IRS Issues Final Regulations on SALT Limitation Workarounds

Date August 14, 2020
Authors Cassandra Baubie, JD
Categories

Background: TCJA and the $10,000 cap

The IRS has recently released final regulations that provide information as well as a safe harbor provision relating to the $10,000 State and Local Taxes (“SALT”) deduction limitation imposed under the Tax Cuts and Jobs Act (“TCJA”).

Prior to TCJA there was no limit to the amount of SALT that could be deducted as an itemized deduction on an individual’s income tax return. Taxpayers had the ability to deduct all property taxes and to deduct either sales taxes paid, or state income taxes paid. For taxable years beginning after December 31, 2017, TCJA placed a $10,000 limitation on the amount of SALT deductions that are allowed as an itemized deduction. Many states with higher than average state taxes have been seeking work arounds since TCJA passed.

State Response

Several states including New York, New Jersey, Maryland and Connecticut in an attempt to fight the new $10,000 cap on state and local tax deductions, have legislation in place in an attempt to bypass this limitation. The suggested workaround for many of these states involved variations on a state and local charitable fund that taxpayers could make payments to in satisfaction of their state and local liabilities. These payments would then be re-characterized as a fully deductible charitable contribution completely bypassing the $10,000 cap on state and local deductions under the TCJA. The IRS has stated that attempts by states to circumvent this deduction cap would not be valid. Alternatively, states such as Connecticut and New Jersey have enacted additional legislation which allows state and local taxes to effectively become an income tax through pass-through entity level recharacterization. These “workarounds” allow for flow through entities to elect to pay income taxes at the entity level instead of at the individual level, allowing the businesses to take them as a busines expense that is fully deductible.

Proposed Regulations

In proposed regulations when a charitable gift is given, if the taxpayer receives anything in return the Fair Market Value (FMV) of what you receive must not be included in your total charitable deduction. This is a well-established principal that the IRS is now applying in the context of state work around charitable funds. When a taxpayer contributes to one of these workaround charitable funds, they are expecting a benefit in return, the state or local tax credit in return for their contribution. The IRS will now be looking at the receipt of these benefits as quid pro quo, and taxpayers will not be permitted to claim the full value of the deduction. The proposed regulations state that the amount that would otherwise be a deductible charitable contribution must be reduced by the amount of state or local tax credit received or expected.

Final Regulations

The IRS issued long awaited final regulations regarding the $10,000 SALT limitation and the charitable entity work arounds that attempt to circumvent this deduction cap. The final regulations do not reference alternative work around methods in states such as Connecticut and New Jersey which allow owners of pass-through entities to pay income tax at the entity level instead of on their personal taxes.

These final regulations provide information on how to calculate and apply the limitation, and how this limitation applies to a consolidated group, partnership, and in international context as well as providing safe harbor provisions for REITS. The most notable impact of the final regulations is what is not included in them. The IRS chose not to expressly address the pass-through entity method, thus effectively allowing these entities to elect to pay tax at the entity level in lieu of paying at the individual level. This may be viewed as a win, given the IRS’s aggressive stance on shutting down charitable workarounds.

If there are any questions about how these final regulations impact you or your business please reach out to your HBK Tax Advisor.

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New Proposed Regulations for §1031 Exchanges

Date July 23, 2020
Authors Cassandra Baubie, JD
Categories

The IRS just released proposed regulations that clarify and help to better define “real property” that qualifies for a §1031 exchange. After TCJA §1031 exchanges are only applicable to real property used in a trade or business or held for investment. The proposed regulations make it clear that local definitions of real property are not a controlling factor in deciding as to whether property qualifies federally for a §1031 exchange.

Background
Prior to TCJA §1031 exchanges were permitted for various real property and personal property so long as the exchange of property was for a similar type. Under TCJA §1031 was limited to real property exchanges for transactions occurring after 12/31/2017. The change in the law did not include detailed definitions of what constitutes real property for purposes of these exchanges.

§1031 requires that a taxpayer identify both the relinquished property that is exchanged as well as the replacement property acquired in the exchange. Often personal property is included within the real property that is exchanged. Taxpayers who receive money or incidental personal property in a qualifying §1031 exchange have an obligation to recognize gain or loss for the property or money received as “boot” unless the taxpayer can completely separate the real property and personal property transactions.

Proposed Regulations
The new proposed regulations have specifically defined real property in the context of a §1031 exchange. The proposed regulations highlight that these new definitions control for purposes of §1031 exchanges and that state law definitions of real property will not apply to these analyses.

Pursuant to the new proposed regulations real property includes:

  • Land and improvements to land
  • Unserved crops and other natural products of the land
  • Water and air space superjacent to land

Real property includes improvements to the land. Improvements include:

  • inherently permanent structures, and
  • the structural components of inherently permanent structures

Inherently permanent structures include buildings and other structures that are permanently affixed to real property and are intended to remain affixed for an indefinite period. Examples include shelters with walls and a roof for walking or parking. Additionally, machinery can constitute real property if it is a structural component of an inherently permanent structure and does not contribute to the production of income other than income derived from the use of space (e.g., electrical generator servicing a building). Intangible property will be classified as real property if it is “inseparable” from real property and does not contribute to the production of income other than income derived from the use of space. Licenses and permits solely for the use of real property that are in the nature of a leasehold or easement generally are interests in real property.

When making a determination as to whether the asset can be considered real property the IRS states that a determination needs to be made whether the property constitutes a “distinct asset” based on a facts and circumstances analysis, which considers four factors: (i) whether the item is customarily sold or acquired as a single unit or as a component of a larger asset; (ii) whether the item can be separated from a larger asset and, if so, the cost of doing so; (iii) whether the item is commonly viewed as serving a useful function independent from a larger asset of which it is a part; and (iv) whether separating the item from the larger asset impairs the larger asset’s functionality. If the property is not specifically defined by these regulations this four-factor analysis should be used.

Tangible Personal Property Safe Harbor
Finally, the proposed regulations provide a safe harbor for taxpayers who receive personal property as part of a real property acquisition. If a taxpayer receives personal property as part of a §1031 exchange the safe harbor provided that the acquisition of this personal property will not violate the §1031 rules so long as:

  • The FMV of the personal property is no more than 15% of the FMV of the replacement property received in the exchange
  • AND
  • The personal property received is of a type that is typically transferred together with real property in a commercial transaction

Conclusion
These proposed regulations provide certainty in defining qualifying real property for §1031 exchanges. Although these regulations are proposed taxpayers can rely on these regulations for any exchanges of real property beginning after 12/31/2017.

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CARES Act Tax Updates and Planning Opportunities

Date June 4, 2020
Authors Amy L. Dalen Ben DiGirolamo Joseph C. Ledford Maggie Horne, Gannon U. SBDC
Categories
On Thursday, May 28th, HBK and Gannon University SBDC presented the second installment of their “From Survive to Thrive” webinar series. In this session, Amy Dalen, JD, Chair of the HBK Tax Advisory Group, and Ben DiGirolamo, CPA, JD, provided a tax update for individuals and businesses. Below are some of the highlights from this session. Economic Impact Payments Amy provided an update on the Coronavirus Aid, Relief, and Economic Security (CARES) Act economic impact payments, indicating that a number of payments have been paid incorrectly to deceased individuals and individuals who have been incarcerated. The Internal Revenue Service (IRS) recently released Frequently Asked Questions (FAQs) providing information on how these payments can be repaid. While FAQs can provide us with valuable insight into the positions that the IRS is likely to take, if they are not otherwise published they should not be relied upon as authoritative. Amy pointed out that some of the FAQs provided by the IRS are more restrictive than the statutory language of the CARES Act. Retirement Planning Amy went through a summary of the CARES Act benefits provided for retirement plans, including a waiver of the 10% penalty for early withdrawals up to $100,000 for qualified individuals, and the increase to permissible loan amounts from $50,000 to $100,000. A qualified individual has either been diagnosed with coronavirus, had a spouse or dependent diagnosed with coronavirus, or been financially impacted by coronavirus. Qualified distributions can be recognized as income over a three year period, and can also be repaid to the plan during that time. The IRS is expected to issue additional guidance, and has indicated that the guidance provided will be similar to the guidance issued for distributions allowed in the wake of Hurricane Katrina. In the mean time, the IRS has provided FAQs. Charitable Contributions Amy pointed out that charities have been suffering from a decrease to charitable contributions in the wake of the Tax Cuts and Jobs Act (TCJA) of 2017, which increased the standard deduction and eliminated the charitable deduction benefit for many taxpayers. The CARES Act attempts to address this by making a permanent $300 charitable deduction for individuals that use the standard deduction, which will be an above-the-line deduction. Contributions must be in cash in order to qualify for this deduction. In addition, the CARES Act increased the adjusted gross income (AGI) limitation for cash contributions to certain 501(c)(3) organizations from 60% to 100% for tax year 2020, and increased the corporate charitable deduction limitation to 25%. Contributions in excess of these limits can be carried forward for up to five years. Excess Business Loss Limitation Amy explained that the TCJA created a new limitation for non-corporate taxpayers on business losses that exceed $250,000 for single filers and $500,000 for married filers that file a joint return. The CARES Act eliminates this limitation completely for farm losses, and suspends the limitation for non-corporate taxpayers for tax years 2018 through 2021. This provides an opportunity for taxpayers to amend their 2018 returns and use business losses that were limited. In addition, the CARES Act provided some technical corrections, clarifying that W-2 wages are not considered business income for purposes of the excess business loss calculation, and that capital gains included in the calculation are limited to a taxpayer’s net capital gain. Individual Planning Opportunities Amy pointed out that low interest rates and low market values are providing significant opportunities for taxpayers. Some of these opportunities include Roth IRA conversions, the use of Grantor Retained Annuity Trusts (GRATs) and other estate “freeze” techniques, and the use of related party loans. For any related party loans currently in existence, taxpayers should consider revising them to take advantage of the low AFR rates. Deductibility of PPP Loan Expenses Ben began his presentation covering one negative provision that came out of the CARES Act: the inability of businesses to deduct expenses that are paid for by PPP loan proceeds that are later forgiven. The CARES Act provides that the loan forgiveness is not taxable income, and the IRS is taking the position that any expenses related to that loan forgiveness are not deductible. This leaves businesses in the same boat as if the forgiven amount were taxable and the expenses were deductible. Ben pointed out that Congress may change this position to make the expenses deductible even though the loan is forgiven. Employee Retention Tax Credit Ben covered the new employee retention credit that was put in place by the CARES Act, indicating that it may be taken if a business was fully or partially suspended during a quarter in 2020 due to a government order, or if gross receipts were less than half of those from the same quarter in 2019. Ben pointed out that businesses that have received a PPP loan are not entitled to the credit. The credit is against the employer’s 6.2% share of Social Security payroll taxes, and is equal to fifty (50) percent of a) wages up to $10,000 per employee paid to the employees unable to work because of COVID-19 if the business had more than 100 employees in 2019, and b) all wages up to $10,000 per employee for businesses with less than 100 employees. The employer is allowed to reduce their otherwise required payroll tax deposits by the credit amount, and can file and get a cash refund if the credit exceeds the deposit. Employer Payroll Tax Deferral Ben went over the payroll tax deferral, which allows employers to delay payment of their side of the Social Security tax for deposits made from March 27th through the end of the 2020 calendar year. Fifty (50) percent of the deferred amount will be due at the end of 2021, and the other half will be due by December 31, 2022. Employers are allowed to delay payments until they receive notice from the SBA that any portion of their PPP loan is forgiven. This deferral also applies to fifty (50) percent of self-employment taxes. Net Operating Losses Ben explained that the net operating loss carryback period was extended, which makes a change to the prior elimination of the two-year carryback period by the TCJA. Taxpayers are now allowed a five-year carryback period for 2018, 2019, and 2020 tax years, and the 80 percent limitation that was imposed by the TCJA has also been eliminated for carryforwards. Business Interest Expense Limitations Ben explained that the TCJA provided for a thirty (30) percent adjusted taxable income limitation on the deductibility of interest expense for businesses with $26 million or more in average annual gross receipts. The CARES Act increased this limit to fifty (50) percent for tax years 2019 and 2020, though partnerships are only allowed the increase in 2020. Qualified Improvement Property Ben provided a quick overview of a technical error found in the TCJA which required qualified improvement property (QIP) to have a 39-year life and not qualify for bonus depreciation, which was not the intention of Congress. The CARES Act reduced the life to 15 years and provided that it is eligible for 100 percent bonus depreciation. QIP applies to anything internal, non-structural, and after initial construction. The technical correction is retroactive to 2018 and can be applied using amended returns or by filing an accounting method change. Accelerating Disaster Losses Ben provided an overview of a potential benefit to businesses. When there is a federally declared disaster, businesses may be able to deduct certain financial losses as casualty losses, and may be able to accelerate those losses to the tax year preceding the year of the loss. Since the current situation related to COVID-19 is a federally declared disaster, businesses may be able to accelerate deductions for abandoned leaseholds, capitalized costs from abandoned business deals, contract termination payments, and unrefunded prepaid expenses in to the 2019 tax year. Qualified Disaster Relief Payments Finally, Ben pointed out that employers are able to make tax-free payments to employees during a federally declared disaster in order to reimburse them for certain expenses. These payments are still deductible by the employer. Expenses that employers may be able to reimburse include medical expenses not covered by insurance, medicine and sanitizers, costs to work from home, and childcare. The exclusion does not apply for ordinary wage payments.

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CARES Act and Economic Relief Provisions for Businesses

Date May 29, 2020
Authors Cassandra Baubie, JD
Categories

The Senate through the Coronavirus Aid, Relief and Economic Security Act (“The CARES Act”) has brought with it several economic relief provisions as well as expansions and modifications to several areas of the tax code in an attempt to provide relief to taxpayers during the COVID-19 pandemic.

Among the provisions included in the CARES Act is a modification of the excess business loss (“EBL”) limitation imposed under Internal Revenue Code (“IRC”) §461(l). The Tax Cuts and Jobs Act of 2017 (“TCJA“) created §461(l) which disallows the deduction of EBL’s by non-corporate taxpayers (e.g. individuals, trusts, and estates) starting in the 2018 tax year. The modification under the CARES Act retroactively eliminated the loss limitation for the 2018 and 2019 tax years and suspends the limitation until tax years beginning after December 31, 2020. This allows taxpayers to fully deduct business losses without taking into consideration the limitations imposed under §461(l).

Under TCJA, EBL’s are calculated by looking at the aggregate trade or business deductions compared to the aggregate trade or business gross income/gain. The aggregate of these deductions is taken over the sum of the aggregate gross income attributable to the trade or business and limited to an allowable loss of $250,000 for single filers or $500,000 for married filers that file a joint return. Any excess loss would be carried over as a net operating loss (“NOL”). This change provides an opportunity for taxpayers to amend their 2018 and 2019 (if filed subject to the limitation) tax returns to benefit from the previously disallowed losses. If the 2019 tax return has not yet been filed, the EBL limitations will no longer apply.

Through the CARES Act the current NOL rules from TCJA have been amended for the 2018-2020 tax years, allowing losses that arose in those years to be carried back five years. Additionally, there has been a suspension of the provision which limits NOL’s to only 80% of a taxpayer’s taxable income through tax years ending before 12/31/2020. This may permit taxpayers to fully offset taxable income by carrybacks or carryforwards. These changes together may provide opportunities for taxpayers to receive a refund of income taxes that have been paid in those prior years and receive an influx of cash to help mitigate the losses incurred by the pandemic interruptions.

Along with these opportunities, the CARES Act also includes a technical correction to the TCJA provisions of the EBL. Under the CARES Act, any excess business loss shall be “determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee.” This disallows W-2 wages from being included as business income for purposes of an EBL calculation when the limitation returns in the 2021 tax year. Previously, the tax forms used to calculate the EBL limitation drafted by the IRS allowed W-2 income to be included in business income. Additionally, the CARES Act noted that capital gains are included in the computation of EBL only up to the lesser of gains and losses attributable to a trade or business, or the net capital gain income of the taxpayer. The CARES Act also provided technical corrections to the language of §461(l) clarifying that EBL’s are calculated without including §172 or §199A deductions, and net capital losses are not included in the EBL calculations.

Taxpayers should also be mindful of their state tax implications/liabilities arising from these changes. There are several types of IRC conformity laws that a state may have adopted, for instance static conformity states conform to the updated IRC provisions from a set date, which may not include these changes under the CARES Act. States that have rolling conformity will conform to the current IRC that applies federally, and there are some states which have selective conformity which only adopt specific provisions of the IRC.

As taxpayers are looking to file their 2019 returns, these updates should be taken into consideration and changes to their 2018 returns may be beneficial. Please reach out to your HBK Tax Advisor to discuss how these changes may impact you.

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IRS Issues Proposed Regulations on Trust and Estate Deductions

Date May 12, 2020
Authors Amy L. Dalen Michael E. Walston Sarah Gaymon
Categories
On Thursday, May 7th, the IRS issued proposed regulations addressing the ability of trusts and estates to deduct administrative expenses after the Tax Cuts and Jobs Act (TCJA) of 2017 eliminated miscellaneous deductions that are subject to a 2% adjusted gross income limitation through 2025. In general, the proposed regulations confirm that a trust or estate may still take a deduction for expenses that would not have been incurred if the property the expenses relate to were not held by a trust or estate. In addition, the proposed regulations confirmed that a trust or estate may still deduct the personal exemption allowed for estates and non-grantor trusts, and the distribution deduction for income that is distributed to beneficiaries of the trust or estate. The proposed rules are generally in line with the guidance that was previously published by the IRS in Notice 2018-61. Miscellaneous Deductions Prior to the enactment of the TCJA, individuals, trusts, and estates were allowed to deduct certain expenses described under Internal Revenue Code (IRC) § 67, to the extent that the total of these expenses exceeded 2% of the individual, trust, or estate’s adjusted gross income. Under these rules, administrative expenses of an estate or trust that would normally be subject to this 2% limitation were deductible in full so long as they were paid or incurred in connection with the administration of the estate or trust, and would not have been incurred if the property were not held in the trust or estate. Over the years there has been significant litigation over what expenses are truly considered unique to a trust or estate, and thus are fully deductible. It is generally agreed that administration expenses of an estate (e.g. probate costs, appraisal fees, and storage fees) are considered unique expenses and are therefore deductible. In addition, fiduciary fees, accounting fees, legal fees, and tax return preparation fees have been recognized as fully deductible by trusts and estates. However, investment management fees and other expenses related to investment income have generally not been considered unique to a trust or estate and have therefore been subject to the 2% limitation. The Tax Cuts and Jobs Act of 2017 and Notice 2018-61 The TCJA changed the rules relating to miscellaneous deductions and eliminated the ability of individuals, trusts, and estates to deduct expenses that are described under IRC § 67. As a result, it was not entirely clear whether expenses of a trust or estate that fell within the exception to the 2% limitation were also considered nondeductible under the TCJA. In response to this confusion, the IRS issued Notice 2018-61 which generally explained that these administrative expenses would still be deductible. The Proposed Regulations The proposed regulations confirm that administrative expenses of a trust or estate are not considered miscellaneous itemized deductions subject to the 2% limitation; and, therefore, are still deductible. In addition, the proposed regulations take the position that excess deductions – expenses in excess of a trust or estate’s income that are passed out to the beneficiaries on a final income tax return – retain the character of the specific expense. This means that a portion of the excess deduction may be an administrative expense that is deductible when computing adjusted gross income, a non-miscellaneous itemized deduction that is not subject to the 2% limitation, or a miscellaneous itemized deduction that is subject to the 2% limitation. The character and amount of the excess deductions is determined by allocating the deductions among the trust or estate’s income as provided under IRC § 652. For example, assume an estate’s income and deductions in its final year are as follows: total income of $6,500, consisting of taxable interest of $500, dividends of $3,000, rental income of $2,000, and capital gain of $1,000, and total deductions of $17,500, consisting of probate fees of $1,500, estate tax preparation fees of $8,000, and legal fees of $4,500 (collectively, IRC § 67(e) deductions), and real estate taxes on the rental property of $3,500 (itemized deductions). There are two beneficiaries – A (75%) and B (25%). According to the proposed regulations, the excess deductions are allocated under IRC § 652. Pursuant to those regulations, $2,000 of the real estate taxes is allocated to the $2,000 of rental income. Furthermore, assume that in his discretion allowed under the regulations, the executor allocates $4,500 of the IRC § 67(e) deductions to the remaining $4,500 of income. Therefore, the excess deductions on the termination of the estate are $11,000, consisting of $9,500 of IRC § 67(e) deductions (deductible when computing gross income) and $1,500 of itemized deductions (non-2% deductions). Beneficiary A will be allocated $7,125 of above-the-line deductions and $1,125 of itemized deductions, and beneficiary B will be allocated $2,375 of above-the-line deductions and $375 of itemized deductions. Conclusion While the proposed regulations provide much-needed clarity of deductions that are still allowable for trusts and estates, there are still some unanswered questions that the final regulations may address when they are eventually released. Please contact your HBK advisor to discuss what effect these proposed regulations may have on your tax situation.

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Cash Basis Options

Date February 3, 2020
Authors James Dascenzo
Categories

As we enter a new tax season, manufacturers should consider options that may benefit their business. While this topic has been discussed in past Manufacturing Insights articles, the cash basis method of accounting remains an important concept for many manufacturing companies to consider.

TCJA: A Recap
The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting.

Pros & Cons of Cash Basis Accounting
Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred. The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is Eligible?
The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for the cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of the inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. Likely, many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK Manufacturing Industry Group at 330-758-8613 or manufacturing@hbkcpa.com.

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The Affordable Care Act: What’s New that You NEED to Know

Date January 29, 2020

Several notable changes were made to the Affordable Care Act (ACA) in 2019. Given the complexity of the law and various changes to it since its onset, coupled by the fact that we have just entered a new year and decade, now is an ideal time to review the act’s latest revisions and highlight potentially impactful developments.

Individual Mandate
Under the ACA as it was instituted, individuals who did not qualify for an exemption were required under a provision known as the “individual mandate” to have minimum essential health insurance coverage or be subject to a shared responsibility penalty. The penalty was assessed for each month the required insurance was not maintained. The Tax Cuts and Jobs Act (TCJA) reduced the individual shared responsibility payment amount to “zero” as of January 2019. Therefore, while the individual mandate is technically still in effect, the IRS is no longer enforcing it.

Employer Mandate
Under the ACA, applicable large employers could be subject to a penalty if they do not offer minimum essential coverage to their full-time employees and those employees’ dependents, or if they offer unaffordable coverage or coverage that does not provide minimum value. The so-called “employer mandate,” as well we the related required reporting, remains in effect.

ACA Reporting Deadline Extended
Under Notice 2019-63, the IRS has extended the due date for furnishing individuals the 2019 Form 1095-B, Health Coverage, and the 2019 Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, from January 31, 2020 to March 2, 2020. No additional extensions are allowed. The Notice did not extend the due dates for filing 1094-B, 1095-B, 1094-C and 1095-C, which are February 28, 2020, if not filing electronically, and March 31, 2020, if filing electronically. However, a 30-day extension for filing these forms with the IRS is still available by filing Form 8809, Application for Extension of Time to File Information Returns.

In addition, the Notice includes some relief from certain penalties for reporting entities who can show they have made good faith efforts to comply with the information reporting requirements for 2019—for both furnishing to individuals and filing with the IRS. The relief applies to missing or inaccurate information on the return or statement, including taxpayer identification numbers and dates of birth. No relief is provided to reporting entities that do not make a good faith effort to comply with the regulations, or that fail to file an information return or furnish a statement by the due dates. Employers and providers who do not meet the deadlines should file the overdue forms as soon as possible, because the IRS will take the late forms into account in determining whether to abate the late-filing penalties.

Repeal of Certain ACA Taxes
On December 20, 2019, President Trump signed into law the Further Consolidated Appropriations Act, 2020 (Act). The Act repeals several ACA excise taxes, including the medical device excise tax, the health insurance provider’s fee, and the high-cost employer-sponsored health coverage tax.

Under the ACA, the sale of a taxable medical device by the manufacturer, producer, or importer was subject to a tax of 2.3 percent of the price for which it is sold. The Act repeals the medical device excise tax for sales occurring after December 31, 2019.

The ACA imposed an annual flat fee, effective January 1, 2014, on covered entities engaged in the business of providing health insurance with respect to U.S. health risks. The Act repeals this fee, effective as of 2021.

The ACA also imposed a nondeductible excise tax on insurers when the aggregate value of employer-sponsored health insurance coverage for an employee, former employee, surviving spouse, or other primary insured individual exceeded a threshold amount—commonly referred to as “Cadillac” plans. The Act repeals the Cadillac tax for tax years beginning 2020.

Health Reimbursement Arrangements
An HRA is an arrangement that is paid for solely by the employer—that is, not provided through a salary reduction election or otherwise under a cafeteria plan—that reimburses the employee for qualified medical expenses up to a maximum dollar amount for a coverage period. Currently, there are three types of allowed Health Reimbursement Arrangements (HRAs) under the ACA:

HRA Integrated with Employer-Sponsored Health Coverage
An HRA is “integrated” if an employer offers the HRA in conjunction with other group health insurance in which the employee must be enrolled and that on its own is in compliance with the market reform requirements of the ACA. Typically, this type of HRA is integrated with a high deductible health plan.

HRA Integrated with Individual Health Insurance Coverage
In June 2019, the IRS, Department of Labor (DOL) and Department of Health and Human Services (HHS) issued regulations that allow employers of any size to offer HRAs that can be integrated with individual health insurance coverage and Medicare for plan years beginning January 1, 2020. Previously, these types of arrangements were prohibited by the ACA for applicable large employers and exposed employers to penalties under the market reform provisions of the law. To qualify as an individual coverage HRA, the arrangement must meet several requirements:

  • All individuals covered by the HRA must be enrolled in individual health insurance coverage or Medicare for each month they are covered by the HRA, and reasonable procedures must be in place to verify that employees are enrolled in the individual coverage.
  • The employer cannot offer a traditional group health plan to any class of employees who are also offered the HRA.
  • The HRA must be offered to all employees within the same class on the same terms and conditions.
  • Employees must have the opportunity to opt out of and waive future reimbursements from the HRA at least annually.
  • Certain notice requirements must be met.

Qualified Small Employer HRAs
Since January 1, 2017, small employers—and non-applicable large employers—have been allowed to offer a Qualified Small Employer HRA (QSEHRA) provided they do not offer a group health plan to any of their employees. The requirements of a QSEHRA are similar to those of the individual coverage HRA:

  • The HRA must be funded solely by the employer.
  • It must be provided on the same terms to all eligible employees.
  • The employee must provide proof of individual health coverage before the plan can reimburse medical costs incurred by the employee or employee’s family members.
  • For 2020, the statutory dollar limits of permitted benefits are $5,150 for self-only coverage and $10,450 for family coverage.

Contact a member of HBK at (800) 733-8613 for more information.

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NJ Passes SALT $10,000 CAP Work Around

Date January 14, 2020
Authors Cassandra Baubie, JD

Under the Tax Cuts & Jobs Act (TCJA), taxpayers are now limited to a deduction of $10,000 for state and local taxes. One state that has been impacted heavily by this provision is New Jersey.

New Jersey has higher than average state taxes, and state officials have been looking for a solution or work around to this cap since TCJA was passed. Ultimately, New Jersey unanimously passed the “Pass-Through Business Alternative Income Tax Act.” The Act has passed and was signed by the Governor on December 13, 2019. It went into effect January 1, 2020 and it is expected that this legislation will save New Jersey business owners between $200-$400 million annually on their federal tax bills.

Through this Act, New Jersey is effectively modifying their “state and local” taxes such that they become an income tax through an “elective entity-level” tax for businesses, allowing them to be taken as a business expense. The Act will allow flow through businesses located within the state of New Jersey to elect to pay income taxes at the entity level instead of at the personal level.

State officials have noted that litigation over this issue is likely, although they believe that they have the authority to make these changes.

Since this is a developing story, we will keep you apprised of developments as they occur. If you have specific questions, please contact an HBK advisor in one of our offices in the state of New Jersey or through the HBK Tax Advisory Group.

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2019 Year-End Tax Planning Update

Date December 16, 2019
Authors Amy L. Dalen
Categories

With 2019 coming to a close, individuals and businesses may still benefit from several tax savings strategies. At HBK CPAs & Consultants, we want to ensure that our clients and colleagues are aware of the many opportunities still available and applicable even this late in the year.

Year-end planning for 2019 remains complicated by the various changes to the tax code under the Tax Cuts and Jobs Act (TCJA). Fortunately, the IRS has issued key guidance on some important areas throughout the year that have helped to address many areas of uncertainty following the implementation of the TCJA. However, several questions still linger as 2019 nears its end.

Download the update.

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Effects of TCJA on SALT Refunds

Date September 25, 2019
Authors Sarah N. Gaymon, CPA
Categories

TJCA Backround
Prior to the Tax Cuts and Jobs Act (TCJA) there was no limit to the amount of State and Local Taxes (SALT) that could be deducted as an itemized deduction on an individual’s income tax return. Taxpayers had the ability to deduct all property taxes and to deduct either sales taxes paid, or state income taxes paid. For taxable years beginning after December 31, 2017, TCJA placed a $10,000 limitation on the amount of SALT deductions that are allowed as an itemized deduction. For the 2018 tax year, TCJA also increased the standard deduction to $12,000 for single filers, $18,000 for head of households, and $24,000 for married couples filing a joint return. The increase in the standard deduction along with the new limitation on SALT deductions have complicated the treatment of refunds for overpayments of state and local taxes. In previous years the treatment of state income tax refunds was straight forward; if a taxpayer took an itemized deduction which included state and local taxes paid, they were responsible for reporting any refund of those amounts as gross income. The changes caused by TCJA now force taxpayers to ask the question; what portion of SALT refunds must be included into gross income for tax purposes? Determining the additional benefit received by the taxpayer after taking the itemized deduction is the key to calculating the refund amount that is includable into gross income. Earlier this year, the IRS released Revenue Ruling 2019-11 to offer guidance on this issue.

The tax code states that “gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter”. In short, this means that taxpayers that are unable to itemize their deductions when filing their income tax return receive no additional tax benefit from reporting state and local taxes and therefore any refund of state and local taxes would be excluded from gross income. In the event the taxpayer utilizes itemized deductions, the taxpayer must now consider the tax effect of the limit on SALT deductions and account for the benefit received by the deduction to figure how much of any SALT refunds are includable in gross income. In order to properly assess whether a benefit was received, taxpayers must now calculate what the itemized deduction would have been if the correct amount of taxes were paid in the prior year.

Impact on State and Local Tax Refunds
Revenue Ruling 2019-11 provides four situations to help taxpayers assess whether any SALT refunds received will be included in gross income. These situations will be addressed in detail below. For each scenario, assume that the taxpayer’s filing status is “single” and itemized deductions are used in lieu of the standard deduction. Situation 1: Taxpayer A paid local real property taxes of $4,000 and state income taxes of $5,000 in 2018. A’s state and local tax deduction was not limited by the new TCJA limitation because it was below $10,000. Including other allowable itemized deductions, A claimed a total of $14,000 in itemized deductions on A’s 2018 federal income tax return. In 2019, A received a $1,500 state income tax refund due to A’s overpayment of state income taxes in 2018.

SALT Scenarios
In Situation 1 the taxpayer paid $9,000 in taxes but only owed $7,500 which generated a $1,500 refund. Taxpayer A did not exceed the $10,000 SALT limitation so the full $9,000 of state and local taxes is included in the itemized deductions. If the taxpayer had only paid the $7,500 state and local taxes due, it is apparent that both the itemized deduction and SALT deduction would have been reduced by $1,500. Because Taxpayer A received a $1,500 benefit as a reduction in his 2018 gross income the full $1,500 refund in 2019 is includible as gross income.

Situation 2: Taxpayer B paid local real property taxes of $5,000 and state income taxes of $7,000 in 2018. The TCJA changes limited B’s state and local tax deduction on B’s 2018 federal income tax return to $10,000, so B could not deduct $2,000 of the $12,000 state and local taxes paid. Including other allowable itemized deductions, B claimed a total of $15,000 in itemized deductions on B’s 2018 federal income tax return. In 2019, B received a $750 state income tax refund due to B’s overpayment of state income taxes in 2018.

In Situation 2, Taxpayer B paid $12,000 in state and local taxes and received a $750 refund. Had Taxpayer B just paid the $11,250 tax liability, he would have still exceeded the $10,000 SALT limitation leaving the itemized deduction unaffected by the $750 refund. Regardless of the refund, Taxpayer B’s itemized deductions would remain unchanged, meaning the $750 overpayment provided no additional tax benefit to Taxpayer B. Therefore, Taxpayer B is not required to include the $750 refund in his 2019 gross income.

Situation 3: Taxpayer C paid local real property taxes of $5,000 and state income taxes of $6,000 in 2018. Changes to TCJA limited C’s state and local tax deduction on C’s 2018 federal income tax return to $10,000, so C could not deduct $1,000 of the $11,000 state and local taxes paid. Including other allowable itemized deductions, C claimed a total of $15,000 in itemized deductions on C’s 2018 federal income tax return. In 2019, C received a $1,500 state income tax refund due to C’s overpayment of state income taxes in 2018.

Taxpayer C has exceeded the SALT limitation by $1,000 and $10,000 of the $11,000 taxes paid is included in the itemized deductions. Because the actual tax liability was $9,500 and the taxpayer deducted $10,000, Taxpayer C will be responsible for reporting the additional $500 as gross income for 2019.

Situation 4: Taxpayer D paid local real property taxes of $4,250 and state income taxes of $6,000 in 2018. The changes under TCJA limited D’s state and local tax deduction on D’s 2018 federal income tax return to $10,000, so D could not deduct $250 of the $10,250 state and local taxes paid. Including other allowable itemized deductions, D claimed a total of $12,500 in itemized deductions on D’s 2018 federal income tax return. In 2019, D received a $1,000 state income tax refund due to D’s overpayment of state income taxes in 2018.

Calculating the portion of a SALT recovery that should be included in gross income is tricky when the refund would have taken a client below the itemized deduction limit as in Situation 4. If Taxpayer D never overpaid his prior year taxes, his actual SALT liability would have been $9,250 ($10,250 less his $1,000 refund). The $9,250 is $750 below the SALT limitation. If the taxpayer only reported the $9,250 tax liability, he would not have met the $12,000 itemized deduction minimum. Under this scenario itemizing would not make sense because the standard deduction would have been higher than the benefit of taking the SALT deduction. The taxpayer received a $500 ($12,500 itemized deduction less the $12,000 standard deduction) benefit by including his SALT overpayment in his prior year 1040. Consequentially, $500 of the $1,000 refund must be included into gross income.

Conclusions
As with many other changes from TCJA, the $10,000 limit on SALT deductions has resulted in a greater need for tax professionals to analyze the net effect of SALT refunds. Determining the additional benefit received by the taxpayer after taking the itemized deduction is the key to calculating the refund amount that is includable into gross income. Taxes are not always straight forward, or easy. It is important to seek proper guidance when preparing tax returns. Please contact a member of the Tax Advisory Group at HBK if you have any questions regarding the inclusion of state and local tax refunds in gross income or any other changes to the tax law resulting from TCJA.

Jerrod E. Longley is an Intern in the West Palm Beach, Florida office of HBK CPAs & Consultants and contributed to this story.

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