Tax Reform ‘Red Button’ Issues Creating a Safe Path Forward Leon C. LaBrecque, JD, CPA, CFP®, CFA LJPR Financial Advisors

Tax Cuts and Jobs Act: Tectonic Shift Profound changes to business taxes C-corp. rules changed Pass-though rules changed (massively) Small business changes Depreciation changes Interest changes Loss deductions (NOL and Excess Losses) changed Relevant remaining credits are R&D and low-income housing credit Territorial tax Deemed repatriation of accumulated foreign earnings Individual taxes changed Std. deduction increased Itemized deductions limited Child credit increased Personal exemptions eliminated AMT greatly reduced Estate and gift changed Estate and gift exemption amount doubled to $11.2M Step-up basis retained 4/5/2019

Issues for CPAs CPA Economic 199A Outcome Business Planning Planning Clients Prospects Ethical Duty Fees Economic Outcome 199A Business Planning Planning 4/5/2019

Issues for CPAs Clients Prospects Communicating new rules Coordinating teams CPA Lawyer(s) Other advisors Economics versus planning Prospects Competitive advantage Industry-specific RE Ag Service Mfg Integrating Tax changes to planning 4/5/2019

Rate shift Pre-TCJA, the corporate rate could be as high as 50.47% for shareholders (Corp/double tax dividends, UIIT) Pass-through max rate was 43.4% TCJA, maximum corporate is 39.8% QSB (21% + 0%)? CFC? PHC? Max pass-through is now 29.6% - 40.8% 4/5/2019

Maximum Federal Tax Rates by Entity Entity Choice Rates Maximum Federal Tax Rates by Entity Type of Entity Prior TCJA C- Corp shareholder 50.47% 39.8% Active pass-through owner, no QBI deduction 39.6% 37.0% Passive pass-though owner with no QBI deduction 43.4% 40.8% Active pass-through owner with QBI deduction N/A 29.6% Passive pass-through owner with QBI 33.4% 4/5/2019

1202 (QSBS) Qualified Small Business Stock (QSBS) acquired after 09/27/2010, may be eligible for 100% exclusion on capital gains. Exclusion is greater of $10,000,000 or ten times the basis in the stock. Makes earnings-retained companies who can sell equity very attractive. 4/5/2019

Business Taxes: C-Corps Giant change: rate is now flat 21% Personal Service Corporations (C-corps) are taxed at the 21% flat rate! Qualified small business (QSB) stock eligible for capital gain exclusion 100% exclusion Non-service business (except engineers and architects) $10M gain limit QUESTIONS TO ASK: Should I change my pass-through to a C-corp? Is my service business over $315K(mfj) or $157.5K (all other) of income? Can I use the QSB exemption? Will I retain earnings in my trade or business? 4/5/2019

More C-Corp CFC now taxed at 21%, may warrant using ancient tax break from the 60s. CIT (MI) adds back bonus depreciation, Pass-through does not (no CIT). Losses trapped at entity level in C C- corps unlimited SALT Pass-throughs flow through SALT and limited International operations favor C corps because of deduction for foreign derived intangible income 4/5/2019

Don’t Ignore C-corp. opportunities: Jump to changing entity Accumulation QSB CFC Jump to changing entity Ignore C change is permanent 4/5/2019

Business Taxes: Pass-Through Definition: All trade or businesses not C-corp: S-Corp Partnerships (LLC taxed as partnership) Sole proprietorship Trusts Estates REITs MLPs Entity-by-entity evaluation: each pass-though is separate Basic idea is that there is a 20% deduction for pass-through income Service business exception W-2 exception (50% of W-2 wages) Property exception (2.5% of unadjusted basis + 25% of W-2 wages) Income ‘exception to the exceptions’ on taxable income lower than $315k (mfj) or $157.5k (all others) 4/5/2019

Don’t Crack entities under the new regs. CPA firm owns building, spins it into separate LLC 80%/50% test 4/5/2019

Pass-Through Income Exceptions W-2 rules, property basis rule or service business rules do not apply. Married filing Joint: $315,000 of taxable income (24% bracket) Married filing separately: $157,500 Single: $157,500 Child (including a kiddie tax child): $157,500 Non-grantor completed gift trust: $157,500 Non-grantor incomplete gift trust: $157,500 Estates: $157,500 4/5/2019

C versus Pass-through? Accumulate earnings, sell stock later C-corp.? Have losses, use pass-through? Under $157.5/$315, service business, use LLC/partnership? Over $157.5/$315, non service business, use Sub-S? Over $157.5/$315. service business, use C-corp? Split businesses lines? 4/5/2019

Don’t ‘Crack’ entities under the new regs. Don’t ignore de minimum rules ($25M/10%). 4/5/2019

Pass-Through: The ‘Poor RIA’: Gail is a single RIA, self-employed, earns net income from her practice of $150,000 Her taxable income is about $128,000 She gets a deduction of 20% of her taxable income, or $25,600 Being in a service business doesn’t matter, since she has income under $157,500 4/5/2019

Pass-Through: The ‘Rich RIA’: Gail, from our previous example, gets a nice case on December 12, 2018 and her income goes up by $80,000, to $230,000 Her taxable income is about $208,000 She loses her deduction and is in a higher bracket She made more than $207,500 Her bracket went way up (from 19.2%) She can get the deduction back by: Possibly using a 401(k) plan and employer contribution, she could put $55,000 ($61,000 if she’s over age 50). She could make a charitable donation to her charity or to a donor advised fund. Making the plan deduction saves her taxes on the deduction ($17,600) plus a QBI deduction of $27,724. Bracket shifts from 32% through the level and down to 19.2%. 4/5/2019

Pass-Through: Real Estate Tycoon You can get a QBI deduction on real estate if you have basis in the property (not fully depreciated) 2.5% of the unadjusted basis is limit Example: Scrooge owns a property he bought in 2008 worth $5M. It generates about $400k of rental income He will get a deduction for $80,000, since 20% of income is more than 2.5% of $5M 4/5/2019

Don’t Ignore the new regs impose the (very) ugly standard of §162 to the definition of ‘trade or business’ 4/5/2019

Pass-Through: Splitting with Trusts Suppose Scrooge owns some fully depreciated property worth $5M that generates $500K of income No pass-through deduction, since it is fully depreciated He sets up non-grantor trusts for each of his three nephews, spinning $100K each to them They get pass-through, since the trusts get a $157,500 income exception 4/5/2019

Don’t Use the same beneficiaries of multiple trusts or you run afoul of §678(e). Different beneficiaries and different provisions of multiple trusts. 4/5/2019

Pass-Through: Bigger Non-Service Waldo runs a successful travel agency as a Sub-S corporation He nets $800,000 in income He pays wages of $120,000 He would get the lesser of 20% of $800,000 ($160,000) or 50% of W-2 wages ($60,000), $60,000 He could increase his deduction by paying himself so that 50% of total salaries equal 20% of QBI. Adding $142,500 to wages would generate a $132,500 QBI deduction 4/5/2019

Don’t Forget the 2/7 rule on W-2 for 199A. 4/5/2019

Pass-Through: Shifting Debt Bill and Melinda have rental real estate. It has a basis of $2M, is not fully depreciated and has gross annual rent of $100,000 and interest on a $1.5M note of $75,000 Net is $25,000; QBI deduction is $5,000 If they can pay-off or refinance the debt, the QBI deduction goes up to $15,000 If they had bonds or cash, they could pay off the debt, save the $75,000 of interest (replacing the interest lost on the bonds) and garner a larger deduction. If they used a pledged asset loan (or margin loan) with securities, they can still deduct the interest as investment interest. 4/5/2019

Pass-Through Planning Issues Am I subject to the pass-through rules? (Not C-Corp.) Am I subject to the service company rules? Am I subject to the W-2 rules? Is my income under the threshold? Should I do something about my income? We’re married and one of us has a pass-through. Are we better off filing separately? Should we split off businesses to take better advantage of the new rules? Should we split ownership to other members of our family or to trusts? 4/5/2019

Don’t Ignore the new rules on SSTB. Especially the narrow catch-all on skill of one or more owners or employees. 4/5/2019

QBI Deduction Planning QBI is individual, not entity Wages not included in QBI Guaranteed payment not included in QBI Interest, dividends and cap gains not include in QBI (generally) QBI on per pass-through, not combined QBI losses carry over to QBI in subsequent years QBI allowed for AMT calc. Weird farm co-op rule OBSERVATION: Entity selection will be critical Wages to owner or spouse relevant Gray service businesses 401(k) now Roth makes sense? Non-qualified deferred comp to reduce income? Cash balance plans? Full expensing to knock income down to levels? Biz code important? Depreciation schedules? 4/5/2019

Don’t Ignore Roth 401(k) if income is below the limit. Ignore the usefulness of using deductions to TI if income over the limits: Charity 401(k) HAS 4/5/2019

More Business Changes Under $25 million 3-year average gross revenue: Cash basis No debt restrictions Inventory Completed contract Full expensing of non-real estate Net operating losses: no carryback, limited carry-forward New excess loss limitation Entertainment deduction eliminated Car depreciation changed: Under 6,000 pound GVW Over 6,000 pound GVW Interest deduction limited 4/5/2019

Don’t Forget NOLs are not fully deductible. Ignore the Excess Loss Limitations. Forget to consider the interface of the 199A and full expensing deductions. 4/5/2019

Tax Cuts and Jobs Act Individuals: Taxable Income Seven brackets Std. deduction $12,200/$24,400 >65 or blind: add’l $1,300 or $1,600 Personal exemptions eliminated Child credit increased AMT limits increased Itemized deductions Medical > 7½% AGI SALT up to $10,000/$5,000 PEASE repealed Misc. itemized repealed Charity AGI limit increased Mortgage int. modified 529 expanded Taxable Income Rate Single Married 10% $0 - $9,525 $0 - $19,050 12% $9,526-$38,700 $19,051-$77,400 22% $38,701-$82,500 $77,401-$165,000 24% $82,501-$157,500 $165,001-$315,000 32% $157,501-$200,000 $315,001-$400,000 35% $200,001-$500,000 $400,001-$600,000 37% $500,000+ $600,000+ 4/5/2019

Itemized Deductions Mortgage Interest: Pre-12/16/17 mortgages are grandfathered Refinancing of grandfathered mortgages is grandfathered No deduction for equity loan interest New mortgage interest on first and second residence mortgages are deducible up to a combined $750,000 Medical: 7½% of AGI for 2017 and 2018 SALT: $10,000/$5,000 PEASE eliminated OBSERVATION: Interest still deductible Medical ‘bunching’ in 2018 makes sense SALT ‘bunching’ with charity Elimination of PEASE may help big charitable donations 4/5/2019

Don’t Forget to gather all your ‘bunches’ together. Forget SALT can be used by other entities, like Trusts or kids. Forget to check all 2018 clients for proximity to std deduction. 4/5/2019

More Individual Changes Child credit increases to $2,000 with $1,400 refundable Phase out at $110,000 (single) or $400,000 (married) Capital gain exclusion on principal residence retained §529 expanded to K-12 private and religious schools Charity now limited to 60% of AGI instead of 50% Moving expenses gone OBSERVATION: Child credit better for lower income bracket than deduction §529 allows tax-free savings for K-12 and higher ed., replaces Coverdell New standard deduction rules suggest ‘bunching’ charity over alternating years, or using Donor Advised Fund CRT and CLT’s may be more prevalent 4/5/2019

AMT Retained but exemption amount increased to $109,400 (married) and $70,300 single 2015: 91,450 returns w/AMT filed in Michigan Mostly dead now OBSERVATION: SALT (65.75% of preferences) Personal exemptions (22.28% of preferences) Misc. Itemized changes cautions (10.11% of preferences) NOL (3.23% of preferences) 4/5/2019

Don’t Automatically assume a client in AMT in 2017 will still be in AMT. 4/5/2019

Alimony Changed No deduction for alimony paid but alimony received not taxable Effective for divorces or modifications after 2018 4/5/2019

Tax Cuts and Jobs Act Estate, gift and generation- skipping taxes: Exemption doubled, sunsets after 2025 $11.2M lifetime exemption in 2018 (indexed for inflation annually) Step-up basis remains Excise tax on private university endowments Excise tax on Non-profit executive salaries above $1M 4/5/2019

Don’t Ignore estate taxes on client that may get over the $11M. Forget there are several elections between now and 2025. Allow wealth client to take adventure trips or have ’special drinks’ around the end of 2025. 4/5/2019

Child and Family Credit Old rule: $1,000 credit per child under 17; phased out at $75K (S) and $110K (MFJ) New rule: $2,000 for child (refundable up to $1,400), $500 for non-child dependents (including taxpayers’ and others) (not refundable) New phase out starts: $200K(S, HOH, MFS) & $400K (MFJ) Earned income credit retained 4/5/2019

Don’t Forget this is good for younger kids, but the 17+ now have no personal exemption. File single for college kids? 4/5/2019

Estate, Gift and GST Taxes Doubles exclusion amount for estate, gift and generation-skipping taxes Increased exclusion sunsets after 2025 Step-up in basis on death remains OBSERVATION: Many more people not subject to estate tax Managing step-up may become more important Splitting strategies for income, particularly QBI, becomes relevant OBSERVATION: Many more people not subject to estate tax. Managing step-up may become more important. Splitting strategies for income, particularly QBI, becomes relevant. 4/5/2019

Don’t Forget that there is now an interface on 199A and Estate planning with incomplete Non-Grantor trusts. Fail to review estate planning. 4/5/2019

More Stuff Muni Bonds: Unrelated Business Income Tax: House bill would have made interest on new Private Activity Bonds (PABs), new advance refunding bonds and new bonds issued for professional sports stadium taxable Final bill: all still tax-exempt Unrelated Business Income Tax: House bill would have made broad changes to definition and application of UBIT Final bill: Tax-exempts with more than one source of UBIT (i.e. more than one unrelated business) must calculate income/losses for each separately and can’t combine (net) income/losses to calculate UBIT Private foundation excise tax streamlined to 1.4% Private college and universities excise tax of 1.4% on investment income: More than 500 students Assets over $500,000 per student State college and universities not subject to provision Endowments: Harvard $34.5B, Princeton $22.15B. U of M paltry $10.9B Stock Options restricted stock or RSU in privately traded stock may defer recognition of income for up to 5 years (new 11/06) 4/5/2019

Disclaimer This presentation and these materials are provided for informational and educational purposes based upon publically available information from sources believed to be reliable. This presentation and these materials are provided with the understanding that the author/presenter is not engaged in rendering legal, accounting, or other professional services, and it is not intended to provide any basis for legal, accounting, or other professional services. Due to the constantly changing nature of the subject, this outline should not be used as a resource for any tax or accounting opinion, or tax return position. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. COPYRIGHT ©2018, LJPR Financial Advisors

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