Are you aware of the 2016 tax return due date changes for certain federal and state income tax returns? The changes will have the greatest impact on flow-through entities including S corporations and partnerships, as well as C corporations. Individual income tax return due dates are not impacted. The legislation signed into law by President Obama last year, also known as the Highway Act (P.L. 114-41), generally affects returns with tax years beginning after December 31, 2015. For your convenience, the Aronson tax team has summarized the changes below.
Partnership return due dates have shifted from April 15, to March 15, or the fifteenth day of the third month after a fiscal year-end. This should facilitate timely preparation of Schedule K-1s for individuals and organizational owners or partners whose returns are due on April 15. S corporation income tax returns will remain due on March 15.
Corporate taxpayers’ income tax return is now due on April 15, a month later than the previous March 15, deadline. Corporate income tax returns for fiscal year taxpayers will be due on or before the fifteenth day of the third month following the close of the fiscal year. Certain exceptions apply to C corporations with taxable years ending on June 30.
State Income Tax Returns
Most states have changed their rules to conform to the federal due date modifications, or have existing due dates that do not require changing the rules in order to conform. There are a handful of states that have not conformed to the new federal C corporation return due dates. Notably, Illinois and Massachusetts still have a March 15, deadline for C corporations. Aronson is actively monitoring developments in these jurisdictions and will issue an update early next year.
Other Important Due Date Changes
Other federal due date changes from the Highway Act include:
Adjusting to the new deadlines may be a challenge for some taxpayers. Please feel free to contact Grant Patterson, Michael L. Colavito, Jr., or your Aronson tax advisor at 301.231.6200, if you have any questions or concerns related to these changes.
There are many tax reasons why a small business organized as a limited liability company (LLC) chooses to operate as a flow-through partnership or disregarded entity taxed as a Schedule C filer on Form 1040. What happens, however, if you have successfully operated your business as an LLC, but have reached a point in your personal life that you want to achieve maximum liquidity and are willing to share continued success and the potential upside with your employees? Your exit strategy options may be very limited because you are a small business with a limited pool of viable potential buyers, if any. This is a common scenario among successful, small government contractors that primarily depend on size standards for new contract awards, including re-competes and renewals, making them an unattractive target candidate to larger organizations (i.e., because of contract novation and re-compete constraints).
When you peel back the layers of the onion, so to speak, what generally makes an organization an attractive target? Who knows your business best (i.e., real insider information)? Who is the best candidate to acquire your business? In today’s tight credit market, you will not be able to secure 100% third party financing and will need to partially self-finance the sale transaction and take the junior lien position to third party lenders.
In consideration of all of these important questions, an owner should strongly consider the possibility of selling its business to its employees, including the existing management team. As an inducement to the selling party, the issuance of warrants with an upside (regarding future appreciation rights upon a future sale event) can be attached to the subordinated debt financing. The terms and conditions, however, must be properly structured in order to avoid second class of stock successful determination upon IRS examination, which would entirely and/or severely eliminate all the favorable tax effects of selling to an Employer Stock Ownership Plan (ESOP).
With the proper tax planning, your existing business (organized as an LLC and currently taxed as a partnership or disregarded entity) can be converted to a corporation to successfully consummate a potential future sale to your ESOP in a tax efficient manner. Under the current tax system, an LLC organized under state law and taxed as a partnership or disregarded entity as discussed above cannot participate in or sponsor an ESOP. Moreover, an S Corporation owned 100% by an ESOP stockholder is generally not subject to federal and state income taxes (other than, potentially, built-in gains tax at the S Corporation entity level) upon its conversion from an LLC to S Corporation. Some tax professional describe an S Corporation that is 100% owned by an ESOP as a tax shield (i.e., the ESOP is a tax-exempt entity not subject to federal including most state and local income taxes with respect to pass-through S Corporation taxable income).
There are two basic ways to convert an LLC to a corporation. One way, if applicable under state law, is for the LLC to undergo a formless conversion process and convert to a corporation. Alternatively, if the LLC qualifies (i.e., the LLC did not change its default tax classification within the last 60 months), it can file a federal election (IRS Form 8832), under the check-the-box provisions, to be classified as a corporation for federal and most state taxing provisions. Please note that there are exceptions to the 60-month limitation classification change rule. This latter option requires an additional step to change the legal form of the LLC to a corporation under state law via F reorganization (the LLC will be merged into a newly-formed a corporation with the corporation being the surviving entity). The check-the-box election option gives you more flexibility since the conversion paperwork election can be filed with the IRS on or before 75 days after the targeted effective date of the conversion.
The next step, after the conversion to a corporation, would be for the corporation to elect Subchapter S tax treatment election, which can be effective the same date as the conversion date. Under the check-the-box election, you can use IRS Form 2553 to convert to an association and elect Subchapter S. Furthermore, similar to IRS Form 8832 discussed above, IRS Form 2553 paperwork can be filed with the IRS on or before 75 days after the effective S election date.
In addition to the tax planning required to minimize and mitigate the triggering of built-in gains upon conversion to an S Corporation as mentioned above, there are many other hidden tax traps that should be considered and addressed in advance when incorporating an LLC. This includes any pre-binding buy-sell agreements or other step transaction doctrines that, under certain circumstances beyond the scope of this blog, could entirely negate the tax-free status generally associated with an incorporation of a partnership and make the entire transaction a taxable sale. In addition, because of the conversion mechanics, the converting entity faces complex accounting method matters that require special handling, including the potential filing of a non-automatic accounting method change application and the review and approval of the IRS national office within certain statutory due dates.
Please note that the tax planning option described above might only be ideal for an owner looking for maximum liquidity versus deferral and diversification. Also, stay tuned for future blogs regarding other ESOP sale transactions, including transactions involving a C Corporation and Sec 1042 deferral exchange election treatment, or a combination of sale transactions involving first stage (Sec 1042 deferral) and second stage (electing Subchapter S tax treatment and selling the rest of the ownership). For more information on ESOPs, please visit the website for The National Center for Employee Ownership (NCEO).
If you are a former C corporation with an S election older than five calendar years (i.e., your business has been an S corporation since 1/1/2008) and are currently subject to built-in-gains (BIG) tax implications, there might be immediate relief in 2013 to permanently avoid BIG tax ramifications without IRS scrutiny.
General background information: The BIG tax regime is an S corporation, entity level tax calculated at the highest C corporation federal income tax rate (currently 35%) by some states (i.e., depending on the state taxing jurisdiction) and is imposed on the taxable recognition of net unrealized built-in gains (NUBIG) within the S corporation recognition period, which, unless modified by law, generally stands for the first 10 taxable years (full calendar years) of an electing S corporation. The calculated BIG tax is limited each reporting year within the S corporation recognition period to the calculated taxable income of the electing S corporation as a C corporation. Realized but unrecognized former NUBIG becomes a carried over tax item and is accounted as incurred for purposes of the BIG tax calculation in the subsequent year of the S corporation recognition period.
The NUBIG is comprised of all the C corporation deferred income tax items that include the taxable disposition of appreciated assets as further explained below within the S corporation prescribed recognition period. Depending on the state tax ramifications beyond the scope of this blog, the double taxation regime (i.e., combined S corporation and stockholder level tax on the same pass-through taxable income) could be as much as 70% in some cases. The NUBIG is measured at the S election conversion date and generally stems from either:
Note: The NUBIG items described above do not comprise an all- inclusive list.
The good news is that, thanks to Congress, the recognition period has been temporarily reduced from ten to five calendar years for 2013. Therefore, it is strongly recommended that any S corporation with an S election conversion, effective date of on or before January 1, 2008, should consider accelerating taxable income into 2013 and taking full advantage of the five-year reduced recognition period.
In the context of contemplated Sec 338(h) (10) or Sec 336(e) sales transactions involving a target S corporation with a BIG tax profile, you will need to run the numbers to get the full picture, but it might make sense to induce the seller party to accelerate the contemplated transaction into 2013 by reducing the asking price (i.e., sharing the tax savings).
If you would like more information regarding this topic or have any specific questions or concerns, please call your Aronson tax advisor or contact Jorge L. Rodriguez, CPA, Tax Director, at 301.222.8220.
A U.S. company has several options when it comes to planning for cross-border activities in a foreign country. One option is for the U.S. company to conduct its business activities in a foreign country through a foreign branch. The branch structure allows the U.S. company to operate directly in the foreign country without forming a foreign subsidiary company. Some foreign countries require nonresidents to form a company under the local law of the foreign country in order to do business there. However, many foreign countries allow branch activities by nonresidents. If the U.S. company operates through a foreign branch, all of the income and expenses attributable to the foreign branch are reportable on the U.S. company’s U.S. federal tax return. The foreign branch structure provides an advantage if foreign tax will be paid on the income from the foreign branch activities. If the U.S. company is a Subchapter C corporation, then it generally would be able to claim a foreign tax credit on the U.S. federal tax return for the foreign taxes paid on the foreign income earned through the foreign branch. If the U.S. company is a partnership or S corporation, then foreign taxes paid would pass-through to the partners or the shareholders on the Schedule K-1 of the U.S. federal partnership or S corporation tax return.
Another option is for the U.S. company to form a foreign company that elects to be treated as a pass-through entity for U.S. federal tax purposes. Some foreign companies are required to be treated as foreign corporations for U.S. federal tax purposes, depending on the type of entity under foreign law. Those foreign companies are referred to as per se foreign corporations and they are specified on a list by country in the instructions to the Form 8832 check-the-box election. If the foreign company is not on the list, then it is considered to be a foreign eligible entity that may file a Form 8832 check-the-box election to be classified as either a foreign partnership (more than one owner) or a foreign disregarded entity (one 100% owner) for U.S. federal tax purposes. If the foreign company files the check-the-box election, then the income and expenses of the foreign company will pass-through to the U.S. owner. The U.S. owner then reports the items of income and expense from the foreign company on the U.S. federal tax return. Similar to a foreign branch, the check-the-box election allows the U.S. owner to benefit for U.S. federal tax purposes from foreign taxes paid by the foreign pass-through entity.
The other option to consider, which should not be overlooked in cross-border tax planning, is whether the U.S. taxpayer could benefit from the advantage of deferral. A U.S. taxpayer that owns an interest in a foreign corporation generally may defer U.S. federal taxation on earnings of the foreign corporation until a dividend distribution is repatriated from the foreign corporation to the U.S. shareholder. Deferral may provide a significant advantage where reinvestment in the foreign country’s operations is preferable and immediate cash flow from the foreign operations is not required. However, there could be a limitation on the benefit of deferral if the foreign corporation is engaged in transactions involving the sale of property or providing services outside the country of incorporation. Deferral also could be limited if the foreign corporation has earnings invested in U.S. property or assets. If these limitations apply, the U.S. shareholder could be subject to U.S. taxation on certain undistributed income of the foreign corporation before a dividend is distributed. With the foreign corporation structure, only a U.S. Subchapter C corporation that owns at least 10% of the foreign corporation may claim foreign tax credits for foreign taxes paid on the income of the foreign corporation. The 10% U.S. C corporation shareholder would qualify for the indirect foreign tax credit for foreign taxes paid on income of the foreign corporation that is distributed as a dividend. The indirect foreign tax credit also would be allowed if the anti-deferral rules require the 10% U.S. C corporation shareholder to pay U.S. federal tax on certain undistributed income of the foreign corporation.
Determining the most optimal tax structure to operate your current business enterprise depends on many factors such as the current life cycle of your business model, outside investor requirements, licensing issues, tax matters, financial constraints, bankruptcy considerations, and your exit strategy.
If asked to rank the importance of the listed factors, your exit strategy and tax matters should be considered in conjunction with each other and should be at the top of the list unless there are financial investor pre-requisite requirements. Generally, the correct analysis of these two factors tend to alleviate much of the inherit tension stemming from the other cited factors.
For example, if you are a successful technology company or government contractor, your exit strategy will most likely entail a sale of your business to a private equity investment group or perhaps to a public company. To sweeten the pot and maximize your after tax consideration, the ability to consummate a deemed asset sale treatment election for tax reporting purposes would be critical.
Purely from a seller party tax perspective, as a target, you ideally want to be operating as a pass-through entity (i.e., partnership or an S corporation) with no tainted assets subject to built-in gains tax implications (e.g., subject to potential double taxation) prior to consummating an asset sale transaction. However, this perfect world scenario might not be available to you because of evolving facts and circumstances and/or factors beyond your control such as previous ownership composition or perhaps financing structure involving third party investors requiring preferred equity participation.
Supposing that your future target corporation currently operates as a standalone C corporation or as a subsidiary of a consolidated tax filing group, should you consider restructuring to achieve pass-through tax status? The answer might be “no” because the most likely scenario for your particular exit strategy planning might simply be to sell the target corporation to a private equity investment group or a large public company and agree to make a Sec 338(h)(10) or Sec 336(e) election to account for the stock sales transaction as a deemed asset sale for tax reporting purposes (that would be generally tax favorable to the purchaser because of stepped-up and amortization of intangibles over 15 years). Note that, under the current regulation construct provisions, you can generally restructure without negative tax implications a standalone C corporation into a consolidated group filing tax structure in order to qualify for Sec 338(h)(10) and/or Sec 336(e) election provisions prior to consummating a qualified sales stock transaction.
Now, suppose you started a government contracting business a couple of years ago and you received tax advice that it would be beneficial for you to operate your business model as a C corporation because of the partial gain exclusion provisions under Sec 1202 available to a qualifying C corporation, small business stock upon future sale (i.e., provided the stock was originally issued to you and it was held for more than 5 years). Depending on your exit strategy timetable, economic climate and trends, market niche (including the current positioning of your business), technological advantage, and other factors beyond your control, the suggested tax structure might be quite ideal for you. However, a taxpayer’s ability to retain the use of a favorable accounting method that is generally available to large pass-through entities engaged in providing services (i.e., business model for which material and supplies is not a significant producing income items), such as cash basis, should be also be heavily factored into the overall decision making process. (See previous article: “Exploring Cash Basis for a Competitive Edge”)
If you would like to explore your tax operating structure options with regards to your particular set of facts and circumstances, please contact your Aronson LLC tax advisor or Jorge Rodriguez, CPA, Tax Director, at 301.222.8220.