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NEWS

NEWS

 

The Trump Administration, together with the House Ways and Means Committee and the Senate Finance Committee, recently released its
“Unified Framework for Fixing Our Broken Tax Code.”

Below is a comparison of the current tax law and the framework:

Corporate and International Tax Provisions

 

Current Law

Tax Reform Framework

Top Corporate Tax Rate

35%

20%

Top Pass Through Tax Rate

39.6%

25% on business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations

House and Senate committees to adopt measures to prevent re-characterization of personal income into business income

Carried Interest

Taxed as long-term capital gain

No specific proposal

Corporate Alternative Minimum Tax

Imposed on corporation to extent tentative minimum tax exceeds regular tax

Repeal

Depreciation

Cost recovery over period of years

Full expensing for the cost of new investments in depreciable assets other than structures made after September 27, 2017 for at least 5 years

Interest Expense

Generally deductible

Deduction for net interest expense incurred by C corporations partially limited

Committees to consider appropriate treatment of interest paid by non-corporate taxpayers

Net Operating Losses (NOLs)

Generally may be carried back two years and carried forward 20 years

No information

Research credit

Generally either 20% credit for qualifying research expenses in excess of base amount or 14% alternative simplified credit

Retain

Domestic Production Activities Deduction (IRC Sec. 199)

Up to 9% deduction for certain income attributable to domestic production activities

Repeal

Employer Provided Child Care

$150,000 maximum tax credit for on-site childcare

Portion of credit subject to recapture if child care facilities closed within first 10 years after placed in service

No information

Taxation of International Income

Worldwide with deferral

Territorial

100% exemption for dividends from foreign subsidiaries (in which U.S. parent owns at least 10% interest)

To prevent companies from shifting profits to “tax havens,” rules to protect U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations

Rules to be adopted to “level playing field” between U.S.- headquartered parent companies and foreign-headquartered parent companies

Repatriation

Repatriated foreign source income taxed at full corporate rate subject to foreign tax credit or deduction

Foreign earnings that have accumulated overseas under current system treated as repatriated

Accumulated foreign earnings held in illiquid assets taxed at a lower rate than foreign earnings held in cash or cash equivalents

Payment of tax liability spread over several years

Cross-border transactions

Silent

No information

Subpart F income

Subpart F rules limit deferral for certain foreign income

No information

Individual Tax Provisions

 

Current Law

Tax Reform Framework

Ordinary Income Tax Rates

7 brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%

12%, 25% and 35%

Additional top rate may apply

Use of more accurate measure of inflation for indexing tax brackets and other tax parameters

Capital Gains/Qualified Dividends

Short-term capital gains (held less than 1 year) taxed at ordinary income rates

Long-term capital gains (held 1 year or more) taxed at preferential rates, top rate of 20%

Dividends taxed as ordinary income; qualified dividends taxed at capital gains rates

No Information

Alternative Minimum Tax

Alternate tax calculation based on 26%/28% tax rate, payable if greater than regular tax calculation

Repeal

Net Investment Income Tax

3.8% above $200,000 adjusted gross income (single), above $250,000 (married filing jointly)

No Information

Medicare Surtax on Wages

0.9% --adjusted gross income greater than $200,000 (single), adjusted gross income greater than $250,000 (married filing jointly)

No Information

Personal Exemptions

$4,050; Personal exemption phase-out applies for taxpayers with adjusted gross income above certain amounts

Eliminate

Itemized Deductions

Phase-out applies to taxpayers with adjusted gross income above certain amounts

Eliminate most itemized deductions except home mortgage interest and charitable contributions

Standard Deduction

$6,300 (single and married filing separately)

$9,300 (head of household)

$12,600 (married filing jointly)

Additional standard deduction ($1,250) for elderly or blind

Standard deduction and personal exemption combined and increased to $12,000 (single) and $24,000 (married filing jointly)

Children and Families

Childcare tax credit

Repeal personal exemptions for dependents

Increase Child Tax Credit

First $1,000 of Child Tax Credit refundable as under current law

Increase income levels at which Child Tax Credit begins to phase out

Non-refundable credit of $500 for non-child dependents

Estate / Gift Tax Provisions

 

Current Law

Tax Reform Framework

Estate Tax

Exemption: $5,450,000, adjusted for inflation; top rate of 40%

Additional tax may apply to generation-skipping transfers

Repeal estate and generation-skipping transfer tax

Gift Tax

Lifetime exemption: $5,450,000, adjusted for inflation

Annual exclusion: $14,000 per donee, adjusted for inflation

No specific proposal

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.