New Law. Chapter 1. Other Sec. 199A Issues

Transcription

1 New Law Chapter 1 Other Sec. 199A Issues 2

2 FOUR STEPS (Detail below) 1)Potential QBI Deduction: 20% x QBI 2)W2+UB Limit Phases-in based upon TI: (% W-2 Wages + Unadjusted Basis) 3)SSB Exception Phases-out based on TI: (specified service business = SSB) 4)TI-NCG Limit: Taxable income minus Net Capital Gain. 3 REITS and PTPs [C]ombined qualified business income amount means, an amount equal to (A) the sum of the [QBI] deductions for each qualified trade or business carried, plus (B) 20 percent of the aggregate amount of the qualified REIT dividends and qualified publicly traded partnership income... (so the TI-NCG limit applies) 4

3 The TI-NCG limit applies, but because qualified REIT dividends, qualified publicly traded partnership income, and qualified cooperative dividends are not QBI, the W-2+UB limit does not apply 5 Qualified REIT dividend. A dividend from a REIT that is: Not a capital gain dividend Not qualified dividend income. 6

4 Qualified Publicly Traded Partnership Income. With respect to any qualified T or B, the sum of: Allocable share of income, gain, deduction and loss from a PTP that is not taxed as a corporation. Any gain upon disposition if ordinary income under sec. 751(a) 7 Qualified Cooperative Dividends (QCDs) (Sec. 199A(a)(2)) QCD is defined in sec. 199A(e)(4). QCD s are not qualified business income (sec. 199A(c)(1)) so no W-2+UB limit. Potential deduction is 20% x QCD (sec. 199A(2)(A)) The TI-NCG limit is really the TI-(NCG +QCD) limit and it applies to QCDs. 8

5 Sec. 199A Deduction for Specified Agricultural or Horticultural Cooperatives (SAHCs) (Sec. 199A(g)) The sec. 199A deduction for SAHCs is 20% of the excess of gross income of the SAHC over qualified cooperative dividends. Limits: 1) a W2+U.B. limit (see sec. 199A(g)(1)) and 2) A TI limit (see sec. 199A(g)(2)). 9 Qualified Equity Grants (Sec. 83(i))

6 Applies to non-owner private company employees who receive stock per the exercise of stock options or RSUs. Can elect to defer income for up to five years beyond the date they would be taxable under the current rules. Elect by filing an inclusion deferral election no later than 30 days after the award is substantially vested or transferable, whichever is earlier. 11 Not for owners (1% of stock), CFO or CEO or relatives of either. The company must have a written plan under which at least 80% of its U.S. employees are granted options or RSUs with the same rights and privileges. Numerous additional conditions. Effective Date: Options exercised or RSUs settled beginning in

7 NOLs The NOL deduction to is limited to 80 percent of taxable income (determined without regard to the deduction). Indefinite carryforward period. Effective for losses arising in tax years beginning after o Clarification is needed for fiscal year taxpayers. 14

8 Interest Expense Limit on all Entities and Individuals (Sec. 163(j)) 15

9 Note: New Excess Loss Limit: Apply to taxpayers other than C corps (partner/s shareholder level). New QBI Deduction: All taxpayers except C corps (partner/s shareholder level. New Net Bus. Interest: All taxpayers including C corps (PSP and PTR level; S corp and S Shareholder level). 17 Limit On Business Interest 18

10 Business Interest Defined T or B does not include services performed as an employee 19 Adjusted Taxable Income 20

11 Limit applies to interest on debt with related and unrelated lenders, and to individuals, partnerships and corporations. Disallowed interest is carried forward indefinitely. 21 Exempts taxpayers with average annual gross receipts of $25 million or less for the three-tax-year period ending with the prior tax year. Unless a tax shelter prohibited from using the cash method under sec. 448(c)(3). 22

12 Tax Shelter = Syndicate: a partnership or any other entity [other than a C corporation] if more than 35 percent of the losses during any period are allocable to limited partners or limited entrepreneurs. (Sec. 1256(e)(3)(B) No losses, not a syndicate (PLR ) 23 Partnerships Limit is applied at the partnership (PHP) level (though implemented at PTR level). Allowed interest expenses is a nonseparately state item. Disallowed PHP interest expense is carried over at the PTR level as excess business interest and treated as business interest in the PTR s succeeding tax year. o Note: only the disallowed interest is separately stated on the K-1. 24

13 Partner's share of the partnership's "excess taxable income in later years enables the PTR to deduct the carried over interest ( excess business interest). A partner s share of disallowed interest reduces the PTRs basis in the partnership interest (O.B.). But, upon disposition by the PTR, O.B. is adjusted upward for unused excess business interest. 25 Partner Level ATI So other than excess TI, the PTR is not allowed to consider any partnership items in determining the PTR s ATI. 26

14 Similar rules apply to S corps but no stock adjustment adjustment for disallowed interest. 27 Auto dealers and lessors are also exempt which allows them to fully deduct interest on debt used to acquire motor vehicles. 28

15 Election Out The limit does not apply by election to Any farming business A real property trade or business (Sec. 469(c)(7). 29 The term real property trade or business means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. (Sec. 469(c)(7)(C)) 30

16 [W]hether Mrs. Agarwal is characterized as a broker or a salesperson for State law purposes is irrelevant for Federal income tax purposes--the test is whether she was engaged in brokerage within the meaning of section 469 Consistent with her real estate salesman's license and pursuant to her contract with the brokerage firm, Mrs. Agarwal was engaged in brokerage ; i.e., she sold, exchanged, leased, or rented real property and solicited listings. Therefore, Mrs. Agarwal was engaged in a brokerage trade or business within the meaning of section 469(c)(7)(C). Agarwal v. Comm r, TC Summary Opinion (2009) 31 If farming T or B elects out of interest deduction limit, then must use ADS depreciation for farm property with a recovery period of 10 years or more (such as single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements.) 32

17 A real property trade or business (defined by sec. 469(c)(7)(C) electing out of the interest expense limit must use ADS to depreciate any: Nonresidential property Residential rental property QIP Effective for tax years beginning after 2017 (applies to property already in service). 33 Effective for tax years beginning after December 31, No grandfather rule for existing debt obligations. 34

18 Influence of QBI Deduction (Sec. 199A) on Choice of Entity 35 FOUR STEPS (Detail below) 1)Potential QBI Deduction: 20% x QBI 2)W2+UB Limit Phases-in based upon TI: (% W-2 Wages + Unadjusted Basis) 3)SSB Exception Phases-out based on TI: (specified service business = SSB) 4)TI-NCG Limit: Taxable income minus Net Capital Gain. 36

19 Treatment of reasonable compensation and guaranteed payments. (Sec 199A(c)(4) 37 Qualified business income shall not include: (A)reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business, 38

20 (B) any guaranteed payment described in section 707(c) paid to a partner for services rendered with respect to the trade or business, and (C) to the extent provided in regulations, any payment described in section 707(a) to a partner for services rendered with respect to the trade or business. 39 Example (1) Sole-Prop. $1,000,000 Sch. C. net income. W-2 wages of $400,000 were paid to employees. Assume the TI-NCG limit is not a problem. Assume not an SSB. QBI Ded. $200,000 (20% x 1,000,000) 40

21 Benefits of S corporations No SE tax on distributive share. Also, better than sole-prop. where a highly profitable business and the owner is not paying W-2 wages to third parties (perhaps an engineer or architect). S corp can pay sufficient W-2 wages to qualify for QBI Deduction. S corps may be better than partnerships because PSP cannot pay W-2 wages to a Partner to qualify for QBI deduction. 41 Example (2) S Corp. Same as Example (1) but a 100% owned S corporation and recall that sufficient W-2 wages are paid to non-owner employees. W-2 wages paid to the owner (not QBI) reduce the owner s QBI. If the owner has enough income from other sources, don t pay anything from the corporation to the owner and thus risk 42 recharacterization as W-2 wages.

22 Ex. (3) S Corp. $1,000,000 net income before payment of $300,000 of W-2 wages to S Shareholder and no other W-2 wages paid. Assume S Shareholder T.I. is $700,000. The W2+UB Limit is overcome with the W-2 wages paid to the S Shareholder. QBI Ded. $140,000 (20% x 700,000) If an SSB, no QBI deduction (T.I. too high). Consider C corp. 43 Ex. (4) PSP Two equal partners, A and B, but B gets a guaranteed payment of $300,000. $1,000,000 net income before payment of $300,000 guaranteed payment to partner A. Each partner s distributive share is $350,000. Partner B has GP of $300,000. The PSP needs to pay sufficient W-2 wages or have sufficient unadjusted basis. 44

23 Influence of Lower C Corp. Rate On Choice of Entity 45 Single Tax max: 29.6 but don t forget SE tax. U.S. Sole-Prop., Ptr., S shareholder QBI Domestic Source Income ECI 46

24 Single H of H MFJ Indiv. Bracket Rate on QBI <$9,525 <$13,600 <$19,050 10% 8% <$38,700 <$51,800 <$77,400 12% 9.6% <$82,500 <$82,500 <$165,000 22% 17.6% <$157,500 <$157,500 <$315,000 24% 19.2% <$200,000 <$200,000 <$400,000 32% 25.6% <$500,000 <$500,000 <$600,000 35% 28% >$500,000 >$500,000 >$600,000 37% 29.6% 47 U.S. Individual max 23.8 $79 x 23.8% = After Tax $60.2 C 21% $100 x 21% = $21 E&P = $79 Individual s max. effective rate (average rate) on C Corp. earnings: 39.8% 48

25 Compare C corp. To Individual (MFJ) Assume T.I. is all QBI and W-2+UB Limit does not apply (ignore state inc. tax) C Corp.: $550,000 x 21% = $115,500 Tax Indiv.: TI (w/o 199A) $550,000 from S Corp. QBI Ded ,000 TI 440,000 (35% Brack) Indiv. Tax 105,379 (no SE Tax (an S corp.)) 49 Pre-Tax Net Income of $599,000 Indiv. Calif. State Inc. Tax is $50,895. Calif. State Corporate Inc. Tax (8.84%): $52,951 (deductible federally). 50

26 State and Fed. Tax Cost C Corp.: $546,049 x 21% = $114,670 Fed. Tax Calif. State Tax= $52,951 Total = 167,621 Indiv.: TI (w/o 199A) $575,000* S Corp. share QBI Ded ,000 TI 460,000 (35% Brack) Fed. Indiv. Tax 112,379 Calif. State Indiv. Tax 50, ,274 *No state inc. tax deduction to individual taxpayer but with standard deduction (no SE tax). 51 Pre-Tax Net Income of $300,000 Indiv. Calif. State Inc. Tax is $22,612. Calif. State Corporate Inc. Tax (8.84%): $26,520 (deductible federally). 52

27 State and Fed. Tax Cost C Corp.: $273,480 x 21% = $57,430 Fed. Tax Calif. State Tax= $26,520 Total = 83,950 Indiv.: TI (w/o 199A) $263,864* Sch. C (Std. Ded.) QBI Ded. - 52,773 TI 211,094 (24% Brack) Fed. Indiv. Tax 39,241 SE Tax 24,273 (1/2 = 12,136) Calif. State Indiv. Tax 22,612 86,126 *No state inc. tax deduction to individual taxpayer but ½ SE Tax and standard ded. 53 When are C corporations Attractive? Highly profitable business where the earnings are plowed back into the business. Any SBB where the taxpayer s (or spouse s) other income drives the T.I. above $415K (MJF) or $207,500 (other). 54

28 Hazards of C corporations Double Tax (but second tax is deferred). Accumulated Earnings Penalty Tax. Personal Holding Company Tax. Law change increasing the C corp. rate. Sec. 269A (C and S). 55 Employee Incorporating To Get QBI Deduction (via S) or 21% rate (via C)? See Sec. 269A Personal service corporations formed or availed of to avoid or evade income tax. 56

29 S Corporation Changes Relief for Converting From S to C 58

30 If S status is revoked within 2 years of enactment, and the S corp. is eligible then: Cash Distributions after the PTTP are characterized based upon the ratio of AAA/E&P. 59 Eligible if: (1) is an S corporation the day before the enactment; (2) during the two-year period beginning on the date of such enactment revokes its S corporation election under Section 1362(a); (3) all of the owners on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on the date of such enactment. 60

31 Section 481 adjustment for accounting method changes: A 6 tax year period beginning in the year of change. 61 Changes To Electing Small Business Trusts 62

32 Allows nonresident alien individual to be a current beneficiary of an ESBT. The charitable contribution deduction of an ESBT is not determined by the rules for trusts but rather by the rules applicable to individuals. So percentage limitations and carryforward provisions applicable to individuals apply to the portion of an ESBT holding S corporation stock. 63 Effective Date: The nonresident alien beneficiary provision takes effect on January 1, The change to the charitable deduction applies to tax years beginning after December 31,

33 Partnership Changes Carried Interest Rule (New Sec. 1061) 66

34 Change the LTCG one-year holding period to a three-year holding period for certain capital gains of a taxpayer with respect to applicable partnership interests. LTCG under 3 years becomes STCG. An applicable partnership interest is one transferred to (or held by) a taxpayer in connection with the performance of services. 67 Sec (a)(1) In General 68

35 Does LTCG with respect to such interests refer to LTCGs upon the transfer of the PSP interest or the partner s distributive share of partnership LTCGs? Regulatory guidance is needed for this and other aspects of sec (c)(1) Applicable Partnership Interest 70

36 (c)(2) Applicable Trade or Business 71 (c)(3) Specified Asset real estate held for rental or investment 72

37 (c)(4) Exceptions 73 The provision is effective for tax years beginning after December 31,

38 Charitable Contributions and Foreign Taxes are Limited to Outside Basis (Sec. 704(d)) 75 Mandatory 743(b) Adjustment (Deemed 754 Election) 76

39 Current Law: Mandatory if a substantial built-in loss : total adjusted basis of partnership assets exceed total FMV by >$250, Example -- 10% PSP Interest (no discount/no debt) $ 70,000 Inheritance (DOD FMV)* - 100,000 Inside Basis = <30,000> Sec. 743(b) Adj. *DOD FMV (10%) Asset Tax Basis 1,000,000 Asset FMV 700,000 A discount increases the downward adjustment 78

40 New Law: Also mandatory adjustment if a loss of over $250K would be allocated to the transferee partner, if all assets were sold for FMV 79 Sale by Alice to Connie Alice 1/3 O.B. $4 mil. Bart 1/3 O.B. $4 mil. Connie 1/3 O.B. $4 mil. Bldg. FMV $10 mil. Adj. Basis: $5 mil. Bldg. FMV $5 mil. Adj. Basis: $7 mil. ABC Partnership 80

41 No More Deemed Terminations Under Sec Gain Recognized on Sale by of PSP Interest by Foreign Partner 82

42 Background 83 Grecian Magnesite Mining (GMM), Industrial & Shipping Co., SA, 149 TC No (July 13, 2017) Foreign Corporation's Disposition Of Interest In U.S. Partnership (55 Page Opinion) 84

43 The new law reverses the impact of this judicial decision for sales after 12/31/ Redemption of FC by PSP GMM Other Partner s Greek Corporation 12.6% Other Assets Premier -- U.S. LLC/PSP 86

44 GMM Greek Corporation 12.6% Other Partners Other Assets Premier -- U.S. LLC/PSP U.S. Real Property $10.6 Mil. 87 GMM realized $6.2 million of gain and $2.2 million was attributable to Premier s U.S. real estate. 88

45 GMM stipulated at trial that the gain attributed to the U.S. Real Property was U.S. ECI (taxable) per section 897(g) 89 Tax Court Holding #1 GMM s gain was foreign source based upon the default rule in section 865 that gain on the sale of personal property is sourced based upon residence of the seller. And not U.S. source under the U.S. Office rule. 90

46 As a result, the $4 mil. of remaining redemption gain was not taxable by the U.S. unless ECI 91 IRS Position IRS relied upon Rev. Rul which adopted a look-thru approach similar to section 751 but for ECI generating assets rather than hot assets. 92

47 Tax Court View of Ruling Rev. Rul is not simply an interpretation of the IRS's own ambiguous regulations, and we find that it lacks the power to persuade. Its treatment of the partnership provisions is cursory in the extreme, not even citing section Tax Court Holding #2 GMM s proceeds from the redemption of the U.S. LLC/PSP was not effectively connected with a U.S. trade or business. 94

48 Sequence followed by the Tax Court: section 736(b)(1) leads to section 731, which in turn leads to section 741, but [IRS] evidently thinks such an analysis stops short. 95 Section 741 says that gain on the sale of a PSP interest shall be considered as gain or loss from the sale or exchange of a capital asset. Observation: Same reasoning should protect against SE tax on redemption a U.S. partner. 96

49 Conference Agreement Gain or loss from the sale or exchange of a partnership interest is 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. 97 The transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest 98

50 The proposal is effective for sales and exchanges after December 31, Estate, Gift, and GSTT

51 Estate, Gift, and GSST relief by doubling basic exclusion amount (BEA) from $5 mil. to 10 mil. (inflation adjusted after 2011). So $11.2 Mil. BEA in 2018 (instead of $5.6 mil. Married couple, with portability or bypass trust, can shield $22.4 mil. For estates of decedents dying and gifts made between January 1, 2018 and December 31, No change in ability to step-up (or down) income tax basis at death. No change in current rules for nonresident aliens ($60K exclusion from estate tax and no exemption from gift tax). 102

52 Treasury regulations will clarify how to address differences between the date of death BEA and the date of gift BEA (per the Conference Agreement). 103 International Tax

53 DISC s Terminated Current DISCs and IC DISCS in 2018 terminated. NO Change % Exemption (via DRD) for Foreign-Source Non-Subpart F Dividends (Sec. 245A) ( - $215.5 Bil. over 10 years) 106

54 C Corporations only (not S) 107 Exempt (via 100% DRD) 100% of the foreign-source portion of dividends received by a U.S. corporation from a foreign corporation in which the U.S. corp. owns at least 10%. Most hold foreign stock one year. 108

55 No exemption if the dividend is deductible by foreign corporation in computing foreign tax ( hybrid dividend). Sec. 245A DRD does not apply to S corporations (Sec. 1363), but S corps are subject to the transition tax (discussed below) Effective TYBA Dec. 31, U.S. C Corporation Dividend 100% DRD 10% to 100% Foreign Corp Earning Foreign Source Non-Subpart F Income TYBA 12/31/

56 U.S. Corporation Deemed Dividend 10% to 100% Foreign Corp. Subpart F Income 111 U.S. Individual Deemed Dividend 10% to 100% Foreign Corp. Subpart F Income 112

57 Dividend Max Rate with NIIT 23.8% U.S. Individual U.S. Parent Corporation Dividend 100% DRD Foreign Subsidiary 113 What about a foreign branch? 114

58 U.S. Parent Corporation Foreign Income taxed at 21% Max. Rate offset by FTC Foreign Branch If foreign rate is lower than 20%, then U.S. tax on the difference, but also possible new deduction for Foreign-derived Intangible Income (FDII) 115 What about a U.S. pass-thru? 116

59 U.S. Sole-Prop., Ptr., S shareholder Foreign Source Income Not Eligible for 20% deduction but FTC is available Foreign Branch 117 U.S. Individual Dividend (no DRD) No Indirect FTC 10% to 100% Foreign Corp Earning Foreign Source Non-Subpart F Income 118

60 Deduction For Foreign-derived Intangible Income (FDII) New Sec. 250 (-64.4 billion) 119 C Corporations only (not S or individuals) 120

61 A U.S. C corporation is allowed a deduction equal to 37.5 percent (i.e., a preferential tax rate of 12.5 percent) on its foreign-derived intangible income (FDII) earned in the United States. 121 FDII = deemed intangible return = roughly net income after certain adjustments, reduced by the deemed TANGIBLE return of 10% x adjusted basis of tangible assets. 122

62 Deduction eligible income is income derived in connection with property sold, leased, or licensed to, and services provided to foreign persons. Ultimate use of product sold must be foreign. 123 U.S. Parent Corporation Foreign Income taxed at 21% Max. Rate but FDII deduction Foreign Branch New Deduction for Foreign-derived Intangible Income (FDII) 124

63 U.S. Sole-Prop., Ptr., S shareholder No FDII Deduction Foreign Branch 125 Transition Tax On Deferred Foreign Income (Sec. 965) (+ $184.8 Bil.) 126

64 C Corporations and S Corps. and Individuals 127 One-time tax on a US shareholder owning at least 10% of a foreign corporation on the shareholder's pro rata share of the foreign corporation's post-1986 tax-deferred earnings. Rate is 15.5% (if accumulated earnings held in cash or cash equivalents) or 8% (if accumulated in illiquid assets). 128

65 The tax can be paid over 8 years and a portion of FTCs are available. Shareholder with 10%-or-greater stake in a corporation with post accumulated deficits can offset accumulated earnings. 129 U.S. Parent Corporation Deemed Dividend (Via 10% to 100% Subpart F) Foreign Corp Post-1986 Deferred Accumulated Earnings in last tax year beginning before 1/1/

66 U.S. Individual Deemed Dividend (no undirect FTC) 10% to 100% Foreign Corp. Subpart F Income 131 S Corporations S Corporations are subject to the transition tax (but denied the benefit of the 100% DRD Deduction on CFC dividends) Should an S corp. owing 10% of a foreign corporation convert to C? 132

67 Special Rule for S Corporations Any shareholder of an S corporation can elect to defer the transition net tax liability until a triggering event occurs S status change, liquidation, termination, transfer of shares 133 U.S. S corporation Deemed Dividend 10% to 100% Foreign Corp Post-1986 Deferred Accumulated Earnings in last tax year beginning before 1/1/

68 Current Year Inclusion of Global Intangible Income (GILTI) income (+ $135.5 billion) In Effect: a new category of Subpart F income. 135 A U.S. shareholder of CFC must currently include in income (via deemed dividend) its global intangible low-taxed income (GILTI) in a manner similar to how it includes subpart F income. 136 (Includes Individuals)

69 U.S. tax on at a reduced rate on CFC income above a routine return on tangible (if paying foreign and U.S. tax less than a 13.12% (considering the reduced FTCs) 137 Only 80% of the foreign taxes paid on the income would be allowed as a foreign tax credit. Excluded from GILTI: effectively connected income, subpart F income, foreign oil and gas income, or certain related party payments. 138

70 Applies to C Corps, S Corps and Individuals BUT, only C corporations get the deduction for foreign-derived intangible income earned in the U.S. (discussed below) Incentive to convert S to C. 139 U.S. Individual Deemed GILTI Dividend 10% to 100% CFC 140

71 Inventory Sourcing 141 Sales of Inventory are sourced solely based upon production (outbound and inbound). TYBA