The new tax law enacted in December swapped out a graduated corporate tax rate topping out at 35 percent with a flat 21 percent rate across the board. While this provision, combined with the elimination of the corporate alternative minimum tax (AMT), might seem to have simplified matters considerably, attorney Jerald David August, a tax partner at Kostelanetz & Fink, LLP, who spoke at the Foundation for Accounting Education's conference "Impact of the New Tax Law: a Sid Kess Workshop" today, pointed out some complicating factors.
Speaking at the NYSSCPA's Manhattan headquarters, August said that while the new corporate tax rate is, on paper, 21 percent, other taxes from before the bill's passage and new limits imposed afterward can erode the benefits for certain companies. He conceded that it is tempting to suddenly turn into a C corporation, and that the potential tax savings "does invite, in fact requires, an assessment of whether C is better." However, he said clients need to go into the process with both eyes open.
So for example, while the corporate AMT was eliminated, there's a new Base Erosion and Anti-abuse Tax (BEAT) that, he said, effectively acts like an AMT for large corporations with over $500 million in gross receipts, based on global income. A company subject to the BEAT tax would need to add back to taxable income their current year deductions involving payments to related foreign persons (such as someone who owns at least 25 percent of the company's stock), and then pay 10 percent of the resultant figure.
"So, we got rid of the corporate AMT, but for the real large companies, there is still a global minimum tax," he said.
August also noted that corporate clients, even with a lowered income tax rate, will still need to contend with other taxes, such as the accumulated earnings tax. The accumulated earnings tax is a 20 percent levy on accumulated taxable income. Accumulated taxable income is taxable income (adjusted for things like charitable contributions and capital gains and losses) minus the sum of dividends paid in deduction and the accumulated earnings credit. It was developed to encourage corporations to distribute dividends versus sitting on cash.
"So the point here is if you go to the C corp. world, or if you're already there, and clients love the idea of 21 percent, ... you're going to have to prime them about the accumulation of earnings in the C corporation and whether or not you have a reasonable needs of business defense once the accumulated earnings tax credit of $250,000 or $150,000 for personal service corporations, is exceeded based on prior taxable years," he said.
The tax is targeted at earnings accumulated beyond the reasonable needs of the corporation's business, as the law states that it applies to companies "formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed." Therefore, said August, if a company wants to switch to a C corporation, it will need to prove that its accumulated earnings are a response to a reasonable need.
Another tax he mentioned was the personal holding company tax. He noted that if a company is subject to the accumulated earnings tax, it is not subject to the personal holding company tax, and vice versa. The personal holding company tax applies to C corporations in which more than 50 percent of the outstanding stock is owned, directly or indirectly, by no more than five individuals, and which receive at least 60 percent of their adjusted ordinary gross income from passive sources. The tax rate on undistributed personal holding company income is 20 percent.
He said, however, that this tax might actually be one "you'd want to intentionally run into" because entities could claim deductions if they invest in preferred stocks, which require dividend payments.
He lamented what he said was a dearth of attention to these two taxes when everyone is excited about the new 21 percent corporate income tax rate. But he said there's a lot that people don't know just yet, adding that we are likely to see a boatload of guidance and technical corrections down the road.
"We really don't know what we have yet. We think we know a lot. We have a lot of speculation of what was intended and not intended, what the conference report says and what it omitted to say, but we have this massive piece of clay, if you will, that hasn't been carved down," he said.