On February 13, 2018, Highlights of the tax reform were presented by members of the Barnes Dennig Tax team to local manufacturing and distribution business leaders. With over 1,000 pages of tax reform issued to date and additional guidance continuing to be released, it is an exciting time in the world of tax. Tax reform allows for multiple planning and strategic opportunities for the future. The main highlights of the seminar are recapped below, but for a full playback of our seminar please reach out to Barnes Dennig here.
The favorable cost recovery rules allow not only for accelerated deductions for taxpayers, but a broader base of assets that qualify for the accelerated deductions. These rules keep cost segregation studies as an important planning tool to ensure building costs have the proper recovery life for quicker deductions. In addition, a new planning opportunity comes from structuring mergers and acquisition as an asset sale instead of a stock sale for an immediate deduction of the purchased assets.
Domestic Production Activities Deduction:
Most manufacturers benefited from the 9% deduction from the Domestic Production Activities Deduction (DPAD) which has been repealed for tax years beginning after 12/31/2017. While manufacturers structured as C corporations lose DPAD, they will benefit from the 21% corporate tax rate, and manufacturers structured as a pass-through will see DPAD replaced with the new 20% pass-through deduction.
20% Pass-Through Deduction:
The 20% pass-through deduction is a 20% deduction of qualified business income for individuals for tax years 2018-2025. The deduction is reported by the owners on their individual returns against taxable income not adjusted gross income. The 20% pass-through deduction is subject to wage, property and taxable income limitations. An overview of the calculation is presented below:
The new deduction and its limitations generate planning opportunities to maximize the 20% pass-through deduction, but the IRS has already issued guidance to ensure the planning is not abusive. Items to consider during planning:
- Awareness of potential deduction limitations and how to avoid them
- Consideration of reasonable compensation
- Potential for combining business entities
S Corporation Conversion to C Corporation:
With the lower tax rate for C Corporations and potential limitations to the 20% pass through deduction, a common question is should I convert to a C Corporation? Every situation could result in a different answer so it is important to consider the following:
- Potential tax liability upon conversion
- Negative capital accounts, assets with built-in gains, hot assets
- Suspended/deferred losses
- Termination of QSUBS
- Individual tax situation of each owner
- Whether owners typically take large distributions or leave majority of cash in the business year over year
- Long term plan of the owners
- Sunset of 20% pass-through deduction in 2025
- International operations
International tax provisions received some of the largest overhauls with tax reform. The U.S. is shifting from taxing on a worldwide basis to an exemption system. It is important to consider how the international tax provisions would be impacted when considering tax planning. New provisions that would need to be considered are as follows:
- Transition tax being required by 10% direct and indirect shareholders on previously untaxed post-1986 earnings.
- Global intangible low-taxed income (“GILTI”) being included in the gross income of U.S. shareholder of CFCs.
- Base erosion and anti-abuse tax (“BEAT”) imposing a minimum tax on certain deductible payments made to a foreign affiliate.
- Foreign derived intangible income (“FDII”) can be deducted for C corporations.
Each tax situation is different resulting in different outcomes of how to minimize tax due to tax reform. In addition, the answer could change as additional guidance is issued by the IRS. Barnes Dennig is here to help assess your specific tax situation. For additional guidance please contact us here or call 513-241-8313.