Whenever there is a new Tax Bill we can find opportunities. With the Trump Tax Bill most of the opportunities are in the corporate world. Part of Trump’s reasoning is that if we give tax cuts to the business it will trickle down to the employees. This may be true, but it is also true that the owners of the business will see some “trickle down” too. That might be where the “real” planning opportunity is. Here is a brief summary:
Choice of entity
Choice of entity depends upon tax and non-tax factors. All such factors should be considered when deciding which type of entity is most advantageous. From an income tax law standpoint, the new 21% flat tax on C corporations is attractive. For some business owners, the first instinct might be to change to C corporation status. However, profits of C corporations are still subject to double taxation when distributed to shareholders. Also, if the C corporation sells most or all of its assets to an outside party (often referred to as an “asset sale”), the sale may be subject to double taxation.
Business owners of pass-through entities are subject to one level of taxation based on individual tax rates with a possible 20% tax deduction against their pass-through income. However, the 20% tax deduction may be reduced or eliminated based on individual taxable income and other factors. The possible reduction or elimination of the 20% tax deduction for pass-through income would be an important factor to consider, particularly for business owners of profitable S service corporations. If an S corporation converts to a C corporation, no immediate gain or loss is generally realized upon conversion. Once the S election is revoked or terminated, however, the corporation cannot elect S status again for five years without IRS approval.
Business planning and life insurance
In larger C corporations that were previously subject to the alternative minimum tax, cash value life insurance may be more attractive in the absence of that tax. For some business owners, an executive bonus to a key employee that increases deductible wages may result in a higher qualified business income deduction by raising the wage portion of the calculation. This may increase the appeal of an executive bonus or restricted bonus plan.
With a lower business tax bracket, some business owners may revisit their qualified plans if these plans are the primary vehicle for their retirement funds. With the sunset provision for lower individual income tax rates, business owners may be receiving qualified retirement distributions in a higher tax bracket. A simple non-qualified bonus plan funded with life insurance may be attractive as a supplement to qualified plan benefits.
Personal planning for business owners
Since the new deduction for qualified business income is applied on the basis of an individual owner’s taxable income, taxpayers who own a pass-through business may wish to consider planning steps at the personal level. These may include making charitable gifts, deferring income, and accelerating deductions to manage taxable income levels. A business owner whose spouse has high earnings or income even from an unrelated business may be subject to phaseout of the deduction based on the taxable income on their joint return.
Cross purchase buy-sell arrangements
Many small business owners, particularly in businesses with two or three owners, may prefer to own the policies on themselves that are used to fund a cross purchase agreement, but may have been advised against it. This is due to (a) possible estate inclusion of both the business and the life insurance death benefit, (b) the need for a split dollar agreement and yearly inclusion of the value of the economic benefit, and (c) possible “transfer for value” concerns which may cause a portion of the life insurance death benefit to be considered taxable income to the beneficiary of the proceeds. With the increase in the estate exemption to over $11 million, more owners might find owning the policies themselves more appealing (assuming there’s no “transfer for value” problem).
Key employee retention and retirement
The underlying reasons for these arrangements — to recruit, reward, retain and retire top employees — are unchanged. Bonus plans, non-qualified deferred compensation plans, and split dollar arrangements are commonly used to achieve these goals. The reduced taxes mean that more funds may be available for these plans.
The changing tax environment is a great time to look at business planning goals, such as succession planning, business protection, employee retention, and protection of business owners’ families and lifestyles. The income tax reductions may make more funds available for meeting these goals. In addition, business owners might find that a bonus arrangement or other change in wage structure could offer a more favorable outcome for the new qualified business income deduction.
While many of the benefits of the Tax Cuts and Jobs Act are set to sunset after 2025, the basics and benefits of planning never expire. As with all business planning strategies, it’s vital that businesses consult with local counsel for detailed tax and legal advice. This is your opportunity to be the quarterback on the planning team. Knowledge is power.