Category Archives: Legislation

Tax Reform Swings a Hand Ax at Carried Interests; What Does it Mean and How Can I Plan Around It?

While tax reform has a long march before becoming law, the amended House of Representatives bill passed yesterday swings an ax at lower-tax-rate-capital-gain-eligible “carried” partnership interests, though it swings a smaller ax—like a hand ax rather than a full-sized ax—than proposals in years past.

This latest proposal focuses on limited industries and allows an escape hatch for interests held more than three years. Here are the details:

How Do I Know if I Have a Carried Interest, and Why are Carried Interests Special?

The phrase “carried interest” applies to a partnership interest granted to a partner for services.  The idea is that the capital-investing partners “carry” the service partner, who does not make a capital contribution in proportion to the service partner’s interest.

Partnerships often structure carried interests to have little or no value at grant, causing the recipient to recognize little or no wage or other compensation income at that time.  Later, if the partnership recognizes long-term capital gain, the partnership allocates part of that gain to the service-providing partner.  This results in the service partner paying tax at a tax rate as little as half the rate on wage or compensation income (approximately 20%, as compared to approximately 40%, depending on the circumstances).

Why Change the Tax Treatment of Carried Interests?

Critics complain that carried interest partnership allocations amount to a bonus that should be taxed at the higher ordinary rates, like wage income and other incentive compensation.  The most vocal criticism focuses on hedge funds, private equity firms, and real estate investment firms, where critics see carried interest allocations as the equivalent of management fees.  Past Congressional proposals would have recharacterized a percentage or all partnership allocations to carried interests as compensation income, without regard to industry.

Carried interest advocates respond that many carried interest holders invest years of effort before receiving an allocation to their partnership interests, and therefore make the equivalent of an investment associated with a capital contribution.

Proposed Changes in the House Bill

The amended House bill takes a middle ground between the current law and prior Congressional proposals to curb the eligibility of carried interests for long-term-capital gain allocations. The bill focuses on carried interests in hedge funds, private equity firms, and real estate investment firms, not traditional operating businesses.

In targeted firms, the bill allows a partnership to allocate long-term capital gain to a carried interest partner who has held his or her partnership interest more than three years. If the partner has held the interest for three years or less, the proposal recharacterizes the allocation as short-term capital gain. In most cases, short-term capital gain characterization results in income taxation at the same rate as wage or other compensation income, but still allows the partner to avoid employment taxes.

It remains uncertain whether this proposal will survive reconciliation with a to-be-passed Senate tax reform bill.

Future Planning

Even if the proposal becomes law, look for motivated taxpayers to form “shelf” entities to begin the running of the three-year holding period while undertaking limited business activity. The taxpayers will then have such partnerships ready to use in the future, when a more substantial opportunity arises.

Read the carried interest proposal (see Section 3314 of the House amendment to the Tax Cuts and Jobs Act).

What’s Not to Like About the Proposed Tax Rate Reductions for Small Businesses?

If you run a small business (or even a large closely-held business) taxed as an S corporation or partnership, don’t get too excited about the tax rate reduction headlines in Congress’ latest tax reform proposals.

The House bill touts a 25% tax rate for business income from these entities. Passive investors would enjoy the 25% rate on all business income, which may encourage more investment and lower equity financing costs.  But for an entrepreneur actively involved in the business, the lower rate only applies to 30% of annual income from the business, or to annual business income up to approximately eight percent of adjusted tax basis (roughly, the un-deducted investment amount) in the business assets.  So the House bill is friendly to passive investors, and offers only limited benefits to traditional entrepreneurial small business operators.

The Senate proposal touts a 17.4% deduction against S corporation and partnership business income, but limits that deduction to 50% of the amount the individual taxpayer business owner receives in wages.  In other words, you have to pick up a dollar of income tax at the full individual tax rate and pay employment taxes on that amount, to enjoy the reduced tax rate on fifty cents of non-wage income.  This mix is not much different than the House’s 70% wage income-to-reduced-tax-rate business income ratio.

Like the House plan, the Senate small business tax rate proposal limits benefits to entrepreneurs.  Unlike the House bill, the Senate does little for passive investors, who may have a hard time justifying high wages to bolster their deduction.

The proposed 20% tax rate for traditional C corporation income is more straightforward than the S corporation and partnership tax rate proposals.  This may cause some small businesses to consider converting to C corporation status (the tax status of many larger companies and the vast majority of publicly-traded companies).  But in so doing the businesses (including, especially, Florida businesses) may become subject to state income taxes they otherwise avoid.  Further, any cash removed from the business will either be subject to the full individual tax rates or to a 23.4% dividend tax.  Finally, when the business is sold, the seller may receive a lower price (because the buyer can’t depreciate the purchased assets) or pay tax at an effective tax rate significantly higher than received or paid by the seller of a business structured as a S corporation or partnership.  So while taking advantage of the 20% C corporation tax rate may seem desirable to a growing business that reinvests its profits, the business owner may suffer a significant detriment upon a business sale and pay a higher tax rate on cash removed from the business in the meantime.

Conceivably, if you operate a small business, some flavor of the House and Senate proposals could reduce your tax liability.  There are some clean wins.  For example, both bills would allow many small businesses to immediately deduct much larger volumes of annual asset purchases, rather than take depreciation deductions over time. But if enacted, the tax rate proposals will not make life more simple or reduce difficult choices.

Changes to business tax rates are just the tip of the tax reform iceberg. The bills would make significant changes to many other areas of the tax law.  More to come…

Here is a link to a summary of the House bill: https://waysandmeansforms.house.gov/uploadedfiles/tax_cuts_and_jobs_act_section_by_section_hr1.pdf

Here is link to a summary of the Senate bill: https://www.finance.senate.gov/imo/media/doc/11.9.17%20Chairman’s%20Mark.pdf

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

Why the President’s Latest Tax Reform Proposal Isn’t Even Nine Times Very Little

In April, the last time tax reform bubbled into the news cycle, we discouraged readers from paying much attention. President Trump’s “proposal” was this single page of bullet points that told us too little to evaluate its merit.

Tax reform returned to headlines this week, with the President offering this nine-page proposal.

If we use the “number-of-pages” method to evaluate work product, we might expect the new plan to include nine times as much meaningful information. Even if we discount the new document three and one-half pages for including a cover page and five pages only half-full of text, we might hope the new plan offers five and one-half times the information we gathered from April’s one-page plan.

It doesn’t. The new plan largely replicates the prior plan’s bullet points, adding some additional nontechnical explanation and a more impressive presentation format. It adds little, if anything.

Our advice hasn’t changed.  Don’t get excited.  Don’t exert energy seeking substance about tax reform just yet.

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

Why You Probably Can Ignore President Trump’s Tax Proposal for Now

On Wednesday, President Trump released his tax proposal.

Take a look. It won’t take long. That’s it. One page of bullet points.

For comparison, now look at this discussion of then-candidate Trump’s tax proposals during the presidential election campaign last fall.

Anything new? Not really.

While restating campaign promises may initiate the legislative discussion, doing so tells us little about what might actually appear in legislation hammered out by competing factions in Congress.

So whether you are excited or disappointed about lower corporate tax rates or estate tax repeal, we suggest re-averting your attention to other matters for the time being.

To that end, this missive also ends without further elaboration.

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

Does a Republican Sweep Augur Federal Tax Reform?

Amongst many things, the Republican sweep in yesterday’s election improves prospects for the most significant tax reforms since 1986.

While we instinctually focus on possible changes to our personal tax burdens, business income taxation may offer the most opportunities for structural reforms. Structural changes may or may not reduce the amount of tax revenue. They are, at least in theory, policy driven to encourage business behavior consistent with greater economic growth.

Changes on the table include taxing business income that is reinvested (rather than distributed to owners for their personal uses) at a lower rate, and changing the international tax regime to a territorial system that does not tax income earned in other countries when repatriated to the United States. The former may encourage business investment spending. The latter may reduce distortions in capital flows into the United States caused by the current tax regime. Both changes would bring the United States closer in line with the tax systems in other developed countries.

And, of course, our leaders will revisit Obamacare, including the new taxes it created.

President-Elect Donald Trump’s proposals do not exactly match those in Congress. Disagreement could impede reform. But with House Speaker Paul Ryan and President-Elect Trump both focusing on tax reform, we will see the most serious tax reform debate in many years.

Here are links to recent media discussion of possible tax reforms:

http://www.wsj.com/articles/donald-trump-win-gives-gop-fuel-to-slash-taxes-1478687402

http://www.forbes.com/sites/anthonynitti/2016/11/09/president-trump-what-does-it-mean-for-your-tax-bill/#53ec8be84b8b

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

Has Congress Finally Given a Tax Extenders Holiday Gift That Keeps on Giving?

Congress has once again passed “Tax Extenders” legislation with only two weeks remaining in the year, but retroactively applicable to January 1.  As a result, few will take advantage of its tax breaks in 2015.  In past years Tax Extenders legislation expired at the end of the year, also making it useless in the following tax year.

This year’s bill, however, includes permanent extensions of many useful provisions. Amongst others, permanent extensions applicable now and in the future include:

·       allowing tax-free distributions from IRAs up to $100,000 per year to qualified charities for persons at least 70 and ½ year old,

·       shorting of the post-C-corporation-to-S-corporation-conversion “built-in gains tax” period from ten years to five years,

·       increasing the annual deduction threshold and carryforward years for certain conservation donations,

·       allowing an optional state sales tax deductions for federal income tax purposes, in lieu of a state income tax deduction (particularly useful for residents of Florida, which has no personal income tax),

·       liberalizing depreciation rules for qualified leasehold, restaurant and retail improvements, and

·       increasing first year expensing opportunities for certain capital expenditures.

The bill extends other recurring provisions more than one year, but not permanently.  For example, bonus depreciation now applies through 2019, though the bonus depreciation percentage decreases by ten percent each year from the 50% 2015 percentage, to encourage investment sooner rather than later.

It remains frustrating that by once against waiting until December to act, Congress wasted the opportunity to give taxpayers a better opportunity to use these tax breaks in 2015.  We can, however, at least be grateful for more planning certainty in the years ahead.

Here is a link to a complete summary of the legislation published by the House Committee on Ways and Means: http://waysandmeans.house.gov/wp-content/uploads/2015/12/SECTION-BY-SECTION-SUMMARY-OF-THE-PROPOSED-PATH-ACT.pdf

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

2015 Tax Extenders Thanksgiving Treat?

Once again we approach the end of a year following the so-called “Tax Extenders” legislation, which addresses federal tax incentives that expire on December 31 of each year, unless renewed by Congress.  The2014 bill was enacted with retroactive effect in mid-December 2014, and expired December 31, 2014.  Will Congress give us a 2015 Thanksgiving treat by enacting a similar bill before the end of November?

Unfortunately, replicating the pattern from 2014, it appears 2015 legislation will pass no earlier than mid-December. Several bills exist which could become law before the end of the year.  As in prior years, the potential Tax Extender laws include special depreciation rules for qualified leasehold, restaurant and retail improvements, 50% bonus depreciation provisions, and first year expensing opportunities for certain capital expenditures. Also included is a reduction in S corporation recognition period for the built-in gains tax from ten years, to five years, but only for transactions closing in the year in which the Tax Extender legislation is in effect.  Potential legislation also includes special incentives for conservation-oriented transactions and charitable donations from IRAs.

We remain hopeful another Tax Extenders bill will pass before December 31, 2015.  In the best case, Congress would make some provisions permanent or extend provisions more than one year to give taxpayers a longer time horizon to plan.

If you have a 2015 transaction dependent on the legislation, be ready in advance, because you might have only a short time to act once the legislation passes.  After that, you may be stuck hoping for another chance in 2016.

Here are links to our prior posts relating to Tax Extenders legislation: http://blog.williamsparker.com/businessandtax/2015/10/21/tax-extenders-redux-deja-vu-all-over-again/

http://blog.williamsparker.com/businessandtax/2014/12/17/with-only-two-weeks-left-for-taxpayers-to-act-2014-tax-extenders-bill-finally-to-become-law-should-you-celebrate-yawn-or-yell/

http://blog.williamsparker.com/businessandtax/2014/11/05/with-republican-election-gains-2014-tax-extenders-legislation-could-boost-capital-expenditures-business-merger-and-acquisition-activity/

http://blog.williamsparker.com/businessandtax/2014/04/30/2014-tax-extenders-legislation-uncertainty-impairs-capital-expenditure-planning-business-acquisitions/

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

Legislation Creates Default Rule: All Partnerships to be Audited at Entity Level

On November 2, 2015, President Obama signed into law The Bipartisan Budget Act of 2015 (H.R. 1314) which, among other things, imposes a new audit regime on tax partnerships beginning in 2018. Under the new regime, unless a partnership is eligible to elect out and does so timely, IRS can now collect tax due on partnership adjustments at the entity level, which takes a fundamental premise of partnership taxation – that the entity pays no tax – and turns it on its head. The new regime has many significant impacts. Not the least of which is that the IRS can send a bill for a prior year tax underpayment to the partnership itself, and therefore the current year partners would bear this burden. Our initial analysis is that tax partnerships that are eligible will likely want to elect out of the new regime. A link to the full Act (Title XI – starting on page 42 – is the relevant portion of the Act) is here: www.congress.gov/114/bills/hr1314/BILLS-114hr1314enr.pdf

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Tax Extenders Redux: Déjà Vu All Over Again

The great commentator—and occasional baseball player—Yogi Berra may have left us behind, but Congress continues to prove his words prophetic.   For yet another year, we are in the fourth calendar quarter awaiting federal tax legislation designed to spur economic activity as of the preceding January.

Last year we followed the saga of the so-called “Tax Extenders” legislation, which addresses tax incentives that expire on December 31 of each year, unless renewed by Congress.  The2014 bill was enacted in mid-December 2014, and expired December 31, 2014.  Although the law applied retroactively to January 1, 2014, taxpayers could not act during the first fifty weeks of the year because it was unclear whether the incentives would become law once again.  The mid-term Congressional elections provided a convenient scapegoat for the delayed enactment, but the bill still did little good.

2015 Tax Extenders legislation is playing out similarly, but the budget, debt ceiling, and Speaker of the House of Representatives vacancy are this year’s scapegoats. Several bills exist which could become law before the end of the year.  As in prior years, the potential Tax Extender laws include special depreciation rules for qualified leasehold, restaurant and retail improvements, 50% bonus depreciation provisions, and first year expensing opportunities for certain capital expenditures. Also included is a reduction in S corporation recognition period for the built-in gains tax from ten years, to five years, but only for transactions closing in the year in which the Tax Extender legislation is in effect.  Potential legislation also includes special incentives for conservation-oriented transactions and charitable donations from IRAs.

We aren’t holding our breath for legislation in the next few weeks, but are hopeful another Tax Extenders bill will pass before December 31, 2015.  If you have a transaction dependent on the legislation, be ready in advance, because you might have only a few weeks to act once the legislation passes.  It will be “late early out there” before you know it.  After that, you will be stuck hoping for another chance in 2016.

Here are links to our prior posts relating to Tax Extenders legislation:

http://blog.williamsparker.com/businessandtax/2014/12/17/with-only-two-weeks-left-for-taxpayers-to-act-2014-tax-extenders-bill-finally-to-become-law-should-you-celebrate-yawn-or-yell/

http://blog.williamsparker.com/businessandtax/2014/11/05/with-republican-election-gains-2014-tax-extenders-legislation-could-boost-capital-expenditures-business-merger-and-acquisition-activity/

http://blog.williamsparker.com/businessandtax/2014/04/30/2014-tax-extenders-legislation-uncertainty-impairs-capital-expenditure-planning-business-acquisitions/

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

With Only Two Weeks Left for Taxpayers to Act, 2014 Tax Extenders Bill Finally To Become Law: Should You Celebrate, Yawn, or Yell?

On Tuesday, December 16 the Senate passed the “The Tax Increase Prevention Act of 2014,” popularly known as the 2014 Tax Extenders Bill. President Obama is expected to sign the bill into law. Unfortunately, even in its passage, the new law exemplifies political dysfunction and gridlock.

The bill temporarily extends popular personal and business tax breaks through 2014, but not beyond. Extended provisions include bonus depreciation, a shortening of the period corporate-level tax applies to S corporations that used to be C corporations, and a $100,000 Individual Retirement Account qualified charitable donation exemption from the normally applicable income tax deduction limitations. Past legislation has repeatedly temporarily extended these provisions, but only through 2013, necessitating a further extension through this bill.

Passage of the bill is more a cause for relief than celebration. Some might just yawn. Others will yell.  While some of its tax breaks are supposed to spur investment and business acquisition activity, passing the law with two weeks remaining in 2014 gives most businesses little time to buy equipment or close transactions. It also leaves a small window for Individual Retirement Account charitable donations. The law seems unlikely to significantly benefit the economy by influencing behavior before its tax benefits expire.

The law will not spur meaningful long-term planning or activity, because no one knows with certainty whether a similar bill will become law to further extend the favorable tax provisions into 2015 or beyond. Congress willfully failed to act on this bill through almost all of 2014.  It is not clear the political impetus exists for an earlier extension action–or better yet permanent adoption of the law allowing even longer-term planning—in 2015.

Here is a link to a more detailed summary and text of the bill: https://www.congress.gov/bill/113th-congress/house-bill/5771

Here are links to our prior posts concerning the 2014 Extenders Bill and similar bills: http://blog.williamsparker.com/businessandtax/category/legislation/

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