IRS Website Updates for New Tax Shelter/Syndicate Election
The Tax Cuts and Jobs Act of 2017 (TCJA) contained several provisions that provided accounting method relief for small businesses with average annual gross receipts of $25 million or less. The gross receipts level is adjusted for inflation and currently stands at $26 million.
TCJA Simplified Tax Accounting Methods for Small Businesses
The TCJA allowed small businesses that meet the gross receipts tests the ability to simplify their tax accounting methods in the following areas:
- Ability to use the cash accounting method under IRC Section 448;
- Exemption from applying the business interest limitations under IRC Section 163(j)(3);
- Exemption from the percentage of completion method for accounting for long term contracts under IRC Section 460; and
- Exemption from using the inventory accounting rules under IRC Section 471
However, under these accounting method relief rules, an otherwise qualifying small business that was considered to be tax shelter/syndicate could not use these accounting relief rules. Under the Internal Revenue Code, a business would be considered a tax shelter/syndicate if it was a partnership or S corporation that allocated more that 35% of its losses to limited partners or limited entrepreneurs.
Many small businesses that would otherwise qualify for the relief can generate losses in a given tax year due factors such as the following:
- Startup expenses
- Ability to use the 100% bonus depreciation deduction for new assets acquired during the tax year
- Impact of COVID-19 on the operation of the business
- Accounting method changes under these new relief provisions
If the business has limited partners and allocated more than 35% of the year’s losses to those limited partners, the otherwise qualifying business would not be eligible for the accounting method relief provisions. The magnitude of the loss is irrelevant. In a subsequent tax year when the business did not have losses, the business would be able to qualify for the relief provisions.
New Tax Shelter/Syndicate Election for Small Businesses
On January 5, 2021, the IRS issued final regulations (TD 9942) under these small business accounting method relief provisions. Reg. Section 1.448-2(b)(2)(iii)(B) permits a taxpayer to make an annual election to use the allocations made in the immediately preceding tax year, instead of using the current tax year’s allocations, to determine if the business meets the definition of a tax shelter/syndicate. This regulation will provide much needed relief to many small businesses and will allow them to qualify to use the accounting method relief provisions of the TCJA.
The following rules apply to the mechanics of making the election:
- The taxpayer must attach a statement to a timely filed tax return, including extensions;
- The statement must state that the taxpayer is making an election under Reg. Section 1.448-2(b)(2)(iii)(B)
- The election cannot be made in any other manner. In the case of an S corporation or partnership, the election is made by the entity and not the individual shareholders or partners.
- The election is an annual election and can be made for any year that it is beneficial to the small business. The election is valid only for the tax year it is made, and once made, cannot be revoked.
The effective date of the regulation is generally for tax years beginning on or after January 5, 2021. However, a taxpayer may apply the regulation to a tax year beginning after December 31, 2017, and before January 5, 2021, if the taxpayer satisfies certain requirements under the regulation.
Please note that the election under this regulation may result in a change of accounting method for a taxpayer, and the taxpayer would follow the accounting method change rules.
The IRS has recently updated its website to provide information concerning this election.
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