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Final regulations dealing with the 100 percent bonus depreciation allowance for qualified property acquired and placed in service after September 27, 2017, allow property which is constructed under a pre-September 28, 2017 binding contract to qualify for the 100 percent rate. The final regulations adopt proposed regulations ( REG-104397-18) with certain modifications, including a revised constructed property rule. In addition, the IRS has issued a new set of proposed regulations dealing with issues it is not ready to finalize.

FINAL REGULATIONS: Written Binding Contract Rules
Constructed property. The proposed regulations provided that property manufactured, constructed, or produced for the taxpayer by another person under a written binding contract entered into prior to the manufacture, etc., of the property is acquired pursuant to a written binding contract. Thus, if the contract was entered into before September 28, 2017, the 100 bonus rate did not apply.

That rule was scrapped in response to negative feedback. Instead the final regulations provide that such property is treated as self-constructed property, and the contract is ignored for purposes of determining when the property is deemed acquired. The acquisition date is now the date that the taxpayer begins manufacturing, constructing, or producing the property as determined under rules similar to those that apply to 50 percent bonus property.

Acquisition date. The final regulations provide that the acquisition date of property acquired pursuant to a written binding contract is the later of:

the date on which the contract is entered into;
the date on which the contract is enforceable under state law;
if the contract has one or more cancellation periods, the date on which all cancellation periods end; or
if the contract has one or more contingency clauses, the date on which all conditions subject to such clauses are satisfied.

Liquidated damage clause. When a contract has multiple damage provisions, the final regulations clarify that only the provision with the highest damages is taken into account in determining whether the contract limits damages.

Qualified Improvement Property
The IRS once again declined to make qualified improvement property placed in service after 2017 eligible for bonus depreciation. A legislative change is required to give this property its intended 15-year recovery period. With a 15-year recovery period, qualified improvement property will qualify for bonus depreciation under the general rule that allows bonus depreciation on property with an MACRS recovery period of 20 years or less.

Used Property
Predecessor defined. Property previously used by the taxpayer or a predecessor of a taxpayer does not qualify for bonus depreciation if the taxpayer or predecessor had a depreciable interest in the property. The final regulations define "predecessor" as:

a transferor of an asset to a transferee in a transaction to which Code Sec. 381(a) applies;
a transferor of an asset to a transferee in a transaction in which the transferee’s basis in the asset is determined, in whole or in part, by reference to the basis of the asset in the transferor’s hands;
a partnership that is considered as continuing under Code Sec. 708(b)(2);
the decedent in the case of an asset acquired by an estate; or
a transferor of an asset to a trust.

Depreciable interest look back rule. The final regulations do not define a "depreciable interest" because this is a facts and circumstances issue. However, a five-year look back period is provided for determining whether a taxpayer or predecessor held a depreciable interest in property.

Substantially renovated property. If a taxpayer places substantially renovated property in service and the taxpayer or a predecessor previously had a depreciable interest in the property before it was substantially renovated, the taxpayer’s or predecessor’s prior depreciable interest does not prevent the taxpayer from claiming bonus depreciation. Property is substantially renovated if the cost of the used parts is not more than 20 percent of the total cost of the substantially renovated property, whether acquired or self-constructed.

Syndication transactions. A lessor who reacquires property in a syndication transaction is not treated as having a prior depreciable interest in the property.

Partnerships
The final regulations permit a partnership to claim bonus depreciation on the portion of a Code Sec. 743(b) basis increase that is attributable to built-in gain under Code Sec. 704(c), even if the partnership is using the remedial allocation method. An exception is provided for publicly traded partnerships that need to maintain fungibility for publicly traded partnership units.

If a partnership interest is acquired and disposed of during the same tax year, the bonus deduction is not allowed for any Code Sec. 743(b) adjustment arising from the initial acquisition. However, if a partnership interest is purchased and disposed of in a "step-in-the shoes" Code Sec. 168(i)(7) transaction in the same tax year, bonus on the section 743(b) adjustment is allowed. The section 743(b) adjustment is apportioned between the purchaser/transferor and the transferee.

The final regulations also clarify the treatment of qualified property transferred in a Code Sec. 721(a) transaction to a partnership in the same tax year that the qualified property is acquired by the transferor if the partnership has another partner who previously had a depreciable interest in the qualified property. In this situation, the qualified property is deemed placed in service by the transferor during that tax year, and the bonus deduction is allocated entirely to the transferor and not to the partnership. Thus, the contributing partner has contributed property with a zero basis to the partnership, and the contributed property is Code Sec. 704(c) property in the hands of the partnership.

Film, Television, and Theatrical Productions
The final regulations clarify that a used qualified film, television, or live theatrical production does not qualify for bonus depreciation. Also, the basis of a qualified film, television, or live theatrical production is reduced by the deduction claimed under Code Sec. 181 before computing the bonus deduction.

Using ADS
Using the alternative depreciation system (ADS) to determine the adjusted basis of a taxpayer’s qualified business investment (under Code Sec. 250(b)(2)(B) or Code Sec. 951A(d)(3)) or the adjusted basis of a taxpayer’s tangible assets for allocating business interests expense between excepted and non-excepted trades or businesses (under Code Sec. 163(j)) does not cause a taxpayer’s tangible property to be ineligible for bonus depreciation.

Public Utility Property
An example is added to clarify that the 100 percent bonus rate does not apply to self-constructed property of a regulated public utility if construction begins after September 27, 2017, and the property is placed in service in a tax year beginning after 2017.

Effective Date
The final regulations apply to qualified property placed in service during or after the tax year that includes the date of publication in the Federal Register. However, a taxpayer may choose to apply the final regulations in their entirety to qualified property acquired and placed in service after September 27, 2017, provided the taxpayer consistently applies all rules in the final regulations. Additionally, a taxpayer may rely on the proposed regulations issued on August 8, 2018, to qualified property acquired and placed in service after September 27, 2017, in tax years ending before the date of publication of the final regulations.

PROPOSED REGULATIONS: Acquired and Self-Constructed Components
A taxpayer may elect to treat components of a larger self-constructed property that are acquired or self constructed after September 27, 2017, as eligible for the 100 percent bonus rate, even though manufacture, construction, or production of the larger self-constructed began before September 28, 2017. The larger property must be eligible for bonus depreciation at the 50 percent rate.

Businesses With Floor Plan Financing
Property used in a trade or business that has had floor plan financing indebtedness does not qualify for bonus depreciation if the floor plan financing interest related to the indebtedness is taken into account under Code Sec. 163(j)(1)(C) in determining the allowable business interest deduction.

The proposals provide rules for determining whether interest in floor plan financing indebtedness has been taken into account during a tax year. In general, floor plan interest is not considered taken into account for a tax year if the sum of interest business income for the tax year and 30 percent of the adjusted taxable income for the tax year equals or exceeds business interest as defined in Code Sec. 163(j)(5). The proposals clarify that the determination of whether a trade or business that has had floor plan financing indebtedness has taken floor plan financing interest into account is made annually.

Leased Property
The proposals clarify that taxpayers leasing property to a trade or business with floor plan financing indebtedness or a rate-regulated utility may claim bonus depreciation. The taxpayer, however, may not be a trade or business with floor plan financing indebtedness that prevents it from claiming bonus depreciation or a rate-regulated utility.

Used Property
Five-year lookback. A safe harbor provides that a taxpayer who disposes of property within 90 days after placing it in service did not hold a prior depreciable interest in the property. Consequently, the property is eligible for bonus depreciation if subsequently reacquired.

Partnerships. A taxpayer has a prior depreciable interest in a portion of property if the taxpayer was a partner in a partnership at any time the partnership owned the property. The amount of the prior depreciable interest is based on the partner’s total share of depreciation deductions with respect to the property.

Series of related transactions. Special rules in the original proposed regulations governing the treatment of a series of related transactions for purposes of the used property acquisition requirements are modified and expanded.

Consolidated groups. Significant clarifications to the rules governing the used property acquisition requirements for consolidated groups are also made.

Written Binding Contract Rules
Property not acquired pursuant to a contract. The acquisition date of property that is not acquired pursuant to a written binding contract is the date on which the taxpayer paid or incurred more than 10 percent of the total cost of the property. The cost of land and preliminary activities are excluded from cost for this purpose.

Purchase of entities. Binding contract rules that apply to the purchase of an entity are proposed. The current binding contract rules only deal with purchases of assets.

A contract to acquire all or substantially all of the assets of a trade or business, or to acquire an entity such as a corporation, a partnership, or a limited liability company, is binding if it is enforceable under state law against the parties to the contract. The presence of a condition outside the parties’ control (including, for example, regulatory agency approval) will not prevent the contract from being a binding contract. Further, the fact that insubstantial terms remain to be negotiated by the parties to the contract, or that customary conditions remain to be satisfied, does not prevent the contract from being a binding contract. This proposed rule also applies to a contract for the sale of the stock of a corporation that is treated as an asset sale as a result of a deemed asset acquisition election under Code Sec. 338.

Long Production Property
The proposals provide rules for determining qualifying basis attributable to the manufacture, construction, or production of long production property and certain aircraft eligible for an extended placed in service deadline.

Mid-Quarter Convention
The mid-quarter convention applies to property placed in service during the tax year if 40 percent or more of the basis of the property was placed in service in the last three months of the tax year. The proposals clarify that the basis of property is not reduced by the 100 percent bonus allowance. This rule has always applied to 50 percent bonus property.

Effective Date of Proposals
In general, the proposed regulations apply to qualified property placed in service during or after the tax year that includes the date the proposals are finalized. A taxpayer may rely on the proposals in their entirety to qualified property acquired and placed in service after September 27, 2017.

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Proposed regulations would provide guidance on the inclusion of income and deduction items in the calculation of built-in gains and losses under Code Sec. 382(h). The proposed regulations would:

simplify the application of Code Sec. 382;
provide more certainty to taxpayers in determining built-in gains and losses for Code Sec. 382(h) purposes; and
ensure that the application of certain law changes made by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA) does not further complicate the application of Code Sec. 382(h).

Taxpayers may rely on these proposed regulations until final regulations are issued. When these proposed regulations are adopted as final regulations, it is expected that Notice 87-79, 1987-2 CB 387, Notice 90-27, 1990-1 CB 336, Notice 2003-65, 2003-2 CB 747, and Notice 2018-30, 2018-21 I.R.B. 610, will be withdrawn and declared obsolete.

Built-in Gains and Losses
Generally, Code Sec. 382 imposes a value-based limitation (section 382 limitation) on the ability of a loss corporation to offset its taxable income in periods subsequent to an ownership change with losses attributable to periods prior to that ownership change.

Code Sec. 382(h) provides rules relating to the determination of a loss corporation’s built-in gains and losses as of the date of the ownership change (change date). In general, built-in gains recognized during the five-year period beginning on the change date (recognition period) allow a loss corporation to increase its section 382 limitation. Built-in losses recognized during the recognition period are subject to the loss corporation’s section 382 limitation.

Specifically, if a loss corporation has a net unrealized built-in gain (NUBIG), the section 382 limitation for any tax year ending during the recognition period is increased by the recognized built-in gain (RBIG) for the year, with cumulative increases limited to the amount of the NUBIG. If a loss corporation has a net unrealized built-in loss (NUBIL), the use of any recognized built-in loss (RBIL) during the recognition period is subject to the section 382 limitation.

IRS Guidance and TCJA
Notice 2003-65 provides interim guidance on the identification of built-in gains and losses under Code Sec. 382(h). This notice permits taxpayers to rely on safe harbor approaches for applying Code Sec. 382(h) to an ownership change prior to the effective date of temporary or final regulations issued under that provision.

Notice 2003-65 provides (i) a single safe harbor for computing the NUBIG or NUBIL of a loss corporation, based on principles underlying the calculation of net recognized built-in gain under Code Sec. 1374, and (ii) two safe harbors for the computation of a loss corporation’s RBIG or RBIL: the 1374 approach and the 338 approach.

The 1374 approach identifies RBIG and RBIL at the time of the disposition of a loss corporation’s assets during the recognition period. Generally, this approach relies on accrual method of accounting principles to identify built-in income and deduction items at the time of the ownership change, with certain exceptions.

In contrast, the 338 approach identifies items of RBIG and RBIL generally by comparing the loss corporation’s actual items of income, gain, deduction, and loss recognized during the recognition period with those that would have been recognized had an election under Code Sec. 338 (section 338 election) been made with respect to a hypothetical purchase of all of the outstanding stock of the loss corporation on the change date.

Taxpayers may rely on either the 338 approach or the 1374 approach until the IRS issues temporary or final regulations under Code Sec. 382(h). Compared to the 338 approach, the accrual-based 1374 approach is simpler to apply and administer and provides greater certainty for taxpayers.

Prior to the issuance of Notice 2003-65, the IRS had issued Notice 87-79 and Notice 90-27, which provided much more limited guidance regarding the determination of built-in gains and losses. After the TCJA, the IRS issued Notice 2018-30, which makes the 338 approach unavailable when computing items arising from bonus depreciation under Code Sec. 168(k).

The law changes made by the TCJA created additional uncertainty regarding the application of Code Sec. 382 in general, and Notice 2003-65 in particular. Specifically, certain important changes under the TCJA could potentially compromise the mechanics of the 338 approach and further complicate its application.

1374 Approach
For purposes of computing NUBIG and NUBIL, the proposed regulations would adopt as mandatory the NUBIG/NUBIL safe harbor and the 1374 approach described in Notice 2003-65, with certain modifications. These modifications would include technical fixes to calculations involving cancellation of indebtedness (COD) income, deductions for contingent liabilities, and cost recovery deductions. Additionally, the proposed regulations would clarify that carryovers of Code Sec. 163(j) disallowed business interest are counted only once for purposes of Code Sec. 382.

The modifications to the existing NUBIG/NUBIL safe harbor and the 1374 approach would ensure greater consistency between:

amounts that are included in the NUBIG/NUBIL computation; and
items that could become RBIG or RBIL during the recognition period.

Comment
According to the IRS, the proposed regulations would modestly restrict net operating loss usage by reducing the amount that would qualify as RBIG, reducing the incentive to engage in inefficient, tax-motivated mergers and acquisitions.

NUBIG or NUBIL Computation
The proposed rules for the computation of NUBIG/NUBIL would capture a range of items that closely tracks the NUBIG/NUBIL safe harbor computation in Notice 2003-65. However, the component steps of the proposed NUBIG/NUBIL computation would be more explicit, as follows:

The proposed NUBIG/NUBIL computation would first take into account the aggregate amount that would be realized in a hypothetical disposition of all of the loss corporation’s assets in two steps treated as taking place immediately before the ownership change:
- —Step 1: the loss corporation would be treated as satisfying any inadequately secured nonrecourse liability by surrendering to each creditor the assets securing such debt.
- —Step 2 : the loss corporation would be treated as selling all remaining assets pertinent to the NUBIG/NUBIL computation in a sale to an unrelated third party, with the hypothetical buyer assuming no amount of the seller’s liabilities.
- That total hypothetical amount realized by the loss corporation pursuant to Steps 1 and 2, above, would be then decreased by (i) the sum of the loss corporation’s deductible liabilities (both fixed and contingent), and (ii) the loss corporation’s basis in its assets.
- Finally, the decreased hypothetical total would be then increased or decreased, as applicable, by the following:
- —(i) the net amount of the total RBIG and RBIL income and deduction items that could be recognized during the recognition period (excluding COD income); and
- —(ii) the net amount of positive and negative section 481 adjustments that would be required to be included on the previously-described hypothetical disposal of all of the loss corporation’s assets.

The proposed regulations generally would not allow COD income to be included in the calculation of NUBIG/NUBIL, but would provide certain exceptions.

RBIG and RBIL Items
As mentioned above, the proposed regulations would apply a methodology for identifying RBIG or RBIL that closely tracks the accrual based 1374 approach described in Notice 2003-65. However, the proposed regulations would significantly modify the 1374 approach to include as RBIL the amount of any deductible contingent liabilities paid or accrued during the recognition period, to the extent of the estimated value of those liabilities on the change date.

The proposed regulations also would add a rule clarifying that certain items do not constitute RBIG (such as dividends paid during the recognition period). In addition, limitations would be provided on the extent to which excluded COD income is treated as RBIG. Further, the proposed regulations would provide two different RBIG ceilings with regard to COD on recourse debt, and would provide special rules for COD income on nonrecourse debt.

Finally, rules would be provided for the interaction between Code Sec. 163(j) and Code Sec. 382. To eliminate the possibility of duplication of RBIL items, the proposed regulations would provide that Code Sec. 382 disallowed business interest carryforwards would not be treated as RBIL if such amounts were allowable as a deduction during the recognition period. The proposed regulations also would clarify the treatment of certain items allocated from a partnership.

Applicability Date
The regulations are proposed to be effective for ownership changes occurring after the date the proposed regulations are published as final regulations in the Federal Register. However, taxpayers and their related parties may apply these proposed regulations to any ownership change occurring during a tax year with respect to which the period described in Code Sec. 6511(a) has not expired, so long as the taxpayers and all of their related parties consistently apply the rules of these proposed regulations to such ownership change and all subsequent ownership changes that occur before the applicability date of the final regulations.

Comments and Requests for Hearing
Written or electronic comments must be received by November 9, 2019. Written or electronic requests for a public hearing and outlines of topics to be discussed at the public hearing must be received by November 9, 2019. Electronic submissions must be sent via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-125710-18) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Treasury and the IRS will publish for public availability any comment received to its public docket, whether submitted electronically or in hard copy.

Hard copy submissions must be sent to: Internal Revenue Service, CC:PA:LPD:PR (REG-125710-18), Room 5203, Post Office Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (indicate REG-125710-18), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224.

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The IRS has issued final regulations that amend the rules relating to hardship distributions from Code Sec. 401(k) plans. The final regulations are substantially similar to the proposed regulations. Further, plans that complied with the proposed regulations satisfy the final regulations as well. The regulations are effective on September 23, 2019.

The final regulations:

reflect statutory changes affecting Code Sec. 401(k) plans, including changes made by the Bipartisan Budget Act of 2018 ( P.L. 115-123); and
affect participants in, beneficiaries of, employers maintaining, and administrators of plans that include cash or deferred arrangements or provide for employee or matching contributions.

Deemed Immediate and Heavy Financial Need
The final regulations modify the safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need. The final regulations:

add "primary beneficiary under the plan" as an individual for whom qualifying medical, educational, and funeral expenses may be incurred;
modify the expense listed in existing Reg. §1.401(k)-1(d)(3)(iii)(B)(6) to provide that the limitations in Code Sec. 165(h)(5) do not apply for this purpose; and
add to the list a new type of expense, relating to expenses incurred as a result of certain disasters.

Distribution Necessary to Satisfy Financial Need
The final regulations modify the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need, by:

eliminating any requirement that an employee be prohibited from making elective contributions and employee contributions after receipt of a hardship distribution; and
eliminating any requirement to take plan loans prior to obtaining a hardship distribution.

In particular, the final regulations, like the proposed regulations, eliminate the safe harbor in existing Reg. §1.401(k)-1(d)(3)(iv)(E), under which a distribution is deemed necessary to satisfy the financial need only if elective contributions and employee contributions are suspended for at least six months after a hardship distribution is made and, if available, nontaxable plan loans are taken before the hardship distribution is made.

Expanded Sources for Hardship Distributions
The final regulations modify existing Reg. §1.401(k)-1(d)(3) to permit hardship distributions from Code Sec. 401(k) plans of elective contributions, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on these amounts, regardless of when contributed or earned.

Section 403(b) Plans
A hardship distribution of Code Sec. 403(b) elective deferrals is subject to the rules and restrictions set forth in Reg. §1.401(k)-1(d)(3). Accordingly, the preamble to the proposed regulations had stated that the new rules relating to a hardship distribution of elective contributions from a Code Sec. 401(k) plan generally apply to Code Sec. 403(b) plans. Because this requirement is retained in the final regulations, at Reg. §1.401(k)-1(d)(3)(iii)(B), it applies to Code Sec. 403(b) plans.

Applicability Dates
The changes to the hardship distribution rules made by the Bipartisan Budget Act of 2018 are effective for plan years beginning after December 31, 2018.

Plan Amendments
The Treasury Department and IRS expect that plan sponsors will need to amend their plans’ hardship distribution provisions to reflect the final regulations, and any such amendment must be effective for distributions beginning no later than January 1, 2020. The deadline for amending a disqualifying provision is set forth in Rev. Proc. 2016-37, I.R.B. 2016-29,136.

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For a taxpayer using an accrual method of accounting, the all events test is not met for item of gross income any later than when is included in revenue on an applicable financial statement (AFS) or other financial statement specified by the Treasury Secretary. How the AFS income inclusion rule applies to accrual method taxpayers with an AFS is described and clarified by Proposed Reg. §1.451-3.

Year-by-Year Application
The proposed regulations provide that the AFS income inclusion rule generally applies to accrual method taxpayers with an AFS when the timing of income inclusion for one or more items of income is determined using the all events test. They further clarify that the AFS income inclusion rule applies only to taxpayers that have one or more AFS covering the entire tax year.

The AFS income inclusion rule applies on a year-by-year basis and, therefore, an accrual taxpayer with an AFS in one tax year that does not have an AFS in another tax year must apply the AFS income inclusion rule in the tax year that it has an AFS, and does not apply the rule in the tax year in which it does not have an AFS.

No Change to Income Tax Treatment
The proposed regulations also clarify that AFS income inclusion rule does not change the treatment of a transaction for federal income tax purposes:

The treatment of a transaction or event in a tax year may be different for federal income tax and AFS purposes.
The applicability of any exclusion provision, or the treatment of nonrecognition transactions, in the Code, the Income Tax Regulations, or other guidance does not change.

Partial Payment
The proposed regulations provide that an amount included in the transaction price for AFS purposes may not be treated as contingent on the occurrence or nonoccurrence of a future event if the taxpayer has been paid or has an equitable, contractual, or other right to partial payment for performance completed to date. Additionally, that transaction price may not be reduced for amounts subject to Code Sec. 461, including reward amounts in credit card transactions.

Special Methods and Multi-Year Contracts
The proposed regulations clarify that when a taxpayer uses a special method of accounting, the special method of accounting determines the timing of the income inclusion.

Proposed regulations also provide guidance for taxpayers with a financial reporting period that is different than the taxpayer’s tax year. The taxpayer must use one of three permissible methods in order to determine whether an item of income has been included in revenue on an AFS.

For a contract with multiple performance obligations, the allocation of the transaction price to each performance obligation equals the amount allocated to each performance obligation for purposes of including the item in revenue in the taxpayer's AFS. The proposed regulations clarify that a transaction price does not include amounts collected on behalf of third parties, or amounts that are contingent on the occurrence or nonoccurrence of a future event.

A taxpayer with a multi-year contract applies the all events test by applying a cumulative approach reflecting amounts previously included under Code Sec. 451 rather than an annualized approach.

Fees
Under the proposed regulations if the taxpayer does not treat a fee as discount or as an adjustment to the yield of a debt instrument over the life of the instrument (such as points) in its AFS, and the fee otherwise would be treated as creating or increasing original issue discount (OID) for federal income tax purposes (specified fee), then the rules in the proposed regulations under Code Sec. 451(b) apply before the rules in Code Secs. 1271 through Code Sec. 1275. Removing specified fees and specified credit card fees from the calculation of OID will permit taxpayers to apply only the rules of Code Sec. 451(b) to these fees, without also having to apply the rules relevant to OID.

The proposed section regulations would not apply to determine the time at which OID generally is includible in income.

Effective Date
The regulations are proposed generally to apply to tax years beginning on or after the date the final regulations are published in the Federal Register. However, in the case of a specified fee, Proposed Reg. §1.451-3(i)(2) is proposed to apply for a taxpayer’s first tax year beginning one year after the date the Treasury Decision adopting these regulations as final is published in the Federal Register.

A taxpayer may rely on the proposed regulations (other than the proposed regulations relating to specified fees) for tax years beginning after December 31, 2017 (after December 31, 2018, for specified credit card fees), as long as the taxpayer: (1) applies all the applicable rules contained in the proposed regulations for specified credit card fees; and (2) consistently applies the proposed regulations to all items of income during the tax year (other than specified fees).

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Proposed regulations provide rules for accrual method taxpayers who receive advance payments. The proposed regulations include provisions affecting both taxpayers both with and without applicable financial statements (AFS), and describe and clarify the statutory requirements of Code Sec. 451(c).

Similar to Rev. Proc. 2004-34
The proposed regulations include many provisions similar to those of Rev. Proc. 2004-34, I.R.B. 2004-22, 991. For example the proposed regulations:

provide a similar deferral method for non-AFS taxpayers;
provide a list of items excluded from the definition of advance payment;
provide rules consistent with Rev. Proc. 2004-34 to ensure the acceleration of an advance payment when a taxpayer dies or ceases to exist, or when a taxpayer’s obligation is satisfied or otherwise ends; and
use the short tax year rules of Rev. Proc. 2004-34 for the AFS and non-AFS deferral methods
The proposed regulations also provide additional definitions and clarifications.

Change in Accounting Method
The IRS intends to provide the procedures by which a taxpayer may change its method of accounting to use one of the deferral methods described in these proposed regulations. Until further guidance is issued, a taxpayer may continue to rely on Rev. Proc. 2004-34, as described in Notice 2018-35, I.R.B. 2018-18, 520.

Effective Date
The proposed regulations are to apply to tax years beginning on or after the date the final regulations are published in the Federal Register. Until the date the Treasury Decision adopting these regulations as final regulations is published in the Federal Register, a taxpayer may rely on these proposed regulations for tax years beginning after December 31, 2017, as long as the taxpayer: (1) applies all the applicable rules contained in these proposed regulations, and (2) consistently applies these proposed regulations to all advance payments.

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Taxpayers may use the automatic consent procedures to change accounting methods to comply with the recent proposed regulations described above. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

The proposed regulations provide rules for:

inclusion in gross income under the all events test for taxpayers with an applicable financial statement (AFS) ( NPRM REG-104870-18); and
use of the deferral method for advance payments for taxpayers with or without an AFS ( NPRM REG-104554-18).

Certain qualifying taxpayers may apply for a change to comply with the proposed regulations without filing a Form 3115, Application for Change in Accounting Method.

Taxpayers Affected
The accounting change procedures for inclusion in gross income for taxpayers with an AFS generally apply to taxpayers with an AFS that want to:

change to a method of accounting that treats an item of gross income as meeting the all events test no later than when the item is taken into account as revenue in its AFS under Code Sec. 451(b)(1)(A);
in certain cases, allocate the transaction price to performance obligations under Code Sec. 451(b)(4);
change to a method of accounting that complies with Proposed Reg. §1.451-3; or
change to a method of accounting that complies with Proposed Reg. §1.451-8(c).

The procedures also apply to taxpayers that do not have an AFS and that want to change to a method of accounting that complies with Proposed Reg. §1.451-8(d).

In addition, the procedures apply to a change in AFS in order to apply certain revenue recognition methods of accounting.

Pending Nonautomatic Applications
The IRS will return any Form 3115 requesting a change in method of accounting available under this revenue procedure that:

was filed on or before September 9, 2019, under the non-automatic procedures for a tax year beginning after December 31, 2017; and
is pending with the National Office on September 9, 2019.

The National Office will send a letter to the taxpayer acknowledging the return of the Form 3115, and will return the user fee submitted with the form. A timely resubmitted Form 3115 will be considered filed as of the date the taxpayer originally filed the Form 3115 under the nonautomatic change procedures.

Effective Date
This revenue procedure is generally effective for tax years beginning after December 31, 2017. For specified credit card fees, it is effective for tax years beginning after December 31, 2018.

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Amendments to have been proposed to update the information reporting regulations under Code Sec. 6033, which generally apply to organizations exempt from tax under Code Sec. 501(a). The proposed regulations reflect statutory amendments and certain grants of reporting relief announced through guidance that has been made since the current regulations were adopted. The amendments and grants of relief apply particularly with respect to tax-exempt organizations required to file an annual Form 990, Return of Organization Exempt from Income Tax, or a Form 990-EZ information return.

Annual Return and Reporting Requirements
Code Sec. 6033 outlines various requirements for an annual information return to be filed by organizations that are exempt from tax under Code Sec. 501(a) or are described in Code Sec. 527, including exceptions to the filing requirement. The reporting requirements under Code Sec. 6033(h) mandate controlling organizations to include on their returns:

interest, annuities, royalties, or rents received from each controlled entity under Code Sec. 512(b)(13);
any loans made to each such controlled entity; and
any transfers of funds between such controlling organization and each such controlled entity.

Penalty Relief
Under Code Sec. 6104(b), the IRS must make the filed annual returns available to the public. Under Rev. Proc. 2018-38, I.R.B. 2018-31, 280, tax-exempt organizations (other than charities exempt under Code Sec. 501(c)(3) and Code Sec. 527 political organizations) were no longer required to report the names and addresses of contributors on Schedule B when filing their information returns. This change applied to information reporting for tax years ending on or after December 31, 2018, for donations above certain applicable thresholds.

However, Rev. Proc. 2018-38 has been overturned by a federal district court ( S.C. Bullock, DC Mont., 2019-2 ustc ¶50,245), which held that the IRS failed to follow the notice and comment procedures required by the Administrative Procedure Act (APA).

Code Sec. 6652(c)(1)(A) imposes penalties for a failure to file a return required under Code Sec. 6033, failure to include any required information, or failure to provide correct information. Under Code Sec. 6652(c)(5), the penalty is not imposed if it is shown that the failure was due to reasonable cause. Notice 2019-47 provides that the IRS will consider there to be a reasonable cause based on reliance on Rev. Proc. 2018-38 for any organizations that file Form 990 or 990-EZ and did not include on their 2018 information return such donor information as Rev. Proc. 2018-38 indicated was not required.

Proposed Amendments
The proposed amendments to the regulations would restore relief from the requirement to report contributor names and addresses on the annual returns filed by certain tax-exempt organizations that was previously provided in Rev. Proc. 2018-38 before the federal district court overturned that rule. Therefore, only organizations exempt under Code Secs. 501(c)(3) and 527 would need to continue reporting their donor information on their Forms 990, 990-EZ, or 990-PF.

In addition, the proposed amendments would incorporate into the regulations the existing exception from having to file an annual return for certain organizations that normally have gross receipts of $50,000 or less, found in Rev. Proc. 2011-15, I.R.B. 2011-3, 322.

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With the April 15th filing season deadline now behind us, it’s not too early to turn your attention to next year’s deadline for filing your 2014 return. That refocus requires among other things an awareness of the direct impact that many "ordinary," as well as one-time, transactions and events will have on the tax you will eventually be obligated to pay April 15, 2015. To gain this forward-looking perspective, however, taking a moment to look back … at the filing season that has just ended, is particularly worthwhile. This generally involves a two-step process: (1) a look-back at your 2013 tax return to pinpoint new opportunities as well as "lessons learned;" and (2) a look-back at what has happened in the tax world since January 1st that may indicate new challenges to be faced for the first time on your 2014 return.

Your 2013 Form 1040

Examining your 2013 Form 1040 individual tax return can help you identify certain changes that you might want to consider this year, as well encourage you to continue what you’re doing right. These "key ingredients" to your 2014 return may include, among many others considerations, a fresh look at:

Your refund or balance due. While it is nice to get a big refund check from the IRS, it often indicates unnecessary overpayments over the course of the year that has provided the federal government with an interest-free loan in the form of your money. Now’s the time to investigate the reasons behind a refund and whether you need to take steps to lower wage withholding and/or quarterly estimated tax payments.

If on the other hand you had to pay the IRS when filing your return (or requesting an extension), you should consider whether it was due to a sudden windfall of income that will not repeat itself; or because you no longer have the same itemized deductions, you had a change in marital status, or you claimed a one-time tax credit such as for energy savings or education. Likewise, examining anticipated changes between your 2013 and 2014 tax years—marriage, the birth of a child, becoming a homeowner, retiring, etc.—can help warn you whether your're headed for an underpayment or overpayment of your 2014 tax liability.

Investment income. One area that blindsided many taxpayers on their 2013 returns was the increased tax bill applicable to investment income. Because of the "great recession," many investors had carryforward losses that could offset gains realized for a number of years as markets gradually improved. For many, however, 2013 saw not only a significant rise in investment income but also a rise in realized taxable investment gains that were no longer covered by carryforward losses used up during the 2010–2012 period.

Furthermore, dividends and long-term capital gains for the first time in 2013 were taxed at a new, higher 20 percent rate for higher income taxpayers and an additional 3.8 percent net investment income tax surtax for those in the higher income brackets. Short-term capital gains saw the highest rate jump, from 35 percent to 43.4 percent rate, which reflected a new 39.6 percent regular rate and the new 3.8 percent net investment income tax rate. This tax structure remains in place for 2014.

Personal exemption/itemized deductions. Effective January 1, 2013, the American Taxpayer Relief Act (ATRA) revived the personal exemption phaseout (PEP). The applicable threshold levels are $250,000 for unmarried taxpayers; $275,000 for heads of households; $300,000 for married couples filing a joint return (and surviving spouses); and $150,000 for married couples filing separate returns (adjusted for inflation after 2013). Likewise, for it revived the limitation on itemized deductions (known as the "Pease" limitation after the member of Congress who sponsored the original legislation) for those same taxpayers.

Medical and dental expenses. Starting in 2013, the Affordable Care Act (ACA) increased the threshold to claim an itemized deduction for unreimbursed medical expenses from 7.5 percent of adjusted gross income (AGI) to 10 percent of AGI. However, there is a temporary exemption for individuals age 65 and older until December 31, 2016. Qualified individuals may continue to deduct total medical expenses that exceed 7.5 percent of adjusted gross income through 2016. If the qualified individual is married and only one spouse is age 65 or older, the taxpayer may still deduct total medical expenses that exceed 7.5 percent of adjusted gross income.

Recordkeeping. If you cannot find the paperwork necessary to prove your right to a deduction or credit, you cannot claim it. An organized tax recordkeeping system—whether on paper or computerized–therefore is an essential component to maximizing tax savings.

Filing Season Developments

So far this year, the IRS, other federal agencies and the courts have issued guidance on individual and business taxation, retirement savings, foreign accounts, the ACA, and much more. Congress has also been busy working up a "tax extenders" bill as well as tax reform proposals. All these developments can impact how you plan to maximize benefits on your 2014 income tax return.

Tax reform. President Obama, the chairs of the House and Senate tax writing committees, and individual lawmakers all made tax reform proposals in early 2014. The proposals range from comprehensive tax reform to more piece-meal approaches. Although only small, piecemeal proposals have the most promising chances for passage this year, taxpayers should not ignore the broader push toward tax reform that will be taking shape in 2015 and 2016.

Tax extenders. The Senate Finance Committee (SFC) approved legislation (EXPIRE Act) in April that would extend nearly all of the tax extenders that expired after 2013. Included in the EXPIRE Act are individual incentives such as the state and local sales tax deduction, the higher education tuition deduction, transit benefits parity, and the classroom teacher’s deduction; along with business incentives such as enhanced Code 179 small business expensing, bonus depreciation, the research tax credit, and more. Congress may now move quickly on an extenders bill or it may not come up with a compromise until after the November mid-term elections. Many of these tax benefits are significant and will directly impact the 2014 tax that taxpayers will pay.

Individual mandate. The Affordable Care Act’s individual mandate took effect January 1, 2014. Individuals failing to carry minimum essential coverage after January 1, 2014 and who are not exempt from the requirement will make an individual shared responsibility payment when they file their 2014 federal income tax returns in 2015. There are some exemptions, including a hardship exemption if the taxpayer experienced problems in signing up with a Health Insurance Marketplace before March 31, 2014. Further guidance is expected before 2014 tax year returns need to be filed, especially on how to calculate the payment and how to report to the IRS that an individual has minimum essential coverage.

Employer mandate. The ACA’s shared responsibility provision for employers (also known as the “employer mandate”) will generally apply to large employers starting in 2015, rather than the original 2014 launch date. Transition relief provided in February final regulations provides additional time to mid-size employers with 50 or more but fewer than 100 employees, generally delaying implementation until 2016. Employers that employ fewer than 50 full-time or full time equivalent employees are permanently exempt from the employer mandate. The final regulations do not change this treatment under the statute.

Other recent tax developments to be aware of for 2014 planning purposes include:

IRA rollovers. The IRS announced that, starting in 2015, it intends to follow a one-rollover-per-year limitation on Individual Retirement Account (IRA) rollovers as an aggregate limit.
myRAs. In January, President Obama directed the Treasury Department to create a new retirement savings vehicle, “myRA,” to be rolled out before 2015.
Same-sex married couples. In April, the IRS released guidance on how the Supreme Court’s Windsor decision, which struck down Section 3 of the Defense of Marriage Act (DOMA), applies to qualified retirement plans, opting not to require recognition before June 26, 2013.
Passive activity losses. The Tax Court found in March that a trust owning rental real estate could qualify for the rental real estate exception to passive activity loss treatment.
FATCA deadline. The IRS has indicated that it is holding firm on the July 1, 2014, deadline for foreign financial institutions (FFIs) to comply with the FATCA information reporting requirements or withhold 30 percent from payments of U.S.-source income to their U.S. account holders.
Vehicle depreciation. The IRS announced that inflation-adjusted limitations on depreciation deductions for business use passenger autos, light trucks and vans first placed in service during calendar year 2014 are relatively unchanged from 2013 (except for first year $8,000 bonus depreciation that may be removed if Congress does not act in time.
Severance payments. In March, the U.S. Supreme Court held that supplemental unemployment benefits (SUB) payments made to terminated employees and not tied to the receipt of state unemployment benefits are wages for FICA tax purposes.
Virtual currency. The IRS announced that convertible virtual currencies, such as Bitcoin, would be treated as property and not as currency, thus creating immediate tax consequences for those using Bitcoins to pay for goods.

Please contact this office if you’d like further information on how an examination of your 2013 return, and examination of recent tax developments, may point to revised strategies for lowering your eventual tax bill for 2014.

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One of the most complex, if not the most complex, provisions of the Patient Protection and Affordable Care Act is the employer shared responsibility requirement (the so-called "employer mandate") and related reporting of health insurance coverage. Since passage of the Affordable Care Act in 2010, the Obama administration has twice delayed the employer mandate and reporting. The employer mandate and reporting will generally apply to applicable large employers (ALE) starting in 2015 and to mid-size employers starting in 2016. Employers with fewer than 50 employees, have never been required, and continue to be exempt, from the employer mandate and reporting.

Employer mandate

The employer mandate under Code Sec. 4980H and employer reporting under Code Sec. 6056 are very connected. Code Sec. 4980H generally provides that an ALE is required to pay a penalty if it fails to offer minimum essential coverage and any full-time employee receives cost-sharing or the Code Sec. 36B premium assistance tax credit. An ALE would also pay a penalty if it offers coverage and any full-time employee receives cost-sharing or the Code Sec. 36B credit.

To receive the Code Sec. 36B credit, an individual must have obtained coverage through an Affordable Care Act Marketplace. The Marketplaces will report the names of individuals who receive the credit to the IRS. ALEs must report the terms and conditions of health care coverage provided to employees (This is known as Code Sec. 6056 reporting). The IRS will use all of this information to determine if the ALE must pay a penalty.

ALEs

Only ALEs are subject to the employer mandate and must report health insurance coverage under Code Sec. 6056. Employers with fewer than 50 employees are never subject to the employer mandate and do not have to report coverage under Code Sec. 6056.

In February, the Obama administration announced important transition rules for the employer mandate that affects Code Sec. 6056 reporting. The Obama administration limited the employer mandate in 2015 to employers with 100 or more full-time employees. ALEs with fewer than 100 full-time employees will be subject to the employer mandate starting in 2016. At all times, employers with fewer than 50 full-time employees are exempt from the employer mandate and Code Sec. 6056 reporting.

Reporting

The IRS has issued regulations describing how ALEs will report health insurance coverage. The IRS has not yet issued any of the forms that ALEs will use but has advised that ALEs generally will report the requisite information to the agency electronically.

ALEs also must provide statements to employees. The statements will describe, among other things, the coverage provided to the employee.

30-Hour Threshold

A fundamental question for the employer mandate and Code Sec. 6056 reporting is who is a full-time employee. Since passage of the Affordable Care Act, the IRS and other federal agencies have issued much guidance to answer this question. The answer is extremely technical and there are many exceptions but generally a full-time employee means, with respect to any month, an employee who is employed on average at least 30 hours of service per week. The IRS has designed two methods for determining full-time employee status: the monthly measurement method and the look-back measurement method. However, special rules apply to seasonal workers, student employees, volunteers, individuals who work on-call, and many more. If you have any questions about who is a full-time employee, please contact our office.

Form W-2 reporting

The Affordable Care Act also requires employers to disclose the aggregate cost of employer-provided health coverage on an employee's Form W-2. This requirement is separate from the employer mandate and Code Sec. 6056 reporting. The reporting of health insurance costs on Form W-2 is for informational purposes only. It does not affect an employee's tax liability or an employer's liability for the employer mandate.

Shortly after the Affordable Care Act was passed, the IRS provided transition relief to small employers that remains in effect today. An employer is not subject the reporting requirement for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year. Special rules apply to multiemployer plans, health reimbursement arrangements, and many more.

Please contact our office if you have any questions about ALEs, the employer mandate or Code Sec. 6056 reporting.

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Mid-size employers may be eligible for recently announced transition relief from the Patient Protection and Affordable Care Act's employer shared responsibility requirements. Final regulations issued by the IRS in late January include transition relief for mid-size employers for 2015. Mid-size employers for this relief are defined generally as businesses employing at least 50 but fewer than 100 full-time employees. Exceptions and complicated measurement rules continue to apply. The final regulations also describe the treatment of seasonal employees, volunteer workers, student employees, the calculation of the employer shared responsibility payment, and much more.

Delayed implementation

As enacted in 2010, the Affordable Care Act required applicable large employers (ALEs) to make an assessable payment if any full-time employee is certified to receive a health insurance premium tax credit or cost-sharing reduction, and either:

The employer does not offer to its full-time employees and their dependents the opportunity to enroll in minimum essential coverage (MEC) under an eligible employer-sponsored plan; or
The employer offers its full-time employees and their dependents the opportunity to enroll in MEC under an employer-sponsored plan, but the coverage is either unaffordable or does not provide minimum value.

The employer shared responsibility requirement was scheduled to apply January 1, 2014, the same effective date for the individual mandate and the health insurance premium assistance tax credit. In July 2013, the Obama administration announced that employer shared responsibility requirements would not apply for 2014.

The final regulations make further changes. Under the final regulations, the employer mandate will generally apply to large employers (employers with 100 or more employees) starting in 2015 and to qualified mid-size employers (employers with 50 to 99 employees) starting in 2016. Employers that employ fewer than 50 full-time employees (including full-time equivalents (FTEs)) are not subject to the employer mandate.

Caution. Determining the number of employees for purposes of the employer shared responsibility requirement is a complex calculation for many employers that is beyond the scope of this article. The Affordable Care Act and the final regulations describe how to calculate full-time employees (including FTEs) and also which employees are excluded from that calculation. Please contact our office for details about the Affordable Care Act and your business.

Transition relief for mid-size employers

Qualified employers are not subject to the employer mandate until 2016 if they satisfy certain conditions. Among other requirements, the employer must employ on average at least 50 full-time employees (including FTEs) but fewer than 100 full-time employees (including FTEs) on business days during 2014. Additionally, the final regulations impose a broad maintenance of previously offered heath coverage requirement.

The final regulations do not allow an employer to reduce the size of its workforce or the overall hours of service of its employees in order to satisfy the workforce size condition and thus be eligible for the transition relief. A reduction in workforce size or overall hours of service for bona fide business reasons, however, will not be considered to have been made in order to satisfy the workforce size condition. This provision is certainly one that is expected to generate many questions. The IRS may provide additional guidance and/or clarification in 2014 and our office will keep you posted of developments.

Additionally, the final regulations also modify the extent of required coverage. Proposed regulations required that the employer provide coverage to 95 percent of its full-time employees. The final regulations delay the 95 percent requirement until 2016 for larger employers. For 2015, larger employers need only provide coverage to 70 percent of their full-time employees.

Special types of employees

Since passage of the Affordable Care Act, questions have arisen about the treatment of certain types of employees. These include seasonal employees, short-term employees, volunteer workers, and student employees. The final regulations clarify some of the issues surrounding these employees.

Many industries employ seasonal workers. The final regulations describe who may qualify as a seasonal worker. The retail industry, which employs many workers for the holiday season, asked the IRS to specify which events or periods of time that would be treated as holiday seasons. The final regulations, however, do not indicate specific holidays or the length of any holiday season as these will differ for different employers, the IRS explained.

For volunteer workers, such as volunteer fire fighters and first responders, the final regulations provide that an individual's hours of service do not include hours worked as a "bona fide volunteer." This definition, the IRS explained, encompasses any volunteer who is an employee of a government entity or a Code Sec. 501(c)(3) organization whose compensation is limited to reimbursement of certain expenses or other forms of compensation.

Many college, university and vocational students are engaged in federal and state work-study programs. The final regulations provide that hours of service for purposes of the employer mandate do not include hours of service performed by students in federal or other governmental work-study programs. The IRS noted the potential for abuse by labeling individuals who receive compensation as "interns" to avoid the employer mandate. Therefore, the IRS did not adopt a special rule for student employees working as interns for an outside employer, and the general rules apply.

The final regulations also describe how the employer mandate may or may not apply to adjunct faculty, members of religious orders, airline industry employees, employees who must work “on-call” hours, short-term employees and others. Special rules may apply to these employees in some cases.

Waiting period limitation

The Affordable Care Act generally requires that an employee (or dependent) cannot wait more than 90 days before employer-provided coverage becomes effective. The IRS issued final regulations in February on the 90-day waiting period limitation. The IRS also issued proposed regulations generally allowing employers to require new employees to complete a reasonable orientation period. The proposed regulations set forth one month as the maximum length of any orientation period.

If you have any questions about the final regulations for the employer mandate, the transition relief, the 90-day waiting period, or any aspects of the Affordable Care Act, please contact our office.

TD 9655, TD 9656, NPRM REG-122706-12

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

Regardless of the type of record keeper you consider yourself to be, there are numerous ways to simplify the burden of logging your automobile expenses for tax purposes. This article explains the types of expenses you need to track and the methods you can use to properly and accurately track your car expenses, thereby maximizing your deduction and saving taxes.

Expense methods

The two general methods allowed by the IRS to calculate expenses associated with the business use of a car include the standard mileage rate method or the actual expense method. The standard mileage rate for 2017 is 53.5 cents per mile. In addition, you can deduct parking expenses and tolls paid for business. Personal property taxes are also deductible, either as a personal or a business expense. While you are not required to substantiate expense amounts under the standard mileage rate method, you must still substantiate the amount, time, place and business purpose of the travel.

The actual expense method requires the tracking of all your vehicle-related expenses. Actual car expenses that may be deducted under this method include: oil, gas, depreciation, principal lease payments (but not interest), tolls, parking fees, garage rent, registration fees, licenses, insurance, maintenance and repairs, supplies and equipment, and tires. These are the operating costs that the IRS permits you to write-off. For newly-purchased vehicles in years in which bonus depreciation is available, opting for the actual expense method may make particularly good sense since the standard mileage rate only builds in a modest amount of depreciation each year. For example, for 2017, when 50 percent bonus depreciation is allowed, maximum first year depreciation is capped at $11,160 (as compared to $3,160 for vehicles that do not qualify). In general, the actual expense method usually results in a greater deduction amount than the standard mileage rate. However, this must be balanced against the increased substantiation burden associated with tracking actual expenses. If you qualify for both methods, estimate your deductions under each to determine which method provides you with a larger deduction.

Substantiation requirements

Taxpayers who deduct automobile expenses associated with the business use of their car should keep an account book, diary, statement of expenses, or similar record. This is not only recommended by the IRS, but essential to accurate expense tracking. Moreover, if you use your car for both business and personal errands, allocations must be made between the personal and business use of the automobile. In general, adequate substantiation for deduction purposes requires that you record the following:

The amount of the expense;
The amount of use (i.e. the number of miles driven for business purposes);
The date of the expenditure or use; and
The business purpose of the expenditure or use.

Suggested recordkeeping: Actual expense method

An expense log is a necessity for taxpayers who choose to use the actual expense method for deducting their car expenses. First and foremost, always keep your receipts, copies of cancelled checks and bills paid. Maintaining receipts, bills paid and copies of cancelled checks is imperative (even receipts from toll booths). These receipts and documents show the date and amount of the purchase and can support your expenditures if the IRS comes knocking. Moreover, if you fail to log these expenses on the day you incurred them, you can look back at the receipt for all the essentials (i.e. time, date, and amount of the expense).

Types of Logs. Where you decide to record your expenses depends in large part on your personal preferences. While an expense log is a necessity, there are a variety of options available to track your car expenditures - from a simple notebook, expense log or diary for those less technologically inclined (and which can be easily stored in your glove compartment) - to the use of a smartphone or computer. Apps specifically designed to help track your car expenses can be easily downloaded onto your iPhone or Android device.

Timeliness. Although maintaining a daily log of your expenses is ideal - since it cuts down on the time you may later have to spend sorting through your receipts and organizing your expenses - this may not always be the case for many taxpayers. According to the IRS, however, you do not need to record your expenses on the very day they are incurred. If you maintain a log on a weekly basis and it accounts for your use of the automobile and expenses during the week, the log is considered a timely-kept record. Moreover, the IRS also allows taxpayers to maintain records of expenses for only a portion of the tax year, and then use those records to substantiate expenses for the entire year if he or she can show that the records are representative of the entire year. This is referred to as the sampling method of substantiation. For example, if you keep a record of your expenses over a 90-day period, this is considered an adequate representation of the entire year.

Suggested Recordkeeping: Standard mileage rate method

If you loathe recordkeeping and cannot see yourself adequately maintaining records and tracking your expenses (even on a weekly basis), strongly consider using the standard mileage rate method. However, taking the standard mileage rate does not mean that you are given a pass by the IRS to maintaining any sort of records. To claim the standard mileage rate, appropriate records would include a daily log showing miles traveled, destination and business purpose. If you incur mileage on one day that includes both personal and business, allocate the miles between the two uses. A mileage record log, whether recorded in a notebook, log or handheld device, is a necessity if you choose to use the standard mileage rate.

If you have any questions about how to properly track your automobile expenses for tax purposes, please call our office. We would be happy to explain your responsibilities and the tax consequences and benefits of adequately logging your car expenses.

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Businesses benefit from many tax breaks. If you are in business with the objective of making a profit, you can generally claim all your business deductions. If your deductions exceed your income for the year, you can claim a loss for the year, up to the amount of your income from other activities. Remaining losses can be carried over into other years.

These are very generous tax breaks and sometimes people establish a business to generate losses. They have no intention of ever earning a profit. Other times, they genuinely hope to earn a profit but never do.

The IRS calls these activities "hobbies." Expenses from these activities are never deductible in excess of any income that is declared earned from them. Recently, the IRS issued a new warning in the form of a Fact Sheet (FS-2007-18) to educate taxpayers about the differences between a for-profit business and a hobby.

No bright line

There's no bright line to distinguish a genuine business with a profit motive from a hobby. Over the years, the IRS and the courts have developed a list of factors to determine if an activity has a profit motive or is a hobby. No one factor is greater than the others and the list is not exhaustive. That means that the IRS and the courts have great leeway in their analyses.

Let's take a quick look at the factors:

How the business is run? Is the activity carried on in a businesslike manner? Do you keep complete and accurate business records and books? Have you changed business operations to increase profits?

Expertise. Do you have the necessary expertise to run the business? If you don't, do you seek help from experts?

Time and effort. Do you spend the time and effort necessary for the business to succeed?

Appreciation. Will business assets appreciate in value over time? A profit motive can exist if gain from the eventual sale of assets, plus any other income, will result in an overall profit even if there's no profit from current operations.

Success with other activities. Have you engaged in similar activities in the past?

History of income or loss. This factor looks to when the losses occurred. Were they in the start-up phase? Maybe they were due to unforeseen circumstances. Losses over a very long period of time could, but not always, indicate a hobby.

Amounts of occasional profits. Are your occasional profits significant when compared to the size of your investment and prior losses?

Financial status of owner. Is the activity your only source of income?

Personal pleasure or recreation. Is your business of a type that is not usually considered to have elements of personal pleasure or recreation?

Your financial status

If the activity is your only source of income, you would think that the IRS would automatically treat it as a for-profit business. That's not true. Every case is different and the IRS and the courts look at all the circumstances.

A few years ago, there was a case in the U.S. Tax Court involving a married couple. The husband owned a house framing business. His income was about $33,000 a year. The wife worked as a secretary in an accounting department of a big corporation. Her income was about $28,000 a year.

Together, they also operated a horse breeding and racing activity. They had no experience in breeding or racing horses. They didn't have the best of luck either. Several of their horses suffered injuries and they were involved in a legal dispute over the ownership of one. They did seek help from experts and also kept good financial records.

The Tax Court looked at all the nine factors. It recognized that the couple had a very modest income from their employment and this factor weighed in their favor. However, some of the other factors went against them, especially the fact that they never made a profit after 16 years and lost nearly $500,000. The court knew that the couple "hoped" to make a profit but hope wasn't enough and the court found their business was not engaged in for a profit.

Presumption

Generally, the IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five years, including the current year. If it appears that the business will not be profitable for some years, you won't be able to come within the presumption of profit motive. You'll have to rely on qualifying under the nine factors.

The IRS has a form on which you can officially elect to have the agency wait until the first five years are up before examining the profitability of your business. While it's generally not necessary to file the form in order to take advantage of the presumption, it's usually a good idea.

Types of businesses

Although the IRS is not limited in the kind of businesses that it can challenge as being hobbies, businesses that look like traditional hobbies generally face a greater chance of IRS scrutiny than other types of businesses. These include horse breeding and racing, "gentlemen farming" and craft businesses operated from the home. There are many court cases about these activities and usually the taxpayers lose.

This is a very complicated area of the tax law and many people, like the secretary and her husband, honestly believe they are operating a for-profit business. But as we've seen, the IRS and the courts can, and often do, determine otherwise.

Don't hesitate to contact us if you have any questions about the differences between a business and a hobby ...and how you can set up your operations to have a better chance of falling on the right side of any argument with the IRS.

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Although the old adage warns against doing business with friends or relatives, many of us do, especially where personal or real property is involved. While the IRS generally takes a very discerning look at most financial transactions between family members, you can avoid some of the common tax traps if you play by a few simple rules.

Of course, because there are so many types of potential transactions, there are few hard and fast rules that apply across the board. If you're thinking of selling property to a family member, or buying from a family member, you must evaluate the potential negative tax consequences before agreeing to enter into a transaction. In a worst case scenario, the IRS could set aside the transaction as if it never took place and whatever gain, or loss, you have, would evaporate.

"Arms-length" transactions

The IRS is on alert for transactions between family members because often they are not "arms-length" transactions. Conducting a transaction at "arms-length" means that pricing is established as if the seller and buyer were independent parties. To be considered an "arm's length" transaction, the seller must genuinely wants to sell his or her property at a fair market price and the buyer must offer a fair price. The transaction cannot be motivated primarily by tax avoidance. Transactions between unrelated parties, for example when you buy your new car from an automobile dealer, are "arms length" transactions. The seller is in the business of selling and the buyer is an independent third party.

Transactions between family members - say, the transfer of real estate or other property -- frequently may look, at first glance, to be not quite at arms length. Did the buyer make a fair offer? Did the seller accept a fair price? Was the sale really a gift? The rules allow the IRS to set aside abusive transactions as shams and impose penalties.

Dealing with your children

Tax problems frequently arise in transactions between parents and children. Let's say that you agree to sell your vacation home to your daughter. If your daughter pays the first and only price you gave, some warning bells may sound. Did your selling price reflect the fair market value of the property? Did the buyer investigate, or seek an appraisal, of the value of the property. Did comparable properties sell at similar prices?

If you want to claim a loss from the sale, don't count on it. The tax rules specifically disallow in most situations a loss from the sale - or exchange - of property when the sale or exchange is between members of a family -whether or not you can prove that the price is fair. The IRS's definition of family is pretty broad for this purpose. It includes brothers and sisters (whether by the whole or half blood), spouses, ancestors, and lineal descendants. Ancestors include parents and grandparents, and lineal descendants includes children and grandchildren. Thus, nieces and nephews, aunts and uncles and in-laws are excluded. Stepparents, stepchildren and stepgrandchildren are excluded, but adopted children are treated the same as natural children in all respects

If you claim a gain on the sale, expect some questions from the IRS if your return is audited. The IRS can claim that you recognized too little gain, hoping to tax the rest as a taxable gift. In selling property to a family member, you should build a file of comparable prices in order to be ready for the IRS on an audit of your return.

Divorcing couples also under scrutiny

Divorce spawns many tax consequences. Often, a court will direct one spouse to transfer property to the other spouse. Generally, no gain or loss is recognized when property is transferred incident to the divorce. Problems develop over the last three words, "incident to the divorce." If the transaction is not "incident to the divorce" and one spouse claims large losses, the IRS will examine carefully whether the transaction was genuine.

Gain or loss also is not recognized when a transfer takes place between spouses who are still married, even if they don't file a joint return, and whether or not their relationship is amicable or hostile.

Be proactive to avoid future inquiries

Selling to, or buying from, a family member shouldn't be avoided just because the rules are complex. First, recognize that your transaction may be subject to special scrutiny by the IRS. If it is, you can't go on this road alone without professional backup but you can be proactive by anticipating potential challenges and by taking some simple, common sense steps:

Be prepared. Because documentation is very important to the IRS and plays a very big part in whether a claim will be allowed, it is important that you document your related party transaction every step of the way. All agreements should be in written format and corroborating evidence (such as comparable price lists) should be retained.

Invest in an independent appraisal. Unless you are a professional in selling your particular property, let an expert place a value on it. Having this sort of independent third party verify the reasonableness of the transaction price is exactly the type of documentation the IRS likes to see.

Weigh alternatives to relinquishing total control over the property. Consider "gifting" the property to a family member instead of selling it - the positive tax consequences of gifting are often overlooked.

As illustrated above, there is absolutely nothing wrong with engaging in financial transactions with related persons - as long as all parties involved are aware of the added scrutiny the transaction may bring and properly prepare for such an event. If you are contemplating such a transaction, please feel free to contact the office for additional guidance.

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