Dear clients, potential clients, business partners, and friends:

This letter has been developed to provide actual examples of tax strategies you can use for 2018 and beyond. Most topics discussed below are derived from the Tax Cuts and Jobs Act of 2017 (the “Tax Reform”). If you are short on time and unable to read through this entire letter please consider the following key point:

Action to take advantage of Tax Reform but also protect against negative outcomes due to the Tax Reform is needed now and most of the issues we outline below are not “fixable” after the fact when you may normally meet with your tax adviser in 2019.

The letter consists of 100% original content and is copyrighted by James Crane, CPA. This content may not be copied or otherwise used without the prior express written consent of James Crane, CPA. The information included herein is of a general nature and based on tax law and interpretations that are subject to change. The information included herein should not be applied to specific situations without prior consultation with your tax adviser. In this letter, the author reviews a selection of Tax Reform topics that should primarily be of specific interest to owners or potential owners of small businesses.

The following are some examples of tax strategies we have been implementing and discussing with our clients. We focus on tax strategies that permanently reduce taxes. We are much less interested in tax strategies that only temporarily reduce taxes. It is highly likely that one or more of these tax strategies could benefit you or your business and save you taxes.

Business Tax Strategies

1. Entrepreneurs should always consider organizing a C corporation and issuing themselves qualified small business stock (“QSBS”). Later in the timeline, if the QSBS is held for 5 years or longer, up to 50% of the capital gain generated from the sale of the QSBS could be permanently exempt from income tax.
2. The net operating loss deduction (“NOL”) allows businesses to offset current year income with their net aggregated losses from prior years. Previously, 100% of the current year income of a business could be offset with an NOL thereby avoiding income taxes altogether. Tax Reform limits the NOL to 80% of current year income. As a result, without consideration of any available tax credits, profitable businesses may not be able to avoid income taxes on 20% of their current year income even if they have a large NOL. We expect many businesses will make the mistake of relying on their NOL only to be stuck with a significant tax bill on 20% of their business profits in early 2019. The best solution to this situation is to use the NOL to eliminate taxes on the first 80% of business profits and tax credits to eliminate taxes on the final 20% of business profits. However, significant planning is needed to ensure this strategy works as intended and 100% of a C corporation’s income taxes are eliminated.
3. Tax credit-focused tax planning is a primary action large companies like Amazon and Apple use to avoid paying income taxes. We believe the Tax Reform not only further incentivized the use of tax credits but also opened the door for small businesses and even individuals to use tax credit-based planning that was previously primarily used by large corporations. A few tax credit strategies are discussed below but a full list of available tax credits are provided in Exhibit A to this letter and should be considered by every taxpayer.
4. The research and development credit (“R&D Credit”) has been improved in recent years and deserves consideration by every taxpayer who conducts R&D. A business may not have any income at this time so an immediate benefit from the R&D Credit may not be obvious. However, there is an “almost immediate” benefit that you may not be aware of. The IRS allows the use of the R&D Credit as an offset against employer payroll taxes rather than or in combination with the reduction of income taxes. The payroll tax offset derived from the R&D Credit can result in an immediate ongoing reduction and/or cash refund of payroll taxes in the year following the reporting of the R&D Credit in your business tax return. As long as you have payroll, this results in actual cash savings that could potentially be quite significant. However, we do advise caution with the R&D Credit. We continue to view the R&D Credit as a high audit risk area. We support our clients who wish to use the R&D Credit on their tax returns but we require a substantial amount of additional support from our clients in order to utilize this credit.
5. Certain intellectual property (“IP”), namely personal creations/inventions, no longer qualify as capital assets as a result of Tax Reform. The sale of IP could therefore be subject to Federal income taxes at high ordinary tax rates, i.e. up to 37%. Entrepreneurs whose businesses are built on IP should consider creating and holding their IP in a C corporation. Later in the timeline, the sale of C corporation shares or IP assets could qualify for capital gain tax rates, i.e. 15% or 20% respectively, which could result in Federal tax savings of up to 46%.
6. Businesses structured as pass-through business entities (i.e. every entity except C corporations) may qualify for a new significant tax deduction equal to 20% of your business profits (the “20% Deduction”). However, there are several ways you could be disqualified such that you couldn’t take this deduction. We are working with clients now to develop a plan to ensure they qualify for the 20% Deduction and are able to claim it on their 2018 tax returns. Maximizing the 20% Deduction is perhaps the single most important task a pass-through small business owner should focus their attention on in 2018 and beyond. Business owners that have significant profits above even $500,000 may still qualify for the 20% Deduction as long as they operate in certain industries that do not primarily rely on the reputation of the owner of the business to generate profits. However, planning is necessary before December 31, 2018 to ensure the various qualifications for the 20% Deduction are met.
7. Business entity structuring may allow some business owners to qualify for the 20% Deduction when they otherwise would not have qualified. An S corporation that owns an interest in another pass-through entity such as a partnership may allow the owner of the S corporation to qualify for the 20% Deduction even if the partnership and/or S corporation had significant profits.
8. The use of C corporations and S corporations together can create tax savings in the right circumstances. A business purpose would have to be established to separate business operations between the two (or more) entities. The end result of the separation of business operations between different entities may allow a business to take advantage of both the 20% Deduction for a pass-through entity and the 21% income tax rate for C corporations.
9. Business owners who have significant passthrough income and are considering marriage may benefit from getting married before 2019. The business owner, when single, can only qualify for the full 20% Deduction if their taxable income is $157,500 or less. If they are married as of December 31, 2018 their taxable income could be as high as $315,000 and they would qualify for the full 20% Deduction. If the entrepreneur’s spouse did not have significant taxable income in 2018 then the savings from the marriage, assuming it happens before December 31, 2018, could be as high as $15,000, approximately, assuming a 24 % effective tax rate.
10. Business owners can employ and pay their children up to $12,000 free of Federal income tax each year while taking a full deduction (at the parent or entity’s higher income tax rate) for the payment(s) in the business tax return. Depending on how many children a business owner has this may be significant over the timeline and ultimately could save a very successful business owner up to 37% of the salaries paid to their children while potentially generating significant cash savings for the children that could be used for college or other significant expenses most children are likely to incur.
11. Business owners who own homes and businesses in U.S. states that have high income tax rates such as California, Massachusetts and New York, among others, may determine that a C corporation is the best business structure for them going forward based on the premise that the state income taxes paid by a C corporation are fully deductible whereas the state and local income taxes paid by an individual are limited to $10,000. Other considerations must be made as well but this issue, in combination with others, is likely to cause some business owners to reorganize their business in a C corporation. The potential tax savings generated by deducting all state and local income taxes as opposed to a ceiling of $10,000 could be quite significant for very successful business owners.
12. Businesses who operate or have ties in some way to more than one state may choose to structure their business operations in a way that they intend to qualify for and owe taxes to multiple states but the combined effect of the taxes in each state, and the credits for taxes paid to other states, may ultimately reduce the combined state taxes paid by the business.
13. Businesses that operate in and outside of the US will now have to pay income taxes on their global profits and report financial results for both their US and foreign operating entities. The management of this effort and the attempt to minimize income tax on both US and foreign business profits is a substantial undertaking for any business, especially in the first year where these tax laws are effective, i.e. 2018. We anticipate mistakes and surprises will occur in relation to this aspect of the Tax Reform if detailed tax planning does not occur during 2018. We advise all of our clients who have foreign operations or assets to contact us as soon as possible to address these issues.
14. For profit businesses and not for profit organizations who employ highly compensated management may be penalized for exceeding compensation limits imposed by the Tax Reform. Every business and not for profit should be fully aware of the new laws and should ensure adequate tax planning is completed in order to avoid penalties for over-compensating management.
15. Businesses that have or could have significant hard assets should consider their cashflow and current year tax projections to ensure they can benefit fully from the 100% deduction available for the purchase of up to $1,000,000 qualified equipment. As a result of the Tax Reform now both new and used equipment can qualify for this powerful 100% tax deduction.
16. Business owners and others who own their homes and currently have a mortgage over $1 million and/or a home equity line may wish to restructure their debts to include more debt inside of a business entity where it will be likely be 100% deductible. Home equity line interest expense is no longer deductible for individuals. New mortgage balances that are in excess of $750,000 (or $1,000,000 if the mortgage was originated prior to 2018) is no longer tax deductible for individual taxpayers. However, there is a 30% limitation on the amount of interest expense deducted by a business. This tax strategy requires significant tax planning.
17. The Tax Reform eliminates the deduction for expenses related to an employer’s provision of entertainment, amusement or recreation activities, even if the activities are related to business. However, events such as nondiscriminatory employee holiday parties or employee group recreation activities may still be deductible. Sporting events are not deductible in most circumstances now – with the exception of charitable contributions tied to sports.
18. Business executives could begin considering M&A deal structuring alternatives that were previously not desirable. Asset-based acquisitions could very well be more attractive then equity-based acquisitions due to the fact that used equipment/assets may now be 100% deductible upon the acquisition date for tax purposes.
19. Many businesses report their financial results in accordance with U.S. generally accepted accounting principles (“GAAP”) and follow revenue recognition guidance for multiple deliverable contracts (i.e. ASC 606). Businesses that do not report their financial results and do not follow GAAP should be fully aware that the tax law now requires their tax accounting comply with the same revenue recognition guidance in ASC 606. This is a highly complex area of GAAP that has now transitioned over to tax law and should be reviewed with a professional tax advisor as soon as possible.
20. Many businesses sell both products and services and some businesses bundle those products and services together. The appropriate identification of transaction amounts that apply to a product versus a service are becoming extremely important as many states are aggressively searching for additional sales tax revenue on product sales. If a business were to inappropriately classify revenues as product sales when the revenues actually related to services provided they would be in effect reporting incorrect financial data and would be overpaying sales taxes. Some states also tax services as they are provided. The sales tax rates applying to services and products may differ. As a result, again, there is risk of overpayment of sales tax in this situation.
21. Many employee fringe benefits no longer qualify as legitimate tax deductions. Businesses may want to reconsider how they compensate and assist their employees.

Individual Tax Strategies

1. Individuals with flexible work arrangements may be better off or just prefer working as a contractor rather than as an employee. They could organize a S corporation or LLC, which may make sense in order to qualify for the 20% Deduction. This tax strategy again requires a specific scenario but the benefits are potentially very significant.
2. Individuals who pay significant fees for investment management or tax preparation may determine that organizing a business (an LLC or a corporation) may make sense. The investment management and tax preparation fees may be fully deductible for a business but are no longer deductible for individuals.
3. Individuals who make significant annual charitable contributions should consider managing the timing of their contributions more closely. There is likely a significant benefit to “bundling” charitable contributions for multiple years in one specific year in order to ensure the full value of the contribution benefits you. Business owners should also consider whether charitable contributions would be benefit them more if the contributions were made from their C corporation.
4. Individuals who have significant itemized deductions that are not limited such as qualifying medical expenses and charitable contributions should consider managing and protecting those itemized deductions closely as they are now invaluable since the phaseout of itemized deductions no longer exists. In other words, qualifying medical expenses and charitable contributions can be incurred at substantial levels and still be fully deductible. With adequate tax planning these two types of tax deductions could be used to fully reduce your income tax all the way to $0.
5. Individuals who operate a service or product-based business in a non-passive role and also operate, on a passive basis, rental real estate may want to consider how they could potentially classify all of their business and real estate activities as passive activities. This could result in rental real estate losses being fully deductible and utilized against the profits generated by the individual’s other business activities.
6. Individuals with significant wealth should consider the creation or adaptation of business models that utilize entertainment-related assets such as yachts, planes or other significant personal assets. The 100% depreciation allowance for new and used assets could be used to substantially decrease current year income taxes of the entrepreneur and his/her partners.
7. Individuals who have phantom income associated with the vesting of stock options or restricted stock grants may now qualify and elect to defer taxation of the original value of the stock award. This benefit, which could be substantial for employees, requires a significant amount of planning in order to qualify.

Real Estate Tax Strategies

1. Opportunity Zone (“OZ”) investments are structured using lucrative new tax benefits included in the Tax Reform. First, an OZ allows for the deferral of a capital gain from the sale of a qualifying asset. No tax will be due on this capital gain for at least five years. At the end of the five-year period the capital gain subject to tax could be reduced by 15% if all qualifications under the new OZ rules are met. Third, and most importantly, the capital gain resulting a qualifying investment made in an OZ and held for at least 10 years could qualify for a permanent exemption from taxation. This permanent exemption from taxation is an unparalleled tax benefit and should be extremely appealing to any real estate investor. However, an OZ by definition is located in a low-income area. It may be difficult to find attractive investment opportunities as a result of this significant tax incentive which is surely to increase competition for assets in these locations.
2. Businesses may decide to locate their headquarters or an office in an OZ. Any capital gain on the sale assets held by the business at a location within an OZ may be permanently exempt from income tax – assuming the assets qualify.

This letter does not consider sunset provisions where certain deductions and tax laws in general are set to expire. We are not considering the expiration of these tax laws due to the timeline and likelihood that many of the laws will likely be extended in some way by the time they are currently set to expire in 2025 etc.

Please contact me at +1 617-418-3880 or by email at [email protected] if you would like to discuss any of the content in this letter or have alternative questions about taxes, accounting or the Tax Reform etc.

Best Regards,

James Crane, CPA

Crane & Company, Inc.

Exhibit A – List of Federal Tax Credits for Businesses

1. Increasing Research Activities Credit
2. Investment Credit
3. Alcohol and Cellulosic Biofuels Credit
4. Recapture of Low-Income Housing Credit
5. Qualified Plug-in Electric and Electric Vehicle Credit
6. Renewable Electricity, Refined Coal, and Indian Coal Production Credit
7. American Samoa Economic Development Credit
8. Employer Credit for Paid Family and Medical Leave
9. Empowerment Zone and Renewal Community Employment Credit
10. Credit for Contributions to Selected Community Development Corporations
11. Biodiesel and Renewable Diesel Fuels Credit
12. Credit for Small Employer Pension Plan Startup Costs
13. Credit for Employer-Provided Childcare Facilities and Services
14. Low Sulfur Diesel Fuel Production Credit
15. Qualified Railroad Track Maintenance Credit
16. Distilled Spirits Credit
17. Energy Efficient Home Credit
18. Alternative Motor Vehicle Credit
19. Alternative Fuel Vehicle Refueling Property Credit
20. Mine Rescue Team Training Credit
21. Earned Income Tax Credit
22. Indian Employment Credit
23. New Markets Credit
24. Work Opportunity Credit
25. Production Credit
26. Energy Investment Credit
27. Qualified Child Care Credit
28. Disabled Access Credit
29. Credit for Employer’s Social Security Taxes Paid With Respect to Employee Tips
30. Enhanced Oil Recovery Credit
31. Credit for Producing Oil and Gas from Marginal Wells
32. Credit for Production from Advanced Nuclear Power Facilities
33. Renewal Electricity Production Credit
34. Low-Income Housing Credit
35. Orphan Drug Credit
36. The Rehabilitation Credit

Exhibit B – List of Federal Tax Credits for Individuals

1. American Opportunity Tax Credit
2. Lifetime Learning Credit
3. Child and Dependent Care Credit
4. Savers Tax Credit
5. Adoption Credit
6. Child Tax Credit
7. Credit for the Elderly or the Disabled