2024 year-end tax planning: Federal business tax update

The following is a verbatim output of transcribing from a video recording. Although the information in this transcription is largely accurate, in some cases it may be incomplete or inaccurate due to inaudible passages or grammatical, spelling and transcription errors.

Michael Wronsky: Welcome everyone. Thank you for once again joining Baker Tilly as we host another installment in our fourth quarter edition of the Tax Trends Webinar series. I'm Michael Wronsky director of Baker Tilly Washington Tax Counsel Group and the moderator of today's panel discussion. Today, we'll dive into part one of our Federal Business Tax update, in which a panel of experienced professionals will cover updates in the research and development credit in section 174 Space Inflation Reduction Act updates, including how it may be impacted post-election, and provide an overview of current trends in transactional, tax and mergers and acquisitions.

As I noted, our panel consists of fantastic, experienced professionals representing a variety of specializations, including Diana Walker, who is a senior manager in our Specialty Tax Office's credits and incentive team, who focuses on research and development tax credits, among many others. Jiyoon Choi also a senior manager on our specialty tax office's credit and incentive team who specializes in the Inflation Reduction Act

Energy credits. Dave Gette, the principal and leader of our specialty tax office's transactional tax team. And last but not least, Ben Willis, a director and leader of our Washington Tax Council's corporate and transactional tax team. So, without further ado, I'm pleased to turn the presentation over to our panelists. Diana, would you be so kind as to kick us off?

Diana Walker: Yeah. Thanks, Michael. Good morning everyone. I'm glad to meet you all here virtually. As Michael mentioned, my name is Diana Walker. I'm a senior manager in our credits and incentives group. I'm an attorney by background, and I've been in the R&D space for over 15 years. I'm looking forward to speaking with you all and giving you some updates on the R&D tax credit, as well as section 174.

So we'll go ahead and get started. The first update is regarding the proposed form changes for the form 6765. This is the form that is utilized to claim the R&D credit in your tax filing for this upcoming year. There have been some proposed changes to the form. They actually were rolled out initially in September 2023, and taxpayers and practitioners were given an opportunity to comment.

Then the proposed changes were revised in June of this year and rolled out again for taxpayers and practitioners. To have a heads up on what to expect for the upcoming filing season. So some of the changes to the form, that I'd like to walk through are listed here on this slide, but just to go through them. The first one is to the 280(c) election.

So previously the 280(c) election, which allows taxpayers to select whether or not they want a gross R&D tax credit or a net R&D tax credit, and whichever is selected depends on your tax position that used to be located at the bottom of the form 6765. Now that's going to be located at the top. So that's more of a logistical change.

Not really a substantive change, but there are some sections that have been added that elicit more information when claiming the R&D credit. The sections E and F are two new sections that aren't on the form in the various questions about the claim for the credit. So the sections ask about acquisitions and dispositions that were made during the year, as well as the types and categories of qualified research expenditures that are being included.

And then for those taxpayers that participate in ASC 730, there's specific questions regarding that. So some more questions to elicit information regarding the claim. The biggest change is section D. And this is the section that gives a little bit of heartburn because there's a lot of information that's being elicited here. There's going to be specific information that's requested about the business components that are the the source of the expenses that are being claimed for the credit.

So for those of you all that remember, a few years ago, there was a specificity requirement that was released when claiming an R&D credit on an amended return to the section G kind of hearkens back to that. So there's going to be specific ask about the activities and the costs that are being included for the R&D credit by project and by entity.

Now this section G is actually optional for filers for 2024. So in claiming your credit on the 2024 return that filed this upcoming year in 2025, the section G is optional, but section G will be effective or required when claiming the credit in 2025. So the following year in 26 for claiming those credits, you do have to adhere to that section G.

Now there is an exception for qualified small businesses, those taxpayers, and those would be those taxpayers that have qualified research expenditures that are less than 1.5 million and less than 50 million in gross receipts. So I'll pause there for thoughts or questions from Michael, regarding the form teasers. That's great stuff, Diana. Thank you so much. A couple of questions immediately come to mind.

First and foremost, how do you recommend taxpayers and practitioners get prepared for the changes that you've gone over to this bill on here? That's a great question. So definitely, first, being aware that the form is changing right now, that section G, that is the biggest change is optional. But this would be a good year, this 2024 filing season to get used to that requirement and start, gathering that documentation in advance so that when it is officially rolled out, that impact is not as powerful as it would be had you not been prepared in advance.

Michael Wronsky: Thank you, Diana. And being, that it is the most wonderful time of the year. And this is one of the things that, people look forward to most, when do you expect the form to be finalized?

Diana Walker: So typically the service issues that form in December. So we're definitely watching with bated breath to see when that, form comes out. So, you know, definitely be sure to check with your tax preparer, so that you can keep abreast of when that is rolled out.

Michael Wronsky: Thank you, Diana.

Diana Walker: No problem. So the next update I'd like to give you is regarding a recent case that came out, in the R&D space, it's the Meyer, Boardman and Johnson case. It's out of the eight circuit.

The eighth circuit covers Arkansas, Iowa, Minnesota, Missouri, Nebraska and both of the Dakotas that are covered. So this is a case. It's definitely on point law, for those taxpayers and, tax practitioners that are in that area, but certainly what we call persuasive authority for those that don't stay in those states, I would expect the service would definitely cite this case, or look to this case for guidance in this area.

So just to give you a little bit of background, this is a case specifically on point to the architectural, engineering and construction industry. The taxpayer in this case, filed an R&D credit claim for their efforts in this space and in tax court. The big issue was whether or not the research was funded. And just as a quickie refresher, funding is one of the exclusions for section 41, which is the section that used to claim the R&D credit.

So if you have research that's funded, you're not able to include those expenses for your R&D tax credit claim. There's a two prong analysis for funded, research. You have to have economic risk. That means that at the end of the day, if you're not successful in, completing the research, then you will not be able to claim, be able to receive payment for your efforts.

And then the other prong is that you have to have rights to the research. So it doesn't have to be exclusive, but you have to be able to use the research and other aspects of your business without paying for it. So in the tax court case, they were looking primarily at the economic risk front in the court and the tax court actually, disallowed the credits.

And that was what was put up on appeal. On appeal, the court followed the Tax Court and also disallowed the credits as well. The focus, again, was on that economic risk prong, and the court found that none of the contracts expressly or by clear implication, made payment contingent upon the success of the research. So there needs to be some sort of contractual language that puts that burden on the taxpayer if they're going to be able to include those expenses as part of their R&D tax credit claim.

So you definitely need to as a big takeaway, look at your contracts to make sure whether or not there's either expressed language or by clear implication that your payment is going to be contingent upon the success of the research. So pause there for thoughts for Michael on this topic.

Michael Wronsky: Thank you Diana, once again, should taxpayers outside of the architectural engineering and construction industries be paying attention to this case?

Diana Walker: That is a really good question. And yes, you should. If you are doing work under contract, this could impact your R&D credit claim. So I definitely advise getting with, a specialist. We have a team here at Baker Tilly that I'm a part of where we look at these types of documents and advise clients based on their specific factual circumstances, on how to proceed.

So definitely, if you're a taxpayer that does work under contract, or a tax practitioner that works with clients that do work on the contract, you claim R&D credits, you definitely want to pay attention to this case.

Michael Wronsky: Thanks, Diana.

Diana Walker: No problem. And for my last update, it's going to focus more on section 174. So just to give a little refresher, 174 and the impact definitely began to be felt by taxpayers starting in 2022.

This impact was felt because that Tax Cuts and Jobs Act, which was issued in 2017, changed how, R&D expenses need to be treated for purposes of filing. So before the Tax Cuts and Jobs Act, taxpayers had an opportunity to select one of two ways on how to treat their R&D expenses, they could capitalize and amortize it over, a period of time, or they could expense it within that current filing because that provision expired.

Tax payers now starting in tax year 2022 going forward, have to capitalize and amortize expenses over two different time frames. So five years for US expenses, 15 years for foreign expenses. And remember, foreign is the place that the research is conducted, not the location of the taxpayer. So there was some rumblings at the end of 23 that hopefully that this provision would not come into place, but it did.

There was proposed, legislation that actually got through the House earlier this year that would have actually restored full R&D deductibility for US based expenses, retroactive to 2022, and then, all the way through 25. But unfortunately, when that was voted on in August of this year, it did not pass the Senate. So 174 in its current form still applies to taxpayers.

You do have to capitalize and amortize those expenses over those two timeframes. Depending on where the research was performed. There has been some guidance issued by the service. So in September and in December, there were different notices providing some additional information for taxpayers. The September guidance, pretty detailed, walks through the expense types and how to capitalize and amortize.

And then there were two actual guidances issued in December, one, providing primarily a lot of clarity on contract research and then also accounting methods, questions impacting, taxpayers who, have to adhere to section 174. We are expecting final regulations to come forth in, the new year, hopefully in the first quarter. But right now, compliance at 174 is still mandatory.

For the 24 filing season, just as a quickie refresher, these are the types of expenses that need to be included. Per that guidance that was issued back in September of last year. So labor, cost, whether it be part time or full time employees as well as contractors need to be included. Severance compensation does not need to be.

There are some nuance differences between expenses for wages and contractor costs for 174 section 174 versus R&D credit. We definitely would want to talk with your tax provider about that. Materials or supplies used in, developing R&D products, processes, etc.. Depreciation on buildings or property used in R&D. If you file for patents, the expenses for attorney fees need to be included in your overhead costs like rent, utilities, repairs, maintenance.

A portion of that needs to be included for your 174 cost, as well as if there are any travel expenses related to, R&D efforts that would need to be included. So I'll pause there for, any thoughts from Michael?

Michael Wronsky: Yeah, just the million dollar question here. Diana. What do you think is on the horizon for section 174 in the, rapidly approaching New Year?

Diana Walker: Right. I'm sure everybody is, you know, definitely anxious to see what will happen. Hopefully. Yes. We'll get those final regulations by February or March. I definitely anticipate there will be some further tax reform. Hopefully 174 would be a part of that. But I would say for right now, the key thing is to make sure that you're adhering to the requirements.

If you have expenses that are categorized as section 174 expenses for the 24 filing season. Yeah. So with that...

Michael Wronsky: That all makes great sense. Diana, thank you so much for those insights.

Diana Walker: No problem. And I'll just close out my section with the quick polling question. Which of the updates, that I just discussed will impact you the most during the upcoming 24 filing season?

Will it be the proposed form 6765 changes, section 174, the Meyer, Borgman and Johnson case, or none of these will impact me? Just select your option. And it's been my pleasure speaking with you all.

Michael Wronsky: I think I can safely speak for everyone. Diana. When I say the pleasure was ours. That was great stuff. Thank you so much for your time and again for your insights.

Jiyoon, I think that brings us to you. Please, we'd love to hear about what's happening in your neck of the woods.

Jiyoon Choi: Yeah. Thank you, Michael, for the introduction. During this session, I would like to quickly recap and provide updates on the IRA. There will be mainly three topics. First, I'll spend the most time, the 48 and 48E and 45, 45 wide condition, which will happen on January 1st, 2025.

Second, I'll quickly introduce the recently released Treasury regulations. And third, I'll briefly, have a post-election IRA updates. Okay. For the section 48E and 45Yupdates. So 48 Energy Credit, which is also known as ITC, provides up to 30% credit and then plus bonus credits for taxpayers and tax exempt entities that have invested in certain facilities that utilize renewable energy.

Section 45 Electricity Production Tax Credit, also known as PTC, provides federal tax credits based on electricity produced and sold to unrelated parties. The multiplier and then the bonus credits are the same as the ITC. Also, the PTC is eligible for ten years after a facility is placed in service. Section 48 and 45 have been around for a number of years now, but IRA modified some sections and provisions such as bonus credits, prevailing wage and apprenticeship, transferability or direct pay.

Section 48E Clean Electricity Investment Tax credit and section 45Y, which is included in the next slide. Clean Electricity Production Tax credit, on the other hand, were legislated and added through the IRA, so a lot of provisions under 48E are very similar to that of 48. And the rules under 45Y are very similar to 45. For example, the credits are calculated the same way, and other requirements included in the bottom of the slides are the same as 48 for 48E.

Similarly, section 45 and 45Y are calculated the same way. One of the main differences that I'm going to highlight and other than the main differences that I'm going to highlight in the next slide, 45Y adopted a new requirement that if a taxpayer has a metering device owned or operated by an unrelated person, then the PTC will be eligible.

Under section 45, PTC was only eligible for electricity sold to unrelated parties. There are three major differences for 48E and 45Y. First section 48 is applied to the projects that begins construction before December 31st, 2024. On the other hand, 48E is applicable for projects that are placed in service after December 31st, 2024. This means that a certain properties that begin construction, let's say, sometime in 2024 and then gets placed in service in 2026, will still be eligible to claim section 48 if other criteria are met.

We'll talk about this a little bit further in the coming slides. Second section 48 specified eligible technologies. But section 48E is technology neutral, but it's limited to properties that generate electricity. That means that technologies such as bio gas, unless that generates electricity, will be ineligible for section 48E. Third, on the last pass under section 48E, taxpayers have to show that net greenhouse gas emission rates of the facilities are not greater than zero.

We'll dive into that a little bit further in the comments box. So in order to be eligible for section 48E and 45Y, as I mentioned, taxpayers must show that the net greenhouse gas emission rates are not greater than zero. So the natural question would be how are they calculated? So the Treasury, under the proposed regulations, divided the electricity generating technologies into two categories.

Those are CN combustion and gasification, C&G facilities and non C&G facilities for C&G, In order to show the net zero greenhouse gas rate, a life cycle analysis is required. The life cycle analysis could cover all the process of the greenhouse gas emissions from starting from the feedstock generation all the way to that transmission to the break. However, many of the traditional renewable technologies such as solar, wind and others could fall into non C&G category.

Of those, certain facilities, as mentioned in the bottom of the slide, are automatically qualified for a net zero emission status. So no separate life cycle analysis or greenhouse gas emission calculations would be required. And then moving on to the BOC requirements, as I noted earlier, section 48 and 45 will be transitioned into 48E and then 45Y in 2025.

However, 48 and 45 are still eligible for projects that begin construction before December 31st, 2024. So we have received a lot of questions and inquiries from our clients. How to establish the begin construction date before December 31st, 2024. There are generally two tests that will be eligible to show the beginning of construction a physical work test, and 5% safe harbor.

Basically, if you can show that you perform onsite or offsite, physical work of significant nature, or paid or incur more than 5% of the total eligible project cost before December 31st, 2024 and meet the continuation requirement, you may still be eligible for 48 or 45. So what? What's, what's next on section 48E and 45Y?

Treasury release proposed regulations on section 48E and 45Y and in 2024, we're still waiting to have those finalized, especially to have a clearer calculation methodology, which is for life cycle analysis while this is going on. Treasury also released final regulations on section 48 just last week. The regulations apply to the projects that place in service and the taxable at your beginning after December 12th, 2024, which is going to be the publication date.

Some updates were pretty meaningful for technology that would be more beneficial to be covered under section 48, such as bio gas, for example. The systems such as feedstock collection system, gas upgrading equipment and ancillary systems critical to bio gas production can still qualify as integral property if they function independently with bio gas systems. This means that certain systems, used for bio gas, if they're used independently, would not have to meet the 8020 rules for retrofits.

If you wanted to pay to have any certain type of projects that would not be eligible under section 48E or 45Y, please reach out to us and discuss how to establish and document the begin construction before December 31st, 2024. So make sure that those are going to be eligible. Now we're going to move on to the polling question.

So, what aspect of the Inflation Reduction Act are you most familiar with ITCs, PTCs direct pay, or maybe you're not familiar with the IRA?

While you're answering those questions, I'll move on to the second topic of the agenda. On the recently released Treasury regulation. Typically regulations are effective 60 days after they're posted on the Federal Register. So we expected to see a lot of regulations before November 21st, 2024, which was 60 days before the inauguration date. That, interestingly, did not happen.

But there has been some major guidance released recently, starting from the more recent one that I mentioned earlier. 1.48-9, -13 and -14. On December 4th, final regulations on section 48 was released. It'll be published on December 12th, as I mentioned. So it will be effective for projects at place and service. Actually, mostly for our place and service after that, that December 12th date, the key highlights, are that certain technologies, and energy property have additional performance and quality standard.

Also detailed descriptions on energy properties such as bio gas example that I mentioned earlier was provided. Also, a clarification was made for geothermal systems were made. That was that in order for a taxpayer to claim credit for a geothermal system, the taxpayer needs to own at least one production system and one distribution system. But the main key, change from this regulations was on the project grouping.

So in order for multiple energy properties to be grouped as one energy project, the single project determination is used for beginning of construction dates. So this will impact the eligibility for certain code sections, such as whether you're using section 48 or 48E or eligibility and percentage for domestic content energy communities, or even one megawatt exemptions. In the proposed regulations, the requirement to have the properties, to the group as one project was to have that all by a single taxpayer or related taxpayers, and then meet two out of the seven criteria noted on the right side of the slides.

Under the final regulations, this was changed that now and needs to be owned by a single taxpayer or related taxpayers, plus MIT for at least four out of seven criteria. There were two other, regulations and amendments that were released in the recent months on Treasury regulations 1.671-2 direct pay entities could opt out, partnership roles when the properties were owned by direct pay entities through an unincorporated organization.

So it was expanding the options for direct pay entities, also on section regulations for a section 30C alternative fuel vehicle refueling property credits, the definition of item was made. The credit on the statute is limited to $100,000 per item. So the clarification was definitely a meaningful and helpful. So okay, this is the last slide of the IRA section.

What will happen in the new administration? The questions listed on this slide are the common questions that I have been receiving from our clients so far. Although we cannot say with any certainty what will happen because I don't have any crystal ball. But I can provide some common notes, that experts in the industries were expecting. First, is there any possibility of IRA repeal to lower at a tax rate?

So at this point, it is highly unlikely that the total repeal will happen, especially because the current IRA projects were mostly located in the traditional red state. Also, the new administration wants to build a strong manufacturing base in the US, so certain sections under the Inflation Reduction Act, would actually help that, however, certain sections could be more prone to be amended or dropped to, than others.

That brings me to the second question, whether certain programs are more likely to be removed or modified than others. Also difficult to say with certainty, but some sections that are, tying to manufacturing base, such as section 45x, advanced manufacturing, production tax credit or a zero emission new nuclear power production tax credits. Section 45. You, would be known as less likely to be removed on the other side of the spectrum would be the ones that are related to electric vehicles, such as section 30C, 45W and 30D that are more likely to be amended or modified.

And then, transferability provisions are less likely to be removed than direct pay. Last question is on the timing. If there is any repeal or amendment, is it possible to be retroactive, fully applied? Those are some kind of questions that I've been receiving a lot these days. So there are chances, but incredibly low chances, for any repeal, applying to 2024 projects.

If, however, changes are made sometime in 2025, it is possible to retroactively applied, to the beginning of 2025. However, a consensus that I have been hearing so far is that it will be very difficult to apply to the projects that already began construction, relying on the code sections that are available so far.

So, to wrap up the the section, we should closely monitor what would happen in the future, especially since more regulations can be released by the end of the year, which is the trend as, holiday gift from the Treasury to, the, tax consultants like us. And then potentially some amendments or appeals can be possible for, the Treasury regulations when the new administration starts. So thank you. And, I'll pass it to, Michael.

Michael Wronsky: Thank you so much. Yoon. When you do get your hands on that crystal ball, we'll schedule a follow up discussion so you can tell us exactly what's going to happen with the IRA. And you can tell me what lottery numbers to play. But, no. In all seriousness, thank you.

And I know these, credits are top of mind for quite a few taxpayers. And your content was, not only insightful, but timely and surely well received. So thank you again very much. Now I'm pleased to turn the conversation over to, Dave and Ben, who I understand. You gentlemen are going to spend, the next bit of time we have together having a conversation about, all things trends, topics, M&A. So very much look forward to listening into your conversation. So, I'll turn the floor over to you guys. Thank you so much.

Dave Gette: Thank you, Michael. Yeah. So I appreciate the time here. We wanted to kick it off, on a couple of fronts here. The current focus, a lot of transactions currently are.

Yeah, some of the cross-border things, international tax competition, competitiveness. As a response to of the global minimum tax rules, there's a lot of scrutiny with regards to cross-border transactions and transfer pricing, compliance. You know, that works work out. We're seeing a lot of that work out. And then also ESG, the environmental, social and governance, considerations that are coming into play in structuring transactions as well.

So, Ben and I are going to hit on some, some trends here, some technical updates as well. As, as an M&A tax person, I would be remiss in not mentioning some of the sort of best practices for optimizing your tax outcomes from a buy side in the sell side of a transaction. So, you know, very important to, to have some tax due diligence, either on the buy side or, the sell side as well.

So you really understand what sort of either risks or exposures your, your, inheriting as part of the transaction or from a negotiation perspective, very important to understand it's, you know, what sort of things might be lying out there that a buyer might find with regard to your historical tax compliance as a seller. So you can, you know, appropriately address those is part of the negotiation or planning ahead of the deal.

You know, leveraging off of your tax attributes, you know, net operating losses. You know, tax basis, step up to those sorts of things. And then also, you know, risks associated with, you know, improper valuation, on tax planning and stock or asset transfers, you know, valuations, using tax planning and structuring are really key in getting the results that you want.

As part of the transaction. And you're having that properly documented. It was really a significant component in, in, in sustaining that position going forward. So yeah, kind of getting into some of the trends. And, you know, I just find it interesting to see what the market looks like. You know, if you look at this chart here, doesn't necessarily look great here in the last couple of years from an M&A perspective.

You know, with the higher interest rates and some of the economic conditions in the market is really taken a big dip from the historic highs of 2021. But 2024 is starting to, to pick up a little bit. And, you know, even though it looks like it's it's kind of a decoy, I kind of expect that to hit or maybe exceed the 2023 levels.

So, there seems to be a bit of strength here in the, in the market. And part of the ties to kind of the interest rates here back in September, the fed dropped the rate by 50 basis points. And I just heard today that probably next week they're looking to drop another 25 basis points. So that's going to be helpful in the in the market for financing and things.

So I think that will be one of the the drivers here moving forward to help increase the, the market. A couple of other things, you know, portfolio rebalancing for, for PE funds, and for, for industry as well. And interesting, the, I is also playing a role in some of the, the market catalysts here.

So, just a bit of a market trend here. You look at your from an industry perspective on the, on the left side here, we've got deal volume, business products and services and consumer products and services industries have really accounted for a lot of the the volume of transactions, you know, over 57, roughly 57% of the deal volume in 2027.

But, you know, interestingly, the the value side has really been more, you know, energy and financial services sectors have, have exceeded their deal volume by deal value by quite a lot. And some of that's really driven by some significant mega deals in that space. But, I find it interesting to see where some of the activity lies within the industries in, in the market.

And there's some trends in kind of deal terms over the last three years that are kind of important, and helpful to, to give everyone an idea of what the market is. So if you're entering into a transaction, trying to understand, deals that are coming in from, or the, the specific terms that are coming in from, from either the buyer or seller understanding what the market bears in that space is helpful.

So, SARS Requiem, posted a whole detailed list of some, some trends with regard to deal terms. And so but some of the less significant ones from the tax perspective here from that, you know, 90% of the deals in 2023 included a separate tax indemnity provision in the deal. So kind of pointing to the importance of in tax due diligence and understanding the risks and exposures there.

Weapon warranty insurance is very significant as well. We don't really have, agree detailed number of the, of the transactions and include a revenue warranty but have a total it's probably somewhere around 30%, of the deals. From an economic perspective, deals that are greater than $20 million of, of value are probably the ones that that make the most sense that rep warranty insurance and then the cover, you know, non-tax items but also, you know, tax exposures and risks.

And if you have a significant tax issue, you could actually even get your standalone tax insurance. So, you know, a really important tool in, in the market today, sale consideration, your cash consideration is increased over the last couple of years. A little less equity consideration, possibly because there's been a dip in the private equities, activity in the market, and they often have rollover interest on crude equity.

So, maybe not. The trend going forward, to the extent that the market picks up again, one that I found was quite interesting is the, the big reduction in the full acceleration of options for employees, you know, all the way down from 21% of the deals down to the 8%. So, probably requiring other means of compensating, key employees impacted by the transaction.

So creating some, creativity, I guess, necessary. And then another big, change as well is the use of earn outs with regard to, your valuing companies in the transaction. So that's basically a full third of transactions include or notes as part of the consideration. So thinking from a from a tax perspective, you know the terms of that or not.

You know how are we going to treat it from a tax perspective is going to be sale proceeds. If there's a you requirement for continued employment, is it going to be compensation? So all of those things can come into play in considering how to look at those or not from a, from a tax perspective. So a lot of kind of moving parts there to, to consider.

And you know, with the kind of sunset of some of the TCJA, you know, rates here, we've got the, the individual rate that may go up for 37% back up to 39.6 rate. And then also the qualified business income deduction, for flow through entities could be going in that way as well. You know we've got some some higher individual income tax rates that that we need to consider from a planning perspective.

You know, an individual with the flow through business going from, you know, potentially 29.6% rate all the way up to a 39.6% rate. Is significant. And we compare that to the corporate 21%. It was there's a big, big delta there to cover. And when we look at the pass through structure versus a corporate structure, considering the needs of the, the shareholders and distributions, you know, that also an impact where the yield rate comes in.

Ben Willis: And part of that then is plays into some other planning here, which you want to touch on in. Could you go back for a second. Yeah sure. So back and I know you pointed out to me that the, the rates are actually a little bit closer than I indicated in the slide right here. Yeah. 39.6 is actually really more 30, 39.9, which would reflect, the net investment income tax that, you know, owners of corporations are almost certain to pay.

And part of that then is plays into some other planning here, which you want to touch on in. Could you go back for a second. Yeah sure. So back and I know you pointed out to me that the, the rates are actually a little bit closer than I indicated in the slide right here. Yeah. 39.6 is actually really more 30, 39.9, which would reflect, the net investment income tax that, you know, owners of corporations are almost certain to pay.

Dave Gette: Yeah. And so I just wanted to point that out. Yeah. And that, that 39 point, as you mentioned, the 39.9% with the corporate structure would be the 21% corporate rate. And then assuming full distribution of the net purchase and net after tax, earnings to the, to the shareholder. So, you know, we're looking at, you know, 40% plus state rate.

So we're probably mid 40s of tax on that side. But you know, one thing, we are seeing a lot of corporate structures because of that lower tax rate, about 21% in this if they're not planning to, to distribute out, you know, net earnings or make distributions during holding period. The corporate rate is very beneficial.

And even on top of the kind of ongoing tax costs associated with section 12 of two qualified small business stock provides a significant opportunity to save tax dollars on exit as well. So a qualified small business is really, you know, a business with less than $50 million of net assets growth assets. And actually, at the time of stock issuance, it's a business that 1202 defines as which businesses aren't qualified small businesses for purposes of 1202 but but typically it's, the ones that are excluded are the service businesses, accountants, architects, engineers, financial service businesses, insurance, those sorts of businesses, medical practices are not eligible, but everything else falls into that category.

It's qualified small business. Has to be an active trade or business, meaning that you can't hold passive assets or rental properties or or those sorts of things. And then we have here and it's primarily available to, to individuals. So, once you have your qualified small business stock, it needs to be originally issuance. So you have to get the stock directly from the corporation.

So you can't purchase the stock from, from another shareholder from a third party. And so it has to be at formation or received through, you know, stock compensation or contribution to assets, that sort of things. Hold it for five years and then, to the extent that it was issued after the date here, February of 1993.

We've got a chart here of what the exclusion is. And many of the, the cases that we're seeing recently are driven by the fact that there's a 100% exclusion for stock issued after, 2010. So if you were to sell qualified small business for, you know, $15 million, there's an exclusion of, you know, a minimum exclusion of $10 million.

So you could exclude, you know, 10 million of that $15 million gain. To the extent you have higher bases in your stock, you can even increase that, that exclusion. So it's it's a very significant tool for, for saving tax dollars and exiting out of a small business. And, you're really seeing a lot of people take advantage of that in the last few years, particularly since the the decrease in the corporate rate and corporate structures are are, you know, less tax cost associated with that being in a corporate structure than there had been historically? So this is this has been a huge benefit here in the last several years that we've seen.

All right. We've got a, a cooling question here. And, I guess really kind of the key thing is, have you reached out to anyone to discuss section 12 or 2 stock? Is that something that, that you've seen and, have an interest in? Make a choice here once or twice? Not yet. Several times at least.

Or in a I love this question. I don't know if it was designed to, encourage, collaboration and questions. Not to, Dave's team and my team certainly have some wonderful, section 1202 expertise. And so, I think to the the heart of this question, feel free, don't hesitate at all to reach out to Steve or myself to talk about this important code section.

Ben Willis: Yeah. And there's a lot of planning that we can do to to get into those structures

and, and, and make it, efficient for everyone concerned.

I, before I jump into the, county corporate alternative minimum tax, I'll just say this, I've been hearing over the last couple of weeks thoughts about potential legislative changes for 2025. Everybody is curious what's going to happen. I don't hear a lot of folks screaming about section 1202 of the code. But perhaps, it'll be a contender for, for reconciliation and legislation.

This Kasey Pittman outlined, along with some other areas, the process for that and, and our, and our, federal tax income tax update, 1202 you know, allows specific trades or businesses to, you know, grow, more exponentially than they otherwise would through an investor, you know, these investor, incentives. And so it's certainly possible that they could expand that list, to include more, more activity.

Dave Gette: So. Yeah. Yeah. And, since it's been in place for a number of years, you. Yeah, that's, that would be welcome because the industry and you know that with the expansion of technology, you know, a lot of clarification, more additional clarification to be helpful. Agreed? Agreed. Now, on the committee, the recent regulations were released, and I'll tell you the question I got most when those came out was really.

Ben Willis: The length the complexity, and of course, low power bright, came out and we'll talk about that a little bit later, which, chop down some of the, the value of some regulation caused people to question whether or not, the, the more complex regulations would, endure, you know, going forward. And so, by all accounts, committee is a large revenue raiser.

And chopping it out and future legislation seems like a difficult task whether or not some of the regulations are a little bit, unduly complex and put too much burden on to taxpayers, more so than contemplated by Congress in imposing a tax on roughly 130 corporations. You know, has yet to be seen. But we're certainly, staying attuned and trying to make sure that unintended, taxpayers were not caught in the web, of these of these regulations.

So there's a lot of, trickle down through lower tier entities who have to report in these regs. But just to give a high level overview of the tax, enacted through the Inflation Reduction Act in 2022, imposing a 15% rate, based on FSI. Right. So a financial accounting, measure of income, not only necessarily domestic but also foreign as well.

And so that's always mentioned in some of these comments about the regulations, of course. But foreign parent and multinational groups have, different thresholds. But the general threshold is a billion over a three year period. If it's a US, corporation inside of a group, you've got your million billion dollar FSI threshold, followed by, a $100 million, amount for the U.S corporation.

What's interesting about the recent regulations is that they brought in a concept of a deemed foreign corporation, which I'll highlight very briefly on the next slide. If you see here, we could have partnership structures on the top of a group that, through direct and indirect ownership, could be deemed to result in a foreign corporation at the top and therefore pulling the whole group into this tax regime, perhaps much broadly, broader than originally contemplated.

And so this this can be a little bit of a trap for the unwary. Of course, if you're uncertain, please reach out, with with questions. And most of the clients that we're dealing with here at Baker Tilly, fall within the simplified safe harbor. This was first announced. And notice 2020 3-7, which reduced under a simplified method, the thresholds that I previously mentioned from 1 billion to 500 million and then 1 million to 50 million for those U.S. subsidiaries and, for parent structure.

We of course, there are some uncertainties on how best to, comply with this, especially for much smaller corporations and the burden even imposed on them. But, we think the, the first, filing season that just came about based on the 20, 23 year, was overall, successful. So, we will, ask a quick polling question now, which is, is your organization subject to KMT?

As I mentioned, I suspect most of you will fall into, the simplified safe harbor. But we, we always ask just to, sure. Moving on to the stock repurchase excise tax. Also, additional regulations were released on this recently, adding to some complexity as well, including with some of the funding rules very reminiscent of the, the 3D5 regulations and some of the deemed funding mechanisms there for, determining debt versus equity, some of which were, were, scaled back, pulled back by Treasury and the IRS, largely the documentation requirement.

Some of it was viewed as too harsh. We'll see if some scale backs occur to these regulations, but, they impose a 1% tax on the aggregate fair market value of the stock, subject to buybacks. There was a reduction for netting of issuances that occur in that year. The regs are very complex as to what falls into both of those categories.

One, a buyback which could include, a combination of transactions for upper and lower tier entities that are combined, in order to fall within that rule and then determining whether or not your issuance qualifies, you've got another, for for the netting, you've got a whole other list of 13 items, non stock items options.

Does your convertible that fall into this category in other situations? All of these types of questions are, great questions to reach out to, to the Getty or myself. We're very familiar with some of the substance over four principles that have imbued in these rules, largely relating to, you know, reorganizations and other, distributions and redemptions occurring, close in conjunction with, another transaction.

And so, happy, happy to assist this and have been doing some, I am now going to jump into a trilogy of cases that have impacted our ability to argue that regulations shouldn't be as harmful as they once were. Harmful against taxpayer tax returns and and overbroad in some instances, as determined by the courts. I'm going to go ahead and start off with the low for bright, which was probably the largest, change in in quite some time, when it comes to, precedent and, and, and, the Chevron doctrine, coming from the 80s really gave, federal agencies the power to impose a lot of penalties and taxes and, killing, the force and effect of law, effectively.

And there was a lot of uncertainty. As for how how great that was, when did where did it extend to what types of guidance, what types of regulations? And after some pushing back by the courts over actually many years since the Mayo decision in 2011, the Supreme Court picked this up and reversed the Chevron doctrine, which basically puts taxpayers on an even playing field with the IRS.

And as I have argued in, an article called, taxpayer deference can help close the tax gap. Taxpayers can, in fact, have deference in some courts and the way that you get there is, so through the longstanding, traditional canons of construction, holding revenue, raising laws against their draft. And so going back to 1917, all the way to the famous United Dominion case in 2001, where the Supreme Court said, hey, you know, we should be inclined to rely on the traditional canon that construe as revenue raising laws that impose taxes.

Against their drafter. And so, if, as the court did there in, in, in other instances, if, if it is not entirely clear that a tax is due, then, some courts in fact apply this canon to, fine for the taxpayer. And now, without Chevron deference, I expect that to be more likely.

The two other cases, or corner post, which removes the harm when a taxpayer can challenge the validity of a regulation from when the regulation, was promulgated to when it impacted that taxpayer, which can be much mirror, of course, if they were hit by a regulation promulgated in the 90s and now they're, subject to additional tax by that, they may have a harm in under the EPA.

Can claim a regulation is invalid. And we're seeing this already in the courts. Very and is a big example where the gap period for corporations after the TCJA, which allowed to 245 DRD, at a different time than some of the other mechanisms, Gilti and others, taxes went into effect, to give taxpayers a double benefit in some instances here, the government argued that applying section 78 for distribution, allowing foreign tax credits as well as a DRD during this gap period was, too generous.

And the court said, well, that's what Congress did, and we're not going to let you use regulation to change the effective dates that were clear inside of these regulations. I expect to see much more, litigation and, and positions that are not in line with regulations. Now, as we have seen in the IRS take very, aggressive positions.

What benefits Congress wants, people to have through its laws? I know I'm closing in on time. I'll try to squeeze in a minute real quick on collaboration. From the IRS. We've seen this policy jump up and I'm very excited about it. At the beginning of 2024, the IRS released its web products for how to get peelers on non-recognition transactions, among others.

Corporate tax free transactions reorganizations 355 spin offs. They eliminated largely the significant issue hurdle, meaning that you don't have to prove that your issue is too complex to be addressed effectively. And it opened up comfort rulings very broadly. And so now we're seeing for reorg 351 liquidations, fast track peelers in a 12 week, as opposed to a six month to six nine month timeline all available for you. So as you're thinking about your planning opportunities and how to proceed, whether or not a spin off is caught by camp T or as regulations told us, or not, taxpayer friendly regulations certainly seem more enduring than, not. But, we really have a lot of opportunities for a device of reorg that also falls under 355 or straight, spin offs to assist you and Dave, Kerry and his team have, valuable experience with that as well as myself. So, yeah.

Dave Gette: I think this is really important. You know, a tool that we can use to really gain additional comfort to the extent that we have issues that we want to resolve or haven't even fully got comfortable just based on, I mean, the authorities that are sitting out there.

So I think it's the access to these rulings is going to be, a very useful tool.

Michael Wronsky: Thank you very much. Yeah. Thank you both, gentlemen. It was a terrific, terrific discussion. So, I would also, most certainly like to thank all of you for joining us in our fourth quarterly tax webinar series roundtable. We hope you'll join us again tomorrow as we close out the series with part two of our federal business tax update.

And again, thanks as well to our panelists for a great discussion. Please contact us if you have any questions about the topics covered during the roundtable. The panelists and I would be happy to answer any questions that you may have. So again, thank you all so much for spending your time with us today, and we hope you have a great rest of your Wednesday, Tuesday afternoon again. Thanks, everyone. Take care. Thank you