The IRS and the Treasury intend to provide regulations that will address issues affecting foreign corporations with previously taxed earnings and profits (PTEP). The regulations are in response to changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97)

The IRS and the Treasury intend to provide regulations that will address issues affecting foreign corporations with previously taxed earnings and profits (PTEP). The regulations are in response to changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), and are intended to include rules for:

• the maintenance of PTEP in annual accounts and within certain groups;
• the ordering of PTEP upon distribution and reclassification; and
• the adjustment required when an income inclusion exceeds a foreign corporation's earnings and profits.

The IRS and Treasury intend to withdraw 2006 proposed regulations relating to the exclusion from gross income of PTEP and associated basis adjustments ( NPRM REG-121509-00), and issue new proposed regulations under Code Sec. 959 and Code Sec. 961.

Previously Taxed Earnings and Profits
Previously taxed earnings and profits (PTEP) are a foreign corporation's earnings and profits attributable to amounts which are or have been included in a U.S. shareholder's gross income under Code Sec. 951(a) or under Code Sec. 1248(a). Under the subpart F rules, a U.S. shareholder of a controlled foreign corporation (CFC) is generally currently taxed on certain income earned by the CFC, and on certain earnings invested in U.S. property.

To prevent double taxation, Code Sec. 959 provides that earnings and profits of the foreign corporation that are attributable to the inclusion are excluded from gross income when actually distributed. An exclusion is also allowed when earnings and profits are attributable to amounts included in the U.S. shareholder’s gross income that would otherwise again be included in gross income under the rule for investment of earnings in U.S. property.

To determine the amount of an actual distribution that is not taxable because it represents previously taxed income upon an actual distribution by the CFC, the earnings distributed are treated as attributable in the following order:

• first, to retained earnings that were required in prior years to be included in income on account of investments in excess passive assets, together with the earnings in prior years that were required to be included in income on account of investments in U.S. property under Code Sec. 956, allocated to each category on a pro rata basis ( "section 959(c)(1) PTEP");
• next, to retained earnings that were required to be included in income as subpart F income ( "section 959(c)(2) PTEP"); and
• finally, to other earnings and profits ( "section 959(c)(3) E&P").

Changes made by the TCJA created the need to account for new groups of PTEP, because section 959(c)(2) PTEP may arise due to income inclusions under Code Secs. 951(a)(1)(A), 245A(e)(2), 951A(f)(1), 959(e), 964(e)(4), or 965(a), or by applying Code Sec. 965(b)(4)(A). Those different groups of PTEP may be subject to different rules under Code Secs. 960, 965(g), 245A(e)(3), and 986(c).

In addition, Proposed Reg. § 1.960-3(c) establishes, for purposes of determining the amount of foreign income taxes deemed paid, a system of accounting for PTEP in annual accounts for each separate category of income ( "section 904 category") and further segregate each annual account among 10 PTEP groups.

Annual Accounts and Groups of Previously Taxed Earnings and Profits
The new regulations are expected to provide that an annual account must be maintained and each annual PTEP account must be segregated into 16 PTEP groups in each section 904 category:

• reclassified section 965(a) PTEP;
• reclassified section 965(b) PTEP;
• section 951(a)(1)(B) PTEP;
• reclassified section 951A PTEP;
• reclassified section 245A(e)(2) PTEP;
• reclassified section 959(e) PTEP;
• reclassified section 964(e)(4) PTEP;
• reclassified section 951(a)(1)(A) PTEP;
• section 956A PTEP;
• section 965(a) PTEP;
• section 965(b) PTEP;
• section 951A PTEP;
• section 245A(e)(2) PTEP;
• section 959(e) PTEP;
• section 964(e) PTEP; and
• section 951(a)(1)(A) PTEP.

Section 959(c)(1) PTEP will consist of PTEP groups (1) through (9), and section 959(c)(2) PTEP will consist of PTEP groups (10) through (16). Once PTEP is assigned to a PTEP group within an annual PTEP account for the year of the income inclusion under Code Sec. 951(a)(1) or the year of application of Code Sec. 965(b)(4)(A), the PTEP will be maintained in an annual PTEP account with a year that corresponds to the year of the account from which the PTEP originated if PTEP is distributed or reclassified in a subsequent tax year.

Additionally, the new regulations are expected to provide that:

• to the extent a CFC has E&P in a PTEP group that is in more than one section 904 category, any distribution out of that PTEP group is made pro rata out of the earnings and profits in each such category;
• dollar basis must be tracked for each annual PTEP account, and, to the extent provided in the regulations, separately for each PTEP group within an annual account; and
• distributions from any PTEP group reduce the shareholder’s stock basis under Code Sec. 961(b)(1) without regard to how that basis was originally created.

The regulations also will provide transition rules for annual PTEP accounts maintained before the regulations’ applicability date.

Ordering of Earnings and Profits upon Distribution and Reclassification
The new regulations are expected to provide that:

• a distribution will be a distribution of PTEP only to the extent it would have otherwise been a dividend under Code Sec. 316;
• a "last in, first out" approach will be required for sourcing distributions from annual PTEP accounts, subject to the special priority rule for PTEP arising due to Code Sec. 965;
• PTEP attributable to income inclusions under Code Sec. 965(a) or by reason of Code Sec. 965(b)(4)(A) receive priority when determining the group of PTEP from which a distribution is made; and
• reclassifications of PTEP under Code Sec. 959(a)(2) will be sourced first from section 965(a) PTEP, then section 965(b) PTEP, and then, under a last-in, first-out approach, pro rata from the remaining section 959(c)(2) PTEP groups in each annual PTEP account, starting from the most recent annual PTEP account.

Adjustments Due to an Income Inclusion in Excess of Current Earnings and Profits
The new regulations are expected to provide that:

• current E&P are first classified as section 959(c)(3) E&P, and then section 959(c)(3) E&P are reclassified as section 959(c)(1) PTEP or section 959(c)(2) PTEP, as appropriate, in full, which may result in creating or increasing a deficit in section 959(c)(3) E&P; and
• if a foreign corporation has a current-year deficit in E&P, that deficit will solely reduce the foreign corporation’s section 959(c)(3) E&P without affecting the amount of its section 959(c)(1) PTEP or section 959(c)(2) PTEP.

Application
The new regulations are expected to apply to tax years of U.S. shareholders and successors in interest ending after December 14, 2018, and to tax years of foreign corporations ending with or within the U.S. shareholders’ tax years. Before the regulations are issued, a shareholder can rely on the rules provided in the announcement notice if the shareholder and each related shareholder apply the rules consistently regarding the PTEP of all foreign corporations in which they own stock for all tax years beginning with the shareholder’s or related shareholder’s tax year that includes the tax year end of any such foreign corporation to which Code Sec. 965 applies.

The IRS has proposed regulations on the limitation on the business interest expense deduction under Code Sec. 163(j), as amended by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The IRS also has issued a safe harbor that allows taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under Code Sec. 163(j)(7)(B).

The IRS has proposed regulations on the limitation on the business interest expense deduction under Code Sec. 163(j), as amended by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The IRS also has issued a safe harbor that allows taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under Code Sec. 163(j)(7)(B).

Business Interest Limitation
For tax years beginning after 2017, the deduction of interest paid or incurred on debt properly allocable to a trade or business is limited to the sum of:

30 percent of the taxpayer’s adjusted taxable income (but not less than zero);

the taxpayer’s business interest income (not including investment income); and

the taxpayer’s floor plan financing interest.

The proposed regulations provide general rules and definitions related to the limitation, as well as rules for calculating the limitation in consolidated group, partnership, and international contexts. The regulations affect taxpayers that have deductible business interest expense, other than certain small businesses, electing real property trades or businesses, electing farming businesses, and certain utility businesses. The IRS is also withdrawing a prior notice of proposed rulemaking on the disallowance of a deduction for certain interest paid or accrued by a corporation under former Code Sec. 163(j).

The proposed regulations will generally be effective for tax years ending after the date the Treasury Decision adopting them as final is published in the Federal Register. However, taxpayers can apply certain provisions to tax years beginning after December 31, 2017, so long as the rules are consistently applied.

Safe Harbor
Further, in Rev. Proc. 2018-59, a safe harbor is provided allowing taxpayers to treat certain infrastructure trades or businesses as electing real property trades or businesses not subject to the Code Sec. 163(j) business interest deduction limit. These include trades or businesses that are conducted in connection with the designing, building, managing, operating, or maintaining of certain core infrastructure projects for purposes of private activity bond financing proposals. If a taxpayer makes this election, the taxpayer must use the alternative depreciation system (ADS) to depreciate property. Taxpayers may apply the safe harbor to tax years beginning after December 31, 2017.

Comments Requested
Public comments to the proposed regulations should be submitted no later than 60 days after the date that the notice of proposed rulemaking is published in the Federal Register. Send submissions to: CC:PA:LPD:PR (REG-106089-18), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-106089-18), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, 20224, or sent electronically, via the Federal Rulemaking Portal at http://www.regulations.gov (indicate IRS and REG-106089-18).

A public hearing has been scheduled for February 25, 2019. It will be held on February 25, 2019, beginning at 10 a.m., in the Main IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC 20224.

A nonprofit corporation that operated a medical-marijuana dispensary legally under California law was not allowed to claim deductions for business expenses on its federal return. Code Sec. 280E, which prevents any trade or business that consists of trafficking in controlled substances from deducting any business expenses, applied.

A nonprofit corporation that operated a medical-marijuana dispensary legally under California law was not allowed to claim deductions for business expenses on its federal return. Code Sec. 280E, which prevents any trade or business that consists of trafficking in controlled substances from deducting any business expenses, applied.

Meaning of "Consists of"
The corporation argued that a business does not "consist of" drug trafficking within the meaning of Code Sec. 280E unless its activities relate exclusively with drug trafficking (i.e., selling marijuana). Since its dispensary offered services and goods to its clients other than the sale of medical marijuana, the corporation claimed that Code Sec. 280E does not apply to any of its activities.

The court rejected this argument, noting that it had previously considered and rejected the same argument in an earlier case involving a different taxpayer ( M. Olive, Dec. 59,146, aff’d, CA-9, 2015-2 ustc ¶50,377). Although the phrase "consists of" in common usage refers to an exhaustive or exclusive list, the court noted that the corporation’s interpretation would render Code Sec. 280E ineffective. For example, a drug dealer selling a single item that was not a controlled substance would not be covered by the provision. The court found that various dictionary definitions, certain usage in other Code Sections, and case law that considered the meaning of the phrase did not require an interpretation based on exclusiveness.

Non-Trafficking Trades or Businesses
Although Code Sec. 280E applied to deductions related to the corporation’s marijuana sales, the court had previously ruled that it does not apply to any separate, non-trafficking trades or businesses ( Californians Helping to Alleviate Med. Problems, Inc. (CHAMP), Dec. 56,935). The court considered whether any of the corporation’s non-trafficking activities were separate trades or businesses. According to the corporation, non-trafficking activities consisted of sales of products with no marijuana, therapeutic services, and brand development.

The court concluded that the sale of products other marijuana than at the corporation’s dispensaries was too closely linked to the sale of the marijuana itself to constitute a separate trade or business. The products generally related to the promotion or use of marijuana and were sold by the same staff that sold the marijuana. Similarly, free "holistic" services that were paid for with approximately one percent of the proceeds from its marijuana sales were not a separate trade or business. Finally, the corporation’s brand development activity was entirely entwined with the marijuana business and could not be treated as a separate enterprise.

Cost of Goods Sold
Although the corporation was not entitled to any business deductions, it was liable for tax only on its gross receipts as reduced by cost of goods sold. For purposes of determining cost of goods sold, the court determined that the corporation could not apply Code Sec. 263A to include indirect expenses. Code Sec. 263A(a)(2) specifically prohibits the capitalization of otherwise nondeductible costs, such as drug trafficking expenses. Therefore, only direct expenses (and a few specified indirect expenses) required to be included in cost of goods sold under the general rules of Code Sec. 471 could be taken into account. For purposes of applying Code Sec. 471, the corporation was considered a reseller rather a producer because it had no ownership in the plants from which the marijuana it sold was produced.

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

• business,
• medical, and
• charitable purposes.

Some members of the military may also use these rates to compute their moving expense deductions.

2019 Standard Mileage Rates
The standard mileage rates for 2019 are:

• 58 cents per mile for business uses;
• 20 cents per mile for medical uses; and
• 14 cents per mile for charitable uses.

Taxpayers may use these rates, instead of their actual expenses, to calculate their deductions for business, medical or charitable use of their own vehicles.

FAVR Allowance for 2019
For purposes of the fixed and variable rate (FAVR) allowance, the maximum standard automobile cost for vehicles places in service after 2018 is:

• $50,400 for passenger automobiles, and
• $50,400 for trucks and vans.

Employers can use a FAVR allowance to reimburse employees who use their own vehicles for the employer’s business.

2019 Mileage Rate for Moving Expenses
The standard mileage rate for the moving expense deduction is 20 cents per mile. To claim this deduction, the taxpayer must be:

• a member of the Armed Forces of the United States,
• on active military duty, and
• moving under an military order and incident to a permanent change of station.

The Tax Cuts and Jobs Act of 2017 suspended the moving expense deduction for all other taxpayers until 2026.

Unreimbursed Employee Travel Expenses
For most taxpayers, the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction for unreimbursed employee travel expenses. However, certain taxpayers may still claim an above-the-line deduction for these expenses. These taxpayers include:

• members of a reserve component of the U.S. Armed Forces,
• state or local government officials paid on a fee basis, and
• performing artists with relatively low incomes.

Notice 2018-3, I.R.B. 2018-2, 285, as modified by Notice 2018-42, I.R.B. 2018-24, 750, is superseded.

The IRS has provided guidance and examples for calculating the nondeductible portion of parking expenses. In addition, the IRS has provided guidance to tax-exempt organizations to help such organizations determine how unrelated business taxable income (UBTI) will be increased by the nondeductible amount of such fringe benefit expenses paid or incurred.

The IRS has provided guidance and examples for calculating the nondeductible portion of parking expenses. In addition, the IRS has provided guidance to tax-exempt organizations to help such organizations determine how unrelated business taxable income (UBTI) will be increased by the nondeductible amount of such fringe benefit expenses paid or incurred.

The IRS also has provided transitional estimated tax penalty relief to tax-exempt organizations that offer qualified transportation fringe benefit expenses and were not required to file a Form 990-T, Exempt Organization Business Income Tax Return, last filing season.

Parking Fringe Expenses
The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) added Code Sec. 274(a)(4) to preclude employers from deducting Code Sec. 132(f) qualified transportation fringe benefits expenses paid or incurred after December 31, 2017. Qualified transportation fringe benefits include van pools, transit passes, bicycle commuting, and qualified parking.

There are two types of calculations. The first is for cases where the employer pays a third party for the use of its parking lot for the employer’s employees. The second is for cases where the employer owns or leases the parking lot.

Employer contracts with third party. When an employer contracts with a third party for the use of the parking lot, the disallowance under Code Sec. 274(a)(4) is generally the amount that the employer pays to the third party. However, if that monthly amount exceeds $260 an employee, the employer must treat the excess as additional compensation. Thus, the monthly amount in excess of $260 is excluded from the disallowance amount.

For example, if Employer A pays $300 per month for each of the employer’s ten employees to park, $31,200 (($260 x 10) x 12) is disallowed under Code Sec. 274(a)(4). The remaining $4,800 (($40 x 10) x 12) is not subject to the Code Sec. 274(a)(4) and remains deductible.

Employer owns or leases the parking lot. According to the IRS, until it issues further guidance, employers may use any reasonable method to calculate the Code Sec. 274(a)(4) disallowance in cases where the employer owns or leases the parking lot. The IRS has provided a four-step reasonable method:

• Calculate the disallowance for reserved employee spots.
• Determine the primary use of the remaining spots (for the general public (over 50 percent) or for employees).
• Calculate the allowance for reserved nonemployee spots.
• Determine the remaining use and allocable expenses.

For example, an Employer E, owns a surface parking lot adjacent to its plant. E incurs $10,000 of total parking expenses. E’s parking lot has 500 spots that are used by its visitors and employees. E has 50 spots reserved for management and has approximately 400 employees parking in the lot in non-reserved spots during normal business hours on a typical business day. Additionally, E has 10 reserved nonemployee spots for visitors.

Step 1. Because E has 50 reserved spots for management, $1,000 ((50/500) x $10,000) is the amount of total parking expenses that is nondeductible for reserved employee spots.

Step 2. The primary use of the remainder of E’s parking lot is not to provide parking to the general public because 89% (400/450 = 89 percent) of the remaining parking spots in the lot are used by its employees. Therefore, expenses allocable to these spots are not excluded from the Code Sec. 274(a)(4)

Step 3. Because 2 percent (10/450) of E’s remaining parking lot spots are reserved nonemployee spots, the $200 allocable to those spots ($10,000 x 2 percent)) is not subject to the Code Sec. 274(a)(4) disallowance. That amount continues to be deductible.

Step 4. E must reasonably determine the employee use of the remaining parking spots during normal business hours on a typical business day and the expenses allocable to employee parking spots.

Further guidance will be issued on these and other issues in the form of proposed regulations at a later date.

Increase Unrelated Business Taxable Income
TCJA added Code Sec. 512(a)(7), which requires exempt organizations to increase UBTI by any amount for which a deduction is not allowable under Code Sec. 274 and which is paid or incurred after December 31, 2017, for any qualified transportation fringes and any parking facility used in connection with qualified parking.

The rules governing tax-exempt organizations mirror the rules for employers under Code Sec. 274(a)(4). Therefore, the expenses for a parking facility used in connection with qualified parking are treated as nondeductible qualified fringe benefit expenses. Thus, a tax-exempt organization must increase its UBTI under Code Sec. 512(a)(7) by the disallowed amount. In addition, until the IRS releases further guidance, a tax-exempt organization with only one unrelated trade or business can reduce the increase to UBTI under Code Sec. 512(a)(7) to the extent that the deductions directly connected with the carrying on of that unrelated trade or business exceed the gross income derived from such unrelated trade or business.

Estimated Tax Penalty Relief
An exempt organization may be subject to the unrelated business income tax under Code Sec. 511 at corporate rates. The organization reports its unrelated business income on Form 990-T, Exempt Organization Business Income Tax Return, if its gross income from unrelated business is $1,000 or more. Further, the organization must make quarterly estimated tax installment payments under Code Sec. 6655 if its estimated tax is expected to be $500 or more.

Code Sec. 6655 imposes an addition to tax for failure to make a sufficient and timely estimated income tax payment. To avoid the underpayment penalty, each installment generally must equal at least 25 percent of the lesser of:

• 100 percent of the tax shown on the current year's tax return or of the actual tax if no return is filed (current-year safe harbor); or
• 100 percent of the tax shown on the corporation's return for the preceding tax year, provided a positive tax liability was shown and the preceding tax year consisted of 12 months (preceding-year safe harbor).

The IRS has recognized that Code Sec. 512(a)(7) may cause some exempt organizations to owe unrelated business income tax and have to pay estimated income tax for the first time. These organizations would not be able to use the preceding-year safe harbor, and may need more time to develop knowledge and processes to comply with estimated tax payment requirements.

In light of this, the IRS is waiving the addition to tax for failure to make estimated income tax payments for an exempt organization that:

• provides qualified transportation fringes to an employee for which estimated income tax payments, affected by changes made by TCJA to Code Sec. 274 and Code Sec. 512, would otherwise be required to be made on or before December 17, 2018;
• was not required to file a Form 990-T, Exempt Organization Business Income Tax Return, for the tax year preceding the organization’s first tax year ending after December 31, 2017; and
• timely pays the amount reported for the tax year for which relief is granted.

Taxpayers that do not qualify for this relief can avoid an addition to tax for underpayment of estimated income tax if they meet one of the statutory safe harbor or exception provisions under Code Sec. 6654 or Code Sec. 6655.

To claim the waiver, the exempt organization must write "Notice 2018-100" on the top of its Form 990-T.

The IRS has released initial guidance on the new Code Sec. 83(i), added by the 2017 Tax Cuts and Jobs Act ( P.L. 115-97).

Code Sec. 83 generally provides for the federal income tax treatment of property transferred in connection with the performance of services. Code Sec. 83(i) allows certain employees to elect to defer recognition of income attributable to the receipt or vesting of qualified stock for up to five years.

The IRS has released initial guidance on the new Code Sec. 83(i), added by the 2017 Tax Cuts and Jobs Act ( P.L. 115-97).

Code Sec. 83 generally provides for the federal income tax treatment of property transferred in connection with the performance of services. Code Sec. 83(i) allows certain employees to elect to defer recognition of income attributable to the receipt or vesting of qualified stock for up to five years.

The guidance clarifies three key issues related to Code Sec. 83(i):

• the application of the requirement that eligible corporations must make grants to not less than 80 percent of all employees who provide services to the corporation in the United States;
• the application of federal income tax withholding to the deferred income related to the qualified stock; and
• the ability of an employer to opt out of permitting employees to elect the deferred tax treatment even if the requirements under Code Sec. 83(i) are otherwise met.

Code Sec. 83(i) applies to stock attributable to stock options exercised, or restricted stock units (RSUs) settled, after December 31, 2017. Further guidance will be issued on these and other issues in the form of proposed regulations at a later date.

Eligible Corporations
Companies who wish to be eligible corporations and offer the Code Sec. 83(i) election must have a written plan under which, in such calendar year, not less than 80 percent of all employees who provide services to the corporation in the United States (or any possession of the United States) are granted stock options, or are granted RSUs, with the same rights and privileges to receive qualified stock.

The IRS clarifies that the determination of whether a corporation qualifies as an eligible corporation is made "with respect to any calendar year." Furthermore, to meet the 80-percent requirement, the corporation must have granted "in such calendar year" stock options to 80 percent of its employees or RSUs to 80 percent of its employees. So the determination that the corporation is an eligible corporation must be made on a calendar-year basis, and whether the corporation has satisfied the 80-percent requirement is based solely on the stock options or the RSUs granted in that calendar year to employees who provide services to the corporation in the United States. In calculating whether the 80 percent requirement is satisfied, the corporation must take into account the total number of individuals employed at any time during the year in question as well as the total number of employees receiving grants during the year.

Employment Taxes
Employment taxes include Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) tax, and federal income tax withholding. FICA and FUTA taxes related to deferral stock remain unaffected.

Deferral stock are considered wages under Code Sec. 3402. When the wages are treated as paid, the employer must make a reasonable estimate of the value of the stock and make deposits of the amount of income tax withholding liability based on that estimate. The wages are subject to withholding at the maximum rate of tax, and withholding is determined without regard to the employee’s Form W-4. By January 31 of the following year, the employer must determine the actual value of the deferral stock on the date it is includible in the employee’s income, and report that amount and the withholding on Form W-2 and Form 941. With respect to income tax withholding for the deferral stock that the employer pays from its own funds, the employer may recover that income tax withholding from the employee until April 1 of the year following the calendar year in which the wages were paid. An employer that fails to deduct and withhold federal income tax is liable for the payment of the tax whether or not the employer collects it from the employee.

Not Eligible Stock
Code Sec. 83(i) imposes a number of requirements and limitations that must be met for an election to be allowed. Although the election, if allowed, may be made by an employee, the corporation is responsible for creating the conditions that would allow an employee to make the election. If a corporation does not intend to create the conditions that would allow an employee to make the election, the terms of a stock option or RSU may provide that no election under Code Sec. 83(i) will be available with respect to stock received upon the exercise of the stock option or settlement of the RSU. This designation would inform employees that no Code Sec. 83(i) election may be made with respect to stock received upon exercise of the option or settlement of the RSU, even if the stock is qualified stock.

Highly anticipated foreign tax credit regulations have been issued that provide guidance on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act ( P.L. 115-97).

Highly anticipated foreign tax credit regulations have been issued that provide guidance on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act ( P.L. 115-97). The proposed regulations address:

• allocation and apportionment of the deductions under Code Secs. 861 through 865, and adjustments to the foreign tax credit limitation under Code Sec. 904(b)(4);
• transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under Code Sec. 904(f) and (g), and for the carryover and carryback of unused foreign taxes under Code Sec. 904(c);
• addition of separate foreign tax credit limitation categories for foreign branch income and global intangible low-taxed income (GILTI), and other updates to the foreign tax credit limitation rules;
• calculation of the high-tax income exception from subpart F income;
• determination of the Code Sec. 960 deemed paid credits and the gross-up under Code Sec. 78; and
• the election under Code Sec. 965(n) not to apply the net operating loss deduction when calculating the Code Sec. 965 transition tax.

Deduction Allocation and Apportionment
The proposed regulations generally apply the existing approach of the expense allocation rules to income in the new Code Sec. 951A (GILTI) and foreign branch categories. The proposed regulations also provide for exempt income and exempt asset treatment for income in the GILTI category that is offset by the Code Sec. 250 deduction. This will reduce the amount of expenses apportioned to the GILTI category.

Rules are provided for the allocation and apportionment of the Code Sec. 250 deduction. A new rule addresses loans to partnerships by certain partners and their affiliates to prevent abusive borrowing arrangements that artificially increase foreign source income. Under the proposed regulations, interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate categories in the same manner as the associated interest expense.

The proposed allocation and apportionment regulations also revise the netting rule for controlled foreign corporations (CFCs), and provide rules for: valuing assets, characterizing stock for elections related to research and experimentation (R&E) expenses, and applying the Code Sec. 904(b)(4) adjustment.

Because the existing expense allocation rules have not been updated since 1988, the Treasury Department and IRS expect to reexamine existing approaches to allocating and apportioning expenses, including for example the rules for allocating interest, R&E expenses, stewardship and general and administrative expenses.

Limitations
The proposed regulations eliminate deadwood, and reflect statutory amendments made prior to the TCJA. New and transitional rules account for the separate categories for GILTI and foreign branch income. For example, foreign tax credit carryovers will by default remain in the general category, but taxpayers are allowed to allocate the transitional FTC carryovers to the foreign branch category. Also, the look-through rules are revised to clarify that nonpassive look-through payments cannot be assigned to a Code Sec. 951A category, and are generally assigned to the general category or the foreign branch category.

Additionally, changes are made to the rules relating to the passive category for high-taxed income, export financing income, and financial services income. Also addressed is the separate category for income resourced under a treaty, and rules for assigning the Code Sec. 78 gross-up and Code Sec. 986(c) gain or loss to a separate category.

Deemed Paid Tax Credits
The proposed regulations provide rules for determining a domestic corporation’s deemed paid taxes under Code Sec. 960, as revised by the TCJA. The proposed regulations treat a GILTI inclusion as a subpart F inclusion for purposes of Code Sec. 960(c). The proposed regulations also reflect the changes made by the TCJA to the Code Sec. 78 gross-up.

Proposed regulations provide much anticipated guidance on the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A and related reporting requirements. The regulations are proposed to apply generally to tax years beginning after December 31, 2017, but taxpayers may rely on these proposed regulations until final regulations are published.

Proposed regulations provide much anticipated guidance on the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A and related reporting requirements. The regulations are proposed to apply generally to tax years beginning after December 31, 2017, but taxpayers may rely on these proposed regulations until final regulations are published.

Code Sec. 59A was added by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) and imposes a tax on base erosion payments of taxpayers with substantial gross receipts. The tax is equal to the base erosion minimum tax amount for the tax year. The TCJA also added reporting obligations regarding the BEAT for 25-percent foreign-owned corporations subject to Code Sec. 6038A and foreign corporations subject to Code Sec. 6038C.

Proposed BEAT Rules
The proposed regulations generally provide rules for determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed and rules for computing the taxpayer’s BEAT liability. In particular, the proposed regulations provide rules:

• for determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed ( Proposed Reg. §1.59A-2);
• for determining the amount of base erosion payments (Proposed Reg. § 1.59A-3(b));
• for determining base erosion tax benefits arising from base erosion payments (Proposed Reg. §1.59A-3(c));
• for determining the amount of modified taxable income, which is computed in part by reference to a taxpayer’s base erosion tax benefits and base erosion percentage of any net operating loss deduction (Proposed Reg. §1.59A-4);
• for computing the base erosion minimum tax amount, which is computed by reference to modified taxable income (Proposed Reg. §1.59A-5);
• for applying the proposed regulations to partnerships (Proposed Reg. § 1.59A-7);
• that are specific to banks and registered securities dealers;
• that are specific to insurance companies;
• that disregard certain transactions having a principal purpose of avoiding Code Sec. 59A (anti-abuse rules) (Proposed Reg. § 1.59A-9);
• regarding the general application of the BEAT to consolidated groups (Proposed Reg. § 1.1502-59A);
• addressing limitations on a loss corporation’s items under Code Secs. 382 and 383 in the context of the BEAT (Proposed Reg. § 1.383-1); and
• regarding reporting and record keeping requirements under Code Sec. 6038A.

Proposed Applicability Dates
Consistent with the Code Sec. 59A applicability date, the proposed regulations (other than the proposed reporting requirements for qualified derivatives payments (QDP)) are proposed to apply to tax years beginning after December 31, 2017. However, taxpayers may rely on these proposed regulations for tax years beginning after December 31, 2017, until final regulations are published, provided the taxpayer and all related parties consistently apply the proposed regulations for all those tax years that end before the finalization date.

The proposed reporting requirements for QDPs apply to tax years beginning one year after the final regulations are published. However, the simplified QDP reporting requirements are proposed to apply to tax years beginning after December 31, 2017.

Any provision that is finalized after June 22, 2019, will apply only to tax years ending on or after the date of filing of the proposed regulations in the Federal register.

The IRS will grant automatic consent to accounting method changes to comply with new Code Sec. 451(b), as added by the Tax Cuts and Jobs Act ( P.L. 115-97). In addition, some taxpayers may make the accounting method change on their tax returns without filing a Form 3115, Application for Change in Accounting Method. These procedures generally apply to tax years beginning after December 31, 2017. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

The IRS will grant automatic consent to accounting method changes to comply with new Code Sec. 451(b), as added by the Tax Cuts and Jobs Act ( P.L. 115-97). In addition, some taxpayers may make the accounting method change on their tax returns without filing a Form 3115, Application for Change in Accounting Method. These procedures generally apply to tax years beginning after December 31, 2017. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

All Events Test
Under Code Sec. 451(b), the date that an accrual basis taxpayer takes an item into account as revenue in its applicable financial statement (AFS) is also the deadline for treating the item as satisfying the all events test. This rule also applies to any portion of an item, any other financial statement identified by the IRS, and income from a debt instrument with original issue discount (OID).

Automatic Consent
The automatic consent procedures apply to a taxpayer with an AFS that:

• wants to change to a method of accounting that complies with Code Sec. 451(b); and/or
• for the year of the change, is not adopting Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) financial accounting standards for revenue recognition, titled "Revenue from Contracts with Customers (Topic 606)" that were announced on May 28, 2014.

For income from a debt instrument having OID, the Code Sec. 481(a) adjustment period for the change is six tax years (year of change plus the next five tax years). However, this applies only for the taxpayer’s first tax year beginning after December 31, 2018.

The automatic consent procedures do not apply to a taxpayer that wants to make a change to a method that adopts the FASB/IASB standard, or to a special accounting method as described in Code Sec. 451(b)(2).

Streamlined Procedure
For its first tax year beginning after December 31, 2017, a qualified taxpayer can change its accounting method to comply with Code Sec. 451(b) without filing a Form 3115. An eligible taxpayer must either:

• meet the Code Sec. 448(c) gross receipts test for a small business taxpayers (i.e., taxpayer’s average annual gross receipts for the three prior tax years cannot exceed $25 million); or
• be making the change to comply with Code Sec. 451(b)(1)(A) and/or (b)(4), and the Code Sec. 481(a) adjustment for each of the changes is zero.

These streamlined procedures do not apply to a taxpayer that wants to make a change to a method that adopts the FASB/IASB standard, or to a special accounting method as described in Code Sec. 451(b)(2), or certain other concurrent accounting method changes. Tax shelters also are not eligible.

The IRS warns that consent granted under the streamlined procedures is not a determination that the new accounting method is permissible, and that taxpayers using the streamlined change method do not receive audit protection.

The IRS has issued transition relief from the "once-in-always-in" condition for excluding part-time employees under Reg. §1.403(b)-5(b)(4)(iii)(B). Under the "once-in-always-in" exclusion condition, once an employee is eligible to make elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that he or she is a part-time employee.

The IRS has issued transition relief from the "once-in-always-in" condition for excluding part-time employees under Reg. §1.403(b)-5(b)(4)(iii)(B). Under the "once-in-always-in" exclusion condition, once an employee is eligible to make elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that he or she is a part-time employee.

Part-Time Employee Exclusion Conditions Under Final 403(b) Regulations
The Department of the Treasury and the IRS issued final regulations under Code Sec. 403(b) that were generally effective starting after 2008. Part of the final regulations include Reg. §1.403(b)-5(b)(4)(iii)(B), which covers the conditions that an employer must satisfy before excluding a part-time employee from the plan. The IRS parses the regulation to impose three separate conditions for an employee to be excluded—

• a "first-year" exclusion condition, under which the employer must reasonably expect the employee to work fewer than 1,000 hours during the employee’s first year of employment;
• a "preceding-year" exclusion condition, under which the employee must have actually worked fewer than 1,000 hours in the preceding 12-month period; and
• the "once-in-always-in" exclusion condition, under which the employee may be excluded under the part-time exclusion if and only if, in the employee’s first year of employment, the employee meets the first-year exclusion condition, and, in each exclusion year ending after the first year of employment, the employee has met the preceding-year exclusion condition.

The effect of the once-in-always-in exclusion condition is that once an employee does not meet the part-time exclusion conditions, whether in the initial year of employment or for any exclusion year, the employee may no longer be excluded from making elective deferrals under the part-time exclusion.

Employers Surprised by Once-In-Always-In Condition
Employers requested transition relief because many were unaware that the part-time exclusion included the once-in-always-in exclusion condition. Many employers applied the first-year exclusion condition for an employee’s first year, and applied the preceding-year exclusion condition separately for each succeeding exclusion year, but did not apply the once-in-always-in exclusion condition to prevent an employee who failed to meet either the first-year exclusion condition or the preceding-year exclusion condition from being excluded in all subsequent exclusion years.

Transition Relief for Once-In-Always-In Condition
The IRS is providing transition relief, including—

• operations relief for a transition period referred to as the "Relief Period";
• relief regarding plan language; and
• a fresh-start opportunity after the "Relief Period" ends.

The operations "Relief Period" begins with tax years beginning after December 31, 2008. For plans with exclusion years based on plan years, the "Relief Period" ends for all employees on the last day of the last exclusion year that ends before December 31, 2019. For plans with exclusion years based on employee anniversary years, the "Relief Period" ends, with respect to any employee, on the last day of that employee’s last exclusion year that ends before December 31, 2019.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS and the Treasury Department intend to develop income tax withholding regulations to reflect changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), as well as other changes in the Code since the regulations were last amended, and certain miscellaneous changes consistent with current procedures.

Withholding Allowances
The IRS delayed the release of the 2018 Form W-4, Employee’s Withholding Allowance Certificate, in order to reflect changes made by the TCJA, such as changes in itemized deductions available, increases in the child tax credit, the new credit for other dependents, and the suspension of personal exemption deductions. Notice 2018-14 provided relief for employers and employees affected by the delay.

In June, the IRS released a draft 2019 Form W-4 and instructions, which incorporated changes that were meant to improve the accuracy of income tax withholding and make the withholding system more transparent. However, in response to stakeholders’ comments, the IRS later announced that the redesigned Form W-4 would be postponed until 2020. The IRS intends to release a 2019 Form W-4 before the end of 2018 that makes minimal changes to the 2018 Form W-4.

The 2019 Form W-4 and the computational procedures in IRS Publication 15 (Circular E), Employer’s Tax Guide, will continue to use the term "withholding allowances" and related terminology to incorporate the withholding allowance factors specified in Code Sec. 3402(f) and the additional allowance items in Code Sec. 3402(m). Until further guidance is issued, references to a "withholding exemption" in the Code Sec. 3402 regulations and guidance will be applied as if they were referring to a withholding allowance.

Changes in Status
The guidance provides that if an employee experiences a change of status on or before April 30, 2019, that reduces the number of withholding allowances to which he or she is entitled, and if that change is solely due to the changes made by the TCJA, the employee generally must furnish a new Form W-4 to the employer by May 10, 2019. However, if an employee no longer reasonably expects to be entitled to a claimed number of allowances due to a change in personal circumstances that is not solely related to TCJA changes, the employee must furnish his or her employer a new Form W-4 within 10 days after the change. Similarly, if an employee claims married filing status on Form W-4 but divorces his or her spouse, the employee must furnish the employer a new Form W-4 within 10 days after the change.

Failure to Furnish
The IRS and the Treasury Department intend to withdraw the regulations under Code Sec. 3401(e), and modify other regulations, so that an employee who fails to furnish a Form W-4 will be treated as "single" but entitled to the number of withholding allowances determined under computational procedures provided in IRS Publication 15. Until further guidance is issued, however, employees who fail to furnish a Form W-4 will be treated as single with zero withholding allowances.

Additional Allowances
Until further guidance is issued, a taxpayer may include his or her estimated Code Sec. 199A passthrough deduction in determining whether he or she can claim the additional withholding allowance under Code Sec. 3402(m) on Form W-4.

Alternative Procedure
The IRS and the Treasury Department intend to update the withholding regulations to explicitly allow employees to determine their Form W-4 entries by using the IRS withholding calculator ( www.irs.gov/W4App) or IRS Publication 505, Tax Withholding and Estimated Tax, instead of having to complete certain schedules included with the Form W-4. However, the regulations are expected to provide that an employee cannot use the withholding calculator if the calculator’s instructions state that it should not be used due to his or her individual tax situation. The employee will need to use Publication 505 instead.

Alternative Methods
The IRS and the Treasury Department intend to eliminate the combined income tax withholding and employee FICA tax withholding tables under Reg. §31.3402(h)(4)-1(b), due to this alternative procedure’s unintended complexity and burden.

Lock-In Letters
The IRS may issue a "lock-in letter" to an employer, which sets the maximum number of withholding allowances an employee may claim. If the employer no longer employs the employee, the employer must send a written response to the IRS office designated in the lock-in letter that the employee is not employed by the employer. The IRS and the Treasury Department intend to eliminate the written response requirement. Pending further guidance, employers should not send a written response to the IRS under Reg. §31.3402(f)(2)-1(g)(2)(iv).

Pension, Annuity Payments
The payor of certain periodic payments for pensions, annuities, and other deferred income generally must withhold tax from the payments as if they were wages, unless the individual payee elects not to have withholding apply. Before 2018, if a withholding certificate was not furnished to the payor, the withholding rate was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended this rule so that the rate "shall be determined under rules prescribed by the Secretary." The IRS has determined that, for 2019, withholding on periodic payments when no withholding certificate is in effect continues to be based on treating the payee as a married individual claiming three withholding allowances.

Comments Requested
The IRS and the Treasury Department request comments on both the interim guidance and the guidance that should be provided in regulations. Comments must be received by January 25, 2019. Comments should be submitted to: CC:PA:LPD:PR (Notice 2018-92), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2018-92), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., 20224. Alternatively, taxpayers may submit comments electronically to Notice.comments@irscounsel.treas.gov (include "Notice 2018-92" in the subject line of any electronic submission).

The Tax Code contains many taxpayer rights and protections. However, because the Tax Code is so large and complex, many taxpayers, who do not have the advice of a tax professional, are unaware of their rights. To clarify these protections, the IRS recently announced a Taxpayer Bill of Rights, describing 10 rights taxpayers have when dealing with the agency.

The Tax Code contains many taxpayer rights and protections. However, because the Tax Code is so large and complex, many taxpayers, who do not have the advice of a tax professional, are unaware of their rights. To clarify these protections, the IRS recently announced a Taxpayer Bill of Rights, describing 10 rights taxpayers have when dealing with the agency.

Taxpayer education

The idea for a Taxpayer Bill of Rights has been percolating for several years. One of the leading proponents has been National Taxpayer Advocate Nina Olson. In January 2014, Olson told Congress that a Taxpayer Bill of Rights was long overdue. Even though the rights already existed, many taxpayers did not know about them. More taxpayer education was needed, Olson emphasized. Olson proposed that either Congress pass legislation or the IRS take administrative action to set out a Taxpayer Bill of Rights.

Olson proposed that a Taxpayer Bill of Rights be based on the U.S. Bill of Rights. Olson also recommended that the IRS describe taxpayer rights in non-technical language. Olson's proposal won support from IRS Commissioner John Koskinen earlier this year.

Taxpayer Bill of Rights

In June, IRS Commissioner John Koskinen and Olson together unveiled a 10-point Taxpayer Bill of Rights.

The provisions in the Taxpayer Bill of Rights are:

1. The Right to Be Informed
2. The Right to Quality Service
3. The Right to Pay No More than the Correct Amount of Tax
4. The Right to Challenge the IRS's Position and Be Heard
5. The Right to Appeal an IRS Decision in an Independent Forum
6. The Right to Finality
7. The Right to Privacy
8. The Right to Confidentiality
9. The Right to Retain Representation
10. The Right to a Fair and Just Tax System

"The Taxpayer Bill of Rights contains fundamental information to help taxpayers," Koskinen said. "These are core concepts about which taxpayers should be aware. Respecting taxpayer rights continues to be a top priority for IRS employees, and the new Taxpayer Bill of Rights summarizes these important protections in a clearer, more understandable format than ever before."

As the IRS Commissioner noted, the Taxpayer Bill of Rights does not create new rights. Rather, the Taxpayer Bill of Rights is intended to serve an educational purpose to help taxpayers understand better their existing rights.

IRS Publication 1

The Taxpayer Bill of Rights is highlighted prominently in IRS Publication 1, Your Rights as a Taxpayer. The IRS reported that updated Publication 1 will be sent to taxpayers when they receive notices on issues ranging from audits to collections. Updated Publication 1 initially will be available in English and Spanish, and later in Chinese, Korean, Russian and Vietnamese.

Additionally, the IRS created a special page on its website to highlight the Taxpayer Bill of Rights. The Taxpayer Bill of Rights will be displayed in all IRS offices.

If you have any questions about the IRS Taxpayer Bill of Rights, please contact our office.

IR-2014-72

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

Taxpayers who are self-employed must pay self-employment tax on their income from self-employment. The self-employment tax applies in lieu of Federal Insurance Contributions Act (FICA) taxes paid by employees and employers on compensation from employment. Like FICA taxes, the self-employment tax consists of taxes collected for Social Security and for Medicare (hospital insurance or HI).

The self-employment tax is levied and collected as part of the income tax. The tax must be taken into account in determining an individual's estimated taxes. The self-employed taxpayer is responsible for the self-employment tax, in effect paying both the employer's and the employee's share of the tax. The tax is calculated on Schedule SE, filed with the individual's income tax return, and is then reported on the Form 1040.

Self-Employment Tax Rate

The self-employment tax rate is 15.3 percent of self-employment income. This is the same overall percentage that applies to an employee's compensation. The rate combines the 12.4 percent Social Security tax and the 2.9 percent Medicare tax. Self-employed individuals can deduct one-half of the self-employment tax. (For 2011 and 2012, the Social Security tax rate was reduced from 12.4 to 10.4 percent.) If the individual's net earnings from self-employment are less than $400 (or $100 for a church employee), the individual does not owe self-employment tax.

Like FICA taxes, the 12.4 percent Social Security tax only applies to earning up to a specified threshold. For 2013, this threshold was $113,700; for 2014, the threshold is $117,000. There is no ceiling for applying the 2.9 percent Medicare tax.

Self-Employment

The tax applies to net earnings from self-employment. This is the taxpayer's gross income for the year from operating a trade or business, minus the deductions allowable to the trade or business, plus the taxpayer's distributive share of income or loss from a partnership.

A person is self-employed if he or she carries on a trade or business as a sole proprietor or independent contractor. A general partner of a partnership that carries on a trade or business is also considered to be self-employed. Self-employment does not include the performance of services by an employee. However, an employee who also carries on a separate business part-time can be self-employed with respect to the business.

Additional Medicare Tax

Effective for 2013 and subsequent years, both employees and self-employed individuals must pay an additional 0.9 percent Medicare tax if their FICA wages or self-employment income exceeds specified thresholds $250,000 for joint filers; $125,000 for married filing separately; and $200,000 for all other taxpayers. This tax is determined on Form 8959.

The simple concept of depreciation can get complicated very quickly when one is trying to determining the proper depreciation deduction for any particular asset. Here’s only a summary of some of what’s involved.

The simple concept of depreciation can get complicated very quickly when one is trying to determine the proper depreciation deduction for any particular asset. Here’s only a summary of some of what’s involved.

Identifying the asset

The modified accelerated cost recovery system (MACRS) is generally, but not always, used to depreciate tangible depreciable property placed in service after 1986. The MACRS deduction is computed on Form 4562, Depreciation and Amortization.

Intangible property may not be depreciated under MACRS, but it may be amortized in certain situations. Real estate may not be depreciated, but buildings situated on it may. Sound recordings, films, and videotapes are specifically excluded from MACRS, but may be depreciated using the income forecast method. Deprecation for financial accounting book purposes is generally not the same as tax depreciation. Under MACRS, property placed in service and disposed of in the same tax year is not depreciable. Property converted from business use to personal use in the tax year of acquisition is not depreciable.

The cost of tangible depreciable property also may be deducted immediately if the business and the asset qualifies for Code Section 179 expensing. Bonus depreciation, in years that Congress makes it available, is also available, taken first before the asset’s remaining value is depreciated under MACRS.

Computing depreciation under MACRS

In order to compute depreciation under MACRS, the asset's MACRS property class must be determined. The asset's recovery period (i.e., its depreciation period), applicable depreciation method, and applicable convention depend on the asset's property class. Under MACRS, an asset's property class is based on either the type of asset or the business activity in which the asset is primarily used. The key resource for determining an asset's property class is the asset classification table contained in Revenue Procedure 87-56.

The cost of property in the 3-, 5-, 7-, and 10-year classes is recovered using the 200-percent declining-balance method (i.e., the applicable depreciation method) over three, five, seven, and ten years, respectively (i.e., the applicable recovery period), and the half-year convention (unless the mid-quarter convention applies), with a switch to the straight-line method in the year that maximizes the deduction.

The cost of 15- and 20-year property is generally recovered using the 150-percent declining-balance method over 15 and 20 years, respectively, and the half-year convention, with a switch to the straight-line method to maximize the deduction. The cost of residential rental and nonresidential real property is recovered using the straight-line method and the mid-month convention over 27.5-  and 39-year recovery periods, respectively.

For more specific information on the amount of depreciation you may take for any business asset you own or plan to purchase, please feel free to contact this office.

Nearly half-way into the year, tax legislation has been hotly debated in Congress but lawmakers have failed to move many bills. Only one bill, legislation to make permanent the research tax credit, has been approved by the House; its fate in the Senate still remains uncertain. Other bills, including legislation to extend many of the now-expired extenders before the 2015 filing season, have stalled. Tax measures could also be attached to other bills, especially as the days wind down to Congress' August recess.

Nearly half-way into the year, tax legislation has been hotly debated in Congress but lawmakers have failed to move many bills. Only one bill, legislation to make permanent the research tax credit, has been approved by the House; its fate in the Senate still remains uncertain. Other bills, including legislation to extend many of the now-expired extenders before the 2015 filing season, have stalled. Tax measures could also be attached to other bills, especially as the days wind down to Congress' August recess.

Tax extenders

Legislation to extend nearly all of the extenders seemed to be almost assured of passage in the Senate after the Senate Finance Committee (SFC) approved the EXPIRE Act in April. The EXPIRE Act would extend through 2015 many of the popular but temporary tax incentives, including the higher education tuition deduction, the state and local sales tax deduction, the deduction for mortgage premiums, research tax credit, Work Opportunity Tax Credit (WOTC), and more. In May, the EXPIRE Act became bogged down in procedural votes in the Senate. Democrats and Republicans could not agree whether amendments would be allowed and if so, how many amendments.

In the meantime, individual lawmakers have introduced bills to extend some of the extenders. The bills must be referred to committees (the SFC or the House Ways and Means Committee) for action. Committee chairs ultimately determine if the bills will be brought before the committee. SFC Chair Ron Wyden, D-Ore., has signaled that the EXPIRE Act is likely his best attempt to move an extenders bill. Wyden has also said that he will not promote another extenders bill after 2015 (hence the name, EXPIRE Act). Ways and Means Chair Dave Camp, R-Mich., has largely kept the committee's focus on the proposals outlined in his proposed Tax Reform Act of 2014.

Lawmakers have roughly eight weeks before their month-long August recess to act on the extenders. Our office will keep you posted of developments.

Research tax credit

The research tax credit is a very popular business tax incentive. Its popularity has pushed it to the front of the line in the House for renewal. One drawback is the credit's cost: estimated at $155 billion over 10 years.

In May, the House approved the American Research and Competitiveness Act of 2014. The bill attracted support from both Democrats and Republicans. The bill makes permanent and enhances the research tax credit. The bill is not offset, which is a stumbling block to winning support from Senate Democrats. In fact, President Obama has said he would veto the bill in its present form if it reaches his desk. There is a possibility, albeit slight, that the Senate could pass its own version of the research tax credit and the House and Senate would try to reach a compromise in conference.

Corporate taxation

President Obama, lawmakers from both parties and many taxpayers agree that the U.S. corporate tax rate should be reduced. They disagree on how to pay, or if to offset, any reduction. President Obama continues to promote the elimination of some business tax preferences, particularly tax incentives for oil, gas and fossil fuel producers, as the way to pay for a corporate tax rate cut. The President also has called for using some of the revenues to fund road and bridge construction.

Democrats in the House and Senate have also honed in on so-called "corporate inversions." These occur when U.S. companies merge with foreign ones for tax purposes. The merged entity is often located in a low-tax jurisdiction, such as Ireland with a corporate tax rate of 12.5 percent, compared to the U.S. corporate tax rate of 35 percent. House and Senate Democrats have introduced companion bills (Stop Corporate Inversions Act of 2014) to curb these mergers. Under current law, a corporate inversion will not be respected for U.S. tax purposes if 80 percent or more of the new combined corporation (incorporated offshore) is owned by historic shareholders of the U.S. corporation. The bill would reduce the threshold to 50 percent. House and Senate Republicans are not expected to support the bill.

Other bills

On July 1, the interest rate on federal subsidized Stafford loans is set to increase from 3.4 to 6.8 percent. Legislation introduced in the Senate, the Bank on Students Loan Fairness Act, would provide a one-year "fix" by setting the rate at the primary interest rate offered through the Federal Reserve discount window. The bill would be paid for by the so-called "Buffett Rule," which generally would disallow certain tax preferences to higher income individuals. Along with the student loan bill, lawmakers have on their agenda legislation to renew federal highway spending, as discussed above. A final highway bill with tax-related provisions could be approved before the August recess. Some lawmakers have proposed a hike in the federal gasoline tax but it is unlikely to be approved.

If you have any questions about tax legislation, please contact our office.

Transit incentives are a popular transportation fringe benefit for many employees. Although the costs of commuting to and from work are not tax-deductible (except in certain relatively rare cases), transportation fringe benefits help to offset some of the costs, including the expenses of riding mass transit or taking a van pool to work. Under current law, the value of qualified transportation fringe benefits provided to an employee is excluded from the employee's gross income and wages for income and payroll tax purposes.

Transit incentives are a popular transportation fringe benefit for many employees. Although the costs of commuting to and from work are not tax-deductible (except in certain relatively rare cases), transportation fringe benefits help to offset some of the costs, including the expenses of riding mass transit or taking a van pool to work. Under current law, the value of qualified transportation fringe benefits provided to an employee is excluded from the employee's gross income and wages for income and payroll tax purposes.

Qualified benefits

Only certain transit benefits qualify for this special tax treatment. They are:

• Transportation in a commuter highway vehicle if the transportation is in connection with travel between the employee's residence and place of employment (for example, van pooling),
• Transit passes,
• Qualified parking, and
• Qualified bicycle commuting reimbursements.

Employers have some latitude regarding which, if any, transit benefits they want to offer. An employer may simultaneously provide an employee with any one or more of the first three qualified transportation fringes. However, an employee may not exclude a bicycle commuting reimbursement for any month in which he or she receives any of the other incentives.

Excluded from gross income

As long as the amount of the transit pass, qualified parking or other benefit does not exceed the statutory monthly limits, the amounts are not wages for purposes of Social Security and Medicare, the Federal Unemployment Tax Act (FUTA), and federal income tax withholding. However, if the amounts do exceed the statutory limits, the excess must be included in the employee's gross income.

Amounts

For 2014, the maximum that may be excluded is $250 per month for qualified parking, but only $130 for transit passes and van pooling. The exclusion for qualified bicycle commuting reimbursement is limited to a per employee limitation of $20 per month multiplied by the number of qualified bicycle commuting months during the calendar year.

At the end of 2013, the monthly cap on the transit passes and van pools of the commuter benefit dropped to $130 per month-from $240 per month-because transit benefits parity expired. The amount of qualified parking, however, increased to $250 per month, from $240 per month, because of an adjustment for inflation required under the Tax Code.

Pending legislation

Parity could be restored and made retroactive to January 1, 2014. In April, the Senate Finance Committee approved the EXPIRE Act, which would restore parity by increasing the transit pass and van pool benefits to $250 per month - the same amount as parking. The EXPIRE Act is not a permanent fix. The bill would extend parity through the end of 2015. On January 1, 2016, parity would again expire.

The EXPIRE Act also includes special treatment for bikeshare costs. In 2013, the IRS announced that bikeshare arrangements would not be treated as a transportation fringe benefit unless Congress makes them so. The EXPIRE Act modifies the definition of qualified bicycle commuting reimbursement to include expenses associated with the use of a bikesharing arrangement.

Both the House and Senate must pass legislation in order to extend transit benefits parity. At this time, transit benefits parity has not moved in the House. One deterrent is the cost of extending parity. According to the Joint Committee on Taxation, a two-year extension of parity (through 2015) would cost $180 million over 10 years.

Retroactive extension

Retroactive extension of transit benefit parity would create some administrative challenges for employers. The last time there was a retroactive extension, the IRS provided special guidance to employers on how to account for the retroactive change when filing employment tax returns and Forms W-2. The IRS would likely do the same if there is a retroactive extension of transit benefit parity to January 1, 2014.

Please contact our office if you have any questions about transportation fringe benefits. Our office will keep you posted of developments.

With the April 15th filing season deadline now behind us, it’s not too early to turn your attention to next year’s deadline for filing your 2014 return. That refocus requires among other things an awareness of the direct impact that many "ordinary," as well as one-time, transactions and events will have on the tax you will eventually be obligated to pay April 15, 2015. To gain this forward-looking perspective, however, taking a moment to look back … at the filing season that has just ended, is particularly worthwhile. This generally involves a two-step process: (1) a look-back at your 2013 tax return to pinpoint new opportunities as well as "lessons learned;" and (2) a look-back at what has happened in the tax world since January 1st that may indicate new challenges to be faced for the first time on your 2014 return.

Your 2013 Form 1040

Examining your 2013 Form 1040 individual tax return can help you identify certain changes that you might want to consider this year, as well encourage you to continue what you’re doing right. These "key ingredients" to your 2014 return may include, among many others considerations, a fresh look at:

Your refund or balance due. While it is nice to get a big refund check from the IRS, it often indicates unnecessary overpayments over the course of the year that has provided the federal government with an interest-free loan in the form of your money. Now’s the time to investigate the reasons behind a refund and whether you need to take steps to lower wage withholding and/or quarterly estimated tax payments.

If on the other hand you had to pay the IRS when filing your return (or requesting an extension), you should consider whether it was due to a sudden windfall of income that will not repeat itself; or because you no longer have the same itemized deductions, you had a change in marital status, or you claimed a one-time tax credit such as for energy savings or education. Likewise, examining anticipated changes between your 2013 and 2014 tax years—marriage, the birth of a child, becoming a homeowner, retiring, etc.—can help warn you whether your're headed for an underpayment or overpayment of your 2014 tax liability.

Investment income. One area that blindsided many taxpayers on their 2013 returns was the increased tax bill applicable to investment income. Because of the "great recession," many investors had carryforward losses that could offset gains realized for a number of years as markets gradually improved. For many, however, 2013 saw not only a significant rise in investment income but also a rise in realized taxable investment gains that were no longer covered by carryforward losses used up during the 2010–2012 period.

Furthermore, dividends and long-term capital gains for the first time in 2013 were taxed at a new, higher 20 percent rate for higher income taxpayers and an additional 3.8 percent net investment income tax surtax for those in the higher income brackets. Short-term capital gains saw the highest rate jump, from 35 percent to 43.4 percent rate, which reflected a new 39.6 percent regular rate and the new 3.8 percent net investment income tax rate. This tax structure remains in place for 2014.

Personal exemption/itemized deductions. Effective January 1, 2013, the American Taxpayer Relief Act (ATRA) revived the personal exemption phaseout (PEP). The applicable threshold levels are $250,000 for unmarried taxpayers; $275,000 for heads of households; $300,000 for married couples filing a joint return (and surviving spouses); and $150,000 for married couples filing separate returns (adjusted for inflation after 2013). Likewise, for it revived the limitation on itemized deductions (known as the "Pease" limitation after the member of Congress who sponsored the original legislation) for those same taxpayers.

Medical and dental expenses. Starting in 2013, the Affordable Care Act (ACA) increased the threshold to claim an itemized deduction for unreimbursed medical expenses from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI. However, there is a temporary exemption for individuals age 65 and older until December 31, 2016. Qualified individuals may continue to deduct total medical expenses that exceed 7.5 percent of adjusted gross income through 2016. If the qualified individual is married and only one spouse is age 65 or older, the taxpayer may still deduct total medical expenses that exceed 7.5 percent of adjusted gross income.

Recordkeeping. If you cannot find the paperwork necessary to prove your right to a deduction or credit, you cannot claim it. An organized tax recordkeeping system—whether on paper or computerized–therefore is an essential component to maximizing tax savings.

Filing Season Developments

So far this year, the IRS, other federal agencies and the courts have issued guidance on individual and business taxation, retirement savings, foreign accounts, the ACA, and much more. Congress has also been busy working up a "tax extenders" bill as well as tax reform proposals. All these developments can impact how you plan to maximize benefits on your 2014 income tax return.

Tax reform. President Obama, the chairs of the House and Senate tax writing committees, and individual lawmakers all made tax reform proposals in early 2014. The proposals range from comprehensive tax reform to more piece-meal approaches. Although only small, piecemeal proposals have the most promising chances for passage this year, taxpayers should not ignore the broader push toward tax reform that will be taking shape in 2015 and 2016.

Tax extenders. The Senate Finance Committee (SFC) approved legislation (EXPIRE Act) in April that would extend nearly all of the tax extenders that expired after 2013. Included in the EXPIRE Act are individual incentives such as the state and local sales tax deduction, the higher education tuition deduction, transit benefits parity, and the classroom teacher’s deduction; along with business incentives such as enhanced Code 179 small business expensing, bonus depreciation, the research tax credit, and more. Congress may now move quickly on an extenders bill or it may not come up with a compromise until after the November mid-term elections. Many of these tax benefits are significant and will directly impact the 2014 tax that taxpayers will pay.

Individual mandate. The Affordable Care Act’s individual mandate took effect January 1, 2014. Individuals failing to carry minimum essential coverage after January 1, 2014 and who are not exempt from the requirement will make an individual shared responsibility payment when they file their 2014 federal income tax returns in 2015. There are some exemptions, including a hardship exemption if the taxpayer experienced problems in signing up with a Health Insurance Marketplace before March 31, 2014. Further guidance is expected before 2014 tax year returns need to be filed, especially on how to calculate the payment and how to report to the IRS that an individual has minimum essential coverage.

Employer mandate. The ACA’s shared responsibility provision for employers (also known as the “employer mandate”) will generally apply to large employers starting in 2015, rather than the original 2014 launch date. Transition relief provided in February final regulations provides additional time to mid-size employers with 50 or more but fewer than 100 employees, generally delaying implementation until 2016. Employers that employ fewer than 50 full-time or full time equivalent employees are permanently exempt from the employer mandate. The final regulations do not change this treatment under the statute.

Other recent tax developments to be aware of for 2014 planning purposes include:

• IRA rollovers. The IRS announced that, starting in 2015, it intends to follow a one-rollover-per-year limitation on Individual Retirement Account (IRA) rollovers as an aggregate limit.
• myRAs. In January, President Obama directed the Treasury Department to create a new retirement savings vehicle, “myRA,” to be rolled out before 2015.
• Same-sex married couples. In April, the IRS released guidance on how the Supreme Court’s Windsor decision, which struck down Section 3 of the Defense of Marriage Act (DOMA), applies to qualified retirement plans, opting not to require recognition before June 26, 2013.
• Passive activity losses. The Tax Court found in March that a trust owning rental real estate could qualify for the rental real estate exception to passive activity loss treatment.
• FATCA deadline. The IRS has indicated that it is holding firm on the July 1, 2014, deadline for foreign financial institutions (FFIs) to comply with the FATCA information reporting requirements or withhold 30 percent from payments of U.S.-source income to their U.S. account holders.
• Vehicle depreciation. The IRS announced that inflation-adjusted limitations on depreciation deductions for business use passenger autos, light trucks and vans first placed in service during calendar year 2014 are relatively unchanged from 2013 (except for first year $8,000 bonus depreciation that may be removed if Congress does not act in time.
• Severance payments. In March, the U.S. Supreme Court held that supplemental unemployment benefits (SUB) payments made to terminated employees and not tied to the receipt of state unemployment benefits are wages for FICA tax purposes.
• Virtual currency. The IRS announced that convertible virtual currencies, such as Bitcoin, would be treated as property and not as currency, thus creating immediate tax consequences for those using Bitcoins to pay for goods.

Please contact this office if you’d like further information on how an examination of your 2013 return, and examination of recent tax developments, may point to revised strategies for lowering your eventual tax bill for 2014.

A new tax applies to certain taxpayers, beginning in 2013—the 3.8 percent Net Investment Income (NII) Tax. This is a surtax that certain higher-income taxpayers may owe in addition to their income tax or alternative minimum tax. The tax applies to individuals, estates, and trusts (but not to corporations). Individuals are subject to the tax if they have NII, and their adjusted gross income exceeds a specified threshold—$250,000 for married taxpayers filing jointly; $200,000 for unmarried individuals.

For trusts, the NII tax applies at a much lower income level—the amount at which the highest tax bracket for a trust begins. This may sound high, but in fact, it is not. For 2014, this bracket begins at $12,150. A trust subject to the NII tax may lower or eliminate its potential liability by distributing NII to its beneficiaries, because the tax applies only to the undistributed NII for the year. The tax may then apply to the recipient, but based on the recipient’s income level.

Exempt and nonexempt trusts

Some trusts are exempt from the NII tax: cemetery perpetual care funds; Alaska Native Settlement Trusts electing to be taxed under Code Sec. 646; wholly charitable trusts; and foreign trusts. However, other trusts are not exempt. These include pooled income funds (where individuals donate remainder interests to charity while retaining an income interest); qualified funeral trusts; electing small business trusts; and charitable remainder trusts.

Passive activity

For individuals, trusts, and estates, the tax applies to income from a trade or business that is a passive activity with respect to the taxpayer. A trade or business is not passive if the taxpayer materially participates in the activity (as determined under Code Sec. 469). There is IRS guidance for determining whether an individual materially participates in an activity.

Material participation

The IRS has never provided guidance on how to determine whether a trust or estate materially participates in a trade or business. When the IRS issued final regulations on the NII tax, it said that the issue was under study, but the IRS has not indicated whether it will issue guidance on the issue.

The IRS regulations conclude that the application of the material participation requirements to trust income potentially subject to the NII tax must be determined at the trust level. The treatment of the income as passive or nonpassive, once determined for the trust, flows through to trust beneficiaries who receive a distribution of NII. Thus, if the trust materially participates in the activity that generated the income, the income is nonpassive to both the trust and its beneficiaries, regardless of the age or involvement of the beneficiaries. If the trust did not materially participate, the income is passive to both the trust and its beneficiaries, even if a beneficiary materially participated in the activity.

As virtual currencies such as Bitcoin rise in prominence and use, the IRS has for the first time described how virtual currency will be treated for tax purposes. The agency concluded in new guidance (Notice 2014–21) that Bitcoin and other virtual currencies like it are not to be treated as currency, but as property.

Definition of virtual currency

Actual (or "real") currency is commonly defined as a system of money in general use in a particular country. The U.S. dollar is an example of actual currency. A single definition of virtual currency, on the other hand, has not yet achieved widespread acceptance. Virtual currency (sometimes referred to as "cryptocurrency") is a medium of exchange that operates like actual currency under some circumstances. Currently, virtual currency does not have legal tender status in any jurisdiction.

How virtual currency works

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as "convertible" virtual currency. Currently, the most prominent example of a convertible virtual currency is Bitcoin, which can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real currencies.

A Bitcoin is created, or "mined," electronically, according to a purely mathematical process. A complex computer algorithm is applied. As more and more Bitcoins are mined, the difficulty of doing so will increase, as it becomes computationally more difficult to create them. This process was designed to mimic the production rate of a commodity such as gold.

Companies like BitPay or Coinbase act as intermediaries in Bitcoin transactions. According to Adam White, the Director of Business Development and Sales at Coinbase, over a million customers use Coinbase as their "Bitcoin wallet," allowing Coinbase to accept Bitcoin payments on their behalf using its payment tools. This includes over 28,000 merchants.

Fees associated with virtual currency transactions are relatively small in contrast with higher fees charged to businesses accepting credit cards. Credit card companies generally charge businesses a fee per swipe of the card, plus two to four percent of the total transaction. On the other hand, businesses that use a merchant processor pay fees of one percent, or less, for Bitcoin transactions. However, virtual currencies are volatile and involve high risk. For example, the value of a Bitcoin went from pennies to $1,200 in a five-year period, and then back down to around $500, where it rested as on April 22, 2014.

U.S. tax treatment

The IRS acknowledged that virtual currency may be used to pay for goods or services, or held for investment. The IRS issued guidance providing answers to frequently asked questions (FAQs) about virtual currency, offering Bitcoin as an example. The FAQs at present provide only basic information on the tax implications of transactions in, or using, virtual currency.

Property. Notice 2014–21 states that virtual currency will be treated as property for U.S. federal tax purposes. As such, it is governed by the same general principles that apply to property transactions generally. The sale or exchange of convertible virtual currency, or its use to pay for goods or services in a real-world economy transaction, has immediate tax consequences that would not apply if it were considered pure "legal tender."

Conversion required. A taxpayer who receives virtual currency in payment for goods or services is required to include the fair market value of the virtual currency in computing gross income. This value must be measured in U.S. dollars as of the date the virtual currency was received. The basis in virtual currency is its fair market value on the date of receipt, determined by converting the virtual currency to U.S. dollars (or another real currency which can be converted into U.S. dollars) at the applicable exchange rate in a reasonable manner that is consistently applied.

Capital gain or ordinary income. The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer. If the virtual currency is held as inventory, for example, for sale to customers in a trade or business, gain or loss on its disposition will be ordinary gain or loss. If the virtual currency is held as an investment, gain or loss on its disposition will be capital in nature.

It remains unclear whether Bitcoins will be treated as "coins" for purposes of the 28 percent capital gains rate on collectibles; or whether they will be considered a permitted investment within individual retirement accounts or in other, similar circumstances.

A taxpayer who creates, or mines, virtual currency realizes gross income on receipt of the virtual currency resulting from that activity. The fair market value of the virtual currency as of that date is includible in gross income.

Information reporting. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. Thus, a person who makes a payment of fixed and determinable income using virtual currency with a value in excess of $600 to a U.S. non-exempt recipient is required to report the payment to the IRS and to the payee. This includes payment of rent, salaries, wages, premiums, annuities, and compensation.

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W–2, and are subject to federal income tax withholding. Also, payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply to such payments. Payers using virtual currency must normally issue Form 1099 to the payee.

Penalties. Taxpayers who fail to report their income from virtual currency may potentially be subject to tax penalties. At the April 2 House Committee’s Bitcoin hearing, L. Michael Couvillion, Professor, Plymouth State University, New Hampshire, pointed out that taxpayers who treated virtual currencies inconsistently with IRS Notice 2014–21 before it was issued will not receive penalty relief unless they can establish that their underpayment or failure to properly file information returns was due to reasonable cause. This will require many businesses and individuals to go back and determine the existence of gain or loss on transactions that occurred in the past, perhaps several years in the past.

The applicable federal rates (AFRs) are used for a number of federal tax provisions. For example, Code Sec. 1274 uses AFRs to determine whether a debt instrument has original issue discount (OID or imputed interest). This determination requires the calculation of the present value of payments made on the debt instrument; present value is calculated using a discount rate equal to the AFR, compounded semi-annually.

Determining AFRs

AFRs are based on the average market yield on outstanding marketable obligations of the United States government. Under Code Sec. 1274(d), the AFR includes the federal short-term rate (based on the interest rates for debt instruments of three years or less); the federal mid-term rate (based on the rates for debt instruments of three to nine years); and the federal long-term rate (based on the rates for debt instruments exceeding nine years).

The IRS computes AFRs for each calendar month and publishes them in a revenue ruling. As an example, Rev. Rul. 2014–1, published January 6, 2014, provided the AFRs for January 2014. AFRs may be compounded (and therefore applied) monthly, quarterly, semiannually, or annually. In addition, some amounts are calculated using a higher percentage of the basic AFR. The monthly revenue rulings provide AFRs equal to 110 percent of the base AFR, 120 percent, 130 percent, 150 percent, and 175 percent.

Applying AFRs

The Tax Code uses AFRs to determine appropriate amounts under a multitude of provisions. These include:

• The present value of an annuity, life interest, term of years interest, remainder interest, or reversionary interest under Code Sec. 7520;
• Loans with below-market interest rates, under Code Sec. 7872 (the applicable rate depending on the term of the loan);
• Insurance reserves under Code Sec. 807, as well as insurance provisions under Code Secs. 811 and 812;
• The present value of golden parachute payments under Code Sec. 280G (120 percent of the AFR, compounded semiannually);
• Payments for the use of property or services under Code Sec. 467;
• Unrelated business income and debt-financed income under Code Sec. 514; and
• The recharacterization of gain from straddles under Code Sec. 1058.

The AFR revenue rulings also provide adjusted AFRs, which are used to determine the Code Sec. 382 limits on NOLs following ownership changes, and to determine OID on tax-exempt obligations under Code Sec. 1288.

Code Sec. 162 permits a business to deduct its ordinary and necessary expenses for carrying on the business. However, Code Sec. 274 restricts the deduction of entertainment expenses incurred for business by disallowing expenses of entertainment activities and entertainment facilities. Many expenses are totally disallowed; other amounts, if allowed under Code Sec. 274, are limited to 50 percent of the expense.

The income tax regulations define entertainment as any activity of a type generally considered to be entertainment, amusement, or recreation, such as entertaining at night clubs, lounges, theaters, country clubs, golf and athletic clubs, and sports events, as well as hunting, fishing, vacation and similar trips. There are special rules for the costs of facilities used to entertain the customer, such as a boat or a country club membership. Dues or fees for any social, athletic or sporting club or organization are treated as items involving facilities.

Deduction allowed

Expenses are allowed if the expense was either "directly related" to the active conduct of the taxpayer’s trade or business, or "associated with" the conduct of the trade or business. An activity is "associated with" business if the activity directly precedes or follows a substantial and bona fide business discussion.

Entertainment expenses are not directly related to the business if the activity occurred under circumstances with little or no possibility of engaging in the active conduct of the trade or business. These circumstances include an activity where the distractions are substantial, such as a meeting or discussion at a night club, theater, or sporting event. However, taking a customer to a meal at a restaurant or for drinks at a bar can be considered conducive to a business discussion, if there are no substantial distractions to a discussion.

Substantial business discussion

For expenses that are either directly related to or associated with business, the taxpayer must establish that the he or she conducted a substantial and bona fide business discussion with the customer. The IRS has said that there is no specified length for a discussion to be substantial; all facts and circumstances will be considered. The discussion is substantial if the active conduct of the business was the principal character of the combined business and entertainment activity, but it is not necessary that more time be devoted to business than to entertainment.

For an activity that is associated with, the discussion can directly precede or follow the activity. For a discussion to be directly before or after the activity, it generally must be on the same day as the activity. However, facts and circumstances may allow the entertainment and the discussion to be on consecutive days, for example if the customer is from out of town.

Season tickets

The special rules for facilities do not apply to season tickets. Instead, the taxpayer must allocate the cost of the season tickets to each separate entertainment event. The amount deductible is limited to the face value of the ticket. For a "skybox" or other area leased and used exclusively by the taxpayer and guests, the amount deductible is limited to the face value of non-luxury seats for the area covered by the lease.

Under these rules, it appears that the deductible costs of baseball season tickets must be determined separately for each baseball game. Attendance at a baseball game would involve a "distracting" activity that is not conducive to a business discussion, so the cost of the game would not be directly related to the conduct of the trade or business. However, attendance at a game before or after the conduct of a substantial business discussion could qualify as being associated with the business; in these circumstances, the cost of the event would be deductible.

If the taxpayer provided food to the customer at the baseball game, the cost of the food would be deductible as part of the cost of the event. Some "luxury" seats include food provided by the baseball team to the ticket user. It appears that the taxpayer would have to determine the fair market value of the ticket and the food separately, although the costs of food actually provided to the customer may still be deductible.

The current likelihood that your business will become involved in an employment tax audit or an employment-related income tax audit has increased: the IRS is aggressively attempting to reduce the "tax gap" of uncollected revenues in a time of increasing budget austerity. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue. Add to that total amount over $50 billion in estimated employment-associated income tax lost that is the result of missteps in withholding obligations, tip reporting, and proper fringe benefit classification . . . and employers are forewarned. The IRS is stepping up its auditing in these areas and has been conducting studies to maximize the best use of its agents' time to do so.

Latest audit survey

The IRS is conducting an intensive audit of 6,000 employment tax returns to obtain an up-to-date picture of taxpayers' employment tax practices. This will enable the IRS to better devote its compliance resources to the most important areas of noncompliance and to the taxpayers most likely not to be in compliance.

Based on these audits, the IRS's Chief of Employment Tax Policy has spotlighted several areas of concern that the IRS will focus on. These areas include backup withholding, tip reporting, worker classification, and fringe benefit reporting.

Backup withholding. Backup withholding is the number one problem uncovered in the audits. The IRS can impose backup withholding on income reported on Forms 1099 that is not ordinarily subject to withholding, such as interest, dividends, and nonemployee compensation. Failure to provide a taxpayer identification number (TIN) on the Form 1099, an incorrect TIN, or a TIN that does not match the name on the form can trigger backup withholding. A taxpayer's failure to report the income can also trigger backup withholding.

Tip reporting. Tip reporting is a major concern of the IRS. The IRS considers noncompliance a widespread problem, especially for small businesses that are not aware of the issues. The IRS has been focusing on educating employers, and is not auditing employment tax returns filed before 2014. An important issue is the failure to differentiate between service charges and tips. A payment that is automatically added to a bill may be a service charge. A service charge is characterized as Social Security wages, rather than Social Security tips. The distinction is important, because employers can claim a Social Security credit for FICA obligations attributable to tips that exceed the minimum wage, but cannot claim a credit for taxes paid on service charges.

Worker misclassification. To avoid FICA and FUTA taxes and income tax withholding, some employers intentionally classify employees as independent contractors. This has been a longstanding concern for the IRS, and the recent audits have shown that the problem continues. The agency regularly conducts employment tax audits to reclassify workers as employees. To facilitate reclassification to employee status, the IRS has two settlement programs for employers: the Classification Settlement Program (CSP) for taxpayers under audit, and the Voluntary Classification Settlement Program (VCSP) for companies that are not under an employment tax audit and meet other requirements. The IRS has received 1,550 applications under the VCSP and has reclassified approximately 25,000 workers. Companies that agree to prospectively treat workers as employees generally pay reduced taxes and may get audit protection for past years.

Fringe benefit reporting. Fringe benefits can be cash or noncash benefits provided in addition to regular wages. As a compliance matter, fringe benefits are taxable and must be included in the recipient's income, unless the Tax Code specifically excludes the benefit from taxable income. Moreover, if the recipient is an employee, the value of the benefit is additional compensation subject to employment taxes. Fringe benefits can be a particular problem for small companies, where owners seek to reduce their taxable income by taking noncash benefits, such as the use of company vehicles. A bargain sale of a house to an employee could also generate taxable income subject to employment taxes.

Conclusions

Employment taxes present an increasing risk to employers as the IRS steps up focuses on what it suspects is a heretofore largely untapped source of revenue. The IRS is certain to use the data now being harvested through its latest audit surveys. Many employers may do well to review how their employment tax compliance now measures up to this new degree of scrutiny.

In response to the economic downturn that has affected the retirement portfolios of millions of individuals across the country, Congress has been considering a variety of alternatives to offer relief to those who face financial emergencies and need immediate access to their funds. Two of the most significant proposals that have been recommended include: (1) significant broadening of the suspension of the 10 percent penalty tax on early withdrawals from IRAs and defined contribution plans, and (2) extending the temporary suspension of the penalty tax imposed on individuals age 70 1/2 or older who do not take required minimum distributions (RMDs) from certain retirement plans.

Early withdrawal penalty

To discourage individuals from using money set aside in retirement accounts for expenses incurred outside of retirement, a 10 percent tax is imposed on the amount that is withdrawn, in addition to this amount being included in the individual's gross income and subject to federal (and often, state) income tax. The 10 percent penalty will not apply to distributions made in the following circumstances:

• After the individual has reached age 59 1/2;
• The distribution is made to an individual who is a beneficiary of a deceased IRA owner;
• The individual is disabled;
• For higher education expenses (from IRAs only);
• The distributions are made as part of substantially equal payments over the account holder's life expectancy;
• The individual retires after age 55;
• For unreimbursed medical expenses exceeding 7.5 percent of the individual's adjusted gross income (AGI);
• For medical insurance premiums in the case of unemployment;
• To buy, build, or rebuild a first home (from IRAs only, and subject to a $10,000 withdrawal limit); and
• If the individual is a reservist called to active duty after September 11, 2001.

Caution: The extent to which a withdrawal may be made from an employer-sponsored qualified retirement plan, even with respect to amounts that you contributed, depends upon what is allowed under the written plan itself. Some plans only allow you to withdraw after retirement. Others allow withdrawals for "hardships," which may include medical expenses or other financial crisis. Still other withdrawals, such as withdrawals for higher education or a first home purchase, are never allowed under IRS rules from an employer-sponsored plan.

The 10 percent penalty and, for that matter, the underlying taxable income generated from a withdrawal, do not apply if the funds are properly rolled over within a 60-day period from an employer-sponsored plan to an IRA or from one qualified plan or IRA to another.

Hardship withdrawals. Individuals who take a hardship withdrawal from their defined contribution plan must also pay the 10 percent penalty tax. A hardship is defined as an immediate and heavy financial need. Certain expenses are deemed to meet this definition, but even so, the penalty still applies.

Proposals to suspend the 10 percent penalty

Several proposals have been advanced by policymakers to eliminate or suspend the 10 percent early withdrawal penalty in certain situations. The proposals would generally add a paragraph to Internal Revenue Code Sec. 72(t) to eliminate the penalty in specific circumstances. Proposals include eliminating or suspending the 10 percent early withdrawal penalty for:

• Public safety employees who retire before the age of 55;
• Workers who are unemployed;
• Individuals affected by natural disasters;
• Homeowners at risk of having their mortgage foreclosed;
• Individuals who receive a hardship distribution from a retirement plan; and
• Individuals who have qualified adoption expenses.

RMDs

Individuals with certain qualified retirement plans, as well as traditional IRAs and 403(b) plans, are required to withdraw a certain amount ( a "required minimum distribution" or RMD) from the account each year after reaching age 70 1/2 (Roth IRAs are not subject to the RMD rules). The annual RMD is based on the account balance as of December 31 of the prior year and the account holder's life expectancy. Generally, RMDs must begin no later than April 1 of the year after you reach age 70 1/2.

Proposals to suspend RMDs

RMDs were suspended for 2009 only. RMDs must be taken for 2010 and beyond, unless Congress acts to suspend the RMD rules again. However policymakers have put forth various proposals to eliminate or suspend altogether the RMD requirements. The proposals include:

• Suspending the RMD requirement through 2010;
• Suspending the RMD requirement through 2012;
• Eliminating the RMD requirement; or
• Postponing the required starting date, which would raise the age at which individuals must start taking their RMDs.

When contemplating whether to implement any of these proposals, Congress and Treasury officials must balance a number of considerations, including the immediate financial needs of individuals with the policies behind the penalty taxes; namely, providing funds for retirement and not allowing the money to be used for pre-retirement expenses.

Our office will keep you posted on any legislative proposals that may affect your retirement planning. We also can help you navigate the current rules that would apply should you need to make a withdrawal soon from your retirement savings.