This Year in Review
It has been an extremely busy year related to federal taxes.
The Treasury Department and the Internal Revenue Service were involved throughout the year with interpreting and providing guidance on certain areas of tax law under the Tax Cuts and Jobs Act (TCJA). However, as a result of the COVID-19 pandemic, the Service had to deal with a new reality and develop rules under the massive pieces of legislation passed by Congress and numerous Executive Orders signed by the President to provide relief to affected taxpayers. In addition, natural disasters throughout the country created additional need for relief. This all had to be done while the Service itself was short-staffed due to the closure of IRS centers under lock-down conditions.
This article provides a brief review of COVID-19 actions taken by the IRS and Congress and updates some non-COVID-related issues which occurred during this past year.
Declaration of a Disaster
After the confirmation of the first coronavirus case in the United States, the Secretary of Health and Human Services (HHS) declared a public health emergency on January 31, 2020.
On March 13, 2020, President Trump declared a nationwide emergency under the Stafford Act, which meant that governors would not need to request individual emergency declarations to get federal assistance. The federal declaration proclaimed the COVID-19 outbreak a national emergency. All 50 states, the District of Columbia, and four territories were approved for major disaster aid. Additionally, 32 tribes would work directly with the Federal Emergency Management Agency (FEMA) under the declaration.
Declaring the entire country a disaster area affected by COVID-19 produces a number of federal tax consequences under the Internal Revenue Code (“IRC” or “Code”):
- The Treasury Secretary becomes empowered under IRS to provide up to one year of relief for the filing and payment of certain taxes.
- Personal casualty losses in a disaster area are eligible to be deducted.
- Losses related to a disaster are eligible to be deducted, at the taxpayer’s election, in the year prior to the year of the loss.
- Amounts paid as Qualified Disaster Relief Payments can be excluded from the income of the recipient.
The Families First Coronavirus Response Act (FFCRA) requires that all comprehensive health insurance plans cover FDA-approved testing needed to detect or diagnose COVID-19, including in-person or telehealth visits to a doctor’s office, urgent care center, or emergency room, which eliminates co-pays or deductibles for testing. The Coronavirus Aid, Relief and Economic Security (CARES) Act extended this requirement to cover certain non-FDA-approved testing.
The IRS then issued relief providing for a deferral for filing tax returns and payments of tax. As a result, the deadline to file and pay income taxes, including the first quarterly estimated tax, was extended to July 15 without limitation and applied to all taxpayers. Subsequently, the Treasury expanded the deferral to include the second quarterly estimated tax, if normally due before July 15, and other “time sensitive acts” including making section 83(b) elections, completing like-kind exchanges, involuntary conversions, gain rollovers, and contributions to IRAs or health savings accounts.
The TCJA suspended, for tax years 2018 through 2025, the deduction for personal casualty losses. However, an exception applies allowing a personal casualty loss deduction for these years for such losses which are “attributable to a federally declared disaster.” The Presidential declaration effectively makes the COVID-19 pandemic a federally declared disaster throughout the country. However, a question remains concerning how the casualty loss rules apply to the pandemic. A casualty loss arises from fire, storm, shipwreck, or other casualty. It normally produces physical damage to property which is sudden and does not occur over time. As of this writing, the Treasury and IRS have not issued any guidance as to the application of the casualty loss rules in relation to the coronavirus. The Internal Revenue Code provides that losses otherwise allowed, which occur in a “disaster area” and are “attributable to a Federally declared disaster,” can be deducted, at the taxpayer’s election, in the year prior to the year of loss. This means that a COVID-19-related loss may be taken on a 2019 return. Given the impact of the virus on 2020 earnings, 2019 may produce a better tax result since the deduction could offset income taxed at a higher rate. Additionally, taxpayers do not need to wait until filing a 2020 tax return, but can get the benefit of a refund by filing under a quick refund process.
There are many business losses where this rule would also seem to apply, including abandonment of leasehold improvements due to closure of a business location, selling off excess and unsaleable inventory due to the lack of demand, contract cancellation payments, and loss of nonreturnable deposits. If you or your business are experiencing losses in 2020, review the facts to determine if these rules apply.
The Code allows employers to make “qualified disaster relief payments” on a tax-free basis to the recipient. This was intended to permit a payer, generally an employer, to provide resources to cover certain costs, including:
- To reimburse and pay reasonable and necessary personal, family, living or funeral expenses incurred as a result of a qualified disaster;
- To reimburse or pay reasonable and necessary expenses incurred in the repair or rehabilitation of a personal residence or replacement of its contents, to the extent the need for such repair, rehabilitation, or replacement is attributable to a qualified disaster.
Prior guidance indicates that an employer can provide deductible qualified disaster relief to an employee. However, the Service has stated in Frequently Asked Questions that replacement of compensation is taxable and does not constitute qualified disaster relief. The IRS has not issued guidance on which specific expenses incurred in connection with the pandemic may be deducted or how to determine if they are “reasonable and necessary.” These may include costs to help pay for an office in the home or related expenses, increased medical expenses, and/or increased commuting costs for employees. A best practice would be for the employer to have a written policy with an administrative process and restrictions in place to determine appropriate payments to recipients.
Families First Coronavirus Response Act (FFCRA) Credits
Congress passed the FFCRA, creating two payroll tax credits impacting employers with fewer than 500 employees:
- Emergency Paid Sick Leave – Covered employers are required to provided covered employees with two weeks of paid leave (i.e., 10 days) where the employed:
- Is subject to a federal, state or local quarantine or isolation order related to COVID-19.
- Has been advised by a healthcare provider to self-quarantine.
- Is experiencing COVID-19 symptoms and seeks medical diagnosis.
- Is caring for an individual subject to an order described in (1) or (2) above.
- Is caring for a child whose school is closed or whose childcare provider is unavailable for reasons related to COVID-19.
- Is experiencing any other substantially similar condition specified by the Secretary of Health and Human Services, along with the Secretaries of Labor and Treasury.
- Emergency Family and Medical Leave (EFML) – Covered employers are required to provide up to an additional 10 weeks of job-protected leave to covered employees. However, the sole reason for which EFML is allowed is to care for a son or daughter under age 18 if their school is closed or whose childcare provider is unavailable for reasons related to COVID-19.
The law provides certain exemptions from covered employer status, including: (a) a small business with fewer than 50 employees, if the payment would jeopardize the viability of the business as a going concern; and (b) certain healthcare providers and emergency responders.
The FFCRA payments made to employees are funded through a refundable credit provided to the employer against payroll taxes, so that this benefit should have no
cost to the employer.
There are various methods for an employer to obtain the credit. The employer can reduce the amount of federal payroll taxes and employee income tax withholding to be deposited in anticipation of receiving the credit. If this reduction does not cover the amount which is paid to covered employees, the employer can request a refund for the balance on its quarterly payroll tax return. The IRS also created new Form 7200 which employers can use to request an advance payment of the credit.
The law provides that a self-employed taxpayer is eligible for an equivalent payment as a credit against his/her 2020 income taxes. Quarterly estimated payroll taxes can be reduced to anticipate the benefit of the credit.
In March 2020, Congress enacted the Coronavirus Aid, Relief and Economic Security (CARES) Act, which includes many provisions to assist businesses, as well as several tax provisions.
Paycheck Protection Program Loans
A key element of the law benefiting businesses was the creation of Paycheck Protection Program (PPP) loans. This program was intended to provide a direct incentive for small businesses to keep workers on the payroll. Under the program, the Small Business Administration (SBA) will forgive loans where employee retention criteria are satisfied and funds are utilized for specific purposes.
These loans have an interest rate of 1% and a maturity date of two years for loans issued before June 5 and five years for those issued subsequently. In general, loan payments are deferred for borrowers who make an application for loan forgiveness and satisfy all of the requirements. Generally, forgiveness should be requested within 10 months of the end of the borrower’s covered period (either 8 weeks or 24 weeks) to avoid payments on the loan.
The law specifically states that any amount of PPP loan that is forgiven is not considered to be taxable income to the borrower. However, the Treasury has stated that businesses would not be entitled to a deduction for amounts paid with PPP loan proceeds which are forgiven. The Service relies on the Internal Revenue Code and related regulations, which disallow a deduction to the extent that it is allocable to a class of income that is wholly exempt from federal income tax. The IRS reasons that the amount received under the PPP loan is earmarked for the specific purposes designated under the CARES Act. Use of the funds for these purposes causes the funds to be nontaxable income and, consequently, these expenses are related to such exempt income. Lawmakers have stated “…the intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible. This position is contrary to that intent.” The House Ways and Means Committee Chair announced that Congress intends to fix this result. While proposals have been issued, we have yet to see if such language is ultimately passed by Congress.
Currently, businesses are in a quandary as to how to apply this Treasury position. Since the business will probably not know at the time of filing its 2020 return how much of the PPP loan has been forgiven, should the 2020 payments be deducted on that return, or should the taxpayer’s belief that the loan amounts will be forgiven control? Another option is that the costs may be deductible in 2020 and become taxable in the year that forgiveness is approved by the SBA. At this point, we have no guidance from the Service and may not receive any until Congress passes a new stimulus bill, which may address the matter.
Cash Stimulus Payment
The CARES Act provided for a cash payment to taxpayers of up to $1,200 per person ($2,400 for a married couple) and an additional $500 for each qualifying child. These payments were subject to phase-out based on adjusted gross income and filing status.
The amount payable to an individual is actually an advance payment of a credit which is to be determined in 2020. The payments were based on 2018 tax filings (in some cases 2019), but there is a “true-up” of the amount payable in 2020, i.e., the correct credit is determined in 2020 based on that year’s facts and circumstances. If the taxpayer received an advance that is less than the 2020 calculated credit, the taxpayer is entitled to a credit or refund of the additional amount. However, if the taxpayer has been overpaid, the excess amount received is not owed back to the government.
The IRS set up a procedure to obtain information in order to compute and deliver the cash payment based on the prior year’s tax filings. Non-filers were able to provide the Service with information via the “Get My Payment” website using a “Where’s My Refund” tool.
Certain persons are ineligible for the credit – a nonresident alien individual, a person who is a dependent of another, and possibly, incarcerated persons. In May, the IRS issued a release noting that payments may have been made to ineligible persons and requesting a return of payments. This included payments to anyone who died before the date of receipt.
Retirement Plan Rules
Required Minimum Distributions: The CARES Act waived Required Minimum Distributions (RMDs) for 2020. The Joint Committee on Taxation Report and IRS Notice 2020-51 confirms that this rule:
- Applies to inherited IRAs, so that 2020 is not counted in the five-year payout period.
- Waives the 2019 initial RMD payment, which could be deferred until April 1, 2020.
- Waives the 2020 initial RMD payment, which could be deferred until April 1, 2021. However, the 2021 RMD will have to be made in that year.
Since the CARES Act did not become law until March 27, 2020, many individuals may have already received their RMDs for 2020 and already be beyond the normal 60-day rollover period to avoid taxation. To address this, the IRS extended the rollover period for distributions made before the enactment date to August 31, 2020.
The law generally limits the amount of IRA rollovers to one every 12 months. Given the unusual current circumstances, the Service states that repayments to an IRA through August 31 will not be considered a rollover with respect to this rule. This may require changes to be made to the plan, which can generally be done by the 2022 plan year (2024 for government plans).
Understanding the need that retirement plan participants could have for cash due to the pandemic, the CARES Act relaxed a number of rules related to distributions and loans:
- The 10% Premature Distribution Penalty (for distributions to a participant younger than 59.5) will not apply to a coronavirus-related distribution of up to $100,000.
- Coronavirus-related distributions of up to $100,000 will be (a) subject to income tax over three years (i.e., one-third taxable in each year); and (b) can be repaid to the plan within the three-year period. Any tax paid in a prior year can be claimed on an amended return when the proceeds are rolled over during the three-year period.
- Loans from qualified plans can be made up to $100,000 or 100% of the participant’s accrued benefit (considering prior loans), increased from the normal $50,000 or 50% of the accrued benefit, and not to be treated as distributions. Some deferral of payment terms is allowed.
There is a coronavirus-related distribution or loan where: i) the taxpayer, spouse, or dependent is diagnosed with COVID-19; ii) the taxpayer suffers adverse financial consequences due to being quarantined, furloughed, laid-off, or had work hours reduced due to COVID-19; iii) there was a closing or reduction of business owned or operated by taxpayer due to COVID-19; or iv) other factors to be determined by Treasury.
Plans can accept employee certification as satisfaction of these conditions.
Limitation on Net Business Losses Suspended
For non-corporate taxpayers, the TCJA limited the use of net business losses to the extent of $250,000 ($500,000 for married filing joint). The CARES Act provides that taxable incomes for 2018, 2019 and 2020 can be computed without this limitation.
This creates opportunities to claim a refund for 2018, where the business loss may have been limited on the original filing. In conjunction with the Net Operating Loss carryback rule (discussed below), this can create a significant current benefit.
The limitation is only suspended for 2018, 2019 and 2020. The limitation will continue to apply for 2021 and future years.
Charitable Contribution Deductions
The CARES Act makes a couple of significant changes to the individual charitable contribution deduction for 2020.
First, up to $300 of charitable contributions can be taken as a deduction in reaching Adjusted Gross Income. This rule applies only to an individual who does not itemize.
Secondly, the 60% AGI limitation for cash contributions is eliminated for 2020 for certain qualified contributions. This permits an individual to contribute up to 100% of his or her income. However, this rule applies only to cash contributions and not to contributions to certain non-operating private foundations or donor advised funds.
With the waiver of the required minimum distribution, there is less incentive for an IRA owner who is 70.5 or older to make a qualified charitable distribution directly from the IRA to the charity. However, this may still be an effective strategy to receive the effective benefit of 100% of the charitable deduction, through the exclusion of the income. A qualified charitable distribution may benefit someone in a state like Connecticut, which does not permit a charitable deduction, but bases its personal income tax on a modified adjusted gross income.
Employee Retention Credit
The law permits an eligible employer to receive a refundable Employee Retention Credit against employment taxes, equal to 50% of qualified wages for each employee taken into account for the calendar quarter. Qualified wages are limited for any employee to $10,000 of qualified wages paid from March 13through December 31, 2020, for all calendar quarters ($5,000 maximum credit per employee for the entire covered period).
An eligible employer is one that has a trade or business with respect to any quarter for which:
- The business operation is fully or partially suspended due to orders from an appropriate governmental authority limiting commerce, travel or group meetings due to COVID-19 (“government order” rule); or
- There has been a significant decline in gross receipts (i.e., less than 50% of gross receipts for the same quarter in the prior year) and ending with the calendar quarter for which gross receipts are greater than 80% in the same calendar quarter in the prior year (“significant decline” rule).
Since this is a payroll tax credit, tax-exempt organizations can also take advantage of this credit.
Different rules apply depending upon whether the employer has 100 or fewer employees (small business) or more than 100 employees (large business) in the prior year. In making this determination, related entities are aggregated. Full-time employee status is considered to be 30 hours/week or 120 hours/month. Full-Time Equivalent employees may also be including when determining eligibility for this credit.
For a small business, all wages paid to employees and related health benefits are included in qualified wages eligible for the credit. However, for a large business, only wages paid to employees for hours the employee does not provide service, and associated health care benefits, are considered as qualified wages.
An employer who receives a PPP loan is not eligible for the employee retention credit.
Like the FFCRA credits (discussed above), the Employee Retention Credit is allowed:
- (i) As a reduction of deposits otherwise required to be made for the quarter;
- (ii) As a Form 941 refund or credit; or
- (iii) As an advance requested on Form 7200.
The Joint Committee on Taxation Report (JCTR) and the IRS FAQ provide some guidance on important aspects of the credit.
Deferral of Employer Share of Payroll Taxes (or SECA for Self-Employed)
For the period beginning on the date of enactment to January 1, 2021, the CARES Act allows a deferral of the employer share of social security tax (6.2%). 50% of deferred tax is payable on December 31, 2021, and the balance on December 31, 2022. This provision is elective to the employer, which is not required to take advantage of this provision.
The law provides that this deferral does not apply to employers that take a PPP loan which is forgiven. The question was whether there would be an immediate requirement to pay the deferred tax on the date of forgiveness. IRS Frequently Asked Questions issued in April 2020 states that the deferral applies to all employers, including those who receive PPP loans. Taxes cannot be deferred after the date that PPP loan forgiveness is received. However, taxes deferred up to that date continue to be deferred and do not have to be repaid immediately upon the forgiveness. Given the amount of time that will be involved in receiving a final forgiveness notice, as a practical matter, this will permit deferral through the end of the year.
The Service has amended Form 941 for both the CARES Act and FFCRA credits. The form splits the credits between a nonrefundable portion (amount needed to offset other taxes due) and a refundable amount. However, the instructions to the form indicate that the deferral of the employer share of payroll taxes cannot be taken if
the taxes have already been deposited.
Immediate Refund of the Corporate AMT Credit
Under the TCJA, the corporate alternative minimum tax was eliminated for C corporations. For entities with an alternative minimum tax credit, the law provided for a four-year period (2018-2011) to offset regular tax liability and recover any additional AMT credit. The CARES Act allows recovery of the credit over a two-year period: 2018 and 2019. Alternatively, a corporation can elect to recover the credit solely in 2018, which would require an amended return but creates an immediate opportunity for C corporations to recover refunds for these credits.
Net Operating Losses – Carrybacks with No Income Limitation
The CARES Act changed the rules applicable to Net Operating Losses (NOL) for 2018, 2019 or 2020.
The TCJA repealed the rule permitting a carryback of Net Operating Losses created in 2018 and later years. The CARES Act reversed this rule to allow a five-year carryback for NOLs created in 2018, 2019 and 2020. In addition, the TCJA rules limiting the use of NOLs created in 2018 and later years to 80% of taxable income do not apply to 2018, 2019 and 2020. However, losses created for these years will be subject to the 80% limit when carried to years after 2020.
The law permits taxpayers to waive a carryback of losses under an election made no later than the extended due date for filing the tax return for the loss year.
Where the NOL carryback is to a year where Section 965 income (foreign transition tax income) has been recognized, the NOL carryback is not applied to the Section 965 income. Alternatively, the taxpayer can elect not to carry it back to the Section 965 tax year. However, the tax year is still considered as one of the five carryback years.
The IRS also issued special rules for the use of Forms 1045 for individuals and 1139 for corporations under a quick refund procedure.
Bonus Depreciation Allowed on Qualified Improvement Property (QIP) Costs
The rushed legislative process for the TCJA produced a drafting error which impacted real estate. It was the clear intention of that law (as expressed in the Conference Committee reports) that commercial real estate qualified improvement property would be eligible for 15-year depreciation and 100% bonus depreciation. However, due to the drafting error, the language including this type of real estate improvement as 15-year property was never written into the statute. This inclusion would have made the property automatically eligible for bonus depreciation. As a consequence, for property placed in service after 2017, the law did not permit bonus depreciation, and 39-year depreciation applied.
The Congressional tax writers attempted to convince the IRS and Treasury to permit bonus depreciation and a 15 year write-off through regulations, but Treasury responded that legislative action would be needed to correct the error for QIP acquired after December 31, 2017.
The CARES Act fixes the legislative drafting error and allows Qualified Improvement Property to be treated as 15-year property. This makes QIP eligible for an immediate bonus depreciation deduction. This provision is retroactive to enactment of the TCJA.
Qualified improvement property is defined as improvements made by a taxpayer to the interior portion of nonresidential real property that are placed in service after the building was first placed in service. It excludes costs for enlargement of the building, elevators and escalators, or work to the building’s internal structural framework.
The CARES Act changes created a number of planning issues with respect to 2018 and 2019 returns. If 39-year depreciation was taken on eligible QIP placed into service in either year, there is an opportunity to claim refunds to benefit from the change in law. The IRS issued procedures rules for making such claims.
Business Interest Expense Limitation
A change to the interest expense limitation rules pursuant to Section 163(j) was enacted by the TCJA. Under the new rules, every business, regardless of form, is subject to a disallowance of the deduction for net interest expenses (i.e., business interest expense in excess of business interest income) exceeding the sum of (i) certain floor plan financing interest, plus (ii) 30% of adjusted taxable income (ATI). For years beginning before January 1, 2022, adjusted taxable income is business taxable income without considering the deductions for depreciation, amortization, or depletion.
The law contains several exceptions:
- A small business exception excludes from this limitation a business whose average gross receipts do not exceed $25 million ($26 million for 2019 and 2020). In making this determination, the gross receipts of certain commonly controlled businesses must be aggregated.
- Certain businesses can elect out of this interest limitation. They include electing real property trades or businesses (ERPTB) or electing farming trades or businesses (EFTB). The cost of this election is that the business is required to use the Alternate Depreciation System (ADS) instead of the normal cost recovery rules for certain property. ADS requires the use of longer lives and the straight-line method. Of greater significance, those required to use ADS cannot take bonus depreciation on the affected assets.
- Certain floor plan interest is excluded from this rule.
- Certain regulated public utilities and electric cooperatives are not subject to this rule.
The CARES Act made a number of changes to these rules for 2019 and 2020 involving the ATI limit.
First, the limit is increased from 30% to 50% of ATI. This increase is elective with respect to either year or both years, which allows some flexibility to use the expense in a higher tax bracket year if business interest expense would be limited.
However, the 50% ATI limit does not apply to entities taxed as partnerships for their 2019 tax year. It only applies to the 2020 tax year. Instead, the new law creates a more complex regime. If the partnership allocated to a partner any Excess Business Interest Expense (i.e., business interest expense which cannot be deducted due to these limits) for 2019, the partner must carry this amount forward to 2020, but is able to use 50% of the carryover in that year without being subject to the Section 163(j) limits. However, the other 50% of the carryover is subject to the normal partner rules imposed on Excess Business Interest Expense.
Secondly, Congress recognized that incomes are likely to be lower in 2020 compared to 2019 due to the economic impact of the pandemic. The law allows a taxpayer to elect to use 2019 ATI instead of 2020 ATI in computing the section 163(j) limitation.
Corporate Charitable Contributions
The CARES Act increased the ability of C corporations to deduct charitable contributions for 2020. Normally, charitable contributions are limited to 10% of a corporation’s taxable income. This limit is increased to 25% of taxable income for 2020.
Additionally, the limitation on the deduction for the contribution of food inventory based on value is ordinarily limited to 15% of net income. For 2020, this has been increased to 25%.
Miscellaneous Tax Developments
Final Regulations and New Proposed Regulations
Final regulations and a new set of proposed regulations were issued by the IRS this year, dealing with the business interest expense limitation rules. These regulations are very extensive and cover many specialized areas and situations.
The Service also made some significant reversals of position in the final regulations (when compared to prior proposed regulations).
Sec 263A capitalized depreciation, amortization and depletion: In determining ATI, the Service will permit add-back of depreciation, amortization and depletion that is capitalized under IRC Section 263A. Its prior position was that these items lost their character as depreciation, amortization or depletion after capitalization. Additionally, there is no need to match the add-back to when inventory or other items into which the depreciation, amortization or depletion has been capitalized are released through cost
Section 179 expense deduction: This amount is considered to be amortization and can be added back in determining ATI.
Limitation of the definition of Business Interest Expense: The original proposed regulations had created four categories of expenses which could be treated as interest. Category #3 was broad and included as interest commitment fees, debt issuance costs, and guaranteed payments for use of capital. These are excluded from the definition of interest under the final regulations.
Business interest is not retested at the pass-through entity owner level: The former proposed regulations suggested that owners of a pass-through entity that was exempt from the business interest limitation rules under the small business exception would need to retest interest expense of the entity to determine if a Section 163(j) limitation applies. The final regulation eliminates this issue.
Executive Order to Defer Employee Social Security Taxes
The enhanced unemployment benefits under the CARES Act expired on August 1. Due to the problems with getting a timely new stimulus bill, the President signed an Executive Order directing the Treasury Secretary to exercise his authority to defer payroll taxes for the period September 1, 2020, to December 31, 2020, for employees who earn up to $4,000 bi-weekly ($104,000 annually). This deferred amount will not be charged interest, penalty or additional assessments. The IRS issued additional guidance on this employee payroll tax deferral.
Many employers have expressed concerns that this could cause a hardship for employees during this payback period. Others worry that this may create an incentive for employees to leave their jobs at the beginning of next year. In any event, it would be prudent for employers to notify employees of these consequences and document an agreement to recover the deferred taxes should the employee leave employment.
Qualified Opportunity Zone Relief
Due to the impact that the COVID-19 pandemic has had on business transactions, the Service has provided significant relief for Qualified Opportunity Zone (QOZ) investments.
- Extension of the 180-Day Investment Period: To avoid current taxation, the amount of qualifying capital gains to be deferred must be invested in a Qualifying Opportunity Fund (QOF) within a 180-day investment period. Generally, this is measured as 180-days from the recognition event. However, for an owner of a pass-through entity that has capital gain allocation, the investment period begins on the last day of the entity’s tax year. Where the last day for investment would fall between April 1, 2020, and December 31, 2020, the IRS has extended the reinvestment date to December 31, 2020. This means that some 2019 gains may still be eligible for deferral. However, the investor must make a valid deferral election on Form 8949.
- 90% Asset Test Failure: Generally, a QOF must satisfy a 90% investment standard test, based on the average of two semi-annual periods. Failure of the test can cause the fund to become subject to penalties. Additionally, a failure will not prevent the entity from qualifying as a QOF nor cause the taxpayer’s investment in the fund to become a non-qualifying investment.
- Working Capital Safe Harbor Exception Extension: A QOZ business can retain cash under a working capital exception for a 31-month period. Under certain circumstances, this period is subject to an increase of up to 31 months. The Service extended these applicable periods by 24 months.
- 30 Month Substantial Improvement Period: Property already situated in a QOZ can be treated as “original use” property if it substantially improved within a 30-month period. This generally requires making improvements which cost an amount equal to the basis of the property (excluding the cost of land).
Affordable Care Act (ACA) Protective Claim and Related Taxes
The U.S. Supreme Court has agreed to hear a case from Texas involving the constitutionality of the ACA after the elimination of the individual shared responsibility payment (individual mandate).
In Texas v U.S., the U.S. Court of Appeals declared that the requirement for individuals to carry health insurance under ACA was unconstitutional, based largely on the penalty’s reduction to zero under the Tax Cuts and Jobs Act (TCJA), starting in 2019. On March 2, 2020, the United States Supreme Court accepted an appeal by 21 state attorneys general, led by California in California v Texas (formerly Texas v U.S.) and the cross-appeal by Texas. The Court has indicated that it will issue its decision either in the fall of 2020 or in 2021.
If the law is found unconstitutional, this could cause a retroactive invalidation of the ACA-related taxes (3.8% Net Investment Income Tax, .9% Additional Medicare Tax, and the Individual Mandate penalty) paid in 2016 and later years. Since the prior U.S. Supreme Court found that the Individual Mandate penalty was essentially a tax and legitimate exercise of Congress’ power to tax, it is not clear that, even if parts of the law are determined to be unconstitutional, this would apply to actual taxes. However, given this potential, many taxpayers have filed protective claims with respect to the 2016 tax year (which would otherwise be closed when a decision is issued).
This discussion is just an introduction to the federal income tax issues that have surfaced thus far this year. Pending stimulus bills and election results, not to mention unforeseen events, could also have significant impact on year-end tax planning.
Hopefully this article and the others contained in this guide will motivate you to consider how these developments affect you, your family, and your business in the near and long-term future.