Tax and financial advice from the Silicon Valley expert.

Tax tips and developments relating to partnerships

Are you a winner or loser under tax reform?

Many Americans are probably wondering whether they will pay more or less taxes under proposals released by President Trump and the tax-writing committees of Congress.

If you listen to President Trump’s sales presentations for the plan, everyone will be better off, but it ain’t necessarily so.

The proposals are still rather sketchy.  The taxable income amounts for which the various tax brackets will apply haven’t even been announced.  Here is my speculation about who are some of the winners and who are some of the losers under the proposals.  Since a combination of factors may apply, each family will need their own computations of tax before and after the changes when the details of the plan are ultimately released if Congress is successful in passing tax reform legislation.

Winners

U.S. corporations with accumulated earnings “parked” offshore.  U.S. multinational corporations haven’t brought their cash from offshore subsidiaries to the U.S. to avoid having them taxed.  Under the tax proposal, they would be able to repatriate the cash at low tax rates, payable over up to five years.  This could make the cash available to pay as dividends to U.S. shareholders to make investments in the U.S.  It could also be just a transfer from a foreign bank to a U.S. bank.

U.S. multinational corporations.  Under the proposal, dividends paid to U.S. corporations from offshore subsidiaries that are at least 10% owned by the U.S. corporation would be tax exempt.  U.S. corporations would no longer be subject to tax on their worldwide income, but only their U.S. operations.

U.S. business owners.  The maximum corporate tax rate would be reduced from 38% to 20%.  The maximum tax rate for individuals on business income would be reduced from 39.6% to 25%.  Investments in depreciable assets (equipment) other than structures (buildings) would be currently deductible for at least five years.

Employees with incentive stock options.  The exercise of incentive stock options isn’t subject to the regular tax, but is currently taxable under the alternative minimum tax.  Since the alternative minimum tax would be repealed, the exercise of incentive stock options would be deferred until the stock is sold or there is another disqualified disposition.  The original tax benefit of incentive stock options would be restored.

Healthy retired empty nesters.  Many of these taxpayers already use the standard deduction.  Their standard deductions will increase under the tax proposals, likely resulting in a tax reduction.

Very wealthy families.  The federal estate tax would be repealed.  Very few Americans are currently subject to the federal estate tax at death.  The exemption equivalent for 2017 is $5.49 million per individual, or nearly $11 million for a married couple.  The federal estate tax rate is 40% for the excess.  (Note there is no proposal to repeal the federal gift tax!)

High income individuals.  The maximum income tax rate would be reduced from 39.6% to 35%.  The additional 3.8% tax on net investment income is also proposed to be repealed.

Losers

Very large families.  The personal exemption would be repealed.  The rationale is the larger standard deduction would cover the elimination of the personal exemption, but it is a flat amount.  The dependent exemption for 2017 is $4,050.  With the $12,700 standard deduction for married couples for 2017, a family of three would have a combined deduction of $24,850 — exceeding the proposed standard deduction for married couples of $24,000.

Single parent families.  It appears the head of household filing status, a very significant tax break for single parent families, would be eliminated.

People who live in states with high income taxes.  States with high income tax brackets include California, New York, New Jersey, Minnesota and others.  (Note many of them are “blue” states.)  The deduction for state income taxes would be repealed.

People who pay high real estate taxes.  The deduction for real estate taxes would be repealed, eliminating a significant tax benefit of home ownership.

People in nursing homes.  Since the medical deduction would be eliminated, people who are uninsured or underinsured and pay for long-term care will lose a signficant tax benefit.  (For many of them, their medical expenses eliminates most of their taxable income.)

Employees with employee business expenses.  Employee business expenses are an itemized deduction that would be repealed.

Corporations that issue bonds or borrow money.  The deduction for interest expense for C corporations would be partially limited.

People who pay high legal fees.  Some legal fees now qualify to be deducted as miscellaneous itemized deductions.  This deduction would be repealed.

People who have high investment management expenses.  Investment management expenses for taxable investments are miscellaneous itemized deductions.  This deduction would be repealed.

Tax return preparers.  Actually, pluses and minuses.  Taxpayers will be totally confused by the tax law changes and will seek help in sorting them out.  Many tax returns will be simpler to prepare, resulting in lower fees.  Tax professionals will need to approach planning more from a financial planning point of view.  Tax return preparers who serve high net worth clients will still have plenty of business.  These clients will still have complex tax issues to deal with

Let your representatives in Congress know what you think about these proposals.  Here is a web site with contact information:  https://www.usa.gov/elected-officials

.

How will businesses be affected by California’s Proposition 39?

Although California’s Proposition 39 was “sold” as closing a tax loophole for out of state businesses, it’s not quite as simple as that. Some California businesses will also be affected.

The allocation and apportionment rules apply to all businesses that are “doing business” in California, including corporations, S corporations, partnerships, sole proprietorships and limited liability companies.

The new rules are effective for taxable years beginning on or after January 1, 2013.

Businesses are considered to be “doing business” in California and therefore subject to the allocation and apportionment rules subjecting some of their income to California tax if any of these apply:

1. The taxpayer is organized or commercially domiciled in California.
2. Sales of the taxpayer in California exceed the lesser of $500,000 or 25% of the the taxpayer’s total sales. Sales of the taxpayer include sales by an agent or independent contractor of the taxpayer.
3. The real property and tangible personal property of the taxpayer in California exceed the lesser of $50,000 or 25% of the taxpayer’s total real property and tangible personal property.
4. The amount paid in California by the taxpayer for compensation exceeds the lesser of $50,000 or 25% of the total compensation paid by by the taxpayer.
(California Revenue and Taxation Code Section 23101(b).)

Before the changes, California businesses had a choice to either compute the share of their income taxable by California based on (1) the share of their sales in California divided by their total sales, or (2) a formula based on the share of sales, payroll and property in California.

Under Proposition 39, the second alternative is eliminated.

The reason for eliminating the second alternative is businesses could reduce their California tax by locating their property and employees outside of California. In addition to avoiding California tax, this feature made the second alternative appear to be a “job killer” for California. Of course, there are other disincentives for locating a business in California that are beyond the scope of this article.

There is another feature of this change that hasn’t been widely discussed. It is the definition of whether income from services are “sourced” to California. Under alternative (1), which will now be the only alternative, income from services are allocated according to where the purchaser of the services received the benefit of the services. For example, if a CPA firm prepares income tax returns for a New York client, the income will be sourced to New York. Under the old rules of alternative (2), income from services were allocated according to where the services were performed. For example, if a employees of a CPA firm located in a California office prepared income tax returns for a New York client in the California office and never went to New York, the income would be sourced to California.
(The rule under alternative (1) is at California Revenue and Taxation Code Section 23136(a).)

This change in the source rules for income from services is being adopted in many states, which means more service businesses will have to file income tax returns in many states. This can be a burden, but smaller businesses might fall under an exception like 2. above, having less than $500,000 of gross receipts in the state and less than 25% of total gross receipts in the state.

See your tax advisor for more details about how your business is affected.

If you have a net worth of $10 million or more, consider making big gifts during 2011 and 2012

If you have a very large estate, say exceeding $10 million, you should meet with your tax advisor and estate planning attorney to discuss whether you should make big gifts during 2011 or 2012, which assets are good candidates for gifts, and how they should be transferred.

Read More

Tax and financial advice from the Silicon Valley expert.