Nonqualified Equities Redemption and Deferred Tax Asset Valuation after Tax Reform

Transcription

1 Nonqualified Equities Redemption and Deferred Tax Asset Valuation after Tax Reform WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor Tax, Finance & Accounting Conference for Cooperatives August 7, 2018 Nick Falk, CPA

2 Agenda Why this subject now? Background of nonqualified equities Rules surrounding the redemption of nonqualified equities Examples of redemptions Valuation of the deferred tax asset for outstanding nonqualified equities 2

3 Why This Subject Now? August 4, 2015 this was covered by David Antoni, Teree Castanias and Sharon Appelt Tax reform Equity strategies should be reviewed Deferred tax asset may have retained its value. 3

4 Background of Nonqualified Equities WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor 4

5 Two Types of Nonqualified Equities Nonqualified written notice of allocation Definition 1388(d) Deduction 1382(b)(2) or 1382(c)(2)(B) (Exempt Co-op only) Nonqualified per-unit retain certificate Definition 1388(i) Deduction 1382(b)(4) 5

6 Nonqualified Written Notice of Allocation Patronage income can go to Patrons (patronage dividend) Cash or other property (FMV) Written notices of allocation (equity at stated $ amount) Qualified Nonqualified Unallocated reserve (watch out for bylaws, state statute and operating on a cooperative basis) 6

7 Nonqualified Per-Unit Retain Certificate How does a marketing co-op pay a patron for their product? Cash or other property Per-Unit Retain Certificate (equity at stated $ amount) Qualified Nonqualified 7

8 What Does Nonqualified Mean? Year of issue Cooperative does not get a deduction Patron does not have taxable income Year of redemption in cash or other property Cooperative gets a deduction Patron has taxable income 8

9 Why Nonqualified Equities? Co-op s tax rate is less than patrons Coop s federal tax rate 21% Individual patrons federal tax rate can range from 0-50% (including SE tax) Co-op wants to allocate net savings but does not want to redeem it for the foreseeable future 9

10 Why Nonqualified Equities? (continued) Flatten taxable income from one year to the next Book basis may lead into too much taxable income or loss Allocate nonqualified equities to increase taxable income Redeem nonqualified equities to decrease taxable income 10

11 Why Nonqualified Equities? (continued) Instead of allocating 199 or 199A(g) deduction to patrons Patrons are in a loss or breakeven Co-op has higher tax rate than patrons Co-op has NOL carryforwards 11

12 Rules Surrounding the of Redemption Nonqualified Equities WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor 12

13 Rules of Redemption For cash or other property (FMV) Reg (c) if an amount is paid within the payment period for two or more taxable years, it will be allowable as a. deduction only for the earliest of such taxable year Effective payment period is the last 3 ½ months of the tax year to 8 ½ months after the tax year 13

14 Example Co-op s fiscal year end is April 30 and has calendar year patrons. Co-op redeems $100K in nonqualified equities in the first half of January 2019 Patrons have $100K in income in calendar year 2019 Co-op has a $100K deduction in fiscal year ending April 30,

15 1383 Computation of Tax When a co-op redeems a nonqualified equity the federal tax equals the lesser of Tax for the taxable year computed with the deduction for the redemption of nonqualified equities (normal method), or An amount equal to the tax for the taxable year without the redemption deduction, minus the decrease in tax for any prior taxable year (or years) resulting solely from treating the amount of cash or other property paid to redeem the nonqualified as qualified at issuance (alternative method) 15

16 1383 Computation of Tax (continued) Most practitioners call this an alternate calculation of tax, not taxable income However 1383(b)(3) says that if tax is computed under the alternative method then the redemption deduction is not taken into account except for

17 1383 Computation of Tax (continued) What does 1383(b)(3) mean? Reg (d) specifically says if the alternative method is used then redemption deduction does not create or increase a NOL. This could be a negative if the NOL would have been worth more. Other carryover issues? Does this create state issues? 17

18 1383 Computation of Tax (continued) The alternative method can go negative. Treated as a tax payment on the last day of the redemption year Preserves one level of tax When calculating the alternative method you have to follow though any hypothetical NOL s, released credits, AMT, etc. for all the prior years 18

19 Examples of Redemptions All examples are for 100% patronage cooperatives WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor 19

20 Example Taxable income $300,000 Nonqualified written notices of allocation issued $100, Taxable income before redemption deduction $500,000 Redeemed all 2015 nonqualified equities 20

21 Example 1 (continued) As Filed Alternative Normal Alternative Income b4 redemption 300, , , ,000 Redemption deduction (100,000) (100,000) Taxable income 300, , , ,000 Income tax 100,250 61,250 84, ,000 Decrease from as filed to alternative 39,000 39,000 Income tax alternative 66,000 Lesser of normal or alternative 66,000 21

22 Example 1 (continued) Notice the difference between the normal method and alternative is 18K 18K dividend by 100K in redemption deduction is 18%. Same difference between the 39% bracket in 2015 and 21% flat tax in

23 Example 1 (continued) Tax return presentation A No redemption deduction on Sch H Tax return presentation B 100,000 redemption deduction on Sch H Taxable income is $500,000 $105,000 tax on Sch J $39, adjustment Taxable income is $400,000 $84,000 tax on Sch J $18, adjustment 2 3

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25 Example Taxable income $300,000 Nonqualified written notices of allocation issued $300, Taxable income before redemption deduction $0 Redeemed all 2015 nonqualified equities 25

26 Example 2 (continued) As Filed Alternative Normal Alternative Income b4 redemption 300, , Redemption deduction (300,000) (300,000) Taxable income 300,000 - (300,000) - Income tax 100, Decrease from as filed to alternative 100, ,250 Income tax alternative (100,250) Lesser of normal or alternative (100,250) 26

27 Example 2 (continued) Get back a tax liability for a previous year (preserves single level of tax for cooperatives) Since the alternative method was used the $300,000 tax loss in the 2020 will not create a NOL States starting at $300,000 loss or zero 27

28 Example Taxable income $50,000 Nonqualified written notices of allocation issued $50, Taxable income before redemption deduction $100,000 Redeemed all 2015 nonqualified equities 28

29 Example 3 (continued) As Filed Alternative Normal Alternative Income b4 redemption 50,000 50, , ,000 Redemption deduction (50,000) (50,000) Taxable income 50,000-50, ,000 Income tax 7,500-10,500 21,000 Decrease from as filed to alternative 7,500 7,500 Income tax alternative 13,500 Lesser of normal or alternative 10,500 29

30 Example 3 (continued) The difference between the normal method and alternative is 3K 3K dividend by 50K in redemption deduction is 6%. Same difference between the 15% bracket in 2015 and 21% flat tax in

31 Example Taxable income $0 Nonqualified per-unit retain certificates issued $100, Taxable income before redemption deduction $500,000 Redeemed all 2015 nonqualified equities 31

32 Example 4 (continued) As Filed Alternative Normal Alternative Income b4 redemption , ,000 Redemption deduction (100,000) (100,000) Taxable income - (100,000) 400, ,000 Income tax , ,000 Decrease from as filed to alternative - - Income tax alternative 105,000 Lesser of normal or alternative 84,000 32

33 Example 4 (continued) 2015 creates a hypothetical $100,000 NOL Need to calculate the decrease for all the prior years Assuming no opt out of carryback election in taxable income $75, taxable income $150,000 33

34 Example 4 (continued) As Filed Alternative As Filed Alternative Income b4 redemption 75,000 75, , ,000 NOL carry back from 2015 (75,000) (25,000) Taxable income 75, , ,000 Income tax 13,750-41,750 32,000 Decrease from as filed to alternative 13,750 9,750 34

35 Example 4 (continued) As Filed Alternative Normal Alternative Income b4 redemption , ,000 Redemption deduction (100,000) (100,000) Taxable income - (100,000) 400, ,000 Income tax , ,000 Decrease from as filed to alternative - 23,500 Income tax alternative 81,500 Lesser of normal or alternative 81,500 35

36 Example Taxable income $50,000 Nonqualified per-unit retain certificates issued $100,000 Taxable income before redemption deduction $0 Redeemed all 2015 nonqualified equities All carry back/forward prior years are breakeven 36

37 Example 5 (continued) As Filed Alternative Normal Alternative Income b4 redemption 50,000 50, Redemption deduction (100,000) (100,000) Taxable income 50,000 (50,000) (100,000) - Income tax 7, Decrease from as filed to alternative 7,500 7,500 Income tax alternative (7,500) Lesser of normal or alternative (7,500) 37

38 Example 5 (continued) The effective tax savings of the redemption of the nonqualified equities was only 7.5% The NOL would have been 21% Need to be careful what year s equities co-op s are redeeming. 38

39 Valuation of the Deferred Tax Asset for Outstanding Nonqualified Equities WEALTH ADVISORY OUTSOURCING AUDIT, TAX, AND CONSULTING Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor 39

40 It matters. Enacted rate is 21% 1383 may preserve the pretax reform value (maximum 39%) Cooperative may consider nonqualified equities permanent Valuation allowance? Net to zero? 40

41 Let s look back at our examples. Assume it s 2018 so redemptions have not happened Example 1 the tax rate is 39% Example 2 the composite tax rate is 33.4% Example 3 the tax rate is 21% Example 4 the composite tax rate is 23.5% Example 5 the tax rate is 21% - WHY? 41

42 Question? Nick Falk, CPA