Business Entity IssuesChapter 12 pp. 445-4852018 National Income

Tax Workbook™

Business Entity Issuesp. 445

Tax-Exempt Entities Update

Choice of Entity under the TCJA

Opting Out of the Centralized Partnership Audit Regime

Choice of Entity under TCJA p. 458

Changes due to TCJA:

▪ Tax rate for C corporations is flat 21%

▪ New Qualified Business Income (QBI) deduction IRC §199-A

Check the Box Regulationspp. 458 - 459

Selecting a C Corp. p. 459

Things to consider:▪ Tax rate/amount of income▪ Is income subject to SE tax▪ Income retained & distributed to owners▪ Is owner subject to NIIT▪ Tax consequences of conversion▪ QBI deduction▪ Other factors (both tax & non-tax considerations)

Tax Rates for C Corp p. 460

Individual tax rates 10%-37%

C corporation tax rate 21%

▪ MFJ marginal rate exceeds 21% when income > $77,400

▪ Average rate of tax for MFJ reaches 21% when income > $332, 921

SE Tax considerations pp. 460 - 461

If all income subject to SE tax, incorporated business is better Figure 12.4:

Retained Income p. 461

Business that retains income:▪ Generally owes less tax as C Corp ▪ Except if owner in 10% or 12% bracket

Business that distributes income:▪ Generates less tax as disregarded or pass

through entity:• Second level of tax• Net investment income tax (NIIT)

Examples 12.7 thru 12.12pp. 461 - 467

Fig 12.7 shows:With up to $202,600 income & a 50% distributionC corp & S corp both better than disregarded

Figure 12.8 shows:Above $202,600 & 50% distribution C corp is the better option

Figure 12.9 shows:If 100% distribution S Corp & disregarded are better

Net Investment Income Tax p. 467

3.8% on unearned income

Over threshold amount:▪ $250,000 for MFJ & qualifying widow(er)

with dependent child ▪ $125,000 for MFS▪ $200,000 for single & HOH (with

qualifying person)

No C distributions/ No NIIT

Examples 12.13 thru 12.16pp. 467 - 470

Examples 12.13 thru 12.16pp. 467 - 470

Tax Consequences of Conversion to C Corp p. 470

Partnership or multi-member LLC can do transfer, merger, election

If converting partnership doesn’t qualify or elect S Corp status, it will be a C

S Corp can revoke or terminate election

Transfer to New Corporationpp. 470 - 471

Assets-over form▪ Contributes assets & liab for stock

Assets-up form▪ Distributes assets & liab to members/partners▪ Members/partners contribute to corp

Interests-over form▪ Members/partners contribute interest for stock

Liabilities on Incorporation pp. 471 - 473

Liabilities can generate gain if:

▪ Contributed liabilities for tax avoidance or no business purpose

▪ Basis in assets transferred less than liabilities assumed by corp. excess is boot

S Conversion to C p. 473

Revoke election▪ File statement to revoke▪ More than 50% consent▪ Can be retroactive or prospective

Terminate election▪ Too many shareholders, ineligible

shareholder, second class of stock, etc.

S Termination Year pp. 473 - 474

Two returns: ▪ beginning of tax year through date of termination ▪ day after termination to end of the year

No reelection for 5 years

Reduce to 1 year if change in ownership and termination beyond control

QBI Deduction pp. 474 - 475

Reduces individual income tax rate by 20%

C corporation doesn’t qualify

S Corporation vs. SMLLC p. 475

Both pass through entities

SMLLC owner pays SE on all income

S corp. and owner pay FICA on wages▪ S corp. must pay reasonable compensation

S Corp. vs. SMLLC p. 475

S Corp can decrease SE tax by increasing wages

Wages paid by S Corp reduce QBI

Benefit of decreased SE tax offsets reduced QBI deduction

S Corp. vs. SMLLC pp. 475 - 476

S wages have 3 effects:

1. S Corp. & shareholder pay FICA

2. Converts to income that is not QBI

3. Above threshold, TP can claim higher QBI deduction

Figure 12.13 p. 476

Combining/Separating Entitiesp. 481

Compute QBI for each trade or business

Use grouping of activities to increase the QBI deduction for the combined group

Separate activities if one doesn’t qualify for QBI deduction

Grouping Businesses p. 481

Prop. Treas. Reg. 1.199A-4:1. Same person owns majority interest in each

trade or business

2. Majority ownership for majority of tax year

3. All items reported on returns w/ same tax year

4. None are specified service trade or business

5. Meet 2 of three factors

Factors Demonstrating Integration p. 481

Meet 2 of 3 factors:

a. Products/services are the same or customarily provided together

b. Share facilities or centralized business element

c. Operated in coordination w/ or reliance on others

Separating Businesses p. 481

Prop. Treas. Reg. 1.199A-5

Anti-abuse Rule 1▪ Specified Service includes any trade or

business that provides 80% or more of property or services & there is ≥ 50% of common ownership

▪ Less than 80%, only include portion

Separating Businesses p. 482

Prop. Treas. Reg. 1.199A-5

Anti-abuse Rule 2

If ≥ 50% or more common ownership & shared expenses, trade or business will be part of Specified Service if gross receipts not more than 5% of combined receipts

Separating Businesses p. 482

Partnership can distribute line of business to partners who then contribute it to new partnership

Corporation can do a spin-off, split-off, split-up▪ Need active conduct of trade or business, ▪ Transfer one complete trade or business, ▪ Retain one complete trade or business, and ▪ Not a device to distribute E&P

Opting out of the Centralized Partnership Audit Regime p. 483

May elect out of new regime if eligible

Eligible partnership▪ 100 or fewer partners during the year Based on required # of K-1s If H & W both partners = 2 S corp = number of S SH’s + S corp

Eligible Partners p. 483

Eligible partner includes:▪ Individual▪ C corporation▪ Eligible foreign entity▪ S corporation▪ Estate of deceased partner

Non-eligible Partners p. 483

Eligible partner does not include:▪ Partnerships▪ Trusts▪ Foreign entities that are not eligible▪ Disregarded entities▪ Nominees▪ Estates

How to Elect Out p. 483

Elects on timely filed return (w/extensions)

Election revocable only with IRS consent

Must disclose name, correct TIN, federal tax classification of all partners (includes S SHs if an S corp is a partner)

Each partner must be notified w/in 30 days of election

Effect of Opting Out p. 483

Audits conducted under pre-TEFRA rules

Exam at partnership level

Agreement or disagreement with adjustments at partner level

Advantages to Opt Out p. 484

1. Partners keep control of decisions2. No one person makes decisions for all3. Adjustments only for partners of reviewed year4. Audit adjustments in audit year5. No partnership role after exam6. Each partner gets computation of adjustment7. Each partner makes his/her own decision8. Differing results on appeal

Advantages to Opting Out Cont. p. 484

9. SOL determined at partner level10. Adjustments for smaller partners may be below

tolerance level11. Takes more IRS resources to audit large

partnership12. Aggregate liability is more realistic13. Adjustments more straight forward14. No need for partnership representative 15. All regulations are not final

Disadvantages of Opting Out pp. 484 - 485

1. Closer scrutiny of individual returns2. All partners need SSN, ITIN, or EIN3. Opt-out is limited by type and # of partners4. Higher cost per partner for appeal5. Different results on appeal may be unfair6. Partnership has to collect info 7. IRS can later determine election invalid8. Revocation of election only w/ IRS consent

Guidance for DAFs p. 446

Donor-advised fund (DAF)▪ Sponsoring organization controls fund

▪ Separately identified donor contributions

▪ Donor advises distributions

▪ Excise tax if donor (or related persons) advises distribution and receives more than incidental benefit

Notice 2017-73 p. 447

Can donor/adviser advise DAF to pay for donor’s participation in charity event?

Can donor/adviser advise DAF to satisfy a charitable pledge?

Is the DAF being used to avoid public support limits

Charity Sponsored Events p. 447

No DAF distribution allowed that subsidizes attendance at charity event

No DAF distribution allowed for membership fee

Donor/adviser should pay directly

Charitable Pledges p. 447

Can use DAF distribution to satisfy donor/adviser’s charitable pledge if:

▪ No reference to pledge when making distribution

▪ No other benefit

▪ Donor/adviser doesn’t claim deduction for distribution

Public Support pp. 447 - 448

Individuals using DAF to avoid the Public Support Limits

Public Support Test:

▪ Exempt entity must receive substantial support from the public

▪ Grants/contributions from individual >2% don’t count

▪ 2% limit doesn’t apply to Public Charities (DAF)

Public Support Con’tp. 448

Regs would treat contribution from DAF as contribution from donor

Anonymous contributions treated as coming from one person

Distributions from supporting organization, not subject to limit if they specify not from DAF

UBTIpp. 448 - 449

Unrelated Business Taxable Income (UBTI):

▪ Tax on trade or business income unrelated to exempt activities

▪ $1,000 or more report on 990-T

UBTI Exclusionsp. 449

UBTI Exclusions:

▪ Volunteers perform all work

▪ Income from sale of donated goods

▪ Activities carried on for the convenience of anyone associated with the organization

▪ Trade Shows, State Fairs and Bingo

▪ Distribution of low cost items

Calculating UBTI pp. 449 - 450

Prior to 2018:▪ Aggregate all trade & business activities▪ Subtract all deductions from all▪ $1,000 deduction

For 2018:▪ Calculate separately for each trade & business▪ Deduction from one can’t offset income from other ▪ $1,000 deduction applies to each▪ UBTI includes non-deductible fringe benefits

Written Advice for Private Foundation Grants pp. 450 - 452

General rules▪ Private foundation has to make minimum

distributions - grant to public charity counts

▪ Private foundation no expenditure responsibility for distribution to public charity

Rev. Proc. 2017-53▪ Foreign charity treated like 501(c)(3) charity

Written Advice Guidelines pp. 450 - 451

Foreign charity has no US determination letter

Make equivalency determination

Safe harbor written advice guidelines:▪ Reasonable factual/legal assumptions▪ Identify/consider all fact/circumstances▪ No unreasonable reliance▪ Relate applicable law/authorities▪ Don’t consider audit possibility

501(c)(3) Written Advice p. 451

MUST INCLUDE:English translation Controlled organizations

Exempt purpose List of activities

Distribution provisions Verify not a terrorist

No ownership Policy against discrimination

Don’t influence legislation

Form 1023-EZpp. 452-454

Form 1023-EZ Streamlined Application for Recognition of Exemption under 501(c)(3)

Use if: Annual gross receipts $50,000 or less

▪ Projected for current & next 2 years▪ Actual for prior 3 years

FMV assets not more than $250,000

Ineligible to use Form 1023-EZ pp. 452 - 453

Can’t use if: Foreign/no US mailing address Terrorist orgs Trusts, LLCs or for-profit entities Revoked (other than non-filers) Churches, schools, hospitals, etc. Community foundations Private foundations

Form 1023-EZ Updates p. 453

Changes to Form 1023-EZ:

▪ Part III description of activities

▪ Verify annual gross receipts, assets & classification

▪ Reinstatement requires same classification for auto-revoked entities

▪ Check boxes added to designate if church, school, or hospital

1023-EZ Processingp. 454

Reject if auto-revoked and seeking different classification

Refer if private foundation seeking reinstatement as public charity

Refer if contrary narrative

Reject or refer if incomplete narrative

Reject if not eligible

New Form 1024-A pp. 454 - 455

Form 1024-A – application for 501(c)(4) status

Application only 4 pages (down from 19 pages)

Civic leagues, social welfare, employee association

Filing F1024-A is optional – Form 8976 is not

Modification of Procedures pp. 455 - 456

Rev. Proc. 2018-5▪ Procedure to request exempt status▪ No determination for marijuana bus.▪ No determination to relinquish status

Rev. Proc. 2018-10▪ Submit 1024-A for (c)(4), 1024 for others▪ Authorized representative must sign▪ TP must sign penalty of perjury declaration

Change in Form or Place of Organization pp. 456 - 457

Rev. Proc. 2018-15, no new app if change in:▪ Incorporation▪ Reincorporation in a diff. state▪ Statutory merger

Surviving org. is domestic bus. entity, corp., same purpose