® Quickfinder

Small Business Quickfinder® Handbook (2019 Tax Year)

Updates for December 2019 Legislation and Other Recent Guidance

Replacement Pages for Two-Sided (Duplex) Printing

Instructions: This packet contains “marked up” changes to the pages in the Small Business Quickfinder® Handbook that were affected by December 2019 legislation, which was enacted after the Handbook was published. Additionally, changes were made based on other guidance issued after the Handbook was published.

This is a specially designed update packet for owners of the 3-ring binder version of the Handbook who have access to a printer that prints two-sided (duplex). Simply print the entire PDF file (make sure to select two-sided or duplex printing), three-hole punch the pages, and then replace the pages in your Handbook. It’s that easy.

 Reference Materials and Worksheets Tab A Topics Where to File: Business Returns Estate Inventory Worksheet...... Page A-13 Filing Addresses—2019 Returns...... Page A-1 Reconciliation of Income Reported on Principal Business Activity Codes— Final Form 1040 and Estate’s Fiduciary Forms 1065, 1120, and 1120S...... Page A-1 Return (or Beneficiary’s Return)...... Page A-14 Business Quick Facts Data Sheet...... Page A-1 Allocation of Indirect Costs to Ending Inventory Under IRC Sec. 263A...... Page A-15 Types of Payments—Where to Report...... Page A-2 Business Valuation Worksheet...... Page A-16 Guide to Information Returns...... Page A-3 Foreign Asset Reporting—Forms 8938 Cash and Accrual Accounting Methods— and FinCEN 114...... Page A-17 Treating Commonly Encountered Items...... Page A-6 Types of Foreign Assets and Whether S Corporation Shareholder’s Adjusted They are Reportable...... Page A-17 Basis Worksheet...... Page A-7 Worksheet to Allocate Purchase/Sale Partner’s Adjusted Basis Worksheet...... Page A-8 Price to Specific Assets...... Page A-18 Tax Info for Partnership, Corporation, Qualified Business Income (QBI) Deduction LLC, and LLP Returns...... Page A-9 Planning Checklist...... Page A-19 Transferor’s Section 351 Statement...... Page A-11 Qualified Business Income (QBI) Deduction Tax Info Sheet for Gift Tax Returns...... Page A-12 Flowchart...... Page A-20 Where to File: Business Returns Filing Addresses—2019 Returns Note: At the time of publication, the IRS had not released the 2019 filing addresses for business returns. This information will be posted to the Handbook Updates section of tax.thomsonreuters.com/quickfinder when available. Principal Business Activity Codes—Forms 1065, 1120, and 1120S Note: At the time of publication, the IRS had not released the 2019 principal business activity codes for business returns. This information will be posted to the Handbook Updates section of tax.thomsonreuters.com/quickfinder when available. Business Quick Facts Data Sheet 1 2020 2019 2018 2017 2016 FICA/SE Taxes Maximum earnings subject to tax: Social Security tax $ 137,700 $ 132,900 $ 128,400 $ 127,200 $ 118,500 Medicare tax No Limit No Limit No Limit No Limit No Limit Maximum tax paid by: Employee—Social Security $ 8,537.40 $ 8,239.80 $ 7,960.80 $ 7,886.40 $ 7,347.00 SE—Social Security 17,074.80 16,479.60 15,921.60 15,772.80 14,694.00 Employee or SE—Medicare No Limit No Limit No Limit No Limit No Limit Business Deductions Section 179 deduction—limit $ 1,040,000 $ 1,020,000 $ 1,000,000 $ 510,000 $ 500,000 Section 179 deduction—SUV limit (per vehicle) 25,900 25,500 25,000 25,000 25,000 Section 179 deduction—qualifying property phase-out threshold 2,590,000 2,550,000 2,500,000 2,030,000 2,010,000 Depreciation limit—autos (1st year with special depreciation) 2 18,100 18,000 11,160 11,160 Depreciation limit—autos (1st year with no special depreciation) 2 10,100 10,000 3,160 3,160 Depreciation limit—trucks and vans (1st year with special depreciation) 2 18,100 18,000 11,560 11,560 Depreciation limit—trucks and vans (1st year with no special depreciation) 2 10,100 10,000 3,560 3,560 Retirement Plans SIMPLE IRA plan elective deferral limits: Under age 50 at year end $ 13,500 $ 13,000 $ 12,500 $ 12,500 $ 12,500 Age 50 or older at year end 16,500 16,000 15,500 15,500 15,500 401(k), 403(b), 457, and SARSEP elective deferral limits: Under age 50 at year end 19,500 $ 19,000 $ 18,500 $ 18,000 $ 18,000 Age 50 or older at year end 26,000 25,000 24,500 24,000 24,000 Profit-sharing plan/SEP contribution limits 57,000 56,000 55,000 54,000 53,000 Compensation limit (for employer contributions to profit-sharing plans) 285,000 280,000 275,000 270,000 265,000 Defined benefit plans—annual benefit limit 230,000 225,000 220,000 215,000 210,000 Key employee compensation threshold 185,000 180,000 175,000 175,000 170,000 Highly compensated threshold 130,000 125,000 120,000 120,000 120,000 Estate and Gift Taxes Estate tax exclusion $11,580,0003 $ 11,400,0003 $11,180,0003 $ 5,490,0003 $5,450,0003 Gift tax exclusion 11,580,0003 11,400,0003 11,180,0003 5,490,0003 5,450,0003 GST tax exemption 11,580,000 11,400,000 11,180,000 5,490,000 5,450,000 Gift tax annual exclusion 15,000 15,000 15,000 14,000 14,000 1 See Tab 3 in the 1040 Quickfinder® Handbook for an expanded Quick Facts Data Sheet. 2 Amount not released by IRS at publication time; will be posted to the Handbook Updates section of tax.thomsonreuters.com/quickfinder when available. 3 Plus the amount of any deceased spousal unused exclusion and/or any restored exclusion related to lifetime gifts to a same-sex spouse—see Tab H.

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook A-1 Types of Payments—Where to Report Source: 2019 General Instructions for Certain Information Returns (Forms 1096, 1097, 1098, 1099, 3921, 3922, 5498, and W-2G). 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ƖʹʿƖ A-2 2019 Tax Year | Small Business Quickfinder ® Handbook Tax Info for Partnership, Corporation, LLC, and LLP Returns (Page 1 of 3) Name of Business EIN

Business address

Check one:  C Corporation  S Corporation  Domestic General  Domestic Limited Partnership Liability Company

 Domestic Limited  Domestic Limited  Foreign Partnership  Other Liability Partnership Partnership

Check accounting method:  Cash  Accrual  Other (specify)

State of organization or incorporation

State tax ID number Corporate charter or LLC certificate number

Date organized or incorporated Date business activity started

If S corporation, effective date of election as an S corporation

Description of business activity and principal product or service

Name, address, ID number, and percentage of ownership for each principal shareholder, partner or member of business (attach additional sheets as needed):

1)

2)

3)

4)

5)

6)

Number of shareholders, partners or members at the end of the year

Note: If percentage of ownership changed within the tax year, provide details of the change on a separate sheet.

Partnership representative (PR). Enter name, address, phone number, and tax ID number of PR (and if applicable designated individual):

Additional Information Needed • Income Statement per books, Balance Sheet, Depreciation Schedule per books, and Cash Reconciliation of business bank accounts with ending cash balance. A bookkeeping fee will be charged in addition to tax preparation fees if the books are not balanced. • Provide details about any name or address change, accounting method (cash, accrual, hybrid, etc.), and method used for valuing closing inventory (cost, lower of cost or market, etc.). • Details of any withdrawals by owners. Distributions of C and certain S corporation earnings require Form 1099-DIV to be filed. • If a new client, a copy of last year’s tax return. If this is the first tax year for the business, provide a copy of state incorporation papers, partnership agreement or LLC articles of organization. • If the business is an S corporation, provide a copy of Form 2553 (Election by a Small Business Corporation) which was filed with the IRS along with the acceptance letter from the IRS stating that the corporation can file as an S corporation. • If the business has elected an entity classification other than its default classification (check the box election), provide a copy of Form 8832 (Entity Classification Election). • If the business has employees or independent contractors, a copy of all W-2, 1099-MISC, and any other forms issued to workers. • If the business has pension or welfare benefit plans, provide details (Forms 5500, Summary Plan Descriptions, etc.). • If any partner, member or shareholder lives out-of-state or outside the U.S., the business may be required to withhold certain taxes from that partner, member or shareholder. Provide details of the situation. • If the business conducts out-of-state or outside the U.S. business, or has any out-of-the-U.S. financial accounts, provide details. • Other Information

2019 Tax Year | Small Business Quickfinder ® Handbook A-9 Tax Info for Partnership, Corporation, LLC, and LLP Returns (Cont.) (Page 2 of 3) Answer the following questions for all returns (1065, 1120, and 1120S): Provide details for any item answered yes.  Yes  No 1) Was there any change in determining quantities, cost, or valuations between opening and closing inventory?  Yes  No 2) At any time during the year, did this business have an interest in or a signature or other authority over a financial account in a foreign country (such as a bank, securities or other financial account)?  Yes  No 3) Does this business have any foreign partners, members or shareholders? If yes, provide details.  Yes  No 4) Did this business pay any taxes to a foreign government during the tax year?  Yes  No 5) Did this business have any debt canceled or forgiven or have terms of any debt modified?  Yes  No 6) Has this business filed, or is it required to file, a return under IRC Sec. 6111 on any reportable transaction?  Yes  No 7) Did this business have a Section 163(j) election for a real property or farming business in effect during the tax year?  Yes  No 8) Did this business conduct any activity or have any expenditure during the tax year that may entitle it to any of the following general business credits? If so, please indicate which ones on the list below:  Yes a) Pay differential wages?  Yes b) Provide access to the disabled?  Yes c) Pay FICA on tips above minimum wage?  Yes d) Provide child care and related services to employees?  Yes e) Business located in an empowerment zone or renewal community?  Yes f) Pay wages/health insurance for Indian tribe members/spouses?  Yes g) Own any residential rental building providing qualified low-income housing?  Yes h) Start new pension plan for business with less than 100 employees?  Yes i) Conduct research and experimental projects?  Yes j) Pay at least 50% of a qualified health arrangement for employees (if a small employer)?  Yes k) Employ specifically targeted groups of individuals?  Yes l) Invest in qualifying rehabilitation of historical structures?  Yes m) Invest in property qualifying for the certain energy credits including: fuel cell vehicles (Form 8910), plug-in electric drive motor vehicles credit (Form 8936), and alternative fuel vehicle refueling property (Form 8911)? Answer the following questions for all partnerships, and LLCs and LLPs filing Form 1065:  Yes  No 1) Is any partner/member in this partnership/LLC/LLP also a disregarded entity, partnership (or entity taxed thereas), S corporation, trust, estate or nominee (or similar person)?  Yes  No 2) Did this partnership/LLC/LLP own an interest in another partnership or a foreign disregarded entity?  Yes  No 3) Is this entity a publicly traded partnership as defined in IRC Sec. 469(k)(2)?  Yes  No 4) At any time during the calendar year, did the entity have an interest in or a signature or other authority over a financial account in a country outside the U.S.?  Yes  No 5) During the tax year, did the entity receive a distribution from, or was it grantor of or transferor to, a foreign trust?  Yes  No 6) Was there a distribution of property or transfer (by sale or death) of a partnership interest, etc. during tax year? If yes, provide details.  Yes  No 7) Has the entity previously made (and not revoked) a Section 754 election?  Yes  No 8) At tax year end, did any individual, estate, foreign or domestic corporation, partnership, trust, tax exempt organization or foreign government own (directly or indirectly) 50% or more in the profit, loss or capital of the entity? If yes, provide details.  Yes  No 9) At tax year end, did the entity own directly 20% or more, or own directly or indirectly 50% or more of total voting stock or profit/ loss/capital of any foreign or domestic corporation, partnership or beneficial interest of a trust? If yes, provide details.  Yes  No 10) Did the entity, at any time during the current or prior tax year, distribute (or contribute to another entity) any property received in a like-kind exchange?  Yes  No 11) Did the entity, at any time during the tax year, distribute to any owner a tenancy-in-common or other undivided interest in entity property?

A-10 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Corporations  • Late payment penalty: tax not paid by due date of a return is Tab C Topics subject to a penalty of one half of one percent per month or part Basics of Corporations...... Page C-1 of a month, up to a maximum of 25% [IRC Sec. 6651(a)(2)]. Capital Contributions...... Page C-3 If the corporation is assessed a penalty for late payment of tax for Stock...... Page C-5 the same period in which a late filing penalty applies, the penalty for late filing is reduced by the amount of penalty for late payment, Section 1244 Stock Losses...... Page C-6 but not below the amount of the minimum penalty for late filing Small Business Stock...... Page C-7 discussed earlier. Penalties for late filing and late payment will Distributions...... Page C-8 not be imposed if the corporation can show the failure was due to Earnings and Profits (E&P)...... Page C-11 reasonable cause. A statement explaining the reasonable cause should be attached to the tax return. For reasonable cause ex- Accumulated Earnings Tax...... Page C-12 ceptions, see Section 20.1.1.3—Criteria for Relief from Penalties, Corporate Income and Expenses...... Page C-13 of the Internal Revenue Manual (available at www.irs.gov/irm). Corporate AMT...... Page C-16 Losses and Miscellaneous Items...... Page C-16 Tax Rates on Taxable Income Corporation Example...... Page C-17 The Tax Cuts and Jobs Act of 2017 (TCJA) changed the corporate tax rate to a flat 21%. This rate also applies to personal service corporations (PSCs) [see Personal Service Corporation (PSC) on Page F-12]. Prior to January 1, 2018, graduated tax rates applied, Basics of Corporations with a top rate of 35% if taxable income exceeded $10 million. Form 1120; see also IRS Pub. 542 PSCs were taxed at a flat rate of 35%. Tax rate exceptions. Personal holding companies (PHCs) are Filing Requirements subject to a 20% tax on undistributed PHC income [see Personal Every corporation (except exempt—although exempt organizations Holding Company (PHC) on Page F-14]. C corporations may also that are corporations could be required to file other forms such as be subject to a 20% accumulated earnings tax on accumulated 990 and 990-T) must file regardless of the amount of income or taxable income (see Accumulated Earnings Tax on Page C-12). loss. A corporation must continue to file until it is dissolved. Filing deadline. For most C corporations, by the 15th day of the Corporation Defined fourth month following the close of the tax year. For federal tax purposes, corporations include the following:  Note: For tax years beginning in 2016 or later, C corporation 1) Businesses organized under a federal or state law that identi- returns are due April 15 (or the 15th day of the fourth month follow- fies the entity as a corporation. ing the close of a fiscal year). For tax years beginning before 2016, 2) Joint stock companies. the deadline was the 15th day of the third month following the close 3) Insurance companies. of the tax year. For corporations with a June 30 year end, the due 4) Certain banks. date change will be effective for tax years beginning after 2025. 5) Business entities wholly owned by a state or any political Electronic filing of Form 1120 is required for C corporations that subdivision thereof. have $10 million or more in assets and annually file 250 or more 6) Certain foreign business entities. returns of any type (including information returns such as Forms Other entities, such as publicly traded partnerships, may be treated W-2 and 1099). However, these corporations can request a waiver as corporations by other Code sections. of the electronic filing requirements (Notice 2010-13). Check-the-box rules. Noncorporate entities, such as sole propri- Extension deadline and form number. Form 7004 extends the etorships and partnerships, may elect to be taxed as corporations deadline (1) six months for calendar year C corporations, (2) seven by filing Form 8832 (Entity Classification Election). months for June 30 year end C corporations or (3) six months for  Note: Corporations cannot elect out of corporate tax treatment. other fiscal year C corporations (Reg. 1.6081-3). An extension to If an entity is classified as a corporation under IRS regulations, the file does not extend the time for paying tax. entity must file as a corporation. Penalties:  Caution: Some states have rules that classify entities for tax • Estimated tax underpayment: see Estimated Tax on purposes. Not all states recognize reclassification of an entity Page C-2. under check the box rules. • Failure to make tax payments utilizing authorized See Check-the-Box Rules—Entity Classification Election (Form methods: see Tax Payments on Page C-2. 8832) on Page F-2 for more information. • Late filing penalty: 5% of the unpaid balance per month or part of a month, up to a maximum of 25% (plus any underpayment and/or late payment penal- Limited Liability A corporation formed under state law shields owners from liability ties and interest) [IRC Sec. 6651(a)(1)]. for the corporation’s actions. A shareholder’s risk of loss is limited to • Minimum penalty for late filing in 2020 (including 2019 tax year the amount invested in stock. This is in contrast to sole proprietors returns due in 2020): if a return is more than 60 days late (in- or general partners in partnerships, who are personally liable for cluding extensions), lesser of $435 or 100% of the amount of tax debts of the business. required to be shown on the return [IRC Sec. 6651(a)]. State laws determine an entity’s liability status. A proprietor or  Note: The statutory penalty amount is indexed by a cost-of- partnership cannot receive limited liability status simply by elect- living adjustment (COLA). ing to be taxed as a corporation under the check the box rules.

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook C-1 Courts have disregarded the limited liability status of corpo- these corporations may complete the schedule only through Part rate shareholders in the following circumstances: I, and then complete Schedule M-1 of Form 1120 (or Form 1120- • Fraud. C, if applicable) instead of completing Parts II and III of Schedule • Bad faith. M-3. In addition, these filers are not required to file Schedule B • Failure to observe corporate formalities. (Form 1120) or Form 8916-A. If this option is selected, make sure • Need to accomplish substantial justice. line 1 of Schedule M-1 equals line 11 of Part I of A shareholder owning 100% of the stock of a corporation is particu- Schedule M-3. larly susceptible to having the corporate veil pierced. Incorporating A corporation filing Schedule M-3 must check the a business is not a substitute for liability insurance. box on Form 1120, page 1, item A(4), indicating Other shareholder liability. A corporation will not protect a share- that Schedule M-3 is attached (whether required or holder from liability directly linked to the individual. For example, voluntary). For IRS website information on Schedule a shareholder who personally guarantees a corporate loan is M-3, search for “Schedule M-3” at www.irs.gov. liable for repayment. Similarly, if a shareholder performs services using his own vehicle and is Schedule UTP—Uncertain Tax Position involved in an accident, he may be liable for damages because he owns the vehicle. Statement A corporation must file Schedule UTP with Form 1120 if it (1) has assets equal to or exceeding $10 million, (2) issued or is included Tax Treatment of C in audited financial statements for all or part of the tax year, and (3) Corporations has one or more tax positions that must be reported on Schedule For federal income tax purposes, a C corpora- UTP. A tax position must be reported if (1) the corporation has tion is a separate taxpaying entity. A corporation conducts taken a tax position on its return for the current or a prior tax year business, realizes net income or loss, pays taxes, and distributes and (2) either the corporation or a related party has recorded a profits to shareholders. Income is taxed to the corporation when reserve in an audited financial statement for that position or expects earned, and taxed again when distributed to the shareholders as to litigate the position. A corporation required to file Schedule UTP dividends. The corporation does not receive a tax deduction for also must check “Yes” to Form 1120, Schedule K, Question 14. the dividends paid.

Example: Lookback Corporation is taxed at a flat 21% and its sole shareholder Tax Payments is in the highest individual bracket. The corporate tax on $1,000 of profits equals Estimated tax payments and any tax due on Form 1120 are re- $210. The remaining $790 dividend will incur tax of $188 to the shareholder quired to be deposited electronically using EFTPS. See Electronic since he is in the highest bracket (20% individual tax rate on dividends plus Federal Tax Payment System on Page I-3 for EFTPS rules. 3.8% net investment income tax). This leaves $602 in after-tax profits for the The corporation is subject to a failure to deposit penalty if required shareholder and results in an effective combined tax rate of 39.8%. procedures are not followed, unless the failure was due to reason- able cause and not willful neglect (IRC Sec. 6656). Unlike S corporations and partnerships, various types of income do not retain their character as they pass from a C corporation by dividends to shareholders. Estimated Tax • No penalty for underpaying estimates if tax is less than $500 Example: The BCA Corporation received tax-exempt interest and distributed [IRC Sec. 6655(f)]. it to shareholders as taxable dividends. The fact that the money was originally • No penalty will be assessed if each quarterly installment is at tax-exempt interest is of no consequence to a shareholder. However, if the least 25% of the corporation’s current-year income tax. company was an S corporation or a partnership, the tax-exempt interest would • No underpayment penalty will be assessed if each installment retain its character as it passed through to shareholders or partners. is at least 25% of the income tax on the prior-year return. This provision does not apply if: 1) The prior tax year was less than 12 months, Schedule M-3 (Form 1120)—Reconciliation 2) The corporation did not file a return for the prior year, of Books With Tax Return 3) The prior-year return did not show a liability for tax, or Domestic corporations with total assets of $10 million or more 4) The corporation had at least $1 million of modified on the last day of the tax year must complete Schedule M-3 [Net taxable income (disregarding NOL and capital Income (Loss) Reconciliation for Corporations With Total Assets of loss carrybacks and carryovers) in any of the $10 Million or More]. The schedule requires detailed explanations last three tax years. of the transactions that create book-tax differences, and is filed A corporation that had at least $1 million of tax- in place of Schedule M-1. Schedule M-3 is filed as an attachment able income in any of the last three years can to Form 1120. In addition, Form 8916-A (Supplemental Attach- use prior-year tax liability for the first installment ment to Schedule M-3) is filed to reconcile cost of goods sold and and current-year tax liability for installments two, interest income and expense reported on Schedule M-3. Mixed three, and four. consolidated return groups (those including certain insurance • Instead of four equal installment payments, estimates can be companies) must also file Form 8916 (Reconciliation of Schedule based on an annualized income method or the adjusted seasonal M-3 Taxable Income with Tax Return Taxable Income for Mixed installment method. See Annualized Income Methods on Page Groups) to reconcile Schedule M-3 with their returns (Forms 1120, C-3. For more on the adjusted seasonal installment method, 1120-L, and 1120-PC). see the instructions to Form 2220 and IRS Pub. 542. • Estimated payments must be made by the following dates: A corporation filing Form 1120 that is not required to file Schedule M-3 may voluntarily file Schedule M-3 in place of Schedule M-1. First payment...... 15th day of the fourth month For these corporations, and for those that are required to file Second payment...... 15th day of the sixth month Schedule M-3 but have less than $50 million in total assets at the Third payment...... 15th day of the ninth month end of the tax year, there is an option concerning how Schedule Fourth payment...... 15th day of the 12th month M-3 is completed. In lieu of completing all parts of Schedule M-3, C-2 2019 Tax Year | Small Business Quickfinder ® Handbook • Paying off business debts. • Section 303 redemptions. A corporation can accumulate earn- ings in anticipation of a need to redeem stock from a deceased Corporate Income and Expenses shareholder’s estate. See also Organizational and Start-Up Costs on Page M-6 • Supplier or customer needs. A corporation can accumulate Computation of gross income for a corporation is similar to the earnings to provide for investments or loans to suppliers computation of gross income for an individual taxpayer. In general, or customers if necessary to maintain the business of business income, gains from property transactions, interest, rents, the corporation. royalties, and dividends are included in corporate income [IRC • Working capital. A corporation may need an amount Sec. 61(a)]. Certain exclusions, such as municipal bond interest, of working capital to conduct business. For example, are allowed for both individuals and corporations. a supermarket needs $4 million of inventory on hand to Gains and losses from property transactions are handled in the operate. The corporation can accumulate earnings to same manner. IRC Sec. 1221 makes no distinction between obtain inventory. corporate and noncorporate taxpayers in defining a capital asset. • Providing for contingencies such as the payment of rea- sonably anticipated product liability losses, actual or potential Corporations and individuals are similar in the areas of like-kind lawsuits, loss of a major customer, or self insurance. exchanges (IRC Sec. 1031) and involuntary conversions (IRC Sec. 1033). Appropriated retained earnings account. If a corporation needs to accumulate earnings, the board of directors should discuss the Corporation business deductions also parallel those of an indi- need and the discussion should be reflected in the corporation’s vidual. Ordinary and necessary rules of IRC Sec. 162(a) apply for minutes. This will help the taxpayer demonstrate that the accumula- both. Many tax credits are also available to both individuals and tion is for reasonable business needs in the event of IRS audit. The corporations. See Business Tax Deductions on Page O-1 and Tax financial statements should also reflect the need to accumulate Credits on Page O-4, which generally apply to both individuals earnings so shareholders will know the appropriate amount of and corporations. earnings available for dividends. Corporations commonly reflect This section covers some of the basic rules for income and ex- such business needs by establishing an appropriated retained penses of corporations that differ from those for individuals. earnings account. Not reasonable business needs. The following purposes are not Dividends-Received Deduction considered reasonable business needs: Qualified dividends received from domestic corporations are • Accumulating income to avoid dividend distributions. partially deductible by C corporations. This deduction is meant • Providing loans to shareholders. to reduce the negative effects of the double tax on C corporation • Paying expenses for the personal benefit of shareholders. profits distributed to shareholders as dividends. Dividend income • Providing loans that have no reasonable relation to the conduct is reported, and the dividends-received deduction is computed, on of the business. Schedule C of Form 1120. • Providing loans to related corporations or shareholders. A corporation may, subject to limitations, deduct 50% of the • Investments unrelated to business activities. dividends received from a domestic corporation if the receiving • Providing for unrealistic hazards. corporation owns less than 20% of the distributing corporation Court Case: A corporation subject to the accumulated earnings tax argued that (IRC Sec. 243). it should be able to reduce accumulated taxable income by the amount of tax If a corporation owns 20% but less than 80% of the corporation accrued on an installment sale of real estate. The taxpayer also argued that it distributing dividends, the receiving corporation may, subject to should be able to deduct a contested tax liability it had paid. certain limits, deduct 65% of the dividends received. The Tax Court ruled against the taxpayer on both counts. The court did not If a corporation owns 80% or more of the corporation distributing allow a reduction for tax accrued against installment sale income that had dividends, the receiving corporation may, subject to certain limits, not yet been reported. With regard to the adjustment for the contested tax deduct 100% of the dividends received. liability, the taxpayer relied on Reg. 1.535-2(a)(1), which states, “In computing the amount of taxes accrued, an unpaid tax which is being contested is not Dividends Received Deduction By Ownership Percentage considered accrued until the contest is resolved.” The court found that in this Dividends case, the fact that the taxpayer had paid the contested liability did not mean Received Dividends Received Ownership % in Distributing Deduction % for Deduction % for the contested liability could be accrued. [Metro Leasing and Development Corporation Corporation, 119 TC 8 (2002). On appeal, the 9th Circuit agreed with the Tax Pre-2018 Tax Post-2017 Tax Years Court (94 AFTR 2d 2004-5251)]. Years Less than 20% 70% 50% At least 20% 80% 65% Bardahl Formula but less than 80% A method commonly used to substantiate rea- 80% or more 100% 100% sonable accumulation of earnings for working capital is called the Bardahl Formula. Exceptions. The dividends received deduction does not apply to The IRS assessed accumulated earnings tax dividends received from certain banks and savings institutions, on Bardahl Manufacturing Corporation. The Tax Court held that real estate investment trusts, public utilities, regulated investment accumulation of earnings by Bardahl was not unreasonable and companies, tax-exempt corporations, cooperatives and DISCs [IRC accepted the company’s stated method of computing necessary Secs. 243(d) and 246]. operating capital. The formula calculates the amount needed to Taxable income limit. The otherwise allowable 50% and 65% fund inventory by analyzing the average number of days in an deductions are generally limited to a percentage of the recipient’s operating cycle, average inventory, average accounts receivable taxable income [IRC Sec. 246(b)]. The taxable income percent- and average accounts payable, and then comparing the current age limitation is the same as the dividends received deduction working capital needs with actual accumulations of earnings (Bar- percentage (50% or 65%). For example, if the recipient corporation dahl Manufacturing Corp.,TC Memo 1965-200). 2019 Tax Year | Small Business Quickfinder ® Handbook C-13 owns 30% (by vote and value) of the payor corporation’s stock, the • Dividends received. basic deduction amount is 65% of any dividend received, limited to • Premium on repurchase of convertible debt. an amount not exceeding 65% of the recipient’s taxable income. • Foreign-derived intangible income and global intangible low-taxed The preceding limits are figured without regard to NOL, qualified income. business income or dividends-received deductions; nontaxable • Dividends paid on certain public utility preferred stock. portion of an extraordinary dividend or capital loss carrybacks. • Net operating loss carrybacks. When a corporation sustains an NOL, the above 65% or 50% • Capital loss carrybacks. limitation of taxable income does not apply. • Income attributable to domestic production activities of specified Example #1: BNG Corporation sustains a $43,500 loss from operations. It re- agricultural or horticultural cooperatives. ceived $90,000 in dividends from a 20%-owned corporation. Its taxable income Unused contributions from this limitation can be carried forward for is $46,500 ($90,000 – $43,500) before the deduction for dividends received. five years. No carryback is allowed [IRC Sec. 170(d)(2)]. By claiming the full dividends-received deduction of $58,500 ($90,000 × 65%), State and local tax credits. The IRS clarified that payments made BNG Corporation calculates its NOL as follows: by business taxpayers to charities or government entities in ex- Operating losses...... ( $ 43,500) change for credits against their state and local taxes are generally deductible as business expenses (IR-2018-178). Dividend income...... 90,000 An exception to the contribution limit applies Dividends-received deduction...... ( 58,500) Research property. to contributions of scientific equipment for use in experimentation NOL...... ( $ 12,000) or for certain research training. This exception is only available Since BNG has an NOL, the 65% of taxable income limitation does not apply for C corporations other than PHCs or service organizations as and it is entitled to a full dividends-received deduction of $58,500. described in IRC Sec. 414(m)(3) [IRC Sec. 170(e)(4)]. These con- tributions are subject to the special computation rules discussed Example #2: Assume the same facts as Example #1, except BNG loses at Charitable Contributions of Inventory on Page C-14. $10,000 from operations instead of $43,500. Taxable income before the Intellectual property. In addition to the initial deduction, a tax- dividends-received deduction is $80,000 ($90,000 – $10,000). After claiming payer who has donated qualified intellectual property may claim a dividends-received deduction of $58,500 ($90,000 × 65%), the corporation a subsequent charitable contribution based on a percentage of has net income of $21,500 ($80,000 – $58,500). the net income received by the charity (other than certain private Since in this example there is no NOL after a full dividends-received deduction, foundations) from the property [IRC Sec. 170(m)]. the allowable dividends-received deduction is limited to 65% of taxable income, Substantiation requirements. Strict rules exist for substantiating or $52,000 ($80,000 × 65%). BNG calculates income as follows: charitable contributions. For all monetary contributions, the cor- Operating losses...... ( $ 10,000) poration must maintain a bank record or a receipt, letter or other Dividend income...... 90,000 written communication from the donee organization indicating the Dividends-received deduction (DRD) organization’s name, the date of the contribution, and the amount (limited to 65% of taxable income before DRD)...... ( 52,000) [IRC Sec. 170(f)(17)]. There is no de minimis exception. For con- Taxable income...... $ 28,000 tributions of $250 or more of either cash or property, the taxpayer must have a contemporaneous written acknowledgement from Foreign dividends received. For distributions after 2017, a 100% the donee (a canceled check will not suffice) [Reg. 1.170A-13(f)]. deduction is provided for the foreign-source portion of dividends Charitable contributions of property over $5,000. C corpo- received from certain 10%-or-more-owned foreign corporations rations are required to obtain a qualified appraisal for donated (IRC Sec. 245A). No foreign tax credit or deduction is allowed for property if the claimed deduction exceeds $5,000. If the claimed any taxes paid or accrued with respect to a dividend that qualifies deduction of property other than cash, inventory or publicly traded for the deduction. The deduction is available only to C corporations and does not apply to RICs or REITs. securities exceeds $500,000, a qualified appraisal must be at- tached to the donor’s tax return. Business Interest Expense Limitation Conservation easements. A deduction is available for qualified The TCJA added a business interest expense deduction limitation donations. See Conservation easements on Page N-15. [IRC Sec. 163(j)]. Business interest expense is limited to the sum of a taxpayer’s (1) business interest income, (2) 30% of adjusted Charitable Contributions of Inventory taxable income (if a positive amount), and (3) floor plan financing The deduction for a charitable contribution of inventory or other interest of vehicle dealers. Generally, taxpayers (other than tax ordinary income producing property is generally limited to the shelters) with annual gross receipts for the three-year-tax period adjusted basis of the property. ending with the prior tax year of $25 million or less (as adjusted for inflation—$26 million or less in 2019) are not subject to this limita- A provision in the Code allows a C corporation (not an S corpora- tion. See Business Interest Expense Limitation on Page B-6 for tion) to donate inventory to charity and deduct up to one-half of additional information and applicable elections that are available. FMV above cost as a charitable contribution [IRC Sec. 170(e)(3) and Reg. 1.170A-4A]. For purposes of this provision, depreciable property under IRC Sec. 1221(a)(2) also qualifies for the deduction. Charitable Contributions C corporations are allowed to deduct charitable contributions as a The following rules must be met [IRC Sec. 170(e)(3)]: business expense. The deduction is limited to 10% of the corpora- 1) The charity must be a Section 501(c)(3) organization; tion’s taxable income [IRC Sec. 170(b)(2) and (c)]. 2) The charity must use the donated property solely for the care  of the ill, the needy or infants; Disaster Relief Alert: The 10% of taxable income limit does 3) The charity cannot exchange the donated property for money, not apply to qualified contributions for relief efforts in qualified disaster other property or services; areas. See Taxpayer Certainty and Disaster Tax Relief Act of 2019 4) The corporation must be given a written statement from the on Page Q-1. charity that says it will follow rules 2 and 3; Taxable income for limitation purposes is calculated without 5) If the property is subject to the Federal Food, Drug, and Cos- regard to the deductions for [IRC Sec. 170(b)(2)(D)]: metic Act regulations, all such regulations must be satisfied; • Charitable contributions. and C-14 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020  S Corporations adjusted for inflation. A $270 penalty for Schedules K-1 required to Tab D Topics be furnished in 2020 (2019 tax year filings) is imposed with respect Basics of S Corporations...... Page D-1 to each Schedule K-1 for which a failure occurs. This penalty ap- plies for failure to furnish Schedule K-1 when due, failure to include S Corporation Taxes...... Page D-7 all required information, or for including incorrect information (Rev. Reasonable Wages...... Page D-9 Proc. 2018-57). The $270 penalty may be reduced to $50 or $110 Shareholder’s Basis...... Page D-10 per failure, depending on when and whether the failure is corrected Distributions...... Page D-11 (IRC Sec. 6722). Higher penalties apply if the failure is due to intentional disregard of the law. See IRC Sec. 6722 for details. S Corporation Example...... Page D-13 Reasonable cause exception. The penalties discussed here will S Corporation Shareholder Codes for not be imposed if the failure was due to reasonable cause (IRC Schedule K-1, Form 1120S...... Page D-23 Secs. 6651, 6699, and 6724). Estimated tax requirements. Shareholders pay estimated tax for Basics of S Corporations their individual returns. The S corporation pays estimated tax only Form 1120S if corporate-level taxes apply [IRC Sec. 6655(g)(4)]. Filing Requirements C Corporation vs. S Corporation Every S corporation must file a return, regardless of the amount An eligible domestic corporation can elect to be taxed as an S cor- of income or loss (IRC Sec. 6037). It must file even if it stops con- poration. An S corporation generally does not pay federal income ducting business. Filing ends when totally dissolved. tax—its profits and losses pass through directly to shareholders. This avoids the C corporation double tax, and allows shareholders Filing deadline. By the 15th day of the third month following the to deduct corporate losses on their individual returns. close of its tax year or date of dissolution (March 15 for calendar year S corporations). C Corporation S Corporation Electronic filing of Form 1120S is normally required for S corpora- Taxation Double taxation of profits. Profits are passed through tions that have $10 million or more in assets and annually file 250 Income is taxed at the directly to shareholders, escaping corporate level; profits corporate-level tax. Qualified or more returns of any type (including information returns such as distributed as dividends are business income (QBI) from a Forms W-2 and 1099) (Reg. 301.6037-2). See Notice 2010-13 for taxed at the individual level. taxpayer’s qualified businesses is the requirements to request a waiver. eligible for a QBI deduction. See Extension deadline and form number. A six-month extension Qualified Business Income (QBI) of time to file may be obtained by filing Form 7004 (Application Deduction on Page D-1. for Automatic Extension of Time To File Certain Business Income Dividends Dividends paid by a C S corporation earnings passed corporation are generally through to a shareholder are taxed Tax, Information, and Other Returns). taxed to the individual at the as ordinary income. Penalties. The statutory penalty amount for failure to file an S same rate as long-term capital corporation return is indexed by a cost-of-living adjustment (COLA). gains (0%, 15% or 20%). The COLA adjusted penalty amount for failure to file a return in Ordinary C corporation losses are Losses are passed through 2019 is $200 ($205 for 2020) per month or part of a month per Losses not passed through to directly to shareholders. Current- shareholder up to 12 months (IRC Sec. 6699; Rev. Procs. 2017-58 shareholders. Losses can be year losses are deductible up deducted only at the corporate to the shareholder’s basis in S and 2018-57). The penalty is assessed against the corporation. level as NOL carrybacks corporation stock and loans to the If S corporation taxes are due, a late filing penalty may be imposed (for certain entities) and S corporation. equal to 5% of tax owed per month, up to 25%. If the return is more carryforwards. than 60 days late (including extensions) a minimum penalty of the Capital Taxed at the same rate as Pass through to shareholders and lesser of $210 for returns required to be filed in 2019 (annually Gains ordinary income. are eligible for favorable capital indexed for inflation) or the amount of unpaid tax applies. A late gain tax rates for individuals. payment of tax penalty may also be imposed equal to one-half of Capital Allowed only to the extent Pass through to shareholders. Losses of capital gains. Net capital Capital losses are deductible one percent per month, up to 25% (IRC Sec. 6651). losses are carried back three subject to limitations on the  Law Change Alert: For returns required to be filed after 2019, years and forward five years. shareholder’s return. the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act, enacted December 20, 2019) increased For tax purposes, S corporations are treated similar to partner- the failure to file penalty to $435 (indexed for inflation for returns ships. Many rules governing S corporations are intended to subject required to be filed in calendar years beginning after 2020). S corporation shareholders to the same tax treatment as partners. In an IRS Program Manager Technical Advice (PMTA 2013-15) the An S election can be useful in a corporation’s early years, since IRS concluded that an untimely S corporation return should not be losses pass through to shareholders. subject to both the general failure to file penalty under IRC Sec. 6651(a)(1) (which does not apply unless the S corporation owes Qualified Business Income (QBI) Deduction tax) and the failure to file an S corporation return penalty under The TCJA added IRC Sec. 199A, which applies to tax years IRC Sec. 6699(a)(1) at the same time. 2018–2025. Under this new provision, individuals, estates and Additional information regarding penalties is found at Penalties: on trusts may deduct up to 20% of their QBI from sole proprietorships Page C-1 and in the table Taxpayer First Act of 2019 on Page Q-4. (including farms) and pass-through entities. Schedule K-1 deadline. S corporations must furnish a Schedule N Observation: IRC Sec. 199A is intended to provide tax relief K-1 to each shareholder by the due date, including extensions, of to businesses not benefitting from the reduction in the top corporate the corporation tax return (Form 1120S). This penalty is annually rate from 35% to 21%. Thus, pass-through businesses (S corpo- Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook D-1 rations, partnerships, and LLCs) as well as sole proprietorships not meet the reasonable compensation requirement. The preamble (including single-member LLCs) are eligible for the deduction. The to the proposed regulations clarified that even if an S corporation rules are complex and subject to phase-outs and limits. Under- fails to pay a reasonable wage to its shareholder-employees, standing the mechanics of the QBI deduction is essential to effec- the shareholder-employees are still prevented from including an tive planning to maximize its tax benefit. [See Qualified Business amount equal to reasonable compensation in their QBI. Income (QBI) Deduction on Page F-4 for additional information.]  Note: The final regulations did not provide additional guidance S corporation/shareholder considerations. When applying the with respect to what constitutes reasonable compensation for a QBI rules to S corporations and shareholders, keep the following shareholder-employee of an S corporation. in mind: N Observation: S corporations may have an advantage over • The deduction applies at shareholder level, but the shareholder’s partnerships with respect to the wage/investment limit as they may tax basis in the S corporation is not reduced by the QBI deduction be able to increase the limit by paying their shareholder-employees [Reg. 1.199A-1(e)(1)]. Each shareholder takes into account his a salary that qualifies as reasonable compensation. Partners in a allocable share of the S corporation’s QBI from each of its busi- partnership are not considered employees and therefore cannot nesses. Also, for computing the wage/investment limit on QBI, be paid W-2 wages, and guaranteed payments are not considered shareholders take into account their allocable shares of the S wages for QBI purposes. Note: The final regulations did not provide corporation’s W-2 wages and its investment in qualified property. additional guidance with respect to what constitutes reasonable • S corporations must provide information on Schedule K-1, includ- compensation for a shareholder-employee of an S corporation. ing information regarding shareholders’ shares of QBI, W-2 wages and investment in qualified property for each of their qualifying S Corporation Considerations businesses (as defined for the QBI rules) and whether any of The tax rate for individuals on most dividends is the same rate as those businesses are specified service trades or businesses long-term capital gains. This reduces the negative effects of double (SSTBs). S corporations must also report any amounts reported taxation at the C corporation level. Considering that S corporation to them by pass-through entities, as well as any qualified REIT profit passed through to shareholders is taxed as ordinary income, dividends or qualified publicly traded partnership (PTP) income in certain situations it may be advantageous for an S corporation to they received [Reg. 1.199A-6(b)(3)]. This may require capturing terminate its S status and convert to a C corporation. For example, new data in the accounting system. If the S corporation fails to if the business needs to retain its income to fund growth, paying tax report this information, the shareholder’s share (and the share on the income at the 21% corporate tax rate may be more tax ef- of any upper-tier indirect owner) of positive QBI, W-2 wages and ficient than paying tax at the shareholders’ potentially much higher investment in qualified property attributable to the entity’s busi- personal tax rates. However, the effect of the QBI deduction must nesses will be presumed to be zero [Reg. 1.199A-6(b)(3)(iii)]. be taken into consideration based on each individual’s tax situation. • Items excluded from QBI include reasonable compensation paid U Caution: The marginal tax rates (current and projected) of to a taxpayer by any qualified trade or business of the taxpayer specific shareholders and corporations should be used in determin- for services rendered with respect to the trade or business [IRC ing the most tax-favorable form of business organization (such as Sec. 199A(c)(4)]. Thus, reasonable compensation received by a C corporation versus an S corporation). an S corporation shareholder is excluded from the shareholder’s Factors to consider: QBI, but the compensation reduces the S corporation’s QBI if it • The accumulated earnings tax rate for C corporations is 20% is deductible and allocable to the business [Reg. 1.199A-3(b)(2) (IRC Sec. 531). (ii)(H)]. • An S corporation that elects to revoke its S status must generally • Previously disallowed losses or deductions (for example, under wait five years before it can again elect S corporation status [IRC the at-risk or passive activity loss rules, or due to the limits on S Sec. 1362(g)]. corporation losses due to lack of basis) are taken into account for computing QBI, except for losses or deductions that were • Previously taxed S corporation profits not distributed within disallowed, suspended, limited or carried over from years ending one year from the date of S corporation termination generally before 2018. are converted to taxable earnings and profits (E&P). See Post- Termination Transition Period on Page D-12. • Determining whether a taxpayer is engaged in a SSTB is a critical step since income from such a business is not QBI unless the • C corporations may be subject to personal holding company taxpayer’s taxable income is at or below an annually adjusted (PHC) taxes. See Tab F. threshold. Whether the business is a SSTB is determined at S • C corporations with accumulated E&P may be subject to addi- corporation level [Reg. 1.199A-6(b)(3)(i)(B)]. tional taxes upon conversion to an S corporation. See S Corpora- • Shareholder’s share of S corporation’s W-2 wages is determined tion Taxes on Page D-7. in same manner as shareholder’s share of S corporation’s wage • S corporation losses flow through to shareholders. C corporations expense. Each shareholder’s share of qualified property is a do not pass losses through. share of the unadjusted basis proportionate to the ratio of shares • Unlike C corporations, S corporations pass through QBI to their in the S corporation held by the shareholder over the total shares shareholders. The QBI deduction can reduce an S shareholder’s of the S corporation [Reg. 1.199A-2(a)(3)(iii)]. taxable income, even if the S corporation conducts a SSTB. Al- @ Strategy: S corporations may be able to increase the wage/ though SSTBs generally are not qualified businesses, for taxpay- investment limit by paying their shareholder-employees a salary. ers with taxable income (before considering any QBI deduction) at However, the amount paid out as salary reduces the S corporation’s or below an annually adjusted threshold (for 2019, $321,400 for QBI. So, there is a point at which the increase in the wage/invest- MFJ, $160,725 for MFS, and $160,700 for all others), the SSTB ment limit due to paying salary is more than offset by the reduction exclusion does not apply. In other words, these taxpayers treat a in the QBI deduction. This point depends on the amount of wages SSTB as if it were a non-SSTB for the QBI deduction. At taxable paid to nonowners and any qualified property (since these also income of $421,400 for MFJ, $210,725 for MFS, and $210,700 potentially affect the wage/investment limit). Also, S corporations for all others, the phase-in of the SSTB limitation is complete, must pay their shareholders reasonable compensation, so merely so no QBI deduction is allowed with respect to a SSTB when computing the wage amount that maximizes the QBI deduction may taxable income exceeds those amounts.

D-2 2019 Tax Year | Small Business Quickfinder ® Handbook abuses are not corrected within the taxable period, an additional Exceptions. The following may qualify as Section 501(c)(3) ex- penalty of 200% of the excess benefit is imposed on the individual. empt organizations that are not private foundations (IRC Sec. 509): 1) Churches, educational institutions, hospitals and medical Excise Tax on Excessive Compensation research organizations, charitable organizations receiving a major portion of their support from the general public or United There is a 21% excise tax imposed on excessive compensation, generally in excess of $1 million, paid to top executives by exempt States, a state or a political subdivision, governmental units. organizations in tax years beginning after December 31, 2017. 2) Organizations that are broadly supported by the general public, The tax applies to the sum of (1) compensation in excess of $1 by governmental units or by organizations described in item 1. million paid to a covered employee and (2) any excess parachute 3) Organizations organized and operated exclusively to benefit payment made to a covered employee. A covered employee is those described in items 1 or 2 (a supporting organization). one of the five highest compensated employees of the tax-exempt 4) Organizations organized and operated exclusively for testing organization for the tax year or was a covered employee of the or- for public safety. ganization (or a predecessor) for any preceding tax year beginning To satisfy the public support provision in item 2 under Exceptions after 2016. Special rules apply to compensation paid to licensed on Page E-3, both of the following tests must be satisfied: medical professionals (IRC Sec. 4960). The IRS issued interim 1) One-Third Support Test. The organization normally must receive guidance in Notice 2019-9 to assist in applying the new excess more than one-third of its support from gifts, grants, contributions tax until proposed regulations are issued. and membership fees, and gross receipts from admissions, sales of merchandise, performance of services or the furnishing of Estimated Tax Payments facilities that is not an unrelated trade or business. Tax-exempt organizations expecting a tax liability of $500 or more 2) Not More Than One-Third Support Test. Limits the amount of from unrelated business activity must make estimated tax pay- support normally received from the following sources to one- ments under the same rules and depositary methods as corpora- third of the organization’s support for the tax year: tions. See Tax Payments on Page C-2. • Gross investment income and Form 990-W. To figure estimated tax liability. • Excess unrelated business taxable income over UBI tax. Electronic deposits. Qualifying exempt organizations must use the Electronic Federal Tax Payment System. See Tab I. Timely Notice An organization is required to file Form 1023 [Application for Payments generally are due by the 15th day of the Due dates. Recognition of Exemption Under Section 501(c)(3) of the Internal fourth, sixth, ninth and last months of the tax year. See Tab C Revenue Code] within 27 months from the end of the month in for more details. A private foundation’s first quarter estimated tax which it was formed. To establish that the organization is a private payment is due by the 15th day of the fifth month of its tax year. operating foundation, complete Part X of the Form 1023 exemption application. A user fee must accompany Form 1023.  Note: Technically, Form 1023 is due within 15 months (Reg. 1.508- Private Foundations 1). However, the filing date is automatically extended 12 months by See also IRC Sec. 507–509 Reg. 301.9100-2, so the IRS treats the due date as being 27 months. A private foundation is essentially a privately-funded charitable orga- nization set up to hold donated assets until those assets are distrib- Private Family Foundations uted to publicly supported charities or used to make grants to other The most common type of private foundation is the family founda- organizations or individuals. It receives less beneficial tax treatment tion. Family foundations often fund other charitable organizations, and has more rules to comply with than a public charity because it but typically do not carry out any charitable activities themselves. is not directly supported by and operated for the good of the public. Because of the nature of family foundations, raising funds through Organizations that are not private foundations are generally those solicitations or grants is generally not done. that have broad public support or actively function in a supporting Deductions to private family foundations are limited as follows. relationship to those organizations. The donor may deduct: Establishing a private foundation during a donor’s lifetime provides • Cash contributions up to 30% of adjusted gross income (AGI) the significant tax advantage of a current tax deduction while [IRC Sec. 170(b)]. retaining some control of the assets as to how they’re ultimately • The FMV of qualified appreciated stock (including mutual funds) used for charitable purposes. up to 20%-of-AGI. Qualified appreciated stock means (1) stock that is quoted on an established securities market, (2) which is Determination of Status capital gain property in donor’s hands, and (3) where the donor Most organizations described in IRC Sec. 501(c)(3) are presumed and donor’s family have contributed less than 10% in value of to be private foundations unless they notify the IRS within a speci- that corporation’s stock to the foundation. [IRC Sec. 170(e)(5)] fied period of time that they are not. • The basis of all other property not mentioned above up to 20%-of- Even if an organization falls within one of the categories excluded AGI [IRC Sec. 170(b)]. from the definition of private foundation, it will be presumed to Example: Delia donates an art collection to a private family foundation. The be a private foundation, with some exceptions, unless it gives deduction is limited to the basis in the art collection and 20% of Delia’s AGI. timely notice to the IRS that it is not a private foundation. The only exceptions to this requirement are those organizations Court Case: A taxpayer donated shares of a bank holding company to the fam- that are exempted from the requirement of filing Form 1023 [Ap- ily’s foundation. The taxpayer deducted the FMV of the shares, using the bank’s plication for Recognition of Exemption Under Section 501(c)(3) of current book value as the established FMV. There was an established list of the Internal Revenue Code]. potential buyers for the shares. The IRS stated that the shares were not listed on a stock exchange or regularly traded in the open market. The Tax Court agreed. References to Form 1023 also include Form 1023-EZ, which is much The deduction is limited to the basis in the shares [Todd, 118 TC 334 (2002)]. shorter and less complex than Form 1023. See Becoming an Exempt Organization on Page E-4 for a discussion on which organizations  Note: The value of donations disallowed due to AGI limitations have the option of filing Form 1023-EZ instead of Form 1023. may be carried forward for five years. 2019 Tax Year | Small Business Quickfinder ® Handbook E-3 Private Operating Foundations they knowingly allow the self-dealing to take place. The maximum Private operating foundations engage in charitable activities (for amount of tax imposed on the foundation manager with respect to example, museums, nursing homes, libraries, and sites preserved any one act of self-dealing shall not exceed $20,000. for historical reasons). Donations to private operating foundations Failure to distribute income. Private foundations must annually fall under the more liberal deductibility laws of public charities. distribute to charity the greater of their net investment income or • Donors may deduct cash contributions up to 50%-of-AGI [IRC 5% of net investment assets. IRC Sec. 4942 imposes a 30% tax on Sec. 170(b)(1)(A) and (F)]. undistributed amounts. If corrective action is not taken in a timely • Donors may deduct the full FMV of appreciated long-term capital manner, a second tier tax of 100% of the undistributed income may be gain property up to 30% of AGI [IRC Sec. 170(e)(1)]. For example, imposed. Note: This does not apply to private operating foundations. a donor establishes a private operating foundation to donate a Excess business holdings. Combined holdings of a private family library that will lend the collection to other libraries. The foundation and its disqualified persons are not permitted to exceed donor may deduct full FMV of the library up to 30%-of-AGI. 20% of a corporation’s voting stock, 20% of the profits interest in U Caution: Donating tangible personal property not related to a partnership, or 20% beneficial interest in other entities. A 10% the exempt purpose of the foundation limits the donor to a deduc- initial excise tax is imposed on the excess business holdings. A tion of basis only. second-tier tax equal to 200% of the excess holdings is imposed if corrective action is not taken in a timely manner (IRC Sec. 4943). Guidelines for a private operating foundation require that it spend at For tax years beginning after 2017, certain businesses contributing least 85% of the lesser of adjusted net income or minimum invest- all profits to charity and wholly owned by a private foundation are ment return directly on the active conduct of its exempt activities not subject to the excess business holdings tax [IRC Sec. 4943(g)]. (the income test). It must also qualify under one of the following: the asset test, the endowment test or the support test. Disqualified persons generally include a substantial contributor (in- cluding family members), a manager or a more-than-20% owner of a substantial contributor (including family members) to the private Form 990-PF foundation. See IRC Sec. 4946(a) for more details. All private foundations are required to file an annual return on Form The excess business holdings tax applies to donor advised funds. 990-PF (Return of Private Foundation). Terminations. A private foundation generally must give notice and Restrictions and requirements on private foundations: pay an excise tax under IRC Sec. 507(c) to terminate its status. 1) Restrictions on self-dealing between private foundations and To avoid tax, it can distribute all its assets to a qualifying Section their substantial contributors and other disqualified persons. 509(a)(1) organization that has been in continuous existence for 2) Requirements that the foundation annually distribute income at least 60 months prior to the distribution (Rev. Rul. 2003-13). for charitable purposes. 3) Limits in their holdings in private businesses. 4) Provisions that investments must not jeopardize the carrying Becoming an Exempt Organization out of exempt purposes. Application Procedure 5) Provisions to assure expenditures further exempt purposes. Organizations seeking exempt status from federal income tax Violating these provisions results in taxes and penalties against the must file a written application with the IRS. An organization apply- private foundation and, in some cases, its managers, substantial ing under IRC Sec. 501(c)(3) submits Form 1023 [Application for contributors and certain related persons. Recognition of Exemption Under Section 501(c)(3) of the Internal Disclosure. A private foundation must make its annual returns Revenue Code] or if they qualify, Form 1023-EZ [Streamlined Ap- and exemption application available for public inspection. See plication for Recognition of Exemption Under Section 501(c)(3) of Disclosure Requirements on Page E-6 for a discussion of the the Internal Revenue Code]. (See Form 1023-EZ on Page E-5 for a discussion on who qualifies to file the shorter Form 1023-EZ.) penalties for failure to disclose. Unlike other tax-exempt organiza- Other organizations submit Form 1024 [Application for Recognition tions, a private foundation is required to disclose the names and of Exemption Under Section 501(a)]. Certain organizations filing addresses of its contributors. for tax exempt status under IRC Sec. 501(c)(4), use Form 1024-A U Caution: Do not report personal information about grantees [Application for Recognition of Exemption Under Section 501(c)(4) or others that is not required and could be used for identity theft of the Internal Revenue Code]. See the Organization Reference (for example, social security number or bank account information). Chart in IRS Pub. 557 for the proper form. The following organizations may be considered tax-exempt under Excise Taxes IRC Sec. 501(c)(3) even if they do not file Form 1023: Private foundations are subject to excise taxes on (1) net invest- • Churches and integrated auxiliaries of churches, and conventions ment income, (2) self-dealing, (3) failure to distribute income, (4) or associations of churches. excess business holdings, (5) investments that jeopardize exempt • Any organization that is not a private foundation and has gross status, and (6) expenditures that do not further the exempt purpose. receipts in each tax year of normally not more than $5,000.  Note: Item 1 is reported on Form 990-PF, and items 2–6 are Even if not required to file to be tax-exempt, organizations may reported on Form 4720 (Return of Certain Excise Taxes Under choose to file Form 1023 to receive a determination letter that Chapter 41 and 42 of the IRC). recognizes their 501(c)(3) status and specifies whether contribu- tions to them are tax deductible. Net investment income. IRC Sec. 4940 imposes a 2% (1.39%  for tax years beginning after December 20, 2019) excise tax on Note: An interactive version of Form 1023 is available at www. the net investment income (interest, dividends, rents, royalties, irs.gov by searching for “interactive application.” securities loan payments, and income from similar sources) and Expedited process. The IRS will expedite applications if there is a capital gain net income of private foundations. compelling reason to process the case ahead of others. Compelling Self-dealing. IRC Sec. 4941 imposes on the disqualified person reasons include: (1) a pending grant that is needed to secure the (not the foundation) an excise tax equal to 10% of the self-dealing organization’s ability to continue operating, (2) a newly created amount, plus an additional 200% tax if the action is not corrected. organization providing disaster relief to victims of emergencies Managers of the foundation may also be subject to a 5% tax if such as floods and hurricanes or (3) IRS errors causing undue

E-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 exchange for the contribution, even if no such goods or services Disclosure Requirements were provided (Durden, TC Memo 2012-140). Section 501(c)(3) organizations must make their Forms 990-T  Note: Volunteers may deduct unreimbursed out-of-pocket available for public inspection. expenses incurred for qualified charities if properly substantiated [Van Dusen, 136 TC 515 (2011)]. Unrelated Business Income Tax (UBIT) Tax is levied on unrelated business income (UBI). Without a tax, Sale of Donated Property taxable organizations would be placed at a disadvantage when Disposing of donated property within three years of receiving it requires trying to compete with exempt organizations. UBIT is intended to the organization to file Form 8282 (Donee Information Return) within neutralize the tax differences. The unrelated trade or business 125 days of the disposition. A copy must be given to the original donor could result in the loss of exempt status if the activity is determined (IRC Sec. 6050L). Form 8282 is not required if the property is valued to be the primary purpose of the organization. at $500 or less or is consumed or distributed for charitable purposes. Exempt organizations with UBI are subject to corporate tax rates, Property covered by this rule is any property for which the orga- with the exception of charitable trusts that are subject to the tax nization signed an appraisal summary as donee (thus, it does not rates for estates and trusts (IRC Sec. 511). Organizations with UBI include cash or publicly traded securities). The original appraisal are also subject to estimated tax rules for corporations and trusts. summary for value exceeding $5,000 is attached to the donor’s in- come tax return on Form 8283 (Noncash Charitable Contributions). The information required by Form 8282 helps the IRS determine Unrelated Trade or Business whether the donor might have claimed a deduction for more than Three factors must be present for activities to be considered an the FMV of the property. In addition, the information will indicate unrelated trade or business (IRC Secs. 512 and 513): whether the organization used the property for an exempt purpose. 1) Organization conducts a trade or business. A donor’s deduction is limited to his tax basis in tangible personal 2) Trade or business is not substantially related to the exempt property, rather than FMV, if it is not used for the donee organiza- purpose of the organization. tion’s exempt purpose. 3) Trade or business is regularly carried on by the organization. Trade or business. Includes any activity conducted for the Nondeductible Contributions or Dues production of income from selling goods or performing services. Organizations receiving donations that are not deductible by the The activity does not need to produce a profit. Income from an donor must state this in their solicitations for contributions. unrelated trade or business used exclusively for carrying on the Membership dues used for lobbying expenses may not be deduct- exempt organization’s purpose is still considered UBI. ible. See Proxy Tax on Page E-6 for more information.  Note: For tax years beginning after 2017, the TCJA provides that unrelated business taxable income is to be calculated sepa- rately for each trade or business, and a loss from one business Unrelated Business Income Tax cannot offset income from another business [IRC Sec. 512(a)(6)]. (Form 990-T) Example: Historic Ltd., an exempt organization, restores historic buildings to See also IRS Pub. 598 their original condition. Historic Ltd. charges admission to tour its buildings. Ad- mission fees do not cover all of the restoration costs, so Historic Ltd. runs a motel Filing Requirements for tourists to stay in while visiting. The income generated by the motel is UBI. If an exempt organization has unrelated business income (UBI) of $1,000 or more, it is required to file Form 990-T. Gross income for Not substantially related to the exempt purpose. Not only this purpose is gross receipts or sales (net of returns and allowances) must the trade or business contribute to the accomplishment of less costs of goods sold. This form is in addition to other annual filing the tax-exempt purpose, but there must be a substantial causal requirements, such as Form 990, 990-EZ, 990-N or 990-PF. The filing relationship between the activity and the achievement of the or- of Form 990-T also applies to organizations that may not be required ganization’s exempt purpose. to file Form 990 (for example, a church or a school). Example: Young Act, an exempt organization, operates a training school for Disallowed Fringe Benefits Create UBI young children in the performing arts. A vital part of the children’s training is The TCJA provided that a tax-exempt organization must increase its performing for the general public. The children are paid minimum wage, and unrelated business taxable income (UBTI) by any disallowed fringe Young Act generates income through admission fees. The income is not UBI benefit expenses for amounts paid or incurred after December 31, because the performances contribute importantly to the exempt purpose. 2017 [former IRC Sec. 512(a)(7)]. Specifically, the costs of providing qualified transportation (such as parking) were to be included in UBI. Regularly carried on. Specific business activities of an exempt This provision could have caused a Form 990-T filing requirement organization are deemed to be regularly carried on if they are for organizations that have never had this requirement. pursued in a manner similar to comparable commercial activities.  Law Change Alert: Section 302 of the Taxpayer Certainty Factors determining if an activity is regularly carried on: and Disaster Tax Relief Act of 2019 (enacted December 20, 2019) • Frequency of the activity. repealed IRC Sec. 512(a)(7), effective for amounts paid or incurred • Continuity of the activity. after December 31, 2017. Thus, the TCJA provision discussed in • Manner in which the activity is conducted. the preceding paragraph does not apply.

Replacement 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook E-11 Example #1: An exempt organization owns an office building and adjacent U Caution: Even though tax-exempt organizations may be ex- parking lot. During the week, the employees park in the lot. On the weekends, empt from paying income taxes, they may be subject to withholding, the exempt organization rents spaces in the parking lot to individuals who are occupation and wagering excise taxes. shopping or visiting the area. Since the activity is regularly carried on (every Example: Church, a tax-exempt organization, volunteers conduct weekly bingo weekend), the income from the parking lot rentals is UBI. games in order to raise money for Church’s missions ministry. State and local Note: For years beginning after 2017, the employer’s cost associated with laws provide that bingo games may be conducted by tax-exempt organizations. provided parking is a qualified transportation fringe benefit included in UBTI. In addition, bingo games are not conducted by any for-profit businesses in the See Disallowed Fringe Benefits Create UBI Disallowed Fringe Benefits Create area. Church’s bingo games are not considered unrelated business income. UBI on Page E-11 for more information.

Example #2: A church owns land located next to the state fairgrounds. During Token Benefits—Distribution of Low-Cost the 10 days of the fair, the parking lot is used for fair parking, and fees are Articles charged for parking (no services are provided). This activity is not considered If an exempt organization distributes low-cost items [$11.10 or less to be regularly carried on, therefore, it is not UBI. for 2019 (Rev. Proc. 2018-57)] and the distributions are incidental to the solicitation, these distributions may not be considered an Exceptions to unrelated trade or business classification: unrelated trade or business. • Volunteer labor. Substantially all (generally 85% or more) the work of the trade or business is performed by volunteers. For Incidental means: example, retail store run by an orphanage and staffed with unpaid • Person receiving item did not request it. volunteers. • Person receiving item receives it without his/her consent. • Donated goods. Trade or business consists of merchandise sales, • Item is accompanied by a request for a charitable contribution. and substantially all of the merchandise has been received as gifts or contributions. For example, thrift shop run by an organization. • Contribution request includes a statement that the person may • Convenience of members. For Section 501(c)(3) organizations keep it even if no contribution is made. and governmental colleges or universities, the trade or business is conducted primarily for the convenience of the organization’s Qualified Sponsorship Payments members, students, patients, officers or employees. For example, Qualified sponsorship payments (QSPs) are not subject to UBIT. a laundry operated by the college for laundering linens and stu- A QSP is a payment by a business for which it will receive no sub- dents’ clothing. stantial benefit other than the use of its name, logo or product lines • Other special exceptions are provided for in IRC Sec. 513, in- by the nonprofit. Reg. 1.513-4 provides guidance and examples cluding public entertainment events at fairs and trade shows (for example, agricultural event at a state fair designed to promote on QSPs, including the tax treatment of any payment (or portion the breeding of animals), bingo games, hospital services, pole of a payment) that is not a QSP. rentals, distribution of low-cost articles (see Token Benefits—Dis- tribution of Low-Cost Articles on Page E-12), and sponsorship Advertising or Charitable Donation payments (see Qualified Sponsorship Payments on Page E-12). Tax-exempt organizations can publicly acknowledge donors for their contributions. However, if the exempt organization conducts Dues advertising for the donor, the donation would be considered taxable Agricultural and horticultural organizations that require members to income to the exempt organization [IRC Sec. 513(i)]. pay annual dues of $169 or less for 2019 (Rev. Proc. 2018-57) are Donations to tax-exempt organizations are taxable income if the not required to include the dues revenue as UBI [IRC Sec. 512(d)]. organization, in return, provides a valuable benefit or service to the donor. Mere recognition of a contributor as a benefactor Gaming (value-neutral acknowledgement) is incidental to the contribution. Gaming includes, but is not limited to, bingo, pull-tabs, Texas Hold- Tax-exempt organizations that go beyond recognition and promote em poker and other card games, raffles, video games, 21, punch the donor are engaging in advertising, which is unrelated to the boards and lotteries. Income from regularly conducted gaming mission of tax-exempt organizations. In these cases, exempt or- activities is treated as UBI and may result in loss of exempt status. ganizations must pay UBIT on the payment received in exchange (See IRS Pub. 3079.) for advertising services provided. Volunteer labor exception. If substantially all (generally 85% or All the facts and circumstances of the relationship between the more) of the work is performed by unpaid volunteers (including sponsor and the exempt organization must be considered. Items tips), the activity will not be considered UBI. to consider include the value of the service provided in exchange Gaming is not UBI for: for the payment and the terms under which payments and services • Section 501(c)(3) or (4) organizations if gaming is not regularly are rendered (Ann. 92-15). carried on. • Section 501(c)(5) or (6) organizations if the gaming activities are Example #1: A symphony maintains a website that contains performance considered to further the exempt organization’s purpose. schedules. Corporate sponsors help fund the performances. In appreciation, • Section 501(c)(7), (8), (10) or (19) organizations if the gaming the symphony lists the sponsors and web addresses but it does not promote activities provide social or recreational activities for members or advertise their merchandise. However, users may hyperlink (jump) to the only. sponsors’ websites. This is not considered advertising and payments for A qualified bingo game is not considered an unrelated trade sponsorships are not UBI (Ltr. Rul. 200303062). or business if three requirements are satisfied [IRC Sec. 513(f)]: 1) The bingo game is legal under both state and local law, 2) Commercial bingo games (conducted for profit) ordinarily are Example #2: The same facts as above, except the user hyperlinks to a not permitted in the area and corporate sponsor to find an endorsement of the sponsor’s product by the 3) Wagers are placed, winners determined and prizes distributed exempt organization. The endorsement is advertising and the payment for in the presence of all persons wagering in the game. sponsorship is UBI.

E-12 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020  Fiduciary Tax Returns (Form 1041) if no will is probated, to the trust primarily responsible for paying Tab G Topics the decedent’s debts, taxes and administration expenses.) Fiduciary Return Facts...... Page G-1 • Trusts (and estate tax years ending two or more years after the decedent’s death). Estimated payments are required if tax after Trust and Estate Terminology...... Page G-2 subtracting withholding and credits is $1,000 or more, and with- Overview of Income Taxation of Trusts and Estates... Page G-3 holding and credits is less than the smaller of [IRC Sec. 6654(d)]: Qualified Business Income (QBI) Deduction...... Page G-8 1) 90% of the tax for the current year or Grantor Trusts...... Page G-9 2) 100% of the tax from the previous year. Grantor Trusts—Tax Returns and Reporting However, if a return was not filed in the previous year, or the Requirements...... Page G-9 previous year’s return did not cover a full 12 months, then item Simple Trust—Detailed Example...... Page G-11 2 does not apply. If adjusted gross income (AGI) in the previous year was more than $150,000, and less than two-thirds of gross Complex Trust—Detailed Example...... Page G-12 income is from farming or fishing, the safe harbor is 110% (not Form 1041, Schedule K-1 Codes...... Page G-16 100%) of the previous year’s tax. A domestic estate or trust that had a full 12-month prior tax year Fiduciary Tax Rate Schedules with no tax liability for that year is not required to make ES pay- ments the next year. 2019 rates—See Form 1041 on the front cover A trust (or an estate in Related Information Estimated tax allocated to beneficiaries. its final year) may allocate all or any portion of its estimated tax pay- • Decedent’s final Form 1040; Estate’s Form 706—Tab H ments to beneficiaries under IRC Sec. 643(g) by filing Form 1041-T • Estate planning—Tab 15, 1040 Quickfinder® Handbook; Tab 15, by the 65th day after the close of the tax year (March 6, 2020 for Tax Planning for Individuals Quickfinder® Handbook calendar year 2019). Form 1041-T can be filed with Form 1041 • Worksheet to reconcile income reported on final Form 1040 and or filed separately. If filed separately, Form 1041-T should not be Form 1041—Tab A attached to Form 1041. The estimated tax allocated to beneficiaries • IRS Pub. 559 (Survivors, Executors, and Administrators) should be reported on line 13 (Code A) of their Schedules K-1. Estimated tax—special rules: Fiduciary Return Facts • Individuals calculate estimated tax payments using income for months ending before the due date of the installment. For example, Filing requirements: the June 15 payment is based on income through May 31. For trusts • Estates. Gross income of $600 or more, or a nonresident alien and estates, the period ends one month earlier [IRC Sec. 6654(l)(4)]. beneficiary. Estimated payments are based on income through February 28 • Trusts. Any taxable income, gross income of $600 or more, or a (April 15 payment), April 30 (June 15 payment), July 31 (September nonresident alien beneficiary. 15 payment) and November 30 (January 15 payment). • Grantor Trusts. See the chart Grantor Trusts—Tax Returns and • Estates and trusts are subject to the 3.8% net investment income Reporting Requirements on Page G-9. tax (NIIT), and the calculation of estimates should include the li- Tax year: ability for this tax. See Net Investment Income Tax on Page G-7. • Estates. Day after death is the beginning of the first tax year. The • A beneficiary is not required to include income distributed during first year can cover any period of 12 months or less that ends on the first 65 days of the following year in annualized income for the the last day of a month. The executor chooses a tax year when January 15 payment when a trust or estate elects to treat such the first fiduciary return is filed. income as if it were paid during the current year (Rev. Rul. 78-158). • Trusts. Calendar year. Exception: A grantor trust that files Form 1041 uses the same tax year as the grantor. Tax withholding. Backup withholding reported to an estate or trust Filing deadlines: on Form 1099 (for interest income, dividends or other income) is • Calendar year 2019: April 15, 2020. reported on line 11, Schedule G of Form 1041. Backup withhold- • Fiscal year: The 15th day of the fourth month following ing distributed to the beneficiaries is reported on Schedule K-1, the close of the tax year. box 13 (Code B). Other than backup withholding, withheld income tax cannot be passed through to beneficiaries on Form 1041-T or File a 2019 Form 1041 for: Schedule K-1. • Calendar year 2019. • Fiscal year beginning in 2019 and ending in 2019 or 2020. Employer identification number (EIN). Any estate or trust re- • Fiscal year beginning in 2020 if the 2020 form is not avail- quired to file Form 1041 must obtain an EIN. See inside front cover. able by the due date for the return. Use 2020 tax rates and incorporate any law changes. Exemptions Estates...... $ 600 Beneficiary’s year. Beneficiaries report income in the tax year Trusts required to distribute all income currently...... 300 in which the trust or estate year ends. For example, the estate of a decedent who died on February 17, 2019, closes its first year Trusts permitted to accumulate income...... 100 on January 31, 2020. The estate files a 2019 Form 1041 for the Extensions. Form 7004 is used for an automatic extension of 5½ first year. A calendar-year beneficiary reports any items from the months for Form 1041. Thus, for calendar-year trusts and estates, Schedule K-1 on his or her year 2020 Form 1040 even though the the extended due date will be September 30. items are reported on a 2019 Schedule K-1. Penalties. Late filing penalty of 5% of tax per month up to 25%, Estimated tax requirements (Form 1041-ES): plus late payment penalties and interest. If a return is more than • Estates. Estimated payments are only required for tax years 60 days late, the minimum late filing penalty is the smaller of $435 ending two or more years after the decedent’s death [IRC Sec. [for tax returns required to be filed in 2020 per IRC Sec. 6651(a)] or 6654(l)]. (This rule also applies to a decedent’s grantor trust that the tax due. The penalty may be waived if an explanation showing will receive the residue of the estate under the decedent’s will or, reasonable cause for the delay is attached to the return. Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook G-1 Grantor trusts in the year of death. Grantor trust rules apply to Complex trust. A trust that is allowed to accumulate income, has the grantor only through the date of the grantor’s death. The trust a charitable beneficiary or distributed principal in the tax year. must file Form 1041 for the short tax year from the date of death N Observation: A trust may be simple one year and complex the and ending December 31. Exception: A qualified revocable trust next. A trust that is permitted but not required to distribute principal (QRT) can elect to be treated as part of the decedent’s estate is complex in years when principal is actually distributed, but may under IRC Sec. 645. be simple in a year when no distributions of principal are made. Section 645 election (Reg. 1.645-1). A QRT is any trust (or portion A trust that can either distribute or accumulate income is always thereof) treated as owned by the decedent (thus, a grantor trust) a complex trust even in years when all income is distributed. All due to a power to revoke that was held by the decedent on the trusts are complex in their final year because principal must be date of death. A trust can be a QRT even if the decedent’s spouse distributed when the trust terminates. or a nonadverse party (a person or entity not having an economic  Note: The terms of a trust are found in the trust agreement interest in the trust) must consent to the revocation. or the will creating the trust. The document should include the The election, which can be made for more than one QRT, must be information needed to determine whether a trust is classified as filed by the due date for Form 1041 for the first tax year of the es- simple or complex. tate, including extensions, regardless of whether there is sufficient Corpus. The assets in a trust. Also called trust principal. income to require the filing of that return. The election is made by filing Form 8855 (Election To Treat a Qualified Revocable Trust as Crummey power. A provision in a trust instrument that allows Part of an Estate). The executor and trustee must both sign the beneficiaries to withdraw principal from a trust for a limited time. election. If there is no court-appointed executor, the trustee alone The purpose of the power is to qualify gifts to a trust for the annual can make the election. exclusion from gift tax. An employer identification number (EIN) must be obtained for the Example: Walt transfers $4,000 into an irrevocable trust each year to pay QRT following the decedent’s death. premiums on a life insurance policy owned by the trust. A Crummey Power in During the election period, Form 1041 is filed for the combined the trust gives Opal, the beneficiary of the trust, 30 days after each transfer estate and trust under the name and TIN of the estate. The trust to withdraw the funds. Although gifts to an irrevocable trust ordinarily do not is only required to file a separate Form 1041 if it terminates dur- qualify for the annual exclusion from gift tax because they are gifts of future ing the election period. See Reg. 1.645-1(h)(2)(i)(B). If there is no interests, the Crummey Power qualifies Walt’s transfers for the annual exclu- probate estate, the trustee files Form 1041 under the EIN for the sion by making them gifts of present interests. trust. The Form 1041 filed should follow tax rules for estates. A trust filing as an estate can use a fiscal year. Distributable net income (DNI). A modified form of trust taxable income before the distribution deduction. It is the maximum amount The election period begins on the date of death and terminates of income for which the fiduciary can claim an income distribution when both the trust and estate have distributed all assets or, if deduction and the maximum amount required to be included in earlier, on the day before the applicable date. If Form 706 is re- the beneficiaries’ gross income. quired, the applicable date is the later of (1) 2 years after the date of death or (2) six months after the date of final determination of Distribution. A payment of income or principal to a beneficiary. liability for estate tax. If Form 706 is not required, the applicable Distributions may be paid in cash or in property. date is the day two years after the date of death. Electing small business trust (ESBT). Certain trusts can qualify to own Subchapter S stock by electing to be treated as a small business trust [IRC Sec. 1361(e)]. The S portion of the trust is Trust and Estate Terminology treated as a separate trust and taxed at the highest trust rate with Accounting income. Trust accounting income is determined by no exemption, unless the income qualifies as long-term capital using the terms of the governing instrument and applicable local gains, in which case a capital gain rate applies [IRC Sec. 641(c)]. (state) law. It is distinguished from taxable income, gross income, Estate. The legal entity that holds title to a decedent’s probate and distributable net income (DNI). Also called fiduciary account- property from the date of death until the property is distributed ing income. to the heirs. Adjusted gross income (AGI). AGI for an estate or trust [IRC Fiduciary. Person who acts in a trustee capacity for another per- Sec. 67(e)] is determined by subtracting the following from line 9 son. Fiduciaries include personal representatives, trustees and of Form 1041: guardians. Also refers to the fiduciary entity—an estate or trust. • Administration expenses from lines 12, 14, and 15a; Fiduciary duty. The duty to act solely for someone else’s benefit • The income distribution deduction (line 18—see further discus- without regard to personal interests. A trustee has a fiduciary sion at Income Distribution Deduction on Page G-17); duty to all beneficiaries of a trust—both income beneficiaries and • The amount of the exemption (line 21); and remainder beneficiaries. • The NOL deduction from line 15b. Five and five power. A limitation to a power of appointment, where Adverse party. A beneficiary with a substantial interest in a trust the power to appoint is limited to the greater of $5,000 or 5% of who would be adversely affected by another person’s exercise the value of principal, usually to prevent inclusion of trust property of a power. If a grantor can only receive a benefit from the trust in beneficiary’s gross estate. with consent of an adverse party, the trust income is not taxed to Grantor. The person who creates or gives assets to a trust. Also the grantor. called a settlor. A person who receives or has a right to receive income Beneficiary. Grantor trust. A trust that can distribute all or part of its income to or principal from a trust. the grantor, requires that the property be returned to the grantor Bypass trust. A trust that holds assets from a decedent’s estate at the end of the trust, or otherwise gives the grantor sufficient equal to the applicable exclusion amount not used by the decedent control over the trust so that he or she is considered its owner for during his or her lifetime. Also referred to as a credit shelter trust. income tax purposes. It is a valid legal trust under state law but Charitable lead trust. A split-interest trust that provides income to is not recognized as a separate entity for income tax purposes. charity and the remainder to noncharitable beneficiaries. Although grantor trusts are subject to the same filing requirements Charitable remainder trust. A split-interest trust that provides as regular trusts, they may be able to use a simplified alternative income to the grantor or other noncharitable beneficiaries and the reporting method instead. See Grantor Trusts—Tax Returns and remainder to charity. Reporting Requirements on Page G-9.

G-2 2019 Tax Year | Small Business Quickfinder ® Handbook Income and Expense Chart for a Decedent (Continued) —Cash Method of Accounting— Category Where to Report Explanation Claims Against Estate Form 706, Schedule K Enforceable personal obligations of decedent at time of death plus interest accrued up to time of death. Credit for the Elderly Final Form 1040, Calculate as though decedent lived full year. or the Disabled Schedule R Deductions in Respect Form 706 and Form 1041 Business expenses, income-producing expenses, interest, and taxes for which decedent was liable but which are of a Decedent (DRD) (or beneficiary’s return) not deductible on final Form 1040. Depreciation Final Form 1040 Depreciation for period ending on date of death. Short tax year rules apply; see Tab J. Form 1041, Form 4562 If estate continues to operate decedent’s business or rental property, depreciation is allocated between estate and income beneficiaries (assuming estate is claiming an income distribution deduction) based on income allocated to each. Estate is not allowed Section 179 deduction. Short tax year rules apply for any tax year of the estate less than 12 months. See Tab J for short tax year rules. Dividend Income Final Form 1040, Dividends received through date of death. Schedule B Form 1041, Schedule B Dividends received after date of death. Estates and trusts are subject to same reduced tax rate on qualified (or beneficiary’s return) dividends as individuals (20% maximum rate for trusts and estates with net gains or taxable income over $12,950). Form 706, Schedule B Dividends declared to shareholders of record before death, but not available or received until after death (IRD). and Form 1041 (or beneficiary’s return) Earned Income Credit Final Form 1040, Available even if decedent’s return covers only a part year and decedent would not have qualified with a full year’s (EIC) Schedule EIC income. A decedent’s credit is refundable. Estate Tax Deduction Form 1041 (or If federal estate tax was paid on IRD, a deduction can be claimed on the income tax return that reports the IRD. beneficiary’s Form 1040, Schedule A) Exemptions Final Form 1040 No exemption. Form 1041 An estate is allowed a $600 exemption even if first return period is less than 12 months. Funeral Expenses Form 706, Schedule J Allowed only on Form 706. State law generally determines which items are deductible funeral expenses. Reg. 20.2053‑2 classifies the following as funeral expenses if allowable under local law: tombstone, monument, mausoleum, burial lot for decedent or family (including costs for future care) and transportation of the person bringing body to burial place. Income and Expenses Final Form 1040 Income received and expenses paid before death. Generally Form 1041 (or Income received and expenses paid after death, including income and expenses in respect of a decedent. beneficiary’s return) Form 706 Income and expenses in respect of decedent (also reported on Form 1041 or beneficiary’s return). Income in Respect of Form 706 and Form 1041 All gross income that the decedent had the right to receive and is not includable on final Form 1040. If estate tax is a Decedent (IRD) (or beneficiary’s return) paid on this income, a deduction for estate tax paid can be claimed on the income tax return that reports income. Income Tax Due on Form 706, Schedule K Federal and state income taxes unpaid at date of death, including tax due on final Form 1040 prepared and filed Final Form 1040 after death. Installment Sale Final Form 1040, Form Payments received through date of death. Contracts Held by 6252 Decedent Form 706 and Form 1041 If note cancels at death under decedent’s will, date-of-death value is reported on Form 706 and unrecognized gain (or beneficiary’s return) on Form 1041 (as IRD). If decedent and obligor are related, FMV of installment note cannot be less than its face value. Form 1041 (or If note is self-canceling at death (referred to as a self-canceling installment note or SCIN), unrecognized gain is beneficiary’s return) included on Form 1041 (as IRD). Form 706 and Form 1041 If contract is not canceled at death, difference between face amount of obligation and decedent’s basis is reported (or beneficiary’s return) on Form 706 and is considered IRD [IRC Sec. 691(a)(4)]. As payments are collected, recipient reports income using (attach Form 6252) decedent’s gross profit percentage. Interest Earned Final Form 1040, Interest received through date of death plus original issue discount (OID) earned through date of death. Schedule B Form 706, Schedule Interest accrued but unpaid at date of death is IRD. B and Form 1041 (or beneficiary’s return) Form 1041 (or Interest earned and received after date of death. beneficiary’s return) Interest Expense Final Form 1040 Deductible interest paid before death. Form 706 and Form 1041 Deductible interest expense accrued before death but paid after death (DRD). Nondeductible interest accrued before (or beneficiary’s return) death but paid after death is allowed as a debt of estate on Form 706, Schedule K. Form 1041 (or Deductible interest paid after death. Use Form 4952 for investment interest expense. Interest expense on beneficiary’s return) decedent’s personal residence is qualified residential interest only if a beneficiary uses it as a residence during estate administration [IRC Sec. 163(h)(4)]. Otherwise, the interest is either investment interest (subject to limitations on Form 4952), rental interest expense or nondeductible interest. Investment interest expense attributable to tax- exempt income is not deductible. IRA, SEP, SIMPLE, Form 706, Schedule I The account balance of all tax-deferred benefits at the time of death. Benefits are taxable to the beneficiary when Keogh, 401(k), etc. distributed (IRD). Beneficiaries can roll over IRA funds. Final Form 1040 Amounts actually received before death. Form 1041 (or Distributions made after death (IRD). These distributions are not subject to the 10% early withdrawal penalty [IRC beneficiary’s return) Sec. 72(t)(2)(A)(ii)].

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2019 Tax Year | Small Business Quickfinder ® Handbook H-3 Income and Expense Chart for a Decedent (Continued) —Cash Method of Accounting— Category Where to Report Explanation Medical Expenses Final Form 1040, Medical expenses paid before death. Can elect to deduct medical expenses incurred before death but paid from the estate Schedule A within one year of the day following death [Reg. 1.213-1(d)]. Election does not apply to medical expenses for a decedent’s dependents. To elect, attach a statement to Form 1040 stating the estate has waived the right to claim medical expense for estate tax. With the election, deduction is taken on Form 1040, Schedule A in year costs were incurred (a Form 1040X may be needed). Amounts not allowed due to 7.5%-of-AGI threshold cannot be claimed on Form 706. Form 706, Schedule K Unpaid medical expenses at death are reported on Form 706 as a claim against the estate, unless an election is made to report on decedent’s final Form 1040. Amounts deducted on Form 706 are not subject to the 7.5%-of-AGI deduction threshold. If deduction taken on Form 1040, amount not allowed due to 7.5%-of-AGI threshold cannot be claimed on Form 706. Form 1041 Any insurance reimbursements after death of amounts previously deducted on Form 1040. Report as IRD. Miscellaneous Final Form 1040, Miscellaneous itemized deductions that would not have been subject to the 2%-of-AGI limit that are paid before Itemized Schedule A death. Generally, most miscellaneous deductions are not deductible. Deductions Form 706, Schedule J or Unpaid miscellaneous itemized deductions at date of death are reported on Form 706. When paid, if the item would Form 1041 not have been subject to the former 2%-of-AGI limitation, deduct on Form 1041 as DRD. Form 1041 Incurred, paid after death, and would not be subject to the former 2%-of-AGI limit. See Deductions on Page G-5. Net Investment Form 8960 Estates are subject to the 3.8% net investment income tax. See Tab G for additional discussion. Income Tax Partnership Income Final Form 1040, Income (or loss) up to date of death using any reasonable method of allocating income (loss). Allocation is often (Loss) Schedule E based on pro rata amount for year or interim closing of books. Form 1041 (or Income (or loss) after death not included on final Form 1040. beneficiary’s return) Passive Losses Final Form 1040 Losses are allowed to extent of passive income, plus accumulated unused losses to extent they exceed any increase in basis allocated to the activity. For example, if a passive activity’s basis is increased $6,000 upon taxpayer’s death, and unused passive activity losses as of date of death are $8,000, decedent’s deduction is $2,000 ($8,000 – $6,000). Form 1041 Estates are subject to the same passive loss limitation rules as individuals. The fiduciary’s level of participation determines the classification. If decedent actively participated in a rental real estate activity before death, the estate will be allowed the special $25,000 rental real estate exemption for up to two years after decedent’s death. Personal Residence Form 1041 The Section 121 exclusion of gain from sale of personal residence does not apply to estates. If personal residence is a capital asset to the estate (either held for investment or rental purposes), estate can deduct loss on sale. If property is used by estate beneficiaries for personal purposes, loss on sale is not deductible. If home was not subject to probate and passed directly to heirs, sale of home is reported on beneficiaries’ Form 1040. Real Estate, State and Final Form 1040, Paid before death, subject to $10,000 limitation ($5,000 if MFS). General sales taxes deductible if state and local Local Income Taxes Schedule A income taxes not deducted [IRC Sec. 164(b)(5)]. The total deduction for state and local real property, personal property, income and general sales taxes is generally limited to $10,000. Exceptions apply for taxes paid in carrying on a trade or business or for the production of income. Form 706, Schedule Real estate taxes accrued before death but paid after death. Note: The $10,000 limit for deducting taxes mentioned K and Form 1041 (or previously applies to Form 1041 as well unless the property is held for the production of income. beneficiary’s return) Form 1041 (or Accrued and paid after death. Note: The $10,000 limit for deducting taxes mentioned previously applies to Form beneficiary’s return) 1041 as well unless the property is held for the production of income Rental Income and Final Form 1040, Income and expenses received or paid before death. Expenses Schedule E Form 706 and Form 1041 Income and expenses accrued before death but not actually received or paid until after death (IRD and DRD). (or beneficiary’s return) Passive activity loss rules apply to estates (for Form 1041 reporting). Form 1041 (use Schedule Income and expenses accrued and received or paid after death. Passive loss rules apply to estates. E of Form 1040) S Corporation Income Final Form 1040, Pro rata share of income (or loss) up to death. Generally, amount of income (or loss) is computed as follows: (Loss) Schedule E S corporation income or loss for the year, divided by number of days in S corporation’s year, multiplied by number of days shareholder was alive. Can elect under Section 1377(a)(2) to close S corporation books on day of death. Form 1041 (or Income (or loss) after date of death and not included on final Form 1040. beneficiary’s return) Savings Bond Interest Final Form 1040 or Form Two options (Rev. Rul. 68-145): (Decedent did not 1041 1) Executor elects to report interest accrued before death on final Form 1040. Interest accrued after death is elect to report interest reported on Form 1041 (or beneficiary’s return) in year bond is redeemed or matures. annually) 2) All interest (both before and after death) is reported on Form 1041 (or beneficiary’s return) in year bond is re- deemed, matures or an election is made to report income. Interest accrued before death is IRD. Alternatively, recipient of an inherited bond can elect to report interest annually (Rev. Rul. 64-104). Form 706, Schedule B FMV of bonds, including interest accrued up to date of death, which may be IRD. Savings Bond Interest Final Form 1040 Interest accrued up to date of death. (Decedent elected Form 1041 (or Interest accrued after death. Note that the last Series E bonds matured in 2010 and the last Series H bonds matured to report interest beneficiary’s return) in 2009. These bonds stopped paying interest at that time and any deferred interest should have been recognized annually) on the 1040 in the year the bond matured. Form 706, Schedule B FMV of bonds as of date of death. No IRD. Social Security Final Form 1040 Payments cease at death; therefore, subject to reporting on final Form 1040. Standard Deduction Final Form 1040 Full amount allowed. No proration required. Wages Final Form 1040 Wages received before death. Form 706, Schedule Wages earned before death but received after death (IRD). F and Form 1041 (or beneficiary’s return)

H-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Special Types of Employment and Payments Practice Tip: USCIS now has a Form I-9 Desktop Widget that The employees listed below receive special treatment for purposes of payroll allows employers to access a fillable Form I-9 online at www. tax withholding. This is not an exclusive list and there are exceptions to the ones uscis.gov/i-9-central/form-i-9-desktop-widget. listed. For a complete list and possible exceptions, see IRS Pubs. 15 and 15-A. For federal income tax (FIT) only, exempt means the employer is not required to State New Hire Reporting withhold federal income taxes. The employee, however, is still generally subject Every state must have a new hire reporting program conforming to income tax on wages paid (there are some exceptions). Exempt for FICA and to federal standards that require employers to submit information FUTA purposes means neither the employer nor the employee is subject to the tax. on newly hired employees to their State Directory of New Hires, FIT FICA FUTA which is forwarded to the National Directory of New Hires. A new Child under 18 employed by parent1...... Withhold Exempt Exempt employee is an employee (1) not previously employed by the re- porting entity or (2) previously employed by the entity but has been 1 Withhold Taxable Exempt Child under 21 employed by parent ...... separated from that employment for at least 60 consecutive days. Child under 21 employed by parent for Generally, employees returning after a leave of absence are not domestic work in the parent’s home...... Exempt Exempt Exempt required to be reported as long as they were not removed from the Decedent—year of death...... Exempt Taxable Taxable payroll system. If a new Form W-4 is required when they return, Decedent—year after death...... Exempt Exempt Exempt they should be reported as new hires. Distributions from qualified retirement plans...... Withhold Exempt Exempt Who must file. Employers required to give an employee a Form Elective contributions and deferrals to a W-2 must file a report. 401(k) plan up to IRC Sec. 402(g) limit...... Exempt Taxable Taxable Due date. 20 days from the employee’s first day of service under Employer contributions to a qualified federal rules, unless the employer transmits reports electronically retirement plan...... Exempt Exempt Exempt or magnetically, which must be done twice monthly (not less than Hospital intern...... Withhold Taxable Exempt 12 or more than 16 days apart). States may have reporting time- Household employee2...... Exempt Taxable Taxable frames shorter than 20 days. Newspaper carrier under 18...... Exempt Exempt Exempt What to report. The information required to be reported includes: Noncash payments to farm labor...... Exempt Exempt Exempt 1) Employee’s name, address, and social security number. Noncash payments to household employees...... Exempt Exempt Exempt 2) Date services for pay were first performed. 3) Employer’s name, address, and federal EIN. Outplacement services provided by employers for terminated employees3...... Exempt Exempt Exempt 4) Any additional information required by the relevant state. Parent employed by child in the child’s æ Practice Tip: Form W-4 (Employee’s Withholding Allowance Withhold Taxable Exempt business...... Certificate) now includes fields for the employer’s name, address, Railroad employees...... Withhold Exempt Exempt and EIN, as well as the date services for pay are first performed Severance pay...... Withhold Taxable Taxable by a new employee. Therefore, all information that is needed for new hire reporting purposes is on the Form W-4. Spouse employed by spouse’s business...... Withhold Taxable Exempt To contact states. Website: www.acf.hhs.gov/css/employers/ Statutory employee ...... Exempt Taxable4 —5 employer-responsibilities/new-hire-reporting. Students working for their school (generally)6..... Withhold Exempt Exempt Tips—less than $20 per month...... Exempt Exempt Exempt Unemployment compensation...... Withhold Exempt Exempt Payroll Tax Reporting Workers’ compensation...... Exempt Exempt Exempt 1 E-Filing of Employment Tax Returns If in sole proprietorship or parent-owned partnership (not corporation). Forms 940, 941, 943, 944, and 945 can be filed electronically. 2 FICA exempt if employee’s wage is under $2,100 (in 2019). Exempt from FUTA Available options include the Employment Tax e-File System (for if employer paid less than $1,000 in total household wages per quarter. authorized IRS e-File providers and businesses using payroll ser- 3 Excludable as a working-condition fringe benefit only if terminated employee is vice providers) and the 940, 941, 943, 944, and 945 Modernized seeking employment in the same line of work (Rev. Rul. 92-69). e-File Program (for businesses using payroll service providers). 4 If paid $100 or more in cash in a year {homeworkers only [Reg. 31.3121(a)(10)-1]}. For more information, see www.irs.gov/businesses/small- 5 FUTA exempt only if full-time life insurance salesperson or homeworker. businesses-self-employed/e-file-form-940-941-or-944-for- 6 Safe harbor: The student must be enrolled in at least one half of the normal full- small-businesses or call the IRS e-Help Desk at (866) 255-0654. time load as gauged by the individual undergraduate, graduate or professional program. Additional restrictions apply (Rev. Proc. 2005-11). Employer’s Quarterly Federal Tax Return (Form 941) New Hire Reporting Used by employers who withhold income, social security, and Medicare tax from employee wages. Form I-9 (Employment Eligibility Verification) • Household employers must use Schedule H (Form 1040) Employers must retain completed Form I-9 documenting that each (Household Employment Taxes). See Household Employment new employee (including citizens and noncitizens) is eligible to Tax (Schedule H) on Page I-7. However, sole proprietors fil- work in the U.S. Form I-9 is available at www.uscis. ing Form 941 or Form 944 for business employees may include gov/i-9-central. Section One must be completed taxes for household employees on these returns. by the employee no later than the first day of work • Farm employers must use Form 943 (Employer’s Annual Federal (but not before accepting a job offer) and Section Tax Return for Agricultural Employees). Two must be completed by the employer within Filing requirements. An employer (other than household or farm) three business days of the first day of employ- must file Form 941 for every quarter (even if the employer pays ment. Be sure to use the current version of Form no wages for the quarter), unless he qualifies as a seasonal em- I-9—dated 8/31/19 at the time of this publication. ployer. Seasonal employers who regularly pay no wages in certain

2019 Tax Year | Small Business Quickfinder ® Handbook I-5 quarters should check the box on line 18 of Form 941 Annual Return of Withheld Federal Income every quarter the form is filed. Generally, the IRS Tax (Form 945) will not inquire about unfiled returns if at least one Form 945 is used to report federal income tax withheld for non- taxable return is filed each year. payroll items, which may include backup withholding, withholding Deposit threshold. If the tax liability for the quarter for pensions, annuities, IRAs, and gambling winnings. Generally, is less than $2,500, it may be paid with Form 941. separate deposits must be made via EFTPS. However, exceptions Otherwise, the withheld taxes must be deposited on exist to this rule (for example, if net taxes in full for the year are either a semiweekly or monthly basis. See Deposit less than $2,500 and the amount is being paid in full with the timely Deadlines (Forms 941, 944, and 945) on Page I-2. filed return, Form 945-V (Payment Voucher) may be used). Do not Filing deadlines: combine this deposit with Form 941 or other payroll tax deposits. Quarter Ending Due Date Nonpayroll income tax withholding reported on Form 1099 or Form W-2G must be reported on Form 945. All income tax withholding March 31 April 30 reported on Form W-2 must be reported on Form 941 or 943 (for June 30 July 31 agricultural employees) or 944 (for small employers—see above), September 30 October 31 Schedule H (Form 1040) for household employees, or Form CT-1 December 31 January 31 (for railroad employees). Backup withholding. If a taxpayer fails to provide a payer with a Extensions. If all taxes were timely deposited for the quarter, the current taxpayer identification number (TIN), the payer must with- due dates are extended 10 days. There is no additional extension hold federal taxes at a 24% rate for 2019 (IRC Sec. 3406). Rev. for filing Form 941. Proc. 2014-43 provides procedures for validating TINs to prevent Paper and computer-generated substitute Forms 941, W-2, and or stop back-up withholding. See also IRS Pub. 1281. W-3. See Rev. Procs. 2016-20, 2018-24, and 2018-37 for the rules. Penalties: Employer’s Federal Unemployment Tax • The penalty for filing a tax return late is 5% of the tax due for Return (Form 940) each whole or part month the return is not filed when required. Used by employers to report annual federal unemployment tax The maximum penalty is 25% of the unpaid tax. If the return is (imposed on the employer, not the employee). over 60 days late, the minimum penalty is the lesser of $435 or Filing requirements. Employers who were not household or the tax due [IRC Sec. 6651(a)(1)]. agricultural employers must file Form 940 if they paid a total of • The penalty for paying the tax late is 0.5% of the tax due for $1,500 or more in wages in any calendar quarter (of the current or each whole or part month the tax is not paid when required. The prior year), or had one or more employees for some part of a day maximum penalty is 25% of the unpaid tax. The IRS can also in any 20 different weeks during the current or prior year. Count all charge interest on the balance due [IRC Sec. 6651(a)(2)]. regular, temporary, and part-time employees. A partnership should • If both penalties apply in any month, the failure to file penalty is not count its partners. Form 940 can be filed electronically through reduced by the amount of the failure to pay penalty. the IRS’s e-file Program (Rev. Proc. 2007-40). • If the employer fails to withhold and pay over the tax, a respon-  If the employer receives a preprinted Form 940 and is sible person can be held liable for 100% of the tax in place of Note: not liable for FUTA tax because no payments to employees were the employer. See Trust Fund Recovery Penalty on Page I-11. made during the year, check box c. on page 1, sign and return it Credits for increasing research activities. A credit may be to the IRS. claimed on Forms 941, 943, or 944 from Forms 8974 (Quali- pay FUTA tax and file Form 940 if, during fied Small Business Payroll Tax Credit for Increasing Research Agricultural employers the current or preceding calendar year, they meet either of two tests Activities) and 6765 (Credit for Increasing Research Activities) to regarding agricultural laborers [IRC Sec. 3306(a)(2)]: accommodate the R&D credit against payroll taxes. This permits 1) Pay them wages ≥ $20,000 during any calendar quarter or taxpayers with annual gross receipts of less than $5 million to offset 2) Employ ≥ 10 of them for some part of a day (whether or not at the employer portion of social security taxes with up to $250,000 of the same time) during any 20 or more different weeks. qualified research expenses [IRC Sec. 41(h)]. See Notice 2017-23 for interim guidance on claiming the credit and IRS internal legal Wages paid for agricultural labor performed by aliens lawfully advice AM 2017-003 regarding timing issues. Clarifying procedures admitted to the U.S. on a temporary basis to work peak seasons for claiming the credit on Form 943 or 944 have been posted at are not subject to FUTA tax. However, the services performed by www.irs.gov (search “research payroll credit”). such aliens are still counted in determining whether an agricultural employer meets either of the two preceding tests. Employer’s Annual Federal Tax Household employees. Wages paid to household employees are subject to FUTA tax if they total $1,000 or more during any Return (Form 944) calendar quarter of the current or preceding calendar year [IRC Employers with a total annual tax (social security, Sec. 3306(a)(3)]. Household employers use Schedule H of Form Medicare, and FITW) liability of $1,000 or less may 1040 to report and pay FUTA taxes for their household employees. be eligible to file Form 944 (Employer’s ANNUAL However, if a household employee’s wages are reported on Forms Federal Tax Return) once a year instead of Form 941, 943, or 944, the employer must deposit the tax and use Form 941 quarterly. 940 to report FUTA tax. U Caution: Employers that were previously notified Filing deadline. Form 940 is due by January 31, 2020. by the IRS to file Form 944 must continue filing Form 944 until opting out of the program or being notified by the IRS Extensions. If all tax is deposited when due, the deadline is ex- that Forms 941 must be filed. Employers may request to opt out tended 10 days. There is no additional extension for Form 940. of filing Form 944 by calling (800-829-4933) or writing the IRS at Penalties: the addresses specified in the Form 944 instructions before the • Late filing penalty of 5% of tax per month up to 25%. applicable due date. See Rev. Proc. 2009-51 for guidance. • Late payment penalty of 0.5% of tax per month up to 25%.

® I-6 2019 Tax Year | Small Business Quickfinder Handbook Replacement Page 1/2020 Depreciation and Amortization  See the 1040 Quickfinder® Handbook for the following information: Tab J Topics Tab 10, Depreciation Partial Table of Class Lives and Recovery • General depreciation rules and Form 4562 filing requirements. Periods—IRS Pub. 946, Appendix B...... Page J-1 • Half-year, mid-month, mid-quarter conventions. Section 179 Deduction...... Page J-3 • Expensing policy, repairs, additions and improvements. • Tax depreciation tables. Recapture—IRC Sec. 179 and Listed Property...... Page J-3 • Cost segregation. Short Tax Year—MACRS...... Page J-4 • Special (bonus) depreciation allowance. Allowed or Allowable Depreciation...... Page J-6 • Alternative minimum tax (AMT) adjustments. Depreciation Recapture...... Page J-6 • Alternative depreciation system (ADS) rules. • Section 179 deduction rules. General Asset Account (GAA) Depreciation...... Page J-7 • Change of use of MACRS property. Capitalization Rules...... Page J-7 • Dispositions of MACRS property. Amortization...... Page J-9 • Depreciation recapture. Depletion...... Page J-10 • Computer software. Oil and Gas...... Page J-10 • Qualified improvement property. • Correcting depreciation errors. Auto Depreciation...... Page J-11 • Intangible assets. Contributed Property...... Page J-11 Tab 11, Autos and Listed Property • Leased autos and inclusion tables. • Autos, trucks and vans Section 280F limitations and standard mileage rate chart. Partial Table of Class Lives and Recovery Periods—IRS Pub. 946, Appendix B Asset Class Life GDS Life Description of assets included: ADS Class (in years) (MACRS) 00.11 Office furniture, fixtures and equipment. Includes furniture and fixtures that are not a structural component of a building. Includes such assets as desks, files, safes, and communications equipment. Does not include communications equipment that is included in other classes...... 10 7 10 00.12 Information systems. Includes computers and peripheral equipment. Excluded from this class is office equipment described in Class 00.13. Peripheral equipment consists of the auxiliary machines that are designed to be placed under the control of the computer such as printers, keyboards, etc. This class does not include computers that are an integral part of other capital equipment that is included in other classes of economic activity. See IRS Pub. 946 for a complete definition of information systems included in this class...... 6 5 5 00.13 Data handling equipment, except computers. Includes only typewriters, calculators, adding and accounting machines, copiers, and duplicating equipment...... 6 5 6 00.21 Airplanes (airframes and engines), except those used in commercial or contract carrying of passengers or freight, and all helicopters (airframes and engines)...... 6 5 6 00.22 Automobiles, taxis ...... 3 5 5 00.23 Buses...... 9 5 9 00.241 Light general purpose trucks. Includes trucks for use over the road (actual weight less than 13,000 pounds)...... 4 5 5 00.242 Heavy general purpose trucks. Includes heavy general purpose trucks, concrete ready mix- trucks, and ore trucks, for use over the road (actual unloaded weight 13,000 lbs. or more)...... 6 5 6 00.26 Tractor units for use over-the-road...... 4 3 4 00.27 Trailers and trailer-mounted containers...... 6 5 6 00.28 Vessels, barges, tugs, and similar water transportation equipment, except those used in marine construction...... 18 10 18 00.3 Land improvements. Includes improvements directly to or added to land, provided such improvements are depreciable. Examples include sidewalks, roads, canals, waterways, drainage facilities, sewers (not including municipal sewers in Class 51), wharves and docks, bridges, fences, landscaping shrubbery, and radio and television transmitting towers. Does not include land improvements explicitly included in any other class, buildings or structural components. Excludes public utility initial clearing and grading land improvements...... 20 15 20 01.1 Agriculture. Includes machinery and equipment, grain bins, and fences but no other land improvements that are used in the production of crops or plants, vines and trees; livestock; the operation of farm dairies, nurseries, greenhouses, sod farms, mushroom cellars, cranberry bogs, apiaries and fur farms; and the performance of agriculture, animal husbandry, and horticultural services...... 10 71 10 01.11 Cotton ginning assets ...... 12 7 12 Continued on the next page 2019 Tax Year | Small Business Quickfinder ® Handbook J-1 Partial Table of Class Lives and Recovery Periods—IRS Pub. 946, Appendix B (Continued) Asset Class Life GDS Life Description of assets included: ADS Class (in years) (MACRS) 01.21 Cattle, breeding or dairy...... 7 5 7 01.221 Any breeding or work horse 12 years old or less at the time it is placed in service2...... 10 7 10 01.222 Any breeding or work horse more than 12 years old at the time it is placed in service2...... 10 3 10 01.223 Any race horse more than two years old at the time it is placed in service2...... 3 3 12 01.224 Any horse more than 12 years old at the time it is placed in service that is neither a race horse nor a horse described in Class 01.2222...... 3 3 12 01.225 Any horse not described in Classes 01.221, 01.222, 01.223, or 01.2242...... 3 7 12 01.23 Hogs, breeding ...... 3 3 3 01.24 Sheep and goats, breeding...... 5 5 5 01.3 Farm buildings except structures included in Class 01.4...... 25 20 25 01.4 Single-purpose agricultural or horticultural structures [within the meaning of IRC Sec. 168(i)(13)]...... 15 104 15 10.0 Mining. Includes assets used in the mining and quarrying of metallic and nonmetallic minerals (including sand, gravel, stone, and clay) and the milling, beneficiation and other primary preparation of such materials...... 10 7 10 13.1 Drilling of oil and gas wells. Includes assets used in the drilling of onshore oil and gas wells and the provision of geophysical and other exploration services; and the provision of such oil and gas field services as chemical treatment, plugging and abandoning of wells, and cementing or perforating well casings...... 6 5 6 13.2 Exploration for and production of petroleum and natural gas deposits. Includes assets used by petroleum and natural gas producers for drilling of wells and production of petroleum and natural gas, including gathering pipelines and related storage facilities...... 14 7 14 15.0 Construction. Includes assets used in construction by general building, special trade, heavy and marine construction contractors, operative and investment builders, real estate subdividers and developers, and others, except railroads...... 6 5 6 23.0 Manufacturing of apparel and other finished products. Includes assets used in the production of clothing and fabricated textile products; does not include apparel from rubber and leather...... 9 5 9 24.1 Timber cutting equipment...... 6 5 6 24.4 Assets used in the manufacturing of wood products and furniture ...... 10 7 10 27.0 Printing, publishing and allied industries. Includes assets used in printing by one or more processes, such as letter-press, lithography, gravure or screen; the performance of services for the printing trade, such as bookbinding, typesetting, engraving, photo-engraving and electrotyping; and the publication of newspapers, books, and periodicals...... 11 7 11 39.0 Manufacture of athletic, jewelry, and other goods. Includes assets used in the production of: jewelry; musical instruments; toys and sporting goods; motion picture and television films and tapes; and pens, pencils, office and art supplies, brooms, brushes, caskets, etc...... 12 7 12 57.0 Distributive trades and services. Includes assets used in wholesale and retail trade, and personal and professional services. Includes Section 1245 assets used in marketing petroleum and petroleum products...... 9 5 95 79.0 Recreation. Assets used in the provision of entertainment services for a fee or admission charge, such as bowling alleys, pool halls, theaters, concert halls, and miniature golf courses. Does not include amusement and theme parks and specialized land improvements such as golf courses, sports stadiums, race tracks, ski slopes, and buildings...... 10 7 10 Personal property with no class life...... 7 12 Section 1245 real property with no class life...... 7 40 Residential rental real property...... 27.5 30 Nonresidential real property. Includes office buildings, warehouses, and qualified office-in-home...... 39 40 1 5 years if the asset’s original use began with the taxpayer after 12/31/17 (new assets); 7 years otherwise (used assets). 2 Race horses placed in service after 2008 and before 2021, regardless of age, are three-year property. Outside of that date range, race horses more than two years old when placed in service are three-year property, and race horses two years old or younger are seven-year property. A horse is more than two (or 12) years old after the day that is 24 (or 144) months after its actual birthdate. 3 Properties described in asset classes 01.223, 01.224, and 01.225 are assigned recovery periods but have no class lives. 4 Seven years if property was placed in service before 1989. 5 High technology medical equipment is assigned a five-year recovery period for alternate MACRS method (ADS). GDS General Depreciation System. 200% declining-balance (DB) depreciation method for three-year, five-year, seven-year and 10-year property; 150% DB for farm placed in service before 2018, 15-year and 20-year property; straight-line (SL) depreciation method for 27.5- and 39-year property; and recovery years for alternative minimum tax (AMT) depreciation for assets placed in service after 1998. ADS Alternative Depreciation System. Recovery years for AMT depreciation for assets placed in service prior to 1999, C corporation book depreciation and exempt organizations. Can be elected for tax depreciation. Note: Use this table for assets placed in service after 1986. See IRS Pub. 946 for a list of all asset recovery periods.

J-2 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Nondiscrimination Rules for Employee Benefits If an employee benefit plan discriminates in favor of highly compensated or key employees, the benefits are taxable to the highly compensated or key employee. Types of Benefit Definitions Nondiscrimination Rules No-Additional-Cost Highly compensated employee definition Benefits must be on substantially equal terms and must be available to: Services, Qualified [IRC Sec. 414(q)]: 1) All employees or Employee Discounts, 1) A 5%-or-more owner (or a family member of 2) A group of employees classified such that it does not favor highly compensated Meals Provided at that owner) at any time during the current or employees. Employer-Operated preceding year or Eating Facility 2) An employee who for the preceding year Dependent Care received more than $120,000 (if the preceding A plan will favor highly compensated employees if: Assistance year is 2018—Notice 2017-64) or $125,000 (if 1) More than 25% of benefits during the year are paid to more-than-5% owners, or Program the preceding year is 2019—Notice 2018-83) 2) Average benefits provided to employees who are not highly compensated are in compensation. The employer can elect to less than 55% of the average benefits provided to the highly compensated apply this requirement only to employees who employees. were also in the top 20% of employees when For this test, do not consider the following employees: ranked by pay. • Employees under age 21 with less than one year of service. For purposes of determining the number • Certain union employees. of employees in the top 20%, the following employees are excluded [Temp. Reg. • Employees who earn less than $25,000 if benefits are provided through a salary 1.414(q)-1T, Q/A-9]: reduction arrangement. Adoption Assistance • Employees who have worked less than six A plan will favor highly compensated employees if more than 5% of benefits are Program months. provided to more-than-5% owners. • Employees who normally work less than 17½ Do not consider certain union employees for purposes of this test. Qualified Retirement hours per week. Contributions or benefits must not discriminate in favor of highly compensated Plans • Employees who normally work less than six employees. months per year. • Employees under age 21. • Certain union or nonresident alien employees. Group Term-Life Key employee definition. An employee is The plan must meet one of the following eligibility tests: Insurance considered a key employee if, during the plan year, 1) At least 70% of all employees benefit from the plan, the employee was [IRC Sec. 416(i)(1)]: 2) At least 85% of employees who participate are not key employees, 1) An officer with compensation in excess of 3) The plan benefits employees who qualify under a set of rules found by the IRS $180,000 for 2019—Notice 2018-83; not to favor key employees or 2) A more-than-5% owner or 4) The plan is part of a cafeteria plan that meets the eligibility test for those plans. 3) A more-than-1% owner with compensation in Do not consider the following employees for purposes of these tests: excess of $150,000. • Employees with less than three years of service. • Part-time or seasonal employees. • Nonresident aliens who receive no U.S. source earned income from the employer. • Certain union employees. The plan must meet one of the following benefits tests: 1) The plan does not favor key employees as to the type and amount of insurance provided, 2) The amount of insurance provided may be based on the pay rate of each participating employee or 3) The same fixed amount of insurance is provided for all covered employees. Cafeteria Plans A plan will favor key employees if more than 25% of the total nontaxed benefits for all employees go to key employees. A plan that favors highly compensated employees is also discriminatory. For this purpose, a highly compensated employee is: 1) An officer, 2) A more-than-5% owner or 3) A spouse or dependent of an officer or more-than-5% owner. Self-Insured Medical Highly compensated employee definition A plan cannot discriminate in favor of highly compensated individuals as to Reimbursement Plans [IRC Sec. 105(h)(5)]: eligibility to participate or benefits [IRC Sec. 105(h); Reg. 1.105-11]. A plan does not 1) One of the five highest paid officers, discriminate as to eligibility if it covers any of the following: 2) More than 10% owner (direct or indirect), or 1) At least 70% of all employees. 3) In the top 25% of highest paid employees. 2) At least 80% of eligible employees, but only if at least 70% of all employees are eligible to benefit under the plan. 3) Employees who qualify under a classification set up by the employer and found by the IRS not to be discriminatory in favor of highly compensated individuals. Qualified Retirement Highly compensated employee definition Tax-free benefit applies to highly compensated employees only if such services Planning Services [IRC Sec. 414(q)]: are available on substantially the same terms to each member of the group of See definition above in first cell of this column. employees normally provided education and information regarding the employer’s qualified employer plan. In other words, such services can be restricted to only certain employees based on something besides their compensation level, such as a restriction related to how close the employees are to retirement age.

2019 Tax Year | Small Business Quickfinder ® Handbook K-3 2019 Employer and Self-Employed Retirement Plan Chart 2019 Employer and Self-Employed Retirement Plan Chart SEP IRA SEP IRA Defined-Contribution SIMPLE IRA Defined-Benefit 401(k) 403(b) (Self-Employed) (Employee) (Profit-Sharing) Who can establish? Anyone (regardless of age) with self- Any employer. Employers with 100 or fewer employees (including self-employed Any employer. Tax-exempt religious, charitable, or employment (SE) income.1 individuals) that do not maintain another retirement plan. educational organizations. Eligible employees2 N/A. But, if contributions are made Employees at least age 21 who Employees who have earned at least $5,000 from employer Employees at least age 21 with one year of service (1,000 hours). Employees6 who work 20 or more hours per for self-employed, they must also be worked for the employer during at in any prior two years, and are reasonably expected to do so week, do not participate in another 401(k), made for eligible employees. least three of the last five years in the current year. 457 or 403(b) plan and will contribute more and received at least $600 in than $200 per year. compensation from employer in 2019. Maximum 20% of net SE income after SE 25% of wages up to maximum Employee elective deferrals limited to $13,000 (additional Actuarially determined contribution. Contributions per participant up to Employee elective deferrals limited to $19,000 Employee elective deferrals limited to Contributions tax deduction up to a maximum contribution of $56,000. $3,000 if age 50 or older at end of the year). Maximum benefit payout limited to lesser of 100% of compensation (additional $6,000 if age 50 or older at end of $19,000 (additional $6,000 if age 50 or older Allowed contribution of $56,000. SARSEPs established before 1997 The employer can either: 100% of average compensation or $56,000. Employer deduction the year). Employer deduction limited to 25% at end of the year). Special formula applies SARSEPs established before 1997 follow 401(k) contribution limit rules. 1) Match employee elective deferrals dollar for dollar up for the three consecutive years limited to 25% of aggregate of combined wages of all employees (elective to additional employer contributions based follow 401(k) contribution limit rules. to 3% of wages (can be reduced to as low as 1% in of highest compensation (limited compensation (limited to $280,000 deferrals do not reduce wages for the 25% limit). on years of service. Combined employer any two out of five years) or to $280,000), but not to exceed per employee) for all participants Combined employer contributions and employee contributions and employee elective deferrals 7 2) Contribute 2% of wages (up to $280,000) for all $225,000. (20% of net SE income after SE tax elective deferrals per employee limited to lesser per employee limited to lesser of 100% of 7 employees (including nonparticipants). deduction for self-employed). of 100% of wages or $56,000 (additional $6,000 wages or $56,000 (additional $6,000 for for employees age 50 or older by year-end).7 employees age 50 or older by year-end).7 1 Penalties for 10% of distribution. (See Exceptions to 10% Withdrawal Penalty Before Age 10% of distribution, or 25% if withdrawn within two years 10% of distribution. (See Exceptions to 10% Withdrawal Penalty Before Age 59 /2 on Page K-5.) 1 Early Withdrawal 59 /2 on Page K-5.) from the date first participated in plan. (See Exceptions to 1 (Before Age 591/2) 10% Withdrawal Penalty Before Age 59 /2 on Page K-5.) When Withdrawals By April 1 of the year following the year the account owner turns age 701/2. For self-employed and >5% owners, by April 1 of the year following the year the account owner turns age 701/2. For all other employees, April 1 of the year following the Must Begin Note: Contributions can still be made to the account after age 701/2 if the individual has earned income. year the account owner turns age 701/2 or retires, whichever is later. Date to Establish Plan Return due date, including extensions, for the year the plan is to be effective. • Establish plan by October 1, 2019 for new plans first in December 31, to establish plan. Return due date, including extensions December 31 to establish plan. For employer contributions, return due date including and Make effect for 2019.3 for profit-sharing plan contributions. 81/2 months after year-end for extensions.8 Contributions • Make employer contributions by the return due date, defined benefit plan contributions. including extensions.4 Employer Contributions No No Yes Yes No Generally no. Required? Borrowing Permitted? No No No Yes, if plan permits. Must pay back in five years (unless used to buy a principal residence). Rollover Allowed? Yes Yes Yes Yes Yes Yes Yes Penalty for Excess 6% excise tax for both self-employed individuals and employees if excess contribution (plus earnings) is not withdrawn by return due date Employers are subject to a 10% excise tax on nondeductible (excess) Employee’s elective deferral: No penalty or tax if 2019 excess is withdrawn by April 15, 2020 Contributions?5 (including extensions). Employers are subject to a 10% excise tax on nondeductible (excess) contributions, unless an exception applies. contributions, unless an exception applies. (but allocable earnings are taxable in year withdrawn). If not withdrawn by April 15, 2020, excess is taxed twice—once in the year of excess contribution and again when distributed because no cost basis is allowed for excess contribution. Employer’s contribution: 10% penalty on excess contributions (resulting from plan failing average deferral percentage test) unless distributed (with earnings) to highly compensated employee(s) within 21/2 months after the close of the plan year (taxable to employee in year of deferral). Failure to distribute excess within 12 months after close of plan year results in plan failing to qualify for that plan year and all subsequent plan years for which the excess contributions remain uncorrected. 1 A SEP is established at the employer level. For a partner, the partnership establishes and contributes to the SEP. 6 Includes self-employed ministers. 2 Plans can set less restrictive participation requirements, but not more restrictive ones. 7 Nondiscrimination rules may affect contributions/deferrals for certain employees. 3 New employers that come into existence after October 1 may establish a plan as soon as administratively possible. 8 The Tax Code does not specify when the employer is required to deposit employee elective deferrals into the employee’s account. However, under ERISA regulations, 4 Employee and self-employed elective deferrals must be deposited as soon as reasonably possible, but no later than 30 days after the end of the month in which the amounts employee elective deferrals must be contributed to the employee’s 401(k) plan account as soon as reasonably can be segregated from the employer’s general assets, but would otherwise have been payable to the employee in cash. A self-employed taxpayer’s elective deferral must be deposited by January 30 of the following year (January not later than the 15th business day of the month immediately after the month in which the contributions either were withheld or received by the employer. 30, 2020 for 2019 amounts). Disaster Relief Alert: Special rules apply for distributions and loans to victims of qualified disasters. See Taxpayer Certainty and Disaster Tax Relief Act of 2019 on Page Q-1. 5 Excess contribution penalties are cumulative each year until corrected. The penalty is reported on IRS Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans).

Advantages to Employer and Self-Employed Plans

Qualified plans, SEPs, and SIMPLEs: • Contributions are generally tax deductible by the contributor and tax deferred for the plan participant. Earnings on contributions are tax deferred until withdrawn. • Maximum contributions (including SEPs and SIMPLEs) are generally greater than IRAs. • Deductible contributions allowed after age 701/2. SEPs and SIMPLEs: • Easy to set up and maintain. • Allow plan participant to choose how funds are invested as opposed to a plan administrator through employer. • Participant is always 100% vested in the plan. SEPs: • No annual reporting requirements; easy to administer. • Do not require recurring contributions. SIMPLEs: Similar to 401(k) employee elective deferral and employer matching, without complex nondiscrimination and “top-heavy” rules. 401(k) and 403(b) plans: • Employers allowed to match employee contributions; employee is generally fully vested sooner than with other qualified plans. • Plan is managed by professionals. • Easy for employees—contributions through payroll reductions. • Certain tax-free borrowing from plan is permitted.

K-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 2019 Employer and Self-Employed Retirement Plan Chart 2019 Employer and Self-Employed Retirement Plan Chart SEP IRA SEP IRA Defined-Contribution SIMPLE IRA Defined-Benefit 401(k) 403(b) (Self-Employed) (Employee) (Profit-Sharing) Who can establish? Anyone (regardless of age) with self- Any employer. Employers with 100 or fewer employees (including self-employed Any employer. Tax-exempt religious, charitable, or employment (SE) income.1 individuals) that do not maintain another retirement plan. educational organizations. Eligible employees2 N/A. But, if contributions are made Employees at least age 21 who Employees who have earned at least $5,000 from employer Employees at least age 21 with one year of service (1,000 hours). Employees6 who work 20 or more hours per for self-employed, they must also be worked for the employer during at in any prior two years, and are reasonably expected to do so week, do not participate in another 401(k), made for eligible employees. least three of the last five years in the current year. 457 or 403(b) plan and will contribute more and received at least $600 in than $200 per year. compensation from employer in 2019. Maximum 20% of net SE income after SE 25% of wages up to maximum Employee elective deferrals limited to $13,000 (additional Actuarially determined contribution. Contributions per participant up to Employee elective deferrals limited to $19,000 Employee elective deferrals limited to Contributions tax deduction up to a maximum contribution of $56,000. $3,000 if age 50 or older at end of the year). Maximum benefit payout limited to lesser of 100% of compensation (additional $6,000 if age 50 or older at end of $19,000 (additional $6,000 if age 50 or older Allowed contribution of $56,000. SARSEPs established before 1997 The employer can either: 100% of average compensation or $56,000. Employer deduction the year). Employer deduction limited to 25% at end of the year). Special formula applies SARSEPs established before 1997 follow 401(k) contribution limit rules. 1) Match employee elective deferrals dollar for dollar up for the three consecutive years limited to 25% of aggregate of combined wages of all employees (elective to additional employer contributions based follow 401(k) contribution limit rules. to 3% of wages (can be reduced to as low as 1% in of highest compensation (limited compensation (limited to $280,000 deferrals do not reduce wages for the 25% limit). on years of service. Combined employer any two out of five years) or to $280,000), but not to exceed per employee) for all participants Combined employer contributions and employee contributions and employee elective deferrals 7 2) Contribute 2% of wages (up to $280,000) for all $225,000. (20% of net SE income after SE tax elective deferrals per employee limited to lesser per employee limited to lesser of 100% of 7 employees (including nonparticipants). deduction for self-employed). of 100% of wages or $56,000 (additional $6,000 wages or $56,000 (additional $6,000 for for employees age 50 or older by year-end).7 employees age 50 or older by year-end).7 1 Penalties for 10% of distribution. (See Exceptions to 10% Withdrawal Penalty Before Age 10% of distribution, or 25% if withdrawn within two years 10% of distribution. (See Exceptions to 10% Withdrawal Penalty Before Age 59 /2 on Page K-5.) 1 Early Withdrawal 59 /2 on Page K-5.) from the date first participated in plan. (See Exceptions to 1 (Before Age 591/2) 10% Withdrawal Penalty Before Age 59 /2 on Page K-5.) When Withdrawals By April 1 of the year following the year the account owner turns age 701/2. For self-employed and >5% owners, by April 1 of the year following the year the account owner turns age 701/2. For all other employees, April 1 of the year following the Must Begin Note: Contributions can still be made to the account after age 701/2 if the individual has earned income. year the account owner turns age 701/2 or retires, whichever is later. Date to Establish Plan Return due date, including extensions, for the year the plan is to be effective. • Establish plan by October 1, 2019 for new plans first in December 31, to establish plan. Return due date, including extensions December 31 to establish plan. For employer contributions, return due date including and Make effect for 2019.3 for profit-sharing plan contributions. 81/2 months after year-end for extensions.8 Contributions • Make employer contributions by the return due date, defined benefit plan contributions. including extensions.4 Employer Contributions No No Yes Yes No Generally no. Required? Borrowing Permitted? No No No Yes, if plan permits. Must pay back in five years (unless used to buy a principal residence). Rollover Allowed? Yes Yes Yes Yes Yes Yes Yes Penalty for Excess 6% excise tax for both self-employed individuals and employees if excess contribution (plus earnings) is not withdrawn by return due date Employers are subject to a 10% excise tax on nondeductible (excess) Employee’s elective deferral: No penalty or tax if 2019 excess is withdrawn by April 15, 2020 Contributions?5 (including extensions). Employers are subject to a 10% excise tax on nondeductible (excess) contributions, unless an exception applies. contributions, unless an exception applies. (but allocable earnings are taxable in year withdrawn). If not withdrawn by April 15, 2020, excess is taxed twice—once in the year of excess contribution and again when distributed because no cost basis is allowed for excess contribution. Employer’s contribution: 10% penalty on excess contributions (resulting from plan failing average deferral percentage test) unless distributed (with earnings) to highly compensated employee(s) within 21/2 months after the close of the plan year (taxable to employee in year of deferral). Failure to distribute excess within 12 months after close of plan year results in plan failing to qualify for that plan year and all subsequent plan years for which the excess contributions remain uncorrected. 1 A SEP is established at the employer level. For a partner, the partnership establishes and contributes to the SEP. 6 Includes self-employed ministers. 2 Plans can set less restrictive participation requirements, but not more restrictive ones. 7 Nondiscrimination rules may affect contributions/deferrals for certain employees. 3 New employers that come into existence after October 1 may establish a plan as soon as administratively possible. 8 The Tax Code does not specify when the employer is required to deposit employee elective deferrals into the employee’s account. However, under ERISA regulations, 4 Employee and self-employed elective deferrals must be deposited as soon as reasonably possible, but no later than 30 days after the end of the month in which the amounts employee elective deferrals must be contributed to the employee’s 401(k) plan account as soon as reasonably can be segregated from the employer’s general assets, but would otherwise have been payable to the employee in cash. A self-employed taxpayer’s elective deferral must be deposited by January 30 of the following year (January not later than the 15th business day of the month immediately after the month in which the contributions either were withheld or received by the employer. 30, 2020 for 2019 amounts). Disaster Relief Alert: Special rules apply for distributions and loans to victims of qualified disasters. See Taxpayer Certainty and Disaster Tax Relief Act of 2019 on Page Q-1. 5 Excess contribution penalties are cumulative each year until corrected. The penalty is reported on IRS Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans).

Exceptions to 10% Withdrawal Penalty Before Age 591/2 Note: Distributions treated as a return of nondeductible contributions, distributions of excess contributions or deferrals and distributions of excess aggregate contributions to meet nondiscrimination requirements are not subject to the 10% penalty. Form 5329 Applies to Exception Number distributions from: 01...... Qualified plan Distribution made to an employee after separating from service in or after the year he reaches age 55 (age 50 for qualified public safety employees). 02...... Qualified plan or IRA Distribution is part of a series of substantially equal periodic payments made over the life expectancy of the participant or joint lives of participant and his beneficiary. 03...... Qualified plan or IRA Distribution made due to total and permanent disability. 04...... Qualified plan or IRA Distribution made due to death. 05...... Qualified plan or IRA Distribution to the extent the individual’s unreimbursed medical expenses exceed 7.5% of his AGI. 06...... Qualified plan Distribution made to an alternate payee pursuant to a qualified domestic relations order (QDRO). 07...... IRA Distribution to pay for health insurance premiums for certain unemployed individuals. 08...... IRA Distribution to the extent of the qualified higher education expenses for the year of the taxpayer, spouse, child or grandchild. 09...... IRA Distribution for first-time home purchases (no home ownership in prior two years). Exception limited to $10,000 (lifetime). 10...... Qualified plan or IRA Distribution due to an IRS levy on the qualified plan or IRA. The exception will not apply if funds are withdrawn to avoid a levy or to satisfy a levy on other property. 11...... Qualified plan or IRA Distribution to reservists while serving on active duty for at least 180 days. 12...... — Various other exceptions. See Form 5329 instructions and IRS Pubs. 575 and 721 for more information.

Replacement 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook K-5 2019 Medical Reimbursement Account Comparison Chart Health Savings Accounts (HSAs)1 Archer Medical Savings Health Flexible Spending Health Accounts (MSAs) Arrangements (FSAs)2, 3 Reimbursement Arrangements (HRAs)2, 4, 5, 6 IRC IRC Sec. 223 IRC Sec. 220 IRC Sec. 125 IRC Sec. 105 Description Taxpayer makes tax deductible contributions to the savings plan (or employer makes Employee chooses to Employer reimburses excludable contributions to the plan on behalf of the employee). Taxpayer can then defer a portion of salary the employee tax free withdraw funds tax free to pay for medical costs not covered by insurance. pre-tax into a savings for medical costs not plan. Employee can then covered by insurance. withdraw funds tax free to The employee does pay for medical costs not not defer any salary covered by insurance. into the plan.

Qualifications to Must be covered under a high deductible Must be covered under a high deductible Must work for an employer that offers this benefit. Not Participate health plan. Cannot be covered under any health plan. Must work for a small employer available to self-employed individuals. in Plan other non-high deductible plan.8 Cannot that offers this benefit, or be self-employed. be entitled to Medicare benefits. Cannot Cannot be covered under any other non- be claimed as a dependent on another high deductible plan. Cannot be entitled to person’s tax return. Medicare benefits. Cannot be claimed as a dependent on another person’s tax return.

Contribution Individual = $ 3,500 Maximum annual contribution limit is 65% Salary reduction The employee makes Limits Family = $ 7,000 of the annual deductible for individuals and contributions are limited no contributions Additional contribution limit— 75% of the annual deductible for families. to $2,700 for tax years to the plan. The age 55 or older = $ 1,000 Contributions are further limited to net SE beginning in 2019 employer payment/ earnings or compensation of employee (Rev. Proc. 2018-57). reimbursement of No income requirement to make from the business establishing the high qualified medical deductible contributions. deductible health plan. expenses is limited to $5,150 per eligible employee ($10,450 for family coverage). Health Plan Individual = $ 1,350 Individual = $ 2,350 No annual deductible required. Minimum Annual Family = $ 2,700 Family = $ 4,650 Deductible Health Plan Individual = $ 6,750 Individual = $ 3,500 No annual deductible required. Maximum Annual Family = $ 13,500 Family = $ 7,000 Deductible/Out-of- Maximum annual limit on total out-of- Maximum out-of-pocket expense limitation Pocket pocket expenses other than premiums. (other than premiums) is $4,650 for Maximum limit does not apply to out-of- individuals and $8,550 for families. network services.

Can Unused Yes Yes Generally no; however, a Yes Amounts at End plan can permit either a of Year Be Carried 21/2 month post-year end Forward? grace period or up to $500 carryover.7

Can Accumulated Yes Yes. However, new contributions to plan are No No Funds Be Utilized not allowed if new employer does not offer After Employee an MSA to employees. Changes Jobs?

Distributions Included in gross income and subject to Included in gross income and subject to Distributions are not Included in gross Not Used for a 20% penalty. Exceptions to the penalty a 20% penalty. Exceptions to the penalty allowed unless receipts income as taxable Medical Purposes include distributions after beneficiary’s include distributions after beneficiary’s for qualified medical wages. No penalty death, disability or attainment of age 65. death, disability or attainment of age 65. expenses are submitted to applies. the plan administrator for reimbursement. 1 Notice 2008-59 provides additional guidance on health savings accounts. A nonexclusive list of circumstances in which an employer may request the return of contributed amounts due to an employer’s or trustee’s administrative or processing errors is provided by the IRS in INFO 2018-0033. 2 Reimbursements for medicine or drugs are limited to prescribed drugs or insulin. See Over-the-Counter Drugs on Page K-12. 3 FSAs that are not excepted benefits and do not meet the Affordable Care Act market reform provisions may be subject to penalties under IRC Sec. 4980D. See Notice 2013-54. 4 Notice 2002-45. 5 Qualified Small Employer Health Reimbursement Arrangements (QSEHRAs) on Page K-10 are not subject to Section 4980D penalties. 6 See Employer Reporting for Health Insurance on Page K-12 for employer reporting requirements. 7 Qualified reservist distributions to military reservists called to active duty may be made after an FSA’s cut-off date. See IRC Sec. 125(h) and Notice 2008-82. 8 Services administered by the Secretary of Veterans Affairs for a service-connected disability are not disqualifying.

K-6 2019 Tax Year | Small Business Quickfinder ® Handbook Determining the car’s FMV. If the employer bought the car in an not provide or pay for fuel, the cents-per-mile rate can be reduced arm’s-length transaction, its cost (including applicable sales tax, by up to 5.5¢ per mile. title fee, and other transaction costs) can be used as FMV. Requirements for Cents-per-Mile Method If the employer leases the auto, the manufacturer’s suggested retail price (including applicable sales tax, title fees, and other Requirement Description transaction costs) less 8% can be used as the safe-harbor Period of Use The employer must expect that the car will be used FMV figure. Or, a leased auto’s FMV can be regularly for business for the entire year (or, if less, the time the employer owns the car) OR determined by reference to the retail value of OR the auto as reported by a nationally recognized Required Mileage The car must be driven (primarily by employees) pricing source. Finally, for leased autos, the at least 10,000 miles (pro-rated if not owned the entire year) during the calendar year. employer can use the manufacturer’s invoice The car’s FMV must be less than $50,400 (2019 price (including applicable options) plus 4% Cap on FMV amounts per Notice 2019-34). as the auto’s FMV (Notice 89-110). In general, the employer must adopt the cents-per-mile method for Commuting Value Method an auto by the first day an employee uses it for personal purposes. In rather limited circumstances, an employee’s personal use of a Once the cents-per-mile method is used for an auto, it must be used as long as that auto is eligible for it. But, if an auto later qualifies company car can be valued at $3 per round-trip to and from work for the commuting value method, that method can be used even ($1.50 per one-way commute) [Reg. 1.61-21(f)]. If multiple em- though the cents-per-mile method was used earlier. ployees commute in the same vehicle, the imputed personal use income for each is $3 per round trip/$1.50 per one-way commute. Recordkeeping Requirements Requirements for Commuting Value Method An employee may not exclude from income any portion of the Requirement Description value of an employer-provided automobile unless the use is sub- Employee required to For valid business reasons, the employee is stantiated by records. commute in the employer required to commute to work in the vehicle The records should contain (Temp. Reg. 1.274-5T): provided vehicle (for example, a job requires 24-hour on-call • Date of each use. availability). • Mileage per trip. Personal use prohibited The employer has an enforced, written policy • Business purpose of the trip. that prevents the employee (and/or anyone • Description of destination, business purpose, benefit derived, whose use would be taxable to the employee, etc. (for travel outside tax home area). such as a spouse) from using the car for personal reasons other than commuting to and • Total mileage for the year. from work.1 Records must be kept at or near the time of the use. If there are no No personal use occurs The employee does not actually use the car for written records, the employee may provide a statement containing personal use other than commuting.1 information related to the automobile’s use or may provide other Employee is not a control A control employee is: corroborative evidence sufficient to establish use. However, without employee • Officer with compensation ≥ $110,000 (for written records, the IRS may disallow the exclusion from income. 2019);2 • Director; • Employee with compensation ≥ $225,000 (for Reporting Employee Personal Use on 2019) or2 Business Tax Return • Owner of 1% or more of the employer’s equity, When the personal use of a company car is included in an em- capital or profits. ployee’s wages as taxable compensation, the employer recovers 1 De minimis personal use (such as a trip to the grocery store on the way home the cost of the car as if it were used entirely for business purposes. from work) is allowed. Section A in Part V of Form 4562 on the employer’s tax return 2 Notice 2018-83. would then show business-use percentage as 100%.

Safety Requirement for Commuting The TCJA specifically allows the employer to take Qualified Retirement Plans an income tax deduction for expenses incurred or A qualified retirement plan is one of the best tax-saving tools avail- paid for providing transportation, or any payment able, since the plan contributions are deductible by the employer or reimbursement, to an employee for travel be- and tax deferred to the employee. The rules governing retirement tween the employee’s residence and place of em- plans are lengthy and complex. Some of the general rules are ployment when necessary for ensuring the safety of covered below. For more coverage see the IRA and Retirement the employee [IRC Sec. 274(l)(1)]. Other expenses for such travel Plan Quickfinder® Handbook. are specifically disallowed. At the time of this publication, the IRS  Disaster Relief Alert: Special rules apply for distributions and had not provided guidance on how to determine what expenses loans to victims of qualified disasters. See Taxpayer Certainty and are considered necessary to ensure the safety of an employee. Disaster Tax Relief Act of 2019 on Page Q-1. Practitioners should be alert for additional information. Qualified retirement plans fall into two basic categories: • Defined-contribution plans. Cents-per-Mile Method • Defined-benefit plans. Sometimes, the standard business mileage rate 1) Defined-contribution plans provide benefits based on the (58¢ for 2019) can be used to value an employee’s amount contributed to an employee’s individual account plus personal use of a company car [Reg. 1.61-21(e); Rev. any income, expenses, gains, losses, and forfeitures of other Proc. 2010-51; Notice 2019-2]. If the employer does employees that are allocated to the account [IRC Sec. 414(i)].

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® Replacement 1/2020 2019 Tax Year | Small Business Quickfinder Handbook K-17 Plan contributions are determined by formula and not by actu- Elective Deferrals Not Taken Into Account arial requirements (except for target benefit plans). for Purpose of Deduction Limits Defined-contribution plans include: The definition of compensation is not reduced by • Profit-sharing plans. certain employee elective deferral amounts, and • Target benefit plans. the employee elective contributions are not taken • Stock bonus plans. into account when calculating the employer’s annual • Employee stock ownership plans (ESOPs). deduction limitation. This rule applies to employee • Thrift or savings plans. salary reduction contributions to: • 401(k) plans. 1) 401(k) plans, 2) Defined-benefit plan. Any qualified retirement plan that is not 2) SARSEPs, considered a defined-contribution plan [IRC Sec. 414(j)]. Under 3) 403(b) plans (plans of exempt organizations and public a defined-benefit plan, the annual retirement benefits must be schools), and definitely determinable using a formula contained in the plan. 4) SIMPLEs. Forfeitures under a defined-benefit plan cannot be used to This rule applies to the 25% of compensation limit on employer increase the benefits any employee would otherwise receive deductions under [IRC Sec. 404(n)]: under the plan. Benefits under a defined benefit plan are fixed 1) IRC Sec. 404(a)(3) for contributions to stock bonus and profit- under a definite formula. Typically, the formula expresses the sharing trusts, benefits in one of the following ways: 2) IRC Sec. 404(a)(7) for combinations of defined-benefit and a) Fixed benefit plan. A certain percentage of an employee’s defined-contribution plans, compensation averaged over the employee’s entire career 3) IRC Sec. 404(a)(9) for ESOPs where the contributions are used or a limited number of years. to repay loan principal incurred to acquire employer securities, b) Flat benefit plan. A specified or flat dollar monthly payment. and c) Unit credit plan. A certain unit percentage of compensation 4) IRC Sec. 404(h)(1)(C) for SEP contributions. or dollar amount for each year of service with the employer. The amount of the employer contributions to a defined benefit plan is determined annually by an actuary. Tax Advantages of Qualified Retirement Plans • Employers receive an immediate tax deduction. Annual Limitations to Qualified Plans • Income earned within the plan fund is tax deferred. Defined-contribution plan. The annual addition to any partici- • Employees incur no tax liability until amounts are distributed. pant’s account is the sum of the following: (1) employer contribu- • Qualified distributions can be rolled over tax free. tions, plus (2) employee contributions, plus (3) forfeitures. • If qualifying distributions are made in the form of stock of the IRC Sec. 415(c)(1) limits contributions and other additions to a par- employer corporation, tax on the appreciation in the value of the ticipant’s account to the lesser of $56,000 for 2019 or 100% of the stock is deferred until the stock is sold. participant’s compensation. In addition, IRC Sec. 404(a)(3) limits the deduction for contributions to stock bonus and profit-sharing plans to the greater of 25% of compensation paid to all beneficia- Profit-Sharing Plans ries under the plan or the amount the employer is A profit-sharing plan is a defined-contribution plan to which the required to contribute if it is a SIMPLE plan. company agrees to make substantial and recurring, though gen- erally discretionary, contributions. Contributions are invested and If a defined-contribution plan is combined with a accumulate tax deferred for eventual distribution to participants or defined-benefit plan, IRC Sec. 404(a)(7) limits their beneficiaries either at retirement, after a fixed number of years the total deductible amount to the greater of or upon the occurrence of some specified event (that is, disability, 25% of compensation paid to all beneficiaries death, or termination of employment). under the plan or the amount contributed to the Contributions to a profit-sharing plan are usually linked to the exis- defined-benefit plan needed to satisfy minimum funding standards tence of profits. However, neither current nor accumulated profits of IRC Sec. 412. Additional limits apply to employee elective defer- are required for a company to contribute. Even if the company has rals under 401(k) and 403(b) plans (see the 2019 Employer and profits, it can generally forego or limit its contribution for a particular Self-Employed Retirement Plan Chart on Page K-4). year if the plan contains a discretionary formula. Defined-benefit plan. Annual limitations apply to the payment of benefits with respect to an employee. Under IRC Sec. 415(b), the annual retirement benefit is limited to the lesser of: Section 401(k) Plans What distinguishes the 401(k) plan from other qualified defined- 1) $225,000 for 2019 or contribution plans is its employee salary deferral feature. Employ- 2) 100% of the employee’s average compensation for the highest ers are not required to make matching contributions to the plan, three years. although many plans are set up where there is a combination of Since a defined-benefit plan provides a predetermined annual employee salary deferrals and discretionary employer contribu- retirement benefit, the deduction limitation for contributions to the tions. When the employer makes contributions to the plan, they plan under IRC Sec. 404(a)(1)(A) is the amount necessary to fund can either be in the form of a match of employee salary deferrals, or based on a percentage of employee compensation. Thus, when such benefits that are provided to the beneficiaries of the plan. the employer makes discretionary contributions to a 401(k) plan, Minimum funding standards under IRC Sec. 412 are designed to it is actually a profit-sharing plan. prevent employers from coming up short when the time comes to pay out benefits. For example, a self-employed individual with Contributions to the plan are excluded from gross income for fed- net earnings above $225,000 for at least three years could set up eral income tax, but must be included in the FICA taxable wage a defined-benefit plan and deduct contributions (for 2019) in the base as well as in the FUTA taxable wage base. amount necessary to fund the plan so that it will provide an annual See the 2019 Employer and Self-Employed Retirement Plan Chart retirement benefit of $225,000. on Page K-4 for 401(k) contribution limits.

K-18 2019 Tax Year | Small Business Quickfinder ® Handbook Example: In 2019, Nell’s share of partnership profits (box 1, Part III of Schedule Other Employer Retirement Plans K-1, Form 1065) equals $15,000, which is reported on Schedule E and line  Disaster Relief Alert: Special rules apply for distributions and 2 of Schedule SE, Form 1040. Nell contributes $10,000 to a SIMPLE as an loans to victims of qualified disasters. See Taxpayer Certainty and employee deferral. Compensation for purposes of the employer’s match is Disaster Tax Relief Act of 2019 on Page Q-1. $13,853 ($15,000 × .9235, line 4 of Schedule SE). The employer’s 3% match equals $416 ($15,000 × .9235 × 3%). Nell’s Schedule K-1 reports $10,416 in SIMPLEs box 13, Code R as total contributions to her SIMPLE. Nell deducts $10,416 Savings incentive match plans for employees. Qualified em- on Schedule 1, Form 1040. A similar calculation is made for Schedules C ployers (including self-employed individuals) may establish Sec- and F filers. tion 408(p) SIMPLE retirement plans. A SIMPLE is a written salary reduction arrangement that allows eligible employees to defer Distributions are taxed like IRAs (except the 10% early withdrawal compensation tax free and employers to make either matching penalty is increased to 25% if made within first two years of par- contributions for employees who elect to participate, or nonelec- ticipation) [IRC Sec. 72(t)(6)]. tive contributions for all eligible employees (including those who  Disaster Relief Alert: Generally, Section 72(t) will not apply do not elect to participate). to qualified distributions and certain loans from qualified plans to SIMPLEs do not fall under the complicated 401(k)-type rules victims of qualified disasters. See Taxpayer Certainty and Disaster that require a certain level of employee participation. A SIMPLE Tax Relief Act of 2019 on Page Q-1. can operate as an IRA with an individual account set up for each Other requirements (Notice 98-4): employee (SIMPLE IRA) or in a 401(k) format with contributions 1) The employer and employee contributions must be 100% made to a trust or annuity contract [SIMPLE 401(k)]. Both types of vested at all times. plans have many common requirements (differences are noted): 2) The employer (or self-employed person) must deposit em- Qualified employers/employees: ployee (or his own) elective deferrals as soon as reasonably 1) The employer must have 100 or fewer employees who earned possible, but no later than 30 days after the end of the month $5,000 or more during the preceding calendar year, during which the contributions were withheld from wages. 2) The employer cannot currently maintain another qualified plan 3) The employer contribution must be made by the due date of (except for certain union employees), the employer’s income tax return, including extensions. 3) Employees must receive at least $5,000 in compensation from the employer during any two preceding years (not necessar- ily the immediately preceding two years), and be reasonably Simplified Employee Pensions (SEPs) See the 2019 Employer and Self-Employed Retirement Plan Chart expected to receive at least $5,000 in the current year, and on Page K-4. 4) Eligible employees may participate in another employer’s qualified plan, but are subject to the combined elective defer- ral limitations of $19,000 for 2019—Notice 2018-83) for all Deemed (Payroll Deduction) IRAs Employers can set up separate accounts or annuities (payroll plans. An employee who is age 50 or older can contribute an deduction IRAs) for employees [IRC Sec. 408(q)]. These are additional $6,000 for a total of $25,000 for 2019). treated as IRAs (deemed IRAs) rather than part of a qualified plan. Contributions: Employees may make voluntary contributions via payroll deduction 1) Employer contributions must either: into traditional or Roth IRA accounts. Employee contributions are • Match employee contributions dollar for dollar up to 3% of included in the employee’s income, but the employee may deduct employee compensation, such amounts under the rules that normally apply to traditional IRA • Match employee contributions up to a reduced percentage deductions (Roth IRA contributions are nondeductible). Employees of employee compensation, not less than 1% of compensa- may adjust their federal income tax withholding (via their Form W-4) tion and not for more than two out of any five years [this for deductible contributions to traditional IRAs in order to receive employer election is not available for SIMPLE 401(k) plans] a more immediate tax benefit from their contributions. or • Be nonelective contributions equal to 2% of compensation for all eligible employees. Form 5500 2) Employee elective deferrals cannot exceed the lesser of The Form 5500 series of returns is used by qualified plans to re- $13,000 for 2019 ($16,000 if age 50 or over―$13,000 plus port information concerning the plan to the IRS and Department $3,000 catch-up limit) or total compensation for the year. of Labor (DOL). Simplified forms in the 5500 series are filed for 3) Compensation limit for qualified plans ($280,000 for 2019) one-participant, certain foreign and fewer-than-100 participant does not apply to the 3% matching contributions to SIMPLE plans. See Form 5500 Reporting Requirements on Page K-20 for IRAs. The compensation limit does apply to the 2% nonelective a summary of which plans are eligible to file which forms. Informa- contributions, and to any matching contributions to SIMPLE tion on Form 5500 filing requirements is available at www.efast. 401(k) plans. dol.gov. The “Form 5500 Version Selection Tool,” accessible by 4) Employer contributions are excluded from employee wages searching “5500 Selection Instructions” at www.dol.gov, can be for both income and employment tax purposes (FICA and used to determine which version to use when filing or amending FUTA). Contributions made by employees and self-employed prior years’ 5500 series forms. individuals are subject to employment taxes (SE, FICA, and Due date. Form 5500, 5500-SF, or 5500-EZ is normally due by FUTA). (Notice 98-4, Q&A I-1) the last day of the seventh month after the plan year ends (for a 5) A self-employed individual’s compensation for purposes of calendar year plan, July 31 of the following year). A 21/2 month employee deferrals and employer matching is defined as the filing extension may be obtained by filing Form 5558 (Application amount entered on line 4, Section A or line 6, Section B of for Extension of Time To File Certain Employee Plan Returns) on Schedule SE (Form 1040), before subtracting any contribu- or before the normal return due date. If the employer maintains tions made to a SIMPLE IRA on behalf of the self-employed more than one plan, a separate Form 5558 must be filed for each individual. plan requesting an extension.

® Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder Handbook K-19 Form 5500 Reporting Requirements

Plan Form to File Comments

Small plan with following characteristics: Form 5500-SF (Short Form Must be filed online using EFAST2’s web-based • Fewer than 100 participants at the beginning of the plan year. Annual Return/Report of filing system or through an EFAST2-approved • Meets the conditions for being exempt from the requirements that the plan’s books Small Employee Benefit Plan) vendor. and records be audited by an independent qualified public accountant. • Has 100% of its assets invested in certain secure investments with a readily determinable fair value. • Holds no employer securities. • Not a multiemployer plan.

One-participant plan with more than $250,000 in assets and either of the following is Form 5500-EZ [Annual A one-participant or foreign plan required to true: Return of A One-Participant file an annual return must file either a paper • The plan covers only the owner (or owner and spouse) and the owner (or owner (Owners/Partners and Their Form 5500-EZ with the IRS or, if eligible, Form and spouse) own the entire business (whether incorporated or unincorporated). Spouses) Retirement Plan or 5500-SF electronically. (Form 5500-EZ is the • The plan covers only one or more partners [or partner(s) and spouse(s)] in a A Foreign Plan] only version of Form 5500 that can be filed with business partnership. the IRS in paper form; a copy of this form is available on the IRS website. Forms 5500 and Certain foreign pension plans maintained outside the U.S. primarily for nonresident 5500-SF are not available on the IRS website; aliens—see Form 5500-EZ instructions. however, they are available at www.efast.dol. gov and must be filed electronically per the instructions on that website.)

One-participant plan (defined above) with $250,000 or less of assets at the end of the None Form 5500-EZ must be filed by all one- plan year. participant plans for a final plan year, regardless of plan assets. The final plan year is the year in which distribution of all plan assets is completed.

All other defined benefit and defined contribution plans (not eligible to file Form 5500- Form 5500 (Annual Return/ Must be filed online using EFAST2’s web-based SF or 5500-EZ). Report of Employee Benefit filing system or through an EFAST2-approved Plan) vendor.

Notes

— End of Tab K —

K-20 2019 Tax Year | Small Business Quickfinder ® Handbook Accounting Methods and Principles  See IRS Pub. 538 but it is not deposited until January of 2020. Constructive receipt Tab L Topics occurs and income is recognized in 2019. Accounting Methods...... Page L-1 Cash method expenses generally are de- Tax Year...... Page L-5 ductible when actually paid. However, special Inventories...... Page L-7 rules apply to prepaid expenses. See Prepaid Expenses on Page L-4. Uniform Capitalization Rules...... Page L-8 Accrual method income is reported when (1) all events have oc- Bookkeeping Basics...... Page L-10 curred that fix the right to receive the income and (2) the amount Double-Entry Bookkeeping...... Page L-11 can be determined with reasonable accuracy [Reg. 1.451-1(a)]. Balance Sheet...... Page L-14 The first part of this test (the right to the income is fixed) is met on Accounting Terms...... Page L-15 the earliest of (1) the date the required performance occurs, (2) the date payment is due, or (3) the date payment is made (Rev. Rul. 84-31). Following enactment of the Tax Cuts and Jobs Act (TCJA), for Accounting Methods tax years beginning after 2017 the all events test for recognizing An accounting method determines timing of income and expenses. income is met no later than when the income is recognized on the An accounting method must clearly reflect income. taxpayer’s (1) applicable financial statement (AFS), as defined in IRC Sec. 451(b)(3) or (2) other financial statement as specified by Consistency rule. IRC Sec. 446(a) states that for tax purposes, income must be computed under the same method used for books. the IRS (the AFS conformity rule) [IRC Sec. 451(b)(1)(A)]. However, because of conflicts between tax and financial accounting  Note: If a taxpayer’s financial results are reported on an AFS rules, such as differences between generally accepted account- for a group of entities, the AFS for that group is the AFS for the ing principles (GAAP) and tax treatment of certain items, the IRS taxpayer [IRC Sec. 451(b)(5)]. Also, if the taxpayer has a contract generally considers the consistency rule met if the taxpayer’s that contains multiple performance obligations, the allocation of books can be readily reconciled with the tax return. For example, the transaction price to each obligation is equal to the amount a taxpayer using an accrual method for internal books was allowed allocated to that obligation for including it in revenue in the AFS to use the cash method for tax purposes (Rev. Rul. 68-35). [IRC Sec. 451(b)(4)]. A taxpayer must apply the same accounting method to all transac- æ Practice Tip: The AFS conformity rule does not: tions within a particular trade or business. If a taxpayer owns more • Require income recognition if tax realization hasn’t occurred [for than one trade or business, a different accounting method may example, a taxpayer is not required to recharacterize a sale as be used for each. The businesses must be separate and distinct, a lease (or vice versa) to conform to its AFS]. including separate books, and the combination of methods must • Prevent taxpayers from using special methods of accounting, clearly reflect income. such as the installment method or long-term contract methods [IRC Sec. 451(b)(2)]. Choosing an Accounting Method • Apply to taxpayers without an AFS or other financial statement A taxpayer chooses a tax accounting method by using the par- specified by the IRS [IRC Sec. 451(b)(1)(B)(i)]. ticular method on its first tax return and checking the appropriate • Apply to income in connection with a mortgage servicing contract box on the return. The method actually used to compute taxable [IRC Sec. 451(b)(1)(B)(ii)] (taxpayers will continue to use pre- income the first year appears to control even if different from the TCJA law, which recognizes income upon the earlier of when it method indicated by checking the box. Any subsequent change in is earned or received). accounting method generally requires IRS consent. Under certain • Prevent revenue from being recognized for tax purposes before circumstances, automatic consent for change of accounting meth- it is reported on an AFS. od is available. See Change in Accounting Method on Page L-4. • Require accrued market discount under IRC Sec. 1276 to be The cash method is the simplest, and is used by most small busi- included in income (Notice 2018-80). nesses. However, not all taxpayers are allowed to use the cash Accrual method expenses are reported in the period to which method. See Limitations on Use of Cash Method on Page L-2. they apply, without regard for when the expenses are paid. The accrual method measures earnings more accurately than the Expenses are deducted or capitalized when (1) the taxpayer be- cash method since it records income and expenses in the period comes liable for the expense, (2) the amount can be determined to which they apply, instead of simply reflecting cash flow. with reasonable accuracy, and (3) economic performance occurs The choice of accounting methods is not limited to accrual or [Reg. 1.461-1(a)(2)]. cash. Special methods, including combinations of methods, may Economic performance occurs at the time property or service is be allowed or required under various provisions of the Tax Code. provided or used. For example, a calendar-year taxpayer takes For a comparison of the accrual and cash methods, see the Cash delivery of supplies in December 2019, but does not make payment and Accrual Accounting Methods—Treating Commonly Encoun- until January 2020. Under the accrual method, since the taxpayer tered Items on Page A-6. became liable and economic performance (delivery) occurred in Cash method income is reported when constructively received. 2019, the expense is reported in 2019. Constructive receipt occurs when money or property is available A taxpayer using the accrual method of accounting incurs a liability for use by the taxpayer without any restrictions. For example, a for services or insurance at the earlier of (1) the occurrence of the check is received by a cash basis taxpayer on December 31, 2019 event fixing liability or (2) the payment due date (Rev. Rul. 2007-3).

2019 Tax Year | Small Business Quickfinder ® Handbook L-1 An accrual-basis taxpayer can take a deduction (or add a cost to Other excepted businesses. Both farming businesses and quali- its basis in property) in the year of payment if it reasonably expects fied PSCs are eligible to use the cash method without having to the property or services to be provided within 31/2 months of pay- satisfy the $25 million ($26 million for 2019) gross receipts test. ment [Reg. 1.461-4(d)(6)(ii)]. 1) Farming businesses (including the operation of a nursery or sod Economic performance typically occurs as services or property farm and the raising, harvesting, or growing of trees bearing are provided to, or ratably as property is used by, the taxpayer fruits, nuts, or other crops, or ornamental trees). An evergreen unless the recurring item exception applies. Accrual method tax- tree more than six years old at the time severed from the roots payers are required to recognize lease liabilities ratably over the shall not be treated as an ornamental tree [IRC Sec. 448(d) lease period unless the liability was immaterial or early expense (1)]. recognition results in a better matching of expenses and income 2) Qualified PSCs in which substantially all of the activities in- (Rev. Rul. 2012-1). volve the performance of services in the fields of health, law, Effective for tax years ending on or after July 30, 2015, the IRS has engineering, architecture, accounting, actuarial issued guidance for accrual method taxpayers to treat economic science, performing arts or consulting, and performance as occurring ratably on contracts that provide services substantially all of the stock of which (by on a regular basis. Under this safe harbor, a taxpayer can ratably value) is held by employees, retired employ- expense the cost of regular and routine services as provided. ees or their estates [IRC Sec. 448(d)(2)]. The guidance defines a Ratable Service Contract and provides Tax shelters, including partnerships and other enti- examples of what will and will not satisfy the definition. Examples ties (but not C corporations) where more than 35% of of services that may qualify include contracts for regular janitorial losses are allocated to limited partners or limited entrepreneurs and landscape maintenance. Contracts that provide for a single {persons who have an interest in an enterprise other than as a deliverable (for example, an environmental impact study) will not limited partner and do not actively participate in management [IRC qualify (Rev. Proc. 2015-39). Sec. 461(k)(4)]}, are prohibited from using the cash method [IRC Hybrid method. Here, two or more accounting Secs. 448(d)(3), 461(i)(3), and 1256(e)(3)]. methods are combined. The most common hybrid Gross receipts includes all receipts recognized under the method is used by taxpayers with inventory, account- method of accounting used by the taxpayer for that tax year ing for purchases and sales of inventory using the [Temp. Reg. 1.448-1T(f)(2)(iv)]. It includes sales (net of returns accrual method, and accounting for service income and allowances), credit card payments and amounts received and related expenses using the cash method. The from services, bartering, interest, dividends, rents, royalties, and combination of methods must clearly reflect income and annuities. Failure to include payments reported on Form 1099-K be consistently used. For example, if the accrual method is used (Payment Card and Third Party Network Transactions) could raise to report income, it must also be used to report related expenses. questions with the IRS. If a combination of methods includes the cash method, the ac- Automatic accounting method change. Taxpayers (other than counting method is treated as the cash method for purposes of tax shelters) that meet the $25 million ($26 million for 2019) gross limitations on use of the cash method. receipts test (small business taxpayers) and wish to make any of the following accounting method changes must use the automatic Limitations on Use of Cash Method change procedures in Rev. Procs. 2015-13 and 2018-31 (or any Pre-2018. Before enactment of the Tax Cuts and Jobs Act (TCJA), successors such as Rev. Proc. 2019-43): (1) from the overall the cash method was available to (1) taxpayers with average accrual method to the overall cash method; (2) from capitalizing annual gross receipts of $1 million or less; (2) certain farming C costs under IRC Sec. 263A to no longer capitalizing such costs; (3) corporations and partnerships with C corporation partners with from a Section 471 method of accounting for inventory items to (a) annual gross receipts for each prior year of $1 million or less; (3) treating inventory as non-incidental materials and supplies or (b) C corporations and partnerships with C corporation partners, but conforming to the taxpayer’s method of accounting reflected in its not certain farming C corporations or partnerships, with $5 million applicable financial statements or books and records; and (4) for or less in average annual gross receipts; (4) individuals, S corpo- (a) exempt long-term construction contracts, from the percentage- rations and individually owned partnerships engaged in service of-completion method to an exempt contract method or (b) home activities when average annual gross receipts were $10 million or construction contracts, from capitalizing costs under IRC Sec. 263A less; (5) certain family farm corporations with annual gross receipts to not capitalizing such costs. In addition, the IRS has waived the for each prior year of $25 million or less; and (6) qualified personal five-year restriction on eligibility for making automatic changes for service corporations (PSCs). a taxpayer’s first, second or third year beginning after 2017 (Rev. Proc. 2018-40). Post-2017. For tax years beginning in 2018, the TCJA significantly expanded the availability of the cash method by replacing more limited exceptions to the accrual method available under prior law Accounting Methods for Inventory with a $25 million gross receipts test [IRC Sec. 448(c)(1)]. The $25 Also see Inventories on Page L-7. million ($26 million for 2019) gross receipts test applies regardless Under the general rule, taxpayers are required to use the ac- of whether the purchase, production, or sale of merchandise is an crual method for purchases and sales of inventory, even if ending income-producing factor. inventory is always zero [Reg. 1.446-1(c)(2)(i)]. A taxpayer with Gross receipts test. A corporation or partnership satisfies the $25 inventory may use the overall accrual method or a hybrid method million ($26 million for 2019) gross receipts test for any tax year the using accrual for purchases and sales of inventory, and cash for taxpayer seeks to use the cash method if average annual gross other income and expenses. receipts for the three-year period preceding the current tax year Beginning in 2018, taxpayers that meet the $25 million ($26 million does not exceed $25 million ($26 million for 2019). Taxpayers are for 2019) gross receipts test may use an accounting method for no longer required to have satisfied the three-year average test inventories that either treats inventories as non-incidental materials for all prior years as was necessary under prior law. and supplies or conforms to the taxpayer’s financial accounting treatment of inventories [IRC Sec. 471(c)].

L-2 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Purchases and sales of materials that do Materials and supplies. Example: Fred gives dance lessons and receives in 2019 an advance payment not fall under the category of inventory may be accounted for under for a two-year contract for 96 lessons. He provides eight lessons in 2019, 48 the cash method. However, a cash basis taxpayer may not deduct in 2020, and 40 in 2021. In his accounting records, he recognizes 1⁄12 of the the cost of nonincidental materials until they are actually used or payment in 2019, 6⁄12 in 2020, and 5⁄12 in 2021. For tax purposes, under IRC consumed, or until the taxpayer pays for the items, whichever is Sec. 451(c), Fred must include 1⁄12 of the payment in gross income in 2019 later. See Costs to Acquire Tangible Property on Page J-8 and and the remaining 11⁄12 of the payment in 2020. Materials and supplies on Page O-3 for more information. The IRS has modified and clarified the advance payment rules Other Accrual Method Matters for certain gift cards (Rev. Proc. 2011-18, as modified by Rev. Nonaccrual experience (NAE) method permits accrual method Proc. 2013-29). taxpayers to not accrue income that, based on their experience, Service warranty contracts. Taxpayers selling multi-year service they do not expect to collect [Reg. 1.448-2(a)]. warranty contracts in connection with the sale of motor vehicles A taxpayer may compute its uncollectible amount by multiplying the or other durable consumer goods that, in turn, immediately pay a portion of the year-end allowance for doubtful accounts attributable third party to insure their risks under the contracts are allowed to to current year NAE-eligible accounts receivable on its applicable use a special method of accounting for the advance payments. financial statement by 95% (Rev. Proc. 2011-46). Under the service warranty income method, income is recognized Bonuses to a group of eligible employees are deductible for an over the life of the warranty obligation (Rev. Proc. 97-38). accrual method taxpayer who becomes obligated to pay a fixed Loyalty discounts. The liability associated with supermarket fuel amount of bonuses at the end of the year in which services were rewards discounts unclaimed at year end was deductible under rendered, even though the employer does not know the identity of the all events test (see Choosing an Accounting Method on Page recipients or the amount of bonus payable to each until after the L-1) since there was both an absolute liability and near certainty end of the tax year (Rev. Rul. 2011-29). However, if an employee the liability would soon be discharged [Giant Eagle, Inc., 117 AFTR leaves the company after year end but before bonuses are paid, 2d 2016-1476 (3rd Cir. 2016), nonacq., AOD 2016-03]. and the bonus reverts back to the company (instead of being real- located to other employees), the deduction is allowed only in the year paid (CCA 201246029). Related Parties—Accrual vs. Cash Basis Advance payments for certain services to be performed or goods An accrual basis taxpayer cannot deduct an expense payable to a to be provided in a later tax year must be included in gross income cash basis related party until the amount is includable in income of by an accrual method taxpayer in the year of receipt unless the the recipient [IRC Sec. 267(a)(2)]. Once the expense is accrued, taxpayer elects to defer recognition to the following tax year. How- the rule still applies even if the parties cease to be related before ever, the one-year deferral is not available for any portion of the the amount is includable in the income of the recipient. See also advance payment that must be recognized in the year received Related-Party Transactions on Page O-18. under the AFS conformity rule discussed at Accrual method income on Page L-1. The remaining portion of the advance payment is Installment Sales included in gross income in the tax year following the tax year of An installment sale occurs when property is sold and at least one receipt. This one-year deferral method can be used even if the payment is to be received after the end of the tax year [IRC Sec. agreement term extends beyond the end of the following tax year. 453(b)(1)]. Under the installment method, income is reported as If the deferral election is made, it is an accounting method that payments are received, and gain is recognized based on the gross applies to the current and all future years unless the taxpayer gets profit percentage from the original sale. Use of the installment IRS permission to change it [IRC Sec. 451(c)]. method is generally required unless the taxpayer elects out. A Generally, an advance payment is a payment for goods, services taxpayer who reports the entire gain in the year of sale on a timely or other such items identified by the IRS if including the payment filed return (including extensions) has elected out. in the year of receipt is a permissible accounting method for tax See Installment Sales on Page N-18 for using the installment sale and, if the taxpayer has an AFS, is included in income in that AFS in a later year [IRC Sec. 451(c)(4)(A)]. method when selling a business. Advance payments do not include [IRC Sec. 451(c)(4)(B)]: 1) Rent. Long-Term Contracts 2) Life insurance premiums. A long-term contract is a contract for building, installing, construc- tion, or manufacturing that will not be completed within the tax year 3) Payments with respect to financial instruments. entered into. Long-term contracts generally must be accounted for 4) Payments with respect to warranty or guarantee using the percentage-of-completion method (PCM) (IRC Sec. 460). contracts under which a third party is the primary obligor. PCM. The taxpayer reports income based on the percentage of 5) Payments to certain foreign persons subject to the contract that is completed during the tax year. The percentage tax under IRC Sec. 871(a) or 881 or withholding is computed by dividing contract costs incurred by total estimated under IRC Sec. 1441 or 1442. costs. The taxpayer includes a portion of the total contract price 6) Payments in property to which IRC Sec. 83 applies. in gross income as he incurs allocable contract costs. See Reg. 1.460-5 for more details on allocating costs under this method. 7) Other payments identified by the IRS. Exemptions: The TCJA added IRC Sec. 451(c) for tax years beginning after • Home construction contract. Exempt when 2017 to codify the rules for deferring taxability of advance payments 80% or more of estimated total contract cost received in connection with services and some nonservices previ- is allocated to construction of dwelling units in ously provided by Rev. Proc. 2004-34. Recognizing that this ap- proach overrides the deferral method found in current regulations, buildings containing four or fewer dwelling units the IRS has issued final regulations that remove Reg. 1.451-5. In [IRC Sec. 460(e)]. addition, the final regulations remove references to Reg. 1.451-5  Note: Residential construction contracts may that are found in other regulations. The final regulations, which use a percentage-of-completion/capitalized cost method. See adopt without change regulations proposed in October 2018, apply Regs. 1.460-3(c) and 4(e). to tax years ending on or after July 15, 2019 (TD 9870). Continued on the next page 2019 Tax Year | Small Business Quickfinder ® Handbook L-3 • Other construction contracts. Exempt if the work will be completed consent is available. Form 3115 (Application for Change in Ac- within two years from the commencement of the contract date counting Method) is used to request a change in method. and meets the $25 million ($26 million for 2019) gross receipts User fees. If the change is not automatic, a user fee of $10,800 test for the tax year in which the contract is entered into. See applies for all requests received by the IRS after February 1, 2019 Gross receipts test on Page L-2. (Rev. Proc. 2019-1). Reduced user fees of $7,600 and $2,800 are  Note: Exempt long-term contracts may use the completed available for businesses with gross income of less than $1 million contract method—the taxpayer reports all income and expenses or $250,000 respectively. See Rev. Proc. 2019-1, Appendix A, for from the contract in the year of completion. more information about user fees (the IRS updates and issues a Look-back rules. Since the percentage-of-completion method new Rev. Proc. each year). There is no fee for filing Form 3115 if computes yearly income based on estimated costs, when the the change in accounting method is eligible for automatic consent. contract is complete, the taxpayer must look back to compare the  Note: All user fee payments must be made through www.pay. estimates with the actual final costs (Reg. 1.460-6). The purpose gov (Rev. Proc. 2019-1). of the look-back rules is to compute interest on either (1) underpay- Consent required to change accounting method. Rev. Proc. ment of tax (estimated costs exceed actual costs) or (2) overpay- 2015-13 sets forth procedures for obtaining a nonautomatic change ment of tax (actual costs exceed estimates), resulting in either an in accounting method. amount owed to the IRS or a refund due the taxpayer. Automatic consent to change accounting method. Rev. Proc. De minimis rule (look-back). If estimated costs reported in a 2015-13 also sets forth procedures for obtaining automatic consent look-back year are within 10% of actual costs (both on a cumula- for a change in accounting method. Highlights of the procedure tive basis), the taxpayer can elect not to apply the look-back rules include: [IRC Sec. 460(b)(6)]. The exception still applies if additional costs • One copy of Form 3115 (signed and dated) is filed with the IRS are incurred after the project is completed. [address is listed in Form 3115 instructions and in Section 9.05(2) Example: In the final year of a contract, a taxpayer using the percentage- of Rev. Proc. 2019-1] and the original is attached to the income of-completion method looks back to what income would have been if actual tax return for the year of change. The return must be filed by the costs had been used: due date (including extensions), and the copy filed with the IRS Year 1...... $20,000 Year 2...... $24,000 Year 3...... $26,000 must be filed no later than the tax return. Neither copy may be The taxpayer may elect not to apply the look-back rules if cumulative income filed before the first day of the tax year of change. reported, based on estimates, was: • Provisions exist for limited relief for late filing of the application Year 1...... Between $18,000 and $22,000. on an amended return within six months of the original due date. Year 2...... Between $39,600 and $48,400. • The application must clearly identify the method to be changed By making the election, the taxpayer does not pay or receive interest on the by including the designated automatic accounting method change underpayment or overpayment of tax. number (from Rev. Proc. 2018-31, as modified through the date of this publication by Rev. Procs. 2018-35, 2018-40, 2018-44, Prepaid Expenses 2018-49, 2018-56, 2018-60, 2019-8, and 2019-10, or any suc- A prepaid expense is deductible only in the year to which it applies cessor such as Rev. Proc. 2019-43) on the appropriate line of unless it qualifies under the so-called 12-month rule. the Form 3115. 12-month rule. Prepaid expenses are deductible when paid if the Many automatic accounting method changes are contained in Rev. rights or benefits to the taxpayer do not extend beyond the earlier Proc. 2018-31, as modified through the date of this publication by of the following [Reg. 1.263(a)-4(f)(1)]: Rev. Procs. 2018-35, 2018-40, 2018-44, 2018-49, 2018-56, 2018- • 12 months after the right to the benefit begins or 60, 2019-8, and 2019-10, or any successor such as Rev. Proc. • The end of the tax year after the tax year the payment is made. 2019-43, including (but not limited to): • Changing to an overall cash method for farmers. Example: On December 1, 2019, ZAP Corp. prepays a $10,000 insurance • Deducting accrued bonus and vacation pay in the year the all premium for a property insurance policy with a one-year term beginning Febru- events test has been met to establish the liability and the pay ary 1, 2020. Because the right or benefit attributable to the $10,000 payment is received by the employee by the 15th day of the third month extends beyond the end of the tax year following the tax year in which the following year end. payment is made, the 12-month rule does not apply. ZAP must capitalize the • Changing from cash to accrual method for specific items. $10,000 payment and deduct it over the term of the policy. • Advance payments, including certain gift cards. Variation: Assume the same facts, except that the policy’s one-year term • California franchise tax deductions. begins December 15, 2019. Now, the 12-month rule applies because the right • Change in connection with whether the recurring-item exception or benefit attributable to the payment neither extends more than 12 months to the economic performance rules of an accrual method taxpayer beyond December 15, 2019 (the first date the benefit is realized), nor beyond applies with respect to the prepayment of lease or service contract the end of the tax year following the tax year in which the payment is made. extending over two years (Rev. Rul. 2012-1). Accordingly, ZAP can deduct the $10,000 when paid. • Changes in connection with the tangible property regulations related to accounting methods for amounts paid to acquire, The IRS gives automatic consent to taxpayers that want to change produce or improve tangible property (Rev. Proc. 2014-16). their accounting method to use the 12-month rule for prepaid • Changes in connection with the tangible property regulations expenses. See Rev. Procs. 2006-12 and 2006-37 for guidance. related to dispositions of tangible depreciable property (Rev. Taxpayers must follow the automatic change procedures of Rev. Procs. 2014-17 and 2014-54). Proc. 2015-13 (see discussion that follows). Also see Intangible • Changes by a taxpayer using the retail inventory method to com- Assets on Page O-15 for more information. ply with regulations under Reg. 1.471-8 clarifying a taxpayer’s treatment of certain sales-based vendor allowances, margin Change in Accounting Method protection payments, permanent markups and markdowns, and To change an accounting method, a taxpayer generally must temporary markups and markdowns when determining the cost receive IRS consent. Under certain circumstances, automatic complement (Rev. Proc. 2014-48).

L-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 • Change from applying the Section 263A UNICAP rules to certain citrus replanting costs to instead deducting such costs (Rev. Proc. Tax Year 2018-35). The tax year is the period for which taxable income will be com- • Changes specified in Rev. Proc. 2018-40 as discussed at Auto- puted and reported. matic accounting method change on Page L-2. An entity adopts a tax year when it files its first tax return. The tax • Change to an overall accrual method by an eligible terminated S year can be a calendar or fiscal year. Once a tax year is adopted, corporation for which the resulting positive or negative Section 481(a) adjustment is taken into account over a six-tax year period beginning IRS approval is generally required to change it, even if changing with the year of change [IRC Sec. 481(d); Rev. Proc. 2018-44]. from an improper tax year. See Changing a Tax Year on Page L-6. • Changes for adopters or early adopters of the FASB “New Standards” for identifying performance obligations, allocating Calendar Tax Year transaction price to performance obligations, and/or considering Generally, any entity can adopt a calendar tax year. A calendar performance obligations satisfied (see discussion below) (Rev. year must be used if a taxpayer [IRC Sec. 441(g)]: Procs. 2018-29, 2018-31 or any successor such as Rev. Proc. 1) Does not keep adequate records, 2019-43, and 2018-49). 2) Has no annual accounting period, • Changes to comply with Section 451(b) as discussed at Accrual 3) Has an accounting period that does not qualify as a fiscal tax method income on Page L-1 (Rev. Proc. 2018-60). Also see year, or CCA 201852019. 4) Is required to use a calendar year by a provision of the Code or Regulations. Section 481 adjustment. When a business changes its accounting method, an income adjustment is required under IRC Sec. 481 to Fiscal Tax Year make sure income and expenses are not duplicated or omitted. A A fiscal year is either [IRC Sec. 441(e)]: positive adjustment resulting from an automatic consent to change 1) A 12-month period ending on the last day of any month except of accounting method is generally recognized over four years. December or Under a de minimis rule set forth in Rev. Proc. 2015-13, a positive 2) A 52–53 week tax year. adjustment of less than $50,000 may be recognized in the year of 52–53 week tax year. A 52–53 week tax year always ends on the change. A negative adjustment (in favor of the taxpayer) is fully same day of the week, and must end either on the date that day recognized in the year of change. Guidance for a Section 481(a) last falls in a particular calendar month, or the date that day falls adjustment for a nonautomatic method change and for an automatic nearest to the last day of a particular calendar month. method change is provided by Rev. Proc. 2015-13, Section 7.03. Example #1: ZAP Corporation elects a 52–53 week tax year that will end on Example: Don owns Goodware Sales as a sole proprietor. Gross receipts the last Friday in October. In 2019, ZAP’s tax year ends on Friday, October 25. for all past tax years have been less than $1 million. Don has been using the hybrid method of accounting—accrual for purchases and sales of merchandise Example #2: TAB Corporation elects a 52–53 week tax year that will end on and cash for other income and expenses. the Friday closest to the last day of November. In 2019, TAB’s tax year ends In 2019, Don decides to change to the cash method of accounting under Rev. on Friday, November 29. Proc. 2018-31. Balance sheet items include the following: Accounts receivable...... $ 100,000 When computing depreciation or amortization, a 52-53 week tax Accounts payable...... ( 40,000) year is generally considered a 12-month tax year. Negative 481 adjustment...... $ 60,000 To elect a 52–53 week tax year, attach a statement to the tax return showing [Reg. 1.441-2(b)(1)]: By switching to the cash method of accounting, Don deducts a Section 481 1) The day of the week on which the tax year will always end, adjustment of $60,000 for tax year 2019. 2) Whether it will end on the last such day of the week in the In computing the net Section 481(a) adjustment, consider all rel- calendar month or on the date such day of the week occurs nearest the end of the month, and evant accounts. For example, the Section 481(a) adjustment for a 3) The month in which (or with reference to which) the tax year change in the proper time for deducting salary bonuses under IRC will end. Sec. 461 should reflect any necessary adjustments for amounts C corporations and estates generally can elect a fiscal tax year of salary bonuses capitalized to inventory under IRC Sec. 263A without any special restrictions. The fiscal year is chosen when (Rev. Proc. 2015-13, Sec. 3.15). the first tax return is filed. A small business taxpayer changing to the cash method for a trade Trusts must use a calendar tax year (but see Tax year on Page or business must include open accounts receivable in income. An G-1 for a limited exception). open accounts receivable is any receivable that is due in full in 120 S corporations, PSCs and partnerships must use a “required days or less and not subject to the mark to market rules for dealers tax year.” See Required Tax Year on Page L-6. in securities under IRC Sec. 475 [Rev Proc. 2018-40, Sec. 3.02(1)]. A partnership or corporation reports a Section 481 adjustment on Short Tax Year the “Other income” line of the tax return. A short tax year is a tax year of less than 12 months [IRC Sec. Guidance on financial revenue recognition standards. In 443(a)]. Rev. Procs. 2018-29 and 2018-49, the IRS provides procedures The two situations that result in a short tax year are: for taxpayers to obtain automatic consent to change a method of 1) Entity is not in existence for an entire tax year such as the first accounting used to recognize income for federal tax purposes to or last tax return of a partnership or corporation. a method in which the taxpayer uses the new financial accounting 2) Entity changes its accounting period. standards for income recognition [FASB’s Revenue From Contracts Entity not in existence for an entire year. If the entity was not With Customers (Topic 606)] to (1) identify performance obligations, in existence for an entire year, the filing requirements and the tax (2) allocate transaction price to performance obligations and/or (3) computation generally are the same as if the return was for a full consider performance obligations satisfied. 12 months ending on the last day of the short tax year.

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook L-5 Partnership. Generally, a partnership must use the same tax year Example #1: AAA Corporation came into existence on September 9, 2018, as its partners. If partners’ tax years differ, the following methods and elected a fiscal year ending the last day of April. The C corporation has are used to determine the partnership tax year (Reg. 1.706-1): a short tax year for the period September 9, 2018 to April 30, 2019. The due • Majority interest. If one or more partners having the same tax date for the return is August 15, 2019. year own more than 50% capital and profits of the partnership, the partnership must use the tax year of those partners. Example #2: NOM Corporation, a calendar-year taxpayer, dissolved on • Principal partner. If there is no majority interest tax year, the July 21, 2019. The C corporation’s final year is a short tax year for the period partnership must use the tax year of all its principal partners. January 1 to July 21. The due date for NOM’s final return is November 15, 2019. A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. The tax computation for the preceding examples is calculated as if the tax year was a full 12 months. However, depreciation will • Least aggregate deferral. If the partnership does not fall under need to be figured under the short tax year rules. See Tab J either of the above, the partnership must use a tax year that for a discussion of short-year depreciation. results in the least aggregate deferral of income to the partners. Exceptions to the required tax year rules [Reg. 1.706-1(b)(2)(ii)]: Changing a Tax Year 1) Tax year with an acceptable business purpose, Changing a tax year generally requires IRS consent. The 2) Tax year elected under IRC Sec. 444, or request for change of tax year is made by filing Form 3) 52–53 week tax year that ends with reference to required or 1128 (Application To Adopt, Change, or Retain a Tax Section 444 tax year. Year). Changes that require IRS consent are subject to user fees. Business Purpose Tax Year Certain changes are given automatic consent if require- Partnerships, S corporations, and PSCs may use a tax year other ments are met. Provisions for automatic change of tax than a required tax year by establishing a substantial business year generally involve establishing a business purpose purpose for the tax year. Both tax and nontax factors must be for a fiscal year or changing to a 52–53 week year. considered in determining if there is a substantial business purpose The IRS has issued the following guidance to provide for a requested tax year (Rev. Proc. 2002-39, Sec. 5.02). comprehensive information about changes in tax years: Safe harbor. Rev. Proc. 2006-46 describes a safe harbor for Rev. Procs. 2002-37, 2006-45, and 2007-64. Automatic approval establishing a business purpose tax year known as a natural provisions for C corporations. business year. A business can adopt a natural business year with- out permission from the IRS (that is, automatic approval) provided Automatic approval provisions Rev. Procs. 2002-38 and 2006-46. it receives at least 25% of its annual gross receipts during the last for partnerships, S corporations, PSCs and trusts. two-month period of that year for each of the last three fiscal years. Rev. Proc. 2002-39. Provisions for nonautomatic changes of tax years where IRS consent is required. Example: Sascha and Tilly are shareholders in an S corporation tax preparation Rev. Proc. 2018-17. Modifies Rev. Procs. 2002-39 and 2006-45 business, which has a calendar-year tax year. They file Form 1128 seeking for tax year change requests by certain foreign corporations. an April 30, 2020 fiscal year. Rev. Proc. 2003-34 modifies Rev. Procs. 2002-37 and 2002-39, Under the natural business year test, the 25% test is applied for the fiscal year allowing carryback in certain instances of capital losses and NOLs, ending April 30, 2020, and the two preceding fiscal years ending on April 30. which were not allowed in the original Rev. Procs. Gross income for the three years is as follows: Fiscal Year May–February March–April Total Percentage Rev. Procs. 76-10, 79-3 and 85-58. Automatic approval provisions for tax-exempt organizations. 2020 $42,000 $158,000 $200,000 79% 2019 $31,400 $148,600 $180,000 83% Rev. Proc. 85-15. Automatic approval provisions to change from an improper tax year to a calendar tax year. 2018 $72,800 $167,200 $240,000 70% The S corporation qualifies for a natural business year because in each of the three years, at least 25% of gross receipts fall in the last two months of Required Tax Year the fiscal year. S corporations are required to use (1) a calendar year, (2) a fiscal year that has an established business purpose, or (3) a tax year A partnership or corporation that uses a natural business year elected under the provisions of IRC Sec. 444. (Reg. 1.1378-1) (1) does not fall under the deposit requirements of a Section 444 Personal service corporations (PSCs) must use a calendar tax election fiscal year taxpayer and (2) may apply for automatic year unless they can establish a business purpose for a different approval to change years on Form 1128 (Application To Adopt, tax year [IRC Sec. 441(i)], or unless they make a Section 444 Change or Retain a Tax Year). election. For this purpose, a PSC is a corporation where the prin- cipal activity during the testing period is performance of personal Section 444 Election services by employee-owners. Generally, the testing Partnerships, S corporations, and PSCs may elect under IRC Sec. period for a tax year is the prior tax year. For new 444 to use a tax year that is different from the required tax year. corporations, the testing period begins on the The Section 444 election does not apply if the entity establishes first day of the tax year and ends on the earlier a business purpose for a different period. The election is available of (1) the last day of its tax year or (2) the last if the entity: day of the calendar year. To fall under these 1) Is not a member of a tiered structure (with limited exceptions), rules, the employee-owners must own more than 10% of the fair market value (FMV) of the corporation’s stock on the last day of 2) Has not previously had a Section 444 election in effect, and the testing period. 3) Elects a year that meets the deferral period requirement.

L-6 2019 Tax Year | Small Business Quickfinder ® Handbook 5) Indirect materials and supplies. 12) Costs connected with producing any plant that has a prepro- 6) Tools and equipment that are not otherwise capitalized. ductive period of two years or less for farming activities that 7) Quality control and inspection. are not required to use the accrual method (Reg. 1.263A-4). 8) Taxes (other than state, local, or foreign income taxes) that 13) Costs of a freelance writer, photographer, or artist incurred to relate to labor, materials, supplies, equipment, land, or facilities. produce the composition. Other costs such as demo tapes are Does not include taxes that are treated as part of the cost of subject to UNICAP (TAM 9643003). property. 14) Amounts allowed as a deduction under IRC 9) Depreciation, amortization, and cost recovery allowances on Sec. 179. equipment and facilities. 10) Depletion (whether or not in excess of cost). This is not capital- Allocable Portion of Indirect ized until the property is sold. Costs 11) Direct and indirect costs incurred by any Under UNICAP, a cost allocation method is used administrative, service or support function, to determine how to add indirect costs to the direct costs of ac- or department, to the extent the costs are quiring or producing a product. The regulations allow for a variety allocable to particular activities. of methods. 12) Compensation paid to officers attributable to Facts-and-circumstances methods. These detailed or specific services performed in connection with particular methods include specific identification, burden rate, standard cost, activities (but not including any cost of selling). and other reasonable methods [Reg. 1.263A-1(f)]. A burden rate 13) Insurance on the plant, machinery or equipment, or insurance method allocates indirect costs to inventory using predetermined on a particular activity. rates that approximate the actual costs incurred in connection 14) Deductible contributions paid to or under a stock bonus, pen- with producing a product. Burden rates can be based on direct sion, profit-sharing, or annuity plan. costs, labor hours, or other similar items. For example, a burden rate percentage can be calculated by dividing direct labor hours 15) Employee benefit expenses, including worker’s compensation, by total labor hours. See the worksheet Allocation of Indirect payments under IRC Sec. 404A, life and health insurance Costs to Ending Inventory Under IRC Sec. 263A on Page A-15 premiums, and miscellaneous employee benefits. to compute the allocation. 16) Rework labor, scrap, and spoilage. 17) Bidding costs incurred in solicitation of contracts that are Example: YAZ Corporation is a manufacturer. Assembly line employees and awarded. their supervisors worked a combined total of 30,000 hours during the year. Administrative personnel worked a combined total of 10,000 hours. Total hours 18) Engineering and design costs. worked by YAZ employees equal 40,000 hours. Percentage of direct labor 19) Storage and warehousing costs, purchasing costs, hours to total labor hours is 75% (30,000 ÷ 40,000). handling, processing, assembly and repackaging Assume YAZ uses a burden rate method based on a ratio of direct labor hours costs, and a part of general and administrative to total labor hours. costs. YAZ incurred the following direct costs during the year: 20) Licensing and franchise costs. Materials...... $ 50,000 21) Environmental remediation expense (Rev. Rul. Direct labor + Payroll taxes...... 240,000 2004-18). Depreciation of assembly equipment...... 20,000 Interest on debt connected with the production of the asset is Total direct costs...... $ 310,000 included in inventory costs. Interest connected with the acquisition YAZ incurred the following indirect operating costs during the year: and holding for resale of the asset is excluded from the capitaliza- Advertising...... $ 30,000 tion rules. See Capitalization of Interest on Page L-10. Administrative wages + Payroll taxes...... 150,000 Costs not capitalized [IRC Sec. 263A; Reg. 1.263A-1(e)(3)(iii)]: Depreciation of office equipment...... 1,000 1) Marketing, selling, advertising, and distribution costs. Rent...... 30,000 2) Bidding expenses incurred in solicitation of contracts not Utilities...... 6,000 awarded. Miscellaneous...... 15,000 3) General and administrative expenses and compensation paid Total operating expenses...... $ 232,000 to officers attributable to the performance of services that do Because YAZ does not meet the $200,000 de minimis exception for indirect not directly benefit or are not incurred by reason of a particular costs (see item 9 under Exceptions where UNICAP rules do not apply on production activity. Page L-8), YAZ must add $151,500 of indirect costs to the cost of inventory 4) Research and experimental costs allowable as deductions [($232,000 operating expenses minus $30,000 advertising) × 75% = $151,500] under IRC Sec. 174. (advertising is not counted as an indirect cost). 5) Losses deductible under IRC Sec. 165. Assume the direct cost of beginning inventory was $30,000 and the indirect cost was $5,000. Assume the direct cost of ending inventory equals $40,800. 6) Income taxes. By using the Allocation of Indirect Costs to Ending Inventory Under IRC Sec. 7) Costs attributable to strikes. 263A on Page A-15, indirect costs allocated to ending inventory equal $18,780 8) Depreciation, amortization, and cost recovery allowances on {($5,000 + $151,500) × ($40,800 ÷ [$30,000 + $310,000])}. equipment and facilities that are temporarily idle. Cost of goods sold (COGS) for YAZ is calculated: 9) Warranty and product liability costs. Beginning inventory ($30,000 + $5,000)...... $ 35,000 10) On-site storage costs. Direct costs...... 310,000 Section 263A costs...... 151,500 11) Costs connected with producing or raising animals for farming Minus ending inventory ($40,800 + $18,780)...... ( 59,580) activities that are not required to use the accrual method (Reg. 1.263A-4). COGS...... $ 436,920

2019 Tax Year | Small Business Quickfinder ® Handbook L-9 Simplified methods: Capitalized interest is recovered through COGS, an adjustment to 1) Simplified production method without historic absorption ratio basis, depreciation, amortization or other methods. election [Reg. 1.263A-2(b)(3)].  Note: The interest deduction limitation rules under IRC Sec. • If the taxpayer uses FIFO for direct costs, indirect costs 163(j) are applied after the interest capitalization rules of IRC allocated to inventory at the end of the year are determined Sec. 263A. by multiplying the total direct costs of inventory remaining on hand at the end of the year by an absorption ratio, which Capitalization of Pre-Production Costs equals the additional 263A costs incurred during the year Direct and indirect expenses allocable to property that is held for divided by the direct costs of inventory incurred during the future production must be capitalized [Reg. 1.263A-2(a)(3)(ii)]. For year. example, a manufacturer must capitalize the costs of storing and • Taxpayers using LIFO multiply the absorption ratio by their handling raw materials before the raw materials are committed LIFO increment for the year [see Reg. 1.263A-2(b)(3)(iii), to production. In addition, a real estate developer must capitalize which also covers allocating costs if there is a LIFO decre- property taxes incurred on property held for future development. ment]. Farmers. Special exceptions to the UNICAP rules apply to farming • Additional 263A costs generally are those costs, other than businesses [IRC Sec. 263A(d)]. See IRS Pub. 225 (Farmer’s Tax interest, that were not capitalized under the taxpayer’s Guide) for how to apply the UNICAP rules to farming businesses. method of accounting immediately prior to the Section Authors, photographers, artists. Reg. 1.263A-5 has been 263A effective date, but that are required to be capitalized reserved for creative expenses incurred by free-lance authors, under IRC Sec. 263A. photographers, and artists. 2) Simplified production method with historic absorption ratio election [Reg. 1.263A-2(b)(4)]. A historic absorption ratio elec- tion lets a taxpayer compute its absorption ratio based on its Adopting/Changing UNICAP Methods The rules on adopting/changing UNICAP accounting methods are Section 263A costs in the three tax years prior to the election included in Rev. Proc. 2018-31 (Section 12) as modified by Rev. year. The resulting ratio is used for five years, then tested for Procs. 2018-35 and 2018-40, or in any successor to Rev. Proc. accuracy and changed if necessary. 2018-31 such as Rev. Proc. 2019-43. 3) Simplified resale method [Reg. 1.263A-3(d)], either with or without a historic absorption ratio election. 4) Simplified service cost method for determining the capitaliz- Bookkeeping Basics able amount of mixed service costs [costs partially allocable to production or resale activities and partially allocable to other Supporting Documents activities—see Reg. 1.263A-1(e)(4)]. This method may be Bookkeeping is the detailed recording and summarizing of eco- used in connection with either a facts-and-circumstances or a nomic activity, business transactions, and events. It starts with simplified method [Reg. 1.263A-1(f) and (h)]. supporting documents that are generated when there are trans- actions such as purchases, sales, and payroll. Supporting docu- ments contain information about the transactions evidencing that Capitalization of Interest they took place and provide support for the entries in the books Generally, interest is deducted in the year paid or accrued on and on the tax return. Supporting documents include sales slips, debt that is related to a trade or business activity. However, under paid bills, invoices, receipts, deposit slips, canceled checks, and UNICAP certain interest payments must be added to the cost signed agreements. basis of property that is produced and generally recovered when • Sales documents. Documents supporting sales should show the the property is sold or through depreciation, amortization, etc. amount and sources of the sale. Sales documents include cash Interest paid or incurred during the production period of qualified register tapes, bank deposit slips, receipt books, sales invoices, property must be capitalized. and credit card charge slips. For this purpose, qualified property is [IRC Sec. 263A(f)(1); • Purchase documents. Documents supporting purchases of items Reg. 1.263A-8]: bought for resale or for use in the manufacturing process should 1) Real property, show the amount paid and the nature of the purchase. Purchase 2) Personal property with class life of 20 years or more, documents include canceled checks, cash register tape receipts, purchase invoices, and credit card slips. 3) Personal property with an estimated production period of more than two years, or • Expense documents. Documents supporting costs incurred (other than purchases) to carry on the business, such as salaries and 4) Personal property with an estimated production period of more wages, rent, utilities, etc., should show the amount paid and na- than one year if the estimated cost of production is more than ture of the expense item. Expense documents include canceled $1 million. checks, cash register receipts, invoices, credit card slips, vendor Property is considered produced if it is constructed, built, installed, statements, and petty cash slips for small cash payments. manufactured, developed, improved, created, raised, or grown. • Asset documents. Documents supporting property used in the For real property, the production period begins when physical ac- business, such as land, buildings, machinery, equipment, and tivity is first performed on the property. For all other property, the furniture, should provide information used to determine (1) the production period begins when production costs equal or exceed cost basis to capitalize, (2) depreciation, and (3) the gain or 5% of the total estimated production costs that will be incurred on loss if the assets are sold. Asset supporting documents include the property (Reg. 1.263A-12). purchase invoices, canceled checks, vendor statements, real estate closing documents, etc. De minimis rule. Interest is not required to be capitalized if the [Reg. 1.263A-8(b)(4)]: • Production period does not exceed 90 days and Recording Business Transactions • Total production expenditures do not exceed $1 million divided Once business transactions are determined based on the sup- by the number of days in the production period. porting documents that the transactions generate, the supporting

L-10 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 • Compensate a key employee. artistic composition; a letter, memorandum or similar property • Separate regulated and nonregulated businesses. held by (a) the person who created it, (b) for a letter, memoran- • Enhance customer relations. dum or similar property, the person for whom it was prepared or produced or (c) by transferees whose basis is determined • Reduce labor problems by separating union and nonunion busi- by reference to the basis of the property to a person listed in nesses. (a) or (b). (A taxpayer, however, can elect to treat the sale or • Comply with divestiture orders of courts or government. exchange of a musical composition or copyright in musical work • Prevent hostile takeovers by eliminating undervaluation. created by the taxpayer as the sale or exchange of a capital asset. See Reg. 1.1221-3 for guidance on the election.) 4) Accounts or notes receivable acquired through normal busi- Section 338 Election ness operations. 5) Certain U.S. government publications. IRC Sec. 338 allows a corporation acquiring 80% or 6) Any commodities derivative financial instrument held by a more of the total voting power and value of the stock commodities derivatives dealer unless identified otherwise. of another corporation (called the target corporation) 7) Any hedging transaction that is clearly identified as such before to make an irrevocable election to treat the stock the close of the day on which it was acquired, originated, or purchase as a purchase of the target corporation’s entered into. assets. The purchasing corporation will have a basis in the target corporation’s assets equal to its basis in 8) Supplies regularly used or consumed in the business. the target corporation’s stock. The target corporation is IRC Sec. 1231 refers to depreciable personal property and real deemed to have sold its assets for an amount equal to the purchas- property used in a trade or business held for over one year. ing corporation’s basis in the target corporation’s stock, adjusted • Does not include inventory; property held for sale to customers; for liabilities of the target corporation. The target corporation does patents; inventions; models or designs (whether or not patented); not have to be liquidated for IRC Sec. 338 to apply. a secret formula or process; copyrights; literary, musical, or When a purchasing corporation makes a Section 338 election, the artistic compositions held by a person listed in item 3 target corporation must recognize gain or loss on the sale of its under IRC Sec. 1221 on Page N-13; or certain U.S. assets. The target corporation (old target) is treated as having sold government publications. all of its assets in a single transaction for their FMV at the close of • Net gains are the amount that exceed depreciation the acquisition date, and is then treated as a new corporation (new allowed or allowable on the asset. target) that purchased all of the assets as of the beginning of the • Net gains are treated as long-term capital gains. [But day after the acquisition date. Both old target and new target must nonrecaptured Section 1231 losses (net Section 1231 attach Form 8883 (Asset Allocation Statement Under Section 338) losses deducted in the prior five years) are recaptured to their tax returns for the year the acquisition occurs. by treating an equal amount of subsequent year net The election is made on Form 8023 (Elections Under Section 338 Section 1231 gain as ordinary rather than long-term capital gain.] for Corporations Making Qualified Stock Purchases). The election • Net losses are treated as ordinary losses. must be made by the 15th day of the ninth month beginning after IRC Sec. 1244 refers to losses on small business stock. the month in which the qualified stock purchase occurs. Under • Stock losses of an individual or a partnership are treated as certain conditions, Rev. Proc. 2003-33 provides an automatic ordinary losses up to $50,000 per year ($100,000 MFJ). extension of 12 months from the date of discovery of failure to • Stock is defined as stock in a domestic corporation that meets file the Form 8023. the following qualifications: 1) It was issued as Section 1244 stock by a small business corporation with $1 million or less in contributed capital; Disposition of Assets 2) It was issued in exchange for money or property other than Form 4797; see also IRS Pub. 544 stock and securities, and Partnerships and corporations report the sale or disposition of 3) During the five-year period before the date the loss was business property on Form 4797 (Sales of Business Property) sustained, 50% or less of the corporation’s gross receipts similar to individuals. came from royalties, rents, dividends, interest, annuities, Short term. If the property was held short term, the gain or loss or stock sales. is entered in Part II. IRC Sec. 1245 refers to gains from the disposition of certain de- Long term. If depreciable property was held long term and sold at preciable property. a gain, it is first entered in Part III. If long-term property was sold • Property includes depreciable personal property, certain tangible at a loss, it is entered in Part I. assets, certain real property (not including a building or its struc- tural components), single purpose agricultural or horticultural Generally, gain from the disposition of property used in a trade or structure, petroleum storage facility, railroad grading, or tunnel business is exempt from the 3.8% net investment income tax (NIIT) bore. [IRC Sec. 1411(c)(1)(A)(iii)]. For NII purposes, trade or business • Gains include Section 179 deductions. is defined the same as for Section 162 purposes. • Gains are ordinary income to the extent of depreciation allowed or allowable on the property; any excess is Section 1231 gain. Basic Summary of IRC Sections—Nature of IRC Sec. 1250 refers to gains from the disposition of cer- Gain (Loss) When Property Is Sold tain depreciable real property [other than real property per IRC Sec. 1221 defines capital assets as any property held by a IRC Sec. 1245(a)(3)]. taxpayer that is not: • Gains as a result of accelerated depreciation (as opposed to SL) 1) Inventory items or other property held for sale to customers. are treated as ordinary income. 2) Property used in a trade or business that (a) can be depreci- • Gains as a result of SL depreciation receive capital gain treatment ated under IRC Sec. 167 or (b) is real property. (subject to the 25% maximum rate for unrecaptured Section 1250 3) A patent; invention; model or design (whether or not patented), gains). a secret formula or process; a copyright; a literary, musical, or Continued on the next page 2019 Tax Year | Small Business Quickfinder ® Handbook N-13 • Gains from the disposition of a commercial building depreciated Replacement period. To postpone the gain, the property must under the prescribed accelerated cost recovery system (ACRS) be replaced within a specified period of time [IRC Sec. 1033(a)]. percentages (including an office in the home) are ordinary income Replacement period begins on the earlier of: to the extent of total depreciation claimed. 1) Date on which the condemned property was disposed of or • Gains from the disposition of residential rental property depre- 2) Date on which the threat of condemnation began. ciated under the prescribed ACRS percentages are ordinary Replacement period ends two years after the close of the first tax income to the extent of the excess over SL depreciation claimed. year in which any part of the gain on the conversion is realized. • Depreciation of commercial and residential rental property under Exception: Three-year replacement period for real property used modified ACRS (MACRS) is described as only SL depreciation. in a trade or business or for investment. For corporations, IRC Sec. 291(a)(1) provides that 20% of the Property acquired from related parties. Certain taxpayers must excess (if any) of (1) ordinary income that would have resulted if recognize gain on involuntary conversions if the replacement prop- the property was Section 1245 property over (2) the amount treated erty is acquired from a related party, including [IRC Sec. 1033(i)]: as ordinary income under IRC Sec. 1250, is treated as gain that 1) C corporations, is ordinary income under IRC Sec. 1250. 2) Partnerships in which C corporations own more than 50% of the capital or profits interest, and 3) Any other taxpayer, including individuals, if the Involuntary Conversions realized gain is greater than $100,000. An involuntary conversion occurs when property is destroyed, sto- Exception: Recognition of gain under these rules will len, condemned, or disposed of under the threat of condemnation, not apply if the related party acquired the replace- and the taxpayer receives other property or money in payment, ment property from an unrelated party during the re- such as insurance or a condemnation award. placement period. For definitions of related parties, see Gain from an involuntary conversion may be postponed to the IRC Secs. 267(b) and 707(b)(1). extent that the taxpayer purchases replacement property that is Electing to defer gain. A taxpayer is not required to similar to the old property or related in service or use (or like-kind defer recognition of gain on an involuntary conversion, but rather in the case of condemned real estate). Replacement property held is allowed to elect to either defer recognizing the gain or recognize for the same function as the converted property can be excluded it in the current year. The election to defer the gain from income from gain recognition [Gaynor News, 22 TC 1172 (1954), acq. in the current year is made by excluding the deferred gain from 1955-2 CB 6]. In order to postpone the entire amount of the gain, income and attaching a statement to the return reporting all details the cost of replacement property must be at least as much as the of the conversion [Reg. 1.1033(a)-2]. Including the gain in income amount realized on the conversion. Gain must be recognized, in the year of sale is an election to recognize the gain in that year. however, to the extent that the taxpayer receives unlike property See Tab 9 of the Depreciation Quickfinder® Handbook for more as reimbursement. The new property’s basis equals the adjusted information on involuntary conversions. basis of the old property. Example #1: A retail store is located beside a highway that is to be converted into a Casualties wider freeway. Under threat of condemnation, the store sells its property (needed for  Disaster Relief Alert: Special rules apply to victims of qualified freeway lanes) to the highway department. Using the cash proceeds from the sale, disasters. See Taxpayer Certainty and Disaster Tax Relief Act of the store relocates across town. The new store is similar to the old store. The sale 2019 on Page Q-1. of the old store is an involuntary conversion. The gain from the sale is postponed, and the basis of the new store is the basis of the old store plus the cost of sale. For 2018–2025, personal casualty losses in excess of personal casualty gains are deductible only if attributable to a federally declared disaster and are subject to AGI and dollar thresholds. Example #2: An auto repair shop has some tools and equipment stolen. The Casualty losses on business property (other than employee tools and equipment were expensed in prior years so that their adjusted basis property) and income-producing property are not subject to these is zero. The auto repair shop received $12,000 in insurance proceeds from limits. See Tab 5 in the 1040 Quickfinder® Handbook for discussion the theft. The proceeds were used to purchase new tools and equipment. This of personal casualty losses and Tab 4 in the Individuals—Special qualifies as an involuntary conversion; the insurance reimbursement is not Tax Situations Quickfinder® Handbook for an expanded discussion taxable, and the purchase of the new tools and equipment is not deductible. of disaster victims. The basis of the new tools and equipment is zero. Federally declared disaster. A casualty loss occurring in, and attributable to, a federally declared disaster can be deducted in IRS Ruling: The IRS ruled that gain realized from insurance proceeds for the year the disaster occurred or in the year preceding the loss hurricane damage to an apartment complex could be deferred to the extent [IRC Sec. 165(i)]. The election must be made on or before the that such proceeds were used to repair damaged buildings, clubhouses, and date that is six months after the original due date for the taxpayer’s landscaping; demolish destroyed buildings; or reinvest in qualified replacement federal tax return for the disaster year (without extensions). The property. In addition, the IRS allowed the taxpayer to defer gain realized from taxpayer need not request a filing extension for the disaster year the sale of what remained of the apartment complex, but only if the insurance to benefit from this due date. The taxpayer makes the election to proceeds were reinvested in replacement property in a transaction that other- deduct the loss in the preceding tax year by deducting the loss on wise qualified under IRC Sec. 1033 (Ltr. Rul. 200743010). an original (if not yet filed) or amended return for the preceding year and attaching a specified election statement to the return. Court Case: A manufacturer processed trees at lumber and paper mills. The election can be revoked within 90 days of its due date (Temp. Before the trees were fully mature and ready for harvest, they were damaged Reg. 1.165-11T; Rev. Proc. 2016-53). by storms, fire, and insects. Instead of selling the damaged trees as is, the taxpayer processed the trees and sold the products manufactured from the See IRS Pubs. 547 (Casualties, Disasters, and Thefts) and 976 damaged trees. The taxpayer claimed involuntary conversion and deferred the (Disaster Relief) for additional discussion. portion of the gain attributable to the difference between the basis in the trees For purposes of the involuntary conversion rules, a special allow- and their FMV prior to salvage of the trees began. ance applies to property destroyed in a federally declared disaster The IRS argued the taxpayer had processed the trees into end products in area [IRC Sec. 1033(h)]. If business or income-producing property the ordinary course of business and was not entitled to involuntary conversion is destroyed in such an area, any tangible replacement property treatment. The Court disagreed and allowed the taxpayer to defer a portion of acquired for use in a business qualifies as “similar or related in the gain because the conversion was involuntary and the trees were not avail- service or use.” This relaxed definition for replacement property able for their original intended business use [Willamette, 118 TC 126 (2002)]. allows business owners to postpone gain when starting a new

N-14 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Deductions, Credits, and Books vs. Tax  that provide a criminal penalty for loss of license or privilege to Tab O Topics engage in a trade or business. Business Tax Deductions...... Page O-1 Capital expenses. Capitalizable expenditures typically are per- manent improvements or betterments that increase the value of Qualified Business Income (QBI) Deduction...... Page O-4 property, restore its value or use, substantially prolong its useful Tax Credits...... Page O-4 life or adapt it to a new or different use [IRC Secs. 168 and 263(a)]. Selected Energy Tax Incentives for Businesses..... Page O-5 Incidental expenses that do not materially add to the value of a Net Income per Books vs. Taxable Income...... Page O-8 property or appreciably prolong its useful life are deductible as incurred. Materials and supplies are typically deductible in the year used or consumed. See Improvements and repairs on Page O-2 and Materials and supplies on Page O-3. Business Tax Deductions Reg. 1.263(a)-3(d) dictates that expenditures are typically capital- Accountable plan. Employer reimbursements for an employee’s ized if they result in: business expenses are deductible by the employer and not in- • A betterment, cluded in the employee’s income. The expenses must have a • A restoration, or business purpose and be substantiated by the employee, and • An adaptation to a new or different use. the employee must return any excess reimbursements within a The regulations provide that, for property other than buildings, all reasonable period of time. If the expenses are not substantiated functionally interdependent components of a property comprise a or excess expenses are not returned within the required period of single unit of property if placing one component in service depends time, the expenses are treated as paid under a nonaccountable on placing the other component in service [Reg. 1.263(a)-3(e)(3)]. plan. See Nonaccountable plan on Page O-3. For buildings, expenditures are capitalized if they result in an Advertising. Advertising costs that relate to business activities improvement to the building (including its structural components) are deductible as current operating expenses. Advertising is not or any of the following building systems [Reg. 1.263(a)-3(e)(2)]: capitalized under UNICAP. Advertising to influence legislation is 1) Heating, ventilation, and air conditioning (HVAC). not deductible. Prepaid advertising costs are deductible in the year 2) Plumbing systems (including pipes, drains, valves, sinks, to which they apply. bathtubs, and toilets). Amortization. See Tab J. 3) Electrical systems (including wiring outlets, junction boxes, and lighting fixtures). Attorneys, etc. See Lawyers’ costs incurred on behalf of clients 4) Escalators. on Page O-3 and Legal and professional fees on Page O-3. 5) Elevators. Auto expenses. Passenger automobiles rated at or below an 6) Fire protection and alarm systems. unloaded gross vehicle weight of 6,000 pounds (gross vehicle 7) Security systems. weight, without the unloaded stipulation, for a truck or van) are 8) Gas distribution systems. listed property [IRC Sec. 280F(d)(5)]. Deduction limits and sub- 9) Other structural components identified in stantiation requirements apply. published IRS guidance that are excepted The value of an employer-provided vehicle must generally be in- from the building structure. cluded in the employee’s wages. See Employer-Provided Vehicle Repairs that are subject to capitalization under on Page K-15 for more information. the UNICAP rules or any other provision of Self-employed individuals, including partners in a partnership, and the Code or regulations cannot be deducted employees who do not use more than four vehicles at a time for (Reg. 1.162-4). business are allowed to compute their deduction using the standard See Capital Improvements vs. Deductible Repairs on Page J-8 mileage rate. The 2019 standard mileage rate is 58¢ per mile. for more information. Generally, a corporation can deduct 100% of the costs associ- Cell phones. Cell phones and similar telecommunications ated with an auto. The business portion of the employee’s use equipment are not included in the definition of listed property is deductible as a transportation expense while the personal use (to which strict substantiation rules and deduction limits apply) is deductible either as additional compensation or as a taxable [IRC Sec. 280F(d)(4)(A)]. See Employer provided cell phones on fringe benefit. Page K-7 for guidelines on their proper tax treatment. Awards and bonuses. Bonuses paid to employees are deductible Charitable contributions. See Charitable Contributions on Page if intended as additional pay for services. Gifts to customers are O-11. For C corporations, see Charitable Contributions on Page limited to $25 per year, per individual [IRC Sec. 274(b)]. Although C-14 and Charitable Contributions of Inventory on Page C-14. de minimis non-cash gifts to employees can be deducted by the employer and excluded from the employees’ income, cash gifts, Circulation expenses. The cost of increasing circulation of a or gift certificates given to employees must be treated as taxable newspaper, magazine or other periodical is deductible as a cur- wages. Also see Employee Achievement Awards on Page K-9. rent operating expense, or may be capitalized and amortized as a deferred expense (IRC Sec. 173). Bad debts—business. See Business Bad Debts on Page O-9. Club dues are generally nondeductible if the club has a principal Barrier removal for disabled or elderly. Up to $15,000 of the purpose of providing access to or conducting entertainment activi- cost of removing barriers to make a facility more accessible for ties for members or their guests. disabled or elderly individuals may qualify for a current deduction (IRC Sec. 190). Some barrier removal costs may also qualify for Computer software. See Computer Software on Page O-12. the disabled access credit (Form 8826). See the table Selected Cost of goods sold. See Cost of Goods Sold (COGS) on Page O-12. General Business Tax Credits on Page O-7. Demolition expenses. Costs incurred to demolish a structure are Bribes or kickbacks. Payments are not deductible if made to any added to basis of the land where the demolished structure was person in violation of a federal, state or local law, including ones located. (IRC Sec. 280B) 2019 Tax Year | Small Business Quickfinder ® Handbook O-1 Depletion. See Tab J. benefit or the amount included in the employee’s taxable wages. Depreciation. See Tab J. This rule applies to expenses for activities generally considered to be entertainment, amusement, or recreation and facilities used Development costs. Costs of developing a mine or other natural in connection with such activities, such as a company airplane. deposit (other than an oil or gas well) may be deducted. The costs must be paid after the discovery of ores or minerals in commercially Specified individuals generally include officers, directors, and 10% marketable quantities [IRC Sec. 616(a)]. An election can be made or greater owners [IRC Sec. 274(a) and (e)(2)(B)]. to treat the costs as deferred expenses deducted ratably as the Environmental clean-up costs. Rev. Rul. 94-38 held that costs ores/minerals are sold [IRC Sec. 616(b) or to amortize the costs incurred to construct groundwater treatment facilities were capi- over ten years [IRC Sec. 59(e)]. tal expenses. Other costs incurred to clean up land and to treat Disaster losses. For 2018–2025, personal casualty losses are groundwater contaminated with hazardous waste resulting from limited to federally declared disaster areas and are subject to AGI business operations were deductible as business expenses. Other- and dollar thresholds. Casualty losses on business property (other wise deductible costs incurred by a manufacturing operation must than employee property) and income-producing property are not be included in inventory under the uniform capitalization rules of subject to these limits. Per IRC Sec. 165(i), any loss occurring in IRC Sec. 263A (Rev. Rul. 2004-18). a disaster area and attributable to a federally declared disaster Taxpayers must capitalize amounts paid to ameliorate (make better may, at the election of the taxpayer, be taken into account for the or more tolerable) a material condition or defect that existed prior to tax year immediately preceding the tax year in which the disaster a taxpayer’s acquisition of property, whether or not the taxpayer was occurred (not just business losses). aware of the defect at the time of acquisition [Reg. 1.263(a)-3(j)]. See Tax Relief for Disaster Victims on Page Q-1. Therefore, if a taxpayer purchases land contaminated prior to  Disaster Relief Alert: Special rules apply to victims of qualified acquisition, the clean-up cost is capitalized. disasters. See Taxpayer Certainty and Disaster Tax Relief Act of The IRS has privately applied rules similar to those for soil re- 2019 on Page Q-1. mediation costs to a taxpayer removing mold from a building. A Donations of patents, etc. A deduction for a contribution of a deduction was allowed for the cost of removing mold from a nursing patent or certain other items of intellectual property to charity is home where the facility was not contaminated at acquisition and limited to the lesser of (1) the taxpayer’s basis in the property or the mold removal did not prolong the building’s life or increase its (2) the FMV. Taxpayers may deduct certain additional amounts in value (Ltr. Rul. 200607003). later years, based on a specified percentage of qualified income received by the charitable organization from the contributed prop- Environmental remediation costs incurred to clean up land contami- erty. No deduction is permitted for income received by the charity nated with a taxpayer’s hazardous waste during operation of the after the expiration of the legal life of the patent or other intellectual taxpayer’s manufacturing activities are allocable to the inventory property [IRC Sec. 170(e) and (m)]. produced under IRC Sec. 263A during the year costs are incurred Education expenses. An employer can deduct the following (Rev. Rul. 2005-42). employee education expenses: Fines. See Penalties and Fines on Page O-18. • Educational Assistance Program. Up to $5,250 of qualified Franchise. See Intangible Assets on Page O-15. educational assistance can be excluded from an employee’s Fringe benefits. See Tab K. income (IRC Sec. 127). See Tab K for more information about educational assistance programs. Gifts. See Awards and bonuses on Page O-1. • Working Condition Fringe Benefit [IRC Sec. 132(d)]. Employer- Goodwill. See Intangible Assets on Page O-15. provided education is excludable from an employee’s income if Impact fees on real estate development. Impact fees are one- the expense would have been deductible as a business expense time charges imposed by a state or local government for offsite if paid out of the employee’s pocket. An individual is generally capital improvements necessitated by a new or expanded devel- not allowed to deduct education expenses if (1) the education is opment. The IRS has ruled that impact fees are capital expenses required to meet minimum requirements of the individual’s em- ployment or trade, or (2) the education will qualify the individual that are added to the basis of buildings. This allows developers for a new trade or business. See Work-Related Education Costs to depreciate impact fees over the life of constructed buildings, in Tab 5 of the 1040 Quickfinder® Handbook for more information rather than adding the fees to the basis of nondepreciable land. about deducting education expenses for individuals. Impact fees may also be considered for purposes of computing the low-income housing credit (Rev. Rul. 2002-9). Employee awards. See Awards and bonuses on Page O-1. See Impairment Losses on Page O-14. Employee benefit programs. See Tab K. Impairment losses. Entertainment. Before 2018, the expense of providing entertainment Improvements and repairs. Taxpayers may deduct amounts paid to a client, customer, or employee could qualify as an ordinary and for repairs or maintenance of tangible property provided the amounts necessary business expense provided it directly related to or was are not otherwise required to be capitalized (Reg. 1.162-4). associated with the active conduct of the trade or business. Entertain- Insurance. See Insurance on Page O-14. ment activities included the cost of meals (food, beverage, tax, tip). Intangible assets. See Intangible Assets on Page O-15. The TCJA provides that no deduction is allowed for any enter- Intangible drilling costs. See Intangible Drilling Costs on Page O-15. tainment expenses paid or incurred after 2017, except for certain meal expenses associated with operating a trade or business. See Interest. See also Interest Expenses on Page O-16. Meals on Page O-3. The TCJA added IRC Sec. 163(j), which limits the annual deduc- Entertainment expenses included in W-2 wages. Entertain- tion of business interest expense to the sum of a taxpayer’s: (1) ment expenses are completely nondeductible [unless one of the business interest income, (2) 30% of adjusted taxable income (if exceptions in IRC Sec. 274(e) applies]. IRC Sec. 274(e) was not a positive amount), and (3) floor plan financing interest of vehicle changed by the TCJA. This includes expenses for goods, services, dealers. Adjusted taxable income is taxable income computed and facilities that are treated as compensation to an employee on without regard to any item not properly allocable to a trade or the employer’s income tax return and as wages to the employee business; business interest income or expense; any net operating for withholding purposes. When an employer adds the personal loss deduction under IRC Sec. 172; deductions for depreciation, value of a benefit to a specified individual’s taxable W-2 wages, the amortization, or depletion (for tax years beginning before January employer’s deduction is limited to the lesser of the actual cost of the 1, 2022); or the Section 199A deduction. However, taxpayers (other

O-2 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 than tax shelters) with average annual gross receipts for the prior 3) A unit of property [Reg. 1.263(a)-3(e)] that has an economic three years of $25 million or less ($26 million or less for 2019) are useful life of 12 months or less, beginning when the property exempt from this limitation [IRC Sec. 163(j)(3)]. See Business is used or consumed in the taxpayer’s business. Interest Expense Limitation on Page B-6 for further discussion. 4) A unit of property that has an acquisition or production cost (as Form 8990 [Limitation on Business Interest Expense Under Section determined under IRC Sec. 263A) of $200 or less (or another 163(j)] is used to report the disqualified interest for the tax year. amount as may be published by the IRS). 5) Identified by the IRS in future published guidance as materials Inventories. See Inventories on Page L-7. and supplies. Lawyers’ costs incurred on behalf of clients. Costs such as Amounts for incidental materials and supplies (on-hand, non- filing fees, travel expenses, expert witness fees, etc., paid by a inventoried parts) are deducted when paid or accrued. The cost law firm on behalf of a client may be deductible depending on the of non-incidental materials and supplies is deducted in the year fee structure. Such expenses paid under a contingent net fee ar- first used or consumed. See Materials and supplies on Page J-9 rangement (an agreement stating expenses will be paid out of a settlement before the lawyers’ fees are determined) have generally for more information. been considered by the courts as nondeductible advances when Meals. In general, 50% of business-related meal expenses are incurred, and are not included in income when recouped. In con- deductible [IRC Sec. 274(n)]. The limit applies to employers trast, client expenses paid under a gross fee arrangement (where (including partnerships and corporations) even if they reimburse lawyers’ fees are based solely on a percentage of a settlement) employees for 100% of the expenses. See Tab K for discussion are ordinary and necessary business expenses and deductible and exceptions to the 50% limit. See Entertainment on Page O-2 when incurred [Boccardo, 75 AFTR 2d 95-2244 (9th Cir. 1995)]. for TCJA changes to the meals and entertainment rules. Lease payments. See Lease and Rental Expenses on Page O-17. Nonaccountable plan. Employee expense reimbursements made Legal and professional fees. Legal, accounting, and other profes- under a plan that does not meet the requirements for an account- sional fees that are ordinary and necessary expenses of operating able plan (see Accountable plan on Page O-1) are considered a business are deductible as a current operating expense. Fees made under a nonaccountable plan. Reimbursements made under paid to acquire a business asset must be added to its basis. Fees a nonaccountable plan are taxable wages to the employee. paid to organize a partnership or corporation are deducted as a Not-for-profit activities. If an activity is not engaged in for profit, current business expense up to $5,000. The $5,000 deduction is the deduction for expenses associated with the activity is limited reduced for organizational costs exceeding $50,000. Any remaining to income. The deduction limit applies to individuals, partnerships, organizational costs are amortized over 180 months (IRC Secs. estates, trusts, and S corporations, but not to C corporations 195, 248, and 709). See Organizational and Start-Up Costs on [Reg. 1.183-1(a); IRS Pub. 535]. Page M-6. The TCJA disallows miscellaneous itemized deductions that were Licenses and fees. Annual license and regulatory fees formerly subject to the 2%-of-AGI threshold. This is where the paid to state or local governments generally are deductible deduction for hobby expenses was allowed. Therefore, for these [Reg. 1.263(a)-4(f)(8), Ex. 5]. However, costs for licenses that are years the hobby income must be reported with no benefit from essential to the establishment of a taxpayer’s trade or business related expenses allowed. must be capitalized if their value extends beyond the end of the See Home Office for the Small Business on succeeding tax year. For example, the initial costs of acquiring a Office in home. Page P-6. liquor license, taxicab medallion or license, or a television or radio broadcasting license must be amortized as Section 197 intangibles. Organizational costs. See Organizational and Start-Up Costs on Page M-6. Lodging. Expenses incurred in connection with business travel are deductible if reasonable and necessary. The travel must Outplacement services. The cost of providing outplacement ser- be directly related to the conduct of the taxpayer’s business. vices to employees to help them find new employment is deductible Personal activities during business travel will not automatically if the services are provided on the basis of need and a substantial disqualify the deduction, but the trip must be primarily for busi- business benefit exists for the employer (positive business image, ness in order to qualify for deduction [IRC Sec. 162(a)(2)]. Under maintaining employee morale, avoiding wrongful termination suits, a safe harbor, local lodging expenses incurred at business meet- etc.). If the employee can choose to receive cash or taxable ben- efits in place of the services, the value of the services is included ings and conferences are deductible if certain conditions are met in the employee’s income (Rev. Rul. 92-69). [Reg. 1.162-32(b)]. See Meals and Lodging on Page K-10 and Tab 9 in the 1040 Quickfinder® Handbook for more information. Payroll. See Salaries and Wages on Page O-19 and Taxes on Page O-21. See Tab I and Tab K for more information. Losses. See Business Bad Debts on Page O-9, Capital Gains and Losses on Page O-11, Demolition Expenses or Losses on Penalties and fines. See Penalties and Fines on Page O-18. Page O-13 ,and Impairment Losses on Page O-14. Personal expenses. In general, personal expenses are not de- Machinery installation. The cost of installing newly purchased ductible [IRC Sec. 262(a)]. If an expense relates to an item that is machinery is added to the machinery’s basis. used for both personal and business purposes, only the business Machinery parts. Unless the Uniform Capitalization Rules on Page portion may be deducted. L-8 apply, the cost of replacing short-lived parts of a machine Political and lobbying expenses. Amounts paid to influence legisla- to keep it in working condition are deductible. See the discussion tive matters or to participate in political campaigns generally are not in Capitalization Rules on Page J-7 to determine if the costs deductible [IRC Sec. 162(e)]. Dues paid to a tax-exempt organization meet the tangible property regulations’ qualification standards for are not deductible to the extent the amounts are used by the organi- deductibility. zation for nondeductible lobbying activities. Paying for advertising in Materials and supplies. Materials and supplies include tangible convention programs or admission to dinners or inaugural events is property used or consumed in the taxpayer’s business that is not considered an indirect political contribution and is not deductible if any inventory and is any of the following [Reg. 1.162-3(c)]: of the proceeds are for the benefit of a party or candidate. 1) A component used to maintain, repair, or improve a unit of A de minimis exception states that in-house expenses connected tangible property, which is not acquired as part of any single with lobbying are deductible, but only if the total of such expenses unit of tangible property. do not exceed $2,000 for the tax year [IRC Sec. 162(e)(4)(B)]. A 2) Fuel, lubricants, water, and similar items reasonably expected professional lobbyist is allowed to deduct business expenses in to be consumed in 12 months or less. connection with lobbying. 2019 Tax Year | Small Business Quickfinder ® Handbook O-3 Reimbursed employee expenses. See Accountable plan on N Observation: Section 199A is intended to provide tax relief to Page O-1. businesses not benefitting from the reduction in the top corporate Rent. See Lease and Rental Expenses on Page O-17. rate from 35% to 21%. The rules are complex and subject to phase- Repairs. See Improvements and repairs on Page O-2. outs and limits. In conjunction with the enactment of Section 199A, former Section 199, which provided a 9% deduction for qualified Research and development costs. See Research and Develop- production activities income, was repealed. ment Costs on Page O-19. Understanding the mechanics of the QBI deduction is essential to Restaurant or tavern smallwares (Rev. Proc. 2002-12, as modified effective planning to maximize its tax benefit. See Qualified Busi- by Rev. Proc. 2018-31 or any successor such as Rev. Proc. 2019-43). ness Income (QBI) Deduction on Page B-7, as it relates partner- Costs of replacing smallwares such as glassware, dinnerware, pots ships and partners; Qualified Business Income (QBI) Deduction and pans, tabletop items, kitchen utensils, and food storage supplies on Page D-1, as it relates to S corporations and shareholders; are deducted in the year they are available for use at a taxpayer’s Qualified Business Income (QBI) Deduction on Page F-4 for more restaurant. An automatic change in accounting method is available detailed coverage of the deduction; and Qualified Business Income subject to limitations set forth in the revenue procedure. (QBI) Deduction on Page G-8, as it relates to estates and trusts.  Note: The deduction is for replacement items only. Costs of opening a restaurant with an inclusive package of smallwares purchased as part of a business acquisition must be deducted and/or amortized or capitalized as start-up costs. Tax Credits Retirement plans. See Tab K. Unlike deductions—which reduce a taxpayer’s tax liability by the Rotable, temporary, and standby emergency spare parts. marginal tax rate times the deduction amount (cents on the dol- Rotable spare parts are materials and supplies that are acquired lar)—tax credits reduce the tax liability on a dollar for dollar basis. for installation on a unit of property, removable from that unit of See the table Selected General Business Tax Credits on Page property, generally repaired or improved, and either reinstalled on O-7 for more information on the component credits of the general the same or other property or stored for later installation. Temporary business credit. spare parts are materials and supplies that are used temporarily until a new or repaired part can be installed, at which time they General Business Credit are removed and stored for later (emergency or temporary) instal- A taxpayer must file Form 3800 (General Business Credit) to claim lation [Reg. 1.162-3(c)(2)]. Standby emergency spare parts are any of the general business component credits. also treated as materials and supplies [Reg. 1.162-3(c)(3)]. The costs are generally deducted when the parts are disposed of [Reg. Compute each component credit separately on its applicable After each component credit is separately computed on its 1.162-3(a)(3)]. Alternatively, taxpayers can elect to capitalize and form. applicable form, it is then carried to Form 3800, where the com- depreciate the costs [Reg. 1.162-3(d)] or, if eligible, deduct the ponent credits are separately listed and then combined into one costs under the de minimis safe harbor [Reg. 1.162-3(f)]. (See general business credit (GBC). The combined credit is subject to a Capital Improvements vs. Deductible Repairs on Page J-8 for limitation based on tax liability. Follow the line-by-line steps of Part more information.) An optional method of accounting for rotable II of Form 3800 to figure the limitation. Attach to the return Form or temporary spare parts is also available—see Reg. 1.162-3(e). 3800 and the separate forms for each credit claimed. Start-up costs. See Organizational and Start-Up Costs on Page M-6. Exception: Taxpayers whose only source of credits listed on Form Taxes. See Taxes on Page O-21. 3800, Part III, is from pass-through entities may not be required Tools. The cost of tools with a useful life of less than one year is to complete and file separate credit forms to claim the general generally deductible when purchased, unless the Uniform Capital- business credit—see the Form 3800 instructions. If a credit is ization Rules on Page L-8 apply. Tools with a useful life of more being reported from a pass-through entity, that entity’s employer than one year are depreciated. Tab J covers depreciation. identification number must be entered in Part III. Trademark and trade names. See Intangible Assets on Page O-15. Form 3800, Part III includes several check boxes for the specific cat- Travel. Costs for transportation, lodging, and meals are generally egories of GBC being reported. A taxpayer must complete a separate deductible if the expenses are reasonable and necessary, and if Part III for each box checked, and an additional consolidated Part III if the trip is primarily for business. See Lodging on Page O-3 and certain conditions are met. See the Form 3800 instructions for details. Meals on Page O-3. See Tab 9 in the 1040 Quickfinder® Handbook Carryback/carryforward of unused credits. The passive activ- for more information. ity limit and carryover amounts for all GBCs are also reported on Truck and trailer tires. Under the original tire capitalization Form 3800. The general business credit is limited to net income method (OTCM), the cost of original tires is depreciated as part tax reduced by the greater of [IRC Sec. 38(c)(1)]: of the vehicle and the cost of replacement tires is deducted as a • Tentative minimum tax or current expense. A taxpayer must use the OTCM consistently for • 25% of the amount by which the net regular tax liability exceeds $25,000. all its vehicles. (Rev. Proc. 2002-27) If the full general business credit may not be claimed because Wages. See Salaries and Wages on Page O-19. of the limitation, unused credits are carried back one year and forward 20 years (IRC Sec. 39). However, no part of any unused current year business credit attributable to a component credit Qualified Business Income (QBI) may be carried back to tax years before the first tax year that the Deduction component credit was allowable. IRC Sec. 199A Unused credits. Credits as defined in IRC Sec. 196(c) that re- main unused after the 20-year carryforward period may be taken The TCJA added IRC Sec. 199A, which applies to tax years as a deduction in the first tax year following the expiration of the 2018–2025. Under this new provision, individuals, estates and 20-year period. Unused credits may also be taken as a deduction trusts may deduct up to 20% of their QBI from sole proprietorships if a taxpayer dies or goes out of business. See the instructions (including farms) and pass-through entities. for Form 3800 for more information about deducting carryovers.

O-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Other Tax Credits for Businesses The 90% test looks to the average percentage of QO Zone prop- In addition to the various components of the general business erty held by the fund on the last day of the first half of the tax year credit, several other tax credits are available to business taxpay- and the last day of the tax year. Note that a QO Fund cannot be ers, including those shown in the following table. organized for the purpose of investing in other QO Funds. U Caution: A QO Fund that fails the 90% test is subject to a Other Tax Credits for Business Taxpayers Summary penalty for each month of noncompliance [IRC Sec. 1400Z-2(f)]. Tax The penalty amount is calculated under the following formula: Tax Credit IRC Sec. Forms (90% of aggregate assets − aggregate Section 6621(a)(2) underpayment Federal Fuels Tax Various 4136 × amount of QO zone property) rate for the month 1116 Foreign and U.S. Possessions Tax 901 1118 No penalty is imposed if the failure is due to reasonable cause 8801 Prior-Year Minimum Tax/Refundable Minimum Tax 53 [IRC Sec. 1400Z-2(f)(3)]. 8827 The IRS released Form 8996 (Qualified Opportunity Fund), which 852(b)(3)(D) Undistributed Capital Gains of REITs and RICs 2439 is filed annually by corporations or partnerships that are organized 857(b)(3)(D) and operated as a QO Fund. Federal fuels tax. Taxpayers may be eligible to claim a refund or credit for federal and state excise taxes paid for motor fuels for vehicles and equipment. These excise taxes are collected for Selected Energy Tax highway and road construction and maintenance. Therefore, if Incentives for Businesses the equipment or vehicle is used off-road, typically in a trade or business, the excise taxes are refundable. Alternative Motor Vehicle Credit Refundable Minimum Tax. For tax years beginning in 2018–2021, See also Form 8910; IRC Sec. 30B a C corporation’s minimum tax credit limitation is increased by the For vehicles purchased after 2011, the credit is available only for AMT refundable credit amount. The portion of the credit treated as qualified fuel cell motor vehicles. refundable is 50% (100% for a tax year beginning in 2021) of the  The alternative motor vehicle credit excess of minimum tax credits available over the regular tax liability. Expired Provision Alert: has expired for vehicles acquired after 2017. The follow- A corporation with a short tax year must prorate the refundable ing discussion is included in the event the credit is credit based on the number of days in the tax year. extended. Qualified fuel cell vehicle credit. Qualified fuel cell Qualified Opportunity Zones motor vehicles include, for example, vehicles that run To encourage economic growth and investments in distressed on hydrogen power cells. Only new vehicles placed in areas, Congress often uses tax legislation to spur the growth. The service after 2005 and purchased before 2021 qualify TCJA created qualified opportunity zones (QO Zones). These are for the credit. certain low-income communities that meet the requirements of IRC Sec. 1400Z-1. Investing in QO Zones can result in three major tax The IRS will certify the credit amount for qualifying breaks (IRC Sec. 1400Z-2): vehicles. Taxpayers can rely on this certification (Notice 2008-33). • Temporary deferral of capital gains reinvested in a qualified op- Reporting. Form 8910 (Alternative Motor Vehicle Credit) is used to portunity fund (QO Fund), claim the alternative motor vehicle credit. The business/investment- • Permanent exclusion of post-acquisition capital gains from the use percentage of the credit is then transferred to Form 3800. sale or exchange of an investment in a QO Fund held for at least The personal-use portion of the credit is transferred to the “Non- 10 years, and refundable Credits” line 6 of Schedule 3, Form 1040 (check box • The “building” of basis in deferred gain (10% or 15%, based on c and write “8910” in the space next to that box). Any part of the holding period). personal-use portion of the credit that can’t be used in the current Taxpayers continue to be allowed to recognize losses associated year is lost. It cannot be carried over to other years. with investments in QO Funds. Recapture. The IRS has been instructed to issue regulations on Designation of QO Zones. A QO Zone is a population census the rules for recapturing the credits for vehicles that cease to qualify tract that is a low-income community. In addition, the IRS must for the credits [IRC Sec. 30B(h)(8)], except that no recapture will certify and designate the community as a QO Zone [IRC Sec. be required if the vehicle ceases to qualify because it is converted 1400Z-1(a)]. The term low-income community is borrowed from to a qualified plug-in electric drive motor vehicle. As of the date of the Section 45D new markets tax credit [IRC Sec. 1400Z-1(c)(1)]. It this publication, no regulations have been issued. includes any population census tract with a poverty rate of at least 20%. It also includes a tract whose median family income does not Vehicle Refueling Property Credit exceed 80% of statewide median family income. For tracts located See also Form 8911; IRC Sec. 30C within a metropolitan area, the standard is 80% of the greater of :  Expired Provision Alert: This credit is not available after 2017 • Statewide median family income or unless legislation is enacted that extends the provision. This sec- • The metropolitan area median family income. tion is included in the event the rules for the credit are extended. The IRS has published a complete list of all population census Taxpayers may claim a 30% credit for the cost of installing clean- tracts that the Dept. of Treasury has designated as QO Zones fuel vehicle refueling property to be used in a trade or business or (See Notice 2018-40). installed at the taxpayer’s principal residence. The credit generally Definition of a QO Fund. A QO Fund is any investment vehicle that: applies to property placed in service after 2005 and before 2021. 1) Is organized as a corporation or partnership for investing in The maximum allowable credit is: QO zone property and 2) Holds at least 90% of its assets in QO Zone property [IRC Sec. • $30,000 for business property. 1400Z-2(d)]. • $1,000 for property installed at a principal residence.

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook O-5 Qualified alternative fuel vehicle refueling (QAFVR) property is any Two-Wheeled Electric Vehicles property, not including a building and its structural components, See also Form 8936; IRC Sec. 30D(g) whose original use begins with the taxpayer, that is depreciable  Expired Provision Alert: This credit is not available after 2017 (not required for the $1,000 credit) and that: unless legislation is enacted that extends the provision. This sec- 1) Stores or dispenses a clean-burning fuel into the fuel tank of tion is included in the event the rules for the credit are extended. a vehicle propelled by that fuel, but only A credit for purchasing qualified two-wheeled plug-in electric ve- if the storage or dispensing of the fuel hicles is available for vehicles purchased in 2015–2020. Among is at the point where the fuel is delivered other criteria, the vehicle must be (1) capable of achieving a speed into the fuel tank of the vehicle or of 45 miles per hour or greater and (2) manufactured for use on 2) Recharges vehicles propelled by electricity, public roads. The credit equals 10% of the vehicle’s cost (limited but only if the property is located at the point where the vehicles to $2,500) [IRC Sec. 30D(g)]. are recharged. Recapture. The IRS has been instructed to issue regulations on Clean-burning fuels include: the rules for recapturing the credits for plug-in vehicles that cease • Any fuel at least 85% of which consists of one or a mixture of to qualify for the credits [IRC Sec. 30D(f)(5)]. As of the date of this ethanol, natural gas, compressed natural gas, liquefied natural publication, no regulations have been issued. gas, liquefied petroleum gas, or hydrogen. • Any fuel that is a mixture of diesel fuel and biodiesel determined Energy Efficient Home Builders Credit without regard to any use of kerosene and containing at least See also Form 8908; IRC Sec. 45L 20% biodiesel.  Expired Provision Alert: This credit is not available after 2017 • Electricity. unless legislation is enacted that extends the provision. This sec- The tax basis of QAFVR property is reduced by the portion of the tion is included in the event the rules for the credit are extended. property’s cost allowed as a credit. Notice 2007-43 provides interim guidance on the credit pending issuance of regulations. Contractors (including producers of manufactured homes) that build new energy-efficient homes in the U.S. are eligible for a credit of $2,000 per dwelling unit (IRC Sec. 45L). The credit is reported Plug-In Electric Drive Motor Vehicle Credit on Form 8908 (Energy Efficient Home Credit). Partnerships and See also Form 8936; IRC Sec. 30D S corporations transfer the amount to Schedule K. All others carry Taxpayers can claim a credit for each new qualifying vehicle it to Form 3800 (General Business Credit). purchased for use or for lease, but not for resale. The credit • To qualify, the dwelling unit must be certified to have annual amount ranges from $2,500 to $7,500. The portion of the credit energy consumption for heating and cooling that is at least 50% attributable to the vehicle’s business-use percentage is treated less than comparable units and meet certain other requirements. as part of the taxpayer’s general business credit. The remainder is a nonrefundable personal credit that can offset both regular tax • The credit can also apply to a substantial reconstruction and and AMT (IRC Sec. 30D). rehabilitation of an existing dwelling unit. Qualifying vehicles. These are new four-wheeled plug-in electric • A manufactured home that meets a 30% reduced energy con- vehicles manufactured primarily for use on public streets, roads, sumption standard can generate a $1,000 credit. and highways that meet certain technical requirements. • These credits only apply to homes sold by contractors for use However, the following do not qualify: as personal residences. 1) Vehicles manufactured primarily for off-road use (such as golf • The contractor’s tax basis in the home is reduced by the amount carts). of the credit. 2) Vehicles weighing 14,000 pounds or more. • Construction must be substantially completed 3) Low-speed vehicles (four-wheeled vehicles that can obtain a after August 8, 2005, and the home must be speed of 20 but not more than 25 miles per hour and a gross purchased after 2005 and before 2021. vehicle weight rating of less than 3,000 pounds). Certification. The IRS issued guidance on the An Index to Manufacturers of qualified vehicles can be found at certification process that builders must complete www.irs.gov by searching for “Plug-in electric drive motor vehicle.” to qualify for the credit. The notices also provide Manufacturer’s certification. The IRS will a public list of software programs that may be acknowledge a manufacturer’s (or in the used in calculating energy consumption for case of a foreign vehicle manufacturer, its obtaining a certification. See Notice 2008-35 for standard homes domestic distributor’s) certifications that a rules. Notice 2008-36 covers manufactured homes. vehicle meets the standards to qualify for the credit. Taxpayers may rely on such a Energy-Efficient Commercial Building certification (Notice 2009-89). Deduction The credit begins to phase out for a manufacturer’s vehicles when  Expired Provision Alert: This deduction is not available after at least 200,000 qualifying vehicles manufactured by that manufac- 2017 unless legislation is enacted that extends the provision. turer have been sold for use in the U.S. (determined cumulatively This section is included in the event the rules for the deduction for sales after 2009). For General Motors, LLC and Tesla, Inc. are extended. the phaseout period begins in 2019. For the latest on the phase IRC Sec. 179D allows businesses to deduct, rather than capitalize out amounts, see the IRS website at www.irs.gov/businesses/ and depreciate, all or part of the cost of energy efficient commercial irc-30d-new-qualified-plug-in-electric-drive-motor-vehicle- building property. The deduction is allowed for new and existing credit. buildings but only for qualifying property placed in service in 2006  Note: A vehicle is considered acquired on the date when title through 2020. to that vehicle passes under state law (Notice 2009-89). Continued on Page O-8

O-6 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Selected General Business Tax Credits 1 Tax Credit Name IRC Sec. For Rate Forms Employment Credits Differential Wage Payment 45P Small business employers paying differential wages to qualified 20% of eligible differential wage payments; 8932 employees that are active duty uniformed service members. $20,000 maximum wages/year/employee. Disabled Access 44 Expenses to make business accessible to/usable by disabled. 50%; $5,000 maximum credit. 8826 Employer-Paid FICA on Tips 45B Amount paid on tips (not service charges) above minimum 100% of eligible amounts. 8846 wage. Employer-Provided Child Care 45F Employers who provide child care and related services to 25% of qualified child care facility plus 10% of 8882 employees. resource and referral costs. Empowerment Zone 1396 Wages paid to employees working in selected geographic 20% of wages up to $15,000. 8844 Employment2 areas. Family and Medical Leave 45S Eligible employers that pay wages to qualifying employees 12.5% of wages paid to employees on leave, 8994 while they are on family and medical leave. Note: This increased (but not above 25%) by .25 % pts. for provision expires December 31, 2019. each % pt. by which payment exceeds 50%. Indian Employment2 45A Wages and health insurance costs paid to members of an 20% of increase over amount paid in 1993. 8845 Indian tribe or spouse for services performed on a reservation. Small Employer Pension Plan 45E Credit for start-up costs of new employer retirement plans. 50% of eligible costs up to a maximum credit of 8881 Start-Up Costs Employer cannot have more than 100 employees. $500, for first 3 years of plan. Small Employer Health 45R Qualified small employers that pay at least 50% of a qualified Up to 50% (35% for tax-exempt organizations) 8941 Insurance Premiums health arrangement for their employees. of the lesser of: (1) the amount contributed or (2) 990-T the small business benchmark premium. Work Opportunity 51 Effective for work begun by certain targeted groups through Rates vary for certain targeted groups. 5884 2020. 8850 Other Credits Biodiesel and Renewable 40A Use in the production of biodiesel mixture; use of biodiesel in a Biodiesel mixture: $1 per gallon used. 8864 Diesel Fuels2 trade or business or sale at retail; production of qualified agri- Biodiesel: $1 per gallon used or sold at retail. biodiesel. For biodiesel mixture and biodiesel components, $1 Agri-biodiesel: 10¢ for each gallon produced. rate applies if agri-biodiesel or renewable diesel (may include certain aviation fuel) is used. Biofuel Producer2 40(b)(6) Producers of second generation biofuel. Generally, $1.01 for each gallon produced. 6478 Distilled Spirits 5011 Wholesalers and warehousers of distilled spirits. 15.878¢/case of distilled spirits purchased or 8906 stored. Energy Credits2 Var. See Selected Energy Tax Incentives for Businesses on Page Varies Var. O-5. Investment Credit: • Rehabilitation Property 47 • Certified historic structures. • 20%, taken ratably over five years. 3468 • Energy Credit 48 • Equipment that uses solar energy to generate electricity, heat • 10%; 30% for solar energy property and or cool a structure (or provide hot water for use in), provide property using fiber-optic distributed sunlight solar process heat or illuminate the inside of a structure using under construction before 2022, and qualified fiber-optic distributed sunlight. Also, equipment (1) used to fuel cell, or small wind energy property. Note: produce, distribute or use energy derived from a geothermal The 30% rate is reduced to 26% for property deposit; (2) that is a qualified fuel cell or microturbine, that begins construction after December 31, combined heat and power system or qualified small wind 2019. energy property; or (3) that uses the ground or ground water as a thermal energy source to heat or cool a structure. • Qualifying Advanced Coal 48A • Investment in qualifying advanced coal project. • 15%, 20% or 30% of qualified investment (QI). • Qualifying Gasification 48B • Investment in qualifying gasification project. • 20% or 30% of QI. • Qualifying Advanced Energy 48C • Investment in qualifying advanced energy project. • Up to 30% of QI. Low-Income Housing 42 Owners of residential rental buildings providing qualified low- 70% (or 30%) of qualified building basis over 10 8586 income housing. years. 8609-A New Markets 45D Investment in community development entities. 5% – 6% per year over seven years. 8874 Orphan Drug 45C Expenses in testing certain drugs for rare diseases or 25% of qualified clinical testing costs. 8820 conditions. Research Activities 41 Business research and experimental expenditures. 20% of expenses over base amount. 6765 Qualified Opportunity Zones 1400Z-1- Investment in low-income communities as designated as a QO Temporary deferral of gain from the sale of the 8996 and Qualified Opportunity and Zone by the Dept. of Treasury. property and permanent exclusion of post- Funds 1400Z-2 acquisition capital gains on disposition when held for 10 years. 1 See the current version of Form 3800, the other referenced forms and their instructions for details of these credits. 2 This credit is not available after 2017 unless legislation is enacted that extends the provision. The credit is included in this table in the event the credit is extended.

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook O-7 Qualifying property. Energy efficient commercial building property The Codification organizes U.S. GAAP into approximately 90 ac- is depreciable property that is: counting topics arranged in a consistent structure. All guidance • Installed on or in a building located in the U.S. that is not a (1) contained in the Codification carries an equal level of authority, single-family house, (2) multi-family structure of three stories or and any accounting literature not included in the Codification is fewer above grade, (3) mobile home, or (4) manufactured house. considered nonauthoritative. Amendments to the Codification are issued in the form of FASB Accounting Standards Updates (ASU). • Part of the (1) interior lighting system, (2) heating, cooling, ven- tilation, and hot water systems or (3) building envelope. Building If the accounting treatment for a transaction or event is not speci- envelope includes insulation materials primarily designed to fied within a source of authoritative GAAP, an entity should first reduce heat loss or gain, exterior windows, skylights, exterior consider accounting principles for similar transactions or events doors, and some metal roofs [IRC Sec. 25C(c)(2)]. within a source of authoritative GAAP and then consider nonau- thoritative guidance from other sources. Nonauthoritative sources • Certified that it will reduce or is part of a plan of guidance and literature include: to reduce the overall energy costs of these systems by 50% or more. • Practices that are widely recognized and prevalent either gener- ally or in the industry. Deduction limits. There are several deduction • FASB Concepts Statements. limits to consider: • AICPA Issues Papers. • Qualifying property. For any one building, the total deduction for property meeting the 50% or more energy reduction requirement • International Financial Reporting Standards (IFRSs) of the Inter- is limited to $1.80 times the building square footage. national Accounting Standards Board (IASB). • Partially qualifying property. A summary of energy savings per- • Pronouncements of other professional associations or regulatory centages necessary to qualify for a partial deduction (60¢ times agencies. building square footage) is available in Notice 2012-26. • Technical Questions and Answers (Q&A) included in AICPA Technical Practice Aids. Certification. Before claiming the deduction, the property must be certified as meeting the requirements by an unrelated qualified • Accounting textbooks, handbooks, and articles. and licensed engineer or contractor. Taxpayers must retain these When considering the appropriateness of other accounting certifications in their tax records. literature, consideration should be given to its relevance in the circumstances, the degree of specificity of the guidance, whether Software programs. The Department of Energy maintains a public the issuer is recognized as an authority and the extent of its use list of software that may be used to calculate energy and power in practice. consumption and costs as part of the certification process. The list appears at http://energy.gov/eere/buildings/qualified-software- Earnings and profits (E&P). Taxable income modified by certain calculating-commercial-building-tax-deductions. adjustments determines how much profit is available for distribu- tion to shareholders of a C corporation. A distribution from the E&P account is taxable to the shareholder as a dividend. Net Income per Books vs. Taxable income is net income or loss subject to income tax under the rules of the Internal Revenue Code and related regulations is- Taxable Income sued by the U.S. Treasury Department. For a business expense to A comparison between GAAP and tax accounting rules be tax deductible, it must be both ordinary and necessary. Net income per books is not the same as taxable income. Thus, • Ordinary Expense. One that is common and accepted in the certain nontaxable income and nondeductible expenses for tax taxpayer’s trade or business. However, an unusual expense is purposes are included as income and expenses for book purposes. ordinary if reasonably related to the taxpayer’s business. For example, assume a business pays $200 in interest expense • Necessary Expense. One that is helpful and appropriate for the related to tax-exempt municipal bond interest income. For tax taxpayer’s trade or business. An expense does not have to be and AMT purposes, the $200 is nondeductible. However, for book essential or indispensable to be considered necessary. purposes under GAAP and E&P rules, the $200 is an expense Taxable income is modified by because it reduces net earnings available for distribution to the Alternative minimum tax (AMT). certain adjustments and preferences, and an alternative tax rate business’ owners. is applied. If the alternative tax is greater than regular tax, the dif- Schedule M-1 or M-3. Partnerships, LLCs that are not treated ference is called AMT. as disregarded entities and corporations reconcile the difference The TCJA repealed the AMT for C corporations; however, it did not between net income per tax return and net income per books on repeal the AMT for individuals. The Act increased the individual Schedule M-1 or M-3, Form 1065, 1120, or 1120S. Schedule M-3 AMT exemption amounts and significantly increased the exemption is required for larger businesses—see Tab B, Tab C, and phase-out thresholds. In addition, the TCJA eliminated or limited Tab D for more information. some deductions that often caused individuals to be subject to Generally accepted accounting principles (GAAP) include the AMT (personal exemption deduction, state and local taxes, and measurement and disclosure principles that apply to all financial miscellaneous itemized deductions). Therefore, it’s likely fewer statements (except those prepared on a special purpose frame- individuals will be subject to AMT. work, which is also referred to as an other comprehensive basis of accounting). They specify when a transaction will be recorded and the amounts to be recorded and dictate the numbers and Comparison Table A table that compares the GAAP, tax, E&P, and AMT (non-corporate other information that must be presented in financial statements. taxpayers only) accounting treatment of many commonly en- FASB Accounting Standards Codification (FASB ASC) 105 (Gen- countered business transactions starts on Page O-9. For more erally Accepted Accounting Principles) establishes the FASB information on the financial accounting treatment of these and Accounting Standards Codification as the single source of au- many other business transactions, see PPC’s Guide to GAAP, thoritative U.S. GAAP for nongovernmental entities. Rules and which presents the accounting standards in a single, easy-to-use interpretive releases of the Securities and Exchange Commission source. To order PPC publications, call (800) 431-9025 or order (SEC) are also sources of GAAP for SEC registrants. online at tax.thomsonreuters.com.

O-8 2019 Tax Year | Small Business Quickfinder ® Handbook Accounting for Bookkeeping Accounting for Income Tax Capital Gains Realized gains and losses on the sale of securities Individuals including partners and S corporation shareholders. and Losses classified as held to maturity are included in income. Current-year deduction for net capital loss is limited to $3,000 ($1,500 MFS). For nonpublic entities with years beginning on or before December Excess over $3,000/$1,500 is carried forward to the next tax year [IRC Sec. 15, 2018: Securities classified as trading are adjusted to FV on the 1211(b)]. balance sheet and the unrealized gain or loss is included in earnings. Corporations. Current-year deduction for capital loss is allowed only to the extent Securities classified as available for sale are adjusted to FV on the of capital gains [IRC Sec. 1211(a)]. Net capital loss is carried back three years balance sheet; however, the unrealized gain or loss is reported as and forward five years [IRC Sec. 1212(a)(1)]. other comprehensive income. The net change in value is reported as Banks and other financial institutions. Gain or loss from the sale of Fannie a separate equity account until gain or loss is realized, at which time Mae or Freddie Mac preferred stock is treated as an ordinary rather than a gain or loss is included in income. capital gain or loss if the taxpayer held the stock on September 6, 2008 (Rev. For years beginning after December 15, 2018: Investments in debt Proc. 2008-64). securities classified as trading securities and equity securities are adjusted to FV on the balance sheet and the unrealized gain or loss If AMT adjustments that affect basis were made in the current year or is included in earnings. prior years, gain or loss is recomputed using the AMT adjusted basis. A common Debt securities classified as available for sale are adjusted to FV example is the AMT depreciation adjustment. on the balance sheet and the unrealized gain or loss is reported as other comprehensive income. The net change in value is reported as a separate equity account until gain or loss is realized, at which time gain or loss is included in income

If capital losses exceed capital gains, the excess is fully deductible except to the extent the wash sale rules apply to a loss [Reg. 1.312-7(b)(1)]. Charitable Generally expensed as incurred and recorded at FV. An Individuals (including partners and S corporation shareholders) Contributions unconditional promise to give cash should be recorded at the time can deduct charitable contributions on Schedule A of Form 1040. The it is promised by increasing a liability and recording contribution deduction is generally limited to 50% of AGI (100%, 60%, 30% and 20% limits expense. apply to certain contributions) [IRC Sec. 170(b)(1)]. Excess contributions are carried forward for five years. Fully deductible. No adjusted gross income (AGI) or taxable C corporations can deduct charitable contributions as a business expense. income limitation. The deduction is generally limited to 10% of the corporation’s taxable income before considering the charitable contribution [IRC Sec. 170(b)(2)]. Contributions that exceed the 10% limit are carried forward for five years [IRC Sec. 170(d)(2)(A)]. Circulation Generally expensed as incurred. The cost to establish, maintain or increase circulation of a newspaper, Expenses magazine or other periodical is currently deductible, or may be capitalized and amortized as a deferred expense (IRC Sec. 173). Capitalized and written off as part of basis if the asset has a reasonably determinable useful life [IRC Sec. 312(n)(3)]. For noncorporate taxpayers, expenses are amortized over three years [IRC Sec. 56(b)(2)].

Table continued on the next page

Notes

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook O-11 Accounting for Bookkeeping Accounting for Income Tax Computer FASB ASC 350-40 (Intangibles—Goodwill and Other— Cost of acquired computer software: Software Internal Use Software) governs accounting for internal-use software, • Software included in the purchase price of a computer (not separately stated) which is software acquired, internally-developed, or modified solely to is added to the basis of the computer and depreciated over five years, or meet the entity’s internal needs, if during the software’s development expensed under IRC Sec. 179. or modification, no substantive plan exists or is being developed to • Software readily available for purchase by the general public is depreciated market the software externally. over 36 months using the SL method, beginning with the month the software Capitalized or Expensed Software is placed in service [IRC Sec. 167(f)(1)]. Note: Include depreciation on line Preliminary Project Stage. Internal and external costs are expensed 16 of Form 4562 as “Other depreciation.” as incurred. • The cost of off-the-shelf computer software is eligible for a Section 179 Application Development Stage. Internal and external costs incurred deduction [IRC Sec. 179(d)(1)]. are capitalized. Costs to develop or obtain software allowing for • Certain computer software is eligible for 100% bonus depreciation access or conversion of old data by new systems are capitalized. [IRC Sec. 168(k)(2)(A)(i)(II)]. Training costs and data conversion costs not mentioned in the previ- • Software purchased with a useful life of less than one year is deductible as a ous sentence, are expensed as incurred. current expense [Reg. 1.263(a)-4(f)(1)]. Post-Implementation/Operation Stage. Internal and external training Cost of developing software (Rev. Proc. 2000-50). The cost of developing costs and maintenance costs are expensed as incurred. software closely resembles research and experimental expenses under IRC Capitalized Software Sec. 174. Capitalized costs of computer software developed or obtained for • Treat costs as a current expense, or internal use include: (1) external direct costs of materials and ser- • Capitalize and amortize over 60 months from the date of completion of the vices used in developing or obtaining the software; (2) payroll, payroll development, or 36 months from the date the software is placed in service taxes, and employee benefit costs for employees directly associated (Rev. Proc. 2000-50). with and devoting time to the internal-use software project, to the extent time is spent directly on the project and (3) interest costs Leased or licensed software. Deduct as a rental expense. incurred in developing internal-use software. Software included in the purchase price of a trade or business. Amortize Note: General and administrative costs and overhead costs incurred over 15 years [IRC Sec. 197(e)(3)]. in developing or obtaining internal-use software are expensed as incurred. Software’s Purchase Price Includes Multiple Elements The purchase price of developing or obtaining internal-use software can include multiple elements, such as software training, main- tenance, data conversion, reengineering, future upgrades, and enhancements. In such a case, the entity allocates the purchase price among the different elements. The elements of cost are then expensed or capitalized in accordance with the rules discussed above regarding expensing versus capitalization. Observation: Different capitalization versus expensing rules may ap- ply for software sold, leased, or otherwise marketed and for software used in research and development. See Research and Development Costs on Page O-19. Cost of Goods Revenue is recognized as promised goods or services are The cost of an item that is produced or purchased for sale to Sold (COGS) transferred to customers. GAAP requires the accrual accounting customers is deductible. An inventory account must be kept when the method so that revenues and related expenses are reported in the production, purchase or sale of merchandise is an income-producing factor. same accounting period. The accrual accounting method must generally be used for inventory In determining the cost of goods sold (COGS), an inventory account transactions, even though the cash method may be used for service-related is maintained to keep track of the tangible personal property on transactions (Reg. 1.446-1). hand that may be classified as raw materials, work in process and See Inventory Methods on Page L-7. finished goods. Long-term assets subject to depreciation and selling UNICAP. Under IRC Sec. 263A, an allocable portion of most indirect costs expenses are not included in inventory. GAAP requires certain must be included in inventory and expensed under the cost of goods sold rules. overhead expenses to be included in inventory. See Uniform Capitalization Rules on Page L-8 for more information. Under the periodic system, a physical count of inventory on hand Exceptions: For tax years beginning after 2017, the TCJA significantly expands is taken as of a specific date. The net change between the beginning the availability of cash method accounting (see Limitations on Use of Cash and ending inventories determines the COGS amount. Various Method on Page L-2). An exception to the accrual requirement for inventory COGS expense accounts are used to record daily transactions applies for taxpayers with average annual gross receipts of $25 million ($26 such as purchases, purchase returns and allowances, purchase million for 2019) or less (see Accounting Methods for Inventory on Page L-2). discounts, and freight-in. At the end of the period, inventory is debited An exception to the UNICAP rules applies for any producer or reseller that or credited to its actual balance, the expense accounts are debited meets the $25 million ($26 million for 2019) gross receipts test (see Uniform or credited to eliminate existing balances, and a COGS account is Capitalization Rules on Page L-8). debited to balance the entry. See Accounting Methods on Page L-1 for more details. Under the perpetual system, inventory records are maintained and updated continuously as items are purchased and sold. The inventory account is debited when an item is purchased. The COGS account is debited and inventory is credited when the item is sold. At the end of the accounting period, inventory is adjusted to the actual physical count.

O-12 2019 Tax Year | Small Business Quickfinder ® Handbook Tax Planning for the Small Business  Tax Rate Changes Tab P Topics Tax rates for both individuals and corporations, which drive tax Basics of Tax Planning...... Page P-1 planning strategies for businesses, have changed substantially Tax Rate Changes...... Page P-1 due to the TCJA. Accounting Method Changes...... Page P-1 Hiring Dependents...... Page P-2 Individuals Tax rates. The following seven tax brackets apply for years begin- Qualified Business Income (QBI) Deduction...... Page P-2 ning in 2018–2025: 10%, 12%, 22%, 24%, 32%, 35% and 37% (for Partnership Preferred Returns vs. Guaranteed 2019, the top tax rate applies to individuals with taxable income Payments for QBI...... Page P-3 greater than $612,350 for MFJ, $510,300 for Single or HOH, and Kiddie Tax...... Page P-4 $306,175 for MFS). Lodging and Meals for Shareholder-Employees...... Page P-4 Alternative minimum tax (AMT). For years beginning in 2019 the Deducting Medical ExpensesPaid to following AMT exemptions apply: $111,700 for MFJ, $71,700 Employee-Spouse...... Page P-5 for Single or HOH, and $55,850 for MFS. The exemptions are reduced by 25% of alternative minimum taxable income (AMTI) Fringe Benefits...... Page P-6 over $1,020,600 for MFJ and $510,300 for Single, HOH, or MFS. Home Office for the Small Business...... Page P-6  Note: For years 2019–2025 these amounts are inflation indexed. Hobby Losses...... Page P-6 S Corporation vs. C Corporation...... Page P-7 Corporations Partnership vs. S Corporation—SE Tax...... Page P-8 Tax rates. For years beginning after 2017, the corporate income tax Partnership Converts to a C Corporation...... Page P-9 rate is changed to a flat 21%. The flat 21% rate also applies to per- Organizational and Start-Up Costs...... Page P-9 sonal service corporations (PSCs) for years beginning after 2017. Unsuccessful Attempt to Acquire Business— AMT. Repealed by the TCJA for years beginning after 2017. Section 1244 Loss...... Page P-10 Tax on Appreciated Real Estate...... Page P-10 Conversion of Single-Owner to Multiple-Owner Accounting Method Changes LLC...... Page P-11 Change to Cash Method of Accounting Conversion of Multiple-Owner to Single-Member The cash method of accounting was greatly expanded by the LLC...... Page P-12 TCJA to apply to businesses (other than tax shelters) with up to Adjustment to Basis of Partnership Property— $25 million ($26 million for 2019) in gross receipts. In addition, the Section 754 Election...... Page P-12 exemption from the requirement to maintain inventories and to ap- Shareholder Loan to C Corporation...... Page P-13 ply the uniform capitalization (UNICAP) rules has been expanded Shareholder Loan toS Corporation ...... Page P-14 to $25 million ($26 million for 2019) in gross receipts. U S Corporation Built-In Gains Tax...... Page P-14 Caution: Tax shelters, including partnerships and other enti- ties (but not C corporations) where more than 35% of losses are Termination of S Corporation Shareholder’s allocated to limited partners or limited entrepreneurs (persons who Interest...... Page P-15 have an interest in an enterprise other than as a limited partner Corporate Stock vs. Asset Sale...... Page P-16 and do not actively participate in management), are prohibited from Transferee Liability...... Page P-16 using the cash method [IRC Sec. 448(a)(3)] See Tax shelters on Gifting Family Business Interests...... Page P-17 Page B-6 and Syndicates on Page B-6 for additional discussion. Buy/Sell Agreement Funding...... Page P-17 Problem. Prior to the enactment of the TCJA, the cash method was available to (1) taxpayers with average annual gross receipts S Corporation Year-End Planning Checklist...... Page P-18 of $1 million or less; (2) C corporations and partnerships with C Partnership Year-End Planning Checklist...... Page P-19 corporation partners with $5 million or less in average annual gross receipts; and (3) individuals, S corporations, and individually owned partnerships engaged in service activities when average annual gross receipts were $10 million or less. Basics of Tax Planning The cash method provides several advantages that were previously unavailable to many businesses. For example, under the cash method: The following tax planning ideas are general in nature and are 1) Cash basis taxpayers don’t report accounts receivable as intended to provide possible federal tax savings strategies for revenue until constructively received [Reg. 1.451-1(a)]; small business owners. There are many other factors that should 2) Expenses are deducted in the tax year actually paid [Reg. be considered before using any of these ideas. 1.461-1(a)(1)]; The Tax Cuts and Jobs Act (TCJA) provided many changes that 3) Near the end of a tax year, cash method taxpayers can defer greatly impact tax planning for businesses and their owners. These the receipt of income and accelerate the payment of expenses changes include lower tax rates (both corporate and individual), to minimize taxable income for that year; and expanded ability to use the cash method of accounting, and the 4) When the taxpayer wants to report more taxable income for Section 199A qualified business income (QBI) deduction to name the year (for example, to use an expiring net operating loss), just a few. income can be accelerated and deductions deferred. 2019 Tax Year | Small Business Quickfinder ® Handbook P-1 Solution. For years beginning after 2017, the cash method of ac- 4) Wages paid by a parent to a child are deductible by the parent’s counting under IRC Sec. 448(c) is available to taxpayers (other business if the work is done by the child in connection with the than tax shelters) that satisfy a $25 million ($26 million for 2019) parent’s trade or business. gross receipts test, regardless of whether the purchase, production Solution. An employer-parent can shield self-employment (SE) or sale of merchandise is an income-producing factor. In addition, income from taxation by hiring his child. In addition, this could such taxpayers are not required to maintain inventories under IRC help reduce or avoid the 0.9% additional Medicare tax for the Sec. 471 or apply the Section 263A UNICAP rules. Instead, taxpay- employer-parent. See Additional Medicare tax on Page I-2 for ers may treat inventories as nonincidental materials and supplies more information. or conform to their financial accounting treatment of inventories.  Note: Wages paid to a child must be reasonable in relation The gross receipts test is based on the three-tax-year period before to the services rendered [IRC Sec. 162(a)]. The business owner the testing year; however, it doesn’t have to be met for all prior tax should keep detailed records of the child’s employment, including years. If a taxpayer hasn’t been in existence for three years, the payroll records, in case federal or state taxing authorities or labor test period includes the number of years the taxpayer has existed. departments seek verification. See information about child labor Finally, gross receipts for short tax years must be annualized [IRC laws under Fair Labor Standards Act on Page M-8. Sec. 448(c)(3)]. Example: Marshall is a self-employed rocket scientist, operating as a sole Small Contractor Exemption from proprietor. His marginal federal tax rate is 24% and his state tax rate is 8%. Marshall has a 16-year-old son named Junior. Marshall hires Junior as a ray Percentage of Completion Method (PCM) gun tester at the current market rate of $24 per hour. Junior works 40 hours The small contractor exemption from the PCM has been greatly per week through the summer and 5 hours a week on Saturdays the remainder expanded by the TCJA to apply to contractors with up to $25 mil- of the year, earning total wages of $16,320 for the year. lion ($26 million for 2019) in gross receipts. Marshall may deduct $16,320 as wage expense from his business income. Problem. Prior to enactment of the TCJA, income from small The wages are exempt from FICA, and Junior pays $0 income tax. Junior’s construction contracts didn’t have to be computed using the PCM. Form 1040 for tax year 2019 reports the following: However, this exception applied only if all of the following condi- tions were met: Wages...... $ 16,320 1) The contract was a construction contract. IRA deduction...... ( 6,000) 2) At the time the contract was entered into, the taxpayer expected Standard deduction...... ( 12,200) the project to be completed within two years. Taxable income...... $ 0 3) The taxpayer’s average annual gross receipts for the three tax Total tax...... $ 0 years preceding the year the contract was entered into didn’t Ignoring for simplicity the SE and state tax deductions, Marshall would have exceed $10 million. paid $7,529 in total tax on the $16,320 of income at his rate [SE tax $2,306 Solution. For contracts entered into after 2017, small construc- ($16,320 × 92.35% × 15.3%) + federal income tax $3,917 ($16,320 × 24%) + tion contractors are no longer required to use the percentage of state income tax $1,306 ($16,320 × 8%)]. completion method (PCM) if their gross receipts do not exceed Note: It may be possible to increase the retirement plan deduction by contribut- $25 million ($26 million for 2019) and the contract is expected to ing to an employer’s savings incentive match plan for employees (SIMPLE) be completed within two years [IRC Sec. 460(e)]. IRA. See SIMPLEs on Page K-19 for more information.

Applying for the Method Changes  Note: This strategy may be helpful in increasing the QBI de- To take advantage of these TCJA changes, Form 3115 (Application duction for a taxpayer subject to the phaseout range. However, a for Change in Accounting Method) is required to be filed. The IRS reduction of QBI (and the related deduction) occurs when wages has issued automatic consent procedures for taxpayers seeking are paid to family member employees. to change to one or more of these methods. If eligible, taxpayers must use the procedures in Rev. Procs. 2015-13 and 2018-31 (or any successors such as Rev. Proc. 2019-43) as modified by Rev. Qualified Business Income (QBI) Proc. 2018-40. Deduction For more information on applying for these automatic accounting method changes see Change in Accounting Method on Page L-4. Problem. The flat 21% C corporation tax rate under the TCJA could make proprietorships and pass-through entities less attractive. Solution. For tax years 2018–2025, the TCJA enacted the com- Hiring Dependents plex QBI deduction under IRC Sec. 199A available to individuals, estates and trusts that is intended to create some parity with the Problem. Combined income and payroll tax can devour half the 21% flat rate applicable to C corporations. Individual owners of profit of a self-employed individual. It may be possible to shift in- S corporations, partnerships, LLCs, and sole proprietorships (in- come to a dependent child who will pay tax at a lower rate, or no tax. cluding farmers) are eligible for the QBI deduction. In addition, a Applicable rules: qualified rental real estate enterprise will qualify for the QBI deduc- 1) Wages are exempt from FICA for a child under 18 employed tion (Rev. Proc. 2019-38). In general, these taxpayers compute in a parent’s unincorporated business (sole proprietorship), a a deductible amount for each of their trades or businesses. The partnership in which each partner is a parent of the child, or deductible amount is 20% of the individual’s share of the business’s a single-member LLC (SMLLC) [IRC Sec. 3121(b)(3); Reg. QBI, limited to an amount based on the business’s W-2 wages 31.3121(b)(3)-1(c) and (d)]. or a combination of its W-2 wages and its investment in qualified 2) A dependent’s standard deduction ($12,200 maximum in 2019), property (the wage/investment limitation) when the individual’s can be used to shelter up to $350 of the child’s unearned taxable income exceeds certain threshold amounts. The rules are income plus the child’s earned income up to the $12,200 limit complex and the deduction is subject to phase-outs and limits. [IRC Sec. 63(c)(5)]. [For definitions, thresholds and calculation guidance, see Qualified 3) A child may qualify to contribute up to $6,000 to a traditional Business Income (QBI) Deduction on Page F-4.] or Roth IRA for 2019 [IRC Sec. 219(b)].

P-2 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 Thresholds. Taxpayers with taxable income (before the QBI 707(c) or disguised payments for services under IRC Sec. 707(a) deduction) at or below the thresholds ($321,400 MFJ, $160,725 [IRC Sec. 199A(c)(4)]. MFS, $160,700 all others for 2019) are not subject to the wage/ If a partner’s taxable income exceeds certain threshold amounts, his investment limitation on their QBI deduction, but their QBI deduc- QBI deduction will be limited to an amount based on the partnership’s tion may be limited by the overall taxable income limitation (20% W-2 wages or a combination of its W-2 wages and its investment of the excess of taxable income before the QBI deduction over the in qualified property. This is commonly referred to as the wage/ taxpayer’s net capital gain). Taxpayers with taxable income above investment limit. When computing this limit, partners take into ac- the threshold are subject to a phase-in of the wage/investment count their allocable share of the partnership’s W-2 wages (based limit, and the deduction for specified service businesses phases- on their share of wage expense) and qualified property {based on out. See the table QBI Deduction—Taxable Income Thresholds their share of book depreciation expense [Reg. 1.704-1(b)(2)(iv)(g)]}. (2019) on Page F-7. Some partnerships pay little or no W-2 wages because all or most Specified service trade or business (SSTB). Income from an of the work is performed by partners who are compensated with SSTB is not QBI unless the taxpayer’s taxable income is at or guaranteed payments and/or a distributive share of the partner- below an annually adjusted threshold. A business whose principal ship’s income. However, these partnerships may still generate QBI asset is the reputation or skill of one or more of its owners (or if they’re engaged in a qualified trade or business. employees) or that involves the performance of services in one of the following 12 fields is generally an SSTB: health, law, ac- A preferred return is a preferential cash distribution to a partner that counting, actuarial science, performing arts, consulting, athletics, is intended to be treated as a reduction in capital. If the preferred financial services, brokerage services, investing and investment return isn’t guaranteed, it will be treated as a current partnership management, trading, or dealing. [See IRC Sec. 199A(d)(2) and distribution subject to the rules in IRC Sec. 731 (that is, gain is Reg. 1.199A-5.] See the discussion Qualified Business Income recognized to the extent cash exceeds outside basis). (QBI) Deduction on Page F-4 for guidance. Solution. Compensating partners with preferred returns may be better than guaranteed payments because a guaranteed payment QBI Deduction Planning Strategies is not QBI to the partner and reduces the partnership’s income Entity Type Strategy (and, therefore, its QBI). In contrast, a preferred return doesn’t All entities • Keep taxable income (TI) below $321,400 (MFJ), reduce the partnership’s income and QBI. (except $160,725 (MFS), or $160,700 (others) by deferring There are several considerations before changing a compensation C corporations) income, managing taxable portfolio income, accelerating strategy— deductions, maximizing retirement plan contributions, and utilizing charitable donations. • Understand the economic differences between a guaranteed • Consider making a deductible IRA contribution instead of payment and a preferred return, especially if enough partnership a SEP IRA contribution based on Schedule C net profit. income is not generated to satisfy the preferred return. • Consider normalizing depreciation deductions over • Know that the IRS could reclassify preferred returns as a guar- several years by not claiming bonus depreciation and anteed payment or disguised payment for services so be certain Section 179 deductions. that the partnership agreement is properly structured to avoid • Shift income to family by hiring the business owner’s reclassification. dependent children. See Hiring Dependents on Page P-2. • Under IRC Sec. 707(c), guaranteed payments are payments • Consider MFS status in separate property states. determined without regard to the partnership’s income. However, • Revisit entity structure to maximize QBI deduction. the term income is not defined by the Code or regulations. Gener- • Determine if the de minimis rule applies for businesses ally, payments based on net or taxable partnership income, or a that both sell products and perform services and can particular segment or division of the business are considered to be take advantage of being a partial SSTB [thereby avoiding determined with regard to income, thus, not guaranteed payments. SSTB status or allowing partial SSTB treatment under The treatment of payments based on gross income is not clear. Reg. 1.199A-5(c)]. • Determine if it is advantageous to aggregate qualifying trades • Payments for services followed by a direct or indirect allocation of or businesses (meeting the requirements of Reg. 1.199A-4). income and a distribution, if (when viewed together) are properly C Corporation N/A-QBI deduction is not available. characterized as between a partnership and a person acting in a nonpartner capacity, would not be QBI [IRC Secs. 707(a)(2) S Corporation • For a business in the phase-out range, determine if wages paid to shareholders are in the proper ratio to and 199A(c)(4)(C)]. optimize the QBI. (Note: Wages must be reasonable and • Factors indicating a payment is a disguised payment for services this is a hot IRS issue.) (and not QBI) include the following [Prop. Reg. 1.707-2(c)]: Partnership or • Decrease guaranteed payments to partners for services – Lack of significant entrepreneurial risk by the service provider LLC (classified as rendered with respect to the business. relative to the partnership’s overall risk. a partnership) – The service provider would hold (or be expected to hold) the partnership interest for only a short duration. – The service provider would receive an allocation and distribu- tion in a time frame comparable to one a nonpartner would Partnership Preferred Returns vs. typically have to receive payment. Guaranteed Payments for QBI – The service provider would become a partner primarily to obtain tax benefits that wouldn’t have been available if the services Problem. Partner compensation structures may preclude partners were rendered to the partnership in a third-party capacity. from optimizing the QBI deduction. Using preferred returns to – The value of the service provider’s interest in partnership profits partners may boost the partners’ QBI deduction. would be small in relation to the allocation and distribution. – The arrangement would provide for different allocations or Applicable Rules distributions with respect to different services received, the QBI is generally defined as the net amount of items of income, gain, services would be provided either by one person or by related deduction, and loss from a qualified trade or business conducted persons, and the terms of the differing allocations or distribu- within the U.S. (including Puerto Rico) [IRC Sec. 199A(c)(3)]. It tions would be subject to levels of entrepreneurial risk that doesn’t, however, include guaranteed payments under IRC Sec. vary significantly. 2019 Tax Year | Small Business Quickfinder ® Handbook P-3 Preferred returns may mitigate the business interest expense This can be accomplished by buying and retaining any of the fol- limit. Unless an exception applies, IRC Sec. 163(j) limits a tax- lowing investments until the child is no longer subject to kiddie tax: payer’s business interest expense deduction to 30% of adjusted • Capital growth securities and mutual funds that produce little or taxable income (ATI) plus any business interest income and any no current income. floor plan financing interest paid by motor vehicle dealers. The • Vacant land that is expected to appreciate in value. limit applies at the partnership level, and any deduction for al- lowable business interest expense is considered in determining • Stock in a closely held family business that is expected to ap- the nonseparately stated taxable income or loss of the partner- preciate as the business expands, but which pays little or no ship [IRC Sec. 163(j)(4)]. Regulations proposed by the IRS in dividends. November 2018 adopt a broad definition of the term interest. For • Tax-exempt municipal bonds and bond funds. example, guaranteed payments for the use of capital under IRC • U.S. Series EE bonds because recognition of income can be Sec. 707(c) are treated as interest subject to IRC Sec. 163(j) [Prop. deferred until the bonds mature, are cashed in, or an election to Reg. 1.163(j)-1(b)(20)(iii)(I)]. However, preferred returns aren’t recognize income annually is made. specifically mentioned in the proposed regulations. This leads to • Annuities and/or cash-value life insurance policies. the question of whether partnerships should abandon guaranteed payments for the use of capital in favor of preferred returns. • Market discount bonds. Also, if the child is the beneficiary of a trust, coordinate trust income N Observation: A major advantage of preferred returns is their potential to boost a partner’s QBI deduction under IRC Sec. 199A. with the child’s income. The first $2,600 (for 2019) of trust income However, partnership agreements should be carefully drafted to is taxed at the 10% rate. In certain cases, a trust instrument may make sure preferred returns won’t be reclassified as guaranteed allow the trustee to allocate realized capital gains to income in payments or disguised payments for service. whole or in part. [Reg. 1.643(a)-3(b)] Solution 3: Transfer parents’ money. Another strategy is to transfer the parents’ money to qualified tuition plans (529 plans) or Kiddie Tax education savings accounts. (See Qualified Tuition Programs and Education Savings Accounts in Tab 13 of the 1040 Quickfinder® Problem. Under the Section 1(j)(4) kiddie tax, for years 2018– Handbook.) 2019, the taxable income of a child attributable to earned income is taxed under the rates for single individuals and taxable income of a child attributable to net unearned income is taxed according Lodging and Meals for to the brackets applicable to trusts and estates. For the kiddie tax to apply, the child must: Shareholder-Employees 1) Have at least one living parent, at tax year-end; Problem. In certain situations an employ- 2) Not file a joint return for the tax year; and either er must pay for employee meals and 3) Be under age 18 at tax year-end; or lodging in order to conduct business. 4) Be age 18, or a full-time student age 19 through 23, at tax The value of the meals and lodging will year-end with earned income of 50% or less than the amount be considered taxable income to the employee of his support (without regard to certain scholarship income). unless certain factors are present. IRC Sec. 119 sets forth rules  Note: Under the kiddie tax rules as modified by the TCJA, a determining if employer-paid expenses for meals and lodging are portion of a child’s (or young adult’s) net unearned income can be eligible for exclusion from the employee’s income. taxed at the federal income tax rates paid by trusts and estates. Applicable rules. To be excluded from the employee’s income, The trust and estate rate structure is unfavorable because the rate expenses for meals and lodging must first pass the “convenience brackets are compressed compared to the brackets for a single of the employer” test. If the employer furnishes meals to employ- individual. There is no longer a connection between the kiddie ees for a substantial, noncompensatory business reason, they are tax and the parents’ return, unless the parents elect to report the furnished for its convenience (Reg. 1.119-1). child’s income on their return. 1) Meals. To exclude employer-provided meals from income, they Solution 1: Generate earned income. Paying wages to an age- must be provided on the business premises. 18 or older child can potentially eliminate the kiddie tax liability 2) Lodging. To exclude lodging from income, the employee must if the wages cause the child’s earned income to exceed 50% of accept the lodging as a condition of employment and the lodg- his support. Of course, if the child’s after-tax wages are actually ing is furnished on the business premises of the employer. used to provide for his support (as opposed to being saved or invested), the parent’s ability to claim the child as a dependent  Note: Under the TCJA, an employer’s deduction for the cost may be in jeopardy. of business meals is limited to 50% for amounts paid or incurred from January 1, 2018–December 31, 2025 [IRC Sec. 274(n)]. No If the child is in college, his college costs are usually the largest deduction is allowed after 2025 [IRC Sec. 274(o)]. part of his support. Certain scholarships are not considered sup- port. By increasing the amount of a child’s scholarship to cover Also see Meals and Lodging on Page K-10 for more informa- his education costs, using the child’s own funds for support and/ tion. or choosing a less expensive school, the child can more easily meet the more than 50% support test to avoid the kiddie tax. For Example #1: Farmer Jones is the sole shareholder in Dell Farms, a C cor- the years that a student is 19 to 23 years old, the rule is purely poration, and is the corporation’s only employee. Dell owns and operates a mechanical. There is no requirement for the child to actually spend livestock farm where it requires Jones to live in a corporate-owned residence to any of the earned income on his own support. be available for emergencies, day or night. All criteria are met to exclude meals and lodging from Jones’ wages, and to deduct the corporation’s expenses. In Solution 2: Pick the right investments. A family should try to push 2019, the cost of providing the meals and lodging for Farmer Jones amounts investment income that would have been earned in an earlier year to $9,600 for the year. The corporation deducts $4,800 and Jones receives and taxed at the higher trust rates into a year that the investment the meals and lodging tax free. income would be taxed at the child’s lower rate.

P-4 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020  What’s New the United States to warrant assistance by the Federal Government Tab Q Topics under the Robert T. Stafford Disaster Relief and Emergency As- Inflation-Adjusted Amounts...... Page Q-1 sistance Act, and the term disaster area means the area so deter- Tax Legislation...... Page Q-1 mined to warrant such assistance [IRC Sec. 165(i)(5)]. A federally declared disaster includes a major declaration or an emergency Tax Relief for Disaster Victims...... Page Q-1 declaration under the Act (Rev. Rul. 2003-29; IRS Pub. 547). Taxpayer First Act of 2019...... Page Q-4 Help for Disaster Victims—Quick Summary For taxpayers impacted by a disaster, the Code may provide necessary relief. The Code permits the IRS to grant taxpayers af- Inflation-Adjusted Amounts fected by a federally declared disaster additional time to perform certain time-sensitive acts, including filing returns and paying taxes For a summary of inflation-adjusted amounts for 2019 (plus 2020 when the original or extended due date of the return or payment and 2018 and prior years) see the Business Quick Facts Data falls within the disaster period. In addition, affected individual Sheet on Page A-1. and business taxpayers in a federally declared disaster area can more quickly obtain a refund by claiming losses related to the di- saster on the tax return for the previous year, usually by filing an Tax Legislation amended return. See Federally declared disaster on Page N-14. See Tab 5 of the 1040 Quickfinder® Handbook for discussion of personal casualty losses and Tab 4 of the Individuals—Special Tax December 2019 Legislation Situations Quickfinder® Handbook for an expanded discussion of Taxpayer Certainty and Disaster Tax Relief Act of 2019. disaster victims. Enacted on December 20, 2019, the Act retroactively extends The IRS website has information on the most recent tax relief certain expired provisions, generally through 2020. This means provisions for taxpayers affected by disaster situations. Search that taxpayers can apply many of these provisions to both 2019 and already-filed 2018 tax returns. The Act also provides relief for for “Disaster Assistance and Emergency Relief for Individuals and taxpayers affected by qualified disasters occurring from January Businesses” at www.irs.gov for a listing of covered disaster areas 1, 2018 through January 19, 2020. In addition, the Act includes and tax relief provided in response to a federally declared disas- other provisions not related to expired provisions or disasters. ter. Information on prior tax relief provided by the IRS in disaster situations, based on Federal Emergency Management Agency Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). Enacted on December 20, 2019, the (FEMA) declarations of individual assistance, is also available. Act expands opportunities for individuals to increase their savings, Helpful IRS materials include Pubs. 547 (Casualties, Disasters, and makes administrative simplifications to the retirement system. and Thefts) and 2194 (Disaster Resource Guide for Individuals and Businesses). For an additional resource, see the table 2019 Quickfinder tax act summaries. See the Handbook Updates section of the Quickfinder website (tax.thomsonreuters.com/ Federally Declared Disasters in Tab 4 of the Individuals—Special ® quickfinder) for tables summarizing key provisions of the De- Tax Situations Quickfinder Handbook. cember 2019 legislation. Affected taxpayer. A taxpayer does not have to be located in a federally declared disaster area to be an affected taxpayer. Taxpayer First Act of 2019 Taxpayers are affected if records necessary to meet a filing or The Taxpayer First Act (TFA) was enacted on July 1, 2019. The payment deadline postponed during the relief period are located key purpose of this legislation is to alter the management and in a covered disaster area. oversight of the IRS with the aim of improving customer service An affected taxpayer can be: and the appeals process. The TFA also provides new confidenti- • An individual (includes relief workers). ality safeguards as taxpayers interact with the IRS. An important provision of the TFA requires the Treasury Department to submit • Any business entity or sole proprietor. to Congress by September 30, 2020 a comprehensive written plan • Any partner or shareholder in an affected partnership or to redesign the IRS. The plan must (1) streamline the structure of S corporation. the agency, including minimizing the duplication of services and  Note: See Deadlines postponed on Page Q-2 for a list of responsibilities; (2) best position the IRS to combat cybersecurity taxpayer acts that may be postponed in response to a federally and other threats to the agency; and (3) address whether the declared disaster. IRS’s Criminal Division should report directly to the Commissioner. Affected tax preparer. Disaster relief applies to tax preparers Beginning one year after the plan is submitted, the IRS’s current who are unable to file returns or make payments on behalf of their structure, which features operating units that serve particular clients because of the disaster. A taxpayer outside of the disaster groups of taxpayers with similar needs, will cease to apply. For a area may qualify for relief if: summary of the key provisions of the TFA, see Taxpayer First Act of 2019 on Page Q-4. • His preparer is located in the disaster area, and • The preparer is unable to file or pay on the taxpayer’s behalf. To get the postponement for filing or payment, a taxpayer should: Tax Relief for Disaster Victims • Call the Disaster Assistance Hotline at (866) 562-5227. • Explain that the necessary records are located in a covered  Disaster Relief Alert: See December 2019 Legislation on disaster area. Page Q-1 regarding legislative relief for taxpayers affected by • Provide the FEMA Disaster Number of the county where the tax certain qualified disasters. preparer is located. The Internal Revenue Code provides a number of special tax relief Casualty losses. Affected taxpayers have the option of claiming provisions available to victims of a federally declared disaster. For casualty losses attributable to federally declared disasters on their purposes of these provisions, the term federally declared disaster federal income tax return for either the current tax year or the previ- means any disaster subsequently determined by the President of ous tax year. Claiming the loss on an original or amended return

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook Q-1 for the prior year will allow the taxpayer to receive a refund earlier, and local or Indian tribal government efforts in providing emergency but waiting to claim the loss on the current year’s return could services, such as the protection of lives, property, public health result in a greater tax saving, depending on other income factors. and safety, or to lessen or avert the threat of a catastrophe in any If claiming the disaster loss on the previous year’s tax return, put part of the U.S. The total amount of assistance provided for in a the disaster designation in red ink at the top of the form so that single emergency may not exceed $5 million. Federal assistance the IRS can expedite the processing of the refund. available under emergency declarations may include limited types Other relief. The IRS will waive the usual fees and expedite of public assistance and/or individual assistance. requests for copies of previously filed tax returns for affected Major disaster declarations. The President can declare a major taxpayers who need them to apply for benefits or to file amended disaster for any natural event, including any hurricane, tornado, returns claiming casualty losses. Form 4506 (Request for Copy of storm, high water, wind-driven water, tidal wave, tsunami, earth- Tax Return) should be filed with the assigned disaster designation quake, volcanic eruption, landslide, mudslide, snowstorm, or in red ink at the top and submitted to the IRS. drought, or, regardless of cause, fire, flood, or explosion, that he Affected taxpayers who are contacted by the IRS on a collection or determines has caused damage of such severity that it is beyond examination matter should provide an explanation of how they were the combined capabilities of state and local governments to impacted by the disaster so that the IRS can provide appropriate respond. A major disaster declaration provides a wide range of consideration to their case. federal assistance programs for individuals and public infrastruc- ture, including funds for both emergency and permanent work. Drought-stricken farmers. Farmers and ranchers who were Not all federal assistance programs are activated for every major forced to sell livestock due to drought may have an additional disaster. FEMA disaster assistance programs that may apply to a year to replace the livestock and defer tax on any gains from the specific major disaster include several different types of individual forced sales. To qualify for relief, the farmer or rancher must be assistance, public assistance, and hazard mitigation assistance. in an applicable region. This is a county designated as eligible for For more information on the FEMA disaster declaration process, federal assistance plus counties contiguous to that county. The see www.fema.gov/disaster-declaration-process. relief generally applies to capital gains realized by eligible farmers and ranchers on sales of livestock held for draft, dairy, or breed- ing purposes. Sales of other livestock, such as those raised for IRS Disaster Filing and Payment Relief slaughter or held for sporting purposes, or poultry, are not eligible. The Code and regulations authorize the IRS to postpone cer- The sales must be solely due to drought, flooding, or other se- tain tax-related deadlines for up to one year (IRC Sec. 7508A; vere weather causing the region to be designated as eligible for Reg. 301.7508A-1). The IRS usually limits this relief to major di- federal assistance. Livestock generally must be replaced within saster areas eligible for federal individual assistance or individual a four-year period, instead of the usual two-year period. The IRS and public assistance. is also authorized to further extend this replacement period if the Covered disaster area. The regulations and the IRS refer to drought continues. an area for which deadlines have been postponed as a covered disaster area. The one-year extension gives eligible farmers and ranchers until the end of the tax year after the first drought-free year to replace Deadlines postponed. The tax deadlines the IRS may postpone the sold livestock. The IRS provides this extension to farmers and include those for filing income, excise, and employment tax returns; ranchers located in the applicable region who qualified for the paying income, excise, and employment taxes; and making contri- butions to a traditional or Roth IRA. If any tax deadline is postponed, four-year replacement period if any county that is included in the the IRS will publicize the postponement in the impacted area and applicable region is listed as suffering exceptional, extreme, or publish a news release and, where necessary, a revenue ruling, severe drought conditions during any week between September revenue procedure, notice, announcement, or other guidance. Spe- 1, 2018 and August 31, 2019. This determination is made by the cifically, deadlines for performing the following acts are extended: National Drought Mitigation Center. All or part of 32 states, plus Guam, the U.S. Virgin Islands, Puerto Rico, and the Northern • Filing any return of income, estate, gift, generation-skipping Mariana Islands, are eligible. See Notice 2019-54. transfer, excise, or employment tax. Qualified farmers and ranchers whose drought-sale replacement • Paying any income, estate, gift, generation-skipping transfer, period was scheduled to expire at the end of this tax year, Decem- excise, or employment tax, including making estimated tax pay- ber 31, 2019 in most cases, now have until the end of the next ments. tax year. Because the normal drought-sale replacement period is • Making certain contributions or distributions, recharacterizing four years, this extension immediately impacts drought sales that contributions, or making a rollover to or from a qualified retire- occurred during 2015. The replacement periods for some drought ment plan. sales before 2015 are also affected due to previous drought-related • Filing certain petitions with the Tax Court. extensions affecting some of these localities. • Filing a claim for credit or refund of any tax. See Tab 6 of the Individuals—Special Tax Situations Quickfinder® • Bringing suit upon a claim for credit or refund. Handbook for further discussion of this and other weather-related • Certain other acts described in Rev. Proc. 2018-58. tax provisions that may benefit farmers and ranchers. Penalty and interest abatement. The IRS may abate the interest and penalties on any underpaid income, estate, gift, employment, or excise tax for the length of any postponement of tax deadlines. FEMA Disaster Declarations If the IRS postpones a tax deadline, the fol- According to FEMA, there are two types of disaster declarations Eligible taxpayers. lowing taxpayers are eligible for the postponement: provided for in the Stafford Act: emergency declarations and major disaster declarations. Both declaration types authorize the Presi- • Any individual whose main home is located in a covered disaster dent to provide supplemental federal disaster assistance. However, area. the events related to the two different types of declaration, and the • Any business entity or sole proprietor whose principal place of scope and amount of assistance, differ. business is located in a covered disaster area. • Any individual who is a relief worker affiliated with a recognized Emergency declarations. The President can declare an emer- government or philanthropic organization and who is assisting gency for any occasion or instance when he determines federal in a covered disaster area. assistance is needed. Emergency declarations supplement state

Q-2 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020 • Any individual, business entity, or sole proprietorship whose • Qualified disaster relief and mitigation payments (IRC Sec. 139). records are needed to meet a postponed tax deadline, provided • Casualty losses (IRC Sec. 165). those records are maintained in a covered disaster area (the • Involuntary conversions (IRC Sec. 1033). main home or principal place of business does not have to be located in the covered disaster area). • Any estate or trust that has tax records necessary to meet a Legislative Relief Provisions These are provisions that are not part of the automatically avail- postponed tax deadline, provided those records are maintained able Code relief provisions. They may be enacted by Congress, in a covered disaster area. • The spouse on a joint return with a taxpayer who is eligible for typically only for the most serious disasters, and apply to taxpayers postponements. and areas as specifically defined in the legislation. Such legislation • Any individual, business entity, or sole proprietorship not located in may provide different types of tax relief for different areas, and a covered disaster area, but whose records necessary to meet a may be enacted as Code sections or as separate laws that are postponed tax deadline are located in the covered disaster area. not incorporated into the Code. Examples of such relief legislation • Any individual visiting the covered disaster area who was killed are the Disaster Tax Relief and Airport and Airway Extension Act of or injured as a result of the disaster. 2017, which provided temporary tax relief for certain 2017 hurricane • Any other person determined by the IRS to be affected by a victims, and the Bipartisan Budget Act of 2018, which extended federally declared disaster. this relief to certain California wildfire victims. In December 2019, Congress enacted the Taxpayer Certainty and Disaster Tax Relief Additional Code Disaster Relief Provisions Act of 2019 (see December 2019 Legislation on Page Q-1). These relief provisions are automatically available to victims of a federally declared disaster (emergency or major). They provide special rules for the tax treatment of:

Notes

Replacement Page 1/2020 2019 Tax Year | Small Business Quickfinder ® Handbook Q-3 Taxpayer First Act of 2019 Effective Item IRC Sec. Date New Law Before Law Change Reorganization of the IRS Organizational N/A 9/30/20– The Treasury Department must submit to Con- Per the IRS Restructuring and Structure 9/30/21 gress a comprehensive written plan to redesign Reform Act of 1998 (RRA), the the organization of the IRS. Beginning one year IRS was organized into units that after the plan is submitted, the current IRS operat- served particular groups of taxpay- ing units will be dissolved. ers with similar needs. Establishment of 7803(e) 7/1/19 The Act codifies the requirements of an indepen- After receiving a notice, a tax- IRS Independent dent administrative appeals function at the IRS. payer had the right to request a Office of Appeals The IRS Independent Office of Appeals, led by conference with the IRS Office of the Chief of Appeals, resolves federal tax con- Appeals or a settlement officer. troversies without litigation in a fair and impartial Rules pertaining to the appeals manner. If an appeals request is denied, the IRS process were set out in the Internal must provide written notice that explains the basis Revenue Manual. for the decision and the procedures for protesting the denial. Also, for cases in which the appeals conference occurs more than one year after the effective date, individuals with AGI not exceed- ing $400,000 and entities with gross receipts not exceeding $5 million have the right to access the nonprivileged portions of the case file. Office of the 7803(c) 7/1/19 The IRS Commissioner or Deputy Commissioner The NTA issued TADs to the IRS National Taxpayer must modify, rescind, or ensure compliance that identified systemic problems Advocate with a Taxpayer Advocate Directive (TAD) within and mandated changes to IRS tax 90 days after issuance. If a TAD is modified or administration or other processes. rescinded, the National Taxpayer Advocate (NTA) Certain IRS Deputy Commission- may appeal to the Commissioner within 90 days. ers could modify or rescind a TAD. The NTA must report to Congress any TADs not addressed by the IRS. Upon request, the IRS must provide statistical support to the NTA, who must coordinate research efforts with the Treasury Inspector General for Tax Administration (TIGTA) to avoid duplicative efforts. IRS Employees 7804(d) 7/2/20 The IRS is required to submit to Congress a N/A. written report providing a comprehensive training strategy for IRS employees. 7/1/19 The IRS is prohibited from rehiring any employee who has been involuntarily separated for misconduct. Improved IRS Service Comprehensive N/A 7/2/20– The IRS is required to submit to Congress a writ- Per the RRA, the IRS was Customer 7/2/22 ten comprehensive customer service strategy. required to restate its mission Service Strategy Within two years of the Act’s enactment, the to place a greater emphasis on agency must make the plan and training materi- serving the public and meeting als available to the public. taxpayers’ needs. Offers in 7122(c) 7/1/19 An individual whose AGI for the most recent tax As a matter of policy, the IRS did Compromise year does not exceed 250% of the applicable not require certain low-income poverty level is not required to submit an applica- taxpayers to submit an application tion fee or partial lump-sum payment. fee or partial lump-sum payment when pursuing an offer in com- promise. Closure of N/A 90 days If the IRS is planning on closing a Taxpayer Through its TACs, the IRS Taxpayer prior to Assistance Center (TAC), it must publicly notify provided face-to-face assistance Assistance closure (including by nonelectronic means) affected tax- with understanding tax laws and Centers payers. The notice must include the date of the preparing returns. proposed closure and information on alternative forms of assistance.

Q-4 2019 Tax Year | Small Business Quickfinder ® Handbook Taxpayer First Act of 2019 (Continued) Effective Item IRC Sec. Date New Law Before Law Change Cybersecurity, Identity Protection, and Information Technology (Continued) Notification of 7431(e) 12/29/19 The IRS is required to notify a taxpayer if the Taxpayers could bring a civil Unauthorized IRS or a federal or state agency proposed an action for damages if there was Inspection of administrative determination as to disciplinary or an unauthorized disclosure or Returns adverse action against an employee arising from inspection of returns or return his unauthorized inspection or disclosure of the information. taxpayer’s return or return information. Electronic Filing 6011(e) 2021 For taxpayers other than partnerships, the Taxpayers other than partner- of Returns number of returns threshold to require electronic ships did not have to e-file returns filing is reduced from 250 to 100. The rules for unless they were required to file partnerships are retained through 2021. at least 250 returns during the calendar year. For partnerships, the number went from 200 for calendar year 2018 to 20 for cal- 2022 The number is reduced to 10. The IRS may endar years after 2021. However, waive the e-filing requirement for tax return partnerships with more than 100 preparers who demonstrate there is a lack of partners were required to e-file. internet availability (other than dial-up or satellite service) in the geographic location in which the return preparation business is operated.

Uniform 6061(b) 1/1/20 The IRS must publish guidance to establish N/A. Standards for uniform standards and procedures for accepting Use of Electronic taxpayers’ electronic signatures with respect to a Signatures power of attorney or request for disclosure. Payment of 6311(d) 7/1/19 This restriction is removed to the extent the fees The IRS could not pay any fee or Taxes by Debit are fully recouped by the IRS (that is, fees are provide any other consideration in and Credit Cards paid to the IRS by taxpayers). connection with the use of credit, debit, or charge cards for the pay- ment of income taxes. Authentication N/A 12/28/19 The IRS must verify the identity of any individual N/A. of e-Services opening an e-Services account. Accounts Tax-Exempt Organizations E-Filing 6033(n) 7/1/19 For tax years beginning after the effective date, The following tax-exempt orga- and the e-file requirement applies to all tax-exempt nizations were required to e-file 6104(b) organizations required to file statements or re- their annual information returns: turns in the Form 990 series or Form 8872. The (1) tax-exempt corporations with IRS is required to make the information provided assets of $10 million or more that on the forms available to the public in a machine- filed at least 250 returns during a readable format as soon as practicable. Transi- calendar year; (2) private founda- tion relief (up to two years) is provided for certain tions and charitable trusts that organizations. filed at least 250 returns during a calendar year; and (3) orga- nizations that filed Form 990-N (e-Postcard). Notice for Failure 6033(j) 2nd year The IRS must provide notice to an organiza- Charities and other nonprofit to File returns tion that fails to file a Form 990 series return or organizations automatically lost due after postcard for two consecutive years. Among other their tax-exempt status if they 12/31/19 things, the notice must explain how to comply failed to file annual information re- with the annual information return requirements. turns for three consecutive years. Once revoked, the organization had to refile for tax-exempt status.

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2019 Tax Year | Small Business Quickfinder ® Handbook Q-9 Taxpayer First Act of 2019 (Continued) Effective Item IRC Sec. Date New Law Before Law Change Other Provisions Volunteer Income 7526A N/A Unless otherwise provided by specific appropria- Through its VITA program, the Tax Assistance tion, the IRS may allocate up to $30 million per IRS partnered with volunteer (VITA) Program year in matching grants to qualified entities for organizations to provide free tax the development, expansion, or continuation of return filing assistance to low- qualified tax return preparation programs. The income populations, persons with IRS may use mass communications and other disabilities, taxpayers with limited means to promote the VITA program. English proficiency, and other underserved communities. Low Income 7526 7/1/19 IRS personnel may advise taxpayers of the The IRS could provide up to Taxpayer Clinics availability of, and eligibility requirements for $6 million per year in matching receiving, advice and assistance from quali- grants to low-income taxpayer fied low-income taxpayer clinics. They also can clinics. However, IRS personnel provide location and contact information for the were generally prohibited from clinics. referring taxpayers to clinics for advice and assistance. Whistleblower 6103(k) 7/1/19 The IRS may exchange information with whistle- Individuals who submitted infor- Reforms and blowers, but only if such information would mation leading to the detection 7623(d) further the investigation. Also, the IRS must of a tax underpayment (or the notify whistleblowers of the status of their claims detection, trial, and punishment of at certain points in the review process. Under violators of internal revenue laws) penalty of law, whistleblowers are prohibited from could file a claim for an award. disclosing information received from the IRS. Whistleblowers receive anti-retaliation protection similar to that provided by the False Claims Act and the Sarbanes-Oxley Act. Feasibility of N/A 7/1/19 These requirements are repealed. The RRA required the IRS to Return-Free Tax study the feasibility of, and devel- System op procedures for, the implemen- tation of a return-free tax system for appropriate individuals. The IRS was required to report an- nually on the development of the system. Failure to File 6651 1/1/20 For returns required to be filed on or after Absent reasonable cause, if a re- Penalty the effective date, the $205 penalty amount turn was filed more than 60 days described in the Before Law Change column after its due date, the failure to file is increased to $330 (adjusted for inflation for penalty was the lesser of $205 or returns required to be filed in a calendar year 100% of the tax amount required beginning after 2020). Note: Subsequently, the to be shown on the return. The SECURE Act (enacted 12/20/19) increased the $205 amount was subject to an $330 amount to $435. inflation adjustment ($215 for 2019).

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Q-10 2019 Tax Year | Small Business Quickfinder ® Handbook Replacement Page 1/2020