Page 226 - TaxAdviser_2022

TAX CLINIC

Sec. 196 also applies when an indi- up to practitioners to employ a reason- tax credits that can offset the current-
vidual taxpayer dies or a corporate tax- able method to compute the amount of year liability; this amount becomes
payer ceases to exist before the unexpired the Sec. 196(b) deduction when a client a fixed amount that will be used in
general business tax credits can be fully dies or ceases to exist. subsequent steps.
utilized. Specifically, Sec. 196(b) pro- On its face, the language in Sec. ■ Step 4: Subtract the fixed amount of
vides that “[i]f a taxpayer dies or ceases 196(b) suggests that to calculate the credits from Step 3 from the credits
to exist before the first taxable year amount of the deduction, taxpayers computed in Step 1. The residual
following the last taxable year for which first compute the amount of business is the amount of credits that would
the qualified business credits could, tax credits that can be used to offset otherwise go unused. Pursuant to
under section 39, have been allowed as a the tax liability for the year of death Sec. 196, this residual converts to a
credit, the amount described in subsec- or business cessation, applying the tax tax deduction.
tion (a) (or the proper portion thereof) liability limitation discussed earlier. ■ Step 5a: If Sec. 196 is being applied
shall, under regulations prescribed by the Credits remaining after this initial tax due to the expiration of the credit
Secretary, be allowed to the taxpayer as a credit computation convert to a Sec. carryforward period, the tax deduc-
deduction for the taxable year in which 196 deduction. Next, a second version tion computed in Step 4 is deducted
such death or cessation occurs.” of the tax return for the year of death on the subsequent year’s tax return.
In other words, the Sec. 196 deduc- or business cessation is prepared with ■ Step 5b: If Sec. 196 is being applied
tion for unused business credits is avail- the new Sec. 196 deduction. While the due to the death or the cessation of a
able both where the credit carryforward inclusion of this new deduction will taxpayer, the residual is deducted on
period expires (Sec. 196(a)) and when have the effect of lowering the taxable the tax return for the year of death
a taxpayer dies or ceases to exist (Sec. income and tax liability for the tax year, or cessation. Practitioners will need
196(b)). a literal interpretation of Sec. 196(b) to prepare a second version of the tax
(and its cross reference to Sec. 196(a)) is return to incorporate the new Sec.
Sec. 196 mechanics that the allowable amount of tax credits 196(b) deduction computed in Step
The mechanics of the Sec. 196(a) tax initially computed for this tax year are 4.
deduction are straightforward. Taxpayers again used in the second computation of ■ Step 6: The fixed amount of credits
simply compute their credit usage for tax liability. But requiring taxpayers to determined in Step 3 is used to offset
the year, and to the extent there are un- recompute the allowable credit amounts the revised tax liability determined in
used credits remaining after the 20-year after the inclusion of the original Sec. Step 5b.
carryover period that would otherwise 196(b) deduction would result in a new
expire, these credits are deducted in full amount of remaining credits and hence a Sec. 196: Tax savings
on the subsequent year’s tax return. Al- new Sec. 196 deduction, which, in turn, opportunity
though current tax forms do not include would result in a revised tax liability and Beyond the obvious application of Sec.
a line for a Sec. 196 deduction, common a new amount of allowable credits and 196 to situations where credits expire
practice for C corporation taxpayers yet another Sec. 196 deduction. The lan- or a taxpayer dies or ceases to exist, Sec.
is to report the deduction as an “other guage of Sec. 196(b) does not reasonably 196 can also be used as a tax savings
deduction” and for individual taxpayers contemplate this unnecessarily compli- strategy. One such example is the use
to report the deduction as an above- cated circular computation. of Sec. 196 in a taxable acquisition of a
the-line “other adjustment” to income Steps to follow: The Code’s word- business that is taxed as a C corporation.
on Schedule 1, Part II, line 24z of Form ing supports the following multistep Consider a privately held corporation
1040, U.S. Individual Income Tax Return. approach to compute the deduction for that desires to sell 100% of its stock in a
The language in Sec. 196(b), which unused business credits: taxable transaction. Savvy buyers prefer
applies when a taxpayer dies or ceases ■ Step 1: Determine the amount of to acquire assets in order to obtain a
to exist, is not as straightforward, leav- general business credits for the stepped-up basis that is recoverable via
ing the computation of this deduction current tax year and carryovers to the depreciation or amortization deductions.
subject to interpretation. Sec. 196(b) year. This is especially true in transactions
contemplates the release of Treasury ■ Step 2: Compute the regular tax involving asset-intensive businesses, with
regulations to provide guidance on the liability before general business bonus depreciation providing buyers
computation methodology, but in the 40 credits for the current year. with an immediate tax write-off of some
years since Sec. 196 was enacted, regula- ■ Step 3: Apply the Sec. 38 tax liability or all of the purchase price. To obtain
tions have yet to be issued. As such, it is limitation to compute the amount of a step-up in basis, buyers can make a

8 May 2022 The Tax Adviser