2018 VERMONT TAX SEMINAR NAVIGATING CHOICE OF ENTITY IN THE WAKE OF TCJA

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1 2018 VERMONT TAX SEMINAR NAVIGATING CHOICE OF ENTITY IN THE WAKE OF TCJA EXAMPLES #1-4 Steve Trenholm, CPA, MST Gallagher, Flynn & Company, LLP {B }

2 Example #1 Specified Service Business: Taxable Income Does Not Exceed Threshold Lanny Grant, a single individual, is the sole owner of LGU, LLC, a licensed accounting practice. All of LGU's income is from the practice of accounting and is thus a specified service business. LGU has not elected out of its default tax status as a disregarded entity. As a result, Lanny reports all of the income from the accounting practice on his Schedule C. He does not itemize deductions. Lanny's 2018 Form 1040 shows the following: Income from accounting practice, sole practitioner $125,000 Other ordinary income, not from trade or business, rent or royalty 30,000 SE Tax deduction (9,563) AGI $145,438 Standard Deduction (12,000) Taxable Income before 199A deduction $133,438 See next page for QBI deduction calculations. 2

3 Income from accounting practice, sole practitioner 125,000 Other ordinary income, not from trade or busniess, rent or royalty 30,000 SE Tax deduction (9,563) AGI 145,438 Standard Deduction (12,000) Taxable Income before 199A deduction 133,438 Income from LGU 125,000 Tentitive deduction 20% 25,000 Taxable Income 133,438 Taxable Income limitation 133,438 Tentitive deduction 20% 26,688 Deduction 25,000 AGI 145,438 Standard deduction (12,000) QBI deduction (25,000) Income 108,438 Tax at 2018 rates Income tax 20,315 SE tax 19,125 Total Tax 39,440

4 Example #2 Specified Service Business: Taxable Income Does Not Exceed Threshold, Taxable Income Limitation Applies Assume the same facts in Example #1 except that $12,000 of Lanny's income was from qualified dividends and $18,000 was income that did not qualify for either the QBI deduction or capital gain rates. These sources could be foreign source income, annuities, short term capital gains, etc. Lanny's 2018 Form 1040 shows the following: Qualified Dividends $12,000 Income from accounting practice, sole practitioner 125,000 Other ordinary income, not from trade or business, rent or royalty 18,000 SE Tax deduction (9,563) AGI $145,438 Standard Deduction (12,000) Taxable Income before 199A deduction $133,438 See next page for QBI deduction calculations. 3

5 Qualified Dividends 12,000 Income from accounting practice, sole practitioner 125,000 Other ordinary income, not from trade or busniess, rent or royalty 18,000 SE Tax deduction (9,563) AGI 145,438 Standard Deduction (12,000) Taxable Income before 199A deduction 133,438 Income from LGU 125,000 Tentitive deduction 20% 25,000 Taxable Income 133,438 Less Qualified Dividends (12,000) Taxable Income limitation 121,438 Tentitive deduction 20% 24,288 Deduction 24,288 AGI 145,438 Standard deduction (12,000) QBI deduction (24,288) Income 109,150 Tax at 2018 rates Income tax 19,406 SE tax 19,125 Total Tax 38,531

6 Example #3 Specified Service Business: Taxable Income Exceeds Threshold Assume the same facts in Example #2 except that Lanny's income from LGU was $205,000 Lanny's 2018 Form 1040 shows the following: Qualified Dividends $ 12,000 Income from accounting practice, sole practitioner 205,000 Other ordinary income, not from trade or business, rent or royalty 18,000 SE Tax deduction (10,933) AGI $224,067 Standard Deduction (12,000) Taxable Income before 199A deduction $212,067 See next page for QBI deduction calculations. 4

7 Qualified Dividends 12,000 Income from accounting practice, sole practitioner 205,000 Other ordinary income, not from trade or business, rent or royalty 18,000 SE Tax deduction (10,933) AGI 224,067 Standard Deduction (12,000) Taxable Income before 199A deduction 212,067 Income from LGU 205,000 Tentitive deduction 20% 41,000 Taxable Income 212,067 Less Qualified Dividends (12,000) Taxable Income limitation 200,067 Tentitive deduction 20% Deduction AGI 224,067 Standard deduction (12,000) QBI deduction Income 212,067 Tax at 2018 rates Income tax 47,513 SE tax 21,912 Total Tax 69,425

8 Example #4 Specified Service Business: Taxable Income Exceeds Threshold but not phaseout range Assume the same facts in Example #3 except that Lanny's income from LGU was $180,000 Lanny's 2018 Form 1040 shows the following: Qualified Dividends 12,000 Income from accounting practice, sole practitioner 180,000 Other ordinary income, not from trade or business, rent or royalty 18,000 SE Tax deduction (10,571) AGI 199,429 Standard Deduction (12,000) Taxable Income before 199A deduction 187,429 See next page for QBI deduction calculations. 5

9 Qualified Dividends 12,000 Income from accounting practice, sole practitioner 180,000 Other ordinary income, not from trade or busniess, rent or royalty 18,000 SE Tax deduction (10,571) AGI 199,429 Standard Deduction (12,000) Taxable Income before 199A deduction 187,429 Taxable Income before 199A 187,429 Threshold (157,500) Excess 29,929 Phaseout Range 50,000 Excess as a % of phaseout (Excess divided by phaseout) 59.86% Percent of deduction allowed 40.14% Service QBI deduction before limit 36,000 QBI 14,451 AGI 199,429 Standard deduction (12,000) QBI deduction (14,451) Income 172,978 Tax at 2018 rates Income tax 35,003 SE tax 21,142 Total Tax 56,145 13K saved due to 25K less in income

10 CHOICE OF ENTITY: COMPARISON OF C CORPORATION vs S CORPORATION SEE ATTACHED 6

11 Key Assumptions Current Fair Market Value $ 14,406,000 Annual Taxable Income $ 1,978,000 $200,000 Annual After tax Operating Cash Retained by Corporation Annual Dividends Paid (Net of Tax) $ 1,200,000 Tax Basis of Assets $ 8,645,000 Internal Growth Rate 1% $ $(200,000) $(400,000) $(600,000) Year C Corporation After tax Cash S Corporation After tax Cash $15,000,000 $10,000,000 $5,000,000 After tax Cash to Shareholder Stock Sale $15,000,000 $10,000,000 $5,000,000 After tax Cash to Shareholder Asset Sale $ Year $ Year C Corporation After tax Cash S Corporation After tax Cash C Corporation After tax Cash S Corporation After tax Cash Disclaimer The information contained herein is general in nature and based on authorities that are subject to change. Gallagher, Flynn & Co., LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Gallagher, Flynn & Co., LLP assumes no obligation to inform the user of any changes in tax laws or other factors that could affect information contained herein. This document does not, and is not intended to, provide legal, tax or accounting advice.

12 Company A C vs. S Analysis Summary Year Year Year Year Year Year Year Year Year Year Year Annual Operations C corporation tax on income 548, , , , , , , , , , ,557 Shareholder tax on dividend 584, , , , , , , , , , ,364 Total C corporation taxes 1,132,589 1,149,759 1,167,217 1,184,970 1,203,021 1,221,377 1,240,042 1,259,024 1,278,327 1,297,957 1,317,921 Shareholder tax on S corporation income 763, , , , , , , , , , ,292 S corporation taxes Total S corporation taxes 763, , , , , , , , , , ,292 Current tax savings (cost) of S corporation 369, , , , , , , , , , ,629 Cumulative tax savings (cost) of S corporation 369, ,872 1,136,324 1,534,740 1,943,342 2,362,355 2,792,011 3,232,545 3,684,196 4,147,211 4,621,840 Present value of tax savings (cost) 369, ,839 1,082,176 1,426,343 1,762,500 2,090,809 2,411,424 2,724,503 3,030,199 3,328,662 3,620,043 Sale of Business Assets C corporation tax on sale 1,301,098 1,260,700 1,212,754 1,156,970 1,093,054 1,020, , , , , ,099 S corporation tax on sale 486, , , , , , , , , , ,390 Cumulative annual tax variance from above 369, ,872 1,136,324 1,534,740 1,943,342 2,362,355 2,792,011 3,232,545 3,684,196 4,147,211 4,621,840 Earnings on tax savings - 3,692 11,207 22,683 38,257 58,073 82, , , , ,042 Total savings (cost) of S corporation 1,184,106 1,482,367 1,786,207 2,095,721 2,411,006 2,732,162 3,059,290 3,392,491 3,731,871 4,077,534 4,429,590 Present value of total variance 1,184,106 1,411,778 1,620,143 1,810,363 1,983,541 2,140,721 2,282,889 2,410,980 2,525,877 2,628,415 2,719,384 Sale of Stock C corporation tax on sale 141,903 73,639 (1,715) (84,398) (174,658) (272,749) (378,931) (493,471) (616,643) (748,727) (890,012) S corporation tax on sale 213, , , , , , , , , , ,365 Cumulative annual tax variance from above 369, ,872 1,136,324 1,534,740 1,943,342 2,362,355 2,792,011 3,232,545 3,684,196 4,147,211 4,621,840 Earnings on tax savings - 3,692 11,207 22,683 38,257 58,073 82, , , , ,042 Total savings (cost) of S corporation 297, , ,645 1,147,110 1,442,960 1,745,342 2,054,403 2,370,293 2,693,168 3,023,185 3,360,506 Present value of total variance 297, , , ,916 1,187,127 1,367,521 1,533,027 1,684,523 1,822,842 1,948,772 2,063,059 NOTE: The compound impact of annual operations is included in the calculated impact of a sale transaction. Disclaimer The information contained herein is general in nature and based on authorities that are subject to change. Gallagher, Flynn & Co., LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Gallagher, Flynn & Co., LLP assumes no obligation to inform the user of any changes in tax laws or other factors that could affect information contained herein. This document does not, and is not intended to, provide legal, tax or accounting advice.

13 Company A C vs. S Analysis CRD SEE ADDITIONAL INPUT TO RIGHT ----> INPUT SHEET Input Field Valuations and Income Items Current fair market value of net equity of corporation 14,406,000 x Current inside tax basis in corporate assets (after reduction for liabilities) 8,645,000 x Current shareholder basis in stock 13,709,000 x Estimated pre-tax taxable income each year 1,978,000 x Total income before "pass-through" deduction in Senate Bill and before deduction of state taxes Net after-tax dividends or distributions 1,200,000 x Tax impact of distributions in excess of stock basis, AAA and E&P not accounted for in the tool Section 1411 Percentage of income subject to NIIT 1.2% x Only used for dividends and asset sales in this model, operating taxes paid proporationally at highest rate Built-in Gain / LIFO Recapture Built-in gain period remaining 0 x Must key in all scenarios years; if currently a C corporation, entry should be full recognition period (i.e., 5 years Built-in gain at date of "S" election 0 Zero or blank are valid entries. Do not include any amounts that that will be input below as LIFO recapture gain. LIFO recapture amount - Do not include LIFO recapture as BIG above. Tax-exempt Shareholders Percentage owned by tax-exempt shareholders 0.0% Discount Rates and Growth Rates Discount rate for present value analysis 5.00% x This is used on the "Numeric Summary" tab to calculate the present value of the cumulative tax benefit/(cost) of being an S corp Annual growth rate for income 1.00% x Should incorporate anticipated inflation adjustment and assumed real earnings growth Annual growth rate for business value and accumulated earnings 1.00% x Rate is applied to net equity when determining inside appreciation of company net assets Annual growth rate for net after-tax dividends or distributions Should incorporate anticipated inflation adjustment and assumed real growth in dividends to be paid (only applicable if making d 2.00% x NOTE: When inputting tax rates, choose the estimated rate that would apply totaxable shareholders. Use the "tax-exempt shareholders" input to indicate portion of income passed through to tax-exempt shareholders. Federal Tax Rates Individual ordinary tax rate 29.60% x This rate will apply to S Corporation income. Generally the effective tax rate for the shareholder with the highest rate of tax Individual dividend and long-term gain tax rate 20.00% x This rate will apply to C corporation dividends and to stock sales. A blended rate can be used if 0%, 15% or 20% rate would ap Individual rate on sale of S corporation assets 23.36% x This rate will apply to the gain on the sale of assets inside of the S corporation and can be adjusted to account for Sec an Passive Medicare Tax Rate 3.80% x Changes to this rate are not recommended Built-in gains tax rate 21.00% x Assume impact of Pease amendment? N Removed C corporation tax rate on income Table Rate Table rates used C corporation tax rate on sale of assets Table Rate Table rates used State Tax Rates Individual ordinary tax rate 8.95% x This will apply to all S corporation income Individual long term capital gain tax rate 5.37% x Individual rate on sale of S corporation assets 6.62% x C corporation tax rate 8.50% x This will apply to all C corporation Income S corporation tax rate 0.00% If a state level tax is imposed on the S Corporation (e.g., Illinois), key it here Federal Tax Rates - With Blended 1411 Rate Individual ordinary tax rate 29.60% Individual dividend and C corporation long-term gain tax rate 23.80% Individual S corporation long-term gain tax rate 20.05% Individual asset sale tax rate 23.41% State Built in Gain tax rate 0.00%

14 Combined Rates before non-taxable adjustments Individual ordinary tax rate 38.55% Individual ordinary tax rate - with Full % Used to calculate Active SH Pro-rata adjustment Individual dividend tax rate 32.75% Individual asset sale tax rate 30.03% Individual long-term gain tax rate - S corporation 25.42% Individual long term gain tax rate - C corp 29.17% Corporation tax rate on income Table Rate Corporation tax rate on sale of assets Table Rate S corporation tax rate 0.00% Built in gains tax rate 21.00% Combined Rates adjusted for non-taxable shareholders Individual ordinary tax rate 38.55% Individual ordinary tax rate - with Full % Individual dividend tax rate 32.75% Individual asset sale tax rate 30.03% Individual long term gain tax rate - S corp 25.42% Individual long term gain tax rate - C corp 29.17% Corporation tax rate on income Table Rate Corporation tax rate on sale of assets Table Rate S corporation tax rate 0.00% Built in gains tax rate 21.00% Taxable Non-UBIT Income 100% Taxable UBIT Income 100%

15 2017 Conference Committee commentary as of 12/13/ % Rate is built into charts Wages Paid 11,000,000 Business Income 1,978,000 Pass-Through Deduction Rate Pass-through deduction (395,600) 20.00% 50% of Wages (5,500,000) Income after deductions 1,582,400 Fed Tax Rate to apply 37.00% Total Tax 585, Total Federal Rate 29.60% Corporate Rate to Use 21%

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