an original PPP covered loan and filed a federal income tax return or information return for the 2020 tax year on or before December 27, 2020. The taxpayer must have paid or incurred original eligible expenses during the taxpayer’s 2020 tax year that the taxpayer did not deduct because:

the expenses resulted in forgiveness of the original PPP covered loan; or
the taxpayer reasonably expected at the end of the 2020 tax year that the expenses would result in forgiveness.

Electing the Safe Harbor

A taxpayer elects the safe harbor by attaching a statement to a timely, including extensions, federal income tax return or information return for the taxpayer’s first tax year following the 2020 tax year in which the original eligible expenses were paid or incurred. The statement must include:

the taxpayer’s name, address, and social security number or taxpayer identification number;
a statement that the taxpayer is applying the safe harbor provided by section 3.01 of Revenue Procedure 2021-20;
the amount and date of disbursement of the taxpayer’s original PPP loan; and
a list, including descriptions and amounts, of the original eligible expenses.

Certain Expenses and Loans Not Covered

The safe harbor applies only to original eligible expenses, and not to additional expenses that were added by the Consolidated Appropriations Act. The safe applies only to original PPP loans. It does not apply to PPP second draw loans.

Close

Individuals may use two special procedures to file returns for 2020 that allow them to receive advance payments of the 2021 child credit and the 2021 Recovery Rebate Credit.

Individuals may use two special procedures to file returns for 2020 that allow them to receive advance payments of the 2021 child credit and the 2021 Recovery Rebate Credit. Under the procedures:

individuals who are not required to file returns for 2020 can use a simplified federal income tax return filing procedure; and
individuals with zero adjusted gross income (AGI) for 2020 can file electronic returns by entering "$1" in several fields.

Simplified Return Procedures

Individuals may file simplified 2020 returns electronically or on paper if they have not filed and are not required to file 2020 returns. The simplified procedures apply to Forms 1040, 1040-SR and 1040-NR.

The individual should write "Rev. Proc. 2021-24" at the top of a paper return. The procedure includes detailed instructions for providing identification, income and direct deposit information.

Zero AGI

Many filing systems for electronic returns will not accept returns that report zero AGI. To file an electronic return, in addition to all other information required to be entered on Form 1040, Form 1040-SR, or Form 1040-NR, an individual with no AGI should report:

$1 as taxable interest on line 2b of the form;
$1 as total income on line 9 of the form; and
$1 as AGI on line 11 of the form.

Filers of Form 1040-NR with no AGI should also report $1 as itemized deductions on lines 7 and 8 of Schedule A (Form 1040-NR) and line 12 of Form 1040-NR.

Returns Must Be Accurate

Simplified returns and zero-AGI electronic returns are federal income tax returns for all purposes. Thus, the individual must properly sign the return under penalties of perjury. The returns must also provide accurate information. However, the IRS will not challenge the accuracy of income items reported by taxpayers using these special procedures.

Individuals Who Filed 2020 Returns

Individuals who have already filed their 2020 returns do not have to do anything further to:

receive advance child credit payments for an eligible child shown on that return;
receive a third-round Economic Impact Payment (EIP) for the 2021 recovery rebate credit that is attributable to a dependent shown on that return; or
claim a previously claimed 2020 recovery rebate credit and additional 2020 recovery rebate credit for themselves and for each eligible qualifying child.

Similarly, an individual who filed a federal income tax return for 2019, including by entering information in the "Non-Filers: Enter Information Here" tool on the IRS website, also do not need to file any additional forms of contact the IRS in order to receive advance child credit payments for a qualifying child shown on that return. An individual who did not receive EIPs for the full amount of the 2020 Recovery Rebate Credits may claim them by filing a 2020 federal income tax return.

U.S. Territory Residents

The simplified return and zero-AGI procedures do not apply to residents of American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, the Commonwealth of Puerto Rico, or the U.S. Virgin Islands.

Residents of Puerto Rico may be eligible to claim the child tax credit from the IRS under procedures to be announced at a later date, but they are not eligible to receive advance child tax credit payments.
Residents of other U.S. territories should contact their local territory tax agency for additional information about the child tax credit and advance child tax credit payments, third-round economic impact payments, the 2020 recovery rebate credit, and the additional 2020 recovery rebate credit.

Close

The IRS has provided guidance for employers, plan administrators, and health insurers regarding the new credit available to them for providing continuation health coverage to certain individuals under the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) during the COVID-19 (Coronavirus) emergency.

COBRA provides eligible former employees, retirees, spouses, former spouses, and dependent children with the right to temporary continuation of health coverage at group rates. COBRA generally covers health plans maintained by private-sector employers with 20 or more full and part-time employees. It also covers employee organizations or federal, state or local governments. State mini-COBRA laws often provide similar benefits for insured small employers not subject to Federal COBRA.

The American Rescue Plan Act ( P.L. 117-2) provided a temporary 100% reduction in the premium that individuals would have to pay when they elect COBRA continuation health coverage following a reduction in hours or an involuntary termination of employment. The new law provides a corresponding tax credit for the entities that maintain group health plans, such as employers, multiemployer plans, and insurers. The 100% reduction in the premium and the credit are also available with respect to continuation coverage provided for those events under comparable state laws, sometimes referred to as "mini-COBRA."

Under the new law, COBRA premium assistance is available to eligible individuals as of the first period of coverage beginning on or after April 1, 2021, and will not be available for periods of coverage beginning after September 30, 2021. For each Assistance Eligible Individual, COBRA premium assistance does not extend beyond the period of COBRA continuation coverage in the event that the period ends prior to September 30, 2021. If an individual receiving premium assistance becomes eligible for coverage under any other group health plan or for Medicare, the premium assistance period ends.

Example: On April 1, 2021, the individual’s employment is terminated, and the individual becomes a qualified beneficiary. The individual elects COBRA continuation coverage and becomes an Assistance Eligible Individual with COBRA continuation coverage beginning on April 1, 2021, the date the individual lost coverage. On July 1, 2021, the individual becomes eligible for coverage under a group health plan sponsored by the employer of the individual’s spouse and ceases to be an Assistance Eligible Individual. The individual ceases COBRA continuation coverage as of July 1, 2021, and enrolls in coverage in the group health plan sponsored by the employer of the individual’s spouse. On August 1, 2021, the individual’s spouse has an involuntary termination of employment, and as a result the individual and spouse lose coverage. The individual and spouse become qualified beneficiaries due to the loss of coverage and elect COBRA continuation coverage with the plan sponsored by the spouse’s employer. The individual and spouse become Assistance Eligible Individuals with respect to COBRA continuation coverage as of August 1, 2021.

In Notice 2021-31, the IRS has provided information regarding the calculation of the credit, the eligibility of individuals, the premium assistance period, and other information vital to employers, plan administrators, and insurers to understand the credit.

Close

The IRS has reminded employers that under the American Rescue Plan Act of 2021 (ARP) ( P.L. 117-2), small and midsize employers and certain government employers are entitled to claim refundable tax credits that reimburse them for the cost of providing paid sick and family leave to their employees due to COVID-19. This includes leave taken by employees to receive or recover from COVID-19 vaccinations.

ARP tax credits are available to eligible employers that pay sick and family for leave from April 1, 2021, through September 30, 2021. Under the Act, eligible employers include any business, including tax-exempt organizations with fewer than 500 employees who are not able to work or telework due to reasons related to COVID-19, including needing to recover from any injury, disability, illness or condition related to the vaccinations.

The IRS has informed taxpayers that the paid leave credits under the ARP are tax credits against the employer’s share of the Medicare tax. The tax credits are refundable, and the employer is entitled to payment of the full amount of credits if it exceeds the employer’s share of the Medicare tax. The tax credit for paid sick leave wages is equal to the sick leave wages paid for COVID-19 related reasons, for up to two weeks at 100 percent of the employee’s regular rate of pay. Further, the tax credit for paid family leave wages is equal to the family leave wages paid for up to twelve weeks, at 2/3rds of the employee’s regular rate of pay. Importantly, the amount of these tax credits increases according to allocable health plan expenses and contributions for certain collectively bargained benefits, as well as the employer’s share of social security and Medicare taxes paid on the wages.

Eligible employers are recommended to report their total paid sick and family leave wages, health plan expenses and collectively bargained contributions, including their share of social security and Medicare taxes on the paid leave wages for each quarter on their federal employment tax return. Form 941, Employer’s Quarterly Federal Tax Return, can be used to report income tax and social security and Medicare taxes withheld from employee wages.

Further, in anticipation of claiming the credits on the Form 941, eligible employers can retain the federal employment taxes that they otherwise would have deposited, including federal income tax withheld, the employees’ share of social security, Medicare taxes and their share of social security and Medicare taxes with respect to all employees up to the amount of credit for which they are eligible. If, however, an eligible employer does not have enough federal employment taxes set aside for deposit to cover amounts provided as paid sick and family leave wages, the eligible employer may request an advance of the credits by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19. The eligible employer will then have to account for the amounts received as an advance when they file Form 941, Employer's Quarterly Federal Tax Return, for the relevant quarter. Finally, self-employed individuals may claim comparable tax credits on their individual Form 1040, U.S. Individual Income Tax Return.

Close

The IRS has reminded taxpayers who owe 2020 taxes that there are different ways to pay their taxes online, including payment options for many people who cannot pay in full.

The IRS stated that the most important thing that taxpayers with a tax bill should do is file a return by the May 17 due date, even if they cannot pay in full, or request a six-month extension to avoid higher penalties for failing to file on time. The IRS emphasized that even though automatic tax filing extensions are available, these extensions do not change the payment deadline.

Further, interest, plus the much smaller late-payment penalty, will apply to any payments made after May 17. Normally, the late-payment penalty is one-half-of-one percent (0.5%) per month. The interest rate, adjusted quarterly, is currently 3% per year, compounded daily.

The IRS urges taxpayers to use Direct Pay, which is the fastest and easiest way to pay a personal tax bill. In addition, the IRS has noted that online payment plans are processed more quickly than requests submitted with electronically-filed tax returns.

There are two main types of online payment plans:

Short-term payment plan: The payment period is 120 days or less and the total amount owed is less than $100,000 in combined tax, penalties and interest. A 180-day payment plan is also possible, but is only available by calling or writing the IRS.
Long-term payment plan ( "installment agreement"): Payments are made monthly, and the amount owed must be less than $50,000 in combined tax, penalties and interest. If the IRS approves an installment agreement, a setup fee normally applies, but low-income taxpayers may qualify to have the fee waived or reimbursed. In addition, for anyone who filed their return on time, the late-payment penalty rate is cut in half while an installment agreement is in effect. This means that the penalty accrues at the rate of one-quarter-of-one percent (0.25%) per month, instead of the usual one-half-of-one percent (0.5%) per month.

Taxpayers who do not qualify for an online payment agreement may still be able to arrange to pay in installments. If the IRS determines a taxpayer is unable to pay, it may delay collection until their financial condition improves. Taxpayers can request a delay by calling the phone number on their IRS notice or 800-829-1040.

Some taxpayers can qualify to settle their tax bill for less than the full amount due through an offer in compromise. Though there is typically a $205 non-refundable application fee, it is generally waived for low-income taxpayers, and for offers based on doubt as to liability. The Offer in Compromise Pre-Qualifier tool can help determine eligibility for anyone interested in applying.

Close

The IRS reminds taxpayers that May includes National Hurricane Preparedness Week and National Wildfire Awareness Month. It urges taxpayers to create or review emergency preparedness plans for surviving natural disasters.

The IRS advises taxpayers to do the following:

Secure key documents such as tax returns, birth certificates, deeds, titles and insurance policies inside waterproof containers in a secure space. Keep duplicates of these documents with a trusted person outside the area of the taxpayer. Scan these documents for backup storage on electronic media such as a flash drive.
Take current photos or videos of a home or business’s contents, especially expensive and high value items. The IRS disaster-loss workbooks in IRS Pub. 584-B can help individuals and businesses compile lists of belongings or business equipment.
Employers who use payroll service providers should ask the provider if it has a fiduciary bond in place. The bond could protect the employer in the event of default by the payroll service provider.
Reconstructing records after a disaster may be required for tax purposes, getting federal assistance or insurance reimbursement. Taxpayers who have lost some or all their records during a disaster can visit IRS’s Reconstructing Records webpage as one of their first steps.

Close

Dependent care assistance benefits carryovers and extended claims period amounts that would have been excluded from income if used during the preceding tax year will remain excludable in tax years ending in 2021 and 2022. In addition, these benefits will not be taken into account in determining the dependent care benefits exclusion limit for the tax years ending in 2021 and 2022.

Dependent Care Assistance Exclusion

Employees may exclude amounts their employer pays or incurs for dependent care assistance benefits if furnished pursuant to a dependent care assistance program. For 2020, the exclusion could not exceed $5,000, $2,500 if married filing separately (for 2021 only, increased to $10,500, $5,250 if married filing separately). Unused benefits may be used during a 2 1/2 month grace period following the plan year’s end. However, if the sum of the benefits used in the tax year (including unused benefits used during a grace period that falls in the tax year) exceeds the limitation, the excess is taxable.

Carryovers and Extensions

Beyond the grace period, carryovers of unused dependent care assistance program amounts generally are not permitted. However, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 ( P.L. 116-260) allowed employers to amend their plans to permit carryovers to plan years ending in 2021 and 2022, or to extend the permissible period for incurring claims to plan years over the same period.

Under Notice 2021-15, I.R.B. 2021-10, 898, if an employer adopts the carryover or the extended period, the annual limits apply to amounts contributed for a year, and not to amounts reimbursed or otherwise available for reimbursement.

Notice 2021-26 clarifies that dependent care assistance program benefits that would have been excluded from income if used during the tax year ending in 2020 or 2021, remain eligible for exclusion from the participant’s gross income, and are disregarded in applying the limits for the employee's subsequent tax years when they are carried over from a plan year ending in 2020 or 2021 or permitted to be used pursuant to an extended claims period.

Notice 2021-26 also provides examples illustrating the possible tax consequences of electing $10,500 in benefits for a plan year beginning in 2021 but ending in 2022.

Close

The Treasury Department has released a statement discussing investment in the IRS and improving tax compliance.

The Treasury Department has released a statement discussing investment in the IRS and improving tax compliance. While roughly 99 percent of the taxes due on wages are remitted to the IRS, compliance across other forms of income is substantially less, because the IRS has had difficulty verifying whether income from unverified sources is properly reported. The Treasury states that noncompliance is concentrated at the top of the distribution: according to a recent study, the top one percent failed to report 20 percent of their income, and failed to pay nearly $175 billion in taxes owed annually.

The Treasury states that lower levels of compliance not only negatively impact tax progressivity, but also lower tax revenue and deteriorate the country’s fiscal position. If left unaddressed, the difference between taxes owed to the government and taxes actually paid will total approximately $7 trillion in the next 10 years. This massive gap in revenue would mean that policymakers must choose between higher taxes elsewhere in the tax system, lower spending on fiscal priorities, or rising budget deficits. This tax gap has many underlying causes, with insufficient resources being at the forefront. In addition, budget cuts over the past decade have resulted in an IRS that lacks the capacity to address sophisticated tax evasion efforts. Over this period, audit rates for taxpayers making over $1 million in income have fallen by almost 80 percent.

To ensure a fair and effective tax system, the Treasury says that a robust and sustained investment in the IRS is necessary. The IRS requires access to 21st century technology and to better information, so that it can target its efforts at offenders while helping compliant taxpayers avoid unnecessary and costly audits. Importantly, this investment will also put the IRS in a position to provide taxpayers with timely answers to questions.

The Treasury has listed some considerations that provide the basis for a series of proposals in the American Families Plan (AFP). The AFP intends to overhaul tax administration and provide the IRS with the resources and information it needs to address tax evasion. These reforms are expected to generate an additional $700 billion in tax revenue over the course of a decade. The reforms are expected to:

Provide the IRS with necessary resources to stop sophisticated tax evasion. A key component of this initiative is the provision of a sustained, multi-year stream of funds to help the IRS tackle costly tax evasion.
Provide the IRS with more complete information on third parties. When the IRS has information from third parties, income is accurately reported, and taxes are fully paid. Importantly, this proposal intends to provide additional information to the IRS without an increased burden on taxpayers. It leverages the information that financial institutions have about account holders, requiring that they add to their regular, annual reports information about aggregate account outflows and inflows.
Overhaul outdated technology to help IRS identify tax evasion, by providing the IRS with resources to modernize its technological infrastructure.
Improve taxpayer service and deliver tax credits. Service enhancement will improve the ability of the IRS to communicate with taxpayers securely and promptly. The proposal would also include the necessary resources to ensure that the IRS efficiently delivers credits to families and workers, including newly expanded child tax credits and child and dependent care tax credits.
Regulate paid tax preparers by providing the IRS with legal authority to implement safeguards in the tax preparation industry. This includes stiffer penalties for unscrupulous or "ghost preparers" who fail to identify themselves on tax returns and defraud taxpayers.

Close

Michael Jackson’s image and likeness, as well as his interests in two trusts—one trust (NHT II) that held his interest in the Sony/ATV Music Publishing, LLC, and one trust (NHT III) that held Mijac Music—were valued for estate tax purposes.

Image and Likeness

The estate claimed that the decedent’s image and likeness was valued at about $2,000. However, at trial, the estate brought in additional experts and increased the value to about $3 million. This amount was based on a 10-year revenue projection, which examined pre-death revenue, post-death rights, and growth and decline rates using pre-death marketability and a potential post-death boom. An estimate of expenses incurred in administering the image and likeness and expenses related to rehabilitation of the decedent’s image reduced the revenue stream. As a result, the Tax Court determined that the date-of-death value of the decedent’s image was $4.1 million.

Interest in Sony/ATV

In the years prior to his death, the decedent had borrowed against his interest in the Sony/ATV company. The company was valued using the discounted cash flow method. After finding the value of the company as a whole, a discount for lack of control was applied to one-half of that amount to reflect the decedent’s 50-percent interest. Because of the debt secured by the interest, however, the Tax Court determined that the date-of-death value of NHT II was zero.

Interest in Mijac Music

The major asset of NHT III was Mijac Music, which owned compositions from many artists, including the decedent. The decedent also assigned the income he earned from his writer’s share of certain performance revenue to NHT III. The discounted cashflow analysis was used again and the court determined the revenue streams of Mijac Music and the writer’s share of revenue. After subtracting the trust’s liabilities from the revenue, the Tax Court determined the value of NHT III was $107 million.

No Penalties

Although the values differed widely, the estate was not liable for accuracy-related penalties. Its reliance on the appraisal values was reasonable.

Close

The American Institute of CPAs (AICPA) has renewed its call for immediate guidance on new Code Sec. 199A. The AICPA highlighted questions about qualified business income (QBI) of pass-through income under the Tax Cuts and Jobs Act ( P.L. 115-97). "Taxpayers and practitioners need clarity regarding QBI in order to comply with their 2018 tax obligations," the AICPA said in a February 21 letter to the Service.

New Deduction
The Tax Cuts and Jobs Act created Code Sec. 199A. The deduction is temporary and begins this year.

Generally, qualified taxpayers may deduct up to 20 percent of domestic QBI from a partnership, S corporation or sole proprietorship. Congress put in place a limitation based on wages paid, or on wages paid plus a capital element, among other requirements. Certain service trades or businesses generally may not take advantage of the deduction but there are exceptions.

Almost immediately after passage of the new tax law, the AICPA and other tax professional groups urged on the IRS to move quickly on guidance. Recently, the National Society of Accountants (NSA) reported that the IRS would issue guidance on Code Sec. 199A this summer.

Immediate Concern
The AICPA identified several areas of immediate concern. They are:

Definition of Code Sec. 199A qualified business income.
Aggregation method for calculation of QBI of pass-through businesses.
Deductible amount of QBI for a pass-through entity with business in net loss.
Qualification of wages paid by an employee leasing company.
Application of Code Sec. 199A to an owner of a fiscal year pass-through entity ending in 2018.
Availability of deduction for Electing Small Business Trusts (ESBTs).

Services
The AICPA asked the IRS to describe what activities are included in the definition of a services trade or business. "The guidance should clarify that the definition of the term ‘accounting services’ includes any services associated with the determination of tax liabilities including preparation, tax planning, cost segregation services, services rendered with respect to tax credits and deductions, and similar consultative services,"the AICPA told the Service.

Close

The Tax Cuts and Jobs Act did not directly change the tax rate on capital gains: they remain at 0, 10, 15 and 20 percent, respectively (with the 25- and 28-percent rates also reserved for the same special situations). However, changes within the new law impact both when the favorable rates are applied and the level to which to may be enjoyed.

Capital gains rates

The maximum rates on net capital gain and qualified dividends are generally retained after 2017 and are 0 percent, 15 percent, and 20 percent. The breakpoints between the zero- and 15-percent rates ("15-percent breakpoint") and the 15- and 20-percent rates ("20-percent breakpoint") are generally the same amounts as the breakpoints under prior law, except the breakpoints are indexed using the new C-CPI-U factor in tax years beginning after 2018. For 2018:

the 15-percent breakpoint is $77,200 for joint returns and surviving spouses (one-half of this amount ($38,600) for married taxpayers filing separately), $51,700 for heads of household, $2,600 for estates and trusts, and $38,600 for other unmarried individuals; and
The 20-percent breakpoint is $479,000 for joint returns and surviving spouses (one-half of this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals.

“Zero” rate. In the case of an individual (including an estate or trust) with adjusted net capital gain, to the extent the gain would not result in taxable income exceeding the 15-percent breakpoint, such gain is not taxed.

Comment. The breakpoints are not aligned with the new general income tax rate brackets. For example, alignment for joint filers would have the 15-percent breakpoint at $77,400 rather than $77,200; and, more significantly, 20 percent at $600,000 rather than at $479,000. Instead, they continue the alignment themselves more closely to the prior-law rate brackets.

Comment. As under prior law, unrecaptured section 1250 gain generally is taxed at a maximum rate of 25 percent, and 28-percent rate gain is taxed at a maximum rate of 28 percent. In addition, an individual, estate, or trust also remains subject to the 3.8 percent tax on net investment income (NII tax).

Kiddie tax

Effective for tax years beginning after December 31, 2017, and before January 1, 2026, the "kiddie tax" is simplified by effectively applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child. A child’s "kiddie tax" is no longer affected by the tax situation of his or her parent or the unearned income of any siblings.

Taxable income attributable to net unearned income is taxed according to the brackets applicable to trusts and estates, with respect to both ordinary income and income taxed at preferential rates. For 2018, that means that the 15-percent capital gain rate starts at $2,600 and rising to 20 percent when $12,700 is reached.

Carried interest

Capital gain passed through to fund managers via a partnership profits interest (carried interest) in exchange for investment management services must meet an extended three-year holding period to qualify for long-term capital gain treatment. Under new Code 1061(a), if a taxpayer holds an applicable partnership interest at any time during the tax year, this rule treats carried interest as short-term capital gain—taxed at ordinary income rates— based on a three-year holding period instead of the usual one-year period.

SSBIC rollovers

For sales after 2017, the new law repeals the election to defer recognition of capital gain realized on the sale of publicly traded securities if the taxpayer used the sale proceeds to purchase common stock or a partnership interest in a specialized small business investment company (SSBIC). Prior to 2018 under former Code Sec. 1044, C corporations and individuals could elect to defer recognition of capital gain realized on the sale of publicly traded securities if the taxpayer used the sales proceeds within 60 days to purchase common stock or a partnership interest in a specialized small business investment company (SSBIC).

Like-kind exchanges

Like-kind exchanges have often been used to defer taxable gains. Going forward, like-kind exchanges are allowed only for real property after 2017 (Code Sec. 1031(a)(1)). Like-kind exchanges are no longer available for depreciable tangible personal property, and intangible and nondepreciable personal property after 2017. Gain on those assets will no longer be allowed to be deferred.

Code Sec. 199A deduction

The concept of capital gain is intertwined within the new passthrough deduction for partnerships, S corporations and sole proprietorships under Code Sec. 199A in several ways. A noncorporate taxpayer can claim a Code Sec. 199A deduction for a tax year for the sum of—

(1)

the lesser of —

(a) the taxpayer’s "combined qualified business income amount"; or

(b) 20 percent of the excess of the taxpayer’s taxable income over the sum of (i) the taxpayer’s net capital gain under Code Sec. 1(h) and (ii) the taxpayer’s aggregate qualified cooperative dividends; plus

(2)

the lesser of —

(a) 20 percent of the taxpayer’s aggregate qualified cooperative dividends; or

(b) the taxpayer’s taxable income minus the taxpayer’s net capital gain (Code Sec. 199A(a), as added by the 2017 Tax Cuts Act).

Comment. As a result, the Code Sec. 199A deduction cannot be more than the taxpayer’s taxable income reduced by net capital gain for the tax year, making monitoring of capital gains a “must” for some taxpayers.

Close

The Tax Cuts and Jobs Act modifies Section 529 qualified tuition plans to allow the plans to distribute up to $10,000 in tuition expenses incurred during the tax year for designated beneficiaries enrolled at a public, private, or religious elementary or secondary school. Section 529 plans used to only be allowed for college tuition, up to full tuition amounts. That provision for college tuition remains the same.

Although contributions are not tax deductible for federal tax purposes, funds within a Section 529 plan can accumulate tax-free within the plan until they are distributed tax-free to the educational institution for the child-beneficiary. The new $10,000 limitation applies on a per-student, not per-account basis. As a result, if an individual is a designated beneficiary of multiple accounts, a maximum of $10,000 in distributions will be free of income tax, regardless of whether the funds are distributed from multiple accounts. Some state plans provide a limited deduction against state income taxes for contributions to Section 529 plans. They may also provide caps on contributions.

The expansion of Section 529 plans to cover elementary and secondary school education applies to distributions made after December 31, 2017. Since existing Section 529 set up for a child-beneficiary’s college education may now be redirected earlier to primary and secondary tuition, parents, grandparents and other contributors will need to decide how best to manage each child’s combined accounts: whether amounts needed to cover college tuition should accumulate tax-free until those years, or whether they should be used earlier. Generally, if contributions are limited either by a donor’s financial resources or by state caps, use for college tuition will allow a greater amount to accumulate tax-free. If projected accumulated contributions can cover more than college tuition, then using remaining Section 529 balances for secondary and even elementary school may make sense.

These expanded rules are still young, however, with expected IRS regulations and other guidance overlaid onto the basic law under the Tax Cuts and Jobs Act sure to come. But although the tax-free growth benefits of any Section 529 plans have a long-term perspective, giving some thought to how these expanded Section 529 plans might be used in your family situation might start soon. Please contact our offices for further details.

Close