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Navigating the Tax Cuts and Jobs Act: Volume 2 – Rate reductions

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Posted by Evan Piccirillo, CPA

The most straightforward and significant change of the Tax Cuts and Jobs Act (TCJA) is the reduction in income tax rate to corporations and individuals.  This is the “giveth” of the TCJA, and while there are many “taketh aways,” which we will discuss later on, all things being equal, most entities and people will consequently pay less tax.

Corporations

Corporations pay a flat 21% tax on income, and this provision is permanent (meaning there is no language in the law that builds in an expiration of this provision).  Prior to 2018, corporations would pay tax based on graduated rates as determined by their taxable income for the year (taking into account the dreaded alternative minimum tax (AMT)).

Here are the rates for 2017:

TCJA Rate Reductions Chart 5-1-2018.JPG

You may have noticed that this table contains a rate that is lower than 21%, namely the lowest bracket for corporations with taxable income of less than $50k.  Those corporations will be paying more tax under the new regime.  That aside, the 21% rate will result in a much lighter tax burden for most corporations.  I stress here again that this is under an “all things being equal” scenario.  There are other provisions of the TCJA (which we will address in future posts) that will add to these corporations’ tax burdens, given certain circumstances.

Fiscal year taxpayers (that is, corporations with year-ends other than 12/31) will pay tax on a blended rate.  The blended rate is the sum of the ratios of the old tax rate for the number of days in 2017 and the new tax rate for the number of days in 2018.  For example a June 30 year-end will have a blended rate of about 28%.

Also, the corporate AMT is eliminated!  Certain AMT credits will be recoverable as well, which mean those benefits will not be lost.

Individuals

Individuals will pay a 7-bracket, progressive tax.  The rates for most of the brackets drops from 1-3% and most brackets will begin at a higher dollar amount of income as compared to prior years.  This rate reduction will be in effect for only 8 years and then revert to the pre-2018 structure, so remember this “giveth” has an expiration date, unless our legislators decide to extend it.  Prior to 2018, the tax methodology was similar, but at less favorable rates.

In spite of many of the itemized deductions that are suspended while these individual rate reductions are in effect (which we will discuss in later posts), many individual taxpayers will be pay less tax under this regime.  It may vary on a case-by-case basis (as individual tax always does), but for the most part, this is a clear benefit to individuals.

The (kind of) bad news is that the individual AMT has not been eliminated in fact, but I do believe that it has been eliminated in effect.  The thresholds and exemptions have been increased and the primary culprit in determining AMT applicability for most taxpayers (the itemized state tax deduction) is severely limited.  It will be a very rare instance that AMT will apply.

The TCJA has many “giveths" and “takeths", but the rate reductions are a clear “giveth” on the corporate side and individual side alike.  Don’t get too excited yet, because our legislators have found many, often very complex, ways to recover some of this lost tax revenue.

If you have any questions or would like to better understand this, reach out to your trusted advisor, or email me.  Stay tuned for our next post, where we will explore a significant “taketh” provision!

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.

Trumping the Tax Code

Posted by David Roer, CPA

Image courtesy iStock

Image courtesy iStock

I’m not sure if you heard, but a Presidential election happened this past year!

As with every inaugural year, there’s an expectation that the President will push certain talking-points into action sooner vs. later. This year is no different.

A big talking point within the Trump administration has been the urgency regarding tax reform and an indication that the reform could happen within 2017. With the Republicans controlling the White House and both houses of Congress, the expectation for tax reform to rapidly occur seems all the more likely.

With that in mind, it’s important to remember that the following is not fact, but rather a ‘guesstimate’ as to what President-elect Trump may push through as reform, as it is solely based on his stated agenda throughout the election process.

INDIVIDUAL INCOME TAX

As it’s referred to on President-elect Trump’s website (donaldjtrump.com/policies/tax-plan), the ‘Trump Plan’ calls for reducing the individual income tax brackets from the current seven to three (the following are for married-filing-joint):

  1. < $75,000 – 12%
  2. $75,000 – $225,000 – 25%
  3. > $225,000 – 33%

Most notably, the Trump Plan would look to repeal the alternative minimum tax (AMT) as well as the 3.8% Net Investment Income tax (which was created to help with Obamacare).

But, as we’ve all been taught, if there’s a yin, there must be a yang: while the Trump Plan aims to reduce individual income tax rates, several deductions will be lost as well; most notably, itemized deductions will be capped at $200,000 for married-filing-joint filers or $100,000 for single filers.

CORPORATE TAX

The Trump Plan also seeks to lower the corporate tax rate from 35% to 15% (and, similar to the individual plan, eliminate the corporate AMT).

In an effort to bring business from overseas, the Plan also calls for a one-time “amnesty” 10% tax on repatriation of corporate profits held offshore. This repatriation would be a significant draw for US corporations that own foreign corporations that conduct at least 25% of the group’s total business activity.

On the deduction side, the Plan would eliminate several business tax credits, most notably the domestic production activities deduction (Section 199 ‘DPAD’). Carried interest would be taxed as ordinary income, and the Research & Development credit would remain intact.

Additionally, the Plan would look to allow firms engaged in manufacturing within the US to elect to expense (rather than capitalize) capital assets, but lose the deductibility of corporate interest expense. The election could be revoked within the first three years of election; however, after three years, the election would be irrevocable.

ESTATE TAX

The Trump Plan seeks to repeal the ‘death’ tax entirely. However, any capital gains held until death and valued over $10 million would be subject to tax.

Since this could leave room for asset-shifting abuse, contributions of appreciated assets into a private charity established by the decedent (or their relatives) would be disallowed.

CHILDCARE

The Plan also would allow an above-the-line deduction for children under 13 up to $5,000 of child care expenses (this deduction would be eliminated for married-filing-joint filers of $500,000 or a single individual of $250,000).

In addition, the Plan would propose Dependent Care Savings Accounts (DCSAs), which would allow parents to make annual contributions of up to $2,000 per year. All deposits and earnings would be free from taxation, with unused balances available to be rolled over from year-to-year.

As further incentive for the DCSA, the Trump administration would provide a 50% match on contributions (i.e. a $1,000 contribution by the government).

While it’s yet to be seen whether any or all of the above proposals become enacted, it is safe to say that some form of tax reform is headed our way. As tax practitioners and taxpayers, it’s important to stay updated on these issues, so as best to prepare and plan for the coming years ahead.

Our REM Cycle team will keep you updated as developments unfold.

IC-DISCS 101

Posted by David Roer, CPA

The subject of Interest-Charge Domestic International Sales Corporations (commonly known as an IC-DISC) is complex, but often worth exploring. The IC-DISC is a corporate tax remedy – one that provides U.S. exporters and manufacturers large tax incentives in order to mitigate potentially significant tax burdens. With international economic growth on the rise, it’s crucial for exporters and manufacturers to be privy to the IC-DISC concepts.

Congress created the Domestic International Sales Corporation (DISC) in 1971 to encourage U.S. exporters to help economic growth by engaging in activities. In simple terms, a U.S. exporter was allowed to allocate a portion of its export profits to a domestic subsidiary – a DISC, which per IRC Section 991 is not subject to US Corporate tax – to reduce its U.S. taxes.

How does this tax advantage work and do you qualify? First, the exporting company pays a commission to the IC-DISC based on foreign sales of products manufactured or produced within the United States (please consult your tax advisor regarding determination of the commission amount). This commission is then deducted from ordinary business income by the exporting company and acts as commission receipts received by the IC-DISC. From a kneejerk perspective, the IC-DISC receives and reports the commission income tax-free, while the exporting corporation receives a deduction at ordinary rates, at a maximum rate of 39.6%.

According to IRC section 995(b), a shareholder of an IC-DISC will treat any distributions as taxable dividend income at the favorable qualified dividend tax rate (maximum rate of 23.8% comprising qualified dividend rates and the net investment income tax). Effectively, the export company receives a deduction at the ordinary tax rate and the identical amount is paid out as a dividend, flowing through to the owners at qualified dividend rates.  It is important to remember that if the IC-DISC chooses to not pay dividends to its shareholders, an interest charge – these are interest-charged DISCS – will apply to the deferred tax, usually based on Treasury Bill Rates.

To attain IC-DISC status, four criteria must be met by the Corporation – it is important that you consult your tax advisor regarding whether or not your Corporation’s facts and circumstances are applicable.

Bottom line: The IC-DISC concept is a way to secure a 15.8% direct tax benefit by merely setting up a separate corporation and adhering to the necessary rules and restrictions. While this introduction hits the highlights, the remaining IRC rules and regulations are more complex. Proactive measures such as these can result in significant tax savings.