As 2020 draws to a close, we look back at significant tax legal developments this year (most, but certainly not all, related to COVID-19 relief) and look ahead to potential tax changes being contemplated by the incoming Biden administration. Please consult your Herrick, Feinstein tax advisor if you have questions about any of the following:
I. The CARES Act and other COVID-19 Relief
A. Deductibility of Expenses Paid with Paycheck Protection Program (“PPP”) Loans
1. The IRS clarified that expenses paid with PPP loan proceeds cannot be deducted if the taxpayer reasonably expects the PPP loan to be forgiven. Revenue Ruling 2020-27.
2. The IRS provided a safe harbor procedure for claiming a deduction for expenses paid with unforgiven PPP loan proceeds. Revenue Procedure 2020-51.
B. Relaxation of Net Operating Loss Limitations
The CARES Act temporarily relaxed certain limitations on net operating losses (“NOLs”), allows NOLs arising in 2018, 2019 or 2020 to be carried back 5 years, and permitted the use of historic NOLs to offset income earned in tax years 2018-2020.
Please see Herrick’s prior alerts, The CARES Act Giveth, the IRS Taketh Away… and CARES Act Changes for Retirement Plans.
C. Business Interest Deduction Limitation
The CARES Act increased the limitation on the business interest deduction under Code Section 163(j) for tax years 2019 and 2020 to 50% of adjusted taxable income.
II. Real Estate Related Tax Rules
A. Qualified Opportunity Zones
The IRS extended certain deadlines and requirements under the qualified opportunity zone program, including the following:
1. The 31-month working capital safe harbor period during which a qualified opportunity zone business can hold nonqualified financial property is extended by as much as 24 months.
2. Any failure by a qualified opportunity fund to meet the 90 percent asset test on a testing date that falls from April 1, 2020 through December 31, 2020 will be treated as due to reasonable cause and will be disregarded.
3. The period from April 1, 2020 through December 31, 2020 is disregarded in determining whether the 30-month test for substantial improvement of property is met.
Please see Herrick’s prior alert, IRS Defers Due Dates for QOZ Actions to Provide Relief for Taxpayers Affected by the Coronavirus Pandemic.
B. Like-Kind Exchanges
The IRS released final regulations governing Section 1031 like-kind exchanges clarifying, among other things, what constitutes “real property” for purposes of Section 1031 and the treatment of incidental personal property received in the exchange.
III. Partnerships
A. Pass Thru of SALT Deduction
The IRS announced that it will issue rules clarifying that state and local taxes (“SALT”) paid by a pass-through entity are not a separate deduction item to be allocated to the pass-through owners. Rather, any SALT paid by a pass-through entity reduces that entity’s non-separately stated income (or loss) and is not subject to the owner’s individual SALT deduction limitation. Notice 2020-75.
B. Carried Interest
The IRS issued proposed regulations under the Section 1061 “carried interest” rules (which generally extend the one year holding period for long term capital gain treatment to three years for certain partnership interests received in exchange for services). The proposed regulations clarify the details of this three year holding period, including what constitutes an “applicable partnership interest” subject to the rules.
IV. International Tax
A. Withholding on the Sale of a Partnership Interest by a Non-U.S. Person
The IRS released final regulations under Section 1446(f) clarifying withholding rules with respect to the disposition of a partnership interest by a non-U.S. person when gain or loss on the disposition is deemed to be effectively connected with the conduct of a trade or business under Section 864(c)(8).
B. High Tax Exclusion from GILTI
The IRS released final regulations expanding the income that is eligible for “high tax exclusion” from the calculation of global intangible low-taxed income (GILTI). US shareholders of a controlled foreign corporation that elect to exclude the high-taxed income are not taxed currently on income qualifying for the exclusion.
V. Trusts & Estates
A. The Estate and Gift Tax Exclusion Set to Increase in 2021; “Sunset” in 2026
On January 1, 2021, the estate and gift tax exemptions or “unified credit” will increase to $11.7 million for individuals and $23.4 million for married couples. The exemptions will continue to rise (adjusting for inflation) each year until 2026 when the law expires and the exemptions “sunset” to their pre-2018 levels.
B. Annual Gift Tax Exclusion to Remains $15,000
In 2021, the U.S. Federal annual gift tax exclusion will remain at $15,000 for individuals per donee.
C. Historically Low Interest Rates
The Applicable Federal Rate for December 2020 for mid-term loans (interest compounded annually) continues to be historically low at 0.48%. and this low rate enhances planning opportunities involving the use of intra-family loans and certain trusts
VI. Compensation & Benefits
A. Excise Tax on Exempt Organization Compensation in Excess of $1 Million
In 2020, the IRS issued proposed regulations under Code Section 4960 governing the excise tax on certain tax-exempt organizations for compensation paid in excess of $1 million and for any excess parachute payments paid by such organizations. Among other things, the proposed regulations clarify which employees are subject to the limitations of Code Section 4960 and which entities are considered related to the tax-exempt organization.
B. Expiration of Required Minimum Distribution Waiver
The CARES Act waived the requirement to take required minimum distributions (“RMDs”) from IRAs and retirement plans in 2020. That waiver is set to expire on December 31, 2020 and therefore RMDs will need to resume in 2021. In addition, the CARES Act waiver does not apply to individuals who turned 72 in 2020 because their first RMD is not due until April 1, 2021.
VII. The Biden Administration Tax Proposals
The ability to pass any significant tax reform hinges on the political balance in the Senate, which is still uncertain. Nevertheless, even if there is a divided Congress, the Biden administration may introduce some or all of the following tax proposals:
A. Revenue Raising Proposals
1. Corporations: raising the corporate income tax rate from 21% to as much as 28% and reinstating the corporate alternative minimum tax.
2. Estate and Gift Tax: lowering the estate and gift exemption amount from $11,580,000 for individuals ($23,160,000 for married couples) to as low as $3.5 million for individuals ($7 million for married couples).
3. Estate and Gift Tax: eliminating step-up in basis at death to fair market value.
4. Real Estate: eliminating like-kind exchanges of real property for taxpayers with taxable income over $400,000.
5. Individuals: taxing long-term capital gains and qualified dividends at the rate of 39.6% for individuals earning over $1 million.
B. Tax Spending Proposals
1. Child-focused tax credits
2. Tax incentives for clean energy and infrastructure
3. Elimination of the $10,000 cap on state and local tax deductions
4. Advanceable tax credits for domestic manufacturing and workforce investment
