The Tax Practice Group is an integral part of the firm's transactional practice. We work closely with our business lawyers to structure and effectuate complex transactions from a tax perspective to better fit our client's business objectives. We also maintain an independent tax practice that focuses on public and private domestic and foreign business entities (corporations, partnerships and limited liability companies), private clients and tax-exempt organizations, including federal, state and local tax controversy matters for all of the foregoing.
Many of our lawyers are recognized authorities in their fields, consultants to other professional advisors, frequent speakers and panelists at tax conferences and authors of tax articles and treatises.
Responding to our clients' needs, we provide tax advice in connection with:
- Choice of Entity
- Mergers, Acquisitions, Dispositions and Restructurings
- International Tax Planning
- Tax Structuring of Workouts and Bankruptcies
- Real Estate Transactions, including Syndications, REITS and Section 1031 Transactions
- Venture Capital
- Low-Income Housing and Historic Rehabilitation Tax Credit Transactions
- Municipal Bonds
- Tax-Exempt Entities
State and Local Tax Matters
Our state and local tax attorneys have multistate experience in such matters as:
- Sales, Use and Gross Receipts Taxes
- Real Property and Transfer Taxes
- Required Recordkeeping
- State Income and Franchise Taxes
- State Tax Exemptions
- State Tax Implications of e-Businesses
- Unclaimed Property Matters
- State Tax Aspects of Mergers and Acquisitions
- Tax Amnesty and Tax Disclosure Agreements
International Tax Matters
Duane Morris' international tax attorneys provide United States tax advice to our multinational clients on a wide range of cross-border business activities, including:
- Cross-Border Transfer Pricing: Planning and Compliance
- Tax-Efficient Realignment of Foreign Subsidiaries
- CFC and PFIC Tax Planning
- Tax Treaty Utilization and Compliance
- Foreign Tax Credit Planning
- U.S. Tax Withholding on Payments to Foreign Persons
- Cross-Border Employee Transfer Planning
- Pre-Immigration Planning
Civil and Criminal Tax Controversy Practice
Our tax controversy lawyers have in-depth experience in client representation:
- At Federal Tax Examinations and IRS Appeals Offices
- Before U.S. Tax Court and Federal Appellate Court
- At State and Local Tax Examinations and Administrative Proceedings
- Before State Trial and Appellate Courts
- In Administrative and Grand Jury Criminal Tax Investigations
Our tax lawyers, working closely with our attorneys in other practice groups, advise private clients on the tax consequences of their activities, including the following:
- Family Tax and Business Succession Planning
- Executive Compensation Structures
- Charitable Giving, including Use of Private Foundations
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T⁴: Tax Tips for Troubled Times
During COVID-19, many taxpayers are experiencing economic uncertainty and are looking for ways to preserve cash resources. Taxpayers, particularly those in states with high taxes, may want to consider deferring payments of state and local taxes (“SALT”) until sometime in 2021 rather than “prepaying” them in 2020.
Under current law, federal itemized deductions for SALT are limited to $10,000 per tax filer (or $5,000 for a married person filing separately). Although this limitation (added in 2017) is scheduled to sunset after 2025, there is a reasonable possibility that it may be lifted as soon as next year, either as part of a comprehensive revision of the Internal Revenue Code (the “Code”) or as part of a future stimulus package enacted to provide relief during the pandemic.
If your 2020 SALT expenses are expected to exceed the current $10,000 deduction limitation, you may want to consider deferring payments of SALT expenses you would otherwise make in the 4th quarter of the year, such as your real estate taxes or SALT estimated payments, until next year. Not only will this defer actual payment of the expenses (temporarily conserving cash during these uncertain economic times), but it may also provide a permanent federal income tax benefit to you next year, should the $10,000 limitation be lifted next year. In most states, 2020 4th quarter estimated SALT payments are not due until sometime in January 2021. In addition, depending on the state in which you own real estate, your 2020 real estate taxes may be payable in 2020 but not due until 2021. For instance, if you own real estate in Florida, your 2020 real estate taxes are payable as of November 1, 2020, but not considered delinquent until April 1, 2021. Should the Code be changed to remove the SALT deduction limitation next year, and your SALT expenses are greater than what the limitation would otherwise allow, you may wish to elect not to prepay your real estate or other SALT expenses in 2020, but instead pay those SALT expenses when they are due in 2021. You should speak to a tax adviser in your jurisdiction for specific advice.
Of course, if your real property is subject to a mortgage and payment of your real estate taxes is made from escrowed funds, you will need to discuss possible deferral of payment with your lender promptly. Some lenders uniformly make these SALT payments of escrowed funds on the first date payment is permitted. In that case, some lenders may prefer to distribute the escrowed funds to you, the borrower, to make the payment directly next year. However, this must be addressed with your lender before payment is made by the lender.
On July 31, 2020, the U.S. Treasury Department released proposed regulations to provide guidance on the application of section 1061 of the Internal Revenue Code of 1986, as amended. The proposed regulations have been particularly welcomed by managers in the private equity, venture capital and hedge fund industries, as section 1061 is particularly applicable to the taxation of carried interest.
Section 1061 extends the long-term capital gains holding period from one year, to greater than three years, for any interest in a partnership that is transferred to a taxpayer in connection with the performance of services in any applicable trade or business.
An “applicable trade or business” is defined as any trade or business whose activity generally consists of (a) raising or returning capital and (b) either (i) investing in (or disposing of) specified assets or (ii) developing specified assets. For purposes of section 1061, “specified assets” are defined as “securities, certain commodities, real estate held for rental or investment, cash or cash equivalents, options or derivative contracts with respect to the foregoing, and an interest in a partnership to the extent of the partnership’s interest in any of the foregoing.”
An “applicable partnership interest” does not include, however, “any interest in a partnership directly or indirectly held by a corporation” or capital interests in a partnership to the extent that (i) the taxpayer shares in partnership capital in accordance with the amount of such partner’s capital contribution or (ii) the interest is subject to tax under section 83 of the Internal Revenue Code upon its receipt or vesting schedule.
Proposed Regulations Three-Year Holding Period
Subject to the application of the lookthrough rule (described below), the proposed regulations provide that it is the holding period of the asset sold that controls the analysis. For example, if a partnership disposes of an asset, it is the partnership’s holding period in the asset that matters; conversely, if the taxpayer disposes of its applicable partnership interest, it is the holding period of such interest that matters. In other words, the taxpayer’s holding period in the applicable partnership interest is only relevant if the applicable partnership interest is being sold.
A limited “look-through rule” may apply to taxpayers that dispose of an applicable partnership interest (including through tiered partnerships) with a holding period of more than three years. The proposed regulations require a taxpayer that is disposing of its applicable partnership interest with a holding period of greater than three years to look through to the assets of the underlying partnership(s) to potentially re-characterize the capital gain realized on the disposition as, in whole or in part, short-term capital gain. Specifically, the look-through rule will generally apply if “80 percent or more of the assets of the partnership in which the [applicable partnership interest] is held, based on fair market value, are assets that would produce capital gain or loss that are not [generally exempt from section 1061] if disposed of by the partnership and have a holding period of three years or less,” known as the “substantially all test.” For these purposes, items that are generally exempt from section 1061 include section 1231 gains (e.g., gains from real or depreciable business property held for more than one year), gains from section 1256 contracts and straddles (e.g., mark-to-market gains from nonequity options, foreign currency contracts, regulated futures contracts, dealer equity options and dealer securities futures contracts), qualified dividends under section 1(h)(11)(B) and certain other gains that are not determined under the holding period rules of section 1222 (e.g., gains characterized under the mixed-straddle rules).
In the event the taxpayer is a partner in a tiered partnership structure, the look-through rule will apply if the applicable partnership interest has been held for more than three years and either (i) the partnership in which the taxpayer holds the applicable partnership interest has a holding period of three years or less in its own underlying applicable partnership interest or (ii) the partnership in which the taxpayer holds the applicable partnership interest has a holding period of more than three years in its underlying applicable partnership interest and the assets of such second-tier partnership meet the substantially all test.
The proposed regulations will generally become effective beginning on, or after, the date the final regulations are published. However, as a general matter, taxpayers may rely on them now. The following examples demonstrate the application of the holding period rule and look-through rule in the proposed regulations:
Example 1: All Applicable Partnership Interests and Assets Are Held for More Than Three Years and API is Sold
P, an individual taxpayer, holds an applicable partnership interest (API) in GP, an entity taxed as a partnership. GP’s sole asset is an interest in an investment partnership (Fund), which holds one capital asset (Capital Asset). Capital Asset is not exempt from the application of section 1061. P has held its API in GP for more than three years, GP has held its interest in Fund for more than three years, and Fund has held Capital Asset for more than three years. P sells its API in GP for a $100 gain. P’s $100 gain on the sale of its API is long-term capital gain under section 1061.
Example 2: Application of the Look-through Rule When P Sells API with Holding Period of More Than Three Years and Fund Holds Capital Asset for Three Years or Less
Same facts as Example 1, except that Fund has held Capital Asset for three years or less. Because GP has held its interest in Fund for more than three years, P must determine whether the look-through rule applies to Capital Asset. The look-through rule will generally apply if the substantially all test applies. In this instance, since Capital Asset is not exempt from section 1061 and only has a holding period of three years or less, the look-through rule will apply to the sale of P’s API in GP. Because GP’s sole asset is its interest in Fund and because Fund’s sole asset is Capital Asset, all of P’s $100 gain on the sale of the API will be short-term capital gain under section 1061.
Same facts as Example 1, except that P does not sell its API in GP, and instead, Fund sells Capital Asset for $110 gain ($100 of which is ultimately allocable to P). Because the holding period of the owner of the asset controls under the proposed regulations, P will take into account the $100 gain as long-term capital gain under section 1061 because Fund is the seller and it owned Capital Asset for more than three years.
Example 4: API Is Held for More Than Three Years and Fund Sells Capital Asset with Holding Period of Three Years or Less
Same facts as Example 3, except that Fund has only held Capital Asset for three years or less. As in Example 3, because the holding period of the owner of the asset controls under the proposed regulations, P will take into account the $100 gain as short-term capital gain under section 1061 because Fund is the seller and it owned Capital Asset for three years or less. P’s holding period for API is irrelevant.
Example 5: API Is Held for Three Years or Less and Fund Sells Capital Asset with Holding Period of More Than Three Years
Same facts as Example 3, except that P has only held its API in GP for three years or less. As stated in Examples 3 and 4, because the holding period of the owner of the asset controls under the proposed regulations, P will take into account the $100 gain as long-term capital gain under section 1061 because Fund is the seller and it owned Capital Asset for more than three years. P’s holding period for API is irrelevant.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law on March 27, 2020, changed the 2020 required minimum distribution (“RMD”) rules for any defined contribution retirement plan subject to RMD payments (such as an IRA or 401(k)) If you would have otherwise been subject to a mandatory RMD, you may choose to forgo those distributions for the 2020 year. This does not include an RMD to an individual who attained 70 ½ in 2019, who is required to take an RMD by April 2020. However, this otherwise applies to any required minimum distribution, whether the retirement account is your own, or is an inherited retirement account.
If you do not plan on using your RMD payment to meet your expenses, you may find it beneficial to take advantage of this temporary rule change. This would allow the “untaken” 2020 RMD payment to grow with your remaining retirement account funds, tax deferred. It may also allow you to avoid liquidating a portion of your account to make the RMD payment in a volatile market.
If you have already taken your 2020 RMD, but wish to reverse it, there is an option available. However, you must act quickly. Although a previously taken RMD cannot be “reversed,” the IRS has issued Notice 2020-51, which allows you to “re-contribute” any previously taken RMD for 2020, so long as you do it prior to August 31, 2020. Generally, except as specifically provided in Notice 2020-51, the rules allow for taxpayers to re-contribute or rollover a distribution only once per twelve month period, but any re-contribution must be done within 60 days of the distribution, and a re-contribution is not available for inherited retirement accounts. However, Notice 2020-51 has briefly suspended these re-contribution limitations, and any re-contribution made before August 31, 2020, will not be subject to those limitations.
In these dog days of August, COVID-19 continues to wreak havoc on the physical and economic well-being of Americans, and Congress continues to try to thrash out a new stimulus bill to keep the economy afloat during the pandemic. In the background, the Internal Revenue Service is beginning to wake from its four-month shut-down, and focus substantial parts of its workforce on collection and enforcement actions. In July, the IRS announced that starting in October it will carry out hundreds of audits against U.S. individual shareholders suspected of not paying the U.S. tax they owe on foreign corporate earnings.
The IRS’s Large Business and International Division recently announced a new compliance effort focused on U.S. individual shareholders with interests in foreign corporations who were supposed to pay tax on profits deemed repatriated in 2017 (or 2018) under Internal Revenue Code Section 965. This announcement follows the IRS's campaign that was announced in November 2019, which focused on corporate shareholder compliance with Code Section 965.
Code Section 965, enacted under the Tax Cuts and Jobs Act in 2017, generally required United States shareholders of certain foreign corporations to pay a transition tax on the untaxed earnings as though those earnings were repatriated to the United States in the last tax year of the foreign corporation that began before January 1, 2018. A U.S. shareholder of such a foreign corporation was subject to U.S. tax on such foreign earnings at 15.5% if the earnings were considered to be held in cash and cash equivalents, with the remaining non-cash amounts taxed at 8%.
As part of this campaign, the IRS will select returns to audit, and will also send letters to taxpayers to suggest reviewing their Code Section 965 computations on their previously filed returns, and to consider amending their returns if the tax was improperly computed or omitted. Although the specific details of the audit campaign have not yet been announced, it is likely that the IRS will examine taxpayers' earnings and profits calculations, the classification of assets as cash versus non-cash, and how taxpayers determined their foreign tax credits, among other issues.
According to the LB&I Division Commissioner, the IRS believes that there’s a high likelihood of noncompliance in this area, acknowledging that Code Section 965 is complex, and many errors may have been committed because taxpayers had difficulty obtaining the information they need to compute shareholder liability.
As discussed previously in "Working From Home” During COVID-19 Requires Individuals and Businesses to be Alert to Inadvertent State Tax Foot Faults (see below), the COVID-19 pandemic has brought along with it a host of state tax issues that have the opportunity to plague employers and their employees alike, including, unknowingly, traveling healthcare workers who have left their state of residence to provide assistance to states that have been deeply affected by the virus. Typically, states have authority to tax nonresidents who earn income while being physically present in the state. For example, a lawyer who travels to Colorado and earns income while in the state will be liable for Colorado state income taxes on the income sourced to the state. Further, businesses with employees working in a nonresident state are also subject to “nexus” concerns, potentially resulting in state business income taxes in states where none had existed before.
While these tax principles are generally understood, the concept came to the forefront as a result of volunteer workers travelling around the country to assist with the fight against COVID-19. As of early May, more than 20,000 healthcare workers flocked to New York to help the state’s over-worked healthcare system. Though the healthcare workers only temporarily came to New York, Governor Andrew Cuomo, in an effort to stymie the state’s already growing deficit, declared that the out-of-state healthcare workers would be responsible for New York state income tax on income earned during their time in the state.
Gov. Cuomo’s measure was immediately met with disapproval. In response, on June 18, 2020, the U.S. Senate proposed the bipartisan Remote and Mobile Worker Relief Act. The bill, which would be effective retroactively to January 1, 2020 (thereby predating COVID-19), relieves employees and their employers from nonresident income tax and withholding if the employees are working in a nonresident state for less than 30 days during the calendar year. The bill increases the day count to 90 days in the case of any employee who is performing duties in a nonresident state as a result of the pandemic. The bill, however, specifically excludes its application to, inter alia, certain public figures, entertainers and athletes. Moreover, the bill also provides relief to businesses with temporarily remote employees, such as healthcare workers, eliminating a state’s nexus claim due to the temporary work arrangement.
Due to strong bipartisan support, there is a high likelihood that the bill will be passed either individually, or in conjunction with an additional stimulus package that is currently being debated in Congress. It is therefore prudent for employees and businesses to monitor the time spent by an employee in a nonresident state, and vigilantly document such actions in each state. Doing so could result in substantial tax savings should the Remote and Mobile Worker Relief Act become law.
The COVID-19 pandemic has caused the shutdown of much of the economy resulting in many businesses and individuals struggling for their continued existence, let alone keeping current with their tax payment obligations. Notwithstanding personal economic struggles or global recessions, the IRS expects to be paid, and will enforce its rights to do so. Struggling businesses and individuals should be aware of the federal tax liability payment options available to them.
Full Payment Agreements (up to 120 days)
If you cannot pay your current taxes in full immediately, you may qualify for additional time–up to 120 days–to pay in full. There is no fee charged by the IRS for this full payment plan; however, interest and any applicable penalties continue to accrue until your liability is paid in full.
If you are not able to pay your tax liability (including interest and penalties) in full immediately, or within 120 days, you may qualify for a monthly payment plan (including an installment agreement). See Form 9465, Installment Agreement Request, to pay off your liability in up to 72 months.
The IRS generally charges a user fee (up to $225) when you enter into a payment plan, although it can be reduced or waived under certain circumstances.
Before your installment payment plan request can be considered, you must be current on all tax return filing and payment requirements. Taxpayers in an open bankruptcy proceeding are not generally eligible. You must specify the amount you can pay and the day of the month, you will make payment. You should base your monthly installment payment amount on your ability to pay and it should be an amount you can pay each month to avoid defaulting. Usually within 30 days, the IRS will respond to your request to advise you if it has approved it, denied it, or needs more information.
Offer in Compromise or Partial Payment Installment Agreement
If you cannot full pay under an installment agreement, you may propose a partial payment installment agreement (PPIA) or an offer in compromise (OIC). A PPIA is an agreement between you and the IRS, providing for less than the full payment of the tax liability by the expiration of the collection period. An OIC is an agreement between you and the IRS that resolves your tax liability by payment of an agreed upon reduced amount.
Before the IRS will consider either option, you must have filed all tax returns, made all required estimated tax payments for the current year, and made all required federal tax deposits for the current quarter if the taxpayer is a business owner with employees. Taxpayers in an open bankruptcy proceeding aren’t eligible to enter into an OIC or a PPIA.
Temporarily Delay Collection
If you cannot pay any of the amount due because payment would prevent you from meeting your basic living expenses, you can request that the IRS delay collection until you are able to pay. If the IRS determines that you cannot pay any of your tax debt because of financial hardship, the IRS may temporarily delay collection by reporting your account as currently not collectible until your financial condition improves. Being currently not collectible does not mean the debt goes away. It means the IRS has determined you cannot afford to pay the debt at this time. Penalties and interest continue to accrue until you have paid off the debt in full. The IRS may ask you to complete a Collection Information Statement (Form 433-F (PDF), Form 433-A (PDF) or Form 433-B (PDF)) and provide proof of your financial status (including information about your assets and your monthly income and expenses) before approving your request to delay collection. The IRS may temporarily suspend certain collection actions, such as issuing a levy until your financial condition improves. However, the IRS may still file a Notice of Federal Tax Lien while your account is suspended.
Responding to IRS Notices
It is important to respond to an IRS notice. If you do not pay your tax liability in full, or make an alternative payment arrangement, the IRS has the right to take collection action. Although those forced collection actions are presently not being strongly enforced, this period of leniency will not last forever.
Employers who make wage payments are required to withhold U.S. federal taxes from their employees' earnings and pay them over to the U.S. Treasury. To encourage employers to comply with their duty to withhold and remit such taxes, employers are liable for these so-called “trust-fund taxes” that should have been withheld from their employees' earnings, regardless of whether the funds were actually withheld by the employer. In addition, to further ensure that employees, officers, directors and others with the authority to direct payments to creditors of the employer (referred to as “responsible persons”) understand the importance of making these trust fund tax payments, the liability for failure to pay these taxes to the IRS attaches to them personally under Internal Revenue Code section 6672, the so-called “trust fund recovery penalty." The failure to pay over trust fund taxes can result in the assessment of civil penalties on any responsible person and in some instances criminal prosecution.
The liability of a “responsible person” under section 6672 for the trust fund recovery penalty is separate from the liability of the employer. This does not mean that the IRS can collect the trust fund taxes twice, but if the employer does not remit the taxes to the IRS, the IRS will almost always impose the trust fund recovery penalty against a “responsible person” in order to secure payment. In addition, a responsible person's reliance on a third party such as a payroll service to withhold and make the trust fund tax payments does not relieve the employer or necessarily a responsible person of the responsibility to remit the trust fund taxes to the IRS.
In February of this year, the IRS announced that the Internal Revenue Service would step up efforts to visit high-income taxpayers who in prior years have failed to timely file one or more of their tax returns. Following the hiring of additional enforcement personnel, IRS revenue officers across the country were tasked with increasing face-to-face visits with high-income taxpayers who had not filed tax returns in 2018 or previous years.
Then COVID-19 hit, and IRS examination efforts were temporarily put on hold. Yet, the moratorium on IRS examinations ends on July 15, 2020. During its 4-month COVID-19 pause, the IRS has been busy teeing up examinations of hundreds of high-income individuals and related entities controlled or owned by them. Those examinations will commence between July and September of this year. Coincident with this program will be the commencement of examination of thousands of private foundations with ties to the high-income persons. The stated goal in part is to examine the entire “enterprise” of a high-income person. In the past, an IRS examination of an individual’s income tax return frequently focused solely on that return. Now the IRS examination will look beyond the Form 1040 to related entities both foreign and domestic such as trusts, foundations, partnerships, LLCs and other pass through entities.
In the past, individuals with income of $1 million or more faced a less than 1% chance of being examined by the IRS. In fact, in 2018, only 0.05% of individuals earning between $1 and $5 million were audited. The percentage fell to 0.03% for those earning $10 million or more.
This protocol is changing rapidly and the reasons seem clear based on recent letters from the Senate Finance Committee to the Commissioner of the IRS.
The Chairman of the Senate Finance Committee recently wrote to the IRS Commissioner noting that on Monday, June 1, 2020, the Treasury Inspector General for Tax Administration (TIGTA) released an audit report titled, “High-Income Non-filers Owing Billions of Dollars Are Not Being Worked by the Internal Revenue Service.” This report found that for the tax years 2014 through 2016, nearly 900,000 high-income taxpayers who should have filed a tax return did not do so, which equated to about $45.7 billion in taxes they did not pay.
In a second letter from the Senate Finance Committee to the IRS Commissioner, the Committee noted that the TIGTA report found that out of this group of nearly 900,000 non-filers, TIGTA took a close look at the top 100 by income for tax years 2014, 2015, and 2016 — so 300 nonfilers in total. TIGTA concluded that had the IRS audited these 300 nonfilers alone, the IRS might have collected $9.9 billion more in taxes owed.
With much of the U.S. workforce still working from home since March due to COVID-19, working remotely has become the required (or preferred) working arrangement for many across the country. For those individuals and businesses who now as a consequence have a footprint in multiple states, this new “work-life” arrangement can lead to a host of state tax headaches, including income, franchise, gross receipts and sales/use tax exposure.
An individual is generally taxed differently by a given state depending upon whether the individual is considered a tax “resident” of that state. Most states typically define residency as either (1) “domicile” in the given state (a subjective test, taking into account all facts and circumstances, including the time spent in a given location, involvement in the community, family connections, etc.) or (2) spending more than 183 days in a given state and maintaining a permanent abode in such location. With the United States entering its fourth full month of “work from home” status, many workers have found themselves “temporarily” working and living in states other than their usual state of residence/employment (including city dwellers working from their weekend/country homes in neighboring states). As a result, these individuals may now find themselves bumping up against the 183-day residency test in a state in which they are not domiciled.
Similarly, businesses with employees working from home may be subject to unforeseen business tax issues by virtue of their employees working remotely from different states. In general, a business is taxed by a state only if it has “nexus” in that state. In most states, an employer is considered to have nexus with a state if the employer has employees working in the state conducting substantial activities for the business. Remote working arrangements of employees may create nexus for an employer in a state where none had existed before. While some states like New Jersey have explicitly stated that they will waive the nexus implication of employees working from their homes during COVID-19, not all states have similarly weighed in on the matter.
During COVID-19, cash-strapped business owners may be able to free-up much needed cash by entering into a sale-leaseback transaction. With a sale-leaseback, the business owner receives additional working capital from the sale yet retains possession of the actual equipment/real estate for use in the business by way of the leaseback. The funds received in the sale can be used to finance other business or non-business activities. When coupled with the tax advantages available to both the buyer and the seller, a sale-leaseback can provide a viable alternative to taxpayers who no longer meet their bank’s lending parameters or have encountered obstacles in obtaining traditional forms of business financing.
There is a plethora of tax law dealing with when a sale-leaseback transaction will be treated as a sale-leaseback versus a financing for U.S. federal income tax purposes. For sale-leaseback treatment, the parties must consider especially whether (i) the lease is negotiated at arm’s length, (ii) there is a business purpose behind the transaction, and (iii) the lessee has relinquished its ownership interest in the property (e.g., the lessee doesn’t have a reversionary interest, the lessor maintains risk of ownership, etc.).
From a US tax perspective, if the transaction is characterized as a financing, the buyer/lessor will not be permitted to take depreciation deductions on the property because it would not be treated as the property’s tax owner, the property will not obtain a new useful life in the hands of the buyer/lessor, the payment proceeds on the sale will be deemed to be a loan by the buyer/lessor to the seller/lessee, the seller/lessee’s “rental” payments will be characterized as interest subject to the interest deduction limitation rules, the buyer/lessor’s receipt of the rental payments will be characterized as the receipt of interest, etc. In contrast, if the transaction is characterized as a sale-leaseback of the property, the seller/lessee will be treated as selling the property and then leasing it back from the buyer/lessor. If the sale generates a loss, the seller will have a potential net operating loss (NOL) carryback if the loss causes the seller to incur an overall NOL (as computed under the NOL rules) for the taxable year.
The Coronavirus Aid Relief and Economic Security Act (“CARES Act”) was enacted earlier this year as a response to economic hardships attributable to the COVID-19 shutdowns. Among other things, the CARES Act temporarily repeals the 80% NOL limitation and carryback restriction. Thus, corporate taxpayers who generate NOLs as a result of either (i) the sale, (ii) the lease payments or (iii) the depreciation deductions (including 100% bonus depreciation) generally will be able to carry back 100% of those NOLs for up to five years. For years prior to 2018, the corporate tax rate was as high as 35%, whereas the current corporate tax rate is 21%. Consequently, corporate taxpayers using the NOL carryback could benefit from a statutorily-sanctioned 14% rate arbitrage on the carryback.
The CARES Act’s rate arbitrage and other tax benefits are not limited to corporate taxpayers. The CARES Act also temporarily modified the limitation on excess business losses for non-corporate taxpayers, permitting an individual taxpayer to offset its excess business losses against its nonbusiness income (subject to the passive activity loss rules, at-risk loss rules, etc.); hence, an individual taxpayer’s excess business losses are no longer placed in a silo only to be used when the individual taxpayer generates business income. Further, the CARES Act NOL carryback provisions enable an individual taxpayer to utilize NOLs incurred to be carried back for 5 years to reduce prior years’ income and obtain income tax refunds for taxes paid in those prior years.
As the global economy continues to sputter under the pressures of COVID-19 lockdowns, and as interest rates in the United States and across the world fall as a result of central bank intervention, an increasing number of debtors and creditors find themselves in the position of wanting (or needing) to modify the terms of their existing loans. Often lost among the various legal and contractual challenges surrounding debt modifications and workouts are the potential (and often adverse) tax consequences that may result when one or more terms of a debt instrument (“DI”) are modified.
Under Treasury Regulations §1.1001-3, the modification of a DI is treated for federal income tax purposes as the exchange of the original DI for a modified DI if the modification is “significant”. This deemed exchange is a taxable event that may result in gain or loss for the holder/creditor, cancellation of indebtedness income for the issuer/debtor, and/or the unintended creation of original issue discount.
A “modification” is essentially any alteration of a legal right or obligation under a DI, whether evidenced by an express agreement (oral or written), conduct of the parties, or otherwise. Subject to certain exceptions, an alteration of a legal right or obligation is not a “modification” if it occurs by operation of the terms of the DI.
A “significant modification” is a modification that causes a change in yield, a change in timing of payments, changes in the obligation or security or other credit enhancement, changes in the recourse nature of the DI, changes that result in a DI not being treated as debt for federal income tax purposes, or additions, deletions, or changes in financial covenants of a DI. Any modification of a DI that does not fall within the preceding categories is considered “significant” under the regulations if, based on all facts and circumstances (and taken collectively with any other modifications), the legal rights or obligations that are altered and the degree to which they are altered are economically significant.
PE Funds and other business owners, for whatever reasons that existed in the past, may have some businesses in corporate solution (i.e., within a C corporation), potentially experiencing two levels of taxation – first at the corporate level and ultimately, a second time, at the shareholder level. If these C corporations could be converted into S corporations or limited liability companies (LLCs), a single level of tax (only at the shareholder level) on future profits can be achieved. Unfortunately, if the underlying corporate assets have significantly appreciated, there can be adverse tax consequences associated with the conversion itself. If the C corporation is converted to an S corporation, the S corporation will be taxable on built-in gains that the C corporation had when the S election becomes effective if those gains are recognized within five years after the conversion. If, on the other hand, the C corporation converts to an LLC, the conversion will trigger a corporate level tax in the year of conversion on the otherwise unrealized gain in the corporation’s assets at the time of the conversion and a shareholder tax to the extent of the appreciation in the stock held by the shareholder in the converting C corporation. In both cases (conversion of the C corporation to either an S corporation or LLC), the economic downturn caused by COVID-19 may result in a meaningful decline in corporate assets values thereby significantly reducing or eliminating the adverse tax consequences that would have otherwise resulted from a conversion to an S corporation or LLC. Now is the time to consider whether you can actually benefit from COVID-19 - by unlocking any business assets trapped in a C corporation.
As a result of COVID-19 travel restrictions and disruptions, individuals may be forced to temporarily conduct activities outside of the United States or in a U.S. territory that would not otherwise have been conducted there. Absent guidance, uncertainty exists regarding whether these activities give rise to increased U.S. tax obligations under the dual consolidated loss rules and information reporting on Form 8858. Now, Rev. Proc. 2020-30 provides guidance in this area and concludes that “temporary activities” will not give rise to such increased tax or filing obligations.
According to the IRS, COVID-19 travel restrictions and disruptions (“COVID-19 Emergency Travel Disruptions”) may include transportation disruptions, shelter-in-place orders, quarantines, border closures, and recommendations to implement social distancing and limit exposure to public spaces. See prior Duane Morris Tax Team T4 Tip titled IRS Offers Tax Relief to Taxpayers “Stranded” and Working From the United States During COVID-19 Pandemic for coverage of Rev. Proc. 2020-20 (discussing restrictions and disruptions that may restrict the ability of an individual to leave the United States).
Dual Consolidated Loss Rules
In general, the dual consolidated loss rules under Internal Revenue Code section 1503(d) limit the ability of a U.S. domestic corporation to use a “dual consolidated loss,” which is defined to include a net loss attributable to a “foreign branch separate unit.” A “foreign branch separate unit” generally means a business operation outside the United States that, if carried on by a U.S. person, would constitute a foreign branch as defined in Treas. Reg. §1.367(a)-6T(g)(1).
Form 8858 is used by certain U.S. persons that directly or indirectly operate a foreign branch. For purposes of Form 8858, a foreign branch includes a foreign branch as defined in Treas. Reg. §1.367(a)-6T(g)(1).
Foreign Branch Definition
Treas. Reg. §1.367(a)-6T(g)(1) defines a foreign branch as activities that, based on all the facts and circumstances, constitute an integral business operation carried on by a U.S. person outside the United States. For this purpose, evidence of the existence of a foreign branch includes, but is not limited to, the existence of a separate set of books and records and the existence of an office or other fixed place of business used by employees or officers of the U.S. person in carrying out business activities outside the United States. Further, activities outside the United States are deemed to constitute a foreign branch if the activities constitute a permanent establishment under the terms of a treaty between the United States and the foreign country in which the activities are carried out. Whether a taxpayer has a permanent establishment in a foreign country is determined under the rules of the relevant U.S. income tax treaty.
Rev Proc. 2020-30 Guidance
Rev. Proc. 2020-30 provides that “temporary activities” will not be taken into account for purposes of determining whether a U.S. domestic corporation has a “foreign branch separate unit” for dual consolidated loss purposes or whether a U.S. person has a foreign branch and is required to file a Form 8858.
The term “temporary activities” means activities of a taxpayer conducted by one or more individuals in a foreign country during any single consecutive period of up to 60 calendar days selected by the taxpayer within calendar year 2020, to the extent that the individual(s) were temporarily present in the foreign country during the period and the activities would not have been conducted in the foreign country but for COVID-19 Emergency Travel Disruptions with respect to the individual or individuals.
Rev. Proc. 2020-30 urges taxpayers that treat activities as “temporary activities” for these purposes to retain (and be prepared to provide to the IRS upon request) contemporaneous documentation to establish that the activities are temporary activities. Such documentation could include cancelled plane tickets, employee diaries/emails, documentation of published travel restrictions in place in the relevant jurisdictions during the chosen 60-day period, as well as affidavits from employees/management specifying that the activities would not have been conducted in the foreign country but for COVID-19 Emergency Travel Disruptions with respect to the individual(s).
Starting on June 1, the IRS is bringing back its employees who had been working from home since March due to COVID-19. Despite the closure of numerous IRS functions during the COVID-19 pandemic, the IRS Large Business and International Division (LB&I) has numerous active “campaigns” focused on high net worth individuals and their advisors. The campaigns allow LB&I to address significant compliance and resource challenges. Campaign development involves strategic planning by the IRS and deployment of specific resources, training and tools. Several campaigns are tasked to the Withholding & International Individual Compliance practice area and under the direction of the same “Lead Executive” and are coordinated efforts to investigate the tax compliance shortcomings of high net worth persons.
There are substantial civil penalties and criminal prosecution potentially flowing from the failure to file any of the numerous IRS forms relating to foreign financial assets. Accordingly, these IRS campaigns hold the potential for significant revenue for the government, particularly at this time when the government needs to generate revenue to offset massive stimulus payments made to taxpayers during COVID-19.
Swiss Bank Program Campaign
In 2013, the U.S. Department of Justice announced the Swiss Bank Program as a path for Swiss financial institutions to resolve potential criminal liabilities. Banks that are participating in this program provide information on the U.S. persons with beneficial ownership of foreign financial accounts. This campaign addresses noncompliance, involving taxpayers who are or may be beneficial owners of these accounts, through examinations and letters inquiring about apparent failure to comply with certain U.S. tax filing requirements.
High Income Non-filer
U.S. citizens and resident aliens are subject to tax on worldwide income. This is true whether or not taxpayers receive a Form W-2 Wage and Tax Statement, a Form 1099 (Information Return) or their foreign equivalents. Through income tax examinations, this IRS campaign will concentrate on bringing into compliance those taxpayers who have not filed tax returns.
Offshore Private Banking Campaign
U.S. persons are subject to tax on worldwide income from all sources including income generated outside of the United States. It is not illegal or improper for U.S. taxpayers to own offshore structures, accounts, or assets. However, taxpayers must comply with income tax and information reporting requirements associated with these offshore activities.
The IRS admittedly is in possession of records that identify taxpayers with transactions or accounts at offshore private banks. This campaign addresses tax noncompliance and the information reporting associated with these offshore accounts. The IRS will initially address tax noncompliance through examination and letters addressing alleged noncompliance. Additional “treatment streams” (perhaps criminal investigations) may be developed based on feedback received throughout the campaign.
Offshore Service Providers
The focus of this campaign is to address U.S. taxpayers who engaged Offshore Service Providers that facilitated the creation of foreign entities and tiered structures to conceal the beneficial ownership of foreign financial accounts and assets, generally, for the purpose of tax avoidance or evasion. The treatment stream for this campaign will be issue-based examinations.
U.S. persons with international tax compliance issues continue to be the focus of IRS attention. The key to resolving these issues is to reach out to the IRS before the IRS reaches out to you. Numerous IRS programs and other techniques are potentially available to eliminate or lessen the financial impact of any IRS inquiry. Deferring mitigation or corrective action can result in substantial penalties and possible criminal prosecution. Taking action now is often the best practice.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) signed into law on March 27, 2020, brought some much-needed good news for certain real estate owners, specifically restaurants and retail companies.
Due to a drafting error in previously enacted legislation in 2017 (the “2017 Tax Act”) many improvements to interior parts of nonresidential buildings (“qualified improvement property”) placed in service after December 31, 2017, were treated for depreciation purposes as 39-year, rather than 15-year, property and were not eligible for 100% bonus depreciation under the 2017 Tax Act. Therefore, the cost of qualified improvement property had to be deducted over a 39-year period (using the General Depreciation System) instead of allowing the taxpayer to deduct 100% of such costs in the year the property was placed in service.
The CARES Act corrects this bonus depreciation drafting error in the 2017 Tax Act and now allows most businesses to claim 100% bonus depreciation for qualified improvement property so long as certain requirements are met. Even better, the CARES Act correction is retroactive and applies to any qualified improvement property placed into service in 2018 and 2019.
To enable partnerships (and entities treated as partnerships for tax purposes) to take advantage of this CARES Act bonus depreciation benefit, the IRS issued Rev. Proc. 2020-23 permitting partnerships to choose to amend their 2018 and 2019 tax returns (and file revised Forms K-1) before September 30, 2020. Absent Rev Proc. 2020-23, such prior year amendments would not have been allowed for partnerships governed by the centralized partnership audit regime. Rather, these partnerships would have had to file an administrative adjustment request, and the reduction in applicable tax would be delayed until after the partnership filed its 2020 tax return.
As an added benefit, if the CARES Act bonus depreciation claimed in 2018 or 2019 generates a net operating loss in such years, the net operating loss may be available to be carried back to each of the five tax years preceding the tax year of such loss under the new net operating loss carryback rules also contained in the CARES Act. For prior T4 coverage of CARES Act relaxation of carryback and carryforward limitations on net operating losses see COVID-19 Increases the Availability of Tax Refunds by Allowing Net Operating Losses to be Carried Back Five Years below.
New legislation and IRS guidance relating to bonus depreciation and net operating loss carrybacks may enable real estate owners to receive refunds of up to seven years of previously-paid tax liabilities. In many cases, partnerships should not delay exploring the availability of these new refund opportunities as certain of the requisite amended partnership tax filings may need to be made BEFORE September 30, 2020.
COVID-19 has left many businesses searching for sources of funds to keep their businesses afloat in these troubled times. In addition to the various government funded stimulus programs in the recently enacted Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), the CARES Act contains provisions that allow many taxpayers to monetize their net operating losses (“NOLs”) and obtain refunds of taxes paid in prior taxable years.
Prior to the enactment of the CARES Act, a taxpayer with NOLs incurred in taxable years beginning on or after December 31, 2017, was not allowed to carry back those NOLs to prior taxable years. Those NOLs were required to be carried forward and could not offset more than 80% of taxable income in a given taxable year. The CARES Act temporarily suspends these restrictions for NOLs incurred in taxable years beginning after December 31, 2017, and before January 1, 2021, (i.e., 2018, 2019 and 2020 for a calendar-year taxpayer) and allows NOLs incurred in such years to be carried back to each of the 5 preceding taxable years, unless the taxpayer affirmatively elects to forgo the carryback. For example, a calendar-year corporate taxpayer with a 2018 NOL is now permitted to carryback the 2018 NOL to 2013 to offset its 2013 taxable income and obtain a refund of taxes paid with respect to 2013. In addition, the CARES Act allows NOL carryforwards to offset up to 100% (not 80%) of taxable income in taxable years beginning before January 1, 2021.
To expedite the processing of refund claims related to these changes, the IRS is accepting CARES Act NOL refund claims via a special dedicated fax line. In addition, the IRS has also issued guidance on:
- the making of various elections available under the CARES Act NOL provisions
- a 6-month extension of time to file IRS Form 1045/1139 (as applicable) for certain 2018 NOL carrybacks; and
- special NOL tax filing relief for partnerships
A taxpayer who has incurred NOLs in 2018, 2019 or 2020 could receive significant tax refunds from the carryback of those NOLs to prior taxable years. The IRS has issued guidance regarding the procedures and deadlines for obtaining such refunds on an expedited basis.
A taxpayer with NOLs should evaluate the potential tax savings of carrying back its NOLs before the deadlines for doing so expire. Time may be of the essence.
On April 21, 2020, the IRS issued guidance, in the form of two revenue procedures and a list of frequently asked questions (‘FAQ”), that provides U.S. federal income tax relief for a variety of persons who may be present in the United States as a result of COVID-19 travel disruptions, including travel bans, government mandated lockdowns, and canceled flights.
Rev. Proc. 2020-20 allows an individual to claim a COVID-19 medical condition travel exception for purposes of determining if they are a U.S. tax resident under the “substantial presence test” if COVID-19-related measures effectively prevented the individual from leaving the United States during the individual’s COVID-19 emergency period. An individual’s “COVID-19 emergency period” is a period of up to 60 consecutive calendar days selected by the individual starting between February 1 and April 1 during which the individual was physically present in the United States on each day. Rev. Proc. 2020-20 makes clear that the COVID-19 medical condition travel exception is in addition to, and can be used in conjunction with, other available “substantial presence test” exceptions (such as the closer connection and medical condition exceptions).
Rev. Proc. 2020-27 relates to the ability of certain U.S. taxpayers living abroad who seek to claim the foreign earned income exclusion and housing costs exclusion and/or the foreign housing deduction under IRC §911. Rev. Proc. 2020-27 waives certain time requirements otherwise imposed under IRC §911 for those who reasonably expected to meet the IRC §911 eligibility requirements during 2019 or 2020 but cannot do so because they departed a foreign country as a result of COVID-19 measures. The guidance states that the COVID-19 pandemic is an “adverse condition that precluded the normal conduct of business” in China from December 1, 2019, and globally from February 1, 2020. It further states that qualifications for the IRC §911 exclusions will not be affected by days spent outside a foreign country because of COVID-19, based on specific departure dates. Thus, under the Rev. Proc., an individual who left China or another foreign country on, or after, the listed dates but on or before July 15, 2020 (unless the end date is extended in the future by the Treasury and the IRS), will be treated for purposes of IRC §911 as a qualified individual with respect to the period during which that individual was present in, or was a bona fide resident of, that foreign country if the individual establishes a reasonable expectation that he or she would have met the requirements of IRC §911(d)(1) but for the COVID-19 emergency.
The IRS FAQs provide that a nonresident alien, foreign corporation, or partnership in which either is a partner may choose an uninterrupted period of up to 60 calendar days starting between February 1 and April 1, 2020, during which its services or other activities conducted in the United States won’t be considered in determining whether it is “engaged in a U.S. trade or business” if the services or activities were performed by one or more individuals temporarily present in the United States and would not have been performed in the United States were it not for COVID-19 emergency travel disruptions. Such activities also will not be considered in determining whether the nonresident or foreign corporation has a “permanent establishment” in the United States under a tax treaty. Protective federal income tax returns that among other things start the statute of limitations for assessment running and preserve the ability to claim deductions and credits may be filed by the affected person(s).
Recently-issued IRS guidance may provide tax relief for certain foreign businesses with employees unable to easily depart the United States and U.S. and foreign individuals “stranded” in the United States due to COVID-19 travel disruptions. However, this relief does not apply to all and the requirements to satisfy the relief provisions, including documentation and certain procedural steps, should be carefully reviewed.
In addition to the unprecedented government funded stimulus programs in the recently enacted Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), the CARES Act contains provisions designed to incentivize taxpayers to support all qualifying charitable organizations, including those that are providing critical services and community support during the COVID-19 pandemic.
To encourage taxpayers to donate to charities during this difficult time, the CARES Act allows any taxpayer who does not itemize deductions to deduct up to $300 in contributions to charitable organizations as an “above the line” deduction, for at least 2020. For those taxpayers who do itemize, the CARES Act raises the annual cap on the deduction for cash charitable contributions, increasing it (for 2020 only) from 60 percent to 100 percent of adjusted gross income. For corporations, the CARES Act increases the annual deduction limit from 10 percent to 25 percent of taxable income, for 2020 only.
Consider accelerating or enhancing your charitable giving this year to benefit chosen charities and maximize your tax savings. Limitations on federal income tax deductions for cash contributions made during 2020 to qualifying charities (including but not limited to those that are providing critical services and community support during the COVID-19 pandemic) have been loosened by the CARES Act.
Every state has an unclaimed property law that requires businesses to annually file an unclaimed property report and to turn over any unclaimed funds to the state. These laws are commonly called “Escheat Laws." Generally, the unclaimed property report is required to be filed with respect to money or property owed to a person or business and not paid or returned to such person or business within a statutory abandonment period (generally between one and seven years). These unclaimed property laws apply not only to uncashed checks or unused deposits, but to any debt or property owed by the business to another business or person.
The COVID-19 crisis has resulted in many businesses owing a substantial amount of unpaid debt, such as unpaid wages, unpaid suppliers, unpaid servicemen, paid for but undelivered goods, etc. As time goes on if these debts are not paid, this can result in a significant unclaimed property obligation of the debtor business requiring the business to ultimately turn over the amount owed to the state. As these debtor businesses exit this crisis they should plan for what to do about these unpaid debts. With proper advice, there are ways to not only reduce or eliminate the debt but also eliminate any unclaimed property obligation to a state. In other cases, different planning opportunities will have to be considered.
The only thing certain is that businesses with substantial unpaid debts as a result of this financial crisis should seek professional advice on how to not only pay off such debts but how to reduce or eliminate any potential unclaimed property obligation to the state that may arise as a result of such unpaid debt.
Through the People First Initiative – COVID-19, the IRS has quite properly suspended many of its forced collection actions against delinquent taxpayers (See: IR-2020-59). But not all IRS collection activity is currently suspended (particularly against high net worth individuals) and collection mistakes can and will happen.
Taxpayers have rights when it comes to IRS collection action. The exercise of these rights can force the IRS to stop the collection action. BusinessT⁴ Tipes and individual taxpayers should not ignore notices from the IRS, especially notices sent by certified mail. If a taxpayer ignores a notice of planned collection action, the ability to stop the IRS may be lost.
Do not ignore notices from the IRS, especially during troubled times. Opportunities may be available to you to halt collection activity but only if proper procedures are followed.
If you or your company has any questions about these issues, please contact us at Duane Morris Tax.
The T⁴ team includes Tom Ostrander, the principal author of this T⁴ Tip, Hope Krebs, Stephen DiBonaventura, Jon Grouf, Stan Kaminski, Anastasios Kastrinakis, Lisa Merrill, William Rohrer and David Sussman.
During the current work and legal environment the resources we have in place allow us to continue to serve you seamlessly. Please rest assured that our law firm is — and will continue to be — up and running, working to serve your best interests.