Year-end planning strategies for businesses
When we first covered the tax implications of the Affordable Care Act (ACA) back in 2013, the key words were “play or pay.” This reflected an employer’s choice to “play” by providing required levels of healthcare to its employees or “pay” a penalty into the system to help employees pay to obtain that coverage. The focus was on large employers, defined as those where the sum of full-time and full-time-equivalent (FTE) employees is 50 or more.
Employer mandate: “Play or pay” continues for employers with 50 or more employees
On January 1, 2016, the Employer Mandate will be fully phased in. The Employer Mandate pertains to applicable large employers (ALEs) with 50 or more full-time or FTE employees. Employers meeting this threshold must offer coverage to 95% of their full-time employees (and their dependents under age 26) or be subject to penalties (or “shared responsibility payments”). (Prior to January 1, 2016, an ALE could satisfy the requirement by offering coverage to 70 percent.)
The ACA’s Individual Mandate went into effect on January 1, 2014. It requires that all non-exempted individuals meet the ACA requirements by either buying benefits through a variety of sources or being subject to an individual penalty. Penalties are adjusted for each calendar year.
The penalty for failure to have individual Minimum Essential Coverage for 2015 (assessed in 2016) is the higher of (a) $325 per adult (up to $975/family) or (b) 2 percent of household income over the tax return filing requirement threshold for your filing status (penalties for children under 18 without coverage are less than those for adults). For 2016, that penalty increases to $695 for an adult (up to $2,085/family) or 2.5 percent of household income over the tax return filing requirement threshold for your filing status. The penalty is capped and cannot exceed the national average cost of a bronze plan. However, as with any complex law, several exceptions apply.
Beginning in January 2016, for the calendar year 2015, ALEs are required to provide Forms 1095-C to each full-time employee and file Form 1094-C with the IRS to demonstrate that the health coverage offered is compliant with ACA requirements. All employers that sponsor self-insured plans also have Form 1094-B and 1095-B requirements regardless of ALE status. Plan sponsors must work closely with their insurance carriers, third-party administrators, payroll administrators, internal human resources and information systems personnel, and benefit plan advisor/broker/agent to retain and monitor the data and prepare the forms. These providers should be contacted immediately to help you comply with these requirements.
Surface transportation act: Tax provisions
Although 2015 was another quiet year for tax legislation, in late summer, the Surface Transportation and Veterans Healthcare Choice Improvement Act of 2015 (the “Act”) was passed. The Act is a stopgap measure to provide long-term financing for highway and transportation funding that must be revisited later this year
As with any act, there are a few major changes and several minor adjustments. The major changes affecting businesses include changes in filing deadlines for certain returns and changes in reporting bases to ensure consistency between estate tax valuations and bases used for income tax purposes for assets acquired from a decedent.
Tax return due dates
The Act accelerated due dates for most partnership tax returns by one month. For calendar-year partnerships, the due date will be moved from April 15 to March 15 beginning with the 2016 calendar-year returns. The Act also generally changed the due date for C corporations one month. For calendar-year C corporations, the due date would be moved from March 15 to April 15. It should be noted that the due date for C corporations with a fiscal year end of June 30 is not affected, presumably to keep the revenue within the government’s fiscal year ending September 30. Lastly, the due date for FBAR (Foreign Bank Account Reporting) forms will be moved from June 30 to April 15, the same date that individual and corporate returns are due. These provisions are effective for tax years beginning after December 31, 2015.
The due date-related provisions will provide greater consistency in reporting with “pass through” entities since S corporation returns and partnership returns will generally be due at the same time and one month before taxpaying entities (individuals and C corporations). This information will be beneficial to taxpaying entities, which will now generally share a common due date of April 15.
When a beneficiary receives an asset from a decedent’s estate, the income tax basis of the asset is the same as the fair market value of the asset reported on the estate’s tax return. Prior to this revision, estates weren’t required to provide detailed information on asset bases to beneficiaries or to the IRS. The new law requires that detailed information be provided to the IRS and to the beneficiary to ensure that the income tax basis used on a subsequent sale of the property is consistent with the valuation used for determining estate tax.
Basic business year-end planning
It’s important that all businesses begin their year-end planning early enough to effectively implement tax-saving strategies. Here are a few tips.
Net income deferral (or acceleration)
Cash basis taxpayers should consider accelerating deductions into 2015 by prepaying eligible expenses. If cash is in short supply, cash basis taxpayers may deduct credit card charges in 2015 that are paid off in 2016. Similarly, cash basis taxpayers should consider deferring income to 2016. Income can be deferred if it wasn’t actually or constructively received in 2015.
Accrual basis taxpayers may generally deduct cash payments made within 2½ months of the tax year end for employee compensation and bonuses. Payments made to long-term incentive plans may also be deductible, though payments to owners may not be. Payments made within 8 ½ months for certain “recurring items” may also be deducted if an election has been made.
The installment method of reporting gain
Taxpayers selling real estate may consider the installment method, which allows gain to be recognized over the period of time that payments are received rather than reporting the entire gain in the year of the sale.
Losses from pass-through entities like partnerships, LLCs, and S corporations may not be deductible if a partner, member, or shareholder is passive with regard to the investment or lacks sufficient basis. These basis rules differ by entity type, so determining basis limitations can often be complex.
Businesses often have carryovers of tax attributes like research and development credits, foreign tax credits, charitable contributions, capital losses, and net operating losses. It’s important to review these attributes and develop strategies to maximize their use. Similarly, businesses should determine if they qualify for any new credits or incentives available under the Internal Revenue Code.
An important tax benefit to domestic manufacturers, farmers, and architecture and engineering firms is the domestic production activities deduction (DPAD). This benefit reduces taxable income by 9% of qualified production activities income. The documentation of qualifying income and activities is important due to increased IRS scrutiny of this benefit.
In last year’s Year-End Tax Guide, we noted that companies were finally preparing to adopt the Tangible Property Regulations passed in September 2013. The regulations provided a long sought after clarification of expenditures that must be capitalized and expenditures that can be deducted as repairs. As taxpayers grappled with the new rules and reporting for their capitalization policies, the IRS granted relief, in February 2015, to “small taxpayers,” defined as those with less than $10 million in assets or $10 million or less in average annual gross receipts. The relief eliminated the requirement for small taxpayers to calculate the impact on historical taxable income. However, small taxpayers are required to apply the regulations prospectively.
While the Tangible Property Regulations require documentation of policies and procedures and the understanding of new, more complex, capitalization vs. repair rules, they also provide greater clarity. It should also be noted that some changes are taxpayer friendly, so there may be refund opportunities to deduct assets capitalized under old rules that can be expensed under the new rules.
As we near year end, all taxpayers should have adopted policies that comply with the new Tangible Property Regulations and should be applying the new rules. Since this is the first full year after implementation, now is a great time to make sure that businesses are in compliance with the new rules. Remember, capitalization policies have been updated, and taxpayers should be looking to maximize depreciation and expenses allowed under these regulations.
At the time this article was written, a group of 50 credits and deductions known as the tax extenders expired on December 31, 2014. This list includes:
- Research and Development Credit
- Low-income Housing Credit
- New Markets Tax Credit Work Opportunity Credit
- Accelerated depreciation of qualified leasehold improvement, restaurant, and retail improvement property
- Accelerated depreciation of certain business property (bonus depreciation)
- Increased expensing allowance for business assets, computer software, and qualified real property (i.e., leasehold improvement, restaurant, and retail improvement property)
- The reduction of the recognition period of built-in gains of S corporations
History has provided ample evidence that most, but perhaps not all, of these important tax deductions and credits will be passed retroactively back to January 1, 2015, and, potentially, extended into 2016. While Congress seems to debate whether to make certain credits permanent (like the Research and Development Tax Credit), budgetary concerns make passage of permanent tax cuts difficult.
Entity information: Tax classification
When forming a new business, a taxpayer should carefully consider the type of legal entity that should be formed since it may impact liability protection, governance, and registration requirements. The taxpayer should also carefully consider how the entity will be classified for tax purposes.
The most important factor of the tax classification is whether the entity will pay its own tax (like a C corporation) or pass through its income to its members, partners, or shareholders (like S corporations and partnerships).
C corporations are business entities that pay their own tax rather than “passing through” the income to their shareholders. However, C corporation shareholders are subject to a second level of taxation when dividends are distributed by C corporations to their owners. The top income tax rate for C corporations is 35 percent, while qualified dividends are currently taxed at up to a 20 percent rate (plus 3.8 percent surtax where applicable). S corporations and partnerships generally “pass-through” their taxable income to their owners. The owners, typically individuals, pay the tax on the entity’s income at individual income tax rates.
The top individual income tax rate on pass-through income is 39.6 percent (plus 0.9 percent or 3.8 percent surtax where applicable). Although the income tax rate imposed on owners of pass-through entities may be higher than the rate imposed on C corporations, the income earned by pass-through entities is generally not taxed a second time when it’s distributed. Through most of the last decade, effective individual income tax rates have been higher than C corporation tax rates. As a result, C corporations that don’t pay dividends may have a tax advantage compared to pass-through entities; however, pass-through entities have the advantage of not being subjected to double taxation when dividends are paid. Selecting the right type of entity and how it’s classified for tax purposes is important to minimize current taxes, taxes on dividends or distributions paid, and taxes on a company’s future sale.
Captive insurance companies
Captive insurance companies have been an effective planning tool for U.S. businesses since the 1950s. Captives are used for many different purposes, including easier access to foreign reinsurance markets, the ability to share risks with similar companies with similar risk management goals, or simply to allow greater control over a company’s risks (like health insurance).
While different forms of captives have attracted the attention of the IRS from time to time, the small insurance company (otherwise known as an 831(b) captive) is currently on the IRS’s “2015 Dirty Dozen List of Tax Scams.” This list provides insight into IRS priorities and areas that it will focus on in an audit. The captives being targeted by the IRS are described as those promoted by “unscrupulous promoters” who draft and price insurance policies that cover “esoteric, implausible risks for exorbitant premiums.”
If your company has a captive insurance company, all aspects of the arrangement should be documented and be on an arm’s-length basis.