Despite Legislative Stalemate, Tax Regulators Press On
Given the litany of headline-grabbing events that have taken place in 2020 – from the spread of a global pandemic and civil unrest, to the impeachment of President Donald Trump and a contentious election cycle – it’s no surprise that tax policy has taken somewhat of a back seat.
But even with legislation largely stalled in Congress, there have been some notable developments on the tax front. While certainly not exhaustive, below are three policy highlights from the recent weeks that may affect NAIOP members and their businesses.
Signed into law at the end of 2017, the Tax Cuts and Jobs Act was the largest overhaul of the Internal Revenue Code in more than three decades. Among its numerous changes, one of the most significant (and, to be sure, controversial) was the implementation of a $10,000 cap on state and local tax (SALT) deductions. Many partnerships and subchapter S corporations have balked at the new limitations, since they were deemed to apply only to pass-through entities; C corporations, on the other hand, could continue writing off the full amount of their non-federal taxes.
In response, and amid failed efforts by congressional Democrats to repeal the cap, some states took matters into their own hands, crafting legislative workarounds. The first iterations attempted to allow firms to make charitable contributions in exchange for state tax credits, but were quickly shot down by the IRS.
Undeterred, states such as Connecticut, New Jersey and Wisconsin tried a different approach, this time creating an entity-level tax on pass-through businesses, which is deductible on a federal return. To offset the payment, taxpayers receive a corresponding personal income tax credit from the state.
Though subtle, the tweak was ultimately blessed by federal regulators, who in November announced forthcoming rules allowing this type of workaround. It’s a welcome development for many property owners, particularly in high-tax areas, whose state tax liabilities can far exceed the $10,000 cap.
It’s unclear whether the regulations will hold up under a Biden administration. But given Democrats’ opposition to the SALT caps in general, many expect the IRS to move forward with finalization of the rules sometime in 2021. In the meantime, it’s likely additional states will pass their own workarounds to remain competitive.
Another change made by the Tax Cuts and Jobs Act was the limitation of like-kind exchanges only to real property. But since the law’s passage, regulators have struggled to navigate scenarios involving assets associated with an exchanged property, such as structural components and personal property.
To address these questions, the IRS in November finalized its rules governing like-kind exchanges. Compared to a proposal released in June, the regulations generally broaden the definition of property that qualifies for tax-deferred treatment under Section 1031.
That earlier proposal introduced a “function-based test” to determine whether assets affixed to real property are eligible. But after a number of groups, businesses, and practitioners criticized the approach during the public comment period, the IRS backtracked. Per the final rules, as long as the property in question (for example, a piece of machinery or equipment) is “permanently affixed to real property and will ordinarily remain affixed for an indefinite period of time,” it is deemed eligible.
Regulators also provided clarity around the amount of incidental personal property that can be included in a transaction, without disqualifying a like-kind exchange in its entirety. The new rules will go into effect immediately.
A cornerstone of the March coronavirus relief package, known as the CARES Act, was the Paycheck Protection Program, a roughly $670 billion pool of funds that was distributed to struggling businesses. The funds were structured as loans, but under certain conditions could be forgiven entirely.
However, a key question that emerged was whether expenses paid for with PPP proceeds were deductible. The ambiguity stemmed from language in the CARES Act, which explicitly exempts forgiven loans from being taxed, but is silent on whether deductions are allowed.
Despite backlash from Congress, regulators issued guidance disallowing the deductions. Treasury Secretary Steve Mnuchin at the time defended the decision, arguing that “the money coming in the PPP is not taxable. So if the money that’s coming is not taxable, you can’t double dip.” As a result, some tax practitioners reported firms being forced to pay more on their quarterly estimated taxes to reflect the lack of deductions. Others worried that the confusion could cause owners to face fines in the future for noncompliance.
For months it seemed lawmakers were ready to take action and override Treasury, but in the end these efforts came up short. The final nail in the coffin for PPP deductibility came in mid-November, when officials finalized regulatory guidance disallowing the write-offs. Though it’s unlikely large numbers of real estate firms would have benefitted directly, given that only 3 percent of PPP recipients were designated as “Real Estate and Rental and Leasing” businesses, the deductions would have surely helped thousands of tenants experiencing revenue shortfalls. The issue is likely to be raised again if Congress advances additional coronavirus stimulus funds.
These descriptions provide a brief glimpse at notable developments in the tax policy space, but are by no means exhaustive. They are also inherently complex, and subject to alteration, particularly since a new presidential administration is expected to take control of the White House in early 2020. Individuals or businesses with questions about these or other statutory changes should speak with their accountant or tax advisor.
Alex Ford is NAIOP’s Director of Federal Affairs.
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