Business Law and Practice Section MCLE Meeting Attorney ... · 11/12/2019 · Business Law and Practice Section MCLE Meeting Attorney Resource Center November 12, 2019 11:45 AM –

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


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





http://www.dcba.org/

http://www.dcba.org/





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

[email protected]

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.



• 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.



• Corporations:

§ Graduated marginal tax rates ranging from 0% - 38%

§ Cash to owners via salary or dividends

§ Double taxation of dividend at preferred tax rates



• 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


Choice of Entity ConsiderationsNew Tax Law

• Why does the new tax law affect choice of entity decisions?


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


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.


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.


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.


Choice of Entity ConsiderationsNew tax rates overview


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.


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.


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


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.


Choice of Entity ConsiderationsPotential Cost vs. Benefit of Incorporating


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


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%


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%


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.


After Tax Cash Consequences – No Distributions


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


After Tax Cash Consequences – Annual Distributions


Cash Management Active Partner

(no 199A)

Active Partner

(w/ 199A)

Passive Partner

(no 199A)

Passive Partner

(w/ 199A)

Corporate Entity


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


After Tax Cash Consequences


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 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


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.


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


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


Choice of Entity Considerations

Questions?


Thank You!

Documents

Business Law and Practice Section MCLE Meeting Attorney ... · 11/12/2019 · Business Law and Practice Section MCLE Meeting Attorney Resource Center November 12, 2019 11:45 AM –