Forgivable Paycheck Protection Program (PPP)

The part of the Act known as the Keeping Americans Paid and Employed Act provides a comprehensive set of rules through which small business employers and employers of not more than 500 employees can maintain those employees on the payroll without incurring expense or significant expense. There is no requirement of ongoing operations. In a nutshell, and somewhat oversimplified, an eligible employer may obtain a loan to meet ongoing payroll obligations and, at the end of the day, for those funds so spent the “loan” will be forgiven. As with most such government arrangements, there are a number of conditions for obtaining such a loan, using the funds, and ultimately either obtaining a total or partial forgiveness. Moreover, as discussed further below, there are alternatives to the Paycheck Protection Loans which may ultimately be more suitable to the particular employer’s situation, such as tax credits to help offset a work slowdown.

 Loan Eligibility

In general, any business concern, nonprofit organization, veteran’s organization, or Tribal business concern is eligible to receive a covered loan if it is either a “small business” [1] or employs not more than 500 employees. For purposes of determining whether a business is eligible, this article focuses on the expanded coverage offered by the Act rather than the traditional small business rules and regulations. The determination of whether a business concern, non-profit organization, veterans’ organization, or Tribal business concern employs not more than 500 employees, begins with the term ‘employee’ which includes individuals employed on a full-time, part-time, or other basis. Individuals employed on a part-time or other basis. Part-time and temporary employees are counted the same as full-time employees. Individuals who operate under a sole proprietorship or as an independent contractor and eligible self-employed individuals are also eligible to receive a covered loan.

 Loan Amounts

Subject to certain exceptions, the maximum PPP loan amount is 2.5 times the average total monthly payments by the applicant for payroll costs incurred during the 1-year period before the date on which the loan is made, not to exceed $10,000,000. Alternatives for determining the amount are provided for certain circumstances, including, but not limited to, where an eligible recipient was not in business during the period beginning on February 15, 2019 and ending on June 30, 2019. Moreover, in the case of a seasonal employer (as determined by the Administrator) the average total monthly payments for payroll are determined from the 12-week period beginning February 15, 2019, or at the election of the employer, March 1, 2019, and ending June 30, 2019.

 “Payroll costs” are the sum of payments of any compensation with respect to employees that is a:

• salary, wage, commission, or similar compensation;

• payment of cash tip or equivalent;

• payment for vacation, parental, family, medical, or sick leave;

• allowance for dismissal or separation;

• payment required for the provisions of group health care benefits, including insurance premiums;

• payment of any retirement benefit; and

• payment of State or local tax assessed on the compensation of employees.

Although the Act also includes within “payroll costs” the sum of payments of any compensation to or income of a sole proprietor or independent contractor, the Interim Final Rule is clear that amounts paid to independent contractors are not considered for either payroll costs or forgiveness.

 Payroll Costs also do not include the compensation of an individual employee in excess of an annual salary of $100,000, as prorated for the covered period, taxes withheld or paid by the borrower for income tax or FICA and paid sick leave or paid family medical leave under the Families First Coronavirus Response Act. In addition, any compensation of an employee whose principal place of residence is outside of the United States is not a Payroll Cost. 

 Allowable Uses of Loans

During the covered period, an eligible recipient may use the loan proceeds to pay payroll costs, costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums, employee salaries, commissions, or similar compensations, payments of interest on any mortgage obligation (which shall not include any prepayment of or payment of principal on a mortgage obligation), rent (including rent under a lease agreement), utilities; and interest on any other debt obligations that were incurred before the covered period.

  Obtaining a Paycheck Protection Loan

In order to obtain a Paycheck Protection Loan, the Act requires that an eligible recipient must make a “good faith certification” of the following:

•  that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations of the eligible recipient;

• acknowledging that funds will be used to retain workers and maintain payroll or make mortgage payments, lease payments, and utility payments;

• that the eligible recipient does not have an application pending for a loan under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan; and

• during the period beginning on February 15, 2020 and ending on December 31, 2020, that the eligible recipient has not received amounts under this subsection for the same purpose and duplicative of amounts applied for or received under a covered loan.

  In addition to those matters required to be certified under the Act, the Updated Borrower Application includes numerous other matters to certify, including certification that no false statements or documents are being used to obtain the loan, the tax returns provided are identical to those submitted to the IRS and that:

•  That the Applicant is eligible to receive a loan under the rules in effect at the time the application is submitted that have been issued by the SBA implementing the Paycheck Protection Program.

• That the Applicant (1) is an independent contractor, eligible self-employed individual, or sole proprietor or (2) employs no more than the greater of 500 or employees or, if applicable, the size standard in number of employees established by the SBA in 13 C.F.R. 121.201 for the Applicant’s industry.

• All SBA loan proceeds will be used only for business-related purposes as specified in the loan application and consistent with the Paycheck Protection Program Rule.

• To the extent feasible, the borrower will purchase only American-made equipment and products.

• Documentation verifying the number of full-time equivalent employees on payroll as well as the dollar amounts of payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities for the eight-week period following this loan will be provided to the lender.

 Loan Forgiveness and Repayment

This is undoubtedly not only the goal of most employers but the Act as well in that the Act seeks to keep employees retained and paid, rather than being laid off or furloughed. The recipient is eligible for forgiveness of the PPP loan in an amount equal to the sum of certain costs incurred and payments made during the eight weeks following the date of the origination of the covered loan. A “covered loan” is a loan made under the Keeping Americans Paid and Employed Act during the period beginning on February 15, 2020, and ending on June 30, 2020. The “costs incurred and payments made” which are subject to forgiveness are: (1) Payroll costs; (2) Any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation); (3) Any payment on any covered rent obligation; and (4) Any covered utility payment.[2] Although such “costs incurred and payments made” are subject to forgiveness, whether the entire amount so spent is forgiven depends on whether the employer laid off and/or furloughed employees. Forgiven amounts are not taxable as income to the borrower.

 In general, the amount of loan forgiveness is reduced, but not increased, by multiplying the amount subject to forgiveness by the quotient obtained by dividing the average number of full-time equivalent employees per month employed by the eligible recipient during the covered period by either the average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on February 15, 2019 and ending on June 30, 2019 or the average number of full-time equivalent employees per month employed by the eligible recipient during the period beginning on January 1, 2020 and ending on February 29, 2020. The time period utilized is at the election of the borrower. A caveat to this approach is that in the case of an eligible recipient that is seasonal employer, as determined by the Administrator, the average number of full-time equivalent employees per month employed by the eligible recipient is for the period beginning on February 15, 2019 and ending on June 30, 2019.

 The amount of the Loan forgiven is also reduced by the total reduction in salary or wages during the 8 weeks following origination of the Loan of any employee earning less than $100,000 on an annualized basis that exceeds 25% of the total salary or wages of the employee during the preceding full quarter in which the employee was employed prior to the date of the Loan.

To the extent not forgiven, the PPP Loans will have the following terms: 

• 2-year maturity period[3]

• % interest[4]

• No personal guarantees required

• No recourse against owners, directors or officers of the borrower

Lenders are required to treat every borrower as having been impacted by the COVID-19 and to defer the loan repayment for no less than 6 months and no longer than 1 year if the borrower requests deferral.

 Loans for Mid-Size Businesses Not Eligible for Paycheck Protection Loans

Mid-size businesses, which are not eligible for Paycheck Protection Loans, those with 500 to 10,000 employees, may be eligible for direct loans under the Emergency Relief and Taxpayer Protections of the Act. For a business to receive this type of loan under the Act, it must make a “good-faith certification” that it will comply with certain requirements listed in the Act. This certification will likely occur on a form provided as part of the application for the loan and the failure to comply with the certification could result in rescission of the loan.

 There are several conditions the future compliance with which must be certified before receiving such a loan. Among other things, the business must certify that:

• the uncertainty of economic conditions as of the date of the application makes necessary the loan request to support the ongoing operations of the recipient;

• the funds it receives will be used to retain at least 90 percent of the recipient’s workforce, at full compensation and benefits, until September 30, 2020;

• the recipient intends to restore not less than 90 percent of the workforce of the recipient that existed as of February 1, 2020, and to restore all compensation and benefits to the workers of the recipient no later than 4 months after the termination date of the public health emergency declared by the Secretary of Health and Human Services on January 31, 15 2020, under section 319 of the Public Health Services Act (42 U.S.C. 247d) in response to COVID–19;

• the recipient is an entity or business that is domiciled in the United States with significant operations and employees located in the United States;

• the recipient is not a debtor in a bankruptcy proceeding;

• the recipient is created or organized in the United States or under the laws of the United States and has significant operations in and a majority of its employees based in the United States; 

• the recipient will not pay dividends with respect to the common stock of the eligible business, or repurchase an equity security that is listed on a national securities exchange of the recipient or any parent company of the recipient while the direct loan is outstanding, except to the extent required under a contractual obligation that is in effect as of the date of enactment of this Act;

• the recipient will not outsource or offshore jobs for the term of the loan and 2 years after completing repayment of the loan;

• the recipient will not abrogate existing collective bargaining agreements for the term of the loan and 2 years after completing repayment of the loan; and

• that the recipient will remain neutral in any union organizing effort for the term of the loan.

SBA Economic Injury Disaster Loan (EILD)

In response to the pandemic, small business owners are eligible to apply for an Economic Injury Disaster Loan advance of up to $10,000. The SBA’s Economic Injury Disaster Loan program provides small businesses with working capital loans of up to $2 million that can provide vital economic support to small businesses to help overcome the temporary loss of revenue they are experiencing. Funds will be made available within three days of a successful application. Repayment terms may be as much as 30 years.

 The Disaster Loan advance does not have to be repaid even if the loan application is subsequently denied, however, if the loan applicant that receives an advance transfers into, or is approved for, the Paycheck Protection PPP Loan, the advance amount is reduced from the loan forgiveness amount for a loan for payroll costs made under that program.

 The Economic Injury Disaster Loans for small businesses have a fixed interest rate of 3.75 percent and for non-profit businesses a fixed interest rate of 2.75 percent. There is no payment for the first 12 months.

 The Disaster Loan advance may be used to address any allowable purpose for a loan made under section 18 7(b)(2) of the Small Business Act, including:

•  providing paid sick leave to employees unable to work due to the direct effect of the COVID–19;

• maintaining payroll to retain employees during business disruptions or substantial slowdowns;

• meeting increased costs to obtain materials unavailable from the applicant’s original source due to interrupted supply chains;

• making rent or mortgage payments; and

• repaying obligations that cannot be met due to revenue losses.

Tax Credits for Retaining Employees Despite Work Slowdown

The tax credit is available to employers who do not receive a Paycheck Protection Program Loan and whose operations were fully or partially suspended due to a COVID-19 related shut-down order, or whose gross receipts declined by more than 50% when compared to the same quarter in the previous year. Where the basis for receipt of the tax credit is a 50% decline in gross receipts, the employer remains eligible until gross receipts are greater than 80 percent of gross receipts for the same calendar quarter in the prior year.

 The employee retention tax credit generally provides eligible employers with a refundable payroll tax credit (it is treated as an overpayment) for 50% of the qualified wages paid by employers between March 13, 2020, and December 31, 2020, for the first $10,000 of compensation, including health benefits, paid to an eligible employee. For employers with more than 100 full-time employees, “qualified wages” may include the employer’s contribution to the employee’s health insurance costs but excludes any amounts that the employer already received a tax credit for under the Families First Coronavirus Response Act (FFCRA). Moreover, “qualified wages” are wages paid to employees when they are not providing services due to the fully or partially suspended operations. For employers with 100 or fewer employees, all employees’ wages qualify for the credit, whether the employer is open for business or subject to the shutdown order.

 Deferral of Payment of Payroll Tax

In an effort to provide employers more available cash, the Act provides that employers may defer payment of their portion of the Social Security taxes. Deferred payroll taxes are required to be paid over the next two years with half of the amount owed to be paid not later than December 31, 2021, and the remaining half by not later than December 31, 2022.

 Changes to Leave Provisions of the Family First Coronavirus Relief Act (“FFCRA”)

There are several changes made in the Act to the FFCRA. While most of these are not relevant to the discussion here, the Act revises the EFMLA to address leave entitlement under that provision for rehired employees. The Act provides that for purposes of the EFMLA, the term “employed for at least 30 calendar days” includes an employee who was laid off on or after March 1, 2020, had worked for the employer for not less than 30 of the last 60 calendar days prior to their layoff, and was rehired.

 The Act also revises the EFMLA by enabling employers to obtain an “advance” refunding of tax credits according to forms and instructions provided by the Secretary. The employer may anticipate the refunding of tax credits by withholding employment tax deposits and the Secretary of the Treasury shall waive any penalty for any failure to make a deposit.

 Unemployment Insurance Provisions

The Act includes the “Relief for Workers Affected by Coronavirus Act” which provides for expansion of unemployment benefits to those whose employment has been adversely affected as a result of the impact of COVID-19. The subject period runs from January 27, 2020, to December 31, 2020. Covered individuals are provided with unemployment benefit assistance when they are not entitled to any other unemployment compensation or waiting period credit. The unemployment benefit provided by the Act is an additional $600 per week until July 31, 2020, on top of the amount determined under state law. In addition, the Act extends the period for unemployment benefits to 39 weeks. Any state waiting period is waived for purposes of the additional benefit provided for in these provisions.

 Expanded Coverage and Eligibility

A ‘‘covered individual’’ is an individual who is not eligible for regular compensation or extended benefits under State or Federal law or pandemic emergency unemployment compensation, including an individual who has exhausted all rights to regular unemployment or extended benefits under State or Federal law or pandemic emergency unemployment compensation; and provides self-certification that the individual is otherwise able to work and available for work within the meaning of applicable State law, except the individual is unemployed, partially unemployed, or unable or unavailable to work because:

•  the individual has been diagnosed with COVID–19 or is experiencing symptoms of COVID–19 and seeking a medical diagnosis;

• a member of the individual’s household has been diagnosed with COVID–19;

• the individual is providing care for a family member or a member of the individual’s household who has been diagnosed with COVID–19;

• a child or other person in the household for which the individual has primary caregiving responsibility is unable to attend school or another facility that is closed as a direct result of the COVID-19 public health emergency and such school or facility care is required for the individual to work;

• the individual is unable to reach the place of employment because of a quarantine imposed as a direct result of the COVID-19 public health emergency;

• the individual is unable to reach the place of employment because the individual has been advised by a health care provider to self-quarantine due to concerns related to COVID–19;

• the individual was scheduled to commence employment and does not have a job or is unable to reach the job as a direct result of the COVID-19 public health emergency;

• the individual has become the breadwinner or major support for a household because the head of the household has died as a direct result of COVID–19;

• the individual has to quit his or her job as a direct result of COVID–19;

• the individual’s place of employment is closed as a direct result of the COVID–19 public health emergency; or

• the individual meets any additional criteria established by the Secretary for unemployment assistance under this section; or

• is self-employed, is seeking part-time employment, does not have sufficient work history, or otherwise would not qualify for regular unemployment or extended benefits under State or Federal law or pandemic emergency unemployment compensation and meets conditions for receipt of unemployment applicable to covered individuals generally listed above.

 The Act also extends unemployment coverage to persons who are self-employed, who are seeking part-time employment, who do not have a sufficient work history, or otherwise would not qualify for regular unemployment or extended benefits if they meet a qualifying condition. The Act excludes those who would otherwise be a covered individual if they have the ability to telework with pay or if they receive paid sick leave or other paid leave benefits.

  Unemployment Assistance to States

While there is little of concern to employers with regard to assistance to States, the provisions do include a matter of importance that the employer should communicate to employees being laid off or suffering reduced hours during the pandemic. The Act incentivizes states to provide the enhanced unemployment compensation without a waiting period that the State may currently impose so that unemployed individuals can start getting benefits immediately upon separation.

 Direct Payments and other Assistance to Individuals

The Act provides for direct assistance payments to individuals. For most taxpayers filing individually with an adjusted gross income of $75,000 or less or $112,500 as head of household, the Act provides, generally, for a tax credit of $1,200 plus $500 for each child of the taxpayer. For joint taxpayers, the Act provides, generally, for a $2,400 tax credit when the adjusted gross income is not more than $150,000. The amount of the tax credit rebate is reduced when the adjusted gross income exceeds the cap at a rate of 5% per dollar of qualified income. As an example, the tax credit for a taxpayer filing single, without children, will be reduced to zero if the adjusted gross income is $99,000. Taxpayers who do not file under their SSN, usually filers using an Individual Tax Identification Number, are generally excepted.

 In addition to the tax credit rebates, an individual may also access funds, up to $100,000, from a qualified retirement account without incurring an early withdrawal penalty when it is necessary to access those funds for COVID-19 related purposes. The income attributable to the distribution is subject to tax ratably spread over three years. The taxpayer may recontribute the funds within three years and in doing so is not subject to the cap on contributions. The Act also provides for special treatment of loans from specified retirement plans obtained for COVID-19 relief. 

 On a related note, given recent guidance with regard to eligibility for receive paid sick leave or expanded family and medical leave under FFCRA, which is effective April 1, 2020, unemployment insurance may be the only available assistance for an individual furloughed before the operative date of FFCRA. That guidance directs that if an employer furloughs an employee because it does not have enough work or business, the employee is not entitled to then take paid sick leave or expanded family and medical leave.

 Health Care Provisions The Act continues the requirement that health insurers and group health plans cover certain COVID-19 diagnostic testing however, it omits previous language requiring that the testing be performed at a qualifying clinical lab. It also provides specific guidance on pricing and requires the federal government to require health insurers and group health plans to cover any “qualifying coronavirus preventive service.

 The Act also does not disqualify high deductible health plans for failure to have a deductible for remote health care services such as telehealth. A safe harbor is provided for telehealth services provided in plan years beginning on or before December 31, 2021.

   [1]Although the Act says “small business concern,” which, depending upon the industry may be defined under the Small Business Act by numbers of employees or amount of annual receipts, the Interim Final Rule appears to limit application of the PPP to small business concerns based the size standard in number of employees established by the SBA in 13 C.F.R. 121.201 for the Applicant’s industry.

 [2] The Interim Final Rule however, provides that not more than 25 percent of the loan forgiveness amount may be attributable to non-payroll costs.

 [3] The Act provides for a maximum payback of 10 years however, the Interim Final Rule provides for a 2-year payback time.

 [4] The interest rate is specified as a maximum interest rate of 4% however, the Interim Final Rule provides for an interest rate of 1.0 %.

Creating Value in Your Business to Get top Dollar When You Leave It

Did you ever wonder why one business has buyers lined up willing to pay top dollar while another sits on the market for months, or even years? What do buyers look for in a prospective business acquisition?

There are many opinions about what attributes or characteristics buyers seek, but here’s what we know: the characteristics buyers seek must exist before the sale process even begins and it is your job as the owner to create value within your business prior to the sale. We call characteristics that impact value “Value Drivers.”

Walk A Mile In A Buyer’s Shoes

To get an idea of the importance of Value Drivers when preparing to sell your business, it is important to put on the buyer’s shoes for a minute. Let’s look at a hypothetical case study that illustrates how a buyer might compare two similar companies with a different emphasis on Value Drivers.

The A Factor Company has EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of $2 million, an owner who runs the business and the systems and processes that create growth. The A Factor Company doesn’t have a real management team in place and the owner generates a majority of its sales. The owner is the center point of the company, holding both the CEO and CFO positions. With this level of responsibility, the owner is burning out quickly.

In comparison, The B Factor Company also has EBITDA of $2 million and a solid management team that runs the business, systems and processes. The management team creates efficiencies within the business and the owner vacations for six weeks a year.

If you were a buyer comparing these two companies, which would provide a more attractive business opportunity? How much more would you pay for a business with a strong management team (one of the most important Value Drivers)? Would you even be interested in buying a business whose management team (the owner) walks out when you walk in?

Investment bankers understand that companies that lack strong Value Drivers also lack a bevy of buyers. Those buyers that do come to the table do not arrive with pockets full of cash.

Let’s look at several of the more important Value Drivers common to all industries:

• A stable and motivated management team. If you can wait a year to sell your business, we suggest that you consider an incentive compensation system, cash or stock-based, that rewards key employees as the company performs (usually measured by increases in pre-tax income). Sophisticated buyers know that with a solid management team in place, prospects are good for continued business success. Without a strong management team, it may be very difficult to sell your business to a third party or transfer it to an insider.
• Operating systems that improve sustainability of cash flows. Operating systems include the computerized and manual procedures used in the business to generate its revenue and control expenses, (i.e. create cash flow), as well as the methods used to track how customers are identified and how products or services are delivered. The establishment and documentation of standard business procedures and systems demonstrate to a buyer that the business can be maintained profitably after the sale.
• A solid, diversified customer base. Buyers typically look for a customer base in which no single client accounts for more than 10 percent of total sales. A diversified customer base helps insulate a company from the loss of any single customer. If the majority of your customer base is made up of only one or two good customers, consider reinvesting your profits into additional capacity that will make developing a broader customer base possible.
• A realistic growth strategy. Buyers tend to pay premium prices for companies with realistic strategies for growth. Even if you expect to retire tomorrow, it makes sense to have a written plan describing future growth and how that growth will be achieved based on industry dynamics, increased demand for the company’s products, new product lines, market plans, growth through acquisition, and expansion through augmenting territory, product lines, manufacturing capacity, etc. It is this detailed growth plan, properly communicated, that helps to attract buyers.
• Effective financial controls. Financial controls are not only a critical element of business management, but they also safeguard a company’s assets. Effective financial controls support the claim that a company is consistently profitable. The best way to document that your company has effective financial controls and that its historical financial statements are correct is through a certified audit or perhaps a verified financial statement by an established CPA firm.
• Stable and improving cash flow. Ultimately, all Value Drivers contribute to stable and predictable cash flow. It is important, especially in the year or so preceding the sale of the business, that cash flow be substantial and on an upswing. You can begin increasing cash flow today by simply focusing on ways to operate your business more efficiently by increasing productivity and decreasing costs.

You can install these Value Drivers and better position your company to secure a premium price upon your exit with the help of a trained Exit Planning Advisor.

If you have any questions about increasing the value of your business prior to your exit, please contact us to discuss your particular situation. We can help you identify and strengthen the current Value Drivers in your business, install additional Value Drivers, and create a road map to meet your overall exit objectives. We also have additional resources that explain Value Drivers in more detail and help you apply these concepts to your business.

Bill Roeser

2018 Tax Reform

The Tax Cuts and Jobs Act ....

is the most sweeping update to the U.S. tax code in more than 30 years. The reforms will simplify taxpaying for many individual Americans, lower taxes on individuals and businesses, and update the business tax code so that American corporations and the people they employ can be globally competitive again.

The Tax Cuts and Jobs Act has the potential to unleash higher wages, more jobs, and untold opportunity through a larger and more dynamic economy. The bill’s pro-growth components include a deep reduction in the corporate tax rate, a scaled-back state and local tax deduction, full (albeit temporary) expensing, and lower individual tax rates. The bill also repeals Obamacare’s individual mandate, expands college savings accounts, and increases some non–growth-enhancing tax credits and deductions.

The conference report demonstrates a serious effort to reform a complex and badly broken system that provides significant relief to the vast majority of taxpaying Americans. While Congress surrendered to the pressures of special interests in several areas, eroding many of the boldest components of their original proposals, the conference agreement nevertheless reflects a critical step in the right direction.

Business Tax Reform

The Tax Cuts and Jobs Act’s most significant changes are to modernize the tax treatment of businesses in the United States. Taken together, the business reforms will result in a significant boost to the U.S. economy by attracting international business investment and jobs to America.

Previous analysis of the two similar bills, independently passed by the House and the Senate, estimates that the economy could grow between 2.6 percent and 2.8 percent larger in the long run.

21 Percent Corporate Rate. The bill permanently lowers the corporate tax rate to 21 percent starting in 2018.  This is a flat rate.  No longer progressive rates of 15, 25, 34, 35%.

Historically, U.S. businesses have faced some of the highest statutory corporate tax rates in the developed world.

 A 21 percent corporate tax rate, down from the current federal rate of 35 percent, is the most pro-growth component of the Tax Cuts and Jobs Act. The reform will encourage significant new investment in the U.S., which will benefit workers primarily through higher wages and more jobs.

A 21 percent federal corporate tax rate still leaves the United States with a higher rate than many of its largest trading partners around the world. When average state taxes are added, the U.S. will have a cumulative rate around 26 percent—higher than the worldwide average of 23 percent.

Bonus Depreciation = Full Write-Off. The bill expands the current-law 50 percent bonus depreciation for new short-lived capital investments to 100 percent or “full expensing” for five years and then phases out over the subsequent five years. Expensing allows companies to deduct the cost of investments (new & used) immediately and removes a current tax bias against investment.

The bill also expands expensing for small businesses under Section 179 by raising the cap on eligible investment from $500,000 to $1 million. The phaseout increases from a $2 million cap to a $2.5 million cap on total equipment purchases. In 2022, businesses will no longer be able expense their research and development costs; this is a step in the wrong direction toward longer write-off schedules rather than toward expensing.

20 Percent Pass-Through Deduction. Small and pass-through businesses that pay their taxes as individuals (and face the new lower individual tax rates) will receive a newly created deduction. Pass-through businesses will be able to deduct 20 percent of certain types of non-salary business income, bringing the top marginal tax rate (on most pass-through income) down from 39.6 percent under current law to 29.6 percent. This 20% deduction also applies to sole proprietorships.  Certain service providers in the fields of health, law, consulting, athletics, financial, or brokerage services are denied the deduction if their income is over a $315,000 threshold, where the deduction begins to phase out.

Although lower marginal tax rates for small and pass-through businesses are an important component of economic growth, the discrepancy in top rates between individual income and small and pass-through business income will increase the incentives to treat income from wages artificially as business income. This new tax privilege has no consistent policy rationale, arbitrarily favors certain types of businesses over others, introduces new complexity, and will provide new opportunities for unproductive tax planning.

• Example 1: Jack, a single taxpayer, has a “regular” job where he earns a $100,000 salary as an employee. He also “moonlights” as a consultant and earns $50,000 of net profit via his Schedule C sole proprietorship. Now suppose that after accounting for deductions for self-employment taxes and the standard deduction, Jack’s taxable income is $133,500 (before application of the pass-through deduction).  Here, Jack’s business income of $50,000 is less than his taxable income of $133,500. As a result, the 20% pass-through deduction will be applied to Jack’s $50,000 of business income, resulting in a $10,000 ($50,000 x 20% = $10,000) deduction.

• Example 2: Jill, a single taxpayer, is a real estate agent who earns $100,000 of net profit via her Schedule C sole proprietorship. This is Jill’s only source of income. After factoring in Jill’s deductions for self-employment taxes and the standard deduction, her taxable income is $73,000 (before application of the pass-through deduction).

Contrary to our first example, here, Jill’s taxable income of $73,000 is less than her eligible business income of $100,000. Therefore, Jill’s 20% pass-through deduction will be applied to her $73,000 of taxable income. This results in a $14,600 (73,000 x 20% = $14,600) deduction.

Repatriation. 

The act imposes a new onetime transition tax on international firm’s accumulated overseas profits. The onetime tax rate is 15.5 percent for liquid assets and 8 percent for physical assets.

Limited Interest Deduction. The current unlimited deduction for net interest expense for C-corporations is capped at 30 percent of earnings before interest and taxes. For the first four years, the cap applies to a slightly different definition of earnings before interest, taxes, depreciation, and amortization. This only applies to businesses with receipts exceeding 25 million annually.

Individual Reform

For a vast majority of Americans, the Tax Cuts and Jobs Act will lower their federal tax bill in 2018. This is accomplished through lower tax rates, a larger standard deduction, and an expanded child tax credit. Most of the individual tax changes revert to current law before 2025 to meet political constraints and Senate budget rules. Although temporary tax policy is never ideal, the expirations give Congress an incentive to revisit the tax code in the coming years to provide more far-reaching and permanent reform.

Lower Individual Tax Rates. The framework lowers rates for almost every tax bracket. The current seven brackets remain, but with new, generally higher income thresholds and lower rates. Table 1 describes the changes for single and married filers; the bill also retains the head of household status with similar adjustments to income brackets.

 Larger Standard Deduction. The standard deduction is almost doubled, consolidating the additional standard deduction and personal exemptions into one larger deduction. For married joint filers, the deduction will be $24,000; for single filers, it will be $12,000. The expanded deduction simplifies tax filing by cutting the percentage of tax filers who will need to itemize their deductions in half. Approximately 9 of 10 taxpayers will simply claim the new standard deduction.

The change will also exempt more people from paying any income tax at all. When fewer people pay income taxes, the harmful side effect is that government appears to cost less for those taxpayers. Decreasing the number of households that pay any federal income tax at all lowers their personal cost of future government expansions, which could lead to higher overall tax rates in the future.

$2,000 Child Tax Credit. The child tax credit (CTC) is doubled from a current-law level of $1,000 to $2,000 per child. The new larger credit begins to phase out for married filers with incomes of more than $400,000—an increase from $110,000 under current law. The new larger credit offsets the repeal of the personal exemption for dependents. For any family in the 25 percent tax bracket or lower, this is an expansion of the tax subsidy for children.

The new larger child tax credit is refundable for taxpayers with no federal income tax liability. This effectively allows a taxpayer to accrue a negative tax liability that results in a federal spending outlay of up to $1,400 per child in 2018. The refundable threshold is indexed to inflation, capping out at the full $2,000 value. A new non-refundable credit of $500 is added for non-child dependent care like care for adult family members with disabilities or elderly parents.

$10,000 State and Local Tax Deduction. Taxpayers who itemize their taxes will be able to deduct up to $10,000 of state and local property taxes and income taxes (or sales taxes) paid. Only about one in 10 taxpayers is expected to itemize deductions under the new tax code.

$750,000 Limit on Mortgage Interest Deduction. The bill does not change the treatment of existing mortgages. Interest paid on up to $750,000 of new home mortgage debt will remain deductible for residences (1st & 2nd) for taxpayers who itemize. The new rules lower the threshold from the current-law level of $1 million and exclude the ability to deduct interest on equity lines of credit.  Existing mortgages and lines of credit are grandfathered and protected under the rules existing before the new law. 

Charitable Deduction Expanded. The charitable deduction expands for those who itemize, from 50 percent of income to 60 percent. The charitable deduction is denied for payments made in exchange for seats at college sports games.

Other Itemized Deductions Retained. The most politically sensitive itemized deductions and exclusions for medical expenses, tuition compensation, private activity bonds, student loan interest, and teacher spending are all retained. The bill expands the deduction for medical expenses for two years for expenses exceeding 7.5 percent of adjusted gross income, down from the current-law level of 10 percent.

529 College Savings Accounts Expanded. 529 college savings accounts—named after their section of the Internal Revenue Code—are expanded to allow parents to save for K–12 and homeschooling expenses. The reform increases the ability of parents to pay for education options outside the public school system, giving families more education choices.

Individual Mandate Repealed. Obamacare’s individual mandate tax (penalty) is repealed. Zeroing out the tax, which is intended to force individuals to buy health insurance, provides tax relief to millions of Americans who cannot afford the rising costs of Obamacare insurance.

Death Tax Remains. The basic exclusion from the estate tax doubles from its current $5.6 million per person to about $12 million.   For married couples, the total would approximate 24 million. 

Individual Alternative Minimum Tax Remains. The exemption for the alternative minimum tax (AMT) increases from $86,200 to $109,400 for married filers. The exemption phases out starting at $1 million, up from $164,100. The new exemption is $70,300 for non-married filers and phases out beginning at $500,000.

The AMT applies a two-rate alternative tax schedule to a more broadly defined measure of income and allows a narrower set of deductions. The tax increases the tax liability of those who can uniquely lower their effective tax rate through the normal tax system. The AMT does its intended job poorly and inefficiently by burdening taxpayers with additional paperwork and not addressing the underlying problem: The tax code has too many credits and deductions that are easily gamed. Full repeal of the AMT, as included in the House bill, would have been a far better policy.

PEP and Pease Repealed. The bill rightly repeals two obscure provisions that complicate the tax code and increase effective marginal tax rates. The personal exemption phaseout (PEP) adds more than one percentage point per person to affected taxpayers’ marginal tax rates. For example, it can add 4.5 percentage points to a family of four’s marginal tax rate. The phaseout of itemized deductions (Pease) adds an additional percentage point to affected taxpayers’ marginal tax rates. Repealing these provisions simplifies the code and reduces marginal tax rates.

Conclusion

The U.S. tax code is sorely in need of reform, and the Tax Cuts and Jobs Act is a pro-growth plan that simplifies taxpaying for many individuals, lowers tax rates, and updates the business tax code so that American corporations and the people they employ can be globally competitive again.

Bill Roeser, CPA

Preparing for the Worst: Business Continuity Planning for Business Owners

Contemplating  one's  own  demise  can  be  challenging  but  is  paramount  to sole  owners  and  their  businesses.  Consider  the  fictional  Harry  Withers,  the 54-year-old  owner  of  Withering  Hikes,  a  chain  of  seven  retail  apparel stores  for  outdoor  enthusiasts  on  the  Western  Slope  of  Sierra Nevada mountains.  Harry was scouting new hiking trails and disappeared.

After  several  months  of  fruitless  searching,  Harry's  family  opened  probate  proceedings  only  to  find  that Harry's  once-thriving  business  also  had  disappeared.  However,  Withering  Hikes's  disappearance  was  far more  typical  than  Harry's.  Because  Harry  had  dreamed  of  selling  his  company  at  60,  he  had  given  little thought  to  what  would  happen  to  his  business  if  something  happened  to  him.  Thus,  Withering  Hikes  died  of all-too-common  causes—human  error  and  neglect—setting  off  a  chain  reaction  of  ever-worsening consequences  for  Harry's  family  and  business:

1.  Harry's key employees  left  the  company  for  jobs  with  more  certain  futures.  They  feared  that  neither Withering  Hikes  nor  their  salaries  would  continue  without  Harry  at  the  helm.

2.   The departure  of  key  employees  meant  that  there  was  no  one  to  manage  the  business.  Total chaos  reigned, and  revenue  took  an  immediate  and  irreversible  nosedive.  Longtime customers grew uneasy with what they perceived to be a  rudderless  ship  and  took  their  business  to  Harry's competitors.  Further, the  company's  vendors  demanded  cash  payments,  cash  that  the  company  no longer  generated.

3.   Harry's bank  saw  the  drop  in  revenues  and  decided  to  call  in  the  company's  debt,  debt  Harry  had  personally  guaranteed.

4.    Because Harry  left  no  instructions  or  recommendations  about  who  could  run  the  business,  who  could offer  advice,  or  even  what  to  do  with  the  business  should  something  happen  to  him,  both  his business  and  family  suffered.

Withering  Hikes  didn't  just  wither  away;  it  fell  off  a  cliff.  It could not survive without its  top employees  or Harry's  leadership.

The  point  of  reviewing  this  list  of  mortal  blows  is  to  demonstrate  that  business-continuity  planning  is  vitally important  to  owners'  companies  and  families.  Without  a  well-considered  business  survival  plan,  the consequences  for  owners'  employees,  customers,  and,  most  importantly,  family  and  estate  are  dire  (estates rarely  escape  the  notice  of  business  creditors).

Fortunately,  there  is  a  process  that  sole  owners  can  quickly  and  easily  use  to  help  avoid  the  type  of  business collapse  that  Withering  Hikes  experienced.

First, sole owners  must  motivate  top  employees  to  stay  on  after  their  demises  by  creating  financially meaningful  incentive  compensation  plans  for  them  that  vest  over  time.  Creating  a  plan  that  provides  these employees  a  substantial  bonus  (called  a  stay  bonus)  for  remaining  with  the  company  beyond  an  owner's demise  is  a  strong  strategy.  The  company  can  usually  fund  the  stay  bonus  with  life  insurance  on  the  owner's life.  This  funded  stay  bonus  provides  designated  employees  with  a  cash  bonus  (usually  about  50%  of  annual compensation)  and  a  salary  guarantee  if  those  employees  stay  (typically  12-18  months)  after  the  owner's death.  The  sole  owner's  job  is  to  communicate  these  actions  to  these  employees  and  assure  them  that  he  or she  has  made  additional  plans  to  ensure  the  continuation  of  the  business.

Second,  sole  owners  should  alert  their  banks  about  their  continuity  plans.  Meeting  with  a  banker  to  discuss the  arrangements  made  and  showing  him  or  her  that  the  necessary  insurance  funding  to  implement  these plans  is  in  place  can  allow  an  ownership  transfer  to  proceed  smoothly.  Additionally,  it  is  wise  to  determine whether  major  creditors  are  comfortable  with  the  succession  plan.  Sole  owners  should  ask  major  creditors which  arrangements  they  would  like  to  see  in  place.

Third, create a written plan that does the following:

1.  Names  the  person(s)  who  will  take  on  the  responsibility  of  running  the  business.

2.    States  whether  the  business  should  be  continued,  liquidated,  or  sold  (if  so,  to  whom).

3.   Names  the  resources  heirs  should  consult  regarding  the  company's  sale,  continuation,  or  liquidation.

Creating  a  contingency  plan  for  your  company  should  you  depart  unexpectedly  is  a  vital  part  of  your  overall Exit  Planning process.  Failing  to  do  so  invites  the  kind  of  disaster  that  befell  Withering  Hikes,  Harry's employees,  and  his  family.

Our expertise  in  crafting  business-continuity  plans  that  work  can  help  you  be  prepared  for  the unexpected.  Contact us today to learn more about how to begin creating a contingency plan and the options available for your business.

Bill Roeser, CPA

See also:  ValleyValuations.com 

Copywrite Business Exit Institute

Tax Reform - Changes Affecting Businesses

Overview of New Tax Reform Changes Affecting Businesses

On December 22, the President signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). The 503-page TCJA is the largest tax overhaul since the 1986 Tax Reform Act and it will affect almost every individual and business in the United States. Unlike the provisions for individuals, which generally expire after 2025, the business-related provisions in the TCJA are permanent and generally take effect in tax years beginning after 2017.

For businesses, highlights of the TCJA include: (1) an increase in amounts that may be expensed under bonus depreciation and Section 179; (2) a 21 percent flat corporate tax rate; (3) a new business deduction for sole proprietorships and pass-through entities; and (4) the elimination of the corporate alternative minimum tax (AMT).

Changes Affecting Businesses

The following is a summary of some of the more significant changes under the new tax law that may affect your business.

Reduction in Corporate Tax Rate and Dividends Received Deduction

TCJA eliminates the graduated corporate tax rate structure and instead taxes corporate taxable income at 21 percent. It also eliminates the special tax rate for personal service corporations and repeals the maximum corporate tax rate on net capital gain as obsolete.

A corresponding change reduces the 70 percent dividends received deduction available to corporations that receive a dividend from another taxable domestic corporation to 50 percent, and the 80 percent dividends received deduction for dividends received from a 20 percent owned corporation to 65 percent.

Corporate Alternative Minimum Tax (AMT) Eliminated

TCJA repeals the corporate AMT. It also allows the AMT credit to offset the regular tax liability for any taxable year. In addition, the AMT credit is refundable for any taxable year beginning after 2017 and before 2022 in an amount equal to 50 percent (100 percent in the case of taxable years beginning in 2021) of the excess of the minimum tax credit for the taxable year over the amount of the credit allowable for the year against regular tax liability.

Enhanced Bonus Depreciation Deduction

TCJA extends and modifies the additional first-year (i.e., "bonus") depreciation deduction, which had generally been scheduled to end in 2019, through 2026 (through 2027 for longer production period property and certain aircraft). Under the new law, the 50-percent additional depreciation allowance is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023.

The 100-percent allowance is phased down by 20 percent per calendar year for property placed in service, and specified plants planted or grafted, in taxable years beginning after 2022 (after 2023 for longer production period property and certain aircraft).

TCJA also maintains the bonus depreciation increase amount of $8,000 for luxury passenger automobiles placed in service after December 31, 2017, that had been scheduled to be phased down in 2018 and 2019.

TCJA also removes the requirement that, in order to qualify for bonus depreciation, the original use of qualified property must begin with the taxpayer. Thus, the provision applies to purchases of used as well as new items.

TCJA also expands the definition of qualified property eligible for the additional first-year depreciation allowance to include qualified film, television and live theatrical productions, effective for productions placed in service after September 27, 2017, and before January 1, 2023.

Enhanced Section 179 Expensing

TCJA increases the maximum amount a taxpayer may expense under Code Sec. 179 to $1,000,000, and increases the phase-out threshold amount to $2,500,000. Thus, the maximum amount you may expense, for taxable years beginning after 2017, is $1,000,000 of the cost of qualifying property you place in service during the tax year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,500,000.

In addition, TCJA expands the definition of Code Sec. 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging.

TCJA also expands the definition of qualified real property eligible for Code Sec. 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.

Modifications to Depreciation Limitations on Luxury Automobiles and Personal Use Property

TCJA increases the depreciation limitations that apply to listed property, such as luxury automobiles. For passenger automobiles that qualify as luxury automobiles (i.e., gross unloaded weight of 6,000 lbs or more) placed in service after December 31, 2017, and for which the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. The limitations are indexed for inflation for luxury passenger automobiles placed in service after 2018.

In addition, TCJA removes computer or peripheral equipment from the definition of listed property. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.

Modification of Like-Kind Exchange Rules

TCJA modifies the rule for like-kind exchanges by limiting its application to real property that is not held primarily for sale. While the provision generally applies to exchanges completed after December 31, 2017, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.

Other Changes Relating to Cost Recovery and Property Transactions

TCJA makes the following additional changes with respect to cost recovery and property transactions:

(1) allows for expensing of certain costs of replanting citrus plants lost by reason of casualty;

(2) shortens the alternative depreciation system (ADS) recovery period for residential rental property from 40 to 30 years;

(3) allows an electing real property trade or business to use the ADS recovery period in depreciating real and qualified improvement property;

(4) shortens the recovery period from 7 to 5 years for certain machinery or equipment used in a farming business;

(5) repeals the required use of the 150-percent declining balance method for depreciating property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property);

(6) excludes various types of self-created property from the definition of a "capital asset", including: patents, inventions, models or designs (whether or not patented), and secret formula and processes;

(7) specifies situations in which a contribution to the capital of a corporation is includable in the gross income of a corporation (i.e., contributions by a customer or potential customer, and contributions by governmental entities and civic groups); and

(8) tweaks the carried interest rule to provide that a profits interest must be held for three years, rather than one year, in order to receive favorable long-term capital gain treatment.

Repeal of Domestic Activities Production Deduction

TCJA repeals the deduction for domestic production activities.  For our construction and manufacturing clients, this could be the loss of a substantial deduction.

New Deduction for Qualified Business Income

If you are a sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership (hereafter, "partner"), or a shareholder in an S corporation, TCJA provides a new deduction for qualified business income for taxable years beginning after December 31, 2017, and before January 1, 2026. Trusts and estates are also eligible for this deduction.

The amount of the deduction is generally 20 percent of the taxpayer's qualifying business income from a qualified trade or business.

Example: In 2018, Joe receives $100,000 in salary from his job at XYZ Corporation and $50,000 of qualified business income from a side business that he runs as a sole proprietorship. Joe's deduction for qualified business income in 2018 is $10,000 (20 percent x $50,000).

The deduction for qualified business income is claimed by individual taxpayers on their personal tax returns. The deduction reduces taxable income. The deduction is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income.

The deduction is subject to several restrictions and limitations, discussed below.

Qualified Trade or Business. A qualified trade or business means any trade or business other than (1) a specified service trade or business, or (2) the trade or business of being an employee. A "specified service trade or business" is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Special Rule Where Taxpayer's Income is Below a Specified Threshold. The rule disqualifying specified service trades or businesses from being considered a qualified trade or business does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the restriction is phased in over a range of $50,000 in taxable income ($100,000 for joint filers). If an individual's income falls within the range, he or she is allowed a partial deduction. Once the end of the range is reached, the deduction is completely disallowed.

"Domestic" Business Income Requirement. Items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States.

Qualified Business Income. Qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer, or any guaranteed payment (or other payment) to a partner for services rendered with respect to the trade or business. Qualified items do not include specified investment-related income, deductions, or losses, such as capital gains and losses, dividends and dividend equivalents, interest income other than that which is properly allocable to a trade or business, and similar items.

Loss Carryovers. If the net amount of qualified business income from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business in the next tax year (and reduces the qualified business income for that year).

W-2 Wage Limitation. The deductible amount for each qualified trade or business is the lesser of:

(1) 20 percent of the taxpayer's qualified business income with respect to the trade or business; or

(2) the greater of: (a) 50 percent of the W-2 wages with respect to the trade or business, or (b) the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (generally all depreciable property still within its depreciable period at the end of the tax year).

Example: Susan owns and operates a sole proprietorship that sells cupcakes. The cupcake business pays $100,000 in W-2 wages and has $350,000 in qualified business income. For the sake of simplicity, assume the business had no qualified property and that the variation of the limitation involving the unadjusted basis of such property isn't relevant. Susan's deduction for qualified business income is $50,000, which is the lesser of (a) 20 percent of $350,000 in qualified business income ($70,000), or (b) the 50 percent of W-2 wages ($50,000).

The W-2 wage limitation does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the W-2 limitation is phased in over a range of $50,000 in taxable income ($100,000 for joint filers).

Allocation of Partnership and S Corporations Items. In the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner in a partnership takes into account the partner's allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the taxable year equal to the partner's allocable share of W-2 wages of the partnership. Similarly, each shareholder in an S corporation takes into account the shareholder's pro rata share of each qualified item and W-2 wages.

Additional Limitations on the Deduction for Qualified Business Income. This deduction for qualified business income is subject to some overriding limitations relating to taxable income, net capital gains, and other items which are beyond the scope of this letter and will not affect the amount of the deduction in most situations.

Carryover of Business Losses

TCJA provides that, for taxable years beginning after December 31, 2017, and before January 1, 2026, excess business losses of a taxpayer other than a corporation are not allowed for the taxable year. Instead, if you incur such losses, you must carry them forward and treat them as part of your net operating loss (NOL) carryforward in subsequent taxable years. Thus, TCJA generally repeals the two-year carryback and the special carryback provisions under prior law; however, it does provide a two-year carryback in the case of certain losses incurred in the trade or business of farming. NOL carryovers generally are allowed for a taxable year up to the lesser of your carryover amount or 80 percent of your taxable income determined without regard to the deduction for NOLs.

Relaxed Gross Receipts Test for Various Accounting Methods

TCJA expands the universe of taxpayers who can use various accounting methods by increasing the gross receipts threshold ("gross receipts test") under which those methods may be used. TCJA increases the limit for the gross receipts test to $25 million for using the cash method of accounting (including the use by farming C corporations and farming partnerships with a C corporation partner).

The new law also increases the limit for the gross receipts test to $25 million for exemption from the following accounting requirements/methods:

(1) uniform capitalization rules;

(2) the requirement to keep inventories (allowing taxpayers to treat inventories as non-incidental materials and supplies, or in another manner conforming with the taxpayer's financial accounting treatment of inventories); and

(3) the requirement to use the percentage-of-completion method for certain long-term contracts (allowing the use of the more favorable completed-contract method, or any other permissible exempt contract method).

Additional requirements and restrictions apply to the use of the above-mentioned accounting methods. For most, only the dollar limit for the gross receipts test has been relaxed.

Accounting Method Rules Relating to Income Recognition Modified

TCJA revises the rules associated with the recognition of income. Specifically, the new law requires a taxpayer subject to the all events test for an item of gross income to recognize such income no later than the taxable year in which such income is taken into account as income on an applicable financial statement or another financial statement under rules specified by the Secretary, but provides an exception for long-term contract income to which Code Sec. 460 applies.

TCJA also codifies the current deferral method of accounting for advance payments for goods and services provided by the IRS under Rev. Proc. 2004-34. That is, the law allows taxpayers to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes.

Interest Deduction Rules Changed for Certain Taxpayers

Under TCJA, a taxpayer's deduction for business interest is limited to the sum of business interest income plus 30 percent of adjusted taxable income for the taxable year. There is an exception to this limitation, however, for certain small taxpayers, certain real estate businesses that make an election to be exempt from this rule, and businesses with floor plan financing, which is a specialized type of financing used by car dealerships, and for certain regulated utilities.

For smaller taxpayers, TCJA exempts from the interest limitation taxpayers with average annual gross receipts for the three-taxable year period ending with the prior taxable year that do not exceed $25 million. Further, at the taxpayer's election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses.

Limitation on Deduction by Employers of Expenses for Fringe Benefits

TCJA provides that no deduction is allowed with respect to:

(1) an activity generally considered to be entertainment, amusement or recreation;

(2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes; or

(3) a facility or portion thereof used in connection with any of the above items.

Thus, the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer's trade or business (and the related rule applying a 50 percent limit to such deductions) is repealed.

TCJA also disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee's residence and place of employment.

A business may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees during work travel). For amounts incurred and paid after December 31, 2017, and until December 31, 2025, this 50 percent limitation is expanded to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after December 31, 2025 are not deductible.

Employer Credit for Paid Family and Medical Leave

For 2018 and 2019, TCJA allows eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.

Observation: An employer must have a written policy in place that provides family and medical leave to all employees on a non-discriminatory basis in order to qualify for the credit. Given the cost of implementing such a policy and complying with yet-to-be-announced reporting requirements, the credit may be impractical for many employers to pursue during the short period it's available. For companies that already have a qualifying family and medical leave plan in place, however, the credit may provide a nice windfall.

Partnership Rule Changes

Several changes were made to the partnership tax rules.

First, gain or loss from the sale or exchange of a partnership interest is treated as effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. Any gain or loss from the hypothetical asset sale by the partnership is allocated to interests in the partnership in the same manner as nonseparately stated income and loss.

Second, the transferee of a partnership interest must withhold 10 percent of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.

Third, TCJA modifies the definition of a substantial built-in loss such that a substantial built-in loss is considered to exist if the transferee of a partnership interest would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership's assets in a fully taxable transaction for cash equal to the assets' fair market value, immediately after the transfer of the partnership interest.

Fourth, TCJA modifies the basis limitation on partner losses to provide that a partner's distributive share of items that are not deductible in computing the partnership's taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner's adjusted basis in its partnership interest at the end of the partnership taxable year in which an expenditure occurs. Thus, the basis limitation on partner losses applies to a partner's distributive share of charitable contributions and foreign taxes. Lastly, TCJA repeals the rule providing for technical terminations of partnerships. Under that rule, a partnership's existence did not necessarily end; rather, it resulted in the termination of some tax attributes and the possibly early closing of the tax year.

S Corporation Changes

TCJA makes several changes to the tax rules involving S corporations. First, it provides that income that must be taken into account when an S corporation revokes its election is taken into account ratably over six years, rather than the four years under prior law. Second, it allows a nonresident alien individual to be a potential current beneficiary of an electing small business trust (ESBT). Third, it provides that the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

International Tax Changes

TCJA makes sweeping changes to the Unites States' international tax regime through a series of highly complex provisions that are beyond the scope of this letter.

Concluding Thoughts

As you can see, the provisions in the TCJA are quite extensive and complicated – simplification was certainly not achieved.

Be assured we will be contacting you regarding how these changes will impact your business, and what kind of strategies we can adopt to ensure that your business gets the best possible tax outcome under the new rules. 

Let us know of any questions.

Your Team at Roeser Accountancy Corporation

Tax Reform - Changes Affecting Individuals

Overview of New Tax Reform Changes Affecting Individuals

The following is a brief overview of the Tax Cuts and Jobs Act  (TCJA) key changes (and non-changes) affecting individuals.

Tax Rates and Brackets. The new tax reform provides seven tax brackets, with most rates being two to three points lower than the ones under present law (the top rate goes from 39.6 percent to 37 percent). The top rate kicks in at $600,000 of taxable income for joint filers, $300,000 for married taxpayers filing separately, and $400,000 for all other individual taxpayers.

Observation: While applicable rates at any given level of income generally go down by two to three points, some go up. For example, the rate for single individuals with taxable income between $200,000 and $400,000 goes from 33 percent to 35 percent.

Capital Gain Rates and Net Investment Income Tax. Tax rates on capital gains and the 3.8 percent net investment income tax (NIIT) are unchanged by TCJA.  This special tax does not generally apply to the sale of one’s business stock.

Personal Exemptions and Standard Deduction. TCJA repeals the personal exemption deductions, but nearly doubles the standard deduction amounts to $24,000 for joint filers and surviving spouses, $18,000 for heads of household, and $12,000 for single individuals and married filing separately (additional amounts for the elderly and blind are retained).

Observation: The fact that the standard deduction has nearly doubled may create the misleading impression that you'll reap a large tax benefit from the change. But, because the increase in the standard deduction was coupled with the repeal of the deduction for personal exemption ($4,150, per exemption in 2018), the actual benefit is fairly modest. For example, the overall amount of income that is exempt from tax will increase by $2,700 for joint filers - a nice increase, but nowhere near double the $13,000 standard deduction under prior law.

Because the standard deduction is generally claimed only when its amount exceeds available itemized deductions, the increases will not benefit you if you itemize (the repeal of personal exemptions, by contrast, will affect you whether you itemize or not).

Exemption for Dependents and Child Tax Credit. As part of the repeal of personal exemption deductions, TCJA repealed exemptions for dependents. To compensate, TCJA increases the child tax credit to $2,000 ($1,400 is refundable), up from $1,000 (fully refundable) under present law. The modified adjusted gross income threshold where the credit phases out is $400,000 for joint filers and $200,000 for all others (up from $230,000 and $115,000, respectively). The maximum age for a child eligible for the credit remains 16 (at the end of the tax year).

TCJA also provides a $500 nonrefundable tax credit for dependent children over age 16 and all other dependents. Most families with non-child dependents will lose some ground here, as the $500 credit will generally be less valuable than the $4,150 exemption deduction it replaces.

Other Tax Breaks for Families Unchanged. The child and dependent care expenses credit, the adoption credit, and the exclusions for dependent care assistance and adoption assistance under employer plans are all unchanged by TCJA.

Passthrough Tax Break. TCJA creates a new 20 percent deduction for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. The deduction, which is available to both itemizers and nonitemizers, is claimed by individuals on their personal tax returns as a reduction to taxable income. The new tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $157,500 ($315,000 for joint filers) are simpler and more permissive than the ones that apply above those thresholds.

Example: In 2018, Joe receives a salary of $100,000 from his job at XYZ Corporation and $50,000 of qualified business income from a side business that he runs as a sole proprietorship. Joe has no other items of income or loss. Joe's deduction for qualified business income in 2018 is $10,000 (20 percent of $50,000).

Observation: The effective marginal tax rate on qualified business income for individuals in the top 37-percent tax bracket who are able to fully apply the new deduction will be 29.6 percent - fully 10 points lower than the top rate under current law.

Deduction for State and Local Taxes (SALT). TCJA imposes a $10,000 limit on the deduction for state and local taxes, which can be used for both property taxes and income taxes (or sales taxes in lieu of income taxes) and repeals the deduction for foreign property taxes. There is no limit on the amount of the SALT deduction under present law.

Mortgage Interest Deduction. TJCA reduces to $750,000 (from $1 million) the limit on the loan amount for which a mortgage interest deduction can be claimed by individuals, with existing loans grandfathered. TCJA also repeals the deduction for interest on home equity loans.

Deduction for Medical Expenses. An early version of the tax overhaul passed by the House would have repealed the deduction for unreimbursed medical expenses. TCJA retains that deduction and enhances it for 2017 and 2018 by lowering the adjusted gross income (AGI) floor for claiming the deduction from 10 percent to 7.5 percent for all taxpayers.

Deduction for Casualty and Theft Losses. TCJA repeals the deduction for casualty and theft losses, except for losses incurred in presidentially declared disaster areas.

Observation: The new law does, however, provide enhanced relief for victims in federally declared disaster areas in 2016 and 2017.

Deduction for Charitable Contributions. TCJA retains the charitable contribution deduction and increases the maximum contribution percentage limit from 50 percent of a taxpayer's contribution base to 60 percent for cash contributions to public charities.

Deduction for Certain Miscellaneous Expenses. TCJA repeals the deduction for any miscellaneous itemized deductions subject to 2-percent of AGI floor.

Repeal of Alimony Deduction. TCJA repeals the deduction for alimony paid and also the corresponding inclusion in income by the recipient, effective for tax years beginning in 2019. Alimony paid under separation agreements entered into prior to 2019 will generally be grandfathered under the old rules.

Education-Related Tax Breaks Preserved. TCJA retains deductions for student loan interest and educator expenses, and also exclusions for graduate student tuition waivers and employer educational assistance programs.

Alternative Minimum Tax. TCJA increases alternative minimum tax (AMT) exemption amounts by 27 percent, and sharply increases the income level where the exemption is phased out. Combined with the effects of other TCJA changes, many individuals who are currently subject AMT in 2017, will not be in 2018 and beyond.

Expanded Uses for 529 Plan Distributions. TCJA allows up to $10,000 in aggregate 529 distributions per year to be used for elementary and secondary school tuition. Under present law, 529 distributions can only be used for higher education expenses.

Repeal of Individual Healthcare Mandate. TCJA repeals the tax penalty on individuals who fail to carry health insurance enacted as part of the Affordable Care Act (ACA).

Estate and Gift Tax Exclusion. TCJA permanently doubles the basic exclusion amount for estate and gift tax purposes from $5.6 to $11.2 million, per person. So a married couple can pass on approximately 22 million without incurring estate taxes on their death.  The annual gift tax exclusion was raised from $14,000 per person to $15,000 per person starting in year 2018. Therefore, a married couple can gift $30,000 per year to an individual such as their children without tax consequences.  

Please let us know of any questions.

Your Team at Roeser Accountancy Corporation

Personal Use of Autos by Employees and Owners

In some situations, it makes sense for a company to give its employee's company owned or leased vehicles for their everyday use.  If you’re an employee who drives an employer-provided vehicle, you should be aware of some tax implications if you also use the vehicle for personal use.  If you are an owner and employee, these rules apply to you as well.

When an employer provides a vehicle to an employee (or owner) with no restrictions on the use, it is assumed that the vehicle will be driven for both business and personal reasons (commuting to and from work, for business during work days, and personally on the weekends and outside of work hours).  Personal use of the company-provided vehicle is considered to be a fringe benefit for the employee – a form of “non-cash” compensation.  Because of this, the employer should report the value of the employee’s personal use of the vehicle in the employee’s wages (included in box 1 on Form W-2).

This concept is important for small businesses to keep in mind. An S Corporation with two shareholders, for example, each using a company-owned vehicle, must account for the business versus personal use of the vehicles.  If the S Corporation purchased or leases the vehicles, depreciates them and takes deductions for all related expenses, the employee-shareholders are receiving a fringe benefit for the personal use of the vehicles.  The employee-shareholders should be including the value of that personal use as income on their personal returns.

The rule is for the business to include only the value associated with the employee’s personal use on their W-2.  In this case, the employee-shareholder would only be included in income the amount associated with their personal use and, therefore, would not deduct any expenses for business use on his or her individual return (unless there are some additional expenses unreimbursed by the employer).  The IRS publishes a table to determine the value of the personal use; the Annual Lease Value Table.  Please contact us for a copy.

The personal use amount should be included in the W2 and is subject to federal and state tax withholding and other usual payroll taxes such as Social Security. 

Please contact our office for further assistance with calculating the personal use amounts.

Roeser Accountancy Corporation

December 2017

 

Health Insurance for S-Corp Owners

As the 2017 year-end closes in, it’s a good time to revisit the proper treatment of health insurance premiums and S corporation “2 percent shareholders.”

If you own more than 2 percent of the outstanding stock of an S corporation (or stock giving you more than 2 percent of the total voting power), a good chance may exist that your health insurance premiums are not being handled properly at the corporate level. As a result, you could be at risk from a personal tax standpoint.

Health insurance premiums paid by an S corporation on behalf of its 2 percent shareholders should be reported as wages on shareholder W-2 forms. Too often, these payments are not included in wages because the premiums are paid along with those for rank-and-file employees.

From the corporation’s perspective, premiums are different than payroll. Unfortunately, in the eyes of the IRS, they belong on the W-2.

Excluding these amounts from wages jeopardizes the 2 percent shareholders’ ability to deduct these premiums on their personal tax return as self-employed health insurance in arriving at adjusted gross income (AGI). Based on the cost of health insurance, the value of this tax deduction is not something to take lightly.

If there are family members employed by the corporation and covered under the health plan, premium payments made on their behalf may also be required to be included in their wages. Generally, this applies to a spouse, sons, daughters, parents and other direct relatives of 2 percent shareholders.

As wages, these amounts are subject to withholding. But what about Social Security and Medicare tax?

If the 2 percent shareholders are participating in a corporate plan established for the benefit of employees and their dependents, these amounts are not subject to Social Security and Medicare. But they are subject if there is no such plan for the employees.

As far as premium payments and the personal deduction for AGI, it’s important that the corporation make the premium payment or reimburse the 2 percent shareholder making the payment. The 2 percent shareholder cannot make the payment personally.

For those clients who request, we will make the adjustments in your QuickBooks software and process payroll appropriately. 

 Roeser Accountancy Corporation

December 2017