Year-End Tax Strategies | Part II
Planning for Businesses
Understand the latest federal, state and local, and international tax laws and how businesses could be affected by the House Ways and Means Committee tax proposals. Our corporate tax specialist will identify actionable planning opportunities that you and your business can take advantage of right now to mitigate your 2023 income tax liabilities and prepare for the future.
Anthony Cuti: Thank you very much, Astrid. Good afternoon, everybody. My name is Anthony Cuti, I'm a Senior Tax Manager with EisnerAmper. I'll be handling the federal tax planning considerations portion of our seminar today. We wanted to kick off with a refresh of some of the key items we see impacting some businesses on a day-to-day basis here, that were passed under the Inflation Reduction Act of 2022. This was the last legislation that was passed and signed by the president back in August of 2022.
The act increased the amount of research tax credit that can be applied by qualified small business under Section 41(h) against payroll tax liability from $250,000 to $500,000 for tax years beginning after December 31st, 2022. The first $250,000 of the credit is applied against the employer portion of the FICO payroll tax liability, and the second $250,000 is applied against the employer portion of Medicare payroll tax liability. The act also extended the limitation of the deductibility of excess business losses by non-corporate taxpayers under 461(I) for another two years. We'll get into this in more detail later on in the presentation.
The act also provided for approximately $80 billion of additional IRS funding over the next nine years, more than half of the additional funds would be allocated to enforcement efforts and modernization of the business systems. The mission of this act was not to raise taxes on low to middle income taxpayers. The act states that none of the IRS appropriations were intended to increase taxes on taxpayers with tax income below $400,000. During 2023, House Republicans were able to reclaw back 25% of the funds appropriated to the IRS since the signing of this act.
Our next topic is not necessarily a tax concept, but we felt it was important to note. That is the Corporate Transparency Act, which was passed in 2021. This becomes effective January 1, 2024 and will be regulated by the Financial Crimes Enforcement Network or FinCEN. The intention around this is really to minimize money laundering and other items, as it requires many businesses to disclose ownership information with their initial reports being due on January 1st, 2025 for entities that were in existence as of December 31st, 2023. This is developing and we expect it to impact many small businesses. Our firm will be issuing more guidance on this as we approach and enter the new year, as noncompliance with the Corporate Transparency Act can result in some severe penalties.
Getting back to our tax topics for 2023, many of the tax rates are remaining the same as the federal corporate tax rate remains at 21% for 2023, and the top tax rate for individuals remains at 37%, along with the net investment income tax at 3.8%, and the additional Medicare tax of 0.9%. Our self-employment tax, Social Security portion remains at 12.4% on the first $160,200 of income for 2023, and that's getting indexed for inflation for 2024 up to $168,600. Medicare remains at 2.9% with no maximum base. It's important when tax planning to review multiple years, and not just specifically one current year.
Another big tax planning item that we've seen, and I don't want to steal any of Denisse's thunder from her state local portion of her presentation, but there's the pass-through entity taxes, which have been around for the last couple of years. We've seen taxpayers save serious federal tax dollars from these elections, for both partnership and S corp owners. For cash method taxpayers, business expenses are generally deducted when paid. However, the PTET taxes must be paid before 12/31/2023 in order to secure a 23 deduction even for accrual-based companies.
Some other tax planning tools, when selecting between your entity choice of C corporation and pass-through entities of S corps and partnerships, there are many elections that are typically due right around the start of the new year. That's S corp elections, LLCs that get treated as a partnership. If you would like to review your availability to take the Section 199A deduction and your eligibility... I also wanted to note, again, not to step on Denisse's toes, but to review your state tax nexus issues prior to year-end. In our new remote hybrid environment, we're finding that a lot of new state filings are arising after the new year when it's determined that employees are working remotely in other states.
Some other reminders for year-end is to set up your qualified retirement before year-end if you haven't done so yet. Also, to take a look at your basis and at-risk limitations, and the ability to deduct those losses. The partnership K-1s are continuing to report capital on a tax basis, and the S corp K-1s are still required to attach Form 7203, which tracks the shareholder basis. If entities are still receiving PPP loan forgiveness in 2023, which would've likely been early in 2023, that is still considered federal tax-exempt income. Restaurant meals will be reverting back to a 50% adaptability in 2023. We'll touch on this in a little bit more detail later on.
The exception for small businesses, the average gross receipts threshold has been increased to $29 million for 2023, and $30 million for 2024, and that's based on the prior three years of gross receipts. We see a lot of taxpayers be able to take advantage of some small business exceptions, and save both tax dollars in compliance courses over the year. The next topic is the Research and Development Capitalization. This was a big change for 2022, as it saw many of the research and development expenditures under Section 174 needed to be capitalized as opposed to expense. So, 2023 is the second year of this rule.
Expenditures research conducted in the US are amortized over 5 years, and outside the US, over 15 years. This was passed on the Tax Cuts and Jobs Act of 2017, and it eliminated the option to deduct the full expense in the year that it was incurred. So if a company had $500,000 of R&D cost prior to 2022, they would've been able to expense that at 100%. Starting in 2022, and now again for 2023, that saved $500,000. It was required to be capitalized and amortized over 60 months, meaning we have taxpayers going from having a $500,000 expense in year one to only $50,000. The House Ways and Means Committee appears to have some focus on extending this, with some bipartisan support. Unfortunately, as of right now, it doesn't look likely for 2023, but we'll continue to monitor it and advise accordingly. We've reached our second polling question.
Astrid Garcia: Polling Question #2
Anthony Cuti: Thanks, Astrid. I saw a couple of questions in the Q&A about the A174 update. Unfortunately, as of right now, there's been no legislation out there, but the hope is that they were going to for '23. But I think once we pass into the new year, it's going to be difficult to get that for '23.
Astrid Garcia: Thank you. I will now be closing the polling question, please make sure you submitted your answer.
Anthony Cuti: Correct. The correct answer was false. Our next topic revolves around the deductions, and the first topic is for bonus depreciation. The criteria for assets to qualify for bonus depreciation are assets with a recovery period of 20 years or less. That includes computer software, among other things. Some common disqualifiers related to building and structural framework for a 39-year property, we've seen elevators/escalators be considered structural and not qualify for bonus, as well as new expansions to an existing building, those do not qualify, and any expenses on a residential property or 27.5-year property do not qualify as well.
You can elect out of bonus depreciation by asset class. Meaning, if you elect out of your 5-year property, all of your 5-year assets, machinery, equipment, you would opt out. Same for 7-year property, furniture and equipment, you have to elect out of all 7-year property. We wanted to stress for the bonus depreciation that it's decreasing from a 100%, which was in place since September of 2017 through December 31st, 2022. It's gone down to 80% for the calendar year of 2023. Again, in the same vein as the R&D rules, many have speculated about the possibility of the legislation by year-end, reinstating the 100% bonus depreciation for '23.
However, it's important to note, as of today, the bonus depreciation is down to 80% of the cost of the assets. There was some planning for some fiscal year companies. If you do have some assets that were placed in service in 2022, they would still qualify for a 100% bonus. Calendar year companies are down to 80% in '23 and 60% in '24, before getting completely phased out over the next couple of years. Sticking with depreciation, we have Section 179 expense, and the annual tax write-off under Section 179 has been increased to $1,160,000 for 2023, and it gets completely phased out once you have $4,050,000 of additions. The future years are indexed for inflation as well, and for 2024, that amount's going to increase to $1,220,000.
It's important to note for a Section 179, that you do need to have taxable income in order to take it, and you cannot produce a loss. The criteria for Section 179 assets consists of tangible personal property, machinery, equipment, furniture, computer software, qualified improvement property, roofs, HVAC, and so on. A couple of reminders related to depreciation, a cost segregation study can be used to shorten the lives of improvements to real property. If you have more than 40% of your assets placed in service in the fourth quarter of a year, the mid-quarter convention would apply. All this does is reduces the current year depreciation deduction that's allowed.
As I mentioned earlier, you can elect out of the bonus depreciation by asset class. I also wanted to note to be aware that states do have different rules when applying bonus depreciation, or Section 179. We've seen, throughout the course of production, that states that decouple from the federal rules of 179 bonus, that taxpayers wind up having a higher state taxable income in the year compared to federal because they don't allow as high of a 179 or bonus altogether. We also wanted to mention the importance of the de minimis safe harbor election, which has been around for a couple of years now.
If you have a written expensing policy in place at the beginning of the year for both book and tax, you can expense up to $5,000 per item with an applicable financial statement. Again, it must be the same for book and tax. If you don't have an audited financial statement, the limit is $2,500. So by using the de minimis expensing safe harbor election, you can avoid running into any of those state decoupling modifications that we talked about, and save some state tax dollars, as well as some cost to analyze the assets.
The next topic is the Employee Retention Credit, which has been around since the CARES Act back in 2020. Some recent developments related to that, in September of '23, the IRS announced a moratorium on the processing of new employer retention claims through December 31st, 2023, in response to a surge in questionable claims resulting from aggressive ERC promoters, which are typically non-CPA firms. We find these non-CPA firms to often be misleading to taxpayers while charging excessive commissions and fees.
It's extremely important to have documentation as the IRS has five years to audit an employee retention claim, and they can look to call back those funds in the future. If these non-CPA firms that assisted with those claims are no longer around, taxpayers could be out of pocket those fees charged, plus penalties and interest. Also wanted to note the deadline to claim the employer retention credit for the 2020 tax year is April 15th, 2024, as the statute of limitations of that period is closing, and the deadline to claim the 2021 employee retention credit is April 15th of 2025. You can also go about withdrawing an ERC claim if you feel it wasn't done properly by amending your 941-X.
The next topic is the Qualified Business Income Deduction. This has been around, again, since the Tax Cuts and Jobs Act, so about five or six years now, and this allows owners of sole proprietors, partnerships and S corps to deduct up to 20% of domestic income earned by the business. This is currently set to sunset in 2025. If you qualify for the Section 199A deduction, the top effective tax rate is 29.6%. This applies is whether a taxpayer is active or passive in the business.
I found this to be very valuable over the last couple of years, as I've had a few clients that are passive entities that were sold during the year and they had a portion of the gain on the sale, the ordinary versus capital, and they were able to benefit from the QBI deduction of the ordinary portion of the gain, so wound up saving some clients serious tax dollars there.
The qualified trades or business, if your trade or business involves the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, or financial services, or any trade or business whose principal asset is a reputation or skill of one of its employees or owners, they would not qualify for the QBI deduction unless their income is below a phase-out threshold. For 2023, that phase-out threshold is $364,200 for a married filing joint, and about half that for single filers. Passive entities are required to disclose the necessary information for the QBI deduction on their K-1s, so you shouldn't get the qualified business income, the W2 wages associated with it, and the unadjusted basis of fixed assets as well.
Coming back to the meals and entertainment, entertainment remains to be 0% deductible for 2023, unless certain exceptions are met. Meals, again, are reverting back to 50%. In 2021, Congress passed the Consolidated Appropriations Act, which for 2021 and 2022 tax years, meals purchased from the restaurant were 100% deductible, as they tried to revive the restaurant industry after the pandemic. Again, just to note, for 2023, they were reverting back to 50%. If you have a fiscal year company out there that does have some months in that year, in 2022, that those restaurant meals paid in 2022 could still qualify for the 100% deduction.
Moving on to our business interest expense limitation, this is applicable for businesses with 3-year average gross receipts of $29 million or more in 2023, and $30 million or more in 2024. This is essentially a 30% of your earnings before income tax, and no longer EBITDA, which it used to be. So the adjusted taxable income is the taxpayers taxable income computed without regard to any items of non-business income, business interest expense, NOL, QBI, and again the depreciation and amortization.
We saw many clients wind up losing interest expense deductions in 2022 due to no longer including depreciation and amortization in their adjusted taxable income calculation. In a couple of slides, we have a quick example showing the impact. The 163(j) limitation rules apply to all taxpayers and all debt, both domestic and foreign, and across individuals, C corporations, S corporations, and partnerships. Real estate trades of business can elect out of 163(j). However, there is a trade-off which requires the use of longer depreciation periods, and no bonus depreciation allowed, and that election is irrevocable.
Up on the screen we have our 163(j) example, and the impact of no longer including or adding back your depreciation and amortization expense to arrive at adjusted taxable income. In this example, we have a taxpayer with $50,000 of taxable income before Section 163(j) and that taxpayer has $35,000 of interest expense. So by not including the $50,000 of depreciation and amortization expense, their adjusted taxable income goes from $140,000 under the old rules that were applicable in 2021, to $90,000 in 2022, which makes $8,000 of their $35,000 interest expense non-deductible in the current year. We've seen this impact many, many clients over the last 12 months, or so.
Astrid Garcia: Polling Question #3
Anthony Cuti: So, this is the topic we just went over. This was a change that took place in '22, and we did see this impact a lot of our clients, as the add back of depreciation expense not being included really made their adjusted taxable income considerably lower and impacted their ability to deduct their interest expenses. Especially in a year with high interest rates, it was difficult.
Astrid Garcia: Thank you. I will now be closing the polling question, please make sure you've submitted your answer.
Anthony Cuti: Thank you. The correct answer was false. So you're not required, you no longer have to add back the depreciation and amortization to arrive at adjusted taxable income in 2023. Okay. Our next topic is Net-
Anthony Cuti: Okay, so our next topic is net operating losses for corporations. So prior to 2021, you could carry back your corporate NOLs without any limitation going back five years, and then you could carry forward 20 years back then. So starting in years 2021, there is no longer any carryback and you can carry forward indefinitely. However, you can only use 80% of your NOL against taxable income, meaning corporations that could have tax liability even if their NOLs exceed their current year taxable income.
Finally, so we have section 461A, which is the loss limitation rules for taxpayers other than corporations. And for 2023, the loss limitation is $578,000 in the case of a joint return and half that for single filers. So any net business losses in excess of $578,000 will be disallowed for 2023 and carry forward as a net operating loss. The CARES Act had delayed the implementation of 461 for tax years 2018 through 2020, and the limitation, which was originally only supposed to be in effect through 2026 again has been extended through 2028 by the Inflation Reduction Act.
That's the end of my presentation. I'll pass it off to Denisse to handle the state and local.
Denisse Moderski: Thank you. Thank you Anthony. Hi everyone. My name is Denisse Mordersky. I'm a Tax Director in our state and local tax group, and I'm going to cover a few items that I think are helpful and important during this time, especially for year-end planning. So before we go into anything, here's our agenda. We're going to cover some PTET, a high level overview of what is the PTET, highlighting four states that had major changes regarding PTET. Then we're going to talk about some changes. In fact, some of them effective 2023 for state sourcing and apportionment regarding for partnerships and corporations. And last but not least, we'll talk about some sale partnership interest. This is also a very hot topic and very important to note, especially for planning purposes, and some trending issues on domicile and residency. So we'll start with PTET. Just a quick refresher of what is the PTET.
So in 2017 when Tax Cuts and Jobs Act became effective, essentially any state and local income tax deduction was limited to $10,000 for personal income taxpayers. So individuals that were prior to this change able to deduct all of their state and local tax expense, they are now limited to $10,000. For example, think about someone who resides in New York, Connecticut, New Jersey, California, where state income taxes are at the highest rate. So you are well over the $10,000 limitation. That's not including your real estate taxes. You can imagine this is a big impact to those taxpayers with this limitation.
So what happened after this law became effective is Connecticut was the first state that came out with a pass-through entity tax, making it a mandatory. It's an entity level tax and a partnership, and it was mandatory starting in 2018 with Connecticut. Generally speaking, partnerships are not subject to tax. These are conduit vehicles that you flow the income to the shareholders members and they pick up the tax at their level. But with this PTET, you're basically creating an entity level tax, the entity, whether it's a partnership or an S corporation,
Then this PTET, this limitation, it's also effective from 2018 and scheduled to sunset in 2025. But there has been speculations and right now that they're trying to increase this SALT cap limitation, but that's still uncertain. Still we don't know what's going to happen. So for now, PTET is here and it is a very valuable area for planning purposes and I'm going to go a little bit more into it now for some changes.
There are about 36 states that have a PTET in New York City, and the way it works is you are making an election at the entity level. Again, I mentioned it's eligible entities are pass-through entities or S corporations. And you make an election, it's an annual election and you take a deduction for federal purposes of your state income tax deduction. And the way the individuals get the benefit is because when they received their K-1, this is netted off that expense, right? So the entity is not subject to the $10,000 limitation that you would be limited if you were to pick up the income at the individual level and subject to the $10,000 limitation.
So that's the way it works with the PTET. You are creating a federal benefit. That's the most important thing. One thing to get out of this session is that it is a federal benefit, right? So think about any individual taxpayers that are taxed at the highest rate, 37% in the federal rate, so you multiply that times your PTET, then that's creating a beneficial credit for the individuals. Other things... Oh, we'll have a polling question.
Astrid Garcia: Polling Question #4
Denisse Moderski: And while people are answering this question, I'll just go through a little bit more on the high level review, right? PTET. As I mentioned, this is a very important and complex area for planning purposes because all the states have their own rules. They are not one state. You can't apply one state specific rule to another. So that's where this area, it's a little complex and it does require special considerations because if you are a pass-through entity or if you're an S corporation, who are the members? Where do they reside? There are a lot of pieces that go into play and that's just on the PTET election. But then you also have to think about your nexus issues, your sourcing issues. There are a lot of components that go into play with PTET.
So again, it's very important to understand what are our projected income is going to look like for the year and it doesn't make sense to make a PTET election. And if so, what states do we want to make a PTET election for?
Astrid Garcia: Great, thank you. I will now be closing the polling question. Please make sure you've submitted your answer.
Denisse Moderski: Good. Glad to almost everyone got the answer correct. We do have 36 states in New York City. There are a few states that have a draft bill but it hasn't been enacted yet. So you can imagine we expect that there will be more states coming out with the PTET. All right. So I talk about what the PTET is. I do want to highlight some of the important changes with some states, especially with 2023 as we're working into planning and quarterly estimates. California is one of the states that have very robust rules in terms of PTET, and one of the things that I want to highlight is that in order to make a PTET election in California, there has to be a requirement of a prepayment satisfy. Otherwise, your PTET election may become invalidated. So this is a little bit different than you see from other states.
And the PTET election due date for California, it's by the original due date of return, which is March 15 or under extended due date, October 15th. However, in order to qualify for your PTET, you have to make a payment of a $1,000 minimum payment by June 15th or 50% of your prior year liability. It's the greater of. So the 50% only applies if you actually had an election made in 2022. So provided we didn't have an election made in 2022 and you are making an initial election for 2023, a $1,000 must be paid in by June 15.
Other forms that go along with the PTET, it's form 3804. This is very important because although the form, it's not an annual return on election form per se, but it does have the breakout of how the PTET is calculated and who gets the credit and how much each individual is getting. This form has to be attached to the partnership return or the S corporate return. And that is one of the communications we got from the state that if you don't have this, you may have issues or the state may challenge your PTET election.
The tax base and the way it's computed is you break it out between your resident partners and your non-resident partners, and you take the aggregate of those two partners and that's how you come up with your PTET taxable base. Then we apply 9.3% rate, which is fixed rate for PTET, and that's how you come up with the credit. California does have an option that not all members have to opt into the PTET. You can't have members opt out. It's not mandatory that it's made for all of them, but the only eligible members, which are individual taxpayers states and trust, including renter trust, those are the only members that are allowed to get a PTET credit.
If you have a tier structure like a partnership with pass-through members or corporate members, they do not disqualify the entity from making an election. But however, they do not get included into the PTET. Therefore, they wouldn't get a credit. It's only going to be your non-corporate partners that are getting a credit. The credit, it's a non-refundable credit and any access is carried over for five years. So this is important because if you have taxpayers, individual taxpayers, California residents that are getting credits for taxes paid to other states, and let's say they have significant material credits coming from let's say non-resident withholding and you have a PTET, the way it works starting in 2022 is you have to use the credit for taxes paid to other states first before you applied any PTET.
So to the extent you have all these credits from let's say non-resident withholding, you have to use that first. And let's say all of that absorbs your taxable income, you may be in a position where you have a suspended PTET credit and that needs to be carried over for five years. So this is where planning comes into place, where you may want to take advantage of doing a non-resident withholding exemption. So basically you opt out of withholding requirements from your other investments and that way you have that waiver in and you can utilize the PTET. And again, because the credits only carry over for five years, you want to make sure that you're tracking that, that it really makes sense to make a PTET. You may have members that have NOLs, they may not want to get a PTET, right? They may want to opt out of the PTET and just utilize their NOL. So that is one good benefit with California, that you don't have to have all members opting to the PTET.
Non-resident withholding requirements still applies. So in California, as corporations, partnerships are required to withhold them their non-resident members if they have more than a $1,000 of California source income. So by making a PTET election does not get rid of that requirement. However, if you don't want to make the two payments, you can request for a non-resident withholding exemption with the state, and that's a form 588 that gets filed with California. The state approves it and then the entity is exempt from making any withholding and therefore they can just make the PTET election.
I mentioned here about California Legal Ruling 2022-01. This is a change to state sourcing and I'm going to go into detail in the other slides, but just want to highlight here that this also impacts your PTET, right? Like I mentioned, PTET is a very complex area. There's a lot of components that go into play like nexus and sourcing. This is one of the areas that because of this legal ruling, there could be some changes in the way we calculate our California receipts, and that California source income also impacts how you calculate your PTET for your non-resident members.
Credit ordering list, I mentioned that you apply your credit for taxes paid to other states before any PTET. One thing it's important, the June 15 prepayment, it's a requirement to make an election, but what happens if you have an entity that was formed after June 15? If I have an S corporation that was organized, let's say in August 15, they are not subject to the June 15th prepayment. So to the extent you have any entities that were formed after, they can still make the election for California PTET, as long as they comply with the requirement and submittal of the payment by the original due date, which is March 15. However, for cash basis taxpayers and even accrual taxpayers, we do recommend making any payments by December 31st so that they can get a federal benefit in the year it was paid.
Other changes, major changes here are Connecticut. Connecticut was the first state that came out with their PTET in 2018 making it a mandatory. They now have converted into an optional PTET election starting 2024, and now they are back to being a mandatory composite return. So prior to PTET, Connecticut requires a mandatory composite payment to be made for all their non-resident, non-corporate members. So that's back into play starting 2024. So to the extent you have any non-resident individuals, pass-through entities stage trust, they are subject to this composite filing, composite tax, but if you do make a PTET election, you can apply the PTET credit against your composite tax.
The way it works is prior to this change of 2024, you had two bases to compute your Connecticut source income. You can do it based on your Connecticut source, which is the default method, or you can obtain to this alternative base method, which is basically comprised of your modified Connecticut source income and any unsourced income. And I will talk a little bit about that in a minute. There was an option also to do a combined entity election for PTET in Connecticut. So if you have brother, sister entities or any pastoral entities that are owned by a common ownership of more than 80%, you can make an election to pay the tax at the parent level and include all of the income from your subsidiaries and make that election.
Each entity will still be required to file their Connecticut return, but you don't pay the tax at each level. You will just make that payment at the parent level. That's been eliminated starting 2024, so you no longer have that option. Each entity is responsible to make their own PTET election and make their own payment. The tax rate remains at 6.99% and there's still a credit limitation of 87.5%. There was some discussions under the draft bill to raise this limitation to 93.01%, but that did not go through. So the credit is still limited to 87.5%.
And this is important to know because if you have an entity that is making an election, they're going to pay a tax on all their income. But the members getting this credit, I'm not getting a 100% of their credit, they're only getting 87.5%. So the state's getting a little bit of a haircut. Owner filing requirements. Now, because Connecticut is a mandatory composite state, any non-resident individuals, if they're included in a composite, they will not have any filing requirement at their level. That requirement will be satisfied by the entity, provided they don't have any other source, right? To the extent they have other Connecticut sources, let's say from wages or any other activities, they may still be subject to file a return.
So here with the changes, it's important, those two bases of how you compute your Connecticut source has been eliminated starting 2024. So in order to compute a PTET, you have to do a base on an alternative base. And the way this alternative base is comprised is you take your modified Connecticut source income, which is basically your apportion income to Connecticut, minus any Connecticut source income that flows from an underlying investment. So if you have a tier structure, you take out any Connecticut source income that flows from that underlying investment and you just take your operating level activities in Connecticut, that will be your modified Connecticut source plus any unsourced income. And by unsourced income, we're really talking about any income that is not sourced to any state in which the pastoral entity has nexus.
Now, how do you determine nexus in other states? Prior to 2024, Connecticut require you to use their nexus and apportionment rules to determine whether an entity had nexus in other states. You no longer have to do that, which is actually beneficial if you think about it because Connecticut has a $500,000 threshold to determine nexus. If you have, let's say $500,000 gross receipts in let's say California, under Connecticut rules, you have nexus and that income would not be considered your unsourced income, right?
So with this change, you don't have to apply Connecticut's rules. You just look at other states where your company has nexus and you pulled all that activity out to come up with your unsourced income. That's the whole point. You come up with unsourced income. As a good example of unsourced income, think about entities that have investments, operating entities that may invest in a bank and they just have securities or anything that is not related to your trade or business. That could be investment income. That may fall under unsourced income. You have portfolio income. That portfolio income, it's not sourced to any states. So that will go into your unsourced income in order to compute your alternative base, and that's beneficial for your Connecticut residents because by including this unsourced income for the Connecticut partners, they're maximizing their benefit.
Connecticut's different than California or New York, where you compute the tax, the PTET based on resident versus non-resident pool. We don't have that in Connecticut. It's either alternative base or standard, but now it's only alternative base. So this unsourced income portion is very beneficial for those Connecticut members, residents where they can maximize the PTET.
Corporate members are not include in PTET for Connecticut also. That's different. So to the extent you have any partnership with corporate members, corporate partners, they have to be making their quarterly estimates on their own. They will not be getting a PTET credit from Connecticut starting 2024. Other major changes are New Jersey. New Jersey prior to 2023 for partnerships, you were required to source based on a cost of performance approach and a three factor apportionment. So you will take your payroll, your property, your sales to New Jersey and come up with an evenly weighted ratio. And the way you source is by any services performed in New Jersey, that's how you determine your sales to New Jersey. Now with the changes, New Jersey became a single sales factor apportionment for partnerships. S Corporations does not come into play here because they follow the corporate rules, which is based on single sales apportionment, but it's just only for partnerships.
Also, New Jersey came out with a relief that because of this change to the extent any entities that make quarterly estimate in 2023 and now have to change their apportionment, there will not be any penalties and interest assessed for tax year 2023. So we highly recommend that as we're planning and doing our year-end planning, we have to factor in any catch-up payment because of the change in sourcing and apportionment to New Jersey For any partnerships that are computing any PTET, for example. The PTET was based on the partnership rule. Now with this change, the New Jersey base, which is their PTET election, you'll compute it based on a single sales factor and market-based sourcing rule.
There is a $100,000 economic nexus threshold for corporations. New Jersey did not come out with any minimal threshold for partnerships. From a practical standpoint, we believe that a $100,000 could be a reasonable approach to determine whether you have Nexus in New Jersey for partnerships. So something to keep in mind. Other major changes related to PTET are New York State, New York City. New York State in 2022 came out with guidance that any PTET taxes that are deducted for federal purposes, whether it's New York or any other states, needs to be added back when your compute your PTET. New York City also extended their PE to include states and trust. Prior to this change, it was only New York City individual residents. Now you can have states and trust that are New York City members.
For anyone making any reorganization elections, New York came out with a guidance that if you have an entity that engaged in S corporation that made in every election, that PTET election that was made by your old entity now carries over to the new entity provided that they meet that every organization rules. And here's some of the parts that you have to comply with in order to be able to validate this PTET election is that the successor entity is a continuation of the original entity.
Even if there's a change of EIN, it has to be a continuation of the original entity. There cannot be a final return. And the successor entity reports all of the income from pre and post reorganization. So this is an N test. You have to meet these three steps in order to be considered qualified to carry over your PTET election from the old entity to the new entity under the F reorg.
Late elections, very important. I mentioned North States have similar rules when it comes to PTET. This is a big one that always comes up. New York State, New York City is one of those states that have a very strict deadline of when you make the election. It has to be made by March 15 in the same year of the tax year. So right now, 2023 is past due, right? We already missed the window. That was due March 15th, 2023. So for planning purposes, we need to start thinking about for 2024, tax year 2024. All your elections for New York State, New York City are due by March 15th, 2024. There are no late elections to the extent you don't have any visibility into what your income looks like. And this is very important. Again, I suggest factor in, does it make sense to make an election? Because if you missed the March 15 window, there's no going back to the extent you have, let's say a sale of goodwill or a partnership interest down the road and you want to take advantage of this PTET, you cannot go back to make the election.
So worst case scenario is you make an election. Let's say you end up at a loss. So you paid and then you end up in law...
Also, you paid and then you end up in a loss position, you can get the money back. You can file a return or a zero return and get that payment back as a refund. But the worst thing is that if you do have a profitable transaction and you want to take advantage of this PTET, and we seen this a lot with 338(h)(10) elections, self punish interest, that's something to consider. Any overpayments between New York State or New York City PTET, you can apply one against the other. So that's helpful, right? As we're working with estimates, you may end up overpaying one versus the other. You can apply one against the other to minimize penalties. Okay? So those are the big changes on PTET. Now we're going to talk about a little bit some changes in terms of sourcing and apportionment. So California is a big one for services providers, right?
When we're talking about service receipts, California issued a legal ruling last year and this rule, it's effective 2023. So think about your service companies when you're trying to determine the California receipts, what do they really look for? They're looking at your, where's your customer... They apply a market based sourcing rule, but there is a look through approach, meaning that they're looking at the ultimate beneficiary, right? So if I have a software company and they're providing software to various vendors, let's say Microsoft, and Microsoft releases the license to other end users, the way the ruling applies for California is they're not looking at your direct customer, Microsoft. They're looking who's the ultimate beneficiary? Who's getting the benefit, the ultimate benefit. It's really happening at the end users. Many companies don't have information or visibility to look through the end.
So there are a hierarchy of methods that you can come out with an approximation, but this is a big change where we've seen, right? You may not think that you have California Nexus because, oh, my direct customer is Microsoft, they're in Washington. I don't have anything in California. Well, that may not be the case because if you have end users that are getting licenses from Microsoft for the software that it's our company, you may have California Nexus. So something to factor in for services. And there is also an economic nexus threshold for California. I believe it's around 600 and change for 2022, and they constantly update it for inflation.
I mentioned this a little bit. Who was the customer? What is the service? Here are some examples. I can kind of go over two of them. So example number one, we have an event planner source sales to where that event occurs, not where the planning services are performed. Again, California is a market-based sourcing state. So you wouldn't source your sales to where the service is performed. You will be sourced based on where the event occurs, and that's what we meaning where is your benefit derived? Where's your benefit received?
Here are some other changes for New Jersey corporate taxpayers. New Jersey actually had a very major corporate tax change in this year for applicable to 2023, and here are some of the highlights of that. There is a bright line economic nexus threshold of a hundred thousand dollars for corporate taxpayers. So if you have any corporations that are generating more than a hundred thousand dollars of New Jersey receipts, be aware that you may have nexus and filing requirements.
Also, they adapted the MTC rules for public law 86 to 72 related to online activities. Now they're conforming. Combined reporting has been another change. They now include captive REITs, New Jersey investment companies and bricks. And another big one is the shift of Finnegan method from Joyce. So New Jersey prior to this change is the way you compute your apportionment, you'll use the Joyce rules. Now you are required to use Finnegan and by Finnegan we're really looking at when you're calculating your apportionment is you're looking at all of the entities of the combined group, right? Even those entities that have no nexus are now included your apportionment, which is different from Joyce, where you're only picking up your entities with Nexus in New Jersey.
Other changes here are section 174. This has been a big change for federal purposes. New Jersey came out with rules and guidance that now you are allowed to take section 174 expenses for any research and development that are in New Jersey. And there is a position right now where contrary to what the guidance has in the state versus what the statute reads, where it's only, you can take expense this R&D expenses in New Jersey for all of your expenses, not just New Jersey related. But there may be a position where if to the extent you claim R&D credits in New Jersey, you can expand those R&D expenses in New Jersey for all of your expenses, not just New Jersey.
Other facts here are conformity with federal IRC173J. They now conform. NOLs prior to 2029 can now be shared in a combined group, which is good, beneficial because now you don't lose those NOLs prior to the change. And just to kind of give a quick background, in 2019, New Jersey converted their NOL rules from a pre apportionment to post apportionment. So now with this change, you are allowed to take some of those NOLls prior to 2019. DRD can now be a 100%. There's a 5% clawback and also the DRD is allowed before NOLs. So those are tax friendly benefits.
Other major changes are New York. New York has been... There was a major corporate tax reform in 2015 for New York corporate tax purposes. And now there have been draft proposed rules for quite a decade now, and now it looks like it's moving forward. So we do anticipate these rules to change and become into statutory as they're moving along. Some of those proposed and highlights rules are in terms of service companies, right? When we're computing sourcing, when we're looking into sourcing. New York under the proposed regulation have these two rules. One for passive investment companies. The way you're computing your receipts. Before it was like you source it based on where the commercial domicile of your customer is, but now with this passive investment company rules, it's sort of like a look through. You're looking through who is the beneficiary here. So, let's put it as an example.
If you're thinking about a company that provides advisory services and they provide it to a business entity and that business entity has New York shareholders, the passive investment company's rules is looking at, well, is the customer... What is the function of the customer? Are they in the function of pooling capital, pooling money? And then who is getting the benefit here? So you'll look through those shareholders of your direct customer. It's basically looking through. So that's important because this may create nexus, and this is often what I've seen with some of my clients is corporations that are relocating outside of New York, moving to Texas or Florida thinking that they'll get out of New York, I don't have to worry about filing New York.
Well, with this passive investment company rule, you may still be brought up into New York even if you move your domicile or your headquarters out of New York, right? Because they're looking through who are the shareholders, who are the beneficiaries getting the benefits of your services? Other important rules are self partnership interest. In the current law, you don't have to include any gain associated from a self partnership interest into your sales factor. Under the proposed rules you do, so that's something to keep in mind. Other big changes are the MCTMT. This is a big one, right, where there were exceptions for limited partners in those partnerships. Think about the LLCs.
Now there has been guidance that they could be subject to the MCTTMT tax and there was an increase in those tax rates from .34% to 0.6% for New York City employers. Other audit activity areas where we've seen it's UBT, New York City UBT. This is a big and big one. We see this a lot in audits where what is considered an add-back more often than not we see taxpayers where if you claim if are paying any health insurance premiums or if you have any 401k paid to partners, and that's deducted for UBT, that's not a deduction for UBT purposes. Anything that is paid on behalf of a partner has to be added back.
And this has been a big area in audits where we see salaries or certain expenses paid to partners being readjusted and increasing your taxable rates in New York City. Personal income tax credit, big one, as I mentioned, right, with California and New Jersey. Change of sourcing and apportionment, you may have companies that are subject to tax more than a 100% of their income. So give or take, you may have states like New York, New York's for example, that the way they compute a credit for individual tax purposes is by using their rules. So, there could be some area here where you may be subject, you may be end up paying more than a 100% taxing in other states.
One more state with changes, and this is not effective 2023, but something to definitely keep in mind. Massachusetts, they changed their apportionment formula. It's currently a double weighted sales three factor apportionment. Now effective 2022 corporations and partnerships will be used in single sales factor. It's still market-based sourcing, so that did not change, but it is now based on a single sales factor apportionment. Financial institutions to the extent, if you haven't, prior to the change, any income from investment or training activities was previously assigned to the state if your regular operations or your commercial domicile was in Massachusetts. Now with this change in 2025, the way you compute that, your sales for financial institution is based on any activity taking place in the state.
So if you have any lending, any credit card leasing activity in the state, that's how you would compute and source your Massachusetts receipts. Changes to personal income tax, the short term capital gain tax rate has been decreased from 12% to 8.5 and that's effective 2023, so that's a benefit to individual taxpayers. There's now a requirement to file joint return in Massachusetts if you file the same for federal purposes, and this is effective 2024.
One thing I do want to mention is Massachusetts has a 4% tax, a millionaires tax on any individuals that have more than a million dollars income. So for any entities that is making a Massachusetts PTET, keep in mind that the Massachusetts PTET is based on a 5% tax rate. So if you have individuals that are subject to the millionaires tax, there's going to be an additional tax there, right? So there will be a gap between the credit that they're getting for PTET versus what they're subject to it. They have not changed this in the proposed bill. They've talked about it. They mentioned it maybe potentially increasing it to match the millionaires tax, but that has not been enacted yet. So to the extent we have individuals that are in the higher tax rate and subject to millionaires tax, they should be making quarterly estimates at that individual level to factor in for that discrepancy between the PTET credit versus that tax at the personal income tax level.
I am going to go a little bit quick on this because my colleague Jennifer has to catch up on international tax updates. So I want to give everyone some time, enough time, and we can spend a whole day on sale and local tax as well, but I'm not going to do that to you guys. So we'll go through some main areas here. Sale partnership interest. This has been a big one and I think we've seen this a lot, especially in anyone with private equity investments, investment partnership investments. Sale partnership interest has been a very challenging and contested area amongst the states. We don't really have a lot of clarity or guidance as to how do you treat this. There's so many factors and nuances that go into your self partnership interest, right? Like who's selling that partnership interest? Is it sell directly by the individual? Is it sell by a corporate partner, by a partnership partner or holding company?
There's so many pieces that go into it, but this has been a big area for planning and opportunities, especially with the proposed bills in New York state where we have seen the sale partnership interest now will be included into your sales factor. So, there's a lot of areas here for planning. Some of the key areas, when we're talking about sale partnership interest, is that gain apportionable or is it directly eligible? Do you include it? Do you exclude it from the sales factor? How do you compute the gain in a tier structure? Do you use an aggregate method? Do you use a entity method? Which rules applies? And also the impact of this transaction. How does that impact your PTET? Like I mentioned earlier, California, when you are doing your PTET, California has guidance where if you have a self, a stock, that's not considered qualified income for PTET purposes.
So it's very important how this self partnership interest is being classified itself. Is self an intangible? It's a business asset, it's a non-business? What is the character of that income and how does that impact your PTET? So all these topics kind of go related with each other. And here I mentioned some of the highlights, who's the seller is important. When we're talking about corporation, and this is specific to New York state, but when we're talking about corporate taxpayer selling a partnership interest, generally speaking, that's going to be included in your taxable base for New York.
All of your income is included for corporate taxpayer purposes in New York unless you have investment income, but that's very limited to what's considered investment income. The big question is how do you compute that gain if you have a corporation that selling an interest in a partnership, but that partnership is just an investment, it's not really connected to their trader business. How do you factor that income in? With the proposed regulations there is a separate accounting election. Basically it says that any corporate partners can elect to report only the distributed share of income coming from the K one investment and not pick up any of that gain of a partnership interest provided that it's a limited partner. It has nexus with New York only because of the partnership interest, meaning that you cannot have any activities or any operations in New York besides just the investment in the partnership interest, and it cannot be unitary. So there could be a position here and opportunities for any corporations that are selling a partnership interest on separate accounting election.
If you have an S corporation, also different rules may apply. First of all, there has to be an S corp election made. New York does not conform to federal for S corporations, they have to have a separate election made in order to be treated as an S corporation. If you have an S corporation for example, that sells a partnership interest and has an IRC 338 H10 election and makes an installment method, the way it works with S corporation is you use the apportionment percentage in the year the 338 H10 election was made.
Now on the partnership side, if you have a partnership in a tier structure selling partnership interest, there's really no clear guidance of how you report it because there's different methodologies, whether you're doing a apportionment reporting, whether you're aggregating all of your investments and apportioning or if you're doing a direct allocation to the extent that you don't have any activities in New York City, you just have a K one income coming through. So there's no clear guidance here. So this is a very complex area. How do you report it? Who are the selling partners? What is the activity? What is the nexus in New York City with UBT? And I think we have one more polling question.
Astrid Garcia: Polling Question #5
Denisse Moderski: So while everyone's answering this question, I do want to just say, so this is specific to New York State, right? I was focusing more on the sale partnership interest for New York because they provided more guidance in their proposed, right? But there are many states out there when it comes to when it comes to sale partnership interest, there's no guidance. It's a really gray area and requires careful planning and special considerations. And the answer can really differ if you are a partnership partner or an individual or a corporate partner. I mean, I can tell you the list goes on. Also, how involved is the selling member with a partnership? Is it an active member? Is it a general partner? It's a limited partner? I mean, I can go on and on, but there's just so many case laws, and this has been a very challenging area for taxpayers and practitioners. So, if you have any partnership interests, we definitely have... This is a good area to start planning because it not only impacts your individual taxpayers, but also PTET, Nexus, apportionment and more.
Astrid Garcia: Thank you. I will now be closing the polling question. Please make sure you've submitted your answer.
Denisse Moderski: Actually, this is a good answer. It depends because I realized we did not put here under the proposed rules. If it was under the proposed rules, the answer will be yes. So I think it depends is good. That means people are paying attention, so thank you. And last but not least, trending residency issues. This is also a big one. With COVID, many taxpayers fled New York, New York City, so things to keep in mind for residency purposes. How do you establish nonresidency in New York State? There's a whole list of checklists that we try to get engaged with our clients and start planning. The big thing is to stay out of New York. Unless you really have to, stay out of New York, number one.
Second thing is change all your records, your driver's license, your voting rights with your new state, your living will. Things as silly as your LinkedIn profile, but this has come into audits where we had auditors. I'm like, well, everything is showing Florida here, but their LinkedIn profile still shows New York, so what is this person doing in New York? So little things like that and social media, you'd be surprised how many auditors will look at things like that. So the more you do the better. And the number one thing is stay out of the state if you want to take a position that you're not a New York State resident.
And that's all for me. Thanks everyone. I'll pass it on to you now, Jennifer.
Jennifer Sklar: Thanks, Denisse. Good afternoon everyone. Okay, so I'm going to talk about international tax in I think about 15 minutes, so this is going to be fun. So, how I decided to approach international tax this year is really just to talk about some tax updates. International tax, there's really not much that can be done in terms of year-end planning. It's more of a prospective planning. So I think it makes sense to know what's been going on in the international tax world so you can think about that for your clients prospectively in the next couple of years.
And so, here, we're going to start. So first we're going to start with general update. So we've got one deadline extension as a result of the terrorist attacks in Israel on October 7th. There's tax relief under notice 2023-71 where the IRS is providing relief for tax related actions a year past the terrorist attacks. So October 7th, 2024. The extension applies to both individuals and businesses and it pretty much relates to just about any tax related action and any action that was due on or before October 7th, 2023, and then before October 7th, 2024. So this is important because we do have a deadline coming up for US citizens that are outside of the US. So if we have citizens that are in Israel, their December 15th deadline has now been extended.
General update on foreign tax credit rules. So in 2021, the IRS announced significant changes to the foreign tax credit regulations and they were going to seriously limit the creditability of foreign taxes. So luckily, as we were trying to get our heads wrapped around all of these different changes and how they were going to affect our clients, the IRS announced in July in notice, 2023-55, that the taxpayers can use the existing rules for now through December 31st, 2023 while they consider certain modifications. The IRS does expect a guidance package by the end of 2023, and they did note that it's going to address some new rules on partners in partnerships and how the foreign tax credit regs will influence partners and partnerships. So more to come on that.
Again, these are very complicated rules and the changes are substantial and could definitely impact the credibility of the taxes that we've taken for granted in the past and taken the foreign tax credit for. Okay, so I've got some proposed law changes. Some of these things have been in the works for a while, so that's why I have here pending or not. One of the most significant is going to be the TCJA provisions for GILTI and FIDII that are sunsetting in the next couple of years. So currently we have the section 250 deduction, which is the 50%. For GILTI it's going to be reduced to 37.5%.
... is going to be reduced to 37.5%. And then we've got the FDII deduction of 37.5% that's expected to decrease to 21.875% all for tax years beginning after December 31st, 2025. So in particular with GILTI where you used to be able to get a 10.5% effective tax rate, that's now going to be about 13.125%. The IRS has been talking about a number of other proposed regs guidance that we should be expecting. Some of it is on the previously taxed earnings and profits rules. As some of you hopefully know, the PTEP rules relate to income that comes out of a controlled foreign corporation that has already been taxed, won't be taxed again. So there are certain rules that are expected to come out in early 2024, addressing the PTEP rules.
Also, guidance quote, unquote, "in the near term," the words of the IRS that will address certain basis adjustments in CFC stock that's held by another CFC. And then we've got some proposed regs on the 15% corporate alternative minimum tax that came about under the Inflation Reduction Act. There's some issues with potential double counting of CFC distributions. So those are supposed to be addressed in some proposed regs going forward. Also, some revised procedures on the US residency certifications, that's the Form 6166 that you have to apply on a Form 8802 to the IRS in order to have a lower rate of withholding on certain payments.
So for those of you who are into the crypto and the digital asset space, there's supposed to be some global coordination under the OECD for imposing global digital asset reporting standards on US taxpayers. So we just recently had some domestic rules and now we potentially have some global based rules as well. So here's something the IRS is not expecting to finalize, which I'm sure many of you who deal with PFICs are very happy to hear. There were PFIC regulations. There we go. We got some hats and claps and a wow face. So the IRS is not expecting to finalize the proposed regs on partnerships in PFICs anytime soon. Essentially what the plan is was to treat PFICs in the aggregate similar to the way we treat CFCs and we don't have to worry about those. Those will stay on the drawing board until the IRS decides to address them.
So I want to talk a little bit about FBAR penalties. So I'm sure all of you are aware that we have FBAR filings that are required by individuals and entities who hold foreign accounts. Oops, I just lost one of my... Okay. Failure to file penalties are $10,000 for non-willful failures and the greater of a 100,000 or 50% of the value of the account for a willful failure to file. So the IRS has frequently assessed penalties on a per account basis for non-willful failure to file cases. So in Bittner, which was a very important case in early 2023, the taxpayer challenged the IRS's assessment of a $10,000 per account, non-willful failure to file. So they had 272 unreported accounts. So 10,000 times 272 unreported accounts, that was the penalty that was assessed by the IRS.
The Supreme Court sided with the taxpayer thankfully saying that non-willful failures to file must be calculated on a per report or per FBAR basis and they're therefore limited to the $10,000 per report. So that is a very significant court ruling and thankfully for this taxpayer who had a significant penalty, they don't have to worry about it. So it's going to be per FBAR and until something has changed with respect to the penalty for willful failures to file those remain, again, this is just non-willful. Okay. There are a few notable cases in international tax. One of them the most significant is Moore versus United States is currently pending in the Supreme Court. It's supposed to be heard next month.
The significance of this is the IRC section 965 transition tax, which I didn't think I would ever have to talk about after 2018, but here it is again. So the Moores are challenging the imposition of the transition tax in 2017 and the argument that they're making is that under the 16th amendment it is unconstitutional for those unrealized earnings to be included in income and taxed. The 16th amendment requires that income is realized and taxed once it's recognized. So realized and recognized, it has never been challenged since the 1920s, even though historically we've had a number of statutory provisions that have taxed unrealized income. So prior to the 2017 TCJA, a CFC's undistributed earnings were not taxed until they were repatriated to the shareholders except for a current income inclusion under Subpart F.
So the Supreme Court granted certiorari in June of 2023 and like I said, the case is expected to be heard in December of 2023. This decision could have massive impact on past payments of the transition tax and the court could potentially find that 965 is unconstitutional under the 16th amendment. And this of course, will lead to questions about refund claims, the impact on state and local taxes, and the validity of other statutory provisions like Subpart F, GILTI, the new corporate alternative minimum tax. So this can have significant impact going forward. Another important case was Farhy and that dealt with Form 5471 and whether or not the IRS has the statutory authority to assess penalties under the code. Code section 6038 addresses the filing requirements for controlled foreign corporations and other foreign corporations in which US shareholders have an interest.
The court determined that because these penalties are not assessable under the statute, meaning they're not assessable under code section 6038, they can only be assessed by the IRS or the treasury suing. So that is very interesting. The court did not address whether any refund claims would be permissible. They also didn't address how this would impact other international information returns like the 8865 and the 8858. The IRS has filed a notice of appeal. So we're going to see how that plays out. And then I do want to stress this ruling does not affect the obligation to file a Form 5471. So this just goes to how the IRS is able to assess the $10,000 penalties.
Another case, Amanasu Environment Corp. This is a case that dealt with rather than the 5471, it dealt with its counterpart, the 54 72, which deals with inbound foreign corporations. The case was filed before Farhy. So we have to see if Farhy is going to affect the assessment of penalties in the 5472 context. Here, essentially there is automatic, and I'm sure anyone who has dealt with 5472 in that $25,000 penalty, as you know, they've historically been automatically assessed. So now we have a taxpayer who came in and said that they shouldn't be assessed that there needed to be some supervisory approval. And the IRS is asserting, well, there's no human involvement, they're automatically assessed by a computer and so they can't be expected to have supervisory approval. So another case where the IRS's authority to assess penalties is being questioned. Polling question: The IRS can still automatically assess 5471 penalties. True or false? Sorry, Astrid, I think you were supposed to be able to say that. So I'm sorry I took that from you.
Astrid Garcia: Polling Question #6
Jennifer Sklar: Sure. So I just want to be clear about the IRS can still automatically assess 5471 penalties. So I just went through three cases. One of them dealt with 5471, one of them dealt with 5472. So hopefully you're not going to get them confused.
Astrid Garcia: Okay, I'll be closing the polling question now. Let's just make sure you submit your answer, give it a few more seconds. We still have some participants answering the polling question. We'll still have some people coming in. All right, I will be closing the polling question now. Back to you.
Jennifer Sklar: So the answer is false. So most of you said true. So the Farhy case essentially said that there's no more automatically assessing the 5471 penalties. The IRS is required to actually bring a lawsuit against the taxpayer in order to collect the penalties. Okay. Very quickly, because we are running out of time. Altria Group, this has to deal with the repeal of the downward attribution. Unfortunately, I'm sure a lot of you who have some real substantial org charts where you have a number of different foreign entities and US entities within a particular structure have had to deal with the repeal of the CFC downward attribution rules. Essentially, very quickly, the repeal of the attribution rules results in significant compliance burden and a potential income inclusion for some US shareholders at the very top. So in a situation where you have a foreign parented US company that also has foreign subsidiaries, you have a situation where the foreign parents ownership of its foreign subsidiaries can be attributed to its US subsidiary to make those foreign subsidiaries CFCs with respect to the US subsidiary.
So if there is a US shareholder at the top that owns at least 10% of the foreign parent, they can actually have an income inclusion as a result of the brother sister relationship between the US and foreign subsidiaries of the foreign parent. So the IRS did come out with some relief in terms of filing. There are some exclusions from filing the 5471 in those instances and if you meet those you don't have to file. But in terms of the income inclusion at the very top, if you do have a US shareholder that owns at least 10% of a foreign parent that has US and foreign subsidiaries, there could be a GULTI or a Subpart F income inclusion. So that's very important to consider. I just wanted to quickly mention Christensen. This is actually in the individual income tax world, but this is breaking news.
This has to do with getting a foreign tax credit in the US for the 3.8% net investment income tax. This just came out, I think it was last week. So this is important to note that generally when you're taking a foreign tax credit under the treaty against capital gains or a dividend for example, you're going to be able to offset the 20% capital gains or qualified dividend rate and not the 3.8% Obamacare tax. So this has changed. The court has declared that under the France US Tax Treaty, you can actually get a foreign tax credit against the net investment income tax. So the France US Income Tax Treaty is a very common treaty. The language is very similar to other treaties in particular European countries. So this could have a huge impact on foreign tax credit credibility. Very quickly in the relief from double taxation world, we finally have the workings of a US Chile income tax treaty that we've been trying to get together since 2010.
The treaty was first signed in 2010 and it was approved by Chile in 2015 and we just have not been able to get this enacted. And then finally it came up again and the Senate approved the treaty in June of 2023. They did put some reservations in there. So now it had to be reapproved or ratified by the Chilean Congress, which as of last week it was unanimously approved. So now it just needs to be signed by Chile's president and then it should be able to go into effect. So this is huge, especially obviously for those of you who have clients who have dealings with Chile or entities in Chile. And this is only the third Latin American country with which we have an income tax treaty, Venezuelan and Mexico being the other two.
We also have significant US Taiwan tax agreement. This is not a tax treaty. We cannot currently have a tax treaty with Taiwan, given that we formally recognize Taiwan is a separate country consistent with the US acknowledgement of the one China policy. So the next best thing, we have a double taxation relief agreement that we entered into with Taiwan, which now has resulted in a new code section 894 cap A, which will create benefits for residents of Taiwan. And as soon as they also apply reciprocal benefits to US persons, this code provision will go into effect. So that's going to be very helpful.
And we've got a tax information exchange agreement with Uruguay. That just means that the two countries will exchange information and it does have hopefully poses a positive step in the future for actually having an income tax treaty in place. And we are totally running out of time. So I'm just going to say quickly, OECD, global tax deal. This is a global tax deal with about 140 countries have signed on to this global tax deal. The US has not formally done it. There are two pillars. One has to do with a nexus and profit allocation rule and the other has to do with a global minimum tax. If this is passed, this global minimum tax is a 15% tax and there's all sorts of ways in which that this tax could be implemented within a particular country, a top up tax, an income inclusion rule, or an undertaxed profits rule. So there's a lot going on every day. There's another country that's signing on, but what's most significant from our perspective is going to be the US.
So the critical issue for the US and pillar 1, which is signing onto a multilateral treaty, is the freezing of digital service taxes, which is a huge thing. Canada in particular is a country that still has digital taxes and the IRS, before they sign on to anything they want to see those eliminated. Pillar 2, which is the global minimum tax, is the bigger thorn in the side of the treasury and the IRS given we have GULTI and most of Congress is happy with our current guilty tax. So they're not jumping for joy in terms of signing on to a global minimum tax of 15%. So that's also something that is on the horizon. We have to see how the US is going to deal with that. And I think this should be the very last thing. Section 987 proposed regulations have finally been issued. The applicability dates have been delayed. So anyone who files Form 8858 has a foreign disregarded entity. This is going to impact you. So it's important to keep that in mind. And Astrid, I'm going to give you the last polling question.
Astrid Garcia: Polling Question #7
Jennifer Sklar: I guess, I can take this opportunity to mention to those of you who are a part of EisnerAmper that we will be having a discussion and a presentation on the CTA that Anthony had mentioned earlier on in his presentation. I believe it's next Monday, so that should give a little bit of guidance on how we're going to be approaching that.
Year-End Tax Strategies | Part I
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