Navigating the Field - Wednesday November 7, 2018 Entity Choice …content.sfbar.org/source/BASF_Pages/PDF/G180505.pdf · 2018-11-07 · Navigating the Field . Entity Choice in the

THE BAR ASSOCIATION OF SAN FRANCISCOCONTINUING LEGAL EDUCATION

WednesdayNovember 7, 2018MCLE Registration: 11:30 a.m. - 12:00 p.m.

Program: 12:00 - 1:30 p.m.

The Estate Planning, Probate and Trust Section

Navigating the Field - Entity Choice in the Era of 199A

Topics• Benefits and limitations of §199A• Key considerations for choosing the right legal entity• New possibilities in light of current law and regulations

Section Chair: Melissa Hung, Farella Braun + Martel

Register online: www.sfbar.org/calendar or complete form below.

Mail to: Continuing Legal Education | The Bar Association of San Francisco 301 Battery Street, Third Floor | San Francisco, CA 94111 or Fax to: 415.477.2388.

Speakers

Frank F. Huang Freeland Cooper & Foreman LLP

Frederick W. Lien Freeland Cooper & Foreman LLP

Patty Trick, CPA Calegari & Morris

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CLE Webcast: www.sfbar.org/online-cle

Recorded Available 11/14/18

Live

Navigating the Field

Entity Choice in the Era of 199A

Speaker Bios

Frank F. Huang

Frank is a partner in the Corporate and Business Transactions group and the Real Estate group. His practice includes representing companies, investors and individuals in mergers and acquisitions, real estate acquisitions and leases, venture capital, private equity and debt transactions. He also has extensive experience advising clients on the formation of new companies and entities, start-ups, partnerships, business contracts, corporate governance and securities law compliance.

Prior to joining this firm, Frank was a corporate attorney at major law firms in San Francisco and Boston, where he represented companies and investors in start-ups, private placements, IPO’s and public mergers and acquisitions.

In addition, Frank represents and advises high net worth individuals on their personal investments and business interests. As part of his practice, Frank works closely with the firm’s estate planning attorneys to ensure that clients’ investment and business strategies correspond with their estate plan. He also advises clients on structures and strategies to protect clients’ identities from unwanted disclosures.

Frederick W. Lien

Fred is an associate in the Corporate and Business Transactions group and the Estate Planning group. He leverages his corporate transaction, commercial, and financing experience to advise clients with their estate and business planning needs, developing comprehensive and considered solutions.

Prior to joining Freeland Cooper & Foreman, Fred developed his corporate practice at major international law firms in the San Francisco Bay Area and New York, where he represented private and public companies, and institutional and strategic investors throughout the life cycle of business ventures, including entity formation, complex venture and debt financing transactions, federal and state securities law compliance, and mergers and acquisitions.

Patty Trick, CPA

Patty has extensive experience in the areas of complex Limited Liability Companies, partnerships, S Corporations, multi-state entities, and high net-worth individuals.

She earned her Bachelor of Science in Accountancy at the University of Illinois Urbana-Champaign and began her career with Arthur Andersen, first working as an audit senior before specializing in tax and rising to the position of Tax Manager. She continued her education at Golden Gate University with a Master of Science degree in Finance with additional concentrations in tax and financial planning.

Patty serves a diverse clientele at Calegari & Morris providing business advisory, tax, and review and compilation services for a variety of closely held businesses, along with tax planning and compliance services for the high net-worth individuals who own these businesses. She is well equipped to assist clients with selecting the legal entity that best supports their business and personal objectives.

Patty has exceptional technical expertise and has consulted and advised on complex business formation issues and transactions such as acquisitions, dispositions, liquidity events, and exchanges of real estate. As a pass-through entities expert she is well versed in profits interest equity compensation and partnership ownership changes including buying and selling of interests, member redemptions, and partnership terminations.

Patty enjoys serving business owners by working together with them to coordinate both business and personal goals through proactive planning and advice.

Navigating the Field Entity Choice in the Era of 199A

© 2018 Freeland Cooper & Foreman LLP © 2018 Calegari & Morris Certified Public Accountants

Tax Cuts and Jobs Act of 2017 2

Let’s Compare Book Romeo & Juliet The Great Gatsby Catcher in the Rye Harry Potter and the Sorcerer’s Stone Tax Cuts and Jobs Act of 2017 The Scarlet Letter The Da Vinci Code Harry Potter and the Goblet of Fire A Game of Thrones Les Misérables

Number of Words 24,500 47,000 73,000 77,000

83,000 ** 87,000

170,000 190,600 292,000 530,000

** Amount includes sections headings and numbers. 3

Overview

I. Common Entity Choices II. Costs and Filings; Liability Protection III. Tax Considerations Under 199A IV. A Sample Calculation V. Questions and Answers

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Common Entity Choices • Types:

• Sole Proprietorship • General Partnership or Limited Partnership • Limited Liability Company or “LLC” • S-Corporation • C-Corporation

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Costs and Filings Sole Proprietorship: General partnership: Limited Partnership: Limited Liability Company: S Corporation: C Corporation:

No filing with the Secretary of State No mandatory filing with the Secretary of State but there is the optional “Statement of Partnership Authority” (Form GP-1); No annual franchise tax; No annual statement Need to file “Certificate of Limited Partnership” (Form LP-1); Annual $800 franchise tax; No annual statement of information Need to file “Articles of Organization” (Form LLC-1); Annual $800 franchise tax; Bi-annual statement of information If the LLC has annual total income equal to or above $250,000, there is an additional LLC fee that ranges from $900 to $11,790. Need to file “Articles of Incorporation” and make the S election; Annual $800 franchise tax plus a tax of 1.5% on its net income; Annual statement of information Need to file “Articles of Incorporation”; Pays separate corporate income tax

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Liability Protection Shareholders of a Corporation Significant factors that may cause a court to “pierce the corporate veil”: 1. Undercapitalization 2. Nonobservance of corporate formalities 3. Nonpayment of dividends 4. Siphoning of funds by controlling shareholders

for their personal use 5. Nonfunctioning officers and directors 6. Absence of corporate records 7. Use of the corporate entity as facade for the

personal operations of the controlling shareholder

8. Use of the corporate entity to promote fraud or injustice.

Members of a Limited Liability Company The trend in most states is to treat members of a limited liability company like a shareholder of a corporation.

Limited Partners The general test is whether the limited partner appears to be a general partner or participates in management and control of the partnership’s business. Under California Corporations Code Section 15903.03(b), the following activities are among those not considered “participating in the control of the business”: 1. Being an independent contractor or employee of the limited partnership 2. Being an officer, director, member or partner of the entity that is the general partner of the limited partnership 3. Consulting or advising the general partner 4. Guaranteeing the debt of the partnership or general partner 5. Voting on an amendment to the partnership agreement 6. Winding up the partnership 7. Serving on an audit committee An activity that is not included in Section 15903.03(b) is not automatically considered “participating in the control of the business.”

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Tax Considerations 199A Snapshot

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* Note – Taxable income thresholds are for joint-filers. Relevant thresholds for single-filers are $157,500 and $207,500

Taxable Income* Specified Service Business Non-Specified Service Business

Below $315,000

20% deduction allowed

Between $315,000 and $415,000

Phase-out of Specified Services;

Deduction reduced by phase-in of Wage and

Asset Tests

Deduction reduced by phase-in of Wage and Asset

Tests

Above $415,000 No deduction allowed Subject to limitation by Wage and Asset Tests

Phase-out of Specified Services Applicable Percentage: For Joint Filers: 100% - • Applies to qualified income, W-2 Wages, and Unadjusted Basis of Qualified

Property.

Taxable Income - $315,000

$100,000

© 2018 Freeland Cooper & Foreman LLP

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Phase-in of Wage and Asset Tests Between $315,000 and $415,000 of taxable income, the 20% deduction is reduced by a Reduction Amount, calculated as follows:

Taxable Income - $315,000

$100,000 X (20% X QBI) - Wage and Asset Test

Amount

Also known as the “Excess Amount” described in 199A(b)(3)(iii)

Tax Considerations 199A Analysis – Specified Services

• Health; • Law; • Accounting; • Actuarial science; • Performing arts, athletics; • Consulting and Financial services; • Brokerage services; • Investing and investment management; • Trading, or dealing in securities; • Where the principal asset is the reputation or skill of one or more of

its employees.

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Tax Considerations 199A Analysis – Aggregation Rules

Taxpayers may aggregate trades or businesses to combine qualified business income, W-2 wages and unadjusted basis before applying the deduction limitations if all of the following apply.

• The same persons must own directly or indirectly 50% or more of each trade or business to be aggregated.

• The 50% ownership requirement must be met for a majority the tax year. • The businesses must report income in the same tax year. Short years will not disqualify. • None of the businesses can be a specified service trade or business. • The businesses must satisfy two of the following factors.

1. Products and services are the same or customarily offered together. 2. Facilities or centralized business elements such as personnel, accounting, legal, manufacturing, purchasing, human resources, or IT are shared. 3. The business is operated in coordination with or reliance upon one of the businesses in the aggregated group.

An aggregation grouping applies to all subsequent years although new qualifying businesses can be added to the group. Groupings must be reported in detail annually with the tax return. Aggregation Strategy Generally it makes sense to aggregate businesses with wages with other wage heavy businesses and separately aggregate all qualifying businesses relying on the unadjusted asset basis limit.

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Sample Calculation

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199A Analysis for Sole Proprietor Assumptions Gross Revenue $ 650,000 Contract Labor $ (125,000) Other Expenses $ (85,000) Business Net Income $ 440,000 Retirement Plan Contribution $ (172,000) Other Self Employment Deductions (health insurance, HSA, self-employment taxes) $ (24,000) Itemized Deductions $ (29,000)

Taxable Income $ 215,000 Potential Changes Under 199A Convert Reduce Convert to an Contractor to Income by S Corp with Do Nothing W-2 wages $60,000 Owner W-2 Wages Maximum Deduction $43,000 $40,688 $31,000 $41,300 199A Income Limitation ($43,000) -- -- -- _____ Available 20% 199A Business Deduction -- $40,688 $31,000 $41,300 Tax Savings -- $16,804 $12,803 $11,859 Additional Payroll Costs -- ($7,613) -- ($4,686) Entity Tax Return Preparation -- -- -- ($5,000)_____ Net Tax Savings -- $9,191 $12,803 $2,173 Additional tax deferral if income reduction is through increased retirement contribution -- -- $24,780 --

Sample Calculation

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Options to reduce income: Switch to tax exempt interest and dividends Sell loss investments Larger contribution to retirement plan Slow billing Prepay expenses Purchase equipment Costs and Burdens to Converting to an S Corporation: Pay yourself a wage (but there is the risk you do not pay an “adequate” wage) Additional costs for having a separate entity (formation costs, separate tax returns, maintaining corporate records and minutes) Need new retirement plan for entity

Questions and Answers

FREELAND COOPER & FOREMAN LLP 150 Spear Street, Suite 1800 San Francisco, CA 94105 Main: 415.541.0200 | Fax: 415.495.4332 www.freelandlaw.com Frank F. Huang ([email protected]) Frederick Lien ([email protected])

123 Mission Street 18th Floor San Francisco, CA 94105 Main: 415.981.8766 | Fax: 415.655.7159 Patty Trick ([email protected]) Direct Dial: 415.955.0359

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Potential 20% Business Deduction

Do Nothing Phase-out Calculation

2018 Schedule C Net Income 440,000$ Lesser of 20% of qualified business income or 20% of taxable income less net capital gain

Contract Labor 125,000$ Qualified Business Income 440,000$ 88,000$ 20% of QBI

Retirement Plan Contribution (172,000)$ Taxable Income 215,000$ 43,000$ 20% of TI

2018 Taxable Income 215,000$ Threshold for single taxpayer 157,500$

Insignificant Property and Equipment Excess over Threshold 57,500$

Insignificant Capital Gain Income

Excess Divided by 50,000 115%

Available Deduction 0% -$

Convert Contractor to W-2 Wages

2018 W-2 Wages 125,000$ Qualified Business Income less payroll exp 428,438$ 85,688$ 20% of QBI

Deduction using W-2 Wages 40,688$ Taxable Income less payroll exp 203,438$ 40,688$ 20% of TI

50% of Wages 62,500$

Federal Tax Savings at 32% 13,020$ Lesser of TI or wage limitation 40,688$

CA Tax Savings at 9.3% 3,784$

Permanent tax savings 16,804$

Better fit with CA law

Employment tax expense 5,613$

Payroll Administration Costs 2,000$

Additional employment costs 7,613$

Reduce Income by $60,000 with additional pension contribution

Federal Tax Savings at 32% ($31,000 x 32%) 9,920$ Qualified Business Income 440,000$ 88,000$ 20% of QBI

CA Tax Savings at 9.3% ($31,000 x 9.3%) 2,883$ Taxable Income 155,000$ 31,000$ 20% of TI

Permanent tax savings 12,803$ Lesser of TI or QBI limitation 31,000$

Tax Deferral with contribution to retirement plan

Federal Tax Deferral at 32% ($60,000 x 32%) 19,200$

CA Tax Deferral at 9.3% ($60,000 x 9.3%) 5,580$

Tax Deferral 24,780$

Convert to S Corp with Owner W-2

Wages to owner $85,000 QBI less wage and payroll exp 346,498$ 69,300$ 20% of QBI

Taxable Income less payroll exp 206,498$ 41,300$ 20% of TI

Federal Tax Savings 13,216$ Deduction using 50% of Wages 85,000$ 42,500$

CA Tax Savings 3,841$ Lesser of TI or wage limitation 41,300$

CA S Corp tax at 1.5% (5,197)$

Permanent tax savings 11,859$

Loss of payroll tax deduction on employee portion 2,686$

Payroll Administration Costs 2,000$

Additional employment costs 4,686$

Convert to an S Corporation

Pay yourself a wage

Risk that you aren't paying yourself an adequate wage

Additional cost of another entity $5,000/year

Formation costs 3,000

Need corp officers and minutes

Need new retirement plan for entity