2015 Year End Brings With It a Number of Tax Changes
On December 18, 2015, as part of the Consolidated Appropriations Act, 2016, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The PATH Act permanently extends certain taxpayer-friendly measures that for years have been extended one year at a time, while extending other provisions for one year or four years. It has become a recent Washington tradition for these measures to be extended one year at a time, often at the end of the year to which the extension applied, making it difficult for businesses to plan ahead to take advantage of the potential tax savings (or making them fret that certain anticipated tax savings would not be available). For taxpayers caught in this situation, the PATH Act may bring a sigh of relief. The new law also modifies the rules that apply to real estate investment trusts (REITs), amends the Foreign Investment in Real Property Tax Act (FIRPTA), and creates a new mandatory registration for social welfare organizations seeking tax exemption under Code Section 501(c)(4).
The following is a brief summary of just a few of the PATH Act’s provisions. (For more information about provisions of the PATH Act applicable to employee benefits and retirement savings, see Employee Benefits Developments.)
Sales of Small Business Stock
Code Section 1231 provides for an exclusion from tax for gain on the sale of qualified small business stock held by a non-corporate taxpayer for more than five years. For this purpose, qualified small business stock is typically stock in a C (taxable) corporation engaged in certain types of business with gross assets of less than $50 million when the stock was issued. The permanent rule had been a 50% exclusion of such gain, but in recent years the exclusion was repeatedly but temporarily increased to 100%. The PATH Act now permanently provides for a 100% exclusion.
If a C (taxable) corporation converts to an S (pass-through) corporation and then sells assets within a certain period after the conversion, the corporation must pay tax on the difference between the fair market value of the assets at the time of the conversion over their basis at that time. The post-conversion period has historically been ten years long, but it has been reduced to five years on a temporary basis in recent years. The PATH Act now permanently provides for taxation of recognized built-in gains of S corporations for only five years post-conversion.
The PATH Act also permanently extends a previously temporary provision allowing S corporation shareholders to reduce their stock basis only by the adjusted basis of corporate property donated to charity. Absent this provision, S corporation shareholders were often denied the full tax benefit of such charitable contributions.
Additional Charitable Incentives
In addition to the above rule with respect to S corporation shareholders, the PATH Act makes permanent the ability of taxpayers to claim deductions for conservation easements, charitable distributions from IRAs after age 70½, and contributions of food inventory.
After years of discussion, the PATH Act finally makes permanent the federal research and development tax credit. It also extends through 2019 the new markets tax credit (to encourage investment in low-income areas) and the work opportunity tax credit (to promote the hiring of long-term unemployed individuals).
The PATH Act also permanently extends the ability of taxpayers to fully depreciate certain leasehold improvements, restaurant property and improvements of interior retail space over fifteen years, and the ability of certain business owners to immediately deduct up to $500,000 per year spent on tangible business property and business software (i.e., Section 179 property). The PATH Act also extends certain “bonus depreciation” provisions through 2019.
Medical Device Excise Tax
The PATH Act provides for a two-year moratorium on the 2.3% tax imposed on the sale of medical devices. This excise tax was enacted as part of the 2010 healthcare reform and has been in effect since 2013.
REITs offer a tax-preferred method of investing in real estate, provided that a number of often cumbersome requirements are met. Besides being corporations for tax purposes with at least 100 shareholders, REITs must, among other things, pass certain tests with respect to the composition of their income and assets each year, and they must distribute at least 90% of their income to shareholders annually. The reward for meeting these stringent requirements is not having to pay corporate-level income taxes on real estate investments held through a REIT – which can be particularly useful for publicly-traded companies, as well as tax-exempt investors who are subject to unrelated business income tax (UBIT) on debt-financed investments.
In recent years, corporations have attempted to spin off their real estate into REITs, in order to avoid corporate income taxes on income related to the properties. The PATH Act denies tax-free treatment to such spinoff transactions going forward unless the company spinning off the REIT is itself a REIT. The PATH Act also makes a number of other changes to the REIT rules, including:
- reducing the percentage of a REIT’s assets that may be invested in taxable subsidiaries from 25% to 20% starting in 2018;
- permitting REITs to treat debt issued by publicly offered REITs as real estate assets for purposes of the asset tests (but no more than 25% of a REIT’s assets may consist of such debt investments) and for one of the two income tests;
- treating certain ancillary personal property that is leased with real property as real property for purposes of the asset and income test; and
- allowing taxable REIT subsidiaries to provide marketing and certain other services to the REIT.
FIRPTA requires foreigners holding U.S. real estate investments, including stock of companies with substantial real estate holdings, to pay U.S. taxes on their sale of those investments. Buyers of such properties are obligated to withhold and remit to the IRS a portion of the purchase price, unless the seller can establish that it is not a foreign person or an exception to FIRPTA applies.
The PATH Act increases the rate of withholding under FIRPTA from 10% to 15% of purchase price, except in the case of sales of personal residences for $1 million or less, in which case the 10% rate still applies. The Act also increases from 5% to 10% the amount of a publicly-traded company’s stock a person can own before considering whether the stock constitutes a real property interest under FIRPTA, and exempts foreign pension funds from paying tax or being subject to withholding under FIRPTA.
New Rules for 501(c)(4)s
Civic leagues and organizations that exist to promote social welfare, but that do not qualify as charities (i.e., 501(c)(3) organizations) may nevertheless be exempt from tax under Code Section 501(c)(4). Because donations to 501(c)(4) organizations are not deductible, these organizations have historically not been subject to as much scrutiny as 501(c)(3) organizations. For example, while 501(c)(3) organizations are required to register with and be approved by the IRS, registration for 501(c)(4) organizations has been optional – until now.
The PATH Act establishes a streamlined registration process for 501(c)(4) organizations (likely motivated by Congress’s concerns about the IRS’s scrutiny of Tea Party-related 501(c)(4) organizations), but mandates registration for all 501(c)(4) organizations. The PATH Act also allows 501(c)(4) organizations to challenge adverse determinations by the IRS in federal court, and exempts gifts to such organizations (along with labor unions, agricultural organizations, business leagues and chambers of commerce – 501(c)(5) and 501(c)(6) organizations) from U.S. federal gift tax.
See below for links to additional articles from the February 2016 Riker Danzig Tax, Trusts & Estates UPDATE: