Tax Reforms Impact on Depend On Corporations, Our People - - PDF document

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Depend On Count On

Our People Our Advice

Tax Reform’s Impact on Corporations, S-Corporations, LLC’s and Partnerships

Olsen Thielen Presenters: Matthew Klein, CPA Joe Mayer, CPA, MST 952-829-3415 651-621-8334 mklein@otcpas.com jmayer@otcpas.com

Topics

• Policy
• Corporate Tax Implications
• Pass-through Tax Implications
• New Fringe Benefit Rules
• Updated Depreciation Rules
• Individual Income Tax & Alternative Minimum Tax
• Accounting Method Changes for Small Taxpayers
• Interest Expense Limitation
• Miscellaneous Provisions

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Policy

• $1.5 Trillion in tax cuts over 10 years
• According to the Joint Committee on Taxation (JCT)
• Individuals get 56 percent of the tax cuts
• Business get 44 percent of the tax cuts
• If tax cuts were distributed in proportion to the distribution of individual and corporate

income taxes paid

• Individuals would get 86% of tax cuts
• Corporations would get 14% of tax cuts
• Common theme: Benefits for business, grow entire tax base

Statistics from RSM

Corporate Tax Implications

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Background

• Prior to Tax Reform, the U.S. had highest corporate rate among the Organization of

Economically Developed Countries (OEDC) topping out at 35%

• The 35% rate forced many multinational corporations to focus on sourcing income outside

the U.S.

• The rate also discouraged bringing profit earned overseas back to the U.S. (repatriation).
• This trend has forced Congress to address the corporate tax rate to make it more

competitive with other industrialized countries.

Corporate Rates

• Effective for years beginning 1/1/2018, C Corporations are taxed at a 21% flat rate
• Previous system was a bracketed system topping out at 35%
• Corporate alternative minimum tax has been eliminated
• This helps ensure the effective tax rate of corporations do not rise above the 21% statutory rate.

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Dividends Received Deductions (DRD)

• To avoid potential for three layers of taxation, C corporations receive a deduction for

dividends received from other corporations in which it holds an equity interest in

• Amount of deduction depends on the stock ownership percentage in the other corporation

Stock Ownership Old Law DRD % New Law DRD% <20% 70% 50% Between 20% and <80% 80% 65% >80% 100% 100%

International Taxation Implications

• Historically, the U.S. was a ”Worldwide” income taxing regime.
• Foreign Tax Credit for taxes paid to other countries
• Forced corporations to shift income to lower taxing jurisdictions and claim domicile outside
• f the U.S.
• The Act adopts a ”Territorial” income tax system
• Only the income earned in the U.S. taxed at 21%
• Repatriation tax on assets currently sitting overseas
• Immediate tax of 15.5% for liquid assets and 8% for illiquid assets
• Paid over installment period: 8% in years 1-5; 15% in year 6; 20% in year 7, and 25% in

year 8

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Pass-through Tax Implications

Background

• Majority of privately-owned businesses are organized as pass-through entities and sole

proprietorships

• S Corporations
• Partnerships
• LLC’s taxed as partnerships
• LLC’s with a single owner
• Generally, more favorable due to one layer of taxation and taxed at the owner’s individual

rate on his/her return

• Since Congress reduced the C corporation tax rate, pass-through entities must be

addressed

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Qualified Business Income Deduction – In General

• Section 199 (DPAD) vs. New Section 199A(Qualified Business Income Deduction)
• Rather than cut the rate, Congress enacted a 20% deduction at the owner level for

Qualified Business Income (QBI) from partnerships, S corporations, and sole proprietorships

• Deduction is limited to 20% of taxable income adjusted for capital gain income/loss of the

individual shareholder

• QBI deduction reduces the effective top marginal tax rate on pass-through income to

about 29.6% vs. 39.6% previously.

• QBI is defined as taxable income from a U.S. trade or business excluding investment

income/expenses (STCG, STCL, LTCG, LTCL, Dividends, Interest)

• Earned income (wages, guaranteed payments) excluded from QBI

Qualified Business Income Deduction – Limitations

• Generally, 20% QBI Deduction is limited to the greater of:
• 50% of W-2 compensation paid by the entity or;
• 25% of W-2 compensation paid by the entity plus 2.5% unadjusted basis of assets

(Alternative Method) – Real Estate

• Taxpayers who are below a threshold amount of $315,000 for MFJ or $157,500 for all
• thers are not subject to above limits
• Deduction begins phasing out at $315,000 (MFJ) and entirely phased out at $415,000

(MFJ)

• W-2 limitation greatly devalues the 20% deduction and raises effective tax rate closer to
• rdinary individual rates

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Example A: No Limitation

Joe, a married taxpayer filing joint, owns a wholly owned manufacturing business called Widget. Joe receives $200,000 in wage income, $500,000 of qualified business income from Widget, $50,000 of capital gain and $100,000 of itemized deductions. Widget pays a total W-2 wages of $1,000,000 and has $1,000,000 of unadjusted basis in its assets

Example A: No Limitation (cont.)

Joe’s Qualified Business Income Deduction of $100,000 would be calculated as follows:

Step 1: 20 % of Qualified Business Income Step 4: Calculate 20% of adjusted taxable income net of capital gain 20% of QBI (500,000 * 20%) 100,000 A Wage Income 200,000 Step 2: Greater of 50% of W‐2s or 25% W‐2 and 2.5% asset unadjusted basis Qualified Business Income 500,000 Capital Gain 50,000 50% W‐2 wages 500,000 B Itemized Deductions (100,000) Taxable Income 650,000 25% W‐2 Wages and 2.5% asset unadjusted basis 275,000 C Less Capital Gain (50,000) Taxable Income adjusted for capital gain 600,000 F Greater of B or C 500,000 D 20% of F 120,000 G Step 3: Qualified Business Income Amount Lesser of A or D 100,000 E Step 5: Lesser of Qualified Business Income Amount or 20% of adjusted taxable income net of capital gain (Lesser of G or E) 100,000

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Example B: W-2 Limitation

Joe, a married taxpayer filing joint, owns a wholly owned manufacturing business called Widget. Joe receives $50,000 in wage income, $500,000 of qualified business income from Widget, $50,000 of capital gain and $100,000 of itemized deductions. Widget pays a total W-2 wages of $150,000 and has $300,000 of unadjusted basis in its assets.

Example B: W-2 Limitation (cont.)

Joe’s Qualified Business Income Deduction of $75,000 would be calculated as follows:

Step 1: 20 % of Qualified Business Income Step 4: Calculate 20% of adjusted taxable income net of capital gain 20% of QBI (500,000 * 20%) 100,000 A Wage Income 50,000 Step 2: Greater of 50% of W‐2s or 25% W‐2 and 2.5% asset unadjusted basis Qualified Business Income 500,000 Capital Gain 50,000 50% W‐2 wages 75,000 B Itemized Deductions (100,000) Taxable Income 500,000 25% W‐2 Wages and 2.5% asset unadjusted basis 45,000 C Less Capital Gain (50,000) Taxable Income adjusted for capital gain 450,000 F Greater of B or C 75,000 D 20% of F 90,000 G Step 3: Qualified Business Income Amount Lesser of A or D 75,000 E Step 5: Lesser of Qualified Business Income Amount or 20% of adjusted taxable income net of capital gain (Lesser of G or E) 75,000

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Example C: Alternative W-2 Limitation

Ryan, a married taxpayer filing joint, owns a wholly owned real estate business called RE Biz. Ryan receives $500,000 of qualified business income from RE Biz, $50,000 of capital gain and $100,000 of itemized deductions. RE Biz pays a total W-2 wages of $0 and has $1,000,000 of unadjusted basis in its assets. :

Example C: Alternative W-2 Limitation (cont.)

Ryan’s Qualified Business Income Deduction of $25,000 would be calculated as follows:

Step 1: 20 % of Qualified Business Income Step 4: Calculate 20% of adjusted taxable income net of capital gain 20% of QBI (500,000 * 20%) 100,000 A Wage Income ‐ Step 2: Greater of 50% of W‐2s or 25% W‐2 and 2.5% asset unadjusted basis Qualified Business Income 500,000 Capital Gain 50,000 50% W‐2 wages ‐ B Itemized Deductions (100,000) Taxable Income 450,000 25% W‐2 Wages and 2.5% asset unadjusted basis 25,000 C Less Capital Gain (50,000) Taxable Income adjusted for capital gain 400,000 F Greater of B or C 25,000 D 20% of F 80,000 G Step 3: Qualified Business Income Amount Lesser of A or D 25,000 E Step 5: Lesser of Qualified Business Income Amount or 20% of adjusted taxable income net of capital gain (Lesser of G or E) 25,000

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Conversions to C Corporations

• On the surface, 21% flat tax rate compared to 29.6% effective tax rate seems like an easy

decision

• HOWEVER, double taxation for C Corporations make this decision much less obvious.
• Conversions need to be considered for each specific fact pattern and fit long-term strategy
• f the organization.
• May make sense for high-growth business where all earnings are reinvested in the

business

Example D – C Corporation Conversion

Passthrough C Corp Income 100.00 100.00 QBI Deduction (20.00) ‐ Taxable Income 80.00 100.00 Tax @ highest rate 29.60 21.00 Cash Remaining 70.40 79.00 Tax on Cash Distributed Out @ 15% ‐ 11.85 Cash Remaining 70.40 67.15 Effective Tax Rate 29.6% 32.9%

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New Fringe Benefits Rules

Entertainment Expenses and Transportation Expenses

• Entertainment
• Pre-Act - 50% of entertainment expenses associated with the taxpayer’s trade or

business was deductible

• New law – entire 100% of entertainment expenses regardless if associated with

taxpayer’s trade or business is disallowed

• Employer provided meals are 50% deductible through 2025
• Transportation
• Beginning 1/1/2018, deductions for employee transportation fringe benefits (e.g. parking

and public transit) are disallowed.

• Still excluded as gross income to the employee
• Commuting expenses are denied

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Employee Reimbursed Moving Expenses

• Moving Expenses
• Pre-Act - Moving expense reimbursement not taxable to employee;

unreimbursed/out of pocket expenses deductible on personal return

• New law – Moving expense reimbursements are now taxable to the

employee; out of pocket expenses nondeductible on personal return

Other Employee Fringe Benefits

• Employee Achievement Awards
• Pre-act generally allows for a deduction and exclusion of employee’s income up to

$400 ($1,600 if part of a qualified plan)

• New law provides a narrow definition of “tangible personal property”
• Tangible personal property does not include cash, cash equivalents, gift cards, gift

coupons, or gift certificates; or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items

• Working Condition Fringe Benefits
• Exclude from income if employee could otherwise deduct
• Repeal of 2% Miscellaneous Itemized Deductions could change this (tax prep fees)

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Updated Depreciation Rules

First Year Bonus Depreciation

• With the passage of the Protecting Americans from Tax Hikes act of 2015 favorable

depreciation provisions such as bonus depreciation were to sunset and expire fully on December 31, 2019

• Favorable depreciation provisions we have come to know have been expanded and

extended.

• For years beginning after 12/31/2017, bonus depreciation on qualified property will be

increased to 100% of the depreciable basis of the asset acquired

• New and Used Property
• Applies to assets placed in service after September 27, 2017.
• Qualified Leasehold Improvement property is no longer eligible

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Qualified Improvement Property

• Formerly Qualified Leasehold Improvement Property and predesignated as Qualified

Improvement Property beginning in 2016

• Allowed Related Party Rentals
• Repealed requirement that the property be at least 3 years old
• Deduction available to either lessor or lessee
• Eligible for Section 179 or Bonus Depreciation
• With the Act, beginning 12/31/17, qualified improvement property is no longer eligible for

bonus depreciation

• Still eligible for Section 179 expensing

Section 179 Expensing

• Prior to The Act, taxpayers could expense up to $500,000 of business property placed in

service during the tax year

• Deduction phases out when Section 179 eligible property placed in service during the year

exceeds $2,000,000 adjusted for inflation.

• Beginning in years after 12/31/17, taxpayers can now expense up to $1,000,000 of

business property with the phase out threshold increased to $2,500,000.

• What is the benefit of Section 179 now that there is 100% bonus depreciation for new and

used property?

• Qualified Leasehold Improvements are eligible for Section 179 but not Bonus depreciation.

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Real Property

• Real Property Applicable Recovery Period
• 25 year MACRS depreciable life for both residential and commercial property did not

pass

• Remains at 39 years
• Alternative Depreciation System life of residential real estate was reduced to 30 years
• Non-residential real estate remains at 40 years

Luxury Automobile Depreciation Limits

• Limited Section 179 expensing and depreciation for certain passenger autos
• Pre-Act Law
• Maximum Year 1 - $3,160 plus additional $8,000 if bonus depreciation is claimed
• Maximum Year 2 - $5,100
• Maximum Year 3 - $3,050
• Maximum Year 4 and beyond - $1,875
• Bonus depreciation was phase down by $1,600 per calendar year beginning in 2018
• New Law
• Maximum Year 1 - $10,000 plus additional $8,000 if bonus depreciation is claimed and is held constant
• Maximum Year 2 - $16,000
• Maximum Year 3 - $9,600
• Maximum Year 4 and beyond - $5,760

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Individual Income Tax & Alternative Minimum Tax

Tax Rate Updates

Credit: AICPA Kiddie tax is applied at trust and estate rates for unearned income

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Tax Rate Updates (cont.) – Comparison of MFJ Rates

Credit: AICPA

Tax Rate Updates (cont.) –Comparisons

Credit: AICPA

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Tax Rate Updates (cont.) –Comparisons - $250,000 & Lower

Credit: AICPA

Reduced Deductions

Credit: AICPA

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Alternative Minimum Tax

Credit: AICPA Limit on State and Local Tax Deduction will also put more taxpayers

• ut of AMT

Corporate AMT has been repealed

Active Loss

• Active business losses are now limited to $500,000 (MFJ)
• Similar to passive losses, limitation is applied at the taxpayer level vs. entity level
• No carrybacks; can be carried forward indefinitely

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Accounting Methods for Small Taxpayers

Background

• As an effort to simplify the Code and reduce the burden for small taxpayers, Congress

expanded some accounting methods that were historically limited to a small population of taxpayers.

• These methods include availability of the cash method of accounting and removing

the requirement for the Uniform Capitalization Rules for certain businesses

• Historically, for C corporations, many of these methods were only available if the

corporation had gross receipts under $5 million.

• Beginning after 12/31/2017 these methods are now available for corporations with

revenue under $25 million.

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Cash Method of Accounting

• Beginning on 1/1/2018, C corporations with gross receipts under $25 million can now

calculate their taxable income on a cash method of accounting

• Under the cash method of accounting, taxpayers recognize revenue when cash is

received and deduct expenses with cash is paid

• Provides greater control to the taxpayer regarding the timing of recognizing revenue

and deducting expenses compared to the accrual method of accounting

• To convert from an accrual to a cash method of accounting a Form 3115 Application

for Change of Accounting Method needs to be filed.

Reduced Inventory Tracking Requirements

• Producer or reseller that three year average annual gross receipts does not exceed $25

million

• Not required to account for inventories under previous “accrual accounting” methods
• Instead can either:
• Treat inventories as non-incidental materials and supplies or
• Conforms to the financial statements
• Non-incidental materials are not expensed until the year in which they are used and still

required to track inventory and take deduction in the year of sale.

• Relieved from maintaining a formal cost of goods schedule

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Research and Development Costs

• Under the new law for R&D expenses paid or incurred after 12/31/2021, certain R&D

expenses must be capitalized and amortized over five years

• Research and Development Credit is still in effect

Income Inclusion

• Applicable Financial Statement (AFS) Conformity Rule
• Beginning after 12/31/17, income must be recognized no later than the tax year in

which the income is taken into account as income on an AFS or another financial statement as prescribed by the IRS.

• Deferred Revenue
• Previous IRS guidance where advance payments received and deferred for financial

purposes can be deferred no longer than one year is codified

• Accrual basis taxpayer only
• Election

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Income Inclusion (cont.)

• Expanded Completed Contract Method
• Generally required for a long-term contract to use percentage-of-completion method
• Under new law, taxpayers whose gross receipts are under the $25 million threshold

may now use the completed contract method for contracts expecting to completed within two years

• Accounting Method Change Required

Interest Expense Limitation

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Limitation on Deductible Interest Expense

• Businesses have generally been able to deduct of the interest paid to lenders with some exceptions.
• Under the Act, for businesses that have an average gross receipts of greater than $25,000,000, interest

deductions are limited to the aggregate of

• business interest income for the year, plus
• 30% of the taxpayer’s adjusted taxable income for the year, plus
• the taxpayer’s floor plan financing interest for the year.
• Adjusted taxable income is computed without regards to deductions allowable for depreciation,

amortization, or depletion.

• Disallowed interest would be carried forward indefinitely
• Certain real property and construction business can elect out but must use an Alternative Depreciation

System to depreciate their assets at a longer life compared to conventional methods

• This limitation will force many businesses to re-evaluate their capital structure to avoid any potential

limitation.

Limitation on Deductible Interest Expense (cont.)

• Sonny and Cher own a record manufacturing business
• Business has enormous capital requirements and pays over $2,000,000 of interest

annually

• Average gross receipts are $35 million and adjusted taxable income is $5,000,000
• The deductible amount of interest is limited to $1,500,000
• The $500,000 excess is carried forward

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Miscellaneous Provisions

Like-Kind (Section 1031) Exchanges

• Under Section 1031, taxpayers could exchange certain business property for like-kind

property and defer the gain related to the property being given up

• Applied to both real property or personal property (i.e. vehicles or machinery)
• The Act now only allows like-kind exchanges to be available for real property (such as

land or buildings)

• Special consideration will have to be given to building cost segregation studies
• The taxpayer will likely not be able to defer any gain associated with personal property

included in the exchange

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Net Operating Losses

• Prior to 1/1/2018, net operating losses could be carried back two years and carried

forward twenty years

• Net operating losses previously could fully offset any of the year’s taxable income

(excluding Alternative Minimum Taxable Income)

• Beginning 1/1/2018, net operating losses can no longer be carried back but can be carried

forward indefinitely

• Net operating loss carryforwards can only offset 80% of taxable income

Executive Compensation

• Previously deduction for compensation paid to a covered employee of a publicly

traded corporation is limited to $1,000,000 per year.

• Exceptions include commissions, performance based pay including stock options,

payments to qualified retirement plan

• Beginning after 12/31/2017, above exceptions are repealed. Deduction is limited to

$1,000,000

• Transition rules for certain contracts in effect on 11/2/2017

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Questions?