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The IRS has provided transition relief for third party settlement organizations (TPSOs) for reportable transactions under Code Sec. 6050W during calendar years 2024 and 2025. These calendar years will be the final transition period for IRS enforcement and administration of amendments made to the minimum threshold amount for TPSO reporting under Code Sec. 6050W(e).

Background

Code Sec. 6050W requires payment settlement entities to file Form 1099-K, Payment Card and Third Party Network Transactions, for each calendar year for payments made in settlement of certain reportable payment transactions. Among other information, the return must report the gross amount of the reportable payment transactions regarding a participating payee to whom payments were made in the calendar year. As originally enacted, Code Sec. 6050W(e) provided that TPSOs are not required to report third party network transactions with respect to a participating payee unless the gross amount that would otherwise be reported is more than $20,000 and the number of such transactions with that payee is more than 200.

The American Rescue Plan Act of 2021 (P.L. 117-2) amended Code Sec. 6050W(e) so that, for calendar years beginning after 2021, a TPSO must report third party network transaction settlement payments that exceed a minimum threshold of $600 in aggregate payments, regardless of the number of transactions. The IRS has delayed implementing the amended TPSO reporting threshold for calendar years beginning before January 1, 2023, and for calendar year 2023 (Notice 2023-10; Notice 2023-74).

For backup withholding purposes, a reportable payment includes payments made by a TPSO that must be reported on Form 1099-K, without regard to the thresholds in Code Sec. 6050W. The IRS has provided interim guidance on backup withholding for reportable payments made in settlement of third party network transactions (Notice 2011-42).

Reporting Relief

Under the new transition relief, a TPSO will not be required to report payments in settlement of third party network transactions with respect to a participating payee unless the amount of total payments for those transactions is more than:

$5,000 for calendar year 2024;
$2,500 for calendar year 2025.

This relief does not apply to payment card transactions.

For those transition years, the IRS will not assert information reporting penalties under Code Sec. 6721 or Code Sec. 6722 against a TPSO for failing to file or furnish Forms 1099-K unless the gross amount of aggregate payments to be reported exceeds the specific threshold amount for the year, regardless of the number of transactions.

In calendar year 2026 and after, TPSOs will be required to report transactions on Form 1099-K when the amount of total payments for those transactions is more than $600, regardless of the number of transactions.

Backup Withholding Relief

For calendar year 2024 only, the IRS will not assert civil penalties under Code Sec. 6651 or Code Sec. 6656 for a TPSO’s failure to withhold and pay backup withholding tax during the calendar year. However, TPSOs that have performed backup withholding for a payee during 2024 must file Form 945, Annual Return of Withheld Federal Income Tax, and Form 1099-K with the IRS, and must furnish a copy of Form 1099-K to the payee.

For calendar year 2025 and after, the IRS will assert those penalties for a TPSO’s failure to withhold and pay backup withholding tax.

Effect on Other Documents

Notice 2011-42 is obsoleted.

Notice 2024-85

IR-2024-299

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The Treasury Department and IRS have issued final regulations amending regulations under Code Sec. 752 regarding a partner’s share of recourse partnership liabilities and the rules for related persons.

Background

Code Sec. 752(a) treats an increase in a partner’s share of partnership liabilities, as well as an increase in the partner’s individual liabilities when the partner assumes partnership liabilities, as a contribution of money by the partner to the partnership. Code Sec. 752(b) treats a decrease in a partner’s share of partnership liabilities, or a decrease in the partner’s own liabilities on the partnership’s assumption of those liabilities, as a distribution of money by the partnership to the partner.

The regulations under Code Sec. 752(a), i.e., Reg. §§1.752-1 through 1.752-6, treat a partnership liability as recourse to the extent the partner or related person bears the economic risk of loss and nonrecourse to the extent that no partner or related person bears the economic risk of loss.

According to the existing regulations, a partner bears the economic risk of loss for a partnership liability if the partner or a related person has a payment obligation under Reg. §1.752-2(b), is a lender to the partnership under Reg. §1.752-2(c), guarantees payment of interest on a partnership nonrecourse liability as provided in Reg. §1.752-2(e), or pledges property as security for a partnership liability as described in Reg. §1.752-2(h).

Proposed regulations were published in December 2013 (REG-136984-12). These final regulations adopt the proposed regulations with modifications.

The Final Regulations

The amendments to the regulations under Reg. §1.752-2(a) provide a proportionality rule for determining how partners share a partnership liability when multiple partners bear the economic risk of loss for the same liability. Specifically, the economic risk of loss that a partner bears is the amount of the partnership liability or portion thereof multiplied by a fraction that is obtained by dividing the economic risk of loss borne by that partner by the sum of the economic risk of loss borne by all the partners with respect to that liability.

The final regulations also provide guidance on how a lower-tier partnership allocates a liability when a partner in an upper-tier partnership is also a partner in the lower-tier partnership and bears the economic risk of loss for the lower-tier partnership’s liability. The lower-tier partnership in this situation must allocate the liability directly to the partner that bears the economic risk of loss with respect to the lower-tier partnership’s liability. The final regulations clarify how this rule applies when there are overlapping economic risks of loss among unrelated partners, and the amendments add an example illustrating application of the proportionality rule to tiered partnerships. They also add a sentence to Reg. §1.704-2(k)(5) clarifying that an upper-tier partnership bears the economic risk of loss for a lower-tier partnership’s liability that is treated as the upper-tier partnership’s liability under Reg. §1.752-4(a), with the result that partner nonrecourse deduction attributable to the lower-tier partnership’s liability are allocated to the upper-tier partnership under Reg. §1.704-2(i).

In addition, the final regulations list in one section all the situations under Reg. §1.752-2 in which a person directly bears the economic risk of loss, including situations in which the de minimis exceptions in Reg. §1.752-2(d) are taken into account. The amendments state that a person directly bears the economic risk of loss if that person—and not a related person—meets all the requirements of the listed situations.

For purposes of rules on related parties under Reg. §1.752-4(b)(1), the final regulations disregard: (1) Code Sec. 267(c)(1) in determining if an upper-tier partnership’s interest in a lower-tier partnership is owned proportionately by or for the upper-tier partnership’s partners when a lower-tier partnership bears the economic risk of loss for a liability of the upper-tier partnership; and (2) Code Sec. 1563(e)(2) in determining if a corporate partner in a partnership and a corporation owned by the partnership are members of the same controlled group when the corporation directly bears the economic risk of loss for a liability of the owner partnership. The regulations state that in both these situations a partner should not be treated as bearing the economic risk of loss when the partner’s risk is limited to the partner’s equity investment in the partnership.

Under the final regulations, if a person owning an interest in a partnership is a lender or has a payment obligation with respect to a partnership liability, then other persons owning interests in that partnership are not treated as related to that person for purposes of determining the economic risk of loss that they bear for the partnership liability.

The final regulations also provide that if a person is a lender or has a payment obligation with respect to a partnership liability and is related to more than one partner, then the partners related to that person share the liability equally. The related partners are treated as bearing the economic risk of loss for a partnership liability in proportion to each related partner’s interest in partnership profits.

The final regulations contain an ordering rule in which the first step in Reg. §1.762-4(e) is to determine whether any partner directly bears the economic risk of loss for the partnership liability and apply the related-partner exception in Reg. §1.752-4(b)(2). The next step is to determine the amount of economic risk of loss each partner is considered to bear under Reg. §1.752-4(b)(3) when multiple partners are related to a person directly bearing the economic risk of loss for a partnership liability. The final step is to apply the proportionality rule to determine the economic risk of loss that each partner bears when the amount of the economic risk of loss that multiple partners bear exceeds the amount of partnership liability.

The IRS and Treasury indicate that they are continuing to study whether additional guidance is needed on the situation in which an upper-tier partnership bears the economic risk of loss for a lower-tier partnership’s liability and distributes, in a liquidating distribution, its interest in the lower-tier partnership to one of its partners when the transferee partner does not bear the economic risk of loss.

Applicability Dates

The final regulations under T.D. 10014 apply to any liability incurred or assumed by a partnership on or after December 2, 2024. Taxpayers may apply the final regulations to all liabilities incurred or assumed by a partnership, including those incurred or assumed before December 2, 2024, with respect to all returns (including amended returns) filed after that date; but in that case a partnership must apply the final regulations consistently to all its partnership liabilities.

T.D. 10014

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Final regulations defining “energy property” for purposes of the energy investment credit generally apply with respect to property placed in service during a tax year beginning after they are published in the Federal Register, which is scheduled for December 12.

The final regs generally adopt proposed regs issued on November 22, 2023 (NPRM REG-132569-17) with some minor modifications.

Hydrogen Energy Storage P property

he Proposed Regulations required that hydrogen energy storage property store hydrogen solely used for the production of energy and not for other purposes such as for the production of end products like fertilizer. However, the IRS recognize that the statute does not include that requirement. Accordingly, the final regulations do not adopt the requirement that hydrogen energy storage property store hydrogen that is solely used for the production of energy and not for other purposes.

The final regulations also provide that property that is an integral part of hydrogen energy storage property includes, but is not limited to, hydrogen liquefaction equipment and gathering and distribution lines within a hydrogen energy storage property. However, the IRS declined to adopt comments requesting that the final regulations provide that chemical storage, that is, equipment used to store hydrogen carriers (such as ammonia and methanol), is hydrogen energy storage property.

Thermal Energy Storage Property

To clarify the proposed definition of “thermal energy storage property,” the final regs provide that such property does not include property that transforms other forms of energy into heat in the first instance. The final regulations also clarify the requirements for property that removes heat from, or adds heat to, a storage medium for subsequent use. Under a safe harbor, thermal energy storage property satisfies this requirement if it can store energy that is sufficient to provide heating or cooling of the interior of a residential or commercial building for at least one hour. The final regs also include additional storage methods and clarify rules for property that includes a heat pump system.

Biogas P property

The final regulations modify several elements of the rules governing biogas property. Gas upgrading equipment is included in cleaning and conditioning property. The final regs clarify that property that is an integral part of qualified biogas property includes but is not limited to a waste feedstock collection system, landfill gas collection system, and mixing and pumping equipment. While a qualified biogas property generally may not capture biogas for disposal via combustion, combustion in the form of flaring will not disqualify a biogas property if the primary purpose of the property is sale or productive use of biogas and any flaring complies with all relevant laws and regulations. The methane content requirement is measured at the point at which the biogas exits the qualified biogas property.

Unit of Energy P property

To clarify how the definition of a unit of energy property is applied to solar energy property, the final regs update an example illustrate that the unit of energy property is all the solar panels that are connected to a common inverter, which would be considered an integral part of the energy property, or connected to a common electrical load, if a common inverter does not exist. Accordingly, a large, ground-mounted solar energy property may comprise one or more units of energy property depending upon the number of inverters. For rooftop solar energy property, all components of property that are installed on a single rooftop are considered a single unit of energy property.

Energy Projects

The final regs modify the definition of an energy project to provide more flexibility. However, the IRS declined to adopt a simple facts-and-circumstances analysis so an energy project must still satisfy particular and specific factors.

T.D. 10015

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The IRS has provided relief from the failure to furnish a payee statement penalty under Code Sec. 6722 to certain partnerships with unrealized receivables or inventory items described in Code Sec. 751(a) (Section 751 property) that fail to furnish, by the due date specified in Reg. §1.6050K-1(c)(1), Part IV of Form 8308, Report of a Sale or Exchange of Certain Partnership Interests, to the transferor and transferee in a Section 751(a) exchange that occurred in calendar year 2024.

Background

A partnership with Section 751 property must provide information to each transferor and transferee that are parties to a sale or exchange of an interest in the partnership in which any money or other property received by a transferor in exchange for all or part of the transferor’s interest in the partnership is attributable to Section 751 property. The partnership must file Form 8308 as an attachment to its Form 1065 for the partnership's tax year that includes the last day of the calendar year in which the Section 751(a) exchange took place. The partnership must also furnish a statement to the transferor and transferee by the later of January 31 of the year following the calendar year in which the Section 751(a) exchange occurred, or 30 days after the partnership has received notice of the exchange as specified under Code Sec. 6050K and Reg. §1.6050K-1. The partnership must use a copy of the completed Form 8308 as the required statement, or provide or a statement that includes the same information.

In 2020, Reg. §1.6050K-1(c)(2) was amended to require a partnership to furnish to a transferor partner the information necessary for the transferor to make the transferor partner’s required statement in Reg. §1.751-1(a)(3). Among other items, a transferor partner in a Section 751(a) exchange is required to submit with the partner’s income tax return a statement providing the amount of gain or loss attributable to Section 751 property. In October 2023, the IRS added new Part IV to Form 8308, which requires a partnership to report, among other items, the partnership’s and the transferor partner’s share of Section 751 gain and loss, collectibles gain under Code Sec. 1(h)(5), and unrecaptured Section 1250 gain under Code Sec. 1(h)(6).

In January 2024, the IRS provided relief due to concerns that many partnerships would not be able to furnish the information required in Part IV of the 2023 Form 8308 to transferors and transferees by the January 31, 2024 due date, because, in many cases, partnerships would not have all of the required information by that date (Notice 2024-19, I.R.B. 2024-5, 627).

The relief below has been provided due to similar concerns for furnishing information for Section 751(a) exchanges occurring in calendar year 2024.

Penalty Relief

For Section 751(a) exchanges during calendar year 2024, the IRS will not impose the failure to furnish a correct payee statement penalty on a partnership solely for failure to furnish Form 8308 with a completed Part IV by the due date specified in Reg. §1.6050K-1(c)(1), only if the partnership:

timely and correctly furnishes to the transferor and transferee a copy of Parts I, II, and III of Form 8308, or a statement that includes the same information, by the later of January 31, 2025, or 30 days after the partnership is notified of the Section 751(a) exchange, and
furnishes to the transferor and transferee a copy of the complete Form 8308, including Part IV, or a statement that includes the same information and any additional information required under Reg. §1.6050K-1(c), by the later of the due date of the partnership’s Form 1065 (including extensions), or 30 days after the partnership is notified of the Section 751(a) exchange.

This notice does not provide relief with respect to a transferor partner’s failure to furnish the notification to the partnership required by Reg. §1.6050K-1(d). This notice also does not provide relief with respect to filing Form 8308 as an attachment to a partnership’s Form 1065, and so does not provide relief from failure to file correct information return penalties under Code Sec. 6721.

Notice 2025-2

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The American Institute of CPAs is encouraging business owners to continue to collect required beneficial ownership information as required by the Corporate Transparency Act even though the regulations have been halted for the moment.

AICPA noted that the while there a preliminary injunction has been put in place nationwide by a U.S. district court, the Financial Crimes Enforcement Network has already filed its appeal and the rules could be still be reinstated.

"While we do not know how the Fifth Circuit court will respond, the AIPCA continues to advise members that, at a minimum, those assisting clients with BOI report filings continue to gather the required information from their clients and [be] prepared to file the BOI report if the inunction is lifted," AICPA Vice President of Tax Policy & Advocacy Melanie Lauridsen said in a statement.

She continued: "The AICPA realizes that there is a lot of confusion and anxiety that business owners have struggled with regarding BOI reporting requirements and we, together with our partners at the State CPA societies, have continued to advocate for a delay in the implementation of this requirement."

The United States District Court for the Eastern District of Texas granted on December 3, 2024, a motion for preliminary injunction requested in a lawsuit filed by Texas Top Cop Shop Inc., et al, against the federal government to halt the implementation of BOI regulations.

In his order granting the motion for preliminary injunction, United States District Judge Amos Mazzant wrote that its "most rudimentary level, the CTA regulates companies that are registered to do business under a State’s laws and requires those companies to report their ownership, including detailed, personal information about their owners, to the Federal Government on pain of severe penalties."

He noted that this request represents a "drastic" departure from history:

First, it represents a Federal attempt to monitor companies created under state law – a matter our federalist system has left almost exclusively to the several States; and

Second, the CTA ends a feature of corporate formations as designed by various States – anonymity.

"For good reason, Plaintiffs fear this flanking, quasi-Orwellian statute and its implications on our dual system of government," he continued. "As a result, the Plantiffs contend that the CTA violates the promises our Constitution makes to the People and the States. Despite attempting to reconcile the CTA with the Constitution at every turn, the Government is unable to provide the Court with any tenable theory that the CTA falls within Congress’s power."

By Gregory Twachtman, Washington News Editor

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The IRS has launched a new enforcement campaign targeting taxpayers engaged in deferred legal fee arrangements and improper use of Form 8275, Disclosure Statement. The IRS addressed tax deferral schemes used by attorneys or law firms to delay recognizing contingency fees as taxable income.

The IRS highlighted that plaintiff’s attorneys or law firms representing clients in lawsuits on a contingency fee basis may receive as much as 40 percent of the settlement amount that they then defer by entering an arrangement with a third party unrelated to the litigation, who then may distribute to the taxpayer in the future. Generally, this happens 20 years or more from the date of the settlement. Subsequently, the taxpayer fails to report the deferred contingency fees as income at the time the case is settled or when the funds are transferred to the third party. Instead, the taxpayer defers recognition of the income until the third party distributes the fees under the arrangement. The goal of this newly launched campaign is to ensure taxpayer compliance and consistent treatment of similarly situated taxpayers which requires the contingency fees be included in taxable income in the year the funds are transferred to the third party.

Additionally, the IRS stated that the Service's efforts continue to uncover unreported financial accounts and structures through data analytics and whistleblower tips. In fiscal year 2024, whistleblowers contributed to the collection of $475 million, with $123 million awarded to informants. The IRS has now recovered $4.7 billion from new initiatives underway. This includes more than $1.3 billion from high-income, high-wealth individuals who have not paid overdue tax debt or filed tax returns, $2.9 billion related to IRS Criminal Investigation work into tax and financial crimes, including drug trafficking, cybercrime and terrorist financing, and $475 million in proceeds from criminal and civil cases attributable to whistleblower information.

Proper Use of Form 8275

The IRS stressed upon the proper use of Form 8275 by taxpayers in order to avoid portions of the accuracy-related penalty due to disregard of rules, or penalty for substantial understatement of income tax for non-tax shelter items. Taxpayers should be aware that Form 8275 disclosures that lack a reasonable basis do not provide penalty protection. Taxpayers in this posture should consult a tax professional or advisor to determine how to come into compliance. In its review of Form 8275 filings, the IRS identified multiple filings that do not qualify as adequate disclosures that would justify avoidance of penalties. Finally, the IRS reminded taxpayers that Form 8275 is not intended as a free pass on penalties for positions that are false.

FS-2024-32

IR-2024-310

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In many parts of the country, residential property has seen steady and strong appreciation for some time now. In an estate planning context, however, increasing property values could mean a potential increase in federal estate tax liability for the property owner's estate. Many homeowners, who desire to pass their appreciating residential property on to their children and save federal estate and gift taxes at the same time, have utilized qualified personal residence trusts.

What is a QPRT?

The qualified personal residence trust, referred to as a "QPRT," is an estate planning technique used to transfer a personal residence from one generation to the next without incurring federal estate tax on the trust property. This type of irrevocable trust allows a homeowner to make a future gift of the family home or a vacation property to his or her children, while retaining the right to continue living in the home for a term of years that the homeowner selects.

Creating a QPRT

The homeowner transfers title to his or her residence into trust for a set time period (for example, 10 years), but retains the right to live in the house during the trust term. At the end of the term, the trust property is distributed to the donor's children without passing through the donor's estate, thereby avoiding federal estate tax on the trust assets. However, if the donor wishes to continue living in the residence after the end of the trust term, the donor must pay fair market rent to his or her children, the new owners of the residence.

Gift tax advantage

Through the use of a QPRT, the full value of your residence can be transferred to your children. However, for federal gift tax purposes, the property is valued at a discount. The actual value of the gift (and the gift tax savings) depends upon your age, the length of the QPRT term, and the federal interest rates in effect at the time you transfer the house to the trust. For example, the longer the trust term, the lower the gift value for gift tax purposes and the greater the gift tax savings. Also, the higher the applicable federal interest rate, the greater the potential gift tax savings.

If you would like to discuss how a QPRT might work for you as part of your overall estate plan, or if you currently have an established QPRT and you wish to review its effect in light of current interest rates and other factors, please do not hesitate to contact this office.

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Possible changes on the tax front including Estate Taxes, 1031 Exchange limitations, and a SALT workaround for some Californians

September 1, 2021

We are pleased to bring you the next edition of Praetorian Advisors’ every so often tax musings direct from our national office in Corona del Mar; ok, our only office. It is our hope that this edition finds you both happy and healthy.

So, what is the latest on the tax front? Well, there has been a lot of talk but no action on the federal level (that is not a bad thing), and a recent welcome surprise for some of those impacted by California income taxes. Here is the rundown:

Federal Income, Estate & Gift Changes

Since before the Biden administration took over in January, a wish list of income tax increases, and estate and gift exemption decreases has been much discussed. We fielded questions from some of you in the spring about moves to make given this wish list. Having been in this business for almost 20 years at Praetorian Advisors (anniversary gifts accepted in October), and in the tax business for another 7 (Patti) and 12 years (Paul, because it’s always fun to remind him he is older) prior to Praetorian’s inception, we have seen many proposals come and go over the years. As a result, we typically do not advise drastic actions be taken based on the prospect of tax law changes and have felt the same way so far in 2021...although we continue to keep an eye on the landscape. Our view on the Biden proposed tax increases is one of extreme positions in so many tax areas that the end game is to get a few of the proposals passed, allowing the administration to claim the “Great Compromise of 2021”.

Given the very narrow majorities in both the House and Senate, the differing goals of the moderate and extreme wings of the Democrats, and mid-terms being a mere 15 months away, less change is more likely than a lot of change. When Afghanistan, inflation, rising gas prices, immigration and border issues, and Covid are considered, tax increases presumably will or at least should be a lower priority. Here are some of the more impactful proposals:

Ordinary and capital gains tax rates – the Biden administration wants to restore the top ordinary tax rate to 39.6% and increase the top long term capital gains rate from 20% to the same 39.6% for those with over $1 million of income. Add the Obamacare/net investment income tax of 3.8% on top of that and 43.4% is the new proposed top rate. This would impact far too much of our client base. Add another 13.3% for our California clients and 56.4% is your number. That hardly inspires one to recognize any gains or motivate to build a business and provide jobs to many.

Perhaps our bias as your tax advisors that you should get to keep more of your money than the government is shining through. When politicians and talking heads mention that the top tax rate was 70% decades ago, they dishonestly fail to mention that taxpayers could deduct just about anything they spent money on back then. Today, the most impactful individual deductions are down to: $10,000 of state and local taxes (SALT) that includes real property taxes, mortgage and investment interest, and charitable contributions.

Section 1031 Exchanges – Also called the like-kind exchange, this provision of tax law dates back almost 100 years and allows the taxpayer to defer gain on the sale of trade or business assets (limited to real estate only by President Trump as of 2018) if the proceeds are reinvested into another piece of property. President Biden wants to eliminate the Section 1031 exchange for those with income over $400,000.

Corporate Tax Rates – Proposed increase from 21% to 28% (was 35% in 2017). Many, including us, feel this has a better chance to pass than the other proposals because it is still 7% lower than the rate before Trump cut them a few years ago. What many fail to realize is that corporations pass along price increases, whether it be for product or taxes, onto the consumer which has an inflationary effect. In our opinion it makes little sense to be pushing for a corporate tax increase at home while pushing for a global minimum tax rate of 15% abroad. We will let the economists handle the rest of that one.

Estate and Gift Tax (Part 1) – The current estate and gift tax exemption is $11.7 million per person, meaning someone can gift up to this amount without having to pay a gift tax to the government. To the extent the gift exemption is not fully utilized, each person can use the estate exemption against his or her assets before having to pay an estate or death tax at the end of life. The current proposal is to reduce the estate exemption to $3.5 million and the gift exemption to $1 million. Even Obama was good with a $5 million estate and gift exemption.

Planning Tip: Note that the current estate exemption (adjusted for inflation each year) is set to expire and return to approximately $6 million at the end of 2025. Therefore, if you might otherwise be making substantial gifts by the end of 2025, DO IT NOW. We advise this for those who can live at their accustomed lifestyle with remaining assets after the gifting, and those who are much closer to the end than the beginning (was that gentle enough?) who have enough assets to live out the remainder of their lives. If you will be implementing a gifting plan, you need to consult with us or your estate attorney (or both) as some assets are better to gift than others.

Estate and Gift Tax (Part 2) – For many decades (Paul was 10 and Patti 4 at the time), people’s estates have received a “basis step up” upon death, adjusting the tax basis of assets left for a surviving spouse or heirs to the date of death value. For example, you bought a home on Balboa Island in 1983 for $300,000 and today it is worth $6 million. Assuming the home is part of your estate (not shifted/gifted to an irrevocable trust), there will be a step up in basis to $6 million at your death, meaning your surviving spouse or heirs can sell that home and not recognize a capital gain on sale. How can this be you ask? The idea is that because an estate tax exists that assesses a tax based on the value of your assets, an income tax on sale of the same asset should not apply.

The Biden administration has proposed not only an elimination on the basis step up rules, but also an immediate capital gains tax at death for someone not subject to the estate tax! Assume you die before the end of 2025. Your Balboa home combined with your investments total $9 million. Under this proposal, your heirs would have to pay capital gains tax on the $5.7 million “gain” even though the home isn’t sold…yet…plus whatever gains exist in your investment portfolio. At 43.4%, that’s almost $2.5 million of capital gains tax! It sounds like the kids will have to sell the house after the funeral reception there.

Estate and Gift Tax (Part 3) – Biden wants to eliminate use of effective estate and gift planning trusts called Grantor Retained Annuity Trusts (GRATs) and dynasty (multi-generational) trusts, and has also proposed capital gains tax upon transfer of assets to a trust. Yikes!

Retroactive Application - The administration also floated retroactive application to January 1, 2021 of any new tax law changes. Isn’t that unconstitutional you ask? We all thought so until the Clinton tax increases of 1993 which were retroactive, and it held up in court. While retroactivity is a possibility, with each passing day it is less and less probable. Given that we are already into the 8^th month of the year and so much is still up in the air, we expect any (if any) changes will be effective January 1, 2022.

Another factor is the IRS still being months behind processing returns and correspondence due to what we call their Covid vacation. It turns out the good people working at the IRS do not take kindly to the vacation comment, but the fact remains they are months behind where they should be. Retroactive application of tax law changes at this juncture might be the end of them. Now there is an idea!

Crystal Ball Predictions

If we had to guess, our prediction is the corporate tax rate hike is most likely to pass, the estate and gift tax provisions the least likely to pass, the income tax rate changes less likely to pass, and elimination of the 1031 exchange – your guess is as good as ours.

The SALT Workaround – Relief for some Californians

Are you tired of hearing about the rich and how they need to pay their fair share? We sure are because we see how much you pay. Not just the numbers, but the percentage of income paid in taxes by some of you is astounding.

Have you also been trained to think that you got completely hosed by the $10,000 state and local tax (SALT) limitation? As we have shown to many of you that has not been the case…for some. Significant changes to the Alternative Minimum Tax (AMT) structure and a lower tax rates have resulted in lower overall tax liability even though the SALT limit has created higher taxable income. Now for those over $1 million of ordinary income (you know who you are), the sting of the SALT limitation is real.

Relief is on the way due to a recent California law enacted, but only for those with income from partnership and S Corp K-1s, and even that is not as straightforward as it sounds. Given that there are a multitude of questions to be answered by the state government given the newness of the law, here we provide a top-level overview here of how it is designed to work.

S Corporations and partnerships doing business in California may make an election on March 15, 2022 to remit California taxes at 9.3% of flow through income on behalf of its shareholders/partners, and get a federal tax deduction for the taxes remitted. A quick example: you own a S Corp that reports $1,000,000 of income on your K-1. Rather than you remitting quarterly individual estimated taxes to California on the expected K-1 income, the S Corp instead elects to remit $93,000 in March 2022 on your behalf. Your K-1 from the S Corp will now reflect federal taxable income of $907,000 instead of $1,000,000. State taxes have never been deductible for state purposes, so your California K-1 will still show $1,000,000 plus or minus other federal/California tax differences. At the 37% tax rate, the $93,000 deduction saves $34,410 in federal taxes. That’s the concept in a nutshell. Here is what else we know:

If the S Corp or partnership fails to make the election and remit the tax by March 15, 2022 then it is an opportunity missed. However, to get the deduction on your 2021 federal K-1, the tax must be remitted before December 31, 2021 on a yet to be published estimate form. You can already see that this is going to get confusing!
To be eligible for the 2022 tax year, the greater of $1,000 or 50% of what was paid by March 15, 2022 for the 2021 tax year must be remitted by June 15, 2022. The balance owed for 2022 will be due March 15, 2023. For each subsequent year, it is rinse, lather, repeat but only through 2025 when the SALT limitation is set to expire, or until (if) the SALT limitation is repealed by Congress. If the proper June 15^th payment is not remitted, it’s an opportunity missed for that year.

However, if you want the deduction to be reflected on your 2021 K-1 the entity will need to remit the tax before December 31, 2021 on a yet to be published tax form.
The workaround applies to all types of income on a K-1, including ordinary income, rental income, and investment income (interest, dividends, capital gains, etc).
If a partnership has another partnership as even one of its partners, the entire partnership, and hence all individual partners, are disqualified from participating in the SALT workaround. This will likely eliminate participation if you are in a large investment partnership with hundreds of partners.
Each eligible partner or shareholder must make the election with the partnership or S Corporation.
For those of you who earn your income solely from W-2 wages, this whole concept is not applicable. We have said before that we prefer tax law that avoids choosing winners and losers, but this idea only passes muster with the IRS when a flow through entity is involved, trusts excluded.
Planning Alert! (emoji with red sirens here if I knew how to do that): many of you have single member LLCs (SMLLC) for operating businesses, rental properties, etc that provide legal liability protection without the hassle of filing a separate federal entity return. While they are great vehicles for simplification and protection, the SALT workaround does not apply to SMLLCs. Depending on the amount of income generated by your SMLLC, converting to a multi-member LLC has the potential to save significant tax dollars even after paying for preparation of additional tax returns. For 2021, whether the full year’s LLC activity or only the multi-member period can be counted for the SALT workaround is not known at this time.
If you are in a higher California tax bracket (up to 13.3%) and/or have other sources of income from wages, investment income, etc, there likely will still be a need to remit quarterly estimated tax payments that are subject to the SALT limitation.
Unrelated to the California law, many other states to date have SALT workaround laws in varying formats. The current list of states that have passed or have pending SALT workaround legislation are: Arizona, Connecticut, Georgia, Idaho, Illinois, Louisiana, Maryland, Massachusetts, New Jersey, New York, North Carolina, Oklahoma, Rhode Island, and Wisconsin (no doubt with more to come). For those of you in these states, we can review your situation to ensure maximum tax savings are achieved as well.

There is the quick rundown on what we do know, but there is much to still be clarified. As we learn more about application of the new law, we will contact you about your next planning move, but do expect that this could impact the third and fourth quarter estimated tax payments for some of you.

Five pages of updates is enough for now. Stay tuned for more in the future, and we look forward to continuing to serve your tax and financial needs.

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Tax preparation during a global pandemic

Latest Praetorian Advisors Tax Season Update – Please Read!

Well, much has changed in the past several days. We are on lockdown and can no longer work from our office. While not a huge deal because we can get work done from our home offices, it is still disruptive to our normal tax season life. There is an oxymoron: “normal tax season life” as there is nothing normal about the way we live during tax season! In addition, the internet and the news is all virus, all the time.

One minute it feels like this may all be a severe overreaction when the numbers are put into perspective. The California governor predicts 22 million of the 40 million Golden State’s residents will get the virus (56%), while China claims (insert chuckle here) 81,000 cases with 1.6 billion people (billion with a B – less than 1/100^th of 1%), and Italy has 41,000 cases with 60 million people, well less than 1/10^th of 1%). Virus deaths globally now total over 10,000, while the flu typically kills about 35,000 Americans annually. Imagine if we got an e-mail or phone call from building management or a restaurant every time it was determined someone had been there with the flu; it would make us nuts. The governor’s math seems quite fuzzy, and it sure feels like an overreaction…

…Until the next minute we hear of doctors in ICU, few test kits available, well respected Dr. Fauci sounding alarm bells, cases spiking, people rushing stores to potentially hunker down for months, the most populous state in the country on lockdown, while this ultimate Black Swan event crushes a thriving economy as we come to a grinding halt. Unless you are a U.S. Senator, your stock portfolio has also been crushed.

Time will tell if the spring breakers in Florida or the toilet paper hoarders/preppers were correct. The truth most likely lies somewhere in the middle.

While we have additional thoughts, the Op-Ed is over; now to the tax season update:

Finally, the federal tax deadline to file and pay remaining 2019 taxes was extended this morning to July 15^th. California is conforming as well, like many other states. Some states have yet to extend deadlines, and we are keeping an eye on those states for you, if applicable to your filings.

Note that for federal purposes, if you owe more than $1 million for 2019 you can only defer payment on the first $1 million, while the remainder must be paid by April 15^th.
The extension of time to file and pay applies to all entities, including trusts.
Federal first quarter 2020 estimated tax payments are now due June 15^th. The second quarter estimate is also due June 15^th. The $1 million cap on deferral also applies to estimated tax payments.
California has made everything simpler. Any payments, including balances due, the $800 minimum tax for entities, 2020 estimated taxes, etc, are due July 15^th. This includes first and second quarter 2020 estimates. For those of you filing in other states, we will be in touch to discuss your filing and payment deadlines.

Our approach to the lengthened tax season is to continue working hard but get a little more sleep than we normally do this time of year to try to stay healthy, while dealing with the challenges to our lives that we all face right now. We are prioritizing completion of returns as follows, being mindful of the disruption in cash flow this has all caused for many people:

Partnership and S Corporation returns with K-1s that are to be distributed to investors in the entities, so we are not delaying someone’s ability to claim a refund.
Individual and trust returns expecting a refund that will not be applied to 2020.
Returns for which we had all information in early.
Returns for which we have all information that came in later. This includes returns that may have been extended at April 15^th in the past, but we will be able to complete before the extended deadline this year.
For those of you who file in the Fall because you are waiting on K-1s well into the Summer, we will work on your extension calculations after April 15^th, except for those who may owe over $1 million who need to know the figures sooner.

Given all that is going on, as a firm we welcome the extension this year. However, we have no desire to be in busy season mode for the next four months. As hectic as the April 15^th deadline is, we also look forward to tax season being over every year so we can get back to our lives and families, and take a little time off. To that end, we ask you to continue getting us information so we can continue working diligently on your behalf. If you normally get us information right about now, stick with it rather than thinking you can show up on July 1^st with a stack of information and expect that we will get it done by the July 15^th deadline. That would be misguided thinking on your part. There are only so many closets you can clean or movies you can watch while in lockdown, so spend some time getting that tax information together, too.

Once we get more clarity on this lockdown, hopefully we can get back into the office for at least a limited time and have some drop off hours. Stay tuned.

Lastly, we encourage you to consider that this is not the end of the world; many of us may have already had the virus and not even known it; don’t beat your spouse or kick the dog while having all of this together time; watch some old classic movies or newer ones you have been meaning to get to; do a puzzle or play a board game with your family; drink that special bottle of wine you have been saving, just live your life while taking prudent precautions to be safe. In the meantime, we will be doing taxes.

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Tax change possibilities following the election

Great News! Only one more month to go and 2020 will finally be behind us! Turning back the clock one hour in November wasn’t worth the extra sleep, and 2020 even managed to slip in an extra day on us back in February – cruel, cruel, cruel.

Although there is much to say about 2020 with liberal use of four letter words a big part of it, our purpose here is to look forward at some thoughts and ideas as we look forward to turning the page on 2020. Here we focus on your wealth matters… because your wealth matters. See what we did there? Not bad for CPAs, huh?

Over the past 10 or so years, there have been several significant tax law changes signed into law in mid to late December creating year end planning chaos crammed into a few short days, during the holidays. Lumps of coal for all our “friends” in D.C. This year we won’t have that, it’s worse! The never-ending election still hasn’t ended, and we won’t know the color of the Senate majority until January. Why does this matter?

As it relates to your taxes and wealth, we aren’t 100% certain. There seem to be a few schools of thought, both of which assume President Trump’s multiple legal appeals fall short and Joe Biden becomes President. Note that if President Trump miraculously was successful in the appeals, then most of this letter was mostly a waste of time because nothing will change on the tax front.

School One – The Senate is blue, along with the House and Presidency. Bring on the Green New Deal and more regulations, back in the Iran nuclear deal and Paris accord, higher income taxes, and lower gift and estate tax exemptions, just to name a few.

School Two – The Senate, House, and Presidency are all blue but the moderate Democrats, sleeping with one eye open and knowing the 2022 midterms are just around the corner, push back against the far left of the party and vote Republicans on major legislation in the name of their own political survival. Don’t even forget it’s not about you, but about politician’s political survival. A case in point: Joe Manchin, Democrat Senator from West Virginia, has already announced he won’t have any part in a Supreme Court packing scheme (his words, not ours). If the Dems do get control of Congress and the White House, it will be by the slimiest of majorities, and not the mandate Nancy Pelosi likes to claim. In fact, if both Georgia Senate seats go blue, it will be a 50-50 tie, with Kamala Harris as the tiebreaking vote.

School Three – At least one of the Georgia Senate seats goes red, Mitch McConnell maintains his leadership position, and he advances to the Senate floor what he wants, albeit with a tad more pressure to compromise than he has faced the past four years. This is what we call gridlock, a dirty word when trying to get home on the 405 on a Friday afternoon. In politics however (and down on Wall St.), gridlock is viewed as a positive by the 70% or so in the middle (center-left to center-right).

So what does all this uncertainty mean to you? With your thumb holding your pinky, hold up your other three fingers on your right hand together – try again, not just the one finger but all three – that’s better, and do as the Boy Scouts do – Be Prepared!

Wagering on Schools Two or Three may very well be a solid bet, which we think are more likely then School One… but be prepared for School One just in case.

Income Taxes

Assuming School One wins out, advice here is trickier than you might think depending on your income. We have a secret shared with some of you over the past two years. The 2017 Tax Cuts and Jobs Act (TCJA) was the biggest federal tax overhaul since 1986. That’s not the secret though. The secret is that most of the tax benefits were in fact for the “middle” class (middle in quotes as we have seen taxes go down for those earners up to roughly $800,000, not your classic definition of middle class). Yes, this is true even with the limitations on state tax and property tax deductions. (SALT). Lower tax rates, an overhaul to the good of Alternative Minimum Tax (AMT), and a deduction for certain Qualified Business income have all contributed to these lower taxes.

Although the media and certain politicians have been saying otherwise, the people paying more taxes under the TCJA are those with ordinary income in the seven figure and up range. Why? Without getting into great detail here, those of you in this income neighborhood were previously getting SALT benefit from the deduction. Those below $800,000 weren’t reaping full benefit due to the dreaded AMT. The million plus earners are now capped b y SALT and paying higher total federal income taxes.

Our advice is not one size fits all, but here are general guidelines. We can work with you specifically on your situation.

If income acceleration or deferral is possible, maximize taxes paid at the 24% income tax bracket (and maybe higher).
For the seven figure earners, do not pay your fourth quarter 2020 estimate until it is due in January 2021. This is president in the event Biden and company restore the SALT deduction, something Pelosi and Schumer have both been wanting for their high state income tax constituents.

Capital Gains

Joe Biden has talked about increasing the long term capital gains rate from 20% to a person’s marginal tax rate which is currently as high as 37% (and going higher?? BE PREPARED!) Slap the 3.8% Obamacare tax on there and you are looking at a long term rate of almost 41% (or higher – BE PREPARED!)

You already have the easy answer to that, right? Sell your long term gains before year end and take “advantage” of the lower rates. Not so fast my friend. Other factors need to be considered:

Cost opportunity. Assuming California residency and a 11% income tax at the state level, you will pay roughly 35% tax on those gains (24% fed including Obamacare tax and 11% Cal). Paying tax on a $100,000, or $35,000 less working for you.

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2020 Filing deadline extended and lingering questions about estimated tax due dates...

Praetorian Advisors Brief Tax Update
Spring 2021

Greetings from Praetorian Advisors!

As you may have heard, the individual tax deadline has been extended for the second straight year, this time to May 17^th (the 15^th is a Saturday so it bumps to Monday). This means that no remaining tax payments are due for the 2020 tax year until that date as well. All states except Arizona and New Hampshire have complied with the extended due date. Given the sheer volume of information and ever-expanding disclosure requirements of the government, we would welcome a permanent due date change to May, but they haven’t asked us yet.

The IRS left the April 15^th due date unchanged for corporations and trusts. That’s simple enough and reasonable. What isn’t simple and is unreasonable is the IRS did not change the first quarter due date for estimated taxes, which was kept at April 15^th.

Originally, the IRS commissioner resisted changing any due dates in spite of the IRS’ 6 month backlog, claiming that extending any due dates would be confusing. So he agreed to extend some due dates but not others, which is…what’s the word…oh yes, confusing!

We held off sending this update, awaiting further guidance from the IRS on one key issue. The so-called guidance came out a few days ago and only reiterated what was originally announced, leaving out the answer to the following question:

What if a taxpayer includes Q1 2021 payments in an extension payment not remitted until May 17^th? Will the overpayment be applied as if made on April 15^th or May 17^th?

This is an obvious question to be answered yet we wait.

As those of you who extend every year know, building a Q1 payment into your extension is standard operating procedure here, as it serves two purposes: 1) it allows you to remit one payment rather than two, and 2) it provides cushion if the extension amount is short of what was needed, and we can make up for it in a subsequent quarter’s payment.

Because of the IRS’ lack of clarity, we will go the “safe” route and provide a Q1 2021 estimate for payment on April 15^th, with the 2020 extension payments happening by May 17^th unless better guidance is announced. Those of you who do not typically remit estimates can ignore all of this!

In the meantime, we continue to grind away at a busy season pace even with the individual extended due date. We appreciate you and appreciate your patience as we work through another tax season.

Patti, Paul, and your team at Praetorian Advisors.

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