Taxpayers are still feeling repercussions far and wide from the extensive changes to the tax code made by the 2017 law known as Tax Cuts and Jobs Act (TCJA). Because the TCJA was passed so quickly, many of its nuances required clarification, and this year’s tax reform-related updates are certain to affect your company’s year-end tax planning. While a fix for qualified improvement property is still in the works, the following provisions have received final and proposed regulations in 2019.
Qualified Business Income Deduction
Treasury released final regulations to specify computational, definitional, and anti-abuse rules for the 20% Qualified Business Income (QBI) deduction under Internal Revenue Code (IRC) Section 199A, including:
- Netting rules for multiple businesses when at least one has negative QBI
- Elective aggregation rules to treat multiple businesses as one
- Impact upon self-employment, net investment income, and alternative minimum tax (AMT)
- Sources of W-2 wages for limitation purposes (the IRS also released a notice providing additional guidance on determining W-2 wages for QBI deduction purposes)
- Determination of unadjusted basis of property involving carryover basis transactions
- Treatment of Section 1231 gains and losses for QBI purposes
- Scope of Specified Service Trades or Businesses (SSTBs)
QBI Clarification for Rental Real Estate
The IRS provided administrative guidance to address some questions for the rental real estate sector. Landlords have long had questions for the IRS about their ability to use the 20% QBI deduction. The IRS finalized a safe harbor rule in September that allows taxpayers to treat certain interests in rental real estate, including interests in mixed-use property, as a qualified trade or business for purposes of the deduction.
In order to qualify for this safe harbor, taxpayers or relevant pass-through entities must meet these requirements:
- Maintain separate books and records to reflect income and expenses for each rental real estate enterprise
- Treat commercial and residential properties as separate trades or businesses
- If rental real estate enterprises have been in existence for less than four years, taxpayers must be able to demonstrate through written documentation that they performed more than 250 hours of rental services per year
- For rental real estate enterprises that have been in existence longer, taxpayers must be able to demonstrate through written documentation that they have more than 250 hours of rental services performed in at least three of the past five years
- Maintain contemporaneous records, including time reports, logs, or similar documents about services performed
In order to claim the deduction for the tax year, the taxpayer (or relevant pass-through entity) must attach a statement to that year’s tax return. It’s also important to note that rental real estate activity may still be a qualified trade or business under common law standards, even where the taxpayer does not elect the safe harbor.
Tax Revenue Recognition
The tax reform law created an “Earlier of Test” for tax revenue recognition that requires taxpayers to include revenue in gross income at the earlier of the time when the revenue is recognized under the traditional “All Events Test,” or when it is included for financial accounting purposes (appearing in either an applicable financial statement or other qualifying financial statements).
In 2019, the IRS issued proposed regulations to help taxpayers implement these new requirements for tax revenue recognition.
Proposed regulations implementing IRC Section 451(b) clarify that the applicable financial statement acceleration rule applies year-by-year. The rule only applies in instances when the applicable financial statement covers the entire tax year. With multi-year contracts, taxpayers will apply the applicable financial statement acceleration rule using a cumulative (rather than annualized) approach. This requires taxpayers to include the revenue in income in the given tax year by comparing the cumulative applicable financial statement revenue with the cumulative gross income otherwise recognized for tax purposes.
Proposed regulations implementing IRC Section 451(c) extend the deferral method to taxpayers without an applicable financial statement, using criteria similar to that provided under Rev. Proc. 2004-34. They expand the types of advance payments eligible for the deferral method to include all those covered by Rev. Proc. 2004-34 and also to those received under loyalty programs or for “reward points.” Advance payments for “specified goods” are excluded from the scope of the Section 451(c) deferral method.
State and Local Tax Workarounds
Final regulations released in June essentially bar state workarounds for the TCJA’s $10,000 state and local tax deduction limitation. Some states had offered state tax credits for taxpayers who made charitable contributions to a state or local government fund. These credits were designed to offset taxpayers’ state and local tax obligations. The IRS’s final regulations require taxpayers who receive state tax credits to reduce their federal charitable contribution deductions by the amount of the credit they receive or expect to receive. Taxpayers receiving a state tax deduction for a charitable contribution do not have to reduce their federal deduction, nor do the taxpayers have to reduce their federal charitable deduction if the credit is not more than 15% of their contribution.
Another important update in the state and local tax limitation conversation involved a recent court decision. A New York U.S. District Court recently dismissed a lawsuit from a group of states that tried to block the tax reform’s $10,000 limitation on state and local tax. With the IRS’s final regulations and the court’s decision, taxpayers should assume the limitation is going to be effective for the foreseeable future.
Qualified Opportunity Zones
Updated qualified opportunity zone (QOZ) regulations released in 2019 were mostly beneficial for taxpayers. One provision clarified that a QOZ fund or business could lease property if certain requirements were met. This will allow taxpayers who held property in a QOZ prior to the enactment of the TCJA to potentially benefit from the QOZ’s capital gains deferral and exclusion provisions.
Another key aspect of the released guidance clarifies the “substantially all” requirements for the holding period and use of the tangible business property:
- 70% of the property must be used in a qualified opportunity zone.
- Tangible property must be QOZ business property for at least 90% of the QO Fund’s or QOZ business’s holding period.
- The partnership or corporation must be a QOZ business for at least 90% of the QO Fund’s holding period.
Global Intangible Low-Taxed Income
Final regulations related to the TCJA’s Global Intangible Low-Taxed Income (GILTI) provision clarify that the GILTI inclusion occurs at the partner or shareholder level. Proposed regulations for Subpart F would also have domestic partnerships and S corporations treat Subpart F inclusion the same as they do the GILTI inclusion.
As a result of the GILTI updates, domestic partnerships and S corporations will not have GILTI inclusion nor Subpart F inclusion at the entity level. Additional proposed regulations for GILTI will allow companies to elect into a GILTI high-tax exception. The election in IRC Section 962 to treat an individual as a corporation allows individuals to use the foreign income taxes paid by their controlled foreign corporation.
‘Grain Glitch’ Correction
The TCJA’s new 20% deduction against qualified business income created inadvertent tax incentives for cooperatives, and put non-cooperative farming businesses at a disadvantage. A correction in the Consolidated Appropriations Act of 2019 corrected this so-called “grain glitch.” The clarification stipulates that agricultural cooperatives selling products to independent buyers can determine the 20% Section 199A deduction based on net income, or alternatively can pass through the deduction to patrons under rules similar to the former Section 199 Domestic Production Activities Deduction.
What Tax Reform Updates Mean for 2019 Tax Filings
Tax reform has created more moving parts than ever for your business’s tax strategy. Staying up-to-date on the modifications and changes will be essential. For more information about how tax reform might affect your company’s 2019 tax return, please contact a member of our team.
Published on December 12, 2019