The AICPA has sent a letter dated August 13, 2018 asking for immediate guidance on issues arising from the Tax Cuts and Jobs Act related to S corporations and excess business losses under IRC §461(l). This request was developed by the AICPA S Corporation Taxation and Trust, Estate, and Gift Taxation Technical Resource Panels and approved by the AICPA Tax Executive Committee.
The AICPA letter notes:
Taxpayers and practitioners need clarity on S corporation issues in order to comply with their 2018 tax obligations and to make informed decisions regarding cash-flow, entity structure, and tax planning issues.
Accompanying the letter is a 16-page memorandum setting out in detail the various items the AICPA is seeking guidance on. The letter summarizes the major items for which information is begin requested as follows:
1.Guidance on the application of the new laws on loss carryforwards.
a. Clarify how to coordinate various loss and deduction limitations with section 199A qualified business income (QBI) carryover losses by applying the order as follows: section 163(j), 1366(d), section 465, section 469, section 461(l), and section 199A.
b. Clarify that the carryforward rule under section 163(j)(2) applies to S corporations despite section 1371(b)(2).
c. Clarify the definition of real property trades or businesses beyond section 469(c)(7)(C) for purposes of the disallowed business interest deduction under section 163(j).
d. Clarify the application of the section 461(l) limitation on net operating losses (NOLs).
2. Guidance on certain provisions relating to the post-termination transition period (PTTP) and the eligible terminated S corporation period (“ETSC Period”) under section 1371(f).
a. Clarify how a corporation computes its accumulated adjustments account (AAA) upon re-electing S corporation status if the corporation was an ETSC and if the corporation was not an ETSC.
b. Clarify how the ETSC Period rules of section 1371(f) apply when a corporation has more than one PTTP.
c. Identify the shareholders eligible to receive distributions from a corporation's AAA during the ETSC Period.
d. Clarify how distributions are allocated between the AAA and accumulated earnings and profits (AE&P) under section 1371(f).
e. Clarify how AAA is adjusted during the PTTP and the ETSC Period.
3. Guidance on the treatment of deferred foreign income upon transition to participation exemption system of taxation (section 965) for S corporation trust shareholders3 and what trust transactions are section 965 triggering events and how a transferee of S corporation stock held in trust might assume the liability for the section 965 transition tax.
a. Clarify that transition tax on deferred foreign income is not triggered by transfer to an irrevocable grantor trust or a revocable grantor trust.
b. Provide clarity regarding the assumption of the section 965 transition tax liability on the death of the grantor of a grantor type irrevocable trust that holds S corporation stock, as well as on the death of the grantor of a revocable trust making the section 645 election.
c. Provide clarity regarding a qualified subchapter S trust (QSST) and whether the trust or the beneficiary assumes the liability for the section 965 transition tax.
d. Provide clarity on whether a QSST conversion to an electing small business trust (ESBT) conversion, or an ESBT to QSST conversion, is a triggering event for purposes of the section 965 transition tax.
e. Provide clarity on whether the severance or division of a trust into separate shares is a triggering event for purposes of the section 965 transition tax.
f. Provide clarity on the material modifications in trusts or trust beneficiaries that Treasury and the IRS would treat as a triggering event for purposes of section 965(i)(2)(A)(iii).
One of the comments is of special interest as it has application beyond the S corporation context and deals with broader TCJA issues. The question raised in the memorandum is whether a §461(l) loss carried into the following year would be once again subjected to the §IRC 461(l) excess business loss limitation.
As the memorandum notes:
Under the TCJA, new section 461(l) provides that an “excess business loss” of a taxpayer other than a corporation is not allowed for the tax year. Any disallowed excess business loss of the taxpayer is treated as the taxpayer's NOL and carried forward for utilization in a subsequent tax year (subject to certain taxable income limitations).
Those limits are $250,000 for individual taxpayers other than married taxpayers filing a joint return, for whom the limit doubles to $500,000. A net business loss in excess of those limits is denied in the year incurred and converted into a net operating loss carryover that begins to be taken into effect in the following year.
The AICPA memorandum describes the potential issue and how the organization suggests it be resolved as follows:
For taxable years beginning after December 31, 2017 and before January 1, 2026, excess business losses of a taxpayer other than a corporation are not allowed for the taxable year. These losses are carried forward and treated as an NOL carryforward.
An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer (determined without regard to the limitation of the provision), over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount.7 The threshold amount for a taxable year is $250,000 (or $500,000 in the case of a joint return). The threshold amount is indexed for inflation.
Once the NOL has been established, there is a question as to whether an “aggregate deduction” of the taxpayer’s trade or business in a subsequent tax year should include the NOL. Treating the NOL in this manner would potentially subject the original NOL to an additional loss limitation deferral under section 461(l). We believe that subjecting the NOL to a loss limitation in a subsequent year is a misinterpretation of the statute.
The new statute explicitly states that the disallowed loss becomes an NOL and there is no mention that this amount is retested under section 461(l) in a subsequent tax year. Furthermore, the new provision does not parallel pre-2018 section 461(j), which involved subsidized farming losses. The pre-2018 section 461(j) explicitly provided that disallowed subsidized farm losses retained their character in a subsequent tax year. New section 461(l) does not contain a similar character-retention rule. Accordingly, it would appear that the NOL generated under section 461(l) is no longer subject to other loss limitation provisions (but nevertheless remains subject to taxable income limitations).
Treasury and IRS should provide guidance that an NOL that is created upon the occurrence of the loss limitation provisions of section 461(l) is not included in the definition of aggregate deductions of the taxpayer, and therefore is not subject to the loss limitation provisions of section 461(l) in a subsequent year.
Will the IRS heed the AICPA’s call to issue timely guidance on this issue and the others raised in the letter? Unfortunately, the track record on the letters issued to date in getting an IRS response hasn’t been encouraging.
While the AICPA wrote the IRS asking for immediate guidance on various §199A matters in late February 2018, the first guidance did not appear until early August. Similarly, the AICPA wrote indicating the need for immediate guidance on meals and entertainment issues in early April and that guidance has yet to emerge from the IRS.
This isn’t surprising—the IRS is receiving a lot of correspondence from various interested parties regarding the need for guidance on various provisions of the TCJA and most are asking for an immediate answer.
That doesn’t mean these letters don’t matter—they are part of the input Treasury will take into account in developing the rules. As well, they remind us of the areas of uncertainty that still exist in dealing with TCJA issues many months after the bill was signed into law.