Tag Archives: S corporation

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

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

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

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

IRS Refuses Investment Fund Management Partnership the Same Self Employment Tax Break It Gives S Corporations

In a recent ruling, the IRS confronted a partnership serving as a management company for investment partnerships and funds.  Management fees were its sole source of  income.  The management company paid reasonable compensation subject to employment or self employment taxes to its owner-managers.  Following a planning technique available to S corporations, the partnership treated its partner distributions as being exempt from self employment taxes.  The IRS disagreed with the partnership’s position.  The IRS ruled that the partner distributions were subject to self employment taxes notwithstanding the reasonableness of compensation paid as such to its owner-managers.

The ruling is significant because distributions from an S corporation structured in the same way probably would not have been subject to self employment tax.  Indeed, the partnership in question used to be an S corporation, and the IRS specifically held that the S corporation rules do not apply to the new partnership.

The ruling underscores an evolving IRS position that treats service S corporations and service partnerships differently for self employment tax purposes.  While technically understandable because different statutory and regulatory provisions govern the different entity types, the differing self employment tax treatment of these entities defies common sense.

Unless a sensible unified self employment tax policy emerges, when possible it remains wise to structure management or service companies either as S corporations or as partnerships with S corporation partners, to take advantage of the more flexible self employment tax planning options available for S corporations.

Here is  link to the ruling:  http://www.irs.gov/pub/irs-wd/201436049.pdf

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