Form 1099-NEC Basics
Employers must use Form 1099-NEC to report non-employee compensation if the payment (1) was made to a non-employee; (2) was made for services provided in the ordinary course of business; (3) was made to an individual, partnership, or LLC; and (4) exceeded $600 during the year. If the independent contractor is registered as a C corporation or S Corporation, then a 1099-NEC is not required.
If the taxpayer hired an independent contractor during the year that meets the above criteria, then the taxpayer is required to fill out two copies of Form 1099-NEC (Copy A and Copy B) for every independent contractor. Copy A will be filed with the IRS and Copy B will be sent to the independent contractor. The independent contractor will use Copy B to report earnings on Schedule C of their individual return.
The due date for Form 1099-MISC and Copy A of Form 1099-NEC is January 31 in the year following the year the payments were made. If January 31 does not fall on a business day, then the due date is moved to the next business day. For example, the due date in 2021 will be February 1 because January 31 falls on a Sunday. If the taxpayer misses the deadline, penalties may be assessed based on when the taxpayer files the 1099 forms in relation to the original due date ($50 for the first 30 days; $100 for more than 30 days but before August 1; $260 if after August 1). Copy B of Form 1099-NEC can be emailed to the independent contractor with their consent. Additionally, Copy B should be provided to the independent contractor by January 31.
Most states also require Form 1099s to be filed with the state. The new Form 1099-NEC will not be included in the IRS/state information sharing program, so it must be separately reported and filed with most states. Alaska, Florida, Illinois, Nevada, New Hampshire, New York, South Dakota, Tennessee, Texas, Washington, and Wyoming do not require an additional filing. Although the new Form 1099-NEC does not substantively change a taxpayer’s payment obligation, taxpayers should be aware of the new filing requirements to avoid any penalties.
On November 3, 2020, San Francisco voters approved two new tax measures impacting corporate taxpayers. Both measures were passed by voters with overwhelming majorities.
Proposition F, or the Business-Tax Overhaul, supported by 68% of voters, will be effective in 2021. The measure provides relief for small businesses by raising the exemption ceiling for both business registration fees and the gross receipts tax. The measure also eliminates the payroll expense tax and gradually increases gross receipts tax rates and administrative office tax rates for all business activities through 2024. While most businesses will see a gradual increase of approximately 40% over 4 years, other businesses, such as information services, biotechnology and financial services will see increases of up to 85%. The measure was sponsored by San Francisco’s Mayor and Board of Supervisors to help close the city’s $1.5 billion budget deficit, boost the economy, and recover jobs.
Proposition L, or the Overpaid CEO Tax, supported by 65% of voters, will be effective in 2022. The measure places an additional tax on businesses in San Francisco when their highest-paid managerial employee earns more than 100 times the median compensation paid to their employees. The “highest-paid managerial employee” group includes any employee regardless of where the employee works, while the “median compensation employees” are limited to those who work in San Francisco. The tax based on gross receipts ranges from 0.1% to 0.6% depending on the magnitude of the pay discrepancy. For taxpayers engaged in business as an administrative office, the tax based on payroll expense ranges from 0.4% to 2.4%. With the passing of Proposition L, San Francisco becomes the second city after Portland, Oregon to enact such a tax; however, the overwhelming support seen in San Francisco may mean that more cities will look toward CEO pay as a source of tax revenue in the future.Read More
At the beginning of 2020, the Organization for Economic Co-operation and Development (OECD) expected to complete its global taxation transformation known as “BEPS 2.0” by the end of the year. However, with the COVID-19 pandemic and U.S. dissatisfaction with the direction of the initiative, negotiations stalled.
As the year draws to a close, the OECD is attempting to get the initiative back on track with the issuance of a “Blueprint” which fills in the details of its Two-Pillar approach to addressing its concerns over fairly imposing taxes on the digital economy. Pillar One addresses new global standards for nexus and profit allocation. Pillar Two, also referred to as the “GloBE” proposal, provides a mechanism for jurisdictions to “tax back” income that has not been taxed by the primary taxing authority or is subject to low levels of taxation. In essence, it provides a minimum tax on global profits similar to the Global Intangible Low-Taxed Income (GILTI) provisions under the U.S. Tax Cuts and Jobs Act of 2017.
The Blueprint is intended to provide a pathway for successful implementation of the pillars by mid-2021. However, achieving agreement on a comprehensive overhaul on global taxation between all 140 member countries collaborating on BEPS 2.0, referred to as the OECD Inclusive Framework (“IF”), is an ambitious effort fraught with nationalistic interests.
Current U.S. Position
Pillar One Blueprint: Digital Service Taxes as the Default
The Blueprint for Pillar One addresses the digitalization of businesses. Specifically, the Blueprint prescribes a formula for taxing profits related to “automated digital services,” which the IF refers to as Amount A, Amount B, and Amount C.
Amount A is a share of the residual profits that is unique to digital businesses and attempts to capture the value created through the reach of the business into markets where the business has no physical presence, including the value created by tracking the interactions with customers and among customers within the market. Amount B is a baseline measure of the routine returns on distribution or marketing functions that take place in the market. Amount C captures the value of any in-country functions that exceed the baseline activity compensated under Amount B. Amount A creates a new taxing right, but Amounts B and C do not create any new taxing rights and are based on existing nexus and transfer pricing profit allocation rules.
The recently released Blueprint aims to address many technical details, including:
- The dollar amount threshold of Amount A, including a possible “safe harbor” (which the U.S. has insisted upon);
- Determination of industries that are within the reach of Pillar One;
- Whether Amount A will be implemented solely for digital services, or if consumer-facing businesses with digital capabilities will also fall within the scope;
- The required amount of profit reallocation for Amount A, including whether digital services will enjoy a preferential dollar amount threshold;
- The amount of distribution or marketing profit for purposes of Amount B;
- Dispute resolution provisions for Amount A.
Pillar Two Blueprint: Taxing the GloBE
Tuesday, November 17, 2020 from 10:00 AM to 11:00 AM PST
This is an online event.
CCW/Crowe and KBF CPAs invite you to join us for this internationally-focused webinar to learn about the strategies we are seeing our clients employ as they seek to grow their revenue and expand their footprint in markets outside of the US. We will cover a range of topics, with a focus on the EMEA and APAC regions.
- Why expand globally now?
- Where should you focus your efforts?
- How easy is it to achieve growth through global initiatives with everything going on in the world right now?
- Is it expensive and complicated to hire talent overseas or are there shortcuts?
- Local talent and immigration/tax challenges.
- Global regulatory and compliance insights.
- Steps you can take to create a flexible foundation for future international success.
- Assessing opportunities and creating a roadmap for your company.
Metro Payroll Tax
Preschool Tax on High-Earners
New California small business hiring credit for 2020. Especially attractive for restaurants and retail industries
Small businesses are able to get a nonrefundable credit of $1,000 for each net full time equivalent employee addition. The total credit can range from $1,000-$100,000. The increase is measured by comparing the average number of full time employees in the second quarter of 2020 to the average number in the 5 month period 7/1/2020-11/30/2020.
An eligible small business is a business with fewer than 100 employees at 12/31/2019 that had a 50% decrease in gross receipts in the second quarter of 2020 compared to the second quarter of 2019.
Monthly full time equivalent for hourly paid qualified employees is calculated by taking the total number of hours worked per month for the small business, not to exceed 167 hours per month per qualified employee, divided by 167. For salaried qualified employees, monthly full time equivalent is calculated by taking the total number of weeks worked per month for the small business divided by 4.33.
Any business using the Competes Credit or Employment Credit is ineligible.
This credit needs to be reserved with California Department of Tax and Fee Administration (CDTFA) between 12/1/2020-1/15/2021. The maximum cumulative total allocation for all taxpayers is $100 million. The credit will be allocated on a first come first served basis.
The credit can be used against corporate franchise (income) tax or personal income tax credit or the small business can make an irrevocable election to apply the small business hiring credit against qualified sales and use tax.Read More
Please join us in welcoming Debbie Spyker to KBF.
Debbie is joining KBF as an Employment Tax Services Consultant where she will focus on growing and developing our Employment Tax Services practice. Debbie is a firmwide resource and will assist clients in all of the markets KBF serves.
Debbie was previously a Managing Director at Ernst & Young LLP’s Employment Tax Services Group and has deep knowledge of U.S. employment tax and information reporting issues. Her experience includes U.S. employment reporting and withholding, expatriate technical compliance, inpatriate technical compliance, information reporting, audit representation and worker classification.
Debbie has been a speaker at national and local chapter meetings of the American Payroll Association; the University of Denver Graduate Program’s Annual Tax Institute; the St. Louis Chapter of International Accounts Payable Professionals, Relocation Taxes; and the Employment Taxes Committee panels of the American Bar Association Section of Taxation.
Debbie has edited prior editions of Principles of Payroll Administration and The Payroll Practitioner’s Compliance Handbook, published by Thomson Reuters/Research Institute of America.Read More
Little guidance has been released for individuals working remotely in Oregon. However, that does not mean that employees should ignore the effects of their new working arrangements. For example, a taxpayer’s resident state usually taxes all their income, regardless of where it is earned. When a taxpayer works in more than one state during the year, the taxpayer must allocate their income to the respective state in which it was earned. The taxpayer will be entitled to claim a tax credit for income tax paid to another state, which reduces their taxes payable on their resident state return. Thus, if a taxpayer normally works in a different state than their resident state, they could incur penalties for not making sufficient tax payments in their home state because they will no longer be receiving a state income tax credit from the state where they normally work. Taxpayers should make sure they have changed their withholding requirements to ensure they do not incur penalties.
Corporate Activity Tax
- Insufficient funds due to COVID-19 that caused the business to not be able to pay a full quarterly installment.
- The impact of COVID-19 made it so the business could not reasonably calculate a quarterly payment.
- The taxpayer could not determine whether it will have a CAT liability in 2020.
- The taxpayer made a reasonable estimate based on information available at the time.
- The taxpayer relied on information that was contained in a proposed administrative rule.
Business & Occupation (B&O) Tax
The Washington Department of Revenue has offered favorable guidance for businesses that received federal financial assistance. Businesses that received any federal assistance (including the federal Paycheck Protection Program (PPP)) should not report the assistance as gross receipts for B&O tax purposes for now. However, this is not a final decision, and the Department of Revenue indicated that it would continue to analyze the various programs more thoroughly. It will issue a final decision once the Legislature has had an opportunity to act, so businesses should be mindful that this is not a final ruling.
Washington has not released any guidance regarding the “physical presence” threshold for its B&O tax. In Washington, a business must pay B&O tax if it (1) has physical presence nexus in Washington; (2) has more than $100,000 in combined gross receipts sourced to Washington; or (3) is organized or commercially domiciled in Washington. The Washington Administrative Code says that even the “slightest presence” of a single employee may trigger the physical presence nexus. Thus, a remote worker could trigger nexus and an additional filing requirement for a company even if they do not normally meet the $100,000 threshold.
Earlier this summer, Apple won a $15 billion State Aid case related to its Irish operations. This decision was rendered by the EU’s lower court. In late September, the European Commission decided to appeal the outcome. Now that the appeal has been filed, it could take the European Court of Justice up to two years to issue a ruling. Meanwhile, EU efforts to redistribute the tax obligations of American technology companies on several other fronts are likely to advance well before the case is decided.
Apple is being sued for allegedly receiving two preferential tax rulings from the Irish government. Those rulings allowed two Apple units in Ireland to attribute a small percentage of some $130 billion in profit to Ireland over an 11-year period. The EC argued that all of the profit should be taxed in Ireland. But Apple and the Irish government pointed to the fact that virtually all of the Apple intellectual property is developed in the U.S. as justification for the allocation. Further, Ireland claimed that the rulings did not provided preferential incentives to Apple but were merely an expression of Irish law as applied generally.
EU Commission Executive Vice President, Margrethe Vestager, has been using the EU State Aid laws designed to crack down on tax deals that give companies an unfair advantage against other member states in a series of challenges against U.S.-based multinationals such as Starbucks, Nike, and Amazon. The results have been mixed at best, emboldening tax activists who say that the result reinforce their calls for new, more effective rules.
The judgement of the EU’s second-highest court was clearly in favor of Apple and Ireland. When the Commissioner appealed the decision, she stated that the court made “a number of errors of law.” Legal errors are the only basis for an appeal of the decision. However, the lower-court stated that the Commissioner misinterpreted the facts of the case, and, on that basis, she was mistaken as to how much profit should have been allocated and taxed in Ireland. Given the court’s assertion of matters of fact, rather than law, the Commissioner will seemingly face an uphill battle in overturning the decision.
The Commission has repeatedly stated that it will continue to fight against aggressive tax planning by multinational companies. The U.S. government views the EC’s ongoing State Aid challenges to be just one front in an ongoing money grab of U.S. tax revenues for their own coffers.
Convinced by the Apple decision of the deficiencies of the existing State Aid statutes as an effective weapon against the alleged exploitation of European markets by American companies, the Commission has stated that it will explore EU reform that would “allow taxation proposals to be adopted by qualified majority rather than unanimity” to ensure that member states are not abusing state-aid principles. Meanwhile, EC efforts at a comprehensive, multilateral overhaul of international tax standards through the initiative known as “BEPS 2.0” is stalled due to U.S. opposition. The “nuclear” option led by France and in various stages of enactment, development or consideration by many nations is imposing digital service taxes. “DSTs” serve as a blunt instrument to impose gross receipts excise taxes on technology companies who have no presence in a jurisdiction other than revenues. Given the slog through the courts, the complexity of reaching consensus on an ambitious global framework such as BEPS and the ravages of COVID-19 on the fiscal health of most national governments, unilateral DSTs and trade retaliation by the U.S. may define the future of international taxation.Read More
The Financial Accounting Standards Board (FASB) establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP). The FASB is recognized by the Securities and Exchange Commission as the designated accounting standard setter for public companies. FASB standards are recognized as authoritative by many other organizations, including state Boards of Accountancy and the American Institute of CPAs (AICPA).
The FASB issues an Accounting Standards Update (“ASU”) to communicate changes to the FASB Codification, including changes to non-authoritative SEC content. Since September 2009, the FASB has issued various ASU’s that have a direct impact to Accounting Standards Codification (“ASC”) 740 Income Taxes. This is the first in a series of KBF Technical Alerts that discusses the various ASUs issued by the FASB since 2009 related to ASC 740.
Accounting for Uncertain Tax Positions – Background
The rules for the accounting for uncertain tax positions (“UTPs”) are found in ASC 740. The rules clarify the accounting for uncertainty in income taxes recognized in an entity’s financial statements. They establish rules for recognizing and measuring tax positions taken in an income tax return.
The UTP rules mandate that companies evaluate all material income tax positions for periods that remain open under applicable statutes of limitation, as well as positions expected to be taken in future returns. The UTP rules then impose a recognition threshold on each tax position. A company can recognize an income tax benefit only if the position has a “more likely than not” (i.e., more than 50 percent) chance of being sustained on the technical merits. In making this determination, the possibility that the company will not be audited, or the position will escape an auditor’s notice, cannot be taken into account.
If a tax position does not meet the “more likely than not” recognition threshold in the first tax period, the benefits cannot be recognized. However, they may be recognized later if: (1) the threshold is met in a later period; (2) the matter is resolved with the appropriate taxing authority; or (3) the statute of limitations expires. The UTP rules call for derecognition of a previously recognized position in the first tax period in which it is no longer “more likely than not” that the position would be sustained on its technical merits.
If a position passes the recognition threshold, then as a second step, the UTP rules require that the position be measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement.
Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in (1) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable; (2) a reduction in a deferred tax asset or an increase in a deferred tax liability; or (3) both (1) and (2).
The UTP rules also provide guidance on interest and penalties, accounting in interim periods, disclosure, and transition.
The UTP rules apply to all entities that prepare GAAP financial statements.
 Accounting for Uncertain Tax Positions (FIN 48) Manager, Wolters Kluwer
ASC 740-10-50-15 and ASC 740-10-50-19 provides unrecognized tax benefit related disclosure guidance.
Specifically, ASC 740-10-50-15 provides that all entities shall disclose all of the following at the end of each annual reporting period presented:
- The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position
- For positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date:
- The nature of the uncertainty
- The nature of the event that could occur in the next 12 months that would cause the change
- An estimate of the range of the reasonably possible change or a statement that an estimate of the range cannot be made
- A description of tax years that remain subject to examination by major tax jurisdictions
In addition to the above, and prior to the issuance of ASU 2009-06, ASC 740-10-50(a) & (b) required that an entity would have to disclose all of the following at the end of each annual reporting period presented:
a. A tabular reconciliation of the total amounts of unrecognized tax benefits at the beginning and end of the period, which shall include at a minimum:
- The gross amounts of the increases and decreases in unrecognized tax benefits as a result of tax positions taken during a prior period
- The gross amounts of increases and decreases in unrecognized tax benefits as a result of tax positions taken during the current period
- The amounts of decreases in the unrecognized tax benefits relating to settlements with taxing authorities
 Accounting for Uncertain Tax Positions (FIN 48) Manager, Wolters Kluwer
* For a downloadable and printable version of this article please click here.Read More
On August 9, 2020, President Trump signed an executive order that allows for the deferral of withholding, deposits, and payments of the employee portion of Social Security tax from September 1 to December 31, 2020. Further to this, on August 28, 2020 the Treasury issued Notice 2020-65 providing guidance on the implementation of President Trump’s executive order.
The deferral is only available to employees whose biweekly compensation is less than $4,000, or $104,000 per year. The $4,000 is evaluated on a per payroll period basis. Additionally, only the employee portion of the Social Security tax is deferred. The employee portion of the Medicare tax is not impacted by the executive order. The executive order came into effect on September 1 and will end on December 31, 2020. Employers are not required to defer the withholding or deposit of Social Security tax. Notice 2020-65 provides only that no interest and penalties will be imposed if the employer does not deposit the tax.
The deferred taxes must be “repaid” because they are currently only deferred per the guidance released, and not forgiven. Under existing tax law, an employer is liable for payroll taxes, including the employee portion of Social Security taxes, even if it is not withheld from an employee. Nothing in the Treasury guidance or the Presidential Memorandum changes that principle.
The Notice explains that an employer must repay the deferred tax by withholding extra social security taxes ratably from wages paid to employees whose Social Security tax was deferred between January 1, 2021, and April 30, 2021 (resulting in lower employee net pay during that period). If an employer fails to “repay” the deferred taxes, interest and penalties will be imposed on the employer with respect to the unpaid or underpaid amount beginning May 1, 2021.
This is not the first time that Social Security tax relief has been given to taxpayers. In 2009 and 2010, a tax credit of $400 was given to individuals and $800 to families during the Obama administration. However, this was done through legislation, not through an executive order. When it comes to the collection of deferred tax in 2021, the Payroll Tax Deferral program leaves many questions unanswered, including whether state laws even allow deduction of deferred taxes from future earnings.Read More
Supreme Court Denies Review of Tax Breaks for Big Tech Companies in Altera but the Controversy Continues
The Supreme Court denied a petition of certiorari in Altera v. Commissioner on June 22, 2020, a closely followed case from the Ninth Circuit concerning the validity of a 2003 Treasury regulation requiring participants to include stock-based compensation (SBC) as intangible development costs (IDCs) in cost-sharing arrangements (CSAs). Altera argued that Treasury violated the Administrative Procedure Act (APA) by concluding that their final rule was consistent with the arm’s-length standard notwithstanding contrary evidence presented that unrelated parties would never agree to share each other’s SBCs. Despite a rare unanimous 15-0 Tax Court opinion in favor of Altera, the Ninth Circuit reversed in a 2-1 June 2019 decision which held that the Government had adequately supported its position in the record and that the position on the underlying issue did not constitute a policy change.
Despite this multi-billion dollar win for the Treasury at the court of last resort, the holding is only binding on companies in the Ninth Circuit, so this is not the end of the Altera issue. Meanwhile, technology companies must evaluate how to respond in their tax filings, on their financial statements and to contractual clauses that may have just been triggered in their CSAs.
Stock-Based Compensation and Cost Sharing Arrangements
The regulations that Altera contested required it to include SBC as a component of its IDCs shared with its foreign subsidiaries in order to develop technology benefiting domestic and foreign markets. Like many other tech companies, Altera established a foreign subsidiary in a low tax rate jurisdiction, transferred the non-U.S. rights to intangible property to it, and then shared the costs to develop the core technology pursuant to a CSA.
In the relatively high U.S. tax rate climate that prevailed until tax reform became effective in 2018, U.S. companies optimized the value of the tax deductions arising from these CSAs by allocating more costs to the U.S. and by limiting the costs in the base that were required to be allocated in the first place. Whether measured in terms of the tax deductions they produce or the financial statement expenses recorded for them, including SBC in a CSA results in an enormous shift of tax liability to the U.S. and a significant increase on the global tax burden due to the resulting adverse tax rate arbitrage.
After the Ninth Circuit reversal, Altera, which is now owned by Intel, and other tech companies based in the Ninth Circuit reportedly faced billions of dollars in cash payments and financial statement charges. Those that waited for the Supreme Court outcome will face those consequences in the quarter just concluded. Further, many companies stopped cost sharing of SBC and inserted a “reverse clawback” clause in their CSAs after the 2015 invalidation of the Treasury regulations by the Tax Court. This clause provides that if the regulations were ultimately upheld, the U.S. company would be required to charge out to the foreign CSA participants the quantum of costs that should have been shared in the intervening years.
The Supreme Court’s action is likely a triggering event for many of these reverse clawback charges which presents a myriad of issues and implications. For example, some taxpayers may want to report the payments all in the current year rather than amending prior year returns. On the surface this seems advantageous given the favorable rate arbitrage of 21% today versus the 35% rate in pre-TCJA years and the commensurate reduction in foreign earnings and profits subjected to the Section 965 transition tax. However, the IRS might contest such an application of these contractual clauses. CARES Act NOL carrybacks complicate the analysis. Foreign governments may well object to a deduction for the payments which could be material since many companies migrated their offshore intangibles from tax havens to locations with “DEMPE” such as Ireland or the Netherlands in response to the OECD’s BEPS initiative. Statute of limitations issues complicated by an overlay of transfer pricing rules are implicated as well, potentially exposing taxpayers to a whipsaw where income could be double taxed through an IRS assessment for inclusion of the chargeback in the prior years while denying a compensating adjustment to remove it in the current year once reported on an original return.
In order to avoid penalties when taking a position on a U.S. tax return, a company must be able to muster sufficient precedential support constituting “substantial authority” or, alternatively, a “reasonable basis” with adequate disclosure of the position to the IRS. Practitioners typically measure substantial authority, as a position that has a 40-45% chance of success and reasonable basis at a 20-25% chance of success. The authorities that companies can rely on in making this highly judgmental assessment include the Internal Revenue Code; Treasury regulations, both final and proposed; revenue rulings; legislative committee reports; and court cases.
Obviously, a Supreme Court decision or refusal to hear a case ranks among the highest authorities. By denying certiorari, the Ninth Circuit’s reversal of the Tax Court’s decision is binding on all companies in that circuit. Since many large tech companies with this issue are headquartered in the Ninth Circuit, Treasury has essentially won the Altera issue for the time being. However, the Tax Court has nationwide jurisdiction, so companies outside the Ninth Circuit can still rely on the Tax Court’s unanimous decision. Large tech companies would welcome a decision by another circuit court affirming the Tax Court’s decision because the Supreme Court would be much more likely to take certiorari if there is a split decision amongst the circuits. However, the Altera issue took seventeen years to work through the court system, so it is unlikely that any new developments will produce clarity, much less relief, any time soon. Therefore, the Altera issue will likely persist and create controversy for some time to come even though the ruling is unlikely to affect current corporate tax strategies because of changes made in the 2017 tax reform law.
ASC 740 Considerations
Companies in the Ninth Circuit that already accounted for the adverse outcome in Altera last year when the Circuit Court issued its opinion will not face extreme financial statement consequences for the quarter just concluded. However, if a company in the Ninth Circuit has not recorded any uncertain tax positions, its quarterly financial statements will likely reflect a substantial tax expense from the Altera issue.
Companies outside of the Ninth Circuit most likely will not report any change for Altera regardless of their position on the underlying substantive position of inclusion of SBC compensation in a CSA. Most will likely have followed the Tax Court’s favorable decision. The Altera decision was procedural so it has no direct impact on the substantive issue. As noted above, these companies can rely on the Tax Court’s decision for the procedural issue. Such taxpayers should have previously concluded on the more-likely-than-not threshold for recognition on the substantive issue based on other relevant authorities. The only avenue for an adjustment in reserves by such companies based on the Alteradevelopments would be a change in judgment regarding the measurement standard based on “new information” regarding an emboldened IRS that would be very unlikely to negotiate the issue at this point. However, that change likely already occurred in July 2019 when the IRS very publicly instructed its agents to once again pursue enforcement of the contested regulation shortly after the Ninth Circuit reversal.
As amended by the Tax Cuts and Jobs Act (TCJA), Internal Revenue Code (“IRC”) Section (“Sec.”) 274(a)(4) disallows deductions for the expense of any qualified transportation fringe (QTF) as defined in IRC Sec. 132(f) provided to an employee of the taxpayer for amounts paid or incurred after December 31, 2017. The value of a qualified transportation fringe benefit provided by an employer to an employee is excluded from the employee’s income, subject to monthly limits. Under pre-TCJA law, a deduction was not barred for the expenses of providing qualified transportation fringe benefits or other transportation or commuting benefits to an employee.
Although the TCJA denies the employer a deduction for the qualified transportation fringe benefit, it does not change the employee’s exclusion of the benefit from income under IRC Sec. 132, except in the case of qualified bicycle commuting reimbursements.
Employees are allowed to exclude, from their gross income, up to $270 per month as a QTF benefit pursuant to IRC Sec. 132(f)(2). The monthly limit is adjusted annually for inflation. Amounts paid in excess of $270 per month are considered taxable income to the employees and deductible by the employer. As mentioned previously, amended IRC Sec. 274(a)(4) provides that no deduction is allowed for the expense of any QTF provided to an employee of the taxpayer.
It should be noted that the rules that disallow the deduction for QTF benefits are subject to three important exceptions which include amounts paid by the employer that are includible in the employees taxable income; amounts paid for goods, services, and facilities made available by the taxpayer to the general public; and finally, amounts paid for goods or services (including the use of facilities) that are sold by the employer in a bona fide transaction for an adequate and full consideration in money or money’s worth.
Notice 2018-99 provided interim guidance for taxpayers to determine the amount of parking expenses for qualified QTFs that is nondeductible under IRC Sec. 274(a)(4). That Notice had a four-step method for making that determination where the taxpayer owned or leased the parking facilities. Those four steps are summarized as:
Step 1. Calculate the disallowance for reserved employee spots.
Step 2. Determine the primary use of remaining spots (the “primary use test”).
Step 3. Calculate the allowance for reserved nonemployee spots.
Step 4. Determine remaining use and allocable expenses.
The IRS recently released proposed regulations (REG-119307-19) clarifying how to determine the amount of QTF expenses that are nondeductible. Until final regulations are issued, taxpayers may rely on the proposed regulations or the guidance in Notice 2018-99. The proposed regulations would create Regulation (“Reg.”) Sec. 1.274-13 which addresses QTF parking expenses paid or incurred by an employer (along with certain exceptions in IRC Sec. 274(e)) and Reg. Sec. 1.274-14 to address expenses incurred to provide any transportation, or any payment or reimbursement, to an employee in connection with travel between the employee’s residence and place of employment, except as necessary for ensuring the safety of the employee.
Parking Guidance (Reg. Sec. 1.274-13)
The proposed regulations delineate between situations where the employer pays a third party for its employee’s QTF and situations where the employer owns or leases the parking facility.
Where Taxpayer Pays a Third Party – The proposed regulations provide that if the taxpayer pays a third party for its employee’s QTF, the IRC Sec. 274(a)(4) disallowance is generally calculated as the taxpayer’s total annual cost of the QTF paid to the third party.
Where the Taxpayer Owns or Leases the Parking Facility – With regard to QTF parking expenses, the proposed regs provide that if the taxpayer owns or leases all or a portion of one or more parking facilities, the Code Sec. 274(a)(4) disallowance may be calculated using a general rule or any one of three simplified methodologies. These methodologies are an annual election that are made on a facility by facility basis.
- General rule
- Qualified Parking Limit Method
- Primary Use Method
- Cost per Space Method
General Rule: The taxpayer can use a reasonable interpretation to calculate its QTF expenses, which is limited in three ways: (1) the expense cannot be calculated based on the value of the employee parking; (2) the taxpayer cannot deduct expenses related to spaces reserved for employees; and (3) the taxpayer cannot improperly apply the exception for qualified parking made available to the public. Regarding the third limitation, the employer cannot treat a parking facility regularly used by employees as available to the general public simply because the general public has access to the parking facility.
Qualified Limit Methodology: The taxpayer can determine the monthly qualified limit disallowance of deductions by multiplying the total number of spaces used by employees during the peak demand period, or the total number of taxpayer’s employees, by the monthly per employee limitation on exclusion ($270 in 2020). This methodology may be used only if the taxpayer includes the value of the qualified transportation fringe in excess of the sum of the amount, if any, paid by the employee for the qualified transportation fringe and the applicable statutory monthly on the taxpayer’s Federal income tax return as originally filed as compensation paid to the employee and as wages to the employee for purposes of withholding under chapter 24 of the Code (relating to collection of Federal income tax at source on wages).
Primary-Use Methodology: The taxpayer may use the primary-use methodology to determine its QTF expense by using the following four-step approach to calculate the disallowance of deductions for each parking facility:
- Step 1. Calculate the disallowance for reserved employee spots.
- Step 2. Determine the primary use of remaining spots (the “primary-use test”).
- Step 3. Calculate the allowance for reserved nonemployee spots.
- Step 4. Determine remaining use and allocable expenses.
Cost Per Space Methodology: The taxpayer can calculate the disallowance of deductions for QTF parking expenses by multiplying the cost-per-space by the total number of available parking spaces used by employees during the peak demand period. The product of that amount is the deduction for total parking expenses that are disallowed. The term peak demand period is defined as the period in a typical business day when the greatest number of the taxpayer’s employees are using parking spaces in the taxpayer’s facility.
Additional Guidance in the Proposed Regulations
Typically, an employer that owns its parking facility will have a variety of expenses associated with the facility that makes it difficult to identify the parking portion of the expenses. If the employer elects to use the primary-use methodology or the cost-per-space methodology, the proposed regulations allow the employer to allocate the “mixed parking expenses” using any reasonable methodology, with a 5% safe harbor. This means that the IRS will not question a taxpayer’s return if it takes a deduction of 5% of the total mixed parking expenses. Mixed parking expenses include any rental agreement expenses, property taxes, interest expense, and expenses for utilities and insurance.
The proposed regulations also broaden the applicability of the aggregation rule for parking spaces in the same geographic location. The aggregation rule allows a taxpayer to combine spaces together that are located in the same geographic region. The proposed regulations would allow taxpayers to apply the aggregation rule when calculating the QTF expenses using the general rule and the cost-per-space methodology.
Expenses for transportation in a commuter highway vehicle or transit pass (Reg. Sec. 1.274-14)
The proposed regulations clarify that, unless the expenses are incurred for the safety of the employee, no deduction is allowed for any expense incurred for providing any transportation, or any payment or reimbursement, to an employee of the taxpayer in connection with travel between the employee’s residence and place of employment. Travel between the employee’s residence and place of employment includes travel that originates at a transportation hub near the employee’s residence or place of employment. For example, an employee who commutes to work by airplane from an airport near the employee’s residence to an airport near the employee’s place of employment is traveling between the residence and place of employment.
The proposed regulations provide much needed guidance to assist taxpayers in determining the amount expenses related to QTF benefits that are or are not deductible. By making the expense allocations both an annual election and one that is made on a facility by facility basis, the IRS is providing the taxpayers with the flexibility to determine the optimal methodology or methodologies which will result in the least amount of disallowed expenses.
California has at times either restricted the ability of individuals and corporations to utilize the full carryover amount of net operating losses (“NOLs”) or completely suspended net operating loss deductions for business entities and individuals with business income in response to facing budgetary constraints. For example, in response to the global mortgage crisis that began in 2008 and the severe recession that followed and triggered a state budget crisis, California suspended NOL deductions for years from 2008 through 2011.
CA Assembly Bill 85
With the COVID-19 pandemic an omnipresent influence on daily life, state governments are trying to recoup lost funds through tax law changes. As a result of the coronavirus pandemic, California has a projected budget deficit of around $54 billion. To mitigate the effects of lost general fund revenues and increased health and human services costs, on June 29, 2020, Governor Gavin Newsom signed into law Assembly Bill 85 (“AB 85”). Two of the main provisions of AB 85 mirror the state’s historical efforts to regain lost revenues by suspending NOL deductions and limiting business incentive tax credits. The projected revenues for these two provisions of AB 85 total $9.2 billion: $4.4 billion in 2020-2021, $3.3 billion in 2021-2022, and $1.5 billion in 2022-2023.
Suspension of Net Operating Loss Utilization
NOL usage for California taxpayers with net business income of $1 million or more will be suspended for tax years beginning on or after January 1, 2020 and before January 1, 2023. As with similar provisions previously enacted, the carryover period for suspended NOLs has been extended. For losses incurred in taxable years beginning on or after January 1, 2021, and before January 1, 2022, the carryover period has been extended one year. For losses incurred in taxable years beginning on or after January 1, 2020, and before January 1, 2021, the carryover period has been extended two years. For losses incurred in taxable years beginning before January 1, 2020, the carryover period has been extended three years. However, under Legal Ruling 2011-4, the California Franchise Tax Board (“FTB”) takes the position that unless a taxpayer could utilize at least $1 of NOL during a suspension year, the taxpayer is not entitled to the extended carryover periods.
Limitation of business incentive credits
AB 85 also limits the use of business incentive tax credits for taxable years 2020, 2021, and 2022 by requiring that credits not reduce the applicable tax by more than $5 million. This limitation is applied on a combined group basis. Similar to the suspended NOLs, credit carryforward periods have been extended by an additional year for each year the credit is impacted by the limitation. The limitation on the utilization of credits extends to the California research and development (“R&D”) credit, jobs tax credit, motion picture production credits, and California competes credit and impacts both corporate and personal income taxpayers. Certain credits, however, including the low-income housing tax credit and earned income tax credit, among others, are excluded from this limitation.
Implications and Tax Planning
As this assembly bill was passed prior to the close of calendar year entities’ quarter 2 close, it is necessary to evaluate the implications as part of any Q2 2020 filings and disclosures. Companies should consider whether or not it makes sense to implement tax planning strategies to increase taxable income in 2019 to utilize unrestricted NOLs and/or to reduce taxable income below $1 million for years 2020, 2021 and 2022 to the extent possible, such as, among many planning ideas, accelerating deductions, adopting accounting method changes, and making California 59(e) elections on 2019 tax returns to push deductions to years when the NOL is suspended. In addition, based on the methodology applied by the FTB under Legal Ruling 2011-8, depending on the value of the NOL available by year, under a cost versus benefit analysis, it may be advantageous for a taxpayer to increase taxable income above $1 million during one or more of the suspension years in order to obtain the additional carryover periods for certain prior year net operating loss carryforwards.
While this tax law change is inconvenient for many business entities, it is not a new method for states, particularly California, to employ to regain lost revenues. There is historical precedent for similar revenue generating measures instituted by California dating back many years. While COVID-19 continues to present ongoing business, economic, personnel, and planning challenges, ways to mitigate the impact of the California NOL suspension and the business incentive credit limitation should be highlighted and investigated.Read More
Multnomah County Reviewing Two Tuition-Free Preschool Measures for November Ballot – Both Seek to Tax High-Earners
Multnomah County has two tuition-free preschool measures that may go to the ballot this November. The first campaign, Universal Preschool Now, has received enough signatures to be considered by the Multnomah County Board of Commissioners. This campaign has been developed by an independent task-force group. The other campaign, Preschool For All, is developed by a county-based task force. The Preschool For All measure is spearheaded by County Commissioner Jessica Vega Pederson, and since it is backed by the county, it will not need to collect signatures before being referred to the ballot this fall.
The Universal Preschool Now has collected enough signatures to send it to the Multnomah County Board of Commissioners for consideration. The Board of Commissioners has until September 3 to decide what it will do with the measure. It can either send the measure to the ballot for voter approval this November, or it can adopt the measure and have it become an ordinance of Multnomah County. If the Board of Commissioners elects to adopt the measure, it will still have the ability to take action and amend the measure as it sees fit. The Preschool For All campaign is still being developed by a county-based task force, but it will likely be put on the ballot as well this fall.
Universal Preschool Now
The Universal Preschool Now measure is the more aggressive tax of the two tuition-free preschool measures. If voters pass the measure in November, Multnomah County residents will be subject to a 3.9% tax on personal Oregon taxable incomes over $165,000 and joint incomes over $190,000. A taxpayer is considered a Multnomah County resident if they are domiciled in Multnomah County for any portion of the taxable year. If passed, the tax will begin on or after January 1, 2021. Multnomah County single-filing residents would be subject to a 14.8% (4.9% Local + 9.9% State) incremental state and local tax rate on income over $165,000. This new tax, coupled with the recent 1% tax to fund housing services for homeless people in the metro area would cause Multnomah County taxpayers to pay some of the highest taxes in the country.
The County Attorney, Jenny Madkour, stated that since the measure was not born in Multnomah County, it would likely need to be right-sized, reviewed, and revised to make sure it fits within the County’s administrative functions and processes. She did state that the measure is “tax legal” and is going through the proper process, so it would withstand legal scrutiny.
Preschool For All
The Preschool For All measure targets a broader range of taxpayers, at lower rates. If this measure passes in November, single filers with incomes over $125,000 and joint incomes over $200,000 will be subject to a 1.5% tax. Single filers with incomes over $250,000 and joint incomes over $400,000 will be subject to an additional 1.5% tax (3% total). Both taxes will get an automatic bump of 0.8% in January 2026, which would raise the rates to 2.3% for the lower-income level, and 3.8% for the higher-income level. The tax would be imposed on both resident and non-resident incomes that are earned in Multnomah County. The Preschool For All measure will also go into effect on or after January 1, 2021.
With potentially two tuition-free preschool measures on the ballot this fall, there is a chance that both measures will pass. If this happens, both would be a part of the Multnomah County ordinance structure. The Board would then have the authority to change, alter, or amend these ordinances, as long as it is lawful. The Universal Preschool Now measure needed 23,000 signatures in order to be referred to the Multnomah County Board of Commissioners, and it collected over 32,000 signatures, which is a strong indication that one of these measures may pass if it goes to the ballot this fall. This measure is also similar to the education levy passed by Seattle voters in 2018, which passed by a wide margin. If either measure is passed, high-earners in Multnomah County can expect to pay some of the highest incremental tax rates in the country.Read More