Category: Perspectives

The following is a summary of important tax developments that occurred in January, February, and March of 2019 that may affect you, your family, your investments, and your business. Please contact me for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Estimated tax penalty relief. The IRS announced that it is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. This waiver covers taxpayers whose total withholding and estimated tax payments are equal to or greater than 80% of their taxes owed, rather than the usual statutory percentage threshold of 90%. The provided relief expanded that initially offered by IRS; the earlier relief pertained to taxpayers who had paid 85% of their taxes owed. The relief was prompted by changes in the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), some of the which might impact withholding (e.g., the repeal of the personal exemptions and many itemized deductions and the capping the state and local income tax deduction at $10,000). A Government Accountability Office (GAO) report estimated that nearly 30 million taxpayers could be underwithheld in 2018. IRS also provided procedures for requesting the waiver and procedures under which taxpayers who have already paid underpayment penalties but who now qualify for relief may request a refund.

For more information, see this IRS News Release.

Employer identification number (EIN). As part of its ongoing security review, the IRS announced that, starting May 13, only individuals with tax identification numbers may request an Employer Identification Number (EIN) as the “responsible party” on the application. Individuals named as responsible party must have either a Social Security number (SSN) or an individual taxpayer identification number (ITIN). Under Code Sec. 6109(a)(1), persons are required to include taxpayer identifying numbers on returns, statements, or other documents filed with the IRS. One of the principal types of taxpayer identifying numbers is an EIN. IRS generally assigns an EIN for use by employers, sole proprietors, corporations, partnerships, nonprofit associations, trusts, estates, government agencies, certain individuals, and other business entities for tax filing and reporting purposes. A person required to furnish an EIN must apply for one with the IRS on a Form SS-4 (Application for Employer Identification Number). The new change will prohibit entities from using their own EINs to obtain additional EINs. The requirement will apply to both the paper Form SS-4 and online EIN application.

As of May 13, 2019, only individuals with tax identification numbers may request an EIN. You can read the IRS press release here.

Electric car credit declines. IRS announced that, during the fourth quarter of 2018, General Motors (GM) reached a total of more than 200,000 sales of vehicles eligible for the plug-in electric drive motor vehicle credit under Code Sec. 30D(a). Accordingly, the credit for all new qualified plug-in electric drive motor vehicles sold by GM began to phase out April 1, 2019. Qualifying vehicles from GM purchased for use or lease are eligible for a $7,500 credit if acquired before April 1, 2019. Beginning Apr. 1, 2019, the credit will be $3,750 for GM’s eligible vehicles. Beginning Oct. 1, 2019, the credit will be reduced to $1,875. After Mar. 31, 2019, no credit will be available.

You can read the IRS press release on this issue here.

Deduction for back alimony. The Tax Court held that an ex-husband’s payment of alimony arrearages resulted from a contempt order by a Family Court was not a “money judgment”, and so qualified as deductible alimony. With respect to divorce instruments executed before Jan. 1, 2019, amounts received as alimony or separate maintenance payments are taxable to the recipient and deductible by the payor in the year paid. An alimony payment is one that meets the certain specific requirements, such as it must be made under a divorce or separation instrument and the payor’s obligation to make the payment must end at the death of the payee spouse. On the other hand, a money judgment is a document issued by a court stating that the creditor (or other plaintiff) has won a lawsuit and is entitled to a certain amount of money. A New York court found a taxpayer to be in contempt due to his failure to make his alimony payments and sentenced him to 150 days in jail unless he paid $225,000 to his former spouse. The taxpayer paid the $225,000 at issue and claimed an alimony deduction. The Tax Court found that the court’s order was not a money judgment, but rather a contempt order to achieve the payment of alimony arrearages which retained their character as alimony.

You can download the court’s opinion in the Siegel case, TC Memo 2019-11, here.

Qualified business income deduction: final regulations. The IRS issued final Code Sec. 199A regulations for determining the amount of the deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate (the qualified business income deduction). The regulations cover a wide range of topics and discuss the operational rules, including definitions, computational rules, special rules, and reporting requirements; the determination of W-2 wages and unadjusted basis immediately after acquisition of qualified property; the computation of qualified business income, qualified real estate investment trust (REIT) dividends, and qualified publicly traded partnership income; the optional aggregation of trades or businesses; the treatment of specified services trades or businesses and the trade or business of being an employee; and the rules for relevant passthrough entities, publicly traded partnerships, beneficiaries, trusts, and estates.

IRS released in January of 2019 various guidance associated with the Qualified Business Income (QBI) deduction:

• A set of regulations, finalizing proposed regulations issued last summer, as well as a new set of proposed regulations providing guidance on several aspects of the QBI deduction, including qualified REIT dividends received by regulated investment companies
• A revenue procedure providing guidance on determining W-2 wages for QBI deduction purposes,
• A notice on a proposed revenue procedure providing a safe harbor for certain real estate enterprises that may be treated as a trade or business for purposes of the QBI deduction

Qualified business income deduction: calculating W-2 wages. IRS provided three methods for calculating W-2 wages under Code Sec. 199A, the qualified business income deduction, for purposes of the deduction limitation based on W-2 wages and for purposes of the deduction reduction for certain specified agricultural and horticultural cooperative patrons. Under Code Sec. 199A, W-2 wages include:

1. The total amount of wages as defined in Code Sec. 3401(a) (dealing with income tax withholding);
2. The total amount of elective deferrals (within the meaning of Code Sec. 402(g)(3));
3. Compensation deferred under Code Sec. 457; and
4. The amount of designated Roth contributions.

For any taxable year, a taxpayer must calculate W-2 wages for purposes of Code Sec. 199A using one of the three methods provided by IRS. The first method (the unmodified Box method) allows for a simplified calculation, while the second and third methods (the modified Box 1 method and the tracking wages method) provide greater accuracy. The Box numbers referenced under each method refers to those on the Forms W-2 (Wage and Tax Statement).

The IRS published Notice 2018-64, which explains the calculation of W-2 wages for purposes of Code Section 199A. You can download the Notice here.

Qualified business income deduction: rental real estate safe harbor. The IRS provided a safe harbor under which a rental real estate enterprise will be treated as a trade or business for purposes of the qualified business income deduction under Code Sec. 199A. That Code provision provides a deduction to non-corporate taxpayers of up to 20% of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship, as well as a deduction of up to 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. Solely for this purpose, a rental real estate enterprise will be treated as a trade or business if:

• Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;
• For tax years beginning prior to Jan. 1, 2023, 250 or more hours of rental services were performed per year with respect to the rental enterprise; and
• The taxpayer maintains contemporaneous records on the hours of all services performed; a description of all services performed; the dates on which such services were performed; and who performed the services. (This contemporaneous records requirement doesn’t apply to tax years beginning before Jan. 1, 2019).

You can download IRS Notice 2019-07 here. It explains the IRS views on the safe harbor. Observe that the question of whether triple-net leases qualify as a trade or business for purposes of Section 199A remains unanswered, although it appears they will not qualify under the safe harbor.

Options for those unable to pay taxes due. The April 15th deadline for filing 2018 income tax returns (for most taxpayers, at least; April 17 for Maine, Massachusetts, and the District of Columbia) has recently passed. The IRS advised taxpayers who don’t have cash to pay the balance due on their returns, that taxpayers can avoid penalties but not interest if they can get an extension of time to pay from the IRS. However, such extensions merely postpone the day of reckoning for the period of the extension (generally, six months). The IRS has described other ways in which financially distressed persons may be able to defer paying their income taxes, including installment agreements (a short-term 120-day payment plan and a long-term payment plan) and an offer in compromise with the IRS.

The IRS offers brief explanations of some of the payment alternatives available to taxpayers:

https://www.irs.gov/payments/alternative-payment-plans-hardship-information

These notes are intended only for clients and friends of my law practice. These notes illustrate general principles only and are not intended as legal or tax advice. The reader is cautioned to discuss his or her specific circumstances with a qualified professional before taking any action. In some jurisdictions, this newsletter may be considered attorney advertising.

On May 31, 2018, Governor Malloy signed P.A. 18-49, which fundamentally changes how income earned by pass through entities such as S corporations, partnerships, and multi-member LLCs are taxed. The new legislation does not affect the taxation of publicly traded partnerships, sole proprietorships, or single member LLCs.

The legislation is retroactively effective to January 1, 2018. For tax years beginning on or after that date, a pass-through entity is now subject to tax, at a rate of 6.99%, on its own income. The new law provides a tax credit that partners may claim on their Connecticut income tax return, intended, generally, to ensure that the pass-through entity’s income is not taxed twice.

The policy goal of the legislation is fairly novel. It is intended as a revenue-neutral work around to the $10,000 limitation to the deduction for state and local taxes contained in the revisions to the federal tax law. The new Connecticut tax law transfers the Connecticut income tax deduction from the business owners to the entity itself. Because the new state tax will be an expense of the pass-through entity that pays it, the tax reduces the federal taxable income of the individual owners of pass-through entities, it offsets, at least in part, the effects of the federal law’s new limitation on the deduction for state and local taxes. Each such owner is now provided a refundable credit against the Connecticut personal income tax in an amount equal to 93.01% of that owner’s pro rata share of the tax paid by the pass-through entity. An individual owner who is either a full year or part year resident of Connecticut is also entitled to a credit against the Connecticut personal income tax for that individual’s pro rata share of taxes paid to another state or the District of Columbia on income of the pass-through business entity if the Commissioner of Revenue Services determines that the tax is substantially similar to the new Connecticut pass through entity tax.

A nonresident individual whose only Connecticut source income is from one or more Connecticut pass-through entities which entities pay the pass-through entity tax will not need to file a Connecticut personal income tax return. However, an individual member of a pass-through entity that has elected to file a “combined return” with one or more other pass through entities and pass-through chooses to file a combined return and the offsetting credit for the pass-through’s tax payment does not completely satisfy the nonresident’s Connecticut personal income tax liability.

Because the new Connecticut tax law is made retroactive to the beginning of 2018 and requires pass-through entities to make estimated tax payments quarterly (i.e. April 15, June 15, and September 15 of 2018, and January 15 of 2019), the affected entities are, in effect already late on the first payment due. The Department of Revenue Services has stated that entities may make solve this issue in any of three ways:

1. Make a catch-up payment with the June 15, 2018 estimated payment that satisfies both the first and second estimated payment requirements;
2. Make three estimated payments (by each of June 15 and September 15 in 2018, and by January 15 in 2019) each equaling 22.5% of the total tax liability, with the final payment due with the tax return; or
3. Annualize their estimated payments for the taxable year

Further, DRS will allow pass-through entities to recharacterize all or a portion of any April 15, 2018, June 15, 2018, or September 15, 2018, income tax estimated payments made by any of their individual partners, with such partner’s consent, so that the payments are applied against the pass-through entity’s 2018 estimated payment requirements. The recharacterization of these 2018 income tax estimated payments must be completed by December 31, 2018. The recharacterized amount will be deemed to have been made by the pass-through entity on the date that the individual partner remitted the estimated payment to DRS. DRS will provide information by September 30, 2018, about the mechanism to re-characterize these estimated payments.

A pass-through entity may make its June 15, 2018 estimated tax payment by completing an estimated tax payment coupon and mailing it to DRS with a check. The estimated tax payment coupon may be downloaded here.  For the September 15, 2018 estimated payment, a pass-through entity may also make its estimated payment at http://www.ct.gov/tsc.

Because individual partners will get a credit for the Pass-Through Entity Tax paid by their pass-through entity, many resident individual and trust partners will no longer need to make estimated income tax payments to cover their Connecticut income tax liability arising from their pass-through entity income. A partner may still be required to make estimated income tax payments depending upon the method the pass-through entity uses to calculate the Pass-Through Entity Tax, if the partner has income from other sources, or if the individual partner is an employee who will not have enough income tax withheld from their wages. Partners should consult with their pass-through entities and tax counsel to determine how they will be affected.

DRS has stated it is aware that some individual partners have already remitted the first-quarter estimated income tax payment and may have scheduled the automatic payment of the second, third and fourth quarter estimated income tax payments. If an individual partner determines that he or she no longer needs to make estimated income tax payments, the partner may cancel any pending scheduled payments.

In circumstances where partners or other owners of affected pass through entities have already made estimated individual income tax payments, there are two options:

1. The individual partners (or other owners) will receive a refund when they file their 2018 Connecticut returns; or
2. The individual partners may have all or a portion of their 2018 income tax estimated payments re-characterized so that the payments are applied against their pass-through entity’s 2018 estimated payment requirements. This must be done by December 31, 2018.

The new law provides for a taxpayer to elect either of two methods of calculating the tax:

1. Multiply the applicable rate by the entity’s Connecticut source income; or
2. If timely elected, the taxpayer may apply the rate to an “alternative tax base” that is equal to the “resident portion of unsourced income” plus “modified Connecticut source income.”

Some definitions will help here.

Unsourced income generally equals the business’s net income as calculated for federal tax purposes, increased or decreased by applicable personal tax deductions and without regard to the location from which the items of income and adjustments are derived, minus the business’s Connecticut sourced income without any adjustments for tiered business entities and also minus the business’s net income, for federal tax purposes, that is derived from sources in another state with jurisdiction to tax the entity, as increased or decreased by any adjustments that apply under the personal income tax that are derived from, or connected to, sources in another state with jurisdiction to tax the entity.

Modified Connecticut source income is defined as the business’s Connecticut source income multiplied by a percentage equal to the sum of ownership interests in the business that are owned by individual members that are (i) subject to the Connecticut personal income tax or (ii) pass-through businesses subject to the entity tax to the extent that such businesses are directly or indirectly owned by individuals subject to the Connecticut personal income tax.

The resident portion of unsourced income is “unsourced income” multiplied by a percentage equal to the portion of the ownership interests in the business entity owned by individual members who are Connecticut residents.

While there is not yet published guidance, election of the alternative tax base seems likely to be more attractive to Connecticut residents because it increases the available tax credit to include “unsourced income” as well as Connecticut sourced income. This alternative tax calculation should also permit a business to avoid paying the pass-through entity tax to the extend of income earned by owners who are not subject to the Connecticut personal income tax, such as Subchapter C corporations and tax-exempt entities.

Partners in a pass-through entity that files on a fiscal year basis appear to need to continue to make 2018 estimated income tax payments. If a pass-through entity is a fiscal year filer, the distributive share of the entity’s income from its 2018 return will be included in such partner’s 2019 income tax return. Hence, the credit associated with the entity’s 2018 return will not be claimed until the partner’s 2019 Connecticut income tax return is filed.

We are still awaiting guidance on some issues that remain unresolved with the new law, such as:

(i)      The impact on nonresident owners who reside in jurisdictions with an income tax that

may not grant a credit for the new Connecticut tax;

(ii)     The applicability of the tax to guaranteed payments; and

(iii)    The impact of the Connecticut modification from federal adjusted gross income for

Connecticut taxes. In addition, any sole proprietorship operated as a single member

limited liability company treated for federal tax purposes as a disregarded entity, should

consult with a tax advisor as to whether the owner should convert to pass-through status

by adding a nominal partner to take advantage of the tax benefit afforded by this legislation

This information is provided as a review of general principles only and is not intended as legal or tax advice. The reader is cautioned to discuss his or her specific circumstance with a qualified practitioner before taking any action.

On May 31, 2018, Governor Malloy signed P.A. 18-49, which fundamentally changes how income earned by pass through entities such as S corporations, partnerships, and multi-member LLCs are taxed. The new legislation does not affect the taxation of publicly traded partnerships, sole proprietorships, or single member LLCs.

The legislation is retroactively effective to January 1, 2018. For tax years beginning on or after that date, a pass-through entity is now subject to tax, at a rate of 6.99%, on its own income. The new law provides a tax credit that partners may claim on their Connecticut income tax return, intended, generally, to ensure that the pass-through entity’s income is not taxed twice.

The policy goal of the legislation is fairly novel. It is intended as a revenue-neutral work around to the $10,000 limitation to the deduction for state and local taxes contained in the revisions to the federal tax law. The new Connecticut tax law transfers the Connecticut income tax deduction from the business owners to the entity itself. Because the new state tax will be an expense of the pass-through entity that pays it, the tax reduces the federal taxable income of the individual owners of pass-through entities, it offsets, at least in part, the effects of the federal law’s new limitation on the deduction for state and local taxes. Each such owner is now provided a refundable credit against the Connecticut personal income tax in an amount equal to 93.01% of that owner’s pro rata share of the tax paid by the pass-through entity. An individual owner who is either a full year or part year resident of Connecticut is also entitled to a credit against the Connecticut personal income tax for that individual’s pro rata share of taxes paid to another state or the District of Columbia on income of the pass-through business entity if the Commissioner of Revenue Services determines that the tax is substantially similar to the new Connecticut pass through entity tax.

A nonresident individual whose only Connecticut source income is from one or more Connecticut pass-through entities which entities pay the pass-through entity tax will not need to file a Connecticut personal income tax return. However, an individual member of a pass-through entity that has elected to file a “combined return” with one or more other pass through entities and pass-through chooses to file a combined return and the offsetting credit for the pass-through’s tax payment does not completely satisfy the nonresident’s Connecticut personal income tax liability.

Because the new Connecticut tax law is made retroactive to the beginning of 2018 and requires pass-through entities to make estimated tax payments quarterly (i.e. April 15, June 15, and September 15 of 2018, and January 15 of 2019), the affected entities are, in effect already late on the first payment due. The Department of Revenue Services has stated that entities may make solve this issue in any of three ways:

1. Make a catch-up payment with the June 15, 2018 estimated payment that satisfies both the first and second estimated payment requirements;
2. Make three estimated payments (by each of June 15 and September 15 in 2018, and by January 15 in 2019) each equaling 22.5% of the total tax liability, with the final payment due with the tax return; or
3. Annualize their estimated payments for the taxable year

Further, DRS will allow pass-through entities to recharacterize all or a portion of any April 15, 2018, June 15, 2018, or September 15, 2018, income tax estimated payments made by any of their individual partners, with such partner’s consent, so that the payments are applied against the pass-through entity’s 2018 estimated payment requirements. The recharacterization of these 2018 income tax estimated payments must be completed by December 31, 2018. The recharacterized amount will be deemed to have been made by the pass-through entity on the date that the individual partner remitted the estimated payment to DRS. DRS will provide information by September 30, 2018, about the mechanism to re-characterize these estimated payments.

A pass-through entity may make its June 15, 2018 estimated tax payment by completing an estimated tax payment coupon and mailing it to DRS with a check. The estimated tax payment coupon may be downloaded here.  For the September 15, 2018 estimated payment, a pass-through entity may also make its estimated payment at http://www.ct.gov/tsc.

Because individual partners will get a credit for the Pass-Through Entity Tax paid by their pass-through entity, many resident individual and trust partners will no longer need to make estimated income tax payments to cover their Connecticut income tax liability arising from their pass-through entity income. A partner may still be required to make estimated income tax payments depending upon the method the pass-through entity uses to calculate the Pass-Through Entity Tax, if the partner has income from other sources, or if the individual partner is an employee who will not have enough income tax withheld from their wages. Partners should consult with their pass-through entities and tax counsel to determine how they will be affected.

DRS has stated it is aware that some individual partners have already remitted the first-quarter estimated income tax payment and may have scheduled the automatic payment of the second, third and fourth quarter estimated income tax payments. If an individual partner determines that he or she no longer needs to make estimated income tax payments, the partner may cancel any pending scheduled payments.

In circumstances where partners or other owners of affected pass through entities have already made estimated individual income tax payments, there are two options:

1. The individual partners (or other owners) will receive a refund when they file their 2018 Connecticut returns; or
2. The individual partners may have all or a portion of their 2018 income tax estimated payments re-characterized so that the payments are applied against their pass-through entity’s 2018 estimated payment requirements. This must be done by December 31, 2018.

The new law provides for a taxpayer to elect either of two methods of calculating the tax:

1. Multiply the applicable rate by the entity’s Connecticut source income; or
2. If timely elected, the taxpayer may apply the rate to an “alternative tax base” that is equal to the “resident portion of unsourced income” plus “modified Connecticut source income.”

Some definitions will help here.

Unsourced income generally equals the business’s net income as calculated for federal tax purposes, increased or decreased by applicable personal tax deductions and without regard to the location from which the items of income and adjustments are derived, minus the business’s Connecticut sourced income without any adjustments for tiered business entities and also minus the business’s net income, for federal tax purposes, that is derived from sources in another state with jurisdiction to tax the entity, as increased or decreased by any adjustments that apply under the personal income tax that are derived from, or connected to, sources in another state with jurisdiction to tax the entity.

Modified Connecticut source income is defined as the business’s Connecticut source income multiplied by a percentage equal to the sum of ownership interests in the business that are owned by individual members that are (i) subject to the Connecticut personal income tax or (ii) pass-through businesses subject to the entity tax to the extent that such businesses are directly or indirectly owned by individuals subject to the Connecticut personal income tax.

The resident portion of unsourced income is “unsourced income” multiplied by a percentage equal to the portion of the ownership interests in the business entity owned by individual members who are Connecticut residents.

While there is not yet published guidance, election of the alternative tax base seems likely to be more attractive to Connecticut residents because it increases the available tax credit to include “unsourced income” as well as Connecticut sourced income. This alternative tax calculation should also permit a business to avoid paying the pass-through entity tax to the extend of income earned by owners who are not subject to the Connecticut personal income tax, such as Subchapter C corporations and tax-exempt entities.

Partners in a pass-through entity that files on a fiscal year basis appear to need to continue to make 2018 estimated income tax payments. If a pass-through entity is a fiscal year filer, the distributive share of the entity’s income from its 2018 return will be included in such partner’s 2019 income tax return. Hence, the credit associated with the entity’s 2018 return will not be claimed until the partner’s 2019 Connecticut income tax return is filed.

We are still awaiting guidance on some issues that remain unresolved with the new law, such as:

(i)      The impact on nonresident owners who reside in jurisdictions with an income tax that

may not grant a credit for the new Connecticut tax;

(ii)     The applicability of the tax to guaranteed payments; and

(iii)    The impact of the Connecticut modification from federal adjusted gross income for

Connecticut taxes. In addition, any sole proprietorship operated as a single member

limited liability company treated for federal tax purposes as a disregarded entity,

should consult with a tax advisor as to whether the owner should convert to

pass-through status by adding a nominal partner to take advantage of the tax benefit

afforded by this legislation.

This information is provided as a review of general principles only and is not intended as legal or tax advice. The reader is cautioned to discuss his or her specific circumstance with a qualified practitioner before taking any action.