Getting in shape for tax season

New due-diligence requirements and individual and business provisions promise a workout for completing 2016 returns.
By Paul Bonner

Getting in shape for tax season
Image by Scar1984/iStock

The good news for practitioners this year is that they do not have many "extenders" to worry about as they get in shape for tax season. Uncertainty about the fate of extender provisions, that raft of incentives that taxpayers rely on and Congress continually renews for a year or two at a time, often hampers tax season preparation. In late 2015, however, many of the most popular extenders were made permanent, in some cases in modified form, or extended through 2019 by the Protecting Americans From Tax Hikes (PATH) Act of 2015, part of the Consolidated Appropriations Act, 2016, P.L. 114-113. (For more on these extensions, see "Congress Extends Expired Tax Provisions and Makes Some Permanent," JofA, Feb. 2016).

However, the PATH Act and other legislation enacted in 2015 imposed new procedural or technical requirements for taxpayers and preparers, some of them related to the extended provisions. CPAs should take a moment to review those changed requirements, which include new due-diligence provisions, with potential preparer penalties attached.

PRACTICE AND PROCEDURE ISSUES

Tax practice data security

While it has long been sounding warnings to taxpayers about the threat of identity theft tax fraud, throughout the summer and fall of 2016, the IRS sought to make preparers more vigilant in taking cybersecurity measures as well. Not only have most practitioners increasingly in recent years had to deal with this scourge afflicting their clients, but they themselves, with troves of taxpayer data in their care, have come under attack, the IRS says.

The Service has urged preparers to monitor recorded use of their preparer tax identification numbers (PTINs) and warned of phishing schemes targeting tax practices. Thieves have attempted to hack into preparers' computers and gain access to systems and records including through such deceptions as emails with links masquerading as tax software updates. The IRS's "Protect Your Clients; Protect Yourself" campaign webpage collects these tips at irs.gov. Vigilance should be part of any practitioner's training and preparation for the current tax season (see also "Tax Practice Corner: Keeping Clients' Tax Data Secure," JofA, Oct. 2016).

More tax credits subject to due diligence

The PATH Act also instituted provisions effective with the 2016 tax year for practitioners, requiring due diligence in claiming certain tax credits. In making permanent both the American opportunity tax credit and the higher refundable amount of the child tax credit, the PATH Act modified those credits to include requirements similar to already existing ones for the earned income tax credit (EITC). Sec. 6695(g), as amended, requires tax return preparers to comply with due-diligence requirements for determining eligibility for and amounts of the American opportunity tax credit, the child tax credit, the additional child tax credit, or the EITC claimed on a return or a claim for refund, or pay a $510 penalty (for returns filed in 2017) for each failure to do so, effective for tax years beginning after Dec. 31, 2015.

Temporary and proposed regulations (T.D. 9799 and REG-102952-16) provided guidance on these new requirements. Temp. Regs. Sec. 1.6695-2T provides the due-diligence requirements for the credits, reflecting this change. The IRS also has modified Form 8867, Paid Preparer's Due Diligence Checklist, formerly designated only for the EITC, for this purpose. Temp. Regs. Sec. 1.6695-2T(b)(3) provides that preparers must not know or have reason to know any information used in determining the credits is incorrect; may not ignore the implications of information furnished to them; and must make reasonable inquiries regarding any information that appears to be incorrect, inconsistent, or incomplete. Preparers must also contemporaneously document any such inquiries and responses in their files.

NEW PROVISIONS AFFECTING INDIVIDUALS

More attention to TINs

The PATH Act also extended taxpayer identification number (TIN) provisions to the child tax credit and American opportunity tax credit. These provisions are also similar to preexisting ones that apply to the EITC. The PATH Act also instituted a new rule, applicable to all three credits, that the TIN (which for the EITC must be a Social Security number) must have been issued on or before the due date for filing the return for the credit to be allowed. This is the case for both a qualifying child for the child tax credit and the taxpayer claiming the credit (Sec. 24(e)), and, for the American opportunity tax credit, the taxpayer and the individual (if different) who incurs qualified tuition and related expenses. This could pose a difficulty on late-filed 2016 returns requiring one or more applications for a TIN, including an individual tax identification number (ITIN) (see also "Tax Practice & Procedures: ITINs: The Rules Have Changed," The Tax Adviser, July 2016). The provision applies to any return, or any amendment or supplement to a return, filed after Dec. 18, 2015 (other than timely filed 2015 returns).

Speaking of ITINs, another new PATH Act requirement may crop up in some returns involving ITIN holders. The PATH Act also requires renewal of ITINs issued after Dec. 31, 2012, that have not been used on a federal return for three consecutive years. Thus, an affected ITIN will no longer be valid as of Jan. 1, 2017, if it had not been used since Jan. 1, 2014. In addition, all ITINs issued before Jan. 1, 2013, must be renewed on a rolling schedule based on the fourth and fifth (middle) digits of the ITIN. ITINs with middle digits of 78 and 79 were required to be renewed by Jan. 1, 2017. The IRS will announce the expiration and renewal schedule for ITINs with other middle digits in future guidance.

Currently affected ITIN holders (identified by middle ITIN digits of 78 or 79) should have received a notice by mail from the IRS in October with instructions for submitting a renewal Form W-7, Application for IRS Individual Taxpayer Identification Number.

Refunds delayed for early returns claiming an EITC or additional child tax credit

In yet another PATH Act change (Sec. 6402(m)), beginning with taxpayer account credits or refunds made after Dec. 31, 2016, if a taxpayer is allowed an EITC or (refundable) additional child tax credit, no credit or refund of an overpayment (whether or not it results from the tax credit or credits) will be issued before the 15th day of the second month following the end of the tax year of the return for which the taxpayer was allowed the tax credit or credits. Thus, preparers might inform clients who file early in the season and claim either of these credits not to expect to receive any refund they are due until after Feb. 15.

More requirements for credits or above-the-line deduction for qualified tuition and related expenses of higher education

Form 1098-T, Tuition Statement, also takes on greater importance this filing season for taxpayers claiming the American opportunity tax credit, the lifetime learning credit, or a deduction under Sec. 222 for qualified tuition and related expenses. Under the Trade Preferences Extension Act of 2015, P.L. 114-27, for tax years beginning after its enactment on June 29, 2015, no credit or deduction is allowed if the taxpayer or student did not receive Form 1098-T from the eligible educational institution, with a few exceptions. Regulations proposed but not yet finalized as of this writing would remove a previous exception from the requirement for educational institutions to provide the form to nonresident aliens and students whose qualified tuition and related expenses are entirely paid by scholarships or under a formal billing arrangement as defined under Regs. Sec. 1.6050S-1(a)(2)(iv).

In addition, the PATH Act now requires taxpayers claiming the American opportunity tax credit to include on their return the employer identification number of the educational institution to which qualifying tuition and related expenses were paid. It also requires institutions to report only amounts paid rather than, as previously, either amounts billed or paid, but in Announcement 2016-17, the IRS excused institutions from this requirement for calendar 2016.

Other new features for CPAs to heed for 2016 individual returns include at least two that intersect with estate and wealth planning.

Consistent basis reporting between estate and person acquiring property from decedent

The new estate basis consistency rules enacted by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, P.L. 114-41, require that the value of property for estate tax purposes and its initial basis in the hands of an inheritor or acquirer should generally be the same. The new basis reporting rules require the value of property that must be reported on an estate tax return to be reported to the IRS and to every person acquiring an interest in property included in the gross estate for estate tax purposes. The reporting rules apply to estate tax returns filed after July 31, 2015, so the income tax returns of taxpayers with income from a sale or disposition of inherited assets could be affected in this filing season. As of this writing, guidance on these rules exists only in the form of proposed regulations and the instructions to Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent (available at irs.gov). Since the consequences of noncompliance are potentially severe (the inherited property could have a zero basis in the hands of the heir), these momentous provisions warrant keeping feelers out for any affected clients.

To briefly recap, for property with respect to which an estate tax return is filed after July 31, 2015, and whose inclusion in the decedent's estate increased liability for estate tax (reduced by allowable credits), the basis of the property in the hands of a person acquiring the property from the decedent cannot exceed either (1) the value of the property for which the final value has been finally determined for purposes of the estate tax, or (2) for any property not described in (1), its value as identified in a statement furnished to the IRS and the recipient under new Sec. 6035. For more, see "Estate Basis Consistency and Reporting: What Practitioners Need to Know," JofA, June 2016.

Designated Roth account rollover allocations

Clients who have designated Roth accounts with an employer may have taken advantage during 2016 of final regulations (T.D. 9769) simplifying allocation rules for disbursements, making them similar to disbursements from other types of accounts. For taxpayers making a disbursement partly to themselves and partly as a direct rollover to a Roth IRA or another designated Roth account, the pretax amount of the distribution is allocated first to the direct rollover. Formerly, any amount paid in a direct rollover to a Roth IRA or other designated Roth account and any amount paid directly to the taxpayer were treated as separate distributions, with the pretax and after-tax amounts being allocated pro rata to each distribution. Also, under the new regulations, for disbursements directly rolled over into multiple accounts, taxpayers may direct the allocation of pretax and after-tax amounts for each destination. These rules apply to distributions made on or after Jan. 1, 2016, although taxpayers could have applied them under proposed regulations on or after Sept. 18, 2014.

Sec. 83(b) election statement not needed with return

Clients can make an election under Sec. 83(b) to include currently in gross income the fair market value of property received (over any amount paid for it) as compensation for services. For property transfers before 2016, a taxpayer made the election by filing an election statement with the IRS within 30 days of the transfer and filing a copy of the election statement with the return for the year the property was transferred. Under final regulations issued during 2016 (T.D. 9779), for property transfers after Jan. 1, 2016, taxpayers are no longer required to include a copy of the election statement with their returns for the year of transfer. This change is intended to facilitate e-filing for these returns, which formerly had to be filed on paper so the statement could be attached.

A drag on travel plans?

A provision enacted and taking effect in December 2015 does not affect tax returns but may be worth mentioning to clients in any return-related communications, particularly U.S. citizens living abroad. The Fixing America's Surface Transportation Act, P.L. 114-94, included new Sec. 7345, which allows the revocation or limitation of U.S. passports of any person with a "seriously delinquent" tax debt, defined as exceeding $50,000 (adjusted annually for inflation), on which the IRS has issued a levy or filed a notice of lien for which the administrative rights for a hearing have been exhausted. Exceptions are allowed for debt on which a taxpayer is making timely payments under an IRS installment plan or for which collection has been suspended due to a request for innocent spouse relief or a requested or pending Collection Due Process proceeding.

NEW PROVISIONS AFFECTING BUSINESSES

Work opportunity tax credit expanded

The PATH Act extended the work opportunity tax credit retroactively to 2015 and forward through the end of 2019. It also modified the credit to introduce a new category of "targeted groups" of employees whose hiring qualifies an employer for the credit: "qualified long-term unemployment recipient[s]." These are individuals certified by the designated local agency as being unemployed at least 27 consecutive weeks, during some period of which they received unemployment compensation benefits.

No more separate limit for expensing ofqualified real property

Other business-related PATH Act items include higher expensing limits of Sec. 179, now permanent and indexed for inflation (for 2016, a $500,000 limitation and a $2,010,000 phaseout threshold). Most of the PATH Act changes to Sec. 179 were retroactive to the beginning of 2015, but the act's elimination of the separate $250,000 ceiling with respect to qualified real property (Sec. 179(f)) took effect beginning in 2016, so for this tax season, practitioners should pay special attention to the potential benefit for clients with subject property placed in service during the year. The PATH Act also removed the former limitation on the carryforward of unused Sec. 179 expensing amounts attributable to qualified real property, effective with the 2016 tax year.

Partner/employee distinction for disregarded entities clarified

During 2016, the IRS in temporary regulations (T.D. 9766) targeted a position that it said some taxpayers have taken, that where a disregarded entity is solely owned by a partnership, that partnership's partners can be treated as employees of the disregarded entity. Thus the IRS added Temp. Regs. Sec. 301.7701-2T(c)(2)(iv)(C)(2), which clarifies that (1) the rule that a disregarded entity is treated as a corporation for employment tax purposes does not apply to the self-employment tax treatment of any individuals who are partners in a partnership that owns a disregarded entity, and (2) the rule that the entity is disregarded for self-employment tax purposes applies to partners in the same way that it applies to a sole proprietor owner. Accordingly, the partners are subject to the same self-employment tax rules as partners in a partnership that does not own a disregarded entity. For any affected employee plans, taxpayers had until the later of Aug. 1, 2016, or the first day of a new plan year beginning after May 4, 2016, to implement the new rule.

Early adoption of new partnership audit rules

The Bipartisan Budget Act of 2015, P.L. 114-74, repealed the TEFRA (Tax Equity and Fiscal Responsibility Act of 1982, P.L. 97-248) rules governing examinations of partners and partnerships and instituted a new centralized partnership audit regime, effective for partnership tax years beginning after Dec. 31, 2017. However, in temporary regulations (T.D. 9780), partnerships receiving notices of selection for examination for tax years beginning before then may elect to have the new audit rules apply. The election must be made within 30 days of the date of the notice of selection for examination. For more on the new rules, see "Partnership Audit Rules for the Next Decade," The Tax Adviser, July 2016.

OUT OF THE STARTING BLOCKS

Often in the past, congressional machinations over the fate of extender provisions have injected considerable uncertainty, sometimes delaying the start of tax season. This time around, CPAs would seem to have no impediment from that quarter. However, as noted above, some of the finer points of complying with PATH Act requirements, including due diligence and TINs, still needed clarification as of this writing, so CPAs will need to review developments through the end of 2016 and the beginning of the new year. As always, they can rely on journalofaccountancy.com and thetaxadviser.com for tax news posted daily as it happens. And they can hope for a relatively trouble-free tax season, now through April 17.


About the author

Paul Bonner is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at pbonner@aicpa.org or 919-402-4434.


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