Tick-tock on the tax clock

How accountants feel the day after tax deadline. Wikipedia

How accountants feel the day after tax deadline. Wikipedia

Posted by Evan Piccirillo, CPA

Time constraints coupled with the sheer volume of work makes tax season an incredibly stressful time for taxpayers and tax preparers.  Taxpayers will have to compile all of their tax information for the prior year and send it over to their accountant who will no doubt have a series of uncomfortable, probing questions.  The ever-present apprehension of having to write a large check looms overhead like a coming storm.  Tax preparers will spend countless hours poring over tax documents and IRS code sections trying to efficiently turn around tax returns, leaving no deduction or credit on the table.  The late nights and delivery food build up in preparers’ systems and erode their constitutions transforming them into mere husks of their former selves.

As each grain of sand runs through the hourglass, it feels as if the noose is tightening.

For taxpayers, the procrastination builds on itself like a cancer.  Dealing with all of this is painful, so why not put it off until tomorrow?  All of a sudden the calendar page turns and it is April 1st… not only has nothing been sent to the preparer’s office, the envelopes on many tax documents are still sealed and sitting in a pile on the desk.  In a frenzy, the documents (still sealed) are shoved into a large manila folder and mailed out, without a proper care and review.  Are some things missing?  Probably, but we have time right?  We can count on our trusted preparers!  There are still two weeks left!

For tax preparers, the work piles up and it seems impossible that there is a chance it will be completed on time.  Each day more packages arrive.  Each day the lists grow.  The arms on the clock spin at an astonishing rate.  How many returns did we get out today?  None!  This client still has open items, that client has yet to return their electronic filing authorizations, and by the way, they have a new trust return this year.  Tensions grow high and at any point a tiny spark could burst into a raging fire.  It is a marvel that we are able to maintain a level of calm in such conditions.

As the deadline comes into view just over the horizon, it feels like a blessing and a curse at the same time.  Knowing that it will soon come to an end is little solace when all one can think about is the final sprint to the finish line.  Tax preparers, many of whom have now fallen into the same rut as those for whom they are servicing, will likely still need to finish their own tax returns.  Many taxpayers are now growing anxious about making the deadline in addition to what they might owe in tax and that added stress pours like a waterfall over the preparers.

It builds and builds, panic turns to madness, the only thing fueling us is the little bit of adrenaline left in the tank.  Focus in such a torrent comes at a premium, and only the hardiest can maintain.  Frantically, the last of the returns are finalized and somehow all clients are either filed timely or on extension.  And then finally, as if waking from a nightmare, it is over.

Now that tax season is at an end, spring can truly begin.  Both taxpayers and tax preparers can breathe a collective sigh of relief and gather their wits.  Tax preparers can perhaps take some days off to be with their families, who at this point might have forgotten what they look like.  Taxpayers can worry about all of the other things in their life that need attention.  We can all forget what a test of wit and fortitude it has been until next year (actually four or five months).

So I say to you all as emphatically as I might: Happy End-of-Tax-Season!

A day in the life

iStock

iStock

Posted by Gigi Boudreaux, CPA, MBA

Editor’s Note: There is no “TrumpWatch” this month, as David Roer is busy doing what he does best – being a tax accountant. As you can imagine, we’re all pretty busy here at the REM Cycle. You’re probably aware that things are hectic for us during tax season, but what does an accountant actually do? What’s it actually like? We asked Gigi Boudreaux to explain.

I’m often asked about my life and experiences during tax season. To appease the curiosity, here’s a breakdown of a typical day for me during the height of tax season.

I arrive at work well before 9:00 AM in an attempt to get settled before the chaos begins. My office feels like I only left a few minutes ago. The only difference is me – I’m wearing different clothes, carrying a different lunch, and starting the new day with a fresh attitude. It’s going to be a good, productive day!

First thing I do every day, open my email. I have already glanced at my inbox earlier this morning, but decide to wait until I arrive at work to manage the myriad emails that arrived overnight. Most of the emails are junk. Delete! I am constantly unsubscribing, but the junk keeps coming. Do I want to rent a private jet? Really?! At least I got a chuckle out of that one. I move on to the important emails. One contains e-file authorizations I’ve been waiting for. Great! Wait – client only sent Federal authorizations. Ugh. Another email is from one of my partners, “Can you please handle a complicated issue for me? I had someone else, but I think you will handle it better and faster.” This will set me back a bit, but I’ll do my best. I hardly ever say no.

Soon after I arrive, a colleague enters my office, clearly distressed. She needs to take time off for a family issue. She says, “I know it’s tax season, but it is very important.” I tell her that family always comes first and that we will work together to make it work.

People start to arrive, coffee starts to brew, and my phone starts to ring. Calls from clients include, “Did you get my fax? Where do I sign on the e file authorization? Is my return done yet?” A call from an IRS agent, “I have been out sick for a month so I haven’t looked at your case, but now I am back. Can you get me several documents ASAP?” I reply sheepishly, “Uh…it’s tax season.” Agent: “So?” Then, I am part of a conference call with our IT department and our software provider, because all three scan machines in our NYC office are offline, which is kind of a big deal. While on the conference call, my husband calls in to see how I’m doing. I’ll call him back later.

The managing partner arrives, practically bouncing off the walls with energy and enthusiasm. Not sure I can match his energy, but he has inspired me to step it up.

A colleague (who is also a friend) emails me to say she’s made a quiche for lunch. Do I want some? Yes, of course! This will be the highlight of my day.  It’s so silly what makes me happy this time of year.

An extremely distressed coworker who has lost a tax return file calls: “Can you please help me?” I stop what I am doing and we find the return. I get enormous satisfaction from helping her.

Later in the day, I have a scheduled phone call with a client who has been waiting for my attention for a day, which is a long time to wait. I am conscious of this. It’s a long call and we address all of the issues on his list. He is happy with the advice. I hang up and wonder how I’m going to bill that time; he’s never going to pay for it. Yet, he is content and so am I.

I receive a text from my sister-in-law: “Hey, can I stop by later today to drop off my tax stuff?” I respond, “I won’t be home till very late.” She sighs, “Really? How late? I also need to use your printer to get one of my tax documents because my printer is broken.” Frustrated that she still doesn’t understand the hours I work after so many years, I suggest she come on the weekend. I know she is counting on her refund.

Client calls: “Can you tell me how much money I made? And I have several questions about my tax return.” This takes time, but by the end of the conversation, he understands and is thankful. I am happy to have helped.

My daughter texts from college: “Mom, I think I failed Logic. Can you talk?” Of course. Although I cannot make time for my husband, there is always time for her. I guess I need to work on that.

I meet with potential new client. Meeting new people and hearing about how passionate they are about their business is always exciting and interesting. It is contagious. This one looks promising, but you never know.

Okay, now it’s time to start my productive day and get down to doing work. I glance out the window and suddenly realize its dark outside. Clock reads 8:00 PM! Really?! I haven’t even addressed the first item on my daily to-do list. Well, I guess it’s going to be another long night.

The chaos of tax season is challenging and exciting and maddening all at the same time. You can see that there is so much more than simply putting numbers on a form and telling people how much money they owe to Uncle Sam. On any given day, I am an advisor, a technician, a juggler, a therapist, and a mentor. Why do I keep coming back each day? The satisfaction of being able to help others, clients and coworkers alike, truly inspires and motivates me. When I go home at the end of a long day, there is nothing better than knowing that I did something good for someone today.

Regarding that disregarded entity...

Posted by Lisa S. Goldman, CPA, TEP

The Treasury Department has clamped down on a key reporting exemption that was previously enjoyed by foreign-owned, single-member limited liability companies (SMLLCs).  This change has significant impacts on any foreign person or entity with holdings in U.S. SMLLCs that are disregarded for federal income tax purposes.  Previously, these entities were exempt from the comprehensive record maintenance and associated compliance requirements that applied to 25% foreign-owned domestic corporations.  Now, substantially any transaction between U.S. domestic disregarded entities and their foreign owners, including any of the owner’s related entities, may be reportable.

These regulations are part of a larger effort by the Treasury Department to increase financial transparency.  Entities subject to these regulations will continue to be treated as disregarded for other federal tax purposes.  The Treasury Department explained that there is a class of foreign-owned U.S. entity (typically SMLLCs) that has no obligation to report information to the IRS or even obtain a tax identification number.  According to the government, these “disregarded entities” could be used to shield the foreign owners of non-U.S. assets or bank accounts.  By treating domestic disregarded entities that are wholly owned by a foreign person as a domestic corporation separate from its owner (for these limited reporting and compliance requirements), the regulations enable the IRS to determine the existence and magnitude of any tax liability and share information with tax authorities in other countries.

Requirements

Previously, certain disregarded entities and their foreign owners may not have had an obligation to file a tax return or obtain an Employer Identification Number (EIN).  The final regulations require foreign owned domestic disregarded entities to:

  • Obtain EINs from the IRS
  • Annually file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
  • Identify “reportable transactions” between the LLC and any related parties, including the LLC’s foreign owner
  • Maintain supporting books and records

Regulations

These rules treat U.S. disregarded entities as stand-alone foreign-owned domestic corporations.  Therefore, they are now required to file Form 5472 with respect to reportable transactions between the entity and its foreign owner or other foreign related parties. Transactions are reportable as if the entity were a corporation for U.S. tax purposes. These entities also are required to maintain records sufficient to establish the accuracy of the information return and the proper U.S. tax treatment of such transactions.

Please see the regulations for examples of reportable transactions that require reporting, elimination of certain reporting exemptions, and overlap rules affecting controlled foreign corporations and foreign sales corporations.

Tax Year

The final regulations require the domestic reporting corporations to have the same tax year as their foreign owner if that foreign owner has an existing U.S. reporting obligation. If the foreign owner has no U.S. return filing obligation, then the domestic reporting corporation must report on a calendar year basis.

Effective Date

The final regulations are effective December 13, 2016, and apply to tax years beginning on or after January 1, 2017, and ending on or after December 13, 2017.

TRUMPWATCH 2017: Border Patrol

https://en.wikipedia.org/w/index.php?curid=31462687

https://en.wikipedia.org/w/index.php?curid=31462687

Although the attention has been on who will build the border between the U.S. and Mexico this past year, an even hotter topic in the coming months may be the potential border, both figurative and literal, between the Republican-led House of Representatives and Trump.

The Border Adjustment Tax is being discussed vehemently these days, both in Congress and in the White House. House Speaker Paul Ryan and the GOP are strong advocates for it, while President Trump has been outspoken against it (although, in recent weeks, has started to warm up to the idea. Tremendous!).

Before delving into the minutiae, let’s start with the basics: as touched on in prior TrumpWatch columns, the current U.S. corporation tax rate is 35%.

Under current law, corporations are taxed on their net profits, meaning the tax is based on the company’s gross income minus expenses. These expenses are made up of direct cost of goods sold, various operating costs (general administrative expenses, interest expense, advertising, etc.), as well as depreciation, which allows you to write off the cost of a fixed asset over several years, depending on the asset type. To quote Kramer from Seinfeld:

“Jerry, these big companies, they write off everything! ... I don’t know what that means, but they do, and they’re the ones writing it off!”

As discussed in our most recent TrumpWatch on international taxation, U.S. corporations are taxed on profits earned overseas and repatriated back to the U.S.

The proposed GOP plan, backed by House Speaker Ryan and Kevin Brady, Chairman of the House Ways & Means Committee, would create a destination-based-cash-flow-tax-with-a-border-adjustment, aka DBCFT (maaaaaybe we’ll just stick with “Border Adjustment Tax” for short).

This proposal indicates that a U.S. company would pay tax on where the goods are sold (i.e., where they end up), not where they are produced. In other words, the proposal would push towards the “consumption tax” concept instead of the “income tax” concept. In addition, the proposal would look to reduce the corporate rate and tax domestic revenue minus domestic costs from 35% to 20% (although Trump’s still proposing a reduction to 15%).

As much as I love to bold and underline words, there actually is a reason for the emphasis on “domestic.” Current law allows for companies to be able to deduct the cost of imported costs and materials from their revenues. The proposal would eliminate this concept: since we’d be shifting to a “consumption tax” (again, taxation on where the goods are consumed), import costs would not be an allowable deduction. Contrarily, exports and other foreign sales would be made tax-free (remember, tax only on where the goods were consumed). The goal: keep businesses, production, and manufacturing within the U.S.

While losing deductions for imported materials may be detrimental to several companies (like retailers, who derive a bulk of their goods from imports), several economists have noted that this shift in taxation may increase the value of the dollar; thus, if the dollar were to increase, those same imported goods would be less expensive. In simple terms: the increase of the dollar may offset the tax increase to importers. Importantly, consumers will most likely pay more for those products.

Just for comparison’s sake, most other countries use what’s referred to as the Value Added Tax (VAT) system. This is, for all intent and purpose, the same as the proposed Border Adjustment Tax, the only difference being under the VAT, a company cannot deduct wages, while under the proposed plan, wage-deduction would be fair game.

As things stand, there still is that figurative border between the House’s proposal and Trump’s own corporate tax reform proposal (despite Trump warming up to the concept). Either way, the months ahead should prove to be very interesting as to what ultimate corporate tax reform the U.S. will be adopting in the near future.

Stay tuned to the REM Cycle for further TrumpWatch updates.

You Need My WHAT Now? New York Among States Requiring Driver’s License for Electronic Filing

New York State is so demanding already in terms of personal information required to file your individual tax return.  They want your name, address, social security number, date of birth, your income, employer’s name and address… the list goes on and on.  Starting in 2016, we get to add another piece of sensitive data to that list: your driver’s license information.

In an effort to strengthen identity fraud protection, New York has added this required information as a new layer to identity verification within their electronic filing system.  Taxpayers must provide this information to their preparers to comply with the new rule.  New York accepts a valid driver’s license or state-issued ID to satisfy this requirement.  A third option exists: if you don’t have either (or are deceased, in which case you’re probably not reading tax blogs), then your preparer can “opt out” of providing the information.

New York is emphasizing that this is required for all taxpayers and is advising preparers that they must collect and enter this information to their tax software.  The “opt out” should only be used when the taxpayer doesn’t have such a document (or has passed on). New York State’s official FAQ publication posted on the Tax Department’s website regarding compliance states:

Q. If my client is known to have a valid driver license or state-issued ID, but chooses not to disclose it, can I check the No Applicable ID box without repercussion? Am I required to disclose this (similar to when a taxpayer refuses to e-file)?
A. As with any return data, you should submit the information as it’s provided by your client.

Interpret that answer at your own risk, but at an FAE conference in January of 2017, Nonnie Manion, the Executive Deputy Commissioner of the New York State Department of Taxation and Finance, advised preparers to “just check the “No Applicable ID” box for now” in cases where the taxpayer has an ID issued by any state other than New York.

I applaud New York’s effort to combat identity fraud, which is a real issue facing taxpayers everywhere, but putting even more sensitive identity data in a single place seems like it is begging identity thieves to increase their efforts to target tax preparers.  For taxpayers attempting to safeguard their information, sharing information is a major activity to avoid.  In a way, New York’s effort is in direct opposition of basic identity protection.

I just hope that in 2017, New York doesn’t require your first pet’s name and the street where you grew up as additional layers of electronic filing identity verification.  For now, New York taxpayers will have to provide to their preparers one of the three options New York State is willing to accept.

TRUMPWATCH 2017: Re-Patriots Day

Posted by David Roer, CPA

With inauguration day finally behind us, all of the political talk that’s taken over 2016 and 2017 can finally come to an end, right? Wrong. Sad.

Since President Trump has now officially taken office, further details regarding the (probable) tax reform are sure to emerge. One of the key terms you may hear a lot about in the next few weeks is ‘repatriation.’

While many may assume this has to do with the New England Patriots winning yet another Super Bowl title (as a lifelong Seattle Seahawk fan, I am not pleased about that!), it actually has to do with the upcoming proposal to repatriate money from overseas to the United States.

As alluded to in our first Trump Watch post, President Trump’s tax proposal is looking to offer a one-time amnesty to help bring business back from overseas.

As a general rule, the US has a worldwide taxation system. Effectively, this means that if you’re a US citizen, you pay tax on your worldwide income. This concept is similar for corporations: multi-national corporations (think Apple, Microsoft, or GE) must first pay tax to the foreign country in which the foreign subsidiary does business and earns the profit and then to the IRS, once those profits have been properly repatriated back to the US.

Under current law, if these multi-national companies repatriated money back to the US, they would be subject to the top rate of 35%. To give an idea, based on a recent forecast study done by Capital Economics, there is approximately $2.5 trillion of profits from US multi-national companies currently abroad – at the 35% rate, that’s approximately $875 billion in tax dollars!

As you can imagine, major companies are leaving those profits overseas to avoid paying such a tax burden. That is, unless a proper incentive were put in place.

In the hope of increasing jobs (as well as general economic growth), President Trump is pushing for a repatriation ‘tax holiday:’ US firms could repatriate their overseas profits to the US and pay only a one-time 10% amnesty tax, instead of the current 35% rate. Important notes regarding repatriation:

  1. President Trump is proposing a reduction in tax rates from 35% to 15%. If both the tax reduction and amnesty tax proposals pass, the repatriation of profits would save 5% in taxes, not 25% (nonetheless, 5% savings would still be a significant draw).
  2. Per the proposal, this tax would be payable over a ten-year span. This, in addition to the potential low 10% rate, could act as significant incentive to bring cash from overseas.
  3. The Trump proposal also includes a revision to the current international taxation system. As mentioned above, US corporations with foreign subsidiaries do not pay US tax until the money has been repatriated. Under President Trump’s proposal, any future profits of foreign subsidiaries of US companies would be taxed each year as the profits are earned. This would effectively eliminate the repatriation tax concept prospectively, without affecting any of the prior accumulation of profits (that is, the aforementioned ‘tax holiday’ would also apply to prior profits).
  4. Finally, and this is more food-for-thought: it’s important to note that just because a company brings cash domestically, doesn’t necessarily mean they’ll use it towards job growth and/or domestic investments (domestic economic growth).

A similar repatriation ‘tax holiday’ was offered in 2004 under President Bush, which included specific language that prohibited the repurchase of stock with repatriated funds. Unfortunately, studies show that companies found loopholes to work around this, thereby allowing for corporate stock buybacks and dividends. With that in mind, I’m curious if the repatriate proposal would contain verbiage with caveats as to specifically how such money would need to be used.

With Trump’s presidency officially underway, we can surely expect to hear and see a push towards an ultimate tax proposal. While the above analysis is based only on President Trump’s proposal, it is likely that repatriation will be a hot-topic issue in the months to come.

Stay tuned to the REM Cycle for further Trump Watch updates.

End of the AMT? Good Riddance

The time for year-end tax planning is over and a tax season with new due dates looms. Hopefully you have accelerated deductions, because in 2016 that is perhaps more important than the previous years as President Trump’s tax proposal forecasts significant cuts to tax rates. So, what deductions can we accelerate? The Internal Revenue Code allows for only a handful of deductions for individual taxpayers, the largest of which are state and local income taxes, real estate taxes, and mortgage interest. In New York, we pay among the highest state income taxes AND some of the highest property taxes in the country. My clients would love to take advantage of these burdensome taxes and deduct them early, but the dreaded Alternative Minimum Tax (“AMT”) dashes their hopes. What the heck is the AMT anyway?!

The AMT is an antiquated tax originally enacted in 1969 to prevent tax avoidance by wealthy taxpayers. Unlike the regular income tax, the AMT parameters were not indexed for inflation. As a result, with economic growth and inflation over time, more and more middle-income taxpayers find themselves paying the AMT. What does this mean? It means that those ridiculously high New York state income AND property taxes are not deductible. That’s right – you are getting zero benefit for the largest tax deductions you pay each year.

This is how I explain the AMT to my clients: The AMT is an alternative taxing system that exists in the background to the regular taxing system. All taxpayers MUST pay the higher of the result of the two taxing systems. The regular taxing system, as we know, is a series of graduated rates (currently seven; Trump’s proposing only three) from as low as 10% to the highest of 39.6%. As your income increases, you pay a higher rate of tax. The AMT has only two rates (26% and 28%) and taxes a much broader income tax base. Both the regular tax and the AMT start in the same place by summing all sources of income. From there, the two systems differ. For regular tax, taxpayers can deduct dependency exemptions and itemized deductions, which include medical expenses, state and local income taxes, mortgage interest expense, charitable contributions, and, to a limited extent, miscellaneous deductions. For AMT, only charitable contributions and limited mortgage interest deduction are allowed. So for New York families whose largest deductions on their tax returns are personal and dependency exemptions and state and local taxes (including real estate taxes), will be paying AMT, a tax higher than their regular tax.

Here’s some good news. President Trump is proposing to eliminate the AMT. While Democrats and Republicans disagree on many of Trump’s proposals, I believe this is one that all Long Islanders can agree upon. According to tax estimates from the Tax Policy Center, last year approximately 27% of households nationwide with incomes between $200,000 and $500,000 were affected by the AMT. My estimation is that many of those households reside here in New York because those who are most vulnerable to the AMT are those taxpayers with large families (three or more children) living in high state and local tax states.

So, while experts agree that Trump’s proposed tax rate reduction will only help the wealthiest taxpayers, many New York taxpayers may see a reduction in tax if the AMT is repealed. Questions still remain on Trump’s proposal to limit itemized deductions, which may affect the tax savings on the elimination of the AMT. Other issues that may surface will be the AMT credit carryovers (the government attempt to ease the AMT burden) and the AMT interplay with net operating loss carryovers.

One thing remains certain: no one will be unhappy to see the AMT go away.

Worried About Undisclosed Foreign Assets? The Offshore Voluntary Disclosure Program May Offer a Solution

Posted by Evan Piccirillo, CPA

As I've said before: Being a good tax citizen is important.  Sometimes it is difficult to navigate the stormy seas of compliance to achieve that end.  One such hazard is the difficulty of adhering to complex international reporting requirements.

I must pause here to note that if you do have significant international compliance issues, you should consult legal counsel in addition to a tax professional due to the many civil and criminal consequences imposed by the Department of Justice and Department of the Treasury.

Imagine a normal day in the life of a hard-working taxpayer.  She always files her tax return on time and doesn’t take any undue deductions.  One day she learns a wealthy relative left her interest in a profitable commercial property in Croatia.  How fortunate!  But wait, this wealthy relative left it to her a couple of years ago and it has been generating income this whole time.  Oh no!  There are full pages in the IRS instructions detailing penalties for the forms she didn’t file over that period that could amount in many thousands of dollars and even jail time.  What is our hard-working taxpayer to do?

The IRS, in an effort to provide a bridge to compliance, has enacted the 2012 Offshore Voluntary Disclosure Program (“OVDP”), modified effective July 1, 2014.  This program is designed to incentivize taxpayers (entities and individuals) to come to the IRS with undisclosed assets and accounts rather than the IRS having to hunt them down; it offers a reduction in penalties and potential elimination of the risk of criminal prosecution.  The penalties described in the Internal Revenue Code for failing to comply with foreign reporting are incredibly brutal; in some cases 100% of the highest value of an asset during a given year, plus other penalties, plus interest, plus criminal prosecution.  That, coupled with the increasing risk of being detected by the US Government by their new, more aggressive approach to treaties and policy, creates a very compelling argument for taxpayers to come forward.

This relief a taxpayer receives from this program is not completely painless.  Paying the offshore penalty of 27.5% plus the accuracy-related penalty of 20% is a hard pill to swallow, but when weighed against the alternative (potentially 100% and criminal prosecution), it should go down a little easier.

Eligibility for the OVDP is contingent upon coming forward before the IRS is aware of the unreported foreign assets; if they find you, OVDP is off the table.  In some cases, a taxpayer may have already amended and submitted reports, referred to as a “quiet disclosure.”  These taxpayers still run the risk of full penalties and criminal prosecution if they don’t apply to the OVDP.

In our example, the hard-working taxpayer has the ability to compile all information on the property and the unreported income and then submit an application via Forms 14454 and 14457 to the IRS OVDP.  If accepted, original and amended tax returns accounting for the foreign income and forms reporting the foreign transactions and activity must be prepared and submitted. In addition, the taxes, penalties, and interest due must be paid or arrangement to pay must be made.  All this just to be a good tax citizen!

The Offshore Voluntary Disclosure Program offers a bumpy path to compliance that is not without its difficulties.  It is important for someone considering this path to enlist the counsel of professionals in law and accounting.

TRUMPWATCH 2017: We are the 15%

Posted by David Roer, CPA

There’s been an abundance of 2016 headlines you’ve no doubt heard on loop this year and are probably sick of listening to – Brexit! Zika! ISIS! The election! Star Wars!

One headline that we at REM Cycle can’t get enough of is the Trump Tax proposal. Last month, we broke down some of the key talking points within President-Elect Trump’s proposal. Since this tax proposal seems like one of the more likely policies to be enacted within Trump’s first year of presidency, we felt it important to offer a continued look, providing updates throughout the coming months as news develops in a recurring feature aptly named “TrumpWatch 2017.”

Our first TrumpWatch tackles the newly proposed corporate tax rate.                        

As you know, President-Elect Trump is proposing a significant decrease in individual rates (reduction to three rates of 12%, 25%, and 33%) as well as the corporate tax rate: a reduction from 35% to 15%. This is a substantial tax cut for C Corporations, who already have the burden of double taxation (in the form of taxation at the C Corporation level, as well as dividend taxation to the individual shareholder). This corporate reduction proposal has mass implications.

“But I don’t have a C Corporation! How could this possibly affect me?”

It may affect you more than you think. Trump’s proposal would allow pass-through entities (such as S Corporations and Partnerships) to elect to have their pass-through income taxed at the same 15%.

Under current law, pass-through entities pay no corporate-level tax, but report all their pass-through income/loss to the individual at their respective individual rate, which is a current top rate of 39.6%. Even with the potential new Trump individual rates, this means that most individuals from small businesses and closely-held corporations would be able to reduce their tax rate by 18% (i.e., top individual rate of 33% compared to 15% pass-through income rate).

The ramifications of this potential reduction in pass-through income are provocative, to say the least.

We may see an uptick in individuals seeking to establish themselves as independent contractors: by becoming a contractor (i.e. a non-salaried individual), an individual could create their own pass-through entity, receive payment in the form of 1099s instead of a W-2, and as such, elect to have the pass-through income be taxed at the 15% potential rate. The Department of Labor already keeps a watchful eye on ensuring that businesses classify employees correctly – in light of this situation, that eye will be even more watchful.

It’s important to remember that partnership income would still be subject to self-employment tax, and S-Corporations would still have a requirement to pay shareholders their respective reasonable compensation.

This leads to another potential ramification: an increase in IRS scrutiny of reasonable compensation. S-Corporations have a requirement to pay “reasonable compensation” to a shareholder-employee in return for services that said employee provides to the business (e.g., the employee-shareholder will receive a K-1 with all pass-through income/loss, as well as a W-2 reflecting reasonable compensation).

Due to its vagueness, the term “reasonable compensation” has brought on ample amounts of court cases, all attempting to add clarity to the definition of “reasonable” (as a general rule, each case must be looked at independently on a facts-and-circumstance basis).

Be cautious. While this 15% seems enticing, it may not always be the right tax strategy to go with. If the 15% proposal for pass-through is an election by the entity (which, although still unclear in the proposal, it appears to be), it may be in the individual’s best interest to not elect: for instance, in the case of substantial (and deductible) losses, which the individual could offset against other forms of ordinary income (essentially, utilize pass-through losses at a potential max 33% individual rate).

As a similar caveat to our prior Trump blog post, it’s yet to be seen whether any or all of the proposals will become enacted. While there’s still speculation regarding the Trump tax proposal (as well as the above 15% pass-through concept), the best we as practitioners and taxpayers can do is stay up to date!

Stay tuned to the REM Cycle for further TrumpWatch updates.

The Bigger, Better R&D Credit

Image courtesy iStock

Image courtesy iStock

Businesses may receive a research and development (“R&D”) tax credit for qualifying research expenditures incurred when developing and designing new or improved products and processes.  While it is a common misconception that the R&D credit mostly applies to large businesses in the scientific and medical industries, the reality is that the credit has a much wider breadth of business niches. The credit can apply to a broad range of industries including (but not limited to) tech, manufacturing, design, and construction companies.

For tax years beginning January 1, 2016, Congress has made several changes to allow more businesses to reap the benefits of the R&D credit.

What are qualified research activities and expenditures, and who may be eligible?

Any activity that falls under the definition of “qualified research” may be eligible for the credit. Essentially, a business’s research activities must be related to a process or product’s new or improved function, performance, reliability, and/or quality. These can include activities conducted to improve or modify techniques or methods in a process. Qualified expenditures include wages, supplies, and contracted research expenses.

Of course, expenses related to “qualified research” encompasses an array of activities, whether it’s finding a new method/technique to print a graphic design on a T-shirt or changing the way a house is built to make it more energy efficient.

As you can see, the ambiguity surrounding what activities could qualify is relatively significant. One key indicator that a business may be eligible for the credit is if it employs product development personnel, engineers, or software developers. Tech startups, especially, must be informed about this credit as there has been an increasing boom in the industry.

How much is the credit?

The credit is based on a percentage of qualified research expenditures, including wages, supplies, and contracted research expenses.

Recent Developments

There are three major developments in the Protecting Americans from Tax Hikes (“PATH”) Act of 2015.

  • The PATH Act made the credit permanent, prospectively. Since 1981, the credit was only extended from year to year.
  • The R&D credit is now considered a general business credit. This allows eligible small businesses or owners of those businesses to apply the credit against their Alternative Minimum Tax (“AMT”). This provision is most helpful to businesses that have an overall net loss, but owe tax due to AMT. Historically, the company would still owe tax, because the R&D credit could not be used to offset AMT.
  • Lastly, qualified small businesses with gross receipts of less than $5,000,000 can now apply the credit against the employer’s portion of payroll taxes of up to $250,000 per year. The credit against payroll taxes is especially beneficial for new businesses, since startup companies are inherently prone to incurring losses during their first few years of operations. Previously, startups that sustained losses were unable to utilize the R&D credit because, generally, there wouldn’t be any tax to apply the credit towards. As businesses begin to turn a profit, they can finally utilize the credit and save in taxes.

The R&D tax credit rules are highly complex. If you think you may be eligible for the R&D credit, please consult a tax professional.