Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11 was issued concurrently to provide further guidance on the definition of wages. Also, a proposed revenue procedure, Notice 2019-7, was issued concurrently to provide a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: What is your general overview of the revised, final regulations for the Section 199A Qualified Business Income (QBI) or "pass-through" deduction?

Tom West: I think it is admirable that Treasury and IRS were able to publish these final regulations so quickly and address so many of the comments and questions that the proposed regulations generated. I think they realized how important this particular package was to so many taxpayers for the 2018 filing season and, while questions obviously remain, having these rules out in time to inform decisions for this year’s tax returns is helpful. In particular, the liberalized aggregation rules and the additional examples regarding certain specified service trades or businesses (SSTBs) are the most consequential in my mind.

Wolters Kluwer: What should taxpayers and practitioners keep in mind in consideration of relying on either the proposed or final regulations for the 2018 tax year?

Tom West: I have to imagine that when choosing between the two, for most taxpayers the final regulations will ultimately provide the better result. The ability to aggregate at the entity level, which was only provided in the final regulations, may be a key consideration for those taxpayers with more complicated or tiered structures. That said, I do think taxpayers need to be careful in their aggregation modeling because you are going to be stuck with your aggregation once you’ve filed. It may be that some taxpayers wait on getting locked into a particular aggregation and continue to study the new rules—and even wait on additional guidance that may be coming. However, it may be important to note that the final regulations provide that if an individual fails to aggregate, the individual may not aggregate trades or businesses on an amended return—other than for the 2018 tax year.

Wolters Kluwer: How is the removal of the proposed 80 percent rule regarding specified service trades or businesses (SSTBs) from the final regulations likely to impact certain taxpayers?

Tom West: First of all, I think the removal of this rule is a demonstration of two important dynamics. One, the critical importance of the engagement of taxpayers in the comment process, and, two, the government’s willingness to listen and adapt in their rule-making. I don’t know if there are particular industries or taxpayers who will be impacted, but I do know that the change is a very logical and appropriate one, and logic doesn’t always prevail in these processes, so I’m happy to give the regulators credit when it does.

Wolters Kluwer: Which industries may have been helped or hindered by the final regulations with respect to SSTB rules?

Tom West: I’m not sure specific industries were helped, but the biggest positive in terms of the SSTB final rules is the carryover from the proposed regulations of the treatment of the skill or reputation provision. Had Treasury and the IRS gone in a different direction, there was a risk of that provision swallowing the rest of the 199A regime—not to mention how much more subjective the already sometimes difficult SSTB determinations would have become.

Wolters Kluwer: Are there any lingering, unanswered questions among taxpayers or practitioners that particularly stand out when determining what constitutes SSTB income?

Tom West: I think many taxpayers who have both SSTB and non-SSTB activities were hoping for more clarity, either in rules or examples, on how to acceptably segregate business lines or on when (or if) certain activities are inextricably tied together. There are also still lingering questions regarding when a trade or business is an SSTB—particularly in the field of health.

Wolters Kluwer: Were there any surprises in the final regulations?

Tom West: I don’t know if I’m surprised, knowing the concerns that led them to the decisions they made, but the fact that Treasury and IRS held the line on some of the SSTB-related rules is notable. I’m thinking specifically of the so-called "cliff" effect of the de minimis rule and the fact that owners of certain kinds of SSTB businesses, e.g., sports teams, are not allowed to benefit from the Section 199A deduction.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

Republicans’ 2017 overhaul of the tax code created a new 20-percent deduction of qualified business income (QBI), subject to certain limitations, for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction—also called the "pass-through" deduction—has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.

The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language have created many questions for taxpayers and practitioners.

The IRS first released much-anticipated proposed regulations for the new QBI deduction, REG-107892-18, on August 8, 2018. The proposed regulations were published in the Federal Register on August 16, 2018. The IRS released the final regulations and notice of additional proposed rulemaking on January 18, 2019, followed by a revised version of the final regulations on February 1, 2019. Additionally, Rev. Proc. 2019-11, I.R.B. 2019-9, 742, was issued concurrently to provide further guidance on the definition of wages. Also, a proposed Revenue Procedure, Notice 2019-7, I.R.B. 2019-9, 740, was issued, concurrently providing a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.

Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, about the Section 199A QBI deduction regulations. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy. This article represents the views of the author only and does not necessarily represent the views or professional advice of KPMG LLP.

Wolters Kluwer: Neither the proposed nor final regulations for Section 199A give guidance as to when rental real estate activity constitutes a Section 162 trade or business. How might the application of the safe harbor provided for in IRS Notice 2019-7 offer taxpayers clarity? And how might failure to qualify for the safe harbor impact the determination of whether the rental activity is a trade or business under Section 199A?

Tom West: The safe harbor is helpful but it appears to be intended for relatively smaller taxpayers who may have had questions about their activities rising to the level of a trade or business. I don’t think falling outside of the safe harbor is dispositive—especially in light of the recent policy statement from Treasury regarding sub-regulatory guidance.

Wolters Kluwer: Can you speak to the some of the complexity that may be involved in tax planning with respect to achieving the right balance between adequate W-2 wages and QBI?

Tom West: Other than for small taxpayers, there is only a benefit under Section 199A if the limitations are met. It does not do any good to have QBI but then have insufficient W-2 wages and qualified property to meet the limitations. So when taxpayers are evaluating what constitutes a qualified trade or business (or whether to aggregate qualified trades or businesses) they will need to determine the amount of W-2 wages with respect to each QTB. Aligning the W-2 wages with the QTB will be important—but the salary expense will also result in a reduction in the amount of QBI and therefore the amount of any Section 199A benefit—so modeling becomes critical. Consideration should also be given to any collateral consequences—for instance the impact of the alignment on allocation and apportionment for state taxes.

Wolters Kluwer: According to a March 18, 2019, Treasury Inspector General for Tax Administration (TIGTA) report, Reference Number: 2019-44-022, IRS management indicated that the timeline related to the issuance of Section 199A guidance did not provide enough time for the IRS to develop a QBI deduction tax form. Although the IRS did create a worksheet, do you have a prediction on what key elements may be included on the new form once released?

Tom West: I do think that worksheets could be developed that would facilitate the reporting of Section 199A information—particularly through tiered structures—so as to ease the reporting burden and enhance compliance.

Wolters Kluwer: The IRS has estimated that nearly 23.7 million taxpayers may be eligible to claim the Section 199A deduction and that more than 22.2 million (94 percent) of those eligible taxpayers will not require a complex calculation for the deduction. What notable differences do you expect there are between "complex" and the majority of calculations?

Tom West: For taxpayers under the Section 199A income thresholds ($157.5K single, $315K joint), the deduction is very easy to calculate and claim. Those taxpayers don’t need to worry about being in an SSTB, how much wages they paid, or the basis of their property. Once those taxpayers hit those income thresholds though, even in the phase-out range, things very quickly get complex—and that’s as a consequence of the statute; it is not something that the regulators can change.

Wolters Kluwer: Do you anticipate the IRS will issue further guidance on the Section 199A deduction?

Tom West: I do. As I said at the top, I think part of the government’s motivation in finalizing these regulations so quickly was providing guidance to taxpayers ahead of the tax-filing season. And while for the majority of taxpayers who are below the 199A cap there is probably now sufficient guidance, I think there are still a lot of questions for those with more complex situations. Given the number of taxpayers who are eligible for this deduction, and the importance of Section 199A as the big benefit to non-corporate businesses in what the Administration views as a signature legislative achievement, I have to believe that the government will be responsive to taxpayers’ requests for additional help on this provision. However, given that the provision is due to sunset, it will be important that any guidance is forthcoming in fairly short order to be of any usefulness to taxpayers.

Wolters Kluwer: At this time, do you have any recommendations for taxpayers and practitioners moving forward?

Tom West: As people are going through their tax filings this year, I’d keep a list of issues, questions, and areas where additional guidance would be helpful. It often happens that problems with new legislation or regulations don’t reveal themselves until taxpayers have to put pencil to paper and track their real-world numbers through returns. We’ll all have that experience this year and, with those lists of issues and questions in hand, there may be an opportunity to approach the IRS and Treasury in the hopes of getting resolution going forward. Keeping that list could also help identify areas for tax planning and perhaps ease the complexity of filing for 2019.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

A bipartisan House bill has been introduced that would fix a GOP tax law drafting error known as the "retail glitch." The House bill, having over a dozen co-sponsors, is a companion measure to a bipartisan Senate bill introduced in March.

Immediate Expensing

The Restoring Investment in Improvements Act (HR 1869), sponsored by House tax writers Reps. Jimmy Panetta, D-Calif., and Jackie Walorski, R-Ind., would allow restaurants, retailers, and other leaseholders to immediately write off the cost of certain improvements. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), enacted at the end of 2017, inadvertently excludes qualified improvement property (QIP) from the new 100 percent bonus depreciation provision.

The measure is a "small but critical fix for our job creators, and technical corrections like this are a normal part of the process when Congress enacts major reforms," Walorski said in a recent press release. "This bipartisan, commonsense bill will allow restaurants, retailers, and other small businesses to unlock the full benefits of tax reform and continue driving our nation’s economic growth."

Similarly, Panetta highlighted the negative impact that the loss of immediate expensing has caused many small businesses. "Our bill will allow restaurants, retailers, and other businesses to make the improvements they need to keep their stores competitive and safe and plan for the future," he said.

Although the "retail glitch" measure has solid bipartisan support, Democrats in general have seemed hesitant to fix any errors in the GOP tax law. To that end, House Ways and Means Committee Chairman Richard Neal, D-Mass., has said he would like to hold a hearing on technical corrections for the TCJA. The committee’s March 27 hearing on the TCJA did not specifically address technical corrections.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

The House on April 9 approved by voice vote a bipartisan, bicameral IRS reform bill. The IRS bill, which now heads to the Senate, would redesign the IRS for the first time in over 20 years.

IRS Reform

The Taxpayer First Act of 2019 (HR 1957), as amended, cleared the House Ways and Means Committee by voice on April 2. The House and Senate both introduced the bicameral, bipartisan measure on March 28. If enacted, the bill would make numerous reforms to the IRS, some of which include modernizing antiquated information technology systems and enhancing taxpayer services and identity protections.

"With a new tax code, it is time for a new tax administrator," House Ways and Means Committee ranking member Kevin Brady, R-Tex., said in an April 9 statement. "I applaud the House for passing the Taxpayer First Act—a bold step to redesign the IRS to be an agency with one singular mission: putting taxpayers first."

The IRS Reform bill has been "years in the making," Brady said on April 9, echoing a joint statement that he and Ways and Means Chairman Richard Neal, D-Mass., along with other bipartisan tax writers recently issued. "The House Ways and Means Committee and the Senate Finance Committee have carefully and thoughtfully developed this legislation over several years, after numerous hearings and roundtables, in a bipartisan, bicameral manner," the lawmakers said.

AICPA Applauds Taxpayer First Act

The American Institute of CPAs (AICPA) issued an April 9 statement commending the House for passing HR 1957. "The AICPA appreciates the bipartisan recognition by members of the U.S. House of Representatives for bringing the Internal Revenue Service into the 21st Century," Edward S. Karl, vice president of taxation, said in a statement on behalf of the AICPA. "The AICPA has long been interested in and active in working to find ways to modernize the IRS so that it can better serve the needs of taxpayers and tax practitioners."

Free File Alliance

However, the bipartisan, bicameral bill has not advanced without its share of criticism. Several Democratic lawmakers have criticized a provision within the bill that would codify the Free File Alliance, which is an agreement between the IRS and certain tax preparation companies that includes the IRS being unable to directly assist in tax return preparation.

"Again and again in my service in the Senate I have battled the tax-preparation software industry to simplify filing taxes for the typical American," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said in an April 9 statement. "During the debate on the tax administration bill, my staff pushed back on a prohibition on the agency competing with private tax preparation services, and I will continue to push for my proposal for the pre-filed ‘simple’ return and the principle that a taxpayer should not have to use a private company to pay their taxes online," he added.

Looking Ahead

It remains unclear when the Senate will take up the Taxpayer First Act bill. However, the bill is presently expected on Capitol Hill to easily be approved in the Senate.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

Proposed regulations address gains that may be deferred when taxpayers invest in a qualified opportunity fund (QOF). Taxpayers may generally rely on these new proposed regulations. The IRS has also requested comments.

The proposed regulations also withdraw and replace placeholder provisions in an earlier set of proposed regulations ( REG-115420-18). These concern:

• the definition of "substantially all"regulations
• transactions that can trigger includible gain;
• the timing and amount of deferred gain that is included;
• treatment of leased property used in the qualified opportunity zone (QOZ) business;
• use of QOZ business property in the QOZ;
• sourcing of income to the QOZ business; and
• the reasonable period for a QOF to reinvest proceeds from the sale of qualifying assets.

In addition, within a few months the IRS expects to address administrative rules for a QOF that fails to maintain the required 90-percent investment standard, as well as information reporting requirements.

Finally, the IRS expects to revise Form 8996, Qualified Opportunity Fund, for 2019 and subsequent tax years. These revisions may require additional information, including the employer identification number (EIN) for the QOF business, and the amounts invested by QOFs and QOZ businesses located in particular QOZs.

"Substantially All" for QOZ Business

The 2018 regulations provided that a trade or business satisfies the "substantially all" test for a QOZ business if at least 70 percent of its tangible property is qualified opportunity zone business property. The new proposed regulations generally extend this 70-percent threshold to the "substantially all" tests for use. However, in the holding period context, the "substantially all" threshold is 90 percent.

Original Use of Purchased Tangible Property

The proposed regulations generally provide that the "original use" of tangible property acquired by purchase by any person starts on the date when that person or a prior person:

• first places the property in service in the qualified opportunity zone for purposes of depreciation or amortization; or
• first uses the property in the qualified opportunity zone in a manner that would allow depreciation or amortization if that person were the property’s owner.

Used tangible property will satisfy the original use requirement with respect to a QOZ so long as the property has not been previously used (that is, has not previously been used within that QOZ in a manner that would have allowed it to depreciated or amortized) by any taxpayer

In addition, a building or other structure that has been vacant for at least five years before being purchased by a QOF or QOZ business satisfies the original use requirement. Improvements made by a lessee to leased property satisfy the original use requirement and are considered purchased property for the amount of the unadjusted cost basis of the improvements.

Land can be treated as QOZ business property only if it is used in a trade or business of a QOF or QOZ business. The holding of land for investment does not give rise to a trade or business, and the land cannot be QOZ business property. Anti-abuse rules determine whether unimproved land can be qualifying property. However, other purchased real property generally must be substantially improved, determined on an asset-by-asset basis.

Leased Tangible Property in QOZ

Leased tangible property may be QOZ property if:

• the lease is entered into after 2017; and
• substantially all of the property’s use is in a QOZ during substantially all of the lease period.

However, the first-use requirement does not apply to leased tangible property. The leased property can generally also be acquired from a related person, though several conditions apply. The proposed regulations also provide methods for valuing the leased property.

QOZ Businesses

The proposed regulations:

• provide that in determining whether a substantial portion of intangible property of a QOZ is used in the active conduct of a trade or business, a substantial portion is at least 40 percent;
• address real property that straddles a QOZ;
• provide three safe harbors and a facts-and-circumstances test for determining whether a corporation or partnership derives at least 50 percent of its gross income from the active conduct of a qualified business;
• define "trade or business" by reference to Code Sec. 162, except that the ownership and operation (including leasing) of real property used in a trade or business can also be the active conduct of a trade or business; and
• provide a safe harbor for working capital.

Other Business Rules

The proposed regulations also address:

• Section 1231 gains;
• relief regarding the 90 percent asset test, including relief for newly contributed assets and QOF reinvestments;
• the amount of an investment for purposes of the deferral election;
• inclusion events, the timing on basis adjustments, includible amounts, and special rules for partnerships and S corporations;
• gifts and bequests;
• exceptions for disregarded transfers and some nonrecognition transactions;
• distributions and contributions;
• consolidated return provisions;
• holding periods and tacking rules;
• anti-abuse rules;
• special rules for Indian tribes and tribally leased property.

Comments Requested; Public Hearing Scheduled

A public hearing on the proposed regulations is scheduled for 10 am on July 9, 2019, at the New Carrollton Federal Building in Latnham, MD. Public comments may be mailed or hand-delivered to the IRS, or submitted via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-120186-18).

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.

Value of Professional Sports Contracts

Professional sports teams enter into contracts with their personnel (e.g., managers, coaches, players, etc.). Typical personnel contracts provide an agreed-upon amount of compensation for a certain duration of service. The value of such a contract may fluctuate based on a variety of factors, including:

• player performance;
• the changing needs of the team and of other teams;
• a player’s effect on fan attendance; and
• the number of years until a player becomes a free agent and is able to sign a contract to play for any team in a league.

Other considerations affecting the value of a player contract include:

• the size of the team’s market (i.e., whether a smaller city or a major urban population);
• the cost of player development; and
• the impact of injuries and slumps on player performance.

In most cases, teams do not trade personnel contracts or draft picks unless the team thinks that it is receiving contracts of an equal or greater value. Because each party believes that they are receiving personnel contracts or draft picks of an equal or greater value, it is difficult to assign a monetary value to them. Accordingly, the IRS developed a safe harbor whereby each team is able to treat the traded contracts or draft picks as having a basis of zero, thus avoiding the recognition of gain or loss on the trade.

Safe Harbor Requirements

In order to use the safe harbor, professional sports teams must meet the following requirements:

• all teams involved in the trade must use the safe harbor;
• teams may only trade personnel contracts, draft picks, and/or cash;
• personnel contracts and/or draft picks cannot be Code Sec. 197 intangibles; and
• the financial statements of all teams involved in the trade must not reflect assets or liabilities resulting from the trade other than cash.

Application

Sports teams using the safe harbor will not recognize any gain or loss if they only trade personnel contracts or draft picks. However, teams that receive cash in a trade will recognize the amount of cash received as gain. In addition, the team providing cash to another team in the trade will receive basis in the personnel contract or draft pick equal to the amount of cash that it provided. A team providing cash to another team in a trade for two or more draft picks or personnel contracts must allocate its basis to each personnel contract or draft pick received from the other team by dividing the basis by the number of personnel contracts or draft picks received.

In certain cases, a team may have unrecovered basis in a draft pick or personnel contract under Code Sec. 167(c). In those instances, the team may recognize gain or loss based on the difference between the unrecovered basis and any cash received.

Effective Date

Teams may use the safe harbor for any trades involving personnel contracts or draft picks entered into after April 10, 2019. However, teams may choose to apply these rules in any open tax year.

Amounts received as an annuity are included in gross income to the extent that they exceed the exclusion ratio, which is determined by taking the original investment in the contract, deducting the value of any refund features, and dividing the result by the expected yield on the contract as of the annuity starting date. In general, the expected return is the product of a single payment and the anticipated number of payments to be received, i.e., the total amount the annuitant can expect to receive. In the case of a life annuity, the number of payments is computed based on actuarial tables provided in IRS Regulation Sec. 1.72-9.

If a contract provides for fixed payments to be made to an annuitant for a guaranteed period but specifies that the payments will cease on the annuitant's death, the expected return is computed as if the arrangement were a temporary life annuity rather than a fixed term annuity.  The applicable IRS tables under Regulation Sec. 1.72-9 contain multiples based on the guaranteed period (rounded to the nearest whole number of years) and age at the annuity starting date.  The expected return under the contract is the product of this multiple and the total annual amount of annuity payments.

Example:  Smith is to receive $100 each month for five years, beginning on his 60th birthday, but the payments will cease abruptly and all obligations will be terminated on his death.  Either Pursuant to Table IV under IRS Regulations Sec. 1.7209, a 60-year-old male receiving payments for a term of five years can expect to live 4.8 of those five years; that multiple multiplied by $1,200 yields an anticipated return of $5,760.  If Table VIII is applicable, the expected return is $5,880, based on a multiple of 4.9.

Another form of annuity provides for fixed periodic payments for the duration of the recipient's life, but for a changing amount: payments of a first amount for an initial guaranteed period, followed by payments of a reduced amount thereafter.  In determining the expected return, the contract is treated as a combination of two annuities: (1) a whole life annuity providing payments at the lower amount, commencing at the annuity starting date; and (2) a separate temporary life annuity, of the kind discussed above, providing payments in the amount of the difference between the two specified amounts.

Q: After what period is my federal tax return safe from audit? A: Generally, the time-frame within which the IRS can examine a federal tax return you have filed is three years. To be more specific, Code Sec. 6501 states that the IRS has three years from the later of the deadline for filing the return (usually April 15th for individuals) or, if later, the date you actually filed the return on a requested filing extension or otherwise. This means that if you file your 2014 return on July 10, 2015, the IRS will have until July 10, 2018 to look at it and "assess a deficiency;" not April 15, 2018.

Q: After what period is my federal tax return safe from audit?

A: Generally, the time-frame within which the IRS can examine a federal tax return you have filed is three years. To be more specific, Code Sec. 6501 states that the IRS has three years from the later of the deadline for filing the return (usually April 15th for individuals) or, if later, the date you actually filed the return on a requested filing extension or otherwise. This means that if you file your 2014 return on July 10, 2015, the IRS will have until July 10, 2018 to look at it and "assess a deficiency;" not April 15, 2018.

There are exceptions and caveats to this general principle, however. If you file prior to April 15, the IRS still has until April 15 of the third year that follows to audit your return. This means that if you filed an income tax return on February 10, 2017, you still won't be out-of-the-woods until April 15, 2020. For taxpayers who file fraudulent returns, incorrect returns with the intent to evade tax, and those who do not file at all, the IRS may open an audit at any time.

(Don't confuse the deadline for IRS tax assessments with your right to file a refund claim for an amount that you overpaid, either on a filed return or through withholding or estimated tax payments. That deadline is the later of three years from the filing deadline or two years from your last tax payment.)

You may also find some comfort in the practical IRS audit-cycle rhythm. While you are never truly beyond an audit until the statute of limitations has properly run, there are some general standards to keep in mind. Office audits are usually done within 1 1/2 years of the time the return was filed, and field office audits are complete by 2 1/2 years. The rule of thumb is that if you haven't been contacted within this time frame, you're probably not going to be. Especially for small businesses, the IRS has promised to shorten its normal audit cycle so that those taxpayers are not "left hanging" on potential tax liabilities (with interest and penalties) until the three-year limitations period has expired. Whether this shortened period happens, however, is still open to speculation. Most businesses should continue to make it a practice to keep "tax reserves" to cover such audit liabilities.

The closely-held corporate form of entity is widely used by family-owned businesses. As its name implies, the owners of the business are typically limited to a small group of shareholders. Many businesses operate for years as closely-held corporations without giving a second thought to a little-known danger: the personal holding company tax.

The personal holding company tax lurks in the background to prevent the use of closely-held family corporations as reservoirs in which to collect investment income. The government wants corporations to distribute income rather than enabling shareholders to build an investment portfolio subject only to the corporate income tax.

The tax is triggered by a corporation's percentage of investment to total income. It is imposed on undistributed earnings and is added to the regular corporate tax. One frequent trigger for the personal holding company tax is the accumulation of income earmarked for expanding the business. Despite its ominous nature, the tax can be anticipated and maybe even averted through strategic planning.

Some triggers

Here are some scenarios that have unfortunately triggered the personal holding company tax for other businesses:

• A consolidated return group becomes unaffiliated, or an ineligible group, as the result of a change in stock ownership or a line of business
  
• A large amount of insurance proceeds are invested until replacement property can be purchased
  
• For asset protection purposes, a corporation holds investment assets or operating equipment without engaging in other operations
  
• During a plan of liquidation, a line of business is sold and the sale proceeds are invested while management is attempting to sell remaining assets or businesses
  
• As part of a plan to invest in a new line of business, a line of business is sold and the sale proceeds are invested while management is attempting to acquire a business or grow its new line of business

Two tests

It's important to remember that any corporation can be a personal holding company. The IRS has developed two tests: (1) an income test and (2) an ownership test.

Income test

The income test is met if 60 percent or more of the corporation's adjusted ordinary gross income is "personal holding company income." This type of income is frequently derived from investment properties and includes:

• Interest, dividends and royalties,
• Rents,
• Mineral, oil and gas royalties,
• Copyright royalties,
• Produced film rents,
• Amounts received in compensation for use of the corporation's property,
• Compensation from personal contracts, where the corporation is not a personal service company, and
• Estate and trust income.

There are some important exceptions to this list. Some types of royalties, for example, are excluded.

Note. The PHC income test is not a test of gross receipts. The income test compares gross receipts less the cost of goods sold to investment income less its direct costs. Gross profit margins are significant to the test and investment activities generally have few direct costs. Thus, an increase in investment income is leveraged for purposes of the PHC income test and an increase in investment income that is insignificant to total gross income can cause investment income to exceed 60 percent of adjusted gross income (AGI). Manufacturing businesses are at a disadvantage. Because of high cost of goods sold when compared to a service business that has little or no costs of goods sold.

Ownership test

The ownership test is met if five or fewer individuals owned more than 50 percent of the corporation's stock value at any time during the last half of the tax year. The ownership test also has some important exceptions. Some important - and common - types of corporations are excluded:

• S corporations,
• Tax-exempt corporations,
• Banks, lending or finance companies,
• Small business investment companies, and
• Corporations in bankruptcy.

The personal holding company tax doesn't have to be an unwelcome and expensive surprise. If your business has experienced - or is planning - any of the events that could trigger the tax, give our office a call.  Careful planning can help avoid or minimize the tax; at any rate, it can alert you to your possible liability for the tax.

Many people are surprised to learn that some "luxury" items can be deductible business expenses. Of course, moderation is key. Excessive spending is sure to attract the IRS's attention. As some recent high-profile court cases have shown, the government isn't timid in its crackdown on business owners using company funds for personal travel and entertainment.

First class travel

The IRS doesn't require that your business travel be the cheapest mode of transportation. If it did, businesspeople would be traveling across the country by bus instead of by plane. However, the expense as it is relative to the business purpose must be reasonable. Taking the Queen Mary II across the Atlantic to a business meeting in the U.K. could raise a red flag at the IRS.

As long as your business is turning a profit and is operated legitimately as a business and not a hobby, traveling first class generally is permissible. Even though a coach airline seat will get you to your business appointment just as quickly and an inexpensive hotel room is a place to sleep, the IRS generally won't try to reduce your deduction.

However, if your trip lacks a business purpose, the IRS will deny your travel-related deductions. Don't try to disguise a family vacation as a business trip. Many people are tempted; it's not worth the consequences, especially in today's environment where the IRS is aggressively looking for business abuses.

Conventions

Convention expenses are deductible if a sufficient relationship exists to your profession or business and the convention is in North America. No deduction is allowed for attending conventions or seminars about managing your personal investments.

Overseas conventions definitely get the IRS's attention. If you want to deduct the costs of attending a foreign convention, you have to show that the convention is directly related to your business and it is as reasonable to hold the convention outside North America as within North America.

Country clubs expenses

Country club dues are not deductible. In fact, no part of your dues for clubs organized for business, pleasure, recreation, or social purposes is deductible.

Some country club costs may be partially deductible if you can show a direct business purpose and you meet some tough written substantiation requirements. These include greens fees as well as food and beverage expenses. They may be deductible up to 50 percent.

Meals and entertainment

Younger colleagues don't remember when business meals were 100 percent deductible and deals were brokered at "three martini lunches." Meals haven't been 100 percent deductible for a long time and, like other entertainment expenses, the IRS combs them carefully for abuses.

Expenditures for meals, entertainment, amusement, and recreation are not deductible unless they are directly related to, or associated with, the active conduct of your business. The IRS also requires you to keep a written or electronic log, made at the time you make the expenditure, recording the time, place, amount and business purpose of each expense.

Even if you pass the two tests, only 50 percent of meal and entertainment expenses are deductible.  If you write-off business meals through your company and there is a proper reimbursement arrangement in place, you won't be charged with any imputed income for the half that is not deductible, but your company will be limited to a 50 percent write-off.

Whether a parent who employs his or her child in a family business must withhold FICA and pay FUTA taxes will depend on the age of the teenager, the amount of income the teenager earns and the type of business.

FICA and FUTA taxes

A child under age 18 working for a parent is not subject to FICA so long as the parent's business is a sole proprietorship or a partnership in which each partner is a parent of the child (if there are additional partners, the taxes must be withheld). FUTA does not have to be paid until the child reaches age 21. These rules apply to a child's services in a trade or business.

If the child's services are for other than a trade or business, such as domestic work in the parent's private home, FICA and FUTA taxes do not apply until the child reaches 21.

The rules are also different if the child is employed by a corporation controlled by his or her parent. In this case, FICA and FUTA taxes must be paid.

Federal income taxes

Federal income taxes should be withheld, regardless of the age of the child, unless the child is subject to an exemption. Students are not automatically exempt, though. The teenager has to show that he or she expects no federal income tax liability for the current tax year and that the teenager had no income tax liability the prior tax year either. Additionally, the teenager cannot claim an exemption from withholding if he or she can be claimed as a dependent on another person's return, has more than $250 unearned income, and has income from both earned and unearned sources totaling more than $800.

Bona fide employee

Remember also, that whenever a parent employs his or her child, the child must be a bona fide employee, and the employer-employee relationship must be established or the IRS will not allow the business expense deduction for the child's wages or salary. To establish a standard employer-employee relationship, the parent should assign regular duties and hours to the child, and the pay must be reasonable with the industry norm for the work. Too generous pay will be disallowed by the IRS.

Owning a vacation home is a common dream that many people share...a special place to get away from the weekday routine, relax and maybe, after you retire, a new place to call home. When thinking about buying a vacation home, you should also think about what you will ultimately do with it. Will it one day be your principal residence? Will you sell it in five, 10 or 20 years? Will you rent it? Will you leave it to your children or other family members? These decisions have important tax consequences.

You'll want to think about:

Capital gains

The maximum long-term capital gains tax rate for 2009 is currently 15 percent taxpayers in the highest brackets. For taxpayers in the 10 and 15 percent brackets, the maximum long-term capital gains rate is zero through 2010. However, these lower rates expire at the end of 2010. The maximum rate is set to rise to 20 percent in 2011. Congress also eliminated a special holding period rule but, again, only through the end of 2011.

The process of computing capital gains because of all these changes is very complicated. Yet, "doing the math" up front in assessing the benefits of a vacation home as a long term investment as well as a source of personal enjoyment is recommended before committing to such a large purchase. Our office can help you make the correct computations.

Renting your vacation home

Renting your vacation home to help defray some or a good portion of your carrying costs, especially in the early years of ownership, can be a sound strategy. Be aware, however, that renting raises many complex tax questions. Special rules limit the deduction you can take. The rules are based on how long you rent the property. If you rent your vacation home for fewer than 15 days during the year, all deductions directly attributable to the rental are not allowed, but you don't have to report any rental income. If you rent your vacation home for more than 15 days, you must recognize the rental income while being allowed deductions only on certain items depending on your personal use of the property. The methodology is very complicated. We can help you pin down your deductions and plan the true cost of ownership, especially if you're planning to swing a vacation home purchase on plans to rent it out.

Home sale exclusion

One of the most generous federal tax breaks for homeowners is the home sale exclusion. If you're single, you can generally exclude up to $250,000 of gain from the sale of your principal residence ($500,000 for married joint filers). Generally, you have to have owned your home for at least two of the five years before the sale, but like all the tax rules, there are exceptions.

Congress modified the home sale exclusion for home sales occurring after December 31, 2008. Under the new law, gain from the sale of a principal residence home will no longer be excluded from gross income for periods that the home is not used as a principal residence. This is referred to as "non-qualifying use." The rule is intended to prevent use of the home sale exclusion of gain for appreciation attributable to periods after 2008 during which the residence was used as a vacation home, or as a rental property before being used as a principal residence. However, the new income inclusion rule is based only on periods of nonqualified use that start on or after January 1, 2009, good news for vacation homeowners who have already owned their properties for a number of years.

Buying a vacation home is a big investment. We can help you explore all these and other important tax consequences.

A remainder interest is the interest you receive in property when a grantor transfers property to a third person for a specified length of time with the provision that you receive full possessory rights at the end of that period. The remainder is "vested" if there are no other requirements you must satisfy in order to receive possession at the end of that period, such as surviving to the end of the term. This intervening period may be for a given number of years, or it may be for the life of the third person. Most often, this situation arises with real estate, although other types of property may be transferred in this fashion as well, such as income-producing property held in trust. The holder of a remainder interest may wish to sell that interest at some point, whether before or after the right to possession has inured.

To determine the amount of gain or loss on the sale of an interest in property, you must first need to know the basis in that property. Generally, the basis of property is either the transferor's basis, if the transferor made a gift of the property while still living, or the fair market value at the time of the transfer if it was a testamentary gift. However, the value of a remainder interest is not the full value of the property, because someone else has an intervening right to its use.

The value of the remainder interest is equal to the undivided value of the property minus the value of the intervening interest. The value of this interest depends on applicable interest rates and the duration of the interest. In the case of a life estate, the duration depends on the age of the recipient and is determined with reference to mortality tables published in the Treasury regulations. The applicable interest rate is specified in Code Sec. 7520 as being 120 percent of the applicable federal rate (AFR) for that month, rounded to the nearest 0.2 percent. You may find these tables at the IRS web site.

IRS Pub. 1457 is known as Actuarial Values Book Aleph and contains tables that express the values of life estates, term interests and remainders. In this publication, you will need to select the appropriate section based on whether the interest is a term for years or a life estate. In each section is a series of tables based on interest rates ranging from 2.2 to 22.2 percent. Find the age of the life estate holder or duration of the term in the first column of the table. Next to it, under the column for remainder interests, is a decimal representation of the fractional interest represented by the remainder. Multiply this decimal by the basis of the property and you have the basis of the remainder interest.

Examples: Bob's grandfather died in March of 2009 and left a house valued at $100,000 to his mother for life, with the remainder interest to Bob. Bob's mother is 65 years old. The Sec. 7520 rate for that month is 2.4 percent, and the fractional value of the remainder is .67881. The value of Bob's interest in the house is $67,881.

For U.S. taxpayers, owning assets held in foreign countries may have a variety of benefits, from ease of use for frequent travelers or those employed abroad to diversification of an investment portfolio. There are, however, additional rules and requirements to follow in connection with the payment of taxes. Some of these rules are very different from those for similar types of domestic income, and more than a few are quite complex.

Two documents do not apply directly to federal income taxation, but are nevertheless highly important. The first of these is a Treasury form, Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts. Any individual or organization that owns or has control over a bank or brokerage account must complete this form if the aggregate value of all such accounts under that taxpayer's ownership or control exceeds $10,000. The second such form is not a requirement per se, but taxpayers who have income in a foreign country with which the United States has a treaty would be seriously remiss in failing to complete it. IRS Form 8802, Application for United States Residency Certification, helps to speed and simplify the application process for eligible taxpayers claiming the benefits of tax treaties in connection with foreign taxes paid. Requirements for organizations that may have dual or layered status offer complications that depend on the type of entity, so these instructions must be parsed carefully.

Taxes on real and personal property held overseas are treated quite differently for purposes of federal income taxation, as opposed to the treatment of domestic property. Individuals may claim foreign real property taxes as itemized deductions on Schedule A of Form 1040, just as they would with U.S. real estate. However, taxes on personal property may only be deductible if used in connection with a trade or business or in the production of income.

U.S. taxpayers who own homes in foreign countries are eligible for the capital gains exclusion on the sale of a principal residence subject to the same requirements as domestic homeowners. Likewise, if a taxpayer derives rental income from a home, the rules for reporting income and deductions are the same. However, claiming depreciation expenses in connection with rental income subjects taxpayers to a different set of rules. Code Sec. 168(g) indicates that tangible property used predominantly outside the United States must be depreciated using the alternative depreciation system (ADS), rather than the modified accelerated cost recovery system (MACRS), and involves longer recovery periods. This is true whether the tangible property in question is the residence itself or household appliances contained therein, as well as any other tangible property.

Intangible property such as patents, licenses, trademarks, copyrights and securities produce a variety of types of income, and the taxation of such income may be subject to different rules than similar domestic income. The provisions for taxation of foreign income are often subject to modification by treaty, and the United States has negotiated treaties with over sixty nations.

Income from all sources must be reported in U.S. dollars, regardless of how it is paid. One exception to this rule is that if income is received in a currency that is not convertible to U.S. dollars because of prohibitions placed on conversion by the issuing country, then the taxpayer may choose when to report the income. The income may be reported either in the year earned, according to the most accurate valuation means available, with the taxes paid from other income, or the taxpayer may choose to wait until the currency becomes convertible again.