TXCPA Committee Responds to IRS Rules Proposing to Limit Advance Notice of Third-Party Contacts

 

This week, TXCPA’s Federal Tax Policy Committee issued a comments letter to the IRS on rulemaking that seeks to limit taxpayer rights. The proposed regulations REG-117542-22 would give the IRS discretion to reduce a congressionally-mandated 45-day notice to 10 days to taxpayers before contacting a third party – friends, colleagues, employers, vendors – with respect to the determination of tax collection. Imminent statute situations often occur because of decisions made by the IRS regarding resources or in some cases due to lack of diligence by IRS employees. The committee feels strongly that the 45-day notification period should be respected unless there is some compelling reason to disregard it. Taxpayers should not be disadvantaged by possible IRS delays.

 

Read the letter.

Houston April 2024 Tornadoes and Hurricane Beryl Casualty Losses

 

By Gerard H. Schreiber, Jr., CPA, and Elizabeth G. Brennan, CPA

 

Texas residents dealing with the aftermath of the Houston April 2024 tornadoes and Hurricane Beryl are learning that the tax treatment of casualty losses from these weather events are not as expected, adding to the complexities and uncertainties associated with the recovery process.

 

Casualty losses are defined in Code Section 165. The tax treatment of disaster losses has been revised five times since 2017 as follows:

 

• Disaster Tax Relief and Airport Extension Act of 2017;
• Tax Cut and Jobs Act of 2017;
• Bipartisan Budget Act of 2018;
• Taxpayer Certainty and Disaster Tax Relief Act of 2019; and
• Taxpayer Certainty and Disaster Tax Relief Act of 2020 (TCDTRA 2020), which passed as part of the Consolidated Appropriations Act of 2021 (CAA 2021).

 

Most Texas practitioners and taxpayers are familiar with the tax treatment allowed for Hurricane Harvey. This was special treatment allowed for casualty losses incurred only for Hurricanes Harvey, Irma and Maria in 2017. The legislation was included in the FAA Reauthorization Act of 2018.

 

The Houston April 2024 tornadoes and Hurricane Beryl casualty losses are governed by the most recent revision to the tax treatment of disaster losses, contained in the TCDTRA 2020. The provisions of TCDTRA 2020 are not part of the Internal Revenue Code but are nonetheless federal tax law. TCDTRA 2020 provides special rules for “qualified disaster losses.” The special rules include:

 

• Waiver of the 10% of AGI limitation;
• Increased per-casualty floor of $500 (vs. the standard $100); and
• Addition of a casualty loss deduction to the individual’s standard deduction.

 

Per IRS Publication 547, a “qualified disaster loss” is an individual's casualty and theft loss of personal-use property that is attributable to:

 

• A major disaster declared by the President under Section 401 of the Stafford Act in 2016;
• Hurricane Harvey;
• Tropical Storm Harvey;
• Hurricane Irma;
• Hurricane Maria;
• The California wildfires in 2017 and January 2018;
• A major disaster that was declared by the President under Section 401 of the Stafford Act and that occurred in 2018 and before Dec. 21, 2019, and continued no later than Jan. 19, 2020 (except those attributable to the California wildfires in January 2018 that received prior relief); and
• A major disaster that was declared by Presidential Declaration that is dated between Jan. 1, 2020, and Feb. 25, 2021 (inclusive). However, in order to qualify under this expansion, the major disaster must have an incident period beginning between Dec. 28, 2019, and Dec. 27, 2020 (inclusive). Further, the major disaster must have an incident period ending no later than Jan. 26, 2021. A qualified disaster does not include those losses attributable to any major disaster that has been declared only by reason of COVID-19.

 

The Houston April 2024 tornadoes and Hurricane Beryl occurred after the TCDTRA 2020 window for the special rules; therefore, losses from these weather events do not meet the definition of “qualified disaster loss.” As a result, taxpayers with losses from the Houston April 2024 tornadoes and Hurricane Beryl are currently subject to less favorable tax treatment, including the inability to: deduct casualty losses that do not exceed 10% of AGI, elect to claim the loss in the preceding tax year or deduct the loss without itemizing other deductions on Schedule A (Form 1040).

 

Federal legislation is required to grant the “special rules” to disaster losses attributable to losses from the Houston April 2024 tornadoes and Hurricane Beryl.

 

In addition, the IRS allowed those affected by Hurricanes Harvey, Irma and Maria to use safe harbor cost index tables in Revenue Procedure 2018-09 to compute casualty losses. No similar authority is available at this time for the Houston April 2024 tornadoes and Hurricane Beryl.

 

IRS Cracking Down on U.S. Transfer Pricing Enforcement

 

By Josh Whitworth, CPA-Dallas

 

In late 2023 as part of the funding the IRS received from the Inflation Reduction Act, the IRS has expanded its transfer pricing enforcement efforts on U.S. subsidiaries of foreign companies that distribute goods in the U.S. The IRS sent letters to around 180 U.S. subsidiaries of large corporations reminding taxpayers of their tax obligations. These taxpayers filed Form 1120, had a Form 5472 (Information Return of a 25% Foreign-owned U.S. Corporation), were engaged in the purchase and resale of tangible goods from a foreign related party and had reported losses or low margins. 

 

This is to remind taxpayers to review existing transfer pricing documentation if there are transactions between a U.S. subsidiary and a non-U.S. parent, as the IRS is cracking down on enforcement in this area.

 

Increased U.S. transfer-pricing enforcement: What’s at stake? (thetaxadviser.com)

Last Chance for Clients to File Foreign Financial Accounts Reports for 2023

 

Individuals, partnerships, corporations and others that have financial interests in, or signature authority or other authority over, bank, securities or other financial accounts in a foreign country are required to annually report these if the balance is over $10,000 at any time during the year. The report for 2023 was due April 15, 2024, but there is an automatic extension (no request required) until Oct. 15. FinCEN Form 114 can be e-filed up until that date to avoid harsh penalties ($10,000 for each unreported account unless it is willful, in which case the penalty rises to the greater of 50% of the largest balance during the year or $100,000). For more information, see https://www.irs.gov/pub/foia/fincen-form114-fbar.pdf. 

 

Corporate Transparency Act – I don’t own anything, but my spouse does; should I be worried?

By Luz E. Villegas, J.D., LLM

Co-authored by Christi Mondrik, J.D., CPA-Austin

 

Starting Jan. 1, 2024, the Corporate Transparency Act (CTA) requires business entities (LLCs, Corporations, LPs) to file a Beneficial Ownership Information Report (BOIR) with the Financial Crimes Enforcement Network (FinCEN). This report requires not only information about the reporting entity but also about its beneficial owners.

 

Beneficial Owner Definition

 

The CTA provides two definitions for a “beneficial owner”: (1) an individual who has substantial control; or (2) an individual who owns at least 25% of the entity directly or indirectly.

 

Community Property Relevancy

 

The question for our purposes is whether community property is relevant when analyzing whether an individual owns at least 25% of the entity directly or indirectly.  

 

The answer is, it could be. The relevant regulations do not explicitly refer to community property as a form of indirectly owning an entity. However, the regulations define ownership as follows:

 

Ownership or control of ownership interest. An individual may directly or indirectly own or control an ownership interest of a reporting company through any contract, arrangement, understanding, relationship, or otherwise, including (31 CFR 1010.380(d)(2)(ii)(A)):

(A) Joint ownership with one or more other persons of an undivided interest in such ownership interest;

. . .

[emphasis added]

 

Generally, states that observe community property laws provide that community property is owned in equal parts by both spouses. This could be construed as a relationship that, per the law, causes ownership by the non-title owner spouse.

 

There are nine states in the U.S. considered “community property states”: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Five other states have an “opt-in” community property regime: Alaska, Florida, Kentucky, South Dakota and Tennessee. Each community property state or “opt-in” state has independent and potentially different rules that need to be analyzed in a case-by-case basis by local counsel.

 

The analysis is not complete once it is determined a shareholder, member, or partner lives in a community property state. As a general rule, states observing community property laws have provisions that exclude from the community certain assets received via gifts or inheritance, or certain separate property acquired before marriage. This is important because, even if a shareholder, member, or partner, is married in a community property state, the specific interest being analyzed may not be community property.

 

Thus, when analyzing whether the ownership of one spouse should be allocated to the other spouse for BOIR purposes, it is important to inquire about how the specific ownership was acquired. It is also important to inquire if there is any agreement that could change the character of the ownership of shares, membership interests, etc. For example, a pre-nuptial or postnuptial agreement designating certain property as separate.  

 

Non-U.S. Owners

 

This topic also becomes relevant when analyzing the ownership of foreign individuals. There are countries, like Mexico, that allow couples to elect into the community property regime (“regimen de bienes mancomunados”) at the time of marriage. If they do, this analysis becomes relevant.

 

Final Considerations

 

The government has not provided specific guidance as to how this question should be addressed. While some guidance may be coming from FinCEN or Treasury, a reporting entity may need to ask each owner the following questions in anticipation of working through the legal analysis of who is a beneficial owner for BOIR purposes:

 

1. Is the owner married?
2. If yes, what state does he or she reside?
3. If in a community property state, were the shares (or membership interest or partnership interest) acquired before or during marriage?
4. Were the shares (or membership interest or partnership interest) received by inheritance or gift?
5. Is there any other agreement that could change the character of the shares (or membership interest or partnership interest)? For example, a pre-nuptial or postnuptial agreement.

 

Given these many permutations, businesses responsible for BOIR reporting should put into place checklists for gathering data to help ensure the accuracy of the information reported, and implement periodic updates to information to aid in compliance with ongoing reporting requirements as ownership changes.

TXCPA Committee Assists Senator Cruz’s Office with Panhandle Wildfire Federal Tax Relief Bill

Last month, TXCPA’s Federal Tax Policy Committee collaborated with the office of Senator Ted Cruz on a bill to create specified federal tax relief for qualified taxpayers who were victims of the February 2024 Panhandle wildfires. The total damage of these wildfires did not meet the qualification threshold of a major disaster declaration. The committee assisted with technical questions related to the definition of areas eligible for federal relief, clarification of allowable deductions and the tax treatment of benefits received. S. 4806 accomplishes the following:

 

1. Exempts government relief payments and settlement payments from Xcel Energy from the definition of gross income, exempting them from an income tax liability.

 

2. If farmers or ranchers are forced to sell more livestock than they would normally sell because of the fires, the additional amount sold shall be treated as an involuntary conversion and no capital gain will be recognized.

 

3. In instances where taxpayers receive dissimilar property from an involuntary conversion stemming from the fires, they will have four years, rather than two, to convert the dissimilar property back into livestock.

 

4. If it is not feasible, because of the fires, for cattlemen to reinvest proceeds received from involuntarily converted livestock into property similar to livestock, other property used for farming purposes shall be treated as property similar to livestock.

 

5. Adds the word “fire” to the list of weather-related causes for which a taxpayer may defer recognizing income, should he/she be forced to sell livestock due to a weather-related cause. However, this is only available to farmers who use the cash accounting method. 

 

 

Depreciation Rewind

By Janet C Hagy, CPA-Austin

 

Depreciation method choices became even more complex beginning in 2023 with the reduction of 100% bonus depreciation to 80% of the cost of qualified property placed in service in 2023. For 2024, the percentage will be reduced to 60% of the cost and is scheduled to phase out completely after 2026. It is not affected by the sunset of the Tax Cuts and Jobs Act (TCJA) in 2025.

 

Other depreciation methods have always been available, but businesses usually preferred to claim the maximum amount allowable, which was 100% bonus depreciation beginning Sept. 28, 2017, through 2022.

 

Bonus depreciation is mandatory unless a formal election-out is attached to the timely filed tax return for the year placed in service. The opt-out election to forgo bonus depreciation applies to all qualified properties in the same class placed in service in that year. (See IRC Section 168(k)(7).) The formal election must designate the Code section type of election (Section 168(k)(7) or (5)) and each class of property covered under the opt-out election. (See IRC Regulation 1.168(k)-2(f).)

 

Failure to file a properly completed opt-out election statement can result in expensive consequences for the taxpayer, including IRS penalties, and harrowing legal consequences for the preparer if discovered while under IRS examination or by a successor tax preparer.

 

Remedies

 

Timing is everything for the opt-out election and the remedies to fix a failed election. Failure to opt-out in a timely filed tax return while using other methods of depreciation, or not claiming depreciation at all, is considered to be the use of an improper method of accounting. Revenue Procedure 2024-23 describes the nuances of making an opt-out election under the automatic change in accounting method procedures.

 

Failure to include the opt-out election when bonus depreciation was not claimed can be fixed with an amended return and Form 3115 during specific time periods. Automatic changes can only be requested for the taxpayer’s first or second year after the year the property was placed in service. A Form 3115 with a Section 481(a) adjustment will be generated and included in that filing year. Absent an approved change request, allowable bonus depreciation will be considered to have been claimed in the placed-in-service year, thereby affecting or eliminating subsequent year allowable depreciation. Upon discovery of the improper method, amended returns may be required for open years. Fortunately, there is a saving procedure if an improper method of deducting depreciation was used and the two-year automatic change window has passed. In the year of sale, Form 3115 can be filed to claim any missed depreciation. (See the DCN 107 explanation in the Form 3115 instructions.)

 

If the opt-out election is made in error and is discovered quickly, an amended return revoking the election and showing the resulting changes can be filed within six months after the original due date, not including extensions. This procedure is only for revocation of the opt-out election. Failure to meet this deadline will require a private letter ruling to request revocation.

 

Automatic changes to making or revoking a bonus depreciation election are not available after the windows described above have expired. Changes can still be requested but the taxpayer will have to submit an IRS private letter ruling (PLR) request. This is a time-consuming and expensive process. IRS user fees apply to non-automatic changes of accounting method. (See Rev Proc 2024-1.)

 

Section 179 Election

 

With the bonus percentage phase out, electing Section 179 expensing for all or part of the cost of qualified property, in lieu of bonus depreciation, may be advantageous. Section 179 is the election to expense qualified property in the year placed in service. The deduction is limited to net income before the deduction, with the excess carried over to the next year. The Section 179 amount elected for each property can be dialed in to meet the needs of the taxpayer. The elected amount of Section 179 for each property reduces the basis available for bonus depreciation and the amount potentially subject to the mid-quarter convention. No opt-out election is required for the Section 179 elected amount. The Section 179 election is made by completing Part I of Form 4562 and including the form in the tax return or

 

by showing as a separate item on the taxpayer's income tax return the following items:
(1) The total Section 179 expense deduction claimed with respect to all Section 179 property selected, and
(2) The portion of that deduction allocable to each specific item. (See IRC Regulation 1.179-5.)

For example:

In 2023, XYZ Company purchases and places in service a five-year asset for $100,000. Net income before the Section 179 deduction exceeds $100,000. XYZ may elect any amount of Section 179 deduction up to $100,000. XYZ elects to deduct $80,000 under Section 179. The remainder of $20,000 would be subject to bonus depreciation at 80% or $16,000, plus regular first year five-year class depreciation at 20% of the remaining $4,000 or $800. The total depreciation for this asset would be $96,800 in 2023.  

 

Alternatively, XYZ could elect to opt-out of bonus depreciation for the remaining $20,000 basis, producing $4,000 in regular depreciation or $84,000 total deduction for 2023.

 

Section 179 elections are allowed for individual and corporate taxpayers. Trusts, estates and certain non-corporate lessors may not use the Section 179 election. S corporations and partnerships make the election at the entity level, but the deduction is passed through to the shareholders and partners. Each owner calculates their allowable deduction. Estate and trust members of passthrough entities cannot use the Section 179 deduction. Therefore, consider the member’s ability to use the Section 179 deduction when making a Section 179 election at the entity level. For the portion that would have been allocated to the trust or estate, a partnership or S corporation may claim a depreciation deduction under Section 168. (See IRC Regulation 1.179-1(f)(3)). For more information about this issue, see AICPA’s article, Reporting Depreciation When Trusts Own Business Entities.

 

Federal maximum amounts of Section 179 deductions for 2023/2024 are $1,160,000 and $1,220,000, respectively. Dollar-for-dollar reduction in the amount of the Section 179 deduction begins when the cost of property placed in service in 2023 exceeds $2,890,000, and $3,050,000 in 2024.

 

Qualifying Section 179 property includes purchased MACRS class property with a life of no more than 20 years, qualified nonresidential real property improvements, and certain specific use properties. (See Section 179(d).) Property acquired from related parties is ineligible for Section 179. In a win for nonresidential property owners, TCJA added roofs, HVAC and other previously capitalized improvements to the list of qualified Section 179 property. (See Section 179(e).) Residential property that qualifies as a trade or business may also qualify for Section 179. Tread with caution on this as the trade or business rules for residential real estate are complex.

 

Consideration of the opportunities and limitations for depreciating business property is more complicated than in the recent past. Differences in state tax depreciation rules for bonus depreciation and Section 179 must also be considered. Adding review of depreciation elections and required tax return disclosures to the preparer and reviewer checklists and educating less experienced staff who have only dealt with 100% bonus depreciation is a wise decision.

 

Remote Work and Circular 230

By Kathy Ploch, CPA-Houston

 

The traditional landscape of working as a tax professional has changed. Today’s practitioners have more responsibilities than ever before due to the increased usage of remote workers, social media, technology, cybersecurity and AI. It begs the question – does remote work compromise compliance with Circular 230? Does your firm have the necessary policies and procedures in place to exercise due diligence?

 

In a recent presentation before TXCPA’s Relations with IRS Committee and other tax preparer organizations, IRS Office of Professional Responsibility Attorney Advisor Laura Zelman shared that tax professionals must assess and adjust their obligations under Circular 230 to encompass these changes. Several Circular 230 standards, as well as Internal Revenue Code statutes, can be triggered when a firm uses non-traditional work arrangements.

 

Firms should implement a structure that provides for appropriate supervision of remote workers – especially new employees – to ensure competency, due care, document management, sharing procedures to safeguard taxpayer data, along with other confidentiality concerns of any remote work.

 

Treasury Department Circular 230 has not been revised since June 2014. It would be a good idea for tax professionals in August to review Circular 230 to ensure that their professional responsibilities are being met with these new changes in our work environment.

 

Expiring Tax Provisions—Limitation on Casualty Losses

By David Donnelly, CPA-Houston

 

There are dozens of tax provisions in the 2017 Tax Cuts and Jobs Act (TCJA) that expire on Dec. 31, 2025. Tax practitioners should be aware of the more important of these provisions—one of which is the treatment of personal casualty losses.

 

Prior to the 2017 TCJA, personal casualty losses were deductible as an itemized deduction to the extent that the losses exceeded 10% of AGI.* The TCJA added Internal Revenue Code Section 165(h)(5), which states that personal casualty losses are not allowed after Dec. 31, 2017, and before Jan. 1, 2026, except for federally declared disaster areas.

 

For many taxpayers, a material casualty loss is a financially devastating event whether it occurs in a federal disaster area or not. Softening the effect of these losses by allowing a tax deduction for the casualty losses goes back to the 1867 amendment to the Civil War income tax act and has been carried forward in various ways since then. 

 

The automatic expiration of the provisions of Code Section 165(h)(5) allows the deductibility of personal casualty losses after Dec. 31, 2026. Whether this will be allowed to happen will be a matter of political debate, which debate will include the rest of expiring provisions of the TCJA. Allowing the personal casualty deduction to come back into the law does seem taxpayer friendly and hopefully Congress will allow it.

 

*This 10% of AGI limitation was waived for “Qualified Disaster Losses” that are defined statutorily to include Hurricanes Harvey, Irma, Maria, the California wildfires in 2017 and 2018, and certain other disasters between Dec. 28,2019, and before Dec. 27, 2020. The 10% AGI limitation continues in effect for “Federal Casualty Losses” and “Disaster Losses.” For these definitions, see the Page 1 of the 2023 Instructions for Form 4684.

 

Final Regs Recently Issued on Digital Assets Reporting

By Aaron Klein, CPA-East Texas

 

On June 28, 2024, the U.S. Department of Treasury and Internal Revenue Service issued final regulations related to the reporting of sales and exchanges of digital assets. The final regulations generally mirror the proposed regulations and require broker reporting of gains and losses for transactions occurring after Jan. 1, 2026. In addition, the regulations provide further guidance for taxpayers to determine their basis, gain, and loss from digital asset transactions and backup withholding rules.

 

Additional information, including some transition relief and delayed reporting rules can be found at https://www.irs.gov/newsroom/treasury-irs-issue-final-regulations-requiring-broker-reporting-of-sales-and-exchanges-of-digital-assets-that-are-subject-to-tax-under-current-law-additional-guidance-to-provide-penalty-relief-address.