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Business Law and Practice Section MCLE Meeting Attorney Resource Center
November 12, 2019
11:45 AM – Noon Welcome/Introductions
Markus May, Business Law and Practice Section Chair
Noon – 1:00 PM Choice of Entity for Business Owners in Light of the New Tax Act
Susan Penno, CPA – Sassetti LLC
Speaker’s Bio
Susan Penno is a tax Partner at Sassetti LLC. She began her career
at Price Waterhouse Coopers and her experience is concentrated on
accounting solutions for the private sector. She returned to public
accounting at Sassetti after spending time with a large public
company, holding progressive roles in their finance group and with
a small private company as their CFO. Susan is a trusted business
and tax advisor for privately held companies, entrepreneurs, trust
and estate administrators, and high net worth individuals. Susan’s
public and private sector experience gives her invaluable insight to
help clients through mergers and acquisitions, exit and succession
planning, and client accounting services.
Choice of entity is among the most important decisions business
owners can make when doing business. Whether just starting up,
in the growth phase or planning for succession, the new tax law has
brought many new tax planning considerations as to what choice of
entity business owners should be considering. Join us on
November 12th for the highlights of this new tax law and to have a
general understanding of when you should raise the question of
which entity choice is best with your clients and their CPA’s.
Next Meeting: 12/10/2019 – Employment Agreements: Issue-Spotting & Key
Provisions – Ross Molho, Clingen Callow & McLean, LLC
DCBA Events: November 21st – Lawyers Lending a Hand Annual Coat Drive
Sorting – Bar Center Classroom
November 21st – DCBA Unwind – Lynfred Winery, Roselle
December 12th – DCBA/DAWL/Justinians Inaugural Grand
Holiday Gala - Harry Caray’s, Lombard
Earn CLE Online!
DCBA OnDemand CLE is Now Powered by IICLE The Illinois Institute for Continuing Legal
Education (IICLE®) and the DuPage County Bar Association (DCBA) are excited to offer a new
IICLE®Share collaboration to provide DCBA members a high quality and reliable online
learning experience. Members can find the link to The Illinois Institute for Continuing Legal
Education (IICLE) on the DCBA website under “Legal Community”→OnDemand CLE
→Online CLE Catalog. You must be logged into your DCBA Membership Profile in order to
view courses for free or at a reduced price.
View & Print All CLE Certificates through the DCBA Website:
Manage Profile -> Professional Development (under content & features) and choose the icon to
the left of each meeting to print your certificate directly or choose to have them emailed to you
to save to your computer (you MUST be logged in to view this feature)
1
Business Law Section Council – CASELAW UPDATE – November 2019
900 North Rush LLC and LP Holdings HSR I, LLC v. Intermix Holdco, Inc., 2019 IL App (1st) 181914
(Opinion Filed August 26, 2019)
HOLDING: The Appellate Court affirmed the underlying summary judgment granted in favor of
the defendant, a tenant under a commercial lease, in an eviction proceeding, but slightly modified the
grant of attorneys’ fees to the defendant, reducing the $125,832 in attorneys’ fees awarded by
$9.904.17.
The defendant was occupying a commercial retail space under a long-term lease with a 5-year option and
intended to exercise the option to remain in the space for another 5 years. An attorney from the legal
department for Gap, the defendant’s corporate parent, timely wrote a letter to the original landlord’s
successor-in-interest, the plaintiff, seeking to extend the lease. Unfortunately, the signature block in the
letter exercising the option referenced a sister-company, Old Navy, and not the tenant’s name. The Plaintiff
filed suit seeking an eviction and the recovery of holdover rent, contending that the option to renew was
not properly exercised by the party to the lease. The defendant filed an affirmative defense that the lease
option had been exercised, extending the term of the lease. The defendant also filed a motion for summary
judgment. The trial court granted the motion for summary judgment, finding that the lease did not specify
who had to give the notice of the exercise of the option for the tenant. Once the trial court granted the
defendant’s motion for summary judgment, the defendant filed a fee petition and was awarded $125,832 in
attorneys’ fees as well.
The appellate court noted that a commercial tenant wishing to extend or cancel a lease pursuant to an option
must strictly comply with the terms of the option. However, the appellate court noted that, when read as a
whole, the attempt to exercise the option by the member of the Gap’s legal department was properly
construed as an exercise of the option by the defendant (despite the Old Navy signature block) as it was in
writing, was timely, referenced the lease in question and the actual parties to that lease and was written by
someone who had authority to act for the tenant. Significantly, the Old Navy signature block was found to
be immaterial to the exercise of the option as the plaintiff admitted that he knew that the defendant was
trying to exercise its option, but simply made a mistake in the signature block.
With respect to the petition for attorneys’ fees and costs, over the plaintiff’s argument that the fees and
costs were unreasonably large, the appellate court generally approved the award of attorneys’ fees and costs
to the defendant, including fees incurred for both Illinois and California counsel. The appellate court did
modify the amount awarded slightly by: a) eliminating the grant of fees that were not sufficiently described
in the supporting bills, and b) reducing the costs awarded as airfare and hotel charges are not recoverable
costs.
Submitted by: Desmond Curran, a partner with Sullivan Hincks & Conway in Oak Brook
2
Business Law Committee - Links for Committee Members
LinkedIn Group for Business Law Committee – DuPage County (IL) Bar Association
https://www.linkedin.com/groups/12013153
LinkedIn Group for DuPage County Bar Association
https://www.linkedin.com/groups/849357
Online Demand CLE on DCBA
http://www.dcba.org/ then log in.
From logged in on home page, go to bottom center of page beige bar to “Quick Links”. Then click on “On
Demand CLE”., which brings you to this page:
https://dcba.site-ym.com/?page=Online
Then go to “Click Here to Launch the DCBA Catalog”:
Which brings you to the IICLE Page at:
https://www.iicle.com/dcba?affiliateid=4&pagesize=12
Illinois Institute for Continuing Legal Education (IICLE) and the DCBA
https://c.ymcdn.com/sites/dcba.site-
ym.com/resource/resmgr/mcle_seminars/How_to_Access_OnDemand_CLE.pdf
Choice of Entity for Business
Owners in Light of the New Tax
ActBy Susan Penno, CPA
November 12, 2019
Susan Penno, CPA 630-577-9074, ext 309
Choice of Entity ConsiderationsAgenda
§ Introduction
§ Review of Choice of Entity Tax Considerations before new tax law
§ Tax Reductions for Corporate Entities
§ Tax Reductions for Pass-Through Rates
§ New Tax Law Choice of Entity Financial Example
§ C to S-corp conversion considerations
§ Incorporation and liquidation considerations
§ Final questions and answers
Choice of Entity ConsiderationsIntroduction
§ Choice of entity is one of the most important decisions taxpayers can make when
doing business.
§ The following entities are considered by business owners based on a number of
factors both before and after the new tax law.
§ Sole Proprietorships/Disregarded Entities
§ Partnerships
§ S corporations
§ C corporations
§ Changing entity classification may carry an immediate tax burden but future tax
reductions may offset the cost of conversion.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsConsiderations prior to the new tax law
• Partnerships:
§ No federal tax paid by the partnership
§ Net taxable income passed through to the owner and taxed at their
marginal rates
§ Partners are taxed on partnership earnings whether or not they receive any
distributions
§ Cash to partners via non-taxable distributions
§ For closely held partners who materially participate in the business,
partnership earnings are subject to self employment tax on their personal
return.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsConsiderations prior to the new tax law
• S-Corporations:
§ No federal tax paid by the s-corporation
§ Net taxable income passed through to the owner and taxed at their
marginal rates
§ Owners are taxed on S-corporation earnings whether or not they receive any
distributions
§ Cash to owners via salary and non-taxable distributions
§ Requirement for > 5% owners to be paid a reasonable wage.
§ Taxation on net s-corporation earnings is not subject to self employment
taxes in the owner’s personal return.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsConsiderations prior to the new tax law
• Corporations:
§ Graduated marginal tax rates ranging from 0% - 38%
§ Cash to owners via salary or dividends
§ Double taxation of dividend at preferred tax rates
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsConsiderations prior to the new tax law
• Client choice of entity talking points before Jan 1, 2018
§ How quickly they have a personal need for the business excess cash or will it
be reinvesting it in the business
§ Projected profit or loss
§ Personal versus corporate marginal tax rates
§ Impact of dividend double taxation
§ Self employment taxes – reasonable s-corporation wage versus partnership
self employment earnings
§ Check with your lawyer for their preference
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsNew Tax Law
• Why does the new tax law affect choice of entity decisions?
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsNew Tax Law
• Why does the new tax law affect choice of entity considerations?
§ Change in marginal tax rates
§ for corporations and individuals
§ The much talked about Sec 199a Qualified Business Income Deduction
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsRate Reduction for Corporate Entities
§ The 35% tax rate for C corporations would is permanently reduced by forty percent to
a flat rate of 21%.
§ After adding the highest dividend rate of 20%, the total tax paid at both the corporate and individual
levels under these tax rates is lower than the top individual tax rate of 37%.
§ Although other taxes could impact the ultimate effective tax rate (e.g., 3.8% net
investment income tax ), the rate drop from 35 to 21% is certain to increase the
popularity of C corporations for all types of taxpayers.
§ Taxpayers who would prefer to defer income to a future year that better aligns with their tax posture
and financial needs.
§ Accumulated earnings tax and personal holding company tax should be considered although business
judgement rule generally applies for respecting accumulated cash needs.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsRate Reduction for Corporate Entities
§ Other new tax law factors that could impact the effective corporate rate include:
§ Interest deductions up to 30% of adjusted taxable income,
§ Section 168(k) 100% expensing/bonus depreciation for certain capital investments for five years
followed by a four year phase-out, and
§ indefinite net operating loss carryforwards (limited to 80% of taxable income per year).
§ C corporations no longer need to consider the corporate alternative minimum tax,
which is repealed under the conference agreement.
§ Companies should consider whether deferral or regular dividend distributions
provide the most benefit to their owners.
§ Companies must consider their expectations for capital investments that would
provide for full-expensing.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsRate Reductions for Partnerships and S-corporation Entities
§ Individual marginal tax rates reduced from 39.6% to 37%.
§ Marginal tax brackets “widened”.
§ New qualified business deduction of 20% on business earnings (not quite this
simple).
§ Elimination of personal AMT
§ Other new tax law factors that could impact the effective pass thru business tax rate
include:
§ Interest deductions up to 30% of adjusted taxable income,
§ Section 168(k) 100% expensing/bonus depreciation for certain capital investments for five years
followed by a four year phase-out, and
§ indefinite net operating loss carryforwards (limited to 80% of taxable income per year on 1040).
§ Companies must consider their expectations for capital investments that would
provide for full-expensing.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsNew tax rates overview
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Prior Tax Law
C Corporation Shareholder Corp Rate (0 - 38%) + Dividend (15/20%) + NII
Rate (3.8)
Partner/S Corp SH Ind. Rate (39.6) + NII Rate (3.8%)
New Tax Law
C Corporation Shareholder Corp Rate (21%) + Dividend (15/20%) + NII Rate
(3.8)
Partner/S Corp SH with no QBI Ind. Rate (37) + NII Rate (3.8%)
Partner/S Corp SH with QBI 199A Deduction (20%); Individual (37%) + NIIT
(3.8)
Choice of Entity ConsiderationsMuch talked about Sec 199a Qualified Business Income Deduction
§ Section 199A provides a deduction of up to 20% of “qualified business income”
generated through any business that is not a traditional C-corporation.
§ The Section 199A deduction can reduce a business owner’s personal effective highest
maximum rate on their business income to 29.6% (down from the highest statutory
rate of 37%)
§ Business specific factors will impact the ultimate effective tax rate borne by individual
owners, e.g., active vs. passive, personal taxable income, etc.
§ The impact of the Sec 199a deduction on choice of entity decisions requires careful
analysis and application of entirely new terms & concepts. Ask your clients to
consult with their CPA’s.
§ The devil is in the details because there are significant limitations that may result in
the inability to achieve the reduced 29.6% tax rate.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsMuch talked about Sec 199a Qualified Business Income Deduction
§ Overview of some of the limitations:
§ If the business owner’s taxable income is < $315,000. There are no
limitations.
§ If their income is > $315,000 , the 20% deduction could be subject to
limitations depending on the wages and invested assets in the business.
§ If a service business (specifically defined in the new tax law), then the 20%
is subject to phase out for taxable income between $315,000 and $415,000.
ZERO deduction if the owner’s taxable income is > $415,000.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsSpecified Service Businesses
§ What service businesses are designated as “specified service businesses” (SSB)?
§ Health care professionals
§ Accounting
§ Actuarial science
§ Performing arts
§ Athletics
§ Consulting
§ Financial and Brokerage Services
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsSpecified Service Businesses
§ What service businesses are designated as “specified service businesses” (SSB)?
§ And Legal
§ Eighteen months later there is lots of detailed clarity on subsets of businesses
that might appear to be an SSB, but are not per the new tax law.
§ Don’t presume that just because your client is an SSB they shouldn’t review
choice of entity decisions under the new tax law.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsPotential Cost vs. Benefit of Incorporating
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Example – Income & Basis Assumptions
Income from Operations $5,000,000
Disposition Proceeds* $50,000,000
Partner’s Outside Basis** $0
Shareholder’s Basis in Stock $0
* Disposition proceeds increased to the extent of undistributed earnings
** Partner’s outside basis is increased for distributive share of earnings and reduced by cash
distributions
Choice of Entity ConsiderationsPotential Cost vs. Benefit of IncorporatingExample: Effective Tax Rate Assumptions
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Effective Tax Rate – Income from Operations Pass-Thru Entity (Active) Pass-Thru Entity (Passive) Corporate Entity
Federal Income Tax Rate* 37.0% 37.0% 21.0%
State Income Tax Rate 6.0% 6.0% 4.7%
Self-Employment/NII Tax Rate 3.6% 3.8% 0.0%
Tax on Income from Operations 46.6% 46.8% 25.7%
Effective Tax Rate – Distributions Pass-Thru Entity (Active) Pass-Thru Entity (Passive) Corporate Shareholder
Federal Income Tax Rate 0.0% 0.0% 20.0%
State Income Tax Rate 0.0% 0.0% 6.0%
Net Investment Income Tax 0.0% 0.0% 3.8%
Total Tax on Distributions 0.0% 0.0% 29.8%
Effective Tax Rate – Entity Disposition Pass-Thru Entity (Active) Pass-Thru Entity (Passive) Corporate Shareholder
Federal Income Tax Rate 20.0% 20.0% 20.0%
State Income Tax Rate 6.0% 6.0% 6.0%
Net Investment Income Tax Rate 0.0% 3.8% 3.8%
26.0% 29.8% 29.8%
* Pass-thru rate is presented at the highest statutory rate. This rate may be effectively reduced to 29.6% with respect to qualified business income eligible for the 20%
Section 199A deduction.
Choice of Entity ConsiderationsPotential Cost vs. Benefit of Incorporating
After Tax Cash Consequences – No Distributions
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Cash Management Active Partner
(no 199A)
Active Partner
(w/ 199A)
Passive Partner
(no 199A)
Passive Partner
(w/ 199A)
Corporate Entity
Cash from Operations $5,000 $5,000 $5,000 $5,000 $5,000
Entity-level Tax -0- -0- -0- -0- (1,287)
Owner-level Tax (2,330) (1,864) (2,340) (1,872) -0-
Cash Retained $2,670 $3,136 $2,660 $3,128 $3,713
Cash from Disposition 50,000 50,000 50,000 50,000 50,000
Subtotal $52,670 $53,136 $52,660 $53,128 $53,713
Owner-level Tax (13,000) (13,000) (14,900) (14,900) (16,006)
Net Cash to Owner $39,670 $40,136 $37,760 $38,228 $37,707
Choice of Entity ConsiderationsPotential Cost vs. Benefit of Incorporating
After Tax Cash Consequences – Annual Distributions
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Cash Management Active Partner
(no 199A)
Active Partner
(w/ 199A)
Passive Partner
(no 199A)
Passive Partner
(w/ 199A)
Corporate Entity
Cash from Operations $5,000 $5,000 $5,000 $5,000 $5,000
Entity-level Tax -0- -0- -0- -0- (1,287)
Owner-level Tax (2,330) (1,864) (2,340) (1,872) (1,106)
Cash Distributed $2,670 $3,136 $2,660 $3,128 $2,607
Cash from Disposition 50,000 50,000 50,000 50,000 50,000
Subtotal $52,670 $53,136 $52,660 $53,128 $52,607
Owner-level Tax (13,000) (13,000) (14,900) (14,900) (14,900)
Net Cash to Owner $39,670 $40,136 $37,760 $38,228 $37,707
Choice of Entity ConsiderationsPotential Cost vs. Benefit of Incorporating
After Tax Cash Consequences
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
After-Tax Cash
(No Distributions)
Active Partner
(no 199A)
Active Partner
(w/ 199A)
Passive Partner
(no 199A)
Passive Partner
(w/ 199A)
Corporate Entity
Cash from Operations $0 $0 $0 $0 $0
Cash on Disposition 39,670 40,136 37,760 38,228 37,707
Total Cash Received $39,670 $40,136 $37,760 $38,228 $37,707
After-Tax Cash
(Full Distributions)
Active Partner
(no 199A)
Active Partner
(w/ 199A)
Passive Partner
(no 199A)
Passive Partner
(w/ 199A)
Corporate Entity
Cash from Operations $2,670 $3,136 $2,660 $3,128 $2,607
Cash on Disposition 37,000 37,000 35,100 35,100 35,100
Total Cash Received $39,670 $40,136 $37,760 $38,228 $37,707
Choice of Entity ConsiderationsConsiderations after the new tax law
• Client choice of entity talking points after Jan 1, 2018
§ How quickly they have a personal need for the business excess cash or will
it be reinvesting it in the business
§ Projected profit or loss
§ Personal versus corporate marginal tax rates
§ Impact of dividend double taxation
§ Self employment taxes – reasonable s-corporation wage versus partnership
self employment earnings
§ Check with your lawyer for their preference
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsC to S-corp conversions
§ So your client decides it make sense to convert from a C-corp to an S-corp - what
next?
§ Make sure they meet the rules to be an s-corporation:
§ S corporations limitations include the 100 shareholder limit.
§ Note that now a nonresident alien individual may now be in indirect shareholder of an S
corporation as a potential current beneficiary of an electing small business trust.
§ One class of stock.
§ C-to-S conversions are generally tax-free subject to certain limits.
§ Section 1374 built-in-gain tax with 5-year holding period.
§ Section 1375 sting tax for those with E&P and significant passive income for three years.
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsOther factors when considering incorporating
§ Preference for S corporation rules (e.g., SE Tax)
§ Entity structure simplification
§ Potential reduction in overall tax liability
§ Facilitate a transaction including an IPO or formation of a REIT or RIC
§ Tax administration complexity or simplification
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity ConsiderationsOther incorporation and liquidation considerations
§ For client’s who are in the start up phase:
§ Cash flow need in the business
§ Projections for profitability versus loss
§ For client’s who are planning for liquidation/succession:
§ Cash flow need in the business – more likely to want to get their cash out prior to
liquidation irrespective of new tax law impact
§ S-corporation conversations have a 5 year time line or built in gains are realized
§ Who will they sell to? What is the easiest entity form to facilitate the sale
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Choice of Entity Considerations
Questions?
Oak Park: (708) 386-1433 | Naperville: (630) 577-9074 www.sassetti.com
Thank You!