© Grant Thornton LLP. All rights reserved. 1. Tax Planning While Waiting for Tax Reform Mel SchwarzBarbara Koosa Ryan PartnerPartner Washington National

© Grant Thornton LLP. All rights reserved. 1

© Grant Thornton LLP. All rights reserved.

Tax Planning While Waiting for Tax Reform

Mel Schwarz Barbara Koosa RyanPartner PartnerWashington National Tax Office Columbia, [email protected] [email protected]


Where is Tax Reform Anyway?



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


Why everyone was talking tax reformCamp corporate rate cut

Proposed change in corporate rate

Income Current Proposed

$0 + 15%

25%

$50,000+ 25%

$75,000+ 34%

$100,000+ 39%

$335,000+ 34%

$10 million+ 35%

$15 million+ 38%

$18.3 million+ 35%

Phased in:• 2015: 33%• 2016: 31%• 2017: 29%• 2018: 27%• 2019: 25%

AMT repealed


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.


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


Camp Discussion DraftBusiness Proposals

Repeal Accelerated Depreciation

Trailers (00.27) Tractor Units (00.26) Motor Freight (42.0)

Year Current Camp Current Camp Current Camp

1 200 98 333 140 200 78

2 320 195 444 276 320 153

3 192 190 148 269 192 149

4 115 184 74 261 115 146

5 115 179 54 115 142

6 58 154 58 138

7 134

8 60

9

Depreciation deduction per $1,000 of basis

assumes 3% annual inflation rate


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 $10 m. gross receipts• Like-kind exchange repealed• Limits on deductible retirement contributions


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



Proposed changes in individual tax rates

Single Joint Current Proposed

$0+ $0+ 10%10%

$9,075+ $18,150+ 15%

$36,900+ $73,800+ 25%

25%*$89,350+ $148,850+ 28%

$186,350+ $226,850+ 33%

$405,101+ $405,101+ 35%

$406,750+ $457,600+ 39.6% 25% + 10% surtax**

Top dividend and cap gains rate 20% 21% effective rate****The starting point for the 25% bracket would be reduced slightly**Surtax would apply to certain income beyond taxable income***Cap gains & dividends are ordinary income with 40% exclusion (does not include NII tax)

Individual proposalsRates in Camp discussion draft


Individual proposalsCamp 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


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










Map by 270towin.com

Senate Races in 2014


Senate Outlook based on Current Polls

Map by 270towin.com



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 at the First Lutheran Church, Ottawa, Kansas, April 21, 2014.



• 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



Combined Corporate Income Tax Rate

Combined Corporate Income Tax Rate(Includes State and Local)

United States39%

OECD Average25%



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


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



• 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



• Depreciation and cost segregation

• Be prepared to exploit expired provisions if/when they are extended


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


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


Extenders – House ActionVeto threat if cost not offset

Ways and Means Permanent Provisions Approved 4/29

Status Cost*

Research credit Passed House $155.5 billion

Active financing exception $58.8 billion

CFC look-through rule $20.3 billion

Reduced 5-year holding period for BIG tax after C Corp election to S Corp

Vote on 6/12 $1.5 billion

Limitation in basis reduction of gifts of S Corp stock to charity

Vote on 6/12 $700 million

179 expensing Vote on 6/12 $73.1 billion

Total $310.5 billion

* 10-year cost estimated by Joint Committee on Taxation


The Retroactive Extension Tradition



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


Minimize Impact of Obamacare Taxes:

Net Investment Income Tax


What is the net investment income tax?

• New 3.8% tax on net 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


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


What is Net Investment Income?

Three separate buckets of income:

1. Rents, royalties, dividends, interest, annuities– Unless derived in ordinary course of non-passive

trade or business (can't be trading financials)

2. Any other income from passive trade or business– Plus income from trading business

3. Capital gain – Unless held in non-passive trade or business


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


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)


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


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



Material participation

Meet 1 of 7 material participation tests

1. More than 500 hours participation

2. Substantially all of the participation

3. More than 100 hours if no one has more

4. Significant participation activities

5. Material participation 5 of past 10 years

6. Material participation in personal service activity in any of 3 prior years

7. Facts and circumstances


Pass-through businessesWhat is a passive activity?

Material participation

Meet 1 of 3 material participation tests if limited partner:

1. More than 500 hours participation

2. Substantially all of the participation

3. More than 100 hours if no one has more

4. Significant participation activities

5. Material participation 5 of past 10 years

6. Material participation in personal service activity in any of 3 prior years

7. Facts and circumstances



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



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


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


Pass-through businesses Special exception for self-charged interest

• Interest income from a loan to a pass-through business in which you materially participate:– Can exclude this self-charged interest up to your

allocable share of the interest deduction (as long as interest deduction is not taken against SE income)


Pass-through income:Can you avoid both NII and SE tax?

Net investment income §1411 tax

Self-employment income§1402 tax

Sweet spot?

S corporation:Non-salary

Partnership:Active limited partner?


Dispositions of business interestsReproposed regulations

• Calculation of gain/loss includable in NII:– Gain = lesser of gain on sale of interest or allocable

share of net gain from a deemed sale of property– Similar rule when a transferor recognizes a loss– Use valuation rules under § 1.469-2T(e)(2)):

• Valuation on activity-by-activity basis, rather than property-by-property basis

• Allocate disposition gains/losses among activities in accordance with § 1.469-2T(e)(3) (other than 1.469-2T(e)(3)(iii))


Dispositions of business interestsOptional simplified method

• Optional simplified method for calculating gain/loss– General aim: When gain from passive assets

owned by the pass-through is likely to be small– Intended to limit information-sharing burden on

pass-throughs by allowing transferors to rely on readily available information

– Generally allows taxpayers to assign gain from a disposition to NII in the same proportion as historic pass-through distributive shares have been NII



• Generally eligible if:– $250,000 or less in gain from sale or– $5 million or less in gain from sale and 5% or less of

separately stated income/gain/loss/deduction in NII calculations in sale year & the two previous years



• Method not available where:– Interest held for less than 12 months– Certain distributions and contributions during

holding period– Significantly modified composition of assets– Recent conversion from C to S corporation– Partial disposition (five listed situations)


Net Investment Income TaxWhat Does It All Mean?

• Managing NII– C corporations can defer, but not eliminate exposure

• Tax triggered by dividend payment – Pass throughs

• Can avoid the tax for active owners• Must pay currently for passive owners


Questions?


Tax Professional Standards Statement

This presentation supports Grant Thornton LLP’s marketing of professional services, and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document we encourage you to contact us or an independent tax advisor to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from Disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this document is not intended by Grant Thornton to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.


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© Grant Thornton LLP. All rights reserved. 1. Tax Planning While Waiting for Tax Reform Mel SchwarzBarbara Koosa Ryan PartnerPartner Washington National