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The IRS has issued guidance to implement the deferral of the employee share of Social Security tax. But employers still have questions and concerns about whether, and how, to implement the deferral.

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The IRS has provided guidance to employers regarding the recent presidential action to allow employers to defer the withholding, deposit and payment of certain payroll tax obligations. The three-page guidance in Notice 2020-65 was issued to implement President Trump’s executive memorandum signed on August 8. Private employers still have questions and concerns about whether, and how, to implement the optional deferral. The President’s action only defers the employee’s share of Social Security taxes; it doesn’t forgive them, meaning employees will still have to pay the taxes later unless Congress acts to eliminate the liability. (The payroll services provider for federal employers announced that federal employees will have their taxes deferred.) Deferral basics President Trump issued the memorandum in light of the COVID-19 crisis. He directed the U.S. Secretary of the Treasury to use his authority under the tax code to defer the withholding, deposit and payment of certain payroll tax obligations. For purposes of the Notice, “applicable wages” means wages or compensation paid to an employee on a pay date beginning September 1, 2020, and ending December 31, 2020, but only if the amount paid for a biweekly pay period is less than $4,000, or the equivalent amount with respect to other pay periods. The guidance postpones the withholding and remittance of the employee share of Social Security tax until the period beginning on January 1, 2021, and ending on April 30, 2021. Penalties, interest and additions to tax will begin to accrue on May 1, 2021, for any unpaid taxes. “If necessary,” the guidance states, an employer “may make arrangements to collect the total applicable taxes” from an employee. But it doesn’t specify how. Be aware that under the CARES Act, employers can already defer paying their portion of Social Security taxes through December 31, 2020. All 2020 deferred amounts are due in two equal installments — one at the end of 2021 and the other at the end of 2022. Many employers opting out Several business groups have stated that their members won’t participate in the deferral. For example, the U.S. Chamber of Commerce and more than 30 trade associations sent a letter to members of Congress and the U.S. Department of the Treasury calling the deferral “unworkable.” The Chamber is concerned that employees will get a temporary increase in their paychecks this year, followed by a decrease in take-home pay in early 2021. “Many of our members consider it unfair to employees to make a decision that would force a big tax bill on them next year… Therefore, many of our members will likely decline to implement deferral, choosing instead to continue to withhold and remit to the government the payroll taxes required by law,” the group explained. Businesses are also worried about having to collect the taxes from employees who may quit or be terminated before April 30, 2021. And since some employees are asking questions about the deferral, many employers are also putting together communications to inform their staff members about whether they’re going to participate. If so, they’re informing employees what it will mean for next year’s paychecks. How to proceed Contact us if you have questions about the deferral and how to proceed at your business. © 2020

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For 2021, the Social Security tax wage cap will be $142,800, and Social Security and Supplemental Security Income (SSI) benefits will increase by 1.3 percent. These changes reflect cost-of-living adjustments to account for inflation.

2021 Wage Cap
The Federal Insurance Contributions Act (FICA) tax on wages is 7.65 percent each for the employee and the employer. FICA tax has two components:

a 6.2 percent Social Security tax, also known as Old Age, Survivors, And Disability Insurance (OASDI); and
a 1.45 percent Medicare tax, also known as hospital insurance (HI).

For self-employed workers, the Self-Employment tax is 15.3 percent, consisting of:

a 12.4 percent OASDI tax; and
a 2.9 percent HI tax.

OASDI tax applies only up to a wage base, which includes most wages and self-employment income up to the annual wage cap.

For 2021, the wage base is $142,800. Thus, OASDI tax applies only to the taxpayer’s first $142,800 in wages or net earnings from self-employment. Taxpayers do not pay any OASDI tax on earnings that exceed $142,800.

There is no wage cap for HI tax.

Maximum Social Security Tax for 2021
For workers who earn $142,800 or more in 2021:

an employee will pay a total of $8,853.60 in social security tax ($142,800 x 6.2 percent);
the employer will pay the same amount; and
a self-employed worker will pay a total of $17,707.20 in social security tax ($142,800 x 12.4 percent).

Additional Medicare Tax
Higher-income workers may have to pay an Additional Medicare tax of 0.9 percent. This tax applies to wages and self-employment income that exceed:

$250,000 for married taxpayers who file a joint return;
$125,000 for married taxpayers who file separate returns; and
$200,000 for other taxpayers.

The annual wage cap does not affect the Additional Medicare tax.

Benefits Increase for 2021
Finally, a cost-of-living adjustment (COLA) will increase social security and SSI benefits for 2019 by 1.3 percent. The COLA is intended to ensure that inflation does not erode the purchasing power of these benefits.

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The IRS has adopted previously issued proposed regulations ( REG-106808-19) dealing with the 100 percent bonus depreciation deduction. In addition, some clarifying changes have been made to previously issued final regulations ( T.D. 9874). Changes to the proposed and earlier final regulations are largely in response to various comments submitted by practitioners, and generally relate to:

the definition of qualified used property;
the election to claim bonus depreciation on components acquired or self-constructed after September 27, 2017, for larger self-constructed property for which manufacture, construction, or production began before September 28, 2017;
application of the mid-quarter convention;
clarifications to the definition of qualified improvement property, predecessor, and class of property; and
clarifications to the rules for consolidated groups
The rules for consolidated groups have also been moved from Proposed Reg. §1.168(k)-2(b)(3)(v) to new Reg. §1.1502-68.

Used Property
The 2019 final regulations provide that in determining whether the taxpayer or a predecessor had a depreciation interest in property prior to its acquisition, only the five calendar years immediately prior to the current placed-in-service year are considered. The latest IRS regulations clarify that the five calendar years immediately prior to the current calendar year in which the property is placed in service by the taxpayer, and the portion of such current calendar year before the placed-in-service date of the property without taking into account the applicable convention, are taken into account. In addition, the five-year look-back period applies separately to the taxpayer and a predecessor.

Furthermore, if the taxpayer or a predecessor, or both, have not been in existence during the entire look-back period, then only the portion of the look-back period during which the taxpayer or a predecessor, or both, have been in existence is taken into account.

Expanded Component Election
The prior regulations allow taxpayers to election to claim 100 percent bonus depreciation on components of certain larger constructed property that qualifies for bonus depreciation if the construction of the larger property began before September 28, 2017. The components must be acquired or constructed after September 27, 2017, and the larger property must be placed in service before 2020 (2021 in the case of property with a longer construction period). The final regulations remove the 2020/2021 cutoff date. In addition, the final regulations provide that eligible larger self-constructed property also includes property that is constructed for a taxpayer under a written contract that is not binding and that is entered into prior to construction for use in the taxpayer’s trade or business. The definition of a larger constructed property is also clarified.

Qualified Improvement Property
The 15-year recovery period for qualified improvement property applies only to improvements "made by the taxpayer." The final regulations clarify that an improvement is considered made by a taxpayer if the property is constructed for the taxpayer. However, qualified improvement property received by a transferee taxpayer in a nonrecognition transaction described in Code Sec. 168(i)(7) is not eligible for bonus depreciation.

Mid-Quarter Convention
The final regulations clarify that depreciable basis is not reduced by the amount of bonus deduction in determining whether the mid-quarter convention applies.

Binding Contracts
Generally, property acquired pursuant to a binding contract entered into after September 27, 2017, does not qualify for bonus depreciation at the 100 percent rate. The final regulations clarify that a contract for a sale of stock of a corporation that is treated as an asset sale as the result of a Code Sec. 336(e) election made for a disposition described in Reg. §1.336-2(b)(1) is a binding contract if enforceable under state law.

Floor Plan Financing
The IRS intends to issue guidance relating to transition relief for taxpayers with a trade or business with floor plan financing indebtedness that want to revoke elections not to claim bonus depreciation for property placed in service during 2018.

The IRS will not allow a taxpayer to limit the amount of its otherwise deductible floor plan interest in order to qualify for bonus depreciation. However, guidance will address transition relief for the 2018 tax year for taxpayers that treated Code Sec. 168(j)(1) as providing an option for a business with floor plan financing indebtedness to include or exclude its floor plan financing interest expense in determining the amount allowed as a deduction for business interest expense for the tax year.

Effective Date
In general, the regulations apply to property acquired after September 27, 2017, and placed in service during or after a tax years that begins on or after January 1, 2021. However, they may be relied on for earlier tax years.

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Final regulations reflect the significant changes that the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) made to the Code Sec. 274 deduction for travel and entertainment expenses. These regulations finalize, with some changes, previously released proposed regulations, NPRM REG-100814-19.

Changes to Code Sec. 274 under the TCJA
For most expenses paid or incurred after 2017, TCJA:

repealed the "directly related to a trade or business" and the business-discussion exceptions to the general disallowance of entertainment expense deductions;
eliminated the general business expense deduction for 50 percent of entertainment (but not meal) expenses; and
repealed the special substantiation rules for deductible entertainment (but not travel) expenses. Taxpayers may rely on the proposed regulations until they are finalized.

Entertainment Expenses
Among other things, Reg. §1.274-11:

restates the statutory rules of Code Sec. 274(a), including the entertainment deduction disallowance rule for dues or fees to any social, athletic, or sporting club or organization;
substantially incorporates the existing definition of "entertainment" from Reg. §1.274-2(b)(1); and
confirms that the nine exceptions in Code Sec. 274(e) continue to apply to deductible entertainment expenditures.

The regulations also confirm that "entertainment" does not include food or beverages unless they are provided at or during an entertainment activity, and their costs are included in the entertainment costs.

Food and Beverage Expenses
As under the proposed regulations, Reg. §1.274-12 allows taxpayers to deduct 50 percent of business meal expenses if:

the expense is an ordinary and necessary business expense;
the expense is not lavish or extravagant; the taxpayer or an employee is present when the food or beverage is furnished;
the food or beverage is provided to a current or potential business customer, client, consultant, or similar business contact; and
food and beverages that are provided during or at an entertainment activity are purchased separately from the entertainment, or their cost is separately stated.

With respect to the fourth requirement listed above, the final regulations adopt the definition of "business associate" in Reg. §1.274-2(b)(2)(iii), but expands it to include employees. Thus, these requirements would apply to employer-provided meals to employees as well as non-employees. The final regulations also flesh out the fifth requirement listed above, and clarify that the separate charges for entertainment-related food and beverages must reflect their actual cost, including delivery fees, tips, and sales tax. Indirect expenses such as transportation to the food are not included in the actual cost.

Exceptions and Special Rules
Food or beverage expenses for employer-provided meals at an eating facility do not include expenses for the operation of the facility, such as salaries of employees preparing and serving meals, and other overhead costs. The final regulations apply the TCJA changes to the exceptions and special rules for deductible food and beverages in Code Sec. 274(e), Code Sec. 274(k) and Code Sec. 274(n), including:

reimbursed food or beverage expenses;
recreational expenses for employees;
items available to the public; and
goods or services sold to customers.

The final regulations also provide examples on several specific scenarios to illustrate the rules.

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The IRS has issued a final regulation addressing tax withholding on certain periodic retirement and annuity payments under Code Sec. 3405(a), to implement amendments made by the Tax Cuts and Jobs Act ( P.L. 115-97) (TCJA). The regulation affects payors of certain periodic payments, plan administrators that are required to withhold on such payments, and payees who receive such payments. The final regulation adopts, without modification, a proposed regulation that updated and replaced the provisions of three questions and answers with a new regulation regarding the default withholding rate on periodic payments made after December 31, 2020.

Withholding on Periodic Payments
Before the TCJA, if a withholding certificate (Form W-4P) was not in effect for a periodic payment, the default withholding rate on the payment was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended Code Sec. 3405(a)(4) so that the default withholding rate on such a periodic payment is instead determined under rules prescribed by the Treasury Secretary.

After the TCJA was enacted, the IRS issued three notices providing that, for calendar years 2018, 2019, and 2020, the default withholding rate on periodic payments under Code Sec. 3405(a)(4) is based on treating the payee as a married individual claiming three withholding allowances ( Notice 2020-3, I.R.B. 2020-3, 330; Notice 2018-92, I.R.B. 2018-51, 1038; Notice 2018-14, I.R.B. 2018-7, 353).

Under new Reg. §31.3405(a)-1, the default rate of withholding on periodic payments made after December 31, 2020, is determined in the manner described in the applicable forms, instructions, publications, and other guidance prescribed by the IRS.

Applicability Date
The final regulation applies to periodic payments made after December 31, 2020.

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The IRS has issued final regulations that provide guidance for employers on federal income tax withholding from employees’ wages.

The IRS has issued final regulations that provide guidance for employers on federal income tax withholding from employees’ wages. The final regulations:

address the amount of federal income tax that employers withhold from employees’ wages;
implement changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97); and
reflect the redesigned Form W-4, Employee’s Withholding Certificate, and related IRS publications.

TCJA Changes
The TCJA made many amendments affecting income tax withholding on employees’ wages. The TCJA made many amendments affecting income tax withholding on employees’ wages.After the TCJA was enacted, the IRS issued guidance to implement the changes (for example, Notice 2018-14, I.R.B. 2018-7, 353; Notice 2018-92, I.R.B. 2018-51, 1038; Notice 2020-3, I.R.B. 2020-3, I.R.B. 2020-3, 330). The IRS updated Form W-4 and its instructions with significant changes intended to improve the accuracy of income tax withholding and make the withholding system more transparent for employees. It also released IRS Publication 15-T, Federal Income Tax Withholding Methods, which provides percentage method tables, wage bracket withholding tables, and other computational procedures for employers to use to compute withholding for the 2020 calendar year.

On February 13, 2020, the IRS published a notice of proposed rulemaking ( REG-132741-17) to update the regulations under Code Sec. 3401 and Code Sec. 3402 to reflect the legislative changes, and expand the rules to accommodate changes necessary to fully implement the redesigned Form W-4 and its related computational procedures, along with most existing computational procedures that apply to 2019 or earlier Forms W-4.

The final regulations adopt the proposed regulations with a few revisions.

Form W-4
The final regulations do not require all employees with a 2019 or earlier Form W-4 in effect to furnish a redesigned Form W-4. Comments expressed concerns that the proposed regulations and the related forms, instructions, publications, and other IRS guidance would require employers to maintain two different systems for computing income tax withholding on wages: one for 2019 or earlier Forms W-4, and another for the redesigned Forms W-4.

In response, the IRS is acknowledging concerns with (1) instructions to the redesigned Form W-4 for employees with multiple jobs and (2) optional computational “bridge” entries permitted under the regulations and described in Publication 15-T that will allow employers to continue in effect 2019 or earlier Forms W-4 as if the employees had furnished redesigned Forms W-4.

The final regulations revise Reg. §31.3402(f)(4)-1(a) to provide that an employer’s use of the computational bridge entries to adapt a 2019 or earlier Form W-4 to the redesigned computational procedures as if using entries on a redesigned Form W-4 will continue in effect such a Form W-4 that was properly in effect on or before December 31, 2019.

Lock-in Letters
The IRS issues a "lock-in" letter to notify an employer that an employee is not entitled to claim exemption from withholding, or is not entitled to the withholding allowance claimed on the employee’s Form W-4. The lock-in letter prescribes the withholding allowance the employer must use to figure withholding. After the lock-in letter becomes effective, the IRS may issue a subsequent modification notice, but only after the employee contacts the IRS to request an adjustment to the withholding prescribed in the lock-in letter.

Under the final regulations, employers are not required to notify the IRS that they no longer employ an employee for whom a lock-in letter was issued. Further, the final regulations do not require the IRS to reissue lock-in letters or modification notices solely because of the redesigned Form W-4.

The final regulations revise Reg. §31.3402(f)(2)-1(g)(2)(iv) relating to lock-in letters. and Reg. §31.3402(f)(2)-1(g)(2)(vii) relating to modification notices, to provide that an employer may comply with a lock-in letter or modification notice that is based on a 2019 or earlier Form W-4, as required by the regulations, if the employer implements the maximum withholding allowance and filing status permitted in a lock-in letter or modification notice by using the computational bridge entries as set forth in forms, instructions, publications, and other IRS guidance to calculate withholding for such a Form W-4.

Estimated Tax Payments
The final regulations revise Reg. §31.3402(m)-1(d) to allow employees to take estimated tax payments into account, as long as the employee (1) follows the instructions to the IRS’s Tax Withholding Estimator (available at https://www.irs.gov/individuals/tax-withholding-estimator) or IRS Publication 505, (2) is not subject to a lock-in letter or modification notice, and (3) does not request withholding from wages that falls below the pro rata share of income taxes attributable to wages determined under forms, instructions, publications, and other IRS guidance. The IRS intends to update its Tax Withholding Estimator and Publication 505 to reflect this rule.

Applicable Date
The final regulations generally apply on the date they are published in the Federal Register. Reg. §31.3402(f)(2)-1(g), regarding withholding compliance, applies as of February 13, 2020. Reg. §31.3402(f)(5)-1(a)(3), regarding the requirement to use the current version of Form W-4, applies as of March 16, 2020. The removal of Reg. §31.3402(h)(4)-1(b), regarding the combined income tax withholding and employee FICA tax withholding tables, applies on and after January 1, 2020.

Except for the removal of Reg. §31.3402(h)(4)-1(b), taxpayers may choose to apply the final regulations on and after January 1, 2020, and before their applicability date set forth in the regulations.

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The Treasury and IRS have released final regulations that provide guidance for Achieve a Better Living Experience (ABLE) programs under Code Sec. 529A to help eligible individuals pay for qualified disability expenses.

The Treasury and IRS have released final regulations that provide guidance for Achieve a Better Living Experience (ABLE) programs under Code Sec. 529A to help eligible individuals pay for qualified disability expenses. The regulations provide guidance on:

the requirements for ABLE programs,
requirements for establishing and contributing to an ABLE account for a designated beneficiary,
rules regarding changes in the designated beneficiary of an ABLE account,
rollover and transfers from one ABLE account to another, and
federal gift and generation-skipping tax consequences of an ABLE account.

The final regulations adopt proposed rules issued in 2015 and 2019 with a few modifications.

Qualified ABLE Programs
A qualified ABLE program is a program established and maintained by a State, or agency or instrumentality of a State. Several factors are provided in the final regulations in determining whether a State, or its agency or instrumentality, is actively involved in the administration of the program. Among those factors is the nature and extent of the State’s role in selecting and overseeing private contractors contracted to provide administrative or other services (for example, Community Development Financial Institutions (CDFIs)).

A qualified ABLE program may be maintained by two or more States or agencies or instrumentalities of a State in a consortium to offer broader investment choices, streamlined program administration, and lower fees for account holders. Consistent with legislation, the final regulations eliminate any reference to a residency requirement and a qualified program may allow an ABLE account to be established for an eligible individual regardless of his or her residence.

ABLE Accounts
An ABLE account is a tax-favored savings account established and owned by an eligible individual under a qualified ABLE program to pay qualified disability expenses of a designated beneficiary. The designated beneficiary of an ABLE account is the eligible individual who established and owns the ABLE account or who has succeeded the former designated beneficiary through a rollover distribution or change of beneficiary.

The final regulations provide that an ABLE account may be established on behalf of the eligible individual by his or her parent, legal guardian, or agent under a power of attorney. In addition, the regulations provide an expanded ordering rule of persons who may establish an ABLE account exercise signature authority over an individual’s ABLE account if necessary.

A qualified ABLE program may provide a certification process that an individual is eligible for an ABLE account, under penalties of perjury. Certification may be made by verifying that the individual is eligible for benefits under title II or XVI of the Social Security Act and the disability giving rise to those benefits occurred before the date on which he or she attained age 26. The other method of satisfying the definition of an eligible individual is by obtaining a disability certification and filing it with the Secretary.

A designated beneficiary is generally limited to only one ABLE account at a time. Once an ABLE account is established, generally no account that is subsequently established for that beneficiary can be treated as an ABLE account except for rollover and transfer purposes, as well as the return of excess contributions. Under the final regulation, an eligible individual is not prohibited from establishing an ABLE account merely because he or she previously closed another ABLE account.

Distributions and Transfers
Distributions from an ABLE account are excluded from the designated beneficiary’s gross income to the extent of his or her qualified disability expenses for the tax year. The final regulations maintain the expansive definition of qualified disability expenses, but the regulations do not provide either a comprehensive list of qualified disability expenses or a short list of expenses that would not satisfy that standard.

A qualified ABLE program may permit a successor designated beneficiary to be named during the lifetime of the designated beneficiary. If no successor designated beneficiary is named, the assets in the ABLE account are payable to the beneficiary’s estate and subject to the Federal estate tax. Moreover, the final regulations permit a qualified ABLE program to limit successor designated beneficiaries to a sibling who is an eligible individual. If a successor designated beneficiary is not a sibling, the former designated beneficiary receives a deemed distribution of the amount transferred to the successor.

The final regulations continue to permit rollovers from ABLE account but do not require the use of a program-to-program transfer. A rollover may occur from a qualified tuition account under Code Sec. 529 to an ABLE account for the same designated beneficiary. However, upon a rollover or program-to-program transfer, all the attributes of the former ABLE account are applicable to the recipient account.

Federal Gift and GST Taxes
The final regulations provide that contributions to an ABLE account by a person other than the designated beneficiary are treated as completed gifts. Thus, no distribution from an ABLE account to the designated beneficiary is treated as a taxable gift. Also, neither gift nor GST taxes apply to the change of designated beneficiary of an ABLE account if the new designated beneficiary is an eligible individual who is a sibling of the former designated beneficiary.

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The IRS has released final regulations clarifying that the following deductions allowed to an estate or non-grantor trust are not miscellaneous itemized deductions.

The IRS has released final regulations clarifying that the following deductions allowed to an estate or non-grantor trust are not miscellaneous itemized deductions:

costs paid or incurred in connection with the administration of an estate or non-grantor trust that would not have been incurred if the property were not held in the estate or trust;
the personal exemption of an estate or non-grantor trust;
the distribution deduction for trusts distributing current income; and
the distribution deduction for estates and trusts accumulating income.

These deductions are not affected by the suspension of the deductibility of miscellaneous itemized deductions for tax years beginning after December 31, 2017, and before January 1, 2026. The final regulations also provide guidance on determining the character, amount, and allocation of deductions in excess of gross income succeeded to by a beneficiary on the termination of an estate or non-grantor trust. The regulations affect estates, non-grantor trusts (including the S portion of an electing small business trust), and their beneficiaries.

Clarifications of Proposed Regs
A notice of proposed rulemaking ( NPRM REG-113295-18) containing proposed regulations under Code Secs. 67 and 642(h) was published on May 11, 2020. The final regulations summarize the provisions of Code Secs. 67 and 642(h) and of the proposed regulations.

In response to comments, Reg. §1.642(h)-2 was clarified so that a beneficiary may claim all or part of the excess deductions before, after, or together with the same character of deductions separately allowable to that beneficiary. Reg. §1.642(h)-5(b), Example 2 was clarified to (1) offset the real estate expenses on rental property with the rental income to avoid any unintended issues with Code Sec. 469; (2) include personal property tax paid by the trust rather than taxes attributable to rental real estate; and (3) illustrate the application of trustee discretion as found in Reg. §1.652(b)-3(b) and (d).

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The IRS has issued final regulations that address the gain or loss of certain foreign persons on the sale or exchange of an interest in a partnership that is engaged in a trade or business in the United States. The regulations provide guidance on determining the amount of gain or loss treated as effectively connected income under Code Sec. 864(c)(8), as well coordination rules. The final regulations retain the basic approach and structure of the proposed regulations ( REG-113604-18) with certain revisions. Proposed regulations ( REG-105476-18) on information reporting and withholding on dispositions of these interests will be finalized at a later date.

Deemed Sale Gain or Loss
If a nonresident alien or foreign corporation disposes of an interest in a partnership that is engaged in any trade or business in the United States, the gain or loss is treated as effectively connected gain or loss under Code Sec. 864(c)(8). The amount of gain or loss is limited to the portion of the foreign transferor's distributive share of gain or loss that would have been effectively connected had the partnership sold all of its assets at fair market value (the deemed sale limitation).

The foreign transferor must first determine its gain or loss on the transfer of the partnership interest (outside gain or outside loss). Once the outside gain or loss is determined, the following steps are taken to derive the limitation based on the deemed sale, against which the outside gain or loss is compared:

Step 1: Determine the amount of gain or loss from each partnership asset as if the partnership conducted a deemed sale of all of its assets on the date of transfer (these amounts are referred to as deemed sale gain or deemed sale loss);
Step 2: Determine the amount of the deemed sale gain or loss that would be treated as effectively connected gain or loss with respect to each asset (these amounts are referred to as deemed sale EC gain or deemed sale EC loss); and
Step 3: Determine the foreign transferor’s distributive share of deemed sale effectively connected gain or deemed sale effectively connected loss.

Sourcing Rules
The final regulations address the sourcing rules that are often material in determining whether gain or loss is effectively connected with the conduct of a trade or business within the United States (Step 2). Because the sales are deemed sales, the regulations provide simplifying factual assumptions that generally treat deemed gain and loss as U.S. source where there is a partnership office in the United States (U.S. office attribution rule). The final regulations clarify that the general rules apply to personal property held by the partnership on the date of the deemed sale. The regulations also clarify that the U.S. office attribution rule does not apply unless the partnership maintains an office or other U.S. fixed place of business in the United States.

The final regulations provide additional sourcing rules for determining the foreign source portion of deemed sale gain and loss attributable to inventory, intangibles, and depreciable personal property specifically included in the deemed sale. The sourcing rules are needed because gain or loss from actual sales of each of these assets would be subject to specific sourcing rules under the Code, but sourcing deemed sale gain or loss under those rules would generally require facts that are not determinable in a deemed sale.

Under a 10-year rule, assets that have no nexus to the United States are removed from the deemed effectively connected gain or loss determination. The 10-year period is adjusted for partnerships not in existence for the period. The testing period is also adjusted to include periods during which the asset was held.

Treaties and Coordination Rules
The final regulations also address treaty coordination rules and provide that (1) treaty provisions are taken into account in computing the Step 3 amount, above; and (2) treaty benefits are available only if the transferor meets limitation of benefits (LOB) requirements. The final regulation also provide additional rules to coordinate the regulations with treaty provisions governing the disposition of U.S. real property interests.

The Step 3 amount does not include amounts that are excluded from the foreign transferor’s gross income or otherwise exempt from U.S. federal income tax by reason of an applicable provision of the Code, or amounts excepted under Code Sec. 897.

The final regulations clarify the interaction between the Code Sec. 897 coordination rule (i.e., application of Code Sec. 864(c)(8) over Code Sec. 897(g)) and the nonrecognition rules. Any transfer of an interest in a partnership as part of a nonrecognition transaction will not be subject to Code Sec. 864(c)(8) to the extent that the gain or loss on the transfer is not recognized. Rather, if the partnership owns one or more U.S. real property interests, Code Sec. 897(g) and its regulations will apply with respect to the unrecognized gain or loss.

Applicability Dates
The regulations generally apply to transfers occurring on or after December 26, 2018, which is the date on which the proposed regulations were filed with the Federal Register. Additionally, the final regulations apply to amounts taken into account on or after December 26, 2018, pursuant to an installment sale (as defined in Code Sec. 453(b)) occurring on or after November 27, 2017, and before December 26, 2018.

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