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Taxpayers Provided With Flexibility To Make Favorable Adjustments To Depreciation

Posted on April 2020 by info

In April 2020, the IRS released several pieces of guidance providing taxpayers with the ability to receive immediate cash flow benefits and implement tax planning opportunities associated with changes made to depreciation under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The procedures in the guidance summarized below present taxpayers with a limited time period in certain circumstances to claim additional depreciation expense for assets placed in service during 2018, 2019 and 2020. While many of the benefits are associated with the depreciation of qualified improvement property (QIP), several provisions apply to other types of depreciable property as well.

The legislative history to the 2017 tax law known as the Tax Cuts and Jobs Act (TCJA) signaled Congress’ intent to treat QIP as 15-year, bonus-eligible property. However, due to a drafting error, QIP was inadvertently characterized as 39-year property ineligible for bonus depreciation. On March 27, 2020, the CARES Act corrected this drafting error by treating QIP placed in service after December 31, 2017, as bonus-eligible, 15-year property. In response to the retroactive correction, the IRS released Rev. Proc. 2020-25 to provide guidance allowing taxpayers to claim additional depreciation by amending their prior return(s) or filing an automatic Form 3115, Application for Change in Accounting Method. As further discussed below, Rev. Proc. 2020-25 also provides taxpayers the ability to revoke a prior election out of bonus depreciation or make a late election to elect out of bonus depreciation while Rev. Proc. 2020-22, provides taxpayers with the ability to make or revoke a late election under Section 163(j). Additionally, Rev. Proc. 2020-22 sets forth the procedures for taxpayers to make other Section 163(j) elections under the CARES Act, including the election out of the 50% adjusted taxable income (ATI) limitation for 2019 or 2020 and the election to use 2019 ATI in a 2020 taxable year.

Under Section 163(j)(7)(A), as amended by TCJA, certain taxpayers are allowed to make an irrevocable election (real property trade or business election or farming business election) to opt out of the interest expense deduction limitation under Section 163(j). In exchange for being able to deduct the full amount of business interest expense, taxpayers making the election must calculate depreciation expense for nonresidential real property, residential rental property, and qualified improvement property using the Alternative Depreciation System (ADS), which generally requires longer recovery periods as compared to the General Depreciation System (GDS).

Given the drafting error in the TCJA, many taxpayers with QIP placed in service during 2018 or 2019 chose to make the real property trade or business election (or farming business election) due to the minimal difference between GDS and ADS depreciation for QIP. Now that QIP is bonus-eligible, many taxpayers may find more benefit if they deduct additional depreciation expense relative to the deferral of interest expense under Section 163(j). Accordingly, Rev. Proc. 2020-22 provides such taxpayers relief by allowing them to revoke their election made on prior year returns and claim additional depreciation expense under GDS.

Taxpayers that adjust their prior-year depreciation (and/or Section 163(j) limitation, if revoking an election under Rev. Proc. 2020-22) will need to consider any ancillary effects of the adjustments. For instance, provisions such as Section 263A, which requires taxpayers to capitalize depreciation associated with the production or resale of inventory, or Section 250, which involves the computation of a taxpayer’s depreciable basis in tangible property, may need to be adjusted in certain instances. In addition, if the additional depreciation expense from QIP results in a taxpayer generating a loss in a taxable year that is eligible for carryback to a prior year with a higher tax rate, the difference in tax rates may generate permanent tax savings. As such, it is essential for taxpayers to consider the comprehensive impact on their tax positions when evaluating potential action steps provided under the two revenue procedures.

Rev. Proc. 2020-25 – Adjusting Depreciation Expense for Prior Years

Rev. Proc. 2020-25 provides that changing the depreciation of QIP to 15-year, bonus-eligible property constitutes a change from an impermissible to permissible method of accounting. With respect to QIP placed in service by the taxpayer after December 31, 2017, the revenue procedure allows taxpayers to correct their depreciation expense by either amending their returns or filing an automatic Form 3115 with a timely filed (including extensions) federal tax return.

Important considerations under Rev. Proc. 2020-25 are summarized below:

Taxpayers choosing the amended returns option generally must file on or before October 15, 2021. Partnerships subject to the centralized partnership audit regime may file an amended Form 1065 under Rev. Proc. 2020-23, but must do so before September 30, 2020. If a partnership subject to the centralized partnership audit regime chooses not to file an amended Form 1065 or cannot file an amended Form 1065 (e.g., because the placed-in-service year of QIP is not within the scope of Rev. Proc. 2020-23), it may file an administrative adjustment request (AAR) instead. Partnerships that are not subject to the centralized partnership audit regime cannot file an AAR and must therefore file an amended return.
The amended returns or AARs must include the adjustment to taxable income for the change in QIP depreciation expense as well as any collateral adjustments (e.g., Section 263A). Such collateral adjustments may include adjustments to original or amended returns for any affected succeeding taxable years as well, such as depreciation expense on a 2019 return that was filed by a partnership on or before March 15, 2020.
Taxpayers choosing to file a Form 3115 may avail themselves of a new automatic change #244, which applies only to QIP placed in service after December 31, 2017. This new method change provides taxpayers with streamlined procedures by temporarily waiving certain eligibility rules and offering reduced filing requirements. If taxpayers choose the Form 3115 option, the additional depreciation is computed as a Section 481(a) “catch-up adjustment” that is included in the return as a reduction to taxable income for the year of change.
Taxpayers are also allowed to make a late election to opt out of bonus depreciation, make a late election to use ADS, or revoke an election out of bonus depreciation by filing an amended return, amended Form 1065 or AAR for the year the property was placed in service. Alternatively, taxpayers can forego amending returns (or filing an AAR) by filing an automatic method change #245 for the first or second taxable year after the taxable year in which the taxpayer placed the property in service, or, if later, the taxable year for which the taxpayer timely files an original federal income tax return on or after April 17, 2020, and on or before October 15, 2021. Importantly, these late elections and revocation are not limited to QIP only.
Rev. Proc. 2020-25 also clarifies that for purposes of the Remodel-Refresh Safe Harbor under Rev. Proc. 2015-56, taxpayers may treat capital expenditures under the remodel-refresh safe harbor as QIP to the extent the taxpayer can substantiate that such expenditures qualify as QIP.

Rev. Proc. 2020-22 – Elections under Section 163(j)

Rev. Proc. 2020-22 allows taxpayers to retroactively withdraw or make a late election under Sections 163(j)(7)(B) (real property trade or business) or 163(j)(7)(C) (farming business). Additionally, taxpayers may also make certain elections related to amendments made to Section 163(j) under the CARES Act. Key considerations of Rev. Proc. 2020-22 are described in further detail below:

Taxpayers may withdraw a Section 163(j)(7) election for their 2018, 2019 or 2020 taxable year by filing an amended federal income tax return, amended Form 1065, or AAR, as applicable, on or before October 15, 2021. Partnerships filing an amended Form 1065 pursuant to Rev. Proc. 2020-23 must file the amended return and furnish corresponding Schedules K-1 before September 30, 2020. The adjustments to taxable income for the late Section 163(j) election must include any collateral adjustments to taxable income or to tax liability, including any additional depreciation allowed under GDS. Further, a taxpayer must also file amended federal income tax returns, amended Forms 1065, or AARs, as applicable, for any affected succeeding taxable years.
Rev. Proc. 2020-25 clarifies that a taxpayer withdrawing an election under Section 163(j)(7) must do so under the provisions of Rev. Proc. 2020-22 exclusively. That is, taxpayers cannot retroactively withdraw a real property trade or business or farming business election by filing a Form 3115 and claiming additional depreciation or adding back interest expense via a Section 481(a) adjustment. Partnerships contemplating claiming additional depreciation will need to fully evaluate the manner in which these benefits are obtained since a Form 3115 allows the current year partners to benefit from the bonus depreciation whereas an amended return or AAR gives the benefit to adjusted year partners.
Taxpayers may make a late election under Section 163(j)(7) for their 2018, 2019 or 2020 taxable year by filing an amended federal income tax return, amended Form 1065, or AAR, as applicable, on or before October 15, 2021. Partnerships filing an amended Form 1065 pursuant to Rev. Proc. 2020-23 must file the amended return and furnish corresponding Schedules K-1 before September 30, 2020. Similar to the revocation of the Section 163(j)(7) election, the adjustments to taxable income for the late Section 163(j) election must include any collateral adjustments to taxable income or to tax liability, such as the amount of depreciation allowed or allowable as determined under the rules provided in Rev. Proc. 2019-8.
Taxpayers may elect out of the 50% adjusted taxable income (ATI) limitation, which was increased from 30% under the CARES Act for a 2019 or 2020 year. A partnership can make this election only for a 2020 taxable year. To effectuate the election, a taxpayer must timely file a federal income tax return or Form 1065, an amended return, amended Form 1065, or AAR, as applicable, using the 30% ATI limitation. No formal statement is required.
If a taxpayer made the election not to apply the 50% ATI limitation for 2019 or 2020, but wishes to revoke the election later, it may file an amended federal income tax return, amended Form 1065, or AAR, as applicable, for the applicable tax year using the 50% ATI limitation.
Taxpayers may also elect to use their ATI for the last taxable year beginning in 2019 as the ATI for any taxable year beginning in 2020 under Section 163(j)(10)(B). This can be accomplished by timely filing a federal income tax return, Form 1065, an amended federal income tax return, amended Form 1065, or AAR, as applicable, for the 2020 taxable year using the amount of ATI from 2019. The election can also be revoked by amending the return/Form 1065 or filing an AAR.
A partner may elect out of the 50% excess business interest expense (EBIE) rule by timely filing a federal income tax return or Form 1065, an amended federal income tax return, amended Form 1065, or AAR, as applicable, for the partner’s first taxable year beginning in 2020. The election is made by not applying the 50% EBIE rule in determining the Section 163(j) election. Similar to the election under Section 163(j)(10)(B), the election can be revoked by amended the return/Form 1065 or filing an AAR.

Key Takeaways

Rev. Procs. 2020-25 and 2020-22, in conjunction with the changes made under the CARES Act, provide taxpayers with a multitude of immediate cash flow benefits and planning opportunities. As many of these changes involve multiple avenues for taxpayers seeking relief, taxpayers must consider several pertinent factors in assessing the most advantageous approach for their positions, including any corollary effects on other provisions, the NOL carryback potential from a year when the tax rate was 21% to a tax year when rates were as high as 35 percent, and the administrative complexities associated with implementing the opportunities. For example, while amending a prior year return may be more burdensome from a compliance standpoint, taxpayers may find the additional effort worthwhile in exchange for the ability to receive an immediate refund and interest. Generally, filing a Form 3115 provides taxpayers with a more streamlined process of claiming additional depreciation, although additional complexities may arise if the taxpayer is a partnership with different partners in the year of change versus the year(s) the assets were originally placed in service.

As several of the beneficial opportunities provided in Rev. Proc. 2020-25 and Rev. Proc. 2020-22 must be made within a limited time period, taxpayers should begin evaluating their options as soon as possible to ensure adequate time to implement an appropriate action plan.

COVID-19 Postponement Relief Under Notice 2020-23 Expanded By IRS

Posted on April 2020 by info

On April 9,2020, the IRS issued Notice 2020-23, which contains expanded relief for those tax forms and other filings that are postponed as was originally announced last month. See the IRS Coronavirus website for more details.

First, the payments and returns eligible for relief are expanded. Any tax return or payment due on or after April 1, 2020, and before July 15, 2020, is now automatically postponed to July 15, 2020—no extension forms, letters, or other forms of documentation or communication are required to make use of this relief. This will now cover, for example, calendar-year 2020 second quarter estimated tax payments, among other things. If an Affected Taxpayer as defined by the notice needs additional time to file, such taxpayer may choose to file the appropriate extension form by July 15, 2020, to obtain a filing extension. However, the taxpayer’s extension date may not exceed the original statutory or regulatory extension date. For example, a taxpayer can file Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, by July 15, 2020, to extend the due date of their 2019 calendar year tax return (generally due on April 15, 2020). However, the extension granted will only be to October 15, 2020, which is the original extension date for 2019 calendar year individual tax returns.

Second, the IRS has expanded the forms that are now postponed. These forms now include: 1040-series, 1120-series, 1065, 1066, 1041, 706 (estate tax payments and returns), 709 (gift tax payments and returns), 8971, 990-T, and estimated tax payments. The relief includes not just the specified forms, but also all schedules, returns, and other forms filed as attachments, such as schedule H, schedule SE, and Forms 3520, 5471, 5472, 8621, 8858, 8865, and 8938.

Overview of Extensions Granted in Notice 2020-23
Type of Tax Return	Form ¹	2020 Deadline
Individual/Married Tax Return & Payments	Form 1040, 1040-SR, 1040-NR, 1040-NR- EZ, 1040-PR, 1040-SS	7/15/2020
Trust & Estate Tax Return & Payment	Form 1041, 1041-N, 1041-QFT	7/15/2020
Partnership Returns	Form 1065; Form 1066	7/15/2020
Corporation Tax Return & Payments	Form 1120, 1120-C, 1120-F, 1120-FSC, 1120-H, 1120-L, 1120-ND, 1120-PC, 1120- POL, 1120-REIT, 1120-RIC, 1120-S, 1120-SF	7/15/2020
United States Estate and Generation-Skipping Transfer Tax Return & Payment	Form 706; 706-NA, 706-A, 706-QDT, 706- GS(T), 706-GS(D), 706-GS(D-1)	7/15/2020
Form 706 Pursuant to Rev. Proc. 2017-34	Form 706	7/15/2020
Information Regarding Beneficiaries Acquiring Property from a Decedent	Form 8971	7/15/2020
United States Gift and Generation- Skipping Transfer Tax Return and Payment	Form 709	7/15/2020
Exempt Organization Business Income Tax Return & Payment	Form 990-T	7/15/2020
Excise Tax Payments on Investment Income & Payment	Form 990-PF; Form 4720	7/15/2020
Quarterly Estimated Income Tax Payments & Payments	Form 990-W; Form 1040-ES; 1040-ES (NR), 1040-ES (PR); Form 1041-ES; Form 1120-W	7/15/2020
Return of Organization Exempt from Income Tax ²	Form 990	7/15/2020
Annual Return/Report of Employee Benefit Plan²	Form 5500	7/15/2020

¹ – This relief includes not just the filing of specified Forms, but also all schedules, returns, and other forms that are filed as attachments to specified forms or are required to be filed by the due date of Specified Forms
²– This relief comes through Rev. Proc. 2018-58 for affected taxpayers with a time sensitive act which is due to be performed on or after April 1, 2020.

NOTE: The above list is not intended to be all inclusive. Rev. Proc. 2018-58 provides other disaster-related relief for time-sensitive actions and elections.

The period beginning on April 1, 2020, and ending on July 15, 2020, will be disregarded in the calculation for interest, penalty, or addition to tax for failure to file the forms or make payments that are temporarily postponed by Notice 2020-23. Such amounts will accrue starting on July 16, 2020.

Welcome Relief For Partnership Filings To Obtain CARES Act Benefits

Posted on April 2020 by info

General Rules for Amending Partnership Returns

Prior to 2018, partnerships were generally subject to unified partnership audit and litigation rules enacted by the Tax Equity and Fiscal Responsibility Act of 1982, commonly referred to as the TEFRA partnership procedures.

For taxable years beginning after December 31, 2017, the Bipartisan Budget Act of 2015 (BBA) replaced the TEFRA audit procedures with a centralized partnership audit regime. These new audit procedures apply to all partnerships, unless the partnership makes a valid election not to have those procedures apply. Partnerships subject to the centralized partnership audit regime are referred to as BBA partnerships.

Partnerships file annual returns on Form 1065 each taxable year and report each partner’s distributive share of income, gain, loss, deduction and credit on Schedule K-1. Partnerships are required to furnish a copy of Schedule K-1 to each partner.

BBA partnerships are generally prohibited from amending the information required to be furnished to their partners after the due date of the return, unless specifically provided by the Secretary of the Treasury or his delegate. On April 8, 2020, the Internal Revenue Service issued Revenue Procedure 2020-23, which exercises that authority to allow a BBA partnership to file an amended partnership return and issue amended Schedules K-1 for taxable years that began in 2018 or 2019, and only under certain circumstances.

Impact of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act)

The CARES Act provides retroactive tax relief that affects partnerships, including relief for the taxable years ending in 2018, 2019, and, in some cases, 2020. Without the option to file amended returns, BBA partnerships that already filed their Forms 1065 for the affected years generally are unable to take advantage of the CARES Act relief for partnerships except by filing Administrative Adjustment Requests (AARs). Filing an AAR would result in the partners only being able to receive any benefits from that relief on the current taxable year’s federal income tax return. Thus, if an AAR were filed during 2020 affecting taxable years that began in 2018 or 2019, the partners generally would not be able to take advantage of CARES Act benefits from an AAR until they file their current year returns, which could be in 2021. In the view of the IRS, this process would significantly delay the relief provided in the CARES Act intended to provide an immediate benefit to taxpayers.

Special Rule for Filing Amended Partnership Returns

Revenue Procedure 2020-23 allows BBA partnerships the option to file an amended return instead of an AAR. However, the revenue procedure does not prevent a partnership from instead filing an AAR to obtain the benefits of the CARES Act or any other tax benefits to which the partnership is entitled. A BBA partnership that files an amended return pursuant to this revenue procedure is still otherwise subject to the centralized partnership audit procedures enacted by the BBA.

BBA partnerships that filed a Form 1065 and furnished all required Schedules K-1 for the taxable years beginning in 2018 or 2019 prior to the issuance of Revenue Procedure 2020-23 may file amended partnership returns and furnish corresponding Schedules K-1 before September 30, 2020. The amended returns may take into account tax changes brought about by the CARES Act as well as any other tax attributes to which the partnership is entitled by law.

Insights

One of the principal tax benefits under the CARES Act for which partnerships may now file amended returns is the correction of the so-called “retail glitch” that prevented investments in qualified improvement property (QIP) from qualifying for bonus depreciation. This drafting error in the Tax Cuts and Jobs Act significantly increased the after-tax cost of making QIP investments. Partnerships who amend 2018 and 2019 tax returns to report bonus deprecation on QIP will issue amended Schedules K-1 to their partners who can file their own amended tax returns to potentially obtain refunds of taxes previously paid.
Notwithstanding the ability to claim bonus depreciation via filing amended returns, partnerships may want to consider filing Form 3115 instead. By filing a Form 3115, the partnership will report a favorable adjustment reducing current year taxable income. The benefit of this adjustment will be allocated to the existing partners which may not be the same partner group as existed during the 2018 and 2019 taxable years.
The Tax Cuts and Jobs Act added limitations on excess business losses for noncorporate taxpayers (IRC section 461(l)) for tax years beginning after December 31, 2017, and before January 1, 2026, limiting the ability above a threshold amount to offset business losses against non-business income. The CARES Act suspended these excess loss rules for tax years 2018 through 2020. If noncorporate partners (e.g., individuals) are allocated additional bonus depreciation expenses and they amend their 2018 or 2019 income tax returns, assuming that other loss limitation rules do not apply (e.g., basis, at-risk or passive activity limitations), they are not subject to the excess loss rules and may generally take a deduction against non-business income without limitation.
The CARES Act permits taxpayers to carry back net operating losses that arise in tax years 2018, 2019 and 2020 to their five preceding taxable years. If a bonus depreciation deduction allocated to a partner results in generating a net operating loss for that partner, the partner can potentially obtain a refund of taxes paid by carrying back the net operating loss to its five preceding taxable years.
The relief provisions under Revenue Procedure 2020-23 is not limited to provisions relating to the CARES Act. Partnerships can take advantage of these rules to amend their 2018 and 2019 tax returns for other matters. For example, an amended return could be filed to correct prior income or loss allocations which could create net operating losses eligible for the carryback provisions.
The CARES Act generally increases the business interest expense limitation percentage under Section 163(j) from 30% to 50% of adjusted taxable income. However, the CARES Act also creates a special rule for the business interest expense limitation under section 163(j) as it applies to partnerships. Specifically, there is an increase in the adjusted taxable income considered in determining the limitation from 30% to 50%. However, this increased adjusted taxable income percentage does not apply to a partnership’s 2019 tax year. Instead, 50% of the excess business interest expense from 2019 may be carried forward to 2020 and deducted exclusive of the Section 163(j) limitation. This rule is not impacted by Revenue Procedure 2020-23.
Eligible partnerships may have previously made an election to be treated as an electing real property trade or business in order to be exempt from the business interest expense limitation under Section 163(j). The cost for making such an election is that the partnership must use the alternative depreciation system for any nonresidential real property, residential rental property, and qualified improvement property used in its trade or business (i.e. no bonus depreciation permitted for qualified improvement property). Now that the CARES Act has corrected the retail glitch and bonus depreciation may be taken on qualified improvement property, partnerships are undoubtedly thinking about whether they can revoke their election to be an electing real property trade or business. Unfortunately, Revenue Procedure 2020-23 does not provide relief for partnership wanting to revoke their prior election. We await further guidance from the IRS on this issue.
REITs and other entities that either chose to use ADS life or are required to use ADS life for QIP may still benefit from the technical correction of the “retail glitch” as the CARES Act, in addition to correcting QIP to be 15-year property, also changes the ADS life to a 20-year life. REITs may prefer to file a Form 3115 to report a favorable adjustment in the current year in order to reduce their distribution requirements and retain more cash in 2020.

Other Considerations

The relief under Revenue Procedure 2020-23 is available only to BBA partnerships that filed Forms 1065 and furnished Schedules K-1 for the partnership taxable years beginning in 2018 or 2019 prior to the issuance of this revenue procedure. The amended return replaces any prior return (including any AAR filed by the partnership) for the taxable year for purposes of determining the partnership’s treatment of partnership-related items.

Filing Requirements

To take advantage of the option to file an amended return, a BBA partnership must file a Form 1065 (with the “Amended Return” box checked) and furnish corresponding amended Schedules K-1. The BBA partnership must clearly indicate the application of this revenue procedure on the amended return and write “FILED PURSUANT TO REV PROC 2020-23” at the top of the amended return and attach a statement to each Schedule K-1 sent to its partners with the same notation. The BBA partnership may file electronically or by mail, but the IRS notes that filing electronically may allow for faster processing of the amended return. It is important to note that the revenue procedure explicitly provides that the amended partnership returns are to be filed via Form 1065. Consequently, Form 1065-X should not be used for purposes of filing an amended partnership return pursuant to this revenue procedure.

There are special rules for BBA partnerships whose returns are under examination or who have previously filed an AAR. In addition, the revenue procedure provides clarifying guidance about a partnership’s obligation to provide information under the proposed regulations for Global Intangible Low-Taxed Income, or GILTI.