by Kyle Massey on Monday, Feb. 12, 2018 12:00 am 7 min read
When Little Rock tax lawyer Matthew C. Boch arrived to talk about what Arkansas businesses need to know about the new federal tax code, he carried two documents: 163 pages of “initial observations” from KPMG and an 80-page synopsis by Deloitte.
“And those are just the plain-English summaries” of the law, the Harvard-trained member of the Dover Dixon Horne firm said.
Most businesspeople know by now that C-corporation taxes fell from 35 to 21 percent, and that a new 20 percent deduction on qualified business income is available to sole proprietors, partnerships, LLCs and S-corporations. Overall, the law cuts taxes by an estimated $1.46 trillion over 10 years, according to the Joint Committee on Taxation.
♦ Marginal tax rate for C-corporations generally falls from 35 percent to 21 percent.
♦ A new 20 percent pass-through deduction, though complicated, is available for qualified business income in sole proprietorships, partnerships and S-corporations.
But intriguing and obscure details pepper the law, which cleared Congress in a late-night frenzy complete with alterations scrawled into the bill’s margins. Unexpected results range from a new tax burden on golf games with clients to a less-cushioned state tax bite that could encourage wealthy Arkansans to move to states without individual income taxes.
Tax professionals are “still eagerly awaiting guidance from the IRS” on many details, including the fine print of the qualified business income deduction, said Brian L. Thompson, a partner in Bailey & Thompson Tax & Accounting in Little Rock. But he said the pass-through deduction “could be a game-changer for many business owners.”
Arkansas Business asked a panel of tax experts for insights on the new code, which was signed by President Donald J. Trump in late December. After hitting the highlights, they delved into provisions that surprised them.
♦ New rules on expensing capital investments essentially accelerate depreciation deductions, a change that tax attorney Matthew Boch and CPA Joe Sanford say could spur capital investment.
“It’s a huge law, and I still haven’t read it all cover to cover,” Boch said, noting that the overhaul is the greatest change in the U.S. tax system since Ronald Reagan’s 1986 tax cuts. In Boch’s legal practice, a new cap on deductions for state tax payments looms large. “Wealthy Arkansans sure like to move to Florida and Tennessee,” he said. “This might accelerate that trend.”
Boch said the new 20 percent deduction on qualified business income was designed to keep structures like LLCs “in the game” as lower taxes make the C-corp structure more attractive. But the details of the pass-through deduction remain fuzzy.
“Will you get the new 20 percent QBI deduction?” asked Kelly Phillips, a CPA and principal in Bell & Co. of North Little Rock and Conway. “The rules are extensive and complicated.” She told Arkansas Business that considerations include whether a company is a service business, how much W-2 compensation is paid to owners and employees and the company’s filing status.
“This is a way to keep the delta between the corporate tax rates and the pass-through entity tax rates at 10 percent so the business world isn’t turned upside down with a slew of reorganizations.” But “not everyone gets the 20 percent,” she warned.
CPA Joseph A. Sanford of Sanford & Co. in Fort Smith cited a Forbes.com analysis noting that the owners of identical companies with identical revenue could have vastly different tax repercussions hinging on whether the business is a sole proprietorship, a partnership or an S-corporation.
♦ Cash-basis accounting is now available to many business under a $25 million gross receipts threshold.
♦ The standard deduction for single filers is up from $6,350 to $12,000; for couples filing jointly, it’s $24,000, up from $12,700.
“Good luck digesting this,” Sanford said, calling it “a particularly puzzling part of the new tax law. Nobody seems to know the right answer, and this is going to affect many, many taxpayers.” Advice from informed accountants and more clarity from the Internal Revenue Service are crucial, all the experts said.
Several Arkansas corporations, including Tyson Foods, Murphy USA, Acxiom, ArcBest Corp. and USA Truck, have already credited the new law as a factor in surging financial results. Walmart Inc. of Bentonville, the world’s largest company by revenue, stands to reap a multibillion-dollar windfall and has shared the largesse with employee bonuses of up to $1,000, crediting the tax law.
Sanford noted that other portions of the law create “an entirely new paradigm for international corporate taxation by removing common motivations for doing business in foreign jurisdictions.”
Walmart, for example, operates in more than 25 foreign countries and could reap a windfall by bringing home some $6 billion in reserves held overseas. A one-time 15.5 percent tax would trim that to about $5 billion in free-and-clear cash. The C-corporation tax cut, according to TheStreet.com, would have saved the retailer about $2.5 billion if it had been in effect in 2017.
Walmart is still working through the details, but spokesman Randy Hargrove told Arkansas Business the new tax code will dovetail with company goals. “We’re assessing all opportunities that tax reform is going to create for us, our customers and associates,” he said. “There are some guiding things that are clear and consistent: Lower prices for our customers, better wages and training for our associates, and investments in the future, including technology. Tax reform will give us the opportunity to be more competitive globally and to accelerate our plans for the U.S.”
♦ The mortgage interest deduction is reduced, and the deduction for state and local taxes is capped at $10,000. This could push some Arkansans to relocate to places without state income taxes.
Murphy Oil Corp., the oil exploration and production giant based in El Dorado, also expects good things eventually from the global repatriation changes, but its fourth-quarter results reflected a $274 million noncash tax charge associated with the law. Bank holding companies Simmons First National Corp. and Home BancShares similarly took tax-related hits in the fourth quarter.
A change limiting local tax deductions to $10,000 could pinch Arkansas’ coffers if wealthy earners leave the state, which has a 6.9 percent income tax. “Losing the deduction makes Arkansas a much less favorable place for high-income folks to live,” Boch said, and states without personal income taxes look all the more attractive. IRS figures show that since 1992, Arkansas has lost $358 million in adjusted gross income as residents moved to Florida, and $118 million from those heading to Tennessee, which taxes only interest and dividend income.
No Entertainment Break
Arkansas companies that lump meal and entertainment costs together on company expense forms will now need to make them separate line items, Thompson said. Entertainment is generally no longer deductible.
“Meals are still 50 percent deductible, but taking clients golfing or to a concert won’t be. So companies are going to need to segregate those expenses, because their accountants are going to need to know,” he said.
“No more company golf games or sporting tickets,” Phillips said. In an email, she laid out the precise language: No deductions are allowed for activities “generally considered to be entertainment, amusement or recreation … or membership dues for any club organized for business pleasure recreation or other social purposes.”
What were some other surprises?
“The disallowance of moving benefits and fringe benefits normally offered by a company as tax free,” Phillips said. “All of those are no longer deductible by the company if they are tax free to the employee.” To take the deduction, companies must include the benefits as compensation on the employee’s W-2 form.
♦ The estate tax now applies to far fewer inheritances; it now exempts $11 million for individuals and $22 million for married couples.
♦ Multinational corporations won’t owe federal taxes on income made offshore, but they will pay a one-time 15.5 percent tax on cash assets they bring back home.
“I’m also surprised that they allowed some items that are traditionally thought of as 39-year property for depreciation purposes to be eligible for the Section 179 expensing,” Phillips said. “Roofs, HVAC, big stuff that would normally be 27.5- or 39-year assets can now be written off in their first year of service.”
Another quirk in the bill, Thompson said, involves like-kind exchange transactions under Section 1031. “Previously like-kind exchanges were allowed for both real estate and other types of fixed assets,” he said. “While the new law still permits like-kind exchanges for real estate, it eliminates the tax-free exchange of business autos. … For example, when a business trades in a company vehicle for another company vehicle, the transaction will now be reported as a sale.”
Businesses are likely to avoid much harm, though, because of an increase in first-year depreciation guidelines for “luxury” autos, as well as “the new 100 percent bonus depreciation and increases in Section 179,” Thompson said.
He said some companies may have to conjure a way to compensate employees who no longer get a tax deduction for unreimbursed work expenses.
“If you spend $10,000 a year on pencils, to use an absurd example, and your office doesn’t reimburse you, you had been able to deduct that. Now you won’t, but then again the new law doubles the standard deduction, so most taxpayers may not be hurt. But in jobs like truck driving, which involves per diem, businesses will have to find a way to put money back in employees’ pockets.”
Gov. Asa Hutchinson
Dear California, Arkansas Is Open For Business
When Gov. Asa Hutchinson read about a move by two California lawmakers to claw away some profits California companies will derive from the recent federal tax cuts, he had a notion of his own: Arkansas is the place they ought to be.
Democrats Phil Ting of San Francisco and Kevin McCarty of Sacramento proposed a 10 percent surcharge on California companies whose tax windfall totals more than $1 million a year.
So Hutchinson pounced, with more than a splash of whimsy, dashing off a letter to California business executives.
The Jan. 25 note refers to the legislative effort “to punish companies, like yours, for being successful.” McCarty and Ting, it says, “believe you are not entitled to benefits of the recently passed Trump Administration tax bill, which reduces corporate income tax rates by 14 percent. Instead, they want you to pay a 10 percent surcharge.”
There is an alternative, he says. “It’s called Arkansas.”
After reeling off a list of Fortune 500 companies that call Arkansas home, including Walmart, Tyson, J.B. Hunt and Dillard’s, he gets to the point of his appeal. “Arkansas welcomes and encourages successful companies by providing a low cost of doing business, lower tax rates, a skilled workforce, and an easy-to-navigate regulatory environment.”
The governor, who has made economic development a cornerstone of his administration, urged the executives to put their federal tax savings into their businesses and their employees, “not simply hand it over to the state.” The letter directs them to the Arkansas Economic Development Commission’s website, and gives the office number for Mike Preston, the commission’s director.
“Arkansas is open for business,” the governor concludes, “and we would welcome the opportunity to visit with you.”
There’s no word yet on whether any Californians have taken up the offer.
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