(d) As of January 1, 2024 (the beginning of the first taxable year succeeding the end of the recovery period), the adjusted depreciable basis of the passenger automobile is $8,401 ($60,000 unadjusted depreciable basis less the total depreciation allowable of $51,599 for 2018-2023 (see above table)). Accordingly, for the 2024 taxable year, X deducts depreciation of $5,760 for the passenger automobile (the lesser of the adjusted depreciable basis of $8,401 as of January 1, 2024, or the section 280F(a)(1)(B)(ii) limitation of $5,760).
(e) As of January 1, 2025, the adjusted depreciable basis of the passenger automobile is $2,641 ($8,401 adjusted depreciable basis as of January 1, 2024, less the depreciation claimed of $5,760 for 2024). Accordingly, for the 2025 taxable year, X deducts depreciation of $2,641 for the passenger automobile (the lesser of the adjusted depreciable basis of $2,641 as of January 1, 2025, or the section 280F(a)(1)(B)(ii) limitation of $5,760).
Example 2—Section 179 deduction claimed. The facts are the same as in Example 1, except X elects to treat $18,000 of the cost of the passenger automobile as an expense under section 179. As a result, this passenger automobile is not within the scope of this revenue procedure pursuant to section 3.01(4) of this revenue procedure. Accordingly, the safe harbor method of accounting in section 4.03 of this revenue procedure does not apply to the passenger automobile. For 2018, the 100-percent additional first-year depreciation deduction and the section 179 deduction for this passenger automobile is limited to $18,000 under section 280F(a)(1)(A)(i) (see Table 2 of Revenue Procedure 2018-25). Therefore, for 2018, X deducts $18,000 for the passenger automobile under section 179, and X deducts the excess amount of $42,000 beginning in 2024, subject to the annual limitation of $5,760 under section 280F(a)(1)(B)(ii).
Example 3—Section 168(k)(7) election made. The facts are the same as in Example 1, except X makes an election under section 168(k)(7) to not claim the 100-percent additional first-year depreciation deduction for 5-year property placed in service during 2018. As a result, the 100-percent additional first-year depreciation deduction is not allowable for the passenger automobile. Accordingly, the passenger automobile is not within the scope of this revenue procedure pursuant to section 3.01(2) of this revenue procedure, and the safe harbor method of accounting in section 4.03 of this revenue procedure does not apply to the passenger automobile. For 2018 and subsequent taxable years, X determines the depreciation deductions for the passenger automobile in accordance with the general depreciation system of section 168(a), subject to the section 280F(a) limitations.
3. We suppose it makes sense that racehorses have a swift recovery period.
Section 114 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 retroactively extended the section 168(e)(3)(A)(i) classification of racehorses as three-year MACRS property so that the classification applies to racehorses placed in service before January 1, 2021. A racehorse placed in service after December 31, 2020, qualifies for the three-year recovery period only if it is more than two years old when placed in service. This provision allowing classification of all racehorses as three-year property regardless of age had expired for racehorses placed in service after December 31, 2017.
4. Good news for those who placed motorsports entertainment complexes in service during 2018 and 2019 or who will do so in 2020.
Section 115 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 retroactively extended the section 168(e)(3)(C)(ii) classification of motorsports entertainment complexes as seven-year property to include property placed in service through December 31, 2020. Such property is depreciable over a seven-year recovery period using the straight-line method. This provision had expired for property placed in service after December 31, 2017.
F. Credits
1. A three-year credit for small employers that implement automatic contribution arrangements.
Section 105 of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) added new section 45T, which provides a $500 credit to certain small employers that implement an eligible automatic contribution arrangement (as defined in section 414(w)(3)) in a qualified employer plan (as defined in section 4972(d)). Generally, an automatic contribution arrangement allows an employer automatically to deduct elective deferrals from an employee’s wages unless the employee makes an election not to contribute or to contribute a different amount. The credit is available for each of three years to an “eligible employer,” which is defined in section 408(p)(2)(C)(i) as an employer that has 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year. An eligible employer can include the credit among the credits that are components of the general business credit under section 38(b). New section 45T applies to taxable years beginning after December 31, 2019.
2. Congress gives a “thumbs up” to new energy efficient homes.
Section 129 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 retroactively extended the section 45L credit of $2,000 or $1,000 (depending on the projected level of fuel consumption) an eligible contractor can claim for each qualified new energy-efficient home constructed by the contractor and acquired by a person from the contractor for use as a residence during the tax year. As extended, the credit is available for homes acquired before January 1, 2021. This provision had expired for homes acquired after December 31, 2017.
3. Congress has extended through 2020 the credit for employers that pay wages to certain employees during periods of family and medical leave.
Section 142 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 extended section 45S, which was enacted as part of the TCJA, through December 31, 2020. Section 45S provides that an “eligible employer” can include the “paid family and medical leave credit” among the credits that are components of the general business credit under section 38(b). The credit is equal to a percentage of the amount of wages paid to “qualifying employees” during periods in which the employees are on family and medical leave. The credit is available against both the regular tax and the alternative minimum tax.
Amount of the credit. To be eligible for the credit, the employer must pay during the period of leave at a rate that is at least 50% of the wages normally paid to the employee. The credit is 12.5% of the wages paid, increased by 0.25 percentage points for each percentage point by which the rate of payment exceeds 50%. The maximum credit is 25% of wages. Thus, if an employer pays an employee at a rate that is 60% of the employee’s normal wages, the credit is 15% of wages paid (12.5% plus 2.5 percentage points). The credit reaches 25% when the employer pays at a rate that is 100% of the employee’s normal wages. The credit cannot exceed the amount derived from multiplying the employee’s normal hourly rate by the number of hours for which the employee takes leave. The compensation of salaried employees is to be prorated to an hourly wage under regulations to be issued by the Treasury Department. The maximum amount of leave for any employee that can be taken into account for purposes of the credit is 12 weeks per taxable year.
Eligible employer. An eligible employer is defined as one who has in place a written policy that (1) allows all full-time “qualifying employees” not less than two weeks of annual paid family and medical leave and that allows all part-time qualifying employees a commensurate amount of leave on a pro rata basis and (2) requires that the rate of payment under the program is not less than 50% of the wages normally paid to the employee.
Eligible employee. An eligible employee is defined as any employee as defined in section 3(e) of the Fair Labor Standards Act of 1938 who has been employed by the employer for one year or more and who, for the preceding year, had compensation not in excess of 60% of the compensation threshold for highly compensated employees. For 2019, the threshold for highly compensated employees (see section 414(q)(1)(B)) was $125,000. Thus, for purposes of determining the credit in 2020, an employee is an eligible employee only if his or her compensation for 2019 did not exceed $75,000 ($125,000 x 60%).
Family and medical leave. The term “family and medical leave” is defined as leave described under sections 102(a)(1)(a)–(e) or 102(a)(3) of the Family and Medical Leave Act of 1993. (Generally, these provisions describe leave provided because of the birth or adoption of a child, a serious health condition of the employee or certain family members, or the need to care for a service member with a serious injury or illness.) If an employer provides paid leave as vacation leave, personal leave, or other medical or sick leave, this paid leave is not considered to be family and medical leave.
No double benefit. Pursuant to section 280C(a), no deduction is allowed for the portion of wages paid to an employee for which this new credit is taken. Thus, if an employer pays $10,000 to an employee and takes a credit for 25%, or $2,500, the employer may deduct as a business expense only $7,500 of the wages.
Effective date. The credit is available for wages paid in taxable years beginning after December 31, 2017, and before January 1, 2021.
4. Employers who retained employees despite becoming inoperable in areas affected by qualified disasters are eligible for a 40% employee retention credit.
Section 203 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 provides that an “eligible employer” can include “the 2018 through 2019 qualified disaster employee retention credit” among the credits that are components of the general business credit under section 38(b). The credit is equal to 40% of “qualified wages” for each “eligible employee.” The cap on the amount of qualified wages of an employee that can be taken into account is $6,000 (reduced by the amount of qualified wages with respect to the employee that may be taken into account for any prior taxable year). Thus, the maximum credit per employee is $2,400.
An “eligible employer” is an employer that conducted an active trade or business in a qualified disaster zone at any time during the incident period of the relevant qualified disaster, if the trade or business became inoperable at any time during the period beginning on the first day of the incident period of the qualified disaster and ending on December 20, 2019 (the date of enactment) as a result of damage sustained by reason of such qualified disaster. An “eligible employee” is an employee whose principal place of employment with an eligible employer, determined immediately before the relevant qualified disaster, was in the disaster zone of that qualified disaster.
The term “qualified wages” means wages (as defined in section 51(c)(1), but without regard to section 3306(b)(2)(B)) paid or incurred by an eligible employer with respect to an eligible employee during the period beginning on the date the trade or business first became inoperable at the employee’s principal place of employment and ending on the earlier of (1) the date on which the trade or business resumed significant operations at the principal place of employment or (2) the date that is 150 days after the last day of the incident period of the relevant qualified disaster. Wages can be qualified wages regardless of whether the employee performed no services, performed services at a different location, or performed services at the employee’s principal place of employment before significant operations resumed. An employee is not considered an eligible employee if the employer is allowed a credit with respect to the employee under section 51(a), i.e., an eligible employer cannot claim the 40% credit with respect to an employee for any period if the employer is allowed a Work Opportunity Tax Credit with respect to the employee under section 51 for that period.
Several key terms are defined in section 201 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019. These are as follows:
- The term “incident period” with respect to any qualified disaster is the period specified by FEMA as the period during which the disaster occurred, except that the period cannot be treated as beginning before January 1, 2018, or ending after January 19, 2020 (the date that is 30 days after the date of enactment of the legislation).
- The term “qualified disaster zone” is the portion of the qualified disaster area determined by the President to warrant individual or individual and public assistance from the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of the qualified disaster with respect to the qualified disaster area.
- The term “qualified disaster area” is an area with respect to which the President declared a major disaster from January 1, 2018, through February 18, 2020 (the date that is 60 days after the date of enactment of the legislation), under section 401 of the Stafford Act if the incident period of the disaster began on or before December 20, 2019 (the date of enactment). To avoid providing double benefits, the legislation excludes the California wildfire disaster area, for which similar relief was provided by the Bipartisan Budget Act of 2018.
- “The term ‘qualified disaster’ means, with respect to any qualified disaster area, the disaster by reason of which a major disaster was declared with respect to such area.”
G. Natural Resources Deductions & Credits
There were no significant developments regarding this topic during 2019.
H. Loss Transactions, Bad Debts, and NOLs
1. The Eleventh Circuit reversed a federal district court and held that the government failed to establish that an individual who reimbursed her ex-husband for federal taxes could not determine her tax liability under section 1341 for the year she paid the reimbursement.
In Mihelick v. United States, the taxpayer, Nora Mihelick, and her husband, Michael Bluso, divorced in 2005. During their marriage, they had both worked at Gotham Staple Company, a closely held Ohio corporation owned by her ex-husband’s family and for which her ex-husband served as chief executive officer. While their divorce was pending, her ex-husband’s sister, a minority shareholder in Gotham Staple Company, sued the taxpayer’s ex-husband and asserted claims of breach of fiduciary duty on the basis that he had excessively compensated himself at Gotham’s expense. Although the taxpayer initially resisted it, she and her ex-husband negotiated a provision in their separation agreement under which any liability arising from the litigation over her ex-husband’s alleged breach of fiduciary duty would be a marital liability for which they would be jointly and severally liable because, if such a liability came into existence, it would arise from the acquisition of marital assets during their marriage. In 2007, the taxpayer’s ex-husband settled the litigation pending against him and paid $600,000. The taxpayer resisted reimbursing her ex-husband, but after being advised by her attorney that she had an obligation to do so, she paid him $300,000 in 2009.
The taxpayer’s ex-husband determined his federal income tax liability for the year in which he made the $300,000 settlement payment by applying section 1341, which, if certain requirements are met, allows a taxpayer who must repay an amount previously included in income either to deduct the amount repaid or take a tax credit for the amount of tax overpaid in the year the income was included. On the taxpayer’s federal income tax return for 2009, the year in which she reimbursed her former husband, she determined her tax liability by applying section 1341 and claimed a refund, which the Service denied. Following the denial of her refund claim, the taxpayer brought a legal action seeking a refund in federal district court. The district court concluded that the taxpayer did not satisfy all requirements to determine her tax liability under section 1341, granted summary judgment for the government, and the taxpayer appealed.
In an opinion by Judge Rosenbaum, the Court of Appeals for the Eleventh Circuit held that the evidence supported the conclusion that the taxpayer satisfied all of the elements of section 1341 and that it was inappropriate for the district court to have granted summary judgment in favor of the government. The Eleventh Circuit remanded to the district court to determine whether there was any genuine issue of material fact concerning any of the elements of section 1341 and, if not, to enter judgment in favor of the taxpayer. If the district court concluded that there was a genuine issue of material fact, then the case had to proceed to trial. In either case, if the taxpayer prevailed, she would be entitled to determine her tax liability for 2009 by choosing whichever of the following provided her with the better result: (1) a deduction of the $300,000 she paid to her former husband in 2009 or (2) hypothetically recalculating her tax liability for the prior year in which she included the $300,000 in gross income by omitting the $300,000 from gross income, determining the amount by which her tax liability would have been reduced in that year, and taking the amount of the reduction as a credit in 2009.
To obtain the benefit of section 1341, four requirements must be satisfied. The court analyzed these requirements as follows:
The first requirement is that the taxpayer must have included an item in gross income for a prior year “because it appeared that the taxpayer had an unrestricted right to such item.” The government argued that this requirement was not met because the taxpayer’s former husband had no unrestricted right to the income in the year the couple included it in gross income because he had misappropriated the funds, and therefore she could not have had an unrestricted right to the income. The court rejected this argument because there was no proof her former husband had misappropriated the funds and the settlement agreement that resolved the litigation against him expressly disclaimed any wrongdoing. The court similarly rejected the argument that the taxpayer had no unrestricted right to her former husband’s income under the provisions of Ohio law concerning marital property: “What matters is whether [the taxpayer] sincerely believed she had a right to Bluso’s income, not the correctness of her belief.” The court concluded that there was enough evidence in the record to support the taxpayer’s sincere belief that she had an unrestricted right to his income in the years they were married.
The second requirement for a taxpayer to use section 1341 is that the taxpayer must have later learned that she actually “did not have an unrestricted right” to that income. According to the court, “[t]o make this showing, the taxpayer must demonstrate that she involuntarily gave away the relevant income because of some obligation, and the obligation had a substantive nexus to the original receipt of the income.” The court concluded that both aspects of this requirement were satisfied. In doing so, the court rejected the government’s argument that the fact that the taxpayer had reimbursed her former husband and had not paid her portion of the liability directly to the opposing party in the lawsuit precluded her from satisfying this requirement.
The third requirement of section 1341 is that the amount the taxpayer did not have an unrestricted right to and repays must have exceeded $3,000. The parties agreed that this requirement was satisfied.
The final requirement of section 1341 is that the amount the taxpayer did not have an unrestricted right to and repays must be deductible under another provision of the Internal Revenue Code. The court held that this requirement was met because her former husband was entitled to deduct the payment as a loss under section 165(c)(1) (losses incurred in a trade or business) and, by extension, the taxpayer was as well.
I. At-Risk and Passive Activity Losses
1. The taxpayer materially participated in an activity even though some of his hours were not hours when he was physically present at the business location.
In Barbara v. Commissioner, the taxpayers, a married couple, resided in Florida. The husband had owned and managed Barbara Trucking, a Chicago-area garbage-collection and waste-management business, which he sold for millions of dollars. He used the proceeds of the sale to start a lending business. The business had an office in Chicago with two full-time employees. Mr. Barbara divided his time between Florida and Chicago, spending 40% of his time in Chicago and 60% in Florida. He performed all executive functions for the lending business and worked 200 days per year. While in Chicago, he devoted 5.75 hours per day to the business and while in Florida devoted two hours per day. The Service proposed various adjustments for the returns filed by the taxpayers for 2009 through 2012.
One issue in the case was whether Mr. Barbara had materially participated in the lending business in 2009 through 2012. The Tax Court (Judge Morrison) held that he had materially participated. The court framed the question as whether Mr. Barbara had materially participated in the business under the seventh test in Regulation section 1.469-5T(a), which requires that the taxpayer participate more than 100 hours in the activity during the year and that the taxpayer’s participation be “regular, continuous, and substantial.” The court calculated that Mr. Barbara had devoted 460 hours per year while in Chicago (200 days x 40% x 5.75 hours) and 240 hours per year while in Florida (200 days x 60% x 2.0 hours), for a total of 700 hours, which more than met the 100-hour requirement. The court also concluded that his participation was regular, continuous, and substantial.
III. Investment Gain and Income
A. Gains and Losses
1. “Bitcoin is not a currency.” “No surprise” says Professor Omri Marian.
a. Notice 2014-21 “describes how existing general tax principles apply to transactions using virtual currency.” The Notice has two main components: (1) a substantive part (i.e., how Bitcoin transactions should be taxed) and (2) an information reporting part (i.e., how income on Bitcoin transactions should be reported and how tax can be collected).
(i) Substance. The substantive part of the Notice provides very few surprises. The most important conclusions are as follows.
(a) Bitcoin is not a currency for tax purposes; it is property. As such, gain and losses on the disposition of Bitcoins can never be “exchange gain or loss.” This may come as a disappointment to taxpayers who lost money in Bitcoin investments and may have hoped to have the losses classified as exchange-losses, and, as such, as ordinary losses. On the other hand, taxpayers who have disposed of appreciated investment positions in Bitcoins may enjoy capital gains treatment. Taxpayers who hold Bitcoin as inventory will be subject to ordinary gains and losses upon disposition.
(b) The receipt of Bitcoin in exchange for goods and services is taxable at the time of receipt. The amount realized is the U.S. dollar value of the Bitcoins received. The disposition of Bitcoin in exchange for goods and services is a realization and recognition event to the extent the value of Bitcoin has changed since the time it was acquired. Thus, if a taxpayer bought one Bitcoin for $500 and later used one Bitcoin to purchase a TV when Bitcoin was trading at $600, the taxpayer has a taxable gain of $100.
This part of the Notice has attracted some criticism from several commentators. A New York Times article summarized this critique, noting that characterizing Bitcoin as property
could discourage the use of Bitcoin as a payment method. If a user buys a product or service with Bitcoin, for example, the I.R.S. will expect the individual to calculate the change in value from the date the user acquired the Bitcoin to the date it was spent. That would give the person a basis to calculate the gains—or losses—on what the I.R.S. is now calling property.
This criticism is partially justified, although the result would have generally been the same had the Service decided to classify Bitcoin as a foreign currency. Under current law, U.S. taxpayers whose functional currency is the U.S. dollar (practically all U.S. taxpayers) must track their basis in any foreign currency they hold and recognize exchange gain or loss as soon as they dispose of the currency, but only to the extent their exchange gain or loss exceeds $200. Thus, the criticism might have some merit, as capital gains or losses are taxed from the first dollar while exchange gain or losses are subject to the $200 threshold. This could be corrected if a de minimis threshold would be made applicable to Bitcoin transactions as well, but it is not clear that there is any legal basis for the Service to do so. The only way to completely avoid taxation upon disposition of Bitcoin is to characterize it as a functional currency, which could only conceivably happen if the U.S. adopts Bitcoin as a legal tender. This is much to ask for, and certainly not within the power of the Service to decide.
(c) Since taxes are paid in U.S. dollars and not in Bitcoin, the Bitcoin value must be converted to U.S. dollars for purposes of determining gains and losses. Fair market value is determined by reference to the BTC/USD price quoted in an online exchange if “the exchange rate is established by market supply and demand.” The problem with this determination is that there are multiple such exchanges, and the BTC/USD spot price may vary significantly among such exchanges. For example, in March, 2013, the price difference between various exchanges varied by as much as $100, for an average trading price across exchanges of about $575. Taxpayers could cherry-pick their BTC/USD exchange rate and reduce tax gains or increase tax losses. Notice 2014-21 prescribes that BTC to USD conversion must be made “in a reasonable manner that is consistently applied.” It is not clear what “consistency” means in this context, and more guidance on this issue is needed.
(d) Mined Bitcoins are includable in gross income, and thus taxed, upon receipt. Bitcoins come into existence by a mining process. “Miners” use their computing resources to validate Bitcoin transactions and, in return, are compensated with newly created Bitcoin. Unsurprisingly, the Service concluded that such income is taxable upon receipt.
The Service did not explicitly rule on the character of mining income, but it is most likely ordinary under several possible theories: (1) It is income from services—miners are paid in newly generated Bitcoin for handling the bookkeeping of the Bitcoin public ledger. The Service describes an example of mining income as income received from using “computer resources to validate Bitcoin transactions and maintain the public Bitcoin transaction ledger.” This may imply that the Service views mining income as income from the provision of services. (2) It is wagering income—from a technical point of view mining is guessing the correct answer to a complex cryptography problem. (3) Mining pools—most miners mine through mining pools, where multiple individual miners pool together their computing resources in order to generate Bitcoins. Mining pools might be classified as partnerships for tax purposes. If the mining pool is a partnership, the mining pool itself is clearly in the business of mining Bitcoins. Any income from a trade or business of the partnership (the pool) passes through as ordinary income to the partners (the miners). If the mining pool is not a partnership, miners essentially rent out their computing capacity to the mining pool’s operator. Rental income is ordinary income.
(ii) Information reporting and backup withholding. Notice 2014-21, as expected, also concludes that payments in Bitcoins are subject to information reporting and backup withholding. Thus, a person who in the course of trade or business makes Bitcoin payments in excess of $600 to a non-exempt U.S. person must report such payments to the Service and to the recipient on the applicable Form 1099. The payments are also subject to backup withholding to the extent the payor is unable to solicit the requisite tax information from the payee.
This interpretation is perfectly reasonable, but its practical significance is left to be seen. The U.S. information reporting system is built on the assumption, among others, that parties to a taxable transaction know each other (or can reasonably obtain information about one another and send information to each other). As such, for example, taxpayers can send Forms 1099 to each other. The operation of Bitcoin defeats this assumption. Bitcoin is specifically designed to allow for exchange of value without having the parties to a transaction ever know each other. In fact, a Bitcoin payor is not always in a position to know whether payments he or she makes are made to the same person or to different people. Payors may have a hard time even deciding whether the $600 threshold is met. The default is backup withholding. It is not clear, however, how the Service can enforce reporting and withholding requirements when both parties to a transaction are anonymous both to the Service and to each other. The ramifications may be significant. Consider for example mining pools. In order to be in compliance, U.S. based mining pools would have to identify their participants by name (rather than by anonymous address), a result that the Bitcoin community is all but certain to dislike. The alternative—backup withholding by the pool operator in respect of the Bitcoin mined—would probably drive Bitcoin miners to mining pools operated by non-U.S. taxpayers. It will be interesting to see how these requirements pan out.
(iii) Unaddressed issues. The Service is well aware of the limited breadth of Notice 2014-21, and it has solicited comments from taxpayers. Some specific issues not addressed by the Notice that may be of significance are as follows:
- Whether Bitcoin and Bitcoin-wallets are financial assets and financial accounts, respectively, for purposes of FATCA and FBAR reporting requirements. This may not be of immediate relevance to most taxpayers due to the dollar amount thresholds applicable in such contexts, but as Bitcoin grows in popularity, such issues may become relevant.
- Whether Bitcoin service providers (such as wallet service providers, Bitcoin exchanges, Bitcoin mining pools and so on) are financial institutions for reporting, withholding, and FATCA purposes.
- Whether Bitcoin mining pools are entities for tax purposes. Some Bitcoin mining pools may conceivably be classified as entities separate from their owners for tax purposes and, as such, may qualify as partnerships. This may carry with it significant tax consequences to Bitcoin miners.
- Can Bitcoin be classified as a commodity for purposes of section 475(e), allowing dealers to elect mark-to-market accounting?
(iv) Summary. The Service guidance is clear, concise, and correct on the law. While some obscurities remain, most major interpretative issues are addressed. Notice 2014-21 does an excellent job explaining how transactions involving Bitcoin are taxed. It got all of the substantive issues right. In the context of information reporting, however, the Notice exposes the limitations of current tax law when it comes to collecting tax on Bitcoin transactions. While the Service got the information reporting part right as well, the practical ability of the Service to enforce such requirements may be limited in certain contexts. The main challenge remains in the area of collection. Time will tell whether the arsenal at the disposal of the Service is enough to deal with tax evasion through Bitcoin or whether Congress will have to supply the Service with additional ammo.
b. Are virtual currency accounts reportable on the FBAR? In a Service webinar broadcast on June 4, 2014, a Service program analyst in the Small Business/Self-Employed Division stated that the Service and the Treasury Department’s Financial Crimes Enforcement Network (FinCen) have been closely monitoring developments around virtual currencies such as Bitcoin. FinCen has said that virtual currency is not going to be reportable on the FBAR, at least for this filing season, but that could change in the future. More recently, according to the Journal of Accountancy, the AICPA Virtual Currency Task Force reached out to FinCEN regarding this issue, and “FinCEN responded that regulations (31 C.F.R. section 1010.350(c)) do not define virtual currency held in an offshore account as a type of reportable account. Therefore, virtual currency is not reportable on the FBAR, at least for now.”
c. The Service has announced a virtual currency compliance campaign. On July 2, 2018, the Service announced on its website—as one of five, large business and international compliance campaigns—a virtual currency campaign. The website describes the campaign as follows:
The Virtual Currency Compliance campaign will address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21. The IRS will continue to consider and solicit taxpayer and practitioner feedback in education efforts, future guidance, and development of Practice Units. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The IRS is not contemplating a voluntary disclosure program specifically to address tax non-compliance involving virtual currency.
d. The Service has begun sending letters to taxpayers with virtual currency transactions who potentially failed to report their transactions properly. In July, 2019, the Service announced that it has begun sending letters to taxpayers with virtual currency transactions who potentially failed to report income or otherwise report the transactions properly. The Service expected that more than 10,000 taxpayers would receive the letters by the end of August, 2019. The Service urged those receiving the letters to take them very seriously and to take corrective action by amending returns and paying any tax and penalties due. The announcement stated that “[t]he names of these taxpayers were obtained through various ongoing IRS compliance efforts.”
e. If you are dealing with hard forks or airdrops of virtual currency you will want to read this Revenue Ruling. Revenue Ruling 2019-24 addresses whether a taxpayer has gross income as a result of either (1) a hard fork of a cryptocurrency that the taxpayer owns if the taxpayer does not receive units of a new cryptocurrency or (2) an airdrop of a new cryptocurrency following a hard fork if the taxpayer receives units of the new cryptocurrency. The Ruling provides definitions of a hard fork and an airdrop, which are very technical and require a detailed understanding of the mechanisms through which virtual currency transactions are carried out. The Ruling concludes that a taxpayer does not have gross income in the first situation but does have gross income in the second.
f. The draft Schedule 1 for the 2019 Form 1040 asks about virtual currency transactions. On October 10, 2019, the Service released a draft of Schedule 1 (Additional Income and Adjustments to Income) for the 2019 individual income tax return on Form 1040. The revised Schedule 1 asks the following question at the top of the form: “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?”
2. ♫♪ We’re off to see the wizard, the wonderful wizard of QOZ! ♪♫
Section 13823 of the TCJA added sections 1400Z-1 and 1400Z-2 to the Code relating to qualified opportunity zones (QOZs) and qualified opportunity funds (QOFs). New sections 1400Z-1 and 1400Z-2 are designed to encourage investors to free up capital and invest in economically distressed census tracts (i.e., QOZs) by providing federal income tax benefits to taxpayers who realize capital gains and reinvest them in certain funds (i.e., QOFs) that, in turn, invest in businesses and real estate located in these designated communities. More than 8,700 census tracts have been designated as QOZs. There are designated QOZs in all 50 states, the District of Columbia, and several U.S. territories. Sections 1400Z-1 and 1400Z-2 are effective December 22, 2017. To satisfy this effective date, it appears that the qualified reinvestment in a QOF must take place after December 22, 2017.
In October, 2018, the Treasury Department and the Service published its first set of Proposed Regulations under section 1400Z-2 and published a second set of Proposed Regulations in May, 2019. These two sets of Proposed Regulations are generally proposed to be effective on the date they are published as final regulations, but taxpayers can rely on them before that date if applied in their entirety and in a consistent manner.
a. Taxpayers Eligible to Use Section 1400Z-2. The tax benefits of investing in a QOF are set forth in section 1400Z-2. Virtually any type of taxpayer having a qualifying capital gain (“eligible gain”) may qualify for the tax benefits provided by section 1400Z-2 including individuals, C corporations (including regulated investment companies and real estate investment trusts), partnerships, S corporations, and trusts and estates. The Preamble to the Proposed Regulations states that eligible taxpayers also include common trust funds described in section 584 as well as qualified settlement funds, disputed-ownership funds, and other entities taxable under the section 468B Regulations.
b. Overview of Tax Incentives for Investing in QOFs. The tax incentives provided by section 1400Z-2 are summarized briefly below.
(i) Deferral of Capital Gain to Extent Invested in QOF Within 180 Days. Generally, section 1400Z-2 allows taxpayers to defer capital gains (long-term or short-term) to the extent the gains are invested in a QOF within 180 days of realizing the capital gain.
(ii) Investment in QOF Held for at Least Five Years—Ten-Percent Exclusion. If the investment in the QOF is held for at least five years, then the taxpayer can exclude from gross income ten percent of the original deferred capital gain.
(iii) Investment in QOF Held for at Least Seven Years—Additional Five-Percent Exclusion. If the investment in the QOF is held for at least seven years, then the taxpayer can exclude from gross income an additional five percent of the deferred capital gain for a total exclusion of 15% of the original deferred capital gain. Because gain deferred under section 1400Z-2 is taxed upon the earlier of the date the investment in the QOF is sold (or disposed of in a taxable transaction) or December 31, 2026, a taxpayer must invest in a QOF by December 31, 2019, to meet the seven-year holding period and thereby receive the additional five-percent exclusion.
(iv) Remaining Deferred Capital Gain Taxed No Later Than December 31, 2026. Any remaining deferred capital gain is generally taxed on the earlier of (1) the date the investment in the QOF is sold (or disposed of in a taxable transaction) or (2) December 31, 2026.
(v) Investment In QOF Held for at Least Ten Years—Post-Acquisition Gain Excluded from Income. For qualified investments in a QOF held for at least ten years, the taxpayer may elect to exclude from gross income any gain from post-acquisition appreciation (i.e., may elect to increase the basis of the fund to the fair market value of the fund on the date the investment in the fund is sold or exchanged).
c. Acquisition of a Qualifying QOF Interest. The discussion of investment in QOFs discussed in this outline assumes that the taxpayer invested cash in the QOF because it is generally presumed that the vast majority of investments in QOFs will be in cash. However, the Proposed Regulations provide detailed guidelines for how these rules would operate if the taxpayer transferred noncash property in return for a qualifying QOF interest. A taxpayer may not acquire a qualifying QOF interest in return for providing services to the QOF. A taxpayer can acquire a qualifying QOF interest from someone other than the QOF.
d. Qualifying Capital Gains Eligible for Deferral and or Exclusion. The requirements for capital gains to be eligible for deferral or exclusion are summarized below.
(i) “Capital” Gains Eligible for Deferral Treatment Under Section 1400Z-2. Proposed Regulation section 1.1400Z-2(a)-1(b)(2) provides that a gain eligible for deferral or exclusion treatment under section 1400Z-2 (“eligible gain”) is generally a gain that (1) is “treated as capital” for federal income tax purposes, (2) would otherwise have been recognized for federal income tax purposes before January 1, 2027, except for the deferral under section 1400Z-2, and (3) does not arise from a sale or exchange with a “related party.” The Preamble to the Proposed Regulations provides that even the “capital gain” portion (if any) of a dividend would generally qualify for deferral treatment under section 1400Z-2.
Although all gains treated as “capital gains” under the Code will generally be “eligible gains,” there are certain limitations on capital gains from section 1256 contracts and other gains that are part of an “offsetting-position” transaction.
(ii) Short-Term Capital Gains. There is no prohibition for qualifying short-term capital gains. However, if a short-term capital gain is deferred by a qualifying investment in a QOF, it will retain its short-term capital gain treatment when the deferred gain is ultimately recognized.
(iii) Gains Arising from a Sale to a “Related Party” Do Not Qualify. For this purpose, persons are related to each other if they are described in section 267(b) or section 707(b), determined by substituting 20% for 50% wherever it appears in those sections.
(iv) Capital Gains to Owners Resulting from Operating or Liquidating Distributions from Their C Corporations, S Corporations, or Partnerships. Generally, a capital gain is triggered under section 301 or section 731 if a C corporation, S corporation, or partnership makes an actual or deemed cash distribution in excess of the owner’s basis in the stock or partnership interest. A capital gain from such a distribution should generally be an “eligible gain” for purposes of deferral under section 1400Z-2. However, if the distributee-owner and the distributing entity meet the 20% ownership test for “related parties” discussed above (a fairly common situation), the gain on the distribution would not qualify for deferral.
(v) Capital Gains Under Section 1231. Proposed Regulation section 1.1400Z2(a)-1(b)(2)(iii) states:
The only gain arising from section 1231 property that is eligible for deferral under section 1400Z-2(a)(1) is capital gain net income for a taxable year. This net amount is determined by taking into account the capital gains and losses for a taxable year on all of the taxpayer’s section 1231 property. The 180-day [Reinvestment P]eriod . . . with respect to any capital gain net income from section 1231 property for a taxable year begins on the last day of the taxable year.
(a) Property Subject to Section 1231. Generally, section 1231 gains and losses arise from the sale or exchange or compulsory or involuntary conversion of “property used in the trade or business.” Section 1231(b)(1) generally defines “property used in a trade or business” as property used in a trade or business that is held for more than one year that is either (1) subject to the allowance for depreciation under section 167 or (2) real property. However, this category also includes timber held for more than one year when the taxpayer elects to treat the cutting as a sale and timber sold with a retained economic interest under section 631; coal or domestic iron ore sold with a retained economic interest as described under section 631; certain livestock; and certain unharvested crops.
(b) Section 1231 Tax Treatment. If, for the tax year, a taxpayer’s total section 1231 gains from sales or exchanges (i.e., those in the so-called “main hotchpot”) exceed the taxpayer’s total section 1231 losses, the gains are treated as long-term capital gains and the losses are treated as long-term capital losses. By contrast, if for the tax year a taxpayer’s total section 1231 losses exceed the taxpayer’s section 1231 gains, the gains are treated as ordinary income and the losses are treated as ordinary losses. As noted above, the Proposed Regulations provide that only a taxpayer’s “capital gain net income” under section 1231 is eligible for deferral under section 1400Z-2(a)(1). The term “capital gain net income” seems to suggest that only the “net” section 1231 gain amount is eligible for deferral. Assuming this interpretation is correct, if for the tax year a taxpayer had a single section 1231 gain of $100 and a single section 1231 loss of ($80), only the net section 1231 gain of $20 ($100 less $80) would be eligible for deferral. However, since the entire section 1231 gain of $100 is a long-term capital gain under a literal reading of section 1231(a)(1), some have argued that the entire $100 should be available for deferral.
Several professional groups have submitted comment letters to the Treasury Department recommending that the final regulations clarify that once a taxpayer has a net section 1231 gain, then each “gross” section 1231 gain ($100 in the above example) would be available for deferral if that amount is invested in a QOF.
(c) 180-Day Reinvestment Period for Net section 1231 Gains. For any given tax year, whether a taxpayer has a net section 1231 gain (qualifying for deferral) cannot be determined until the end of the tax year. Consequently, as noted above, the Proposed Regulations provide that the 180-day reinvestment period to invest in a QOF with respect to a net section 1231 gain does not begin until the last day of the taxable year.
Practice Alert! If, for example, a calendar-year taxpayer has only a single gain from the sale of a section 1231 asset during 2019, the earliest the taxpayer could purchase a qualifying interest in a QOF in order to defer the net section 1231 gain would be December 31, 2019. Presumably, unless we get further guidance on this issue, the taxpayer in this example would have to wait until December 31, 2019, to reinvest in the QOF even if the taxpayer knew in advance that there would be no section 1231 losses during the remainder of the year.
Several professional organizations (e.g., AICPA, ABA, and the State Bar of Texas Tax Section) have submitted comments to the Treasury Department recommending that the final regulations provide a more flexible 180-day period for section 1231 gains. For example, several of the comments recommended an option to start the 180-day period on the date of the sale of the section 1231 property (particularly if the taxpayer was able to predict with some certainty that it would end up with a net section 1231 gain by the end of the year).
(d) Section 1231 Gains Generated by Partnerships and S Corporations. Net section 1231 gains and losses generated by a pass-through entity (e.g., a partnership or S corporation) pass through to the owners as “separately stated” items. The owners (partners and S corporation shareholders) then combine the net section 1231 gains and losses that pass through with their own section 1231 gains and losses to determine whether they have an overall net section 1231 gain or a net section 1231 loss on their individual returns. Consequently, even if the pass-through entity has a net section 1231 gain at the entity level, it is entirely possible that the net section 1231 gain passing through to the owner, when combined with the owner’s separate section 1231 losses, could ultimately be taxed to the owner as a “net” section 1231 loss.
This treatment of net section 1231 gain passed through by a partnership or S corporation raises a question as to whether a partnership or an S corporation can make the election at the entity level to defer the net section 1231 gain (determined at the entity level) by investing in a QOF. According to media reports on the ABA Tax Section’s May meeting, Bryan Rimmke, an attorney-adviser in the Treasury Department’s Office of Tax Legislative Counsel, stated that “the government allows a partnership to net its gains against its losses for section 1231 purposes, and if it ends up with a net gain, the partnership can elect to invest that gain into a qualified opportunity fund.” It was reported that Mr. Rimmke agreed that this netting of section 1231 gains and losses at the partnership level is allowed for purposes of reinvesting the net gain in a QOF “[e]ven if a partnership doesn’t have a per se [section] 1231 netting.” Hopefully the Service will provide clear guidance on this issue in the final regulations.
(e) Impact of Recapture Rules on Eligible Section 1231 Gain. If, and to the extent, a net section 1231 gain is recharacterized as ordinary income under the depreciation recapture provisions of section 1245 or section 1250 or under the five-year look-back rule under section 1231(c), the ordinary income portion would not be eligible for deferral under section 1400Z-2.
Section 1231(c) generally provides that a taxpayer’s net section 1231 gain for the current year will be recharacterized as ordinary gain to the extent of the taxpayer’s net section 1231 losses recognized in the preceding five years. However, section 1231(c) is a section 1231 loss “look-back” rule, not a section 1231 loss “look-forward” rule. To illustrate, assume that for 2019 a taxpayer (1) has had no net section 1231 losses in the preceding five years, (2) in 2019 has already recognized a single section 1231 gain of $100, and (3) is now considering selling a single section 1231 asset for a loss of ($90). If the taxpayer sells the section 1231 loss asset before the end of 2019 generating a section 1231 loss of ($90), the taxpayer would have a “net” section 1231 gain for 2019 of $10 ($100 less $90) which would qualify for deferral under section 1400Z-2. However, if the taxpayer waits until 2020 to recognize the section 1231 loss of ($90), she will have a net section 1231 gain for 2019 of $100 eligible for deferral under section 1400Z-2. Moreover, if taxpayer has no other section 1231 transactions in 2020 other than the section 1231 loss of ($90), she would then be able to deduct fully the ordinary loss of ($90) against all other 2020 income. In this situation, the five-year look-back rule under section 1231(c) would not apply to 2020 because that rule applies only when there are net section 1231 losses reported in the preceding five years.
e. General Tax Benefits of Investing in Qualified Opportunity Funds (QOFs). The tax benefits provided by section 1400Z-2 for those investing in QOFs are described in more detail below.
(i) Gain-Deferral Benefits Under section 1400Z-2. A taxpayer may defer recognition of a qualifying capital gain by investing the amount of the gain in a QOF within 180 days of realizing the capital gain. For example, assume that a taxpayer sold a capital asset for $100 with a basis of $10 (realizing a $90 qualifying capital gain). The taxpayer could defer 100% of the $90 capital gain by investing $90 (i.e., the amount of the gain) in a QOF within 180 days. The initial basis of the QOF investment acquired as a result of the reinvestment of the taxpayer’s qualified capital gain is zero. So, in the above example, the taxpayer’s initial basis in the QOF investment is zero, even though the taxpayer paid $90 for it.
(a) Maximum Period of Gain Deferral. The deferred gain (e.g., $90 in the above example) must be recognized on the earlier of (1) December 31, 2026 (whether or not the taxpayer sells the QOF interest) or (2) the date the taxpayer sells or exchanges the interest in the QOF.
(b) Maximum Gain Recognized When Deferred Gain Triggered. When the deferred gain is triggered, the maximum amount of deferred gain that will be recognized is the lesser of (1) the amount of gain originally deferred or (2) the fair market value of the QOF investment as determined on the recognition date, over the taxpayer’s basis in the QOF investment. Again using the above example, assume that after four years the taxpayer sold the QOF investment for $75. This would result in a deferred gain of only $75 being triggered even though the original deferred gain was $90. This generally means that, if on the recognition date the value of the QOF interest has dropped below the initial investment amount in the QOF interest (e.g., in the above example that would be below $90), the amount of the deferred gain recognized will generally be reduced by the post-acquisition loss in value.
(ii) Reduction of Deferred Gain Based on Five- or Seven-Year Holding Periods. As mentioned previously, after the taxpayer holds the QOF investment for at least five years, ten percent of the deferred gain will be excluded from the taxpayer’s gross income. If the QOF investment is held at least seven years, then an additional five percent (a total of 15%) of the deferred gain will be excluded from the taxpayer’s gross income. This exclusion results from the taxpayer getting an automatic increase in the basis of the QOF interest of ten percent of the deferred gain at five years and an additional increase of five percent at seven years. Again using the above example, after the taxpayer has held the QOF investment for five years, her basis goes from zero to $9 (i.e., ten percent of the deferred gain of $90), and after holding it for seven years, her basis goes to $13.50 (i.e., 15% of the deferred gain of $90). As noted earlier, because gain deferred under section 1400Z-2 is taxed upon the earlier of the date the investment in the QOF is sold (or disposed of in a taxable transaction) or December 31, 2026, a taxpayer must invest in a QOF by December 31, 2019, to meet the seven-year holding period and thereby receive the additional five-percent exclusion.
Impact of Potential Increases in Capital Gains Tax Rates. Even in the best case scenario, 85% of the original deferred capital gain will be taxed no later than December 31, 2026, at whatever capital gains rates exist in 2026. If the current effective maximum long-term capital gains rate of 23.8% is increased between now and 2026, the increase in the capital gains rates would dilute the tax benefit of the tax deferral. Assuming a 15% deferred gain exclusion, it would appear that the top effective capital gains rate would have to be increased to above 28% (i.e., 28% x 85% equals 23.8%) before the top effective rate would be greater than the current top effective capital gains rate of 23.8%.
(iii) 100% Gain Exclusion After Holding QOF for Ten Years. After the taxpayer holds the QOF investment for at least ten years, the taxpayer can exclude 100% of the gain realized from the sale or exchange of the QOF interest. This gain, in essence, represents the appreciation that occurred in the QOF investment after the taxpayer purchased it. To receive the benefit of this exclusion, the taxpayer must sell the interest in the QOF before 2048. To illustrate, recall in the above example that the taxpayer sold a capital asset for $100 with a basis of $10 (realizing a $90 qualifying capital gain) and deferred the gain by investing $90 in a QOF within 180 days. If the taxpayer holds the QOF investment for at least ten years, sells it for $150, and elects to step the basis up to the fair market value of the QOF investment on the date of the sale as provided in section 1400Z-2(c), the taxpayer could exclude 100% of the $60 gain (i.e., sales proceeds of $150 less the initial investment of $90 in the QOF).
(a) Generally No Taxable Gain Triggered on Investment in QOF After Ten-Year Holding Period. The sale, exchange, or other disposition of a QOF investment (acquired solely to defer previous gain) that is held by the taxpayer for at least ten years should not trigger any taxable gain because (1) all of the initial deferred gain reflected in the investment in a QOF must be fully recognized no later than December 31, 2026, and (2) 100% of the post-acquisition gain is excluded if the QOF investment is held at least ten years.
(b) Ten-Year Rule Applies Only to QOF Investment That Allowed Taxpayer to Defer Initial Capital Gain. The only portion of the investment in the QOF that qualifies for this 100% gain exclusion is the portion of the investment that allows the taxpayer to defer a previous capital gain. If a taxpayer invests in a QOF and only a portion of the investment is used to defer a previous capital gain, then the investment in the QOF will be treated as two separate investments. For example, again recall the facts in the previous hypothetical in which the taxpayer sold a capital asset for $100 with a basis of $10 (realizing a $90 qualifying capital gain). Assume further that the taxpayer used the entire sales proceeds of $100 to purchase an interest in a QOF for $100. In that event (1) the QOF interest representing $90 of the purchase price (i.e., the amount of gain deferred) will be treated as a separate QOF investment and can qualify for the 100% exclusion if held at least ten years, and (2) the QOF interest representing $10 of the purchase price will likewise be treated as a separate QOF investment but will not qualify for the 100% exclusion. In this example, although the separate QOF investment represented by the $90 will qualify for the 10 to 15% bump-up in basis if held five or seven years, the separate QOF investment represented by the $10 will not qualify for any basis bump. Thus, an investor who simply invests in a QOF (without attempting to use the investment to defer previously-realized capital gain) will receive no special tax treatment under section 1400Z-2 when the investor later sells the QOF interest.
(c) QOF’s Sale of “Qualifying Ozone Business Property” After Ten Years. Generally, section 1400Z-2 allows a taxpayer who has met the ten-year holding period requirement to exclude 100% of the gain resulting from the sale of the taxpayer’s QOF interest. Thus, for example, if a taxpayer meeting the ten-year holding period requirement sold S corporation stock or a partnership interest in an entity that was a QOF and elected to step up the basis to fair market value, the entire gain would be excluded. Moreover, it appears that the entire gain on the sale a QOF partnership interest would be excluded even if the partnership held so-called “hot assets” under section 751(a).
Sale of Assets by QOF. The Proposed Regulations provide special rules for allowing an investor to exclude pass-through “capital gains” and pass-through “capital gain net income from section 1231 property” triggered by a QOF selling its qualifying ozone business property after the ten-year holding period. Note: Even if the ten-year holding period is satisfied, it appears that the QOF investor could not exclude pass-through ordinary gain (e.g., sections 1245 and 1250 depreciation recapture gain, cash-basis receivables, inventory gain, etc.) from the sale of the assets by the QOF. Consequently, if the investor sells an ownership interest in a QOF (S corporation stock or partnership interest) after meeting the ten-year holding period requirement, the taxpayer can exclude 100% of the gain. By contrast, if the QOF sells the assets of the business, any ordinary income passing through to the QOF investor will be fully taxed.
(iv) Gain Triggered On Disposition of Entire Interest in QOF May Be Deferred if Reinvested in QOF Within 180 Days, But Reinvestment Starts New Holding Period. The Preamble to the Proposed Regulations states:
If a taxpayer acquires an original interest in a QOF in connection with a gain-deferral election under section 1400Z-2(a)(1)(A), if a later sale or exchange of that interest triggers an inclusion of the deferred gain, and if the taxpayer makes a qualifying new investment in a QOF, then the proposed regulations provide that the taxpayer is eligible to make a section 1400Z-2(a)(2) election to defer the inclusion of the previously deferred gain. Deferring an inclusion otherwise mandated by section 1400Z-2(a)(1)(B) in this situation is permitted only if the taxpayer has disposed of the entire initial investment. . . .
The Preamble also provides:
[I]f an investor disposes of its entire qualifying investment in QOF 1 and reinvests in QOF 2 within 180 days, the investor’s holding period for its qualifying investment in QOF 2 begins on the date of its qualifying investment in QOF 2, not on the date of its qualifying investment in QOF 1.
f. “Inclusion Events” That Trigger Deferred Gain. The events that trigger recognition of a taxpayer’s deferred gain are described below.
(i) Deferred Gain “Inclusion Events.” Section 1400Z-2(b)(1)(A) generally requires the deferred gain to be recognized if the investment in the QOF is “sold or exchanged” before December 31, 2026. (Note: The following “inclusion events” are relevant only for the deferred gain through December 31, 2026, because any deferred gain remaining after application of the five- and seven-year exclusion rules must be recognized no later than December 31, 2026, even if the taxpayer is still holding the QOF investment.) Proposed Regulation section 1.1400Z2(b)-1(c) includes a long list of transactions (called “inclusion events”) that trigger all or a portion of the deferred gain reflected in an investment in a QOF. The list of “inclusion events” is long, technical, detailed, and the following is merely an overview of selected provisions. Generally, the “inclusion events” under the Proposed Regulations fall into two categories: (1) certain transactions that reduce the taxpayer’s equity interest in the QOF and (2) certain distributions of property from the QOF.
(a) Overview of “Equity Reductions” in Taxpayer’s Interest in QOF That Could Trigger Deferred Gain. Transactions that reduce a taxpayer’s equity interest (directly or indirectly) in the QOF that could trigger all or a portion of the deferred gain include (1) dispositions of all or a portion of an interest in a QOF by sale or exchange, (2) disposition by gift (even if the donee is a tax-exempt organization), (3) liquidation of the QOF, (4) certain liquidations of an owner of an interest in a QOF, (5) disposition of an interest in a partnership that is an owner in a QOF, and (6) an aggregate change in ownership in excess of 25% of an S corporation that holds an interest in a QOF.
The Proposed Regulations also provide that the deferred gain will be triggered if a taxpayer claims a worthlessness deduction under section 165(g) with respect to a qualifying QOF investment.
(b) Overview of Certain Distributions of Property That Could Trigger Deferred Gain. An inclusion event could occur whenever there is an actual or deemed distribution of property (including cash) by a QOF partnership or corporation in which the distributed property has a FMV in excess of the taxpayer’s basis in the QOF partnership or corporation. This could include a distribution from a QOF corporation or partnership that exceeds the owner’s basis and is thus taxed as a sale or exchange under sections 301, 731, or 1368.
(c) More Details on Inclusion Events. Please see Proposed Regulation section 1.1400Z2(b)-1(c) for additional details, including a complete list of inclusion events.
(ii) Overview of Certain Transactions That Do Not Trigger Deferred Gain. The Proposed Regulations also identify transactions that generally are not inclusion events, including (1) certain transfers of an investment in a QOF upon the death of a taxpayer (however, the deferred gain is treated as income in respect of a decedent under section 691 when triggered, but the recipient receives the decedent’s holding period in the QOF for purposes of the five-, seven-, and ten-year rules), (2) the contribution of an ownership interest in a QOF to a grantor trust, (3) section 721 contributions (i.e., contributions of property to a partnership in exchange for a partnership interest), and (4) the election, revocation, or termination of S corporation status.
If certain rigid requirements are satisfied, a QOF may be able to sell all or a portion of its qualifying opportunity zone property without triggering a penalty on the QOF for failing to invest 90% of its assets in qualified opportunity zone property if the proceeds are reinvested in qualifying opportunity zone property during a 12-month testing period. However, it appears under the Proposed Regulations that any gain (including capital gains) recognized by the QOF on the sale and reinvestment of its qualified opportunity zone property will pass through and be taxed to an investor in the QOF who has not held his or her interest for at least ten years. As previously discussed, if the investor has held the QOF interest for at least ten years, the pass-through capital gains or net section 1231 gains generated by the QOF should be tax-free to the investor.
g. Timing and Reporting Requirements for Deferred Gains Invested in a QOF. The timing and reporting requirements for deferred gains invested in a QOF are summarized below.
(i) The 180-Day Reinvestment Requirement. Generally, for an eligible capital gain to be deferred under section 1400Z-2, the taxpayer must purchase a qualifying investment in a QOF no later than 180 days following the date of the sale, exchange, or other disposition that generated the eligible gain. However, the Proposed Regulations provide that generally the first day of the 180-day period is the date on which the gain would be recognized for federal income tax purposes, without regard to the deferral available under section 1400Z-2. There are at least two examples in which the starting date of the 180-day period begins after the date of the sale or exchange: (1) net section 1231 gains—as discussed above—and (2) pass-through entities—if a partnership or S corporation has an “eligible gain,” the pass-through entity may elect to defer the gain and invest in a QOF within 180 days of the disposition. However, if the pass-through entity does not elect to defer the gain, each owner has the option to elect to defer the owner’s respective portion of the pass-through eligible gain by directly investing in a QOF. In this latter situation, the beginning of the 180-day period for the owners generally begins on the last day of the pass-through entity’s tax year.
(ii) Election Mechanics—Form 8949. A taxpayer must affirmatively elect to defer an eligible gain by making the election on Form 8949 (“Sales and Other Dispositions of Capital Assets”) in accordance with the Form’s instructions by reporting the eligible gain and entering “Z” in column (f). In addition, the instructions to the 2018 Form 8949 provide:
If the gain is reported on Form 8949, do not make any adjustments for the deferral in column (g). Report the deferral of the eligible gain on its own row of Form 8949 in Part I with box C checked or Part II with box F checked (depending on whether the gain being deferred is short-term or long-term). If you made multiple investments in different QO Funds or in the same QO Fund on different dates, use a separate row for each investment.
(iii) Service Says Election to Defer Gain Can Be Made on an Amended Return. On its website, the Service answered this question in a segment entitled “Opportunity Zones FAQs” which contains the following Q&A: “Q. Can I still elect to defer tax on that gain if I have already filed my tax return? A. Yes, but you will need to file an amended return, using Form 1040-X and attaching Form 8949.”
3. Tax Court holds that individuals’ amount realized from foreclosure sale of real property was bid price at foreclosure sale and, taking into account their basis in foreclosed properties, they realized a $4.3 million long-term capital loss.
In Breland v. Commissioner, Charles and Yvonne Breland, a married couple, sold real property in both 2003 and 2004, deposited the proceeds with an intermediary, and acquired other real property. They treated the transactions in 2003 and 2004 as like-kind exchanges eligible for deferred recognition of gain under section 1031. One of the properties that the taxpayers acquired in the like-kind exchange in 2004 was a lot on Dauphin Island, Alabama (Dauphin Island 1), for which they reported an adjusted basis of $6,689,113. In 2005, they acquired a second property on Dauphin Island (Dauphin Island 2) for $5,613,287. They financed the purchase of Dauphin Island 2 with a recourse mortgage loan from Whitney Bank in the amount of $11.2 million. The taxpayers used this loan, which was secured by both Dauphin Island 1 and Dauphin Island 2, not only to acquire Dauphin Island 2, but also to refinance indebtedness they had incurred with respect to Dauphin Island 1. In early 2009, the taxpayers defaulted on the loan from Whitney Bank, which had an outstanding balance at that time of $10.7 million. Whitney Bank foreclosed on the loan and held a foreclosure sale in 2009 at which Whitney Bank was the high bidder with a bid of $7.2 million. The taxpayers later filed for chapter 11 bankruptcy protection in federal court, and Whitney Bank filed a proof of claim in that proceeding for $6.3 million.
On their federal income tax return for 2009, the taxpayers initially reported a capital loss from the sale of Dauphin Island 1 and Dauphin Island 2 of $1.8 million, which they determined by treating the outstanding loan balance (approximately $10.7 million) as their amount realized and comparing it to their adjusted bases in the properties. They subsequently filed an amended return for 2009 on Form 1040X on which they reported a capital loss from the sale of Dauphin Island 1 and Dauphin Island 2 of $5.3 million, which they determined by treating the bid price at the foreclosure sale (approximately $7.2 million) as their amount realized and comparing it to their adjusted bases in the properties. The Service challenged their determination of both their amount realized and their adjusted bases in the properties sold at the foreclosure sale. According to the Service, the taxpayers had overstated the amount of their capital loss from the foreclosure sale.
a. The amount realized in the foreclosure sale was the $7.2 million bid price, not the full $10.7 million outstanding loan balance. The Tax Court (Judge Pugh) first concluded that the amount realized by the taxpayers from the 2009 foreclosure sale of Dauphin Island 1 and Dauphin Island 2 was the $7.2 million bid price for which the properties were sold, not the $10.7 million outstanding loan balance. Generally, under section 1001(b), a taxpayer’s amount realized from the sale or exchange of property is the amount of money received plus the fair market value of any property received. According to Regulation section 1.1001-2(a)(1), a taxpayer’s amount realized also includes the amount of any liabilities from which the taxpayer is discharged as a result of transferring the property. The Tax Court explained that this rule applies in the case of nonrecourse debt, that is, the amount realized includes the full amount of the nonrecourse debt that is discharged by transferring the property. In the case of recourse debt such as the debt in this case, however, the taxpayer’s amount realized is limited to the fair market value of the property. The court relied for this proposition on Regulation section 1.1001-2(a)(2), which provides that “[t]he amount realized on a sale or other disposition of property that secures a recourse liability does not include amounts that are (or would be if realized and recognized) income from the discharge of indebtedness under section 61(a)(12).”
The Service argued that the $7.2 million bid price for the Dauphin Island properties at the foreclosure sale did not establish their fair market value because the sale was compelled and not a sale between a willing buyer and a willing seller. According to the court, however, “in the case of mortgaged property sold at a foreclosure sale, we presume fair market value to be the bid price, absent clear and convincing evidence to the contrary.” In this case, the court concluded there was no clear and convincing evidence to the contrary, the bid price established the fair market value of the foreclosed properties, and the amount realized by the taxpayers was $7.2 million. In reaching this conclusion, the court rejected the Service’s argument that, if the bid price is treated as the amount realized, then the taxpayers should have recognized discharge of indebtedness income of approximately $5.5 million, which was the remaining loan balance. According to the court, the preponderance of the evidence, including Whitney Bank’s filing of a proof of claim in the taxpayers’ bankruptcy proceeding, suggested that the remaining loan balance had not been discharged.
b. The aggregate basis the taxpayers had in the properties sold at the foreclosure sale was $11.5 million, and therefore they realized a capital loss of $4.3 million. The Tax Court concluded that the taxpayers had not adequately substantiated their basis in the Dauphin Island 1 property. Specifically, the court concluded that they had not adequately substantiated their basis in the relinquished property they had exchanged for Dauphin Island 1 and therefore had not adequately substantiated the basis that carried over to Dauphin Island 1. Accordingly, the court reasoned that their basis in Dauphin Island 1 was $5.9 million, which was the amount of money they had paid for it plus the amount of indebtedness they had incurred to purchase it, less the amount of liabilities satisfied in the transaction in which they acquired Dauphin Island 1. Their basis in Dauphin Island 2 was $5.6 million, the amount they had paid for the property. Therefore, their aggregate basis in the two properties was $11.5 million. Their capital loss from the foreclosure sale was the amount by which their $11.5 million adjusted basis in the properties exceeded their $7.2 million amount realized, or $4.3 million. Because they had held both properties for more than one year, the loss was a long-term capital loss.
c. Anti-deficiency statutes must be considered. As the Tax Court pointed out in Breland, if the debt secured by foreclosed properties is nonrecourse debt, then the taxpayers’ amount realized from the foreclosure sale generally will be the full amount of the nonrecourse debt. In determining whether debt is nonrecourse, it is necessary to consider so-called state anti-deficiency statutes, which prohibit lenders from holding borrowers responsible for the difference between the amount of the mortgage loan secured by the property and the price for which the property is sold at the foreclosure sale. If a state anti-deficiency law applies, then the debt will be treated as nonrecourse debt and the taxpayers’ amount realized from the foreclosure sale generally will be the full amount of the debt. For example, in Simonsen v. Commissioner, the Tax Court held that debt secured by real property sold by the taxpayers in a short sale was nonrecourse debt when California’s anti-deficiency statute precluded the lender from pursuing the taxpayers for the balance of the loan that was not satisfied by the short sale. For this reason, the court in Simonsen treated the full amount of the mortgage loan as the taxpayers’ amount realized in the short sale.
B. Interest, Dividends, and Other Current Income
There were no significant developments regarding this topic during 2019.
C. Profit-Seeking Individual Deductions
1. The Service gets hoisted by its own petard, and in the process, we get an unusual lesson in “following the money” for purposes of the interest expense deduction limits under section 163.
Although the facts are a bit convoluted in Lipnick v. Commissioner, the Tax Court (Judge Lauber) reaffirmed the “follow the money” principles for determining deductible interest expense under section 163, including for debt-financed partnership distributions and the aftermath thereof. The taxpayer’s father held membership interests in several limited liability companies (LLCs) classified as partnerships for federal income tax purposes. The LLCs owned and managed very profitable residential rental properties in the Washington, D.C., area. The LLCs made nonrecourse debt-financed distributions to the taxpayer’s father totaling approximately $80 million. The taxpayer’s father used the proceeds of these debt-financed distributions to purchase investment assets that he held personally. Similarly, in 2012, the taxpayer’s father received, directly and indirectly, yet another debt-financed distribution of approximately $1.7 million from a residential rental property limited partnership (LP) in which he and his family limited partnership (FLP) were partners. The taxpayer’s father also used the proceeds of this debt-financed distribution to purchase investment assets that he held personally.
For the years 2009–2012, pursuant to Notice 89-35 and Temporary Regulation section 1.163-8T(a)(4)(i)(C), the taxpayer’s father reported his allocable share of the LLCs’ and the LP’s interest expense (including the LP’s interest expense passed through his FLP) as investment interest for purposes of the section 163(d)(1) limitation on the deductibility of investment interest. (Incidentally, it appears that the taxpayer’s father was able to deduct his entire allocable share of the LLCs’ and LP’s interest expense during the years 2009–2012 because the taxpayer’s father had ample investment income during those years.) Midway through 2011, the taxpayer’s father gave a portion of his membership interests in the LLCs to his taxpayer-son. Then, in October of 2012, the taxpayer’s father died bequeathing his partnership interests in the LP and FLP to his taxpayer-son. The foregoing transfers from the father to the taxpayer-son were treated as part-sale/part-gift transactions because the father’s allocable share of the LLCs’ and LP’s debt (including debt allocated via the FLP) was treated as an amount realized by the father, and an amount paid by the taxpayer-son, under Regulation section 1.752-1(h) and section 1.1001-2(a)(4)(v). In fact, the taxpayer’s father had reported taxable capital gains of approximately $23 million from his “gift” of the LLC interests to his taxpayer-son in 2011. (Presumably, no capital gains were realized or recognized upon the taxpayer father’s bequest of the LP and FLP interests to his taxpayer-son in 2012 due to the estate’s stepped-up basis.)
After receiving the foregoing LLC, LP, and FLP interests, the taxpayer-son did not continue to report his allocable share of the LLCs’ and LP’s interest expense as investment interest. Rather, the taxpayer-son reported his allocable share of the LLCs’ and LP’s interest expense for the years 2012 and 2013 as properly allocable to the underlying real estate assets and rental income of the LLCs and the LP. Accordingly, the taxpayer-son deducted his allocable shares of the interest expense against his allocable shares of the rental income. The Service, noticing the change in treatment of the interest, audited the taxpayer-son (because the LLCs and the LP were not subject to TEFRA-partnership audit rules), disallowed the deduction of the interest expense against the rental income of the LLCs and the LP, and proposed deficiencies for 2012 and 2013 totaling approximately $500,000. (Presumably, unlike his father, the taxpayer-son did not have sufficient investment income to be able to fully deduct his allocable share of the interest expense from the LLCs and LP.)
In support of his position that the interest expense was properly allocable to and deductible against the rental income of the LLCs and the LP (including debt allocated via the FLP), the taxpayer-son relied upon Regulation section 1.752-1(h) and section 1.1001-2(a)(4)(v) cited above as well as the Regulations under section 163. Specifically, Temporary Regulation section 1.163-8T(c)(3)(ii)(C) provides that if a taxpayer “takes property subject to debt,” and no debt proceeds are disbursed to the taxpayer, the debt is treated as being used to acquire the property. Accordingly, the associated interest expense is allocated to the acquired property for purposes of the deduction limitations of section 163. The taxpayer-son contended that even though his LLC interests were received via a “gift,” and the LP interest was received via a bequest, the taxpayer-son was allocated a share of LLCs’ and the LP’s debt, and he thus acquired his interests “subject to debt.” Further, the taxpayer-son relied upon Notice 89-35, which provides in relevant part that:
In the case of debt proceeds allocated under section 1.163-8T to the purchase of an interest in a passthrough entity (other than by way of a contribution to the capital of the entity), the debt proceeds and the associated interest expense shall be allocated among all the assets of the entity using any reasonable method.
The Service argued that the taxpayer-son was bound by the father’s treatment of the interest as an investment expense because a “once investment interest, always investment interest” rule should apply. Moreover, the Service argued that Temporary Regulation section 1.163-8T(c)(3)(ii)(C) was not relevant because the taxpayer-son did not actually take his LLC and LP interests “subject to a debt” as contemplated by the Regulations and Notice 89-35; rather, the rules of Regulation section 1.752-1(h) and section 1.1001-2(a)(4)(v) use such an approach for purposes of Subchapter K, not section 163.
The Tax Court (Judge Lauber) disagreed with the Service, citing Temporary Regulation section 1.163-8T(c)(3)(ii)(C) and Notice 89-35, as noted above. Judge Lauber determined that the Service’s position had no authoritative support and that the taxpayer-son’s position was correct. Judge Lauber wrote “[i]n short, whereas [the taxpayer’s father] received a debt-financed distribution, [the taxpayer-son] is treated as having made a debt-financed acquisition of the partnership interests he acquired from [his father].” Therefore, reasoned Judge Lauber, the Service’s own Notice 89-35 expressly allows the interest expense to be allocated to the real estate assets and income generated by the LLCs and LP (as was done by the taxpayer-son).
D. Section 121
There were no significant developments regarding this topic during 2019.
E. Section 1031
There were no significant developments regarding this topic during 2019.
F. Section 1033
There were no significant developments regarding this topic during 2019.
G. Section 1035
There were no significant developments regarding this topic during 2019.
H. Miscellaneous
1. No depositors, no regulation, no “bank,” no bad debt deduction for worthless asset-backed securities. An otherwise profitable victim of the financial meltdown can’t deduct any losses over $500,000,000 on asset-back securities. This one ain’t funny.
In MoneyGram International, Inc. v. Commissioner, MoneyGram’s core business was to provide consumers and financial institutions with payment services that involve the movement of money through three main channels: money transfers, money orders, and payment processing services. MoneyGram derived its revenue from the transaction fees paid by its customers and from management of currency exchange spreads on international money transfers. When a customer purchased a money order by giving cash to a MoneyGram agent, the agent had to remit the funds to MoneyGram immediately. However, MoneyGram typically entered into agreements with its agents allowing them to retain and use the funds for an agreed-upon period. MoneyGram also derived revenue from the temporary investment of funds remitted from its financial institution customers until such time as the official checks and money orders cleared. MoneyGram was not subject to regulation as a bank, and it had never been regulated as a bank by any federal banking regulator. On its 2007 and 2008 Forms 1120, MoneyGram classified its business as “nondepository credit intermediation.”
During 2007 and 2008, MoneyGram undertook a recapitalization that included writing down or writing off a substantial volume of partially or wholly worthless securities. MoneyGram claimed ordinary section 166(a) bad debt deductions with respect to the partial or complete worthlessness of hundreds of millions of dollars of non-REMIC, asset-backed securities in which it had invested. (Treating these losses as capital losses would have generated no current tax benefit for MoneyGram because it had no capital gain net income during 2007 and 2008 against which the capital losses could be offset.) The Service determined that the securities were “debts evidenced by a security” under section 165(g)(2)(C), that MoneyGram was entitled to ordinary bad debt deductions (via section 582(a)), as opposed to capital losses, but only if it were a “bank” within the meaning of section 581, and that MoneyGram was not a “bank;” thus, the Service disallowed the bad debt deductions.
The Tax Court (Judge Lauber) upheld the deficiency. To qualify as a “bank” under section 581, a taxpayer must satisfy three distinct requirements.
First, it must be “a bank or trust company incorporated and doing business” under Federal or State law. Second, “a substantial part” of [its] business must “consist[] of receiving deposits and making loans and discounts.” Third, [it] must be “subject by law to supervision and examination” by Federal or State authorities having supervision over banking institutions.
Under this test, during 2007 and 2008 MoneyGram did not qualify as a “bank” because it did not display the essential characteristics of a bank as that term is commonly understood and because a substantial part of its business did not consist of receiving bank deposits or making bank loans. Because MoneyGram was not a “bank” within the meaning of section 581, it was ineligible to claim ordinary loss deductions on account of the worthlessness of its securities under section 582. The losses were capital losses.
a. Maybe MoneyGram is a bank. The Fifth Circuit reversed and remanded for consideration whether MoneyGram was receiving “deposits” and whether it was making “loans and discounts.” In a per curiam opinion, the Court of Appeals for the Fifth Circuit vacated the Tax Court’s decision and remanded for further proceedings. One requirement to qualify as a “bank” under section 581 is that “a substantial part” of the taxpayer’s business must “consist[] of receiving deposits and making loans and discounts.” Section 581 does not define the terms “deposits” or “loans.” The Tax Court held that the term “deposits” as used in section 581 means “funds that customers place in a bank for the purpose of safekeeping,” that are “repayable to the depositor on demand or at a fixed time,” and which are held “for extended periods of time.” The Tax Court concluded that the funds received by MoneyGram in exchange for issuing money orders and the funds received from its financial institution customers were not “deposits” because MoneyGram did not hold these funds for safekeeping or for an extended period of time. The Tax Court also held that a “loan” as that term is used in section 581 “is memorialized by a loan instrument, is repayable with interest, and generally has a fixed (and often lengthy) repayment period.” The Tax Court concluded that the funds MoneyGram permitted its agents to keep temporarily, which were reflected on MoneyGram’s books as accounts receivable, were not loans but merely accounts receivable typical of any business that provides goods or services.
The Fifth Circuit disagreed with the definitions the Tax Court assigned to the terms “deposits” and “loans.” With respect to the term “deposits,” the Fifth Circuit held that the Tax Court had erred by interpreting it to require that MoneyGram hold funds received “for an extended period of time.” With respect to the term “loans,” the Fifth Circuit disagreed entirely with the definition used by the Tax Court. According to the Fifth Circuit, the “central inquiry” for determining if a transaction is a loan for tax purposes is whether the parties intend that the money advanced be repaid. The Fifth Circuit noted that it has adopted a non-exhaustive, seven-factor test to determine whether the parties to a transaction intended an arrangement to be a loan. Finally, the Fifth Circuit observed that section 581 requires as a condition of “bank” status that the taxpayer make loans and discounts. The Tax Court had not addressed whether MoneyGram made discounts. Because the Tax Court had applied incorrect definitions of the terms “deposits” and “loans” and had not addressed whether MoneyGram made “discounts,” the Fifth Circuit reversed the Tax Court and remanded for reconsideration.
b. We got it right the first time, says the Tax Court. MoneyGram is not a bank. On remand, in a lengthy opinion by Judge Lauber, the Tax Court concluded that MoneyGram neither received deposits nor made loans. The court also concluded that MoneyGram did not make discounts. Therefore, the court held, MoneyGram was not a “bank” within the meaning of section 581 and its losses were capital rather than ordinary losses. With respect to the issue whether MoneyGram received deposits, the Tax Court held that MoneyGram did not receive funds “for the purpose of safekeeping.” Although it received funds from its agents who issued money orders and received funds from its financial institution customers (such as banks) in connection with the processing of checks, in neither case, the court held, did MoneyGram receive the funds for the purpose of safekeeping.
The Tax Court also concluded that MoneyGram did not make “loans” when it allowed its agents that issued money orders to keep the funds for short periods of time before remitting them to MoneyGram. The court was influenced in part by the fact that MoneyGram had argued in several cases involving the bankruptcy of its agents that “the agent’s obligation to it arises by operation of law upon the agent’s defalcation as Trustee, not from a debtor-creditor relationship of the sort created by an ordinary secured loan.” Finally, the Tax Court held that MoneyGram did not make discounts. The court described the term “making discounts” in section 581, which provides a definition of “bank” that dates from 1936, as “somewhat old-fashioned terminology.” The term describes a practice more common at that time of a bank customer who held a bill or promissory note who would ask the bank to “discount” the note by paying the customer a lesser amount, say 90 cents on the dollar. The court analyzed MoneyGram’s investments in asset-backed securities and its purchase of commercial paper and concluded that neither activity constituted making discounts within the meaning of section 581.
IV. Compensation Issues
A. Fringe Benefits
1. Ministers pray this “crabby” case gets reversed (again!) on appeal.
In Gaylor v. Mnuchin, a case that had previously been overturned on appeal to the Seventh Circuit, the District Court for the Western District of Wisconsin (Judge Crabb) held section 107(2) to be unconstitutional because it violates the First Amendment’s establishment clause. Section 107(2) excludes from gross income a “rental allowance” paid to a minister as part of his or her compensation. Section 107(1) excludes the “rental value of a home” furnished to a minister as part of his or her compensation. For technical reasons, only section 107(2)’s “rental allowance” exclusion was at issue in the case. The named plaintiff, Gaylor, is co-president of the true plaintiff, Freedom from Religion Foundation, Inc. (FFRF).
In a prior iteration of the case, Freedom from Religion Foundation, Inc. v. Lew, the Court of Appeals for the Seventh Circuit vacated Judge Crabb’s prior ruling striking down section 107(2) by determining that FFRF lacked standing to sue; however, the Seventh Circuit essentially instructed FFRF on how it might obtain standing. FFRF dutifully followed the Seventh Circuit’s directions and then refiled its establishment clause claim with Judge Crabb. FFRF argued that section 107(2) violates the establishment clause because it “demonstrate[s] a preference for ministers over secular employees.” Judge Crabb agreed and ruled that section 107(2) is unconstitutional and ordered the Service to cease enforcing the statute. In a subsequent decision, Judge Crabb ordered that the court’s injunction prohibiting enforcement of the statute be stayed until 180 days after resolution of any appeal. In other words, stay tuned . . . .
a. Prayers answered! On appeal, the Seventh Circuit reversed and upheld the constitutionality of section 107(2). The Treasury Department and the Service argued before the Seventh Circuit that, although section 107(2) seems to advance a religious purpose by excluding rental allowances paid to “ministers of the gospel,” the history of section 107(2) reveals a secular purpose. To wit, Congress enacted section 107 in 1923 as a response to the Service’s original position in 1921 that the “convenience of the employer” exception for employer-providing housing (now codified at section 119(a)(2)) did not apply to ministers. The Treasury Department and the Service argued that section 107(2) was merely an extension of the “convenience of the employer” exception to gross income, not an impermissible government “establishment” of a religious preference. Writing for the court, Judge Brennan agreed, stating:
Reading § 107(2) in isolation from the other convenience-of-the-employer provisions, and then highlighting the term “minister,” could make the challenged statute appear to provide a government benefit exclusively to the religious. But reading it in context, as we must, we see § 107(2) is simply one of many per se rules that provide a tax exemption to employees with work-related housing requirements.
Moreover, Judge Brennan explained that although section 107(2) has broader application than the “convenience of the employer” exception of section 119(a)(2), the breadth of section 107(2) does not render the statute unconstitutional. In fact, Judge Brennan reasoned that section 107(2) is broadly written to avoid excessive government entanglement with the internal operations of a church. Otherwise, without section 107(2), section 119(a)(2) would require the Service to interrogate ministers as to the use of their homes for religious purposes. Further, section 119(a)(2) would require the Service to determine the scope of the “business” of the church and where and how far the “premises” of the church extend. As written, section 107(2) avoids such excessive entanglement of government into the affairs of the church. Similarly, the court determined that section 107(2) does not unconstitutionally “advance” religion over secular purposes because providing a tax exemption does not “connote[] sponsorship, financial support, and active involvement of the [government] in religious activity.” Finally, the court ruled that section 107(2) passes the “historical significance” test under the establishment clause because tax exemptions have been provided to religious and religious-affiliated organizations by Congress almost since the Sixteenth Amendment authorized the federal income tax in 1913.
2. Service Chief Counsel says that an individual who is a 2-percent S corporation shareholder pursuant to the section 318 constructive ownership rules is entitled to a deduction under section 162(l) for amounts paid by the S corporation under a group health plan for all employees and included in the individual’s gross income if the individual otherwise meets the requirements of section 162(l).
In Chief Counsel Advice 2019-12-001, the Service Office of Chief Counsel concluded that an individual who was treated as a 2-percent S corporation shareholder—because the stock of a family member was attributed to the individual under the constructive ownership rules of section 318—could deduct the amounts paid by the S corporation under a group health plan and included in the individual’s gross income.
a. Background. Under section 1372(a), an S corporation is treated as a partnership and a 2-percent shareholder of an S corporation is treated as a partner for purposes of applying the provisions of the Code relating to employee fringe benefits. For this purpose, a “2-percent shareholder” is any person who owns (or is considered to own under the constructive ownership rules of section 318) on any day during the S corporation’s tax year more than two percent of the corporation’s outstanding stock or stock possessing more than two percent of the total combined voting power of all stock of the corporation. According to Revenue Ruling 91-26, accident and health insurance premiums paid by an S corporation on behalf of a 2-percent shareholder-employee as compensation for services are treated like guaranteed payments to partners under section 707(c). Therefore, the S corporation can deduct the premiums and the 2-percent shareholder-employee must include an appropriate portion of the premiums in gross income. The S corporation must report the premiums on the 2-percent shareholder-employee’s Form W-2, but according to Service Announcement 92-16, such amounts are not wages subject to Social Security and Medicare taxes if the requirements of the exclusion in section 3121(a)(2)(B) are met. Section 162(l) authorizes an above-the-line deduction for a taxpayer who is an employee within the meaning of section 401(c)(1) for an amount equal to the amount paid during the year for insurance that constitutes medical care for the taxpayer and the taxpayer’s spouse, dependents, and children who have not attained the age of 27. This deduction is available to a 2-percent shareholder-employee of an S corporation if the plan is established by the S corporation. The deduction is limited to the taxpayer’s earned income from the trade or business with respect to which the plan providing medical care is established and is not available if the taxpayer is eligible to participate in a subsidized health plan maintained by an employer of the taxpayer or of the taxpayer’s spouse or dependents.
b. Facts. An individual owned 100% of an S corporation, which employed the individual’s family member. Because of the family relationship, the family member was considered to be a 2-percent shareholder pursuant to the attribution of ownership rules under section 318. The S corporation provided a group health plan for all employees, and the amounts paid by the S corporation under the group health plan were included in the family member’s gross income. Chief Counsel was asked whether an individual who was a 2-percent shareholder of an S corporation pursuant to the constructive ownership rules of section 318 by virtue of being a family member of the S corporation’s sole shareholder was entitled to the deduction under section 162(l) for amounts that were paid by the S corporation under a group health plan for all employees and included in the individual’s gross income.
c. Chief Counsel’s Conclusion. Chief Counsel concluded that:
[A]n individual who is a 2-percent shareholder of an S corporation pursuant to the attribution of ownership rules under § 318 is entitled to the deduction under § 162(l) for amounts that are paid by the S corporation under a group health plan for all employees and included in the individual’s gross income if the individual otherwise meets the requirements of section 162(l).
B. Qualified Deferred Compensation Plans
1. They were just kidding! Treasury and the Service no longer plan to amend the Regulations under section 401(a)(9) to prohibit giving retirees receiving annuity payments the option to receive a lump-sum payment.
A number of sponsors of defined benefit plans have amended their plans to provide a limited period during which certain retirees who are currently receiving lifetime annuity payments from those plans may elect to convert their annuities into lump sums that are payable immediately. These arrangements are sometimes referred to as retiree lump-sum windows. In Notice 2015-49, the Service announced that the Treasury Department and the Service planned to amend the required minimum distribution Regulations under section 401(a)(9) to provide that qualified defined benefit plans generally are not permitted to replace any joint and survivor, single life, or other annuity currently being paid with a lump-sum payment or other accelerated form of distribution. With certain exceptions, the amendments to the Regulations were to apply as of July 9, 2015.
Notice 2019-18 provides that the Treasury Department and the Service no longer intend to propose the amendments to the Regulations under section 401(a)(9) that were described in Notice 2015-49. The Notice indicates that the Treasury Department and the Service will continue to study the issue of retiree lump-sum windows. The Notice further provides:
Until further guidance is issued, the IRS will not assert that a plan amendment providing for a retiree lump-sum window program causes the plan to violate § 401(a)(9), but will continue to evaluate whether the plan, as amended, satisfies the requirements of §§ 401(a)(4), 411, 415, 417, 436, and other sections of the Code. During this period, the IRS will not issue private letter rulings with regard to retiree lump-sum windows. However, if a taxpayer is eligible to apply for and receive a determination letter, the IRS will no longer include a caveat expressing no opinion regarding the tax consequences of such a window in the letter.
2. Some inflation-adjusted numbers for 2020.
Elective deferrals in sections 401(k), 403(b), and 457 plans are increased from $19,000 to $19,500 with a catch-up provision for employees aged 50 or older that is increased from $6,000 to $6,500.
The limit on contributions to an IRA remains unchanged at $6,000. The AGI phase-out range for contributions to a traditional IRA by employees covered by a workplace retirement plan is increased to $65,000–$75,000 (from $64,000–$74,000) for single filers and heads of household, increased to $104,000–$124,000 (from $103,000–$123,000) for married couples filing jointly in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, and increased to $189,000–$199,000 (from $193,000–$203,000) for an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered. The phase-out range for contributions to a Roth IRA is increased to $196,000–$206,000 (from $193,000–$203,000) for married couples filing jointly, and increased to $124,000–$139,000 (from $122,000–$137,000) for singles and heads of household.
The annual benefit from a defined benefit plan under section 415 is increased to $230,000 (from $225,000).
The limit for defined contribution plans is increased to $57,000 (from $56,000).
The amount of compensation that may be taken into account for various plans is increased to $285,000 (from $280,000), and is increased to $425,000 (from $415,000) for government plans.
The AGI limit for the retirement savings contribution credit for low- and moderate-income workers is increased to $65,000 (from $64,000) for married couples filing jointly, increased to $48,750 (from $48,000) for heads of household, and increased to $32,500 (from $32,000) for singles and married individuals filing separately.
3. Proposed Regulations provide guidance under section 401 relating to new life expectancy and distribution period tables used to calculate minimum distributions from qualified plans, IRAs, and annuities.
The Treasury Department and the Service have issued Proposed Regulations that provide guidance on the use of updated life expectancy and distribution period tables under Regulation section 1.401(a)(9)-9. In general, the Proposed Regulations seek to update the existing tables using current mortality data based on mortality rates for 2021. The new tables allow for longer life expectancies than the current tables under the existing Regulations and generally result in a reduction of required minimum distributions. In turn, this allows for retention of larger amounts in retirement accounts in contemplation of participants having slightly longer lives.
The updated life expectancy and distribution period tables are proposed to apply to distributions on or after January 1, 2021. Thus, for an individual who attains the age at which required minimum distributions must begin in 2020, the Proposed Regulations would not apply to the distribution for the 2020 calendar year (which is due by April 1, 2021). The Proposed Regulations would apply to the required minimum distribution for the individual’s 2021 calendar year, which is due by December 31, 2021. As an aside, while the Proposed Regulations indicate age 70½ as the age at which required minimum distributions must begin, the authors note that section 114 of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) amended section 401(a)(9)(C)(i)(I) to increase the age at which required minimum distributions must begin to 72. Presumably, these Proposed Regulations will be amended to reflect this change.
The Proposed Regulations also include a transition rule that applies under certain circumstances if an employee dies prior to January 1, 2021. The transition rule applies in three situations: (1) the employee dies before the required beginning date with a non-spousal designated beneficiary, (2) the employee dies after the required beginning date without a designated beneficiary, and (3) the employee, who is younger than the designated beneficiary, dies after the required beginning date. Under these circumstances, a set of specific rules applies in relation to the distribution period for calendar years following the calendar year of the employee’s death.
4. The cap on elective deferrals to section 401(k) plans pursuant to automatic contribution arrangements is now 15%.
Section 102 of the SECURE Act amended section 401(k)(13)(C)(iii) to increase the cap on elective deferrals to a section 401(k) plan under an automatic contribution arrangement from 10% to 15%. An automatic contribution arrangement allows an employer automatically to deduct elective deferrals from an employee’s wages unless the employee makes an election not to contribute or to contribute a different amount. This change applies to plan years beginning after December 31, 2019.
5. Congress has increased the age at which RMDs must begin to 72.
Section 114 of the SECURE Act amended section 401(a)(9)(C)(i)(I) to increase the age at which required minimum distributions (RMDs) from a qualified plan (including IRAs) must begin from 70½ to 72. Pursuant to this amendment, RMDs must begin by April 1 of the calendar year following the later of the calendar year in which the employee attains age 72 or, in the case of an employer plan, the calendar year in which the employee retires. This latter portion of the rule allowing deferral of RMDs from employer plans until retirement does not apply to a five-percent owner (as defined in section 416). The increase in the age at which RMDs must begin until age 72 applies to distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after such date.
6. No more stretching out RMDs from non-spousal inherited qualified retirement accounts.
Section 401 of the SECURE Act amended section 401(a)(9)(E) to modify the required minimum distribution (RMD) rules for inherited retirement accounts (defined contribution plans and IRAs). The amendments require all funds to be distributed by the end of the tenth calendar year following the year of death. There is no requirement to withdraw any minimum amount before that date. The current rules, which permit taking RMDs over many years, continue to apply to a designated beneficiary who is (1) a surviving spouse, (2) a child of the participant who has not reached the age of majority, (3) disabled within the meaning of section 72(m)(7), (4) chronically-ill within the meaning of section 7702B(c)(2) with some modifications, or (5) an individual not in any of the preceding categories who is not more than ten years younger than the deceased individual. These changes generally apply to distributions with respect to those who die after December 31, 2019.
7. Penalty-free withdrawals for birth or adoption.
Section 113 of the SECURE Act amended section 72(t)(2) to add new section 72(t)(2)(H), which provides for penalty-free withdrawals from “applicable eligible retirement plans” for a “qualified birth or adoption distribution.” A “qualified birth or adoption distribution” is defined as “any distribution from an applicable eligible retirement plan to an individual if made during the one-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized.” A distribution can be treated as qualifying only if the taxpayer includes the name, age, and taxpayer identification number of the child on the taxpayer’s tax return for the taxable year. The maximum penalty-free distribution is $5,000 per individual per birth or adoption. This change applies to distributions made after Dec. 31, 2019.
8. “Difficulty of care” payments that are excluded from gross income are now treated as compensation for purposes of contributing to defined contribution plans and IRAs.
Section 116 of the SECURE Act amended section 408(o) to add new section 408(o)(5) and amended section 415(c) to add new section 415(c)(8). These provisions allow taxpayers receiving “difficulty of care payments” that are excludable from gross income under section 131 to treat such payments as compensation for purposes of the limits on contributing to a defined contribution plan or IRA. Generally, difficulty of care payments are defined in section 131(c)(1) as compensation for providing additional care to a qualified foster individual that is required by reason of the individual’s physical, mental, or emotional handicap and that is provided in the home of the foster care provider. This change applies to contributions to IRAs after December 20, 2019, the date of enactment, and applies to defined contribution plans for plan years beginning after December 31, 2015.
In Feigh v. Commissioner, the Tax Court held that, although Notice 2014-7 treats Medicaid waiver payments as difficulty of care payments that are excludable from gross income under section 131, such payments are earned income for purposes of the earned income credit and the child tax credit. Generally, Medicaid waiver payments are payments made by a state that has obtained a Medicaid waiver that allows the state to include in the state’s Medicaid program the cost of home or community-based services (other than room and board) provided to individuals who otherwise would require care in a hospital, nursing facility, or intermediate care facility. The legislative changes made by the SECURE Act do not alter the result in Feigh.
9. Loans from qualified employer plans are treated as taxable distributions if they are made through the use of credit cards or similar arrangements.
Section 108 of the SECURE Act amended section 72(p)(2) to redesignate section 72(p)(2)(D) as section 72(p)(2)(E) and to add new section 72(p)(2)(D), which provides an additional requirement for a loan from a qualified employer plan to avoid being treated as a taxable distribution. Under section 72(p)(1), a loan from a qualified employer plan is treated as a distribution unless it meets certain requirements set forth in section 72(p)(2). One requirement (provided in section 72(p)(2)(A)) is that the loan must not exceed the lesser of (1) $50,000 or (2) the greater of one-half of the present value of the employee’s nonforfeitable accrued benefit or $10,000. A second requirement (provided in section 72(p)(2)(B)) is that the loan must be repaid within five years. A third requirement (provided in section 72(p)(2)(C)) is that substantially level amortization of the loan (with payments not less frequently than quarterly) must take place over the term of the loan. New section 72(p)(2)(D) provides a fourth requirement, which is that the loan must not be “made through the use of any credit card or any other similar arrangement.” This requirement applies to loans made after December 20, 2019, the date of enactment.
10. Congress has made access to retirement plan funds easier for survivors of certain natural disasters.
Section 202 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019 provides special rules that apply to distributions from qualified employer plans and IRAs and to loans from qualified employer plans for survivors of certain natural disasters.
a. Qualified Disaster Distributions. A “qualified disaster distribution” is defined as any distribution from an eligible retirement plan as defined in section 402(c)(8)(B) (which includes qualified employer plans and IRAs) that was made: (1) before June 17, 2020 (the date that is 180 days after December 20, 2019, the date of enactment of the legislation), (2) on or after the first day of the incident period of a qualified disaster, and (3) to an individual whose principal place of abode at any time during the incident period of the qualified disaster was located in the qualified disaster area of that qualified disaster and who sustained an economic loss by reason of that qualified disaster.
Section 202(a) of the legislation provides four special rules for qualified disaster distributions.
1. The legislation provides that qualified disaster distributions up to an aggregate amount of $100,000 for each qualified disaster are not subject to the normal ten-percent additional tax of section 72(t) that applies to distributions to a taxpayer who has not reached age 59½.
2. The legislation provides that, unless the taxpayer elects otherwise, any income resulting from a qualified disaster distribution is reported ratably over the three-year period beginning with the year of the distribution.
3. The legislation permits the recipient of a qualified disaster distribution to contribute up to the amount of the distribution to a qualified employer plan or IRA that would be eligible to receive a rollover contribution of the distribution. The contribution need not be made to the same plan from which the distribution was received but must be made during the three-year period beginning on the day after the date on which the distribution was received. If contributed within the required three-year period, the distribution and contribution are treated as made in a direct trustee-to-trustee transfer within 60 days of the distribution. The apparent intent of this rule is to permit the taxpayer to exclude the distribution from gross income to the extent it is recontributed within the required period. Because the recontribution might take place in a later tax year than the distribution, presumably a taxpayer would include the distribution in gross income in the year received and then file an amended return for the distribution year upon making the recontribution.
4. Qualified disaster distributions are not treated as eligible rollover distributions for purposes of the withholding rules and, therefore, are not subject to the normal 20% withholding that applies to eligible rollover distributions under section 3405(c).
b. Recontributions of Withdrawals Made for Home Purchases. Section 202(b) of the legislation permits an individual who received a “qualified distribution” to contribute up to the amount of the distribution to a qualified employer plan or IRA that would be eligible to receive a rollover contribution of the distribution. A qualified distribution is a hardship distribution that an individual received from a qualified employer plan or IRA during the period that is 180 days before the first day of the incident period of the relevant qualified disaster and ending on the date that is 30 days after the last day of the incident period that was to be used to purchase or construct a principal residence in a qualified disaster area that was not purchased or constructed on account of the qualified disaster. The contribution need not be made to the same plan from which the distribution was received but must be made during the “applicable period,” which is the period beginning on the first day of the incident period of the qualified disaster and ending on the date that is 30 days after the last day of the incident period. The distribution and contribution are treated as made in a direct trustee-to-trustee transfer within 60 days of the distribution. The apparent intent of this rule is to permit the taxpayer to exclude the distribution from gross income to the extent it is recontributed within the required period.
c. Loans. For qualified individuals, section 202(c) of the legislation increases the limit on loans from qualified employer plans and permits repayment over a longer period of time. Normally, under section 72(p), a loan from a qualified employer plan is treated as a distribution unless it meets certain requirements. One requirement is that the loan must not exceed the lesser of (1) $50,000 or (2) the greater of one-half of the present value of the employee’s nonforfeitable accrued benefit or $10,000. A second requirement is that the loan must be repaid within five years. In the case of a loan made to a “qualified individual” during the period from December 20, 2019 (the date of enactment) through June 16, 2020 (the 180-day period beginning on the date of enactment), the legislation increases the limit on loans to the lesser of (1) $100,000 or (2) the greater of all of the present value of the employee’s nonforfeitable accrued benefit or $10,000.
The legislation also provides that, if a qualified individual has an outstanding plan loan on the first day of the incident period of a qualified disaster with a due date for any repayment occurring during the period beginning on the first day of the incident period and ending on the date which is 180 days after the last day of the incident period, then the due date is delayed for one year. If an individual takes advantage of this delay, then any subsequent repayments are adjusted to reflect the delay in payment and interest accruing during the delay. This appears to require reamortization of the loan.
A “qualified individual” is defined as an individual whose principal place of abode at any time during the incident period of a qualified disaster is located in the qualified disaster area with respect to that qualified disaster and who sustained an economic loss by reason of the qualified disaster.
d. Defined Terms. Several key terms are defined in section 201 of the Taxpayer Certainty and Disaster Tax Relief Act of 2019. These are as follows:
(i) The term “incident period” with respect to any qualified disaster is the period specified by FEMA as the period during which the disaster occurred, except that the period cannot be treated as beginning before January 1, 2018, or ending after January 19, 2020 (the date that is 30 days after the date of enactment of the legislation).
(ii) The term “qualified disaster zone” is the portion of the qualified disaster area determined by the President to warrant individual or individual and public assistance from the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of the qualified disaster with respect to the qualified disaster area.
(iii) The term “qualified disaster area” is an area with respect to which the President declared a major disaster from January 1, 2018, through February 18, 2020 (the date that is 60 days after the date of enactment of the legislation), under section 401 of the Stafford Act if the incident period of the disaster began on or before December 20, 2019 (the date of enactment). To avoid providing double benefits, the legislation excludes the California wildfire disaster area, for which similar relief was provided by the Bipartisan Budget Act of 2018.
(iv) “The term ‘qualified disaster’ means, with respect to any qualified disaster area, the disaster by reason of which a major disaster was declared with respect to such area.”
C. Nonqualified Deferred Compensation, Section 83, and Stock Options
There were no significant developments regarding this topic during 2019.
D. Individual Retirement Accounts
1. A rollover that was deposited 62 days after withdrawal from an IRA was not taxable because it constituted a bookkeeping error and qualified for a hardship waiver.
In Burack v. Commissioner, the taxpayer withdrew $524,981 from her IRA to purchase a home while waiting for her former home to sell. She planned to redeposit the funds in her IRA within the 60-day period permitted by section 408(d)(3)(A) for making a tax-free rollover of IRA funds. Pershing, LLC served as custodian of the IRA. The taxpayer’s financial adviser was a representative of Capital Guardian, LLC. The relationship between Pershing and Capital Guardian was not entirely clear. Capital Guardian generated statements for the taxpayer’s IRA and the statements listed both Pershing and Capital Guardian.
Pursuant to instructions from Capital Guardian, on Thursday, August 21, 2014, 57 days after the taxpayer’s withdrawal, the taxpayer sent a check for $524,981 by overnight delivery to Capital Guardian, which received the check the next day. For reasons that are not clear, the check was not deposited at Pershing in the taxpayer’s IRA until Tuesday, August 26, 2014, which was 62 days after the taxpayer’s withdrawal. The Service issued a notice of deficiency in which the Service asserted that the taxpayer had to include the withdrawn funds in gross income because the taxpayer had not rolled them over within the required 60-day period.
The Tax Court (Judge Ruwe) held that the taxpayer was entitled to treat the transaction as a tax-free rollover for two reasons. The court first concluded that the withdrawn funds were not redeposited in a timely manner because of a bookkeeping error by Capital Guardian, stating that “[b]ecause the check was received by Capital Guardian during the rollover period but not book-entered by Capital Guardian until after, we find that the late recording is due to a bookkeeping error.” The court reasoned that the situation was analogous to that in Wood v. Commissioner, in which the court reached a similar conclusion when the taxpayer had transferred stock to Merrill Lynch within the 60-day period with instructions that it be deposited in the taxpayer’s IRA, but Merrill Lynch deposited the stock in a nonqualified account before transferring it to the IRA after the 60-day period.
The court then held that the taxpayer was eligible for a hardship waiver under section 408(d)(3)(I). An automatic waiver under section 408(d)(3)(I) is granted if, prior to the expiration of the 60-day period, a financial institution receives funds on behalf of a taxpayer, the taxpayer follows all procedures required by the financial institution for depositing the funds into an eligible retirement plan (including giving instructions for deposit of the funds), and “solely due to an error on the part of the financial institution, the funds are not deposited into an eligible retirement plan within the 60-day rollover period” provided two further conditions are satisfied: (1) the funds are deposited into an eligible retirement plan within one year from the beginning of the 60-day rollover period and (2) a valid rollover would have occurred if the financial institution had deposited the funds as instructed. The court concluded that all requirements for an automatic hardship waiver had been satisfied and that this served as an alternative basis for treating the taxpayer’s withdrawal and contribution as a tax-free rollover.
2. Amounts paid to an individual to aid in the pursuit of graduate or postdoctoral study and included in the individual’s gross income are now treated as compensation for purposes of contributing to an IRA.
Section 106 of the SECURE Act amended section 219(f)(1) to provide that amounts paid to an individual to aid in the pursuit of graduate or postdoctoral study and included in the individual’s gross income are now treated as compensation for purposes of the limit on contributing to an IRA. Such amounts include taxable stipends and non-tuition fellowship payments received by graduate and postdoctoral students. This change applies to taxable years beginning after December 31, 2019.
3. ♪♫ I don’t know, but I’ve been told, if you [contribute to an IRA] you’ll never grow old. ♫♪ Congress has eliminated the age restriction for contributions to traditional IRAs.
Section 107 of the SECURE Act repealed former section 219(d)(1). The effect of this change is to eliminate the age restriction (age 70½ for contributions to traditional IRAs). The legislation also amends section 408(d)(8)(A), which allows taxpayers who are age 70½ or older to make tax-free distributions to a charity from an IRA of up to $100,000 per year, to reduce a taxpayer’s ability to make such tax-free distributions to a charity by the amount of deductible IRA contributions made after age 70½. The reduction in the $100,000 annual limit under section 408(d)(8)(A) is the amount by which the taxpayer’s aggregate deductible contributions to an IRA made after age 70½ exceed the aggregate reductions of the $100,000 limit in all prior taxable years. These changes apply to contributions and distributions made for taxable years beginning after December 31, 2019.
