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NEWS

NEWS

 
 
 

Section 1202 of the Internal Revenue Code allows non-corporate taxpayers to exclude from federal income tax 100% of the gain on the sale of certain qualified small business stock (QSBS), limited to the greater of $10 million or 10 times the adjusted basis of the investment. Unlike in prior years, this creates possible opportunities for non-corporate taxpayers who dispose of QSBS in a taxable transaction to potentially exclude the entire gain for federal tax purposes.

The Creating Small Business Jobs Act of 2010 was developed to encourage individual taxpayers to make additional equity investments in startup corporations during the remainder of calendar year 2010. The 2010 Jobs Act included an amendment that for the first time provided for a complete US federal income tax exemption (with no application of the alternative minimum tax) for specific gains recognized by non-corporate investors on the sale of QSBS held for more than five years ? but only if the stock was purchased at original issue in the limited window after September 27, 2010, and before January 1, 2011.

Although initially intended as a tax incentive for stock issued during a limited period, the 0 percent rate for gains on QSBS became so popular that Congress began expanding it. In fact, Congress repeatedly extended the applicable window for issuance of the 0 percent-eligible QSBS in successive one-to-two-year tranches. And recently, on December 15, 2015, President Barack Obama signed into law the Protecting Americans From Tax Hikes Act of 2015, making the 0 percent rate for specific gains from sales of QSBS a permanent tax benefit.


Thus, assuming all applicable requirements are met, the 0 percent federal income tax rate could now apply to gains from sales of QSBS acquired at any time after September 27, 2010.

However, several requirements must be satisfied before those benefits can be realized, and even if those requirements are met, there are important limitations on the amount of gain that can qualify for the 0 percent rate. These requirements and limitations are further discussed below.

GENERAL REQUIREMENTS

The general requirements for qualifying for the 0 percent federal tax rate on gains from the sale of QSBS include the following:

(i) Original issue.

The taxpayer recognizing the gain must not be a corporation and must have acquired the stock at original issue from a US domestic C corporation.

(ii) Five-year holding period.

The taxpayer must have held the stock for more than five years.

(iii) After September 27, 2010.

The taxpayer must have acquired the stock at original issue after September 27, 2010, in exchange for cash, property other than cash or stock, or services.

(iv) After September 27, 2010.

The aggregate gross assets of the corporation that issued the stock cannot have exceeded $50 million at any time before (and including the time immediately after) the issuance of the stock to the taxpayer. Importantly, the amount of a corporations assets at any given time is generally measured by the corporations adjusted tax basis in those assets, except when any property is contributed to the corporation. In that case, the property must be taken into account for this purpose based on its fair market value (FMV) at the time of the contribution.

(v) Active Business Test.

During substantially all of the taxpayer is holding period of the stock, at least 80 percent of the issuing corporation is assets must be used by the corporation in the active conduct of one or more qualified trades or businesses. This includes assets used in furtherance of a prospective active business, i.e., startup activities, research and experimentation, and in-house research. It also includes working capital, investments expected to finance research and experimentation or increased working capital within two years, and computer software rights that produce active business royalties. After the corporation has existed for two years, however, no more than half of its assets can be working capital or investments held for future research or working capital.

Although many types of trade or business should qualify for this purpose, the following are specifically excluded: any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services. Also specifically excluded is any trade or business for which the principal asset is the reputation or skill of any of its employees.

(vi) No significant redemptions.

The issuer of the stock must not have engaged in specific levels of buybacks (redemptions) of its own stock during specified periods before or after the date of issuance of the stock to the taxpayer.

LIMITATIONS

A non-corporate taxpayer who recognizes gain from the sale of stock meeting the above requirements can thus generally qualify for a 0 percent federal income tax rate. The amount of gain eligible for this 0 percent rate is subject to a cap, however. Section 1202(b)(1) states that the aggregate amount of gain for any taxpayer regarding an investment in any single issuer that may qualify for these benefits is generally limited to the greater of (a) $10 million, or (b) 10 times the taxpayer is adjusted tax basis in the stock. For a taxpayer who invests cash in the QSBS, basis would generally be equal to the cash purchase price. There is a special rule, however, for when a taxpayer instead purchases the QSBS for in-kind property (that is, other than cash). In those cases, the taxpayer is basis in the QSBS, solely for purposes of these Section 1202 rules, is deemed to be an amount not less than the FMV of the property transferred for that QSBS (often referred to as the basis-is-not-less-than-value rule). The general purpose of the basis-is-not-less-than-value rule is to ensure that inherent built-in gain for any property contributed to a corporation in exchange for QSBS does not qualify for the Section 1202 benefits. Only the gains from the sale of QSBS that are attributable to appreciation in value of the QSBS occurring after the date of issuance are potentially eligible for the 1202 benefits.

Additionally, although this potential planning opportunity may lead to significant federal tax savings, many states, including California, do not follow federal income tax treatment of QSBS under Sec. 1202.

ROLLOVER OF GAIN

A taxpayer other than a corporation (i.e., individuals, partnerships, S corporations, estates and trusts) may elect to roll over capital gain from the sale of QSBS held for more than six months if QSBS is purchased by the taxpayer during the 60-day period beginning on the date of sale. Accordingly, gain is recognized only to the extent that the amount realized on the sale exceeds the cost of the replacement QSBS purchased during the 60-day period, as reduced by the portion of such cost, if any, previously taken into account. To the extent that capital gain is not recognized, that amount will be applied to reduce the basis of the replacement small business stock. The basis adjustment is applied to the replacement stock in the order the replacement stock is acquired.

TREATMENT FOR PASS-THROUGH ENTITIES

Gain on qualified stock held by a partnership, S corporation, RIC, or common trust fund is excludable if the entity held it for more than five years and if the partner, shareholder, or participant to whom the gain passes through held an interest in the entity when the entity acquired the stock and at all times thereafter. The partner, shareholder, or participant cannot exclude the gain to the extent that his or her share in the entity is gain is greater than what it was when the entity acquired the qualified stock, however.

 
 
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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.

Richard Levychin, CPA Featured Speaker With Joseph Romano, CPA
on Tax Cuts and Jobs Act and How it Impacts Businesses

Richard Levychin, CPA and Joseph Romano, CPA teamed up to discuss the key business components of the Tax Cuts and Jobs Act at a recent Morning MOJO. Included in the session was a detailed discussion of the 20% deduction for pass through entities, and a discussion of expenses that are no longer deductible

Please click on link below to view:
http://kbl.com/video/kbl_MorningMojo.mp4

Why Your CQ is Just as Important as Your IQ (and EQ)

Cultural intelligence is increasingly important for business success.

By Richard Levychin, CPA, CGMA

Many factors contribute to professional success. Hard work is one, but it is not enough. Having a high IQ combined with hard work is no longer enough.

Having a high EQ, which stands for emotional quotient and measures one's ability to connect to people on an emotional level, combined with hard work and a high IQ used to be enough, but it is also no longer sufficient to lead to professional success.

Today's and tomorrow's professionals will also have to own a high CQ, a measure of cultural intelligence and the ability to interact comfortably and successfully with other cultures. Studies have shown that people with a high CQ perform better on multicultural work teams than those with a low CQ. A study published in 2011 in the Journal of Social Issues found that cultural intelligence was a stronger predictor of the cross-border effectiveness of Swiss military leaders than either general intelligence or emotional intelligence.

The person deciding whether you get access to your next opportunity, be it a job offer, project, financing, or something else, may have a different cultural background than yours. Do you possess a high enough CQ to engage with him or her in such a way that distinguishes you from your competition and gets you the opportunity?

As business becomes more global, CPA firms and other business entities will begin to measure a prospective candidate's cultural intelligence as a way of determining if he or she can engage with clients or customers who are from different cultures.

The primary purpose for improving CQ is to increase a firm's revenue. To implement a platform that encourages increasing the CQ of a firm's professionals for any purpose other than one that is directly tied to a significant positive impact on the firm's profit-and-loss statement will run out of steam quickly. The business case for CQ ends with a positive return on investment.

FINDING COMMON GROUND

Several years ago I was referred to a well-known and powerful synagogue in Stamford, Conn. When I went to the synagogue, I was the only person of color in the building. I went to meet with the synagogue's rabbi and financial officer and before entering the rabbi's offices donned a yarmulke. The three of us then engaged in a 30- to 45-minute conversation on Jewish culture and the history of the synagogue before discussing the synagogue's specific business issues. I ended up closing the business.

A few weeks later I met with the managing partner of a midsize law firm who had been born in Israel and had served in the Israeli army. I happened to mention that that synagogue was a client. That literally was the icebreaker of the meeting. I ended up with a referral to a client of theirs in the airline industry that became a public company audit client of our firm, as well as a technology company whose principals were also from Israel and also became an audit client.

Possessing cultural intelligence, particularly as it relates to Jewish culture, was probably the differentiating factor that put me ahead of my competition in securing that business. I have had similar success meeting with decision-makers who were black, Asian, female, gay, Hispanic, or combinations of the above.

Having a high CQ also comes into play when attracting quality talent. Today's up-and-coming professionals want more cultural diversity in both their personal and business lives. And they also want their places of work to be culturally diverse. To attract and retain the quality of talent that can interact in a global marketplace, firms will need to increase their CQ so that they can speak to and attract a larger number of quality professionals. The more people you are exposed to, the better chance you have to hire the right staff members.

So how does one develop and improve his or her CQ?

Accounting is a profession that combines continued learning and application of that learning. Cultural intelligence cannot be learned. The road to cultural intelligence starts with unlearning the unconscious biases that we have developed and embedded into our belief systems over time as they relate to other cultures (see "How to Counteract Unconscious Biases"). Unlearning involves creating a state called "no mind," which is based on being able to interact with others without having assumptions about who you think they are playing in the background of your thoughts while you engage with them.

PRACTICE INTERACTIONS

I believe that to authentically engage in the practice of "no mind" one needs to first acknowledge that maintaining such a state permanently is impossible. In other words, you cannot just simply flip an "off" switch and have unconscious biases go away forever. You can only maintain this state for periods of time.

Despite its name, the concept of "no mind" is a form of mindfulness. As you probably know, the practice of mindfulness has been around for a while. However, it is a practice. It is not a "perfect." And when you don't practice the state of "no mind," all you can do is work harder to do better next time. Even the most evolved person has unconscious biases. Realize that you have unconscious biases and there are times that they will influence your actions and decisions, and that is part of being human. Acknowledge it when it happens from a very human space, and then learn the lesson that the opportunity of screwing it up afforded you, and then move forward. 

I recently served on the AICPA's National Commission on Diversity & Inclusion. I introduced a session called "Conversations About Race" that was led by an interracial married couple. Within the session participants were matched with other accounting professionals from different cultures. Within these groups they were put through a series of exercises that allowed everyone to interact from this place of "no mind." After the exercises the session leaders engaged in a conversation about cultural diversity. The participants were highly engaged in the conversation and participated enthusiastically. By first actually engaging with someone of a different culture from the space of "no mind," participants had the physical experience of what this felt like. This provided the necessary relativity of what the opposite would look like.

The concepts of cultural intelligence discussed here focus on creating a platform of experiential learning where all cultures participate together and interact directly. These platforms create experiences of what it feels like to be in diverse environments and, for those who choose to engage in these types of practices in their firm, recommend that measurement of success be tied directly to the firm's profit-and-loss statement, specifically to how increased CQ contributes to increased revenue, increased staff retention rates, and lower labor costs.

Soft skills and team-building courses combined with content that focuses on cultural diversity are good starts toward the unlearning process and developing a higher CQ. But, like anything else, mastery comes from practice. And practice consists of a professional's willingness to consistently enter situations that include people from different cultures and engage in deep conversations and interactions with them, with an eye toward creating the state of "no mind." The more you engage in these types of interactions, the more key cultural nuances you will learn and the higher your CQ will become.

 

The Tax Consequences of Dealing in Cryptocurrency

The coolness factor of digital currency is being closely scrutinized by one of the least coolest agencies on the planet: The Internal Revenue Service. Given the speed at which these currencies have caught on — Bitcoin was released only in 2009 — the IRS hasn’t quite kept pace. They issued basic guidelines in 2014 for digital currencies, but tax experts say some of the rules are subject to interpretation.

In 2016 the IRS made it clear that it was searching for cryptocurrency tax evaders: The agency sent a broad request to Coinbase, one of the larger cryptocurrency exchanges in the United States, requesting records for all customers who bought digital currency from the company from 2013 to 2015. Coinbase balked, but a court ruled that it had to provide the records of roughly 14,000 customers, fewer than 1 percent of its patrons, who made transactions involving more than $20,000 of virtual currencies.

So, come April people who have bought and sold cryptocurrency such as Bitcoin will be expected to report any profits on their federal tax returns. And considering digital currency’s wild increases in value in 2017, there are probably many people who incurred gains or losses for the first time. But how much tax you owe will depend on how and when you acquired the digital currency.

Here are some basics about the tax implications of virtual currency:

I sold digital currency last year. What does that do to my tax return?

If you are holding digital currency as an investment, any gains or losses on the sale are treated as capital assets like a stock or bond. The gain or loss is calculated against the market value of the currency when you acquired it (your basis).

If you held the currency for more than a year, you qualify for the less onerous long-term capital gains rates (generally 0, 15 or 20 percent). Short-term gains, from digital coins held for a year or less, are taxed as ordinary income.

As on the stock market, losses can be used to offset capital gains, subject to certain rules, and losses that are not used to offset gains can be deducted — up to $3,000 — from other kinds of income. Unused losses can be carried over to future years.

I’ve successfully ‘mined’ digital currency. Now what?

All cryptocurrency transactions are recorded in a public ledger, which is maintained by a decentralized network of computers. Mining refers to the process in which new digital currency coins are created and then awarded to the computers that are the first to process these transactions coming onto the network. The people whose computers do this most quickly collect a fresh helping of cryptocurrency.

These virtual miners must report the fair market value of the currency (on the day they received it) as gross income and are ultimately required to pay federal, state and most likely self -employment taxes, assuming that the mining constitutes a trade or business.

What are the tax consequences of being paid in digital currency?

Receiving wages from an employer in a virtual currency is like being paid in dollars: it is taxable to the employee, must be reported by the employer on a Form W-2 and is subject to FICA, and federal and state income tax withholding. Independent contractors paid in digital currency must also treat that as gross income and pay self-employment taxes.

What if I paid someone in cryptocurrency for their services?

When you pay an independent contractor in excess of $600 for services performed for your “trade or business,” that should be reported to the IRS and the person receiving the payment for an amount equal to the value of the cryptocurrency when paid.

Can I reduce my tax bill by donating my cryptocoins?

Only people who itemize their tax returns can deduct their charitable donations.

For those who itemize their deductions it may be possible to directly donate their cryto currency just as they can directly donate, for example, highly appreciated stock. Just as long as the charity accepts it.

For example, Fidelity Charitable, a donor-advised fund, allows people to give money, take a tax deduction in the same year, and then invest and allocate the money to select charities over time. Fidelity Charitable works with Coinbase, the exchange, to immediately turn the Bitcoin or Ether into cash, which is then invested as its donor wishes.

Will I receive any tax forms such as 1099s from my exchange?

Generally speaking, brokers and exchanges are not yet required to report cryptocurrency transactions to the IRS., as they do when you sell a stock at a profit or loss (and you receive a 1099-B or a 1099-DIV for a mutual fund).

But you will need to keep track of every move you make. Coinbase, for example, refers you to your account transaction history for records to compute your gains and losses; it also provides customers a “cost basis for taxes” report.

How did the new tax bill affect digital currency?

The bill eliminated what some interpreted to be a tax break for virtual currency holders. Under the old rules, some cryptocoin investors applied a legal maneuver often used with real estate investments to defer their capital gains. Under what is called a 1031 exchange, taxpayers can sell one property and defer taxes as long as the proceeds were reinvested in a similar, or “like-kind,” property and met certain requirements.

The IRS didn’t say this strategy could be used with virtual currencies, but some tax experts argued that it was a reasonable — albeit debatable — interpretation since the coins were considered property. Now that the tax legislation limits the use of 1031 exchanges to real estate, this strategy no longer applies. That is if it ever did.