Tax Planning To Prepare For Today and Tomorrow

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TAX PLANNING TO PREPARE FORTODAY AND TOMORROWPresented by Plante & Moran’s Tax Team


Today’s Presenters

Kurt Piwko, Tax Manager Macomb, [email protected]

Mark Jolley, Tax PartnerAnn Arbor, [email protected]

Michael Petersmark, Tax ManagerEast Lansing, [email protected]

Tax Planning to Prepare for Today and Tomorrow


About Today’s Webinar

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Housekeeping Items

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Agenda

State of the Current Tax Environment General Pending Legislation Congressional Calendar Expectation of Enactment of

Tax Legislation Tax Planning in the Current

Environment Maximum Future Tax Rates Considerations in Tax Planning Rate of Return on Tax Planning Accounting Methods Other Tax Planning Ideas Choosing a Form of Doing

Business

Year-end Tax Planning Consent Dividends §1202 Stock Roth IRA Conversions IC-DISC

Tax Legislation Enacted in 2010 2010 HIRE Act Health Care Act Education Jobs Act of 2010 2010 Small Business Act

Other Current Developments Uncertain Tax Position

Reporting Domestic Production Activities

Deduction International Tax Issues


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General

Uncertainty Penalties Information reporting Closing “loopholes” Enforcement

State of the Current Tax Environment

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Pending Legislation on the Congressional Agenda

Estate tax reform Tax extenders Sunset of Bush tax cuts in 2011 Medicare “doc fix” Annual appropriations Other

State of the Current Tax Environment (cont.)

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Pending Tax Legislation – Estate Tax Reform

2010 rules No estate tax Decedents receive a carryover basis in property inherited

2011 rules (current law) 55% tax rate $1 million exemption

Proposals 45%, $3.5 million exemption 35%, $5 million exemption Infinite other variations

Priority Likely last tax item on the agenda


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Pending Tax Legislation – Tax Extenders

Provisions to be extended AMT patch Research and development credit State and local sales tax deduction Shorter depreciation for leasehold and restaurant improvements New markets tax credit Tuition and fees deduction

Proposed revenue raisers Assess self-employment tax on professional S corporations and partnerships Tax carried interest as ordinary income

Proposals Extend most items 1 year Extend most items 2 years Extend “desirable” provisions permanently and let the rest expire

Priority More important than estate tax, less important than Bush tax cuts


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Pending Tax Legislation – Bush Tax Cuts

Provisions expiring Ordinary income, capital gain, and dividend tax rate decreases Personal exemption phase-out elimination Itemized deduction phase-out elimination “Marriage penalty” relief Increased child tax credit, dependent care credit, and adoption credit Increase of §179 immediate fixed asset expensing Employer provided tuition assistance non-taxable

Proposals Permanently extend everything Permanently extend cuts for “middle class” only Extend all tax cuts for 2 years

Priority Top tax priority but behind “doc fix” and appropriations


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Pending Non-Tax Legislation

Medicare “doc fix” 23% fee cut for Medicare service providers Takes effect on December 1, 2010 Proposal exists to extend through the end of 2011

Annual appropriations Government currently operating without a 2011 fiscal year budget Operating on a “Continuing Resolution” expiring on December 3, 2010

Other


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Congressional Calendar

Congress returned to Washington on November 15 Week largely filled with party issues and organizing Congressional

leadership when the new Congress reconvenes in January

Began a one week recess on November 22 for Thanksgiving Lawmakers returned to Washington on November 29

Intended to be beginning of actual work period “Doc fix” and appropriations bill likely taken up first

Lawmakers intended to recess for the year on December 3 Staff have indicated that this is no longer realistic and Congress will stay

in session for an unspecified period


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Expectation on Enactment of Tax Legislation

Scenario 1 (Ideal) All legislation passed before year-end

Scenario 2 (Possible) Extenders and Bush tax cut legislation passed before year-end to allow

for necessary income tax planning

Scenario 3 (Unfortunately Realistic) Some legislation impacting 2010 gets deferred until early 2011

Scenario 4 Who knows


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Maximum Future Tax Rates

2010 2011 ‐CurrentLaw

2011 –ObamaProposal

2013

Maximum marginal income tax rate

35.0% 39.6% 39.6% 43.4%*

Maximum long term capital gain rate

15.0% 20.0% 20.0% 23.8%*

Maximum qualified dividend rate

15.0% 39.6% 20.0% 23.8/43.4%*

C‐Corporation 35.0% 35.0% 35.0% 35.0%

* Includes 3.8% unearned Medicare contribution tax

Tax Planning in the Current Environment

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Considerations in Tax Planning

Traditional planning Accelerate deductions Defer income

Tax planning with looming tax rate increases Accelerate income Defer deductions

Uncertainty Whether the tax rate increases will get postponed or eliminated by

Congress If the tax rates get postponed or eliminated, will it occur prior to the

end of 2010 Even the best planning strategy can be derailed if Congress

retroactively changes the rules Value of planning ideas involving timing can be more valuable

Should think of tax planning as investment opportunity

Tax Planning in the Current Environment (cont.)

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Rate of Return from Accelerating Ordinary Income

Ordinary Income 2010 2011

Taxable Ordinary Income 1,000,000 1,000,000

Tax Rate on Ordinary Income 35.00% 39.60%

Income Tax on Ordinary Income 350,000 396,000

Tax Savings by Accelerating Income 46,000 Investment Made 350,000 Tax-Free IRR from Accelerating Income 13.14%

The return on investment from accelerating the tax on ordinary income is more than 13% Ignores the consideration of state taxes


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Rate of Return from Accelerating Capital Gains

The return on investment from accelerating the tax on capital gain income is more than 33% Ignores the consideration of state taxes

Capital Gain Income 2010 2011

Taxable Capital Gain Income 1,000,000 1,000,000

Tax Rate on Capital Gain Income 15.00% 20.00%

Income Tax on Capital Gain Income 150,000 200,000

Tax Savings by Accelerating Gain 50,000 Investment Made 150,000 Tax-Free IRR from Accelerating Income 33.33%


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Rate of Return from Accelerating Dividend Income

The return on investment from accelerating the tax on capital gain income is 164% Ignores the consideration of state taxes

Dividend Income 2010 2011

Taxable Dividend Income 1,000,000 1,000,000

Tax Rate on Dividend Income 15.00% 39.60%

Income Tax on Dividend Income 150,000 396,000

Tax Savings by Accelerating Income 246,000 Investment Made 150,000 Tax-Free IRR from Accelerating Income 164.00%


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Rate of Return from Accelerating Income


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Accounting Methods – One Year Items

Delay payment of certain liabilities deductible only if paid within 2 ½ or 8 ½ months of year-end Income & property taxes Compensation Retirement plan payments

Delay filing an accounting method change for one time deduction accelerations Prepaid insurance Property taxes Self-insured health insurance accruals Depreciation corrections or cost segregations

Cash method taxpayers can accelerate cash receipts and defer payment of expenses


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Accounting Methods – Multi-Year Items

Depreciation Elect slower depreciation methods Elect longer depreciation periods Elect out of bonus depreciation or §179 expensing

Elect to amortize research and development expenses Advisability of any multi-year planning item must be weighed

against the rate of return provided over that period If cost of capital/opportunity cost is greater than the rate of

return, the planning idea may not be worth the investment Risk of uncertainty of future tax law is magnified when

multiple years are at issue


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Other Tax Planning Ideas

Defer recognition of capital losses If future appreciation potential on various investments are similar,

sell the investment with the lowest basis first

Accelerate recognition of capital gains If the asset is intended on being held for only a relatively short

period of time, selling and rebuying to harvest gain at a lower rate may be advisable

Consider existing capital loss carryforwards

Accelerate payments of dividends from related corporations Defer payments of state and local income taxes, property taxes,

or charitable contributions Consider itemized deduction phase-out that may be reinstated in

2011 as well as AMT implications


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Other Tax Planning Ideas (cont.)

Convert regular retirement accounts to Roth accounts May be even more advantageous if net operating losses exist so

that itemized deductions would otherwise go unused

Elect to carryforward net operating losses instead of carrying back

Alternative Minimum Tax (AMT) There is no proposed increase in AMT rates Increase in regular tax rates will cause a larger gap between

regular tax and AMT which will pull more taxpayers out of AMT Getting pulled out of AMT may allow for increased tax planning

related to AMT limited deductions (e.g., state and local tax deductions) or AMT limited credits (e.g., research and development credit)


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Choosing a Form of Doing Business

Double tax generally makes a C corporation structure more expensive overall (even if tax rates do increase)

The exit strategy from the business is also a critical factor with significant tax consequences

Net present value of all cash flows throughout the life of the business, including on disposition, must be evaluated to determine ideal structure

State taxes can have a significant impact on any analysis


C

Corporation

Flow-

Through

Cost/

(Savings)

2013 Tax Rate

Differential

2010 Tax Rate

Differential

Tax on Operations 340,000 434,000 (94,000) -9.40% -1.00%

Tax on Dividends 157,080 - 157,080 15.71% 9.90%

Total Tax 497,080 434,000 63,080 6.31% 8.90%

Effective Rates 49.71% 43.40% 6.31%

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Choosing a Form of Doing Business (cont.)

Corporation can be beneficial if: Income can be controlled to take advantage of lower tax brackets Dividends can be limited over time

If all shareholders are also employees, cash flow needs can be satisfied with wages instead of dividends

The business is held for a very long period of time The business does not appreciate in value over time Tax attributes such as net operating losses or credit carryovers

already exist The business has significant current cash flow needs so that lower

current tax rates supersede all other considerations


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Choosing a Form of Doing Business (cont.)

There is no single answer for all business The choice must be made on a holistic basis Converting a business from a pass-through entity to a C

corporation, or vice versa, may have its own advantages and disadvantages

Any evaluation involves a significant amount of projections and assumptions which may prove to be inaccurate

Risk of projecting future tax law exists in this area more than others


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Consent Dividends & Bypass Elections

Strategy accelerates dividends into 2010 that would have been paid in a later year

Applies to S corporations that have accumulated earnings from a period when it was taxed as a C corporation A dividend is deemed paid to the shareholder and deemed contributed

back into the S corporation Shareholder taxed on the dividend but receives basis in their stock for

the same amount

Year-end Tax Planning

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Consent Dividends & Bypass Elections (cont.)

Strategy applicable to both situations where tax rates are rising and where tax rates remain the same

Consent dividends are best utilized in the following situations Suspended losses exist

Tax basis or at-risk basis limitations Immediate cash flow needs exist Ownership is shifting to other related parties Shareholder is elderly

Sale of the company may occur in the near future Excess net passive income tax may be assessed at some point in the

near future

Year-end Tax Planning (cont.)

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§1202 Small Business Stock

100% of the gain from the sale of eligible small business stock can be excluded from income Applies only to stock issued between September 27, 2010 and January

1, 2011 Gain excluded from income not subject to AMT

Requirements Issuer of the stock must be a C corporation Stock must be issued for money, property or compensation for services Business must have assets less than $50 million Business cannot be in an ineligible business such as financial services,

farming, professional services, hotel, restaurant and others Stock must be held for at least 5 years to qualify

Excluded gain may not exceed the greater of $10 million or 10 times the original investment in the corporation


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§1202 Small Business Stock (cont.)

While the application of this rule may be limited, there may be opportunities to take advantage of it where it may not otherwise be apparent Form corporations in 2010 with an intent to acquire a qualifying

business at a later date Capitalize new corporations with partnership interests

Business economics may stay the same but new form may eliminate future tax on the sale of the business

May be able to take advantage of lower corporation income tax rates in the meantime

Transfer existing C corporation to a new holding company in a taxable transaction

Have a new C corporation acquire certain assets from related companies

Little guidance exists on these rules so caution is urged with any planning strategy implemented


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Roth IRA Conversions

Certain retirement accounts can be rolled over into Roth IRAs Includes traditional IRAs, nondeductible IRAs, and certain pension and

profit-sharing plans

Beginning in 2010, no income limitations exist to be eligible for rollovers

Rollovers are generally taxable For rollovers occurring in 2010, income from rollover is treated as

follows: Default: Income spread evenly between 2011 and 2012 Election: Income taxed entirely in 2010

Consider impact of future tax rates on when rollovers occur and which income recognition method is selected

Can be a powerful planning technique when NOLs exist from business losses


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Interest Charge Domestic International Sales Corporation (IC-DISC)

Converts ordinary income into qualified dividends Can provide benefits if the ordinary income tax rates are higher than

dividend tax rates Most indications suggest that this will continue to be the case at least

for another 2 years

Benefits based on goods manufactured in the U.S. and exported to foreign countries Benefits can be based on either taxable income or sales from exports Example

$1 million of export sales could result in a $40,000 commission Company would deduct commission at ordinary tax rates Shareholder of IC-DISC records commission income as a dividend Tax rate differential results in an overall $8,000 tax savings in

2010


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Summary of Major Legislation

Hire Incentives to Restore Employment Act (“2010 HIRE Act”) Signed March 18, 2010

Patient Protection and Affordable Care Act & Health Care and Education Reconciliation Act of 2010 (“Health Care Act”) Signed March 23, 2010 and March 30, 2010

Education Jobs and Medicaid Assistance Act (“Education Jobs Act of 2010”) Signed August 18, 2010

Small Business Jobs Act of 2010 (“2010 Small Business Act”) Signed September 27, 2010

14 other tax bills were enacted (so far) that impact 2010 taxes Most provisions in this legislation had only minor impacts on tax law or

major impacts but to very narrow areas

Tax Legislation Enacted in 2010

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2010 HIRE Act

6.2% employer OASID payroll tax abatement Abated for wages earned from March 19, 2010 to December 31, 2010

Maximum benefit of $6,622 per employee hired Applies only to unemployed individuals hired after February 3, 2010

Cannot have been employed for more than 40 hours during the 2 months prior to hiring

Business tax credit for hiring unemployed individuals Credit is the lesser of $1,000 or 6.2% of the employees wages over a

52-week period Applies to same employees described above Only eligible if employee is retained for 52 consecutive weeks

Tax Legislation Enacted in 2010 (cont.)

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2010 HIRE Act (cont.)

Extended increased §179 expensing levels through December 31, 2010 2010 Small Business Act increased this even further

Created a number of new disclosure and withholding requirements for interests in foreign financial assets and foreign entities Rules are very complicated and IRS has yet to provide detailed

guidance on their implementation Penalties for failure to provide required disclosure face stiff penalties

Usually begin at $10,000 but can be significantly larger for some issues

Any taxpayer who holds foreign assets or investments should consult their tax advisor to determine


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Health Care Act

Health Care Act reaches far outside of just tax Visit the following link for several webinars sponsored by Plante &

Moran dedicated to the tax and non-tax implications of this new law http://www.plantemoran.com/perspectives/webinars/Pages/tax-

webinars.aspx

2010 - Small employer health care tax credit Credit equal to 35% of health care costs paid but only if the employer

covers at least half the cost of coverage Employers with less than 10 employees and annual wages of less than

$25,000 may qualify for the full credit Credit phases out for employers with up to 25 employees and up to

$50,000 of annual compensation In many cases, the cost to comply with and calculate the credit may

exceed the credit itself


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Health Care Act (cont.)

2010 – Codified economic substance doctrine Requires transactions to meaningfully change the taxpayer’s economic

position and requires that the taxpayer have a substantial purpose for engaging in the transaction

Federal tax benefits generally do not count 20%-40% strict liability penalty applies if transactions do not meet

requirements

2011 – Reporting of health benefit value on W-2 IRS has optionally deferred this reporting until 2012 (i.e., for benefits

paid in 2012) Questions remain about what is considered health coverage and how

self-insured plan benefits are calculated

2011 – Over the counter drugs no longer eligible for reimbursement from FSA or HSA


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Health Care Act (cont.)

2012 – 1099 reporting requirement Requires businesses to report essentially all payments in excess of $600 to

IRS on form 1099 Applies to payments made in 2012 and later years A significant effort is underway to repeal this provision

2013 – Medicare surcharges Applies if AGI exceeds $200,000 ($250,000 for joint returns) .9% surcharge on earned income 3.8% surcharge on unearned income

Interest, dividends, rents, royalties, capital gains, income from a business that is a passive activity

Does not include tax exempt income or distributions from retirement accounts

2013 – 7.5% floor on itemized medical expense deduction increases to 10% Individuals aged 65 and older will be exempt from this rule until 2018


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Education Jobs Act of 2010

Includes a variety of international tax and foreign tax credit reforms Eliminates foreign tax credit splitting Reduces foreign tax credits on certain foreign asset acquisitions Restricts treaty use to recourse U.S. income as foreign Limits use of foreign tax credits on certain §956 deemed dividends Repeals 80/20 rules and reinstates withholding

Repeals advanced earned income tax credit


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2010 Small Business Act

Extends bonus depreciation into 2010 Increased §179 immediate fixed asset expensing

Applicable to 2010 and 2011 tax years Maximum expense is $500,000 Benefits phase out if asset purchases exceed $2 million Added certain leasehold, restaurant and retail property to the list of

assets eligible to be expenses

S corporation built-in gain tax suspended for 2011 if the S election was made prior to 2007 Previous laws suspended the built-in gains tax in 2009 if the S election

was made prior to 2003 and in 2010 if the S election was made prior to 2004

Eliminates substantiation requirements and depreciation limitations for employer provided cell phones


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2010 Small Business Act (cont.)

Eligible small businesses (or their owners) able to carryback certain 2010 business credits 5 years instead of 1 and those credits may offset AMT An eligible small business must have less than $50 million of average

gross receipts over the prior 3 years

Increases the exclusion from income on gain from the sale of qualified small business stock from 75% to 100% Applies to stock issued between September 27, 2010 and December

31, 2010 Gain also excluded from AMT

Self-employed taxpayers able to deduct cost of health insurance from self employment income for 2010

Eligible taxpayers able to rollover 401(k), 403(b) and 457(b) accounts into Roth versions of those accounts


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Uncertain Tax Position Reporting

Schedule UTP now requires corporations which have recorded FIN 48 liabilities for U.S. federal tax issues on their financial statements to disclose information about those issues on their tax returns For 2010 and 2011, only corporations with $100 million or more of

assets are required to report For 2012 and 2013, asset threshold decreases to $50 million For 2014, asset threshold decreases to $10 million

Generally does not require reporting of recorded FIN 48 issues occurring before 2010

Other Current Developments

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Domestic Production Activities Deduction

Deduction based on a percentage of qualifying income earned from production activities occurring in the U.S.

For 2010, deduction percentage is increased from 6% to 9% Deduction is a Tier 1 issue for the IRS

Issue required to be reviewed when under audit 9% deduction level will likely increase the scrutiny on future audits

Other Current Developments (cont.)

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International Tax Issues

IRS has reorganized its Large & Mid-Size Business Unit (LMSB) and renamed it the Large Business & International Unit (LB&I) Reorganization will result in significantly more personnel being

allocated to auditing international tax issues More audits will have international auditors or specialists assigned

from the beginning IRS is continuing its enforcement of compliance initiatives

Looking for completion of proper disclosures, proper withholding on payments made to foreign persons, proper application of deferral and foreign tax credit rules

Penalties are becoming the norm when issues are encountered whether the issues are intentional or unintentional


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International Tax Issues (cont.)

Report of Foreign Bank and Financial Account (Form 90-22.1 or “FBAR”) Required to be filed by any “person” that holds an interest in a foreign

financial account of greater than $10,000 at any time during the year Person includes business entities as well as individuals and may

require reporting at multiple levels of a “tiered” business structure An interest in an account may include a direct ownership interest or

simply signatory authority over an account May require that CFOs and other financial personnel within a

business file an FBAR even though they do not own an account Penalties for failure to file the report when required can result in

penalties ranging from $10,000 to 50% of the account balance (up to $100,00) and criminal penalties can be assessed


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Q&A


Today’s Presenters

Kurt Piwko, Tax Manager Macomb, [email protected]

Mark Jolley, Tax PartnerAnn Arbor, [email protected]

Michael Petersmark, Tax ManagerEast Lansing, [email protected]



THANK YOU!

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