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Has The Government Jumped The Gun On Opening Tax Season?

by
Lee Reams, BSME, EA
on
1/9/2019
Has The Government Jumped The Gun On Opening Tax Season?

2018 has given taxpayers a historic change in tax law, the Tax Cuts and Jobs Act (TCJA), that rivals the complexity of the last major overhaul of the tax laws in 1986, which introduced a number of new complexities including the passive loss limitations. The TCJA, like the 1986 tax act, was billed as tax simplification; you may recall the TCJA touted a postcard tax return for most taxpayers. Several of my colleagues in the tax industry expressed concern that the new law would put them out of business. I reminded them that whenever Congress embarks on tax simplification it turns out to be just the opposite, and the 2018 tax reform has been no exception. To keep from having egg on their faces for not having the promised postcard size tax return, the IRS actually cut up the existing 1040 tax return into 2 large postcard size forms with six additional new back-up schedules, creating further complications. (While the TCJA was actually signed into law in December 2017, we are referring to it as 2018 tax reform because the vast majority of the provisions aren’t effective until tax year 2018.)

This new law is so complicated that the IRS has been overwhelmed with the task of writing new, and revising old, tax regulations. As a result, we are entering tax season with little, and in some cases misleading, guidance related to a number of important issues, making it almost impossible to prepare some returns correctly. On top of that, there is pending legislation, the Retirement, Savings and Other Tax Relief Act of 2018 that would extend certain provisions that expired in 2017 along with some special provisions for 2018 disaster victims. Those supposedly in the know don’t think it will pass, but you never know for sure. Ah, and did I mention that there are a number of “technical corrections” (more legislation) needed to correct oversights, unintended consequences and confusing language in the TCJA?

So, that raises the question, is the IRS opening the tax-filing season too soon with all these uncertainties? Should the government extend the April 15, 2019 filing deadline?  Here are examples of unanswered issues, and there are others:

Rentals as a Trade or Business - One of the more important issues related to the legislation is the definition of a “trade or business” since that describes the kind of activity that can create income for purposes of the new Sec. 199A deduction (aka the pass-thru deduction). The tax code does not provide a definitive “bright line” definition of a trade or business, and the new proposed regulations simply adopted an existing subjective definition that relies on the outcomes of past court cases and interpretive rules the IRS has issued under code section 162, which is the most familiar provision using the term “trade or business”.

This leaves some room for interpretation; most notably whether or not rental real estate income qualifies for the Sec. 199A deduction. Our tentative research finds that virtually all court cases refer to real estate rental activities as a trade or business with one notable exception for triple net leases. Thus it is our belief rental activities qualify as a trade or business except for:

  • Triple net leases
  • Vacation home rentals
  • Short-term rentals through online sites like AirBnB or HomeAway. Although in some cases these may rise to the level of a trade or business.

However the IRS recently released a draft version of IRS Publication 535 related to business expenses, and the publication includes the following passage (bolding added) that further clouds the issue rather than providing clarification.

The ownership and rental of real property doesn’t, as a matter of law, constitute a trade or business, and the issue is ultimately one of fact in which the scope of your activities in connection with the property must be so extensive as to give rise to the stature of a trade or business. However, the rental or licensing of property to a commonly controlled trade or business is considered a trade or business under section 199A.

The wording “so extensive” is subjective and places a cloud over the issue, putting into doubt whether a run of the mill rental will qualify as a trade or business. This is contrary to the extensive research we did through a number of court cases, which almost universally treat rentals as a trade or business. So we still have this unanswered question as we approach the start of tax season. 

Brokerage Services – TCJA treats brokerage services as specified service trades or businesses (SSTBs) for purposes of the limitations imposed on the Sec 199A pass- through deduction. TCJA proposed reliance regulations define the field of brokerage services as follows (bolding added):

Proposed Regulation Sec 1.199A-5(b)(2)(x) - Meaning of services performed in the field of brokerage services. For purposes of section 199A(d)(2) and paragraph (b)(1)(ix) of this section only, the performance of services in the field of brokerage services includes services in which a person arranges transactions between a buyer and a seller with respect to securities (as defined in section 475(c)(2)) for a commission or fee. This includes services provided by stockbrokers and other similar professionals, but does not include services provided by real estate agents and brokers, or insurance agents and brokers.

However, the recently released 2018 Draft Pub 535 included the following statement in the section describing SSTBs: 

“Brokerage services, including arranging transactions between a buyer and a seller for a commission or fee such as stockbrokers, real estate agents and brokers, insurance agents and brokers, and intellectual property brokers.”

This inclusion of real estate and insurance agents and brokers as SSTBs contradicts proposed Treasury Regulation Sec 1.199A-5. Does this mean the authors of the publication have reason to believe the final regulations will treat real estate and insurance brokers and agents as SSTBs?

Tracing Equity Debt – Prior to the passage of TCJA, taxpayers who itemized their deductions could deduct the interest on up to $100,000 of home equity debt. Home equity debt had to be secured by the home and could not be traced to the use of the funds unless the taxpayer made an affirmative election to treat the debt as unsecured by the home.

With the passage of TCJA, the deduction for home equity debt interest is no longer deductible and taxpayers will want to trace the use of the funds to a deductible purpose wherever they can. However, TCJA only suspended the deduction for home equity and did not address the issue of whether or not the first $100,000 of equity debt secured by the home would be treated differently than the pre-TCJA law and be allowed to be traced to other uses. This is an issue that will come up frequently where taxpayers have used the home equity loan proceeds for business or investment purposes. (We should note that home equity interest is deductible as qualified home mortgage interest when the proceeds of a home equity debt are used to buy, build or substantially improve the home and the home mortgage debt limit hasn’t been exceeded.) 

Extender Legislation Pending – If you recall, last year in February, over a month after the opening of tax season, Congress passed an unexpected extender bill that caused the IRS to scramble with forms and forcing some early filers to amend returns in order to take advantage of the extended provisions. Although most sources doubt this legislation will pass, it is something that needs to be watched. Here is a list of the most prominent proposed extenders:     

  • Nonbusiness energy property (Residential $500 Credit). 
  • Qualified fuel cell motor vehicles. 
  • Alternative fuel refueling property credit. 
  • 2-wheeled plug-in electric vehicle credit. 
  • Credit for electricity produced from certain renewable resources. 
  • Energy efficient homes credit. 
  • Classification of certain racehorses as 3-year property. 
  • Energy efficient commercial buildings deduction $2,000. 
  • 7-year recovery period for motorsports entertainment complexes.
  • Accelerated depreciation for business property on an Indian reservation.
  • Expensing rules for certain film, TV and live productions. 
  • Indian employment credit. 
  • Exclusion from gross income of discharge of qualified principal residence 
  • Treatment of mortgage insurance premiums as qualified residence interest.
  • Above-the-line deduction of qualified tuition and related expenses. 

Pending Disaster Legislation – There is also pending legislation that would aid victims of certain 2018 disasters, and like the extender legislation, most Washington-watchers don’t think it will pass, but because of the severity of the disasters in 2018 and because Congress passed similar legislation to help victims of hurricanes Harvey, Irma and Maria, our legislators may be inclined to vote yes despite their political differences.  Most notably included in the disaster legislation is the suspension of the 10% of AGI limitation accompanied by an increase of the per casualty limit of $100 to $500. 

Both the extender and disaster legislation are incorporated in the Retirement, Savings and Other Tax Relief Act of 2018 along with some additional tax law changes. Although it is doubtful the Act will pass in its entirety, there is a chance portions of it may pass, including the extender and disaster portion. 

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Lee Reams, BSME, EA

Lee Reams, BSME, EA

Editor-in-Chief

Besides his role at CountingWorks as an educator and speaker to thousands of accountants nationwide, Lee manages a technical research service for a large group of tax accountants which sharpens his technical skills. Lee served on the Board of Blackline Systems, is a former Board of Director for the California Tax Education Council, is a Past President of the San Fernando Valley Chapter of Enrolled Agents, Member and Past Director for the California Society of Enrolled Agents.

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