Tax News Highlights 04.29.22
What’s Up in Washington, D.C.
Summer/Fall Legislative Catalog
With 2022 midterm elections quickly approaching, Congress effectively only has a few months to pass legislation before its members strike a pose out on the campaign trail. Here are a few potentials that could hit the D.C. runway:
Bipartisan bill “SECURE 2.0” has passed the House and currently sits with Senate where it is likely to see changes to combine the House and Senate versions before finalizing. The retirement-focused bills would follow on the heels of the 2019 SECURE Act and potentially raise the RMD age and require certain employers to auto-enroll employees into retirement plans, among other changes.
Bipartisan China-competitiveness legislation that involves several manufacturing-related provisions promoting domestic innovation and jobs. Again, House and Senate versions exist and would need to be combined into one bill both chambers can agree on. Potential for a delay on the mandatory §174 research expense capitalization requirement here? Uncertain; it’s reportedly unlikely many tax provisions would make it into this bill to avoid additional partisan debate, but full research expensing has support across the aisle and if it doesn’t show up here, could be seen elsewhere as it had been in the ole BBB.
A tax reform reconciliation bill à la Build Back Better could try to make a comeback, though it will probably avoid the BBB name as to not scare away Senator Manchin. Speaking of, the West Virginia centrist is once again showing support of an ultra-light tax reform bill to address climate/energy, raising tax rates, and battling inflation and the deficit.
Manchin is pushing for a bipartisan effort, rather than promoting a single-party agenda, which will likely upset progressives who could lose social program provisions they support. However, he’s not opposed to Dems going it alone if necessary. But we’ve seen this cover story before - big talk no delivery. Believing political posturing may be going out of style.
But Congress seems to love the last-minute drama, and expired tax provisions also need to be addressed, per usual. So what could also happen is a yearend omnibus bill containing provisions from all of the above – we’ll have to wait to see if this year is a show stopper or another big flop. And let’s not forget that their discussion agenda also includes additional COVID preparedness funding, support for Ukraine, and managing rising gas prices, which all take time to hash out.
Proposed Estate & Gift Tax Changes
Proposed regulations relating to the basic exclusion amount (BEA) that is used in calculating the federal estate and gift taxes would apply an exception to the special rule for transfers made allowing an exemption in a current year relating to gifts made under a higher BEA in that existed in prior years. The rules take effect for estates of decedents dying once the proposed regulations have been published as final.
Your favorite topic is trending again! E-filing of Schedules K-2 and K-3 for S corporations is now delayed further to late-July (rather than mid-June), say the IRS FAQs updated this week.
Additional FAQs were added on April 11, 2022 as well pertaining to K-2/K-3 requirements.
ProPublica continues to print stories involving leaked confidential tax return information obtained covering over 15 years of the nation’s wealthiest people, and Congress is again pushing the IRS for answers. Republican tax committee leaders sent a letter to Treasury Secretary Janet Yellen requesting an update on the investigation, as no one has yet to be identified in the potential data breach. The letter asserts the information is being politicized and is also misleading, stating “ProPublica often muddles concepts of wealth (a stock) and income (a flow) to make claims of ‘true tax rates’.”
Tax Naughty List
A Chicago-area tax preparer was charged with filing false tax returns as a side hustle to her U.S. Postal Service job. The indictment alleges she deliberately included bogus education expenses and inflated business income resulting in improper refunds for her clients, in addition to claiming false education credits for herself over several years. A maximum penalty of three years for each false return could apply, coupled with up to 20 years in prison for each count of wire fraud.
Pinch of SALT
Colorado with a couple newsworthy items this week:
As a result of excess funds in the coffer, tax rebates to individuals will be sent out over the summer: $400 for single filers and $800 for MFJ. More details to come.
The state is moving forward with a bill to allow retroactive application to its passthrough entity tax program. Many states have enacted the SALT cap workarounds, but Colorado would be the first to do so on a retroactive basis.
Case of the Fridays
A married couple in Ohio were denied nonpassive loss claims on rental properties due to their inability to support their supposed real estate professional status.
Mr. Sezonov owned and operated an HVAC business, DBS (a single-member LLC). DBS purchased two Florida rental properties and subsequently rented them out during 2013 and 2014. During those years, Mr. Sezonov worked full-time in his HVAC business and had no employees. The Sezonovs managed the rental properties, with Mrs. Sezonov leading the day-to-day activities such as advertising, cleaning, and scheduling rental periods, and Mr. Sezonov performing maintenance and repairs and assisting with email correspondence. The Sezonovs claimed nonpassive losses on Schedule E of their individual tax return with respect to the Florida rentals, which the IRS disallowed. The Tax Court agreed with the IRS that the pair were not real estate professionals and therefore could not treat their rentals as other than passive activities.
Taxpayers may deduct ordinary and necessary expenses paid or incurred in the ordinary course of business under §162, however, activities deemed to be passive face deduction limitations under §469 where passive losses are limited to passive income in a taxable year.
Under §469(c)(1) and (2) a “passive activity” is any trade or business in which the taxpayer does not materially participate or any rental activity regardless of whether the taxpayer materially participates in the activity. While §469(c)(2) generally treats all rental activity as passive, there is an exception for taxpayers who qualify as real estate professionals under §469(c)(7)(B). For these taxpayers, the rental activity is treated as a trade or business that can potentially be a nonpassive activity if the taxpayer materially participates in the activity.
A taxpayer qualifies as a real estate professional for a taxable year if:
1) More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and
2) Such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
In the case of a joint return, these requirements are considered satisfied only if either spouse separately satisfies both requirements.
A real property trade or business for these purposes is defined under §469(c)(7)(C) and means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
With respect to the material participation hours assessment, each rental property will stand alone unless an aggregation election under §469(c)(7)(A) is made. However, the 750-hour test may use all of the taxpayer’s real property trade or business activity, regardless of an aggregation election.
Treas. Reg. § 1.469-9(c)(4) provides that in determining whether a married taxpayer materially participated in a real property trade or business, but not for any other purpose under section 469(c) such as the 750-hour test, work performed by the taxpayer’s spouse is treated as performed by the taxpayer.
To prove material participation, Temporary Treasury Regulation §1.469-5T(f)(4) states that hours may be supported by any reasonable means, including “the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.”
Why They Lost
The couple initially failed to maintain contemporaneous records of hours spent working on the rental properties, but created a time log after the fact upon petitioning the Tax Court based on rental agreements and emails related to the properties, summarized below:
By reviewing their hours, the Sezonovs do not independently pass the real estate professional 750-hour test so they cannot pass go and collect $200; this stop is where they get off on the nonpassive journey. Since this first hurdle isn’t cleared, the rentals stay inherently passive under §469(c)(2) and it doesn’t matter if they materially participated or not – losses from these activities are limited under the passive activity loss rules.
The Sezonovs also failed to make the aggregation election, meaning had the couple passed the 750-hour real estate professional test, the Court would have assessed material participation hours for each property independently making it harder achieve nonpassive status for both properties.
And finally, the Court notes the time records provided were often unclear as to which spouse was performing services and that the estimates appeared excessive. But even if the Court accepted the logs as credible and accurate, the real estate participation 750-hour test was not met for either of the Sezonovs, as evidenced in their time logs. Mr. Sezonov also faced the hurdle of proving he spent more than half of his working hours on the rentals, as he already had a full-time job in his HVAC business.
Real estate professional rules are complex and proper documentation to support the hours necessary to pass the tests is required.
It can be difficult for a person who works full-time in a business that isn’t a real property trade or business to pass the real estate professional test.
Have a great weekend!