New Partnership Audit Rules and Tax Law Changes

There have been two major pieces of legislation signed into law that affect each individual and entity.  The first is the Bipartisan Budget Act of 2015 (“BBA”) which became effective as of January 1, 2018, and the second is the Tax Cuts and Jobs Act of 2017 (“TCJA”) which applies for tax years beginning after December 31, 2017 (and in many instances ending before January 1, 2026).[1]  This letter will give a general overview of the changes that may affect you, but you should consult with your attorney or other tax professional for an in depth determination of whether or not you need to take any immediate action.

BBA Changes to Entities Taxed as a Partnership: The BBA repealed and replaced the 1982 Tax Equity and Fiscal Responsibility Act (also known as “TEFRA”). The BBA institutes new rules that focus on partnership-level determinations, assessments, and collections of tax.  The BBA will force most entities taxed as a partnership, including limited liability companies, to amend their partnership agreements or company agreements in order to comply with the new law.  You should consult with your attorney or other tax professional to determine if your partnership agreement or company agreement should be amended.

Tax Changes under the TCJA regarding Individuals:

  • Standard Deduction – taxpayers are allowed to reduce their adjusted gross income (“AGI”) by the standard deduction. The TCJA increased the standard deduction to $24,000 for married individuals filing jointly (up from $13,000), $18,000 for head-of-household filers (up from $9,550), and $12,000 for single individuals and married individuals filing separately (up from $6,500).
  • Tax Brackets – the TCJA applies seven new tax brackets for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
  • Personal Exemptions Suspended – prior to the TCJA, taxpayers determined their taxable income by subtracting from their AGI any personal exemption deductions. After the TCJA, the deduction for personal exemptions is effectively suspended.
  • Kiddie Tax – the TCJA made modifications to the taxable income of a child attributable to earned income and net unearned income.
  • Capital Gains – the TCJA generally retains the pre-TCJA rates, but indexes them for inflation.
  • New Deduction for Pass-Through Income – net income from sole proprietorships, partnerships, limited liability companies, and potentially trusts or estates, may be subject to a deduction which reduces taxable income.
  • Carried Interest – the TCJA imposes a three year holding period in order for certain interests received in connection with the performance of services to be taxed as a long-term capital gain rather than ordinary income.
  • Limitations of “Excess Business Loss” – the TCJA provides that the excess farm loss limitation does not apply and instead a non-corporate taxpayer’s “excess business loss” is disallowed. Such excess business losses are not allowed for the tax year but are instead carried forward and treated as part of taxpayer’s net operating loss carry forward in subsequent tax years.
  • Personal Casualty & Theft Losses – the personal casualty and theft losses deduction may be suspended, except for personal casualty losses incurred in a Federally declared disaster.
  • Child Tax Credit – the TCJA increased the child tax credit to $2,000 per child (up from $1,000 per child), subject to phase outs.
  • State and Local Tax Deduction – the TCJA limits state and local level tax deductions (including real and personal property taxes, income taxes, and sales taxes).
  • Mortgage and Home Equity Indebtedness Interest Deduction – the TCJA suspends the deduction for interest on home equity indebtedness and limits the deduction for mortgage interest.
  • Charitable Contribution Deduction Limitation – the TCJA increases the percentages of taxpayer’s contribution base.
  • Alimony & Separate Maintenance Payments – alimony and separate maintenance payments are not deductible by payor spouse and are not included in the income of payee spouse for any divorce or separation agreement executed after December 31, 2018 or modified thereafter.
  • Miscellaneous Itemized Deductions – the TCJA suspends deductions for miscellaneous itemized deductions that are subject to the 2% floor.
  • Pease Limitations – the TCJA suspends the Pease limitation on itemized deductions.
  • Exclusion of Moving Expense Reimbursement & Moving Expense Deductions – the TCJA suspends exclusion for qualified moving expense reimbursements and deduction for moving expenses, except for members of the Armed Forces on active duty who move pursuant to a military order.
  • Medical Expense Deduction & Affordable Care Act (Obamacare) – the TCJA made various changes to the medical expense deduction and Affordable Care Act.
  • Estate & Gift Tax Retained – the TCJA doubled the estate and gift tax exemptions. The estate tax exemption is increased to $10,000,000 (up from $5,000,000), as such amounts are indexed for inflation, and the annual gift tax exclusion is increased to $15,000 (up from $14,000).
  • Alternative Minimum Tax – the TCJA increases the alternative minimum tax exemption amounts for individuals.
  • 529 Plans – the TCJA allows for distributions from a 529 Plan to be used for tuition at an elementary school or secondary public, private, or religious school.
  • Student Loan Discharged on Death or Disability – loans that are discharged on account of death or total and permanent disability are excluded from gross income under the TCJA.

 

Tax Changes under the TCJA regarding Businesses:

  • Tax Rates – the TCJA reduces the corporate tax rate to a flat 21% rate.
  • Dividends Received Deduction Percentages – the TCJA reduces the dividends received deduction rates.
  • Alternative Minimum Tax – the TCJA repealed the corporate alternative minimum tax.
  • Section 179 Expensing – the TCJA increased the maximum amount a taxpayer may expense under Section 179 to $1,000,000, and the phase-out threshold amount is increased to $2,500,000, as such amounts are indexed for inflation.
  • First Year Bonus Depreciation – the TCJA contemplates a 100% first year deduction, which is phased down in 2024, 2025, 2026, and 2027.
  • New Farming Equipment and Machinery – the TCJA decreases the cost recovery period from seven to five years, with some exceptions.
  • Recovery Period for Real Property Shortened – the TCJA shortened various recovery periods, among other changes, with certain exceptions.
  • Limits on Deduction of Business Interest – the TCJA generally disallows a deduction for net interest expense in excess of 30% of a business’s adjusted taxable income.
  • Modification of Net Operating Loss Deduction – the TCJA repealed certain two-year carryback and special carryback provisions and made various changes to net operating loss carryovers.
  • New Deduction for Pass-Through Income – The TCJA added a new Section 199A to the Internal Revenue Code regarding Qualified Business Income.
  •  Domestic Production Activities Deduction – the TCJA repealed the domestic production activities deduction.
  • Like-Kind Exchange Treatment – the TCJA modified the like-kind exchange rules to allow for like-kind exchanges only with respect to real property that is not held primarily for sale.
  • Research and Experimentation Expenses – the TCJA requires research and experimentation expenses to be capitalized and amortized ratably over a 5-year period (15 years if conducted outside the United States).
  • Employer’s Deduction for Fringe Benefit Expenses – the TCJA disallows entertainment expenses and modifies the deductibility of business meals.
  • Employer-Paid Family and Medical Leave – the TCJA allows businesses to claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period which such employees are on family and medical leave if the rate is 50% of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of the payment exceeds 50%.  All full-time employees have to be given at least two weeks of annual paid family and medical leave (all less-than-full-time qualifying employees have to be given a commensurate amount of leave on a pro rata basis).
  • Accounting Method Changes – the TCJA made a number of accounting method changes.

 

Tax Changes under the TCJA regarding S corporations and Partnerships:

  • Partnership Technical Termination – the TCJA repealed Section 708(b)(1)(B) of the Internal Revenue Code requiring a technical termination of a partnership if there is a sale or exchange of 50 percent or more of the total interests in partnership capital and profits.
  • Look-Through Rule Applied to Gain on Sale of Partnership Interest – the TCJA requires the transferee of a partnership interest to withhold 10% of the amount realized on the sale or exchange of a partnership interest unless transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.
  • Partnership “Substantial Built-In Loss” – the TCJA modified the definition of a substantial built-in loss for purposes of Section 743(d) of the Internal Revenue Code.
  • Treatment of S Corporation Converted to C Corporation – the TCJA requires any Internal Revenue Code Section 481(a) adjustment of an eligible terminated S corporation attributable to the revocation of its S corporation election to be taken into account ratably during a 6-year period beginning with the year of change.

 

Tax Changes under the TCJA regarding Estate and Gift Taxes:

  • Estate and Gift Tax Retained – the TCJA doubled the estate and gift tax exemptions. The estate tax exemption is increased to $10,000,000 (up from $5,000,000), as such amounts are indexed for inflation, and the annual gift tax exclusion is increased to $15,000 (up from $14,000).
  • Tax Brackets – the TCJA applies four new tax brackets for individuals: 10%, 24%, 35%, and 37%.
  • Inflation – the TCJA requires the use of a new measure to determine inflation.

 

Tax Changes under the TCJA regarding Bonds:

  •  Advance Refunding of Bonds – the TCJA disallows advance refunding bonds.
  •  Current Refunding Bonds – the TCJA maintains the 90 day call period.
  •  Private Activity Bonds – the TCJA retains their tax-exempt treatment.
  •  Qualified Tax Credit Bonds (including Qualified School Construction Bonds) – the TCJA eliminated qualified tax credit bonds.
  •  Tax Credits, including New Markets Tax Credits and Low Income Housing Tax Credits – The TCJA preserves them.
  •  Historic Rehabilitation Tax Credits – the TCJA preserves them, with new limitations.
  •  Elimination of Alternative Minimum Tax – The TCJA reduces collateral tax consequences for corporate owners of public securities.

 

The TCJA also made various changes to pension and benefits, foreign income, and foreign persons, among many other changes, that you should be aware of.

The changes made by the BBA and the TCJA are sweeping and the full effects may not be known until later in the year, however, generally understanding the changes made may help you and your business plan for the rest of 2018 and beyond.  You should consult with your attorney or tax advisor as soon as possible to discuss changes that may affect you or your company.

This Client Alert was prepared by the Underwood Law Firm for its clients.  It is intended to be used for general information only and is not to be considered legal advice.  For legal advice regarding your particular situation, please consult an attorney.

 

[1] Much of this client alert stems from comments and articles published by Thomson Reuters Tax & Accounting News.

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