Tax Alert

Special report: New partnership audit rules allow IRS to impose tax assessments on partnerships

audit-rules.jpg

Abstract: A new partnership audit regime gives the IRS the ability to impose tax assessments on partnerships under audit. Here, we discuss the options available to partnerships. Doing nothing or making an uninformed decision could cause the partnership to pay a higher than necessary tax assessment and/or cause the partnership and its partners to waste time and money on unnecessary compliance. As always, we strongly encourage our clients to consult with their trusted tax professionals before making these decisions.

For years ending after December 31, 2017, the Bipartisan Budget Act of 2015 (“BBA”) created a new Centralized Partnership Audit Regime (“CPAR”). These new rules are applicable to all entities treated as a partnership for federal tax purposes and for the first time, makes partnerships liable for U.S. federal income tax assessments.

Why are the new rules important?

Absent a timely election out by qualifying partnerships (discussed below), these rules fundamentally change how tax is assessed and collected upon a partnership audit. For starters, partnerships will be required to designate a partner (or other person) with a substantial presence in the U.S. to be the Partnership Representative (“P-REP”) who will have the sole and binding authority to act on behalf of the partnership with the IRS. The P-REP effectively replaces the Tax Matters Partner of the old TEFRA partnership audit rules that are repealed by the BBA.

The general/default rule will have partnerships paying a tax (“imputed underpayment”) using the highest Section 1 tax rate in effect (currently at 37% for 2018), ignoring (1) the nature of the adjustment(s) (for example, long-term capital gains that would otherwise be subject to a lower tax rate) and (2) the nature of the partners (for instance, a partner that is a tax exempt entity not subject to an income tax). Favorable adjustments that do not offset unfavorable adjustments will be a reduction to income in the adjustment year (usually the year that the audit closes). There are significant and tedious rules surrounding the grouping and netting of unfavorable and favorable adjustments, which are outside the scope of this summary.

There are many obvious inequities associated with the default rules of this new audit regime. For instance, if there has been a change in ownership, new partners could bear the economic burden for tax assessments relating to unfavorable adjustments (and/or benefit from favorable adjustments) relating to years when they were not partners. Fortunately, there are alternatives that can help alleviate some of these inherent inequities; though some of these options (which we will discuss shortly) will come with additional monetary cost and compliance. The P-REP will have many decisions to make, which at times may benefit some partners to the detriment of others.

While the focus of this memo is the effect that the new statute will have on the audit process, the new rules also affect the process for making adjustments to previously-filed partnership tax returns, which is outside the scope of this memo.

Election out for certain partnerships with 100 or fewer partners             

Certain partnerships may be able to “elect out” of the new rules if the following eligibility requirements are met:

  1. Fewer than 100 partners, meaning fewer than 100 K-1’s issued, or that have potential to be issued, e.g., a husband and wife joint K-1 counts as two and each S-corporation shareholder member counts as one.
  2. Must have eligible partners, meaning all partners must be one of the following: individuals; C corporations (including RICs and REITs); certain foreign entities that would be treated as a C corporation, were they domestic; S corporations; or an estate of a deceased partner.

Partnerships with trusts, partnerships, or LLCs (including disregarded entities/single-member LLCs) are not eligible to elect out.

This election is made yearly on the partnership’s timely filed tax return and is binding to the partnership and all the partners unless the IRS determines that the election was invalid.

If such an election is made, the partnership and the partners will be subject to the pre-TEFRA rules causing audits to be performed at the individual partner level; therefore expanding the potential scope of the audit. It will also be possible to for multiple partners to be audited by different auditors; having the potential for the same partnership item to be audited by several auditors with no requirement that their results conform to one another. Accordingly, partnerships should carefully weigh the pros and cons before making this election.

Other options are available

If the partnership is unable to elect out or chooses not to, the partnership will need to consider the various options available to them throughout the audit process. There are several modifications that a partnership can request to reduce the assessment; the partnership will also have the ability to elect to push out the audit adjustments and not pay the tax. Time constraints exist with each option, so procrastination could be costly.

Modification of imputed underpayments

A partnership that has received a notice of proposed partnership adjustment (“NOPPA”) may request one or more modifications to the proposed imputed underpayment.

The proposed regulations list several types of modifications, which include (but are not limited to):

  1. Amended returns by reviewed year partners. If one or more partners of the reviewed year return include their respective share of the NOPPA adjustment(s) on an amended return for such year (including any other affected intervening year(s), and pay all taxes due), then the imputed underpayment of the partnership shall be determined without regard to such adjustment(s).
  2. Tax-exempt partners. If the partnership demonstrates that a portion of the adjustment(s) is allocable to a reviewed year partner that would owe no tax by reason of its status as a tax-exempt entity, then the imputed underpayment will be determined without regard to such adjustment(s).
  3. Modification based on a rate of tax lower than the highest applicable tax rate. A modification based on a lower rate of tax may be requested with respect to a reviewed year partner that is a C corporation and adjustments with respect to capital gains or qualified dividends that are attributable to reviewed year partners that are individuals.
  4. Other modifications. Modifications that are not specifically described by the regulations may be requested and allowed if the IRS determines that such modifications are accurate and appropriate.

Alternative to payment of imputed underpayment by partnership (“push-out election”)

The partnership can also make an election (commonly referred to as the “push-out election”) and not pay the imputed underpayment. If elected, the partnership is not required to pay the imputed underpayment but is instead required to furnish statements to the reviewed year partners, who must then take into account their share of the partnership adjustments (both favorable and unfavorable), and calculate and pay their respective tax, penalties and interest (for the reviewed year and any affected intervening year). Refunds will not be issued for any year that the tax is lower as a result of such adjustments.

This election comes at the price of cumbersome compliance at both the partnership and partner level, and will be further complicated when tiered structures are involved. Furthermore, partners will also be subject to an additional 2% interest charge above the normal underpayment rate.

Now what?

While the IRS is still in the process of issuing and finalizing regulations for this regime, and the state response/impact is still unknown, the federal statute is in place and is not expected to be postponed. Therefore, it is still strongly recommended that partnerships should ready themselves now and start the process of amending their operating agreements to take into consideration such things like:

  1. Identifying the P-REP
  2. Limiting the P-REP’s liability and exposure for litigation from disgruntled partners
  3. Outline required communications between the P-REP and the partners during an audit. Regardless of such terms being included in an operating agreement, the actions of the P-REP will be completely binding on the partnership and its partners
  4. Cooperation clauses for partners dealing with such items as:
    1. Departed partners (amending returns, possible reimbursement of imputed underpayments paid by the partnership, etc.)
    2. If it is the partnership’s intention to elect out of the CPAR, there should be clauses eliminating a partner’s ability to transfer their interests to an ineligible partner (such as a trust or single-member LLC)

For further information, please contact Jodi Bloom-Piccione.

Special report: Update on the Tax Cuts and Jobs Act

 
Tax Cuts and Jobs Act 2017.png
 

For the benefit of Raich Ende Malter clients, we have distilled the tax changes affecting individuals in the H.R. 1 tax bill into a comprehensive, accurate list. The information contained in this list is culled from several reliable sources. We believe these points are the changes most likely to affect you:

  • Lower income tax rates and brackets.
  • The standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers, adjusted for inflation in tax years beginning after 2018.
  • The deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero.
  • Child tax credit increased to $2,000 per qualifying child. The credit phases out at $400,000 for married taxpayers filing jointly and $200,000 for all other taxpayers. Certain non-child dependents will have a nonrefundable $500 credit. Refundable credit amount increases to $1,400 per qualifying child up to the base amount of $2,000. Earned income threshold for the refundable portion of the credit will be reduced from $3,000 to $2,500.
  • “Kiddie tax” law: Taxable income of a child attributable to earned income is taxed under the rates for single individuals, and taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. This rule applies to the child’s ordinary income and his or her income taxed at preferential rates. (Note: kiddie tax applies to a child if 1) the child either has not attained age 19 by the end of the tax year or is a full-time student under the age of 24, and either parent is alive; 2) the child’s unearned income exceeds $2,100 for 2018; and 3) the child does not file a joint return.)
  • Breakpoints for capital gains taxes remain the same, but will be indexed for inflation using the Chained Consumer Price Index for All Urban Consumers (C-CPI-U).
  • Gambling losses: All deductions for expenses incurred in carrying out wagering transactions (in addition to gambling losses) are limited to the extent of gambling winnings.
  • SALT deductions: For tax years beginning after December 31, 2017 and before January 1, 2026, subject to the exception described below, state, local, and foreign property taxes, and state and local sales taxes, are deductible only when paid or accrued in carrying on a trade or business or an activity for the production of income. State and local income, war profits, and excess profits are not allowable as a deduction.
    • A taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the aggregate of 1) state and local property taxes not paid or accrued in carrying on a trade or business or activity and 2) state and local income, war profits, and excess profits taxes (or sales taxes in lieu of income, etc. taxes) paid or accrued in the tax year. Foreign real property taxes may not be deducted.
    • For tax years beginning after December 31, 2016, in the case of an amount paid in a tax year beginning before January 1, 2018 with respect to a state or local income tax imposed for a tax year beginning after December 31, 2017, the payment will be treated as paid on the last day of the tax year for which such tax is so imposed. Therefore, a taxpayer who, in 2017, pays an income tax that is imposed for a tax year after 2017, can’t claim an itemized deduction in 2017 for that prepaid income tax.
  • Mortgage and home equity: For tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately).
  • “Binding contract” exception: A taxpayer who has entered into a binding written contract before December 15, 2017 to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, shall be considered to incur acquisition indebtedness prior to December 15, 2017.
  • Refinancing: The $1 million/$500,000 limitations continue to apply to taxpayers who refinance existing qualified residence indebtedness that was incurred before December 15, 2017, so long as the indebtedness resulting from the refinancing doesn’t exceed the amount of the refinanced indebtedness.
  • Medical expense deductions: For tax years beginning after December 31, 2016 and ending before January 1, 2019, the threshold on medical expense deductions is reduced to 7.5% for all taxpayers. The rule limiting the medical expense deduction for AMT purposes to 10% of AGI doesn’t apply to tax years beginning after December 31, 2016 and ending before January 1, 2019.
  • Charitable contribution deduction limit increased: For contributions made in tax years beginning after December 31, 2017 and before January 1, 2026, the limitation for cash contributions to public charities and private foundations is increased to 60% of AGI. Contributions exceeding the 60% limit are generally allowed to be carried forward and deducted for up to five years, subject to the later year’s ceiling.
  • Casualty losses: Under the Act, taxpayers can take a deduction for casualty losses only if the loss is attributable to a declared disaster.
  • Alimony treatment: For any divorce or separation agreement executed after December 31, 2018, or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor spouse and are not included in the income of the payee spouse. Instead, income used for alimony is taxed at the rates applicable to the payor spouse.
  • Miscellaneous itemized deductions: For tax years beginning after December 31, 2017 and before Jan. 1, 2026, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended.
  • “Pease” limitation on itemized deductions is suspended.
  • Repeal of ACA mandate: For months beginning after December 31, 2018, the amount of the individual shared responsibility payment is reduced to zero. This repeal is permanent.
  • Alternative minimum tax (AMT): For tax years beginning after December 31, 2017 and before Jan. 1, 2026, the Act increases the AMT exemption amounts for individuals as follows:
    • For joint returns and surviving spouses, $109,400.
    • For single taxpayers, $70,300.
    • For marrieds filing separately, $54,700.
    • Under the Act, the above exemption amounts are reduced (not below zero) to an amount equal to 25% of the amount by which the income of the AMT taxpayer exceeds the phase-out amounts, increased as follows:
      • For joint returns and surviving spouses, $1 million.
      • For all other taxpayers (other than estates and trusts), $500,000.
      • For trusts and estates, the base figure of $22,500 and phase-out amount of $75,000 remain unchanged. All of these amounts will be adjusted for inflation after 2018 under the new Chained Consumer Price Index for All Urban Consumers (C-CPI-U) inflation measure.
  • ABLE account changes: Effective for tax years beginning after the enactment date and before January 1, 2026, the contribution limitation to ABLE accounts with respect to contributions made by the designated beneficiary is increased, and other changes are in effect as described below. After the overall limitation on contributions is reached (i.e., the annual gift tax exemption amount; for 2018, $15,000), an ABLE account’s designated beneficiary can contribute an additional amount, up to the lesser of 1) the Federal poverty line for a one-person household; or 2) the individual’s compensation for the tax year.
  • Expanded use of 529 accounts: For distributions after December 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, up to a $10,000 limit per tax year.
  • Discharged student loan debts for reasons of death or permanent disability will be excluded from gross income.
  • Recharacterization of IRA contributions: For tax years beginning after December 31, 2017, the rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, recharacterization cannot be used to unwind a Roth conversion
  • ·Rollover period extended for rollover of plan loan offset amounts. For plan loan offset amounts which are treated as distributed in tax years beginning after December 31, 2017, the period during which a qualified plan loan offset amount can be contributed to an eligible retirement plan as a rollover contribution will be extended to the due date (including extensions) for filing the Federal income tax return for the tax year in which the plan loan offset occurs (the tax year in which the amount is treated as distributed from the plan).
  • Self-created property: Certain self-created property will no longer be treated as a capital asset. Effective for dispositions after December 31, 2017, the Act excludes patents, inventions, models or designs (whether or not patented), and secret formulas or processes, which are held either by the taxpayer who created the property or by a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created), from the definition of a “capital asset.”
  • Estate and gift tax: Increased exemption amount. For estates of decedents dying and gifts made after December 31, 2017 and before January 1, 2026, the Act doubles the base estate and gift tax exemption amount from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011 and is expected to be approximately $11.2 million in 2018 ($22.4 million per married couple).

Further changes to the tax bill are possible, but unlikely. If you have questions about how these points will affect you, please contact your trusted REM tax professional.

NYS Paid Family Leave Act effective January 1, 2018

Beginning January 1, 2018, all private employers will be required to participate in the New York State Paid Family Leave (NYS PFL) benefit law, which is meant to provide paid leave for employees in certain situations. NYS PFL goes beyond what is required under the Family and Medical Leave Act (FMLA) with regard to protections and payments, and thereby imposes new family leave obligations on New York employers.

NYS PFL will provide eligible employees (both full- and part-time) with up to eight weeks (and up to 12 weeks when fully implemented by 2020) of paid family leave annually to care for an infant (or newly-adopted or fostered child – including those born or placed for adoption prior to January 1, 2018), a family member with a serious health condition (including a spouse, domestic partner, child, parent, parent-in-law, grandparent, or grandchild), or to assist with family obligations when a family member is called to active duty. Note: NYS PFL is not available for prenatal conditions or an employee with serious health conditions.

Employers subject to NYS PFL

NYS PFL applies to all private employers with at least one employee in New York State. This includes out-of-state employers that have one or more employees working in New York (e.g., those working remotely). Public employers are generally exempt from NYS PFL.

Employees entitled to NYS PFL     

Full-time employees who have been employed for at least 26 weeks are eligible, while part-time employees (defined as those scheduled to work fewer than 20 hours per week) must work at least 175 days to be eligible. Those requirements apply regardless of the number of hours per week actually worked and regardless of the employer’s size. Note: Both non-U.S. citizens and undocumented employees who otherwise meet eligibility requirements are eligible for NYS PFL. Employees working fewer than 26 weeks or 175 days in a consecutive 52-week period (e.g., short-term or seasonal employees) may file an NYS PFL waiver, in which case the NYS PFL payroll contribution deductions will be waived (as would the employer’s responsibility to provide benefits to that employee).

Funding

NYS PFL will be completely funded through employee payroll deductions.

Details

  • Covered employers are required to carry NYS PFL insurance or comply with the requirements to self-insure by January 1, 2018. We strongly recommend that you contact your NYS Disability Insurance carrier regarding adding an NYS FPL rider to your current disability policy as soon as possible. This policy should be effective by January 1, 2018.
  • The maximum employee contribution for coverage beginning January 1, 2018 will be 0.126% of an employee’s weekly wage up to and not to exceed the statewide average weekly rate, which is currently set at $1,305.92. For employees who earn more than $1,305.92 per week, the NYS PFL deduction will be capped at $1.65 per week ($1,305.92 x 0.126%). The deduction percentages and caps may change annually – the deduction percentage may change on January 1; the cap may change on July 1.
  • NYS PFL insurance coverage is designed to be funded through employee payroll deductions; however, employers may choose to cover the premium payments and not deduct contributions from employees. The number of weeks of leave available to eligible employees under the NYS PFL and the benefits paid will be phased in over several years. The phase-in schedule is:

This is a summary of the PFL. As of today, New York has not finalized the regulations regarding PFL. The final regulations are expected to be placed into effect within the next several weeks. As soon as we have additional information, we will forward it to you.

If you have any questions regarding NYS PFL, please contact your disability insurance company or the New York State website: https://www.ny.gov/programs/new-york-state-paid-family-leave.

New law for NYC independent contractors takes effect May 15, 2017

Monday, May 15, 2017, a new law takes effect for businesses using independent contractors in New York City.  The New York City Freelance Isn’t Free Act (“FIFA”) makes it easier for freelance workers and independent contractors to collect payment.  It also imposes hefty penalties for anyone who does not get agreements in writing and pay on time.

 
 

Who FIFA affects

FIFA applies to individuals doing work as independent contractors in New York City.  It includes organizations and individuals with no more than one employee, whether incorporated or not,  that provide services in exchange for compensation.  It does not matter whether the hiring person or organization is located in New York City.  It excludes sales representatives, attorneys and licensed medical professionals.

FIFA applies to services over $800, either in a single contract or in multiple agreements entered during any 120-day period.

Requirements

FIFA requires that all contracts be in writing and contain at least the following information:

  1. Name and mailing address for all parties,
  2. An itemization of the services to be provided,
  3. The rate and method of compensation, and
  4. The date payment is due (either an exact date or how to calculate it).

If there is no specific date for payment, the default is 30 days from the date the contractor completed the work.  Note: this is not 30 days from delivery of the work or delivery of an invoice.  If there are no other express agreements, payment is due 30 days from the time of completion.

In addition, FIFA makes it illegal to retaliate against a freelancer for asserting rights protected under FIFA or to condition payment to the freelancer on acceptance of less than the previously-agreed-upon amount.

Penalties

FIFA provides an administrative complaint process with the NYC Office of Labor Standards (“OLS”) and even allows the freelancer or the City to bring a civil lawsuit.  Failure to enter a qualifying contract automatically entitles the independent contractor to a $250 statutory damages award.  The penalties to businesses for failing to comply with FIFA can also be assessed up to double the amount due to the freelancer for failing to make timely payment, plus attorneys’ fees. For repeated violators, FIFA imposes a $25,000 civil penalty, payable to the City’s general fund.

What you can do to protect your business

In order to be in compliance with FIFA, make sure all service and independent contractor agreements are in writing and contain an accurate description of the freelancer’s duties, when payment is due or how payment will be calculated, and the contact information of everyone involved.  Make sure that your organization makes the payments on time.  If your organization normally takes longer to pay, account for that when agreeing on payment dates for all future agreements.  Also, make sure that you have an updated W-9 for all independent contractors that your organization uses for 1099-MISC purposes.

We cannot stress enough the importance of following the above-referenced procedures to protect your business.

Questions, email Lucille Southard at lsouthard@rem-co.com or call her at (516) 228-9000, extension 3212.

© 2017

How to score a home run with your board meeting minutes

Minutes of your board’s meetings may seem like a mere formality, but they’re much more than that. Board meeting minutes reflect on your board of directors and your organization’s actions. Savvy nonprofits don’t bunt their way through creating these documents — they try to hit them “out of the park.”

Here are some best practices for developing minutes that will document your meetings clearly and accurately.

Covering the basics

Meeting minutes should cover such fundamentals as the date and time, whether it was a special or regular meeting, and the names of directors attending as well as names of directors who didn’t attend. The minutes should record any board actions (such as motions, votes for and against and resolutions). They also should note whether a quorum was reached, whether any board members left and re-entered the meeting — say, in the case of a possible conflict of interest — and whether there were any abstentions from voting or discussions.

Additionally, minutes should include summaries of key points from reports to the board and of alternatives considered for important decisions. For instance, describe how the board evaluated bids for outsourcing IT work or chose a particular venue for a fundraising event. Another important component: The minutes should record action items — that is, follow-up work that will be needed — and who’ll be responsible. Last, all information in the minutes should be presented clearly and succinctly.

There’s no particular requirement about how much detail should be recorded in your minutes. But attorneys often advise their clients to include enough information so that they can be offered as evidence that an action was properly taken and that directors fulfilled their fiduciary duties. When in doubt about the depth of detail to include in your minutes, consult your attorney.

Meeting privately

At times, your board likely will meet “behind closed doors” to discuss particularly sensitive or confidential issues, such as a staff dismissal or key person salaries. Details of these sessions shouldn’t be included in the board meeting minutes, although a notation should be made that the board moved to an executive session; the notation should provide the general topic of the conversation. Also be aware of your state’s Sunshine Laws that may require open meetings and outline exactly what must be documented.

Details of an executive session can be communicated confidentially in some other form. Nonprofit attorneys sometimes advise their clients not to label this communication as “minutes.” 

Generally, your minutes should be ready for inspection by the next board meeting or within 60 days of the date of the original meeting, whichever comes first. IRS Form 990 asks whether there is “contemporaneous,” or timely, documentation of the board and board committee meetings in minutes or written actions.

Understanding multiple uses

If your organization is ever audited by the IRS, your meeting minutes likely are among the first documents the agency will request to see. Keep in mind that any attachments, exhibits and reports can be considered part of the minutes.

Meeting minutes also can serve as evidence in court. For example, if someone alleges that the board made a hasty decision in cutting a program, board meeting minutes can be used to present the data that was considered when making that decision.

Considering readability

Many not-for-profits today strive for transparency. But your board isn’t being open about its transactions if its meeting minutes are so abbreviated that only the keenest insider can understand the full meaning.

The person assigned to take minutes at your organization’s board meetings should produce minutes that are a straightforward and complete report of all actions taken and the basis for any decisions. Simple and unambiguous wording works best.

With that goal in mind, it’s a good idea to have a second person review the meeting minutes. That person (as well as the original writer) should ask, “Would this report make sense if I hadn’t been at the meeting, and had been unfamiliar with the issues addressed? Would I be able to see at a glance the information provided and decisions made?”

Holding up under inspection

Always keep in mind that the minutes of your board’s meetings can be viewed by many sets of eyes. Make sure that they show the real score.

If you have any questions, email Barry Wechsler at bwechsler@rem-co.com or call him at (212) 944-4433, extension 2408.

© 2017

Discriminatory plans that meet statutory requirements

The IRS issued a warning to plan sponsors whose plan designs satisfy numeric antidiscrimination tests, yet still have the effect of steering a disproportionate amount of benefits to highly compensated employees (HCEs). The IRS’s message: Simply satisfying numeric tests doesn’t guarantee that you’re complying with antidiscrimination regulations.

IRS findings and examples

In a recent announcement, the IRS reported seeing an uptick in plan designs that provide significant benefits to HCEs. Specifically, it noticed plans benefiting a group of non-highly compensated employees (NHCEs) who work few hours and receive little compensation. These plans tend to exclude other NHCEs from plan participation.

The IRS provided some examples of such designs. In one, the plan bases participation eligibility on job classification, and the classification formula covers a small group of low-pay or short-tenure employees. In another, coverage is available to only NHCEs who work on an as-needed basis and earn a meager salary each year.

Another example: Plans that require 1,000 hours to earn a year of service for vesting purposes, but not for allocation purposes. “In these plans,” the IRS explains, “the low paid or short service NHCEs receive an accrual or allocation, but don’t vest because they never complete a year of vesting service.” A variation on that theme is requiring 12 consecutive months of employment to satisfy a vesting requirement, allowing the NHCEs to vest, but only “in the very small plan benefit.”

The IRS also provides an extreme example in which a participant who earns only $200 in annual compensation receives a $200 profit sharing allocation — 100% of compensation. To allow the plan to clear the antidiscrimination test, an HCE earning $200,000 would receive a $50,000 benefit, or 25% of compensation.

IRS warning              

The IRS warns that these plan designs don’t pass muster. The relevant regulations require that all antidiscrimination rules be reasonably interpreted to prevent discrimination in favor of HCEs.

If you have any questions, contact Elaine Fazzari at efazzari@rem-co.com or (973) 267-4200, extension 5124.

© 2017

6 Classic techniques for protecting your assets

If your professional, business, or other activities expose you to potential financial liability, asset protection should be a key component of your wealth planning efforts. After all, no matter how successful you are at building wealth, if you don’t protect your assets a large portion could be lost to a lawsuit or an unreasonable creditor’s claim.

Good defense

Everyone’s situation is different, but the following are six asset protection techniques that have benefited many higher-net-worth individuals:

  1. Outright gifts. Giving assets to your spouse, children or other family members is one of the simplest and most effective ways to protect those assets from your creditors. The downside is that you’ll lose control over the assets and any economic benefits associated with them.
     
  2. Tenancy by the entirety. If it’s authorized in your state, you and your spouse should hold title to your principal residence or other eligible property as tenants by the entirety (a special type of joint tenancy). This form of ownership insulates assets against your or your spouse’s individual creditors. It doesn’t, however, protect you from joint liabilities.
     
  3. Retirement plans. Qualified retirement plans — such as pension, profit-sharing or 401(k) plans — are surprisingly effective asset protection vehicles. Qualified plans generally are protected against creditors’ claims, both inside and outside bankruptcy. IRAs offer more limited protection. In bankruptcy, they’re exempt from creditors’ claims up to a specified threshold: currently, $1,283,025. (However, this limit doesn’t apply to rollovers from qualified plans to an IRA.) Outside bankruptcy, the level of creditor protection varies from state to state.
     
  4. Irrevocable trusts. By including “spendthrift” provisions in a trust, you can protect the assets against claims by your beneficiaries’creditors. These provisions prohibit beneficiaries from selling or assigning their interests in the trust (either voluntarily or involuntarily). You can also place the trust beyond the reach of yourcreditors, so long as you relinquish any interest in the assets. If, on the other hand, the trust is “self-settled” — that is, if you name yourself as a beneficiary — then the assets generally aren’t protected against your creditors, except as described below.
     
  5. Domestic asset protection trusts (DAPTs). Permitted in several states, these are self-settled, irrevocable spendthrift trusts that provide protection against your creditors even if you’re a discretionary beneficiary. To use a DAPT, you don’t necessarily have to live in a state with a DAPT law. But you’ll need to locate some or all of the trust assets in one of those states and use a local financial institution to administer the trust. The level of creditor protection varies by state. The main disadvantage of DAPTs is uncertainty over whether they’re enforceable in court, particularly when the grantor is a nonresident.

    A potentially less risky option is a “hybrid DAPT,” which is initially established for the benefit of your children or other third parties. Hybrid DAPTs enable your trustee to add you as a discretionary beneficiary later.
     
  6. Offshore trusts. If you want an even higher level of protection, consider offshore trusts, which are similar to DAPTs but are established in foreign countries with favorable asset protection laws. Typically, they’re irrevocable for a specified term, enabling you to retrieve the assets down the road when your risk may be lower. An ideal jurisdiction for an offshore trust is one that doesn’t recognize judgments from U.S. courts and whose laws place various administrative obstacles in the way of U.S. creditors attempting to collect debts there.

    Offshore trusts have a shady reputation as vehicles designed to hide assets or evade taxes. But when used correctly, they offer legitimate protection against unreasonable or excessive claims. If you establish an offshore trust or foreign account, you’ll need to file information returns. 

A legitimate tool

It’s important to note that asset protection planning is meant to protect you against unanticipated future claims. It provides you with legitimate methods of setting aside wealth for your heirs, deterring litigants and providing creditors with an incentive to settle.

Asset protection planning is not a tool for evading taxes or other obligations, hiding assets, or defrauding creditors. Indeed, fraudulent conveyance laws prohibit you from transferring assets with the intent to hinder, delay or defraud existing creditors or foreseeable future creditors. To ensure you don’t step over any lines, always work with reputable financial and legal advisors.

The sooner, the better

These six tips are only a few of the techniques available to protect and preserve wealth. Whichever strategies you choose, it’s critical to implement them as early as possible. If you wait until creditor claims are imminent, it’ll likely be too late.

If you have any questions, contact Roberto Viceconte at rviceconte@rem-co.com or (212) 944-4433, extension 2480.

© 2017

C corp vs. S corp: is it time for you to make the switch?

The Protecting Americans from Tax Hikes (PATH) Act of 2015 accomplished more than just extending certain tax breaks. It also made some taxpayer-friendly provisions permanent — including the shortened recognition period for companies that convert from C corporation to S corporation status. This change is causing many manufacturers and distributors to re-evaluate their corporate status.

After weighing the pros and cons, many companies are electing Subchapter S status to gain enhanced flexibility in business decisions and to lower taxes. Here are some important issues to consider before you convert.

Tax considerations

C corporations pay taxes twice. First, they’re charged corporate-level income taxes. Shareholders then pay tax personally on C corporation distributions and dividends. But S corporations are flow-through entities for tax purposes. This means that income, gains and losses flow through to the owners’ personal tax returns. S corporations generally aren’t taxed at the corporate level.

However, double taxation of C corporations may become a major issue when the owners decide to sell assets or transfer equity. Historically, if a company elected Subchapter S status and sold assets or transferred equity any time within a 10-year “recognition period,” it was charged corporate-level tax on any built-in gains that occurred while the company was a C corporation. Any gains that occurred after making the S election passed through the owners’ personal tax returns.

Under the PATH Act, the recognition period has been permanently shortened to five years. If a business sells assets or stock within the recognition period, only the appreciation in value from the date of the S corporation election will be exempt from corporate-level tax.

So it’s important to establish the company’s fair market value at the conversion date and to allocate it to the company’s assets. This enables taxpayers to quantify which portion of the gain should be taxed as C corporation gain and which portion should be taxed as a flow-through gain to shareholders.

Subchapter S qualifications

For businesses contemplating a Subchapter S election, there’s no time like the present to start the clock on the five-year recognition period. But not every business qualifies for this election. It’s available to only domestic corporations that use a calendar fiscal year and offer just one class of stock (though differences in voting rights are permitted). Qualifying businesses also must have no more than 100 shareholders — including individuals, certain trusts and estates but excluding partnerships, corporations, foreign individuals and entities, and ineligible corporations.

Beware, too, that Subchapter S status restricts how the company distributes cash and liquidates assets. All payouts must be made to shareholders on a pro rata basis. If these rules aren’t followed or if the company merges with another entity that doesn’t qualify, the company will lose its Subchapter S status.

Potential pitfall

Although S corporations are required to make pro rata distributions to shareholders, they aren’t required to distribute income to shareholders. So shareholders who lack control over making distributions may find themselves required to pay personal-level taxes on S corporation income, regardless of whether the company distributed any cash to cover those tax liabilities.

The annual tax burden can be substantial for highly profitable S corporations — and even more substantial for high-income taxpayers. As a courtesy, most S corporations pay enough distributions to cover shareholders’ tax obligations. But there’s no guarantee of distributions for shareholders who lack control over the business.

A tough choice

Before electing to S status, your business must obtain the approval of all shareholders. Although there are many benefits to making the switch — especially now that the recognition period to avoid corporate-level capital gains tax has been permanently shortened — it’s not a prudent option for every business. Your legal and tax advisors can help determine the right choice for your circumstances.

If you have any questions, contact Thomas Turrin at tturrin@rem-co.com or (212) 944-4433, extension 2404.

© 2016

Prepare for major changes to federal rules on employee pay and benefits

One of your most dreaded tasks is probably managing human resources (HR). The rules are ever-changing and becoming increasingly complex. Here are two major developments related to the federal rules governing employee pay and benefits that employers should be ready for this year.

Complying with new ACA requirements

The Affordable Care Act (ACA) requires applicable large employers (ALEs) to offer their full-time employees and their dependents minimum essential coverage that is affordable and provides minimum value. An ALE is defined as one having 50 or more full-time and full-time equivalent employees.

The ACA requirements are set to gradually unfold over several years to give companies time to ramp up their health care coverage. New reporting requirements that should be on an ALE’s radar for 2016 include two new forms:

Form 1095-C, “Employer-Provided Health Insurance Offer and Coverage.” Employers must send copies of this form (similar to Form W-2, “Wage and Tax Statement”) to both the IRS and full-time employees. It reports the following information, for each full-time employee, broken down by month:

  • Details about the type of coverage offered to each employee,
  • Whether the employee was enrolled in the plan,
  • The employee’s share of the lowest-cost self-only minimum value coverage, and
  • Whether the affordability safe harbor or other transition relief applies.

Form 1094-C, “Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns.” This form is similar to a Form W-3,“Transmittal of Wage and Tax Statements.” To complete an authoritative transmittal on Form 1094-C, employers must report:

  • Whether coverage was offered to at least 70%  of the organization’s full-time employees in 2015 (or 95% of its full-time employees in 2016 and beyond),
  • The total number of 1095-C forms the organization issued,
  • The number of full-time employees and total number of employees by month,
  • Information about members of the aggregated employer group (if applicable), and
  • Whether the organization qualifies for transition relief.

These forms are due to the IRS by February 29, 2016 (or March 31, 2016, if filing electronically) for the 2015 tax year. Employee statements must be furnished no later than February 1, 2016.

A potential pitfall may occur when employers assume that someone else is handling their ACA compliance. But the responsibility ultimately lies with the company, not its audit firm, benefits provider, insurer, payroll company or tax preparer. If you want outside assistance, you need to specifically ask your advisor for it.

Paying additional overtime

The U.S. Department of Labor (DOL) sets federal labor guidelines that apply to most public and private sector employees. On June 30, 2015, the DOL proposed changes to the overtime rules under the Fair Labor Standards Act (FLSA) that would make an estimated 5 million more workers eligible for overtime pay.

When employees work more than 40 hours per week, they’re entitled to overtime pay equal to 1.5 times the usual pay rate. Under the current rules, white-collar employees are exempt from overtime pay if they meet these three requirements: First, they must be paid a predetermined and fixed salary. Second, they must be paid more than a specific salary threshold, currently $455 a week ($23,660 for a full-year worker). And, third, they must primarily perform executive, administrative, or professional duties, as defined in DOL regulations.

Under the DOL’s proposed revisions, the salary threshold for the white collar exemption would increase to approximately $970 a week ($50,440 for a full-year worker) and would be adjusted annually. 

When the comment period ended on September 4, the DOL had received nearly 150,000 responses from concerned stakeholders. The DOL could take several months to issue a final rule, which may include one-time or gradual increases in the proposed salary thresholds. Or the proposal could be derailed indefinitely, causing significant uncertainty for HR professionals and employees.

Seeking outside help

To simplify matters, some smaller manufacturers and distributors opt to outsource all of their HR functions. Doing so allows management to focus on what they do best — making quality products and delivering them to customers. 

Tatz-Howard

If you have any questions, contact Howard Tatz at htatz@rem-co.com or (516) 228-9000, extension 3204.

IRS revisits discount techniques for estate planning

The Treasury Department has recently issued Proposed Regulations under Internal Revenue Code Section 2704 that, if enacted as written, would impact the use of discount techniques for estate planning purposes in the context of intra-family transfers of family controlled entities. These discounting techniques have been a staple of estate planning for many years and have been on the radar of the Treasury Department just as long. The Regulations affecting the discounts would become effective 30 days after publication.

These new Regulations are proposed, and there is a commentary period for public response. A number of practitioners have raised the issue that these new regulations may exceed the scope of authority of the Treasury, as they go against established case law. As there is a degree of uncertainty as to the final outcome, anyone contemplating estate planning should be aware of this new situation and should consult their team of professionals.

If you have any questions, contact Roberto Viceconte at rviceconte@rem-co.com or (212) 944-4433, extension 2480.

© 2016

Section 1231: the best of both worlds

Most owners and developers know that the sale of a business asset, including real estate, can have significant tax implications. The tax effects generally come down to whether the sale results in a gain or a loss. Ideally, gains would be treated as long-term capital gains, subject to lower tax rates, and losses would be considered ordinary losses, which could be applied to offset ordinary income. Section 1231 of the Internal Revenue Code (IRC) permits just such advantageous treatment — the best of both worlds — for certain types of property in certain circumstances.

Eligible property

Sec. 1231 generally applies to depreciable property used in a trade or business that’s held for more than one year. A sale or exchange of property held mainly for sale to customers isn’t a Sec. 1231 transaction. On the other hand, property used to generate rents is considered to be used in a trade or business.

Notably, the IRS has taken the position that real property purchased or constructed for use in a trade or business qualifies for Sec. 1231 treatment even if it was never placed in service but instead was sold — as long as the property was held for more than a year, running from the purchase date to the sale date. In other words, property doesn’t have to be placed in service to be considered property used in a trade or business.

Treatment of Sec. 1231 gains and losses

To determine the treatment of Sec. 1231 gains and losses, you combine all of your Sec. 1231 gains and losses for the year. If you have a net Sec. 1231 loss, it’s an ordinary loss. Not only can such a loss be used to offset your ordinary income, but you’re also not subject to the normal $3,000 limit per year limitation on how much of the loss can be used against ordinary income. Plus, the loss could give rise to a net operating loss that can be carried back or forward.

If you have a net gain, it’s considered ordinary income up to the amount of your nonrecaptured Sec. 1231 losses from previous years. The remainder, if any, is long-term capital gain that can offset other capital losses from sales of non-Sec. 1231 property.

The recapture issue

As suggested above, the benefits of long-term capital gains treatment might not be available if you had a nonrecaptured Sec. 1231 loss in the prior five years. That means that, for every year in the last five in which you have a net Sec. 1231 gain, you must “look back” to determine whether you had an aggregate net Sec. 1231 loss. You have a nonrecaptured loss if the total net Sec. 1231 losses exceed the total Sec. 1231 gains for the prior five years. Real property may also be subject to depreciation recapture under Sec. 1250.

A complicated matter

While the benefits of Sec. 1231 transactions are straightforward and clear, the applicable rules and their potential interaction with other provisions of the tax code are anything but. Your financial advisor can help you decipher the proper timing and planning to get the best of both worlds.

If you have any questions, contact Jodi Bloom-Piccione at jbloom@rem-co.com or (516) 228-9000, extension 3207.

© 2016

Business owners: is it time for Section 199?

The Section 199 tax deduction was first introduced with the American Jobs Creation Act of 2004. It was intended to primarily benefit America's manufacturing industry. Indeed, sometimes the tax beak is called the "manufacturers' deduction" or the "domestic production activities deduction." But, helpfully, eligibility for the break is broad enough to include many other types of businesses.

Among the primary requirements for the deduction is that your company regularly perform “qualified production activities.” These are generally defined as tasks related to manufacturing, producing, constructing, growing or extracting property “in significant part” within the United States. If any of that sounds familiar, it may be time for you to check out Sec. 199.

Identifying and gathering

To get started, you’ll need to identify and document your qualified production activities, and then determine how much income you’ve derived from them. Doing so will require gathering gross receipts from the lease, rental, exchange or other transfer of qualifying production property minus out-of-pocket expenses, such as materials costs. Eligible items include tangible personal property, computer software and sound recordings used in qualified production activities.

Having done all of this, you may then be able to claim a deduction equal to 9% of the lesser of either your net income derived from your qualified production activities or your entire taxable income for the year. There is, however, an important caveat: The deduction can’t exceed 50% of the W-2 wages paid to employees during the calendar year that are allocable to domestic production gross receipts.

Crunching the numbers

Let’s take a hypothetical look at the Sec. 199 deduction and how it might benefit a business. Say your company nets $800,000 in taxable income on $4 million in gross receipts in 2016, entirely from qualified production activities. Assuming your W-2 wages paid are adequately substantial, the deduction at the 9% rate will be $72,000, for a federal tax savings of over $25,000 based on a 35% rate. That would presumably be a nice cash flow boost.

Perhaps the biggest challenge of the Sec. 199 deduction, and one that many companies underestimate, is the administrative burden that may be associated with claiming it. You’ll need to meticulously track and maintain documentation for your business’s qualifying production activities.

Getting everything in order

If you’re intrigued by the Sec. 199 deduction, please call us. Not only are the administrative requirements challenging, but the calculations involved often get complex as well.

If you have any questions, contact Fred Steinmann at fsteinmann@rem-co.com or (212) 944-4433, extension 2468.

© 2016

8 Tips for improving productivity in the construction industry

In an industry as labor-intensive as construction, few things can hurt a contractor’s profitability more than unproductive workers. Here are eight tips for improving productivity.

  1. Don’t blame your workers. While it’s tempting to blame poor productivity on lazy workers, late starts and excessive breaks, the fact is that most construction workers strive to be productive. More often than not, poor productivity is the result of waste and inefficiencies that are within management’s control.
  2. Focus on unproductive time. Research by the Construction Industry Institute shows that craft workers typically spend less than half of their time on tasks. The remaining time is spent on unproductive activities, such as waiting for equipment and materials, waiting for instructions or waiting for work areas to be ready. If, for example, workers spend only 30% of their time on direct work, your greatest opportunity for productivity gains is to focus on the 70% of worker time spent off task. In other words, reducing the amount of time workers spend off task will produce greater benefits than attempting to improve their efficiency during the time they spend on task.
  3. Conduct an activity analysis. Spend some time monitoring activities on jobsites and analyzing the results. Often, this process will reveal opportunities to improve productivity. For example, better scheduling and logistics can reduce delays that result when workers have to wait for materials or equipment, or for other workers to complete their work. In many cases, solutions are surprisingly simple, such as finding a way to store materials, equipment or tools closer to the areas where they’re needed, or storing materials on wheels so they can be moved more easily. Strategies for reducing personal time — such as locating portable toilets closer to work areas — can also have a significant impact on productivity. On one high-rise project, a structural contractor reduced the amount of time it took for workers to have lunch by arranging for a sandwich shop to operate alongside the structure.
  4. Improve communications. Poor communication between supervisors and workers can result in unnecessary mistakes and redo work, causing productivity to suffer. With proper training, supervisors can learn how to communicate assignments to workers and ask the right questions to ensure they get it right the first time.
  5. Take advantage of technology. Web-based project management applications, scheduling software, and other technological innovations can boost productivity by speeding up communications, providing workers with the latest project information in real time and making the construction process more efficient.
  6. Set realistic goals. Performance-based incentives can be an effective tool for motivating workers and improving productivity. But it’s critical to set realistic goals. If workers feel that performance targets aren’t achievable, productivity may actually decline.
  7. Pay attention to safety. The most important reason to have a strong safety program is to prevent injuries. But good safety practices also reduce the delays and downtime associated with accidents on the job site.
  8. Manage overtime. Excessive overtime can result in fatigue, higher accident rates, absenteeism and worker turnover, all of which can hurt productivity. Proper planning, scheduling and supervision can help keep overtime to a minimum.

Improving productivity is one of the most effective strategies a contractor can employ to boost its bottom line. 

If you have any questions, please contact John Boykas.

© 2016

Juggling family wealth management is no trick

Preserving and managing family wealth requires addressing a number of major issues. These include saving for your children’s education and funding your own retirement. Juggling these competing demands is no trick. Rather, it requires a carefully devised and maintained family wealth management plan.

Start with the basics

First, a good estate plan can help ensure that, in the event of your death, your children will be taken care of and, if your estate is large, that they won’t lose a substantial portion of their inheritances to estate taxes. It can also guarantee that your assets will be passed along to your heirs according to your wishes.

Second, life insurance is essential. The right coverage can provide the liquidity needed to repay debts, support your children and others who depend on you financially, and pay estate taxes.

Prepare for the challenge

Most families face two long-term wealth management challenges: funding retirement and paying for college education. While both issues can be daunting, don’t sacrifice saving for your own retirement to finance your child’s education. Scholarships, grants, loans and work-study may help pay for college — but only you can fund your retirement.

Uncle Sam has provided several education incentives that are worth checking out, including tax credits and deductions for qualifying expenses and tax-advantaged savings opportunities such as 529 plans and Education Savings Accounts (ESAs). Because of income limits and phaseouts, many higher-income families won’t benefit from some of these tax breaks. But, your children (or your parents, in the case of contributing to an ESA) may be able to take advantage of them.

Give assets wisely

Giving money, investments or other assets to your children or other family members can save future income tax and be a sound estate planning strategy as well. You can currently give up to $14,000 per year per individual ($28,000 if married) without incurring gift tax or using your lifetime gift tax exemption. Depending on the number of children and grandchildren you have, and how many years you continue this gifting program, it can really add up.

By gifting assets that produce income or that you expect to appreciate, you not only remove assets from your taxable estate, but also shift income and future appreciation to people who may be in lower tax brackets.

Also consider using trusts to facilitate your gifting plan. The benefit of trusts is that they can ensure funds are used in the manner you intended and can protect the assets from your loved ones’ creditors.

Charitable giving

Do charitable gifts have a place in family wealth management? Absolutely. Properly made gifts can avoid gift and estate taxes, while possibly qualifying for an income tax deduction. Consider a charitable trust that allows you to give income-producing assets to charity, but keep the income for life — or for the charity to receive the earnings and the assets to later pass to your heirs. These are just two examples; there are more ways to use trusts to accomplish your charitable goals.

Overcome the complexities

Creating a comprehensive plan for family wealth management and following through with it may not be simple — but you owe it to yourself and your family. We can help you overcome the complexities and manage your tax burden. 

If you have any questions, please contact Thomas Turrin, Partner-in-Charge of Personal Advisory, at tturrin@rem-co.com.

What you should know about capital gains and losses

When you sell a capital asset, the sale results in a capital gain or loss. A capital asset includes most property you own for personal use (such as your home or car) or own as an investment (such as stocks and bonds). Here are some facts that you should know about capital gains and losses:

Gains and losses. A capital gain or loss is the difference between your basis and the amount you get when you sell an asset. Your basis is usually what you paid for the asset.

Net investment income tax (NIIT). You must include all capital gains in your income, and you may be subject to the NIIT. The NIIT applies to certain net investment income of individuals who have income above statutory threshold amounts — $200,000 if you are unmarried, $250,000 if you are a married joint-filer, or $125,000 if you use married filing separate status. The rate of this tax is 3.8%.

Deductible losses. You can deduct capital losses on the sale of investment property. You cannot deduct losses on the sale of property that you hold for personal use.

Long- and short-term. Capital gains and losses are either long-term or short-term, depending on how long you held the property. If you held the property for more than one year, your gain or loss is long-term. If you held it one year or less, the gain or loss is short-term.

Net capital gain. If your long-term gains are more than your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your net short-term capital loss, you have a net capital gain.

Tax rate. The capital gains tax rate, which applies to long-term capital gains, usually depends on your taxable income. For 2016, the capital gains rate is zero to the extent your taxable income (including long-term capital gains) does not exceed $74,900 for married joint-filing couples ($37,450 for singles). The maximum capital gains rate of 20% applies if your taxable income (including long-term capital gains) is $464,850 or more for married joint-filing couples ($413,200 for singles); otherwise a 15% rate applies. However, a 25% or 28% tax rate can also apply to certain types of long-term capital gains. Short-term capital gains are taxed at ordinary income tax rates.

Limit on losses. If your capital losses are more than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year, or $1,500 if you are married and file a separate return.

Carryover losses. If your total net capital loss is more than the limit you can deduct, you can carry over the losses you are not able to deduct to next year’s tax return. You will treat those losses as if they happened in that next year.

If you have any questions, please contact Kenneth Lindenbaum at klindenbaum@rem-co.com or 516-228-9000, ext. 3258.

© 2016