SOPHISTICATED CHOICE OF ENTITY, PART 1 & PART

Transcription

1 SOPHISTICATED CHOICE OF ENTITY, PART 1 & PART 2 First Run Broadcast: February 20 & 21, PM EDT, 12PM CDT, 11AM MDT, 10AM PDT (60 minutes each day) Choosing the right entity for a closely-held business is not about a single point in time but planning for that business over long stretches of time and the likelihood of substantial change. One of those changes is the change wrought by tax law, specifically the recently enacted tax reform legislation. The new law substantially alters familiar tax law considerations when choosing the right entity for client goals, particularly when considering a range of pass-through entities. These and a multitude of other considerations often involve a sophisticated tradeoff of benefits and costs. This program will provide you with a practical guide to sophisticated choice of entity considerations, including detailed consideration of the new tax law. Day 1: February 20, 2018: Advanced choice of entity considerations management, tax, finance, regulatory, employee benefit and other considerations Impact of industry norms, investor expectations, and regulatory requirements on choice of entity Management and information rights, and the ability to restrict Fiduciary duties and liability of owners and managers, and the ability to modify these duties Economic rights choosing among capital rights, income rights, tracking rights Special considerations for service-based businesses Day 2: February 21, 2018: Impact of new 2018 tax law on C Corps, S Corps, and pass-through entities Planning for distributions of property Anticipating liquidity events sale of the company, liquidation of the company, new investors/members Employment tax planning disparities among entities State and local tax considerations Owner and employee fringe benefit considerations When the first choice wasn t correct considerations when an entity needs to convert Speaker: Paul Kaplun is a partner in the Washington, D.C. office of Venable, LLP where he has an extensive corporate and business planning practice, and provides advisory services to emerging growth companies and entrepreneurs in a variety of industries. He formerly served as an Adjunct Professor of Law at Georgetown University Law Center, where he taught business planning. Before entering private practice, he was a Certified Public Accountant with a national accounting firm, specializing in corporate and individual income tax planning and compliance. Mr. Kaplun received his B.S.B.A., magna cum laude, from Georgetown University and J.D. from Georgetown University Law Center.

2 Norman Lencz is a partner in the Baltimore, Maryland office of Venable, LLP, where his practice focuses on a broad range of federal, state, local and international tax matters. He advises clients on tax issues relating to corporations, partnerships, LLCs, joint ventures and real estate transactions. He also has extensive experience with compensation planning in closely held businesses. Mr. Lencz earned his B.S. from the University of Maryland and his J.D. from Columbia University School of Law.

3 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Sophisticated Choice of Entity, Part 1 Teleseminar February 20, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER February 13, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

4 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Sophisticated Choice of Entity, Part 2 Teleseminar February 21, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER February 14, 2018 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

5 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 20, 2018 Seminar Title: Sophisticated Choice of Entity, Part 1 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

6 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: February 21, 2018 Seminar Title: Sophisticated Choice of Entity, Part 2 Location: Credits: Program Minutes: Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

7 Sophisticated Choice of Entity After the Tax Cuts and Jobs Act Paul Kaplun, Partner Corporate, Securities, and Business Transactions Practice Group Chris Davidson, Counsel Tax and Wealth Planning Practice Group

8 Introduction The recent enactment of the Tax Cut and Jobs Act has dramatically changed the tax landscape for all taxpayers, but the legislation has a particularly significant impact on choice of entity consideration. While the typical nontax considerations continue to play an important role, the tax changes may cause some taxpayers to re-evaluate their previous choice of entity decisions. While the new rules certainly create many opportunities for tax savings, careful planning is necessary to ensure that pass-through entities and their owners take maximum advantage of these new opportunities. Given the speed with which the legislation was passed, there are many unanswered questions as to how the new rules will apply. This presentation will assist practitioners in understanding how to best navigate some of these new rules, as well as an in-depth analysis of the impact of the new rules on the choice-of-entity decision. 2

9 Choice of Entity Comparison Chart Ownership; Liability of Owners Sole Proprietorship C Corporation S Corporation - One owner; unlimited - Up to 100 shareholders personal liability - Unlimited number of shareholders without restrictions as to types of owners - Shareholder liability limited to the amount of capital contribution - Generally, only US citizens or residents can be shareholders - Certain trusts and taxexempt organizations are eligible shareholders - Shareholder liability limited to the amount of capital contribution Limited Liability Company (taxed as a Partnership) - Unlimited number of members without restriction as to types of owners (this chart assumes at least two members) - Member liability limited to the amount of capital contribution Limited Partnership - Unlimited number (but at least two, one of whom is a general partner) of partners without restriction as to types of ownership - Unlimited personal liability of general partner - Limited partner liability limited to the amount of capital contribution 3

10 Choice of Entity Comparison Chart (continued) Formation/ Organizational Documents Sole Proprietorship C Corporation S Corporation - Trade Name Certificate - Articles/ - Articles/ or equivalent, if Certificate of Certificate of desired/necessary Incorporation Incorporation - Bylaws - Shareholders Agreement - Bylaws - Shareholders Agreement Limited Liability Company (taxed as a Partnership) - Certificate of Formation/ Articles of Organization - Limited Liability/Operating Agreement Limited Partnership - Certificate of Limited Partnership - Limited Partnership Agreement - Form 2553 (Election of S Corporation status); may need to file state elections as well 4

11 Choice of Entity Comparison Chart (continued) Management/ Governance Sole Proprietorship C Corporation S Corporation - Rests with sole proprietor - Board of Directors responsible for overall management - Officers responsible for day-to-day management; serve at the pleasure of the Board - Shareholders may vote to approve certain major matters/ Transactions - Board of Directors responsible for overall management - Officers responsible for day-to-day management; serve at the pleasure of the Board - Shareholders may vote to approve certain major matters/ Transactions Limited Liability Company (taxed as a Partnership) - Flexibility in allocating management responsibilities between members and managers, including, if desired, the adoption of a corporate governance structure - Interplay of governing state statute and Limited Liability/Operating Agreement Limited Partnership - General partner responsible for overall management; limitations can be imposed and certain matters can be subject to vote of the limited partners - Some state statutes permit elimination of Board of Directors - Some state statutes permit elimination of Board of Directors 5

12 Choice of Entity Comparison Chart (continued) Equity/Capital contributions Sole Proprietorship C Corporation S Corporation - Governed by owner s - Common and preferred contribution to the stock business - Multiple classes; series within a class; differences in rights and preferences - Distributions proportionate to stock ownership within a class where class preferences exist - One class of stock; differences in voting rights permitted - Avoidance of second class of stock through debt and equity equivalent issuances - Distributions proportionate to stock ownership Limited Liability Company (taxed as a Partnership) - Membership interests can be held in proportion to ownership and can be classified into multiple classes with differences in rights and preferences similar to common and preferred stock - Distributions may be disproportionate to ownership Limited Partnership - Distribution between general and limited partner classes - Distributions may be disproportionate to ownership 6

13 Choice of Entity Comparison Chart (continued) Employee Equity Incentives Sole Proprietorship C Corporation S Corporation - Not applicable - Stock options - Stock options (nonqualified/ (nonqualified/ qualified typically qualified typically incentive stock options incentive stock options (ISOs)) (ISOs)) Limited Liability Company (taxed as a Partnership) - Profits interests - Options and equity equivalent awards are possible but not common Limited Partnership - Profits interests - Options and equity equivalent awards are possible but not common - Restricted Stock - Stock appreciation rights/phantom stock - Restricted Stock - Stock appreciation rights/phantom stock - Equity incentives need to be structured to comply with single class of stock requirement 7

14 Choice of Entity Comparison Chart (continued) Tax Considerations Sole Proprietorship C Corporation S Corporation Limited Liability Company (taxed as a Partnership) Limited Partnership 1. General - One level of tax to owner; state law may impose tax at business level - Potential for two levels of tax - Potential of two levels of tax if S corporation was formerly a C corporation 2. Current Distributions - Not taxable - Generally taxable - Generally not taxable unless amount exceeds stock basis or if S corporation was formerly a C corporation with earnings and profits 3. Self-employment tax - Applicable to owners - Not applicable - Not applicable but subject to reasonableness 4. Sale of Ownership Interest - Gain/loss may be capital and/or ordinary - Gain/loss generally capital of wages - Gain/loss generally capital - One level of tax to members; state law may impose tax at entity level; new audit rules may impose entity level tax - Generally not taxable unless amount exceeds basis - May/may not be applicable - Gain/loss generally capital - One level of tax to partners; state law may impose tax at entity level; new audit rules may impose entity level tax - Generally not taxable unless amount exceeds basis - Applicable to general partners - Gain/loss generally capital 8

15 Choice of Entity Comparison Chart (continued) Tax Considerations Sole Proprietorship C Corporation S Corporation Limited Liability Company (taxed as a Partnership) Limited Partnership 5. Sale of Assets - One level of tax to owner - Potential for two levels of tax - Potential two levels of tax if S corporation was formerly a C corporation - One level of tax to members - One level of tax to partners 6. Liquidating Distributions 7. Potential for tax-free organization - No tax - Generally taxable - Generally not taxable unless amount exceeds stock basis or if S corporation was formerly a C corporation with earnings and profits - Not taxable unless amount exceeds basis No Yes Yes No No - Not taxable unless amount exceeds basis 9

16 C Corporation Changes Corporate income tax rate is permanently lowered to 21% beginning in 2018 Corporate AMT permanently repealed Dividends received deduction reduced 10

17 Pass-Through Deduction In General New below the line deduction for qualified business income from pass-through entities and sole proprietorships Maximum deduction is 20% of qualified business income (QBI) Maximum 20% deduction is also available for qualified REIT Dividends and qualified cooperative dividends Non-corporate taxpayers (including estates and trusts) are eligible to claim the deduction Effectively reduces the rate on pass-through income to eligible taxpayers to 29.6% Sunsets in

18 Pass-Through Deduction - Qualified Business Income Generally, the ordinary income, gain, deduction, and loss of a qualified trade or business What is a qualified trade or business? Generally, any business other than a specified service business or the trade or business of performing services as an employee Specified service business - a 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, or where the principal asset of the business is the reputation or skill of one or more of its employees, or which involves the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities. Excluded items: the taxpayer s wages (or reasonable compensation), guaranteed payments, and investment-type income (capital gains, interest, dividends) 12

19 Pass-Through Deduction - Calculation Subject to certain limits and thresholds, the deduction generally is the sum of: The lesser of: 20% of the taxpayer s qualified business income; or The greater of: 50% of the W-2 wages with respect to the business, or 25% of the W-2 wages with respect to the business plus 2.5% of the unadjusted basis of all qualified property Plus 20% of qualified REIT dividends and distributions from publicly traded partnerships Plus 20% of qualified cooperative dividends 13

20 Pass-Through Deduction Limits Availability and/or calculation of the deduction is subject to limits based on the taxpayer s income and the type of business conducted: Total Taxable Income Not Exceeding Threshold (Single - $157,500 / Joint - $315,000) Threshold Plus Phase In Over Threshold (Single - $207, 501 / Joint - $415, 001) Specified Service Full 20% deduction, no W2/basis limit 20% deduction subject to phase-out, W2/basis limit phased in No deduction permitted Non-Specified Service Full 20% deduction, no W2/basis limit 20% deduction subject to phase-in of W2/basis limit 20% deduction permitted but fully subject to W2/basis limit 14

21 Pass Through Deduction - Example Example 1: A wholly-owned business purchases an office building for $6M ($3M building, $3M land). The building generates annual rental income of $500,000. The maximum potential allowable pass-through deduction would be $100,000 (20% of $500,000). If the business paid no wages, the business would qualify for a deduction of only $75,000 (2.5% x $3M = $75,000). 15

22 Pass Through Deduction - Example Example 2: Same facts as Example 1, but assume $4M is allocated to the building. The deduction would not be limited and thus the full $100,000 (2.5% x $4M = $100,000) would be deductible. 16

23 Pass Through Deduction - Example Example 3: Same facts as Example 1, but assume the business pays $100,000 of W-2 wages. The full $100,000 pass-through deduction would now be available, calculated as follows: 25% x $100,000 of W-2 wages = $25, % x $3M unadjusted basis = $75,000 $25,000 + $75,000 = $100,000 17

24 Pass Through Deduction Taxable Income Limit Deduction is limited to 20% of the excess of taxable income over net capital gain Example: $100,000 of QBI, $200,000 of long-term capital gain and $50,000 of itemized deductions, resulting in taxable income of $250,000. Before application of this limit, deduction is equal to 20% of QBI of $100,000, or $20,000 Taxable income less net capital gain is $50,000 ($250,000-$200,000 = $50,000). So the deduction will be reduced under this limit from $20,000 to 20% of $50,000, or $10,000 Note that dividends are not subtracted, even though taxed at capital gain rate 18

25 Pass-Through Deduction - Open Issues Is rental real estate a qualified trade or business? Aggregation/grouping issues multiple projects under common ownership Real estate management company model do management company wages count? Two buildings, one fully-depreciated, with high income, the other brand new, with no or little income. If treated as separate businesses, no 20% deduction available If they can be aggregated, full 20% deduction available When is a principal asset of the business the reputation or skill of one or more of its employees? Will reasonable comp principles apply to partnerships? 19

26 Pass-Through Deduction Planning Opportunities Switch from W-2 employee to 1099 independent contractor (IC) Loss of employee benefits (e.g., health insurance, 401K, etc.) IC must pay all self-employment taxes Employer may prefer paying W-2 employees in order to max out on its passthrough deduction Need to revisit employee vs. IC classification criteria Can a specified service business spin off qualifying portions of its business (e.g., HR, IT, IP)? Separate books and records for two lines of business, one a specified service business and the other a qualified trade or business? 20

27 Pass-Through Deduction Planning Opportunities Multiply $157,500 per person threshold through children and trusts Switch from guaranteed payments (which don t qualify) to preferred returns (which do qualify) S corp vs. LLC Wages paid to S corp owners count towards W-2 limit, guaranteed payments to LLC don t because of K-1 rule Possible solution use tiered structure, employed at lower-tier, own equity through upper-tier reasonable comp requirement for S corps Switch from 1099 (IC) to W-2 employee to increase W-2 limit 21

28 Choice of Entity Effective Rates As a result of the new lower corporate rate, should taxpayers reconsider their choice of entity? C Corporation Pass-Through Income Tax Rate 21% 29.6% (effective)* Dividend/Exit Tax Rate 20% + 3.8% = 23.8% 0% Aggregate Tax Rate 39.8% 29.6% State/Local Tax Deduction 100% Property taxes deductible, SALT income taxes not deductible *Assumes no 3.8% tax applicable and full use of 20% pass-through deduction 22

29 Choice of Entity Other Considerations Potential for future changes Many disadvantages to C corp status Easy to move into C corp status, but difficult to move out Triggering of Section 311(b) gain on conversion/liquidation But S corp election possible after potential 5-year wait Limits on ability to defer C corp distributions Cash needs of shareholders Accumulated earnings tax Personal holding company rules 23

30 Restructuring F Reorganization If a business is being conducted in corporate form, it may be possible to work around some of the disadvantages of corporate form through an F reorganization This can be helpful in the context of sales, employee compensation, removing assets from corporate solution 24

31 Step 1: A, B and C form Newco and contribute their S Corporation stock to Newco in exchange for Newco stock. Newco makes an S corporation election and S Corporation makes a QSub election. As a result, S Corporation becomes a disregarded entity for tax purposes. A B C A B C Newco S Corporation S Corporation (QSub) 25

32 Step 2: S Corporation, now a QSub, converts to a LLC under a state law conversion statute or by merger. As a result, the LLC continues to be a disregarded entity for tax purposes. A B C A B C Newco Newco S Corporation (QSub) converts LLC LLC 26

33 Choice of Entity - REITs REITs do especially well: Only one level of tax Shareholders entitled to a 20% qualified business income deduction for ordinary distributions with no W2/basis limits But REIT compliance and maintenance rules are onerous 27

34 FOR FURTHER INFORMATION, CONTACT: Paul Kaplun Chris Davidson Venable LLP Venable LLP Baltimore, MD Baltimore, MD