While the Tax Cuts and Jobs Act, enacted at the end of 2017, promises on the whole good news for taxpayers for 2018, tax planning to take maximum advantage of those provisions has been difficult due to continuing uncertainties as to how to interpret various provisions of the tax reform legislation.
The Internal Revenue Service has yet to issue any proposed regulations on the subject, instead issuing a series of notices, information releases and frequently asked questions telegraphing what that guidance is likely to say on certain key points when it is eventually issued. Congress has also not been quick to follow up on the enacted legislation with technical corrections or with its promised Tax Reform II effort.
Adding to the uncertainty is that, like in 2017, we are going through 2018 without knowing whether Congress will extend the more than 30 tax breaks that expired at the end of 2017.
Many are cautioning taxpayers not to do anything too drastic in anticipation of the provisions of the TCJA until that guidance is released, but it is looking like that guidance may not be rapidly forthcoming. Acting IRS Commissioner Dave Kautter has indicated that TCJA guidance may take a couple of years and that, in some cases, the best guidance to taxpayers may come from the instructions to forms for 2018 tax returns. In the meantime, here is a little of what we have been told so far. (For a slideshow version of these points, click here.)
Individual tax issues
- The pass-through deduction. The principal issue of concern to individual taxpayers is how to prepare for and handle the new 20 percent deduction from qualified business income for pass-through businesses. The issues involve how “qualified business income” will be defined, what constitutes a “specified service business” that will have more limited access to the deduction, and how “W-2 wages” and “qualified property” will be defined. Taxpayers have been considering changing their business entity or splitting their businesses into more than one entity to maximize the availability of the deduction. The IRS has indicated informally that, in evaluating the reasonable compensation exception to what constitutes qualified business income, it will consider “reasonable compensation” to only be applied in the S corporation context and will not try to come up with a new definition of reasonable compensation for partnerships or sole proprietorships. That is generally good news for taxpayers and tends to indicate that owners of many sole proprietorships and partnerships with income under the $157,500 limit ($315,000 for joint filers) will likely be entitled to the full 20 percent deduction. The one technical correction that Congress has enacted so far corrected the so-called “grain glitch” that penalized farmers unless they sold their crops to a cooperative. There has been some hope expressed that proposed regulations might be issued by the end of July 2018.
- The SALT deduction. The TCJA placed a $10,000 annual limit on the state and local tax deduction. While the legislation restricted the prepayment of 2018 income taxes in 2017, it did not address prepayment of property taxes. Many taxpayers prepaid property taxes normally due in 2018 before the end of 2017 to avoid the new limit. In Information Release 2017-210, the IRS stated that 2018 property taxes can only be prepaid if they were assessed by the local jurisdiction in 2017. Some tax professionals are questioning the IRS position on a matter on which the drafters of the legislation chose to be silent. Several states have also enacted or are proposing alternatives to preserve a federal deduction, such as contributions to state charities or payroll tax deductions. In Information Release 2018-122, the Treasury and the IRS indicated that they intend to issue proposed regulations addressing the deductibility of such payments, indicating a likely attempt to restrict or prohibit such deductions. A number of states had historically allowed charitable deductions which were also allowed for federal tax purposes. Any change in the IRS position on this issue could also endanger those historic deductions.
- Interest on home equity loans. The TCJA prohibits the deduction of interest on home equity loans after Jan. 1, 2018, both for pre-existing and new home equity loans. In Information Release 2018-32, the IRS clarified that taxpayers may still be able to deduct interest paid on home equity loans where the funds were used to buy, construct or improve the home, subject to the overall limit on mortgage loan indebtedness.
- Withholding. With the new tax rates under the TCJA, the IRS issued new withholding tables, reducing withholding. The tables were not issued until January 2018 and were not required to be put into effect until March, likely leaving many employees somewhat overwithheld at the start of the year. The IRS, at the end of February 2018, released an updated Withholding Calculator and Form W-4 to help update 2018 withholding. Since then, the IRS has issued a number of reminders to do a “paycheck checkup” on the accuracy of 2018 withholding: Information Releases 2018-73, 2018-118, 2018-120, and 2018-124. Information Release 2018-93 also addresses revised estimated tax payments for 2018 due from many self-employed individuals, retirees and investors. Employees should be encouraged to take the time to check their withholding for 2018 to ensure it still accurately reflects their tax situation under the new tax law.
Business tax issues
- Deduction of business interest. The TCJA put new limits on the deduction of business interest, in particular a limit of 30 percent of adjusted gross income. This has resulted in a number of questions related to what constitutes investment interest rather than business interest, and how the limit is applied to pass-through entities and consolidated groups. Notice 2018-28 clarified that all corporate debt is considered to be business interest rather than investment interest. It also clarified that interest payments on debt of members of a consolidated group would be allocated at the consolidated group level. IRS representatives have expressed the hope that proposed regulations might be issued as soon as the end of June 2018.
- Expensing of business assets. The TCJA provided for 100-percent bonus depreciation on both new and used qualified property and an expanded Code Sec. 179 deduction for smaller businesses. While on the whole good news, there has been concern that a legislative oversight unintentionally limited the deduction of qualified leasehold property. There has also been confusion as to how the expensing provisions apply in a partnership context. Notice 2018-30 provides some guidance as to how to address built-in gains and losses, and FS-2018-9 addresses some depreciation deductions. Some states are also looking at decoupling from this federal provision and not allowing full expensing for state income tax purposes.
- Moving, mileage and travel expenses. The TCJA made changes to the treatment of moving expenses and unreimbursed employee business expenses. Information Release 2018-127 provides some guidance on the handling of these issues.
- Financial statement and tax conformity. The TCJA requires greater conformity under the tax laws as to when items are recognized for financial accounting purposes and the handling of advance payments. Notice 2018-35 indicates that the IRS intends to provide additional guidance with respect to advance payments and that taxpayers may rely on pre-TCJA law until that guidance is issued.
- Blended corporate tax rate. The TCJA provides that a corporation with a fiscal year that includes Jan. 1, 2018, will pay a blended corporate tax rate, not just the new 21 percent corporate tax rate. Notice 2018-38 provides guidance on how to calculate corporate taxes using the two rate regimes.
Other pass-through tax issues
- Carried interest holding period. The TCJA imposed a new three-year holding period for long-term capital gain treatment for carried interest but provides an exception for “corporations.” A number of hedge funds, seeking to take advantage of this exception, had been setting up Delaware limited liability companies and electing S corp status. Information Release 2018-37 and Notice 2018-28 state that the IRS intends to issue regulations to the effect that “corporation” for this purpose does not include S corporations. Some commentators feel that this interpretation is contrary to the express language of the statute and that only Congress can change the statutory language.
- Withholding of transfers of partnership interests. The TCJA, in conjunction with a new withholding tax on transfers of a partnership interest involving a foreign entity, requires that any transfer of a partnership interest without withholding must have a certification to the IRS that the transfer does not involve a foreign entity. Many practitioners have pointed out the significant administrative burden this could create for the many transfers not involving foreign entities. Information Release 2018-81 and Notice 2018-29 indicate that the IRS intends to issue regulations that provide for a number of exemptions from the withholding and certification requirements, and suspend secondary partnership-level withholding requirements.
International tax provisions
- The transition tax. Multinational corporations have already had to deal with the obligation to pay a tax on unrepatriated foreign earnings under the TCJA. The tax is calculated for the 2017 tax year but can be spread over an eight-year period. The IRS released a set of frequently asked questions to help those taxpayers deal with calculating and reporting this tax obligation. In early June 2018, the IRS added some additional frequently asked questions providing some additional penalty and filing relief. The IRS also issued Notice 2018-26 addressing some anti-avoidance issues, such as electing a November end to the fiscal year to try to defer the transition tax for an additional 11 months. It also addressed reduced deferred earnings and profits, reduced foreign cash and increased deemed paid foreign tax credits. The notice also provided some relief with respect to stock attributions rules and penalties with respect to estimated tax requirements. Further guidance has been released in Notices 2018-07 and 2018-13 and Information Releases 2017-212, 2018-09, 2018-25, 2018-53, and 2018-79. Proposed regulations are expected in 2018.
- Other international provisions. The TCJA, as part of the transition to what has been called a “quasi-territorial” tax system, has also proposed a new GILTI tax, a new BEAT tax, and a new FDII deduction. Many concerns have been raised as to the scope and unintended reach of these provisions. Proposed regulations are also expected in each of these areas as well.
- Fines and penalties. The TCJA expanded the categories of fines and penalties that do not qualify as a business deduction. The Treasury has indicated that proposed regulations will also be issued in this area. The Treasury has also indicated that these will be the first proposed regulations to qualify for review under a new agreement with the Office of Management and Budget calling for review of tax regulations with a sufficient non-revenue economic impact.
- IRS levy. The TCJA provided additional time to file an administrative claim or to bring a civil suit for a wrongful levy or seizure. Information Release 2018-126 provides some guidance on these issues.
- Inflation adjustments. The TCJA requires a change in the calculation of many inflation-adjusted items in the Tax Code to use of chained CPI. The IRS, before enactment of the TCJA, had issued inflation-adjusted numbers for 2018. In Information Release 2018-94, the IRS provided revised inflation-adjusted figures. One of the changes lowered the limitation on deductions for contributions to health savings accounts. To address problems that had been identified with lowering the limit after the start of the year, Information Release 2018-107 and Rev. Proc. 2018-27 modified the annual limitation and deductions for contributions to health savings accounts to return to the previous higher limit. Information Release 2018-19 also clarified that the TCJA does not affect the previously announced dollar limitations for retirement plans.
After enactment of the TCJA, Congress retroactively extended more than 30 tax breaks that had expired at the end of 2016 for 2017 only. Congress is currently reviewing the merits of extending each of these tax breaks for 2018. The uncertainty of their fate for 2018 only adds to the current uncertainty for tax planning.
It is not unusual that a major piece of tax legislation would be accompanied by a lot of uncertainty. What is somewhat unusual is the relative secrecy with which it went through the legislative process and that it was enacted less than a month before it went into effect.
The IRS also has still not been provided with the complete resources that it has requested to address the significant tax law changes in a timely manner. Also, Congress has not addressed many technical correction issues or the many tax breaks that had expired at the end of 2017.
While taxpayers have generally been advised to wait for additional guidance before taking action to take full advantage of TCJA, that guidance has been slow in coming. The IRS seems to be trying to provide some indications of guidance to come on some of the more important issues facing taxpayers, but for many taxpayers and their tax advisors 2018 is likely to be a difficult planning year with uncertainties hanging over important issues throughout the year.