Tag Archives: tax

Accrual-Method Taxpayers with Audited Financials May Have to Recognize Income Sooner

Section 13221 of the 2017 Tax Cuts and Jobs Act amended IRC section 451 to link the all events test for accrual-method taxpayers to revenue recognition on the taxpayer’s audited and certain other financial statements. Specifically, new IRC section 451(b) (old 451(b) through (i) were redesignated as 451(d) through (k)) provides that for accrual-method taxpayers “the all events test with respect to any item of gross income (or portion thereof) shall not be treated as met any later than when such item (or portion thereof) is taken into account in revenue in” either (1) an applicable financial statement or (2) another financial statement specified by the IRS. In other words, taxpayers subject to this rule must include an item in income for tax purposes upon the earlier satisfaction of the all events test or the recognition of such item in revenue in the applicable or specified financial statement. For example, any unbilled receivables for partially performed services must be recognized for income tax purposes to the extent the amounts are taken into income for financial statement purposes, instead of when the services are complete or the taxpayer has the right to invoice the customer. The new rule does not apply to income from mortgage servicing rights.

The new rule defines an “applicable financial statement” as (1) a financial statement that is certified as being prepared in accordance with generally accepted accounting principles and that is (a) a 10-K or annual statement to shareholders required to be filed with the SEC, (b) an audited financial statement used for credit purposes, reporting to shareholders, partners, other proprietors, or beneficiaries, or for any other substantial nontax purpose, or (c) filed with any other federal agency for purposes other than federal tax purposes; (2) certain financial statements made on the basis of international financial reporting standards filed with certain agencies of a foreign government; or (3) a financial statement filed with any other regulatory or governmental body specified by the IRS. It appears that (1)(b) would capture accrual-method taxpayers that have audited GAAP financial statements as a requirement of their lender or as a requirement of their owners, such as a private equity fund owner.

This new rule should also be considered by affected taxpayers in relation to the relatively new and complex revenue recognition standards in ASC 606, Revenue from Contracts with Customers, which becomes applicable to nonpublic GAAP companies later this year (unless adopted earlier). For example, a taxpayer’s tax function and financial accounting function would need to coordinate to ensure that the sales price of contracts containing multiple performance obligations (i.e., bundles of goods and services, such as software sales agreements that include a software license, periodic software updates, and maintenance and support services) is allocated to the separate components in the same manner for financial statement and tax purposes.

The new tax rule is effective for tax years beginning after 2017.

Discussion of the new tax rule begins on page 272 of the new Tax Cuts and Jobs Act Conference Report.

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

Williams Parker to Participate in International Trade Symposium at Port Manatee

On Thursday, February 22, 2018, Williams Parker will be participating in an International Trade Symposium organized by the International Trade Hub at Port Manatee hosting an association of trade commissioners from Chile, Colombia, Costa Rica, Ecuador, Spain, Guatemala, Honduras, Mexico, Peru, Uruguay, Dominican Republic, Brazil, Argentina, and Canada. These trade commissioners cooperate to expand and facilitate the international commercial relations with Florida and are mainly based in Miami. Following the symposium at Port Manatee, a luncheon will take place at the Manatee Chamber of Commerce featuring a brief presentation by Williams Parker attorney Jamie Koepsel regarding the international aspects of the recent tax legislation.

If you are in the retail industry or simply interested in international trade and want to learn more about how you can expand your business to international markets, you may want to consider participating in the event. A great number of the trade commissioners have already confirmed their participation in the event. Establishing relationships with the trade commissioners will be valuable to your business growth plans. The trade commissioners will help you navigate the markets and cultures of the countries where you want to do business.

Please contact Williams Parker attorney Juliana Ferro for more information.

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

The U.S.-Japan Income Tax Treaty

Japan has long been one of the United States’ largest trading partners.  Japan is also one of the United States’ longest-standing tax treaty partners.  The first U.S.-Japan income tax treaty was concluded in 1954.  Updated treaties were signed in 1971 and 2003, and a protocol in 2013 further modernized the treaty.  The U.S.-Japan income tax treaty largely follows the model tax convention published by the Organisation for Economic Co-operation and Development (OECD), of which both countries are members.

The U.S.-Japan income tax treaty helps reduce the incidence of double taxation and encourages the cross-border movement of people and goods.  In general, the tax treaty allocates or restricts taxing rights between the two countries so that a resident of either the United States or Japan does not pay tax in both countries with respect to the same income (or pays reduced rates of tax in one of the countries).

For example, dividends paid by a company which is a resident of the United States to a resident of Japan may generally be taxed in both Japan and the U.S., but the rate of tax imposed by the United States with respect to such dividends is limited to either 5% or 10% (or, in some circumstances, such tax may be eliminated).  In the case of interest and royalties paid by a resident of one of the countries, only the country in which the recipient of the interest or royalty payment resides may tax such payments.  Similarly, capital gains derived by a resident of the United States or Japan from the sale of property other than real estate are generally taxable only by the country in which the seller of the property resides.  Gains from the sale of real estate and certain real estate holding companies, however, remain taxable in both countries under the tax treaty.

The tax treaty also provides for tie-breaker rules so that the same person is not considered a resident of both countries and provides a limited safe harbor for wages and salaries paid to residents of one country who perform employment services in the other country.  Other provisions relate to the taxation of diplomats, athletes, and branches or “permanent establishments” of multinational businesses, among other special situations.  Where disputes regarding the taxation of cross-border activities arise, notwithstanding the provisions of the treaty, the treaty provides a dispute resolution mechanism whereby the U.S. and Japanese governments can come to a mutual agreement to reduce or eliminate the additional taxation.

Recent U.S.-Japan income tax treaty documents and Treasury Department technical explanations are available at treasury.gov.

Nicholas A. Gard
ngard@williamsparker.com
(941) 552-2563

Williams Parker Convinces IRS to Waive $224,640 Penalty Asserted Against Client

An LLC taxed as a partnership with 128 partners failed to file its partnership tax return electronically, resulting in the IRS asserting a penalty of $224,640 under IRC section 6698(a)(1). Partnerships with more than 100 partners are required to file their tax returns electronically under IRC section 6011(e). Williams Parker represented the partnership in connection with a penalty waiver request pursuant to IRS Announcement 2002-3, 2002-1 CB 305 (Jan. 14, 2002). Shareholder Mike Wilson at Williams Parker convinced the IRS that the partnership was entitled to a penalty waiver under the criteria of the Announcement, and therefore the IRS withdrew the entire $226,640 penalty. Information regarding the Announcement criteria and related guidance can be found at irs.gov.

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

Section 1059A – A Trap for the Unwary?

Our community is near multiple major ports, including Port Manatee and the Port of Tampa.  Taxpayers that import goods through these ports should be aware of U.S. tax issues that can arise from their actions.  U.S. taxpayers that import goods from related parties outside the United States have several tax rules to consider in setting their transfer prices and reporting income, including the transfer pricing regimes in both the importing and exporting jurisdictions.  Among the U.S. tax rules that such importers must consider is a lesser-known Internal Revenue Code section, Section 1059A.

Section 1059A provides that the maximum amount a U.S. taxpayer may claim as basis in inventory goods imported from a related party is the amount that was determined for customs purposes when the goods were imported.  The statute is designed to prevent taxpayers from claiming low values for customs purposes (reducing the amount of U.S. customs duties owed) and high values for transfer pricing purposes (reducing the amount of U.S. taxable income).

A trap for the unwary can occur when related parties retroactively modify their intercompany pricing after goods are imported.  For example, a U.S. company may increase the amount paid for an imported good at the end of the year in order to satisfy the arm’s length standard for transfer pricing purposes.  This additional amount is generally be subject to customs duties, but reporting additional customs duties can fall through the cracks if a company’s personnel responsible for tax and customs compliance do not communicate regarding the adjustment.  In addition, even where additional amounts are reported for customs purposes, the timing of an upward adjustment in the customs price could prevent taxpayers from including the adjustment in the basis of the inventory for tax purposes if the adjustment is made after the customs value has been “finally-determined” (generally, 314 days after the date of entry).  These issues may frequently arise when taxpayers retroactively adjust transfer prices in accordance with Advance Pricing Agreements.

In recent years, practitioners have called for better coordination between the Internal Revenue Service and U.S. Customs and Border Protection along with reforms to eliminate the potential whipsaw of Section 1059A.  It remains to be seen whether current tax reform proposals will reach this issue.

Nicholas A. Gard
ngard@williamsparker.com
(941) 552-2563

The Republican Tax Plan Is Out. What Now?

On November 2, 2017, House Republicans unveiled their widespread rewrite of the U.S. Tax Code. The tax plan, called the Tax Cuts and Jobs Act of 2017, is a 429-page bill that provides changes to many aspects of tax law including the corporate tax rate, individual tax rates, the taxes levied on pass-through businesses such as partnerships, and estate taxes. While the bill is unlikely to be signed into law in its present form, certain key provisions of the proposal highlight the direction Republicans hope to take the U.S. Tax Code.

A notable provision is the slashing of the corporate tax rate from its current 35 percent rate to a new 20 percent rate. While earlier proposals considered a temporary rate reduction, the current proposal would make this tax cut permanent. Another much-discussed change is the introduction of a 25 percent tax rate for pass-through businesses such as partnerships and S-corporations. Most items of active income being passed through a business to partners or shareholders would be taxed at a maximum 25 percent rate, rather than the current 39.6 percent minimum rate.

The new tax plan also provides significant changes to how individuals are taxed. Key provisions reduce the seven individual tax brackets to four brackets of 12 percent, 25 percent, 35 percent, and 39.6 percent. The 39.6 percent top bracket will only apply for married couples earning at least $1 million a year or individuals earning at least $500,000 a year. The estate tax exemption would be raised to $11.2 million from its current $5.6 million amount, with the estate tax repealed entirely by 2024.

This is only the beginning of tax reform. The bill must still pass the Senate and be approved by the President, a tall task even if Republicans control each aspect of the legislative process. The reaction of Senators, and more importantly the reaction of voters, will determine whether the tax plan is passed, amended, or rejected entirely.

Jamie E. Koepsel
jkoepsel@williamsparker.com
(941) 552-2562

IRS Sees the Light and Withdraws §2704 Proposed Regulations

The Treasury Department’s issuance of proposed regulations under Code Section 2704 were met with significant criticism and confusion. The §2704 proposed regulations were intended to provide the IRS with an additional sword to reduce and in some cases eliminate valuation discounts on family-controlled business entities.

After thousands of comments were received and a public hearing was held where numerous taxpayer advocacy groups, business advisors, and valuation experts provided their concerns, the IRS finally blinked. On October 20, 2017, the IRS published a withdrawal notice of proposed rulemaking, which removes the potential for these proposed regulations to be finalized. The elimination of the proposed regulations is fantastic news for all family-controlled business owners that would be subject to estate and gift taxes. More information regarding the withdrawal is available at federalregister.gov.

Thomas J. McLaughlin
tmclaughlin@williamsparker.com
(941) 536-2042