As we discussed in our February 27, 2018 blog post, the Tax Cuts and Jobs Act ("TCJA") eliminated the deduction for entertainment expenses. Despite commentary to the contrary, we have consistently reported that meals continue to be deductible (subject to the 50% limitation under Code Section 274(n)) post TCJA under Code Section 274(k) as long the meals are not lavish or extravagant, and the taxpayer (or an employee of the taxpayer) is present at the furnishing of the meals. Our position relative to meals is supported by guidance from the Service (IRS Notice 2018-76) issued on October 3, 2018. More importantly, the recently issued guidance focuses on an issue raised in our prior blog post, namely whether meals purchased at an entertainment event are deductible provided the requirements of Code Section 274(k) are satisfied. We suspected that the Service would issue guidance on this issue. It did.
The Service issued proposed regulations corresponding to IRC § 199A today. As discussed in a prior blog post, IRC § 199A potentially allows individuals, trusts and estates to deduct up to 20% of qualified business income (“QBI”) received from a pass-through trade or business, such as an S corporation, partnership (including an LLC taxed as a partnership) or sole proprietorship.
The deduction effectively reduces the new top 37% marginal income tax rate for business owners to approximately 29.6% (i.e., 80% of 37%) in order to put owners of pass-through entities on a more level playing field with owners of C corporations who now have the benefit of the greatly reduced 21% top corporate marginal tax rate under the Tax Cuts and Jobs Act (“TCJA”). The concept sounds simple, but the application is complex. The new Code provision contains complex definitions and limitations, requires esoteric calculations, and is accompanied by many traps and pitfalls.
The Tax Cuts and Jobs Act (“TCJA”) will significantly impact merger and acquisition (“M&A”) activity. Although billed as tax reform, the TCJA did not reform or simplify the Internal Revenue Code (“Code”).
Virtually none of the provisions of the TCJA directly impact M&A transactions. Rather, the TCJA added or modified several sections of the Code that indirectly impact transaction structuring, pricing, negotiations and due diligence. Making matters more complex, some of these provisions of the TCJA are temporary.
This blog post briefly highlights several key provisions of the TCJA and the impact on M&A.
Charitable organizations work hard to maintain exempt status. These organizations operate in a highly regulated landscape: In exchange for enjoying freedom from income taxes, they must comply with strict organizational and operational rules. Even before the Tax Cuts and Jobs Act (“TCJA”), adhering to these rules required constant oversight. The TCJA changes the rules, impacting both the operations and funding of these organizations.
On the operational side, we review below: Changes to the rules on unrelated business taxable income and employee fringe benefits, the new excise taxes imposed on executive compensation, and college and university endowments, and changes to substantiation requirements for certain donations.
On the funding side, we review below: How changes to the standard deduction (addressed in more detail in a prior blog post), cash contribution limits, deductions for payments to colleges and universities for the right to purchase athletic event tickets, and the estate tax may impact donors and charitable giving patterns.
The Tax Cuts and Jobs Act (“TCJA”) creates the need for tax planning with respect to several major life-changing activities individuals may encounter, including marriage, divorce, home ownership, casualty losses, medical expenses and parenting. More specifically, the TCJA makes major changes to the existing framework of personal exemptions and itemized deductions, the child tax credit, the tax treatment of alimony and spousal maintenance payments made as a result of divorce, and the alternative minimum tax (“AMT”).
The primary focus of this blog post is the provisions of the TCJA that significantly impact families and individuals. Many of these provisions have been exhaustively reviewed by other commentators in the past several weeks. In those instances, our discussion is brief. Rather, we decided to place the bulk of our discussion on the less obvious provisions of the TCJA that may have significant impact on families and individuals.
The Tax Cuts and Jobs Act (“TCJA”) creates, modifies or eliminates a number of employment and employee fringe benefit related provisions of the Code. Both employers and employees need to be aware of these changes. Accordingly, this installment of our ongoing review and analysis of the TCJA focuses on these employer and employee fringe benefit provisions.
“Neither a borrower nor a lender be…” or at least, if you insist on borrowing (and we understand the appeal), we are here to help you stay abreast of the new rules on deducting interest.
Interest on a business or investment related debt is, in most instances, a deductible expense of the borrower and taxed as income to the lender. With a few exceptions, such as mortgage interest on a personal residence, borrowers generally cannot deduct personal interest. A borrower’s deduction is subject to a number of limitations set forth in Code Section 163. The Tax Cuts and Jobs Act (“TCJA”) has changed some of these limitations.
Before the enactment of the TCJA, nondeductible interest included any interest on a taxpayer’s debt not arising from a trade or business, home mortgage, investment activity, or qualified student loans (in other words, interest arising from those debts was deductible).
The Tax Cuts and Jobs Act (“TCJA”) adopted a new 20% deduction for non-corporate taxpayers. It only applies to “qualified business income.” The deduction, sometimes called the “pass-through deduction,” is found in IRC § 199A. There has been a significant amount of media coverage of this new deduction. Rather than repeat what you have undoubtedly already read or heard, we chose to focus this blog post on the not so obvious aspects of IRC § 199A—the numerous pitfalls and traps that exist for the unwary.
As indicated at the end of 2017, I intend to provide our readers with an in-depth review of the Tax Cuts and Jobs Act (“TCJA”). With the help of two of my colleagues, Steven Nofziger and Miriam Korngold, we will do this in a series of bite-size blog posts. Our goal is to not only review the technical elements of the new law, but to offer practical insights that will be helpful to tax practitioners and their clients.
Many of the provisions of the TCJA have already received significant attention by the media. Rather than start our multi-part series with any of those provisions, we decided to commence the journey with a discussion about a rather obscure provision of the new law. This provision, while it may not have received any media attention, could be a huge trap for the unwary. It also highlights several aspects of the new law that have received little discussion.
Earlier this week, United States Tax Court Judge Richard T. Morrison ruled, in the case of Emmanuel A. Santos v. Commissioner, T.C. Memo 2016-100 (May 17, 2016), that the government will not pay the cost of a taxpayer obtaining a law degree.
This is a pro se case. While the record was not very clear, the taxpayer, Emmanuel A. Santos, claimed he earned a degree in accounting from Indiana University in 1988. Thereafter, he began a career as a tax return preparer. In 1996, he obtained a master’s degree in taxation. Eventually, Mr. Santos expanded his tax return preparer practice to include accounting and financial planning services.
Mr. Santos attended a law school in California, graduating in 2011. He was admitted to the California Bar Association and the United States Tax Court in 2014. In 2015, Mr. Santos and his father started Santos & Santos Law Offices LLP, a law firm offering attorney, tax planning, accounting and financial planning services.
On his 2010 federal income tax return, Mr. Santos deducted, in addition to various expenses, including laundry costs, $20,275 for law school tuition and fees. On audit, many of these deductions were denied.
After likely losing at the IRS Office of Appeals, Mr. Santos headed to the United States Tax Court. The sole issue in dispute was whether the deduction of $20,275 for law school tuition and fees was allowable under Code § 162 as an ordinary and necessary business expense.
When Educational Expenses Are Considered Deductible (and When They Are Nondeductible)
Treas. Reg. § 1.162-5(a) is clear—educational expenses that either: (i) maintain or improve skills required by the taxpayer in his or her current employment; or (ii) are required by the taxpayer’s employer (or applicable law) as a condition to continued employment or rate of compensation, are deductible. On the other hand, certain types of educational expenses are expressly nondeductible, including expenses for education that qualify the taxpayer for a new trade or business. Treas. Reg. § 1.162-5(b)(1) provides examples of these nondeductible educational expenses. One of the examples set forth in the regulations specifically references a taxpayer practicing accounting who pursues a law degree. The costs of attending law school are nondeductible because the course of study qualifies the taxpayer for a new trade or business. The law degree is not required to continue practicing accounting.
Previous Tax Court Holdings
Judge Morrison cited numerous cases where the courts have held, consistent with the Treasury Regulations, a law degree qualifies a taxpayer for a new trade or business, and thus the cost of the degree is a nondeductible educational expense. This is true, even if the degree improves the taxpayer’s accounting and tax skills, and the taxpayer remains practicing accounting (i.e., never practices law). See e.g., Taubman v. Commissioner, 60 T.C. 814 (1973).
Despite the clear language of the Treasury Regulations and the numerous cases supporting the government’s position, Mr. Santos brought his case to the United States Tax Court. He appears to have argued that the holdings in the cases where the court relied upon the Treasury Regulations are incorrect because the regulations are invalid. Mr. Santos’s argument, at first blush, appeared intriguing to me. By gosh, I recently won an Oregon Tax Court case invalidating a long-existing administrative rule (which is akin to Treasury Regulations).
Shortly after Treasury promulgated Treasury Regulation § 1.162-5, the United States Tax Court ruled that it was valid. The Ninth Circuit Court of Appeals affirmed the tax court’s conclusion. See Weiszmann v. Commissioner, 52 T.C. 1106 (1969), aff’d 443 F.2d 29 (9th Cir. 1971).
Giving It the Old College Try
Mr. Santos argued that the court in Weiszmann employed the wrong standard to examine the validity of the regulation at issue. Unfortunately for him, the tax court quickly dismissed the argument without much discussion. Then, Mr. Santos asserted that Treasury failed to adequately respond to public comments before finalizing the regulations at issue, thus making the regulations invalid. Unfortunately, Mr. Santos did not raise that issue until after the trial had concluded. Consequently, the trial court record contained no evidence upon which the tax court could even evaluate his assertion. While his argument was creative and certainly intriguing, it never gained any traction. If he had offered evidence on the issue at trial, the tax court’s opinion would have been a much more interesting read. Who knows if any evidence exists to support his assertion of invalidity – Mr. Santos lost!
The clear take-away from this case is that: educational expenses are generally only deductible if they are incurred to maintain or improve the skills required for current employment or to retain current employment or current compensation. The costs of education required to prepare for a new trade or business are generally nondeductible.
The outcome of these cases is generally dependent upon the facts and circumstances. For example, if Mr. Santos had been a practicing tax lawyer (i.e., had already obtained his J.D. degree, had already passed the bar examination and was practicing as a tax lawyer), the costs of obtaining his LL.M. (taxation) may have been deductible.
Many nuances exist in this area of tax law. Consequently, careful analysis is required.
Larry J. Brant
Larry J. Brant is a Shareholder in Foster Garvey, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; Washington, D.C.; New York, New York, Spokane, Washington; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long-term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "The Oregon Corporate Activity Tax," Oregon Society of Certified Public Accountants (OSCPA) 2020 OSCPA State & Local Tax ConferencePortland, OR, 1.6.20
- "The Road Between Subchapter C and Subchapter S – It May Be A Well-Traveled Two-Way Thoroughfare, But It Isn’t Free of Potholes and Obstacles," The J. Nelson Young Tax InstituteChapel Hill, NC, 4.23.2020-4.24.2020