Not Your Basic Bean Counter

Not Your Basic Bean Counter
2018 Gear Up Business Entities Welcome! Michael A. Gordon, CPA Not Your Basic Bean Counter

Preliminaries…. Schedule Protocol Breaks Lunch Evening Recess Phones
Questions & Comments

My Objectives for me: Cover new material (this could take 24 hours!!)
Cover those areas of partnership taxation that tend to give practitioners fits.

My Objectives for YOU: Convince you of one of these:
Partnership taxation is complex, confusing, convoluted, agonizing and ridiculous. Therefore, give it up and prepare NO MORE 1065’s….or, Partnership taxation is so complex that you need to have SERIOUS TAX RESEARCH PRODUCTS in your office.

Limited Liability Companies (LLCs)
CHAPTER 14 Limited Liability Companies (LLCs)

Chapter 14 - LLCs Page 269 Item I.B.1. Participation in management Item I.D.2. Compare to a general partnership where there is “joint and several” liability. Page 270

Chapter 14 - LLCs Box in middle of page. Operating Agreements. Will be discussed more on page 317. Page 270 Page 270 Item II.A.1. An important concept to grasp.

Chapter 14 - LLCs Item B.3. Same important concept as it relates to participation in the management of the LLC. Page 271 Page 271 Item C. Various issues here. Item D.2. Personal liability for own torts. My story of why I switched to SMLLC. Page 272

Chapter 14 - LLCs Example at bottom of page Can’t “lump” it all on line 1 of K-1. Must still report separately on line 2 of the K-1….for rental activity. Page 273 Item B.1. Multiple rental properties? Consider multiple LLCs. Watch out for “due on sale” clauses. Page 274

Chapter 14 - LLCs Item VI.A. Adding another member. I prefer to make that person merely a debtor, if possible. Much cleaner that way! Why should my client give the future success away if the other member will only be a passive investor anyway? Page 275

Chapter 14 - LLCs Item XII…LLC electing to be taxed as an S corporation File Form No Form 8832 is required. Use % ownership, since no stock is being issued. Be careful preparing financial statements! Do NOT use “capital stock” on balance sheet. Page 281

Chapter 14 - LLCs REMINDER box…..LLC to S corp Liabilities in excess of basis….watch out for this. Use a good checklist!! Big Trap…..basis issues. Remember, in an LLC all debt is allocated to members, but in an S corp only DIRECT debt gives basis. Page 282

Chapter 14 - LLCs Item XV…SE tax for LLC members Several items to discuss in this section. Biggest concept to grasp is IRC § In particular, it is IRC §1402(a)(13) that causes all the problems! Bottom line: this topic is dreadful, awful, confusing, unclear and in desperate need of clarification from Treasury. Hey, c’mon now….it’s only been 21 years! Pages

Chapter 14 - LLCs Item E….Series LLCs Good discussion on pages I will NOT be covering this subject. Important to grasp what is on page 292 item E about the lack of guidance. Also, good examples and NOTE on page 292. Page 292

LLC Partnership has formed a disregarded LLC
LLC Partnership has formed a disregarded LLC. It treats its members as “employees” of the disregarded entity that are not subject to self-employment taxes. Will this work? Yes Yes- if you don’t get caught. No

Introduction to Partnerships
CHAPTER 15 Introduction to Partnerships

Chapter 15 – Intro to Partnerships
New Partnership Audit Regime Rules There is a virtual MOUNTAIN of information on these new rules in the manual. Pages

New Partnership Audit Regime Rules Easier for the IRS May clear the way for more partnership audits (this is good?!) TMP now replaced by the new term “partnership representative” Not in book

WHY? Chapter 15 – Intro to Partnerships
New Partnership Audit Regime Rules Not in book IRS does NOT want us electing OUT WHY? Because, effectively, an electing out partnership can go back to the “bad old days” when the IRS had to audit individual partners.

New Partnership Audit Regime Rules Not in book IRS does NOT want us electing OUT NOTE: IRS has indicated that one area of focus will be partnerships that elect out of the new regime. Will this really happen? Only time will tell.

New Partnership Audit Regime Rules IF NOT ELECTING OUT Under this regime any taxes and penalties will be assessed at the partnership level, and it is the partnership that will have to pay. Whether electing out or not, a judicious use of checklists is recommended. Page 294

New Partnership Audit Regime Rules IF NOT ELECTING OUT Potential big problem #1 (Item C.4.) Any assessment will be on the partnership, and the partners who are partners at that time will bear the financial burden of that assessment. Page 294 Purchasers of partnership interests may find themselves liable for a prior year’s deficiency under the new audit rules!

New Partnership Audit Regime Rules IF NOT ELECTING OUT Potential big problem #2 This brand new “partnership representative” will have broad authority. How partnerships control this person and how he/she will be indemnified for his/her actions will need to be addressed. Not in book

New Partnership Audit Regime Rules IF NOT ELECTING OUT Remember, if you are NOT electing out, that means that any assessments will be made at the partnership level. HOWEVER, the rules allow the partnership to make a “push out” election. Pages

New Partnership Audit Regime Rules IF NOT ELECTING OUT The “push out” election will push out the assessment to the partners. This election will not be made until such time as the IRS has computed an assessment and it is made at the partnership level. At that time, the partnership can elect to “push out” the assessment to the individual partners. Pages

New Partnership Audit Regime Rules IF NOT ELECTING OUT SPECIAL NOTE: This “push out” election pushes the assessment out to the “review” year partners existing during the year being audited. Pages

New Partnership Audit Regime Rules EXAMPLE 1 ABC Partnership decides to NOT elect out. In 2018, the IRS audits the 2015 tax return and comes up with an assessment of tax and penalties in the amount of $45,000. In 2015, the partners were Mike, Abe and Gary. In 2017, Rick bought out Mike.

New Partnership Audit Regime Rules EXAMPLE 1…continued Without making a “push out” election, that $45,000 will be the responsibility of the existing partners in 2017 (Abe, Gary and Rick). If the partnership makes the “push out” election, that $45,000 will be pushed out to the partners that existed during the year being audited (Mike, Abe and Gary).

New Partnership Audit Regime Rules ELECTING OUT No big deal…….page 295 starts the discussion on how to “elect out”. Pages Obviously, if “electing out” there is no need to designate a “partnership representative”.

ELECTING OUT See Example on pg 295.
Chapter 15 – Intro to Partnerships New Partnership Audit Regime Rules ELECTING OUT Must have 100 or fewer partners. See Example on pg 295. Page 295

New Partnership Audit Regime Rules ELECTING OUT Obviously, there is no “push out” election since there will NOT be any assessment at the partnership level.

New Partnership Audit Regime Rules ELECTING OUT Items B, C, D and E The reporting requirements are ENORMOUS and there is no official form for this! Page 296

At My Firm Chapter 15 – Intro to Partnerships
New Partnership Audit Regime Rules At My Firm So far, we are contemplating which direction to go…..elect out or not? If we have our clients NOT elect out the door is still open for us to use the “push out” election if we want. However, we will wait for further guidance and/or articles to obtain better information. We reserve the right to change our minds several times as more info surfaces!!!

The Circle of Subchapter K Items XI.A, B and C are great reads! Page 309 Item D points out that it’s all about partner BASIS. That’s the key….and the stumbling block for many practitioners.

Flexibility is what causes the majority of problems we face as practitioners Item B. will launch us into a unique way to study partnership tax law. I hope you will enjoy this journey we are about to undertake. Page 311 The 7 Deadly Sins

We will now launch into the land of…… The 7 Deadly Sins

Now that we are back from visiting the 7 Deadly Sins, we need to finish up some important issues remaining in Chapter 15.

Qualified Joint Ventures
Chapter 15 – Intro to Partnerships Qualified Joint Ventures The QJV rules became effective in I have found that it is a very misunderstood topic. IT IS IMPORTANT THAT WE GET THIS! Page 316 Let’s look at several items on pages

Partnership Agreements
Chapter 15 – Intro to Partnerships Partnership Agreements This is an area where we can be of real help and value to our clients. I will go over a real situation that happened in my office several years ago that will illustrate the issues and how we can help. Page 317

Methods of Accounting Page 319 Main thought here: THINK THIS THROUGH!

Formation of Partnerships
CHAPTER 16 Formation of Partnerships

Chapter 16 Formation of Partnershipsv
Let’s start with a couple of things I have seen misunderstood and just missed!

CYA point here: Documentation….DON’T MISS IT!!
Chapter 16 Formation of Partnerships If Mike puts in $50,000 and Rhoda puts in $30,000 can they have a 50/50 partnership? YES, but the deal should “smell” right. It should make sense to us. CYA point here: Documentation….DON’T MISS IT!!

Chapter 16 Formation of Partnerships
Page 325 Item I.A. and B. are EASY IN

Item F. Documentation is always a key factor for future protection. Page 326

TAX BASIS (HISTORICAL COST)
Chapter 16 Formation of Partnerships Example 2, page 328 Opening journal entry TAX BASIS (HISTORICAL COST) G/L Account Debit Credit Trucks 105,000 Land 80,000 A/D – Trucks 8,716 Capital-W 96,284 Capital-C Pages

Example 2, page 328 Opening journal entry BOOK BASIS (FMV) G/L Account Debit Credit Trucks 105,000 Trucks – FMV > Basis-W 50,000 Land 80,000 Land – FMV > Basis-C 75,000 Capital-W 155,000 Capital-C Pages

No need to keep “book” capital accounts if not making special allocations. “Outside basis” is best maintained by the 1040 preparer. Page 329

Item VI.A. Contributed property, generally, goes in at adjusted basis (carryover basis rule). Item VII.A. Holding period rule (good stuff). Page 330

Item IX. Depreciation method rules (nothing strange here). Item X. Dealing with any suspended losses that are attached to contributed property. Page 332

Page 335 DEADLY SIN #1 Page 336 DEADLY SIN #2 Page 338 DEADLY SIN #3 & 4 Page 339 DEADLY SIN #5

IMPORTANT ISSUE Pre-development Gain (Contractors beware) Page 338, item XVI.B. and Example 11 (same page) details the potential trap here. This issue is brought up again on page 418, item E and Example 6.

IMPORTANT ISSUE Pre-development Gain (Contractors beware) Potential solution: Sell the property to an S Corporation. S Corp law has no equivalent code section. However, be careful to make it look like a bona-fide sale. IRS has been successful attacking this by calling it a capital contribution when the “sale” occurred at the same time stock was transferred. A review of court cases and research materials is needed!

Item C. These 3 methods are SO MUCH FUN! They take up an entire 11 pages!! Pages PCBIG

Allocating Income and Loss to Partners
CHAPTER 17 Allocating Income and Loss to Partners

Chapter 17 Allocating Income/Loss to Parners
Item III.B. This is Deadly Sin #7 which we have already discussed earlier. Page 356

Substantial Economic Effect rules
Chapter 17 Allocating Income/Loss to Parners Substantial Economic Effect rules Page 354 starts the discussion of the “substantial economic effect” rules. This goes on for 8 pages!

Chapter 17 Allocating Income/Loss to Parners Substantial Economic Effect rules KEY CONCEPT: If you are NOT doing “special allocations” you will NOT need to deal with the “substantial economic effect” rules.

Chapter 17 Allocating Income/Loss to Parners Substantial Economic Effect rules WARNING: If you ARE going to do “special allocations” you need to know that the IRS has been fairly successful at DISALLOWING them. The ramifications are alarming!

Next, if time allows, we will look at some items on page 369.
Chapter 17 Allocating Income/Loss to Parners Current Distributions Next, if time allows, we will look at some items on page 369. In my experience, these rules give practitioners problems. Pages

Basis and At-Risk Rules for Partnerships
CHAPTER 18 Basis and At-Risk Rules for Partnerships

On July 7, 2017 IRS reported that its new regulations for allocating recourse liabilities was:
A great step forward. Unduly burdensome or complex. Made taxes great again.

Chapter 18 DISTURBING REALITY There are a LOT of practitioners that do NOT compute/track basis. This is true for S Corporations as well as Partnerships.

Chapter 18 I HAVE THE CURE Pizza and beer….and a good friend who is a tax practitioner! Seriously……

Page 374-375, Example 2 Journal Entry Debit Credit Land 105,000
Chapter 18 Page , Example 2 Journal Entry Debit Credit Land 105,000 Mtg Payable 84,000 Capital – Brad 21,000

Page 374-375, Example 2 K-1, item k (allocation of liabilities)
Chapter 18 Page , Example 2 K-1, item k (allocation of liabilities) Nonrecourse 42,000 QNRF Recourse

Page 374-375, Example 2 K-1, item l (partner capital account)
Chapter 18 Page , Example 2 K-1, item l (partner capital account) Beginning Capital contributed 21,000 Withdrawals & Distrib. Ending capital account

Chapter 18 Page , Example 2

Page 374-375, Example 2 By the way……. Did you catch the PCBIG?
Chapter 18 Page , Example 2 By the way……. Did you catch the PCBIG? $155,000 FMV less $105,000 basis gives a PCBIG of $50,000

Page 375, Example 3 Journal Entry Debit Credit Land 20,000 Mtg Payable
Chapter 18 Page 375, Example 3 Journal Entry Debit Credit Land 20,000 Mtg Payable 84,000 Capital – Brad 64,000

Page 375, Example 3 K-1, item k (allocation of liabilities)
Chapter 18 Page 375, Example 3 K-1, item k (allocation of liabilities) Nonrecourse 42,000 QNRF Recourse

Page 375, Example 3 K-1, item l (partner capital account) Beginning
Chapter 18 Page 375, Example 3 K-1, item l (partner capital account) Beginning Capital contributed -64,000 Withdrawals & Distrib. Ending capital account

Chapter 18 Page 375, Example 3

Page 375, Example 3 By the way……. Did you catch the PCBIG?
Chapter 18 Page 375, Example 3 By the way……. Did you catch the PCBIG? $155,000 FMV less $20,000 basis gives a PCBIG of $135,000

Chapter 18 This chapter has a wonderful and detailed discussion about basis and at-risk. It ends with a very usable worksheet on page 398 for calculating partner basis. Of particular interest should be the pages discussing how the types of debt are allocated….recourse and non-recourse.

Chapter 18 For allocating recourse debt, look to pages , item B. Example 6 on page 381 is good and gives a different answer than you might expect. For allocating nonrecourse debt, look to pages , but pay special attention to item E on page 383 (the 3 tier allocation process) and Example 8 on page 384.

At-Risk Rules Page 386 begins a great discussion on at-risk rules.
Chapter 18 At-Risk Rules Page 386 begins a great discussion on at-risk rules. KEY TO UNDERSTANDING THIS: See the TIP box on page 387. “Qualified nonrecourse debt” (page 389) is a peculiar animal….we will discuss this in greater detail.

B.A.P. B. = Basis A. = At-Risk P. = Passive

Practitioners MUST be familiar with each of these 3 items separately.
B.A.P. Practitioners MUST be familiar with each of these 3 items separately.

B.A.P. In my experience, it is the interaction of these 3 items that causes problems for practitioners. Accordingly, we will now go over a few rules and then look at an example that will clarify this interaction.

B.A.P.

Basis At-risk Passive

BASIS/AT-RISK/PASSIVE
Remember, your homework is NOT complete until ALL 3 have been done!! Think of 3 flour sifters.

This B.A.P. thing…. Is going to be really annoying
Should be shortened to only 2 letters Will make taxes great again…and fun Makes me want to sell yogurt instead

PASSIVE ACTIVITY Road Map
The “Room of Doom” The six exceptions The “OK Corral” The 7 tests The 3 police officers

BASIS – Regular (1120S & 1065) Partner/member can have a disparity between INSIDE and OUTSIDE basis. Can an S Corp shareholder?

S Corp…..“Direct Debt” only
BASIS – Debt (1120S & 1065) S Corp…..“Direct Debt” only Ptp/LLC…All debt gets allocated (much more broad than S Corp)

Recourse Debt BASIS – Debt (1065)
Allocated to whoever bears the “economic risk of loss”. “No Value Liquidation” approach.

Non-Recourse Debt BASIS – Debt (1065)
Generally, allocated based on profit & loss ratios. If PCBIG is present, then must allocate via Reg (a) 3-tier process. See page 383, item X.E.

AT-RISK TIP: The major difference between outside basis (the “B” basis) and at-risk basis (the “A” basis) is the treatment of…. nonrecourse loans.

Qualified Nonrecourse Financing
AT-RISK Nonrecourse loans increase “B” basis but not “A” basis. There is one exception… Qualified Nonrecourse Financing See page 389

AT-RISK A history lesson: TAX SHELTERS 101

AT-RISK A QNRF history lesson: REAL ESTATE LOBBY 101

AT-RISK Basically, only 2 situations where a shareholder, partner, or member may have plenty of “B” basis but not enough “A” basis.

AT-RISK Situation #1: IRC 465(b)(3) Not “at-risk” for amounts borrowed from a person (or someone related to this person pursuant to IRC 267) having an interest in the activity other than as a creditor. See page 389

AT-RISK NOT AT RISK Situation #1: Example 1
Mike, a shareholder, puts in $50,000 for his initial stock. He borrowed it from Bob, the other shareholder. NOT AT RISK

(because Bob’s aunt is not “related” per IRC 267)
AT-RISK Situation #1: Example 2 Same as example 1, except Mike borrows the money from Bob’s aunt. OK…AT RISK (because Bob’s aunt is not “related” per IRC 267)

AT-RISK NOT AT RISK Situation #1: Example 3
Same as example 1, except Mike borrows the money from Bob’s mom. NOT AT RISK

AT-RISK AT RISK! Situation #1: Example 4
Same as example 1, except Mike borrows the money from his dad. AT RISK!

AT-RISK Situation #2: IRC 465(B)(4) Not “at-risk” for amounts protected against loss through nonrecourse borrowing, guarantees, stop loss agreements, or other similar things.

AT-RISK Exception to #2: IRC 465(B)(6) This code section is the EXCEPTION to IRC 465(b)(4), on previous slide, and says that QNRF will give “at-risk” basis.

AT-RISK ONE LAST WARNING: Be ever on the alert for “RECAPTURE” events.
See page 393, item XVI. Also, see example 13 on page 394.

PASSIVE ACTIVITY RULES
ROOM OF DOOM IRC 469(c)(2) dictates that all rental activities are tainted, automatically, as “passive”.

ROOM OF DOOM There are ONLY 2 places where we can find exceptions to this rule. IRC 469(c)(7)…..REP rules Temp. Reg T(e)(3)(ii)…. The famous six exceptions.

ROOM OF DOOM IRC 469(c)(7)…..REP rules

ROOM OF DOOM The six exceptions: Avg. period of use 7 days or less. (vacation condo, motel)

ROOM OF DOOM The six exceptions: Avg. period of use 30 days or less and significant personal services provided. (dude ranch)

ROOM OF DOOM The six exceptions: Extraordinary personal services provided. (hospital, boarding school dorm)

ROOM OF DOOM The six exceptions: Rental of the prop. incidental to a non-rental activity of taxpayer. (PPC has great example)

ROOM OF DOOM The six exceptions: Taxpayer makes the property available during defined hours for nonexclusive use. (golf course)

ROOM OF DOOM The six exceptions: Taxpayer, as an owner, provides the property for use in an activity which is not a rental activity. (Letter Ruling )

THE OK CORRAL This is the room you either START in (if you are NOT a rental activity) or MOVE to (if you started in the Room of Doom and meet one of the 6 exceptions).

THE OK CORRAL Here, you must pass ONE of the 7 tests to rise to the level of “material participation”. Temp. Reg T

THE OK CORRAL – 7 tests More than 500 hours Substantially all participation, including that of non-owners. More than 100 hours and more than anyone else.

THE OK CORRAL – 7 tests Significant participation activity (see example 4 in the temp. reg.) Prior year material participation (the 5 out of 10 look-back rule)

THE OK CORRAL – 7 tests Personal service activity test. Look-back to ANY 3 prior years for service businesses. Facts and circumstances! Good luck with this one!

THE 3 COPS These are commonly referred to as the “recharacterization” rules.

THE 3 COPS These rules will only come into play when there is INCOME (now, that’s a switch!) that a taxpayer would LIKE to be shown as passive.

THE 3 COPS These rules will result in passive income being re-characterized as non-passive.

THE 3 COPS Self-rental rule Reg (f)(6) Ground rents rule Reg T(f)(3) Property rented that is incidental to a development activity Reg (f)(5)

Regarding the “3 cops”… They are really outlaws
They do mean things to nice taxpayers They will make taxes great again…and lots of fun Makes me want to sell yogurt instead

Time to put this all together in a skit!!

Setup for skit Mike and Gary form an LLC to make widgets. Each puts in $10,000. Mike had to borrow $4,000 of his $10,000 from Gary. Mike’s K-1 shows an $11,000 loss on line 1. Mike does NOT materially participate.

Setup for skit…continued Mike, obviously, wants to DEDUCT the entire $11,000 loss and is devastated when you tell him that he cannot do that. Then he says he is going to abandon his interest in the business next year.

Setup for skit…continued You tell him not to worry, and go over IRC 469(g)(1) with him explaining that he will be able to deduct that loss once he “disposes” of his entire interest in the activity.

$11,000 - $1,000 = $10,000 on to “A” B

$10,000 - $4,000 = $6,000 on to “P” A

= $0 able to deduct! $6,000 - $6,000 P

$1,000 $4,000 $6,000 B A P Now, after closing the Company, what do we do with the $$ left hanging on each of the hula hoops?

$1,000 This $1,000 is a BASIS limitation, so it goes away! Don’t be confused…it is NOT a passive limitation. B

This $4,000 is an AT-RISK limitation, so what will happen here depends on Gary! $4,000 A Option 1: Gary forgives this. Result? At-risk basis does NOT increase, so it goes away! Option 2: Mike pays Gary. Result? At-risk basis increases, so Mike gets a deduction. Again, this is NOT a passive limitation….it’s an at-risk limitation.

$6,000 This $6,000 is a passive activity suspended loss and will automatically flow out to Mike once the activity is disposed of. P

Bad news for limited partners!
SOME ADDITIONAL INFORMATION: PASSIVE ACTIVITY RULES THE OK CORRAL – No ltd Partners IRC 469(h)(2)…ltd partners are PASSIVE. Bad news for limited partners!

THE OK CORRAL – No ltd Partners
SOME ADDITIONAL INFORMATION: PASSIVE ACTIVITY RULES THE OK CORRAL – No ltd Partners Temp. Reg T(e)(2) to the rescue! Limited partners CAN avail themselves of tests 1 (500 hrs), 5 and 6 (the look-back rules).

THE OK CORRAL – LLC members??
SOME ADDITIONAL INFORMATION: PASSIVE ACTIVITY RULES THE OK CORRAL – LLC members?? IRS position LLC members…same as Ltd partners. Tax court says “BAD IRS”! Garnett v. Comm., 132 TC No. 19 (6/30/09)

Transactions With Partners/Members
CHAPTER 19 Transactions With Partners/Members

Chapter 19 Transactions with Partners/Members
There are many issues dealt with in this chapter. We have discussed several of them already via the 7 Deadly Sins. We will go lightly through this chapter and talk about some of the more important issues and concepts to grasp.

Guaranteed Payments Page 399 Think of these as similar to wages in an S corp. If paid for a capital expenditure, payment must be capitalized. Usually subject to SE tax. Do not issue W-2s to partners/members. Page 400

Entity Expenses Paid by Partners Item IV.A……main item to note is that the partnership agreement should specifically address this issue and delineate exactly what IS reimbursable and what is NOT. Item IV.B.2…..If qualified, enter UPE on page 2 of Schedule E. Page 401

Disguised Sale Rules Remember, this is Deadly Sin #6, which we have already discussed. The book covers this topic from page It is a LOT of material with good examples. My recommendation? Use this as a reference source and consult if/when you think you might have a disguised sale. Page 405

Disguised Sale Rules Page 406 Item G. Remember the 2 year “taint”. And, keep in mind that it is a rebuttable presumption. Items P, Q, R and S. The disclosure rules are draconian at best! Probably good to heed the OBSERVATION box and the WARNING box on page 411. Page

IRC §754 Election Turn to page 416, where we begin the discussion of this topic. We will “discuss” it enough so that you get a general understanding. The examples in the book are long and would take quite a bit of time to go through in detail, so I recommend doing that on your own time. Page

Jane has a new partnership client
Jane has a new partnership client. In 2016, she notes a new partner purchased a substantial interest at a premium and the prior accountant failed to make the Sec 754 election on the return. Jane should inform the client that…. The prior accountant blew it and there is nothing she can do. The prior accountant did them a big favor! She has found a loophole to make the election provided less than 12 months has past and they are willing to pay the fee. Answer: Automatic 12 month extension page 417. Chapter 19

Partnership Termination On Sale, Retirement or Death
CHAPTER 20 Partnership Termination On Sale, Retirement or Death

Partnership Termination – OLD LAW
Chapter 20 Pgs Partnership Termination – OLD LAW “Technical termination” information: Sale of 50% or more interests Within a 12-month period (NOT a calendar year test!!!!) 2 tax returns will be needed Use same EIN PROBLEM: You may not know until after filing deadline (see ALERT at top of page 426) OPPORTUNITY: New elections (item f, pg 426) BUMMER: Depreciation restart rules (item g, pg 426) Exceptions: See pg 427, items i and j

Partnership Termination – NEW LAW
Chapter 20 Page 427 Partnership Termination – NEW LAW Items B and C. at bottom of page. “Technical termination” rules are repealed for 2018 and forward. No more filing 2 short year returns. No more depreciation restart. Of course, elections cannot be redone….so sorry.

Hot Assets – IRC 751 Chapter 20
Pgs Hot Assets – IRC 751 Here, it helps to contrast S Corporations with Partnerships. For this issue, the S Corporation has the advantage. S Corp: When a shareholder sells his/her ownership interest (stock) the gain is capital (LT or ST depending on holding period). The underlying assets of the corp. are irrelevant. Partnership: When a partner/member sells his/her interest the gain must be bifurcated based on the presence of “hot assets” (those assets that, if sold, would give rise to ordinary income). Thus, the gain will be split between ordinary income and capital gain.

Hot Assets – IRC 751 Chapter 20
There are a few more items to be aware of….. The ordering rule can have an odd result (see pg 428, item D)…ordinary gain followed by capital loss. See Example 2 on page Easy to miss: Unrealized receivables. Cash basis partnership will often have these (but you won’t see them on the balance sheet)….pg 428, item E. Other points in the text.

Complete Liquidation – IRC 736
Chapter 20 Pgs Complete Liquidation – IRC 736 Another complex arena for us to wade through…. The rules here do NOT apply to a sale of a partner’s interest (we have discussed that already). Here we are concerned with a situation where the entity itself is giving consideration (usually money) to a partner in exchange for his/her entire partnership interest.

Chapter 20 Complete Liquidation – IRC 736 The major issue to take note of here is the necessity to split the liquidation gain, if any, between IRC 736(a) payments and IRC 736(b) payments. Sorry to add one more level of complexity, but the “hot asset” rules can interplay here as well.

Chapter 20 Complete Liquidation – IRC 736 IRC 736(a) payments are deductible by the entity and ordinary income to the partner. IRC 736(b) payments are a residual item that is calculated only after determining the amount of 736(a) payments. They are treated as payments for partnership property and will be capital in nature (unless the IRC 751 “hot asset” rules interplay).

Chapter 20 Complete Liquidation – IRC 736 The book is loaded with great information and several good (long) examples. Great late night reading if you have a couple of hours to spare!! Excited!!

OK….we are DONE with partnerships!
This would be a GREAT time to go for a ride and shake the cobwebs out!

Remember what my Objectives for YOU were?

Convince you of one of these:
Partnership taxation is complex, confusing, convoluted, agonizing and ridiculous….therefore, give it up and prepare NO MORE 1065’s….or, Partnership taxation is so complex that you need to have SERIOUS TAX RESEARCH PRODUCTS at your beck and call.

So….how’d I do?

QUALIFIED BUSINESS INCOME DEDUCTION
Page 449 CHAPTER 21 IRC §199A QUALIFIED BUSINESS INCOME DEDUCTION

THIS IS WHERE ALL THE ACTION IS GOING TO BE!!
Chapter 21 IRC §199A…QBID THIS IS WHERE ALL THE ACTION IS GOING TO BE!!

IT’S NOT REALLY THAT BAD!!
Chapter 21 IRC §199A…QBID IT’S NOT REALLY THAT BAD!!

Chapter 21 IRC §199A…QBID Before getting into the chapter itself, I want to go over some preliminary items with you.

REFORM SIMPLIFICATION
Chapter 21 IRC §199A…QBID WARNING: You will see the following words used throughout the text of the new law….. REFORM SIMPLIFICATION These words are strictly for the ignorant! Do NOT believe them….the only thing you need to remember is:

Guaranteed Full Employment!!!
Chapter 21 IRC §199A…QBID This tax act is “G.F.E.” Guaranteed Full Employment!!!

Chapter 21 IRC §199A…QBID LOVE THE HUNT !!!

Chapter 21 IRC §199A…QBID WARNING: Do NOT stick your head in the sand and say “I don’t need to learn this new tax law until later.”

BEWARE THE DISPARITIES !!
Chapter 21 IRC §199A…QBID BEWARE THE DISPARITIES !! I have been teaching this all over the country. I have attended over 10 webinars taught by top tax attorneys and CPAs. I subscribe to several top level tax newsletters. Regarding sound tax advice, as it relates to the new tax law, the disparity I am seeing from these sources is ASTOUNDING.

Chapter 21 IRC §199A…QBID BEWARE THE DISPARITIES !! Disparities I am witnessing…. We are now done with S corporations. Everyone should become a C corporation. Everyone should become a sole proprietor. Every multi-member LLC or partnership should immediately suspend “guaranteed payments” and, instead, begin special allocations to the members/partners in the same amount.

Chapter 21 IRC §199A…QBID BEWARE THE DISPARITIES !! Disparities I am witnessing….continued ALL rental activities reported on page 1 of Schedule E count as qualifying businesses for the QBI deduction. At first blush this may seem nice and very attractive. But be careful what you wish for! If this turns out to be the case, the “netting” rule is going to hurt rental owners showing losses. NO rental activities reported on page 1 of Schedule E will count as qualifying businesses for the QBI deduction.

Chapter 21 IRC §199A…QBID BEWARE THE DISPARITIES !! Disparities I am witnessing….continued ONLY those rental activities reported on page 1 Schedule E as a number 7 (self- rental) will count as qualifying businesses for the QBI deduction. ONLY those rental activities electing to be treated as REP will count as qualifying businesses for the QBI deduction.

Disparities in understanding, when dealing with new laws, are…
Beautiful Just differences of opinion Crazy people saying crazy things All of the above

Some interesting facts…RC 199 vs IRC 199A
Chapter 21 IRC §199A…QBID IRC 199 versus IRC 199A Some interesting facts…RC 199 vs IRC 199A The new QBI rules are enacted under IRC 199A (a new code section). Do you remember the “old” IRC 199? It was the DPAD rules….one of the best deductions ever invented! It got repealed with TCJA.

Chapter 21 IRC §199A…QBID IRC 199 versus IRC 199A Some interesting facts…RC 199 vs IRC 199A Under the DPAD rules you got a certain % (9%) of qualifying income as an additional deduction on page 1 of the 1040. Under TCJA you also get a certain % (20%) of qualifying income as an additional deduction, but on page 2 of the 1040.

Chapter 21 IRC §199A…QBID IRC 199 versus IRC 199A Some interesting facts…RC 199 vs IRC 199A Under the DPAD rules architects and engineers succeeded in getting a special “carve out” and, thus, were allowed to participate. Strong lobby!! Under TCJA, architects and engineers got a special “carve out” and are NOT considered an SSTB…so, they get away with murder. Strong lobby!!

Some interesting facts…IRC 199 vs IRC 199A
Chapter 21 IRC §199A…QBID IRC 199 versus IRC 199A Some interesting facts…IRC 199 vs IRC 199A Under the DPAD rules the calculated deduction was subject to a 50% wage limitation test which applied to first dollar. Under TCJA, there is also a 50% wage limitation test (a bit different, but not by much) after crossing a certain threshold.

OKAY….TAKE A DEEP BREATH….IT’S TIME TO DIVE INTO THE MANUAL.
Chapter 21 IRC §199A…QBID OKAY….TAKE A DEEP BREATH….IT’S TIME TO DIVE INTO THE MANUAL.

ALL DONE WITH CHAPTER 21 IN THE BOOK?
Chapter 21 IRC §199A…QBID ALL DONE WITH CHAPTER 21 IN THE BOOK? LET’S GO OVER A FEW MORE ITEMS/ISSUES.

Now answered in the new proposed regs.
Chapter 21 IRC §199A…QBID Fiscal Year PTE Sooooooo…….what do we do if our PTE has a fiscal year? How does this impact the QBI deduction for the 1040 taxpayer? Now answered in the new proposed regs.

Chapter 21 IRC §199A…QBID Page 450, item III.D. What about a business that has a large amount of cash on hand (because it is planning on expending it for some big capital projects in the next months) that is placed in an interest-bearing account to earn interest. Should this be considered as interest income that is “allocable to a trade or business”? CLARIFICATION NEEDED

Regarding UBIA (see item H and example on Pg 456
Chapter 21 IRC §199A…QBID Regarding UBIA (see item H and example on Pg 456 Here’s another example illustrating something that could easily be missed. On April 1, 2010, a partnership placed in service a $50,000 piece of machinery that had a 5 year MACRS life. The partners can take into account their allocable share of the $50k unadjusted basis in 2018 even though it is fully depreciated. They can do it again in 2019, but NOT in 2020 (the 10 year rule).

Regarding UBIA (see item H and example on Pg 456)
Chapter 21 IRC §199A…QBID Regarding UBIA (see item H and example on Pg 456) Hopefully, you understand the implication of this example….. From a compliance perspective this is going to be something of a nightmare for practitioners. You (and me) will have to look through pages of assets (detail depreciation schedules) to determine which ones are qualifying property.

More issues regarding UBIA
Chapter 21 IRC §199A…QBID More issues regarding UBIA Common question: What if we place in service a 5- year property and IRC 179 it this year? Can we still count the unadjusted basis for 10 years? The answer is YES…as long as it is still in service, of course. Clarification needed: can a partnership electing the step-up basis rules of IRC 754 include that step-up amount as part of UBIA? Now answered in new proposed regs.

More issues regarding UBIA
Chapter 21 IRC §199A…QBID More issues regarding UBIA Next, what about inherited property that received a step-up in basis? Still unclear. Finally, regulations will need to be issued giving us rules for determining the unadjusted basis for any property acquired via a 1031 transaction or via an involuntary conversion. Now answered in new proposed regs.

Don’t forget….The QBI deduction does NOT decrease SE income.
Chapter 21 IRC §199A…QBID SE Tax Reminder See page 449, item I.B. Don’t forget….The QBI deduction does NOT decrease SE income. So, if Mike has a Schedule C with $200,000 of QBI and gets the full $40,000 deduction on page 2 of the 1040, you STILL send the entire $200,000 back to Schedule SE…not $160,000.

Independent Contractor vs. Employee?
Chapter 21 IRC §199A…QBID Not in Book Independent Contractor vs. Employee? Interesting true story about the large medical clinic in my town. Some of my physician clients will want to “switch” and some won’t. We’ll discuss. New proposed regs could really HURT some of my clients due to the new “former employee” rules.

QBI….Sole Prop. Versus S Corp planning
Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 1…Sole Proprietor Who Mike & Rhoda Filing Status MFJ QBI $100,000 from Mike’s retail bus. Entity Sole Proprietor 1040 Taxable Income $150,000 Wages Paid $0 (no employees) UBQBP $0 SSTB? No

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 1…Sole Proprietor Calculation of QBI Deduction $100,000 QBI x 20% = $20,000 tentative QBI deduction Taxable income limitation: $150,000 x 20% = $30,000 Lesser of 1 or 2 = $20,000

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 2…S Corp. Who Mike & Rhoda Filing Status MFJ QBI $25,000 from Mike’s business Entity S Corp. 1040 Taxable Income $150,000 Wages Paid $75,000 to Mike UBQBP $0 SSTB? No

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 2…S corp. Calculation of QBI Deduction $25,000 QBI x 20% = $5,000 tentative deduction Taxable income limitation: $150,000 x 20% = $30,000 Lesser of 1 or 2 = $5,000

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Can you see that Example 1 is exactly the same as Example 2? The only difference is that Mike took a salary of $75,000 from the S Corp, thus reducing the QBI from $100,000 (as in Example 1) to $75,000. Compare the answers QBI as a sole proprietor is $20,000 QBI as an S corporation is only $5,000 BIG DIFFERENCE!!

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Given what we are seeing, it is tempting to tell Mike that he should: Ditch the S corporation…..or, Keep the S corp. but reduce his wages. At first blush, that may seen logical and correct.

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning My personal opinion is that we need to “RUN SOME NUMBERS” to see if that really makes sense. We need to look at ALL the taxes…in particular, we need to factor in the SE tax impact of the 2 scenarios. Ready? Here we go!!

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 1…Sole Proprietor with SE tax FICA on 15.3% 15,300 A Taxable income before QBI deduction 150,000 QBI deduction -20,000 Final taxable income 130,000 Tax on final taxable income (using new rates) 20,479 B Total tax paid 35,779 A+B

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 1…Sole Proprietor with SE tax FICA on 15.3% 15,300 Taxable income before QBI deduction 150,000 QBI deduction -20,000 Final taxable income 130,000 Tax on final t.i. (using new rates) 20,479 Total tax paid (15,300+20,479) 35,779

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Example 2…S Corp. with SE tax FICA on 15.3% 11,475 Taxable income before QBI deduction 150,000 QBI deduction -5,000 Final taxable income 145,000 Tax on final t.i. (using new rates) 23,779 Total tax paid (11,475+23,779) 35,254

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Now, it is the S Corporation that is the clear winner….granted it is only a $525 difference! OF COURSE, I DID NOT TAKE INTO ACCOUNT ANY FUTA OR OTHER SIMILAR EMPLOYER TAXES. I am NOT trying to make a case here. I only want to point out that there are many factors at play here that we will need to take into account. Aren’t you excited?!

Chapter 21 IRC §199A…QBID Not in Book QBI….Sole Prop. Versus S Corp planning Finally, remember that one other option was to reduce Mike’s wages, which will serve to increase QBI and, thus, increase the deduction. As his wages go down, the QBID gets bigger and wins out (over the sole prop.) even more. Final caveat: Never forget/overlook the “reasonable compensation” issue with S corporations.

When dealing with entity choice for the new QBI rules it is obvious that:
It shouldn’t take more than 5 minutes to make an intelligent decision There could be differences of opinion This may have to be approached on a case-by-case basis….and it could take some serious time on our part to do the analysis (oh, bummer).

New Proposed Regulations under 1.199A
Chapter 21 IRC §199A…QBID Not in Book New Proposed Regulations under 1.199A Book sent to press in July 2018. New proposed regulations issued early Aug. 2018 Gear Up intends to have something on their website for attendees on this.

Chapter 21 IRC §199A…QBID Not in Book New Proposed Regulations under 1.199A I hate to admit it, but I spent OVER 30 hours reading and reviewing the new regs. I had, originally, planned on spending no more than minutes on this.

Chapter 21 IRC §199A…QBID Not in Book New Proposed Regulations under 1.199A These proposed regs are FULL of stuff that we MUST be aware of! They have clarified many things. BUT, they have also left many things unclear. They have also brought up all kinds of NEW stuff!!

Chapter 21 IRC §199A…QBID Not in Book New Proposed Regulations under 1.199A There are a LOT of traps and pitfalls that we, as practitioners, can easily fall into if we neglect to learn what is in the new proposed regulations. SORRY!!! So, I have prepared a 55 slide deck presentation in PowerPoint that we will now go over.

Choosing The Proper Entity
Page 471 CHAPTER 22 Choosing The Proper Entity

Chapter 22 Choosing the Proper Entity
Page 471 Don’t practice law! And document any discussions in writing. Page 472 GEAR UP OBSERVATION box. This is excellent advice. Remainder of chapter has good discussion and examples.

Capitalization and Depreciation
Page 491 CHAPTER 23 Capitalization and Depreciation

Chapter 23 Capitalization and Depreciation
Page 492 GREAT summary page listing the major changes under TCJA. These pages cover the “repair regs” as issued by the IRS, via T.D. 9636, on 9/13/2013. Those regulations rocked our world! Pgs

TCJA impacts “bonus” depreciation. Now 100% Now can count used property Don’t forget to consider the impact on the QBID Understand the NEW UNCLEAR LAW box on page 526 Pgs

TCJA impacts “179” depreciation. Now includes personal property used predominately in furnishing lodging or in connection with the furnishing of lodging. Includes beds, other furniture, refrigerators, ranges etc. Pgs

TCJA impacts the 179 expensing of qualified real property. Previously, 3 definitions…now only one. Added roofs, HVAC, fire-protection and alarm systems, and security systems. See PLANNING box on pg 530 See the NOTE box on pg 531….we need more clarification on this issue. Pgs

Remainder of chapter covers several other issues impacted by TCJA and several dealing with non-TCJA items. Pgs

One thing for sure about capitalization and depreciation……
It would be a disaster if they kept changing the rules every year. It’s getting so much easier to comply. One more change and I’m going into the frozen yogurt business.

CHAPTER 24 Accounting Methods
Page 547 CHAPTER 24 Accounting Methods

Chapter 24 Accounting Methods
TCJA expanded 3 areas for taxpayers with gross receipts of $25 million or less.

What got expanded? Use of cash method. Small contractor exception for use of “% completion” method. Taxpayer exception to the IRC Sec. 263A UNICAP rules.

MY BIG WARNING Never do something JUST BECAUSE YOU CAN!!

MY BIG WARNING…continued Just because a taxpayer, who was NOT able to use the cash method previously, is able to now doesn’t mean that he/she should!

MY BIG WARNING…continued I have many clients who CAN use the cash method but don’t. Why? Because it is not the best method for them to make intelligent decisions for their companies. They need to see accrual financial statements. So, they should clearly be on the accrual method. Inventories, COGS, payables, receivables and other accruals are often necessary for a client to see to make good decisions. And it may be the best method to use if they are providing accounting info to banks, sureties, etc.

MY BIG WARNING…continued The same logic holds true for the issue of % completion and the UNICAP rules. My main point here is that we need to THINK hard about this and have some very deep and detailed discussions with our clients about what will help them the most. THAT is how the decision should be reached….never simply because the law allows something.

When it comes to accounting methods and other TCJA changes…
I want all of it to be automatic. If it can’t be automatic, I want someone else to do it for me. Thinking takes up far too much brain power. I’d rather not….

Basis and At-Risk Rules. Case Study.
Page 563 CHAPTER 25 Basis and At-Risk Rules. Case Study. This chapter contains an exhaustive 5 year case study. I heartily recommend taking the time (1-3 hours) to go through it.

Will not be covering this chapter….use as a resource
Page 575 CHAPTER 26 Related Parties – Compensation and Loans to Officers/Shareholders/Members Will not be covering this chapter….use as a resource

Page 601 CHAPTER 27 IRS and Payroll Issues Will not be covering this chapter….use as a resource

Page 625 CHAPTER 28 NEXUS Will not be covering this chapter….use as a resource

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