The tax reform legislation that Congress approved Wednesday has a number of complexities that could prove problematic for tax professionals and their clients.
“In the international tax arena, the 100 percent exemption for foreign source portion of dividends received from a 10 percent owned foreign corporations could result in the IRS ramping up its scrutiny of transfer pricing policies and applying a stricter application of the sourcing rules," said Leo Parmegiani, a tax partner at PKF O’Connor Davies. "Multinational corporations will need to be aware the game has changed and plan accordingly. Also not well publicized is that this exemption is only available to C corporations that are not RICs or REITs . Additionally, contrary to the intended stimulus on the U.S. economy, this new provision could actually encourage businesses to move their resources offshore if such earnings could be repatriated back to the US without further taxation. A comparison of the new lower U.S. tax rate could mitigate this concern.”
Bill Smith, managing director of CBIZ MHM’s National Tax Office, thinks businesses may want to use the existing expensing rules by the end of the year before they go away. “One issue is for businesses to take advantage of the full expensing by buying and placing tangible assets in service by Dec. 31 to take advantage of the higher entity and pass-through effective rates this year (the provision applies for assets after Sept. 27),” he said.
He cautioned against an earlier recommendation of paying 2018 state income taxes in 2017, pointing out that the conference committee has now killed that option.
Smith advises modeling this year’s taxes based upon the deductions that are disappearing next year. “You may want to do the opposite of the traditional idea of deferring income to a lower tax rate year, if you have enough deductions to reduce your high tax rate year,” he said.
The American Institute of CPAs expressed disappointment that the tax reform bill didn’t provide the same favorable tax treatment for accounting firms as it does for other pass-through businesses and for C corporations. “While the tax reform legislation contains several provisions that should be welcomed by CPAs and their clients, the AICPA is very disappointed by lawmakers’ decision to exclude CPAs from the measure’s treatment of pass-through entities,” said AICPA president and CEO Barry Melancon in a statement. “Congress should have provided parity for pass-throughs, regardless of their line of business, in order to achieve a fairer, simpler, and more competitive tax code. The AICPA pointedly and repeatedly made the case that all professional service firms–including accounting firms–should have received the new deduction. The professional services sector, a critical element of America’s economic success, has been ignored.”
Melancon pointed out that it’s not easy for CPA firms to simply reorganize themselves as C corporations. “Accounting firms play an important role in the nation’s growth and job creation and legislators erred in excluding them,” he said. “Those who suggest that CPA firms can adjust to the change by reforming as C corporations do not understand that the nature of state licensing regulations make such a transition impractical, if not impossible.”
Jon Traub, managing principal of tax policy at Deloitte Tax LLP, acknowledged the bill may have unintended consequences. “The scope of what Congress was able to achieve cannot be over-emphasized and will have major ramifications,” he said in a statement. “Congress approved tax reform in record time; however we will not see its full impact for some time, as Treasury implements it and companies react to it. With a bill of this size and complexity, there will be unintended consequences that will need to be worked out on both the regulatory and policy levels. The Treasury Department will be very busy in 2018 and beyond, helping provide certainty to taxpayers, soliciting comments and drafting guidance. Companies will have to carefully consider the impact of the law in their own context.”
Accountants should start on earnings and profits studies early if their companies might be subject to the new deemed repatriation rules for multinational companies, Smith recommended. “Determine if there is any benefit to actual repatriation prior to year-end, given your foreign tax credit situation,” said Smith.
Corporations are getting more benefits from the new tax reform bill than professional services businesses such as accounting firms. Some service businesses may decide to reconstitute themselves as C corporations, but that opens up new complications. Some accountants may find themselves using some familiar old tax strategies once again. “If for some reason there’s a resurgence of using C corporations, some of the old rules that have been pushed aside or neglected, such as the sale or disposition of stock in a corporation at a loss, would be resurrected,” said Edward Mendlowitz, a partner with WithumSmith+Brown. “Also tax-free incorporations under section 351, or investment in small business corporations under section 1202, would start to be used more. Assuming the C corporation route makes more sense, the pass-through entities like LLCs can elect to be taxed as a corporation on Form 8832, so you don’t have to be a C corporation to be taxed as a C corporation.”
Some service businesses may balk at the different treatment they will now receive under the tax reform bill.
“They’re making a major change, a big change,” said Mendlowitz. “They actually discriminated against different types of businesses. They separated heavily capital intensive businesses from service businesses.”
Nevertheless many service businesses employ working capital to invest in areas such as artificial intelligence technology. “My firm has a very large investment in artificial intelligence,” said Mendlowitz of Withum. “They’re ignoring that service businesses are doing that. They’re ignoring that service businesses are growing. Those growing businesses need capital in the business just to fund growth. A service business needs to buy real estate. If you’re an accounting firm or an architecture firm you have to spend a lot of money building offices. These are issues that are going to be coming. We want to look at ways to help our clients as much as possible.”
The legislation is likely to require a technical corrections bill to fix drafting errors and loopholes, along with extensive regulations to work out the details of what's in the law.
“After the dust settles and Congressional Republicans celebrate their hard-won victory, their attention will likely soon turn to the inevitable legislative work of fine-tuning and perfecting the new tax framework,” said John Gimigliano, partner-in-charge of Federal Tax Legislative and Regulatory Services at KPMG, in a statement. “As we’ve seen with other major tax legislation, it can often take years to issue all the regulations and revisions related to a bill, and there’s no reason to think this one will be any different.”
States will also face dilemmas with how to set tax policy as the tax reform bill limits deductions for state and local income taxes, sales taxes, and property taxes to $10,000. Scott Peterson, vice president of U.S. tax policy at the tax software company Avalara, used to be director of sales tax for South Dakota, where the only income tax applies to banks. “Every time Congress changed their corporate income tax, the state would have to hire an economist and a CPA to look at how that would affect the income reported by banks in South Dakota to see does this increase revenue to the state, or does it decrease revenue to the state,” he recalled. “Regardless of whether there was a positive or a negative, the state legislature would have to decide do we want to collect less revenue or do we want to collect more revenue. It’s always a decision the state makes.”
The impact of the tax reform bill is likely to be far-reaching for the coffers of many state and local governments around the country. “Just about everything that’s part of the darn federal corporate and personal income tax has changed somewhat," said Peterson. "There’s going to be an immense amount of work required by state legislatures and state economists to try to understand how those things flow down to their taxes and whether or not they want that outcome or not. If you’re a legislature and you’ve got to make all these changes to your personal and corporate income tax, you might throw your sales tax into the mix just to see maybe there’s something you can’t do to resolve an issue in your personal or corporate income tax, but you can’t do it in your sales tax. I’m expecting to see lots of conversations because it truly is an immense undertaking that these states are going to have to go through just to understand what the effect is. Often, I remember we had to hire outside people to do the analysis because we did not have the data to know whether even relatively minor changes to the federal corporate income tax would affect the income tax on banks. In this case, every business is going to be affected.”
If anything, the tax reform bill will encourage businesses to consult with their accountants for advice on all the new changes. “There are a lot of moving parts, so it has never been a more important time to get with their accountants and model out scenarios of options this year versus next year,” said Smith.
(This story was updated to remove advice about a provision that was changed regarding FICA and Medicare taxes for S corporations)
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