Tax Planning While Waiting for Tax Reform
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Transcript Tax Planning While Waiting for Tax Reform
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Tax Planning While
Waiting for Tax Reform
Mel Schwarz
Partner
Washington National Tax Office
[email protected]
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Barbara Koosa Ryan
Partner
Columbia, SC
[email protected]
Where is Tax Reform
Anyway?
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Handicapping Tax Reform
A Cloudy Crystal Ball
• 2014 – Seems unlikely
• 2015 – Could depend on who takes Senate
• 2016 – Presidential election years do not facilitate
bipartisan legislation
• 2017 – Seems more likely
– The reasons we began this discussion will still
be there.
– New players, new opportunities
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Why everyone was talking tax reform
Camp corporate rate cut
Proposed change in corporate rate
Income
Current
$0 +
15%
$50,000+
25%
$75,000+
34%
$100,000+
39%
$335,000+
34%
$10 million+
35%
$15 million+
38%
$18.3 million+
35%
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Proposed
25%
Phased in:
• 2015: 33%
• 2016: 31%
• 2017: 29%
• 2018: 27%
• 2019: 25%
AMT repealed
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Why does Tax Reform in 2014 seem unlikely?
• House Republican leadership has been reticent
about allowing Camp to go to markup, preferring to
stay focused on Obamacare, Benghazi and other
issues.
• Senate Finance Chairman Baucus has left for
China.
• No agreement on the basic issue of whether or not
taxes must contribute to reducing the deficit.
• Necessary revenue offsets are unpopular.
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How do you pay for tax reform?
Major domestic business tax expenditures
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Camp Discussion Draft
Business Proposals
Repeal Accelerated Depreciation
Depreciation deduction per $1,000 of basis
Trailers (00.27)
Tractor Units (00.26) Motor Freight (42.0)
Year
Current
Camp
Current
Camp
Current
Camp
1
200
98
333
140
200
78
2
320
195
444
276
320
153
3
192
190
148
269
192
149
4
115
184
74
261
115
146
5
115
179
54
115
142
6
58
154
58
138
7
134
8
60
9
assumes 3% annual inflation rate
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Camp Discussion Draft
Other Business Changes
• Repeals most credits and incentives, including
WOTC and section 199
• Cash method prohibited if > $10 m. gross receipts
• Like-kind exchange repealed
• Limits on deductible retirement contributions
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International proposals
Camp discussion draft
• Shift to territorial tax system:
– 95% dividends received deduction
– Retain subpart F
• Transition tax on all current offshore earnings:
– 8.75% on cash and cash equivalents
– 3.5% on remaining E&P
• To prevent income shifting:
– 15% rate on foreign base company intangible
income under Subpart F
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Individual proposals
Rates in Camp discussion draft
Proposed changes in individual tax rates
Single
Joint
Current
$0+
$0+
10%
$9,075+
$18,150+
15%
$36,900+
$73,800+
25%
$89,350+
$148,850+
28%
$186,350+
$226,850+
33%
$405,101+
$406,750+
$405,101+
35%
$457,600+
39.6%
25% + 10% surtax**
20%
21% effective rate***
Top dividend and cap gains rate
Proposed
10%
25%*
*The starting point for the 25% bracket would be reduced slightly
**Surtax would apply to certain income beyond taxable income
***Cap gains & dividends are ordinary income with 40% exclusion (does not include NII tax)
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Individual proposals
Camp surtax
• MAGI for purposes of surtax includes:
– Standard & itemized deductions (except charity)
– Employer and self-employment health coverage
– Foreign income exclusion
– Tax-exempt interest
– 401(k) contributions
– HSA contributions
– All Social Security benefits
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SE tax on pass-through owners
Camp proposal
• Eliminate exception for limited partners, LLC owners,
and S corp shareholders
• If materially participate:
– 70% self-employment income
– 30% percent return on investment
– Exception from NII tax retained
• No change to §1411, so if no material participation,
all income still NII
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Handicapping Tax Reform
A Cloudy Crystal Ball
• 2014 – Seems unlikely
• 2015 – Could depend on who takes Senate
• 2016 – Presidential election years do not facilitate
bipartisan legislation
• 2017 – Seems more likely
– The reasons we began this discussion will still
be there.
– New players, new opportunities
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Senate Races in 2014
Map by 270towin.com
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Senate Outlook based on Current Polls
Map by 270towin.com
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Even if Republicans Take the Senate
Can they pass tax reform that Obama will sign?
• "I thought I was a conservative, but we’ve got
some in Congress now who are so far right they’re
about to fall out of the Capitol.”
– Bob Dole, speaking at the First Lutheran
Church, Ottawa, Kansas, April 21, 2014.
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Handicapping Tax Reform
A Cloudy Crystal Ball
• 2014 – Seems unlikely
• 2015 – Could depend on who takes Senate
• 2016 – Presidential election years do not
facilitate bipartisan legislation
• 2017 – Seems more likely
– The reasons we began this discussion will still
be there.
– New players, new opportunities
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Handicapping Tax Reform
A Cloudy Crystal Ball
• 2014 – Seems unlikely
• 2015 – Could depend on who takes Senate
• 2016 – Presidential election years do not facilitate
bipartisan legislation
• 2017 – Seems more likely
– The reasons we began this discussion will still
be there
– New players, new opportunities
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Combined Corporate Income Tax Rate
Combined Corporate Income Tax Rate
(Includes State and Local)
United States
39%
OECD Average
25%
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What do I do while I
am waiting for tax
reform?
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Tax Planning While Waiting for Tax Reform
Take Advantage of Benefits While You Can
• Major changes are likely to wait for tax reform
– Depreciation
– Accounting methods
– Taxation of reinvested foreign profits
– Changes to large dollar tax benefits for
individuals
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Tax Planning While Waiting for Tax Reform
Take Advantage of Benefits While You Can
• Accounting changes implemented today generally
produce an immediate benefit through the 481
adjustment. If later repealed, expect a spread.
–
–
–
–
Repair studies
Advance payments and prepaid expenses
Disputed amounts
Self-developed software
• current expensing
• section 199
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Tax Planning While Waiting for Tax Reform
Take Advantage of Benefits While You Can
• Depreciation and cost segregation
• Be prepared to exploit expired provisions if/when
they are extended
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Problem of Expiring Tax Provisions
• Over 50 provisions expired at the end of 2013
• Retroactive extension likely for most
– timing?
• What might not be extended?
– 50% bonus depreciation
• Financial accounting implications
– Cannot anticipate enactment – affects 2014 10Q
– Potential affect on unrepatriated earnings
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Extenders – Congressional Action
• Senate EXPIRE Act:
– All but 2 expired provisions retroactively restored as
part of 2-year extension:
– Includes:
• Increased section 179 expensing limit
• 50% bonus depreciation
– Consideration by full Senate delayed by dispute over
possible amendments
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Extenders – House Action
Veto threat if cost not offset
Ways and Means Permanent
Provisions Approved 4/29
Status
Research credit
Passed House
Cost*
$155.5 billion
Active financing exception
$58.8 billion
CFC look-through rule
$20.3 billion
Reduced 5-year holding period for BIG Vote on 6/12
tax after C Corp election to S Corp
$1.5 billion
Limitation in basis reduction of gifts of
S Corp stock to charity
Vote on 6/12
$700 million
179 expensing
Vote on 6/12
$73.1 billion
Total
$310.5 billion
* 10-year cost estimated by Joint Committee on Taxation
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The Retroactive Extension Tradition
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Tax Planning While Waiting for Tax Reform
Don't be afraid to "pass through"
• A single level of tax is still best
– Top current rates have not changed yet
• Active participant in pass through avoids NII tax
• Other benefits of pass through status
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Minimize Impact of
Obamacare Taxes:
Net Investment
Income Tax
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What is the net investment income tax?
• New 3.8% tax on net investment income to the
extent MAGI exceeds high-income threshold
• IRC Section 1411 under new Chapter 2A
– Creates new tax base with different rules than either
income or payroll taxes
• Companion to increased Medicare tax on earned
income to extent MAGI exceeds threshold
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What's the high-income threshold?
• Modified adjusted gross income:
– Single: $200,000
– HoH: $200,000
– Joint: $250,000
– Separate: $125,000
– Trust: $11,950 (indexed)
• MAGI is AGI without foreign income exclusion
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What is Net Investment Income?
Three separate buckets of income:
1. Rents, royalties, dividends, interest, annuities
– Unless derived in ordinary course of non-passive
trade or business (can't be trading financials)
2. Any other income from passive trade or business
– Plus income from trading business
3. Capital gain
– Unless held in non-passive trade or business
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What is Net Investment Income?
Exclusions
What's NOT Net Investment Income?
– Income already subject to SE tax
– Exclusions under other code provisions
• Excluded gain from sale of primary residence
• Exempt bond income
– Qualified retirement plan distributions
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What deductions reduce net Investment Income?
• Net operating losses
– Final regs allow deduction of portion of NOL arising
from NII against allocable deductions
• Passive losses
– Carry-forwards (even pre-2011) offset NII
• Capital losses
– Cannot offset other NII (except $3,000 used against
ordinary income)
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Pass-through businesses
What income is NOT subject to tax?
• Passive activity:
– All income subject to tax
• Non-passive activity:
– Rents, royalties, interest, dividends, rents UNLESS
Derived in the ordinary course. . .
OR
Gain from property held in. . .
. . . .a trade or business
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Pass-through businesses
What is a passive activity?
• Determination of passive activity uses the existing
rules in §469
• Taxpayer must materially participate or the activity
is passive
• These rules matter for non-loss companies for the first
time
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Pass-through businesses
What is a passive activity?
Material participation
Meet 1 of 7 material participation tests
1. More than 500 hours participation
2. Substantially all of the participation
3. More than 100 hours if no one has more
4. Significant participation activities
5. Material participation 5 of past 10 years
6. Material participation in personal service activity in
any of 3 prior years
7. Facts and circumstances
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Pass-through businesses
What is a passive activity?
Material participation
Meet 1 of 3 material participation tests if limited partner:
1. More than 500 hours participation
2. Substantially all of the participation
3. More than 100 hours if no one has more
4. Significant participation activities
5. Material participation 5 of past 10 years
6. Material participation in personal service activity in
any of 3 prior years
7. Facts and circumstances
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Pass-through businesses
What is a passive activity?
Grouping rules under §469
• Can use grouping rules in § 469 to establish material
participation for "appropriate economic unit"
– Look at multiple activities as one
• Special rules for grouping rental activities with a trade
or business
• "Fresh start" allows one-time regrouping in either
2013 or first year subject to § 1411
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Pass-through businesses
What is a passive activity?
Grouping rules under §469
• How much flexibility in grouping rules? Significant
• Regs provide five nonexclusive factors:
– Similarities and differences in trades or businesses
– Extent of common control
– Extent of common ownership
– Geographical location
– Interdependence between or among activities
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Pass-through businesses
Special exception for rental income
• Final § 1411 regs provide that for rental income, if:
– Treated as nonpassive due to self-rental rules
OR
– Grouped with a trade or business in which the group
is nonpassive
• The income is deemed to be derived in the ordinary
course of a trade or business
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Pass-through businesses
Special exception for self-charged interest
• Interest income from a loan to a pass-through business
in which you materially participate:
– Can exclude this self-charged interest up to your
allocable share of the interest deduction (as long as
interest deduction is not taken against SE income)
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Pass-through income:
Can you avoid both NII and SE tax?
Sweet spot?
Self-employment
income
§1402 tax
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S corporation:
Non-salary
Partnership:
Active limited
partner?
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Net investment income
§1411 tax
Dispositions of business interests
Reproposed regulations
• Calculation of gain/loss includable in NII:
– Gain = lesser of gain on sale of interest or allocable
share of net gain from a deemed sale of property
– Similar rule when a transferor recognizes a loss
– Use valuation rules under § 1.469-2T(e)(2)):
• Valuation on activity-by-activity basis, rather than
property-by-property basis
• Allocate disposition gains/losses among activities in
accordance with § 1.469-2T(e)(3) (other than 1.4692T(e)(3)(iii))
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Dispositions of business interests
Optional simplified method
• Optional simplified method for calculating gain/loss
– General aim: When gain from passive assets
owned by the pass-through is likely to be small
– Intended to limit information-sharing burden on
pass-throughs by allowing transferors to rely on
readily available information
– Generally allows taxpayers to assign gain from a
disposition to NII in the same proportion as historic
pass-through distributive shares have been NII
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Dispositions of business interests
Optional simplified method
• Generally eligible if:
– $250,000 or less in gain from sale or
– $5 million or less in gain from sale and 5% or less of
separately stated income/gain/loss/deduction in NII
calculations in sale year & the two previous years
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Dispositions of business interests
Optional simplified method
• Method not available where:
– Interest held for less than 12 months
– Certain distributions and contributions during
holding period
– Significantly modified composition of assets
– Recent conversion from C to S corporation
– Partial disposition (five listed situations)
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Net Investment Income Tax
What Does It All Mean?
• Managing NII
– C corporations can defer, but not eliminate
exposure
• Tax triggered by dividend payment
– Pass throughs
• Can avoid the tax for active owners
• Must pay currently for passive owners
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Questions?
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