In the hospitality industry, tips form a significant part of workers' income, with servers and bartenders in restaurants and bars earning 50-70% of their income from tips. Hotel staff, such as bellhops and housekeepers, receive a smaller portion, around 10-20%, while other roles like valet attendants and spa staff see tips contributing 20-40%.

As of 2024, the hospitality sector employs about 16.8 million people in the U.S., with millions relying on tips, including 2.5 million waiters and waitresses and nearly half a million bartenders. Since 1965, the IRS has taxed tips, requiring employees to report them as income and employers to withhold taxes.

Recently, former President Donald Trump, a presumptive presidential candidate of the Republican Party, promised during a rally in Nevada on June 8, 2024, to change federal laws to exempt tip income from taxes for hospitality workers if elected. This potential change could relieve many in the sector from tax burdens and mitigate economic hardships from rising prices. While it is too soon to assume that Trump will reclaim the White House, if he does, taxpayers can expect to see many of the tax provisions included in the 2017 tax cuts extended. Additionally, many other tax incentives would likely be introduced to revitalize the economy.

However, some are skeptical that such a promise would be fulfilled unless Trump reclaims the White House and the Republicans secure a majority in both the Senate and the House.  Additionally, Trump would need to introduce offsetting provisions to balance the budget, as Congress holds the sole authority over tax legislation.

A recent Tax Court ruling in Soroban Capital Partners Op, et al v. Commissioner, 161 T.C. No. 12, Nov. 28, 2023 examined if a limited partner's share of partnership profits is exempt from self-employment tax under Sec. 1402(a)(13). This provision generally excludes limited partners' distributive shares from self-employment income, except for guaranteed payments for services rendered.

The court emphasized the need to analyze the partner’s role and function within the partnership to determine eligibility for this tax exclusion. Historically, under state law, limited partners lose their limited liability if they control the partnership's business. The Revised Uniform Limited Partnership Act (RULPA) of 1976 outlined activities that do not constitute control, suggesting that limited partners who avoid managerial roles should qualify for the tax exemption.

Past cases involving LLPs and PLLCs have influenced the interpretation, often focusing on partners' activities rather than their control over the business. The Tax Court's decisions in Renkemeyer, Campbell & Weaver, LLP v Commissioner, 136 T.C. 137, 2011 and Castigliola v. Commissioner (T.C. Memo. 2017-62) show a preference for examining the extent of partners' participation in business operations to determine tax liability.

The IRS issued a proposed regulation in 1997 outlining conditions under which an individual would not be treated as a limited partner, including personal liability, authority to contract, or participation in business for more than 500 hours annually. Though not finalized, these guidelines suggest avoiding excessive control or contractual authority to maintain limited partner status.

In summary, limited partners must avoid significant control or excessive participation in the partnership's daily operations to qualify for the self-employment tax exclusion under Sec. 1402(a)(13). This ongoing legal interpretation necessitates careful review and potential adjustments to partnership agreements to ensure compliance and tax benefits.

The economic downturn has resulted in a significant decrease in profits for many businesses. This sudden financial strain has made it increasingly difficult for businesses to deduct interest expenses due to the limitations imposed by Section 163(j) of the Internal Revenue Code. In this challenging environment, businesses must explore strategic measures to optimize their tax positions and maintain financial stability. One such measure is adopting an accounting method change to capitalize interest expenditures into inventory costs. This approach can effectively convert interest expenses, which are subject to Section 163(j) limitations, into costs of goods sold (COGS), which are not subject to these limitations.

Section 163(j) limits the deduction of business interest expenses to the sum of business interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest. Due to the economic downturn, many businesses are experiencing lower ATI, which in turn reduces the allowable interest deduction. Consequently, a significant portion of interest expenses may become disallowed, further exacerbating financial challenges.

Capitalizing interest expenditures involves adding the interest costs incurred during the production of inventory to the cost basis of that inventory. This process aligns with the Uniform Capitalization (UNICAP) rules under Section 263A of the Internal Revenue Code, read in combination with Sections 263(a) and 266. By capitalizing interest costs, businesses can transform interest expenses subject to Section 163(j) limitations into COGS, which are deductible when the inventory is sold and are not subject to the same limitations.

Capitalized interest is not considered interest for Section 163(j) purposes and thus avoids disallowance. This enables businesses to fully utilize their interest expenses as part of COGS. Aligning interest costs with the period in which inventory is sold can smooth taxable income, potentially lowering tax liabilities during periods of reduced profitability. Furthermore, capitalizing interest can help increase the foreign-derived intangible income (FDII) deduction.

Businesses should evaluate their eligibility to capitalize interest under Section 263A. Conducting financial modeling to assess the impact of capitalizing interest on taxable income and overall tax position is essential. Consulting with tax advisors to understand the regulatory requirements and implications of changing the accounting method is crucial. The formal change can be implemented by filing Form 3115 (Application for Change in Accounting Method) with the IRS and obtaining their approval.

In the face of an economic downturn, businesses must proactively explore strategies to navigate the challenges posed by Section 163(j) limitations. Capitalizing interest expenditures into inventory costs offers a viable solution to convert interest expenses subject to disallowance into deductible COGS. By adopting this accounting method change, businesses can optimize their tax positions and improve cash flow. Given the complexities involved, it is crucial to conduct thorough financial modeling and consult with tax advisors to ensure a smooth and compliant transition. Businesses interested in exploring this strategy should consult with their tax advisors.

The U.S. Treasury Department on May 11, 2024, released the “Green Book,” which is the Treasury’s “General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals.” This 256-page document details the tax proposals in the Biden Administration’s FY 2025 budget, also released and transmitted to Congress.

These proposals, as explained in the Green Book, aim to increase and reform corporate taxation and raise individual taxes to “reduce the deficit by cracking down on fraud, cutting wasteful spending, and making the wealthy and corporations pay their fair share.” Here are some key proposals included in the Green Book:

• Increase the corporate rate to 28% from the current 21%
• Increase the CAMT rate to 21% from the current 15%
• Increase the global intangible low-taxed income (GILTI) rate to 21% from the current 10.5%
• Repeal the foreign-derived intangible income (FDII) deduction, which was enacted by Trump to provide a tax break for businesses in export and effectively reduced the corporate tax rate to 13.125% for qualifying taxpayers
• Quadruple the stock buyback tax from the current 1%
• Deny the deduction for all compensation over $1 million for all C corporations
• Eliminate tax-free treatment of like-kind exchanges
• Strengthen the limitation on losses for noncorporate taxpayers
• Increase the top individual income tax rate from the current 37% to 39.6%
• Increase the Medicare rate and net investment income tax rate to 5% from the current 3.8%
• Apply the net investment income tax to pass-through business income
• Impose a 25% minimum tax on those with wealth exceeding $100 million
• Tax capital gains at ordinary rates for households with over $1 million in earnings
• Tax unrealized gains at death

The Biden administration proposes these tax hikes to control the current inflation crisis and promote “equality” and “equity.” In theory, raising taxes can potentially ease inflation and reallocate wealth to those in need, but it can also slow down the economy, resulting in higher unemployment and reduced economic growth, and decrease everyday people’s buying power—a situation known as “stagflation.”

We expect strong pushback from Republicans on the proposal, and it is likely that the proposal will face significant challenges in Congress. Therefore, enactment of these proposals is unlikely. However, taxpayers should keep an eye on developments.

임금의 일부를 스톡 옵션으로 지급 받는 개인들은 소득세가 없는 주로 이주할 경우의 관련 세금 영향을 고민한다. 이는 캘리포니아 주민에게 특히 중요한데, 이 뉴스레터는 캘리포니아 주민이 다른 주로 이주하였을 때 스톡 옵션에 대한 소득세를 피할 수 있는지에 대해 탐구한다.

핵심은 캘리포니아 주민이었을 때 받은 스톡 옵션을 소득세가 없는 주로 이주한 후 행사하였을 때에 소득세 회피 가능 여부이다.

캘리포니아 세무 규정은 거주자에겐 전 세계 소득에 대해 과세하는 반면 비거주자에겐 캘리포니아에서 발생한 소득에만 과세를 한다. 스톡 옵션에 경우, 캘리포니아는 스톡 옵션을 얻기 위한 서비스 또는 노동을 행한 장소를 기준으로 소득을 배분하는 “source rule”을 사용한다.

Gene and Joann Clark 의 항소 사례(2001-SBE-006)에서 the California State Board of Equalization (이하 캘리포니아 주세위원회) 는 조세를 위한 스톡 옵션 소득 분배를 다루었다. Gene Clark 은 캘리포니아에서 고용 되었을 때 스톡 옵션을 받았고, 다른 주로 이주한 후 해당 옵션을 행사하였다.

위원회는 스톡 옵션의 귀속 기간 동안 캘리포니아에서 근무한 시간의 비율에 따라 관련 소득을 과세키로 결정하였다. 판결은 구체적으로 스톡 옵션 부여일부터 귀속 또는 행사일까지의 기간 중 근무한 시간을 기준으로 소득이 배분되어야 함을 확정하였다. 이는 캘리포니아에서 근무한 시간에 해당하는 스톡 옵션 소득에 대해서만 과세함을 의미한다.

캘리포니아 주민이었을 때 받은 스톡 옵션은 해당 주에서 행한 서비스에 대한 보상으로 간주한다. 즉, 소득세가 없는 주로 이주하여 캘리포니아 비거주자로 변경이 되더라도 해당 스톡 옵션 행사에 대한 소득은 캘리포니아 소득세에 대상이 되며, 이는 부여일부터 귀속 또는 행사일까지의 기간 중 캘리포니아에서 근무한 시간의 비율을 기준으로 계산된다.

소득세가 없는 주로 이주하는 것은 캘리포니아 주민이었을 때 부여받은 스톡 옵션에 대한 캘리포니아 소득세를 면제시키지 못한다. 캘리포니아는 주에서 행한 서비스에 따라 소득을 과세한다. 핵심 결정 요인은 행사 시점의 거주지가 아닌 소득의 출처지이다.

Many individuals who receive stock options as part of their compensation package ponder the tax implications if they relocate to a state with no income tax. This issue is particularly relevant for those who were California residents when they received their stock options. This newsletter explores whether moving out of California can help you avoid California income tax on these stock options.

The core question is: Can a former California resident avoid California state income tax on stock options received while a resident but exercised after moving to a state with no income tax? 

California's tax regulations stipulate that residents are taxed on worldwide income, while non-residents are taxed on income derived from California sources. For stock options, California uses a source rule, which allocates income based on where the services that earned the options were performed.

In the case of the Appeal of Gene and Joann Clark (2001-SBE-006), the California State Board of Equalization addressed the issue of how to apportion income from stock options for tax purposes. Gene Clark received stock options while he was employed in California. He later exercised these options after moving out of state.

The Board determined that the income from the stock options was subject to California tax based on the proportion of time Clark had worked in California during the vesting period of the options. Specifically, the ruling confirmed that the income should be apportioned according to the period of service performed in California relative to the total period from the grant date to the vesting or exercise date. This meant that only the portion of the stock option income attributable to the time he worked in California would be subject to California income tax.

If you received stock options while a resident of California, these options are considered compensation for services rendered during your employment in the state. Upon moving to a no-income-tax state, you change your residency status to non-resident. However, the income from exercising these stock options will still be subject to California tax based on the proportion of time you were employed in California relative to the total time from the grant date to the vesting or exercise date.

Relocating to a no-income-tax state does not exempt you from California income tax on stock options received while you were a California resident. California will tax the portion of the stock option income that corresponds to services performed in the state. The key determinant is the source of the income, not your residency at the time of exercise.

The U.S. Treasury Department and IRS released proposed regulations (REG-124850-08) to guide the reporting of transactions with foreign trusts, large foreign gifts, and loans and property use from foreign trusts. These regulations also amend rules for foreign trusts with U.S. beneficiaries and provide special rules for dual resident and dual status taxpayers in the U.S.

These regulations apply to transactions and gifts for tax years starting after the final regulations are published. However, taxpayers can rely on these proposed regulations for tax years ending after May 8, 2024, if they consistently apply them in their entirety until the final regulations take effect.

Form 3520 is used to report certain transactions with foreign trusts and large gifts or bequests from foreign persons. Noncompliance with Form 3520 can result in significant penalties.  For failing to report a foreign trust or gift, the penalty is the greater of $10,000 or 35% of the gross reportable amount of the trust or gift.

The proposed regulations provide special rules for a “dual resident taxpayer” (a foreign national considered a resident of both the U.S. and a treaty country under each country's internal laws). A dual resident taxpayer, who computes U.S. income tax liability as a nonresident alien and complies with specific filing requirements, is exempt from the Form 3520 filing requirement for any covered gifts received during the period they are treated as a nonresident alien. This exemption ensures that these taxpayers do not need to report such gifts on Form 3520 while they are considered nonresidents.

The Treasury Department and the IRS have issued an announcement, under IR-2024-12 dated January 16, 2024, stating that businesses are not required to report the receipt of digital assets in the same way they report cash transactions over $10,000. This directive follows the Infrastructure Investment and Jobs Act, which expanded the definition of cash in section 6050I of the Code to include digital assets. However, the implementation of this provision awaits the issuance of specific regulations by the Treasury and IRS.

The current rules for reporting cash receipts over $10,000 on Form 8300 remain unaffected by this announcement. The upcoming regulations will detail the procedures for reporting digital asset transactions and will provide opportunities for public comment and participation in a public hearing.

In the meantime, transactions involving digital assets are exempt from the reporting requirements applicable to cash transactions of similar amounts. This transitional guidance will remain until the necessary regulations are published.

For U.S. citizens, Green Card holders, and those considered U.S. persons for tax purposes, understanding and complying with international tax requirements is essential. These obligations primarily revolve around the Foreign Account Tax Compliance Act (FATCA), the Foreign Bank and Financial Accounts Report (FBAR), and IRS Form 5471. These regulations are designed to combat tax evasion and ensure transparency of international financial transactions and holdings.

FBAR (FinCEN Form 114)

U.S. persons must file an FBAR if they have a financial interest in or signature authority over one or more foreign financial accounts, with an aggregate value exceeding $10,000 at any time during the calendar year. Failure to file an FBAR can result in hefty penalties: up to $12,921 for non-willful violations and the greater of $129,210 or 50% of the account balance at the time of the violation for willful violations.

FATCA (Form 8938)

U.S. taxpayers with specified foreign financial assets that exceed certain thresholds must report these assets on Form 8938, filed with their annual tax returns. Penalties for failing to file Form 8938 start at $10,000 and can go up to $50,000 for continued failure after IRS notification. Additionally, understatement of tax attributable to non-disclosed assets can result in a 40% penalty on the understatement.

Form 5471

U.S. shareholders, officers, or directors of certain foreign corporations are required to file Form 5471 to report their connection to the foreign corporation and its activities. The initial penalty for failing to file Form 5471 is $10,000 for each annual accounting period of each foreign corporation that is not reported. Additional penalties of $10,000 may apply for each 30-day period of continuing noncompliance (after the IRS notifies the taxpayer of the failure to report), up to a maximum of $50,000 per return.

Treaty-Based Relief for Nonresidents

Individuals who are dual residents of the U.S. and another country may claim treaty benefits to be treated as a nonresident alien of the U.S. for tax purposes. This election can significantly affect their reporting requirements.

To claim treaty benefits, an individual must file IRS Form 8833, Treaty-Based Return Position Disclosure, with their tax return. This disclosure allows them to be treated as a nonresident alien, altering their tax and information reporting obligations under U.S. law.

While claiming treaty benefits may alter an individual's income tax obligations, it does not exempt them from FBAR filing requirements, as FBAR is determined by legal residency status and not tax residency. However, for FATCA, individuals treated as nonresident aliens for part of the tax year and who comply with all relevant filing requirements (including timely filing Form 1040-NR and attaching Form 8833) are not required to report specified foreign financial assets on Form 8938 for that part of the tax year.

Special considerations apply to Form 5471 for individuals claiming treaty benefits. Under certain conditions outlined in Reg. 1.6038-2(j)(2)(ii), such individuals may fulfill their reporting obligations by filing the audited financial statements of the foreign corporation, provided no other U.S. person is required to furnish information under section 6038 with respect to the foreign corporation.

Navigating the complexities of international tax compliance requires a thorough understanding of the regulations and the potential consequences of noncompliance. For those eligible to claim treaty benefits, understanding the specific alterations to your reporting obligations is crucial. Given the severe penalties for noncompliance, individuals with international tax obligations should consult with their tax service providers to ensure full compliance and to leverage treaty-based positions effectively.

As the November 2024 presidential election draws near, the tax policies of the two presumptive candidates, Joe Biden and Donald Trump, are at the forefront of economic discussions. Both candidates propose vastly different approaches to taxation, reflecting their broader economic philosophies. These policies not only signal the future direction of the U.S. economy but also have direct implications for businesses, individuals, and the overall fiscal health of the nation. Here's a comparative analysis of Biden and Trump's tax proposals.

Joe Biden

Joe Biden's tax policy under his proposed budget for fiscal year 2024 emphasizes increasing tax rates on corporate, individual, and capital gains income. Additionally, Biden aims to expand tax credits for workers and families and broaden the tax base to include more types of income.

Business Taxes

• Increase in Corporate Taxes:  Biden proposes raising the corporate income tax rate to 28%, aiming to fund infrastructure and social programs.

• Increase GILTI tax rate & repeal FDII deduction:  The plan includes increasing the global intangible low-taxed income (GILTI) tax rate from 10.5% to 21% and repealing favorable tax rates on foreign-derived intangible income (FDII).

• Expansion of Investment Income Tax:  The proposal extends the net investment income tax to cover nonpassive business income and increases taxation on the fossil fuel industry.

Individual Taxes

• Limit favorable long term capital gains tax rate:  For incomes above $1 million, long-term capital gains and qualified dividends would be taxed at ordinary income tax rates. Additionally, a minimum effective tax rate of 20% on an expanded measure of income for households with net wealth above $100 million is proposed.

• Estate and Wealth Taxes:  Biden's policy includes tightening rules related to the estate tax, aiming to prevent wealth accumulation through inheritance.

• Expansion of Tax Credits: The Child Tax Credit and Earned Income Tax Credit would see significant enhancements, alongside an expansion of premium tax credits.

• Individual Income Tax Rate Increase: An increase in the top individual income tax rate to 39.6% for high earners and an extension of certain TCJA tax changes for those making under $400,000.

Donald Trump

Donald Trump's tax policy focuses on maintaining low tax rates, particularly for businesses and high-income individuals, and implementing aggressive tariffs, especially against China.

Business Taxes

• Maintain Corporate Tax Rate:  Trump intends to keep the corporate income tax rate at 21%, maintaining the TCJA level.

• Estate Tax Cut: The plan includes making the TCJA's estate tax cuts permanent, benefiting high-net-worth estates.

• Import Tariffs:  A notable policy is the imposition of a universal baseline tariff on all U.S. imports and a significant 60% tariff on imports from China, aiming to encourage domestic production and address trade imbalances.

Other Proposals

• Taxation of University Endowments:  Trump proposes taxing large private university endowments, targeting institutions that he perceives as having significant untaxed wealth.

The tax policies of Joe Biden and Donald Trump present clear contrasts in their vision for America's economic future. Biden's approach focuses on increasing tax rates for higher earners and corporations to fund social programs and infrastructure, aiming for a more equitable tax system. On the other hand, Trump's strategy emphasizes low taxes to spur economic growth and aggressive tariffs to correct trade imbalances. As voters head to the ballot box in November 2024, the economic implications of these policies will undoubtedly play a crucial role in their decision-making process.