Tag: Tax

Charitable organizations and their donors should be aware that the $300 deduction made available under the CARES Act expires at the end of 2020.  Because this addition to the standard deduction has had such an appreciable and positive effect on charitable donations so far this year, eligible organizations might timely remind potential donors of this opportunity to support their missions.

The data suggest that many donors, particularly smaller donors, have increased giving in 2020 because of the provision in the CARES Act, P.L. 116-136,1 which provides a $300 above the line charitable deduction to taxpayers who use the standard deduction and do not itemize. 2  While first quarter donations of less than $250 were up 5.8% year on year in the first quarter of 2020, they rose 19.2% at the end of the first half of the year, strongly indicating that the CARES Act, which went into effect on March 27, incented smaller donors substantially more than larger donors. Figure 1 illustrates the first quarter and first half donor data.

	< $250	$250-$999	≥$1,000
Q1 2020	+ 5.8%	-2.2%	-7.4%
Q1 & Q2  2020	+19.2%	+8.1%	+6.4%

 

These data further suggest that small donors would increase their giving were the ceiling for qualified charitable contributions to be raised.

Nearly nine out of ten taxpayers now take the standard deduction and no longer itemize since the Tax Cuts and Jobs Act, P.L. 115-97 increased the standard deduction, nearly doubled the standard deduction, and eliminated or restricted many itemized deductions for years 2018 through 2025.

The deductibility of qualified charitable contributions may be further limited by each donor’s circumstances and they should be advised to consult with their professional advisors. Organizations which receive donations of $250 or more from any donor in a calendar year are obliged to provide that donor timely written acknowledgment of the donation that complies with Reg. §§  1.170A-16(b).

These notes are provided to illustrate general principles only. They are not legal or tax advice. The reader is cautioned to discuss his or her specific circumstances with a qualified professional before taking any action.

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<sup>1. Fundraising Report January 1, 2020- June 30, 2020, Association of Fundraising Professionals Foundation for Philanthropy [downloadable from my server here until December 20, 2020]
2. See, §2204 of the CARES Act, referring to donations made under this provision as “qualified charitable contributions.” §2205(a)(3)(A)(i) of the Act further limits the deduction to  contributions “paid in cash during calendar year 2020 to an organization described in section 170(b)(1)(A) of such Code.”</sup>

The mathematics of the annual testing for compliance with the rules requiring qualified plans to demonstrate nondiscrimination are spread though several sections of the tax law, rendering the calculations needed somewhat opaque. This note attempts to summarize some of the calculations so that plan sponsors might feel better empowered to assess the effect on compliance of both current and anticipated plan features.

Among the many compliance tests that qualified plans must meet in order to retain their qualified status are nondiscrimination tests which assure that the benefits of tax-deferred compensation do not accrue disproportionately to highly compensated employees (HCEs). There are several tests within this regime, but two of the more important tests, for our purposes, are the annual Actual Deferred Percentage (ADP) and Actual Contribution Percentage (ACP) calculations. While ADP considers only employee deferrals, ACP also includes employer contributions. Plan sponsors of non-exempt plans must conduct both tests, whether or not their results match.

The purpose of 401(k) nondiscrimination tests is to ensure that all employees are benefitting from plan participation. Otherwise, those who own the company and Highly Compensated Employees (HCEs) would stand to benefit disproportionately from being able to defer their income for tax purposes over Non-Highly Compensated Employees (NHCEs).  Because, for example, a plan to increase the share of compensation that only HCEs may defer could cause a non-exempt plan to fail one or more nondiscrimination tests, thereby exposing the plan sponsor to penalties and possible loss of the qualified status of the plan, it is worth considering the calculations used in the ADP and ACP tests and how those calculations might be affected by adding the feature of increased deferral rights for HCEs.

For purposes of this testing, an HCE is an individual who either:

• Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
• For the preceding year, received compensation from the business of more than$125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

One of the qualifications a plan must meet to be or remain a “qualified plan” within the meaning of Code Section 401 is that it not discriminate in favor of highly compensated employees. This condition is described at §401(a)(4):[[

(4) if the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees (within the meaning of section 414(q)). For purposes of this paragraph, there shall be excluded from consideration employees described in section 410(b)(3)(A) and (C) [providing definitions for, respectively, the “year of service” and “hours of service” generally allowed as conditions for vesting]

Actual Deferral Percentage – 26 C.F.R. §1.401(k) -2

The ADP test calls for employers to compare the average annual deferral rates of HCEs and NHCEs. This test excludes employer matching and measures only employee deferrals. See, Reg. §1.401(k)-2. The ADP test also measures employee compensation only in cash and stocks. Health insurance and other fringe benefits are excluded. The employer (usually the plan administrator handles this tax, but the employer is responsible). This equation is used, separately, for both HCEs and NHCEs:

Where

n= total number of either HCEs or NHCEs

D= total employee deferrals, both pretax and Roth, for each employee

C=each employee’s total annual compensation

 

Actual Contribution Percentage – 26 C.F.R. §1.401(m) -2

The ACP test follows a similar patter but uses different variables. This test also measures HCE and NHCE results separately:

Where

n=total number of either HCE or NHCEs

T=total of each employee’s deferrals, after tax contributions, and employer matching

C=each employee’s total annual compensation

 

The largest difference between the two is that the ADP test compares relative deferrals among HCEs and NHCEs but the ACP test compares the contributions of both groups that include employer matching.

The employer then compares the test outcomes to this table:

A plan must pass both tests or the employer must take prescribed corrective action. That corrective action is not within the scope of this memo.

Using these equations, an employer can calculate its plan’s compliance at given HCE deferral rates and evaluate the effect on compliance with the nondiscrimination rules.

To be sure, the compliance tests for qualified plans are numerous, and these notes do not address the many nuances and exceptions to nondiscrimination testing. Rather, I seek here to pull back the curtain on but two often baffling, and always important, tests for qualified plans.

These notes discuss general principles only and are not intended as tax or legal advice.  The reader is encouraged to discuss his or her specific circumstances with a qualified practitioner before taking any action.

The mathematics of the annual testing for compliance with the rules requiring qualified plans to demonstrate nondiscrimination are spread though several sections of the tax law, rendering the calculations needed somewhat opaque. This note attempts to summarize some of the calculations so that plan sponsors might feel better empowered to assess the effect on compliance of both current and anticipated plan features.

Among the many compliance tests that qualified plans must meet in order to retain their qualified status are nondiscrimination tests which assure that the benefits of tax-deferred compensation do not accrue disproportionately to highly compensated employees (HCEs). There are several tests within this regime, but two of the more important tests, for our purposes, are the annual Actual Deferred Percentage (ADP) and Actual Contribution Percentage (ACP) calculations. While ADP considers only employee deferrals, ACP also includes employer contributions. Plan sponsors of non-exempt plans must conduct both tests, whether or not their results match.

The purpose of 401(k) nondiscrimination tests is to ensure that all employees are benefitting from plan participation. Otherwise, those who own the company and Highly Compensated Employees (HCEs) would stand to benefit disproportionately from being able to defer their income for tax purposes over Non-Highly Compensated Employees (NHCEs).  Because, for example, a plan to increase the share of compensation that only HCEs may defer could cause a non-exempt plan to fail one or more nondiscrimination tests, thereby exposing the plan sponsor to penalties and possible loss of the qualified status of the plan, it is worth considering the calculations used in the ADP and ACP tests and how those calculations might be affected by adding the feature of increased deferral rights for HCEs.

For purposes of this testing, an HCE is an individual who either:

• Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
• For the preceding year, received compensation from the business of more than$125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

One of the qualifications a plan must meet to be or remain a “qualified plan” within the meaning of Code Section 401 is that it not discriminates in favor of highly compensated employees. This condition is described at §401(a)(4):[[

(4) if the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees (within the meaning of section 414(q)). For purposes of this paragraph, there shall be excluded from consideration employees described in section 410(b)(3)(A) and (C) [providing definitions for, respectively, the “year of service” and “hours of service” generally allowed as conditions for vesting]

Actual Deferral Percentage – 26 C.F.R. §1.401(k) -2

The ADP test calls for employers to compare the average annual deferral rates of HCEs and NHCEs. This test excludes employer matching and measures only employee deferrals. See, Reg. §1.401(k)-2. The ADP test also measures employee compensation only in cash and stocks. Health insurance and other fringe benefits are excluded. The employer (usually the plan administrator handles this tax, but the employer is responsible). This equation is used, separately, for both HCEs and NHCEs:

Where

n= total number of either HCEs or NHCEs
D= total employee deferrals, both pretax and Roth, for each employee
C=each employee’s total annual compensation

Actual Contribution Percentage – 26 C.F.R. §1.401(m) -2

The ACP test follows a similar pattern but uses different variables. This test also measures HCE and NHCE results separately:

Where

n=total number of either HCE or NHCEs
T=total of each employee’s deferrals, after tax contributions, and employer matching
C=each employee’s total annual compensation

The largest difference between the two is that the ADP test compares relative deferrals among HCEs and NHCEs but the ACP test compares the contributions of both groups that include employer matching.

The employer then compares the test outcomes to this table:

A plan must pass both tests or the employer must take prescribed corrective action. That corrective action is not within the scope of this memo.

Using these equations, an employer can calculate its plan’s compliance at given HCE deferral rates and evaluate the effect on compliance with the nondiscrimination rules.

To be sure, the compliance tests for qualified plans are numerous, and these notes do not address the many nuances and exceptions to nondiscrimination testing. Rather, I seek here to pull back the curtain on but two often baffling, and always important, tests for qualified plans.

These notes discuss general principles only and are not intended as tax or legal advice. The reader is encouraged to discuss his or her specific circumstances with a qualified practitioner before taking any action.

On July 6, 2020, the Department of Revenue Service (“DRS”) released initial guidance, in a Q&A format, addressing some of the issues concerning the impact of the federal Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, on interpretation of Connecticut tax law. These notes provide a summary of some of the more important issues reviewed in the guidance.

Individual Income Tax

DRS observes that, because calculation of Connecticut state income tax begins with the individual’s federal adjusted gross income (“AGI”), which is then subjected to certain state law modifications to arrive at Connecticut adjusted gross income, and the federal economic impact payments are excluded from federal adjusted gross income, they are, therefore, not included in Connecticut adjusted gross income and not subject to Connecticut income tax.

Coronavirus Related Distributions from Qualified Retirement Accounts

Likewise, Connecticut law includes no modifications to include coronavirus-related distributions from qualified retirement accounts. Hence, insofar as federal law includes or excludes such distributions in or from income, Connecticut tax law will do the same.

Coronavirus-related distributions from a qualified retirement account, as allowed under the CARES Act, are, however, subject to the statutory 6.99% withholding unless the recipient submits a Form CT-W4P to the payor requesting that no or a lesser amount of Connecticut income tax be withheld.

Inclusion in Income of Loans Forgiven in Business or Individual Income Tax

Loans forgiven under the CARES Act Paycheck Protection Program are excluded from AGI under federal law. Because Connecticut law includes no modification of the federal treatment of AGI for state tax purposes with regard to PPP loan forgiveness, such forgiven loans are not included in Connecticut AGI for either individual income tax or corporation business tax purposes.

State Law Effects of CARES Act NOL Provisions

Corporations

Connecticut corporation business taxes are not affected by the federal carryforward and carryback rules.

Individuals

The carryback of federal net operating losses that affect an individual’s state tax liability must be done consistent with the 2014 Connecticut Superior Court opinion of Adams v. Sullivan. In that case, the court held that, because Connecticut law makes no provision for individual taxpayers to deduct federal Net Operating Losses (“NOLs”) from Connecticut AGI, those NOLs may offset Connecticut AGI for a given year only to the extent the taxpayer used those NOLs to offset federal AGI for that year. These NOLs are also subject to C.G.S. §12-727(b) (generally requiring that taxpayers filing a federal amended tax return also file with DRS a corresponding Connecticut tax return).

Note that individuals with a Connecticut source loss but with no corresponding federal loss are not affected by the NOL treatment changes of the CARES Act. Such individuals are still required to comply with Connecticut Regulation §12-711(b)(6).

Business Loss Limitation

The Tax Cuts and Jobs Act (P.L. 115-97) created a new Section l in Code Section 461. This section, among other things, disallows business losses of noncorporate taxpayers in excess of $250,000 ($500,000 for joint filers).  This threshold is subject to indexing for inflation.  Any amount disallowed is carried forward to the next tax year. This provision sunsets on December 31, 2025.

The CARES Act, however, repeals the excess business loss limitation for tax years 2018, 2019, and 2020. The Act also provides two additional important revisions to the law:

• NOLs incurred in a year beginning after December 31, 2017 and before January 1, 2021 can be carried back for up to five years preceding the year in which the loss was incurred and
• The CARES Act suspended the rule limiting NOL utilization to 80% of taxable income for tax years beginning before January 1, 2021

Because Connecticut law provides no specific statutory modifications to the excess business loss limitation, that calculation is applied to federal adjusted gross income calculations and thence to Connecticut AGI calculations under applicable state law.

The Department of Revenue Services is likely to update its guidance on this issue as more information becomes available.

These notes are intended only to review general principles and are not intended as legal or tax advice. The reader is encouraged to discuss his or her specific circumstances with a qualified professional before taking any action.

The following is a summary of the second round of tax developments implemented by the US Treasury. Please click the link to view the full article.

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https://Proposed Regulations v2.pdf

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.