The American Institute of CPAs (AICPA) has urged the IRS and Treasury in an August 12 letter to issue guidance on President Trump’s payroll tax deferral memorandum. The executive action signed by the president on August 8 instructs Treasury to defer the collection and payment of payroll taxes from September 1 through years-end for eligible employees.

The American Institute of CPAs (AICPA) has urged the IRS and Treasury in an August 12 letter to issue guidance on President Trump’s payroll tax deferral memorandum. The executive action signed by the president on August 8 instructs Treasury to defer the collection and payment of payroll taxes from September 1 through years-end for eligible employees.

The presidential memorandum to defer payroll taxes has "caused confusion and concern among accountants and businesses," according to the AICPA. Thus, in its letter released on August 13, the AICPA asks IRS Commissioner Charles "Chuck" Rettig and Assistant Treasury Secretary David Kautter to issue guidance on a number of related issues, including the following items:

• Guidance stating that the deferral is voluntary and that an "eligible employee" is responsible for making an affirmative election to defer the payroll taxes;
• Guidance stating that an "eligible employee" is an employee whose wages are less than $4,000 per bi-weekly pay period;
• Guidance stating that the $4,000 limit should apply separately to each employer of an employee; and
• Guidance stating a payment due date(s) for the deferred taxes and a mechanism for employees to pay the deferred taxes.

Payroll Tax Forgiveness

Notably, Treasury Secretary Steven Mnuchin indicated earlier this week that participation in the deferral of payroll taxes is not mandatory. "We cannot force people to participate," Mnuchin said in a televised interview. "But I think many small businesses will do this and pass on the benefits." Additionally, Mnuchin alluded that Trump intends to make the deferral a cut if reelected, essentially forgiving the deferred taxes.

To that end, White House economic advisor Larry Kudlow attempted to clarify Trump’s position that the payroll tax deferral should be forgiven rather than delayed. And when Trump talks about "terminating the payroll tax", he is only referring to those taxes specified within the presidential memorandum, not the entire payroll tax as a whole, according to Kudlow.

"I just want to be clear that the president is saying that he will provide forgiveness; he will terminate the deferral on a forgiveness basis," Kudlow told reporters at the White House on August 13. "That is what he is saying just to be clear…there was some confusion about that."

Additionally, Kudlow told reporters that the payroll tax deferral would apply to the self-employed. Although the applicable presidential memorandum is not currently written as such, Kudlow added that the administration "will make a technical change to it."

The IRS has released final regulations that address the interaction of the $10,000/$5,000 cap on the state and local tax (SALT) deduction and charitable contributions. The regulations include:

• a safe harbor for individuals who have any portion of a charitable deduction disallowed due to the receipt of SALT benefits;
• a safe harbor for business entities to deduct certain payments made to a charitable organization in exchange for SALT benefits; and
• application of the quid pro quo principle under Code Sec. 170 to benefits received or expected to be received by the donor from a third party.

The IRS has released final regulations that address the interaction of the $10,000/$5,000 cap on the state and local tax (SALT) deduction and charitable contributions. The regulations include:

• a safe harbor for individuals who have any portion of a charitable deduction disallowed due to the receipt of SALT benefits;
• a safe harbor for business entities to deduct certain payments made to a charitable organization in exchange for SALT benefits; and
• application of the quid pro quo principle under Code Sec. 170 to benefits received or expected to be received by the donor from a third party.

The final rules generally adopt the proposed regulations issued in December 2019 ( NPRM REG-107431-19) with minor clarifications.

SALT Limit

An individual’s itemized deduction of SALT taxes is limited to $10,000 ($5,000 if married filing separately) for tax years beginning after 2017. Some states and local governments adopted laws that allowed individuals to receive a state tax credit for contributions to certain charitable funds. These laws are aimed at getting around the SALT deduction limit by creating a charitable deduction for federal income tax purposes.

Under previously issued regulations, the receipt of a SALT credit for a charitable contribution is the receipt of a return benefit (quid pro quo benefit). Thus, the taxpayer must reduce any contribution deduction by the amount of any SALT credit received or expected to receive in return. A de minimis exception is available if the SALT credit does not exceed 15 percent of the taxpayer’s charitable payment.

A taxpayer is not required to reduce the charitable contribution deduction because of the receipt of SALT deductions. However, the taxpayer must reduce the charitable deduction if it receives or expects to receive SALT deductions in excess of the taxpayer’s payment or the fair market value of property transferred.

Payments by Individuals

The final regulations adopt the safe harbor for individuals whose have a portion of a charitable deduction disallowed due to the receipt of a SALT credit. Any disallowed portion of the charitable contribution deduction may be treated as the payment of SALT taxes for the purposes of deducting taxes under Code Sec. 164. The safe harbor is allowed in the tax year the charitable payment is made, but only to the extent that the SALT credit is applied as provided under state or local law to offset the individual’s SALT liability for the current or preceding tax year. Any unused credit may be carried forward as provided under state and local law.

The final regulations are not intended to permit a taxpayer to avoid the SALT deduction cap. Thus, any payment treated as a state or local tax under Code Sec. 164 is subject to the limit. Also, a taxpayer is not permitted to deduct the same under more than one rule, so a taxpayer who relies on this safe harbor to deduction payments as SALT taxes may also not deduct the same payment under any other Code provision.

Payments by Business Entities

The final regulations adopt the safe harbor that business entities may continue to deduct charitable contributions in exchange a SALT credit. A business entity may deduct the payments as an ordinary and necessary business expenses under Code Sec. 162 if made for a business purpose.

If a C corporation or specified passthrough entity makes the charitable payment in exchange for a SALT credit, it may deduct the payment as a business expense to the extent of any SALT credit received or expected to be received. In addition, if the charitable payment bears a direct relationship to the taxpayer’s business, then it may be deducted as a business expense rather than a charitable contribution regardless of whether the taxpayer receives or expects to receive a SALT credit.

The safe harbor for C corporations and specified passthrough entities applies only to payments of cash and cash equivalents. The safe harbor for specified passthrough entities does not apply if the credit received or expected to be received reduces a state or local income tax.

Benefits from Third Party

If a taxpayer receives any goods, services, or other benefits from a charitable organization in consideration for a contribution, then the charitable deduction must be reduced by the value of those benefits. If the contribution exceeds the fair market value of the benefits received, then only the excess is a deductible as a charitable contribution.

The final regulations continue to provide that this quid pro quo principal applies regardless of whether the party providing the goods, services, or other benefits is the charitable organization or not. A taxpayer will be treated as receiving goods and services in consideration for the taxpayer’s charitable contribution if, at the time the taxpayer makes the payment or transfer, the taxpayer receives or expects to receive goods or services in return. The final rules clarify that the quid pro quo principle applies regardless of whether the party providing the quid pro quo is the donee or a third party.

The IRS has issued final regulations regarding the limitation for the business interest expense deduction under Code Sec. 163(j), including recent legislative amendments made for the 2019 and 2020 tax years. Also, a safe harbor has been proposed allowing taxpayers managing or operating residential living facilities to qualify as a real property trade or business for purposes of the limitation. In addition, new proposed regulations are provided for a number of different areas.

The IRS has issued final regulations regarding the limitation for the business interest expense deduction under Code Sec. 163(j), including recent legislative amendments made for the 2019 and 2020 tax years. Also, a safe harbor has been proposed allowing taxpayers managing or operating residential living facilities to qualify as a real property trade or business for purposes of the limitation. In addition, new proposed regulations are provided for a number of different areas.

Section 163(j) Limitation

A taxpayer’s deduction of business interest expenses paid or incurred for the tax year is generally limited to the sum of:

• the taxpayer’s business interest income for the tax year for which the taxpayer is claiming the deduction (not including investment income);
• 30 percent of the taxpayer’s adjusted taxable income (ATI), but not less than zero; and
• the taxpayer’s floor plan financing interest.

The percentage limit is generally increased to 50 percent of ATI for 2019 and 2020. For a partnership, however, the 50 percent limit applies for 2020 only, and a special allocation of excess business interest expense (EBIE) to a partner may apply for the 2019 tax year. A taxpayer may elect not to use the 50 percent ATI limit, and any taxpayer other than a partnership may elect for 2020 to use its ATI from the 2019 tax year to calculate its limitation.

The 163(j) limitation does not apply to certain small businesses whose gross receipts are less than a threshold amount ($26 million for 2020). It also does not apply to electing real property trades or businesses, electing farming businesses, and certain regulated public utilities.

Final Regulations

The final regulations generally adopt proposed rules that were issued in December 2018, with some modifications. Taxpayer may continue to rely on some of the rules in the proposed regulations. One significant change is that the final regulations provide any that any depreciation, amortization, or depletion that is capitalized into inventory under Code Sec. 263A before 2022 will be added back to tentative taxable income in calculating ATI.

This is change from the proposed rules which effectively resulted in taxpayers with inventory to effectively use earnings before interest and tax (EBIT) instead of earnings before interest, tax, depreciation, and amortization (EBITDA) before 2022 in calculating ATI. Also, the final rules eliminate the “lesser of” standard with respect to sales and disposition of stock, and require taxpayers to back out depreciation deductions that were allowed or allowable during the EBITDA period.

The IRS had adopted the broad definition of business interest in the proposed rules, including the definition of substitute interest and the embedded loan rule with some modifications. However, the final regs exclude commitment fees, debt issuance costs, guaranteed payments (except used as capital), and hedging rules. The IRS has also modified the anti-avoidance rule for time value of money.

Qualified Residential Living Facilities

The IRS has proposed a safe harbor for a trade or business that manages or operates a qualified residential living facility to be treated as a real property trade or business solely for purposes of qualifying as an electing real property trade or business. A facility is qualified if it:

• consists of multiple rental dwelling units within one or more structures that generally serve as primary residences on a permanent or semi-permanent basis to individual customers or patients;
• provides supplemental assistive, nursing, or other routine medical services; and
• has an average period of customer or patient use of the individual rental dwelling units that is 90 days or more.

The safe harbor is proposed to apply to tax years beginning after December 31, 2017.

Proposed Regulations

In addition to the final regulations, the IRS has issued new proposed regulations that provide rules regarding:

• different computational methods a taxpayer can choose in determining certain adjustments to tentative taxable income;
• the treatment of EBIE allocated to a partner in 2019, and the election to use ATI from 2019 for the 2020 tax year under Code Sec. 163(j)(10);
• interest expense associated with debt proceeds of partnerships and S corporations (passthrough entities);
• application of the limitation for a partnership’s self-charged lending transactions, partnerships engaged in trades or businesses that are not passive activities, publicly traded partnerships, certain section 734(b) adjustments, and tiered partnership structures;
• application to U.S. shareholders of controlled foreign corporations (CFCs) and to foreign persons with effectively connected income in the United States; and
• application to corporate look-through provisions.

Finally, the IRS has also released FAQs that provide a general overview of the aggregation rules that apply for purposes of the gross receipts test, and that apply to determine whether a taxpayer is a small business that is exempt from the business interest expense deduction limitation.

The IRS has issued proposed regulations that implement the "carried interest" rules under Code Sec. 1061 adopted by Congress as part of the Tax Cuts and Jobs Act of 2017 ( P.L. 115-97). Some key aspects of the lengthy proposed regulations include the definition of important terms, how the rules work in the context of tiered passthrough structures, the definition of "substantial" services provided by the carried interest holder, and the level of activity required for a business to meet the definition of an "applicable trade or business."

The IRS has issued proposed regulations that implement the "carried interest" rules under Code Sec. 1061 adopted by Congress as part of the Tax Cuts and Jobs Act of 2017 ( P.L. 115-97). Some key aspects of the lengthy proposed regulations include the definition of important terms, how the rules work in the context of tiered passthrough structures, the definition of "substantial" services provided by the carried interest holder, and the level of activity required for a business to meet the definition of an "applicable trade or business."

In general, a "carried interest" is an interest in a partnership in the investment management business that consists of the right to receive future partnership profits. Carried interests are given to a partner in exchange for performing asset management services for businesses such as private equity funds, venture capital funds, and hedge funds.

Prior to Code Sec. 1061, taxpayers tended to treat carried interests as interests in partnership profits subject to long-term capital gain rates. Code Sec. 1061, however, reflects that a carried interest may in fact be compensation for services and therefore properly subject to ordinary income rates. As a result, Code Sec. 1061 applies a longer, three-year holding period to certain net long-term capital gain with respect to any "applicable partnership interest" (API)—essentially, any carried interest. The effect of this is to recharacterize as short-term capital gain certain net long-term capital gain of a partner who holds one or more APIs.

The proposed regulations define the amount of otherwise long-term capital gain that fails to meet the three-year holding period as the "recharacterization amount," and refers to the person who is subject to income tax on the recharacterization amount as the "owner taxpayer." In addition, the proposed regulations provide a framework for determining the recharacterization amount when an API is held though one or more tiers of passthrough entities.

A partnership interest is an API if it is transferred in connection with the performance of "substantial" services. Under the proposed regulations, services are presumed to be substantial with respect to a partnership interest transferred in connection with those services. Basically, this means that the partnership is presumed to get good value for the partnership interest it transfers in exchange for services.

Generally, an API is any interest in a partnership that is transferred to or held by the taxpayer in connection with the performance of services by the taxpayer in any "applicable trade or business" (ATB). Under Code Sec. 1061(c)(2), to qualify as an ATB, an activity must be "conducted on a regular, continuous, and substantial basis." Under the proposed regulations, an activity is conducted on a regular, continuous, and substantial basis if it meets the "ATB activity test." Under this test, the total level of activity conducted in one or more entities must meet the level of activity to establish a trade or business for purposes of trade or business expenses under Code Sec. 162.

The Treasury and the IRS have issued temporary and proposed regulations to:

• reconcile advance payments of refundable employment tax credits provided under the Families First Coronavirus Response Act (Families First Act) ( P.L. 116-127) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136), and
• recapture the benefit of the credits when necessary.

The Treasury and the IRS have issued temporary and proposed regulations to:

• reconcile advance payments of refundable employment tax credits provided under the Families First Coronavirus Response Act (Families First Act) ( P.L. 116-127) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136), and
• recapture the benefit of the credits when necessary.

The text of the temporary regulations serves as the text of the proposed regulations.

Background

Under the Families First Act, many employers with fewer than 500 employees must provide paid leave to employees due to circumstances related to the Coronavirus Disease 2019 (COVID-19). Certain employers must provide an employee with up to 80 hours of paid sick leave if the employee cannot work or telework due to specific reasons related to COVID-19. The Families First Act also amends the Family and Medical Leave Act of 1993 to require employers to provide expanded paid family and medical leave to employees who cannot work or telework for certain reasons related to COVID-19.

Eligible employers may receive a refundable payroll credit for required qualified sick leave wages or qualified family leave wages paid to an employee, plus allocable qualified health plan expenses. The credits are allowed against the taxes imposed on employers by Code Sec. 3111(a) (the Old-Age, Survivors, and Disability Insurance tax (social security tax)), first reduced by any credits claimed under Code Sec. 3111(e) and (f), and Code Sec. 3221(a) (the Railroad Retirement Tax Act Tier 1 tax), on all wages and compensation paid to all employees. The credits are increased by the amount of the employer’s share of Medicare tax on qualified leave wages.

The paid leave credits have per-day and maximum dollar limits for each employee, and apply to qualified leave wages paid with respect to the period beginning on April 1, 2020, and ending on December 31, 2020.

The CARES Act provides an employee retention credit for certain employers experiencing economic hardship related to COVID-19 but who pay qualified wages to their employees. Employers eligible for the employee retention credit are those that carry on a trade or business during calendar year 2020 and tax-exempt organizations that either have a full or partial suspension of operations during any calendar quarter in 2020 due to an order from an appropriate governmental authority limiting commerce, travel, or group meetings (for commercial, social, religious, or other purposes) due to COVID-19, or experience a significant decline in gross receipts during the calendar quarter.

Qualified wages are those paid by an employer to some or all employees after March 12, 2020, and before January 1, 2021, and include the employer’s qualified health plan expenses that are properly allocable to such wages or compensation. Qualified wages differ depending on whether the employer averaged more than 100 full-time employees during 2019, or 100 full-time employees or fewer during 2019.

The employee retention credit is a fully refundable tax credit for employers equal to 50 percent of qualified wages; the maximum for an eligible employer for qualified wages paid to any employee is $5,000. The credit is allowed against the taxes imposed on employers by Code Sec. 3111(a), first reduced by:

• any credits allowed under Code Sec. 3111(e) and (f),
• the paid leave credits described above, and
• the taxes imposed under Code Sec. 3221(a) that are attributable to the Code Sec. 3111(a) rate in effect, first reduced by any paid leave credits allowed, on all wages and compensation paid to all employees.

The same wages or compensation cannot be counted for both the Families First Act leave credits and the CARES Act employee retention credit.

Refundability of Credits

If the amount of the paid sick and family leave credits is more than the taxes imposed by Code Sec. 3111(a) or Code Sec. 3221(a) for any calendar quarter, the excess is treated as an overpayment that must be refunded under Code Sec. 6402(a) and Code Sec. 6413(b). A similar refund is required for the employee retention credit.

The IRS has revised Form 941, Employer's Quarterly Federal Tax Return, and is revising the other employment tax returns, so that employers can use these returns to claim the paid sick and family leave credits and the employee retention credit. The revised returns will provide for any credits in excess of the employment taxes imposed as described above, to be credited against other employment taxes and then for any remaining balance to be refunded to the employer.

Advance Payment of Credits and Erroneous Refunds

In anticipation of the paid sick and family leave credits, including any refundable portions, these credits may be advanced as provided by IRS forms and instructions, up to the total allowable amount and subject to applicable limits for the calendar quarter.

The IRS has created Form 7200, Advance Payment of Employer Credits Due To COVID-19, which employers can use to request an advance of the paid sick or family leave credits, the employee retention credit, or two or more of them. Employers must reconcile any advance payments claimed on Form 7200 with total credits claimed and total taxes due on their employment tax returns. A refund, a credit, or an advance of any portion of these credits to a taxpayer in excess of the amount to which the taxpayer is entitled is an erroneous refund for which the IRS must seek repayment.

Temporary Regulations

The temporary regulations provide that erroneous refunds of the credits are treated as underpayments of the taxes imposed under Code Sec. 3111(a) or Code Sec. 3221(a), and authorize the IRS to assess any portion of the credits erroneously credited, paid, or refunded in excess of the amount allowed as if those amounts were tax liabilities subject to assessment and administrative collection procedures. This allows the IRS to efficiently recover the amounts, while also preserving administrative protections afforded to taxpayers with respect to contesting their tax liabilities under the Code and avoiding unnecessary costs and burdens associated with litigation. These procedures will apply in the normal course in processing employment tax returns that report advances in excess of claimed credits and in examining returns for excess claimed credits.

The temporary regulations also provide that employers against whom an erroneous refund of credits can be assessed as an underpayment include persons treated as the employer under Code Sec. 3401(d), Code Sec. 3504, and Code Sec. 3511, consistent with their liability for the employment taxes against which the credit applied.

The temporary regulations apply to all paid leave credit refunds advanced or paid on or after April 1, 2020, and all employee retention credit refunds advanced or paid on or after March 13, 2020. Further, the temporary regulations apply to all paid leave credits (including any increases in the credits) refunded on or after April 1, 2020, including advanced refunds, as well as all employee retention credits that are refunded on or after March 13, 2020, including advanced refunds.

Applicability Date

The temporary regulations are effective July 29, 2020, the date they are scheduled to be published in the Federal Register.

Comments and Requests for Public Hearing

The Treasury Department and IRS request comments on all aspects of the proposed regulations. A public hearing will be scheduled if requested in writing by any person who timely submits electronic or written comments. Written or electronic comments and requests for a public hearing must be received by 60 days after the proposed regulations are published in the Federal Register.

Submit electronic submissions via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-111879-20) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The IRS expects to have limited personnel available to process public comments that are submitted on paper through the mail. Until further notice, any comments submitted on paper will be considered to the extent practicable. The Treasury and IRS will publish for public availability any comment submitted electronically, and to the extent practicable on paper. Send paper submissions to: CC:PA:LPD:PR (REG-111879-20), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, D.C. 20044.

The IRS has provided guidance on the special rules relating to funding of single-employer defined benefit pension plans, and related benefit limitations, under Act Sec. 3608 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (P.L. 116-136). The guidance clarifies application of the extended contribution deadline, and the optional use of the prior year’s adjusted funding target attainment percentage (AFTAP), with examples.

The IRS has provided guidance on the special rules relating to funding of single-employer defined benefit pension plans, and related benefit limitations, under Act Sec. 3608 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (P.L. 116-136). The guidance clarifies application of the extended contribution deadline, and the optional use of the prior year’s adjusted funding target attainment percentage (AFTAP), with examples.

Affected Funding Rules

A single-employer defined benefit plan is subject to minimum required contribution rules under Code Sec. 430. The minimum required contribution for a plan year generally depends on a comparison of the value of plan assets (reduced by any credit balances) with the plan's funding target. If the value of plan assets is less than the funding target of the plan for the year, the minimum required contribution for that plan year is the sum of:

• the target normal cost for the plan year;
• the shortfall amortization installments for the plan year; and
• the waiver amortization installments for the plan year.

The minimum required contribution for a plan year must be paid within 8-1/2 months after the close of the plan year ( Code Sec. 430(j)). Payments made on a date other than the valuation date for the plan year must be adjusted for interest accruing for the period from the valuation date to the payment date, at the effective interest rate for the plan for the year. Employers maintaining plans that had a funding shortfall for the preceding plan year (i.e., the value of plan assets, reduced by credit balances, was less than the funding target for the preceding year) must make quarterly contributions to the plan. If the employer fails to pay the full amount of a required quarterly installment, interest is assessed at the plan's effective interest rate plus five percentage points.

Benefit limits apply to plans that have funded target attainment percentage for the preceding year below designated thresholds are deemed to be in "at-risk" status and are subject to increased target liability. The benefit limits on single-employer defined benefit plans are based on the plan’s AFTAP ( Code Sec. 436(b)). Generally, a plan's funding target attainment percentage is the ratio of the value of plan assets for the plan year (reduced by any funding standard carryover balance and prefunding balance) to the funding target for the plan year (determined without regard to the plan's at-risk status) ( Code Secs. 430(d)(2) and 436(j)(1)).

CARES Act Relief
Minimum required contributions to a single-employer retirement plan otherwise due in calendar year 2020 (including any quarterly contributions) are delayed until January 1, 2021. The amount of each such contribution is increased by any interest accruing for the period between the original due date (without regard to the delay) for the contribution and the payment date. A plan sponsor also may elect to treat the plan’s AFTAP for the last plan year ending before January 1, 2020, as the AFTAP for plan years that include calendar year 2020 (Act Sec. 3608 of P.L. 116-136.

Extended Deadline and Interest
The extended contribution due date of January 1, 2021, does not apply to a multiemployer plan, a CSEC plan, a fully-insured plan, or a money purchase pension plan. If the contribution deadline for a plan year is during 2020, a contribution in excess of the amount needed to satisfy the minimum required contribution for the plan year that is made by January 1, 2021, may be designated as a contribution for that plan year.

Any payment made after the original due date for the contribution and by the extended due date must be increased for the period between the original due date and the payment date at the effective interest rate for the plan year that includes the payment date. If the contribution is less than the amount that was due on the original due date for the minimum required contribution, as increased with interest pursuant to the CARES Act, then a portion of the minimum required contribution for that plan year would remain unpaid. The unpaid portion of the minimum required contribution, determined as of the valuation date and based on contributions made on or before January 1, 2021, with the contributions discounted for interest to the valuation date, would give rise to an unpaid minimum required contribution that would be subject to an excise tax. Furthermore, a contribution made after January 1, 2021, to satisfy that unpaid minimum required contribution must be adjusted for interest for the period between the date that the contribution is made and the valuation date at the effective interest rate for the plan year for which the contribution is made (with additional interest as required to reflect any late quarterly installments for the plan year).

The CARES Act specifies that to determine the amount of a quarterly installment due by the extended due date, the amount of that installment is increased from the installment’s original due date to the payment date at the effective interest rate for the plan year that includes the date the quarterly installment is paid. If a plan sponsor does not satisfy a quarterly installment originally due during 2020 by the extended due date, then the unpaid portion of that installment is subject to a higher interest rate for the period during which the installment (or a portion thereof) remains unpaid when determining the amount of the minimum required contribution that is satisfied by a contribution.

A contribution made after the original due date for a plan year but on or before the extended due date is taken into account as of a valuation date for a plan year after the plan year for which the contribution was made. For purposes of determining the value of plan assets, if an employer makes a contribution to the plan after the valuation date for the current plan year and the contribution is for an earlier plan year, then the present value of the contribution determined as of that valuation date is taken into account as an asset of the plan as of the valuation date, provided the contribution is made before a specified deadline. The specified deadline is the deadline for contributions for the plan year immediately preceding the current plan year. However, that deadline is extended by the CARES Act. Furthermore, the interest adjustment rules override the discounting rules that apply generally for this purpose. Note, however, that certification of the AFTAP for a plan year must not take into account contributions that are expected to be made after the certification date.

If the plan year is a plan year for which the extended due date for minimum required contributions applies, then the deadline for a plan sponsor’s election to increase a prefunding balance or to use a prefunding balance or a funding standard carryover balance to offset the minimum required contribution for that plan year is extended to January 1, 2021. However, the extended due date does not change the date by which a contribution must be made in order to be deducted for a tax year. A taxpayer is deemed to have made a payment on the last day of the preceding tax year if the payment is on account of that tax year and is made no later than the time prescribed by law for filing the return for that tax year (including extensions).

Guidance for AFTAP Election

A plan sponsor may elect to apply the AFTAP for the last plan year ending before January 1, 2020, for a plan year that includes any portion of calendar year 2020. For example, if a plan sponsor makes an election for a plan year that runs from July 1, 2019, to June 30, 2020, then the AFTAP that applies is the certified AFTAP from the plan year that ends on June 30, 2019. That plan sponsor may separately elect to use that same AFTAP for the plan year that begins on July 1, 2020.

The AFTAP election must be made using the procedures that apply for elections relating to funding balances. Thus, the plan sponsor must provide written notification of the election to the plan's actuary and the plan administrator. If a plan’s actuary has not certified the plan’s AFTAP for a plan year before the plan sponsor makes the election, then the plan sponsor’s election is treated as a certification of the AFTAP. Thus, beginning with the date of the election, the AFTAP for the last plan year ending on or before December 31, 2019, applies for the plan year for which the election is made, rather than any presumed AFTAP.

A plan’s actuary generally must certify the plan’s AFTAP for a plan year for which the plan sponsor makes the election. However, if the plan sponsor makes the election for a plan year that begins in 2019 and ends in 2020 and also makes an election for the next plan year, then the actuary is not required to certify the plan’s AFTAP for the plan year that begins in 2019. If the plan’s actuary has certified an AFTAP for a plan year, then the Schedule SB of Form 5500, Annual Return/Report of Employee Benefit Plan, for that plan year should reflect the certified AFTAP.

If a plan’s actuary certified the plan’s AFTAP for a plan year before the plan sponsor makes the election, then the plan sponsor’s election is treated as a subsequent determination of the AFTAP for that plan year. However, the plan sponsor’s election is eligible for deemed immaterial treatment, and the election is treated as the recertification on the part of the actuary that is otherwise required for deemed immaterial treatment. Thus, the AFTAP that applies pursuant to the plan sponsor’s election is applied on a prospective basis beginning with the election date.

If the AFTAP that applies is pursuant to a plan sponsor’s election, then the restriction on plan amendments and unpredictable contingent event benefits is applied, except that the AFTAP that applies pursuant to the election is substituted for the presumed AFTAP. Thus, for example, the AFTAP that applies pursuant to the plan sponsor’s election will be used to calculate a presumed adjusted funding target and an inclusive presumed AFTAP.

The AFTAP that applies pursuant to a plan sponsor’s election for a plan year generally will not apply for purposes of the presumptions used in a subsequent plan year. Instead, the actual AFTAP for the plan year that was certified by the plan’s actuary generally is used for purposes of applying the presumption rules the subsequent plan year.

The IRS has released proposed regulations that implement new Code Sec. 7602(f), which bars non-government persons who are hired by the IRS from questioning a witness under oath whose testimony was obtained pursuant to a summons issued under Code Sec. 7602. The regulations prohibit any IRS contractors from asking a summoned person’s representative to clarify an objection or assertion of privilege. The IRS has also withdrawn a notice of proposed rulemaking ( NPRM REG-132434-17) that contained proposed rules addressing the participation of persons described under Code Sec. 6103(n) in the interview of a summoned witness and excluding certain non-government attorneys from participating in an IRS examination.

The IRS has released proposed regulations that implement new Code Sec. 7602(f), which bars non-government persons who are hired by the IRS from questioning a witness under oath whose testimony was obtained pursuant to a summons issued under Code Sec. 7602. The regulations prohibit any IRS contractors from asking a summoned person’s representative to clarify an objection or assertion of privilege. The IRS has also withdrawn a notice of proposed rulemaking ( NPRM REG-132434-17) that contained proposed rules addressing the participation of persons described under Code Sec. 6103(n) in the interview of a summoned witness and excluding certain non-government attorneys from participating in an IRS examination.

Section 7602(f)

The 2016 Summons Interview Regulations under Reg. §301.7602-1(b)(3) were issued, in part, to clarify that persons described in Code Sec. 6103(n) and Reg. §301.6103(n)-1(a) may receive and review books, papers, records, or other data summoned by the IRS. The regulations were also issued to clarify that, in the presence and under the guidance of an IRS officer or employee, these non-government persons could participate fully in the interview of a person whom the IRS had summoned as a witness to provide testimony under oath, allowing a contractor to ask a summoned witness substantive questions. Code Sec. 7602(f) was enacted by section 1208 of the Taxpayer First Act of 2019 ( P.L. 116-25).

Comment Request

Written or electronic comments and requests for a public hearing must be received by October 6, 2020. Commenters are strongly encouraged to submit public comments via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-132434-17) by following the online instructions for submitting comments. Comments submitted on paper will be considered to the extent practicable. The Treasury Department and the IRS will publish for public availability any comment submitted electronically, and to the extent practicable on paper, to its public docket. Paper submissions can be sent to: CC:PA:LPD:PR (REG-132434-17), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044.

Proposed regulations adopt the post-2017 simplified accounting rules for small businesses.

Proposed regulations adopt the post-2017 simplified accounting rules for small businesses.

Implementation

The Tax Cuts and Jobs Act ( P.L. 115-97) put in place a single $25 million gross receipts test (adjusted annually for inflation after 2018) for determining whether certain taxpayers can use the cash method of accounting, are not required to use inventories, are not required to apply the uniform capitalization (UNICAP) rules, and are not required to use the percentage of completion method for a small construction contract.

The proposed regulations address a variety of issues. For example, they address application of the gross receipts test to taxpayers that are not corporations or partnerships. The gross receipts test is applied by taking into account the amount of gross receipts derived from all of the taxpayer's trades or businesses. Under the proposed regulations, amounts not related to a taxpayer's trade or business—items such as Social Security benefits, personal injury awards and settlements, disability benefits, and wages received as an employee reported on Form W-2—are generally excluded from gross receipts. Similar rules are provided for each of the exemptions.

Other issues addressed in the proposed regulations include rules:

• implementing the Code Sec. 263A(i) small business taxpayer exemption for purposes of the requirement to capitalize interest;
• permitting farmers who had been using a farming exception to the Code Sec. 263A rules to adopt the small business exception, and vice versa;
• permitting a taxpayer to elect to use the allocated taxable income or loss of the immediately preceding tax year to determine whether the taxpayer is a syndicate for purposes of Code Sec. 448(d)(3) for the current tax year;
• requiring a taxpayer that meets the gross receipts test in the current tax year to obtain IRS written consent before changing to the cash method if the taxpayer had previously changed its overall method from the cash method during any of the five tax years ending with the current tax year;
• applying the look-back method to redetermine the taxpayer’s modified taxable income under Reg. §1.59-3(b) and the taxpayer’s base erosion minimum tax amount (BEMTA) for the tax year; and
• clarifying the treatment under Code Sec. 471(c) for small business taxpayers with and without applicable financial statements.

Applicability Date

The regulations are proposed to apply for tax years beginning on or after the date the Treasury Decision adopting these proposed regulations as final is published in the Federal Register. However, for tax years beginning after December 31, 2017, a taxpayer may rely on the proposed regulations, provided that the taxpayer follows all the applicable rules contained in the proposed regulations for each Code provision that the taxpayer chooses to apply.

The IRS has modified two safe harbor explanations in Notice 2018-74, 2018-40 I.R.B. 529, that can be used to satisfy the requirement under Code Sec. 402(f) that certain information be provided to recipients of eligible rollover distributions. The modifications were necessary due to recent changes in law made by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). One safe harbor explanation is for payments not from a designated Roth account, and the other is for payments from a designated Roth account. The Code Sec. 402(f) notice may be provided as many as 180 days before the date on which the distribution is made (or the annuity starting date).

The IRS has modified two safe harbor explanations in Notice 2018-74, 2018-40 I.R.B. 529, that can be used to satisfy the requirement under Code Sec. 402(f) that certain information be provided to recipients of eligible rollover distributions. The modifications were necessary due to recent changes in law made by the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). One safe harbor explanation is for payments not from a designated Roth account, and the other is for payments from a designated Roth account. The Code Sec. 402(f) notice may be provided as many as 180 days before the date on which the distribution is made (or the annuity starting date).

Qualified Birth and Adoption Distributions

Code Sec. 72(t)(1) generally provides for a 10-percent additional tax on a distribution from a qualified retirement plan, unless the distribution qualifies for an exception. The SECURE Act permits an individual to receive up to $5,000 for a qualified birth or adoption distribution from an applicable eligible retirement plan without being subject to the 10 percent additional tax. A qualified birth or adoption distribution is any distribution from an applicable eligible retirement plan to an individual if made during the 1-year period beginning on the date on which the child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized.

Additionally, an individual may recontribute a qualified birth or adoption distribution (not to exceed the amount of the distribution) to an eligible retirement plan in which the taxpayer is a beneficiary and to which a rollover can be made. Although the distributions may be recontributed, a plan administrator is not required to provide a Code Sec. 402(f) notice to a recipient of a qualified birth or adoption distribution.

Required Minimum Distributions

The SECURE Act also amended Code Sec. 401(a)(9) to change the required beginning date for minimum distributions from retirement plans. The new required beginning date for an employee or an IRA owner is April 1 of the calendar year following the calendar year in which the individual attains age 72, rather than April 1 of the calendar year following the calendar year in which the individual attains age 70-1/2. This is effective for distributions required to be made after December 31, 2019, with respect to individuals who will attain age 70-1/2 after that date. As a result of this change, employees and IRA owners who will attain age 70-1/2 in 2020 will not have a required beginning date of April 1, 2021.

Model Notices

To assist with the implementation of the modified safe harbor explanations, the IRS has released two model safe harbor explanations: one for distributions that are not from a designated Roth account, and the other for distributions from a designated Roth account. Both explanations should be provided to a participant if the participant is eligible to receive eligible rollover distributions from both a designated Roth account and an account other than a designated Roth account. A plan administrator or payor may customize a safe harbor explanation by omitting any information that does not apply to the plan. Alternatively, a plan administrator or payor may provide an explanation that is different from a safe harbor explanation. Any explanation must include the information required by Code Sec. 402(f) and must be written in a manner designed to be easily understood.

The IRS has reminded taxpayers that the Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136) can provide favorable tax treatment for withdrawals from retirement plans and Individual Retirement Accounts (IRAs). Under the CARES Act, individuals eligible for coronavirus-related relief may be able to withdraw up to $100,000 from IRAs or workplace retirement plans before December 31, 2020, if their plans allow. In addition to IRAs, this relief applies to 401(k) plans, 403(b) plans, profit-sharing plans and others.

The IRS has reminded taxpayers that the Coronavirus Aid, Relief, and Economic Security (CARES) Act ( P.L. 116-136) can provide favorable tax treatment for withdrawals from retirement plans and Individual Retirement Accounts (IRAs). Under the CARES Act, individuals eligible for coronavirus-related relief may be able to withdraw up to $100,000 from IRAs or workplace retirement plans before December 31, 2020, if their plans allow. In addition to IRAs, this relief applies to 401(k) plans, 403(b) plans, profit-sharing plans and others.

Also, until September 22, 2020, individuals eligible to take coronavirus-related withdrawals may be able to borrow as much as $100,000 (up from $50,000) from a workplace retirement plan, if their plan allows. Loans are not available from an IRA. For eligible individuals, plan administrators can suspend, for up to one year, plan loan repayments due on or after March 27, 2020, and before January 1, 2021. A suspended loan is subject to interest during the suspension period, and the term of the loan may be extended to account for the suspension period.

To be eligible for COVID-19 relief, coronavirus-related withdrawals or loans can only be made to an individual if:

• the individual is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetics Act);
• the individual’s spouse or dependent is diagnosed with COVID-19 by such a test; or
• the individual, their spouse, or a member of the individual’s household experiences adverse financial consequences from: (1) being quarantined, furloughed or laid off, having work hours reduced, being unable to work due to lack of childcare, having a reduction in pay (or self-employment income), or having a job offer rescinded or start date for a job delayed, due to COVID-19; or (2) closing or reducing hours of a business owned or operated by the individual, the individual’s spouse, or a member of the individual’s household, due to COVID-19.

Taxpayers can learn more about these provisions in IRS Notice 2020-50, I.R.B. 2020-28, 35. The IRS has also posted FAQs that provide additional information.

The Treasury and IRS have issued final and proposed regulations under the global intangible low-taxed income (GILTI) and subpart F provisions for the treatment of high-taxed income. The final regulations provide guidance on determining the type of high-taxed income that is eligible for the exclusion (the "GILTI high-tax exclusion" or GILTI HTE).

The Treasury and IRS have issued final and proposed regulations under the global intangible low-taxed income (GILTI) and subpart F provisions for the treatment of high-taxed income. The final regulations provide guidance on determining the type of high-taxed income that is eligible for the exclusion (the "GILTI high-tax exclusion" or GILTI HTE).

Proposed regulations generally conform the rules for the subpart F high-tax exception to the rules for the GILTI high-tax exclusion. A single election is provided under Code Sec. 954(b)(4) for purposes of subpart F and tested income.

Under the Code Sec. 954(b)(4) high tax exception, income received by a controlled foreign corporation (CFC) is excluded under subpart F, if the income is subject to an effective rate of foreign tax that is greater than 90 percent of the maximum U.S. corporate tax rate.

Final Regulations on the GILTI HTE

The final regulations:

• provide that the GILTI HTE applies, on an elective basis, to high-taxed income of a CFC that is excluded from foreign base company (FBCI) ( Code Sec. 954) or insurance income ( Code Sec. 953) under Code Sec. 954(b)(4), regardless if the income would otherwise be FBCI or insurance income;
• provide that the effective foreign tax rate is determined on a tested unit basis;
• provide rules to determine the net amount of income (i.e., tentative tested income) and the foreign taxes paid or accrued with respect to such net amount of income that are used to compute the effective rate of tax;
• indicate how to make a GILTI HTE election; and
• do not provide rules that account for the use of foreign tax NOL carryforwards.

An exception under Code Sec. 954(b)(4) for purposes of the GILTI HTE applies to any item of income that is subject to an effective rate of tax greater than the maximum U.S. corporate tax rate, which is 18.9 percent based on a 21 percent tax. Controlling domestic shareholders of CFCs can elect to apply the exception to items of income that would not otherwise be FBCI or insurance income. An item of gross income is subject to a high-rate of foreign tax, if after taking into account properly allocable expenses, the net item of income is subject to an effective rate of tax above the statutory threshold.

The high-tax exception is applied on the basis of the items of gross income of a tested unit of a CFC, rather than the CFC as a whole. All tested units of a CFC in the same country are generally grouped together to determine the effective foreign tax rate for the purpose of applying the high-tax exclusion. The approach minimizes the blending of tax rates within a CFC and is thought to provide a more accurate idea of the income subject to a high-rate of foreign tax.

The election to exclude high-taxed income from gross tested income is generally made or revoked for a one-year period.

Proposed Regulations Single Election

The proposed regulations provide for a single election under Code Sec. 954(b)(4) for purposes of both subpart F and GILTI, based on the final GILTI high-tax exclusion regulations.

Under the proposed regulations:

• the election is made with respect to all members of a CFC group (rather than on a CFC-by-CFC basis);
• the determination of whether income is high taxed is made on a tested unit-by-unit basis;
• the determination of high tax income is simplified by grouping certain income that would otherwise qualify as subpart F income with income that would otherwise qualify as tested income for purposes of determining the effective foreign tax rate, and for purposes of the high-tax exception; and
• the method for allocating and apportioning deductions to items of gross income is modified for purposes of the high-tax exception.

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.

Under the so-called "kiddie tax," a minor under the age of 19 (or a student under the age of 24) who has certain unearned income exceeding a threshold amount will have the excess taxed at his or her parents' highest marginal tax rate. The "kiddie tax" is intended to prevent parents from sheltering income through their children.

A child with earned income (wages and other compensation) in excess of the filing threshold is a separate taxpayer who is generally taxed as a single taxpayer. If a child in one of the following categories has unearned income (i.e., investment income) in excess of the "threshold amount" ($950 in 2009) that unearned income is taxed at the parent's marginal tax rate, as if the parent received that additional income.

• A child under the age of 19;
• A child up to age 18 who provides less than half of his or her support with earned income; or
• A19 to 23 year-old student who provides less than half of his or her support with earned income.

If the child's unearned income is less than an inflation-adjusted ceiling amount ($9,500 in 2009), the parent may be able to include the income on the parent's return rather than file a separate return for the child (and which the tax based on the parent's marginal rate bracket is computed on Form 8615).

Any distribution to a child who is a beneficiary of a qualified disability trust is treated as the child's earned income for the tax year the distribution was received.

Example:  Greta is a 16-year-old whose father is alive. In 2009, she has $3,000 in unearned income, no earned income, and no itemized deductions. Her basic standard deduction is $950, which is applied against her unearned income, reducing it to $2,050. The next $950 of unearned income is taxed at Greta's individual tax rate. The remaining $1,100 of her unearned income is taxed at her parent's allocable tax rate. Assuming her father's tax rate bracket is 25 percent, her tax on the $1,100 is $275.

If you own a vacation home, you may be considering whether renting the property for some of the time could come with big tax breaks. More and more vacation homeowners are renting their property. But while renting your vacation home can help defray costs and provide certain tax benefits, it also may raise some complex tax issues.

Determining whether to use your vacation home as a rental property, maintain it for your own personal use, or both means different tax consequences. How often will you rent your home? How often will you and your family use it? How long will it sit empty? Depending on your situation, renting your vacation home may not be the most lucrative approach for you.

Generally, the tax benefits of renting your vacation home depend on how often you and your family use the home and how often you rent it. Essentially, there are three vacation home ownership situations for tax purposes. We will go over each, and their tax implications.

Tax-free rental income

If you rent your vacation home for fewer than 15 days during the year, the rental income you receive is tax-free; you don't even have to report it on your income tax return. You can also claim basic deductions for property taxes and mortgage interest just as you would with your primary residence.

You won't, however, be able to deduct any rental-related expenses (such as property management or maintenance fees). And, if your rental-related expenses exceed the income you receive from renting your vacation home for that brief time, you can't take a loss. Nevertheless, this is an incredibly lucrative tax break, especially if your vacation home is located in a popular destination spot or near a major event and you don't want, or need, to rent it out for a longer period. If you fit in this category of vacation homeowners and would like more information on this significant tax benefit, call our office.

Pure rental property

Do you plan on renting your vacation home for more than 14 days a year? If so, the tax rules can become complicated. If you and your family don't use the property for more than 14 days a year, or 10% of the total number of days it is rented (whichever is greater), your vacation home will qualify as rental property, not as a personal residence.

If you rent your vacation home for more than 14 days, you must report all rental income you receive. However, now you can deduct certain rental-related expenses, including depreciation, condominium association fees, property management fees, utilities, repairs, and portions of your homeowner's insurance. How much you can deduct will depend on how often you and your family use the property. But, as the owner of investment property, you can take a loss on the ultimate sale of your rental homes, which second-homeowners can't do.

Income and deductions generated by rental property are treated as passive in nature and subject to passive activity loss rules. As passive activity losses, rental property losses can't be used to offset income or gains from non-passive activities (such as wages, salaries, interest, dividends, and gains from the sale of stocks and bonds). They can only be used to offset income or gains from other passive type activities. Passive activity losses that you can't use one year, however, can be carried forward to future years.

However, an owner of rental property who "actively participates" in managing the rental activities of his or her vacation home, and has an adjusted gross income that doesn't exceed $100,000, can deduct up to $25,000 in rental losses against other non-passive income, such as wages, salaries, and dividends. It's not all that difficult to meet the "active participation" test if you try.

Personal use for more than 14 days

If you plan on using your vacation home a lot, as well as renting it often, your vacation home will be treated as a personal residence. Specifically, if you rent your home for more than 14 days a year, but you and your family also use the home for more than 14 days, or 10% of the rental days (whichever is greater), your vacation home will qualify as a personal residence, not a rental property, and complex tax issues arise.

All expenses must be apportioned between rental and personal use, based on the total number of days the home is used. For example, you must allocate interest and property taxes between rental and personal use so that a portion of your mortgage interest payments and property taxes will be reported as itemized deductions on Schedule A (the standard form for itemized deductions) and a portion as deductions against rental income on Schedule E (the form for rental income and expenses.) You will only be able to deduct your rental expense up to the total amount of rental income.  Excess losses can be carried forward to future years though.

Proper planning

With proper planning and professional advice, you can maximize tax benefits of your vacation home. Please call our office if you have, or are planning to buy, a vacation home and would like to discuss the tax consequences of renting your property.

The benefits of owning a vacation home can go beyond rest and relaxation. Understanding the special rules related to the tax treatment of vacation homes can not only help you with your tax planning, but may also help you plan your vacation.

The benefits of owning a vacation home can go beyond rest and relaxation. Understanding the special rules related to the tax treatment of vacation homes cannot only help you with your tax planning, but may also help you plan your vacation.

For tax purposes, vacation homes are treated as either rental properties or personal residences. How your vacation home is treated depends on many factors, such as how often you use the home yourself, how often you rent it out and how long it sits vacant. Here are some general guidelines related to the tax treatment of vacation homes.

Treated as Rental Property

Your home will fall under the tax rules for rental properties rather than for personal residences if you rent it out for more than 14 days a year, and if your personal use doesn't exceed (1) 14 days or (2) 10% of the rental days, whichever is greater.

Example - You rent your beach cottage for 240 days and vacation 23 days. Your home will be treated as a rental property. If you had vacationed for 1 more day (for a total of 24 days), though, your home would be back under the personal residence rules.

Income: Generally, rental income should be fully included in gross income. However, there is an exception. If the property qualifies as a residence and is rented for fewer than 15 days during the year, the rental income does not need to be included in your gross income.

Expenses: Interest, property taxes and operating expenses should all be allocated based on the total number of days the house was used. The taxes and interest allocated to personal use are not deductible as a direct offset against rental income. In the example above, the total number of days used is 263, so the split would be 23/263 for personal use and 240/263 for rental.

Any net loss generated will be subject to the passive activity loss rules. In general, passive losses are deductible only to the extent of passive income from other sources (such as rental properties that produce income) but if your modified adjusted gross income falls below a certain amount, you may write off up to $25,000 of passive-rental real estate losses if you "actively participate". "Active participation" can be achieved by simply making the day-to-day property management decisions. Unused passive losses may be carried over to future years

Planning Note: If your personal use does exceed the greater of (1) 14 days, or (2) 10% of rental days, the special vacation home rules apply. This means you drop back into the personal residence treatment, which allows you to deduct the interest and taxes and usually wipe out your rental income with deductible operating expenses. This is explained in greater detail below.

Treated as Personal Residence

If you use your vacation home for both rental and a significant amount of personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose. Remember that personal use includes use by family members and others paying less than market rental rates. Days you spend working substantially full time repairing and maintaining your property are not counted as personal use days, even if family members use the property for recreational purposes on those days.

Rented 15 days or more. If you rent out your home more than 14 days a year and have personal use of more than (1) 14 days or (2) 10% of the rental days, whichever is greater, your home will be treated as a personal residence.

Income: You must include all of your rental receipts in your gross income. Again, however, if the property qualifies as a residence and is rented for fewer than 15 days, the rental income does not need to be included in your gross income.

Expenses:

Interest and Taxes: Mortgage interest and property taxes must be allocated between rental and personal use. Personal use for this allocation includes days the home was left vacant.

Example: You rent your mountain cabin for 4 months, have personal use for 3 months, and it sits empty for 5 months. The amount of interest and taxes allocated to rental use would be 33% (4 months/12 months) and since vacant time is considered personal use, you would allocate 67% (8 months/12 months) to personal use. The rental portion of interest and taxes would be included on Schedule E and the personal part would be claimed as itemized deductions on Schedule A.

Operating Expenses: Rental income should first be reduced by the interest and tax expenses allocated to the rental portion (33% in our example above). After that allocation is made, you can deduct a percentage of operating expenses (maintenance, utilities, association fees, insurance and depreciation) to the extent of any rental income remaining. When calculating the allocation percentage for operating expenses, vacancy days are not included. Any disallowed rental expenses are carried forward to future years.

Planning Note: It would be wise to try to balance rental and personal use so that rental income is "zeroed" out since, even though losses may be carried forward, they still risk going used. Mortgage interest should be fully deductible on Schedule A as a second residence. If more than two homes are owned, choose the vacation home with the biggest loan as the second residence. Property taxes are always deductible no matter how many homes are owned.

Rented fewer than 15 days. If you have the opportunity to rent your home out for a short period of time (< 15 days), you will not have to worry about the tax consequences. This rental period is "ignored" for tax purposes and the house would be treated purely like a personal residence with no tricky allocation methods required.

Income: You do not include any of the rental income in gross income.

Expenses: Interest and taxes are claimed on Schedule A. You can not write off any operating expenses (maintenance, utilities, etc...) attributable to the rental period.

Planning Note: Take advantage of this "tax-free" income if you get the chance. Short-term rentals during major events (such as the Olympics) can be a windfall.

IMPORTANT DISCLOSURE INFORMATION

Harrison Berkman and Claypool, PLLC (“HBC”) is a firm of Certified Public Accountants located in Seattle, Washington.  The firm and its members are in compliance with the current licensing and registration requirements of the Washington State Board of Accountancy and are members of the American Institute of Certified Public Accountants.  The firm also maintains necessary licensing and/or registration in certain other states depending on client needs and state requirements. HBC’s web site is limited to the dissemination of general information pertaining to its accounting services, together with access to additional tax and financial information, publications, and links.  Accordingly, the publication of HBC’s web site on the Internet should not be construed by any consumer and/or prospective client as HBC’s solicitation to provide tax or accounting services in the state where the prospective client resides.

HBC Financial Services, PLLC (“HBCFS”) is an SEC registered investment adviser located in Seattle, Washington.  HBCFS and its representatives are in compliance with the current filing requirements imposed upon SEC registered investment advisers by those states in which HBCFS maintains clients.  HBCFS may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.  HBCFS’ web site is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links.  Accordingly, the publication of HBCFS’ web site on the Internet should not be construed by any consumer and/or prospective client as HBCFS’ solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet.  Any subsequent, direct communication by HBCFS with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of HBCFS, please contact the SEC or the state securities regulators for those states in which HBCFS maintains a notice filing.  A copy of HBCFS’ current written disclosure statement discussing HBCFS’ business operations, services, and fees is available from HBCFS upon written request. 

 HBC and/or HBCFS do not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to this web site or incorporated herein, and takes no responsibility therefore.  All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by HBCFS), will be profitable or equal any historical performance level(s).

Certain portions of HBCFS’ web site (i.e. newsletters, articles, commentaries, etc.) may contain a discussion of, and/or provide access to, HBCFS (and those of other investment and non-investment professionals) positions and/or recommendations as of a specific prior date.  Due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or recommendation(s).  Moreover, no client or prospective client should assume that any such discussion serves as the receipt of, or a substitute for, personalized advice from HBCFS, or from any other investment professional.  HBCFS is neither an attorney nor an accountant, and no portion of the web site content should be interpreted as legal, accounting or tax advice on the part of HBCFS. 

Rankings and/or recognition by unaffiliated rating services and/or publications should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results if HBCFS is engaged, or continues to be engaged, to provide investment advisory services, nor should it be construed as a current or past endorsement of HBCFS by any of its clients.  Rankings published by magazines, and others, generally base their selections exclusively  on information prepared and/or submitted by the recognized adviser.

To the extent that any client or prospective client utilizes any economic calculator or similar interactive device contained within or linked to HBCFS’ web site, the client and/or prospective client acknowledges and understands that the information resulting from the use of any such calculator/device, is not, and should not be construed, in any manner whatsoever, as the receipt of, or a substitute for, personalized individual advice from HBCFS, or from any other investment professional.

Each client and prospective client agrees, as a condition precedent to his/her/its access to HBC and HBCFS’ web site, to release and hold harmless HBC and/or HBCFS, its officers, directors, owners, employees and agents from any and all adverse consequences resulting from any of his/her/its actions and/or omissions which are independent of his/her/its receipt of personalized individual advice from HBC and/or HBCFS.