Q&A … With Dan Friederich
The managing director for the tax division of CBIZ reflects on changes wrought by the federal reforms passed in December 2017, mistakes that business owners continue to make, and where things stand as tax season begins.
“ The current tax rate disparity provides businesses the opportunity to revisit this paradigm and reconsider business issues that may favor a different entity selection”
— Dan Friederich, Managing Director, Tax Practice, CBIZ
>Q: With a year under our belts to really digest the implications of the December 2017 tax reforms, have there been any significant revelations in there that have come to be more fully understood throughout 2018?
A. The IRS spent 2018 clarifying several provisions and have issued an enormous amount of guidance. They have done a pretty good job wading through the massive tax law change and trying to give taxpayers clarification of the new laws. Specifically, a few items that stand out included:
- Additional clarity on the operation of the new 20 percent deduction for pass through entities (Section 199A). The IRS issued regulations defining the types of businesses that qualify and don’t qualify for the deduction. Furthermore, the IRS put definition on how to aggregate or not aggregate related businesses for purposes of this computation.
- Under 163(j), the interest-deduc-tion limitation rules, the IRS issued an unpopular regulation trying to disallow the depreciation addback for com-puting the deductible portion of interest expense. The standard rule for the first few years of the law was that interest deductions were limited to 30 percent of an adjusted income number typically understood to be income before taxes, amortization and depreciation. The IRS interpretation disallows the addback of depreciation to the extent it relates to the cost of goods sold portion of the taxpayer. This interpretation caught many by surprise.
- Parking expenditures for employ-ees and taxable fringe benefits also caught many by surprise. The IRS provided guidance recently to help taxpayers quantify this previously tax-free fringe benefit to employees. Now, practically, employers are no longer deducting any costs associated with employee parking costs.
- Within the new law, a provision about book (GAAP) and tax conformity for revenue recognition under ASC 60—a GAAP provision providing guidance on book revenue recognition—has provided some significant issues for some taxpayers. The legislative intent of this provision’s applicability is probably not as wide as the framers provided. This will be an interesting issue to watch as the wheels of Congress try to find resolution soon.
Q. What’s the impact of that “uh-oh” moment with the 163(j) determination?
A. It’s just math: people will be paying more taxes than they were anticipating all year long.
Q. How will the parking provisions you just mentioned play out in a car-centric community like Kansas City?
A. It’s going to be an unpleasant surprise for some people. But there’s a lot of free parking in Kansas City. This
rules approach the IRS has provided is more appropriate for the New Yorks, Los Angeleses, and Chicagos of the
world and less applicable to the Kansas City metro area.
Q. How significantly did that rewriting of the tax laws change the game for corporations?
A. For most businesses in the Kansas City area, the new laws provided an opportunity for closely held businesses to revisit entity selection. In the past, flow- through entities were highly preferred due to rate equivalency and more efficient exit strategies. The current tax rate disparity provides businesses the opportunity to revisit this paradigm and reconsider business issues that may favor a different entity selection. For larger corporations, the entire tax reform was a big game changer. While the overall rates went down from 35 percent to 21 percent, the ability for deferrals using multinational structuring was significantly impaired. Some companies are saving money and some are spending more on taxes. It probably favored domestic-based corporations more than multinational companies. But that will be analyzed thoroughly over the coming years.
Q. Which types of corporate enti-ties were most positively affected, and which might not have benefitted (based on revenue or employee size, perhaps, geography or other considerations)?
A. Businesses with less than $25 million in revenue received a few tax-sim-
plification rules that will provide immediate tax savings via deferral mech-
anisms. They probably received the biggest positive effect.
Q. Can you elaborate for a bit on what those deferrals might include, and how they could be applied?
A. There are a few opportunities, the first of them choosing your overall method of accounting for revenue recognition. Typically, businesses run on the accrual method; now, any company that as less than $25 million of 3-year trailing average revenue can use cash method. That becomes important for businesses that have large receivables and small payables.
Q. For instance?
A. Trucking is a classic example, where you have payroll out on a weekly basis, but companies you carry for are paying you at 60 or 90 days. That’s the biggest, easiest way to take advantage of these changes for small businesses.
Q. Are there other opportunities for small business owners to maximize the benefits of current tax law?
A. Unfortunately, because the tax law has broad implications, the only way to answer this question is to model out different scenarios which may include growth strategies, entity selection, exit strategies. Businesses should have (last year) or plan to (this year) undertake a comprehensive modeling exercise so the business owners and taxpayers fully understand the integration of the tax laws with the business.
Q. For smaller companies, what impact is Section 199A of the new law having? And have you seen any data that suggests owners are failing to recognize the availability of that provision?
A. Generally, taxpayers are well aware of Section 199A. This provision is of significant benefit to those qualifying businesses operating as a flow through entity. It effectively takes the highest marginal rate from 37 percent to 29.6
percent, which is a big tax difference. However, the reduced rate under Section 199A is still higher than the
statutory rate inside of corporations which is 21 percent.
Q. What continue to be the biggest mistakes they might make (such as inaccurate payroll records, improperly calculating quarterly estimates, employee/contractor confusion, etc.)?
A. It’s too early to really know this. Several taxpayers will be extending this
year due to the significant law changes. The extensions will allow for the tax-payers to better understand how to implement the new rules as the IRS is providing clarity on a weekly basis.
Q. How has the Kansas turn-about on small business tax structures played out with companies that had made the move to capitalize on that?
A. We have not seen a specific example where this provision has instigated a relocation. However, it will con-
tinue to be a factor when the states try to attract new or expanding business in the metro area.
Q. What other developments and trends in business tax law—and in individual tax law as it applies to business owners—has your team been working hard to communicate
A. The biggest development, in addition to the continued guidance and clarity of the new law, is the Op-
portunity Zones. We recently received and anticipate additional regulations soon codifying the rules on how to execute these tax strategies. The tax incentive has broad bi-partisan support and will be around for many decades. Different investment funds, private and broadly distributed, are focused on capitalizing on this market. This will be something to monitor over the next few years.
Q. Does anything else stand out?
A. Generally speaking, for the smaller business, this is really an op-portunity for planning and effective management of taxes: How do we take advantage of some of the simplification provisions of the new tax law? There weren’t too many surprises. But when-ever there is change, there are some compliance issues, but this is really an opportunity for planning.
Q. The best way to approach that?
A. This tax law has driven home the need for business owners to plan and forecast. But getting to the answer is a process you can’t always do effectively. It’s the inputs: how much money will you make three or four years from now? The planning process to take advantage of the new tax law has never been more important.
Q. Does that imply use of or cre-ation of new metrics or planning tools for owners?
A. No, but what really came out of it was the ability for owners to rethink their overall organizational structure. For decades, it was easy for advisers, accountants or attorneys to advise closely held c0mpanies to be pass-through entities. This law made those businesses at least reconsider that. It’s no longer an easy decision, and a lot more variables go into that. The math isn’t quite as clear any more.