The IRS has issued guidance clarifying that taxpayers receiving loans under the Paycheck Protection Program (PPP) may deduct their business expenses, even if their PPP loans are forgiven. The IRS previously issued Notice 2020-32 and Rev. Rul. 2020-27, which stated that taxpayers who received PPP loans and had those loans forgiven would not be able to claim business deductions for their otherwise deductible business expenses.

The IRS has issued guidance clarifying that taxpayers receiving loans under the Paycheck Protection Program (PPP) may deduct their business expenses, even if their PPP loans are forgiven. The IRS previously issued Notice 2020-32 and Rev. Rul. 2020-27, which stated that taxpayers who received PPP loans and had those loans forgiven would not be able to claim business deductions for their otherwise deductible business expenses.

The COVID-Related Tax Relief Act of 2020 ( P.L. 116-260) amended the CARES Act ( P.L. 116-136) to clarify that business expenses paid with amounts received from loans under the PPP are deductible as trade or business expenses, even if the PPP loan is forgiven. Further, any amounts forgiven do not result in the reduction of any tax attributes or the denial of basis increase in assets. This change applies to years ending after March 27, 2020.

Notice 2020-32, I.R.B. 2020-21, 83 and Rev. Rul. 2020-27, I.R.B. 2020-50, 1552 are obsoleted.

The IRS has waived the requirement to file Form 1099 series information returns or furnish payee statements for certain COVID-related relief that is excluded from gross income.

The IRS has waived the requirement to file Form 1099 series information returns or furnish payee statements for certain COVID-related relief that is excluded from gross income.

Reporting Affected

The IRS waives the requirement to file Form 1099 series information returns, or furnish payee statements, for the following:

• forgiveness of covered loans under the original Paycheck Protection Program (PPP);
• forgiveness of covered loans under the Paycheck Protection Program Second Draw (PPP II);
• Treasury Program loan forgiveness under section 1109 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136);
• certain loan subsidies authorized under section 1112(c) of the CARES Act;
• certain COVID-related student emergency financial aid grants under section 3504, 18004, or 18008 of the CARES Act or section 277(b)(3) of the COVID-related Tax Relief Act of 2020 (COVID Relief Act) (Division N, P.L. 116-260);
• Economic Injury Disaster Loan (EIDL) grants under section 1110(e) of the CARES Act or section 331 of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act) (Division N, P.L. 116-260); and
• shuttered venue operator grants under section 324(b) of the Economic Aid Act.

Other Reporting

The waivers do not affect requirements to file and furnish other forms, such as forms in the 1098 series. For example, the waiver does not apply to the requirement to file and furnish Form 1098-T, Tuition Statement, for qualified tuition and related expense payments, including qualified tuition and related expenses paid with COVID-related student emergency financial aid grants. Also, because borrowers may deduct mortgage interest that the Small Business Administration paid to lenders, lenders may include those mortgage interest payments in Box 1 of Form 1098, Mortgage Interest Statement. Lenders who are unable to furnish with this information by February 1, 2021, are encouraged to furnish a corrected Form 1098 as promptly as possible.

Due to the COVID-19 pandemic, certain employers and employees who use the automobile lease valuation rule to determine the value of an employee’s personal use of an employer-provided automobile may switch to the vehicle cents-per-mile method.

Due to the COVID-19 pandemic, certain employers and employees who use the automobile lease valuation rule to determine the value of an employee’s personal use of an employer-provided automobile may switch to the vehicle cents-per-mile method.

Background

Under the general rule, an employer who provides an employee a vehicle must adopt one of the following methods to determine the value of an employee’s personal use of the vehicle: the automobile lease valuation rule, or the vehicle cents-per-mile valuation rule. (In certain cases, a third method, the commuting valuation rule, may be used.)

The employer and the employee must use the chosen valuation method consistently (that is, in each subsequent year), except that the employer and the employee may use the commuting valuation rule if its requirements are satisfied.

As a result of the pandemic, many employers suspended business operations or implemented telework arrangements for employees, thus reducing business and personal use of employer-provided automobiles, This has increased the lease value to be included in an employee’s income for 2020 compared to prior years. In contrast, the vehicle cents-per-mile valuation rule includes in income only the value that relates to actual personal use, providing a more accurate reflection of the employee’s income in these circumstances.

Switch to Cents-per-Mile

Due to the suddenness and unexpected onset of the COVID-19 pandemic, the IRS is allowing an employer that uses the automobile lease valuation rule for the 2020 calendar year to instead use the vehicle cents-per-mile valuation rule beginning on March 13, 2020, if:

• at the beginning of 2020, the employer reasonably expected that an automobile with a fair market value not exceeding $50,400 would be regularly used in the employer’s trade or business throughout the year; and
• due to the COVID-19 pandemic, the automobile was not regularly used in the employer’s trade or business throughout the year.

Employers that choose to switch from the automobile lease valuation rule to the vehicle cents-per-mile valuation rule in the 2020 calendar year must prorate the value of the vehicle using the automobile lease valuation rule for January 1, 2020, through March 12, 2020.

Employers that switch to the vehicle cents-per-mile valuation rule during 2020 generally may:

• revert to the automobile lease valuation rule for 2021; or
• continue using vehicle cents-per-mile valuation rule for 2021.

In either case, the special valuation rule used in 2021 must be used for all subsequent years.

Employees must use the same special valuation rule used by their employer.

Estimated tax underpayment penalties under Code Sec. 6654 are waived for certain excess business loss-related payments for tax years beginning in 2019. The relief is available to individuals, as well as trusts and estates that are treated as individuals for estimated tax payment penalty purposes.

Estimated tax underpayment penalties under Code Sec. 6654 are waived for certain excess business loss-related payments for tax years beginning in 2019. The relief is available to individuals, as well as trusts and estates that are treated as individuals for estimated tax payment penalty purposes.

Rules Delayed

Certain business losses were limited in tax years beginning in 2017 through 2025 by the excess business loss rules of Code Sec. 461(l). Under these rules, any disallowed excess business losses are carried forward as net operating losses (NOLs). The Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136) postponed application of the excess business loss rules to tax years beginning after December 31, 2020.

Relief for 2019

The relief is available only for estimated tax income tax installments due on or before July 15 2020 for a tax year that began in 2019.

An individual taxpayer may have underpaid one or more installments for the tax year that began in 2019, if the individual anticipated having a lower required annual payment after using an NOL carried forward from a prior-year excess business loss that, before the enactment of the CARES Act, would have been available to reduce taxable income in the tax year that began in 2019.

Waiver Request

To qualify for the relief, the taxpayer must:

• have filed a timely 2019 federal income tax return;
• complete the 2019 version of Form 2210, Underpayment of Estimated Taxes, or Form 2210-F, Underpayment of Tax for Farmers and Fishermen; and
• include certain required attachments and calculations.

The IRS has extended the time period during which employers must withhold and pay the employee portion of Social Security tax that employers elected to defer on wages paid from September 1, 2020, through December 31, 2020.

The IRS has extended the time period during which employers must withhold and pay the employee portion of Social Security tax that employers elected to defer on wages paid from September 1, 2020, through December 31, 2020. Specifically:

• the end date of the period for withholding and paying the deferred tax is postponed from April 30, 2021, to December 31, 2021; and
• any interest, penalties, and additions to tax for late payment of any unpaid deferred tax will begin to accrue on January 1, 2022, rather than on May 1, 2021.

Notice 2020-65, I.R.B. 2020-38, 567, is modified.

Employee Tax Deferral

In response to the coronavirus (COVID-19) disaster, President Trump issued a memorandum on August 8, 2020, directing the Treasury Secretary to use his Code Sec. 7508A authority to defer the withholding, deposit, and payment of the employee portion of the 6.2-percent old-age, survivors and disability insurance (OASDI) tax (Social Security tax) under Code Sec. 3101(a), and the Railroad Retirement Tax Act (RRTA) Tier 1 tax that is attributable to the 6.2-percent Social Security tax under Code Sec. 3201. The deferral was available only for tax on wages paid from September 1, 2020, through December 31, 2020, and only for employees whose biweekly, pre-tax pay was less than $4,000, or a similar amount where a different pay period applied.

The Treasury Secretary and the IRS then issued Notice 2020-65, directing employers that elected to apply the deferral to withhold and pay the deferred taxes ratably from wages and compensation paid between January 1, 2021, and April 30, 2021. Interest, penalties, and additions to tax would begin to accrue on May 1, 2021, on any unpaid applicable taxes.

Payment Period Extended

The recent COVID-related Tax Relief Act of 2020 (Division N, P.L. 116-260) extended the payment period, and required the Treasury Secretary to apply Notice 2020-65 by substituting "December 31, 2021" for "April 30, 2021" and substituting "January 1, 2022" for "May 1, 2021."

Employers that elected to defer employees’ payroll taxes can now withhold and pay the deferred tax throughout 2021, instead of just during the first four months of the year.

The IRS has issued guidance that provides partnerships with relief from certain penalties for the inclusion of incorrect information in reporting their partners’ beginning capital account balances on the 2020 Schedules K-1 (Forms 1065 and 8865). The IRS has also provided relief from accuracy-related penalties for any tax year for the portion of an imputed underpayment attributable to the inclusion of incorrect information in a partner’s beginning capital account balance reported by a partnership for the 2020 tax year.

The IRS has issued guidance that provides partnerships with relief from certain penalties for the inclusion of incorrect information in reporting their partners’ beginning capital account balances on the 2020 Schedules K-1 (Forms 1065 and 8865). The IRS has also provided relief from accuracy-related penalties for any tax year for the portion of an imputed underpayment attributable to the inclusion of incorrect information in a partner’s beginning capital account balance reported by a partnership for the 2020 tax year.

Penalty Relief

A partnership will not be subject to a penalty under Code Secs. 6698, 6721, or 6722 for the inclusion of incorrect information in reporting its partners’ beginning capital account balances on the 2020 Schedules K-1 if the partnership can show that it took ordinary and prudent business care in following the 2020 Form 1065 Instructions. Under those instructions, a partnership can report its partners’ beginning capital account balances using any one of the following methods: tax basis method, modified outside basis method, modified previously taxed capital method, or section 704(b) method.

In addition, a partnership will not be subject to a penalty under Code Secs. 6698, 6721, or 6722 for the inclusion of incorrect information in reporting its partners’ ending capital account balances on Schedules K-1 in tax year 2020, or its partners’ beginning or ending capital account balances on Schedules K-1 in tax years after 2020, to the extent the incorrect information is attributable solely to the incorrect information reported as the beginning capital account balance on the 2020 Schedule K-1 for which relief is provided by this guidance.

Finally, on certain conditions, the IRS will waive any accuracy-related penalty under Code Sec. 6662 for any tax year with respect to any portion of an imputed underpayment that is attributable to an adjustment to a partner’s beginning capital account balance reported by the partnership for the 2020 tax year. However, this waiver will be granted only to the extent the adjustment arises from the inclusion of incorrect information for which the partnership qualifies for relief under section 3 of this guidance.

Final regulations provide guidance related to the limitation on the deduction for employee compensation in excess of $1 million.

Final regulations provide guidance related to the limitation on the deduction for employee compensation in excess of $1 million. Specifically, the regulations address:

• what constitutes a publicly held corporation for purposes of Code Sec. 162(m)(2);
• the definition of a covered employee for purposes of Code Sec. 162(m)(3);
• the definition of compensation for purposes of Code Sec. 162(m)(4);
• the application of Code Sec. 162(m) to a taxpayer’s deduction for compensation for a tax year ending on or after a privately held corporation becomes public; and
• what constitutes a binding contract and material modification for purposes of the grandfather rule in Code Sec. 162(m)(4)(B).

The IRS has adopted the proposed regulations with a small number of modifications.

Background

The Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA) modified the definitions of "covered employee," "compensation," and "publicly held corporation" for purposes of the limitation on the deduction for excessive employee compensation paid by publicly held corporations.

Publicly Held Corporations

The TCJA expanded the definition of publicly held corporation to include: (1) corporations with any class of securities and (2) corporations that are required to file reports under section 15(d) of the Exchange Act. The final regulations adopt the prosed regulation’s stance that a corporation is publicly held if, as of the last day of its tax year, its securities are required to be registered under section 12 of the Exchange Act or is required to file reports under section 15(d). A foreign private issuer (FPI) is also a publicly held corporation if it meets the same requirements.

Under the regulations, a publicly held corporation includes an affiliated group of corporations (affiliated group) that contains one or more publicly held corporations. In addition a subsidiary corporation that meets the definition of publicly held corporation is separately subject to Code Sec. 162(m) compensation limitations. Furthermore, an affiliated group includes a parent corporation that is privately held if one or more of its subsidiary corporations is a publicly held corporation. The regulations provide further clarification for affiliated groups where certain members are not publicly held. In the case where a covered employee of two or more members of an affiliated groups is paid by a member of the affiliated group that is not a publicly held, the compensation is prorated for purposes of determining the deduction.

In instances where a privately held corporation becomes public, Code Sec. 162(m) applies to the deduction for any compensation that is otherwise deductible for the tax year ending on or after the date that the corporation becomes a publicly held corporation. The regulations provide that a corporation is considered to become publicly held on the date that its registration statement becomes effective either under the Securities Act or the Exchange Act.

Covered Employees

Under the TCJA, a covered employee is the principal executive officer (PEO), the principal financial officer (PFO), or one of the three other highest compensated executives. The final regulations adopt the proposed regulation’s stance that there is no requirement that an employee must an executive officer at the end of the tax year to be a covered employee. Covered employees may include employees who have left the corporation. Furthermore, the definition applies regardless of whether the executive officer’s compensation is subject to disclosure for the last completed fiscal year under the applicable SEC rules.

The term "covered employee" also includes any employee who was a covered employee of any predecessor of the publicly held corporation for any preceding taxable year beginning after December 31, 2016. The regulations provide rules for determining the predecessor of a publicly held corporation for various corporate transactions. With respect to asset acquisitions, the regulations provide that, if an acquiror corporation acquires at least 80% of the net operating assets (determined by fair market value on the date of acquisition) of a publicly held target corporation, then the target corporation is a predecessor of the acquiror corporation for purposes of covered employees.

Applicable Employee Compensation

The final regulations define compensation as the aggregate amount allowable as a deduction for services performed by a covered employee, without regard for Code Sec. 162(m). Compensation includes payment for services performed by a covered employee in any capacity, including as a common law employee, a director, or an independent contractor. The regulations clarify that compensation also includes an amount that is includible in the income of, or paid to, a person other than the covered employee, including after the death of the covered employee.

In cases where a publicly held corporation holds a partnership, it must:

• take into account its distributive share of the partnership’s deduction for compensation paid to the publicly held corporation’s covered employee and
• aggregate that distributive share with the corporation’s otherwise allowable deduction for compensation paid directly to that employee in applying the Code Sec. 162(m) deduction limitation.

Grandfather Rules

The amendments made by the TCJA to Code Sec. 162(m) do not apply to any compensation paid under a written binding contract that is effect on November 2, 2017, and is not materially modified after that date. A contract is binding if it obligates a publicly held company to pay the compensation if the employee performs services or satisfies requirements in the contract. Under the final regulations:

• The TCJA amendments apply to any amount of compensation that exceeds the amount that applicable law obligates the corporation to pay under a written binding contract that was in effect on November 2, 2017.
• A provision in a compensation agreement that purports to give the employer discretion to reduce or eliminate a compensation payment (negative discretion) is taken into account only to the extent the corporation has the right to exercise that discretion under applicable law, such as state contract law.
• Under an ordering rule, the grandfathered amount is allocated to the first otherwise deductible payment paid under the arrangement, then to the next otherwise deductible payment, etc. For tax years ending before December 20, 2019, the final regulations allow the grandfathered amount to be allocated to the last otherwise deductible payment or to each payment on a pro rata basis.
• A material modification occurs when a contract is amended to increase the amount of compensation payable to the employee. However, a modification that defers compensation is not a material modification if any compensation that exceeds the original amount based on a reasonable rate of interest or a predetermined actual investment.

The final regulations depart from the proposed regulations with respect to the recovery of compensation. Under the proposed regulations, a corporation’s right to recover compensation is disregarded in determining the grandfathered amount only if the corporation recovery right or obligation depends on a future condition that is objectively outside of the corporation’s control. However, the final regulations recognize that a recovery right is a contractual right that is separate from the corporation’s binding obligation to pay the compensation. Accordingly, the final regulations provide that the corporation’s right to recover compensation does not affect the determination of the amount of compensation the corporation has a written binding contract to pay under applicable law as of November 2, 2017.

The final regulations also clarify the application of the grandfather rule to compensation payable under nonqualified deferred compensation (NQDC) plans. Specifically, the grandfathered amount under an is the amount that the corporation is obligated to pay under the terms of the plan as of November 2, 2017. The regulations also provide rules for calculating the grandfather amount for account balance plans, and analogous rules for nonaccount balance plans when:

• the corporation is obligated to pay the employee the account balance that is credited with earnings and losses and has no right to terminate or materially amend the contract;
• the terms of a plan that is a written binding contract as of November 2, 2017, provide that the corporation may terminate the plan and distribute the account balance to the employee; or
• the plan provides that the corporation may not terminate the contract, but may discontinue future contributions and distribute the account balance.

However, the corporation may instead elect to treat the account balance as of the termination or freeze date as the grandfathered amount regardless of when the amount is paid and regardless of whether it has been credited with earnings or losses prior to payment.

In addition, the final regulations provide that all compensation attributable to the exercise of a non-statutory stock option or a stock appreciation right (SAR) is grandfathered if the option or SAR is grandfathered and the extension satisfies Reg. §1.409A-1(b)(5)(v)(C)(1).

Effective Dates

Generally, these final regulations apply to taxable years beginning on or after the date that they are published as final in the federal register. However, taxpayers may choose to apply these final regulations to a taxable year beginning after December 31, 2017. Taxpayers that elect to apply the final regulations before the effective date must apply the final regulations consistently and in their entirety to that taxable year and all subsequent taxable years.

In addition, the final regulations include special applicability dates for certain aspects of the definition of:

• a covered employee,
• a predecessor of a publicly held corporation,
• compensation, and
• a written binding contract and material modification.

The regulations also include a special applicability date for the application of the Code Sec. 162(m) deduction limitations deductible for a taxable year ending on or after a privately held corporation becomes a publicly held corporation.

The IRS has issued final regulations providing additional guidance on the limitation on the deduction for business interest under Code Sec. 163(j). The regulations finalize various portions of the proposed regulations issued in 2020 with few modifications. They address the application of the limit in the context of calculating adjusted taxable income (ATI) with respect to depreciation, amortization, and depletion. The regulations also finalize rules on the definitions of real property development and redevelopment, as well as application to passthrough entities, regulated investment companies (RICs), and controlled foreign corporations.

The IRS has issued final regulations providing additional guidance on the limitation on the deduction for business interest under Code Sec. 163(j). The regulations finalize various portions of the proposed regulations issued in 2020 with few modifications. They address the application of the limit in the context of calculating adjusted taxable income (ATI) with respect to depreciation, amortization, and depletion. The regulations also finalize rules on the definitions of real property development and redevelopment, as well as application to passthrough entities, regulated investment companies (RICs), and controlled foreign corporations.

Calculating ATI

A taxpayer’s ATI for purposes of the Section 163(j) limit is the taxpayer’s tentative taxable income for the tax year with certain adjustments. For example, depreciation, amortization, and depletion for tax years beginning before January 1, 2022, is added back to tentative taxable income, but is subtracted from tentative taxable income if the taxpayer sells or disposes the property before January 1, 2022.

The final regulations provide that a taxpayer has the option to use an alternative computation method for property dispositions where the ATI adjustment is the lesser of: (1) any gain recognized on the sale or disposition; or (2) the greater of the allowed or allowable depreciation, amortization, or depletion deduction of the property sold before January 1, 2022.

Similar rules apply for the sale or other disposition of an interest in a partnership or stock of a member of a consolidated group. However, the negative adjustment to tentative taxable income is reduced to the extent the taxpayer establishes that the additions to tentative taxable income in a prior tax year did not result in an increase in the amount allowed as a deduction for business interest expense for the year.

Real Property Development

The Section 163(j) limit does not apply to certain excepted trades or businesses, including an electing real property trade or business. An electing real property trade or business is any trade or business described in Code Sec. 469(c)(7)(C).

In response to comments about the application of this definition to timberlands, the 2020 proposed regulations provided definitions for real property development and redevelopment for clarity relying on the Code Sec. 464(e) definition of farming for that purpose. Section 464(e) generally excludes the cultivation and harvesting of trees (except those bearing fruit or nuts) from the definition of "farming".

The final regulations retain these definitions for real property development and real property redevelopment. Thus, to the extent the evergreen trees may be located on parcels of land covered by forest, the business activities of cultivating and harvesting such evergreen trees are a component of a "real property development" or "real property redevelopment" trade or business.

Self-Charged Lending

The final regulations adopt the proposed rules for self-charged lending transactions between partners and partnerships without change. For a transaction between a lending partner and a borrowing partnership in which the lending partner owns a direct interest, any business interest expense of the borrowing partnership attributable to a self-charged lending transaction is business interest expense of the borrowing partnership.

However, to the extent the lending partner receives interest income attributable to the self-charged lending transaction and also is allocated excess business interest in the same tax year, the lending partner may treat that interest income as an allocation of excess business income from the borrowing partnership to the extent of the lending partner’s allocation of excess business interest expense.

The IRS has released final regulations that address the changes made to Code Sec. 162(f) by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), concerning the deduction of certain fines, penalties, and other amounts. The final regulations also provide guidance relating to the information reporting requirements for fines and penalties under Code Sec. 6050X.

The IRS has released final regulations that address the changes made to Code Sec. 162(f) by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), concerning the deduction of certain fines, penalties, and other amounts. The final regulations also provide guidance relating to the information reporting requirements for fines and penalties under Code Sec. 6050X.

The final regulations adopt proposed regulations released last May ( NPRM REG-104591-18), with modifications.

TCJA Changes

Under changes made to Code Sec. 162(f) by the TCJA, businesses may not deduct fines and penalties paid or incurred after December 21, 2017, due to the violation of a law (or the investigation of a violation) if a government (or similar entity) is a complainant or investigator. Exceptions to this rule are available if the payment was for restitution, remediation, taxes due, or paid or incurred to come into compliance with a law. For the exceptions to apply, the taxpayer must identify the payment as restitution, remediation, or compliance in a court order or settlement agreement. In addition, Code Sec. 6050X now requires the officer or employee that has control over the suit or agreement to file a return with the IRS

The final regulations establish that a taxpayer generally may not take a deduction for any amount that was paid or incurred:

• by suit, agreement, or otherwise;
• to, or at the direction of, a government or governmental entity; and
• in relation to the violation, or investigation or inquiry by the government or governmental entity into the potential violation, of any civil or criminal law.

This rule applies regardless of whether the taxpayer admits guilt or liability, or pays the amount imposed for any other reason. This includes instances where the taxpayer pays to avoid the expense or uncertain outcome of an investigation or litigation.

The final regulations also clarify that a suit or agreement is treated as binding under applicable law even if all appeals have not been exhausted.

Governmental Entities

Under the final regulations, governmental entities include nongovernmental entities that exercise self-regulatory powers, including imposing sanctions.

The regulations also clarify that, for purposes of the information reporting requirements in Code Sec. 6050X, a nongovernmental entity treated as a governmental entity does not include a nongovernmental entity of a territory of the United States, including American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands, a foreign country, or a Native American tribe.

Violations of Law

Under the final regulations, violations of the law do not include any order or agreement in a suit in which a government or governmental entity enforces rights as a private party.

Investigations

The final regulations also make clear that amounts paid or incurred for required routine investigations or inquiries continue to be deductible. In general, amounts paid or incurred for routine investigations or inquiries, such as audits or inspections, required to ensure compliance with rules and regulations applicable to the business or industry, which are not related to any evidence of wrongdoing or suspected wrongdoing, are not amounts paid or incurred relating to the potential violation of any law.

Establishing Payment

Under the final regulations, a taxpayer can establish that a payment was made for restitution or remediation by providing documentary evidence of the following:

• the taxpayer was legally obligated to pay the amount that the order or agreement identified as restitution, remediation, or to come into compliance with a law;
• the amount paid or incurred for the nature and purpose identified; and
• the date on which the amount was paid or incurred.

The final regulations expand the list of documentary evidence that may be used to meet the establishment requirement. According to the regulations, taxpayers may be able to use documentary evidence in a foreign language to satisfy the establishment requirement if the taxpayer provides a complete and accurate certified English translation of the documentary evidence.

Reporting of the amount by a government or governmental entity under Code Sec. 6050X alone does not satisfy the establishment requirement.

Disgorgement, Forfeiture of Profits

Under the final regulations, a taxpayer’s claim for a deduction for amounts paid or incurred through disgorgement or forfeiture of profits will be permitted if:

• the amount is otherwise deductible;
• the order or agreement identifies the payment, not in excess of net profits, as restitution, remediation, or an amount paid to come into compliance with a law;
• the taxpayer establishes that the amount was paid as restitution, remediation, or an amount paid to come into compliance with a law; and
• the origin of the taxpayer’s liability is restitution, remediation, or an amount paid to come into compliance with a law.

However, amounts paid or incurred through disgorgement will be disallowed if the amounts are disbursed to the general account of the government or governmental entity for general enforcement efforts or other discretionary purposes.

Restitution, Remediation

Final Reg. §1.162-21(e)(4)(i) clarifies that restitution and remediation do not include amounts paid to a general account or for discretionary purposes. In addition, the final regulations provide that if amounts paid by the taxpayer pursuant to an order or an agreement is returned, the taxpayer must include the amount in its income under the tax benefit rule.

Reg. §1.162-21(e)(4)(i)(A) also provides special restitution and remediation rules to address amounts paid or incurred for irreparable harm to the environment, natural resources, or wildlife.

Coming into Compliance

The final regulations list certain payments that will not be treated as “paid or incurred to come into compliance with a law.” In addition, the taxpayer must perform any required services or take any required action in order to come into compliance with the law.

The final regulations also modify an example to clarify that when a taxpayer upgrades equipment or property to a higher standard than what is required to come into compliance with the law, the taxpayer will be able to deduct the difference between what the taxpayer paid and the amount required to come into compliance.

Identification

Under Code Sec. 162(f)(2)(A), an order or agreement must identify the amount paid or incurred as restitution, remediation, or to come into compliance with a law. The final regulations modify the proposed rule for payment amounts not identified. Under this rule, the identification requirement may be met even if the order or agreement does not allocate the total lump-sum payment amount among restitution, remediation, or to come into compliance with the law. The rule also applies when the order or agreement fails to allocate the total payment among multiple taxpayers. In addition, the final regulations clarify that the identification requirement may be met even in cases where the order or agreement does not provide an estimated payment amount.

Consistent with Code Sec. 162(f)(2)(A)(ii), the final regulations provide that the order or agreement, not the taxpayer, must meet the identification requirement with language specifically stating or describing that the amount will be paid or incurred as restitution, remediation, or to come into compliance with a law.

The final regulations eliminated the rebuttable presumption for the identification requirement. Instead, the identification requirement is met when the order or agreement specifically states that the payment constitutes restitution, remediation, or an amount paid to come into compliance with a law, or when it uses a different form of the required words. For orders or agreements in a foreign language, in order to meet the identification requirement the taxpayer must provide a complete and accurate certified English translation that describes the nature and purpose of the payment using the foreign language equivalent of restitution, remediation, or coming into compliance with the law.

According to the final regulations, an order or agreement will also meet the identification requirement if it describes the damage done, harm suffered, or manner of noncompliance with a law, and describes the action required of the taxpayer to (1) restore the party, property, or environment harmed or (2) perform services, take action, or provide property to come into compliance with that law.

Taxes and Interest

Under Code Sec. 162(f)(4), taxpayers may still deduct any taxes due, including any related interest on the taxes. However, the final regulations clarify that if penalties are imposed with respect to otherwise deductible taxes, a taxpayer may not deduct the penalties or the interest paid with respect to such penalties.

Multiple Payors

The final regulations address situations where there are multiple payors and the aggregate amount they are required to pay, or the costs to provide the property or the service, meets or exceeds the threshold amount. In those instances, the appropriate official should file an information return and furnish a written statement for the separate amount that each individually liable payor is required to pay, even if a payor’s payment liability is less than the threshold amount.

Material Change

According to the TCJA, the amendments to Code Sec. 162(f) apply to agreements entered into on or after December 22, 2017. However, the proposed regulations clarified that if the parties to an agreement that was binding prior to December 22, 2017, make a material change to that agreement on or after the date that the proposed regulations become final, the regulations will apply to the agreement. The final regulations have eliminated that requirement.

Reporting Requirements

The final regulations provide that if the aggregate amount a payor is required to pay equals or exceeds the threshold amount of $50,000 under Reg. §1.6050X-1(f)(6), the appropriate official of a government or governmental entity must file an information return with the IRS with respect to the amounts or incurred paid and any additional information required. That information includes:

• the amounts paid or incurred pursuant to the order or agreement;
• the payor’s taxpayer identification number (TIN); and
• other information required by the information return and the related instructions.

The official must provide this information by filing Form 1098-F, Fines, Penalties, and Other Amounts, with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, on or before the annual due date. However, the regulations do not require an appropriate official to file information returns for each tax year in which a payor makes a payment pursuant to a single order or agreement. Instead, the appropriate official should only one information return for the aggregate amount identified in the order or agreement.

In instances where the final amount is unknown but is expected to meet or exceed the $50,000 threshold amount, the appropriate official should report the threshold amount on Form 1098-F.

The appropriate official must also furnish a written statement with the same information to the payor. They can satisfy this requirement by providing a copy of Form 1098-F. This statement must be provided by January 31 of such year.

Effective Date

The final regulations apply to tax years beginning on or after the date of publication in the Federal Register. The final regulations under Reg. §1.6050X-1 apply only to orders and agreements, pursuant to suits and agreements, that become binding under applicable law on or after January 1, 2022.

The IRS has provided a safe harbor allowing a trade or business that manages or operates a qualified residential living facility to be treated as a "real property trade or business" solely for purposes of qualifying to make the Code Sec. 163(j)(7)(B) election. This guidance formalizes the proposed safe harbor issued in Notice 2020-59, I.R.B. 2020-34, 782. Taxpayers may apply the rules to tax years beginning after December 31, 2017.

The IRS has provided a safe harbor allowing a trade or business that manages or operates a qualified residential living facility to be treated as a "real property trade or business" solely for purposes of qualifying to make the Code Sec. 163(j)(7)(B) election. This guidance formalizes the proposed safe harbor issued in Notice 2020-59, I.R.B. 2020-34, 782. Taxpayers may apply the rules to tax years beginning after December 31, 2017.

Qualified Residential Living Facilities

A facility is deemed to be a "qualified residential living facility" if it:

• consists of multiple rental dwelling units within one or more buildings or structures that generally serve as primary residences on a permanent or semi-permanent basis to individual customers or patients;
• provides supplemental assistive, nursing, or other routine medical services;
• has an average period of customer or patient use of individual rental dwelling units of 30 days or more; and
• retains books and records to substantiate requirements.

Further, taxpayers must use the Code Sec. 168(g) alternative depreciation system to depreciate the property under Code Sec. 168(g)(8).

Taxpayers satisfying the requirements of the safe harbor after a deemed cessation of the electing trade or business will have their initial election under Code Sec. 163(j)(7)(B) automatically reinstated.

The IRS has released final regulations addressing the post-2017 simplified accounting rules for small businesses. The final regulations adopt and modify proposed regulations released in August 2020.

The IRS has released final regulations addressing the post-2017 simplified accounting rules for small businesses. The final regulations adopt and modify proposed regulations released in August 2020.

Implementation of the Rules

The Tax Cuts and Jobs Act ( P.L. 115-97) put in place a single $25 million gross receipts test for determining whether certain taxpayers qualify as small taxpayers that can use the cash method of accounting, are not required to use inventories, are not required to apply the Uniform Capitalization (UNICAP rules), and are not required to use the percentage of completion method for a small construction contract.

Highlights of Changes in the Final Regulations

Annual syndicate election. The proposed regulations permit a taxpayer to elect to use the allocated taxable income or loss of the immediately preceding tax year to determine whether the taxpayer is a syndicate under Code Sec. 448(d)(3) for the current tax year. Under the proposed regulations, a taxpayer that makes this election must apply the rule to all subsequent tax years, unless it receives IRS permission to revoke the election.

The final regulations provide additional relief by making the election an annual election. The election is valid only for the tax year for which it is made, and once made, cannot be revoked. The IRS intends to issue procedural guidance to address the revocation of an election made under the proposed regulations as a result of the application of the final regulations.

Five-year written consent requirement relaxed. The proposed regulations require a taxpayer that meets the gross receipts test in the current tax year to obtain the written consent of the Commissioner before changing to the cash method if the taxpayer had previously changed its overall method from the cash method during any of the five tax years ending with the current tax year. The final regulations remove the 5-year restriction on making automatic accounting method changes for certain situations.

Other changes. Additional changes include the following:

• To reduce confusion about the nature of property treated as non-incidental materials and supplies under Code Sec. 471(c)(1)(B)(i), the final regulations refer to the method under that provision as the "section 471(c) NIMS inventory method."
• The final regulations provide that inventory costs includible in the section 471(c) NIMS inventory method are direct material costs of the property produced or the costs of property acquired for resale.
• Examples are added to clarify the principle that a taxpayer may not ignore its regular accounting procedures or portions of its books and records under the non-AFS section 471(c) inventory method.
• The final regulations clarify how a taxpayer treats costs to acquire or produce tangible property that the taxpayer does not capitalize in its books and records.

Applicability Date

The final regulations are applicable for tax years beginning on or after the date of publication in the Federal Register. However, a taxpayer may apply the final regulations under a particular Code provision for a tax year beginning after December 31, 2017, if the taxpayer follows all the applicable rules contained in the regulations that relate to that Code provision for the tax year and all subsequent tax years, and follows the administrative procedures for filing a change in method of accounting.

Whether for a day, a week or longer, many of the costs associated with business trips may be tax-deductible. The tax code includes a myriad of rules designed to prevent abuses of tax-deductible business travel. One concern is that taxpayers will disguise personal trips as business trips. However, there are times when taxpayers can include some personal activities along with business travel and not run afoul of the IRS.

Business travel

You are considered “traveling away from home” for tax purposes if your duties require you to be away from the general area of your home for a period substantially longer than an ordinary day's work, and you need sleep or rest to meet the demands of work while away. Taxpayers who travel on business may deduct travel expenses if they are not otherwise lavish or extravagant. Business travel expenses include the costs of getting to and from the business destination and any business-related expenses at that destination.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

• Travel by airplane, train, bus, or car to/from the business destination.
• Fares for taxis or other types of transportation between the airport or train station and lodging, the lodging location and the work location, and from one customer to another, or from one place of business to another.
• Meals and lodging.
• Tips for services related to any of these expenses.
• Dry cleaning and laundry.
• Business calls while on the business trip.
• Other similar ordinary and necessary expenses related to business travel.

Business mixed with personal travel

Travel that is primarily for personal reasons, such as a vacation, is a nondeductible personal expense. However, taxpayers often mix personal travel with business travel. In many cases, business travelers may able to engage in some non-business activities and not lose all of the tax benefits associated with business travel.

The primary purpose of a trip is determined by looking at the facts and circumstances of each case. An important factor is the amount of time you spent on personal activities during the trip as compared to the amount of time spent on activities directly relating to business.

Let’s look at an example. Amanda, a self-employed architect, resides in Seattle. Amanda travels on business to Denver. Her business trip lasts six days. Before departing for home, Amanda travels to Colorado Springs to visit her son, Jeffrey. Amanda’s total expenses are $1,800 for the nine days that she was away from home. If Amanda had not stopped in Colorado Springs, her trip would have been gone only six days and the total cost would have been $1,200. According to past IRS precedent, Amanda can deduct $1,200 for the trip, including the cost of round-trip transportation to and from Denver.

Weekend stayovers

Business travel often concludes on a Friday but it may be more economical to stay over Saturday night and take advantage of a lower travel fare. Generally, the costs of the weekend stayover are deductible as long as they are reasonable. Staying over a Saturday night is one way to add some personal time to a business trip.

Foreign travel

The rules for foreign travel are particularly complex.  The amount of deductible travel expenses for foreign travel is linked to how much of the trip was business related.  Generally, an individual can deduct all of his or her travel expenses of getting to and from the business destination if the trip is entirely for business.

In certain cases, foreign travel is considered entirely for business even if the taxpayer did not spend his or her entire time on business activities. For example, a foreign business trip is considered entirely for business if the taxpayer was outside the U.S. for more than one week and he or she spent less than 25 percent of the total time outside the U.S. on non-business activities. Other exceptions exist for business travel outside the U.S. for less than one week and in cases where the employee did not have substantial control in planning the trip.

Foreign conventions are especially difficult, but no impossible, to write off depending upon the circumstances. The taxpayer may deduct expenses incurred in attending foreign convention seminar or similar meeting only if it is directly related to active conduct of trade or business and if it is as reasonable to be held outside North American area as within North American area.

Tax home

To determine if an individual is traveling away from home on business, the first step is to determine the location of the taxpayer’s tax home. A taxpayer’s tax home is generally his or her regular place of business, regardless of where he or she maintains his or her family home. An individual may not have a regular or main place of business. In these cases, the individual’s tax home would generally be the place where he or she regularly lives.  The duration of an assignment is also a factor. If an assignment or job away from the individual’s main place of work is temporary, his or her tax home does not change. Generally, a temporary assignment is one that lasts less than one year.

The distinction between tax home and family home is important, among other reasons, to determine if certain deductions are allowed. Here’s an example.

Alec’s family home is in Tucson, where he works for ABC Co. 14 weeks a year.  Alec spends the remaining 38 weeks of the year working for ABC Co. in San Diego. Alec has maintained this work schedule for the past three years. While in San Diego, Alec resides in a hotel and takes most of his meals at restaurants.  San Diego would be treated as Alec’s tax home because he spends most of his time there. Consequently, Alec would not be able to deduct the costs of lodging and meals in San Diego.

Accountable and nonaccountable plans

Many employees are reimbursed by their employer for business travel expenses. Depending on the type of plan the employer has, the reimbursement for business travel may or may not be taxable. There are two types of plans: accountable plans and nonaccountable plans.

An accountable plan is not taxable to the employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and federal employment taxes. Accountable plans have a number of requirements:

• There must be a business connection to the expenditure. The expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his or her individual income tax return.

• There must be adequate accounting by the recipient within a reasonable period of time. Employees must verify the date, time, place, amount and the business purpose of the expenses.

• Excess reimbursements or advances must be returned within a reasonable period of time.

Amounts paid under a nonaccountable plan are taxable to employees and are subject to all employment taxes and withholding.  A plan may be labeled an accountable plan but if it fails to qualify, the IRS treats it as a nonaccountable plan. If you have any questions about accountable plans, please contact our office.

As mentioned, the tax rules for business travel are complex. Please contact our office if you have any questions.

Exempt organizations

Charitable organizations often are organized as tax-exempt entities. To be tax-exempt under Code Sec. 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes in Code Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization; that is, it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Churches that meet the requirements of Code Sec. 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Tax-exempt organizations must file annual reports with the IRS. If an organization fails to file the required reports for three consecutive years, its tax-exempt status is automatically revoked. Recently, the tax-exempt status of more than 200,000 organizations was automatically revoked. Most of these organizations are very small ones and the IRS believes that they likely did not know about the requirement to file or risk loss of tax-exempt status.  The IRS has put special procedures in place to help these small organizations regain their tax-exempt status.

Contributions

Contributions to qualified charities are tax-deductible. They key word here is qualified. The organization must be recognized by the IRS as a legitimate charity.

The IRS maintains a list of organizations eligible to receive tax-deductible charitable contributions. The list is known as Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986.  Similar information is available on an IRS Business Master File (BMF) extract.

In certain cases, the IRS will allow deductions for contributions to organizations that have lost their exempt status but are listed in or covered by Publication 78 or the BMF extract.  Additionally, private foundations and sponsoring organizations of donor-advised funds generally may rely on an organization's foundation status (or supporting organization type) set forth in Publication 78 or the BMF extract for grant-making purposes.

Generally, the donor must be unaware of the change in status of the organization. If the donor had knowledge of the organization’s revocation of exempt status, knew that revocation was imminent or was responsible for the loss of status, the IRS will disallow any purported deduction.

Churches

As mentioned earlier, churches are not required to apply for tax-exempt status. This means that taxpayers may claim a charitable deduction for donations to a church that meets the Code Sec. 501(c)(3) requirements even though the church has neither sought nor received IRS recognition that it is tax-exempt.

Foreign charities

Contributions to foreign charities may be deductible under an income tax treaty. For example, taxpayers may be able to deduct contributions to certain Canadian charitable organizations covered under an income tax treaty with Canada.  Before donating to a foreign charity, please contact our office and we can determine if the contribution meets the IRS requirements for deductibility.

The rules governing charities, tax-exempt organizations and contributions are complex. Please contact our office if you have any questions.

With school almost out for the summer, parents who work are starting to look for activities for their children to keep them occupied and supervised. The possibilities include sending a child to day camp or overnight camp. Parents faced with figuring out how to afford the price tag of these activities may wonder whether some or part of these costs may be tax deductible. At least two possible tax breaks should be considered: the dependent care credit in most cases, and the deduction for medical expenses in certain special situations.

Dependent care credit. To qualify for the dependent care credit, expenses must be employment-related. The child also must be under age 13 unless he or she is disabled.

The child care expenses must enable the parent to work or to look for employment. The IRS has indicated that the costs of sending a child to overnight camp are not employment-related. However, the costs of sending a child to day camp are treated like day-care costs and will qualify as employment-related expenses (even if the camp features educational activities). At the same time, the costs of sending a child to summer school or to a tutor are not employment-related and cannot be deducted even though they also watch over your child while you are at work..

In some situations, the IRS requires that expenses be allocated between child care and other, nonqualified services. However, the full cost of day camp generally qualifies for the dependent care credit, without an allocation being required. If the parent works part-time, camp costs may only be claimed for the days worked. However, if the camp requires that the child be enrolled for the entire week, then the full cost qualifies.

Example. Tom works Monday through Wednesday and sends his child to day camp for the entire week. The camp charges $50 per day and children do not have to enroll for an entire week. Tom can only claim $150 in expenses. However, if the camp requires that the child be enrolled for the entire week, Tom can claim $250 in expenses.

Amount of Credit. The maximum amount of employment-related expenses to which the child care credit may be applied is $3,000 if one qualifying individual is involved or $6,000 if two or more qualifying individuals are involved. If you earn over a certain amount, the credit may be reduced. The credit amount is equal to the amount of qualified expenses times the applicable percentage, as determined by the taxpayer's adjusted gross income (AGI). Taxpayers with an AGI of $15,000 or less use the highest applicable percentage of 35 percent. For taxpayers with an AGI over $15,000, the credit is reduced by one percentage point for each $2,000 of AGI (or fraction thereof) over $15,000 The minimum applicable percentage of 20 percent is used by taxpayers with an AGI greater than $43,000. Bottom line: those with higher incomes are entitled to a maximum child care credit for one qualifying dependent is $1,050 and $2,100 for two or more qualifying dependents.

Dependent care costs also may be reimbursed by a flexible spending account (FSAs) under an employer-sponsored arrangement. FSAs allow pre-tax dollars to fund the account up to specified maximum. Each FSA may limit what it covers so check with your employer before assuming the day camp or similar child care is on its list of reimbursable expenses.

Medical expenses. The cost of camp generally is not deductible as a medical expense. The cost of providing general care to a healthy child is a nondeductible personal expense.

Example. The child's mother works; the child's father is ill and cannot take care of the child. The cost of sending the child to summer camp is not deductible as a medical expense; however, the costs may still qualify for the dependent care credit.

However, camps specifically run for handicapped children and operated to assist the child may come under the umbrella of medical expenses. The degree of assistance is usually determinative in these situations.

Dependency exemption. In any case, the cost of sending a child to camp can be treated as support, for claiming a dependency exemption. For a parent to claim a dependency exemption, the child cannot provide more than half of its own support. The parent must provide some support but does not necessarily have to provide over half of the child's support. If the child is treated as a qualifying relative (because he or she is too old to be a qualifying child), the parent must still provide over half of the child's support.

The rules on the deductibility of camp costs are somewhat complicated, especially in borderline situations. Please check with this office if you have any questions.

As a result of recent changes in the law, many brokerage customers will begin seeing something new when they gaze upon their 1099-B forms early next year.  In the past, of course, brokers were required to report to their clients, and the IRS, those amounts reflecting the gross proceeds of any securities sales taking place during the preceding calendar year.

In keeping with a broader move toward greater information reporting requirements, however, new tax legislation now makes it incumbent upon brokers to provide their clients, and the IRS, with their adjusted basis in the lots of securities they purchase after certain dates, as well. While an onerous new requirement for the brokerage houses, this development ought to simplify the lives of many ordinary taxpayers by relieving them of the often difficult matter of calculating their stock bases.

When calculating gain, or loss, on the sale of stock, all taxpayers must employ a very simple formula. By the terms of this calculus, gain equals amount realized (how much was received in the sale) less adjusted basis (generally, how much was paid to acquire the securities plus commissions). By requiring brokers to provide their clients with both variables in the formula, Congress has lifted a heavy load from the shoulders of many.

FIFO

The new requirements also specify that, if a customer sells some amount of shares less than her entire holding in a given stock, the broker must report the customer's adjusted basis using the "first in, first out" method, unless the broker receives instructions from the customer directing otherwise. The difference in tax consequences can be significant.

Example.  On January 16, 2011, Laura buys 100 shares of Big Co. common stock for $100 a share. After the purchase, Big Co. stock goes on a tear, quickly rising in price to $200 a share, on April 11, 2011. Believing the best is still ahead for Big Co., Laura buys another 100 shares of Big Co. common on that date, at that price. However, rather than continuing its meteoric rise, the price of Big Co. stock rapidly plummets to $150, on May 8, 2011. At this point, Laura, tired of seeing her money evaporate, sells 100 of her Big Co. shares.

Since Laura paid $100 a share for the first lot of Big Co. stock that she purchased (first in), her basis in those shares is $100 per share (plus any brokerage commissions). Her basis in the second lot, however, is $200 per share (plus any commissions). Unless Laura directs her broker to use an alternate method, the broker will use the first in stock basis of $100 per share in its reporting of this first out sale. Laura, accordingly, will be required to report a short-term capital gain of $50 per share (less brokerage commissions). Had she instructed her broker to use the "last in, first out" method, she would, instead, see a short-term capital loss of $50 per share (plus commissions).

Dividend Reinvestment Plans

As their name would suggest, dividend reinvestment plans (DRPs) allow investors the opportunity to reinvest all, or a portion, of any dividends received back into additional shares, or fractions of shares, of the paying corporation. While offering investors many advantages, one historical drawback to DRPs has been their tendency to obligate participants to keep track of their cost bases for many small purchases of stock, and maintain records of these purchases, sometimes over the course of many years. Going forward, however taxpayers will be able to average the basis of stock held in a DRP acquired on or after January 1, 2011.

Applicability

The types of securities covered by the legislation include virtually every conceivable financial instrument subject to a basis calculation, including stock in a corporation, which become "covered" securities when acquired after a certain date. In the case of corporate stock, for example, the applicability date is January 1, 2011, unless the stock is in a mutual fund or is acquired in connection with a dividend reinvestment program (DRP), in which case the applicable date is January 1, 2012. The applicable date for all other securities is January 1, 2013.

Short Sales

In the past, brokers reported the gross proceeds of short sales in the year in which the short position was opened. The amendments, however, require that brokers report short sales for the year in which the short sale is closed.

The Complex World of Stock Basis

There are, quite literally, as many ways to calculate one's basis in stock as there are ways to acquire that stock. Many of these calculations can be nuanced and very complex. For any questions concerning the new broker-reporting requirements, or stock basis, in general, please contact our office.

Many more retirees and others wanting guarantee income are looking into annuities, especially given the recent experience of the economic downturn. While the basic concept of an annuity is fairly simple, complex rules usually apply to the taxation of amounts received under certain annuity and life insurance contracts.

Amounts received as an annuity are included in gross income to the extent that they exceed the exclusion ratio, which is determined by taking the original investment in the contract, deducting the value of any refund features, and dividing the result by the expected yield on the contract as of the annuity starting date. In general, the expected return is the product of a single payment and the anticipated number of payments to be received, i.e., the total amount the annuitant(s) can expect to receive. In the case of a life annuity, the number of payments is computed based on actuarial tables.

If the annuity payments are to continue as long as the annuitant remains alive, the anticipated number of payments is based on the annuitant's (or annuitants') life expectancy at the birthday nearest the annuity starting date. The IRS provides a variety of actuarial tables, within unisex tables generally applicable to all contracts entered into after June 1986. The expected return multiples found in the actuarial tables may require adjustment if the contract specifies quarterly, semiannual or annual payments or if the interval between payments exceeds the interval between the annuity starting date and the first payment.

In connection with annuity calculations, one recent tax law change in particular is worth noting. Under the Creating Small Business Jobs Act of 2010, enacted on September 27, 2010, if amounts are received as an annuity for a period of 10 years or more or on the lives of one or more individuals under any portion of an annuity, endowment, or life insurance contract, then that portion of the contract will now be treated as a separate contract for tax purposes. As result, a portion of such an annuity, endowment, or life insurance contract may be annuitized, while the balance is not annuitized. The allowance of partial annuitization applies to amounts received in tax years beginning after December 31, 2010.

If you need help in "crunching the numbers" on an annuity, or if you'd like advice on what annuity options might best fit your needs, please do not hesitate to contact our office.

Most people are familiar with tax withholding, which most commonly takes place when an employer deducts and withholds income and other taxes from an employee's wages. However, many taxpayers are unaware that the IRS also requires payors to withhold income tax from certain reportable payments, such as interest and dividends, when a payee's taxpayer identification number (TIN) is missing or incorrect. This is known as "backup withholding."

Backup Withholding in General

A payor must deduct, withhold, and pay over to the IRS a backup withholding tax on any reportable payments that are not otherwise subject to withholding if:

• the payee fails to furnish a TIN to the payor in the manner required;
• the IRS or a broker notifies the payor that the TIN provided by the payee is incorrect;
• the IRS notifies the payor that the payee failed to report or underreported the prior year's interest or dividends; or
• the payee fails to certify on Form W-9, Request for Taxpayer Identification Number and Certification, that he or she is not subject to withholding for previous underreporting of interest or dividend payments.

The backup withholding rate is equal to the fourth lowest income tax rate under the income tax rate brackets for unmarried individuals, which is currently 28 percent.

Only reportable payments are subject to backup withholding. Backup withholding is not required if the payee is a tax-exempt, governmental, or international organization. Similarly, payments of interest made to foreign persons are generally not subject to information reporting; therefore, these payees are not subject to backup withholding. Additionally, a payor is not required to backup withhold on reportable payments for which there is documentary evidence, under the rules on interest payments, that the payee is a foreign person, unless the payor has actual knowledge that the payee is a U.S. person. Furthermore, backup withholding is not required on payments for which a 30 percent amount was withheld by another payor under the rules on foreign withholding.

Reportable Payments

Reportable payments generally include the following types of payments of more than $10:

• Interest;
• Dividends;
• Patronage dividends (payments from farmers' cooperatives) paid in money;
• Payments of $600 or more made in the course of a trade or business;
• Payments for a nonemployee's services provided in the course of a trade or business;
• Gross proceeds from transactions reported by a broker or barter exchange;
• Cash payments from certain fishing boat operators to crew members that represent a share of the proceeds of the catch; and
• Royalties.

Reportable payments also include payments made after December 31, 2011, in settlement of payment card transactions.

Failure to Furnish TIN

Payees receiving reportable payments through interest, dividend, patronage dividend, or brokerage accounts must provide their TIN to the payor in writing and certify under penalties of perjury that the TIN is correct. Payees receiving other reportable payments must still provide their TIN to the payor, but they may do so orally or in writing, and they are not required to certify under penalties of perjury that the TIN is correct.

A payee who does not provide a correct taxpayer identification number (TIN) to the payer is subject to backup withholding. A person is treated as failing to provide a correct TIN if the TIN provided does not contain the proper number of digits --nine --or if the number is otherwise obviously incorrect, for example, because it contains a letter as one of its digits.

The IRS compares TINs provided by taxpayers with records of the Social Security Administration to check for discrepancies and notifies the bank or the payer of any problem accounts. The IRS has requested banks and other payers to notify their customers of these discrepancies so that correct TINs can be provided and the need for backup withholding avoided.

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

Taxpayers are required to keep accurate, permanent books and records so as to be able to determine the various types of income, gains, losses, costs, expenses and other amounts that affect their income tax liability for the year. The IRS generally does not require taxpayers to keep records in a particular way, and recordkeeping does not have to be complicated. However, there are some specific recordkeeping requirements that taxpayers should keep in mind throughout the year.

Business Expense Deductions

A business can choose any recordkeeping system suited to their business that clearly shows income and expenses. The type of business generally affects the type of records a business needs to keep for federal tax purposes. Purchases, sales, payroll, and other transactions that incur in a business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. Supporting documents for business expenses should show the amount paid and that the amount was for a business expense. Documents for expenses include canceled checks; cash register tapes; account statements; credit card sales slips; invoices; and petty cash slips for small cash payments.

The Cohan rule. A taxpayer generally has the burden of proving that he is entitled to deduct an amount as a business expense or for any other reason. However, a taxpayer whose records or other proof is not adequate to substantiate a claimed deduction may be allowed to deduct an estimated amount under the so-called Cohan rule. Under this rule, if a taxpayer has no records to provide the amount of a business expense deduction, but a court is satisfied that the taxpayer actually incurred some expenses, the court may make an allowance based on an estimate, if there is some rational basis for doing so.

However, there are special recordkeeping requirements for travel, transportation, entertainment, gifts and listed property, which includes passenger automobiles, entertainment, recreational and amusement property, computers and peripheral equipment, and any other property specified by regulation. The Cohan rule does not apply to those expenses. For those items, taxpayers must substantiate each element of an expenditure or use of property by adequate records or by sufficient evidence corroborating the taxpayer's own statement.

Individuals

• Record keeping is not just for businesses. The IRS recommends that individuals keep the following records:
• Copies of Tax Returns. Old tax returns are useful in preparing current returns and are necessary when filing an amended return.
• Adoption Credit and Adoption Exclusion. Taxpayers should maintain records to support any adoption credit or adoption assistance program exclusion.
• Employee Expenses. Travel, entertainment and gift expenses must be substantiated through appropriate proof. Receipts should be retained and a log may be kept for items for which there is no receipt. Similarly, written records should be maintained for business mileage driven, business purpose of the trip and car expenses for business use of a car.
• Business Use of Home. Records must show the part of the taxpayer's home used for business and that such use is exclusive. Records are also needed to show the depreciation and expenses for the business part of the home.
• Capital Gains and Losses. Records must be kept showing the cost of acquiring a capital asset, when the asset was acquired, how the asset was used, and, if sold, the date of sale, the selling price and the expenses of the sale.
• Basis of Property. Homeowners must keep records of the purchase price, any purchase expenses, the cost of home improvements and any basis adjustments, such as depreciation and deductible casualty losses.
• Basis of Property Received as a Gift. A donee must have a record of the donor's adjusted basis in the property and the property's fair market value when it is given as a gift. The donee must also have a record of any gift tax the donor paid.
• Service Performed for Charitable Organizations. The taxpayer should keep records of out-of-pocket expenses in performing work for charitable organizations to claim a deduction for such expenses.
• Pay Statements. Taxpayers with deductible expenses withheld from their paychecks should keep their pay statements for a record of the expenses.
• Divorce Decree. Taxpayers deducting alimony payments should keep canceled checks or financial account statements and a copy of the written separation agreement or the divorce, separate maintenance or support decree.

Don't forget receipts. In addition, the IRS recommends that the following receipts be kept:

• Proof of medical and dental expenses;
• Form W-2, Wage and Tax Statement, and canceled checks showing the amount of estimated tax payments;
• Statements, notes, canceled checks and, if applicable, Form 1098, Mortgage Interest Statement, showing interest paid on a mortgage;
• Canceled checks or receipts showing charitable contributions, and for contributions of $250 or more, an acknowledgment of the contribution from the charity or a pay stub or other acknowledgment from the employer if the contribution was made by deducting $250 or more from a single paycheck;
• Receipts, canceled checks and other documentary evidence that evidence miscellaneous itemized deductions; and
• Pay statements that show the amount of union dues paid.

Electronic Records/Electronic Storage Systems

Records maintained in an electronic storage system, if compliant with IRS specifications, constitute records as required by the Code. These rules apply to taxpayers that maintain books and records by using an electronic storage system that either images their hard-copy books and records or transfers their computerized books and records to an electronic storage media, such as an optical disk.

The electronic storage rules apply to all matters under the jurisdiction of the IRS including, but not limited to, income, excise, employment and estate and gift taxes, as well as employee plans and exempt organizations. A taxpayer's use of a third party, such as a service bureau or time-sharing service, to provide an electronic storage system for its books and records does not relieve the taxpayer of the responsibilities described in these rules. Unless otherwise provided under IRS rules and regulations, all the requirements that apply to hard-copy books and records apply as well to books and records that are stored electronically under these rules.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.