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El Triunfo Corporation
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Here are a few key tax-related deadlines for businesses during Q1 of 2018. JAN. 31: File 2017 Forms W-2 with the Social Security Administration and provide copies to employees, and provide copies of 2017 Forms 1099-MISC to recipients. FEB. 28: File 2017 Forms 1099-MISC if paper filing. (Forms 1099-MISC reporting nonemployee compensation in Box 7 must be filed by Jan. 31.) MAR. 15: If a calendar-year partnership or S corp., file or extend your 2017 tax return. Contact us to learn more about the filing requirements and ensure you’re meeting all applicable deadlines.
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The year is quickly drawing to a close, but there’s still time to take steps to reduce your 2017 tax liability. You just must act by December 31. Here are 3 ideas: 1) Pay tuition for academic periods that will begin in January, February or March of 2018 (if it will make you eligible for a tax credit on your 2017 return), 2) sell investments at a loss to offset capital gains you’ve recognized this year, and 3) ask your employer if your bonus can be deferred until January. If you’re unsure whether these steps are right for you, consult us before taking action.
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As the end of 2017 approaches, the prospect of dramatic tax reform makes year-end tax planning especially challenging for businesses. In late September, the Trump administration and Republican congressional leaders unveiled their Unified Framework for Fixing Our Broken Tax Code. The framework proposes reduced tax rates for businesses and changes to a variety of business tax benefits. But there’s a great deal of uncertainty over when — and if — tax reform will be implemented and which proposals could make their way into possible new tax legislation.

So, what can you do now? Start by projecting your business’s income and expenses for 2017, 2018 and beyond and see what your tax picture would look like under various tax reform scenarios. You may want to delay implementing year-end strategies until further details emerge about proposed tax reform. But unless Congress makes significant progress in the coming weeks, you may have to make some educated guesses and plan accordingly.

What are the key business-related proposals?

The proposed framework calls for:
Reducing the top corporate income tax rate from 35% to 20%. (It also suggests that tax-writing committees consider methods to reduce double taxation of corporate earnings.)
Eliminating the corporate alternative minimum tax.
Providing for 100% bonus depreciation, for at least five years, for new investments in depreciable assets (other than structures) made after September 27, 2017. Current law allows 50% bonus depreciation for such assets, dropping to 40% next year and 30% in 2019, after which it will be eliminated.
Partially limiting the deduction for net interest expense by C corporations.
Preserving the research and low-income housing credits. Most other business credits would be eliminated, although some may be retained if budgetary limitations allow it.
Eliminating the Section 199 deduction for domestic production activities, as well as most industry-specific deductions and exclusions.
Taxing “business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations” at a top rate of 25%. Currently, sole proprietors and owners of pass-through entities are taxed at individual rates as high as 39.6%. Antiabuse provisions would “prevent the recharacterization of personal income into business income.”
The framework would also have significant implications for U.S. multinational corporations. It contemplates moving from our current worldwide tax regime to a territorial regime under which U.S. parent corporations would enjoy a 100% exemption on dividends received from foreign subsidiaries in which they own at least a 10% stake. As part of the transition to this new system, there would be a deemed repatriation of deferred foreign profits accumulated prior to the change. The framework doesn’t specify the tax rate that would be applied to those profits, except to say that foreign earnings held in illiquid assets would be taxed at a lower rate and that payment of the tax would be spread out over several years.

What does this mean for year-end tax planning?

Traditional year-end planning principles say that, if you expect your marginal tax rate to remain roughly the same or go down in 2018, you should consider strategies for deferring income to 2018 or accelerating deductions into 2017. For example, cash-basis businesses might defer income by delaying invoices or accelerate deductions by prepaying certain expenses. Accrual-basis businesses have less flexibility to control the timing of income and deductions, although there may be opportunities to postpone the delivery of products or performance of services, defer taxes on certain advance payments or deduct certain year-end bonuses accrued in 2017 but paid in early 2018 (by March 15).

On the other hand, if you expect your business’s marginal tax rate to be substantially higher next year, you may be better off doing the opposite: accelerating income into 2017 and deferring deductions to 2018. However, keep in mind that, even though this strategy reduces your overall tax liability for 2017 and 2018, paying taxes sooner rather than later can strain your cash flow.

If the proposals outlined in the framework become law, it’s a good bet that many, if not most, businesses will see their effective tax rates go down in 2018. But there are no guarantees. For example, limits on net interest deductions may hurt highly leveraged corporations. And businesses currently benefiting from industry-specific deductions or exclusions or other tax breaks slated for elimination may see their taxes go up next year. For sole proprietorships and pass-through entities, the answer may depend in part on how tax reform legislation defines certain terms, such as “business income” and “small and family-owned businesses.”

What about capital expenditures?

Timing planned capital expenditures is particularly challenging. Businesses often acquire equipment or other depreciable assets before the end of the year to take advantage of enhanced depreciation tax breaks, such as bonus depreciation and Section 179 expensing. Sec. 179 allows you to deduct 100% of the cost of qualified new or used depreciable assets. (Bonus depreciation is available only for new assets.) But there’s a limit on Sec. 179 deductions ($510,000 this year) and the deduction is phased out after a business’s total purchases exceed a specified threshold ($2,030,000 this year). Keep in mind that the framework is silent regarding the future of Sec. 179 expensing, although many believe it will be retained.

Typically, businesses try to time these purchases when the deductions will do them the most good. Usually, that means this year rather than next, to enjoy the cash-flow benefits of a lower tax bill. But for businesses that expect a substantially higher tax rate in 2018, there may be an advantage to waiting until next year. Another issue to consider is the effective date of the proposed 100% bonus depreciation. The framework would offer this tax break for investments after September 27, 2017, but tax reform legislation could make it effective January 1, 2018, or some later date. Should businesses otherwise entitled to 50% bonus depreciation postpone asset purchases until the effective date for 100% bonus depreciation becomes clear? That’s a tough question.

Are you entitled to Sec. 199 deductions?

The Section 199 deduction, also commonly referred to as the manufacturers’ deduction or the domestic production activities deduction (DPAD), allows you to deduct up to 9% of your income from qualified domestic production activities, including certain manufacturing, construction, engineering, architecture, software development and agricultural activities. If you believe the deduction will be eliminated, as the tax reform framework proposes, it may pay to accelerate qualifying income into 2017 to avoid losing these deductions permanently.

Next steps

Given the uncertainty over the timing and content of new tax legislation, it may be advisable to delay implementing year-end planning, if practical, until the tax reform picture becomes clearer. But don’t wait too long; some year-end strategies take time to execute. For example, to take advantage of deductions for capital investments, it’s not enough to purchase an asset — you’ll need to place it into service by year’s end. Please contact us with questions on how tax reform legislation may affect your business’s tax planning.

© 2017
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President Trump has proposed a 15% federal income tax rate on business income — whether it’s earned by a traditional C corporation or by a pass-through entity such as an S corporation, limited liability company (LLC), partnership or sole proprietorship. If the 15% rate becomes law, what new tax planning opportunities might be opened up? And what limitations might Congress impose on that ultra-low 15% rate to prevent too much tax revenue leakage?

Potential impact on C corporations

Under the current federal income tax rules, the maximum effective tax rate on a C corporation’s income is 35%. The maximum marginal rate on income passed through to an individual taxpayer by a pass-through entity is 39.6%. So C corporations currently have a tax-rate advantage if you ignore the issue of double taxation.

Double taxation arises when C corporation income is taxed once at the corporate level and again at the shareholder level after the income is paid out as dividends. (The current tax rates on qualified dividends are 0%, 15% and 20%.) However, C corporation status remains a viable option for many businesses, despite the double taxation issue, for reasons including the following:
Rapidly growing and capital-intensive C corporations may pay little or nothing in dividends because they need to retain all their cash flow for internal purposes.
C corporation status is usually preferred by businesses that go public, and many publicly traded corporations pay dividends without worrying about double taxation.
If a 15% corporate federal income tax rate were enacted, C corporations would likely become more attractive. The lower rate could free up cash for C corporations to hire more workers and pay for capital costs, potentially leading to faster growth. Publicly traded corporations would also reap these benefits and could pay bigger dividends.

Advocates of the 15% rate say the federal government could actually collect more tax revenue than it does now because the low rate would stimulate business growth and make companies less inclined to set up operations abroad. In addition, more taxes could be collected on higher dividends paid to investors and on wages paid to additional employees.

Potential impact on pass-through entities

Under the current federal income tax rules, business income passed through to individual taxpayers by S corporations, LLCs, partnerships and sole proprietorships is taxed at ordinary income rates, which can range from 0% to 39.6%. While President Trump has proposed a lower maximum individual rate (35%), enacting a maximum 15% rate on pass-through business income without any limitations would greatly benefit higher-income business owners.

Higher-income individual taxpayers would also have a huge incentive to figure out new and different ways to route income through pass-through entities to take advantage of the low 15% rate. For example, individuals who are currently highly paid salaried employees might choose to become self-employed independent contractors who are treated as sole proprietors for tax purposes. Then, they could pay a 15% rate on their self-employment income instead of the higher rates that apply to salary income.

Similarly, individuals who are currently salaried employees might band together to form S corporations, LLCs and partnerships and offer their services through those entities. That way, they could pay a 15% rate on their pass-through income instead of the higher rates that apply to salary income.

These types of maneuvers would likely lead Congress to impose limitations on the 15% pass-through rate to prevent too much lost tax revenue. In fact, U.S. Treasury Secretary Steven Mnuchin recently said tax reform legislation would include rules to prevent people from reclassifying income in ways that aren’t intended. “What this is not going to be is a loophole to let rich people, who should be paying higher rates, pay 15%,” Mnuchin said.

Possible ways to help prevent abuse

The White House and Congress haven’t proposed any specific limitations on a 15% pass-through rate, but here are some that could potentially be put in place:

1. Reasonable compensation limitation. Congress could stipulate that a portion of pass-through income paid to active owners be treated as compensation and taxed at the higher rates that apply to salary income. Pass-through amounts in excess of reasonable compensation could then be taxed at the lower 15% rate.

In effect, this concept is already being applied to S corporations in relation to federal payroll taxes. Under the current rules, only amounts paid by S corporations as salary are subject to Social Security and Medicare taxes. Additional amounts paid to shareholder-employees are exempt from these taxes as long as the salary amounts are reasonable. As a result, many S corporations pay modest salaries to their shareholder-employees to minimize federal payroll taxes. The IRS often scrutinizes S corporation shareholder-employee compensation and will challenge it if, based on the facts and circumstances (there currently are no statutory or regulatory limits or specific guidelines), it seems unreasonably low.

Imposing a reasonable compensation rule for the 15% rate could create a compliance nightmare for the IRS. Many pass-through entity owners would take an aggressive approach by paying themselves minimal salaries. The IRS would have to conduct thousands of audits to discourage tax-avoidance behavior. The IRS doesn’t currently have the resources to do that. Therefore, a reasonable compensation rule would likely be open to manipulation by pass-through entity owners and hard for the IRS to enforce.

2. Simple formula limitation. Some sort of simple formula approach could be used to limit the low 15% tax rate on pass-through entity business income. For example, 70% of pass-through income could automatically be treated as compensation that’s subject to the higher tax rates that apply to salary income and to federal payroll taxes. The remaining 30% could qualify for the lower 15% business tax rate and be exempt from federal payroll taxes.

This type of approach has no theoretical underpinning. But it has the advantage of simplicity and would be easier to enforce.

3. Return on investment limitation. Congress could try to limit the 15% rate on pass-through business income using some sort of rate-of-return approach. Pass-through income that’s treated as a return on the owner’s investment could be taxed at the lower 15% rate and be exempt from federal payroll taxes. Additional pass-through income could be taxed at the higher rates that apply to salaries and be subject to federal payroll taxes.

While this approach could be less subjective and simpler to enforce than a reasonable compensation rule, the IRS would have to issue guidelines to define what constitutes a reasonable return on investment for businesses in various circumstances. Those rules would almost certainly be controversial.

4. Disallowance of 15% rate for personal service firms. Currently, personal service corporations — such as law and accounting firms and medical practices — pay income tax at a flat 35% rate. The 15% rate could follow that model and be disallowed for pass-through entities that deliver personal services.

Stay tuned

These ways to potentially prevent tax avoidance are purely speculative. And, of course, in order for a 15% rate for C corporations and pass-through entities to become reality, it must become part of tax legislation that passes Congress and is signed into law by the President. It’s also possible that the 15% rate could be negotiated to 20% or some other, higher rate.

Many new tax planning and compliance issues will arise if a lower business tax rate becomes law. Stay tuned for developments, and keep in touch with us. We can assist you in maximizing your tax-saving no matter what happens.

©2017
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If your company is over budget at year end, it’s a bit of a disappointment, to say the least. But don’t lose hope. You can still cut costs to either improve this year’s numbers or perhaps next year’s. Reassess your staffing levels to see if you can reorganize and eliminate underperforming positions. Also, review your approach to purchasing and consider canceling un- or underused services. Look into downscaling marketing efforts that aren’t paying off, too. Let us conduct a full assessment of your company’s budget and help you find ways to keep it in line.
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Many businesses throw a party at year end. If you do, be sure to practice the fine art of inclusion. Involve staff members of different faiths and cultures in the planning. Also, rather than prohibiting all holiday-specific ornamentation, allow an assortment of decorations reflecting your staff’s varying traditions. And look for ways to say thanks to everyone, be it with holiday cards or verbal kudos. Last, mind details such as disabled access and dietary needs. We can help you manage the effectiveness of your employee engagement activities.
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The Tax Cuts and Jobs Act takes another step toward becoming law.
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Corporate tax reform has been a hot topic for many months and it’s now beginning to be addressed in Washington in a little more (but not a lot more) detail. On September 27, the President and Republican congressional leaders released the nine-page “Unified Framework for Fixing Our Broken Tax Code,” which includes a framework for corporate tax reform. Many businesses and their owners are wondering how corporate tax reform could affect them. The framework is a bit sparse on details, but let’s shed some light on those it does include.

Corporate tax rate

The framework would lower the federal income tax rate for profitable C corporations from the current 35% to 20%. However, many corporate tax breaks would be eliminated.

While a lower rate to be more competitive with other countries globally and the elimination of tax breaks to simplify the tax code may seem like laudable goals, that doesn’t mean they’ll garner universal support from American businesses.
For some companies, the 20% rate could be higher than the effective rate they’re currently paying after existing tax breaks are figured in. According to one U.S. Government Accountability Office report, for example, in some recent years profitable large U.S. corporations (generally those with at least $10 million in assets) paid, on average, federal income tax amounting to about 14% of the pretax net income reported in their financial statements. However, in some cases, low effective tax rates are achieved by keeping earnings offshore where they aren’t subject to U.S. taxes.

Pass-through entity tax rate

Partnerships, limited liability companies and S corporations are so-called “pass-through entities.” They pay no entity-level federal income tax. Instead, their taxable income, deductions and credits are passed through to their owners and taken into account on owner-level tax returns.

If the owners are individuals, the federal income tax rate on passed-through income can be up to 39.6% under current law. The 39.6% rate can also apply to income earned by small businesses that are operated as sole proprietorships. The vast majority of small and family-owned businesses are conducted using pass-through entities and sole proprietorships.

In general, the framework would tax business income earned by pass-through entities and sole proprietorships at a maximum federal rate of 25%, which could provide them significant tax savings. However, many pass-through entities currently benefit from some of the “corporate” tax breaks that would likely be eliminated under the framework. That could counter some of the tax savings from the 25% rate.

The framework notes that Congress will need to adopt measures to prevent wealthy individuals from using pass-through entities to recharacterize personal income into lower-taxed business income. The bottom line is that hard work will need to be done to make sure the tax rate structure for pass-through entities is fair in comparison to the corporate rate structure without introducing excessive complexity.

One possible solution is disallowing the 25% rate for pass-through entity service businesses, or disallowing the 25% rate for a percentage of service firms’ taxable income. Pass-through income that isn’t eligible for the 25% rate could be taxed at the higher rates that apply to other income earned by individual taxpayers.

Expensing of business capital investments

Under existing law, capital investments are generally depreciated over several years, though there are exceptions. For example, with the Section 179 deduction, businesses can elect to immediately write off assets up to a certain amount each year ($510,000 for tax years beginning in 2017, but subject to a phaseout if asset purchases for the year exceed $2.03 million; these amounts are indexed annually for inflation). And bonus depreciation allows an additional first-year depreciation deduction of 50% for qualifying assets placed in service in 2017. (The bonus depreciation rate is scheduled to drop to 40% for 2018 and 30% for 2019 and to expire on December 31, 2019.)

The framework would allow companies to immediately expense an unlimited amount of new depreciable assets, other than buildings. Because of the Sec. 179 deduction that is available under current law, expensing without limits would primarily benefit larger businesses.

It’s also important to keep in mind that, while immediate expensing reduces current-year taxes, it basically is just accelerating tax benefits that otherwise would be recognized in future years. So it generally doesn’t provide permanent tax savings. That said, expensing could improve after-tax cash flow in a meaningful way, and larger businesses would be enthusiastic about that.

Business credits and deductions

The framework generally doesn’t give much detail about which business credits and deductions would be retained and which ones would be reduced or eliminated. However, it does state that the research credit and the low-income housing credit would be retained, and that interest expense deductions for C corporations would be limited. The same may be true for interest expense incurred by noncorporate taxpayers.

The domestic production activities deduction and numerous other deductions, credits and special provisions would be repealed or cut back. Again, many businesses would still come out ahead because of lower tax rates, but some could actually find themselves paying more than they do under the current tax regime.

Foreign income

The framework would remove tax provisions that currently encourage companies to keep profits and jobs offshore. Under the current system, offshore earnings aren’t subject to U.S. taxes as long as they’re kept offshore, but domestic earnings are taxed at one of the highest rates in the world. So companies have an incentive to make their investments offshore and keep the related jobs offshore. Under the framework, there would be no federal income tax on future foreign profits that are repatriated (brought back) to the United States, and dividends paid by foreign subsidiaries to U.S. parents that own at least a 10% stake would be tax-free.

These proposed changes are intended to encourage companies to keep their earnings in the United States, which would result in more investments and job creation in this country. Of course, the U.S. Treasury would also benefit from a larger corporate tax base.

To transition to the new system, all accumulated untaxed offshore earnings would be immediately charged a one-time tax at a fixed and presumably low rate (perhaps 10%). A higher rate would apply to cash and liquid assets and a lower rate to offshore earnings tied up in nonliquid assets, such as factories. The bill for the one-time transition tax would be spread over several years.

This change is intended to encourage companies to bring back their accumulated offshore earnings, because they’d have to pay the one-time tax whether they did so or not. Therefore, this change, in conjunction with the new 0% U.S. tax rate on future repatriated earnings (explained earlier), could increase the pool of corporate funds kept in this country and thereby encourage domestic investments and job creation.

The framework also includes measures to prevent the “offshoring” of business profits to tax havens in the future by taxing the foreign profits of U.S. multinational corporations at a reduced rate and on a global basis. These provisions would apparently apply to foreign earnings that are not repatriated and would, if nothing else, at least increase the U.S. corporate tax base.

Unpredictability and potential pushback

In light of the various crises going on, it’s difficult to predict when Congress will begin filling in more details on exactly what corporate tax reform will include and whether such legislation will be signed into law this year. And Republicans will likely receive some pushback on certain proposed changes, not just from Democrats but also from the business community and even some members of their own party.

If you have questions about how you and your business could be affected, please contact us. We’ll be keeping a close eye on legislative developments and how they might affect our clients.

© 2017
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