Significant 2014 & 2015 Tax Changes
Author: Scott Humphrey
Note: The Tax Increase Prevention Act of 2014, passed in late December 2014, extends many federal tax provisions that had expired at the end of 2013. The article below is accurate as of November 14, 2014.
Taxpayers beginning their year-end tax planning are focused on what Congress will do with the more than 50 temporary tax breaks that expired on December 31, 2013. While the fate of tax extenders still is unclear, taxpayers should not overlook several recently enacted tax law changes and clarifications that could significantly impact their situation.
Final Disposition Rules & Tangible Property Regulations
In an effort to reduce controversy between taxpayers and the IRS, the tangible property regulations—commonly referred to as the “repair regulations”—are designed to help taxpayers distinguish a current deductible repair from a capital expense. Business taxpayers who have not early adopted the repair regulations likely will need to file accounting method change forms with the IRS during the upcoming tax filing season. Of particular importance to capital-intensive businesses is the opportunity to make a late partial disposition for tax years beginning before January 1, 2015. This allows taxpayers to look at historical capitalized repairs and determine if the replaced component can be deducted. Taxpayers should carefully analyze capitalized repairs to avoid missing this time-sensitive opportunity.
NIIT Planning Considerations
Taxpayers should consider planning opportunities to reduce the net investment income tax (NIIT) liability. Now in its second year, the NIIT is a 3.8 percent tax on the lesser of net investment income or the excess (if any) of modified adjusted gross income less the applicable threshold. The applicable thresholds have not changed from last year and are not indexed for inflation—the threshold is $250,000 for married taxpayers filing jointly and surviving spouses, $125,000 for married taxpayers filing separately and $200,000 for all other taxpayers. Estates and certain trusts also are subject to the NIIT on the lesser of undistributed net investment income or the excess (if any) of adjusted gross income (AGI) over the dollar amount at which the highest tax bracket begins for the taxable year ($12,150 for 2014). Taxpayers should discuss the following planning opportunities with their tax advisor:
- Philanthropic taxpayers should consider donating appreciated securities to charity rather than cash.
- Taxpayers with income exceeding the applicable threshold should carefully consider options to accelerate deductions and defer income.
- Taxpayers should consider options to characterize otherwise passive income as nonpassive and exempt from the NIIT; examples include grouping elections, self-rental recharacterization, safe harbors for real estate professionals and material participation by a trust.
- Trusts subject to the NIIT should consider the ability to distribute investment income to beneficiaries not subject to the NIIT; this can be done within 65 days of year-end by making a 65-day election.
Aragona Case Adds Support for Material Participation by a Trust
Frank Aragona Trust v. Commissioner was a major victory for taxpayers, as the tax court clarified what constitutes material participation by a trust. The Frank Aragona trust was the sole owner of a business. The trust included six trustees, three of whom were employed by the trust-owned business. The IRS disallowed the losses from the business, reasoning the trustee could not be a material participant in the trust because the trustee’s duties were performed as an employee of the business. The court disagreed and ruled the activities of the trustees as employees of the business can be considered in determining if the trust materially participated.
Severance Payments Subject to FICA
Earlier this year, the U.S. Supreme Court ruled severance payments paid to involuntarily terminated employees are subject to Federal Insurance Contributions Act (FICA) taxes. However, severance payments tied to the receipt of state unemployment benefits remain exempt from FICA taxation. Protective claims filed in anticipation of this court case now are invalid. Employers that chose not to withhold on severance pay pending a decision should evaluate whether amended payroll tax returns are required to remit unpaid tax.
Proposed IRS Regulations Could Eliminate Bottom-Dollar Guarantees
Partnership members can obtain at-risk basis by personally guaranteeing all or a bottom portion of partnership debt. This often allows partners to deduct losses in excess of their capital contribution. The IRS, concerned that “bottom-dollar” guarantees do not expose partners to true economic loss, proposed regulations to redefine when a debt is treated as a recourse obligation. The regulations require the guarantor to meet the following six standards:
- The guarantor must maintain a commercially reasonable net worth.
- The guarantor must periodically document its financial condition.
- The payment term of the guarantor must not end before that of the partnership.
- The payment obligation cannot require the partnership to hold liquid assets exceeding the guarantor’s reasonable needs.
- The guarantor must receive arm’s-length consideration in exchange for assuming the payment obligation.
- The guarantor must be liable for the full amount of the payment obligation, i.e., no bottom-dollar guarantee.
The regulations are currently proposed, but taxpayers should consider the effect bottom-dollar guarantees may have on their current tax situation.
Clarification & Relief on IRA Rollovers
For rollovers occurring after 2014, the IRS confirmed the individual retirement account (IRA) one-rollover-per-year limit applies on an aggregate basis to all of a taxpayer’s IRAs rather than on an account basis. Direct transfers from one IRA trustee to another will not be affected, as such transfers are not subject to the limitation. IRA trustees are encouraged to offer IRA owners requesting a distribution for rollover the option of a trustee-to-trustee transfer between IRAs.
Virtual Currency Treated as Property, Not Currency
The IRS announced that virtual currency, e.g., Bitcoin, will be treated as property instead of currency. By treating virtual currency as property, the FMV of the virtual currency will need to be determined when a transaction occurs for tax purposes. For example, purchasing a $6 sandwich with virtual currency bought for $3 would trigger a $3 gain for the sandwich eater and $6 of gross income for the sandwich shop.
Portability Elections for Individuals Dying Between 2010 & 2013 Still May Be Available
The IRS released procedures allowing surviving spouses an extension through December 31, 2014, to make a late portability election for a spouse who died after December 31, 2010, and on or before December 31, 2013. A portability election allows a surviving spouse to apply the decedent spouse’s unused unified estate and gift tax exclusion amount (up to $5.25 million in 2013) to the survivor’s estate and gift tax. This relief applies only to taxpayers who did not previously file an estate tax return because the value of the estate was under the filing threshold.
Conservation Reserve Program Payments Not Subject to SECA in Certain Cases
Conservation Reserve Program (CRP) payments are made by the Farm Service Agency as payments in exchange for removing environmentally sensitive land from agricultural production. In a recent court case, a taxpayer leased a portion of land to farmers and received CRP payments. The CRP payments were determined to be rental income not subject to Self-Employment Contributions Act (SECA) tax, because the taxpayer was not an active farmer. If the taxpayer would have operated a farm instead, the CRP payments would have been subject to SECA.
These are just some of the new issues that could affect taxpayers. Your BKD advisor can help you determine which issues could affect your specific situation.