The IRS recently clarified how employers should treat payments and reimbursements they make in 2018 for work-related moves that employees made in a prior year, in light of the new tax law.
The Tax Cuts and Jobs Act that the government quickly passed into law at the end of 2017 requires employers to treat moving expenses as taxable income to employees. However, when an employee receives reimbursement in 2018 for moving expenses they incurred in a prior year, they may treat those amounts as tax-free for 2018 federal income and employment tax purposes. The same is true if the employer pays a moving company in 2018 for qualified moving services provided to an employee prior to 2018.
This tax relief is not available for moves that occur in 2018 or later unless the employee is an active-duty member of the U.S. Armed Forces whose move is due to or related to his or her military service.
The new tax law makes a number of changes to how employers and employees may treat certain work-related expenses in 2018 through 2025. Taxpayers should meet with experienced advisors and accountants before the end of the year to plan accordingly.
About the Author: Flor Escudero, CPA, is a senior manager of Tax Services with Berkowitz Pollack Brant, where she provides domestic and international tax guidance to businesses and high-net-worth individuals. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
Businesses across all industries are facing a serious time crunch to come onto compliance with two new accounting standards that will materially affect the financial metrics and performance they report in the future. While most private companies have focused the majority of their efforts on meeting the more time-sensitive deadline of Dec. 15, 2018, to apply the new revenue recognition standards, many are woefully unprepared to tackle the equally complex and time-consuming lease accounting requirements that go into effect one year later.
The new lease accounting standard requires businesses to identify and record for the first time on their balance sheets all operating lease agreements, including assets, liabilities and expenses with terms greater than 12 months. In addition to recording a right-of-use asset and the corresponding lease liability on their balance sheets at the present value of the lease payments, business will also need to record amortization of the right-of-use asset on their income statements, generally on a straight-line basis over the lease term.
From an organizational perspective, identifying qualifying leases necessitates commitments of time, careful planning and collaboration across many business units beyond the finance and/or accounting functions. For example, it is not sufficient for businesses to merely look back at last year’s financial statements and convert leases previously included in notes as line items on their balance sheets going forward. Instead, identifying leases will internal executives and external advisors who oversee real estate, transportation, equipment procurement, legal contracts and IT across multiple offices to physically comb through all of the existing contracts and purchase orders in their physical and digital file cabinets to determine if they involve lease arrangements. Under certain circumstances, the existence of a lease may be not be easily identifiable. For example, service contracts for IT software and systems commonly include embedded leases, which businesses may easily overlook and fail to include on their balance sheets.
After a business locates every single one of their qualifying leases, they must inventory those arrangements with exacting detail, perhaps on a spreadsheet or entering them into any of the new lease accounting software programs that store and automate the future reporting requirements for those and other leases. At that point, the business must analyze each contract and extract from each individual lease arrangement all relevant data, including lease payments, variable lease payments, debt obligations and lease renewal options, which must move onto the balance sheet. This can be a challenge considering that not all employees tasked with uncovering leases will have the skillset required to cull needed information from those contracts, nor will every employee understand the potential risks or rewards of those arrangements.
For businesses with significant portfolios of leased assets, transitioning to the new lease standard may negate and eliminate the use of many of the tax-planning strategies they relied on in the past to keep leases off their balance sheets. Additionally, businesses with a high-dollar value of lease obligations must be mindful that the new accounting standard may result in substantial changes to the net income, cash flow, return on assets and other metrics that they report and that they and their stakeholders rely on to make important business decisions. To minimize the impact of these balance sheet changes, businesses must begin planning immediately and carefully to identify with as much accuracy as possible the amount they expect to record as lease assets in the future. This will give businesses ample time to prepare for the changes, communicate them with stakeholders and seamlessly implement new strategies to mitigate any potentially damaging effects on their future operational and financial performance.
A final warning to businesses preparing for the new lease accounting standards is the need to establish appropriate systems, policies and controls for monitoring existing leases, flagging new lease arrangements and recognizing them on their balance sheets in the future. This may require an investment in new technology, the hiring of new employees and/or the engagement of outside advisors who are qualified to manage these responsibilities.
There is no doubt that the lease accounting standards will add new complexities to a broad range of business functions, including sales, lending, contracting and financial reporting. However, under the new rules, businesses will be able to centralize the inventory and management of all lease arrangements and gain a clearer view of whether those assets are improving business performance.
Coming into compliance with the new lease standards by the deadline date may seem overwhelming, especially in light of the multitude of pressures businesses face complying with other new reporting standards, the new tax laws and the day-to-day demands of running a profitable operation. However, there is little time left for procrastination. Business should allocate needed resources now to get started on implementing a scalable lease accounting compliance program that is sustainable over the long term. One way that businesses can ease their compliance burdens is to meet with their accountants and auditors, who can develop and implement strategies that may ultimately improve financial performance.
About the Author: Whitney K. Schiffer, CPA, is a director of Audit and Attest Services with Berkowitz Pollack Brant, where she works with hospitals, health care providers, HMOs, third-party administrators and real estate businesses. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Here is a list of some of the new tax rules, issues and year-end planning opportunities that we are discussing with our clients:
Corporate and General Business Provisions
- New 21% corporate tax rate, repeal of corporate AMT (taxpayers with AMT credit can still use the credit to offset regular tax and claim refunds) and new NOL use limitations (80% of TI, repeal of two-year carryback, indefinite carryforward).
- More taxpayers are now eligible to use cash method of accounting and exempt from requirements to maintain inventories and use certain long-term contract accounting and UNICAP rules ($25M average annual gross receipts threshold).
- Increased immediate expensing under Section 179 (up to $1M), new phase-out threshold amount ($2.5M) and expanded definition of “qualified real property.”
- 100% bonus depreciation on qualified property (phased down after 2022) and expanded definition of qualified property (including used property).
- New interest expense limitation (30% of EBITDA) for higher income taxpayers, but certain taxpayers (e.g., real property businesses and farms) may be able to elect not to apply the limitation.
- New revenue recognition rules for accrual-basis taxpayers with applicable financial statements (this should be considered in conjunction with adoption of new GAAP revenue recognition standards under ASC 606).
- New rules for amortization of research & experimental (R&E) expenditures, including software development expenditures (generally amortized over 5 years).
- Repeal of Sec. 199 deduction for domestic production activities.
- Repeal of deduction for entertainment activities, membership dues, and certain employee transportation fringe benefits.
- Expanded limitations on deductibility of officer compensation and related restructuring considerations for senior executive compensation programs.
- State tax implications of the federal tax reform and new post-Wayfair sales tax economic nexus laws passed by many states.
Flow-through Entities and Real Estate Businesses
- New 20% pass-through (Section 199A) deduction on certain qualified business income, REIT dividends and publicly traded partnership income, and related restructuring opportunities and aggregation elections.
- Qualified Opportunity Zones – temporary (and some permanent) deferral of capital gains reinvested in Qualified Opportunity Funds (QOF) and permanent exclusion of gains from sale of investment in QOF after 10 years of ownership.
- Section 1031 like-kind exchanges – nonrecognition treatment limited to real properties, but it may be possible to mitigate unfavorable impact on personal property by using immediate expensing provisions.
- Carried interest rules – new three-year hold requirement to treat capital gains as long-term capital gains for certain partnership profits interests, and related deal structuring and planning considerations.
- Repair studies and analysis of fixed asset additions under tangible property regulations is still very relevant.
- Cost segregation studies are now more beneficial than ever due to new bonus depreciation rules (i.e., used personal property and land improvements are now eligible for 100% bonus depreciation).
- Real property businesses that elect out of interest expense limitation rules are required to use Alternative Depreciation System (with no bonus depreciation, but ADS recovery period for residential rental property shortened to 30 years).
- Certain capital contributions, such as contributions in aid of construction, subjected to tax under modified Section 118.
- Repeal of local lobbying expense deduction.
- 100% of foreign-source portion of dividends received from certain foreign subsidiaries (of which US Corp owns at least 10%) are exempt from US tax.
- Global intangible low-taxed income (GILTI) and Subpart F income planning.
- Domestic International Sales Corporation (DISC) and Foreign Derived Intangible Income (FDII) regimes and related tax planning.
- Repatriation of foreign earnings subject to the Sec. 965 toll charge before the end of 2018.
- Non-U.S. planning to reduce withholding tax that may no longer be creditable in the U.S. due to tax reform.
- Certain gains/losses on foreign partner’s sale of a partnership interest treated as ECI, which may create additional tax and withholding requirements.
- Repeal of certain cross border attribution rules which may cause tax inefficiencies to existing structures
- Trust planning for cross border families with U.S. beneficiaries who will no longer be able to rely on the 30-day rule to plan out of controlled foreign corporation (“CFC” status)
- Changes in tax rates, larger standard deductions (but no personal exemptions), no phase out of itemized deductions, larger AMT exemptions and child tax credit.
- Elimination of miscellaneous itemized deductions, including portfolio deductions, but some planning including use of investment management LLCs may still be available.
- New “excess business loss” limitations (for business losses over $500,000 for joint filers / $250,000 for all other filers), converting disallowed losses to NOLs.
- Grouping of trade or business activities for purposes of minimizing passive loss limitations and the 3.8% net investment income tax is still very important, and now there is another level of complexity with new aggregation rules for purposes of 20% flow-through deduction on certain qualified business income.
- Mortgage interest deduction limited to interest on $750,000 of acquisition indebtedness (but certain mortgages are grandfathered).
- State and local tax deductions limited to $10,000, but taxes on property used in a trade or business or held for investment may still be deductible.
- Increased depreciation deduction for certain luxury passenger automobiles.
- Charitable contribution deductions limit increased to 60% of AGI for cash and CG property contributions to public charities and private operating foundations.
- Personal casualty loss deductions limited to losses incurred in federally declared disaster areas.
- Section 529 qualified tuition plans can now be used not only for college tuition expenses but also for K-12 tuition expenses up to $10,000 per year.
- Estate and gift tax – basic exclusion amount increased to $10M, indexed for inflation after 2011.
- Need for new independent valuations for purposes of partner / shareholder buy-sell agreements.
Individual consumers are not the only victims of identity theft. According to the IRS, criminals are increasingly targeting small businesses and the confidential data they manage. Too often, businesses neither have the proper controls in place to prevent or detect frauds nor are they prepared to deal with the fallout that can occur after a breach, including loss of income and irreparable damage to their reputations. To minimize their risks and defend against these scams, businesses must have a strong offense.
One of the most common forms of small business identity theft involve scammers using a business, partnership, trust or estate’s legitimate Employer Identification Number (EINs) to apply for a line of credit or file a fraudulent tax return with the hope of receiving a bogus refund. To protect themselves from these schemes, businesses should take the time to verify the legitimacy of the tax returns they file by responding to the following “know your customer” requests from the IRS, state taxing agencies and/or their tax preparers:
- What is the name and Social Security number of the individual who signed the tax return?
- What are the company’s tax filing and tax payment history?
- Provide information about the business’s parent company.
- Provide additional information about the deductions the business claimed.
Sole proprietorships that file Schedule C and partnerships filing Schedule K-1 with Form 1040 may be asked to provide additional information, such as a driver’s license number, in order to help taxing authorities identify suspicious business-related tax returns.
It is equally important that businesses stay on alert and recognize these signs that may indicate that they have in fact become victims of identity theft:
- The IRS rejects a business’s e-filed tax return or extension to file request because it already has on file a duplicate Employer Identification Number or Social Security number or tax return with this information;
- Taxpayers receive from the IRS Letter 5263C or 6042C notifying them that their identities have been stolen;
- Taxpayers receive an unexpected receipt of a tax transcript or IRS notice that does not correspond to anything they submitted to taxing authorities;
- A business fails to receive expected and routine correspondence from the IRS, which could mean that a thief changed the business’s mailing address.
Small businesses looking to protect and secure their identity should speak with their accountants to help assess their existing security protocols and efforts to minimize risks, make recommendations to better protect information assets, and educate employees on how to spot and avoid falling victim cyberattacks.
About the author: Joseph L. Saka, CPA/PFS, is CEO of Berkowitz Pollack Brant, where he provides a full range of income and estate planning, tax and business consulting and compliance services, and financial planning expertise to entrepreneurs, high-net-worth families and family companies and business executives in the U.S. and abroad. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via e-mail at email@example.com.
Investors around the world continue to view U.S. commercial real estate as an attractive asset to diversify their portfolios, minimize exposure to market volatility and build wealth. However, most of these projects require more capital than the average individual has to invest. In response, a growing number of businesses that own, operate or finance commercial properties are pooling their assets into public and private real estate investment trusts (REITs) to attract capital from individuals and institutional investors and yield preferential tax treatment. Understanding the nuances of qualifying for this type of real estate holding structure and adhering to a maze of complex regulatory requirements for structuring and negotiation REIT-related transactions requires the assistance of experienced tax professionals.
What is a REIT?
A REIT is a company that owns and operates income-producing real-estate assets, such as office buildings, shopping malls, multi-family properties, and warehouses, or that invests in mortgages secured by real estate. It typically includes a portfolio of real estate investments and is comparable to a mutual fund in that it allows a significant number of investors to own a share of large-scale real estate projects and receive dividend income without requiring them to invest significant dollars up front or exposing them to liquidity risks.
REITs may be traded publicly in the equity markets or a group of investors may hold them privately. They generally come in three forms:
- Equity REITs own and operate income-producing real estate,
- Mortgage REITs provide money to real estate owners through mortgages or mortgage-backed securities,
- Hybrid REITs are a combination of equity and mortgage REITs
What are the Tax Benefits of REITs?
For tax purposes, REITs are treated as C Corporations, similar to mutual funds, they receive the benefit of a tax deduction for the dividends they pay to their shareholders. As a result, REITs typically do not pay income tax at the corporate level. Instead, they enjoy a lower effective tax rate than typical C Corporations, which, beginning in 2018 is a 21 percent flat federal income tax rate.
Investors who own shares in REITs must pay taxes on the dividends they receive, which can be either ordinary or capital gains dividends. Indirectly, REIT shareholders get the benefit of the deductions that are usually available to real estate owners. These include interest payments, depreciation, and operating expenses taken at the REIT level. In addition, beginning in 2018, the Tax Cuts and Jobs Act (TCJA) introduces a substantial benefit for individual REIT shareholders by establishing a deduction equal to 20 percent of the shareholder’s ordinary REIT dividend income. Unlike a similar deduction for flow-through entities, REIT shareholders are not subject to limitations on this deduction based on the wages paid and the basis of qualified property.
REITs can also provide significant benefits to foreign investors, who may use REITs as “blockers” to help minimize their U.S. federal and state tax filing obligations. In addition, domestically controlled REITs, in which U.S. persons own more than 50 percent of the value of its stock directly or indirectly, can be structured to allow foreign investors to sell their stock of the domestically controlled REIT without incurring U.S. tax.
How can a Real Estate Holding Company Qualify as a REIT?
In exchange for preferential tax treatment, REITs must meet a number of burdensome organizational and operational requirements, including the following:
- REITS must be organized as corporations, trusts or associations, and managed by one or more trustees or directors;
- Beneficial ownership must be evidenced by transferable shares;
- There must be a minimum of 100 shareholders; and
- More than 50 percent of REIT shares cannot be held by five or fewer individuals.
Quarterly Asset Tests
- At least 75 percent of the value of total assets at the end of each quarter must consist of cash or cash items, government securities and real estate assets, including real property, mortgages on real property, shares in other REITs, and certain personal property leased with real property (that does not exceed 15 percent of combined real and personal property value);
- No more than 20 percent of the value of REIT may consist of securities of one or more Taxable REIT Subsidiary (TRS);
- No more than 25 percent of the value of the REIT assets may be represented by non-qualified publicly offered REIT debt instruments;
- Investment in securities of any one issuer (except for securities qualifying for the 75% asset test and securities of a TRS) cannot 1) exceed 5% of the value of the REITs total assets, 2) represent more than 10% of the total voting power of any one issuer’s securities, or 3) represent more than 10% of the value of the securities of any one issuer.
At least 75 percent of the REIT’s gross income for the taxable year must be derived from the following items:
- rents from real property,
- interest from mortgage obligations,
- gain from the sale of real property and mortgages on real property,
- other specified real estate source income,
- dividends from other REITs,
- abatements or refunds from real property tax,
- income and gain from “foreclosure property,”
- certain commitment fees, and
- income from certain temporary investments of new capital.
In addition, at least 95 percent of the REIT’s gross income must be from income items that qualify for the 75 percent income test, and other interest, dividends and gain from the sale of stock or securities.
For income-test purposes, rents that REITs receive from real property may include 1) amounts received for the right to use real property; 2) additional amounts collected from tenants for their share of real estate taxes or operating expenses and utilities; 3) rent attributed to personal property leased under a lease for real property if personal property rent does not exceed 15 percent of the total rent; and 4) charges for “customary” services rendered in connection with rental or real property.
Rents from real property generally exclude 1) rent based on net income or profits of any person (however, rents based on gross income are generally permissible), 2) related party rents (if the REIT owns 10% or more interest in the tenant, determined by applying specific attribution rules), and 3) impermissible tenant services income. If impermissible service income from a property exceeds 1% of total revenue derived from the property, then all income from the property is “tainted” as non-qualifying income (however, a TRS can generally provide impermissible services income to REIT’s tenants without tainting rents).
REITs must distribute 90 percent of their real estate investment trust taxable income (REITTI). The deduction they receive for dividends paid to shareholders in a taxable year must generally equal or exceed 90 percent of REITTI (excluding capital gain and without regard to the dividends paid deduction).
Failing to meet any of the REIT qualification requirements can lead to significant fines, treatment as a regular C corporation (i.e., losing the dividends paid deduction) and a loss of REIT status for five years.
Forming a private or public REIT structure can be a tax-efficient way for real estate businesses to attract capital from a wide variety of domestic and foreign investment sources, especially under the new U.S. tax laws. While REITs can raise capital and hold assets directly, most use more complicated structures in order to take advantage of certain tax benefits and the additional flexibility that these structures may provide. Structuring and managing this type of REIT structure is a complex, time consuming and potentially costly undertaking for which experienced real estate tax advisors should be engaged early on in the planning process.
About the Author: Arkadiy (Eric) Green, CPA, is a director of Tax Services with Berkowitz Pollack Brant, where he works with real estate companies, commercial and residential developers, property management companies, real estate investors and high-net-worth individuals to structure investments and complex transactions for maximum tax efficiency. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.