Attending the IRS Tax Forum in Washington D.C.

Our firm will be attending the National IRS tax forum in Washington D.C. this Summer.  The forum is a 3 day conference that allows practitioners to work closely with the IRS staff on a one to one level.

IRS extends relief from underpayment penalty

The IRS announced on Friday that it is amending Notice 2019-11 to lower the amount of tax that an individual must have paid in 2018 to avoid the underpayment of estimated income tax penalty to 80% (Notice 2019-25). The change was made after concerns were raised that the earlier relief, which lowered the underpayment penalty threshold from 90% to 85%, did not go far enough given all the uncertainties taxpayers and tax practitioners faced after the many changes wrought by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.

Under Sec. 6654(d)(1)(B), the required annual income tax payment an individual taxpayer is required to make to avoid an underpayment penalty is the lesser of (1) 90% of the tax shown on the return for the tax year or (2) 100% of the tax shown on the taxpayer’s return for the preceding tax year (110% if the individual’s adjusted gross income on the previous year’s return exceeded $150,000). Sec. 6654(a) imposes an addition to tax for failure to make a sufficient and timely payment of estimated income tax. The IRS, however, is entitled to waive the addition to tax in certain unusual circumstances if its imposition would be against equity and good conscience.

With Friday’s notice, the IRS is waiving the Sec. 6654 addition to tax for failure to make estimated income tax payments for the 2018 tax year otherwise required to be made on or before Jan. 15, 2019, for any individual taxpayer whose total withholding and estimated tax payments made on or before Jan. 15, 2019, equal or exceed 80% of the tax shown on that individual’s 2018 return.

To request the waiver, an individual taxpayer must file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with his or her 2018 income tax return. The taxpayer should check the waiver box in Part II, box A, of the form and include the statement “80% waiver” on the return.

Sale of Fixed Assets and gains attributable to those assets

When you sell a business asset you can potentially have different types of gains and losses, even within the same transaction.  The gains and losses can be: short term capital gains, short term capital losses, long term capital gains, long term capital losses, section 1245 depreciation recapture, section 1250 depreciation recapture, unrecaptured 1250 gain, and 28% gain (relating to the sale of certain collectibles).  Each of these categories of gains and losses are treated differently and taxed at different rates.

When determining what character of gain you will have when you sell a business asset it is first important to determine what kind of asset you are selling and also what type of entity the asset is being held in.  The three categories of assets that are most commonly sold are (1) Section 1231 property, (2) Section 1245 property, and (3) Section 1250 property.  If the asset that is sold is being held in a C-Corporation the gain is taxed at ordinary tax rates despite what kind of property the asset is.  If the asset that is being sold is held in an entity other than a C-Corporation then you can potentially have different layers of gain, depending on the type of asset that is sold.

Section 1231 property are assets that are used in your trade or business and are held by the Taxpayer for more than one year.  A gain on the sale of Section 1231 business property is treated as long-term capital gain and is taxed at a maximum rate of 15%, at least through December 31, 2012.   A loss on the sale of Section 1231 business property is treated as ordinary loss and can reduce ordinary income on the Taxpayer's return and is not subject to the capital loss limitations ($3,000 limitation for individuals or capital gain limitation for corporations).   However there is a Section 1231 recapture rule that if you sell business property at a gain and you have deducted ordinary losses due to the sale of Section 1231 property in that past five years then the Section 1231 gain that you recognize will be taxed as ordinary income, using the Taxpayer's ordinary income rate, and not the preferential 15% maximum capital gain rate.

Section 1245 property is (1) all depreciable personal property, whether tangible or intangible, and (2) certain depreciable real property (usually, real property that performs specific functions, for example, a storage tank, but not buildings or structural components of building). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset that was sold.  Any gain up to the amount of the previously taken depreciation will be taxed at ordinary income rates.  The amount of gain that exceeds the depreciation previously taken is then treated as Section 1231 gain (subject to the Section 1231 rules mentioned above).  The Section 1245 recapture rules do not apply if the asset is sold at a loss.  If a section 1245 asset is sold at a loss, the loss is treated as a Section 1231 loss and is deducted as an ordinary loss which can reduce ordinary income.

Section 1250 property consists of real property that is not Section 1245 property (as defined above), generally buildings and their structural components.  When you sell Section 1250 property you will have to be aware of possible Section 1250 depreciation recapture as well as "unrecaptured Section 1250 gain".  If you sell Section 1250 property that is placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to Section 1250 depreciation recapture.  If you depreciated nonresidential real property which was placed in service before 1987 and you depreciated the property placed in service using just straight-line depreciation, there would be no Section 1250 depreciation recapture. However, if at any time an accelerated depreciation method was used, the gain on the sale will be taxed as ordinary income to the extent that the amount of accelerated depreciation taken exceeded depreciation that would have been allowed if you used the straight line depreciation method.  This Section 1250 depreciation recapture is taxed at ordinary income rates.

Any gain in excess of the amount treated as ordinary income because of Section 1250 recapture, but not exceeding the total depreciation claimed, is "unrecaptured Section 1250 gain".   Unrecaptured Section 1250 gain will be taxed at a maximum rate of 25%.  

Any remaining gain in excess of both the Section 1250 depreciation recapture and unrecaptured Section 1250 gains will be treated as Section 1231 gain (long term capital gain), which will be taxed at a maximum rate of 15%, through December 31, 2012.  The sale of Section 1250 property at a loss produces a Section 1231 loss and is deducted as ordinary loss which can reduce ordinary income. The Section 1250 recapture provisions only apply to gains, not losses.

As I'm sure you can see it is not as simple as just selling a business asset.  Every sale of business assets can have many possible tax treatments, producing various tax results.  The tax treatment of the sale of business assets can be quite complex and if you are unsure of the possible tax consequences you should contact your Dermody, Burke, and Brown tax advisor to explain how the sale should be treated.

Basis Limitation for k-1 losses

Basis Limitations for K-1 Losses
Definition
The basis limitation is a limitation on the amount of losses and deductions that a partner of a partnership or a shareholder of a S-Corporation can deduct. The basis limits are the first of three limitations that are applied to Schedule K-1 losses and deductions. After the basis limits are applied, the At-risk limits (Form 6198) are applied. If losses are allowed by the basis and at-risk limits, the passive limits (Form 8582) are applied, if applicable.



Per Schedule E (1040), shareholders of S Corporations are required to attach a basis calculation to their tax return each year. There is no form for the basis limitation, but a worksheet, and some instructions have been provided in the partner and shareholder instructions for Schedule K-1.

It is important to note that the capital account shown on the Partner's K-1 is not the same as basis. According to the Partner's Instructions for Schedule K-1, the basis schedule represents outside basis while the capital account represents inside basis. These can differ, even when the partnership maintains its books and records on a tax basis. One way this difference can occur is when a partner buys his partnership interest from another partner, since the purchase price becomes the starting point for his outside basis. (For more information on general K-1 issues, please see K-1 Issues for Individual Taxpayers, General)



Computation
The starting point for the basis limitation is adjusted basis at the beginning of year. The adjusted basis at the beginning of the year is the ending adjusted basis from last year reduced by loss allowed in the previous year. In the initial year, basis is equal to the adjusted basis of property contributed to the partnership, plus any gain recognized on the contribution of property.

The following adjustments are made to arrive at the beginning adjusted basis used in applying the basis limitation:



Increases:
Adjusted basis is increased by current income from the activity, additional amounts invested in the activity, and depletion in excess of the oil and gas property basis.

Additionally, the adjusted basis of a partner's interest in a partnership includes the partner's share of the partnership's liabilities. This is not the case for shareholders in an S-Corporation. Because the S-Corporation is a corporation, it is a distinct legal entity separate from the shareholder, so the shareholder does not increase his or her basis by their share of liabilities. The shareholder only increases their basis by the loans they make directly to the corporation.



Increases to Shareholders' debt basis:
Once losses have reduced a shareholder's stock basis to zero, basis in loans that the shareholder has made to the S-corp is used to allow losses. In future years, any net increases increase debt basis before stock basis. It is important to note "Net Increases" is determined by netting together current year income, losses, prior year losses and distributions. If prior year losses are in excess of current year income, there is no "net increase" and therefore no restoration of debt basis. For more information, please see IRC. 1367(b)(2)(B)).



Decreases:
Distributions, decreases in a partner's share of partnership debt, and repayments on loans the shareholder made to the S corporation are all reductions to a partner's or a shareholder's basis.

If the current year plus prior year disallowed losses exceed basis, some of the loss is disallowed. Any disallowed loss is carried to the following year return and is treated as incurred in the following tax year.

For partners, the allowed loss is allocated pro-rata to each category of loss or deduction (Ordinary, 1231, capital gains/losses, 179 expense, etc). For shareholders, there are ordering rules. Nondeductible expenses and depletion are allowed in full first, unless the shareholder has filed an election to do otherwise. (Regulation 1.1367-1(f))



Distributions in excess of basis
Per Internal Revenue Code Sections 704(a)(2) and 1367(a)(2) basis can never fall below zero. If there has been a distribution in excess of basis, then gain has to be recognized on the distribution. This gain is not reported on schedule K-1. The partner/shareholder reports the gain on their tax return.

Per Internal Revenue Code Section 1368, the treatment of a distribution in excess of stock basis depends upon whether or not the S-Corporation has any earnings or profits from when it was a C-Corporation.

If there were no earnings and profits, then any amount distributed in excess of stock basis is considered gain from the sale or exchange of property. IRC. 1368(b)(2)). The character of the gain is dependent upon the holding period of the S-Corporation stock.

If the S-Corporation had earnings and profits from when it was a C-Corporation, then, per Internal Revenue Code section 1368(c) the following rules apply:

A. The portion of the distribution that does not exceed the accumulated adjustments account is treated as a gain from the sale or exchange of property.

B. The portion of the distribution remaining after step A above is treated as a dividend to the extent it does not exceed accumulated earnings and profits of the S corporation.

C. Any distribution remaining after applying the two steps above is treated as gain from the sale or exchange of property.

For partners, Distributions in excess of basis also results in gain. (IRC. 731(a)(1)) Any gain recognized is considered gain from the sale of exchange of the partnership interest. See Internal revenue code section 731 for how to determine the character of the gain.



Alternative Rule for computing partnership basis
In circumstances where the general rule for computing a partner's basis cannot be practicably followed, an alternative method of computing basis may be available. This alternative method computes the partner's basis by referencing the partner's share of the adjusted basis of partnership property they would receive upon termination of the partnership. (See Regulation 1.705-1(b) for more details about the alternative rule).

Thanks to Intuit for this information