Author Archives: E. John Wagner, II

Applicable Federal Rates for October 2018

The Internal Revenue Code prescribes minimum imputed interest rates and time-value-of-money factors applicable to certain loan transactions and estate planning techniques. These rates are tied formulaically to market interest rates. The Internal Revenue Service updates these rates monthly.

These are commonly applicable rates in effect for October 2018:

Short Term AFR (Loans with Terms <= 3 Years)                                          2.55%

Mid Term AFR (Loans with Terms > 3 Years and <= 9 Years)                    2.83%

Long Term AFR (Loans with Terms >9 Years)                                              2.99%

7520 Rate (Used in many estate planning vehicles)                                    3.4%

Here is a link to the complete list of rates.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Applicable Federal Rates for September 2018

The Internal Revenue Code prescribes minimum imputed interest rates and time-value-of-money factors applicable to certain loan transactions and estate planning techniques. These rates are tied formulaically to market interest rates. The Internal Revenue Service updates these rates monthly.

These are commonly applicable rates in effect for September 2018:

Short Term AFR (Loans with Terms <= 3 Years)                                          2.51%

Mid Term AFR (Loans with Terms > 3 Years and <= 9 Years)                   2.86%

Long Term AFR (Loans with Terms >9 Years)                                             3.02%

7520 Rate (Used in many estate planning vehicles)                                    3.4%

Here is a link to the complete list of rates.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

IRS Issues Small Business Tax Reform Regulations, Clarifies Combinations of Business Entities

The tax reform legislation Congress passed in December left many details unanswered, especially regarding the small business tax benefit giving some businesses a twenty percent deduction against their income if the businesses satisfy certain employee payroll and property ownership thresholds. On August 8, the Internal Revenue Service issued proposed regulations attempting to address many of the open questions.

One of the biggest questions was whether taxpayers can treat employee payroll and property owned across multiple business entities (like corporation and limited liability companies) as a single combined business for the purpose of satisfying the employee payroll and property ownership tests.

For most types of businesses, the regulations generally would allow aggregation of property and payroll amongst different entities (such as partnerships and S corporations) if the same group of persons own the majority of the business for the majority of the year, the entities satisfy certain integration and interdependence tests, and the taxpayers follow specified filing procedures.

Those rules will not apply to most professional businesses, which are subject to limitations in the use of the small business deduction. These businesses are subject to rules forcing aggregation of income to prevent circumvention of the deduction limitations.

The rules are not fully binding until finalized, but IRS will apply the anti-abuse rules retroactively. Taxpayers can rely on these proposed rules until they are finalized.

We will provide more perspective on these important new rules soon. In the meantime, for more details, you can read the proposed regulations at irs.gov.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

For Want of a Nail? How Long-Term Capital Gain Eligibility Can Turn on a Single Piece of Paper

An old proverb teaches that the absence of a horseshoe nail can cause the downfall of a kingdom. A recent Tax Court cases suggest a real estate owner’s eligibility for long-term capital gain can turn on something just as trivial:  a single piece of paper.

The Sugar Land case involved real estate businesspersons who, though various entities, held some land for investment purposes and other land for development purposes. During 2008, they decided to abandon development plans for raw land they originally intended to develop. In 2008, they executed an owner resolution expressing their change of intent. Their land holding company subsequently sold most of the property to an unrelated homebuilder in three transactions in 2011 and 2012. The company then sold substantially all the remaining property to related entities in four transactions spanning 2012 through 2016. The related entities developed that land for resale.

The IRS asserted that the 2012 sales should have generated ordinary income instead of long-term capital gain. Despite several factors militating against capital gain eligibility—including nearby development activity by related entities–the Tax Court found that the sales qualified as long-term capital gain. The court identified the 2008 owner resolution as the critical factor showing their intent.

The Sugar Land opinion is a bookend to the Fargo case we discussed in 2015. In Fargo, the Tax Court held that a taxpayer who held land without developing it for over a decade recognized ordinary income on its sale. The court reasoned that the long holding period did not overcome the absence of an owner resolution or other documentation evidencing the abandonment of the owner’s original development plan. The taxpayer could not recognize long-term capital gain.

Lesson learned? Silly or not, documenting the non-development intent for holding raw land can make a big difference in the income tax bill when the property is sold. If you want long-term capital gain, take a few minutes to make sure the owners execute a contemporaneous resolution or governing documents expressing the intent to hold the property for investment, not development. Otherwise you might tell a tale of losing your own financial kingdom, for want of just one piece of paper.

Helpful Resources:

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

When is a Rose Not a Rose? IRS Tries to Plug Carried Interest Loophole by Claiming Roses are Not Flowers

The sweeping tax law passed in December requires partners holding some “carried interests” (partnership interests disproportionately large as compared to the relative capital contributed) to recognize gain at ordinary income tax rates (up to 37%) if their holding periods do not exceed three years, as opposed to the one-year holding period normally required to qualify for 20%-tax-rate long-term capital gain. The idea is that these interests are associated with services — often performed by hedge fund and private equity managers — that don’t carry the investment risk associated with a normal capital asset, and therefore holders of these partnership interests should have to own the interests longer to qualify for a low tax rate.

The statute categorically exempts partnership interests held by “corporations” from the new rules. Without explanation, the IRS announced this week it will take the position that “S corporations” are not “corporations” for the purposes of the carried interest law, even though by definition the opposite is true throughout the Internal Revenue Code. Their interpretation is akin to claiming roses aren’t flowers.

There are common sense reasons why S corporations should not be exempt from the carried interest statute. Because S corporations are pass-through entities, there is no practical difference between an individual owning a carried interest directly, as opposed to owning it through an S corporation. Yet read literally, the statute produces different results in these practically comparable situations.

Still, statutes are supposed to mean what they say. S corporations are corporations, just like roses are flowers. Unless Congress changes the statute, the Internal Revenue Service may have a hard time defending its position in litigation.

See our prior discussion of the new carried interest law:

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Tax Savings Estimator: Qualified Business Income Deduction

If you own a business taxed as a sole proprietorship, partnership, or S corporation, the new Section 199A Qualified Business Income Deduction offers one of the biggest potential tax benefits under the recently-enacted Tax Cuts and Jobs Act. It allows you to deduct up to twenty percent of your business income. If your income exceeds $157,500 ($315,000 for a married joint filer), the deduction is limited by filters tied to your company’s employee payroll and depreciable property ownership. There are other restrictions, but for most business owners our calculator offers a useful, simplified estimate of tax savings from the new deduction.

Curious whether you should change the tax status of your company? Read our analysis here: Should You Reform Your Business for Tax Reform?

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Planning to Live Beyond 2025? How You Can Still Enjoy Estate Tax Reform’s Sunset Special

The just-enacted Tax Cuts and Jobs Act doubles the federal estate, gift, and generation-skipping transfer lifetime tax exemptions through 2025. The exemptions revert to their pre-Act levels on January 1, 2026. Ignoring inflation adjustments, the combined exemptions for a married couple will then fall from over $22 million to $11 million. At the 40% Federal transfer tax rate, a 2026 sunset will increase a married couple’s estate tax by $4.4 million.

Do you want to avoid $4.4 million of estate tax, even if you plan to celebrate the 2026 New Year amongst the living?

A married couple can permanently harvest the increased exemptions by gifting assets with value up to the full $22 million exemption amount before 2026. If you gift into a generation-skipping trust, the exempted assets can pass through many generations free of transfer tax. With valuation discounts for lack of control and lack of marketability still fully available, family business assets are particularly attractive for gifting.

A taxpayer can not use the increased exemption until he or she first make gifts exhausting his or her pre-Act exemption. An individual does not create an additional tax benefit until he or she first gifts about $5.5 million worth of property. A couple does not capture the full additional benefit until they give away property worth over $22 million.

These ordering rules create an obstacle for many, who can not afford to give away that much property. Married taxpayers in that situation may consider funding “Spousal Lifetime Access Trusts.” Each spouse gifts assets to a trust for the other spouse, leaving the gifted assets available to the beneficiary spouse for his or her lifetime. When the beneficiary spouse dies, the remaining trust assets pass to children or other beneficiaries free of estate tax. Persons who created such trusts shortly before 2013, when another legislative sunset almost reduced the lifetime exemptions, can fund their existing trusts with additional gifts.

Many families will wait until 2026 is closer before taking action. Families with sufficient wealth to afford substantial gifting, who also expect estate tax liability even with the increased exemptions, should consider gifting sooner, to remove appreciation in the gifted assets before 2026 from their future taxable estates.

For more information regarding the Tax Cuts and Jobs Act, follow these links:

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Rethinking Large 2017 Year-End Charitable Gifts

With the standard exemption increasing and federal income tax rates generally falling in 2018, accelerating charitable gifts into 2017 may seem like a no-brainer. You might want to think twice if you plan a large charitable gift.

Under current law, the income tax charitable deduction and many other itemized deductions gradually phase out as income increases above $313,800 for married jointly filing taxpayers. The phase out continues until the deductions are reduced by 80%.

The just-enacted Tax Cuts and Jobs Act suspends this limitation, allowing charitable and other itemized deductions without the income-based phase out.  This could cause a 2018 charitable gift to produce a more valuable tax benefit than a 2017 gift, particularly for large gifts.

If you are unsure how to proceed, ask your CPA to run the numbers in both scenarios.  Better to wait a year for the deduction, than to receive a much smaller benefit than you expected.

For more information regarding the Tax Cuts and Jobs Act, follow these LINKS:

http://blog.williamsparker.com/businessandtax/2017/12/18/whats-tax-reform-bill/

http://blog.williamsparker.com/businessandtax/2017/12/18/reform-business-tax-reform/

http://blog.williamsparker.com/businessandtax/2017/12/19/2017-year-end-planning-art-equipment-non-real-estate-1031-exchanges/

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

 

2017 Year-End Planning for Art, Equipment, and Other Non-Real Estate 1031 Exchanges

The Tax Cuts and Jobs Act eliminates Section 1031 Exchanges for non-real estate transactions effective January 1, 2018.  But you still have time to plan If you anticipated executing an early-2018 1031 Exchange with art, equipment, or other non-real estate investment assets.

The Act includes a transition rule that allows a taxpayer to complete a non-real estate 1031 Exchange during 2018 if the taxpayer either acquires replacement property for a “reverse” exchange or disposes of relinquished property for a “forward” exchange before January 1, 2018.

To take advantage with property you haven’t sold, consider causing a related-party taxpayer—such as a corporation you control—to purchase the property before year-end, and escrowing the proceeds with a qualified intermediary. The related party can sell the property to an unrelated party with a stepped-up tax basis a few years later.  You can complete the 1031 Exchange in 2018 using the escrowed proceeds in the usual 1031 Exchange time frames.

For a reverse exchange, you can park replacement property purchased before year end with an accommodation titleholder, and complete the exchange by selling the relinquished property in 2018 within the usual 1031 Exchange time frames, with the same result.

These strategies are not risk-less.  For example, in the forward exchange scenario, you will recognize gain and pay tax if you can’t complete the exchange within 180 days, even though you initially “sold” property to a related party.  But in the right situation, some taxpayers might nevertheless use the transition rules to make something out of nothing.

To read the transition rules, see page 192 of the Act.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

 

Should You Reform Your Business for Tax Reform?

If you own a closely-held business, it likely utilizes a “pass-through” S corporation or partnership tax classification.  The owners pay income tax individually on pass-through entity income, whether or not the business distributes the income.

C corporations are different.  C corporations pay tax on their own income.  The shareholders pay an additional dividend tax only when the C corporation distributes dividends.

Under the Tax Cuts and Jobs Act that Congress likely will pass Tuesday, the federal tax rate on retained C corporation income will drop from 35% to 21%.  The top individual tax rate, which also applies to pass-through entities, will equal 37%.  The Act makes C corporation tax status more attractive than in the past.

Should you convert your pass-through business to a C corporation?  

Should you change the tax classification of your business?

The short-answer: Probably not, unless you plan to own the business a long time and indefinitely reinvest profits.

A longer answer:

Under the Act, converting your business into a C corporation creates a trade-off between:

  1. a lower tax rate on operating income, leaving more cash to reinvest in the business; and
  2. paying more tax (or getting a lower purchase price) when you sell the company, and having less flexibility taking profits out of the business in the meantime.

If you convert your Florida-based pass-through business to a C corporation, the business will pay state income taxes that pass-through entities avoid. The C corporation’s combined federal and state tax rate will reach just over 25% on reinvested income.

The problems? You will pay a higher or equivalent tax rate, as compared to the pass-through tax rate, if you take the profits out of the corporation.  If you sell the business as a C corporation you will (1) pay about a 43% combined corporate-level and shareholder-level tax rate on the sale gain (versus a likely 20% or 23.8% rate as a pass-through), or (2) receive a lower purchase price to compensate a buyer willing to purchase the corporation stock for forgoing a tax basis step up in the corporate assets.  And if laws or circumstances change, you cannot always readily convert back to pass-through status without negative tax consequences.

What’s in the Act for Pass-Through S Corporations and Partnerships?

The Act includes a new deduction of up-to-20% of income for pass-through businesses.  If your business earns $10 million of income, you might qualify to deduct $2 million.  The deduction would save $740,000 in federal income tax and reduce the business’ effective income tax rate from about 36% to approximately 29%.

The catch?  For taxpayers with income over about $400,000 (or a lower threshold for persons other than married, joint filers), the Act limits the deduction to (1) 50% of the wages paid to employees, or (2) the sum of 25% of wages, plus 2.5% of the value of owned depreciable property.  If the business earns a $10 million profit, but its payroll is $3 million, you may only qualify to deduct $1.5 million, not $2 million. Unless the business has a lot of payroll or owns substantial depreciable property, its tax rate may remain in the mid-to-high 30% range.

Despite the new deduction, the Act leaves most pass-through entity owners paying a higher tax rate than C corporations pay on reinvested business profits.  But most pass-through entities retain the advantages of a lower tax rate on profits distributed to owners and on the sale of the business.

What to Do?

If you can predict future payroll and equipment purchases, the price and timing of a business sale, and Congress’ whims, you can perform a present value calculation to decide whether pass-through or C corporation tax status is best for your business.  The calculation would compare the pre-business-sale tax savings from the reduced C corporation tax rate on reinvested profits, against the increased tax on distributed profits and from a future business sale.

The math is more complicated for businesses qualifying for other tax breaks, such as the Section 1202 small business stock gain exclusion.  It grows even more complicated if the model considers the tax effects of an owner’s death.

If your crystal ball isn’t clear, you are stuck making best guesses about the future of politics and your business.  But if you frequently take profits out of your business or imagine selling it in the foreseeable future, you probably will stick with the pass-through  tax status your business already uses.

For more comprehensive information regarding the Tax Cuts and Jobs Act, follow this link to our previous post.

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037