IRS Issues Guidance on New Business Interest Expense Deduction Limit
On November 26, 2018, the IRS issued proposed regulations providing guidance on the business interest deduction limitation under the recently enacted Tax Cuts and Jobs Act of 2017.
Under the new law, companies can deduct interest costs up to 30% of earnings before interest, tax, depreciation and amortization, or EBITDA, until 2022. After that, the cap narrows to 30% of earnings before interest and taxes, or EBIT. Under prior law, business interest expense was generally deductible in the year in which the interest was paid or accrued.
Interest that cannot be deducted by businesses under the new limitations may be carried forward to future years. Amounts carried forward under old law as disallowed disqualified interest are included as disallowed business interest expense carryforwards of a taxpayer to the extent that the amounts otherwise qualify as business interest expense of the taxpayer.
The new law does not apply to taxpayers whose average annual gross receipts are $25 million or less for the three previous tax years. This amount will be adjusted annually for inflation starting in 2019.
Other exclusions from the limit are certain trades or businesses, including performing services as an employee, electing real property trades or businesses, electing farming businesses and certain regulated public utilities. Note, electing real property trades or businesses may not qualify for other tax benefits, such as bonus depreciation for qualified improvement property.
Of note, private equity firms may invest more in equity and use less debt in structuring certain transactions to avoid the new limitations. However, there are rules in the proposed regulations aimed at insuring that certain interest equivalent payments are treated as interest and debt payments and not return on equity.
The IRS stated that taxpayers can rely on the rules in the proposed regulations until the final regulations are published in the Federal Register.
Along with the proposed regulations, the IRS released Rev. Proc. 2018-59, which provides a safe harbor that allows certain infrastructure financing arrangements to be treated as real property trades or businesses not subject to the new limitation. Taxpayers may apply the safe harbor to tax years beginning after December 31, 2017.
The proposed regulations can be found here.
Revenue Procedure 2018-59 can be found here.
IRS Proposes to Protect Estates After 2025 for Gifts Made Now
The IRS recently issued proposed regulations that protect individuals who take advantage of the increased estate and gift tax exclusion amount in effect from 2018 to 2025 from being adversely impacted after 2025, when the exclusion amount is scheduled to decrease to the pre-2018 level.
The recently enacted Tax Cuts and Jobs Act of 2017 doubled the estate and gift tax lifetime exclusion to $10 million, adjusted for inflation, which is $11.18 million for 2018. The new law provides that the exclusion amount returns to its pre-2018 amount, i.e., $5 million, adjusted for inflation, after December 31, 2025. The reversion of this amount could create situations where different exclusion amounts apply at a donor’s date of death versus at the time of the prior lifetime gift such that donors could have owed estate tax on those transfers in later years, when the exclusion amount is lower than in the year the gift was made.
To address concerns that gifts exempt from gift tax by the increased exclusion amount could later be subject to estate tax, the proposed regulations provide that the donor’s estate may apply the higher exclusion amount available at the time of the gift, instead of the lower exclusion amount that returns after 2025.
As a result, individuals planning to make large gifts between 2018 and 2025 can do so with the certainty that they will not lose the tax benefit of the higher exclusion amount once it decreases after 2025.
The proposed regulations can be found here.
Football Officiating Organization Denied Exempt Status
In PLR 201845030, an organization providing officiating services for scholastic football games was denied exempt status under IRC § 501(c)(7) because the organization exceeded the allowable levels of nonmember income and was not organized and operated exclusively for the pleasure and recreation of its members.
IRC § 501(c)(7) provides for the exemption from federal income tax of clubs organized for pleasure, recreation, and other non-profitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.
Treasury Regulation § 1.501(c)(7)-l(a) states the exemption provided by IRC § 501(c)(7) applies only to clubs which are organized and operated exclusively for pleasure, recreation, and other non-profitable purposes, but does not apply to any club if any part of its net earnings inures to the benefit of any private shareholder. In general, this exemption extends to social and recreation clubs which are supported solely by membership fees, dues and assessments.
Treasury Regulation § 1.501(c)(7)-1(b) states, in part, that a club which engages in business is not organized and operated exclusively for pleasure, recreation and other non-profitable purposes, and is not exempt under IRC § 501(a).
Moreover, Public Law 94-568, 1976-2 C.B. 596 provides that a social club may receive up to 35% of its gross receipts, including investment income, from sources outside its membership without losing exemption. Within this 35% amount, not more than 15% of the gross receipts should be derived from the use of a social club’s facilities or services by the general public.
In PLR 201845030, the organization did not have any organized social activities and merely acted as a clearinghouse for football officials to secure work at local schools. In addition, the organization derived greater than 35%, and in fact nearly all, of its revenue from schools paying fees for officiating services rather than from its member-officials paying dues. Accordingly, the IRS denied the organization exempt status under IRC §501(c)(7).