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Posts tagged Internal Revenue Code.

INTRODUCTION[1]

M&A dealThe Tax Cuts and Jobs Act (“TCJA”) will significantly impact merger and acquisition (“M&A”) activity. Although billed as tax reform, the TCJA did not reform or simplify the Internal Revenue Code (“Code”).

Virtually none of the provisions of the TCJA directly impact M&A transactions. Rather, the TCJA added or modified several sections of the Code that indirectly impact transaction structuring, pricing, negotiations and due diligence. Making matters more complex, some of these provisions of the TCJA are temporary.

This blog post briefly highlights several key provisions of the TCJA and the impact on M&A.

INTRODUCTION

charitable givingCharitable organizations work hard to maintain exempt status. These organizations operate in a highly regulated landscape: In exchange for enjoying freedom from income taxes, they must comply with strict organizational and operational rules. Even before the Tax Cuts and Jobs Act (“TCJA”), adhering to these rules required constant oversight. The TCJA changes the rules, impacting both the operations and funding of these organizations.

On the operational side, we review below: Changes to the rules on unrelated business taxable income and employee fringe benefits, the new excise taxes imposed on executive compensation, and college and university endowments, and changes to substantiation requirements for certain donations.

On the funding side, we review below: How changes to the standard deduction (addressed in more detail in a prior blog post), cash contribution limits, deductions for payments to colleges and universities for the right to purchase athletic event tickets, and the estate tax may impact donors and charitable giving patterns.

INTRODUCTION

extended familyThe Tax Cuts and Jobs Act (“TCJA”) creates the need for tax planning with respect to several major life-changing activities individuals may encounter, including marriage, divorce, home ownership, casualty losses, medical expenses and parenting. More specifically, the TCJA makes major changes to the existing framework of personal exemptions and itemized deductions, the child tax credit, the tax treatment of alimony and spousal maintenance payments made as a result of divorce, and the alternative minimum tax (“AMT”).

The primary focus of this blog post is the provisions of the TCJA that significantly impact families and individuals. Many of these provisions have been exhaustively reviewed by other commentators in the past several weeks. In those instances, our discussion is brief. Rather, we decided to place the bulk of our discussion on the less obvious provisions of the TCJA that may have significant impact on families and individuals.

EntertainmentBACKGROUND

The Tax Cuts and Jobs Act (“TCJA”) creates, modifies or eliminates a number of employment and employee fringe benefit related provisions of the Code. Both employers and employees need to be aware of these changes. Accordingly, this installment of our ongoing review and analysis of the TCJA focuses on these employer and employee fringe benefit provisions.

“Neither a borrower nor a lender be…” or at least, if you insist on borrowing (and we understand the appeal), we are here to help you stay abreast of the new rules on deducting interest.

BACKGROUND/PRIOR LAW

IRCInterest on a business or investment related debt is, in most instances, a deductible expense of the borrower and taxed as income to the lender. With a few exceptions, such as mortgage interest on a personal residence, borrowers generally cannot deduct personal interest. A borrower’s deduction is subject to a number of limitations set forth in Code Section 163. The Tax Cuts and Jobs Act (“TCJA”) has changed some of these limitations.

Before the enactment of the TCJA, nondeductible interest included any interest on a taxpayer’s debt not arising from a trade or business, home mortgage, investment activity, or qualified student loans (in other words, interest arising from those debts was deductible).

BACKGROUND

Qualified business incomeThe Tax Cuts and Jobs Act (“TCJA”) adopted a new 20% deduction for non-corporate taxpayers. It only applies to “qualified business income.” The deduction, sometimes called the “pass-through deduction,” is found in IRC § 199A. There has been a significant amount of media coverage of this new deduction. Rather than repeat what you have undoubtedly already read or heard, we chose to focus this blog post on the not so obvious aspects of IRC § 199A—the numerous pitfalls and traps that exist for the unwary.

BACKGROUND/PRIOR LAW

PartnershipUnder IRC § 708(a), a partnership is considered as a continuing entity for income tax purposes unless it is terminated. Given the proliferation of state law entities taxed as partnerships today (e.g., limited liability companies and limited liability partnerships), a good understanding of the rules surrounding termination is ever important.

Prior to the Tax Cuts and Jobs Act (“TCJA”), IRC § 708(b)(1) provided that a partnership [1] was considered terminated if:  

1.  No part of any business, financial operation, or venture of the partnership continues to be carried on by any of the partners of the partnership; or

2.  Within any 12-month period, there is a sale of exchange of 50% or more of the total interests of the partnership’s capital and profits.

Hollywood signAs indicated at the end of 2017, I intend to provide our readers with an in-depth review of the Tax Cuts and Jobs Act (“TCJA”). With the help of two of my colleagues, Steven Nofziger and Miriam Korngold, we will do this in a series of bite-size blog posts. Our goal is to not only review the technical elements of the new law, but to offer practical insights that will be helpful to tax practitioners and their clients.

Many of the provisions of the TCJA have already received significant attention by the media. Rather than start our multi-part series with any of those provisions, we decided to commence the journey with a discussion about a rather obscure provision of the new law. This provision, while it may not have received any media attention, could be a huge trap for the unwary. It also highlights several aspects of the new law that have received little discussion.

U.S. Tax ReformThis is the first of a series of posts on Tax Reform. In this series, I will be covering: what Tax Reform means, the legislative process for enacting it, the likely timing of its arrival, the estate & gift tax and income tax proposals already presented by the Trump administration and the U.S. House of Representatives, and possible planning strategies that businesses and individuals may wish to consider.

What Tax Reform Is 

As a starter, what exactly is “Tax Reform”? Is it something you will know if you see it? Are there objective standards as to what constitutes “Tax Reform”?

The late Senator Russell B. Long, a Democrat from Louisiana, served more than four decades in the U.S. Senate. He was Chairman of the U.S. Finance Committee from 1966 to 1981, and was very influential in shaping our tax laws during the ’60s, ’70s and ’80s. In fact, he was one of the major contributors to the Tax Reform Act of 1986.

As a footnote, the ’86 Act, enacted over thirty years ago, was the last major tax reform legislation passed by our lawmakers. So, it has been a long time since we have seen Tax Reform.

As many employers have painfully learned, misclassifying employees as independent contractors can be an expensive mistake. Worker misclassification may become even more costly in 2014, when a new potential trap for the unwary will exist. If a non-complying employer gets caught in this new trap, it could be faced with significant monetary penalties.

Beginning in 2014, as a result of the Patient Protection and Affordable Care Act, employers who misclassify employees as independent contractors may be subject to an additional penalty regime. Section 4980H(a) of the Internal Revenue Code (the “Code”) imposes a penalty on “large employers” who fail to offer full-time employees health insurance with a minimum level of coverage. Because employers generally do not provide health care coverage to independent contractors, reclassification of an independent contractor to a full-time employee could trigger this penalty.

Large Employers and Full-Time Employees

The new penalty applies only to “large employers.” Whether an employer is a large employer is not always a simple determination. In general, a large employer is any employer with fifty or more full-time employees.

A full-time employee is an individual who works at least thirty hours per week. Currently, the Internal Revenue Service (“IRS” or “Service”) proposes the term “employee” include an individual who is an employee under the “common-law standard.” Prop. Treas. Reg. § 54.4980H–1(a)(13). A determination under the common law standard hinges on whether the employer has the right to control the individual who performs the services. Whether or not the “employer” exerts actual control is irrelevant. In determining whether the employer has the right to control, the Service analyzes numerous factors. Due to the large number of factors, the Service’s determination of whether an employer has the right to control a worker is highly subjective and its determinations are not always consistent.

The Penalty

Beginning in 2014, an employer may be subject to a penalty attributable to each month when:

  1. It is a “large employer” (because of reclassification or otherwise);
  2. It fails to offer all of its full-time employees (and dependants) the opportunity to enroll in “minimal essential coverage” under an “eligible employer-sponsored plan”; and
  3. At least one full-time employee is certified to the employer as having, for that month, enrolled in a qualified health plan with respect to which an “applicable premium tax credit or cost-sharing reduction” is allowed or paid.

IRC § 4980H(a). For each month the employer is noncompliant, the penalty is equal to:

  • The applicable payment amount per month (currently 1/12 of $2,000 or $166.67, adjusted for inflation after 2014), multiplied by
  • The number of full-time employees during any month (reduced by 30).

The penalty can be surprisingly high. Consider the following example:

Example. For all of 2014, an employer reports it has forty-five full-time employees and thirty-five independent contractors. On audit, it is determined the independent contractors are actually full-time employees and, therefore, the employer is a “large employer.” If one reclassified employee receives a tax credit, the employer becomes subject to the 4980H(a) penalty because it fails to offer minimum essential coverage and has eighty full-time employees.

$100,000 Penalty. For 2014, (for eighty employees) the penalty would be (80 – 30) × $2,000, or $100,000. In other words, for each employee over the thirty-employee threshold, the employer owes $2,000 ($166.67 × 12 months), for a total penalty of $100,000 ($2,000 × 50 (that is, 80 ? 30)).

Section 4980H(a) of the Code imposes the penalty on large employers who fail to offer their full-time employees health insurance meeting a minimum level of coverage and where at least one employee receives a tax credit or cost sharing reduction. This penalty could be triggered by an unsuspecting, otherwise compliant employer, if the government reclassifies one or more of its independent contractors as employees. In such cases, the employer could easily face a huge additional penalty.

Conclusion

Incorrectly classifying workers could become very costly with the addition of this new penalty to the government’s arsenal. As exemplified above, some employers could face penalties in excess of $100,000 per year. Thus, it is very important employers evaluate whether their independent contractors are at risk of being reclassified as employees.

Image courtesy of Flickr by SEIU International

 

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Larry Brant
Editor

Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.

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