ASU 2016-16 Adds Transparency and Simplifies Reporting
The presently prescribed method of accounting for income taxes on the sale of assets between affiliated companies (intra-entity transfers) has in recent years generated discord between accounting professionals and the Financial Accounting Standards Board (FASB). With FASB’s October 24, 2016 issuance of ASU 2016-16, however, the concerns of the accounting profession in this respect have been largely addressed.
FASB stipulations to this point have required that recognition of the income tax effects of intra-entity transfers be deferred until the asset is subsequently sold outside the affiliated group, a rule running counter to the general ASC 740 principle that current and deferred income taxes be recognized in the year that the event triggering them occurs.
Under the newly enacted ASU 2016-16, this deferral methodology goes away for all intercompany asset sales other than sales of inventory (which will remain under the previous FASB guidance). Companies will now be required to recognize the income tax effects (current and deferred) of intercompany non-inventory asset sales in the period in which they occur, despite the transaction being eliminated from consolidated pre-tax income. Thus, this new guidance both simplifies the accounting procedures for intra-entity transfers and adds transparency to their financial reporting, as the income statement tax effects recorded will typically coincide with any cash tax impact incurred in the same reporting period.
While FASB did not prescribe new financial statement disclosure requirements in this pronouncement, it has commented that existing disclosure requirements may apply to intra-entity transfers and their tax ramifications. For instance, companies may have to cite the tax effects of intra-entity transfers within their effective tax rate reconciliations or in disclosing the types of temporary differences giving rise to their deferred tax assets and liabilities.
ASU 2016-16 becomes effective for publicly traded companies in years beginning after December 15, 2017, including interim periods within those years (i.e., first quarter of 2018 for calendar-year companies). For non-public entities, they become effective for annual reporting periods beginning after December 15, 2018 and for interim reporting periods within annual reporting periods beginning after December 15, 2019. Early adoption is permitted, but can only occur in the first quarter of a reporting year (e.g., first quarter 2017 for calendar year companies).
Questions? Contact us to discuss the new reporting requirements and what they might mean for your company.View full article
Options for Calculating an Overall Capitalization Rate
As a real estate owner or investor, you want to know the value of your commercial property.
Appraisers commonly estimate market value using the direct-capitalization approach, which divides net operating income by an overall capitalization rate.
Value = Net Operating Income / Overall Capitalization Rate
The overall capitalization rate (cap rate) is the factor that has the biggest impact on the value estimate. Consider the following examples.
NOI = $100,000
Cap Rate = 10 percent
Value = $1 million
NOI = $100,000
Cap Rate = 12 percent
Value = $833,333
As illustrated above, a two-percentage point difference in the cap rate significantly affects the market value estimate, so appraisers must proceed with great diligence in determining the overall cap rate on commercial property.
Selecting A Cap Rate
The appraiser will take into consideration a variety of factors, including the availability and reliability of market data and perceived risk associated with the property, in choosing one (or more) methods for determining a cap rate. Following are a few examples.
What the Market Will Bear
Real examples always carry more weight, and a cap rate derived from a sale of actual property is more likely to convince investors and underwriters. The formula for a market-extracted rate is:
Cap rate = Property NOI / Sale price
However, this rate will only hold water if the sale property is similar to the appraised property. Occupancy, age, location and quality of the property are all characteristics an appraiser will consider when comparing properties.
In the absence of comparable market data, an appraiser has several options for constructing an overall cap rate.
- Band of investment method bases the cap rate on a composite of mortgage and equity funds. The appraiser will gather market data on the proportion of debt to equity in typical deals, as well as survey data regarding mortgage interest and equity return rates.
- Debt coverage ratio method takes the bank’s perspective. The appraiser multiplies debt coverage ratio by loan-to-value ratio by the mortgage constant.
- Yield capitalization is based on a rate of return, and it anticipates changes in income and value over a period of time.
Each of these methods relies on the accuracy of the underlying data and the appraiser’s professional judgment. Appraisers often use more than one method to determine a cap rate; ideally, the rates derived from each of the methods will vary only slightly.
Business-Related Cell Phones 100% Deductible
Do you provide cell phones for your employees, or reimburse employees for business-related use of their personal cell phones? If so, did you know that this is expense is nontaxable?
The IRS recently issued guidance that clarifies this tax treatment and also states that employers are no longer required to comply with onerous recordkeeping requirements.
The Back Story
Before the Small Business Jobs Act of 2010 removed cell phones from the definition of “listed property,” employers had to track the business versus personal use of the phone to substantiate their position that it was excludible from the employee’s income.
While the Act removed this substantiation requirement, one question still remained: Could employers now deduct 100 percent of cell phone costs as an ordinary and necessary business expense?
The final verdict: Employer-provided cell phones are 100 percent deductible … with one caveat.
The Fine Print
This favorable tax treatment is only available when the cell phone is used primarily for business purposes. The IRS provides the following examples of acceptable business purposes:
- The need for the employee to be available at all hours for work-related emergencies
- The need for the employee to be available to speak with clients when the employee is away from the office
- The need to speak with clients in other time zones, which requires the employee to make calls outside of the normal work day
In the absence of such justifiable business purposes, an employer-provided cell phone would be considered part of the employee’s compensation, and therefore taxable.
The Bottom Line
Thanks to this IRS guidance, businesses can exclude the full cost of employees’ business-related cell phones from taxable income -- without spending time and money on onerous recordkeeping.Are you up to date on IRS and state tax rules and regulations? We can help make sure you don’t miss a step when it comes to tax planning. Contact us or call 716.847.2651.
Are Charitable Freezes Worth Considering?
Hedging strategies are generally considered smart business. So is a strategy to hedge against additional taxes as a result of an IRS revaluation the right move?
In our last post, we described the successful case of Anne Petter, who was able to defend her use of the charitable freeze as a tax-minimization tool.
Could this approach work for you?
Following are a few of our observations about this case and the potential implications on estate and gifting strategies.
Charitable Freezes Are Hot… For Now
In the case of a transfer of hard-to-value assets, a charitable freeze can successfully mitigate the risk of unexpected gift taxes as a result of an IRS audit.
For taxpayers that have already implemented a charitable freeze that is being challenged by the IRS, the Ninth Circuit ruling will bolster the taxpayer’s case.
But don’t get too excited…
Potential Chilling Effect
Yes, the Ninth Circuit essentially gave the green light to the charitable freeze as a gifting strategy. But the court also invited the IRS to change its regulations if it doesn’t like the court’s conclusion.
The IRS also could argue that the formula Petter’s estate used to calculate the additional charitable gifts are against public policy – an argument they unsuccessfully used in U.S. Tax Court and then dropped on the appeal.
Personal tax planning requires careful balancing of estate objectives and ever-changing tax rules and court positions. Our tax professionals can help you evaluate the variables in your personal tax equation. For a complementary consultation, contact us or call 716.847.2651.
Taxpayer Fights IRS … and Wins!
Between the possibility that the gift and estate tax exemptions will sunset after 2012 and the low values of many assets, many taxpayers are weighing the pros and cons of making large gifts before the end of the year.
The IRS’ ace in the hole – challenging valuations of transferred assets – could put a damper on these gifting strategies. But one taxpayer, Anne Petter, successfully implemented a strategy to avoid additional gift taxes as a result of an IRS revaluation.
Taxpayer v. IRS
The Ninth U.S. Circuit Court of Appeals supported Petter’s gifting strategy that avoided additional gift taxes by coupling gifts of LLC units to her children with gifts to charitable foundations. This strategy is known as a charitable freeze.
Here’s how a charitable freeze works:
In the event of a successful revaluation of a transferred asset by the IRS, the excess amount goes to one or more charities, thus avoiding additional estate or gift taxes.
In Petter’s case, the IRS did subsequently determine that the LLC units had been undervalued, triggering the charitable freeze. But then the IRS refused to allow Petter to claim a charitable gift tax deduction on the additional units transferred to the foundations.
To support this position, the IRS cited Section 2522, which says that a charitable gift can’t be “dependent upon the performance of some act or of the happening of a precedent event.”
The IRS claimed the additional charitable gifts were dependent on the happening of a precedent event (the IRS revaluation). Fortunately for Petter, the Ninth Circuit disagreed. In fact, the court argued, the number of units had been predetermined. The only variable was the value of one LLC unit.
While Petter prevailed in this case, it was a long, protracted legal battle. In our next post, we’ll explore the potential implications of Ninth Circuit ruling on personal tax planning strategies. In the meantime, to discuss your gift and estate planning strategies, contact us or call 716.847.2651.
Ownership Alternatives for Foreign Investment in U.S. Real Estate
Deciding to invest in U.S. real estate can be a rewarding endeavor – and a complex one.
Foreign property investors structuring an investment in U.S. real estate must take into account the income tax consequences both in the United States and their home country.
The four most common ownership options for foreign property investors in U.S. real estate include:
- Direct ownership by the foreign individual
- Investment in U.S. real estate via U.S. limited liability company (LLC)
- Investment in U.S. real estate via foreign corporation
- Investment in U.S. real estate via foreign corporate and U.S. corporation/LLC
Choosing the most appropriate alternative depends on the priority the investor places on each of the following factors.
Both direct ownership and ownership through a U.S. LLC allow a foreign property investor to take advantage of the typically lower U.S. federal capital gains tax rates. Investment via a foreign corporation requires foregoing these favorable rates.
On the flip side, foreign corporations are not liable for U.S. estate tax. Direct ownership not only triggers U.S. estate tax, but also foreign individuals must pay regular estate tax rates on the entire estate, compared with the generous exclusion amounts permitted U.S. residents.
In some cases, a foreign individual is planning to invest in a large U.S. real estate fund that uses a U.S. LLC as the investment structure. To eliminate U.S. estate tax issues, the investor might establish a foreign corporation to own their share of the U.S. real estate. (Note that this approach also has the downside of giving up potentially favorable U.S. capital gain rates.)
Personal Income Tax Requirement
Direct ownership or ownership via a U.S. LLC both require foreign property owners to file U.S. federal and state individual income tax returns for each year of ownership, regardless of whether any income tax is owed. Ownership of U.S. real estate via a foreign corporation eliminates this personal income tax filing requirement.
Transfer of Ownership Interest
Under the Foreign Investment in Real Property Tax Act (FIRPTA), the transfer of U.S. real estate by a non-resident alien will trigger a withholding tax generally equal to 10 percent of the fair market value at the time of the transfer. This withholding tax applies to any foreign individual or corporation.
How do these considerations affect your situation? Our real estate professionals can help you determine the most appropriate structure for your planned investment. For more information, contact us or call 716.847.2651.
How Will Taxmaggedon Affect You?
Will you be paying more tax in 2013?
Unless Congress acts, many tax breaks and incentives for individuals and corporations will soon expire. The Tax Relief Act of 2010 extended the Bush-era tax cuts. But the sun sets on those provisions at the end of 2012 – potentially bringing to an end an era of favorable tax legislation.
Here’s a look at the categories of cuts that are expiring (barring new legislation). Be sure to talk to your accountant about whether and to what degree these changes could affect your tax position.
- Income-tax rates would increase across the board, with the maximum marginal tax rate jumping from 35 percent to 39.6 percent, compounded by expiration of the 2 percent employee-side payroll tax cut.
- Marriage penalty relief would expire. Instead of twice the basic standard deduction, the deduction for married couples filing jointly will be 167 percent of the deduction for single taxpayers.
- The Pease limitation, which reduces the total amount of a higher-income taxpayer’s itemized deductions, would be reinstated.
- Personal exemption phaseout, which reduces or eliminates exemptions for higher-income taxpayers, would be revived.
- Earned income credit would be reduced.
- The child tax credit would drop from $1,000 to $500.
- The adoption and child and dependent care credits would be reduced.
- Capital gains would be taxed at a higher rate – a maximum of 20 percent for non-corporate taxpayers vs the current 15 percent.
- Dividends would be taxed at ordinary income tax rates – maximum of 39.6 percent.
- The AMT patch expired at the end of 2011. For 2012, AMT applies to married couples making $45,000 and singles making $33,750.
- Several education-related tax incentives would expire or be significantly reduced after 2012, such as the Coverdell Education Savings Account, the student loan interest deduction and higher education tuition deduction. The American Opportunity Tax Credit would revert back to the lower benefits of the Hope credit.
- The federal estate tax rate would jump from 35 percent to 55 percent, with the exclusion amount dropping precipitously from $5 million to $1 million.
- The federal gift tax would be reunified with the estate tax.
- Generation-skipping transfer (GST) tax would once again be equal to the highest estate and gift tax rate – scheduled to be 55 percent in 2012.
So what’s the likelihood that these sunsets will occur? Unfortunately, pretty high. While both Democrats and Republicans have proposed tax reform, it’s unlikely these camps will come to an agreement before the November elections. Congress is also feeling significant budgetary pressures, making further extension of many of these tax cuts unlikely.
Tax Planning Steps
Despite the uncertainty, there are steps you can take in anticipation of these sunsetting provisions. Such as:
- Consider accelerating income and capital gains into 2012.
- To the extent possible, defer deductions into 2013.
- If you own a pass-through entity, take another look at the benefits of a C corporation.
Tax Planning Opportunity for Real Estate Owners
IRS modifies recognition of section 481(a) adjustments resulting from concurrent depreciation method changes
Real estate owners now have the ability to separate or consolidate the section 481(a) adjustments* resulting from concurrent depreciation method changes made on a single Form 3115. Taxpayers looking to either minimize or maximize taxable income will find this to be a useful tool, as it provides a planning opportunity with respect to the recognition of the resulting section 481(a) adjustments, i.e., the increases or decreases in taxable income that generally result from a change in method of accounting.
Most impermissible to permissible depreciation method changes include multiple assets for which the taxpayer is changing assets from long-lived to short lived, as well as short-lived to long-lived, all within the same Form 3115. Permitting concurrent changes on a single Form 3115 - when a taxpayer implements an impermissible to permissible depreciation method change for more than one asset for the same year of change – may be a sound planning strategy depending upon the taxpayer’s situation.
As a property owner, you may have two options – the choice of either:
- Aggregating the section 481(a) adjustment for all assets included in the Form 3115 and taking the adjustment into account in the year of change or over four taxable years, depending on whether the netted number is negative or positive; or
- Aggregating all negative section 481(a) adjustments into one net number that will be taken into account in the year of change, and aggregating all positive\ section 481(a) adjustments into one net number that will be taken over four taxable years.
To determine if this is indeed a tax planning opportunity for you, please contact the tax team at FreedMaxick by calling 716.847.2651, or clicking here.
About Section 481(a) Adjustments
The section 481(a) adjustment equals the difference between the total amount of depreciation taken into account in computing taxable income for the property under the taxpayer’s former method of accounting, and the total amount of depreciation allowable for the property under the taxpayer’s new method of accounting, for open and closed years prior to the year of change. However, the amount of the section 481(a) adjustment must be adjusted to account for the proper amount of the depreciation allowable that is required to be capitalized under any provision of the Code (for example, section 263A) at the beginning of the year of change.
Because the adjusted basis of the property is changed as a result of a method change made under section 6.01 of Rev. Proc. 2011- 14, items are duplicated or omitted. Accordingly, this change is made with a section 481(a) adjustment. The adjustment may result in either a negative section 481(a) adjustment (a decrease in taxable income) or a positive section 481(a) adjustment (an increase in taxable income) and may be a different amount for regular tax, alternative minimum tax, and adjusted current earnings purpose.
Is Your Organization Ready?
Accounting rules are changing as United States Generally Accepted Accounting Principles (GAAP) continue to converge with the globally accepted International Financial Reporting Standards (IFRS). The transition from the rules-based GAAP approach to the principles-based IFRS approach will require considerable adjustments for all companies.
The SEC recently announced a Roadmap for Convergence, which lays out a plan for the implementation of IFRS standards in the United States. The current plan calls for all public companies to adopt the IFRS standards by Dec. 15, 2016. The largest public filers can elect to adopt IFRS for fiscal years beginning as early as Dec. 15, 2009. If the current roadmap holds, large accelerated filers will be required to adopt IFRS in 2014, accelerated filers in 2015, and non-accelerated filers in 2016. In 2011, the SEC will review progress and decide whether the current Roadmap will continue or whether amendments to the timeline are necessary.
With the SEC’s release of the Roadmap for Convergence, it is clear that convergence with IFRS is only a matter of time.
The Financial Accounting Standards Boards (FASB) and the International Accounting Standards Board (IASB) are working to develop a common set of standards that would apply to all companies, not just public companies. So, while nonpublic entities may not be fully adopting IFRS, they will be affected nearly as much as their public counterparts. It is, therefore, wise to begin preparations now.
All industries will need to make adjustments as they progress with conversion. For real estate companies, issues like fair value, business combinations, non-controlling interest, investment properties and lease accounting will demand particular attention. Following is an outline of some of those issues.
Business Combinations and Non-controlling Interest
The FASB issued two pronouncements effective for calendar 2009 that bring reporting methods for business combinations and non-controlling interest into close alignment with IFRS. Issues addressed in those pronouncements include:
- Contingent consideration
- Transaction costs of the acquirer
- Initial measurement of non-controlling interest
- Classification of non-controlling interests
- Accounting of other issues, such as:
- Restructuring costs
- Adjustments made to fair value allocation during the measurement period
- Contingencies acquired or assumed in a business combination
- Deferred taxes of acquirer
- Bargain purchase
- Increases and decreases in the ownership percentage of the subsidiary, so long as the parent retains control
Fair value has been a problematic issue in the convergence process, as U.S. GAAP now has specific guidelines for the term, while IFRS has yet to formulate a definition. There are also considerable difference between the two standards concerning the depth and breadth of assets and liabilities that can be recorded at fair value.
An initiative to move GAAP standards into a position more congruent with IFRS, partly by allowing fair value to branch out to further nonfinancial instruments, such as investment properties is being temporarily delayed, but will be revisited in the future, as a broader use of fair value is a key component of IFRS.
FASB and IASB also are jointly addressing the concepts under which companies account for leases, which are obviously key issues for the real estate industry. The two governing bodies are developing a joint standard that will be more streamlined than the current FAS 13, Accounting for Leases. Topics under discussion for this standard include:
- Continuing to develop the right-of-use model
- Recognition of assets and liabilities under all leases, including operating leases
- Leasee obligations to incur costs to return the leased item, return the leased item in specified condition and maintain the leased item
- Variable lease payments
- Options to extend or terminate a lease.
With the SEC’s release of the Roadmap for Convergence, it is clear that convergence with IFRS is only a matter of time. While the impact will differ from industry to industry and company to company, it is clear that all companies will have to address this issue to one degree or another. The best approach is to assess the impact on your organization now and to prepare your operations for convergence.
To this end, the Tax and Real Estate experts at FreedMaxick can help. Contact or call us today at 716.847.2651 for a confidential discussion of your situation.
How to Claim a Business Tax Deduction on a Failed Corporate Subsidiary
A corporate liquidation of a subsidiary is never a pleasant event. But there might be a light at the end of the tunnel in the form of a business tax deduction if that corporate subsidiary can be classified as worthless stock.
Internal revenue code Section 165 (g) (3) allows for an ordinary loss deduction on a corporate liquidation or other disposition of a worthless subsidiary.
Claiming an Ordinary Loss Deduction
To claim an ordinary loss tax deduction on worthless stock, a domestic parent corporation must satisfy two tests:
- Ownership test - The parent must directly control the subsidiary, defined as owning at least 80 percent of the subsidiary’s stock. Note that this definition of control includes foreign subsidiaries, as well as domestic subsidiaries.
- Gross receipts test - More than 90 percent of the subsidiary’s aggregate gross receipts for all taxable years must be from sources other than royalties, rents, dividends, interest, annuities and gains from sales or exchanges of stocks and securities.
Insolvency is not enough to qualify a subsidiary for a worthless stock deduction. The parent must establish worthlessness through a completed transaction, such as a corporate liquidation, which establishes that the shareholder will never receive value for its stock. Methods of liquidating that trigger the worthless stock deduction include:
- Legal liquidation or dissolution
- Election to treat the subsidiary as a disregarded entity
- Merger of the subsidiary with an entity disregarded from the parent
- Sale of the subsidiary with a corresponding Section 338 (h) (10) transaction
Intercompany Debt and Potential Disallowance
There are two additional issues that must be considered when determining whether an ordinary loss deduction can be claimed to reduce a company’s tax liability.
The first is the proper recognition of intercompany debt. Distinguishing intercompany debt from equity can be tricky, and the IRS and numerous courts have weighed in on how to distinguish between the two. If the account is not classified as debt for tax purposes, and the value of the assets exceed the sum of external liabilities, the subsidiary may be deemed solvent. However, even when intercompany accounts cannot be classified as debt, if the account represents a preferred class of equity, it may still qualify for the worthless stock deduction.
Second, companies must evaluate compliance with the unified loss rules (ULR), which are intended to disallow non-economic losses and eliminate duplicate losses on the disposition of a consolidated entity.
If your business is saddled with an insolvent subsidiary, we can help you determine whether or not you can offset taxable income by taking a worthless stock deduction. Contact or call us today at 716.847.2651 for a confidential discussion of your situation.