The permanent reduction of the corporate income tax rate from a maximum of 35 percent to a flat 21 percent has led many businesses to reevaluate their current tax positions and reconsider their entity choice. The decision to convert from a pass-through entity to a C corporation, however, should not be based solely on how the IRS will tax business earnings in the short-term. Instead, business owners should consider a broader range of short- and long-term factors unique to their specific circumstances, including, but not limited to, their stage of development, the industry in which they operate, the makeup of their investors, their plans for distributing earnings, and their exit strategies.
Over the last few decades, pass-through structures have been the entity of choice for most closely-held domestic businesses. Owners of S corporations, LLCs and partnerships, could avoid both the U.S.’s corporate tax rate, which was among the highest in the world, and the imposition of a second level of tax on dividends distributed to their owners or the sale of corporate stock. On the contrary, owners of these businesses pay taxes just once, at their individual income tax rates, on their share of the entities’ profits. With tax reform and the reduced corporate tax rate changes, C corporations are now a more attractive structure for tax purposes. This is especially true when entities meet the requirements for issuing qualified small business stock (QSBS) and there is a likelihood of selling those shares as part of an exit strategy five years or more down the road.
Under Section 1202 of the tax code, individuals who acquired stock after Sept. 27, 2010, in a qualifying small business structured as a C corporation may exclude up to 100 percent of the gain they incur from selling those shares after Dec. 31, 2017. The amount of the gain eligible for exclusion can be as much as the greater of $10 million or 10 times the shareholder’s basis in the stock, which could translate to hundreds of millions of dollars in tax savings for qualifying C corporation shareholders. In other words, business owners and investors can realize a 0 percent tax rate on the profits they reap from selling stock in qualified small business corporations, provided they meet a long list of requirements. For example, they must have acquired the stock directly from the issuing entity or by gift or inheritance and held onto it for a minimum of five years before the sale. Special care should be taken to document any tangible or intangible property shareholders contribute to the corporation in exchange for the QSBS.
Electing to be a C corporation that issues QSBS is especially beneficial to start-up businesses that seek to raise as much capital as possible, in as many rounds as needed, from private investors and/or the public equity markets. Unlike S corporations that are limited to a maximum of 100 shareholders, C corporations can issue stock to an unlimited number of investors, including private equity funds.
On the downside, C corporations will continue to pass a second level of tax at a rate of 23.8 percent onto their shareholders when they pay dividends to them. However, the slashing of the corporate rate to 21 percent lessens this blow as does a business’s ability to control the timing of the dividend distributions and related tax liabilities they pass on to their owners.
In general, businesses in start-up and early stages are more likely to retain and reinvest earnings, building up ample working capital to finance their operations and continuous growth, rather than distributing profits to shareholders. In fact, owners of C corporations may limit their tax burden to only 21 percent of corporate earnings and avoid additional tax exposure for many years as long as they plan carefully and refrain from paying out dividends or becoming subject to an accumulated earnings tax. Conversely, owners of S corporations will pay taxes on all of their businesses’ earnings at a rate as high as 37 percent as well as a potential 3.8 percent Net Investment Income Tax (NIIT) regardless of whether or not they receive dividend distributions. The only saving grace for these pass-through entities, if they qualify based on such factors as their lines of business, their income, the wages they pay to employees and the cost of their fixed assets, is a new deduction of up to 20 percent on certain items of business income. Yet, even with the full benefit of this qualified business income (QBI) deduction, S corporation owners will still be subject to a top effective income tax rate of 29.6 percent plus potential Net Investment Income Tax of 3.8%, as opposed to C corporations which can limit their tax liabilities to a flat 21 percent rate, plus state income taxes, if any.
In order for shareholders to be issued QSBS, entities must have gross assets of less than $50 million on the date they issue stock to investors and immediately thereafter, taking into account the amount they raised through the stock issuance. In addition, they must use at least 80 percent of their assets to actively conduct non-service-oriented business activities, which specifically excludes those businesses that provide services in the fields of banking, finance, insurance, investing, hospitality, farming, mining and owning, dealing in, or renting real estate. In fact, no more than 10 percent of the value of the issuing company’s net assets may consist of real estate or stock and securities of unrelated corporations.
While the reduction of the corporate income tax rate may increase interest in C corporation status, there is little doubt that such an election will yield even more favorable tax savings for owners of start-up, early stage and smaller companies that intend to go public or be sold for a profit in the future. QSBS investors can enjoy tax-free income from the sale of the corporation’s stock or even roll over their gains free of taxes into shares of another qualified small business corporation without losing the benefit of the gain exclusion upon the sale of the replacement QSBS. With the new tax law, businesses and their owners should plan even more carefully than ever with the guidance of experienced advisors and accountants in order to maximize the potential benefits of a C corporation.
About the Author: Barry M. Brant, CPA, is director of Tax, Consulting and International Services with Berkowitz Pollack Brant, where he leads the firm’s private client group and provides guidance on complex tax matters, including multi-national holdings, cross-border treaties and wealth preservation and protection. He can be reached at the CPA firm’s Miami office at (305) 379-7000, or via email at firstname.lastname@example.org.
Tax reform’s aim to protect the US tax base and prevent domestic companies from shifting jobs, manufacturing and profits to lower tax jurisdictions overseas resulted in a significant benefit to export businesses. Not only does the new law preserve the preferential tax treatment of Interest Charge-Domestic International Sales Corporation (IC-DISC), it also introduces a new tax incentive for C corporations that sell American-made goods or services to foreign customers for consumption outside of the U.S.
Interest Charge-Domestic International Sales Corporation (IC-DISC)
U.S. businesses that sell, lease or distribute goods made in the US to customers in foreign countries may realize significant tax benefits when they create an IC-DISC to act as their foreign sales agent to which they pay commission as high as 4 percent of gross receipts or 50 percent of taxable income from the sale of export property.
Essentially, a qualifying business forms the IC-DISC as a separate US-based “paper” company, typically with no offices, employees or tangible assets, to receive tax-free commissions that the business can claim as deductions that ultimately reduce its taxable income. The amount of the tax savings the business may reap for the commission it pays to the IC-DISC can be as high as 37 percent, depending on its structure (21 percent for C corporations beginning in 2018) and its source of income. Only when the IC-DISC distributes earnings to shareholders will there be a taxable event. At that time, the shareholders will be liable for paying taxes on the IC-DISC earnings at lower qualified dividend rates not to exceed 23.8 percent.
While businesses that make IC-DISC elections are most commonly exporters and distributors of U.S.-manufactured products or their components, software companies, architects, engineers and other contractors who provide certain limited types of services overseas may also qualify to take advantage of this permanent tax benefit.
Foreign Derived Intangible Income (FDII)
To encourage U.S. corporations to keep their exporting operations and profits in the country, the TCJA introduces a new tax-savings opportunity in the form of a deduction of as much as 37.5 percent on profits earned from Foreign Derived Intangible Income (FDII).
This new concept of FDII is defined as income C corporations earn from (1) sales or other dispositions of property to a foreign person for a foreign use; (2) an IP license granted to foreign person for a foreign use; and (3) services provided to a person located outside of the U.S. The types of services that qualify for FDII are not severely restricted, like they are for IC-DISC applications.
Under the law, FDII earned after Dec. 31, 2017, is subject to an effective tax rate of 13.125 percent until 2025, when the rate is scheduled to increase to 16.046 percent for a total FDII deduction of 21.87 percent. That’s quite an incentive for domestic businesses to use the U.S. as its export hub and distribute products made in the country to foreign parties located outside the country!
It is important to note that like most provisions of the tax code, the FDII deduction is subject to a number of restrictions and calculation challenges. For example, it applies only to domestic C corporations, which under the TCJA are subject to a permanent 21 percent income tax rate beginning in 2018, down from 35 percent before tax reform. In addition, the amount of the deduction is reduced annually by 10 percent of the corporation’s adjusted basis of depreciable tangible assets used to produce FDII.
Corporate taxpayers that combine the benefits of an IC-DISC and the new FDII deduction may receive enhanced tax savings. However, every business entity is unique and not all businesses will qualify to apply the benefits of both export tax incentives. However, with proper planning under the guidance of experienced tax professionals, businesses can maximize the benefits that are available to them.
For example, an S corporation or LLC with an IC-DISC may not realize the added tax savings of the FDII deduction, which is only available to C corporations. While an S corporation may consider changing its entity structure to a C corporation to take advantage of the lower tax rate, it must first consider its unique business goals and weigh them in context against all of the new provisions of the new tax code, which will affect the tax liabilities of both the business and its shareholders.
Companies doing business across borders can successful plan around the new provisions of tax law with the strategic counsel and guidance of knowledgeable advisors and accountants with deep experience in these matters.
About the Author: James W. Spencer, CPA, is a director of International Tax Services with Berkowitz Pollack Brant, where he focuses on a wide range of pre-immigration, IC-DISC, transfer pricing and international tax consulting issues for individuals and businesses. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service
The IRS issued its annual update to the daily rates that employers may use to reimburse employees for lodging, meals and other incidental expenses that workers incur while traveling for business purposes.
The per diem rates are fixed amounts that employers may use to more easily reimburse workers for ordinary and necessary business travel expenses without requiring the collection and calculation of actual costs incurred. These payments are not considered taxable income to employees as long as workers substantiate their claims with detailed expenses reports. However, should a business reimburse an employee for more than the per diem rate, the employee is responsible for paying taxes on that amount.
Effective Oct. 1, 2018, the per diem meal and incidental allowances for taxpayers in the transportation industry are $66 within the continental U.S. and $71 for travel outside of the region. These expenses include all meals, laundry and dry cleaning services, and tips provided to food servers, porters, baggage handlers and other hotel employees.
For purposes of the high-low substantiation method, the per diem rates are $287 for travel to a high-cost locality and $195 for travel to any other locality within the continental U.S. The per diem rates for solely meals and incidental expenses is $71 for travel to high-cost localities and $60 for any other area within the continental U.S. In addition, the IRS updated its list of localities, including New York City, San Francisco and Aspen, Colo., which have a high cost of living during all or a portion of the year and therefore have a federal per diem rate of $241 or more.
The per diem rates are especially important to workers in 2018 because the Tax Cuts and Jobs Act eliminates their ability to deduct unreimbursed job expenses and miscellaneous itemized deductions through 2025. Therefore, it behooves workers to speak with their employers and request reimbursements for those business-travel expenses in order to recoup even a portion of the money they personally lay out to pay for costs that are necessary for their jobs.
About the Author: Dustin Grizzle is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides corporate structuring, tax-planning and compliance services to real estate developers, management firms and investment companies; manufacturing businesses with large inventories; and high-net-worth families. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
With the tax year coming to an end, it is critical that business owners remember they have obligations to report by Jan. 31, 2019, the compensation they paid to employees and to all independent contractors and service providers during the prior tax year. This leaves businesses with limited time after an often hectic holiday season to review their records and issue Forms 1099-MISC to each non-employee to whom they paid more than $600 during the year.
To help your business expedite this process and meet the filing deadline, consider working with Berkowitz Pollack Brant’s Accounting Intelligence team. Our advisors can help you identify and gather information about contactors and vendors to whom who have a reporting obligation. Subsequently, we will prepare the required IRS forms and submit them on your behalf to both the government and each vendor who receives compensation from you. If you are required to file more than 250 information returns, which include W-2s and 1099s, you must file electronically or you will be subject to significant IRS penalties.
In addition, with the prospect of the New Year, it is a good time to review your accounting records and ensure that you have on file Forms W-9 for each and every vendor you pay. This will help enable you to more easily determine which vendors should receive Form 1099-MISC from you next year.
To learn more about how we can help you to ease the administrative burden of your information reporting requirements, please contact one of our Accounting Intelligence team members at (954) 712-7066.
About the Author: Laurence Bernstein, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant and the leader of the firm’s Accounting Intelligence group.
He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at email@example.com.
Businesses today are challenged by what may be considered the most rapid pace of change in history. New technological advancements and accelerated economic swings are creating a perfect storm for which organizations have little time to prepare and adapt for survival, let alone for success. However, the one beacon of light that an organization can rely on to guide it through these treacherous waters and protect it from irreparable damage is its organizational culture. The question then becomes, what is an organizational culture and how can an entity develop and hone it to serve as its lighthouse in a storm.
Organizational culture can be defined as the collective norms, values, attitudes and work habits that the members of an organization share and agree to uphold. To put it another way, if a company’s brand is its face, its organizational culture is its soul. It reflects the formal and informal behaviors, interactions and underlying traditions, beliefs and processes that tie individuals to an organization and keep them there, whether they be loyal employees, clients, business partners or even donors. It is how individuals would describe the organization, its structure, unique attributes and vision, under oath, using both tangible and intangible concepts. In this sense, an organization’s culture must align with its vision and subsequently be woven into its strategy.
Yet, unlike the fact-based economic and contractual nature of business, corporate culture is both subjective and objective, and therefore much more difficult for an organization to standardize. While a culture can change based on the influence of internal and external sources, including the behaviors of an organization’s leadership, a CEO or business owner cannot dictate or will a cultural change without backing up his or her words with action.
Following are eight strategies that organizations can rely on to build and strengthen organizational trust and a cohesive culture that becomes the motivation and rallying cry for its success and the success of its individual employees.
Create a Compelling and Shared Vision
A vision helps an organization identify what it hopes to be famous for and connects workers to that shared goal. Not only does it encourage employees to work together, but it also centers them around a common purpose that inspires them to learn, grow and give their best efforts every day. When you involve employees in the vision-planning process, you allow them to have a voice and contribute to creating something special and meaningful. Consequently, they are more likely to be engaged in their jobs and loyal to their employers.
Define the Culture to Support Business Strategies
Businesses must invest in policies and practices that facilitate employees’ efforts to integrate the demands of their professional work with the obligations of their personal lives. Special care should be taken to help employees avoid a tug of war between work and family, which will ultimately undermine the goals of the organization and lead to higher incidence of employee burnout and turnover. Instead, select a set of guiding behaviors to define the desired culture and reinforce them through a variety of measurable team-building and team-training programs.
Spend Quality Time Together.
Most working professionals spend the majority of their time on the job, whether that be in an office or out in the field with coworkers, clients or business partners. While this requires workers to get along, it does not always translate to lasting friendships, which ultimately affect loyalty and culture. Instead, organizations should look for opportunities to gather together employees and their family members outside of the work environment, where they can interact on a more social level and create strong emotional connections that tie workers to each other and to the organizations themselves.
Create Quality Traditions
Organizations can strengthen genuine connections and reinforce loyalty by developing high-quality and consistent traditions, practices and other experiences that members of an organization share on a regular basis. For example, a business may employ a policy of dress-down Fridays, host an annual bring-your-child to work day or encourage workers to bring their pets to the office. Similarly, organizations can help workers build deep connections in their communities by organizing teams to participate in charitable fundraising events or volunteering their time to help others in need. The more these traditions involve family members, the more fun workers will have and the more emotional their connections will be to the organization.
Improve Organizational CommunicationA strong and resilient culture cannot develop in a vacuum. Organizations must work diligently to create a two-way street of open, honest and transparent communication between all of its members. Moreover, they must recognize when there are weaknesses in this open flow of information and take steps to repair them. Not only should organizations create open discussion forums for their CEOs or presidents, but they should also expect and even encourage workers to ask questions and receive answers.
Help Employees Build Their SkillsPeople want to be a part of organizations that are interested in their development as individuals. A healthy organizational culture provides a stimulating environment that emphasizes and encourages employees’ professional and personal growth. This may involve investment in employee training and education, mentoring and other leadership-development programs as well as annual reviews of worker performance.
Monitor Employee Satisfaction
To gauge the effectiveness of their culture-building strategies, organizations need to look no further than its front-line employees. Are workers satisfied? The only way to answer this question is to ask. By monitoring employee satisfaction on a frequent and consistent basis, organizations can more quickly identify and respond to areas that need improvement.
Make Culture an Ongoing Organizational Commitment
Because an organization’s culture will radiate outside of its workforce to its clients and its bottom line, it is critical that culture programs receive high priority. In fact, a half-hearted commitment to developing and cultivate culture can be far worse than no commitment at all. The goal should be to inspire employee engagement and build genuine connections based on trust, rather than requiring employees to grudgingly comply with a laundry list of top-down rules and regulations.
Creating the right organizational culture is crucial to an entity’s long-term success and profitability. It is the only distinctive and sustainable long-term competitive advantage available to businesses. It starts at the level of internal policies and procedures and extends to how leaders interact with employees and demonstrate their commitment to workers’ individual successes. From there it radiates outside of the organization’s physical walls, affecting the level of services it provides and the reputation that it needs to project to attract and retain quality workers and develop trusted relationships with clients.
About the Author: Richard A. Berkowitz, JD, CPA, is founding and executive chairman of Berkowitz Pollack Brant and Provenance Wealth Advisors (PWA), where he provides business consulting, growth strategies and succession-planning consulting to entrepreneurs and companies. He can be reached at the firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at firstname.lastname@example.org.