IRS Provides Update on Voluntary Disclosure Process

IRS

Nardone Limited’s tax attorneys advise taxpayers about U.S. tax reporting requirements and obligations regarding foreign and domestic financial accounts and the importance of reporting previously undisclosed accounts or income. For example, if a taxpayer has a financial interest in, or signature authority over, a foreign financial account, the taxpayer may be required to report the account annually by electronically filing a FinCen Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”). If a taxpayer fails to follow the Internal Revenue Service (“IRS”) reporting requirements, such as filing the FBAR, and the failure is due to willful behavior, the taxpayer could face potential criminal liability or substantial civil penalties. The IRS, however, has historically offered taxpayers a way to potentially avoid criminal liability by voluntarily disclosing the taxpayer’s willful non-compliance.

Background

On March 26, 2009, the IRS announced its first Offshore Voluntary Disclosure Program (“OVDP”), which offered taxpayers who had undisclosed foreign accounts a pathway to compliance with U.S. tax law. The OVDP was originally created for taxpayers with exposure to potential criminal liability and substantial civil penalties due to a willful failure to report foreign financial assets and to pay the tax due on those assets. The first OVDP ran through October 15, 2009. The IRS then announced a second OVDP, which ran through September 9, 2011. On January 9, 2012, the IRS reopened the OVDP, which remained in effect until September 28, 2018. While the OVDP is no longer in effect, the IRS established a new voluntary disclosure procedure, which may provide non-compliant taxpayers relief from criminal liability.  

Nardone Limited Comment: It should be noted that the Streamlined Filing Compliance Procedures (“SFCP”) are still available for taxpayers whose behavior is not due to willful non-compliance. If you are unsure whether your non-compliance is due to willful or non-willful behavior, it is important that you contact an attorney who is experienced in communicating with the IRS. For more information on the SFCP, or what the government considers to be willful behavior, see our previous blog article.

The Updated Voluntary Disclosure Practice

On November 20, 2018 the IRS released a memorandum to taxpayers, detailing the new process for voluntarily disclosing violations due to willful behavior. The new program titled the “Updated Voluntary Disclosure Practice” (“UVDP”), applies to both domestic and offshore matters, whereas the OVDP only applied to undisclosed offshore accounts. The purpose of the UVDP is to provide taxpayers—who are concerned that their conduct is willful or fraudulent—a way to come into compliance with the law and avoid potential criminal prosecution. The IRS set out the following procedures regarding the UVDP.

The IRS has indicated that Criminal Investigation (“CI”) will screen all voluntary disclosure requests to determine whether the taxpayer is eligible to make a voluntary disclosure. To be eligible to make a voluntary disclosure, taxpayers are required to submit a preclearance request on Form 14457. The form must be submitted to CI via fax or mail. If CI accepts the taxpayer’s preclearance, the taxpayer must promptly submit to CI all required voluntary disclosure documents using Form 14457. This form requires the taxpayer to submit information related to the taxpayer’s non-compliance. If CI accepts the taxpayer’s voluntary disclosure, it will send a preliminary acceptance letter to the taxpayer. CI will then send the letter and attachments to the IRS’ Large Business & International (“LB&I”) division in Austin, Texas for case preparation before examination. Once received by LB&I, the IRS will not require the taxpayer to submit any additional information or documentation to the Austin unit. The LB&I Austin unit then forwards cases for case building and field assignment to the appropriate Business Operating Division and Exam function for civil examination. Examiners within LB&I will develop the case, use appropriate information gathering tools, and determine the taxpayer’s liability and applicable penalties.

When speaking with the IRS about the taxpayer’s non-compliance, it is imperative that the taxpayer answer truthfully, timely, and completely. The taxpayer must show a willingness to cooperate, or the IRS will not consider the disclosure to be voluntary. As part of that cooperation, the IRS expects that voluntary disclosures be resolved by agreement with full payment of all taxes, interest, and penalties for the disclosure period. I.R.M. 9.5.11.9.4. If a taxpayer fails to cooperate, the examiner may request that CI revoke the preliminary acceptance. Thus, it is important that taxpayers ensure that they are timely replying to the IRS and that they are making arrangements, in advance, to pay off their delinquent taxes.   

Conclusion

We strongly encourage our clients to be compliant with any and all U.S. reporting requirements relating to their foreign or domestic financial accounts, even if they have not done so in the past. The IRS offers options to non-compliant taxpayers when it comes to disclosing unreported financial accounts or income. But, taxpayers must be diligent when it comes to communicating with the IRS. That is why it is important to seek help from an attorney who has vast experience representing taxpayers before the IRS. Ultimately, if you are concerned that your failure to report income or pay tax is due to willful conduct, we encourage you to contact Nardone Limited at 614-223-0123 to discuss your options.  

April 03, 2019

IRS Concludes Free Employee Meals are Not Excludable under IRC Section 119

Employee_food

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists businesses with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article will discuss the recently published Technical Advice Memorandum (“TAM”) which analyzes whether free meals provided by an employer to its employees is excludable under IRC 119.

IRC Section 119 and the Convenience of the Employer Test

On January 18, 2019, the IRS released a TAM informing business owners that free meals to employees under IRC Section 119 are not excludable under the “convenience of the employer” test if the employer cannot show a substantial non-compensatory business reason for the free meal. TAM 2019030171. Generally, an employee’s gross income includes certain fringe benefits such as gym memberships and prizes. But, under IRC Section 119(a), meals and lodging furnished to an employee by or on behalf of their employer for the convenience of the employer is excluded from the employees income if (i) the meals are furnished on the business premises, or (ii) in the case of lodging, the employee is required to accept such lodging on the business premises of his employer as a condition of his employment. Whether meals are furnished for the convenience of the employer is a question of fact to be determined based on the facts and circumstances of each case. Further, free meals provided by an employer to its employees are considered furnished for the convenience of the employer if such meals are furnished for a “substantial non-compensatory business reason.” The regulations have identified the following substantial non-compensatory business reasons: (i) the employer’s business requires that the employee be restricted to a short meal period during which the employee could not be expected to eat elsewhere; (ii) the employee must be available for emergency calls during the meal period; or (iii) the employee could not otherwise secure proper meals within a reasonable meal period. Additionally, free snacks provided to employers are excludable as de minimis fringes.

Analyzing the Facts

In the case presented before the IRS, the employer provided meals, without charge, to all employees, contractors, and visitors. In one area, meals were eaten at seating in or near the snack areas, or at the employee’s desks. The employer also had a cafeteria where meals were consumed. In addition to meals, the employer provided unlimited snacks and drinks. The reasons the employer had for providing these free meals were: (i) to foster collaboration and innovation; (ii) to protect the employer’s confidential and proprietary information; (iii) to protect the employees due to unsafe conditions surrounding the business premises; (iv) to provide healthy eating options for employees to improve employee health; (v) because the employees cannot secure a meal within a reasonable meal period; (vi) because demands of the employees job functions allow them to only take a short break; and (vii) to provide meal so that employees are available to handle emergencies that regularly occur.

In analyzing the facts of the case, the TAM stated that it did not doubt the legitimacy of the of the employer’s reasons listed above, but the fact that these reasons are legitimate does not quality them as substantial non-compensatory business reasons. In particular, several items were for the benefit of the employee and not the employer. Further, the TAM noted that these goals did not have specific policies to implement them. According to the TAM, policies are necessary to connect a business goal to the business necessity for furnishing meals to employees in order to achieve that goal. But, it is not enough for a policy to exist, the employer must actually enforce the policy and demonstrate how the policy relates to the furnishing of meals to employees. Finally, the TAM concluded that the value of snacks provided by employers to it employees is excludable from gross income as a de minimis fringe benefit, because the value of the portions consumed by each employee are hard to quantify and given the low value of each snack portion it would be administratively impracticable.

The TAM, however, does not address situations where the employer provides occasional meals to employees, such as food provided at company parties, or pizza lunches. Fortunately, the IRS has covered these situations in IRS Publication 15-B (the “Publication”). According to the Publication, you can generally exclude from the employee’s wages, the value of de minimis meals employers provide to employees. Further, per the Publication, meals furnished to employees for recreational or social activities, are 100% deductible, provided they are primarily for the entire company and not weighted towards top owners or highly compensated employees.

Contact Nardone Limited

If your business provides free meals to employees, you should consider how the TAM may affect you and your employees. Ensuring that you have policies that address the reason for the free meals and that you are prepared to demonstrate how the policy relates to the free meals are things your business should be considering. If you or your business need help navigating the tax laws regarding employee benefits or need help creating employment policies, it is important that you seek guidance from a legal professional experienced in tax matters.

Nardone Limited represents employers with federal tax issues and provides guidance regarding changes and shifts to tax laws. If you are unsure how the TAM will affect you or your business, you should contact an experienced tax attorney. Nardone Limited’s tax attorneys and professionals are experienced in representing businesses regarding federal tax issues.

 


1You can find the full TAM here.

March 25, 2019

Real or Personal Property? It Makes a Tax Difference

Dissolution_business2

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation (the “Department”). As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the Department.

Introduction

Taxpayers and businesses with business real estate often hire contractors to construct and fabricate buildings and other structures on their property to use for business operations. Sometimes a business constructs an entire building to contain and protect their business operations. Other times a business constructs smaller projects described as improvements to already existing property or projects that allow the business to expand into a new business venture.

To the unsuspecting business owner, these projects result in property that the business owner, and many others, would categorize as real property. But, according to the Department’s assessments and Ohio case law, this is not always the case.

Each year the Department assesses Ohio business owners use tax on projects like those described above. This is because the Department classifies the resulting property from a project as tangible personal property, rather than real property. This distinction might not seem important at first, but this classification can present serious sales and use tax implications for the taxpayer.

Ohio Sales and Use Tax Generally

Sales tax is levied on all sales transactions unless otherwise excluded. A sale includes any transaction by which title or possession in an item of tangible personal property is transferred. A sale also includes a transaction where an item of tangible personal property is installed, unless the transaction is otherwise excluded for sales tax purposes. A sale does not include a transaction established under a construction contract to construct or fabricate real property.

Use tax is levied on the consumption of tangible personal property or the benefit realized in the state on any service provided. An exception exists for the acquisition of tangible personal property that is already subject to sales tax, in which case use tax is not assessed. Generally, for construction projects, it is assumed that the builder pays any necessary sales tax upon purchasing the construction materials. However, use tax would be assessed on the value of any materials used that were not assessed sales tax when purchased.

Order of Analysis

So, how is a taxpayer supposed to determine whether a project should be taxed as real or personal property? Ohio law provides three distinct categories for property: real property; personal property; and business fixtures.

Through case law, the Ohio Supreme Court provides the following guidelines to determine whether property is real property, personal property, or a business fixture under Ohio Revised Code sections 5701.02 and 5701.03:

  1. Determine whether the property is defined as real property under § 5701.02;
  2. If the property does not meet the definition of real property under § 5701.02, then the property is personal property;
  3. If the property is defined as real property under § 5701.02, then the property is real property unless defined as a business fixture under § 5701.03;
  4. If the property is defined as a business fixture under § 5701.03, then the property is personal property.

Real property includes the land and all buildings, structures, improvements, and fixtures of whatever kind on the land. Ohio law defines buildings, structures, improvements, and fixtures as follows:

  1. A building is any fabrication or construction consisting of foundations, walls, columns, girders, beams, floors, and a roof that is intended as a habitation or shelter for people, animals, or tangible personal property.
  2. Fixtures are any items of tangible personal property that are permanently attached or affixed to the land or to a building, structure, or improvement for the primary benefit of the real property, rather than a business conducted on the property.
  3. Improvements are any permanent additions, enlargements, or alterations to a building or structure that would be considered part of the building or structure had they been completed during the initial construction process.
  4. Structures are permanent fabrications or constructions, other than a building, that are attached or affixed to the land and increases or enhances the utilization or enjoyment of the land.

At the end of the day, real property is distinguished from other types of property in that fact that the primary intent of real property is to benefit the realty and the taxpayer’s use of the land.

Personal Property and Business Fixtures under § 5701.03

Personal property includes every tangible item that is the subject of ownership, including business fixtures, but does not constitute real property. This definition acts as a catchall category of property.

A business fixture, as referenced above, is an item of tangible personal property that is permanently attached or fixed to the land, building, structure, or improvement for the primary benefit of a business conducted on the premises. Unlike real property, the primary intent of real property is to benefit a business. A business fixture also includes any portion of the building, structure, or improvement that is specially designed, constructed, and used for a business conducted in the building, structure, or improvement.

Even with these statutory definitions, many taxpayers are left to determine whether a project is a structure, which is real property, or a business fixture, which is tangible personal property.

Structures or Business Fixtures

At the core of any determination is whether the project increases or enhances the utilization or enjoyment of the land, or whether the project primarily benefits a business conducted on the premises. The Ohio General Assembly and Ohio Supreme Court state that the decisive test is whether the property at issue is devoted primarily to the business conducted on the premises, or whether the property is devoted primarily to the use of the land upon which the business is conducted.

The Department makes these determinations on a case by case basis depending on the facts and circumstances surrounding the project.

Conclusion

Whether you received a similar assessment from the Department or are considering a similar project at your place of business, it is important to work with a qualified tax professional to review the tax implications of the project. The tax and business attorneys at Nardone Limited are experienced in Ohio tax law and have the necessary abilities to scrutinize your project to determine the appropriate classification. If you believe the Department wrongfully assessed use tax on your project, our firm can help you appeal the assessment.  Contact us today for a consultation.

 

 

 

 

February 22, 2019

Section 199A: The New Small Business Tax Break—Part III

working_calculator

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article is the third in a series of articles exploring what some tax professionals describe as the best small business tax break of the last half-century—the Section 199A Qualified Business Income Deduction (the “Deduction”).

Brief Reintroduction

Our last article on Section 199A introduced the concept of a specified service trade or business (“SSTB”), which we said is not a qualified trade or business (“QTOB”) for Section 199A purposes. At first pass, the statutory language suggests that SSTB-classification disqualifies a trade or business from the Deduction; however, there is an exception (the “Exception”).i Before we discuss the Exception, we should revisit the definition of an SSTB.

SSTB Defined

For purposes of Section 199A, an SSTB is any trade or business that involves the performance of services in one of the following fields: health; law; accounting; actuarial science; performing arts; consulting; athletics; financial services; brokerage services; investing and investing management; trading; dealing; or a business where the principal asset is the reputation or skill of one or more of its owners or employees.ii Although the Code is broad, the Regulations provide more specific examples of jobs within these fields that do, and do not, fall in SSTB purview.

Calculating the Deduction for an SSTB

The Deduction for qualified business income (“QBI”) from an SSTB is subject to a “phase-out” (the “Phase-out”) once a taxpayer’s taxable income exceeds $157,500 for single filers and $315,000 for joint filers (the “Threshold”).iii

Similar to a QTOB, a taxpayer with QBI from an SSTB enjoys a full 20 percent deduction is their taxable income is less than or equal to the Threshold. But, unlike a QTOB, the Deduction for an SSTB is eliminated once a taxpayer’s taxable income exceeds $207,500 for single filers and $415,000 for joint filers.  The gray area between $157,500 to $207,500 and $315,000 to $415,000 for single and joint filers, respectively, is where the Phase-out occurs.

Calculating the Phase-out

Mechanically speaking, the Phase-out is better described as a “phasing-in” of the “wage/investment” limitation for a QTOB (the “Limitation”) described in our previous article. If you recall, the Limitation is a function of QBI, W-2 wages, and the unadjusted basis in qualified property associated with a trade or business. For an SSTB, these three variables are “phased-out” of the Deduction calculation as a percentage (described in the next paragraph) of their actual values used in the QTOB calculation. Meaning, the QBI, W-2 wages, and unadjusted basis in qualified property values used in the SSTB calculation are less than those used in the QTOB calculation. This difference in value results in a difference in the Deduction between QTOBs and SSTBs.

The percentage described above is equal to 100 percent minus a percentage calculated by the difference between taxable income and the Threshold, divided by either $50,000 for single filers or $100,000 for joint filers (the “Phase-Out Percentage”). The Phase-Out Percentage cannot be less than zero, which results in the complete phase-out of the Deduction once taxable income hits $207,500or single filers and $415,000 for joint filers. The Phase-Out Percentage is then multiplied against the QBI, W-2 wages, and qualified property amounts associated with the SSTB, reducing their values.

Finishing the Deduction Calculation

Once the Phase-On Percentage is applied, the Deduction calculation for an SSTB is lockstep with that of a QTOB. But, because the SSTB calculation QBI, W-2 wages, and qualified property values are a percentage of those used for the QTOB calculation, the SSTB Deduction is smaller. The following are the final steps for the Deduction calculation; however, they are no different than those described in the previous article.

When taxable income exceeds the Threshold, the Limitation is the lesser of: (i) 20 percent of QBI from an SSTB, or (ii) the greater of: (a) 50 percent of W-2 wages from an SSTB, or (b) 25 percent of W-2 wages from an SSTB, plus 2.5 percent of the unadjusted basis in qualified property associated with an SSTB. 

The percentage of phase-in is the difference between a taxpayer’s taxable income and the Threshold, over either $50,000 for single filers or $100,000 for joint filers (the “Phase-In Percentage”). The Phase-In Percentage is used to determine the reduction amount used against the 20 percent of QBI deduction starting point.

The Phase-In Percentage is multiplied against the difference between: (i) 20 percent of QBI and (ii) the Limitation. This figure represents the phase-in of the Limitation, or the amount by which the 20 percent of QBI starting point is reduced to determine the Deduction amount.

Businesses Related to an SSTB

Many taxpayers with SSTB enterprises operate under an organizational structure that keeps their operational entity separate from their real estate entity and sometimes even a management entity. For example, it is not uncommon that an accountant, attorney, dentist, or doctor will conduct their business using two entities. The first entity contains the primary operations of the firm or practice. And, the second entity contains the real property in which the first entity operates.

Under the Section 199A Regulations, when a trade or business provides property or services to an SSTB, and there is a 50 percent or more common ownershipiv between the two trades or businesses, the portion of the trade or business providing property or service to the SSTB is treated as an SSTB.v Thus, the Deduction for either entity is subject to the SSTB Phase-Out limitations even though the entity providing the property or services is otherwise considered a QTOB.

Example: Doctor, a dentist, operates his dental practice using three different entities: Clinic LLC, which holds the clinical operations of the practice; Real Estate LLC, which holds the office building used by the practice; and Management LLC, which holds the non-clinical operations of the practice.  Doctor is the 100 percent owner of all three entities. 

On their own, the activities of Real Estate LLC and Management LLC qualify them as QTOBs, which would subject them to the lesser restrictive Deduction limitations for QTOBs. Clinic LLC is an SSTB because it holds the operations of a trade or business in the health field, which would subject it to the more restrictive Deduction limitations for SSTBs. However, because Real Estate LLC and Management LLC provide property or services to Clinic LLC, with which they share over 50 percent common ownership, all three entities are considered SSTBs.

Therefore, Doctor is unable to take the Deduction for any QBI generated by the three entities once Doctor’s taxable income exceeds $207,500 (if filing single) or $415,000 (if filing joint). Doctor would remain eligible for the Deduction if Doctor’s taxable income falls below these thresholds.

Conclusion

There is a common theme across these first three Section 199A articles—the Deduction is complex.  We now see that the Deduction, in the case of an SSTB, requires an additional level of calculations.  There is also additional analysis required to determine if or when the trade or businesses ancillary to a taxpayer’s SSTB are required to be included as an SSTB even though they would otherwise qualify as a QTOB.  Therefore, it is important that taxpayers work with experienced tax law professionals who understand Section 199A from a legal perspective.  The tax and business attorneys at Nardone Limited have this understanding and are prepared to discuss your Section 199A planning today.

 


i I.R.C. § 199A(d)(3).

ii Reg. § 1.199A-5(b)(1).

iii I.R.C. § 199A(d)(3)(A).

iv Common ownership means a direct or indirect ownership by related parties within the meaning of Sections 267(b) or 707(b). Reg. § 1.199A-5(c)(2)(ii).

v Reg. § 1.199A-5(c)(2)(i).

February 08, 2019

Section 199A: The New Small Business Tax Break—Part II

Small_business2

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS. This article is the second in a series of articles exploring what some tax professionals describe as the best small business tax break of the last half-century—the Section 199A Qualified Business Income Deduction (the “Deduction”).

Tax Law Update: On January 18, 2019 the IRS released its final versions of the Proposed Regulations to Section 199A, which it released in August of 2018.

Brief Reintroduction

As stated in our first Section 199A article, the owners of “pass-thru entities” have the potential to receive a deduction equal to 20 percent of the qualified business income (“QBI”). QBI is the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business (“QTOB”) of the taxpayer.1 As part of our initial understanding of QBI, it is important that we first consider what constitutes a QTOB.

QTOB, or Not QTOB, That Is the Question

QTOB is broadly defined by Section 199A as any trade or business other than: (i) a specified service trade or business (“SSTB”), or (ii) the trade or business of performing services as an employee.2 Let’s first address what Section 199A defines as a non-QTOB trade or business.

Non-QTOB Trades or Businesses

The definition of QTOB does not include an SSTB, which is defined as any trade or business involving the performance of services in one of the following fields: health; law; accounting; actuarial science; performing arts; consulting; athletics; financial services; brokerage services; investing and investing management; trading; dealing; or a business where the principal asset is the reputation or skill of one or more of its owners or employees.3 The Regulations go on to give examples of what specific trades or businesses within each of these fields are, and are not, considered an SSTB. But, it is important to understand that just because a trade or business is considered an SSTB, it does not necessarily mean that the income related to that trade or business does not qualify for the deduction. Part III of this series will further discuss this matter.

Also, a QTOB does not include the trade or business of performing services as an employee. Meaning, an employee who receives W-2 wages cannot take the Deduction for those wages. To prevent potential circumventions of this rule, the IRS added an anti-abuse measure that bars the Deduction from employees who terminate their employment and then re-establish a relationship with the employer as an independent contractor.4

What is Considered a QTOB Trade or Business

The definition of trade or business under the Regulations is equally as vague as the definition in Section 199A. The Regulations state that a Section 199A trade or business is the same as a Section 162 trade or business.5 Section 162 typically requires case law analysis to determine whether an activity is a trade or business. The Court in Commissioner v. Groetzinger held that a taxpayer engages in a trade or business when they are “involved in the activity with continuity and regularity” for the “primary purpose” of earning “income or profit.”6 Although this holding seems broad and open to interpretation, the IRS doubles down on the idea that the Section 199A analysis of a “trade or business” should be as restrictive as the analysis under Section 469 for passive losses.

Unlike Section 162, the Regulations provide that the renting or licensing of tangible or intangible property to a related trade or business is a trade or business under Section 199A so long as there is common ownership as defined by Reg. § 1.199A-4(b)(1)(i).7 But, as we will discuss in our next Section 199A article, there are additional considerations involved where one of the related trades or businesses is an SSTB.

Proposed Treatment for Rental Real Estate Activity Under Section 199A: The treatment of rental real estate activity as a trade or business is an area of uncertainty in many Code sections. This uncertainty is due to inconsistencies in the case law for determining whether the generally “passive” act of renting real estate satisfies the definition of trade or business. The IRS hopes to eliminate such uncertainty as it relates to Section 199A. To do so, the IRS published Notice 2019-07 contemporaneously with the release of the Section 199A final regulations (the “Notice”). The Notice specifically addresses the treatment of rental real estate activity and describes a proposed revenue procedure that provides safe harbor treatment for certain rental real estate activity as a trade or business under Section 199A. Nardone Limited will publish a separate article that discusses the Notice and highlights the requirements for the safe harbor treatment to apply.

Identifying Items Included in QBI

Remember that QBI includes the net amount of income, gain, deduction, and loss from a taxpayer’s QTOB.8 The Code defines this to include everything from the trade or business’s operating income to the ordinary gains and losses resulting from the disposition of assets used in the trade or business.9 But, QBI does not include short-term and long-term capital gains and losses, interest income other than that allocable to a trade or business, and C corporation dividend income.10 

Calculating the Deduction for a QTOB

As discussed in our first Section 199A article, the Deduction is subject to a “wage/investment” limitation (the “Limitation”) when QBI comes from a QTOB and the taxpayer’s taxable income exceeds $157,500 for single filers and $315,000 for joint filers (the “Threshold”).11


Taxpayers whose taxable income is less than or equal to the Threshold enjoy a full 20 percent deduction. But, the Limitation phases-in once a taxpayer’s taxable income exceeds the Threshold. Regardless of the Limitation, the starting point for the Deduction is always 20 percent of QBI.

Calculating the Limitation

When taxable income exceeds the Threshold, the Limitation is the lesser of: (i) 20 percent of QBI from a QTOB, or (ii) the greater of: (a) 50 percent of W-2 wages from a QTOB, or (b) 25 percent of W-2 wages from a QTOB, plus 2.5 percent of the unadjusted basis in qualified property.

Phase-In of the Limitation

The percentage of phase-in is the difference between a taxpayer’s taxable income and the Threshold, over either $50,000 for single filers or $100,000 for joint filers (the “Phase-In Percentage”). The Phase-In Percentage is used to determine the reduction amount used against the 20 percent of QBI deduction starting point. It is important to note that the Phase-In Percentage is capped at 100 percent.

The Phase-In Percentage is multiplied against the difference between: (i) 20 percent of QBI and (ii) the Limitation. This figure represents the phase-in of the Limitation, or the amount by which the 20 percent of QBI starting point is reduced to determine the Deduction.

Conclusion

If all of that seems confusing, it’s because it is. First, the taxpayer is required to determine whether their trade or business constitutes a QTOB. The taxpayer must then determine the amount of QBI generated from their QTOB, which, in comparison, is relatively easy. After all of that, the taxpayer can then start to calculate their Deduction—which we know can be a mess. Calculating the taxpayer’s Deduction is far from simple and requires one to understand the impact of figures beyond the QBI realm (e.g., wages, the unadjusted basis in qualified property, etc.). This introduces an additional level of complication. Maybe that is why the IRS estimates Section 199A creates an additional 25-million-hour burden annually?12 25 million hours!

Therefore, it is important that taxpayers not only work with their bookkeepers and external accountants, but also with experienced tax law professionals who understand the Code’s implications from a legal perspective. The tax and business attorneys at Nardone Limited have this understanding and are prepared to discuss your Section 199A planning today.

P.S. Keep an eye out next week for Part III where we discuss the Deduction from the perspective of an SSTB owner, and the potential impact the SSTB classification has on otherwise “clean” QBI from a QTOB.


1 I.R.C. § 199A(c)(1).

2 I.R.C. § 199A(d)(1).

3 Reg. § 1.199A-5(b)(1).

4 Reg. § 1.199A-5(d)(3).

5 Reg. § 1.199A-1(b)(14).

6 Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987).

7 I.R.C. § 1.199A-1(b)(14).

8 I.R.C. § 199A(c)(1).

9 Reg. § 1.199A-3(b).

10 I.R.C. § 199A(c)(3)(B).

11 I.R.C. § 199A(b)(3).

12 Preamble to the § 199A Final Regulations release January 18, 2019.

January 24, 2019

Section 199A: The New Tax Break for Small Business

Business_owners

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation.  As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS.  This is the first blog in a series which will explore what some tax professionals describe as the best small business tax break of the last half-century—the Section 199A Qualified Business Income Deduction (the “Deduction”).

Background

    The Tax Cuts and Jobs Act of 2017 (the “TCJA”) added the Deduction, which is enacted to apply for tax years 2018 through 2025.  The Deduction comes in conjunction with a repeal of the Section 199 deduction, enacted under the American Jobs Creation Act of 2004.  The Section 199 deduction provided up to a 9-percent deduction based on the qualified production activities income for businesses that perform domestic manufacturing and other production activities.  Commentary surrounding the Deduction suggests that it is intended to provide tax relief to the owners of “pass-thru entities” that are unable to take advantage of the TCJA reduction to the corporate tax rate.

    For purposes of the Deduction, the term “pass-thru entities” includes sole proprietorships, partnerships (including publicly traded partnerships), S corporations, certain real estate investors, and trusts and estates to the extent they own and operate a trade or business.  In certain circumstances the Deduction also applies to limited liability companies, real estate investment trusts, and qualified cooperatives.

How Much Is the Deduction Worth?

    The Deduction offers its greatest impact on taxable income that would otherwise be treated as ordinary income and taxed at the highest individual tax rates (i.e., 32, 35, and 37-percent).  Owners of “pass-thru entities” have the potential to receive a deduction equal to 20-percent of the qualified business income (“QBI”).1 For example, taxpayers taxed at the new 32, 35, or 37-percent individual tax rates have the potential to save $640, $700, or $740 for every $10,000 of pass-thru taxable income, respectively.  Thus, the higher the QBI and tax rate, the greater the tax savings.

Who Does the Deduction Apply To?

    The Deduction generally applies without limitation. However, additional considerations and restrictions apply when a taxpayer’s taxable income exceeds a certain threshold or when QBI is generated from a specified trade or business (“STOB”), rather than from a qualified trade or business (“QTOB”).

    For 2018, the taxable income threshold is $157,000 for single filers and $315,00 for joint filers (the “Threshold).2  In essence, taxpayers with taxable income below the Threshold enjoy the full 20-percent deduction regardless of the QBI source.  But, when taxable income exceeds the Threshold either the “wage/investment” limitation (when QBI is sourced to a QTOB)3 or the “Deduction phase-out” (when QBI is sourced to a STOB)4 will apply. [NOTE: Both of these concepts will be further explained in later blog articles]

Start Planning Today In Order to
Take Advantage of the Deduction

    In its commentary from the proposed regulations for Section 199A, the IRS discusses the significant work anticipated to implement the Deduction into the tax preparation process.  On average, the estimated additional annual burden is a combined 3 to 4 hours for taxpayers and the “pass-thru entities” that they own.5  Certain taxpayers may need to make operational, legal, and or accounting changes in order to take advantage of the Deduction. Therefore, it is imperative to discuss the Deduction with a qualified tax professional today in order to maximize your potential benefit.

    Although certain instances provide a clean application of the Deduction, other instances where a limitation or phase-out applies will require a greater understanding of the applicable tax and business law.  The tax and business attorneys at Nardone Limited have this understanding, and are prepared to discuss your Section 199A planning today.

 


1 I.R.C. §§ 199A(a) and (b)

2 I.R.C. § 199A(e)

3 I.R.C. § 199A(b)(3)

4 I.R.C. § 199A(d)(3)

5 Preamble to the § 199A proposed regulations.

January 18, 2019

When Should Married Couples File Separately?

Wedding-cake

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists businesses with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys help individuals analyze their options when it comes to their tax-filing status. For example, when filing their taxes, married couples have the option to either file jointly or separately, and must weigh the pros and cons of each. While most married couples file their returns jointly, there are instances when filing separately may be advantageous based on the taxpayer’s situation.

Joint and Several Liability

    For starters, taxpayers who file joint tax returns are jointly and severally liable for liabilities arising from mistakes or omissions on that joint return. Imposition of joint and several liability means that each taxpayer is legally responsible for the entire liability—unless the taxpayer qualifies for innocent spouse relief. This means that the IRS can proceed against either spouse—or both—to resolve the tax liability. IRC §6013(d)(3). For this reason, a taxpayer may want to consider filing separately if they have an untrustworthy spouse or suspect that their spouse is not complying with their tax obligations. A spouse should also consider filing separately if one or both spouses own a business—and that business is a pass-through entity—and the spouses is not involved in the day-to-day activities of the business. We say this because if a business owner spouse is not paying or properly reporting the business’s tax liability to the government, the innocent spouse may also be liable, since the entity’s profit and loss would be reported on the couple’s income tax return.

Nardone Limited Comment: Taxpayers should be aware that qualifying for innocent spouse relief is very time consuming and difficult to achieve. Generally, it is tough for the petitioning spouse to prove that they did not know or have reason to know of the tax deficiency, since they did in fact sign the income tax return. For more information on innocent spouse relief, see our previous blog, “Tax Relief for Innocent Spouses.”

Additional Considerations

    A spouse may also choose to file separately if at least one spouse has significant itemized deductions that are limited to adjusted gross income (“AGI”), or one or both spouses qualify for head of household status because the couple is living apart or separated. Common itemized deductions limited by AGI are medical expenses, personal casualty losses, miscellaneous itemized expenses, and charitable contributions. Taxpayers should also be advised that, to qualify for head of household status: (i) you and your spouse cannot have lived together during the last six months of the year; (ii) the spouse’s home must have been at least one of the children’s primary residence for more than half of the year; and (iii) the spouse filing for head of household status must have paid more than half the cost of keeping up the home for the year. IRS Pub. 501 (2018).

    In sum, before a taxpayer decides to file a joint return or a married filing separate return, the taxpayer should work with their tax return preparer or attorney to better understand the intended and unintended consequences of that filing. If a married couple’s goal is to simply limit their tax liability, it may be helpful to prepare the tax return both ways. That way, the couple can see which filing status would give them the biggest tax savings.

Contact Nardone Limited

    The tax attorneys at Nardone Limited have experience in advising taxpayers when it comes to deciding how to file their taxes, as well as preparing requests for innocent spouse relief. If you are married and are unsure whether you should file your taxes jointly or separately, then you should contact one of our experienced attorneys. We will thoroughly review your case and determine the most advantageous option based on your specific circumstances.

December 28, 2018

Tax Cuts and Jobs Act-Impact on Charitable Giving

Tax cuts and jobs act

The tax attorneys at Nardone Limited, in Columbus, Ohio, assist businesses and taxpayers with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys advise taxpayers of the affects and consequences of changes to federal tax law. The recently enacted Tax Cuts and Jobs Act (“TCJA”) will affect charitable contributions made by taxpayers, as well as how taxpayers will strategize their contributions to ensure they are receiving the maximum benefits.

More Taxpayers May Choose
Standard Deduction Over Itemizing

During this time of year, many taxpayers consider making charitable contributions because those who itemize their deductions are entitled to deduct the amount of contributions made to qualified charitable organizations from their taxable income. Qualified charitable organizations are those that exist exclusively for the advancement of religious, charitable, or educational purposes. Congress allows taxpayers to deduct charitable contributions from their taxable income because it believes that a robust charitable sector is vital to the U.S. economy. The recent increase in the standard deduction, as a result of the TCJA, however may negatively affect Congress’ efforts to incentivize taxpayers to donate to charities going forward.

Nardone Limited Comment: Taxpayers should be aware that there are rules for substantiating different types of charitable donations. If audited or examined by the IRS, taxpayers must be familiar with the types of documentation required by the IRS. For more information on documentation requirements, as it relates to charitable contributions, see our blog article titled, “IRS Documentation Requirements Concerning Charitable Contributions.”

The TCJA increases the standard deduction for individuals from $6,350 to $12,000, and from $12,000 to $24,000 for married couples. Generally, if a taxpayer itemizes their deductions rather than taking the standard deduction, the tax deduction for charitable contributions helps to reduce the taxpayer’s taxable income. But, due to the increase in the standard deduction, it is much more difficult for itemizing taxpayers to meet the threshold of the standard deduction in order to benefit from itemizing their deductions. Professionals, however, suggest a strategy called “bunching” in order for taxpayers to still benefit from charitable giving. This strategy suggests that, rather than giving a smaller amount to charity every year, the taxpayer gives every other year instead. This way taxpayers are in a better position to get their itemized deductions over the standard deduction amount, and thus benefit from the charitable giving.

Nardone Limited Comment: The TCJA also increases the charitable contribution-base percentage (the taxpayer’s adjusted gross income) for deductions of cash contributions, for individuals, from 50% of the taxpayer’s contribution-base to 60%. Note, that cash contributions taken into account for purposes of applying the 60% limit are not taken into account again in applying the 50% limit for non-cash contributions.

Contact Nardone Limited

The tax attorneys at Nardone Limited have vast experience representing taxpayers involved in IRS audits and examinations. To the extent that you have questions regarding the effects of the TCJA or charitable tax deductions and substantiations, you should contact one of the experienced attorneys at Nardone Limited.

December 14, 2018

IRS Criminal Investigation releases Fiscal Year 2018 Annual Report

Irs_criminal_investigations

As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists individuals and businesses with representation in tax examinations, audits, appeals, and civil litigation with the Internal Revenue Service (the “IRS”) and the Ohio Department of Taxation. As part of that representation, our tax attorneys keep individuals and businesses informed about new information and guidance provided by the IRS.

Updates regarding Criminal Tax Enforcement

The Internal Revenue Service recently released the Criminal Investigation Division’s (CI) annual report reflecting significant accomplishments and criminal enforcement actions taken in fiscal year 2018. According to the IRS:

“This report shows that as financial crime has evolved and proliferated around the world, so have IRS Criminal Investigation special agents and their abilities to track the proceeds of financial crime,” said IRS Commissioner Chuck Rettig. “CI uses cutting-edge technology combined with sophisticated investigative work to bring the most impactful cases that affect tax administration. I am extremely proud of our special agents and professional staff and their work serving the nation.”

In prior years, CI would involve itself with violent crime-type matters, like drug cases and criminal organizations. But, from our perspective, that is not the best use of their time. Thus, it was good to see that a major focus of CI in fiscal 2018 was traditional tax cases, including international tax enforcement, employment tax, refund fraud and tax-related identity theft. Other areas of emphasis included public corruption, cybercrime, terrorist financing and money laundering.

Criminal Tax Enforcement Statistics

Again, according to the IRS:

“We prioritized the use of data in our investigations in fiscal 2018,” said Don Fort, Chief of CI. “The future for CI must involve leveraging the vast amount of data we have to help drive case selection and make us more efficient in the critical work that we do. Data analytics is a powerful tool for identifying areas of tax non-compliance.”

CI initiated 2,886 cases in fiscal 2018, with traditional tax cases accounting for 73 percent of the total. The number of CI special agents dipped below 2,100 by the end of fiscal 2018, which is the lowest level since the early 1970’s. Consequently, CI turned to data analytics to assist in finding the most impactful cases.

CI is the only federal law enforcement agency with jurisdiction over federal tax crimes. CI achieved a conviction rate of 91.7 percent in fiscal 2018, which is among the highest of all federal law enforcement agencies. According to commentators, which we would agree with, the high conviction rate reflects the thoroughness of CI investigations and the high quality of CI agents. CI is routinely called upon by prosecutors across the country to lead financial investigations on a wide variety of financial crimes.

Nardone Limited Comment: The takeaway for our individual and business clients is, seek the appropriate tax advice and tax professionals to ensure that integrity, fairness, and respect for our voluntary tax system.  We want to make sure that you are not put in a position where you have intentionally crossed the line or inadvertently crossed the line by following the advice of your tax professional.  These statistics make it pretty clear that the IRS, once they have placed their focus and efforts on your particular case, it will be difficult to cause CI to redirect their focus.  Rather, at that point, it becomes more of an effort of minimizing the potential disruption or punishment, versus all-together avoiding it.

Contact Nardone Limited

Nardone Limited frequently represents individuals and businesses in federal, state, and local civil tax matters.  If you or your business have been contacted by the IRS, or are struggling with tax liabilities, you should contact one of our tax attorneys today. We will thoroughly review your case to determine what options and alternatives are available to you.

 

Tax Attorney Vince Nardone Speaks at Day Two of the 2018 Mega Tax Conference

Ohio society of cpas

    On December 11, 2018, tax attorney Vince Nardone spoke on day two of The Ohio Society of CPAs Mega Tax Conference. Vince discussed the various voluntary disclosure programs to a group, consisting mostly of CPAs and accountants from across the state of Ohio. The presentation focused on the most common voluntary disclosure programs at both the federal and state levels. We spent a good bit of time discussing the IRS’ closure of the 2014 Offshore Voluntary Disclosure Program, and the Streamlined Filing Compliance Procedure submission program.  Nardone also discussed the benefits and strategies available in each voluntary disclosure, while avoiding pitfalls. 

    The Ohio Society of CPAs is the #1 provider of CPE for Ohio CPAs year after year, and the 2018 Mega Tax Conference was a great opportunity for CPAs to learn about the latest advancements on a variety of important topics in the industry.  We appreciate and thank The Ohio Society of CPAs’ accounting learning manager, Amber McAuliffe, for inviting us and allowing us to participate. 

December 12, 2018

Tax Attorney Vince Nardone Speaks at the 2018 Mega Tax Conference

Ohio society of cpas

    On December 10, 2018, tax attorney Vince Nardone spoke at The Ohio Society of CPAs Mega Tax Conference. Vince presented “Ethics in Tax Practice” to a group, consisting mostly of CPAs and accountants from across the state of Ohio. The presentation focused on reviewing Circular 230 and other federal and state laws impacting CPAs, as well as Board of Accountancy rules governing the conduct of CPAs performing tax services in Ohio.  Nardone spent a lot of time discussing best practices in terms of tax return preparation, interacting with clients and the tax authorities, and the important aspects of protecting their own businesses and livelihood.

    The Ohio Society of CPAs is the #1 provider of CPE for Ohio CPAs year after year, and the 2018 Mega Tax Conference was a great opportunity for CPAs to learn about the latest advancements on a variety of important topics in the industry.  We appreciate and thank The Ohio Society of CPAs’ accounting learning manager, Amber McAuliffe, for inviting us and allowing us to participate. 

 

April 03, 2019

March 25, 2019

February 22, 2019

February 08, 2019

January 24, 2019

January 18, 2019

December 28, 2018

December 14, 2018

December 12, 2018

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