Tax Cuts and Jobs Act: Entity Choice and Sec 199A QBI Deduction Part I

1. Tax Cuts and Jobs Act: Entity Choice and Sec 199A QBI DeductionPart I Nicole R. Suk, CPA November 29, 2018

2. Agenda Part I – Entity Selection • Entity choices • Tax implications of conversion • Examples Part II – Sec 199A Qualified Business Income Deduction • What is 199A • How is 199A calculated • Examples • Reporting and Planning

3. Choices of Entity Partnership Sole Proprietorship General partnership Limited partnership Limited liability partnership Limited liability company S Corporation C Corporation

4. Why Talk About This Now? • Tax Cuts and Jobs Act of 2017 • Tax Rates

5. Predictions • Penn Wharton Budget Model (PWBM) • Predicts 235,780 US business will switch from pass-through entity to C-corporation • 77% of whom have income of at least $500,000 • The biggest switchers will include doctors, lawyers and investors, especially if owners can afford to defer receipt of business income to a later year • Projects that about 17.5% of all pass-through Ordinary Business Income will switch to C-corporations

6. Pass-Through Entities • Reduces double taxation • No income tax at entity level • Owners are taxed on their portion of the net income of the business • No tax on cash distributions • Possible self-employment tax on earnings • Individual tax rate reduced to 37% max – sunsets in 2025 • Possible 20% QBI deduction • Losses can offset other personal income

7. C Corporations • Taxed at corporate level • Double taxation when net earnings are distributed to the shareholder as a dividend.  • May retain the profits - be aware of the accumulated earnings tax • Permanent 21% rate reduction • No AMT tax

8. Key TCJA Provisions to Consider • Key pass-through provisions such as qualification to claim Sec 199A deductions • Key individual provisions such as owner tax rate • Comparison of pass-through provisions to corporate provisions • International provisions

9. Other Provisions to Consider • Amount of annual distributions now and in future • Character and timing of income recognized (LTCG) • State income tax liabilities • Exit strategy and timing consideration for shareholder and/or partners • Current and future cash needs of business

10. Sole Proprietorship • Includes single member LLCs • Disregarded for federal income tax and all items of income and deductions are reported on owner’s income tax return • Self-employment tax on income • Sole proprietorship often avoided due to unlimited personal liability • Higher IRS audit rate on Schedule C

11. Partnership • Includes general partnerships, limited partnerships, limited liability partnerships and limited liability companies (if multiple owners) • Tax free distribution of taxed profits • Flexibility in allocating income as long as allocation has substantial economic effect • Sec 754 election available • May be subject to self-employment tax • No restrictions on types of partners

12. S Corporation • Income passes through and is taxed to shareholders • Avoids “double” taxation • Tax free distribution of taxed profits • No more than 100 shareholders • Restrictions on types of shareholders • Must only have one class of stock • Differences in voting rights are ignored

13. S Corporation • No SE tax • “Reasonable compensation” to SH; not based on ownership • Income and distributions must be allocated to shareholders in accordance with stock ownership • Limitation on taking losses (basis) • Basis obtained from capital contributions and loans from shareholder to corporation • No basis in corporate debt • No 3.8% NIT on sale of “active” stock

14. C Corporation • Limited liability • No restrictions of shareholders • Income taxed at corporate level • Potential double taxation if corporation pays dividends to shareholders • Dividends and sale of stock subject to 3.8% NIT

15. C Corporation - Advantages 1202 Stock Benefits • Depending on acquisition date of QSBS, gain exclusion upon disposition:

16. C Corporation - Advantages • Excluded gain limited to the greater of $10M or 10x the adjusted basis of the investment. • Five criteria must be met to be QSBS: • Stock must be held for more than 5 years, • Stock acquired directly from C corporation, • Aggregate gross assets can not exceed $50M at any time prior to QSBS issuance, • The C corporation and shareholders must consent to supply documentation regarding QSBS, and • The C corporation is a qualified active trade or business.

17. C Corporation - Advantages • Section 1045 provides non-corporate taxpayers a tax deferred rollover of gain on QSBS stock held more than 6 months • New QSBS stock must be acquired within 60 day period after sale • Replacement investment can be made through acquisition of partnership interest

18. C Corporation - Disadvantages Accumulated Earnings Tax • 20% tax penalty on undistributed taxable income less amounts retained for “reasonable” needs • Accumulate up to $250K, $150K for service businesses • Tax is assessed by IRS and burden of proof falls to corporation • Solutions - pay higher salaries to shareholders, document business needs, S corporation election

19. C Corporation Personal holding company • 60% or more of gross income is passive AND • 50% of the stock owned by 5 or fewer individuals during last 6 months of the taxable year. • Tax on 20% of undistributed income • When income is finally distributed will be taxed again at shareholder level • Conversion to S corporation eliminates this tax

20. C Corporation

21. C Corporation

22. C Corporation

23. Tax Implications Convert C to S • 5 year built in gain on sale of appreciated assets • Cannot use NOLs except against BIG • LIFO recapture - difference between FIFO and LIFO inventory is income and tax is paid over 4 years • Distributed accumulated C corp E&P taxable as dividends

24. Tax Implications Convert S to C • Undistributed profits available to SH tax free • Can’t go back for 5 years • Possible increased state and local taxes • Sale of business in future may be subject to double taxation • Ability to have different fiscal year ends

25. Example – C Corporation

26. Example – C Corporation

27. Example – Pass-through

28. Example – Cash Savings Full C corporation and S corporation dividends:

29. Example – Cash Savings No C corporation and full S corporation dividends:

30. Example – Cash Savings

31. Example – Stock Sale

32. Example – Stock Sale

33. Example – Stock Sale

34. Example – Stock Sale – 1202 Stock

35. Example – Stock Sale – 1202 Stock

36. Example – Asset Sale

37. Example – Asset Sale

38. Example – Asset Sale

39. Example – Asset Sale

40. Take Away • What are the cash needs of the business? • What are your personal cash needs? • Will you be eligible for the Sec 199A deduction? • Passive versus active ownership? • What are future plans to sell? • What type of sale will it be – stock or asset? • Will the stock qualify as 1202 Stock? • What happens when tax reform expires? All comes down to today versus tomorrow

42. Questions? Nicole Suk, CPA Principal Windham Brannon 3630 Peachtree Road Suite 600 Atlanta, Georgia 30326 Main: 404.898.2000 Direct: 678.510.2785 Fax: 404.898.2010 Email: nsuk@windhambrannon.com

43. Tax Cuts and Jobs Act: Entity Choice and Sec 199A QBI DeductionPart II Nicole R. Suk, CPA November 29, 2018

44. Agenda Part I – Entity Selection • Entity choices • Tax implications of conversion • Examples Part II – Sec 199A Qualified Business Income Deduction • What is 199A • How is 199A calculated • Examples • Reporting and Planning

45. Section 199A – What is it? • Tax years beginning after December 31, 2017 • Pass-through taxpayers who have “Qualified Business Income” (QBI) • Up to a 20% deduction on QBI • Effectively reduces tax rate in QBI from 37% to 29.6% • Set to sunset after 2025

46. Section 199A – What is it? • Fiscal year businesses • Sec 199A applies to taxable years beginning after 2017 and before 2026 • Proposed regulations state that if an individual “receives any of these items” from a fiscal year entity with a fiscal year ending after 2017 “such items are treated as having been incurred during the individual’s tax year” • Income actually earned in 2017 but during a fiscal year ending in 2018 will qualify as QBI for 2018

47. Section 199A – QBI • Net amount of income, gain, deduction, and loss relating to any qualified trade or business of the taxpayer • Business income other than investment income • Interest income properly allocable to a trade or business is allowed • Included or allowed in determining taxable income for the tax year

48. Section 199A – QBI • Does not include: • Investment income – ST and LT capital gains and losses, dividends, and interest income not properly allocable to a trade or business • Guaranteed payment income • Shareholder compensation income • Foreign earned income • Qualified REIT dividends or qualified cooperative dividends • Qualified publicly traded partnership income

49. Section 199A – QBI • Passive and active ownership eligible • Available for non-corporate taxpayers including trusts and estates • Grantor trusts – treated as if individual owns directly • Income from specified businesses may not be eligible for the deduction

50. Section 199A – Specified Businesses • Trade or business involving the performance of services other than engineering or architecture • Investment and investment management, trading, or dealing in securities • Performance of services in the fields of health, law, accounting, performing arts, consulting, athletics, financial services, brokerage services