The SECURE 2.0 Act of 2022 (SECURE 2.0 or the Act), enacted on Dec. 29, 2022, provides for a new tool that allows employers to contribute a matching contribution to a defined contribution plan based on the amount of an employee’s student debt repayments. The purpose of the provision is to assist employees who may, because of their student loan debt, decide against making elective contributions by payroll reduction and as a result, miss out on employer matching contributions.

Starting in 2024, an employer may amend the plan to provide for a student loan matching contribution on behalf of an employee making periodic student loan repayments to a third party. The amount of the match is calculated as if the employee had elected to contribute the loan repayment amount to the plan by payroll deduction, even though the employee’s pay is not actually reduced by that amount and the employee does not in fact make any elective contributions to the plan.

The student loan match provision applies to Internal Revenue Code (Code) sections 401(k), 403(b), 457(b) governmental plans, and SIMPLE-IRA plans. Student loan repayments considered for match purposes cannot exceed an amount equal to the annual maximum deferral limit ($22,500 for 401(k)/403(b)/457(b) and $15,500 for SIMPLEs), less the elective deferrals made by the employee. Additionally, the provision requires that the eligibility, match rate, and vesting requirements applicable to the student loan match must be the same as that for the match on regular elective deferrals. For administrative convenience, the student loan match may be made less frequently than regular matching contributions but must be made at least annually.

Under the provision, an employer is not required to request or obtain student loan documents, evidence of payment, or other documentation relating to the student loan match. Instead, the participants may simply certify that the student loan repayments were made and the amount of each payment, although some employers may want more.

The intent behind the student loan match provision suggests it would be available only to employees who are repaying their own student loans. However, there are questions around whether a parent who is repaying debt obtained to pay for a child’s higher education would be able to take advantage of the match. Changes made by SECURE 2.0 reference section 221(d)(1), which notes that a “qualified education loan” is any indebtedness by the individual which is used to pay for higher education expenses and incurred on behalf of the individual, the individual’s spouse or any dependent. Hopefully, clarification will be included with regulations to be issued by the treasury.

Non-safe harbor 401(k) plans are required to apply a nondiscrimination test to both elective deferrals (ADP) and employer match (ACP) contributions. SECURE 2.0 allows a plan to apply a separate ADP test to participants who choose to take advantage of the student loan match provision. This makes sense because employees who take advantage of the provision are either not contributing elective deferrals to the plan or are contributing at a lower rate. It may also be that these employees are primarily non-highly compensated, and the ADP test could be negatively impacted if they were included in testing with the entire plan population. There is no similar provision for the ACP test because the student loan match made for non-highly compensated participants not otherwise participating in the plan would positively impact the test.

A plan’s ADP and ACP nondiscrimination testing are often completed within a couple of months of year-end so that failures can be corrected in the form of refunds prior to 2-1/2 months after year-end, which is the deadline under the applicable Code sections to avoid an excise tax. It is worth noting that the deadline for self-certification can be no earlier than three months after the end of the plan year. Therefore, testing typically done during the 2-1/2 months after year-end may have to be delayed pending completion of the self-certifications. Employers will need to determine if this timing conflict will be an issue for them.

Further, because the SECURE 2.0 provision defines the employer contribution as a match, the student loan match satisfies the contingent benefit rule. According to the contingent benefit rule, no other benefit may be directly or indirectly conditioned (directly or indirectly) whether the employee elects to make an elective contribution under the plan, except as a matching contribution made by reason of such an election. Section  1.401(k) – 1(e)(6) and IRS PLR 201833012 (Aug. 17, 2018) issued to Abbott Laboratories.

Consider the following example of the impact of a student loan match on an employee’s account balance:

Company’s 401(k) plan matches 100% of deferrals up to 3% of eligible compensation and provides for a match on student loan repayments. Andy’s annual take-home compensation is $125,000. His annual student loan repayments equal $9,600, and he is trying to decide what, if anything, he can afford to have withheld from his pay as an elective deferral and still the receive maximum employer match available to him, which is 3% of compensation, or $3,750. On Nov. 1, 2024, he self-certifies the information required to receive a student loan match. The examples below show how he might make his decision.

• Scenario #1 – Andy does not make any regular deferrals for 2024, and his take-home pay is not reduced. His annual student loan repayments of $9,600 are treated as equivalent to a deferral of 7.6% of his compensation, and he receives the maximum match of $3,750 available to him. His ending 401(k) account balance for 2024, not counting earnings, is $3,750, and his take-home pay remains at $125,000.
• Scenario #2 – Andy decides he can afford a regular deferral of 1.5% of pay, and his take-home pay is reduced by $1,875 per month. The sum of his regular deferral and student loan repayments is treated as if he had deferred 9.2% of compensation and he receives the maximum 3% match of $3,750. His ending 401(k) account balance for 2024, not counting earnings, is $5,625, and his take-home pay is reduced to $123,125.
• Scenario #3 – Andy decides to maximize his matching contribution solely by making regular deferrals. He does not self-certify for the student loan match, and his loan repayments are not counted in the match calculation. His deferral is 3% of pay, and he receives the maximum match of $3,750. His ending 401(k) account balance for 2024, not counting earnings is $7,500, and his take-home pay is $121,250.

The following chart illustrates the above three scenarios:

Scenario	#1	#2	#3
Annual compensation	$125,000	$125,000	$125,000
Certified monthly student loan payments treated as deferrals for match purposes	$9,600	$9,600	$0
401(k) pre-tax elective deferrals withheld from pay	$0	$1,875	$3,750
Total of loan payments & deferrals as a percentage of annual compensation	7.6%	9.2%	3.0%
Take-home pay	$125,000	$123,125	$121,250
Employer match	$3,750	$3,750	$3,750
401(k) balance	$3,750	$5,625	$7,500

• Scenario #4 – By way of illustration, however, assume that the plan has an unusually high matching contribution rate. Andy certifies that he has student loan repayments of $15,000 and elects to make regular deferrals of $10,000 (no catch-up contribution included). In that case, not all of Andy’s $15,000 student loan repayment could be considered for a student loan match because the maximum annual deferral limit of $22,500 (in 2023) would be reduced by the regular deferrals ($22,500 – $10,000), and only $12,500 of the student loan repayment would count for purposes of the student loan match.

The cost to an employer for adding a student loan match provision to the plan comes in a couple of forms – the increased match contribution and administrative expenses. If the provision becomes highly popular among employees, the employer could see a significant increase in the amount of its matching contributions. Administrative costs will stem from:

1. increased per-participant fees due to participation by employees who might not otherwise elect to make any deferrals,
2. additional fees for nondiscrimination testing, and
3. tracking and maintaining student loan match self-certifications.

The IRS is expected to issue guidance on the SECURE 2.0 provision, including implementing regulations and a model plan amendment for those employers wanting to make this optional plan change.

Employer business considerations

The first consideration in adopting a student loan match under SECURE 2.0 is whether it makes business sense, for example, in recruiting and retaining talent. Employers should assess how many employees are currently repaying qualified student loans, as well as the jobs they hold. The student loan match may make sense for employers who wish to assist all employees with student debt without regard to salary level or job function. In any event, employers should assess the costs and administrative burdens of the student loan match. Another consideration is how the student loan match fits into an employee’s total compensation package and the extent to which student loan repayment obligations were already built in, e.g., in the form of higher compensation or other benefits.

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This article was written by Joni Andrioff, Christy Fillingame, Catherine Davis and originally appeared on Mar 22, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/secure-20s-new-tool-for-helping-employees-with-student-loans.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.

Family offices are focusing on operational excellence to drive efficiencies and future-proof the organization in a constantly changing environment.

Family offices continue to be the preferred way for ultra-high net worth individuals and families to manage assets and to support the goals and legacy of their family. But today the existing 14,000+ family offices across the globe are facing new challenges and complexities, raising concerns about whether their operating model is providing the transparency and efficiency needed to be successful today while being flexible enough for tomorrow.

Rather than being reactive, leading family offices are focusing on operational excellence to accomplish the family goals and objectives. By assessing and creating roadmaps around people, process, technology, and data, leading family offices can have an organization that truly delivers the control, flexibility, and visibility needed to meet their needs.

Do you have a sustainable human capital strategy that delivers the right outcomes for your family office?

Family offices require high performing and engaged teams with the competencies to manage the complex needs of the family.

Family offices also struggle with a tight talent pool that requires new strategies to attract and retain workers possessing specialized knowledge and skills. At the same time, key personnel spend significant time on completing manual, redundant processes, which often require additional or unnecessary resources.

Closing the talent gap and aligning people to the right roles are top of mind for family offices, with careful thought given to diverse staffing approaches, including in-house talent and outsourcing.

At what cost to productivity and value creation?

From a heavy reliance on excel spreadsheets to manual data entry, inefficient processes are found in everyday operations.

Inefficient and manual processes can result in errors and labor-intensive staff constraints. With re-designed and optimized processes with clear controls, you’ll save time, increase compliance, reduce risk and costs, and enhance employee performance. 

Where are the real savings?

Many family offices rely on legacy technology systems that are disconnected, outdated and ineffective in running a modern enterprise. In addition to being inefficient, aging systems are more susceptible to cybersecurity risks and often require more maintenance than their newer counterparts. Where are the real savings?

Embracing technology doesn’t have to disrupt the family enterprise. Change management can help ease the transition, starting with enhanced, cross-enterprise technology and that leads to accurate and timely reporting within a more robust integrated architecture. 

What impact could this have on business and investment decisions?

The fragmentation of data is a challenge for many family offices. The more data a family office regularly pulls from different sources and stores in siloed locations, the harder it becomes to access that data and maximize its usage.

Leveraging data enables family offices to turn valuable information into actionable insights to drive family goals forward.

Watching a new era unfold understandably raises many considerations for family offices—most importantly, how to grow and mature the family enterprise to sustain multigenerational success. An operating model is a fundamental driver of a family office’s strategic road map for the enterprise; however, its usefulness diminishes if traditional approaches are not adapted to keep up in a fast-moving world.

A focus on operational excellence and bringing the application of the right people, processes, technology and data can be the key to a family office achieve its long-term goals.

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This article was written by RSM US LLP and originally appeared on Mar 22, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/family-office/Is-your-family-office-reaching-its-full-potential.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.

The financial shock affecting the U.S. economy will most likely result in tightened lending standards, tip the economy into recession this year and cause mild disinflation.

The quandary faced by the Federal Reserve—balancing price stability, full employment and financial stability—requires an estimate of just how large that shock will be.

The counterfactual analysis we present here implies that our estimate of the shock is equivalent to 50 basis points of policy tightening as long as the current crisis does not deteriorate further and financial conditions remain tightened.

This creates a proxy rate one half of one percent higher than wherever the policy rate rests following the Federal Reserve’s decision on Wednesday. That proxy rate will move well into restrictive terrain and most likely create the conditions for a near-term peak in the policy rate.

Should the crisis deteriorate further, with more bank seizures and further problems inside systemically important financial institutions, then the degree of financial shock is equivalent to 150 basis points of tightening.

If the Fed increases its policy rate by 25 basis points on Wednesday, to a range of 4.75% to 5% from 4.5% to 4.75%, the proxy rate would be the equivalent of 5.25% to 5.5%, and that would most likely be the final rate hike in this cycle, all else being equal.

That is a big “if,” given the uncertainties around inflation in recent months.

It is important for the market, especially financial institutions, to treat these uncertainties with the utmost priority. Our estimates work only if our key assumption—that banks have learned not to underestimate the Fed’s determination to restore price stability—holds.

Failing to account for upside inflation risks and, ultimately, upside credit risks by prematurely pricing for rate cuts would lead to the same vicious cycle.

By contrast, the loosening of financial conditions in anticipation of rate cuts would mean stickier inflation, more rate hikes, and more bank failures.

More ominously, should the Fed hike by 25 basis points and financial conditions deteriorate, it would be the equivalent of a proxy rate closer to 6.5%.

At that point, the Fed would have created the conditions for a deeper recession than necessary to obtain price stability, at the cost of much higher unemployment.

Scenarios

We subject the economy to a shock to estimate two counterfactual scenarios where the peak policy rate would otherwise be roughly 5%.

• Liquidity crisis: The first is a shock along the lines of the one affecting the economy and does not materially deteriorate or abate until the end of the second quarter. While credit risk and pervasive uncertainty remain, recent policy steps are sufficient to prevent the liquidity crisis from transforming into an economy-wide credit crunch. This implies that the Fed is well positioned to hike the policy rate by 25 basis points or could choose to pause with the knowledge that the proxy rate would climb to somewhere between 5% and 5.25%. The consumer price index under this scenario would return to near the Fed’s 2% inflation target by the end of next year.
• Credit crunch: In our alternative to the baseline, the crisis intensifies with more bank failures and bank seizures, causing extreme volatility across asset classes, hurting systemically important financial institutions and resulting in a credit crunch that would lead to an increase of 150 basis points in the policy rate. Under this scenario, inflation would return to a rate below the 2% target to roughly 1.8% by the end of next year.

The takeaway

Judgment calls on policy are always difficult. During a banking crisis, it is impossible to balance the need to restore price stability against rising unemployment and financial stability.

Our estimate of where this balance lands is not encouraging. At the very least, the current shock, if it is contained and does not abate until midyear, is equal to roughly 50 basis points of policy tightening.

Alternatively, should conditions deteriorate, then the tightening of financial conditions would be equal to roughly 150 basis points of policy restriction.

This is the difference between a liquidity crisis, which we are in, and a broader credit crunch, which has yet to happen.

Whatever the case, the financial shock hitting the economy will result in the Fed pushing its policy rate well into restrictive terrain and create the conditions for a near-term peak as lending becomes tight.

Such is the price of a banking crisis when inflation remains elevated.

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This article was written by Joseph Brusuelas, Tuan Nguyen and originally appeared on 2023-03-21.
2022 RSM US LLP. All rights reserved.
https://realeconomy.rsmus.com/financial-shock-sending-the-fed-proxy-rate-into-restrictive-terrain/

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.

The SECURE 2.0 Act of 2022 (SECURE 2.0 or the Act), enacted on Dec. 29, 2022, may be the most comprehensive legislation concerning retirement plans in decades. The Act has numerous provisions affecting retirement savings through employer-provided retirement plans and individual retirement accounts (IRAs). The focus of the Act is to provide incentives for employees to save more for retirement, for example by increasing contribution limits. The Act also provides incentives for more employers to offer retirement plans by reducing both start-up costs and administrative burdens.

Many SECURE 2.0 provisions apply specifically to small businesses with 100 or fewer employees (small employers). This article discusses the impacts of SECURE 2.0 on small employer retirement plans.

Small employer retirement plans

While small employers are free to adopt the same types of retirement plans as larger employers, such as 401(k) and defined benefit pension plans, three types of retirement plans are geared toward small employers, including simplified employee pension plans (SEPs), Savings Incentive Match Plan for Employees (SIMPLE) IRAs, and, less commonly, SIMPLE 401(k) plans, can be adopted by small employers, including sole proprietorships, partnerships, S-corporations, and C-corporations. In general, these three types of plans are designed to make it easier and less expensive to set up and administer.

SEPs have their own unique characteristics. SIMPLE- IRAs and SIMPLE 401(k) plans are similar to each other in many respects but also have their own unique characteristics. These plans are described below.

1. SEPs. A SEP may be adopted by employers of any size but is most typically adopted by small employers. Employer contributions to a SEP are made directly to an individual IRA set up by, or on behalf of, an individual employee.

   All eligible employees of the employer and its related businesses must be covered by the SEP and the employer must make contributions on behalf of each employee in the same percentage of compensation or the same uniform dollar amount as made on the behalf of an owner, although greater contributions may be possible for higher earners based on social security integration. All employees must be covered by the SEP if they are at least age 21, have worked in at least 3 of the last 5 years, earn at least $750 (2023, as indexed), and are not union employees covered by a collective bargaining agreement or nonresident aliens. Employee contributions are not allowed under a SEP.

   Annual SEP contributions are limited to 25% of the employer’s aggregate employee compensation or, for businesses that have no employees, 25% of the owner’s compensation. With respect to each SEP participant, the maximum annual compensation that may be considered is $330,000 (2023, as indexed), and annual SEP contributions are limited to $66,000 (2023, as indexed). An employer does not have to contribute to a SEP every year.

   SEPs are easier to administer than some other retirement plans because they are not subject to the same types of nondiscrimination testing or annual reporting requirements applicable to qualified plans. SEPs may be set up simply by completing IRS Form 5305-SEP; or by adopting an IRS-approved prototype or individually designed plan document (e.g., provided by the financial institution where the SEP IRAs are set up).

   Starting in 2023, an employer may amend a SEP to allow employees to elect to have their employer-funded contribution treated as a Roth contribution. Previously, Roth contributions were not allowed in a SEP. As noted, SEPs are funded by employers not by employees. The mechanics of this election are uncertain, and guidance will be necessary from the IRS, and SEP-IRA custodians will need time to prepare new plan documents and adapt their administrative systems to accommodate this new option.

2. Characteristics of both SIMPLE 401(k) plans and SIMPLE-IRAs. Only small employers may adopt a SIMPLE 401(k) plan or SIMPLE-IRA. A small employer who sponsors either SIMPLE plan may not sponsor any other type of retirement plan. SIMPLE 401(k) plans and SIMPLE-IRAs are not subject to nondiscrimination testing for elective contributions, provided all requirements are satisfied.

   Starting in 2023, in SIMPLE 401(k) plans, eligible employees are allowed to make both pre-tax and/or Roth elective contributions to the plan by payroll deduction, up to an annual limit of $15,500 (2023, as indexed), as well as catch-up contributions starting at age 50 of $3,500 (2023, as indexed). Starting in 2023, SECURE 2.0 allows employer after-tax Roth contributions in SIMPLE-IRAs.

   Under current rules, with respect to both SIMPLE 401(k) plans and SIMPLE-IRAs, employers are required to make a fully vested employer contribution either as a 3% matching contribution or a 2% nonelective contribution. Starting in 2024, however, SECURE 2.0 increases the maximum contribution limits for both SIMPLE 401(k) and SIMPLE-IRAs. The new rule allows an employer with 25 or fewer employees to make nonelective employer contributions over and above the required 2% amount, capped at the lesser of 10% of the employee’s compensation or $5,000 (2024, as indexed). Further, under SECURE 2.0, the maximum amount an employee can elect to contribute to the plan is 110% of the annual limit established by the IRS ($15,500, 2023). Employers with 26 or more employees can take advantage of this increase in the elective contribution limit only if they increase the required 3% matching contribution to 4% or increase the required 2% nonelective contribution to 3%.

3. Unique characteristics of SIMPLE 401(k) plans and SIMPLE-IRAs.
   1. SIMPLE 401(k) Plans. A SIMPLE 401(k) plan must cover all employees who are at least age 21 and are credited with at least 1,000 hours in the prior year. Employees covered under a collective bargaining agreement and nonresident aliens may be excluded. A SIMPLE 401(k) plan is subject to many of the same rules that apply to traditional 401(k) plans, including, for example, that plan assets must be held in a trust. Plan loans, hardship withdrawals, and other in-service withdrawals are allowed in a SIMPLE 401(k). Unlike a traditional 401(k) plan, a SIMPLE 401(k) plan is not subject to nondiscrimination testing for elective deferrals and top-heavy testing, provided certain requirements are satisfied. A small employer may adopt a SIMPLE 401(k) plan by using an IRS-preapproved 401(k) plan document and electing it to be a SIMPLE-401(k) in the adoption agreement.
   2. SIMPLE-IRA. Employer contributions and employee elective contributions are made to an individual IRA set up by or on behalf of an individual employee, rather than to a trust as is needed for SIMPLE 401(k) plans. Unlike a SIMPLE 401(k), no minimum age requirement applies to a SIMPLE-IRA, and it must cover all employees who earned at least $5,000 in any two prior calendar years (or who expect to earn at least $5,000 in the current year). A SIMPLE-IRA cannot offer loans, and withdrawals from a SIMPLE-IRA before age 59 1/2 will likely incur a 10% or 25% early distribution penalty, depending on the circumstances. An employer may set up a SIMPLE-IRA by adopting Form 5304 or Form 5305, or by adopting an IRS-approved prototype plan. Certain plan notification requirements apply, however, there are no annual filing requirements with a SIMPLE-IRA.

SECURE 2.0 provides that, starting in 2024, a small employer sponsoring a SIMPLE 401(k) or SIMPLE-IRA is permitted to terminate the SIMPLE and replace it with a safe harbor 401(k) or 403(b) plan in the current year. This may occur, for example, because SECURE 2.0’s increased limits would allow a SIMPLE plan sponsor to make nonelective employer contributions of 3% – the same nonelective contribution required under a safe-harbor 401(k) plan. In that instance, an employer sponsoring a SIMPLE 401(k) plan may wish to convert to take advantage of the safe-harbor 401(k) plan’s higher limits for elective contributions ($22,500 vs. $15,500 for 2023) and catch-up contributions ($7,500 vs. $3,500). Additionally, a safe harbor 401(k) plan may be more flexible than a SIMPLE with respect to discretionary provisions. For example, a profit-sharing contribution may be built into a safe-harbor 401(k) plan – which may be desirable as the company grows.

SECURE 2.0 provisions applicable to small employer plans

Tax credits for small employer plans. SECURE 2.0 provides the following tax credits for small employers:

• Increased tax credit for new pension plan start-up costs. Starting in 2023, the tax credit for start-up costs of setting up a new defined contribution plan is increased for small employers. For employers with 50 or fewer employees, the tax credit increases from 50% up to 100% of the qualified costs incurred in the first three years of starting up a new plan. The credit is still limited to $5,000 per year. Employers with 51 to 100 employees are still eligible for the credit of 50% of qualified start-up costs for the first three years, with a maximum credit of $5,000 annually.
• Credit for employer contributions. Beginning in 2023, small employers can claim a credit for the employer contribution for the first five tax years beginning when the plan is set up. A per employee cap of $1,000 applies. Subject to the per employee limit, 100% of the employer contribution can be claimed in the first and second tax years; 75% in the third year; 50% in the fourth year; and 25% in the fifth year. For employers with 51 to 100 employees, the credit is reduced by 2 percentage points for each employee over 50. No credit is allowed for employer contributions on behalf of employees with wages that exceed $100,000 (2023, as indexed), or if the employer has more than 100 employees.
• Tax Credit for Military Spouse Retirement Plan Eligibility. The Act provides a tax credit of $200 for each non-highly compensated military spouse who participates in a small employer’s defined contribution plan subject to certain conditions, plus an added credit for employer contributions of up to $300 for the military spouse’s first three years of plan participation, as part of the general business credit.

“Starter” deferral only plans

Effective in 2024, the Act created a new type of “starter plan” available to employers of any size but seems more suited for small employers, who have not sponsored a retirement plan in the last three years. The starter plan allows only employee elective contributions and catch-up contributions. The annual contribution limit is capped at $6,000 (effective 2024, as indexed), with a maximum of $1,000 (effective 2024, as indexed for IRAs) catch-up contribution. A starter deferral-only plan must require automatic contributions starting at 3% of compensation, up to a maximum of 15%, and is not subject to nondiscrimination testing.

Extended deadline for retroactive elective contributions by a sole proprietor

The Act extends the retroactive elective contribution deadline for sole proprietors for the first year of a new plan from the end of the first year of the plan, to the sole proprietor’s tax return due date (determined without regard to any extensions) for the year the plan is adopted. For example, under the SECURE 2.0 provision, a sole proprietor with no employees could, at any time before his or her 2023 tax return due date (determined without regard to any extensions), decide to retroactively set up a 401(k) plan with a Jan. 1, 2023, effective date and contribute elective contributions up to the 2023 maximum annual limit. Prior to SECURE 2.0, the retroactive plan had to be adopted by the end of the year for which the contributions were made.

SECURE 2.0 provisions affecting both large and small employers

Automatic enrollment is mandatory for new 401(k) and 403(b) plans, except SIMPLEs

Starting in 2025, plan sponsors will have to include an eligible automatic contribution arrangement in most new 401(k) or 403(b) plans set up after Dec. 31, 2024. The automatic contribution rate during a participant’s first year of participation must not be less than 3% or greater than 10% unless the participant opts out, with automatic 1% annual deferral increases up to at least 10% but not more than 15% (10% for 401(k) safe harbor plans). After deferral, the plan must provide that participants have the right to withdraw automatic contributions from the plan within 90 days of the first contribution.

Automatic contribution arrangements, however, will not be mandatory for SIMPLE 401(k) or SIMPLE-IRA plans; plans of employers with 10 or fewer employees; plans of employers in existence for less than three years; and governmental and church plans. Automatic enrollment remains voluntary for 401(k) and 403(b) plans already in existence as of Dec. 29, 2022.

Expansion of coverage to long-term part-time employees

Under current law, temporary, seasonal, and part-time employees credited with less than 1,000 hours of service may be excluded from qualified plan participation. Starting in 2024, however, a 401(k) plan is required to enroll such employees if credited with more than 500 hours of service in three consecutive 12-month periods, solely for making elective deferrals. Starting in 2025, SECURE 2.0 extends the provision to 403(b) plan and reduces the three consecutive 12-month periods to two. This provision applies to SIMPLE 401(k) plans but not SIMPLE-IRAs.

The mandatory enrollment of these long-term part-time employees has serious implications for industries such as retail, food and beverage, healthcare and private clubs, and other industries that typically employ large numbers of seasonal, temporary, and part-time employees. Employers will be required to determine whether any of these employees is credited with 500 hours of service under a 401(k) plan in 2021, 2022, and 2023, and then further determine whether the employee had 500 hours in any three, or after 2025, two consecutive 12-month periods for both 401(k) and 403(b) plans. For 403(b) plan sponsors, years prior to 2023 can be disregarded. If an employer decides to provide a matching contribution to such long-term part-time employees, each year in which the employee is credited with at least 500 hours of service starting in 2021 (2023 for 403(b) plans) must be counted for vesting service. Long-term part-time employees may be excluded for purposes of nondiscrimination and top-heavy testing.

Student loan repayments may be treated as elective deferrals for matching purposes.

Starting in 2024, employers may make a matching contribution to a SIMPLE-IRA plan (as well as 401(k), 403(b), and 457(b) plans), based on the amount of a qualified student loan repayment made by a participant to a lender during the applicable period. The loan repayment amount is treated as if the participant deferred the amount under the plan, even though no deferral amount is actually withheld from the participant’s eligible compensation or contributed to the plan by the participant. Changes made by SECURE 2.0 reference Internal Revenue Code section 221(d)(1), which defines a “qualified education loan” as any indebtedness by the individual which is used to pay for higher education expenses and incurred on behalf of the individual, the individual’s spouse or any dependent. One question is whether the provision will extend to participants responsible for paying another person’s student loans, such as a son or daughter. Hopefully, clarification of this provision will be included with regulations to be issued by Treasury.

A plan may accept an employee’s self-certification with respect to the payment, although some employers may want more documentation. This provision is optional, and, in making the decision to adopt it, an employer should consider the needs of its particular workforce.

Election to treat fully vested employer contributions as Roth contributions

Effective Dec. 29, 2022, SECURE 2.0 provides that qualified plans may allow employees to choose to treat fully vested employer matching and other employer contributions as after-tax Roth contributions. This provision does not apply to SIMPLE-IRAs. Employees making the election are subject to income tax on the employer contributions in the election year. The IRS is expected to issue guidance on withholding on the employer contributions subject to the election, and how the provision applies to employer contributions that vest ratably. The provision is optional.

Small immediate incentives for participating in a qualified plan

Employers are allowed, starting after Dec. 29, 2022, to encourage employees to save by providing a de minimis financial incentive to employees that is contingent on an election to make 401(k) or 403(b) plan deferrals, e.g., giving away a gift card or promotional item if they enroll. These incentives are allowed in SIMPLE 401(k) plans.

Increase in the small account balance mandatory cash-out limit

Starting in 2024, the maximum small account balance mandatory cash-out limit is increased to $7,000 (was $5,000) and applies to all distributions made after Dec. 31, 2023, from defined contribution plans, including SIMPLE 401(k) plans. This provision is not relevant for SIMPLE-IRAs.

Changes in the required minimum distribution rules apply to qualified plans, including SEPs, SIMPLE 401(k)s, and SIMPLE-IRAs.

• The age for required minimum distributions from IRAs or qualified plans is increased to age 73 for persons who reach age 72 after 2022 and age 73 before 2033; further increases to age 75 for persons who reach age 74 after 2032.
• The excise tax applicable to failures to receive required minimum distributions is reduced from 50% to 25%, and, starting in 2025, may be further reduced to 10% if corrected during the applicable correction window ending on the earlier of (1) the last day of the second tax year that begins after the year the excise tax is imposed, or (2) the date of a notice or assessment of tax.
• Required minimum distributions from a designated Roth account in a qualified plan are not needed prior to the participant’s death, for distributions related to years after 2023.

Catch-up contribution changes

• Starting in 2024, participants with annual wages up to $145,000 may make catch-up contributions with respect to both pre-tax and Roth contributions. However, participants with wages over $145,000 may make catch-up contributions only as after-tax Roth contributions. “Wages” for this purpose are defined under section 3121(a) as wages from employment, so the provision does not apply to self-employed individuals, although this point may be addressed in future IRS guidance. As noted above, after-tax Roth contributions are allowed in SIMPLE 401(k) plans and, starting in 2023, are allowed in SIMPLE-IRAs under SECURE 2.0.
• In addition, starting in 2025, the annual catch-up limit for participants ages 60, 61, 62, or 63 at the close of any tax year in a qualified plan is increased from $7,500 (2023, as indexed) at age 50 to $10,000 (or, if greater, 150% of the 2024 annual limit). For SIMPLE plans only, the annual catch-up limit increases from $3,500 (2023, as indexed) at age 50 to $5,000 (or, if greater, 150% of the 2025 annual catch-up limit). Special indexing rules apply.

It should be noted, however, that under current law, qualified plans are not required to provide for Roth accounts. Thus, under the SECURE 2.0 provision, employees with wages over $145,000 who participate in a plan that does not provide for Roth accounts would not be permitted to make any catch-up contributions and would not be able to take advantage of the increased catch-up contribution limits for participants ages 60 through 63.

Permissible emergency distributions added

In lieu of the disaster-by-disaster approach in current law, Congress has added permanent rules for plan loan and distributions related to federally declared disaster areas. Key features of the new provisions are:

• Up to $22,000 may be distributed to a participant per disaster,
• The amount of income included can be spread over three years,
• Amounts distributed may be repaid within three years,
• The maximum dollar amount of a disaster-related loan is the lesser of 50% of the account balance or $100,000 (increased from $50,000), and
• The 10% early withdrawal penalty on amounts included in income is waived.

These rules are effective for disasters occurring on or after Jan. 26, 2021.

Domestic abuse provisions

Starting in 2024, special provisions have been added to benefit victims of domestic abuse, including the following:

• A domestic violence victim may take a penalty-free early withdrawal of up to the lesser of $10,000 (indexed) or 50% of the value of the employee’s vested account balance in the plan.
• Amounts withdrawn may be re-contributed to the plan within three years.
• This will be a permitted in-service distribution event for 401(k), 403(b), and governmental 457(b) plans.

Self-certified emergency personal expenses

Effective Jan. 1, 2024, defined contribution plans including IRAs may allow penalty-free withdrawals of up to $1,000 per year for unforeseeable or immediate financial needs relating to personal or family emergency expenses. Similar to other provisions in the Act, the taxpayer may repay the withdrawal within three years. However, only one withdrawal per three-year repayment period is allowed if the first withdrawal in the period has not either been repaid or the recipient has not contributed as a current contribution to the plan at least the amount of the withdrawal.

Emergency savings accounts

The Act allows plans to permit participants to open “pension-linked emergency savings accounts” in qualified plans which are separately accounted for. The pension-linked emergency savings account contributions are capped annually at $2,500 and are included in the maximum participant deferral limits applicable to the plan.

Takeaways and reminders

SECURE 2.0 has a number of provisions encouraging small employers to set up retirement plans by reducing start-up costs, increasing maximum annual contribution limits, and decreasing administrative burdens. Employers with less than 100 employees should review their retirement plans and analyze whether SECURE 2.0 provides opportunities for changing their plans or improving existing plans. In addition, employers who have considered adopting a retirement plan in the past but have not due to costs, administrative burdens, or for other reasons may wish to reconsider in light of SECURE 2.0. Small employers should identify and analyze new compliance issues under SECURE 2.0.

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This article was written by Joni Andrioff, Christy Fillingame, Catherine Davis, Chloe Webb and originally appeared on Mar 20, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/what-does-secure-20-mean-for-small-employers.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.

Financial institutions need to understand what led to the recent failures of Silicon Valley Bank, Signature Bank of New York and Silvergate Bank so they can enhance their organizations’ risk management activities and meet increased regulatory expectations while also maintaining customer confidence.

As the industry continues to assess the impact of these failures, leadership teams at financial institutions can take proactive steps to mitigate risks stemming from the numerous precipitating factors. Various forms of stress-testing, scenario modeling and risk management are key solutions that enable banks to improve their planning and readiness for the future.

Such solutions will be especially crucial given the carousel of money—in the hundreds of billions—moving to and from various financial institutions at a rapid clip since the bank failures. Institutions have already tapped into $11 billion of loans from the Bank Term Funding Program and moved $150 billion into money market funds over the last week and more than $100 billion to the Federal Reserve’s repo facility. Roughly $120 billion moved from financial institutions into money market mutual funds between March 8 and March 15. Much of that was likely from small and medium-sized banks.

Here are critical areas heavily affected by current volatility in the sector and the broader macroeconomic environment, along with key actions leadership teams may consider:

Liquidity and asset liability management

• Evaluate the need to update existing liquidity stress indicators, metrics, guidelines, and limits, and their impact on the frequency, depth, and escalation of liquidity modeling and monitoring
• Intensify both the severity and duration of liquidity stress scenarios
• Expedite testing of contingency funding plans—including accessibility to Fed fund lines, lines of credit, and other sources of liquidity—as well as communication plans that can be internally escalated at a rapid pace
• Identify and pledge qualifying assets to secure additional borrowing capacity for existing lines of credit
• Monitor the utilization of borrowers’ unfunded lines of credit and determine the corresponding impact on the institution’s liquidity position; analyze borrowers’ credit quality as access to capital tightens
• Plan for scenarios that may lead to use of the Federal Reserve’s Bank Term Funding Program
• Increase the frequency of interest rate risk (IRR) modeling routines
• Update IRR modeling stress scenarios to reflect recent and projected changes to short- and long-term interest rates (incorporating both upward and downward shocks), and anomalous deposit behavior
• Reevaluate and sensitivity-test core IRR modeling assumptions (e.g., asset prepayment rates, liability decay rates, betas, lags, etc.) reflecting current market conditions
• Evaluate courses of action outlined in a liquidity contingency plan, and their potential impact on the balance sheet and prospective exposure to IRR
• Evaluate reliance on noncore funding, the transient nature of potential new deposits, and any corresponding repricing implications 

Concentration risk

• Monitor customer concentration risks, for both lending and deposit (e.g., by industry, geography or specialization)
• Assess new concentrations of credit risk resulting from recent events (e.g., suppliers/vendors for technology or life sciences companies that may be acutely affected, commercial real estate credit risk due to a hybrid workforce, and associated downstream changes)
• Monitor unrealized loss positions within the investment portfolio (consider both market- and credit-related loss attribution) and explore opportunities to reposition the investment portfolio’s duration and issuer mix 
• Evaluate counterparty exposures 

Customer considerations

• Update public relations plans and communicate expectations across the enterprise
• Leverage existing customer relationship management platforms or data to identify and strengthen transactional relationships
• Reinforce the importance of operational and customer service excellence at the first line
• Monitor the potential for fraud and compliance risks related to new accounts
• Monitor news and filings for geographic peers as an input to strategic decision-making
• Proactively communicate with customers whose balances exceed the limits insured by the Federal Deposit Insurance Corp. regarding the relative strength of the institution’s balance sheet, liquidity and capital position

At a higher level, leadership teams should also understand the integral role the risk function plays in analyzing and mitigating the many risks that affect their institution. A formalized enterprise risk assessment that is updated on a regular basis can assist an institution in identifying areas of increasing or outsize risk in a timely fashion. This should trigger deployment of a mitigation strategy to prevent massive shocks and potential failure that could come to fruition if not addressed.

Furthermore, the board and relevant board-level committees should zero in on the issues detailed above to ensure they are not only providing proper governance to management but effectively challenging the institution’s risk management processes when needed.

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This article was written by Nicholas Hahn, Andrew Broucek, Angela Kramer, Brandon Koeser and originally appeared on Mar 20, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/financial-institutions/taking-action-what-financial-institutions-can-do-bank-failures.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.

Trust is the lubricant that makes modern commerce possible. It facilitates an uninterrupted operation of finance that allows firms to fund expansion and modern economies to operate efficiently. It reduces transaction costs, minimizes frictions and creates the conditions for broader and deeper forms of economic interaction.

Ask yourself this question: Do you get a receipt after buying gas or withdrawing money from an ATM?

For many, the answer is no.

Why is that?

Trust in the system.

But in the banking sector, that trust is eroding, albeit on a grander scale. Evolving financial conditions and key risk metrics show this erosion as concerns about counterparty risk multiply. Regional banks are tapping wholesale funding at the Federal Home Loan Banks as private sector financial institutions pull back from lending.

The fragile nature of trust in modern finance demands that we follow a number of metrics that reflect risk in the system.

Here we present our RSM US Financial Conditions Index, along with the forward rate agreement and the overnight index swap rate, or the FRA/OIS spread, as two key barometers of trust in the financial system.

As of Wednesday morning, the RSM index was at 1.4 standard deviations below neutral, indicating increases in volatility and risk priced into financial assets, with the prospect of diminished investment and economic growth.

U.S. markets are attempting to come to terms with the result of relaxed oversight of the banking industry, the vulnerability of small and midsize banks with exposure to interest-rate risk, and the bursting of the cryptocurrency and tech bubbles. (On Tuesday morning, Meta said it would cut 10,000 jobs and scrapped plans to hire 5,000 more.)

The weekend collapse of a third regional U.S. bank and concerns of contagion in Europe are the immediate cause of a reassessment of risk in the equity and money markets.

That spilled over into the bond market, where a shift in expectations regarding economic growth precipitated a drop in both two-year and 10-year yields.

The instability in the money markets is particularly distressing for the business community, which depends on money markets for day-to-day operations.

Another metric we follow that reflects basic counterparty risk and is our preferred barometer of trust within the banking system is the FRA/OIS spread.

A forward rate agreement swaps future fixed interest payments for variable ones. The overnight index swap is derived from contracts in which investors swap fixed and floating rate cash flows. The higher the FRA/OIS spread, the greater the perception of risk.

An important rate is the secured overnight financing rate, or SOFR, which is the benchmark that underscores interest rates on trillions of dollars of financial instruments like credit cards, auto loans and mortgages.

Movement in benchmarks

The FRA/OIS spread has increased notably in recent days and now reflects a 57 basis-point difference, which is up from a near zero reading just days ago. While nowhere near 2008 levels—this is not yet a 2008-type of crisis—it is approaching levels observed during the pandemic era.

While the surge in the FRA/OIS spread signals increased expectations of risk, volatility in short-term credit spreads signals uncertainty regarding economic growth and the availability of short-term loans that permit day-to-day business operations.

All of these are consistent with growing counterparty risk, which could make interbank lending more risky.

Since banks would take losses if other banks fail or are seized, they will demand higher interest rate payments to lend to one another, which causes an increase in the FRA/OIS spread.

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This article was written by Joseph Brusuelas and originally appeared on 2023-03-15.
2022 RSM US LLP. All rights reserved.
https://realeconomy.rsmus.com/its-a-matter-of-trust-financial-conditions-tighten-on-stability-risks/

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.

Direct pay is perhaps the greatest benefit for exempt organizations to come out of the Inflation Reduction Act of 2022 (“the Act”). Section 6417 was added to the Internal Revenue Code, allowing for an elective payment (also referred to as direct pay) of certain federal energy tax credits for “applicable entities,” which includes exempt organizations.  In essence, the Act enables tax-exempt entities to claim energy incentives including solar, wind, combined heat and power, and many others, through the direct pay mechanism that essentially allows for nonrefundable income tax credits to be converted to payments against tax for these entities. In addition to direct pay for applicable credits, the Act also enables tax-exempt entities to allocate a section 179D deduction to the designer of qualifying energy-efficient commercial building property the entity may be installing.

Clean energy incentives – Overview

Energy and climate incentives worth $369 billion are a focal point of the Act through 29 separate provisions that create or modify renewable energy-related credits and incentives. The Act extends and expands the energy investment tax credit which applies to entities placing in service certain renewable energy property at their facility – including solar, geothermal, battery storage, waste energy recovery property, and combined heat and power cogeneration systems. The Act also includes significant changes to facilitate the purchase of passenger and commercial electric vehicles and refueling equipment. The Act also provides new opportunities for monetization of some of the credits by making some of the credits effectively refundable through the “direct pay” provision.

Historically, tax-exempt organizations would not directly engage in the construction of projects related to energy credits, or if they did, they had little use for the utilization of a tax credit.  Instead, these entities would engage in power purchase agreements for clean electricity and indirectly receive the benefit of the credit through reduced costs for green power. These deals had much complexity and, in some cases, leveraged tax equity structuring to monetize the developer’s investments in renewable energy property in exchange for allocating certain tax benefits to an investor through a partnership structure. Tax equity deals are complex in nature and result in a loss in benefit by increasing tax compliance issues and involving outside investors. Direct pay provides a less complex option for tax-exempt entities to directly invest in clean energy projects by providing them with the ability to monetize the clean energy tax credits by converting them to cash through the direct pay mechanism.

Monetization

The Act added section 6417 to the Internal Revenue Code. This provision allows applicable entities to monetize tax credits that would have previously been of little to no monetary value. The use of direct pay unlocks a world of opportunity for tax-exempt entities to benefit from investing in renewable energy property.

Section 6417 defines an applicable entity as any of the following:

• Any organization exempt from tax imposed by subtitle A;
• Any state or political subdivision thereof;
• The Tennessee Valley Authority;
• An Indian tribal government;
• Any Alaska native corporation; or
• Any corporation operating on a cooperative basis which is engaged in furnishing electric energy to persons in rural areas.

Additionally, section 6417 provides that the following credits are available for a section 6417 elective payment:

• Section 30C “Alternative fuel refueling property credit”
• Section 45(a) “Renewable electricity production credit (PTC)”
• Section 45Q “Credit for carbon oxide sequestration”
• Section 45U “Zero-emission nuclear power production credit”
• Section 45V “Credit for production of clean hydrogen”
• Section 45W “Qualified commercial clean vehicles credit”
• Section 45X “Credit for advanced manufacturing production”
• Section 45Y “Clean electricity production credit”
• Section 45Z “Clean fuel production credit”
• Section 48 “Energy credit (ITC)”
• Section 48C “Qualifying advanced energy project credit”
• Section 48E “Clean energy investment credit”

For tax years beginning after Dec. 31, 2022, applicable entities will be able to make elective payments for the applicable credits listed above. Section 6417(a) provides that an applicable entity making the election will be treated as if it made an income tax payment. That payment may be refunded, but may first be required to offset unrelated business income tax. Applicable entities should be thoughtful of placed in service dates or other events that give rise to credits to avoid generating credits in a tax year when the credit cannot be monetized.

Additional guidance is needed to clarify the form(s) and/or process that will be used to make elective payments as this is a new procedure for tax purposes. For applicable entities with tax return filing requirements, an election for direct pay must not be made later than the due date (including extensions of time) for the return of tax for the taxable year for which the election is made, but in no event earlier than Feb. 12, 2023. For applicable entities without a tax return filing requirement, additional guidance is needed to determine the election’s due date.

Exempt organizations may also be shareholders in passthrough entities (e.g., partnerships, S corporations). If an applicable credit is determined with respect to a passthrough entity and an applicable entity is a shareholder, an elective payment could potentially still be available for that shareholder.  

There is no requirement that an applicable entity have unrelated business income to make an elective payment with respect to applicable credits. Additionally, tax-exempt entities do not have to use the potentially qualifying property in an unrelated trade or business for the allowable credits to be eligible for direct pay. Although property used by states and political subdivisions usually cannot generate certain federal income tax credits, this prohibition is disregarded for purposes of direct pay

Base and bonus rates – Apprenticeship and prevailing wage requirements

Applicable to many energy-related incentives, the Act made significant changes by replacing the existing credit regime with a two-tiered system that provides a minimum “base” credit amount and a maximum “bonus” credit amount that is five times the base amount. Both amounts will vary depending on the relevant project. The bonus credit amount will be available only if certain prevailing wage and apprenticeship requirements, as described in Notice 2022-61, are satisfied in connection with the relevant project. RSM issued this tax alert when the IRS published initial guidance on the prevailing wage and apprenticeship requirements.

In general, to satisfy the apprenticeship requirements, the taxpayer must ensure that, with respect to the construction of a qualified facility, qualified apprentices are incorporated into construction, alteration, and repair work through a percentage of total labor hours requirement, a journey worker-to-apprentice ratio requirement, and a participation requirement. Additionally, to satisfy the prevailing wage requirement, the taxpayer must ensure that any laborers and mechanics employed by the taxpayer, their contractor, or their subcontractor for a renewable energy project are paid prevailing wages (as determined by the Secretary of Labor) in the locality in which the project is located. The prevailing wage requirements may be imposed on the construction of certain property, on repairs and maintenance of a facility for a period after it is placed in service, and/or on repairs and maintenance of a facility for each year a facility is generating a credit eligible for a bonus rate.

Credit “Adders” – Domestic content requirements, energy communities, and special rules for solar and wind facilities placed in service in connection with low-income communities

The Act also provides increases to various energy credits that are placed in service after December 31, 2022, and meet certain “domestic content” requirements and/or are located in specified areas or communities.

An increased tax credit rate for qualified renewable energy projects may apply if certain domestic content requirements are met. To meet this requirement, taxpayers must ensure that the steel, iron, or other manufactured products that comprise the project are produced in the United States. Generally, a manufactured product will be considered manufactured in the United States if a specified percentage of the total cost of the components is attributable to components that are mined, produced, or manufactured in the United States.

Additionally, an increased credit rate may apply for certain projects located in an “energy community”.  An energy community is either (1) a brownfield site; (2) an area that has certain levels of employment or local tax revenue related to extraction, processing, transport, or storage of coal, oil, or natural gas and an unemployment rate at or above the national average; or (3) a census tract where a coal mine has closed or a coal-fired electric generating unit has been retired, or a census tract directly adjoining the mine or unit. 

Finally, the Act added an application-based program that increases the energy credit percentage for certain solar and wind projects. Certain solar and wind facilities placed in service in connection with low-income communities may be eligible for an addition of 10 or 20 percent to the energy credit percentage. To earn a credit increase under this program, taxpayers must apply for a capacity limitation allocation.

Recently, the IRS provided guidance to establish a program to allocate amounts of environmental justice solar and wind capacity limitation to qualified solar and wind facilities eligible for the investment tax credit. See our recent RSM tax alert for more information.

Energy credit overview

As discussed above, twelve energy credits now qualify for direct pay if claimed by applicable entities.  Below is an explanation of the credits most likely to be claimed by tax-exempt organizations.

Incentives for investing in property to reduce greenhouse gas emissions and utility costs

The Act modified the section 48 energy credit, a component of the investment tax credit (“ITC”). In general, the credit is calculated as a percentage of the basis in qualifying property. The Act modified the credit to allow for a jump in credit percentage if taxpayers can meet prevailing wage and apprenticeship requirements; the credit rate goes from 2 percent or 6 percent of the basis to 10 percent or 30 percent of the basis in qualifying property if these requirements are met. There are additional credit increases available for domestic content, energy communities, and through the low-income communities bonus credit program. The construction of eligible property must generally begin before Jan. 1, 2025, to qualify for the energy credit. However, the Act added a new technology-neutral credit that may be available for property that is placed in service after 2024.

The following energy properties may be eligible for a credit rate of 30%:

• Qualified fuel cell property
• Qualified small wind energy property
• Qualified waste energy recovery property
• Qualified energy storage technology*
• Qualified biogas property*
• Qualified microgrid controllers*
• Qualified electrochromic glass (dynamic glass)*
• Qualified solar property
• Qualified combined heat and power property
• Qualified geothermal property
• Certain hydrogen production facilities for which the entity elects to treat as energy property*

The following energy properties may be eligible for a credit rate of 10%:

• Qualified microturbine property
• Interconnection property*

*must be placed in service after Dec. 31, 2022, to qualify for the energy credit.

The following types of energy property may be most relevant to exempt organizations: solar property, wind energy property, energy storage property, microgrid controller property, geothermal property, combined heat and power systems, and interconnection property.

Incentives for transportation

The Act added a new tax credit for qualified commercial clean vehicles under section 45W. The credit amount is equal to the lesser of:

• 30 percent of the cost of each vehicle that does not rely on a gasoline or diesel internal combustion engine (or 15 percent in the case of hybrid vehicles), or
• The incremental cost of the vehicle (i.e., the cost differential of the clean vehicle and a comparable vehicle that relies entirely on a gasoline or diesel internal combustion engine)

The maximum credit per vehicle is $7,500 for new vehicles that weigh less than 14,000 pounds and $40,000 for all other vehicles. This credit is available under Section 45W for vehicles acquired after Dec. 31, 2022, and on or before Dec. 31, 2032.

Incentives for EV charging stations

The Act modified and extended the credit for alternative fuel vehicle refueling property under section 30C. EV charging equipment is qualifying property for this credit. For property installed after Dec. 31, 2022, the base credit of such qualifying property is 6%. However, if certain prevailing wage and apprenticeship requirements are met during the construction of such property, the credit increases to 30%. The credit is capped at $100,000 per item of qualifying property and property must be installed in a low-income or rural census tract.

Section 179D deduction – A bargaining chip for tax-exempt organizations

The Act amended section 179D (“energy efficient commercial buildings deduction”) to allow tax-exempt entities to allocate the allowable deduction to the designer of the energy-efficient property, for taxable years beginning after Dec. 31, 2022.

Energy-efficient commercial building property must meet the following requirements:

• The property must be subject to depreciation or amortization;
• The property must be installed in a building located in the United States;
• The property must be installed as part of the interior lighting system, heating, cooling, ventilation, hot water systems, and/or the building envelope; and
• The property must reduce the total energy and power costs by a certain percentage when compared to a reference building meeting standards established by the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America).

In general, the deduction is limited to the excess of the product of (i) the applicable dollar value and (ii) the square footage of the building (iii) over the aggregate amount of section 179D deductions during the four taxable years ending with the taxable year a tax-exempt entity is allocating the deduction. The deduction cannot exceed the cost of qualifying property reduced by the aggregate amount deducted in the prior four tax years ending with the year of the allocated deduction. The deduction varies based on a building’s increased energy efficiency. If prevailing wage and apprenticeship requirements are met with respect to the installation of the energy-efficient commercial building property, the deduction can be as much as $5.00 per square foot. The statutory limitation if prevailing wage and apprenticeship requirements are not met is $1.00 per square foot. RSM issued this tax alert when the IRS issued recent guidance on energy efficiency reference standards for purposes of the section 179D deduction.

Opportunities for tax-exempt organizations

State and local governments, Indian tribal governments, and Alaska Native Corporations

State and local governments, Indian tribal governments, and Alaska Native Corporations are key players in the renewable energy space. The Act incentivizes these entities to continue making investments in renewable energy to meet their net zero emissions goals and create a sustainable future for their communities. Transitioning to renewable sources to power public buildings may be more attractive when direct pay is factored into construction costs. Projects such as production of renewable natural gas at landfill or wastewater treatment facilities through anaerobic digestion may also be considered. Further, the electrification of vehicles or transition to clean fuel transportation may also be especially attractive with the use of direct pay.

The Act created a program to allocate additional ITC credit increases for environmental justice solar and wind energy projects for projects located in certain low-income communities and on Indian land. Notice 2023-17 provides initial guidance on the “Low-Income Communities Bonus Credit Program” (the Program) and additional guidance is expected from the IRS and Treasury in the coming months. Applicable entities that intend to develop solar or wind projects in a community that falls within the Program’s guidelines should carefully review application procedures and other program information in upcoming guidance.

Educational institutions and universities

Many universities and educational institutions are deeply focused on setting and meeting net zero carbon emissions goals over the next several years. Universities are looking to meet these goals through a variety of means including the use of electricity from renewable sources, student and faculty EV charging stations on campus, and clean vehicle campus transportation. These may include investments in geothermal, solar, wind, energy storage, dynamic glass, combined heat and power, and microgrid controller property, All these activities may give rise to various credits eligible for direct pay.

Universities seek to innovate with modern, eco-friendly residence halls, student unions, and academic buildings. Section 179D provides an accelerated depreciation deduction for qualified construction or rehabilitation projects for energy-efficient commercial buildings. The Act created an opportunity for tax-exempt entities to allocate this deduction to the designer of such buildings, creating a bargaining chip for exempt organizations as they seek bids from project designers.

Healthcare industry

Over 100 healthcare organizations have joined the White House and Human Health Services (HHS) Health Sector Climate Pledge (the Pledge) to commit to reducing greenhouse gas emissions and building climate-resilient infrastructure. The Pledge is indicative of a strong industry-wide commitment to making changes focused on sustainability and renewable energy. Whether pursuing the goals of this climate pledge or unique goals of the organization, entities in the health sector are investing in new, energy-efficient technologies. Additionally, healthcare organizations are often focused on providing reliable power and are investing in solar, energy storage, and combined heat and power systems in order to take themselves off the grid.  Many of these technologies fit within the policy goals of the Act. As tax-exempt healthcare organizations continue to make these investments, they will want to consider monetizing tax credits for qualified project through the direct pay election. These organization should also consider the bonus credit and other adder program provided in the Act.

Private foundations and other exempt organizations

Many private foundations and other tax-exempt organizations may be focused on reducing their carbon footprint as part of their organization’s mission to better serve their communities. Traditionally, tax-exempt organizations would have had little or no use for a tax credit. However, direct pay may reduce the cost burden of investing in clean energy. Tax-exempt organizations that are looking to electrify their vehicle fleet, install electric vehicle (“EV”) charging infrastructure, or install other green technologies such as solar arrays or energy storage can now take advantage of the available credits to reduce their cost burden and increase their impact for years to come.

Many of these exempt organizations that serve low-income or energy communities may also benefit from the additional credits and credit adders, including the “Low-Income Communities Bonus Credit Program” mentioned above.

Washington National Tax Takeaways

Direct pay opens a world of opportunity for tax exempt entities to facilitate investment in clean energy initiatives and further give back to the communities they serve.

Direct pay is available to applicable entities for taxable years beginning after Dec. 31, 2022. Entities using a fiscal tax year-end must be cautious about triggering credits in a period before direct pay is available to them.  

We are still awaiting guidance from Treasury on administration of the direct pay provisions. Treasury requested comments on implementation of these provisions in Notice 2022-50.  Guidance is expected later this year.

Tax-exempt organizations planning to construct or upgrade energy-efficient commercial buildings should consider their eligibility for a section 179D deduction. Previously of no use to tax-exempt organizations, the ability to allocate the deduction to a designer could now produce an indirect benefit. Prior to the Act, only certain governmental entities were allowed this benefit. This deduction should be considered early in the commercial building construction planning process so the allocation can be considered early in the bidding process.

Applicable entities should carefully consider the modifications and new provisions under the Act, as well as any released and upcoming IRS guidance. Documentation, recordkeeping and substantiation requirements for prevailing wage and apprenticeship requirements will be critical. Applicable entities should work with tax advisors to assist with energy credit planning to ensure the proper credit rates are applied and available bonus rates and other adders are substantiated.

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This article was written by Deborah Gordon, Erika Farr, Brent Sabot, Leo Rich and originally appeared on 2023-03-14.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/tax-exempt-organizations-clean-energy-incentives-and-direct-pay.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.

The Federal Reserve, Treasury Department and Federal Deposit Insurance Corporation took decisive action Sunday to stem what was clearly a potential bank run.

The $25 billion Bank Term Funding Program, announced Sunday night, was necessary to prevent a much larger crisis that would spread through the financial channel to the real economy and almost certainly tip the economy into recession.

The critical point here is that by accepting collateral at par—if a bank owns bonds that are trading at 60 cents to the dollar it can exchange it at the Fed’s discount window for $1 in liquidity—this effectively removes the risk of a bank run.

What’s more, it clears the way for the Fed to increase its policy rate by 25 basis points on March 22 at its next policy meeting.

The Fed will want to strike a careful balance between restoring price stability and financial stability so soon following a near miss on a financial panic.

Bank runs cause real economic damage, and the action taken by the Fed, Treasury and FDIC intends to avoid a much larger and more expensive set of policies later.

The time to stop a bank run is before it begins. It is easier for the central bank, Treasury and FDIC to step in now rather than wait for a “white knight” to step forward with a private capital solution.

That white knight did not step forward, requiring the large and decisive action taken.

The collapse and seizures of banks in the past week created the conditions for a classic run on banks that borrow short and lend long.

The mix of illiquid assets like business or mortgage loans and liquid liabilities like deposits, which may be withdrawn at any time, can easily give rise to self-fulfilling panics.

That is an apt description of the current moment and is what necessitated the creation of the $25 billion financing program.

The primary policy objective of the Bank Term Funding Program is to restore confidence in the banking system and protect the real economy by preventing a bank run.

In our estimation the policy approach put forward is the appropriate framework to address a liquidity crisis.

Financing will be made available through the creation of a new Bank Term Funding Program, offering loans of up to one year to banks, savings associations, credit unions and other eligible depository institutions pledging U.S. Treasury bonds, agency debt and mortgage-backed securities, and other qualifying assets as collateral.

These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.

Depository institutions may obtain liquidity against a wide range of collateral through the discount window, which remains open and available. In addition, the discount window will apply the same margins used for the securities eligible for the BTFP, further increasing lendable value at the window.

While all depositors will be made whole, shareholders and certain unsecured debtholders will not be protected. Senior management has also been removed. Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.

This is a policy put in place to protect deposits and is not a bailout of the bank, shareholders or debtholders.

The Federal Reserve also announced it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors.

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This article was written by Joseph Brusuelas and originally appeared on 2023-03-13.
2022 RSM US LLP. All rights reserved.
https://realeconomy.rsmus.com/fed-launches-25-billion-lending-program-to-prevent-bank-run/

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.

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Most middle market businesses know they need a firewall but don’t always know where to start. A firewall is your company’s first line of defense against breaches. It is the first step in a necessarily layered approach to security. The firewall helps close security gaps by blocking threat actors who try to get unauthorized access to your network and internal systems.

To protect against ransomware and other targeted attacks, small and medium-sized businesses need to choose the right kind of firewall for their unique business and technical requirements,

Right-sizing your firewall

Typically, middle market businesses don’t have the in-house experience to choose the correct firewall. Specialized knowledge is needed to understand which type of firewall fits a company’s budget while still allowing for investment in other security layers.

Middle market companies need to right-size their firewalls to reduce complexity. A larger, more complex firewall, for instance, makes it difficult for small and medium-sized businesses to gain visibility into whether it is operating as it should.

Before selecting a firewall, companies should consider how many users are connected to their virtual private network (VPN). The size of their internet connection is also a consideration because smaller firewalls may not be rated for larger connections.

Firewall management

Once size and pricing have been considered, decision-making comes down to management. Middle market companies need to determine who will be responsible for firewall management: the company, a managed service provider or another third party.

Management is an aspect of firewalls your company doesn’t want to get wrong. The right rules and policies need to be set to prevent specific threats, such as ransomware. Middle market companies need a firewall that is simple to set up and manage. Cloud-based firewalls provide ease of management while delivering the levels of bandwidth and reliability companies require.

Management concerns also include updates. The firewall should be easy to upgrade without the need to do a lot of research. Some firewalls make it possible to set up update windows for automatic upgrades.

Meeting firewall challenges

Middle market companies may want to explore next-generation firewalls (NGFWs) as challenges to traditional firewalls increase. One of those challenges comes when companies create hybrid workplaces that allow employees to work both remotely and in the office. Remote workers may need a VPN, but as companies move more applications to the cloud the need for a VPN dissipates.

NGFWs address the limitations of traditional firewalls by replacing a physical appliance with firewall as a service. Updates and management are handled through a provider in the cloud, eliminating hardware costs.

Remote workers can connect to a cloud firewall, and the NGFW provides additional features that aren’t available through a traditional firewall. Because of its extra features and anti-ransomware capabilities, an NGFW is often a requirement for obtaining cybersecurity insurance.

Don’t handle your firewall alone

Due to the complexity and severity of cyberthreats, middle market companies should know if their firewall is operating effectively. Firewall as a service through a managed service provider means companies can have advanced capabilities and don’t need to go it alone.

With firewall as a service, a managed service provider manages the firewall on your behalf. The provider can assess the firewall to make sure it is configured properly, and you can focus on the business and won’t be solely responsible should a breach occur.

RSM can help your company choose, configure and manage your firewall. We have experience working with companies in many industries, so we understand how to set up firewalls to meet the security requirements of banks, schools, manufacturers and more.

As a certified Cisco partner, RSM can help you with leading solutions including Cisco Umbrella cloud and on-premises firewalls as well as easy-to-manage Cisco Meraki.

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This article was written by RSM US LLP and originally appeared on Mar 12, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/technology/cisco/how-to-choose-the-right-firewall-for-your-middle-market-business.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.

Executive summary: Drastic changes to FTC for 2022

Over the course of this past year, Treasury and the IRS have released final 2022 regulations (T.D. 9959), a set of technical corrections (2022-15867 and 2022-15868) and proposed 2022 regulations (REG-112096-22) all aimed at addressing the creditability of foreign income taxes for purposes of the foreign tax credit (FTC). In general, these new rules revised the net gain requirement, ensuring that a foreign tax is only a creditable net income tax if the determination of the foreign tax base conforms in essential respects to the determination of taxable income under the Internal Revenue Code. This effectively shifts the definition of a creditable tax from an income tax (i.e., a tax on income) to being a tax that is sufficiently similar to the Code. Under these new rules, a foreign tax will only satisfy the net gain requirement if the tax satisfies four sub requirements: realization, gross receipts, cost recovery (i.e., formerly the net income requirement), plus a new attribution requirement. 

The 2022 final regulations further stipulate that determining whether a foreign tax satisfies each component of the net gain requirement is generally based on the terms of the foreign tax law governing the computation of the tax base rather than empirical analysis. Also, the 2022 final regulations maintain the long-standing all-or-nothing rule. A foreign tax either is or is not a foreign income tax, in its entirety, for all persons subject to the foreign tax. 

In a nutshell, historically creditable taxes may no longer be creditable for tax years beginning on or after Dec. 28, 2021 (i.e., 2022 calendar year taxpayers). Note that while certain foreign income taxes may no longer be creditable, non-creditable taxes are generally still deductible as general business expenses.

As taxpayers begin to plan for their 2022 tax provisions, they will need to consider how these changes impact their FTC, global intangible low-taxed income (GILTI) computations and other related aspects of their federal tax provision. Looking to the upcoming compliance season and beyond, it’s also important to be cognizant of certain filing deadlines and understand how recent FTC guidance will impact their filing situation. Failure to plan ahead and apply the changing law could result in penalties, tax inefficiencies and lost opportunities. Here are ten important reminders for year-end planning.

Ten quick reminders for FTC

1. Section 174 research and experimental expenditures

As the 2022 tax year-end has come and gone, taxpayers closely monitoring Capitol Hill in hopes of a fix to the impending changes coming to section 174 will be devastatingly disappointed. The now in-force changes result from a delayed provision under TCJA, effective beginning with tax years beginning after Dec. 31, 2021 (i.e., 2022 calendar year taxpayers), which requires mandatory capitalization and amortization of costs incurred under section 174. 

Prior to Dec. 31, 2021, research and experimental (R&E) expenditures under section 174 (R&E expenditures) were by default deducted as incurred. As such, taxpayers following that treatment did not typically track and categorize R&E expenses based on the Code’s definition of such costs. Going forward, taxpayers will need to identify the R&E expenditures not only of their U.S. companies, but of their foreign subsidiaries as well, in order to comply with the capitalization requirement. Foreign R&E expenditures must be capitalized and recovered over 15 years, while domestic costs may be recovered over five years. A half year convention applies in year one.

From an FTC perspective, this change is relevant when calculating foreign source income (FSI). Based on the concept that R&E is an inherently speculative activity that may contribute to unexpected benefits, taxpayers are required to allocate and apportion section 174 R&E expenditures against FSI. Going forward, this new capitalization requirement could be quite beneficial to taxpayers, in the context of a taxpayer’s ability to claim an FTC. Taxpayers will only be required to allocate and apportion a fraction (i.e., one-fifth or one-fifteenth) of the section 174 R&E expenditures incurred, which, in theory, will lead to increased FSI. Note that section 174 R&E expenditures differ from section 41 R&E (e.g., R&E expenditures eligible for the R&E credit). 

As a final reminder, the 2020 final regulations (T.D. 9922) confirm gross intangible income excludes dividends and amounts included in income under sections 951 (i.e., subpart F), 951A (i.e., GILTI) and 1293. R&E expenditures should not be allocated against the GILTI basket. The theory being that controlled foreign corporation’s (CFC’s) are obligated to pay arm’s length royalties for the use of the U.S. parent’s intangibles, and any net GILTI generated by a CFC after paying for the intangibles does not arise from the parent’s R&E.

2. Section 163(j) interest

Similar to section 174, taxpayers will be disappointed to hear that there has been no fix implemented before year-end to the impending changes coming to section 163(j). Another delayed provision under TCJA, these changes apply to tax years beginning after Dec. 31, 2021 (i.e., 2022 calendar year taxpayers). 

Beginning Jan. 1, 2022, depreciation, amortization and depletion may no longer be added back to a company’s adjusted taxable income (ATI) calculation. ATI, which closely mimicked EBITDA (earnings before interest, taxes, depreciation and amortization), will now more closely resemble EBIT (earnings before interest and taxes). This update could significantly impact a taxpayer’s ability to deduct interest expense beginning after Dec. 31, 2021. The application of section 163(j) is once again relevant when calculating FSI. Based on the concept that interest is fungible, taxpayers are required to allocate and apportion interest expense against FSI. The allocation of interest expense is after the application of section 163(j). In theory, the less interest expense deducted by a U.S. taxpayer, the higher FSI will be. 

3. Global intangible low-taxed income & high-tax exception

The technical corrections to the 2022 final regulations have officially closed a potential loophole with respect to the section 901(m) haircut. The technical corrections amend the GILTI high-tax exception (HTE) regulations to now refer to “eligible current year taxes” as opposed to “current year taxes” when determining foreign income taxes paid or accrued with respect to a tentative tested income item. This seemingly small revision ensures that when computing the effective tax rate (ETR) for purposes of the GILTI HTE, only creditable foreign income taxes, not those for which an FTC is unavailable, are taken into consideration. Eligible current year taxes exclude taxes for which a credit is disallowed at the level of a CFC (e.g., under sections 245A(d) or 901(j), (k), (l) or (m). In other words, taxpayers must compute the ETR after applying the section 901(m) haircut to their foreign income tax.

The delayed TCJA provisions mentioned above, section 174 R&E and section 163(j) interest, will likely impact a taxpayer’s GILTI inclusion through increased tested income and an altered ability to claim the HTE. From an FTC perspective, taxpayers are likely to encounter increased FSI, which will have a direct impact on their ability to claim an FTC.

Lastly, under the 2022 final regulations, historically creditable taxes may no longer be creditable for tax years beginning on or after Dec. 28, 2021 (i.e., 2022 calendar year taxpayers). Note that while certain foreign income taxes may no longer be creditable, non-creditable taxes are still deductible for tested income purposes. In terms of GILTI, these changes could have a drastic impact on a taxpayer’s ability to claim the HTE and / or FTC.

Taxpayers looking for additional information on GILTI can view RSM’s previous tax alerts (Ten quick year-end reminders for GILTI)

4. Expiring credits and the statute of limitations

In general, the statute of limitations (SOL) for claiming a credit or a refund is either three years from the date the return is filed, or two years from the date the tax was paid, whichever is later. However, there is a special rule when it comes to refund claims related to the FTC. According to the courts, if the credit or refund relates to an overpayment attributable to foreign taxes paid for which a credit is allowed, the SOL period is extended to 10 years from the due date of the return for the tax year the foreign taxes were paid (Trusted Media Brands, Inc., No. 17-3733-cv (2d Cir. 8/10/18)). In other words, a taxpayer has 10 years to switch from a deduction to a credit. The reverse switch, credit to a deduction, is only allowed within the normal SOL (i.e., the special 10-year rule does not apply). 

Taxpayers with expiring credits (i.e., those exceeding the 10-year carryover period) will want to analyze whether they should amend to take the deduction before the SOL expires. Taxpayers most at risk with expiring credits are those in a net operating loss (NOL) position. Calendar year-end taxpayers that extended their tax returns typically have until Oct. 16, 2023, to amend their 2019 tax returns.

Taxpayers looking for additional information on the SOL can view RSM’s previous tax alerts (10-year refund statute applies only to foreign tax credits).

5. Contested taxes

The 2022 final regulations provide new rules in determining whether a taxpayer may claim a credit for contested taxes paid. In general, contested income taxes (i.e., taxes owed to a foreign government which a taxpayer disputes) do not accrue and cannot be claimed as a credit until the contest is resolved (i.e., when the liability is finally determined) even if the tax is remitted to the foreign country. However, the 2022 final regulations now allow taxpayers to claim a provisional credit (but not a deduction) for the portion of taxes already remitted to the foreign government, if the taxpayer agrees to notify the IRS when the contest concludes and agrees not to assert the SOL as a defense to assessment of U.S. tax if the IRS determines that the taxpayer failed to take appropriate steps to secure a refund of the foreign tax. Doing so alleviates taxpayer cash flow restraints that could result from temporary double taxation during the period of dispute resolution and at the same time, provides the IRS with appropriate information to ensure proper action is taken regarding dispute resolution.

It’s important to note that once the contest is resolved and the foreign income tax liability is determined and paid, the tax liability accrues in the year in which the taxes relate (i.e., the relation-back year). The taxes do not accrue in the year the contest is resolved.

To claim a provisional credit, the taxpayer must file Form 1116, FTC (Individual, Estate or Trust), or Form 1118, FTC – Corporations, for the year in which the tax relates (i.e., elect under section 901 to claim the credit, instead of the deduction) and a provisional FTC agreement. 

The IRS recently released new Form 7204, Consent To Extend the Time To Assess Tax Related to Contested Foreign Income Taxes—Provisional Foreign Tax Credit Agreement, to comply with these regulations. At this time, instructions to this required filing have not yet been released. 

Taxpayers looking for additional information on Form 7204 can view RSM’s previous tax alerts (Tax year 2022 brings more changes to international tax reporting).

6. Refundable credits

Many taxpayers may be surprised by the 2022 final regulations and how the new guidance will severely limit their ability to claim an FTC for foreign taxes that are reduced by refundable local-country credits (e.g., R&E). 

Historically, the regulations provided that a payment to a foreign country was not treated as an amount of tax paid to the extent that it was reasonably certain that the amount would be refunded, credited, rebated, abated or forgiven. Further, it is not reasonably certain that an amount would be refunded, credited, rebated, abated or forgiven if the amount was not greater than a reasonable approximation of the final tax liability to the foreign country. In the context of refundable local-country credits and multiple levies, this language is unclear and often lead to uncertainty and inconsistency in application. 

Treasury and the IRS address this uncertainty in the 2022 final regulations in a single, clear-cut, rule. A taxpayer can no longer claim a FTC for foreign taxes that are reduced by a refundable local-country tax credit if the local law requires the credit first reduce the taxpayer’s local-country tax liability prior to refund. The exception to this new rule is where the local country tax credit is fully refundable in cash at the option of the taxpayer. 

Taxpayers that receive local-country tax credit incentives will want to analyze the impact of this new rule with respect to claiming a U.S. FTC.

7. Distributions of previously taxed earnings and profits and creditability 

Typically, a FTC can only be claimed to the extent a taxpayer has FSI. Thus, taxpayers are faced with a unique issue in the context of CFC previously taxed earnings and profits (PTEP) distributions in their ability to claim a credit on foreign taxes withheld associated with such a distribution (i.e., PTEP distributions do not generate FSI). Section 960(c) provides a special rule in this scenario.

In the year of receipt of PTEP, section 960(c) allows for an increase in the FTC limitation, to the extent certain conditions are met. The amount of increase is limited to the lessor of:

• The amount of foreign taxes paid on the distribution, or
• The amount in the taxpayer’s ‘excess limitation account’ as of the beginning of the taxable year.

Note that the annual maintenance of the excess limitation account, along with the rules surrounding the ability to claim a limitation increase, are complex and require rigorous analysis. Taxpayers that have or are looking to receive a dividend distribution from their CFC(s) will want to consider the ability to claim an increase in limitation for FTC purposes.

As a final reminder, Treasury is planning to issue further PTEP guidance in the form of regulations within the first half of 2023.

8. Royalties and the single country exception 

The 2022 proposed regulations provide a new, and narrow, exception (the single-country exception), to the source-based attribution requirement where a taxpayer can substantiate that a withholding tax is imposed on royalties received in exchange for the right to use intellectual property (IP) solely within the territory of the taxing jurisdiction. To qualify for this limited exception, a taxpayer must have proper documentation in place in the form of a written license agreement. The single-country exception applies where:

1. The income subject to the tested foreign tax is characterized as gross royalty income, and
2. The payment giving rise to such income is made pursuant to a single-country license.

A payment will not be treated as made pursuant to the single-country license if the taxpayer knows, or has reason to know, that the required agreement misstates the territory in which the IP is used or overstates the amount of the royalty with respect to the part of the territory of the license that is solely within the foreign country imposing the tax. This agreement must be executed no later than the date on which the royalty is paid. There is a special transitory rule in place for royalties paid on or before May 17, 2023. Further, the agreement must be maintained by the taxpayer and provided to the IRS within 30 days of a request by the Commissioner, absent an exception.

Of importance, the single-country exception does not apply to services, sales of copyrighted articles or instances in which the IP is licensed outside the foreign country imposing tax.

Prior to May 17, 2023, taxpayers subject to royalty withholding will want to analyze executing the single-country exception. Questions worth considering prior to execution include:

• How does the local country source royalties? Under the new FTC rules, royalties, absent an in-force income tax treaty, must be sourced based on place of use, or right to use, the IP to be creditable.
• Whether the payment is in fact classified as a royalty under both U.S. and local law?
• Is there already documentation in place with respect to the royalty agreement? Does the existing documentation satisfy the new terms and conditions to qualify for the single-country exception or is a new agreement required?
• Who is the licensee? Is the license with a related party or third party? If with a third-party, will they want to re-negotiate the terms? If with a related party, is the transfer pricing policy up to par?
• Where is the IP license physically being used? Which country or countries?
• Have there been any payments subject to withholding made to date?

9. Accounting methods

Both U.S. taxable income and foreign tested income can have an impact on a taxpayer’s ability to utilize both a current year FTC as well as a carryforward FTC from prior years. In addition, as mentioned above, the changes to section 174 R&E and section 163(j) interest expense limitations are likely to increase FSI, which will have a direct impact on a taxpayer’s ability to claim an FTC.

Proactive planning with respect to accounting methods, both for domestic entities trying to utilize an FTC, as well as CFCs, can influence both U.S. taxable income as well as CFC tested income to increase utilization of FTCs.

An accounting methods review involves the identification of one or more specific technical accounting areas where the U.S. shareholder or CFC may be applying an improper or unfavorable method of accounting, the related research into permissible methods, and the selection/implementation of the ideal accounting method given the facts, circumstances and tax strategy of the CFC and U.S. shareholders.

10. ASC740

U.S. accounting rulemakers are planning to issue a proposal early next year calling on companies to provide detailed breakdowns about the federal, state and foreign income taxes they pay. This proposal is in direct response to long-running complaints from those using financials (e.g., investors and analysts) that disclosures provide little insight into tax exposure. While U.S. companies are required to provide total cash taxes they pay on their financials, they are not required to give a country or state breakdown. The proposed disclosures will include a requirement that companies disclose in annual reports the income taxes paid disaggregated by individual jurisdictions based on a threshold of 5% of the total income taxes paid. The proposal will also require that public companies provide additional information in the rate reconciliation regarding foreign tax effects and the effects of cross-border tax laws. 

Final Reminders

Taxpayers looking for additional information on the 2022 final FTC regulations and 2022 proposed FTC regulations can view RSM’s previous tax alerts (Treasury releases technical corrections to final FTC regulations and Treasury releases much anticipated proposed FTC regulations). These alerts provide detailed insights on how taxpayers can satisfy the revamped cost recovery requirement, along with the new attribution requirement, which are two key steps in determining whether a foreign income tax is creditable under the new framework.

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This article was written by Ramon Camacho, Darian A. Harnish, Mandy Kompanowski and originally appeared on 2023-03-10.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/Ten-quick-reminders-FTC.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.