While tax reform reduced the income tax rate for corporations and eliminated the corporate alternative minimum tax (AMT), it also limited many tax breaks or got rid of them altogether.
Below is an outline of three opportunities that could change how you file to receive a potential tax break in addition to three important requirements to help you remain complaint.
You can also visit our pages for tax reform and tax planning. To learn more about cost-savings opportunities, please see 5 Tax Credits and Incentives That Could Help Increase Cash Flow.
The following opportunities could help you better align with your tax strategies and provide potential cost-savings:
- Choice of entity
- Qualified opportunity zones
Choice of Entity
Many businesses have a better understanding of tax reform’s impact on their tax liabilities now that 2018 returns have been prepared and filed.
The adoption of the 21% flat corporate tax rate, the favorable treatment of a qualified small business stock under Section 1202, and the 20% qualified business income deduction under Section 199A have attracted attention; the ability to use many of these provisions are directly tied to the type of entity a taxpayer uses to conduct their business.
Choice of entity could affect not only current taxes but also significantly impact taxes during any transition of ownership. A change in the owners’ needs could also warrant a change in the choice of entity to one better aligned with cash flow needs and potential exit strategies.
A review of the different entity choices could provide an opportunity to create significant immediate value, an increase in long-term value to owners, and an entity that better aligns with business strategies.
Here’s a list of considerations if you’re thinking about a change in entity:
- Ask your CPA to develop a comparison between the types of entities.
- Account for new investor preferences if capital raises or new investments are expected.
- Consider the impact choice of entity could have if future growth includes acquisitions.
- Examine exit strategies of current or future shareholders.
- Determine whether your current entity choice still meets your strategic goals and those of the owners.
- Develop an action plan if a change in entity is needed.
Qualified Business Income Deduction—Section 199A
This tax break is available to individuals, estates, and trusts that own interests in pass-through business entities. The deduction generally equals 20% of Qualified Business Income (QBI) subject to certain wage and property limitations.
For more information, read our Insight.
The section 199A deduction is generally not available for real estate investors who rent property under triple net leases. Landlords may want to consider renegotiating lease terms to qualify the rental property for section 199A.
Aggregating entities that meet certain requirements could allow the taxpayer to combine W2 wages or property with QBI from other entities to potentially allow for a larger deduction.
Certain specified service businesses generally do not qualify for the section 199A deduction. Where the taxpayer has income below certain threshold amounts, owners of these business may be able to claim all or a portion of the section 199A deduction.
The section 199A deduction comes with more complexity for pass-through entities compared to the reduction in the corporate tax rates. With careful planning pass-through owners can effectively navigate the rules to maximize the benefit.
- Evaluate aggregating entities that meet certain requirements in order to maximize the deduction.
- Plan the timing of expenses and capital expenditures. This could be an effective way to keep the taxpayer under threshold amounts that could limit the deduction.
- Consider if shareholders or members could receive a larger deduction if payroll was increased due to the increased wage limitation.
Qualified Opportunity Zones (QOZ)
The Opportunity Zone Program seeks to encourage long-term investment in distressed communities.
Taxpayers who invest capital gains in a Qualified Opportunity Fund could receive the following tax benefits:
- Deferral of tax on reinvested gains until the earlier of sale of the QOF investment or December 31, 2026
- Reduction in gain recognized on December 31, 2026 by 10% when the investment is held at least five years
- Reduction in gain recognized on December 31, 2026 by an additional 5%, for a total of 15%, when the investment is held at least seven years
The last day for making an investment that qualifies for the 15% tax basis increase is December 31, 2019.
Qualifying increases to the tax basis will reduce gain on disposition of the investment or upon automatic gain recognition on December 31, 2026.
For more information about this program, read our Insight.
Do you have or anticipate significant capital gains in the near term?
If you already have material gains from the sale or exchange of property in 2019, or anticipate material gains in the future, investing in a Qualified Opportunity Fund could be a strategic tool to lower your overall tax burden. In order to receive the additional 5% benefit for investments held for seven years, capital gains must be reinvested on or before December 31, 2019.
The following items require attention because failure to correctly file could result in significant penalties:
- Compensation and benefits
- 1099 reporting
- Economic nexus
Compensation and Benefits
Tax reform has led to many changes in the way businesses engage with customers and attract and retain employees. It also made substantial changes to the ways businesses manage their expenses requiring additional scrutiny, increased data management, and extra review of contract details.
Meals and Entertainment
Entertainment expenses paid or incurred after 2017 are generally disallowed even if related to the conduct of a taxpayer’s trade or business. Client business meal expenses and employee meals—including meals provided at an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer—are 50% deductible. Examples of employee business meals include meals while traveling and snacks and coffee provided primarily for employees on business premises.
For more information, read our Insight.
Qualified Transportation Fringe Benefits
Employers generally cannot deduct the costs of providing commuting, transit, or parking to their employees. These expenses are known as qualified transportation fringe benefits, and the disallowance is effective for amounts paid or incurred on or after January 1, 2018.
At the same time, many state and local governments are requiring employers with 20 or more employees to begin offering commuter benefits to employees on a pre-tax basis. While this is a tax benefit for employees, it may create an additional administrative burden for employers.
For more information, see our Insight.
It’s important for companies to consider if they’re going to make changes to their benefit programs and, if they do, how to communicate those changes to their employees. This may include reviewing current reimbursement policies and accountable plan strategies as well as outstanding employment offer letters for any possible negative tax impacts to individual employees, the company, or both.
Employers should periodically review local changes in laws and regulations to ensure they are properly accounting for recent mandates. If your company is subject to new state and local transportation requirements for employees, now is the time to understand these changes and be prepared to offer the benefits.
Even if changes aren’t made, companies need to evaluate their internal accounting procedures for these expenditures. For items that are no longer deductible or where the deduction is limited, adjustments will be required to compute taxable income. This makes it important to verify these costs can be easily identified and appropriately classified. For instance, meals and entertainment should be accounted for separately in your general ledger.
Employers could also consider taking steps to provide their accounting department employees with additional guidance regarding these changes.
Information Reporting Obligations
As the year comes to an end, it is important to prepare for annual information reporting obligations.
Forms 1099 and 945
If you are making payments to US non-exempt recipients, you could be required to file an information return report on Form 1099. If backup withholding was required, you will also be required to file a Form 945.
The most common types of payments that trigger a 1099 reporting obligation include: payments to independent contractors, payments for services performed, rent, royalties, interest, dividends, and distributions from retirement plans. Standardized collection of Forms W-9 and using the IRS TIN matching service could improve this reporting process and reduce penalty exposure.
If you are making payments of US source income to non-US recipients, you are required to file both a Form 1042 and 1042-S. The payments within scope for 1042-S reporting include: payments for services performed, dividends, interest, royalties, pensions, rent, scholarships, grants, and prizes.
Many payments made to non-US recipients carry a withholding obligation, which could be reduced or eliminated via a tax treaty or statute. The documentation—Forms W-8—and reporting obligations connected to these payments can be complex. It is important you have the right information upfront.
Preparing ahead of time will ensure that you are withholding and reporting in accordance with the required regulations. It will also help ensure that you avoid unnecessary penalties, which have increased each year. Currently, the penalties can range from $270 per 1099/1042-S, up to $550, along with a variety of other penalties for failure to withhold, late deposit, and late filing of Form 1042.
Review payments made during the calendar year to determine if you have a 1099 or 1042-S reporting obligation. If payments were made within scope, review the documentation on file for those payees to ensure that proper withholding was done, and also review all reporting information.
Deadlines can vary for the type of information return required so pay attention to filing deadlines.
The US Supreme Court’s historic ruling in South Dakota v. Wayfair in 2018 determined sales tax can be imposed on remote retailers with no property or employees within a state via economic nexus.
In this case, the US Supreme Court held remote sellers making sales into South Dakota with at least $100,000 in sales or at least 200 transactions in the state have economic nexus with South Dakota and are required to collect and remit state sales tax.
Businesses should expect more changes to sales and use tax laws in the coming year.
Effects of Wayfair
Here’s what businesses need to pay attention to:
- Thresholds by state. As of January 1, 2020, 44 of the 46 states, including Washington D.C., that impose state sales tax will have enacted their own economic nexus thresholds. Many states have adopted the above thresholds. However, some are enacting higher gross receipts thresholds and some states are beginning to remove the 200 transactions from their threshold.
- Marketplace facilitator laws. In efforts to increase sales and use tax collection, many states have enacted laws requiring marketplace facilitators to collect and remit sales tax on sales made by marketplace sellers in addition to the marketplace facilitators’ own sales. By January 1, 2020, at least 37 of the 46 states that imposes state sales tax will have enacted marketplace facilitator laws.
- Additional Services. Some states, including Connecticut, Washington, D.C., Kentucky, and Rhode Island have moved to pull more services into the sales and use tax base.
Sales and use tax will continue to keep businesses on their toes in 2020.
Businesses should continue to monitor their activities in the states and be prepared to:
- Register for sales and use tax as they trigger the nexus thresholds
- Become familiar with the taxability of the products and services in states where they have activities
- Establish policies and procedures for complying with sales and use tax laws
We’re Here to Help
To learn more about tax strategies and how they might affect or benefit your company, contact your Moss Adams professional or firstname.lastname@example.org.
You can also visit our dedicated tax reform and tax planning pages for a deeper dive, and you can read more about potential cost-savings in our article 5 Tax Credits and Incentives That Could Help Increase Cash Flow.