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NEWS

NEWS

 

It is not too early for business leaders to try to make sense of the implications of the United Kingdoms vote to leave the European Union (Brexit). Events are still in flux and are likely to remain uncertain for a while. But for now lets take a look at some quick points on the potential impact of Brexit on American businesses:

Currency

The British pound plunged roughly 10 percent in the immediate wake of the Brexit vote, hitting levels not seen since the 1980s. If you are an American company seeking to invest in growing a UK operation, things just got a lot cheaper. If you are a British company seeking to expand into the US, your pound now buys substantially less.

The pound has also fallen against the Euro, but in the long-term the health of the Euro must also be questioned as its strength depends on that of the European Union itself. And Britain exiting the EU suggests that the EU has much work to do to address the structural and philosophical concerns that underpinned the British vote.

If a foreign corporation such as the Foreign company takes the position that it is not required to file a return because its United States federal income tax liability is fully satisfied by withholding based on the provisions of an income tax treaty, then the foreign corporation must file a return to disclose the treaty-based position, although the return need include only the corporation's name, address, and taxpayer identification number (if any), as well as an attached statement disclosing the treaty-based return position.

Stock Market

Look for stock markets to be volatile.  However, things are likely to stabilize as the initial shock wears off, but they may well stabilize at lower levels as the market prices in long-term uncertainty as Britain begins to negotiate its departure from the EU.

For companies seeking to raise funding or for those nearing closer to a potential liquidity event, access to capital is likely to become more limited in the near to medium term. Investors are likely to be more cautious, resulting in lower valuations for those that can get funding, and the need for startups to manage cash more carefully under the assumption that funding will be harder to come by.

Regulation

With its more liberal regulatory environment, Britain has been a counterweight to the greater regulatory zeal found on the continent.   France and Germany, who tend to be more aggressive on regulatory matters, are likely to feel more empowered to go after the big tech giants on matters such as privacy and antitrust.  Which could impact business expansion in those countries and other countries that choose to follow suit, including US businesses with EU expansion plans. 

Longer term, businesses will need to understand the implications for harmonizing their business activities across Europe. Currently, a financial passport allows companies registered in one EU country to do business freely across all EU countries. As Britain negotiates its exit, this is likely to change. UK registered companies may find they face new limitations on their ability to operate in EU markets. Which also impacts American companies with European affiliations.

Immigration

Immigration was one of the driving issues in the Brexit debate, with Pro-Leave campaigners finding it the argument that resonated most with voters. Now that Brexit has won the day, it is likely that controlling the borders will continue to be a central issue as Britains departure from the EU is negotiated.

Companies accustomed to bringing talent readily across borders into the UK may find this ability restricted in the future. With much tech talent originating from overseas, it may become more difficult for UK companies to source the specialized talent they need. Working remotely and an increase in virtual teams may provide an alternative. US companies that outsource talent from the UK may see an increase in these labor costs.

This is an area of great uncertainty, as Britains ability to negotiate new trade deals with Europe may depend on its acceptance of some freedom of movement. This may not sit well with many Brexit voters, so expect much delicacy regarding the immigration issue.

Politics

The Brexit vote is nevertheless a huge shock to the European Union as an institution, and to the centrist governments that have long supported it. European political leaders will scramble to understand and address what went wrong. Brexit might trigger a domino effect that sees other countries also voting on whether or not to leave the EU. Fear of such a domino effect is likely to cause the EU to negotiate hard with Britain, seeking to set an example that would discourage other countries from following a similar path. Immigration will also remain a hot-button issue in Europe, potentially making borders less open than before. Which could result in higher labor costs for businesses.

Scotland voted heavily for Remain and they will not easily accept being dragged out of the EU by English voters south of the border. Therefore, expect to see calls for a new referendum on Scottish independence. This is not likely to happen for a few more years, until the dust settles on the terms of a British exit from Europe and until Scotlands ruling Scottish National Party can be sure that a referendum will pass. But if and when it happens, the outcome may be that Scotland leaves the UK and applies independently to rejoin the EU.

France and Germany both will see elections in 2017 and these will be closely watched. If momentum swings toward populist parties, all bets are off regarding the European project.

American companies with international operations will see a bumpy ride happening over the next few months. However, the long term impact of Britain exiting the European has ramifications that have yet to be determined.

 

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IRS to Target Specific S Corporation Areas as Part of New Compliance Campaign

The Internal Revenue Service’s Large Business and International Division has approved five new compliance campaigns in several areas including specific areas related to S corporations. The LB&I Division has been moving toward issue-based examinations and a compliance campaign process in which it decides which compliance issues present enough of a risk to require a response in the form of one or multiple treatment streams to achieve tax compliance objectives. The five new campaigns were identified through data analysis and suggestions from IRS employees. The goal is to improve return selection, identify issues representing a risk of non-compliance, and make the best use of the division’s limited resources.

As part of the S corporation campaign, the IRS noted that S corporations and their shareholders are supposed to properly report the tax consequences of distributions. The service has targeted three issues as part of this campaign:

  • When an S corporation fails to report gain upon the distribution of appreciated property to a shareholder.
  • When an S corporation fails to determine that a distribution, whether in cash or property, is properly taxable as a dividend; and,
  • When a shareholder fails to report non-dividend distributions in excess of their stock basis that are subject to taxation.

For this campaign, the IRS plans to conduct issue-based examinations, suggest changes to tax forms, and conduct stakeholder outreach.

As part of the campaign, any examinations that result from this campaign will probably touch upon other S corporation related issues including the methods S corporations use to determine reasonable compensation and its impact on potential under-reported FICA taxes.

Taxation of Cryptocurrency Mining Activities

There are new rules which the US Congress passed in December 2017 that change the way the IRS treats cryptocurrency. Before the US Congress put forth a clearer ruling in 2017, the classification category of cryptocurrency assets was up for interpretation according to many tax experts. That’s because many cryptocurrency miners and traders treated cryptocurrency similar to real-estate for tax purposes by citing the like-kind exchange rules of IRS Code Section 1031.

Following this ruling a miner could theoretically trade a mined cryptocurrency for another cryptocurrency without having to pay taxes. With 1031 exchanges limited to real estate transactions under the recent tax act this treatment is now out the window. Now anyone with cryptocurrency mining operations in 2018 will have to pay taxes beginning in 2019.

There are a couple of things to consider when paying taxes for cryptocurrency mining. You have two different income streams to consider. The first taxable event occurs whenever a miner mines a new coin. The IRS considers this to be income even if the miner decides to only hold the coins as “inventory”. When you mine the coins, you have income on the day the coin is "created" in your account at that day's exchange value. If you are reporting activity as an individual taxpayer, you can report the income as a hobby or as self-employment. If you report as a hobby, you include the value of the coins as "other income" on line 21 of form 1040. Your ability to deduct any expenses is limited -- expenses are itemized deductions subject to the 2% rule.

If you report as self-employment income (you are doing work with the intent of earning a profit) then you report the income on schedule C. You can fully deduct your expenses. The net profit is subject to income tax and self-employment tax. Similar treatment occurs if you operate as a multi-member LLC except that the transactions are reported on the LLC’s tax return with the individual members having their shares of the net profits or losses reported on individual K-1s.

Your second income stream comes when you actually sell the coins to someone else for dollars or other currency. Then you have a capital gain or a capital loss.

Finally, if you immediately sell the coins for cash, then you only have income from the creation and you don't also have a capital gain or loss.

Now, as far as expenses are concerned, if you are doing this as a business, you can take an expense deduction for computer equipment you buy (as depreciation) and your other expenses (for example electricity and other business expenses). But if you are doing this as a home-based business you need to be able to prove those expenses, such as with a separate electric meter or at least having your computer equipment plugged into a portable electric meter so you can tell how much of your electric bill was used in your business. Unless your expenses are very high, they won't offset the extra self-employment tax, so you will probably pay less tax if you report the income as hobby income and forget about the expenses.

Supreme Court Rules States Have Authority To Require Online Retailers To Collect Sales Taxes

The U.S. Supreme Court, in a 5-4 decision, has held that states can assert nexus for sales and use tax purposes without requiring a seller’s physical presence in the state, thereby granting states greater power to require out-of-state retailers to collect sales tax on sales to in-state residents. The decision in South Dakota v. Wayfair, Inc., et al overturns prior Supreme Court precedent in the 1992 decision Quill Corp. v. North Dakota which had required retailers to have a physical presence in a state beyond merely shipping goods into a state after an order from an in-state resident before a state could require the seller to collect sales taxes from in-state customers. That was before the surge of online sales, and states have been trying since then to find constitutional ways to collect tax revenue from remote sellers into their state.

The Court noted: “When the day-to-day functions of marketing and distribution in the modern economy are considered, it is all the more evident that the physical presence rule is artificial in its entirety”. The Court also rejected arguments that the physical presence test aids interstate commerce by preventing states from imposing burdensome taxes or tax collection obligations on small or startup businesses. The Court concluded that South Dakota’s tax collection plan was designed to avoid burdening small businesses and that there would be other means of protecting these businesses than upholding Quill.

In his dissenting opinion, Chief Justice John Roberts argued that, although he agreed that the enormous growth in internet commerce in the interim years has changed the economy greatly, Congress was the correct branch of government to establish tax rules for this new economy. He also took issue with the majority’s conclusion that the burden on small businesses would be minimal.

Prior to the decision, many states had already begun planning for the possible overturn of Quill.

Congress may now decide to move ahead with legislation on this issue to provide a national standard for online sales and use tax collection, such as the Remote Transactions Parity Act or Marketplace Fairness Act, or a proposal by Rep. Bob Goodlatte, R-Va., that would make the sales tax a business obligation rather than a consumer obligation. Under that proposal, sales tax would be collected based on the tax rate where the company is located but would be remitted to the jurisdiction where the customer is located.

 

C Corp vs S Corp or LLC:
How The Tax Cuts and Jobs Act Impacts This Decision

The Qualified Business Income Deduction section of the Tax Cuts and Jobs Act included a new deduction meant for S corps, LLCs, partnerships and sole proprietorships (commonly referred to as pass-through entities). The deduction is calculated at 20% of the trade/business income of these entities. There are limitations based on owner’s taxable income, W-2 salaries of the business, assets in the business and whether or not the business is a service or non-service entity.

Accordingly, not all pass-through entities will qualify for the 20% deduction.

The Tax Cuts and Jobs Act has also dropped the C corporation tax rate to 21% and a lot of questions have arisen from closely held business owners about converting their limited liability company (LLC) or S corporation (S corp) to a C corporation (C corp) including questions from the owners of entities that don't qualify for the 20% deduction. Does it make sense to switch to or start a C corp? The answer is not that simple. Much depends on your business and the business model you operate under.

While the federal tax rate for C corps has dropped favorably to a flat 21%, there are still limitations to a C corp’s tax structure. C corps are subject to double tax. When a C corp issues dividends on their profits, the shareholders receiving the dividends are then taxed on their personal tax return, while the C corp receives no deductions for these payments. Whereas, if you are structured as an LLC or an S corp, you are taxed on the net taxable income that flows through to the owner’s individual tax return and you can distribute the funds out of your company, without double tax. If the goal of the business is to reinvest the earnings back into the company, C corps are a favorable option to take advantage of the lower tax rates.

As a practical matter, for current operations, closely held C corporations do not normally pay dividends. Owners in these entities are often active in the business and draw a salary. The corporation gets a deduction for the salaries, but owners receiving the salary pay federal tax on that salary at a rate as high as 37%.

Upon exiting a closely held business, the sale of the assets of the business are, normally, the only viable option. Very few buyers will want to buy the ownership interest in a closely held business. If you decide to sell your business as a C corp, income generated from the sale of assets is taxed at the corporate level first and then taxed again when the net cash is distributed out to the shareholders.

Also, consider the timing issues when switching to and from a C corporation. Let’s say your business is currently structured as an S corp. You and your shareholders deem your business is better suited as a C corp and you want to convert your organization. It is fairly easy to switch to a C corp. But there is a “buyer beware” with that enterprise. You must wait five years after the switch to a C corp to switch back to an S corp. Once you switch back to an S corp, you could be subject to double taxation on built-in gains (unrealized appreciation on assets held while the entity is a C corporation) for an additional five years after the switch. At a minimum, you will need to live with the possibility of some degree of double taxation for up to ten years.

So what is the bottom line on all of this?

If you have a business that you plan on keeping fairly small, with fewer than 100 shareholders and located in the U. S, you probably want to be an S corp or an LLC. But if your goal is to reinvest profits back into your business to finance future organic growth then the C corporation is probably a good fit. If you have big plans for growing your company to position it for future sale or to go public, you might want the flexibility to take on investors, raise capital, issue different kinds of stock, and invite foreign investors into your business as a C corp.

As always, it is best to consult your advisors before commencing any changes in business structure.