Tag: Trump Tax Reform 2017

Posted on Jan 15, 2018

The most immediate concrete change the Tax Cuts and Jobs Act (TCJA) will bring about for employers is new payroll tax withholding rates. Here’s the latest word from the IRS: “We anticipate issuing the initial withholding guidance in January reflecting the new legislation, which would allow taxpayers to begin seeing the benefits of the change as early as February. The IRS will be working closely with the nation’s payroll and tax professional community during this process.”

Under the new law, the tax rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%. Under prior law, the tax rates were 10%, 15%, 25%, 28%, 33%, 35% and 39.6%

Sexual Harassment Subject to Nondisclosure Agreement

Under the new law, effective for amounts  paid or incurred after December 22, 2017, no tax deduction is allowed for settlements, payouts, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

In general, a taxpayer generally is allowed a deduction for ordinary and necessary expenses paid or incurred in carrying on a trade or business. However, among other exceptions, there’s no deduction for: illegal bribes, illegal kickbacks or other illegal payments; certain lobbying and political expenses; fines or similar penalties paid to a government for the violation of any law; and two-thirds of treble damage payments under the antitrust laws.

Family and Medical Leave

Another change involves tax incentives to encourage employers to pay employees — though not necessarily their full salaries — when they’re absent due to their own sickness or that of a family member. (Employers in several areas are already required to do so by  their own state laws.)

To receive a general business tax credit in 2018 and 2019, employers must grant full-time employees a minimum of two weeks of annual family and medical leave during which they receive at least half of their normal wages. Ordinary paid leave that employees are already entitled to, such as vacation or personal leave, or any form of leave already required by state and local laws, doesn’t qualify for the tax credit.

Employees whose paid family and medical leave is covered by this provision must have worked for the employer for a year or more, and not had pay in the preceding year exceeding 60% of the highly compensated employee threshold, set at $120,000 for 2018 (which works out to $72,000).

The minimum credit equals 12.5% of the eligible employee’s wages paid during that leave, up to a maximum of 25%. Within that range, the amount of the credit rises as employees are paid more than the minimum of half their normal compensation during their leave period. Employers that qualify may claim the tax credit for a maximum of 12 days per year of family and medical leave.

Save the Savings?

While most authors of the TCJA are probably hoping employees who will see a higher paycheck will use the difference to stimulate the economy by spending it immediately, there’s another scenario employers might consider: Employers that are concerned their employees aren’t saving enough for retirement could suggest that some might elect to “bank” their tax cut “raise” in the form of an increased 401(k) contribution.

One tool for motivating employees to save more for the future is to provide some illustrations of the long-term impact of a higher savings rate. For example, a $50 increase in 401(k) savings deducted from a biweekly paycheck would accumulate around $50,000 in greater savings over a 20-year period, assuming a 6% annual growth rate.

It’s also noteworthy that early versions of the TCJA would have drastically reduced employee opportunities to save for retirement in a 401(k) using pre-tax dollars. One proposal that would’ve hit many taxpayers hard would have limited contributions by requiring them to combine participation in multiple plans, including mandatory employee contributions to defined benefit pensions.

Those ideas were dropped.

401(k) Loan Rule Change

The TCJA did, however, make some technical changes in the retirement plan arena. Most notable is that the new law gives a break to plan participants that have outstanding 401(k) loan  balances when they leave their employers. Under current law, a participant with such a loan who fails to make timely payments due to his or her separation from the employer is deemed to have received a distribution in the amount of that outstanding balance, triggering adverse tax consequences. The participant, however, is permitted to roll that amount — assuming he or she has sufficient funds available — into an IRA without tax penalty if he or she does so within 60 days.

Under the new law, former employees in that situation have until the due date of their tax returns to move funds equal to the outstanding loan balances into IRAs without penalty. The same opportunity would apply if they were unable to repay their loans due to their plans’ termination.

Taxing Employee Awards

Some TCJA provisions affecting employee benefits seek to recoup tax relief granted in other parts of the law. For example, the TCJA tightens up the definition of employee achievement awards eligible for tax deductions on the part of employers, and exclusion from income taxation for the employees.

“Tangible” achievement awards still qualify, but the following award categories are no longer considered tangible: cash and cash equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, tickets to theater or sporting events, stocks and bonds.

The Inflation Effect and Other Changes

Another section of the law alters the inflation index used to periodically adjust the limits on contributions to health flexible spending accounts, health savings accounts, and the threshold for the value of health benefits subject to the 40% “Cadillac tax” (currently scheduled to take effect in 2020).

Instead of using the regular consumer price index (also known as the CPI-U), annual limit adjustments will be set using the “chained CPI-U.” That “chained” version tends to rise at a slower rate than the unchained index. The same formula change was made applicable to IRA contribution limits.

Finally, here are three other changes affecting employee benefits:

  • Employees’ ability to exclude the value of employer-provided reimbursements for moving expenses has been taken away. (An exception is made for active-duty military personnel, however.)
  • Employers can no longer deduct the cost of qualified transportation fringe benefits granted to employees, such as reimbursement for commuting expenses. And, similarly:
  • Employers can no longer deduct payments to employees who commute to work by bicycle.

When you add it all up, many employers and employees are likely to be happy with the overall effects of the TCJA. The task of digesting all the changes might cause a few headaches in the short run, however.

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Posted on May 18, 2017

This is not a political article. It is more about pondering the possibilities for manufacturers who are waiting to see how a new federal tax plan may change how they structure their businesses. With tax reform on the legislative horizon, we looked at a handful of potential changes under discussion to provide some context for tax planning later this year.

Seven Considerations as You Plan for the Plan

You have your Trump tax plan and you have your Republican “A Better Way” blueprint for America plan. I’m not stepping into the role of telling you which plan is better. That’s why we elect political representatives and choose which media to follow. I’m going to attempt, given the current legislative updates, to highlight the areas of most importance to manufacturers and distributors. We expect that some version of tax reform will occur in 2017. In the meantime, use this as a guide to anticipate a change in business structure or other tax planning decisions.

We will address the following areas:

  • Capital expenditures
  • Interest expense deduction
  • Tax rates by business structure
  • Cross-border provisions
  • Employer mandates for health care coverage
  • Export income exclusion
  • Carried interest

100% First-Year, Write-offs of Capital Expenditures

The Republican tax plan aligns with the Trump plan on allowing companies to write off all spending on new capital investments, from equipment to computers. The idea is to boost spending on productivity-enhancing outlays, according to an article in Bloomberg. In theory, it sounds better to write off all your capital expenses in one year rather than over time, as the current tax code allows.That being said, it may be a non-event for many mature companies with minimal annual capital expenditures, as we currently enjoy a potential $500,000 annual full expensing election under Section 179 and there is also additional bonus depreciation available under the current law.

So this proposed change will particularly benefit companies with significant capital spending plans or the expansion into a new production line or lines that may have been postponed.

It was interesting to note in the Bloomberg article that companies with large capital outlays may be viewed as more progressive or “newer,” and therefore more attractive to future investors. Regardless, companies so far don’t seem to be rushing out to buy new equipment in anticipation of 100 percent, first-year write-offs.

Conclusion: Stick to your budgets and plan your capital expenditures as if it’s still 2016. Don’t place reliance on this additional tax benefit if you exceed these limits, but consider it a potential  “bonus” if the law falls in your favor.

Loss of Interest Expense Deduction

In addition to potentially boosting the cost of PE deals and making asset deals more attractive, the loss of the interest expense deduction is designed to make debt financing less attractive for businesses and individuals.

Under the current tax code, interest expense on debt financing — from home mortgages, business loans, stock purchases — is deductible. It’s deductible for private equity firms that use investor cash and third-party leverage to finance the purchase of stock. With the exception of the mortgage interest deduction on your primary home, the Trump and Republican tax plans both propose to eliminate the interest expense deduction to offset the loss of tax revenue from the proposed 100 percent capital expense depreciation.

Companies that purchase physical assets will be better off expensing capital purchases than relying on interest expense deductions. However, companies that are heavily leveraged and PE firms potentially end up paying more tax.

Conclusion: Make a plan to pay off or refinance any high interest debt in 2017 and actively try to lock in any low interest debt for long term installment loans.

Change Business Structure or Not?

Both the Trump and Republican tax plans propose a large federal corporate/business tax rate reduction, putting the new rate at 15 or 20 percent. It was a key campaign promise, and comments made by President Trump in March regarding a tax reform package emphasized that he wants to lower the overall tax burden on businesses. Followers expect that release of details is still months away.

It’s unclear so far whether manufacturers should consider a business structure change. One proposal  talks about a lower tax rate for all businesses, while another noted that only C Corps would get the tax rate reduction to bring them in line with the tax structure of S Corps.

Conclusion: Watch for more details on the proposed tax rate reductions this summer. If your business is structured as an S Corp, there may (or may not) be a reason to discuss a structure change.

Zero Deduction for Cost of Imported Materials

One area that hasn’t been talked about much in the media, but will need more attention, is the cross-border provision for imported materials. Currently, manufacturers that use imported materials in their products can deduct the cost of those materials. A new proposal would eliminate the deduction on imported materials and only allow a deduction on U.S. sourced materials.

With a dramatic increase in the cost of materials to produce products, any lowering of the corporate tax rate will offer far less benefit for these manufacturers. It will also hit distributors of imported foreign materials hard.

With this proposal, I anticipate reporting complexity for manufacturers that have some products with imported materials and others with no imported materials.    Also, if a product is partially assembled in a foreign country, is the cost of labor still deductible while the materials cost is excluded? Enterprise systems would have to be reconfigured to account for proper tracking.

If passed, this increased cost will likely be passed on to retailers and consumers — adding to inflationary concerns.

Conclusion: Consider to what extent — if any — your company currently imports materials or partially assembled products. The jury is out on what form cross-border protections will take and may include a phased-in approach to offset huge tax burdens on U.S. importers.

Elimination of the Employer Mandate

Although not completely related to tax reform, something that President Trump and Republicans both agree on is elimination of the employer mandate to provide health care benefits. Because a healthcare reform plan is still a work in progress , we still have the employer mandate.

Conclusion: Although we will all be pleased with the reduction in the exhaustive paperwork and reporting requirements of Obamacare,  provide health care benefits anyway. It’s a baseline competitive feature for recruitment and retention of your most talented.

Planned Income Exclusion for domestically produced exported goods may eliminate need for IC-DISC structure

One of the cross-border tax proposals is that U.S. manufacturers that are exporting goods will get a 100 percent exclusion of these export revenues from U.S. tax. There are significant practical issues and questions surrounding this broad brush proposal, not limited to what is defined as U.S. manufacturing. Does use of  domestic distribution that does both export and domestic distribution qualify for this exclusion, will certain countries be excluded, will certain maquiladora arrangements be grandfathered or phased in over time?

Export tax minimization has been historically achieved through the IC-DISC (Interest Charge-Domestic International Sales Corporation). This helpful and sometimes misunderstood tax break for manufacturers and some professionals will be mostly obsolete if a tax reform bill excludes tax 100 percent on U.S.-based exports.

Set up as a separate entity, the IC-DISC is available to small and mid-sized manufacturers that export goods, but it may also apply to professionals like engineering or architectural firms that work on a project that will be built overseas. Manufacturers of parts of products that are exported may also be eligible. IC-DISC allows a reduction on 50 percent of export income by more than 50 percent. Profits are taxed at the lower dividend rate (15%) as opposed to ordinary income tax rates (34%+).

The elimination of taxes on exports may provide a boon to U.S. manufacturers, but it is widely anticipated that other countries may combat the U.S. shift in tax law with additional tariffs or import fees – that may eliminate or at least dampen the ability of manufacturers to use this tax advantage to help compete in overseas markets.

Conclusion: Investigate the IC-DISC if you think your company’s  export activities are sufficient to set up this structure, and use this as a back-up position in the event the “as defined” export exclusion becomes a more narrowly defined opportunity for utilizing this tax advantage. That being said, do the up front due diligence and cost benefit modeling – but delay any structure set-up action until later this summer.      

Eliminating the Carried Interest in Private Equity Structures

I don’t know how many times President Trump talked about eliminating “the carried interest loop-hole” during his campaign, but I’m sure someone tracked it in a video montage. Carried interest is defined by IRS regulation rather than statute, so the President could move forward without the assistance of Congress. The Republican tax proposal doesn’t mention this tax break.

Elimination of carried interest would result in equity investors paying more for distributions coming out of portfolio companies, which doesn’t impact owner-operator companies insofar as their tax rates, but it could add to concerns over inflation as investors seek to make up the losses through improved corporate performance.

Conclusion: If you have private equity investors as shareholders or they are a significant part of your overall exit plan, make sure you have a clear understanding of the changing tax metrics to this investor class, as there may be a required change(increase) to tax distributions from the Operating Company to address these metrics. Overall, it could cause some revision or amendment to various waterfall calculations and preferred return calculations to address the economic impact to this shareholder group.

While we’re waiting to see which elements of which tax reform proposal come out on top, consider the results of your previous tax year. If there are areas that didn’t pan out as you hoped, the Tax Group at Cornwell Jackson is available to review your returns and identify any opportunities that make sense — for 2017 at least.

 

Gary Jackson, CPA, is the lead tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax planning to individuals and business leaders across North Texas. Contact him at gary.jackson@cornwelljackson.com.

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