Monthly Archives: April 2017

The Most Beautiful Summary of Trump’s Business Tax Cut. Period.

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Republican U.S. presidential candidate Donald Trump speaks during a campaign rally at the Treasure Island Hotel & Casino in Las Vegas, Nevada June 18, 2016. REUTERS/David Becker - RTX2GYKG

With some very broad brushstrokes, the Trump administration laid out its tax plan.  It is still very early in the process, and skepticism about how much of the plan will survive negotiations should be maintained.  This article will discuss a substantial reduction in taxes for business owners.

Very Major Overview

During the campaign, Donald Trump proposed cutting the maximum business tax rate to 15%.  There was uncertainty as to whether this 15% maximum tax rate would also apply to pass through entities such as LLCs and S corporations.  The uncertainty has been resolved as it is now clear that the 15% maximum tax rate applies to pass through entities and to sole proprietorships.

Tremendous and Beautiful Tax Cut

Example:  John owns an S corporation and it has profit of $200,000.  Assume John has other income and he is in the 35% tax bracket.  Under current law, his tax liability on the $200,000 S corporation profit would be $70,000 (35% times $200,000).  Under the Trump proposal, John’s maximum tax rate on the S corporation profit would be 15%, so his tax under the Trump plan would be $30,000. 

Example:  Same facts as above except John is a member of an LLC and his share of the LLC profit is $200,000.  Again, his maximum tax rate under the Trump plan is 15%, so his tax on the share of the LLC profit would be $30,000.

You May Even Get Tired of Paying Lower Taxes and You’ll Say “Please, Please, It’s Too Much.  We Can’t Take It Anymore.”   

There has been an incentive for S corporation owners to minimize officer compensation because S corporation owners only incur payroll taxes on their payroll, not on the remaining business profit.  The Trump plan would further encourage S corporation owners to minimize officer compensation because officer compensation would remain subject to higher income tax rates, while S corporation profit would be subject to the 15% maximum rate.

Example:  Jennifer has an S corporation with $100,000 profit before officer compensation.  Assume she has other income and is in the 35% tax bracket.  She has officer compensation of $60,000 and S corporation profit of $40,000 after officer compensation. 

Under current law, her tax would be:

Tax on Officer Compensation:       $21,000 (35% times $60,000)

Tax on S corporation profit:         $14,000 (35% times $40,000)

Total Tax                                             $35,000

Under the Trump plan, her tax would be:

Tax on Officer Compensation:    $21,000 (35% times $60,000)

Tax on S corporation profit:         $6,000 (15% times $40,000)

Total Tax                                             $27,000

 Joan prefers paying tax at the 15% tax rate so she reduces her payroll to $40,000 (leaving S corporation profit of $60,000). 

Under Trump plan with officer compensation reduction, her tax would be:

Tax on Officer Compensation      $14,000 (35% times $40,000)

Tax on S corporation profit:         $9,000 (15% times $60,000)

Total Tax                                             $23,000

Joan saves $4,000 by reducing her higher-taxed payroll and increasing her S corporation profit that is taxed at the 15% maximum rate.

There is already incentive for S corporation owners to minimize officer compensation because officer compensation is subject to payroll taxes (generally 15.3% FICA plus unemployment taxes) while S corporation profit is not subject to payroll taxes.  The Trump plan increases the incentive to minimize officer compensation.

If you need help with small business taxes,

sign up for a FREE tax consultation.

 Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Realistic Like-Kind Exchange Scenarios

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A like-kind exchange allows a property owner to exchange properties with another person and defer paying tax on the exchange.  A prior post explained the basic mechanics of like-kind exchanges.  This post will focus on a couple more complicated, but also more realistic, situations.  These situations occur:

  • when one of the parties wants to receive cash instead of replacement property.  This situation usually involves a third or fourth person to qualify the transaction as a like-kind exchange.
  • when the exchanges do not occur simultaneously

Three Party Exchanges

Marty owns Property M.  Doc owns Property D.  Marty wants to enter into a like-kind exchange with Doc to acquire Property D.  Doc wants to sell Property D for cash.  After some searching, Marty finds Biff who wants to buy Property M for cash.

The three parties enter into a three party exchange as follows:

  1. Biff buys Property D from Doc for cash
  2. Biff exchanges Property D for Marty’s Property M in a like-kind exchange.

Everyone is happy—Doc gets the cash he wants; Marty exchanged Property M for Property D in a like-kind exchange; Biff paid cash and ultimately ended up owning Property M.

Four Party Exchanges

Assume the same facts as above, except that Biff does not want to acquire Property D because of environmental liability concerns.  A like-kind exchange can be accomplished through a four party exchange involving a qualified intermediary.

A qualified intermediary is a person who is not the taxpayer or a disqualified person and who expressly agrees under the terms of an exchange agreement to acquire the taxpayer’s relinquished property, transfer the relinquished property to another taxpayer, acquire the replacement property, and transfer the replacement property to the taxpayer.

A disqualified person is either related to the taxpayer or someone that has acted as the taxpayer’s agent, such as an attorney, accountant, real estate agent/broker,  at any time during the prior two years.  However, routine financial services provided to the taxpayer during this time by a financial institution (i.e., a bank), title insurance company, or escrow company are not taken into account—these institutions may serve as qualified intermediaries.

To see this in action, assume four parties enter into the following simultaneous exchanges:

  1. Marty engages Title Company as a qualified intermediary
  2. Title Company borrows money and buys Property D from Doc for cash (Doc receives the cash he wanted)
  3. Title Company exchanges Property D with Marty’s Property M (Marty exchanges Property M for Property D in a like-kind exchange)
  4. Title Company sells Property M to Biff for cash and pays off the loan (Biff pays cash to directly purchase Property M)

When Exchanges Do Not Occur Simultaneously

These exchanges are referred to as deferred exchanges.  These can occur when someone who wants to enter into a like-kind exchange finds a cash buyer for his property but needs additional time to find replacement property.  In these situations, the person will transfer property to the buyer, the buyer will transfer proceeds to an escrow agent, and the escrow agent will purchase replacement property to the seller once replacement property has been identified.  The seller cannot take possession of the cash, otherwise the transaction will fail as a like-kind exchange; that is why the escrow agent takes possession of the cash.

There are two primary requirements in deferred exchanges:

  • Identification Period:  Before this period expires, the taxpayer must identify replacement property to the other party who is obligated to transfer the replacement property to the taxpayer.  The identification period begins on the date the taxpayer transfers the relinquished property and ends 45 days after.  Up to three replacement properties can be identified without regard to the market value of the replacement property.  If more than three replacement properties are identified, the market value of all identified replacement properties cannot exceed 200% of the relinquished property.
  • Exchange Period:  Before this period expires, the taxpayer must receive the replacement property.  The exchange period also begins on the date the taxpayer transfers the relinquished property and ends on the earlier of (1) 180 days after OR (2) the due date (including extensions) of the tax return for the year in which the transfer of the relinquished property occurs.

Example:  Fred wants to exchange Property F in a like-kind exchange.  Barney wants to buy Property F for cash.  Fred enters into a deferred exchange where he transfers the property to Barney and Barney transfers cash to an escrow agent who will acquire the replacement property when it’s identified by Fred.  Fred has 45 days to identify replacement property to the escrow agent beginning the date he transfers the property to Barney.  Fred has 180 days to receive the replacement property beginning on the date he transfers the property to Barney. 

Assume Fred transfers the property to Barney in December.  Fred believes the exchange period will end in 180 days during June.  He files his tax return by April 15 and does not file an extension.  Fred closes on the replacement property in May, within the 180 days.  However, Fred failed the exchange period requirement because his return was not extended.  Remember—the exchange period ends on the earlier of (1) 180 days after the transfer or (2) the due date (including extensions) of the tax return.  Here, the April 15 unextended due date marked the end of the exchange period because it is earlier than 180 days after the transfer.  The exchange does not qualify as a like-kind exchange and Fred has a taxable gain based on the difference between the market value of the new property and his cost in the relinquished property. 

If you need help with small business taxes,

sign up for a FREE tax consultation.

 Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

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