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Treasury Decision 9787

 

Treasury Decision 9787 – Final Regulations Under §707 Regarding Disguised Sales and §752 Regarding the Allocation of Excess Partnership Nonrecourse Liabilities to a Partner

On October 4, 2016, the Treasury Department and IRS released for publication final, temporary, and proposed regulations under sections 707 and 752. The final regulations substantially adopt 2014 proposed regulations with revisions to certain proposed rules in response to comments received. While the newly published regulations address several long standing partnership issues, at HLB Gross Collins, we believe the provisions that have the greatest potential to impact our clients relate to the allocation of partnership liabilities:

In determining if there is a disguised sales of property where there is a Debt-Financed Distribution and
In determining a partner’s share of recourse liabilities in the case of a Bottom Dollar Payment Obligation.

Disguised Sales
Generally, §721 provides that no taxable gain or loss shall be recognized to a partnership or any of its partners when a partner contributes property to the partnership in exchange for partnership interests. A disguised sale occurs when a partner contributes property to a partnership and in return receives any consideration other than partnership interests. Consideration can include cash distributions and relief of certain liabilities. Section 707 provides rules concerning disguised sales, and states that when such transactions occur, losses are disallowed and gains must be recognized as ordinary income. However, the final §707 regulations provide further guidance on the exceptions to the disguised sale rules.

One such exception is for Debt-Financed Distributions – If a partner transfers property to a partnership, the partnership incurs a liability, and all or a portion of the proceeds of that liability are traceable to a transfer of money or other consideration to the partner, the transfer of money or other consideration is considered a disguised sale only to the extent that the amount of money or the fair market value of other consideration exceeds the partner’s allocable share of the partnership liability. The final regulations state that partners must determine their share of any liability, whether recourse or nonrecourse based on the partner’s share of partnership profits.

In a case where the distribution of the proceeds from the liability is not made in the same proportion as the allocation of partnership profits, there would likely be a disguised sale. This is a change from prior practice where it was possible to avoid this outcome when the debt was allocated to the partner as recourse debt.

There are other exceptions including a distribution to reimburse preformation capital expenditures and a deemed distribution due to the partnership’s assumption of a qualified liability. These provisions were not materially changed from the proposed regulations.

Allocation of Partnership Liabilities in the case of Bottom Dollar Payment Obligations
Generally, §752 provides that any increase or decrease in a partner’s share of partnership liabilities is considered a contribution or distribution, respectively. Therefore, a partner’s basis increases and decreases when their share of partnership liabilities increases and decreases, respectively. In the past, special agreements known as bottom dollar payment obligations were used to change the character of liabilities from nonrecourse to recourse, and allocate the liabilities to a specific partner. In simple terms, a bottom dollar payment obligation is a guarantee where a partner agrees to repay partnership debt only if the creditor collects less than the guaranteed amount from the partnership.

The new §752 temporary regulations provide a special exception to the general rule above and state that bottom dollar payment obligations are not included in the guarantor partner’s share of partnership liabilities as a recourse liability. Instead, the debt is included in the excess nonrecourse liabilities and allocated based on the allocation of partnership profits.

HLB Gross Collins, P.C. is committed to providing clients with the best planning advice for maximum tax savings. Contact your HLB Gross Collins, P.C. tax specialist to discuss your specific situation and avoid missing out on potentially significant tax savings.

Department of Labor New Overtime Rules

New DOL overtime rules issued May 18, 2016, are currently scheduled to go into effect December 1, 2016. The final rule focuses primarily on updating the salary and compensation levels needed for Executive, Administrative and Professional (EAP) workers to be exempt from minimum wage and overtime pay protection under the Fair Labor Standards Act (FLSA). Automatic updates to these salary level requirements will now occur every three years, beginning January 1, 2020. Unless specifically exempted, employees covered by the FLSA must receive time-and-a-half pay for hours worked in excess of 40 in a workweek.

To qualify for exemption, a white collar employee generally must:

  1. Be salaried, meaning that they are paid a predetermined and fixed salary that is not subject to reduction because of variations in the quality or quantity of work performed (the “salary basis test”);
  2. Be paid more than a specified weekly salary level, which is $913 per week (the equivalent of $47,476 annually for a full-year worker) under this Final Rule (the “salary level test”); and
  3. Primarily perform executive, administrative, or professional duties, as defined in the DOL’s regulations, the “duties test” (see below).

Prior to the December 1, 2016 change the salary level test required a pay of at least $455 per week or $23,660 annually. Non-discretionary bonuses can satisfy up to 10 percent of the new salary requirement as long as they are paid on a quarterly or more frequent basis. Certain employees are not subject to either the salary basis or salary level tests (for example, doctors, teachers, and lawyers).

Highly compensated employees (HCE) may also be exempt from the overtime pay requirements if they meet certain requirements. HCE’s must be paid at least $134,004 annually and satisfy a minimal duties test. Furthermore under the Final Rule employers must pay HCE workers at least the standard weekly salary level of $913 per week on a salary or fee basis, while the remainder of the total annual compensation may include commissions, non-discretionary bonuses, and other non-discretionary compensation. Because employers may fulfill almost two-thirds of the HCE total annual compensation requirement with commissions, non-discretionary bonuses, and other forms of non-discretionary deferred compensation, the DOL determined that it would not be appropriate to permit employers to also use non-discretionary bonuses and incentive payments to satisfy the standard salary amount (the $913 per week).

Job titles do not determine exempt status, and the fact that a white collar employee is paid on a salary basis does not alone provide sufficient ground to exempt that employee from the FLSA’s minimum wage and overtime requirements. For an exemption to apply, an employee’s specific job duties and salary must meet all of the applicable requirements provided in the DOL’s regulations.

In response to the overtime rules employers can:

  1. Pay time-and-a-half for overtime work;
  2. Raise workers’ salaries above the new threshold;
  3. Limit workers’ hours to 40 per week; or
  4. Some combination of the above.

Nothing in the FLSA or in the overtime rule requires the choice between flexible work arrangements or opportunities for career advancement and complying with basic labor standards. There is no requirement that a worker must have a predetermined schedule, and nothing prohibits working whenever, wherever or however the worker and the employer agree. Although the FLSA requires that employers keep certain records to ensure that workers get paid the wages they earn and are owed, it’s up to the employer to choose the method that works best for them and the needs of their workforce. There’s no requirement that employees “punch in” and “punch out.” Employers have flexibility in designing systems to make sure appropriate records are kept to track the number of hours worked each day.

The final rules currently do not make any changes to the “duties test” that determines whether white collar salaried workers earning more than the salary threshold are ineligible for overtime pay.

Information on Executive, Administrative, Professional, Computer and Outside Sales Employees under the FLSA can be found at: https://www.dol.gov/whd/overtime/fs17a_overview.htm. Additional information is also available at: https://www.dol.gov/whd/overtime/fact_sheets.htm.

A number of states and business organizations have filed lawsuits challenging the new overtime regulations. Nonetheless businesses should be prepared to comply with the new overtime rules once they take effect. For more information on the new rules you may want to refer to the DOL website at https://www.dol.gov/WHD/overtime/final2016/.

Year-End Business Tax Planning

The PATH Act’s many provisions also include a permanent increase in the amounts allowed under IRC Section 179, which permits rapid deduction (expensing) of funds spent for business equipment. For 2015, expensing up to $500,000 of equipment was allowed with no phaseout beginning at $2 million of purchases. For 2016, the inflation adjusted amount is $2,010,000. In addition, the PATH Act makes permanent the treatment of off-the-shelf computer software as Sec. 179 property.

The bottom line is that small companies can confidently purchase equipment and software this year. As long as total outlays don’t top $2.01 million, expenses up to $500,000 can be deducted for 2016 rather than spread over several years. To qualify for the IRC Section 179 tax break, the equipment or software must be purchased, financed or leased, and placed into service by December 31. The deduction will equal the full purchase price.

For companies that spend more on equipment than the IRC Section 179 deduction allows, the PATH Act’s extension of “bonus depreciation” may help. For 2016 as well as 2017, a taxpayer may generally deduct 50% of qualifying equipment’s cost (reduced by the amount of any Sec. 179 expense deduction taken for the cost of the equipment). However, bonus depreciation applies only to new equipment while the first-year IRC Section 179 deduction applies to new and used equipment.

Paperwork now, payment later

The end of the year is also a good time to review your company’s retirement plan situation. If you have one, should you make a change? If you don’t have a company-sponsored retirement plan, do you want to establish one? Such a plan not only will benefit your employees, it will enable you to put aside funds for your own retirement on a tax-favored basis.

Today, a 401(k) can be considered the “standard” company plan. Many prospective employees expect to have a 401(k) at work, so offering such a plan may enable you to attract good people and retain valued workers. Contributions generally are funded by the employees themselves, but many companies provide matching contributions in some form.

December 31 is the deadline for establishing a 401(k) plan for 2016, assuming your company uses a calendar year. Employee contributions for 2016 must be withheld from 2016 paychecks and must be sent to the relevant financial firm as soon as possible. Employer contributions, deductible for 2016, can be made up to the company’s tax return due date, including extensions.

A variation of the basic 401(k) is often known as the solo 401(k) or the individual 401(k). Other names may apply. However the plan is titled by the financial firm involved, it is open only to business owners and their spouses who are employed by the company. For 2016, the maximum contribution to a solo 401(k) is $53,000 per participant, if certain conditions are met, or $59,000 for those age 50 or older. Basic 401(k) plans have contribution limits of $18,000 or $24,000 before any employer match.

Again, the deadline for establishing a solo 401(k) in 2016 is December 31 of this year. Some tax deductible contributions may be made up to the tax return deadline, including extensions, in 2017.

Beyond 401(k)s

Other retirement plans for small businesses also have a December 31 deadline for signing the forms to receive tax benefits in 2016. These plans also have an extended due date for making contributions. They include profit sharing plans, which are funded by the employer. Profit sharing plans may motivate employees to help the company’s earnings grow. Annual employer contributions are discretionary, so companies aren’t locked in.

Yet another option is a defined benefit plan, which can provide a traditional life-long pension. These plans are offered mainly by public employers and some large companies, but small firms also may benefit. The best prospects might be companies where the principal is, say, 50 or older, with few employees. In such situations, the business may make extremely large, tax-deductible contributions to the principal’s retirement account. Again, the plan must be established by December 31 for 2016 tax benefits.

Year-End Retirement Tax Planning

Many people save money for retirement in a traditional IRA. The funds might have come from annual IRA contributions, or from rolling over an employer sponsored retirement account such as a 401(k). Either way, the dollars in your traditional IRA are probably pretax, so they’ll be taxed on withdrawal.

You can leave the money in your traditional IRA for ongoing tax deferral. However, you might need cash now, especially if you’re retired or have had unexpected expenses. In another scenario, you may expect your traditional IRA to be extremely large by the time you reach age 70½ and RMDs begin. Those RMDs might be so large that they’ll be heavily taxed in a high bracket.

Therefore, you might want to take withdrawals from your traditional IRA before year-end 2016, so they’ll count in this year’s taxable income. With savvy planning, you can minimize the tax bite by staying within your current tax bracket.

Example 1: Greg and Heidi Jackson’s taxable income last year was $100,000. They expect their taxable income to be about the same this year. In 2016, the 25% bracket goes up to $151,900. Thus, the Jacksons can take as much as $50,000 from their traditional IRAs before December 31 this year, without moving into a higher tax rate. They might withdraw, say, $20,000 from their IRAs, pay $5,000 in tax at a 25% rate, and have $15,000 left for other purposes.

The right timing

If you’re taking money from a traditional IRA, the best time may be between ages 59½ and 70½. After age 59½, the 10% early withdrawal penalty won’t apply; before 70½, you won’t be subject to RMDs, which will restrict your flexibility about IRA withdrawals.

If you’re younger than 59½, you still might avoid the 10% penalty by qualifying for an exception. Several exceptions are available, including one for higher education expenses.

Example 2: Suppose Greg and Heidi Jackson from example 1 are both younger than 59½. If they take $20,000 from their IRAs this year, as indicated in that example, a $2,000 (10% of $20,000) penalty will be added to their $5,000 (25%) tax bill. However, if the Jacksons pay at least $20,000 in 2016 for their daughter’s college bills, they can take that $20,000 from their IRAs and owe the 25% income tax but not the penalty.

Canny conversions

After withdrawing funds from a traditional IRA at a low tax, un-penalized rate, you can use the after-tax dollars to pay college bills or for living expenses in retirement. If there is no immediate need for cash, you can move the money into a Roth IRA. After five years and age 59½, all withdrawals from a Roth IRA will be tax-free.

Converting traditional IRA money to a Roth IRA will trigger income tax. That might not be a major issue if you’re staying in the 15%, 25%, or 28% tax brackets. However, if you convert too much, you could wind up moving into a higher bracket and paying more income tax than you’d like.

Fortunately, the tax code offers a solution to this potential problem. You can recharacterize (reverse) a Roth IRA conversion, in whole or in part, by October 15 of the following year, and owe tax only on the amount that stays in the Roth IRA.

Example 3: In the previous examples, Greg and Heidi Jackson expect to have around $100,000 in taxable income this year. Their 25% tax bracket goes up to $151,900 in 2016. The Jacksons, hoping to convert as many dollars as possible at the 25% tax rate, convert $50,000 of Greg’s IRA to a Roth IRA by year-end 2016.

When the Jacksons prepare their income tax return for 2017, they learn that their 2016 taxable income was higher than expected. Not including the Roth IRA conversion, their taxable income was $118,500. A full $50,000 Roth IRA conversion would put part of the conversion amount into the 28% bracket, generating more tax than the Jacksons want to pay.

In this situation, the Jacksons could recharacterize enough of Greg’s Roth IRA conversion to wind up with a $33,400 conversion, retroactively. They would use up the full 25% tax bracket while the recharacterized dollars would return to Greg’s traditional IRA, untaxed. If you are interested in this type of lookback fine tuning, our office can help you with a year-end Roth IRA conversion and a possible 2017 recharacterization.

Beyond IRAs

The 2016 contribution limit for 401(k) plans is $18,000 per participant plus $6,000 if you’re 50 or older by year-end. If you are not maximizing your 401(k) contributions and wish to put more into the plan this year for increased tax deferral, contact your plan administrator. Meanwhile, keep in mind that many retirement plans impose RMDs after age 70½. Make sure you’re withdrawing at least the minimum amount, if you’re required to do so, in order to avoid a 50% penalty on any shortfall.

Year-End Planning for Medical Donations

The PATH Act of 2015 is not the only recent tax law affecting year-end planning this year. One provision of the Affordable Care Act, passed back in 2010, comes into play now. For taxpayers age 65 or older, it may pay to incur optional medical expenses by December 31, 2016.

Under the Affordable Care Act, the threshold for deducting unreimbursed medical and dental outlays was raised in 2013 from 7.5% to 10% of AGI. However, the 7.5% hurdle was kept in place for four years for taxpayers 65 or older. (Only unreimbursed medical bills greater than the threshold can be deducted.)

Example 1: Owen Palmer, age 63, has an AGI of $100,000 in 2016 and $9,500 in medical bills. For Owen, the deductibility threshold is $10,000 (10% of $100,000), so he’ll get no medical deduction.

Example 2: Owen’s neighbor Rona Sanders, has the same $100,000 AGI and $9,500 in medical bills. However, Rona is 67, so her threshold is only $7,500 (7.5% of $100,000). Therefore, Rona can deduct $2,000 of her medical costs.

Starting in 2017, the 10% threshold will apply to everyone. Therefore, seniors have an incentive to increase their medical outlays if they’ll reach the lower percentage this year. Once you’ve cleared the relevant hurdle, all medical costs will be fully deductible.

Premiums included

You might be surprised at how many expenses can be classed as medical deductions. Medicare Part B premiums, for example, count as potentially deductible medical expenses. That’s true even if you have those premiums withheld from the Social Security payments that are deposited into your bank accounts each month. The same is true for any premiums paid for Medicare Part D prescription drug plans and for money you spend directly on prescription drugs as well as for premiums paid for Medicare Supplement (Medigap) policies.

In addition, money spent on long-term care (LTC) insurance policies probably will be deductible, up to certain age-based limits. For 2016, policyholders age 41-50 can include LTC premiums up to $730 as medical expenses. The deductible amount increases to $1,460 for taxpayers age 51-60, $3,900 for taxpayers age 61-70 able to include LTC premiums, and $4,870 for taxpayers age 71 or older.

Sooner rather than later

For effective year-end tax planning, it pays to estimate your possible medical expenses for 2016 early in the fourth quarter. If you think you’ll be near or greater than the 7.5% or 10% threshold for tax deductions, push certain medical and dental expenses into November and December. Buy prescription eyeglasses, get physical exams, and so on if they’ll likely be tax deductible. If you’re nowhere near the 7.5% or 10% levels, consider deferring health care costs until 2017, when your total outlays may reach tax deductible territory.

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