On-Demand: Financial Services Year-End Tax Planning | Part II

And we also have Miri Forster. Miri is the head of our Tax Controversy Group, spends her time when the IRS comes calling, helping us deal with those issues as they come up. She'll be giving an update on the IRS in general, and just in terms of tax controversy and where the IRS is focused, continues to be focused and keeps announcing new focuses of the IRS. So it's a good thing to be aware of and to know that things, there is an increased focus on our industry in general. So without further ado, I will hand it over, I believe, to Stephanie and enjoy, and thank you again for joining. Steph?

Stephanie Hines:Thanks, Simcha. Hi, everyone. And just to reiterate what Simcha was saying, thank you for joining us today during your lunch hour. My name is Stephanie Hines and as stated, I'm a partner in the Personal Wealth Advisory Group. Today, we're going to cover at a pretty high level 2021, where we started, where we are today and then some year-end considerations. So as we know, 2021 has been a pretty active year when it comes to tax policy and politics. Leaving politics on the side, which nobody wants to hear me speak about politics. Anyway, you can see that it's been a pretty busy year, beginning back in March when the American Rescue Plan Act had been signed into law. So this Act, which was also known as the COVID-19 stimulus package, was a $1.9 trillion stimulus legislation that had actually been built off of a number of the provisions in the CARES Act of 2020, and was signed into law by President Biden in order to speed up the country's recovery from both the economic and the health impact of the COVID-19 pandemic.

So fast forward to September 13, 2021, this is when the Budget Reconciliation bill was introduced by the House Ways and Means Committee. And as we all remember, this was a proposed $3.5 trillion bill and had a startling number of provisions included, anywhere from increased tax rates to the exclusion of a grantor trust as a viable estate planning tool. And then on October 27th, the Billionaires' Tax had been introduced by Senator Biden and was promptly scratched within 24 hour period, when the Build Back Better Act was finally introduced. Now, this brings us to where we are today, with the Build Back Better Act having been approved by the house on November 19th. This act has been voted in as a $1.75 trillion legislation, which is a dramatic reduction from the original $3.5 trillion in spending over 10 years, but also with a vastly different outline than what was originally introduced in September.

So as you can see, just on this slide here, I've also included a quick summary outlining the four wealthiest individuals in the country. You've got Warren Buffet, Jeff Bezos, Michael Bloomberg and Elon Musk, all which as we know, have shared their thoughts on the imposing, not only the Billionaires' Tax, but the act in and of itself. I believe it was last night on an interview with the Wall Street Journal, Elon Musk came out and said, "Can it." So we'll see what impact that's going to have. I won't spend any more time speaking to this portion. I just thought that it was interesting in seeing wealth appreciation to total taxes paid over the years. And as we know, and one thing to always remember, net worth isn't necessarily the driver of taxable income. So as you're reading things and hearing and looking at slides, just remember that net worth doesn't always drive total taxes paid or income reported.

Now the Billionaires' Tax, so why am I even addressing it when it's off the table? So ultimately, until the most recent proposal is pass and not just approved by the House, anything's possible. It may not remotely be likely, but again, anything's possible even when the lifespan, like I'm saying was just under 24 hours. So if the Billionaires' Tax were to be included as it was originally proposed, who would it apply to? It would apply to any individual who meets either an income test or an asset test. The income test would be met if an individual's adjusted gross income exceeded 100 million or 10 million, if it were a trust, for the three years immediately preceding the current year. And then the asset test would be met if the aggregate value of all assets held by the taxpayer as of December 31st, exceeded $1 billion for the three years immediately preceding the current year. So if the taxpayer qualified, then essentially they would be subject to a mark to market regime and would be taxed on their wealth appreciation. Now, with that being said, and thinking about the previous slide where the wealth appreciation for those four individuals was significant, this would lend to a hefty tax liability, clearly not included in the House approved version.

So let's move on and take a look at a couple of other things. We're going to spend a little bit of time on this slide. As we know, the Build Back Better Act doesn't deal strictly with tax matters. There's a lot of green energy and then some foreign issues that we won't be covering. However, I will go over certain highlights impacting individuals. I'll also touch upon some of the provisions impacting businesses, but from the corporate tax side, this really has been watered down significantly. So the chart that you're looking at here outlines what was originally included, what's now out, and now what's currently included in the House approved version. So let's start with some of the items that did not make the final bill. Again, I'm going to review these just because there's always a chance of modification as the bill moves through the Senate.

So what's out? For starters, we're not going to see an increase in tax rates for either individuals or corporations. So that respective 39.6% and 26.5% rates are no longer included. The increased preferential capital gain rates are also gone, but there is one capital proposal that did stick. It relates to section 1202, so your qualified small business stock. But again, it's essentially the only capital treatment from the original draft. And we'll discuss that a little bit later. Now, surtax percentage is higher than the originally proposed, but the applicable floor was raised. There was also originally a discussion of limiting the section 199 or the qualified business income deduction to 500,000, but that's not in the final bill either. And then surprisingly, most of the anti rollovers, business startup and supersized IRAs are out of the bill, except, and this is important, the bill does prohibit additional contributions to a Roth or a traditional IRA if the contributions would cause the total value to exceed $10 million.

So if this does occur and the taxpayer has income in excess of 450,000 or 400,000, if single or married filing separate, then a minimum distribution would be required for the following year to get those IRAs under 10 million. Now this provision isn't applicable until the tax years beginning after December 31st, 2028. So there's still some time until obviously 2029. This next item, which is a tool that a number of the clients that I work with use, is being eliminated as well. And that's backdoor Roth conversion. So that's where contribution to an after-tax traditional IRA is made. And then an immediate conversion is made into Roth. Therefore, you'll be able to take advantage of the non-taxable growth. So this relates to both after-tax IRAs and after-tax employer sponsored plan. So it's not just the after-tax IRA.

The act would prohibit all contributions from being converted to a Roth regardless of the income levels. So the 450,000 and the 400,000 that I just mentioned previously, that's not applicable. Now, however, this if passed, would be applicable to tax years beginning after December 31st, 2021. So we've got about three weeks. Now, given there isn't a significant amount of time to plan, especially relating to the conversion, if either of these are applicable to you, then you're really going want to have this discussion sooner rather than later, and review if it's beneficial to roll into a Roth conversion, but also just reviewing your IRAs in general. And again, this may not be voted in as is, but I also don't suspect it's going to be vastly different.

Now lastly, and probably the most impactful change regarding the excluded items relates to estate planning. So essentially everything that was included in the September proposal, from the significant reduction of the exemption to, as I said before, the elimination of the grantor trust provisions, have been excluded. Now, there had been much speculation as to if these would ever even get passed because that, what was included would have changed the baseline of estate planning as we know it. The proposal would have included grantor trust established after the effective date to be included in the taxpayer's estate, which would remove the ability to transfer assets out of your estate, but also reviewing or sorry, removing the ability to further reduce an estate annually by personally paying the tax liability generated from those trust assets.

The provision would have also have complicated life insurance trusts because unless they were pre-funded, it would have been applicable to any transfers made to existing trusts after the effective date of the bill. That's what's been excluded. So now let's talk about what did actually make it in there. And these are the real issues, right? So looking at the bill now, if a taxpayer's adjusted gross income is less than 400,000, then not a lot is going to directly affect them. It will indirectly affect them through the general impact on the economy, but there'll be no direct tax implication to them.

Now you'll see that I have four highlighted topics, and I'll speak more specifically to these in a bit, but this summary outlines some of the other provisions included: abandonment partnerships, Wash-Sale rules for digital assets, some international tax changes relating to GILTI and FDII, some of the corporate is a 1% tax on buybacks for publicly traded companies and then a potential 15 minimum tax on book income for certain large corporations.

Lexi D'Esposito:Polling question one. Prior to the trust and estate provisions being removed from the Build Back Better Act, did you transfer additional assets to utilize the current lifetime exemption? A, yes; B, no; C, yes, however in prior years or D, I am waiting until we are closer to the provisions sunsetting as of December 31st, 2025.

Stephanie Hines:Thank you. It's always interesting because when we're talking about transferring of assets, many people said yes, the majority said no. It really comes down to where you are in your lifetime, like are you ready for more estate planning? And the big thing is to always remember, keep that oxygen mask on yourself, because if you are gifting to say, children, spouses, and for ultimately your children, you don't ever want to give away so much where you're going to depend upon them to take care of you as you age.

But anyway, so that was interesting. Thank you. So applicable to high income individuals and trusts, there are two separate surcharges that would be imposed when a certain level of modified adjusted gross income is met. So for this purpose, modified adjusted gross income is defined as adjusted gross income, less investment interest expense, that's reported on Schedule A. So remember, any investment interest expense applicable to a flow through entity and is deductible on Schedule E is already included in your AGI. So no further reduction would be allowed. The first threshold is applicable to taxpayers whose modified adjusted gross income is in excess of 10 million for single or married filing joint, and then 5 million if married, filing separate. Once met, a 5% surcharge would be imposed on that excess amount. Now there's an additional surcharge as if 5% wasn't enough, that's equal to 3% and would be imposed on taxpayers who have modified AGI in excess of 25 million, again, if single or married filing joint or 12.5 million, if married, filing separate.

Now, remember these aren't 5%, 3% of taxable income. It's modified adjusted gross income. So unfortunately, you're not allowed to take into consideration charitable contributions. This also isn't a tax for tax credit purposes, which is interesting. So if you have non-refundable tax credits and you're able to wipe out some, or even all of your taxable income with these credits, you're not going to be able to reduce the sur tax, and taking it one step further, the way that this is currently written, it's also not going to come into play when determining AMT. This is still a separate and additional tax. So the surcharge is also applicable to trusts, however at much lower thresholds, so similar to tax brackets, as they compare between trust and individuals, where individuals' tax brackets, you hit the highest tax bracket at a much higher income level, these thresholds still disconnect from the ones that are imposed on individuals.

So when a trust modified adjusted gross income is in excess of 200,000 versus 10 million, then the 5% surcharge would be imposed. And if the trust has modified adjusted gross income of greater than 500,000 versus 25 million with individuals, then the additional 3% surcharge would be applicable. As I stated, modified AGI doesn't consider charitable contributions. However, if there's only a charitable interest remaining in the trust, then that trust would meet the exemption. So this means that a trust would have to be wholly for charity and not structured as say, a charitable remainder trust or something similar where there are income beneficiaries other than the qualified charity, and also for trusts, modified AGI doesn't include the income distribution deductions. So this could actually make the surcharge pretty expensive. Now remember, this is going to be different than when planning for 65 day election and being able to have income deemed distributed as of the end of the year, in order to take advantage of a potentially lower tax bracket at the individual level.

The surcharge is based on a pre income distribution basis, so the question then becomes if distributions are made from the trust and included in the modified adjusted gross income of the beneficiary, would there be an allowable credit at the individual level for the surcharge that would be required to be at the trust level? I would think so, but again, we have to wait and see and perfect timing for disclosure, all of this is potential for change. So we're getting closer to the end of the year. Hopefully we'll see something soon. Not everybody thinks we will. It depends on the day of where I think we're going to land as far as timing, but just remember that a lot of these things are really dependent upon what the final act comes through Senate, if it does.

So now, if passed, the bill is also to broaden the reach of the net investment income tax. So the net investment income tax is currently applicable to all investment income. However, if passed, the bill is going to subject to all ordinary income, that's not already subject to FICA to this additional 3.8 net investment income tax. And their goal here is that they're trying to capture the income that currently escapes both the net investment income and the self-employment tax, specifically flow through income, and just ensure that it's taxed accordingly.

So for example, if we have a management company that's currently structured as an LP, the way that the current law is written, LP income is not subject to net investment income or self-employment tax. But if imposed, this income is now going to be subject to the additional tax of 3.8%. Now this has been in discussion for a while, and we knew it was being reviewed, but until it was actually included in the Build Back Better Act, it's provided a great savings and planning technique.

Now the question is, is there another way to structure it? Before doing anything, you really need to look at this from a cost effectiveness, and if it makes sense. For instance, so if the current LP interest was to theoretically be dropped into a single member LLC, so therefore subjecting the flow through income to tax as self-employment because LLC is your self-employment income tax, is that more cost effective and can it be done? You'd automatically think yes, because you're just dropping an LP into an LLC, but if you run the numbers, you may find that that additional 3.8% NII tax that's now being remitted may not be as expensive in comparison to the required aggregate of self-employment tax, FICA, and then your additional Medicare tax that you'd potentially be subject to. Now taking it even one step further, if you're in New York, that income would then be subject to the Metropolitan Commuter Transportation Mobility tax, or your MCTMT, which is just another added expense.

So this slide is a model of how to think about itemized deductions and it will tie into the next slide as well. So essentially, there are two buckets of income: bucket one, which is comprised of your preferential income, such as your long term capital gains and qualified dividends, and then bucket two, which is your ordinary income tax at the higher tax rates. The thing to remember is that your itemized deductions go against ordinary income first, and clearly, the goal is to reduce ordinary income as much as possible and have more of the taxable income be preferential in character. So just looking at a quick analysis, you'll see the facts are on the right side, and how we get down to the 250 million taxable income, inclusive of charitable deductions and investment interest expense that's not already included on Schedule E.

I'm not going to walk through it in detail, but it's a comparison of the Fed tax liability of an individual, like I was saying with adjusted gross income is 275 million, taxable income is 250 million. Column one reflects the liability as determined under TCGA, which is our current law. Column two reflects the liability as determined under the Build Back Better Act, which was approved back in November 19th. Now this takes into consideration the 5% surcharge, the 3% surcharge, and then the additional income subject to the 3.8 net investment income tax. So as you can see, just simply by running this, no change to income or deductions, this taxpayer's effect rate would increase by roughly 9%. So the question is, is why only 9% and not 11.8%, which would essentially have been the sum of the 5%, the 3%, and then the 3.8%. And that's just because the 3.8% historically has already been applied to investment income, and now it's an additional tax only on the portion of income that was previously excluded.

Simcha David:Hey, Stephanie, I just wanted to point out something. I just wanted to point out something in that example. I think you made the assumption that the management fee of 150 million under the TCGA, that whoever set up that structure was not subjecting that to self-employment tax, because that would have been similar, not exactly the same as the 3.8 because part of it's deductible, but similar. So this assumes that the 150 was not subject at all to any self-employment tax or net investment income tax, and then you layered on, excuse me, the net investment income tax.

Stephanie Hines:Yep, exactly.

Simcha David:Okay.

Stephanie Hines:Thanks. Okay, so I already see in the chat box some questions regarding excess business loss and what's going on as far as how it's being treated in subsequent years. So let's go to limitations on qualified small business stock and on excess business losses. So these are two other provisions that would remove or defer the ability to realize certain capital exclusions or ordinary losses. Let's look at number two first since we already have a couple of questions. The limit on excess business losses, so currently, for years beginning after December 31st, 2021, losses in excess of 500,000 for married filing joint are disallowed and carried forward, but would have been treated as a net operating loss in subsequent years, and then you would have been subject to potential 80% limitation, and had to fall under the net operating loss rules.

Now, the recent Act would permanently disallow excess business losses, similar to what I just stated, 500,000 if you're married filing joint, change for inflation, I believe it's 524,000 this year. However, the bill throughout the net operating loss concept, meaning that any excess business loss carried forward would be treated as a business loss in the subsequent year and would be required to be retested annually under the excess business loss rules, as opposed to only being tested in year one as an excess business loss, and then transferred over to being treated as a net operating loss. Both pros and cons, the good news is that gains attributed to the trader business are still to be considered in the excess business loss calculation. The bad news is, is that wages are not. So even if they're directly related to the trader business, they're not included in the calculation. Now, the limitation was originally written to sunset after December 31st, 2025. But if approved, like I said a minute ago, it's going to be made permanent.

So qualified small business stock, this exclusion, so this is the only capital provision impacting individuals that remains in the Build Back Better Act. Currently, with the way that it's written beginning with acquisitions after September, 2010, taxpayers can exclude 100% of the capital gain up to $10 million or 10 times their tax basis on any stock that qualifies as a small business stock, as long as it was held for more than five years. Well, that benefit is potentially gone. What would happen is this bill would bring us back to the 2009, so the pre-2010 version, which limits taxpayers to a 50% exclusion, not 75%, not 100%, those would just be lost. They're not even deferred. The most, so again, the most that an individual would be able to exclude from their capital gains is 50%, providing that all other requirements have been met.

So your holding period, your 10 million basis, the 50 million on original purchase, all of the underlying qualified small business stock requirements are still going to have to be met. Now additionally, and you can see this just on the two squares that I have on that slide, the 7% AMT add back is also going to be reinstated. So again, it could be, it's going to be impactful. Now, something else to note is that estates and non-grantor trusts still are not eligible for this exclusion. Grantor trusts are again, because it's deemed as if the taxpayer's the owner for tax purposes. Unfortunately there isn't much advanced planning relating to the 100% exclusion that can be done at this time because the effective date, if enacted, is going to be September 13, 2021. However, it's still so important to review positions and be aware going forward. And like I said, I really do feel that the limitation or this limitation out of them all is going to have more of a significant impact just because it's the elimination of a benefit and not necessarily a deferral of loss.

Lexi D'Esposito:Polling question number two, what part of the Build Back Better Act is going to impact you the most? A, surcharge tax; B, limitation on the qualified exclusion; C, limitation on excess business losses or D, no immediate impact.

Stephanie Hines:Yeah. So I've had, this is interesting. I've had many, many conversations just regarding the potential impact of passing this Act as is. And no conversation is the same because it doesn't impact everybody the exact same. It really depends on what you hold, what your investments are, what your income or your adjusted gross income liability is. Yeah, so again, thank you. It's interesting to see where the touch points are. Okay, so before getting into some of the year end considerations, let's just touch upon a few other provisions from the Build Back Better act that are worth mentioning. So as approved, and we've all been waiting for this one, the limitation on the state and local tax deduction would increase from $10,000 to $80,000, $40,000 if it were for trust or married filing separate. Now I think we all expected a little bit more.

And the fact that they gave 80,000, I'm not sure how impactful that will be, but it is effective for years beginning after 2020. So it will apply to 2021, but it will also extend through December 31st, 2030. So for 2031, the deduction would then be clawed back to 10,000, 5,000 if you're married, filing separate, and then sunset as of 2032, probably going to have changes before then, but worthless securities and abandonment of a partnership interest. So currently a worthless security is deemed worthless as of the end of the year. But if it's passed, the security would be deemed worthless on the actual date that it becomes worthless and no longer December 31st. So taxpayers are going to have to be able to identify this date, but also they're going to have to be able to evidence the date. Outside of timing, this may not be a big deal, but I do suspect that there'll be a bit more work that will need to go into proving when it's worthless.

Now, how does this impact a partnership interest? So previously, the abandonment of a partnership interest where debt's allocated, would have been treated as an ordinary loss. It's now to be treated as a capital loss. So the bill has essentially redefined the term security to include partnership debt and a security can't be abandoned. And because you can't abandon a security, it's no longer considered an ordinary loss, and therefore it's going to be considered a capital loss. Finally, a complete new section was drafted to be included, which encompasses a worthless partnership interest where there's no debt allocated. This would also no longer qualify as an ordinary loss as the abandonment would now be considered sale or exchange of a capital asset, and limit the loss to the capital transaction rules. So this essentially repeals the revenue or would repeal the revenue ruling stating the ability to abandon a partnership interest for no debt is allocated and providing ordinary treatment.

So if you're doing any kind of planning with abandonment, just be aware that this technique is potentially going away. With regards to digital assets, it's worth mentioning, especially how much crypto we've seen over the past couple of years, this section was also basically rewritten and outside of increased reporting, as it relates to the broadening of the definition of broker, which would possibly include now include minors or other participants that you wouldn't typically consider as a broker, the Act is going to modify the Wash-Sale rules and apply them to losses claimed with respect to digital assets. In addition to Wash-Sale rules, the act would add digital assets that are marketable securities for you did.

We're going to get to the year-end considerations in a moment. So I'm not speaking specifically to any slide right now. But additionally, going back to, in addition to the Wash-Sales, the act would also add digital assets that are marketable securities for purposes of analyzing if a constructive sale has taken place, definitely going to need additional guidance as the Act doesn't clarify when a digital asset is actually a marketable security, or when it's a commodity that's subject to the exception.

And then finally this one is absolutely worth mentioning, relates to carried interest, in that there's no change. There had been discussion of extending the three years to five years, but that provision was excluded. Okay, so now onto year end, so year end's coming in quickly, we've got about three weeks left. So let's just take a look at some of the year end considerations that relate to individuals, trusts, estate and gifts, charitable giving, and then a couple of others.

Now, some of these are all these book goodies, and then others taken to the possibility of the enactment of the Build Back Better Act. Now, regardless of the timing of enactment, it's never too soon to start planning. Individuals can utilize strategies to accelerate income and capital gains where the current rates are lower. This not only includes accelerating the payment of bonuses and deferred compensation, as well as collecting on accounts receivable for cash basis taxpayers, but also potentially realizing capital gains in 2021, and then possibly repurchasing the same or similar investment. A gain would be triggered, but the cost is then upon repurchase, the cost is then reset at a higher basis. And then it's going to result in a lower gain when sold in the future, potentially at a higher rate.

Taxpayers that are considering the sale of a business or a rental property may also wish to accelerate the sale to take advantage of potentially lower rates. This also includes opting out of installment sales. Now just with the rental property, you'd want to look at that a little bit more if it's for investment and passive, and there are potential passive losses, because at that point in time, you may want to utilize those in future years, depending upon where the tax rates may go.

So as I mentioned earlier, backdoor Roth conversions, great year to take advantage of the ability to convert an after-tax IRA to a Roth IRA. Because remember after 2021, if this Act is passed, there's potential and for these to come off the table. So deferring deductions is another consideration. Taxpayers should consider electing to capitalize and amortize prepaid expenses rather than taking the expense as a current deduction. The timing of when an asset is placed into service should be considered as well as not necessarily electing bonus depreciation and foregoing the section 179 expense election. Both of these would defer deductions to future years as opposed to receiving the benefit this year.

And then finally, the easy one, postponing the payment of deductible expenses until after the close of the year. Now, something to be mindful of is that the analysis must be done on a rolling annual analysis as there are other limitations such as the excess business loss that you really need to take into consideration. Tax loss planning is also something to consider. If you recently sold a stock in 2021, but realize that it's going to offset long term cap gains, you can postpone recognition by triggering Wash-Sale rule to your advantage. Trigger the Wash-Sale and postpone the loss recognition if the loss is within the restricted time period. You can repurchase those shares so that the loss is disallowed. And then that loss is included in the basis, and any newly purchased shares are included in the basis of any newly purchased shares, and then ultimately deferred.

Now from an income perspective, the same income acceleration and expense deferral applies to trusts. However, utilization of taxable distributions to an income beneficiary is another way to mitigate having a larger liability at the trust level. If the trust is a complex trust, comparing the taxable income of the trust with that of the income beneficiary may lend to additional planning. If the beneficiary would still be in a lower bracket, then the trust inclusive of receiving a taxable distribution, it may make sense to take advantage of the 65 day rule. This rule, also known as the section 663B election, pardon me, allows complex trusts to elect to treat distributions made within the first 65 days of the current year as distributions made during the prior tax year. Now, I would be completely remiss if I didn't mention this, annual exclusion gifts and then reviewing your remaining lifetime exemption.

So for 2021, the annual exclusion remains at 15,000 per donee. But beginning in 2022, this amount is actually increased to 16,000 per person. For 2021, the lifetime exemption amount is 11.7 million. And for 2022, it's increasing to 12,060,000. Now there's planning done earlier in the year to move assets due to our concern of the reduction of the lifetime exclusion, but assets have yet to be moved. It's probably worth having the discussion and confirming if it makes sense to still transfer these assets now, taking into consideration both asset and income requirements of the transfer. Alternatively, if you've moved on your state plan, it probably makes sense to top off and utilize the additional exemptions that are available due to inflation. So even though a change to the estate and gift tax exemptions aren't considered in the current legislation, the current provision is set to sunset in 2025, unless made permanent between now and then, and it will be carved back to a significantly lesser amount.

Now I know I'm speaking a little bit past my time, so I'm going to go kind of quickly through these last couple of points. 2021 is the final year where individuals can make cash contributions to qualifying charities up to 100% of their AGI. Contributions to most charitable organizations qualify. However, contributions to a donor advised fund or a private foundation will not qualify. Utilizing various charitable entities and contributing appreciated assets is another way to benefit from a charitable contribution as well as removing the appreciation from your estate. So contribution of appreciated assets to a private foundation or a donor advised fund, they're not going to trigger capital gains and will provide for a current income tax deduction up to a certain AGI limitation. But if you're looking to achieve, call it alternative philanthropic goals, charitable remainder trust or charitable lead trust are another option.

A charitable remainder trust will allow for a contribution of appreciated assets without triggering capital gains, and excuse me, it will provide for current income tax deduction equal to the present value of the remainder interest of the assets that are being contributed. The trust will also provide for an annual income stream for the term of the trust and upon termination, the asset appreciation will be distributed to the charity. And then there's a charitable lead trust, which as you suspect is the reversal of the charitable remainder trust. This trust provides an annuity to the charity for the term of the trust, with the asset appreciation transferring to the beneficiaries. And as long as the trust is structured as a non-grantor trust, the trust will receive 100% charitable deduction for the annual distribution to the charities.

Qualified opportunity fund investments, where investors can defer current realized capital gains by making a timely investment into a qualified opportunity fund, if the investment is made prior to December 31st, 2021, the investor would meet the required, would still need the required five year holding period to be eligible for a 10% step up in basis, which would ultimately reduce the deferred capital gain by 10%.

Now, remember the reduced gain is required to be picked up and liability paid on the 2026 tax return. Additionally, providing that certain holding periods are met, there's also potential for a 10% exclusion on the appreciation of the investment into the opportunity fund, so two different opportunities there. Now, given the timing, you may want to consider reinvesting some of the realized capital gains within the December 31st, '21 cutoff date in order to be eligible for the 10% step up in basis.

And finally, before turning it over to my esteemed partner, Miri, I'd like to mention that there are several states that now permit pass through entity elections, New York, Connecticut, New Jersey, amongst others, as well as others are currently considering doing the same. This election allows for an entity level deduction for state taxes paid for the benefit of the individual member, ultimately providing a flow through benefit to the member at the federal level.

Now, as we get close to the end of the year, again we're three weeks out, just please make sure you're having these discussions. The key is to not panic, given the unknown, but also don't let the tax tail wag the dog. I know anybody who's heard me speak or has dealt with me, hears me say that a million times over. If it's not a good investment or an idea, don't do it for tax purposes only. And remember, all of this is subject to change. If we had a crystal ball, it would be great. We don't, so we're not able to bet on this 100%. It's possible the Senate doesn't make any just. It's also possible that they do. And with that said, thank you and Miri, it is all you.

Miri Forster:Great, Stephanie, thank you so much. And thanks to everyone for joining us today. I'm Miri Forster and I'm delighted to share what's going on at the IRS right now, and some expectations for the future. So last month, IRS Commissioner Rettig made an impassioned plea for Congress to approve additional funding in the Build Back Better plan. And you may remember funding was originally in the infrastructure plan, but it was pulled, all of it at the very last minute. So in Build Back Better, and like Stephanie said approved by the House, waiting for action by the Senate, there's about 80 billion appropriated to the IRS over the next 10 years. And the breakout is on the slide, but you'll see that the funding would be used to strengthen and expand enforcement activities to increase voluntary compliance and to modernize the IRS' information technology, among other areas.

The administration estimates that from this increase in enforcement and funding, that they'll generate additional revenues about 400 billion. The CBO estimates a more modest number, I think closer to about 150 billion. But regardless, what's clear from the bill and I want to quote the language, it says, "No use of these funds is intended to increase taxes on any taxpayer with taxable income below 400,000." So you're looking at enforcement focused on your high income taxpayers, your larger partnerships and corporations, and likely to extend to employment taxes and to non-filers with big numbers.

Now in the meantime, the pandemic has had it pluses and minuses for the service. In terms of positives, the service has implemented a whole bunch of technology enhancements since the pandemic started. For one, they're allowing more digital communications so there are online portals available to exchange documents, and with respect to paper filed returns, they've actually added 42 different tax forms that even though they have to be paper filed, you can now sign digitally instead of with ink. The latest set was released last week, and that's in place until October, 2023. The list includes your 709 form, which is your gift tax returns, some of the 706 estate tax return forms, your form 8832, which is your check the box election form. And the newest edition is your 1042, annual withholding tax return.

And then in October, the service began honoring requests for secure video conferencing in place of in-person calls or meetings. They're now using WebEx and Zoom, but the intent by 2022 is to transition to Teams. Now in terms of difficulties, and I'm sure we've all been strained by service center operations, calls to the service center are five times higher than normal. And during the first half of the year, they had less than 15,000 people to handle more than 240 million calls received. And if you want to put that in perspective, during fiscal year 2021, they had about 70 million calls answered, so much, much less than the number that were received. They did add about 1,000 customer services representatives to help out this summer, but still, it's very hard to get through to the service. The IRS does say they're current with opening new mail, but there are still significant delays with the processing of amended returns and tentative refunds. So if you have a 1045 tentative refund that is still pending, know that we're seeing them take about six to nine months to process rather than the 90 day period that's set forth by statute for these limited review refunds to be issued.

And in some cases we've seen processing that's inconsistent to be frank. We sometimes helped with submissions of four related taxpayers. Two could, a few with similar numbers, two could be processed, no problem in the six months. One just never shows up, even though there's a certified mail showing it was received, and one is rejected incorrectly as untimely. So you really have to watch those things. And then, please feel free to come to us if you have those situations on various routes to pursue, to try to get them resolved.

For your amended returns, your 1040s, your 1120xs, there's a backlog of about 2.7 million unprocessed returns as of mid-November. They're taking a minimum of 20 weeks, but mostly longer to process. And even the taxpayer advocate said they are temporarily not helping with amended returns because they just cannot meaningfully expedite those cases because the backlog at the service is so significant. Now despite the pandemic, there's been plenty of IRS exam activity relevant to the financial services industry, just like Simcha said at the beginning. The IRS just released its fiscal year 2022 focus guide, which sets forth the IRS' strategic goals. And to start, partnership compliance is high on the list. I guess before we get going, let's do the third polling question, Lexi.

Lexi D'Esposito:Polling question three. What areas of IRS enforcement are you most interested in? A, international tax; B, self-employment tax and impact on limited partners in limited partnerships; C, virtual currency; or D, noncash charitable contributions.

Miri Forster:And the question came in about whether I said that gift tax returns could be eFiled. I didn't say they could be eFiled. I said they could be e-signed, so electronic, digitally signed. That's a distinction. So thanks for asking that question.

Miri Forster:Great. So second tax remains high on the list. Thanks for that. We'll talk about that in a minute. Okay, so I said before, partnership compliance is high on the list. In October, the IRS rolled out its large partnership compliance pilot program. It's LPC for short. It's modeled after large corporate compliance program that the IRS has had in existence for years and years, where they examine the largest of the largest corporations and they have big teams of IRS examiners and specialists. So now they're doing an LPC, the same for complex multi-tiered partnerships and their unique complex tax issues. They are assessing risk. And when they're looking at risk, they're looking at substantive sub chapter K issues. So your distributions, guaranteed payments, other Sub-K partnership issues. And they're also looking at operational issues that may or may not be specific to partnerships, like an example would be research credit issues. The first set of exam notices were issued in October. The exams were of the 2017, I'm sorry, the 2019 year to start. BBA audit procedures apply, so the exams you should expect to take a little bit longer since those procedures are complex. And the agency did hire about 50 lateral partnership specialists who are going to be involved with these examinations. And I said the BBA audit rules are complex. Here's just a roadmap. We're not going to go into it today, but feel free after the presentation to reach out with any questions.

Okay, so not only is the LPC in play, but the IRS continues to announce new compliance campaigns. And there are about 50 of them currently. Two worth mentioning for 2021, the first is the Puerto Rico Act 22 campaign. The Act encouraged taxpayers to relocate to Puerto Rico in exchange for tax incentives and credits. And the campaign focuses on taxpayers claiming benefits under the Act that either do not meet the residence and sourcing rules for U.S. possessions. So they're excluding income that's subject to U.S. tax, or they do meet those rules, but they're erroneously reporting U.S. source income as Puerto Rico income to avoid U.S. tax. The IRS is conducting examination, doing practitioner outreach and issuing soft letters on the issue. In addition, a second campaign for 2021 is the financial services entities that engage in lending activities campaign. This follows a Chief Council memo issued in 2015, where the IRS considered whether a U.S. fund manager that made loans and acted as an independent agent for a foreign fund caused that foreign fund to be in a U.S. trader business.

And the CCA, in it, the service concluded that the trading safe harbor didn't apply and that the foreign fund was subject to U.S. withholding tax. There's also a court case pending on the issue right now, YA global investments. For right now, the goal of the campaign is just to better understand the financial services industry, how it operates, the type of structures they use, and to look beyond the phase of the return for potential non-compliance. They also want to add exams to their inbound portfolio. They do a lot of outbound work, and they've said a few times, like I've said, they want to increase their coverage of partnerships. So this campaign falls into that quite well. Lexi, can you do the next polling question?

Lexi D'Esposito:Our fourth and final poll, given the current tax environment, have you considered moving to Puerto Rico? A, yes or B, no.

Miri Forster:So as people are responding, and since we're running out of time, a few other campaigns to mention, the TCJA campaign, that campaign is not issue focused, but it's looking at a lot of the provisions enacted by TCJA. So for example, FDII, GILTI, Section 163J, interest deductions, all things that will be in part three of our financial services series on international tax. And the expectation for 2022 is more tailored campaigns on specific TCJA provisions based on the feedback. Now I know since everybody's interested in SECA, I'm going to skip over to talking about that.

The emphasis on self-employment tax is still out there under the campaign. The IRS is focused on asset managers set up as limited partnerships with limited partners who claim they're exempt from self-employment tax under 1402(a)(13). The campaign started a few years ago. There are now cases at examination at appeals, and some are even being litigated. The IRS continues to rely on Renkemeyer v. Commissioner, where the tax court held that an attorney and a partner in a limited liability partnership was not a limited partner for purposes of 1402(a)(13), because he was active in his law firm. And so the limited partner in that case was subject to SECA tax on his distributive share of income. There are also similar cases that deal with limited liability companies with similar outcomes as Renkeyer, but currently there's still no cases to suggest that the exemption in 1402(a)(13) may not apply to a limited partner in a traditional limited partnership.

Now, in terms of recent litigation, this past April, a petition was filed in the tax court on behalf of a limited partnership that received a final partnership administrative adjustment notice on this exact issue. The partnership was a Delaware limited partnership with over 40 employees. The LPs received a guaranteed payment for services, in addition to their distributive share, and the FPA increased net earnings from self-employment by nearly 70 billion, 70 million claiming that the taxpayer didn't establish it was a limited partner. Now due to administrative issues, it appears the statute extensions in that case were not signed by an authorized party, so the FPAs were not considered timely. And that court never got to decide on the substantive issue here. So this issue continues to be a wait and see, and hopefully if I'm invited back, I can share more details the next time.

Some other focus areas, virtual currency, Stephanie talked about it. I mean there's expanded information reporting for brokers in the bill, in the infrastructure plan, and that's going to add transparency. Non-cash contributions are also a big focus area, and it's important to have proper documentation in place to support those deductions. And then last is and to lead into next week on the 16th on our international series, international tax compliance is expected to get heightened scrutiny as well. We have the new issuance of the K-2 and the K-3 for 2021. Its purpose is to increase transparency, make it easier for the IRS to verify international compliance. And there are penalties. If you don't comply. Now, there is a transition rule if you show good faith, a good faith effort in 2021, but it won't be an easy exercise. So the recommendation is to try to get these forms going sooner rather than later, because it's a lot of information. So in closing, since it is 1 o'clock, I'm going to pass it over to Simcha or Lexi.

Simcha David:Give me two seconds to close it out and then we'll let everybody go. Thank you so much, Stephanie and Miri. Thank you both for your presentation. I think Miri that if the net investment income, net investment tax, the 3.8% gets passed, which is a backdoor to kind of get to the limited partnership interests that are right now not subject to self-employment tax. So we'll see, if that actually gets passed, whether this whole campaign will kind of die down a little bit or not, because either way, the tax is coming to the IRS, although there's all the prior years that they might continue to try to fight on. So thank you, all for joining us. As Miri mentioned, part three will be next week. We'll be discussing international tax and all the wonderful new possibly new rules that might come into play as well as some year-end tax planning as well. So, thank you, all and have a wonderful day.

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