FEI is made up of over 10,000 Chief Financial Officers, Vice Presidents of Finance, Corporate Treasurers, Controllers and other senior financial executives from 74 chapters across the United States. Nearly 60% of our members work for private companies, and the Committee on Private Company Policy (CPC-P) focuses on these members’ policy concerns. The CPC-P commends Congress and the Trump Administration for successfully enacting the Tax Cuts and Jobs Act (TCJA).
We applaud the establishment of tax deduction for qualified pass-through business income which will help enable private companies to retain a greater share of their earnings for reinvestment back into their operations, allowing them to grow their businesses, create jobs and better compete with C-corporation competitors, the CPC-P has identified a number of important issues contained in the TCJA that should be addressed either through legislation, regulatory action or IRS guidance. These include:
Need for Permanence of Section 199A Deduction of Qualified Business Income for Pass-Through Entities: The deduction for qualified pass-through income will expire in 2025. The temporary nature of the deduction places a significant burden on pass-through businesses in their planning for future operations. The deduction should be made permanent.
Lenient Transition Rules for Pass-Through Businesses That Elect to Become a C-Corporation: As long as the TCJA’s provisions relating to pass-through entities is temporary, it would be unfair to force pass-through businesses to go through the legal and structural changes to analyze and convert to a C-corporation for each separate entity based on the law that will sunset in 2025. At minimum, businesses should be provided safe harbor relief to revert back to pass-through status without restriction due to the uncertainty posed by the TCJA’s temporary pass-through provisions. In addition, several other significant costs and key items impact the decision such as the following considerations.
- Limitations on Electing- Current law prohibits companies from changing their elected status for 5 years. Thus, many pass-throughs that have made an election within the prior 5 years would be ineligible to change its status.
- Tax Accounting for Financial Purposes- Conversion of a pass-through entity to a C corp will create onerous results with respect to additional tax accounting required by U.S. GAAP.
- Conflicts with other tax rules including foreign/state tax disparity-Foreign and state tax consequences need to be addressed since many states and most foreign jurisdictions do not recognize a U.S. federal check-the-box election for onshore or offshore entities. A pass-through entity may have ownership constraints for trust and estate planning that may preclude a conversion to C corp status, such as some a grantor retained annuity trusts (GRAT), which is commonly used with S-Corps for family transition planning.
- Structural, Ownership, and Complexity Limitations- Pass-throughs have limited ownership; generally, the intent is to maintain ownership of the entity within a limited group of owners. An S corporation with an LLC structure can benefit from reduced level of corporate complexity compliance/formalities (e.g. required meetings).
- Accumulated Earnings Tax (AET) and Personal Holding Company (PHC) tax for C corps. Additional complexity and tax cost is created for pass-through entities businesses that convert to C corps due to the taxes imposed by AET and PHC.
Clarification of Pass-Through Deduction to Service Businesses: The exception for specified service businesses that preclude a deduction from Qualified Business Income eligible for the deduction for specified service businesses in the TCJA provides needs an exception. Specified service business clarification is needed.
Treatment of international earnings of pass-through businesses: Under the TCJA, a pass-through’s foreign earnings are subject to a worldwide tax, while C-corporations are provided an alternate territorial tax system under a narrow tax base using the domestic only territorial system. This disparate treatment provides a disincentive for pass-throughs to reinvest capital in the US on foreign earnings to create U.S. jobs and presents an additional disparity and inequity for the private business owner. Pass-through businesses should be included in the territorial tax system established by the TCJA.
Potential solution: Annual Pass-Through Business Election to Be Taxed as a C-Corporation under Section 962 overlooked. A combined solution for pass-through transition to C-corporation and international earnings is to annually elect to be taxed as a C-corporation for international and domestic earnings under Section 962. This potential solution is to allow a pass-through to annually elect to be taxed as a C-corporation under the existing Section 962 rules to achieve parity for retained capital that would be subject to the second level of C-corporation dividend tax when distributed to the owners. The Election to Be Taxed as a C-Corporation under Section 962 would include both the tax incentives (carrots), minimum taxes and anti-tax abuse rules (sticks) highlighted below.
- 100% dividends received deduction
- 50% deduction of new global intangible low taxed income (GILTI) amounts,
- 37.5% deduction of "foreign-derived intangible income",
- foreign branch income at C-corporation rates,
- Minimum tax rules
- Base Erosion Anti-Abuse Tax
Definition of Qualified Business Income: Under Section 199A: Clarification is needed as to what pass-through income is eligible for the deduction under Section 199A.
- Income from Sourced Goods: Guidance needed regarding whether income from sourced goods (inventory purchased outside of the United States from third party contract manufacturers and sold within the United States) would be Qualified Business Income. Clarification should include the definition of contract manufacturers and how it integrates with existing regulation.
- Specified Service Business: The exception from Qualified Business Income for specified service trade or businesses should be clearly defined. Many businesses in the U.S. do not produce tangible goods through manufacturing, such as IT operations or consumer-based services, and need certainty as to whether they will qualify for the deduction. In addition, the reference to any trade or business in which the principal asset is “the reputation or skill of 1 or more of its employees [or owners] needs to be clearly and objectively defined. A potential solution to eliminate ambiguity would be for the issuance of a specific list of services to be included and/or excluded.
- Reasonable Compensation and Guaranteed Payments: The exception from Qualified Business Income for these elements should be well-defined with objective standards.
- Clarification of items to be included in Qualified Business Income resulting from transactional activities is needed, such as a sale of a business.
Elimination of Deductions: Under Section 199A: Clarification is needed as to what pass-through income is eligible for the deduction under Section 199A.
- Attracting Qualified Talent: The TCJA eliminated a deduction that private companies have relied on to help attract qualified talent. These include the elimination of the moving expense deduction which has hampered businesses’ ability to attract qualified new employees to small town America. This will have a negative impact on the startup and growth of US companies.
- Supporting Domestic Manufacturing: The TCJA eliminated deduction that private companies have relied on to help support domestic manufacturing. These include the elimination of the domestic production activities deduction (Sec 199). This will have an impact on the startup and growth of US companies.
FEI’s private company members would be pleased to work with you to find solutions to address these and any other issues so that private companies and pass-through businesses can fully maximize the benefits promised by the TCJA.
For Additional Information please contact:
Brian Cove
Managing Director, Technical Activities
Financial Executives International (FEI)
973.765.1092
[email protected]