Tax Reform Has Passed – We are Moving Forward at Last
With the enactment of the Tax Cuts and Jobs Act (H.R. 1) on December 22, 2017, many companies have been scrambling to incorporate the impact into their year-end financial statements. While implementation guidance has been slowly making its way to tax professionals, it is imperative that organizations start taking proactive measures to plan for the most significant changes to the tax code in over three decades.
This article identifies some measures your organization should start evaluating to complete appropriate operational and tax planning measures.
The Reduced Corporate Tax Rate
The corporate tax rate has been lowered from a top rate of 35% to 21% for tax years beginning on or after January 1, 2018. Corporate taxpayers with a fiscal year end that includes January 1, 2018 will need to apply a blended overall rate that is based upon the portion of the year the organization was subject to the 21% rate and the portion of the year the entity was taxed at the historical rate.
With the corporate tax rate dropping for most corporations, how can you maximize benefits on the tax rate arbitrage?
Companies should consider the following actions to maximize the benefits before and after the tax rate changes.
Maximize available tax deductions
Have you maximized the deductions available to your organization based upon the elements within your control? Have you reviewed your tax methods of accounting? Have you considered whether method changes would be beneficial to your organization? Have you considered whether the method changes (when permissible) are automatic or whether they require approval?
Have you considered making payments on accruals eligible to deduct payments subsequent to the tax year end? Does your organization have a bonus plan that is based upon a bonus pool and require employees to be at the company to receive the bonus? If the bonus is paid out within 2.5 months of year-end, you may be eligible to accelerate those deductions into a tax year with a higher federal income tax rate. (If you are not on this method, fiscal year taxpayers may be able change to the pooling approach with board approval (prior to the fiscal year end) and a method change for income tax purposes.)
Increasing net operating losses now?
Is your company an organization that has a history of net operating loss carryforwards? If I told you to accelerate deductions, would you think we’ve lost it? Maybe we have. Or maybe we are thinking of other tax reform changes that were revenue raisers that will increase your taxable income in future years. Increasing net operating losses prior to the limitation will (1) allow for a net operating loss carryback two years for a refund for cash paying entities and (2) will allow for a net operating loss carryforward that will not be hindered by the 20% haircut on utilization. (Stated alternatively, the net operating losses generated in tax years beginning after December 31, 2017 will limit the NOL (utilization) benefit to 80% of taxable income.)
One of the most significant revenue raisers impacting companies is the interest deduction limitation capped at 30% of adjusted taxable income. For taxpayers with low or no taxable income and business interest expense, taxpayers may find themselves in a taxable income position.
Is the Research Tax Credit available to you? Or have you historically passed on the credit opportunity?
Tax Reform did not repeal the research tax credit. As a result of some of the “lost” or deferred deductions via Tax Reform, many companies should reconsider the benefits of generating Research credits which can be carried back one year and forward twenty years. That carryforward benefit should be viewed in the same light as in the NOL example above.
In addition, companies electing to tax the reduced credit under I.R.C. 280C will see the benefit which previously (for companies in the highest tax bracket) saw a 65% benefit of the credit generated will now (2018 and beyond) see a 79% benefit as a result of the lower corporate tax rate.
Looking to invest in depreciable property?
One of the major benefits to corporate taxpayers is the ability to take 100% bonus depreciation on qualified property acquired and placed in service after September 27, 2017 and before January 1, 2027. For tax years through 2022, 100% expensing applies to new and used property acquired. For years from 2023 – 2026, the eligible bonus depreciation is reduced by 20% per year.
Taxpayers electing 100% bonus depreciation will have the added benefit of increasing the interest deduction base subject to the 30% limitation, but only through 2021 (for calendar year taxpayers).
Executive compensation (Section 162(m))
For publicly traded corporations, the expansion of covered employees to include CEO and CFO at any time of the year and the eliminated exclusion for qualified performance-based compensation will likely lead to more disallowed executive compensation. Have you included in your analysis stock-based compensation? As a result of the disallowance, has your organization considered the higher cost of compensation along with shareholder perception of performance based compensation? Does the change to executive compensation require more analysis around your deferred tax assets for expected realization, and possible reduction of your DTA?
Has your organization taken a fresh look at your capital structure? Does the reduced corporate tax rate make a corporate structure more attractive? If you have a partnership structure, is the (potential) 20% deduction allowable based upon the business operations of your entity? Are you reconsidering financing options in the wake of interest deduction limitations?
As your company considers the tax implications of Tax Reform, you will need to evaluate how the impact to your financial statements and cash flow may impact your organization’s goals, relationships with your lenders, and possible changes to overall operations.
Will your organization have additional free cash flow as a result of lower taxes? If so, your interest coverage ratio may have improved and your company has increased the loan borrowing capacity. If you are a taxpayer that has an increased tax liability (for example – as a result of the interest deduction limitation), will your borrowing capacity be hindered? Will financial ratio movements have an impact on your interest rate, borrowing capacity and risk profile?
Does the employee bonus plan need to be revisited if tax expense plays into your computation? In 2017, did the revaluation of deferred tax assets and liabilities increase (in the case of net DTAs) or decrease (in the case of net DTLs) your income tax expense? For 2018 and beyond, has the presumed reduction to income tax expense elevated your organizations goals?
For companies negatively impacted by the interest deduction limitation – Do you not foresee the DTA benefit being utilized in the near term? How is your organization adapting to the impact? Are you reconsidering equity investors, further evaluating lending options, or currently on hold?
Congress attempted to equalize the benefits of the reduced corporate income tax rate to pass-through entities, such as partnerships, S Corporations, trusts, as well as sole proprietorships. Have you identified the potential benefit of the Qualified Business deduction based upon your organization’s (1) domestic qualified business income (2) W-2 wages subject to wage withholding and (3) qualified fixed assets?
Have you considered the impact of the three-year holding period requirement to be eligible for carried interest treatment as capital gain income? Does the repeal of the technical termination rule have an impact on your structure or tax treatment for transfers of partnership interests, acquisitions or restructuring after December 31, 2017? Will the limitation on losses and interest deductions or non-deductibility of investment advisory fees for taxpayers other than corporations have an impact on your cash needs in 2018 and beyond?
Stay tuned for a future True Alert devoted to Pass-Through Entities.
Has your organization given consideration to the accounting documentation or changes that should be made to account for tax reform. For example, many companies include meals and entertainment as one amount and include fringe benefits (in general) together. Segregating the entertainment from meals as well as further detailing fringe benefits are proactive moves we are seeing many of our clients implement now.
State Tax Considerations
While many states are still evaluating the impact Federal Tax Reform will have on their revenues and taxpayers, some have already taken action to either conform to the changes or decouple. While state legislatures are scrambling to respond, one thing for certain is that the state tax landscape will be even more complex for businesses to navigate.
While companies enjoy a reduced tax rate at the federal level, their state tax liability may actually increase due to tax reform’s base-broadening provisions since state corporate tax rates have not changed.
With a reduced federal corporate tax rate, the state income tax provision will have a more material impact on your effective tax rate. Has your organization considered whether to move from a blended to a state by state provision calculation for current or deferred provision purposes? If so, be proactive in the calculation and communication so your C-Suite, auditors, and other reporting groups within your organization are prepared for the impact. Stay tuned in the coming months for updates on significant state responses to Tax Reform affecting your organization.
The Toll Charge, GILTI, and BEAT
Has the Toll Charge taken a toll on you yet?
Has your company turned its attention to the reporting of the transition tax with its income tax return? While more guidance is pending related to the implementation of Section 965, the Treasury Department has now issued limited guidance related to reporting the information required by the transition tax. Specifically, they are requiring each US Shareholder of a Specified Foreign Corporation (“SFC”) to include an IRC Section 965 Transition Tax Statement with their return. Does your company already have all of the required information collected and verified? Has your company completed an in-depth analysis of its specified foreign corporations’ earnings and profits (“E&P”) balances? This analysis, along with the substantiation of each SFCs’ tax pools, is expected to be a main focus of scrutiny by taxing authorities in the year of the transition tax. Have you considered the quarterly implications of the transition tax? Did you change your indefinite reinvestment assertion due to the transition tax? What is the likelihood of actually repatriating cash to the U.S.? Have you considered the FX implications of your PTI balance under Sec. 986(c)? Have you set up a deferred tax asset or liability for the FX on PTI? If dividends were paid from lower tier CFCs, were withholding tax obligations in each jurisdiction accounted for?
GILTI and BEAT Tax – Do you have all the pieces of this puzzle?
Has your company considered Sec. 861 expense allocation and apportionment rules in applying the Foreign Tax Credit (“FTC”) limitations to your GILTI Income? Companies could be in for a big shock when including expense allocations to their GILTI income as their FTC could be further limited due to a lower GILTI income basket. Applying the Sec. 861 rules is the next step in determining your ability to use FTCs. Has your company determined whether the High Tax Exemption under Sec. 954(b)(4) could apply to exclude any of their tested income under the GILTI calculation? Does your company have an Overall Foreign Loss (“OFL”) or Overall Domestic Loss (“ODL”) and how will the limitations and recapture rules for these apply to your GILTI calculation? Has your company elected a policy for treating GILTI as a period cost or a deferred item for your 2018 quarterly provision? Unlike the transition tax, the GILTI is not a “one-time” tax. Therefore, it is very important to understand the mechanics of the calculation and what will be required going-forward as the shift from a World-Wide Tax regime to a Territorial Tax regime becomes baked into both reporting and compliance requirements.
Stay tuned for a future True Alert on these topics.
True is here for you
Whether you have questions about tax reform, desire our assistance with tax planning, compliance with the new law as well as upcoming reporting obligations, or simply want to connect, our team is here to help you navigate the benefits as well as the pitfalls of Tax Reform. We look forward to contributing to your journey.