Friday, December 15, 2017

Continued Live blog of the bill's tax accounting provisions

1. Qualified Leasehold Improvement Property, Qualified Retail Property, and Qualified Restaurant Property are axed in favor of Qualified Improvement Property starting in 2018.

2. Electing Real Property Trades or Businesses form a new class mandatory ADS property starting in 2018.

3. Research and experimentation expenses now must be amortized over five years, unless they are for specified foreign research, in which case the period rises to fifteen years. This starts in 2022.

4. The development of new software is now defined as an R&E expense. This also starts in 2022.

5. The accrual method has been modified so that income cannot be delayed any later than when it is included for financial income reporting purposes. Rev Proc 2004-34 has been made into a statute. These rules apply starting in 2018.

6. Interest is now limited to the business interest income plus 30% of the adjusted taxable income of the taxpayer plus the floor plan finance interest of the taxpayer. Small taxpayers that meet the $25 million test are exempt from this limit.

7. The Section 199 DPAD is repealed.

Overview of the Tax Cuts and Jobs Act Conference Report's Tax Accounting Provisions

If you don't have it already, you can find the bill here.

1. Section 179. Following the Senate version, the Section 179 expensing dollar limitation increases to $1 million and the phaseout (reduction in limitation) increases to $2.5 million. In a new development, the MACRS' Qualified Improvement Property is now Qualified Real Property for section 179 purposes. So are roofs, HVAC, fire protection and alarm systems, and security systems if they are subsequent improvements to nonresidential real estate. In another new development, the section 179 exclusion for property used in lodging has been repealed. This means that section 179 will not be available for section 1245 property used in residential rental property. These provisions are effective for tax years beginning after 12/31/2017. 

2. Increased Cash Method Availability and Related Rules. The conference report follows the House version of the bill and increases the availability of the cash method of accounting to taxpayers with $25 million or less in average annual gross receipts. This provision is now adjusted for inflation. Section 263A "UNICAP" no longer applies to taxpayers that meet the $25 million test. Similarly, section 471 is modified so that the Service may no longer force taxpayers to use inventories (and the accrual method of accounting) if they meet the $25 million test. Taxpayers who meet the $25 million test will also be allowed to treat inventory as non-incidental materials and supplies, (similar to how Revenue Procedures 2001-10 and 2002-28 currently work), OR are permitted to use an inventory method that conforms to their financial accounting method or, if they don't have financials, their book method. There will also be a similar exemption from the Percentage Completion Method for taxpayers with long-term contracts. All of these provisions will apply across entity types (including sole proprietorships) and will be available in tax years beginning after 12/31/2017.

3. 100% Expensing. Bonus depreciation goes to 100% in 2018 with a 20% per year drawdown starting in 2023. Bonus depreciation will now be available for used property not previously used by the taxpayer and that was not acquired from certain related parties or the basis of which is not determined with reference to the adjusted basis in the hands of another taxpayer (including the basis step-up of property received from a decedent). Taxpayers involved in real property trades or businesses or who have certain floorplan financing arrangements. The new 100% bonus rules generally apply for property placed-in-service after September 27, 2017 so long as the property was not acquired before September 28, 2017. 

Friday, April 28, 2017

California Announces Revision to Method Change Policy

Yesterday, the California FTB issued FTB Notice 2017-03. In this notice, the FTB announced that it was withdrawing FTB Notice 96-3 and will now follow the federal Rev. Proc. 2016-29. This notice was issued to clear up confusion regarding the application of Notice 96-3.

Overview. In FTB Notice 96-3, the FTB announced that it would not follow IRS Rev Proc 96-31. This revenue procedure allowed taxpayers to obtain automatic consent to change their accounting methods when they claimed less than the depreciation allowable. This procedure was republished with slight modifications in IRS Rev Proc 97-37. In IRS Rev Proc 98-60, the procedure was modified so that taxpayers could obtain automatic consent both when they claimed less than the depreciation allowable and when they claimed more. (With slight modifications, this procedure can now be found in section 6.01 of IRS Rev. Proc. 2017-30, which is the quite recent replacement of Rev. Proc. 2016-29.)  In FTB Notice 2000-8, the FTB announced their general policy under which taxpayers could obtain consent to change their accounting methods for California tax purposes. This notice was generally understood as permitting Federal method changes for California tax purposes under California's "deemed election" provisions of Revenue and Taxation Code sections 17024.5 and 23051.5 when there was no conflict between California and Federal tax laws, which was generally the case for non-C corp taxpayers seeking depreciation method changes.

In discussing the new notice with its author, I have learned that the FTB always took the position that Notice 96-3 applied only to Rev. Proc. 96-31 and did not apply to Rev. Proc. 97-37 and its successors. Therefore, the general understanding of Notice 2000-8 was the correct interpretation.

Practice Tips

1. The federal automatic consent change procedures are strict compliance procedures. See Hawse v. Comm'r, T.C. Memo 2015-99, at 22. Even though the IRS may not have rejected an automatic consent Form 3115, the taxpayer may not have received IRS consent to make the change. Id. at 24. Since California's deemed election rules require a "proper election filed with the Internal Revenue Service in accordance with the Internal Revenue Code or regulations", automatic consent Forms 3115 that comply with some, but not all, of the requirements of the automatic change procedures are vulnerable to FTB examination changes.

This is relevant to this topic because many depreciation method changes arise from cost segregation studies. In my experience, most practitioners omit some of the required statements for certain depreciation method changes. When filing a Form 3115 to implement a cost segregation study, practitioners most often omit the statement required under section 6.01(3)(b)(vii) of Rev. Proc. 2017-30 (and predecessors). (This section requires a statement of the facts and law supporting the new classification of each section 1245 asset.)

2. Taxpayers may continue to rely on FTB Notice 2000-8 to request different accounting methods for California purposes than the ones they elect for Federal purposes.