Trump’s Return and Legislative Agenda

Former President Donald Trump has secured a second term in office, gaining broad Republican support and control over both chambers of Congress. With little expected opposition, his administration is poised to advance an ambitious agenda, particularly in the realm of taxation.

One of Trump's top priorities is to make permanent the 2017 tax cuts, a move with significant implications for both individuals and businesses. As these potential changes loom, taxpayers and businesses alike should familiarize themselves with what lies ahead in the tax landscape.

Key Proposals in Trump's Tax Agenda

Business Tax Cuts Trump is advocating to lower the corporate income tax rate from 21% to 20%, with a potential reduction to 15% for companies that manufacture products in the U.S. While details remain sparse, this could incentivize domestic production.

Furthermore, Trump aims to impose tariffs, possibly up to 20% across the board and 60% on imports from China. These tariffs are projected to raise government revenue but could lead to price increases for consumers.

Additional proposed business tax changes include:

• Eliminating clean-energy tax credits introduced in the 2022 Inflation Reduction Act.
• Reinstating 100% first-year bonus depreciation.
• Allowing businesses to deduct research and development expenses in the year incurred, rather than amortizing over multiple years.

Estate Taxes

The 2017 tax reform law nearly doubled the estate and gift tax exemption to $13.61 million per person, with this figure set to drop after 2025. Trump’s goal of making the 2017 tax cuts permanent may extend to maintaining the higher estate tax exemption, but it’s uncertain if further relief will be included.

Individual Income Tax

Trump has signaled a desire to permanently lower individual tax rates set by the 2017 Tax Cuts and Jobs Act and possibly reduce the current top income tax rate of 37%. Although specifics are yet to be announced, other proposed changes include:

• Lowering the long-term capital gains rate to 15%, down from the current 20%.
• Increasing the child tax credit to $5,000 per child (a 250% rise).
• Making tipped income nontaxable.
• Abolishing income tax on Social Security benefits, a measure popular with retirees but with potential budgetary impacts.
• Introducing tax incentives to promote homeownership, and proposing a tax deduction for the cost of generators in storm-prone areas.

SALT Deduction Cap Revisions

The $10,000 cap on state and local tax (SALT) deductions, introduced in 2017, could see modifications under Trump’s renewed administration. Despite his initial support for the cap, he is now open to increasing or removing it, though the decision is contested among his advisors. This change would benefit taxpayers in high-tax states but could also reduce federal revenue, affecting funding for other proposed cuts.

Preparing for Change

Trump’s tax proposals could significantly impact both personal finances and business operations, especially in high-tax states. While many details are pending, taxpayers should begin evaluating how potential tax reforms could affect them.

With control over Congress, Trump is positioned to advance these tax changes swiftly. Stay tuned for further developments as his administration provides more clarity on the specifics of each proposal.

The Tax Cuts and Jobs Act (TCJA) of 2017 significantly restricted the deduction of business-related interest expense under Section 163(j), limiting the deduction to 30% of adjusted taxable income (ATI) plus business interest income and floor plan financing interest. Initially, ATI was calculated like EBITDA, but since 2022, the add-back of depreciation and amortization has expired, increasing tax liabilities for higher-leveraged taxpayers.

To mitigate or eliminate the limitations, several strategies are available:

Small Business Exception

Businesses with average annual gross receipts of less than $30 million in 2024 may qualify for an exception under Sec. 163(j)(3), although aggregation rules may apply for related businesses.

Real Property Trade or Business (RPTOB) Election

Real property businesses, such as those involved in development, construction, or leasing, may elect to opt out of the interest deduction limitation, though they must switch to an alternative depreciation system and forgo bonus depreciation.

Self-Charged Interest

For partner loans to partnerships, the final 2021 regulations offer some relief by allowing certain interest expense allocations back to the lending partner.

Capitalization Strategies

Taxpayers can capitalize interest on certain properties including inventories, reducing their business interest expense. This applies after any required interest capitalization under Sec. 263A.  This allows for elective capitalization of certain costs, like interest, improving timing for deductions.

Buy vs. Lease Considerations

Taxpayers must weigh the benefits of leasing versus buying assets, considering both tax and financial reporting. With changes to depreciation and interest deduction limits, capital leases (now finance leases under GAAP) might be less attractive than before, as operating leases may allow for more flexible deductions.

Overall, the Sec. 163(j) limitation presents challenges but also opportunities for strategic tax planning, particularly in choosing between exceptions, capitalization, or restructuring to optimize deductions.

IRS Practice Units, developed by the IRS’s Large Business and International (LB&I) division, serve as training and guidance tools to help examiners and agents navigate complex tax laws consistently and effectively. These materials often focus on key areas of tax law subject to audits or enforcement actions, such as international tax, transfer pricing, and corporate tax matters.

One notable area that taxpayers should watch closely is the "U-turn" transaction concept, which was first introduced in Battelstein v. Commissioner and Davison v. Commissioner. The May 2023 LB&I Concept Unit addresses the interest expense limitation on related foreign party loans under IRC section 267(a)(3). The concept of U-turn transactions was reintroduced in Chief Counsel Advice (CCA) 201334037, and the IRS has since applied this concept to disallow deductions for interest payments in specific situations.

In CCA 201334037, the IRS concluded that wire transfers of funds to related foreign persons, which the taxpayer claimed as interest payments, were not deductible under IRC section 267(a)(3). The taxpayer, USS, recorded what it considered interest payments for funds advanced by FP, a related foreign party. However, the IRS found that USS obtained sufficient funds to cover these payments either through additional loans from FP or through draw-downs on lines of credit with FP, which were credited to USS’s general account shortly before or after the claimed interest payments. Citing Battelstein and Davison, the IRS disallowed these deductions, citing the circular nature of the cash flow.

The IRS’s position was that when funds are loaned by FP to the taxpayer and "paid" back via wire transfers, the U-turn transaction does not alter the economic position of either the lender or borrower. While the wire transfers appeared in form to be interest payments, they did not lead to any substantive economic change. Additionally, because FP had an equity interest in the taxpayer, it was willing to indefinitely defer the realization of returns on its investment. Applying the Tax Court’s analysis in these cases, the IRS concluded that the borrowed funds used to “satisfy” the interest obligation were, in essence, the same funds advanced by FP. Consequently, the claimed interest payments were deemed superficial, and the taxpayer was not entitled to a deduction for interest under the cash method of accounting.

Once again, the IRS’s characterization of transactions for tax purposes hinges on substance rather than solely on form. Enterprises with debt arrangements involving foreign parents or affiliates should carefully consider the U-turn transaction concept to avoid conflicts with the IRS when deducting interest payments.

For additional details, please see LB&I Concept Unit May 16, 2023  Interest Expense Limitation on Related Foreign Party Loans Under IRC 267(a)(3) (irs.gov)

For tax years beginning after 2022, the Inflation Reduction Act of 2022 amended section 55 to impose a new corporate alternative minimum tax (CAMT) based on the adjusted financial statement income (AFSI) of an applicable corporation.

An appliable corporation is liable for the corporate alternative minimum tax to the extent that its “tentative minimum tax” exceeds its regular U.S. federal income tax liability plus its liability for the base-erosion and anti-abuse tax (BEAT). An applicable corporation’s tentative minimum tax is 15% of its adjusted financial statement income to the extent the tax exceeds the corporate alternative minimum tax foreign tax credit for the tax year. The corporate alternative minimum tax applies to any corporation (other than an S corporation, regulated investment company, or real estate investment trust) whose average annual adjusted financial statement income exceeds $1 billion for any three consecutive tax years preceding the tax year. When determining adjusted financial statement income for the $1 billion qualification test, the act generally treats adjusted financial statement income of all persons considered a single employer with a corporation under Sec. 52(a) or (b) as adjusted financial statement income of the corporation.

For a corporation that is a member of a foreign-parented multinational group, (1) the three-year average annual adjusted financial statement income must be over $1 billion from all members of the foreign-parented multinational group (without regard to certain adjustments as specified in Sec. 59(k)(2)(A)), and (2) the corporation must have average annual adjusted financial statement income, determined without regard to loss carryovers, of $100 million or more. A foreign-parented multinational group means two or more entities if (1) at least one entity is a domestic corporation and another is a foreign corporation; (2) the entities are included in the same applicable financial statement; and (3) the common parent of those entities is a foreign corporation (or the entities are treated as having a common parent that is a foreign corporation).

The IRS has issued series of notices providing targeted guidance.  The following notices contain interim rules, prior to the issuance of Treasury regulations, related to CAMT:

• Notice 2023-3, Internal Revenue Bulletin: 2023-03 | Internal Revenue Service (irs.gov)
• Notice 2023-10, Internal Revenue Bulletin: 2023-10 | Internal Revenue Service (irs.gov)
• Notice 2023-26, Internal Revenue Bulletin: 2023-26 | Internal Revenue Service (irs.gov)
• Notice 2023-40, Internal Revenue Bulletin: 2023-40 | Internal Revenue Service (irs.gov)
• Notice 2024-03, Internal Revenue Bulletin: 2024-03 | Internal Revenue Service (irs.gov)

As the CAMT is effective for tax years beginning after December 31, 2022, taxpayers potentially subject to the CAMT should consider how guidance in the Notice may impact previous positions that may have been taken based on a reasonable interpretation of the statute and prior interim guidance. Treasury and the IRS have indicated an intent to issue proposed regulations in early 2024 consistent with the interim guidance provided in, and modified and clarified by, the Notice.

The four key limitations on loss deductions for high-net-worth individuals include the basis limitation, at-risk limitation, passive activity loss limitation, and the excess business loss limitation. Each of these restrictions is grounded in specific sections of the Internal Revenue Code (IRC) and plays a crucial role in determining how and when individuals can deduct losses on their tax returns.

The basis limitation is found in IRC §§ 704(a) and 1367(a) and restricts the deductibility of losses to the taxpayer’s adjusted basis in a partnership or S corporation. If a taxpayer's basis is insufficient to absorb the loss, that loss is suspended and can only be deducted when additional basis becomes available. This basis can be increased through capital contributions, direct loans made to the entity (in the case of S corporations), recourse and non-recourse debts in the case of partnerships or earnings that increase the partner’s share of the entity’s value. In situations where a taxpayer’s basis is too low to deduct current losses, a strategic infusion of capital or loans could unlock those suspended losses.

The at-risk limitation, under IRC § 465, limits the amount of losses a taxpayer can deduct to the extent they are economically at risk in the activity. This typically includes the amount of money invested or any loans for which the taxpayer is personally liable. Non-recourse loans, where the taxpayer is not personally liable, do not increase the at-risk amount, thus restricting the ability to deduct losses.  Yet the qualified non-recourse or recourse debts increase at-risk limitation.  To navigate this limitation, one could convert non-recourse loans into recourse loans or increase equity contributions, thereby raising the at-risk amount and unlocking the ability to deduct more losses.

The passive activity loss limitation, as laid out in IRC § 469, prevents taxpayers from offsetting passive activity losses against non-passive income. A passive activity is one in which the taxpayer does not materially participate, such as rental real estate or limited partnerships. Losses from these activities can only be used to offset income from other passive activities. To avoid this limitation, a taxpayer could materially participate in the business or activity, making it "active" rather than passive, which would allow the losses to be deducted against non-passive income. Grouping certain activities together under the aggregation rules could help meet material participation requirements, which would increase the likelihood of deducting those losses.  Additionally, some sophisticated individuals with large volume of investment in real properties can explore a tax strategy provided for ‘real estate professionals.’

The excess business loss limitation, governed by IRC § 461(l), applies to noncorporate taxpayers and limits the amount of aggregate business losses that can be deducted. For 2023, the deductible loss is capped at $305,000 for individuals, or $610,000 for married couples filing jointly. Losses that exceed this threshold are carried forward as part of a net operating loss for use in future tax years. One potential strategy to mitigate this limitation involves spreading out deductible losses across multiple years, thereby avoiding triggering the threshold in any one year.

Overall, these limitations are designed to prevent taxpayers from taking excessive deductions in a single year and to ensure that loss deductions are grounded in the economic reality of the taxpayer’s involvement and investment in the activity. However, with careful planning, high-net-worth individuals can often structure their investments, participation, and financing in a way that maximizes the deductibility of losses while staying compliant with tax regulations.

When it comes to retirement planning, using tax-efficient savings strategies can significantly enhance long-term financial outcomes. One such strategy, particularly beneficial for high-income earners, is the Backdoor Roth IRA. This approach allows individuals to bypass the IRS income limits that prevent direct contributions to a Roth IRA. In this article, we will explain how the Backdoor Roth IRA works, explore its benefits, and discuss important considerations.

Understanding the Backdoor Roth IRA

A Backdoor Roth IRA is not a special type of IRA but rather a method that enables high-income earners to contribute indirectly to a Roth IRA. Roth IRAs offer significant advantages, including tax-free withdrawals in retirement and the absence of required minimum distributions (RMDs). However, individuals whose income exceeds IRS limits cannot contribute directly. As of 2024, the income ceiling for making direct Roth IRA contributions is $153,000 for single filers and $228,000 for married couples filing jointly. High-income individuals can still gain the benefits of a Roth IRA by using the Backdoor Roth IRA method.

The process begins with a contribution to a traditional IRA. Unlike Roth IRAs, traditional IRAs do not have income restrictions for making contributions. However, for those earning above certain limits, the contribution may not be tax-deductible. For this reason, high-income individuals typically make non-deductible contributions to their traditional IRAs.

Once the contribution is made, the next step is to convert those funds into a Roth IRA. The conversion itself is not subject to the same income restrictions, allowing anyone, regardless of income level, to take advantage of the Backdoor Roth IRA strategy. The conversion step is essential, as it moves the funds into a Roth IRA, where they can grow tax-free and be withdrawn tax-free during retirement.

The tax implications of the conversion depend on whether the original traditional IRA contribution was deductible or non-deductible. If the contribution was non-deductible, the conversion will generally be tax-free, provided that there are no earnings on the funds before conversion. However, if there are other pre-tax IRA assets, the pro-rata rule comes into play. This rule requires that any conversion be taxed proportionally based on the ratio of pre-tax and after-tax funds across all traditional IRAs held by the individual.

Why Consider a Backdoor Roth IRA?

For high-income earners, the Backdoor Roth IRA offers several important benefits. One of the most significant is the ability to grow investments tax-free. Once funds are placed in a Roth IRA, they are not subject to taxes on investment gains, which can lead to significant growth over time. In addition, withdrawals from a Roth IRA during retirement are tax-free, offering an excellent source of income that does not impact taxable income.

Another major advantage of the Roth IRA is that it does not require the account holder to take required minimum distributions (RMDs). Unlike traditional IRAs, which mandate withdrawals starting at age 73, Roth IRAs allow account holders to keep their funds invested for as long as they wish. This provides greater flexibility in managing retirement income and tax obligations.

The flexibility offered by Roth IRAs extends beyond the absence of RMDs. Roth IRAs also provide flexibility in managing retirement income taxes. Since withdrawals from a Roth IRA are not taxed, individuals can use these funds to help keep themselves in a lower tax bracket during retirement. This is particularly useful for high-income individuals who want to manage their tax liability effectively.

The estate planning benefits of a Roth IRA also make the Backdoor strategy appealing. Roth IRAs can be passed down to heirs, and beneficiaries typically receive tax-free withdrawals. This allows families to preserve wealth across generations in a tax-efficient way.

Important Considerations and Potential Pitfalls

While the Backdoor Roth IRA can be an effective strategy, it is important to consider some potential complexities. The pro-rata rule is one of the key issues to keep in mind. If the individual holds other pre-tax IRA assets, the pro-rata rule will allocate a portion of the conversion as taxable income, based on the ratio of pre-tax and after-tax contributions across all traditional IRAs. This can create an unexpected tax liability if not planned for correctly.

Contribution limits must also be adhered to. For 2024, the maximum contribution limit to an IRA is $6,500, with an additional $1,000 allowed for individuals aged 50 or older. Exceeding these limits can result in penalties, so it’s crucial to stay within the annual contribution limits.

Finally, it’s important to consider the timing of the conversion. Converting traditional IRA funds to a Roth IRA can have tax consequences, especially if the conversion is done in a year when the individual is already in a high tax bracket. Proper planning is necessary to ensure the conversion is done at the most opportune time to minimize tax liability.

Is a Backdoor Roth IRA Right for You?

For high-income earners, the Backdoor Roth IRA offers a powerful opportunity to maximize retirement savings through tax-free growth and tax-free withdrawals. However, it is not without its challenges. The pro-rata rule, tax considerations, and contribution limits must all be carefully considered to avoid unintended tax consequences.

Before pursuing a Backdoor Roth IRA, it is advisable to consult with a financial advisor or tax professional. An experienced advisor can guide you through the conversion process, helping you navigate potential pitfalls and optimize your retirement strategy. For many high-income individuals, the Backdoor Roth IRA is a valuable tool that can significantly enhance long-term financial security.

The Backdoor Roth IRA is an excellent strategy for high-income earners who are seeking a tax-efficient way to grow their retirement savings. By understanding the steps involved, the potential tax implications, and the key benefits, individuals can unlock the full potential of this approach. With careful planning and execution, a Backdoor Roth IRA can help you build a more secure and flexible retirement plan, providing you with the financial freedom to enjoy your retirement on your terms.

Bankruptcy filings, both personal and business, increased by 16.2% in the twelve-month period ending June 30, 2024. Business bankruptcies saw a significant rise of 40.3%, increasing from 15,724 to 22,060 cases. Non-business bankruptcies also grew, reaching 464,553, up from 403,000 the previous year.

One of the most common tax issues faced by debtors during bankruptcy is the recognition of cancellation-of-debt (COD) income. This occurs when a debt is discharged for less than the amount owed, requiring the debtor to recognize the difference as taxable income. While this concept is straightforward in theory, its application can be complex, especially in bankruptcy scenarios. The tax consequences vary significantly depending on factors such as whether the debt is recourse or nonrecourse.

The general rule is that COD income is taxable, but several exceptions and exclusions exist under the tax law. The most relevant for debtors in bankruptcy are the exclusions provided under Section 108(a)(1)(A) for bankrupt taxpayers and Section 108(a)(1)(B) for insolvent taxpayers. These provisions allow debtors to exclude COD income from their gross income under certain conditions.

Insolvency is determined by comparing the fair market value of the debtor's assets to their liabilities immediately before the debt discharge. If a debtor is insolvent, they may exclude COD income, but only to the extent of their insolvency. For bankrupt taxpayers, all COD income can be excluded if the discharge occurs under a Title 11 bankruptcy proceeding. However, these exclusions come with the requirement to reduce certain tax attributes, such as net operating losses and property basis, as a form of deferred tax recognition.

Taxpayers have the option to elect a different order in reducing their tax attributes, which requires careful planning to optimize the tax benefits. Understanding the implications of these exclusions and the associated attribute reductions is crucial for effective tax planning, particularly in times of economic uncertainty when debt restructurings are common.

Overall, the rules surrounding COD income and its exclusions are intricate, requiring a deep understanding of tax law to navigate effectively. Affected taxpayers must be vigilant in learning and understanding these tax rules, as the proper application of exclusions can significantly influence their financial outcomes during bankruptcy. Careful attention to the details of these complex rules is essential during debt workouts and restructurings to ensure that the financial benefits are maximized and potential tax liabilities are minimized.

The political landscape in the United States has recently witnessed significant developments, including President Biden's abrupt withdrawal from the presidential race, the Democratic leaders' selection of Kamala Harris as his replacement, and an assassination attempt on former President Trump. As Harris emerges as the most likely Democratic nominee, it is crucial to understand her stance on key issues, particularly taxation. While we await her official campaign promises, analyzing her past proposals and comments provides valuable insights into her potential tax policies. Here’s a summary of what we know so far and the key questions surrounding her tax stance.

Corporate Tax Rate

The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from 35% to 21%. Harris has previously suggested returning the rate to 35%. The direction she chooses could significantly impact the business community and economic landscape.

Introduction of Financial Transaction Tax

During her 2020 presidential campaign, Harris proposed a financial transaction tax (FTT) to fund healthcare coverage. This included taxes on stock, bond, and derivative trades. Although it is uncertain if she will reintroduce this idea, it highlights her approach to leveraging taxes for broad social programs.

Harris’ Other Historical Tax Proposals

Harris has proposed various tax measures in the past, which provide a glimpse into her potential policy directions:

• Top Marginal Income Tax Rate: Increase top marginal tax rate for individuals to 39.6% from 34%.
• Income-Based Premium: A 4% tax on households making over $100,000 for Medicare for All (including all undocumented migrants).
• Repeal of Long Term Capital Gains Tax Rate: Raise rates to align with ordinary income tax rates. Appeal the current preferred long term capital gains tax rate of 20%.
• Estate Tax: Expansion of the current estate tax.
• Financial Transaction Tax: 0.2% on stock trades, 0.1% on bond trades, and 0.002% on derivative transactions.

Kamala Harris’s tax policy platform is anticipated to largely reflect her past proposals.  As more details emerge, it will be essential to monitor how her policies evolve and their implications for businesses and individuals.

Stay informed and prepared as the political landscape shifts.

California Senate Bill 167, signed into law on June 27, 2024, introduces tax changes aimed at addressing the 2024-2025 budget shortfall of $27.6 billion and the projected $28.4 billion deficit for 2025-2026. This budget shortfall is largely due to two significant measures: Starting January 1, 2024, California became the first state to offer health insurance to all undocumented immigrants through Medi-Cal, California’s version of the federal Medicaid program for low-income individuals, regardless of age. Additionally, Governor Gavin Newsom signed a suite of bills to address the homelessness crisis and enhance California’s response to people suffering from mental health issues on the streets, as part of his $22 billion housing affordability and homelessness package.

Senate Bill 167 suspends net operating losses (NOLs) from January 1, 2024, to January 1, 2027, for both corporate and personal income taxes, with exemptions for taxpayers with net business income or modified adjusted income below $1 million. The existing 20-year carryforward period for NOLs is extended by up to three years if the losses cannot be used due to the suspension.

Additionally, Senate Bill 167 limits the use of business credits to $5 million annually from January 1, 2024, to January 1, 2027. This limit applies to both the Corporation and Personal Income Tax laws, though certain personal income tax credits and the low-income housing credit are excluded. The carryover periods for these credits are extended by the number of years they are disallowed.

Senate Bill 175, pending signature, provides relief for businesses affected by the measures in Senate Bill 167. It offers the potential for an early sunset of the NOL suspension and credit limitation if the Director of Finance determines by May 14, 2025, or 2026, that the General Fund money is sufficient without these revenue measures.

서비스 산업에서 팁은 종사자들의 소득의 상당 부분을 차지한다. 레스토랑과 바에서 일하는 서버와 바텐더는 소득의 50-70%를 팁에서 얻으며, 호텔 직원인 벨보이와 하우스키퍼는 약 10-20%를, 발레 파킹 직원과 스파 직원 등은 20-40%의 수입을 팁으로 받는다.

2024년 기준으로 서비스 산업에는 약 1,680만 명의 사람들이 고용되어 있으며, 수백만 명이 팁에 의존하고 있다. 여기에는 250만 명의 웨이터와 웨이트리스, 거의 50만 명의 바텐더가 포함된다. 1965년부터 IRS는 팁을 과세 대상으로 삼아, 직원들이 이를 소득으로 보고하고 고용주가 세금을 원천 징수하도록 요구해 왔다.

최근 공화당의 유력 대선 후보인 도널드 트럼프 전 대통령은 2024년 6월 8일 네바다에서 열린 집회에서, 당선될 경우 서비스 산업 종사자들의 팁 소득을 비과세로 전환하는 연방 법률 변경을 약속했다. 이러한 변화는 서비스 업에 종사하는 많은 사람들에게 세금 부담에서 벗어나도록 도와줄 수 있으며, 물가 상승으로 인한 경제적 어려움을 완화시킬 수 있을 것으로 예상된다. 트럼프가 다시 백악관에 입성할지 여부는 아직 알 수 없지만, 만약 그렇게 된다면 2017년 세금 감면에 포함된 많은 세금 규정들이 연장될 것으로 예상된다. 또한, 경제를 활성화하기 위해 많은 다른 세금 인센티브들이 도입될 것으로 보인다.

하지만·위 공약은 트럼프의 백악관 입성과 공화당의 상·하원석 다수 확보가 필요하기에 일각에서는 위 공약의 이행 가능성 여부에 대한 의구심이 일고 있다. 게다가, 세금 법률에 대한 유일한 권한은 의회가 가지고 있기 때문에 트럼프는 줄어든 세수의 균형을 맞추기 위한 보완 조항을 도입해야 할 것이다.