Elected Farm Income May be Used to Figure QBI

The IRS has explained how farmers and fishermen who use the income averaging method compute their Section 199A qualified business income (QBI) deduction. One of the requirements for qualified items of income, gain, deduction and loss is that the item is "included or allowed in determining taxable income for the tax year.” In a post on its website on April 19, the IRS said in figuring the QBI deduction, income, gains, losses and deductions from farming or fishing should be taken into account, but only to the extent that the deduction is attributable to your farming or fishing business and is included in elected farm income on line 2a of Schedule J (Form 1040).

https://www.irs.gov/forms-pubs/elected-farm-income-may-be-used-to-figure-qualified-business-income-deduction-19-apr-2019

 

Advising SALT “Economic Refugees”—Buy Boots and a Hat!

William Stromsem, Assistant Professor, George Washington University

The April 15 tax filing deadline brought home the reality of the state and local tax (SALT) deduction limits to many high-income, high-net worth individuals in California, New York, New Jersey, Connecticut, Maryland, D.C. and other high tax states. With SALT rates sometimes exceeding 10% of income and real estate taxes around 1% of assessed value, the $10,000 limit on federal SALT deductions has resulted in additional federal income taxes of $10,000 or more. (The average SALT deduction for citizens of the states mentioned above is around $20,000, but those with higher income and real estate taxes could easily top $50,000 where a 30% federal tax rate could cost $15,000 for the year.) Many who had not used the standard deduction for decades took the higher federal standard deduction rather than itemizing, adding “salt” to the wounds as charitable contributions and other deductible expenses yielded no tax benefit. 

Several states have sued the federal government. Their representatives in Congress are seeking to change the law and governors have proposed workarounds, such as state deductions for charitable contributions to state universities. However, the lawsuits do not seem to be progressing. In addition, the proposed legislation has political complications. The IRS shot down some of the proposed workarounds in IR-2018-172 by alerting taxpayers and the various states they would be policing quid pro quo arrangements that seek to substitute charitable contributions for SALT deductions. The states are facing pressure to cut taxes now that the SALT taxes are only partially deductible for many taxpayers. Real estate markets are softening, with formerly hot markets in the New York area cooling so much that realtors are seeking buyers rather than buyers seeking houses. States are losing revenue as the caravan of “SALT refugees” grows.

The added cost of taxes, coupled with virtual work arrangements becoming more common, has caused some to pack up and move to a better life in the few states that do not tax individual income—Texas, Florida, Nevada, South Dakota, Washington, Alaska and Wyoming—with Texas and Florida receiving the most SALT refugees.

The states are not giving up their tax base easily. Some states—particularly New York and California—are aggressively performing residency audits to ensure taxpayers have sufficiently severed nexus. High tax bracket taxpayers are more likely to be impacted by such an audit. Preparers advising a recently settled SALT refugee should provide advice on how to evidence their severance with their former state, particularly if they retain a home there or commute there. Regardless of the new state of residence, taxpayers will still have to pay tax on income sourced within their former states.

In general, the former state will look at time spent in the new state versus the old one. Some states aggressively claim that if you cannot prove you were out of the state for a day, you are presumed to be in the former state for that day. Emigres should keep records of days in Texas versus the former state, including airline tickets, gas receipts and calendars with notations or other evidence to show when they were in Texas. Get a clean cutoff date of when residency is established in Texas, since you will need to allocate prior income to the former state. Save documents to help prove your Texas residency. 

Here are some items that may be helpful in showing Texas residency:

• Obtain a Texas driver’s license.
• Consider selling your old home and using temporary quarters when you visit the old state. Consider buying in Texas instead of renting. Some states presume that if you retain a residence in the former state, you are only temporarily out of the state.
• Stop state income tax withholding and estimated tax payments to the former state, if appropriate. This places the collection burden on the state, rather than placing the refund burden on the taxpayer.
• Open a bank account, register to vote and register your car in Texas.
• Charge items in Texas to create evidence of presence in Texas.
• Change your billing address to Texas for other mail such as magazine subscriptions, even if you have mail forwarded from your former state.
• Get a library card, and/or fishing or hunting license.
• If you are a professional, get re-licensed in Texas or at least join local professional associations (such as TXCPA).
• Hire a group of local professionals—CPA, doctor, dentist, lawyer, investment adviser, etc.
• Join a local country club.
• Consult residency audit guidelines for your former state, if available.
• And finally, buy some Texas boots!

House Passes IRS Reform Legislation

 

On April 9, the House passed by a voice vote H.R. 1957, “Taxpayer First Act of 2019.” The bill had bipartisan support in the House and appears to have bicameral support, as well. The Senate Finance Committee is considering an identical bill in S. 928.

H.R. 1957 would modify requirements to the IRS’ organizational structure, customer service procedures and training, enforcement procedures, information technology and electronic systems. It includes the following provisions:

·         establish an independent IRS appeals office;

·         require the commissioner to appoint a chief information officer;

·         establish a response deadline to the National Taxpayer Advocate’s directives;

·         notify Congress 90 days before a proposed closure of a Taxpayer Assistance Center;

·         develop a comprehensive customer service strategy;

·         continue the IRS Free File Program;

·         exempt certain low-income taxpayers from offer-in-compromise payments and from referral to the IRS’ private debt collection program;

·         modify tax enforcement procedures on property seizures, summons, joint liability and third-party contact;

·         modify whistleblowers procedures;

·         update cybersecurity and identity protection requirements;

·         provide a single point of contact for tax-related identity theft victims;

·         within five years, offer identity protection personal identification numbers nationwide;

·         allow the IRS to require additional taxpayers to file electronically; 

·         require partnerships having more than 100 partners to file returns on magnetic media;

·         waive the electronic filing requirement for certain preparers in areas without internet access;

·         require mandatory e-file by exempt organizations, but provide notice before revoking an exempt status for failure to file return;

·         implement internet platforms for Form 1099 filings and for third-party income verification;

·         develop uniform standards for the acceptance of electronic signatures;

·         streamline critical pay authority for the IRS’ information technology positions;

·         ensure that contractors comply with confidentiality safeguards; and

·         prohibit the rehiring of certain IRS employees removed for misconduct.

 

As an offset, the legislation would increase the penalty for failing to file a tax return and for improper disclosure or use of information by return preparers.

 

Penalty Waivers for Underpayment of Tax

In Notice 2019-25, the IRS expands its penalty waiver for underpayment of 2018 withholdings and estimated tax payments if those payments equaled at least 80 percent of the tax due upon filing the federal return. In prior Notice 2019-11, the penalty was waived only if at least 85 percent of the tax was paid prior to filing.

Any taxpayer eligible for the additional relief who has already filed his/her return can claim a refund of the penalty amount by filing Form 843 and completing Line 7 with the statement, “80% waiver of estimated tax penalty.”

Late February, “qualified” farmers and fishermen also received an underpayment penalty waiver. Prior to Notice 2019-17, these taxpayers were required to make one estimated installment payment by Jan. 15 of the year following the taxable year or file their return by March 1. The notice waives the underpayment penalty for these businesses if they file their 2018 tax return and pay the full amount due by April 15.

https://www.irs.gov/pub/irs-drop/n-19-25.pdf

https://www.irs.gov/pub/irs-drop/n-19-17.pdf

IRS Commissioner Meets with Tax Professionals

On March 6, 2019, IRS Commissioner Charles Rettig met with a group of 15 tax practitioners, including CPAs, attorneys and enrolled agents, at the Austin IRS service center. TXCPA members in attendance were Lara Akinboye, Gary Brown, Julie Dale, Ira Lipstet, Christi Mondrik, and Jaime Vasquez.

Rettig was also in Austin to conduct town hall meetings with service center employees.

The Commissioner’s Life and Family

As many of the practitioners were aware, Rettig served 36 years as a tax controversy attorney with a practice in Beverly Hills, California.

His wife was a Vietnamese refugee who was inside the U.S. Embassy when it fell in 1975. She escaped and sold tobacco leaves on the street as a small child to support her family. Her father was taken to a “reeducation camp” where he lost one eye and became severely disabled before escaping. After moving to the U.S., Rettig’s wife was an auditor with the California Franchise Tax Board for 10 years. As immigrants, it was a proud moment for her family to file their first tax returns after arriving safely in the U.S.

He spoke about his son whose military service in the United States Army resulted in two deployments and living in a shipping container in the desert where there was a hotbed of terrorist activity. His daughter is a veterinarian.

The commissioner’s nomination and induction into office was a very proud moment for him and his family, as he is now able to join his son in serving his country. While he acknowledged that he does not necessarily know what it is like to be in their shoes, he did say it helps give him perspective.

The Importance of Service to Taxpayers

Rettig realizes that IRS tax revenue represents around 93 percent of the U.S. gross revenue. He realizes the needs of low income, ESL (English as a second language) and unrepresented taxpayers. More resources are needed to serve those who are unrepresented or underrepresented. He has also been working to enhance the IRS’ multilingual sensitivity.

Customer service is very important to him. Recently, he listened to telephone call etiquette at the Atlanta, Georgia service center. He heard IRS representatives field calls about refund issues and noted their conversational and friendly tones with individuals whose refunds were critical to the well-being of the taxpayers and their families. The care that employees took in seeking to resolve taxpayers’ issues was as unobtrusive as possible.

He also showed up on a Saturday for Pro Bono Day in D.C., where IRS volunteers addressed 14 cases; two revenue officers and low-income taxpayer clinic representatives volunteered to spend part of their weekend helping taxpayers. The volunteers resolved 12 of the 14 cases.

The Government Shutdown

The 35-day government shutdown hit the IRS’ 80,000 employees hard. Rettig held daily calls with the executive management team dealing with issues like furloughed employees who could not pay their childcare bills or receive unemployment compensation. The Department of Labor was denying unemployment claims, because the workers would eventually get paid when the government reopened.

The Filing Season

Despite all odds, the filing season has run smoothly. Lots of tax returns are being filed and lots of refunds issued. The IRS set a record this season in the most returns processed per hour. (Statistics are posted every Thursday.)

The IRS still lacks resources. The productivity it has achieved with limited resources is a direct result of the care, dedication, desire and pride of the workforce. Rettig eats lunch with the employees in the cafeteria each day so he can get to know them better. He has great conversations about career goals and other important topics.

Top Priority: Enforcement

Criminal investigation is an important investment tool. The IRS is using the tools it has to make surgical strikes. The indictment season is open until April 15. Rettig recognizes the indictment season from his years in practice representing taxpayers in criminal investigations.

Now, he is on the enforcement side and it is a top priority. He acknowledges that most taxpayers make a reasonable attempt to properly file a correct tax return and he does not want to punish them for trying their best. However, people who intentionally cross the line should be concerned that he is commissioner.

Modernization

The IRS needs modernization. His goal is to maximize resources using collective ideas. The IRS is piloting a customer callback program like those available at some insurance companies. You can call, leave a message, get a call back and not lose your place in the queue.

Its IT department is thwarting up to 3 million daily cyber threats, requiring staff to work as creatively and efficiently as possible with limited resources. The IRS is fighting for funding. Rettig has participated in frequent one-on-one meetings with legislators. They are also looking for ways to collaborate with big companies for IT internships.

Part of the Solution

Rettig appreciates the support from the practitioner community; tax professionals are part of the solution … they help streamline the process. Working with qualified tax professionals makes everyone’s job more efficient.

The best thing practitioners can do to help the IRS improve is to say something positive about the IRS workforce when you see them doing good things. The dedication and care of the workforce is more than we realize. Nice comments go a long way.

Talking to Clients About Tax Extensions

As CPAs, we know how to navigate challenging filing seasons. One of those maneuvers is to file tax extensions on behalf of some of our clients. This lengthens the time we have to complete their returns and helps us adhere to our quality control procedures and standards. However, it can be difficult for clients to recognize the benefits.

Clients can have difficulties understanding the purpose of tax extensions and may feel uncomfortable with the process, particularly if they have never gone on an extension before. Before notifying a client that an extension is necessary, CPAs should prep them for this possibility.

Because of tax reform, more people than usual may face tax extensions this year. That means you will likely be talking to clients who have had little or no exposure to these kinds of filings.

Clients with small businesses are highly likely candidates for extensions this year. The new Section 199A deduction for passthroughs is advantageous, but the new law was unclear, guidance was slow coming, and interpretation and implementation questions still exist among tax practitioners.

There is also a new group of clients likely to go on extension this year - those who are in shock or disbelief over the initial results of their return. The loss of personal exemptions and the massive changes to Schedule A are taking many by surprise.   

Other clients who may benefit from extensions include:

• Those affected by natural disasters.
• Certain taxpayers who are out of the country.
• Those with unexpected life events like a death in the family.

Keeping the following points in mind can ease the tax extension discussion and help your clients understand the process.

How extensions work — A tax extension is a six-month postponement on the time to file, but not on the time to pay. Your client must understand that the estimated tax liability seen on the extension form is their responsibility and they should plan on making an estimated tax payment at the time the extension is filed. This payment can reduce or eliminate interest and late-payment penalties.

Benefits and risks — The advantage of a tax extension is it gives a preparer more time to compile all the needed information to file a return accurately. Extensions are often more cost effective than filing an amended return later down the line and do not increase the likelihood of an audit. However, there are risks involved with a tax extension, including accruing interest and penalties. A client who misses the extended deadline will face steep penalties.

April 15 deadline still matters — All payments on taxes owed must be paid by the April 15 deadline or your client may be charged interest and penalties. April 15 is also the last day your client may set up an IRA or make IRA contributions for the 2018 tax year. Married couples are not permitted to change their filing status from married filing jointly to married filing separately after the April 15 deadline even if they go on an extension.

Business rules — It is likely more business clients than usual will face tax extensions this year due to pending tax reform guidance. Those who own C corporations must file their 2018 tax return or extension by April 15. Like individual tax returns, a business extension filed through Form 7004 is an extension of time, not an extension to pay.

Tax reform and state rules — Many states allow for an automatic filing of state extensions when a federal extension is filed, but other states may have different procedures or impose greater interest and penalties. Review the state rules with your clients.

Due diligence — Because of the volume and complexity of tax extensions this year, extra due diligence is necessary. CPAs must obtain written authorization from their clients before filing tax returns on their behalf. This document should also include details of the extension like estimated tax payment amounts and an explanation of possible interest and penalties. Consult the AICPA Code of Conduct, Circular 230, AICPA Statements on Standards for Tax Services (SSTSs) and the Internal Revenue Code (IRC) while preparing your clients’ tax extensions this year.

And while it goes without saying, extensions are a tried and true method for spreading out the workload, especially during this last stretch when days are getting longer and patience is running shorter.

Penalty Relief for Missing Negative Tax Basis Capital Account Information

Notice 2019-20 provides a waiver of penalties under IRC Sections 6722 and 6698 to certain partnerships that file Schedules K-1 that fail to report information about partners’ negative tax basis capital accounts for the partnerships’ 2018 tax year. The relief is conditioned on the partnerships providing the missing information in a separate schedule by March 15, 2020.

https://www.irs.gov/pub/irs-drop/n-19-20.pdf

 

Some in Congress Concerned About Corporate Share Buybacks

William Stromsem, CPA, J.D., Assistant Professor, George Washington University School of Business

 

In recent years, many corporations have been buying back their own stock, thereby reducing the number of outstanding shares and increasing the proportional ownership of the remaining shares. This trend could increase as lower corporate tax rates and repatriation of foreign earnings bring in more cash. In some cases, there has been a dramatic reduction in outstanding shares. Apple, for example, bought back shares to the extent that outstanding shares dropped from 6.6 billion in 2012 to 4.7 billion today. Cisco, Wells Fargo, Pepsi, Starbucks and McDonalds have had similarly dramatic reductions in the number of their shares. Buybacks, which were once illegal, are accelerating in frequency and amounts. (In 1982, the Securities and Exchange Commission passed Rule 10b-18, which created a legal process for buybacks.)

 

Some members of Congress have expressed a concern that many corporations may use the tax benefits from the Tax Cuts and Jobs Act (TCJA) to buy back their stock rather than for increased wages, capital formation or job creation. In response, various proposals are being floated on Capitol Hill. Senator Marco Rubio (R-FL) has stated that stock buybacks should be treated as if the remaining shareholders were given a dividend and chose to use it to purchase additional shares to increase their percentage ownership of the corporation. Other members of Congress believe that the business breaks in the TCJA should be used to create jobs and raise wages, not just to enrich shareholders. Senator Chuck Schumer (D-NY), for example, has expressed the view that before a corporation can benefit its remaining shareholders with a buyout, it should be required to give more benefits to employees, such as higher wages, health care insurance coverage and sick leave.

 

The analysis that a buyback is a tax-free distribution is somewhat overstated: if a corporation buys back shares, a tax on the capital gain is being paid currently by those whose shares are purchased, and the value of the remaining shares is not dramatically increased, because corporate assets are reduced by the cash being paid out to purchase the shares. Also, while the buyback may result in a deferred capital gain until the remaining shareholders sell their shares, this is like deferring tax by holding the cash at the corporate level rather than paying a dividend.

 

It is unlikely that Washington will be able to agree to do anything until possibly after the next elections. However, buybacks are regulated by government agencies other than the Internal Revenue Code, so a legislative change may not be required. Cash-rich companies that are considering a share buyback should be aware that there is a potential for less favorable tax treatment if the political climate changes.

https://thehill.com/opinion/finance/376947-blame-congress-not-companies-for-share-buybacks

Business Interest Limitation Under 163(j)—Unresolved Issues

On Feb. 21, AICPA sent a letter to the IRS requesting guidance on many areas associated with Section 163(j). These include:

 

1.        Definition of interest expense

2.       Aggregation/consolidation of groups

3.       Allocation rules

4.       Ordering rules, including whether Section 163(j) is a method of accounting

5.       Interaction between Sections 163(j) and 108 (discharge of indebtedness)

6.       Partnership related items—tiered partnerships, disposition of partnership interests

7.       International items

8.       Small business relief from tax shelter definition

 

Some of these items only affect a small number of taxpayers, but some affect a great many taxpayers. The letter is comprehensive with 51 pages. All practitioners with affected clients should be aware of the major issues during this filing season.

https://www.aicpa.org/content/dam/aicpa/advocacy/tax/downloadabledocuments/20190221-aicpa-comments-sec-163j-prop-regs.pdf

 

Section 199A Resource Listing

By Julie Dale, CPA-Austin

The Tax Cuts and Jobs Act enacted in 2017 included new Section 199A to provide a potential tax reduction to qualified businesses operating as flow-through entities. A more in-depth discussion of the mechanics of the deduction can be found in the article entitled, The Qualified Business Income Deduction, published on the TXCPA website on Feb. 13, 2019. This deduction is currently available for tax years 2018 to 2025.

Guidance Issued

The IRS guidance required surrounding this new deduction is substantial. The IRS declined to issue any tax forms specifically for the calculation of this deduction in 2018. Below is a summary of recent primary guidance issued. These items include examples that will be useful in verifying accuracy of the computations involved with this deduction.

1. Final Regulations (page numbers referenced below are for the corrected version as drafted at date of the article’s publication):
2. Regulation Section 1.199A-1, Operational rules, page 156
3. Regulation Section 1.199A-2, Determination of W-2 wages and unadjusted basis immediately after acquisition of qualified property, page 176
4. Regulation Section 1.199A-3, Qualified business income, qualified real estate investment trust (REIT) dividends, and qualified publicly traded partnerships (PTP) income, page 197
5. Regulation Section 1.199A-4, Aggregation, page 205
6. Regulation Section 1.199A-5, Specified service trades or businesses and the trade or business of performing services as an employee, page 217
7. Regulation Section 1.199A-6, Relevant passthrough entities (RPEs), PTPs, trusts, and estates, page 239
8. Regulation Section 1.643(f)-1, Treatment of multiple trusts, page 248
9. Notice 2019-7 for rental real estate safe harbor
10. Revenue Procedure 2019-11 for wage calculation and qualified property

Section 199A on Information Returns

A variety of information returns will include Section 199A data. Below is a listing of a few forms you may regularly see with this information included:

1. Form 1099-DIV
2. Form 1099-PATR
3. Schedules K-1

There are other forms that should be considered in evaluating eligibility for the Section 199A deduction even though there is no specific information regarding the deduction included on the forms. The most common examples will be Form 1099-MISC, Form 1099-K or other documents provided by a sole proprietor. These forms may contain income that qualifies for the deduction, but additional analysis is necessary.

2019 Form 8995

On Feb. 13, 2019, the IRS issued a draft version of 2019 Form 8995, Qualified Business Income Deduction Simplified Computation. Although this is a 2019 tax form, it may serve as a template for the simplified computation. For an expanded discussion of this form, see the Tax Adviser article published recently.

Form Instructions and Publications

The IRS has issued instructions for forms, publications and FAQs that reference Section 199A:

1. Form 1040 Instructions
2. Form 1041 Instructions
3. Form 1065 Instructions
4. Form 1120S Instructions
5. Publication 535, Business Expenses
6. Publication 5318, What’s New for Your Business – Tax Reform 2018
7. Qualified Business Income Deduction FAQs

Guidance Remaining

There may be additional guidance issued, so this area should be monitored closely for modifications and expanded information to come during this tax season. If questions should arise during tax season that appear to be unanswered, please consider posting your question in TXCPA Exchange to see if others have run across similar concerns. This may be a valuable resource to learn more about this deduction as tax season unfolds.