Friday, February 15, 2019
Tax Matters – Where Are We Now?
If you missed last week’s seminar/webinar, I covered the status of extender legislation, technical corrections, tax software issues and, of course, issues with the qualified business income deduction and the associated transition rule applicable to agricultural cooperatives and their patrons.
If you’d like to view the video and get my 25-page technical outline, you can click here: https://vimeo.com/ondemand/2019taxfilingupdate
An update on where things sit in the midst of tax season – that’s the topic of today’s post.
Where Art Thou Technical Correction and Extender Legislation?
On January 2, 2019, the House Ways and Means Committee released a draft technical corrections bill that sought to correct “technical and clerical” issues in the Tax Cuts and Jobs Act (TCJA). However, the newly constituted Ways and Means Committee with a Democratic majority is reported to be unlikely to take up the draft according to a staffer who made the comment at a conference in Washington, D.C. on January 29.
As for extender legislation, nothing has been enacted as of today to extend provisions for 2018 that expired at the end of 2017. Extender legislation was introduced in early December, but then the bill was revised with the extender provisions stripped-out. In mid-January Sen. Grassley, the chair of the Senate Finance Committee, said that he wanted to push an extender bill through, but there haven’t been any hearings scheduled yet. On February 14, he said that he would push for a retroactive extension of expired tax credits that would last for two years (2018 and 2019).
There are numerous individual, business and energy-related provisions that await renewal, including the following:
- Above-the-line deduction for certain higher-education expenses, including qualified tuition and related expenses, under R.C. §222.
- The treatment of mortgage insurance premiums as qualified residence interest under I.R.C. §163(h)(3)(E).
- The exclusion from income of qualified canceled mortgage debt income associated with a primary residence under I.R.C. §108(a)(1)(E).
- 7-year recovery for motorsport racing facilities under I.R.C. §168(i)(15).
- Empowerment zone tax incentives under I.R.C. §1391(d)(1)(A).
- 3-year depreciation for race horses two years or younger under I.R.C. §168(e)(3)(A)(i).
- The beginning-of-construction date for non-wind facilities to claim the production tax credit (PTC) or the investment tax credit (ITC) in lieu of the PTC under I.R.C. §45(d) and §48(a)(5).
- The credit for construction of energy efficient new homes under I.R.C. §45L.
- The energy efficient commercial building deduction under I.R.C. §179D.
- Alternative fuel vehicle refueling property credit under I.R.C. §30C(g).
- Incentives for alternative fuel and alternative fuel mixtures under I.R.C. §6426(d)(5) and §6427(E)(6)(c).
- Incentives for biodiesel and renewable diesel under I.R.C. §40A(a); I.R.C. §6426(e)(3); and I.R.C. §6427(e)(6)(B).
New Items for 2019
While the TCJA generally applies beginning with tax years effective after 2017, there are some unique provisions that change for 2019. These include the following:
- Medical expenses become more difficult to deduct. For 2018, itemizers could deduct medical expenses to the extent they exceeded 7.5% of the taxpayer’s adjusted gross income (AGI). For 2019, the "floor" beneath medical expense deductions increases to 10%. R.C. §213(f).
- Big shift in the alimony tax rules. For payments required under divorce or separation instruments that are executed after Dec. 31, 2018, the deduction for alimony payments is eliminated, and recipients of affected alimony payments will no longer have to include them in taxable income. The rules for alimony payments also apply to payments that are required under divorce or separation instruments that are modified after Dec. 31, 2018, if the modification specifically states that the new-for-2019 treatment of alimony payments (not deductible by the payer and not taxable income for the recipient) applies. R.C. §§215; 71.
- Shared responsibility payment is history. Obamacare generally provides that individuals must have minimum essential coverage (MEC) for health care, qualify for an exemption from the MEC requirement, or make an individual shared responsibility payment (i.e., pay a penalty) when they file their federal income tax return. The TCJA reduced the individual shared responsibility payment to zero for months beginning after Dec. 31, 2018. I.R.C. §5000A(c). However, the I.R.C. §4980H “employer mandate” (also known as an employer shared responsibility payment, or ESRP) remains on the books. The employer mandate general provides that an employer that employed an average of at least 50 full-time employees, including full-time equivalent employees, on business days during the preceding calendar year is required to pay an assessable payment if: (i) it doesn't offer health coverage to its full-time employees; and (ii) at least one full-time employee purchases coverage through the Marketplace and receives an I.R.C. §36B premium tax credit.
- Liberalized rules for hardship distributions from 401(k) plans. R.C. §401(k) plans may provide that an employee can receive a distribution of elective contributions from the plan on account of hardship (generally, because of an immediate and heavy financial need of the employee; and in an amount necessary to meet the financial need). Under Treas. Reg.§1.401(k)-1(d)(3)(iv)(E), an employee who receives a hardship distribution cannot make elective contributions or employee contributions to the plan and to all other plans maintained by the employer, for at least six months after receipt of the hardship distribution. The IRS has modify the regulation to delete the six-month prohibition on contributions and to make “any other modifications necessary to carry out the purposes of” I.R.C. §401(k)(2)(B)(i)(IV). The revised regs are to apply to plan years beginning after Dec. 31, 2018.
- There are other tax changes starting in 2019. For example, the debt-equity documentation regulations apply to issuances in 2019; the accelerated phaseout of the tax credit for wind facilities continues; and many tax-exempt organizations face eased donor disclosure requirements. Also, while not brand new for 2019, the election out of 100% bonus depreciation into 50 percent bonus is not available unless the tax year includes September 27, 2017.
Final I.R.C. §199A Regulations
Deductions. While I have addressed the final qualified business income deduction (QBID) regulations in prior posts, software issues remain. One lingering issue involves how to handle business-related deductions. The final regulations are consistent with the proposed regulations on the treatment of the self-employed health insurance deduction and retirement plan contributions. Prop. Treas. Reg. §1.199A-1(b)(4) defines QBI as the net amount of qualified items of income, gain, deduction and loss with respect to a trade or business as determined under the rules of Prop. Treas. Reg. §1.199A-3(b). The above-the-line adjustments for S.E. tax, self-employed health insurance deduction and the self-employed retirement deduction are examples of such deductions.
The basic starting point is that QBI is reduced by certain deductions reported on the return that the business doesn’t specifically pay, including the deduction for one-half of the self-employment tax, the self-employed health insurance deduction, and retirement plan contributions. The self-employed health insurance deduction may only “apply” to Schedule F farmers because, with respect to partnerships and S corporations, it is actually a component of either shareholder wages for an S corporation shareholder or guaranteed payments to a partner and, thus, may not reduce QBI. The self-employed health insurance deduction should not be removed from an S-corporate owner on their individual return because it has already been removed on Form 1120-S. Do not deduct it twice. If QBI were reduced by the amount of the I.R.C. §162(l) deduction on the 1040, QBI would be (incorrectly) reduced twice. In other words, QBI should not be reduced by the self-employed health insurance from the S corporation or the partnership. The deduction for the S corporation shareholder is allocated to the wage income, and the deduction for the partner is from the guaranteed payment. The one-half self-employment tax deduction for the partner is allocated between guaranteed payments (if any) and that portion of the K-1 allocated income associated with QBI. Some tax software programs are not treating this properly. Watch for updates, such as a box to check on the self-employed health insurance screen.
The final regulations also clarify that the deduction for contributions to qualified retirement plans under I.R.C. §404 is considered to be attributable to a trade or business to the extent that the taxpayer’s gross income from the trade or business is accounted for when calculating the allowable deduction, on a proportionate basis. See Prop. Treas. Reg. §1.199A-3(b)(vi). When an S corporation makes an employer contribution to an employer-sponsored retirement plan, that contribution, itself, reduces corporate profits. Thus, there is less profit on which the QBID can potentially apply. Thus, for some S corporation owners, a contribution to an employer-sponsored retirement plant will effectively result in a partial deduction, but still subject the entire contribution, plus all future earnings, to income tax upon distribution. The final regulations make clear that sole proprietors and partners must also “back-out” these amounts from business profits before applying the QBID. This rule will make 401(k)s with a Roth-style option more valuable.
The final regulations do not address how deductions for state income tax imposed on the individual’s business income or unreimbursed partnership expenses are to be treated. The final regulations also don’t mention whether the deduction for interest expense to a partnership interest or an S corporation interest is business related.
Some tax software is presently reducing QBI passed through from an S corporation or partnership by the I.R.C. §179 amount which is passed through separately. Other tax software allows the practitioner to either include or exclude the I.R.C. §179 amount. A suggested approach is to always exclude it at the entity level because it is not known if it can be deducted on the taxpayer’s personal return. Operating properly, tax software should calculate QBI with a reduction for the I.R.C. §179 deduction at the individual level.
Fiscal year entities. The final regulations in January put an earlier report to rest that had surfaced in November of 2018. The problem that was reported to be the case did not materialize. Instead, under the final regulations, for purposes of determining QBI, W-2 wages, and the unadjusted basis in assets of qualified property, if an shareholder/partner/member receives any of these items from a passthrough entity having a fiscal year beginning in 2016 and ending before December 31, 2017, the items are treated as having been incurred by the individual during the individual's 2017 taxable year. No QBID would be available. On the other hand, if an individual receives any of these items from a passthrough entity that has a fiscal year beginning in 2017 and ending in 2018, the items are treated as having been incurred by the taxpayer during the individual’s 2018 tax year. That means the items may be taken into account in determining the individual’s QBID for 2018.
During the webinar/seminar on Feb. 8, I also covered the transition rule that bridges the gap between the original QBID cooperative rule and the “fix” that occurred in March of 2018. My detailed outline associated with the seminar goes through the various computations that might be encountered. Of course, under the transition rule, a farmer’s calculation of their QBID for 2018 does not include grain sold to a cooperative if the cooperative accounted for those sales when calculating its domestic production activities deduction (DPAD) under former I.R.C. §119 on its 2018 return. That means that a tax preparer is going to need certain information from the cooperative to prepare the patron’s return properly. And, yes, in spite of what some tax software companies are saying the 2018 Form 8903 is available via the IRS website (Dec. 2018 version).
For further elaboration on these points and you can read up on my lecture outline and slide presentation associated with the Feb. 8 seminar/webinar. I also went into detail on how to handle farm rentals with various scenarios. That issue still seems to bedevil practitioners. Again, you can access the video (no CE credit for not watching it live), my lecture outline and slides here: https://vimeo.com/ondemand/2019taxfilingupdate