Choosing the Best Business Entity Structure Post-TCJA

For tax years beginning in 2018 and beyond, the Tax Cuts and Jobs Act (TCJA) created a flat 21% federal income tax rate for C corporations. Under prior law, C corporations were taxed at rates as high as 35%. The TCJA also reduced individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and, typically, limited liability companies (LLCs). The top rate, however, dropped only slightly, from 39.6% to 37%.

On the surface, that may make choosing C corporation structure seem like a no-brainer. But there are many other considerations involved.

Conventional wisdom

Under prior tax law, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations: A C corporation pays entity-level income tax and then shareholders pay tax on dividends — and on capital gains when they sell the stock. For pass-through entities, there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, their new 21% tax rate helps make up for it. This issue is further complicated, however, by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction equal to as much as 20% of qualified business income (QBI), subject to various limits. But, unless Congress extends it, the break is available only for tax years beginning in 2018 through 2025.

There’s no one-size-fits-all answer when deciding how to structure a business. The best choice depends on your business’s unique situation and your situation as an owner.

3 common scenarios

Here are three common scenarios and the entity-choice implications:

1. Business generates tax losses. For a business that consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. A pass-through entity will generally make more sense because losses pass through to the owners’ personal tax returns.

2. Business distributes all profits to owners. For a profitable business that pays out all income to the owners, operating as a pass-through entity generally will be better if significant QBI deductions are available. If not, it’s probably a toss-up in terms of tax liability.

3. Business retains all profits to finance growth. For a business that’s profitable but holds on to its profits to fund future growth strategies, operating as a C corporation generally will be advantageous if the corporation is a qualified small business (QSB). Why? A 100% gain exclusion may be available for QSB stock sale gains. If QSB status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level.

Many considerations

These are only some of the issues to consider when making the C corporation vs. pass-through entity choice. We can help you evaluate your options.

For more than 25 years, we have relied on the Quill Corporation v. North Dakota decision which stated that businesses could not be required to collect and remit sales tax unless they had physical presence in a state.

On Thursday, June 21, 2018, in a 5-4 ruling on South Dakota v. Wayfair, Inc., the U.S. Supreme Court overturned the 1992 Quill Corporation v. North Dakota decision. The majority held that a physical presence standard as defined in Quill is “unsound and incorrect.” This will allow states to use an economic nexus rule to require sales tax compliance.

As a result, state and local governments may now require businesses to collect and remit sales taxes if they have substantial sales or transactions into their jurisdictions, even without having physical presence. Several states had passed legislation in disregard for Quill which until now have been sitting on the books waiting for Quill to be overturned. Many states copied from South Dakota’s law. South Dakota’s law requires all businesses with either 200 or more separate transactions or $100,000 of sales to collect and remit sales tax on all taxable sales.

All businesses will need to evaluate and determine in which additional states and localities they now have sales tax exposure and collection requirements.

For more information, please contact your Yeo & Yeo advisor or a member of Yeo & Yeo’s State and Local Tax (SALT) Services Group.

Here are some of the key tax-related deadlines affecting businesses and other employers during the quarter of 2018. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

July 31

Report income tax withholding and FICA taxes for second quarter 2018 (Form 941), and pay any tax due. (See the exception below, under “August 10.”)
File a 2017 calendar-year retirement plan report (Form 5500 or Form 5500-EZ) or request an extension.

August 10

Report income tax withholding and FICA taxes for second quarter 2018 (Form 941), if you deposited on time and in full all of the associated taxes due.

September 17

If a calendar-year C corporation, pay the third installment of 2018 estimated income taxes.
If a calendar-year S corporation or partnership that filed an automatic six-month extension:
- File a 2017 income tax return (Form 1120S, Form 1065 or Form 1065-B) and pay any tax, interest and penalties due.
- Make contributions for 2017 to certain employer-sponsored retirement plans.

Purchasing a new piece of equipment is a difficult, but necessary, decision for any business owner. With the cost of equipment starting at a few thousand dollars and climbing to upwards of $1 million, the decision requires a significant amount of consideration. Fortunately, the newly reformed tax laws that begin in 2018 can help a great deal with making these decisions. More specifically, the changes to bonus depreciation and the Section 179 deduction may work to your benefit.

Section 179 limits increased

Beginning in 2018, the limit on the amount that can be deducted for Section 179 has been increased to $1,000,000 with a spending cap of $2,500,000. This means that up to $1,000,000 of new and used equipment purchased and placed in service for use on the farm or business can all be deducted as an expense in the current year, as long as the total dollar amount of equipment purchased does not exceed $2,500,000. Once the spending cap is exceeded, the deduction received is reduced dollar for dollar. For example, if your total cost of equipment purchased during the year is $3,000,000, the deduction you would receive would be $500,000. These limits on Section 179 have increased significantly from an allowable deduction of $510,000 with a spending cap of $2,030,000 in 2017.

Bonus depreciation has increased too

As for bonus depreciation in 2018, 100 percent of the cost of new and used equipment acquired and placed in service can be deducted in the current year as opposed to 50 percent in 2017 on new equipment only. The increase was a pleasant surprise to taxpayers as, before tax reform, the 2018 deduction was expected to be only 40 percent.

Which method is best for your tax situation?

Just as in the past, with increased thresholds, farmers and other businesses have two ways to take an immediate write-off for part or all of the cost of newly acquired equipment. So, you may be asking, “Why take Section 179 when I can expense everything 100 percent with bonus depreciation?”

To answer, more specific rules and planning aspects must be considered. In some asset classes, a deduction can be allowed for one and not the other. Also, the Section 179 deduction can be elected on an individual asset-by-asset basis, whereas bonus depreciation is applied on an asset class basis. This means, to utilize bonus depreciation, you must elect all or none for a certain asset “life” class. For example, all assets with a 5-year life or all assets with a 20-year life would have to be treated the same, as a group. With Section 179, on the other hand, you can pick and choose the assets for which you would like to utilize the deduction.

The utilization of one deduction over the other can be a great tax planning technique. Although excess Section 179 amounts can be carried over from one year to the next, the Section 179 deduction cannot create a net operating loss in any given year, while bonus depreciation can. If you do elect bonus depreciation and a net operating loss is created, you have the opportunity to carry the loss back to previous years where income was shown to potentially receive a tax refund. The availability of the Section 179 deduction to be used on specifically selected assets allows businesses to control their taxable income so that it arrives at a target amount. This can be useful to possibly show enough profit to contribute to a retirement plan without having to pay too much in taxes, or even to maximize the new 20 percent pass-through deduction (also new for 2018).

Although this information relates mainly to construction, manufacturing and farm equipment purchased, other newly acquired assets may also qualify for Section 179 and/or bonus depreciation. It is important when considering acquiring equipment and other assets that you consult your Yeo & Yeo tax professional for timely, effective tax planning.

Eligible Manufacturing Personal Property (EMPP) claimants need to certify and pay the Essential Services Assessment (ESA) no later than August 15, 2018.

Essential Service Assessment ESA statements were released on the Michigan Treasury Online (MTO) website on May 1, 2018. If you are a first-year filer, a link to instructions f for setting up an account is provided below. Once you log onto MTO, you will be able to view your ESA statement, view correspondence from the Treasury, make changes to your statement, certify your statement, and pay your ESA liability. The link below will walk you through how to complete all of these steps.

Certification and payment are due by August 15, 2018. There is a one percent late fee for each week that is overdue with a maximum of a five percent penalty.
A statute provides a waiver of late payment penalty for first-year filers if the ESA statements and full payment are electronically submitted by September 15, 2018. ESA payments must be made electronically. Any checks mailed to the State will be refunded to the filer, and will not be applied to any ESA liability or penalty.
If not paid by October 15, 2018, the Eligible Manufacturing Personal Property (EMPP) exemption will be rescinded for the following year, and the taxpayer will need to file Form 632, which could result in higher taxes.

Eligible claimants may amend a previously certified ESA statement through MTO by September 15, 2018. An amendment includes changes in acquisition costs reported and adding or removing a parcel. Any increase in ESA liability resulting from any amendment made to a certified ESA statement will be subject to the one percent per week late payment penalty.

Step-by-step instructions for viewing, certifying, and paying ESA on MTO as well as setting up an MTO profile are available at www.michigan.gov

If you need assistance, contact your Yeo & Yeo professional.

Technology trends change in the blink of an eye. To stay competitive, manufacturers need to know what will move their business forward, what processes have become obsolete and what innovations are on the horizon. The 2018 MFG Forum was held on May 9 to guide industry leaders through these emerging issues and provide resources to maintain Michigan’s manufacturing advantage. The focus of the MFG Forum was how to take a proactive approach to Industry 4.0.

What is Industry 4.0? Seen as the fourth industrial revolution, Industry 4.0 looks to bring computers and automation together to create a cyber-physical system. New “Smart Factories” will have robotic processes connected remotely to a wireless computer system that allows the physical equipment to communicate with one another and to cooperate with human operators in real time.

Keynote speaker Paul Eichenberg discussed the impact of Industry 4.0 on the auto industry since Michigan manufacturing has predominantly revolved around the auto industry. Eichenberg believes, “The electrification of manufacturing is the biggest disruption in the history of the industry.” The majority of this disruption is because as much as 80 percent of vehicles’ current components are found in the combustion engine. During 2017, the top automotive manufacturers announced that they would convert the majority (if not all) of their vehicle lineup to electrical between the years 2020 and 2030. If the industry is going to see such a major shift, its suppliers will need to undergo major changes.

Presentations by many other industry leaders focused on the opportunities and threats of Industry 4.0 as it relates to technology and what the manufacturing industry should expect. The common subtheme for the day was cyberwarfare and the exposure to cybercrime.

The manufacturing industry is among the top targets for ransomware and malware. What can manufacturers do to protect their organizations? Gus Hendrickson, IT Consultant of Yeo & Yeo Technology, and Amy Buben, Principal of Yeo & Yeo CPAs & Business Consultants, explained how to shield manufacturing companies against cybercrime. They presented three case studies from MMA members and the results of their phish-prone tests, along with cybersecurity benchmarking data for Michigan manufacturers. In partnership with the MMA, Yeo & Yeo Technology extended a complimentary phish-prone assessment to all in attendance. Yeo & Yeo is further extending the offer to you.Register for our complimentary assessment.

Overall, Industry 4.0 will have a major impact on Michigan manufacturers. Whether your company is large or small, make sure you are ready for the changes to come with Industry 4.0.

Nonprofit organizations have a responsibility to be good stewards of the resources they’re given. The commitment of the Board of Directors and leadership to ethical behavior sets the tone for the entire organization. Emphasizing the importance of integrity from the top down creates an environment where internal controls will be most effective. The reality is that nonprofit organizations are continually asked to do more with fewer resources. Often the organizations are driven by volunteers looking to improve their communities, serve a need, and do some good in the world. Many times, nonprofit organizations are understaffed, and the concept of segregation of duties seems daunting, if not impossible. It’s imperative for nonprofits of all sizes to protect themselves and ensure they can continue their good works well into the future.

Let’s look at ways a small nonprofit organization can do that.

What is segregation of duties?

What, exactly, does segregation of duties mean? It’s one of those accounting jargon terms that non-accountants might not fully understand. To put it simply, it is the system of checks and balances an organization puts in place to separate who is responsible for recording, authorizing or approving, and who has access to the related asset. Ideally, multiple people would be involved so that one person is not responsible for multiple functions.

Take, for example, a volunteer parent who is treasurer of the parent-teacher organization. That parent sits at the bake sale table, accepting cash from paying customers. The parent also deposits the money into the bank account, reconciles the bank statement, and records all the transactions in a spreadsheet to provide as the treasurer’s report. This parent and the organization have both left themselves open to the possibility of error or inappropriate or fraudulent actions. For both the individual and the organization to protect themselves, it is important to separate the steps in the organization’s revenue process.

How can a small nonprofit segregate key duties?

The difficulty for many nonprofits and other small organizations is the lack of people who can be used to spread the various steps of the process. Management must consider all the possible people involved with the organization who could help perform the functions, assigning duties to volunteers and members of the Board of Directors to augment the various duties. Also consider outsourcing some functions to an independent third party, like a CPA.

See recommendations for How to Segregate Duties in Smaller Organizations in a two-person, three-person and four-person office.

Hiring additional staff or finding suitable volunteers may be difficult, if not impossible. It is important for management to consider the processes and procedures that are particular to their organization and assess where they are at risk. If separating duties is not practical or cost-effective, or if the risk is low, then alternate options should be considered. Management must balance their approach to include different types of controls. The goal is to reduce the risk of error or fraud.

Watch the budget, and implement expense policies and procedures

Using a budget can be an important step for nonprofit organizations. The overall objectives of the budget should be set by the Board or management at the beginning of the process. Then the organization should set a revenue budget and receive input from program directors to set the expense budgets. The proposed expense budgets and the revenue budget should be analyzed together and brought into the desired relationship, based on the overall objectives set by the Board and/or management. Management should provide consistent, meaningful review and monitor the progress throughout the year through variance reports and determine corrective action, if necessary.

By using a budget, the organization can give the authority to approve expenses that are within budget to the program directors while requiring specific authorization for checks written over a certain dollar amount, or for certain types of transactions, like a wire transfer of any amount. No one should be permitted to sign a check payable to themselves. Expense reimbursements to management should be approved by a Board member.

Use software to restrict access

The features of the accounting software should be used to help separate duties by restricting access to certain areas of the software and donor database. Management should also restrict physical access to assets. For example, a church may collect an offering during a service that is immediately put into a locked safe until it can be counted by two or more people, and then put into a sealed deposit bag and taken to the bank.

Numerous solutions are available to protect nonprofit organizations when the Board of Directors and management insist on high standards of ethics and integrity. The trick is finding the combination of controls that are right for each organization, including segregation of duties, ensuring that the individuals and the organization are both protected. That’s where Yeo & Yeo can help. Our professionals can assess the internal controls in place and provide suggestions for improvement tailored to your organization.

Has your organization accepted noncash donations? Chances are you have, and chances are you don’t have a gift acceptance policy in writing. While it may be hard to say “no, thank you” to well-meaning donors, there are times when that is exactly what you should do. A gift acceptance policy can help prevent unintended hardships related to noncash donations in several ways.

A policy can help you communicate to your donors why certain gifts are unacceptable. Maybe they are in contradiction with your values, or they come with added expenses (like property tax on land). It can also help staff members by providing guidance and wording to use when communicating with donors. In addition, the policy can state what the organization will do with certain donations. For example, a donation of stock will be sold within ten days. To be effective, the gift acceptance policy must be shared with donors and staff alike. Adopt yours today.

Check Out Our eBook on Creating Policies for Your Nonprofit

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The audit process, and review of financial statements, can be a bit overwhelming for you as an elected official if you don’t have a strong financial background. Here are five tips to help you wrap your arms around this task.

1. Look through last year’s audited financial statements.

Ask for a copy of the previous year’s financial statements and look through them. Especially take time to read the Management Discussion & Analysis section (MD&A). The MD&A is a great overview in layman terms as to what happened during that year, as well as expectations and projections for the future. The audited financial statements can also be found on the Michigan Department of Treasury’s website at www.michigan.gov/treasury.

2. Ask about the various funds that exist at your municipality.

Besides the general fund, which is the government’s basic operating fund, most municipalities utilize various other funds. The number of funds can vary significantly from one government to another. Unlike a private business, where all funds are accounted for as a single entity, governmental accounting is tracked through separate funds that balance in and of themselves. The accountant, bookkeeper or Chief Financial Officer will be able to give you an overview of the types of funds and, more importantly, the purpose of each fund.

3. Understand the internal controls in place at your municipality.

Internal controls are a series of events or methods put in place by the municipality to ensure the integrity of accounting and financial information. It is also a process of applying management policies throughout the entire entity. It is very important that internal controls are documented to provide an audit trail, and it is management’s responsibility to establish and maintain the internal controls. This will give you an understanding of the flow of information into and out of the municipality.

Organizations with a limited number of staff need to work especially hard to maintain the segregation of duties. Tasks must be delegated to different people to ensure no single individual is in a position where they could authorize, record, and be in custody of a financial transaction and the resulting asset.

4. Review the Budget to Actual Report often.

The Budget to Actual Report is a useful tool for decision-making, which is a responsibility of the elected officials. The budget is the “best guess” of how much money will come into the government and how much will go out each fiscal year. The budget should be updated throughout the year as events and circumstances change the government’s original “best guess.” It is a state law that the local unit’s actual expenditures are within the amounts authorized in the budget.

5. Ask questions about the draft financial statements and or audit process.

Ask questions when you aren’t sure of something or need clarification. The audited financial statements are the responsibility of management. Therefore, having a good understanding of the statements, schedules, and footnotes is required. Please speak up during the exit conference or draft meeting and ask questions. Your auditors love to talk numbers and internal control processes and procedures.

If you would like specific training related to understanding the audit process and or financial statements, please contact us.

Join David Jewell, CPA and Danielle Cary, CPA in a comprehensive overview of the impact of Tax Reform on individuals and families, and planning strategies for 2018 and beyond.

This webinar has concluded.

You’ve worked hard to get your business off the ground. Business is good— so good that you’re ready to trade up from your leased space and build your own building. You’ve met with the bank and they’ve given you preliminary approval on a loan package. But the bank representative says she needs to see your financial statements before she can finalize your loan.

You know that timely, accurate and understandable financial statements are necessary to gauge how well your business has performed and to assess the strength of its financial position. You know that they are the foundation upon which you make important business decisions.

Over the last several years, virtual currency has become increasingly popular. Bitcoin is the most widely recognized form of virtual currency, also commonly referred to as digital, electronic or crypto currency.

While most smaller businesses aren’t yet accepting bitcoin or other virtual currency payments from their customers, more and more larger businesses are. And the trend may trickle down to smaller businesses. Businesses also can pay employees or independent contractors with virtual currency. But what are the tax consequences of these transactions?

Bitcoin 101

Bitcoin has an equivalent value in real currency and can be digitally traded between users. It also can be purchased with real currencies or exchanged for real currencies. Bitcoin is most commonly obtained through virtual currency ATMs or online exchanges.

Goods or services can be paid for using “bitcoin wallet” software. When a purchase is made, the software digitally posts the transaction to a global public ledger. This prevents the same unit of virtual currency from being used multiple times.

Tax impact

Questions about the tax impact of virtual currency abound. And the IRS has yet to offer much guidance.

The IRS did establish in a 2014 ruling that bitcoin and other convertible virtual currency should be treated as property, not currency, for federal income tax purposes. This means that businesses accepting bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received, measured in equivalent U.S. dollars.

When a business uses virtual currency to pay wages, the wages are taxable to the employees to the extent any other wage payment would be. You must, for example, report such wages on your employees’ W-2 forms. And they’re subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date received by the employee.

When a business uses virtual currency to pay independent contractors or other service providers, those payments are also taxable to the recipient. The self-employment tax rules generally apply, based on the fair market value of the virtual currency on the date received. Payers generally must issue 1099-MISC forms to recipients.

Finally, payments made with virtual currency are subject to information reporting to the same extent as any other payment made in property.

Deciding whether to go virtual

Accepting bitcoin can be beneficial because it may avoid transaction fees charged by credit card companies and online payment providers (such as PayPal) and attract customers who want to use virtual currency. But the IRS is targeting virtual currency transactions in an effort to raise tax revenue, and it hasn’t issued much guidance on the tax treatment or reporting requirements. So bitcoin can also be a bit risky from a tax perspective.

To learn more about tax considerations when deciding whether your business should accept bitcoin or other virtual currencies — or use them to pay employees, independent contractors or other service providers — contact us.

Tuesday, June 12, 2018
11:30 AM – 12:30 PM EST

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The “Tax Cuts & Jobs Act” (TCJA), the first major tax code overhaul in over 30 years, made sweeping changes to the tax code that impact nearly every American. The new law favorably reduces marginal tax brackets and rates. It also eliminates or limits many popular tax deductions. It’s highly recommended that all taxpayers familiarize themselves with the tax law changes and begin developing a plan for its potential impact. Concerned about tax reform’s impact on your personal tax situation?

Join Yeo & Yeo’s David Jewell, CPA, and Danielle Cary, CPA, as they provide a comprehensive overview of the tax law changes impacting individuals and families, and discuss critical planning considerations and opportunities.

TOPICS:

Overview of the new tax rates and brackets
In-depth analysis of changes to itemized deductions
Opportunities for planning to maximize the benefit of the new rules

PRESENTERS:

David Jewell, CPA, Principal
Leader, Tax Services Group
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Danielle Cary, CPA, Principal
Leader, State & Local Tax Services Group
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A security upgrade is necessary for all connections used by QuickBooks Desktop, 2015 and later. After May 31, 2018, you will need to meet certain system requirements to access Intuit services. It is highly recommended to consider all of your services and how the new system requirements will affect them. If these requirements are not met, critical services including–but not limited to–the following will be impacted:

All connected services such as payroll, payments, online banking, etc.
QuickBooks Desktop activation on a new computer
Password reset tool
Services that require Intuit account credentials (One Intuit Identity – OII) such as My apps, secure webmail, contributed reports etc.
Intuit Data Protect (IDP)
Help pages
Ordering checks and supplies

Follow these steps to ensure greater security and stability with TLS 1.2, an internet security protocol. If you want to learn more about TLS 1.2, click here.

Make sure the QuickBooks Desktop version you are using is updated to the latest release.
Run the TLS 1.2 Readiness tool from this QuickBooks article on the computer where QuickBooks is installed to confirm your system readiness for TLS 1.2.
If the TLS 1.2 Readiness tool indicates failure, you should review the details here to take the necessary steps.

For more information, please view this QuickBooks article. Contact your Yeo & Yeo professional for additional assistance.

If you own a business and have a child in high school or college, hiring him or her for the summer can provide a multitude of benefits, including tax savings. And hiring your child may make more sense than ever due to changes under the Tax Cuts and Jobs Act (TCJA).

How it works

By shifting some of your business earnings to a child as wages for services performed, you can turn some of your high-taxed income into tax-free or low-taxed income. For your business to deduct the wages as a business expense, the work done must be legitimate and the child’s wages must be reasonable.

Here’s an example: A sole proprietor is in the 37% tax bracket. He hires his 20-year-old daughter, who’s majoring in marketing, to work as a marketing coordinator full-time during the summer. She earns $12,000 and doesn’t have any other earnings.

The father saves $4,440 (37% of $12,000) in income taxes at no tax cost to his daughter, who can use her $12,000 standard deduction (for 2018) to completely shelter her earnings. This is nearly twice as much as would have been sheltered last year, pre-TCJA, when the standard deduction was only $6,350.

The father can save an additional $2,035 in taxes if he keeps his daughter on the payroll as a part-time employee into the fall and pays her an additional $5,500. She can shelter the additional income from tax by making a tax-deductible contribution to her own traditional IRA.

Family taxes will be cut even if an employee-child’s earnings exceed his or her standard deduction and IRA deduction. Why? The unsheltered earnings will be taxed to the child beginning at a rate of 10% instead of being taxed at the parent’s higher rate.

Avoiding the “kiddie tax”

TCJA changes to the “kiddie tax” also make income-shifting through hiring your child (rather than, say, giving him or her income-producing investments) more appealing. The kiddie tax generally applies to children under age 19 and to full-time students under age 24. Before 2018, the unearned income of a child subject to the kiddie tax was generally taxed at the parents’ tax rate.

The TCJA makes the kiddie tax harsher. For 2018-2025, a child’s unearned income will be taxed according to the tax brackets used for trusts and estates, which for 2018 are taxed at the highest rate of 37% once taxable income reaches $12,500. In contrast, for a married couple filing jointly, the 37% rate doesn’t kick in until their taxable income tops $600,000. In other words, children’s unearned income often will be taxed at higher rates than their parents’ income.

But the kiddie tax doesn’t apply to earned income.

Other tax considerations

If your business isn’t incorporated or a partnership that includes nonparent partners, you might also save some employment tax dollars. Contact us to learn more about the tax rules surrounding hiring your child, how the kiddie tax works or other family-related tax-saving strategies.

Today many employees receive stock-based compensation from their employer as part of their compensation and benefits package. The tax consequences of such compensation can be complex — subject to ordinary-income, capital gains, employment and other taxes. But if you receive restricted stock awards, you might have a tax-saving opportunity in the form of the Section 83(b) election.

Convert ordinary income to long-term capital gains

Restricted stock is stock your employer grants you subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it.

At that time, you pay taxes on the stock’s fair market value (FMV) at your ordinary-income rate. The FMV will be considered FICA income, so it also could trigger or increase your exposure to the additional 0.9% Medicare tax.

But you can instead make a Sec. 83(b) election to recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

The Sec. 83(b) election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly. With ordinary-income rates now especially low under the Tax Cuts and Jobs Act (TCJA), it might be a good time to recognize such income.

Weigh the potential disadvantages

There are some potential disadvantages, however:

You must prepay tax in the current year — which also could push you into a higher income tax bracket or trigger or increase the additional 0.9% Medicare tax. But if your company is in the earlier stages of development, the income recognized may be relatively small.
Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or sell it at a decreased value. However, you’d have a capital loss in those situations.
When you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8% net investment income tax.

It’s complicated

As you can see, tax planning for restricted stock is complicated. Let us know if you’ve recently been awarded restricted stock or expect to be awarded such stock this year. We can help you determine whether the Sec. 83(b) election makes sense in your specific situation.

It’s not uncommon for businesses to sometimes generate tax losses. But the losses that can be deducted are limited by tax law in some situations. The Tax Cuts and Jobs Act (TCJA) further restricts the amount of losses that sole proprietors, partners, S corporation shareholders and, typically, limited liability company (LLC) members can currently deduct — beginning in 2018. This could negatively impact owners of start-ups and businesses facing adverse conditions.

Before the TCJA

Under pre-TCJA law, an individual taxpayer’s business losses could usually be fully deducted in the tax year when they arose unless:

The passive activity loss (PAL) rules or some other provision of tax law limited that favorable outcome, or
The business loss was so large that it exceeded taxable income from other sources, creating a net operating loss (NOL).

After the TCJA

The TCJA temporarily changes the rules for deducting an individual taxpayer’s business losses. If your pass-through business generates a tax loss for a tax year beginning in 2018 through 2025, you can’t deduct an “excess business loss” in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

Your aggregate business income and gains for the tax year, and
$250,000 ($500,000 if you’re a married taxpayer filing jointly).

The excess business loss is carried over to the following tax year and can be deducted under the rules for NOLs.

For business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes, the new excess business loss limitation rules apply at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on the owner’s personal federal income tax return for the owner’s tax year that includes the end of the entity’s tax year.

Keep in mind that the new loss limitation rules apply after applying the PAL rules. So, if the PAL rules disallow your business or rental activity loss, you don’t get to the new loss limitation rules.

Expecting a business loss?

The rationale underlying the new loss limitation rules is to restrict the ability of individual taxpayers to use current-year business losses to offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains.

The practical impact is that your allowable current-year business losses can’t offset more than $250,000 of income from such other sources (or more than $500,000 for joint filers). The requirement that excess business losses be carried forward as an NOL forces you to wait at least one year to get any tax benefit from those excess losses.

If you’re expecting your business to generate a tax loss in 2018, contact us to determine whether you’ll be affected by the new loss limitation rules. We can also provide more information about the PAL and NOL rules.

The Tax Cuts and Jobs Act (TCJA) introduced a flat 21% federal income tax rate for C corporations for tax years beginning in 2018 and beyond. Under prior law, profitable C corporations paid up to 35%. This change has caused many business owners to ask: What’s the optimal choice of entity for my start-up business?

Choosing the Optimal Business Structure

Under prior tax law, conventional wisdom was that most small and midsize businesses should be set up as sole proprietorships, or so-called “pass-through entities,” including:

Single-member limited liability companies (LLCs) treated as sole proprietorships for tax purposes,
Partnerships,
LLCs treated as partnerships for tax purposes, and
S corporations.

View our Tax Reform Pass-through Deduction Flowchart.

The big reason that pass-through entities were popular was that income from C corporations is potentially taxed twice. First, the C corporation pays entity-level income tax. And then, corporate shareholders pay tax on dividends and capital gains. The use of pass-through entities avoids the double taxation issue, because there’s no federal income tax at the entity level.

Although C corporations are still potentially subject to double taxation under the TCJA, the new 21% corporate federal income tax rate helps level the playing field between C corporations and pass-through entities.

This issue is further complicated by another provision of the TCJA that allows noncorporate owners of pass-through entities to take a deduction of up to 20% on qualified business income (QBI). (See “QBI Deductions for Pass-Through Businesses” at right.)

There’s no universal “right” answer when deciding how to structure your business to minimize taxes. The answer depends on your business’s unique situation and your situation as an owner. Here are three common scenarios and choice-of-entity implications to help you decide what’s right for your start-up venture.

1. Business Generates Tax Losses

If your business consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. So, it probably makes sense to operate as a pass-through entity. Then, the losses will pass through to your personal tax return (on Schedule C, E, or F, depending on the type of entity you choose).

2. Business Distributes All Profits to Owners

Let’s suppose your business is profitable and pays out all of its income to the owners. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. After paying the flat 21% federal income tax rate at the corporate level, the corporation pays out all of its after-tax profits to its shareholders as taxable dividends eligible for the 20% maximum federal rate.

So, the maximum combined effective federal income tax rate on the business’s profits — including the 3.8% net investment income tax (NIIT) on dividends received by shareholders — is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax rate on the dividends, which are reduced by the corporate level tax [(20% + 3.8%) x (100% – 20%)]. While you would still have double taxation here, the 39.8% rate is lower than it would have been under prior law.

Results with a pass-through entity. For a pass-through entity that pays out all of its profits to its owners, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the self-employment (SE) tax (whichever applies). This example assumes that, if the SE tax applies, the additional 0.9% Medicare tax on high earners increases the rate for the Medicare tax portion of the SE tax to 3.8%.

If you can claim the full 20% QBI deduction, the maximum federal income tax rate is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a pass-through entity is probably the way to go if significant QBI deductions are available. If not, it’s basically a toss-up. But operating as a C corporation may be simpler from a tax perspective.

3. Business Retains All Profits to Finance Growth

Let’s suppose your business is profitable, but it socks away all of its profits to fund future growth strategies. Here are the implications of operating as a C corporation vs. a pass-through entity under this scenario.

Results with a C corporation. In this example, we’re going to assume that retained profits increase the value of the corporation’s stock dollar-for-dollar, and that shareholders eventually sell the shares and pay federal income tax at the maximum 20% rate for long-term capital gains.

The maximum effective combined federal income tax rate on the venture’s profits is 39.8%. That equals 21% for the corporate level tax, plus the personal level tax on gain that is reduced to reflect the 21% corporate tax [(20% + 3.8%) x (100% – 21%)]. While you would still have double taxation here, the 39.8% rate is better than it would have been under prior law. Plus, shareholder-level tax on stock sale gains is deferred until the stock is sold.

If the corporation is a qualified small business corporation (QSBC), the 100% gain exclusion may be available for stock sale gains. If so, the maximum combined effective federal income tax rate on the venture’s profits can be as low as 21%. Ask your tax advisor if your venture is eligible for QSBC status.

Results with a pass-through entity. Under similar assumptions for a pass-through entity, the maximum effective federal income tax rate on the venture’s profits is 40.8%. That equals the highest federal income tax rate for individuals (37%), plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). That’s slightly higher than the 39.8% rate that applies with the C corporation option.

However, here’s the key difference: For a pass-through entity, all taxes are due in the year that income is reported. With a C corporation, the shareholder-level tax on stock sale gains are deferred until the shares are sold.

If you can claim the full 20% QBI deduction, the maximum effective rate for a pass-through entity is reduced to 33.4%. That equals the highest federal income tax rate for individuals on passed-through income that is reduced to reflect the QBI deduction [37% x (100% – 20%)], plus 3.8% for the NIIT or 3.8% for the Medicare tax portion of the SE tax (whichever applies). However, the QBI deduction is allowed only for 2018 through 2025, unless Congress extends it.

In this scenario, operating as a C corporation is probably the way to go if the corporation is a QSBC. If QSBC status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level. If you expect to be eligible for the full 20% QBI deduction, pass-through entity status might be preferred. Discuss this issue with your tax advisor to evaluate all of the pros and cons.

Other Related Issues to Consider

Business owners can use a variety of strategies to help lower their tax bills, and those strategies may vary depending on the type of entity you choose. Before deciding on the optimal business structure for your start-up, here are some other issues to consider.

Deductions for capital expenditures. For the next few years, C corporations and pass-through entities will be able to deduct 100% of the cost of many types of fixed assets, thanks to the TCJA’s generous Section 179 rules, which are permanent, and the 100% first-year bonus depreciation deduction, which is generally available for qualifying property placed in service between September 28, 2017, and December 31, 2022.

These changes under the new tax law may significantly reduce the federal income tax hit on a capital-intensive business over the next few years. However, reducing pass-through income with these favorable first-year depreciation rules will also reduce allowable QBI deductions.

Deductions for “reasonable” compensation. Closely held C corporations have historically sought to avoid double taxation by paying shareholder-employees as much as possible in deductible salaries, bonuses and fringe benefits. However, salaries, bonuses and benefits must represent reasonable compensation for the work performed.

For 2018 through 2025, this strategy is a bit more attractive because the TCJA’s rate reductions for individual taxpayers mean that most shareholder-employees will pay less tax on salaries and bonuses. In addition, any taxable income left in the corporation for tax years beginning in 2018 and beyond will be taxed at only 21%. Finally, C corporations can provide shareholder-employees with some tax-free fringe benefits that aren’t available to pass-through entity owners.

S corporations have historically tried to do the reverse. That is, they’ve attempted to minimize salaries paid to shareholder-employees to reduce Social Security and Medicare taxes. The IRS is aware of this strategy, so it’s important to pay S corporation shareholder-employees reasonable salaries to avoid IRS challenges.

The TCJA makes this strategy even more attractive for many businesses, because it maximizes the amount of S corporation income that’s potentially eligible for the QBI deduction. Guaranteed payments to partners (including LLC members treated as partners for tax purposes) and reasonable salaries paid to S corporation shareholder-employees do not count as QBI. But S corporation net income (after deducting salaries paid to shareholder-employees) does qualify as QBI.

Appreciating assets. If your business owns real estate, certain intangibles and other assets that are likely to appreciate, it’s still generally inadvisable to hold them in a C corporation. Why? If the assets are eventually sold for substantial profits, it may be impossible to get the profits out of the corporation without double taxation.

In contrast, if appreciating assets are held by a pass-through entity, gains on sale will be taxed only once at the owner level. The maximum rate will generally be 23.8% or 28.8% for real estate gains attributable to depreciation.

Spin-offs. A major upside for pass-through entities is the QBI deduction. But the disallowance rule for service businesses may wipe out QBI deductions for certain types of businesses, such as medical practices and law firms, that are set up as pass-through entities.

However, a spin-off might allow you to take a partial QBI deduction. How? If you can spin off operations that don’t involve the delivery of specified services into a separate pass-through entity, income from the spin-off may qualify for the QBI deduction.

The IRS hasn’t yet issued guidance on this strategy. Plus, the QBI deduction is scheduled to expire after 2025, unless Congress extends it. So, making big changes to create QBI deductions may not be worth the trouble. Talk to your tax advisor before attempting a spin-off.

Need Help?

The TCJA has far-reaching effects on business taxpayers. Contact your tax advisor to discuss how your business should be set up on opening day to lower its tax bill over the long run.

For simplicity, this article focuses on start-ups. If you own an existing business and wonder whether your current business structure still makes sense, many of the same principles apply. But the tax rules and expense for converting from one type of entity to another add another layer of complexity. Discuss your concerns with a tax pro who can help you with the ins and outs of making a change.

Audits have a stigma that leads people to believe that audits (and the auditors) are only a requirement to check off the annual business cycle. Hopefully, you have a great relationship with your auditor that allows the audit process to go smoothly. Once the financial statements have been released, the audit submitted to the State, and the Board or Council presentation completed, you’re ready to kick those auditors to the curb and tackle the next priority. We can hardly blame you! However, auditors have much more potential than just completing the annual audit that you could harness to benefit your organization year round.

Risk-Based Auditing

First, our audit teams take a risk-based approach to developing and customizing each client’s audit. What does that mean? We gather historical and current information about the organization, interview employees, members of management and members of the Board or Council, and then use that information to brainstorm possible ways things could go wrong in your organization. After our brainstorming session, the customized audit plan is developed accordingly. The audit plan can incorporate areas where the organization could benefit from further efficiency, or areas where management or the Board or Council has additional concerns. Here are some examples:

If the organization routinely has issues with getting all employees to timely submit credit card receipts, we can focus attention to this area. Our testing will likely result in a recommendation that provides management with leverage for initiating change. If management can say the auditors are looking at an area, employees are more likely to comply.
If bank accounts aren’t being reconciled as timely throughout the year as the manager would like, he/she can ask the auditor to review the reconciliation completion dates without having to be the bad guy.

These and many other areas of organizations can be improved by being an active participant in your audit.

Institutional Knowledge

Second, auditors have a significant amount of institutional knowledge. Many of my clients have been with me more than five years and I know their organization well, maybe better than most within their organization. When moving into the future, take advantage of that historical knowledge. Auditors can help with long-term analysis, in some cases projections of where the organization is heading, and can help your organization avoid taking a path that was already traveled which resulted in a less than desirable outcome. Helping the organization move in the right direction makes everyone feel like a winner.

Credibility

Another area in which auditors can be used is to gain creditability. For example, when there are new members of management or new members of the Finance Committee, those new members are trying to get up to speed, and in some cases challenge the establishment while having little to no history of the organization. Auditors can explain the hurdles that were faced, describe how the organization has grown and dealt with issues in the past, and work to support the qualifications and work of members of management. In some cases, we have even provided Board or Council training related to financial statements or internal controls. Auditors are generally well respected and knowledgeable; use that to your advantage.

Interim Help

Lastly, when an organization experiences turnover in management and staff, or there are large projects that no one has time to complete, your auditor might be the answer. As previously mentioned, in many cases auditors know your organization and internal controls better than most in your organization. With that knowledge, auditors can help you design controls to cover the organization in the interim and can even do certain types of projects that don’t include management functions. Sometimes this can keep the organization from falling woefully behind while they look to replace lost team members, or help move projects off of the to-do list and keep the organization moving forward.

These ideas are just the tip of the iceberg. The main point is that we are your auditors all year long, not just at the time of the audit. We want to hear from our clients and are always willing to go the extra mile to help out when we can.

Yeo & Yeo CPAs & Business Consultants is pleased to announce that Christopher M. Sheridan, CPA, has achieved the Certified Valuation Analyst (CVA) credential, awarded by the National Association of Certified Valuators and Analysts (NACVA).

“This is a great achievement for Chris as a professional,” says David Schaeffer, Managing Principal of Yeo & Yeo’s Saginaw office. “He joins our growing business valuation group of three CVAs across the firm.”

A CVA is the premier accreditation for CPAs. Adding a CVA designation along with Chris’ efforts as a member of Yeo & Yeo’s Litigation Support , Valuation and Fraud & Forensics Services Group, allows him the ability to provide sound and reliable business valuation services for attorneys and successful business owners. Yeo & Yeo provides business valuations for privately held businesses and business owners as part of success planning, and as part of business strategy to more efficient business growth.

Chris is a senior accountant and a member of Yeo & Yeo’s Manufacturing Services Group. He holds additional memberships with the MICPA’s Manufacturing Task Force, the Great Lakes Bay Manufacturers Association, the Michigan Manufacturers Association and the National Association of Certified Valuators and Analysts.