The IRS and the Treasury intend to provide regulations that will address issues affecting foreign corporations with previously taxed earnings and profits (PTEP). The regulations are in response to changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97)

The IRS and the Treasury intend to provide regulations that will address issues affecting foreign corporations with previously taxed earnings and profits (PTEP). The regulations are in response to changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), and are intended to include rules for:

• the maintenance of PTEP in annual accounts and within certain groups;
• the ordering of PTEP upon distribution and reclassification; and
• the adjustment required when an income inclusion exceeds a foreign corporation's earnings and profits.

The IRS and Treasury intend to withdraw 2006 proposed regulations relating to the exclusion from gross income of PTEP and associated basis adjustments ( NPRM REG-121509-00), and issue new proposed regulations under Code Sec. 959 and Code Sec. 961.

Previously Taxed Earnings and Profits
Previously taxed earnings and profits (PTEP) are a foreign corporation's earnings and profits attributable to amounts which are or have been included in a U.S. shareholder's gross income under Code Sec. 951(a) or under Code Sec. 1248(a). Under the subpart F rules, a U.S. shareholder of a controlled foreign corporation (CFC) is generally currently taxed on certain income earned by the CFC, and on certain earnings invested in U.S. property.

To prevent double taxation, Code Sec. 959 provides that earnings and profits of the foreign corporation that are attributable to the inclusion are excluded from gross income when actually distributed. An exclusion is also allowed when earnings and profits are attributable to amounts included in the U.S. shareholder’s gross income that would otherwise again be included in gross income under the rule for investment of earnings in U.S. property.

To determine the amount of an actual distribution that is not taxable because it represents previously taxed income upon an actual distribution by the CFC, the earnings distributed are treated as attributable in the following order:

• first, to retained earnings that were required in prior years to be included in income on account of investments in excess passive assets, together with the earnings in prior years that were required to be included in income on account of investments in U.S. property under Code Sec. 956, allocated to each category on a pro rata basis ( "section 959(c)(1) PTEP");
• next, to retained earnings that were required to be included in income as subpart F income ( "section 959(c)(2) PTEP"); and
• finally, to other earnings and profits ( "section 959(c)(3) E&P").

Changes made by the TCJA created the need to account for new groups of PTEP, because section 959(c)(2) PTEP may arise due to income inclusions under Code Secs. 951(a)(1)(A), 245A(e)(2), 951A(f)(1), 959(e), 964(e)(4), or 965(a), or by applying Code Sec. 965(b)(4)(A). Those different groups of PTEP may be subject to different rules under Code Secs. 960, 965(g), 245A(e)(3), and 986(c).

In addition, Proposed Reg. § 1.960-3(c) establishes, for purposes of determining the amount of foreign income taxes deemed paid, a system of accounting for PTEP in annual accounts for each separate category of income ( "section 904 category") and further segregate each annual account among 10 PTEP groups.

Annual Accounts and Groups of Previously Taxed Earnings and Profits
The new regulations are expected to provide that an annual account must be maintained and each annual PTEP account must be segregated into 16 PTEP groups in each section 904 category:

• reclassified section 965(a) PTEP;
• reclassified section 965(b) PTEP;
• section 951(a)(1)(B) PTEP;
• reclassified section 951A PTEP;
• reclassified section 245A(e)(2) PTEP;
• reclassified section 959(e) PTEP;
• reclassified section 964(e)(4) PTEP;
• reclassified section 951(a)(1)(A) PTEP;
• section 956A PTEP;
• section 965(a) PTEP;
• section 965(b) PTEP;
• section 951A PTEP;
• section 245A(e)(2) PTEP;
• section 959(e) PTEP;
• section 964(e) PTEP; and
• section 951(a)(1)(A) PTEP.

Section 959(c)(1) PTEP will consist of PTEP groups (1) through (9), and section 959(c)(2) PTEP will consist of PTEP groups (10) through (16). Once PTEP is assigned to a PTEP group within an annual PTEP account for the year of the income inclusion under Code Sec. 951(a)(1) or the year of application of Code Sec. 965(b)(4)(A), the PTEP will be maintained in an annual PTEP account with a year that corresponds to the year of the account from which the PTEP originated if PTEP is distributed or reclassified in a subsequent tax year.

Additionally, the new regulations are expected to provide that:

• to the extent a CFC has E&P in a PTEP group that is in more than one section 904 category, any distribution out of that PTEP group is made pro rata out of the earnings and profits in each such category;
• dollar basis must be tracked for each annual PTEP account, and, to the extent provided in the regulations, separately for each PTEP group within an annual account; and
• distributions from any PTEP group reduce the shareholder’s stock basis under Code Sec. 961(b)(1) without regard to how that basis was originally created.

The regulations also will provide transition rules for annual PTEP accounts maintained before the regulations’ applicability date.

Ordering of Earnings and Profits upon Distribution and Reclassification
The new regulations are expected to provide that:

• a distribution will be a distribution of PTEP only to the extent it would have otherwise been a dividend under Code Sec. 316;
• a "last in, first out" approach will be required for sourcing distributions from annual PTEP accounts, subject to the special priority rule for PTEP arising due to Code Sec. 965;
• PTEP attributable to income inclusions under Code Sec. 965(a) or by reason of Code Sec. 965(b)(4)(A) receive priority when determining the group of PTEP from which a distribution is made; and
• reclassifications of PTEP under Code Sec. 959(a)(2) will be sourced first from section 965(a) PTEP, then section 965(b) PTEP, and then, under a last-in, first-out approach, pro rata from the remaining section 959(c)(2) PTEP groups in each annual PTEP account, starting from the most recent annual PTEP account.

Adjustments Due to an Income Inclusion in Excess of Current Earnings and Profits
The new regulations are expected to provide that:

• current E&P are first classified as section 959(c)(3) E&P, and then section 959(c)(3) E&P are reclassified as section 959(c)(1) PTEP or section 959(c)(2) PTEP, as appropriate, in full, which may result in creating or increasing a deficit in section 959(c)(3) E&P; and
• if a foreign corporation has a current-year deficit in E&P, that deficit will solely reduce the foreign corporation’s section 959(c)(3) E&P without affecting the amount of its section 959(c)(1) PTEP or section 959(c)(2) PTEP.

Application
The new regulations are expected to apply to tax years of U.S. shareholders and successors in interest ending after December 14, 2018, and to tax years of foreign corporations ending with or within the U.S. shareholders’ tax years. Before the regulations are issued, a shareholder can rely on the rules provided in the announcement notice if the shareholder and each related shareholder apply the rules consistently regarding the PTEP of all foreign corporations in which they own stock for all tax years beginning with the shareholder’s or related shareholder’s tax year that includes the tax year end of any such foreign corporation to which Code Sec. 965 applies.

The IRS has proposed regulations on the limitation on the business interest expense deduction under Code Sec. 163(j), as amended by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The IRS also has issued a safe harbor that allows taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under Code Sec. 163(j)(7)(B).

The IRS has proposed regulations on the limitation on the business interest expense deduction under Code Sec. 163(j), as amended by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The IRS also has issued a safe harbor that allows taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under Code Sec. 163(j)(7)(B).

Business Interest Limitation
For tax years beginning after 2017, the deduction of interest paid or incurred on debt properly allocable to a trade or business is limited to the sum of:

30 percent of the taxpayer’s adjusted taxable income (but not less than zero);

the taxpayer’s business interest income (not including investment income); and

the taxpayer’s floor plan financing interest.

The proposed regulations provide general rules and definitions related to the limitation, as well as rules for calculating the limitation in consolidated group, partnership, and international contexts. The regulations affect taxpayers that have deductible business interest expense, other than certain small businesses, electing real property trades or businesses, electing farming businesses, and certain utility businesses. The IRS is also withdrawing a prior notice of proposed rulemaking on the disallowance of a deduction for certain interest paid or accrued by a corporation under former Code Sec. 163(j).

The proposed regulations will generally be effective for tax years ending after the date the Treasury Decision adopting them as final is published in the Federal Register. However, taxpayers can apply certain provisions to tax years beginning after December 31, 2017, so long as the rules are consistently applied.

Safe Harbor
Further, in Rev. Proc. 2018-59, a safe harbor is provided allowing taxpayers to treat certain infrastructure trades or businesses as electing real property trades or businesses not subject to the Code Sec. 163(j) business interest deduction limit. These include trades or businesses that are conducted in connection with the designing, building, managing, operating, or maintaining of certain core infrastructure projects for purposes of private activity bond financing proposals. If a taxpayer makes this election, the taxpayer must use the alternative depreciation system (ADS) to depreciate property. Taxpayers may apply the safe harbor to tax years beginning after December 31, 2017.

Comments Requested
Public comments to the proposed regulations should be submitted no later than 60 days after the date that the notice of proposed rulemaking is published in the Federal Register. Send submissions to: CC:PA:LPD:PR (REG-106089-18), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-106089-18), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC, 20224, or sent electronically, via the Federal Rulemaking Portal at http://www.regulations.gov (indicate IRS and REG-106089-18).

A public hearing has been scheduled for February 25, 2019. It will be held on February 25, 2019, beginning at 10 a.m., in the Main IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC 20224.

A nonprofit corporation that operated a medical-marijuana dispensary legally under California law was not allowed to claim deductions for business expenses on its federal return. Code Sec. 280E, which prevents any trade or business that consists of trafficking in controlled substances from deducting any business expenses, applied.

A nonprofit corporation that operated a medical-marijuana dispensary legally under California law was not allowed to claim deductions for business expenses on its federal return. Code Sec. 280E, which prevents any trade or business that consists of trafficking in controlled substances from deducting any business expenses, applied.

Meaning of "Consists of"
The corporation argued that a business does not "consist of" drug trafficking within the meaning of Code Sec. 280E unless its activities relate exclusively with drug trafficking (i.e., selling marijuana). Since its dispensary offered services and goods to its clients other than the sale of medical marijuana, the corporation claimed that Code Sec. 280E does not apply to any of its activities.

The court rejected this argument, noting that it had previously considered and rejected the same argument in an earlier case involving a different taxpayer ( M. Olive, Dec. 59,146, aff’d, CA-9, 2015-2 ustc ¶50,377). Although the phrase "consists of" in common usage refers to an exhaustive or exclusive list, the court noted that the corporation’s interpretation would render Code Sec. 280E ineffective. For example, a drug dealer selling a single item that was not a controlled substance would not be covered by the provision. The court found that various dictionary definitions, certain usage in other Code Sections, and case law that considered the meaning of the phrase did not require an interpretation based on exclusiveness.

Non-Trafficking Trades or Businesses
Although Code Sec. 280E applied to deductions related to the corporation’s marijuana sales, the court had previously ruled that it does not apply to any separate, non-trafficking trades or businesses ( Californians Helping to Alleviate Med. Problems, Inc. (CHAMP), Dec. 56,935). The court considered whether any of the corporation’s non-trafficking activities were separate trades or businesses. According to the corporation, non-trafficking activities consisted of sales of products with no marijuana, therapeutic services, and brand development.

The court concluded that the sale of products other marijuana than at the corporation’s dispensaries was too closely linked to the sale of the marijuana itself to constitute a separate trade or business. The products generally related to the promotion or use of marijuana and were sold by the same staff that sold the marijuana. Similarly, free "holistic" services that were paid for with approximately one percent of the proceeds from its marijuana sales were not a separate trade or business. Finally, the corporation’s brand development activity was entirely entwined with the marijuana business and could not be treated as a separate enterprise.

Cost of Goods Sold
Although the corporation was not entitled to any business deductions, it was liable for tax only on its gross receipts as reduced by cost of goods sold. For purposes of determining cost of goods sold, the court determined that the corporation could not apply Code Sec. 263A to include indirect expenses. Code Sec. 263A(a)(2) specifically prohibits the capitalization of otherwise nondeductible costs, such as drug trafficking expenses. Therefore, only direct expenses (and a few specified indirect expenses) required to be included in cost of goods sold under the general rules of Code Sec. 471 could be taken into account. For purposes of applying Code Sec. 471, the corporation was considered a reseller rather a producer because it had no ownership in the plants from which the marijuana it sold was produced.

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

• business,
• medical, and
• charitable purposes.

Some members of the military may also use these rates to compute their moving expense deductions.

2019 Standard Mileage Rates
The standard mileage rates for 2019 are:

• 58 cents per mile for business uses;
• 20 cents per mile for medical uses; and
• 14 cents per mile for charitable uses.

Taxpayers may use these rates, instead of their actual expenses, to calculate their deductions for business, medical or charitable use of their own vehicles.

FAVR Allowance for 2019
For purposes of the fixed and variable rate (FAVR) allowance, the maximum standard automobile cost for vehicles places in service after 2018 is:

• $50,400 for passenger automobiles, and
• $50,400 for trucks and vans.

Employers can use a FAVR allowance to reimburse employees who use their own vehicles for the employer’s business.

2019 Mileage Rate for Moving Expenses
The standard mileage rate for the moving expense deduction is 20 cents per mile. To claim this deduction, the taxpayer must be:

• a member of the Armed Forces of the United States,
• on active military duty, and
• moving under an military order and incident to a permanent change of station.

The Tax Cuts and Jobs Act of 2017 suspended the moving expense deduction for all other taxpayers until 2026.

Unreimbursed Employee Travel Expenses
For most taxpayers, the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction for unreimbursed employee travel expenses. However, certain taxpayers may still claim an above-the-line deduction for these expenses. These taxpayers include:

• members of a reserve component of the U.S. Armed Forces,
• state or local government officials paid on a fee basis, and
• performing artists with relatively low incomes.

Notice 2018-3, I.R.B. 2018-2, 285, as modified by Notice 2018-42, I.R.B. 2018-24, 750, is superseded.

The IRS has provided guidance and examples for calculating the nondeductible portion of parking expenses. In addition, the IRS has provided guidance to tax-exempt organizations to help such organizations determine how unrelated business taxable income (UBTI) will be increased by the nondeductible amount of such fringe benefit expenses paid or incurred.

The IRS has provided guidance and examples for calculating the nondeductible portion of parking expenses. In addition, the IRS has provided guidance to tax-exempt organizations to help such organizations determine how unrelated business taxable income (UBTI) will be increased by the nondeductible amount of such fringe benefit expenses paid or incurred.

The IRS also has provided transitional estimated tax penalty relief to tax-exempt organizations that offer qualified transportation fringe benefit expenses and were not required to file a Form 990-T, Exempt Organization Business Income Tax Return, last filing season.

Parking Fringe Expenses
The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) added Code Sec. 274(a)(4) to preclude employers from deducting Code Sec. 132(f) qualified transportation fringe benefits expenses paid or incurred after December 31, 2017. Qualified transportation fringe benefits include van pools, transit passes, bicycle commuting, and qualified parking.

There are two types of calculations. The first is for cases where the employer pays a third party for the use of its parking lot for the employer’s employees. The second is for cases where the employer owns or leases the parking lot.

Employer contracts with third party. When an employer contracts with a third party for the use of the parking lot, the disallowance under Code Sec. 274(a)(4) is generally the amount that the employer pays to the third party. However, if that monthly amount exceeds $260 an employee, the employer must treat the excess as additional compensation. Thus, the monthly amount in excess of $260 is excluded from the disallowance amount.

For example, if Employer A pays $300 per month for each of the employer’s ten employees to park, $31,200 (($260 x 10) x 12) is disallowed under Code Sec. 274(a)(4). The remaining $4,800 (($40 x 10) x 12) is not subject to the Code Sec. 274(a)(4) and remains deductible.

Employer owns or leases the parking lot. According to the IRS, until it issues further guidance, employers may use any reasonable method to calculate the Code Sec. 274(a)(4) disallowance in cases where the employer owns or leases the parking lot. The IRS has provided a four-step reasonable method:

• Calculate the disallowance for reserved employee spots.
• Determine the primary use of the remaining spots (for the general public (over 50 percent) or for employees).
• Calculate the allowance for reserved nonemployee spots.
• Determine the remaining use and allocable expenses.

For example, an Employer E, owns a surface parking lot adjacent to its plant. E incurs $10,000 of total parking expenses. E’s parking lot has 500 spots that are used by its visitors and employees. E has 50 spots reserved for management and has approximately 400 employees parking in the lot in non-reserved spots during normal business hours on a typical business day. Additionally, E has 10 reserved nonemployee spots for visitors.

Step 1. Because E has 50 reserved spots for management, $1,000 ((50/500) x $10,000) is the amount of total parking expenses that is nondeductible for reserved employee spots.

Step 2. The primary use of the remainder of E’s parking lot is not to provide parking to the general public because 89% (400/450 = 89 percent) of the remaining parking spots in the lot are used by its employees. Therefore, expenses allocable to these spots are not excluded from the Code Sec. 274(a)(4)

Step 3. Because 2 percent (10/450) of E’s remaining parking lot spots are reserved nonemployee spots, the $200 allocable to those spots ($10,000 x 2 percent)) is not subject to the Code Sec. 274(a)(4) disallowance. That amount continues to be deductible.

Step 4. E must reasonably determine the employee use of the remaining parking spots during normal business hours on a typical business day and the expenses allocable to employee parking spots.

Further guidance will be issued on these and other issues in the form of proposed regulations at a later date.

Increase Unrelated Business Taxable Income
TCJA added Code Sec. 512(a)(7), which requires exempt organizations to increase UBTI by any amount for which a deduction is not allowable under Code Sec. 274 and which is paid or incurred after December 31, 2017, for any qualified transportation fringes and any parking facility used in connection with qualified parking.

The rules governing tax-exempt organizations mirror the rules for employers under Code Sec. 274(a)(4). Therefore, the expenses for a parking facility used in connection with qualified parking are treated as nondeductible qualified fringe benefit expenses. Thus, a tax-exempt organization must increase its UBTI under Code Sec. 512(a)(7) by the disallowed amount. In addition, until the IRS releases further guidance, a tax-exempt organization with only one unrelated trade or business can reduce the increase to UBTI under Code Sec. 512(a)(7) to the extent that the deductions directly connected with the carrying on of that unrelated trade or business exceed the gross income derived from such unrelated trade or business.

Estimated Tax Penalty Relief
An exempt organization may be subject to the unrelated business income tax under Code Sec. 511 at corporate rates. The organization reports its unrelated business income on Form 990-T, Exempt Organization Business Income Tax Return, if its gross income from unrelated business is $1,000 or more. Further, the organization must make quarterly estimated tax installment payments under Code Sec. 6655 if its estimated tax is expected to be $500 or more.

Code Sec. 6655 imposes an addition to tax for failure to make a sufficient and timely estimated income tax payment. To avoid the underpayment penalty, each installment generally must equal at least 25 percent of the lesser of:

• 100 percent of the tax shown on the current year's tax return or of the actual tax if no return is filed (current-year safe harbor); or
• 100 percent of the tax shown on the corporation's return for the preceding tax year, provided a positive tax liability was shown and the preceding tax year consisted of 12 months (preceding-year safe harbor).

The IRS has recognized that Code Sec. 512(a)(7) may cause some exempt organizations to owe unrelated business income tax and have to pay estimated income tax for the first time. These organizations would not be able to use the preceding-year safe harbor, and may need more time to develop knowledge and processes to comply with estimated tax payment requirements.

In light of this, the IRS is waiving the addition to tax for failure to make estimated income tax payments for an exempt organization that:

• provides qualified transportation fringes to an employee for which estimated income tax payments, affected by changes made by TCJA to Code Sec. 274 and Code Sec. 512, would otherwise be required to be made on or before December 17, 2018;
• was not required to file a Form 990-T, Exempt Organization Business Income Tax Return, for the tax year preceding the organization’s first tax year ending after December 31, 2017; and
• timely pays the amount reported for the tax year for which relief is granted.

Taxpayers that do not qualify for this relief can avoid an addition to tax for underpayment of estimated income tax if they meet one of the statutory safe harbor or exception provisions under Code Sec. 6654 or Code Sec. 6655.

To claim the waiver, the exempt organization must write "Notice 2018-100" on the top of its Form 990-T.

The IRS has released initial guidance on the new Code Sec. 83(i), added by the 2017 Tax Cuts and Jobs Act ( P.L. 115-97).

Code Sec. 83 generally provides for the federal income tax treatment of property transferred in connection with the performance of services. Code Sec. 83(i) allows certain employees to elect to defer recognition of income attributable to the receipt or vesting of qualified stock for up to five years.

The IRS has released initial guidance on the new Code Sec. 83(i), added by the 2017 Tax Cuts and Jobs Act ( P.L. 115-97).

Code Sec. 83 generally provides for the federal income tax treatment of property transferred in connection with the performance of services. Code Sec. 83(i) allows certain employees to elect to defer recognition of income attributable to the receipt or vesting of qualified stock for up to five years.

The guidance clarifies three key issues related to Code Sec. 83(i):

• the application of the requirement that eligible corporations must make grants to not less than 80 percent of all employees who provide services to the corporation in the United States;
• the application of federal income tax withholding to the deferred income related to the qualified stock; and
• the ability of an employer to opt out of permitting employees to elect the deferred tax treatment even if the requirements under Code Sec. 83(i) are otherwise met.

Code Sec. 83(i) applies to stock attributable to stock options exercised, or restricted stock units (RSUs) settled, after December 31, 2017. Further guidance will be issued on these and other issues in the form of proposed regulations at a later date.

Eligible Corporations
Companies who wish to be eligible corporations and offer the Code Sec. 83(i) election must have a written plan under which, in such calendar year, not less than 80 percent of all employees who provide services to the corporation in the United States (or any possession of the United States) are granted stock options, or are granted RSUs, with the same rights and privileges to receive qualified stock.

The IRS clarifies that the determination of whether a corporation qualifies as an eligible corporation is made "with respect to any calendar year." Furthermore, to meet the 80-percent requirement, the corporation must have granted "in such calendar year" stock options to 80 percent of its employees or RSUs to 80 percent of its employees. So the determination that the corporation is an eligible corporation must be made on a calendar-year basis, and whether the corporation has satisfied the 80-percent requirement is based solely on the stock options or the RSUs granted in that calendar year to employees who provide services to the corporation in the United States. In calculating whether the 80 percent requirement is satisfied, the corporation must take into account the total number of individuals employed at any time during the year in question as well as the total number of employees receiving grants during the year.

Employment Taxes
Employment taxes include Federal Insurance Contributions Act (FICA) taxes, Federal Unemployment Tax Act (FUTA) tax, and federal income tax withholding. FICA and FUTA taxes related to deferral stock remain unaffected.

Deferral stock are considered wages under Code Sec. 3402. When the wages are treated as paid, the employer must make a reasonable estimate of the value of the stock and make deposits of the amount of income tax withholding liability based on that estimate. The wages are subject to withholding at the maximum rate of tax, and withholding is determined without regard to the employee’s Form W-4. By January 31 of the following year, the employer must determine the actual value of the deferral stock on the date it is includible in the employee’s income, and report that amount and the withholding on Form W-2 and Form 941. With respect to income tax withholding for the deferral stock that the employer pays from its own funds, the employer may recover that income tax withholding from the employee until April 1 of the year following the calendar year in which the wages were paid. An employer that fails to deduct and withhold federal income tax is liable for the payment of the tax whether or not the employer collects it from the employee.

Not Eligible Stock
Code Sec. 83(i) imposes a number of requirements and limitations that must be met for an election to be allowed. Although the election, if allowed, may be made by an employee, the corporation is responsible for creating the conditions that would allow an employee to make the election. If a corporation does not intend to create the conditions that would allow an employee to make the election, the terms of a stock option or RSU may provide that no election under Code Sec. 83(i) will be available with respect to stock received upon the exercise of the stock option or settlement of the RSU. This designation would inform employees that no Code Sec. 83(i) election may be made with respect to stock received upon exercise of the option or settlement of the RSU, even if the stock is qualified stock.

Highly anticipated foreign tax credit regulations have been issued that provide guidance on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act ( P.L. 115-97).

Highly anticipated foreign tax credit regulations have been issued that provide guidance on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act ( P.L. 115-97). The proposed regulations address:

• allocation and apportionment of the deductions under Code Secs. 861 through 865, and adjustments to the foreign tax credit limitation under Code Sec. 904(b)(4);
• transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under Code Sec. 904(f) and (g), and for the carryover and carryback of unused foreign taxes under Code Sec. 904(c);
• addition of separate foreign tax credit limitation categories for foreign branch income and global intangible low-taxed income (GILTI), and other updates to the foreign tax credit limitation rules;
• calculation of the high-tax income exception from subpart F income;
• determination of the Code Sec. 960 deemed paid credits and the gross-up under Code Sec. 78; and
• the election under Code Sec. 965(n) not to apply the net operating loss deduction when calculating the Code Sec. 965 transition tax.

Deduction Allocation and Apportionment
The proposed regulations generally apply the existing approach of the expense allocation rules to income in the new Code Sec. 951A (GILTI) and foreign branch categories. The proposed regulations also provide for exempt income and exempt asset treatment for income in the GILTI category that is offset by the Code Sec. 250 deduction. This will reduce the amount of expenses apportioned to the GILTI category.

Rules are provided for the allocation and apportionment of the Code Sec. 250 deduction. A new rule addresses loans to partnerships by certain partners and their affiliates to prevent abusive borrowing arrangements that artificially increase foreign source income. Under the proposed regulations, interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate categories in the same manner as the associated interest expense.

The proposed allocation and apportionment regulations also revise the netting rule for controlled foreign corporations (CFCs), and provide rules for: valuing assets, characterizing stock for elections related to research and experimentation (R&E) expenses, and applying the Code Sec. 904(b)(4) adjustment.

Because the existing expense allocation rules have not been updated since 1988, the Treasury Department and IRS expect to reexamine existing approaches to allocating and apportioning expenses, including for example the rules for allocating interest, R&E expenses, stewardship and general and administrative expenses.

Limitations
The proposed regulations eliminate deadwood, and reflect statutory amendments made prior to the TCJA. New and transitional rules account for the separate categories for GILTI and foreign branch income. For example, foreign tax credit carryovers will by default remain in the general category, but taxpayers are allowed to allocate the transitional FTC carryovers to the foreign branch category. Also, the look-through rules are revised to clarify that nonpassive look-through payments cannot be assigned to a Code Sec. 951A category, and are generally assigned to the general category or the foreign branch category.

Additionally, changes are made to the rules relating to the passive category for high-taxed income, export financing income, and financial services income. Also addressed is the separate category for income resourced under a treaty, and rules for assigning the Code Sec. 78 gross-up and Code Sec. 986(c) gain or loss to a separate category.

Deemed Paid Tax Credits
The proposed regulations provide rules for determining a domestic corporation’s deemed paid taxes under Code Sec. 960, as revised by the TCJA. The proposed regulations treat a GILTI inclusion as a subpart F inclusion for purposes of Code Sec. 960(c). The proposed regulations also reflect the changes made by the TCJA to the Code Sec. 78 gross-up.

Proposed regulations provide much anticipated guidance on the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A and related reporting requirements. The regulations are proposed to apply generally to tax years beginning after December 31, 2017, but taxpayers may rely on these proposed regulations until final regulations are published.

Proposed regulations provide much anticipated guidance on the base erosion and anti-abuse tax (BEAT) under Code Sec. 59A and related reporting requirements. The regulations are proposed to apply generally to tax years beginning after December 31, 2017, but taxpayers may rely on these proposed regulations until final regulations are published.

Code Sec. 59A was added by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) and imposes a tax on base erosion payments of taxpayers with substantial gross receipts. The tax is equal to the base erosion minimum tax amount for the tax year. The TCJA also added reporting obligations regarding the BEAT for 25-percent foreign-owned corporations subject to Code Sec. 6038A and foreign corporations subject to Code Sec. 6038C.

Proposed BEAT Rules
The proposed regulations generally provide rules for determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed and rules for computing the taxpayer’s BEAT liability. In particular, the proposed regulations provide rules:

• for determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed ( Proposed Reg. §1.59A-2);
• for determining the amount of base erosion payments (Proposed Reg. § 1.59A-3(b));
• for determining base erosion tax benefits arising from base erosion payments (Proposed Reg. §1.59A-3(c));
• for determining the amount of modified taxable income, which is computed in part by reference to a taxpayer’s base erosion tax benefits and base erosion percentage of any net operating loss deduction (Proposed Reg. §1.59A-4);
• for computing the base erosion minimum tax amount, which is computed by reference to modified taxable income (Proposed Reg. §1.59A-5);
• for applying the proposed regulations to partnerships (Proposed Reg. § 1.59A-7);
• that are specific to banks and registered securities dealers;
• that are specific to insurance companies;
• that disregard certain transactions having a principal purpose of avoiding Code Sec. 59A (anti-abuse rules) (Proposed Reg. § 1.59A-9);
• regarding the general application of the BEAT to consolidated groups (Proposed Reg. § 1.1502-59A);
• addressing limitations on a loss corporation’s items under Code Secs. 382 and 383 in the context of the BEAT (Proposed Reg. § 1.383-1); and
• regarding reporting and record keeping requirements under Code Sec. 6038A.

Proposed Applicability Dates
Consistent with the Code Sec. 59A applicability date, the proposed regulations (other than the proposed reporting requirements for qualified derivatives payments (QDP)) are proposed to apply to tax years beginning after December 31, 2017. However, taxpayers may rely on these proposed regulations for tax years beginning after December 31, 2017, until final regulations are published, provided the taxpayer and all related parties consistently apply the proposed regulations for all those tax years that end before the finalization date.

The proposed reporting requirements for QDPs apply to tax years beginning one year after the final regulations are published. However, the simplified QDP reporting requirements are proposed to apply to tax years beginning after December 31, 2017.

Any provision that is finalized after June 22, 2019, will apply only to tax years ending on or after the date of filing of the proposed regulations in the Federal register.

The IRS will grant automatic consent to accounting method changes to comply with new Code Sec. 451(b), as added by the Tax Cuts and Jobs Act ( P.L. 115-97). In addition, some taxpayers may make the accounting method change on their tax returns without filing a Form 3115, Application for Change in Accounting Method. These procedures generally apply to tax years beginning after December 31, 2017. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

The IRS will grant automatic consent to accounting method changes to comply with new Code Sec. 451(b), as added by the Tax Cuts and Jobs Act ( P.L. 115-97). In addition, some taxpayers may make the accounting method change on their tax returns without filing a Form 3115, Application for Change in Accounting Method. These procedures generally apply to tax years beginning after December 31, 2017. Rev. Proc. 2018-31, I.R.B. 2018-22, 637, is modified.

All Events Test
Under Code Sec. 451(b), the date that an accrual basis taxpayer takes an item into account as revenue in its applicable financial statement (AFS) is also the deadline for treating the item as satisfying the all events test. This rule also applies to any portion of an item, any other financial statement identified by the IRS, and income from a debt instrument with original issue discount (OID).

Automatic Consent
The automatic consent procedures apply to a taxpayer with an AFS that:

• wants to change to a method of accounting that complies with Code Sec. 451(b); and/or
• for the year of the change, is not adopting Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) financial accounting standards for revenue recognition, titled "Revenue from Contracts with Customers (Topic 606)" that were announced on May 28, 2014.

For income from a debt instrument having OID, the Code Sec. 481(a) adjustment period for the change is six tax years (year of change plus the next five tax years). However, this applies only for the taxpayer’s first tax year beginning after December 31, 2018.

The automatic consent procedures do not apply to a taxpayer that wants to make a change to a method that adopts the FASB/IASB standard, or to a special accounting method as described in Code Sec. 451(b)(2).

Streamlined Procedure
For its first tax year beginning after December 31, 2017, a qualified taxpayer can change its accounting method to comply with Code Sec. 451(b) without filing a Form 3115. An eligible taxpayer must either:

• meet the Code Sec. 448(c) gross receipts test for a small business taxpayers (i.e., taxpayer’s average annual gross receipts for the three prior tax years cannot exceed $25 million); or
• be making the change to comply with Code Sec. 451(b)(1)(A) and/or (b)(4), and the Code Sec. 481(a) adjustment for each of the changes is zero.

These streamlined procedures do not apply to a taxpayer that wants to make a change to a method that adopts the FASB/IASB standard, or to a special accounting method as described in Code Sec. 451(b)(2), or certain other concurrent accounting method changes. Tax shelters also are not eligible.

The IRS warns that consent granted under the streamlined procedures is not a determination that the new accounting method is permissible, and that taxpayers using the streamlined change method do not receive audit protection.

The IRS has issued transition relief from the "once-in-always-in" condition for excluding part-time employees under Reg. §1.403(b)-5(b)(4)(iii)(B). Under the "once-in-always-in" exclusion condition, once an employee is eligible to make elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that he or she is a part-time employee.

The IRS has issued transition relief from the "once-in-always-in" condition for excluding part-time employees under Reg. §1.403(b)-5(b)(4)(iii)(B). Under the "once-in-always-in" exclusion condition, once an employee is eligible to make elective deferrals, the employee may not be excluded from making elective deferrals in any later exclusion year on the basis that he or she is a part-time employee.

Part-Time Employee Exclusion Conditions Under Final 403(b) Regulations
The Department of the Treasury and the IRS issued final regulations under Code Sec. 403(b) that were generally effective starting after 2008. Part of the final regulations include Reg. §1.403(b)-5(b)(4)(iii)(B), which covers the conditions that an employer must satisfy before excluding a part-time employee from the plan. The IRS parses the regulation to impose three separate conditions for an employee to be excluded—

• a "first-year" exclusion condition, under which the employer must reasonably expect the employee to work fewer than 1,000 hours during the employee’s first year of employment;
• a "preceding-year" exclusion condition, under which the employee must have actually worked fewer than 1,000 hours in the preceding 12-month period; and
• the "once-in-always-in" exclusion condition, under which the employee may be excluded under the part-time exclusion if and only if, in the employee’s first year of employment, the employee meets the first-year exclusion condition, and, in each exclusion year ending after the first year of employment, the employee has met the preceding-year exclusion condition.

The effect of the once-in-always-in exclusion condition is that once an employee does not meet the part-time exclusion conditions, whether in the initial year of employment or for any exclusion year, the employee may no longer be excluded from making elective deferrals under the part-time exclusion.

Employers Surprised by Once-In-Always-In Condition
Employers requested transition relief because many were unaware that the part-time exclusion included the once-in-always-in exclusion condition. Many employers applied the first-year exclusion condition for an employee’s first year, and applied the preceding-year exclusion condition separately for each succeeding exclusion year, but did not apply the once-in-always-in exclusion condition to prevent an employee who failed to meet either the first-year exclusion condition or the preceding-year exclusion condition from being excluded in all subsequent exclusion years.

Transition Relief for Once-In-Always-In Condition
The IRS is providing transition relief, including—

• operations relief for a transition period referred to as the "Relief Period";
• relief regarding plan language; and
• a fresh-start opportunity after the "Relief Period" ends.

The operations "Relief Period" begins with tax years beginning after December 31, 2008. For plans with exclusion years based on plan years, the "Relief Period" ends for all employees on the last day of the last exclusion year that ends before December 31, 2019. For plans with exclusion years based on employee anniversary years, the "Relief Period" ends, with respect to any employee, on the last day of that employee’s last exclusion year that ends before December 31, 2019.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS and the Treasury Department intend to develop income tax withholding regulations to reflect changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), as well as other changes in the Code since the regulations were last amended, and certain miscellaneous changes consistent with current procedures.

Withholding Allowances
The IRS delayed the release of the 2018 Form W-4, Employee’s Withholding Allowance Certificate, in order to reflect changes made by the TCJA, such as changes in itemized deductions available, increases in the child tax credit, the new credit for other dependents, and the suspension of personal exemption deductions. Notice 2018-14 provided relief for employers and employees affected by the delay.

In June, the IRS released a draft 2019 Form W-4 and instructions, which incorporated changes that were meant to improve the accuracy of income tax withholding and make the withholding system more transparent. However, in response to stakeholders’ comments, the IRS later announced that the redesigned Form W-4 would be postponed until 2020. The IRS intends to release a 2019 Form W-4 before the end of 2018 that makes minimal changes to the 2018 Form W-4.

The 2019 Form W-4 and the computational procedures in IRS Publication 15 (Circular E), Employer’s Tax Guide, will continue to use the term "withholding allowances" and related terminology to incorporate the withholding allowance factors specified in Code Sec. 3402(f) and the additional allowance items in Code Sec. 3402(m). Until further guidance is issued, references to a "withholding exemption" in the Code Sec. 3402 regulations and guidance will be applied as if they were referring to a withholding allowance.

Changes in Status
The guidance provides that if an employee experiences a change of status on or before April 30, 2019, that reduces the number of withholding allowances to which he or she is entitled, and if that change is solely due to the changes made by the TCJA, the employee generally must furnish a new Form W-4 to the employer by May 10, 2019. However, if an employee no longer reasonably expects to be entitled to a claimed number of allowances due to a change in personal circumstances that is not solely related to TCJA changes, the employee must furnish his or her employer a new Form W-4 within 10 days after the change. Similarly, if an employee claims married filing status on Form W-4 but divorces his or her spouse, the employee must furnish the employer a new Form W-4 within 10 days after the change.

Failure to Furnish
The IRS and the Treasury Department intend to withdraw the regulations under Code Sec. 3401(e), and modify other regulations, so that an employee who fails to furnish a Form W-4 will be treated as "single" but entitled to the number of withholding allowances determined under computational procedures provided in IRS Publication 15. Until further guidance is issued, however, employees who fail to furnish a Form W-4 will be treated as single with zero withholding allowances.

Additional Allowances
Until further guidance is issued, a taxpayer may include his or her estimated Code Sec. 199A passthrough deduction in determining whether he or she can claim the additional withholding allowance under Code Sec. 3402(m) on Form W-4.

Alternative Procedure
The IRS and the Treasury Department intend to update the withholding regulations to explicitly allow employees to determine their Form W-4 entries by using the IRS withholding calculator ( www.irs.gov/W4App) or IRS Publication 505, Tax Withholding and Estimated Tax, instead of having to complete certain schedules included with the Form W-4. However, the regulations are expected to provide that an employee cannot use the withholding calculator if the calculator’s instructions state that it should not be used due to his or her individual tax situation. The employee will need to use Publication 505 instead.

Alternative Methods
The IRS and the Treasury Department intend to eliminate the combined income tax withholding and employee FICA tax withholding tables under Reg. §31.3402(h)(4)-1(b), due to this alternative procedure’s unintended complexity and burden.

Lock-In Letters
The IRS may issue a "lock-in letter" to an employer, which sets the maximum number of withholding allowances an employee may claim. If the employer no longer employs the employee, the employer must send a written response to the IRS office designated in the lock-in letter that the employee is not employed by the employer. The IRS and the Treasury Department intend to eliminate the written response requirement. Pending further guidance, employers should not send a written response to the IRS under Reg. §31.3402(f)(2)-1(g)(2)(iv).

Pension, Annuity Payments
The payor of certain periodic payments for pensions, annuities, and other deferred income generally must withhold tax from the payments as if they were wages, unless the individual payee elects not to have withholding apply. Before 2018, if a withholding certificate was not furnished to the payor, the withholding rate was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended this rule so that the rate "shall be determined under rules prescribed by the Secretary." The IRS has determined that, for 2019, withholding on periodic payments when no withholding certificate is in effect continues to be based on treating the payee as a married individual claiming three withholding allowances.

Comments Requested
The IRS and the Treasury Department request comments on both the interim guidance and the guidance that should be provided in regulations. Comments must be received by January 25, 2019. Comments should be submitted to: CC:PA:LPD:PR (Notice 2018-92), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2018-92), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., 20224. Alternatively, taxpayers may submit comments electronically to Notice.comments@irscounsel.treas.gov (include "Notice 2018-92" in the subject line of any electronic submission).

A taxpayer's expenses incurred due to travel outside of the United States for business activities are deductible, but under a stricter set of rules than domestic travel. Foreign travel expenses may be subject to special allocation rules if a taxpayer engages in personal activities while traveling on business. Expenses subject to allocation include travel fares, meals, lodging, and other expenses incident to travel.  

Allocation expenses

Frequently, international business trips have a personal aspect. A taxpayer who travels outside of the United States for both business and pleasure may deduct no part of his or her travel expenses (airfare, cabs, hotel, meals, etc.) if the trip is not primarily related to business. However, business expenses incurred while at the destination are deductible even though the travel expenses are not.

If the trip is primarily related to business, then that portion of travel properly allocated to the business portion may be deducted. Proper allocation is based on the amount of time spent on each activity. "Primary purpose" is a purpose of more than 50 percent. Foreign travel for purposes of allocation is travel outside the 50 states and the District of Columbia.

The general "primary purpose" rule on foreign business travel, fortunately, has two huge exceptions, one for anyone who travels a week or less and the other for most employees on business trips under an expenses allowance arrangement.

The allocation rules do not apply to taxpayers:

• who do not have substantial control over the business trip;
• whose travel outside the United States is a week or less in duration; 
• who establish that a personal vacation was not a major factor in deciding to take the trip; and
• whose personal activities conducted during the trip are less than 25 percent of the total travel time.

Taxpayers who travel under reimbursement or other expense allowance arrangements are not considered to have substantial control over the business trip unless they are the managing executive of the employer or a party related to, or more than 10 percent owner of the employer.

Conventions

Business conventions come under a separate rule. A taxpayer cannot deduct travel expenses for attending a convention, seminar or similar business meeting held outside the "North American area" unless specific criteria are satisfied. The "North American area" includes not only the US, Canada, and Mexico but also Costa Rica, Honduras and many islands in the Atlantic, Caribbean, and the Pacific.

If you are unsure of how to allocate your business travel expenses and need additional information, please give our office a call. We would be glad to help.

With the subprime mortgage mess wreaking havoc across the country, many homeowners who over-extended themselves with creative financing arrangements and exotic loan terms are now faced with some grim tax realities. Not only are they confronted with the overwhelming possibility of losing their homes either voluntarily through selling at a loss or involuntarily through foreclosure, but they must accept certain tax consequences for which they are totally unprepared.

Many homeowners - whether in connection with their principal residence or a vacation property - may not anticipate that foreclosure and a home sale that produces a loss can trigger significant and unexpected income tax liabilities, especially when the sale does not produce enough gain to pay off outstanding mortgage debt.

Selling at a loss

Homeowners may be unpleasantly surprised to learn that they can not write-off losses incurred from the sale of their home. When a homeowner is forced to sell their personal residence for less than the price they paid, the loss incurred on the sale is considered to be a non-deductible personal expense for federal income tax purposes. What's more, if the homeowner eventually buys another home that is sold down the road at a taxable profit, previous losses cannot be used to offset that gain.

Faced with such a situation, the technique of renting out the home, rather than selling it, might help some homeowner buy time until better times. If renting eventually stops making financial sense, the homeowner who sells at a loss might then succeed in establishing a deductible business loss from the business of renting property. However, only losses incurred after the property is converted may be deducted.

Debt forgiveness

Homeowners who sell their property when their mortgage debt exceeds the net sale price of the home (a so-called "short sale") may find that they owe taxes to the IRS. For example, assume you paid $500,000 for a home that you sell for a net sale price of $400,000, but you have a mortgage of $550,000 on the property. For tax purposes, you have incurred a $100,000 loss on the sale because the sale price is lower than your tax basis in the property ($400,000 sale price - $500,000 basis = $100,000 loss). Moreover, you still owe $150,000 to your mortgage lender since a mortgage note is a personal liability in addition to being an encumbrance on the house itself. If the lender refuses to discharge the remaining debt, you'll have to pay off the loan and there is no tax break or write-off for doing so.

On the other hand, if the mortgage lender forgives part or all of the remaining $150,000 debt, the amount discharged is considered taxable income. With few exceptions, discharged debt of all types is treated as income, taxable at ordinary rates just like a salary. It is irrelevant to the IRS that no tangible income was actually received on the sale of the home or forgiveness of debt by the lender. You will owe taxes on the amount of mortgage debt that the lender discharges. What's more, there is no offset from your $100,000 loss on the sale of the property; nor is this income covered by the $250,000 exclusion on taxable gain on the sale of a principal residence ($500,000 for joint filers).

A lender who discharges any part or all of a homeowner's debt must report the forgiven debt on Form 1099-C (Cancellation of Debt) to you and to the IRS. You must report the amount of discharged debt as income on your tax return in the year the mortgage debt is forgiven.

Foreclosure

Foreclosure also produces tax consequences that may be wholly unanticipated by the homeowner. Taxable gains and income from mortgage debt forgiveness also occur in foreclosure. Tax liability upon foreclosure depends on whether you have a nonrecourse or recourse loan. A recourse loan permits the lender to sue the borrower for any outstanding debt. When a foreclosure occurs on the property of a homeowner with a nonrecourse loan, however, the lender is only entitled to collect the amount that the home is sold for, and the borrower has no further liability.

Example. Your tax basis in your home is $400,000. You have a recourse loan and your mortgage debt totals $350,000. But at the time of foreclosure the fair market value of your home has decreased to $325,000. However, the lender forgives the remaining unpaid mortgage debt of $25,000 (usually because the lender sees that the former homeowner has little assets left, the remaining debt would be hard to collect, and an immediate write off gives the lender an immediate tax deduction). Tax law treats you as having received ordinary income from the cancellation of the debt in the amount of $25,000.

Alternatively, if you had a nonrecourse loan in the amount of $350,000 and your home sold at auction for $325,000, you would have no further liability to the lender since it cannot pursue you for the lost $25,000. Therefore, since your mortgage lender cannot legally pursue you for the remaining $25,000, there will be no debt for them to discharge. Such nonrecourse loans, however, are very rare in personal, non-business settings.

Moreover, if property is foreclosed and sold at auction for more than the home's tax basis, the sale produces taxable gain. In this case, however, the gain from a foreclosure sale of an individual's principal residence may be excluded to the extent of up to $250,000 ($500,000 for married homeowners filing jointly), depending on the length of homeownership. No exclusion, however, is given on vacation property that is not a principal residence.

Future relief for homeowners?

In mid-April, Reps. Robert E. Andrews (D-New Jersey) and Ron Lewis (R-Kentucky), introduced the Mortgage Cancellation Relief Act of 2007 (H.R. 1876), a bill that would assist many homeowners affected by the loss of their home through foreclosure or short sale. The legislation would exempt discharged debt on primary home mortgages from treatment as income subject to income taxation. Currently, the bill is before the House Ways and Means Committee.

If you would like more information on the tax consequences of foreclosure or the potential implications of taking a loss on the sale of your home or vacation property, please call our office and we can discuss your options for minimizing your tax liabilities.

These days, both individuals and businesses buy goods, services, even food on-line. Credit card payments and other bills are paid over the internet, from the comfort of one's home or office and without any trip to the mailbox or post office.

Now, what is probably your biggest "bill" can be paid on-line: your federal income taxes.

There are three online federal tax payment options available for both businesses and individuals: electronic funds withdrawal, credit card payments and the Electronic Federal Tax Payment System. If you are not doing so already, you should certainly consider the convenience -and safety-- of paying your tax bill online.  While all the options are now "mainstream" and have been used for at least several years, safe and convenient, each has its own benefits as well as possible drawbacks. The pros and cons of each payment option should be weighed in light of your needs and preferences.

Electronic Funds Withdrawal

Electronic funds withdrawal (or EFW) is available only to taxpayers who e-file their returns. EFW is available whether you e-file on your own, or with the help of a tax professional or software such as TurboTax. E-filing and e-paying through EFW eliminates the need to send in associated paper forms.

Through EFW, you schedule when a tax payment is to be directly withdrawn from your bank account. The EFW option allows you to e-file early and, at the same time, schedule a tax payment in the future. The ability to schedule payment for a specific day is an important feature since you decide when the payment is taken out of your account. You can even schedule a payment right up to your particular filing deadline.

The following are some of the tax liabilities you can pay with EFW:

• Individual income tax returns (Form 1040)
• Trust and estate income tax returns (Form 1041)
• Partnership income tax returns (Forms 1065 and 1065-B)
• Corporation income tax returns for Schedule K-1 (Forms 1120, 1120S, and 1120POL)
• Estimated tax for individuals (Form 1040)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax return (Form 944)
• Private foundation returns (Form 990-PF)
• Heavy highway vehicle use returns (Form 2290)
• Quarterly federal excise tax returns (Form 720)

For a return filed after the filing deadline, the payment is effective on the filing date. However, electronic funds withdrawals can not be initiated after the tax return or Form 1040 is filed with the IRS. Moreover, a scheduled payment can be canceled up until two days before the payment.

EFW does not allow you to make payments greater than the balance you owe on your return. Therefore, you can't pay any penalty or interest due through EFW and would need to choose another option for these types of payments. While a payment can be cancelled up to two business days before the scheduled payment date, once your e-filed return is accepted by the IRS, your scheduled payment date cannot be changed. Thus, if you need to change the date of the payment, you have to cancel the original payment transaction and chose another payment method. Importantly, if your financial institution can't process your payment, such as if there are insufficient funds, you are responsible for making the payment, including potential penalties and interest. Finally, while EFW is a free service provided by the Treasury, your financial institution most likely charges a "convenience fee."

Credit Card Payments

Do you have your card ready? The Treasury Department is now accepting American Express, Discover, MasterCard, and VISA.

Both businesses and individual taxpayers can make tax payments with a credit card, whether they file a paper return or e-file. A credit card payment can be made by phone, when e-filing with tax software or a professional tax preparer, or with an on-line service provider authorized by the IRS. Some tax software developers offer integrated e-file and e-pay options for taxpayers who e-file their return and want to use a credit card to pay a balance due.

However, there is a convenience fee charged by service providers. While fees vary by service provider, they are typically based on the amount of your tax payment or a flat fee per transaction. For example, you owe $2,500 in taxes and your service provider charges a 2.49% convenience fee. The total fee to the service provider will be $62.25. Generally, the minimum convenience fee is $1.00 and they can rise to as much as 3.93% of your payment.

The following are some tax payments that can be made with a credit card:

• Individual income tax returns (Form 1040)
• Estimated income taxes for individuals (Form 1040-ES)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax returns (Form 944)
• Corporate income tax returns (Form 1120)
• S-corporation returns (Form 1120S)
• Extension for corporate returns (Form 7004)
• Income tax returns for private foundations (Form 990-PF)

However, as is the case is with the EFW option, if a service provider fails to forward your payment to the Treasury, you are responsible for the missed payment, including potential penalties and interest.

Electronic Federal Tax Payment System

EFTPS is a system that allows individuals and businesses to pay all their federal taxes electronically, including income, employment, estimated, and excise taxes. EFTPS is available to both individuals and businesses and, once enrolled, taxpayers can use the system to pay their taxes 24 hours a day, seven days a week, year round. Businesses can schedule payments 120 days in advance while individuals can schedule payments 365 days in advance. With EFTPS, you indicate the date on which funds are to be moved from your account to pay your taxes. You can also change or cancel a payment up to 2 business days in advance of the scheduled payment date.

EFTPS is an ideal payment option for taxpayers who make monthly installment agreement payments or quarterly 1040ES estimated payments. Businesses should also consider using EFTPS to make payments that their third-party provider is not making for them.

EFTPS is a free tax payment system provided by the Treasury Department that allows you to make all your tax payments on-line or by phone. You must enroll in EFTPS, however, but the process is simple.

We would be happy to discuss these payment options and which may best suit your individual or business needs. Please call our office learn more about your on-line federal tax payment options.

Fringe benefits have not only become an important component of employee compensation, they also have a large financial impact on an employer's business. Fringe benefits are non-compensation benefits provided by an employer to employees. Unless they fall within one of the specific categories of tax-exempt fringe benefits, however, are taxable to employees.

Qualified employee discounts are among several categories of fringe benefits that are non-taxable to the employee under Code Sec. 132 and also deductible by the employer as an ordinary and necessary business expense. If you want to give employee discounts, this is the type you should consider first.

Qualified employee discounts

For an employee discount to be excludable from an employee's income and deductible by the employer, it must constitute a qualified employee discount. A qualified employee discount is an employee discount provided on qualified property or services. If the benefits are not qualified, they are taxable to the employee.

Qualified employee discounts are those that are provided on products or services sold in the ordinary course of the employer's line of business. For instance, employee discounts on items sold only at an employee store are not excludable from gross income because they are not offered for sale to non-employee customers in the ordinary course of the employer's line of business.

An employer may exclude the value of an employee discount provided to an employee from his or her wages, up to the following limits:

• For a discount on services, 20% of the price the employer charges non-employee customers for the service.

• For a discount on merchandise or other property, the employer's gross profit percentage times the price the employer charges non-employee customers for the property.

For example, if an employer's business sells a product for $100 and its cost is $75, the gross profit margin is $25. Therefore, to be tax-free to the employee, the discount cannot exceed $25. If an employer charges customers $100 for a certain service, the employee's tax-free discount for the same service cannot exceed $20 (i.e. 20 percent of the value of the service). Any excess discount will be treated as taxable income to the employee.

Qualified employee discounts can be provided through a direct reduction in the price of property or services as well through a cash rebate system. However, the discounts cannot be provided on real estate or investment property, such as stocks and bonds.

Non-discrimination

Qualified employee discounts must be available to employees on a nondiscriminatory basis, which requires that the benefits be available on substantially the same terms to all employees or to each member of a reasonable classification of employees that does not discriminate in favor of highly compensation employees. An employer engaged in more than one line of business must treat each line of business separately in applying the discrimination test. If an employer's plan fails the test, only your employees who are not highly compensated may exclude the value of the benefit from income.

Business expense deduction

An employer can deduct the actual cost of providing fringe benefits to employees as an ordinary and necessary business expense, whether or not the benefits are taxable to the employees. Employers can deduct the cost of providing qualified employee discounts as either compensation for services rendered or as a tax deductible business expense under Code Sec. 162.

As with other business expenses incurred by an employer for which tax deductions are sought, expenses paid or incurred in carrying on a trade or business are deductible only if they are ordinary and necessary. Ordinary and necessary expenses must be reasonable in amount to be deductible.

Because a qualified employee discount is a type of fringe benefit (albeit tax exempt), and fringe benefits are a form of employee compensation under Code Sec. 61, a qualified employee discount will meet the business expense requirements of Code Sec. 162, providing for deduction by an employer. Thus, employers can deduct the cost of qualified employee discounts and not pay any employment taxes on them.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

There are tax benefits for which you may be eligible if you are paying education expenses for yourself or an immediate member of your family. In the rush to claim one of two education tax credits or the higher-education expense deduction, IRS statistics indicate that a more modest yet still significant tax break is often being overlooked: the higher education student-loan interest deduction.

The student loan interest deduction for 2006 was the smaller of $2,500 or the amount of interest paid. The deduction amount may be gradually reduced or eliminated based on your filing status and modified adjusted gross income (MAGI).

Form 1098-E

Form 1098-E will help you calculate your student loan interest deduction. An institution that received interest payments of $600 or more during a calendar year on one or more qualified student loans must send Form 1098-E to each borrower.

Modified adjusted gross income

For 2007, the $2,500 maximum deduction for interest paid on qualified education loans begins to phase out ratably for taxpayers with modified adjusted gross income in excess of $55,000 ($110,000 for joint returns), and is completely phased out for taxpayers with modified adjusted gross income of $70,000 or more ($140,000 or more for joint returns).

Reduced deduction

If your credit must be reduced because of your MAGI, you must calculate your reduced deduction. To calculate your reduced amount, multiply your interest deduction (before the reduction) by a fraction. The numerator is your MAGI minus $55,000 ($110,000 for joint return filers). The denominator is $15,000 ($30,000 for joint return filers). Subtract the result from your deduction (before the reduction). This result is the amount you can deduct.

Example A. During 2007 Ed pays $800 interest on a qualified student loan. Ed's 2007 MAGI is $130,000 and he files a joint return. $800 X ($130,000-$110,000 / $30,000) =$533. Ed must reduce his deduction by $533. His reduced student loan interest deduction is $267 ($800 - $533).

Example B. During 2007 Bea, who is single, pays $2,750 interest on a qualified student loan. Bea's maximum deduction for 2007 is $2,500. However, Bea must further limit her maximum deduction since her MAGI is $60,000. Her required reduction is $2,500 x ($60,000 - $55,000 / $15,000) or $833.33 Her reduced student loan interest deduction is $2,500 - $833.33 or $1,666.67.

If you are unsure of your eligibility for the student loan interest deduction, please give our office a call and we will be happy to assist you.