Outline of Fiscal Year 2026 Tax Reform Announced

Introduction

The outline for tax reform in fiscal year 2026 has been announced. Significant revisions have been made in the valuations of certain rental-use real estate in inheritance and gift tax calculations, which are expected to have a major impact.

Background of the Revisions

For inheritance and gift taxes, the value of real estate is generally calculated using standards set by the national and local governments, such as "roadside land prices" or "fixed asset tax assessment values." “Roadside land prices” are determined annually based on factors like officially-announced land prices and actual transaction examples, and are set lower than actual transaction prices. As a general rule, they are said to be around 80% of market values.

This system has been used for many years due to its advantages of enabling uniform nationwide valuations, and the ease of calculations. However, in recent years, especially in urban areas, real estate prices have continued to rise, leading to an increasing number of cases where a significant gap exists between actual transaction prices and inheritance tax valuation amounts. As a result, situations have arisen where holding (inheriting) real estate rather than cash significantly reduces inheritance tax liability, raising questions about the fairness of tax burdens.

Shift Toward Market-Based Valuations

The 2026 tax reform outline proposes shifting the valuation approach for certain rental properties away from the traditional roadside land prices-based land valuation system, towards a method closer to actual market prices (real transaction prices). This reflects an effort to capture the value of land at the time of inheritance more realistically.　Bringing valuations closer to actual market conditions is expected to reduce perceived unfairness based on the composition of inherited assets, and enhance overall acceptance of the tax system. However, since some properties may see higher valuations than before, cases where inheritance or gift tax burdens increase are also possible. The aim of the system reform is not a blanket tax increase, but rather taxation based on actual value.

Real Estate Acquired Within the Past 5 Years is the Focus

Particular attention in this tax reform outline is focused on the treatment of "certain rental properties acquired within five years prior to inheritance." For such properties purchased within this period, consideration is being given to a valuation method based upon the purchase prices, rather than the "roadside land prices" or "fixed asset tax assessment values” used until now. This is seen as a response to the practice of purchasing real estate immediately before inheritance in order to significantly lower the assessed values of inheritances. The aim is to emphasize the actual purchase prices of certain rental properties acquired within a relatively short period, thereby discouraging real estate purchases made solely to save on taxes. It is important to note that this review focuses specifically on the timing of acquisitions, and does not uniformly affect rental properties held for long periods.

Item	Current	evision (Proposed)
Valuation methods	"Roadside land prices" (approximately 80% of market price) or fixed asset tax assessment values	Valuations closer to actual market prices
Targets	All real estate properties	Certain rental properties acquired within five years prior to inheritance
Tax savings effects	Easy to lower the assessed values of inheritances through real estate purchases	Limited effect for relatively short-term acquisitions

Key Points for Future Inheritance Planning

If this revision is implemented, the approach to inheritance planning utilizing real estate will face a major turning point. In particular, the method of purchasing land or buildings relatively soon before inheritance, with inheritance in mind, may no longer yield the same level of tax savings as before. Therefore, the notion that, "Buying real estate reduces inheritance tax.” may no longer hold true going forward. On the other hand, this does not negate the use of real estate for inheritance planning itself.　Appropriate strategies vary based on holding period, usage status, family composition, and other factors. It is essential to monitor legislative developments, organize relevant information early, and consider inheritance strategies tailored to your specific circumstances.

The Pitfalls regarding “Advance Notification of Fixed Compensation to Officers”

Introduction

In companies such as limited liability companies (LLC’s - 合同会社, Godo Gaisha) or special limited liability companies (特例有限会社, Tokurei Yūgen Gaisha) where directors' terms are not fixed, salaries paid usually cannot be deducted as business expenses. In order to be able to deduct them as expenses, “advance notification of fixed compensation to officers” is necessary; for this, sufficient advance preparation is essential.

What is “Advance Notification of Fixed Compensation to Officers”?

Compensation paid to officers are generally not recognized as deductible expenses. However, as an exception, utilizing “advance notification of fixed compensation to officers” allows the payment amounts to be treated as deductible expenses. This is achieved by predetermining the timing & amounts of payments, and notifying the competent tax office.  This system is critically important for companies seeking to set up flexible arrangements for officers’ compensation.

The system's purpose is based on the principle of preventing arbitrary profit adjustments, while allowing properly-planned executive compensation to be treated as deductible expenses. Attempting to use this system without understanding this point often leads to neglecting filing deadlines and proper documentation management, ultimately rendering the system unusable for some potential beneficiaries.

Systemic Issues Lurking in Limited Liability Companies and Special Limited Liability Companies

There are points requiring caution regarding limited liability companies (LLC’s) and special LLC’s. A key characteristic is the absence of officer terms under the Companies Act. Furthermore, LLC’s don’t carry out "General Meetings of Members” as legally-mandated governing bodies.

In the case of a corporation, “advance notifications of fixed compensation to officers” can be filed within one month after the company’s regular shareholders' meeting, or within four months from the start of its fiscal year - whichever is earlier. However, LLC’s and special limited liability companies do not have the concept of officer terms in the first place, and LLC’s also have no obligation to hold regular shareholders' meetings like corporations do.

Consequently, no statutory filing deadline arises, making it difficult to file the notification itself. This results in a situation where, even if a potentially eligible payment plan exists, the compensation cannot be recognized as a deductible expense under the “advance notification of fixed compensation to officers” system.

This point is often overlooked in practice. Many cases are seen where compensation is paid under the mistaken belief that "Just filing the notification is sufficient," - only for the employing companies to later face unfavorable tax rulings. Even when companies are aware of the system's existence, many cases in tax consultations involve situations where the system couldn't be used due to the prerequisites not having been met.

What Happens if the Expenses Aren't Deductible?

If the “advance notification of fixed compensation to officers” system can’t be used, the entire amount of the compensation paid to the officer(s) becomes non-deductible, increasing the company’s tax burden. This often results in unexpected tax liabilities, particularly for small and medium-sized enterprises (SME’s) that consider adjusting officer compensation as a tax-saving measure. In practice, we also see cases where substantial tax burdens arise due to misunderstandings like, "We understood the system, but didn't know there was a filing deadline."

Compensation is difficult to revoke once paid, and mishandling the situation can impact the company's cash flow, so this requires careful attention.

Countermeasures and Future Considerations

To resolve this issue, institutional improvements are necessary, such as amending the articles of incorporation to establish officer terms and establish general employee meetings. Setting up officers’ employment terms creates "term commencement dates" as reference points, thereby fixing the notification deadlines for the “advance notification of fixed compensation to officers” system. Additionally, considering the timing of officers’ compensation reviews and your company’s fiscal year-end schedule, methods for complying with the prerequisites should be explored. It is important to understand that the issues reside not in the LLC or special limited company structures themselves, but in your paying compensation to officers without first establishing the proper framework.

Year-End Parties, New Year’s Parties, and Income Taxes

Introduction

Many companies plan year-end parties and New Year's gatherings as internal events during this time. While these events can foster employee bonding and boost morale, the tax treatment of expenses borne by the company can sometimes become an issue.

Basic Tax Rules for Company Events

Many companies hold year-end and New Year parties as annual traditions during the holiday season. These internal events, aimed at rewarding employees, boosting morale, and enhancing communication, contribute to fostering a positive workplace atmosphere and strengthening organizational cohesion. They play a role in corporate activities that cannot be ignored. From a tax perspective, the key issue is whether the benefits received by employees from the company are subject to income tax. The treatment varies depending on the purpose of the payment and the scope of beneficiaries. Generally, if a year-end or New Year's party is held for all employees as a welfare benefit, and the employees receive the food, drink, and venue costs provided, it is not considered that individual employees have received economic benefit. Therefore, employees at such events are not thereby subject to payroll taxation.

When year-end and New Year parties are not limited to specific groups like executives or particular departments, and participation opportunities are equally offered to all, they are typically treated as welfare expenses. In such cases, there are generally no issues with the company claiming these as business expenses. Therefore, while year-end and New Year parties themselves rarely pose tax risks, it is important to note that exceptions can occur depending on how the events are managed.

Caution is Required regarding Prizes and Awards

On the other hand, prizes offered at popular year-end party or New Year's party entertainment events such as bingo games or raffles are treated differently from food and drink offerings.

Since these prizes are not deemed necessary for business operations and are considered benefits accruing to individual employees, their tax classification as income becomes an issue. The key point to remember here is that prizes received from bingo games or raffles fall under "temporary income." Temporary income refers to non-recurring, incidental income, treated similarly to horse racing payouts, contest winnings, or campaign prizes. Return gifts from hometown tax donations are also a representative example of temporary income. While a special deduction of 500,000 yen is allowed from the total annual temporary income amount, if the prize is high-value or  is combined with other temporary income, it may become taxable. This is not widely known, and requires caution.

Types of Prizes	Tax Treatment	Company Response
Goods (appliances, food, etc.)	Can be treated as welfare expenses within reasonable limits. High-value items may be considered temporary income.	For high-value items, explanations to employees are recommended
Cash	Generally treated as "salary (bonus)"	Tax withholding is required
Gift certificates/gift cards	Generally treated as "salary (bonus)"	Tax withholding is required

Steps to Avoid Risks

For tax handling of year-end and New Year parties, it is important to clarify the event's purpose, scope of participants, and offerings beforehand. If the entire event is recognized as employee welfare, providing meals and drinks to employees is exempt from payroll taxation. However, since prizes comprise a different nature of income, please ensure that you note the amounts, types, and recipients, and establish a system to explain the income classifications, if needed.

For accounting purposes, carefully distinguish between welfare benefits and entertainment expenses, and maintain records that can be used for explanations during tax audits. Confirming the rules before the company events prevents unnecessary tax issues.