“LAST MINUTE” YEAR-END 2016 TAX-SAVING MOVES FOR INDIVIDUALS

Although there are only three weeks left to go before the year ends, it’s not too late to implement some planning moves that can improve your tax situation for 2016 and beyond. This article reviews some actions that you can take before December 31 to improve your overall tax picture.

Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who is an eligible individual under the health savings account (HSA) rules for December 2016, is treated as having been an eligible individual for the entire year. Thus, an individual who first became eligible on, for example, Dec. 1, 2016, may then make a full year’s deductible-above-the-line contribution for 2016. If he makes that maximum contribution, he gets a deduction of $3,350 for individual coverage and $6,750 for family coverage (those age 55 or older also get an additional $1,000 catch-up amount).

Nail down losses on stock while substantially preserving one’s investment position. A taxpayer may have experienced paper losses on stock in a particular company or industry in which he wants to keep an investment. He may be able to realize his losses on the shares for tax purposes and still retain the same, or approximately the same, investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them, or by selling the original holding then buying back the same securities at least 31 days later.

Accelerate deductible contributions and/or payments of medical expenses. Individuals should keep in mind that charitable contributions and medical expenses are deductible when charged to their credit card accounts (e.g., in 2016) rather than when they pay the card company (e.g., in 2017). Additionally, for 2016, itemizing taxpayers age 65 or older can deduct medical expenses to the extent they exceed 7.5% of adjusted gross income (AGI), but that “floor” will rise to 10% in 2017 (i.e., to the same floor that currently applies to taxpayers under age 65). Thus, it may pay for itemizing taxpayers who are 65 or older to accelerate discretionary or elective expenses into this year.

Solve an underpayment of estimated tax problem. Because of the additional .9% Medicare tax and/or the 3.8% surtax on unearned income, more individuals may be facing a penalty for underpayment of estimated tax than in prior years. An employed individual who is facing a penalty for underpayment of estimated tax as a result of either of these new taxes or for any other reason should consider asking his employer—if it’s not too late to do so—to increase income tax withholding before year-end. Generally, income tax withheld by an employer from an employee’s wages or salary is treated as paid in equal amounts on each of the four estimated tax installment due dates. Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates.

Retirement plan distribution. An individual can take an eligible rollover distribution from a qualified retirement plan before the end of 2016 if he is facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution at a 20% rate and will be applied toward the taxes owed for 2016. He can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2016, but the withheld tax will be applied pro rata over the full 2016 tax year to reduce previous underpayments of estimated tax.

Accelerate big ticket purchases into 2016 to get sales tax deduction. Taxpayers who itemize their deductions rather than take the standard deduction have the option of deducting state and local sales taxes in lieu of state and local income taxes. As a result, individuals who are considering the purchase of a big-ticket item (e.g., a car or boat) should consider whether it is advantageous to elect on their 2016 return to do so.

Prepay qualified higher education expenses for first quarter of 2017. Unless Congress extends it again, the above-the-line deduction for qualified higher education expenses will not be available after 2016. Thus, individuals should consider prepaying in 2016 eligible expenses for 2017 courses if doing so will increase their 2016 deduction for qualified higher education expenses. Generally, a 2016 deduction is allowed for qualified education expenses paid in 2016 in connection with enrollment at an institution of higher education during 2016 or for an academic period beginning in 2016 or in the first three months of 2017. The deduction is limited to $4,000 for taxpayers with modified adjusted gross income (AGI) of not more than $65,000 ($130,000 for married taxpayers filing joint returns), and $2,000 for taxpayers with modified AGI of not more than $80,000 ($160,000 for married taxpayers filing joint returns).

Potential to earn tax-free gains. An individual may exclude all (or, in some cases, part) of the gain realized on the disposition of qualified small business stock (QSBS) held for more than five years. For QSBS acquired after Sept. 27, 2010, an individual can exclude all of the gain on the disposition of QSBS stock. For QSBS acquired after Feb. 17, 2009 and before Sept. 28, 2010, individuals can exclude 75% of any gain realized on the disposition of QSBS. For QSBS acquired before Feb. 18, 2009, individuals can exclude 50% of the gain on the disposition of QSBS. Taxpayers should consider these rules in determining which stock to sell to maximize their exclusion for 2016 or to not sell if the holding period hasn’t yet been satisfied.

Be sure to take required minimum distributions (RMDs). Taxpayers who have reached age 70-½ should be sure to take their 2016 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned age 70-½ in 2016 can delay the first required distribution to 2017. However, taxpayers who take the deferral route will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. That could make sense if the taxpayer will be subject to a lower tax rate next year.

Use IRAs to make charitable gifts. Taxpayers who have reached age 70-½, own IRAs and are thinking of making a charitable gift, should consider arranging for the gift to be made directly by the IRA trustee. Such a transfer (not to exceed $100,000) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. But, since such a distribution is not includible in gross income, it will not increase AGI for purposes of the phaseout of any deduction, exclusion, or tax credit that is limited or lost completely when AGI reaches certain specified level.

Make year-end gifts. A person can give any other person up to $14,000 for 2016 without incurring any gift tax. The annual exclusion amount increases to $28,000 per donee if the donor’s spouse consents to gift-splitting. Annual exclusion gifts take the amount of the gift and future appreciation in the value of the gift out of the donor’s estate, and shift the income tax obligation on the property’s earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).

 

Andy Farkas, CPA
Farkas Tax Advisors Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

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“LAST MINUTE” YEAR-END 2016 TAX-SAVING MOVES FOR BUSINESSES

As year-end approaches, you should consider whether you could benefit from the following “last minute” tax-saving moves, including adjustments to income to preserve favorable estimated tax rules for 2017, deferral of certain advance payments to next year, and fine-tuning bonuses to make the most of the Code Sec. 199 domestic production activities deduction.

Accelerating or deferring income can preserve estimated tax break. Corporations (other than certain “large” corporations) can avoid being penalized for underpaying estimated taxes if they pay installments based on 100% of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100% of the current year’s tax. However, the 100%-of-last-year’s-tax safe harbor isn’t available unless the corporation filed a return for the preceding year that showed a liability for tax. A return showing a zero tax liability doesn’t satisfy this requirement. Only a return that shows a positive tax liability for the preceding year makes the safe harbor available.

A corporation (other than a “large” corporation; see below) that anticipates a small net operating loss (NOL) for 2016 (and substantial net income in 2017) may find it worthwhile to accelerate just enough of its 2017 income (or to defer just enough of its 2016 deductions) to create a small amount of net income for 2016. This will permit the corporation to base its 2017 estimated tax installments on the relatively small amount of income shown on its 2016 return, rather than having to pay estimated taxes based on 100% of its much larger 2017 taxable income. Also, by accelerating income from 2017 to 2016, the income may be taxed at a lower rate in 2016, e.g., at 15% instead of at 25% or 34%. However, where a 2016 NOL would result in a carryback that would eliminate tax in an earlier year, the value of the carryback should be compared to the cost of having to pay only a small amount of estimated tax for 2017.

Accrual-basis business can take a 2016 deduction for some bonuses not paid till 2017. An accrual-basis business can take a deduction for its current tax year for a bonus not actually paid to its employee until the following tax year if

  1. The employee doesn’t own more than 50% in value of the business,
  2. The bonus is properly accrued on its books for the current tax year, and
  3. The bonus is actually paid within the first 2 1/2 months of the following tax year (for a calendar year taxpayer, within the first 2 1/2 months of 2017).

The 2016 deduction won’t be allowed, however, if the bonus is paid by a personal service corporation to an employee-owner, by an S corporation to an employee-shareholder, or by a C corporation to a direct or indirect majority owner.

For employees on the cash basis, the bonus won’t be taxable income until the following year.

Accrual-basis taxpayers can defer inclusion of certain advance payments. Accrual-basis taxpayers generally may defer including in gross income advance payments for goods until the tax year in which they are properly accruable for tax purposes if the income inclusion for tax purposes isn’t later than it is under the taxpayer’s accounting method for financial reporting purposes.

An advance payment is also eligible for deferral—but only until the year following its receipt—if:

  1. Including the payment in income for the year of receipt is a permissible method of accounting for tax purposes;
  2. The taxpayer recognizes all or part of it in its financial statement for a later year; and
  3. The payment is for
    • Services
    • Goods (other than goods for which the deferral method discussed above is used)
    • The use of intellectual property (including by lease or license)
    • The occupancy or use of property ancillary to the provision of services
    • The sale, lease, or license of computer software
    • Guaranty or warranty contracts ancillary to the preceding items
    • Subscriptions in tangible or intangible format
    • Organization membership or
    • Any combination of the preceding items.

Example: An accrual-basis, calendar-year taxpayer received a payment on Nov. 1, 2016 for a contract under which it will repair a customer’s computer equipment for two years. In its financial statements, the taxpayer recognizes 25% of the payment in 2016, 50% in 2017, and 25% in 2018. For tax purposes, under the deferral method discussed above, the taxpayer can report 25% in 2016 and defer 75% to 2017.

The deferral method cannot be used for

  1. Rent
  2. Insurance premiums
  3. Payments on financial instruments (e.g., debt instruments, deposits, letters of credit, etc.)
  4. Payments for certain service warranty contracts
  5. Payments for warranty and guaranty contracts where a third party is the primary obligor
  6. Payments subject to certain foreign withholding rules and
  7. Payments in property to which Code Sec. 83 applies.

If an advance payment is only partially attributable to an eligible item, it may be allocated among its various parts, and the deferral rule may be used for the eligible part.

Taxpayers wishing to change to the above method may use automatic consent provisions (with certain modifications). Advance consent procedures apply in certain cases, e.g., where advance payments are allocated.

Businesses that qualify for the deferral should not let tax considerations keep them from accepting advance payments before the end of 2016.

Making the most of the domestic production activities deduction. Businesses can claim a domestic production activities deduction (DPAD) under Code Sec. 199 to offset income from domestic manufacturing and other domestic production activities.

The Code Sec. 199 deduction equals 9% of the smaller of—

  1. The taxpayer’s “qualified production activities income” or QPAI, for the tax year, or
  2. The taxpayer’s taxable income (modified adjusted gross income, for individual taxpayers), without regard to the Code Sec. 199 deduction, for the tax year.

However, the Code Sec. 199 deduction can’t exceed 50% of the W-2 wages of the employer for the tax year. And the otherwise allowable Code Sec. 199 deduction of a taxpayer with oil-related QPAI is subject to a special reduction.

Qualified production activities eligible for the deduction include items such as: the manufacture, production, growth or extraction of qualifying production property (i.e., tangible personal property such as clothing, goods, or food as well as computer software or music recordings) by a taxpayer either in whole or in significant part within the U.S.; construction or substantial renovation of real property in the U.S., including residential and commercial buildings and infrastructure such as roads, power lines, water systems, and communications facilities; and engineering and architectural services performed in the U.S. and relating to the construction of real property. (Code Sec. 199(c)(4))

Generally, wages are the sum of the aggregate amounts that must be included on the Forms W-2 of employees under Code Sec. 6051(a)(3) (i.e., wages subject to withholding) and Code Sec. 6051(a)(8) (elective deferrals). The wages must be allocable to the taxpayer’s domestic production activities, and they include tips and other compensation as well as elective deferrals to 401(k) and other plans.

It is important for businesses to calculate the tentative Code Sec. 199 deduction and the W-2 deduction cap before year-end. If the deduction cap will limit the otherwise available deduction—for example, in the case of a closely held business whose owners do not draw substantial salaries—the business may want to bonus out additional compensation to maximize the Code Sec. 199 deduction. Bear in mind that in some cases, an accrual-basis business can deduct a bonus that is declared before year-end but not paid until the following year (see discussion above).

Taxpayers also need to factor the Code Sec. 199 deduction into other year-end tax planning strategies. For example, when determining whether to defer or accelerate income, a taxpayer must determine the marginal tax rate for each year. Depending on the type of income or deduction that the taxpayer is dealing with when working on such strategies, the Code Sec. 199 deduction may have the effect of decreasing the taxpayer’s marginal rate.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

YEAR-END MOVES FOR THOSE WHO BELIEVE PRESIDENT-ELECT TRUMP WILL CUT THEIR TAXES NEXT YEAR

In his first televised interview, President-elect Trump declared that a “major tax bill lowering taxes in this country” would be one of his top three priorities. Those middle and upper income taxpayers who are betting he can deliver on this promise, and put his tax reduction plan in place for 2017, should revisit their year-end tax moves to make the most of what might be windfall savings next year.

Defer income to 2017. The Trump tax plan would feature three tax brackets instead of current law’s seven, and a top tax rate of 33% instead of current law’s 39.6%. The upshot of these and other tax-reduction changes, if retained in the final tax plan, would be reduced taxes for middle and upper income taxpayers, with the biggest tax savings realized by the wealthiest taxpayers.

The standard year-end tax-savings wisdom always has been to defer income, where possible, into the coming year. This standard approach would make even more sense for middle and upper income taxpayers if the Trump tax plan prevails over others in Congress, and goes into effect for tax year 2017.

Here are some of the ways to defer income until 2017:

  • An employee who believes a bonus may be coming his way may be able to request that his employer delay payment of any bonus until early in the following year. For example, if a bonus would normally be paid on Dec. 15, 2016, an employee may ask the employer before Dec. 15 to defer any bonus coming his way until Jan. 2, 2017. By deferring the bonus, the employee will succeed in having it taxed in 2017. But note that if an employee waits until a bonus is due and payable to request a deferral, the tax on the bonus will not be deferred. Also, if the deferral extends beyond 2-½ months after the close of the tax year, the bonus will be treated as non-qualified deferred compensation (currently includible in income to the extent not subject to a “substantial risk of forfeiture” if the arrangement fails to meet certain distribution, acceleration of benefit, and election requirements).
  • Income that a cash basis taxpayer earns by rendering services isn’t taxed until the client, patient etc., pays. If the taxpayer (e.g., consultant, business person, medical professional) holds off billing until next year—or until so late in the year that no payment can be received in 2016—he will succeed in deferring taxable income until next year.
  • Defer “first year” required minimum distributions (RMDs) from an IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year a taxpayer reaches age 70-½. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Although RMDs must begin no later than April 1 following the year in which the IRA owner attains age 70-½, the first distribution calendar year is the year in which the IRA owner attains age 70-½. Thus, if a taxpayer turns age 70-½ in 2016, he can delay the first required distribution to 2017, but if he does so, there will have to take a double distribution in 2017—the amount required for 2016 plus the amount required for 2017. Delaying 2016 distributions to 2017 thus will bunch income into 2017, but that would be beneficial if the taxpayer winds up in a substantially lower bracket that year.
  • Defer a traditional IRA-to-Roth IRA conversion until 2017. Such a conversion generally is subject to tax as if it were distributed from the traditional IRA or qualified plan and not recontributed to another IRA. Thus, a taxpayer who plans to make such a conversion should defer doing so if he believes the conversion will face a lower tax next year.

Defer property sales. The President-elect’s plan to repeal the Affordable Care Act (“Obamacare”) also would repeal the 3.8% surtax on investment income. This surtax applies to the lesser of

  1. Net investment income or
  2. The excess of modified adjusted gross income (MAGI) over the threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers).

As a result, if the surtax is repealed for 2017, taxpayers within the reach of the surtax, and are contemplating the sale of property that would generate a large investment gain, would benefit by deferring the sale until next year (assuming of course that the sale price would stay more or less the same).

If the sale can’t be postponed, it may be possible to structure the deal as an installment sale. By making a sale this year with part or all of the proceeds payable next year or later, a non-dealer seller to whom the installment method applies becomes taxable in any year on only that proportion of his profit which the payments he receives that year bear to the total sale price. If the 3.8% surtax is repealed for tax years beginning after 2016, the profit on the post-2016 installment payments would escape the surtax. Note that the Trump tax plan would keep current law’s maximum tax rate of 20% of capital gains.

On the deduction side. Itemized deductions produce no tax savings for a year in which a taxpayer claims the standard deduction, and many more taxpayers would claim the standard deduction under President-elect Trump’s tax plan. It calls for a dramatically increased standard deduction: $30,000 for joint filers (up from $12,600 for 2016) and $15,000 for singles (up from $6,300). If the boosted standard deduction makes it into law for 2017, many taxpayers who itemize under current law and wouldn’t be able to under the Trump plan would be better off accelerating next year’s itemized deductions into this year, when they will generate a tax savings. And, even if the standard deduction proposal is watered down, itemized deductions still will be more valuable to a taxpayer this year than next if he expects to be in a lower marginal tax bracket in 2017.

For example, those whose medical expenses exceed the 10% of AGI floor (7.5% of AGI for those age 65 or older) could accelerate into this year discretionary or elective medical procedures or expenses, such as dental implants or expensive eyewear. Individuals could boost charitable contributions (e.g., making two years worth of contributions this year to a favorite cause), pay state income tax and local property tax a bit early (keeping in mind that such taxes are not deductible for alternative minimum tax purposes), or making a year-end mortgage payment.

 

Andy Farkas, CPA
Farkas Tax Advisors, Inc.
2173 Salk Ave., Ste 250
Carlsbad, CA 92008
(760) 237-4000 Office
(619) 204-6052 Cell
andy@farkascpa.com
www.farkascpa.com

Disclaimer: Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, we would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.

THINGS TO COME? A LOOK AT TRUMP’S AND HOUSE REPUBLICANS’ TAX PROPOSALS

Beginning Jan. 20, 2017, the Republican Party will be in control of both houses of the U.S. Congress as well as the Presidency. On November 9, the day after the election, House Ways and Means Committee Chairman Kevin Brady (R-TX) and Senate Majority Leader Mitch McConnell (R-KY) indicated that they want to take up tax reform early in the next session of Congress. Here we present some of the recent tax proposals from both President-elect Donald Trump and House Republicans.

President-elect Trump’s proposals. As of Nov. 10, 2016, President-elect Trump’s Tax Plan website lists the following proposals:

For individual taxpayers:

    • Tax rates and breakpoints for Married-Joint filers would be:
      • Less than $75,000: 12%
      • More than $75,000 but less than $225,000: 25%
      • More than $225,000: 33%;

 

    • Brackets for single filers would be ½ of these amounts;
    • “Low-income Americans would have an effective income tax rate of 0”;
    • The existing capital gains rate structure (maximum rate of 20%) would be maintained, with tax brackets shown above;
    • Carried interest would be taxed as ordinary income;
    • The Affordable Care Act would be repealed; as part of this repeal, the 3.8% tax on investment income would be repealed;
    • The alternative minimum tax (AMT) would be repealed;
    • The standard deduction for joint filers would increase to $30,000, and the standard deduction for single filers would be $15,000;
    • Personal exemptions would be eliminated;
    • Head-of-household filing status would be eliminated;
    • Itemized deductions would be capped at $200,000 for Married-Joint filers and $100,000 for Single filers;
    • The estate tax would be repealed, but capital gains on property held until death and valued over $10 million would be subject to tax, with an exemption for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives would be disallowed;
    • The Trump website makes no mention of the gift tax.

 

    • There would be the following child care and elder care rules:
      • An above-the-line deduction for children under age 13, that would be capped at state average for age of child, and for eldercare for a dependent. The exclusion would not be available to taxpayers with total income over $500,000 for Married-Joint or $250,000 for Single;
      • Rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit (EITC). The rebate would be equal to 7.65% of remaining eligible childcare expenses, subject to a cap. This rebate would be available to married joint filers earning $62,400 ($31,200 for single taxpayers) or less;
      • All taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children. Total annual contributions to a DCSA would be limited to $2,000 per year from all sources. The government would provide a 50% match on parental contributions of up to $1,000 per year for these households.

 

For business taxpayers:

    • The business tax rate would decrease from 35% to 15%;
    • The corporate AMT would be eliminated;
    • There would be a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10%;
    • “Most corporate tax expenditures”, except for the research and development credit, would be eliminated;
    • Firms engaged in manufacturing in the U.S. could elect to expense capital investment and lose the deductibility of corporate interest expense. An election once made could only be revoked within the first three years of election; and
    • The annual cap for the business tax credit for on-site childcare would be increased to $500,000 per year (up from $150,000), and the recapture period would be reduced to five years (down from ten years).

 

The House Republican’s “A Better Way” plan. On June 24, House Republicans released an installment of their “A Better Way” Our Vision for a Confident America” that contained a number of tax reform proposals. At that time, the Republicans announced that the document (“blueprint”) was meant to serve as the basis of tax reform legislation which will be “ready for legislative action in 2017”. It reflects several months of deliberation by the Tax Reform Tax Force, led by Chairman Brady.

Previously, on June 22, House Republicans had released another installment of their “A Better Way” Our Vision for a Confident America”; this installment contained a number of health care reform proposals.

On November 9, both Chairman Brady and Speaker of the House Paul Ryan (R-WI) mentioned the blueprint as being taken up by Congress, in concert with Mr. Trump, at the beginning of the next session of Congress.

Among its tax provisions regarding individuals, the blueprint would:

    • Reduce both the top rate (to 33%) and the number of brackets (to three);
    • Provide for reduced and progressive tax rates on capital gains, dividends and interest income;
    • Eliminate the AMT;
    • Consolidate a number of existing family tax benefits into a larger standard deduction and a larger child and dependent tax credit;
    • Continue the EITC, but look for ways to improve it;
    • Simplify tax benefits for higher education;
    • Eliminate all itemized deductions except the mortgage interest deduction and charitable contribution deduction;
    • Continue current tax incentives for retirement savings; and
    • Repeal the estate and generation-skipping transfer taxes.
    • The blueprint makes no mention of the gift tax.

 

Business tax provisions in the blueprint include:

    • Creating a new business rate for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates;
    • Reducing the corporate tax rate to 20%;
    • Providing for immediate expensing of the cost of business investments;
    • Allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies);
    • Allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carrybacks;
    • Retaining the research credit (but evaluating options to make it more effective);
    • Generally eliminating certain (but unspecified) special interest deductions and credits;
    • Shifting to a territorial tax system;
    • Moving “toward a consumption-based tax approach”;
    • Providing a 100% exemption for dividends from foreign subsidiaries; and
    • Generally simplifying international tax rules, including elimination of most of the subpart F rules.

 

The blueprint suggests a number of IRS reforms, including provisions to:

    • “Streamline” the agency and center it on three major units: one for families and individuals, one for business, and a new “small claims court” unit that would be independent of IRS and designed to allow routine disputes to be resolved more quickly;
    • Reform IRS leadership so that it is headed by an Administrator, appointed by the President with the consent and advice of the Senate for a single 3-year term;
    • Have a “Service First” mission; and
    • Commit to taxpayer assistance.

 

And the health care reform proposals would:

    • Repeal the Affordable Care Act;
    • Make the following changes to health savings accounts (HSAs): allow spouses to make catch-up contributions to the same HSA account; allow qualified medical expenses incurred before HSA-qualified coverage begins to be reimbursed from an HSA account as long as the account is established within 60 days; set the maximum contribution to an HSA at the maximum combined and allowed annual deductible and out-of-pocket expense limits; and expand accessibility for HSAs to certain groups (e.g., those who get services through the Indian Health Service and TRICARE).
    • Allow certain purchasing platforms, like private exchanges, to expand. The plan would encourage the use of direct or “defined contribution” methods, such as health reimbursement accounts (HRAs).
    • Encourage the portability of health insurance. Everyone would have access to financial support for an insurance plan chosen by the individual, which could be taken with them job-to-job, to non-work environments and into retirement years. For those who do not have access to job-based coverage, Medicare, or Medicaid, the proposal would provide an advanceable, refundable tax credit. The portable payment would be increased as the recipient aged.

 

Comparing the Trump and House proposals. Both the Trump and House Republicans proposals would repeal the Affordable Care Act, significantly lower tax rates on both individuals and businesses, eliminate the AMT, eliminate estate taxes, lessen the relevance of itemized deductions, eliminate some business credits and deductions, and tighten the rules on business interest deductions.

On the other hand, Trump puts great emphasis on new child and elder care tax breaks, and the House Republicans do not. And, the House Republicans consider many changes to existing tax rules that Trump doesn’t mention. And, while the House Republicans’ plan contains, and previous proposals by Trump contained, a special tax rate for businesses that operate as pass-through entities, the current Trump website has no such proposal.

Things to come? Given the newness of the election and its surprise results, we are probably pretty far from understanding the dynamics of the workings of the 115th Congress that will begin its work in January-including whether the Republicans will attempt to pass tax legislation in the Senate under the legislative process called “reconciliation” which only requires a simple majority, or will, instead, allow the Senate filibuster rules to apply to the tax legislation. Similarly, we are probably pretty far from understanding the push and pull between Congressional leaders and President-elect Trump. Thus, even given the large overlap between the proposal of the House Republicans and that of Mr. Trump, we probably have a long way to go in predicting a lot of the specifics of 2017 tax legislation. However, some significant 2017 tax legislation and some significant health care reform legislation seem quite likely.

 

Farkas Tax Advisors, Inc.
2173 Salk Ave., Suite 250
Carlsbad, CA 92008
info@farkascpa.com
Phone: (760) 237-4000
http://www.farkascpa.com

TAX TIPS FOR THE 2016 GRADUATE

TAX TIP #1
Avoid over-withholding in 2016 by increasing the “number of allowances” on Form W-4. Remember to change to the proper “number of allowances” at the beginning of 2017.

TAX TIP #2
Be prepared to file the 2016 Federal income tax return early to obtain a refund. The refund can be hastened by labeling the envelope containing the return “REFUND” and using the appropriate post office box number. Alternatively, electronic filing will also shorten the time between filing and receiving a refund. Use of the direct deposit option is also recommended.

TAX TIP #3
Determine and document the source and reason for all interest payments during
2016. Pay particular attention to loans used to pay qualified education expenses
since up to $2,500 of interest is deductible when computing Adjusted Gross Income.

TAX TIP #4
Prepare and maintain a record of the expenses involved in moving to the first place
of employment. These include: the actual moving expenses; travel and lodging
costs incurred en route to the place of employment.

TAX TIP #5
Familiarize yourself with the types of deductible expenses incurred as part of your
employment. Prepare and maintain a record of these expenses which can include
travel, meals, lodging, entertainment and educational costs. Also, if possible, insist
on specific item reimbursement instead of a general allowance system.

TAX TIP #6
Don’t attempt to itemize deductions unless you’ve incurred substantial
unreimbursed medical costs, state and local income taxes, home mortgage interest,
real estate and/or personal property taxes during 2016 and expect this total to
surpass the 2016 standard deduction amount for your filing status.

TAX TIP #7
Claim the American Opportunity Tax Credit or Lifetime Learning Credit for 2016 tuition and fee payments (including prepayments) made to any “eligible educational institution.” Alert your parent(s) to the eligibility requirements that may allow the reporting of the American Opportunity Credit on their 2016 tax return.

TAX TIP #8
Examine situations that would enable you to recognize income in 2016, instead of 2017. Where possible, shift that income into 2016.

TAX TIP #9
Protect the dependency exemption of your parent(s) by (a) documenting your support spending before and after you are employed and (b) spending less on your support from your funds than the amount spent by your parent(s) and others who provided resources for your support.

TAX TIP #10
When you are not reported as a dependent by your parent(s), document the relationship of educational expenses to (a) requirement established by state or employer or (b) maintenance and/or improvement of skills required in your current trade or business. Following an up to $4,000 Tuition and Fees Deduction, determine whether your tax liability is reduced more by treating the remaining eligible educational expenses as a miscellaneous itemized deduction or by using all of the educational expenses in computing the Lifetime Learning Credit.

TAX TIP #11
Do not waste precious time and space maintaining information about spending that
has no tax consequences. Furthermore, tax returns and the supporting data should
be kept for at least three years.

TAX TIP #12
Establish an IRA (Individual Retirement Account) or similar retirement arrangement — such as a 401(k) Plan – as soon as possible. Contribute the maximum amount to the IRA and allow it to grow until retirement.

I hope this information is helpful. If you would like more details about these or any other aspect of the tax law, please do not hesitate to call at (760) 237-4000 or e-mail at andy@farkascpa.com.

REPUBLICAN WALKER PROPOSES HEALTH TAX CREDITS BY AGE, NOT INCOME

Republican presidential contender Scott Walker on Tuesday unveiled his healthcare plan: repeal Obamacare and replace it with age-based tax credits that Americans could use to offset the cost of purchasing their own coverage.
Under his plan, the Wisconsin governor said he would give up to $3,000 directly to taxpayers to buy health insurance. The amount would range from $3,000 in credits for those aged 50 to 64 and scale down to $900 for those age 17 and under, and go to those without health insurance from their jobs.

Walker also backed longstanding Republican health proposals to allow consumers to purchase insurance out-of-state, loosen restrictions on health savings accounts and reform medical malpractice lawsuits.

“This gives them a way to get an affordable healthcare plan,” he said in a speech in Minnesota, highlighting the plan’s tax credits.

Republicans have long vowed to repeal President Barack Obama’s signature 2010 healthcare law, commonly known as Obamacare. While most of the 17 Republican presidential candidates have echoed that pledge, few have offered detailed alternatives.

Under the law, consumers who do not get health insurance from their employer or government programs such as Medicare and Medicaid can buy it under federal or state-run insurance exchanges. Those who qualify receive a subsidy to offset the costs.

Walker criticized that system and the role of the Internal Revenue Service in overseeing the subsidies.

“Unlike ObamaCare policies that give subsidies to insurance companies, these tax credits belong to consumers,” Walker wrote in his plan, released on his website.

He said consumers should be able to buy health insurance across state lines, although it was not immediately clear where consumers would buy it or what would happen to the current exchanges.

Additionally, Walker called for overhauling Medicaid, the federal-state health insurance program for the poor, through block grants and other changes.

U.S. Senator Marco Rubio of Florida, another contender to be the Republican presidential nominee in the November 2016 election, also has called for healthcare changes. In an opinion piece in Politico late on Monday, he reiterated his promise to seek tax credits for Americans who buy their own health insurance but offered few new details.

Another candidate, Louisiana Governor Bobby Jindal, who laid out his healthcare policy ideas last year, criticized Walker’s plan. He said Walker was accepting the premise of Obamacare and “merely quibbling over the details.”

DON’T FALL FOR NEW TAX SCAM TRICKS BY IRS POSERS

Though the tax season is over, tax scammers work year-round. The IRS advises you to stay alert to protect yourself against new ways criminals pose as the IRS to trick you out of your money or personal information. These scams first tried to sting older Americans, newly arrived immigrants and those who speak English as a second language. The crooks have expanded their net, and now try to swindle virtually anyone. Here are several tips from the IRS to help you avoid being a victim of these scams:

  • Scams use scare tactics.  These aggressive and sophisticated scams try to scare people into making a false tax payment that ends up with the criminal. Many phone scams use threats to try to intimidate you so you will pay them your money. They often threaten arrest or deportation, or that they will revoke your license if you don’t pay. They may also leave “urgent” callback requests, sometimes through “robo-calls,” via phone or email. The emails will often contain a fake IRS document with a phone number or an email address for you to reply.
  • Scams use caller ID spoofing.  Scammers often alter caller ID to make it look like the IRS or another agency is calling. The callers use IRS titles and fake badge numbers to appear legit. They may use online resources to get your name, address and other details about your life to make the call sound official.
  • Scams use phishing email and regular mail.  Scammers copy official IRS letterhead to use in email or regular mail they send to victims. In another new variation, schemers provide an actual IRS address where they tell the victim to mail a receipt for the payment they make. All in an attempt to make the scheme look official.
  • Scams cost victims over $20 million.  The Treasury Inspector General for Tax Administration, or TIGTA, has received reports of about 600,000 contacts since October 2013. TIGTA is also aware of nearly 4,000 victims who have collectively reported over $20 million in financial losses as a result of tax scams.

The real IRS will not:

  • Call you to demand immediate payment. The IRS will not call you if you owe taxes without first sending you a bill in the mail.
  • Demand that you pay taxes and not allow you to question or appeal the amount that you owe.
  • Require that you pay your taxes a certain way. For instance, require that you pay with a prepaid debit card.
  • Ask for credit or debit card numbers over the phone.
  • Threaten to bring in police or other agencies to arrest you for not paying.

If you don’t owe taxes or have no reason to think that you do:

  • Do not provide any information to the caller. Hang up immediately.
  • Contact the Treasury Inspector General for Tax Administration. Use TIGTA’s “IRS Impersonation Scam Reporting” web page to report the incident.
  • You should also report it to the Federal Trade Commission. Use the “FTC Complaint Assistant” on FTC.gov. Please add “IRS Telephone Scam” in the notes.

If you know you owe, or think you may owe taxes:

  • Call the IRS at 800-829-1040. IRS workers can help you if you do owe taxes.

Stay alert to scams that use the IRS as a lure. For more, visit “Tax Scams and Consumer Alerts” on IRS.gov.

RECENTLY-ENACTED LAW CONTAINS TAX RETURN FILING DUE DATES CHANGES

On July 31, 2015, President Obama signed into law P.L. 114-41, the “Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.” Although this new law was primarily designed as a 3-month stopgap extension of the Highway Trust Fund and related measures, it includes a number of important tax provisions, including revised due dates for partnership and C corporation returns and revised extended due dates for some returns. This letter provides an overview of these provisions, which may have an impact on you, your family, or your business.

Revised Due Dates for Partnership and C Corporation Returns

Domestic corporations (including S corporations) currently must file their returns by the 15th day of the third month after the end of their tax year. Thus, corporations using the calendar year must file their returns by Mar. 15 of the following year. The partnership return is due on the 15th day of the fourth month after the end of the partnership’s tax year. Thus, partnerships using a calendar year must file their returns by Apr. 15 of the following year. Since the due date of the partnership return is the same date as the due date for an individual tax return, individuals holding partnership interests often must file for an extension to file their returns because their Schedule K-1s may not arrive until the last minute.

Under the new law, in a major restructuring of entity return due dates, effective generally for returns for tax years beginning after Dec. 31, 2015:

  • Partnerships and S corporations will have to file their returns by the 15th day of the third month after the end of the tax year. Thus, entities using a calendar year will have to file by Mar. 15 of the following year. In other words, the filing deadline for partnerships will be accelerated by one month; the filing deadline for S corporations stays the same. By having most partnership returns due one month before individual returns are due, taxpayers and practitioners will generally not have to extend, or scurry around at the last minute to file, the returns of individuals who are partners in partnerships.   Form 1120S Instructions    Form 1065 Instructions
  • C corporations will have to file by the 15th day of the fourth month after the end of the tax year. Thus, C corporations using a calendar year will have to file by Apr. 15 of the following year. In other words, the filing deadline for C corporations will be deferred for one month.  Form 1120 Instructions

Keep in mind that these important changes to the filing deadlines generally won’t go into effect until the 2016 returns have to be filed. Under a special rule for C corporations with fiscal years ending on June 30, the change is deferred for ten years — it won’t apply until tax years beginning after Dec. 31, 2025.

Revised Extended Due Dates for Various Returns

Taxpayers who can’t file a tax form on time can ask the IRS for an extension to file the form. Effective for tax returns for tax years beginning after Dec. 31, 2015, the new law directs the IRS to modify its regulations to provide for a longer extension to file a number of forms, including the following:

  • Form 1065 (U.S. Return of Partnership Income) will have a maximum extension of six-months (currently, a 5-month extension applies). The extension will end on Sept. 15 for calendar year taxpayers.
  • Form 1041 (U.S. Income Tax Return for Estates and Trusts) will have a maximum extension of five and a half months (currently, a 5-month extension applies). The extension will end on Sept. 30 for calendar year taxpayers.
  • The Form 5500 series (Annual Return/Report of Employee Benefit Plan) will have a maximum automatic extension of three and a half months (under currently law, a 2½ month period applies). The extension will end on Nov. 15 for calendar year filers.

FinCEN Report Due Date Revised

Taxpayers with a financial interest in or signature authority over certain foreign financial accounts must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Currently, this form must be filed by June 30 of the year immediately following the calendar year being reported, and no extensions are allowed.   FinCEN Form 114 Instructions

Under the new law, for returns for tax years beginning after Dec. 31, 2015, the due date of FinCEN Report 114 will be Apr. 15 with a maximum extension for a 6-month period ending on Oct. 15. The IRS may also waive the penalty for failure to timely request an extension for filing the Report, for any taxpayer required to file FinCEN Form 114 for the first time.

I hope this information is helpful. If you would like more details about these changes or any other aspect of the new law, please do not hesitate to call at 760-237-4000 or e-mail at andy@farkascpa.com.

EXCHANGE OF RIGHTS TO MANUFACTURE AND/OR DISTRIBUTE PRODUCTS WAS LIKE-KIND EXCHANGE

In a private letter ruling, IRS has held that a taxpayer’s exchange of certain manufacturing and/or distribution rights with respect to a given group of products, for other manufacturing and/or distribution rights with respect to that same group of products, was a like-kind exchange with no recognition of gain or loss.

Background. Code Sec. 1031(a)(1) provides generally that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of a like kind which is to be held either for productive use in a trade or business or for investment.

Reg. § 1.1031(a)-1(b) provides that, as used in Code Sec. 1031(a), the words “like kind” have reference to the nature or character of the property and not to its grade or quality, and that an exchange of one kind or class of property for a different kind or class is not a like-kind exchange.

Reg. § 1.1031(a)-2(c)(1) provides that an exchange of intangible personal property qualifies for nonrecognition of gain or loss under Code Sec. 1031 only if the exchanged intangible properties are of a like kind. No like classes are provided for intangible properties. Whether intangible personal property is of a like kind to other intangible personal property generally depends on (i) the nature or character of the rights involved (e.g., a patent or a copyright) and (ii) the nature or character of the underlying property to which the intangible personal property relates.

Facts. Taxpayer entered into two types of agreements: the Single Activity Agreements and the Dual Activity Agreements.

Under the Single Activity Agreements, Taxpayer has rights to distribute BB, a group of Products of various different brand names, appearances, ingredients, packaging, manufacturing processes, and marketing strategies, within Territory 1 or Territory 2.

Under the Dual Activity Agreements, Taxpayer has rights to manufacture and distribute AA, a group of Products of various different brand names, appearances, ingredients, packaging, and marketing strategies, that are different from BB. Products are nondepreciable tangible personal property. The Dual Activity Agreements grant Taxpayer the right to manufacture and distribute AA within Territory 1 or Territory 2.

The length of the term, the renewable periods, and the geographical territories covered for the rights vary among the agreements within the Dual Activity Agreements and the Single Activity Agreements. In addition, the conditions imposed in connection with the manufacturing and distribution rights such as marketing, quality control, and inventory maintenance also vary among the agreements.

Another party, Exchanger, entered into two types of agreements: the Replacement Dual Activity Agreements and the Replacement Single Activity Agreements. These agreements have the same set of counter parties as Taxpayer’s agreements. The Replacement Single Activity Agreements grant Exchanger the right to distribute BB within Territory 3, Territory 4, or Territory 5. The Replacement Dual Activity Agreements grant Exchanger the right to manufacture and distribute AA within Territory 3, Territory 4, or Territory 5. The length of the term, the renewable periods, and the geographical territories covered for the rights vary among the agreements within the Replacement Dual Activity Agreements and the Replacement Single Activity Agreements. In addition, the obligations imposed in connection with the distribution rights such as marketing, quality control, and inventory maintenance also vary among the agreements.

For economic and historical reasons, manufacturers of AA have long acted as distributors of AA. The inclusion of both business activities in the Dual Activity Agreements and Replacement Dual Activity Agreements reflects the underlying economics and longstanding historical relationship between the two. Manufacturing and distribution of AA is frequently best performed by a single entity as part of an integrated business process.

Taxpayer enters into two exchanges with Exchanger. In the first exchange, Taxpayer will simultaneously exchange its Single Activity Agreements with Exchanger’s Replacement Single Activity Agreements. In the second exchange, Taxpayer will simultaneously exchange its Dual Activity Agreements for Exchanger’s Replacement Dual Activity Agreements.

The rights under the Dual Activity Agreements and the Single Activity Agreements are held by Taxpayer for productive use in a trade or business. The rights under the Replacement Dual Activity Agreements and the Replacement Single Activity Agreements will be held by Taxpayer for productive use in a trade or business. The proportionate values of the manufacturing and distribution rights are roughly similar across both the Dual Activity Agreements and the Replacement Dual Activity Agreements.

Both of the exchanges were exchanges of like-kind property. IRS determined that both of the exchanges are exchanges of like-kind property only.

The Agreements are intangible property that grant rights related to the manufacturing and/or distribution of BB or AA. Because, in both exchanges, Taxpayer and Exchanger will simultaneously exchange the Agreements, the only issue is whether the exchanged Agreements are of a like kind. That determination depends on (i) the nature or character of the rights involved and (ii) the nature or character of the underlying property to which the agreements relate. (Reg. § 1.1031(a)-2(c)(1))

The exchanged Single Activity Agreements. The Single Activity Agreements and the Replacement Single Activity Agreements are both in the nature of BB distribution agreements. Distribution of BB is a single business activity. The terms of the agreements are substantially similar, and any difference among them is a difference in grade or quality.

Accordingly, the nature or character of the Single Activity Agreements and the Replacement Single Activity Agreements are of a like kind.

The second requirement for the Agreements to be of a like kind is that the underlying property subject to the Single Activity Agreements and Replacement Single Activity Agreements must itself be of a like kind. The underlying property to which the intangible rights relate is BB, a group of Products that are distributed in a largely similar manner. BB includes Products with different brand names, appearances, ingredients, packaging, manufacturing processes, and marketing strategies. Nevertheless, all of BB are distributed in a substantially similar manner to a largely common set of customers who resell them to end customers who, in turn, use each of the Products of BB for a substantially similar purpose. Any differences among BB that are relevant to distribution are differences in grade or quality, and not differences in nature or character.

Accordingly, the underlying property subject to the Single Activity Agreements and the Replacement Single Activity Agreements is of a like kind.

The exchanged Dual Activity Agreements. The Dual Activity Agreements and the Replacement Dual Activity Agreements are both in the nature of AA manufacturing and distribution agreements. Manufacturing and distribution are two distinct business activities and the rights to each would not, absent some close connection between these activities, be of a like kind.

IRS, however, noted the economic and historic connections between manufacturing and distributing AA. In addition, manufacturing rights and distribution rights granted under the agreements can only be exercised in conjunction with each other under the agreements. The proportionate values of the manufacturing rights and the distribution rights are roughly the same across all of the Dual Activity Agreements and Replacement Dual Activity Agreements. Accordingly, while manufacturing and distribution are business activities of a different nature or character, the close economic and unique historical connection between the manufacturing and the distribution of AA demands that they be treated as two aspects of a single business activity where the rights to manufacturing and distribution are contained within the same integrated agreement.

The terms of the agreements are substantially similar in granting rights to manufacture and distribute AA. Each agreement grants rights related to a single business activity, the integrated manufacturing and distribution of AA. The differences in the length of the term, renewable periods, geographical territories covered, quality control provisions, marketing activity obligations, etc. vary among the Dual Activity Agreements and the Replacement Dual Activity Agreements. These differences, however, are insubstantial, relating as they do to the grade or quality of the rights rather than to their nature or character.

Consequently, the nature or character of the manufacturing and distribution rights in the Dual Activity Agreements and Replacement Dual Activity Agreements are of a like kind.

The second requirement for the agreements to be of a like kind is that the underlying property subject to the Dual Activity Agreements and the Replacement Dual Activity Agreements must itself be of a like kind. The underlying property to which the intangible rights to manufacture and distribute relate is AA, a group of Products that share substantially similar manufacturing and distribution processes. AA includes Products with different brand names, appearances, ingredients, packaging, and marketing strategies. Nevertheless, all of AA are manufactured using a substantially similar process in facilities of a common design, and they are distributed in a substantially similar manner to a largely common set of customers who resell them to end customers who, in turn, use each of the Products of AA for a substantially similar purpose. Any differences among AA that are relevant to manufacturing or distribution are differences in grade or quality, and not differences in nature or character.

Accordingly, under the second prong of the test in § 1.1031(a)-2(c), the underlying property to which the tangible rights granted by the Dual Activity Agreements and the Replacement Dual Activity Agreements relate is of a like kind.

FINAL REGS ISSUED ON PARTNERSHIP VARYING INTERESTS RULE

IRS has issued final regs on the determination of a partner’s distributive share of partnership items of income, gain, loss, deduction, and credit when a partner’s interest varies during a partnership tax year. The final regs also modify the existing regs on the required tax year of a partnership.

For proposed regs issued contemporaneously with the final regs on the interaction of the allocable cash basis item rules and the tiered partnership rules with the rules for determining a partner’s distributive share when a partner’s interest varies.

Background on partners’ distributive shares. A partner separately takes into account his distributive share of partnership items of income, gain, loss, deduction, or credit. (Code Sec. 702(a)) Each partner reports his distributive share of the partnership income, deductions and other items (including guaranteed salary and interest payments) for a partnership tax year on his return for his tax year within or with which the partnership tax year ends. (Code Sec. 706(a))

Under Code Sec. 706(d), subject to exceptions, if there is a change in a partner’s interest in the partnership during the partnership’s tax year, each partner’s distributive share of any partnership item of income, gain, loss, deduction or credit for such tax year is determined by using any method prescribed by regs which takes into account the varying interests of the partners in the partnership during the year (varying interests rule). Code Sec. 706(d) was added by the Deficit Reduction Act of ’84 (P.L. 98-369) to clarify that the varying interests rule applies to the disposition of a partner’s entire interest in the partnership as well as the disposition of less than a partner’s entire interest, and to authorize IRS to prescribe methods for determining a partner’s distributive share of partnership items when there is a change in the partners’ interests during the partnership’s tax year. The existing regs have not been revised to reflect these ’84 Act changes.

Under a change made by the Taxpayer Relief Act of ’97 (P.L. 105-34), the tax year of the partnership closes with respect to a partner whose entire interest in the partnership terminates by reason of death. (Code Sec. 706(c)(2)(A)) However, the existing regs do not reflect this ’97 Act change.

In 2009, IRS issued proposed regs for determining partners’ distributive shares of partnership items in any year in which there is a change in a partner’s interest in the partnership, whether by reason of a disposition of the partner’s entire interest or less than the partner’s entire interest, or by reason of a reduction of a partner’s interest due to the entry of a new partner or partners (the 2009 proposed regs.

Final regs. The final regs finalize the varying interest rules contained in the 2009 proposed regs and include modifications to the proposed regs. Reg. § 1.706-4 provides rules for determining the partners’ distributive shares of partnership items when a partner’s interest in a partnership varies during the tax year as a result of the disposition of a partial or entire interest in a partnership (as described in Reg. § 1.706-1(c)(2) and Reg. § 1.706-1(c)(3)), or with respect to a partner whose interest in a partnership is reduced (as described in Reg. § 1.706-1(c)(3)), including by the entry of a new partner (collectively, a “variation”). The final regs further provide that, in all cases, all partnership items for each tax year must be allocated among the partners, and no items may be duplicated, regardless of the particular provision of Code Sec. 706 which applies, and regardless of the method or convention adopted by the partnership.

The final regs contains two exceptions for allocations that would otherwise be subject to the rules of Reg. § 1.706-4: one exception applies to certain partnerships with contemporaneous partners, and the other exception applies to certain service partnerships. The final regs expand the scope of the former exception as provided in the 2009 proposed regs to include allocations of items attributable solely to a particular segment (see below) of a partnership’s year among partners who are partners of the partnership for that entire segment. Under the contemporaneous partners exception, the general rule with respect to the varying interests of a partner won’t preclude changes in the allocations of the distributive share of items among contemporaneous partners for the entire partnership tax year (or among contemporaneous partners for a segment if the item is entirely attributable to a segment), if: (1) any variation in a partner’s interest isn’t attributable to a contribution of money or property by a partner to the partnership or a distribution of money or property by the partnership to a partner; and (2) the allocations resulting from the modification satisfy Code Sec. 704(b) and its regs. (Reg. § 1.706-4(b)(1))

The final regs apply the service partnership safe harbor exception to any partnership (rather than to service partnership as narrowly defined in the 2009 regs) for which capital isn’t a material income-producing factor. For any tax year in which there is a change in any partner’s interest in a partnership for which capital isn’t a material income-producing factor, the partnership and such partner may choose to determine the partner’s distributive share of partnership income, gain, loss, deduction, and credit using any reasonable method to account for the varying interests of the partners in the partnership during the tax year provided that the allocations satisfy Code Sec. 704(b). (Reg. § 1.706-4(b)(2))

Interim closing and proration. Under the final regs, a partnership takes into account any variation in the partners’ interests in the partnership during the tax year in determining the distributive share of partnership items under Code Sec. 702(a) by using either the interim closing method or the proration method. The regs allow a partnership to use different methods for different variations within the partnership’s tax year. However, the regs provide that IRS may place restrictions on the ability of a partnership to use different methods during the same tax year in guidance published in the Internal Revenue Bulletin. (Reg. § 1.706-4(a)(3)(iii))

A partnership may, by agreement of the partners, perform regular interim closings of its books on a monthly or semi-monthly basis, regardless of whether any variation occurs. The final regs require a partnership using the interim closing method with respect to a variation to perform the interim closing at the time the variation is deemed to occur, and do not require a partnership to perform an interim closing of its books except at the time of any variation for which the partnership uses the interim closing method.

Any partnership using the interim closing method (but not partnerships using the proration method) may use a monthly convention to account for partners’ varying interests. Under the monthly convention, in the case of a variation occurring on the first through the 15th day of a calendar month, the variation is deemed to occur at the end of the last day of the immediately preceding calendar month. And in the case of a variation occurring on the 16th through the last day of a calendar month, the variation is deemed to occur at the end of the last day of that calendar month. The final regs provide that the selection of the convention must be made by agreement of the partners. In the absence of an agreement to use a convention, the partnership will be deemed to have chosen the calendar day convention.

Partnerships using the proration method must use a calendar day convention. Partnerships using the interim closing method have the option of using a semi-monthly or monthly convention in addition to the calendar day convention.

Because the final regs allow partnerships to use both the proration and interim closing methods during a tax year, the final regs provide that the partnership and all of its partners must use the same convention for all variations for which the partnership chooses to use the interim closing method.

The final regs provide that all variations within a tax year are deemed to occur no earlier than the first day of the partnership’s tax year, and no later than the close of the final day of the partnership’s tax year. Thus, under the semi-monthly or monthly convention, a variation occurring on January 1st through January 15th for a calendar year partnership will be deemed to occur at the beginning of the day on January 1. The conventions aren’t applicable to a sale or exchange of an interest in the partnership that causes a termination of the partnership under Code Sec. 708(b)(1)(B); instead, such a sale or exchange will be considered to occur when it actually occurred.

The final regs provide that in the case of a partner who becomes a partner during the partnership’s tax year as a result of a variation, and ceases to be a partner as a result of another variation, and under the application of the partnership’s conventions both such variations would be deemed to occur at the same time, the variations with respect to that partner’s interest will instead be treated as occurring when they actually occurred. Thus, in such a case, the partnership must treat the partner as a partner for the entire portion of its tax year during which the partner actually owned an interest. (Reg. § 1.706-4(c)(2)(ii))

Extraordinary items. The final regs, as the 2009 proposed regs did, provide special rules for the allocation of extraordinary items listed in Reg. § 1.706-4(e)(2) (e.g., items from the disposition or abandonment of certain items, from assets disposed of in an applicable asset disposition, from an accounting method change initiated after a variation occurs, etc.). The final regs provide that the extraordinary item rules apply to partnerships using the interim closing method. Thus, the final regs require the allocation of extraordinary items as an exception to (1) the proration method, which would otherwise ratably allocate the extraordinary items across the segment, and (2) the conventions, which might otherwise inappropriately shift extraordinary items between a transferor and transferee. Extraordinary items continue to be subject to any special limitation or requirement relating to the timing or amount of income, gain, loss, deduction, or credit applicable to the entire partnership tax year (for example, the limitation for Code Sec. 179 expenses).

Under the final regs, extraordinary items must generally be allocated based on the date and time on which the extraordinary items arise, without regard to the partnership’s convention or use of the proration method or interim closing method. Thus, the allocation of extraordinary items will generally be the same regardless of the partnership’s selected method or convention. If a partner disposes of its entire interest in a partnership before an extraordinary item occurs (but on the same day), the partnership and all of its partners must allocate the extraordinary item in accordance with the partners’ interests in the partnership item at the time of day on which the extraordinary item occurred; in such a case, the transferor will not be allocated a portion of the extraordinary item, regardless of when the transfer is deemed to occur under the partnership’s convention.

Publicly traded partnerships. The final regs provide that a publicly traded partnership (PTP) must use the calendar day convention with respect to all variations relating to its non-publicly traded units for which the PTP uses the proration method. A PTP using a monthly convention generally may consistently treat all variations occurring during each month as occurring at the end of the last day of that calendar month, if the PTP uses the monthly convention for those variations. (Reg. § 1.706-4(c)(2)(iii)) Because PTPs are also allowed to use the semi-monthly and monthly conventions with respect to variations for which the PTP uses the proration method, the final regs provide that PTPs must use the same convention for all variations during the tax year. PTPs may, but are not required to, respect the applicable conventions in determining who held their publicly traded units at the time of the occurrence of an extraordinary item. The exception in Reg. § 1.706-4(c)(2)(ii) does not apply to PTPs with respect to holders of publicly traded units (as described in Reg. § 1.7704-1(b) or Reg. § 1.7704-1(c)(1))

Segments and proration periods. Under the final regs, segments are specific periods of the partnership’s tax year created by interim closings of the partnership’s books, and proration periods are specific portions of a segment created by a variation for which the partnership chooses to apply the proration method. The partnership must divide its year into segments and proration periods, and spread its income among the segments and proration periods according to the rules for the interim closing method and proration method, respectively.

The first segment begins with the beginning of the tax year of the partnership and ends at the time of the first interim closing of the partnership’s books. Any additional segment begins immediately after the closing of the prior segment and ends at the time of the next interim closing. However, the last segment of the partnership’s tax year ends no later than the close of the last day of the partnership’s tax year. If there are no interim closings, the partnership has one segment, which corresponds to its entire tax year. (Reg. § 1.706-4(a)(3)(vi))

The first proration period in each segment begins at the beginning of the segment, and ends at the time of a variation for which the partnership uses the proration method. The next proration period begins immediately after the close of the prior proration period and ends at the time of the next variation for which the partnerships uses the proration method. However, each proration period ends no later than the close of the segment. Thus, segments close proration periods. Therefore, the only items subject to proration are the partnership’s items attributable to the segment containing the proration period. (Reg. § 1.706-4(a)(3)(iii))

The final regs continue to provide that each segment is generally treated as a separate distributive share period. For purposes of determining allocations to segments, any special limitation or requirement relating to the timing or amount of income, gain, loss, deduction, or credit applicable to the entire partnership tax year will be applied based on the partnership’s satisfaction of the limitation or requirements as of the end of the partnership’s tax year. For example, the expenses related to the election to expense a Code Sec. 179 asset must first be calculated (and limited if applicable) based on the partnership’s full tax year, and then the effect of any limitation must be apportioned among the segments in accordance with the interim closing method or the proration method using any reasonable method. Thus, the segments aren’t treated as separate tax years for purposes of Code Sec. 461(h) and Code Sec. 404(a)(5). Other provisions of the Code providing a convention for making a particular determination still apply; thus, conventions under Code Sec. 168 would apply first to determine when the property is placed in service or when the property is disposed of, and Code Sec. 706 would apply second to determine who was a partner during that segment.