Federal Income Taxation

September 03, 2024

749 / How are business expenses reported for income tax purposes?

<div class="Section1"> A deduction is permitted for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Examples of deductible business expenses include: (1) expenditures for reasonable salaries, (2) traveling expenses (within limits), and (3) certain rental expenses incurred for purposes of a trade or business.<a href="#_ftn1" name="_ftnref1">1</a> Illegal payments made in the course of business, such as bribes to government officials or illegal rebates (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="658">658</a>), are not deductible.<a href="#_ftn2" name="_ftnref2">2</a> Under the 2017 Tax Act, certain expenses paid to (or at the direction of) a government or government entity in relation to the violation of any law, or investigation into potential violations of the law, are not deductible.<a href="#_ftn3" name="_ftnref3">3</a> Further, amounts paid in relation to sexual harassment suits that are subject to a nondisclosure agreement are not deductible.<a href="#_ftn4" name="_ftnref4">4</a> <hr> Planning Point: The IRS released a memorandum addressing whether a lawsuit settlement could be deducted as an expense under IRC Section 162(a). It determined that the business itself was required to prove whether the payments were compensatory, and thus deductible, or punitive (such as a fine or penalty, and thus nondeductible). This was the case despite the fact that the settlement specifically provided that the payments were not to be construed as fines or penalties. A deductible payment under Section 162 is generally one meant to compensate another party or to ensure compliance with a law. In this case, the IRS required further factual analysis to determine the nature of the payments, highlighting the fact that a settlement agreement alone will not be controlling.<a href="#_ftn5" name="_ftnref5">5</a> <hr> In 2024, the business standard mileage is 67 cents per mile driven for business purposes.  In 2023, the business standard mileage rate is 65.5 cents per mile (up from 58.5 cents per mile for the first half of 2022 and 62.5 cents for the second half of 2022, 56 cents per mile in 2021, 57.5 cents in 2020, 58 cents in 2019 and 54.5 cents in 2018).<a href="#_ftn6" name="_ftnref6">6</a> <hr> Planning Point: The IRS increased the business standard mileage rate in the second half of 2022 in response to rising gas prices. <hr> The amount of the deduction for expenses incurred in carrying on a trade or business depends upon whether the individual is an independent contractor or an employee. Typically, whether an insurance agent is considered an independent contractor or employee is determined on the basis of all the facts and circumstances involved; however, where an employer has the right to control the manner and the means by which services are performed, an employer-employee relationship will generally be found to exist.<a href="#_ftn7" name="_ftnref7">7</a> The IRS has ruled that a full-time life insurance salesperson is not an “employee” for purposes of IRC Sections 62 and 67, even though he is treated as a “statutory employee” for Social Security tax purposes.<a href="#_ftn8" name="_ftnref8">8</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3928">3928</a>. Furthermore, according to decisions from the Sixth and 11th Circuit Courts of Appeals, the fact that an insurance agent received certain employee benefits did not preclude his being considered an independent contractor, based on all the other facts and circumstances of the case.<a href="#_ftn9" name="_ftnref9">9</a> The IRS has determined, however, that a district manager of an insurance company was an employee of the company, and not an independent contractor.<a href="#_ftn10" name="_ftnref10">10</a> On the other hand, the IRS has determined that individuals who were regional and senior sales vice presidents of an insurance company (but who were not officers of the company) were independent contractors and not employees of the insurance company.<a href="#_ftn11" name="_ftnref11">11</a> <hr> Planning Point: The Sixth Circuit Court of Appeals confirmed in 2019 that life insurance agents were properly classified as independent contractors, rather than employees. The case involved eligibility for benefits under ERISA, and a district court, using the traditional Darden factors for determining classification status, had ruled in 2017 that the agents were employees who were eligible for ERISA benefits. In reversing the lower court, the Sixth Circuit gave weight to the fact that both parties had expressed their intent that an independent contractor relationship would apply. The case also opens the possibility that the weight given to the various Darden factors should vary based upon the context of the case—for example, in this case, financial benefits were at issue, so the court gave more weight to the financial structure of the relationship.<a href="#_ftn12" name="_ftnref12">12</a> <hr> Independent contractors may deduct all allowable business expenses from gross income (i.e., “above-the-line”) to arrive at adjusted gross income.<a href="#_ftn13" name="_ftnref13">13</a> Prior to 2018, the business expenses of an employee were deductible from adjusted gross income (i.e., “below-the-line”) if he or she itemized instead of taking the standard deduction, but only to the extent that they exceeded 2 percent of adjusted gross income when aggregated with other “miscellaneous itemized deductions.” All miscellaneous itemized deductions subject to the 2 percent floor were suspended for 2018-2025. Industrial agents (or “debit agents”) are treated as employees for tax purposes.<a href="#_ftn14" name="_ftnref14">14</a> Thus, as in the case of any employee, a debit agent can deduct transportation and away-from-home traveling expenses from adjusted gross income if he itemizes, only to the extent that the aggregate of these and other miscellaneous itemized deductions exceed 2 percent of adjusted gross income (prior to 2018 and, presumably, after 2025).<a href="#_ftn15" name="_ftnref15">15</a> Self-employed taxpayers are permitted a deduction equal to one-half of their self-employment (i.e., Social Security) taxes for the taxable year. This deduction is treated as attributable to a trade or business that does not consist of the performance of services by the taxpayer as an employee; thus it is taken “above-the line.”<a href="#_ftn16" name="_ftnref16">16</a> In Allemeier v. Commissioner,<a href="#_ftn17" name="_ftnref17">17</a> the Tax Court held that the taxpayer could deduct his expenses ($15,745) incurred in earning a master’s degree in business administration to the extent those expenses were substantiated and education-related. The court based its decision on the fact that the taxpayer’s MBA did not satisfy a minimum education requirement of his employer, nor did the MBA qualify the taxpayer to perform a new trade or business. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a discussion of the business expense deduction for meals and entertainment, including a discussion of how the IRS has interpreted the changes imposed post-tax reform. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 162(a). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 162(c). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 162(f). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 162(q). <a href="#_ftnref5" name="_ftn5">5</a>. ILM 201825027. <a href="#_ftnref6" name="_ftn6">6</a>. IR 2017-204, Notice 2019-02, IR-2019-215, IR-2020-279, Notice 2022-03, A-2022-13, Notice 2024-08. <a href="#_ftnref7" name="_ftn7">7</a>. Butts v. Commissioner, TC Memo 1993-478, aff’d, 49 F.3d 713 (11th Cir. 1995); Let. Rul. 9306029. <a href="#_ftnref8" name="_ftn8">8</a>. Rev. Rul. 90-93, 1990-2 CB 33. <a href="#_ftnref9" name="_ftn9">9</a>. Ware v. U.S., 67 F.3d 574 (6th Cir. 1995); Butts v. Commissioner, above. <a href="#_ftnref10" name="_ftn10">10</a>. TAM 9342001. <a href="#_ftnref11" name="_ftn11">11</a>. TAM 9736002. <a href="#_ftnref12" name="_ftn12">12</a>. Jammal v. American Family Life Insurance Co., 2019 U.S. App. LEXIS 2905 (6th Cir. 2019). <a href="#_ftnref13" name="_ftn13">13</a>. IRC § 62(a)(1). <a href="#_ftnref14" name="_ftn14">14</a>. Rev. Rul. 58-175, 1958-1 CB 28. <a href="#_ftnref15" name="_ftn15">15</a>. IRC § 67. <a href="#_ftnref16" name="_ftn16">16</a>. IRC § 164(f). <a href="#_ftnref17" name="_ftn17">17</a>.  TC Memo 2005-207. </div></div>

August 30, 2024

677 / Are Social Security and railroad retirement benefits taxable?

<div class="Section1"> Under certain circumstances, a portion of Social Security benefits and tier 1 railroad retirement benefits may be taxable. If a taxpayer’s modified adjusted gross income plus one-half of the Social Security benefits (including tier I railroad retirement benefits) received during the taxable year exceeds certain base amounts, then a portion of the benefits are includible in gross income as ordinary income. “Modified adjusted gross income” is a taxpayer’s adjusted gross income (disregarding foreign income, savings bonds, adoption assistance program exclusions, the deductions for education loan interest and for qualified tuition and related expenses) plus any tax-exempt interest income received or accrued during the taxable year.<a href="#_ftn1" name="_ftnref1">1</a>A taxpayer whose modified adjusted gross income plus one-half of his or her Social Security benefits exceed a base amount is required to include in gross income the lesser of (a) 50 percent of the excess of such combined income over the base amount, or (b) 50 percent of the Social Security benefits received during the taxable year.<a href="#_ftn2" name="_ftnref2">2</a> The “base amount” is $32,000 for married taxpayers filing jointly, $25,000 for unmarried taxpayers, and zero ($0) for married taxpayers filing separately who have not lived apart for the entire taxable year.<a href="#_ftn3" name="_ftnref3">3</a> In addition to the initial tier of taxation discussed above, a percentage of Social Security benefits that exceed an adjusted base amount will be includable in a taxpayer’s gross income. The “adjusted base amount” is $44,000 for married taxpayers filing jointly, $34,000 for unmarried taxpayers, and zero ($0) for married individuals filing separately who did not live apart for the entire taxable year.<a href="#_ftn4" name="_ftnref4">4</a> If a taxpayer’s modified adjusted gross income plus one-half of his or her Social Security benefits exceed the adjusted base amount, his or her gross income will include the lesser of (a) 85 percent of the Social Security benefits received during the year, or (b) the sum of – (i) 85 percent of the excess over the adjusted base amount, plus (ii) the smaller of – (A) the amount that is includable under the initial tier of taxation, or (B) $4,500 (single taxpayers) or $6,000 (married taxpayers filing jointly).<a href="#_ftn5" name="_ftnref5">5</a> <blockquote>Example 1. A married couple files a joint return. During the taxable year, they received $12,000 in Social Security benefits and had a modified adjusted gross income of $35,000 ($28,000 plus $7,000 of tax-exempt interest income). Their modified adjusted gross income plus one-half of their Social Security benefits [$35,000 + (½ of $12,000) = $41,000] is greater than the applicable base amount of $32,000 but less than the applicable adjusted base amount of $44,000; therefore, $4,500 [the lesser of one-half of their benefits ($6,000) or one-half of the excess of $41,000 over the base amount (½ × ($41,000 – $32,000), or $4,500)] is included in gross income. Example 2. During the taxable year, a single individual had a modified adjusted gross income of $33,000 and received $8,000 in Social Security benefits. His modified adjusted gross income plus one-half of his Social Security benefits [$33,000 + (½ of $8,000) = $37,000] is greater than the applicable adjusted base amount of $34,000. Thus, $6,550 [the lesser of 85 percent of his benefits ($6,800), or 85 percent of the excess of $37,000 over the adjusted base amount (85 percent × ($37,000 – $34,000), or $2,550) plus the lesser of $4,000 (the amount includable under the initial tier of taxation) or $4,500] is included in gross income.</blockquote> An election is available that permits a taxpayer to treat a lump sum payment of benefits as received in the year to which the benefits are attributable.<a href="#_ftn6" name="_ftnref6">6</a> Reductions of Social Security Benefits that do not Reduce the Amount Included in the Computation of Taxable Benefits Workers’ compensation pay that reduced the amount of Social Security received and any amounts withheld from a taxpayer’s Social Security benefits to pay Medicare insurance premiums do not reduce the amount that are included in the computation of taxable Social Security benefits.<a href="#_ftn7" name="_ftnref7">7</a> In Green v. Comm.,<a href="#_ftn8" name="_ftnref8">8</a> the taxpayer argued that his Social Security disability benefits were excludable from gross income<a href="#_ftn9" name="_ftnref9">9</a> because they had been paid in lieu of workers’ compensation. Thus, they should not be included in the computation of taxable Social Security benefits. The Tax Court determined, however, that Title II of the Social Security Act is not a form of workers’ compensation. Instead, the Act allows for disability payments to individuals regardless of employment. Consequently, the taxpayer’s Social Security disability benefits were includable in gross income. Similarly, in a case of first impression, the Tax Court held that a taxpayer’s Social Security disability insurance benefits (payable as a result of the taxpayer’s disability due to lung cancer caused from exposure to Agent Orange during his Vietnam combat service) were includable in gross income under IRC Section 86 and not excludable under IRC Section 104(a)(4). The court reasoned that Social Security disability insurance benefits do not take into consideration the nature or cause of the individual’s disability. Eligibility for purposes of Social Security disability benefits is determined on the basis of the individual’s prior work record, not the cause of the disability. Moreover, the amount of Social Security disability payments is computed under a formula that does not consider the nature or extent of the injury. Consequently, because the taxpayer’s Social Security disability insurance benefits were not paid for personal injury or sickness in military service within the meaning of IRC Section 104(a)(4), the benefits were not excluded from gross income under IRC Section 104(a)(4).<a href="#_ftn10" name="_ftnref10">10</a> Railroad retirement benefits (other than Tier I benefits) are taxed in the same way as benefits received under a qualified pension or profit sharing plan. For this purpose, the Tier II portion of the taxes imposed on employees and employee representatives is treated as an employee contribution, while the Tier II portion of the taxes imposed on employers is treated as an employer contribution.<a href="#_ftn11" name="_ftnref11">11</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 86(b)(2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 86(a)(1). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 86(c)(1). In a Tax Court case, the term “live apart” means living in separate residences. In that case, the taxpayer lived in the same residence as his spouse for at least thirty days during the tax year in question (even though maintaining separate bedrooms). The Tax Court ruled that he did not “live apart” from his spouse at all times during the year; therefore, the taxpayer’s base amount was zero. McAdams v. Commissioner, 118 TC 373 (2002). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 86(c)(2). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 86(a)(2). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 86(e). <a href="#_ftnref7" name="_ftn7">7</a>. Rev. Rul. 84-173, 1984-2 CB 16. <a href="#_ftnref8" name="_ftn8">8</a>. TC Memo 2006-39. <a href="#_ftnref9" name="_ftn9">9</a>. Under IRC § 104(a)(1). <a href="#_ftnref10" name="_ftn10">10</a>. Reimels v. Commissioner, 123 TC 245 (2004), aff’d, 436 F.3d 344 (2d Cir. 2006); Haar v. Commissioner, 78 TC 864, 866 (1982), aff’d, 709 F.2d 1206 (8th Cir. 1983), followed. <a href="#_ftnref11" name="_ftn11">11</a>. See IRC § 72(r)(1). </div>

August 27, 2024

765.01 / How did the Inflation Reduction Act of 2022 modify the tax credit for new energy efficient homes?

<div class="Section1">Under the Inflation Reduction Act of 2022, the tax credit for new energy efficient homes under IRC Section 45L was extended through 2032 (and retroactively through 2022, although the pre-existing rules will continue to apply for 2022). The tax credit is designed to provide an incentive for builders of both residential homes and multi-family dwellings to use materials designed to reduce energy consumption.</div> <div class="Section1"> Beginning in 2023, the credit is also modified by increasing the maximum amount of the credit to either $2,500 or $5,000 (the prior maximum was $2,000 per unit). The new programs also eliminate the height restrictions, so that the previously-existing three-story or less requirement no longer applies beginning in 2023. Builders must satisfy certain energy-efficient criteria qualify for the $2,500 credit. Beginning in 2023, single-family homes must satisfy the requirements of the Department of Energy’s “Energy Star Single Family New Homes Program,” Version 3.1 for homes constructed before January 1, 2025 and Version 3.2 for later years. It is expected that additional details will be provided. Manufactured homes are required to satisfy the latest Energy Star Manufactured Home National Program requirements that are in effect on the later of (1) January 1, 2023 or January 1 of the year that is two calendar years prior to the date the dwelling is acquired. If the single-family or manufactured home is certified as a DOE Zero Energy Ready Home (ZERH) (or meets the requirements of a successor program implemented by the Department of Energy), a higher $5,000 credit is available. For multi-family dwellings, a $500 credit is available if the home satisfies the criteria of the Energy Star Single Family New Homes Program and a $1,000 credit is available if the building is ZERH certified.<a href="#_ftn1" name="_ftnref1">1</a> Builders must also satisfy prevailing wage standards beginning in 2023. To qualify, workers must be paid wages at rates not less than the prevailing rates for construction, alteration, or repair of a similar character in the locality in which such residence is located as most recently determined by the Secretary of Labor. To qualify for the tax credit, the taxpayer must obtain an audit that provides an estimate of the energy and cost savings of each energy-efficient home improvement. Beginning in 2024, that audit must be conducted by a Qualified Home Energy Auditor, which is an auditor who has been certified by one of the certification programs listed by the Department of Energy on its certification programs page for the energy efficient home improvement credit. For 2023, a transition rule applies so that the auditor need not be a Qualified Home Energy Auditor.<a href="#_ftn2" name="_ftnref2">2</a> The IRS has also appropriated funds and authorized the Department of Energy to distribute funds to establish rebate programs for owners and occupants of residential property who engage in qualifying transactions under the law. For tax purposes, a rebate paid to or on behalf of a purchaser pursuant to the DOE Home Energy Rebate Programs will be treated as a purchase price adjustment for the purchaser and is not taxable income. For rebates provided at the time of sale, the amount of the rebate provided in connection with the DOE Home Energy Rebate Programs is not included in a purchaser’s cost basis under IRC Section 1012. For rebates provided at a later time, the amount of the rebate constitutes an adjustment to basis under IRC Section 1016. Payments of rebate amounts to the purchaser that are treated as a purchase price adjustment are not subject to information reporting under IRC Section 6041.<a href="#_ftn3" name="_ftnref3">3</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 45L(c), as modified by Inflation Reduction Act § 13304. <a href="#_ftnref2" name="_ftn2">2</a>. Notice 2023-59. <a href="#_ftnref3" name="_ftn3">3</a>. A-24-19. </div>

June 14, 2024

727 / How does the depreciation deduction impact an individual’s basis in the property? Must depreciation ever be “recaptured”?

<div class="Section1">Each year, an individual’s basis is reduced by the amount of the depreciation deduction taken so that his adjusted basis in the property reflects accumulated depreciation deductions. If depreciation is not deducted, his basis must nonetheless be reduced by the amount of depreciation allowable, but the deduction may not be taken in a subsequent year.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> Recapture Upon disposition of property, the seller often realizes more than return of basis after it has been reduced for depreciation. Legislative policy is that on certain dispositions of depreciated property the seller realizes a gain that is, at least in part, attributable to depreciation. To prevent a double benefit, the IRC requires that some of the gain that would otherwise generally be capital gain must be treated as ordinary income. In effect, it requires the seller to “recapture” some of the ordinary income earlier offset by the depreciation.<a href="#_ftn2" name="_ftnref2">2</a> In addition, if depreciated property ceases to be used predominantly in a trade or business before the end of its recovery period, the owner must recapture in the tax year of cessation any benefit derived from expensing such property.<a href="#_ftn3" name="_ftnref3">3</a> This provision is effective for property placed in service in tax years ending after January 25, 1993.<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1016(a)(2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 1245, 1250. <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.179-1(e)(1). <a href="#_ftnref4" name="_ftn4">4</a>. Treas. Reg. § 1.179-6. </div>

June 14, 2024

698 / What is a “capital asset”?

<div class="Section1">For tax purposes, a “capital asset” is any property that, in the hands of the taxpayer, is not: (1) property (including inventory and stock in trade) held primarily for sale to customers; (2) real or depreciable property used in his trade or business; (3) copyrights and literary, musical, or artistic compositions (or similar properties) created by the taxpayer, or merely owned by him, if his tax basis in the property is determined (other than by reason of IRC Section 1022, which governs the basis determination of inherited property) by reference to the creator’s tax basis; (4) letters, memoranda, and similar properties produced by or for the taxpayer, or merely owned by him, if his tax basis is determined by reference to the tax basis of such producer or recipient; (5) accounts or notes receivable acquired in his trade or business for services rendered or sales of property described in (1), above; (6) certain publications of the United States government; (7) any commodities derivative financial instrument held by a commodities derivatives dealer; (8) any hedging instrument that is clearly identified as such by the required time; and (9) supplies of a type regularly used or consumed by the taxpayer in the ordinary course of his trade or business.<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> Generally, any property held as an investment is a capital asset, except that rental real estate is generally not a capital asset because it is treated as a trade or business asset (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7791">7791</a>).<a href="#_ftn2" name="_ftnref2">2</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1221; Treas. Reg. § 1.1221-1. <a href="#_ftnref2" name="_ftn2">2</a>. See IRS Pub. 544. </div></div>

June 14, 2024

661 / Who is taxed on the income from property that is transferred to a minor under a uniform “Gifts to Minors” act?

<div class="Section1"> As a general rule, the income is taxable to the minor. However, in the case of unearned income (such as trust income) of most children under age nineteen (age 24, if the child is a full-time student), different rules may apply. Prior to 2018 and after 2019, the unearned income taxable to the child generally is taxed at the parents’ marginal rate when it exceeds $2,700 (in 2025, $2,600 in 2024, $2,500 in 2023, $2,300 in 2022 and $2,200 in 2015 to 2021, as adjusted for inflation).<a href="#_ftn1" name="_ftnref1">1</a> <hr /> Planning Point: Taxpayers had the option of applying a different set of rules in 2018 and 2019 under the 2017 tax reform legislation. If the election was made, earned income of minors would be taxed according to the individual income tax rates prescribed for single filers,<a href="#_ftn2" name="_ftnref2">2</a> and unearned income of minors would be taxed according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that is subject to ordinary income tax rates and in determining the capital gains rate that will apply if long-term capital gains treatment is appropriate).<a href="#_ftn3" name="_ftnref3">3</a> <hr /> To the extent that income from the transferred property is used for the minor’s support, it may be taxed to the person who is legally obligated to support the minor.<a href="#_ftn4" name="_ftnref4">4</a> State laws differ as to a parent’s obligation to support. The income will be taxable to the parent only to the extent that it is actually used to discharge or satisfy the parent’s obligation under state law.<a href="#_ftn5" name="_ftnref5">5</a> The 2017 Tax Act aimed to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. The SECURE Act<a href="#_ftn6" name="_ftnref6">6</a> repealed this rule for tax years beginning in 2020 and thereafter. For 2018 and 2019, taxpayers had the option of electing which set of rules to apply, and may apply for refunds if appropriate for these tax years. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1(j)(4)(B). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1(j)(4). <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 56-484, 1956-2 CB 23; Rev. Rul. 59-357, 1959-2 CB 212. <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 677(b). <a href="#_ftnref6" name="_ftn6">6</a>. PL 116-94, 133 Stat. 2534 (12-20-2019) </div>

June 14, 2024

721 / Are there any situations where a taxpayer can now claim bonus depreciation with respect to used property in which the taxpayer previously held an interest? How do the bonus depreciation rules apply to leased property?

<div class="Section1">In order to claim bonus depreciation with respect to used property, the property must not be used by the taxpayer or a predecessor at any time before the taxpayer acquired the property (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). This requirement raised questions as to whether bonus depreciation could be available with respect to property that the taxpayer previously leased, or in which the taxpayer previously held an interest but did not own entirely. See the heading below for a discussion of the short holding period exception proposed in the 2019 regulations.<div class="Section1"> Under the regulations, bonus depreciation may now be available for property that a taxpayer previously leased and later acquired. In some situations, a taxpayer may make improvements to property that is leased and obtain a depreciable interest in the property as a result. If the taxpayer later acquires the property, bonus depreciation is unavailable with respect to the portion of the property in which the taxpayer held a depreciable interest during the lease period.<a href="#_ftn1" name="_ftnref1">1</a> Relatedly, if a taxpayer originally held a depreciable interest in property, and later acquires an additional depreciable interest in an additional portion of the same property, the additional depreciable interest is not treated as though it was used by the taxpayer prior to acquisition (i.e., it is eligible for bonus depreciation under the used property rules if all other requirements are satisfied). If the taxpayer previously had a depreciable interest in the subsequently acquired additional portion, bonus depreciation is not available. A different rule applies in situations where a taxpayer sells a partial interest in property and later buys a partial interest in the same property. If a taxpayer holds a depreciable interest in a portion of the property, sells that portion or a part of that portion, and later acquires a depreciable interest in another portion of the same property, the taxpayer is treated as previously having a depreciable interest in the property up to the amount of the portion for which the taxpayer held a depreciable interest in the property before the sale.<a href="#_ftn2" name="_ftnref2">2</a> Under the 2019 regulations, the mere fact that a business leases property to a disqualified business (i.e., one that does not qualify to use bonus depreciation, such as certain businesses with floor plan financing interest) does not “taint” the property, meaning that such exclusion from the additional first year depreciation deduction does not apply to lessors of property to a trade or business described in IRC Section 168(k)(9) so long as the lessor is not described the section.<a href="#_ftn3" name="_ftnref3">3</a> Short Holding Period Exception The 2019 regulations provide an exception to the depreciable interest rule in situations where the taxpayer disposes of the property within a short period of time after placing the property in service. If the following are true: (a)a taxpayer acquires and places in service property, (b)the taxpayer or a predecessor did not previously have a depreciable interest in the property, (c)the taxpayer disposes of the property to an unrelated party within 90 calendar days after the date the property was originally placed in service by the taxpayer (without taking into account the applicable convention), and (d)the taxpayer reacquires and again places in service the property, then the taxpayer’s depreciable interest in the property during that 90-day period is not taken into account for determining whether the property was used by the taxpayer or a predecessor at any time prior to its reacquisition by the taxpayer.<a href="#_ftn4" name="_ftnref4">4</a> The proposed rule does not apply if the taxpayer reacquires and again places in service the property during the same taxable year the taxpayer disposed of the property. </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(B)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(B)(2). <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. § 1.168(k)- 2(b)(2)(ii)(F). <a href="#_ftnref4" name="_ftn4">4</a>. Prop. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(B)(4). </div></div>

June 14, 2024

720 / How do the bonus depreciation rules apply to used property under the 2017 tax reform legislation?

<div class="Section1">The bonus depreciation rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>) may be applied to used property if the property was not used by the taxpayer (or a predecessor) prior to the acquisition. The property is considered to have been used by the taxpayer or a predecessor prior to the acquisition if the taxpayer or predecessor had a depreciable interest in the property at any time prior to the acquisition, regardless of whether depreciation deductions were actually claimed.<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> Under the 2019 final regulations, “predecessor” is defined to include (i) a transferor of an asset to a transferee in a transaction to which IRC Section 381(a) applies, (ii) 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 hands of the transferor, (iii) a partnership that is considered as continuing under IRC Section 708(b)(2), (iv) the decedent in the case of an asset acquired by an estate, or (v) a transferor of an asset to a trust.<a href="#_ftn2" name="_ftnref2">2</a> Further, all of the following must be true: (1)the property was not acquired from certain related parties, including: (a) the taxpayer’s spouse, ancestors and descendants, (b) an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the individual, (c) a grantor and a fiduciary of any trust, (d) a fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts, (e) a fiduciary and a beneficiary of a trust, (f) a fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts, (g) a fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust, (h) a person and an organization to which IRC Section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual, (i) a corporation and a partnership if the same person owns more than 50 percent of the outstanding stock in the corporation or capital interest or profits of the partnership, (j) an S corporation and another S corporation if the same person owns more than 50 percent of the outstanding stock of each corporation, (k) an S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation, (l) the executor and beneficiary of an estate, (m) two partnerships in which the same person owns more than 50 percent of the capital interests and profits or (n) a partnership and a person owning more than 50 percent of the capital interests and profits of the partnership. <hr> Planning Point: The IRS regulations on the bonus depreciation rules contain a general anti-abuse rule that will apply to determine related party status. The rules provide that in a series of related transactions, the property is treated as though it was transferred directly from its original owner to its ultimate owner. The relationship between the original owner and the ultimate owner is tested immediately after the last transfer in the series of transactions. The 2019 final regulations provide for a five-year “lookback” period in making the determination as to whether the property was previously used by a prohibited party.<a href="#_ftn3" name="_ftnref3">3</a> <hr> (2)the property was not acquired by one member of a controlled group from another member of that group, (3)the property was acquired by purchase, within the meaning of IRC Section 179, (4)the basis of the property in the hands of the person acquiring it is not determined in whole or part by reference to the adjusted basis of the property in the hands of the person from whom it was acquired or under IRC Section 1014(a) (basis of property acquired from a decedent), (5)the cost of the property does not include the basis of the property as determined by reference to the basis of other property held by the taxpayer.<a href="#_ftn4" name="_ftnref4">4</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(B)(1). <a href="#_ftnref2" name="_ftn2">2</a>. Treas. Reg. § 1.168(k)-2(a)(2)(iv). <a href="#_ftnref3" name="_ftn3">3</a>. Prop. Treas. Reg. § 1.168(k)-2(b)(3)(iii)(C). <a href="#_ftnref4" name="_ftn4">4</a>. IRC §§ 168(k)(2)(E)(ii), 267(b), 707(b). </div></div>

June 14, 2024

807 / How is an S corporation’s deduction for qualified business income determined?

<div class="Section1">Entities that are taxed under the rules governing pass-through taxation are generally entitled to a 20 percent deduction for qualified business income (QBI, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). This deduction is equal to the sum of: (a)  the lesser of the combined qualified business income amount for the tax year or an amount equal to 20 percent of the excess of the taxpayer’s taxable income over any net capital gain and cooperative dividends, plus (b)  the lesser of 20 percent of qualified cooperative dividends or taxable income (reduced by net capital gain).<a href="#_ftn1" name="_ftnref1">1</a> The sum discussed above may not exceed the taxpayer’s taxable income for the tax year (reduced by net capital gain). Further, the 20 percent deduction with respect to qualified cooperative dividends is limited to taxable income (reduced by net capital gain). The deductible amount for each qualified trade or business is the lesser of: (a)  20 percent of the qualified business income with respect to the trade or business or (b)  the greater of (x) 50 percent of W-2 wage income or (y) the sum of 25 percent of the W-2 wages of the business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>).<a href="#_ftn2" name="_ftnref2">2</a> <hr> Planning Point: The regulations provide guidance on how UBIA should be calculated in the case of a like-kind exchange or involuntary conversion. The regulations follow the Section 168 regulations in providing that property acquired in a like-kind exchange, or by conversion, is treated as MACRS property, so that the depreciation period is determined using the date the relinquished property was first placed into service unless an exception applies. The exception applies if the taxpayer elected not to apply Treasury Regulation § 1.168(i)-6. As a result, most property acquired in a like-kind exchange or involuntary conversion under the new rules will have two relevant placed in service dates. For calculating UBIA, the relevant date is the date the taxpayer places the property into service. For calculating its depreciable period, the relevant date is the date the taxpayer placed the original, relinquished property into service. <hr> Concurrently with the regulations, the IRS released Notice 2018-64, which contains a proposed revenue procedure with guidance for calculating W-2 wages for purposes of the Section 199A deduction for qualified business income. This guidance was finalized in Revenue Procedure 2019-11. The guidance provides three methods for calculating W-2 wages, including the “unmodified box method”, the “modified Box 1 method”, and the “tracking wages method”. The guidance further specifies that wages calculated under these methods are only taken into account in determining the W-2 wage limitations if properly allocable to QBI under Proposed Treasury Regulation § 1.199A-2(g). The unmodified box method involves taking the lesser of (1) the total of Box 1 entries for all W-2 forms or (2) the total of Box 5 entries for all W-2 forms (in either case, those that were filed with the SSA by the taxpayer for the year). Under the modified Box 1 method, the taxpayer subtracts from its total Box 1 entries amounts that are not wages for federal income tax withholding purposes, and then adds back the total of Box 12 entries for certain employees. The tracking wages method requires the taxpayer to actually track employees’ wages, and (1) total the wages subject to income tax withholding and (2) subtract the total of all Box 12 entries of certain employees. Revenue Procedure 2019-11 clarifies that, in the case of short taxable years, the business owner is required to use the “tracking wages method” with certain modifications. The total amount of wages subject to income tax withholding and reported on Form W-2 can only include amounts that are actually or constructively paid to the employee during the short tax year and reported on a Form W-2 for the calendar year with or within that short tax year. With respect to the amounts reported in Box 12, only the portion of the total amount reported that was actually deferred or contributed during the short year can be included in W-2 wages. If the taxable income is below the applicable threshold levels (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>), the deduction is simply 20 percent.<a href="#_ftn3" name="_ftnref3">3</a> If the taxable income exceeds the relevant threshold amount, but not by more than $50,000 ($100,000 for joint returns), and the amount determined under (b), above, is less than the amount under (a), above, then the deductible amount is determined without regard to the calculation required under (b). However, the deductible amount allowed under (a) is reduced by the amount that bears the same ratio to the “excess amount” as (1) the amount by which taxable income exceeds the threshold amount bears to (2) $50,000 ($100,000 for joint returns). The “excess amount” means the excess of amount determined under (a), above, over the amount determined under (b), above, without regard to the reduction described immediately above. “Combined QBI” for the year is the sum of the deductible amounts for each qualified trade or business of the taxpayer and 20 percent of the taxpayer’s qualified REIT dividends and qualified publicly traded partnership income.<a href="#_ftn4" name="_ftnref4">4</a> Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend.<a href="#_ftn5" name="_ftnref5">5</a> “Qualified cooperative dividends” includes a patronage dividend, per-unit retain allocation, qualified written notice of allocation, or any similar amount that is included in gross income and received from (a) a tax-exempt benevolent life insurance association, a mutual ditch or irrigation company, cooperative telephone company, like cooperative organization or a taxable or tax-exempt cooperative that is described in section 1381(a), or (2) a taxable cooperative governed by tax rules applicable to cooperatives before the enactment of subchapter T of the Code in 1962.<a href="#_ftn6" name="_ftnref6">6</a> “Qualified publicly traded partnership income” means the sum of: (1)  the net amount of the taxpayer’s allocable share of each qualified item of income, gain, deduction, and loss from a publicly-traded partnership that does not elect to be taxed as a corporation (so long as the item is connected with a U.S. trade or business and is included or allowed in determining taxable income for the year and is not excepted investment-type income, also not including the taxpayer’s reasonable compensation, guaranteed payments for services or Section 707(a) payments for services), and (2)  gain recognized by the taxpayer on disposing its interest in the partnership that is treated as ordinary income.<a href="#_ftn7" name="_ftnref7">7</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8581">8581</a> - Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8601">8601</a> for a more detailed discussion of the Section 199A regulations. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 199A(a) <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 199A(b)(2). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 199A(b)(3). <a href="#_ftnref4" name="_ftn4">4</a>.  IRC § 199A(b)(1). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 199A(e)(3). <a href="#_ftnref6" name="_ftn6">6</a>.  IRC § 199A(e)(4). <a href="#_ftnref7" name="_ftn7">7</a>.  IRC § 199A(e)(5). </div></div>

March 13, 2024

756 / Who may file a joint return?

<div class="Section1">Two spouses may file a joint return. Same-sex couples who are married under state law must now file either jointly or married filing separately for 2013 and beyond because of the Supreme Court’s Windsor decision.<a href="#_ftn1" name="_ftnref1">1</a> Gross income and deductions of both spouses are included; however, a joint return may be filed even though one spouse has no income. A widow or widower who has a dependent child may file as a “surviving spouse” and calculate tax using joint return tax rates for two years after the taxable year in which the spouse died. However, no personal exemption is allowed for the deceased spouse except in the year of death (note that the personal exemption was suspended from 2018-2025).<a href="#_ftn2" name="_ftnref2">2</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Windsor v. U.S., 133 S. Ct. 2675 (2013). <a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 1(a), 2(a), 6013(a). See IRC § 151(b). </div>