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Tax Reform and its Impact on U.S. Businesses by Laurence Bernstein, CPA

Posted on April 20, 2018 by Laurence Bernstein

It can be argued that U.S. businesses and their shareholders will be the biggest winners from the Tax Cuts and Jobs Act (TCJA). However, because the law falls short of its aim to simplify the tax code, significant advance planning under the guidance of professional advisors is recommended to help taxpayers dig through the law’s complexity and reap its potential benefits.

Business Taxes

One of the most significant provisions of the TCJA is an immediate and permanent reduction in the corporate tax rate from 35 percent to a flat 21 percent and a complete repeal of the corporate alternative minimum tax. This historically low rate takes the U.S. off its perch as the country with the highest corporate tax rate and puts it a more competitive position compared with other advanced economies around the globe.

For businesses organized as pass-through entities, which represent more than 90 percent of all U.S. businesses, the new law is far more complicated. In general, the TCJA introduces a potential 20 percent deduction on certain income that flows from S Corporations, partnerships, LLCs and sole proprietors through to their owners’ individual income tax returns.  However, there are a number of limitations and exclusions to this deduction based on such factors as the new concept of qualified business income (QBI), the amount of W-2 wages a business pays and the cost of the depreciable income-producing property owned by the business. Additional limitations apply to “specified service businesses” in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, and financial and brokerage services or any other business whose primary asset is the reputation or skill of its owner or employees. How the IRS will interpret this provision remains to be seen as of today. What is known if that, unlike the corporate tax reduction, the treatment of pass-through businesses, is scheduled to expire in 2025.

With just these provisions in mind, it makes sense for some pass-through businesses to weigh the pros and cons of restructuring as C corporations in the near future. Consideration should be given to such matters as state and local tax liabilities and deductibility, exposure to double taxation and the tax treatment of retained profits and dividends paid to owners and partners of C corporations. If business owners intend to reinvest profits in their companies, a C corporation structure may make the most sense. Alternatively, if businesses intend to pull profits out their companies to distribute them to their owners, a C corporation with double-tax treatment may be more expensive. Based on the taxpayer’s specific and unique facts and circumstances, a conversion may not be the best option for minimizing tax liabilities.

Credits and Deductions

The TCJA provides corporations with a mixed bag of both limited and enhanced credits and deductions that may require careful planning in 2018 to minimize future tax liabilities.

For example, gone are deductions for domestic production activities. In addition, businesses may no longer deduct expenses for entertainment, including costs they incur for seats or suites at entertainment venues, tickets and meals for sporting events and concerts, and dues for membership in in business, recreational and social organizations.

The costs that a taxpayer incurs when treating clients or prospective customers to a business-focused lunch or dinner remains 50 percent deductible, as long as the meal occurs outside of an entertainment facility. Similarly, a company may continue to deduct 50 percent of the reimbursement for meals they provide to traveling employees and 100 percent of costs for a holiday party or similar employee event. However, under tax reform, businesses have until Dec. 31, 2025, to deduct on an annual basis only 50 percent of the costs for meals they provide to their employees for their benefit or in an employer’s on-site cafeteria. Despite these limitations, the law does provide businesses with some enhanced benefits.

Net Operating Losses (NOLs)

Net operating losses are a prime example of the ying and yang of tax reform. While NOL carrybacks areno longer allowed beginning in 2018, unused losses that were previous limited to 20 years of carryforwards are now permitted to be carried forward indefinitely. Yet, only 80 percent of taxable income will be can be offset with an NOL carryforward. As a result, corporations will no longer be able to use NOLs to bring their tax liabilities to zero.

Limitations to Business Interest Deduction

The deduction for business interest, including interest on related-party debt, is limited for certain taxpayers under the new law to 30 percent of earnings before interest taxes, depreciation and amortization (EBITDA) until 2021. At that point, the limitation is set to apply to earnings before interest taxes (EBIT). Any remaining business interest expense that is not allowed as a deduction may be carried forward indefinitely and applied to future tax years. An exception to the 30 percent limitations exists for businesses whose gross receipts for the three most recent tax ears are less than $25 million, as well as for qualifying taxpayers who accrued interest in real property trades or business that elect the slower alternative depreciation system or ADS. Additional guidance on this topic is forthcoming from the IRS.

Limitations to Carried Interest

The TCJA preserves the favorable long-term capital gains treatment of gains from partnership interest held by managers and partners for a share of a business or project’s future profits. Yet, it also limits the benefit to assets held for a minimum of three years, rather than the previous holding period of one year, unless a corporation owns the partnership interest.  The new longer holding period applies to capital assets.  Curiously, the law does not apply the longer holding period to trade or business assets, also known as Section 1231 assets, which typically include apartments, office buildings and other depreciable property used in a trade or business and held for more than one year. We will watch for additional guidance from the IRS and on this topic.

Expanded Opportunities to Expense Business Assets

One significant bright spot in corporate tax reform deductions is available for businesses that invest in capital assets. For one, qualifying tangible property that businesses acquire and put into service after Sept. 27, 2017, and before Jan. 1, 2023, may be eligible for 100 percent “bonus” depreciation in the year of purchase. The new law defines qualifying property as tangible personal property with a recovery period of 20 years or less and including for the first time used property. Prior to the TCJA, bonus depreciation was limited to 50 percent of the cost of new tangible property or non-structural improvements to the interiors of nonresidential building.

Expanded Definition and Expensing of Section 179 Property

The new law expands the definition of Section 179 qualifying improvement property and business assets to include improvements to nonresidential property, such as roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems; and security systems improvements. In addition, the law increases the maximum amount a taxpayer may expense under Section 179 to $1 million per year. Previously, the Section 179 deduction was limited to $500,000, and it began to phase out at $2 million.

Changes in Accounting Methods

The TCJA qualifies a larger percentage of corporations and partnership to use the cash method of accounting when filing their tax returns, rather than the accrual method, by raising the gross receipts test from $5 million to $25 million over a three-year period. Moreover, taxpayers that meet the average gross receipts test are no longer required to account for inventory using the accrual method. Rather, taxpayers have the option to either treat inventory as non-incidental materials and supplies or rely on the same method of accounting they use for financial statement purposes.

In order for businesses to take advantage of what may be the largest corporate tax cut in history, proper and timely planning is required. The professional advisors with Berkowitz Pollack Brant work with domestic and international businesses to implement tax efficient strategies that comply with complex laws and minimize taxpayer’s liabilities.

About the Author: Laurence Bernstein, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides tax and consulting service to high-net-worth families, entrepreneurs and growth-oriented business owners.  He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at lbernstein@bpbcpa.com.

Information contained in this article is subject to change based on further interpretation of the law and guidance issued by the Internal Revenue Service.

IRS Provides Initial Guidance on New Tax and Withholding Rules for Foreign Partners Disposing of Partnership Interests by Arthur Dichter, JD

Posted on April 19, 2018 by Arthur Dichter

The IRS issued Notice 2018-29 providing guidance relating to the new withholding rules that apply when a foreign person disposes of a partnership interest. An IRS notice does not have the force and effect of actual regulations, but it does provide taxpayers with direction on how the IRS expects to enforce rules and eventually issue regulations in the future.

The recent tax reform law codified a long-held IRS position that gain or loss from the sale, exchange or other disposition of a partnership interest by a nonresident alien or a foreign corporation is taxable to the extent that the foreign person would have been subject to tax had the partnership sold all of its assets at fair market value. This rule applies to dispositions occurring on or after November 27, 2017. The notice does not provide any further guidance on determining the actual gain that is subject to tax.

The Tax Cuts and Jobs Act (TCJA) added an obligation for the acquirer (transferee) of a partnership interest to withhold a 10 percent tax on the amount realized on the transfer unless the transferor furnishes an affidavit or certificate to the transferee stating that the transferor is not subject to withholding. If the transferee fails to withhold the tax, the partnership is required to withhold from distributions to the transferee until the unpaid withholding tax (plus interest) has been satisfied. The recent Notice does not address the mechanics for this withholding. The IRS previously issued guidance suspending the withholding requirement on dispositions of certain publicly traded partnerships.

Notice 2018-29 generally adopts the forms and procedures for withholding on dispositions of U.S. real property interests under the Foreign Investment in Real Property Act (FIRPTA), which requires the purchaser of a U.S. real property interest from a foreign person to withhold and remit 15 percent of the sale proceeds as a withholding tax. The purchaser uses Forms 8288 and 8288-A to report the amount realized and the amount of tax withheld to the IRS, which then processes the withholding tax and returns a stamped copy of Form 8288-A to the transferor. In order to claim a credit for the withholding tax on their income tax return reporting the sale, the transferor must attach a copy of the IRS-stamped copy of Form 8288-A.

The Notice further provides that the transferee of a partnership interest should write “Section 1446(f)(1) withholding” at the top of Forms 8288 and 8288-A and remit payment within 20 days of the transfer of partnership interest. Transferees who fail to withhold properly are liable for the tax, and failure to submit the withholding tax may result in other civil and criminal penalties. The IRS will not assert penalties or interest when transferees file these forms and pay amounts to the IRS on or before May 31, 2018.

Under the Notice, transferees may eliminate their withholding obligation when they receive the following certifications:

  • A certification of non-foreign status or IRS Form W-9 from the transferor;
  • A certification from the transferor that no gain will be recognized on the transfer;
  •  A certification from the transferor that the partnership interest had been held for at least two years and his or her allocable share of partnership effectively connected income (ECTI) was less than 25 percent of his allocable share of all partnership income;
  •  A certification from the partnership that if it sold all of its assets, the amount of gain that would have been treated as ECTI (including gain from U.S. real property interests) would be less than 25 percent of the total gain; or
  •  A certification from the transferor that a non-recognition provision applies.

The exact information that transferees must receive differs for each certification. However, in general, the transferor or partnership must sign the certification under penalties of perjury. The transferee can rely on the certification unless he or she has knowledge that the information is false.

For purposes of determining the amount realized that is subject to withholding, the disposing partner must consider the amount of liability relief he or she obtained and include the amount realized on the transfer. A partner who owned a less than 50 percent interest in partnership capital, profits, deductions or losses may provide the transferee with a certification that provides the following:

  • the amount of the partner’s share of partnership liabilities reported on his or her most recently received Schedule K-1, and
  •  confirmation that he or she does not have actual knowledge of events occurring after the issuance of the Schedule K-1 that would cause the amount of his or her share of partnership liabilities to be more than 25 percent above than the amount shown on the K-1.

The partnership may also issue a certification relating to the transferor partner’s share of liabilities. The notice does not specify a method for a partner who owns 50 percent or more of the partnership to certify his or her share of partnership liabilities. Therefore, in that situation, presumably the partnership certification would be required.

The total amount withheld cannot exceed the amount the transferor realized (without considering the transferor’s liabilities). If the transferee is unable to determine the amount realized because certification of the transferor’s share of liabilities is not provided, the transferee must withhold the entire amount he or she realized, determined without regard to the transferring partner’s liabilities.

The tax and withholding rules apply to partnership distributions in excess of the foreign partner’s basis in the partnership that would be treated as a capital gain (a partial disposition of the partnership interest).

These rules also apply in cases involving tiered partnerships. If a transferor transfers an interest in an upper-tier partnership that owns an interest in a lower-tier partnership, and the lower-tier partnership would have effectively connected taxable income (ECTI) on the deemed disposition of all of its assets, a portion of the gain recognized by the transferor is characterized as effectively connected gain. Therefore, the lower-tier partnership would be required to provide the upper-tier partnership with information in order for the upper-tier partners to be able to comply with these rules.

The advisors and accountants with Berkowitz Pollack Brant work with domestic and foreign individuals and businesses to comply with international tax laws, maximize tax efficiency and reduce unnecessary compliance costs.

About the Author: Arthur Dichter, JD, is a director of International Tax Services with Berkowitz Pollack Brant, where he works with multi-national businesses and high-net worth foreign individuals to structure their assets and build wealth in compliance with U.S. and foreign income, estate and gift tax laws. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.

 

 

 

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