H2R CPA Blog
Tax Reform Resource Center
by H2R CPA Team
Congress has yet to tackle several outstanding uncertainties frustrating both businesses and individual taxpayers. The Tax Cuts and Jobs Act (TCJA), for example, contains several “glitches” requiring legislative fixes. Congress also has neglected to pass the traditional “extenders” legislation that retroactively extend certain tax relief provisions that expired at the end of an earlier year, in this case 2017.
The sprawling TCJA signed into law in late 2017 contains some inadvertent glitches that range from a lack of clarity to significant drafting errors. In some cases the glitches may produce unintended and costly consequences. Here are examples of two glitches that still need to be addressed and one that has been addressed recently:
The “retail” glitch. This prevents retailers, restaurants and other businesses from enjoying 100% bonus depreciation on certain assets. Before the TCJA’s enactment, qualified retail improvement property, qualified restaurant property and qualified leasehold improvement property were depreciated over 15 years under the modified accelerated cost recovery system (MACRS) and over 39 years under the alternative depreciation system (ADS).
The TCJA classifies all of these property types as qualified improvement property (QIP). QIP generally is defined as any improvement to the interior of a nonresidential real property that’s placed in service after the building was placed in service.
Congress intended QIP that is placed in service after 2017 to have a 15-year MACRS recovery period and a 20-year recovery under the ADS. Because 15-year property is eligible for bonus depreciation, Congress also intended QIP to be eligible for that break.
Yet, the 15-year recovery period for QIP doesn’t appear in the statutory language of the TCJA, even though it’s found in the Joint Explanatory Statement of Congressional Intent. Until technical corrections are made, therefore, QIP has a 39-year MACRS recovery period, making it ineligible for bonus depreciation.
In late March 2019, a bipartisan bill that would fix the error was introduced in the U.S. House of Representatives. The Restoring Investment in Improvements Act mirrors bipartisan legislation introduced in the Senate in mid-March. But many Democrats in Congress haven’t supported this and other TCJA fixes, due to their complaints about how the law was enacted. Some lawmakers advocate tying such fixes to other tax code changes that might otherwise come up short on the votes necessary for passage.
In the meantime, taxpayers who have invested in QIP might consider cost segregation studies. By separating out QIP from other types of property, they could still qualify for some bonus depreciation.
Effective date glitch for the NOL deduction. The TCJA implemented several changes to deductions for net operating losses (NOLs). Specifically, it limits the deduction to 80% of taxable income, eliminates most NOL carrybacks and allows unlimited carryforwards (vs. 20 years under prior law).
The statutory text states that changes to carrybacks and carryforwards apply to NOLs arising in taxable years ending after December 31, 2017 — but the Conference Report says they apply to NOLs arising in taxable years beginning after December 31, 2017. The statute and the report agree that the 80% limitation applies to losses arising in taxable years beginning after December 31, 2017. Because statutory language controls, a mismatch now exists between the effective dates for the 80% limitation and the changes to NOL carrybacks and carryforwards.
Congress’s Joint Committee on Taxation has confirmed that all of the changes should apply to NOLs in tax years beginning after 2017. It notes, though, that technical corrections may be necessary. As of this writing, no correcting legislation has been introduced in Congress.
The “grain” glitch. This is one glitch that has been addressed. An error in the Section 199A deduction for pass-through entities incentivized farmers to sell their crops to cooperatives, rather than to private businesses. The deduction typically is referred to as the qualified business income (QBI) deduction, but Sec. 199A actually had two parts — one for QBI and one for qualified cooperative dividends (QCD).
The QBI deduction was based on the net amount of business income, but the QCD was based on the gross amount of sales. In addition, the QCD deduction wasn’t subject to the same limitations as the QBI deduction (for example, the wage limit and income-related phaseouts).
In other words, the deduction for sales to co-ops was more generous than the deduction for income from sales to businesses. In some circumstances, farmers could have avoided income taxes altogether.
But the appropriations bill President Trump signed on March 23, 2019, includes a section addressing this glitch. It eliminates the QCD concept, leaving farmers with the same QBI deduction as other pass-through businesses have, subject to the same limitations. The law also revives the former Sec. 199 domestic production activities deduction for cooperatives, allowing a deduction of 9% of the qualified production activities (limited to 50% of the W-2 wages of the cooperative), which generally is passed through from the cooperative to its members.
Proposed tax extenders
Many of the income tax provisions that Congress enacts are temporary. As a result, Congress routinely temporarily reauthorizes some of these more popular provisions before or after they expire.
In late February 2019, Sens. Chuck Grassley (R-IA) and Ron Wyden (D-OR) introduced the Tax Extender and Disaster Relief Act of 2019. Among other things, the legislation would extend through 2019 more than two dozen tax breaks that expired at the end of 2017, including the:
As of this writing, corresponding legislation hasn’t been introduced in the U.S. House of Representatives.
A waiting game
In light of the current political climate in Washington, D.C., it remains to be seen whether any of the outstanding issues will be resolved in the near future. We’ll keep you apprised of any updates.
Contact H2R CPA at 412-391-2920 or firstname.lastname@example.org for assistance with your tax planning.
by H2R CPA Team
Merger and acquisition activity has been brisk in recent years. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.
Stocks vs. assets
From a tax standpoint, a transaction can basically be structured in two ways:
1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.
The now-permanent 21% corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.
The TCJA’s reduced individual federal tax rates may also make ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, the TCJA’s individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.
2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.
Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask your tax advisor for details.
Buyer vs. seller preferences
For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the deal closes.
A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.
Meanwhile, sellers generally prefer stock sales for tax and non-tax reasons. One of their main objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock or partnership or LLC interests) as opposed to selling business assets.
With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).
Keep in mind that other issues, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.
Professional advice is critical
Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results. Contact us for the best way to proceed in your situation.
Contact H2R CPA at 412-391-2920 or email@example.com for assistance with tax planning or to inquire about our transaction advisory services.
by H2R CPA Team
The Trump administration has released its long-awaited proposed rule to update the overtime exemptions for so-called white-collar workers under the Fair Labor Standards Act. The rule increases the minimum weekly standard salary level for both regular workers and highly compensated employees (HCEs). It also increases the total annual compensation requirement for HCEs that’s required to qualify them as exempt. In addition, it retains the often confusing “duties test.”
The Trump administration rule generally is more favorable to employers than the Obama administration’s 2016 rule, which a federal district court judge in Texas halted before it could take effect. While the latter was expected to make 4.1 million salaried workers newly eligible for overtime (absent some intervening action by their employers), the U.S. Department of Labor (DOL) predicts that the newly proposed rule will make 1.3 million currently exempt employees nonexempt. The DOL estimates the direct costs for employers under the proposed rule will ring in at $224 million less per year than under the 2016 rule. (It’s unclear whether these figures take into account payroll tax obligations.)
The current rule
The regulations regarding the overtime exemptions for executive, administrative and professional employees haven’t been updated since 2004. Under them, an employer generally can’t classify a white-collar employee as exempt from overtime requirements unless the employee satisfies three tests:
Neither job title nor salary alone can justify an exemption; the employee’s specific job duties and earnings must also meet applicable requirements.
Certain employees (for example, doctors, teachers and lawyers) aren’t subject to either the salary basis or salary level tests. The current rules also provide an easier-to-satisfy duties test for certain HCEs who are paid total annual compensation of at least $100,000 (including commissions, non-discretionary bonuses and other non-discretionary compensation) and at least $455 salary per week.
The Obama administration’s proposed rule
The 2016 rule focused primarily on the salary level test, increasing the threshold for exempt employees to $913 per week, or $47,476 per year. The levels would have automatically updated every three years beginning January 1, 2020. At the time, President Obama argued that the overtime regulations had “not kept up with our modern economy.”
By more than doubling the salary level test, the rule would have made it unnecessary for employers to even consider an employee’s duties in many cases. If the employee’s pay fell under the threshold for exemption, the duties would be irrelevant — the employee already couldn’t be exempt.
The Obama rule also would have raised the HCE threshold above which the looser duties test applies. It boosted the level to the 90th percentile of full-time salaried workers nationally, or $134,004 per year. The rule would have continued the requirement that HCEs receive at least the full standard salary amount — or $913 — per week on a salary or fee basis without regard to the payment of non-discretionary bonuses and incentive payments. However, such payments would have counted toward the total annual compensation requirement.
The Obama rule was scheduled to take effect on December 1, 2016. On November 22, 2016, however, a district court judge granted a preliminary injunction stopping the implementation. The Fifth Circuit Court of Appeals subsequently declined to review the case until the DOL issued revisions.
The latest proposed rule
The DOL’s newly proposed rule would raise the standard salary level threshold to $679 per week, or $35,308 per year. For employees whose salary exceeds this level, overtime eligibility will depend on whether they primarily perform executive, administrative or professional duties. That determination would continue to turn on various checklists of criteria, many of which can seem outdated and not reflective of today’s workplace. Moreover, they’ve long invited litigation by employees challenging their employers’ application of the criteria.
The proposed rule raises the total annual compensation requirement for HCEs to $147,414, and HCEs also must make at least $679 per week on a salary or fee basis without regard to the payment of nondiscretionary bonuses and incentive payments. But it would allow employers to use nondiscretionary bonuses and incentive payments (including commissions) that are paid annually or more frequently to satisfy up to 10% of the standard salary level test. This means an employee’s production or performance bonuses could push him or her over the threshold and into exempt status (assuming the salary basis and looser duties tests are satisfied).
A catch-up payment is allowed for employees who don’t earn enough in non-discretionary bonus or incentive payments in a given 52-week period to meet the HCE salary threshold and retain his or her exempt status. Within one pay period of the end of the 52-week period, the employer can make a payment of up to 10% of the total standard salary level for the preceding 52-week period. This payment will count toward only the previous year’s salary amount — it doesn’t count toward the salary amount in the year it’s paid.
The duties test isn’t the only part of the existing rules that wouldn’t change under the proposed rule. No changes are made to the overtime protections for certain categories of employees, including police officers; firefighters; paramedics; nurses; and specified non-management employees, such as production-line employees and maintenance and construction workers.
The proposed rule also leaves out the automatic adjustments to the salary thresholds that were included in the Obama rule. The DOL acknowledges, though, that such thresholds can become “substantially less effective over time.” It proposes updates every four years and solicits public comment on how best to implement these future updates.
Not a sure thing
The DOL has solicited public comments on the proposed rule and indicated it expects the finalized rule to take effect on January 1, 2020. Legal challenges are likely from both business and worker groups, though. Some have questioned whether the DOL even has the authority to base overtime eligibility on salary levels. Stay tuned for more developments.
Contact H2R CPA at 412-391-2920 or firstname.lastname@example.org with any questions.
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