Category: Small Business

November 26, 2024 | by Atherton & Associates, LLP

The Pros and Cons of Different Business Entities: A Comprehensive Guide

Choosing the right business structure is one of the most critical decisions entrepreneurs and business owners face. The entity you select will have profound implications on how your business operates, how it is taxed, your personal liability, and your ability to raise capital. With several options available, each with its own advantages and drawbacks, making an informed choice requires careful consideration.

In this comprehensive guide, we’ll explore the various types of business entities, dissecting their pros and cons to help you determine which structure aligns best with your business goals and needs.

Factors to Consider When Choosing a Business Entity

Before diving into the specifics of each business entity, it’s essential to understand the key factors that should influence your decision:

• Liability Protection: The extent to which your personal assets are protected from business liabilities.
• Tax Implications: How the business and its owners are taxed, including opportunities for tax savings or risks of double taxation.
• Management and Control: Who will manage the business, and how decisions will be made.
• Administrative Requirements: The complexity and cost of forming and maintaining the entity, including paperwork and compliance obligations.
• Capital Raising: The entity’s ability to attract investors and raise funds for growth.
• Flexibility: How easily the business can adapt to changes in ownership, management, or strategic direction.
• Future Needs: Long-term goals such as expansion, succession planning, or going public.

Overview of Different Business Entities

Sole Proprietorship

A sole proprietorship is the simplest form of business entity, where an individual operates a business without forming a separate legal entity. It’s an attractive option for solo entrepreneurs starting small businesses.

Pros

• Easy and Inexpensive to Establish: Minimal legal paperwork and costs are required to start operating.
• Complete Control: As the sole owner, you make all decisions and have full control over the business.
• Simplified Tax Filing: Business income and losses are reported on your personal tax return, eliminating the need for a separate business return.

Cons

• Unlimited Personal Liability: You’re personally responsible for all business debts and obligations, putting personal assets like your home at risk.
• Difficulty Raising Capital: Investors and lenders may be hesitant to finance sole proprietorships due to perceived higher risk.
• Lack of Continuity: The business may cease to exist upon the owner’s death or decision to stop operating.
• Limited Tax Deductions: Certain business expenses deductible by corporations may not be available to sole proprietors.

While a sole proprietorship offers simplicity and control, the trade-off is significant personal risk and potential challenges in growing the business beyond a certain point.

Partnerships

Partnerships involve two or more individuals (or entities) joining to conduct business. They share profits, losses, and management responsibilities. There are different types of partnerships, each with unique characteristics.

General Partnership

In a general partnership, all partners share management duties and are personally liable for business debts and obligations.

Pros

• Combined Expertise and Resources: Partners can pool skills, knowledge, and capital, enhancing the business’s potential.
• Pass-Through Taxation: Profits and losses pass through to partners’ personal tax returns, avoiding corporate taxes.
• Relatively Easy Formation: Establishing a general partnership typically requires a partnership agreement but involves fewer formalities than corporations.

Cons

• Unlimited Personal Liability: Each partner is personally liable for the business’s debts and the actions of other partners.
• Potential for Disputes: Differences in vision or management style can lead to conflicts affecting the business.
• Lack of Continuity: The partnership may dissolve if a partner leaves or passes away unless otherwise stipulated in the agreement.
• Difficulty Attracting Investors: Investors may prefer entities that offer ownership shares and limit liability.

Limited Partnership (LP)

An LP includes general and limited partners. General partners manage the business and have unlimited liability, while limited partners contribute capital and have liability limited to their investment.

Pros

• Liability Protection for Limited Partners: Limited partners’ personal assets are protected beyond their investment amount.
• Attracting Passive Investors: The structure is appealing to investors seeking to invest without involving themselves in management.
• Pass-Through Taxation: Similar to general partnerships, avoiding double taxation.

Cons

• Unlimited Liability for General Partners: General partners remain personally liable for business debts and obligations.
• Complex Formation and Compliance: LPs require formal agreements and adherence to state regulations, increasing administrative burdens.
• Limited Control for Limited Partners: Limited partners risk losing liability protection if they take an active role in management.

Limited Liability Partnership (LLP)

An LLP offers all partners limited personal liability, protecting them from certain debts and obligations of the partnership and actions of other partners. It’s often used by professional service firms like law and accounting practices.

Pros

• Limited Personal Liability: Partners are typically not personally liable for malpractice of other partners.
• Flexible Management Structure: All partners can participate in management without increasing personal liability.
• Pass-Through Taxation: Business income passes through to personal tax returns.

Cons

• State Law Variations: LLP regulations differ significantly by state, affecting liability protections and formation processes.
• Potential Restrictions: Some states limit LLPs to certain professions or business types.
• Administrative Complexity: LLPs may have additional filing and reporting requirements.

Partnerships offer the benefit of shared responsibilities and resources but come with risks related to personal liability and potential internal conflicts.

Corporations

Corporations are independent legal entities separate from their owners (shareholders), offering robust liability protection and the ability to raise capital through the sale of stock.

C Corporations

A C corporation is the standard corporation under IRS rules, subject to corporate income tax. It’s suitable for businesses that plan to reinvest profits or seek significant outside investment.

Pros

• Strong Liability Protection: Shareholders are not personally liable for corporate debts and obligations.
• Unlimited Growth Potential: Ability to issue multiple classes of stock and attract unlimited investors.
• Deductible Business Expenses: C corporations can deduct the full cost of employee benefits and other expenses not available to other entities.
• Perpetual Existence: The corporation continues to exist despite changes in ownership.

Cons

• Double Taxation: Corporate profits are taxed at the corporate level, and dividends are taxed again on shareholders’ personal tax returns.
• Complex Formation and Compliance: Incorporation requires significant paperwork, ongoing record-keeping, and adherence to formalities.
• Higher Costs: Legal fees, state filing fees, and ongoing compliance expenses can be substantial.

S Corporations

An S corporation is a corporation that elects to pass corporate income, losses, deductions, and credits through to shareholders for federal tax purposes, thus avoiding double taxation.

Pros

• Pass-Through Taxation: Profits and losses pass through to shareholders, preventing double taxation.
• Liability Protection: Similar to C corporations, personal assets are generally protected from business liabilities.
• Attractive to Investors: Offers the credibility of a corporate structure, which can be appealing to some investors.

Cons

• Strict Eligibility Requirements: Limited to 100 shareholders who must be U.S. citizens or residents; can only issue one class of stock.
• Limited Deductible Benefits: Certain employee benefits are not fully deductible for shareholders owning more than 2% of the company.
• Administrative Responsibilities: Must adhere to corporate formalities like holding annual meetings and maintaining records.

Corporations offer significant advantages in liability protection and capital raising but come with increased complexity and potential tax disadvantages.

Limited Liability Company (LLC)

An LLC combines the liability protection of a corporation with the tax efficiencies and operational flexibility of a partnership. It’s a popular choice for many businesses due to its adaptability.

Pros

• Limited Liability Protection: Members are generally shielded from personal liability for business debts and claims.
• Flexible Tax Treatment: Can choose to be taxed as a sole proprietorship, partnership, S corporation, or C corporation, offering potential tax advantages.
• Flexible Management Structure: Can be member-managed or manager-managed, providing options for how the business is run.
• Less Compliance Paperwork: Fewer formal requirements compared to corporations, though an operating agreement is highly recommended.

Cons

• Varied Treatment by State: LLC laws and fees vary by state, possibly affecting profitability and operations.
• Self-Employment Taxes: Members may be subject to self-employment taxes on their share of profits, potentially increasing tax burdens.
• Investor Reluctance: Some investors may prefer corporations due to familiarity and ease of transferring shares.
• Complexity in Multi-State Operations: Operating in multiple states can complicate tax and regulatory compliance.

The LLC offers a balance of flexibility and protection, making it suitable for many businesses, though it’s essential to understand specific state laws and tax implications.

Comparing Business Entities

Taxation Differences

The way a business entity is taxed can significantly impact its profitability and the owner’s personal tax burden.

• Sole Proprietorships and Partnerships: Income and losses pass through to owners’ personal tax returns, and taxes are paid at individual rates.
• C Corporations: Subject to corporate tax rates, with potential double taxation when profits are distributed as dividends.
• S Corporations and LLCs: Generally enjoy pass-through taxation, avoiding double taxation, but with specific eligibility requirements (S corporations).

Liability Protection

• Sole Proprietorships and General Partnerships: Owners have unlimited personal liability for business debts and obligations.
• Limited Partnerships: Limited partners have liability protection, but general partners do not.
• LLPs, LLCs, and Corporations: Offer varying degrees of liability protection, generally shielding personal assets from business liabilities.

Management and Control

• Sole Proprietorships: The owner has total control over decisions and operations.
• Partnerships: Management is shared among partners; roles should be defined in a partnership agreement.
• Corporations: Managed by a board of directors and officers; shareholders have limited direct control.
• LLCs: Offer flexibility; management can be structured to fit the owners’ preferences.

Administrative Requirements and Costs

• Sole Proprietorships and General Partnerships: Minimal setup costs and ongoing formalities.
• Limited Partnerships and LLPs: Require formal agreements and state registrations, increasing complexity and costs.
• Corporations: Higher formation costs and ongoing compliance obligations, including annual reports and meetings.
• LLCs: Moderate costs; while less formal than corporations, they still require an operating agreement and may have state filing requirements.

Choosing the Best Form of Ownership for Your Business

Determining the optimal business entity involves evaluating your specific situation against the characteristics of each entity type.

Consider the following steps:

• Assess Your Liability Exposure: If your business involves significant risk, entities offering liability protection may be more suitable.
• Evaluate Tax Implications: Consult with a tax professional to understand how each entity will impact your tax obligations.
• Consider Management Structure: Decide how you want the business to be managed and the level of control you wish to maintain or share.
• Plan for Capital Needs: If raising capital is a priority, structures like corporations may offer advantages in attracting investors.
• Reflect on Future Goals: Your long-term objectives, such as expansion or succession planning, should align with the entity’s capabilities.
• Understand Compliance Requirements: Be prepared for the administrative responsibilities associated with more complex entities.

Remember, there’s no one-size-fits-all answer. Your business’s unique needs and your personal preferences will guide the best choice. Furthermore, as your business grows and evolves, you may need to reevaluate your entity choice.

How Atherton & Associates LLP Can Help

Navigating the complexities of choosing the right business entity is challenging, but you don’t have to do it alone. Atherton & Associates LLP offers comprehensive tax and advisory services to guide you through this critical decision-making process.

Tax Compliance & Planning

Our team assists businesses and individuals in staying compliant with tax laws and regulations. We provide strategic tax planning to help minimize liabilities and maximize potential savings, all while ensuring adherence to ever-changing tax laws.

Entity Choice Consultation

We provide personalized guidance in selecting the most suitable business entity. By analyzing your unique business situation, goals, and potential risks, we suggest the most beneficial entity type—be it a sole proprietorship, partnership, corporation, or LLC.

Estate & Trust Planning

Protecting your assets and planning for the future are paramount. Our specialized estate and trust planning services aim to reduce the potential tax impact on your beneficiaries. We work closely with you to develop a comprehensive plan that aligns with your financial goals, ensuring a seamless transition of wealth to the next generation.

With Atherton & Associates LLP, you’re partnering with experienced professionals dedicated to your business’s success. Our expertise spans various industries, including agriculture, real estate, construction, retail manufacturing, and distribution services. We understand that each client is unique, and we’re committed to providing tailored solutions that meet your specific needs.

Conclusion

Selecting the right business entity is a foundational step that affects every aspect of your business, from daily operations to long-term growth. By thoroughly understanding the pros and cons of each entity type and considering your individual circumstances and goals, you can make an informed decision that positions your business for success.

At Atherton & Associates LLP, we’re here to support you through this process, offering expert advice and services that help you navigate the complexities of business ownership. Whether you’re just starting or looking to reassess your current structure, our team is ready to assist in charting the best path forward for your business.

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Contributors

Jackie Howell, Tax Partner

Email: [email protected]

Jackie Howell has been in public accounting since 2010, with a concentration in tax compliance and planning for individuals, privately held corporations, partnerships, non-profit organizations, and multi-state taxation. Her unique skill set allows her to assist clients across a broad range of industries, including agriculture, real estate, construction, retail manufacturing, and distribution services.

Natalya Mann, Tax Partner

Email: [email protected]

Natalya Mann brings seventeen years of experience as a Certified Public Accountant and business advisor. She specializes in tax compliance, tax planning, business consulting, and strategizing the best solutions for her individual and business clients. Natalya collaborates with clients in healthcare, professional services, real estate, manufacturing, transportation, retail, and agriculture industries.

Craig Schaurer, Tax Partner, Managing Partner

Email: [email protected]

With a career in public accounting since 2006, Craig Schaurer focuses on tax compliance and planning for the agricultural industry, including the entire supply chain from land-owning farmers to commodity processing and distribution. His expertise encompasses entity and individual tax compliance, specialty taxation of Interest Charged Domestic International Sales Corporations (IC-DISCs), and cooperative taxation and consultation.

Rebecca Terpstra, Tax Partner

Email: [email protected]

Rebecca Terpstra specializes in tax planning, consulting, and preparation for individuals and all business entities. She has extensive experience working with large corporations and high-net-worth individuals across various industries, including agriculture, manufacturing, telecommunications, real estate, financial institutions, retail, and healthcare.

Michael Wyatt, Tax Manager

Email: [email protected]

Michael Wyatt has been serving in public accounting since 2019. He specializes in corporate, partnership, and individual taxation, as well as tax planning. Michael provides tax services for clients in the agricultural, real estate, and service industries. He has experience with estate and business succession planning and multi-state taxation, assisting clients through complex transactions.

November 14, 2024 | by RSM US LLP

Now that Republicans have won the House of Representatives, businesses have more clarity about the direction in which the Trump administration and unified Republican Congress will steer tax policy in 2025.

Republicans are expected to quickly pursue legislation that continues policies they implemented in the Tax Cuts and Jobs Act of 2017 (TCJA), which sought to broaden the tax base and lower tax rates for both individuals and businesses. However, the estimated $4.0 trillion cost of extending TCJA provisions, plus interest costs of $600 billion, add uncertainty to tax policy outcomes. Even nonexpiring TCJA provisions and provisions that were not part of TCJA are subject to change.

Here are five key business issues that potential tax changes could affect, as well as corresponding planning considerations to help businesses make smart, timely decisions.

Cash flow, profitability and investment strategy

Potential tax changes: Corporate and individual tax rates

Modified tax rates could affect businesses’ cash flow and liquidity. Trump has proposed decreasing the corporate tax rate from 21% to 20%, and potentially to as low as 15% for companies that manufacture in the United States.

He intends to extend the TCJA provisions for taxation of individuals, which would entail keeping the top individual income tax rate at 37% along with extending the 20% qualified business income deduction available to pass-through businesses.

Policy perspective

Congressional Republicans generally have been supportive of retaining the current tax rate structure. However, several House Republicans have acknowledged a potential need to increase the corporate rate to raise revenue to offset extension of provisions in the TCJA.

Budgetary considerations will also help shape the discussion about extending individual income tax provisions, which would cost an estimated $3.2 trillion, according to the nonpartisan Congressional Budget Office.

Planning consideration: Accounting method review

Prepare now for changes in income tax rates by developing a playbook of tax accounting methods and elections that can change the timing of income and deductions.

Increased tax liabilities could impact cash flow strategies, liquidity and investment strategies for many corporate taxpayers while placing a premium on alternative strategies—such as shifting to domestic manufacturing—that could yield a more favorable tax rate and return on investment.

Capital expenditures and investments

Potential tax change: Bonus depreciation

For qualified assets, 100% accelerated bonus depreciation may return. Currently, the ability to claim a full depreciation deduction is being phased down and will be eliminated for most property placed in service starting in 2027.

Policy perspective

Trump and congressional Republicans support restoring “bonus” cost recovery for capital expenditures that drive infrastructure and business growth. However, restoring full bonus depreciation would cost an estimated $378 billion, an amount that would likely invoke a broader discussion around the need for revenue raisers.

Planning consideration: Capital expenditure and tax depreciation planning

Review planned capital expenditure budgets and determine which projects have the most flexibility for acceleration, deferral or continuing current course. Quickly identifying such projects and associated placed-in-service considerations will likely strengthen tax results in any legislative scenario. When analyzing the effect of any proposed bonus depreciation changes, take care to model the broad impact of the reduction in taxable income.

Debt analysis

Potential tax change: Deduction of business interest expense

The ability of businesses to deduct business-related interest expenses became less favorable in 2022. Generally, this limitation challenges companies that traditionally rely on debt financing. Such companies may also face other complex issues associated with debt refinancings, modifications and restructuring, which could trigger numerous tax issues, such as potential cancellation of debt income.

Policy perspective

There is Republican support for a more favorable deduction limit, but it was not a top priority for either party in negotiations that produced the ill-fated Tax Relief for American Families and Workers Act early in 2024. The cost of more favorable tax treatment will factor heavily in what Congress does.

Planning considerations: Review debt structure and terms

Review existing debt structures, including the need for potential refinancing based on debt maturity. Intercompany debt agreements could be reviewed, as well as intercompany transfer pricing, to accurately capture debt and interest at the correct entity. This could support strategies to minimize tax impacts under current law.

Global footprint, structuring and supply chain

Potential policy changes: U.S. international taxation and trade

Trump has proposed raising revenue through increases in tariffs, which could have profound implications for U.S. importers specifically and the economy in general.

In addition, several U.S. international tax rates are scheduled to increase at the end of 2025, as required by the TCJA: Global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and the base erosion and anti-abuse tax (BEAT).

Meanwhile, many U.S. multinationals are operating in countries that have adopted the Organisation for Economic Co-operation and Development’s (OECD) Pillar Two framework, which is designed to combat profit shifting and base erosion.

Policy perspective

Republicans prefer to maintain the current GILTI, FDII and BEAT rates. Extending the current rules would cost an estimated $141 billion.

They also prefer current U.S. international tax rules and have resisted adopting the OECD’s Pillar Two framework due to their concerns about the global competitiveness of U.S. businesses and a potential loss of tax sovereignty.

Planning considerations: Review global structure and entity type

A shift in income tax rates raises questions for businesses about whether their tax structure is optimal for their business objectives. Reviewing the differences between C corporate taxation and pass-through taxation could identify ways to improve cash flow and other areas of the business.

Businesses should also evaluate how scheduled U.S. international tax rate increases could affect their global footprint, supply chain and economic presence in foreign jurisdictions. A review of corresponding international tax strategies, including transfer pricing and profit allocation, could help businesses identify additional tax savings. While the goal is optimization, these analyses also bring out areas of tax leakage in a global legal structure which would increase a business’ overall global effective tax rate.

To prepare for tariff increases, importers may be able to capitalize on several well-established customs and trade programs.

Innovation and research and development

Potential tax changes: Tax treatment of R&D expenses

Reinstating immediate R&D expensing would reduce the financial burden companies take on when they invest in new products or technologies. The tax treatment of R&D expenses became less favorable beginning in 2022, as required by the TCJA. Companies must capitalize and amortize costs over five years (15 years for R&D conducted abroad.)

Policy perspective

There is bipartisan support for reinstating immediate R&D expensing. But it’s uncertain how much it would cost the government to implement more favorable R&D expensing rules and how that cost would factor into a broader tax package.

In addition, companies are seeing more IRS exam activity around R&D credit issues. IRS funding remains a source of contention between congressional Republicans and Democrats. After Democrats in 2022 committed approximately $46 billion to IRS enforcement as part of $80 billion in funding for the agency through 2031, Republicans rescinded approximately $21 billion through budget legislation. Expect them to try to claw back more.

Planning considerations: Review R&D spending and sourcing plans

Businesses should review their R&D spending plans with an eye on how their approach to innovation might change with more favorable expensing. Focus on:

• Whether it makes financial sense to outsource R&D.
• Differences between conducting R&D domestically or internationally.
• Interplay between the R&D tax credit and R&D expense deductions.

Also, as companies are analyzing their R&D expenditures, it is wise to review prior R&D credit documentation to ensure complete and accurate reporting for R&D tax credit claims and R&D expenses.

The tax policy road ahead

With more than 30 provisions in the TCJA scheduled to expire at the end of 2025, Republican lawmakers have indicated a desire to act quickly on tax legislation after taking office in January. Under Republican majorities in both chambers, the budget reconciliation process would allow the Senate to pass legislation with a simple majority.

However, the estimated cost of tax changes could complicate an agreement between Senate and House Republicans, given continued concerns about the size of the existing federal debt and the continuing annual federal deficits.

In other words, even under a unified Republican government, some complicating factors continue to shroud tax policy outcomes in uncertainty.

Proactive planning will be crucial to navigate tax changes and optimize tax positions. Businesses that work with their tax advisor to monitor legislative proposals and model the effects on cash flows and tax obligations will be best equipped to make smart, timely decisions based on policy outcomes.

We invite you to register to attend our tax policy webcast on Nov. 18. We will discuss:

• Aligning business structure with your current strategy and potential tax changes 
• Income accelerations and deduction deferrals to enhance cash flow 
• Preparing for potential adjustments in your business transition plans for either a family transfer or a sale

October 28, 2024 | by Atherton & Associates, LLP

Navigating the decision to acquire a vehicle for your business isn’t as simple as choosing a color or model. The more critical dilemma often boils down to whether you should lease or buy. As a business owner, this choice transcends just finances, as you will need to consider the tax implications and your long-term plans as well.

You can’t always expense a vehicle

Before we dive into the lease vs. buy considerations, it’s important to understand that you can’t always expense a vehicle. If your vehicle is never used for business purposes, you can’t claim it as a business deduction, regardless of whether you lease or buy. Likewise, if you use a vehicle for personal and business use, your personal use will limit your deductions.

A universal perk, though, is the ability to deduct business mileage, as this applies to both leased and purchased vehicles, as well as those you already own.

Leasing basics

Leasing is akin to having a long-term rental car. While this might lower your monthly payments, there are also strings attached. A lease is a contract, and, like all contracts, any missteps will cost you.

First, most leases have caps on mileage, and exceeding these limits can result in costly penalties. For instance, many leases have a limit of 12,000 – 15,000 miles over the course of the term, so if you plan to cover a lot of ground, a lease may not be practical.

There’s also the matter of wear and tear. Vehicles naturally accrue some light scratches and dings from ordinary use. However, with a lease, there’s a fine line between acceptable wear and what’s deemed excessive. At the end of the term, if the lessor determines that the vehicle has been damaged beyond normal wear and tear, it could result in additional fees.

Regular maintenance may also be bundled into your lease payments, which is often a perk, but where you service your vehicle may be non-negotiable. For some brands, DIY maintenance or visiting your local garage may be off the table. Instead, you could be tethered to authorized dealerships, which may be inconvenient in certain circumstances.

In a nutshell, it’s imperative to scrutinize the fine print on any leasing agreements. Your initial savings can be offset by additional fees if you breach any terms of the agreement.

Preliminary considerations

Leasing and buying a vehicle both present unique considerations.

Leasing: 

• Typically demands a smaller downpayment and lower monthly payments.

• You can upgrade your vehicle more frequently, as most lease terms last 2-3 years.

• At the end of the term, you can simply return the vehicle without worrying about the complexities of a resale.

• Insurance premiums may be more expensive, as full coverage is often required.

• Mileage limits and wear-and-tear clauses can lead to additional fees.

Buying: 

• Every payment brings you closer to owning the vehicle outright.

• You’re free from mileage limits and can customize the vehicle as you see fit.

• You can recover some costs by selling the vehicle later.

• Purchasing often requires a larger down payment and higher monthly payments.

• You’re responsible for all maintenance and repair costs.

Tax deductions

For both buying and leasing, the IRS allows deductions for business use of a vehicle. However, the nature and extent of these deductions vary.

Leasing: straightforward but limited

Leasing’s beauty lies in its simplicity, especially when it comes to deductions. If you use the leased vehicle exclusively for business, you can deduct the lease payments in full. If you occasionally use the vehicle for personal reasons, you can still deduct the business portion of your lease payments – just keep meticulous mileage logs and documentation. For instance, if you drive a total of 10,000 miles in a year, and 7,000 of those are for business purposes, you can claim 70% of your lease payments as a business expense.

Yet, leasing isn’t without limitations. One notable setback is the ineligibility for depreciation deductions, which can be substantial.

Buying: greater deduction potential

When you purchase a vehicle for your business, you’re not just acquiring an asset; you’re potentially unlocking several tax deduction opportunities.

One of the most notable perks of buying is the ability to tap into depreciation deductions. You have the option to claim an upfront 100% depreciation by taking a Section 179 deduction, although you cannot deduct more than your business’s net income for the year. To enjoy this benefit, however, the vehicle’s weight must fall between 6,000 and 14,000 lbs., and it must be used for business purposes more than 50% of the time. If your vehicle does not qualify for the Section 179 deduction, you may still be able to claim bonus depreciation; however, the value of this deduction started phasing out in 2023.

The advantages of purchasing a business vehicle don’t stop at depreciation. If you’ve chosen to finance your vehicle purchase, the interest paid on the loan is also deductible.

For businesses eyeing environmentally-friendly vehicles, you may also be able to claim the Clean Vehicle Tax Credit. For brand-new vehicles, this credit can slash your tax bill by up to $7,500. If you’re considering a used vehicle, you can claim the lesser of $4,000 or 30% of its sale price. However, it’s vital to note that this credit is subject to several limitations, so you’ll need to determine that a vehicle is eligible before claiming the tax credit.

Hybrid approach

A hybrid approach may enable you to experience the best of both worlds. Some businesses find merit in leasing a vehicle at first, then buying it out at the end of the lease term. This approach offers initial flexibility, lower upfront costs, and an eventual asset.

This approach will probably make the most sense if:

• You’re uncertain about a vehicle’s long-term suitability

• Your business travel needs are initially limited, but you project an uptick in business-related travel in the future

• The lower monthly cost of leasing is attractive now, but you plan to own a vehicle as a business asset in the future

Consult with our experts

Deciding whether to lease or buy a vehicle for your business is a significant decision with long-lasting implications. While this article offers a general overview, the optimal choice depends on your specific circumstances, financial situation, and business goals.

For personalized guidance tailored to your unique needs, please contact our office.

October 14, 2024 | by Atherton & Associates, LLP

Starting a business involves a significant amount of planning, research, and preparatory work, which often comes with a price tag. However, when it comes to the tax treatment of these costs, things can get a bit unclear. 

Are these expenses deductible before your business officially launches? And how does it change if your idea never gets off the ground? 

To help answer these questions, let’s take a closer look at the tax rules and a recent court case that sheds light on the subject. 

Section 162: deductibility of business expenses

Section 162 of the Internal Revenue Code (IRC) is key to understanding what business expenses you can deduct. It allows you to write off “ordinary and necessary” expenses related to running your business. But those terms have been the subject of much debate (and litigation). 

In this context, “ordinary” doesn’t necessarily mean frequent or common. An expense can be ordinary even if it only occurs once in a particular taxpayer’s lifetime. Most courts have held that the provision refers to expenses that are normal or customary in a particular trade. Likewise, “necessary” generally implies that a specific expense is appropriate and helpful for a business’s development. 

However, the plain language of Section 162 indicates that businesses must already be up and running for an expense to be deductible. So, what does that mean for costs incurred pre-startup? 

Section 195: deductibility of pre-startup costs

Costs incurred before the official launch of a business might be deductible under Section 195 of the IRC. Congress introduced this provision to help business owners recover these early expenses. For businesses starting in 2024, you can deduct up to $5,000 of pre-startup costs, provided total startup costs are less than $50,000.

Once startup costs exceed $50,000, your first-year deduction is reduced dollar-for-dollar. Any remaining costs beyond the first-year deduction must be amortized over 180 months, starting the month the business begins. 

To qualify as startup costs, expenses must be related to investigating or creating a business and be costs that could generally be deducted if the business were already operating. These can include things like market surveys, advertisements, or salaries for training employees. Capital expenses like buildings, vehicles, and equipment are treated separately for tax purposes. 

Eason v. Commissioner: determining when a business starts

Understanding when a business officially begins operations is necessary for deducting both pre-startup costs and ongoing business expenses. However, the line between preparatory efforts and active operations can be difficult to define. A recent court case highlights this ambiguity. 

In Eason v. Commissioner, Eason spent over $40,000 on real estate investment courses and formed a corporation with the intent to provide real estate guidance. Despite these efforts, the business failed to generate income by the end of the year. Nevertheless, Eason treated the costs as deductible pre-startup expenses on his tax return. 

The IRS denied the deductions, sparking litigation. Their main argument was that Eason’s expenses were not deductible since the business hadn’t truly become operational. Although Eason set up a corporation, attended courses, and printed business cards and other stationery, the court found no evidence that he actually started providing services or generating income by the year-end. Without this evidence, the business couldn’t be considered operational as required under Sections 162 and 195. 

The case illustrates that simply forming a business entity and taking preparatory steps aren’t enough. There must be a real attempt to offer services or generate revenue to meet the IRS’s standards. Even then, the IRS could argue that the business is more of a hobby than a legitimate business if it doesn’t show consistent efforts to operate. 

Things to keep in mind when deducting pre-startup costs

The deductibility of pre-startup costs is a complex area of tax law that requires careful consideration. Here are some practical steps you should keep in mind: 

• Document everything: keep thorough records of all expenses and actions taken to launch the business.

• Know the criteria: some pre-startup costs may be deductible once your business begins, but they must meet specific criteria. 

• Hobby vs. business: be cautious that your venture doesn’t appear more like a hobby, which would limit deductions. 

• Consult a CPA: a CPA can ensure compliance with IRS regulations, help maximize deductions, and strategically balance your costs to align with your long-term business goals. 

Starting a business is challenging, and making the right choices can have a big impact on your tax savings. To ensure you’re maximizing deductions while staying compliant, it’s wise to consult an experienced CPA. If you’d like help navigating business tax laws and making informed decisions that align with your long-term goals, please contact our office. 

June 24, 2024 | by Atherton & Associates, LLP

Nearly every business asset, from machinery to office equipment, inevitably faces obsolescence. Technology advances, operational needs change, and items wear out, requiring continual investments in the very items necessary to run your business. Fortunately, the tax code recognizes this economic reality, offering tax breaks for depreciation. 

But there’s more than one way to account for depreciation, and understanding how to leverage various depreciation methods can maximize your tax savings – transforming a simple accounting practice into a strategic advantage. 

Depreciation basics

Put simply, depreciation is a way for businesses to account for the loss of value that occurs over time with capital assets. As long as the expense helps your business make money and you will use it for a year or more, you can likely depreciate it. But there are rules about what is depreciable. For example, inventory, land, and assets held for investment can’t be depreciated. 

Certain assets, due to their short useful life or low cost, are directly expensed rather than depreciated. If the asset doesn’t deteriorate over time, like land, or is relatively liquid, like inventory, it’s not depreciable. 

The Modified Accelerated Cost Recovery System (MACRS) is the default method of depreciation for most assets under the tax code. It accelerates depreciation, providing larger deductions in the earlier years of an asset’s lifespan. However, businesses have the flexibility to choose other methods to maximize their tax savings. 

Accounting for depreciation

There are several ways to deduct depreciable assets, each with its own rules and benefits. However, once a depreciation method is applied, you are generally required to stick with that method for the duration of the asset’s life. 

The Section 179 deduction enables businesses to expense the cost of qualifying assets immediately, but there are limitations. Likewise, bonus depreciation allows businesses to deduct most of the cost of an asset in the first year, according to a set percentage. And, there are other less commonly used methods to calculate depreciation based on different formulas.

Section 179 deduction

The Section 179 deduction isn’t really a method of calculating depreciation. Rather, it allows businesses to immediately expense up to $1.22 million of the purchase price of qualifying assets (as of 2024). Qualifying property includes tangible assets such as computer software, equipment, and machinery. Certain improvements to non-residential real estate, such as roofs, HVAC, security, and fire protection systems, also qualify. However, it generally cannot be taken on rental properties.

Vehicles used more than 50% for business purposes are eligible for the Section 179 deduction, but the deduction amount can vary significantly based on the type and usage of the vehicle. For instance, the deduction for vehicles weighing less than 6,000 lbs. is capped at $19,200, and vehicles weighing 6,000-14,000 lbs. are capped at $30,500. Heavy vehicles above 14,000 lbs. can potentially qualify for the full deduction amount up to the $1.22 million limit. 

The deduction begins to phase out dollar-for-dollar once total asset purchases exceed $3.05 million. If, for instance, you placed $3.10 million of assets in service this year, the deductible amount would be reduced by $50,000, so you could only deduct $1.17 million instead of the full $1.22 million. 

Additionally, Section 179 cannot be used to create or increase a net operating loss. This means the deduction is limited to the amount of taxable income, and losses can’t be carried forward to future tax years. 

Bonus depreciation

Bonus depreciation is another way to write off the majority of an asset’s cost upfront. In 2024, businesses can deduct 60% of the cost of qualifying assets without any upper limits. However, bonus depreciation is phasing out by 20% annually and will phase out entirely by the end of 2026 unless new legislation extends it. 

Unlike Section 179, bonus depreciation can be used to create a net operating loss and can also be carried forward. Better yet, businesses can use Section 179 and bonus depreciation in the same year.  On each individual asset, Section 179 must be applied first to expense all or a portion of the cost basis, before applying bonus depreciation to the balance. If the business is operating near a loss, Section 179 can only be used to reduce taxable income to zero. Any remaining cost can then be addressed with bonus depreciation, potentially creating a loss that offers tax savings in future years. 

For example, consider a business that purchases $500,000 in qualifying property but only has $100,000 in taxable income for the year. Using Section 179, the business can immediately expense $100,000, reducing its taxable income to zero. Bonus depreciation can be applied to the remaining $400,000 resulting in a loss that can be carried forward to offset taxable income in the future. 

However, these deductions must be used judiciously to avoid “double-dipping” or claiming more than one type of depreciation for the same dollar spent on an asset. 

Other depreciation methods

While Section 179 and bonus depreciation are popular for their ability to offer substantial tax cuts upfront, several other methods are available that calculate the rate of depreciation differently. These methods generally offer varying rates of acceleration, differing primarily in the timing and size of the deductions. Straight-line depreciation, however, is distinctive for its simplicity and predictability. 

This method spreads the cost of an asset evenly across its useful life and is the only option available for depreciating intangible assets like patents or copyrights. And, unlike accelerated depreciation methods, it reduces the risk of depreciation recapture. This occurs when an asset is sold for a price higher than its depreciated value, which can result in the IRS “recapturing” some of the accelerated depreciation benefits previously claimed. This recapture is taxed as ordinary income. With the straight-line method, the asset’s book value decreases at a slower, more consistent rate, more closely aligning with its actual market value over time. 

Choosing the best option

The best choice for your business will depend on several factors, including your total investment in depreciable assets, current income, and future income projections. 

Here are a few scenarios to show each strategy in action: 

• Section 179. A business purchases $500,000 in new machinery. Profits are substantial and stable. Section 179 will allow the business to expense the entire amount in the first year, providing immediate tax relief that can be reinvested into the business quickly. 

• Bonus depreciation. A startup in its early stages expects to ramp up its earnings significantly over the next few years. It invests $2 million in high-tech equipment. Using bonus depreciation enables the startup to deduct 60% (or $1.2 million) of the investment immediately, even if it creates a loss. That loss can be carried forward to offset taxable income in future profitable years. The remaining 40% of the assets’ cost can also be depreciated over time. 

• Straight-line depreciation. A business acquires vehicles, intellectual property, and equipment totaling $100,000. The company enjoys moderate, stable income but has minimal tax liabilities for the current year. They’re also unsure how long they will keep the vehicles before reselling. Straight-line depreciation can be applied to the IP assets and ensures the company benefits from predictable tax relief in the future when tax liabilities may be greater. It also reduces the risk of recapture if the company decides to sell the vehicles within the next few years. 

Best practices

Effective management of depreciation not only impacts your tax obligations but also plays a crucial role in optimizing cash flow. Here are a few best practices applicable across all depreciation methods that can enhance your financial strategy: 

• Time your purchases. If you anticipate tax liabilities as you approach the end of the fiscal year, consider acquiring necessary assets during this period. This approach allows you to claim deductions for the full year, even if the asset was only in service for a short time. 

• Reinvest early savings. Initial savings from accelerated depreciation or Section 179 should be reinvested into the business. This can fuel growth and prepare the business for future periods when tax liabilities may increase. 

• Leverage technology. Consider purchasing or working with professionals who use software to track depreciation schedules. This can ensure accuracy and save time and resources. 

Consult with tax professionals

While seemingly simple, depreciation involves complexities that are best navigated with professional guidance. Our expert advisors can tailor your depreciation strategy to maximize tax benefits based on your specific business needs. 

If you’d like to learn more, please contact our office. We’ll help you turn depreciation into a strategic advantage while staying compliant with evolving regulations. 

June 20, 2024 | by Atherton & Associates, LLP

The Tax Cuts and Jobs Act (TCJA) introduced many changes in late 2017, but many provisions were temporary, with an approaching expiration as early as January 1, 2026. 

The good news is that not everything will change. One of the most significant and lasting changes introduced by the TCJA was the restructuring of the corporate tax rate. Prior to the TCJA, C-corporations faced a graduated tax rate structure with a top rate of 35%. The TCJA implemented a flat 21% tax rate, regardless of the amount of corporate taxable income. Unlike many other provisions of the TCJA, this change is permanent and will not expire at the end of 2025. 

However, businesses will need to prepare for the provisions that are set to change, taking advantage of existing opportunities while they are still available. 

In this article, we’ll briefly explore some of the major changes and provide actionable recommendations to help you prepare financially. 

Qualified business income (QBI) deduction

The TCJA introduced a deduction of up to 20% of qualified business income for owners of passthrough businesses, including partnerships, S corps, and sole proprietorships. In 2026, passthrough business owners will no longer be able to claim this deduction. 

Business owners of affected entities should consider strategies to maximize the use of the QBI deduction before it expires. This may include accelerating income into years where the deduction is still available. Also, speak with a tax advisor about ways to optimize business expenses and deductions in other areas to offset the increased tax burden once the QBI deduction is no longer available. 

Bonus depreciation

Under normal depreciation rules, businesses must deduct the cost of new investments over a period ranging from 3 to 39 years, depending on the asset. However, the TCJA allowed for an additional first-year depreciation deduction, known as bonus depreciation. Between 2017 and 2023, businesses could take a 100% first-year deduction on qualified property. This change could also be applied to used property, which was a departure from previous rules. 

This provision started phasing out in 2023, and currently, businesses can only take a 60% first-year depreciation deduction. In 2025, this will drop to 40%, and in 2026, the deduction will drop to 20%. After 2027, normal depreciation rules will apply.

To maximize tax benefits, plan significant purchases of qualified property to take advantage of the higher bonus depreciation rates before they phase out.

Opportunity zones

Opportunity zones were created under the TCJA to spur economic development and job creation in distressed communities by offering tax incentives to investors. Capital gains from investments in these zones can be deferred and excluded from income if specific requirements are met. 

The ability to defer capital gains by investing in opportunity zones will expire after December 31, 2026. After this date, there will be no tax benefits available for new investments in opportunity zones.

Work with a tax advisor to understand the specific requirements and benefits of Opportunity Zone investments and to ensure that any investments made comply with IRS regulations to maximize the tax advantages before they expire.

Employer credit for paid leave

The TCJA introduced a business tax credit for wages paid to employees on family and medical leave. Employers can currently claim a credit of up to 25% of wages paid for up to 12 weeks of leave, provided the leave is not mandated by law. This credit encourages employers to offer paid leave benefits beyond what is legally required.

Starting in 2026, this tax credit will no longer be available. 

Continue to take advantage of this credit while it is available, but consider how the loss of this credit will impact your business in the future. You may need to plan adjustments to manage these costs more effectively. Talk to a tax advisor about other tax-advantaged strategies to support employee well-being once this credit expires. 

Fringe benefits exclusions

Not all of the impending changes are bad news for employers. Under the TCJA, employer-provided reimbursements for bicycle commuting and moving expenses are included in taxable income for employees (with the exception of moving expenses for the Armed Forces). 

Beginning in 2026, the TCJA’s restrictions will expire, and these fringe benefits will once again be excluded from taxable income. Specifically, up to $20 per month for bicycle commuting expenses and all qualified moving expenses will not be subject to income or payroll taxes. 

In the future, you may consider enhancing your employee benefits package by providing some of these fringe benefits. This may even help offset some of the losses experienced from other changes. 

Limit on losses for noncorporate taxpayers

Under the TCJA, noncorporate taxpayers, such as sole proprietors, partnerships, and S crops, can generally deduct business losses from their taxable income. However, there is an annual limit on the amount of loss that can be deducted: $610,000 for married taxpayers and $305,000 for other taxpayers. 

Starting in 2029, the limits on the deduction for business losses will be relaxed, enabling noncorporate taxpayers to offset more income. 

Preparing for the post-TCJA landscape

As we approach the sunset of the TCJA, it’s crucial to consider how the upcoming changes might affect your tax planning and business strategies.

This article provides a brief overview of some of the key changes and potential benefits that businesses will encounter. However, it does not cover every possible recommendation or strategy. 

For more detailed and personalized guidance tailored to your specific situation, please contact one of our expert advisors.

May 20, 2024 | by RSM US LLP

Executive summary: Introduction to CODI

Cancellation of Debt Income (“CODI”) can have significant tax implications for various entities, depending on their classification for federal income tax purposes, as well as their solvency and bankruptcy status. Understanding the tax treatment of CODI for partnerships, S corporations, and C corporations is vital for taxpayers to make well-informed decisions and optimize their tax positions. With analysis and illustrative examples, this article provides an introductory guide for navigating CODI in different entity structures.

General cancellation of debt provisions

CODI is a fundamental concept in federal tax law, wherein debtors recognize income when they settle their outstanding debt obligations for an amount less than the adjusted issue price (“AIP”). This principle was formally established in the landmark case Kirby Lumber¹ and later codified in section 61(a)(11)² by including CODI as a part of a taxpayer’s gross income. For instance, if a debtor owes $100 of debt but settles it for $60, the debtor generally recognizes $40 of CODI as taxable income.

Certain exclusions are provided, which allow CODI to be excluded from taxable income to the extent a debtor is insolvent.³ The amount excluded by reason of the insolvency exception cannot exceed the amount by which the taxpayer is insolvent immediately prior to the discharge.⁴

Another prominent exclusion is the bankruptcy exclusion, in which CODI is excluded if the discharge occurs in a “title 11 case.”⁵ The term “title 11 case” means a case under the Bankruptcy Code⁶ [1] if the taxpayer is under the jurisdiction of the court; and the discharge of indebtedness is granted by the court or pursuant to a plan approved by the court.⁷ Where a debt cancellation occurs during the bankruptcy process, but not pursuant to a plan approved/granted by the court, the bankruptcy exclusion does not apply.⁸ If the debt discharge occurs pursuant to a plan approved by the court, the level of insolvency of the debtor is irrelevant to the amount of the exclusion. In other words, the burden of proof is on the taxpayer to establish the amount of insolvency outside of a title 11 bankruptcy case.⁹ One benefit of a title 11 bankruptcy filing is the absence of the requirement for the taxpayer to establish the amount of insolvency.

Generally, where an exclusion (i.e., bankruptcy or insolvency) applies, tax attribute reduction is required under section 108(b), which provides mechanical ordering rules.¹⁰

Additionally, as a way to prevent debtors from avoiding CODI by transferring their indebtedness to related parties, the Code treats the acquisition of outstanding debt by a related person as if the debtor had acquired the debt.¹¹ This means that if a party related to the debtor acquires the debtor’s debt at a discount, the debtor is deemed to have realized CODI.

Partnerships

When a partnership’s debt is forgiven, the consequences are shaped by the interplay of general discharge of indebtedness principles and the rules governing allocation of partnership income and liabilities. For federal income tax purposes, partnerships pass through items of income, gain, deduction, loss, and credit to individual partners. Consequently, when income arises from the discharge of partnership indebtedness, such income is determined at the partnership level, and each partner is responsible for reporting their distributive share of the income on their own income tax returns. Such income is allocated in accordance with the partnership agreement and reflected on Schedules K-1 issued by the partnership to its partners.

The insolvency and bankruptcy exclusions are applied at the partner level and each partner’s individual situation determines eligibility to exclude CODI.¹³ As such, even in situations where the partnership itself is insolvent, the insolvency exclusion is unavailable to a partner to the extent that the partner is solvent. Likewise, a partner will generally only qualify for the bankruptcy exclusion if they are a party to the bankruptcy (or join in a bankruptcy filing with the partnership).¹⁴

This allocation of CODI impacts each partner’s basis in the partnership interest, effectively increasing it by the amount of their share of income.¹⁵ However, this increase in basis is generally, accompanied by an offsetting reduction due to the partnership tax rules treating a decrease in a partner’s share of partnership liabilities as a distribution of money.¹⁶ As a result, partners must include in their income their pro rata share of the discharged debt without enjoying a net basis increase that usually accompanies other types of partnership income.

As mentioned above, to the extent there is CODI excluded there are attribute reduction ordering rules that apply. In the case of partnerships, attribute reduction applies at the partner level based on the amount of excluded CODI and based on the partner’s tax attributes.

As mentioned above, to the extent there is CODI excluded there are attribute reduction ordering rules that apply. In the case of partnerships, attribute reduction applies at the partner level based on the amount of excluded CODI and based on the partner’s tax attributes.

S corporations

While S corporations are similar to partnerships in their flow-through nature, for purposes of CODI, the insolvency and bankruptcy exclusions are applied at the corporate level as opposed to the shareholder level. ¹⁷ Just as a partner in a partnership is entitled to deduct their share of the partnership’s losses, so too is the shareholder of an S corporation entitled to deduct their share of the corporate losses.¹⁸ In the S corporation context, losses are taken into account by the shareholder, but are generally limited to the shareholder’s basis in the stock or debt of the corporation. As such, a shareholder may have losses allocated in excess of basis which are suspended.¹⁹

Shareholders must carry forward their suspended losses, and since there is no carryover at the S corporation level, a special rule treats these suspended losses of the shareholder as deemed NOLs of the corporation for that tax year.²⁰ As a result, the suspended losses are subject to reduction when CODI is excluded from income under the insolvency or bankruptcy exclusions.²¹

CODI that is taxable to the S corporation, increases the shareholders tax basis ²², and also increases the S corporation’s accumulated adjustments account (“AAA”)²³. However, to the extent that CODI is excluded from the S corporation’s income because of its bankruptcy status or insolvency, the shareholders do not increase their basis for the excluded CODI.²⁴

C corporations

C corporations recognize CODI at the corporate level, and is included in gross income, subject to specific exceptions. As mentioned above, Section 108(a) outlines circumstances under which CODI is excluded from a C corporation’s gross income and generally include discharge in a Title 11 bankruptcy and discharge when the corporation is insolvent.²⁵ Again, while Section 108 allows for the exclusion of CODI, it generally comes at a cost by way of tax attribute reduction.²⁶

The ordering rules generally provide reduction in the following order:

1. Net Operating Losses (“NOL”)
2. General Business Credits
3. Minimum Tax Credits
4. Capital Loss Carryovers
5. Basis Reduction
6. Passive Activity Loss and Credit Carryovers
7. Foreign Tax Credit Carryovers

To the extent that any CODI remains after the attribute reduction is applied, it is essentially erased, something that practitioners have come to refer as “Black-hole Cancellation of Debt (COD) ”. By reducing tax attributes, to the extent they exist, the debtor is provided with a fresh start, but also facilitates an equitable tax deferral, rather than a permanent tax difference.

Additionally, the attribute reduction, described above, occurs after determination of the debtor’s tax liability for the year of the debt discharge.²⁷ This ordering rule can significantly impact a debtor corporation’s tax liability, particularly in instances of liquidating bankruptcies. When it is clear that a corporation will not become profitable even after its outstanding debt is reduced, the purpose of the bankruptcy process is then to ensure the orderly liquidation and distribution of the debtor’s assets to its creditors.²⁸ A liquidating bankruptcy process often involve taxable sales of debtor assets under section 363 of the Bankruptcy Code, and also potential CODI.

Here Debtor Corp. will recognize a $10x gain on the sale of the assets, and likely recognizes $90x of CODI. The CODI would likely be excluded under section 108(a) and will reduce the $10x NOLs after the determination of the tax for the year of the discharge.²⁹ As such the ordering rule will allow Debtor Corp. to use its NOLs to offset the gain on the sale, prior to the attribute reduction. Thus, when the attribute reduction is made, there are no attributes left to reduce and the entire $90x of CODI is Black-hole COD.

Consolidated Group Setting³⁰

If a debtor corporation, that is a member of a consolidated group, recognizes CODI and excludes it from income under section 108(a), there are special rules regarding attribute reduction.³¹ The consolidated group’s tax attributes are generally subject to reduction, after reduction of the debtor’s own tax attributes, following a mechanical ordering rule. Additionally, in the consolidated context, there is a “tier-down” attribute reduction mechanism that applies to reduce the tax attributes of a lower-tier member in certain circumstances.³²

For U.S. federal tax purposes, the exclusion of CODI under section 108(a) (i.e., bankruptcy, insolvency, etc.) does not apply to cancellation transactions between members of a consolidated group involving intercompany debt.³³

The ultimate impact of debt workouts for a consolidated group are complex, and often can have odd results depending upon which a consolidated group member is the true debtor. Careful consultation and modeling from knowledgeable tax advisors is always recommended in these contexts.

Conclusion

The tax consequences of CODI are highly dependent on the entity’s classification, solvency, and bankruptcy status. Successfully navigating the complexities of CODI requires a thorough understanding of the tax implications specific to each entity type and the equity owners. Consulting with experienced tax advisors and legal professionals is critical in handling CODI and related tax matters effectively.

[1] Kirby Lumber v. United States, 284 U.S. 1 (1931).

[2] All section references are to the Internal Revenue Code of 1986 (the “Code”), as amended, or to underlying regulations.

[3] Section 108(a)(1)(B).

[4] Section 108(a)(3).

[5] Section 108(a)(1)(A).

[6] Title 11 U.S.C.

[7] Section 108(d)(2).

[8] For example, if during the bankruptcy proceedings, the debtor and creditor independently agree to a modification of the debt, or the debtor buys back its debt for stock at a discount, all without the court’s approval.

[9] Note that a Chapter 7 (liquidating) or Chapter 11 (reorganizing bankruptcy) are two examples of title 11 bankruptcies.

[10] The mechanics of the attribute reduction resulting from excluded CODI is beyond the scope of this article.

[11] Section 108(e)(4);. Reg. section 1.108-2.

[12] Timing of the acquisition of the debt when compared to the timing of becoming related is also relevant, for example:  Reg. section 1.108-2(c)(3) “a holder of indebtedness is treated as having acquired the indebtedness in anticipation of becoming related to the debtor if the holder acquired the indebtedness less than 6 months before the date the holder becomes related to the debtor.”

[13] Section 108(d)(6).

[14] Reg. section. 1.108-9(b); Note: There are Tax Court cases wherein a partner was permitted to exclude CODI, where the partnership was in bankruptcy, but the partner was not in their individual capacity, however the IRS has come out against these decisions in nonacquiescence in A.O.D. 2015-001. See e.g., Estate of Martinez v. Commissioner, T.C. Memo. 2004-150; Gracia v. Commissioner, T.C. Memo. 2004-147; Mirarchi v. Commissioner, T.C. Memo. 2004-148; and Price v. Commissioner, T.C. Memo. 2004-149 (essentially identical opinions for three partners in the partnership).

[15] Section 705.

[16] See Sections 752(b) and 733. Note however, that depending on the nature of the debt discharged, the basis decrease may differ from the increase pursuant to Section 705.

[17] Section 108(d)(7)(A).

[18] Section 1366(a)(1).

[19] Section 1366(d)(1); (d)(2).

[20] Section 108(d)(7)(B).

[21] Reg. section 1.108-7(d).

[22] Section 1367(a)(1)(A).

[23] Section 1368(e).

[24] Section 108(d)(7)(A).

[25] Note: also includes discharge of qualified farm indebtedness

[26] Section 108(b).

[27] Section 108(b)(4)(A).

[28] This process has various tax consequences, but for purposes of this article the discussion is limited to CODI.

[29] Section 108(b)(4)(A).

[30] A detailed discussion of the consolidated return rules regarding CODI is beyond the scope of this limited discussion.

[31] Reg. section. 1.1502-28.

[32] Reg. section. 1.1502-28(b).

[33] Reg. section. 1.1502-13(g)(4)(i)(C).

April 29, 2024 | by RSM US LLP

Executive summary:

House Ways & Means Committee Chairman Jason Smith (R-MO)  and House Tax Subcommittee Chairman Mike Kelly (R-PA) recently announced the formation of 10 “Committee Tax Teams”.  Each team will address key tax provisions from the 2017 Tax Cuts and Jobs Act (TCJA) that are set to expire in 2025 and identify legislative solutions that seek to help many taxpayers.

Tax policy and potential legislation will be top of mind for many as we move closer to the expiration of many TCJA provisions.

The journey to 2025 tax reform begins

Last week, House Ways & Means Committee Chairman Jason Smith and House Tax Subcommittee Chairman Mike Kelly announced the formation of 10 “Committee Tax Teams”. Each committee is comprised of Republican Ways and Means Committee members tasked with identifying legislative solutions to various policy areas that will be part of discussions as we approach the expiration of several provisions from the 2017 Tax Cuts and Jobs Act (TCJA) at the end of 2025.

While not unexpected, the announcement loosely resembles a similar action taken in 2017 as Congress began deliberations leading to the enactment of the TCJA. It is noteworthy that there are no Democratic members assigned to these teams.

It is important to keep in mind that the advancement of Republican and Democratic priorities will be largely dependent upon the results of the upcoming presidential and congressional elections later this year. While policymakers will face pressure to reach a consensus on extending the sunsetting provisions, the outcome of the election will significantly determine how both the process moves forward and the outcome of that process.

Key TCJA-related provisions that are scheduled to change after 2025 going into 2026 include:

• An increase in the top individual tax rate from 37% to 39.6%
• A decrease (by roughly 50%) in the standard deduction amount
• A decrease (by roughly 50%) in the estate tax exemption amount
• A return of personal exemptions for taxpayers and dependents
• Changes to various itemized deductions and the alternative minimum tax – including the elimination of the $10,000 State and Local Tax (SALT) cap
• Expiration of the Section 199A pass-through deduction (allowing for a 20% deduction of qualified business income)
• An increase in the Base Erosion and Anti-Abuse Tax (BEAT) rate from 10% to 12.5%
• The research credit no longer being a benefit for any BEAT taxpayers
• An increase in the Global Intangible Low-Taxed Income (GILTI) tax rate
• The Foreign-Derived Intangible Income (FDII) benefit becoming less generous.

It is important to realize that the TCJA enacted a number of permanent tax law changes, such as a reduction in the statutory corporate tax rate, and substantive changes to the way international corporations are taxed. Even though those provisions are permanent, they will be part of the upcoming tax reform debate and are subject to change as part of the upcoming tax reform process. There are also a number of other non-TCJA extenders that have either expired or are due to expire, as well as a broad array of tax proposals that were part of the Build Back Better deliberations a few years ago but which did not ultimately become enacted into law. All of these provisions are on the table, as are the tax provisions that were enacted as part of the Inflation Reduction Act – including the corporate alternative minimum tax, the stock buy back excise tax, and numerous alternative energy tax incentives.

Attached below are the Tax Team Assignments. We will continue to monitor events as they evolve. For more information, see the Ways and Means Committee Press Release.

Attachment: Tax Team Assignments

Area of Focus	Chair	Members
American Manufacturing	Rep. Buchan	Rep. Murphy* Rep. Arrington Rep. Tenney Rep. Malliotakis
Working Families	Rep. Fitzpatrick	Rep. Malliotakis* Rep. Moore Rep. Steel Rep. Carey
American Workforce	Rep. LaHood	Rep. Carey* Rep. Wenstrup Rep. Smucker Rep. Fitzpatrick
Mainstreet	Rep. Smucker	Rep. Steube* Rep. Buchanan Rep. A. Smith Rep. Arrington Rep. Van Duyne
New Economy	Rep. Schweikert	Rep. Van Duyne* Rep. Murphy Rep. Tenney Rep. Steel
Rural America	Rep. Adrian Smith	Rep. Fischbach* Rep. Feenstra* Rep. Kustoff Rep. Steube
Community Development	Rep. Kelly	Rep. Tenney* Rep. LaHood Rep. Moore Rep. Carey
Supply Chain	Rep. Miller	Rep. Kustoff* Rep. Wenstrup Rep. Ferguson Rep. Fishbach Rep. Feenstra
Innovation	Rep. Estes	Rep. Steel* Rep. Schweikert Rep. Ferguson Rep. Hern Rep. Murphy
Global Competitiveness	Rep. Hern	Rep. Moore* Rep. Kelly Rep. Estes Rep. Miller Rep. Feenstra

*Denotes Vice-Chair