With another year-end tax planning season now upon us, a survey of some of the new developments that have taken place over the past year is often useful. Assessing income and deductions currently realized in 2015 and forecasting for the remainder of the year and into 2016 has become an ingrained part of year-end planning, in which tax brackets are balanced, and a variety of adjusted gross income ceilings and floors between years are manipulated to a taxpayer’s best advantage. This column, however, takes a look at some of what’s new so far in 2015 in generating ideas that may have an impact on year-end planning.
At the top of the list on Congress’ tax agenda for the fall is passage of must-do legislation to renew approximately 50 tax incentives, known as extenders. Tax changes may also appear in a multi-year highway bill and/or as stand-alone legislation before year-end 2015. So far this year, however, no major changes impact 2015 year-end tax planning.
1. Tax extenders. Once again, passage of a “tax extenders” package may prove to be a cliffhanger. At stake are over 50 provisions that officially expired at the end of 2014. The hope is not only to retroactively reinstate them, but also to extend them through 2016. High on the list of extenders impacting individuals are the state and local sales tax deduction, the exclusion of discharge of qualified principal residence indebtedness, the mortgage insurance premium deduction, and the teachers’ classroom expense deduction. Business extenders include, among many others, extension of Section 179 expensing, the research credit, transit benefits parity, and the Work Opportunity Credit.
2. Trade Act. President Obama on June 29 signed the Bipartisan Congressional Trade Priorities and Accountability Act of 2015 (HR 2146) and the Trade Preferences Extension Act of 2015 (HR 1295). The trade bills touch on several tax provisions that carry year-end planning implications:
The Health Coverage Tax Credit under Code Sec. 35, used to help offset the cost of health insurance by workers whose jobs have been outsourced, has been renewed. The revived HCTC is made retroactive to Jan. 1, 2014, and available for months beginning before Jan. 1, 2020.
The Defending Public Safety Employees’ Retirement Act, included in HR 2146, provides certain federal public safety officers with an exemption from the 10 percent penalty on early distributions from a qualified retirement plan. The provision applies to distributions made after Dec. 31, 2015, so affected taxpayers should postpone taking advantage of the new law until 2016.
The major tax change brought about by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (a.k.a., the Highway Bill) involves revised due dates of certain returns and extensions. For the most part, however, they only start to impact taxpayers in 2017. Likewise, enhanced mortgage reporting and estate tax valuation connected to stepped-up basis have effective dates that removed them from 2015 year-end planning consideration.
The Supreme Court’s 2015 Obergefell decision on same-sex marriage did little to change treatment on the federal tax level. Rev. Rul. 2013-17 had already determined that for federal tax purposes, the state of celebration would control whether a same-sex couple should file jointly and otherwise be treated as married. Nevertheless, a shake-out of strategies to take advantage of the changes brought about by the Supreme Court’s Windsor decision in 2013 continues to evolve.
Benefits have been one focal point. A few weeks after Obergefell, the Social Security Administration made a focused effort to encourage spouses, divorced spouses, and surviving spouses of a same-sex marriage to apply for benefits in light of the decision. The SSA also reported that it was working with the Department of Justice to analyze the decision and provide instructions for processing claims.
MORTGAGE INTEREST DEDUCTION
In a pro-taxpayer case brought by a same-sex unmarried couple but not necessarily confined in its application, the Ninth Circuit in Voss held that multiple owners of a single residence can claim home mortgage interest deduction in excess of the $1 million and $100,000 home equity indebtedness cap. In reversing the Tax Court, the appellate court said that the IRS’s interpretation of the ceiling was wrong and that the language that set the limits were not per residence, but rather per taxpayer (with a reduced limit imposed on married taxpayers filing separately).
This case, which in effect can double the ceiling to $2 million/$200,000 for two owners, might also work in connection with vacation property — say, for example, in a situation in which several members of the same extended family might purchase and jointly mortgage a family compound-like setup. Since only a single appellate circuit has signed on to this expansion of the mortgage interest deduction so far, however, taxpayers should move cautiously and expect continued IRS resistance.
Year-end strategies include the usual consideration of Roth IRA conversions, increasing contributions to 401(k) plans, and computing any required minimum distribution requirement, among others. Gone, however, is the free-wheeling option of withdrawing from multiple IRAs to consolidate or otherwise redistribute balances. Following Bobrow, TC Memo. 2014-21, the IRS ended a grace period and announced that, effective for rollover distributions received on or after Jan. 1, 2015, a taxpayer would be limited to one 60-day rollover per year for all IRA accounts, rather than one 60-day rollover per year for each IRA account. The penalty for ignoring this rule may be immediate recognition of the entire account balance in income, as well as imposition of a 10 percent early withdrawal penalty. Unlimited trustee-to-trustee transfers, however, are still allowed and therefore offer a workaround.
Although first authorized over 18 months ago by the Tax Increase Prevention Act of 2014, A Better Life Experience, or ABLE, accounts remain unavailable. To help jumpstart the process, the IRS in Notice 2015-18 assured states that may soon enact enabling legislation, before guidance is issued, that ABLE accounts may still qualify under Code Sec. 529A even though the legislation or the account documents do not fully comply with subsequent guidance. Later in 2015, the IRS released proposed reliance regs (IR-2015-91, NPRM REG-102837-15)), that provided additional details on the establishment, funding, distribution and reporting of ABLE Accounts.
Accounts may be set up for qualified individuals with disabilities for tax years beginning after Dec. 31, 2014. Contributions to an ABLE account are limited to the annual gift tax exclusion ($14,000 in 2015), which give ABLE contributions a year-end planning dimension. A major drawback to aggressive funding in many cases, however, is that amounts left over in an account after the beneficiary dies must be transferred to the state.
Adjusting capital gains and losses, and dividend income, has always been a year-end staple. With the erratic swings in the stock markets lately, those adjustments may prove even more challenging. Simply because markets are down, however, does not mean that the taxpayer should assume that there are losses. Cost basis may be low due to prior-year holdings as the result of the long-term bull market.
2015 is the third year in which the net investment income tax of 3.8 percent applies. Taxpayers are settling into the routine of computing NII in connection with timing capital gains and other NII-captured transactions and paying estimated tax on them. IRS statistics early in 2015 confirmed that recent run-ups in the financial markets, combined with the fact that the NII thresholds are not adjusted for inflation, have increased the need to implement strategies that can avoid or minimize the NII tax.
Year-end repairs and other expenses are generally more cost-effective if allowed to be written off immediately, rather than capitalized and depreciated. An increase in the de minimis safe harbor threshold amount under the final “repair regs” for taxpayers without an applicable financial statement is needed for small businesses, the American Institute of CPAs told the IRS in early 2015. It urged the IRS to significantly boost the threshold amount from $500 to as much as $2,500.
Currently, a de minimis safe harbor allows taxpayers to deduct certain items costing $5,000 or less (per item or invoice) and that are deductible in accordance with the company’s AFS. IRS regs also continue to provide a $500 de minimis safe harbor threshold for taxpayers without an AFS.
In July, the IRS released a much-anticipated draft version of Form 3115, Application for Change in Accounting Method. Slated for release in final form by December, the new forms will be used to process many more method changes than were required back in 2009 when the current form was issued. While the draft generally follows the basic format of the current form, it makes some significant changes. New instructions are expected to do most of the heavy lifting on navigating the growing complexity of the rules.
At a recent webinar, an IRS representative indicated that taxpayers will be permitted to continue using the current version of Form 3115 (revised December 2009) to file method changes for the 2014 tax year under the repair regs even after the final version is released. This will generally benefit filers who would not need to re-prepare forms on which work has begun, or otherwise change procedures in the preparation of the form at year’s end.
SEC. 199 DEDUCTION ACTIVITIES
A new directive from the IRS Large Business and International Division provided guidance to examiners on whether certain activities qualify for the Sec. 199 domestic production activities deduction (LB&I 04-0315-001). To be eligible for the Sec. 199 deduction, a taxpayer must determine, among other requirements, if it had manufactured, produced, grown or extracted qualified property in whole or in significant part within the United States, the IRS reminded examiners.
The IRS also issued final, temporary and proposed regulations on the allocation of Sec. 199 wages in short tax years. Proposed regulations also clarify how to determine domestic production gross receipts, among other fine points. Those involved with the Sec. 199 deduction should review these regulations with respect to timing receipts and expenditures as a necessary adjunct to year-end planning.
The installment method of reporting gain has been a tried-and-true way to defer gain on a sale into subsequent tax years. Not all income from installment payments may be deferred pro-rata, however. In Mingo, CA-5, Dec. 9, 2014, for example, the Fifth Circuit denied installment method for gain from sale of partnership interest attributable to unrealized receivables. In that case, the Fifth Circuit Court of Appeals found that married taxpayers were not entitled to use the installment method to report income from unrealized receivables the wife received from the sale of her partnership interest in a consulting business. Since the proceeds did not arise from the sale of property, their installment method of accounting did not clearly reflect income.
Existing installment sale regulations (Reg. Sec. 1.453-9(c)(2)) provide the rule that gain is not recognized on a disposition of an installment obligation if another non-recognition provision applies. Subsequently, in Rev. Rul. 73-423, the IRS provided an exception to this non-recognition rule (thus requiring recognition of gain on the disposition) where the transferor of the obligation receives stock in satisfaction of the obligation. Proposed regs (NPRM REG-109187-11) now incorporate the holding of the revenue ruling and also apply it to the receipt of a partnership interest.
PARTNERS’ CHANGING INTERESTS
The IRS issued final regs (TD 9728) during this past summer under Sec. 706(d) to address how to allocate partnership items among partners whose interests in the partnership change during its tax year. Among its changes, the final regulations set forth an expanded scope of the varying interest rule, which requires that partners’ distributive shares of partnership tax items for a tax year must take into account the varying interests of the partners in the partnership during the tax year. This adds a certain degree of flexibility in determining a partner’s distributive share when interests change at year end or otherwise.
ROUTINE SERVICE CONTRACTS
Rev. Proc. 2015-39 has provided a safe harbor under which accrual-basis taxpayers may treat economic performance as occurring on a ratable basis for ratable service contracts. The IRS also indicated that additional safe harbors may be developed. This new safe harbor should prove useful immediately for year-end strategies by accrual-basis taxpayers currently negotiating contracts for regular services that extend into 2016. Done right to fit under the definition of ratable service contracts, a full deduction in the current 2015 tax year may be taken for certain 2015 payments, even though services may not be performed until 2016.
Each year, year-end planning takes some new twists and turns, not only because client situations change from year to year, but also because the tax law is constantly evolving. 2015 is proving no exception to changes in the tax law that may change or enhance year-end strategies. And with 2015 not yet over, additional developments, including but certainly not limited to tax legislation, are sure to further challenge existing tax strategies as we head ever closer to Jan. 1, 2016.