For 2021, the Social Security tax wage cap will be $142,800, and Social Security and Supplemental Security Income (SSI) benefits will increase by 1.3 percent. These changes reflect cost-of-living adjustments to account for inflation.

For 2021, the Social Security tax wage cap will be $142,800, and Social Security and Supplemental Security Income (SSI) benefits will increase by 1.3 percent. These changes reflect cost-of-living adjustments to account for inflation.

2021 Wage Cap
The Federal Insurance Contributions Act (FICA) tax on wages is 7.65 percent each for the employee and the employer. FICA tax has two components:

• a 6.2 percent Social Security tax, also known as Old Age, Survivors, And Disability Insurance (OASDI); and
• a 1.45 percent Medicare tax, also known as hospital insurance (HI).

For self-employed workers, the Self-Employment tax is 15.3 percent, consisting of:

• a 12.4 percent OASDI tax; and
• a 2.9 percent HI tax.

OASDI tax applies only up to a wage base, which includes most wages and self-employment income up to the annual wage cap.

For 2021, the wage base is $142,800. Thus, OASDI tax applies only to the taxpayer’s first $142,800 in wages or net earnings from self-employment. Taxpayers do not pay any OASDI tax on earnings that exceed $142,800.

There is no wage cap for HI tax.

Maximum Social Security Tax for 2021
For workers who earn $142,800 or more in 2021:

• an employee will pay a total of $8,853.60 in social security tax ($142,800 x 6.2 percent);
• the employer will pay the same amount; and
• a self-employed worker will pay a total of $17,707.20 in social security tax ($142,800 x 12.4 percent).

Additional Medicare Tax
Higher-income workers may have to pay an Additional Medicare tax of 0.9 percent. This tax applies to wages and self-employment income that exceed:

• $250,000 for married taxpayers who file a joint return;
• $125,000 for married taxpayers who file separate returns; and
• $200,000 for other taxpayers.

The annual wage cap does not affect the Additional Medicare tax.

Benefits Increase for 2021
Finally, a cost-of-living adjustment (COLA) will increase social security and SSI benefits for 2019 by 1.3 percent. The COLA is intended to ensure that inflation does not erode the purchasing power of these benefits.

The IRS has adopted previously issued proposed regulations ( REG-106808-19) dealing with the 100 percent bonus depreciation deduction. In addition, some clarifying changes have been made to previously issued final regulations ( T.D. 9874). Changes to the proposed and earlier final regulations are largely in response to various comments submitted by practitioners, and generally relate to:

The IRS has adopted previously issued proposed regulations ( REG-106808-19) dealing with the 100 percent bonus depreciation deduction. In addition, some clarifying changes have been made to previously issued final regulations ( T.D. 9874). Changes to the proposed and earlier final regulations are largely in response to various comments submitted by practitioners, and generally relate to:

• the definition of qualified used property;
• the election to claim bonus depreciation on components acquired or self-constructed after September 27, 2017, for larger self-constructed property for which manufacture, construction, or production began before September 28, 2017;
• application of the mid-quarter convention;
• clarifications to the definition of qualified improvement property, predecessor, and class of property; and
• clarifications to the rules for consolidated groups
  The rules for consolidated groups have also been moved from Proposed Reg. §1.168(k)-2(b)(3)(v) to new Reg. §1.1502-68.

Used Property
The 2019 final regulations provide that in determining whether the taxpayer or a predecessor had a depreciation interest in property prior to its acquisition, only the five calendar years immediately prior to the current placed-in-service year are considered. The latest IRS regulations clarify that the five calendar years immediately prior to the current calendar year in which the property is placed in service by the taxpayer, and the portion of such current calendar year before the placed-in-service date of the property without taking into account the applicable convention, are taken into account. In addition, the five-year look-back period applies separately to the taxpayer and a predecessor.

Furthermore, if the taxpayer or a predecessor, or both, have not been in existence during the entire look-back period, then only the portion of the look-back period during which the taxpayer or a predecessor, or both, have been in existence is taken into account.

Expanded Component Election
The prior regulations allow taxpayers to election to claim 100 percent bonus depreciation on components of certain larger constructed property that qualifies for bonus depreciation if the construction of the larger property began before September 28, 2017. The components must be acquired or constructed after September 27, 2017, and the larger property must be placed in service before 2020 (2021 in the case of property with a longer construction period). The final regulations remove the 2020/2021 cutoff date. In addition, the final regulations provide that eligible larger self-constructed property also includes property that is constructed for a taxpayer under a written contract that is not binding and that is entered into prior to construction for use in the taxpayer’s trade or business. The definition of a larger constructed property is also clarified.

Qualified Improvement Property
The 15-year recovery period for qualified improvement property applies only to improvements "made by the taxpayer." The final regulations clarify that an improvement is considered made by a taxpayer if the property is constructed for the taxpayer. However, qualified improvement property received by a transferee taxpayer in a nonrecognition transaction described in Code Sec. 168(i)(7) is not eligible for bonus depreciation.

Mid-Quarter Convention
The final regulations clarify that depreciable basis is not reduced by the amount of bonus deduction in determining whether the mid-quarter convention applies.

Binding Contracts
Generally, property acquired pursuant to a binding contract entered into after September 27, 2017, does not qualify for bonus depreciation at the 100 percent rate. The final regulations clarify that a contract for a sale of stock of a corporation that is treated as an asset sale as the result of a Code Sec. 336(e) election made for a disposition described in Reg. §1.336-2(b)(1) is a binding contract if enforceable under state law.

Floor Plan Financing
The IRS intends to issue guidance relating to transition relief for taxpayers with a trade or business with floor plan financing indebtedness that want to revoke elections not to claim bonus depreciation for property placed in service during 2018.

The IRS will not allow a taxpayer to limit the amount of its otherwise deductible floor plan interest in order to qualify for bonus depreciation. However, guidance will address transition relief for the 2018 tax year for taxpayers that treated Code Sec. 168(j)(1) as providing an option for a business with floor plan financing indebtedness to include or exclude its floor plan financing interest expense in determining the amount allowed as a deduction for business interest expense for the tax year.

Effective Date
In general, the regulations apply to property acquired after September 27, 2017, and placed in service during or after a tax years that begins on or after January 1, 2021. However, they may be relied on for earlier tax years.

Final regulations reflect the significant changes that the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) made to the Code Sec. 274 deduction for travel and entertainment expenses. These regulations finalize, with some changes, previously released proposed regulations, NPRM REG-100814-19.

Final regulations reflect the significant changes that the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) made to the Code Sec. 274 deduction for travel and entertainment expenses. These regulations finalize, with some changes, previously released proposed regulations, NPRM REG-100814-19.

Changes to Code Sec. 274 under the TCJA
For most expenses paid or incurred after 2017, TCJA:

• repealed the "directly related to a trade or business" and the business-discussion exceptions to the general disallowance of entertainment expense deductions;
• eliminated the general business expense deduction for 50 percent of entertainment (but not meal) expenses; and
• repealed the special substantiation rules for deductible entertainment (but not travel) expenses. Taxpayers may rely on the proposed regulations until they are finalized.

Entertainment Expenses
Among other things, Reg. §1.274-11:

• restates the statutory rules of Code Sec. 274(a), including the entertainment deduction disallowance rule for dues or fees to any social, athletic, or sporting club or organization;
• substantially incorporates the existing definition of "entertainment" from Reg. §1.274-2(b)(1); and
• confirms that the nine exceptions in Code Sec. 274(e) continue to apply to deductible entertainment expenditures.

The regulations also confirm that "entertainment" does not include food or beverages unless they are provided at or during an entertainment activity, and their costs are included in the entertainment costs.

Food and Beverage Expenses
As under the proposed regulations, Reg. §1.274-12 allows taxpayers to deduct 50 percent of business meal expenses if:

• the expense is an ordinary and necessary business expense;
• the expense is not lavish or extravagant; the taxpayer or an employee is present when the food or beverage is furnished;
• the food or beverage is provided to a current or potential business customer, client, consultant, or similar business contact; and
• food and beverages that are provided during or at an entertainment activity are purchased separately from the entertainment, or their cost is separately stated.

With respect to the fourth requirement listed above, the final regulations adopt the definition of "business associate" in Reg. §1.274-2(b)(2)(iii), but expands it to include employees. Thus, these requirements would apply to employer-provided meals to employees as well as non-employees. The final regulations also flesh out the fifth requirement listed above, and clarify that the separate charges for entertainment-related food and beverages must reflect their actual cost, including delivery fees, tips, and sales tax. Indirect expenses such as transportation to the food are not included in the actual cost.

Exceptions and Special Rules
Food or beverage expenses for employer-provided meals at an eating facility do not include expenses for the operation of the facility, such as salaries of employees preparing and serving meals, and other overhead costs. The final regulations apply the TCJA changes to the exceptions and special rules for deductible food and beverages in Code Sec. 274(e), Code Sec. 274(k) and Code Sec. 274(n), including:

• reimbursed food or beverage expenses;
• recreational expenses for employees;
• items available to the public; and
• goods or services sold to customers.

The final regulations also provide examples on several specific scenarios to illustrate the rules.

The IRS has issued a final regulation addressing tax withholding on certain periodic retirement and annuity payments under Code Sec. 3405(a), to implement amendments made by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA). The regulation affects payors of certain periodic payments, plan administrators that are required to withhold on such payments, and payees who receive such payments. The final regulation adopts, without modification, a proposed regulation that updated and replaced the provisions of three questions and answers with a new regulation regarding the default withholding rate on periodic payments made after December 31, 2020.

The IRS has issued a final regulation addressing tax withholding on certain periodic retirement and annuity payments under Code Sec. 3405(a), to implement amendments made by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA). The regulation affects payors of certain periodic payments, plan administrators that are required to withhold on such payments, and payees who receive such payments. The final regulation adopts, without modification, a proposed regulation that updated and replaced the provisions of three questions and answers with a new regulation regarding the default withholding rate on periodic payments made after December 31, 2020.

Withholding on Periodic Payments
Before the TCJA, if a withholding certificate (Form W-4P) was not in effect for a periodic payment, the default withholding rate on the payment was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended Code Sec. 3405(a)(4) so that the default withholding rate on such a periodic payment is instead determined under rules prescribed by the Treasury Secretary.

After the TCJA was enacted, the IRS issued three notices providing that, for calendar years 2018, 2019, and 2020, the default withholding rate on periodic payments under Code Sec. 3405(a)(4) is based on treating the payee as a married individual claiming three withholding allowances ( Notice 2020-3, I.R.B. 2020-3, 330; Notice 2018-92, I.R.B. 2018-51, 1038; Notice 2018-14, I.R.B. 2018-7, 353).

Under new Reg. §31.3405(a)-1, the default rate of withholding on periodic payments made after December 31, 2020, is determined in the manner described in the applicable forms, instructions, publications, and other guidance prescribed by the IRS.

Applicability Date
The final regulation applies to periodic payments made after December 31, 2020.

The IRS has issued final regulations that provide guidance for employers on federal income tax withholding from employees’ wages.

The IRS has issued final regulations that provide guidance for employers on federal income tax withholding from employees’ wages. The final regulations:

• address the amount of federal income tax that employers withhold from employees’ wages;
• implement changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97); and
• reflect the redesigned Form W-4, Employee’s Withholding Certificate, and related IRS publications.

TCJA Changes
The TCJA made many amendments affecting income tax withholding on employees’ wages. The TCJA made many amendments affecting income tax withholding on employees’ wages.After the TCJA was enacted, the IRS issued guidance to implement the changes (for example, Notice 2018-14, I.R.B. 2018-7, 353; Notice 2018-92, I.R.B. 2018-51, 1038; Notice 2020-3, I.R.B. 2020-3, I.R.B. 2020-3, 330). The IRS updated Form W-4 and its instructions with significant changes intended to improve the accuracy of income tax withholding and make the withholding system more transparent for employees. It also released IRS Publication 15-T, Federal Income Tax Withholding Methods, which provides percentage method tables, wage bracket withholding tables, and other computational procedures for employers to use to compute withholding for the 2020 calendar year.

On February 13, 2020, the IRS published a notice of proposed rulemaking ( REG-132741-17) to update the regulations under Code Sec. 3401 and Code Sec. 3402 to reflect the legislative changes, and expand the rules to accommodate changes necessary to fully implement the redesigned Form W-4 and its related computational procedures, along with most existing computational procedures that apply to 2019 or earlier Forms W-4.

The final regulations adopt the proposed regulations with a few revisions.

Form W-4
The final regulations do not require all employees with a 2019 or earlier Form W-4 in effect to furnish a redesigned Form W-4. Comments expressed concerns that the proposed regulations and the related forms, instructions, publications, and other IRS guidance would require employers to maintain two different systems for computing income tax withholding on wages: one for 2019 or earlier Forms W-4, and another for the redesigned Forms W-4.

In response, the IRS is acknowledging concerns with (1) instructions to the redesigned Form W-4 for employees with multiple jobs and (2) optional computational “bridge” entries permitted under the regulations and described in Publication 15-T that will allow employers to continue in effect 2019 or earlier Forms W-4 as if the employees had furnished redesigned Forms W-4.

The final regulations revise Reg. §31.3402(f)(4)-1(a) to provide that an employer’s use of the computational bridge entries to adapt a 2019 or earlier Form W-4 to the redesigned computational procedures as if using entries on a redesigned Form W-4 will continue in effect such a Form W-4 that was properly in effect on or before December 31, 2019.

Lock-in Letters
The IRS issues a "lock-in" letter to notify an employer that an employee is not entitled to claim exemption from withholding, or is not entitled to the withholding allowance claimed on the employee’s Form W-4. The lock-in letter prescribes the withholding allowance the employer must use to figure withholding. After the lock-in letter becomes effective, the IRS may issue a subsequent modification notice, but only after the employee contacts the IRS to request an adjustment to the withholding prescribed in the lock-in letter.

Under the final regulations, employers are not required to notify the IRS that they no longer employ an employee for whom a lock-in letter was issued. Further, the final regulations do not require the IRS to reissue lock-in letters or modification notices solely because of the redesigned Form W-4.

The final regulations revise Reg. §31.3402(f)(2)-1(g)(2)(iv) relating to lock-in letters. and Reg. §31.3402(f)(2)-1(g)(2)(vii) relating to modification notices, to provide that an employer may comply with a lock-in letter or modification notice that is based on a 2019 or earlier Form W-4, as required by the regulations, if the employer implements the maximum withholding allowance and filing status permitted in a lock-in letter or modification notice by using the computational bridge entries as set forth in forms, instructions, publications, and other IRS guidance to calculate withholding for such a Form W-4.

Estimated Tax Payments
The final regulations revise Reg. §31.3402(m)-1(d) to allow employees to take estimated tax payments into account, as long as the employee (1) follows the instructions to the IRS’s Tax Withholding Estimator (available at https://www.irs.gov/individuals/tax-withholding-estimator) or IRS Publication 505, (2) is not subject to a lock-in letter or modification notice, and (3) does not request withholding from wages that falls below the pro rata share of income taxes attributable to wages determined under forms, instructions, publications, and other IRS guidance. The IRS intends to update its Tax Withholding Estimator and Publication 505 to reflect this rule.

Applicable Date
The final regulations generally apply on the date they are published in the Federal Register. Reg. §31.3402(f)(2)-1(g), regarding withholding compliance, applies as of February 13, 2020. Reg. §31.3402(f)(5)-1(a)(3), regarding the requirement to use the current version of Form W-4, applies as of March 16, 2020. The removal of Reg. §31.3402(h)(4)-1(b), regarding the combined income tax withholding and employee FICA tax withholding tables, applies on and after January 1, 2020.

Except for the removal of Reg. §31.3402(h)(4)-1(b), taxpayers may choose to apply the final regulations on and after January 1, 2020, and before their applicability date set forth in the regulations.

The Treasury and IRS have released final regulations that provide guidance for Achieve a Better Living Experience (ABLE) programs under Code Sec. 529A to help eligible individuals pay for qualified disability expenses.

The Treasury and IRS have released final regulations that provide guidance for Achieve a Better Living Experience (ABLE) programs under Code Sec. 529A to help eligible individuals pay for qualified disability expenses. The regulations provide guidance on:

• the requirements for ABLE programs,
• requirements for establishing and contributing to an ABLE account for a designated beneficiary,
• rules regarding changes in the designated beneficiary of an ABLE account,
• rollover and transfers from one ABLE account to another, and
• federal gift and generation-skipping tax consequences of an ABLE account.

The final regulations adopt proposed rules issued in 2015 and 2019 with a few modifications.

Qualified ABLE Programs
A qualified ABLE program is a program established and maintained by a State, or agency or instrumentality of a State. Several factors are provided in the final regulations in determining whether a State, or its agency or instrumentality, is actively involved in the administration of the program. Among those factors is the nature and extent of the State’s role in selecting and overseeing private contractors contracted to provide administrative or other services (for example, Community Development Financial Institutions (CDFIs)).

A qualified ABLE program may be maintained by two or more States or agencies or instrumentalities of a State in a consortium to offer broader investment choices, streamlined program administration, and lower fees for account holders. Consistent with legislation, the final regulations eliminate any reference to a residency requirement and a qualified program may allow an ABLE account to be established for an eligible individual regardless of his or her residence.

ABLE Accounts
An ABLE account is a tax-favored savings account established and owned by an eligible individual under a qualified ABLE program to pay qualified disability expenses of a designated beneficiary. The designated beneficiary of an ABLE account is the eligible individual who established and owns the ABLE account or who has succeeded the former designated beneficiary through a rollover distribution or change of beneficiary.

The final regulations provide that an ABLE account may be established on behalf of the eligible individual by his or her parent, legal guardian, or agent under a power of attorney. In addition, the regulations provide an expanded ordering rule of persons who may establish an ABLE account exercise signature authority over an individual’s ABLE account if necessary.

A qualified ABLE program may provide a certification process that an individual is eligible for an ABLE account, under penalties of perjury. Certification may be made by verifying that the individual is eligible for benefits under title II or XVI of the Social Security Act and the disability giving rise to those benefits occurred before the date on which he or she attained age 26. The other method of satisfying the definition of an eligible individual is by obtaining a disability certification and filing it with the Secretary.

A designated beneficiary is generally limited to only one ABLE account at a time. Once an ABLE account is established, generally no account that is subsequently established for that beneficiary can be treated as an ABLE account except for rollover and transfer purposes, as well as the return of excess contributions. Under the final regulation, an eligible individual is not prohibited from establishing an ABLE account merely because he or she previously closed another ABLE account.

Distributions and Transfers
Distributions from an ABLE account are excluded from the designated beneficiary’s gross income to the extent of his or her qualified disability expenses for the tax year. The final regulations maintain the expansive definition of qualified disability expenses, but the regulations do not provide either a comprehensive list of qualified disability expenses or a short list of expenses that would not satisfy that standard.

A qualified ABLE program may permit a successor designated beneficiary to be named during the lifetime of the designated beneficiary. If no successor designated beneficiary is named, the assets in the ABLE account are payable to the beneficiary’s estate and subject to the Federal estate tax. Moreover, the final regulations permit a qualified ABLE program to limit successor designated beneficiaries to a sibling who is an eligible individual. If a successor designated beneficiary is not a sibling, the former designated beneficiary receives a deemed distribution of the amount transferred to the successor.

The final regulations continue to permit rollovers from ABLE account but do not require the use of a program-to-program transfer. A rollover may occur from a qualified tuition account under Code Sec. 529 to an ABLE account for the same designated beneficiary. However, upon a rollover or program-to-program transfer, all the attributes of the former ABLE account are applicable to the recipient account.

Federal Gift and GST Taxes
The final regulations provide that contributions to an ABLE account by a person other than the designated beneficiary are treated as completed gifts. Thus, no distribution from an ABLE account to the designated beneficiary is treated as a taxable gift. Also, neither gift nor GST taxes apply to the change of designated beneficiary of an ABLE account if the new designated beneficiary is an eligible individual who is a sibling of the former designated beneficiary.

The IRS has released final regulations clarifying that the following deductions allowed to an estate or non-grantor trust are not miscellaneous itemized deductions.

The IRS has released final regulations clarifying that the following deductions allowed to an estate or non-grantor trust are not miscellaneous itemized deductions:

• costs paid or incurred in connection with the administration of an estate or non-grantor trust that would not have been incurred if the property were not held in the estate or trust;
• the personal exemption of an estate or non-grantor trust;
• the distribution deduction for trusts distributing current income; and
• the distribution deduction for estates and trusts accumulating income.

These deductions are not affected by the suspension of the deductibility of miscellaneous itemized deductions for tax years beginning after December 31, 2017, and before January 1, 2026. The final regulations also provide guidance on determining the character, amount, and allocation of deductions in excess of gross income succeeded to by a beneficiary on the termination of an estate or non-grantor trust. The regulations affect estates, non-grantor trusts (including the S portion of an electing small business trust), and their beneficiaries.

Clarifications of Proposed Regs
A notice of proposed rulemaking ( NPRM REG-113295-18) containing proposed regulations under Code Secs. 67 and 642(h) was published on May 11, 2020. The final regulations summarize the provisions of Code Secs. 67 and 642(h) and of the proposed regulations.

In response to comments, Reg. §1.642(h)-2 was clarified so that a beneficiary may claim all or part of the excess deductions before, after, or together with the same character of deductions separately allowable to that beneficiary. Reg. §1.642(h)-5(b), Example 2 was clarified to (1) offset the real estate expenses on rental property with the rental income to avoid any unintended issues with Code Sec. 469; (2) include personal property tax paid by the trust rather than taxes attributable to rental real estate; and (3) illustrate the application of trustee discretion as found in Reg. §1.652(b)-3(b) and (d).

The IRS has issued final regulations that address the gain or loss of certain foreign persons on the sale or exchange of an interest in a partnership that is engaged in a trade or business in the United States. The regulations provide guidance on determining the amount of gain or loss treated as effectively connected income under Code Sec. 864(c)(8), as well coordination rules. The final regulations retain the basic approach and structure of the proposed regulations ( REG-113604-18) with certain revisions. Proposed regulations ( REG-105476-18) on information reporting and withholding on dispositions of these interests will be finalized at a later date.

The IRS has issued final regulations that address the gain or loss of certain foreign persons on the sale or exchange of an interest in a partnership that is engaged in a trade or business in the United States. The regulations provide guidance on determining the amount of gain or loss treated as effectively connected income under Code Sec. 864(c)(8), as well coordination rules. The final regulations retain the basic approach and structure of the proposed regulations ( REG-113604-18) with certain revisions. Proposed regulations ( REG-105476-18) on information reporting and withholding on dispositions of these interests will be finalized at a later date.

Deemed Sale Gain or Loss
If a nonresident alien or foreign corporation disposes of an interest in a partnership that is engaged in any trade or business in the United States, the gain or loss is treated as effectively connected gain or loss under Code Sec. 864(c)(8). The amount of gain or loss is limited to the portion of the foreign transferor's distributive share of gain or loss that would have been effectively connected had the partnership sold all of its assets at fair market value (the deemed sale limitation).

The foreign transferor must first determine its gain or loss on the transfer of the partnership interest (outside gain or outside loss). Once the outside gain or loss is determined, the following steps are taken to derive the limitation based on the deemed sale, against which the outside gain or loss is compared:

Step 1: Determine the amount of gain or loss from each partnership asset as if the partnership conducted a deemed sale of all of its assets on the date of transfer (these amounts are referred to as deemed sale gain or deemed sale loss);
Step 2: Determine the amount of the deemed sale gain or loss that would be treated as effectively connected gain or loss with respect to each asset (these amounts are referred to as deemed sale EC gain or deemed sale EC loss); and
Step 3: Determine the foreign transferor’s distributive share of deemed sale effectively connected gain or deemed sale effectively connected loss.

Sourcing Rules
The final regulations address the sourcing rules that are often material in determining whether gain or loss is effectively connected with the conduct of a trade or business within the United States (Step 2). Because the sales are deemed sales, the regulations provide simplifying factual assumptions that generally treat deemed gain and loss as U.S. source where there is a partnership office in the United States (U.S. office attribution rule). The final regulations clarify that the general rules apply to personal property held by the partnership on the date of the deemed sale. The regulations also clarify that the U.S. office attribution rule does not apply unless the partnership maintains an office or other U.S. fixed place of business in the United States.

The final regulations provide additional sourcing rules for determining the foreign source portion of deemed sale gain and loss attributable to inventory, intangibles, and depreciable personal property specifically included in the deemed sale. The sourcing rules are needed because gain or loss from actual sales of each of these assets would be subject to specific sourcing rules under the Code, but sourcing deemed sale gain or loss under those rules would generally require facts that are not determinable in a deemed sale.

Under a 10-year rule, assets that have no nexus to the United States are removed from the deemed effectively connected gain or loss determination. The 10-year period is adjusted for partnerships not in existence for the period. The testing period is also adjusted to include periods during which the asset was held.

Treaties and Coordination Rules
The final regulations also address treaty coordination rules and provide that (1) treaty provisions are taken into account in computing the Step 3 amount, above; and (2) treaty benefits are available only if the transferor meets limitation of benefits (LOB) requirements. The final regulation also provide additional rules to coordinate the regulations with treaty provisions governing the disposition of U.S. real property interests.

The Step 3 amount does not include amounts that are excluded from the foreign transferor’s gross income or otherwise exempt from U.S. federal income tax by reason of an applicable provision of the Code, or amounts excepted under Code Sec. 897.

The final regulations clarify the interaction between the Code Sec. 897 coordination rule (i.e., application of Code Sec. 864(c)(8) over Code Sec. 897(g)) and the nonrecognition rules. Any transfer of an interest in a partnership as part of a nonrecognition transaction will not be subject to Code Sec. 864(c)(8) to the extent that the gain or loss on the transfer is not recognized. Rather, if the partnership owns one or more U.S. real property interests, Code Sec. 897(g) and its regulations will apply with respect to the unrecognized gain or loss.

Applicability Dates
The regulations generally apply to transfers occurring on or after December 26, 2018, which is the date on which the proposed regulations were filed with the Federal Register. Additionally, the final regulations apply to amounts taken into account on or after December 26, 2018, pursuant to an installment sale (as defined in Code Sec. 453(b)) occurring on or after November 27, 2017, and before December 26, 2018.

Taxpayers that place new business assets other than real property in service through 2012 may claim a "bonus" depreciation deduction. Although the bonus depreciation deduction is generally equal to 50 percent of the cost of qualified property, the rate has been increased by recent legislation to 100 percent for new business assets acquired after September 8, 2010 and placed in service before January 1, 2012. Thus, the entire cost of such 100 percent rate property is deducted in a single tax year rather than over the three- to 20-year depreciation period that is normally assigned to the property based on its type or the business activity in which it is used.

Every business should consider taking advantage of 100 percent bonus depreciation while it is available this year. Ironically, the benefits of 100 percent bonus depreciation are so favorable that some of the regular tax rules standing guard under normal circumstances to prevent abuses are being unintentionally triggered. The IRS has now come to the rescue with a few clarifications, elections and workarounds, in the form of Rev. Proc. 2011-26.

The most important clarifications/elections provide:

--A taxpayer is deemed to acquire qualified property when it pays or incurs the cost of the property.

--Bonus depreciation may be claimed at the 100 percent rate even though a pre-September 9, 2010 binding acquisition contract was in effect provided the contract was not in effect before January 1, 2008.

--Qualified property that a taxpayer manufactures, constructs, or produces is considered acquired by the taxpayer when the taxpayer begins constructing, manufacturing, or producing that property.

--A taxpayer may elect to claim 100 percent bonus depreciation on a component of a larger property if the component is acquired after September 8, 2010 even though manufacture, construction, or production of the larger property began before September 9, 2010.

--A taxpayer may elect the 50 percent rate in place of the 100 percent rate but only in a tax year that includes September 9, 2010.

Election Procedures for 2009/2010 FY Taxpayers

Special procedures that mainly affect fiscal-year (FY) 2009-2010 taxpayers who filed returns prior to the reinstatement of bonus depreciation for the 2010 calendar year explain how to claim or not claim the bonus deduction on property placed in service in 2010.

"Safe Harbor" Enhances Bonus Depreciation for Cars

The guidance also provides an important benefit to taxpayers who purchase a new automobile in 2010 or 2011 that is eligible for the 100 percent bonus rate but which is subject to annual depreciation caps because the vehicle has a gross vehicle weight rating of 6000 pounds or less. The benefit comes in the form of a "safe harbor method of accounting," which allows a taxpayer to claim depreciation deductions in each year of the vehicle's depreciation period.

If this safe harbor method of accounting is not adopted, a taxpayer may only claim a depreciation deduction in the tax year that the vehicle is purchased and that deduction is limited to the amount of the first-year depreciation cap ($11,060 for cars and $11,160 for trucks and vans placed in service in 2010).

If the safe harbor method is adopted, a taxpayer may claim the amount of the first-year depreciation cap in the year the vehicle is purchased plus additional amounts in each of the next five tax years of the vehicle's regular depreciation period.

In most cases, the amount of depreciation allowed in each year of a vehicle's recovery period under the safe harbor method is the same amount that could have been claimed if the 50 percent bonus rate applied.

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

Taxpayers are required to keep accurate, permanent books and records so as to be able to determine the various types of income, gains, losses, costs, expenses and other amounts that affect their income tax liability for the year. The IRS generally does not require taxpayers to keep records in a particular way, and recordkeeping does not have to be complicated. However, there are some specific recordkeeping requirements that taxpayers should keep in mind throughout the year.

Business Expense Deductions

A business can choose any recordkeeping system suited to their business that clearly shows income and expenses. The type of business generally affects the type of records a business needs to keep for federal tax purposes. Purchases, sales, payroll, and other transactions that incur in a business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. Supporting documents for business expenses should show the amount paid and that the amount was for a business expense. Documents for expenses include canceled checks; cash register tapes; account statements; credit card sales slips; invoices; and petty cash slips for small cash payments.

The Cohan rule. A taxpayer generally has the burden of proving that he is entitled to deduct an amount as a business expense or for any other reason. However, a taxpayer whose records or other proof is not adequate to substantiate a claimed deduction may be allowed to deduct an estimated amount under the so-called Cohan rule. Under this rule, if a taxpayer has no records to provide the amount of a business expense deduction, but a court is satisfied that the taxpayer actually incurred some expenses, the court may make an allowance based on an estimate, if there is some rational basis for doing so.

However, there are special recordkeeping requirements for travel, transportation, entertainment, gifts and listed property, which includes passenger automobiles, entertainment, recreational and amusement property, computers and peripheral equipment, and any other property specified by regulation. The Cohan rule does not apply to those expenses. For those items, taxpayers must substantiate each element of an expenditure or use of property by adequate records or by sufficient evidence corroborating the taxpayer's own statement.

Individuals

• Record keeping is not just for businesses. The IRS recommends that individuals keep the following records:
• Copies of Tax Returns. Old tax returns are useful in preparing current returns and are necessary when filing an amended return.
• Adoption Credit and Adoption Exclusion. Taxpayers should maintain records to support any adoption credit or adoption assistance program exclusion.
• Employee Expenses. Travel, entertainment and gift expenses must be substantiated through appropriate proof. Receipts should be retained and a log may be kept for items for which there is no receipt. Similarly, written records should be maintained for business mileage driven, business purpose of the trip and car expenses for business use of a car.
• Business Use of Home. Records must show the part of the taxpayer's home used for business and that such use is exclusive. Records are also needed to show the depreciation and expenses for the business part of the home.
• Capital Gains and Losses. Records must be kept showing the cost of acquiring a capital asset, when the asset was acquired, how the asset was used, and, if sold, the date of sale, the selling price and the expenses of the sale.
• Basis of Property. Homeowners must keep records of the purchase price, any purchase expenses, the cost of home improvements and any basis adjustments, such as depreciation and deductible casualty losses.
• Basis of Property Received as a Gift. A donee must have a record of the donor's adjusted basis in the property and the property's fair market value when it is given as a gift. The donee must also have a record of any gift tax the donor paid.
• Service Performed for Charitable Organizations. The taxpayer should keep records of out-of-pocket expenses in performing work for charitable organizations to claim a deduction for such expenses.
• Pay Statements. Taxpayers with deductible expenses withheld from their paychecks should keep their pay statements for a record of the expenses.
• Divorce Decree. Taxpayers deducting alimony payments should keep canceled checks or financial account statements and a copy of the written separation agreement or the divorce, separate maintenance or support decree.

Don't forget receipts. In addition, the IRS recommends that the following receipts be kept:

• Proof of medical and dental expenses;
• Form W-2, Wage and Tax Statement, and canceled checks showing the amount of estimated tax payments;
• Statements, notes, canceled checks and, if applicable, Form 1098, Mortgage Interest Statement, showing interest paid on a mortgage;
• Canceled checks or receipts showing charitable contributions, and for contributions of $250 or more, an acknowledgment of the contribution from the charity or a pay stub or other acknowledgment from the employer if the contribution was made by deducting $250 or more from a single paycheck;
• Receipts, canceled checks and other documentary evidence that evidence miscellaneous itemized deductions; and
• Pay statements that show the amount of union dues paid.

Electronic Records/Electronic Storage Systems

Records maintained in an electronic storage system, if compliant with IRS specifications, constitute records as required by the Code. These rules apply to taxpayers that maintain books and records by using an electronic storage system that either images their hard-copy books and records or transfers their computerized books and records to an electronic storage media, such as an optical disk.

The electronic storage rules apply to all matters under the jurisdiction of the IRS including, but not limited to, income, excise, employment and estate and gift taxes, as well as employee plans and exempt organizations. A taxpayer's use of a third party, such as a service bureau or time-sharing service, to provide an electronic storage system for its books and records does not relieve the taxpayer of the responsibilities described in these rules. Unless otherwise provided under IRS rules and regulations, all the requirements that apply to hard-copy books and records apply as well to books and records that are stored electronically under these rules.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

A business with a significant amount of receivables should evaluate whether some of them may be written off as business bad debts. A business taxpayer may deduct business bad debts if the receivable becomes partially or completely worthless during the tax year.

In general, most business taxpayers must use the specific charge-off method to account for bad debts. The deduction in any case is limited to the taxpayer's adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction, which can serve to offset regular business income dollar for dollar. If the taxpayer holds a security, which is a capital asset, and the security becomes worthless during the tax year, the tax law only allows a deduction for a capital loss. However, notes receivable obtained in the ordinary course of business are not capital assets. Therefore, if such notes become partially or completely worthless during the tax year, the taxpayer may claim an ordinary deduction for bad debts.

For a taxpayer to sustain a bad debt deduction, the debt must be bona fide. The IRS looks carefully at a bad debt of a family member.

To be entitled to a business debt write off, the taxpayer must also make a reasonable attempt to collect the debt. However, in a nod to reality, the IRS does not request the taxpayer to turn the debt over to a collection agency or file a lawsuit in an attempt to collect the debt if doing so has little probability of success.

Deadlines for claiming a write off for any past business bad debt must be watched. Taxpayers have until the later of (1) seven years from the date they timely filed their tax return or (2) two years from the time they paid the tax, to claim a refund for a deduction for a wholly worthless debt not deducted on the original return.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Estimated tax is used to pay tax on income that is not subject to withholding or if not enough tax is being withheld from a person's salary, pension or other income. Income not subject to withholding can include dividends, capital gains, prizes, awards, interest, self-employment income, and alimony, among other income items. Generally, individuals who do not pay at least 90 percent of their tax through withholding must estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year.

Basic rules

The "basic" rules governing estimated tax payments are not always synonymous with "straightforward" rules. The following addresses some basic rules regarding estimated tax payments by corporations and individuals:

Corporations. For calendar-year corporations, estimated tax installments are due on April 15, June 15, September 15, and December 15. If any due date falls on a Saturday, Sunday or legal holiday, the payment is due on the first following business day. To avoid a penalty, each installment must equal at least 25 percent of the lesser of:

• 100 percent of the tax shown on the corporation's current year's tax return (or of the actual tax, if no return is filed); or
• 100 percent of the tax shown on the corporation's return for the preceding tax year, provided a positive tax liability was shown and the preceding tax year consisted of 12 months.

A lower installment amount may be paid if it is shown that use of an annualized income method, or for corporations with seasonal incomes, an adjusted seasonal method, would result in a lower required installment.

Individuals. For individuals (including sole proprietors, partners, self-employeds, and/or S corporation shareholders who expect to owe tax of more than $1,000), quarterly estimated tax payments are due on April 15, June 15, September 15, and January 15. Individuals who do not pay at least 90 percent of their tax through withholding generally are required to estimate their income tax liability and make equal quarterly payments of the "required annual payment" liability during the year. The required annual payment is generally the lesser of:

• 90 percent of the tax ultimately shown on your return for the 2015 tax year, or 90 percent of the tax due for the year if no return is filed;
• 100 percent of the tax shown on your return for the preceding (2014) tax year if that year was not for a short period of less than 12 months; or
• The annualized income installment.

For higher-income taxpayers whose adjusted gross income (AGI) shown on your 2014 tax return exceeds $150,000 (or $75,000 for a married individual filing separately in 2015), the required annual payment is the lesser of 90 percent of the tax for the current year, or 110 percent of the tax shown on the return for the preceding tax year.

Adjusting estimated tax payments

If you expect an uneven income stream for 2015, your required estimated tax payments may not necessarily be the same for each remaining period, requiring adjustment. The need for, and the extent of, adjustments to your estimated tax payments should be assessed at the end of each installment payment period.

For example, a change in your or your business's income, deductions, credits, and exemptions may make it necessary to refigure estimated tax payments for the remainder of the year. Likewise for individuals, changes in your exemptions, deductions, and credits may require a change in estimated tax payments. To avoid either a penalty from the IRS or overpaying the IRS interest-free, you may want to increase or decrease the amount of your remaining estimated tax payments.

Refiguring tax payments due

There are some general steps you can take to reconfigure your estimated tax payments. To change your estimated tax payments, refigure your total estimated tax payments due. Then, figure the payment due for each remaining payment period. However, be careful: if an estimated tax payment for a previous period is less than one-fourth of your amended estimated tax, you may be subject to a penalty when you file your return.

If you would like further information about changing your estimated tax payments, please contact our office.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

The tax rules surrounding the dependency exemption deduction on a federal income tax return can be complicated, with many requirements involving who qualifies for the deduction and who qualifies to take the deduction. The deduction can be a very beneficial tax break for taxpayers who qualify to claim dependent children or other qualifying dependent family members on their return. Therefore, it is important to understand the nuances of claiming dependents on your tax return, as the April 18 tax filing deadline is just around the corner.

Dependency deduction

You are allowed one dependency exemption deduction for each person you claim as a qualifying dependent on your federal income tax return. The deduction amount for the 2010 tax year is $3,650. If someone else may claim you as a dependent on their return, however, then you cannot claim a personal exemption (also $3,650) for yourself on your return. Additionally, your standard deduction will be limited.

Only one taxpayer may claim the dependency exemption per qualifying dependent in a tax year. Therefore, you and your spouse (or former spouse in a divorce situation) cannot both claim an exemption for the same dependent, such as your son or daughter, when you are filing separate returns.

Who qualifies as a dependent?

The term "dependent" includes a qualifying child or a qualifying relative. There are a number of tests to determine who qualifies as a dependent child or relative, and who may claim the deduction. These include age, relationship, residency, return filing status, and financial support tests.

The rules regarding who is a qualifying child (not a qualifying relative, which is discussed below), and for whom you may claim a dependency deduction on your 2010 return, generally are as follows:

-- The child is a U.S. citizen, or national, or a resident of the U.S., Canada, or Mexico;

-- The child is your child (including adopted or step-children), grandchildren, great-grandchildren, brothers, sisters (including step-brothers, and -sisters), half-siblings, nieces, and nephews;

 -- The child has lived with you a majority of nights during the year, whether or not he or she is related to you;

 -- The child receives less than $3,650 of gross income (unless the dependent is your child and either (1) is under age 19, (2) is a full-time student under age 24 before the end of the year), or (3) any age if permanently and totally disabled;

 -- The child receives more than one-half of his or her support from you; and

 -- The child does not file a joint tax return (unless solely to obtain a tax refund).

Qualifying relatives

The rules for claiming a qualifying relative as a dependent on your income tax return are slightly different from the rules for claiming a dependent child. Certain tests must also be met, including a gross income and support test, and a relationship test, among others. Generally, to claim a "qualifying relative" as your dependent:

-- The individual cannot be your qualifying child or the qualifying child of any other taxpayer; -- The individual's gross income for the year is less than $3,650; -- You provide more than one-half of the individual's total support for the year; -- The individual either (1) lives with you all year as a member of your household or (2) does not live with you but is your brother or sister (include step and half-siblings), mother or father, grandparent or other direct ancestor, stepparent, niece, nephew, aunt, or uncle, or inlaws. Foster parents are excluded.

Although age is a factor when claiming a qualifying child, a qualifying relative can be any age.

Special rules for divorced and separated parents

Certain rules apply when parents are divorced or separated and want to claim the dependency exemption. Under these rules, generally the "custodial" parent may claim the dependency deduction. The custodial parent is generally the parent with whom the child resides for the greater number of nights during the year.

However, if certain conditions are met, the noncustodial parent may claim the dependency exemption. The noncustodial parent can generally claim the deduction if:

-- The custodial parent gives up the tax deduction by signing a written release (on Form 8332 or a similar statement) that he or she will not claim the child as a dependent on his or her tax return. The noncustodial parent must attach the statement to his or her tax return; or

-- There is a multiple support agreement (Form 2120, Multiple Support Declaration) in effect signed by the other parent agreeing not to claim the dependency deduction for the year.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.