An update on the most pressing Federal Tax Business issues.

1. January 2014
Federal Tax Update

2. Circular 230 Notice
Any tax advice contained in this program is not
intended to be used and cannot be used for the
purposes of avoiding any penalties that may be
imposed by the Internal Revenue Code.
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3. Here’s what we’ll cover:
• What To Look For In 2014
– 2014 By The Numbers
– “Tax Extenders”
– Serious Problems Facing the IRS in 2014 (Taxpayer
Advocate Report)
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4. Here’s what we’ll cover:
• Regulatory & Administrative
Pronouncements
– New IRS Commissioner
– Final Tangible Property Regulations
– Final Net Investment Income Tax Regulations
– Guidance on Bonus Payments (FAA 20134301F)
– “Use-or-Lose” FSA Rules and Additional Rulings
– International Enforcement -- John Doe Summons
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5. Here’s what we’ll cover:
• Cases
– Glass Blocks v. Commissioner – S Corporation
distributions
• Legislative Updates
– Tax Reform
• Status
• Hurdles
• Baucus Proposals ( Cost Recovery, Tax Accounting,
International)
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6. What To Look For In 2014
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7. 2014 By The Numbers
• The top marginal income tax rate in 2014 (39.6 percent) will apply
to the taxable income of individuals & married couples filing jointly
when their income exceeds $406,750 and $457,600, respectively (up
from $400,00 and $450,000 in 2013).
• In 2014, the Standard Deduction increases to $6,200 (from $6,100).
The personal exemption increases by $50 to $3,950.
• For married couples, the phase-out of the personal exemption
deduction starts with adjusted gross income of $350,050; the
deduction is eliminated once AGI reaches $427,550.
• The FICA wage base increases to $117,000; an increase of $3,300.
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8. 2014 By The Numbers
• The annual dollar limit on contributions to health care flexible
spending accounts remains $2,500.
• The §401(k) contribution limit remains $17,500. The $5,500
“catch-up” contribution allowance for participants older then 50 also
remains unchanged.
• The lifetime estate tax exclusion is increased to $5.34 million (up
from $5.25 million).
• Fees for installment agreement and OIC will increase in 2014:
− Installment Agreement increases to $120 (and $50 for reinstatement )
− OIC increases to $186
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9. “Tax Extenders” - Expiring Tax Provisions
• “Tax extenders” refer to legislation to extend the package
of expiring tax provisions that typically get temporarily
extended by Congress. The extensions tend to be for
short periods of time (e.g., one – two years).
• Many feel that the extension of many of these provisions
is being “tied” up by Congress as they await a more
comprehensive tax reform.
• Most of the expiring provisions were extended by the
American Taxpayer Relief Act of 2012.
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10. “Tax Extenders” - Expiring Individual Provisions
• Individual tax provisions set to expire include:
– Deduction for state and local sales taxes;
– Above-the-line deductions for certain expenses of teachers;
– Above-the-line deductions for qualified tuition and related
expenses;
– Deduction for mortgage insurance premiums deductible as
qualified interest;
– Parity for exclusion for employer-provided mass transit and
parking benefits;
– Exclusion of discharge of principal residence indebtedness from
gross income;
– Credit for health insurance costs.
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11. “Tax Extenders” - Expiring Business Provisions
• Business tax provisions set to expire include:
– Research and experimentation credit;
– Work opportunity tax credit;
– Increase in expensing to $500,000/$2,000,000 and expanded
definition of §179 property;
– Bonus depreciation;
– Exceptions under Subpart F for active financing income;
– Look-through treatment of payments between controlled foreign
corporations (“CFC ”);
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12. “Tax Extenders” - Expiring Business Provisions
• Business tax provisions set to expire (cont’d):
– Special treatment of certain dividends on Regulated Investment
Companies (“REIT”);
– Employer wage credit for activated military reservists;
– Special rules for qualified small business stock;
– Reduction in S corporation recognition period for built-in gains tax;
– Election to accelerate alternative minimum tax (“AMT”) credits in
lieu of additional first-year depreciation;
– 15-year straight line cost recovery for qualified leasehold,
restaurant, and retail improvements
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13. “Tax Extenders” – Tax Costs To Extend
• Projected Tax Costs for extending all of the tax provisions
scheduled to expire between 2013 – 2023 is $938.3
billion.
• Cost for extending all temporary investment incentives
(i.e., partial expensing for investment property and §179
allowances) is $346.1 billion.
• Cost of expending child tax credit, earned income tax
credit and American Opportunity Tax Credit (scheduled to
expire in 2017) is $140.4 billion.
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14. Serious Problems Facing the IRS in 2014 –
Taxpayer Advocate’s Report to Congress
• Sequestration has caused IRS funding to be substantially cut,
translating into a reduction in taxpayer services, including:
– 39%of taxpayer calls going unanswered at the IRS;
– A six-fold increase in hold times before speaking to an IRS
representative;
– A $150m reduction in the training budget (which has lead to an
increase in identity theft, decrease in customer service and
inappropriate adjustments at audit).
– More than 50% of taxpayer correspondence (proposing adjustments
to taxpayer liabilities) going unanswered for more than 45 days
(falling into the “over age” category by IRS standards) leading to an
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unnecessary increase in penalties and interest.
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15. Serious Problems Facing the IRS in 2014 –
New Budget
• House lawmakers on January 15 quickly passed a $1.012-trillion
spending bill for fiscal year (FY) 2014 by a vote of 359 to 67.
– 193 Democrats and 166 Republicans voted for passage
• The Consolidated Appropriations Bill of 2014 (HR 3547) sets
spending levels for all federal agencies, including the IRS, which
will see its budget cut to $11.3 billion, or roughly $526 million
below the FY 2013 level.
• The bipartisan spending bill would also prohibit the IRS from
targeting political groups or overspending on employee training
and bonuses.
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16. Regulatory & Administrative
Pronouncements
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17. New IRS Commissioner
• John Koskinen appointed Commissioner after serving as Deputy
Director of the OMB – considered “turnaround” specialist
• Immediate challenges facing the new Commissioner include:
• 2014 filing season – due to delays from the 2013 government
shutdown, the filing season will be delayed by 10 days.
• 2014 tax collection – due to a congressional budget cuts, the
number of available revenue agents has been decreased.
• Restoration of public confidence – after 2013 “targeting
scandals”.
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18. Tangible Property Regulations
• Final regulations
– Govern the deduction and capitalization of costs
incurred to acquire, maintain or improve tangible
property (personal and real property, not intangible
property)
– Generally effective for tax years beginning on or after
January 1, 2014
– Optional early adoption for 2012 and/or 2013 tax years
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19. Why is this important?
• Example actions required of most taxpayers:
– Review and validate current capitalization policies
• Critical for de minimis safe harbor
– Consider tax accounting method changes for 2013 or 2014 along with
impact on taxable income
– Evaluate opportunities to amend 2012 tax returns
– Consider financial statement implications
• Some book conformity required
• Effect on deferred taxes
– Review and modify fixed asset accounting systems as needed
– Evaluate materials and supplies accounting
– Review prior year treatment of expenditures on repairs &
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maintenance and dispositions
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20. Tax Accounting Considerations
• For tax accounting purposes, the following items are impacted:
– Materials and supplies,
– Acquisitions of tangible assets,
– Improvements to tangible assets,
– Repairs and maintenance expenditures, and
– Dispositions/retirements of tangible assets.
• Many of these tax accounting changes will have an impact on the way
taxpayers report these items on their books – Specific areas requiring
book consistency:
– De minimis safe harbor
– Materials & supplies under the de minimis safe harbor
– Election to capitalize repairs & maintenance
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21. De minimis safe harbor
• De minimis safe harbor -- an annual election that permits
a taxpayer to currently deduct otherwise capital
expenditures (including materials & supplies) if the
taxpayer:
– (1) has an “accounting policy” (at the beginning of the
tax year) that requires expensing of items that cost no
more than a specified dollar amount for book purposes,
and
– (2) consistently applies that policy for book purposes.
• Critical that book and tax treatment of small dollar items be
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understood
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22. De minimis safe harbor
• Both requirements must be satisfied to deduct amounts
otherwise required to be capitalized
• Ceiling for safe harbor depends on whether the taxpayer
has an Applicable Financial Statement (“AFS”)
– AFS is an Audited statement, or
– AFS is also a financial statement required to be
provided to the Federal or State government or their
agencies (consider bonding agencies for contractors)
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23. De minimis safe harbor
• The de minimis safe harbor uses an invoice test:
• Taxpayers with an AFS: A taxpayer may rely on the de
minimis safe harbor only if the amount paid for property
does not exceed $5,000 per invoice or per item as
substantiated by the invoice;
– Note accounting policy must be written
• Taxpayers without an AFS: A taxpayer may rely on the
de minimis safe harbor only if the amount paid for
property does not exceed $500 per invoice or per item
as substantiated by the invoice;
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– Note accounting policy just needs to “exist”

24. De minimis safe harbor
• If book policy is less than the $5,000/$500 ceiling then the
lower amount is the amount allowed for tax
• Since the de minimis rule requires the policy to be in
existence at the beginning of the tax year, to utilize this
rule the policy needs to be prepared in 2013 for 2014 tax
years
• Each taxpayer should be reviewing their capitalization
policy NOW!
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25. Other key areas of these new rules
• Tax rules now allow partial disposition of assets, including building
components (i.e. roof, elevators, walls and ceilings…)
– Consider dispositions that occurred in prior years
– IRS allows a reasonable method to extract cost of asset disposed
from original cost of the building or asset
– Cost segregation concepts apply
– Write-offs would generate an ordinary deduction
– What will be the book treatment?
• Materials & supplies – if the de minimis safe harbor is elected, then
materials & supplies must be considered under the de minimis rules
• Election to capitalize repairs & maintenance – must also capitalize
for book purposes under this election
– Will this be allowed under GAAP?
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26. Net Investment Income – Final Regs
• The Net Investment Income (“NII”) tax is part of the PPACA
and went into effect on January 1, 2013.
• The NII is unlikely to apply to approximately 94% of
Americans.
• The NII will be levied on the lesser of the following two:
– A taxpayer’s net investment income, or
– The excess of the taxpayer’s “modified adjusted gross income” over
taxpayer’s “applicable threshold.” The applicable threshold is
dependent on filing status, and is:
• Married filing jointly:
$250,000
• Single/head of household: $200,000
• Married filing separate:
$125,000
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27. Net Investment Income – Final Regs
• The final regs (found in §1.1411-1 to §1.1411-10) provide
guidance on what constitutes “Net Investment Income” to
which the 3.8% tax is applied and they involve issues that
include:
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Portfolio income
Ordinary trade or business
Trade or business for rental real estate
Net gain calculations
Real estate professionals.
• Note that an additional .09% Medicare tax on wages has
also been implemented as part of the same regulations.
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28. Net Investment Income – Changes in the Regs
• Portfolio income. The IRS rejected the suggestion that the
definition of portfolio income (for purposes of NII) adopts the concepts
used under §469. The final NII regulations observe that the interaction
of §1411 with §469 is generally limited to the determination of
whether those items are attributable to a passive activity within the
meaning of §1411(c)(2)(A).
• Ordinary course of trade or business. Similar to the preamble in
the proposed regulations, the final regulations defer to case law and
administrative guidance applicable to §162 in defining a trade or
business.
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29. Net Investment Income – Changes in the Regs
• Trade or business for rental real estate. The IRS acknowledged that
"in certain circumstances" the rental of a single property may require
regular and continuous involvement such that the rental activity is a
trade or business under §162 (and, therefore, is a trade or business
under §1411 by adoption). However, the IRS refused to provide a
bright-line test to determine when a rental activity rises to the level of a
trade or business "due to the large number of factual combinations that
exist."
• Net gain calculation. The final regulations retained the rule that net
gain within Category (iii) (under §1411(c)(1)(a)(iii)) cannot be less
than zero. However, they allow losses under §1211(b) as offsets
while applying a specific ordering rule designed to prevent a double
deduction of the same loss twice.
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30. Net Investment Income – Changes in the Regs
• Real estate professionals. The IRS rejected suggestions that if a real
estate professional materially participates in real estate activities, the
rental income should be excluded from NII. Instead, the final
regulations provide a safe harbor test for a real estate professional
(within the meaning of §469(c)(7)) who participates in rental real
estate activities for more than 500 hours per year. The rental income
associated with that activity will be deemed to be derived in the
ordinary course of a trade or business.
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31. Net Investment Income – Changes in the Regs
• Regrouping. The 2012 NII proposed reliance regulations provided
taxpayers with the opportunity to regroup their activities in the first tax
year beginning after December 31, 2012. The IRS retained the
regrouping provision in the final regulations. The IRS rejected calls for
a "fresh start" for all individuals (and estates and trusts) regardless of
whether they have NII income or modified adjusted gross income
above the applicable thresholds.
• NOTE - The IRS has not yet published final Form 8960, Net
Investment Income Tax, and Instructions for the 2013 tax year. Form
8960 must accompany Form 1040 or 1041.
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32. New IRS Guidance On Bonus Payments (FAA 20134301F)
• IRS Chief Counsel issued advice stating an accrual-basis taxpayer
cannot deduct bonuses until the year paid where the taxpayer retained
the unilateral right to modify or eliminate the bonuses before payment,
thereby failing to satisfy the all-events test.
• In this instance, the taxpayer had more than a dozen bonus plans.
Under the plans, employee bonuses would be calculated using
formulas that use various measurements. Though performance targets
were set by the board of directors early in the fiscal year, the bonuses
were not paid until the committee approved the settlement and
payment of the bonuses after the end of the fiscal year. All of the
bonuses were paid after the end of the year, but within 2 ½ months
following the end of the year.
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33. FSAs, Retirement Plans and Fringe Benefits
• Healthcare Flexible Spending Accounts
– The “use-or-lose” rule has been amended allowing up to $500 to be
carried over annually (See Notice 2013-71).
• §401(k) safe harbor for plan sponsors (TD 9641)
– Employers facing economic difficulties may reduce or suspend
nonelective contributions to §401(k) plans if the employer is
operating at an economic loss.
• Updated Auto fringe rules
– The cents-per-mile valuation rule is $16,000 for a car and $17,300
for a truck or van.
– The per diem rate is $251 in high-cost areas and $170 in low-cost
areas.
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34. International Compliance – John Doe & OVDI
• Judges in the Northern District of California recently authorized the IRS
to issue John Doe summons on Wells Fargo Bank in an effort to gain
information about U.S. taxpayers with offshore accounts at First
Caribbean International Bank.
– While First Caribbean does not maintain a U.S. branch, it does
access the U.S. banking system through a Wells Fargo
correspondence account.
– The information provided in support of the John Doe summonses
were derived through the offshore voluntary disclosure initiative
(“OVDI”).
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35. International Compliance – John Doe & OVDI
• A number of U.S. taxpayers who were accepted into the OVDI
program were subsequently disqualified from participation. The
overwhelming majority of those taxpayers disqualified from the OVDI
maintained bank accounts with Bank Leumi – an Israeli bank.
• The OVDI has seen more than 38,000 participants enrolled, generating
more than $5 billion in back taxes and penalties.
• A number of participants in the OVDI have pled guilty to criminal tax
evasion with the most common sentence totaling three year’s
probation. In some cases, those seeking to evade U.S. tax (or assist
those in evading U.S. tax) by maintaining numbered Swiss bank
accounts have actually received jail time ranging from 45 days to 40
months.
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36. Cases
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37. Glass Blocks Unlimited v. Comm’r
T.C. Memo. 2013-180
• Petitioner was an S corporation. Petitioner had one
shareholder who was also the only full-time employee.
• Petitioner’s employee transferred funds to the business in
order offset financial difficulties, including operating expenses.
• Petitioner did not make any salary payments to its
employee/shareholder in either 2007 or 2008. Instead,
Petitioner made “distributions” to its employee/shareholder.
• The IRS issued a notice of deficiency asserting the
distributions Petitioner made to its employee should be
recharacterized as wages subject to withholding.
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38. Glass Blocks Unlimited v. Comm’r (contd.)
T.C. Memo. 2013-180
• Petitioner’s employee was deemed to receive wages subject to
Federal employment tax because:
– He performed substantially all of the work necessary to
operate the business
– His services generated all of the S corporation’s income.
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39. Glass Blocks Unlimited v. Comm’r (contd.)
T.C. Memo. 2013-180
• The funds transferred by Petitioner’s employee were found to
be capital contributions (and not loans), as there was no
objective evidence they should be treated as a loan.
– Applying the 13 Factors Test (See, §142(a); Dixie Dairies
Corp v. Comm’r., 74 T.C. at 493), including whether there
were: formal loan documentation; presence of a fixed
maturity date; some loan repayment, etc.
• Here, there was no loan agreement or promissory note, no
evidence of interest accrual (or other similar obligations)
indicating the contributions were equity.
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40. Legislative Updates
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41. Tax Reform – Status and Hurdles
• Congressman Dave Camp (R-Mich) – chairman of the House Ways
and Means Committee and Senator Max Baucus (D-Mont) –
chairman of the Senate Finance Committee have endeavored to lead
legislators to a comprehensive reform of the tax code. Both released
drafts of their reform measures.
• Cong. Camp’s initial proposal aimed at closing tax loopholes while
cutting tax rates (a “revenue neutral” process”). A more
comprehensive look at Cong. Camp’s proposals was undertaken in
previous EOW.
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42. Tax Reform – Status and Hurdles
• It is widely believed that significant tax reform is beyond the
reach of the current Congress. Some hurdles standing in the
way include:
– Sen. Baucus retiring and appointed Ambassador to China;
– Whether the tax code should raise revenue or be revenue neutral;
– Whether “extenders” will be tied to other votes (such as passing a
budget or extending our country’s debt ceiling).
• Senator Baucus offered a comprehensive tax reform proposal
focusing on:
– Simplification of tax administration;
– Overhauling the way the government taxes international
business; and
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– Reforming depreciation rules.
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43. Tax Reform – Baucus Plan
• Depreciation - Replace the current rules with a system tied closer to
estimates from the Congressional Budget Office.
– Reduce the number of depreciation rates from 40 to 5, and
eliminate the need for businesses to calculate depreciation
separately for each of their assets, other than real property.
• Amortization Of Intangibles - Require businesses to deduct the
cost of R&D, natural resource extraction, and 50% of advertising
expenses over 5 years.
• Accounting - Repeal LIFO accounting and like-kind exchange rules.
• Reduce Burdens For Small Businesses - Permanently increase
Section 179 expensing to $1m and expand the definition of qualifying
expenses. Allow all companies with gross receipts under $10m to use
cash accounting and expense inventory costs.
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44. Tax Reform – Baucus Plan (contd.)
• International taxation:
– Reduce incentives for US and foreign multinationals to invest in,
or shift profits to, low-tax foreign countries.
– Reduce incentives for US-based businesses to move abroad,
whether by re-incorporating abroad or merging with a foreign
business.
– Increase the ability of US businesses to compete against foreign
businesses in foreign markets.
– End the "lock-out" effect by taxing the foreign income of US
businesses either immediately when earned or not at all.
– Simplify the international tax rules so that firms with the most
sophisticated tax advisors are not advantaged.
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45. For more information contact:
William M. Smith, Esq.
Managing Director
CBIZ MHM National Tax Office
(301) 951-3636 | billsmith@cbiz.com
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