Tax Gossip – Rumors on Section 179 Expensing and Bonus Depreciation

My colleague recently attended an event where a Congressman who is on the U.S. House of Representatives Ways and Means Committee said it is very likely that 179 expensing and bonus depreciation will be extended in early December before the session break or in early January and applied retroactively.

I hope so. We will see.

For now, I recommend you run year-end planning calculations under both scenarios – no extension of the rules and if they are extended.

YEAR END PLANNING

It is time for year-end tax planning. This should be started in November, not late December.  The following are some of the issues that should be discussed with your advisor.

  1. Deferring or accelerating income
  2. Deferring or accelerating deductions
  3. Purchasing assets before year-end
  4. Selling assets before year-end
  5. Proper documentation and policies for accruing and deducting bonuses
  6. Inventory costing methods
  7. Writing off bad debts
  8. Maximizing the domestic production deduction
  9. Loss planning to make sure losses are not limited under the basis, at risk or passive activity rules
  10. Entity structure for new ventures and 831(b) captive instance planning.
  11. Other items that may reduce you tax burden.

Each of these categories have several tax planning techniques that can be implemented. One must consider the business and economic impact of them in addition to the tax savings.

Also, have your advisor prepare a tax projection for 2014 and illustrate the impact of the planning techniques.

Get on it as soon as you can.

DISNEY and TAXES

I am off to Orlando for a great tax conference. I can’t wait. I am like a kid heading to Disney World. In fact, Cammy and Patrick, our two oldest grandkids, are coming along. Disney at night and on the weekend. I refuse to skip out of the conference. It is going to be a good week.

LLC Members Self Employment Tax

Many tax professionals are changing their stance on how to treat business income allocated to LLC Members for Self Employment Tax (SET) purposes.

In general, per Internal Revenue Code Section (IRC) 1402(a), taxpayers who are allocated business income from an entity taxed as a partnership (e.g., general partnership, limited partnership, LLCs) are subject to SET on such income. However, an exception applies for income allocated to Limited Partners (IRC section 1402(a)13). This exception does not apply to payments for services to such partners as “guaranteed payments.”

That being said, the treatment of LLC members has been somewhat controversial. Are they Limited Partners for purposes of these rules? The IRS has attempted to issue regulations twice, but has never finalized them. The IRS has provided very little guidance on this matter. There have been some recent court cases and a new Chief Council Advice (201436049) that address specific taxpayers’ situations.

It appears that both the courts and the IRS are looking at the type of business income as well as the taxpayers’ role (active vs investor), but not their status as a limited partner under state law. In essence, the IRS and certain courts are applying a special definition of “Limited Partner” under section 1402(a)(13), based on the intent of the law, not their status under State law.

So what do we do?  

Many professionals are treating all Limited Liability Company members’ business income as exempt from SET. Some treat only business service income as subject to SET and some treat all business income as subject to SET.

I believe each situation needs to be reviewed to determine the best position to take. Whether the income is a return on investment or a result of the owner’s services is a key factor. The type of income also matters (service vs. other.) There is no specific rule here. One might want to look at the passive loss rules and apply the material participation test. This type of concept is in the proposed regulation issued by the IRS that was never finalized.

At a minimum, make sure owners who are providing services to the entity are paid a reasonable “guaranteed payment” for such service.

Some advisors recommend using S-Corporations to minimize the SET. Subject to a requirement to pay reasonable compensation, S-Corporation income is not subject to SET. However, the partnership tax rules are generally much better and more flexible compared to the S-Corporation rules. When all else is equal, I always recommend creating entities that can use the partnership tax rules.

One may consider setting up separate S-Corporations for each LLC member to hold their LLC units. This should help avoid the Self Employment Tax on the LLC income and also allow the LLC to treat its taxpayers as employees.

This issue should be part of year-end planning discussions.

 

Personal Update

There’s been lots going on lately. Our Stillwater Condo overlooking the St. Croix River has been expanded by adjoining the small one next door. What a project that was – Jan blew my budget away. Fall has arrived and the boat in Minnesota is put away for the year, but the one in Florida is all ready to go! Our Grandkid’s dancing and hockey activities are in full swing now, lots of fun spectating to look forward to there.

And of course, I’m still reading tax articles daily. Life is good!!

Business Succession Planning

What is business succession planning, and why do it? If you conduct a Google search on this topic, you will get many different answers to these two questions.  But succession planning isn’t all about selling the company; that’s just one of the many solutions.

Before deciding on a solution, there are some important questions you need to ask yourself. For example, will you transfer the business or choose another strategy? To whom should the business be transferred? What is the right timing to proceed with the transition?

In my eyes, there is one guiding theme to answer all of the above questions. Simply ask yourself, what achieves the owners’ goals with regards to the future ownership of the business? By contemplating this, you will come up with the best solution for you and the company at large.

Nothing can be accomplished until the owners spend time determining and communicating their goals with regards to the future ownership of the business.

Make sure the following areas are consistent with such goals:

  • The governance system
  • The management team and its succession
  • The strategic planning system
  • The ownership’s plan and expectations
  • The owners’ estate plans

Failure to get these addressed and aligned can result in various ramifications such as family disharmony, loss of key personnel, lawsuits, forced sales, excess taxes and most importantly, inability to achieve the owner’s goals.

I believe each owner should assemble a team to address the succession plan, and allow those involved to hold ownership accountable for their part of the process. Easy to say, hard for entrepreneurs to do.

If you don’t put in the effort, don’t complain about the consequences.

 

9/11

This week was the anniversary of the September 11th attacks, a tough day for many Americans who lost loved ones. But also a proud day for our nation as we pulled together to deal with the tragedy.

My wife and I have a son serving and deployed in Afghanistan, continuing the fight. We are so proud of all the young courageous members of our military. God bless them all.

Cash Method, Accrual Method, or Both?

Most taxpayers adopt either the cash method or accrual method of accounting for their businesses tax reporting.

I very rarely see both methods applied to different segments of business. If a taxpayer (entity or individual) has two or more trades or businesses that are separate and distinct, each can adopt separate methods of accounting that are allowed, or required, for the specific type of business activity.  Separate books and records must be maintained for each business activity.

This is definitely a planning opportunity. If a business qualifies as separate and distinct for the other business activity of the taxpayer, a change in the accounting method can be requested even if separate methods weren’t used in the past. For most accounting method changes, the IRS has provided automatic consent to change in Revenue Rulings and Procedures.

If you do have separate and distinct businesses owned by yourself or one entity, I recommend operating them through separate LLCs. This helps illustrate the separation from other business activities.

This concept was recently addressed in the taxpayers favor in Chief Counsel Advice 201430013.

Ask your advisor whether you should be separating your distinct business activities and adopting a different method of accounting for some or all of your business activities before year end.

 

Golf Weekend

Just spent three wonderful days with my buddy, Marty, at the Spring Hill Founders Cup golf tournament. What a great host, course, and membership. All first class.

Marty even allowed me to sport my Keith Richards t-shirt at his place on the porch, where we did a little dancing with Patty, Lesley and Mike (to the Rolling Stones, obviously.)

Classic case of the east-sider bringing down the Edina neighborhood.

My claim is that I was the worst golfer in the field. That’s why I boat.

 

Real Estate Professional Rules Confirmed

The IRS in Chief Counsel Advice confirmed a position I have taken and for which I have advocated throughout the years.  Many professionals disagreed, but now it is clear.

Generally, under Internal Revenue Code (IRC) section 469, real estate rental activities are passive activities subject to the loss limitation rules of IRC section 469, regardless of the owner’s level of participation.  However, IRC section 469(c)(7) provides rules that allow real estate professionals to treat certain real estate rental activities as non-passive; and therefore, not subject to the IRC section 469 loss limitations.

A real estate professional is a taxpayer who performs more than 750 hours of service and more than half of all services during the year in real property trades or business in which he or she materially participates.  There are a lot of separate rules to pass in that sentence!  If married taxpayers file a joint return, only one spouse needs to pass each of the rules for them to apply to both on such a return.

When determining whether one materially participates in such real property trades or businesses, the normal IRC section 469 participation rules and definitions of activities apply.  This includes grouping separate trades or businesses and rental operations; and a spouse’s participation counting for the other spouse.

Once an individual qualifies as a real estate professional, the treatment of real estate rental properties as passive is determined separately to each interest in real estate, even if they are grouped under the material participation test used to qualify as a real estate professional.  However, IRC section 469(c)(7)(A) allows one to combine all interest in real estate rental properties as one activity to determine the passive or non-passive classification.  This grouping election is done after the taxpayer qualifies as a real estate professional, not to determine if they are one.

That is where many professionals misinterpreted IRC section 469(c)(7)(A). They claimed the grouping election was used in applying the test to determine real estate professional status. CCA 201427016 makes it clear, it doesn’t.

I like being right.

Log Jam Days

It was Log Jam Days in Stillwater this weekend.  Great boating, music, dancing and fun.  Our grandkids had a blast on the rides and eating junk food.  So did I.

Who Else is Moving out of the US and Minnesota?

Most have read or heard that Medtronic, the huge Minnesota-based medical device company, is completing an inversion and will now be an Irish Company.

Regardless of the press releases and statements from the company, we all know US and Minnesota taxes had a large impact on the decision.

What isn’t publicized is the amount of small closely-held companies looking to move out of the US and Minnesota, or at least leave their profits elsewhere, until we get our act together.

I run into it all the time.

A good example is the businesses with which I work that have activity in Canada.  In the past, we structured operations so companies could immediately repatriate profits in a manner to pay a combined Federal, Canadian  and Minnesota tax at no higher than the combined Federal and Minnesota rate.  No more.  Not with the 50% taxes assessed by the US and Minnesota.  We now leave our funds in Canada, which are taxed at a combined Federal and Provincial rate of about 27%.  All expansion occurs in Canada.  Canada is a tax haven – really?

The same holds true for many European and Asian jurisdictions.

Any taxpayer with foreign operations needs to review their entity structure to see how it should be organized to minimize taxes.  They should decide, like Medtronic, where the best place is to operate using taxes as part of the analysis.

We need tax reform bad. Too bad Washington and most State legislatures are all talk and no action when it comes to promoting business tax reform. Small business is the driver of our economy.

Leaving Minnesota

I have had it with the rain.  I am heading to Florida this weekend to do some boating and where I can actually run at full spread. The St Croix River has been no wake all season. Boring.

However, I need to bring our new puppy along “Woody,” the Golden retriever, named after Stones guitarist Ron Woods.  He is a keeper.

Health Insurance Benefit Rule Clarified by the IRS

The IRS has issued clarification on its WEBSITE, which in short indicates that the technique discussed in my blog dated April 30, 2014 is not allowed.  Some professionals don’t agree with the IRS position.   However, until further guidance or support is provided, I would not engage in the technique suggested.

An option would be to utilize a “Qualified Employer”  group plan established through the exchange.  Premiums paid by employees under such an arrangement can be run through a cafeteria plan pre-tax pursuant to Internal Revenue Code section 125(3)(B).

Basically, a “Qualified Employer” is a “Small Employer” that elects to make all of its full-time employees eligible for one or more qualified health plans offered in the “small group market” through an Exchange that offers such qualified group plans.

A “Small Employer” is one that employed an average of no more than 100 employees on business days during the preceding year.  For plan years beginning before January 1, 2016, States may use 50 employees instead of 100 to apply the rule.

Again, I would not engage in the technique presented in my April 30 blog until, and if, the IRS changes its position.

New Boat

The house boat is sold and a new day boat arrives this week.  I can’t wait to get back to the River this weekend.  I need to determine what “Rolling Stones” song to name it.  Suggestions?