There will be no shortage of activity in the tax landscape in 2020, and with the upcoming presidential and congressional elections, tax-related issues may dominate much of the national discourse until November. Businesses, owners, and their tax teams will have much to consider when it comes to tax planning for 2020 and future years. The following are eight of the most important tax issues and some of the steps that taxpayers can take this year to take full advantage of available benefits.
Outcome of the Federal Election
The major story of 2020 will be the November presidential and congressional elections. Changes in the party that controls the White House or the Senate would not go into effect until 2021, but a significant upset to the status quo could have ramifications for the Tax Cuts and Jobs Act (TCJA) changes that were largely passed along party lines in 2017.
Should Democrats take control of the Senate and the White House, several TCJA provisions may be targeted for change, including the corporate and long-term capital gains tax rates. In addition, several Democratic presidential candidates have called for more funding for healthcare, housing, and education, which may lead to additional taxes or increases in certain tax rates. On the other hand, should Republicans gain a majority in the House of Representatives and retain control of the Senate and White House, there could be additional tax changes, such as President Trump’s recently proposed 10% middle-class tax cut.
Businesses and individuals may want to use 2020 to take advantage of the provisions currently in place, including the enhanced bonus depreciation and the 21% corporate tax rate.
Tax Extenders and the Secure Act
As part of the Further Consolidated Appropriations Act, 2020 (FCAA), which was signed into law on December 20, 2019, Congress included several extender provisions and the Secure Act (Setting Every Community Up for Retirement Enhancement Act of 2019), which addresses a number of retirement savings plan incentives. For example, the credit for employers that establish new retirement plans was increased from $500 to $5,000, and small employers can now offer retirement plans by a pooled retirement plan provider.
For individuals, the age for required minimum distributions was increased from 70½ to 72. Similarly, individuals over age 70½ can now continue to contribute to IRAs. Individuals also will be able to withdraw up to $5,000 penalty-free from retirement accounts in the year following the birth or adoption of a child.
The FCAA permanently repealed the “Cadillac” tax imposed on businesses that sponsor health plans costing more than $10,200 for individuals and $27,500 for families, the 2.3% medical device excise tax, and the annual fee imposed on health insurance providers.
The FCAA also repealed a new tax on not-for-profit organizations attributable to parking and transportation benefits provided to employees. The TCJA enacted the tax with a correlative provision that makes such expenses nondeductible for commercial businesses. The tax was seen as particularly burdensome for not-for-profit organizations because many otherwise owe no tax, and would have to make particularly burdensome calculations and file additional forms in order to comply. The FCAA repeals the tax for not-for-profit organizations retroactively to the date of its original enactment in the TCJA, but leaves intact the nondeductible expense rules for commercial businesses. It also reduces the excise net investment tax income owed by private foundations from 2% to 1.39%, but eliminates eligibility for a reduced 1% rate.
Individual provisions extended retroactively to 2018 and through 2020 include the exclusion of mortgage debt cancellation from taxable income, the treatment of mortgage insurance premiums as mortgage interest for itemized deduction purposes, and a deduction for adjusted gross income of up to $4,000 for qualified tuition and related expenses. The floor used to determine the deductible amount of medical expenses for itemized deduction purposes is reduced from 10% to 7.5%, retroactive to 2019 and through 2020.
Notable business provisions that were extended through 2020 include the following (retroactive to 2018):
- Credits for producers of biodiesel fuels
- Wind energy producers
- Producers of energy from other renewable sources
- Residential energy-efficient property improvements
- Energy-efficient commercial buildings deductions under section 179D
- Incentives for empowerment zones.
The New Markets Tax Credit, the credit for employers that provide paid family medical leave, and the Work Opportunity Tax Credit, all set to expire after 2019, were extended through 2020.
The 30% investment tax credit, commonly used for investments in solar energy property, was not extended, and is scheduled to phase out beginning in 2020.
IRC Section 163(j) Limitation and Carried Interest Regulations
The TCJA placed limits on the amount of interest a business can deduct. The Internal Revenue Code (IRC) section 163(j) limitation caps business interest deductions at business interest income plus 30% of adjusted taxable income [essentially, EBITDA (earnings before interest, tax, depreciation, and amortization) through 2021, thereafter EBIT (earnings before interest and taxes)]. Any unused business interest can be carried forward, but it cannot be carried back. Proposed regulations released in November 2018 clarified the mechanics of calculating the limitation and how to apply it, including to foreign corporations with U.S. partners or shareholders.
Also included in the TCJA were rules governing the holding periods for carried interest that apply in two separate circumstances: capital assets (other than IRC section 1231 property) held by a partnership and partnership interests held by partners. The new carried interest rules apply to either the sale of the partnership interest itself or to qualifying gain allocated from the partnership. In either case, the holding period before the gain is eligible for the long-term 20% capital gains tax rate was increased to three years. Corporations holding interests were exempt from the carried interest changes, which may have created a loophole for S corporations.
There are still some ambiguities around the definition of business interest under IRC section 163(j) and the carried interest loophole for S corporations. Treasury Assistant Secretary for Tax Policy David J. Kautter has indicated that both the carried interest regulations and the final regulations for IRC section 163(j) will be forthcoming.
In the absence of clear guidance, companies with large QIP may want to undertake a cost segregation study to isolate which of their assets may be eligible for shorter depreciation periods.
Partnerships and S corporations will need to monitor for updates carefully. The IRC section 163(j) limitation and carried interest regulations could have a significant impact on the taxable income for these entities.
Qualified Improvement Property’s ‘Retail Glitch’
The tax community is still waiting on a fix for an oversight in the TCJA for qualified improvement property. As part of broader changes to the bonus depreciation deduction, the TCJA created a new category of real property—qualified improvement property (QIP)—that encompasses several types of property previously eligible for bonus depreciation, including qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property. These types of property had been eligible for a 15-year cost recovery period and IRC section 179 expensing, prior to the TCJA. Any other type of real property outside of these categories had a cost recovery period of 39 years.
In creating the new QIP category, however, the TCJA failed to assign it a depreciable life, which means that all QIP defaults to a 39-year cost recovery period and, as a result, is not eligible for bonus depreciation. Bonus depreciation generally allows for faster depreciation of assets with class lives of 20 years or less. Under the TCJA changes, businesses can take a 100% deduction on their cost basis in qualifying property until January 1, 2023. This missing class life for QIP—dubbed the “retail glitch” for the sector most affected by the oversight—means that QIP is not currently eligible for bonus depreciation. Companies holding significant QIP or making qualified improvements are missing out on substantial tax savings opportunities.
In the absence of clear guidance, companies with large QIP may want to undertake a cost segregation study to isolate which of their assets may be eligible for shorter depreciation periods. Cost segregation can be a vital tool for maximizing the benefits of the 100% bonus depreciation deduction while it is in effect. Starting in 2023, the bonus depreciation percentage drops to 80%.
Further SALT Cap Activity
States with higher tax rates, including New York, have fought the TCJA’s $10,000 state and local tax (SALT) deduction limitation from its inception. Some states had offered state tax credits for taxpayers who made charitable contributions to a state or local government fund. These credits were designed to offset taxpayers’ state and local tax obligations.
The IRS issued final regulations in June 2019 that essentially bar these workarounds to the cap. Under the final regulations, taxpayers who receive a state tax credit must reduce their federal charitable contribution deduction by the amount of the credit they receive or expect to receive. Taxpayers receiving a state tax deduction for a charitable contribution do not have to reduce their federal deduction, nor do the taxpayers have to reduce their federal charitable deduction if the credit is 15% or less of their contribution.
A New York U.S. District Court also recently dismissed a lawsuit from a group of states that tried to block the limitation on state and local tax (“Court Ruling Indicates SALT Cap Not Going Anywhere,” CBIZ, Oct. 15, 2019, http://bit.ly/2Fh1Pnn).
Democrats in the House of Representatives have attempted other avenues in order to loosen up the SALT deduction—in part because the states most adversely affected tend to vote Democratic—but the Senate rejected an earlier legislative attempt to alter it. Depending on the outcome of the November 2020 election, 2021 could see another attempt to eliminate the SALT cap.
All evidence suggests that for 2020, the $10,000 SALT deduction limitation is here to stay. Tax professionals may want to encourage their clients most affected by the deduction to look for other planning solutions to offset their taxable income.
Withholding by Partnerships with Foreign Partners
The TCJA expanded the IRC section 1446 withholding requirements to include partnerships with foreign partners who dispose of their partnership interests at a gain. When a foreign partner’s sale of partnership interest qualifies for IRC section 864(c)(8), the partnership must withhold 10% of the amount realized from that disposition. Proposed regulations released in May 2019 clarify when partnerships with foreign partners should withhold taxes on partnership interest sales.
This withholding treatment will only be applicable when the final regulations are released, which could happen in 2020. Partnerships may have not previously withheld taxes on the disposition of foreign partners’ interests, so it will be important to plan for this additional compliance requirement.
Tax professionals working with domestic partnerships that include foreign partners should closely monitor the status of final regulations to help their clients determine when the rule change will affect them and their partners.
Decline in Qualified Opportunity Zone Interest
The TCJA created a Qualified Opportunity Zone (QOZ) program that provides investors and businesses with incentives to operate within low-income areas. Under the QOZ program, taxpayers can defer capital gains tax if they transfer the gains from one investment (or business) into a QOZ fund that supports a qualified business in a designated QOZ area. Benefits available for investors depend on the length of time that the investor holds the QOZ investment. The advantages include capital gains tax deferral through 2026, as well as a “basis bonus” on the deferred gain of up to 15%.
Virtual currencies and cryptoassets are in uncharted territory, which makes them challenging for the tax and accounting professionals who must account for them.
Companies and investors alike have been slow to take advantage of the program, in part because additional regulations were needed to clarify some provisions. Proposed regulations released in 2019 helped to assuage some concerns and spurred additional interest, but the window of opportunity for QOZs may already be closing.
One of the major benefits of the program for investors—an additional 5% basis increase for investments held at least seven years—is not available for QOZ investments made in 2020, so there may be less incentive for investors to contribute to the QOZ fund that supports a QOZ business.
Tax professionals who work with QOZ businesses or fund operators should help prepare management teams for a drop-off in investor interest. Businesses and fund operators can still stress the other benefits of the program to their investors, such as the 10% basis increase in deferred gain for investments held at least five years.
Cryptocurrency Audits and Investigations
Regulators are paying more attention to cryptocurrencies than ever. The IRS released cryptocurrency guidance in 2019 (Revenue Ruling 2019-24) that clarifies some of the income tax treatment of virtual currencies. At the same time, enforcement activities are also on the rise; the IRS issued letters to hundreds of taxpayers in 2019 for failing to report or for misre-porting their cryptocurrency transactions.
Virtual currencies and cryptoassets are in uncharted territory, which makes them challenging for the tax and accounting professionals who must account for them. Adding to these assets’ complexity is the fact that virtual currencies have been used in money laundering and other criminal activities because they are so difficult to trace. Their use makes them of particular interest to regulators, who are on the lookout for corruption and fraud.
Businesses and investors should be approaching new cryptocurrency use cases—whether accepting them as legal tender or holding them as alternative investments—with a degree of caution. Accountants and tax professionals also need to be on watch for additional IRS updates and guidance in order to make sure that cryptocurrencies are being reported accurately.