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With the turbulent real estate market and a continued decline in market values, homeowners and investors alike are increasingly faced with negotiating a short sale or having a lender foreclose. In either case, property owners should understand the tax implications relative to gain or loss treatment and cancellation of indebtedness (“COD”) income prior to a short sale or foreclosure.

Gain or Loss

Gain or loss is the difference between your amount realized and your adjusted basis in the property. In the case of a short sale, the amount realized will be the amount of the agreed upon sale price. In the case of a foreclosure, assuming the lender discharges the balance in foreclosure, the amount realized will generally be the amount of the debt. Special rules apply to debts not fully discharged and to nonrecourse loans. Please consult your tax advisor for more information.

Your adjusted basis in property is generally the amount you paid at purchase, plus improvements, less depreciation claimed.

The rules for the taxation of gains and losses will generally fall into one of three categories:

Personal Residence – Gain is taxable as a capital gain, unless excluded under IRC Section 121. Loss is not deductible.

Investment – Assuming that the property is a capital asset, gain is treated as a capital gain, subject to rules for holding period and subject to depreciation recapture, if applicable. Loss is a capital loss and is subject to capital loss limitations.

Trade or Business – Assuming the property is primarily held for sale in a trade or business, gain or loss may be treated as ordinary income or loss. The majority of cases we currently see involving short sales and foreclosures are properties that have been acquired in more recent years. These troubled situations usually involve a decline in market value that no longer makes the home or investment viable. As a result, property owners are often faced with a loss on the property.

However, sellers should be wary of properties that, even in this declining market, have appreciated in value since acquisition, properties acquired using a like-kind exchange, and properties that have been depreciated for a number of years. Real estate owners with such properties should consider a 1031 tax-deferred exchange prior to the short sale closing or foreclosure.

Sellers should understand whether or not there is a gain or loss on a short sale or foreclosure prior to completing a transaction. A gain may be yet another financial burden in an unpleasant situation. More importantly, a loss on a short sale or foreclosure may be significantly limited depending upon the type of property. In the case of a loss, advanced planning is critical to mitigating a potential mismatch of COD income and loss treatment.

Cancellation of Indebtedness (“COD”) Income

If a property is sold in a short sale, or if a lender forecloses, and the debt is recourse debt, the property owner may have COD income to the extent that the fair market value of the property is less than the unpaid face amount of the debt. COD income is treated as ordinary income and lenders are required to send a Form 1099-C, Cancellation of Debt (COD), reporting the amount of income.

Fortunately, there may be relief available for certain homeowners. Pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, COD income arising from the discharge of “qualified principal residence indebtedness” may be excluded from income.

In addition, there are special rules for the taxation of other COD income. Most notable of the rules are that COD income may be excluded or partially excluded from income if you are insolvent when the debt is cancelled or if the debt is discharged through bankruptcy.

If neither the exclusion for qualified principal residence indebtedness nor COD exclusion rules apply, COD income from many short sales and foreclosures will result in ordinary income.

Income Mismatch

For investments that have turned bad due to the real estate market decline, many short sales and foreclosures may match ordinary income from COD income with limited capital loss deductions.

In fact, we have recently encountered a number of cases involving real estate investment schemes causing this type of problem. In these cases, investors with strong credit have been mislead by promoters of these investments to obtain little or no money down mortgages with the prospect of selling the properties in the near term. Often times, the promoters will offer to find subsequent buyers, to rent the units, or to rehabilitate the properties for future sale as part of the investment scheme. Due to the real estate market decline, these investment schemes have failed and investors are left with properties that are significantly below the amount of mortgages obtained. Investors are often left with no other option than a short sale or lender foreclosure and surprised at a tax bill resulting from a failed investment.

Advanced planning may help to mitigate this potential mismatch. We strongly urge you to consult with a tax attorney or CPA in the event that you are faced with a short sale or foreclosure.

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Amid a growing number of scams and fraudulent activity surrounding the Employee Retention Credit, the Internal Revenue Service will stop processing new claims, effective immediately, at least through the end of the year.

"We are deeply concerned that this program is not operating in a way that was intended today, far from the height of the pandemic in 2020 and 2021," IRS Commissioner Daniel Werfel said during a September 14, 2023, conference call with reporters. "We believe we should see only a trickle of employee retention claims coming in. Instead, we are seeing a tsunami."

Werfel said the agency has received about 3.6 million claims by taxpayers taking advantage of the program and there are more than 600,000 that have yet to be processed, "virtually all of which were received within the last 90 days. That means about 15 percent of all ERCclaims received since the start of the program three and half years ago have been received in the last 90 days. That’s an incredibly large number to have so far beyond the pandemic and nearly two years after the time periods covered by the program."

He attributed the spike in claims to emergence and prevalence of so-called ERC mills.

"This great program to help small businesses has been overtaken by aggressive promoters," Werfel said. "The ads are everywhere. The program has become the centerpiece for unscrupulous marketing and profits from pushing taxpayers to claim a credit that they would not be eligible for."

The agency said in a September 14, 2023, press release that it will process claims already received, but as of today, there will be no new claims processed for the pandemic-era relief program aimed to help small businesses remain in operation while dealing with potential economic hardships due to the COVID-19 pandemic.

However, for those who have filed claims, they can expect longer wait times for the financial relief offered by the credit as the agency conducts more detailed compliance reviews of the claims that have been filed.

And that compliance work as already begun. Werfel stated that as of July 31, 2023, the IRS Criminal Investigation Division has initiated 252 investigations involving more than $2.8 billion worth of potentially fraudulent ERC claims. Fifteen of those cases have resulted in federal charges, with six cases resulting in convictions, and an average sentence of 21 months for those reaching the sentencing phase. He also stated that the agency has referred thousands of claims for audit.

"With the stricter compliance reviews in place during this period, existing ERCclaims will go from a standard processing goal of 90 day to 180 days – and much longer if the claim faces further review or audit," the agency stated in the press release. "The IRS may also seek additional documentation from the taxpayer to ensure it is a legitimate claim."

To help taxpayers who may have fallen victim to an ERC mill, the IRS will be introducing programs in the coming weeks and months to help taxpayers. First, the agency will be providing a process under which taxpayers with unprocessed claims can withdraw those claims. To help taxpayers in self-reviewing their already submitted claims or who may be thinking about submitting claims when the IRS begins processing new claims again, the agency on September 14, 2023, released an updated eligibility checklist. The process to withdraw a claim will be finalized soon.

For those who have had their claims processed, received money and then later received a determination that they were in fact ineligible for the credit, the IRS will be offering a settlement program to help taxpayers pay back funds they should not have received due to eligibility reasons. Details on the settlement program will be released in coming months.

This help may be needed because the IRS recognizes that a business or tax-exempt group c"ould find itself in a much worse financial position if you have to pay back the credit than if the credit was never claimed in the first place," Werfel said.

Werfel is encouraging those who have submitted claims to do an independent verification of eligibility with a trusted tax professional to ensure they were in fact eligible for the credit and if they were not, be ready to take the steps to withdraw the claim if it hasn’t been paid or to look for the settlement program if necessary.

By Gregory Twachtman, Washington News Editor

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The Department of the Treasury is reaching out to Congress to get the appropriate tools to combat the wave of Employee Retention Credit fraud and other future issues.

In a September 14, 2023, letter to Senate Finance Committee Chairman Ron Wyden, the agency made two specific requests. First, the IRS asked for authority to regulate paid preparers, which it sated "could help protect taxpayers from penalties, interest, or avoidable costs of litigation that result from the poor-quality advice they receive."

Second, the IRS asked for legislation specific to the ERC, but it was more vague in what it wants, asking Congress "to consider other ways to help reduce fraud and abuse associated with the ERC, while protecting honest taxpayers. For example, legislating targeting contingency fee practices would help prevent overzealous promoters from profiting off small businesses."

During a September 14, 2023, conference call with reporters, Laurel Blatchford, chief implementation officer of the Inflation Reduction Act at the Treasury Department, said that having the ability to regulate paid preparers would make it easier to target ERC mills that have popped up in recent months.

"Congress should pass legislation making clear these mills have to play by the same rules as other professionals who prepare returns for taxpayers," Blatchford said. "These mills may claim they aren’t paid preparers, but they receive compensation for their advice."

And while the IRS and Treasury could promulgate regulations for something like banning contingency fees that would prevent mills from collecting a portion of the money refunding through the credit,"a legislative prohibition takes effect far more quickly."

By Gregory Twachtman, Washington News Editor

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The Internal Revenue Service detailed plans on some of the high-income taxpayers that will be targeted for more compliance efforts in the coming fiscal year.

IRS Commissioner Daniel Werfel, during a September 7, 2023, teleconference with reporters, said that the new compliance push "makes good on the promise of the Inflation Reduction Act to ensure the IRS holds our wealthiest filers accountable to pay the full amount of what they owe,"adding that the agency will simply be enforcing already-existing laws.

Werfel stated that the IRS will be "pursuing 1,600 millionaires who owe at least $250,000. … The IRS will have dozens of revenue officers focused on these high-end collection cases in fiscal year 2024,"which begins on October 1, 2023. "This group of millionaires owes hundreds of millions of dollars in taxes, and we will use Inflation Reduction Act resources to get those funds back."

He also said that the agency will be making a “dramatic shift” on large partnerships.

"These are some of the most complex cases the IRS faces, and it involves a wide range of activities and industries where it’s been far too easy for tax evaders to cut corners,"Werfel said.

To help with this effort, Werfel highlighted that the agency will be using expanded artificial intelligence programs and additional Inflation Reduction Act resources to help with the audit process for large complex partnerships.

"The selection of these partnership returns for review is the result of groundbreaking collaboration among experts in data sciences and tax enforcement," Werfel said. "They have been working side-by-side to apply cutting-edge machine learning technology to identify potential compliance risks in the area of partnership tax, general income tax, and accounting and international tax in a segment that historically has been subject to limited examination coverage."

The AI will be used to help spot trends that might not be obvious and help the agency determine which partnerships are at the greatest risk of noncompliance, starting with 75 specific partnerships with assets of more than $10 million.

"These are some of the largest [partnerships] in the U.S. that the AI tool helped us identify," Werfel said. "These organizations will be notified of the audit in the coming weeks. These 75 organizations represent a cross section of industries, including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms, and other industries."

Werfel also noted that starting in October, "hundreds of partnerships will receive a special compliance alert from us in the mail. The alert relates to what we have identified as an ongoing discrepancy on balance sheets involving partnerships with over $10 million in assets," adding that taxpayers filing partnership returns are showing more and more discrepancies in recent years. Approximately 500 partnerships will be receiving this mailing.

"We will need to do more in the partnership arena," Werfel said. "But this is historic. And these are examples of how the Inflation Reduction Act funding will make a difference and help ensure fairness in the tax system."

Other areas that will get compliance attention in the coming fiscal year include those with digital assets, high-income taxpayers who use foreign banks to avoid disclosure and related tax obligations, as well as a previously announced effort to target the construction industry where companies are using subcontractors, which are shell corporations, to engage in tax fraud. The agency will also be targeting scammers such as the current trend of Employee Retention Credit mills.

Werfel also noted that there are ongoing efforts to keep hiring people to conduct these enforcement actions.

"We know we need to make more progress in our hiring efforts, as we will be accelerating these," Werfel said. "This is particularly important given our aging workforce and the relatively high attrition rate among IRS employees."

By Gregory Twachtman, Washington News Editor

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The Treasury Inspector General for Tax Administration is calling on the Internal Revenue Service to improve its training of revenue agents that will be focused on auditing high-income taxpayers.

In an August 31, 2023, report, the Treasury Department watchdog noted that despite receiving supplemental funding from the Inflation Reduction Act that has been earmarked, in part, to increase examination of high-income taxpayers, the "IRS’s efforts to train new hires do not appear to be fully leveraging" the expertise it has within the Large Business and International Division.

"The IRS treats this training as specialized and only offers it when necessary for employees auditing in this specialized area," that current continued, recommending that with the new IRA funding, "the IRS should revise its training paradigm and expose new hires to the types of issues associated with high-incometaxpayer returns."

TIGTA also criticized the agency for not having"a unified or updated definition for individual high-incometaxpayers," noting that"current examination activity code schema still uses $200,000 as the main threshold" as established in the Tax Reform Act of 1976. This threshold exists even as the IRS continually uses $400,000 as the income threshold, with the population underneath it not expecting to see a rise in audit rates against historical levels from a decade ago.

"The IRS’s Inflation Reduction Act Strategic Operating Plan sets forth leveraging data analytics to improve the IRS’s understanding of the tax filings of high-wealth individuals and to address potential noncompliance," the report states. "Consequently, the IRS needs to update its high-incometaxpayer definition to better identify and track examination results and manage examination priorities."

IRS in its response to the TIGTA findings, published in the report, did not agree with the recommendation related to the definition of high-income taxpayers, stating that "a static and overly proscriptive definition of high-incometaxpayers for the purposes of focusing on income levels above which taxpayers have unique and varied opportunities for tax would serve to deprive the IRS of the agility to address emerging issues and trends."

By Gregory Twachtman, Washington News Editor

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The IRS has provided additional interim guidance in Notice 2023-64 for the application of the new corporate alternative minimum tax (CAMT). This guidance clarifies and supplements the CAMT guidance provided in Notice 2023-7, I.R.B. 2023-3, 390, and Notice 2023-20, I.R.B. 2023-10, 523, which were issued earlier this year. The IRS anticipates that the forthcoming proposed regulations on the CAMT will be consistent with this interim guidance and that they will apply for tax years beginning on or after January 1, 2024. Taxpayers may rely on the interim guidance for tax years ending on or before the date the forthcoming proposed regulations are published, and for any tax year that begins before January 1, 2024.

CAMT and Prior CAMT Guidance

For tax years beginning after 2022, a 15-percent CAMT is imposed on the adjusted financial statement income (AFSI) of an applicable corporation (generally, a corporation with a three-year average annual AFSI in excess of $1 billion) (Code Secs. 55(a) and (b), and 59(k)). To determine if the threshold is met, corporations under common control are generally aggregated and special rules apply in the case of foreign-parented multinational groups. The CAMT does not apply to S corporations, regulated investment companies (RICs), and real estate investment trusts (REITs).

A corporation’s AFSI is the net income or loss reported on the corporation’s applicable financial statement (AFS) with adjustments for certain items, as provided in Code Sec. 56A. Special rules apply in the case of related corporations included on a consolidated financial statement or filing a consolidated return. Applicable corporations are allowed to deduct financial statement net operating losses (FSNOLs), subject to limitation, and can reduce their minimum tax by the CAMT foreign tax credit (CAMT FTC) and the base erosion and anti-abuse tax (BEAT). They can also utilize a minimum tax credit against their regular tax and the general business credit.

Notice 2023-7 announced that the IRS intends to issue proposed regulations (forthcoming proposed regulations) addressing the application of the CAMT, and provided interim guidance regarding time-sensitive CAMT issues that taxpayers may rely on until the forthcoming proposed regulations are issued.

Notice 2023-20 provided additional interim guidance that taxpayers may rely on until the issuance of the forthcoming proposed regulations, including interim guidance intended to help avoid substantial unintended adverse consequences to the insurance industry arising from the application of the CAMT.

Considering the challenges of determining the CAMT liability, Notice 2023-42, 2023-26 I.R.B. 1085, provided relief from the addition to tax under Code Sec. 6655 in connection with the application of the CAMT (specifically, the IRS will waive the penalty for a corporation’s estimated income tax with respect to its CAMT for a tax year that begins after December 31, 2022, and before January 1, 2024).

Additional Interim Guidance Provided in Notice 2023-64

The IRS intends to propose rules in the forthcoming proposed regulations consistent with the interim guidance in Notice 2023-64, which provides taxpayers with additional clarity in applying the CAMT before the issuance of the forthcoming proposed regulations. Specifically, Notice 2023-64 sets forth the following guidance:

Definition of a taxpayer for purposes of the guidance - a taxpayer includes any entity identified in Code Sec. 7701 and its regulations, including a disregarded entity, regardless of whether the entity meets the definition of a taxpayer under Code Sec. 7701(a)(14).
Determining a taxpayer’s AFS - the guidance provides a definition of an AFS, a list of financial statements that meet the AFS definition, priority rules for identifying a taxpayer’s AFS; rules for certified financial statements, restatements, annual and periodic financial statements; and special rules for an AFS covering a group of entities.
Determining a taxpayer's AFSI - the guidance provides definitions of financial statement income (FSI) and AFSI; general rules for determining FSI and AFSI, including federal tax treatment not relevant for FSI or AFSI; and rules for determining FSI from a consolidated AFS.
Determining the FSI, AFSI, and CAMT of tax consolidated groups – rules are provided for priority of consolidated AFS; calculation of FSI of a consolidated group; and calculation of the CAMT of a tax consolidated group.
Determining AFSI with respect to certain foreign corporations – special rules are provided for the application of Code Sec. 56A(c) to certain foreign corporations.
Determining the AFSI adjustment for certain taxes under Code Sec. 56A(c)(5).
Determining the AFSI adjustment for depreciation – the new guidance modifies and clarifies the guidance for the AFSI depreciation adjustments provided in Notice 2023-7, and provides other AFSI rules for Section 168 property. Taxpayers that choose to rely on the interim guidance in section 4 of Notice 2023-7 on or after September 12, must apply the guidance in section 4 of Notice 2023-7, as modified and clarified by Notice 2023-64.
Determining the AFSI adjustment for qualified wireless spectrum.
Determining adjustments to prevent certain duplications and omissions of AFSI – rules are provided for adjustments resulting from a change in financial accounting principle or restatement of a prior year’s AFS; and adjustments for amounts disclosed in an auditor’s opinion.
Determining the use of financial statement NOL (FSNOL) carryovers - the amount of an FSNOL carried forward to the first tax year a corporation is an applicable corporation (and subsequent tax years) is determined without regard to whether the taxpayer was an applicable corporation for any prior tax year.
Determining an applicable corporation status – specific rules are provided for the application of the aggregation rules under Code Sec. 59(k)(1)(D); for determining an applicable corporation status of members of a foreign-parented multinational group; and for disregarding the distributive share adjustment.
Determining the CAMT foreign tax credit (CAMT FTC) - generally, a foreign income tax is eligible to be claimed as a CAMT FTC in the tax year in which it is paid or accrued for federal income tax purposes by either an applicable corporation or a CFC with respect to which the applicable corporation is a U.S. shareholder, provided the foreign income tax has been taken into account on the AFS of the applicable corporation or CFC.

Applicability Dates, Request for Comments, and Effect on Other Documents

The IRS intends to publish forthcoming proposed regulations regarding the application of the CAMT that would include proposed rules consistent with the interim guidance provided in Notice 2023-7, as modified and clarified by Notice 2023-64, Notice 2023-20, and Notice 2023-64. It is anticipated that the forthcoming proposed regulations would apply for tax years beginning on or after January 1, 2024. Taxpayers may rely on the interim guidance provided in these Notices for tax years ending on or before the date forthcoming proposed regulations are published. However, in any event, a taxpayer may rely on such interim guidance for any tax year that begins before January 1, 2024.

The IRS has requested comments on any questions arising from the interim guidance provided in Notice 2023-64 as well as comments addressing specific questions listed in the guidance.

Sections 3, 4, and 7 of Notice 2023-7 are modified and clarified.

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Taxpayers may rely on a notice that describes proposed regulations that will address the amortization of qualified research and experimentation (R&E) expenses. Before 2022, R&E expenses were currently deductible, but the Tax Cuts and Jobs Act (P.L. 115-97) replaced the deduction with a five-year amortization period (15 years for foreign research).

The notice provides guidance on:

the capitalization and amortization of specified research or experimental expenditures;
the definition of specified research or experimental (SRE) expenditures and software expenditures;
the treatment of SRE expenditures performed under contract with a third party, including long term contracts under Code Sec. 460;
the application of Code Sec. 482 to cost sharing arrangements involving SRE expenditures; and
the disposition or abandonment of SRE expenditures.

The guidance generally applies to tax years ending after September 8, 2023. The notice is not intended to change the rules for determining eligibility for or computation of the Code Sec. 41 research credit, including rules for "research with respect to computer software," and the definitions of "qualified research" and "qualified researchexpenses."

The notice obsoletes section 5 of Rev. Proc. 2000-50. Comments are requested.

Capitalization of SRE Expenditures

The notice requires taxpayers to capitalize SRE expenditures and amortize them ratably over the applicable amortization period beginning with the midpoint of the tax year. The midpoint is the first day of the seventh month of the tax year in which the SRE expenditures are paid or incurred.

However, the midpoint of a short tax year is the first day of the midpoint month. If the short tax year has an even number of months, the midpoint month is determined by dividing the number of months in the short tax year by two and then adding one. For example, for a short tax year with ten months, the midpoint month is the sixth month ((10 / 2) + 1 = 6)). If the short tax year has an odd number of months, the midpoint month is the month that has an equal number of months before and after it. For example, for a short tax year with seven months, the mid-point month is the fourth month.

If a short tax year includes part of a month, the entire month is included in the number of months in the tax year, but the same month may not be counted more than once. If a taxpayer has two successive short tax years and the first short tax year ends in the same month that the second short tax year begins, the taxpayer should include that month in the first short ta year and not in the second short year.

For purposes of the 15-year amortization period, foreign research is any research conducted outside the United States, the Commonwealth of Puerto Rico, or any U.S. territory or other possession of the United States.

SRE Expenditures and Activities

The notice clarifies the scope of Code Sec. 174 by defining SRE expenditures and SRE activities. Otherwise, the notice adopts the definitions provided in Reg. §1.174-2.

SRE expenditures for tax years beginning after 2021 are research or experimental (R&E) expenditures that are paid or incurred by the taxpayer during the tax year in connection with the taxpayer’s trade or business. R&E expenditures must

satisfy the Reg. §1.174-2 requirements, or
be paid or incurred in connection with the development of computer software (defined below), regardless of whether they satisfy Reg. §1.174-2.

SRE activities are software development costs (defined below), or research or experimental activities defined in Reg. §1.174-2.

Costs that may be SRE expenditures include labor costs, materials and supplies costs, cost recovery allowances, operation and management costs and travel costs that are used in the performance or direct support of SRE activities, as well as patent costs. Costs that are not SRE expenditures include general and administrative costs, interest on debt, costs to input content into a website, website hosting and registration costs, amounts representing amortization of SRE expenditures, and expenses listed in Reg. § 1.174-2(a)(6).

Costs are allocated to SRE expenditures on the basis of a cause-and-effect relationship between the costs and the SRE activities or another method that reasonably related the costs to benefits provided to SRE activities. A taxpayer may use different allocation method for different types of costs, but must apply each method consistently. SRE expenditures must also be treated consistently for all provisions under subtitle A of the Code.

Computer Software Development

The notice defines computer software as a computer program or routine (that is, any sequence of code) that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine. The code may be stored on a computing device, affixed to a tangible medium (for example, a disk or DVD), or accessed remotely via a private computer network or the Internet (for example, via cloud computing).

Software includes a computer program, a group of programs, and upgrades and enhancements, which are modifications to existing software that result in additional functionality (enabling the software to perform tasks that it was previously incapable of performing), or materially increase the software’s speed or efficiency. Computer software can include upgrades and enhancements to purchased software.

The notice provides several examples of activities that constitute software development, such as planning the development, designing, building a model, and testing the software or updates and enhancements; and writing and converting source code.

As mentioned above, computer software may include upgrades and enhancements to purchased software. However, software development does not include the purchase and installation of purchased computer software, including the configuration of pre-coded parameters to make the software compatible with the business and reengineering the business to make it compatible with the software, and any planning, designing, modeling, testing, or deployment activities with respect to the purchase and installation of such software.

Contract Research

The notice also provides clarity in the treatment of costs paid or incurred for research performed under contract. For purposes of these rules, a research provider is the party that contracts to perform research services or develop an SRE product for a research recipient. An SRE product is a pilot model, process, formula, invention, technique, patent, computer software, or similar property (or a component thereof) that is subject to protection under applicable domestic or foreign law. For example, mere know-how gained by the research provider that is not subject to legal protection is not an SRE product.

Costs incurred by the research recipient are governed by Reg. §1.174-2(a)(10) and (b)(3). A provider may incur SRE expenditures under the contract if the provider:

bears financial risk sunder the terms of the contract (that is, the provider may suffer a financial loss related to the contract research); or
has a right to use any resulting SRE product in its own trade or business or otherwise exploit through sale, lease or license. The provider does not have such rights if it must obtain approval from another party to the research arrangement that is not related to the provider.

Disposition, Retirement or Abandonment of Property

The notice provides clarity in the treatment of unamortized SRE expenditures if the related property is disposed of, retired, or abandoned in certain transactions during the applicable amortization period. The disposition, retirement or abandonment generally does not accelerate the recovery of unamortized SRE expenditures (that is, the amortized SRE expenditures that have not yet been recovered). Thus, the taxpayer must continue to amortize the expenditures over the remainder of the applicable amortization period.

If a corporation ceases to exist in a Code Sec.381(a) transaction or series of transactions, the acquiring corporation will continue to amortize the distributor or transferor corporation’s unamortized SRE expenditures over the remainder of the distributor or transferor corporation’s applicable amortization period beginning with the month of transfer.

However, a corporation that ceases to exist in any other transaction or series of transactions may generally deduct the unamortized SRE expenditures in its final tax year, unless a principal purpose of the transaction(s) is to allow the corporation to deduct the expenses.

Taxpayers may not rely on these rules for SRE expenditures paid or incurred with respect to property that is contributed to, distributed from, or transferred from a partnership.

Long-Term Contracts and Cost-Sharing Regs

The notice provides that costs allocable to a long-term contract accounted for using the percentage-of-completion method (PCM) include amortization of SRE expenditures under Code Sec. 174(a)(2)(B), rather than the capitalized amount of such expenditures. This amortization is treated as incurred for purposes of determining the percentage of contract completion as deducted.

The notice also makes changes to regulations for cost sharing transaction payments (CST payments) between controlled participants in a cost sharing arrangement (CSA) that are made to ensure that each controlled participant’s share of intangible development costs (IDCs) is in proportion to its share of reasonably anticipated benefits from exploitation of the developed intangibles (RAB share).

Accounting Method Changes

The IRS intends to issue additional guidance for taxpayers to obtain automatic consent to change methods of accounting to comply with this notice. Until the issuance of such procedural guidance, taxpayers may rely on section 7.02 of Rev. Proc. 2023-24 to change their methods of accounting under Code Sec. 174 to comply with this notice. Unless specifically authorized by the IRS or by statutes, a taxpayer may not request or make a retroactive change in accounting method by filing an amended return.

Comments Requested

The IRS request comments on issues arising from the interim guidance provided in the notice, as well as issued that are not addressed. Written comments should be submitted by November 24, 2023; however, the IRS will consider late comments if doing so will not delay the issuance of the forthcoming proposed regulations. Comments may be submitted by mail or electronically via the Federal eRulemaking Portal at www.regulations.gov. The subject line for the comments should include a reference to Notice 2023-63.

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Taxpayers may rely on proposed regulations that detail how to satisfy the prevailing wage and apprenticeship (PWA) requirements for bonus amounts that may apply to several energy and business credits. The regs also explain the correction and penalty provisions that allow taxpayers to claim the bonus credits even if they failed to satisfy the PWA tests. Comments are requested.

PWA Requirements

The Inflation Reduction Act of 2022 (P.L. 117-169) provided bonus credits as part of several new and existing components of the general business credit. The initial credit amount is increased for taxpayers that satisfy the PWA requirements during the construction, alteration and repair of a credit facility.

The bonus credits apply to the following 11 credits, plus one deduction:

the business credit component of the Code Sec. 30C Alternative Fuel Vehicle Refueling Property Credit
the Code Sec. 45 renewable electricity production credit
the Code Sec. 45L New Energy Efficient Home Credit (prevailing wage test only)
the Code Sec. 45Q carbon sequestration credit
the Code Sec. 45U Zero-Emission Nuclear Power Production Credit (prevailing wage test only)
the Code Sec. 45V Credit for Production of Clean Hydrogen
the Code Sec. 45Y Clean Electricity Production Credit
the Code Sec. 45Z Clean Fuel Production Credit
the Code Sec. 48 energy investment credit
the Code Sec. 48C Advanced Energy Project Credit
the Code Sec. 48E clean energy investment credit and
the Code Sec. 179D Energy Efficient Commercial Buildings Deduction (increased deduction).

The IRS previewed these proposed regs in Notice 2022-61 (TAXDAY, I.1, 11/30/2022).

Prevailing Wage Requirements in General

In determining prevailing wages, the proposed regs largely incorporate the Davis-Bacon Act (DBA), as administered by the Wage and Hours Division of the Department of Labor (DOL), to the extent it is relevant and consistent with sound tax administration. However, the regs do not adopt the DBA’s federal contracting provisions, or its exemptions for Tribal governments and the Tennessee Valley Authority. The definition of “employed” is also broader for the PWA tests than it is for other purposes of the Code.

Under the proposed regs, the taxpayer that claims the increased credit would be solely responsible for:

making sure the PWA requirements are satisfied,
keeping appropriate records, and
the correction and penalty provisions and the good faith effort exception.

“Taxpayer” includes an applicable entity that elects to treat the credit as a federal tax payment under Code Sec. 6417, and an eligible taxpayer that elects to transfer the credit to an unrelated person under Code Sec. 6418. Thus, the PWA requirements apply to the eligible taxpayer, not the transferee taxpayer.

The proposed regs define several relevant terms, including applicable wage determination, laborer, mechanic, construction, alteration, repair, locality or geographic area (including DOL site of work definitions), and prevailing wage rate. The proposed regs generally adopt DOL rules that allow lower prevailing wage rates for apprentices.

Prevailing Wage Determinations

The proposed regs would require taxpayers to use the general wage determination in effect when the construction of the facility begins, but would not require taxpayers to update those rates during construction. However, consistent with DOL guidance under the DBA, a new general wage determination would be required when a contract is changed to include additional, substantial construction, alteration, or repair work, or to require work to be performed for an additional time period. Taxpayers would also need to update wage rates for alteration or repairs after the facility has been placed in service.

A general wage determination would be one issued and published by the DOL that includes a list of wage and bona fide fringe benefit rates determined to be prevailing for laborers and mechanics for the various classifications of work performed with respect to a specified type of construction in a geographic area. The proposed regulations would largely incorporate the definition of “wages” from 29 CFR 5.2 for the Prevailing Wage Requirements. This definition is not relevant in determining wages or compensation for other federal tax purposes.

The proposed regs would provide special procedures when a general wage determination does not provide applicable wage rates; as, for example, when no general wage determination has been issued for the geographic area, for the specified type of construction, or for a labor classification. According to the DOL, these situations should be rare. The taxpayer, contractor, or subcontractor would need to request a supplemental wage determination or prevailing wage rate for an additional classification from the DOL. However, taxpayers could not use these requests to split, subdivide, or otherwise avoid classifications in a general wage determination.

A request for a supplemental wage determination or a prevailing wage rate for an additional classification would need to include information consistent with the information that must be provided by a contracting agency when requesting a project wage determination or a conformance for purposes of the DBA. After review, the Wage and Hour Division will notify the taxpayer as to the labor classifications and wage rates to be used. The proposed regulations would also adopt the review and appeal procedures available to any interested party under the DBA with respect to wage determinations generally.

If construction of a credit facility spans adjacent geographic areas, the prevailing wage rate would the highest rate for each classification. For an offshore facility, taxpayers could rely on the general wage determinations in the geographic area closest to the area where the qualified facility will be located.

Prevailing Wage Correction and Penalty Provisions

A taxpayer that fails to satisfy the PWA requirements may still qualify for the increased credit or deduction by satisfying correction and penalty provisions. The proposed regulations would provide that the obligation to make correction payments and pay the penalty would not become binding until the taxpayer files a return claiming the increased credit. The taxpayer generally would have to make correction payments to the underpaid workers before filing the return, and pay any penalty when the return is field.

In addition, the taxpayer would have to make the correction and penalty payments within 180 days after the IRS makes a final determination that a taxpayer failed to satisfy the Prevailing Wage Requirements, which would come in the form of a notice sent by the IRS. Although deficiency procedures would not apply to the penalty payment, deficiency procedures would apply to any IRS disallowance of the increased credit.

Taxpayers that cannot locate the underpaid workers are not excused from the correction requirements. The IRS expect that taxpayers will be able to establish correction payments by using existing state and tax withholding procedures. Taxpayers that underpay workers while waiting for a supplemental wage or additional classification determination would have 30 days after the determination to make correction payments. For purposes of credit transfers under Code Sec. 6418, the correction and penalty requirements would continue to apply to the eligible taxpayer, not the credit transferee.

For purposes of the increased correction and penalty amounts for intentional disregard of the PWA requirements, the proposed regs would provide that failures would be due to intentional disregard if they are knowing or willful, based on all relevant facts and circumstances. There would be a rebuttable presumption against intentional disregard if the taxpayer makes the correction and penalty payments before receiving a notice of an examination.

The proposed regs would provide limited penalty waivers when PWA failures are small in amount or occur in a limited number of pay periods. The penalty also would not apply with respect to a laborer or mechanic employed under a project labor agreement that meets certain requirements, if correction payments are made by the time the taxpayer claims the increased credit. The proposed regs would use the IRS’s general enforcement discretion to allow taxpayers to correct limited failures to pay prevailing wages if the taxpayers pay the mechanics and laborers back wages and interest in a timely manner before claiming the increased credit.

Apprenticeship Requirements

To satisfy the apprenticeship requirement, taxpayers must satisfy:

(1)	1. the Labor Hours Requirement, by ensuring that the applicable percentage of the total labor hours are performed by qualified apprentices;
(2)	2. the Ratio Requirement, by ensuring that any applicable apprenticeship-to-journeyworker ratio is satisfied on a daily basis; and
(3)	3. the Participation Requirement, which is intended to prevent taxpayers from satisfying the Labor Hours Requirement by only hiring apprentices to preform one type of work.

The proposed regs explain that the Labor Hours Requirement generally is subject to the Ratio Requirement, and the Participation Requirement applies in addition to those two requirements.

Failure to Satisfy Apprenticeship Requirements

The proposed regs provide addition guidance regarding the good faith effort exception to the apprenticeship requirements when a taxpayer’s request for a qualified apprentices is denied. The taxpayer may need to submit requests to multiple apprenticeship programs, and each request must include prescribed information. A taxpayer would have to submit a second request within 120 days of a first denial. The good faith exception would apply only to a particular denied request. A taxpayer that does not qualify for the good faith exception may be treated as satisfying the apprenticeship requirements by paying a penalty to the IRS. The proposed regs spell out how taxpayers determine correction amounts are determined.

Failures to meet the Apprenticeship Requirements would be due to intentional disregard if they are knowing or willful under all relevant facts and circumstances. The proposed regulations provide a non-exhaustive list of relevant facts and circumstances.

The proposed regulations would also provide the penalty payment requirement for failures to meet the Labor Hours or Participation Requirement would not apply if a project labor agreement that meets certain requirements is in place. In addition, there would be a rebuttable presumption against intentional disregard if the taxpayer makes the penalty payments before receiving a notice of an examination.

As with the prevailing wage requirements, the proposed regulations would provide that a penalty payment would remain the responsibility of the eligible taxpayer that transfers the increased credit under Code Sec. 6418. The obligation to meet the Apprenticeship Requirements would not be binding until the eligible taxpayer files its return for the year the credit is determined or, if earlier, the transferee taxpayer files its return taking the transferred credit into account.

Recordkeeping Requirements

The proposed regulations would require taxpayers to establish compliance with the Prevailing Wage Requirements at the time a return claiming the increased credit is filed. These requirements are generally consistent with the recordkeeping requirements under the DBA regime. Taxpayers would also have to maintain and preserve sufficient payroll records to establish compliance.

Similarly, the proposed regulations would require taxpayers subject to the Apprenticeship Requirements to maintain sufficient records to establish compliance with the Labor Hours, Ratio and Participation Requirements. It would be the responsibility of the taxpayer to maintain the relevant records for each apprentice engaged in the construction, alteration, or repair on the qualified facility, regardless of whether the apprentice is employed by the taxpayer, a contractor, or a subcontractor.

Finally, if an eligible taxpayer transfers any portion of a credit that includes the increased amount for satisfying the PWA requirements, these recordkeeping requirements would remain with an eligible taxpayer.

Effect on Other Documents

The provisions of sections 3 and 4 of Notice 2022-61 would be obsoleted for facilities, property, projects, or equipment the construction, or installation of which begins after the date these regulations are published as final.

Proposed Applicability Date

The regulations are proposed to apply to facilities, property, projects, or equipment placed in service in tax years ending after the date they are published as final, and the construction or installation of which begins after hat date. However, taxpayers may rely on the proposed regulations with respect to construction or installation of a facility, property, project, or equipment beginning on or after January 29, 2023, and on or before the date the regulations are published as final, provided that beginning after October 30, 2023, the taxpayer follows the proposed regulations in their entirety and in a consistent manner.

Comments Requested

The IRS requests comments on the proposed regs, and a public hearing is scheduled for November 21, 2023, at 10 am EST. Comments and requests to speak at the hearing must be received by October 30, 2023, and requests to attend the hearing must be received by November 17, 2023. Comments and requests may be mailed to the IRS, or they may be submitted electronically via the Federal eRulemaking Portal at https://www.regulations (indicate IRS and REG-100908-23).

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The IRS has provided guidance on the income tax treatment of payments made by states in 2023 and later years. In IRS News Release 2023-23, February 10, 2023, the IRS clarified the federal tax status of special payments made by 21 states in 2022 that were mainly related to the COVID-19 pandemic, with varying terms in the types of payments, payment amounts, and eligibility rules.

State Tax Refunds

The exclusion of state income tax refunds is largely dependent on whether an individual itemized deductions and deducted the amount of state income tax paid. A state income tax refund will be excluded from an individual's gross income if the person claimed the standard deduction for the tax year in which the state income tax was paid. On the other hand, an individual who itemized deductions and deducted the amount of state income tax paid will include a state income tax refund to the extent that the individual received a federal income tax benefit from the prior federal income tax deduction.

A similar rule applies to state property tax refunds.

2022 Payments Covered by IR-2023-23

IR-2023-23 described some 2022 programs that intended to make payments in early 2023. To the extent an individual could exclude such a payment received in 2022 pursuant to the news release, an individual may exclude a state payment received in 2023 under a 2022 program from federal income tax.

General Welfare Payments

Payments that are made under a state program for the promotion of the general welfare are not includible in federal income tax. To be excluded as a payment for the general welfare, the payment must: (1) be made from a governmental fund; (2) be for the promotion of the general welfare, meaning based on individual or family need; and (3) not represent compensation for services.

Comments Requested

The IRS requests comments on the application of these rules and on specific aspects of state payment programs or additional situations where federal guidance would be helpful. Comments should be submitted on or before October 16, 2023. Comments may be mailed to the IRS or submitted electronically via the Federal eRulemaking Portal at https://www.regulations.gov.

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National Taxpayer Advocate Erin Collins is calling on the Internal Revenue Service to alter how it deals with supervisory review of penalties.

"The IRS’s approach to supervisoryreview of penalties is heavy-handed and burdensome on taxpayers," Collins wrote in an August 29, 2023, blog post.

She noted that the while some penalties require supervisory approval before they can be assessed, the statue providing authority "is vague regarding the point at which this approval must occur," which has led to conflicting decisions in tax court about how they should be treated.

Collins noted that the IRS is currently working on the problem and has issued proposed regulations on the subject. A public hearing on this issue will be held on September 11, 2023.

"The proposed regulations succeeded in providing clarity, but it would be nice if they did so in a way that helps taxpayers rather than harming them."

According to Collins, the proposed regulations set up a process by which a supervisory approval can be obtained anytime before the statutory notice of deficiency is issued for pre-assessment penalties subject to Tax Court review. For those penalties not subject to pre-assessment Tax Court review, they can be approved up until the time of assessment itself.

"The IRS’s proposed approach is problematic because the ability to raise potential penalties with taxpayers in the absence of oversight could lend itself to the improper assertion of penalties," Collins wrote. "Practitioners and Congress expressed concerns that some IRS examiners may be tempted to propose a penalty with no real intention of actually imposing it. Rather, the penalty is put forth as a bargaining chip to be negotiated away as part of the case resolution process. The IRS is quick to point out that this practice is unauthorized and is strongly discouraged. Nevertheless, the structure perpetuated in the proposed regulations does nothing to protect taxpayers from potential abuse."

Collins stated that supervisory review "should occur before applicable penalties are communicated to the taxpayer in writing," adding that the proposed regulations "provide the IRS with an excellent chance to reconsider its approach to supervisoryreview. This is an opportunity that the IRS has so far declined to embrace, but there is still time. I urge the IRS to reexamine its policy and I request that Congress consider clarifying the law to protect taxpayers’ rights."

By Gregory Twachtman, Washington News Editor

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Taxpayers, and the accounting and legal professionals who represent them, need to be prepared as the Internal Revenue Service has begun compliance work on those who own and trade in cryptocurrencies.

"A CPA needs to advise their clients that the IRS is looking into this," Paul Miller, CPA and managing partner at Queens, N.Y.-based Miller and Company LLP, said in interview. He recalled that one of his clients was recently audited for his crypto transactions going all the way back to 2018.

Miller suggested that the tip off that the agency would be more closely examining taxpayers’ crypto transactions was the simple question added to Form 1040 asking whether the taxpayer engaged in any transactions.

He also suggested that the IRS could be showing some level of leniency for these early taxpayers who are getting their crypto transactions audited.

"The IRS was pretty reasonable with this man," Miller said. "He wasn’t assessed the fraud penalty. He wasn’t assessed the 25 percent penalty. He just had to amend three or four years of his tax returns for failing to report crypto."

Miller also pointed out that the IRS gave the taxpayer"the benefit of the doubt," recognizing both that he might night have thought about the tax ramifications of his crypto transactions as well as recognizing the fact that he was unable to recover transaction data from 2018.

To that end, Miller stressed that it is very important to keep accurate records and to not necessarily rely on transaction platforms for providing that information.

"If you use Coinbase, Coinbase is pretty good because they give you a 1099," he said, adding that other trading platforms might not provide that information. "Regardless, we tell all our of our clients to keep records, keep track of it" just like they would keep track of information about money in foreign bank accounts.

On the IRS side, Miller suggested that crypto compliance could be a part of the agency’s push to utilizing artificial intelligence as part of the compliance process, noting that with everything else on the agency’s plate, the IRS "literally doesn’t have the manpower." This could make AI a tool for crypto compliance.

Miller also recommended that CPAs be sure to include very specific questions on crypto in their engagement letters.

"It’s all about getting the client to take responsibility off of me and putting it on them," he said. "Because at the end of the day, I’m just preparing the tax return."

He stressed that it does not mean the goal of a CPA is not to give their clients the best advice.

"The goal is that you have a responsibility to pay your taxes," he said. "You have a responsibility to report the information, If you disagree or if you deviate from that, you have to deal with the consequences, not me."

By Gregory Twachtman, Washington News Editor

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Q. I am reviewing my portfolio and considering selling some of my stock. How do I determine what tax basis I have in the publicly-traded shares that I own for purposes of determining my gain or loss if I buy and sell multiple shares at different times? Does keeping track of basis really matter?

A. In order to accurately calculate the gain or loss realized on assets you sell, it is important that you keep track of the bases of all of your assets, including stock. However, when it comes to stock--especially lots of stock bought and sold at different times-- it may seem a bit tricky. Fortunately, the rules related to determining the basis of stock sold make the task more manageable.

In general, the basis of stock sold will be determined under one of the following methods: first-in, first-out (FIFO) or specific identification. However, securities held in mutual funds and received as a result as a corporate reorganization may be handled differently.

First-in, first-out (FIFO)

In general, if you buy identical shares of stock at different prices or on different dates and then you sell only part of the stock, your basis and holding period of the shares sold are determined on a first-in first-out (FIFO) basis, based upon the acquisition date of the securities. However, if specific shares sold are adequately identified by the delivery of certificates, by a broker having custody of them, or by a trustee or executor, the basis will be determined by the specific identification method (see below).

The acquisition date for purpose of applying the FIFO method follows the rules for holding period. For example, the acquisition date of securities received by gift takes into account the donor's holding period, and securities received in an estate distribution includes the holding period of the executor or trustee.

Margin accounts. If your shares are held in a margin account, they are considered sold in the order in which they were purchased, rather than the order in which they were placed in the account.

Stock splits or dividends. If you receive shares as a result of a stock split or tax-free stock dividend, they must be allocated among the original lots to which they relate, with the basis of the original shares allocated between the new shares and the old shares based on their fair market values.

Stock rights. If you acquire additional shares by exercising stock rights, your new shares are treated as a separate lot and your basis in them is equal to the amount paid plus the basis of the stock rights.

Multiple contracts. Shares acquired on the same day under several contracts entered into at different times to purchase stock when issued are deemed acquired for the FIFO rule in the same order as the contracts were entered into.

Specific identification

When you are able to identify the securities to be sold, and do so, FIFO will not apply to your basis allocation. The identity of securities sold or otherwise transferred generally is determined by the certificates actually delivered to the transferee (usually by CUSP number). Thus, if you have records showing the cost and holding period of securities represented by separate certificates, you can often better control the amount of gain or loss realized by selecting the certificates to be transferred. But be careful: delivery of the wrong certificates is binding, despite your intention to transfer securities from a different lot.

Example: You hold 1000 shares of IBM. You purchased 400 shares (actually 100 shares that split twice) in 2000 for $8,000 (net brokerage commissions). You bought 400 more shares in 2005 at $18,000; and 200 more in early 2007 for $16,000. You want to sell 300 shares now when its value is down to $50 per share. If you do not specify to your broker before the trade to sell the 200 shares purchased in 2007 and 100 shares from the 2005 lot, you will realize $9,000 in long term capital gains instead of $500 in long-term capital gain and a $6,000 short-term capital loss.

Mutual funds

If you own shares in a mutual fund, you may elect to determine the basis of stock sold or transferred from your accounts by using one of two average cost methods: either the double-category method or the single-category method. An election to use one of the average basis methods for mutual fund shares must be made on either a timely filed income tax return or the first late return for the first tax year to which the election is to apply. Different methods may be used for accounts in different regulated investment companies.

Securities received in reorganization

An exception to the FIFO rule applies to securities received in reorganization (such as a merger) and not adequately identified. These securities are given an average basis, computed by dividing the aggregate basis of the securities surrendered in the exchange by the number of shares received in the exchange. If securities in the same corporation are received in the exchange, however, they are divided into lots corresponding with those of the securities surrendered and the FIFO principle is applied, in the absence of adequate identification on a later disposition.

As illustrated in an example above, there can be negative tax effects from the misidentification of stock sold. If you are uncertain how to properly identify stock sold, please contact the office for further guidance.

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