Headlights Newsletter – Winter 2024

The latest issue of Headlights, a publication of the AutoCPA Group, is now available.

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State Income Tax Law Changes for the Fourth Quarter of 2023

ARTICLE | January 09, 2024

Authored by RSM US LLP

Executive summary: State tax ASC 740 Q4 update

The following state tax developments were enacted during the fourth quarter of 2023 and should be considered in determining a company’s current and deferred tax provision pursuant to ASC 740, income taxes, for the quarter ended Dec. 31, 2023. This information summarizes the listed developments and may not provide additional nuanced considerations that may be relevant for provision purposes. For questions about these quarterly updates or other recent legislative and regulatory developments, please reach out to your tax adviser for more information. 

State income tax law changes for the fourth quarter of 2023

California court upholds single-sales factor apportionment

The California Court of Appeals upheld Proposition 39, which was approved by voters on a ballot initiative and enacted in 2012. Proposition 39 required the use of single-sales factor apportionment for taxpayers and eliminated the use a three-factor apportionment formula. Proposition 39 also provided a special apportionment rule for cable companies and created a fund for clean energy projects. The taxpayer argued in One Technologies LLC. v. Franchise Tax Board (Cal. Ct. App. (2nd) No. B318787, Oct. 23, 2023), that Proposition 39 violated the state’s single-subject rule for ballot initiatives due to the exceptions noted above. The Court found that Proposition 39 did not violate the state’s single-subject rule and as a result, the taxpayer was required to use the single sales factor apportionment formula.

California court rejects FTB’s attempt to limit PL 86-272 protections on procedural grounds

On Dec. 13, 2023, a California Superior court found Technical Advice Memorandum (TAM) 2022-01 and related Franchise Tax Board (FTB) Publication 1050 to be invalid. American Catalog Mailers Association v. Franchise Tax Board, Case No. CGC-22-601363 (Cal. Superior Ct., San Francisco Cnty., Dec. 13, 2023). Both pieces of guidance clarified the FTB’s interpretation of the protections of P.L. 86-272 for internet-based activities, which were intended to closely follow the guidance issued by the Multistate Tax Commission (MTC) in August of 2021. The court did not rule on the merits of the case, finding instead that TAM 2022-01 and Publication 1050 were invalid because they constituted regulations that were required to be adopted pursuant to the California Administrative Procedure Act (APA), which would have required notice and a period for public comment.

Colorado updates conformity rules

On Nov. 8, 2023, the Colorado Department of Revenue repealed Colo. Regs. Section 39-22-103(5.3), which had clarified that Colorado’s definition of the IRC incorporated federal changes on a prospective basis only. Colorado conforms to the IRC on a rolling basis, and the change was in response to prior legislation and a Colorado Court of Appeals ruling in 2022.

Kansas provides guidance on corporate tax rate reduction

On Oct. 24, 2023, the Kansas Department of Revenue issued Notice 23-10: Change to Corporate Income Tax Rate with guidance on the rate reduction that previously was announced on Aug. 31, 2023. The department explained that, prior to rate reduction of Kansas Stat. Ann. Section 74-50,321, Kansas imposed a corporate income tax rate of 4%, with a surtax of 3% on Kansas taxable income exceeding $50,000. While section 74-50,321 reduces the rate from 4% to 3.5% for tax years beginning on or after Jan. 1, 2024, the 3% surtax continues to apply.

Maine court requires taxpayer to look-through to pharmacy location in sourcing receipts from claims adjudication services

On Nov. 7, 2023, the Maine Supreme Judicial Court held that the receipts the taxpayer received from claims adjudication services in connection with the sale of pharmaceuticals were sourced to the pharmacy location. Express Scripts Inc. et al. v. State Tax Assessor, Me. Sup. Jud. Ct., No. 2023 ME 68 (Nov. 7, 2023). In Express Scripts, Inc., the taxpayer’s clients included health insurers, health maintenance organizations (HMOs), employers, governmental health programs and union-sponsored benefits plans. The clients’ members were individuals and employees covered by the health plans. Maine’s market-based sourcing rules require that receipts from services are sourced to the location that the benefit of the services are received. The taxpayer argued that benefit of the service is received at the location of its business customer (i.e., the headquarters or commercial domicile of the health insurer). The Court disagreed, finding that the services ultimately were received by the individuals at the pharmacy location. In its ruling, the Court pointed to language within the company’s public filings and contracts that indicated the ultimate recipients of the services were the client members of the taxpayer.

Massachusetts enacts single-sales factor apportionment for all business taxpayers

On Oct. 4, 2023, Gov. Maura Healey signed into law House Bill 4101, enacting a comprehensive tax relief measure. Most notable for business taxpayers, the law adopts a single-sales factor apportionment formula for taxpayers of all industries, effective for tax years beginning on or after Jan. 1, 2025. Previously, single-sales factor apportionment was required only for manufacturers and mutual fund service companies, while all other corporations and financial institutions were required to apportion income and non-income taxes to Massachusetts using a three-factor double-weighted sales apportionment formula.

Note that the change to apportionment impacts not only the calculation of a taxpayer’s measure of income tax within the state, but also the measure of non-income tax, which is based either on the taxpayer’s Massachusetts tangible personal property or net worth. Additionally, the law makes changes to the sourcing of certain receipts from investment and trading activities for financial institutions. Please read our article, Massachusetts passes comprehensive tax relief for more information.

Minnesota court affirms decision that the gain on the sale of goodwill is apportionable business income

On Nov. 22, 2023, the Minnesota Supreme Court affirmed the Minnesota Tax Court’s decision in Cities Management Inc., vs. Comm’r of Rev. (Case No. A23-0222, Nov. 22, 2023) that the income earned by a nonresident individual resulting from the sale of her stock ownership interests in two S corporations was business income subject to apportionment. In Cities Management, Inc., the taxpayer made an election under section 338(h)(10) to treat the stock sales as sales of the underlying corporate assets, with a significant portion of the value being goodwill. The Court found that the value of the goodwill could be attributed to the corporation’s business operations and as a result, the gain from the sale was derived from a unitary asset that is treated as business income and subject to apportionment.

Mississippi issues guidance on the election for immediate expensing of certain expenditures

On Oct. 20, 2023, the Mississippi Department of Revenue issued guidance on House Bill 1733, which amended Miss. Code Ann. Section 27-7-17 to revise the methods of depreciation that may be used for certain expenditures and property. House Bill 1733 is effective for tax years beginning after Dec. 31, 2022. The department clarified that:

  • Taxpayers may elect to immediately deduct qualified research and experimental expenses that must be capitalized and amortized for federal purposes pursuant to section 174;
  • Expenditures for business assets that are qualified property or qualified improvement property (QIP) are eligible for 100% bonus depreciation and may be deducted as an expense incurred by the taxpayer during the tax year in which the property was placed in service. Taxpayers may elect to take a bonus depreciation deduction in accordance with section 168;
  • Taxpayer may elect to treat the cost of any section 179 property that was placed in service during the taxable year as an expense that is deductible in the current year.

New Jersey issues several bulletins providing guidance for previously enacted legislation

The New Jersey Department of Taxation issued new and updated tax bulletins throughout Q4 2023 intended to provide guidance on legislation enacted on July 3, 2023, that made significant changes to the corporate income tax. The guidance covers topics including but not limited to:

  • Changes to the rules related to the dividend exclusion, and the ordering of the net operating loss (NOL) deduction, dividend exclusion and international banking facility deduction;
  • Changes to the calculation of the combined group’s NOL deduction;
  • Changes impacting forms and schedules that must be included with the corporate income tax return; and
  • Changes impacting income reporting and accounting methods for non-US corporations that are included in a combined return claiming treaty protection.

For more information please see our article on the legislation, New Jersey enacts most significant tax changes in years and consider reviewing the more recent relevant bulletins: TB- 86R; TB-91R; TB 94R; TB 95R; TB-99R; TB 101R; TB-103R; TR 111; TB-112; TB-113

New York State adopts final regulations related to corporate franchise tax reform of 2014

On Dec. 27, 2023, the New York Department of Taxation formally adopted regulations related to Article 9-A corporate franchise tax and Article 33 insurance corporation franchise tax that were proposed on Aug. 9, 2023. Years in the making, the final regulations provide guidance as it relates to comprehensive franchise tax reform that was enacted in 2014 and as amended in 2015 and 2016. The final regulations cover several topics including but not limited to economic nexus (including protected and unprotected activities under PL 86-272), apportionment, computation of the tax, certain credits, combined unitary reporting and rules impacting specific industries (such as qualified New York manufacturers). The department clarified that the regulations, effective as of Dec. 27, 2023, interpret statutory amendments that are effective for periods beginning on or after Jan. 1, 2015 and thus will apply for the same periods (retroactively as of Jan. 1, 2015). Documents relating to the adoption of the final regulations can be found on the department’s website.

New York City revives tax credit for qualified emerging biotechnology companies

On Dec. 4, 2023, New York City Mayor Eric Adams signed legislation that revives a tax credit for qualified emerging biotechnology companies. The credit may be used to offset the general corporation business tax, the unincorporated business tax, and the corporate tax of 2015. The enacted law has immediate effect and will be available for taxpayers to claim for tax periods beginning on or after Jan. 1, 2023 and prior to Jan. 1, 2026. For additional details on the credit and taxpayer eligibility requirements, please see our article, New York City biotech tax credit revived.

North Carolina enacts changes to the franchise tax and expands the pass-through entity tax

Enacted on Oct. 3, 2023, House Bill 259 caps the franchise tax at $500 on the first $1 million of a corporation’s franchise tax base. For the tax base exceeding $1 million, the rate is $1.50 per $1,000. This change is effective for tax years beginning on or after Jan. 1, 2025 (as reported on the corporate tax return for the 2024 tax year).

The bill also expands the elective pass-through entity tax provisions retroactively for tax years beginning on or after Jan. 1, 2022. Specifically, the legislation expands the list of eligible owners to include entities classified as corporations for federal income tax purposes and partners that are a trust provided that the beneficiary of the trust is limited to any person other than an individual, an estate, a trust or an organization described in section 1361(c)(6) of the IRC.

For additional information, please read our tax article, North Carolina budget passes with tax cuts and other modifications.

Pennsylvania issues guidance on sections 381, 382 and 163(j)

On Oct. 11, 2023, the Pennsylvania Department of Revenue issued Corporation Tax Bulletin 2008-03 which provides revised guidance on the application of sections 381 and 382. The guidance explains that taxpayers are required to consider the impact of section 163(j) in determining the net operating loss deductible for a given tax year. In calculating the applicable section 382 limitation for Pennsylvania purposes, the limitation is equal to the federal section 382 amount multiplied by the Pennsylvania apportionment percentage for the tax period immediately preceding the change. The guidance provides a detailed explanation on the application of sections 382 and 163(j) for purposes of the Pennsylvania corporate income tax return.

On Oct. 12, 2023, the Pennsylvania Department of Revenue issued an updated state corporate net income Corporation Tax Bulletin 2019-03 addressing the application of section 163(j). The bulletin clarifies that where a Pennsylvania taxpayer is part of a consolidated federal return that is subject to interest deduction limitations under section 163(j), each member of the consolidated group that is subject to Pennsylvania corporate income tax must calculate a section 163(j) limitation for Pennsylvania purposes on a pro-forma basis. However, to the extent that the federal consolidated group is not subject to any section 163(j) limitations, there shall be no interest deduction limitations for Pennsylvania purposes. Additionally, the bulletin clarifies that in most instances where there was a federal consolidated section 163(j) limitation for previous periods and a separate company limitation calculated for Pennsylvania purposes, taxpayers that join in the filing of a current year federal consolidated return with no section 163(j) limit may can fully deduct interest expense, plus the interest expense carryforward from prior years for calculating their Pennsylvania corporate income tax.

Texas guidance on compensation deduction

On Oct. 13, 2023, the Texas Comptroller of Public accounts issued 202310005L with guidance on costs that are allowable as benefits in determining the compensation deduction from the Texas Margin tax. For purposes of calculating the compensation deduction, the cost must:

  • Be similar to the items listed in Texas Tax Code section 171.1013(b)(2) (i.e., workers’ compensation benefits, health care, employer contributions HSAs) such that it provides value to an employee in a personal capacity;
  • Be deductible for federal income tax purposes;
  • Not already be included in wages and cash compensation; and
  • Meet the other requirements of title 34 Tex. Admin. Code section 3.589(e).

The comptroller also provided several examples that may be included as benefits in the compensation deduction including but not limited to sports club memberships, health check-ups, cell phones, professional dues, tuition reimbursement, and personal use of a company-owned vehicle. Additionally, the guidance provides examples of costs that must be excluded from the compensation deduction, such as recruiting referral fees, training, travel per diems, and the business use of a company-provided vehicle.

Wisconsin updates conformity to IRC

On Oct. 25, 2023, Wisconsin Gov. Tony Evers signed Assembly Bill 406, updating Wisconsin’s conformity to the IRC. For tax years beginning after Dec. 31, 2022, Wisconsin retroactively conforms to the IRC as amended to Dec. 31, 2022, but not including any amendments to the IRC that are enacted after Dec. 31, 2022. However, note that Wisconsin continues to have exceptions to federal conformity for several provisions of the IRC prior to 2021. Wisconsin issued Tax Bulletin 223 with more explanation of the changes. 


This article was written by Al Cappelloni, Amy Letourneau, Darian A. Harnish, Mo Bell-Jacobs and originally appeared on 2024-01-09.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2024/state-income-tax-law-changes-fourth-quarter-2023.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

IRS Announces Details for ERC Voluntary Disclosure Program

ARTICLE | December 22, 2023

Authored by RSM US LLP

Executive summary:

Employee Retention Credit Voluntary Disclosure program

On Dec. 21, 2023, the IRS announced the details of an anticipated employee retention credit Voluntary Disclosure program (ERC-VDP) for employers who claimed and received an ERC refund for a quarter but were not eligible. The program allows claimants to repay ERC at a reduced rate of 80% of the credit.  In addition, the program waives penalties and interest on the full amount, not just the 80% returned. The IRS is only accepting applications for the program until March 22, 2024. Accepted applicants will be required to execute a closing agreement stating they are not entitled to ERC and must provide the name and contact information for any preparer or advisor who assisted in claiming the ERC. The IRS has also published a set of FAQs relating to the ERC-VDP.

The IRS also announced that they are issuing another round of letters proposing adjustments to tax issued to 20,000 employers that claimed an erroneous or excessive amount of ERC.

IRS announces details for ERC Voluntary Disclosure program 

ERC VDP continuation of ongoing IRS initiative to combat dubious ERC claims

Following the October announcement of the ERC withdrawal process, the IRS has released the details of the new ERC-VDP which will allow ERC claimants who have already received the refund or credit against employment taxes to apply to repay the ERC at a reduced rate of 80% of the claim, without penalties or interest. The ERC-VDP was developed mostly for employers who were induced into claiming ERC and now realize they were not entitled to the credits. In particular, the reduced amount required to be repaid was designed to allow employers who paid a contingency fee to a promoter to repay the improper credit at a lower financial cost. The required disclosure about preparers who assisted in filing the claim will help the IRS gather information on promoters who took aggressive positions in advising taxpayers to claim ERC.

Eligibility for ERC-VDP

Taxpayers who claimed ERC and have received the refund or the credit against their employment taxes are eligible to participate in the program. (Taxpayers who have not yet received an ERC credit or refund but no longer believe they are entitled to ERC can use the withdrawal process to withdraw their claim). Taxpayers are not eligible for ERC-VDP if any of the following apply:

  • The taxpayer is under criminal investigation or has been notified that the IRS intends to commence a criminal investigation;
  • The IRS has already received information alerting it to the taxpayer’s noncompliance;
  • The taxpayer is undergoing an employment tax examination for the period for which it is applying; or 
  • The taxpayer has already received a notice and demand for repayment of all or part of the claimed ERC.

Employers who claimed ERC using a third-party payer, such as a professional employer organization (PEO) or payroll agent, are eligible for ERC-VDP, but the third-party payer must submit the application on the employer’s behalf.  The announcement provides some guidance for third-party payers assisting with such applications.

In order to use the program for a given quarter, the taxpayer must give up the full amount of ERC that was applied for on the Form 941 X for that quarter.  Taxpayers who want to reduce only a portion of the ERC claimed in a quarter are not eligible for ERC-VDP or the withdrawal process; these taxpayers must file an amended return to adjust the ERC claimed.

Terms of participation in ERC-VDP

Employers who are approved to participate in the program (’participants’) will be required to execute a closing agreement which provides that they are not eligible for, or entitled to, any ERC for the tax period(s) at issue. The participant will repay 80% of the claimed ERC to the Department of Treasury. Participants will also be excused from repaying overpayment interest received on any issued ERC refund. Underpayment interest will not be required if the participant makes full payment prior to executing the closing agreement.

The program also provides for the possibility of repaying the ERC amount through an installment arrangement.  If the IRS approves repayment under an installment agreement, interest will only accrue prospectively from the agreement date. The IRS will not assert civil penalties against participants that make full payment of the 80% of claimed ERC prior to executing the required closing agreement.

For many taxpayers, the ERC impacted their income tax obligations as well. Because ERC cannot be claimed on wages that are claimed as a deduction against income, recipients of ERC were expected to reduce wage deductions for the 2020 and/or 2021 tax years equal to the ERC amounts. If participants had not already amended their income tax returns to reduce their wage deduction by any claimed ERC, they will not need to file amended returns or Administrative Adjustment Requests (AARs) to reduce their wage deduction. Participants who already reduced their wage deduction by the claimed ERC may file an amended return or AAR to reclaim the previously reduced wage expense. No income will be attributed to participants as a result of participating in the program.

If a return preparer or advisor assisted the participant in claiming the ERC, the participant must provide the name, address, and phone number of the preparer or advisor as well as a description of services provided.

Under the new application form, a taxpayer can provide a power of attorney to allow another person to represent the taxpayer in making the VDP application.

Applications for ERC-VDP due by March 22, 2024, 11:59 pm local time. 

Taxpayers apply to participate in ERC-VDP by completing Form 15434, Application for ERC-VDP and submitting it via the IRS Document Upload Tool by March 22, 2024. Form 15434 must be signed by an authorized person under penalties of perjury. Taxpayers applying for ERC-VDP for a period ending in 2020 must include a completed and signed statute extension Form ERC-VDP SS-10.  Form 15434 will help calculate the payment required to participate in ERC-VDP. Paying the balance via Electronic Federal Tax Payment System (EFTPS) at the time of applying for ERC-VDP is encouraged and could speed up the resolution of the case. However, as discussed above, participants who are unable to pay the entire balance may be considered for an installment agreement.

The IRS FAQs state that ERC-VDP applications will be handled on a first come, first serve basis. The FAQs indicate that most cases should resolve quickly but also provide there is no way to estimate how long the process will take. Applicants can call the ERC-VDP hotline at 414-231-2222 and leave a voicemail to check on the status of their application or for assistance with the ERC-VDP process, including completing Form 15434.

If a taxpayer’s application is approved, the IRS will prepare a closing agreement under section 7121 of the Code and mail the closing agreement to the participant. Once a participant receives the ERC-VDP closing agreement package, they will be asked to review and return the signed agreement within 10 business days. Participants need to pay balances due prior to signing the agreement in order to receive all the benefits of the program. If the IRS denies a taxpayer’s application to participate in ERC-VDP, there is no method to review or appeal the denial. Further, a taxpayer’s participation in ERC-VDP does not preclude the IRS from later investigating any criminal conduct or provide any immunity from prosecution.


This article was written by Anne Bushman, Alina Solodchikova, Karen Field , Marissa Lenius and originally appeared on 2023-12-22.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/irs-announces-details-for-erc-voluntary-disclosure-program-.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Beware of State Equivalent 1099 Filing Obligations

ARTICLE | December 22, 2023

Authored by RSM US LLP

Executive summary

As the year closes and companies prepare to file federal forms 1099, many will overlook state equivalent 1099 filing requirements which can be extremely complex, are subject to change, and often vary by state and form type.  Take the time now to evaluate your state 1099 filing requirements by confirming that your budget, resources and compliance program are up to par for managing increasing risk and evolving changes.

Beware of state equivalent 1099 filing obligations

Companies operating a U.S. trade or business and controlled foreign corporations that make certain reportable payments to U.S. persons who are not their employees (including vendors, investors and related entities) must be prepared to file U.S. tax information returns.  While many are aware of the U.S. federal requirement to file tax information returns, an area that is frequently overlooked and that can result in material exposure is the requirement to file state equivalent forms 1099.

Many states  require direct filing of state equivalent information returns and  may also have different reporting thresholds and filing deadlines than  federal requirements and that vary by state.  For example, when the IRS released Notice 2023-74  earlier this year announcing the delayed implementation of the lower $600 threshold for filing Forms 1099-K, (see our prior article) many states did not follow suit or were slow to issue guidance, leaving payment processors and on-line marketplaces scrambling to understand and manage their state equivalent form 1099-K filing obligations.  It is therefore important that you that monitor and are aware of your state filing obligations.  Plan to discuss them with your tax advisor or other service provider early to confirm that they have the ability to file the forms and that you have allocated sufficient lead time and budget for managing your state  filing obligations.

What states require direct reporting?

While most states will accept the federal form 1099 and do participate in the Combined Federal/State Filing Program (CF/SF), most still require a separate filing if there’s state withholding tax deducted, and some states do not participate in the program as they prefer not to wait for the IRS to share information with them.  Under the CF/SF Program, the IRS forwards original and corrected information returns filed electronically to participating states free of charge for approved filers, thereby eliminating the need for separate reporting to the participating states.  The IRS created the Combined Federal/State Filing program as a mechanism for sharing data from information returns with the states.

  • As of 2023, the following states participate in the CF/SF program: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Indiana, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, Wisconsin. States that are not listed either do not participate in the program at all, may still require taxpayers to submit a copy of the form even if they participate, or may require direct reporting of certain 1099 series forms and not others.
  • The following states do not participate in the CF/SF program: Florida, Iowa, Illinois, Kentucky, Oregon, Pennsylvania, Rhode Island, Tennessee, Utah, Virginia, West Virginia, Vermont and District of Columbia.  These states all require that forms be filed directly to the state, so be sure to confirm that your 1099 vendor will file these forms on your behalf.
  • The states below participate in the CF/SF program but have certain state specific requirements that filing via the CF/SF does not satisfy: Alabama, Arizona, Connecticut, Delaware, Georgia, Indiana, Kansas, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Montana, North Carolina, North Dakota, Ohio, South Carolina, Wisconsin. Filers must verify filing requirements with the state, which are subject to change. Again, these states participate in the CF/SF, but often have limited options for how information received from the IRS can be used. As such, in order to track, audit and compare all withholding information, filers must provide certain information directly to the state. 

Direct state reporting for 1099s is a complex space, with changes happening annually for individual states and form types.  New reporting requirements, CF/SF participation changes, changing form thresholds and filing methods are just a few examples that businesses must keep in mind when filing forms 1099.

Most commonly filed Forms 1099-NEC present specific challenges

One of the most common and frequently filed information returns is IRS Form 1099-NEC, Nonemployee Compensation.  Companies that paid compensation for services of $600 or more last year to a U.S. person that is not its employee (such as a vendor or independent contractor) must file IRS Form 1099-NEC, Nonemployee Compensation with the IRS and must furnish copies of the forms to recipients by Jan. 31 annually.  Form 1099-NEC is used to report nonemployee compensation, such as payments for services to independent contractors, commissions, board of director fees, legal fees paid  to attorneys (excluding gross proceeds) and other forms of compensation or benefits for services rendered by a nonemployee. Refer to our prior article for more details.  

Form 1099-NEC was added to the CF/SF Program a few years ago, so in most cases, the IRS will share information from the forms with certain states that participate in the CF/SF Program.  However, many states  still require taxpayers to file a separate 1099-NEC form directly to  state taxing authorities.  Further, while some states, such as California, previously indicated when the form was first introduced that they would not impose penalties for failing to file state equivalent forms 1099-NEC, recently more states are imposing penalties and performing compliance inquiries.  It is therefore imperative that companies evaluate their state filing obligations now to avoid penalties and manage risk as they may need to file 1099-NEC forms to the IRS and to several states.  Requirements vary by state and are subject to change.

Other practical considerations

There are also many practical considerations and challenges to navigate with respect to state equivalent forms 1099-NEC.  For example, most states that do require reporting, such as Virginia, only require that a 1099-NEC form is filed if state tax was withheld while other states require the forms if the payee is resident in the state or if services were performed in the state.  However, many companies do not track such data and may opt to report only to the state of the recipient’s address of record, which may not render an accurate result based on each states’ rules.  Finally, many states require withholding agents to register if they have workers in the state and in order to file 1099-NEC, so companies need time to register and may face delays. Registering in a state may have nexus and other state relevant implications, so please consult with a member of our State and Local Tax (SALT) team prior to doing so.

Managing multiple filing deadlines is also a challenge. Guidance for each state, which is subject to change as many states have not published updated guidance yet this year, is available below:

Alabama

Kentucky

North Dakota

Arizona

Louisiana

Ohio

Arkansas

Maine

Oklahoma

California

Maryland

Oregon

Colorado

Massachusetts

Pennsylvania

Connecticut

Michigan

Puerto Rico

District of Columbia

Minnesota

Rhode Island

Delaware

Mississippi

South Carolina

Georgia

Missouri

Utah

Hawaii

Montana

Vermont

Idaho

Nebraska

Virginia

Indiana

New Jersey*

West Virginia

Iowa

New Mexico

Wisconsin**

Kansas

North Carolina

Companies must develop a process for managing risk and ongoing monitoring of their state information return filing obligations.


This article was written by Aureon Herron-Hinds, Lorraine Bodden, Jeffrey Hoberman and originally appeared on 2023-12-22.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/beware-state-equivalent-1099-filing-obligations.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

A Guide to Generation-skipping Tax Planning

ARTICLE | December 22, 2023

Authored by RSM US LLP

This article was originally published in Probate & Property magazine.

Understanding the inclusion ratio of a trust is crucial for effective estate planning. The inclusion ratio determines the portion of a trust’s assets that will be subject to generation-skipping transfer tax (GSTT) upon a triggering event. Generally, a trust is subject to GSTT when there is a taxable termination under section 2612(a) or a taxable distribution under section 2612(b). A taxable termination occurs when there is a termination of a non–skip person’s interest in the trust resulting in only skip persons remaining as beneficiaries. This may occur at death or due to lapse of time, exercise or release of power, disclaimer, or termination of a trust. A taxable distribution occurs when there is a distribution of property to a skip person or termination of a trust.

A trust’s inclusion ratio can change over time, as it is affected by the allocation of the transferor’s generation-skipping tax (GST) exemption, the timing of transfers to the trust, and the timing of certain triggering events such as the death of a beneficiary. To fully understand the inclusion ratio of a trust, you must ask several questions and recreate the history of transfers made to the trust.

  1. When was the trust created?
  2. When were transfers made to the trust?
  3. Is it a GST Trust?
  4. Did transfers to the trust qualify for the GSTT annual exclusion?
  5. Was any GST exemption allocated to the trust?
  6. Were there any general powers of appointment?
  7. Has there been a qualified severance?
  8. When does the statute of limitations close on the inclusion ratio?

Introduction to case study

A new client engages you to review their existing estate plan. You start by reviewing the GST status of her 1984 life insurance trust. The history of this trust is as follows:

  • The trust was created on September 1, 1984, for the benefit of the grantor’s descendants.
  • The trust is a GST Trust under section 2632(c)(3)(B).
  • The trust was funded with $1,000,000 on October 1, 1984. The transferors made a gift-splitting election on their 1984 gift tax returns. There were no withdrawal rights granted to any trust beneficiaries.
  • The transferors made additional gifts to the trust on October 1, 1999, of $1,000,000 and on October 1, 2002, of $100,000. Gift-splitting elections were made on the 1999 and 2002 gift tax returns. There were no withdrawal rights granted to any trust beneficiaries.

When was the trust created?

The current form of GSTT was enacted in 1986 and generally applies to direct skip transfers and indirect skip transfers made to irrevocable trusts after September 25, 1985. Transfers made to a trust on or before 

this date are exempt from GSTT and are deemed to have an inclusion ratio of zero. The regulations under section 2601 provide guidance for determining if a trust qualifies, and if so, it will typically be referred to as a “Grandfathered” trust for GSTT purposes. The regulations further provide that if additions or deemed contributions are made after this date, then a pro rata portion of the trust’s assets will be subject to GSTT,

unless an allocation of GST exemption is made. Appreciation or accumulated income from the Grandfathered portion of a trust will not be considered an addition that affects the trust’s inclusion ratio. Although it may be simple to determine if additions were made to the trust, deemed contributions may not be as straightforward. The release, exercise, or creation of certain powers of appointment can be treated as a deemed contribution that compromises the trust’s Grandfathered GSTT exempt status. Additionally, if certain modifications are made to a Grandfathered trust, the trust can lose its exempt status. There are modification safe harbors provided in the regulations under section 2601. Planners should be mindful of these rules when working with Grandfathered trusts to avoid causing unintended exposure to the GSTT.

Case study

Because this trust was irrevocable as defined in Treas. Reg. § 26.2601-1 on September 25, 1985, the portion of the trust funded on October 1, 1984, is exempt from the GSTT. The portion of the trust funded in later years will need to be looked at separately, and additional questions will need to be answered before the inclusion ratio can be determined as it relates to those transfers.

When were transfers made to the trust?

As with most areas of the tax law, modern GSTT has changed since its enactment, which makes understanding when transfers were made to a trust important for determining a trust’s inclusion ratio. In addition to the September 25, 1985, date, there are other key dates that planners should be familiar with to understand how transfers made during certain years may be treated differently than under current law. For example, many planners are aware that under current law, there are different requirements for applying the gift tax and GSTT annual exclusions. Until 1988 the requirements for both annual exclusions mirrored each other. Only transfers made after March 31, 1988, are subject to the more narrow requirements discussed in depth below.

An amendment to the Tax Reform Act of 1986 also created an exception referred to as a “Gallo” trust, which is exempt from GSTT. A Gallo trust is for the benefit of a single grandchild and will have an inclusion ratio of

zero if funded with up to $2,000,000 before January 1, 1990, as long as it has not been modified beyond what is permitted in the Grandfathered trust safe harbor regulations under section 2601. This exception is found only in the amendment to the 1986 Act and is not found in the Internal Revenue Code or Treasury regulations.

In 2001, section 2632(c)(1) was added, and certain indirect skip transfers made after December 31, 2000, will have an automatic allocation of GST exemption to the extent the transferor has remaining exemption available. A taxpayer can elect in or out of automatic allocation rules, so having a complete copy of the taxpayer’s gift tax returns is necessary to confirm whether any elections were made.

The dates of the transfers matter because of the different rules in place over the period this trust has been in existence.

  • October 1, 1984—Current GSTT was not in place. This trust meets the requirements to be considered irre- vocable as of September 25, 1985, and the portion of the trust funded on or before this date will have an inclusion ratio of zero. It will be necessary to confirm no modifications have been made that would com- promise its Grandfathered status.
  • October 1, 1999—Automatic allocation rules were not in place. You reviewed the gift tax return and determined that there was no manual allocation of the transferors’ GST exemptions to this transfer.
  • October 1, 2002—Automatic allocation rules were in place and the transferors’ GST exemptions would

have been allocated unless an affirmative election was made to opt out of an automatic allocation by the taxpayer on a timely filed gift tax return. You reviewed the gift tax returns and determined no opt-out elec- tion was made.

Is it a GST Trust?

A “GST Trust” is defined broadly in section 2632(c)(3)(B) as a trust that could have a generation-skipping transfer. The statute then describes six exceptions to this definition, most of which relate to certain rights or powers held by non–skip persons. If relying on the application of an automatic allocation, these exceptions should be reviewed carefully because an automatic allocation of available GST exemption will occur only if an indirect skip is made to a GST Trust. These rules apply to transfers made after December 31, 2000.

The exceptions to the definition of a GST Trust can be difficult to navigate, and many planners prefer to make an affirmative election to have the automatic allocation rules apply to a trust or not apply. This election is provided under section 2632 and must be made on a timely filed gift tax return. An election can be made to treat a trust as a GST Trust even if its terms would not otherwise meet the definition. Similarly, a taxpayer may also make an election out of GST Trust treatment if the trust’s terms meet the definition and an automatic allocation is not desired.

Because this trust does not fall under any of the exceptions in section 2632(c)(3)(B) of the Code, it is a GST Trust and the transferors’ GST exemptions were automatically allocated to any transfers made to the trust after December 31, 2000. The clients’ gift tax returns should still be referenced to determine whether a GST election was made on a timely filed return.

Did transfers to the trust qualify for the GSTT annual exclusion?

The current GST annual exclusion rules apply to transfers made after March 31, 1988. For a short period of time before April 1, 1988, there were fewer restrictions on whether a transfer would qualify for the GSTT

annual exclusion. Under current law, in order for a trust to qualify for the GSTT annual exclusion under section 2642(c), it must be a trust that is considered a direct skip trust. If a transfer qualifies for the GSTT annual exclusion, that portion of the transfer would be exempt from the GSTT. For a gift to a trust to qualify for the GSTT annual exclusion, it must meet the following requirements:

  • The gift must be made to a trust, which is for the benefit of one skip person individual.
  • If the skip person beneficiary were to pass away before the trust terminated, the assets of the trust would be included in that skip person’s estate.
  • The gift must be a present interest gift.

This trust is for the benefit of multiple skip and non–skip persons. Also, there are no withdrawal rights, so transfers to this trust are not present interest gifts. Therefore, transfers to this trust would not qualify for the GSTT annual exclusion. An example of a transfer that would qualify is as follows:

  • In 2023, transferor made a gift of $17,000 to a trust for the benefit of their grandchild.
  • The trust agreement gives the grandchild a testamentary general power of appointment over the trust assets.
  • The trust agreement gives the grandchild the right to withdraw the 2023 contribution to the trust.

Was any GST exemption allocated to the trust?

Under current law, each taxpayer is given a lifetime GST exemption that can be allocated to transfers during life or at death. Allocation of the taxpayer’s GST exemption shields transfers from the GSTT. Only the transferor can allocate GST exemption to the transfer. Generally, when a gift-splitting election is made on a gift tax return, 

each spouse is treated as a transferor over one-half of all transfers on the gift tax return for GSTT purposes.

Generally, a transferor will not allocate his GST exemption to a trust that he expects will benefit only non– skip persons, saving it for other planning that is intended to benefit skip persons. There are many ways that a taxpayer can allocate his GST exemption to a trust.

Automatic allocation

Automatic allocation of a transferor’s GST exemption occurs regardless of whether the transfer is reported on a gift tax return. A transferor’s GST exemption is first automatically allocated to any direct skips under section 2632(b). Then, the deemed automatic allocation of GST exemption to indirect skips under section

2632(c)(1) allows the transferor’s GST exemption to be allocated automatically to certain transfers made after December 31, 2000. For indirect skips, an automatic allocation occurs only if the trust is a GST Trust under section 2632(c)(3)(B).

The deemed automatic allocation rules are intended to serve as a safety net. For example, if a transfer to a trust that is a GST Trust and is intended to ultimately benefit skip person beneficiaries was not reported on a gift tax return, it would automatically be protected from the GSTT. However, the well-intended rules also could cause unintended consequences. For example, if a trust is by definition a GST Trust, but the trust will never benefit a skip person due to non–skip persons depleting the trust, the automatic allocation rules could cause a waste of the transferor’s available GST exemption.

Taxpayers are able to elect to affirmatively opt in or opt out of these rules on a timely filed gift tax return. Ideally, it is best to determine whether or not the transferor wants the automatic allocation rules to apply to a trust when reporting the initial transfer to the trust. Although these rules are a helpful safety net in some scenarios, relying on the automatic allocation rules is not recommended.

There are also automatic allocation rules at death under section 2632(e). The taxpayer’s unused GST exemption is first allocated to direct skips occurring at the individual’s death. Second, the unused GST exemption is allocated pro rata to any trusts of which the decedent is the transferor and from which a taxable distribution

or taxable termination might occur at or after the individual’s death. If the taxpayer affirmatively allocates on Schedule R of the estate tax return, the automatic rules for indirect skips will not apply.

Manual allocation

Before January 1, 2001, the transferor’s available GST exemption had to be manually allocated to transfers (other than direct skips) on the transferor’s gift tax return. Taxpayers may still manually allocate on a timely- filed gift tax return if there was no automatic allocation because the trust did not meet the definition of a GST trust or an opt-out election was made. The taxpayer’s unused GST exemption can also be manually allocated at death on Schedule R of his estate tax return. When manually allocating a GST exemption, consider using formula language so that the allocation is adjusted upon changes to values.

Late allocation

Late allocation of the transferor’s GST exemption is available when an existing trust is not exempt from the GSTT and the taxpayer wishes to allocate his available GST exemption to that trust based on current values. Under Treas. Reg. § 26.2642-2(a)(2), an election can be made to treat the allocation as having been made on the first day of the month during which the late allocation is made. The allocation is not effective until a gift tax return reporting the allocation is actually filed with the IRS prior to the end of that same month. The late allocation is considered effective on the date of filing. This election is not effective with respect to the valuation of a life insurance policy if the insured individual passes away prior to the effective date.

Although a late allocation is typically seen as an available remedy for a missed allocation of GST exemption, it is also a planning opportunity in depressed markets. Assets a taxpayer gifted to a trust in one year might have significantly declined in value before the time that the gift tax return for that year is due. If trust assets have significantly declined in value, opting out of an automatic allocation of GST exemption on the timely filed gift tax return for the year of the gift and subsequently making a late allocation of GST exemption immediately after the deadline for filing the gift tax return may result in the transferor using less of his GST exemption.

Retroactive allocation

Section 2632(d) provides for retroactive allocations under certain circumstances intended as a remedy for untimely deaths. The transferor can retroactively allocate GST exemption on a chronological basis to any previous transfer(s) to a trust if the following facts apply:

  1. A non–skip person has an interest or a future interest in a trust to which any transfer has been made and
  2. Such person
    1. is a lineal descendant of a grandparent of the transferor or of a grandparent of the transferor’s spouse or former spouse,
    2. is assigned to a generation below the generation assignmen of the transferor, and
    3. predeceases the transferor.

The retroactive allocation is reported on a timely gift tax return for the calendar year of the non–skip person’s death. The amount of GST exemption that can be allocated is the amount available immediately before the non–skip person’s death. The value used for the retroactive allocation is the value of the transfer on the date it was originally made. Even though the original date-of-transfer value is used, the allocation is deemed to have occurred immediately before the death, not as of the original date of transfer.

GST exemption allocation summary

The below reference chart was prepared in collaboration with Julie Miraglia Kwon based on her lecture “Generation-Skipping Transfer Tax: Exploring the Nooks and Crannies” given to the American Bar Association Real Property, Trust and Estate Law Section on April 18, 2023. She explained that two important concepts should be considered in allocating GST exemption: (1) valuation of the allocation and (2) effective date of the allocation.

The 1984 transfer was exempt from the GSTT and has an inclusion ratio of 0.000. No GST exemption was allocated to the 1999 transfer to this trust, so that portion of the trust is fully subject to the GSTT. Because it is a GST Trust, however, automatic allocation of the transferors’ GST exemptions occurred for the 2002 transfer to the trust. Because the trust has a mixed inclusion ratio, the taxpayer could consider a late allocation of GST exemption if he is concerned about paying GSTT as a result of transfers to skip persons.

Were there any general powers of appointment?

A general power of appointment over a trust’s assets can change the identity of the transferor, which presents

both planning opportunities and pitfalls. An individual must be the transferor to allocate available GST exemption. A right of withdrawal over a portion of a trust’s assets is also considered a general power of appointment, and seemingly simple Crummey withdrawal rights can lead to GSTT issues. The regulations under section 2652 provide that the lapse of a withdrawal right in excess of $5,000 or 5 percent of trust assets will cause the power holder to be deemed to have transferred the excess amount to the trust for GSTT purposes.

To avoid this consequence, withdrawal rights are commonly drafted to avoid the lapse of the power to the extent it is greater than $5,000 or 5 percent of trust assets. This creates what is commonly referred to as a hanging Crummey power, and this portion of the withdrawal right remains in existence. A hanging Crummey power can cause estate tax inclusion.

The trust agreement will need to be reviewed to confirm that no general powers of appointment exist that could cause a change to the transferors for GSTT purposes. There are no withdrawal rights available to the trust’s beneficiaries, so there is no need to determine whether hanging withdrawal rights will cause estate inclusion and changes to the transferors.

Has there been a qualified severance?

Some trust agreements include language that will trigger a severance automatically if an inclusion ratio is other than 0.000 or 1.000. If the trust does not contain that type of language, however, a qualified severance may be necessary. When a trust has an inclusion ratio other than 0.000 or 1.000, the trustee may be interested in doing a qualified severance under section 2642(a)(3)(B) and Treas. Reg. § 26.2642-6(e). A qualified severance divides the trust into two or more trusts so that the resulting trusts either have an inclusion ratio of 0.000 and are exempt from GSTT or have an inclusion ratio of 1.000 and are nonexempt from GSTT. Administering a trust with an inclusion ratio other than 0.000 or 1.000 can be complicated, time consuming, and expensive for the trustee.

When the trust is severed into trusts that are either GST exempt or GST nonexempt, it can be much simpler to administer.

Because this trust has a mixed inclusion ratio, it is a good candidate for a qualified severance. As shown at the bottom of the next page, the inclusion ratio of the trust is 0.346. This means that 34.6 percent of the trust is subject to the GSTT. The trustee can sever 34.6 percent of the trust into a GST nonexempt trust with an

inclusion ratio of 1.000 and 65.4 percent of the trust into a GST exempt trust with an inclusion ratio of 0.000. The trustee could intentionally make distributions from the nonexempt trust to the non–skip beneficiaries and deplete it before it goes on to skip persons. The trustee could use the exempt trust for the benefit of skip person beneficiaries. This would ensure the transferors’ GST exemptions were used efficiently. If the transferors have additional GST exemption in the future because of inflationary increases, they could choose to make a late allocation to the nonexempt trust portion to protect those assets from the GSTT.

When does the statute of limitations close on the inclusion ratio?

Although it is common to report the allocation of GST exemption on a gift tax return, adequate disclosure of the transfer on a gift tax return does not start the statute of limitations with respect to the inclusion ratio of a trust (unless all transfers to the trust were direct skips, which have a different rule). Under Treas. Reg. § 26.2642-5, the inclusion ratio of an indirect skip trust is generally not final until the later of

  • The expiration of the period for assessment with respect to the first GST tax return filed using that inclu- sion ratio or
  • The expiration of the period for assessment of federal estate tax with respect to the estate of the transferor,even if an estate tax return is not required to be filed.

This means the inclusion ratio of a trust is not final until the transferor passes away and a GST tax return is filed. For trusts with somewhat uncertain inclusion ratios other than zero, the trustee may want to consider making a taxable distribution and have the recipient pay a small amount of GSTT after the transferor passes away. This would report the inclusion ratio on a GST tax return and start the statute of limitations to achieve finality with respect to that inclusion ratio.

Case study conclusion

Let’s calculate the inclusion ratio of the trust in our case study. This calculation is simplified, as we have two transferors for GSTT purposes due to the gift-splitting elections made on the gift tax returns. For purposes of this illustration, we have combined the two shares even though, for GSTT purposes, two trusts exist. We have used an illustrative growth rate of about 4 percent.

First, we have the October 1, 1984, transfer of $1,000,000. Because this transfer was made before the enactment of the current GSTT, it is Grandfathered pursuant to Treas. Reg. § 26.2601-1(b). The inclusion ratio for this first transfer is 0.000. This Grandfathered portion is treated as if the transferor had allocated the GST exemption to the transfer for purposes of the inclusion ratio calculation.

Next, we have the October 1, 1999, transfer of $1,000,000. The taxpayer and spouse did not affirmatively allocate any of their GST exemption on the 1999 gift tax return, so no GST exemption was allocated to this transfer. Assuming that the pre-transfer value of the trust’s assets is $1,800,000, the inclusion ratio is calculated as follows:

Applicable fraction: ($1,800,000 [current value of Grandfathered portion]/$2,800,000 [trust value after transfer]) = 0.643;

Inclusion ratio: 1 – 0.643 = 0.357.

Lastly, we have the October 1, 2002, transfer of $100,000. Although the taxpayer and spouse did not affirmatively allocate any of their GST exemption on the 2002 gift tax return, the deemed allocation rules under section 2632(c)(1) applied because this is a GST Trust within the meaning of section 2632(c)(3)(B) and no opt- out election was made. Therefore, $50,000 of the taxpayer’s GST exemption and $50,000 of the spouse’s GST exemption was automatically applied to the transfer. If the pre-transfer value of the trust assets is $3,200,000, the inclusion ratio is calculated as follows:

Applicable fraction: ($2,157,600 [current value of Grandfathered portion of $2,057,600 + $100,000 of GST exemption allocated to this transfer]/$3,300,000 [trust value after transfer]) = 0.654;

Inclusion ratio: 1 – 0.654 = 0.346.

Thus, 34.6 percent of the trust is subject to the GSTT. If you recommend a qualified severance to your client, the trust could be divided into a GST exempt portion with an inclusion ratio of 0.000 and a GST nonexempt portion with an inclusion ratio of 1.000 for ease of administration and distribution planning purposes.

Conclusion

There are remedies available beyond the scope of this article to mitigate unexpected GSTT concerns. These include section 9100 relief and timely allocation relief under Revenue Procedure 2004-46. As you can see, reconstructing a trust’s inclusion ratio can be complicated, and there are many factors to consider. Going through this process can open the door to many planning opportunities and chances to provide significant value for your client.

Published in Probate & Property Volume 37, Number 6, ©2023 by the American Bar Association. Reproduced with permission. All rights reserved.


This article was written by Carol Warley, Amber Waldman, Abbie Everist and originally appeared on 2023-12-22.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/guide-generation-skipping-tax-planning.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

IRS Releases 2024 Retirement Plan Limitations

ARTICLE | November 03, 2023

Authored by RSM US LLP

2024 retirement plan limits released

The IRS issued Notice 2023-75, which made modifications to the annual limits for retirement plans. These limits are updated annually for cost-of-living adjustments.

IRS releases 2024 retirement plan limitations

2024 limits

Effective Jan. 1, 2024, the following limits apply:

2024

2023

2022

2021

401(k), 403(b) and 457 elective deferral limit

$23,000

$22,500

$20,500

$19,500

Catch-up contribution limit (age 50 and older)

$7,500

$7,500

$6,500

$6,500

Annual compensation limit

$345,000

$330,000

$305,000

$290,000

Defined contribution plan limit

$69,000

$66,000

$61,000

$58,000

Defined benefit plan limit

$275,000

$265,000

$245,000

$230,000

Definition of highly compensated employee

$155,000

$150,000

$135,000

$130,000

Key employee

$220,000

$215,000

$200,000

$185,000

IRA contribution limit

$7,000

$6,500

$6,000

$6,000

IRA catch-up contributions (age 50 and older)

$1,000

$1,000

$1,000

$1,000

SIMPLE IRA and SIMPLE 401(k) salary deferral limit

$16,000

$15,500

$14,000

$13,500

SIMPLE IRA and SIMPLE 401(k) catch-up limit

$3,500

$3,500

$3,000

$3,000

Income phase-out ranges for various individual retirement account (IRA) purposes increased from between $73,000 and $83,000 to between $77,000 and $87,000 for single and head-of-household taxpayers. Similar incremental changes were made to the limits for married filing jointly and married filing separately taxpayers. For more information, refer to Notice 2023-75.

Considerations

The increases to the 2024 limits are not as large as the increases were to the 2023 limits and reflect a slowdown in inflation. Of the limits shown in the table above, the IRA contribution limit showed the largest percent increase, followed by the annual compensation and defined contribution plan limits. No catch-up contribution limits were adjusted this year.

Impact of SECURE 2.0 on 2024 limits

  1. The SECURE 2.0 Act (Act) increased the amount that an IRA or defined contribution plan could pay in premiums for a qualified longevity annuity contract to $200,000 for 2023. This limit remains the same for 2024.
  2. The Act authorized indexing of the catch-up contribution limit for IRAs. Despite this change being effective for 2024, the cost- of- living adjustment procedures did not result in an increase to the IRA catch-up contribution limit.
  3. Participants in SIMPLE 401(k) and SIMPLE IRA plans can take advantage of an increased deferral limit of $17,600 (i.e., 110% of the $16,000 annual limit) if their employer meets one of the following conditions:
    1. has 25 or fewer employees receiving at least $5,000 of compensation, or
    2. has more than 25 but not more than 100 employees and makes either a 4% matching contribution or a 3% nonelective contribution.

      The 10% increase in the annual limit also applies to the catch-up deferral limit available to participants who are age 50 or older.

What should you do now?

The limits shown above become effective Jan. 1, 2024. Employers and employees should review these limit changes and consider how they are impacted. Employers sponsoring SIMPLE IRAs or SIMPLE 401(k)s should especially review whether the limit changes going into effect under SECURE 2.0 this upcoming year are applicable to them. Any necessary action to prepare for these limit changes, such as conversations with plan recordkeepers or third-party administrators, should be completed in the near term. Employers are also reminded that retirement plans that run on a fiscal year should be careful in applying these changes, as some limits are always calendar-year limits (e.g., the elective deferral limit), while other limits apply on a plan-year-beginning basis (e.g., the annual compensation limit).


This article was written by Bill O’Malley, Christy Fillingame, Lauren Sanchez and originally appeared on 2023-11-03.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/irs-releases-2024-retirement-plan-limitations.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Major Regulatory Change on the Horizon for Financial Institutions

ARTICLE | November 01, 2023

Authored by RSM US LLP

Although financial institutions have been dealing with the aftermath of bank failures in the first half of 2023, they just received another tidal wave of repercussions, this time in the form of proposed regulations. The industry has been anticipating new interagency proposals, but because bank failures raised urgent questions around both risk management and oversight, the proposals arrived much sooner than expected.

Heightened attention on risk and governance within the banking ecosystem highlights why the recent bank failures will go down in history as landmark events that will permanently change the regulatory landscape.

The Federal Deposit Insurance Corp. has proposed eight rules for financial institutions so far in 2023; several were the culmination of the agency’s work with the Federal Reserve Bank and the Office of the Comptroller of the Currency. (The FDIC has also issued one rule this year that is already in effect and revised another existing rule.)

If finalized, these rules—which are an outcome of the 2023 bank failures—will alter the regulatory environment and be considered one of the key banking developments of this decade. Here’s a look at four of the most significant proposals:

Capital requirements for large banks

The FDIC, FRB and OCC have proposed changes to capital requirements for large banks (those with more than $100 billion in assets) that aim to improve the resiliency of the financial sector by increasing institutions’ existing capital buffers, making it easier to absorb losses in the event of a failure. The proposed rule—known as Basel III Endgame—would also provide more transparency to the regulatory capital framework that larger insured depository institutions use.

Basel III Endgame has been a long time coming, but of course with the banking turmoil that started in March, the proposed rule made an even larger splash than expected, and not just because the proposal is over 1,000 pages.

The proposal makes a number of changes to the existing framework. Three of highest significance would require institutions to:

  1. Include unrealized gains and losses on available-for-sale securities within capital ratios.
  2. Meet the supplementary leverage ratio requirement minimum of 3%.
  3. Comply with the countercyclical capital buffer, a tool that adds extra capital buffer when the economic market is faring well and releasing the buffer in times of hardship.

The first change noted above will have a rather large impact on common equity tier one (CET 1) capital. The rule will no longer allow Category III and IV (those with total assets of $250 billion or more and organizations with at least $100 billion in total assets that don’t fall into categories I-III, respectively) to opt-out of the accumulated other comprehensive income option. Rather, it will require these institutions to recognize most elements (with the exception of the gains and losses that derive from cash-flow hedges) within their capital framework. If implemented immediately, the change is significant, as seen in the graph above. The Q2’23 adjustment would result in a decrease in CET 1 of approximately $129 billion, which would drop the current average CET 1 ratio by 3%.

With these new rules, the agencies are trying to address the issue of consistency across financial institutions, which use a wide range of internal models to calculate their risk-weighted assets. This new standardized approach will help alleviate comparability concerns across institutions, clarify treatment of certain exposures like derivatives and sovereign debt, and overall provide more transparency to the calculations and ultimately to assess capital adequacy.

The agencies will accept comments on their proposal through Nov. 30. Institutions are expected to implement the new framework starting July 2025, but the agencies will allow institutions through June 2028 to fully transition.

Enhanced resolution planning at large banks

Traditionally when it comes to bank failures, the regulators take a purchase-and-assumption transaction approach, typically the least costly option for resolution. But this year’s bank failures posed a new challenge; of the 42 companies (half were financial institutions, the other half were non-bank entities) that were invited to bid on First Republic Bank, only four companies entered a bid. (What’s more is that Silicon Valley Bank only had one viable bid, and Signature didn’t have any.) This market disruption has shown that sizeable failures are not easy to resolve and take much longer to work through than the historical ‘one weekend is all that’s needed’ process.

This shines light on the importance of resolution planning at larger banks, which pose a greater risk in the financial market and could trigger contagion risk if a failure were to occur. The FDIC and FRB have proposed guidance for both domestic and foreign entities, which would require providing a full resolution plan every other year, a full resolution plan every third year or a reduced resolution plan every third year, depending on entity size. This proposal applies to insured depository institutions with $50 billion or more in total assets, however more stringent requirements are in place for institutions sitting above that $100 billion threshold.

To minimize economic disruption, regulators are requiring that institutions consider feedback provided from 2021 resolution reviews alongside incorporating the lessons learned from the 2023 bank failures. Areas of focus may include capital, liquidity, governance mechanisms, and operational capabilities.

One imperative item to consider before creating a strategic analysis is whether your institution will follow a single point of entry strategy, or a multiple point of entry strategy, as the proposed guidance will change dependent on the result.

In addition to this proposed rule for large banks, the regulators released a separate proposal on comprehensive resolution plans, which brings institutions with at least $100 billion in total assets into the spotlight and would require them to submit their plans for review every other year.

This proposal is open for comment through Nov. 30 and is expected to go into effect in 2024.

Requirement for large banks to maintain long-term debt

Under this rule, the FDIC, FRB and OCC for the first time will require financial institutions with $100 billion or more in total assets to maintain long-term debt.

Like the resolution planning rule, the agencies’ aim is to help improve recoverability if a large institution were to fail, and to help the resolution of the failed institution be less burdensome and help alleviate losses incurred by depositors and other creditors.

This rule emphasizes the ability of long-term debt to act as a complex tool and absorb losses if a bank failure were to occur, providing that prioritized financial stability in the market.

As part of its inauguration, the proposed rule will augment loss-absorbing capacity by requiring institutions to maintain, at a minimum, long-term debt that equates to 6% of their risk-weighted assets, 3.5% of their average total consolidated assets and 2.5% of total leverage exposure (if the institution is subject to the supplementary leverage ratio). But the rule will also prohibit institutions from partaking in any transactions that could convolute potential resolution.

The lift won’t be too large based on current financials, as some banks that will be subject to this proposed rule already have enough long-term debt to satisfy the requirements. As of Dec. 31, 2022, average long-term debt as a percentage of risk-weighted assets for institutions with over $100 billion in total assets was 12%. However, when looking at these institutions individually and not in aggregate, current levels indicate that approximately 1% or roughly $11 billion more is needed in long-term debt once this rule has been finalized.

CONSULTING INSIGHT: Financial services compliance

Financial services companies must navigate a complex risk and regulatory environment. Our advisors—many of whom are former regulatory examiners and industry compliance professionals—understand the challenges and intricacies involved with regulations in the financial services environment. Learn how to successfully manage your specific regulatory challenges to reach your business goals.

To top it off, the rule also forces institutions to apply a risk weight of 100% when calculating their risk-weighted assets for any long-term debt issued by other banks, which will deter institutions from doing so and act as a mitigant to interconnectedness within the industry. The comment period will close Nov. 30, and the final rule is expected to be issued in 2024.

“The industry has been anticipating new interagency proposals, but because bank failures raised urgent questions around both risk management and oversight, the proposals arrived much sooner than expected.”

Angela Kramer, RSM US financial services senior analyst

Liquidity risks and contingency planning

Back in 2010, the FDIC, FRB, OCC and other agencies issued guidance to financial institutions to promote sound liquidity risk management. This new interagency guidance, although not a proposal as it was issued in July, acts as an addendum to the initial rule and promulgates the importance of contingency funding plans.

Bank failures this year made clear that unprecedented depositor behavior (intertwined with ever-evolving market conditions) brought into question an institution’s stability in funding sources. No longer can a bank use the same definition to capture their core deposits, nor can they use the same decay rates in stress-testing scenarios.

The guidance requires institutions to have an extensive range of funding sources and highlights the importance of being operationally prepared to borrow. This includes establishing borrowing arrangements, refreshing contracts with the FRB and Federal Home Loan Bank System, regularly testing contingency lines, understanding current collateral positions, analyzing potential collateral movements if needed in an emergency, and the importance of having the discount window as an option.

The recent bank failures continue to be a stark reminder on how integral sound risk and governance practices are for financial institutions and how much they contribute to systematic stability. While the above rules are in the proposal stage, banks would do well to start preparing for these new requirements now.

A readiness assessment can help institutions:

  • Gain a thorough understanding of the proposed rules and their potential impact
  • Assess their capital adequacy and decipher the specific areas they need to strengthen
  • Strategize and develop a plan that includes specific steps to meet the new capital requirements, resolution plans, long-term debt requirements and contingency planning
  • Be transparent with the appropriate stakeholders and effectively communicate the plans in place to internal stakeholders and also to regulators, depositors and shareholders

Perpetual enhancement continues to be a driving force for regulators, and ultimately it is their fiduciary duty to implement the necessary rules and regulations to help financial institutions navigate a rapidly changing world with volatile market conditions.


This article was written by Angela Kramer and originally appeared on 2023-11-01.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/financial-institutions/major-regulatory-change-on-the-horizon-for-financial-institutions.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

Brady Martz is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how the Brady Martz can assist you, please contact us.

Brady Martz Named Among INSIDE Public Accounting’s 2023 “Top 100 Firms”

Brady Martz & Associates is excited to share that the firm was recently named as one of the “Top 100 Firms” of 2023 by INSIDE Public Accounting (IPA).

Each year, IPA releases a ranking of the 500 largest public accounting firms in the U.S. based on each participating firm’s net revenues. The rankings are then broken down even further by 100.

“Being ranked among the top 100 accounting firms in the country by IPA is a true testament to the hard work and dedication of each member of our team,” said Todd Van Dusen, President of Brady Martz. “Our team of skilled professionals strives to anticipate our clients’ needs and provide proactive guidance enabling them to make informed decisions with confidence. The accounting industry is constantly evolving, and we remain committed to staying ahead of the curve.”

In addition to the criteria of U.S. net revenue, rankings are compiled by analyzing responses to IPA’s annual practice management survey. This is IPA’s 33rd annual ranking of the largest accounting firms in the nation. To learn more and to view the 2023 list of “Top 100 Firms,” visit insidepublicaccounting.com/top-firms/ipa-500/.

Founded in 1927, Brady Martz has been providing exceptional client service for nearly a century. Headquartered in Grand Forks, the firm has seven offices throughout North Dakota and Minnesota, and will expand into South Dakota with the acquisition of Woltman Group on October 1. Brady Martz is proud to offer advisory, audit & assurance, and tax services to clients in a wide variety of industries.

Brady Martz and Woltman Group, PLLC to Merge

Top 100 nationally ranked accounting firm Brady Martz & Associates is excited to announce its expansion into the state of South Dakota. Effective October 1, 2023, Woltman Group, PLLC will join Brady Martz.

“We are excited for this opportunity to expand our team and geographic footprint into the growing Sioux Falls market,” said Todd Van Dusen, Brady Martz Chief Executive Officer. “The combination of our firms will enhance career path opportunities for our team members as well as service opportunities for clients.”

Woltman Group has been providing accounting, tax, and advisory services to businesses and individuals since 1988 when they were Pfeiffer Woltman Kutz, PC. From 2008-2010, several additional partners joined the firm and in 2016, it was reorganized and rebranded as Woltman Group. Today, the firm proudly serves thousands of business and individual clients throughout the upper Midwest. Their experienced team provides a wide variety of personalized business advisory services in addition to a full line of traditional accounting and tax services. Woltman Group has offices in Sioux Falls and Marion, South Dakota.

“We can’t wait to start working with the Brady Martz team,” said Eric DeHaan, Managing Shareholder for Woltman Group. “Joining Brady Martz will allow us to continue to create opportunities for our team and increase value and expertise for our clients.”