Doug Houser: From Rea & Associates Studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders, and others who are ready to look beyond the suit and tie culture for meaningful, measurable results. I'm Doug Houser.
We're nearing the end of the year, which means tax prep is once again on the agenda. As you prepare to plan and think about filing your 2019 tax returns, there are several considerations to keep top of mind. Today's guest is going to point us in the right direction. Chris Axene, a principle, and federal tax expert extraordinaire with Rea and one of our regulars here on unsuitable, is here to talk about what you can do to become better prepared for the upcoming tax season. Welcome, Chris.
Chris: Thanks, Doug. Glad to be here.
Doug: Yeah, appreciate it. So talking about preparedness, I was thinking about this with my one daughter who is still at home this morning. I used my famous line on her, "Don't make your lack of planning my crisis." Is that a fair assessment of what you see?
Chris: Fantastic, and I... Absolutely, I was living that this morning myself with a client that came in and we were reliving what happened during the second busy season. And being a perennial procrastinator, that was tough for me to get out and in terms of waiting until the last minute to bring their stuff for last year before we can even start the stage to talk about how we're going to plan for this year. And of course, it's November.
Doug: Right.
Chris: And there's only one month left in the year.
Doug: And right. Or still dealing with the prior year, right?
Chris: That's right.
Doug: And you're asking for information and you get the old response.
Chris: Well you get the "I know, I know I owe you stuff and I'm sorry I'm such a bad person. But I'll get it to you. I'll get it to you. Or is it too late? Was it too late?"
Doug: Yeah. Like secretly maybe that's what they were hoping for, right?
Chris: Maybe they get a free pass. If it's "Oops, it's too late. We'll just skip this one and move on to the next one."
Doug: Here's last year's numbers and estimate, right?
Chris: That is an option. It's kind of a last resort, but yeah, sometimes you have to do that.
Doug: Yeah. So if I'm thinking about preparing for a year-end as we're getting close to the end at 19 what, with the Tax Cut and Jobs Act that came into play, that threw a lot of curveballs into the thing.
Chris: That's right. Tax reform is what we call that. That's what it was labeled as and there were... I'm not sure. It touched so many different areas of the tax code. I don't know that it left any stone unturned, so to speak, which is the Accountants Full Employment Act is another phrase for it. Yeah. There's just so much going on in different aspects of the tax code that impact individuals and whether they're employees in their own personal returns or individuals that are business owners that are running a business. And aspects of the Tax Reform Act that impact them. Part of what happens with that too is in 2018 was the first year that the Tax Reform Act applied to.
Doug: Sure.
Chris: And the whole industry, CPAs, professionals in the IRS, quite frankly, were a lot of it was guessing on how this stuff was supposed to be implemented. And over the course of the year, the IRS issued some guidance in some areas to help. But there were still lots of questions that were unanswered about how appropriately to report some of these things.
Doug: Sure.
Chris: And we're still there. We're still waiting on guidance. And that's a lot of how this works is it'll take several years to work out exactly what we have.
Doug: Still writing the rules as we go.
Chris: We got to pass the bill first to know what's in it, right?
Doug: Right.
Chris: Yeah. So we passed it. Now we've got to live with it for three, four years to figure out how to comply.
Doug: Yeah. So if I'm a business owner, what are some of the keys, I mean, I know the qualified business income deduction, how does that... I mean there are so many different aspects to that. What do I need to be thinking about if I'm preparing?
Chris: Right. So we also call that the 199 CAP A. So I'm a code head and I live in that world. So that's what that means to me. And what that is, is we get a reduction in the tax rate on pass-through income from a business. If you meet the criteria and what counts and all the nuances of a phase-out and the benefit gets reduced if you make too much, some of those things are still being worked out and refined I suppose if you will. But, part of the planning for that is understanding one of the big parts of it is is the owner compensates themselves for their work on the business and then net profit after that.
Doug: Right.
Chris: Well the compensation from the business is not eligible for this benefit in a reduction in the tax rates. So they're going to pay at the top tax rate at 37% if that's what bracket they're in versus business income that would be taxed at a top rate of 29.6%.
Doug: Gotcha.
Chris: With that 20% benefit baked into it.
Doug: Right.
Chris: So planning around, is there the ability to work around to maximize the overall tax rate factoring in compensation and net profits that are in the business. And there's a calculus to that to figure out you can maximize your overall benefit by appropriately adjusting comp within the range of still what's being reasonable to yourself and to others that are employed in the business. So that's one of the big things. But in order to first be able to have those kinds of conversations, what happened in the past can be helpful for what we do in the future. And if we've got a client that waited 10 and a half months to file their prior-year tax return, that doesn't help us help them in terms of trying to save tax in the future.
Doug: Because the key is you want to sit down obviously prior to year-end and do some planning, understand what the business's outlook is for the year.
Chris: That's right.
Doug: And try to figure out what's optimal. Yeah.
Chris: And certainly for those clients that don't procrastinate, you have those conversations. Maybe because there are valid reasons why tax returns get filed and personal returns in September and maybe early October because you're waiting for information from outside third parties that's just not available.
Doug: Right.
Chris: And that happens in that life and that's easy to deal with. It's easy to deal with because you're meeting with those clients outside of that context during the year, talking about how the current year is going and you're managing with book income, which is not taxable income.
Doug: Right.
Chris: There can be differences there, but you've got at least a starting point to have that conversation in June, in July, August, et cetera, instead of waiting until November.
Doug: Yeah. Some idea at least is better than nothing.
Chris: Right. You're right. And for no other reason, because you still have five, six months of which to do something.
Doug: Right. Right.
Chris: As opposed to less than that.
Doug: And you brought up an interesting perspective about the extension of returns. I've heard a lot of noise about not only has it impacted individuals but obviously a lot of K-1's and things like that are getting delayed. So that's just kind of pushing through the system and causing further delays.
Chris: Yeah, and absolutely. And historically it had been a problem because the due date for certain types of returns happen. Extended due date happened to be the same due date ultimately for individuals 10/15. And you can imagine if you are getting the K-1 on 10/15 and your personal return is due on 10/15, that's not a lot of turnaround time. And then so that causes problems for clients, that causes problems for us as preparers and lots of stress and more sleepless nights working.
And so, fortunately, the IRS implemented some changes to due dates. It's been in place now for probably three or four years at least where they moved up by 30 days the due date of all pass-through type returns like partnerships and S corps.
Doug: Sure.
Chris: And so the big ones like hedge funds and alternative type investments that are typically structured as partnerships that would issue K-1 documents, which for those that don't know, some are like a 1099 or a W2, they're going to give you the owner, the investor, something that you then need to give to your accountant because it's going to have income on it, deductions, et cetera, that is needed in order to complete your return.
And so the good news in that respect there is the due date for those returns now is September 15th extended. So we at least have 30 days that however doesn't address those clients that maybe are new to that type of investment that previously never had to extend their tax return.
Doug: Right.
Chris: And we're going to them in busy season saying, "okay, tell me what you have. I'll have this new investment." And as you learn more about, "Oh, it's going to issue a K-1. When is that going to be issued?" Well, I don't know.
Doug: I don't know.
Chris: Well, let's check with your broker. Oh, that trip. Not until minimum at least until August. Well, we got to extend your return.
Doug: Right.
Chris: Why is that?
Doug: Yeah. We're not going to have the information.
Chris: Right. And some of those, even though you may be a small investor, some of those can still kick off a material amount of income that causes the tax that we need to wait and we need to extend. And for some clients that causes them the heartburn because they've never done that before, and they're worried that extending return is an automatic red flag for an audit, which is not true. As we've just talked about, there's a perfectly reasonable explanation in circumstances of why you have to amend. The information isn't there.
Doug: Right.
Chris: And so it doesn't lead to audits in and of itself. One thing that for the audience too that I constantly have to remind clients about though is when you extend the filing date of your personal tax return, that does not extend the date to pay.
Doug: Right.
Chris: Right. So there is no extension of time to pay. So what that means then is we have to do basically a calculation-
Doug: An estimate.
Chris: To figure out what do we think we're going to owe and pay that in April.
Doug: Yes.
Chris: So that when we file our tax return in October, that we either have a small refund or maybe we owe a small amount of money, but the IRS gets real upset if we file a return, and there's a bunch of money owed. So they're going to charge interest and penalty on that.
Doug: Yeah. And speaking of the IRS, have you seen much change in enforcement attitude or diligence since the Tax Reform Act was passed?
Chris: It's too soon to tell on that because the IRS does not audit in real-time. So the 2018 tax returns were the very first year that tax reform would apply to. And so the reality on that is some of those clients just filed their 2018 returns.
Doug: Okay.
Chris: So the IRS is not going to audit them now for... If it comes up on audit, it's going to be probably two years.
Doug: Yeah.
Chris: As we get into 2020, probably the latter half of 2020 and maybe into 2021, we're going to see where is the IRS focused on with regard to tax reform and in auditing. In certain areas we suspect and we may have read about that, that the IRS has said, "Yeah, we're interested in making sure taxpayers are complying." 199 CAP A, the business deduction is one of them.
Doug: Yes.
Chris: Because there's an opportunity for...
Doug: Gaming as we say.
Chris: For gaming the system. Thank you. And so I expect enforcement around that to pick up as well, depending on what type of business entity you are, if you're still a C Corp because the tax rates on C Corps as part of tax reform came down.
Doug: Yes.
Chris: It's now a flat rate at 21%. it's actually now lower than the individual tax rate. Because of that, there may be some game playing to try to keep profits within a C Corp, and so I expect some old and cold tax rules to come back into favor in terms of focus of IRS on audits and-
Doug: Interesting.
Chris: Yeah, so accumulated earnings tax, it's been around forever.
Doug: Haven't heard much about that in a while.
Chris: You haven't because when C Corp rates were closer to individual rates, there was really no reason to play the game and keep money in a C Corp. But now there might be. And so I expect to see some increased enforcement activity in that regard too.
Doug: So if I'm a business owner beyond obviously sitting down with a professional like yourself prior to year-end and walking through some of these issues, what should I be thinking about on my own in terms of preparing and planning? What are the things that I can do prior to sitting down with you, that would help in this process?
Chris: Well, first and foremost, it's understanding the role the CPA has, whether that's somebody internally that they're willing to share information with or you're their external accountant. We're here for a reason. We have a role to play. We can help when you give us the time to help you.
Doug: Right.
Chris: As we say, I'm more effective when I'm a planner versus being a fixer after the fact. So understanding that having that mindset of the CPA is your friend.
Doug: Yes.
Chris: Is on your team to help.
Doug: Right.
Chris: Give them the opportunity to help. Be willing to meet with them.
Doug: Yeah.
Chris: When they call and say, "Hey, it's been a couple months or quarter just ended. Let get together and include me in on what's going on in your world." be open and honest and willing to have those conversations about how the business is going and areas where it's maybe not going as well as they'd hoped it would be.
Doug: Sure.
Chris: Regardless of whether that's something that we may be able to help with directly, we obviously most of the time have a large network of other professionals that may be able to help.
Doug: And the other thing I see too there's so much going on in terms of transactions with businesses, some type of event, whether it's sale insiders, family transition, ESOP, or third party sale, anything like that. And we're dealing with this now where we have a client that went through a transaction and we weren't included in the planning process. So you're fixing and then that to me is a big no-no as well.
Chris: Well, you're going to leave dollars on the table potentially and maybe not get the best deal that you could have. And I see that all the time. In the course of my career, I have probably been involved in let's say a hundred M&A transactions, most of which on the seller side of the table. And I've seen, I hate to call them tricks, but I've seen all kinds of things in LOI's and sale documents and that maybe don't necessarily line up with conversations that the buyer and the seller may have had. Even when they are coming to me that the seller will, "Oh yeah, this is the conversation I had with the buyer. And they said, 'Absolutely, you're going to sell your stock.'"
Yep. And okay, well I'm a skeptic. Prove it to me. Show me the document. Show me the fine print in the document. And then I say, "Uh-huh, look at this." Technically it's a stock sale from a legal perspective, but it's an asset sale from a tax perspective. And that has potentially different consequences for you as the seller. So when all those things upfront while you're still in diligence and negotiating the deal, there's obviously a better opportunity to be able to change the outcome.
Doug: Right. Yeah, absolutely. That's huge. Because again sometimes you get folks that are focused on... They see that top-line dollar number that they think the transaction value is going to be, here's what it's going to be. But as you suggested, that's not really what they realize.
Chris: And I hate to again sound biased, but I absolutely agree with you. They see a number and they fall in love with the number and they start spending it. And I think the buyers understand that.
Doug: Sure.
Chris: And maybe sometimes the unscrupulous ones take advantage of that.
Doug: Right. Yeah, for sure. So looking ahead into 2020, obviously an election year, and we certainly don't want to get into politics, but what changes, if any, do you see coming or areas of emphasis if you have anything that sticks out?
Chris: Well, quite frankly for the last 15 years or more, we've had uncertainty in the tax code in terms of a long-term crystal ball and how cloudy or transparent it is. And while the Tax Reform Act, we have some certainties with regard to time periods in what was passed. All the individual stuff was temporary and right now is set to expire after the end of 2025. Well obviously we're going to have more than one election between now and then, and tax reform and tax law is only as good as the next Congress that comes in and changes it.
Doug: Right.
Chris: So when you factor all that in, the planning is, well geez, I don't have a long-term window. I can plan. I can tell you where we think we are right now, this is what we know because this is good right now. It doesn't mean it's not going to change in two, three years.
Doug: Right.
Chris: So to the things that you can take advantage of, take advantage of them now.
Doug: Yeah.
Chris: Again, business income deduction, trying to maximize that as much as you can. M&A's still hot.
Doug: Yep.
Chris: Lots of dollars looking for deals. And if you're on the seller side, work with professionals and try to maximize your deal. And easy for me to say, be willing to walk away if it's not right. Obviously the worst place to be is where you see a number, you fall in love with it and now you can't walk away and the buyer has you and now you're just going to do whatever deal they want to do.
Doug: Yeah. You get sucked into that deal and it becomes emotional.
Chris: Right.
Doug: Right. Rather than-
Chris: Yeah. When you have the chips and you don't have to sell, obviously you're the one holding the cards and you can then be in a better place to negotiate.
Doug: You talked a little bit about these so-called sunset provisions because of the way they act was passed. Was that due to federal budget restrictions or what was-
Chris: That's right.
Doug: Okay.
Chris: Yeah. So the process of how the sausage gets made is it's all about a 10-year scoring and how it impacts the deficit, et cetera. And because at the time we needed a simple majority, the Republicans in the Senate to ultimately pass a measure of the bill at whatever 51%, the method to do that required that the overall impact on the finances be neutral after 10 years. And so they look at the 10-year period. And so that's why... What was important to them. So you can look at the permanent stuff. So stuff that as of right now is permanent, that all on the corporate side.
Doug: Right.
Chris: I think the idea behind that was while we're trying to incentivize business, manufacturing, bring that back to the United States. We want to incentivize manufacturers that are still here, been here. And so all that stuff on the corporate side is permanent.
Doug: Yeah.
Chris: In order to ultimately make the equation balance at the end, all of the individual side of the tax reform is temporary, and that includes the big estate and gift tax stuff too.
Doug: Okay. Okay. And to be fair, that is proven to be a fallacy because obviously the deficit has ballooned astronomically. So does that in your mind put some of those changes in more jeopardy perhaps or too soon to tell really?
Chris: I think it's too soon to tell. That said, as we have seen from the past when you look at things like bonus depreciation, we get used to, for lack of a better way to say it, we get used to the handouts. And so when they are on the verge of going away, that causes people lots of angst.
Doug: Yeah, absolutely.
Chris: Bonus depreciation came out of 9/11.
Doug: Right.
Chris: In an attempt to spur the economy and expensing of fixed asset purchases. And it's gone through various iterations, and it was in fact scheduled to be phased out prior to this Tax Reform Act, and they brought it back.
Doug: Yeah.
Chris: Just as an example. So notwithstanding that some of those things are temporary in nature to the extent that they provide a benefit to individuals, they're going to get used to getting it.
Doug: Sure.
Chris: An example of that is the higher child tax credit, and $2,000 per child under 17, and the big part of that is increasing the AGI limit on when that benefit phases out.
Doug: Gotcha.
Chris: Previously, if you earn more than a hundred thousand dollars a year, you weren't going to get child tax credit. Now you can earn up to $400,000 a year and still get $2,000 per child. So there may be some calls as we get to 2025 if nothing else happens in the meantime to say, "Oh, this thing is about to expire. Well, maybe we don't want that. So maybe we got to get together and figure out how to keep it going."
Doug: Good luck with that.
Chris: Right.
Doug: As you said, as you told me eloquently though, once before you said, "If we have another one of these tax reforms," you said, "I'm not-"
Chris: I'm out the door. I'm done. I was not in professional practice for the '86 Tax Act. I'll say it that way. So I missed that one. I've gone through this one. I'm not going through another one. Can't.
Doug: I don't blame you.
Chris: It's just too much to try to keep up with.
Doug: Yeah, it is. It is phenomenal that the amount of information that you have to ingest.
Chris: Right.
Doug: Well, thanks, Chris. I appreciate your insight. And I guess the key message, the key takeaway here is plan. Again, don't make your lack of planning our crisis.
Chris: That's right. And your CPA is your friend.
Doug: Yes.
Chris: Don't look at it like you're going to the dentist. We're here to help.
Doug: Right. Absolutely. So that's great stuff. So if you want to hear more business tips and insight or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. Thanks for listening to this week's show. You can subscribe to unsuitable on iTunes or wherever you like to get your podcasts, including YouTube. And while you're there, please leave us a review. I'm Doug Houser. Join us next week for another unsuitable interview from an industry professional.
Disclaimer: The views expressed on unsuitable and Rea Radio are our own and do not necessarily reflect the views of Rea & Associates. The podcast is for informational and educational purposes only and is not intended to replace the professional advice you would receive elsewhere. Consult with a trusted advisor about your unique situation so they can expertly guide you to the best solution for your specific circumstance.
