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McDonald's relaunches 'Dollar Menu' amid fast food wars

Top Finance News - Thu, 01/04/2018 - 6:30am

The introduction of the “$1 $2 $3 Dollar Menu” marks the first time McDonald’s has used the pricing structure since it discontinued the original dollar menu in 2013.

3 Social Security Mistakes That Could Cost You a Fortune

Top Finance News - Thu, 01/04/2018 - 6:03am

One of them could cost you more than $9,000 a year!

Meet the 2018 Dogs of the Dow

Top Finance News - Thu, 01/04/2018 - 6:03am

Learn the basics of this simple dividend-investing strategy.

The McDonald's Dollar Menu Is Back. Here's What You Can Get

Top Finance News - Thu, 01/04/2018 - 6:00am

McDonald's has a new Dollar Menu offering items for $1, $2 and $3

3 No-Brainer Stocks to Buy in the Industrials Sector for 2018

Top Finance News - Thu, 01/04/2018 - 6:00am

These three red-hot industrial stocks look poised to run even higher in 2018.

Trump’s Break With Bannon Over Book Forces GOP to Choose Sides

Top Finance News - Thu, 01/04/2018 - 4:00am

President Donald Trump’s forceful denunciation of his former chief strategist Steve Bannon finalized a divorce that was months in the making and will force a reckoning within the Republican Party.

Tax Reform and Section 199A Deduction of Qualified Business Income of Pass-Through Entities

Tax Publications - Thu, 01/04/2018 - 12:00am

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Summary On Friday, December 22, President Trump signed sweeping tax reform (the “Act”) into law. The Act provides the most comprehensive update to the tax code since 1986 and includes a number of provisions of particular interest to partnerships and their partners. This alert addresses the Section 199A deduction for qualified business income of pass-through entities.
  Details Section 199A Deduction for Qualified Business Income of Pass-Through Entities

General Rule
For tax years beginning after December 31, 2017, taxpayers other than corporations will generally be entitled to a deduction for each taxable year equal to the sum of:
  1. The lesser of (A) the taxpayer’s “combined qualified business income amount” or (B) 20 percent of the excess of the taxpayer’s taxable income for the taxable year over any net capital gain plus the aggregate amount of qualified cooperative dividends, plus
  2. The lesser of (A) 20 percent of the aggregate amount of the qualified cooperative dividends of the taxpayer for the taxable year or (B) the taxpayer’s taxable income (reduced by the net capital gain).
A taxpayer’s combined qualified business income (QBI) amount is generally equal to the sum of (A) 20 percent of the taxpayer’s QBI with respect to each qualified trade or business plus (B) 20 percent of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.

Limitation Based on Wages & Capital
The portion of the deduction attributable to 20 percent of the taxpayer’s QBI cannot exceed the greater of (1) 50 percent of his/her share of W-2 Wages paid with respect to the QBI or (2) the sum of 25 percent of his/her share of W-2 Wages plus 2.5 percent of the unadjusted basis of qualified property determined immediately after its acquisition of such qualified property. The term W-2 Wages is defined to mean the sum of total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the taxable year of the taxpayer. W-2 Wages do not include any such amount that is not properly allocable to QBI.

For example, a taxpayer (who is subject to the limit) does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The limitation in 2020 is the greater of (a) 50 percent of W-2 Wages, or $0, or (b) the sum of 25 percent of W-2 Wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition: $100,000 x .025 = $2,500. The amount of the limitation on the taxpayer’s deduction is $2,500.

Phase-in of Wages and Wages & Capital Limitation
The wages or wages plus capital limitation does not apply to taxpayers with taxable income not exceeding $315,000 (joint filers) or $157,500 (other filers). The limitation is phased-in for taxpayers with taxable income exceeding these amounts over ranges of $100,000 and $50,000, respectively. For example, H and W file a joint return on which they report taxable income of $375,000. W has a qualified trade or business that is not a specified service business, such that 20 percent of the QBI with respect to the business is $15,000. W’s share of wages paid by the business is $20,000, such that 50 percent of the W-2 Wages with respect to the business is $10,000. The business has nominal amounts of qualified property such that 50 percent is W-2 Wages is greater than 25 percent of W-2 Wages plus 2.5 percent of qualified property. The $15,000 amount is reduced by 60 percent (($375,000 - $315,000) / $100,000) of the difference between $15,000 and $10,000, or $3,000. H and W take a deduction for $12,000.
Definition of Qualified Property
The term qualified property is generally defined to mean, with respect to any qualified trade or business, tangible property of a character subject to depreciation under section 167 that is (i) held by and available for use in the qualified trade or business at the close of the taxable year, (ii) which is used at any point during the taxable year in the production of QBI, and (iii) the depreciable period for which has not ended before the close of the taxable year. Importantly, the Conference Agreement defines the term “depreciable period” to mean the later of 10 years from the original placed in service date or the last day of last full year in the applicable recovery period determined under section 168.

Definition of QBI
QBI includes the net domestic business taxable income, gain, deduction, and loss with respect to any qualified trade or business. QBI specifically excludes the following items of income, gain, deduction, or loss: (1) Investment-type income such as dividends, investment interest income, short-term & long-term capital gains, commodities gains, foreign currency gains, and similar items; (2) Any Section 707(c) guaranteed payments paid in compensation for services performed by the partner to the partnership; (3) Section 707(a) payments for services rendered with respect to the trade or business; or (4) Qualified REIT dividends, qualified cooperative dividends, or qualified PTP income.

Carryover of Losses
Section 199A provides rules regarding the treatment of losses generated in connection with a taxpayer’s qualified trades or businesses. Under these rules, if the net amount of qualified income, gain, deduction, and loss with respect to qualified trades or businesses of the taxpayer for any taxable year is less than zero, such amount shall be treated as a loss from a qualified trade or business in the succeeding taxable year. In practice, this will mean that a taxpayer’s net loss generated in Year 1 will be carried forward and reduce the subsequent year’s section 199A deduction.

For example, Taxpayer has QBI of $20,000 from qualified business A and a qualified business loss of $50,000 from qualified business B in Year 1. Taxpayer is not permitted a deduction for Year 1 and has a carryover qualified business loss of $30,000 to Year 2. In Year 2, Taxpayer has QBI of $20,000 from qualified business A and QBI of $50,000 from qualified business B. To determine the deduction for Year 2, Taxpayer reduces the 20 percent deductible amount determined for the QBI of $70,000 from qualified businesses A and B by 20 percent of the $30,000 carryover qualified business loss. Ignoring application of other potential limitations and deductible amounts, Taxpayer would be entitled to a Year 2 Section 199A deduction of $8,000 (($70,000 * 20 percent) – ($30,000 * 20 percent)).
Definition of Qualified Trade or Business
A qualified trade or business includes any trade or business other than a “specified service trade or business” or the trade or business of performing services as an employee. A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities.

Specified Services Limitation
The specified service trade or business exclusion does not apply to the extent the taxpayer’s taxable income does not exceed certain thresholds: $415,000 (joint filers) and $207,500 (other filers). Application of this exclusion is phased-in for income exceeding $315,000 and $157,500, respectively. In computing the QBI with respect to a specified service trade or business, the taxpayer takes into account only the applicable percentage of qualified items of income, gain, deduction, or loss, and of allocable W-2 Wages and qualified property. The applicable percentage with respect to any taxable year is 100 percent reduced by the percentage equal to the ratio of the taxable income of the taxpayer in excess of the threshold amount, bears to $50,000 ($100,000 in the case of a joint return).

For example, Taxpayer (who files a joint return) has taxable income of $375,000, of which $200,000 is attributable to an accounting sole proprietorship after paying wages of $100,000 to employees. Taxpayer has an applicable percentage of 40 percent. In determining includible QBI, Taxpayer takes into account 40 percent (1 – (($375,000 - $315,000) / $100,000)) of $200,000, or $80,000. In determining the includible W-2 Wages, Taxpayer takes into account 40 percent of $100,000, or $40,000. Taxpayer calculates the deduction by taking the lesser of 20 percent of $80,000 ($16,000) or 50 percent of $40,000 ($20,000). Taxpayer takes a deduction for $16,000.

Important Considerations
Taxpayers eligible to claim the full 20 percent deduction on QBI will incur a maximum effective rate of 29.6 percent on the QBI. While this rate reduction is beneficial, it will be important to consider the decrease in corporate tax rates from 35 percent to 21 percent. This rate differential is likely to cause taxpayers to reevaluate their choice of entity decisions. There are a number of factors that need to be considered but, from a simple after-tax cash flow perspective, a key determinative factor is the likelihood of the entity distributing vs. retaining operating earnings. While a common thought is to consider possibly incorporating an existing partnership in order to benefit from the 21 percent corporate tax rate, a corporate-to-partnership conversion should not be dismissed. When corporate tax rates were 35 percent, the tax liability imposed on gain recognized under Section 311(b) was typically prohibitive in a conversion transaction. However, with corporate rates dropping to 21 percent, consideration should now be given to the possible liquidation of a corporation and re-formation as a partnership, especially in situations where the corporation has net operating loss carryovers that could shelter the recognized Section 311(b) gain.

The determination of the combined QBI amount is dependent upon the QBI generated from each qualified trade or business activity. Further, the wages and capital-based limitations are determined with reference to wages and qualified property that is allocable to a particular qualified trade or business activity. It is not clear from the statute whether and the extent grouping rules under sections 469 may be applicable. Complexities are likely to arise in situations where a partnership operates multiple activities. Maintaining adequate information and documentation will be necessary to support application of the lower rates. Consequently, partners and partnerships will need to consider the extent to which additional information will be maintained, how it will be communicated to partners, and whether any incremental administrative costs should be borne by the benefiting partners.

Properly tracking partner income and loss allocations will take on greater importance in order to accurately determine a partner’s annual net business income allocations and carryover loss amounts. This importance will be further magnified as a result of the potential imputed underpayment obligations that could arise under the new partnership audit rules going into effect for tax years beginning after December 31, 2017. 
For more information, please contact one of the following practice leaders:
    Jeffrey N. Bilsky
National Tax Office Partner
Technical Practice Leader, Partnerships   David Patch
National Tax Office Managing Director
    Julie Robins
National Tax Office Managing Director   Will Hodges 
National Tax Office Senior Manager   Katie Pendzich
National Tax Office Senior Manager    

Compensation and Benefit Programs - Thinking Strategically in the Tax Reform Era

Tax Publications - Thu, 01/04/2018 - 12:00am
Summary The Tax Cuts and Jobs Act (the “Act”) was enacted into law on December 22, 2017.  Understanding the implications of this tax reform legislation will be critical in developing a successful total remuneration strategy. 
This article summarizes the key provisions of the Act that will significantly impact various components of an employer’s compensation program – namely, executive compensation, equity awards, qualified retirement plans, fringe benefits, payroll taxes, and employment-related credits – and provides BDO Insights on how these changes may influence plan designs.  Since the tax rate cuts and the provisions described below are scheduled to commence in the first taxable year beginning after December 31, 2017 (unless otherwise noted), employers should immediately assess their total rewards strategies in this tax reform environment. 
Details Companies required to file financial statements with the Security and Exchange Commission (SEC) must determine, pursuant to ASC 740, the impact of these tax law changes in their provision for income taxes.   The SEC issued SAB 118 that provides guidance to employers that cannot complete the analysis of tax law impact before the issuance of its financial statements, including the allowance of a provisional amount based on a reasonable estimate, to the extent an estimate can be made, with subsequent adjustment during a specified measurement period.  The measurement period begins in the reporting period that includes December 22, 2017, and ends when an entity has obtained, prepared, and analyzed the information needed to comply, but no later than December 22, 2018.  During the measurement period, the entity should be acting in good faith to complete accounting under ASC Topic 740.  See BDO’s SEC Flash Report 2017-13.
    Executive Compensation Section 162(m) - $1 Million Deduction Limitation   Prior Law Tax Reform A publicly held corporation generally cannot deduct more than $1 million of compensation in a taxable year for each “covered employee,” unless the pay is excepted from this limit. 
Covered employees are the corporation’s CEO as of the close of the taxable year, or any employee whose total compensation is required to be reported to shareholders by reason of being among the 3 most highly compensated employees for the taxable year (other than the CEO or CFO). 
Certain types of compensation are not subject to the deduction limitation: (i) performance-based compensation; (ii) commissions; (iii) deferred compensation paid after a person ceases to be a covered employee; (iv) tax-favored retirement plans (including salary deferrals); and (v) fringe benefits excluded from income. 
To qualify for the performance-based compensation exception, the compensation must meet certain criteria, including pre-established and objective performance goals certified by a compensation committee composed of outside directors under a program approved by shareholders. Stock options and stock appreciation rights with an exercise price not less than fair market value on date of grant qualify as performance-based compensation, provided the outside directors and shareholder approval requirements are met. Repeals performance-based and commission-based exceptions to the $1 million deduction limitation.
Modifies the definition of “covered employees” to include: (i) any person serving as the PEO or PFO at any time during the taxable year; and (ii) the 3 highest compensated officers (excluding the PEO and PFO) reported in the SEC executive compensation disclosures.  

Continues to apply the deduction limit to former covered employees and their beneficiaries.
Certain types of compensation are not subject to the deduction limitation: (i) tax-favored retirement plans (including salary deferrals); (ii) fringe benefits excluded from income; and (iii) compensation payable under a written binding contract in effect on November 2, 2017, and not materially modified thereafter. 
Extends the $1 million deduction limit to all domestic publicly traded corporations, and all foreign companies publicly traded through ADRs.    BDO Insights

Although performance-based pay is no longer deductible, there are many other reasons for public companies to continue tying pay to performance.  Such pay structures align management’s interests with those of the shareholders, the performance metrics serve as a basis for justifying the executives’ pay in the shareholder disclosures, and the institutional investment community – consisting of large pension funds and mutual fund companies, as well as proxy advisors – will continue to insist on “pay-for-performance” structures.  However, employers now have more flexibility to design such programs since the rigid rules to qualify for the performance-based pay deduction no longer apply.  For example, companies may establish subjective performance goals, whereas prior deduction rules required objective goals determined by a formula; or companies may increase the payout in their discretion, whereas prior deduction rules only allowed discretion to reduce the payout.

The Act realigns the definition of “covered employees” under Section 162(m) with the “named executive officers” under the current SEC executive compensation disclosure rules – including reference to the CEO and CFO as the principal executive officer (PEO) and principal financial officer (PFO).  Under the modified definition, once an employee qualifies as a covered person, the deduction limitation would apply to that person for federal tax purposes so long as the corporation pays compensation to such person (or to any beneficiaries).  Companies will need to maintain lists of covered employees over time and track their compensation into the future (e.g., severance installments, deferred compensation, option exercises, ISO disqualified dispositions, etc.).

Through proper planning, it may be possible to minimize the impact of the deduction limitation by delaying the timing of the income inclusion, which will require planning around the deferred compensation rules of Section 409A.  However, an employer’s objective to preserve its deduction may be at odds with an executive’s desire to receive income earlier.  
The Act expands the application of Section 162(m) beyond all domestic publicly traded corporations.  Now all foreign companies publicly traded through ADRs and certain corporations that are not publicly traded are subject to Section 162(m).  Such non-listed corporations have more than $10 million in assets and at least 2,000 shareholders (or at least 500 shareholders who are “non-accredited” investors).  Accredited investors include executive officers, directors and individuals meeting specified income or net worth tests.  The 2,000 (or 500) shareholder count excludes equity plan shareholders.  Accordingly large private C or S corporations may be subject to Section 162(m).

Under transition rules, companies subject to the deduction limitation may continue deducting any performance-based compensation paid to a covered employee pursuant to a written binding contract that was in effect on November 2, 2017, and not materially modified on or after such date. Based on the legislative history, it is unclear if this transition rule applies only to stock option grants made before that date or to all grants made under the stock option plan itself, such that any underlying option agreements entered into after November 2, 2017, would also be grandfathered.   If the latter, the ability to grant grandfathered options would extend until the earlier of the expiration of the plan’s term or the depletion of its share reserve.  Clarifying guidance is expected regarding this transition rule.   Excise Tax on Excess Tax-Exempt Organization Executive Compensation Tax-exempt organizations (governmental and non-governmental) are subject to a 21 percent excise tax on (i) compensation in excess of $1 million paid during the organization’s taxable year to any of their covered employees; plus (ii) any excess parachute payment paid by such organizations to a covered employee.  
A “covered employee” is an employee (including any former employee) of the tax-exempt organization who is one of the 5 highest compensated employees of the organization for the taxable year or was a covered employee of the organization (or any predecessor) for any preceding taxable year after 2016. 
“Compensation” means wages (as defined for federal income tax withholding purposes), paid by the employing organization or any person or governmental entity related to the tax-exempt organization.   However, compensation does not include any designated Roth contributions.  Compensation is treated as paid when there is no substantial risk of forfeiture of the rights to such pay and includes amounts required to be included in income under Section 457(f).
A “parachute payment” is compensation to a covered employee that is contingent on such individual’s separation from employment and the aggregate present value of all such payments equals or exceeds three times the base amount (i.e., the average annualized compensation includible in the covered employee’s gross income for the 5 taxable years ending before the employee’s separation from employment).  Parachute payments do not include payments under a tax-favored retirement plan or an eligible deferred compensation plan of a governmental employer.  For purposes of the parachute payment, the covered person must be a highly compensated employee whose annual compensation in the prior year exceeded an indexed threshold (e.g., $120,000 for 2017).
An “excess parachute payment” is the amount by which any parachute payment exceeds the portion of the base amount allocated to the payment.     BDO Insights

The Act imposes limits on executive compensation of tax-exempt organizations, which are parallel to limitations facing for-profit corporations under Sections 162(m) and 280G.  However, the penalty for excessive compensation or severance is in the form of a 21 percent excise tax on the organization, rather than a deduction loss.       

Notably, the 21 percent excise tax applies as a result of an excess parachute payment, even if the covered employee’s compensation does not exceed $1 million for the taxable year.  Section 280G calculations will be necessary to determine if the excise tax applies to the severance payments for any covered employee.  Preliminary calculations could be useful to identify strategies to avoid the penalty in future years, such as increasing the base amount through bonuses paid more than one year prior to the termination of employment.  Under proposed Section 457(f) regulations, tax-exempt organizations may defer payout of severance in connection with a noncompete covenant.  It is unclear if organizations may use noncompete covenant valuations to reduce the parachute payments – a strategy for-profit corporations typically employ to mitigate the adverse tax consequences of Section 280G.

It is uncertain if the 5 highest paid employees of a governmental entity is determined on an agency basis.  
Equity Compensation Qualified Equity Grants  
Privately held corporations that provide broad-based equity plans (at least 80 percent of full-time US employees receive stock options or restricted stock units with the same rights and privileges) may allow employees to elect to defer the income inclusion for compensation attributable to stock acquired from the exercise of a stock option or settlement of an RSU for 5 years (or an earlier event, such as an IPO, revocation of the election, or becoming an excluded employee). 
Excluded employees may not make a deferral election.  Excluded employees are (i) one percent owners at any during the current year or 10 preceding calendar years; (ii) CEO and CFO during the current year or any prior time; (iii) persons related to individuals described in (i) and (ii) through attribution rules; (iv) one of the four highest compensated officers of the corporation (based on the SEC’s shareholder disclosure rules for compensation) during the current year or 10 preceding calendar years.
A deferral election is not permitted if (i) a Section 83(b) election was previously made; (ii) the stock was previously traded on an established market; or (iii) certain stock redemptions by the corporation occurred in the preceding year.
The employee agrees in the new Section 83(i) election to satisfy the tax withholding requirements at the end of the deferral period. The Section 83(i) election is made, in a similar manner to a Section 83(b) election within 30 days after vesting in the stock.     
The amount included in income at the end of the deferral period is based on the value of the stock at the time the employee’s right to the stock first becomes substantially vested (even if the stock declined during the deferral period).  The amount to be included will be treated as a non-cash benefit, but is subjected to withholding at the highest income tax rate applicable to individual taxpayers, 37 percent under the Tax Act.  
Subject to a $100 penalty for each failure, employers must notify eligible employees of the deferral opportunity at the time (or a reasonable period before) the income would be taxable under the general rules of Section 83(a).  The penalty is limited $50,000 for a calendar year. 
The employer reports on Form W-2, the amount of income covered by a deferral election (i) in the year of deferral and (ii) for the year income is required to be included in the employee’s income.  In addition, the employer must report on Form W-2 the aggregate amount of income covered by deferral elections, as of the close of the calendar year.
    BDO Insights

The new Section 83(i) election is designed to assist non-owners, other than the CEO and CFO of privately owned corporations, pay the income taxes without having to sell a stake in the employer. Notably, the liquidity concerns still exist for Social Security and Medicare tax withholdings due upon vesting, as well as the federal income taxes that become due at the end of the deferral period.

The requirement to withhold at the maximum rate, currently at 37%, is likely to result in over-withholding on rank and file employees (the majority of individuals eligible for deferral).  Under prior law, the mandatory maximum withholding rate was exclusively reserved for employees whose supplemental wages exceed $1 million during the calendar year.   

The employer’s deduction is deferred until the employer’s taxable year in which or with which ends the taxable year of the employee for which the amount is included in the employee’s income.

If the deferral election is made in connection with the exercise of employee stock purchase plans (ESPPs) or incentive stock options (ISOs), the options would cease to qualify as statutory options and would instead be treated as nonqualified stock options subject to federal income tax withholding and FICA taxes.  

The deferrals will be exempt from Section 409A, broadly governing deferred compensation. 
Fringe Benefits Achievement Awards Prior Law Tax Reform An employee achievement award is an item of tangible personal property given to an employee in recognition of length of service or safety achievement and presented as part of a meaningful presentation.  Such award is excluded from an employee’s income if its cost is deductible to the employer.  Under a qualified plan, the employer may deduct the cost of providing the awards if the average cost of all awards for the year (except those costing less than $50) do not exceed $400; and the maximum deduction allowed for any one employee is $1,600 per year.  Under a nonqualified plan, the employer is limited to a total deduction of $400 per employee per year.
If the achievement award exceeds the limit on the employer’s deductibility, the amount generally included in an employee’s is the difference between the employer’s cost and the deduction limitation.
  Clarifies that “tangible personal property” does not include the following items:
  • Cash and cash equivalents such as gift cards and gift certificates (other than arrangements conferring only the right to select tangible personal property from a limited array of items pre-selected and pre-approved by the employer);
  • Non-tangible personal property such as vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items.
    BDO Insights  

While cash or cash equivalents were never excludable from an employee’s income, the Act clarifies that non-tangible personal property will receive the same treatment as cash, which is consistent with prior rules.  Employers that fulfill the tradition of providing the “gold watch” upon retirement may continue to do so under the previously existing deduction and exclusion rules.       Qualified Bicycle Commuting Reimbursement Prior Law Tax Reform Qualified bicycle commuting reimbursement of up to $20 per “qualifying bicycle commuting month” are excludible from an employee’s gross income.  A qualifying bicycle commuting month is any month in which an employee regularly uses the bicycle for a substantial portion of travel to a place of employment (and during which month the employee does not receive other qualified transportation benefits). 
Qualified reimbursement are any amount received from an employer during a 15-month period beginning with the first day of the calendar moth as payment of reasonable expenses during a calendar year (e.g., purchase, of a bicycle, repair, storage).
Although this qualified bicycle commuting reimbursements are excluded from an employees’ income, employers may deduct the cost of such fringe benefit. Suspends the exclusion from gross income and wages for qualified commuting reimbursements for taxable years beginning after December 31, 2017, and before January 1, 2026. 
A deduction will continue to apply for qualified bicycle commuting reimbursements for any amounts paid or incurred for taxable years after December 31, 2017, and before January 1, 2026.   BDO Insights

Employers that continue to provide bicycle commuting reimbursements are entitled to a compensation deduction for such reimbursements, which are included in their employees’ income during the suspension period, 2018-2025.      Qualified Transportation Fringe Benefits Prior Law Tax Reform Qualified transportation fringe benefits, including transit passes, qualified parking, van pool benefits and qualified bicycle commuting reimbursements are excluded from employee’s income (up to specified limits), while employers may deduct the cost of such fringe benefits. No deduction shall be allowed for any expense incurred for providing any transportation, or any payment or reimbursement to an employee, in connection with travel between the employee’s residence and place of employment, except as necessary for ensuring the safety of the employee.
    BDO Insights

The Act does not repeal the employee’s exclusion from income.  Therefore, qualified parking and transportation fringe benefits (e.g., making a commuter highway vehicle available for employees, purchase of transit passes, vouchers or fare cards, or reimbursement for such items by the employer) continue to be excluded from the employee’s income, notwithstanding the employer’s inability to deduct such costs. Presumably, an employee’s pre-tax contributions to a qualified transportation fringe benefit plan are also nondeductible by the employer.  It remains to be seen if employers will cease transportation fringe benefits which do not qualify for an income tax deduction or continue such benefits to provide competitive employee benefit packages for recruitment purposes.  

In accordance with previously existing regulations, in the event of an unsafe environment (i.e., conditions that, under the facts and circumstances, would cause a reasonable person to consider it unsafe to walk to or from work, or walk to or use public transportation at the time of the employee’s commute), an employer may provide local transportation for the employee and deduct such costs. However, the value of such benefit must be included in the employee’s income at a rate of $1.50 each way.   Qualified Moving Expenses Prior Law Tax Reform Gross income excludes the value of any moving expense reimbursement received, directly or indirectly, by an individual from an employer as payment or reimbursement for expenses which would be deductible as moving expenses if directly paid or incurred by the employee. Suspends the exclusion for qualified moving expense reimbursements for taxable years after December 31, 2017, and before January 1, 2026.  However, the moving expense exclusion continues to apply for members of the Armed Forces on active duty who relocate pursuant to military orders.   BDO Insights

Under prior law, employer payments for nondeductible moving expenses were included in the employee’s income (e.g., house hunting expenses, real estate expenses incurred for selling/buying a residence); while employer payments for deductible moving expenses were excluded from income (e.g., transportation of household goods).  Under the Act, nonmilitary individuals are no longer allowed to deduct moving expenses on their federal income tax return (for 2018 through 2025)  and the employer-paid moving expenses are includible in their income.  For the eight-year period, all moving expenses will be treated the same – nondeductible.

Accordingly, all moving expenses are reportable to employees as taxable compensation and deductible by the employer. 

Employer-paid moving expenses facilitate the national and global recruitment of executives and high-skilled talent that are not available in the regional location of the employer.  The loss of this benefit will add a premium to recruiting for employers who provide a tax gross-up to incentivize the employee to relocate, particularly for relocations abroad.  Companies will have to adjust their relocation packages.  Alternatively, this provision may result in an increase in telecommuting arrangements in lieu of relocations.   Entertainment Expenses Prior Law Tax Reform Generally, no deduction is allowed for expenses relating to entertainment, amusement or recreation activities or facilities (including membership dues with respect to such activities or facilities), unless such meet the “directly-related-to” or “associated-with” the active conduct of the employer’s trade or business test.  Additionally, an employer may deduct expenses for goods, services, and facilities, provided that such expenses are reported as compensation to an employee (or nonemployee). To the extent the employer’s entertainment expense exceeds the amount imputed in income of a “specified individual” (officer, director, 10-percent owner), the employer’s deduction is limited to the amount included in income. Repeals the “directly-related-to” or “associated-with” exceptions to the deduction disallowance for entertainment, amusement or recreation expenses.
No deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues related to such activities.   BDO Insights

The new law eliminates any ambiguity as to whether the entertainment expense meets the “directly-related-to” or “associated-with” test, since no deduction is allowed in absence of income inclusion to employees.

Employers that provide certain perquisites to executives (e.g., golf and country club memberships, entertainment travel aboard corporate jet) face a tradeoff between lost deductions for the company or income inclusion for the executives.

The Act treats all employees the same as officers, directors and 10-percent owners (“specified individuals”).  Under prior law, an employer’s deduction was the lesser of the cost of providing the entertainment benefit or the amount included in the specified individual’s income, while such entertainment costs for non-specified employees were fully deductible without regard to the amount included in their income.  For example, an employee’s income inclusion for personal use of a corporate jet is valued using the IRS’s standard industry fare level (SIFL) rates, which are often significantly less than the aircraft costs allocated to the flight.  Under the Act, an employer may only deduct the amount reported to the employee as compensation and loses a deduction for any excess cost allocated to the entertainment benefit provided to any employee.      50 percent Deduction Limitation on Meals Prior Law Tax Reform Section 274(n) imposes a 50 percent limitation on the deduction of meal expenses, unless an exception applies.  Section 274(n)(2)(B) provides that the 50 percent limitation does not apply if a meal qualifies as a de minimis fringe benefit and meets certain requirements under Section 132(e) and corresponding regulations.  Specifically, the eating facility is located on or near the employer’s business premises; such facility is owned/leased and operated by the employer; access to the facility is available to employees in a nondiscriminatory manner; meals are provided during or immediately before or after the employees’ workday; and meals are furnished for the convenience of the employer.  Food and beverage expenses incurred and paid after December 31, 2017, and until December 31, 2025, through an employer’s eating facility that meets requirements for de minimis fringes and for the convenience of the employer are subject to a 50 percent deduction limitation. No deduction is allowed for these food and beverage expenses for tax years beginning after December 31, 2025.
Off premises entertainment meals are nondeductible for tax years after December 31, 2017. 
    BDO Insights

The Act phases out the deduction for meals provided to employees on or near an employer’s premises for the convenience of the employer which were fully deductible under prior law.  For 2018 through 2025 the expenses are 50 percent deductible and nondeductible after 2025.

Meals incurred for business travel are not considered entertainment meals and therefore continue to be 50 percent deductible. Business travel generally entails travel away from the general area where the employee’s main place of business or work is located.   Affordable Care Act – Repeal of Individual Mandate Prior Law Tax Reform Individuals must be covered by a health plan that provides minimum essential coverage or be subject to a penalty for failure to maintain the coverage (the “individual mandate”).
The penalty for any calendar month is 1/12th of an annual amount.  The annual amount is generally equal $695 for 2017 (and $347.50 for each dependent under age 18), subject to a cap. 
Exemptions from the requirement to maintain minimum essential coverage are provided based on (1) ability to afford coverage, (2) member of an Indian tribe, (3) recognized religious sects, (4) individuals with a coverage gap for a continuous period less than 3 months, and 5) individuals who suffered a hardship. 
  The Act reduces the individual mandate penalty to zero for taxable years beginning after December 31, 2018.   BDO Insights

The elimination of the penalty for a violation of the individual mandate for taxable years may indirectly impact employers in several ways. 

First, the reporting requirements for employers may change after 2018.  Specifically, Part III of Form 1095-C and Form 1095-B that provide information to enforce the individual mandate, serve no purpose as long as the individual mandate is zero.   Accordingly, future guidance may relieve employers with self-insured plans from reporting the employees and dependents covered each month under the plan for years beginning after 2018.  

Third, without the penalty, full-time employees who purchase insurance on the Exchange and receive a federal subsidy may drop coverage, thereby reducing penalties for employers whose coverage was not affordable to such employees.   Retirement Plans Plan Loan Offsets Prior Law Tax Reform Upon a “loan offset,” the plan reduces the participant’s vested accrued benefit (the security interest held by the plan) to satisfy loan repayment, provided the participant is eligible to receive a distribution (e.g., separation from employment, in-service distribution after age 59 ½).  This is treated as an actual distribution of the participant’s benefit.

To avoid taxation on the loan receivable, the participant may rollover the amount to an IRA or another retirement plan within 60 days after the offset by transferring cash to the IRA or other plan.
  Upon plan termination or a participant’s separation from employment while the participant has an outstanding plan loans, the participant would have until the due date (including extensions) for filing his or her individual income tax return for that year to contribute the balance to an IRA or a new employer’s retirement plan in order to avoid the loan being taxed as a distribution.   BDO Insights

Some plan provisions require outstanding loans to be completely paid after termination of employment to avoid having to collect repayments outside of payroll.  A participant may defer taxation by making a timely rollover of an outstanding loan.  Under the Act, a participant can complete the rollover of the loan by contributing cash equal to the loan balance to an individual retirement account (IRA) or an eligible retirement plan of the participant’s new employer by the due date (including extensions) of the individual’s income tax return for the year in which the loan offset occurred.  Alternatively, under previously existing rules, the participant may avoid triggering a loan offset by rolling over the promissory note to another eligible retirement plan with a loan program that accepts the note.  A direct rollover of the note to an IRA is not permissible, because it is a prohibited transaction for an IRA to lend money to the IRA owner.    Use of Retirement Plans for 2016 Disaster Areas A “qualified 2016 disaster distribution” is a distribution from an eligible retirement plan made on or after January 1, 2016, and before January 1, 2018, to an individual whose principal residence at any time during 2016 was located in a 2016 disaster area and who has sustained an economic loss by such events.
Eligible retirement plans included qualified retirement plans, 403(b) plans and governmental 457(b) plans.
The total amount of the distribution cannot exceed $100,000 during the applicable period, and is not subject to the 10 percent early withdrawal tax.  Any amount required to be included in income as a result of such distribution is included in income ratably over the three-year period beginning with the year of distribution, unless the individual elects not to have ratable inclusion apply.
The individual may, at any time during the 3-year period, recontribute all or a portion of the 2016 disaster distribution to an eligible retirement plan.  The individual may file an amended return to claim a refund of the tax attributable to the amount previously included in income.  If under the ratable inclusion provision, a portion of the distribution has not yet been included in income at the time of contribution, the remaining amount is not includible in income.  
  BDO Insights

This provision can apply to distributions already made during 2016 and 2017 provided the written plan is amended with retroactive effect on or before the last day of the first plan year beginning on or after January 1, 2018 (i.e., by December 31, 2018 for calendar year plans).  These distributions are an alternative to plan loans and hardship distributions

By virtue of the retroactive amendment to January 1, 2016, presumably any hardship withdrawals claimed in connection with the 2016 Disaster Areas may be recharacterized as disaster distributions to enable participants to take advantage of the three-year income inclusion, waiver of the early withdrawal penalty and ability to restore amounts to the retirement plan. 
Payroll Taxes Supplemental Wage Withholding Prior Law Tax Reform If supplemental wages paid to an employee (or former employee) during a calendar year do not exceed $1 million, then the amount of the optional flat rate withholding method is one of two ways that federal income tax may be withheld.
Under the optional flat rate withholding method, the employer disregards any withholding allowances claimed or additional withholding amount requested by the employee on Form W-4 and withholds at the flat rate percentage.
Under the regulations, the optional flat rate was 25 percent (the rate in effect under Section 1(i)(2)).
If a supplemental wage payment, when added to the supplemental wage payments previously made by one employer to an employee during the calendar year exceeds $1 million, the rate used in determining the amount of withholding on the excess is equal to the highest rate of tax applicable under Section 1 (39.6 percent for 2017). Suspends the Section 1(i)(2) rate reductions that applied to tax years after 2000.
The highest rate of tax applicable under Section 1 is reduced from 39.6 percent to 37 percent.   BDO Insights

The tax regulations required supplemental withholding at 25 percent (i.e., the rate in effect under Section 1(i)(2)) or 28 percent.  For taxable years beginning after December 31, 2017 and before January 1, 2026, the Act effectively suspends Section 1(i)(2), which served as the basis for the 25% optional flat withholding rate   The change in law creates uncertainty of the correct withholding rate for employers that elect to use the optional flat rate withholding method for 2017 bonuses paid this year, vesting of restricted stock, exercises of options, and other supplemental wage payments.  Will the optional flat rate be 22 percent (since the flat rate has historically mapped to the third bracket rate in effect), stay at 25 percent, or default to the 28 percent stated within the tax regulations?  Since the optional flat withholding rate is set by regulations, employers should continue to apply the 25% rate pending further guidance by the IRS, which is expected to be released in January 2018.    
Employment Related Credits Employer Credit for Paid Family and Medical Leave The Act allows eligible employers to claim a credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to the employee.  The credit is increased 0.25 percent (but not above 25 percent) for each percentage point by which the rate of pay exceeds 50 percent.  The maximum amount of leave that may be taken into account for any employee in a taxable year is 12 weeks.
An eligible employer means any employer that has a written policy that allows all qualifying full-time employees at least 2 weeks of annual paid family and medical leave, and who allow part-time employees (customarily employed for fewer than 30 hours per week) a commensurate amount of leave on a pro rata basis.
A qualifying employee means any employee who has been employed with the employer for at least one year and whose compensation in the preceding year did not exceed 60 percent of the compensation threshold for highly compensated employees. 
Family and medical leave is defined as leave described under the Family and Medical Leave Act of 1993 (FMLA).  If an employer provides paid leave as vacation, personal leave, or medical or sick leave, such paid leave would not be considered to be family and medical leave. 
This program sunsets on December 31, 2019, such that the credit shall not apply to wages paid thereafter.   BDO Insights

Only four states – California, New Jersey, New York, and Rhode Island – currently offer paid family and medical leave.  All four state programs are funded through employee-paid payroll taxes and administered through respective disability programs.  For purposes of this federal credit, any leave which is paid by a state or local government or required by state or local law will not be taken into account in determining the amount of paid family and medical leave provided by the employer.   
For more information, please contact one of the following practice leaders: 
  Joan Vines
Compensation & Benefits Managing Director Carl Toppin
Compensation & Benefits Managing Director     Peter Klinger
Compensation & Benefits Principal Alex Lifson
Compensation & Benefits Principal Andrew Gibson
Tax Regional Managing Partner  

Tax Reform Impacts the Research Tax Credit, Domestic Production Activities Deduction & Orphan Drug Credit

Tax Publications - Thu, 01/04/2018 - 12:00am
Summary On December 22, 2017, President Trump signed into law, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (“tax reform” or the “law”). The law preserves and enhances the value of the Credit for Increasing Research Activities under Internal Revenue Code (IRC) Section 41 (Research Credit) while eliminating or reducing the value of related incentives like the IRC 199 Domestic Production Activities Deduction (DPAD) and IRC 45C Orphan Drug Credit (Orphan Drug Credit).
  Details Background
The Research Credit was enacted in 1981 to incentivize taxpayers to increase investments in developing new or improved products, manufacturing processes, software, techniques, inventions, and formulae in the United States. In 2015, the Protecting Americans against Tax Hikes Act (PATH Act) made the credit a permanent part of the IRC and expanded its benefit to certain small businesses and startups. The DPAD and ODC were enacted subsequent to the Research Credit for similar reasons.

Research Credit’s Value Enhanced

Lower Corporate Tax Rate
The law cuts the corporate tax rate from 35% to 21%. In effect, this cut increases the Research Credit’s net benefit by more than 21%, from its previous amount of 65% to the law’s 79%.

The 21% increase in the credit’s net value is due to IRC Section 280C(c).

Enacted to prevent taxpayers from getting a double benefit for their research-related expenses—i.e., a deduction and a credit for the same expenses—Section 280C(c) requires taxpayers to (1) reduce their deduction for IRC Section 174 allowable expenses by the amount of the Research Credit, or (2) elect a reduced credit generally equal to the Research Credit minus the product of the Research Credit and the maximum corporate tax rate.

With the maximum rate now at 21% instead of 35%, the reduced credit now equals 79% instead of 65% of the Research Credit, i.e., 100% less 21% instead of 100% less 35%.

Corporate Alternative Minimum Tax Repealed
The law repeals the corporate Alternative Minimum Tax (AMT) provisions. This means that taxpayers who would have been subject to AMT and who therefore generally wouldn’t have been able to use Research Credits to offset their federal income tax liability now will be able to do so.

Historically, corporations could only use the Research Credit to offset only ordinary income tax liability, and not their AMT. Starting in 2016, the PATH Act allowed eligible small businesses—viz., privately held businesses with $50 million or less in average gross receipts for the three preceding tax years—to utilize the Research Credit against their AMT.

By eliminating the AMT’s Tentative Minimum Tax for corporations, the law allows the Research Credit to reduce a taxpayer’s liability down to 25% of the amount of net regular tax liability that exceeds $25,000, a limitation imposed by IRC Section 38(c).

Modification of Net Operating Loss Deduction
The law limits the amount of Net Operating Losses (NOLs) that a taxpayer can use to offset taxable income to 80% of its taxable income for losses arising in tax years beginning after December 31, 2017. NOL taxpayers may now find the Research Credit a helpful way to offset the taxes they’ll have to pay.

The law also repeals the provision allowing for the current two-year carryback of NOLs and allows an indefinite carryforward of NOLs arising in tax years ending after December 31, 2017.

Section 199 Domestic Production Activities Deduction (DPAD) Repealed
The law repeals DPAD for tax years beginning after December 31, 2017. Section 199 previously provided a tax deduction to taxpayers deriving income from “qualified production activities” performed in the United States, which included manufacturing of tangible property and software development.

Orphan Drug Credit (ODC) Rate Reduced
For tax years beginning after December 31, 2017, the law reduces the ODC rate to 25%, down from 50%.
Even at 25%, though, the ODC is generally more beneficial than the Research Credit for the same costs to which it applies: the ODC rate is 25%, the Research Credit’s 20%, or about 16% after Section 280C(c); the ODC calculation includes 100% of qualified contractor costs, the Research Credit’s typically only 65%; and the ODC equals 25% of qualified costs, the Research Credit 20% of only the qualified costs that exceed a base amount.

The ODC was enacted to incentivize pharmaceutical companies to develop drugs that treat diseases affecting less than 200,000 patients in the U.S. Developers of such drugs are eligible for a tax credit equal to a percentage of their qualifying costs incurred between the date the FDA grants the taxpayer orphan status and the date the FDA approves its drug for patients.

The law also allows for taxpayers to elect a reduced ODC, similar to the 280C(c)(3) election for the Research Credit.

Amortization of Research and Experimental Expenditures
For amounts paid or incurred in a tax year beginning after December 31, 2021, the law will require taxpayers to capitalize and amortize IRC Section 174 research and experimental (R&E) expenditures over a five year period, beginning with the midpoint of the taxable year in which the expenditure is paid or incurred. Costs for research conducted outside of the U.S. will be amortized over a 15-year period. Further, expenditures for the development of any software will be treated as R&E expenditures. For purposes of this rule, software development costs are included in the definition of R&E expenditures. 

Under current law, Section 174 generally allows taxpayers to deduct R&E expenditures as the amounts are paid or incurred during a tax year; alternatively, taxpayers may elect to capitalize and amortize these expenditures over a period of no less than 60 months.

The new provision will impact taxpayers treating R&E costs as deductible expenses by no longer enabling them to recover costs incurred in the year in which they are incurred. Accordingly, taxpayers currently deducting R&E costs in the year incurred will be required to file an Application to for Change in Method of Accounting (Form 3115) to begin capitalizing and amortizing such costs for tax years beginning after December 31, 2021.
  BDO Insights With the new provisions of tax reform taxpayers should evaluate how the changes above impact their future tax position and how the Research Credit and ODC can help minimize tax liabilities. Key takeaways include:
  • The cut of the corporate tax rate increases the Research Credit’s net benefit by more than 21%, from its previous amount of 65% to the law’s 79%.
  • Taxpayers who would have been subject to AMT and who therefore generally wouldn’t have been able to use Research Credits to offset their federal income tax liability now will be able to do so.
  • NOL taxpayers may now find the Research Credit a helpful way to offset the taxes they’ll now have to pay given the modification of the NOL deduction.
  • While the ODC credit rate has been reduced to 25%, it still provides a meaningful benefit for eligible taxpayers, generally more beneficial than the Research Credit.
  • Taxpayers seeking to maximize the benefit of immediately deducting R&E expenditures should consider the effective date of the required amortization rule (i.e., December 31, 2021) and if possible, accelerate their R&D activities prior to December 31, 2021.  
For more information, please contact one of the following regional practice leaders: 
  Chris Bard
National Leader
Los Angeles, New York   Jonathan Forman
New York   Jim Feeser
Managing Director
Woodbridge   Chad Paul
Milwaukee   Patrick Wallace
Managing Director
Atlanta   David Wong
Los Angeles   Laura Morris
Managing Director
San Francisco   Brad Poris
Managing Director
Long Island   Joe Furey
Managing Director
Chicago   Sanjiv Gaitonde
Senior Manager
Houston     Gabe Rubio
Managing Director
Los Angeles    

​Impact of Reform on Partnerships and Partners

Tax Publications - Thu, 01/04/2018 - 12:00am

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Summary On Friday, December 22, President Trump signed sweeping tax reform (the “Act”) into law. The Act provides the most comprehensive update to the tax code since 1986, and includes a number of provisions of particular interest to partnerships and their partners. This alert addresses the following provisions:
  • Recharacterization of Certain Long-Term Capital Gains
  • Taxation of Gain on the Sale of Partnership Interest by a Foreign Person
  • Repeal of Technical Termination Rules under Section 708(b)(1)(B)
  • Modification of the Definition of Substantial Built-in Loss in the Case of a Transfer of a Partnership Interest under Section 743(d)
  • Charitable Contributions and Foreign Taxes Taken into Account in Determining Basis Limitation under Section 704(d)
  • Like-Kind Exchange Transactions under Section 1031
  Details Repeal of Technical Termination Rules (708(b)(1)(B))
The Act repeals the technical termination rules under Section 708(b)(1)(B) for tax years beginning after 2017. No changes were made to the actual termination rules under Section 708(b)(1)(A). Repeal of the technical termination rule is generally a favorable development, since it will eliminate the need to restart depreciation upon the sale or exchange of more than 50 percent capital and profits interest in a partnership. Additionally, the Act will alleviate the common occurrence of failing to properly identify transactions, giving rise to technical terminations, which leads to late filing of required tax returns, failure to make appropriate elections, and imposition of penalties. However, technical terminations are sometimes used to eliminate unfavorable elections, and the creation of a “new” partnership entity is oftentimes required in connection with international investments in U.S. joint ventures. While it may be possible to continue structuring transactions to achieve these objectives, the simplicity of triggering a technical termination will be eliminated.
Recharacterization of Certain Long-Term Capital Gains (Sections 1061 & 83)
Under general rules, gain recognized by a partnership upon disposition of a capital asset held for at least 1-year will be characterized as long-term capital gain. Additionally, the sale of a partnership interest held for at least 1-year results in long-term capital gain except to the extent Section 751 applies. For tax years beginning after December 31, 2017, long-term capital gain will only be available with respect to “applicable partnership interests” to the extent the capital asset giving rise to the gain has been held for at least 3-years.

An applicable partnership interest is defined to include any partnership interest transferred, directly or indirectly, to a partner in connection with the performance of services by the partner, provided that the partnership is engaged in an “applicable trade or business.” An applicable trade or business means any activity that is conducted on a regular, continuous, and substantial basis consisting of raising or returning capital and either (1) investing in, or disposing of, specified assets (or identifying specified assets for such investing or disposition) or (2) developing such specified assets. For purposes of this provision, specified assets include securities, commodities, real estate held for rental or investment, cash or cash equivalents, options or derivative contracts with respect to any of the foregoing, and an interest in a partnership to the extent of the partnership’s proportionate interest in any of the foregoing.

Consistent with the intent to limit applicability of these rules, the Act provides that applicable partnership interests do not include (A) a partnership interest held directly or indirectly by a corporation or (B) a capital interest in a partnership commensurate with the partner’s capital contributions or the value of the interest subject to tax under Section 83 upon receipt or vesting. However, the fact that an individual may have recognized taxable income upon acquisition of an applicable partnership interest or made a Section 83(b) election with respect to such applicable partnership interest does not change the three-year holding period requirement.

Based on the definitions of applicable partnership interests, applicable trades or businesses, and specified assets, it appears that this rule is targeted at hedge funds and real estate funds with relatively short-term holding periods, i.e., more than one year but less than three years. Private equity and venture capital funds generally have a longer holding period and are unlikely to be affected to the same degree. However, care will need to be taken to ensure the holding period requirements are satisfied in all cases. Further, determination of a partner’s share of capital gains “commensurate with the amount of capital contributed” will likely require detailed record-keeping and tracking of partner Section 704(b) and tax basis capital accounts.
Taxation of Gain on the Sale of Partnership Interest by a Foreign Person (Sections 864(c) and 1446)
Revenue Ruling 91-32 generally provides that a foreign partner will recognize effectively connected income (ECI) on a sale of a partnership interest to the extent a sale of underlying partnership assets would give rise to an allocation of ECI to the transferor partner. The revenue ruling effectively adopts an aggregate approach to determining ECI notwithstanding the entity approach mandated by Section 741. In the recently decided case of Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, the Tax Court ruled that the taxpayer’s gain on sale of its partnership interest was not ECI despite the fact that a sale of the partnership’s assets would have generated ECI allocable to the partner, effectively rejecting Rev. Rul. 91-32.

Under the Act, gain recognized on the sale or exchange of a partnership interest will be treated as ECI to the extent the transferor would be allocated ECI upon a sale of assets by the partnership. This provision would effectively re-characterize otherwise non-ECI capital gain from the sale of partnership interest into ECI. Additionally, the Act provides that Treasury shall issue regulations as appropriate for application of the rule in exchanges described in Sections 332, 351, 354, 355, 356, or 361 and may issue regulations permitting a broker, as agent for the transferee, to deduct and withhold the tax equal to 10 percent of the amount realized on the disposition.  The provision treating gain or loss on the sale of a partnership interest as ECI would be effective for transactions on or after November 27, 2017, while the provision related to withholding would be effective for sales or exchanges after December 31, 2017.

This proposal effectively codifies the holding Revenue Ruling 91-32 and reverses the Tax Court’s decision in Grecian Magnesite. As a result of the coordination of allocable gain on a hypothetical sale of partnership assets with total ECI, accurate tracking of Section 704(c) built-in gain and losses will become significantly more important.
Modification of the Definition of Substantial Built-in Loss in the Case of a Transfer of a Partnership Interest (Section 743(d))
Section 743(b) provides for an adjustment to the basis of partnership property upon the sale or exchange of a partnership interest providing the partnership has a Section 754 election in effect or where the partnership has a substantial built-in loss. Section 743(d) currently provides that a partnership has a substantial built-in loss with respect to a transfer of an interest in a partnership if the partnership's adjusted basis in all of its property exceeds the fair market value of such property by more than $250,000. Under this existing rule, it’s possible that a transferee partner could acquire a partnership interest with respect to which there is a built-in loss of more than $250,000 without there being a mandatory basis adjustment because the partnership does not have an overall built-in loss meeting the threshold.

The Act modifies the definition of a substantial built-in loss for purposes of Section 743(d). Under the Act, in addition to the present-law definition, a substantial built-in loss also exists if the transferee partner would be allocated a loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest. This provision would apply to transfers of partnership interests occurring after December 31, 2017.

It is not clear whether a relatively high number of partnership interest transfers will be captured under this rule. However, given the negative consequences of a potential downward basis adjustment it will become even more critical that partnerships properly track each partner’s Section 704(b) and tax basis capital accounts. Failure to accurately track capital accounts could lead to incorrect downward adjustments resulting in increased exposure to both the transferring and non-transferring partners.
Charitable Contributions and Foreign Taxes Taken into Account in Determining Basis Limitation (Section 704(d))
Under the general rules of Section 704(d), a partner’s ability to deduct its distributive share of partnership losses is limited to the extent of the partner’s outside tax basis in the partnership interest. However, this limitation does not apply to a partner’s allocable share of charitable contributions or foreign tax expenditures. As a result, a partner may be able to deduct its share of a partnership’s charitable contributions and foreign tax expenditures even to the extent they exceed the partner’s basis in its partnership interest. The Act modifies the Section 704(d) loss limitation rule to take into account charitable contributions and foreign taxes. However, in the case of a charitable contribution of property where the fair market value exceeds the adjusted tax basis the Section 704(d) basis limitation would not apply to the extent of the partner’s allocable share of this excess. This provision applies to taxable years beginning after December 31, 2017.

This rule change will increase the importance of ensuring accurate calculation of a partner’s tax basis. Although partners are generally required to determine their own tax basis, it’s not uncommon for partners to look to the partnership to provide relevant data including tax basis capital and liability allocations. The increased importance of outside tax basis calculations will place more pressure on partnerships to accurately track partner capital as well as determining proper liability allocations under Section 752.
Like-Kind Exchanges of Real Property (Section 1031)
For exchanges entered into after December 31, the Act limits application of Section 1031 to transactions involving the exchange of real property that is not held primarily for sale. Section 1031 no longer applies to personal property including personal property that is associated with real property. A transition rules applies for exchanges that began before January 1, 2018. Consequently, if the taxpayer has started a deferred exchange prior to January 1, 2018, Section 1031 may still be applied to the transaction even though completed after December 31, 2017.
For more information, please contact one of the following practice leaders:
  Jeffrey N. Bilsky
National Tax Office Partner
Technical Practice Leader, Partnerships   David Patch
National Tax Office Managing Director
    Julie Robins
National Tax Office Managing Director   Will Hodges 
National Tax Office Senior Manager   Katie Pendzich
National Tax Office Senior Manager    

You Should Diversify With These Dividend Stocks

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Security flaws put virtually all phones, computers at risk

Top Finance News - Wed, 01/03/2018 - 9:25pm

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Tesla Model 3 drives from LA to NYC in record time

Top Finance News - Wed, 01/03/2018 - 8:29pm

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Why Congress won’t reopen the Clinton email investigation

Top Finance News - Wed, 01/03/2018 - 8:23pm

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Should You Buy American Tower Corporation (REIT) (NYSE:AMT)?

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Here’s How Hoda Kotb’s ‘Today’ Show Salary Compares to Matt Lauer’s

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What could go wrong in 2018

Top Finance News - Wed, 01/03/2018 - 6:04pm

Most parts of the global economy are on the upswing, but there are plenty of currents that could form into a storm in 2018.

Tesla misses its Model 3 deliveries by a mile (TSLA)

Top Finance News - Wed, 01/03/2018 - 4:37pm

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Southwest Airlines to Boeing: We'll take the large

Top Finance News - Wed, 01/03/2018 - 4:17pm

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