Where is Tax Reform Anyway?

2. Tax Planning While Waiting for Tax ReformMel Schwarz Barbara Koosa RyanPartner Partner Washington National Tax Office Columbia, SCMel.Schwarz@us.gt.com Barbara.Ryan@us.gt.com

3. Where is Tax Reform Anyway?

5. Handicapping Tax ReformA Cloudy Crystal Ball • 2014 – Seems unlikely • 2015 – Could depend on who takes Senate • 2016 – Presidential election years do not facilitate bipartisan legislation • 2017 – Seems more likely • The reasons we began this discussion will still be there. • New players, new opportunities

6. Why everyone was talking tax reformCamp corporate rate cut Phased in: • 2015: 33% • 2016: 31% • 2017: 29% • 2018: 27% • 2019: 25% AMT repealed

7. Why does Tax Reform in 2014 seem unlikely? House Republican leadership has been reticent about allowing Camp to go to markup, preferring to stay focused on Obamacare, Benghazi and other issues. Senate Finance Chairman Baucus has left for China. No agreement on the basic issue of whether or not taxes must contribute to reducing the deficit. Necessary revenue offsets are unpopular.

8. How do you pay for tax reform? Major domestic business tax expenditures

9. Camp Discussion DraftBusiness Proposals Repeal Accelerated Depreciation Depreciation deduction per $1,000 of basis assumes 3% annual inflation rate

10. Camp Discussion DraftOther Business Changes Repeals most credits and incentives, including WOTC and section 199 Cash method prohibited if > $10 m. gross receipts Like-kind exchange repealed Limits on deductible retirement contributions

11. International proposalsCamp discussion draft • Shift to territorial tax system: • 95% dividends received deduction • Retain subpart F • Transition tax on all current offshore earnings: • 8.75% on cash and cash equivalents • 3.5% on remaining E&P • To prevent income shifting: • 15% rate on foreign base company intangible income under Subpart F

13. Individual proposalsRates in Camp discussion draft

14. Individual proposals Camp surtax • MAGI for purposes of surtax includes: • Standard & itemized deductions (except charity) • Employer and self-employment health coverage • Foreign income exclusion • Tax-exempt interest • 401(k) contributions • HSA contributions • All Social Security benefits

15. SE tax on pass-through ownersCamp proposal • Eliminate exception for limited partners, LLC owners, and S corp shareholders • If materially participate: • 70% self-employment income • 30% percent return on investment • Exception from NII tax retained • No change to §1411, so if no material participation, all income still NII

17. Handicapping Tax ReformA Cloudy Crystal Ball • 2014 – Seems unlikely • 2015 – Could depend on who takes Senate • 2016 – Presidential election years do not facilitate bipartisan legislation • 2017 – Seems more likely • The reasons we began this discussion will still be there. • New players, new opportunities

19. Senate Races in 2014 Map by 270towin.com

20. Senate Outlook based on Current Polls • Map by 270towin.com

22. Even if Republicans Take the SenateCan they pass tax reform that Obama will sign? • "I thought I was a conservative, but we’ve got some in Congress now who are so far right they’re about to fall out of the Capitol.” • Bob Dole, speaking atthe First Lutheran Church, Ottawa, Kansas, April 21, 2014.

23. Handicapping Tax ReformA Cloudy Crystal Ball • 2014 – Seems unlikely • 2015 – Could depend on who takes Senate • 2016 – Presidential election years do not facilitate bipartisan legislation • 2017 – Seems more likely • The reasons we began this discussion will still be there. • New players, new opportunities

25. Handicapping Tax ReformA Cloudy Crystal Ball • 2014 – Seems unlikely • 2015 – Could depend on who takes Senate • 2016 – Presidential election years do not facilitate bipartisan legislation • 2017 – Seems more likely • The reasons we began this discussion will still be there • New players, new opportunities

26. Combined Corporate Income Tax Rate Combined Corporate Income Tax Rate (Includes State and Local) United States39% OECD Average 25%

28. What do I do while I am waiting for tax reform?

29. Tax Planning While Waiting for Tax ReformTake Advantage of Benefits While You Can • Major changes are likely to wait for tax reform • Depreciation • Accounting methods • Taxation of reinvested foreign profits • Changes to large dollar tax benefits for individuals

30. Tax Planning While Waiting for Tax ReformTake Advantage of Benefits While You Can • Accounting changes implemented today generally produce an immediate benefit through the 481 adjustment. If later repealed, expect a spread. • Repair studies • Advance payments and prepaid expenses • Disputed amounts • Self-developed software • current expensing • section 199

31. Tax Planning While Waiting for Tax ReformTake Advantage of Benefits While You Can • Depreciation and cost segregation • Be prepared to exploit expired provisions if/when they are extended

32. Problem of Expiring Tax Provisions • Over 50 provisions expired at the end of 2013 • Retroactive extension likely for most • timing? • What might not be extended? • 50% bonus depreciation • Financial accounting implications • Cannot anticipate enactment – affects 2014 10Q • Potential affect on unrepatriated earnings

33. Extenders – Congressional Action • Senate EXPIRE Act: • All but 2 expired provisions retroactively restored as part of 2-year extension: • Includes: • Increased section 179 expensing limit • 50% bonus depreciation • Consideration by full Senate delayed by dispute over possible amendments

34. Extenders – House ActionVeto threat if cost not offset * 10-year cost estimated by Joint Committee on Taxation

35. The Retroactive Extension Tradition

37. Tax Planning While Waiting for Tax ReformDon't be afraid to "pass through" • A single level of tax is still best • Top current rates have not changed yet • Active participant in pass through avoids NII tax • Other benefits of pass through status

38. Minimize Impact of Obamacare Taxes:Net Investment Income Tax

39. What is the net investment income tax? • New 3.8% tax onnet investment income to the extent MAGI exceeds high-income threshold • IRC Section 1411 under new Chapter 2A • Creates new tax base with different rules than either income or payroll taxes • Companion to increased Medicare tax on earned income to extent MAGI exceeds threshold

40. What's the high-income threshold? • Modified adjusted gross income: • Single: $200,000 • HoH: $200,000 • Joint: $250,000 • Separate: $125,000 • Trust: $11,950 (indexed) • MAGI is AGI without foreign income exclusion

41. What is Net Investment Income? Three separate buckets of income: • Rents, royalties, dividends, interest, annuities • Unless derived in ordinary course of non-passive trade or business (can't be trading financials) • Any other income from passive trade or business • Plus income from trading business • Capital gain • Unless held in non-passive trade or business

42. What is Net Investment Income?Exclusions What's NOT Net Investment Income? • Income already subject to SE tax • Exclusions under other code provisions • Excluded gain from sale of primary residence • Exempt bond income • Qualified retirement plan distributions

43. What deductions reduce net Investment Income? • Net operating losses • Final regs allow deduction of portion of NOL arising from NII against allocable deductions • Passive losses • Carry-forwards (even pre-2011) offset NII • Capital losses • Cannot offset other NII (except $3,000 used against ordinary income)

44. Pass-through businesses What income is NOT subject to tax? • Passive activity: • All income subject to tax • Non-passive activity: • Rents, royalties, interest, dividends, rents UNLESS Derived in the ordinary course. . . OR Gain from property held in. . . . . . .a trade or business

45. Pass-through businesses What is a passive activity? Determination of passive activity uses the existing rules in §469 Taxpayer must materially participate or the activity is passive These rules matter for non-loss companies for the first time

46. Pass-through businesses What is a passive activity? Material participation Meet 1 of 7 material participation tests • More than 500 hours participation • Substantially all of the participation • More than 100 hours if no one has more • Significant participation activities • Material participation 5 of past 10 years • Material participation in personal service activity in any of 3 prior years • Facts and circumstances

47. Pass-through businesses What is a passive activity? Material participation Meet 1 of 3 material participation tests if limited partner: • More than 500 hours participation • Substantially all of the participation • More than 100 hours if no one has more • Significant participation activities • Material participation 5 of past 10 years • Material participation in personal service activity in any of 3 prior years • Facts and circumstances

48. Pass-through businesses What is a passive activity? Grouping rules under §469 • Can use grouping rules in § 469 to establish material participation for "appropriate economic unit" • Look at multiple activities as one • Special rules for grouping rental activities with a trade or business • "Fresh start" allows one-time regrouping in either 2013 or first year subject to § 1411

49. Pass-through businesses What is a passive activity? Grouping rules under §469 • How much flexibility in grouping rules? Significant • Regs provide five nonexclusive factors: • Similarities and differences in trades or businesses • Extent of common control • Extent of common ownership • Geographical location • Interdependence between or among activities

50. Pass-through businesses Special exception for rental income • Final § 1411 regs provide that for rental income, if: • Treated as nonpassive due to self-rental rules OR • Grouped with a trade or business in which the group is nonpassive • The income is deemed to be derived in the ordinary course of a trade or business