Under current U.S. Generally Accepted Accounting Principles (GAAP), the treatment of internal-use software development costs is determined based on the specific stages of the development process. In the preliminary project stage, activities such as planning, evaluating alternatives, and determining feasibility are considered, and all costs incurred during this stage are expensed. During the application development stage, activities include designing the software, coding, installation, and testing. Costs directly related to development, such as fees paid to third parties, payroll for employees working on the project, and interest costs, are capitalized, while training and data conversion costs are expensed. Finally, in the post-implementation or operation stage, which focuses on training and maintenance, all costs are expensed. This stage-based approach is detailed in ASC 350-40, "Intangibles—Goodwill and Other—Internal-Use Software."

In October 2024, the Financial Accounting Standards Board (FASB) proposed updates to this guidance to better align with modern, non-linear software development practices, such as agile and iterative methods. Proposed ASU Targeted Improvements to the Accounting for Internal-Use Software.pdf The proposed changes include eliminating references to sequential development stages and introducing revised criteria for capitalization. Under the proposal, costs would be capitalized once management authorizes and commits to funding the project, and it is probable that the software will be completed and perform its intended function. If significant development uncertainties exist, such as novel or unproven functionalities, the guidance suggests these costs should be expensed until the uncertainties are resolved. Additionally, the proposal requires presenting cash outflows for capitalized internal-use software costs as investing activities in the statement of cash flows to enhance transparency.

The proposed changes offer several advantages. They align better with contemporary software development practices, making the guidance more relevant and easier to apply. Enhanced transparency through improved financial statement disclosure provides stakeholders with clearer insights into software development costs. Simplifying the capitalization process by focusing on management's commitment and project completion likelihood reduces complexity.

However, the proposal also has potential drawbacks. It requires increased judgment to determine the probability of project completion and assess development uncertainties, which could introduce subjectivity and inconsistencies. Organizations may face implementation challenges as they transition to the new criteria, potentially requiring changes to internal processes and controls. The emphasis on resolving significant uncertainties before capitalization could also result in more costs being expensed, affecting financial metrics.

The proposed Accounting Standards Update is expected to be finalized in February 2025.

The U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has announced an extension for filing the "Report of Foreign Bank and Financial Accounts (FBAR)" for specific U.S. individuals. The new deadline is April 15, 2026, and applies to individuals who have only signature or other authority, without financial interest, over certain foreign financial accounts.   FinCEN notice

This marks the 15th extension since 2011. It applies to U.S. employees and officers of specified regulated entities, such as publicly traded companies and financial institutions, for foreign financial accounts they controlled during the 2024 calendar year. The extension also covers reporting deadlines originally extended by earlier FinCEN notices starting in 2011.

The extension is necessary because proposed regulations issued in March 2016—intended to revise the FBAR filing requirements for U.S. individuals with signature or other authority over foreign accounts—remain unfinalized.

For all other U.S. individuals with an FBAR filing obligation, the deadline for calendar year 2024 FBARs is April 15, 2025, with an automatic six-month extension to October 15, 2025.

On November 7, 2024, the IRS unveiled Form 15620, Section 83(b) Election, designed to streamline the process for taxpayers making Section 83(b) elections.

Taxpayers receiving restricted property (e.g., stock or partnership interests) as part of a service-related transfer typically report compensation income when the property “vests,” or is no longer subject to a substantial risk of forfeiture. This amount is calculated as the fair market value at vesting minus any amount paid for the property. However, taxpayers can elect under Section 83(b) to report the income at the time the unvested property is transferred instead, potentially locking in a lower taxable amount. This election must be made within 30 days of the transfer and is generally irrevocable, with strict compliance requirements for validity.

The introduction of Form 15620 marks the first time the IRS has provided a standardized method for making Section 83(b) elections. Previously, taxpayers relied on sample language in Rev. Proc. 2012-29 or adhered to the requirements set forth in Reg. 1.83-2. While use of the form is not mandatory, it simplifies the process and is available for immediate use.

Taxpayers electing to use Form 15620 must mail the completed form to the IRS office where they file their federal income tax return. Additionally, a copy of the form should be provided to the entity for whom the services were performed in connection with the property transfer, consistent with existing procedures.

The IRS has announced plans to enable electronic filing of Form 15620 in the future. Until then, all other requirements for Section 83(b) elections remain unchanged.

Click the link to view the form:  https://www.irs.gov/pub/irs-pdf/f15620.pdf

As we approach the close of 2024, businesses have an excellent opportunity to optimize their tax positions through careful year-end planning. By accelerating deductions or deferring them where advantageous, companies can improve cash flow and maximize tax savings. The following strategies outline key areas where accrual-basis taxpayers may find opportunities to reduce their taxable income. It is essential to take necessary actions and make adjustments before the end of the taxable year.

Bonus Accrual

One area to consider is the deduction of accrued bonuses. In many cases, it is preferable to deduct bonuses in the year they are earned rather than when they are paid. To achieve this, taxpayers should review their bonus plans and consider revising terms to eliminate contingencies that might prevent the liability from meeting the “all events test” under Section 461. Strategies such as using a bonus pool with mechanisms for reallocating forfeited bonuses or implementing a minimum bonus strategy can help secure accelerated deductions while retaining the employment requirement for payment. It is important to fix bonus amounts through binding corporate actions or formulas based on financial data available by year-end. Additionally, scheduling bonus payments within 2.5 months after the tax year ends ensures compliance with Section 404 requirements, making these amounts deductible in the service year.

Prepaid Expenses

Another opportunity lies in the deduction of prepaid expenses. Under the “12-month rule,” certain prepayments, such as insurance, taxes, licensing fees, and software maintenance, may be deducted in the year of payment rather than being capitalized. This rule applies if the benefit period does not extend beyond the earlier of 12 months after the benefit begins or the end of the following taxable year. Identifying and addressing eligible prepaid expenses can provide an immediate deduction benefit, although this may require adopting a new method of accounting.

Inventory Write-Offs

For inventory-related deductions, companies holding obsolete, damaged, or unsellable inventory should consider disposing of these items by year-end to recognize associated losses. An exception applies to subnormal goods, defined as items unsellable at regular prices due to damage, imperfections, or other reasons. These goods may be written down to their actual offering price within 30 days after year-end, less selling costs, even if not sold by that time. Businesses should evaluate inventory levels and take the necessary steps to secure these deductions.

Bonus Depreciation

The continued phase-out of bonus depreciation also merits attention. In 2024, the bonus depreciation percentage drops to 60%. Companies should review fixed asset accounts to identify costs that can be deducted as repairs or maintenance rather than capitalized. Immediate expensing options under Section 179 and methods to reduce recovery periods should also be explored to maximize deductions for new assets placed in service during the year.

Pass-Through Entity Tax for High-Net-Worth Individuals

Finally, high-net-worth individuals participating in pass-through entities (PTEs) should evaluate the potential benefits of state pass-through entity tax (PTET) elections. These elections allow certain PTEs to bypass the $10,000 federal cap on state and local tax deductions. However, not all PTET elections are advantageous. A thorough analysis of federal and state tax impacts is necessary, taking into account the residency status of members and the availability of tax credits for nonresidents in their home states. Evaluating these factors and modeling potential outcomes can help PTEs determine whether a PTET election would be beneficial and avoid unintended tax consequences.

Year-end tax planning provides a valuable opportunity to refine tax strategies and maximize savings. Each of these options requires thoughtful evaluation and action before December 31, 2024. For assistance navigating these opportunities, reach out to your tax service provider.

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.