On-Demand: Federal Tax Update
Our speakers covered the current status of IRS operations, recent IRS enforcement trends, the impact of the CARES Act on NOLs, and potential planning opportunities.
Miri Forster:Good morning everyone. We're very excited that you're joining us today. We have an exciting agenda planned that we'll talk about IRS enforcement trends, the CARES Act and NOL provisions, and we're going to identify some planning opportunities. As the co-chair of the New Jersey TEI Chapter, we're very pleased to partner with EisnerAmper to present this to you today. Also, in case you're unaware, if you have not registered yet, EisnerAmper will be hosting a seminar tomorrow on state tax and on international tax on Thursday. If you're not already registered and it's interesting topics to you, I would encourage you to register. With that, I'll turn it over to Miri. Once again, thank you for joining us.
Thanks, Rocco. Good morning and great to be here with TEI. My name's Miri Forster, and I'm a Principal at EisnerAmper and co-leader of the Tax Controversy Practice, where we help businesses and their owners respond to tax matters under IRS review. For today's agenda, I'm going to discuss the current state of IRS operations. I'll briefly talk about the fiscal year 2021 focus guide that the IRS's large business and international division recently released that lays out its strategic goals for the year. Then I'll talk about what we expect and where we expect the IRS to dedicate its resources going forward, so you can think proactively about how to prepare. After that, I'm going to turn the discussion over to my colleague, Jeff Kelson, to discuss net operating losses, how ownership changes under 382 could impact the availability of those losses, section 165's disaster loss treatment given COVID-19, and the like.
To start, I want to talk a little bit about what's going on at the service centers. All the service centers have now reopened, but most are still working at limited capacity. Movement has been a bit slow, and there's still lots of pieces of mail unopened. If you're a taxpayer that mailed a check to the IRS, it may still be in the backlog of mail that the IRS is processing during COVID-19, but the IRS continues to advise taxpayers not to cancel those checks in order to avoid penalties in address, and has been saying that the payments will be posted to the taxpayer's account as of the date the check was received, rather than the date that the IRS processed the payment. We are starting to see more progress with checks being cleared this month. Those checks were mailed in July, so if you're in that position, hopefully in the next couple weeks, you'll see progress as well.
Obviously, not canceling the check means also keeping sufficient funds in the account to cover the check, but if you do end up with insufficient funds when the check is cashed, the IRS has said that they will consider providing relief from bad check penalties for dishonored checks due to processing delays from COVID-19.
Taxpayers who mailed correspondence to the IRS over the past six months are also experiencing longer wait times just because the mail processing functions are scaled back as well. But because of these delays in services, the IRS has temporarily stopped mailing notices to taxpayers with balances due, so the CP501, 503, 504 letters that typically go to taxpayers when their balance is due on their accounts are temporarily suspended with the hope that they'll lessen any confusion that taxpayers may be experiencing during these backlog times.
Over the past few weeks, I've also gotten a lot of questions on the status of Form 8802's US Treaty Certifications. That unit is up and running, but also with a significant backlog and limited resources. For anyone who's waiting on those certifications, last week the IRS was working on fax submissions from late March, so hopefully that could help you figure out where you are in the queue.
The CAP unit that processes powers of attorneys is also experiencing delays, taking about three times longer to process those, making it harder for advisors to get some information. Typical processing time is about five days, but currently the average time is about 15. What's making these POA authorizations more difficult and time consuming is that powers of attorney need to have ink signatures on them, physical signatures. They can not currently be digitally signed.
The good news is the IRS has acknowledged the burden that this requirement places on taxpayers and practitioners, and also as part of the Taxpayer First Act that I'm going to discuss shortly, there's some electronic mandates required that we're hearing that in early 2021, the IRS is going to have a solution towards accepting electronic signatures on powers of attorney.
That's a good segue to discuss what the IRS has done with respect to eSignatures and electronic transmissions of information as a result of COVID-19 and beyond. Thankfully, they moved quickly to implement a number of efficiencies to help taxpayers and the IRS work successfully in a remote environment. In late March and then updated in June, there was an internal IRS memo from the Commissioner of Services and Enforcement at the IRS that allowed the IRS to accept images of signatures either scanned or photographed and digital signatures on documents related to the determination or collection of tax liability.
Those documents, though were limited in scope, they were extension requests for statutes of limitations, waivers of statutory notice of deficiencies and consents to assessment, closing agreements, and some other forms that were outside of standard filing procedures to your tax returns, and your POAs were not included. But luckily, as the pandemic continued, in late August, the IRS announced that certain tax returns that used to have to be physically signed could temporarily be electronically signed, so long as they were mailed and postmarked to the IRS by December 31, 2020. This is not providing an extension of time to file, it's just allowing you to use a digital signature if you're mailing those documents in.
Then, in early September, some more tax returns were added to the list. Most of these, the deadline has passed, but I did want to mention a few. One is the Form 8832, the Entity Classification Election Form that so many people use. It can be temporarily electronically signed, and then the form gets paper filed with the IRS. Also in the 8802s that I just mentioned, the application for US residency certification, they can be electronically signed as well. The Form 3115, the Application for Change of Accounting Method, can be electronically signed right now as well.
Some good news, and hopefully some of this will stick around, even after COVID-19. The IRS has also allowed for temporary electronic transmission of documents. Some examples of that Form 8886 is the Reportable Transaction Disclosure Form that needs to be filed with OTSA for the first year that a taxpayer participates in a listed or reportable transaction. That typically had to be paper filed with Ogden. Now there are temporary fax procedures to do that. Similarly, the IRS has instituted temporary fax procedures for the copy of the 3115 accounting method change form that needs to be filed with Ogden.
And of course, we need to mention the temporary fax procedures that were instituted early on that allowed taxpayers to file Form 1139 and 1045 Tentative Refund Claims, so that they could use the new five year NOL carryback provisions and the AMT refund provisions that were enacted as part of the CARES Act. What I had hoped from these 1139 and 1045 fax procedures would turn into a permanent solution, unfortunately though is coming to an end soon.
Last week the IRS issued a new FAQ that the last date of fax an eligible refund claim would be December 31, 2020. As of December 31st at midnight, the fax numbers that were provided would no longer be operational, and so if you have a 2019 Form 1139 that you're planning to file, that is due December 31st, and that'll be the last day you have to fax it. If you're claiming a 2019 AMT refund though, note that that is due December 30th. So if you're filing an 1139, both your NOLs and your AMT refunds on one form, you have to file them by December 30, not December 31.
For those that have filed tentative refund claims, initially we saw these claims being processed fairly quickly. We even saw some refunds issued by Memorial Day, but in recent weeks, the release of these refunds has been more inconsistent, and many are hitting the 90 day period within which the IRS instructions say that these refunds are supposed to be issued.
The last point on 1139 refunds is just a reminder that they're tentative refunds. The IRS can examine these. If the amounts meet certain joint committee thresholds, specifically $2 million for individuals and $5 million for corporations, they will be subject to joint committee review and approval. Given the volume of refund claims that are likely going to go in over the next few years and the time that joint committee review can add to an examination, the IRS has said they're looking at ways to optimize the joint committee process. They haven't yet, but stay tuned for that.
The IRS is also in this unusual time busy addressing the mandates of the Taxpayer First Act of 2019. They've been very mindful of their obligations under that. The new law requires the IRS to submit to Congress a plan for modernizing the IRS's organizational structure by September 2020. That date, of course, is delayed due to COVID, but essentially they're supposed to submit a plan that streamlines the agency's structure so that it minimizes duplicate services and responsibilities.
Also, there are three additional parts to the plan. The IRS is supposed to submit a comprehensive taxpayer service strategy, so to make the IRS a more taxpayer-friendly agency. They're supposed to submit a comprehensive employee training strategy that includes taxpayer rights training and a multiyear plan to meet its information technology needs. The last three requirements were all due July 2020, but again, delays are happening because of COVID-19.
But I did want to highlight a few things that may be coming with respect to the IT needs, since it's so important. First, making sure the IRS is in a position to combat cybersecurity threats. Second, by January 1st, 2023, the act requires the IRS to develop an internet portal where taxpayers will be able to electronically file and distribute Form 1099. It's supposed to be modeled after the social security administration's system that employees use to file forms W-2.
Also, starting in 2021, anyone who files 100 or fewer returns in a calendar year will be required to file electronically. After 2021, that number's going to drop to 10 or more returns that are going to require e-filing. In the case of partnerships for 2021, the 100 return threshold will apply. Sorry, for 2020 the 100 threshold will apply, but for 2021, that will be reduced to 50. Expect these changes and more as a result of the Taxpayer First Act.
Then the last point on the slide, I want to highlight that the IRS is accepting applications for the 2021 Compliance Assurance Process Program through November 13, 2020, and that the acceptances will be announced in February 2021. As I'm sure most of you know, new corporate applicants can apply to the CAP program if they have assets of $10 million or more. If they are a US publicly traded corp with a legal requirement to prepare and submit SEC forms 10-K, 10-Q, and 8-K, and they're not under investigation or in litigation with a government agency that would limit the IRS's access to current tax records.
The 2020-21 application process also brings some modifications from prior years. First, the IRS has modified the one filed return rule to allow two filed open returns to give taxpayers some more flexibility, given the difficulties from this past year. Second, only new CAP applicants will have to provide the tax control framework questionnaire, which was put in place last year to give the IRS an understanding of a taxpayer’s internal controls. For returning taxpayers, internal controls will be part of the opening conference. If anything needs to be updated in a questionnaire, they'll have to do it at that time. Third, for 2021, the IRS is still requiring audited financial statements in accordance with US GAP. They have said they will continue to look at this requirement on a go-forward basis.
Last, I wanted to mention the bridge phase that's been around for a few years that's reserved for taxpayers whose risk of non-compliance really doesn't warrant using LB&I resources. The IRS has said that a taxpayer can only be in the bridge phase for two consecutive years, and they did issue some FAQs on the bridge phase just a couple weeks ago, but the position remains that the IRS will not accept any disclosures, conduct any reviews, or provide any assurances during the bridge phase. If there is specific issues that a taxpayer wants the IRS to consider, they're encouraged to submit a pre-filing agreement if they want certainty on an issue.
Moving on, during the first week of October, the IRS's Large Business and International Division released its annual focus guide, which outlines its strategic goals for the year, several of which are continuations from 2020. The first strategic goal is to strengthen compliance activities. To continue to improve case selection, expand coverage of pass through entities, high wealth taxpayers, and high-income individuals. They also want to continue to expand data analytics tools and improve strategies to combat abusive transactions and promoter schemes like the conservation easements and the micro-captive arrangements.
The second goal in the focus guide is to implement major program priorities, to continue to identify taxpayer strategies, ensure taxpayers comply with TCJA, and also the new CARES Act provisions, and just review taxpayer behavior on those new laws. They also want to continue to improve the campaign program and the use of alternative treatment streams, and they want to actively support planning for an implementation of changes in support of the Taxpayer First Act.
A third strategic goal is to expand workforce tools and operations. The IRS's hiring and staffing levels are certainly a bit up from last October 2019. They're working to provide more focused trainings and to expand the use of tools like WebEx and virtual case processing. They're also prioritizing communication and collaboration with employees and external stakeholders because they want to improve LB&I operations and taxpayer service. The last strategic goal is to build and maintain a high-performing, diverse, and inclusive workforce.
I was talking at the beginning about how the service centers were moving pretty slowly, but enforcement at the exam level is anything but slow, and all actions indicate that the IRS is gearing up for controversy eruption. This is consistent with the current commissioner Chuck Rettig's view when he started his tenure a couple years ago, and he said he believed in robust, visible, and transparent enforcement.
Enforcement is happening across all operating divisions, so whether you're a partnership, a corporation, or an individual owner executive, if you feel your documentation isn't in order, or if there are issues on your return that have more potential exposure than others, it's a good time to be proactive and to revisit those areas before the IRS sends you an exam notice.
Currently, there are 59 active LB&I compliance campaigns. There's been a limited number of those that have retired. Like I said before, what's telling is that 10 of them that are listed on this slide were already issued in 2020, and of the 10, eight have been issued since this May, so right in the height of the pandemic.
I am going to go through some of these in a little bit of detail before I pass it on to Jeff, but in addition to these, I just want to make sure to mention that there are also some very active campaigns focused on partnerships, and we expect partnership focused campaigns to continue in the future, especially because the centralized partnership audit regime is in full force, and the intention behind the new regime was to streamline the IRS's ability to audit, assess, and collect taxes from partnerships.
Let's talk about some of these newly released campaigns. The first one is the allocation of success-based fees without Rev. Proc. 2011-29. Success-based fees paid in transactions under the regulations in 1.263(a)-5 are presumed facilitative, and they must be capitalized. But the fees can be allocated to non-facilitative currently deducted. If taxpayers meet certain documentation requirements in the regulations.
In 2011, the IRS wanted to make this a bit easier, and they issued a Rev. Proc. allowing a safe harbor election so that you could apply a 70-30 split between these fees. The IRS is very focused on whether those elections were attached to returns. If they weren't, they are asking for support on whether the 70-30 split is appropriate. In some cases, taxpayers applied a 70-30 split, but didn't make an election are being allowed to apply for 90-100 relief, a retroactive election, but the campaign goal is focused on taxpayer compliance with this law.
Another campaign is the section 6426 fuel credit. It's focused on taxpayers who receive fuel mixture credits but did not treat the credits as a reduction in their excise tax liability under section 4081. The tax treatment for this was settled by the supreme court when they denied Cert in the Sunoco case in 2018. The IRS is starting some examinations to make sure compliance is being followed in this area.
There's also a campaign focused very broadly on the tax cuts and job act. They're going to monitor a number of issues on a select group of returns for 2017 and 2018 and share the information that they've learned throughout LB&I and the other operating divisions of the IRS. They're going to try to identify transactions, restructurings, and technical issues from TCJA and also the CARES Act to better understand taxpayer behavior. The treatment streams are going to include examinations, soft notices, outreach, new and improved practice units, and even possibly future issue-based campaigns.
You might ask, "What issues could they look at?" It could be 199A. It could be 163(j). The IRS has a lot of TCJA training material that's out there that gives some hints on some of the areas that the agents may pick up if you're selected for a TCJA campaign. Separately, and while this is part of TCJA, there's a campaign focused on section 965 transition tax. It's actually two campaigns. One is focused on individuals who are supposed to report the income, and corporations that took the transition tax in 2017 or 2018.
These examinations have agents and also international specialists being brought in to make sure that the calculations have been performed properly, and the TCJA training materials gives you some ideas of some of the questions that the IRS might be asking. Identifying if a taxpayer is a US shareholder under the rules. Identifying specified foreign corporations. Verified correct E&P and tax pool calculations, and reviewing 965(c) deduction calculations and elections as some examples.
Research credit issues are also a new campaign, so they're looking at section 41 and 174. LB&I views research issues as some of the most prevalent tax issues within its division, and the campaign objective is to promote voluntary compliance and focus on the highest risk research issues and increase consistency of examinations. Stay tuned for more examinations on research credit issues.
The IRS also released a couple of campaigns relevant to the insurance industry and how life insurance reserves are computed under section 807(d), both pre and post TCJA. Both of these campaigns, the treatment streams are issue-based examinations of forms 1120L for 2017 and/or 2018 and any related and subsequent tax years.
There's also been a number of campaigns issued on non-resident aliens. First, they're looking at non-resident aliens who receive rental income from US rail property to make sure that they're complying with all reporting and filing requirements. They're going to address non-compliance through exams, education, and outreach. The second campaign is focused on FIRPTA reporting. FIRPTA taxes foreign persons on the dispositions of their US rail property interests, and the buyers are the withholding agents, and they're generally required to withhold 15% of the amount realized on the sale, file the required forms, and remit the withholding tax to the IRS. The IRS wants to make sure that FIRPTA is being complied with, and they're selecting taxpayers for examination and also doing external education and outreach.
The last new campaign for 2020 focuses on consolidated net operating loss carryover limitations due to SRLY rules section 382 and the loss apportionment rules. The IRS is trying to address non-compliance in these areas, and they are going to be issuing examination notices to review this specific area. Jeff, now I pass it over to you to talk in more detail about the NOLs.
Jeffrey Kelson:Thank you, Miri. Morning everybody. Interesting tax year we're having, huh? On top of everything else. Also, I've been back in the office a little bit lately. I can tell you that we have a new dress code. It's anything that still fits, so this goes along with everything that's going on. I'm going to discuss losses in the current climate. It's been, in the net operating loss area, it's been like a four year rollercoaster. They can't stop touching it, making it more difficult, making it more liberal. Let's dive in a little bit and see where we stand in the past, in the present, and in the future.
Once upon a time in the not so distant past, pre-TCJA, NOLs could be carried back two years and carried forward if they could be used for 20 years. You were limited in the alternative minimum tax, once we had that. The NOLs could only offset 80% of AMTI. That was pre-TCJA years of pre-1231 '17. On 1118, we had TCJA. There, the NOLs could not no longer be carried back, but they could be carried forward indefinitely. However, subject to in the 80% limitation. So even though the AMT has been eliminated from the tax code, it was sort of this subs tite on the 80% limitation, so they ensure that if you carry forward the NOLs into a year, that you will derive taxable income that you will not be free from all taxes.
That's how we were for a little bit, or at least under that impression that that's what the world was about, tax world. Well, then there was the CARES Act, at least of course in response to the COVID-19 pandemic. So they changed TCJA, retroactively mind you. But beginning on 1118 for three years through the end of this year, 2020, not only could you carryback, but they made the carryback period five years. Not only did they make it five years, they made it without any 80% limitation. A whole slew of amended returns were being filed, especially for 2018, since those returns had already been filed when this CARES Act was passed carrying back to five years.
People found that not only was that great, but you could also get a rate differential. For instance, you could be carrying back to a 35% tax rate year, where you didn't think you had that opportunity in the past. For 2019 and 2020, it's the same, and the carry forward though is still indefinite. They adopted that portion of the TCJA, that you can carry forward indefinitely and carryback. So very liberal. No limitations, carryback five, carry forward indefinitely, rate differential. All good.
Now the tortoise goes back into its shell on 1121. In about three months there will no longer be a carryback for losses incurred after 1121, but they can still be carried forward indefinitely, and the return on the 80% tax law income limitation. Actually not the return, probably the first time because it's been postponed for a couple years. It will come into play beginning 1121.
What are some of the consequences of all this besides all these carrybacks that Miri had a orchestrate through a closed IRS system. Well, some sort of results happened in acquisitions. An acquisition might have occurred in '18 and '19, never taking into account that there was this opportunity to carryback five years. They probably though, well, it wasn't even contemplated. We have to examine the contracts of sale, see who was eligible for the refund. If we do carry it back five years, who gets it? The buyer or the seller? That's caused some consternation and some negotiations post-transaction.
There's also a consolidated reg section, 1.1502-21(b)(3), where you can split the carryback. The target can carry forward, where the rest of the group can carryback. You can sort of bifurcate it, and that may solve a lot of this situation where you have a five year carryback available. There's a lot of flexibility in what you can do and a lot of things you can assess.
Also, we need to, for financial statement report, reassess deferred assets. All this has changed everything. What was happening before is not happening now, and we have to figure out what the impact is on those poor NOLs and credits sitting on the balance sheets and what the valuation of those is now.
On top of all this, superimposed, was a correction of maybe an error in the drafting of TCJA for qualified improvement property, otherwise known as leasehold improvements. Before, they were not allowed to be fully expensed. Not only that, you had to depreciate them over 39 years. Now you can fully expense them. A lot of the ammunition, the engine for these carrybacks were due to some of these being written off in '18 and '19. The CARES Act has really upended a lot of the loss situations and planning, and given a lot of opportunities for getting cash in the hands of companies, which is what the intention was. Let's talk about section 382 in this environment. Still in effect. Does not apply to carrybacks, so if you had a change in ownership but the law says that you have to be carried back because of the CARES Act, 382 will not limit that because 382 only limits carry forwards. That's a good thing. Even if you had a change of ownership, you might be sitting with an opportunity to carry it back in the five year period.
We have a new tax attribute to add to our 382 arsenal, that's 163(j). If you've had a 163(j) limitation for interest expense, that is subject to 382. It sits alongside net operating losses and tax credits as an attribute that is restricted if you do carry it forward.
382 is now back in play a bit because a lot of folks are contemplating higher tax rates in the future, so the net operating losses and credits on your books might have a greater value going forward. A greater significance is being shown on these attributes because of the potential tax rate increase. We're seeing a lot of activity in that right now. Now for those who are aware of how the 382 formula works, basically it limits your tax attribute utilization in the future based on the value of the company immediately before the change multiplied by the long-term tax exempt rate, should be the long-term tax exempt rate. If you haven't been paying attention, I've never seen it so low.
Right now, you can understand the environment we're in, interest rates are low. For September 2020 for 382 purposes, the long-term tax exempt rate 0.89%. That can really limit you. Really makes it onerous to experience a change in ownership. For instance, if you had a $10 million valuation, 0.89% limits your utilization of losses to $89,000 a year. Not very much. I know there are other rules with built-in gains, but just looking at that in a vacuum, it's really burdensome now. There's been some talk in the community why doesn't the IRS have a floor on the long-term tax exempt rate for 382? I think they never contemplated it getting this low, but here we are.
Now the IRS just before the pandemic, interestingly enough, poorly timed, I might say, put in some proposed regs on limiting recognized built-in gains. I'll just give you a quick overview. I just mentioned how if you have a 382 limitation, you have that formula on how much NOLs you can use. There is, in notice 2003-65 are built-in gain rules that allow you to supercharge that limitation to the extent that you have these built-in gains, and one of the ways that the notice allowed is if you had this kind of pro forma 382 sales. If you sold it and then started amortizing some of those assets. To the extent you've amortized those assets, that would increase your limitation each year.
So my example, we had the $89,000. Maybe you can really supercharge it worth another $300,000 a year that's freeing up based on this fictitious 338 formula. It's been really helpful for a lot of loss clients too that got really limited under the normal formula to really supercharge your NOL utilization in the future.
The IRS saw this as sort of, if it's their own notice, I can't say a loophole, but very lucrative to loss companies. But just based on these regulations, the pandemic hit, and they got mothballed. There's been no talk about it. From the time I wrote this slide, which is just maybe let's say a week ago, the IRS has re-approached this. First of all, what they wanted to do was repeal that 338 safe harbor and just allow you both a 1374 safe harbor, which is the built-in gains under the S-Corp rules, which is a lot less beneficial, a lot less beneficial to loss companies.
Just the other day, I think it's just a few days ago, they had a talk saying that, "Yes, yes. We're still looking at these regs, although maybe we shot too high with an opening gambit." It's interesting because the name of the person in the IRS, the Senior Executive in the IRS in charge of losses, his name is Brian Loss. I thought that was pretty interesting. His last name is what he does. But in any case, he said that they're still looking at it. They've received a lot of feedback, and they will take that into account and into consideration in future rulemaking on this. It's been mothballed, but now it's been taken out of mothballs, but still the proposed regs don't have any teeth yet, so we're still working in an environment with 2003-65 is still in play.
Also, as Miri pointed out, the IRS recently announced it will focus on 382 in a consolidated context where you have rules, and also you look at it on that the corporations are treated as a single company for purposes 382. There's been some situations where you sell a company. You didn't elect to have the 382 go. You might have been under a general limitation, you didn't sign anything to the company that you sold, and maybe the purchaser took it under SRLY rules. The IRS felt that there's maybe some double dipping in the NOL 382 rules where the selling company retained it, but the purchasing company's utilizing it. There's a lot of confusion in that area. That's why I think it's one of the areas of focus.
What planning can we do? Well, one of the planning is to increase losses prior to 123120 where you really get your money's worth, although if tax rates go up in the future, I can't say that this is black and white. But yes, if you want to get cash in your hands now, it's a good way to, especially if you can go to lucrative years of 35%. As we spoke about, you can go back and do the qualified improvement property expense. You can either do it in '18 or you can do a 3115, Form 3115.
There's a change in accounting method, and do it '19, and then just carry that back. It all just depends on the timing of the years. Everybody's situation is different. You've got to look into it. But there's other accounting method changes you can do in '19 or '20 to supercharge or increase the amount of losses you have, so you can carry it back. I'm going to get into section 165(i), the section that talks to disaster losses and accelerating losses in those situations.
Remember, anything you do has to always look at the states. We have a senior partner in our firm, Rich Sackin, says never forget about the state. California doesn't even allow, has a moratorium in NOL, so if you're increasing an NOL, you can be doing some damage in certain states that have moratorium where if you could have had it in a year where you had income, it gets offset immediately. Always look at this under the specter of what about the states?
Okay. Let's talk about 165(i). It's kind of one of those code sections that hide out that doesn’t get much focus until something happens. Normally it's a disaster, physical disaster. This is an unusual situation because this is the first time it's being focused on during a pandemic, which doesn't have any physical disruption that's tangible. As we know, Trump declared an emergency under the Stafford Act. It was dated March 13, 2020. 165(i) losses directly attributable to the disaster can be accelerated. What we mean by that? If the loss occurred in 2020, after March 13 mind you, you can claim it for the taxable year immediately preceding. So if you're counting, that would be for your 2019 year.
So yes, you can have a 2020 loss thrown back to 2019, and you can take it on that year's return. You don't have to; it's an election, and it has to be directly attributable to the disaster. In this case, the COVID-19. I would say most cases you can probably put it on there, but if you have some piece of machinery that just became worthless, nothing to do with COVID-19, that would not be on there. But generally, it's a facts and circumstances type situation. The loss must generable be allowed under code section 165. That means not on the 162, for the most part, but on the 165(i), which is losses. Not necessarily expenses.
Evidenced by closed and a completed transaction. It can't be a temporary blip. It must have actually disposed of it or had a closed or completed transaction in 2020, post March 13. It must be fixed by identifiable event, so you must document, and it must be actually sustained during the year of the event. Documentation is important. There's also been some speculation whether, by the way, it can't be covered by insurance, naturally, and it can't be not loss profits. But there's some speculation that if the loss is in excess of $10 million, maybe subject to the reportable transaction rules and reported in 8886.
There's also some talk about whether, well, I think it's pretty straightforward. If you received a PPP loan that got forgiven, you can't double dip. Those losses are not being, if you're being covered by the loan and forgiven on that, you can't also have the 165(i) in those same losses. You have to elect this. It must be made on a timely filed return or an amended return.
But however, that amended return must be filed within six months of the unextended due date for the year loss. Let's say you’re a calendar year end and your return is due on April 15th, 2021. Even if you missed it for the year, you can do it by in that case October 15th, 2021. If you were in a situation where you wanted 4165(i), and you went on the webinar, it is still in play. You still have time to do it, and it can be done an amended return. You still have about, what? About a year, right? Okay.
What sort of losses, what are some examples? That seems to be the big question, or people want to know. You can have a complete closure of the store in a facility location after March 13th in 2020. Right off all of those expenses, and then throw it back to '19. Again, when you're throwing it back to '19, it might even be more beneficial for certain situations because you might have, it might be before a 382 change or might also be in the year you had income. If any of these states are putting moratoriums, like I said with California, on net operating losses, there's a lot of reasons to look into this. And not maybe have the loss in 2020.
Also, we have a situation where you have a complete abandonment of leasehold improvements. You can have a permanent retirement of fixed assets. If you can dispose unsaleable inventory, so you abandon it or you just dispose of it. That could be thrown back. You might have termination payments to cancel contracts, so you might have had events scheduled in 2020 where you put a deposit on and it's non-refundable. That would be canceled, obviously, due to COVID-19. That would be a situation where you can claim 165(i) loss, worthless securities but not bad debts. It has to be something that would be a worthless security under code section 165(i). And not recoverable, worthless. It's not, again, a temporary blip.
Let's go to the next one. Abandonment of pending business transaction costs. You had identified a target or you had expended costs in a transaction that was not completed, and in essence was forfeited, and that happened during the 2020, post March 13th. You can, again, throw that back to the previous year.
Conferences, events where refunds were not provided. Again, and finally, there's been some talk that losses on mark to mark securities, I would think that would be a complete loss, but there's a lot of facts and circumstances around all of these things. The best thing to do is at anything you're claiming on the 165(i), you need to document. You need to document why it was a loss and why it was due to COVID-19, and those situations need to be examined.
Again, 165(i) is out there. The IRS has addressed it, knowing that a lot of taxpayers are looking at 165(i), so it's on their radar. They didn't say what they were going to do about it, but they know it's out there, and they're going to have their radar up. Again, you have to make sure when you do this that you're doing it with the right amount of diligence and care when you're claiming these losses and throwing it back. It's gotten a lot of attention. I just did a Google search this morning, and I've seen a lot of articles on it. It has gotten on their radar.
All right, someone asked, "If you do not carryback an NOL from 2019, do not have to have a waiver and a return as in the past?" That's right. So that five year carryback is not written in stone. You do not have to carry it back five years. If you think the losses are going to be more useful to you in the future, by all means carry it forward.
Miri Forster: Jeff, there are procedures in Rev. Proc. 2020-24 that explain how to make that waiver election, for anyone that's interested.
Jeffrey Kelson:Thank you, Miri. I'm trying to see if we've got anything else. But I think that's about it.
Oh, somebody asked about the tax ability PPP forgiveness. I think we should discuss this. This is one of the hottest questions around because right now, PPP, the forgiveness is not taxable, but you lose the expenses. At the end of the day, in essence, the PPP forgiveness is taxable. It's not in of itself, but by losing the losses, in essence you're being taxed. But there's a lot of speculation what happens if the forgiveness is not allowed until 2021, and those losses were expended in 2020? What happens then? I think the IRS is going to issue guidance on this. There's too much speculation.
Right now, the conventional wisdom is you don't limit the losses in 2020 because by the end of the year, you have not had the forgiveness. But maybe in 2021 where you do experience the forgiveness, it might be taxable under the tax benefit rule 1-11. I think the IRS is going to have to, I don't know, Miri, if you've heard anything, but I think the IRS is going to have to give some guidance on this. There's a lot of gray areas around that.
Transcribed by Rev.com
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