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Saturday, March 17, 2018

QBI Deduction and Fiscal Years

The Tax Cuts and Jobs Act (P.L. 115-97; 12/22/17) added a new deduction for business owners (other than for C corporation owners). It is Code section 199A, Qualified business income. The deduction, in very simple terms, is equal to 20% of the individual's qualified business income, unless taxable income is lower than QBI.  If a single person has income over $157,500 or $315,000 if MFJ, then additional limitations come into play.  If the individual has income over these amounts and is in a specified service business, such as being an accountant, CPA or health care professional, they are limited but get no deduction if taxable income is more than $50,000 (or $100,000 if MFJ) above the thresholds. This provision is in effect for 2018 through 2025 and is intended to provide some rate relief because the corporate tax rate was lowered from 35% to 21%.

Section 199A is about 9 pages long in single-space and involves several definitions, limitations and special rules. One of the questions I heard from some practitioners is how it applies to income from, for example, a partnership that is using a fiscal year (rather than a calendar year). Since we don't have any administrative guidance, we need to do our best to see what the statute states and how the legislative committee reports might help in understanding the statute.

To that end, I summarized my interpretation in a short article in the AICPA Tax Adviser - "The Sec. 199A qualified business income deduction and fiscal years," 3/15/18. I hope you'll take a look, and leave a comment.

The AICPA Tax Section sent a letter to Treasury and IRS listing several areas in need of guidance.

What do you think?

Monday, February 19, 2018

Guest Post - Tax Practitioners and Marijuana Business Clients

Here is a guest post from Brett A. Podolsky, an attorney who is also a Criminal Legal Specialist certified by the Texas Board of Legal Specialization. He is the former Assistant Criminal District Attorney for the State of Texas. As a criminal defense attorney in Houston, Texas, Mr. Podolsky dedicates his entire practice to litigation. He handles a wide variety of cases, including drug charges, federal crimes, white-collar crimes, and sex crimes. Brett offers some suggestions for practitioners on what you need to know about taxation and marijuana.

Unanswered questions remain concerning whether tax practitioners, e.g. CPAs and attorneys, can aid a marijuana business entity with its tax issues, including tax planning and/or compliance, since the sale of marijuana is still considered a federal crime. Practitioners ask, “Is assisting a marijuana business an ethical violation?” as well. All businesses, including those that sell cannabis, require tax, legal, and accounting assistance. Businesses need answers regarding business structure, taxes, and future financial planning. This post addresses what business owners and advisers should know and contemplate before agreeing to take on a client engaged in the sale, production, or use of marijuana.

State Laws and Marijuana

Today, in many states and the District of Columbia, commercial entities may form under state laws to grow and/or sell cannabis. The laws are strict concerning who may grow (produce) or sell to consumers and who may purchase. Each state’s regulations, statute, and guidelines may also interact with additional laws, e.g. employment or zoning laws. All the while—and despite the fact that states’ laws allow for cannabis production, sales, and use—these actions remain crimes under the Controlled Substances Act of the federal government. Like other businesses seeking advice about the newly passed tax laws, marijuana businesses are likely to want assistance from a tax adviser as well. Certified public accountants and attorneys may be cautious about whether they wish to, or should, assist these businesses. If CPAs and attorneys decide to assist the marijuana business, they will want to ensure that their actions won’t lead to licensure or rules of conduct violations to which they’re subject.

Attorneys and Professional Conduct

The Bar Association of San Francisco (2015) issued Ethics Opinion 2015-1 to discuss whether an attorney in California may ethically represent clients engaged in a medical marijuana business. The opinion concludes that “a lawyer may ethically represent a client on the facts presented consistent with California Rule of Professional Conduct 3-210…provided that (the attorney’s) legal advice and assistance is limited to activities permissible under state law and the lawyer advises the client regarding the possible liability under federal law and other potential adverse consequences under state and federal laws.”

Marijuana Business Overview

Most states and the District of Columbia have passed laws that allow some forms of growing, selling, and using medical marijuana. 

  • Eight states – Washington, Alaska, Oregon, California, Nevada, Colorado, Maine, Massachusetts, and the District of Columbia (about 21 percent of the country’s population) – allow recreational marijuana use. 
  • Although most states allow medical marijuana usage, federal classification of marijuana (cannabis) remains a Schedule I controlled substance. This classification is somewhat at odds with the idea that marijuana may be safely used under medical supervision. 
  • Colorado’s sales taxes, licenses, and fees from marijuana sales continue to show robust growth. Total revenues were about $67.6 M in 2014, $130.4 M in 2015, $193.6 M in 2016, and about $247.4 M in 2017 (Colorado Department of Revenue). 
The marijuana industry is a high growth industry. State taxation of marijuana businesses is widely discussed.

Marijuana Tax Revenues

Businesses selling marijuana have tax compliance issues to consider as well. When states sought to adopt cannabis legalization laws, taxation was an essential element of attracting political support. For that reason, tax rates were set high: 

  • Washington (37 percent), Colorado (29 percent), Alaska (25 percent), and Oregon (25 percent) 
  • The Tax Foundation reports robust growth of tax revenues in these states. 

California established a 15 percent excise tax and other states have pegged revenue rates at 10 – 25 percent. Lawmakers note that consumers have the option to travel to another state with lower marijuana tax rates. Competition in the free and open markets are likely to determine at what rates states tax marijuana businesses in the future.

Tax Reform and Marijuana

The Tax Cuts and Jobs Act (PL 115-97) was passed on December 22, 2017. It’s widely considered as the most notable overhaul of the United States Tax Code since the Reagan Administration.

IRC § 280E

Cannabis businesses must understand how these new laws affect them. The following are some of the significant tax issues cannabis businesses face now: 

  • The Tax Cuts and Jobs Act didn’t repeal IRC § 280E. 
  • This section prevents the cannabis producer, processor, or retailer from subtracting expenses from income (other than those deemed ‘Cost of Goods Sold’). 
  • As a result, cannabis businesses must determine the expenses included in Cost of Goods Sold and identify deductible expenses. As of this writing, little guidance is available to assist taxpayers in making these determinations. 
  • Note that, on audit of a California medical marijuana dispensary, the IRS used IRC § 280E to prohibit it from deducting any operating expenses (e.g. auto expenses and officers’ salaries). In other words, IRS sought to prevent the dispensary from earning a profit on the medical marijuana business. 

Tax experts theorize that IRC § 280E wasn’t repealed because it would’ve been considered a tax cut – which would’ve prompted the U.S. Congress to replace lost revenues. However, cannabis businesses will pay lower federal taxes starting this year. Tax rate decreases mitigate its effect.

Corporate Structure

In addition, cannabis businesses should consider corporate structure under the new tax law: 

  • The Tax Cuts and Jobs Act make “C Corporations” more tax-favorable. 
  • C corporations pay taxes at the corporate level. 
  • Individual shareholders pay taxes on dividends paid by the corporation (at rates up to 20 percent). 
  • In past years, double taxation discouraged C corporations. The Tax Cuts and Job Act effectively reduces this issue by lowering C corporate tax rates to 21 percent. (Tax rates on dividends are unchanged under the Act.) 
  • C corporations also enjoy 1) shareholder audit protection as well as 2) more flexibility in employee benefits. 
The new tax law may disfavor certain Limited Liability Companies (LLCs) and Pass-Through entities: 
  • To date, many new businesses automatically choose the limited liability company corporate structure. 
  • LLCs assume a variety of forms but, commonly, income is passed through to the entity’s owner(s). Pass-through income is taxed at the owners’ or member’s individual tax rates: in some instances, the owners may see (20 percent) of the business’ income. 
  • For instance, a single person in the 24 percent bracket earns net income from an “ancillary” cannabis enterprise that he runs as a sole member of an LLC. The LLC’s income is $100,000. His federal taxes from the enterprise are $19,200, or $100,000 net less $20,000 times 24 percent. 
  • Take note of exceptions: Congress has framed the pass-through entity benefit in the IRS code as a deduction: IRC § 280E disallows the deduction from cannabis retailers, producers, distributors, and manufacturers. In this scenario, the cannabis business referenced above will pay taxes on its full net income.**
  • In this way, the new tax law punishes cannabis businesses. 
  • Although some ancillary businesses benefit from a 20 percent deduction, others (pass-through entities) see the 20 percent deduction minimized or disallowed because of many inter-related and/or complex rule exceptions.

Tax laws favor concerns committing significant capital

Generally speaking, the new tax law exceptions favor those businesses making significant capital investments, e.g. real estate, over concerns that are either labor-intensive or service-focused. For instance, many service businesses, e.g. consulting or health care concerns, don’t qualify for the new deduction (unless overall taxable income, net of several adjustments, is less than $157,500 or $315,000 for joint filers. 

However, an ancillary business, e.g. a real estate lessor, may benefit from an LLC structure.

Possible limited tax deductions for debt financing

Some investors would rather loan money to a cannabis enterprise than invest in it as an equity shareholder. Under IRC § 280E, it’s challenging for the cannabis enterprise to deduct interest expense costs. (Under old tax laws, the ancillary business could deduct 100 percent of its interest costs.) Under the Tax Cuts and Jobs Act, the total amount of interest expenses permitted for deduction can’t be a greater than interest income plus 30 percent of adjusted taxable income plus interest expenses from floor plan finance costs: Adjusted taxable income is usually taxable net (with adjustments for) expense and interest income, losses, and specific capital investments. [IRC Section 163(j)]

Fine-Tuning the Tax Cuts and Jobs Act

The new tax law passed in December 2017 became effective in 2018. It’s probable that the Internal Revenue Service will be hard-pressed to offer guidance to businesses and tax advisers. It’s also likely that the IRS will add regulations this year. If Congress seeks to fine-tune the tax bill or enact additional reforms, might IRC § 280E be repealed, or at least limited in application to state-legal marijuana operations? We'll see.

Contact a Cannabis Business Lawyer

Marijuana businesses are a robust source of tax revenues for state and local governments. Marijuana businesses must pay taxes. Most business owners want to file an accurate return and grow their business to take advantage of significant demand. However, taxes may be an especially complex task for marijuana businesses attempting to figure out their taxation obligations this year. It’s important to get legal assistance concerning your marijuana tax questions. The new cannabis industry is high-regulated at the state level and complicated for many reasons including the fact that it still involves activity illegal under federal law.

**Note from Annette Nellen (host of 21st Century Taxation blog): Brett is correct that the Section 199A Qualified Business Income provision, added by the TCJA, allows a deduction from taxable income. However, it is an odd "deduction" in that it is really a bonus deduction intended to provide some rate reduction to businesses not operating as a C corporation since C corporations got a rate reduction by the TCJA. So, this deduction is not one with a direct cash outlay. The language at Section 280E states, "No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in ..."  Query: May a marijuana business claim a deduction under Section 199A since it is not a deduction "paid or incurred"?  The provision is in Part VI on deductions (in Subchapter B of Chapter 1). But it was addeed for rate relief. If all business owners obtained rate reductions by the TCJA, even marijuana business owners would obtain that benefit. We'll see if the IRS provides any clarification on this matter.

What do you think?

Sunday, February 11, 2018

Tax system now 3 pages more complex; yet more will claim standard deduction

Annually, the Joint Committee on Taxation releases a report entitled - "Overview Of The Federal Tax System As In Effect For [current tax year]." The report for 2018 (JCX-3-18) was released February 7, 2018 and is 38 pages long. The last report for 2017 (JCX-17-17; 3/15/17) was only 35 pages long! And the 2018 report was issued two days before more tax legislation was enacted that mostly affects 2017 - the Bipartisan Budget Act of 2018 (H.R. 1892; P.L. 115-123 (2/9/18)). This new legislation mostly is the continuing budget resolution (CR) but also extends 33 tax items that expired at 12/31/16, mostly through 12/31/17 (retroactively that is!). These expiring provisions are generally not covered in these 30+-page overview reports by JCT. P.L. 115-123 also includes some disaster relief tax provisions and several miscellaneous items such as regarding whistleblower awards and the user fee for installment agreements to pay taxes.

Why is the 2018 report longer? It appears to be due to brief descriptions of new items added by the Tax Cuts and Jobs Act P.L. 115-97; 12/22/17) such as half a page for new Section 199A on the qualified business income deduction that is a 7-page long, temporary provision in the law, plus a few more data tables. These overview reports include interesting data and graphs, such as on sources of revenue, the make-up of income reported by individuals, and distribution of income and taxes.

A few interesting items from the reports:
  • Projected for 2018, 1% of individual filers have income over $500,000. For this purpose, AGI is increased by tax-exempt interest, employer contributions for health insurance, employer share of FICA tax, worker's comp, nontaxable Social Security benefits, AMT preference items, Section 911 foreign earned income exclusion and a few other items.
  • For 2017, JCT estimates that 31.7% of individual filers will itemize deductions rather than claim the standard deduction. For 2018, their estimate is that 13.1% will itemize.  This is a significant drop due to the increase in the standard deduction by the TCJA as well as removal of several itemized deductions.
What do you think?

Thursday, February 8, 2018

FBAR and Describing Return Due Dates

In 2015, due dates for a few types of tax returns were changed. This included for the foreign bank or financial account reporting if you have over $10,000 in foreign accounts (FBAR, or Report 114). For a long time, it was due by June 30 - an odd date in the tax filing world). It was changed to April 15 with possible extension to October 15. Thus, it matched the Form 1040 due dates. 

When the financial crimes division of the US Treasury Department, (FinCEN) explained how to get the extended due date, it told us that if we didn't get the form filed by April 15, we automatically got until October 15 to file the form.

So, wouldn't it be easier to have written the law to say the due date is October 15.  And then when FinCEN provides us the instructions (online, and the form must be filed electronically), it could just say it is due by October 15, but it is recommended to file the form at the same time you e-file your Form 1040 so you don't forget to file it.

FinCEN recently announced that when April 15 falls on a weekend or holiday, as it does for 2018, the form is due the next day - so April 17, 2018. But, if you miss that date, you have until October 15, 2018.

For IRS information on FBAR - click here.

What do you think? What would be the simplest way to describe the due date for any return?

Sunday, February 4, 2018

TCJA - Many areas in need of guidance

The Tax Cuts and Jobs Act enacted December 22, 2017 includes a lot of new provisions. For example, Section 199A, is seven pages long in single space! It allows a deduction for owners of business activity (other than as a C corporation). The purpose is to also provide some rate reduction for businesses other than only a rate reduction for C corporations. The new rule is lengthy because it involves a lot of definitions and special rules. Now, while many business owners have income below the thresholds where they must deal with the complexity, just understanding the basics might be complete for many.

The AICPA Tax Section volunteers and staff have identified 39 areas in need of guidance (as an initial list). Most of these will require IRS work, such as to define terms. Some might be clarifications from Congress or the Joint Committee on Taxation as to what was intended by language that is not completely clear.

Here is the AICPA's January 29, 2018 letter listing various items. And the AICPA also noted in a letter to Congress on January 30, 2018 that IRS needs resources to provide timely guidance.

What do you think? Where do you think guidance is most needed?