Dominic F. Massoni - Newsletters

The IRS expects to issue guidance on the Code Sec. 199A passthrough deduction in July, Acting IRS Commissioner David Kautter has said. Kautter outlined the timeline of various guidance proposals at the American Bar Association (ABA) Section of Taxation May Meeting in Washington, D.C.

Proposed Guidance
More specifically, the proposed guidance on the passthrough deduction is expected to be released by the end of July, an IRS spokesperson told Wolters Kluwer on May 15. "The goal of the guidance is to get things out that are complete," the IRS spokesperson said, reiterating Kautter. "But, it will not cover every question that taxpayers have," the spokesperson added.

Passthrough Deduction
The new passthrough deduction was enacted under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) last December. The new law provides a 20-percent deduction for income from passthrough entities. The deduction is limited by certain controversial factors including business activities, wages paid by the business, and property values.

Questions Expected
Generally, Kautter anticipates initial follow-up questions from taxpayers and practitioners after the proposed guidance is released, the IRS spokesperson told Wolters Kluwer. Kautter has said that it would be better to get the guidance out in "fairly good shape," to allow for public comment and input, rather than taking more time to draft the guidance internally, according to several reports. Kautter has reportedly said that not everyone may agree with that approach, but that a "better product" will likely be created because of it.

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Congressional lawmakers on Capitol Hill continue to focus on tax reform. Republicans and Democrats alike have been discussing the effects of tax reform, albeit reaching different conclusions.

Tax Reform Hearings
The Ways and Means Committee held a hearing during the week of May 14, marking the first in a series of upcoming committee hearings on tax reform. The Ways and Means hearings are each expected to examine the effects of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Small Businesses. Ways and Means Tax Policy Subcommittee Chairman Vern Buchanan, R-Fla., has announced the second tax reform hearing in the series is scheduled for May 23. The subcommittee hearing is expected to focus on the TCJA’s impact on small businesses.

Senate. The Senate Finance Committee (SFC) examined early impressions of the TCJA in a hearing last month. SFC Chairman Hatch, R-Utah has indicated to Wolters Kluwer that he is also currently examining House proposals to reform the IRS.

TCJA Criticism
Meanwhile, Ways and Means Democrats remain united in their opposition against the new tax law. Ranking member Richard Neal, D-Mass., released a Democratic Progress Report which details areas in which Democrats believe the TCJA has fallen short.

The Republican tax law has not put the middle class first or provided relief for small businesses, the progress report notes. Rather, it has provided large " tax cuts to big corporations and wealthy executives," the report added.

Additionally, Democrats have criticized the TCJA for significantly adding to the federal deficit. Neal called the new law "fiscally irresponsible,"during a Ways and Means hearing held during the week of May 14.

However, House Speaker Paul Ryan, R-Wis., called Democratic tax policy ideas and criticisms of the TCJA "bizarre," during a May 17 press briefing. Democrats are in "denial" about the "thriving economy," according to Ryan.

"If you saw yesterday’s Ways and Means hearing, Democrats are still using the same old doom-and-gloom talk that they were using six months ago," Ryan said. "It was bizarre before, and it is even more bizarre now, when Democrats are openly calling for tax increases, which will do nothing but harm our economy," he added.

To that end, several House Democrats have called for raising the corporate tax rate, including certain Ways and Means members during the full committee hearing. Under the TCJA, the corporate tax rate was lowered from 35 to 21 percent.

Senate
Likewise, Senate Democrats across the Capitol have proposed raising the corporate tax rate to 25 percent. Additionally, in a proposal released by Senate Democrats in March, the top individual tax rate would be reinstated to 39.6 percent. Under the TCJA, the top individual tax rate was lowered to 37 percent. These tax rate increases would pay for a $1 trillion infrastructure plan, according to the Democratic proposal.

Ways and Means Open Seat
In related news, Rep. Brad Wenstrup, R-Ohio, may be eyeing a seat in the House’s tax writing committee. The House Steering Committee has recommended Wenstrup to serve as a member of the Ways and Means Committee. Wenstrup is a doctor, war veteran, and small business owner. He would replace Rep. Patrick Meehan, R-Pa., who resigned last month.

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The IRS’s "Achilles’ heel" is using outdated software originating from the 1960s, Acting IRS Commissioner David Kautter told Senate lawmakers. Kautter and Treasury Secretary Steven Mnuchin testified in a May 22 Senate Appropriations Financial Services and General Government Subcommittee hearing.

System Shut Down
2.3 million cyber attacks are launched against the IRS each day, one million of which are sophisticated, Kautter told Senate appropriators. Kautter and Mnuchin testified before the Subcommittee on the Trump Administration’s fiscal year (FY) 2019 Treasury and IRS budget request.

Underscoring the numerous cyber threats against the IRS is its antiquated technology systems currently in use, Kautter said. "59 percent of IRS hardware and 32 percent of IRS software is obsolete," Kautter told Senate appropriators.

Tax Day Glitch. However, the outdated technology at the IRS was not the cause of the partial system shut down that occurred this year on Tax Day, April 17. For eleven hours, certain taxpayers were unable to electronically submit payments through the IRS’s Direct Pay feature. The particular hardware that failed on Tax Day, however, is only a year-and-a-half old, Kautter said.

Five-Year Plan
The IRS and Treasury are currently crafting a new five-year plan to update the IRS’s information technology (IT) systems, both Kautter and Mnuchin testified. A preliminary draft of the plan is expected within 90 days, Mnuchin said.

"The IRS has not done a good job in the past with regard to its technology dollars," Kautter said. However, the leadership team at the IRS is new, energetic, and knowledgeable, and will thus render a different result, he added.

Tax Reform
Technology is the most time consuming and expensive aspect of tax reform implementation, according to Kautter. Additionally, Kautter expects that guidance on all major aspects of tax reform under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) will be out by fall. Recently, Kautter said that proposed guidance on the Code Sec. 199A pass-through deduction will be released in July.

Tax Gap
"In 2016, IRS estimated that the average annual gross tax gap—the difference between taxes owed and taxes paid on time—was $458 billion for tax years 2008-2010," Subcommittee Chairman James Lankford, R-Okla. said during his opening statement. However, the tax gap is most attributable to the "cash" economy, Kautter told lawmakers.

"An individual taxpayer making more than $1 million a year is seven times more likely to be audited than a taxpayer making under $200,000 a year," Kautter said. "The problems with the tax gap tend to be in the cash economy."

Budget
The Trump Administration’s FY 2019 budget request proposes a total of $12.3 billion for Treasury’s operations and bureaus. The budget request proposes $11.135 billion in IRS funding. This figure for the IRS includes "savings and reductions" of $24.5 million compared to the FY 2018 enacted levels, according to Kautter.

The FY 2019 budget request allocates IRS funding for the following:

taxpayer services: $2.24 billion;
operations support: $4.16 billion;
enforcement: $4.63 billion; and
business systems modernization: $110 million.

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The Treasury Department and the IRS, along with the Department of Labor and the Department of Health and Human Services, issued a notice of clarification to more thoroughly explain their decision not to adopt recommendations made by the American College of Emergency Physicians (ACEP) and certain other commenters regarding T.D. 9744. The challenged regulations govern the coverage of emergency services by group health plans and health insurance issuers under the ACA’s copayment and coinsurance limitations.

The ACEP had sued the federal government over the final regulations, which were issued in 2015 under the Patient Protection and Affordable Care Act (ACA) ( P.L. 111-148). Among other things, ACEP argued that the federal government did not adequately respond to their public comments regarding the regulations. On August 31, 2017, the court sent the matter back to the Departments of Health and Human Services, Labor, and Treasury to respond to the public comments from ACEP.

Greatest of Three Regulations
Under T.D. 9744, a plan or issuer satisfies the copayment and coinsurance limitations in the statute if it provides benefits for out-of-network emergency services in an amount equal to the greatest of three possible amounts:

the amount negotiated with in-network providers for the emergency service furnished;
the amount for the emergency service calculated using the same method the plan generally uses to determine payments for out-of-network services (such as the usual, customary, and reasonable charges), but substituting the in-network cost-sharing provisions for the out-of-network cost sharing provisions; or
the amount that would be paid under Medicare for the emergency service.

Each of these amounts is calculated excluding any in-network copayment or coinsurance imposed with respect to the participant, beneficiary, or enrollee. This is sometimes referred to as the "Greatest of Three" or the "GOT" regulation because it sets a floor on the amount that nongrandfathered group health plans, and health insurance issuers offering nongrandfathered group or individual health insurance coverage, are required to pay for out-of-network emergency services under this provision at the greatest of the three listed amounts.

Clarification of Regulations
In their clarification, the departments state that the regulations provide a reasonable and transparent methodology to determine appropriate payments by nongrandfathered group health plans and health insurance issuers offering nongrandfathered group or individual health insurance coverage for out-of-network emergency services. In addition, the departments maintain that ACEP and other commenters did not provide adequate information to support their assertion that the methods used for determining the minimum payment for out-of-network emergency services under the GOT regulation are not sufficiently transparent or reasonable.

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The IRS has issued a new five-year strategic plan to guide its programs and operations and to help meet the changing needs of taxpayers and members of the tax community. "Providing service to taxpayers is a vital part of the IRS mission and the new Strategic Plan lays out a vision of ways to help improve our tax system," remarked IRS Acting Commissioner David Kautter.

The Fiscal Year 2018-2022 IRS Strategic Plan focuses on six goals aimed at improving customer service:

empowering and enabling all taxpayers to meet their tax obligations;
protecting the integrity of the tax system by encouraging compliance through administering and enforcing the tax code;
proactively collaborating with external partners to improve tax administration;
cultivating a well-equipped, diverse, flexible and engaged workforce;
advancing data access, usability and analytics to inform decision-making and improve operational outcomes; and
driving increased agility, efficiency, effectiveness and security in IRS operations.

The Service further urged taxpayers to be aware of their fundamental rights under the Taxpayer Bill of Rights when dealing with the IRS.

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The IRS Large Business and International (LB&I) Division has identified and selected six additional compliance campaigns. The IRS previously announced 13 campaigns on January 31, 2017, followed by an additional 11 on November 3, 2017, and five more on March 13, 2018. These campaigns help LB&I move in the direction of issue-based examinations. In addition, a compliance campaign process helps the organization decide which compliance issues present risks and the best way to respond to such risks.

The additional campaigns were identified through LB&I data analysis, and suggestions from IRS employees. LB&I’s goal is to improve return selection, identify issues representing a risk of noncompliance, and make the greatest use of limited resources.

The six campaigns selected for the rollout are:

Interest Capitalization for Self-Constructed Assets;
F3520/3520-A Non-Compliance and Campus Assessed Penalties;
Forms 1042/1042-S Compliance;
Nonresident Alien Tax Treaty Exemptions;
Nonresident Alien Schedule A and Other Deductions; and
NRA Tax Credits.

The campaigns themselves fall within the Withholding & International Individual Compliance practice area.

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The IRS intends to provide guidance on the new information reporting obligations for certain life insurance contract transactions under Code Sec. 6050Y. The proposed regulations will provide guidance on the modifications to the transfer for valuable consideration rules for life insurance contracts under Code Sec. 101(a). In addition, the IRS has delayed the reporting requirements under Code Sec. 6050Y until the final regulations are issued.

Transfers for Value Rules
For transfers after December 31, 2017, the exceptions to the transfer for value rules do not apply to the transfer of a life insurance contract, or any interest in such a contract, that is a reportable policy sale. Thus, some portion of the death benefit ultimately payable under the contract may be includable in income. A "reportable policy sale" means the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in the life insurance contract. A "reportable death benefit" is an amount paid at the death of the insured under a life insurance contract that was transferred in a reportable policy sale.

Reporting Requirements Delayed
The new reporting requirements of Code Sec. 6050Y apply to reportable death benefits paid and reportable policy sales made after December 31, 2017. However, the transition guidance delays any reporting under Code Sec. 6050Y until final regulations are issued.

Under Code Sec. 6050Y, information returns must be filed in the following situations:

By anyone who acquires a life insurance contract, or any interest in a life insurance contract, in a reportable policy sale;
By an issuer of a life insurance contract upon notice of a transaction required to be reported above, or upon any notice of a transfer of a life insurance contract, or any interest in a life insurance contract, to a foreign person; and
By any payor of reportable death benefits.

Proposed Regulations
The proposed regulations will describe the manner by which and time at which the reporting requirements of Code Sec. 6050Y must be satisfied. They will also clarify which parties are subject to the reporting requirements and other definitional issues. For example, Treasury and the IRS intend to define the term "reportable policy sale" in the proposed regulations to include a viatical settlement. In addition, the proposed regulations will clarify the extent to which Code Sec. 6050Y applies to sales or acquisitions effected by transferors and transferees outside the United States, and to sellers and issuers that are foreign persons for purposes of these reporting rules.

The IRS is requesting public comment on the intended proposed regulations implementing these reporting requirements.

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Starting in 2010, the $100,000 adjusted gross income cap for converting a traditional IRA into a Roth IRA is eliminated. All other rules continue to apply, which means that the amount converted to a Roth IRA still will be taxed as income at the individual's marginal tax rate. One exception for 2010 only: you will have a choice of recognizing the conversion income in 2010 or averaging it over 2011 and 2012.

The Tax Increase Prevention and Reconciliation Act of 2005 eliminated the $100,000 adjusted gross income (AGI) ceiling for converting a traditional IRA into a Roth IRA. While this provision does not apply until 2010, now may be a good time to make plans to maximize this opportunity.

The Roth IRA has benefits that are especially useful to high-income taxpayers, yet as a group they have been denied those advantages up until now. Currently, you are allowed to convert a traditional IRA to a Roth IRA only if your AGI does not exceed $100,000. A married taxpayer filing a separate return is prohibited from making a conversion. The amount converted is treated as distributed from the traditional IRA and, as a consequence, is included in the taxpayer's income, but the 10-percent additional tax for early withdrawals does not apply.

Significant benefits

While recognizing income sooner rather than later is usually not smart tax planning, in the case of this new opportunity to convert a traditional IRA to a Roth IRA, the math encourages it. The difference is twofold:

All future earnings on the account are tax free; and
The account can continue to grow tax free longer than a traditional IRA without being forced to be distributed gradually after reaching age 70 ½.

These can work out to be huge advantages, especially valuable to individuals with a degree of accumulated wealth who probably won't need the money in the Roth IRA account to live on during retirement.

Example. Mary's AGI in 2010 is $200,000 and she has traditional IRA balances that will have grown to $300,000. Assuming a marginal federal and local income tax of about 40 percent on the $300,000 balance, the $180,000 remaining in the account can grow tax free thereafter, with distributions tax free. Further assume that Mary is 45 years of age with a 90 year life expectancy and money conservatively doubles every 15 years. She will die with an account of $1.44 million, income tax free to her heirs. If the Roth IRA is bequeathed to someone in a younger generation with a long life expectancy, even factoring in eventual required minimum distributions, the amount that can continue to accumulate tax free in the Roth IRA can be staggering, eventually likely to reach over $10 million.

Planning strategies

Now is not too early to start planning to take advantage of the Roth IRA conversion opportunity starting in 2010. While planning to maximize the conversion will become more detailed as 2010 approaches and your assets and income for that year are more measurable, there are certain steps you can start taking now to maximize your savings.

Start a nondeductible IRA

The income limits on both kinds of IRAs have prevented higher income taxpayers from making deductible contributions to traditional IRAs or any contributions to Roth IRAs. They could always make nondeductible contributions to a traditional IRA, but such contributions have a limited pay-off (no current deduction, tax on account income is deferred rather than eliminated, required minimum distributions).

While a taxpayer could avoid these problems by making nondeductible contributions to a traditional IRA and then converting it to a Roth IRA, this option was not available for upper income taxpayers who would have the most to benefit from such a conversion. With the elimination of the income limit for tax years after December 31, 2009, higher income taxpayers can begin now to make nondeductible contributions to a traditional IRA and then convert them to a Roth IRA in 2010. In all likelihood, there will be little to tax on the converted amount.

What's more, taxpayers with $100,000-plus AGIs should consider continue making nondeductible IRA contributions in the future and roll them over into a Roth IRA periodically. As a result, the elimination of the income limit for converting to a Roth IRA also effectively eliminates the income limit for contributing to a Roth IRA.

Example. John and Mary are a married couple with $300,000 in income. They are not eligible to contribute to a Roth IRA because their AGI exceeds the $160,000 Roth IRA eligibility limit. Beginning in 2006, the couple makes the maximum allowed nondeductible IRA contribution ($8,000 in 2006 and 2007, and $10,000 in 2008, 2009, and 2010). In 2010, their account is worth $60,000, with $46,000 of that amount representing nondeductible contributions that are not taxed upon conversion. The couple rolls over the $60,000 in their traditional IRA into a Roth IRA. They must include $14,000 in income (the amount representing their deductible contributions), which they can recognize either in 2010, or ratably in 2011 and 2012.

Assuming they have sufficient earned income each year thereafter (until reaching age 70 1/2), John and Mary can continue to make the maximum nondeductible contributions to a traditional IRA and quickly roll over these funds into their Roth IRA, thereby avoiding significant taxable growth in the assets that would have to be recognized upon distribution from a traditional IRA.

Rollover 401(k) accounts

Contributions to a Section 401(k) plans cannot be rolled over directly into a Roth IRA. The lifting of the $100,000 AGI limit does not change this rule. However, they often can be rolled over into a traditional IRA and then, after 2009, converted into a Roth IRA.

Not everyone can just pull his or her balance out of a 401(k) plan. A plan amendment must permit it or, more likely, those who are changing jobs or are otherwise leaving employment can choose to roll over the balance into an IRA rather than elect to continue to have it managed in the 401(k) plan.

For money now being contributed to 401(k) plans by employees, an even better option would be for those contributions to be made to a Roth 401(k) plan. Starting in 2006, as long as the employer plan allows for it, Roth 401(k) accounts may receive employee contributions.

Gather those old IRA accounts

Many taxpayers opened IRA accounts when they were first starting out in the work world and their incomes were low enough to contribute. Over the years, many have seen those account balances grow. These accounts now may be converted into Roth IRAs starting in 2010, regardless of income.

Paying the tax

In spite of all the advantages of a Roth IRA, a conversion is advisable only if the taxpayer can readily pay the tax generated in the year of the conversion. If the tax is paid out of a distribution from the converted IRA, that amount is also taxed; and if the distribution counts as an early withdrawal, it is also subject to an additional 10-percent penalty. For those planning to convert who may not already have the funds available, saving now in a regular bank or brokerage account to cover the amount of the tax in 2010 can return an unusually high yield if it enables a Roth IRA conversion in 2010 that might not otherwise take place.

Careful planning is key

Transferring funds between retirement accounts can carry a high price tag if it is done incorrectly. For those who plan carefully, however, converting from a traditional IRA to a Roth IRA can yield very substantial after-tax rates of return. Please feel free to call our offices if you have any questions about how the 2010 conversion opportunity should fit into your overall tax and wealth-building strategy.

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The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work

The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work.

If you did not owe AMT last year, you still may be at risk. The IRS estimates that half million more individuals will be subject to the AMT in 2006 because of rising deductions and exemptions. If Congress doesn't extend the same AMT exclusion amount given in 2005, an estimated 3 million more taxpayers will pay AMT.

For a system that was intended originally to target only the very rich, the AMT now hits many middle to upper-middle class taxpayers as well. Obviously something has to be done, and will be, eventually, through proposed tax reform measures. In the meantime, expect AMT to be around for at least another year.

Basic calculations. Whether you will be liable for the AMT depends on your combination of income, adjustments and preferences. After all the computations, if your AMT liability exceeds your income tax liability, you will be liable for the AMT. Here are the basic steps to take to determine in evaluating whether you will owe the AMT:

Step #1: Calculate your regular taxable income. If your regular tax were to be determined by reference to an amount other than taxable income, that amount would need to be determined and used in the next steps.
Step #2: Calculate your alternative minimum taxable income (AMTI) by increasing or reducing your regular taxable income (or other relevant amount) by applying the AMT adjustments or preferences. These include business depreciation adjustments and preferences, loss, timing and personal itemized deductions adjustments, and tax-exempt or excluded income preferences. This is the step with potentially many sub-computations in determining increases and reductions in tax liability.
Step #3: If your AMTI exceeds the applicable AMT exemption amount, pay AMT on the excess.

While no single factor will automatically trigger the AMT, the cumulative result of several targeted tax benefits considered in Step #2, above, can be fatal. Common items that can cause an "ordinary" taxpayer to be subject to AMT are:

All personal exemptions (especially of concern to large families);
Itemized deductions for state and local income taxes and real estate taxes;
Itemized deductions on home equity loan interest (except on loans used for improvements);
Miscellaneous Itemized Deductions;
Accelerated depreciation;
Income from incentive stock options; and
Changes in some passive activity loss deductions.

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Starting for tax year 2005, businesses have been able to take a new deduction based on income from manufacturing and certain services. Congress defined manufacturing broadly, so many businesses -just not those with brick and mortar manufacturing plants-- will be able to claim the deduction. The deduction is 3 percent of net income from domestic production for 2005 and 2006. This percentage rises to 6 percent and then 9 percent in subsequent years.

Domestic production includes the manufacture of tangible personal property and computer software in the U.S. It also includes construction activities and services from engineering and architecture. Income from these activities must be calculated on an item-by-item basis and cannot be determined by division, product line or transaction. Direct and indirect costs are subtracted to determine "qualified production income." Land does not qualify as domestic production property.

The 3 percent rate is applied to the lower of net income from domestic production and overall net income. That amount is then capped at 50 percent of wages paid out by the employer for all its business activities.

Example. In 2005, Company X has $300,000 of income from domestic production activities. The company's overall net income was $500,000. The 3 percent rate is applied to $300,000, yielding a potential deduction of $9,000.

Company X paid its employees $50,000 in wages and reported this amount on Forms W-2 for 2005. Since the deduction is limited to 50 percent of wages paid and reported, Company X's deduction for 2005 is capped at $25,000 (50 percent of $50,000 in wages). X is entitled to a $9,000 deduction.

W-2 wage limitation

In some cases, the W-2 wage limit can easily trip up taxpayers. A successful sole proprietor who earns income but has no employees would not have any W-2 wages and, therefore, could not take the deduction. Self-employment income is not treated as wages. Neither are payments made to independent contractors. A small business that is incorporated but has no employees would have the same problem. Because payments to partners are not W-2 wages, a partnership with two partners and no employees also would be unable to take the deduction. Sole proprietors and other small businesses may want to consider putting a family member on the payroll, so that they have W-2 wages to satisfy this requirement.

An incorporated business, such as an S corporation, could put an owner on the payroll and apply the W-2 limit to reasonable wages paid to the owner. Employees include officers of the corporation and common law employees, as defined in the Tax Code. The more labor-intensive the manufacturing process, the more likely that a deduction will not be reduced by the W-2 wage limitation. The more automated the manufacturing process, the more likely it is that the manufacturer will find itself restricted by the wage limitation and not be able to take the full manufacturing deduction.

Code Sec. 199 defines W-2 wages as the sum of the total W-2 wages reported on Forms W-2, "Wage and Tax Statement," for the calendar year ending during the employer's taxable year. W-2 wages are defined as wages and deferred salary that is included on Form W-2. Deferred salary includes elective deferrals for a 401(k) plan or tax-sheltered annuity; contributions to a plan of a state and local government or tax-exempt entity; and designated Roth IRA contributions. IRS guidance provides three methods for calculating W-2 wages.

Our office can help you determine your eligibility for the manufacturing deduction and the amount of the deduction. Give us a call today.

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