On-Demand | Election Tax Proposals, Gain Exclusions & Other Tax Updates
- Oct 29, 2020
Our panelists reviewed the Trump/Biden tax proposals ahead of the historic 2020 presidential election.
Miri Forster: Thanks so much and welcome everyone. And thanks for joining us for today's webinar. My name is Miri Forster, and I'm a principal and co-leader of EisnerAmper's tax controversy practice. We're just days away from the election, so I'm excited to be here with my colleagues to discuss pre-election tax proposals. Continuing on our agenda, we'll share recent updates to section one 199A and some planning ideas. We'll look at the qualified small business stock rules under section 1202, and talk about entity selection considerations in a rising tax rate environment.
We'll spend time on some research credit opportunities as well, and we'll close the session with a discussion of what's going on at the IRS and recent areas of heightened IRS enforcement. Thanks again for joining us and let's get started. Chris, over to you.
Chris Colyer:Thanks Miri this is Chris Colyer, I'm a tax partner based in the New Jersey office of Eisner Amper. I'll be going through the pre-election tax proposals. So 2020, quite a year. A confluence of events. We have a pandemic, had a recession, sustained mass protest, wars, Supreme Court vacancies. And it's raining today in the Metro New York area.
We have federal budget deficits as far as the eye can see in the lower right here, there’s a little graph that shows the past 50 year history of budget deficits. The line across the top, the zero percent that's a balanced budget. Only in the late 90s has the budget actually been balanced. Then more recently even with the strong economy prior to the pandemic, there was growing budget deficits, and of course the pandemic with a budget deficit is going down to 16% of GDP.
The point is that the only way to fund deficits is either current tax increases or future tax increases. Looking forward to long-term tax planning, we should presume that there will be tax increases in the future, no matter who's in control in Washington. Also, should consider the historically low interest rates forecasted over the near term a matter of years and not months.
With low interest rates that reduces the benefit of tax deferral, which is traditionally what tax planners try and accomplish a tax deferred, is a tax not paid. With cost of capital interest rates being so low, that diminishes the value of tax referral and further if there's future tax increases that really questions the whole methodology of tax deferral in this environment. So should we consider accelerating tax in Roth, IRA conversions and accelerating income? Strongly consider it.
Just a Civics 101 lesson. In the media recently there's a lot of lot of coverage in the Biden tax proposal versus what Trump says he wants to do in the second term with tax. But it's important to remember that Congress writes the tax law and not the president.
We have both sides of Congress up for reelection in the Senate. One third is up this year, and there's a chance that Republicans currently control of the Senate. There's a strong chance that Democrats may take control of the Senate. And if they do it's likely Ron Wyden of Oregon, five term Senator would take control of the Senate finance committee, which he becomes a very important person in the conversations coming and going forward if the Democrats take control of the Senate.
Personal income taxes, so the Biden proposal increases the top rate of ordinary income from 37 to 39.6, which is basically just reverting back to the pre-Trump rates which for income, taxable income above $400,000. So unchanged below. That 400,000 is an important threshold in all of this proposals because he's made it very clear he does not want to raise taxes on the middle-class and $400,000 is where they draw the line.
The current capital gains rates are operated 20% right now with a net investment income tax with 3.8, so effectively federal capital gains rates are 23.8. The Trump proposal, and he's talked about possibly reducing capital gains rates that may be very difficult to accomplish with assuming Democrats control the house. Then the past two, he's talked about indexing capital gains rates by executive action by being able to adjust cost basis, which would complicate matters significantly.
Biden has proposed for capital gains to eliminate the preferential tax rate on taxpayers with income over a million dollars. So effectively increasing the capital gains rate to 39.6, doubling the rate for people in that above a million, which is a significant change. It's also talked about scrutinizing opportunity zone investments that came under the Trump tax cuts in recently.
For itemized deductions, Trump has proposed basically extending the current law to make it permanent because current law sunsets in 2025. Biden is proposing a cap and itemized deductions at a 28% rate for those above 400,000. Again, anybody below 400,000 would get full benefit of itemized reductions. Restore a phase out of itemized deductions, which known as a Pease limit, which is a haircut on high income earners about 400,000. He is proposing ending the SALT cap, the $10,000 cap that exists right now.
Biden wants to return that. So taxpayers in high-income tax States, blue States would be able to deduct their state and local taxes, their real estate taxes again. Biden has also proposed a tax credit for family caregivers to take care of their loved ones. Social security, crypto, and carried interest.
On social security. Trump you recall recently issued an executive order, which allowed the deferral of payroll taxes for certain workers, and the people chose not to take advantage of that, but it's something that it's not the loan, it's effectively a loan, not forgiveness and Trump plans if he gets reelected to push through a forgiveness.
Biden has proposed lifting the social security wage base on a high income earners. In 2021, the social security wage base is $142,000, so an individual's wages, the first 142,000 is subject to the full social security tax of 6.2%, as well as the employer of 6.2%. Biden proposes for incomes above 400,000 to eliminate that cap. That social security taxes, the 6.2 only an employer applies to amounts above 400,000, which is a major tax increase. As well as there's a donut hole between the 142,000 wage base and the 400,000 where X would not apply, so it becomes a complicated calculation. We'll see where it goes.
Carried interest. Both Trump and Biden have proposed elimination of carried interest, which is they're targeting the hedge fund, private equity industry, but there's also real estate and commercial enterprises where this impacts them. Cryptocurrency Trump has tweeted, not a fan. Biden has not announced their plan.
It's interesting, JP Morgan came out with an article last week talking about advising clients to consider going into crypto as alternative assets as an alternative to gold and silver and the such, so we'll see what happens in the future there.
Retirement, healthcare, and carbon. These are three complicated areas. I'm not going to go into all the details here, but Trump basically is going to continue the current law, and Biden has some very specific proposals. On carbon specifically Biden talks about supporting the carbon tax, but he's not made the carbon tax part of his overall climate change plan and his pivot away from will.
Corporate Tax Rates. Trump, no change to keep the 21% rate that's currently in place. Biden proposes take taking the rate up to 28% with a 15% alternative minimum tax for large corporations earning more than $100 of book income, but paid zero or negative federal income tax rates.
It would allow for the NOL deduction as well as foreign tax credit carry forward, and it would punish companies that moved jobs offshore, moved production offshore, and then sell back into the US market.
Flow-Thru deduction. The qualified business income deduction, Trump, no change. Biden would end the deduction except for those making under 400,000, which becomes a very complicated calculation. Again, my colleague, Allyson will speak about it later. The state tax, Trump would extend the current law past 2025. Biden has proposed to eliminate the stepped-up basis rule and effectively bring the estate tax system back to the 2009 laws which would limit lifetime gifts to a million, and drop the estate tax exemption exclusion amount to three and a half million, which would be down from $11 million presently.
It's important to note though that if Democrats do end up controlling the Senate. Senate finance chair, Ron Wyden has been supportive in the past of eliminating the estate tax, but be careful what you wish for because some of his alternative proposals get a little bit aggressive. I don't know the elimination of a step-up at death, but also shifting the capital gains taxes into a mark to market system, taxing unrealized capital gains, which looks like a wealth tax.
Allyson Milbrod:Great, thank you, Chris. Hi, good morning. My name is Allyson Milbrod, and I'm a tax director in our New Jersey office. First, I'm going to talk about some hot topics and trends in the section 199 cap A area. Next we're going to touch upon the election and each candidate's proposals with respect to section 199 cap A. Finally end by giving you some section 199 cap A, planning ideas to consider for year end.
Well, first let's start with what is the section 199 cap A deduction? Section 199 cap A, also known as the QBI deduction is a 20% pass through deduction that was added as a result of the tax cuts and jobs act in 2017 to create parody with a lower corporate income tax rate that was enacted of 21% and the highest individual income tax rate of 37% essentially taxing the pass-through income at a rate of 29.6%.
The QBI deduction is calculated by taking the lesser of 20% of qualified business income or 50% of wages or 25% of wages, and two-and-a-half percent of unadjusted cost basis of assets and less taxable income is under certain income thresholds. Additionally, the overall deduction is also limited to 20% of modified taxable income.
PPP loans, which is something that is very important to businesses and specifically pass-through businesses. What is the interplay with the PPP loans and the section 199 cap A deduction? Let's say your business operates as a pass through entity, received the PPP loan, and has met all the criteria to have the loan forgiven.
We know that the amount that will be forgiven is not includable in taxable income. We also know that based on notice 2020-32, that came out in late July, the IRS's position is that the expenses in which the loan was used will be non-deductible.
Well, what happens now to the payroll expenses that may now be non-deductible? As I stated earlier, generally, the QBI deduction depends on wages. If the PPP wages are not deductible, does that also mean that the wages are not considered wages for QBI? Wow! that seems like a double whammy for some businesses and not really the intent of the program.
The answer right now is not crystal clear. If you look at the definition of wages under the section 199 cap A statute, wages are defined as W2 wages that are paid related to the trade of business and are reported to the social security administration. Based on this it would seem that wages for purposes of QBI does not depend on deductibility.
The AICPA is aware of this issue and has written to the IRS and Congress, and we are still waiting from some guidance from either the IRS, the SBA or Congress. Charitable contributions. Is it, or is it not a reduction to QBI?
Section 199 cap A defines qualified income, qualified items of income gain, deduction and loss for purposes of the QBI deduction to be connected to the conduct of a trader business. Well, is charitable contributions considered connected to a trade or business? The preamble to the proposed section 199 cap A regulations specifically excluded charity as a reduction to QBI, but this explicit exclusion did not make it to the final regulations thus causing some confusion.
Additionally, the 2019 form 8995, which is the QBI form specifically indicated the charity was a reduction through qualified business income. Well, some good news folks. It seems the IRS has reversed their position and the draft 2020 form 8995, and the draft form 1065, which have both been published both no longer lists charity as a deduction. A planning note for those taxpayers in which the charitable deduction was material, I reduce your QBI, there may be a planning opportunity to amend your 2019 tax return and get a refund.
QBI losses. We know that QBI losses net against QBI income and the rules do not exactly align with other loss provisions such as the passive activity loss rules and the at-risk loss rules. To make tracking a little easier, the IRS has now published, has posted here a new QBI loss tracking worksheet in the form 8995 instructions to be used going forward.
The election and section 199 cap A. Let's start with Trump first, no official proposal, but there has been talk that if Trump gets reelected, he would like to make all of the TCJA provisions, including the section 199 cap A deduction that is set to sunset in 2025 month permanent.
As far as Biden, his plan calls to eliminate the section 199 cap A deduction, which is in line with the raising of the corporate tax rates. Remember section 199 cap A was put in place to create parody with the lower corporate tax rates. However, Biden has also pledged not to raise taxes on income under 400,000, therefore the QBI deduction is still in play for income under 400,000. The chart below illustrates the difference in rates.
Allyson Milbrod: Okay, so now let's switch gears and let's talk about some planning ideas with respect to QBI.
Entity choice considerations. Let's say your business is operating as an LLC or a schedule C and you're not getting the maximum QBI due to wage limitations. You may want to consider converting from an LLC to an S Corp or possibly a schedule C to an S corp as remember payments to shareholders and owners are considered wages for QBI purposes.
Know your business, know your client's business. The classification on whether income qualifies for the QBI deduction is a year by year analysis. Your business may not have qualified in the prior year, but may qualify this year. Therefore you should always ask the question, has anything changed?
Real estate. If you have a rental activity and you plan on using the 250 hour safe harbor to have this activity qualify as QBI, now is the time to make sure you're on track to meet the 250 hour requirement by year end. Management fees. Let's say you have a business that does not have wages or sufficient wages, and therefore the QBI deduction is limited.
Let's also assume the business cannot aggregate with other businesses or chooses not to. You can have that business pay a management fee for services to an affiliated entity that does pay wages. You will be able to use that portion of the management fee that covers wages as your QBI wages, and therefore get a QBI deduction. Note the management fees should be documented and the affiliated entity must reduce their QBI wages by the amount allocated.
If you're an individual that has pass through income from either a specified service business, let's say for example a law firm or accounting firm, or an entity does not have sufficient wages. The QBI deduction may be limited. You can still get a full or partial QBI deduction if your income is under certain thresholds. For 2020, those thresholds are 213,000 for single taxpayers and 426,000 for married filing joint taxpayers.
To the extent possible, you should try to accelerate the deductions and postpone income to be able to get under the threshold, this way you can possibly qualify every other year. Thank you. And now I'm going to pass it on to my colleague, Ben Aspir, to talk about section 1202.
Ben Aspir:Thanks Allyson. My name is Ben Aspir. I'm a senior tax manager with Eisner Amper and I'll be covering a qualified small business stock under section 1202. What 1202 allows is non-corporate taxpayers to exclude the greater of $10 million or 10 times the basis of a qualified small business stock held for more than five years. I'm not going to be covering section 1045 today due to time limitations, but I just want our participants to be aware of it.
This is the first provision that allows holders of qualified small business stock, or I'll refer to as QSBS if they hold it for more than six months, if they sell it before the five-year period, they can defer the gain. If they identify another qualified small business to invest in.
In today's session on QSBS is going to be a cliff notes version due to time constraints, but on November 18th we will be holding a more in-depth session, so you can sign up at eisneramper.com on the events page, if you are interested.
The amount of the exclusion on under section 1202, the date that the stock is acquired dictates the amount of the exclusions. You can have a 50% exclusion if you qualify under 1202, if the stock is acquired, not August 11th, 93 through February 17th, 2009. If it's acquired February 18th, O9, through September 27th, 2010. They excluded the amount of gain included at 75%. And if it's acquired September 28th, going forward, the exclusion is 100% at the federal tax level. The state treatment on 1202 varies from state to state.
Obviously the best case scenario is if the stock was acquired from September 20 of 2010 and on their aim alternative minimum tax considerations, if you're in the 50% bucket or the 75% bucket. Additionally, if you're in those two exclusion buckets, any gain that's not excluded is actually taxed at 28% instead of the normal 20% capital gains rates that Chris had previously mentioned during his presentation.
What are the qualifications and requirements for qualified small business stock? There are several hurdles that need to be passed before you can qualify. It must be issued by the stock must be issued by a corporation that uses at least 80% of its assets in active trade or business and is not a disqualified business.
Next, it must be issued by a domestic corporation with less than $50 million in assets at the time of and immediately after the issuance of the stock. It must be held by a non-corporate taxpayer. The qualified small business stock must be held by an individual. It could be held by an LLC or a partnership and LP, it can be held by an S corporation. It could be held by a trust. It just can't be held by another C corporation.
Moving on to number four, it must be acquired by taxpayer under original issuance. Number five, the stock must be held for more than five years. It's held for four years and 11 months, and it's sold, you're not eligible for 1202 exclusion, but you are eligible for the deferral provision of 1045 that I mentioned earlier. There is a cap on the exclusion. It's limited to the greater of $10 million or 10 times the basis in the qualified small business stock.
A disqualified trade or business when they qualify for under section 1202. It's really any personal service type of business, such as accounting firm like Eisner Amper, the law firm, engineering. any trade or business with the principal asset of the business if the reputation or skill, baking, insurance, farming business, and business eligible to claim depletion, and the hospitality business such as motels, hotels, and restaurants. You just see a theme here looking more for a company that create products and not necessarily service type businesses.
As I mentioned in a couple of slides earlier, the act of business requirement, in order to be eligible for this section 1202 exclusion, the corporation must use at least 80% of its assets and the act, the conduct of a qualified business. Once an active business and not a holding company sitting on a pile of cash or portfolio security, so just be aware, they're looking for an active business and not just a simply a holding company.
This is key. There's a $50 million gross asset requirement. In order to be an eligible, qualified small business, the company must not exceed $50 million in assets. Generally it's the tax basis and its assets at any time before the stock is issued or immediately after. For example, if at inception, the company is basically has no assets. You issue a bunch of stock. The company does really well, let's say five years later and there's a capital raise and to infuse cash into the company, it's a $53 million capital raise. It infuses $53 million of cash into the company, any stock issued during the capital raise, wouldn't be eligible for 1202, and the company can no longer be a qualified small business.
The question I get often is. what about the stock that was issued five years earlier at inception, or anytime before that capital raise? That stock is not tainted it's grandfather in. So those stockholders could still benefit from section 1202. If property is contributed to the corporation at any time, it's measured at the fair market value and not the tax basis for the $50 million test, so just be aware of that.
The corporation is supposed to provide reports regarding 1202 through shareholders and the IRS, but guidance has yet to be issued. Another important point and requirements in 1202, it must be acquired at original issue. So it cannot be acquired from business partner or another relative, it has to be acquired directly from the company in exchange for money or other property, or as compensation for services performed for the corporation.
QSBS only applies to C corporation stock. It does not apply to an equity interest in a partnership or S-corp stock. Only C corporation stock. It can be held by a partnership or an S Corp, but that stockholder in the S corp must have been a stockholder the entire time, or that partner must have been a partner in that partnership the entire time. If they leave the partnership and come back, they lose their 1203 status, their possibility of claiming the exclusion. Just be aware that if an S corp or a partnership, all the QSBS will qualify for a business stock, the partner or stockholder must have been in the company the entire time and not have left.
The holding period is key, it must be held for five years before selling in order to claim the exclusion. A common question I receive is related to stock options. Do they qualify for QSBS? They do not. It's only upon exercise does the five-year holding period start, and the same thing with restricted stock, not until the holder vests or an 83(B) election is made.
As I mentioned previously, the gain eligible first exclusion is $10 million or 10 times the basis, the greater of. There is a per issuer limit, so each person gets $10 million. However, if you're married, filing jointly it's still sort of a gray area. You can say, "Well, if it's two people, it should be $10 million times two $20 million." But the prevailing opinion is though, the gray area is it still $10 million, whether you're married or filing joint. Or if you're a single taxpayer.
The code specifically does say if you're married and filing separately is $5 million a person. Another common question is, I'm a partnership, can I convert to a C corporation to benefit from 1202? Answer is yes, but valuation should be performed because any prior appreciation prior to conversion is not eligible for 1202, so if a partnership was worth $5 million prior to conversion, that first $5 million is not eligible 1202.
Just a couple of basic examples on 1202, you have A $10 million gain exclusion. On January 1st, 2013, if John invests by buying 200,000 shares of ABC Corp for next to nothing, since it was purchased in 2013, they're in the 100% exclusion bucket, and it's sold six years later, so they held it for five years. And John sold all 200,000 shares with $22 million, which is a great investment. John realizes the $22 million long-term capital gain.
Since John is 100%, he can exclude the first $10 million of capital gain. So that he's saving approximately $2.4 million in federal tax, and the remaining $12 million is taxed at regular capital gains rates. Then there's a 10 times basis calculation that you can go through the slides that were shared. Thank you. I turn the slides over to my colleague, Chris to discuss entity selection.
Chris Colyer:All right, thanks Ben. I'm back to talk a little bit about entity selection considerations in a rising tax rate environment. Picking up where I left off. This is just a highlight data from the IRS, as far as the breakdown of types of returns filed on the 2019 fiscal year C corps are 18%. S corps is the largest share of 44 and a half percent, partnerships are 37% I thought that was interesting. With C corporations in general, the pros for C Corp, the low current federal tax rate of 21%, the potential tax-free exclusion, which Ben just covered in detail. The lack of flow through treatment simplifies the compliance lots of the flexibility, as far as the ownership structure, the types of owner type of equity compensation plans.
The cons are obviously the double taxation and as well as potential for accumulated earnings and personal holding company taxes when new entities accumulate too much and don't pay dividends. Things that the election or a change in administration that could change things, so obviously the risk of a significant corporate tax rate increase from the existing 21 to 28, but just for some historical context, the corporate rate had been 35% prior to 2018. As well as the increase in the tax rate in foreign subsidiaries and low tax jurisdictions, guilty tax actively double in that rate essentially.
The risk of a capital gain or dividend tax rate increase would obviously increase the double tax bite as well, so all this makes the QSBS planning, which Ben covered significantly more valuable and interesting. S corporations, the pros are a single layer of taxation, ability to reduce employment taxes on owner distributions, which that could become a very interesting strategy if the social security tax rate increases under the Biden proposal, so as well as the availability to flow-through deduction, which Allyson covered.
The cons are very rigid ownership structure and the limitations on the type of owners. Some election considerations would be obviously the risk of individual tax rate increases makes that form of business more expensive and the potential risk of the qualified business income deduction, tax payers making more than thousand dollars.
Partnerships, pros is basically the same as S corporations. However, it provides more flexibility for the profit allocations and the ownership structure. On the con side relative to the S Corp, usually the employment taxes are higher, which again, if that social security tax increases go through becomes a significant consideration. Another con is with partnerships, although they're flexible and they're great for tax planning and that tends to be my planning vehicle of choice. That flexibility does introduce complexity, which can make the compliance more complicated than an S Corp or a C corporation would be.
Election considerations again the risk of individual tax rate increases, the risk of loss of QBI below the 400,000. And the talk about the elimination of carried interest and the ability to compensate people with equity on a tax efficient basis is a consideration to keep an eye on.
One thing to also as far as a planning consideration for this year, under the current law there is still the SALT deduction cap at $10,000. States have worked through various types of work arounds, which the IRS has swiftly tried to shut down. But the one interesting one that's still out there is the States have passed through entity tax withholding. So Connecticut, New Jersey just introduced this here one. Wisconsin, Louisiana, I believe Rhode Island have allowed Flow-thru entities to withhold state income taxes at the entity level with the idea estate tax deduction could go against business income rather than a schedule an itemized deduction.
In New Jersey where I reside and my base is, there is a new system, a new form that the New Jersey is putting out. Something to keep in consideration for current year tax planning. So we'll pivot over to my colleague Tim, to talk about the research investment tax credit.
Tim Rankins:Thanks Chris. Updates to the research credit or commonly known as the R&D tax credit. Before I get into the updates, I just wanted to get in to a little bit of high level overview of the R*D tax credit. It's a tax credit rather than a deduction. It goes on the form 6765 of your tax return filing. It's a credit against income tax liability, and it's a general business credit under section 38, so it has a carry forward period of 20 years, and a carryback period of one year. And we have a statute of limitations of three years.
In 2016 under the path act, they created an opportunity for qualified small businesses to monetize the R&D credit against future payroll or FICA tax liability. I'll go into a little bit more detail on the eligibility of that in this presentation. What qualifies as R&D activities? It's activity based test and US based, so the work has to be done in the States, and we got to meet four parts. The activity must relate to a new or improved product or process intended to improve either function, performance, quality, or reliability. We need to be developing or improving upon what the internal revenue calls a business component of product process techniques, software, formula, or invention.
The work has to be technological in nature, meaning it fundamentally relies on the hard sciences. There needs to be a technical uncertainty present regarding either capability, method, or design. So we need to point to challenges of the technical nature as we developed or improved upon our business component. And then in order to overcome the uncertainty the team engaged in a process of experimentation as systematic or iterative process of trial and error.
That's just a general high-level definition before we get into some of the updates eligible costs for the credit, we have labor supplies, contract research expenses, and rental or lease costs of computers. Labor payments made to our internal employees to perform support or supervise our research supplies and supplies used in the testing efforts. Contract research is payments made outside vendors to perform or support our research efforts.
Rental or lease cost of computers, it's relatively new in terms of importance. That's really a cost for cloud hosting expenses where we are paying for an AWS or a Google cloud to host our test environment if we're developing software. The payroll/FICA refund I've been in the R&D tax credit area for 15 years now, and although this came out in 2016, I still think this is probably the most important update of my career.
What I wanted to do is just go through what's the definition of a qualified small business, And then how do we monetize these credits? Qualified small business must have less than five million in gross receipts in the current tax filing. For our most recent filing of 2019, it'd be less than five million gross receipts for the 2019 filing, and then zero gross receipts prior to five tax years from the tax filing. Go through a table of what that means because the wording is a little confusing and I get questions on it all the time.
One thing that I do want to note is the use of PEOs does not disqualify a taxpayer from claiming this. Even though the payroll is being processed through your PEO, you can still claim this opportunity against your payroll tax liability if you are a qualified small business. The key here is the definition of gross receipts. It is any receipt, including interest or a de minimis amount.
By clarifying that rule in notice 2017-23, what they really did was made me qualified small business, a qualified new small business. And so according to the table here if we had our 2019, we needed zero receipts prior to five tax years from our filing, and so the count of the five years includes 2019. That's important, so if we formed in 2014, say, wait 2014, November, December, and we reported $5 of interest on our tax return in 2014, we would not be eligible to elect to use the credits against payroll tax liability.
We can always claim an R&D credit if we have qualified expenses, but this is an opportunity to monetize the credit. How does this work? First and foremost, you have to claim a credit on the form 6765, and at the bottom you have to check line 41 on section D that has to be checked, and then you elect the amount to be used, and you're limited to $250,000 per year. You elect that on line 42.
From there in the next quarter, you're going to provide a form 8974 to your PEO or payroll provider in which they will file that form with your form 941, and you'll be able to save 50% of your payroll tax liability too until that amount runs out. Current 1015 filers, they'll file the 8974 on the Q1 2020 Form 941 filings. I get a lot of questions of, "How does this work with the CARES act?" If you have deferred your payroll tax, the credits will still be out there until you become a payroll tax payer again, and then you can start using the credits again.
Tim Rankins:A couple of IRS exam updates that I wanted to address. In December of 2018, the treasury inspector general for tax administration issued a report reviewing the IRS's procedures associated with auditing these payroll tax credits, or the R&D credits are used against payroll taxes for the qualified small businesses. What they found was the IRS did not have adequate procedures to determine if the company was number one, even eligible or qualified small business, if they claim the payroll offset too early, and if they claim too much credit.
As a result of this, the IRS drafted a compliance plan for how they can classify and select these four exams. One thing that we did see pre COVID was an increase in incidence of audit for some of these companies that are claiming it against payroll tax.
Lastly, a couple of notes that the research credit in section 174, there were included as part of the LB&I compliance plans in February of 2020. It's a little unclear on the specific implications. I know about five years prior to this R&D was considered a tier one issue, they took away the tiered system, but hopefully we get some sort of consistency in approach. They did issue a directive where research risk review team would have to sign off if the case is specialist managers agree to examine the research credit, or if the case and specialist managers disagree on whether to examine the research credit.
If the managers decide not to look at the credit, they don't need this additional approval, but it's certainly something to keep note of, and what I did was I just put a couple of things in here from the substantiation perspective to keep in mind as you're claiming the credits. And with that, I will pass it on to Miri.
Miri Forster:Thanks, Tim so much. And the IRS is definitely focused on research credit issues and the proper application of the rules they're conducting exams so the substantiation documentation is critical, and that's a good segue to what else is happening at the IRS. All the service centers are now reopened, most at limited capacity due to COVID-19 restrictions, so understandably operations are a bit slower than usual.
Initially the agency had about 11 million pieces of unprocessed mail, so lots of uncashed checks when it reopened. As a result the IRS stopped sending balance due notices for a bit so they could get through the backlog, but now it appears the IRS has caught up enough that it's resending those balance due notices, including notices of intent to levy. So if you made a payment by mail and now you get a notice, it's probably time to reach back out to the IRS to get some clarification.
And if anybody's waiting on a form 8802 US residency certification, that unit is back up and running, but with a significant backlog. As of two weeks ago, the IRS was working on fax submissions from late March. There are also some delays with the processing of powers of attorney by the CAF unit, and further delays are happening because POA cannot include electronic signatures currently, they actually need to have original ink signatures. But the good news is that the IRS is working on a solution to accepting electronic signatures on POAs by early 2021.
And that's a good segue to talk about e-signatures and electronic transmissions of information. Thankfully in response to COVID-19 the IRS quickly implemented ways to work efficiently in a remote environment. They allowed some tax returns to be signed electronically instead of requiring ink signatures. And they also set up some fax procedures in place of paper filings. These electronic options were a huge help to taxpayers.
I did want to highlight though that one of the temporary fax procedures is coming to an end soon, specifically with respect to form 1139 and 1045 tentative refund claims those fax procedures will close on December 31st. The 1139 and 1045 claims are being filed in large numbers because of the CARES act that gives the opportunity to carry back NOLs from 2018, 19 or 20 up to five years, and to fully offset taxable income in those years, which had higher tax rates. And it's also providing an election to accelerate AMT refunds to 18 and 19.
Now, while the fax lines closed December 31st, it doesn't change the due dates for filing these claims. So an AMT refund claim on form 1139 is due on December 30th, one day earlier than the line is closed. And if you want to file one combined 1139 for calendar year 19, and that includes both NOL carry backs and the AMT refund, that 1139 would also be due on December 30th.
If you're still waiting for a refund, processing times have been inconsistent. Tentative refund claims are typically issued either within 45 days, so the IRS doesn't have to pay interest or within 90. If you've been waiting for a while, we're here to help try to figure out what the holdup might be.
Switching to exam activity, that is anything but slow. Exam activity across all IRS operating divisions and covering both domestic and international issues is definitely on the rise. That includes global high wealth taxpayers, high income taxpayers, partnerships, and tax exempt government entities such as foundations. And just so everybody's clear on the distinctions, the IRS has a global high wealth group where the focus is on a taxpayer's income and its assets.
A global high wealth exam typically includes an individual examine up to four related entities as part of the same exam. The high income focus though is based on an individual's income and the exam will likely include one related entity. The IRS also continues to release compliance campaigns on issues that it believes pose high compliance risk to the government. And currently there are 59 active compliance campaigns coming from the IRS's large business and international division.
What's very telling to me is that 10 campaigns have been issued already in 2020 with eight of them issued since May, so in the midst of the pandemic, and the IRS has stated publicly that we should expect a few more in the coming weeks. Some of the more active campaigns to date are listed on this slide, and I'm just going to highlight a few.
One is the tax cuts and jobs act campaign, which we'll look at a select group of returns for 17 and 18 to identify transactions restructuring and technical issues resulting from TCJA and also the CARES act to better understand taxpayer behavior under the new laws. From TCJA training material that the IRS has made available. Some areas of focus could be the 199A QBI deduction that Allyson spoke about, or could even be the new interest limitation rules under 163J.
Separately, there are two issue focused TCJA campaigns on the section 965 repatriation tax. One is focused on section 965 at the corporate level, and the other looks at individual US shareholders and their 965 inclusion. The IRS is also expanding its coverage of partnerships, already there are some very active campaigns in the partnership space, for example, the self-employment tax campaign or the secret tax campaign focused on limited partners in limited partnerships that don't pay self-employment tax under 1402, 813 on their distributor share of income. And another campaign focused on sales of partnership interests.
We actually expect more campaigns to be partnership focused since the centralized partnership audit regime is in full force, and the intent behind that regime was to streamline the IRS examination process for partnerships. Then an active individual campaign is the virtual currency campaign. The IRS recently issued FAQs to better educate taxpayers on the tax treatment of virtual currency.
They've sent some soft notices to taxpayers asking if they have engaged in these types of transactions and if they have to report them. There's also a new question on the form 1040 asking if the taxpayers have engaged in these types of transactions. Now that you know exam activity is on the rise, being prepared is the best and easiest way to manage risk. So be proactive.
If you've recently entered into a complicated restructuring, make sure you have a good document management system for your transactional documents. Second revisit your tax positions. How well are they documented? It was a tough tax season with COVID-19 and all the new laws under TCJA and the CARES act. If your documentation isn't in great order, or there are issues on your return with more exposure than others, it's a good time to revisit them before the IRS comes and sends you your exam notification letter.
Then when I think about the CARES act specifically, there are several new opportunities for refunds at beneficial rates, so make sure you know what the statute of limitations is for filing those refund claims so you don't miss out on an opportunity. Since we started this webinar talking about the election, there's still plenty of time to model out some year-end planning options based on the various tax proposals and to consider what steps you might want to take before the end of the year.
That brings us to the end of our webinar. Thanks again for joining us. And I'm going to pass it over to Lexi to close out the session.
Transcribed by Rev.com
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