Corporate Tax Update

Corporate Tax UpdateBy Leo Parmegiani

Executive Tax Forum - November 7, 2013

Federal Corporate Tax Environment

• Surprisingly less aggressive• Tax incentives for purchasing capital items exist but

expiring• New regulations on capitalization contain helpful safe

harbors and de minimis tests• Tax rates have been stable for years (some

discussions)

Executive Tax Forum - November 7, 2013 2

Top Brackets Net Investment Earned Income Income Individuals

Income tax ratePlus: Tax on Net Investment IncomePlus: Tax on Earned Income

Top Bracket on Earned Income 40.5%Top Bracket on Net Investment Income 43.4% Capital Gain Rate 20%Qualified Dividend Rate 20%

Individuals who own flow through entities such as Partnerships, LLCs and S Corporations would pay marginal tax at these rates (assuming they are in the highest tax brackets).


39.6% 39.6% 3.8% __ .9%

43.4% 40.5%

Tax Rates


Corporate Tax RatesTaxable income over- But not over- The tax is: Of the amount over-

0 $50,000 15% 0

$50,000 75,000 $7,500 + 25% $50,000

75,000 100,000 13,750 + 34% 75,000

100,000 335,000 22,250 + 39% 100,000

335,000 10,000,000 113,900 + 34%

335,000 Flat 34%

10,000,000 15,000,000 3,400,000 + 35% 10,000,000

15,000,000 18,333,333 5,150,000 + 38% 15,000,000

18,333,333 35% 0 Flat 35%

Some discussions in Congress (potentially bipartisan) to reduce the highest rate to 25 percent - to be competitive with many countries around the world.

What Entity Should You Choose?As usual under the tax law the answer is “it Depends!”

Choices:• C Corporation• S Corporation• Partnership• Limited Liability Company (taxed as a sole proprietorship)

New Taxes and Increased Individual Tax Rates do not settle the issue

Many factors to consider including:• State and local tax impact• Benefit plans• Reasonable compensation rules• Cash flow available to pay salaries


Entity Comparisons


USING C CORPORATION WITH NO SALARY(All scenarios assume married filing jointly)

TAXABLE INCOME

TAX RATE TAX

C CORP INCOME$

500,000

CORPORATE TAX 500,000 34% $ 170,000

DIVIDEND ($500,000 - 170,000) 330,000 15% 49,500

HIGH INCOME ADDIT MED. TAX ($330,000 - 250,000) $ 80,000 3.8% 3,040

OVERALL TAX USING C CORP WITH NO SALARY

$ 222,540

Entity Comparisons


USING C CORPORATION WITH SALARY OF $300,000

TAXABLE INCOME TAX RATE TAX

C CORP INCOME $200,000

SALARY 300,000

CORPORATE TAX 200,000 30.625% $ 61,250

DIVIDEND ($200,000 - 61,250) 138,750 15% 20,813

SOCIAL SECURITY TAX 113,700 12.40% 14,099

MEDICARE TAX 300,000 2.90% 8,700

HIGH INCOME ADDIT MED TAX ON DIVIDEND

(LESSER OF AGI OR DIVIDEND) 138,750 3.8% 5,273

HIGH INCOME ADDIT MED TAX ON WAGES ($300,000 - 250,000) 50,000 0.9% 450

INDIVIDUAL TAX 300,000 25.9% 77,726

OVERALL TAX USING C CORP WITH SALARY OF $300,000 $ 188,310


Entity ComparisonsUSING C CORPORATION WITH SALARY OF $400,000


C CORP INCOME $ 100,000

SALARY 400,000

CORPORATE TAX 100,000 22.250% $ 22,250

DIVIDEND ($100,000 - 22,250) 77,750 15% 11,663


MEDICARE TAX 400,000 2.90% 11,600

HIGH INCOME ADDIT MED TAX ON DIVIDEND

(LESSER OF AGI OR DIVIDEND) 77,750 3.8% 2,955

HIGH INCOME ADDIT MED TAX ON WAGES ($400,000 - 250,000) 150,000 0.9% 1,350

INDIVIDUAL TAX $ 400,000 27.09% 108,347



Entity ComparisonsUSING C CORPORATION WITH SALARY OF $500,000

TAXABLE INCOME

TAX RATE TAX

C CORP INCOME $ 0

SALARY 500,000

CORPORATE TAX 0 0% $ 0


MEDICARE TAX 500,000 2.90% 14,500


INDIVIDUAL TAX$

500,000 29.13% 145,646



USING LIMITED LIABILITY COMPANY - NO SALARY OPTION


LLC INCOME $ 500,000

SELF EMPLOYMENT TAXABLE INCOME ( .9235) 461,750

SOCIAL SECURITY TAX 113,700 12.4% $ 14,099

MEDICARE TAX 461,750 2.9% 13,391

HIGH INCOME ADDIT MED TAX ($461,750 - 250,000) 211,750 0.9% 1,906

FEDERAL TAX ($500,000 - .5 ($14,099+13,391) $ 486,255 28.8% 140,203

OVERALL TAX USING LLC WITH NO SALARY $ 169,599

Entity Comparisons

Entity ComparisonsUSING S CORPORATION WITH SALARY OF $300,000


S CORP INCOME $ 200,000

SALARY 300,000

SOCIAL SECURITY TAX 113,700 12.40% $ 14,099

MEDICARE TAX 300,000 2.90% 8,700

HIGH INCOME ADDIT MED TAX ON WAGES ($300,000 - 250,000) 50,000 0.9% 450

INDIVIDUAL TAX $ 500,000 29.13% 145,646

OVERALL TAX USING S CORP WITH SALARY OF $300,000 $ 168,895


USING S CORPORATION WITH SALARY OF $400,000


S CORP INCOME $ 100,000

SALARY 400,000


MEDICARE TAX 400,000 2.90% 11,600


INDIVIDUAL TAX $ 500,000 29.13% 145,646

OVERALL TAX USING S CORP WITH SALARY OF $400,000 $ 172,695


Entity Comparisons

USING S CORPORATION WITH SALARY OF $500,000

TAXABLE INCOME

TAX RATE TAX

S CORP INCOME $ 0

SALARY 500,000


MEDICARE TAX 500,000 2.90% 14,500 HIGH INCOME ADDIT MED TAX ON WAGES ($500,000 - 250,000) 250,000 0.9% 2,250

INDIVIDUAL TAX$

500,000 29.13% 145,646

OVERALL TAX USING S CORP WITH SALARY OF $500,000 176,495


Entity Comparisons

2013 Year-End Business Tax Planning

• Generous tax deductions have been available for the purchase of capital assets such as machinery, equipment, furniture and fixtures and in some cases even real estate improvements.

• Taxpayers have been able to write-off from 50% - 100% of acquisition costs under the bonus depreciation rules and up to $500,000 under the Section 179 expensing law.

• These benefits are available through the end the 2013. A significant drop-off in benefits is slated for the new year unless Congress acts to extend into 2014.

Takeaway – Immediate action may be required.Accelerate Purchases to 2013!!Caution – Taxpayer who has expiring NOL carryforwards


Section 179 - Expensing limits for 2013

• For tax years beginning in 2013: (1) Dollar limitation on the expensing deduction is $500,000; and (2) Investment-based reduction dollar limitation starts to take effect when property placed in service in the tax year exceeds $2,000,000 (investment ceiling).

• Under current limits, deduction phases out completely when eligible property exceeds $2,500,000 ($2,000,000 (investment ceiling) + $500,000 (dollar limit)).

• For tax years beginning after 2013, maximum expensing limit is scheduled to drop to $25,000, and investment ceiling is scheduled to drop to $200,000.


Section 179 Phaseout Example

• ABC Corp is a calendar-year taxpayer. In 2013, it buys and places in service $2,300,000 of expensing-eligible 5-year MACRS property.

• ABC may only expense $200,000 of its 2013 purchases [$500,000 expensing limit − ($2,300,000 purchases − $2,000,000 beginning-of-phaseout amount)] and must depreciate the balance of its purchases over its normal recovery period.


Section 179 Planning• Consider expensing election even where a less-than-full tax benefit is

available because of limitations. This way, the right to carry the expensing deduction forward to other years will be preserved.

• As a general rule, a taxpayer should make the expensing election for eligible property with the longest recovery period.


Example: In 2013, XYZ, a calendar-year taxpayer, buys and places in service $500,000 of new 5-year MACRS property and $500,000 of new 7-year MACRS property. It doesn't purchase other property during the year. If it elects to expense the 7-year property, XYZ can write off the balance of its purchases over the 5-year MACRS recovery period. By contrast, if it elects to expense the 5-year property, XYZ will have to write off the balance of its purchases over the 7-year MACRS recovery period.

• Shortens the overall recovery period.

Property Eligible for Section 179 Expensing

• ... tangible personal property (generally, furniture, machinery and equipment), depreciated under the MACRS rules regardless of its depreciation recovery period;

• ... $250,000 of qualified real property; and

• ... Off-the-shelf computer software.

No requirement that the acquired property be new, thus, taxpayers may claim expensing for otherwise eligible used property.


First-Year Bonus Depreciation

• Under current law, a 50% first-year bonus depreciation allowance applies to qualified property acquired and placed in service after December 31, 2011, and before January 1, 2014.

• The adjusted basis of qualified property is reduced by the additional 50% depreciation deduction before computing the amount otherwise allowable as a depreciation deduction for the tax year and any later tax year.

• If Code Section 179 expensing is claimed, the amount expensed "comes off the top" before the additional 50% first-year depreciation allowance is computed.

• Then the taxpayer computes regular first-year depreciation.


Bonus Depreciation ExampleScenario AHotel Inc., a calendar-year business, needs to buy $1,000,000 of five-year MACRS property. If it does so before January 1, 2014, and places the property in service before that date, Hotel Inc., in general, may claim a first-year depreciation allowance of $600,000 [($1,000,000 × .50 = $500,000 bonus depreciation) + ($1,000,000 − $500,000 × .20 = $100,000 regular first-year depreciation)].

Scenario BIf Hotel Inc. waits until 2014 to buy the assets, and bonus first-year depreciation is not extended, Hotel Inc.’s regular first-year depreciation allowance using the half-year convention would be only $200,000 (20% of $1,000,000).

Quantified – Tax savings lost in 2013 would be $400,000 x 35% or $140,000.


Combined Section 179 and Bonus Depreciation Example


• Resort Inc., a calendar-year corporation, is close to buying $1,100,000 of new five-year property. This will be its only equipment purchase for the year. Even though it waits until the last quarter to buy the assets, Resort’s first-year depreciation allowance will be $815,000: Section 179 Expense plus

Bonus DepreciationCost Basis $1,100,000) Section 179 (500,000) $500,000Adjusted Basis 600,000) 50% Bonus Depreciation (300,000) 300,000Adjusted Basis $300,000) MACRS Depreciation (Mid-Quarter Convention)

15,000

Total First Year Depreciation and Expensing Allowed $815,000


Bonus Depreciation Example

• If the bonus depreciation rules are not extended and Section 179 is diminished as scheduled, the incentive depreciation allowance would be only $25,000.

• Total Depreciation and Section 179 for 2014 would be only $215,000 [$25,000 plus (20 percent ($1,100,000 - $25,000)] even if the asset was placed in service in the first quarter of 2014.

Last Year for Extra-generous Luxury Auto Depreciation Limits

• First-year depreciation deduction for new vehicles that qualify for bonus depreciation is:

– $8,000 more than the first-year depreciation limit that would otherwise apply.

• New vehicles bought and placed in service in 2013 that qualify for bonus first-year depreciation

– boosted first-year dollar limit is $11,160 for autos and $11,360 for light trucks or vans .

• Taxpayers thinking of buying a new auto, light truck or van for business use should buy vehicle & place in service in 2013.

• After 2013, first year amount reduced by $8,000.


Expensing of Real Estate?

• Historically, Code Section 179 expensing available only for tangible personal property, but now limited-time-only exception for certain types of real property.

• For any tax year beginning in 2010, 2011, 2012, or 2013, a taxpayer may elect to treat up to $250,000 of qualified real property as Code Section 179 property. After 2013, eligibility unavailable unless Congress extends it.

• Qualified leasehold improvement property• Qualified restaurant property• Qualified retail improvement


What is Qualified Leasehold Improvement Property?• Interior building improvement

• Made “under or pursuant to a lease” by either lessor or lessee,

• Portion of building occupied exclusively by lessee,

• Placed in service > 3 years after date building first placed in service.


Improvements Not Treated as Qualified Leasehold Improvements

• Code doesn’t define eligible building improvements

• Rather, lists property types that can't be so treated, such as:

... enlargement of building,

... elevator or escalator,

... structural component benefiting a common area, and

... internal structural framework of building.


Qualified Leasehold Improvements

• The following types of improvements appear to qualify:

1) electrical or plumbing systems (including sprinkler systems);2) permanently installed lighting fixtures;3) ceilings and doors4) non-load-bearing walls.


• What is qualified restaurant property? – If > 50% of building's square footage devoted to preparation, &

seating for on-premises consumption of prepared meals.

• What is qualified retail improvement property? – Any improvement to interior portion of building that is nonresidential

real property if:... That portion is open to the general public and used in retail trade

or business of selling tangible personal property to general public, and

... Improvement placed in service > three years after building first placed in service.


Qualified Restaurant and Retail Property

Section 199 - Domestic Production Activities Deduction


• Business can claim a deduction if have income from domestic manufacturing or other domestic activities = 9 percent of smaller of:

a) Qualified production activities income (QPAI) for a year - or -

b) Its taxable income without regard to the Section 199 deduction

Overall limit – can’t exceed 50 percent of W-2 wages allocable to domestic production activities

• results in reducing overall tax rates. 35% less [35% X 9%] = 31.85%


Qualified Production Activities Eligible include:

Manufacture, production, growth or extraction property such as clothing, goods or food, computer software produced either in whole or significant part within the U.S. including:

1) Film Production2) Production of Electricity and other utilities3) Construction or Renovation4) Engineering and Architectural Services performed in the

U.S.

Section 199 - Domestic Production Activities Deduction

Year End Tax Planning for Section 199

Usually revolves around two issues:

1. Planning for the W-2 deduction cap by accelerating compensation to increase overall limit.

2. Realignment of business operations to increase domestic production income.Example: having some manufacturing in an overseas facility and then shipping it back to the U.S. for further processing that represents at least 20% of the total COGS – then all income may qualify for Section 199 treatment.


Capitalization vs. Repairs Final Regulations


Capitalization Versus Repairs • Final Regulations issued in September 2013

• Go way beyond what is a repair.

• Provide guidance on amounts paid to acquire, produce or improve tangible property.

• Important new regulations will affect virtually ALL taxpayers.

• Generally effective for costs incurred in tax years beginning on or after January 1, 2014.

33Executive Tax Forum - November 7, 2013

Some Highlights of the New Capitalization Rules

• Unit of Property Modification for Buildings - Now required to analyze improvement costs relative to eight building systems defined in the regulations (plumbing, electrical, HVAC, elevator, escalator, fire protection and alarm, security and gas distribution) to determine proper treatment. Material improvements to any of these systems will require capitalization even though the cost may be small relative to the entire building.

• Replacement of Major Components or Structural Parts of Buildings - Allow for a loss on the disposition or replacement of a major component of a building (for example, a roof). Prior to final regulations, taxpayers were required to continue to depreciate items which had already been replaced.

• De Minimis Safe Harbor - Allow a taxpayer to deduct amounts paid for tangible property if the costs are not greater than specific dollar amounts determined at the invoice or item level if consistent with financial statements. The dollar threshold is $5,000 per invoice or per item as substantiated. ($500 if no audited financial statements)

• New Annual Election - Small business taxpayers may elect a safe harbor for repairs, maintenance and improvements to buildings as long as eligible property does not exceed 2 percent of the unadjusted basis of the eligible building or $10,000.

• Overall Plan of Rehabilitation Doctrine Now Obsolete -The final regulations provide that indirect costs, such as repairs incurred during a period of renovation, do not need to be capitalized if not related to the capitalized improvement. The judicial doctrine which required all costs incurred as part of an overall plan of rehabilitation to be capitalized is obsolete.

34Executive Tax Forum - November 7, 2013

Cost Segregation


What is Cost Segregation?

• Cash Flow Improvement and Tax Deferral Strategy– Strategic Tax Savings tool - Designed to accelerate tax deductions and

improve cash flow through tax deferral.

– Should be considered by all taxpayers that own, construct, renovate or acquire real estate for business or investment purposes.

– Primary goal is to identify construction related costs that can be depreciated and deducted over a much shorter time frame.

– Extremely valuable under current federal tax law which accelerates tax write-offs for tangible personal (Non Real Estate) property.


Improved Depreciation Write-offs

• Typically real estate is written off straight-line over 27½ and 39 year periods for residential and non-residential property, respectively for tax purposes.

• Thus, an annual depreciation deduction for a $1 million investment would be only:

– Residential $36,364– Non-residential $25,641

• A well-supported cost segregation study identifies costs which are more appropriately categorized as land improvements, furniture and fixtures and equipment (which generally have 5-15 year write-off periods). Additionally, Accelerated Depreciation Methods would be available .


Suitable Property for Studies

• Tax benefits are available for most commercial property including:

– Hotels/Motels/Resorts

– Private Clubs and Golf Courses

– Hi-tech Facilities

– Restaurants, Shops and Banquet Halls

– Parking Garages

– Fitness and Recreation Centers
