2025 Year-End Tax Planning Guide for Private Companies

From Survive to Thrive

Private companies find themselves navigating a tax landscape marked by rapid change and increasing complexity. The wave of legislative, economic, and technological developments over the past year has created novel challenges. It’s not enough to merely survive.

All businesses are facing external challenges, and the most agile companies are often the most successful. Private companies should focus on converting new developments into opportunities to thrive. And there is no shortage of new developments this year.

Tariff policy often seemed to change by the hour, and the situation continues to evolve. Fortunately, mitigation tools and planning responses can help companies thrive despite the challenges.

On the tax side, sweeping new legislation will have major implications for private businesses. For example, companies will enjoy new opportunities to accelerate deductions for research and equipment. Changes to the limit on the interest deduction could be even more important for highly leveraged companies, particularly those owned by private equity. The most significant provisions include options for implementation, and planning decisions on one provision can affect others. Modeling will help identify beneficial strategies. A bevy of less heralded changes can also affect tax planning.

Private companies organized as pass-through entities must address a second layer of tax considerations: taxation at the owner level. While this year’s tax legislation doesn’t change the math on entity choice in profound ways, it does create new opportunities to structure business and investment activities tax efficiently. State taxes will be another important factor in these planning decisions, and numerous state tax law changes over the past year present their own issues.

With the multitude of challenges present today, the tax function must operate efficiently to identify tax risk and planning opportunities. Automation and other tools can help companies deploy the necessary resources to integrate tax considerations into critical business decisions.

This guide is a resource for understanding the most pressing tax issues facing private companies as 2025 closes and a new year begins. It covers important tax developments over the past year and offers practical insights and actionable planning strategies. But remember, no guide can cover every possible consideration, and there may be additional developments after the publication date. There is no substitute for a discussion with a tax professional

Unless otherwise noted, the information contained in this guide is based on enacted tax laws and policies as of the publication date and is subject to change based on future legislative or tax policy changes.

 

 

INCOME TAXES

Regardless of whether your private company is taxed as a C corporation at the 21% rate or organized as a pass-through, the rules for calculating and recognizing income have changed significantly. The One Big Beautiful Bill Act (OBBBA) makes major changes to research expensing, bonus depreciation, and the limit on the interest deduction. Accounting methods planning can help leverage the implementation options. Strategically adopting or changing tax accounting methods to defer (or, in certain cases, accelerate) taxable income recognition can also enhance overall cash tax savings for 2025. The legislative and economic changes over the past year should prompt companies to reevaluate income tax planning at year-end.

 

100% Bonus Depreciation 

The OBBBA permanently restores 100% bonus depreciation for most investments in business property acquired and placed in service after January 19, 2025. Property is considered acquired no later than the date the taxpayer enters into a binding written contract for its acquisition. Eligible property includes tangible property with a class life of 20 years or less under the modified accelerated cost recovery system (MACRS), computer software, qualified improvement property, and other property listed in Section 168(k).

Property acquired on or before January 19, 2025, and placed in service after that date remains subject to the bonus depreciation phasedown rules under the Tax Cuts and Jobs Act (TCJA) — 40% for property placed in service in calendar year 2025 (60% for longer production period property and certain aircraft). Used property remains eligible for 100% bonus depreciation if it meets certain additional requirements.

The OBBBA continues to allow taxpayers to elect out of bonus depreciation by property class. However, the OBBBA also gives taxpayers the ability to elect 40% bonus depreciation instead of 100% bonus depreciation for the first tax year ending after January 19, 2025 (60% for longer production period property and certain aircraft).

The OBBBA also increases the annual Section 179 expensing limit from $1 million to $2.5 million, with a phaseout threshold of $4 million (increased from $2.5 million). The changes to Section 179 are effective for property placed in service after December 31, 2024, with both the deduction and the phaseout threshold indexed for inflation in future years. For taxpayers eligible to use Section 179 expensing, the yearly expensing election can be used in addition to bonus depreciation to claim deductions for property not eligible for bonus depreciation or to deduct only a portion of the property’s cost.

Determining the property’s acquisition date. The acquisition date will be critical for determining whether property is eligible for 100% bonus depreciation. It is not clear yet whether the IRS will provide new guidance for determining the acquisition date or rely on existing regulations issued in 2019 and 2020 after the bonus depreciation changes made by the TCJA. Under the existing guidance, if the acquisition is subject to a written binding contract, the taxpayer must look to the terms of the contract to determine the property’s acquisition date for bonus depreciation eligibility.

The property is deemed acquired on the later of the following dates:  

• The date the contract is entered into;   
• The date the contract becomes enforceable under state law;   
• If the contract has one or more cancellation periods, the date on which all cancellation periods end; or   
• If the contract has one or more contingency clauses, the date on which all conditions subject to such clauses are satisfied.   

Self-constructed property is deemed acquired when manufacturing, construction, or production of a significant nature begins, using a facts-and-circumstances test. Under a safe harbor, a taxpayer may choose to determine that physical work of a significant nature begins at the time the taxpayer pays or incurs more than 10% of the total costs of the property. When property is acquired, or manufactured, constructed, or produced for the taxpayer by another person, under a contract that does not meet the definition of a written binding contract, the property’s acquisition date is the date on which the taxpayer has paid or incurred more than 10% of the total cost of the property, excluding the cost of land and preliminary activities.

Under the framework provided in the existing regulations, bonus depreciation can apply to qualifying components of a larger property acquired and placed in service after January 19, 2025, even if the larger property doesn’t meet the requirements.

Planning Considerations 

Accounting methods can be a powerful planning tool with depreciation. The recovery period over which depreciation is claimed impacts the calculation of taxable income over a number of years. In many cases, taxpayers have the flexibility to determine how much depreciation to claim in the year assets are placed in service. By claiming the default 100% bonus depreciation, electing out for certain categories of assets (or all assets), or making other available elections to slow down depreciation, taxpayers can manage taxable income in ways that benefit many other calculations.

New 100% Expensing of Qualified Production Property   

​ The OBBBA adds Section 168(n) to the Internal Revenue Code, which introduces special 100% expensing for a new separate class of building property known as “qualified production property” (QPP). Under Section 168(n), taxpayers can elect to fully deduct amounts invested in QPP in the year the property is placed in service. Unlike bonus depreciation, which applies unless the taxpayer elects out, taxpayers must elect QPP expensing for each tax year it is claimed.

QPP includes any portion of nonresidential real property that meets the following requirements: 

• Construction of the property begins after January 19, 2025, and before January 1, 2029; 
• The property is placed in service within the U.S. or a possession of the U.S. before January 1, 2031; 
• The property is used by the taxpayer as an integral part of a qualified production activity;  
• The property’s original use commences with the taxpayer; and 
• The property is not required to use the alternative depreciation system.  

An exception to the original use requirement applies to certain acquired QPP that is acquired after January 19, 2025, and before January 1, 2029, and was not used in a qualified production activity between January 1, 2021, and May 12, 2025.

QPP does not include any portion of building property used for offices, administrative services, lodging, parking, sales activities, research activities, software engineering activities, or other functions unrelated to a qualified production activity. In addition, QPP does not include property leased by the taxpayer to another party. Special recapture rules apply to dispositions of property that ceases to be used as part of a qualified production activity.

What is a Qualified Production Activity?

A qualified production activity includes the manufacturing, production (limited to agricultural and chemical production), and refining of a qualified product. A qualified product includes tangible property, but excludes food and beverages prepared in the same building as a retail establishment in which they are sold.

A qualified production activity must result in a substantial transformation of the property. The OBBBA directs the IRS to issue guidance regarding what constitutes substantial transformation and indicates the guidance should be consistent with substantial transformation guidance under Section 954(d).

Planning Considerations 

The ability for certain taxpayers to deduct new investments in production facilities also offers a substantial benefit for producers. It will be critical to determine whether the activities meet the definition of production. Companies with qualifying facilities will also need to carve out costs for any nonproduction functions

Deductibility of R&E Expenditures 

 The OBBBA creates new Section 174A, which reinstates the full deductibility of domestic research costs in the year paid or incurred, effective for tax years beginning after December 31, 2024. Software development remains statutorily included in the definition of research costs for purposes of Section 174A. Taxpayers have the option of electing to capitalize and amortize Section 174A amounts beginning with the month in which the taxpayer first realizes benefits from the expenses, with a 60-month minimum amortization period. The legislation also modifies Section 280C(c), requiring taxpayers to reduce their Section 174A deduction by the amount of their research credit or alternatively elect to reduce the amount of their credit.

Prior to the OBBBA, the TCJA required taxpayers to capitalize specified research and experimental (R&E) costs incurred in tax years after December 31, 2021, and amortize the costs of domestic research over five years and 15 years for research conducted outside the U.S. The OBBBA retains the Section 174 15-year amortization requirement for foreign research costs. Given the revisions to the treatment of domestic research, most taxpayers with domestic R&E costs will need to file at least one method change with their first tax year beginning after December 31, 2024, to comply with Section 174A.

The OBBBA includes a transition rule that allows taxpayers to elect to claim any unamortized domestic R&E costs incurred in calendar years beginning after December 31, 2021, and before January 1, 2025, in either their first tax year beginning after 2024 or ratably over their first two tax years beginning after 2024. Note that this election to accelerate the unamortized costs is considered a separate change in method of accounting from the general change to comply with Section 174A described above.

Eligible small business taxpayers can elect to file amended returns to claim full deductions for domestic R&E costs for tax years before 2025 (the small business taxpayer retroactivity election), or to file an accounting method change with tax returns beginning before January 1, 2025, to deduct the costs. This election is not available to small business taxpayers that are tax shelters, such as pass-through entities that allocate more than 35% of their losses to limited partners or limited entrepreneurs.

Rev. Proc. 2025-28 provides procedural guidance for complying with or utilizing various elections available under new Section 174A, including the small business taxpayer retroactivity election and any accounting method change that may be needed for foreign R&E costs.  

Planning Considerations 

For domestic R&E costs, taxpayers should carefully consider whether they wish to change to the new deduction method or the new capitalization and amortization method beginning with the 2025 year. Expenses claimed under the new deduction method are not amortization for purposes of the Section 163(j) interest limitation addback, and expensing Section 174A costs will limit some taxpayers’ ability to deduct current year business interest. Taxpayers will likely not be able to change their method within a five-year period without having to file a non-automatic accounting method change.

The election to accelerate unamortized domestic R&E costs incurred from 2022 through 2024 should also be carefully analyzed to determine whether acceleration is beneficial, considering the impact on other Code sections with calculations based on taxable income. Although there is currently no explicit guidance on this issue, the acceleration of this amortization should still be considered amortization for purposes of the Section 163(j) addback.

Limit on the Interest Deduction

The OBBBA permanently restores the exclusion of amortization, depreciation, and depletion from the calculation of adjusted taxable income (ATI) for purposes of Section 163(j), which generally limits interest deductions to 30% of ATI. The change is effective for tax years beginning after 2024.

The change will be particularly important for portfolio companies owned by private equity funds and other highly leveraged entities. The more favorable treatment may allow many capital-intensive businesses to escape the limit on their interest deductions altogether. Some portfolio companies, however, will still need to plan around the limit.

The OBBBA generally shuts down interest capitalization planning for tax years beginning after 2025. Interest capitalized to other assets, other than interest capitalized to straddles under Section 263(g) or to specified production property under Section 263A(f), will remain part of the Section 163(j) calculation. Further, ATI will exclude income from Subpart F and global intangible low-taxed income (now net CFC tested income) inclusions and Section 78 gross-up for tax years beginning after 2025.

Planning Considerations

Private companies with interest deductions that will remain limited under the new rules in 2025 should consider capitalizing interest in 2025 while the planning is still available. The OBBBA will not claw back any interest capitalized to other assets in tax years beginning before 2026, even if the capitalized interest has not been fully recovered with the asset. Taxpayers managing the limit should also consider the impact of other decisions on the tax return. As discussed above, capitalizing research costs, for example, could allow more interest to be deducted. Modeling will be key in identifying beneficial strategies.

Year-end Opportunities to Defer (or Accelerate) Taxable Income 

Companies still have time to take advantage of opportunities to change their tax accounting methods for 2025 and future years. Companies that want to reduce their 2025 taxable income (or create or increase a net operating loss) should consider “traditional” accounting method planning — method changes that accelerate deductions into 2025 or defer income recognition to a later year. However, some businesses may instead want to use “reverse” accounting method planning to accelerate taxable income into 2025 or defer deductions to later years. Reverse method planning may be prudent, for example, for taxpayers that wish to accelerate the use of net operating losses or to mitigate unfavorable limitations, such as the limitation on the deduction for business interest expense.

In addition to the planning considerations discussed above related to depreciation and R&E costs, common items for which accrual basis taxpayers may have flexibility to change their method of accounting include the following:

Advance payments. A taxpayer may recognize income from certain advance payments (e.g., upfront payments for goods, services, gift cards, use of intellectual property, sale or license of software) in the year of receipt or defer recognizing a portion until the following year.

Recurring liabilities. Certain liabilities such as taxes, warranty costs, rebates, allowances, and product returns are required to be deducted in the year paid but may be accelerated using the “recurring item exception.”

Accrued bonuses. Under carefully drafted bonus plans, taxpayers may deduct employee bonuses in the year they are earned (the service year) or, if the bonuses are not paid within two and a half months after year-end, in the year the bonuses are paid. While many taxpayers wish to have a provision that a bonus is not paid to an employee who departs before the date of the bonus payment, taxpayers may be able to implement strategies that allow for an accelerated deduction for tax purposes while retaining the employment requirement on the bonus payment date.

Prepaid expenses. Under the “12-month rule,” a taxpayer may deduct prepaid expenses for certain incurred liabilities — such as insurance, government licensing fees, software maintenance contracts, and warranty-type service contracts — in the year the expense is paid, rather than having to capitalize and amortize the amounts over a future period.

Uniform capitalization costs. A taxpayer may change its method for calculating the amount of uniform capitalization costs capitalized to ending inventory, including changing to simplified methods available under Section 263A.

Casualty or abandonment losses. A taxpayer may be able to claim a deduction for certain types of losses it sustains during a tax year — including losses due to casualties or abandonment of property, among others — that are not compensated by insurance or otherwise.

Worthless inventory. A taxpayer may be able to accelerate losses related to inventory that is obsolete, unsalable, damaged, defective, or no longer needed by disposing of or scrapping the inventory by the end of the taxable year. Taxpayers also may be able to write down the cost of qualifying “subnormal goods” held at the end of the year.

Electing shorter depreciable lives. A taxpayer may be able to deduct “catchup” depreciation (including bonus depreciation, if applicable) for assets placed in service in prior years and mistakenly classified as longer recovery period property, by reviewing their fixed asset schedules or by performing a cost segregation study to identify assets eligible for an accounting method change to shorter recovery periods.

Accounting Method Changes Require IRS Approval. The rules for changing tax accounting methods are often complex and usually require taxpayers to submit a request to change their method of accounting to the IRS. The procedure for changing a particular method depends on the mechanism for receiving IRS consent, i.e., whether the change is “automatic” or “non-automatic.” Rev. Proc. 2025-23, as modified by Rev. Proc. 2025-28, contains the current list of automatic method changes.

The automatic change procedure generally requires a taxpayer to attach a Form 3115 to the timely filed (including extensions) federal tax return for the year of change and to file a separate copy of the Form 3115 with the IRS no later than the filing date of that return. However, non-automatic method changes, for which more information must be provided and which are more complex, require an application to be filed with the IRS prior to the end of the tax year for which the change is requested — i.e., prior to December 31, 2025, for 2025 calendar-year accounting method changes. Additional issues or procedures may need to be considered if a taxpayer is under IRS exam. Requests for accounting method changes that otherwise qualify as automatic must be submitted using the non-automatic change procedures if the taxpayer has made a change with respect to the same item within the last five years.

Planning Considerations

Taxpayers have numerous options when choosing methods of accounting and elections for various items of taxable income or deductible expense. These decisions may shift the amount of taxable income reported in a taxable year and can have consequences for purposes of other Code provisions. These other provisions may include the Section 55 corporate alternative minimum tax, disallowed business interest expense under Section 163(j), net CFC tested income (formerly global intangible low-taxed income) and/or foreign-derived deduction-eligible income (formerly foreign-derived intangible income) under Section 250, and the amount of base erosion and anti-abuse tax (BEAT). Taxpayers should also consider the impact of their accounting methods and planning on state returns, especially when states do not follow federal Code provisions.

Taxpayers should holistically model the implications of making accounting method changes and elections in all planning scenarios before deciding which method changes or elections to pursue.

IRS Issues Guidance on Tracking Basis for Digital Assets 

Private companies with digital asset investments may no longer use the universal method for determining the tax basis of digital assets held in virtual wallets and accounts as of January 1, 2025. A taxpayer that applied the universal method treated all its digital assets as if held in one wallet or account, even if they were actually owned in multiple wallets or accounts.

Pursuant to final regulations issued in 2024, which implement the reporting requirements enacted by the Infrastructure Investment and Jobs Act, taxpayers must now use the “wallet-by-wallet” approach to digital asset identification for each transaction. Under this approach, on a wallet-by-wallet basis, taxpayers must adequately identify, among other information, the particular units sold, the price of such units, and the basis of such units for each transaction no later than the date and time of the transaction (specific identification). Taxpayers that are unable to adequately identify the specific digital asset prior to or at the time of the sale are required to use the first-in, first-out (FIFO) rule for determining basis.

Taxpayers with digital assets in the custody of a broker may use a standing order or instruction to the broker to adequately identify the digital assets sold, disposed of, or transferred.

Under Notice 2025-7, if the broker does not have the technology needed to accept specific instructions or standing orders communicated by taxpayers, the taxpayer may, until December 31, 2025:

• Make an adequate identification no later than the date and time of the sale, disposition, or transfer and keep a record of such identification for each individual sale throughout the year; or 
• Record a standing instruction on its books and records that applies to a custodial account for every sale during the year. 

These changes align with new IRS requirements for brokers, who now have substantial reporting obligations.  

Planning Considerations 

Specific identification requires more detailed recordkeeping but can result in more tax savings than applying the FIFO rule for each transaction. To simplify the administrative burden, private companies should consider using fewer wallets and use certain cryptocurrency tax software to maintain records. If a taxpayer has digital assets in the custody of a broker or exchange, the taxpayer should consult with their tax advisors to prepare an appropriate standing instruction as soon as possible before the December 31, 2025, deadline.

 

 

PARTNERSHIPS

 

Over the last several years, the IRS has been ramping up its scrutiny of partnership tax positions. Part of this effort included comprehensive basis shifting guidance issued in the summer of 2024. In 2025, the trend toward increased partnership enforcement eased under the new administration, which has withdrawn the bulk of the basis shifting guidance. And while the enactment of OBBBA was the major tax event of the year, the legislation’s direct impact on partnership tax was limited.

Nonetheless, there were some important developments for private companies organized as partnerships in 2025.

Key areas partnerships should be looking into as they plan for year-end and the coming year include:

• Eased partnership Form 8308 reporting requirements
• Limited partner claims of exemption from self-employment tax
• Final rules on partners’ shares of partnership recourse liabilities
• New reporting requirements for distributions of partnership property
• Simplified corporate alternative minimum tax (CAMT) guidance relating to partnership interests

 

Eased Partnership Form 8308 Reporting Requirements

The IRS in August 2025 issued proposed regulations that would modify reporting requirements for partnerships with unrealized receivables or inventory items that are required to furnish Form 8308. The form is generally required to be furnished by January 31 to the transferor and transferee in connection with certain partnership interest transfers that occurred in the previous calendar year.

The IRS expanded Form 8038 reporting in late 2023, but offered temporary relief in Notice 2024-19 and Notice 2025-02. This guidance responded to partnerships’ expressed concerns that they do not have the information necessary to complete the new Part IV of Form 8308 by the January 31 deadline.

The proposed regulations would modify the existing rules to remove the requirement to include Part IV in the statements generally required to be furnished by the January 31 deadline. Other Form 8308 requirements would remain.

Expanded Form 8308 Reporting

Partnerships file Form 8308, Report of a Sale or Exchange of Certain Partnership Interests, to report the sale or exchange by a partner of all or part of a partnership interest when any money or other property received in exchange for the interest is attributable to unrealized receivables or inventory items (that is, when there has been a Section 751(a) exchange).

Final regulations published in November 2020 require a partnership to furnish to a transferor partner the information necessary for the transferor to make the transferor partner’s required statement related to a Section 751(a) exchange. Under applicable regulations, a transferor partner in a Section 751(a) exchange must submit a statement with the transferor partner’s income tax return for the tax year of the transaction separately stating the date of the sale or exchange, the amount of any gain or loss attributable to Section 751 property, and the amount of any gain or loss attributable to capital gain or loss on the sale of the partnership interest.

The IRS significantly expanded the Form 8308 reporting requirements in the revised form released in October 2023. For transfers occurring on or after January 1, 2023, the revised Form 8308 includes expanded Parts I and II and new Parts III and IV. Part IV is used to report specific types of partner gain or loss when there is a Section 751(a) exchange, including the partnership’s and the transferor partner’s share of Section 751 gain or loss, collectibles gain under Section 1(h)(5), and unrecaptured Section 1250 gain under Section 1(h)(6).

Furnishing Information to Transferors and Transferees

Partnerships with unrealized receivables or inventory items described in Section 751(a) (Section 751 property or “hot assets”) are required to provide information to each transferor and transferee that is a party to a Section 751(a) exchange.

Under the existing regulations, each partnership that is required to file a Form 8308 must furnish a statement to the transferor and transferee by the later of (1) January 31 of the year following the calendar year in which the Section 751(a) exchange occurred, or (2) 30 days after the partnership has received notice of the Section 751(a) exchange. A penalty applies under Section 6722 for failure to furnish statements to transferors and transferees on or before the required date, or for failing to include all the required information or including incorrect information.

Proposed Regulations

The proposed regulations would eliminate the current regulatory requirement that partnerships furnish the information required in Part IV of Form 8308 by January 31 of the year following the calendar year in which the Section 751(a) exchange occurred. The IRS plans to update the instructions to Form 8308 in accordance with the proposed regulations.

Under the proposed regulations and modified Form 8308 instructions, partnerships would only be required to furnish the information in Parts I, II, and III of Form 8308 (or a statement with the same information) to the transferor and transferee in a Section 751(a) exchange by the later of (1) January 31 of the year following the calendar year in which the Section 751(a) exchange occurred, or (2) 30 days after the partnership has received notice of the exchange.

Partnerships would still be required to file the completed Form 8308, including Part IV, as an attachment to their Forms 1065, for the tax year of the partnership that includes the last day of the calendar year in which the Section 751(a) exchange took place.

The IRS states that partnerships may rely on the proposed regulations, and the described changes to the Form 8308 instructions, with respect to Section 751(a) exchanges occurring on or after January 1, 2025, and before the date final regulations are published.

Planning Considerations

While the requirement of furnishing Form 8308 statements was not new, the inclusion of numerical “hot asset” (i.e., unrealized receivables or inventory items) information in Form 8308 for transactions in 2023 and later created difficulties, because, in many cases, partnerships do not have all the information required by Part IV of the Form 8308 by January 31 of the year following the calendar year in which the Section 751(a) exchange occurred.

The penalty relief related to the new requirements for the previous two years was welcome – but it was temporary, and it was unclear whether such relief would continue to be offered in future years. The new rules ease the most problematic Form 8308 information reporting requirements and give partnerships more certainty regarding compliance going forward.

 

Limited Partner Claims of Exemption from Self-Employment Tax

Partnerships, particularly management fund entities, may need to revisit their tax positions on self-employment tax after a series of IRS court victories on the issue.

In the latest decision in December 2024, the Tax Court held in Denham Capital Management LP v. Commissioner that “active” limited partners in an investment management company formed as a limited partnership were subject to self-employment (SECA) tax and not entitled to the statutory exemption for limited partners.

The Tax Court relied on its earlier decision in Soroban Capital Partners LP v. Commissioner, which held that the determination of limited partner status is a “facts and circumstances inquiry” that requires a “functional analysis.” However, the Denham case is the first in which the Tax Court applied the functional analysis of whether a state law limited partner was, in fact, active in the business of the partnership and a “limited partner” in name only. The key issue in the Denham case, as in Soroban, was whether limited partners in state law limited partnerships may claim exemption from SECA taxes – despite being more than passive investors.

Application of Functional Analysis in Denham

Denham Capital Management was organized as a limited partnership under Delaware law and offered investment advisory and management services to private equity funds. As the court addressed the functional analysis, it reaffirmed that determinations of eligibility for the exemption under Section 1402(a)(13) require a factual inquiry into how the partnership generated the income in question and the partners’ roles and responsibilities in doing so.

The court noted that, in the years at issue, Denham’s income consisted solely of fees received in exchange for services provided to investors, including advising and operating private investment funds. The court found the partners’ time, skills, and judgment to be essential to the provision of these services. It found unconvincing claims that Denham’s income – largely distributed to the partners as profits – was a return on investments, when only one of the partners had made a capital contribution to obtain their interest.

Moreover, the court stated that all the partners, except for one that had made a capital contribution, were required to “devote substantially all of [their] business time and attention to the affairs of the [p]artnership and its affiliates.” The court determined that the partners treated their roles in Denham as their full-time employment, with each participating in management and playing crucial roles in the business.

Other relevant facts cited by the court included:

• Fund marketing materials made clear that the partners had a significant role in Denham’s operation.

• The partners’ expertise and judgment were a significant draw for fund investors, who could withdraw their investments if certain partners no longer participated.
• Investment decisions for the funds were made by investment and valuation committees, which included the partners.
• The partners each exercised significant control over personnel decisions.
• A sizable number of Denham employees received total compensation exceeding the partners’ guaranteed payments, suggesting such payments were not designed to adequately compensate the partners for their services.

Concluding that “[i]ndividuals that serve roles as integral to their partnerships as those the [p]artners served for Denham cannot be said to be merely passive investors,” the court held that the partners were not “limited partners, as such” under Section 1402(a)(13) and the partners’ distributive shares were ineligible for the SECA tax exemption for limited partners.

Planning Considerations

Denham Capital was another big win for the government. Similar to the Tax Court’s ruling in Soroban Capital, the Tax Court in Denham required a functional analysis centered around the roles and activities of the individual partners. In Denham, the Tax Court detailed the various activities of the partners to show that they were active participants in the business of Denham and not merely passive investors receiving a return on their capital.

The Tax Court again rejected the argument that the partners were eligible for the SECA tax exemption under Section 1402(a)(13) merely because they were limited partners in a state law limited partnership, making it clear that federal law and not state law prescribes the classification of individuals and organizations for federal tax purposes.

Given these decisions, partnerships should reevaluate whether a partner, including a limited partner in a state law limited partnership, is subject to SECA tax by assessing the activities of the partner using a functional analysis similar to the Tax Court’s analysis in Denham. Partnerships should also consider the guidance provided for in 1997 Proposed Reg. §1.1402(a)-2(h), which is instructive despite never being finalized.

Pursuant to this guidance, an individual is considered a limited partner unless the individual:

• Has personal liability for the debts of or claims against the partnership by reason of being a partner;
• Has authority (under the law of the jurisdiction in which the partnership is formed) to contract on behalf of the partnership; or
• Participates in the partnership's trade or business for more than 500 hours during the partnership's tax year.

 

Final Rules on Partner Share of Partnership Recourse Liabilities

The IRS in December 2024 published final regulations (TD 10014) adopting rules – initially proposed more than 10 years earlier – to amend the rules under Section 752 regarding a partner’s share of partnership recourse liabilities and associated special rules for related persons. The rules are critical for determining a partner’s basis in the partnership interest.

Partners’ Liability Shares Under Section 752

Under Section 752, an increase in a partner’s share of partnership liabilities is generally considered a contribution of money by the partner to the partnership, and a decrease in a partner’s share of liabilities is considered a distribution of money to the partner by the partnership. In determining a partner’s share of liabilities, the regulations distinguish between recourse and nonrecourse liabilities.

A partnership liability is generally considered recourse to the extent that a partner or related person bears the economic risk of loss under Reg. §1.752-2. A partner’s share of a recourse liability is equal to the portion of that liability, if any, for which the partner or a related person bears the economic risk of loss. A partner bears the economic risk of loss for a partnership liability if the partner or related person has a payment obligation under Reg. §1.752-2(b), is a lender as provided in Reg. §1.752-2(c), guarantees payment of interest on a partnership nonrecourse liability as described in Reg. §1.752-2(e), or pledges property as a security as provided in Reg. §1.752-2(h).

Final Regulations

The new regulations finalize rules proposed in 2013 covering when and to what extent a partner would be treated as bearing the economic risk of loss for a partnership liability when multiple partners bear economic risk of loss for the same liability, as well as rules addressing tiered partnerships and related parties. They also add an ordering rule. The final regulations apply to any liability incurred or assumed by a partnership on or after December 2, 2024.

Overlapping Economic Risk of Loss

With respect to overlapping economic risk of loss, the final regulations include a proportionality rule that applies when multiple parties bear the economic risk of loss for the same liability. Under this rule, the economic risk of loss borne by a partner equals the amount of the partnership liability (or portion thereof) multiplied by a fraction equal to the amount of economic risk of loss borne by the partner divided by the sum of the economic risk of loss borne by all partners with respect to that liability. The proportionality rule is intended to address uncertainty regarding how partners should share a partnership liability when multiple partners bear economic risk of loss with respect to the same liability.

Tiered Partnerships

For tiered partnerships, the final regulations address how a lower-tier partnership must allocate a liability in cases in which a partner of an upper-tier partnership is also a partner of the lower-tier partnership and that partner bears economic risk of loss with respect to the lower-tier partnership’s liability. The regulations in effect before the final regulations did not address this situation. Under the final regulations, the lower-tier partnership must allocate the liability directly to the partner.

The final rule is broadly consistent with the proposed rule. The final rules add a clarification regarding how the tiered partnership rule applies in a case in which there is overlapping economic risk of loss among unrelated partners and add an example to illustrate the application of the proportionality rule when there are tiered partnerships.

Related-Party Rules

The final regulations also include changes to the related-party rules, including constructive ownership rules, the related-party exception to the related-party rules, and a multiple partner rule.

Ordering Rule

The final regulations add an ordering rule to clarify how the proportionality rule interacts with the multiple partner rule and how the multiple partner rule interacts with the related partner exception. The ordering rule includes three steps to be followed in order, and the final regulations include an illustrative example.

Planning Considerations

The final regulations adopt the regulations that were proposed more than 10 years earlier with only a few minor changes and additions. Among other changes, the final regulations largely resolve uncertainty in several areas, such as when there is an overlapping of economic risk of loss and how to allocate liabilities in a tiered partnership where a partner in an upper-tier partnership is also a partner in a lower-tier partnership. They also adopt the result reached by the Tax Court in IPO II v. Commissioner, 122 T.C. 295 (2004), and change the multiple related partners rule.

As taxpayers may choose to apply the final regulations to liabilities incurred or assumed before the effective date with respect to all returns, including amended returns, filed after the date the regulations were published, taxpayers should evaluate whether the final regulations provide a more favorable result for the partners in the partnership. Note that if a partnership chooses to apply the final regulations to liabilities incurred or assumed prior to the effective date (December 2, 2024), the partnership must apply the final rules consistently to all its partnership liabilities.

 

 

New Reporting for Distributions of Partnership Property

The IRS in December 2024 released the final version of new Form 7217, Partner’s Report of Property Distributed by a Partnership, as well as the accompanying instructions, reflecting a new reporting requirement for partners in tax years beginning in 2024 or later.

This new reporting requirement applies to any partner in any partnership that receives from the partnership distributions of property other than cash and marketable securities treated as cash.

Investment partnerships that meet certain requirements can distribute marketable securities to partners on a tax-free basis, and the recipient partner can defer income recognition until the securities are later sold. Other partnerships are generally required to treat marketable securities as cash, resulting in more immediate tax consequences.

Each partner receiving a tax-free distribution of property, including marketable securities from an investment partnership, is required to file the new Form 7217. A separate Form 7217 is required to be filed for each date during the tax year in which a distribution was received and will be attached to the recipient’s tax return. The information reported must include the basis of the distributed property and any required basis adjustments to such property

Planning Considerations

This new filing requirement reflects a continuation of the IRS’s recent efforts to expand required disclosures from partnerships. Private companies organized as partnerships should be prepared to receive additional requests from limited partners as they comply with the Form 7217 reporting requirement.

 

Simplified CAMT Guidance Relating to Partnership Interests

The IRS announced in Notice 2025-28 that it intends to partially withdraw proposed regulations on the application of the corporate alternative minimum tax (CAMT) to partnerships and CAMT entity partners and to issue revised proposed regulations. Pending publication of the revised proposed regulations, the notice provides interim guidance.

The modified guidance is intended “to reduce burdens and costs” in applying the CAMT to applicable corporations with financial statement income (FSI) attributable to investments in partnerships. The notice includes interim guidance on simplified methods to determine an applicable corporation’s adjusted financial statement income (AFSI) with respect to an investment in a partnership, reporting by partnerships of information needed to compute ASFI, and rules for partnership contributions and distributions.

Key changes in the revised guidance include:

• Adding two alternative methods for calculating a CAMT entity partner’s distributive share of modified FSI (e.g., the top-down election and the limited taxable-income election);
• Loosening requirements for requesting information; and
• Introducing modifications to the AFSI adjustments that apply certain partnership principles in current proposed regulations (i.e., Prop. Reg. §1.56A-20).

CAMT Background and Previous IRS Guidance on Partnership Interests

For tax years beginning after December 31, 2022, the CAMT imposes a 15% minimum tax on the AFSI of applicable corporations (generally, those with average annual AFSI exceeding $1 billion). AFSI is generally defined as the net income or loss of the taxpayer set forth on the taxpayer's applicable financial statement for that tax year, adjusted as further provided in Section 56A.

In September 2024, the IRS issued proposed regulations on the CAMT that included significant new provisions for partnerships. The proposed regulations set out rules for determining and identifying AFSI, including applicable rules for partnerships with CAMT entity partners.

The 2024 proposed regulations set out rules regarding a partner's distributive share of partnership AFSI. The IRS explained in the preamble to the proposed rules that it was proposing adopting a “bottom-up” method, which it believed was consistent with the statute and more conducive to taking into account Section 56A adjustments. Under the proposed bottom-up method, a partnership would calculate its AFSI and provide this information to its partners. Each partner would then need to determine its “distributive share” of the partnership's AFSI. Under the proposed rules, the CAMT entity partner would undertake a four-step calculation to arrive at its distributive share amount.

The 2024 proposed regulations also included rules to provide for adjustments to carry out the principles of Subchapter K regarding partnership contributions, distributions, and interest transfers. For both contributions and distributions of property, the IRS proposed a deferred sale method.

New Interim Guidance and Planned Proposed Regulations

Notice 2025-28 describes interim guidance intended to simplify the rules set out in the 2024 proposed regulations, and the IRS said it anticipates releasing proposed regulations consistent with the guidance to be effective for tax years beginning after the publication of final regulations. For tax years beginning before the forthcoming proposed regulations are issued, taxpayers may choose to apply the guidance described in the notice.

Top-Down Election

The interim guidance allows a CAMT entity partner to make a “top-down election” to determine its amount of AFSI from a partnership investment for each tax year (starting with the first tax year for which the election is in effect) by reference to the amount the CAMT entity partner reflects in its FSI for the tax year with respect to the partnership investment. Under this election, the four-step calculation of a CAMT entity partner’s AFSI under the 2024 proposed regulations would be replaced by a simplified calculation. This alternative calculation equals the sum of (i) 80% of the “top-down amount,” which is defined as “any amounts reflected in the CAMT entity partner’s FSI for the tax year that are attributable to the partnership investment for which the top-down election is in effect,” (ii) amounts included in AFSI from sales or exchanges, and (iii) certain adjustments described in section 3.02 of the notice. The numerous adjustments not enumerated in section 3.02 of the notice are excluded from an electing partner’s AFSI calculation.

Different CAMT Entity Partners in the Same Partnership Can Take Different Approaches

If a CAMT entity partner makes a top-down election, the partnership is no longer required to report its modified FSI to that partner. But if a CAMT entity partner has not made the election, the partnership is still required to compute and report its FSI to a non-electing partner that gives the partnership notice that it requires the partnership to compute and report its modified FSI. A partnership may have both electing and non-electing partners.

Who Can Elect the Top-Down Approach?

Any CAMT entity partner can make the top-down election, provided it is not a partnership. If a CAMT entity is a partner in multiple partnerships, it can choose where it would like to make the election.

Alternative Approaches for Calculating Partnership AFSI

The IRS is also considering a “limited taxable-income election,” pursuant to which some CAMT entity partners may use taxable-income amounts to determine their AFSI from a partnership investment. The notice provides a formula for this, which, broadly speaking, is the sum of taxable income, AFSI attributable to sales/exchanges, and AFSI inclusions attributable to foreign stock.

Calculating a CAMT Entity Partner’s Distributive Share Under the Bottom-Up Approach

New rules will provide greater flexibility in determining a CAMT entity partner’s distributive share. The 2024 proposed regulations set out a rather formulaic approach that was outside of typical Subchapter K concepts. The new rules would provide for certain “reasonable methods” for determining distributive share by using existing Subchapter K concepts, such as net Section 704(b) income or loss.

Requesting Information from Partnerships

The notice gives a CAMT entity more time to request necessary information from the partnership if the “top-down election” is not made. If a partnership fails to provide the requested information, the partner may use its books and records rather than applying required estimate rules.

Contributions and Distributions     

The IRS provides additional rules on how to account for partnership contributions and distributions. Under the notice, CAMT entities may choose from two additional methods to determine AFSI adjustments for partnership contributions and distributions (other than partnership contributions and distributions involving stock of a foreign corporation): the “modified -20 method” and the “full Subchapter K method.”

Under the modified -20 method, a CAMT entity partner may apply Prop. Reg. §1.56A20 with certain modifications provided by the notice. These modifications include (1) applying Sections 752 and 707 in determining whether Sections 721(a) or 731(b) apply to partnership contributions and distributions of property subject to liabilities, and (2) changes to recovery period rules for property to which Section 168 applies as well as property for which there is no applicable recovery period.

Under the full Subchapter K method, a partnership may apply the principles of Sections 721 and 731 to determine its partners’ distributive shares of partnership AFSI resulting from contributions or distributions. If a partnership adopts this method, it must also apply the principles of other relevant Subchapter K provisions (e.g., Sections 704(c), 732, 734, and 737).

Planning Considerations

Notice 2025-28 provides CAMT entity partners with new approaches for determining their AFSI from partnership investments. These approaches are intended to streamline the calculation process and reduce administrative complexity, particularly for taxpayers seeking alternatives to the current, more burdensome distributive share rules. Taxpayers should consider the calculations underlying each approach to determine which would best serve their interests.

While taxpayers may apply the notice’s interim guidance for tax years before new proposed regulations are issued, the IRS anticipates further modifications to be reflected in the anticipated proposed regulations, particularly regarding partnership distributive share and contribution/distribution rules. Accordingly, partnerships with CAMT partners should watch for new guidance and be prepared to adjust their approaches as the rules evolve.

 

 

 

Credits and Incentives

 

With all the challenges facing private companies this year, it’s critical that they leverage every available tax benefit. Fortunately, lawmakers have packed the Code with credits and incentives designed to reward taxpayers for certain types of activities and investments. The OBBBA made significant revisions to energy credits, imposing new restrictions and phasing out many of the credits early. Despite the changes, there is still considerable runway for many projects, and the tax equity financing and credit transfer markets should both be robust over the next several years. In addition, the OBBBA enhanced existing incentives in ways that offer new opportunities for tax-efficient structuring.

 

Energy Provisions Following Enactment of the OBBBA

The OBBBA has reshaped the energy credit landscape. Several credits were extended or enhanced, while many others are subject to new sourcing and investment requirements or are phasing out early. The legislation does not affect the ability to transfer or claim refundable payments for specified credits

Consumer Credits

The OBBBA repeals several energy-related tax credits directed to consumers, each with distinct effective dates:

• Section 25E – Previously Owned Clean Vehicle Credit
  Repealed for vehicles acquired after September 30, 2025.
• Section 30D – Clean Vehicle Credit
  Repealed for vehicles acquired after September 30, 2025.
• Section 45W – Commercial Clean Vehicle Credit
  Repealed for vehicles acquired after September 30, 2025.
• Section 30C – Alternative Fuel Refueling Property Credit
  Repealed for property placed in service after June 30, 2026.
• Section 25C – Energy-Efficient Home Improvement Credit
  Repealed for property placed in service after December 31, 2025.
• Section 25D – Residential Clean Energy Credit
  Repealed for expenditures made after December 31, 2025.
• Section 45L – New Energy-Efficient Home Credit
  Repealed for property acquired after June 30, 2026.

Depreciation

The bill eliminates the five-year depreciable life for qualified energy property, and the Section 179D deduction is repealed for construction beginning after June 30, 2026.

Sections 48E and 45Y – Investment and Production Tax Credits

The OBBBA accelerates the phaseout of the investment tax credit under Section 48E and the production tax credit under Section 45Y. Projects that begin construction after 2033 will generally no longer qualify for these credits, with solar and wind facilities facing even earlier deadlines. To remain eligible, solar and wind projects that begin construction after July 4, 2026, must be placed in service by the end of 2027.

The legislation also introduces new restrictions related to prohibited foreign entities. Facilities beginning construction after December 31, 2025, may not receive material assistance from such entities. Material assistance is determined based on a cost ratio tied to the sourcing of eligible components. In addition, Section 48E now includes stricter domestic sourcing requirements to obtain the 10% bonus credit, reflecting a broader policy shift toward supply chain security and energy independence.

Importantly, the IRS has tightened the rules for establishing that construction has begun for purposes of the July 4, 2026, deadline for solar and wind facilities. Under Notice 2025-43, the 5% safe harbor method is available only if taxpayers can use it to establish that construction began by September 1, 2025. Starting September 2, the physical work test is the sole method for establishing beginning of construction (BOC) for wind and solar projects for purposes of the July 4, 2026, deadline.

This change applies to the credit phaseouts under the OBBBA, but not to the foreign entity of concern (FEOC) rules. For FEOC exemption purposes, facilities may still use the 5% safe harbor to establish that construction began by December 31, 2025. Additionally, low-output solar facilities (≤1.5 MW AC) may continue to use the 5% safe harbor beyond that date. The four-year continuity safe harbor remains in place for projects that meet BOC requirements.

Historically, taxpayers could rely on either the physical work test or the 5% safe harbor. Notice 2025-42 now limits this to the physical work test, which requires significant physical work related to the energy property, either on-site or off-site, under a binding contract. Preliminary activities like design or site clearing do not qualify.

To maintain credit eligibility, taxpayers must also meet the continuity requirement, which can be satisfied if the facility is placed in service within four years of the BOC year.

Planning Considerations

Facilities must establish BOC by December 31, 2025, to avoid FEOC restrictions beginning in 2026, and facilities can continue to rely on the 5% safe harbor specifically for the purpose of meeting this deadline through the end of 2025. Solar and wind projects beginning construction more than 12 months after the OBBBA enactment must be placed in service by the end of 2027 to qualify for Section 48E or 45Y credits. Facilities that establish BOC by the deadline can rely on the four-year continuity safe harbor to place in service and preserve credit eligibility.

Section 45X – Advanced Manufacturing Credit

The advanced manufacturing credit under Section 45X has been modified significantly. While the credit is repealed for wind energy components sold after 2027, it remains available for other eligible components before a phasedown begins in 2031. Components sold in 2031 will qualify for a 75% credit, decreasing to 50% in 2032 and 25% in 2033. The credit is fully repealed for sales occurring in 2034 or later. Notably, the scope of the credit has been expanded to include metallurgical coal. As with other energy provisions, the material assistance restrictions for prohibited foreign entities apply to all qualifying components

Section 45Z – Clean Fuel Production Credit

Under the OBBBA, the clean fuel production credit under Section 45Z has been extended through 2031. The bill also reinstates the small agri-biodiesel credit under Section 40A, which can now be stacked with the 45Z credit. A new geographic restriction has been added, disallowing the credit unless the feedstock is produced or grown in Canada, Mexico, or the U.S. Additionally, the methodology for calculating greenhouse gas emissions has been revised to exclude indirect land use changes. Prohibited foreign entity rules have also been extended to apply to clean fuel production facilities.

Other Energy Provisions

The clean hydrogen production credit under Section 45V is repealed for construction beginning after 2027 — two years later than previously proposed. Section 45Q credit rates for carbon capture used as a tertiary injectant or for productive use are increased to match those for permanent geologic storage, with new foreign entity restrictions.

Publicly traded partnership (PTP) rules now include income from carbon capture; nuclear, hydropower, and geothermal energy projects, as well as the transport or storage of sustainable aviation fuel or hydrogen. The nuclear production credit under Section 45U is also subject to foreign entity restrictions.

Planning Considerations

Taxpayers should assess project timelines and sourcing strategies in light of phaseouts and new restrictions. For Sections 45Y and 48E, construction must begin within eligibility windows — especially for solar and wind projects facing a 2027 placed-in-service deadline.

Supply chain planning is critical to avoid disqualification under foreign entity rules. Manufacturers of wind property eligible for Section 45X should consider accelerating production before the phaseout in 2027. Clean fuel producers must ensure feedstock sourcing complies with geographic limits and updated emissions rules.

Entities pursuing carbon capture, hydrogen, or nuclear projects should factor in expanded PTP eligibility and foreign entity restrictions when structuring financing and partnerships. Early action can help preserve credit eligibility and provide long-term benefits.

 

State Tax Credit Transfers

Following the enactment of the OBBBA, many states have expanded or introduced transferable tax credit programs, particularly in clean energy, affordable housing, and infrastructure. These programs allow taxpayers to sell unused credits to third parties, creating liquidity and broader access to state-level incentives. Transfer mechanisms vary by state, with some requiring pre-approval, certification, or registration, while others impose annual caps or limits on transfer volume. The trend mirrors federal credit transferability under Section 6418 and reflects growing interest in flexible credit monetization strategies.

States are also beginning to adopt market infrastructure—such as broker platforms and insurance products — to support credit transfers and mitigate buyer risk. As more jurisdictions adopt these frameworks, taxpayers with multistate operations should monitor developments closely to identify new opportunities.

Planning Considerations

Taxpayers should assess eligibility and timing for generating transferable credits, especially in states with strict certification or sourcing requirements. Early coordination with legal and tax advisors is essential to confirm compliance with documentation and reporting rules. Buyers should conduct due diligence on project qualification, transfer terms, and potential recapture risks.

Engaging with credit brokers or marketplaces may help improve pricing and identify reliable counterparties. Additionally, taxpayers should consider how state credit transfers interact with federal incentives, particularly in structuring financing and partnership arrangements. Strategic planning now can help enhance credit value and avoid missed opportunities as state programs continue to evolve.

 

OBBBA Makes New Markets Tax Credit Program Permanent

The New Markets Tax Credit (NMTC) program supports capital investments in low-income communities by offering tax credit-subsidized loans to eligible businesses for use toward eligible costs (e.g., real estate and furniture, fixtures, and equipment (FFE)). These loans often feature interest-only terms, below-market rates, and principal forgiveness after seven years, providing a permanent cash benefit to businesses.

Previously set to expire at the end of 2025, the NMTC program was made permanent by the OBBBA, with a continued annual allocation authority of $5 billion. Eligible businesses — both for-profit and nonprofit — can apply for NMTC financing for capital expenditure projects in qualifying census tracts. The program supports a wide range of sectors, including manufacturing, healthcare, education, renewable energy, and retail, though it excludes farming and residential rental activities.

Each year, certified Community Development Entities (CDEs) apply to the CDFI Fund for NMTC allocations. If awarded an allocation, CDEs raise equity from tax credit investors and deploy capital to eligible businesses (otherwise known as Qualified Active LowIncome Community Businesses) based on community impact and strategic priorities, which may vary by geography or industry.

Planning Considerations

The NMTC program remains highly competitive. Early engagement with CDEs and timely application are critical to securing financing. Businesses should prepare detailed project plans that demonstrate strong community impact and align with CDE priorities. Acting early improves the likelihood of receiving funding and may unlock additional benefits

Work Opportunity Tax Credit Set to Expire

The OBBBA did not extend the work opportunity tax credit (WOTC), which is now set to expire for any individuals who begin work after December 31, 2025. The WOTC provides a valuable incentive for employers who often hire workers from certain targeted populations, including veterans, people with disabilities, people on food assistance, certain youth employees, and ex-felons. Employers who frequently screen for qualified individuals as part of their hiring process should monitor the legislative process for a potential extension of the credit.

Pass-Through Deduction

The OBBBA makes permanent the 20% deduction for qualified business income under Section 199A and favorably adjusts the phaseout of the deduction for taxpayers who do not meet the wage expense and capital investment requirements or who participate in a “specified service trade or business.”

Planning Considerations

The permanence of this provision provides welcome certainty for private companies engaged in qualifying activities. The deduction is not available for a range of specified service businesses. There may be opportunities to segregate activities and to increase or allow deductions. The safe harbor for rental activity to qualify as a Section 199A trade or business under Rev. Proc. 2019-38 remains in effect.

R&D Credit Opportunities

The research credit remains one of the most powerful incentives in the tax code, and the IRS continues to receive a high volume of claims, straining examination resources. To improve administration and reduce improper claims, the IRS recently made several changes to Form 6765, clarifying documentation requirements for claiming the credit.

The revised Form 6765 was partially finalized for tax year 2025, with the IRS making optional the mandatory reporting of qualified research expenses (QREs) by business component in Section G of the form. When Section G becomes mandatory for the 2026 tax year, taxpayers will be required to disclose the top 80% of QREs, with controlled group members required to attach detailed breakdowns by entity. Section E is currently mandatory and includes new questions related to officer wages, acquisitions, and use of the ASC 730 directive. These updates reflect the IRS’s ongoing efforts to enhance transparency and strengthen audit readiness.

In response to ongoing compliance concerns, the IRS has increased scrutiny of research credit filings, including more frequent audits. However, due to temporary resource constraints, some IRS Exam functions are operating at reduced capacity, which may delay enforcement actions. Taxpayers should confirm that they are properly documenting claims and explore state credit opportunities.

State Credit Changes

Over the past year, several states have enacted or revised legislation related to research and development (R&D) tax credits. These changes reflect a growing trend to incentivize innovation and attract high-tech investment.

These states include:

Arizona: Arizona now permits use of the alternative simplified credit (ASC) method for computing its credit for increased research activities. This provides greater flexibility and may result in increased benefits. Refundable credits are available for small businesses with fewer than 150 employees, subject to pre-approval from the Arizona Commerce Authority.

Arkansas: Arkansas expanded its credit options, offering up to 33% for strategic research areas and university partnerships. Credits are nonrefundable but can offset 100% of state tax liability and be carried forward for up to nine years.

Connecticut: CoConnecticut expanded its R&D and R&E credits under H.B. 7287. Single-member LLCs may now qualify if they meet specific criteria. Refundability increased to 90% for small biotech firms and 65% for other small businesses, capped at $1.5 million per company annually.

Iowa: Iowa enacted Senate File 657, replacing its research activities credit with a targeted R&D tax credit program effective January 1, 2026. Eligibility is limited to sectors such as advanced manufacturing, bioscience, finance, insurance, and technology. Credits are capped at $40 million annually and require CPA-verified QREs and a competitive application process through the Iowa Economic Development Authority.

Massachusetts: Massachusetts increased the maximum allowable credit for certain industries and introduced new documentation requirements for software development and AI-related R&D.

Michigan: Effective January 1, 2025, Michigan reintroduced its R&D tax credit. Large businesses may claim 3% of qualifying expenses up to a base amount and 10% above it, capped at $2 million. Small businesses may claim 15% above the base amount, capped at $250,000. An additional 5% credit is available for university collaborations, capped at $200,000. The credit is refundable and subject to a $100 million annual cap.

Minnesota: Minnesota introduced partial refundability for its R&D credit: 19.2% for 2025, increasing to 25% for 2026–2027.

Oklahoma: Oklahoma revised its R&D credit to align more closely with federal QRE definitions and introduced a new pre-approval application process.

Texas: Texas enhanced its franchise tax R&D credit via SB 2206 and repealed the R&D equipment sales tax exemption effective January 1, 2026.

Planning Considerations

Navigating the R&D credit has become more complex amid heightened review, evolving case law, and new compliance measures. Taxpayers should make sure claims are well-supported and consistent with updated guidance to reduce audit risk and avoid delays.

Taxpayers should carefully assess eligibility for both federal and state research credits, maintain contemporaneous documentation, and prepare to defend claims under examination. Strategic planning is essential to leveraging available incentives, especially given the complexity and variability of state-level programs. Using a trusted tax advisor can help taxpayers maintain compliance with IRS and state regulations and effectively substantiate research credit claims.

 

OBBBA Changes Rules for Qualified Small Business Stock

The OBBBA significantly enhances a tax-efficient structuring option for private companies. Qualified small business stock (QSBS) under Section 1202 offers tax-free appreciation, and has been increasingly used by private equity in recent years.

Enacted in 1993, Section 1202 generally allows a non corporate taxpayer to exclude a percentage of the gain from the sale or exchange of QSBS held for more than five years. The eligible gain exclusion percentage is based on the date the stock is issued.

For stock issued before July 5, 2025, the maximum amount of gain on QSBS that can be excluded for any tax year by each taxpayer with respect to each issuing C corporation is generally limited to the greater of: (i) $10 million, minus the amount of gain excluded by that taxpayer in prior years with respect to the same issuing corporation; or (ii) 10 times the taxpayer’s aggregate adjusted basis in the QSBS sold during the tax year.

For stock issued after July 4, 2025, the OBBBA increases the $10 million limit to $15 million and adjusts this limit for inflation beginning in 2027. In addition, the OBBBA creates new 50% and 75% gain exclusion categories for QSBS held for at least three and four years, respectively.

The various QSBS exclusion percentages, exclusion limits, and required holding periods by stock issuance date are set out in the table below.

 

QSBS Issued:		Percentage of  Eligible Gain Excluded	Limited to Greater of 10x Basis or	Required Holding Period (Years)
After	and Before
8/10/1993	2/18/2009	50%	$10M	More than 5
2/17/2009	9/28/2010	75%	$10M	More than 5
9/27/2010	7/5/2025	100%	$10M	More than 5
7/4/2025		50%	$15M	3
7/4/2025		75%	$15M	4
7/4/2025		100%	$15M	5 or more

 

The OBBBA also increases the limit on aggregate gross assets to satisfy the qualified small business test for purposes of Section 1202.

These thresholds are now as follows:

• At all times through the date of issuance, the corporations aggregate gross assets must not have exceeded $50 million for issuances before July 5, 2025, or $75 million for issuances after July 4, 2025; and

 

• Immediately after the date of issuance (and after considering amounts the corporation received in the issuance) the aggregate gross assets of the corporation must not exceed $50 million or $75 million for issuances before July 5, 2025, or after July 4, 2025, respectively.

 

Aggregate gross assets are defined as cash plus the aggregate adjusted tax basis of the corporation’s other assets.

Planning Considerations

After an issuance is deemed to be QSBS under Section 1202, the corporation’s gross assets can exceed the applicable threshold (either $50 million or $75 million) at a later date without prohibiting the previously issued stock from receiving Section 1202 treatment. By increasing the threshold, the OBBBA renews an existing corporation’s ability to issue QSBS if their aggregate gross assets have exceeded $50 million in the past but have never exceeded $75 million. This higher threshold also expands the potential QSBS benefits for private equity firms when acquiring target businesses with enterprise values of up to $75 million.

 

Opportunity Zone Extension Creates Tax Planning Options

The OBBBA made the qualified opportunity zone (QOZ) program permanent, preserving one of the most generous tax incentives ever offered by Congress. The provision can offer benefits to investors looking for tax-efficient returns, individual private companies investing in specific geographies, or asset managers setting up funds.

The OBBBA not only makes the program permanent, but it changes the rules in important ways. Funds and investors should consider the implications for their planning strategies. The changes could affect the timing of gain transactions and capital contributions, the location of investments, and the compliance burdens for funds.

The current QOZ designations will expire at the end of 2026. New zones will be designated in rolling 10-year designation periods under new criteria that are expected to shrink the number of qualifying zones.

As under the current program, taxpayers can defer capital gains by investing in a qualified opportunity fund (QOF). For investments made after 2026, taxpayers will be required to recognize the deferred gain five years after making the investment but will receive a 10% increase in basis for holding the investment five years. For QOFs operating in a new category of rural opportunity zones, this basis increase is 30%. Taxpayers who make investments before the end of 2026 must still recognize the deferred gain at the end of 2026.

The more powerful tax benefit may be the tax-free appreciation on the underlying investment itself. Taxpayers will still receive a full basis step-up to fair market value (FMV) for property held 10 years, but the OBBBA added a rule freezing the basis step-up to the FMV at 30 years after the date of the investment.

The operational rules for QOFs and qualified opportunity zone businesses (QOZBs) are generally unchanged, except for property held in a rural opportunity zone. The threshold for establishing the substantial improvement of qualifying property in a rural opportunity zone will be 50% of basis rather than 100%, effective for any determinations after July 4, 2025. QOFs and QOZBs will both be subject to increased reporting requirements.

Companies looking for new tax-efficient investing opportunities and gain deferral strategies should reassess their investment options, paying particular attention to which geographies are likely to qualify in 2027.

Planning Considerations

The timing of capital gains transactions will be important. Delaying a capital gain transaction could allow taxpayers to make a deferral election in 2027 and defer recognizing the gain until well after the current 2026 recognition date. Conversely, taxpayers planning investments in geographic areas that are unlikely to be redesignated may need to make the investments before the end of 2026. Existing QOFs and QOZBs should consider their long-term capital needs because it is not clear whether any “grandfathering” relief will allow additional qualified investments in funds operating in QOZs that are not redesignated. The new reporting rules will apply to both new and existing QOZs and QOZBs for tax years beginning after the date of enactment, and those entities will need to collect and report substantial new information that has never before been required

REIT Structuring and Real Estate Benefits

The real estate investment tax (REIT) structure remains an effective way to structure certain real estate activities with only one layer of tax. The OBBBA raises from 20% to 25% the portion of the gross asset value of a REIT that may be attributable to equity and debt securities of taxable REIT subsidiaries, effective for tax years beginning after 2025. The change should provide added flexibility.

In addition, the OBBBA allows the completed contract method of accounting for many residential condominium, construction, and sale projects, effective for contracts entered into after July 4, 2025. For residential developers that meet the average annual gross receipts test under Section 448 ($31 million in 2025), the maximum estimated contract length is increased from two years to three years to qualify for the exception from the UNICAP rules under Section 263A.

Planning Considerations

This provision provides much-needed tax relief to condo developers who often had to report income under the percentage of completion method, which often required the reporting of income before receiving payment. Allowing the use of the completed contract method of accounting allows better matching of reporting taxable income with the receipt of cash by the developer.  

Unfortunately, the relief is provided only prospectively for contracts entered into after the July 4, 2025, enactment date. Therefore, taxpayers with contracts entered into prior to the enactment date will continue to be subject to the old rules. Moreover, reporting income for projects begun in prior years may be bound to the prior method of accounting

 

 

 

Capital Markets and M&A

 

The current capital markets environment remains marked by volatility, persistent inflationary pressure, and structurally higher interest rates. Companies are facing less predictable financing windows, with higher cost debt and volatile equity valuations. As a result, many issuers are increasingly turning to hybrid instruments such as convertibles, opportunistic equity raises, or converting maturing debt to equity when credit provides unfavorable refinancing options. With the current economic headwinds, companies are proactively recapitalizing to preserve flexibility ahead of potential market tightening.

The same economic factors are affecting the M&A market, which is beginning to rebound. Overall deal values increased over the summer despite fewer transactions, driven partially by digital transformation as companies seek to enhance capabilities.

Whether managing capital needs or engaging in strategic M&A activity, tax considerations should be part of the decision-making process. Several key issues and developments can impact strategy. Debt refinancing and hedging transactions can have important tax implications. Section 382 can restrict the value of tax attributes and may be particularly important with increasing deductions thanks to the OBBBA. The Tax Court has also issued an important ruling on termination fees, and the IRS has rescinded new reporting on certain types of transactions.

 

 

Planning for Section 382 Limitations

Section 382 limitations can significantly reduce the net present value of a corporation’s net operating losses, Section 163(j) interest expense carryforwards, tax credit carryforwards, and Section 174 balances following an “ownership change.” Section 382 limitations also may impact anticipated tax benefits when companies exit non-core businesses.

For purposes of Section 382, an ownership change occurs if there is a 50% shift in the corporation’s 5% shareholder ownership within a rolling three-year period. An ownership change may occur as a result of cumulative transactions between a corporation and its shareholders, or it may come about because of an acquisition or merger. When an ownership change occurs, the analysis required to compute the applicable limitations is complex.

Regular, real-time monitoring of a company’s Section 382 profile can identify opportunities to defer or avoid Section 382 ownership changes and associated tax attribute limitations

Opportunities may include, for example:

• Sizing a stock issuance to keep the ownership shift below 50%.
• Delaying an issuance or similar transaction to allow previous equity events to fall outside the rolling three-year window.
• In certain circumstances, involving potential ownership shifts associated with large cash raises, redeeming non-participating 5% shareholders below 5% in conjunction with the capital raise.
• Implementing strategies such as poison pills and share restrictions to avoid unanticipated ownership changes.

In some situations, triggering an ownership change during high equity valuations may be beneficial to limiting adverse consequences of Section 382 and may increase the company’s flexibility to execute additional issuances or recapitalizations without triggering further ownership changes.

Planning Considerations

Timely, robust Section 382 analyses can provide strategic advantages in M&A transactions by:

• Accurately pricing net operating losses, credits, and Section 174 balances into deal negotiations.
• Identifying opportunities to unlock built-in gains in transactions that increase annual limitation capacity.
• Avoiding post-transaction surprises by structuring ownership changes with Section 382 impacts in mind.

 

Companies with large unamortized Section 174 balances may face higher stakes. The OBBBA has increased the ambiguity of whether these costs constitute built-in-losses for Section 382 purposes, making proactive planning essential to mitigating the risk of unexpected limitations.

With rising costs and volatile valuations, Section 382 planning is vital, and tax departments cannot afford to treat potential Section 382 limitations as an afterthought. By integrating real-time ownership and tax attribute monitoring into strategic tax planning decisions, tax departments can help companies preserve and enhance the value of companies’ tax attributes

Tax Court Supports Deduction for Termination Fee

The Tax Court held earlier this year in AbbVie, Inc. Subsidiaries v. Commissioner that an approximately $1.6 billion termination fee was properly deductible as an ordinary business expense, and should not be treated as a capital loss. The case has important implications for the treatment of termination and cancellation fees.

The case centered on a proposed merger between AbbVie and Shire to combine the two companies into a new holding company in Jersey. The transaction was subject to various conditions, including regulatory and shareholder approval.

The two parties entered into a “Cooperation Agreement” obligating both sides to be bound by the transaction and to perform certain actions to implement it. Significantly, the agreement required AbbVie to pay a break fee to Shire if AbbVie’s board of directors failed to recommend the merger or shareholder approval was not obtained. After unfavorable tax guidance was released, AbbVie’s board of directors withdrew its recommendation for the proposed merger and paid Shire the break fee.

AbbVie and the IRS disagreed on the treatment of the break fee. AbbVie argued the fee was deductible either as an ordinary and necessary expense paid or incurred during the tax year in carrying on any trade or business, or as a loss deductible under Section 165, which allows a deduction for any loss sustained during the tax year that is not compensated by insurance or otherwise. The IRS argued that the break fee was a capital loss under Section 1234A, a provision intended to prevent taxpayers from converting capital transactions into ordinary losses via contract terminations. Section 1234A provides that gain or loss attributable to the cancellation of “a right or obligation... with respect to property which is...a capital asset in the hands of the taxpayer” is itself treated as a capital gain or loss.

The Tax Court rejected the Service’s position, finding that the agreement between AbbVie and Shire was not a right or obligation “with respect to property.” The court's decision was based on a few key determinations. First, the agreement primarily focused on mutual commitments related to obtaining regulatory approval and the provision of corporate facilitative services rather than any direct transaction involving property rights. Second, the Tax Court interpreted the phrase "with respect to property" in Section 1234A to mean a right or obligation in exchange for property interests. The court found that the cooperation agreement included rights or obligations to perform services related to the property, but did not contain rights or obligations to transfer property. Accordingly, the court concluded that Section 1234A limits the scope of the provision to cases in which the taxpayer has a “right or obligation to exchange (i.e., to buy, sell, or otherwise transfer or receive) an interest in property.”

                Planning Considerations[DS1] 

The decision provides welcome and favorable guidance with respect to the tax treatment of termination fees, potentially limiting the scope of Section 1234A. Taxpayers should continue to monitor this area, however, as the IRS has appealed the decision to the Seventh Circuit. It should also be noted that the decision was very fact-specific and relied heavily on the determination that the obligations were largely service-oriented. The result underscores the importance of evaluating whether a contract obligates the parties to complete a transaction, or merely facilitates one. Companies should also note that notwithstanding the holding in AbbVie, a termination fee may not necessarily be currently deductible. Consideration must also be given to Reg. §1.263(a)-5, which generally requires termination fees to be capitalized if the payer is terminating the transaction to enter into another transaction.

 

IRS Rescinds New Reporting Requirements for M&A transactions

The IRS has withdrawn and superseded guidance released just before former President Biden left office that covers the nonrecognition of gain or loss in corporate separations, incorporations, and reorganizations and updated reporting requirements for Section 355 transactions. The Biden-era guidance process started in May 2024 when the IRS updated its private letter ruling policy in Rev. Proc 2024-24 and outlined its views in Notice 2024-38. The IRS followed with two sets of proposed regulations in January 2025 (REG-112261-24 and REG-116085-23), which translated their views into formal guidance and imposed new multiyear reporting requirements.

The IRS has now withdrawn both sets of proposed regulations and issued a new revenue procedure (Rev. Proc. 2025-30) superseding the private letter ruling guidance in Rev. Proc. 2024-24. The maneuver essentially reverts to the rules in place under Rev. Proc. 2017-53 and Rev. Proc. 2018-53.

The move is welcome news for taxpayers, particularly those seeking private letter rulings. Although the regulations were still in proposed form, the IRS had been applying them to private letter ruling requests. The new rules (largely reverting to rules in place before Rev. Proc. 2024-24) will apply for any ruling requests postmarked or received after Sep. 29, 2025.

 

Treasury Tax Review

Treasury groups are facing unprecedented challenges from volatile market conditions. Uncertain interest rates, volatile credit markets, currency fluctuations, and strained commodity markets have all been affecting financing, investing, and cash management and have caused treasurers to reevaluate how and when to hedge various risks. These activities will generally have significant tax consequences and the need for tax departments to be involved in these decisions has never been greater. Companies should evaluate all treasury activities from a tax perspective on a regular basis.

 

Debt Refinancing Transactions

Over the past year, many private companies have refinanced their existing debt to secure current interest rates, with the potential for rates to decrease in the future. Refinancing transactions that result in a “significant modification” of the debt under applicable regulations can have disparate tax consequences depending on the specific circumstances. Although the regulations provide relatively clear rules for determining when a modification is “significant,” the application of these rules is highly fact-dependent and frequently requires relatively complex calculations.

Companies should review their debt modification transactions during the year to confirm their tax impact. Companies that are considering changes to existing credit facilities in the coming year should likewise assess whether the proposed change would amount to a significant modification and, if so, determine the tax implications of the modification

Tax Treatment of Debt Modifications

The income tax treatment of debt refinancing transactions is highly fact-specific and requires careful analysis. Certain refinancing transactions may be treated as a taxable retirement of the existing (refinanced) debt, which may give rise to the ability to write off any unamortized debt issuance costs and original issue discount, the latter as “repurchase premium.” However, in certain situations a refinancing transaction may also give rise to taxable ordinary income in the form of “cancellation of indebtedness income.”

The tax consequences of a debt refinancing transaction hinge in part on whether the transaction results in a significant modification of the debt under rules set out in Reg. §1.1001-3, which results in a deemed retirement of the existing debt in exchange for a newly issued debt instrument.

When Is a Modification Significant?

As a threshold matter, a modification includes not only a change to the terms of an existing debt instrument but would also include an exchange of an old debt instrument for a new one or the retirement of an existing debt instrument using the proceeds of a new debt instrument. Stated differently — it is the substance, not the form, that governs whether debt has been modified for federal income tax purposes.

Whether a modification of a debt instrument constitutes a significant modification depends on the materiality of the changes. The regulations provide a general “economic significance” rule and several specific rules for testing whether a modification is significant. In practice, most debt modifications are covered by two specific rules governing changes in the yield to maturity of a debt instrument (the change in yield test) and deferrals of scheduled payments (the deferral test).

Yield test: Under the change in yield test, a modification is significant if the new yield of the modified debt instrument differs from the old yield of the unmodified debt instrument by more than 25 basis points (i.e., 1/4 of 1%) or 5% of the unmodified yield. Various changes, such as adjusting the interest rate, altering payment schedules, or paying modification fees, can impact the yield. It is not uncommon for a modification with only a minor (or no) change to the stated interest rate to result in a significant modification due to changes in the yield to maturity that result from the payment of modification fees or changes to the due dates for certain payments. This issue is often overlooked.

Deferral test: Under the deferral test, a modification is significant if it causes a material deferral of payments. While the test does not define “material deferral,” it offers a safe harbor: a deferral is not significant if all payments are unconditionally made within the safe harbor period. This safe harbor period starts on the first deferred payment date and lasts for the lesser of five years or 50% of the original term (e.g., the deferral safe harbor for a five-year debt instrument would be twoand-a-half years).

In applying both the change in yield test and the deferral test, taxpayers are required to consider the cumulative effect of the current modification with any prior modifications (or, in the case of a change in yield, modifications occurring in the past five years). This cumulative rule is particularly noteworthy for taxpayers who routinely modify their debt (and often incur modification fees in connection with the modification), as the results of certain modifications may not be significant when viewed in isolation but may be significant when combined with prior modifications.

Tax Implications of Significant Debt Modifications

A significant modification results in the deemed retirement of the existing debt instrument in exchange for a newly issued debt instrument. The existing debt instrument will be deemed retired for an amount equal to the “issue price” of the newly issued debt instrument, together with any additional consideration paid to the lenders as consideration for the modification.

The issue price of a debt instrument depends on whether the debt instrument was issued for cash or property. If a significant amount (generally 10%) of the debt was issued for money, the issue price will be the cash purchase price. Otherwise, assuming the debt instrument is in excess of $100 million, the issue price will be its fair market value (or the fair market value of the property for which it was issued) if it is “publicly traded.” In all other cases, the issue price of the debt instrument will generally be its stated principal amount.

If the issue price of the modified debt instrument (i.e., the repurchase price) is less than the tax-adjusted issue price of the old debt instrument, a borrower will incur cancellation of indebtedness income, which is generally taxed as ordinary income in the current tax year. If instead the repurchase price exceeds the adjusted issue price (this may occur when the old debt instrument had unamortized original issue discount or when the debt is publicly traded and has a fair market value in excess of its face amount), the borrower will incur repurchase premium. Repurchase premium is deductible as interest expense. Special rules apply to determine whether such repurchase premium is currently deductible or is instead amortized over the term of the newly issued debt instrument.

The retirement of an existing debt instrument may also give rise to the ability to deduct any unamortized debt issuance costs. As a general matter, the determination of whether any unamortized debt issuance costs should be written off or carried over and amortized over the term of the new debt instrument generally follows the same analysis as repurchase premium. Notably, debt issuance costs are deducted as ordinary business expenses under Section 162, and therefore are not subject to the limit on business interest expense deduction under Section 163(j).

Finally, a significant modification may give rise to additional tax implications that companies should consider, including the potential for foreign currency gain or loss and the need to “mark-to-market” existing tax hedging transactions.

 

Tax Hedging Identification and Documentation

Most companies enter into hedging transactions to manage risk that arises in their business, such as interest rate, currency, and commodity price risk. These transactions are subject to tax hedging rules, and failure to follow the requirements under those rules could result in negative tax consequences. The tax hedging rules impose a same-day identification requirement with timing and character whipsaw rules that may apply if such transactions are not timely identified.

As part of year-end reviews and planning for next year, companies should review these rules and the sufficiency of their hedging identification and documentation processes so they can properly meet the requirements.

Tax Hedge Qualification & Character

To qualify as a tax hedge, the transaction must occur within the normal course of business and be used to manage interest rate, currency, or commodity price risk with respect to ordinary property or ordinary obligations (incurred or to be incurred) by the taxpayer. For this purpose, property is ordinary if a sale or exchange of the property could not produce capital gain or loss under any circumstances. Taxpayers may manage risk on a transaction-by-transaction basis or, alternatively, may manage aggregate risk (i.e., they may enter into one or more foreign currency contracts to manage aggregate foreign currency risk).

Gain or loss on a tax hedging transaction will be ordinary income or loss if the transaction is properly identified and documented in a timely manner.

Same-Day Identification Requirement

The tax hedging rules require that each tax hedging transaction be identified as such no later than the close of the day on which the hedge was entered into. The hedged item must be identified substantially contemporaneously with the tax hedging transaction, but in no case more than 35 days after the hedging transaction was entered into.

An identification must identify the item, items, or aggregate risk being hedged. Identification of an item being hedged involves identifying a transaction that creates risk and the type of risk that the transaction creates. This identification is made in (and retained as part of) the company’s tax files and is not sent to the IRS. A GAAP (or IFRS) hedge identification will not satisfy the tax hedge identification requirement unless the taxpayer’s books and records make clear that such identification is also being made for tax purposes. Additional regulatory guidance is provided for certain categories of hedging transactions, including hedges of debt issued (or to be issued) by the taxpayer, inventory hedges, and hedges of aggregate risk.

Taxpayers are given significant flexibility regarding the form of such identification. For companies that enter into tax hedging transactions infrequently, a same-day identification may be prepared and saved in the company’s tax files. However, this approach is often challenging for taxpayers that enter into hedging transactions routinely (often on a daily basis). For taxpayers who enter into hedging transactions frequently, the same-day identification requirement can be satisfied through a tax hedging policy. A tax hedging policy will identify the types of transactions entered into to manage risk and the risk managed (and how such risk is managed) and will identify all transactions described in the policy as tax hedging transactions. If properly prepared, the tax hedging policy will serve as identification (for tax hedging purposes) of any transactions described in the policy

Hedge Timing Rules

IRS regulations provide special tax accounting rules for tax hedging transactions known as the “hedge timing rules.” The hedge timing rules provide a general requirement that the method of accounting used to account for hedging transactions must clearly reflect income by matching the recognition of income, deduction, gain, or loss on the hedging transaction to the recognition of income, deduction, gain, or loss on the hedged item. Special rules are provided for specific types of hedging transactions.

Failure to Identify — Timing & Character Whipsaws

Failure to properly identify a hedging transaction generally establishes that the transaction is not a tax hedging transaction. As a result, gain or loss on the hedging transaction is determined under general principles. However, the regulations provide a broad anti-abuse rule that will frequently treat any gains as ordinary, which may result in a character whipsaw in which losses are capital and any gains are ordinary income. The regulations provide an inadvertent-error exception, which, if applicable, may allow taxpayers to treat losses in some circumstances as ordinary.

A proper and timely hedge identification also prevents the application of certain loss deferral rules. One example is the tax "straddle" rules, which may defer losses (but not gains) on certain unidentified hedging transactions.

Planning Considerations

Given the volatility of commodity prices, interest rates, and foreign currency exchange rates, businesses are increasingly incentivized to rely on hedging activities to manage risk and reduce exposure to dramatic market movements. To prevent the character and timing mismatches previously discussed and properly report gains and losses from these hedging transactions, companies should carefully review their tax hedge identification policies or establish them if none exist. These are important planning considerations, and while the identification and documentation requirements are complex, failure to comply with these rules may result in significant adverse tax consequences.

 

 

 

International Tax

 

International tax planning is becoming both more complex and more important. Major changes to foreign currency and digital content rules will have a significant impact across a broad range of companies and international structures. As important as new guidance is, it may have been eclipsed by legislative developments. The international tax reform in the OBBBA raises novel planning considerations, and ongoing negotiations over Pillar Two could result in meaningful changes for private companies in scope of the rules as we approach year-end.

 

International Tax Planning After the OBBBA

The OBBBA enacted several changes to the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and the base erosion and anti-abuse tax (BEAT) regimes. Combined with changes in certain domestic provisions, such as Section 174 and Section 168, the changes could have a significant impact on multinational taxpayers.

GILTI Changes

GILTI is now known as “net CFC tested income” (NCTI). The effective tax rate on NCTI changes from 10.5% to 12.6% as a result of the change in the Section 250 deduction (from 50% to 40%). The NCTI foreign tax credit (FTC) haircut was reduced from 20% to 10% and now applies to previously taxed earnings and profits (PTEP) distributions. The reduction for qualified business asset investment (QBAI) was repealed, and the FTC expense allocation toward NCTI is limited to those expenses that are “directly allocable,” with carveouts for interest and research and experimentation (R&E). In addition, foreign taxes associated with PTEP are no longer treated as deemed paid under the Section 78 gross-up mechanism. Overall, the changes to NCTI could result in taxpayers generating higher NCTI inclusions in the U.S.

FDII Changes

 

FDII is now known as “foreign-derived deduction-eligible income” (FDDEI). The effective tax rate on FDDEI changes from 13.125% to 14% as a result of the change in the Section 250 deduction (from 37.5% to 33.34%). As with NCTI, QBAI was repealed, and the FTC expense allocation toward FDDEI is limited to those expenses that are “properly allocable,” with carveouts for interest and R&E. Additionally, FDDEI excludes income or gain from dispositions of intangible property (IP) (as defined in Section 367(d)) and any other property subject to depreciation, amortization, or depletion by the seller occurring after June 16, 2025. Overall, the changes to FDDEI are taxpayer favorable, making FDDEI more valuable and accessible, particularly for heavy industry. But the deduction is available only to private companies organized as C corporations.

 

BEAT Changes

The tax rate increased from 10% to 10.5%.

The OBBBA made several important domestic tax changes that could affect international planning.

 

These changes were discussed earlier in the corporate income tax chapter and include:

• Permanently restoring full expensing of domestic R&E costs for tax years beginning after December 31, 2024.
• Making bonus depreciation permanent at 100% for property acquired after January 19, 2024.
• Creating a new category of 100% expensing for real property (buildings) involved in qualified production activities if construction begins after January 19, 2025, and before 2030, and the property is placed in service by the end of 2030.
• Permanently removing amortization, depreciation, and depletion from adjusted taxable income for the limit on interest deductions under Section 163(j) for tax years beginning after December 31, 2025.

 

Effective Dates

 

Generally, the NCTI, FDDEI, and BEAT changes are effective for tax years beginning after December 31, 2025. As mentioned, 100% bonus depreciation is effective for property acquired and placed in service after January 19, 2025, while businesses can immediately begin deducting domestic R&E expenditures paid or incurred after December 31, 2024.

 

Planning Considerations

Given the significant changes to NCTI and FDDEI, as well as the changes in the tax rate for BEAT, modeling will be important for multinational taxpayers to effectively plan.

These strategies should be considered, when appropriate:

NCTI

·         Increase tested income taxes, as more taxpayers are likely to be in an excess limitation position for FTC purposes.

·         Accelerate income into 2025 and/or defer deductions until 2026 and beyond.

·         Consider high-tax exclusion election.

FDDEI

·         Expense apportionment and lack of QBAI opens up potential planning opportunities, particularly for capital-intensive and research-heavy taxpayers.

·         Consider potentially onshoring IP.

·         For outbound services, consider increasing inbound income streams if locally deductible.

BEAT

·         Consider capitalizing interest, Section 174, and other items.

·         Evaluate the services cost method (SCM) exception.

·         If subject to Section 1059A, consider increasing cost of goods sold (COGS).

Classifying and Sourcing Digital Content and Cloud Transactions

The IRS on January 10, 2025, released final regulations on the classification of digital content and cloud transactions. The regulations are generally effective for tax years beginning on or after January 14, 2025, with the option to elect to apply to tax years beginning on or after August 14, 2019, and all subsequent tax years.

The IRS also released proposed regulations to determine how income from cloud transactions is to be sourced for U.S. federal tax purposes, and a notice requesting comment on the potential implications of applying the characterization rules for digital content and cloud transactions to all provisions of the Internal Revenue Code.

A Closer Look

The final regulations modify Reg. §1.861-18 to expand its scope to include the transfer of all manner of digital content so that it is no longer limited to computer programs. Digital content is defined as a computer program or any other content, such as books, movies, and music, in digital format that is protected by copyright law or not protected by copyright law solely due to the passage of time or because the creator dedicated the content to the public domain.

Reg. §1.861-18 classifies transfers of digital content into one of four categories:

• A transfer of a copyright right in the digital content;
• A transfer of a copy of the digital content (a copyrighted article);
• The provision of services for the development or modification of the digital content; or
• The provision of know-how relating to development of digital content.

 

The final regulations replace the de minimis transaction rule with a predominant character rule for the characterization of digital content and cloud transactions. Under the new predominant character rule, a transaction that has multiple elements is classified in its entirety as digital content or a cloud transaction if the predominant character is digital content or a cloud transaction.

If a copyright is transferred, the transaction will generally be classified as a sale or license of intangible property. If a copyrighted article is transferred, the transaction will generally be classified as a sale or lease of tangible property.

New sourcing rules provide that when a copyrighted article is sold and transferred through an electronic medium, the sale is deemed to have occurred at the location of the purchasers’ billing address for purposes of Reg. §1.861-7(c). Reg. §1.861-19 provides rules that generally classify all cloud transactions as services income, eliminating a delineation made in the 2019 proposed regulations between lease and services income. A cloud transaction is defined as a transaction through which a person obtains on-demand network access to computer hardware, digital content (as defined in Reg. §1.861-18(a)(2)), or other similar resources. A cloud transaction does not include network access to download digital content for storage and use on a person’s computer or other electronic device.

The addition of numerous examples in Reg. §1.861-18 help illuminate the rules, particularly surrounding the classification of digital content transactions in various industries, including online gaming and streaming of other types of content. The examples emphasize that providers will need to pay careful attention to contracting with customers, including the method and terms of delivery for digital content to achieve a preferred tax outcome. One specific example of this concept is the clarification of rules related to the distribution of “software as a service” or “SaaS.”

Sourcing of Cloud Transactions

The proposed regulations (mostly designated as Reg. §1.861-19(d)) classify cloud transactions (such as SaaS, on-demand platform access) as services and follow Sections 861(a)(3) and 862(a)(3) and some court cases in generally sourcing income to where services are performed. However, the preamble to the proposed regulations recognizes that such general sourcing rules were designed with more traditional operating models in mind. Thus, the proposed regulations attempt to consider the distinctive attributes of cloud transactions. The proposed regulations provide a mechanical formula that is based on the location of intangible assets, employee functions, and tangible property pertaining to the provision of the cloud transaction, and results in a fraction that is applied to the gross income from the cloud transaction to determine source.

One of the most important aspects of the proposed regulations is that the above factors are applied exclusively on a taxpayer-by-taxpayer basis. Therefore, if the cloud transactions involve multiple related parties, the factors and activities of the related parties are not considered for purposes of the sourcing rules. However, attention should be paid to any related parties acting as agents for the taxpayer, as such factors/attributes presumably may be imputed to the taxpayer.

Planning Considerations

Today, most business interactions with customers occur in some form of digital or cloud environment. Until now, there have been no final regulations specifically addressing the treatment of digital content and cloud transactions for federal income tax purposes. Both the characterization and sourcing of income from these transactions are important because they impact the application of various international tax provisions of the Code, including the determination of U.S. withholding tax and other income tax reporting obligations. These regulations will apply to any taxpayer that engages in digital content and cloud transactions across various industries and in a cross-border context.

 

OBBBA Replaces Downward Attribution Prohibition with New Rules

 

The restoration of Section 958(b)(4) under the OBBBA represents a significant change in the determination of controlled foreign corporation (CFC) and U.S. shareholder status.

Prior to the enactment of the TCJA, Section 958(b)(4) prohibited the downward attribution of stock ownership from a foreign person to a U.S. person, which limited the number of foreign corporations classified as CFCs and reduced filing obligations for constructive U.S. shareholders. The TCJA’s repeal of this provision resulted in many foreign corporations being treated as CFCs, triggering new reporting requirements for U.S. shareholders.

Effective for tax years beginning after December 31, 2025, the OBBBA reinstates this downward attribution prohibition, potentially simplifying reporting obligations for certain taxpayers.

In conjunction with the restoration of Section 958(b)(4), the OBBBA introduces Section 951B, which extends the CFC inclusion rules to foreign controlled U.S. shareholders (FCUSS) of foreign controlled foreign corporations (FCFC). Under these new rules, an FCUSS would generally be required to include Subpart F income or net CFC tested income (NCTI) of an FCFC only if it owns a direct or indirect interest, under Section 958(a), in the FCFC. This approach narrows the scope of income inclusions for FCUSSs, focusing on direct and indirect ownership rather than constructive ownership through downward attribution.

Planning Considerations

Guidance is expected to clarify the reporting requirements for FCUSSs and FCFCs, as well as the impact on the passive foreign investment company (PFIC) rules. Taxpayers affected by the prior repeal of Section 958(b)(4) should carefully review these new provisions and forthcoming regulations, particularly regarding reporting for FCUSSs and FCFCs, pro rata share rules, and potential overlap with the PFIC rules.

The restoration of Section 958(b)(4) and introduction of Section 951B may simplify compliance for some taxpayers, but also introduce new complexities and areas requiring regulatory guidance.

 

Section 987 Regulations on Foreign Currency Gain or Losses

The IRS has issued final and proposed regulations under Section 987, which are effective for tax years beginning after December 31, 2024. This marks the end of years of uncertainty, during which the IRS continually deferred proposed rules and were willing to accept “reasonable methods” based on a slew of proposed regulations — a period that earned the regime the nickname “the Wild West.”

Section 987 governs the recognition of foreign currency gain or loss for qualified business units (QBUs) with a different functional currency than its taxpayer. Partnerships and S corporations generally remain outside the scope of the final regulations. Nevertheless, certain applicable provisions may apply (e.g., character and sourcing rules, suspended or deferred losses, and treatment of QBU terminations).

The proposed regulations include an election intended to reduce the compliance burden of accounting for certain disregarded transactions between a QBU and its owner.

Transition Rules

The owner of a QBU must adopt the Section 987 regulations as of the transition date — January 1, 2025 — for calendar year taxpayers (or the day of a termination event after November 9, 2023). Pretransition gain or loss must be computed as if each QBU were terminated the day before the transition date. The method for computing the pretransition gain or loss depends on whether the taxpayer has applied an eligible method for computing Section 987 gains and losses in prior years.

Pretransition Gain or Loss - Eligible Method

The pretransition gain or loss amount, in general, is the amount of Section 987 gain or loss that would have been recognized by the owner under the eligible method if the Section 987 QBU terminated on the transition date and transferred all of its assets and liabilities to the owner.

Pretransition Gain or Loss – No Eligible Method

The pretransition gain or loss amount, in general, is the amount of the “annual unrecognized Section 987 gain or loss” computed each year that the owner held the QBU after September 7, 2006, and before the transition date (the “transition period”). This total amount is adjusted for the amount of Section 987 gain or loss recognized by the owner of such QBU for all those years.

The annual unrecognized Section 987 gain or loss is the amount of Section 987 gain or loss computed as though a current rate election was in effect for each year of the transition period. A current rate election is an election to treat all balance sheet items as a marked item which is translated at the end of year spot rate rather than a historic rate.

The Section 987 regulations provide an alternative method for computing QBU net value for purposes of Reg. §1.987-4(d), but only when a current rate election is made. Thus, this alternative approach may be applied for purposes of computing pretransition gain or loss when an eligible method has not been previously applied, as a current rate election is deemed made for the transition period.

Definition of “Eligible Pretransition Method” 

 

The Section 987 regulations provide that an eligible method includes an earnings and capital method, which is defined as a method that requires Section 987 gain or loss to be determined and recognized with respect to both the earnings of the Section 987 QBU and capital contributed to the Section 987 QBU.

 

The Section 987 regulations further provide that another reasonable method could also qualify as an eligible method if it produces the same total amount of income over the life of the owner of a Section 987 QBU as the earnings and capital method described above.

 

Recognition of Pretransition Gain or Loss

 

Pretransition gain is treated as net accumulated unrecognized Section 987 gain, which will be recognized in future years as remittances are made from the Section 987 QBU. Alternatively, taxpayers may elect to recognize pretransition gain ratably over 10 years.

 

Pretransition loss is generally treated as suspended Section 987 loss, which means that such loss will be recognized in future years to the extent the QBU generates Section 987 gain. If a current-rate election is in effect on the transition date, then the pretransition loss becomes unrecognized Section 987 loss that will be recognized upon remittances in future years. Alternatively, taxpayers may elect to recognize pretransition loss ratably over 10 years.

 

Planning Considerations

Taxpayers have waited a long time for final Section 987 guidance and although clarity in the area is welcome, many issues will need attention. As year-end approaches, taxpayers should inventory their QBUs, quantify pretransition amounts, model election strategies, and coordinate choices across the enterprise. The more immediate concerns are the transition to the new regulations and the computation of pretransition gain or loss. Taxpayers will then need to focus on gathering the required data to compute Section 987 gains and losses as well as evaluating the many elections that are available under the final regulations beginning with the 2025 tax year, modeling the overall impact of the regulations with and without the new elections.

U.S. Withdraws From Global Tax Agreement, Leaving Pillar Two in Limbo

President Donald Trump on January 20, 2025 — his first day in office — issued a memorandum to clarify that the “Global Tax Deal” has no force or effect in the U.S., and directing the Secretary of the Treasury and the U.S. permanent representative to the OECD to notify the global organization that any commitments made by the Biden administration regarding the global tax deal have no force or effect in the U.S. absent an act by Congress adopting the relevant provisions of the deal.

The global tax deal referenced in the memorandum alludes to Pillar Two of the OECD’s two-pillar framework for addressing the tax challenges arising from the digitalization of the economy and may be directed at aspects of Pillar One as well. The global anti-base erosion (GloBE) model rules issued under Pillar Two — which introduced the undertaxed profits rule (UTPR) and the income inclusion rule (IIR) — are designed to ensure that large multinational companies pay a minimum tax of 15% on taxable profit in each jurisdiction in which they operate. While more than 56 jurisdictions have enacted domestic legislation implementing Pillar Two, including all EU member states, the U.S. has not.

On June 28, Treasury released a statement by the G-7 nations asserting that “there is a shared understanding that a side-by-side system could preserve important gains made by jurisdictions in the Inclusive Framework in tackling base erosion and profit shifting and provide greater stability and certainty in the international tax system moving forward.”

The side-by-side system would be based on four principles:

• It would fully exclude U.S.-parented groups from the UTPR and the IIR in respect of both their domestic and foreign profits.
• It would include a commitment to ensure that any risks of base erosion and profit shifting are addressed to preserve the common policy objectives of the side-by-side system.
• Work to deliver a side-by-side system would be undertaken alongside material simplifications being delivered to the overall Pillar Two administration and compliance framework.
• Work to deliver a side-by-side system would be undertaken alongside considering changes to the Pillar Two treatment of substance-based non-refundable tax credits.

A statement from House Ways and Means Committee Chairman Jason Smith (R-MO) and Senate Finance Committee Chairman Mike Crapo (R-ID) indicated that the side-by-side agreement had been predicated on the removal of proposed Section 899 from the OBBBA. Section 899 would have imposed a retaliatory tax on some non-U.S. corporations and individuals if their home jurisdiction had adopted taxes on U.S. taxpayers deemed to be discriminatory or extraterritorial.

The U.S. is now actively negotiating with the OECD to try to reach agreement on a “side-by-side “framework by the end of the year. It has recently been reported that the OECD circulated a 30-page draft proposing targeted changes to the global minimum tax to address how the regime applies to U.S. multinationals.

Reportedly, the draft provides that companies based in a jurisdiction that qualifies as “side-by-side” would not be subject to the IIR and the UTPR.

Planning Considerations

Several OECD countries have fully implemented the UTPR in their domestic tax laws and many more have indicated their intention to do so. Therefore, a looming conflict between U.S. tax law and the OECD Pillar Two regime would need to be addressed during 2025 to avoid a conflict of laws applicable to U.S.-parented multinationals.

Private companies in multinational groups that are within the scope of Pillar Two should carefully consider these international tax developments with their advisors and monitor developments for any impact on tax planning and tax compliance.

 

 

 

 

 

Transfer Pricing

Transfer pricing is consistently one of the top tax issues facing multinational public companies. According to statistics from the Census Bureau, nearly half of all import and export activity occurs between related parties, and every one of those transactions involves transfer pricing. The exposure for companies can be significant, and nearly all of the largest tax disputes in the U.S. involve transfer pricing.

Tariff developments, Pillar Two implementation, and international tax law changes all added to the complexity this year. It’s critical for companies to leverage planning options and confirm they’re satisfying reporting requirements.

Adopting a Proactive Approach to Transfer Pricing

Adopting a proactive approach to tax process improvements can be an aspirational goal for many tax departments. Resource constraints, business pressures, new technical developments, and other factors can cause even the most meticulously planned schedules to go awry, and before anyone realizes it, year-end is upon them once again.

Rather than feeling discouraged, companies can leverage their experience to understand what is achievable and then prioritize improvement projects that are appropriately sized for their business.

Common Year-End Transfer Pricing Challenges

1. Large Transfer Pricing Adjustments: Many companies use transfer pricing adjustments to meet their desired transfer pricing policy. However, significant year-end adjustments can have both income tax and indirect tax implications, leading to further issues and risks.
2. Lack of Transparency in Calculations: Transfer pricing calculations are often built in Excel and amended over the course of the years, perhaps to address one-time issues or changing situations. This can result in workbooks that lack a sufficient audit trail and contain hard-coded data, both of which undermine a reviewer's ability to validate the calculations. Additionally, without documentation, the process becomes dependent on the few people working directly on the process, which can create significant knowledge gaps if one of more of the key people leave the company.
3. Data Constraints: While the mechanics of most transfer pricing calculations are not complex, difficulties arise because of the variety of data needed (revenues, segmented legal entity P&Ls, headcount, R&D spend) and the challenges in accessing that data. This can lead to shortcuts and unvalidated assumptions.
4. Year-end Timing: Some companies close their year-end books with no transfer pricing review, and then rely on book-to-tax adjustments to true up their transfer pricing for tax purposes. While seemingly expeditious, addressing transfer pricing issues in this way can not only result in double taxation, but also may require an election under Revenue Procedure 99-32. For example, to avoid the treatment of any intercompany payments as nondeductible items such as contributions to capital or dividends, the taxpayer should make an election under Rev. Proc. 99-32 and account for the payments using that guidance

Planning Considerations

Develop a Multiperiod Monitoring Process: Implement a process that tracks profitability throughout the year to help reduce significant yearend transfer pricing adjustments. This monitoring can also provide insights into whether underlying intercompany pricing policy changes are needed, allowing for a proactive approach to limit the number and magnitude of year-end adjustments

Identify and Review Material Transactions: Conduct a detailed review of calculation workbooks to pinpoint deficiencies, such as lack of version control, hard-coded amounts with no audit trail, limited or undocumented key assumptions, and an incoherent calculation process. Companies can address one or more of these issues based on timing and resources. Small changes can have a significant impact.

Define a Data-Focused Project: Consider the data needed for transfer pricing calculations, investigate the form and availability of data, identify new data sources, and help data providers understand their importance in the overall process. This can be done on a pilot basis with a material transaction or group of transactions to keep the project manageable. Companies often discover new data sources and form valuable connections with data providers through these projects.

 Learning from the year-end process provides clarity on areas that need improvement. These observations can be captured and converted into small improvement projects as soon as possible after year-end.

 

 

Managing BEAT with Services Cost Method

Companies facing potential BEAT liability may be able to reduce exposure through the services cost method (SCM) exception. The BEAT is a minimum tax that applies to MNEs that had at least $500 million in average annual gross receipts for the previous three years, make “base erosion payments” to foreign related parties, and have a “base erosion percentage” for the tax year of greater than or equal to 3% (2% for some taxpayers, including banks).

The definition of “base erosion payments” is broad and includes “any amount paid or accrued by the taxpayer to a [foreign related party] and with respect to which a deduction is allowable under this chapter.”

However, the BEAT regulations provide an “SCM exception” from inclusion in the base erosion payment calculation for some outbound intercompany payments for certain intercompany services provided by non-U.S. related parties. This exception offers a significant opportunity to reduce BEAT exposure.

The IRS introduced the SCM to simplify the transfer pricing of some controlled services transactions and reduce taxpayers’ compliance burden regarding routine intercompany services. Under Reg. §1.482-9 (b)(1), the SCM “evaluates whether the amount charged for certain services is arm’s length by reference to the total services costs...with no markup.”

To be eligible for the SCM for transfer pricing purposes, a service must meet several requirements:

21. It must be a covered service — either a service enumerated in Rev. Proc. 2007-13, or a service with a median arm’s length markup on total services costs no greater than 7%;
21. It may not be a specifically excluded activity enumerated in Reg. §1.482-9(b)(4);
21. It may not be excluded from SCM due to the business judgment rule, which disallows the use of SCM if the service is related to competitive advantages, core capabilities, or fundamental risks of success or failure of the business; and
21. It must be substantiated in books and records adequately maintained by the taxpayer.

To apply the SCM exception, all the requirements of Reg. §1.482-9(b) listed above must be satisfied, except the business judgment rule. Moreover, adequate books and records must be maintained in accordance with the rules under Reg. §1.59A-3(b)(i)(C), instead of Reg. §1.482-9(b)(6).

If the SCM exception is applied to a transaction that is priced at cost plus a markup, only the cost component can be excluded from BEAT. If another, non-cost-based method is used, such as the comparable uncontrolled services price method, the cost component must be separated from the total payment; only the cost component can be excluded from BEAT. In other words, the markup or profit component is always subject t

Planning Considerations

Multinational enterprises (MNEs) should undertake careful analysis of outbound payments for intercompany services to determine if some of the payment may be excluded from BEAT using the SCM exception, whether or not the SCM was used to determine the transfer pricing of those services.

In addition, MNEs availing themselves of the SCM exception must maintain records that document the total amount of costs of the intercompany services and the method used to apportion those costs between the services eligible for the SCM exception and those that are not.

MNEs should also coordinate their transfer pricing policies and documentation with their BEAT analysis and documentation to support consistency between them. For example, transfer pricing benchmarks with cost-plus markups above 7% may preclude the use of the SCM exception, even if the actual markup used for transfer pricing purposes was below 7%.

The OBBBA restored the full expensing of domestic research costs for tax years beginning after December 31, 2024 (although foreign research costs must still be amortized over 15 years). Moreover, the legislation also restored 100% bonus depreciation for property placed in service after January 19, 2025. As a result of these changes, as well as changes to the business interest deduction calculation, regular tax liability for many U.S. companies may decrease, potentially creating exposure to BEAT in 2025 and going forward. For U.S. companies that may no longer generate sufficient regular tax to offset BEAT as a result of the changes in the OBBBA, the SCM exception should be considered to potentially mitigate this new exposure

 

Public Country-by-Country Reporting

Public country-by-country reporting (CbCR) mandates are already a reality in some jurisdictions, including Australia and the EU member states. U.S.-parented MNEs with constituent entities located in these jurisdictions should be preparing to comply with public CbCR requirements even though the U.S. does not require public reporting of CbCR data.

Australia

The Australian Parliament passed legislation introducing a public CbCR obligation effective from July 1, 2024. The legislation places a filing obligation on both foreign- and Australia-headquartered multinationals that have an Australian presence with more than AUD $10 million (approximately $6.7 million) of Australia-source revenue and AUD $1 billion (approximately $667 million) or more in global income. It requires these MNE groups to submit information on their global financial and tax footprint to the Australian Taxation Office (ATO), which will be made available publicly.

Under the regime, the parent entity of an MNE — rather than the Australian subsidiary — generally has the reporting obligation.

The public CbC report legislation applies for reporting periods beginning July 1, 2024, and reports are due within 12 months of the end of the reporting period

EU

The EU on December 1, 2022, published in the Official Journal a directive that requires reporting entities to make publicly available a country-by-country (CbC) breakdown of the group's profits and certain economic, accounting, and tax aggregates. The directive entered into force on December 21, 2021, and applies from the beginning of the first financial year starting on or after June 22, 2024. The CbC report is to be published within 12 months of the financial year-end, so that the dates for filing the OECD CbC report and for publishing the public CbC report are aligned.

The directive affects two broad categories of entities. First, groups whose “ultimate parent undertaking” is outside the EU must file public CbC reports, if they have subsidiaries or branches within the EU, and if the EUR 750 million revenue threshold is met at a global level. However, EU subsidiaries and branches must report only if certain thresholds are also exceeded at the local level. Second, groups whose ultimate parent is in the EU must file public CbC reports when those groups have a consolidated group revenue of at least EUR 750 million.

The EUR 750 million threshold for the EU’s public CbC report is the same as for the original OECD CbC report, but it must be met for each of the last two consecutive financial years rather than for only the prior year, as is the case for the OECD CbCR obligation.

Although some of the information to be reported for purposes of the OECD CbCR also must be reported in the EU’s public CbC report, the EU public CbC report does not require the disclosure of the full OECD CbC report data.

The public CbCR generally should be published on the reporting entity’s website. However, member states may instead allow publication on a register accessible to any party in the EU, provided that the reporting entity's website provides a link to the register's website.

Noncompliance with the publication obligation will be subject to penalties enacted by each EU member state.

Planning Considerations

Private companies in U.S.-parented MNEs should not assume that they do not have public CbCR filing requirements simply because the U.S. does not impose such a requirement. U.S.-parented MNEs need to be mindful of both the EU and Australian rules and deadlines regarding public CbCR filings.

U.S.-parented MNEs with operations in Australia that fall within the scope of the public CbCR regime there need to file a CbC report to avoid high administrative penalties for noncompliance of up to AUD 825,000 (approximately $535,000). Similarly, U.S.-parented MNEs with operations in EU member states must evaluate the filing requirements in each country to achieve compliance and avoid penalties.

Customs and Trade

 

The current trade environment is marked by rapid and often unpredictable changes, posing significant challenges for businesses. Since the Trump administration took office in January, the president has implemented, paused, retracted, and then changed a series of tariffs targeting both major—and not so major—U.S. trading partners, as well as various industry sectors (e.g., autos and auto parts, steel and aluminum, and copper), with pledges of more sectoral tariffs in the future (e.g., pharmaceuticals). The administration’s tariff authority is also subject to ongoing legal challenges.

 

The impact of the tariffs—within and outside the U.S.—has been consequential and includes threats of retaliatory actions from trading partners, increased costs, and supply chain disruptions, and has resulted in considerable uncertainty for businesses engaged in international trade. Businesses may face unexpected duties on goods they import or export, impacting pricing strategies and profit margins. Additionally, the uncertainty can hinder long-term planning and investment decisions, as companies struggle to anticipate future trade policy shifts. In the M&A world, it’s becoming more challenging to conduct proper due diligence for any mergers, sales, or acquisitions given the complexity of the tariff liability (spanning at least 11 different kinds of tariffs) and significant cash amounts in play.

 

Staying informed and proactive is key to navigating these challenges and increasing duty savings, and there are duty and supply chain strategies importers can consider to mitigate the impact of increased costs. Public companies may be able to benefit from the following strategies to manage costs, improve compliance, and maintain agility in their international trade operations.

 

Duty Drawback

 

Private companies should take advantage of opportunities for cash refunds of up to 99% of duties, fees, and taxes paid through the duty drawback program. This incentive allows for a refund on imported goods that are subsequently exported, unused, destroyed, or used to manufacture a product that is exported. Note that duty drawback is not available for certain tariffs, including Section 232 and International Emergency Economic Powers Act (IEEPA) fentanyl-related tariffs.

 

To enhance this benefit, it is essential to:

 

• Identify the full scope of imports and exports eligible for drawback;
• Estimate the potential cash benefit; and
• Test data and document readiness, especially when the exporter is not the importer of record.

 

This process involves gathering comprehensive import, production (if applicable), and export data for the five-year look-back period, defining a process for ongoing claim data preparation, and conducting additional data and document testing to support compliance and enhance refund opportunities.

 

 

First Sale Rule (FSR)

 

Goods imported into the U.S. must be properly valued at the time of import for U.S. Customs and Border Protection (CBP) to assess the correct amount of import duties. The primary method for determining customs value is transaction value, which refers to the price actually paid or payable for the merchandise when sold for exportation to the U.S. CBP generally presumes the dutiable value is the price paid by the U.S. importer to its direct supplier.

 

The FSR principle is a customs valuation strategy that allows importers to declare the value of goods based on the price paid in the earliest sale in a multitiered international supply chain leading to the import transaction. This often applies when a middleman is involved in the invoice flow but not in the product flow. In such cases, the original factory invoice can serve as the customs value, rather than the marked-up invoices in multitiered transactions, potentially reducing the dutiable value and resulting in significant duty savings. Companies with only a single sale can also create a new middleman (typically, a trading company) to insert a new sale into the import flow to take advantage of FSR.

 

To utilize this rule, clients must support the claim with sufficient documentation, including:

 

• Evidence that goods are clearly destined for export to the U.S.;
• Proof of a bona fide sale, e.g., valid title transfers; and
• Confirmation that all intercompany pricing is arm’s length.

 

 

Cost Unbundling

 

Companies can consider conducting a cost unbundling analysis to reduce tariff liability. By evaluating whether certain cost elements associated with imported merchandise can be excluded from the calculation of the final customs value, companies may be able to lower the existing customs value of their goods and, consequently, reduce the duties owed.

 

Examples of potentially nondutiable cost elements include:

 

• Certain management services fees;
• Buying commissions;
• Exclusive distribution rights fees; and
• U.S.-based R&D costs.

 

If these costs or fees are included in the value of the imported merchandise, U.S. importers may be able to deduct them from the final customs value.

 

Customs Valuation and Transfer Pricing

 

The interaction between customs valuation and transfer pricing should not be overlooked, as this may have a significant economic impact on companies involved in imports of tangible goods from related parties. The connection is all the more important today because with 50% of all world trade in merchandise taking place between related parties, many U.S. distributors will be paying more in customs duties than income taxes.

 

Companies that use transfer pricing studies or advance pricing agreements must pay close attention to CBP’s arm’s length pricing rules, such as the need to document the basis for the declared customs transaction value of imported merchandise and how transfer prices under the IRS rules support the central goal of CBP’s rules, i.e., that the parties’ relationship did not influence the price of any class or kind of merchandise. Keeping up with volatile trade policies and ensuring that transfer pricing policies and supporting documentation are current and compliant for both customs and tax purposes is demanding but can yield impactful results, including potential customs duty refunds for year-end transfer pricing adjustments.

 

Other Considerations

 

Tariff classification is a critical aspect of international trade because it determines the duty rates and regulatory requirements that apply to imported and exported goods. In the current trade environment, it is especially important for companies to review the tariff codes of any merchandise subject to additional trade remedy tariffs such as Section 301 tariffs and confirm their accuracy.

 

If the codes are correct, businesses should determine whether the merchandise qualifies for any product exemptions from additional duties, which could help avoid additional duties

 

 

 

Compensation and Benefits

 

 

Human capital challenges remain at the forefront as private companies look to retain and attract talent and leverage tax rules to efficiently offer competitive equity and benefit programs. This year companies will need to navigate several important new tax considerations. The OBBBA makes significant changes to compensation and benefit rules and imposes new reporting. The challenge will be even greater for companies with a global footprint, as they may need to adjust tax equalization payments to account for the individual tax changes in the new legislation.

 

New Employer Reporting Requirements on Tips and Overtime

Employers will be required to report qualified tips and qualified overtime compensation to both employees and the IRS beginning in 2025 to facilitate new individual deductions under the OBBBA. The deductions are effective from 2025 through 2028.

Businesses will have to make a number of important determinations to properly report tips, including:

• Identifying employees in occupations that customarily and regularly received tips before December 31, 2024
• Determining whether the tips are earned in a disqualified specified service trade or business
• Verifying that the tips are voluntary

For overtime reporting, employers will report only the additional compensation premium due to the higher overtime rate (the “half” in “time-and-a-half”). This includes only federal Fair Labor Standards Act (FLSA) required overtime premiums (not state/local or contractual overtime). Employees cannot use the same compensation as the basis for a deduction on their Form 1040 for both qualified tips and qualified overtime.

Planning Considerations

The IRS announced that it will not revise the 2025 Form W-2 or update 2025 withholding tables for qualified tips or qualified overtime, and it has not yet made clear the form and manner of reporting. Despite the current lack of clarity, employers will still be required to report qualified tips and qualified overtime to employees in 2025. Companies should update payroll and recordkeeping for the new reporting, which requires tracking data points that previously have never been separately identified. There will be transition relief in 2025 whereby the employer can approximate a separate accounting of amounts designated as qualified tips and qualified overtime using any reasonable method specified by the IRS. Qualified tips and qualified overtime remain subject to federal withholding and benefit plan compensation rules.

For 2026, the IRS released a draft Form W-2 that adds a new Box 14b for the tipped occupation code, which will be used to report the deduction for qualified tips on Form 1040, Schedule 1-A. Box 14 (Other) has been renumbered as Box 14a on the draft 2026 Form W-2. However, there are no new boxes for qualified overtime or qualified tips. Instead, there are new codes for Box 12 for those items, as well as a new code for contributions to a “Trump account.”

 

OBBBA Enacts Significant Payroll & Benefits Changes

The OBBBA introduced numerous changes that may affect organizations’ management of payroll and employee benefits and compliance obligations. 

Higher 1099-NEC & 1099-MISC Reporting Threshold for 2026 Onward. For payments made after December 31, 2025, the threshold for providing a Form 1099-NEC (non-employee compensation, which is used for independent contractors) and Form 1099-MISC (used for amounts not reported on 1099-NEC or W-2) increases from $600 to $2,000. Starting in 2027, the $2,000 threshold will be indexed for inflation. This threshold has not changed since 1954.

Employer Tax Credit for Paid Family & Medical Leave (PFML).  For tax years beginning after December 31, 2025, the Section 45S employer tax credit for PFML becomes permanent and will include amounts paid for state-mandated paid leave and insurance premiums. The credit broadens the eligibility of part-time employees, clarifies the aggregation rules, and provides flexibility for multistate employers who operate in states where PMFL is not required even if the employer operates in other states that require PFML. These expansions are expected to make the credit more widely available to employers.

Employer Tax Credit for Employer-Provided On-Site Child Care.  For tax years beginning after December 31, 2025, the Section 45F employer tax credit for on-site employer-provided child care increases from $150,000 to $500,000 ($600,000 for small businesses), indexed for inflation, up to 40–50% of expenses (increased from 25%). The definition of qualified expenditures will expand to include costs of third-party arrangements and jointly owned or operated child care facilities

Employer Student Loan Debt Payments. The OBBBA made permanent the $5,250 annual amount that employers can pay or reimburse tax-free to employees for student loan debt payments if the employer has a written education assistance plan that complies with Section 127. Starting in 2026, the $5,250 will be indexed for inflation.

Planning Considerations

All employers should update their tracking and reporting for Form 1099-NEC and 1099-MISC, based on the significantly higher threshold for issuing those forms for 2026 and beyond.

Employers may want to revisit their eligibility for the expanded PFML and on-site child care tax credits.

Now that Section 127 permanently allows employers to make tax-free payments of student loan debt for employees, employers may want to look into adopting a written education assistance plan. The IRS recently published a model plan document, making it easier for employers to satisfy the written plan requirement.

IRS Issues Guidance for State Paid Family and Medical Leave Programs

 

The IRS recently issued its first-ever guidance on the federal income and employment tax treatment of contributions made to, and benefits paid from, a state-run paid family and medical leave (PFML) program, as well as the related reporting requirements. This had become an area of concern for many employers since more than a dozen states have enacted PFML laws without any federal guidance on how to tax the premiums paid to and benefits paid from such programs.

 

Rev. Rul. 2025-4 provides rules for employers operating in the states (and the District of Columbia) that have mandatory PFML programs and for employees working in those states. These state programs pay employees who can’t work because of non-occupational injuries to themselves or family members, as well as sickness and disabilities. While the details of the programs vary substantially from state to state, PFML programs generally operate as social insurance programs, with premium contributions from both employers and employees and benefits paid at a fixed rate, based on the employee’s wages.

 

2025 Transitional Relief

 

The ruling is effective for PFML benefits paid by a state on or after January 1, 2025. However, it provides transition relief for states and employers for calendar year 2025 from withholding, payment, and information reporting requirements for state PFML benefits. For 2025 only, employers who voluntarily “pick up” the required employee contribution into a state PFML fund are not required to treat those amounts as wages for federal employment tax purposes.

 

Key Points

 

The guidance draws important distinctions on how contributions and benefits are treated for federal income and employment tax purposes. Employers will need to pay careful attention to these new rules.

 

The guidance clarifies the following key points:

 

• Employers can deduct their contributions to state mandatory PFML programs as a payment of an excise tax.
• Employees can deduct their contributions to such programs as a payment of state income tax, if the employee itemizes deductions, to the extent the employee’s deduction for state income taxes does not exceed the state income tax deduction limit. However, required employee contributions to the state PFML program are not excludible from income under Section 106 (i.e., the contributions are after-tax, not pre-tax).
• Employees who receive state-paid family leave payments must include those amounts in the employee’s gross income. Generally, the IRS considers benefits that replace wages during an employee’s leave as wages for income and employment tax purposes, unless the benefits qualify for an exclusion. Paid family leave is generally not eligible for any exclusion. Employees also do not have a “tax basis” in employee or employer pick-up contributions previously treated as taxable wages.
• Employees who receive state paid medical leave payments must include the amount attributable to the employer’s portion of the contributions in the employee’s gross income and such amount is subject to both the employer and employee share of Social Security and Medicare taxes. The amount attributable to the employee’s portion of the contributions is excluded from the employee’s gross income and is not subject to Social Security or Medicare taxes.

 

Thus, except for leave for the employee’s own injury or illness, PFML is not accident or health insurance, so most PFML benefits will be taxable to the employee.

 

Planning Considerations

 

Employers should update their payroll systems to come into compliance with the new rules starting with the 2026 calendar year. Such changes often take significant time to implement.

 

Failure to accurately reflect amounts on an employee’s Form W-2 can subject the employer to IRS penalties. The guidance places new administrative burdens on employers (and their payroll systems) to understand the income and employment tax consequences of such state PFML programs, and to coordinate with the states to obtain information that may be required to correctly report taxable benefits (in a manner similar to that which exists for employers that utilize a third-party insurer to administer short-term or long-term disability). Thus, employers will be expected to correctly determine the taxable and nontaxable contributions and benefits for payroll processing and W-2 reporting purposes. Employers should proactively review their payroll practices to achieve compliance.

 

Global Mobility Provisions Will Impact Tax-Equalized Employees

 

The OBBBA will also have a significant impact on the global mobility programs of private companies with employees working outside their home country. Some of the individual changes are immediately effective for 2025, so employers should quickly assess the implications for any tax equalization programs. The key changes most likely to affect global mobility programs and employees are outlined below.

 

 

Moving expenses: For tax years beginning after 2025, the OBBBA permanently suspends the moving expense deduction for employees (except for active-duty military members and those in the intelligence community) and the income tax exclusion for most taxpayers, which had been previously suspended under the TCJA from 2017 to 2025. Employers who pay employees’ moving expenses must report those amounts as taxable wages on Form W-2, making the amounts subject to income, Social Security, and Medicare taxes. Employers can deduct these amounts as compensation expenses.

 

Individual SALT limitation: The OBBBA temporarily increases the limit on the federal deduction for state and local taxes (the SALT cap) to $40,000 in 2025 (from the current $10,000) and adjusts it annually through 2029. In 2026, the cap will be $40,400, and then will increase by 1% annually, through 2029. Starting in 2030, the SALT cap will revert to the current $10,000.

 

The deduction amount available phases down for taxpayers with modified adjusted gross income (MAGI) over $500,000 in 2025. The MAGI threshold will be increased by 1% each year from 2026 to 2029. The phasedown will reduce the taxpayer’s SALT deduction by 30% of the amount the taxpayer’s MAGI exceeds the threshold amount, but the limit on a taxpayer’s SALT deduction could never go below $10,000

 

Limitations on itemized deductions: The OBBBA permanently repeals the Pease limitation, which had been suspended under the TCJA, but introduces a new rule: starting after 2025, the value of itemized deductions will be reduced by 2/37 of the lesser of the allowable itemized deductions or the excess of taxable income over the 37% tax rate threshold, effectively capping the benefit of itemized deductions at 35% for taxpayers in the highest tax bracket. The legislation also makes permanent the repeal of miscellaneous itemized deductions.

 

Excise tax on certain remittance transfers: The OBBBA imposes a 1% excise tax on electronic fund transfers of cash, money order, cashier’s check, or similar instrument from U.S. senders to foreign recipients, effective for transfers after December 31, 2025. Exemptions apply for transfers from certain financial institutions or those funded by U.S.-issued debit or credit cards. No tax credit is available for this tax.

 

Deduction for qualified residence interest: For tax years after 2025, the OBBBA makes permanent the limit on the mortgage interest deduction to acquisition debt of $750,000 ($375,000 if married filing separately), with the $1 million cap still applying to debt incurred on or before December 31, 2017.

 

Planning Considerations

 

The OBBBA provisions affecting global mobility deserve careful review and modeling of the cost implications for both global businesses and their mobile employees.

 

The greatest impact of the increased SALT cap for tax-equalized employees is that it will affect the employees’ actual and hypothetical tax liabilities, particularly for those who reside in high-tax states. However, high-income taxpayers may not fully benefit from the increased SALT cap because of the limitations on itemized deductions. In addition, because the SALT deduction is an add-back for alternative minimum tax (AMT) purposes, it may render some taxpayers subject to AMT.

 

With the OBBBA making permanent the repeal of miscellaneous itemized deductions, employees repaying income of $3,000 or less will not be entitled to a deduction. Consequently, tax-equalized employees who repay tax settlement balances to their employers cannot receive a tax benefit for this repayment. However, repayments exceeding $3,000 may still be claimed as a credit or deduction on the tax return, since they are eligible for claim of right treatment.

 

Because itemized deductions, such as the mortgage interest deduction, directly impact a tax-equalized employee’s hypothetical and actual tax liability, global mobility programs should work with their tax advisors to determine how program costs may be impacted.

 

 

IRS Instructed to Phase Out Paper Refund Checks

 

An executive order signed on March 25, 2025, instructs the IRS to discontinue issuing paper checks for tax refunds. After September 30, 2025, a taxpayer who is expecting a tax refund from the IRS will generally receive the refund via direct deposit to a U.S. bank account. This could present a problem for global mobility programs and their cross-border employees.

 

Because the IRS limits the number of refunds that can be deposited into a single financial account, many global mobility programs are unable to directly receive U.S. tax refunds for their equalized cross-border employees. Consequently, these employees must first receive their tax refunds in their U.S. bank account and subsequently remit the funds to the company.

 

The absence of paper refund checks creates a challenge for foreign nationals without a U.S. bank account because tax refunds can only be deposited into an account with a routing number linked to a U.S. bank. In addition, those foreign nationals who do have a U.S. bank account will need to maintain their account after departing the U.S. so that any forthcoming tax refunds to be received.

 

Non-U.S. individuals who do not have a U.S. bank account may now need to rely on other options, such as international wire transfers, credit cards, debit cards, or digital wallets.

 

Planning Considerations

 

While additional guidance is expected from the IRS, global mobility programs should proactively prepare for these changes. Preparations may include making changes to the program’s current procedures regarding the receipt of tax settlement payments and exploring alternative digital payment options for their cross-border employees.

 

 

State and Local Taxes

State and local tax (SALT) issues consistently rank among the top concerns of tax and finance professionals. The 2025 BDO Tax Strategist Survey found that the most prevalent issues in audits and disputes were SALT-related (52%). It’s no surprise why. State laws evolve rapidly and vary widely by entity, income, or industry.

This year will only bring more complexity. The OBBBA made significant changes to federal tax law that will have many implications for state tax planning based on conformity decisions. Fortunately, there are plenty of planning strategies, including nexus evaluations and apportionment reviews, to manage state tax issues.

State Conformity Planning Considerations

State considerations will be important for companies implementing the OBBBA changes. The dizzying variety in state conformity regimes can present planning challenges.

States are split roughly 50-50 between conforming to the U.S. Internal Revenue Code on a rolling basis versus a fixed-date basis. Complicating the picture, states in both categories often choose not to conform to specific provisions for policy or revenue reasons.

States with rolling conformity will generally incorporate OBBBA changes by default unless they specifically opt to decouple from particular provisions. States with fixed-date conformity will have to proactively update their conformity dates or rules to implement any OBBBA changes. Fixed-date states are even more likely to make state-specific deviations as part of the process.

Many of the most important provisions in the OBBBA offer multiple implementation options, and the state treatment will be a major factor in planning decisions. Companies should fully assess the state implications of various federal planning strategies.

Key considerations for major provisions include:

• Section 174 expensing: The restoration of expensing of domestic research costs will potentially harmonize the federal and state treatment for the handful of states that have already decoupled from the pre-OBBBA rules requiring five-year capitalization. States that follow the capitalization rules might need to consider whether to revert to expensing and whether to incorporate the federal transition rules for accelerating unused deductions. Companies should pay particular attention to how quickly states with fixed conformity dates react because the provision is generally effective for tax years beginning after 2024.

 

• Section 163(j): Many states will be tempted to decouple from the OBBBA provision restoring the more favorable calculation of the limit on the interest deduction under Section 163(j), which could be costly. Because the rules are generally effective for tax years beginning after 2024, fixed-date conformity states will face an early deadline for action

 

• Bonus depreciation: Many states already decouple from bonus depreciation for revenue reasons and will be unaffected by the restoration of the 100% rate. All states will have to decide whether to conform to the new expensing provision for building property used in some production activities. Current conformity statutes for bonus depreciation likely will not cover the new provision because it was created under new Section 168(n) and not incorporated as part of the existing bonus depreciation rules under Section 168(k).

 

• Base erosion and anti-abuse tax: The BEAT rate will increase from 10% to 10.5%, but taxpayers retain planning options such as interest capitalization and the election to waive deductions under Reg. §1.59A-3(c)(6). Companies should consider the state income tax implications of those choices.

 

• Section 250 deduction: For states that allow the deduction under Section 250 for foreign-derived intangible income (now foreign-derived deduction-eligible income or FDDEI) and global intangible low-taxed income (now net controlled foreign corporation (CFC) tested income or NCTI), the amounts will likely need to be recomputed. When there are differences in profile between a company’s federal consolidated group and state filing (for example, a combined group with different members for state purposes or a state that requires separate filing), companies should remember that the NCTI inclusion must be recomputed.

 

• Charitable contributions: The new 1% floor for corporate charitable deductions is likely to create significant differences in state and federal charitable carryforwards.

 

Turning State Tax Complexities into a Plan for Success

SALT laws evolve rapidly and are becoming increasingly convoluted. However, what makes state tax so challenging isn’t just the complexity – it’s also the inconsistency. Rules vary not just across states but also within the same state based on the type of entity, income, or industry. Navigating the fragmented state tax landscape requires proactive strategies and knowledgeable guidance to manage compliance, reduce tax liabilities, and mitigate risks. That’s why companies of all sizes should consider a range of planning strategies.

A holistic review of state tax issues can unlock tax savings opportunities by helping companies identify nexus and filing obligations, uncover potential past exposures, and leverage voluntary disclosure programs to limit penalties and interest. Companies should also analyze apportionment methods and filing practices to correctly perform tax calculations, and to potentially reveal missed deductions, credits, or alternative methods that can reduce state tax liabilities.

It's critical to have robust internal and external resources in the tax function to strategically plan for changes. Quality professional guidance supports business restructurings, expansions, and mergers and acquisitions by improving state tax outcomes and preventing future risks related to combined reporting and intercompany transactions.

Companies should also make sure they have an effective audit defense. This includes preparing documentation, engaging with tax authorities, and leveraging deep knowledge of state statutes and processes to resolve audits efficiently and avoid prolonged disputes and unfavorable outcomes.

Planning Considerations

State taxation cannot be treated as an afterthought because it can affect where a company operates or how it is structured. Without an informed approach, companies risk missing state tax savings, facing unexpected state tax liabilities, and losing control over a growing portion of their tax profiles. Ensuring the tax function has adequate internal and external support can turn those risks into advantages by offering not just compliance but also strategy and foresight.

 

Harnessing the Power of State Apportionment Rules

Apportioning income across the states where a private company does business is a highly complicated area of SALT, especially given that states continue to change their apportionment rules and the guidance on those rules. It takes a deep tax bench to keep up with the ever-evolving SALT landscape. Understanding apportionment, particularly sales factor sourcing, can help businesses identify tax liabilities and savings opportunities across different states.

While states have shifted from three-factor to single-sales factor formulas, using market-based sourcing for services and intangibles, their methodologies vary. That results in diverse interpretations of where sales are sourced, such as in the context of services which may focus on the location where the service is delivered, where the customer is located, or where the benefit of the service is received. Further, states apply different sourcing rules depending on service type and industry, or how the intangible was used, with cascading rules that require moving through multiple sourcing methods if the location cannot be determined, sometimes requiring reasonable approximations. And despite some state guidance, ambiguities remain, leading to multiple reasonable interpretations of sourcing methods, especially when applying reasonable approximation methods.

Many states also allow requests for alternative apportionment methods if standard methods do not fairly represent activities conducted in the state, but approval depends on following specific procedures and maintaining proper documentation.

Planning Considerations

It is important to examine each company’s facts. The nature of a private company’s revenue streams and business activities influences which sourcing rules apply, with distinctions such as in-person versus electronic services affecting sourcing outcomes. Detailed apportionment studies help uncover tax exposures and savings by analyzing company facts against varied state rules, preventing overreporting or underreporting across states.

 

Addressing SALT Exposure Using Effective Transfer Pricing Strategies

State transfer pricing is an often overlooked but critical element of tax planning. While companies frequently focus on federal and international transfer pricing issues, the state implications can be equally material. Ignoring state transfer pricing considerations can expose companies to substantial state tax risk, unexpected state tax liabilities, and missed opportunities for state tax savings.

Every transfer pricing arrangement that affects related-party transactions has potential state tax consequences, whether in cross-border contexts or purely domestic settings. States apply their own rules, often diverging significantly from federal standards, creating substantial complexity. If state impacts are not analyzed, companies can face duplicative adjustments, double taxation, or disallowed deductions.

Integrating state transfer pricing into overall tax planning delivers two key advantages:

• It reduces exposure to audit challenges and penalties, and it can unlock meaningful tax savings by aligning intercompany pricing with state-specific requirements.
• Companies that proactively incorporate state rules into their transfer pricing policies strengthen compliance, lower risk, and improve after-tax results.

Given the differences in state rules — from separate reporting jurisdictions to combined reporting states with unique adjustment powers — thoughtful planning and detailed documentation are essential. By embedding state transfer pricing analyses into benchmarking, implementation, and continual monitoring, taxpayers can better navigate the evolving SALT landscape while safeguarding enterprise value.

.

Financial Statements

The tax function is under increasing pressure. Legislative changes and new disclosure rules will make accounting for income taxes more complex and challenging. Plus, it’s not enough to be reactive: The tax function also must proactively identify and manage tax risk while incorporating planning considerations into key business decisions. Automation, data management, and analytics can help. It’s important to give tax leaders a seat at the decision-making table and to be aware of major changes in the legal, regulatory, and economic landscapes.

 

OBBBA Implications for Income Tax Accounting

The OBBBA made important tax law changes that will affect U.S. income tax accounting under Accounting Standards Codification (ASC) 740, Income Taxes, including current and deferred taxes, valuation allowances, and financial disclosures. The changes have varied effective dates and will affect corporate tax provisions, international tax rules, energy credits, and state tax considerations.

Key corporate provisions include:

• Restoring 100% bonus depreciation;
• Reinstating expensing for domestic R&E expenditures;
• Modifying the Section 163(j) interest limit;
• Amending the rules for energy credits;
• Expanding Section 162(m) aggregation requirements; and
• Updating the rules for GILTI (now NCTI) and FDII (now FDDEI)

President Trump signed the bill July 4, 2025, which is considered the enactment date under U.S. generally accepted accounting principles (GAAP).

Tax Law Changes

Changes in taxes payable or receivable resulting from the new law are reflected in the annual effective tax rate (AETR) in the period including the enactment date, with discrete recognition of prior-year adjustments. Law changes affecting deferred taxes on temporary differences are also recognized discretely at enactment.

Some companies may be considering an alternative policy to use beginning-of-year temporary differences and related deferred tax balances when evaluating the impact of tax law changes during an interim period. Companies should discuss the approach with their auditors and tax advisors.

Planning Considerations

If a tax law change is retroactive, the accounting treatment depends on whether the impact relates to prior periods or the current year. For prior-period deferred taxes and taxes payable or receivable, the effect is recognized discretely in the period of enactment. However, if the retroactive change affects current-year taxes payable or receivable – when the effective date is before the enactment date but still within the current year – the impact is recognized through an adjustment to the AETR. The updated AETR is then applied to year-to-date ordinary income, resulting in a catch-up adjustment for taxes payable or receivable in earlier interim periods.

Companies should consider that rule when assessing the financial reporting implications of some provisions enacted in July 2025 that are retroactive to the beginning of 2025. That includes provisions such as R&E expensing, Section 163(j) limitation on interest deductions, and 100% bonus depreciation (for property acquired and placed in service after January 19, 2025).

Valuation Allowance

Adjustments to valuation allowances for deferred tax assets (DTAs) existing at enactment are discrete items, while allowances for temporary differences arising after enactment are incorporated into the estimated AETR.

The major corporate provisions discussed above could affect projections of future taxable income, potentially triggering a change in judgment about the realizability of DTAs

Planning Considerations

Before, companies might have recorded a full valuation allowance on their Section 163(j) DTA as a result of the interest deduction limitation being based on 30% of adjusted taxable income, which included amortization, depreciation, and depletion (that is, the earnings before income and taxes limitation). The reinstatement of the earnings before income, taxes, depreciation, and amortization limitation under Section 163(j) for tax years beginning after December 31, 2024, might require a reassessment of the realizability of the current-year disallowed interest deduction and Section 163(j) carryforward DTAs from prior years that were previously subject to a full valuation allowance.

International Taxation

The OBBBA modifies the rules for GILTI (now NCTI) and FDII (now FDDEI) by raising effective tax rates and altering deductions and expense allocations effective for tax years after 2025. It also raises the base erosion and anti-abuse tax (BEAT) rate from 10% to 10.5% for tax years beginning after 2025 and repeals a scheduled 2026 change that would have increased BEAT liability by the sum of all income tax credits.

Because most of the OBBBA international provisions do not take effect until tax years beginning after December 31, 2025, companies will likely see an immediate accounting impact at enactment only if the law change affects their valuation allowance assessments.

Other Changes

The OBBBA curtails Inflation Reduction Act energy tax incentives, imposes new restrictions, and phases out credits.

Companies must assess uncertain tax positions under ASC 740 and analyze state and local tax effects based on conformity with federal tax changes, especially regarding bonus depreciation, R&E expensing, FDII, GILTI, and interest deductibility.

Planning Considerations

Companies need to consider disclosing the expected effects of new tax laws in the notes to the financial statements, management’s discussion and analysis, and risk factors.

Tax law changes enacted after interim balance sheet dates but before financial statements are issued are considered nonrecognized subsequent events, requiring disclosure of nature and estimated effects if material. Annual statements must detail tax effects of enacted changes and reconcile the effective tax rate accordingly.

Companies must assess the impact of the tax legislation on their income tax provision calculations, including current and deferred tax balances, the AETR, valuation allowances, and related financial statement disclosures. The provisions are highly interconnected, so the analysis will likely require extensive modeling and planning. Further, it is important to consider how the changes apply to specific facts and circumstances

New Income Tax Disclosures

Private companies should be preparing for new rules meant to increase the transparency and usefulness of income tax disclosures by improving those related to the rate reconciliation and income taxes paid.

Accounting Standards Update (ASU) No. 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures,” will be effective for entities other than public business entities (PBEs) for fiscal years beginning after December 15, 2025. Early adoption is allowed.

The new rate reconciliation rules involve standardized categories and greater disaggregation of information based on a quantitative threshold. The income taxes paid disclosures must be disaggregated by jurisdiction. ASU 2023-09 further mandates disaggregation of pretax income or loss and income tax expense or benefit from continuing operations and eliminates some disclosures.

Income Taxes Paid

Information on taxes paid (net of refunds) must be disaggregated for federal, state, and foreign taxes. Further disaggregation is required for specific jurisdictions if the income taxes paid (net of refunds) meet or exceed the quantitative 5% threshold.

The quantitative threshold is calculated by dividing the income taxes paid (net of refunds) in a jurisdiction by the total income taxes paid (net of refunds). In quantifying the 5% threshold for income taxes paid, the numerator of the fraction should be the absolute value of any net income taxes paid or income taxes received for each jurisdiction and the denominator should be the absolute value of total income taxes paid or refunds received for all jurisdictions in the aggregate.

The ASU made no changes to interim disclosure requirements.

Rate Reconciliation

Entities other than PBEs must qualitatively disclose the nature and effect of specific categories of reconciling items and the individual jurisdictions that result in a significant difference between the statutory and effective tax rates. They do not have to present the information in tabular format or provide numerical reconciliations. All reconciling items should be presented on a gross basis.

In the annual rate reconciliation disclosures, entities other than PBEs must include:

1. State and local income taxes in the country of domicile net of related federal income tax effects;
2. Foreign tax effects, including state or local income taxes in foreign jurisdictions;
3. Effects of changes in tax laws or rates enacted in the current period;
4. Effect of cross-border tax laws;
5. Tax credits;
6. Changes in valuation allowances;
7. Nontaxable or nondeductible items; and
8. Changes in unrecognized tax benefits.

See Example 3-2 in BDO’s ASU 2023-09 Mini Guide (taken from an example in ASC 740) outlining the differences between reporting for PBEs and non-PBEs.

Income Statement

The ASU made minor changes to the required income statement disclosures relating to income taxes to conform to existing SEC requirements, stipulating that income or loss from continuing operations before income tax expense or benefit be disclosed and disaggregated between domestic and foreign sources.

The update also requires the disclosure of income tax expense or benefit from continuing operations disaggregated by federal, state, and foreign jurisdictions. Income tax expense and taxes paid relating to foreign earnings that are imposed by the entity’s country of domicile would be included in tax expense and taxes paid for the country of domicile.

Eliminated Disclosures for PBEs and Non-PBEs

Entities no longer are required to disclose information concerning unrecognized tax benefits that have a reasonable possibility of significantly changing in the 12 months following the reporting date, nor must they make a statement that an estimate of the range cannot be made.

ASU 2023-09 also removed the requirement to disclose the cumulative amount of each type of temporary difference when a deferred tax liability is not recognized because of the exceptions to comprehensive recognition of deferred taxes related to subsidiaries and corporate joint ventures. Entities still must disclose the types of temporary differences for which deferred tax liabilities have not been recognized under ASC 740-30-50-2(a), (c), and (d).

Using Year-End Lessons to Improve Process

Effective management of the year-end close process is crucial for companies to adapt to changing financial numbers, regulatory environments, and business transformations. Improving the process enhances the tax function’s strategic role and supports accurate, timely financial reporting. Starting it months in advance helps address resource constraints and regulatory complexities, enabling more efficient and accurate closings.

Companies benefit from understanding tax- and accounting-related risks, which prepares them for growth and regulatory changes. To build trust with leadership, tax departments should implement comprehensive reporting that explains key performance indicators (KPIs) and any differences between forecasted and actual results from both GAAP and non-GAAP perspectives.

A flight plan, or a detailed checklist covering calculation methodologies, documentation, and key milestones, can help tax teams manage adjustments (especially late changes) and supports audit readiness. If some adjustments cannot be automated, it is crucial to document estimation methodologies and involve the audit function to achieve accuracy and compliance.

Post-close discussions with C-suite executives about KPI variances and internal reviews of the close process foster transparency and identify areas for enhancement.

Integrating tax provision software and other technologies reduces reliance on spreadsheets, improves accuracy, accelerates calculations, and lowers risk. All that positions the tax function for future challenges.

How Mature Are Your Operations?

Tax function maturity significantly affects risk management. Mature tax functions possess effective processes and technology and are involved in key business decisions, thereby helping reduce operational tax risks. Less mature functions are susceptible to unanticipated tax issues.

Strategic tax goals enhance any overall company impact, making it imperative for tax leaders to have a seat at the decision-making table. Including them in C-suite agendas helps proactively manage tax implications across an array of business lines and initiatives. That in turn drives sustainable value.

Companies must also consider adequate resourcing and strive to build tax teams with the right personnel, processes, and technology. Compliance and reporting benefit from a deep tax bench, and mature tax departments leverage advanced technology for automation, data management, and analytics to improve accuracy and mitigate potential tax risks. Further, tax leaders must develop strategies to improve transparency and align sustainability and tax goals.

The bottom line? Proactivity reduces risk. Tax strategists are proactive in anticipating and mitigating tax risks. Less mature tax tacticians tend to be reactive, which makes their companies more vulnerable to risks and underscores the need for ongoing maturity improvement.

Key Considerations in Addressing Tax Risk

Rapid changes in regulatory requirements, technology, and growth patterns have made tax risk management critical. Despite an increased business and regulatory focus on tax, many organizations have yet to adopt comprehensive tax risk mitigation strategies or fully leverage tax technology. Effective management involves upgrading technology, ensuring the internal tax team is focused on strategy (with possible outsourcing of more routine tasks), and conducting global tax risk reviews with cross-functional collaboration.

Common contributors to heightened risk include:

• Noncompliance, or an inability to keep up, with new laws;
• Organizational changes such as market expansion or mergers;
• Under-resourced tax teams;
• A lack of automation; and
• Failure to seek external advisory services.

To mitigate potential financial, legal, and reputational consequences, tax leaders should consider conducting global tax risk reviews to better understand and manage risk by identifying strengths and weaknesses. Those reviews should involve members from cross-functional teams to anticipate scenarios that could lead to tax risk. Prioritizing those risks and planning mitigation strategies may include implementing tax internal controls, maintaining process documentation, developing contingency plans, and ensuring tax leaders have a seat at the table during business decision-making processes.

 

 

2025 Year-End Tax Planning for Individuals

 

With the passing of the One Big Beautiful Bill Act (OBBBA), the Federal Reserve cutting interest rates, and inflation showing signs of moderating, tax planning remains as important as ever for taxpayers seeking to manage cash flows and reduce their tax liabilities over time. As we approach the end of the year, now is the time for individuals, business owners, and family offices to review their 2025 and 2026 tax situations and identify opportunities for reducing, deferring, or accelerating their tax obligations.

The information contained within this article is based on federal laws and policies in effect as of the publication date. This article discusses tax planning for federal taxes. Applicable state and foreign taxes should also be considered. Taxpayers should consult with a trusted advisor when making tax and financial decisions regarding any of the items below.

 

INDIVIDUAL TAX PLANNING HIGHLIGHTS

 

2025 Federal Income Tax Rate Brackets

Tax Rate	Joint / Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 – $23,850	$0 – $11,925	$0 – $17,000	$0 – $11,925	$0 – $3,150
12%	$23,851 – $96,950	$11,926 – $48,475	$17,001 – $64,850	$11,926 – $48,475	–
22%	$96,951 – $206,700	$48,476 – $103,350	$64,851 – $103,350	$48,476 – $103,350	–
24%	$206,701 – $394,600	$103,351 – $197,300	$103,351 – $197,300	$103,351 – $197,300	$3,151 – $11,450
32%	$394,601 – $501,050	$197,301 – $250,525	$197,301 – $250,500	$197,301 – $250,525	–
35%	$501,051 – $751,600	$250,526 – $626,350	$250,501 – $626,350	$250,526 – $375,800	$11,451 – $15,650
37%	Over $751,600	Over $626,350	Over $626,350	Over $375,800	Over $15,650
2026 Federal Income Tax Rate Brackets
Tax Rate	Joint / Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 – $24,800	$0 – $12,400	$0 – $17,700	$0 – $12,400	$0 – $3,300
12%	$24,801 – $100,800	$12,401 – $50,400	$17,701 – $67,450	$12,401 – $50,400	–
22%	$100,801 – $211,400	$50,401 – $105,700	$67,451 – $105,700	$50,401 – $105,700	–
24%	$211,401 – $403,550	$105,701 – $201,775	$105,701 – $201,750	$105,701 – $201,775	$3,301 – $11,700
32%	$403,551 – $512,450	$201,776 – $256,225	$201,751 – $256,200	$201,776 – $256,225	–
35%	$512,451 – $768,700	$256,226 – $640,600	$256,201 – $640,600	$256,226 – $384,350	$11,701 – $16,000
37%	Over $768,700	Over $640,600	Over $640,600	Over $384,350	Over $16,000

 

 

TIMING OF INCOME AND DEDUCTIONS

Taxpayers should consider whether they can reduce their tax bills by shifting income or deductions between 2025 and 2026. Ideally, income should be received in the year with the lower marginal tax rate, and deductible expenses should be paid in the year with the higher marginal tax rate. If the marginal tax rate is the same in both years, deferring income from 2025 to 2026 will produce a one-year tax deferral, and accelerating deductions from 2026 to 2025 will lower the 2025 income tax liability.

Actions to consider that may result in a reduction or deferral of taxes include:

• Delaying closing capital gain transactions until after year-end or structuring 2025 transactions as installment sales so that gain is deferred past 2025 (see also Long-Term Capital Gains).
• Triggering capital losses before the end of 2025 to offset 2025 capital gains.
• Delaying interest or dividend payments from closely held corporations to individual business-owner taxpayers.
• Deferring commission income by closing sales in early 2026 instead of late 2025.
• Accelerating deductions for expenses such as mortgage interest and charitable donations (including donations of appreciated property) to 2025 (subject to adjusted gross income (AGI) limitations).
• Evaluating whether non-business bad debts are worthless — and should be recognized as short-term capital losses — by the end of 2025.
• Shifting investments to municipal bonds or investments that do not pay dividends to reduce taxable income in future years.

Taxpayers that will be in a higher tax bracket in 2026 may want to consider potential ways to move taxable income from 2026 to 2025, so that the taxable income is taxed at a lower tax rate.

Current-year actions to consider that could reduce 2026 taxes include:

•  
•  
• Accelerating deductions such as large contributions to 2025.
• Accelerating residential and clean energy expenditures.

 

 

 

 

 

 

LONG-TERM CAPITAL GAINS

The long-term capital gains rates for 2025 and 2026 are shown below. The tax brackets refer to the taxpayer’s taxable income. Capital gains also may be subject to the 3.8% net investment income tax.

 

2025 Long-Term Capital Gains Rate Brackets

 

Long-Term Capital Gains Tax Rate	Joint / Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
%	$0 – $96,700	$0 – $48,350	$0 – $64,750	$0 – $48,350	$0 – $3,250
15%	$96,701 – $600,050	$48,351 – $533,400	$64,751 – $566,700	$48,351 – $300,000	$3,251 – $15,900
20%	Over $600,050	Over $533,400	Over $566,700	Over $300,000	Over $15,900

 

2026 Long-Term Capital Gains Rate Brackets

 

Long-Term Capital Gains Tax Rate	Joint / Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
0%	$0- $98,900	$0 - $49,450	$0 - $66,200	$0 - $49,450	$0 - $3,300
15%	$98,901 – $613,700	$49,451 - $545,500	$66,201 - $579,600	$49,451 - $306,850	$3,301 – $16,250
20%	Over $613,700	Over $545,500	Over $579,600	Over $306,850	Over $16,250

 

 

Long-term capital gains (and qualified dividends) are subject to a lower tax rate than other types of income. Investors should consider the following when planning for capital gains:

• Holding capital assets for more than a year (more than three years for assets attributable to carried interests)so that the gain upon disposition qualifies for the lower long-term capital gains rate.
• Adopting long-term deferral strategies for capital gains such as reinvesting capital gains into designated qualified opportunity zones.
• Investing in, and holding, “qualified small business stock” for at least three years.
• Donating appreciated property to a qualified charity to avoid long term capital gains tax (also see Charitable  Contributions).

 

 

 

NET INVESTMENT INCOME TAX

An additional 3.8% net investment income tax (NIIT) applies on net investment income above certain thresholds. The NIIT does not apply to income derived in the ordinary course of a trade or business in which the taxpayer materially participates. Similarly, gain on the disposition of trade or business assets attributable to an activity in which the taxpayer materially participates is not subject to the NIIT.

Impacted taxpayers may wish to consider deferring net investment income for the year, in conjunction with other tax planning strategies that may be implemented to reduce income tax or capital gains tax.

SOCIAL SECURITY TAX

The Old-Age, Survivors, and Disability Insurance (OASDI) program is funded by contributions from employees and employers through FICA tax. The FICA tax rate for both employees and employers is 6.2% of the employee’s gross pay, but is imposed only on wages up to $176,100 for 2025 and $184,500 for 2026. Self-employed persons pay a similar tax, called SECA (or self-employment tax), based on 12.4% of the net income of their businesses.

Employers, employees, and self-employed persons also pay a tax for Medicare/ Medicaid hospitalization insurance (HI), which is part of the FICA tax, but is not capped by the OASDI wage base. The HI payroll tax is 2.9%, which applies to earned income only. Self-employed persons pay the full amount, while employers and employees each pay 1.45%. An extra 0.9% Medicare (HI) payroll tax must be paid by individual taxpayers on earned income that is above certain AGI thresholds: $200,000 for individuals, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. However, employers do not pay this extra tax.

 

LONG-TERM CARE INSURANCE AND SERVICES

Premiums an individual pays on a qualified long-term care insurance policy are deductible as a medical expense. The maximum deduction amount is determined by the individual’s age.

 

Age	Deduction Limitation 2025	Deduction Limitation 2026
40 or under	$480	$500
Over 40 but not over 50	$900	$930
Over 50 but not over 60	$1,800	$1,860
Over 60 but not over 70	$4,810	$4,960
Over 70	$6,020	$6,200

 

 

 

RETIREMENT PLAN CONTRIBUTIONS*

Individuals may wish to maximize their annual contributions to qualified retirement plans and individual retirement accounts (IRAs).

• The maximum amount in elective contributions that an employee can make in 2025 to a 401(k) or 403(b) plan is

$23,500 ($31,000 if age 50 or over and the plan allows “catch-up” contributions). For 2026, these limits are $24,500 and $32,500, respectively.

• Effective January 1, 2025, the catch-up contribution was increased for plan participants who reached age 60, 61, 62,

or 63 during the year. The catch-up contribution limit is the greater of $10,000 or 150% of the general catch-up limit in effect for 2024. For 2025, the super catch-up contributions limit for participants age 60 through 63 is $11,250 ($7,500 multiplied by 1.5). In 2026, the increased catch-up limit remains at $11,250, indexed for inflation.

• The SECURE Act permits a penalty-free withdrawal of up to $5,000 from traditional IRAs and qualified retirement

plans for qualifying expenses related to the birth or adoption of a child after December 31, 2019. The $5,000 distribution limit is per individual, so a married couple could receive a total of $10,000.

• Under the SECURE Act, individuals are now able to contribute to their traditional IRAs in or after the year in which

they turn 70½.

• Beginning in 2023, the SECURE Act 2.0 raised the age at which a taxpayer must begin taking required minimum distributions (RMDs) to 73. If the individual reaches age 72 in 2024, the required beginning date for the first 2025 RMD is April 1, 2026.
• Individuals age 70½ or older can donate up to $108,000 in 2025 ($111,000 in 2026) to a qualified charity directly

from a taxable IRA.

• The SECURE Act generally requires that designated beneficiaries of persons who died after December 31, 2019, take inherited plan benefits over a 10-year period. Eligible designated beneficiaries (i.e., surviving spouses, minor children of the plan participant, disabled and chronically ill beneficiaries, and beneficiaries who are less than 10 years younger than the plan participant) are not limited to the 10-year payout rule. Special rules apply to certain trusts.
• Under final Treasury regulations (issued July 2024) that address RMDs from inherited retirement plans of persons

who died after December 31, 2019, and after their required beginning date, designated and non-designated beneficiaries will be required to take annual distributions, whether subject to a 10-year period or otherwise.

• Small businesses can contribute the lesser of (i) 25% of employees’ salaries or (ii) an annual maximum amount set

by the IRS each year to a simplified employee pension (SEP) plan by the extended due date of the employer’s federal income tax return for the year when the contribution is made. The maximum SEP contribution for 2025 is $70,000.

The maximum SEP contribution for 2026 is $72,000. The calculation of the 25% limit for self-employed individuals

is based on net self-employment income, which is calculated after the reduction in income from the SEP contribution (as well as for other things, such as self-employment taxes).

 

FOREIGN EARNED INCOME EXCLUSION

The foreign earned income exclusion is $130,000 in 2025 and increases to $132,900 in 2026.

ALTERNATIVE MINIMUM TAX

A taxpayer must pay either the regular income tax or the alternative minimum tax (AMT), whichever is higher. The established AMT exemption amounts for 2025 are $88,100 for unmarried individuals and individuals claiming head of household status, $137,000 for married individuals filing jointly and surviving spouses, $68,500 for married individuals filing separately, and $30,700 for estates and trusts. The AMT exemption amounts for 2026 are $90,100 for unmarried individuals and individuals claiming head of household status, $140,200 for married individuals filing jointly and surviving spouses, $70,100 for married individuals filing separately, and $31,400 for estates and trusts.

KIDDIE TAX

A child’s unearned income is taxed at the parents’ tax rate if that rate is higher than the child’s tax rate.

LIMITATION ON DEDUCTIONS OF STATE AND LOCAL TAXES (SALT LIMITATION)

For individual taxpayers who itemize their deductions, the OBBBA increased the SALT cap to $40,000 for 2025 with a phase down to $10,000 for taxpayers with more than $500,000 in income. The $40,000 amount

increases 1% per years 2026-2029. The SALT cap sunsets to $10,000 in 2030.

Notably, the pass-through entity deduction for SALT was retained, depending on client business and state. Various states have enacted new rules that allow owners of pass-through entities to avoid the SALT deduction limitation in certain cases.

 

ESTATE AND GIFT TAXES

For gifts made in 2025, the gift tax annual exclusion is $19,000 and for 2026 it is $19,000. For 2025, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $13.99 million per person. For 2026, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $15 million. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2025 and 2026, only the first $190,000 and $194,000, respectively, of gifts to a non-U.S. citizen spouse are excluded from the total amount of taxable gifts for the year.

Tax planning strategies may include:

•  
• Making larger gifts to the next generation, either outright or in trust.
• Creating a spousal lifetime access trust (SLAT) or a grantor retainedannuitytrust (GRAT) or selling assets to an intentionally defective grantor trust (IDGT).

CHARITABLE CONTRIBUTIONS

Cash contributions made to qualifying charitable organizations, including donor-advised funds, in 2025 and 2026 will be subject to a 60% AGI limitation. The limitation for cash contributions continues to be 30% of AGI for contributions to non-operating private foundations.

The OBBBA created a new 0.5% AGI floor before individual charitable contributions will be deductible. The OBBBA also introduced a new 35% maximum benefit for itemized deductions.

Tax planning around charitable contributions may include:

• Creating and funding a private foundation, donor advised fund or charitable remainder trust.
• Donating appreciated property to a qualified charity to avoid long term capital gains tax.

 

ADDITIONAL TAX PROVISIONS INTRODUCED BY OBBBA

The OBBBA introduced the following additional tax provisions to consider when tax planning:

• No tax on tips - Eligible tipped workers will be able to deduct up to $25,000 of their annual tip income from their federal taxable income for years 2025 through 2028.
• No tax on overtime - Federal income tax deduction for the “half” portion of “time-and-a half” overtime pay, up to a maximum of $12,500 annually for

individuals ($25,000 for joint filers), with the benefit phasing out for higher earners.

• Senior deduction - Individuals aged 65 and older can claim a temporary deduction up to $6,000 ($12,000 for married couples if both qualify). The deduction is available for itemizers and those taking the standard deduction, with the benefit phasing out for higher-income earners.
• Section 529 Plans - Offer greater flexibility, including an increased annual withdrawal

limit for K-12 expenses from $10,000 to $20,000 per student starting in 2026; an expanded list of qualified K-12 costs to cover items like books, tutoring, and standardized test fees; and eligibility for expenses related to workforce training, licensing, and certification programs.

• Deduction on car loan interest - For tax years 2025 through 2028, taxpayers

can deduct up to $10,000 annually for interest paid on a loan for a new, personal-use vehicle that was assembled in the U.S., with the deduction phasing out for higher incomes.

 

NET OPERATING LOSSES AND EXCESS BUSINESS LOSS LIMITATION

Net operating losses (NOLs) generated in 2025 are limited to 80% of taxable income and are not permitted to be carried back. Any unused NOLs are carried forward subject to the 80% of taxable income limitation in carryforward years.

A noncorporate taxpayer may deduct net business losses of up to $313,000 ($626,000 for joint filers) in 2025. The limitation is $256,000 ($512,000 for joint filers) for 2026. A disallowed excess business loss (EBL) is treated as an NOL carryforward in the subsequent year, subject to the NOL rules. With the passage of the OBBBA, the EBL limitation has been made permanent.

 

The president signed into law a sweeping reconciliation tax bill in a July 4 signing ceremony, capping a furious sprint to finish the legislation before the self-imposed holiday deadline. The Senate approved the bill in a 51-50 vote on July 1 after making a number of last-minute changes following intense bicameral negotiations. The House voted 218- 214 on July 3 to send the bill to the president’s desk.

Notable late changes to the version of the tax title released by the Senate Finance Committee on June 16 include:

Cutting Section 899 from the bill after reaching an agreement on Pillar Two with G-7 countries;
• Significantly amending the provisions on global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and the base erosion and anti-abuse tax (BEAT);
• Modifying the energy credits provisions;
• Removing the shutdown of state pass-through entity workarounds to the cap on deducting state and local tax (SALT);
• Removing an unfavorable expansion of the loss limit under Section 461(l);
• Reducing the new tax on remittances;
• Changing the opportunity zone provisions;
• Expanding to all residential construction an exception to the long-term contract rules; and
• Removing a new excise tax on litigation financing.

 

Also, President Donald Trump reportedly promised House conservatives that he would strictly enforce the beginning of construction rules for wind and solar projects and potentially make the permitting process more difficult.

With the legislation now final, taxpayers should focus on assessing its impact and identifying planning opportunities and challenges. The bill offers both tax cuts and increases that would affect nearly all businesses and investors. The Joint Committee on Taxation (JCT) scored the bill as a net tax cut of $4.5 trillion over 10 years using traditional scoring. Under the current policy baseline the Senate used for purposes of the reconciliation rules, that cost drops to just $715 billion. The Senate scored the provisions against a baseline that assumes temporary provisions have already been extended, essentially wiping out the cost of extending the tax cuts in the Tax Cuts and Jobs Act (TCJA).

 

The bill not only makes the TCJA tax cuts permanent but amends them in important ways. The legislation also offers a mix of favorable and unfavorable new provisions. Key aspects of the bill include:

Making 100% bonus depreciation permanent while temporarily adding production facilities;
• Permanently restoring domestic research expensing with optional transition rules;
• Permanently restoring amortization and depreciation to the calculation of adjusted taxable income (ATI) under Section 163(j) while shutting down interest capitalization planning;
• Increasing the FDII effective rate while changing the deduction allocations and other rules;
• Increasing the GILTI effective rate while changing the foreign tax credit (FTC) haircut and expense allocation rules;
• Increasing the effective rate on BEAT;
• Phasing out many Inflation Reduction Act energy credits early and imposing new sourcing restrictions;
• Creating new deductions for overtime, tips, seniors, and auto loan interest;
• Imposing a 1% excise tax on remittances;
• Increasing filing thresholds for Forms 1099-K, 1099-NEC, and 1099-MISC;
• Extending opportunity zones with modifications;
• Increasing transfer tax exemption thresholds; and
• Increasing the endowment tax to a top rate of 8%.

Takeaway
Now that the legislation is final, taxpayers should assess its impact carefully and consider planning opportunities. Several key provisions offer different options for implementation. The effective dates will be important, and there may be time-sensitive planning considerations. 

 

The following offers a more detailed discussion of the provisions. For a comparison of the tax provisions to current law and the campaign platform see BDO’s table. Join BDO July 10 for a webcast discussing the bill and its impact.

 

 

Business Provisions
Bonus Depreciation
The bill permanently restores 100% bonus depreciation for property acquired and placed in service after January 19, 2025. 

The legislation also creates a new elective 100% depreciation allowance under Section 168(n) for any portion of nonresidential real property that is considered “qualified production property.” The election is available if construction on the property begins after January 19, 2025, and before January 1, 2029, and the property is placed in service by the end of 2030.

A qualified production activity includes the manufacturing of tangible personal property, agricultural production, chemical production, or refining. Qualified production property does not include any portion of building property that is used for offices, administrative services, lodging, parking, sales activities, research activities, software engineering activities, or other functions unrelated to qualified production activities. 

There is an exception from the original use requirement if acquired property was not used in a qualified production activity between January 1, 2021, and May 12, 2025. Special recapture rules apply if the property is disposed of within 10 years after it is placed in service. 

The bill also increases the Section 179 deduction to $2.5 million with a phaseout threshold of $4 million for property placed in service after 2024, with both thresholds indexed to inflation in future years.

 

Takeaway
Allowing producers, refiners, and manufacturers to fully expense buildings rather than depreciate them over 39 or 15 years offers a significant benefit. The definition of “production” will be important, and generally requires “a substantial transformation of the property comprising the product.” Taxpayers with buildings that house both qualified production activities and other administrative, office, or research functions will also likely need to perform an analysis to allocate costs between functions.

 

 

Section 174 Research Expensing
The bill permanently restores the expensing of domestic research costs for tax years beginning after December 31, 2024. The permanent expensing rules are created under new Section 174A, while Section 174 is retained and amended to provide for the continued 15-year amortization of foreign research costs. Software development is statutorily included in the definition of research for purposes of Section 174A. Taxpayers retain the option of electing to capitalize domestic research costs and amortize such amounts over either 10 years or the useful life of the research (with a 60-month minimum). 

The bill will generally require taxpayers to implement the new treatment with an automatic accounting method change on a cut-off basis, but it offers two alternative transition rules. Taxpayers can elect to claim any unamortized amounts incurred in calendar years 2022, 2023, and 2024 in either the first tax year beginning after 2024 or ratably over the first two tax years beginning after 2024. Separate transition rules are available for eligible small business taxpayers meeting the gross receipts test under Section 448 ($31 million in 2025) for the first tax year beginning after 2024, allowing those taxpayers to file amended returns to claim expensing for tax years before 2025. Retroactivity is not available to small business taxpayers that are tax shelters, such as pass-throughs that allocate more than 35% of their losses to limited partners or limited entrepreneurs.

The bill also amends Section 280C to again require taxpayers to reduce their deduction for research costs under Section 174A by the amount of any research credit (or reduce their credit by an equivalent amount), effective for tax years beginning after 2024. Under changes made by the TCJA, taxpayers were generally required to reduce their Section 174 capital account only to the extent the research credit exceeded their current-year amortization deduction. For most taxpayers, that meant that the amortization deductions and research credits were both allowed in full. 

 

Takeaway
The restoration of domestic research expensing is somewhat retroactive, and taxpayers will have several options for recognizing unused research amortization and for recovering future research costs. Businesses should consider modeling their options to identify beneficial strategies because the timing of deductions can affect other calculations, including those for Section 163(j), net operating losses, FDII, and GILTI.

 

 

Section 163(j) Interest Deduction Limit 

The bill permanently restores the exclusion of amortization, depreciation, and depletion from the calculation of ATI for purposes of Section 163(j), which generally limits interest deductions to 30% of ATI. The change is effective for tax years beginning after 2024.

 

The bill also makes two unfavorable changes effective for tax years beginning after 2025: 

Excluding income from Subpart F and GILTI inclusions and excluding Section 78 gross-up from ATI; and
• Including interest capitalized to other assets in the limit under Section 163(j), except interest capitalized to straddles under Section 263(g) or to specified production property under Section 263A(f). 

The business interest allowed as a deduction up to the Section 163(j) limit will come first from any capitalized interest. Any disallowed capitalized interest exceeding the cap will be incorporated into the Section 163(j) carryforward and will not be treated as capitalized in future years.  

 

Takeaway
The ability to again exclude amortization and depreciation from ATI will provide welcome relief for many taxpayers, but others will be negatively affected by the changes. The JCT score indicates that the revenue raised from shutting down capitalization planning and excluding new categories of income will save more than one-third of the $60 billion cost of reinstating the exclusion of depreciation and amortization. Taxpayers should model the impact and consider tax attribute and accounting method planning. Although the bill essentially shuts down interest capitalization planning for years beginning in 2026 or later, those strategies remain viable for the 2024 and 2025 tax years. The legislation does not claw back any interest capitalized to other assets in tax years beginning before 2026, even if the capitalized interest has not been fully recovered with the asset. 

 

 

Section 199A
The bill makes permanent the deduction for pass-through income under Section 199A and favorably adjusts the phaseout of the deduction for taxpayers who do not meet the wage expense and capital investment requirements or who participate in a “specified trade or business.” The legislation also creates a minimum deduction of $400 for taxpayers with at least $1,000 of qualifying income. 

 

Opportunity Zones
The bill makes permanent the qualified opportunity zone (QOZ) program and updates the rules for investments made after 2026. As in the current program, taxpayers can defer capital gain by investing in a qualified opportunity fund. For investments made after 2026, taxpayers will be required to recognize the deferred gain five years after the date of the investment but will get a 10% increase in basis. Taxpayers can still receive a full basis step up to fair market value (FMV) for property held 10 years, but the bill adds a rule freezing the basis step up at the FMV 30 years after the date of the investment. 

Current QOZ designations will expire early at the end of 2026. New zones will be designated in rolling 10-year designation periods under new criteria that are expected to shrink the number of qualifying zones. A new category of rural opportunity zones is created. The 10% basis increase is tripled to 30% for investments in rural opportunity zones and the threshold for establishing the substantial improvement of qualifying property would be lowered to 50%.

Both qualified opportunity funds (QOFs) and qualified opportunity zone businesses (QOZBs) will be required to comply with substantial new reporting requirements.

 

Takeaway
The bill does not extend the mandatory recognition date of December 31, 2026, for investment made before 2027, as many taxpayers had hoped. But the program’s extension preserves one of the most powerful tax incentives ever offered by lawmakers. The timing of capital gains transactions may be particularly important. Delaying a capital gain transaction could allow taxpayers to make a deferral election in 2027 and defer recognizing the gain until well after the current 2026 recognition date. On the other hand, QOZ designations are likely to change in 2027. Taxpayers planning investments in geographic areas that are unlikely to be redesignated may need to make the investments before the end of 2026. Existing QOFs and QOZBs should consider their long-term capital needs because it is not clear whether any “grandfathering” relief will allow additional qualified investments into funds operating in QOZs that are not redesignated. The new reporting rules will apply to both new and existing QOZs and QOZBs for tax years beginning after the date of enactment, and those entities will need to collect and report substantial new information that has never before been required.

 

 

Qualified Small Business Stock
The bill enhances the exclusion of gain for qualified small business (QSB) stock under Section 1202 issued after the date of enactment in the following ways:

In addition to the existing 100% exclusion for qualified stock held for five years, taxpayers can qualify for a 50% exclusion after three years and a 75% exclusion after four years;
• The current limit on the exclusion (the greater of $10 million or 10 times basis) is increased to $15 million, indexed to inflation beginning in 2027; and
• The limit on gross assets at the time stock is issued is increased from $50 million to $75 million, indexed to inflation beginning in 2027.

Takeaway
QSB stock is a powerful tax planning tool that can essentially erase gain of up to 10 times the initial basis. The changes make the structure more accessible and increase the size of potential investments. The bill does not change the expansive qualification requirements under Section 1202, and taxpayers should understand the rules clearly and document compliance throughout the holding period.

 

 

Section 162(m)
The bill amends the aggregation rules for applying the $1 million limit on deducting the compensation of a public company’s covered employees under Section 162(m). The current rules identify covered employees separately for each public entity but calculate compensation subject to the limitation on a controlled group basis. The number of covered employees is set to expand by five for tax years beginning in 2027 or later, and there has been some question whether such employees can come from the entire controlled group or only the public entity.

The bill creates a new aggregation rule for tax years beginning after 2025 for identifying who is a covered employee and the amount of compensation subject to the limit. The aggregation rules are based on a controlled group as defined under the qualified plan rules in Section 414. The proposal also provides rules for allocating the $1 million deduction among members of a controlled group.  

 

Takeaway
The provision will have unfavorable consequences for many companies, including requiring the full amount of compensation from a related partnership in the calculation (rather than a pro-rata amount based on ownership percentage). It is estimated to raise almost $16 billion. 

 

 

Form 1099 Reporting
The bill amends Section 6050W to reinstate the 200 transaction and $20,000 threshold for reporting third-party payment network transactions on Form 1099-K. The American Rescue Plan Act of 2021 repealed that threshold and required reporting when aggregate payments exceeded $600, regardless of the number of transactions. The IRS offered transition relief delaying the implementation of the change for two years and then provided a $5,000 threshold for payments made in 2024 and a $2,500 threshold for payments made in 2025. The bill restores the old threshold retroactively so that reporting is required only if aggregate transactions exceeded 200 and aggregate payments exceeded $20,000. 

The bill also increases the threshold for reporting payments under Sections 6041 and 6041A on the respective Forms 1099-MISC and 1099-NEC from $600 to $2,000 in 2026, indexing that figure to inflation in future years.

 

Remittance Tax
The bill imposes a new 1% excise tax on remittances of cash, money orders, cashier’s checks, or other similar physical instruments, with an exception for transfers from most financial institution accounts or debit cards.

 

Takeaway
The tax in the final version affects a much narrower set of payments than the original 5% tax proposed in the House and the 3.5% tax in earlier House and Senate drafts. 

 

 

Exception for Percentage of Completion Method
The bill expands exceptions to the percentage of completion method under the long-term contract rules under Section 460. The exception for home builders is expanded to include all residential construction. Further, the exception from the uniform capitalization rules for home builders meeting the gross receipts threshold under Section 448(c) ($31 million in 2025) is expanded to include all residential construction, and the allowable construction period is extended from two years to three.

 

Employee Retention Credit
The legislation makes several changes to the employee retention credit (ERC), including:

Barring ERC refunds after the date of enactment for claims filed after January 31, 2024;
• Extending the statute of limitations on ERC claims to six years; and
• Increasing preparer and promoter penalties on ERC claims. 

Takeaway
The provision presumably will affect only refund claims that have not been paid by the IRS. The legislative language provides that no credit or refund “shall be allowed or made after the date of enactment” unless the claim was filed on or before January 31, 2024. The IRS had been slow to process claims – potentially in anticipation of this provision, which had been included in a failed 2024 tax extenders bill. The provision is now estimated to raise only $1.6 billion, much less than the $77 billion estimated under the 2024 version. The difference may be the result of refunds that have already been paid, although it remains unclear how fast the IRS is processing claims filed after January 31, 2024.

 

 

International Provisions

Foreign-Derived Intangible Income
The bill makes significant reforms to FDII, including raising the effective rate while making the calculation of income more generous.

The bill permanently lowers the Section 250 deduction from 37.5% to 33.34%, still well above the 21.875% deduction rate that would take effect without legislation. The change will increase the FDII effective rate from 13.125% to 14% (compared to 16.4% absent legislation). 

The bill also repeals the reduction in FDII for the deemed return on qualified business asset investment (QBAI) and provides that interest and research and experimental (R&E) costs are not allocated eligible income. The final version modifies a change from an earlier draft that would have narrowed the allocation of deductions only to those “directly related” to such income. The final bill provides that the calculation includes “properly allocable” deductions.

The changes are effective for tax years beginning after 2025, aside from a new exclusion from FDII-eligible income that would take effect after June 16, 2025. The bill would exclude income or gain from the Section 367(d) disposition of intangible property or property subject to depreciation, amortization, or depletion. The final bill omits a provision from an earlier draft that would have also excluded specified passive income subject to the high-tax kickout.

 

Takeaway
The changes could expand the value of the deduction for many taxpayers despite the effective rate increase, particularly for industries with significant fixed assets and R&E costs. Taxpayers should assess the changes for potential planning and arbitrage opportunities, given the change in rates and rules. There may be accounting methods opportunities that could increase the benefit in current and future years.

 

 

Global Intangible Low-Taxed Income
The bill increases the GILTI effective rate while making both favorable and unfavorable changes to the underlying calculation effective for tax years beginning after 2025.  

The Section 250 deduction for GILTI decreases from 50% to 40%, still higher than the 37.5% deduction rate that would take effect without legislation. The effective rate before the FTC haircut will increase from 10.5% to 12.6% (compared to 13.125% absent legislation). The bill will also reduce the FTC haircut under GILTI from 20% to 10%, resulting in an equivalent top effective rate of 14% (up from the current 13.125% rate and the 16.4% rate that would take effect without legislation). It also provides that 10% of taxes (compared to 20% absent legislation) previously associated with Section 951A taxed earning and profits are not treated as deemed paid for purposes of Section 78.

The deemed return for QBAI is repealed, increasing the amount of income subject to the tax. The provision also changes the allocation of expenses to GILTI for FTC purposes so that it includes only the Section 250 deduction, taxes, and deductions “directly allocable” to tested income. It also specifically excludes interest and R&E costs. 

 

Takeaway
The changes are significant and could affect GILTI calculations in both favorable and unfavorable ways. The legislation does not provide a definition of “directly allocable,” and guidance may be important in this area. Taxpayers should assess the impact and consider FTC and other planning strategies. 

 

 

Base Erosion and Anti-Abuse Tax
The bill increases the BEAT rate from 10% to 10.5% for tax years beginning after 2025, lower than both the 14% rate in the previous Senate draft and the 12.5% rate that would take effect without legislation. The legislation also repeals an unfavorable change to the BEAT scheduled to take effect in 2026 that would effectively require taxpayers to increase their liability by the sum of all income tax credits. The final bill omits several provisions from an earlier draft that would have changed the base erosion percentage, created a high-tax exclusion, and shut down interest capitalization planning. 

 

Takeaway
The final version removed several favorable changes from an earlier draft but potentially still allows for planning that capitalizes interest to other assets.

 

 

Reciprocal Tax for ‘Unfair Foreign Taxes’
The final bill omits proposed Section 899, which would have imposed retaliatory taxes on residents of that impose “unfair foreign taxes.” The provision was removed from the legislation after the Trump administration announced an agreement with the G-7 countries to “exempt” the U.S. from Pillar Two taxes. The G-7 released a statement saying that the countries are committed to working toward an agreement that would create a side-by-side system to fully exclude U.S.-parented groups from the undertaxed profits rule and income inclusion rule while ensuring that risks related to base erosion and a level playing field are addressed. The group also agreed to work toward compliance simplification and consider treating nonrefundable tax credits similarly to refundable tax credits.

 

Takeaway
The ability of G-7 countries to drive broader agreements — and the details emerging from any such agreements — will be critical for U.S. multinationals. The current announcements are largely just statements of intent on a common goal. No countries outside the G-7 were party to the commitments, and there may be resistance from some OECD and EU countries. 

 

 

Other International Provisions
The bill includes several other international provisions effective for tax years beginning after December 31, 2025, including:

Making permanent the controlled foreign corporation (CFC) look-through under Section 954(c)(6);
• Restoring the exception from downward attribution rules under Section 958(b)(4) that was repealed under the TCJA while adding a narrower rule under Section 951B that is more closely aligned with the TCJA’s intent;
• Amending the FTC rules to treat inventory produced in the U.S. and sold through foreign branches as foreign-source income, capped at 50%, likely only for branch category purposes; and
• Amending the pro-rata rules under GILTI and Subpart F.

Takeaway

The changes are generally favorable. The permanent extension of the CFC look-through rule under Section 954(c)(6) preserves an important exception for Subpart F income that is scheduled to sunset at the end of 2025. The restoration of Section 958(b)(4) could simplify reporting obligations for some taxpayers. However, Section 951B gives Treasury the authority to provide guidance on reporting for foreign-controlled U.S. shareholders. The inventory sourcing rule could result in additional foreign-source income for FTC purposes when compared to the current rule, which sources based on production activities. Finally, the pro-rata share rules will require a U.S. shareholder of a CFC to include its pro-rata share of Subpart F or GILTI income if it owned stock in the CFC at any time during the foreign corporation’s tax year in which it was a CFC. That provision removes the requirement that the U.S. shareholder own the CFC’s stock on the last day the foreign corporation was a CFC. The proposal provides Treasury with the authority to issue regulations allowing taxpayers to make a closing of the tax year election if there is a disposition of a CFC. 

 

 

Energy Provisions
Consumer and Vehicle Credits
The bill repeals the following credits with varying effective dates:

Previously owned clean vehicle credit under Section 25E repealed for vehicles acquired after September 30, 2025;
• Clean vehicle credit under Section 30D repealed for vehicles acquired after September 30, 2025;
• Commercial clean vehicle credit under Section 45W repealed for vehicles acquired after September 30, 2025;
• Alternative fuel refueling property credit under Section 30C repealed for property placed in service after June 30, 2026;
• Energy-efficient home improvement credit under Section 25C repealed for property placed in service after December 31, 2025;
• Residential clean energy credit under Section 25D repealed for expenditures made after December 31, 2025; and
• New energy-efficient home credit under Section 45L repealed for property acquired after June 30, 2026.

Depreciation

The bill repeals the five-year depreciable life of qualified energy property. The Section 179D deduction is repealed for construction beginning after June 30, 2026. 

 

Sections 48E and 45Y
The bill will generally begin to phase out the production tax credit under Section 45Y and the investment tax credit under Section 48E for projects beginning construction after 2033 except for solar and wind projects. Wind and solar projects beginning more than 12 months after the date of enactment must be placed in service by the end of 2027.

The bill also creates restrictions related to prohibited foreign entities, most significantly adding limits on receiving material assistance from a prohibited entity for facilities that begin construction after December 31, 2025. Material assistance is based on a cost ratio for sourcing eligible components. The bill also tightens domestic sourcing requirements under Section 48E.  

 

Takeaway
The final language was softened with a last-minute amendment that allows some continued runway for wind and solar projects. The change angered some House conservatives, who blocked a final vote in the House for hours before reportedly extracting a promise from the administration that it would vigorously enforce the beginning of construction rules. Treasury may have limited ability to change the guidance in this area because the statute itself provides that the beginning of construction for some credit purposes shall be determined under rules similar to existing IRS notices.

 

 

Section 45X
The advanced manufacturing credit under Section 45X is repealed for wind energy components sold after 2027 but will otherwise be extended to allow a 75% credit for components sold in 2031, 50% for 2032, 25% for 2033, and fully repealed for 2034 or later. The credit is expanded to cover metallurgical coal. Material assistance rules for prohibited foreign entities apply.

 

Section 45Z
The bill extends the Section 45Z clean fuel production credit through 2031 while reinstating a stackable small agri-biodiesel credit under Section 40A. A new restriction under Section 45Z disallows a credit unless the feedstock is produced or grown in the U.S., Mexico, or Canada. The calculation of greenhouse gas emissions is amended to exclude indirect land use changes and new prohibited foreign entity rules are imposed.

 

Other Energy Provisions 
The bill makes several other changes, including:

Repealing the clean hydrogen production credit under Section 45V for construction beginning after 2027, two years later than earlier versions of the bill would have provided;
• Increasing the rates for carbon capture under Section 45Q for carbon sequestered as a tertiary injectant or for productive use to provide parity with the rates for permanent geologic storage (also adding foreign entity of concern restrictions);
• Expanding the publicly traded partnership rules to allow income from carbon capture facilities nuclear energy, hydropower, geothermal energy, and the transportation or storage of sustainable aviation fuel or hydrogen; and
• Adding new restrictions for foreign entities of concern for the nuclear production credit under Section 45U.

Tax-Exempt Entities

The bill replaces the 1.4% endowment tax rate with graduated brackets based on the size of the endowment per student up to a top rate of 8%. The tax applies only to universities with at least 3,000 students, up from 500.  

The bill also expands the excise tax on executive compensation exceeding $1 million to include all current employees, as well as former employees employed in tax years beginning after 2016.

 

Takeaway
The final version of the bill removed provisions that would have increased the excise tax on private foundations and resurrected the “parking tax,” which included the value of transportation in fringe benefits in unrelated business taxable income. 

 

 

Individual Provisions

Deduction for Tip Income
The bill creates an annual deduction of up to $25,000 for qualified tips reported on Forms W-2, 1099-K, 1099-NEC, or 4317 for tax years 2025 through 2028. The deduction is available without regard to whether a taxpayer itemized deductions but begins to phase out once modified adjusted gross income exceeds $150,000 for single filers and $300,000 for joint filers.

For tips to be deductible, they must be paid voluntarily in an occupation that “traditionally and customarily” received tips before 2025, as provided by the Secretary. The business in which the tips are earned cannot be a specified trade or business under Section 199A, and self-employed taxpayers, independent contractors, and business owners face additional limitations. 

Employers will be required to report qualifying tips to employees on Form W-2. The provision applies only to income taxes and generally does not affect the employer’s FICA tip credit except to extend it to specified beauty services businesses.  

The bill gives Treasury several explicit grants of authority to provide regulations on specific issues. The IRS is required to adjust withholding tables and provide guidance within 90 days to define which occupations “traditionally and customarily” received tips in the past. The IRS will also need to provide rules for determining when a tip is voluntary.  

 

Takeaway
The provision will affect employers in important ways. Hospitality companies will face new reporting requirements that depend on how the business and worker occupations are characterized. Further, an employee’s ability to deduct tips could also depend on employer policies, such as mandatory tips, service charges, or other amounts that are not determined solely by customers. 

 

 

Deduction for Overtime Pay
The bill creates a permanent deduction of up to $12,500 (single) and $25,000 (joint) of qualified overtime compensation for tax years 2025 through 2028. The deduction is available without regard to whether a taxpayer itemized deductions but begins to phase out once modified adjusted gross income exceeds $150,000 for single filers and $300,000 for joint filers.

Qualified overtime compensation is defined as compensation paid to an individual required under Section 7 of the Fair Labor Standards Act (FLSA). Employers must perform new information reporting to separately report overtime pay.

 

Takeaway
Determining whether compensation is qualified overtime pay will not be made using tax rules but will instead depend on the employer’s characterization of the pay under the FLSA.

 

 

Auto Loan Interest Deduction
The bill will create a permanent deduction of up to $10,000 of interest on a qualified passenger vehicle loan for tax years 2025 through 2028. The deduction begins to phase out once modified adjusted gross income exceeds $100,000 for single filers and $200,000 for joint filers. 

The vehicle must be manufactured primarily for use on public streets, roads, and highways, and its final assembly must occur in the U.S. The deduction does not apply to lease financing and the loan cannot be to finance fleet sales, purchase a commercial vehicle, purchase a salvage title, purchase a vehicle for scrap or parts, or be a personal cash loan secured by a vehicle previously purchased by the taxpayer.

 

Takeaway
Auto loan financing companies will face additional reporting requirements and be required to furnish a return with specific information on loans.

 

 

Personal Exemption for Seniors
The bill provides a new $6,000 personal exemption for individuals aged 65 and above for tax years 2025 through 2028. The deduction phases out for taxpayers with modified adjusted gross income exceeding $150,000 for joint filers and $75,000 for all other taxpayers. 

 

Takeaway
The personal exemption is meant to fulfill Trump’s pledge to remove tax on Social Security payments, which is not allowable under reconciliation rules. The legislation does not affect payroll taxes on Social Security payments.

 

 

Individual TCJA Extensions
The bill largely makes the individual TCJA provisions permanent, although with some important modifications. The individual rate cuts and bracket adjustments are made permanent while providing an extra year of inflation adjustment for the lower brackets. The bill also makes permanent:

• The repeal of general personal exemptions;
• The limits on the deductions for mortgage interest (while adding mortgage insurance premiums as qualified interest), personal casualty losses, and moving expenses;
• The repeal of miscellaneous itemized deduction (with an exception for some educator expenses); and
• The exclusion for bicycle commuting reimbursements.

The bill restores an itemized deduction for up to 90% wagering losses, capped at the amount of wagering income. 

The bill makes permanent the increased alternative minimum tax exemption and phaseout thresholds but would claw back inflation adjustments to the phaseout thresholds by resetting them to 2018 levels. The actual phaseout of the exemptions based on the amount of income exceeding the thresholds is slowed by half. 

The bill permanently repeals the Pease limitation on itemized deductions that the TCJA suspended through 2025, but it would create a new limit. The new provision would essentially cap the value of itemized deductions so that the maximum benefit achievable for the deductions is equivalent to offsetting income taxed at a top rate of 35% rather than offsetting income taxed at the higher individual marginal rate of 37%. 

The bill creates a 0.5% haircut on individual itemized charitable deductions but also adds a permanent charitable deduction for non-itemizers of up to $2,000 for joint filers and $1,000 for other taxpayers.

 

SALT Cap
The bill makes the SALT cap permanent while raising the threshold for five years and then reverting it to $10,000 in 2030. The cap is set at $40,000 for 2025 but phases down to $10,000 once income exceeds $500,000. Both thresholds will increase by 1% for each year through 2029. 

 

Takeaway
Earlier drafts of the bill would have shut down taxpayers’ ability to use pass-through entity tax regimes to circumvent the SALT cap; the final version eliminated those provisions. 

 

 

Transfer Taxes
The bill permanently sets the lifetime exemptions for the gift, estate, and generation-skipping transfer taxes at $15 million for 2026 and indexes them for inflation thereafter. The change represents a modest increase from the exemptions under the TCJA, which were initially set at $10 million but reached $13.99 million in 2025 with inflation adjustments.

 

Active Business Losses
The legislation makes the active loss limit under Section 461(l) permanent but reverses recent inflation adjustments in the $250,000 threshold. 

 

Takeaway
The final bill struck an unfavorable provision in earlier drafts that would have required disallowed losses to remain in the Section 461(l) calculation in future years. Under the final bill, disallowed losses still become net operating losses in subsequent years and can offset other source of income. 

 

 

Other Provisions
The bill contains a number of other meaningful tax changes, including:

Creating a 1% floor for charitable deductions for corporations by providing that a deduction is allowed only to the extent it exceeds 1% of taxable income (up to the current 10% cap) for tax years beginning after 2025;
• Changing the explicit regulatory mandate for disguised sale rules under Section 707(a)(2) to clarify that the rules are self-executing without regulations, effective after the date of enactment;
• Raising the percentage of allowable assets a real estate investment trust (REIT) may have in a qualified REIT subsidiary from 20% to 25% effective for tax years beginning after 2025;
• Making permanent the increases to the low-income housing tax credit; 
• Increasing the Section 48D credit for semiconductor manufacturing facilities from 25% to 35% for property placed in service after 2025;
• Making permanent the new markets tax credit;
• Treating spaceports like airports for the private activity bond rules, effective for obligations issued after the date of enactment;
• Increasing the limit on the “cover over” to Puerto Rico and the U.S. Virgin Islands for excise taxes on distilled spirits effective for imports after 2025;
• Allowing the liability from gain on the sale of qualified farmland property to be paid in 10-year installments for sales after the date of enactment; and
• Creating tax-preferred accounts for children, with a pilot program offering a $1,000 contributory credit for qualifying children for tax years beginning after 2025.

Takeaway
The inclusion of the new markets tax credit and the CFC look-through rule, which are both scheduled to expire at the end of 2025, indicates that Republicans do not have much hope for another tax bill this year. House Ways and Means Committee Chair Jason Smith, R-Mo., originally left those provisions off the House bill, saying he hoped to address them in a bipartisan extenders bill. Republicans have also discussed moving a second reconciliation bill, although that may have been a negotiating ploy to appease members whose priorities are not addressed in this bill.

 

 

Next Steps
Taxpayers should assess the potential impact of major provisions when considering the tax efficiency of transactions and investments. There may be planning opportunities that should be considered now, such as accelerating or abandoning energy credit projects or investments and modeling the impact of changes to the limit on the interest deduction under Section 163(j), bonus depreciation, and research expensing under Section 174. Changes to opportunity zone rules could affect the timing for triggering capital gains and making investments. International changes may present arbitrage opportunities to capitalize on favorable changes or mitigate the impact of unfavorable changes.

 

Written  by Dustin Stamper. Copyright © 2025 BDO USA, P.C. All rights reserved. www.bdo.com

Please use links to below to navigate to the section of interest:

2024 Year-End Planning Business Incentives & Tax Credits
• 2024 Year-End Guide – State and Local Tax
• 2024 Year-End Guide – Partnerships
• 2024 Year-End Guide – Tax Accounting Methods

Year-End Planning STS-Business Incentives & Tax Credits

 

I. Credit for Increasing Research Activities: Proposed Changes to Form 6765

The IRS announced the release of a revised draft of Form 6765, Credit for Increasing Research Activities, on June 21, 2024, that reflects feedback from external stakeholders. This follows the IRS's efforts to tighten documentation requirements for claiming the research credit. In September 2023, the IRS previewed proposed changes to Form 6765, adding new sections for detailed business component information and reordering existing fields. These changes aimed to improve information consistency and quality for tax administration but were criticized as overly burdensome.

The updated draft retains Section E from the previous version but requires additional taxpayer information. The "Business Component Detail" section, now Section G, is optional for Qualified Small Business (QSB) taxpayers and those with total qualified research expenditures (QREs) of $1.5 million or less and gross receipts of $50 million or less. Additionally, the IRS reduced the number of business components to be reported in Section G, requiring 80% of total QREs in descending order by amount, capped at 50 business components. Special instructions will be provided for taxpayers using the ASC 730 directive. The revised Section G will be optional for all filers for tax year 2024 to allow taxpayers time to transition to the new format. As outlined by the IRS, Section G will be effective for tax year 2025.

Examination Environment

Currently, the IRS receives a significant number of returns claiming the research credit, which requires substantial examination resources from both taxpayers and the IRS. To ensure effective tax administration for this issue, the IRS aims to clarify the requirements for claiming the research credit by considering all feedback received from stakeholders before finalizing any changes to Form 6765.

In response to ongoing concerns of improper claims of the research credit, the IRS has intensified its focus on reviewing these claims for nonconformities, including conducting more audits. Navigating the complexities of the research credit can be challenging, especially with the increased scrutiny, recent case law, and the newly implemented IRS compliance measures in place.

Planning Considerations

It is important for taxpayers to accurately determine eligibility, validate and properly record contemporaneous documentation to support research credit claims, and defend against examinations. Taxpayers should partner with a trusted tax advisor to ensure compliance with IRS regulations and proper eligibility for the research credit.

 

II. Tax Credit Monetization

 

General IRA Overview

The signing of the Inflation Reduction Act (IRA) on August 16, 2022, marked the largest-ever U.S. investment committed to combat climate change, allocating significant funds to energy security and clean energy programs over the next 10 years, including provisions incentivizing the manufacturing of clean energy equipment and the development of renewable energy generation.

Overall, the act modifies many of the current energy-related tax credits and introduces significant new credits and structures intended to facilitate long-term investment in the renewables industry. Capital investments in renewable energy or energy storage; manufacturing of solar, wind, and battery components; and the production and sale or use of renewable energy are activities that could benefit from the over 20 new or expanded IRA tax credits. The IRA also introduced new ways to monetize tax credits and additional bonus credit amounts for projects that meet prevailing wage and apprenticeship, energy community, and domestic content requirements.

45X – Advanced Manufacturing Production Tax Credit

The 45X advanced manufacturing production credit continues to be a valuable production tax credit meant to encourage the production and sale of energy components in the U.S., specifically related to solar, wind, batteries, and critical mineral components. To be eligible for the credit, components must be produced in the U.S. or U.S. possessions and be sold by the manufacturer to unrelated parties. The Department of Energy has released a full list of eligible components as defined in the IRA, with specific credit amounts that vary according to the component. Manufacturers can also monetize 45X credits through a direct payment from the IRS for the first five years under Internal Revenue Code Section 6417. They may also transfer a portion or all the credit to another taxpayer through the direct transfer system Section 6418 election. The 45X credit is a statutory credit with no limit on the amount of funding available; however, the credit will begin to phase out beginning in 2030 and will be completely phased out after 2033. Manufacturers cannot claim 45X credits for any facility that has claimed a 48C credit.

 

48E and 45Y Clean Electricity Investment and Production Credits

 

For energy property and qualified facilities placed in service after December 31, 2024, Sections 48E and 45Y will replace the longstanding investment tax credit and production tax credit under Sections 48 and 45. The new provisions adopt a technology-neutral approach, whereby qualification for the credits will generally not be based on specific technologies identified in the IRC, but rather on the ability to generate electricity without greenhouse gas emissions. This represents a significant departure from historical practices and is expected to expand the range of technologies eligible for tax credits. Other relevant provisions of the IRA, such as bonus credit additions and monetization options, will still apply to the new Sections 48E and 45Y.

 

45Z Clean Fuel Production Credit

The clean fuel production credit under Section 45Z will become effective for transportation fuel produced at a qualified facility after December 31, 2024. On May 31, 2024, the IRS issued Notice 2024-49, providing guidance on the necessary registration requirements to claim the credit. Fuel that meets additional criteria to qualify as sustainable aviation fuel (SAF) will be eligible for an increased credit amount. As in the case of other renewable credits, the emissions rate is crucial for purposes of the 45Z credit, because the emissions factor for the fuel will directly impact the credit amount. Additionally, prevailing wage and apprenticeship rules will apply to Section 45Z qualified facilities, with certain exceptions.

Planning Considerations

With the passage of Section 6418 as part of the IRA, certain renewable energy tax credits can now be transferred by companies that generate eligible credits to any qualified buyer seeking to purchase tax credits. Through credit transfers, taxpayers have the option to sell all or a portion of their credits in exchange for cash as part of their overall renewable energy goals if they are not able to fully utilize the benefit. Companies with a high amount of taxable income and therefore a larger appetite for tax credits are able to purchase these credits at a discount, with the sale proceeds improving the economics of clean energy development.

The market rate for the sale of credits will be highly dependent on the type of credit being transferred, as well as the substantiation and documentation related to the seller’s eligibility for the credit taken and any bonus credit amounts claimed. The current rate seen in the market for transferring credits is around $0.93 to $0.96 per $1 of credit, but these amounts are subject to change based on specific fact patterns for each individual transaction and the overall market trend.

 

Taxpayers considering buying or selling tax credits that are transferable under the IRA should be looking ahead and forecasting their potential tax liability and resulting appetite for buying and selling credits. These credits can be transferred and utilized against estimated quarterly payments as soon as transfer agreements are finalized. This expedited reduction in cash outlay for the buyer and monetization of credits for the seller is a consideration that should be taken into account for taxpayers interested in entering the market of transferring credits.

III. Bonus Credits

The Inflation Reduction Act not only introduced new and expanded credits for the investment in and production of renewable energy and its related components but also included provisions for bonus credit amounts subject to specific requirements.

The prevailing wage and apprenticeship (PWA) requirement is a 5x multiplier for certain credits that can bring the credit rate from 6% up to 30% by paying prevailing wages to all labor related to the construction, installation, alteration, and repair of eligible property. Additionally, taxpayers must ensure that a specific percentage of these labor hours is performed by qualified apprentices.

The IRS and the Treasury Department issued final regulations on the PWA requirements in June 2024, and projects starting in 2025 and after will be unable to utilize the beginning of construction exemption. Other common credit additions available for taxpayers meeting energy community and domestic content requirements provide a 10% addition to the base rate of the credit. Taxpayer documentation will be required to substantiate the claim of these bonus credit amounts and will need to be presented to a buyer in the event that these credits are transferred under Section 6418.

Planning Considerations

Taxpayers that have current or proposed investments or activities for which they plan to utilize the PWA multiplier should be formulating a documentation strategy and procedure. In the event of an IRS audit or transfer of these credits, taxpayers will be required to substantiate the wages paid to laborers, as well as the number of hours performed by registered apprentices. Depending on the size and amount of labor involved in qualified investments or production, documentation for PWA purposes, as well as for the domestic content requirements, will likely be a highly burdensome task if not planned for at the outset of a project.

IV. NMTC

The federal New Markets Tax Credit (NMTC) program was established in 2000 to subsidize capital investments in eligible low-income census tracts. The subsidy provides upfront cash in the form of NMTC-subsidized loans at below-market interest rates (3%-3.5%). The loan principal is generally forgiven after a seven-year term, resulting in a permanent cash benefit. Funding for these subsidized loans is highly competitive and expected to be depleted quickly.

The U.S. Treasury’s Community Development Financial Institutions (CDFI) Fund recently announced that, for 2025 only, it will double its annual allocation of NMTC funds.

Planning Considerations

Taxpayers across multiple industries may be good candidates for the NMTC.

Applying for the NMTC program involves several steps that help ensure the funding is allocated to projects that will have a meaningful impact on low-income communities. Applicants for the credit are evaluated based on the community impact derived from the investments (such as job creation, community services provided, etc.). In a program as highly competitive as the NMTC, applying early can make the difference between securing a portion of the limited funds available or missing out on funding opportunities. Early applicants are often better positioned to take advantage of available opportunities, and additional benefits may be possible for those who act swiftly.

The following initial questions will help determine if a project is viable for NMTC:

Address of the proposed project
• High-level project description (a few sentences)
  Status of construction/timeline of capital expenditures (midstream projects are permitted)
  • Estimated number of direct jobs to be created by the project

Taxpayers with ongoing or planned capital investments for later in 2024 or 2025 that are eligible to receive NMTC financing should begin reaching out to CDEs. Early outreach provides QALICBs a strong advantage in securing this financing due to the competitive nature and limited funds of the program.

 

SALT 2024 Year-End Planning Guide

With thousands of taxing jurisdictions from school boards to states and many different types of taxes, state and local taxation is complex. Each tax type comes with its own set of rules — by jurisdiction — all of which require a different level of attention. 

This SALT guide can help companies with 2024 year-end planning considerations, and it provides guidance on how to hit the ground running in 2025.

State PTET Elections

Roughly 36 states now allow pass-through entities (PTEs) to elect to be taxed at the entity level to help their residents avoid the $10,000 limit on federal itemized deductions for state and local taxes (the “SALT cap”). Those PTE tax (PTET) elections are much more complex than simply checking a box to make an election on a tax return. Although state PTET elections are meant to benefit the individual members, not all elections are alike, and they are not always advisable.

Before making an election, a PTE should model the net federal and state tax benefits and consequences for every state where it operates, as well as for each resident and nonresident member, to avoid unintended tax results. Before the end of the year, taxpayers should thoroughly consider whether to make a state PTET election, modeling the net tax benefits or costs, and evaluate timing elections, procedures, and other election requirements. If those steps are completed ahead of time, the table has been set to make the election in the days ahead.

When considering a state PTET election, a key question is whether members who are nonresidents of the state for which the election is made can claim a tax credit for their share of the taxes paid by the PTE on their resident state income tax returns. If a state does not offer a tax credit for elective taxes paid by the PTE, a PTET election could result in an additional state tax burden that exceeds some members’ federal itemized deduction benefit.

Therefore, as part of the pre-year-end evaluation and modeling exercise, PTEs should consider whether the election would result in members being precluded from claiming other state tax credits — which ordinarily would reduce their state income tax liability dollar for dollar — in order to receive federal tax deductions that are less valuable.

Liquidity Events

Liquidity events take the form of IPOs; financings; sales of stock, assets, or businesses; and third-party investments. Those events involve different forms of transactions, often driven by business or federal tax considerations; unfortunately, and far too often, the SALT impact is ignored until the 11^th hour — or later.

A liquidity event is not an occasion for surprises. When contemplating any form of transaction, state and local taxes can’t be overlooked; doing so can result in a shock for the client and, at the least, embarrassment for the practitioner. SALT experts can identify planning opportunities and point out potential pitfalls, and it is never too early to involve them. If you don’t consult them until after the transaction occurs or the state tax returns are being prepared, you’ve left it too late.

From state tax due diligence to understanding the total state tax treatment of a transaction to properly reporting and documenting state tax impacts, addressing SALT at the outset of a deal is critical. If involved before the year-end liquidity event, SALT professionals can suggest tweaks to the transaction that may be federal tax neutral but could identify significant state tax savings or costs now rather than later. After the liquidity event, because the state tax savings or costs already have been identified, they can be properly documented and reported post-transaction. Further, because SALT expertise was involved at the front end, state tax post-transaction integration, planning, and remediation can be pursued more seamlessly.

Income/Franchise Taxes

If anything has been learned from the last seven years of federal tax legislation, it’s that state income tax conformity cannot be taken for granted. While states often conform to many federal tax provisions, are you certain an S corporation is treated as such by all the states where it operates? Is that federal disregarded entity disregarded for state income tax purposes as well? Not asking the question can lead to the wrong result. 

Several states don’t conform to federal entity tax classification regulations. Some, including New York, require a separate state-only S corporation election. New Jersey now allows an election out of S corporation treatment. Making those elections — or not — can lead to different state income tax answers, but you should make that decision before the transaction, not when the tax return is being prepared.

If the liquidity event will result in gain, how is the gain going to be treated for state income tax purposes? Is it apportionable business gain or allocable nonbusiness gain? Is a partnership interest, stock, or asset being sold? How will the gain be apportioned? Was the seller unitary with the partnership or subsidiary, or did the assets serve an operational or investment function for the seller? Will the gross receipts or net gain from the sale be included in the sales factor, and, if so, how will they be apportioned?

Those are just some of the questions that are never asked on the federal level because they don’t have to be. But they are material on the state level and can lead to unwelcome surprises if not addressed.

Sales/Use Taxes

 

Most U.S. states require a business to collect and remit sales and use taxes even if it has only economic, not physical, presence. Remote sellers, software licensors, and other businesses that provide services or deliver their products to customers from remote locations must comply with state and local taxes.

Left unchecked, those state and local tax obligations — and the corresponding potential liability for tax, interest, and penalties — will grow. Moreover, neglecting your sales and use tax obligations could result in a lost opportunity to pass the tax burden to customers as intended by state tax laws.

A company could very well experience material sales and use tax obligations resulting from a sale even though the transaction or reorganization is tax free for federal income tax purposes. To avoid any material issues, the following steps should be taken:

Determine nexus and filing obligations;
• Evaluate product and service taxability;
• Quantify potential tax exposure;
• Mitigate and disclose historical tax liabilities;
• Consider implementing a sales tax system; and
• Maintain sales tax compliance.

Real Estate Transfer Taxes

Most states impose real estate transfer taxes or conveyance taxes on the sale or transfer of real property, or controlling interest transfer taxes on the sale of an interest in an entity holding real property. Few taxpayers are familiar with real estate transfer taxes, and the complex rules and compliance burdens associated with those state taxes could prove costly if they are not considered up front.

Property Taxes

For many businesses, property tax is the largest state and local tax obligation and a significant recurring operating expense that accounts for a substantial portion of local government tax revenue. Unlike other taxes, property tax assessments are ad valorem, meaning they are based on the estimated value of the property. Thus, they could be confusing for taxpayers and subject to differing opinions by appraisers, making them vulnerable to appeal. Assessed property values also tend to lag true market value in a recession.

Property tax reductions can provide valuable above-the-line cash savings, especially during economic downturns when assessed values may be more likely to decrease. The current economic environment amplifies the need for taxpayers to avoid excessive property tax liabilities by making sure their properties are not overvalued.

Annual compliance and real estate appeal deadlines can provide opportunities to challenge property values. Challenging a jurisdiction’s real property assessment within the appeal window could reduce related tax liabilities. Taking appropriate positions related to any detriments to value on personal property tax returns could reduce those tax liabilities. Planning for and attending to property taxes can help a business minimize its total tax liability.

P.L. 86-272

P.L. 86-272 is a federal law that prevents a state from imposing a net income tax on any person’s net income derived within the state from interstate commerce if the only business activity performed in the state is the solicitation of orders of tangible personal property. Those orders are sent outside the state for approval or rejection and, if approved, are filled by shipment or delivery from a point outside the state.

The Multistate Tax Commission (MTC) adopted a revised statement of its interpretation of P.L. 86-272 which, for practical purposes, largely nullifies the law’s protections for businesses that engage in activities over the internet. To date, California and New Jersey have formally adopted the MTC’s revised interpretation of internet-based activities, while Minnesota and New York have proposed the interpretation as new rules. Other states are applying the MTC’s interpretation on audit without any notice of formal rulemaking.

Online sellers of tangible personal property that have previously claimed protection from state net income taxes under P.L. 86-272 should review their positions. Online sellers that use static websites that don't allow them to communicate or interact with their customers — a rare practice — seem to be the only type of seller that the MTC, California, New Jersey, and other states still consider protected by P.L 86-272.

The effect of the MTC’s new interpretation on a taxpayer’s state net income tax exposure should be evaluated before the end of the year. Structural changes, ruling requests, or plans to challenge states’ evolving limitation of P.L. 86-272 protections applicable to online sales can be put into place.

However, nexus or loss of P.L. 86-272 protection can be a double-edged sword. For example, in California, if a company is subject to tax in another state using California’s new standard, it is not required to throw those sales back into its California numerator for apportionment purposes.

Partnerships

The IRS in the past year has continued to ramp up its scrutiny partnerships’ tax positions, including several pieces of new guidance taking a multiprong approach to partnership “basis shifting” transactions that the agency views as having the potential for abuse. At the same time, IRS is dedicating new funding and resources to examining partnerships.

These developments, along with some new reporting and regulatory changes, mean there are a number of tax areas partnerships should be looking into as they plan for year end and the coming year:

Evaluate Partnership ‘Basis Shifting’ Transactions That Are Subject of New IRS Scrutiny
• Plan for Partnership Form 8308 Expanded Reporting and January 31 Deadline
• Review Limited Partner Eligibility for SECA Tax Exemption
• Consider Effect of Proposed Rules on Transactions Between Partnerships and Related Persons
• Double-Check Positions on Inventory Items and Unrealized Receivables Under Section 751(a)
• Keep an Eye on Challenges to IRS Rules, Including Partnership Anti-Abuse Rules, Under Loper Bright
• Watch for New Form for Partners to Report Partnership Property Distributions
• Prepare for Partnership Obligations Under Corporate Alternative Minimum Tax Regulations

Evaluate Partnership ‘Basis Shifting’ Transactions That Are Subject of New IRS Scrutiny

The IRS and Treasury have made clear that they intend to take a harder stance on transactions involving basis shifting between partnerships and related parties. On June 17, 2024, the IRS launched a multiprong approach to curtail inappropriate use of partnership rules to inflate the basis of assets without causing meaningful changes to the economics of a taxpayer’s business.

The guidance focuses on complex transactions involving related-party partnerships through which taxpayers “strip” basis from certain assets and shift that basis to other assets where the increased basis is intended to generate tax benefits – through increased cost recovery deductions or reduced gain (or increased loss) on asset sales – in transactions that have little or no economic substance.

To address what it deems the inappropriate use of such transactions to generate tax benefits, the IRS has taken several steps:

1. Notice 2024-54 describes two sets of upcoming proposed regulations addressing the treatment of basis shifting transactions involving partnerships and related parties.
2. Additional proposed regulations (REG-124593-23), issued concurrently with Notice 2024-54, identify certain partnership basis shifting transactions as reportable Transactions of Interest.
3. Revenue Ruling 2024-14 notifies taxpayers that engage in three variations of these related-party partnership transactions that the IRS will apply the codified economic substance doctrine to challenge inappropriate basis adjustments and other aspects of these transactions.

The IRS stated that the types of related-party partnership basis shifting transactions described in the current guidance cut across a wide variety of industries and individuals. It stated that Treasury estimates the transactions could potentially cost taxpayers more than $50 billion over a 10-year period. The IRS added that it currently has “tens of billions of dollars of deductions claimed in these transactions under audit.”

Basis Shifting Transactions Under IRS Scrutiny

An IRS Fact Sheet released concurrently with the basis shifting guidance states that there are generally three categories of basis shifting transactions that are the focus of the new guidance. It describes these three categories of transactions as:

1. Transfer of partnership interest to related party: A partner with a low share of the partnership’s inside tax basis and a high outside tax basis transfers the interest in a tax- free transaction to a related person or to a person who is related to other partners in the partnership. This related-party transfer generates a tax-free basis increase to the transferee partner’s share of inside basis.
2. Distribution of property to a related party: A partnership with related partners distributes a high-basis asset to one of the related partners that has a low outside basis. The distributee partner then reduces the basis of the distributed asset, and the partnership increases the basis of its remaining assets. The related partners arrange this transaction so that the reduced tax basis of the distributed asset will not adversely impact the related partners, while the basis increase to the partnership’s retained assets can produce tax savings for the related parties.
3. Liquidation of related partnership or partner: A partnership with related partners liquidates and distributes (1) a low-basis asset that is subject to accelerated cost recovery or for which the parties intend to sell to a partner with a high outside basis and (2) a high- basis property that is subject to longer cost recovery (or no cost recovery at all) or for which the parties intend to hold to a partner with a low outside basis. Under the partnership liquidation rules, the first related partner increases the basis of the property with a shorter life or which is held for sale, while the second related partner decreases the basis of the long-lived or non-depreciable property. The result is that the related parties generate or accelerate tax benefits.

Notice 2024-54: Forthcoming Proposed Rules Governing Covered Transactions

Notice 2024-54 describes two sets of proposed regulations that the IRS plans to issue addressing certain partnership basis-shifting transactions (covered transactions):

Proposed Related-Party Basis Adjustment Regulations. Proposed regulations under Sections 732, 734, 743, and 755 would provide special rules for the cost recovery of positive basis adjustments or the ability to take positive basis adjustments into account in computing gain or loss on the disposition of basis adjusted property following certain transactions.
• Proposed Consolidated Return Regulations. Proposed regulations under Section 1502 would provide rules to clearly reflect the taxable income and tax liability of a consolidated group whose members own interests in a partnership.

Generally, for purposes of the notice and planned proposed rules, covered transactions:

1. Involve partners in a partnership and their related parties,
2. Result in increases to the basis of property under Section 732, Section 734(b), or Section 743(b), and
3. Generate increased cost recovery allowances or reduced gain (or increased loss) upon the sale or other disposition of the basis-adjusted property.

The IRS intends to propose that the Proposed Related-Party Basis Adjustment Regulations, when adopted as final regulations, would apply to tax years ending on or after June 17, 2024.

The IRS states that the proposed applicability date for the Proposed Consolidated Return Regulations will be set forth in the proposed regulations once issued.

Proposed Rules Identifying Basis Shifting as Transaction of Interest

The proposed regulations issued concurrently with Notice 2024-54 identify related-partnership basis adjustment transactions and substantially similar transactions as reportable Transactions of Interest.

Under the proposed rules, disclosure requirements for these transactions would apply to taxpayers and material advisers with respect to partnerships participating in the identified transactions, including by receiving a distribution of partnership property, transferring a partnership interest, or receiving a partnership interest.

Generally, the identified Transactions of Interest would involve positive basis adjustments of $5 million or more under subchapter K of the Internal Revenue Code in excess of the gain recognized from such transactions, if any, on which tax imposed under subtitle A is required to be paid by any of the related partners (or tax-indifferent party) to such transactions – specifically, Section 732(b) or (d), Section 734(b), or Section 743(b) – for which no corresponding tax is paid.

Notification that IRS Will Challenge Basis Stripping

In Revenue Ruling 2024-14, the IRS notifies taxpayers and advisors that the IRS will apply the codified economic substance doctrine to challenge basis adjustments and other aspects of certain transactions between related-party partnerships. The IRS will raise the economic substance doctrine with respect to transactions in which related parties:

1. Create inside/outside basis disparities through various methods, including the use of partnership contributions and distributions and allocation of items under Section 704(b) and (c),
2. Capitalize on the disparity by either transferring a partnership interest in a nonrecognition transaction or making a current or liquidating distribution of partnership property to a partner, and
3. Claim a basis adjustment under Sections 732(b), 734(b), or 743(b) resulting from the nonrecognition transaction or distribution.

Planning Considerations

The IRS guidance package highlights a ramping up of IRS scrutiny of the described partnership basis shifting transactions, but there are still questions with respect to how specifically the final rules will aim to address these transactions. Additional detail should become available when the IRS issues the proposed regulations described in Notice 2024-54. In drafting those rules, the IRS will have the opportunity to take into account comments submitted on the Notice.

Moreover, particularly in light of the Supreme Court’s recent decision to overturn Chevron deference in Loper Bright Enterprises. v. Raimondo, taxpayers are likely to challenge the IRS’s authority to issue the planned regulations.

Nonetheless, taxpayers that have structured partnership basis shifting transactions or transactions that merely fall under the mechanical rules like those described in the guidance should evaluate the effects of the anticipated rules on their transactions and consider next steps for compliance.

Plan for Partnership Form 8308 Expanded Reporting and January 31 Deadline

The IRS in October 2023 released a revised Form 8308, “Report of a Sale or Exchange of Certain Partnership Interests” seeking additional information on partnership interest transfers. The revised form was initially required for transfers occurring on or after January 1, 2023, affecting 2024 filings. However, the IRS in January 2024 provided some penalty relief with respect to 2023 transfers, provided certain action was taken by January 31, 2024. It is unclear if the IRS will provide such relief again in 2025 with respect to 2024 transfers.

The IRS relief provided in the past year responded to concerns, which are still relevant, that partnerships will not have the information necessary to complete the new Part IV of Form 8308 in time to meet the January 31 deadline for furnishing information to the transferor and transferee.

Expanded Form 8308 Reporting

Partnerships file Form 8308 to report the sale or exchange by a partner of all or part of a partnership interest where any money or other property received in exchange for the interest is attributable to unrealized receivables or inventory items (that is, where there has been a Section 751(a) exchange).

The IRS significantly expanded the Form 8308 reporting requirements in the revised form released in October. For transfers occurring on or after January 1, 2023, the revised Form 8308 includes expanded Parts I and II and new Parts III and IV. New Part IV is used to report specific types of partner gain or loss when there is a Section 751(a) exchange, including the partnership’s and the transferor partner’s share of Section 751 gain and loss, collectibles gain under Section 1(h)(5), and unrecaptured Section 1250 gain under Section 1(h)(6).

Furnishing Information to Transferors and Transferees

Partnerships with unrealized receivables or inventory items described in Section 751(a) (Section 751 property or “hot assets”) are also required to provide information to each transferor and transferee that are parties to a Section 751(a) exchange.

Under the regulations, each partnership that is required to file a Form 8308 must furnish a statement to the transferor and transferee by the later of (1) January 31 of the year following the calendar year in which the Section 751(a) exchange occurred or (2) 30 days after the partnership has received notice of the exchange.

Generally, partnerships must use the completed Form 8308 as the required statement, unless the form covers more than one Section 751 exchange. If the partnership is not providing the Form 8308 as the required statement, then it must furnish a statement with the information required to be shown on the form with respect to the Section 751(a) exchange to which the person is a party.

A penalty applies under Section 6722 for failure to furnish statements to transferors and transferees on or before the required date, or for failing to include all the required information or including incorrect information.

Penalty Relief with Respect to 2023 Transfers

The IRS issued guidance (Notice 2024-19) providing penalty relief for partnerships with unrealized receivables or inventory items that would fail to furnish Form 8308 by January 31, 2024, to the transferor and transferee in certain partnership interest transfers that occurred in 2023. To qualify for the relief, among other requirements, partnerships generally still had to furnish to the transferor and transferee Parts I–III of Form 8308 by the January 31, 2024, deadline.

Notice 2024-19 stated that, with respect to Section 751(a) exchanges during calendar year 2023, the IRS would not impose penalties under Section 6722 for failure to furnish Form 8308 with a completed Part IV by the regulatory due date (i.e., generally, January 31, 2024).

To qualify for last year’s relief, the partnership was required to:

Timely and correctly furnish to the transferor and transferee a copy of Parts I, II, and III of Form 8308, or a statement that includes the same information, by the later of January 31, 2024, or 30 days after the partnership is notified of the Section 751(a) exchange, and
• Furnish to the transferor and transferee a copy of the complete Form 8308, including Part IV, or a statement that includes the same information and any additional information required under the regulations, by the later of the due date of the partnership’s Form 1065 (including extensions) or 30 days after the partnership is notified of the Section 751(a) exchange.

Planning Considerations

While the requirement of furnishing Form 8308 statements is not new, the inclusion of actual “hot asset” (i.e., unrealized receivables or inventory items) information within Form 8308 for transfers in 2023 and later has created difficulties.

Prior to 2023, this requirement could be satisfied by providing a taxpayer with a Form 8308 that merely notifies the transferor that they will have some amount of hot asset recharacterization. With the new form, partnerships are now required to provide actual recharacterization amounts.

The penalty relief for furnishing information in 2024 on 2023 transfers was welcome. However, it is unclear if the IRS will extend the relief for an additional year or otherwise address concerns about the availability of the information necessary to timely meet the requirement.

Review Limited Partner Eligibility for SECA Tax Exemption

There is some additional clarity in the ongoing dispute between the IRS and some partnerships over whether an active “limited partner” is eligible for the statutory exemption from self-employment (SECA) tax.

The U.S. Tax Court on November 28, 2023, responding to a Motion for Summary Judgment, held that nominally being a “limited partner” in a state law limited partnership is insufficient to qualify for the statutory exemption from SECA tax for limited partners (Soroban Capital Partners v. Commissioner, 161 T.C. No. 12). The court agreed with the government that the statutory exemption requires a functional analysis of whether a partner was, in fact, active in the business of the partnership and a “limited partner” in name only.

SECA Tax Exemption for Limited Partners

Under Internal Revenue Code Section 1402(a)(13), the distributive share of partnership income allocable to a limited partner is generally not subject to SECA tax, other than for guaranteed payments for services rendered. However, the statute does not define “limited partner,” and proposed regulations issued in 1997 that attempted to clarify the rules around the limited partner exclusion have never been finalized.

In recent years, courts have held – in favor of the IRS – that members in limited liability companies (LLCs) and partners in limited liability partnerships (LLPs) that are active in the entity’s trade or business are ineligible for the SECA tax exemption.

Despite these IRS successes, some – including the taxpayer in the Soroban case – continued to claim that state law controls in defining “limited partner” in the case of a state law limited partnership. This specific issue – i.e., the application of the exemption in the case of a state law limited partnership – had not previously been addressed by the courts.

Soroban Capital Partners’ Position and IRS Challenge

The Soroban Capital Partners litigation filed with the Tax Court involved a New York hedge fund management company formed as a Delaware limited partnership. The taxpayers challenged the IRS’s characterization of partnership net income as net earnings from self-employment subject to SECA tax. According to the facts presented, each of the three individual limited partners spent between 2,300 and 2,500 hours working for Soroban, its general partner and various affiliates – suggesting that the limited partners were “active participants” in the partnership’s business. For the years at issue, Soroban was subject to the TEFRA audit and litigation procedures.

The government contended that the term “limited partner” is a federal tax concept that is determined based on the actions of the partners – not the type of state law entity. Citing previous cases, the government asserted that the determination of limited partner status is a “facts and circumstances inquiry” that requires a “functional analysis.” The taxpayers in Soroban, on the other hand, argued that such a functional analysis does not apply in the case of a state law limited partnership and that, in the case of these partnerships, limited partner status is determined by state law.

Under the functional analysis adopted by the Tax Court in previous cases (not involving state law limited partnerships), to determine who is a limited partner, the court looks at the relationship of the owner to the entity’s business and the factual nature of services the owner provides to the entity’s operations.

Tax Court’s Analysis

To answer the question of whether Soroban’s net earnings from self-employment should include its limited partners’ distributive shares of ordinary business income, the court turned first to two preliminary questions:

1. What is the scope of the Section 1402(a)(13) SECA tax exemption for “a limited partner, as such”?
2. If the exemption requires looking through to the limited partner’s role in the partnership, does that inquiry concern a partnership item to be resolved in a TEFRA partnership-level proceeding?

With respect to the scope of the exemption – noting that neither the statute nor regulations define “limited partner” – the court highlighted that the statute expressly applies the exemption to “a limited partner, as such”. In interpreting statutes, the court explained that it looks at the ordinary meaning of the terms and that it must avoid rendering any words or clauses to be meaningless. Thus, the court interpreted the addition of the words “as such” to signify that Congress intended the exemption to apply to something more specific than a “limited partner” in name only.

Having concluded that a functional analysis is necessary to determine limited partner status for purposes of the exemption, the court turned to whether this inquiry concerned a “partnership item” under the applicable TEFRA procedures. The court explained that partnership items are those that (1) are required to be taken into account for the partnership tax year under subtitle A of the Internal Revenue Code and (2) are more properly determined at the partnership level.

The court stated the first prong is easily resolved – subtitle A generally requires partnerships to state the amounts of income that would be net earnings from self-employment in the hands of the recipients. The court further determined the second prong was satisfied, stating that a functional analysis of the partners’ activities involves factual determinations that are necessary to determine Soroban’s aggregate amount of net earnings from self-employment.

Accordingly, the court held that a functional analysis applies to determine whether a partner in a state law limited partnership is a “limited partner” for SECA tax exemption purposes, and, for a TEFRA partnership, that inquiry concerns a partnership item subject to a TEFRA proceeding.

Planning Considerations

This Soroban case appeared to be a big win for the government. By denying Soroban’s Motion for Summary Judgment and granting the government’s Motion for Partial Summary Judgment, the Tax Court cleared the way for this case to continue. Once the court proceeds with a functional analysis based on the facts, it can rule on whether the government’s Final Partnership Administrative Adjustments for tax years 2016 and 2017 should be upheld.

Based on prior court cases, the functional analysis will likely center around the roles and activities of the individual partners. If they are merely passive investors, then the analysis likely results in them being classified as limited partners under the SECA statute. However, if they are active in the business and/or are able to contractually bind the business under state law, the court is likely to reach the opposite conclusion.

The Soroban case involves a partnership subject to TEFRA. Although self-employment tax is not covered under the centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015 (BBA), it’s unclear how the IRS will attempt to address this treatment in audits of partnerships subject to the BBA rules instead of TEFRA.

Consider Effect of Proposed Rules on Transactions Between Partnerships and Related Persons

The Department of the Treasury and IRS in November 2023 issued proposed regulations (REG-131756-11) relating to the tax treatment of transactions between partnerships and related persons. The proposed amendments to the regulations under Sections 267 and 707 relate to the disallowance or deferral of deductions for losses and expenses in certain transactions with partnerships and related persons.

Tax Treatment of Transactions with Related Parties Under Current Regulations

In general, Section 267(a)(1) provides that a taxpayer may not deduct a loss on the sale or exchange of property with a related person as defined in Section 267(b). Section 267(a)(2) sets forth a “matching rule” that provides that if because of a payee’s method of accounting, an amount is not (unless paid) includible in the payee’s gross income, the taxpayer (payor) may not deduct the otherwise deductible amount until the payee includes the amount in gross income if the taxpayer and payee are related persons within the meaning of Section 267(b) on the last day of the taxpayer’s taxable year in which the amount otherwise would have been deductible.

As part of enacting the Internal Revenue Code of 1954, Congress added Section 707(b)(1) to the Code to address the sale or exchange of property between a partnership and a partner owning, directly or indirectly, more than 50% of the capital or profit interest in the partnership. Given a lack of statutory and regulatory guidance addressing transactions between a partnership and a related person who was not a partner, the Treasury Department and the IRS issued Reg. §1.267(b)-1(b) in 1958.

Reg. §1.267(b)-1(b) applies an aggregate theory of partnerships to provide that any transaction described in Section 267(a) between a partnership and a person other than a partner is considered as occurring between the other person and the members of the partnership separately. Specifically, Reg. §1.267(b)-1(b) provides that if the other person and a partner are within any of the relationships specified in Section 267(b), no deductions with respect to the transaction between the other person and the partnership will be allowed: (i) to the related partner to the extent of the related partner’s distributive share of partnership deductions for losses or unpaid expenses or interest resulting from the transactions, and (ii) to the other person to the extent the related partner acquires an interest in any property sold to or exchanged with the partnership by the other person at a loss, or to the extent of the related partner’s distributive share of the unpaid expenses or interest payable to the partnership by the other person as a result of the transaction.

Conflict with Statute and Proposed Amendments

Although the U.S. Tax Court upheld the validity of Reg. §1.267(b)-1(b) and its use of the aggregate theory, subsequent statutory changes to Sections 267 and 707(b) have made Reg. §1.267(b)-1(b) inconsistent with the statute. The statutory changes to Sections 267 and 707(b) enacted since 1982 indicate that Congress intended for a partnership to be viewed as an entity, rather than as an aggregate of its partners, in applying the rules of Sections 267 and 707(b). Therefore, the loss disallowance rules of Sections 267(a)(1) and 707(b)(1), the gain recharacterization rules of Section 707(b)(2), and the matching rule of Section 267(a)(2) similarly should be applied at the partnership level and not the partner level.

Accordingly, the IRS proposed changes to the regulations under Section 267, including removing Reg. §1.267(b)-1(b), to conform the regulations with the current statute.

Application of Proposed Regulations

Once the proposed regulations are finalized, Reg. §1.267(b)-1(b) will be stricken. This means that transactions described in Section 267(a) between a partnership and a person other than a partner will no longer be considered as occurring between the other person and each partner separately.

Consider the following example from the current Reg. §1.267(b)-1(b):

Example (1). A, an equal partner in the ABC partnership, personally owns all the stock of M Corporation. B and C are not related to A. The partnership and all the partners use an accrual method of accounting, and are on a calendar year. M Corporation uses the cash receipts and disbursements method of accounting and is also on a calendar year. During 1956 the partnership borrowed money from M Corporation and also sold property to M Corporation, sustaining a loss on the sale. On December 31, 1956, the partnership accrued its interest liability to the M Corporation and on April 1, 1957 (more than 2½ months after the close of its taxable year), it paid the M Corporation the amount of such accrued interest. Applying the rules of this paragraph, the transactions are considered as occurring between M Corporation and the partners separately. The sale and interest transactions considered as occurring between A and the M Corporation fall within the scope of section 267(a) and (b), but the transactions considered as occurring between partners B and C and the M Corporation do not. The latter two partners may, therefore, deduct their distributive shares of partnership deductions for the loss and the accrued interest. However, no deduction shall be allowed to A for his distributive shares of these partnership deductions. Furthermore, A's adjusted basis for his partnership interest must be decreased by the amount of his distributive share of such deductions. See section 705(a)(2).

Once the proposed regulation is finalized, the transactions would be treated as occurring between the ABC Partnership (as an entity) and M Corporation. Under Section 267(b)(10), a corporation and a partnership are related if the same persons own (A) more than 50% in value of the outstanding stock of the corporation, and (B) more than 50% of the capital interest, or the profits interest, in the partnership. In this case, A owns 100% of M Corporation and only 33-1/3% of ABC Partnership. Accordingly, since the partnership and corporation are unrelated, the partners can deduct the accrued interest liability to M corporation, and the partners can also deduct the loss on sale of property to M Corporation.

Planning Considerations

Given the fact that Treasury and IRS have stated in the Notice of Proposed Rulemaking that statutory changes in the 1980s indicate that Congress intended for a partnership to be viewed as an entity, rather than as an aggregate of its partners, there may be reasonable basis to take such a position even before the proposed regulations are issued in final form, as long as a disclosure is made. Taxpayers should consult with their tax advisers if considering relying on the proposed regulations.

Double-Check Positions on Inventory Items and Unrealized Receivables Under Section 751(a)

On appeal from the Tax Court, the U.S. Court of Appeals for the D.C. Circuit has clarified the application of the recharacterization provision under Section 751(a).

Reversing the Tax Court, the circuit court held that gain attributable to inventory (Section 751(a) property) in the sale of a partnership interest by a nonresident alien is still the sale of a partnership interest under Section 751(a) and not taxable as U.S. source income under the law applicable in the year at issue (Rawat v. Commissioner, July 23, 2024).

Taxation of Gain on Partnership Dispositions by Nonresident Aliens

Gain or loss on the sale of partnership interests is generally taxed as a capital gain or loss under Section 741. However, to the extent the gain or loss is attributable to inventory and unrealized receivables – “Section 751(a) property” – the gain or loss is recharacterized as ordinary.

Specifically, Section 751(a) states that an amount realized on the sale of a partnership interest that is attributable to inventory items of the partnership “shall be considered as an amount realized from the sale or exchange of property other than a capital asset.”

Section 864(c)(8), enacted by the Tax Cuts and Jobs of 2017 (TCJA), treats a nonresident alien’s gain or loss from the sale of an interest in a U.S. partnership as taxable U.S.-source income. However, before the enactment of the TCJA, personal property law controlled, and a nonresident alien’s gain or loss from the sale of personal property was generally treated as foreign-source but could be treated as U.S.-source under certain exceptions, including for inventory. A U.S. partnership interest is personal property for purposes of this rule.

Is Gain from Section 751(a) Property Treated as Gain from Selling Inventory?

Rawat, a nonresident alien, sold her interest in a U.S. partnership in 2008 for $438 million, with $6.5 million of her gain attributable to the sale of the company’s inventory. The IRS asserted that the gain attributable to inventory was U.S.-source and taxable. Therefore, Rawat owed $2.3 million in taxes on it. Rawat argued that the inventory-attributed gain was foreign-source and nontaxable. The Tax Court agreed with the government.

The dispute centered on the interpretation of Section 751(a): whether it causes gain from a partnership interest sale that is attributable to inventory merely to be taxed as ordinary income or actually to be treated as the sale of inventory and therefore potentially U.S. source in the hands of a nonresident alien.

There was no dispute that the statute required gain attributable to Section 751(a) property to be taxed as ordinary income if it was taxable to Rawat as U.S.-source income.

D.C. Circuit Finds Narrow Interpretation of Section 751(a)

The D.C. Circuit Court found relevant that the definition of “ordinary income” in Section 64 parallels the language in Section 751(a), with both Code sections referring to gain from the sale or exchange of property that is not a capital asset. It follows, the court reasoned, that the language of Section 751(a) that states that gain (or an amount realized) attributable to inventory “shall be considered as an amount realized from the sale or exchange of property other than a capital asset” may be read more plainly to mean “shall be considered as ordinary income.”

The court stated that this interpretation is further supported by the fact that Section 751(a) operates as a carveout to the general rule in Section 741 that gain on the sale of a partnership interest is treated as capital gain. The court further pointed to legislative history indicating Section 751(a) was enacted to end efforts to evade taxation as ordinary income.

On the contrary, the government argued that, under the statute, gain on the sale of a partnership interest from inventory or Section 751(a) property is not just taxed as ordinary income but is taxed as a sale of inventory rather than as of a partnership interest. The result being that the gain could be U.S.-source income to a nonresident alien under the pre-TCJA law.

However, the D.C. Circuit rejected the argument put forth by the government and previously accepted by the Tax Court. The D.C. Circuit noted that Section 751(a) states that the applicable gain is to be treated as ordinary income, nothing more, and that Congress would have stated more if it meant more. The broader reading of Section 751(a) is not supported by other sections of the Code using similar language or the legislative history, the court concluded. 

Accordingly, the court held that the sale by Rawat of the partnership interest attributable to inventory was still the sale of a partnership interest, and accordingly, under the law applicable at the time, was foreign-source income and non-taxable.

Planning Considerations

This court case has limited direct applicability after the TCJA enacted Section 864(c)(8). However, the court case is instructive in that it supports the idea that, absent a specific statutory exception, the entity theory of partnerships (rather than the aggregate theory) controls with respect to the sale of a partnership interest. Section 751(a) is merely a recharacterization provision and it does not operate to dictate that a partnership interest sale be deemed to be an actual sale of inventory.

Because the Tax Court’s judgment has now been reversed by the circuit court, taxpayers that have relied on a similar theory as that adopted by the Tax Court in Rawat should review their positions. Although the reversal of the Tax Court in Rawat was a win for the taxpayer in the current case, taxpayers have taken other taxpayer-friendly positions based on a similar interpretation of Section 751(a) as argued by the government and originally accepted by the Tax Court in Rawat.

Keep an Eye on Challenges to IRS Rules, Including Partnership Anti-Abuse Rules, Under Loper Bright

In its June 2024 decision in Loper Bright, the Supreme Court overturned the longstanding Chevron doctrine, which gave deference to agency interpretations of silent or ambiguous statutes if the interpretation was reasonable. In overturning this principle, the Supreme Court held that courts must exercise independent judgment.

In light of the Loper Bright decision, taxpayers are bringing new challenges to IRS regulations, including in the Tribune Media case involving the application of a liability allocation anti-abuse rule under Treas. Reg. §1.752-2(j) and the general partnership anti-abuse rule under Treas. Reg. §1.701-2.

Generally, in the Tribune Media case, the government appeals a Tax Court decision that it views as paving the way for inappropriate income tax planning, potentially enabling taxpayers to follow the roadmap created by the taxpayer in Tribune Media to implement leveraged partnership transactions without triggering taxable gain while avoiding incurring meaningful economic risk.

Loper Bright Arguments in Tribune Media

Tribune Media and the government have supplemented their arguments in their pending appeal before the Seventh Circuit on leveraged partnership transactions and the application of partnership anti-abuse rules. Tribune Media has submitted a letter to the court arguing that the U.S. Supreme Court’s decision in Loper Bright reinforces its argument that the general anti-abuse rule in question is invalid.

In its letter to the Seventh Circuit regarding the effect of Loper Bright in its case, Tribune Media challenges the validity of the general anti-abuse rule. It notes that, although the government does not expressly claim Chevron deference for the rule, the Loper Bright decision instructs the court to carefully scrutinize whether the IRS had the authority to issue the rule, which Tribune Media argues is regulatory overreach as “the agency even contends that it can invalidate a transaction that follows ‘the literal words’ of a statute that Congress enacted.” 

In its response, the government contends that the anti-abuse rule does not rely on Chevron deference, is based on established case law, and was promulgated within the bounds of authority granted to the IRS by Congress.

Planning Considerations

The decision in Loper Bright has opened the door for taxpayers to make fresh challenges to the validity of Treasury regulations. The Tribune Media case is an example of the type of challenge that taxpayers are making to the government’s authority to promulgate its interpretation of statutes in existing regulations. The issue in this specific case is whether the government can write broad anti-abuse regulations that change the taxation of transactions that follow a strict reading of the statute, but that the IRS and Treasury contend are abusive or argue aren’t in line with the intent of the statute.

Watch for New Form for Partners to Report Partnership Property Distributions

The IRS has released a draft of new Form 7217, “Partner’s Report of Property Distributed by a Partnership,” and related instructions.

The form is to be filed by any partner receiving a distribution of property from a partnership in a non-liquidating or liquidating distribution. However, partners do not have to file the form for

Distributions that consist only of money or marketable securities treated as money,
• Payments to the partner for services other than in their capacity as a partner under Section 707(a)(1), or
• Payments for transfers that are treated as disguised sales under Section 707(a)(2)(B).

The partner uses the form to report the basis of distributed property, including any basis adjustments to the property required by Section 732(a)(2) or (b). The two-page draft Form 7217 is broken into two parts, with Part I used for reporting the aggregate basis of the distributed property on the distribution date and Part II covering the allocation of basis of the distributed property.

Partners are to file a separate Form 7217 for each date during the tax year that they actually (not constructively) receive distributed property subject to Section 732 – even if property distributions received on different days were part of the same transaction.

The instructions state that Forms 7217 are to be due when the partner’s tax return is due, including extensions. They add that partners should file their Forms 7217 attached to their annual tax return for the tax years in which they actually received distributed property subject to Section 732.

Planning Considerations

The draft form is a continuation of the IRS’s recent efforts to expand required disclosures from partnerships. Based on an initial review of the draft version of the form, it appears likely they IRS will need to make some modifications to appropriately capture the information being requested by the form.

Prepare for Partnership Obligations Under Corporate Alternative Minimum Tax Regulations

The IRS on September 12, 2024, issued proposed regulations on the corporate alternative minimum tax (CAMT), enacted by the Inflation Reduction Act, that include significant new provisions for partnerships with corporate partners subject to the CAMT.

For tax years beginning after December 31, 2022, the CAMT imposes a 15% minimum tax on the adjusted financial statement income (AFSI) of large corporations (generally, those with average annual AFSI exceeding $1 billion).

The proposed regulations set out rules for determining and identifying AFSI, including applicable rules for partnerships with CAMT entity partners. For a general discussion of the CAMT proposed regulations, see the Corporate Tax section of this guide.

CAMT Statute, AFSI Adjustments & Partnerships

Generally, the CAMT is imposed on AFSI – as determined under Section 56A – of an applicable corporation. Under Section 56A, AFSI means, with respect to any corporation for any tax year, the net income or loss of the taxpayer set forth on the taxpayer's applicable financial statement for that tax year, adjusted as further provided within that Code section.

Adjustments to AFSI are set out in Section 56A(c). Regarding partnerships, Section 56A(c)(2)(D) states that, except as provided by the Secretary, if the taxpayer is a partner in a partnership, the taxpayer's AFSI with respect to such partnership is adjusted to take into account only the taxpayer’s distributive share of such partnership’s AFSI. It adds that the AFSI of a partnership is the partnership’s net income or loss set forth on that partnership’s applicable financial statement, as adjusted under rules similar to the rules set forth in Section 56A.

Proposed Rules on for Partner's Distributive Share of Partnership AFSI

The IRS sets out in Prop. Reg. §1.56A-5 rules under Section 56A(c)(2)(D) regarding a partner's distributive share of partnership AFSI. The IRS explains that it is proposing adopting a “bottom-up” method which it believes is consistent with the statute and is more conducive to taking into account Section 56A adjustments. Under the proposed “bottom-up” method, a partnership would calculate its AFSI and provide this information to its partners. Each partner would then need to determine its “distributive share” of the partnership's AFSI. 

The proposed rules generally provide that, if a CAMT entity is a partner in a partnership, its AFSI with respect to its partnership investment is adjusted as required under the applicable regulations to take into account the CAMT entity’s distributive share of the partnership's AFSI.

Under the proposed rules, a CAMT entity's distributive share amount is computed for each tax year based on four steps:

1. The CAMT entity determines its distributive share percentage,
2. The partnership determines its modified financial statement income,
3. The CAMT entity multiplies its distributive share percentage by the modified financial statement income of the partnership (as reported by the partnership), and
4. The CAMT entity adjusts the product of the amount determined in step (3) above for certain separately stated Section 56A adjustments.

There are also related reporting and filing requirements in the proposed rules. Because a CAMT entity may require information from the partnership to compute its distributive share of a partnership’s AFSI, the proposed regulations would require a partnership to provide the information to the CAMT entity if the CAMT entity cannot determine its distributive share of the partnership’s AFSI without the information and the CAMT entity makes a timely request for the information.

Proposed Rules on AFSI Adjustments to Apply Certain Subchapter K Principles

The proposed regulations also include rules to provide for adjustments to carry out the principles of subchapter K regarding partnership contributions, distributions, and interest transfers. The rules, as proposed, would apply to most contributions to or distributions from a partnership, but not with respect to stock of a foreign corporation except in limited circumstances.

For both contributions and distributions of property, the IRS proposes a deferred sale method. Thus, for contributions, the proposed rules generally provide that, if property (other than stock in a foreign corporation) is contributed by a CAMT entity to a partnership in a non-taxable transaction, any gain or loss reflected in the contributor’s financial statement income from the property transfer is included in the contributor’s AFSI in accordance with the deferred sale approach set forth in the proposed rules.

The proposed regulations also include rules relating to the maintenance of books and records and reporting requirements for a partnership and each CAMT entity that is a partner in the partnership.

2024 Year-End Planning Guide – Tax Accounting Methods

Corporations and pass-through entities may have opportunities to effectively improve their federal income tax positions and, in turn, enhance their cash tax savings by strategically adopting or changing tax accounting methods. Companies that want to reduce their current year tax liability (or create or increase a current year net operating loss (NOL)) should consider accounting method changes that accelerate deductions and defer income recognition. On the other hand, for various reasons (for example, to utilize an NOL), companies may choose to undertake accounting methods planning to accelerate income recognition and defer deductions. Importantly, when undertaking any future tax planning, companies should also keep in mind current tax proposals as well as changes that could result based on the outcomes of the 2024 presidential and congressional elections.

The rules covering the ability to use or change certain accounting methods are often complex, and the procedure for changing a particular method depends on the mechanism for receiving IRS consent — i.e., whether the change is automatic or non-automatic. Many method changes require an application be filed with the IRS prior to the end of the tax year for which the change is requested.

The following are some of the many important issues and developments for companies to consider when reviewing their tax accounting methods in 2024:

December 31^st deadline for non-automatic method changes
• Modified procedural guidance for Section 174 R&E costs
• Claiming abandonment and casualty losses
• Tax rules for calculating percentage of completion revenue
• Tax accounting for sales of IRA credits
• Year-end opportunities to accelerate common deductions and losses
• IRS insights into treatment of transferable incentives

December 31st Deadline for Non-automatic Method Changes

Notably, Rev. Proc. 2024-23, released on April 30, 2024, removed from the IRS list of permissible automatic method changes any change made to comply with the Section 451 all-events test applicable for accrual method taxpayers. Effective for Forms 3115 filed on or after April 30, 2024, for a year of change ending on or after September 30, 2023, this method change may only be made using the non-automatic change procedures.

Among the other method changes that must be filed under the non-automatic change procedures are many changes to correct an impermissible method of recognizing liabilities under an accrual method (for example, using a reserve-type accrual), deferred compensation accruals, and long-term contract changes under Section 460. Additionally, taxpayers that do not qualify to use the automatic change procedures because they have made a change with respect to the same item within the past five tax years will need to file under the non-automatic change procedures to request their method change.

Generally, more information needs to be provided on Form 3115 for a non-automatic accounting method change, and the complexity of the issue and the taxpayer’s facts may increase the time needed to gather data and prepare the application. Therefore, taxpayers that wish to file non-automatic accounting method changes effective for 2024 should begin gathering the necessary information and prepare the application as soon as possible. 

IRS Releases Modified Procedural Guidance for Section 174 R&E Costs

On August 29, 2024, the IRS issued Rev. Proc. 2024-34, which provides modified procedural guidance permitting taxpayers with short taxable years in 2022 or 2023 to file an automatic accounting method change for a 2023 year for specified research or experimental expenditures (SREs) under Internal Revenue Code Section 174. The revised procedures are effective for Forms 3115 filed on or after August 29, 2024.

Effective for tax years beginning in 2022, the Tax Cuts and Jobs Act requires taxpayers to capitalize SREs in the year the amounts are paid or incurred and amortize the amounts over five or 15 years. Due to this shift in treatment, taxpayers using a different method of accounting for Section 174 costs were required to file a method change to comply with the new rules for their first taxable year beginning after December 31, 2021.

Rev. Proc. 2024-34 Provides Taxpayers Additional Flexibility

Taxpayers may want or need to file successive accounting method changes to comply with new technical guidance issued by the IRS or correct or otherwise deviate from the positions taken with the initial method change. Prior to the issuance of Rev. Proc. 2024-34, taxpayers seeking to file successive automatic changes to comply with the updated Section 174 rules could only do so for changes made for the first and second tax years (including short tax years) beginning after December 31, 2021. Thus, a taxpayer with two short taxable years in 2022 (for example, due to a transaction) that filed an automatic Section 174 method change for one or both of those years previously would not have been able to file another automatic Section 174 method change for its 2023 year. Rev. Proc. 2024-34 provides taxpayers with additional flexibility to file an automatic Section 174 method change for any taxable year beginning in 2022 or 2023, regardless of whether the taxpayer has already made a change for the same item for a taxable year beginning in 2022 or 2023. Therefore, taxpayers that have not yet filed a federal income tax return for 2023 or have timely filed their 2023 return and are within the extension period for such return (even if no extension was filed), may be able to file an automatic change for SREs even if an accounting method change has been filed for a year beginning after December 31, 2021.

Rev. Proc. 2024-34 also modifies the existing procedural rules to permit taxpayers that are in the final year of their trade or business to use the automatic procedures to change to the required accounting method for SREs for any tax year beginning in 2022 or 2023. Under the prior guidance, taxpayers could only file an SRE method change in the final year of their trade or business for their first or second taxable year beginning after December 31, 2021.

Audit Protection May Not Be Available

Importantly, the updated guidance clarifies that if a taxpayer did not change its method of accounting in an effort to comply with Section 174 for its first taxable year beginning after December 31, 2021, the taxpayer will not receive audit protection for a change made in any taxable year beginning in 2022 or 2023. With this revision, the IRS is effectively denying audit protection for all taxpayers (regardless of whether they had short periods or full 12-month years in 2022 and 2023) that did not originally file a change to comply with Section 174 with their first taxable year beginning after December 31, 2021, unless they defer filing a method change until a tax year beginning in 2024 or after.

Claiming Abandonment and Casualty Losses

A taxpayer may be able to claim a deduction for certain types of losses it sustains during a taxable year — including losses due to casualties or abandonment, among others — that are not compensated by insurance or otherwise. To be allowable as a deduction under Section 165, a loss must be:

Evidenced by a closed and completed transaction,
• Fixed by an identifiable event, and
• Actually sustained during the taxable year.

The loss is allowed as a deduction only for the taxable year in which it is sustained. Further, the loss can be claimed on an originally filed tax return or on an amended tax return. It is important for businesses to be aware of any potential loss that has occurred, or may occur, in a taxable year, and to ensure that appropriate documentation and actions are taken within the taxable year to support the loss deduction. 

Abandonment Losses

To substantiate an abandonment loss, some act is required to evidence a taxpayer’s intent to permanently discard or discontinue the use of an asset in its business. No deduction is allowed if a taxpayer holds and preserves an asset for possible future use or for its potential future value. Suspending operations or merely not using an asset is not sufficient to establish an act of abandonment, nor is a decline in value of an asset sufficient to claim an abandonment loss. To demonstrate abandonment of an asset, a taxpayer must show both written evidence of an intention to irrevocably abandon the asset and an affirmative act of abandonment. Although some guidance exists on when a tangible asset is considered abandoned, showing abandonment of intangibles can be more challenging, and little guidance exists related to current technologies such as software, internet, or website-related intangibles.

Casualty Losses

The IRS defines a casualty broadly to include, for example, earthquakes, fires, floods, government-ordered demolitions or relocations of property deemed unsafe by reason of disasters, mine cave-ins, shipwrecks, sonic booms, storms (including hurricanes and tornadoes), terrorist attacks, vandalism, and volcanic eruptions. Importantly, casualty losses arise only from identifiable events that are sudden, unexpected, or unusual in nature, such as a natural disaster. A casualty loss does not include slow, progressive deterioration.

For a business taxpayer that needs to determine whether its gains or losses during the taxable year are treated as capital or ordinary under Section 1231, there is a special rule for involuntary conversions, which include casualties. An involuntary conversion, in relevant part, is the loss by fire, storm, shipwreck, or other casualty, or by theft, of property used in the taxpayer’s business or any capital asset that is held for more than one year. If losses from involuntarily converted property exceed gains from such property, Section 1231 does not apply to determine the character of the gain or loss. A net loss will be treated as an ordinary loss. If the taxpayer does not have losses from the involuntarily converted property, the general rules under Section 1231 must be followed.

Federally declared disasters. Generally, casualty losses are deducted only in the year in which the casualty event occurs. However, if the casualty loss is attributable to a federally declared disaster, a taxpayer may elect to take the deduction in the prior tax year. Disaster declarations are published on the Federal Emergency Management Agency (FEMA) website. The IRS typically publishes notifications in the Internal Revenue Bulletin shortly after a declaration as well.

Note that for individuals that experience a casualty event between 2018 through 2025, casualty losses are deductible only to the extent they are attributable to a federally declared disaster.

For more information on deducting abandonment, casualty, and theft losses, read the article authored by BDO’s James Atkinson, Developing an Action Plan for Casualty Gains and Losses 183 Tax Notes Federal 2303 (June 24, 2024).

Tax Rules for Calculating Percentage of Completion Revenue

The percentage of completion method (PCM) for long-term contracts, governed by Section 460 of the Internal Revenue Code, is often misapplied by taxpayers as a method of tax accounting. Taxpayers with qualifying construction or manufacturing contracts frequently follow their book methodologies with minimal, if any, adjustments for tax purposes; however, the rules governing PCM under Section 460 differ significantly from those governing over-time recognition under GAAP. Further, PCM method changes are typically non-automatic; thus, calendar-year taxpayers seeking to change their method for long term contracts must file a Form 3115 by December 31, 2024 in order to implement the change for their 2024 tax year.

Defining Long-term Contracts – Eligibility for PCM

Qualification as a PCM-eligible long-term contract is determined on a contract-by-contract basis and has two broad requirements: (i) the contract must be for a qualifying activity (either construction or manufacturing), and (ii) the contract must qualify as long-term.

Construction is considered a qualifying activity if one of the following must occur to satisfy the taxpayer’s contractual obligations:

The building, construction, reconstruction, or rehabilitation of real property (i.e., land, buildings, and inherently permanent structures as defined in Treas. Reg. §1.263A-8(c)(3));
• The installation of an integral component to real property (property not produced at the site of the real property but intended to be permanently affixed to the real property); or
• The improvement of real property.

Manufacturing will satisfy the activity requirement if the item being produced (i) normally requires more than 12 calendar months to produce (regardless of the actual time from contract to delivery); or (ii) is “unique.” In this context, unique means far more than mere customization. The Section 460 regulations provide several safe harbors to assist taxpayers with determining whether the item being manufactured is unique.

To be considered long-term under the PCM rules, a contract must begin and end in two different taxable years. Therefore, in theory, even a two-day contract from December 31 to January 1 could qualify as a long-term contract.

PCM Calculation

For tax purposes, the taxpayer’s inception-to-date contract revenue corresponds to the ratio of inception-to-date contract costs incurred to total estimated contract costs. With respect to expense recognition, Section 460 mandates the accrual method for contract costs, such that deduction generally occurs in the same year the costs are taken into account in the PCM ratio’s numerator. As previously noted, the tax rules governing PCM likely deviate from the book treatment of income/expenses in several aspects. For instance, under Section 460, taxpayers must follow how to determine the types and amounts of costs that are considered in the project completion rule. Further, there are specific rules pertaining to the treatment of pre-contracting costs (e.g., bidding and proposal costs), as well as look-back rules, which require a taxpayer, after the completion of a long-term contract, to perform a hypothetical recalculation of its prior years’ income using the actual total contract price and actual total contract costs, rather than the estimated total contract price and estimated total contract costs used for its prior year returns.

Interplay with Section 174

Many taxpayers with long-term contracts may be impacted by the requirement to capitalize Section 174 R&E expenditures. Taxpayers with significant contract-specific R&E expenditures may see some opportunity to defer the recognition of income in line with the deferral of R&E expense based on the IRS’s requirements for including R&E costs within the numerator and denominator of the completion percentage formula. Notice 2023-63 has clarified that the numerator of the completion percentage formula contains only the amortization of the capitalized R&E costs, not the gross amount of the year’s R&E expenditures. More recent guidance (Rev. Proc. 2024-09, released on December 22, 2023) provides some limited flexibility concerning the inclusion of Section 174 costs in the denominator.

Tax Accounting Considerations for Sales of IRA Tax Credits

Taxpayers either purchasing or selling certain federal income tax credits under the Inflation Reduction Act of 2022 (IRA) should be aware of specific tax accounting rules governing the treatment of amounts paid or received for those credits. These special rules are provided in Section 6418 of the Internal Revenue Code, as well as in final Treasury regulations published in the Federal Register on April 30, 2024.

Taxpayers unaware of the new rules might overlook them and mistakenly apply the more familiar general rules instead, potentially resulting in sellers overstating their taxable income and purchasers claiming impermissible deductions.

The special tax accounting rules apply in preparing federal income tax returns of taxpayers engaging in qualifying transfers of eligible credits in 2023 or later years.

Eligible Credits

The new tax accounting rules apply to qualifying sales of “eligible credits,” which Section 6418(f)(1) defines as the following tax credits:

The portion of the credit for alternative fuel vehicle refueling property allowed under Section 30C that is treated as a credit listed in Section 38(b);
• The renewable electricity production credit determined under Section 45(a);
• The credit for carbon oxide sequestration determined under Section 45Q(a);
• The zero-emission nuclear power production credit determined under Section 45U(a);
• The clean hydrogen production credit determined under Section 45V(a);
• The advanced manufacturing production credit determined under Section 45X(a);
• The clean electricity production credit determined under Section 45Y(a);
• The clean fuel production credit determined under Section 45Z(a);
• The energy credit determined under Section 48;
• The qualifying advanced energy project credit determined under Section 48C; and
• The clean electricity investment credit determined under Section 48E.

Section 6418 allows taxpayers to elect to transfer eligible credits to an unrelated person (but an eligible credit can only be transferred one time). Specific requirements and procedures apply in making such an election. 

Special Tax Accounting Requirements

Qualifying transfers of eligible credits are subject to specific tax accounting rules that differ from tax accounting principles generally applicable to the sale or exchange of property. Section 6418(b) provides that with respect to consideration paid for the transfer of an eligible credit, that amount:

Must be “paid in cash”;
• Is not includible in the seller’s gross income; and
• Is not deductible by the purchaser of the eligible credit.

In the case of eligible credits determined with respect to any facility or property held directly by a partnership or S corporation, if the partnership or S corporation makes a qualifying election to transfer an eligible credit:

Any amount received as consideration for the transfer of the credit is treated as tax-exempt income for purposes of Section 705 (dealing with the basis of a partner’s interest in a partnership) and Section 1366 (dealing with pass-through of items to S corporation shareholders); and 
• A partner’s distributive share of the tax-exempt income must be based on the partner’s distributive share of the otherwise eligible credit for each taxable year.

Just as the seller would not have realized income had it used the eligible credit to reduce its own federal tax liability rather than selling the credit, the final regulations provide a step-in-the-shoes rule for the eligible credit’s purchaser. The purchaser will not realize income upon its use of the credit to reduce its federal tax liability, even if the tax savings exceed the consideration paid to acquire the eligible credit.

For any eligible credit (or portion of an eligible credit) that the taxpayer elects to transfer in accordance with Section 6418, the purchaser takes the credit into account in its first taxable year ending with, or after, the seller’s taxable year with respect to which the credit was determined.

Basis Adjustment Rules

Under Section 6418 and the final regulations, if a Section 48 energy credit, Section 48C qualifying advanced energy project credit, or a Section 48E clean electricity investment credit is transferred, the basis reduction rules of Section 50(c) apply to the applicable investment credit property as if the transferred eligible credit was allowed to the seller, rather than to the purchaser. Section 50(c) generally provides that if a credit is determined with respect to any property, the basis of the property is reduced by the amount of the credit (subject to certain recapture rules).

The basis adjustment will affect the computation of the seller’s available cost recovery deductions for the investment property with respect to which the transferred credits arose, and so must be considered in preparing the returns of taxpayers engaged in the sale of eligible credits.

Applicability Dates

Section 6418 applies to taxable years beginning after December 31, 2022. Sellers must elect to transfer all or a portion of an eligible credit on the seller’s original return for the taxable year for which the credit is determined by the due date of that return (including extensions), but not earlier than February 13, 2023.

The final regulations are applicable for taxable years ending on or after April 30, 2024. Taxpayers may apply the final regulations to taxable years ending prior to that date but must apply them in their entirety if they choose to do so. 

Year-end Opportunities to Accelerate Common Deductions and Losses

Heading into year-end tax planning season, companies may be able to take some relatively easy steps to accelerate certain deductions into 2024 or, if more advantageous, defer certain deductions to one or more later years. The key reminder for all of the following year-end “clean-up” items is that the taxpayer must make the necessary revisions or take the necessary actions before the end of the 2024 taxable year. (Unless otherwise indicated, the following items discuss planning relevant to an accrual basis taxpayer.)

Deduction of accrued bonuses. In most circumstances, a taxpayer will want to deduct bonuses in the year they are earned (the service year), rather than the year the amounts are paid to the recipient employees. To accomplish this, taxpayers may wish to:

Review bonus plans before year end and consider changing the terms to eliminate any contingencies that can cause the bonus liability not to meet the Section 461 “all events test” as of the last day of the taxable year. Taxpayers may be able to implement strategies that allow for an accelerated deduction for tax purposes while retaining the employment requirement on the bonus payment date. These may include using (i) a “bonus pool” with a mechanism for reallocating forfeited bonuses back into the pool; or (ii) a “minimum bonus” strategy that allows some flexibility for the employer to retain a specified amount of forfeited bonuses.

It is important that the bonus pool amount is fixed through a binding corporate action (e.g., board resolution) taken prior to year end that specifies the pool amount, or through a formula that is fixed before the end of the tax year, taking into account financial data as of the end of the tax year. A change in the bonus plan would be considered a change in underlying facts, which would allow the taxpayer to prospectively adopt a new method of accounting without filing a Form 3115.

Schedule bonus payments to recipients to be made no later than 2.5 months after the tax year end to meet the requirements of Section 404 for deduction in the service year.

Deductions of prepaid expenses. For federal income tax purposes, companies may have an opportunity to take a current deduction for some of the expenses they prepay, rather than capitalizing and amortizing the amounts over the term of the underlying agreement or taking a deduction at the time services are rendered. Under the so-called “12-month rule,” taxpayers can deduct prepaid expenses in the year the amounts are paid (rather than having to capitalize and amortize the amounts over a future period) if the right/benefit associated with the prepayment does not extend beyond the earlier of i) 12 months after the first date on which the taxpayer realizes the right/benefit, or ii) the end of the taxable year following the year of payment. Note that accrual method taxpayers must first have an incurred liability under Section 461 in order to accelerate a prepayment under the 12-month rule.

The rule provides some valuable options for accelerated deduction of prepaids for accrual basis companies – for example, insurance, taxes, government licensing fees, software maintenance contracts, and warranty-type service contracts. Identifying prepaids eligible for accelerated deduction under the tax rules can prove a worthwhile exercise by helping companies strategize whether to make prepayments before year end, which may require a change in accounting method for the eligible prepaids.

Inventory write offs. Often companies carry inventory that is obsolete, unsalable, damaged, defective, or no longer needed. While for financial reporting inventory is generally reduced by reserves, for tax purposes a business normally must dispose of inventories to recognize a loss, unless an exception applies. Thus, a best practice for tax purposes to accelerate losses related to inventory is to dispose of or scrap the inventory by year end.

An important exception to this rule is the treatment of “subnormal goods,” which are defined as goods that are unsaleable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar reasons. For these types of items, companies may be able to write down the cost of inventory to the actual offering price within 30 days after year end, less any selling costs, even if the inventory is not sold or disposed of by year end.

Continued phase-out of bonus depreciation. For eligible property placed in service during 2024, the applicable bonus percentage is 60%. As such, year-end tax planning for fixed assets emphasizes cash tax savings through scrubbing fixed asset accounts for costs that can be deducted currently under Section 162 (e.g., as repairs and maintenance costs) rather than being capitalized and recovered through depreciation, assessing eligibility for immediate Section 179 expensing, and reducing the depreciation recovery periods of capital costs where possible.

CCA Provides Insight into Treatment of Transferable Incentives

CCA 202304009 addresses whether a pharmaceutical or biotechnology company must capitalize costs incurred to purchase from a third party a priority review voucher (PRV) issued by the U.S. Food & Drug Administration (FDA). A PRV is a voucher entitling its holder to prioritized FDA review of a new medical treatment the applicant seeks to offer to the public. PRVs are considered valuable assets because their use can significantly reduce the time it would otherwise take to bring a new drug to market. A PRV can be held for use with a future FDA drug application or sold without restriction to another company for their use. PRVs have no expiration date and can be transferred an unlimited number of times.

In CCA 2023040009, the IRS concluded that a taxpayer must capitalize the amount spent to purchase a PRV either as a cost incurred to facilitate obtaining a franchise right or as a cost incurred to acquire a new intangible asset, depending on the intended use of the voucher. The IRS also provided guidance on how the capitalized costs should be recovered.

While CCA 202304009 discusses costs to acquire PRVs, the guidance might help forecast the tax accounting treatment of various other non-tax government incentives as well. For further information and analysis, read the article authored by BDO’s Connie Cunningham and James Atkinson, IRS Provides Insight Into Treatment of Transferable Incentives 65 TMM, 5/16/2024.

2024 Year-End Tax Planning for Individuals

With rising interest rates, inflation, and continuing market volatility, tax planning is as essential as ever for taxpayers looking to manage cash flow while paying the least amount of taxes possible over time. As we approach the end of the year, now is the time for individuals, business owners, and family offices to review their 2024 and 2025 tax situations and identify opportunities for reducing, deferring, or accelerating their tax obligations.

The information contained in this article is based on federal laws and policies in effect as of the publication date. This article discusses tax planning for U.S. federal income taxes. Applicable state and foreign taxes should also be considered. Taxpayers should consult with a trusted advisor when making tax and financial decisions regarding any of the items below.

INDIVIDUAL TAX PLANNING HIGHLIGHTS

2024 Federal Income Tax Rate Brackets

Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 – $23,200	$0 – $11,600	$0 – $16,550	$0 – $11,600	$0 – $3,100
12%	$23,201 – $94,300	$11,601 – $47,150	$16,551 – $63,100	$11,601 – $47,150	–
22%	$94,301 – $201,050	$47,151 – $100,525	$63,101 – $100,500	$47,151 – $100,525
24%	$201,051 – $383,900	$100,526 – $191,950	$100,501 – $191,950	$100,526 – $191,950	$3,101 – $11,150
32%	$383,901 – $487,450	$191,951 – $243,725	$191,951 – $243,700	$191,951 – $243,725
35%	$487,451 – $731,200	$243,726 – $609,350	$243,701 – $609,350	$243,726 – $365,600	$11,151 – $15,200
37%	Over $731,200	Over $609,350	Over $609,350	Over $365,600	Over $15,200

2025 Federal Income Tax Rate Brackets

Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 - $23,850	$0 - $11,925	$0 - $17,000	$0 - $11,925	$0 - $3,150
12%	$23,851 - $96,950	$11,926 - $48,475	$17,001 - $64,850	$11,926 - $48,475	--
22%	$96,951 - $206,700	$48,476 - $103,350	$64,851 - $103,350	$48,476 – 103,350	--
24%	$206,701 - $394,600	$103,351 - $197,300	$103,351 - $197,300	$103,351 – 197,300	$3,151 - $11,450
32%	$394,601 - $501,050	$197,301 - $250,525	$197,301 - $250,500	$197,301 - $250,525	--
35%	$501,051 - $751,600	$250,526 - $626,350	$250,501 - $626,350	$250,526 - $375,800	$11,451 - $15,650
37%	Over $751,600	Over $626,350	Over $626,350	Over $375,800	Over $15,650

TIMING OF INCOME AND DEDUCTIONS

Taxpayers should consider whether they can reduce their tax bills by shifting income or deductions between 2024 and 2025. Ideally, income should be received in the year with the lower marginal tax rate, and deductible expenses should be paid in the year with the higher marginal tax rate. If the marginal tax rate is the same in both years, deferring income from 2024 to 2025 will produce a one-year tax deferral, and accelerating deductions from 2025 to 2024 will lower the 2024 income tax liability.

Actions to consider that may result in a reduction or deferral of taxes include:

Delaying closing capital gain transactions until after year-end or structuring 2024 transactions as installment sales so that gain is deferred past 2024.
• Triggering capital losses before the end of 2024 to offset 2024 capital gains.
• Delaying interest or dividend payments from closely held corporations to individual business-owner taxpayers.
• Deferring commission income by closing sales in early 2025 instead of late 2024.
• Accelerating deductions for expenses such as mortgage interest and charitable donations (including donations of appreciated property) into 2024 (subject to adjusted gross income (AGI) limitations).
• Evaluating whether non-business bad debts are worthless -- and should be recognized as a short-term capital loss -- by the end of 2024.
• Shifting investments to municipal bonds or investments that do not pay dividends to reduce taxable income in future years.

Taxpayers that will be in a higher tax bracket in 2025 may want to consider potential ways to move taxable income from 2025 into 2024, so that the taxable income is taxed at a lower tax rate. Current-year actions to consider that could reduce 2025 taxes include:

Accelerating capital gains to 2024 or deferring capital losses until 2025.
• Electing out of the installment sale method for 2024 installment sales.
• Deferring deductions such as large charitable contributions to 2025.

LONG-TERM CAPITAL GAINS

The long-term capital gains rates for 2024 and 2025 are shown below. The tax brackets refer to the taxpayer’s taxable income. Capital gains also may be subject to the 3.8% net investment income tax.

2024 Long-Term Capital Gains Rate Brackets

Long-Term Capital Gains Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
0%	$0 – $94,050	$0 – $47,025	$0 – $63,000	$0 – $47,025	$0 – $3,150
15%	$94,051 – $583,750	$47,026 – $518,900	$63,001 – $551,350	$47,026 – $291,850	$3,151 – $15,450
20%	Over $583,750	Over $518,900	Over $551,350	Over $291,850	Over $15,450

2025 Long-Term Capital Gains Rate Brackets

Long-Term Capital Gains Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
0%	$0- $96,700	$0 - $48,350	$0 - $64,750	$0 - $48,350	$0 - $3,250
15%	$96,701 – $600,050	$48,351 - $533,400	$64,751 - $566,700	$48,351 - $300,000	$3,251 – $15,900
20%	Over $600,051	Over $533,400	Over $566,700	Over $300,000	Over $15,900

Long-term capital gains (and qualified dividends) are subject to a lower tax rate than other types of income. Investors should consider the following when planning for capital gains:

Holding capital assets for more than a year (more than three years for assets attributable to carried interests) so that the gain upon disposition qualifies for the lower long-term capital gains rate. Considering long-term deferral strategies for capital gains such as reinvesting capital gains into designated qualified opportunity zones.
• Investing in, and holding, “qualified small business stock” for at least five years.
• Donating appreciated property to a qualified charity to avoid long-term capital gains tax.

NET INVESTMENT INCOME TAX

An additional 3.8% net investment income tax (NIIT) applies on net investment income above certain thresholds. The NIIT does not apply to income derived in the ordinary course of a trade or business in which the taxpayer materially participates. Similarly, gain on the disposition of trade or business assets attributable to an activity in which the taxpayer materially participates is not subject to the NIIT.

Impacted taxpayers may want to consider deferring net investment income for the year, in conjunction with other tax planning strategies that may be implemented to reduce income tax or capital gains tax.

SOCIAL SECURITY TAX

The Old-Age, Survivors, and Disability Insurance (OASDI) program is funded by contributions from employees and employers through FICA tax. The FICA tax rate for both employees and employers is 6.2% of the employee’s gross pay, but is imposed only on wages up to $168,600 for 2024 and $176,100 for 2025. Self-employed persons pay a similar tax, called SECA (or self-employment tax), based on 12.4% of the net income of their businesses.

Employers, employees, and self-employed persons also pay a tax for Medicare/Medicaid hospitalization insurance (HI), which is part of the FICA tax, but is not capped by the OASDI wage base. The HI payroll tax is 2.9%, which applies to earned income only. Self-employed persons pay the full amount, while employers and employees each pay 1.45%. An extra 0.9% Medicare (HI) payroll tax must be paid by individual taxpayers on earned income that is above certain AGI thresholds: $200,000 for individuals, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. However, employers do not pay this extra tax.

LONG-TERM CARE INSURANCE AND SERVICES

Premiums an individual pays on a qualified long-term care insurance policy are deductible as a medical expense. The maximum deduction amount is determined by an individual’s age. The following table sets forth the deductible limits for 2024 and the estimated deductible limits for 2025 (the limitations are per person, not per return):

Age	Deduction Limitation 2024	Deduction Limitation 2025
40 or under	$470	$480
Over 40 but not over 50	$880	$900
Over 50 but not over 60	$1,760	$1,800
Over 60 but not over 70	$4,710	$4,810
Over 70	$5,880	$6,020

RETIREMENT PLAN CONTRIBUTIONS

Individuals may want to maximize their annual contributions to qualified retirement plans and individual retirement accounts (IRAs).

The maximum amount in elective contributions that an employee can make in 2024 to a 401(k) or 403(b) plan is $23,000 ($30,500 if age 50 or over and the plan allows “catch-up” contributions). For 2025, these limits are $23,500 and $31,000,
• The SECURE Act permits a penalty-free withdrawal of up to $5,000 from traditional IRAs and qualified retirement plans for qualifying expenses related to the birth or adoption of a child after December 31, 2019. The $5,000 distribution limit is per individual, so a married couple could each receive $5,000.
• Under the SECURE Act, individuals are now able to contribute to their traditional IRAs in or after the year in which they turn 70½.
• Beginning in 2023, the SECURE Act 2.0 raised the age at which a taxpayer must begin taking required minimum distributions (RMDs) to 73. If the individual reaches age 72 in 2024, the required beginning date for the first 2025 RMD is April 1, 2026.
• Individuals age 70½ or older can donate up to $105,000 in 2024 ($108,000 in 2025) to a qualified charity directly from a taxable IRA.
• The SECURE Act generally requires that designated beneficiaries of persons who died after December 31, 2019, take inherited plan benefits over a 10-year period. Eligible designated beneficiaries (i.e., surviving spouses, minor children of the plan participant, disabled and chronically ill beneficiaries, and beneficiaries who are less than 10 years younger than the plan participant) are not limited to the 10-year payout rule. Special rules apply to certain trusts.
• Under final Treasury regulations (issued July 2024) that address RMDs from inherited retirement plans of persons who died after December 31, 2019, and after their required beginning date, designated and non-designated beneficiaries will be required to take annual distributions, whether subject to a 10-year period or otherwise.
• Small businesses can contribute the lesser of (i) 25% of employees’ salaries or (ii) an annual maximum amount set by the IRS each year to a simplified employee pension (SEP) plan by the extended due date of the employer’s federal income tax return for the year that the contribution is The maximum SEP contribution for 2024 is $69,000. The maximum SEP contribution for 2025 is $70,000. The calculation of the 25% limit for self-employed individuals is based on net self-employment income, which is calculated after the reduction in income from the SEP contribution (as well as for other things, such as self-employment taxes).

FOREIGN EARNED INCOME EXCLUSION

The foreign earned income exclusion is $126,500 in 2024 and increases to $130,000 in 2025.

ALTERNATIVE MINIMUM TAX

A taxpayer must pay either the regular income tax or the alternative minimum tax (AMT), whichever is higher. The established AMT exemption amounts for 2024 are $85,700 for unmarried individuals and individuals claiming head of household status, $133,300 for married individuals filing jointly and surviving spouses, $66,650 for married individuals filing separately, and $29,900 for estates and trusts. The AMT exemption amounts for 2025 are $88,100 for unmarried individuals and individuals claiming head of household status, $137,000 for married individuals filing jointly and surviving spouses, $68,500 for married individuals filing separately, and $30,700 for estates and trusts.

KIDDIE TAX

The unearned income of a child is taxed at the parents’ tax rates if those rates are higher than the child’s tax rate.

LIMITATION ON DEDUCTIONS OF STATE AND LOCAL TAXES (SALT LIMITATION)

For individual taxpayers who itemize their deductions, the Tax Cuts and Jobs Act introduced a $10,000 limit on deductions of state and local taxes paid during the year ($5,000 for married individuals filing separately). The limitation applies to taxable years beginning on or after December 31, 2017, and before January 1, 2026. Various states have enacted new rules that allow owners of pass-through entities to avoid the SALT deduction limitation in certain cases.

CHARITABLE CONTRIBUTIONS

Cash contributions made to qualifying charitable organizations, including donor-advised funds, in 2024 and 2025 will be subject to a 60% AGI limitation. The limitations for cash contributions continue to be 30% of AGI for contributions to non-operating private foundations.

Tax planning around charitable contributions may include:

Creating and funding a private foundation, donor-advised fund, or charitable remainder trust.
• Donating appreciated property to a qualified charity to avoid long-term capital gains tax.

ESTATE AND GIFT TAXES

For gifts made in 2024, the gift tax annual exclusion is $18,000 and for 2025 it is $19,000. For 2024, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $13,610,000 per person. For 2025, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $13,990,000. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2024 and 2025, only the first $185,000 and $190,000, respectively, of gifts to a non-U.S. citizen spouse is excluded from the total amount of taxable gifts for the year.

Tax planning strategies may include:

Making annual exclusion
• Making larger gifts to the next generation, either outright or in trust.
• Creating a spousal lifetime access trust (SLAT) or a grantor retained annuity trust (GRAT) or selling assets to an intentionally defective grantor trust (IDGT).

NET OPERATING LOSSES AND EXCESS BUSINESS LOSS LIMITATION

Net operating losses (NOLs) generated in 2024 are limited to 80% of taxable income and are not permitted to be carried back. Any unused NOLs are carried forward subject to the 80% of taxable income limitation in carryforward years.

A non-corporate taxpayer may deduct net business losses of up to $305,000 ($610,000 for joint filers) in 2024. The limitation is $313,000 ($626,000 for joint filers) for 2025. A disallowed excess business loss (EBL) is treated as an NOL carryforward in the subsequent year, subject to the NOL rules. With the passage of the Inflation Reduction Act, the EBL limitation has been extended through the end of 2028.

This is a follow-up to our previous post regarding the Corporate Transparency Act (CTA). On Tuesday, December 3, 2024, a federal district court in Texas issued an order granting a nationwide, preliminary injunction that: (1) enjoins enforcement of the Corporate Transparency Act (CTA) and regulations implementing its beneficial ownership information (BOI) reporting requirements, and (2) stays all deadlines to comply with the CTA’s reporting requirements, including the January 1, 2025 deadline for reporting companies to submit their initial BOI report. The Department of Justice, on behalf of the Department of the Treasury, filed an appeal of the district court’s decision on December 5, 2024.

The Financial Crimes Enforcement Network (FinCEN) has responded that as long as the preliminary injunction remains in effect:

reporting companies are not required to report BOI to FinCEN; and

reporting companies will not be subject to liability for failing to report their BOI.

FinCEN also indicated that reporting companies may continue to voluntarily submit BOI reports.

The future of the CTA and BOI reporting, including when reports need to be submitted, remains fluid and unpredictable. While the Texas district court’s ruling may be the most recent decision issued, it is not the only case in which the CTA has been challenged. Federal district court decisions on the validity of the CTA have conflicted, and three district court cases are currently being appealed to their respective Courts of Appeals.

Given the ongoing developments and uncertainties, it is strongly advised that you continue to closely monitor the situation and be prepared to respond swiftly if necessary. We will keep you informed of any significant updates.

Thank you for your attention to this matter, and please feel free to reach out if you have any questions or concerns.

Corporate Transparency Act — Beneficial Ownership Information Reporting Requirement Starting January 1, 2024, a significant number of businesses will be required to comply with the Corporate Transparency Act (“CTA). The CTA was enacted into law as part of the National Defense Act for Fiscal Year 2021. The CTA requires the disclosure of the beneficial ownership information (otherwise known as “BOI”) of certain entities from people who own or control a company.

It is anticipated that 32.6 million businesses will be required to comply with this reporting requirement. The intent of the BOI reporting requirement is to help US law enforcement combat money laundering, the financing of terrorism and other illicit activity.

The CTA is not a part of the tax code. Instead, it is a part of the Bank Secrecy Act, a set of federal laws that require record-keeping and report filing on certain types of financial transactions. Under the CTA, BOI reports will not be filed with the IRS, but with the Financial Crimes Enforcement Network (FinCEN), another agency of the Department of Treasury.

Below is some preliminary information for you to consider as you approach the implementation period for this new reporting requirement.

What entities are required to comply with the CTA’s BOI reporting requirement?

Entities organized both in the U.S. and outside the U.S. may be subject to the CTA’s reporting requirements. Domestic companies required to report include corporations, limited liability companies (LLCs) or any similar entity created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe.

Domestic entities that are not created by the filing of a document with a secretary of state or similar office are not required to report under the CTA.

Foreign companies required to report under the CTA include corporations, LLCs or any similar entity that is formed under the law of a foreign country and registered to do business in any state or tribal jurisdiction by filing a document with a secretary of state or any similar office.

Are there any exemptions from the filing requirements?

There are 23 categories of exemptions. Included in the exemptions list are publicly traded companies, banks and credit unions, securities brokers/dealers, public accounting firms, tax-exempt entities and certain inactive entities, among others. Please note these are not blanket exemptions and many of these entities are already heavily regulated by the government and thus already disclose their BOI to a government authority.

In addition, certain “large operating entities” are exempt from filing. To qualify for this exemption, the company must:

1. Employ more than 20 people in the U.S.;
2. Have reported gross revenue (or sales) of over $5M on the prior year’s tax return; and
3. Be physically present in the U.S.

Who is a beneficial owner?

Any individual who, directly or indirectly, either:

Exercises “substantial control” over a reporting company, or
• Owns or controls at least 25 percent of the ownership interests of a reporting company

An individual has substantial control of a reporting company if they direct, determine or exercise substantial influence over important decisions of the reporting company. This includes any senior officers of the reporting company, regardless of formal title or if they have no ownership interest in the reporting company.

The detailed CTA regulations define the terms "substantial control" and "ownership interest" further.

When must companies file?

There are different filing timeframes depending on when an entity is registered/formed or if there is a change to the beneficial owner’s information.

New entities (created/registered in 2024) — must file within 90 days
• New entities (created/registered after 12/31/2024) — must file within 30 days
• Existing entities (created/registered before 1/1/24) — must file by 1/1/25
• Reporting companies that have changes to previously reported information or discover inaccuracies in previously filed reports — must file within 30 days

What sort of information is required to be reported?

Companies must report the following information: full name of the reporting company, any trade name or doing business as (DBA) name, business address, state or Tribal jurisdiction of formation, and an IRS taxpayer identification number (TIN).

Additionally, information on the beneficial owners of the entity and for newly created entities, the company applicants of the entity is required. This information includes — name, birthdate, address, and unique identifying number and issuing jurisdiction from an acceptable identification document (e.g., a driver’s license or passport) and an image of such document.

Risk of non-compliance

Penalties for willfully not complying with the BOI reporting requirement can result in criminal and civil penalties of $500 per day and up to $10,000 with up to two years of jail time. For more information about the CTA, visit www.fincen.gov/boi.

This information is meant to be general-only and should not be applied to your specific facts and circumstances without consultation with competent legal counsel and/or other retained professional adviser.We advise you to seek the advice of legal counsel with regard to the obligations under the Corporate Transparency Act.

Please contact our office at 559-449-7688 to discuss your business situation.

Please use links to below to navigate to the section of interest:

2023 Year-End Guide – Tax Accounting Methods
• 2023 Year-End Guide – Income Tax
• 2023 Year End Guide – Business Incentives & Tax Credits
• 2023 Year-End Guide – State and Local Tax
• 2023 Year-End Guide – Partnerships

2023 Year-End Guide – Tax Accounting Methods
A taxpayer’s tax accounting methods determine when income is recognized and costs are deducted for income tax purposes. Strategically adopting or changing tax accounting methods can provide opportunities to drive tax savings and increase cash flow. However, the rules covering the ability to use or change certain accounting methods are often complex, and the procedures for changing methods depend on the mechanism for receiving IRS consent — that is, whether the change is automatic or non-automatic. Many method changes require an application be filed with the IRS prior to the end of the year for which the change is requested.

Among others, taxpayers should consider the following tax accounting method implications and potential changes for 2023 and 2024, which are further discussed below.

Items taxpayers should review by year end:

Be mindful of the December 31st deadline for non-automatic method changes
• Verify eligibility to use small business taxpayer exceptions and evaluate method implications
• Year-end clean-up Items: accelerate common deductions/losses, if appropriate
• Revisit the de minimis book safe harbor for write-offs of tangible property
• Consider methods implications of potential M&A transactions

Items to review in early months of 2024:

Review latest specified research and experimental expenditures guidance (Section 174) and evaluate implications on 2023 tax year
• Review opportunities for immediate deduction of fixed assets
• Consider the UNICAP historic absorption ratio election
• Review leasing transactions for compliance with tax rules
• Evaluate accounting method changes for controlled foreign corporations

Items Taxpayers Should Review by Year End:
Be mindful of the December 31st Deadline for Non-automatic Method Changes
Although the IRS has continued to increase the types of accounting method changes that can be made under the automatic change procedures, some common method changes must still be filed under the non-automatic change procedures. Importantly, a calendar year-end taxpayer that has identified a non-automatic accounting method change that it needs or desires to make effective for the 2023 tax year must file the application on Form 3115 during 2023 (i.e., the year of change). (Technically, a taxpayer with a 12/31/23 year end has until Tuesday, January 2, 2024, to file because December 31 is a Sunday and Monday is the holiday observance of New Year’s Day, therefore, Tuesday is the next business day after the due date).
 
Among the method changes that must be filed under the non-automatic change procedures are many changes to correct an impermissible method of recognizing liabilities under an accrual method (for example, using a reserve-type accrual), and long-term contract changes. Additionally, taxpayers that do not qualify to use the automatic change procedures because they have made a change with respect to the same item within the past five tax years will need to file under the non-automatic change procedures to request their method change. 

Generally, more information needs to be provided on Form 3115 for a non-automatic accounting method change, and the complexity of the issue and the taxpayer’s facts may increase the time needed to gather data and prepare the application. Taxpayers that wish to file non-automatic accounting method changes effective for 2023 should begin gathering the necessary information and prepare the application as soon as possible to avoid a last-minute rush. 


Verify Eligibility to Use Small Business Taxpayer Exceptions and Evaluate Method Implications
A taxpayer that currently qualifies as a small business taxpayer for accounting method purposes is able to use small business taxpayer accounting methods – which include the overall cash method of accounting and other simplifying provisions, such as exemptions from:

Section 471 inventory methods;
• Section 263A uniform capitalization (UNICAP) rules;
• The Section 460 requirements to use the percentage-of-completion method for certain long-term construction contracts; and
• The Section 163(j) limit on the deductibility of business interest expense. 

Generally, a small business taxpayer is a taxpayer, other than a tax shelter under Section 448(d)(3), that meets the Section 448(c) gross receipts test for a given tax year. For a tax year beginning in 2023, a taxpayer meets the gross receipts test if it has average annual gross receipts for the three prior tax years (2022, 2021, 2020) of $29,000,000 or less.  In calculating the gross receipts test, a taxpayer must follow the guidelines for items to be included or excluded from gross receipts, and include the gross receipts of all applicable entities and predecessors under the aggregation rules. 

Taxpayers must evaluate each year whether they qualify as a small business taxpayer by continuing to meet the gross receipts test. In addition, taxpayers should determine whether any M&A activities they have engaged in or anticipate undertaking will affect their small business taxpayer status. If so, the taxpayer should determine for what year accounting method changes may be required, as well as whether it may be advantageous to make the method changes earlier than required. 

Taxpayers should verify as early as possible whether they remain eligible to continue to use their current accounting methods.  If method changes are needed, a taxpayer needs to determine whether:

The change(s) qualify to use the automatic change procedures (in which case Form 3115 can be filed in 2024); or
• A non-automatic accounting method change needs to be filed before the end of 2023 for the change to apply in the first year the taxpayer does not qualify as a small business taxpayer. 

Additionally, if accounting method changes need to be made, taxpayers should consider the impact of the Section 481(a) adjustments on their current year tax returns as well as ensure that the methods being adopted are consistently applied.

Year-end Clean-up Items: Accelerate Common Deductions/Losses
Heading into year-end tax planning season, companies may be able to take some relatively easy steps to accelerate certain deductions into 2023 or, if more advantageous, defer certain deductions to one or more later years. The key reminder for all of the following year-end “clean-up” items is that the taxpayer must make the necessary revisions or take the necessary actions before the end of the 2023 taxable year. (Unless otherwise indicated, the following items discuss planning relevant to an accrual basis taxpayer.)
Deduction of accrued bonuses. In most circumstances, a taxpayer will want to deduct bonuses in the year they are earned (the service year), rather than the year the amounts are paid to the recipient employees. To accomplish this, taxpayers may wish to:

Review bonus plans before year end and consider changing the terms to eliminate any contingencies that can cause the bonus liability not to meet the Section 461 “all events test” as of the last day of the taxable year. Taxpayers may be able to implement strategies that allow for an accelerated deduction for tax purposes while retaining the employment requirement on the bonus payment date. These may include using (i) a “bonus pool” with a mechanism for reallocating forfeited bonuses back into the pool; or (ii) a “minimum bonus” strategy that allows some flexibility for the employer to retain a specified amount of forfeited bonuses.
• It is important that the bonus pool amount is fixed through a binding corporate action (e.g., board resolution) taken prior to year end that specifies the pool amount, or through a formula that is fixed before the end of the tax year, taking into account financial data as of the end of the tax year. A change in the bonus plan would be considered a change in underlying facts, which would allow the taxpayer to prospectively adopt a new method of accounting without filing a Form 3115.
• Schedule bonus payments to recipients to be made no later than 2-1/2 months after the tax year end to meet the requirements of Section 404 for deduction in the service year.

Deduction of commission liabilities. Taxpayers with commission liabilities should consider taking the following actions prior to the end of the 2023 taxable year:

Review commission agreements for needed revisions. By analyzing the terms of the arrangements, taxpayers can determine what event(s) must occur to fix the commission liability and meet the all events test under Section 461. Companies may consider revising commission agreements to remove contingences or otherwise better align their business goals with deduction timing for tax purposes.
• One example of a contingency associated with commission liability is a requirement that a customer remain a customer for a specified time before the employee/agent is entitled to a commission. In this case, the liability would not be considered fixed until the conclusion of the specified time period, thereby precluding the taxpayer’s deduction of the commission liabilities prior to that date.
• Consider the tax treatment of prepaid commissions and associated elections. For financial reporting purposes, many companies capitalize commissions paid to both employees and independent contractors, typically amortizing amounts over the same period as the related revenue stream under ASC 606. Tax requirements for capitalization of commissions and the timing of their deduction will differ based on the recipient of the commission and whether the recipient’s efforts to earn the commission facilitate the acquisition or creation of an intangible.
• The Section 263(a) requirement to capitalize commissions as facilitative costs applies to commissions paid to third parties, including independent contractors, but employee compensation is exempt from this requirement. Thus, commissions paid to employees generally can be deducted in the year the commissions are incurred.
• If the taxpayer prefers to capitalize commissions paid to employees, it may opt to do so by making an annual election. The flexibility to switch between deducting and capitalizing employee commissions each year provides a helpful planning opportunity for companies.
• Schedule accrued commission payments to employee recipients to be made no later than 2-1/2 months after the tax year end. This timing is necessary to meet the requirements of Section 404 for a deduction in the service year. Accrued commissions to third parties (e.g., independent contractors) would generally be deductible in the year incurred.

Deductions of prepaid expenses. For federal income tax purposes, companies may have an opportunity to take a current deduction for some of the expenses they prepay, rather than capitalizing and amortizing the amounts over the term of the underlying agreement or taking a deduction at the time services are rendered.

A cash basis taxpayer can generally deduct prepaid expenses in the year of actual payment as long as the prepaid expense meets an exception referred to as the “12-month rule.” Under the 12-month rule, taxpayers can deduct prepaid expenses in the year the amounts are paid (rather than having to capitalize and amortize the amounts over a future period) if the right/benefit associated with the prepayment does not extend beyond the earlier of i) 12 months after the first date on which the taxpayer realizes the right/benefit, or ii) the end of the taxable year following the year of payment. As taxpayers are required to meet the Section 461 all events test prior to applying the 12-month rule, accrual basis taxpayers must carefully examine the nature of their prepaids to determine whether there is a fixed and determinable liability and whether economic performance has occurred by year end.

The rules provide some valuable options for accelerated deduction of prepaids for accrual basis companies – for example, insurance, taxes, government licensing fees, software maintenance contracts, and warranty-type service contracts. Identifying prepaids eligible for accelerated deduction under the tax rules can prove a worthwhile exercise by helping companies strategize whether to make prepayments before year end, which may require a change in accounting method for the eligible prepaids.

Inventory write offs. Often companies carry inventory that is obsolete, unsalable, damaged, defective, or no longer needed.  While for financial reporting inventory is generally reduced by reserves, for tax purposes a business normally must dispose of inventories to recognize a loss, unless an exception applies. Thus, a best practice for tax purposes to accelerate losses related to inventory is to dispose of or scrap the inventory by year end.
An important exception to this rule is the treatment of “subnormal goods,” which are defined as goods that are unsaleable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar reasons. For these types of items, companies may be able to write down the cost of inventory to the actual offering price within 30 days after year end, less any selling costs, even if the inventory is not sold or disposed of by year end.

Revisit the De Minimis Book Safe Harbor for Write-offs of Tangible Property

Subject to limitations, the so-called tangible property regulations (TPR) permit a taxpayer to elect to deduct the costs of items that likewise are expensed under a written financial accounting policy in place as of the beginning of the tax year. The election must be made annually and, because it is not a method of accounting, can be made for a given year without regard to whether the taxpayer has made the election for a prior year. The taxpayer can adjust the tax benefit of the safe harbor election by modifying the associated financial accounting policy prior to the beginning of the tax year for which the election will be made, changing the ceiling amount for items eligible to be deducted.

Under the safe harbor election, taxpayers with an applicable financial statement (AFS) may deduct amounts paid for tangible property up to $5,000 per invoice or item ($2,500 per invoice or item for taxpayers without an AFS). Deductions must be substantiated by invoice.

Critical year-end action items are:

Review and make desired changes to the associated financial accounting policy prior to the beginning of the upcoming tax year; and
• Plan to attach the required election statement to the timely-filed, original return for the year in which the election is to be effective.

Consider Methods Implications of Potential M&A Transactions
Taxpayers contemplating an acquisition, disposition, or other M&A transaction should consider the opportunities for accounting methods planning as well as any procedural requirements. Both buy-side and sell-side companies can benefit from proactively considering a transaction’s effects on existing accounting methods and related potential risk mitigation or planning strategies. Below are some examples of the opportunities to consider.
 
Final year restrictions. In general, automatic accounting method changes are not permitted in a taxpayer’s final year of a trade or business (e.g., when a taxpayer is acquired in a taxable asset acquisition). During the transaction process, taxpayers may contemplate certain changes in accounting methods, such as the correction of an impermissible method or a change in overall method. It is important to carefully consider the structure of a transaction to determine if any accounting method changes are permitted or required.
 
If a transaction does not result in the cessation of a trade or business, taxpayers may want to plan for the timing of an accounting method change (i.e., whether the change is made pre- vs. post-transaction). For example, certain method changes may be qualified for accelerated taxable income adjustments in a pre-transaction period. By beginning the planning process early, taxpayers may be able to include beneficial terms in the agreement, such as limiting the pre-transaction realization of potential tax benefits to the sellers or requiring the sellers to correct potential exposure items.
 
Due diligence preparation. A taxpayer looking to sell part or all of a company may be able to use accounting methods planning to strengthen its profile in attracting potential buyers. A comprehensive accounting method review can uncover opportunities to mitigate potential risk and identify ways to achieve desired tax attributes well in advance of the formal due diligence process.
 
Post-transaction alignment. Acquisitive taxpayers should consider the impact of a transaction’s structure on the tax attributes — including the tax accounting methods — of acquired companies. In situations where the acquired company’s accounting methods carry over, accounting method changes can align the methods being used across the group to streamline the compliance process. Alternatively, transaction structures resulting in the adoption of new methods can provide opportunities to select methods that best align with the taxpayer’s tax objectives. Taxpayers able to adopt new methods may also benefit from the ability to establish methods that cannot be changed through the automatic procedures at a later date, such as certain percentage-of-completion methods under Section 460 or the 3-1/2 month rule for deducting certain prepaid services.

Items to review in early months of 2024:

Review Latest Section 174 Guidance and Evaluate Implications on 2023 Tax Year

The Tax Cuts and Jobs Act (TCJA)

The Tax Cuts and Jobs Act (TCJA) made significant changes to Internal Revenue Code Section 174, which deals with the deduction of research and experimental (R&E) expenses. Prior to the TCJA, businesses could deduct these expenses in the year they were incurred. However, the TCJA introduced new rules that require businesses to capitalize and amortize R&E expenses over a five-year period or 15-year period for foreign costs, starting from the midpoint of the taxable year in which the expenses were incurred. This change applies to R&E expenses incurred in tax years beginning after December 31, 2021. The changes to Section 174 also included language defining any software developed internally or by third parties as Section 174 expenses. Prior to the change, taxpayers rarely treated its R&E expenses as Section 174 expenses and elected to deduct these costs under Section 162.

IRS Notice 2023-63
In September 2023, the IRS released Notice 2023-63, which contains substantive pre-regulatory guidance on the new Section 174 capitalization requirements and announced that the Treasury and the IRS intend to issue proposed regulations consistent with the Notice. The guidance provides taxpayers with an advance look into upcoming proposed regulations, which the IRS anticipates will apply for taxable years ending after September 8, 2023.
The Notice provides valuable guidance to taxpayers in several key areas. Specifically, it provides clarity on which indirect costs should be treated as Section 174 expenses, such as overhead, depreciation, and personnel costs and which expenses should not be treated as 174 expenses, such as G&A expenses. Additionally, the Notice provides guidance and examples on software development costs that should and should not be treated as 174 expenses, which was a key area of confusion among taxpayers. R&E performed under contract is another key area covered by the Notice The Notice informs taxpayers that they must have no financial risk and no rights to the research in order to treat the expenses performed under contract 162 costs instead of 174 expenses.  
The Notice also provides guidance to taxpayers in the following areas:

Methodology for allocating overhead and depreciation;
• Short tax year treatment;
• Project Completion method expense and revenue treatment;
• Cost sharing agreements; and
• Recovery of the costs for business sold or cease to exist.

Taxpayers that intend to rely on this guidance for the 2023 taxable year should begin to consider how it may differ from positions taken for the 2022 taxable year or in calculating their 2023 estimated tax payments. In doing so, taxpayers should take special note of certain key areas of uncertainty.

For taxpayers with divergent prior positions, the IRS intends to issue new procedural guidance to assist taxpayers in making accounting method changes that are needed to conform to the new guidance.

Planning Considerations for M&A Transactions

Section 7 of the Notice addresses some basic consequences of asset dispositions, entity terminations, and carryover transactions for corporations. However, the Notice leaves unaddressed a number of interactions between Section 174 and other M&A tax rules, including those addressed below.

Section 338(h)(10). While the Notice does not specifically address Section 338(h)(10), the Notice appears to make clear that specified research and experimental (SRE) expenditures capitalized under Section 174 by a target should remain with the selling parent following a Section 338(h)(10) election. As such, the SRE expenditures will provide no current year reduction in gain from the deemed asset sale but may provide the seller utilizable amortization in future tax years. To the extent the buyer and seller are negotiating a gross up payment in conjunction with the election, treatment of the SRE expenditures in the calculation of the gross up should be addressed.

Section 382. To date there has been no guidance on the interaction of Section 174 and the safe harbors outlined in Notice 2003-65. Notice 2003-65 provides two safe harbor methodologies for calculating the NUBIG/NUBIL and RBIG/RBIL from a loss corporation’s Section 382 ownership change, the 338 approach and the 1374 approach. Under both approaches, the NUBIG/NUBIL is the net amount of gain or loss that would be recognized in a hypothetical asset sale, whereby the loss corporation sells all of its assets, and the buyer assumes all of the loss corporation’s liabilities. 

In the absence of specific guidance, the conservative approach has been to factor the SRE expenditures into the calculation of both NUBIG/NUBIL and RBIG/RBIL. To the extent the calculated limit under this approach does not have a detrimental impact on the tax provision or tax filing positions, a company may have the opportunity to wait to see if further guidance on this issue is released. However, for other companies, the Notice’s guidance may support beneficial positions with respect to calculating NUBIG/NUBIL and RBIG/RBIL as neither the 338 or 1374 methods provide for a deemed liquidation or cessation of the loss corporation. As needed, companies should weigh the strength of these potential positions.

Unified Loss Rule. In certain situations when selling a subsidiary member at a loss, a consolidated federal income tax group can reattribute tax attributes (e.g., NOLs and deferred deductions) from the departing subsidiary to the group under an election within the unified loss rule (ULR). This election allows the group to retain valuable tax attributes.

To date there is no guidance on the interaction of SRE expenditures capitalized under Section 174 and the ULR. However, unamortized SRE expenditures (to which Section 174(d) has not been applied) appear distinguishable from deferred deductions or any other category of asset that could be electively reattributed under the ULR. As such, to the extent a group is selling a subsidiary with valuable unamortized SRE expenditures, the group should consider whether to value the SRE amortization as part of the deal consideration or seek a sale structure other than a stock sale.

Cost Sharing Arrangements (CSAs) under Reg. §1.482-7.

Under the cost sharing regulations of Reg. §1.482-7, two or more participants in a qualified CSA agree to bear intangible development costs (IDCs) in proportion to each party’s expected benefit from exploiting the developed intangible property. If during the course of a year, the actual IDC expenditures of each CSA participant are not in proportion to the expected benefit, cost sharing payments are made among CSA participants to achieve the proper expense/benefit allocations. Payments received by a CSA participant payee (from another CSA participant payor) are treated as contra-costs or contra-expenses, and thus serve to reduce the payee’s IDCs.

Notice 2023-63 clarifies that payments made to a CSA participant payee that incurs both immediately deductible IDCs and those that are required to be charged to a capital account should be allocated among these cost categories proportionately. If a CSA payment exceeds the total amount of IDCs in these two categories, the excess is to be treated as income by the payee. Furthermore, to comply with the different amortization periods, taxpayers will have to segregate all IDCs that must be capitalized into U.S.-incurred expenses and non-U.S.-incurred expenses.

Although this guidance regarding Section 174 and cost sharing is welcome, open questions remain. For example, the guidance does not address the treatment of outsourced research and development (R&D) activities within a CSA, and it does not address intercompany R&D CSAs outside of qualified CSAs under Reg. §1.482-7.

It is important for taxpayers who have filed or have previously filed research and development (R&D) tax credits, have software development expenses, or are in a trade or business that incurs research expenses, to perform a Section 174 analysis. For others that may not have tracked or identified these costs or have not historically claimed the R&D tax credit, it is still necessary to identify Section 174 costs specifically, as they are now subject to capitalization. Taxpayers are encouraged to establish a methodology for calculating and documenting a consistent approach to comply with these new rules. Further, with limited guidance from the Treasury and IRS, taxpayers should consider other potential tax impacts.

Review Opportunities for Immediate Deduction of Fixed Assets
Although Congress is considering legislation that would delay the ongoing phase-out of bonus depreciation (which reduces from 80% in 2023 to 60% in 2024), considerable uncertainty remains as to the prospects for its passage. As such, year-end tax planning for fixed assets emphasizes cash tax savings through scrubbing fixed asset accounts for costs that can be deducted currently under Section 162 rather than being capitalized and recovered through depreciation, and reducing the depreciation recovery periods of capital costs where possible.

Fixed Asset Scrubs. Reviewing fixed asset registers for amounts that potentially may be recovered over a shorter depreciable life can yield cash tax benefits. For example, taxpayers may be able to reclassify certain interior improvements to a nonresidential building as “qualified improvement property” eligible for a shorter 15-year recovery period and bonus depreciation. The cash tax benefit from properly reducing the recovery period of depreciable property is achieved using the automatic accounting method change procedures.

Scrubbing fixed asset registers can also identify “ghost assets” that the company has physically disposed of in prior years but for various reasons have not been removed from the company’s accounting records. Identifying and deducting the remaining tax basis through an automatic change in accounting method can yield cash tax benefits as well.

Materials and Supplies. Scrubbing a company’s accounts for items that may be treated as materials and supplies can also yield cash tax benefits. Materials and supplies include spare parts, consumables (fuel, lubes, water, etc.) that will be used within the next 12 months; items costing no more than $200 each; and items that have an economic useful life of no more than 12 months. This definition can apply to a surprising array of items, permitting nearly immediate cost recovery in many cases. Reviewing and adjusting the process by which the company identifies items as materials and supplies and are key to maximizing this opportunity. This potential cash tax benefit is achieved through an automatic change in accounting method.

Additional potential benefits from reviewing the company’s application of the TPR can be found in a Tax Notes article authored by BDO’s James Atkinson.  See J. Atkinson, “Preparing for a Post-Bonus Depreciation World,” 179 Tax Notes 209 (April 10, 2023).

Consider the UNICAP Historic Absorption Ratio Election
Under Section 263A, taxpayers must capitalize direct and indirect costs allocable to real or tangible personal property produced or acquired for resale. The types and amounts of costs required to be capitalized under Section 263A typically go beyond those required to be capitalized for financial accounting purposes.  Accordingly, many taxpayers must undertake a computation each year to capitalize “additional section 263A” costs to property acquired or produced. For taxpayers seeking to streamline this often time-consuming process, the historic absorption ratio (HAR) election may be worth considering.

The historic absorption ratio method

While the Section 263A regulations list numerous methods and sub-methods taxpayers can use to identify and allocate additional Section 263A costs to ending inventory, many taxpayers select one of the three simplified methods (simplified production method, simplified resale method, and modified simplified production method) outlined in the regulations to streamline compliance efforts and reduce potential controversy with the IRS. Although these methods are generally less administratively burdensome in comparison to other alternatives, taxpayers must still dedicate significant efforts in maintaining the annual calculations. Taxpayers currently using one of the simplified methods may be able to further streamline their compliance process by electing to use the HAR method.

A taxpayer qualifies to make the HAR election once it has consistently used one of the three simplified methods for at least three consecutive tax years. In the year the election is made, the taxpayer calculates the HAR by averaging the absorption ratios from the prior three tax years. The HAR is then applied to ending inventory for the next five tax years, beginning with the election year. On the sixth year, the taxpayer must recompute the absorption ratio(s) using actual data for the year under the applicable simplified method:

If the recomputed ratio(s) are within 0.5% of the HAR used for the preceding five years, the taxpayer can continue using the HAR for another five years.
• If the recomputed ratio(s) are not within the 0.5% range, then the taxpayer is required to begin another three year testing period of calculating the actual absorption ratios.

Thus, while the HAR election still requires taxpayers to prepare Section 263A calculations for testing period years, the ability to bypass this exercise for at least five years in a row can save taxpayers a considerable amount of time in their compliance efforts.

Making and terminating the HAR election – weigh the benefits carefully

A taxpayer makes the HAR election by attaching an election statement to the tax return; no method change (Form 3115) or Section 481(a) catch-up adjustment is required. However, terminating the HAR election requires a non-automatic accounting method change, which the IRS generally will grant only in unusual circumstances. Therefore, given the inflexibility of the approach once the HAR election is made, taxpayers should carefully weigh the benefits of the administrative relief associated with making the HAR election against the trade-off of using a locked-in ratio in a year where the actual absorption ratio may be lower. With this in mind, taxpayers should consider making the election for a specific tax year when the absorption ratios used for the testing period are lower than usual, as this strategy might allow them to benefit both from minimizing compliance costs and capitalizing less amounts to ending inventory.

Review Leasing Transactions for Compliance with Tax Rules

The treatment of lease arrangements is a complex area due to many factors, including the diversity of lease structures, changing U.S. GAAP practices, and nuanced tax rules. In recent years, many companies have adopted ASC 842, the new GAAP standard governing lease accounting. The tax classification of an arrangement as a lease is independent of GAAP reporting, so the adoption of ASC 842 does not necessitate a tax accounting method change. However, given the changes in financial accounting practices, taxpayers adopting ASC 842 should perform a comprehensive tax review of their leases to ensure proper tax methods are maintained and to identify any tax accounting method changes that are needed.
 
A lease analysis for tax purposes generally focuses on the following three key areas:
 
Categorization. The classification of an arrangement as a “true” tax lease is a highly facts-based analysis that should be performed on each lease a taxpayer enters. While an arrangement may be presented as a lease for legal and/or financial reporting purposes, the tax classification depends more on the substance of the arrangement than the form. Tax treatment as a lease versus the financing of a purchase, provision of services, or other arrangement is based broadly on the (1) benefits and burdens of ownership and (2) economic substance of the transaction.
 
Timing of income/deductions. Taxpayers with leases may fall into special methods of accounting under Section 467. In general, a taxpayer is subject to Section 467 if the lease meets all of the following criteria:

The lease is for the use of tangible property;
• Total consideration paid under the lease exceeds $250,000; and
• The rent schedule provides for increasing/decreasing payments throughout the term of the lease and/or there is a rent allocation schedule that differs from the payment schedule.

 
In most cases, taxpayers subject to Section 467 should recognize rental income (lessor) or rent expense (lessee) in line with the payment schedule. However, Section 467 may require the use of a different method, such as the proportional rental accrual method. Taxpayers with leases that are not subject to Section 467 should look to their overall method of accounting to determine the timing of income and deductions.
 
By undertaking a tax analysis prior to entering into a new lease, taxpayers may be able to negotiate more favorable lease terms that help align the timing of income/deductions with their overall tax objectives.
 
Maintaining the proper method. As mentioned above, adoption of ASC 842 for GAAP reporting purposes will likely change the way taxpayers compute existing book-to-tax adjustments. To ensure existing tax accounting methods are properly maintained, and to prevent errors or unauthorized method changes, taxpayers should ensure they understand any new lease-related balance sheet accounts and the appropriate tax treatment for such accounts.


Evaluate Accounting Method Changes for CFCs

Controlled foreign corporations (CFCs) are generally subject to the same requirements as U.S. taxpayers to use proper methods of accounting for tax purposes (for example, to calculate earnings and profits and to calculate tested income for GILTI). A CFC that has adopted an improper method of accounting or otherwise wishes to change an accounting method is required to file Form 3115.

A potential benefit of filing Form 3115 to correct an improper method is the ability to receive audit protection. If audit protection is granted, the IRS is precluded from challenging a taxpayer’s improper treatment for open tax years prior to the year of change. For CFCs or 10/50 corporations (foreign corporations with U.S. shareholders owning at least 10% but no more than 50%), however, audit protection may be denied for a tax year before the year the method change was requested under a “150% rule.” The 150% rule is met if one or more of the CFC’s or the 10/50 corporation’s U.S. corporate shareholders report deemed paid foreign taxes for that year that exceed 150% of the average deemed paid foreign taxes reported during the three prior tax years.

For the many CFCs that were subject to the transition tax imposed under Section 965, the 150% rule denying audit protection may have disincentivized them from filing method changes to correct improper accounting methods. Affected taxpayers may now find themselves clear of the rule for the 2023 or 2024 tax year and should consider filing method changes to clean up their impermissible methods prospectively. Some of the more common, automatic method changes that CFCs may encounter include the following:

Changing from computing depreciation under the General Depreciation System (GDS) to the Alternative Depreciation System (ADS);
• Switching to either the full inclusion method or the one-year deferral method for advance payments;
• Changing to a proper Section 461 method to deduct liabilities such as bonuses and commissions in the year the liability is fixed and amounts are paid within 2-1/2 months of year end; and
• Complying with Section 263A and adopting the U.S. ratio method to capitalize costs to ending inventory.

2023 Year-End Guide – Income Tax

What Lessons Can Corporate Tax Departments Take Into 2024?

In 2022, corporate tax departments that were already facing a persistent lack of resources had to adapt tax provision work and control frameworks to account for policy-related changes enacted over the last few years. With 2023 drawing to a close, now is a good time to revisit planning considerations – no matter when your tax year ends.

That is especially true, given the various important changes that are affecting, will affect, and will continue to affect tax functions. For instance, many Inflation Reduction Act rules took effect this year, and other changes, including some under OECD Pillar Two, are set to begin in 2024. Those policies, coupled with staffing and resource challenges, will make it even more important for tax departments to maintain and follow internal controls in the 2023 tax provision season.

Tax practices should therefore be prepared to continue handling complex issues in the year ahead. Addressing topics such as internal controls and tax technology can prepare you for the myriad changes 2024 could bring.

Managing Internal Controls

A tax office is only as strong as its accountability structure, and a strong control environment allows the tax function to operate more thoroughly, accurately, and efficiently. As companies adapt to policy changes and face new requirements and tighter deadlines, building and maintaining reliable control frameworks can help address issues like base erosion and profit shifting. While strong control frameworks are required for public companies under the Sarbanes-Oxley Act, private companies can benefit from implementing similar internal controls. Taking a more rigorous approach to internal controls can enhance organizational accountability, reduce fraud risk, and improve reporting. Private companies can also enlist third-party service providers for support in establishing a control framework.

A business is ultimately responsible for managing whatever tax framework it chooses to build. Even if an internal tax department outsources provision and tax return preparation work to a third-party service provider, it should ask its vendors the right questions and flag items that could result in control issues, such as significant transactions like mergers and acquisitions. Involving the tax department in transactional decision-making will help leadership stay informed and avoid potential tax liabilities and penalties. Further, quarterly controller meetings between internal tax departments and external service providers to discuss recent and ongoing transactions, lessons learned from past activities, and relevant tax issues, as well as each party’s responsibility in addressing them, can help companies develop and maintain effective control frameworks. 

Maintaining Successful Tax Processes

As companies grow, management inevitably becomes more decentralized as local teams are established to handle region-specific operations. Those smaller teams might not have the tax expertise to manage local obligations, such as timely filing returns and statutory audits and remaining compliant with transfer pricing. That leads to financial statement risk and cash tax exposure, complicating calculations of tax provision and taxes owed. Decentralized teams also create concerns for the corporate tax department, which must ensure that local offices are meeting their tax obligations.

Companies can combat those challenges by adding more oversight to local finance teams. Although it would be ideal to employ regional tax professionals to oversee and report into the overall tax function, ongoing shortages of experienced employees makes staffing those positions difficult. For departments unable to hire in-house regional tax professionals, outsourcing specific tax functions like global tax compliance and requirements to third-party tax service teams allows the internal workforce to focus on regional oversight.

Addressing Challenges Faced by Technical Functions

As technical tax functions have become more complex, strong control frameworks have become more important for tax departments. Because of continual changes in national and international tax policy and shifting financial responsibilities resulting from economic uncertainty, tax departments faced their fair share of obstacles in 2023.

Changing Tax Legislation

Between the implications of federal legislation like the Tax Cuts and Jobs Act (TCJA) and changes to corporate income taxation in numerous states, tax functions have had to adapt to many new tax laws. The TCJA eliminated the graduated corporate rate schedule and reduced the top U.S. corporate rate to 21% from 35%, and changes in state law have resulted in corporate rate reductions. While some of those legislative changes ultimately reduce tax liabilities, they impose on tax departments the added responsibility of monitoring and maintaining compliance as evolving laws continue to affect companies’ total tax liability and tax provision computations.

Looking ahead to 2023 and 2024 tax reporting, businesses must navigate how new minimum taxes introduced in the Inflation Reduction Act and the OECD’s Pillar Two framework might affect their tax positions. The U.S. corporate alternative minimum tax applies to companies with U.S. presence that have book income greater than $1 billion for three consecutive years. Once subject to that tax, a company must make adjustments based on current-year income to calculate if there is an additional tax. The global minimum tax introduced in Pillar Two also has a revenue threshold, but it applies only if individual countries have enacted laws to conform to the Pillar Two framework.

Companies that are close to those thresholds should have plans in place for what could happen if they grow beyond them and become subject to the tax requirements.     

Multinational corporations in scope for the Pillar Two global minimum tax will need to pay at least 15% in taxes on profits made in all countries. Although the tax is designed to avoid double taxation by applying a top-up tax to bring the total amount of income tax paid to the minimum of 15%, multinational corporations could be subject to double taxation if jurisdictions do not implement the rules consistently. 

All those legislative and regulatory changes add complexity to the computation of the tax provision and taxes owed, straining corporate tax functions that lack adequate resources and knowledge. Consulting with an experienced tax service provider can help tax departments avoid costly risks, penalties, and restatements stemming from material weaknesses and financial statement errors. 

Understanding Complexities Presented by Valuation Allowances 

Tax consultants can be especially helpful to tax teams in analyzing valuation allowance considerations. Because of economic volatility, many companies had to revisit their profit and loss operating forecasts in 2023. As a result, some changed their positions on whether the deferred tax assets (DTAs) on their balance sheets can be recoverable in the future, making tax provision and liability estimations more complex. Also, the TCJA allowed for the indefinite carryover of net operating losses and interest limitations, like those under Internal Revenue Code Section 163(j), that were generated post-TCJA. That makes the proper documentation and prediction of DTA realization more important because there is theoretically no expiration date for some. In practice, ASC 740 requires companies to apply a valuation allowance to any DTA that will likely not be realized in the near future to reflect a more accurate valuation of the business.

The TCJA amended IRC Section 174 to require the capitalization of some research and experimental expenditures, which can further complicate when and if a valuation allowance is required. Determining how to apply a valuation allowance is a complex process that requires careful judgment. For small tax departments without robust technological resources, determining when a valuation allowance is appropriate and how to apply it correctly can be difficult. 

Taking Advantage of Tax Technology

Today’s tax departments are charged with doing more with less and might still be relying on spreadsheet models, which can be prone to errors and difficult to maintain, for income tax accounting. 

Many companies have turned to tax provision and automation software to overcome those challenges. Tax software can help teams be more accurate and complete in their traditional tax functions, enabling employees to dedicate more time to strategic tax processes. It is also important to thoroughly train tax professionals to ensure technology is used to its full capacity.

Tax departments often encounter budget obstacles in building the business case to add technology. Although some business leaders are concerned about the resources needed to integrate tax technology, the benefits of tax software can reduce costs in the long term by boosting efficiencies. 

Over the last year, tax departments learned a lot as they dealt with increasing complexity. Recent policy changes have added to that, and we expect more of the same in the year ahead. But 2022 taught tax professionals that with proper control frameworks, improved processes, and tax technology, teams can manage challenges and mitigate risk with improved accuracy and efficiency. As obstacles persist in the near term, we expect tax functions equipped with the right resources and support to thrive.

Expanded Use of the Proportional Amortization Method for Tax Equity Investments Simplifies Accounting for Investors

More equity investors involved with projects to receive income tax credits and other income tax benefits might be able to use the proportional amortization method (PAM) to account for their investments.

On March 29, 2023, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2023-02, “Investments – Equity Methods and Joint Ventures,” to expand the use of the PAM for some tax credit equity investments. As the required adoption date for public business entities nears, investors should revisit their tax equity investments to determine whether they will elect the PAM.

Qualifying equity investments are investments with yields generated primarily through income tax credits and other income tax benefits and that meet other criteria. Previously, the PAM was available only to account for low-income housing tax credit (LIHTC) investments as an alternative to either the cost or equity method.

Before, noncontrolling equity investments in other tax credit programs, such as the new markets tax credit (NMTC) and renewable energy tax credit (RETC) programs, were generally accounted for under the equity method of accounting. Under that method, the accounting for the investment and the credits was presented on a gross basis in the income statement, which many stakeholders believed did not accurately reflect the true economics.

After considering stakeholder input, the FASB expanded the use of the PAM to a greater population of tax credit equity investments. That should provide more consistent accounting and a greater understanding of those arrangements by financial statement users. Accordingly, tax equity investments in NMTC structures, RETC structures, or other tax credit programs can now be accounted for using the PAM if all criteria are met and the tax equity investor elects to use that method.

The update also affects tax equity investments in LIHTC structures through limited liability entities that are not accounted for using the PAM method – that is, entities accounted for using the cost or equity method.

New disclosure requirements apply to investments that generate income tax credits and other income tax benefits from a tax credit program for which the entity has elected to apply the PAM (including investments within that elected program that do not meet the conditions to apply the PAM).

PAM Overview

The PAM recognizes the amortization of the equity investment, income tax credits, and other income tax benefits (such as depreciation) on the income tax line of the income statement. The amortization of the equity investment is recognized each period in proportion to the tax equity investor’s share of the income tax benefits for that period over the investor’s share of the total anticipated income tax benefits for the life of the investment.

For a tax equity investor to elect the PAM for an equity investment, it must meet five requirements:

1. It is probable that the income tax credits allocable to the tax equity investor will be available.
2. The tax equity investor is unable to exercise significant influence over the operating and financial policies of the underlying project.
3. Substantially all the projected benefits are from income tax credits and other income tax benefits. Projected benefits include income tax credits, other income tax benefits, and other non-income-tax-related benefits. The projected benefits are determined on a discounted basis using a discount rate that is consistent with the cash-flow assumptions used by the tax equity investor in making its decision to invest in the project.
4. The tax equity investor’s projected yield based solely on the cash flows from the income tax credits and other income tax benefits is positive.
5. The tax equity investor is a limited liability investor in the limited liability entity for both legal and tax purposes and its liability is limited to its capital investment.

Explanation of Provisions

The PAM applies only to arrangements in which a tax equity investor has an equity investment that is within the scope of ASC 323, “Equity Method Investments.” To determine whether an investor has an equity investment in a qualifying entity, it may first need to evaluate intermediary entities for consolidation under ASC 810, “Consolidation.” Whether an investor would consolidate those entities will vary depending on facts and circumstances.

A tax equity investor makes an accounting policy election to apply the PAM based on each tax credit program, rather than by electing to apply the PAM method at the tax equity investor level or to individual investments. Further, a tax equity investor that applies the PAM to qualifying tax equity investments must account for the receipt of the investment tax credits using the flow-through method under ASC 740, “Income Taxes,” even if the investor applies the deferral method for other investment tax credits received.

A tax equity investor should evaluate its eligibility to use the PAM at the time of the initial investment based on facts and conditions that exist at that time. It should reevaluate if there is a change in either the nature of the investment (for example, the investment is no longer a flow-through entity for tax purposes) or the relationship with the limited liability entity that could result in the tax equity investor no longer meeting the conditions to apply the PAM.

Non-income-tax credits (for example, refundable credits) are accounted for in pretax income under U.S. GAAP. Tax credits generated pursuant to the Chips and Science Act of 2022 and some credits enacted in the Inflation Reduction Act of 2022 meet the definition of refundable credits. In applying the “substantially all” test in the third criterion listed above, those credits are considered only as part of the denominator in the fraction, which could make it more difficult -- but not impossible -- to meet that criterion.

Other Changes

ASC 323-740, “Investments-Equity Method and Joint Ventures-Income Taxes,” included specialized guidance for LIHTC investments not accounted for using the PAM. ASU 2023-02 changed some of those rules, including removing the ability to account for LIHTC investments under a specialized cost method. Therefore, if the tax equity investment is not in the scope of the equity method, it will be accounted for under ASC 321, “Investments-Equity Securities.” The update also removed the specific equity method impairment guidance for LIHTC. Now, if a tax equity investment is accounted for under the equity method, impairment will be measured using the other-than-temporary model in the general sections of ASC 323. The update also requires all tax equity investments accounted for using the PAM to use the delayed equity contribution guidance in ASC 323-740-25-3, which requires a liability to be recognized for delayed equity contributions that are unconditional and legally binding or for equity contributions that are contingent on a future event when it becomes probable.

Disclosure Requirements

ASU 2023-02 prescribes disclosure requirements for all investments that generate income tax credits and other income tax benefits from a tax credit program for which the tax equity investor has elected to apply the PAM. Those disclosures are required for interim and annual periods and should include the nature of the investments, as well as the effect of the recognition and measurement of its investments and the related income tax credits and other income tax benefits on its financial position and results of operations.

The required disclosures are:

the amount of income tax credits and other income tax benefits recognized during the period, including the line item in the income statement and cash flow statement in which it has been recognized; and
• the amount of investments and the line item in which the investments are recognized in the balance sheet.

For investments accounted for using the PAM, the required disclosures are:

the amount of investment amortization recognized as a component of income tax expense (benefit);
• the amount of non-income-tax-related activity and other returns received that is recognized outside of income tax expense (benefit) and the line item in the income statement and cash flow statement in which it has been recognized; and
• the significant modifications or events that resulted in a change in the nature of the investment or a change in the relationship with the underlying project.

Effective Date and Transition

Public business entities must adopt ASU 2023-02 in fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. All other entities must adopt for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years.

Early adoption is allowed for all entities in any interim period. If an entity adopts the provisions in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period.

Entities may choose between the retrospective or modified retrospective transition options (see special rules below for LIHTC investments not accounted for using the PAM).

Retrospective Method

The tax equity investor evaluates all investments in which it expects to receive income tax credits or other income tax benefits as of the beginning of the earliest period presented. Determining whether the investment qualifies for the PAM is made as of the investment date. A cumulative-effect adjustment reflecting the difference between the previous and new accounting is recognized in the opening balance of retained earnings as of the beginning of the earliest period presented. 

Specific transition rules apply to LIHTC investments that are affected by the changes with respect to:

the cost method guidance in ASC 323-740;
• the impairment guidance for equity method investments in ASC 323-740; and
• the delayed equity contribution guidance in ASC 323-740.

To recognize the effect of those changes, the tax equity investor must either use its general transition method (for example, retrospective, modified retrospective) or apply a prospective approach. That election may be made separately for each of the three transition adjustment types described above. However, a tax equity investor applies a consistent transition method for each transition adjustment type.

Modified Retrospective Method

The tax equity investor evaluates all investments in which it expects to receive income tax credits or other income tax benefits as of the beginning of the year of adoption. Determining whether the investment qualifies for the PAM is made as of the investment date. A cumulative-effect adjustment reflecting the difference between the previous and new accounting is recognized in the opening balance of retained earnings as of the beginning of the adoption period.

Planning Tips

As the required adoption date for public business entities nears, investors should review their tax equity investments to determine whether to elect the PAM, as well as whether to early adopt.

2023 Year End Guide – Business Incentives & Tax Credits

Employee Retention Credit

The employee retention credit (ERC) is a refundable payroll tax credit for wages and health plan expenses paid or incurred by an employer (1) whose operations were either fully or partially suspended due to a COVID-19-related governmental order; or (2) that experienced a significant decline in gross receipts during the COVID-19 pandemic. The ERC has arguably been one of the most valuable provisions originating under the Coronavirus Aid, Relief, and Economic Security Act — the CARES Act — offering significant payroll tax relief for employers who kept employees on their payroll and continued providing health benefits during the COVID-19 pandemic.

Eligible employers can file a claim retroactively until the statute of limitations closes on April 15, 2024, for the 2020 ERC and April 15, 2025, for the 2021 ERC. Note that the U.S. government has repeatedly revised the requirements for U.S. taxpayers to claim the ERC since its initial codification into law. As a result, many eligible taxpayers have been uncertain as to whether they may properly claim this often-valuable tax credit.

Employers should be certain that one of the two paths for eligibility is satisfied:

Gross receipts in a calendar quarter were less than 80% of the gross receipts for the corresponding quarter in 2019; or
• Business operations were fully or partially suspended during the calendar quarter because of orders from a governmental authority due to COVID-19.

Most eligibility disputes involve the partial suspension test. While most businesses were adversely impacted by COVID-19 related to government actions, not all are eligible for ERC under this provision. To be eligible under the partial suspension test, the suspension must have been material.

Identifying the relevant government orders is another common issue. Qualifying orders must have been mandatory, in effect, and must have caused a suspension of operations for the entire period during which the employer paid the wages supporting the ERC claim.

Also, because the ERC was intended to benefit small businesses, requirements exist that all businesses under common owners be aggregated into a single employer. This rule prevents large businesses from splitting into many entities to qualify. The same aggregation rule used to determine the size of an employer is applied to determine whether the employer experienced a partial suspension that was more than nominal.

In response to mounting concerns over a surge in improper claims for the ERC, on September 14, 2023, the IRS announced an immediate moratorium on processing new claims for the pandemic-era relief program. The moratorium, effective until at least the end of the year, aims to protect businesses from scams and predatory tactics. While the IRS continues to process previously filed ERC claims received before the moratorium, the agency warns that increased fraud concerns will result in longer processing times.
However, the pause on processing new claims does not modify the statute of limitations that expires on April 15, 2024, for wages paid in 2020. Therefore, an employer considering a new request for a legitimate ERC claim should proceed after carefully reviewing Information Releases 2023-169 and 2023 -170, which the IRS released on September 14, 2023. For employers who would like to make a change to a pending claim that has not been processed or paid, the IRS is expected to issue guidance in the near future.
The IRS has also intensified its focus on reviewing ERC claims for compliance concerns, including conducting audits and criminal investigations on promoters and businesses submitting dubious claims. Hundreds of criminal cases are currently under investigation, and thousands of ERC claims have been referred for audit. Those with pending claims should expect extended processing times, while those yet to file should review the guidelines and consult trusted tax professionals.

As the IRS continues to refine its efforts to assist businesses facing questionable ERC claims, it advises businesses to carefully consider their situation and explore the options available to them. The IRS reminds anyone who improperly claims the ERC that they must pay it back, possibly with penalties and interest.

The IRS has stated that it will develop an ERC settlement program in late 2023 for employers that already received an ERC payment based on a claim now believed by the employer to be overstated. Under the settlement program, employers will be able repay the excess ERC amounts while avoiding penalties and other future compliance actions.

Additionally, to assist businesses affected by aggressive promoters, the IRS is developing a special withdrawal option for businesses that have filed an ERC claim but have not yet had it processed. Details of this program are expected to be announced in the coming months.

Given the increased IRS scrutiny of ERC claims, employers should reevaluate their ERC positions regarding eligibility and the amount of the claim. The IRS recommends that taxpayers seek advice from a trusted tax advisor.

Employers that have already filed a claim not prepared by a trusted tax advisor should verify whether any of the red flags or other concerns listed in the two IRS Information Releases apply to their situation. If they do, they should have any already submitted claim reviewed by a trusted tax professional. If the review does not support the claim as it was filed, corrective action should be pursued.

Credit for Increasing Research Activities: Proposed Changes to Form 6765 and Exam Environment

The IRS on September 15, 2023, released a preview of proposed changes to Form 6765, Credit for Increasing Research Activities, which taxpayers use to claim the research credit. The proposed changes, likely to become effective at the beginning of the 2024 tax year, include a new Section E with five questions seeking miscellaneous information and a new Section F for reporting quantitative and qualitative information for each business component, required under Section 41 of the Internal Revenue Code.

The IRS has also requested feedback on whether Section F should be optional for some taxpayers, including those with qualified research expenditures that are less than a specific dollar amount at a controlled group level; with a research credit that is less than a specific dollar amount at a controlled group level; or that are Qualified Small Businesses for payroll tax credit purposes.

It is important to note that if Section F were made optional for certain taxpayers, it would not exempt them from the requirement to maintain books and records or provide Section F information in a similar format, if requested; and it would not apply to amended returns for the research credit.

Examination Environment

Currently, the IRS receives a significant number of returns claiming the research credit, which requires substantial examination resources from both taxpayers and the IRS. To ensure effective tax administration for this issue, the IRS aims to clarify the requirements for claiming the research credit by considering all feedback received from stakeholders before finalizing any changes to Form 6765.

In response to ongoing concerns of improper claims of the research credit, the IRS has intensified its focus on reviewing these claims for nonconformities, including conducting a greater number of audits. Navigating the complexities of the research credit can be challenging, especially with the increased scrutiny, advancement of recent case law, and the newly implemented IRS compliance measures in place.

It is important for taxpayers to accurately determine eligibility, validate and properly record contemporaneous documentation to support research credit claims, and defend against examinations. Taxpayers should work with a trusted tax advisor to support compliance with IRS regulations and proper eligibility for the research credit.


Tax Credit Monetization

The signing of the Inflation Reduction Act on August 16, 2022, marked the largest-ever U.S. investment to combat climate change, allocating $369 billion to energy security and clean energy programs over the next 10 years, including provisions incentivizing the manufacturing of clean energy equipment and the development of renewable energy generation.

Overall, the act modifies many of the current energy-related tax credits and introduces significant new credits and structures intended to facilitate long-term investment in the renewables industry. Capital investments in renewable energy or energy storage, manufacturing of solar, wind, and battery components, and the production and sale or use of renewable energy are activities that could trigger one of the over 20 new or expanded IRA tax credits. The IRA also introduced new ways to monetize tax credits and additional bonus credit amounts for projects meeting prevailing wage and apprenticeship, energy community, and domestic content requirements.

45X – Advanced Manufacturing Production Tax Credit

The 45X Advanced Manufacturing Production Credit is a new production tax credit meant to encourage the production and sale of energy components within the U.S., specifically related to solar, wind, batteries, and critical mineral components. To be eligible for the credit, components must be produced in the U.S. or a U.S. possession and sold by the manufacturer to unrelated parties.

The Department of Energy has released a full list of eligible components as defined by the IRA, with specific credit amounts that vary according to the component. Manufacturers can also monetize 45X credits through a direct payment from the IRS for the first five years under Internal Revenue Code Section 6417. They may also transfer a portion or all of the credit to another taxpayer through the direct transfer system Section 6418 election. The 45X credit is a statutory credit with no limit on the amount of funding available; however, the credit will begin to phase out in 2030 and will be completely phased out after 2033. Manufacturers cannot claim 45X credits for any facility that has claimed a 48C credit.

48C – Qualifying Advanced Energy Project Tax Credit

In 2009, Congress enacted the America Recovery and Reinvestment Act, which included the 48C tax credit for qualifying advanced energy project investments. This credit initially applied to investment in facilities that produced various renewable energy assets and other property that reduced greenhouse gas emissions.

The Inflation Reduction Act provided new funding for the 48C credit and expanded the definition of qualified advanced energy projects to include facilities that produce components used in carbon capture, utilization and storage, energy grid modernization, renewable fuel generation and refinement, components of electric vehicles, and recycling facilities for eligible components. Manufacturers investing to construct, re-equip, or expand a facility that meets the definition of a qualified advanced energy project can apply for an allocation of the 48C credit.

The IRS and Department of Energy will award $10 billion in 48C credits via a two- step application process, with $4 billion reserved for projects located in energy communities. The base amount of the 48C credit is 6%, but the total credit can be as high as 30% if applicants meet prevailing wage and apprenticeship requirements. Recipients can claim 48C credits on federal corporate income taxes for a percentage of eligible investment costs placed into service during the current tax year. Corporations or flow-through entity shareholders who lack the ability to utilize the credits may sell them for cash under the new IRA credit transfer provisions.

Taxpayers applying for 48C allocation must submit an initial concept paper as well as a full application to be reviewed by the IRS and DOE. The first round of 48C allocation will award $4 billion by March 31, 2024. While the current round’s concept paper deadline has already passed, there will be additional rounds for the remaining $6 billion of funding in 2024 and beyond.

6418 – Transferability

Under IRC Section 6418, certain renewable energy tax credits can now be transferred by companies generating eligible credits to any qualified buyer seeking to purchase tax credits. Through credit transfers, taxpayers have the option to sell all or a portion of their credits in exchange for cash as part of their overall renewable energy goals if they are not able to fully utilize the benefit. Companies are able to purchase these credits at a discount, with the sale proceeds improving the economics of clean energy development.

The market rate for the sale of credits will be highly dependent on the type of credit being transferred, as well as the substantiation and documentation related to the seller’s eligibility for the credit taken and any bonus credit amounts claimed. The current rates seen in the market for transferring credits is around $.90 to $.94 per $1 of credit, but these amounts are subject to change based on specific fact patterns for each individual transaction and the overall market trend.

Taxpayers considering buying or selling tax credits that are transferable under the IRA should be looking ahead and forecasting their potential tax liability and resulting appetite for buying and selling credits. These credits can be transferred and utilized against estimated quarterly payments as soon as transfer agreements are finalized. This expedited reduction in cash outlay for the buyer and monetization of credits for the seller is a consideration that should be taken into account by taxpayers interested in entering the market of transferring credits. Note that taxpayers must be able to effectively utilize general business credits for this opportunity to be worthwhile.


Bonus Credits

The Inflation Reduction Act not only introduced new and expanded credits for investment in and production of renewable energy and its related components, it also included provisions for bonus credit amounts subject to meeting specific requirements. The prevailing wage and apprenticeship requirement is a 5x multiplier for certain credits that can bring the credit rate from 6% to 30% by paying prevailing wages to all labor related to the construction, installation, alteration, and repair of eligible property. Additionally, taxpayers must ensure that a certain percentage of these labor hours are performed by a qualified apprentice. Other common credit adders available for taxpayers that meet energy community and domestic content requirements provide a 10% adder to the base rate of the credit. Taxpayer documentation will be required to substantiate the claim of these bonus credit amounts and will need to be presented to a buyer in the event that these credits are transferred under 6418. 

Taxpayers that have current or planned investments or activities for which they plan to utilize the prevailing wage and apprenticeship multiplier should be planning a documentation strategy and procedure. In the event of an IRS audit or transfer of these credits, taxpayers will be required to substantiate the wages paid to laborers as well as the number of hours performed by registered apprentices. Depending on the size and amount of labor involved in qualified investments or production, documentation for PWA as well as the domestic content requirements will likely be a highly burdensome task if not planned accordingly at the outset of a project.

New Markets Tax Credits

The U.S. Treasury’s CDFI Fund recently released its annual allocation of New Markets Tax Credits (NMTCs). The federal New Markets Tax Credit (NMTC) program was established in 2000 to subsidize capital investments in eligible low-income census tracts. The subsidy provides upfront cash in the form of NMTC-subsidized loans fixed at below-market interest (2.5-3.5%). The loan principal is generally forgiven after a seven-year term resulting in a permanent cash benefit. Funding for these subsidized loans is highly competitive and expected to be depleted quickly.

Taxpayers across many industries can be good candidates to participate in the NMTC program.

Recipients are evaluated based on the community impact derived from the investments (e.g., job creation, community services provided, etc.). Ideal projects have at least $7 million in capital expenditure. These initial questions will help interested parties assess if a project is viable for NMTC.

Address of proposed project
• High-level project description
• Status of construction/timeline of CAPEX (midstream projects are permitted)
• Estimate of direct jobs to be created by project (within 3 years of PIS)

Taxpayers with ongoing or planned capital investments for late 2023 or early 2024 that are eligible to receive NMTC financing should begin reaching out to community development entities. The latest round of allocation was announced on September 22, and early outreach provides qualified active low-income community businesses a strong advantage in securing this financing due to the program’s competitive nature and limited funds.

2023 Year-End Guide – State and Local Tax

With thousands of taxing jurisdictions, from school boards to counties and states, and many different types of taxes, state and local taxation is complex. Each tax type comes with its own set of rules — by jurisdiction — all of which require a different level of attention. 

This article provides a high-level overview to help companies with 2023 year-end SALT planning considerations, and it provides guidance on how to hit the ground running in 2024.

This article provides a high-level overview to help companies with 2023

Liquidity Events

Liquidity events take the form of IPOs; financings; sales of stock, assets, or businesses; and third-party investments. Those events involve different forms of transactions, often driven by business or federal tax considerations; unfortunately, and far too often, the SALT impact is ignored until the 11th hour or later.

A liquidity event is not an occasion for surprises. When a taxpayer is contemplating any form of transaction, state and local taxes should not be overlooked. Knowledgeable SALT professionals can help identify planning opportunities and point out potential pitfalls, and it is never too early to involve them. If you wait until after the transaction occurs or until the state tax returns are being prepared, it may be too late to leverage their insight.

From state tax due diligence to understanding the total state tax treatment of a transaction to properly reporting and documenting state tax impacts, addressing SALT at the outset of a deal is critical. If involved before the year-end liquidity event, SALT professionals can suggest helpful adjustments to the transaction that may be federal tax-neutral but could result in identifying significant state tax savings or costs now, rather than later. After the liquidity event, because the state tax savings or costs already have been identified, they can be properly documented and reported post-transaction. Further, because SALT expertise was involved at the front end, state tax post-transaction integration, planning, and remediation can be more seamlessly pursued.

Income/Franchise Taxes

If anything has been learned from the last six years of federal tax legislation, it’s that state income tax conformity cannot be taken for granted. While states often conform to myriad federal tax provisions, it's important to verify S corporations are treated as such by each state they operate in. Further, S corporations must confirm that their status applies to state income taxes. Not asking those questions early can lead to a misunderstanding and potential issues later. 

Several states don’t conform to federal entity tax classification regulations. Some, including New York, require a separate state-only S corporation election. New Jersey now allows an election out of S corporation treatment. Making those elections — or not — can lead to different state income tax answers, so it’s important to understand the available options before the transaction occurs.

Asking important questions early can help provide clarity in the decision-making process:

If the liquidity event will result in gain, how is the gain going to be treated for state income tax purposes?
• Is it apportionable business gain or allocable nonbusiness gain?
• Is a partnership interest, stock, or asset being sold?
• How will the gain be apportioned?
• Was the seller unitary with the partnership or subsidiary, or did the assets serve an operational or investment function for the seller?
• Will the gross receipts or net gain from the sale be included in the sales factor, and, if so, how will they be apportioned?

Those are just some of the questions that are never asked on the federal level because they don’t have to be. But they are material on the state level and, again, are unwelcome surprises.

Sales/Use Taxes

Most U.S. states require a business to collect and remit sales and use taxes even if it has only economic, and no physical, presence. Remote sellers, software licensors, and other businesses that provide services or deliver their products to customers from a remote location must comply with state and local taxes.

Left unchecked, those state and local tax obligations — and the corresponding potential liability for tax, interest, and penalties — will grow. Moreover, neglecting your sales and use tax obligations could result in a lost opportunity to pass the sales and use tax burden to customers as intended by state tax laws.

A company could very well experience material sales and use tax obligations resulting from a sale, even though the transaction or reorganization is tax free for federal income tax purposes. To avoid any material issues, several steps should be taken:

Determine nexus and filing obligations;
• Evaluate product and service taxability;
• Quantify potential tax exposure;
• Mitigate and disclose historical tax liabilities;
• Consider implementing a sales tax system; and
• Maintain sales tax compliance.

Real Estate Transfer Taxes

Most states impose real estate transfer taxes (RETTs) or conveyance taxes on the sale or transfer of real property, or controlling interest transfer taxes when an interest in an entity holding real property is sold. Few taxpayers are familiar with RETTs, and the complex rules and compliance burdens associated with those state taxes could prove costly if they are not considered up front.

State PTE Tax Elections

Roughly 35 states now allow pass-through entities (PTEs) to elect to be taxed at the entity level to help their residents avoid the $10,000 limit on federal itemized deductions for state and local taxes known as the “SALT cap.” Those PTE tax elections are much more complex than simply checking a box to make an election on a tax return. Although state PTE tax elections are meant to benefit the individual members, not all elections are alike, and they are not always advisable.

Before making an election, a PTE should model the net federal and state tax benefits and consequences to the PTE — for every state in which the PTE operates, as well as for each resident and nonresident member — to avoid potential unintended tax results. A thorough evaluation of whether to make a state PTE tax election (or elections) should be completed before the end of the year, modeling the net tax benefits or costs, as should a determination of timing elections, procedures, and other election requirements (e.g., owner consents, owner votes to authorize the election, and partnership or LLC operating agreement amendments). If those steps are completed ahead of time, then the table has been set to make the election in the days ahead.

When considering a state PTE tax election, one of the most important issues to evaluate is whether members who are nonresidents of the state for which the election is made can claim a tax credit for their share of the taxes paid by the PTE on their resident state income tax returns. If a state does not offer a tax credit for elective taxes paid by the PTE, then a PTE tax election could result in additional state tax burden that exceeds some members’ federal itemized deduction benefit ($0.37 is less than $1.00). Therefore, as part of the pre-year-end evaluation and modeling exercise, PTEs should consider whether the election would result in members being precluded from claiming other state tax credits — which ordinarily would reduce their state income tax liability dollar for dollar — in order to receive federal tax deductions that are less valuable.

Does P.L. 86-272 Still Exist?

P.L. 86-272 is a federal law that prevents a state from imposing a net income tax on any person’s net income derived within the state from interstate commerce if the only business activity performed in the state is the solicitation of orders of tangible personal property that are sent outside the state for approval or rejection and, if approved, are filled by shipment or delivery from a point outside the state.

The Multistate Tax Commission (MTC) adopted a revised statement of its interpretation of P.L. 86-272 which, for practical purposes, largely nullifies the law’s protections for businesses that engage in activities over the internet. To date, California and New Jersey have formally adopted the MTC’s revised interpretation of internet-based activities, while Minnesota and New York have proposed the interpretation as new rules. Other states are applying the MTC’s interpretation on audit without any notice of formal rulemaking.

Online sellers of tangible personal property that have previously claimed protection from state net income taxes under P.L. 86-272 should review their positions. Online sellers that use static websites that don't allow them to communicate or interact with their customers — a rare practice — seem to be the only type of seller that the MTC, California, New Jersey, and other states still consider protected by P.L 86-272.

The effect of the MTC’s new interpretation on a taxpayer’s state net income tax exposure should be evaluated before the end of the year. Structural changes, ruling requests, or plans to challenge states’ evolving limitation of P.L. 86-272 protections applicable to online sales can be put into place.

However, nexus or loss of P.L. 86-272 protection can be a double-edged sword. For example, in California, if a company is subject to tax in another state using California’s new standard, then it is not required to throw those sales back into its California numerator for apportionment purposes.

Property Tax

For many businesses, property tax is the largest state and local tax obligation and a significant recurring operating expense that accounts for a substantial portion of local government tax revenue. Unlike other taxes, property tax assessments are ad valorem, meaning they are based on the estimated value of the property. Thus, they could be confusing for taxpayers and subject to differing opinions by appraisers, making them vulnerable to appeal. Assessed property values also tend to lag true market value in a recession.

Property tax reductions can provide valuable above-the-line cash savings, especially during economic downturns when assessed values may be more likely to decrease. The current economic environment amplifies the need for taxpayers to avoid excessive property tax liabilities by making sure their properties are not overvalued.

Annual compliance and real estate appeal deadlines can provide opportunities to challenge property values. Challenging real property assessments issued by jurisdictions within the appeal window may reduce real property tax liabilities. Taking appropriate positions on personal property tax returns related to any detriments to value could reduce personal property tax liabilities. Planning for and attending to property taxes can help a business minimize its total tax liability.

Conclusion

There are 50 states and thousands of local taxing jurisdictions that impose multiple different tax types. Ensuring that your company is in compliance with those state and local taxes — and only paying the amount of tax legally owed — can help reduce your total tax liability.  As a taxpayer, it is more efficient to be proactive, rather than reactive, when it comes to state and local taxes.  Being proactive will help identify issues and solutions that can be applied to other taxing jurisdictions, as well as helping limit audits, notices, penalties, and interest.

2023 Year-End Guide – Partnerships

The IRS in the past year has been actively challenging partnerships’ tax positions in court – from the valuation of granted profits interests to limited partner self-employment exemption claims and the structuring of leveraged partnership transactions. At the same time, the agency is dedicating to new funding and resources to examining partnerships.
These developments, along with some reporting and regulatory changes, mean there are a number of tax areas partnerships should be looking into as they plan for year end and the coming year:

Review Valuation of Granted Profits Interests, Partners’ Capital Accounts
• Consider Active Limited Partners’ Potential Liability for Self-Employment Tax
• Prepare for Expanded IRS Audit Focus on Partnerships
• Review Structure of Leveraged Partnership Transactions, Application of Anti-Abuse Rules
• Prepare for New Reporting on 2023 Form 1065 Schedule K-1
• Evaluate Before Year End Expiration of Partnership Bottom-Dollar Guarantee Transition Rules

Review Valuation of Granted Profits Interests, Partners’ Capital Accounts

In a recent Tax Court case, the IRS attempted — unsuccessfully — to supplant the fair market value agreed to by unrelated parties in a partnership transaction with its expert’s higher estimate, asserting that the taxpayer received a taxable capital interest in exchange for services provided to a partnership, not a nontaxable profits interest. If structured and substantiated properly, profits interests can be valuable tools for compensating providers of services to partnerships at no immediate tax cost. Although the court upheld the taxpayers’ valuation, the IRS challenge highlights the importance for partnerships to:

Properly determine, support and document value when granting and establishing rights to profits interests, and
• Strongly consider revaluing partners’ capital accounts according to Treasury regulations to reflect fair market value when profits interests are granted.

The case, ES NPA Holding LLC v. Commissioner, T.C. Memo 2023-55 (May 3, 2023), involved a partnership (ES NPA) that provided services to another partnership in exchange for a partnership interest. The taxpayers contended that interest was a profits interest, which was not immediately taxable. The IRS argued that, under its higher estimation of the value of the underlying business, ES NPA took a capital interest in the partnership that ostensibly should be immediately taxable.

Relying on the fair market value negotiated among the parties to the transaction, the Tax Court agreed with the taxpayer that there was not a taxable capital shift between partners. Unsurprisingly, the Tax Court also concluded — premised on the IRS’s guidance in Revenue Procedure 93-27 — that receipt of a profits interest will not result in the immediate recognition of taxable income. What is somewhat surprising is that the IRS challenged whether the interest was, in fact, a profits interest.

Facts in ES NPA Holding

Under the basic facts, a partnership (NPA, LLC) had three classes of units, including Class A, Class B and Class C units. Upon liquidation of NPA, LLC, the Class A and Class B units were to receive 100% of the original capital assigned to these units before any amounts would be distributable to the Class C units – which were the units that ES NPA received in exchange for its services.

After an unrelated third party purchased 70% of the company for $21 million, the parties to the transaction agreed that the original capital assigned to the Class A and Class B units was $21 million and $9 million, respectively. Thus, the total agreed to value of NPA, LLC was $30 million. Under this valuation, the Class C units held by ES NPA would have $0 value in the event of a hypothetical liquidation of NPA, LLC, at the time of the transaction – suggesting ES NPA received only a profits interest in NPA, LLC.

IRS Challenge

Despite the parties’ agreement as to the $30 million equity valuation, the IRS argued that the value of NPA, LLC was $52.5 million. Using this value, the IRS determined that the liquidation value of the Class C units held by ES NPA was in excess of $12 million (rather than $0). Assuming this valuation is accurate, the Class C units would be considered capital interests and would not be eligible for the safe harbor under Revenue Procedure 93-27, which generally exempts from immediate taxation profit interests – but not capital interests – received in exchange for the provision of services to a partnership.

Based on its arguments, the IRS appears to believe that such a capital shift would be immediately taxable to the recipient. Although not specifically addressed in the Tax Court’s decision, receipt of a capital interest in exchange for the performance of services is generally a taxable event under established case law. However, there is some question around whether a capital interest received for purposes other than the performance of services would be immediately taxable.

Tax Court’s Holding

Ultimately, the Tax Court concluded that the best estimate of fair market value in this case was the purchase price agreed to by unrelated parties. While acknowledging that formal valuation reports may be helpful in establishing fair market value, the Tax Court noted that such appraisals are not required. Rather, as in this case, deference was provided to the transaction price agreed to by unrelated taxpayers. Importantly, the Tax Court noted that the testimony of the selling taxpayer was credible and unbiased. The Tax Court further noted, “we find nothing in the record to dispute a finding that the transaction was arm’s length and bona fide.”

What If the Court Accepted the IRS’s Narrow Reading of Its Own Revenue Procedure?

Although this case is a “win” for the taxpayer, the IRS presumably didn’t go to court without reason. The IRS believed the recipient of the Class C units should immediately recognize taxable income. However, the IRS’s primary argument sought to prevent application of Revenue Procedure 93-27 via a narrow reading of the guidance. The IRS’s primary argument was not whether the Class C units represented a capital interest. What if the Tax Court agreed that Revenue Procedure 93-27 didn’t apply to these facts?

Revenue Procedure 93-27 is a safe harbor provision that states the IRS will not treat receipt of a profits interest as immediately taxable. If the Tax Court agreed that the safe harbor didn’t apply, as argued by the IRS, the IRS would still need to address judicial precedent holding that receipt of a profits interest is not taxable because the value of the interest received is speculative. Thus, the IRS would then have had to successfully argue that the Class C units had value beyond speculation. Given the result in the IRS’s secondary, capital shift argument, it seems unlikely that it would have prevailed.

Key Considerations and Takeaway

Acknowledging the taxpayer’s success in this case, it is important to note that the IRS sought to challenge the taxpayer in court. This is presumably not a decision taken lightly by the IRS. Is this a warning sign to taxpayers when structuring transactions where the buyer anticipates future upside that may or may not be speculative?

There are a few important factors that, if the facts had been different, potentially could have altered the outcome of the case:

The Tax Court found the selling taxpayer’s testimony to be credible and unbiased, with nothing in the record indicating something other than an arm’s-length transaction.
• The facts did not indicate that the taxpayer needed the cash to support further business operations, was simply looking to monetize his investment as quickly as possible or otherwise facing circumstances prompting the seller to sell at a discount.
• The lack of taxpayer relatedness was important in supporting the use of the agreed fair market value.
• The discussion within the Tax Court’s opinion doesn’t address whether the property owner ever sought other bids for his business or if that would have changed the court’s analysis and conclusion regarding the credibility and unbiased nature of the witness.

Ultimately, while a positive outcome for the taxpayer in this case, the IRS’s decision to take this case to trial should serve as a cautionary tale. Taxpayers are well advised to closely scrutinize the factors in their own transactions to ensure the fair market value positions are fully documented and supported.

When issuing a profits interest, it's critical to document the valuation of the partnership and to strongly consider a book up of capital accounts to reflect the valuation. Analyzing and documenting whether the bargaining positions of the parties are truly adversarial would presumably help substantiate the parties’ agreement of value.

Consider Active Limited Partners’ Potential Liability for Self-Employment Tax

A judicial resolution may be near for the unanswered question of whether limited partners in state law limited partnerships may claim exemption from self-employment (SECA) taxes — despite being more than passive investors. Depending on the outcome in the pending Soroban Capital Partners litigation, limited partners in state law limited partnerships who actively participate in the partnership’s business may lose the opportunity to claim this exemption. If this happens, these limited partners would likely become subject to SECA tax on their partnership income.

SECA taxes can be substantial for active partners in profitable partnerships. The SECA tax rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). While the 12.4% social security tax is currently limited to the first $160,200 of self-employment earnings, partners who are subject to SECA tax must pay the 2.9% Medicare part of the tax on their entire net earnings from the partnership. There is also an additional 0.9% Medicare tax on all earnings from the partnership over a certain base amount (currently $125,000; $200,000; or $250,000 depending on the partner’s tax filing status)

Why are some limited partners in jeopardy of losing their SECA tax exemption?

Under Internal Revenue Code Section 1402(a)(13), the distributive share of partnership income allocable to a “limited partner” is generally not subject to SECA tax, other than for guaranteed payments for services rendered. However, the statute does not define “limited partner,” and proposed regulations issued in 1997 that attempted to clarify the rules around the limited partner exclusion have never been finalized.

More recently, courts have held — in favor of the IRS — that members in limited liability companies (LLCs) and partners in limited liability partnerships (LLPs) that are active in the entity’s trade or business are ineligible for the SECA tax exemption. Despite these IRS successes, some continue to claim that state law controls in defining “limited partner” in the case of a state law limited partnership and, therefore, limited partners in state law limited partnerships — even active limited partners — may be eligible for the SECA tax exemption. This issue has yet to be specifically addressed by the courts, but Soroban Capital Partners may be the first case to squarely resolve it.

What is the issue in the Soroban Capital Partners litigation?

The Soroban Capital Partners litigation filed with the Tax Court involves a New York hedge fund management company formed as a Delaware limited partnership. The taxpayers challenge the IRS’s characterization of partnership net income as net earnings from self-employment subject to SECA tax. According to the facts presented, each of the three individual limited partners spent between 2,300 and 2,500 hours working for Soroban, its general partner and various affiliates – suggesting that the limited partners were “active participants” in the partnership’s business.

In its March 2 objection to the taxpayers’ motion for summary judgment, the government contends that the term “limited partner” is a federal tax concept that is determined based on the actions of the partners – not the type of state law entity. Citing previous cases, the government asserts that the determination of limited partner status is a “facts and circumstances inquiry” that requires a “functional analysis.” The taxpayers in Soroban, on the other hand, argue that such a functional analysis does not apply in the case of a state law limited partnership and that, in the case of these partnerships, limited partner status is determined by state law.

Under the functional analysis adopted by the Tax Court in previous cases, to determine who is a limited partner, the court looks at the relationship of the owner to the entity’s business and the factual nature of services the owner provides to the entity’s operations. For the SECA tax exemption to apply, the government states (citing case law), “an owner must not participate actively in the entity's business operations and must have protection from the entity's obligations.”

What should limited partners do pending the outcome of the Soroban case?

Limited partners who actively participate in the partnership’s business should review their facts and circumstances and potential exposure to SECA tax. Although there is currently no clear authority precluding active limited partners of a state law limited partnership from claiming exemption from SECA tax, such a position should be taken with caution and a clear understanding of the risks—including being subject to IRS challenge if audited. The IRS continues to focus on scrutinizing such claims through its SECA Tax compliance campaign. Moreover, the opportunity to claim the exemption could be significantly narrowed depending on the outcome of Soroban Capital Partners.

Prepare for Expanded IRS Audit Focus on Partnerships

The IRS on September 8, 2023, announced that it will leverage funding from the Inflation Reduction Act to take new compliance actions, including actions focused on partnerships and other high income/high-wealth taxpayers. It intends to use artificial intelligence (AI) and improved technology to identify potential compliance risk areas.

Subsequently, on September 20, the IRS further announced plans to establish a new work unit to focus on large or complex pass-through entities. The new pass-through area workgroup will be housed in the IRS Large Business and International (LB&I) division and will include the people joining the IRS under a new IRS hiring initiative. The creation of this new unit is another part of the IRS’s new compliance effort.

With respect to partnerships, the IRS announcement on new enforcement efforts indicates that the IRS will focus on two key areas:

Expanding its Large Partnership Compliance program by using AI to identify compliance risks, and
• Increasing use of compliance letters focused on partnerships with balance sheet discrepancies.

Large Partnership Compliance and AI

The IRS began focusing on examinations of the largest and most complex partnership returns through its Large Partnership Compliance pilot program launched in 2021. It now plans to expand the program to additional large partnerships, using AI to select returns for examination. The AI, which has been developed jointly by experts in data science and tax enforcement, uses machine learning technology to identify potential compliance risks in partnership tax and other areas.

The IRS stated that it plans, by the end of this month, to have opened examinations of 75 of the largest partnership in the U.S. in a cross section of industries – including hedge funds, real estate investment partnerships, publicly traded partnerships, and large law firms.

Compliance Letters and Balance Sheet Discrepancies

The IRS has identified ongoing discrepancies in balance sheets of partnerships with over $10 million in assets. The IRS announcement explains that there have been an increasing number of partnership returns in recent years showing discrepancies in balances between the end of one year and the beginning of the next year – many in the millions of dollars, without any required attached statement explaining the discrepancy.

The IRS states that it did not previously have the resources to follow up and engage with large partnerships on these discrepancies. Using its new resources, the IRS plans to approach the issue by mailing out compliance letters to around 500 partnerships starting in early October. Depending on the partnerships’ responses, the IRS might take additional action, including potential examination.

Planning Considerations

With the passage of the Bipartisan Budget Act of 2015 (BBA), promulgating new centralized partnership audit rules, there has been an increased focus on partnership compliance. In conjunction, recent reporting updates for Schedule K-1, Schedule K-2, and Schedule K-3 require partnerships to now disclose additional information. This new announcement from the IRS reflects the agency’s continued focus on partnership compliance using a variety of tools, including AI, and further highlights the necessity for consistent and accurate partnership reporting.

With the IRS signaling its areas of focus, taxpayers can proactively enhance their “exam readiness.” Prior to initiation of an exam, taxpayers may wish to consider taking steps such as confirming application of the BBA partnership audit rules across entities within a complex structure, identifying open tax years for entities subject to these rules, assessing completeness of existing tax return workpapers and relevant documentation, and establishing a framework of the exam response process.

Once an audit notice or compliance letter arrives, prepared taxpayers will be ready to implement their exam process. Key to a taxpayer’s exam process will be considering designation of the partnership representative, availability of documentation that the IRS will likely request, familiarity with operating agreements and other transaction documents, and accessibility of qualified advisors to assist in the exam process.  

Review Structure of Leveraged Partnership Transactions, Application of Anti-Abuse Rules

On May 12, the Department of Justice (DOJ) filed its opening brief in its appeal to the Seventh Circuit of the Tax Court’s decision in Tribune Media Co. v. Commissioner (T.C. Memo 2021-122). The government views the Tax Court’s ruling as paving the way for inappropriate income tax planning, potentially enabling taxpayers to follow the roadmap created by the taxpayer in Tribune Media to implement leveraged partnership transactions without triggering taxable gain while avoiding incurring meaningful economic risk.

The appeal is primarily focused on perceived errors by the Tax Court in applying a liability allocation anti-abuse rule under Treas. Reg. §1.752-2(j) and the general partnership anti-abuse rule under Treas. Reg. §1.701-2. If successful on appeal, the case would likely be remanded to the Tax Court for a determination regarding applicability of the liability allocation and general anti-abuse rules. It is unclear whether the Tax Court would reach a different conclusion upon remand.

The initial brief submitted by DOJ contains a discussion of factors determined to be relevant in concluding the taxpayer’s guarantee was without substance. Consideration should be given to these factors – summarized in the conclusion below – when structuring or evaluating transactions.

Summary of Relevant Facts

In 2009, Tribune Media Company completed a transaction in which it contributed the Chicago Cubs baseball team to a partnership in exchange for an interest in the partnership plus a $714 million cash distribution. Under the disguised sale of property rules in section 707(a)(2)(B), the $714 million would be viewed as a consideration received in connection with a partial sale of the Chicago Cubs baseball team. However, through use of liability guarantees, a significant portion of the debt used to fund the cash distribution was allocated to Tribune Media. Under an exception to the disguised sale rules, distributions funded by debt allocated to the distributee are not treated as disguised sale consideration.

Based on rules described in Treas. Reg. §1.752-2, to the extent a partner bears economic risk of loss (EROL) with respect to a liability, the liability will be allocated to the partner. For purposes of determining whether a taxpayer has EROL with respect to a particular liability, the regulations provide for an analysis relying on hypothetical facts. Under Treas. Reg. §1.752-2(b), a partner bears EROL with respect to a liability to the extent that, if the partnership constructively liquidated, the partner or a related person would be obligated to make a payment with respect to the liability. For purposes of this analysis, regulations require the constructive liquidation to be determined under all the following hypothetical facts:

All the partnership’s liabilities become payable in full.
• With the exception of property contributed to secure a partnership liability (see Treas. Reg. §1.752-2(h)(2)), all the partnership’s assets, including cash, have a value of zero.
• The partnership disposes of all its property in a fully taxable transaction for no consideration (except relief from liabilities for which the creditors’ right to repayment is limited solely to one or more assets of the partnership).
• All items of income, gain, loss or deduction are allocated among the partners.
• The partnership liquidates.

To benefit from the debt financed distribution exception to the disguised sale rules, Tribune Media agreed to guarantee a portion of the debt used to fund the distribution. The objective of this guarantee was to create EROL resulting in an allocation of the liability to Tribune Media. Based on the terms of the executed agreements and the general rules described in Treas. Reg. §1.752-2, Tribune Media properly bore EROL. As shown on applicable income tax returns, partnership liabilities were allocated to Tribune Media and reflected its EROL.

Liability Allocation Anti-Abuse Rule

Upon examination, the IRS concluded that the parties’ attempt to create EROL violated the anti-abuse rule under Treas. Reg. §1.752-2(j), which generally provides that an obligation of a partner to make a payment may be disregarded if facts and circumstances indicate that a principal purpose of the arrangement is to eliminate the partner’s EROL with respect to that obligation.

As discussed in both the Tax Court’s opinion and DOJ’s opening appeals brief, the parties structured an arrangement that met the literal requirements to create EROL under Treas. Reg. §1.752-2. However, under the government’s view of the facts, Tribune Media did not bear meaningful risk of loss. The government noted that that “[t]he Tax Court and Tribune itself concluded that Tribune had no more than a ‘remote’ risk under the Senior Guarantee” with “myriad protections in place that all but assured Tribune would never be called upon to repay any portion of the Senior Debt.”

It appears that, in evaluating applicability of the section 752 anti-abuse rule, the Tax Court focused on the fiction that is deemed to occur for purposes of determining EROL under Treas. Reg. §1.752-2. Consequently, the Tax Court assumed the debt became due and all relevant assets became worthless. Under this interpretation, Tribune Media would be called upon to satisfy the outstanding liability. Consequently, the Tax Court concluded that the actual and remote risk to Tribune Media wasn’t relevant to the anti-abuse rule under Treas. Reg. §1.752-2(j). With this ruling the Tax Court would significantly limit the potential effectiveness of the anti-abuse rule.

The government views the reference in Treas. Reg. §1.752-2(j) to “facts and circumstances” to mean a required analysis of the actual economic arrangement of the parties. This contrasts with the view apparently taken by the Tax Court. In the Tax Court’s analysis, the anti-abuse analysis was conducted under the lens of the hypothetical factual assumptions required under the general rule of Treas. Reg. §1.752-2(b). The different views, of course, could have dramatic results in terms of whether and when the anti-abuse rule may apply.

General Partnership Anti-Abuse Rule

In addition to the liability allocation anti-abuse rule under Treas. Reg. §1.752-2(j), the government has also taken issue with the Tax Court’s application of the general partnership anti-abuse rule under Treas. Reg. §1.701-2. In its decision, the Tax Court noted that the Treas. Reg. §1.701-2 anti-abuse rules apply only “to the function of the partnership as a whole.” The government, on the other hand, points out that Treas. Reg. §1.701-2(a)(2) requires that “[t]he form of each partnership transaction must be respected under substance over form principles.”

Ultimately, DOJ believes the Tax Court has misapplied the general anti-abuse rule. Acknowledging that the totality of the transaction may have had a business purpose, analyzing specific aspects under the general anti-abuse rule is appropriate. Similar to the discussion around the liability allocation anti-abuse rule, a recharacterization of the loan guarantee could have a significant impact on the tax consequences to the parties involved.

Conclusion

Based on the status of the Tribune Media case and the government’s appeal, there are a few important factors for consideration and reasonably drawn conclusions.

The government disagrees with the manner in which the Tax Court applied both the liability allocation anti-abuse rule and the general anti-abuse rule. It is reasonable to conclude that, if faced with a similar fact pattern, the IRS will challenge application of the debt-financed distribution exception to the disguised sale rules. In its brief, DOJ described the following factors as critical in its determination that the loan guarantee was without economic substance:

The Cubs’ baseball club had strong revenue flow and structural protections built into the transaction ensuring the ability of the Cubs to meet its financial obligations. In particular, the Cubs had stable and growing cash flow streams from long-term media rights agreements along with strong ticket sale revenue. Debt service arrangements were structured to pull from these cash flow streams.
• As part of obtaining approval from Major League Baseball to complete the transaction, several parties to the transaction executed an operating support agreement intended to provide a “financial safety net” to the Cubs in times of economic uncertainty.
• To prevent potential creditor seizure of the Cubs baseball team, the Commissioner of Major League Baseball had the authority to take significant actions, including requiring funding additional equity contributions, the sale of the team and the provision of a super-senior loan to fund operating expenses.
• There is unique value to the collateral associated with a major league baseball team. Based on S&P valuations, upon a distressed asset sale, a 40% reduction in the value of the collateral would still yield significant value.
• Tribune Media documented its belief that the possibility of its guarantees would be called upon was remote. On its financial statements, Tribune Media disclosed the guarantees in the notes but did not record a liability, create a reserve, or report any value associated with the guarantees. 

The Tax Court evaluated application of both the liability allocation anti-abuse rule and the general anti-abuse rule. The Tax Court concluded that the liability allocation anti-abuse rule was inapplicable. This conclusion was premised on application of the hypothetical transactions described in Treas. Reg. §1.752-2(b), i.e., the loan becomes due and payable, and the obligor has no assets with which to satisfy the obligation. Under this assumption, the Tax Court concluded that the remoteness of the guarantor’s obligation is not relevant. If this approach is accurate, application of the liability allocation anti-abuse rule would certainly seem to be significantly limited. If appropriate to analyze this anti-abuse rule under actual facts, it’s unclear whether the Tax Court would have reached a different end result.

Until resolved on appeal, taxpayers should be able to rely on the Tax Court’s ruling in Tribune Media to structure transactions involving debt-financed distributions. However, taxpayers should likewise be prepared for IRS challenge if audited.

Prepare for New Reporting on 2023 Form 1065 Schedule K-1

The IRS included new and modified reporting requirements in its draft 2023 Form 1065 Schedule K-1 , released on June 14, 2023, including:

A modified reporting requirement concerning decreases in a partner’s percentage share of the partnership’s profit, loss and capital, and
• A new reporting requirement relating to partnership debt subject to guarantees or other payment obligations of a partner.

Decreases in a Partner’s Share of Partnership Profit, Loss and Capital

The modification to the Schedule K-1 reporting reflected on the draft 2023 Schedule K-1 concerns certain decreases in a partner’s percentage share of the partnership’s profit, loss and capital from the beginning of the partnership’s tax year to the end of the tax year.

Reporting a partner’s percentage share of the partnership’s profit, loss and capital at the beginning and the end of the tax year is not a new requirement. Prior versions of the Schedule K-1 require the partnership to check a box indicating if a decrease in a partner’s percentage share of profit, loss and capital from the beginning of the tax year to the end of the tax year is due to a sale or exchange of partnership interests. The draft 2023 Schedule K-1 refines this reporting by distinguishing, in Part II, Item J, between decreases due to sales of partnership interests and decreases due to exchanges. Partnerships must check one box if a decrease in a partner’s percentage share of profit, loss and capital from the beginning to the end of the partnership tax year is due to a sale of partnership interests and a separate box if the decrease is due to an exchange of partnership interests.

While it is unclear why the IRS distinguishes a sale from an exchange in this context, in the absence of clarifying instructions to the 2023 Form 1065, an exchange of partnership interests should be interpreted broadly to encompass any non-sale transfers of partnership interests, whether taxable or not, including by gift, a redemption or otherwise.

Partnership Debt Subject to Guarantees or Other Payment Obligations of a Partner

The new reporting requirement reflected on the draft 2023 Schedule K-1 underscores the importance of properly classifying partnership liabilities as recourse or nonrecourse under the Section 752 rules. The draft 2023 Schedule K-1, in Part II, Item K3, requires the partnership to check a box if a partner’s share of any partnership indebtedness (also reported on the Schedule K-1) is subject to guarantees or other payment obligations by the partner.

The existence of a guarantee or other partner payment obligation is relevant in determining whether a partnership liability is considered recourse or nonrecourse under the rules of Section 752. Regulations state that a partnership liability is a recourse liability to the extent that any partner or related person bears an economic risk of loss with respect to the obligation. A partner that has an obligation to make a net payment to a creditor or other person with respect to a partnership liability upon a constructive liquidation of the partnership, including pursuant to a deficit restoration obligation (DRO) in the partnership agreement, is considered to bear the economic risk of loss of that partnership liability. A partner’s payment obligation with respect to partnership debt may arise pursuant to any contractual guarantees, indemnifications, reimbursement agreements or other obligations running directly to creditors, to other partners or to the partnership.

The existence of a debt guarantee or other payment obligation by the partner with respect to a partnership liability may indicate that the partner bears some or all of the economic risk of loss for such liability, which is a key factor in classifying a partnership liability as recourse or nonrecourse under the rules of Section 752.

Evaluate Before Year End Expiration of Partnership Bottom-Dollar Guarantee Transition Rules

The transition period for “bottom-dollar” guarantees ended on October 4, 2023, and in some cases partners that were relying on bottom-dollar guarantees for partnership tax basis would have needed to have new arrangements in place by that time if they intended to preserve tax basis associated with a bottom-dollar guarantee. However, partners in some partnerships may have until the end of the partnership tax year to set up new arrangements.

Bottom-Dollar Guarantees and Transition Period

A bottom-dollar guarantee is a guarantee by a partner of an amount of partnership debt, where the partner pays only if the creditor collects less than the full amount of the debt from the partnership. Further, in a bottom-dollar guarantee, even if the creditor does not collect the full amount of the debt, the bottom-dollar guarantor pays nothing provided the creditor collects at least the amount of the bottom-dollar payment obligation. For example, a lender loans ABC partnership $100 secured by land and partner A guarantees the bottom $10 of the loan. If the lender can only recover $11 of the $100 loan, then Partner A has no obligation on the guarantee. However, if the lender can only recover $6 of the $100 loan, then Partner A would be liable for $4 under the guarantee ($10 bottom guarantee less $6 recovered).

Regulations under Section 752 issued in 2019 curtailed the use of bottom-dollar payment obligations to establish economic risk of loss for a guarantor to be allocated recourse liabilities on partnership debt incurred after October 5, 2016, unless special transition rules applied. The transition rules in the 2019 regulations allowed taxpayers to continue using bottom-dollar guarantees for debt existing on October 5, 2016, to the extent the basis associated with the allocation of liabilities in connection with the bottom-dollar guarantee under the old rules protected a negative capital account prior to that date.

The transition rules were effective for only a seven-year period that ends on October 4, 2023.

Tax Implications of Transition Period Ending

Upon expiration of the seven-year transition period on October 4, 2023, any debt supported by a bottom-dollar guarantee during the transition period will no longer be adequate to support the allocation of the debt to the guarantor and the liability must be reallocated among the partners based on the rules of Section 752. If debt allocations change due to the expiration of the transition period, a partner with a negative tax capital amount no longer supported by debt may recognize gain under Section 731.

Despite the final demise of bottom-dollar guarantees, other options may be available for partners to achieve desired tax results, such as using “vertical slice guarantees,” under which a partner guarantees a percentage of each dollar of debt, and intelligently managing non-recourse liability allocations.

Planning Considerations

Partnerships should review liability allocations to ensure that tax deferrals continue as planned. The transition period under the 2019 regulations ended October 4, 2023, but there may still be time to make arrangements to preserve tax basis before the end of the partnership tax year.

Partners are required to determine the adjusted basis of their interest in a partnership only when necessary for the determination of their tax liability or that of any other person. Otherwise, the determination of the adjusted basis of a partnership interest is ordinarily made as of the end of a partnership tax year. Therefore, if a partner is not otherwise required to determine the adjusted basis of his or her partnership interest in order to determine the partner’s own tax liability or that of any other person for the period between October 4, 2023, and the end of the partnership’s tax year, the partner may have until the end of the partnership’s tax year to set in place alternative arrangements.

Partnerships must disclose bottom-dollar guarantees on Form 8275 for tax years ending on or after October 5, 2016, in which the guarantee is undertaken or modified.

2023 YEAR-END TAX PLANNING FOR INDIVIDUALS
With rising interest rates, inflation and continuing market volatility, tax planning is as essential as ever for taxpayers looking to manage cash flow while paying the least amount of taxes possible over time. As we approach year end, now is the time for individuals, business owners and family offices to review their 2023 and 2024 tax situations and identify opportunities for reducing, deferring or accelerating their tax obligations.

The information contained within this article is based on federal laws and policies in effect as of the publication date. This article discusses tax planning for federal taxes. Applicable state and foreign taxes should also be considered. Taxpayers should consult with a trusted advisor when making tax and financial decisions regarding any of the items below.

Individual Tax Planning Highlights

2023 Federal Income Tax Rate Brackets

Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 – $22,000	$0 – $11,000	$0 – $15,700	$0 – $11,000	$0 – $2,900
12%	$22,001 –  $89,450	$11,001 – $44,725	$15,701 – $59,850	$11,001 – $44,725	-
22%	$89,451 – $190,750	$44,726 – $95,375	$59,851 – $95,350	$44,726 – $95,375	-
24%	$190,751 – $364,200	$95,376 – $182,100	$95,351 – $182,100	$95,376 – $182,100	$2,901 – $10,550
32%	$364,201 – $462,500	$182,101 – $231,250	$182,101 – $231,250	$182,101 – $231,250	-
35%	$462,501 – $693,750	$231,251 – $578,125	$231,251 – $578,100	$231,251 – $346,875	$10,551 – $14,450
37%	Over $693,750	Over $578,125	Over $578,100	Over $346,875	Over $14,450

2024 Federal Income Tax Rate Brackets

Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 – $23,200	$0 – $11,600	$0 – $16,550	$0 – $11,600	$0 – $3,100
12%	$23,201 – $94,300	$11,601 – $47,150	$16,551 – 63,100	$11,601 – $47,150	-
22%	$94,301 – $201,050	$47,151 – $100,525	$63,101 – $100,500	$47,151 – $100,525	-
24%	$201,051 – $383,900	$100,526 – $191,950	$100,501 – $191,950	$100,526 – $191,950	$3,101 – $11,150
32%	$383,901 – $487,450	$191,951 – $243,725	$191,951 – $243,700	$191,951 – $243,725	-
35%	$487,451 – $731,200	$243,726 – $609,350	$243,701 – $609,350	$243,726 – $365,600	$11,151 – $15,200
37%	Over $731,200	Over $609,350	Over $609,350	Over $365,600	Over $15,200

Timing of Income and Deductions

Taxpayers should consider whether they can minimize their tax bills by shifting income or deductions between 2023 and 2024. Ideally, income should be received in the year with the lower marginal tax rate, and deductible expenses should be paid in the year with the higher marginal tax rate. If the marginal tax rate is the same in both years, deferring income from 2023 to 2024 will produce a one-year tax deferral, and accelerating deductions from 2024 to 2023 will lower the 2023 income tax liability.

Actions to consider that may result in a reduction or deferral of taxes include:

Delaying closing capital gain transactions until after year end or structuring 2023 transactions as installment sales so that gain is deferred past 2023 (also see Long Term Capital Gains, below).
• Considering whether to trigger capital losses before the end of 2023 to offset 2023 capital gains.
• Delaying interest or dividend payments from closely held corporations to individual business-owner taxpayers.
• Deferring commission income by closing sales in early 2024 instead of late 2023.
• Accelerating deductions for expenses such as mortgage interest and charitable donations (including donations of appreciated property) into 2023 (subject to AGI limitations).
• Evaluating whether non-business bad debts are worthless by the end of 2023 and should be recognized as a short-term capital loss.
• Shifting investments to municipal bonds or investments that do not pay dividends to reduce taxable income in future years.
• On the other hand, taxpayers that will be in a higher tax bracket in 2024 may want to consider potential ways to move taxable income from 2024 into 2023, such that the taxable income is taxed at a lower tax rate. Current year actions to consider that could reduce 2024 taxes include:
• Accelerating capital gains into 2023 or deferring capital losses until 2024.
• Electing out of the installment sale method for 2023 installment sales.
• Deferring deductions such as large charitable contributions to 2024.  

Long-Term Capital Gains
The long-term capital gains rates for 2023 and 2024 are shown below. The tax brackets refer to the taxpayer’s taxable income. Capital gains also may be subject to the 3.8% Net Investment Income Tax.
2023 Long-Term Capital Gains Rate Brackets

Long-Term Capital Gains Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
0%	$0 – $89,250	$0 – $44,625	$0 – $59,750	$0 – $44,625	$0 – $3,000
15%	$89,251 – $553,850	$44,626 – $492,300	$59,751 – $523,050	$44,626 – $276,900	$3,001 – $14,650
20%	Over $553,850	Over $492,300	Over $523,050	Over $276,900	Over $14,650

2024 Long-Term Capital Gains Rate Brackets

Long-Term Capital Gains Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
0%	$0 – $94,050	$0 – $47,025	$0 – $63,000	$0 – $47,025	$0 – $3,150
15%	$94,051 – $583,750	$47,026 – $518,900	$63,001 – $551,350	$47,026 – $291,850	$3,151 – $15,450
20%	Over $583,750	Over $518,900	Over $551,350	Over $291,850	Over $15,450

Long-term capital gains (and qualified dividends) are subject to a lower tax rate than other types of income. Investors should consider the following when planning for capital gains:

Holding capital assets for more than a year (more than three years for assets attributable to carried interests) so that the gain upon disposition qualifies for the lower long-term capital gains rate.
• Considering long-term deferral strategies for capital gains such as reinvesting capital gains into designated qualified opportunity zones.
• Investing in, and holding, “qualified small business stock” for at least five years.
• Donating appreciated property to a qualified charity to avoid long term capital gains tax (also see Charitable Contributions, below).

Net Investment Income Tax

An additional 3.8% net investment income tax (NIIT) applies on net investment income above certain thresholds. Net investment income does not apply to income derived in the ordinary course of a trade or business in which the taxpayer materially participates. Similarly, gain on the disposition of trade or business assets attributable to an activity in which the taxpayer materially participates is not subject to the NIIT.

In conjunction with other tax planning strategies that are being implemented to reduce income tax or capital gains tax, impacted taxpayers may want to consider deferring net investment income for the year.

Social Security Tax

The Old-Age, Survivors, and Disability Insurance (OASDI) program is funded by contributions from employees and employers through FICA tax. The FICA tax rate for both employees and employers is 6.2% of the employee's gross pay, but only on wages up to $160,200 for 2023 and $168,600 for 2024. Self-employed persons pay a similar tax, called SECA (or self-employment tax), based on 12.4% of the net income of their businesses.

Employers, employees, and self-employed persons also pay a tax for Medicare/Medicaid hospitalization insurance (HI), which is part of the FICA tax, but is not capped by the OASDI wage base. The HI payroll tax is 2.9%, which applies to earned income only. Self-employed persons pay the full amount, while employers and employees each pay 1.45%. An extra 0.9% Medicare (HI) payroll tax must be paid by individual taxpayers on earned income that is above certain adjusted gross income (AGI) thresholds, i.e., $200,000 for individuals, $250,000 for married couples filing jointly and $125,000 for married couples filing separately. However, employers do not pay this extra tax.

Long-Term Care Insurance and Services
Premiums an individual pays on a qualified long-term care insurance policy are deductible as a medical expense. The maximum deduction amount is determined by an individual’s age. The following table sets forth the deductible limits for 2023 and the estimated deductible limits for 2024 (the limitations are per person, not per return):

Age	Deduction Limitation 2023	Deduction Limitation 2024
40 or under	$480	$470
Over 40 but not over 50	$890	$880
Over 50 but not over 60	$1,790	$1,760
Over 60 but not over 70	$4,770	$4,710
Over 70	$5,960	$5,880

Retirement Plan Contributions
Individuals may want to maximize their annual contributions to qualified retirement plans and Individual Retirement Accounts (IRAs).  

The maximum amount of elective contributions that an employee can make in 2023 to a 401(k) or 403(b) plan is $22,500 ($30,000 if age 50 or over and the plan allows “catch up” contributions). For 2024, these limits are $23,000 and $30,500, respectively.
• The SECURE Act permits a penalty-free withdrawal of up to $5,000 from traditional IRAs and qualified retirement plans for qualifying expenses related to the birth or adoption of a child after December 31, 2019. The $5,000 distribution limit is per individual, so a married couple could each receive $5,000.
• Under the SECURE Act, individuals are now able to contribute to their traditional IRAs in or after the year in which they turn 70½.
• Beginning in 2023, the SECURE Act 2.0 raised the age that a taxpayer must begin taking required minimum distributions (RMDs) to age 73. If the individual reaches age 72 in 2023, the required beginning date for the first RMD is April 1, 2025, for 2024. If the taxpayer reaches age 73 in 2023, the taxpayer was 72 in 2022 and subject to the age 72 RMD rule in effect for 2022. If the taxpayer reached age 72 in 2022, the first RMD was due April 1, 2023, and the second RMD is due December 31, 2023.
• Individuals age 70½ or older can donate up to $100,000 to a qualified charity directly from a taxable IRA.
• The SECURE Act generally requires that designated beneficiaries of persons who died after December 31, 2019, take inherited plan benefits over a 10-year period. Eligible designated beneficiaries (i.e., surviving spouses, minor children of the plan participant, disabled and chronically ill beneficiaries and beneficiaries who are less than 10 years younger than the plan participant) are not limited to the 10-year payout rule. Special rules apply to certain trusts.
• Under proposed Treasury Regulations (issued February 2022) that address required minimum distributions from inherited retirement plans of persons who died after December 31, 2019, and after their required beginning date, designated and non-designated beneficiaries will be required to take annual distributions, whether subject to a ten-year period or otherwise.
• Small businesses can contribute the lesser of (i) 25% of employees’ salaries or (ii) an annual maximum set by the IRS each year to a Simplified Employee Pension (SEP) plan by the extended due date of the employer’s federal income tax return for the year that the contribution is made. The maximum SEP contribution for 2023 is $66,000. The maximum SEP contribution for 2024 is $69,000. The calculation of the 25% limit for self-employed individuals is based on net self-employment income, which is calculated after the reduction in income from the SEP contribution (as well as for other things, such as self-employment taxes).

Foreign Earned Income Exclusion
The foreign earned income exclusion is $120,000 in 2023 and increases to $126,500 in 2024.

Alternative Minimum Tax
A taxpayer must pay either the regular income tax or the alternative minimum tax (AMT), whichever is higher. The established AMT exemption amounts for 2023 are $81,300 for unmarried individuals and individuals claiming head of household status, $126,500 for married individuals filing jointly and surviving spouses, $63,250 for married individuals filing separately and $28,400 for estates and trusts. The AMT exemption amounts for 2024 are $85,700 for unmarried individuals and individuals claiming head of household status, $133,300 for married individuals filing jointly and surviving spouses, $66,650 for married individuals filing separately and $29,900 for estates and trusts.

Kiddie Tax
The unearned income of a child is taxed at the parents’ tax rates if those rates are higher than the child’s tax rate.

Limitation on Deductions of State and Local Taxes (SALT Limitation)

For individual taxpayers who itemize their deductions, the Tax Cuts and Jobs Act introduced a $10,000 limit on deductions of state and local taxes paid during the year ($5,000 for married individuals filing separately). The limitation applies to taxable years beginning on or after December 31, 2017, and before January 1, 2026. Various states have enacted new rules that allow owners of pass-through entities to avoid the SALT deduction limitation in certain cases.

Charitable Contributions
Cash contributions made to qualifying charitable organizations, including donor advised funds, in 2023 and 2024 will be subject to a 60% AGI limitation. The limitations for cash contributions continue to be 30% of AGI for contributions to non-operating private foundations. Tax planning around charitable contributions may include:

Creating and funding a private foundation, donor advised fund or charitable remainder trust.
• Donating appreciated property to a qualified charity to avoid long term capital gains tax.

Estate and Gift Taxes
For gifts made in 2023, the gift tax annual exclusion is $17,000 and for 2024 is $18,000. For 2023, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $12,920,000 per person. For 2024, the unified estate and gift tax exemption and generation-skipping transfer tax exemption is $13,610,000. All outright gifts to a spouse who is a U.S. citizen are free of federal gift tax. However, for 2023 and 2024, only the first $175,000 and $185,000, respectively, of gifts to a non-U.S. citizen spouse is excluded from the total amount of taxable gifts for the year. Tax planning strategies may include:

Making annual exclusion gifts.
• Making larger gifts to the next generation, either outright or in trust.
• Creating a Spousal Lifetime Access Trust (SLAT) or a Grantor Retained Annuity Trust (GRAT) or selling assets to an Intentionally Defective Grantor Trust (IDGT).

Net Operating Losses and Excess Business Loss Limitation

Net operating losses (NOLs) generated in 2023 are limited to 80% of taxable income and are not permitted to be carried back. Any unused NOLs are carried forward subject to the 80% of taxable income limitation in carryforward years.

A non-corporate taxpayer may deduct net business losses of up to $289,000 ($578,000 for joint filers) in 2023. The limitation is $305,000 ($610,000 for joint filers) for 2024. A disallowed excess business loss (EBL) is treated as an NOL carryforward in the subsequent year, subject to the NOL rules. With the passage of the Inflation Reduction Act, the EBL limitation has been extended through the end of 2028.

2021 Year-End Tax Planning for Businesses

As the U.S. entered 2021, many assumed that newly elected President Joe Biden along with Democratic majorities in the House and Senate would swiftly enact tax increases on both corporations and individuals to pay for the cost of proposed new infrastructure and social spending plans, potentially using the budget reconciliation process to do so. Since then, various versions of tax and spending measures have been negotiated and debated by members of Congress and the White House. As 2021 heads to a close, tax increases are still expected, but the timing and content of final changes are still not certain.
 
On November 5, 2021, the U.S. House of Representatives delayed voting on its version of the Build Back Better Act (H.R. 5376), a package of social spending measures funded by tax increases. The delay allows members more time to review the budget impact of the provisions in the bill. Some of the legislation’s major tax proposals, which mainly target large profitable corporations and high-income individuals, include:

A 15% corporate alternative minimum tax on companies that report financial statement profits of over $1 billion.
• A 1% surtax on corporate stock buybacks.
• A 15% country-by-country minimum tax on foreign profits of U.S. corporations.
• A 5% surtax on individual incomes over $10 million, an additional 3% surtax on incomes over $25 million and expansion of the 3.8% Net Investment Income Tax.

At the time of writing, the House had not yet voted on the Build Back Better Act. Once the House votes, the legislation will be taken up by the Senate. If enacted in its current form, the legislation would generally be effective for taxable years beginning after December 31, 2021; however, many of the corporate and international proposals affecting businesses would apply for taxable years beginning after December 31, 2022 – i.e., they would be deferred for one year.

The information contained in this article is based on tax proposals as of November 4, 2021 and is subject to change based on final legislation. Businesses should continue to track the latest tax proposals to understand the impacts of possible new legislation, particularly when engaging in tax planning. Despite the delays and uncertainty around exactly what tax changes final legislation will contain, there are actions that businesses can consider taking to minimize their tax liabilities.

Consider tax accounting method changes and strategic tax elections
The 2017 Tax Cuts and Jobs Act (TCJA) lowered the regular corporate tax rate to 21% and eliminated the corporate alternative minimum tax beginning in 2018. The current version of the proposed Build Back Better Act would leave the 21% regular corporate tax rate unchanged but, beginning in 2023, would create a new 15% corporate alternative minimum tax on the adjusted financial statement income of corporations with such income over $1 billion. Companies with adjusted financial statement income over $1 billion, therefore, should take into account the proposed 15% corporate alternative minimum tax when considering 2021 tax planning actions that could affect future years.

Companies that want to reduce their 2021 tax liability should consider traditional tax accounting method changes, tax elections and other actions for 2021 to defer recognizing income to a later taxable year and accelerate tax deductions to an earlier taxable year, including the following:

Changing from recognizing certain advance payments (e.g., upfront payments for goods, services, gift cards, use of intellectual property, sale or license of software) in the year of receipt to recognizing a portion in the following taxable year.
• Changing from the overall accrual to the overall cash method of accounting.
• Changing from capitalizing certain prepaid expenses (e.g., insurance premiums, warranty service contracts, taxes, government permits and licenses, software maintenance) to deducting when paid using the “12-month rule.”
• Deducting eligible accrued compensation liabilities (such as bonuses and severance payments) that are paid within 2.5 months of year end.
• Accelerating deductions of liabilities such as warranty costs, rebates, allowances and product returns under the “recurring item exception.”
• Purchasing qualifying property and equipment before the end of 2021 to take advantage of the 100% bonus depreciation provisions and the Section 179 expensing rules.
• Deducting “catch-up” depreciation (including bonus depreciation, if applicable) by changing to shorter recovery periods or changing from non-depreciable to depreciable.
• Optimizing the amount of uniform capitalization costs capitalized to ending inventory, including changing to simplified methods available under Section 263A.
• Electing to fully deduct (rather than capitalize and amortize) qualifying research and experimental (R&E) expenses attributable to new R&E programs or projects that began in 2021. Similar planning may apply to the deductibility of software development costs attributable to new software projects that began in 2021. (Note that capitalization and amortization of R&E expenditures is required beginning in 2022, although the proposed Build Back Better Act would delay the effective date until after 2025).
• Electing to write-off 70% of success-based fees paid or incurred in 2021 in connection with certain acquisitive transactions under Rev. Proc. 2011-29.
• Electing the de minimis safe harbor to deduct small-dollar expenses for the acquisition or production of property that would otherwise be capitalizable under general rules.

Is “reverse” planning better for your situation?

Depending on their facts and circumstances, some businesses may instead want to accelerate taxable income into 2021 if, for example, they believe tax rates will increase in the near future or they want to optimize usage of NOLs. These businesses may want to consider “reverse” planning strategies, such as:

Implementing a variety of “reverse” tax accounting method changes.
• Selling and leasing back appreciated property before the end of 2021, creating gain that is taxed currently offset by future deductions of lease expense, being careful that the transaction is not recharacterized as a financing transaction.
• Accelerating taxable capital gain into 2021. 
• Electing out of the installment sale method for installment sales closing in 2021.
• Delaying payments of liabilities whose deduction is based on when the amount is paid, so that the payment is deductible in 2022 (e.g., paying year-end bonuses after the 2.5-month rule).

Tax accounting method changes – is a Form 3115 required and when? Some of the opportunities listed above for changing the timing of income recognition and deductions require taxpayers to submit a request to change their method of tax accounting for the particular item of income or expense. Generally, tax accounting method change requests require taxpayers to file a Form 3115, Application for Change in Accounting Method, with the IRS under one of the following two procedures: The “automatic” change procedure, which requires the taxpayer to attach the Form 3115 to the timely filed (including extensions) federal tax return for the year of change and to file a separate copy of the Form 3115 with the IRS no later than the filing date of that return; or The “nonautomatic” change procedure, which applies when a change is not listed as automatic and requires the Form 3115 (including a more robust discussion of the legal authorities than an automatic Form 3115 would include) to be filed with the IRS National Office during the year of change along with an IRS user fee. Calendar year taxpayers that want to make a nonautomatic change for the 2021 taxable year should be cognizant of the accelerated December 31, 2021 due date for filing Form Only certain changes may be implemented without a Form 3115.

Write-off bad debts and worthless stock

Given the economic challenges brought on by the COVID-19 pandemic, businesses should evaluate whether losses may be claimed on their 2021 returns related to worthless assets such as receivables, property, 80% owned subsidiaries or other investments.

Bad debts can be wholly or partially written off for tax purposes. A partial write-off requires a conforming reduction of the debt on the books of the taxpayer; a complete write-off requires demonstration that the debt is wholly uncollectible as of the end of the year.
• Losses related to worthless, damaged or abandoned property can generate ordinary losses for specific assets.
• Businesses should consider claiming losses for investments in insolvent subsidiaries that are at least 80% owned and for certain investments in insolvent entities taxed as partnerships (also see Partnerships and S corporations, below).
• Certain losses attributable to COVID-19 may be eligible for an election under Section 165(i) to be claimed on the preceding taxable year’s return, possibly reducing income and tax in the earlier year or creating an NOL that may be carried back to a year with a higher tax rate.

Maximize interest expense deductions
The TCJA significantly expanded Section 163(j) to impose a limitation on business interest expense of many taxpayers, with exceptions for small businesses (those with three-year average annual gross receipts not exceeding $26 million ($27 million for 2022), electing real property trades or businesses, electing farming businesses and certain utilities. 

The deduction limit is based on 30% of adjusted taxable income. The amount of interest expense that exceeds the limitation is carried over indefinitely.
• Beginning with 2022 taxable years, taxpayers will no longer be permitted to add back deductions for depreciation, amortization and depletion in arriving at adjusted taxable income (the principal component of the limitation).
• The Build Back Better Act proposes to modify the rules with respect to business interest expense paid or incurred by partnerships and S corporations (see Partnerships and S corporations, below).

Maximize tax benefits of NOLs
Net operating losses (NOLs) are valuable assets that can reduce taxes owed during profitable years, thus generating a positive cash flow impact for taxpayers. Businesses should make sure they maximize the tax benefits of their NOLs.

Make sure the business has filed carryback claims for all permitted NOL carrybacks. The CARES Act allows taxpayers with losses to carry those losses back up to five years when the tax rates were higher. Taxpayers can still file for “tentative” refunds of NOLs originating in 2020 within 12 months from the end of the taxable year (by December 31, 2021 for calendar year filers) and can file refund claims for 2018 or 2019 NOL carrybacks on timely filed amended returns.
• Corporations should monitor their equity movements to avoid a Section 382 ownership change that could limit annual NOL deductions.
• Losses of pass-throughs entities must meet certain requirements to be deductible at the partner or S corporation owner level (see Partnerships and S corporations, below).

Defer tax on capital gains
Tax planning for capital gains should consider not only current and future tax rates, but also the potential deferral period, short and long-term cash needs, possible alternative uses of funds and other factors.

Noncorporate shareholders are eligible for exclusion of gain on dispositions of Qualified Small Business Stock (QSBS). The Build Back Better Act would limit the gain exclusion to 50% for sales or exchanges of QSBS occurring after September 13, 2021 for high-income individuals, subject to a binding contract exception. For other sales, businesses should consider potential long-term deferral strategies, including:

Reinvesting capital gains in Qualified Opportunity Zones.
• Reinvesting proceeds from sales of real property in other “like-kind” real property.
• Selling shares of a privately held company to an Employee Stock Ownership Plan.
• Businesses engaging in reverse planning strategies (see Is “reverse” planning better for your situation?  above) may instead want to move capital gain income into 2021 by accelerating transactions (if feasible) or, for installment sales, electing out of the installment method.

Claim available tax credits
The U.S. offers a variety of tax credits and other incentives to encourage employment and investment, often in targeted industries or areas such as innovation and technology, renewable energy and low-income or distressed communities. Many states and localities also offer tax incentives. Businesses should make sure they are claiming all available tax credits for 2021 and begin exploring new tax credit opportunities for 2022.

The Employee Retention Credit (ERC) is a refundable payroll tax credit for qualifying employers that have been significantly impacted by COVID-19. Employers that received a Paycheck Protection Program (PPP) loan can claim the ERC but the same wages cannot be used for both programs. The Infrastructure Investment and Jobs Act signed by President Biden on November 15, 2021, retroactively ends the ERC on September 30, 2021, for most employers.
• Businesses that incur expenses related to qualified research and development (R&D) activities are eligible for the federal R&D credit.
• Taxpayers that reinvest capital gains in Qualified Opportunity Zones may be able to defer the federal tax due on the capital gains. An additional 10% gain exclusion also may apply if the investment is made by December 31, 2021. The investment must be made within a certain period after the disposition giving rise to the gain.
• The New Markets Tax Credit Program provides federally funded tax credits for approved investments in low-income communities that are made through certified “Community Development Entities.”
• Other incentives for employers include the Work Opportunity Tax Credit, the Federal Empowerment Zone Credit, the Indian Employment Credit and credits for paid family and medical leave (FMLA).
• There are several federal tax benefits available for investments to promote energy efficiency and sustainability initiatives. In addition, the Build Back Better Act proposes to extend and enhance certain green energy credits as well as introduce a variety of new incentives. The proposals also would introduce the ability for taxpayers to elect cash payments in lieu of certain credits and impose prevailing wage and apprenticeship requirements in the determination of certain credit amounts.

Partnerships and S corporations
The Build Back Better Act contains various tax proposals that would affect partnerships, S corporations and their owners. Planning opportunities and other considerations for these taxpayers include the following:

Taxpayers with unused passive activity losses attributable to partnership or S corporation interests may want to consider disposing of the interest to utilize the loss in 2021.
• Taxpayers other than corporations may be entitled to a deduction of up to 20% of their qualified business income (within certain limitations based on the taxpayer’s taxable income, whether the taxpayer is engaged in a service-type trade or business, the amount of W-2 wages paid by the business and the unadjusted basis of certain property held by the business). Planning opportunities may be available to maximize this deduction.
• Certain requirements must be met for losses of pass-through entities to be deductible by a partner or S corporation shareholder. In addition, an individual’s excess business losses are subject to overall limitations. There may be steps that pass-through owners can take before the end of 2021 to maximize their loss deductions. The Build Back Better Act would make the excess business loss limitation permanent (the limitation is currently scheduled to expire for taxable years beginning on or after January 1, 2026) and change the manner in which the carryover of excess business losses may be used in subsequent years.
• Under current rules, the abandonment or worthlessness of a partnership interest may generate an ordinary deduction (instead of a capital loss) in cases where no partnership liabilities are allocated to the interest. Under the Build Back Better Act, the abandonment or worthlessness of a partnership interest would generate a capital loss regardless of partnership liability allocations, effective for taxable years beginning after December 31, 2021. Taxpayers should consider an abandonment of a partnership interest in 2021 to be able to claim an ordinary deduction.
• Following enactment of the TCJA, deductibility of expenses incurred by investment funds are treated as “investment expenses”—and therefore are limited at the individual investor level— if the fund does not operate an active trade or business (i.e., if the fund’s only activities are investment activities). To avoid the investment expense limitation, consideration should be given as to whether a particular fund’s activities are so closely connected to the operations of its portfolio companies that the fund itself should be viewed as operating an active trade or business.
• Under current rules, gains allocated to carried interests in investment funds are treated as long-term capital gains only if the investment property has been held for more than three years. Investment funds should consider holding the property for more than three years prior to sale to qualify for reduced long-term capital gains rates. Although the Build Back Better Act currently does not propose changes to the carried interest rules, an earlier draft of the bill would have extended the current three-year property holding period to five years. Additionally, there are multiple bills in the Senate that, if enacted, would seek to tax all carry allocations at ordinary income rates.
• Under the Build Back Better Act, essentially all pass-through income of high-income owners that is not subject to self-employment tax would be subject to the 3.8% Net Investment Income Tax (NIIT). This means that pass-through income and gains on sales of assets allocable to partnership and S corporation owners would incur NIIT, even if the owner actively participates in the business. Additionally, taxpayers that currently utilize a state law limited partnership to avoid self-employment taxes on the distributive shares of active “limited partners” would instead be subject to the 3.8% NIIT. If enacted, this proposal would be effective for taxable years beginning after December 31, 2021. Taxpayers should consider accelerating income and planned dispositions of business assets into 2021 to avoid the possible additional tax.
• The Build Back Better Act proposes to modify the rules with respect to business interest expense incurred by partnerships and S corporations effective for taxable years beginning after December 31, 2022. Under the proposed bill, the Section 163(j) limitation with respect to business interest expense would be applied at the partner and S corporation shareholder level. Currently, the business interest expense limitation is applied at the entity level (also see Maximize interest expense deductions, above).
• Various states have enacted PTE tax elections that seek a workaround to the federal personal income tax limitation on the deduction of state taxes for individual owners of pass-through entities. See State pass-through entity tax elections, below.

Planning for international operations
The Build Back Better Act proposes substantial changes to the existing U.S. international taxation of non-U.S. income beginning as early as 2022. These changes include, but are not limited to, the following:

Imposing additional interest expense limitations on international financial reporting groups.
• Modifying the rules for global intangible low-taxed income (GILTI), including calculating GILTI and the corresponding foreign tax credits (FTCs) on a country-by-country basis, allowing country specific NOL carryforwards for one taxable year and reducing the QBAI reduction to 5%.
• Modifying the existing FTC rules for all remaining categories to be calculated on a country-by-country basis.
• Modifying the rules for Subpart F, foreign derived intangible income (FDII) and the base erosion anti-abuse tax (BEAT).
• Imposing new limits on the applicability of the Section 245A dividends received deduction (DRD) by removing the application of the DRD rules to non-controlled foreign corporations (CFCs).
• Modifying the rules under Section 250 to remove the taxable income limitation as well as reduce the GILTI and FDII deductions to 28.5% and 24.8%, respectively.

Businesses with international operations should gain an understanding of the impacts of these proposals on their tax profile by modeling the potential changes and considering opportunities to utilize the favorable aspects of the existing cross-border rules to mitigate the detrimental impacts, including:

Considering mechanisms/methods to accelerate foreign source income (e.g., prepaying royalties) and associated foreign income taxes to maximize use of the existing FTC regime and increase current FDII benefits.
• Optimizing offshore repatriation and associated offshore treasury aspects while minimizing repatriation costs (e.g., previously taxed earnings and profits and basis amounts, withholding taxes, local reserve restrictions, Sections 965 and 245A, etc.).
• Accelerating dividends from non-CFC 10% owned foreign corporations to maximize use of the 100% DRD currently available.
• Utilizing asset step-up planning in low-taxed CFCs to utilize existing current year excess FTCs in the GILTI category for other CFCs in different jurisdictions.
• Considering legal entity restructuring to maximize the use of foreign taxes paid in jurisdictions with less than a 16% current tax rate to maximize the GILTI FTC profile of the company.
• If currently in NOLs, considering methods to defer income or accelerate deductions to minimize detrimental impacts of existing Section 250 deduction taxable income limitations in favor of the proposed changes that will allow a full Section 250 deduction without a taxable income limitation.
• In combination with the OECD Pillar One/Two advancements coupled with U.S. tax legislation, reviewing the transfer pricing and value chain structure of the organization to consider ways to adapt to such changes and minimize the future effective tax rate of the organization.

Review transfer pricing compliance
Businesses with international operations should review their cross-border transactions among affiliates for compliance with relevant country transfer pricing rules and documentation requirements. They should also ensure that actual intercompany transactions and prices are consistent with internal transfer pricing policies and intercompany agreements, as well as make sure the transactions are properly reflected in each party’s books and records and year-end tax calculations. Businesses should be able to demonstrate to tax authorities that transactions are priced on an arm’s-length basis and that the pricing is properly supported and documented. Penalties may be imposed for non-compliance. Areas to consider include:

Have changes in business models, supply chains or profitability (including changes due to the effects of COVID-19) affected arm’s length transfer pricing outcomes and support? These changes and their effects should be supported before year end and documented contemporaneously.
• Have all cross-border transactions been identified, priced and properly documented, including transactions resulting from merger and acquisition activities (as well as internal reorganizations)?
• Do you know which entity owns intellectual property (IP), where it is located and who is benefitting from it? Businesses must evaluate their IP assets — both self-developed and acquired through transactions — to ensure compliance with local country transfer pricing rules and to optimize IP management strategies.
• If transfer pricing adjustments need to be made, they should be done before year end, and for any intercompany transactions involving the sale of tangible goods, coordinated with customs valuations.
• Multinational businesses should begin to monitor and model the potential effects of the recent agreement among OECD countries on a two pillar framework that addresses distribution of profits among countries and imposes a 15% global minimum tax.

Considerations for employers
Employers should consider the following issues as they close out 2021 and head into 2022:

Employers have until the extended due date of their 2021 federal income tax return to retroactively establish a qualified retirement plan and fund the plan for 2021.
• Contributions made to a qualified retirement plan by the extended due date of the 2021 federal income tax return may be deductible for 2021; contributions made after this date are deductible for 2022.
• The amount of any PPP loan forgiveness is excluded from the federal gross income of the business, and qualifying expenses for which the loan proceeds were received are deductible.
• The CARES Act permitted employers to defer payment of the employer portion of Social Security (6.2%) payroll tax liabilities that would have been due from March 27 through December 31, 2020. Employers are reminded that half of the deferred amount must be paid by December 31, 2021 (the other half must be paid by December 31, 2022). Notice CP256-V is not required to make the required payment.
• Employers should ensure that common fringe benefits are properly included in employees’ and, if applicable, 2% S corporation shareholders’ taxable wages. Partners should not be issued W-2s.
• Publicly traded corporations may not deduct compensation of “covered employees” — CEO, CFO and generally the three next highest compensated executive officers — that exceeds $1 million per year. Effective for taxable years beginning after December 31, 2026, the American Rescue Plan Act of 2021 expands covered employees to include five highest paid employees. Unlike the current rules, these five additional employees are not required to be officers. 
• Generally, for calendar year accrual basis taxpayers, accrued bonuses must be fixed and determinable by year end and paid within 2.5 months of year end (by March 15, 2022) for the bonus to be deductible in 2021. However, the bonus compensation must be paid before the end of 2021 if it is paid by a Personal Service Corporation to an employee-owner, by an S corporation to any employee-shareholder, or by a C corporation to a direct or indirect majority owner.
• Businesses should assess the tax impacts of their mobile workforce. Potential impacts include the establishment of a corporate tax presence in the state or foreign country where the employee works; dual tax residency for the employee; and payroll tax, benefits, and transfer pricing issues.

State and local taxes
Businesses should monitor the tax rules in the states in which they operate or make sales. Taxpayers that cross state borders—even virtually—should review state nexus and other policies to understand their compliance obligations, identify ways to minimize their state tax liabilities and eliminate any state tax exposure. The following are some of the state-specific areas taxpayers should consider when planning for their tax liabilities in 2021 and 2022:

Does the state conform to federal tax rules (including recent federal legislation) or decouple from them? Not all states follow federal tax rules. (Note that states do not necessarily follow the federal treatment of PPP loans. See Considerations for employers, above.)
• Has the business claimed all state NOL and state tax credit carrybacks and carryforwards? Most states apply their own NOL/credit computation and carryback/forward provisions. Has the business considered how these differ from federal and the effect on its state taxable income and deductions?
• Has the business amended any federal returns? Businesses should make sure state amended returns are filed on a timely basis to report the federal changes. If a federal amended return is filed, amended state returns may still be required even there is no change to state taxable income or deductions.
• Has a state adopted economic nexus for income tax purposes, enacted NOL deduction suspensions or limitations, increased rates or suspended or eliminated some tax credit and incentive programs to deal with lack of revenues due to COVID-19 economic issues?
• The majority of states now impose single-sales factor apportionment formulas and require market-based sourcing for sales of services and licenses/sales of intangibles using disparate sourcing methodologies. Has the business recently examined whether its multistate apportionment of income is consistent with or the effect of this trend?
• Consider the state and local tax treatment of merger, acquisition and disposition transactions, and do not forget that internal reorganizations of existing structures also have state tax impacts. There are many state-specific considerations when analyzing the tax effects of transactions.
• Is the business claiming all available state and local tax credits, e.g., for research activities, employment or investment?
• For businesses selling remotely and that have been protected by P.L. 86-272 from state income taxes in the past, how is the business responding to changing state interpretations of those protections with respect to businesses engaged in internet-based activities?
• Has the business considered the state tax impacts of its mobile workforce? Most states that provided temporary nexus and/or withholding relief relating to teleworking employees lifted those orders during 2021 (also see Considerations for employers, above).
• Has the state introduced (or is it considering introducing) a tax on digital services? The definition of digital services can potentially be very broad and fact specific. Taxpayers should understand the various state proposals and plan for potential impacts.
• Remote retailers, marketplace sellers and marketplace facilitators (i.e., marketplace providers) should be sure they are in compliance with state sales and use tax laws and marketplace facilitator rules.
• Assessed property tax values typically lag behind market values. Consider challenging your property tax assessment.

State pass-through entity elections
The TCJA introduced a $10,000 limit for individuals with respect to federal itemized deductions for state and local taxes paid during the year ($5,000 for married individuals filing separately). At least 20 states have enacted potential workarounds to this deduction limitation for owners of pass-through entities, by allowing a pass-through entity to make an election (PTE tax election) to be taxed at the entity level. PTE tax elections present state and federal tax issues for partners and shareholders. Before making an election, care needs to be exercised to avoid state tax traps, especially for nonresident owners, that could exceed any federal tax savings. (Note that the Build Back Better Act proposes to increase the state and local tax deduction limitation for individuals to $80,000 ($40,000 for married individuals filing separately) retroactive to taxable years beginning after December 31, 2020. In addition, the Senate has begun working on a proposal that would completely lift the deduction cap subject to income limitations.)

Accounting for income taxes – ASC 740 considerations
The financial year-end close can present unique and challenging issues for tax departments. Further complicating matters is pending U.S. tax legislation that, if enacted by the end of the calendar year, will need to be accounted for in 2021. To avoid surprises, tax professionals can begin now to prepare for the year-end close:

Evaluate the effectiveness of year-end tax accounting close processes and consider modifications to processes that are not ideal. Update work programs and train personnel, making sure all team members understand roles, responsibilities, deliverables and expected timing. Communication is especially critical in a virtual close.
• Know where there is pending tax legislation and be prepared to account for the tax effects of legislation that is “enacted” before year end. Whether legislation is considered enacted for purposes of ASC 740 depends on the legislative process in the particular jurisdiction.
• Document whether and to what extent a valuation allowance should be recorded against deferred tax assets in accordance with ASC 740. Depending on the company’s situation, this process can be complex and time consuming and may require scheduling deferred tax assets and liabilities, preparing estimates of future taxable income and evaluating available tax planning strategies.
• Determine and document the tax accounting effects of business combinations, dispositions and other unique transactions.
• Review the intra-period tax allocation rules to ensure that income tax expense/(benefit) is correctly recorded in the financial statements. Depending on a company’s activities, income tax expense/(benefit) could be recorded in continuing operations as well as other areas of the financial statements.
• Evaluate existing and new uncertain tax positions and update supporting documentation.
• Make sure tax account reconciliations are current and provide sufficient detail to prove the year-over-year change in tax account balances.
• Understand required tax footnote disclosures and build the preparation of relevant documentation and schedules into the year-end close process.

Begin Planning for the Future
Future tax planning will depend on final passage of the proposed Build Back Better Act and precisely what tax changes the final legislation contains. Regardless of legislation, businesses should consider actions that will put them on the best path forward for 2022 and beyond. Business can begin now to:

Reevaluate choice of entity decisions while considering alternative legal entity structures to minimize total tax liability and enterprise risk.
• Evaluate global value chain and cross-border transactions to optimize transfer pricing and minimize global tax liabilities.
• Review available tax credits and incentives for relevancy to leverage within applicable business lines.
• Consider the benefits of an ESOP as an exit or liquidity strategy, which can provide tax benefits for both owners and the company.
• Perform a cost segregation study with respect to investments in buildings or renovation of real property to accelerate taxable deductions, and identify other discretionary incentives to reduce or defer various taxes.
• Perform a state-by-state analysis to ensure the business is properly charging sales taxes on taxable items, but not exempt or non-taxable items, and to determine whether the business needs to self-remit use taxes on any taxable purchases (including digital products or services).
• Evaluate possible co-sourcing or outsourcing arrangements to assist with priority projects as part of an overall tax function transformation.

Need Help?

If you think your business can benefit or is interested in any of the above Year-End Planning for Businesses opportunities, BOOS & ASSOCIATES is here to help! To inquire more information please email us at askboos@booscpa.com.

Tax Rate	Joint/Surviving Spouse	Single	Head of Household	Married Filing Separately	Estates & Trusts
10%	$0 - $20,550	$0 - $10,275	$0 - $14,650	$0 - $10,275	$0 - $2,750
12%	$20,551 -    $83,550	$10,276 - $41,775	$14,651 - $55,900	$10,276 -  $41,775	-
22%	$83,551 - $178,150	$41,776 - $89,075	$55,901 - $89,050	$41,776 - $89,075	-
24%	$178,151 - $340,100	$89,076 - $170,050	$89,051 - $170,050	$89,076 - $170,050	$2,751 - $9,850
32%	$340,101 - $431,900	$170,051 - $215,950	$170,051 - $215,950	$170,051 - $215,950	-
35%	$431,901 - $647,850	$215,951 - $539,900	$215,951 - $539,900	$215,951 - $323,925	$9,851 - $13,450
37%	Over $647,850	Over $539,900	Over $539,900	Over $323,925	Over $13,450

The draft Build Back Better Act released on November 3, 2021 would impose a 5% surcharge on modified adjusted gross income that exceeds $5 million for married individuals filing separately, $200,000 for estates and trusts and $10 million for all other individuals. An additional 3% surcharge would be imposed on modified adjusted gross income in excess of $12.5 million for married individuals filing separately, $500,000 for estates and trusts and $25 million for all other individuals. The proposal would be effective for taxable years beginning after December 31, 2021 (i.e., beginning in 2022).

Current Opportunity

Let’s talk about the Work Opportunity Tax Credit (WOTC). This is a Federal Tax Credit available to employers for hiring individuals from certain targeted groups who have consistently faced significant barriers to employment. Currently, the WOTC can range between $1,200 and $9,600 (or more under certain circumstances) per qualified employee and the credit is available to all companies regardless of business location.

On August 10, 2021, the Department of the Treasury, and the Internal Revenue Service (IRS) issued Notice 2021-43. This notice provides transition relief by extending the 28-day deadline for employers hiring individuals who are Designated Community Residents or Qualified Summer Youth Employees who begin work on or after January 1, 2021, and before October 9, 2021, to submit a completed Form 8850 to the designated local agency (DLA) no later than November 8, 2021.

This means your business can now retroactively qualify employees that are a member of the designated community resident targeted group or the qualified summer youth employee targeted group who begin work on or after the beginning of the year until now.

Designated Community Resident (DCR)

• An Empowerment zone
• An Enterprise community
• A Renewal community

AND continues to reside at the locations after employment.

Summer Youth Employee

A “qualified summer youth employee” is one who:

Is at least 16 years old, but under 18 on the date of hire or on May 1, whichever is later, AND is only employed between May 1 and September 15 (was not employed prior to May 1st) AND resides in an Empowerment Zone (EZ), enterprise community or renewal community.

The opportunity to retroactively qualify employees ends November 8, 2021. If your business has not taken advantage of the WOTC and would like to start, now is the time. Get caught up today and let our team of experts assist you in claiming this potentially significant tax credit opportunity.

Future Opportunity

After you take advantage of this current opportunity, our team at Boos & Associates will help you make sure your business continues to claim the WOTC. After November 8, 2021, businesses will only have a 28-day window to submit a completed Form 8850 to the designated local agency after a new hire’s start date. Our team will work closely with your management group to make sure that as your business expands with every new hire, we proactively assist you in determining whether the new hire qualifies you to receive the WOTC.

Note: the Consolidated Appropriation Act, 2021 (Section 113 of Division EE P.L. 116-260) authorized the extension of the WOTC until December 31, 2025.

Additionally, on September 12, 2021, the Congressional Committee released some of its proposed legislative language that is to be included in Biden’s “Build Back Better Act,” a $3.5 trillion reconciliation bill. Among many of the proposals is Section 138513 “Enhancement of Work Opportunity Credit During COVID-19 Recovery Period.” This proposal would:

1) eliminate the restriction against claiming the WOTC for rehired employees,
2) increase the amount of tax credit from 40% of $6,000 in qualified wages to 50% of $10,000, and
3) provide a similar credit for the second year of employment of qualified employees

This bill has not yet been signed into law; however, stay tuned as we are focused on and current with opportunities coming out of Washington.

Need Help?

If you think your business can benefit from the WOTC, please contact us:askboos@booscpa.com.

Expansion of the Employee Retention Credit

The Consolidated Appropriations Act of 2021 (Act), signed into law on December 27, 2020, contains significant enhancements and improvements to the Employee Retention Credit (ERC).  The ERC, which was created by the CARES Act on March 27, 2020, is designed to encourage employers (including tax-exempt entities) to keep employees on their payroll and continue providing health benefits during the coronavirus pandemic. The ERC is a refundable payroll tax credit for wages paid and health coverage provided by an employer whose operations were either fully or partially suspended due to a COVID-19-related governmental order or that experienced a significant reduction in gross receipts.

Employers may use ERCs to offset federal payroll tax deposits, including the employee FICA and income tax withholding components of the employer’s federal payroll tax deposits.

ERC for 2020
The Act makes the following retroactive changes to the ERC, which apply during the period March 13, 2020 through December 31, 2020:

Group health care expenses are considered “qualified wages” even when no other wages are paid to the employee.

 
Insights

 
ERC for 2021 (January 1 – June 30, 2021)
In addition to the retroactive changes listed above, the following changes to the ERC apply from January 1 to June 30, 2021:
 

Increased Credit Amount

The ERC rate is increased from 50% to 70% of qualified wages and the limit on per-employee wages is increased from $10,000 for the year to $10,000 per quarter.

 
Broadened Eligibility Requirements

 
Determination of Qualified Wages

 
Advance Payments

 
Insights

The Act may provide significant opportunities for your company. However, the interplay between the Act, the CARES Act and various Internal Revenue Code sections is nuanced and complicated so professional advice may be needed.

Need Help?
If you think your business can benefit or is interested in claiming the Employee Retention Credit, BOOS & ASSOCIATES is here to help! To inquire more information please email us at askboos@booscpa.com.

 

As an employer, you give many the opportunity to work. These opportunities created allows you to take advantage of many Federal, State, & Local tax incentives offered. At BOOS & ASSOCIATES, we have a dedicated tax credit team with decades of experience in assisting clients to help maximize these benefits. Due to COVID-19, the IRS and the State of California has offered two new tax credits.

New Credits Available

Employee Retention Credit


New Hiring Credit for Small Businesses




On top of the two new credits available to businesses, our team also offers the following services.

Other Tax Credit Services Offered

California New Employment Credit (“NEC”)

Federal Hiring Tax Credits

Work Opportunity Tax Credit ("WOTC")

Research & Development Tax Credits

Need Help?

If you think your business can benefit or is interested in any of the above tax credits, BOOS & ASSOCIATES is here to help! To inquire more information please email us at askboos@booscpa.com.

 

Small businesses are the backbones of their communities. They create millions of jobs annually while catering specifically to the communities surrounding them. Many small businesses still need funding to help them weather today’s environment and ensure they can retain their employees, pay their rent, and survive. Due to this, the state of California has created the California Rebuilding Fund to support California’s small businesses. The experts at Boos can guide you through this process.

The California Rebuilding Fund is a loan program to support California’s small businesses—especially those located in economically disadvantaged and historically under-banked areas of the state. Businesses who employed 50 or less full-time equivalent employees (FTEs) and had gross revenues of less than $2.5 million or below in 2019 are eligible to apply.

The loans are flexible, transparent and are designed to help businesses access the capital and advisory services they need to get through these challenging economic times.

Loan Terms:

LOAN AMOUNT: The maximum available loan amount is $100,000 or up to 100% of your business’ average monthly revenues for three months prior to the COVID pandemic outbreak (in 2019 or early 2020), whichever is less. The maximum loan amount available under this program is $100,000.

INTEREST RATE: 4.25%

REPAYMENT: 36 months or 60 months (first year interest only)

Example:

An example of how your maximum loan amount is calculated:
To determine your business’s average monthly revenue for an estimate of potential loan size, the lender may use the following:


Based on the above-referenced example, the average revenues for the period is $15,000 so 3-months of average revenues would be $45,000. In this example, the maximum loan size would be $45,000

Business Requirements:

The business must have employed 50 or fewer full-time equivalent (FTE) employees prior to March 2020; please note: any and all affiliates are counted in this total, including businesses with shared ownership;

The business must have had gross revenues of less than $2.5 million in 2019;

The business must have suffered a direct economic hardship as a result of COVID-19 which has materially impacted operations (as evidenced by at least a significant reduction in revenues since January 2020);

The business must have returned to or sustained, for at least one-month, at least 30% of pre-COVID revenues relative to a similar period in 2019

The business must have demonstrated positive net income in 2019 (not including depreciation and amortization expenses);

The business must have been in operation since at least June 30, 2019 and be operating at the time of application;

The main office or headquarters for the business must be in California. The loan must be used to support only a business’s California operations

 

Apply > https://www.connect2capital.com/p/californiarebuildingfund/

 

 

Need Help?

If your business is interested in applying for the California Rebuilding Fund loan program, BOOS & ASSOCIATES is here to help! To inquire more information or if you would like assistance with an application please email us at askboos@booscpa.com.