Year End Tax Planning Tools for the Business Owner


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Year End Tax Planning Tools for the Business Owner: Includes 21 Business Planning Points that are geared to save you money!

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Year End Tax Planning Tools for the Business Owner

  1. 1. YEAR END TAX PLANNING TOOLS FOR THE BUSINESS OWNER Leaving No Stone Unturned November 7th, 2013 Presented by:
  2. 2. Opening Remarks Welcome friends, clients, and business associates and Co-Hosts from Comerica Bank • The reason we are here - Our firms overriding theme for our clients is simple: Getting Better Results So as opposed to being transactional or simply historical- a big part of our culture – is to try and get better results for our clients through the discipline of advance tax planning So today’s seminar is just a natural extension of our culture… and what we’ll present today will hopefully give you some take home ideas to apply in your business as opposed to a bunch of technical rules and codes sections. 2
  3. 3. Disclaimer This presentation is intended to serve solely as an aid in year end tax planning for the business owner. Due to the constantly changing nature of the subject of the materials, this product is not appropriate to serve as the sole resource for any accounting opinion or return position, and must be supplemented for such purposes with other current authoritative materials. The information in this presentation has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. In addition, Cornwell Jackson, PLLC, its authors, and instructors are not engaged in rendering legal, accounting, or other professional services as a part of this presentation and will not be held liable for any actions or suits based on these slides or comments made during any presentation. If legal advice or other expert assistance is required, seek the services of your personal tax advisor. 2
  4. 4. Agenda What we will cover: • Impact of the Affordable Care Act • Extenders and key items of Taxpayer Relief Act of 2012 • 2013 Year End Strategies to consider • Long Term Tax Strategies you may want to add to your agenda for 2013 or 2014 • Look for throughout the presentation • Q&A 4
  5. 5. The Affordable Care Act
  6. 6. The Affordable Care Act 2013 Requirements For Employers 0.9% tax on earned income over 200K or 250K respectively- beginning 2013 • FSAs limited to $2,500 per plan year • W-2 reporting • • • MLR rebates appropriately distributed in a timely manner • • Restrictive e-delivery, format, content, and non-English requirements Adverse benefit determination language requirements (non-grandfathered plans) • • Insured plans only 4-Page SBC & glossary for new hires and open enrollment • • Exempt if <250 W-2s issued the prior year Ensure carrier, TPA, or employer offers appeal processes and oral language services in non-English language for employees residing in specified counties Penalty for employers – can kicked down the road to 2015. 6
  7. 7. Expanded Version The Affordable Care Act Notice of Exchange Availability • Exchanges open as of October 1st, 2013 • This hasn’t gone real well for the Administration • Limited signups due to full application required to make a general inquiry or assess the plans • Exchanges only open for individuals, not small business • Biggest issue is the Pay or Play penalty- for not providing minimum coverage to employees for Large Employers(employers with 50 or more FTES) • Penalty for employers – can kicked down the road to 2015. 7
  8. 8. Play or Pay Penalty • If an employer with over 50 FTEs does not offer coverage • $2000 per FTE (Full Time Equivalent) • Times number of employees with 30 hours or more per week • Less first 30 employees • Non deductible penalty • If an employer offers coverage that is “unaffordable” or does not provide “minimum value” • $3,000 X the number of full time employees receiving a premium tax credit/subsidy for exchange coverage • Limited to the max penalty calculated under first method 8
  9. 9. The Affordable Care Act Are You an “Applicable Large Employer”? • Determine if you averaged 50+ full-time equivalents (FTEs) the prior calendar year to qualify as an “applicable large employer” the following calendar year • • • • Transition relief: Since implementation was moved to 2015, full year 2014 will be used to determine if you have 50+ FTEs. An employee working 130 or more hours in a calendar month may be deemed to have met the 30 HR/Week full-time definition Includes special rules for counting seasonal and part-time employees to convert them to FTEs “Controlled groups” must combine their employee counts • • Penalties are evaluated and assessed on an entity by entity basis Sole proprietors, partners, and 2% S-Corp shareholders are not employees 9
  10. 10. Expanded Version The Affordable Care Act Employer Shared Responsibility Requirements – 1/1/15 • Identify populations, support with documentation • • • • Identify financial exposures of “Play or Pay” • • • Full-time (clearly averaging 30+ hours per week) Part-time (clearly averaging <30 hours per week) Variable-hour (hours of service vary weekly/monthly or throughout the year) Employer - determine timing and tracking & reporting mechanism Eligibility: 95% of FT employees and their dependent children to age 26 Coverage: “Affordable” and “Minimum Value” Possible transition relief for fiscal year plans to make changes at 2014 renewal instead of 2013 renewal, but very restrictive requirements 10
  11. 11. Expanded Version The Affordable Care Act 3 to choose from by employee class, may alter each year FPL Safe Harbor Rate of Pay Safe Harbor W-2 Safe Harbor • At beginning of plan year, use 9.5% of single federal poverty line (FPL) • Single figure for everyone, “set it and forget it” ahead of time, easiest to administer • 2012 FPL = $11,170, divided by 12 times 9.5% = $88.43 • Lowest cost plan’s single employee contribution at or below $88.43 at beginning of plan year is “affordable” entire plan year • At beginning of plan year, use 9.5% of pay rate • Evaluated by individual employee, but “set it and forget it” ahead of time using a “gross wage” view rather than W-2 Box 1 view • For salaried, multiply monthly gross wage at beginning of plan year by 9.5% • For hourly, must multiply the employee’s hourly rate at beginning of plan year by 130, then multiply by 9.5% • Safe harbor is void if employer decreases rate of pay for anyone in a class utilizing this safe harbor 11 • Uses 9.5% of employee’s W-2 Box 1 wage divided by 12 (not a gross wage and not known until the calendar year is complete) • Evaluated by individual employee, calendar year only view, and unable to definitively set ahead of time • If not full-time entire calendar year, must multiply W-2 Box 1 wage by number of months offered coverage divided by number of months full-time
  12. 12. Expanded Version The Affordable Care Act 2014 Provisions • At 2014 renewal for all groups: No waiting periods beyond 90 days • No pre-existing condition limitations/exclusions • No annual dollar limits on “essential health benefits” • Outcomes-based wellness incentives may be worth up to 30% of plan cost (plus an additional 20% for tobacco-related programs) • • • New requirements for offering reasonable alternatives Grandfathered plans that had excluded adult children with access to own employer coverage must remove this exclusion and allow them on the plan 12
  13. 13. Expanded Version The Affordable Care Act 2014 Provisions • 2014 Renewal for Small Non-Grandfathered Fully-Insured Plans only: • Insurers must follow new rating requirements • Benefits must meet or exceed the state’s benchmark Essential Health Benefits plan requirements • $2,000 deductible limit ($4,000 for dependent tiers) • Indexed in future years • May only exceed by amount employer contributes to FSA 13
  14. 14. Expanded Version The Affordable Care Act 2014 Provisions 2014 Renewal for all Non-Grandfathered Plans: Clinical trial coverage • Cost-sharing limitations on Essential Health Benefits • • Out-of-pocket limit must include deductible, coinsurance and copays applicable to EHBs • Out-of-pockets restricted to HDHP limits in 2014 (currently $6,250 single and $12,500 family), then indexed separately from HDHP limits in future years 14
  15. 15. The Affordable Care Act Tax Issues: Three Revenue Raisers 1. 0.9% tax on earned income over 200K or 250K respectivelybeginning 2013 2. 3.8% of Investment income on wealthier Americans 3. Lower itemized deduction on Medical – must now exceed 10% of AGI to get a deduct. In 2012 a taxpayer with $100,000 of AGI and 10,000 in unreimbursed medical expenses would have received an itemized deduction of $2,500. In 2013 the deduction would be $0. 15
  16. 16. The Affordable Care Act New Tax on Earnings • An additional 0.9% surtax on higher income households • The tax applies to wages and self- employment income in excess of threshold • There is no employer match on the 0.9 percent tax. This is also nondeductible for self employed. 16
  17. 17. The Affordable Care Act NEW TAX ON INVESTMENT INCOME • Investment Income to date has never been subject to the Medicare tax. • Starting 2013, high-income households, estates and trusts will start paying a 3.8% surtax on at least a portion of their investment income, such as capital gains, dividends, and rental income. • This tax will RAISE the marginal Tax Rate for many Americans: • For Example: a taxpayer in the 39.6% tax bracket (i.e. the highest marginal income tax rate in 2013) would have a REAL marginal rate of 43.4%! 17
  18. 18. The Affordable Care Act Three Critical Terms • Three critical terms associated with the 3.8% Medicare surtax: • “Net investment income” • “Threshold amount” • “Modified adjusted gross income” (“MAGI”) 18
  19. 19. The Affordable Care Act The Medicare Surtax is equal to: 3.8% X the lesser of 1. “Net investment income” for such taxable year OR 2. The excess (if any) of“Adjusted Gross Income” (as defined in Section 67) for such taxable year, over the dollar amount at which the highest tax bracket in section 1(e) begins for such a taxable year [$200,000 / $250,000 / $11,650] SINGLE MFJ TRUSTS 19
  20. 20. The Affordable Care Act Threshold Amount “Threshold amount”: is the key factor in determining the “lesser of” formula for purposes of calculating the surtax. Threshold amounts Single taxpayers—$200,000 • Married taxpayers—$250,000 • Estates/trusts—$11,650 (i.e. top income tax bracket in 2013) • •Beware of the Trust Trap- most income in trusts is passive or portfolio by design 20
  21. 21. The Affordable Care Act Tax Facts & Paying for it MAGI Defined • A potential trap is that MAGI is increased by income items that are not unearned income such as IRA distributions and active business income. As an example, a large IRA distribution may cause MAGI to exceed the threshold and cause the unearned income taxed. If a taxpayer has enough unearned income the effect may be the same as if the IRA distribution was subject to the 3.8% tax. • Consider planning (sec179 or bonus depreciation) deductions to reduce MAGI if it is the only tool you have. 21
  22. 22. The Affordable Care Act Tax Facts & Paying for it Portfolio Income of S-Corporations and Partnerships • Generally interest and dividends will be considered unearned income subject to the 3.8% tax even if earned on working capital. • There is an exception for gross income derived in the ordinary course of a trade or business, but this is narrowly defined as interest income on loans and investment made in the ordinary course of a trade or business of lending money. • In certain cases you may want to review S-Corp business activities and see if you have lending activities that would support a separate business activity of lending. 22
  23. 23. The Affordable Care Act Tax Facts & Paying for it Passive Activity Groupings and the 3.8% Tax • How activities are grouped for the passive activity purposes will impact whether activity is passive or active. • Once a grouping election is made it is binding for future years unless there is a significant change in operations. • The grouping election is made for a new activity on the return for the first year of the activity. • So if you have new activities in 2013, consult with your tax advisor for their input for the grouping elections to be considered. 23
  24. 24. Passive or Active Activity Groupings Grouping an active business activity with a passive activity within the same S-Corp: • Acme Manufacturing – active S-Corp. • Acme Recycling – passive S-Corp related activities to manufacturing • Can make the election to group the activities together making the income from Acme Recycling active and not subject to the net investment income tax on passive income. • Under the Affordable Care Act, rental income is considered investment income regardless of whether or not the activity is considered passive or active. Only exception is for the real estate professional. 24
  25. 25. Passive or Active Activity Groupings Another alternative to grouping entities, would be looking at and adjusting any rents or management fees between related entities. For example: Bill is the sole owner of his manufacturing business, an S-corporation. Bill also has a Family Limited Partnership that he and his wife own 80% of. He and his wife also own an LLC that owns real estate and receives rent form Bill’s S-corporation. For 2013 the income from the entities was: S-corporation – $200,000 Investment Income $200,000 MAGI $400,000 -$250,000 FLP - $100,000 Real estate LLC - $100,000 $200,000 $150,000 Net Investment Income of $7,600. X 3.8% X 3.8% $7,600 $5,700 25
  26. 26. Passive or Active Activity Groupings In the second example, if we reduced rents from the S-corporation and increased management fees paid by the FLP, we would have net income for the year of: Investment Income S-corporation - $350,000 $50,000 FLP - $25,000 MAGI $400,000 -$250,000 Real estate LLC - $25,000 $50,000 $150,000 Tax from net investment income of $0. X 3.8% X 3.8% $1,900 $5,700 With the enactment of the Affordable Care Act grouping to a certain extent had become less important, but the matching of passive income and loses and generating income in Active business activities had become extremely important. RESULTS IN A SAVINGS OF $3,800 26
  27. 27. The Affordable Care Act Strategies for Reducing ‘Net Investment Income’ • Municipal bonds Deferring Income • Tax-deferred annuities • Life insurance • Rental real estate Sheltering or Reducing MAGI • Oil & gas investments • Accelerated depreciation to drive down MAGI Timing Strategies • Timing of estate/trust distributions 27
  28. 28. Sample Scenario - Trust • Trust has taxable income of $100,000. • Sole beneficiary has Adjusted Gross Income of $150,000. No Distributions Trust Individual Total Income Tax $37,958 $29,779 $67,737 NII Tax $3,346 $0 $3,346 TOTAL Tax $71,083 With Distributions Trust Individual Total Income Tax $0 $59,407 $59,407 NII Tax $0 $0 $0 TOTAL Tax • Distributing out all the income from the trust would result in tax savings of $11,676. $59,407 Consult your advisor regarding Corpus distributions and the trust document 28
  29. 29. Why an S-Corp May Be The Best Solution Going Forward For 2013, Any ordinary income a taxpayer receives on a K-1 from a partnership or LLC is either active and subject to self-employment or passive and subject to NII tax. • Active ordinary income a taxpayer receives from a S-corporation K-1 is not subject to self-employment and NOT subject to the NII tax on passive income. • S-corporation shareholders need to pay themselves “reasonable” compensation. • If you can’t convert your LLC to an S-corporation because of liquidation or guaranteed return preferences, consider converting your ownership of the LLC interest to an S-corporation entity. • 29
  30. 30. Why an S-Corp May Be The Best Solution Going Forward $1,000,000 ordinary income from a LLC. • If active: $1,000,000 subject to self-employment tax = $26,782 • • • Additional .9% Medicare tax= $6,750 Ordinary income tax= $382,223 TOTAL TAX: $415,755 If passive: $1,000,000 subject to NII tax of 3.8% = $28,500 • Ordinary income tax= $387,526 TOTAL TAX: $416,026 • If the ownership is structured as a S-Corporation $800,000 ordinary income from S-Corporation $200,000 salary from S-Corp Employment taxes withheld from W-2 = $9,200 Ordinary income tax = $387,526 Additional .9% Medicare tax = $0 NII tax of 3.8% = $0 TOTAL TAX: $396,726 Approx. $20,000 Savings 30
  31. 31. The Affordable Care Act Tax Big Deal ECONOMIC SUBSTANCE Penalties - HRA 2010 (only really interesting to tax geeks) But deadly for those of us who are doing tax planning and transaction architecture to achieve good tax results planning for a living. One of the long running battles between tax courts, practitioners, and Congresswas the common law concept that Economic substance must exist in a valid transaction other than just tax motives. The HRA 2010 codifies the concept that there must be both objective evidence of economic substance and subjective inquiry on the motives for entering into the transaction. So what's the big deal? 20% underpayment penalty for disclosed transactions and 40% for undisclosed transactions found lacking in economic substance!!! 31
  32. 32. American Taxpayer Relief Act of 2012 • Permanent Extension of Bush era tax cuts-January 1,2013 • But several popular provisions are set to expire 1-1-2014 Bonus depreciation 50% write off in year place in service • Sec 179 expensing of qualified property raised to 500,000 for tangible property and 250,000 for qualified real property- returns to 25,000 with phase-out over 200,000 in investment • R&D credit set to expire 1-1-2014(expected to be extended) • Work opportunity credit – expiring 1-1-2014 • • Provisions expected to return in 2014 • R&D Credit • 179(D) – in some form • 2013 limits on Sec 179 32
  33. 33. American Tax Payer Relief Act of 2012 • Provisions on the chopping block LIFO • Lower of Cost or Market accounting for inventory • Bonus Depreciation • • New tax proposals Carried interest taxed as ordinary income • “Fair Share” tax • • Make decisions based upon what you have now- and if a particularly beneficial provision is set to expire- take advantage while you have a sure thing…. Or at least as sure as it gets with tax law….. 33
  34. 34. American Tax Payer Relief Act of 2012 So with that in mind lets look at some year end strategies for 2013 34
  35. 35. Specific Year End Tax Strategies
  36. 36. Specific Year End Tax Strategies Projecting your Tax Position and knowing your alternatives early in Q4 • Take stock of your current financials and project a what if taxable income for full 12 month period assuming no further actions. • Evaluate transactions between affiliate or related entities to insure not paying tax in one entity but having trapped losses due to at risk rules or passive loss rules • Re-review passive and active status grouping elections for all business activities • Have you made any large capital purchases? Do you need to? • Compensation- how much have you taken? • Have you maxed your 401(k) or SEP contributions? • Does it make sense to pay a dividend or distribution at year-end? • Employee bonuses, other payments or deferrals? 36
  37. 37. Specific Year End Tax Strategies Section 179 • 2013 Deduction Limit = $500,000 • 2013 Limit on Capital Purchases = $2,000,000 • 2014 Deduction Limit = $25,000 • 2014 Limit on Capital Purchases = $200,000 Please note the above limits are as of 1/1/2013, and are for tax year 2013. This means qualifying purchases you make in 2013 can now take advantage of the new, higher deduction limits. Section 179 Deduction is available for most new and used capital equipment, and also includes certain software. 37
  38. 38. Specific Year End Tax Strategies Bonus Depreciation Bonus depreciation 2013 • Deduct 50% of the cost of property with a recovery period of 20 years or less, qualified leasehold improvements, certain computer software, and water utility property. • Only new property is eligible Example: 1,500,000 of bonus eligible equipment placed in service in Dec. 2013 • Sec. 179 deduction: $500,000 • Bonus depreciation deduction on remaining $1,000,000: $500,000 • Total current year deduction of capital costs: $1,000,000 • Bonus depreciation 2014: None Also, if you have purchased a building, don’t forget the potential benefits of a cost segregation study and moving some of the costs of the building to shorter lived assets classes, and Sec. 179 eligible classes. 38
  39. 39. Specific Year End Tax Strategies Capital Expenditures Tax Planning • Is this the right time for you to pull the trigger? YES! • Weigh the options on deferral of tax due March or April of 2014 • Can you purchase or finance and get placed in service by year end? • Car and truck rules • Can you do bonus? ** Gross vehicle weight under 6,000 lbs (Ex. BMW Sedan, Cadillac CTS, Porsche Panamera) • With bonus-$11,160 without bonus $3,160 • Gross vehicle weight over 6,000 lbs – (Ex. Hummer, Suburban, Tahoe, F-250) • no $$ limitation on bonus • **MUST HAVE > 50% BUSINESS USE** 39
  40. 40. Specific Year End Tax Strategies • LIFO • Inventory Strategies Adopting price index(LIFO) before year end effective 1-1-2013 if you are in an industry that has had inflation in its material costs- oil field supply, commodities, petroleum based products, food • Subnormal goods- this is perfecting a write down to market value for the less than perfect inventory that’s worth something but not worth what you have it costed on the books- specific requirements to qualify- all must be done before year end • Mitigating overhead absorption - most inventory carrying companies and manufacturers are subject to 263A overhead absorption into their ending inventory- reviewing and retooling costing assumptions can have a significant impact on the end result of % of inventory that is getting this absorption – more important if you are growing inventory as you grow your business 40
  41. 41. LIFO: Why it should still be in your toolbox • IPIC LIFO – relatively easy to adopt • Uses inflation indexes • Requires third party service to maintain indexes and reporting • Can have significant deferral tax advantages if your business cas materials cost inflation in your products • Has to be followed for financial statement purposes and coordinated with your lender • Beware of Target on its back- consensus is that it will be repealed in extractive industries and “large “ companies- but with some safe harbors for existing companies and –Conference committee reports proposal to terminate in 2014 , but with 10 year 481 adjustment to bring it back into income (its been threatened to repeal since 2005) 41
  42. 42. Best Case Scenario - LIFO • Continue to utilize LIFO– your Company falls below the big company rules or alternately no rule is legislated • Deferral builds until such time as business has a terminating event or asset sale to a third party • Additional inflation makes the deferral larger over time • If we hit rapid inflationary period(money supply) 2015 and 2016 it could have a dramatic impact on your tax bill • Exceptions to IFRS for financial reporting is in the works (LIFO was one of the hold out problems for IFRS conformity) 42
  43. 43. Worst Case Scenario -LIFO • You adopt effective 1-1-2013 • You book a 600K LIFO reserve in 2013 that saves you between 34 and 40% combined federal and state taxes • Congress passes the repeal and requires you to take it back into income over 10 years • You get the equivalent of $240,000 in tax savings in 2013, with an interest free loan of $24,000 over ten years • Easy reversion to FIFO or other conventional method for tax and financial reporting as IPIC LIFO does not require altering internal costing. 43
  44. 44. Possibly Last Call for Subnormal Goods Write Downs • Inventory write offs- in general Requirements of IRS • Written evidence of disposal or liquidation • Can’t keep it hanging around or in alternate segregated area- has to be disposed of • Subnormal goods- products that are by their nature impaired, only saleable at below cost, discontinued styles, discontinued SKU’S, damaged goods… you can hold onto these items and still write them down for tax purposes to market value if you follow a process: • Must be able to demonstrate they are subnormal and not just excess inventory. • Make a bon-a-fide written offer to sell them to a liquidator or consolidator at a specific market price (below cost) on or before 30 days after inventory valuation date. • 44
  45. 45. Subnormal Goods Steps • Isolate the inventory SKUs • Check for any sales or active sales activity above cost • Develop a write-down target list • Save any pertinent information photos, letters, turns analysis, or related for the file • Identify potential purchasers • Draft offers to sell to one to three liquidators and save records of this (30 days after year end) • Book a non-cash adjustment allowance for obsolete inventory equivalent to disposal offers less any costs of disposal (freight) • Book the same adjustment for tax purposes 45
  46. 46. Unicap 263A – Managing Absorption • If you are a manufacturer or a distributor with greater than 10 Million in average gross revenues, you are impacted by the capitalization adjustment into ending inventory for tax purposes. • Common tools to lower the impact • Isolating purchasing costs and indirect costs • Segregation of inbound and outbound freight costs • Segregating shipping and receiving personnel • Lower the overall level of inventory by year end • Consider 3115 change in accounting if you are adopting for first year (should have been but weren’t) gives you 481 adjustment to take impact to income over a 4 year period. 46
  47. 47. Specific Year End Tax Strategies Research and Development Credit Take a fresh look • Used to be just for companies producing new products and High Tech companies with research labs. • Under recent regulations, the type of activities and the types of companies that qualify for the credit have SIGNIFICANTLY EXPANDED. • For example, if you are making the same products in your facility but are spending time to make your current manufacturing process more efficient, those activities qualify for the R&D credit. 47
  48. 48. Specific Year End Tax Strategies Research and Development Credit • Certain industries that in the past believed they weren’t eligible for R&D: • Construction, food & consumer packaged goods, furniture & cabinet making, job shops, and engineers. • For example: in construction, industry engineers and machinists often spend a substantial portion of their time developing superior designs and manufacturing practices in an effort to stay competitive. • The credit is not only available for this year, but you can also retroactively take the credit in all open tax years that you had eligible activities. 48
  49. 49. Expanded Version Specific Year End Tax Strategies Research and Development Credit • Examples of construction activities eligible for R&D credits include: • • • • • • • • • • Means and methods and construction techniques Structure and facility design for constructability Construction equipment development and improvement Design for LEED/green initiatives HVAC design Electrical system design Building Information Modeling (BIM) for sub-system coordination Analysis of the functions of a design directed at improving performance, reliability, quality, safety and/or life cycle costs Request for Information Process (RFI's) Mechanical equipment sizing 49
  50. 50. Specific Year End Tax Strategies Research and Development Credit • Example of how the Alternative Simplified Research Credit works: • Total qualified research expenses for the year minus 50% of the average qualified expenses for the past 3 years X 14%= R&D Credit for the year Qualified expenses are usually labor costs for the individuals developing new processes or refining current processes • If actual prototypes are created, the cost of materials would also be qualified expenses • • Proposal in place to increase the ASC credit percentage from 14% to 17% 50
  51. 51. Specific Year End Tax Strategies Compensation Strategies Before YE Bonuses • How to pay yourself - reconsider the obvious • If you are a C-Corp that historically bonuses owner’s compensation to mitigate double level tax- this could put you in a higher tax rate due to NIIT • If you are an S-Corp, this could be great structure to facilitate distributions and mitigate payroll taxes – but beware of reasonableness of compensation, distributions in excess of tax basis, and related issues 51
  52. 52. Specific Year End Tax Strategies Domestic Production Activities Deductiontake a fresh look • The Sec. 199 Domestic Production Deduction benefit is available to all businesses engaged in domestic manufacturing and production activities. • Deduction is equal to the lesser of 9% of your qualified production activities income or taxable income limited to 50% of your W-2 wages. Often thought of as the domestic manufacturing deduction- but can be a hidden deduction if you are doing some value add production activities as a distributor or if you have other “producer activities” you may not have considered 52
  53. 53. Specific Year End Tax Strategies Domestic Production Activities Deduction • Businesses qualifying for the deduction include traditional manufacturers as well as an expanded class of manufacturers including: 1. Construction firms 2. Engineering and architectural firms 3. Film and video producers 4. Firms in the sound recording industry 5. Computer software development companies 6. Electricity and natural gas producers 7. Food and beverage producers 8. Potable water producers 9. Crane rental Companies 53
  54. 54. Specific Year End Tax Strategies 179(d) Deduction, Expiring 12/31/13 for construction companies Deduction of up $1.80 per sq. ft. for energy-saving improvements • Three parts to 179D 1. 2. 3. Heating, cooling, and ventilation systems Interior lighting systems The building envelope Must be independently certified Who is eligible: the building owner or the tenant if the tenant owns the improvements* • Can still apply for benefits on improvements made within the last 6 years. • *If you are a contractor doing work on a government building, you may be able to claim the deduction even though you don’t own the improvement 54
  55. 55. Expanded Version Affiliate Combination and Flow Down Planning • Evaluate all tax paying entities, including the business owner and effective tax rates. • Review impact of Passive activities and at risk limits and qualification requirements for active status on certain activities Example related leasing company - equipment • Example related real estate partnership • Example related intellectual property company that main operating company is paying a royalty • Has active – passive status changed • Will push thru of year end depreciation be useable • Are there changes- supportable by business economics- that can effect the results of the combining impacts or combining limits • 55
  56. 56. Repair Regulations If you’re a fan of hope and change, this is the latest fun. • These regulations were designed to eliminate the controversies related to when something should be capitalized versus expenses for tax purposes... Have some possible applications that will be helpful to the business owner. • Important points for operating business owner that already has audited financial statements: Set policies in place and maintain records to fall under $5000 de minimis exception to enable broader expensing of cap ex and arguable repairs that add future benefit or life of the asset begin 1-12014 and advise accounting department. • If you left some money on the table in 2012 and 2013 (bonus or sec 179 unusable) could also consider using the de minimis exception for these prior years, but have to file 3115 with return and all amendments. • 56
  57. 57. De Minimis Rule • De minimis rule is available for taxpayers with applicable financial statement(AFS) capped at $5,000 per invoice or individual item. AFS are: • Financial statements required to be filed with the SEC • Audited Financial Statements • Financial Statements required to be provided to the federal or state governments or agencies (other than SEC or IRS). This could be SBA, state filings, etc… so could be broader interpretation than audited financials. • Second Chance De minimis rule for Non-audited folks- for taxpayers without AFS capped at $500 per invoice or individual item; • In order to claim these the taxpayer needs to have written accounting procedures/policies as the beginning of the year. 57
  58. 58. Expanded Version Taking Advantage of These Rules • It appears that an election to change one or more tax accounting methods will be required by most business taxpayers. Starting in 2014 this election will be as a statement with the tax return itself and it will not need a separate Form 3115. • Final regulations are effective for tax years beginning on or after Jan. 1, 2014, and for certain provisions, to costs incurred on or after Jan. 1, 2014. • Although mandatory for 2014, the final regulations allow taxpayers to early adopt these rules back to 2012. In this instance a change in accounting method, Form 3115 will need to be attached to the tax return when filed. 58
  59. 59. Own Significant Commercial Real Estate? There’s a De Minimis Rule for you as well: • Key elements in the final capitalization regulations are: • A building and its structural components are now one asset for disposition purposes. Structural components that constitute a building system and are not part of the building’s structure are: • • New safe harbor for expenditures by small taxpayers (average gross receipts for 3 preceding years is less than or equal to $10M) for qualified real property; • • HVAC System, Plumbing, Electrical, Security, Fire/Alarm, Gas Systems, Escalators and Elevators. May elect to NOT capitalize improvements to property that do not exceed the lesser of 2% of the unadjusted basis or $10,000 Routine maintenance to buildings such as inspection, cleaning, testing of structure, and replacement of worn or damaged parts can now be expensed as a repair under the safe harbor. 59
  60. 60. Long Term Tax Strategies
  61. 61. Long Term Tax Strategies Captive Insurance Company • What is it? • A way to insure against risk not covered by your current policies, or to increase the amount of coverage on certain risk areas. • A way to grow wealth and aid your estate plan • IRC 831(b) small captives • Annual premiums of less than $1.2 million • A C-corp taxed only on its net investment income • ADD MIND MAP 61
  62. 62. Long Term Tax Strategies Captive Insurance Company Operating Co. Trust $1 MM Deduction Insurance Co. No Tax on Premium Income. Only Taxed on Investment Income Owns Insurance Co. Receives Dividends. Accumulates Income. $800K Dividend (Net of fees & Claims) 62
  63. 63. Long Term Tax Strategies Captive Insurance Company How it Works: Business owner creates a captive insurance company with the owner being a Trust for the benefit of his two children. • • Business pays one-year policy to the captive of $1million. Captive pays out any claims for the year, and the remaining cash is invested or available for distribution(as a dividend) to the Trust. Over the course of ten years, that would mean tax savings to the business of $3,400,000 Assuming a 5% claim rate, and 300,000 in total administration costs, that would mean $9,200,000 in investible funds inside the captive insurance company and outside of your estate . 63
  64. 64. Long Term Tax Strategies Captive Insurance Company The Basic Rules • Premiums and policies must be market-comparable • Actuarial support needed • Insurance formalities complied with • Risk distribution must be present • Initial capitalization required • Risk distribution usually met by pooling with other captives 64
  65. 65. Long Term Tax Strategies Restructuring your Business Financial reasons • Businesses incorporated as C-corps or elected to be C-corps, that have grown in value or are positioned to grow in value • Appreciated assets (real estate) in a C-Corp with a built in gain • Certain segments of the business doing well but needing to attract capital to grow . 65
  66. 66. Restructuring Your Business: What it means to you. • Acme Steel Company- C-corp • • • • • • • • • Fair market value of the business - $10,000,000 Book value of corp - $2,500,000 Sale of assets = $7,500,000 gain Tax on gain= $2,550,000 at 34% After tax proceeds = $7,450,000 Proceeds distributed as dividend or liquidation subject to 23.8% cap gains tax-next tax bite = $1,773,100 Total taxes = $4,323,100 Effective overall tax rate 43.23% of sales price – BAD Result Versus $7,500,000 taxed at 23.8% = $1,785,000 What could you do with $2,538,100 of additional savings?? 66
  67. 67. What Are a Few Toolbox Methods? • Take an “in the ditch” year or couple of years and do a business valuation while business is at low point and do an S-election and freeze strategy to freeze the Built in Gain or establish a lower value for goodwill. This will freeze a portion of the double level tax upon sale (After ten years, escape all built in gain). • Develop NuCo’s to conduct certain activities for legal or business reasons that are pass-throughs by design- sales companies, brand building, IP housing companies. • If you expand- put new real estate in a NuCo pass thru without double level tax. • Put future high growth divisions or groups inside new wrappers and lease, license or purchase existing assets from OldCo (but be careful and consider valuations for this exercise as well). • Mission is that 5 years from now the acquisition will afford multiple entities for a sale contract taking advantage of Goodwill be entity, and each entities individual contribution. • Possible all of the above in a series of restructuring steps. 67
  68. 68. Other Reasons – Still Financial • Business owners need to create wealth growth outside of their estate, but want to keep a finger on the results and control distributions. • Create family LLC or LPs with themselves or entity they control as the general partner of managing member, but family members or trusts for family members are owners. • Value growth occurs to LLC or LP family members while initial value is low , creating a natural estate planning effect, as value of related enterprise grows over time. • If the $10MM Acme Steel company and its divisions become worth, $20MM, and Acme’s owner dies of a heart attack, and say 49% of it is effectively owned by Kids, or trusts for kids in new well structured and governed entities then 49% or $9,800.000 escapes Estate tax which At 40%= $3,920,000 in tax savings. 68
  69. 69. Long Term Tax Strategies Restructuring your Business Exit planning • Proper structure allows you to keep the largest share of the proceeds possible upon sale by changing the character of the gain or reducing the amount of tax that is paid on the gain. • Proper long- term structure can also prevent or minimize Estate taxes to the owners of rapidly growing or expanding businesses, and make it easier to transition the business to family members without having to impair or cannibalize certain assets of the business to pay estate taxes . 69
  70. 70. Q&A
  71. 71. Derek Northup Gary Jackson Senior Tax Manager Managing Partner, President Derek joined Cornwell Jackson in 2012. As Senior Tax Manager, he is responsible for supervising the operations of the tax services department, overseeing multiple large accounts while providing excellent customer service, training and developing team members and serves as the head of the firm’s dealership group. In addition to preparing and reviewing federal and state income tax returns, Derek provides clients with tax planning, transaction consulting and state and local tax services. Derek works with companies in a variety of industries, including real estate, healthcare, childcare and construction. Gary joined Cornwell Jackson in 1983 and is an active Tax Partner in Cornwell Jackson’s business succession practice as well as the Dallas office director of Legacy Wealth Management of Texas. He provides specialized business succession and tax services to companies and management teams in the manufacturing, distribution, service industries with a focus on metals and steel service centers, construction services and a wide variety of manufacturing enterprises. Contact Derek at or 972.202.8008. Contact Gary at or 972.202.8020.