An S Corporation selling shareholder should always evaluate whether the “one-day note” obligation planning concept will achieve federal and state tax optimization objectives of an asset sale transaction arrangement. There are some exceptions to applying this concept due to business reasons or overriding tax regimes, beyond the scope of this blog.
The current tax provisions of the one-day note tax calculation require that the pre-liquidation calculated tax basis of an S Corporation selling target, following the consummation of an asset sale transaction, should be allocated between the cash and non-cash liquidation components respectively. Accordingly, the selling shareholders will immediately recognize the cash liquidation proceeds less allocated S Corporation tax basis. Any remaining tax basis allocated to the deferred income items will be recognized proportionally as the deferred income items are collected.
The described mandatory allocation mechanism will generally create an acceleration of gain recognition tax effect. This is because a substantial portion of the pre-liquidating stock tax basis calculated, including the gain recognition from the deemed asset sale prior to liquidation, will be allocated to the deferred income item. Such allocated stock basis will not be recognized until the deferred income items are eventually collected. In extreme situations, the non-collection of deferred income items can create an unused capital loss whipsaw tax effect that is beyond the scope of this blog. Therefore, the proper application of the one-day note planning concept will mechanically reduce the pre-liquidation tax basis allocated to the deferred income items and safeguard against the described negative tax implications.
From a state tax minimization perspective, many state taxing jurisdictions currently conform to federal law income tax statutes regarding installment sale reporting rules. This includes the non-taxable treatment and distribution of a deferred note receivable obligation stemming from an asset sale or liquidation scenario. The one-day note planning concept will generally minimize, or in some case totally mitigate, all non-resident income tax burdens incurred by a bona fide residents and selling shareholders living in a no state tax jurisdiction, such as Florida, Texas, and Washington. This concept would also be applicable to certain selling shareholders who would be subject to double taxation because of non-conformity S Corporation pass-through tax treatment, such as the District of Columbia with respect to Virginia residents. This is because the District of Columbia franchise tax is not considered a creditable income tax under Virginia income tax statute.
Please note that the one-day note tax planning concept will only mechanically work pursuant to an approved and adopted plan of liquidation that is beyond the scope of this blog or pursuant to a Sec 338(h) (10) or Sec 336(e) tax election.
If you are interested in scheduling an initial consultation on how to effectively structure the sale of your business, please contact Jorge Rodriguez, Aronson’s Tax Partner specializing in M&A specialized services for middle market businesses, at 301.222.8220 or email him at firstname.lastname@example.org.
As business owners will have their 2016 corporate tax returns prepared in the upcoming months, there are several tools that could be used to help reduce corporate or personal tax liabilities. Here are some strategies that could save you money.
Implement and fund a retirement or profit sharing plan
Business owners can claim a tax deduction for contributions to fund retirement and profit sharing plans on behalf of employees or owners for calendar year 2016. Most plans don’t have to be funded until the tax filing deadline to claim the deduction.
Purchase and place fixed assets into service
Assuming the business is generating a profit, up to $500,000 of fixed assets such as computers, equipment, furniture, and fixtures that were purchased and placed into service before the end of the year can be fully depreciated per Internal Revenue Code Section 179. There is also a 50% bonus depreciation incentive available for new fixed asset purchases placed into service. The 50% bonus depreciation has no asset threshold and also includes leasehold improvements, which is any improvement that is:
Pay out accrued bonuses or wages before March 15
Business owners that use the accrual basis of accounting can deduct wages or bonuses that are accrued at year-end as long as they are paid out before March 15. This is an effective tax strategy that can defer the cash burden of paying year-end bonuses by up to 2.5 months, but also pay out additional compensation that rewards performance and can assist in employee retention.
In issuing the Final Tangible Property Regulations, the IRS has adopted the most dramatic change affecting for-profit taxpayers since the overhaul of the Internal Revenue Code in 1986. The new regulations address, among other things:
Most of these changes must be adopted as a change in accounting method. This requires that, in addition to applying the new rules going forward, taxpayers must determine the impact of these rules on prior years and recognize the tax impact of any changes at the time of adoption.
Taxpayers will be required to file one or more Forms 3115 for each separate entity, trade or business activity. For example, an individual filing a Form 1040 that owns three rental properties reported as separate activities will be required to file three or more separate 3115s. The new regulations can be adopted for tax years as early as 2012, but must be adopted no later than tax year 2014.
Risk: If a taxpayer fails to implement the new rules and properly file the necessary 3115s, they will lose current and future tax depreciation deductions or potential write-offs on previously capitalized assets.
Reward: Implementation of these rules may present significant tax-saving opportunities for many taxpayers. There are now safe harbors for deducting certain de minimis expenditures. Taxpayers may also be able to expense greater amounts for certain repairs, materials and supplies. For many taxpayers there will be opportunities to write-off the undepreciated cost of certain previously capitalized assets. Examples of typical write-off opportunities:
The process of complying with the new regulations is complicated and may require a company to change the way it conducts business and the system it uses to capture information related to expenditures. Likewise, the process of evaluating the impact of changes in accounting method will likely require the collection of facts and documentation related to expenditures stretching years into the past. As such, waiting until the last minute to begin the process is ill-advised.
Aronson’s experts have the expertise and the resources to assist your business in dealing with the new Tangible Property Regulations. If you have questions about how these rules impact your business or what potential tax-saving opportunities may be available to you, please contact Blair Williams at 240.364.2687.
The most powerful tax planning strategy available to an entrepreneur is the selection and integration of an entity structure and accounting method that balances personal needs with the overall business model. Tax constraints and limitations make the selection process complicated, but with some careful planning and foresight, you can achieve tax optimization throughout the business life cycle and design your ideal exit strategy.
The process generally starts with an evaluation of your short-and long-term personal goals and business objectives, including mapping alternate options that address the following issues:
The bottom line is that not taking the time to go through this initial exercise could potentially cost you millions of dollars that you could have used to improve your business model and reward yourself and your workforce. Depending on your particular set of facts and circumstances, however, it might not be too late to convert your current existing tax operating structure and change your accounting method selection.
With the assistance of a qualified tax advisor that specializes in servicing your particular industry, you can achieve a fundamental understanding of the critical interplay between accounting method selection and tax operating structure.
For more information, please contact your Aronson LLC tax advisor or Jorge L. Rodriguez, CPA, Tax Director at 301.222.8220 or email@example.com.