As anticipated, the Tax Cuts and Jobs Act of 2017 (Public Law 115-97) made significant changes to individual and business tax provisions. The sweeping tax reform law also included a number of changes that affect state and local governmental entities. The following is a summary of some of these changes made in addition to the widely-reported adjustments to individual income tax.
Fines and Bonds
Fines, penalties and other amounts.
Generally, no deduction is allowed for any amount incurred, or paid, to a government or governmental entity for violation of a law or the potential violation of a law by a business or individual. This includes fines, penalties and other items such as interest paid to a government. However, the new TCJA has made an exception for amounts constituting restitution if the taxpayer can show that:
This new exception does not apply to any amount paid to a government as reimbursement for costs related to any investigation or litigation.
Any amount of $600 or more paid to a government that qualifies as restitution as described above must be reported to the taxpayer and the IRS. The reporting is to be done by the appropriate officer of the governmental entity that is party to a court case or agreement reached. The report must also separately identify any amounts that are for restitution or remediation of property or corrections made for noncompliance by the government.
Governments and governmental entities will now need to design systems to track the required reporting payments made by a taxpayer, as well as designate the appropriate officers to handle the reporting required to both the taxpayer and the IRS. This will be handled in a similar manner to the reporting of vendor payments on forms 1099-MISC.
As the new law was drafted, any amounts paid or incurred on or after December 22, 2017 would have been included, but transitional guidance has changed the start of such reporting to be a date undefined but occurring after January 1, 2019. That leaves some time to start planning for implementation, including systems adjustments.
Additional IRS guidance is anticipated to fill in some of the details on these new reporting requirements. The IRS has requested comments on the burden of collecting and reporting the information now required from anyone that has a desire to provide that type of information.
A speeding ticket would be a good example of how pervasive this issue may be. Assume a driver was found guilty of driving at 80 mph in a 40-mph zone and was found to be driving under the influence. The court levied a $2,000 fine (the maximum in the jurisdiction,) including $500 in court costs. Under the JCTA, $1,500 would be reported to the driver (taxpayer) as a fine by the government with the remaining $500 reimbursement for costs. The taxpayer would not be allowed to deduct the fine or the costs, as they were violations of the law. However, the $1,500 would need to be reported to the driver.
Instructions to comment on the IRS’ proposal can be found here.
Advance refunding bonds.
For many years, if certain requirements were met, interest received by a bondholder of state and local tax-exempt bonds wasn’t reported as taxable income for federal tax purposes. In the past, governments and governmental entities that use bonds for financing have been able to refund older bonds, usually carrying higher interest rates, with new bonds that carry an interest rate low enough to generate acceptable interest savings after considering the cost of issuance. A current bond refunding requires that within 90 days of the date of issuance, the issuer will use the dedicated proceeds to pay principal and interest on the prior issue. Any refunding not meeting this definition is considered an advance refunding.
Advance refunding is usually involves funding an escrow to pay the old bonds in the future with investments made through money generated by the new bonds. That structure allowed the issuer to have two bonds outstanding at the same time that covered the same governmental activity. However, Congress didn’t believe it was necessary to have two bonds on the same governmental activity subsidized by the federal government. As a result, as provided in the TCJA, any advance refunding bonds issued after December 31, 2017 will no longer be exempt from federal taxation. There was some concern that investors in state and local bonds would move away from investing in advance refunding bonds, but indications are that concern might not be necessary. Many governments have issued advance refunding bonds since the TCJA passage and are either notifying the bondholders of their taxation or issuing crossover refunding bonds.
Crossover advance refunding bonds are extremely difficult to administer as both the old bonds and the new bonds must be reported along with the proceeds held in escrow. Prior to maturity or the call date of the old bonds, pledged revenue sources secure the old debt while the escrow account from the new bond proceeds secure the new debt. After the maturity or call date, the pledged revenue secures the new debt and not the escrow–in other words, crossing over. For the taxpayer, the interest earnings on such transactions are taxable.
Elimination of tax-credit bonds..
Tax-credit bonds, such as qualified tax-credit bonds, clean renewable energy bonds, Build America bonds or direct pay bonds will no longer be issued or allowed after December 31, 2017. Typically, these types of bonds were created with certain allocations provided for implementation. Congress believed enough time had passed for taxpayers to benefit from the tax-credit bond programs, and therefore, termination of the programs was appropriate.
If you need any additional information on one of the items above, or if you have any additional questions, contact a member of the Eide Bailly Governmental Services Group for assistance.