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Energy Tax Credits for a New World Part VII: Low-Income Communities Bonus Credits

National Law Forum — Wed, 18 Sep 2024 14:05:41 +0000

What is the Low-Income Communities Bonus Credit?

The Low-Income Communities Bonus Credit available through the Inflation Reduction Act of 2022 (IRA)[1] is designed to increase the siting of, and access to renewable energy facilities in low-income communities, encourage new market participants, and provide social and economic benefits to individuals and communities that have been historically overburdened with pollution, adverse health or environmental effects, and marginalized from economic opportunities.[2]

The Low-Income Communities Bonus Credit supports “a transformative set of investments designed to create jobs, lower costs for American families, and spur an economic revitalization in communities that have historically been left behind.”[3] With the Low-Income Communities Bonus Credit the U.S. government is helping to “lower energy costs and provide breathing room for hard-working families, invest in good-paying clean energy jobs in low-income communities, and support small business growth.”[4]

The Low-Income Communities Bonus Credit is an investment tax credit (ITC) available for certain clean energy investments in low-income communities, on Indian lands, with certain affordable housing developments, and for certain projects benefiting low-income households.[5] It is an ITC for certain clean energy investments in a “Qualified Solar or Wind Facility,” that is, a facility with a net output of less than five megawatts. Unlike most of the other tax credits we have looked at in this Q&A with Andie series, there is a competitive bidding application process. Projects must receive a “Capacity Limitation Allocation Amount” to receive these credits.

What are the eligibility categories for the Low-Income Communities Bonus Credit?

There are four project eligibility criteria to qualify for the Low-Income Communities Bonus Credit:

It is located in a “low-income community” (Category 1)
It is located on “tribal Indian land” (Category 2)
It is installed on certain federal housing projects that are qualified low-income residential building facilities (Category 3)
It serves low-income households as a “qualified low-income economic project” (Category 4)

These eligibility categories are discussed in what follows.

Which tax credits do Low-Income Communities Bonus Credits apply to?

The Low-income Communities Bonus Credit is an additional bonus credit available for ITC-eligible credits at Internal Revenue Code (Code) Section 48, Energy Property ITC, and Section 48E, Clean Energy ITC (CEITC). Section 48 applies to an “eligible facility” (that is, a qualified solar or wind energy facility) for which construction begins before 2025; while the CEITC applies to construction in qualifying clean electricity generating facilities and energy storage technologies that are placed in service after December 31, 2024.[6] The base credit may be increased by 10 percent (for a project located in a low-income community or on Indian land) or by 20 percent (for a qualified low-income residential building project or a qualified low-income economic benefit project).[7]

Because the Section 48 credit expires at the end of 2024 and the Section 48E (CEIT) becomes effective January 1, 2025, we will need to look at Section 48 separately from Section 48E (CEITC) when we address the allocation procedures.

How is the Low-Income Communities Bonus Credit calculated?

The Low-Income Communities Bonus Credit is one of the few IRA energy tax credits that requires an application process and the granting of a “capacity limitation allocation amount.” For allocations in 2023 and 2024, the Section 48(e) ITC provides an increased tax credit for an eligible facility that is part of a “qualified solar or wind energy facility” and that receives a capacity limitation allocation amount. For allocations in 2025 and thereafter, the Section 48E (CEITC) credit applies to a broader group of facilities than those covered under Section 48(e).[8] For both Section 48 and 48E (CEITC), the base credit amount is six percent of a qualified investment (that is, the tax basis of the energy property), and that amount can be increased by 10- or 20-percentage points with the Low-Income Communities Bonus Credit, depending on whether the project meets certain eligibility category requirements.[9] The 10 percent credit is available for an eligible facility in a low-income community or on Indian land, while the 20 percent credit is available for a “qualified low-income residential building project” or a “qualified low-income economic benefit project.”

What is a qualified solar or wind facility?

A Qualified Solar or Wind Facility is an eligible facility if it meets three requirements.[10] First, it generates electricity solely from a wind facility, solar energy property, or small wind energy property. Second, it has a maximum net output of less than five megawatts as measured in alternating current. And third, it is described in at least one of the four Low-Income Communities Bonus Credit project categories.[11]

Because the eligible facility must have a maximum net output of less than five megawatts as measured in alternating current, can applicants divide larger projects into smaller ones to meet the five megawatts requirements?

No. The Treasury has issued Final Regulations on Low-Income Communities Bonus Credit (Final Low-Income Communities Regulations),[12] effective August 15, 2023. The Final Low-Income Communities Regulations provide that the capacity limitation allocation amounts will be made on a “single project factors test.”[13] This is intended to prevent applicants from artificially dividing larger projects into multiple facilities in an attempt to circumvent the requirement for the maximum net output.[14]

When can a Qualified Solar or Wind Facility be placed in service?

A project cannot be placed in service until after it receives the capacity allocation.[15] This is because the Treasury holds that “requiring projects to be placed in service after allocation provides the best way to promote the increase of, and access to, renewable energy facilities that would not be completed in the absence of the program.”[16] This is not viewed as an impediment because Section 48(e)(4)(E)(i) provides a “lengthy window of four years to place a facility in service following an Allocation of Capacity Limitation.”[17] Section 48E (CEITC) also provides a four-year window to place the facility in service.[18]

Definitions

What is a Category 1 low-income community for purposes of the Low-Income Communities Bonus Credit?

A Category 1 low-income community is a community that is located in a census area where the poverty rate is at least 20 percent or more, or the median family income is 80 percent or less than the median family income in the state where the community is located.[19] If the census tract is in a metropolitan area, the median family income cannot be more than 80 percent of the statewide median family income or the metropolitan area’s median family income.

The poverty rate for an eligible Category 1 low-income census tract is generally based on the threshold for low-income communities set by the New Markets Tax Credit (NMTC) Program, as noted in the Treasury Regulations. The NMTC updates its eligibility data every five years based on poverty estimates from the American Community Survey (ACS). New eligibility tables and maps for the NMTC program were released on September 1, 2023, which use underlying ACS estimates from 2016 to 2020.[20] The next NMTC update will include ACS estimates from 2021 to 2025, at which point applicants will have a period of one year following the date that the 2021-2025 NMTC is released to use the 2016-2020 NMTC dataset.[21]

How is Category 2 tribal Indian land defined?

Category 2 Tribal Indian land is land of “any Indian tribe, band, nation, or other organized group or community that is recognized as eligible for the special programs and services provided by the United States to tribes (Indians) because of their status.”[22] To qualify as Indian land, the property must meet the definition of Section 2601(2) of the Energy Policy Act of 1992, which is defined as, “Indian reservations; public domain Indian allotments; former Indian reservations in Oklahoma; land held by incorporated Native groups, regional corporations, and village corporations under the provisions of the Alaska Native Claims Settlement Act[23]; and dependent Indian communities within the borders of the United States whether within the original or subsequently acquired territory thereof, and whether within or without the limits of a State.”[24]

The Energy Policy Act of 1992 was amended by the Energy Act of 2020 to include in the definition of land occupied by a majority of Alaskan Native Tribe members.[25]

How is a Category 3 qualified low-income residential building project defined?

A Category 3 qualified low-income residential building project is a federally subsidized residential building facility “installed on the same parcel or on an adjacent parcel of land that has a residential rental building that participates in an affordable housing program, and the financial benefits of the electricity produced by such facilities are allocated equitably among the occupants of the dwelling units or the building.”[26] Projects must be part of a “qualified program”: one among various federal housing assistance programs as are set out in the Treasury Regulations. For state programs to qualify to receive the 20 percent bonus credit, they must be part of a qualified federal program. To remain a qualified low-income residential building facility, a project must maintain its participation in a covered housing program for the entire five-year tax credit recapture period.

How does a Category 4 qualified low-income economic benefit project assist low-income households?

A qualified low-income economic benefit project is one where at least 50 percent of the financial benefits of the electricity produced are provided to households with income of less than 200 percent of the poverty line, or 80 percent of the area’s median gross income.[27] The financial benefits of a low-income economic project benefiting low-income households can only be delivered in utility bills savings. “Other means such as gift cards, direct payments, or checks are not permissible. Financial benefits for these facilities must be tied to a utility bill of a qualifying household. The Treasury Department and the IRS may consider other methods of determining Category 4 financial benefits in future years.”[28]

Allocation Process

How is the annual Capacity Limitation allocated across the four facility categories?

The annual Capacity Limitation amount is divided across each facility category as is set out in each program year. For the 2023 and 2024 Program Years, for example, we have IRS Notices setting out the Allocation Process. The Applicable Bonus Credit is available at Section 48. For the calendar year 2025 and succeeding years, the applicable bonus credit is available at Section 48E (CEITC). On September 3, 2024, the Treasury issued Proposed Regulations addressing Section 48E (CEITC) (Proposed 48E Allocation Regulations).[29]

For the 2024 Program Year, for example, the annual Capacity Limitation is divided across each facility category “plus any carried over unallocated Capacity Limitation from the 2023 Program Year.”[30]

Does the Low-Income Communities Bonus Credit have a competitive bidding application?

Yes. The Low-Income Communities Bonus Credit has a competitive bidding application process that applies to each of the four eligibility categories. An annual allocation of up to 1.8 gigawatts (GWs) is available, in the aggregate, to the four categories of qualified solar or wind facilities with a maximum output of less than five megawatts.[32]

How does competitive bidding work?

Since it was introduced for the 2023 program year, competitive bidding has been very successful. The Low-Income Communities Bonus Credit program is extremely popular. The 2023 program—the first year of the competitive bidding process—was significantly over-subscribed with more than 46,000 applications submitted. Applications were for qualified facilities representing 8 GWs of capacity, although only 1.8 GWs of capacity were available for allocation.[33]

For purposes of the Section 48E Low-Income Communities Bonus Credit, we have the Proposed Section 48E Regulations to turn to as to how the competitive bidding process works. The Treasury has provided notice of a public hearing on the Proposed Regulations for October 17, 2024.

What government guidance do we have on the annual Capacity Limitation allocation process for Section 48?

For purposes of the Section 48 Low-Income Communities Bonus Credit, we have the Final Low-Income Communities Regulations. In addition, the IRS has issued revenue procedures and a Notice:

Rev. Proc. 2023-27[34] and Rev. Proc. 2024-19[35] provide information and guidance for the 2023 and the 2024 allocations. These revenue procedures both address the reservation of capacity limitations, allocation selection, and application procedures.
IRS Notice 2023-17,[36] sets out initial guidance on establishing the program to allocate the environmental justice solar and wind capacity limitation under Section 48(e).

What does the 2024 allocation program look like?

The 2024 capacity limitation allocation opened in May of 2024, with 1.8 GWs of capacity being allocated across the four eligible facility type categories.[37]

Are there any additional selection criteria for 2024?

Yes. For 2024, the Treasury has imposed what it refers to as “additional selection criteria” (ASC) for the 1.8 GWs allocation. The 2024 ASC requires at least 50 percent of the 1.8 GWs to be allocated to applications that meet specified ASC ownership and geographic criteria.

The 2024 ASC ownership criteria is based on applicants that qualify as one of the following: Tribal enterprises, Alaska Native Corporations, renewable energy cooperatives, qualified renewable energy companies, qualified tax-exempt entities,[38] Indian tribal governments, and any corporation described in Section 501(c)(12) that furnishes electricity to persons in rural areas.

The 2024 geographic criteria is based on the facility being located in a persistent poverty county or disadvantaged community as identified by the Climate and Economic Justice Screening Tool.[39] The screening tool is at an official U.S. government website, with an interactive map of census tracts that are “overburdened and underserved” and that are “highlighted as being disadvantaged.[40] For these purposes, Alaska Native Villages are considered to be disadvantaged communities.[41] The datasets used in the Screening Tool’s eight “indicators of burdens” are “climate change, energy, health, housing, legacy pollution, transportation, water and wastewater, and workforce development.”[42]

Where do we look for 2025 allocations and beyond?

The selection criteria for 2025 and beyond is addressed in the Proposed Section 48E Regulations.

Application Process

How are applications reviewed and Capacity Limitations allocated?

The Treasury and the IRS have partnered with the DOE to administer the program. The DOE’s “Office of Economic Impact and Diversity administers the program application portal and reviews applications, with the DOE making “recommendations to the IRS” based on the eligibility of the facility.[43] The Treasury and the IRS can adjust the allocations of Capacity in future years “for categories that are oversubscribed or have excess capacity.”[44] “At least 50% of the capacity within each category will be reserved for projects that meet certain ownership and/or geographic selection criteria. The ownership and geographic selection criteria can be found in §1.48(e)-1(h)(2).”[45]

How does an applicant apply for the Low-Income Communities Bonus Credit Program?

A taxpayer seeking to claim the credit must submit an application to the DOE for an allocation of capacity. The DOE allows one application per project. To begin their process, an applicant must create a login.gov account and register using the “Log In” button located at a DOE’s portal page, https://eco.energy.gov/ejbonus/s/. Before registering, applicants are encouraged to read the handy dandy “DOE Applicant User Guide”[46] available at the same web portal address. Applications are submitted through DOE’s online “Low-Income Communities Bonus Credit Program Applicant Portal” accessible at the same URL. The portal’s applicant checklist sets out rigorous documentation and attestation requirements to demonstrate that ownership requirements are being met.

How does an applicant support its allocation of capacity for its Low-Income Communities Bonus Credit application?

An applicant must submit information for each proposed facility allocation, including the “applicable category, ownership, location, facility size/capacity, whether the applicant or facility meet additional selection criteria, and other information.”[47] In addition, the applicant must complete a series of attestations and must upload to the online portal certain documentation in order to demonstrate project maturity.”[48] An allocation must be received by the taxpayer before an eligible facility can be placed in service.[49]

How are applications considered?

“There will be a 30-day period at the start of each program year where applications will be accepted for each category. Applications received within this 30-day period will all be treated as being received on the same day and time. Once the 30-day period is over, the DOE will accept applications on a rolling basis and recommend applicants to the IRS until the entire capacity limitation within the applicable category is diminished.”[50] In addition, once applications are submitted, “the DOE will review the applications and recommend projects eligible for the bonus to the IRS. The IRS will then award the applicant with an allocation of the capacity limitation or reject the application. The DOE will stop reviewing applications once the entire capacity limitation is awarded. Applicants can reapply for the bonus credit in the next program year if they remain eligible.”[51]

What happens if a facility is not placed in service within the four-year deadline?

A facility can be disqualified after it receives an allocation if the facility is not placed in service within the deadline set in Section 48(e)(4)(E) of four years after the date of allocation. “[P]roviding any type of alternative forms of completion within the four year window apart from ‘placed-in-service’ is inconsistent with the statute and not allowed.”[52]

Can a credit recipient face a recapture event?

Yes. Recapture of the benefit of any increased credit due to Section 48E is provided in Section 48(e)(5). The Treasury noted that “Under the recapture provisions of Section 48(e)(5), Congress provided that the period and percentage of such recapture must be determined under rules similar to the rules of Section 50(a). Section 50(a) generally provides that this is a five year period with differing applicable percentages depending on when the property ceases to qualify. Therefore, under Section 48(e)(5), stricter restrictions related to recapture should not be imposed.”[53]

The final regulations clarify that “any event that results in recapture under Section 50(a) will also result in recapture of the benefit of the section 48(e) Increase. The exception to the application of recapture provided in § 1.48(e)-1(n)(2) does not apply in the case of a recapture event under Section 50(a).”[54] This same recapture possibility applies to Section 48E (CEITC) credit recipients.

The firm extends gratitude to Nicholas C. Mowbray for his comments and exceptional assistance in the preparation of this article.

[1] The Inflation Reduction Act of 2022, Pub. L. No. 117-169, 136 Stat. 1818 (2022) (IRA), August 16, 2022.

[2] “Inflation Reduction Act Guide for Local Governments and Other Tax-Exempt Entities; Solar and Storage Projects,” p. 17, New York State, January 2024, available at https://www.nyserda.ny.gov/-/media/Project/Nyserda/Files/Programs/Clean-Energy-Siting/Inflation-Reduction-Act-Guide-for-Solar-and-Storage-Projects.pdf.

[3] “Low-Income Communities Bonus Credit Program,” Department of Energy (DOE), Office of Energy Justice and Equity, available at https://www.energy.gov/justice/low-income-communities-bonus-credit-program.

[4] “U.S. Department of the Treasury, IRS Release Final Rules and Guidance on Investing in America Program to Spur Clean Energy Investments in Underserved Communities,” Press Release, U.S. Treasury, August 10, 2023, available at https://home.treasury.gov/news/press-releases/jy1688.

[5] “Low-Income Communities Bonus Credit,” IRS, available at https://www.irs.gov/credits-deductions/low-income-communities-bonus-credit.

[6] For a discussion of Sections 48 and 48E (CEITC), see Part II of this series: Production Tax Credits and Investment Tax Credits: The Old and The New.

[7] § 48(e).

[8] § 48E(h). “Elective pay and transferability frequently asked questions: Elective pay,” IRS, Overview, Q15, available at https://www.irs.gov/credits-deductions/elective-pay-and-transferability-frequently-asked-questions-elective-pay#q15.

[9] § 48(e)(1).

[10] Section 48(e)(2)(A) and the Treasury Regulations.

[11] Section 48(e)(2)(A)(iii).

[12] 88 FR 55506, “Additional Guidance on Low-Income Communities Bonus Credit Program,” U.S. Treasury, August 15, 2023, available at https://www.federalregister.gov/documents/2023/08/15/2023-17078/additional-guidance-on-low-income-communities-bonus-credit-program.

[13] Ibid.

[14] Ibid, Preamble, Definition of Qualified Solar or Wind Facility.

[15] 88 FR 55506, August 15, 2023.

[16] Ibid.

[17] Ibid.

[18] Ibid.

[19] “Inflation Reduction Act Guide for Local Governments and Other Tax-Exempt Entities; Solar and Storage Projects,” p. 18, New York State, January 2024.

[20] “Frequently Asked Questions, 48(e) Low-Income Communities Bonus Credit Program,” Q47.

[21] Ibid.

[22] Ibid.

[23] 43 U.S.C. § 1601 et seq.

[24] 106 Stat. 3113; 25 U.S.C. § 3501.

[25] The Energy Act of 2020, Section 8013, As Amended Through Pub. L. 117-286, Enacted December 27, 2022. See also “Energy Act of 2020, Section-by-Section,” Section 8013. Indian Energy, available at https://www.energy.senate.gov/services/files/32B4E9F4-F13A-44F6-A0CA-E10B3392D47A.

[26] “Inflation Reduction Act Guide for Local Governments and Other Tax-Exempt Entities; Solar and Storage Projects,” p. 18, New York State, January 2024.

[27] Ibid.

[28] FAQ#53.

[29] 89 Fed. Reg. 71193 (Sept. 3, 2024).

[30] “Low-Income Communities Bonus Credit Program,” DOE, Office of Energy Justice and Equity, available at https://www.energy.gov/justice/low-income-communities-bonus-credit-program. Also see https://www.energy.gov/sites/default/files/2024-05/48e%20Slides%20for%20PY24%20Applicant%20Webinar.pdf and refer to Rev. Proc. 2024-19 (IRS) and Treasury Regulations § 1.48(e)–1 for the full definitions and requirements of each program category.

[31] Such as rooftop solar.

[32] “U.S. Department of the Treasury, IRS Release 2024 Guidance for Second Year of Program to Spur Clean Energy Investments in Underserved Communities, As Part of Investing in America Agenda,” Press Release, U.S Treasury, March 29, 2024. Proposed Section 48E (CEITC) Regulations.

[33] “The Low-Income Communities Bonus Credit Program: Categories and How to Apply,” Morgan Mahaffey, EisnerAmper, May 29, 2024, available at https://www.eisneramper.com/insights/real-estate/low-income-communities-bonus-credit-program-0524/

[34] Rev. Proc. 2023-27, IRS, August 10, 2023, corrected by Announcement 2023-28, September 11, 2023.

[35] Rev. Proc. 2024-19, IRS, March 29, 2024.

[36] Notice 2023-17, IRS, February 13, 2023.

[37] Treas. Reg. §1.48(e)-1 defines the four categories of facilities for Low-Income Communities Bonus Credit.

[38] Including Sections 501(c)(3) and 501(d) entities.

[39] The screening tool is available at https://screeningtool.geoplatform.gov/en/#3/33.47/-97.5.

[40] Ibid.

[41] Ibid.

[42] Climate and Economic Justice Screening Tool, Frequently Asked Questions, available at https://screeningtool.geoplatform.gov/en/frequently-asked-questions#3/31.77/-95.39.

[43] Ibid.

[44] “IRS releases Guidance on Low-Income Communities Bonus Credit Program, Inflation Reduction Act,” Forvis Mazars, LLP, August 15, 2023, available at https://www.forvismazars.us/forsights/2023/08/irs-releases-guidance-on-low-income-communities-bonus-credit-program.

[45] Ibid. See also, § 1.48(e)-1(h)(2), the Reservations of Capacity Limitation allocation for facilities that meet certain additional selection criteria is available at https://www.law.cornell.edu/cfr/text/26/1.48(e)-1.

[46] “Applicant User Guide,” DOE, available at https://www.energy.gov/sites/default/files/2024-05/2024%20DOE%2048%28e%29%20Applicant%20User%20Guide.pdf.

[47] “Low-Income Communities Bonus Credit Program,” DOE, Office of Energy Justice and Equity, available at https://www.energy.gov/justice/low-income-communities-bonus-credit-program.

[48] Ibid.

[49] “Low-Income Communities Bonus Credit,” IRS, available at https://www.irs.gov/credits-deductions/low-income-communities-bonus-credit.

[50] “IRS releases Guidance on Low-Income Communities Bonus Credit Program, Inflation Reduction Act,” Forvis Mazars, LLP, August 15, 2023.

[51] Ibid.

[52] 88 Fed. Reg. 55537.

[53] 88 Fed. Reg. 55538.

[54] 88 Fed. Reg. 55538.

Read Part I, Part II, Part III, Part IV, Part V, and Part VI here.

by: Andie Kramer of ASKramer Law

For more news on Energy Tax Credits, visit the NLR Environmental Energy Resources section.

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Death, Taxes, and Crypto Reporting – The Three Things You Cannot Escape

National Law Forum — Tue, 14 May 2024 23:00:41 +0000

The IRS released a draft of Form 1099-DA “Digital Asset Proceeds from Broker Transactions” in April which will require anyone defined as a “broker” to report certain information related to the sale of digital assets. The new reporting requirements will be effective for transactions occurring in 2025 and beyond. The release of Form 1099-DA follows a change in the tax law.

In 2021, Congress amended code section 6045 to define “broker” to include any “person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.” This is an expansion of the definition of a “broker.” The language ‘any service effectuating transfers of digital assets’ is oftentimes construed by many in the tax practitioner community as a catch-all term, in which the government could use to determine many people involved in digital asset platforms aa “brokers.”

The IRS proposed new regulations in August 2023 to further define and clarify the new reporting requirements. Under the proposed regulations, Form 1099-DA reporting would be required even for noncustodial transactions including facilitative services if the provider is in a “position to know” the identity of the seller and the nature of the transaction giving rise to gross proceeds. With apparently no discernible limits, facilitative services include “services that directly or indirectly effectuate a sale of digital assets.” Position to know means “the ability” to “request” a user’s identifying information and to determine whether a transaction gives rise to gross proceeds. Under these proposed regulations and the expanded definition of “broker,” a significant number of transactions that previously did not require 1099 reporting will now require reporting. There has been pushback against these proposed regulations, but the IRS appears determined to move forward with these additional reporting requirements.

The post Death, Taxes, and Crypto Reporting – The Three Things You Cannot Escape appeared first on The National Law Forum.

Business Taxation of Hedging Transactions Part IV: Tax Timing

National Law Forum — Wed, 01 May 2024 15:01:37 +0000

What are the tax accounting rules for hedges?

Whether or not a qualified tax hedge is properly identified, it must be tax accounted for under a method that clearly reflects income.[1] The timing of gains and losses on hedges must match the timing of income and loss reporting on the hedged items. Aggregate tax hedgers must provide in their Aggregate Programs robust descriptions of the tax accounting methods used for each type of hedge that is part of its Aggregate Program. In addition, the Aggregate Program’s documentation must contain enough detail to sufficiently demonstrate how the clear reflection of income requirement is met.

Which transactions must be tax accounted in a way that clearly reflects income?

As a general matter, a taxpayer must compute all of its taxable income in a way that clearly reflects income. This requirement also applies to qualified tax hedges. Under Treas. Reg. § 1.446-4, a taxpayer must clearly reflect income, regardless of whether the taxpayer properly identified the hedging transaction.[2] A taxpayer cannot avoid the requirement to clearly reflect income by simply failing to identify as a hedge.

Can more than one method of tax accounting clearly reflect income?

Yes. As long as a taxpayer’s hedge accounting method meets the matching requirement to clearly reflect income, the taxpayer has flexibility to adopt an appropriate tax accounting method[3] provided it meets Treas. Reg. § 1.446-4(c).

Do generally accepted accounting principles (GAAP) clearly reflect income for purposes of tax hedge accounting?

No. Although GAAP might clearly reflect taxable income, it might not reasonably match taxable gain and loss on the hedge with that of the hedged item. Regardless of GAAP, a taxpayer must follow the clear reflection of income requirements set out in Treas. Reg. § 1.446-4.

Must all hedges be tax accounted for on the same method?

No. A taxpayer can adopt different methods of tax accounting for different types of hedges if they clearly reflect income and meet two additional conditions.[4] First, once an accounting method is adopted, it must be consistently applied; and second, an accounting method can only be changed with IRS consent.[5]

When is a tax accounting method assumed to have been adopted for hedges?

A taxpayer has adopted a tax accounting method when it has accounted for a “material item” in the same way on two or more consecutively filed tax returns. In this situation, the item “represents consistent treatment of that item” for purposes of satisfying Treas. Reg. § 1.446-1(e)(2)(ii)(a).[6] If a hedge is correctly accounted for in the first year, however, a taxpayer is treated as having adopted an accounting method after the first year.[7] Once a method is adopted, it must be consistently applied and can only be changed with IRS consent.[8]

What happens if the IRS determines that a taxpayer’s method of tax accounting does not clearly reflect income?

If a taxpayer’s accounting method does not clearly reflect income, the IRS can recompute taxable income in a manner that clearly reflects income. Unless the taxpayer can successfully contest this treatment at audit, on appeal, or in subsequent litigation, it must use the IRS’s method to tax account for its hedging gain or loss. To change the method of tax accounting the taxpayer uses for its hedges, it must first obtain IRS consent.[9]

Can a taxpayer change from an impermissible method of tax accounting to a permissible method without first obtaining IRS consent?

No. The taxpayer must obtain consent from the IRS consent in advance of making any tax accounting changes.[10]

What tax timing rules apply to hedges of aggregate risks?

A taxpayer that hedges its risks on an aggregate basis must adopt a tax accounting method that clearly reflects income.[11] As a result, the timing of income, deduction, gain, or loss with respect to hedges must reasonably match that of the items being hedged.[12]

What are the tax timing requirements for hedges of debt instruments?

Hedges of debt instruments, whether held or to be held by the taxpayer, are tax accounted by reference to the period or periods to which the hedge relates.[13] For a debt instrument that provides interest at a fixed or qualified floating rate, constant yield principles generally clearly reflect income.[14] This means that hedging gain or loss is taken into account as if the gain or loss “adjusted the yield of the instrument over the term to which it relates.”[15] For a hedge of an anticipated fixed rate borrowing, gain (loss) is taken into account as if it increased (reduced) the issue price for the debt instrument.[16] It is treated as an adjustment to the debt instrument’s issue price, and it is taken into account over the term of the hedge. If the hedge is entered into but the anticipated debt issuance or obligation is not consummated, the taxpayer will take into account gain or loss from the hedge on a “when realized” basis.[17]

What tax accounting methods are provided in the Treasury Regulations for hedges of inventory?

Four accounting methods are provided in the Treasury Regulations for inventory hedges—the general method, mark-and-spread, and two simplified methods:

(1) General method Gain or loss on hedges of inventory purchases can be taken into account in the same time period as income or loss on the hedged item as if the gain or loss were an element of the cost of the inventory.[18] Gain or loss on hedges of inventory sales can be taken into account as if the gain or loss were an element of the sales proceeds.[19] For specifically identified hedges, this method is easy to comply with because it allows for hedging gain or loss to be taken into account as if it were an element of the cost incurred in (or sales proceeds from) that particular transaction. An aggregate hedger, on the other hand, might not be able to take hedging gains or losses into account directly as part of the cost incurred in (or sales proceeds with respect to) an inventory transaction (an aggregate hedger might not be able to match the hedge with a particular inventory purchase or sale).[20]

(2) Mark-and-spread method To match an inventory hedge to the timing of aggregate hedged items, a taxpayer may account for the hedge under the mark-and-spread method. Mark-and-spread is permissible for an aggregate inventory hedger. With mark-and-spread, a taxpayer periodically marks the hedge to market no less frequently than quarterly, taking the resulting gain or loss into account over the period in which the hedge is intended to reduce the taxpayer’s risk exposure to the hedged item.[21] Gain or loss from marking the hedge to market is then spread over the period that such gain or loss would have been taken into account as if it had been an increase or decrease to inventory cost or gross sales proceeds in that period.

(3) Simplified inventory method Inventory hedgers that do not use the last-in-first-out (LIFO) method of accounting for inventory take into account realized gains or losses on hedges of inventory purchases and sales when they would be taken into account as if the gains or losses were elements of inventory cost during the period realized.[22]

(4) Simplified mark-to-market method Marking hedges to market to take gain or loss into account immediately might clearly reflect income even if the hedged inventory is not on mark-to-market. Mark-to-market hedge accounting might only be appropriate if inventory is not accounted for under the LIFO method or the lower-of-cost-or-market method, and only if the inventory items are held for a short period of time.[23]

[1] Treas. Reg. § 1.446-4.

[2] Rev. Rul. 2003-127.

[3] Treas. Reg. § 1.446-4(c).

[4] Rev. Rul. 2003-127.

[5] Rev. Rul. 2003-127.

[6] Rev. Rul. 2003-127 citing Rev. Rul. 90-38, 1990-1 C.B. 5-7.

[7] Rev. Rul. 2003-127.

[8] Rev. Rul. 2003-127.

[9] Treas. Reg. § 1.446-1(b)(1).

[10] See Rev. Proc. 97-27, 1997-1 C.B. 680 for the procedure to obtain consent.

[11] Treas. Reg. § 1.446-4(b).

[12] Treas. Reg. § 1.446-4(e)(1).

[13] Treas. Reg. § 1.446-4(e)(4).

[14] Id.

[15] Id.

[16] Id.

[17] Treas. Reg. § 1.446-4(e)(8)(i).

[18] Treas. Reg. § 1.446-4(e)(3)(i).

[19] Id.

[20] Treas. Reg. § 1.446-4(e)(1)(i).

[21] Treas. Reg. § 1.446-4(e)(1)(ii).

[22] Treas. Reg. § 1.446-4(e)(3)(ii)(A).

[23] Treas. Reg. § 1.446-4(e)(3)(ii)(B).

Read Part 1

Read Part 2

Read Part 3

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Staying on Course: Navigating Election Year Issues for Exempt Organizations

National Law Forum — Fri, 15 Mar 2024 17:00:58 +0000

With the 2024 election cycle underway, it is important for exempt organizations to understand and comply with relevant restrictions on political campaign activities to safeguard their tax-exempt status and avoid triggering excise tax penalties. This alert provides an overview of the political campaign rules applicable to exempt organizations and specifically highlights the restrictions on political campaign activities applicable to Section 501(c)(3), 501(c)(4), and 501(c)(6) organizations.

Restrictions on Political Activities

Exempt organizations are subject to certain restrictions regarding their participation in political campaign activities, and the amount of permissible participation is a key distinction between Section 501(c)(3), 501(c)(4), and 501(c)(6) organizations. To comply with these restrictions, an exempt organization must (1) know their specific tax-exempt status and the restrictions that apply to them, (2) understand what activities constitute political campaign activities, (3) avoid activities that violate the applicable restrictions, and (4) mitigate the risk that activities conducted by employees in their individual capacities are attributed to the organization.

Prohibited Political Campaign Intervention for Section 501(c)(3) Organizations

Section 501(c)(3) organizations are subject to an absolute prohibition on participation or intervention in political campaign activities. Organizations that violate this ban are subject to the revocation of their tax-exempt status and the imposition of excise tax penalties on both the organization itself and organization managers who approve expenditures used for impermissible political purposes. Therefore, Section 501(c)(3) organizations must avoid activities that violate the prohibition on political campaign intervention.

Prohibited political campaign intervention occurs when an exempt organization “participates in, or intervenes in” a “candidate’s” campaign for “public office” (Section 501(c)(3)).

The term “candidate” refers to any person who has declared an intent to run for national, state, or local office and likely includes incumbents until they announce an intention not to run. A candidate also includes individuals who have yet to declare an intention to run for public office, but whose potential candidacy generates significant public speculation. The term “public office” broadly refers to any national, state, or local elective office, as well as any elected position in a political party.

An organization is considered to “participate in, or intervene in” political campaign activity by making contributions to political campaign accounts or making public statements on behalf of the organization in favor of or in opposition to a candidate for public office. Specifically, the Internal Revenue Service (IRS) regulations define participation in a political campaign as “publication or distribution of written or printed statements or the making of oral statements on behalf of or in opposition to . . . a candidate” (Treas. Reg. § 1.501(c)(3)-1(c)(3)(iii)). The IRS regulations also note that political campaign intervention is not limited to these specified activities.

The IRS has interpreted prohibited political campaign intervention to include even some nonpartisan educational activities. For example, the IRS has ruled that an organization that was formed to promote public education violated the prohibition on political campaign activities when it announced the names of the school board candidates it considered most qualified following an objective review of the candidates’ qualifications (Rev. Rul. 67-71, 1967-1 C.B. 125).

These restrictions on political campaign activities do not extend to the officers, directors, or employees of a 501(c)(3) organization, provided they are acting in their individual capacities. It is particularly important, however, to mitigate the risk that any personal political activities conducted by officers, directors, or employees will be attributed to the organization. An exempt organization should ensure their employees do not use institutional resources to engage in personal political campaign activities or act in a manner that suggests they are speaking on behalf of the organization when engaged in campaign advocacy. Exempt organizations should adopt clear policies regarding political activities and institutional resources and communicate the importance of such policies to employees during an election year.

Permissible Political Activities

Some educational activities that are election-related are permissible, however, and will not be considered prohibited campaign intervention. In order to be considered “educational,” the activities must present “a sufficiently full and fair exposition of the pertinent facts” (Treas. Reg. § 1.501(c)(3)-1(d)(3)). The information presented must “permit an individual or the public to form an independent opinion or conclusion” and not be biased. Activities that satisfy this definition may be considered permissible educational activities rather than prohibited or restricted political activities.

The following types of educational activities, although election-related, are generally permissible:

Voter Registration: Voter registration drives are not considered political campaign activities if they are conducted in a nonpartisan and fair manner. An organization conducting the voter registration drive should not expressly advocate for or against any candidates or political parties as part of the voter registration. They also generally should not name candidates or provide their party affiliations. If any candidates are named, all candidates should be named. All persons interested in registering must also be permitted to register, regardless of their political preference or party affiliation.
Voter Education: Certain forms of voter education, such as the distribution of voter guides and voting records, may qualify as an educational activity provided the organization avoids editorial commentary and ensures the materials cover a broad range of issues. Organizations must not demonstrate a preference toward a certain candidate or only cover a narrow range of issues when engaging in voter education activities.
Candidate Debates and Forums: Providing a fair, neutral forum for candidate debates may qualify as an educational activity so long as the debate provides equal time to all qualified candidates. Organizations should be particularly careful to include all qualified candidates, cover a broad range of topics, have a nonpartisan group compose the questions, and clarify that the candidates’ views are not the views of the exempt organization. The moderator selected by the organization can ensure the candidates follow the ground rules for the debate, but they should not ask questions or comment on the candidate’s statement in a way the indicates support or opposition to the candidate or their positions.

Section 501(c)(4) Organizations

Section 501(c)(4) social welfare organizations have more latitude to engage in political campaign activities than Section 501(c)(3) organizations. Section 501(c)(4) organizations are not subject to an absolute ban on campaign intervention, but instead are permitted to engage in some limited political activities, provided they remain primarily engaged in social welfare activities. The IRS will compare an organization’s political activities and expenditures (plus its non-exempt activities) with its social welfare activities to determine whether the organization remains primarily engaged in promoting social welfare consistent with its tax-exempt status. Accordingly, Section 501(c)(4) organizations should maintain records to ensure they remain primarily engaged in social welfare activities during an election year. If a Section 501(c)(4) organization engages in political activities, it must also provide its members with a notice of how much of their dues were used towards political activities and determine the proxy tax on those expenditures. If member dues are used for political campaign activities, then a portion of the dues may not be a deductible business expense under Section 162.

Section 501(c)(6) Organizations

Business leagues described in Section 501(c)(6) are subject to the same less-stringent rules regarding political campaign activities as Section 501(c)(4) organizations. Section 501(c)(6) organizations may engage in some political activities on a limited basis, provided such political activities are not the organization’s primary activity. If a Section 501(c)(6) organization engages in political activities, it must also provide its members with a notice of how much of their dues were used towards political activities and determine the proxy tax on those expenditures. If member dues are used for political campaign activities, then a portion of the dues may not be a deductible business expense under Section 162.

Related Restrictions

The scope of this alert is limited to restrictions on political campaign activities under federal tax law. Exempt organizations are also subject to campaign finance restrictions and requirements by the Federal Election Commission, as well as rules regarding legislative or lobbying activities imposed by the IRS, the Lobbying Disclosure Act of 1995, and other federal, state, and local laws, which are beyond the scope of this alert.

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Inflation’s Effect on Taxes – The Good and the Bad

National Law Forum — Wed, 29 Mar 2023 18:48:37 +0000

Many federal tax provisions are adjusted for inflation annually, but not all. Rising inflation may result in lower tax bills for many taxpayers in 2023. Unfortunately, the impacts of inflation on taxpayers will not lower their 2022 tax bills even though inflation is at the highest level in the past 40 years.

The standard deduction is indexed for inflation. In 2023, for married couples filing joint tax returns, the standard deduction increased by $1,800 to $27,700; and for single taxpayers the standard deduction increased by $900 to $13,850.

The tax rates for individual tax filers have not changed (with the highest tax rate remaining at 37%), but the income levels have increased between the brackets. For example, in 2023, the 32% tax bracket starts at $364,200 for married couples filing jointly (up from $340,100 in 2022); and the 35% bracket for married couples filing jointly starts at $462,500 (up from $331,900 in 2022).

Estates of decedents who die in 2023 will have an estate tax exemption of $12,920,000 (up from $12,060,000 in 2022). The gift tax exclusions also increased to the same amounts and the annual gift exclusion increased to $17,000 per donee, which allows a married couple to gift $34,000 using their annual exclusion with no limit on the number of donees.

Social security recipients will enjoy an 8.7% increase in their monthly benefits in 2023 compared to 2022.

Other increases, as a result of rising inflation, include higher maximum contributions to retirement plans, health savings accounts and flexible spending accounts.

Inflation will impact taxpayers, employees and employers negatively as well. Employees, employers and self-employed individuals will be subject to social security taxes on earnings of $160,200 (up from $147,000 in 2022).

The limitation on itemized deduction for state and local tax has not increased, although state and local taxes have generally increased and the personal exemption continues to remain at zero. Finally, there has been no reduction in the long-term capital gains tax rate or increase in the deduction for capital losses which remains limited to $3,000 per year in excess of capital gains.

Article By Edwin I. Josephson of Chuhak & Tecson, P.C.

For more tax legal news, click here to visit the National Law Review.

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Diving Into SECURE 2.0: New Changes Ease Plan Sponsor Administrative Burdens

jschaller@natlawreview.com — Thu, 16 Mar 2023 17:00:24 +0000

The SECURE 2.0 Act of 2022 (SECURE 2.0) significantly changes the legal and administrative compliance landscape for U.S. retirement plans. Foley & Lardner LLP is authoring a series of articles that take a “deep dive” into key SECURE 2.0 provisions that will affect how employers structure and administer their 401(k) plans, pension plans, and other types of employer-sponsored retirement plans.

Last month, we discussed SECURE 2.0’s new required minimum distribution (RMD) rules. In this article, we examine certain SECURE 2.0 changes designed to simplify plan administration for sponsors of defined contribution plans (including Code Section 401(k), 403(b) plans, and 457(b) plans)¹ and encourage employees to save for their retirements.

In a 1986 press conference, President Ronald Reagan infamously quipped: “the nine most terrifying words in the English language are: ‘I’m from the government, and I’m here to help.’” While legislation affecting retirement plans can sometimes be frustratingly complex (can you say “ERISA”?), SECURE 2.0 contains a number of provisions designed to lessen the administrative burdens faced by 401(k) plan sponsors (employers).

Optional Changes/Effective Date

Each of the administrative changes discussed below is optional – employers aren’t obligated to adopt any of them.

If an employer elects to do so, however, the changes are generally effective for plan years beginning after SECURE 2.0’s enactment. So, an employer with a calendar year plan (i.e., a plan using a January 1 to December 31 plan year) may incorporate the changes into its 401(k) plan in 2023 (depending on the employer’s own objectives and the ability of its recordkeeper to accommodate any requested changes).

Loosening Hardship Withdrawal Documentation Requirements

Many 401(k) plans permit participants to request hardship withdrawals from their plan accounts to help alleviate the impact of any “immediate and heavy” financial need the participant may be facing. Certain life events (such as funeral expenses, college tuition, expenses to repair a participant’s residence, etc.) automatically constitute an “immediate and heavy” financial need. In the past, 401(k) plan participants requesting hardship withdrawals had to prove both that: (i) the event leading to the financial hardship had occurred, and (ii) the participant lacked the cash or other resources to meet it.

Following a 2019 change in the IRS’s rules, however, employers were permitted to rely on a participant’s certification that he or she had insufficient cash or liquid assets to reasonably meet his or her financial need. To receive a hardship withdrawal, though, the participant still had to prove the hardship event itself occurred.

Now, under the new SECURE 2.0 changes, participants can self-certify both that: (i) the hardship event occurred, and (ii) they lack the financial resources to alleviate it. Unless the employer knows the participant’s certifications are untrue, it may rely on the certifications when determining whether to grant a hardship withdrawal. Employers should nevertheless caution participants to retain underlying documentation of both the hardship event and their financial circumstances, in case the IRS requires the employer to produce such documentation under audit.

This change should streamline the hardship withdrawal process considerably. Employers will no longer need to determine whether a participant has experienced a true hardship or if the participant lacks the funds to address it, and participants will get the funds they need quicker.

Eliminating Unnecessary Plan Notices to Unenrolled Participants

Employers know that printing and distributing required participant notices (describing investment options, fees, and participants’ rights under their 401(k) plan) isn’t cheap. Even if employers provide such notices electronically, they must still take time and effort to ensure the notification process meets IRS and DOL standards.

Another SECURE 2.0 change attempts to ease this burden. Under that change, an employer won’t violate ERISA if it fails to provide required notices to individuals eligible for, but not enrolled in, the employer’s plan. However, this exemption will only apply if those individuals (called “unenrolled participants” by SECURE 2.0) received a summary plan description and other eligibility notices when first eligible to participate in the 401(k) plan.

Consistent with Congress’ aim of improving retirement readiness in the U.S. workforce,² employers can’t just ignore unenrolled participants. SECURE 2.0 requires employers to provide unenrolled participants with annual notices reminding them of their eligibility to participate in the plan. The notice must also describe any employer contributions, vesting schedules, and election deadlines. The employer must also provide unenrolled participants with any otherwise-required documents upon request.

SECURE 2.0 doesn’t specify which notices are covered by this change, and we anticipate further guidance from the agencies addressing that issue, and describing the content of the annual reminder notice. Nevertheless, this change will allow employers to save time, money, and internal resources previously spent on the printing and distribution of unnecessary plan notices.

Offering De Minimis Financial Incentives for Participation

Before the enactment of SECURE 2.0, the only incentive employers could use to encourage 401(k) plan enrollment among employees was the promise of matching contributions. However, consistent with its goal of improving retirement readiness, SECURE 2.0 permits employers to offer “de minimis” financial incentives to encourage plan enrollment. Such incentives may not be paid from plan assets.

While SECURE 2.0 does not define de minimis, the Senate summary of SECURE 2.0 mentions, without further explanation, “low-dollar” gift cards. Regardless of the amount, employers must treat the value of gift cards as taxable income to the employees receiving them. The incentive would also be subject to income and employment taxes. It’s possible certain tangible incentives (such as small gifts of food, books, or flowers) would be excluded from compensation if, considering their value and frequency, it would be unreasonable or impractical for the employer to account for them.³ Guidance from the IRS on this issue would be welcomed.

Treating Employer Contributions as Roth Contributions

Before SECURE 2.0, employers could only make employer matching contributions to their 401(k) plans on a pre-tax basis – Roth matching contributions weren’t permitted. If participants wanted to convert pre-tax employer matching contributions into Roth contributions, they had to complete an in-plan Roth conversion (if permitted by the plan), and pay tax on the amount converted and any accumulated earnings.

Now, under SECURE 2.0, employers may offer 401(k) plan participants the option of receiving employer matching contributions or profit-sharing/nonelective contributions on a Roth basis. Such contributions must, however, be nonforfeitable to the participant (i.e., 100% vested).

Most recordkeepers should be able to accommodate this election. Even before SECURE 2.0’s enactment, many recordkeepers assisted participants in completing in-plan Roth conversions.

Before offering this new SECURE 2.0 option to participants, employers should consider whether, in their circumstances, it makes sense to eliminate vesting requirements imposed on matching or profit-sharing/nonelective contributions.

Facilitating Automatic “Roll-Ins” and Portability

Under current law, employers may automatically cash out the 401(k) plan accounts of terminated participants whose balances don’t exceed $1,000. If a terminated participant’s account balance equals or exceeds $1,000, but is less than $5,000 (increasing to $7,000 in 2024 – another SECURE 2.0 change), the employer may roll the former participant’s account balance over to an individual retirement account (IRA) established on the participant’s behalf.

After being transferred to an IRA, a former participant’s funds will generally be invested in a default investment option intended to protect the former participant’s principal. Despite that intent, the former participant’s funds may be lost or eroded by the IRA provider’s fees.

SECURE 2.0 addresses this issue by permitting employers and their recordkeepers to transfer the IRA balances of former 401(k) plan participants into retirement plans maintained by the individuals’ new employers (unless a former participant elects otherwise). This change will help participants consolidate their retirement savings in a single employer-sponsored retirement plan, lessening the likelihood those funds will be forgotten or lost due to inaction.

What Should Employers Do Now?

As noted above, the SECURE 2.0 changes described in this article are optional – employers aren’t obligated to adopt them. However, employers considering adopting one or more of the SECURE 2.0 changes should work with their recordkeepers to ensure the requested changes can be incorporated into their plans’ administrative processes. Employers may also need to adopt plan amendments to properly document the incorporation of certain SECURE 2.0 changes into their 401(k) plans (for example, updating the plan’s hardship withdrawal determination process or to allowing the employer to make Roth matching contributions). Such plan amendments must be adopted by the end of the plan year in which the change is effective.

These SECURE 2.0 changes should be popular with employers looking to lessen the administrative burden (and cost) of maintaining their 401(k) plans. We anticipate that, over time, the IRS and the DOL will issue guidance clarifying the scope of many of these SECURE 2.0 changes. Employers eager to implement the time- and money-saving SECURE 2.0 changes described herein for the 2023 plan year should take a good faith approach to doing so.

FOOTNOTES

¹ For convenience, in this article, we’ll refer to all such plans, collectively, as “401(k) plans.”

² According to a 2022 survey, 55% of Americans say their retirement savings are not where they need them to be. Around 35% said they were “significantly behind” in saving for retirement.

³ This is the approach taken by the IRS in connection with respect to other de minimis fringe benefits.

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What Taxpayers in the U.S. and Abroad Need to Know about FBAR Compliance

National Law Forum — Tue, 27 Dec 2022 18:00:35 +0000

United States taxpayers have an obligation to report their foreign financial accounts (i.e., offshore or foreign bank accounts) to the federal government. While there are thresholds that apply, these thresholds are relatively low, so most offshore account holders will need to file reports on an annual basis. One of these reports is the Report of Foreign Bank and Financial Accounts, more commonly known as an FBAR (Foreign Bank Account Report).

For U.S. taxpayers, FBAR compliance is extremely important. This is true for taxpayers residing both domestically and overseas. The FBAR is required for US citizens because foreign banks don’t have the same reporting obligations as US-based institutions. Noncompliance in reporting foreign bank accounts can lead to civil or criminal penalties; and, in many cases, failure to file an FBAR will lead to an examination of the taxpayer’s other recent tax filings as well.

“The obligation to file an FBAR applies to most U.S. taxpayers with offshore bank accounts. While many taxpayers are unaware of the FBAR filing requirement, this unawareness is not an excuse for noncompliance. Taxpayers with delinquent FBARs can face substantial penalties regardless of why they have failed to file.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

Technically, FBARs are due on Tax Day along with taxpayers’ annual income tax returns. However, all taxpayers receive an automatic extension to October 15—with no need to file a request and no risk of incurring additional penalties.

10 Key Facts about FBAR Compliance for U.S. Taxpayers

As the extended October 15 FBAR deadline is fast approaching, here is an overview of what taxpayers in the U.S. and abroad need to know:

1. The FBAR Filing Requirement Applies to U.S. Taxpayers Who Hold Foreign Financial Accounts

The FBAR filing requirement applies to U.S. taxpayers who hold foreign financial accounts. It also applies to taxpayers who have “signature or other authority” over these foreign accounts. These obligations exist under the federal Bank Secrecy Act (BSA). Taxpayers covered under the BSA must file FBARs with the Financial Crimes Enforcement Network (FinCEN) annually.

While the FBAR filing requirement applies to most types of foreign financial accounts, there are exceptions. For example, FBAR compliance is not required with respect to accounts:

Owned by governmental entities
Owned by foreign financial institutions
Held at U.S. military banking facilities
Held in individual retirement accounts (IRAs)
Held in certain other retirement plans

FinCEN has publicly taken the position that accounts solely holding cryptocurrency also do not qualify as foreign financial accounts for purposes of FBAR compliance. However, FinCEN has also stated that it “intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding [FBARs] to include virtual currency as a type of reportable account.” As a result, U.S. taxpayers who hold cryptocurrency overseas should continue to review FinCEN’s regulatory announcements to determine if their offshore cryptocurrency accounts will trigger FBAR compliance obligations in the future.

2. The FBAR Reporting Threshold is $10,000

The requirement to file an FBAR applies only to U.S. taxpayers whose foreign financial accounts exceed $10,000 during the relevant tax year. This is an aggregate threshold, meaning that it applies to all foreign financial accounts jointly, and the obligation to file an FBAR is triggered if the aggregate value of a taxpayer’s foreign financial accounts exceeds the $10,000 threshold at any point and for any length of time.

3. U.S. Taxpayers Must File Their FBARs Online

A person residing in the United States who has a financial interest in or signatory power over a foreign financial account is required to file an FBAR if the total value of the foreign financial accounts at any time during the calendar year exceeds $10,000. While U.S. taxpayers have the option to e-file their annual income tax returns, taxpayers must file their FBARs online. Taxpayers can do so through FinCEN’s website.

4. The IRS Enforces FBAR Compliance

Even though U.S. taxpayers must file their FBARs with FinCEN, the Internal Revenue Service (IRS) is responsible for enforcing FBAR compliance. This means that taxpayers that fail to meet their FBAR filing obligations must be prepared to deal with the IRS when it uncovers their delinquent filings. It also means that delinquent filers must follow the IRS’s procedures for coming into voluntary compliance to avoid unnecessary penalties—as discussed in greater detail below.

5. FBAR Filers May Also Need to File IRS Form 8938

In addition to filing an annual FBAR, U.S. taxpayers who own foreign financial accounts may also need to file IRS Form 8938. The obligation to file this form applies to U.S. taxpayers who own foreign financial assets (not solely foreign financial accounts) that exceed the thresholds established under the Foreign Account Tax Compliance Act (FATCA).

6. There are Special Mechanisms for Filing Delinquent FBARs

When individuals learn that they are at risk of facing an IRS audit or investigation due to failure to file an FBAR, their first instinct is often to file any and all delinquent FBARs right away.

However, this is not the IRS’s preferred approach, and it can expose taxpayers to penalties and interest unnecessarily.

The IRS offers two primary mechanisms for U.S. taxpayers to correct FBAR filing deficiencies—one for civil violations and one for criminal violations. The primary mechanism for correcting civil violations is to make a “streamlined filing,” while taxpayers who are at risk for criminal prosecution must make a “voluntary disclosure” to IRS Criminal Investigation (IRS CI).

As the IRS explains, the option to make a streamlined filing is “available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.” The ability to make this certification of non- willfulness is critical. If a taxpayer falsely certifies to non-willfulness (or if the IRS determines that a taxpayer’s certification is fraudulent), the IRS can reject the taxpayer’s streamlined filing and pursue criminal enforcement action.

For those who have willfully failed to file FBARs, coming into compliance generally involves using IRS CI’s Voluntary Disclosure Practice (VDP). As stated by IRS CI, “If you have willfully failed to comply with tax or tax-related obligations, submitting a voluntary disclosure may be a means to resolve your non-compliance and limit exposure to criminal prosecution.” However, as IRS CI also states, “[a] voluntary disclosure will not automatically guarantee immunity from prosecution.”

With this in mind, when seeking to correct past FBAR filing failures, U.S. taxpayers need to make informed and strategic decisions. To do so, they should rely on the advice of experienced legal counsel. While streamlined filings and voluntary disclosures both provide protection from prosecution, they offer protection under different circumstances, and taxpayers must follow a stringent set of procedures to secure the available protections.

7. Failure to File an FBAR Can Lead to Civil or Criminal Prosecution

One of the key requirements for securing protection under the IRS’s streamlined filing compliance procedures or the VDP is that the taxpayer must not already be the subject of an IRS audit or investigation. When facing audits and investigations related to FBAR noncompliance, taxpayers must assert strategic defenses focused on avoiding civil or criminal prosecution.

Both the BSA and FATCA provide federal prosecutors with the ability to pursue civil or criminal charges. Typically, civil cases focus on unintentional violations, while prosecutors pursue criminal charges in cases involving intentional efforts to conceal foreign financial assets from the U.S. government. However, prosecutors may choose to pursue civil charges for “willful” violations as well; and, in some cases, asserting a strategic defense will involve focusing on keeping a taxpayer’s case civil in nature.

8. The Penalties for FBAR Non-Compliance Can Be Substantial

Why is it important to keep an FBAR non-compliance case civil? The simple answer is that in civil cases prison time isn’t on the table. Under the BSA, U.S. taxpayers charged with intentionally failing to file an FBAR can face a criminal fine of up to $250,000 and up to five years of federal imprisonment.

But, even in civil cases, a finding of FBAR noncompliance can still lead to substantial penalties. For non-willful violations, taxpayers can face fines of up to $10,000 per violation. For willful violations prosecuted civilly, taxpayers can face fines of up to 50% of the undisclosed account value or $100,000, whichever is greater (subject to a maximum penalty of 100% of the account value).

9. U.S. Taxpayers Who Have Questions or Concerns about FBAR Compliance Should Seek Help

Given the substantial risks of FBAR non-compliance, U.S. taxpayers who have questions or concerns about compliance should seek help promptly. They should consult with an experienced attorney, and they should work closely with their attorney to make informed decisions about their next steps.

10. FBAR Filers Must Keep Records On-Hand

Finally, in addition to filing their FBARS with FinCEN online, U.S. taxpayers who are subject to the BSA must also comply with the statute’s recordkeeping requirements. Minimally, taxpayers must retain the following records for each account they disclose on an FBAR:

Account number
Account type
Name on the account
Name and address of the foreign bank holding the account
Maximum value of the account during the relevant tax year

According to the IRS, “the law doesn’t specify the type of document to keep with this information,” and taxpayers typically “must keep these records for five years from the due date of the FBAR.”

Article By Dr. Nick Oberheiden of Oberheiden P.C.

For more tax law legal news, click here to visit the National Law Review.

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Now is a Good Time to Confirm Your S Corporation Status

National Law Forum — Sun, 30 Oct 2022 17:53:27 +0000

On October 11, 2022, the IRS published Revenue Procedure 2022-19 providing taxpayers with liberalized procedures for resolving common S corporation issues. Previously, taxpayers would have needed costly IRS letter rulings for certainty on their S corporation status. The new procedures are simpler and less expensive.

The IRS has separately assured taxpayers that LLCs that are classified as S corporations may also qualify for this liberalized relief.

Inadvertent loss of S corporation status can have significant tax consequences and can make your business a less attractive acquisition target. For example, an S corporation that reverts to a C corporation may be subject to a double layer of tax going back several years. As a result, potential acquirers of any S corporation invariably request representations on the validity of the S corporation status.

The new Revenue Procedure describes common situations that the IRS has historically treated as not affecting the validity of S corporation status or qualified S corporation Qsub status, such as:

One class of stock requirement in the governing provisions (including the concept that commercial contractual agreements are not treated as binding agreements unless a “principal purpose” of the agreement is to circumvent the one class of stock requirement);
Disproportionate distributions inadvertently creating a second class of stock;
Certain inadvertent errors or omissions on Form 2553 or Form 8869;
Missing administrative acceptance letters for S corporation or Qsub elections;
Federal income tax return filings inconsistent with an S election; or
Governing provisions that allow for non-identical treatment of shareholders, such as differing liquidation rights (allowing for retroactive corrections).

For these common situations, there are now simpler and cheaper procedures to preserve S corporation status. For example, for certain small errors such as missing officer signatures, S corporations may follow the same simplified procedures as the late election relief procedures in Revenue Ruling 2013-30. Those procedures do not require a private letter ruling request, but only the original election form with a reasonable cause statement. As another example, if the issue is non-identical governing provisions and no disproportionate distributions were made, the S corporation may simply be retroactively treated as an S Corporation if it meets certain eligibility requirements and keeps a copy of a signed statement in its files.

Shareholders of uncertain S corporations should consider taking advantage of these new relaxed and cheaper procedures for curing S corporation mistakes. Each different type of error has a different cure with specific requirements.

Article By Christie R. Galinski and Samuel L. Parks of Miller Canfield

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IRS Delays Additional Amendment Deadlines for Major Retirement Legislation

National Law Forum — Mon, 10 Oct 2022 17:55:56 +0000

The IRS has extended additional deadlines for required retirement plan amendments, similar to the extensions we discussed last month found here. Notice 2022-45 extends the deadline for amending qualified retirement plans to comply with certain provisions of:

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)
The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (“Relief Act”)

Notice 2022-45 specifically extends the amendment deadlines for Section 2202 of the CARES Act and Section 302 of the Relief Act. Section 2202 of the CARES Act permitted plans to: (1) provide coronavirus-related distributions, (2) increase retirement plan loan sizes, and (3) pause retirement plan loan payments. Section 302 of the Relief Act permitted qualified disaster distributions.

Notice 2022-45 extends the amendment deadlines relating to the applicable provisions in the CARES and Relief Acts for non-governmental qualified plans and 403(b) plans to December 31, 2025. Governmental plans (including qualified plans, 403(b) plans maintained by public schools, and 457(b) plans) are granted further delays depending on the underlying circumstances of the plan sponsor. These extended deadlines under Notice 2022-45 align with the previous deadline extensions under Notice 2022-33. Accordingly, most plan sponsors will be able to adopt a single amendment to comply with the SECURE Act, BAMA, the CARES Act, and the Relief Act.

Notably, tax-exempt 457(b) plans do not appear to be covered by the relief granted by either Notice 2022-33 or Notice 2022-45. Accordingly, these plans remain subject to a December 31, 2022, amendment deadline.

Article By Brian T. Gallagher, Samantha A. Kopacz, and Samuel L. Parks of Miller Canfield

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Your Horse May Be Subject to IRS Seizure

National Law Forum — Wed, 24 Aug 2022 17:15:36 +0000

The Internal Revenue Service (IRS) has broad powers to seize assets in payment of outstanding taxes including income tax, excise tax, employment tax, and estate and gift tax. Assets the IRS can seize in exercise of its levy power are those that constitute “property or rights to property” of the taxpayer as defined under local law. Equine industry assets that could be subject to seizure include real estate, equipment, and the horses themselves, although horses valued below $10,090 are exempt from levy. For example, in 2012 the IRS seized hundreds of horses to collect a tax debt from a defendant convicted of stealing millions of dollars in city funds. The defendant used the funds to finance the breeding and showing of American quarter horses. The government auctioned off more than 400 of the seized horses to pay the defendant’s outstanding federal tax obligation.

But because animals require food and veterinary care and could die, the IRS has specific procedures relating to the seizure of livestock, such as horses. If the horses are considered “perishable goods,” section 6336 of the Internal Revenue Code (the Code), which provides the statutory requirements for disposing of perishable goods, will apply. Under section 6336, if it is determined that the seized property is liable to perish, the IRS must appraise the value of the property and either return it to the owner or put it up for immediate sale. The Internal Revenue Manual (IRM) provides further guidance on what constitutes perishable property. IRM 5.10.1.7 (12-20-2019) says that the property must be tangible personal property and have a short life expectancy or limited shelf life.

Prior to July 1, 2019, the definition of perishable goods included property that may “become greatly reduced in price or value by keeping, or that such property cannot be kept without great expense.” Horses would seem to fit within either or both of these categories. Now, under the revised definition of perishable goods, a collection officer would have to show that the horse had a short life expectancy.

A revenue officer seeking to seize perishable property must determine that the property cannot be kept and sold at a public sale under normal sale time frames set forth in section 6335 of the Code. Despite the change in the definition of perishable goods in 2019, the IRM suggests that examples of property likely to perish “may be food, flowers, plants or livestock [emphasis added].” Once the revenue officer determines that the property is perishable, he must secure approval of this finding. The determination is subject to high-level IRS review and planning, including an estimate of the expected net sale proceeds to be received from a forced sale. If the revenue officer concludes that the property is not perishable, sale of the seized property must proceed under normal procedures and within the time frames set forth in the Code.

A recent Bloomberg news article reported that the U.S. government had seized a 15-year-old Holsteiner that had been purchased for $750,000. The horse was a champion show jumper. As might be expected, the cost of maintaining the horse was high. IRS agents determined it would cost $45,000-$50,000 a year to feed the horse, not including the medical costs it might incur. The IRS also learned the value of the horse had dropped sharply from its $750,000 purchase price. Thus, in an unusual deal, the government sold the horse to the taxpayer’s daughter (for whom it had been purchased originally) for $25,000.

The considerations, planning, coordination, documentation, and approval of these types of sales may discourage a revenue officer from seizing perishable property like horses where other assets may be levied more easily. Nonetheless, sometimes the IRS will take action to seize a horse perceived to be valuable, like with the Holsteiner, even if it is not deemed perishable under the Code definition.

Article By Barbara T. Kaplan and Scott E. Fink of Greenberg Traurig, LLP

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