Federal Tax Issues for 2016

1. Federal Tax Issues for 2016 Tony Curatola Joseph F. Ford Professor Of Accounting and Tax Drexel University MACE

2. Part 1 Individual Taxpayers Current Issues MACE

3. JCX-108-15 (September 11, 2015) markup • Purpose: Require Treasury to develop guidelines for ID refund fraud cases and empower them the authority to combat it including: • Criminal penalties • Enhancement of IRS PTIN program & IP PIN (Identity Protection Personal Identification Number) program • Authority to IRS to combat ID theft • Provide Treasury & IRS authority to regulate paid return preparers • And a few other provisions • Status: Markup Before the Senate Committee on Finance Scheduled for September 16, 2015 was Postponed MACE

4. AICPA v. IRS Status • AICPA went to DC’s District Court arguing the IRS lacks statutory authority to implement the AFSP • DC ruled the AICPA did not have standing • Circuit Court has reversed the DC ruling stating the AICPA does have standing for its suit. MACE

5. PTIN • IRS posted the following notice on October 29, 2015 concerning PTINs • TD 9742 provides a temporary rule reducing 2016’s PTIN renewal cost to $33 (down from $50). • In addition, applicants will pay a higher fee to a 3rd party vendor of $17 for all applications (up from $14.25 for new applications and $13 for renewal applications). • Thus, the new fee is $50 (or a savings of $14.25). MACE

6. PTIN Humor • Inspector General urges IRS to revoke tax preparers who fail to comply with IRS rules: • More than 700,000 PTINs were issued in 2015 of which, • 19,496 preparers were potentially noncompliant with their tax filing and payment obligations. MACE

7. PTIN Humor • Inspector General urges IRS to revoke tax preparers who fail to comply with IRS rules: • More than 700,000 PTINs were issued in 2015 of which, • 19,496 preparers were potentially noncompliant with their tax filing and payment obligations; and • 3,001 were self-reported with felony convictions. MACE

8. PTIN Humor • Inspector General urges IRS to revoke tax preparers who fail to comply with IRS rules: • More than 700,000 PTINs were issued in 2015 of which, • 19,496 preparers were potentially noncompliant with their tax filing and payment obligations, and • 3,001 were self-reported with felony convictions, and • 87 reported a crime related to federal tax matters • An error rate of approximately 3%. But what about those preparers without a PTIN? MACE

9. Mortgage Interest Deduction • Voss & Sophy v. Comm. • Issue: Does the $1.1M mortgage interest deduction apply to a residence or to a person. • Tax Court ruled it applies to the residence. MACE

10. Mortgage Interest Deduction • Voss & Sophy v. Comm. • Issue: Does the $1.1M mortgage interest deduction apply to a residence or to a person. • 9th Circuit reverses Tax Court ruling that it applies to the residence. MACE

11. Mortgage Interest Deduction • Voss & Sophy v. Comm. • Issue: Does the $1.1M mortgage interest deduction apply to a residence or to a person. • 9th Circuit reverses Tax Court ruling that it applies to the residence. • Result: Unmarried co-owners are able to deduct mortgage interest on debt of up to $1.1M each. • Policy: Another marriage penalty • Policy: Imagine buying an estate with multiple family owners whereby each person is able to claim interest on $1.1M of debt MACE

12. Mortgage Interest Deduction • Voss & Sophy v. Comm. • Issue: Does the $1.1M mortgage interest deduction apply to a residence or to a person. • 9th Circuit reverses Tax Court ruling that it applies to the residence. • Result: Unmarried co-owners are able to deduct mortgage interest on debt of up to $1.1M each. • Issue: What do we do with our clients? We don’t live in the 9th circuit and the TC is a national court. MACE

13. RMD Reminder • Retirees must take the RMD from qualified retirement plan • From QRP in the calendar year they reach age 70 ½ or retire; or • From IRA in the calendar year they reach age 70 ½. • Exception: • First RMD is required by April 1 of the following year. But this creates a double dip. • Caution: It is wise to check the figure given to the retiree by the plan administrator. MACE

14. Beneficiary Issues • All individuals with retirement plans (qualified and IRAs) should be reminded to have both a beneficiary and a contingent beneficiary on each plan. • All individuals • Children • Divorced individuals • Who to list as the beneficiary? Spouse or child MACE

15. Beneficiary Issues If Owner Dies Before 1st RMD • Designated Spouse (DS): • Treat as own OR • Treat as beneficiary & recalculate life expectancy per year, OR • Distribute within 5 years. • Child beneficiary: • Distribute all within 5 years OR • Elect RMD over child’s life (ALE-1*) • Multiple beneficiaries: • Distribute all within 5 years OR • Elect RMD over oldest beneficiary’s life (ALE-1) • Note: ALE-1 means applicable life expectancy minus one MACE

16. Beneficiary Issues If Owner Dies After 1st RMD • Designated Spouse (DS): • Treat as own, OR • Treat as beneficiary and distribute over life expectancy via recalculation method of either • the owner or • DS • Child Beneficiary: • Distribute over child’s or • owner’s life expectancy via ALE-1 method MACE

17. ABLE Act of 2014 • Purpose: • To encourage and assist individuals and families in saving private funds for the purpose of supporting individuals with disabilities to maintain health, independence, and quality of life. • To provide secure funding for disability-related expenses on behalf of designated beneficiaries with disabilities that will supplement, but not supplant, benefits provided through private insurance, the Medicaid program under title XIX of the Social Security Act, the supplemental security income program under title XVI of such Act, the beneficiary's employment, and other sources. MACE

18. ABLE Act of 2014 • New IRC Section 529A • Limited to annual gift tax amount (i.e., $14,000 in 2015) • Account accumulates on a tax free basis • Qualified distribution amounts are excluded in gross income • Non-qualified distribution amounts are included in gross income • As determined by IRC Section 72, and • 10% additional tax applies unless made after the death of the beneficiary MACE

19. New IRC Section 529A • Estimated number of eligible participants • Between 2.6 & 4 million children, and • Between 4.1 & 8 million adults • All but a few states are actively investigating the establishment of these accounts (including PA) • Treasury received over 20 comments in October on the proposed regs • Major weaknesses are implementation, disability definition, residency issues, and monitoring • Major advantages are providing additional financial support in the long term without the distributed funds counting as income. MACE

20. Understatement Penalty • Chief Counsel issued CCA 201519029 on when it is appropriate to apply the understatement penalty in the presence of willful or reckless conduct • If return is signed but not filed by taxpayer, penalty applies (per Reg. § 1.6694-1(a)(2), a return is deemed prepared when signed) • If return is not signed but is filed, penalty applies if evidence is available to support signing • If Service disallows refund, penalty still may apply • If return is filed after the refund’s statute of limitation expired, penalty does not apply because return is not filed. MACE

21. 20% Accuracy Penalty • Nicholas S. Farris et ux. v. Comm. in TC Summ Op 2015-53 • 20% accuracy penalty applied to taxpayer after failing to qualify as a real estate professional • Key issue was lack of documentation supporting the taxpayer’s participation to qualify them as a real estate professional • Ruling is not precedence but it does send a signal: • "[W]e are not required to accept post event ‘ballpark guesstimates’, nor are we bound to accept the unverified testimony of taxpayers in the absence of adequate documentation” MACE

22. Supreme Court Ruling • Comptroller v. Wynne (Docket No. 13-485, May 18, 2015) • Issue: • Taxpayers are able to take a tax credit against their Maryland state income tax for similar taxes they paid to other states. • However, Maryland does not permit taxpayers to take a credit against the county tax for income taxes paid in other states. MACE

23. Supreme Court Ruling • Example: • Mary lives in Maryland and earns $100,000, entirely from activities in Maryland. • She owes $4,750 in MD state income tax (0.0475 x $100,000) & $3,200 in MD county income tax (0.032 x $100,000) • Total Maryland tax is $7,950. MACE

24. Supreme Court Ruling • John (a resident of MD) earns $100,000 of which $50,000 is earned in MD and $50,000 is earned in PA. • John owes the same MD tax of $7,950 as Mary. • John also owes $2,375 in PA state income tax (0.0475 x $50,000) & $625 PA SNRT (.0125 x $50,000) for a total PA tax of $3,000. • However, he can only claim a tax credit on his MD return for $2,375 • Therefore, John owes $625 more in state income taxes than Mary. MACE

25. Supreme Court Ruling • U.S. Supreme Court held that MD’s personal income tax scheme violates the dormant Commerce Clause, which creates an incentive for taxpayers to opt for intrastate rather than interstate economic activity. • The majority of justices held that MD fails the internal consistency test (assuming that if every state adopted Maryland’s tax structure, interstate commerce would be taxed at a higher rate than intrastate commerce) and by undisputed economic analysis that MD’s tax scheme is inherently discriminatory and operates as a tariff. • Action: Amended tax returns may be needed for taxpayers in MD and also other states that have similar discriminatory provisions. MACE

26. Foreign Gifts and Bequests • We are all well aware that individuals who have a financial interest in or signature authority over a foreign financial account must be familiar with the need to comply with the Report of Foreign Bank and Financial Accounts (FBAR) • But what about gifts and inheritances received from individuals or entitles outside the US? MACE

27. Foreign Gifts and Bequests • The value of property received by a taxpayer by gift, bequest, or inheritance is not include in gross income. This is a donor’s problem. • But are there any special rules when the gifts or inheritances is given by an individuals or entitles outside the US? MACE

28. Foreign Gifts and Bequests • Yes, the amount may need to be reported to the IRS if the amount • Exceeds $100,000 from a nonresident alien individual or foreign estates; or • Exceeds $15,358 for 2015 ($15,671 for 2016) from a foreign corporation or partnership. • But no reporting is needed if the transfers are to a U.S. person for either tuition to a qualified educational organization or to any person who provides medical care on behalf of a U.S. person. • Reporting is to allow the IRS to determine if the amount is truly a gift or income. MACE

29. Non-Away-From-Home Lodging • TD 9696 (09/30/2014), Reg. §1.262-1 • Tax free working condition fringe benefit if all facts & circumstances tests are passed: • Lodging is necessary to participate fully in or be available for a bona fide business meeting, training, conference, etc. • Lodging is for a period not to exceed 5 days in any given quarter, • Employer requires employee to remain at the activity or function overnight, • Lodging is not lavish or extravagant & doesn’t provide any significant element of personal pleasure, recreation, or benefit. MACE

30. TD 9673 - Qualifying Longevity Annuity Contracts • Modify RMD rules: • Purchase of deferred longevity annuity to start at age 80-85 • Maximum Annuity Investment is the lesser of: • 25% of retirement plan account balance, or • $125,000 (was $100,000 under proposed regs) • Issue Raised: • 401(k) plan purchase: gender neutral tables used • IRA plan purchase: sex-based mortality tables used MACE

31. TD 9673 - Qualifying Longevity Annuity Contracts • $125,000 is inflation adjusted at $10,000 increments ($25,000 under proposed regs) • QLAC may contain a return of premium feature that is payable by 12/31 of the year following death. • QLAC cannot consist of variable contract, an equity-indexed contract, or a similar contract. • A failed QLAC due to excess premium limits may be corrected without penalty by withdrawing excess premium to non-QLAC portion of employee’s plan by 12/31 of the following year. MACE

32. Involuntary Conversion of Livestock • In general, gain is not recognized when property is involuntarily converted and then replaced with similar property within the replacement period. • Involuntary conversion (IC) gain is recognized only to the extent the amount realized exceeds the cost of replacement property. • If a sale or exchange of livestock is treated as an IC solely on account of drought, flood, or other weather-related conditions that result in the area being designated eligible for assistance by the federal government, the replacement period ends 4 years after the close of the 1st year in which any part of the gain from the conversion is realized. MACE

33. Involuntary Conversion of Livestock • Notice 2006-82: The IRS will publish in September each year a list of counties, districts, cities, parishes, or municipalities for which exceptional, extreme, or severe drought was reported. Notice 2015-69 (September 29, 2015) is the latest annual list. • For these listed counties, the replacement period is extended to the end of the taxpayer’s 1st taxable year ending after a drought-free year for the region whose taxpayers qualified for a 4-year replacement period & it expires at the end of 2015 • PA: Counties of Berks, Bucks, Carbon, Chester, Lancaster, Lehigh, Luzerne, Monroe, Montgomery, Northampton, Pike, Schuylkill and Wayne. • DE and MD: None listed MACE

34. IRS Notice 2015-76 • Treasury and IRS are considering the exclusion from the tax under IRC §4216(a) frequent flyer miles redeemed other than for taxable transportation of persons by air for items such as but not limited to: • international air transportation, • restaurant gift cards, • magazine and newspaper subscriptions, • free hotel nights, and • items from the airline's shopping catalog • Public comments on issues by March 16, 2016 (+ or -) MACE

35. Chief Counsel Advice 201543014 • Internet Domain Names: • Do we capitalize? and Do we amortize cost? • Non-generic domain is usually a company or product name • Generic domain is not a company or product name (Really!) • In general, the result is yes to both questions whether the domains are purchased separately or as part of an acquisition. MACE

36. Part 2 Protecting Americans From Tax Hikes Act of 2015 (PATH Act) MACE

37. Refundable Child Tax Credit (CTC) • CTC is $1,000 per child & is phased out for taxpayers with MAGI above threshold amounts • The $3,000 earned income threshold is now made permanent: • 15% of taxable earned income over $3,000 • For families with more than 2 children, it is the larger of: • 15% of taxable earned income over $3,000,OR • The excess of taxpayer’s social security taxes over the taxpayer’s EIC for the year • The indexing of the $3,000 threshold is repealed (i.e., not indexed after 2017). MACE

38. Refundable Child Tax Credit (CTC) • The refundable portion of the CTC is NOT applicable to any taxpayer electing to exclude any amount from gross income under the: • Foreign earned income exclusion; or • Foreign housing costs exclusion • This provision is effective for tax years beginning after December 31, 2014. MACE

39. Child Tax Credit Restriction • For tax years beginning after 2015, a taxpayer who erroneously claims the CTC will be subject to the disallowance rules that apply to the EIC. That is, no CTC is allowed after the most recent tax year for • 2 years where the taxpayer’s claim was denied due to reckless or intentional disregard of rules and regulations; or • 10 years where the taxpayer’s claim was denied due to fraud. • In addition, if the denial is the result of a deficiency procedure but not reckless or disregard or fraud, the taxpayer will be required to provide the information required by the IRS when next claiming the CTC. MACE

40. Earned Income Credit (2016) Qualifying Credit Earned Maximum Children % income credit • None 7.65 $ 6,610 $ 506 • 1 34.0 $ 9,920 $3,373 • 2 40.0 $13,930 $5,572 • 3 or more 45.0 $13,930 $6,269 • Under PATH Act, the 45% for 3 or more children becomes permanent (was temporary through 2017) MACE

41. Earned Income Credit Phase-Out (2016) Non Joint Filers Joint Filers Qualifying Phaseout Threshold Threshold Children % Phaseout Range Phaseout Range • None 7.65 $ 8,270 - $14,880 $13,820 - $20,430 • 1 15.98 $18,190 - $39,296 $23,740 - $44,846 • 2 21.06 $18,190 - $44,648 $23,740 - $50,198 • 3 or more 21.06 $18,190 - $47,955 $23,740 - $53,505 • Under PATH Act, the $5,000 increase for joint filers is made permanent (was temporary through 2017) MACE

42. Earned Income Credit • Change in requirement to claim EIC: • For tax returns filed after December 18, 2015 (don’t you just love the date), a taxpayer can claim the EIC only if • A TIN or social security number was issued by the Social Security Administration before the due date for filing one’s tax return. • Also, this provision applies to both the taxpayer and the child. • As the law is currently written, the due date does not include extensions (we may see clarification on this issue later). MACE

43. Itemized Deductions • State Income v. State Sales taxes: • Election to claim either state income taxes or sales taxes as an itemized deduction is retroactively made permanent for years beginning after 2014 MACE

44. Itemized Deductions • State Income v. State Sales taxes: • Election to claim either state income taxes or sales taxes as an itemized deduction is retroactively made permanent for years beginning after 2014 • Mortgage Insurance Premium: • Premiums paid or accrued during the year for qualified mortgage insurance on acquisition indebtedness on primary or secondary residence are retroactively reinstated for years 2015 through 2016. • Phaseout range of $100,000 to $109,000 remains in place MACE

45. Itemized Deductions • Home Mortgage Forgiveness Exclusion: • If taxpayer satisfies the criteria, the home mortgage forgiveness amount is excluded from their gross income. • The exclusion is retroactively reinstated for years 2015 and 2016. • In addition, discharge arrangements entered into prior to 2017 and discharged in 2017 qualify for the exclusion. MACE

46. ABLE Account • A qualified ABLE account may be established for a designated beneficiary that is either disabled or blind. • Prior to the PATH Act, the ABLE account could only be established in the designated beneficiary’s state of residency. • Effective after December 31, 2014, the ABLE account can be established in any state regardless of the designated beneficiary’s state of residency. This legislation eliminates the “contracting state” issue. MACE

47. Depreciation • Bonus depreciation is retroactively reinstated and extended for: • Qualified property placed in service before January 1, 2020; and • Aircraft and long-production property before January 2, 2021. • In addition, bonus depreciation rate is phased down to: • 40% for 2018, and • 30% for 2019 MACE

48. Business Provisions • R&D credit is: • Retroactively restored to 2015 and is made permanent. • Work opportunity tax credit is: • Retroactively restored and extended through 2019, and • Expanded to include long-term unemployment recipients MACE

49. Other PATH Act Provisions • American Opportunity Tax Credit is made permanent (set to expired in 2017) • Elementary & secondary school teacher expenses deduction is made permanent (expired in 2015) • Parity for employer-provided mass transit and parking benefits retroactively extended to months after 2014. MACE

50. Other PATH Act Provisions • Contributions of qualified conservation contributions are retroactively reinstated for 2015 and the provision is made permanent. • Tax-free distributions from IRAs for charitable purposes is retroactively reinstated for 2015 and the provision is made permanent. MACE