Business Counseling

The “amazing loophole.” Time to convert your your LLC or S Corp into a C Corporation?

During my career, I have represented hundreds of small businesses during their formation and start-up phases. For the vast majority of these clients, I recommended an LLC due to the LLC’s ease of legal maintenance and structural practicalities. Very infrequently would I recommend a C Corporation-type. That may change now; the proposed tax consequences may shift the balance in favor of the C Corp. And this also raises the question whether existing LLCs and S-Corps should convert into a C Corp. Per Inc. magazine

“There are many positive aspects to this tax law for small businesses,” Reitmeyer says. But the most eye-catching, in terms of financial relief? The new maximum corporate tax rate of just 21 percent, a substantial drop from the current 35 percent. . .

Here’s why: Most U.S. small businesses currently don’t qualify for the reduced corporate tax rate. The majority of small enterprises are structured as pass-through entities such as limited liability companies or S corporations, where profits are taxed according to the owner’s personal rate. While there is some tax relief in the bill for those pass-through firms–including a temporary ability to deduct up to 20 percent of income–many could access the permanent cut by converting to full-blown C corporations. . .

“I do believe it’s an amazing loophole,” says Anne Zimmerman, founder and CEO of the Cincinnati-based small businesses accounting firm Zimmerman and Co., who is recommending that some of her clients convert to C corps.

This could be huge. Mind you: Pass-through businesses like LLCs and S Corps account for more than 95 percent of all of America’s businesses in 2012. This strategy will not be appropriate for all LLCs and S Corps though.

Some suggest that if your business generates income of less than $315,000, you are already insulated from having to pay higher taxes, since the pass-through deduction will generally apply. “If your annual gross income [AGI] is less than that, there’s probably very little you need to do as far as re-structuring,” Marcum’s Reitmeyer says. “You’ll have no [deduction] limitations.”

UPDATE: If you want a mind-numbing walk-through of the taxation calculus involved for just one phrase of the new law which will be encountered by accountants in 2018, read this article entitled: “Tax Geek Tuesday: Making Sense Of The New “20% Qualified Business Income Deduction.”

Regardless of how the plan may have been sold to the public, the foundation of the recently-enacted Tax Cuts and Jobs Act was the reduction in the C corporation tax rate from 35% to 21%. But Congress couldn’t do this in isolation, because such a a one-sided dramatic decrease would cause the business playing field to tilt, with sole proprietors and owners of flow-through entities losing much of their advantage over their corporate competitors. To wit, the effective combined rate on corporate owners would become 39.8% (21% + (79%*23.8%), while the top rate on ordinary individual income — the rate applied to the income of sole proprietors and owners of flow-through entities, whether distributed or not — would become 37%. Thus, the advantage of a single level of taxation would shrink from 10% to just 2.8%. . .

After the House and Senate initially approached the non-corporate tax break from very different angles, the final law found some common ground, resulting in the creation of Section 199A, a new provision of the Code. On its surface, Section 199A will allow owners of sole proprietorships, S corporations and partnerships — and yes, even stand-alone rental properties reported on Schedule E — to take a deduction of 20% against their income from the business. The result of such a provision is to reduce the effective top rate on these types of business income from 40.8% under current law to 29.6% under the new law (a new 37% top rate * a 20% deduction= 29.6%).

Courtesy of this new deduction, sole proprietors and owners of flow-through businesses retain their competitive rate advantage over C corporations: it is 10% under current law, and will be 10% under the new law (39.8% versus 29.6%).

This is an overly, highly, incredibly broad summary of the law change. Read that article and it will dispel the “File your Taxes on the Postcard argument.” This law could be called the Tax Accountant Full Employment Act.

Converting an LLC or S Corp to a C Corp in Alabama can be quickly performed. Alabama has a statutory procedure to convert an LLC to a corporation.  Alabama allows what is called “statutory conversion.” You do not need to separately form a corporation before the conversion can occur. (As the conversion statute puts it, a converted entity [the new corporation] “is for all purposes the same entity that existed before the conversion.” Per 10A-1-8.01:

The terms and conditions of a conversion of a limited liability company to another entity must be approved by all of the limited liability company’s members or as otherwise provided in the limited liability company’s governing documents.

Accordingly, if you have an LLC or S Corp, you need to seriously consult your accountant and/or tax advisor to ascertain the tax consequences of each entity for your situation.

 

New tax bill will effectively eliminate the federal Estate Tax (What will BigLaw Estate Planning divisions do now?)

Well, this week’s earlier blog post about the 2018 Estate and Gift tax credits and exemption is already stale and probably bad law. Yesterday, Congress passed a stunning tax plan and President Trump is expected to sign the bill. (The bill has received great criticism because it increased the deficit by 1.5 trillion.) The bill makes dramatic alterations to the federal Estate and Gift Taxes.

Let’s examine a bit of history first. When I came out of law school in 1999, the federal unified credit equated to $650,000 . (52,000 estates paid the tax in 2000 when the exemption was $675,000.) Most couples would employ trusts in order to take advantage of each other’s unified credit and not waste it under the standard unlimited marital deduction.

Then the amount increased to $675,000 in 2000. Then for 2002-2003, it was $1 million. Congress had built in automatic increases for 2004-2005 to $1.5 million, $2 million for 2006, 2007, and 2008. Then $3.5 million for 2009. The forgot 2010. Then it was raised to $5 million in 2011. Then President Obama smartly added inflation indexing to the $5 million. So the actual amount began increased based off annual inflation. By 2017, because of inflation, the credit had increased to $5,490,000 per individual. However, President Obama also allowed couples to use each other’s unified credit through a process called portability. (There are some nuances to portability that are not capable of being quickly explained.)  So, as a general principle, a married couple could transfer about $11,000,000 estate tax free.

Now comes the new law. For estates of decedents dying and gifts made after December 31, 2017 and before January 1, 2026, the Act doubles the base estate and gift tax exemption amount from $5 million to $10 million.

As explained on Forbes:

The tax bill, passed by the House and Senate yesterday, temporarily doubles the annual exclusion amount (the exemption) for estate, gift and generation-skipping taxes from the $5 million base, set in 2011, to a new $10 million base, good for tax years 2018 through 2025. The exemption is indexed for inflation, so it looks like an individual can shelter $11.2 million in assets from these taxes. Another federal estate law provision called portability lets couples who do proper planning double that exemption. So, a couple could exclude $22.4 million.

There will be a lot of planning immediately whereby couples will lock in the proposed law before future Congress changes its mind. They will likely employ the lifetime gifting provisions.

The law’s sunset means that, absent further Congressional action, the exemption amount would revert to the $5 million base, indexed. . . Under current law, each person for 2018 had a $5.6 million exemption. Now each person will have an $11.2 million exemption. So, a couple has an extra $11.2 million to gift or transfer at death. “It’s better to give now while the law is certain,” she adds.

What will these gifts look like? A memo circulated yesterday by estate planner Ronald Aucutt with McGuireWoods says strategies to consider include:

  • Making gifts to existing or new irrevocable trusts, including generation-skipping trusts
  • Leveraging gifts to support the funding of life insurance or existing sales to trusts and
  • Pairing gifts with philanthropy (such as a charitable lead trust)

I think this law ultimately eliminates the need for advanced-tax estate planning for most families. Joint Committee on Taxation estimates the number of taxable estates would drop from 5,000 under current law to 1,800 under the new law in 2018 in the entire nation. I am glad I didn’t narrow my practice (as I originally planned in law school) to tax estate planning.

 

 

Pitino should have seen that one coming. Louisville strikes back.

As I wrote about lessons to be learned from Rick Pitino’s lawsuit against Louisville, here is another lesson: when you sue someone, you open the litigation door and you never know what is going to come flying back at you. In Pitino’s case, its a counter-claim; Louisville has sued him back.

Louisville contends that Pitino is liable for breach of contract, negligence and unlawful interference with business relationships between the university and the NCAA, Atlantic Coast Conference, media companies, TV networks and sponsors. Louisville also demands that Pitino indemnify the school for any penalties it must pay to the NCAA for wrongdoing connected to his acts.

There is a technical legal reason why this should have been expected and also a practical one. The technical legal one:

One reason for Louisville to include counterclaims is the legal principle of “res judicata” which is sometimes called “claim preclusion.” In its simplest form, res judicata requires that legal claims stemming from a case must be litigated in that case, and that many types of related claims cannot be litigated once the case is resolved. Federal Rule of Civil Procedure 13(a) outlines res judicata, and it applies to Pitino’s federal lawsuit. As a result, Louisville likely needed to include claims against Pitino while the court (U.S. District Judge David Hale) considers Pitino’s arguments.

And the second is to gain leverage in settlement:

Louisville’s counterclaims are also designed to raise the possibility that Pitino might need to pay the school for the damage it believes he caused. Such damage, Louisville asserts, goes beyond a mere failure to perform his contract.

 

Schiano may get 75% of $27.7 million from UT

As a follow-up on my previous opinions on the Greg Schiano-Tennessee vols mess (see here, here, here), the executed memorandum of understanding has been released:

Paragraph 4 of the MOU deals with termination without cause by the University. It states that the University of Tennessee may, in its sole discretion, terminate the MOU without cause and provide Schiano 75% of the base pay and supplemental pay as stated in the document. The MOU would have paid Schiano $27.7 million over the span of six years.

Ouch.