On December 20, 2019, the President signed the Further Consolidated Appropriations Act, 2020 (“Act”) that contains significant tax legislation. During consideration by the House of Representatives, the Act was amended to include The Taxpayer Certainty and Disaster Tax Relief Act of 2019 (“Disaster Act”) that extended over 30 Code provisions that either had expired or that were scheduled to expire.
In addition, the Act includes retirement savings changes of the Setting Every Community Up for Retirement Enhancement Act (“SECURE Act”). The SECURE Act, which passed the House earlier in 2019 with bipartisan support (but had not been taken up by the Senate), expands the opportunities for individuals to increase their retirement savings and makes administrative simplifications to the retirement system.
During 2019 the government issued various forms of guidance, both informal and formal, addressing key aspects of the Tax Cuts and Jobs Act (TCJA) that was passed in December 2017.
Disaster Act Extenders
The Act extends over 30 Code provisions generally through 2020. While this summary cannot cover all the extended provisions, highlights of some of the more commonly applied changes follow:
Discharge of qualified principal residence indebtedness
The Act retroactively extends the gross income exclusion for discharges of indebtedness of up to $2 million. Prior to the Act, the exclusion was not available for discharges after December 31, 2017, unless they were subject to a binding written agreement signed before January 1, 2018. The exclusion now applies to discharges through December 31, 2020, and binding written agreements entered into before 2021.
Treatment of mortgage insurance premiums as qualified residence interest
Mortgage insurance premiums paid before January 1, 2018, by a taxpayer in connection with acquisition indebtedness on the taxpayer’s qualified residence were treated as deductible qualified residence interest subject to phase-out based on the taxpayer’s adjusted gross income. The Act extends this treatment through 2020.
Reduction in medical expense deduction floor Individuals, for 2017 and 2018, could claim an itemized deduction for unreimbursed medical expenses to the extent that such expenses exceeded 7.5% of adjusted gross income. The Act extends this 7.5% threshold for tax years beginning after December 31, 2018 and before January 1, 2021. Without this change, the threshold would have increased to 10%.
Deduction for qualified tuition and related expenses An above the line deduction for qualified tuition and related expenses for higher education is allowed up to a maximum deduction of $4,000. Phase out rules apply based on a taxpayer’s adjusted gross income. After 2017, this deduction was not available. The Act retroactively extends this deduction through 2020.
Nonbusiness energy property Prior to 2018, a nonrefundable credit was allowed for installation of nonbusiness energy efficient property equal to 10% of the amount paid by the taxpayer for qualified energy improvements to the building envelope (windows, doors, skylights and roofs) of principal residences. Also eligible were credits of fixed dollar amounts ranging from $50 to $300 for energy-efficient property including furnaces, boilers, biomass stoves, heat pumps, water heaters, central air conditioners and circulating fans placed in service before January 1, 2018. These combined credits were subject to a lifetime cap of $500. The Act retroactively extends these credits to property installed through 2020.
Energy efficient commercial buildings deduction A deduction for energy efficiency improvements to lighting, heating, cooling, ventilation and hot water systems of commercial buildings is allowed. The maximum deduction is $1.80 per square foot for construction on qualified commercial property. A partial $.60 per square foot deduction is allowed if certain subsystems meet energy standards but the entire building does not. The Act extends these deductions, which had expired after 2017, to property placed in service before January 1, 2021.
Employer tax credit for paid family medical leave Eligible employers can claim a general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave of up to 12 weeks. The credit is generally 12.5% of eligible wages, but may be increased to a maximum of 25% based on employer facts. The Act extends the credit, which was set to expire at the end of 2019, through 2020.
Work opportunity tax credit An elective general business credit is allowed for employers hiring individuals who are members of one or more of ten targeted groups under the Work Opportunity Tax Credit program. This credit was set to expire at the end of 2019. The Act extends the credit through 2020.
Credit for health insurance costs of eligible individuals There is a refundable credit known as the health coverage tax credit equal to 72.5% of the premiums paid by certain individuals for coverage of the individual and qualifying family members under qualified health insurance. While set to expire after 2019, the Act extends the health coverage tax credit through 2020.
Since many of the extended provisions expired at the end of 2017, many taxpayers did not use the deductions or credits when filing their 2018 tax returns. The wording of the Act prevented the lapse in coverage for the extended provisions thereby providing an opportunity for refunds, particularly for 2018 tax returns. The IRS is expected to issue guidance, hopefully soon, on how taxpayers can benefit from the retroactive extensions. Depending on this guidance, taxpayers may need to weigh the potential benefits of filing amended 2018 returns, as compared with the cost of filing the amended returns.
The Act also includes important provisions affecting some tax-exempt organizations, including:
Repeal of the so-called “parking tax” Effective for amounts paid or incurred after December 31, 2017, the Act repeals the TCJA requirement that tax-exempt organizations increase unrelated business taxable income for expenses related to qualified transportation fringe benefits.
Modify the tax rate on private foundations The Act replaces the former two-tier excise tax on private foundation investment income with a single 1.39% rate for tax years beginning after December 20, 2019.
SECURE Act Provisions
Changes brought about by the SECURE Act provisions incorporated into the Act include:
- Modify the requirements for multiple employer plans to make it easier for small businesses to offer such plans to their employees by allowing otherwise completely unrelated employers to join in the same plan. Changes are effective for plan years beginning after December 31, 2020.
- Increase to 72 the age after which required minimum distributions from certain retirement accounts must begin. Prior law required minimum distributions to be distributed or commence being distributed no later than April 1st of the calendar year following the year in which the participant attained age 70-½. The change in the age requirement is effective for distributions required to be made after December 31, 2019.
- Make it easier for long-term, part-time employees to participate in elective deferrals.
- Allow consolidated filings of Forms 5500 for similar plans for plan years beginning after December 31, 2021.
- Allow penalty-free plan distributions of up to $5,000 to pay expenses related to births and adoptions (for distributions made after December 31, 2019).
- For contributions made for tax years beginning after December 31, 2019, the Act repeals the prohibition on contributions to a traditional IRA by an individual who has attained age 70-½. This allows working individuals to continue making contributions to IRAs and brings traditional IRAs in line with Roth IRAs and 401(k) plans.
- Allow businesses to treat qualified retirement plans adopted after the close of a tax year, but before the due date (including extensions) of the tax return, as having been adopted as of the last day of the tax year. This change is effective for plans adopted for tax years beginning after December 31, 2019.
- Plan participants’ benefit statements will need to provide an annual disclosure illustrating the monthly payments the participant would receive if the total account balance were used to provide a lifetime income stream. This provision is effective one year after the issuance of guidance by the Department of Labor.
- A change permitting the portability of lifetime income options of qualified defined contribution plans, Code Section 403(b) plans or governmental Code Section 457(b) plans is effective for plan years beginning after December 31, 2019.
- After December 31, 2018, tax-free distributions from Section 529 accounts can be used to cover costs associated with registered apprenticeships, and up to $10,000 of qualified student loan repayments (principal and interest). A special rule for qualified student loan repayments allows such amounts to be distributed to a sibling of a designated beneficiary.
- Post-death required minimum distributions rules have been modified effective for distributions from retirement account owners who die after December 31, 2019. Under the Act, distributions to beneficiaries from a retirement account owned by a person who dies, must be made within 10 years after the date of death. The rule applies regardless of whether the account owner dies before, on or after the required beginning date. Exceptions to the 10-year rule are allowed for distributions to:
- The surviving spouse of the account owner;
- A child of the account owner who has not reached majority;
- A chronically ill individual; and
- Any other individual who is not more than ten years younger than the account owner.
- For an eligible designated beneficiary, the account balance must generally be distributed over the life or life expectancy of the eligible designated beneficiary beginning with the year following the year of death of the account owner.
- The TCJA changed how the unearned income of a child under age 19 or under age 24 and a full-time student was taxed. Beginning after December 31, 2017, the net unearned income was taxed according to brackets applicable to trusts and estates. The Act repeals the changes made by the TCJA; unearned income will once again be taxed at the parent’s rate based on the pre-TCJA rules. The change is effective for tax years beginning after December 31, 2019, but taxpayers may elect to apply it to tax years which begin in 2018, 2019, or both.
Qualified Business Income Deduction
For tax years beginning after December 31, 2017, the TCJA generally allows a new deduction under section 199A for individuals, trusts and estates of 20 percent of the domestic qualified business income generated by certain sole-proprietorships and pass-through entities (partnerships, S corporations and LLCs classified for tax purposes as a pass-through entity). Qualified business income includes qualified items of income, gain, deduction and loss effectively connected to a trade or business within the United States.
On February 8, 2019, the U.S. Treasury Department released final regulations for the qualified business income deduction. A summary of important changes from the regulations and other related guidance follows:
- A safe harbor was provided (see Rev. Proc. 2019-38) for treating certain rental real estate income derived from a trade or business as qualified business income eligible for the section 199A deduction. Among the safe harbor requirements are 250 hours of qualifying “rental services” time per taxable year and maintenance of separate books and records. Triple net leases do not qualify for the safe harbor.
- Taxpayers need “complete and separable books and records” to establish a separate trade or business for section 199A purposes.
- Aggregation is allowed at either the entity or individual level.
- Taxpayers must hold qualifying property at the end of the taxable year to use its basis as part of the section 199A limitations test.
- Certain section 743(b) basis adjustments resulting from a section 754 election can count as qualified property for purposes of the section 199A limitations test.
- Failure to report certain necessary information relating to the section 199A deduction on information reporting forms, like Schedules K-1, results in a presumption of the omitted items being zero.
- The deductions for the deductible part of SE Tax, self-employed health insurance and contributions to qualified retirement plans are considered “attributable to a trade or business” for purposes of computing qualified business income, meaning qualified business income is reduced. IRS instructions to newly released Form 8995 indicate that charitable contributions related to the trade or business as well as unreimbursed expenses and business interest expense should also be deductions in arriving at qualified business income.
- Previously disallowed losses from pre-2018 tax years do not reduce qualified business income.
- Previously disallowed losses from 2018 forward (including losses disallowed under section 465, 469, 704(d), and 1366(d)) allowed in the current taxable year generally are taken into account for purposes of computing qualified business income to the extent the disallowed losses are otherwise included in taxable income. Losses are used for purposes of Section 199A, in order of oldest to the most recent on a first-in, first-out basis and are treated as losses from a separate trade or business.
IRS released new Form 8995, Qualified Business Income Deduction Simplified Computation, and Form 8995-A, Qualified Business Income Deduction, which must be completed and attached to Form 1040.
Limitations on Net Business Interest Expense
Deductions for business interest expense are limited to the sum of (1) business interest income, (2) 30 percent of a business’s “adjusted taxable income,” and (3) floor plan financing interest for the tax year. Disallowed business interest expense is carried forward indefinitely.
Adjusted taxable income is a specially defined term, and the definition changes after 2021 in a manner that will potentially make the limitation’s impact more significant. Businesses with average gross receipts of $25 million or less ($26 million or less in 2019 after adjusting for inflation) are generally exempt from this provision. In addition, certain businesses in the real estate and farming businesses can elect for the interest expense limitation to not apply.
On November 26, 2018, the U.S. Treasury Department released proposed regulations. The proposed regulations apply to tax years ending after the date the Treasury decision adopting the regulations as final regulations. However, taxpayers may apply the proposed regulations to a tax year beginning after December 31, 2017. (Note: The Office of Management and Budget’s Office of Information and Regulatory Affairs is currently reviewing the final regulations package.)
The proposed regulations include provisions addressing:
- What constitutes interest expense for purposes of section 163(j).
- Ordering and operating rules to address the interaction of the section 163((j) limitation with other provisions of the Internal Revenue Code.
- The application of Section 163(j) to consolidated groups, pass-through entities and foreign entities.
- Treatment of disallowed business interest expense carryforwards.
- Elections available under Section 163(j).
- Allocating interest expense, interest income and other tax items when the taxpayer conducts a trade or business that is not subject to section 163(j) as well as a trade or business that is subject to section 163(j).
The IRS’ frequently asked questions and answers about the business interest expense limitation can be found here.
Bonus Depreciation Under Section 168(k)
Under the TCJA, 100% bonus depreciation is allowed for qualified property placed in service between September 28, 2017, and December 31, 2022. The 100% bonus depreciation amount phases down 20% per year starting in 2023 for most property.
Generally, qualified property acquired and placed in service in 2018 and after includes:
- Property with a recovery period of 20 years or less
- Personal property boot plus trade-in value
- Computer software
- Both new and used property
Qualified property does not include qualified improvement property acquired and placed in service in 2018 or after. Prior to 2018, qualified improvement property was considered qualified property. A hoped-for technical correction has not been made by Congress to include qualified improvement property in the definition of qualified property, and until a law change is made, qualified improvement property is subject to a 39-year life.
Estate and Gift Tax Changes
For estates of decedents and gifts made after December 31, 2017, and before January 1, 2026, the estate and gift tax exemption amount increases from $5 million to $10 million, before inflation adjustments. For 2019, the inflation adjusted exemption amount was $11.40 million; the amount increases to $11.58 million for 2020. The exemption amount remains unified for estate and gift tax purposes and eliminates the estate and gift tax on property transferred under these amounts via death or gift. Any use of the exemption for gift taxes decreases the estate tax exemption available at death. Prior law permitting a “step-up” in tax basis of assets to fair market value at death continues. The exemption reverts to the rules prior to 2018 (i.e., $5 million exemption) for deaths after December 31, 2025.
On November 22, 2019, the U.S. Treasury Department released final regulations addressing issues relating to the reduction of the exemption amount starting in 2026. The reduction of the exemption amount could, in effect, retroactively deny taxpayers who die after 2025 the full benefit of the higher exemption amount applied to previous gifts.
The final regulations provide that a taxpayer is allowed the higher exemption amount if gifts were made prior to 2026 in excess of the post-2025 exemption amount.
For example, if an unmarried individual made post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by the cumulative $10 million in basic exclusion amount allowable on the dates of the gifts, and the individual dies after 2025, when the basic exclusion amount is $5 million, the special rule allows the applicable credit amount against estate tax to be based on a basic exclusion amount of $9 million.