As corporate tax executives begin considering their year-end tax planning strategies, they are faced with a number of domestic and international tax law changes brought about by legislation enacted in 2010. Further complicating the matter, it is uncertain whether Congress will address a number of pending issues during the lame duck session, particularly given the outcome of the recent mid-term elections. Thus, in addition to implementing tax law changes taking effect in 2011, corporate tax executives must begin making contingency arrangements in the event that items such as the Bush tax cuts and the so-called "extenders" package are not addressed before the end of the year. Given the dynamic and uncertain legislative environment, the following are recommendations as to the "Top 10" year-end tax planning strategies that corporate tax executives should be considering.
1. Executive Compensation Planning. It is widely believed that the Bush tax cuts will be extended for all taxpayers for at least 2011. But, if the Bush tax cuts are not extended, the top individual marginal rate will increase from 36% to 39.6%. Therefore, executive compensation contingency planning to accelerate, to the extent possible, bonuses and other incentive compensation to allow corporate executives to benefit from the reduced rate in 2010 would be prudent. It should be noted, however, that opportunities for accelerating income may be limited due to Code Sections 409A and 162(m). Grandfathered deferred compensation and short-term deferrals are a potential source for acceleration, although Section 162(m) may still be implicated. Further, for public companies, the need for proxy disclosure of such an accelerated payment of compensation may prove to be an obstacle. Finally, in the event that the Bush tax cuts are not extended, consideration should be given, particularly in the closely-held corporate context, to migrating from dividends to bonus structures beginning in 2011. Although both compensation and dividends would be subject to the top individual marginal rates if the Bush tax cuts were not extended, compensation would generate a corporate-level deduction and, therefore, represent a more tax-efficient basis for compensating executives.
2. Dividend Planning. Again, it is widely believed that the Bush tax cuts will be extended for all taxpayers for at least 2011. But, if the Bush tax cuts are not extended, the tax rate on dividends will increase from 15% to 39.6%. Therefore, for taxpayers with available earnings and profits, contingency planning for special dividends or increasing planned dividends before the end of the year would be prudent. Liquidity concerns may be mitigated with a debt-financed distribution or a distribution of a note. Although the Bush tax cuts may in fact be extended before the end of the year, it will be important for corporate tax executives to ensure that the proper corporate law actions and financing are in place to allow for any year-end dividends if necessary. Further, absent new legislation, beginning in 2011 qualification of corporate redemptions by closely-held corporations as capital gains rather than as dividends (already important to avoid deemed dividends to non-redeeming shareholders) will have added importance (as such redemptions will be subject to tax at a maximum capital gains rate of 20% rather than 39.6%).
3. Potential Inaction on the "Extenders" Package. It is uncertain whether Congress will address the traditional "extenders" package of provisions that expired at the end of 2009, including the research and development credit, the Subpart F active financing exception and the CFC "look-through" rule. As a result, corporate tax executives must be mindful that investment decisions and budgets should be made without the resulting tax benefits associated with these provisions. Furthermore, consideration should be given as to whether the loss of these tax benefits results in any financial statement impact or disclosure issues.
4. "Protective" Disclosures for Year-End Transactions In Light of Codification of the Economic Substance Doctrine. The Patient Protection and Affordable Care Act codified the economic substance doctrine and introduced a 20% strict liability penalty for underpayments attributable to a transaction that is determined to lack economic substance. Importantly, this penalty is increased to 40% if the taxpayer does not disclose the transaction in its return. While disclosure is not required until the return is filed, corporate tax executives should consider whether "protective" disclosure of any year-end transactions would be prudent in order to avoid the increased 40% penalty. Furthermore, if they have not done so already, corporate tax executives should implement procedures and processes to ensure that such "protective" disclosure is considered with respect to all transactions on a going-forward basis. See Notice Provides Little Meaningful Guidance on the IRS's Plans to Administer the Economic Substance Doctrine Statute; LMSB Directive Requires High-Level Review Before Assertion of Strict Liability Penalty, September 15, 2010; Practical Implications of the Codification of the Economic Substance Doctrine, April 5, 2010.
5. Potential Exposure to Health Care Reform Excise Tax. Calendar year employer-provided health insurance plans - whether "grandfathered" or "non-grandfathered" - are required to comply with a number of new insurance market reforms as of January 1, 2011 (e.g., provide coverage to "adult children" up to age 26, no lifetime limits on certain benefits, and, in the case of a "grandfathered" plan, adopt internal and external appeals processes). Failure to comply with the new insurance market reforms results in an excise tax of $100 per day per affected individual, capped for a taxable year at the lesser of $500,000 or 10% of the employer’s health care costs for the prior taxable year. The excise tax for any violation must be reported and paid using Form 8928 no later than the employer’s income tax return due date (regardless of an extension of the income tax return due date). In order to avoid exposure to this potential excise tax liability, corporate tax executives should coordinate with their human resources and any outsourced employee benefits functions to ensure that their plans are in fact compliant.
6. Revisit International Tax Planning. As part of the Education Jobs and Medicaid Assistance Act, Congress included a package of international tax "revenue raiser" provisions, including limitations on the ability of taxpayers to utilize foreign tax credits in a variety of circumstances. Corporate tax executives should consider tax planning to mitigate the impact of these provisions before they go in effect in 2011, as well as consider the impact of these provisions on a going-forward basis particularly with respect to future acquisitions and internal restructurings. For example, corporate tax executives should consider whether to repatriate income to prevent the application of new Section 909, which addresses so-called "foreign tax splitter" transactions, to pre-2011 taxes incurred by their foreign subsidiaries. Guidance expected in early December will outline the scope of this provision in this context and will have to be analyzed quickly to determine the most advisable course of action. Further, corporate tax executives that have utilized the so-called "hopscotch" rule under Section 956 to repatriate earnings from high-tax pools should consider the impact of legislation eliminating this strategy, including arrangements that could be put in place before 2011 to preserve the benefits of current structures into the future.
7. S Corporations. Absent legislation extending the Bush tax cuts, traditional tax planning incentives for S corporations - accelerating deductions and deferring income - may be reversed in 2010. In many cases, accelerating income and deferring deductions (other than itemized deductions) will be advantageous. In addition, S corporations with subchapter C earnings and profits may wish to elect, with consent of all affected shareholders, to have 2010 distributions come first from subchapter C earnings rather than from the accumulated adjustments account. This election will apply to all distributions in 2010 and will cause such distributions to be taxable to shareholders as dividends to the extent of the subchapter C earnings and profits. If the Bush tax cuts are not extended, the S corporation may wish to distribute all of its subchapter C earnings prior to year-end.
8. Timing Items. Although there have been some discussions regarding potential corporate tax reform, it is unlikely that corporate tax rates will decrease in 2011. Therefore, there do not appear to be significant rate arbitrage opportunities through the acceleration or deferral of income or expense items. That being said, there may be certain specified opportunities, such as the acceleration of capital investments to take advantage of bonus depreciation before the end of the year, that are worth considering.
9. Continue Monitoring Potential Revenue Raisers. There is some belief that existing exemptions from the "pay-as-you-go" budget rules, combined with the results of the mid-term elections, make it less likely that "revenue raisers" will be used to fund the tax agenda, even in the lame duck session. Indeed, the budget rules provide for exemptions for a number of items, including permanent extension of the Bush tax cuts for the middle class, a two-year AMT patch, and a two-year extension of the 2009 estate tax regime. Further, Republican control of the House and a reduced Democratic majority in the Senate should reduce the use of revenue raisers as a funding mechanism. Nevertheless, it is important for corporate tax executives to monitor the potential use of revenue raisers adverse to their interests both in the lame duck session and in the 112th Congress.
10. Planning for Increased Form 1099 Reporting in 2012. The Patient Protection and Affordable Care Act also expanded the scope of Form 1099 reporting such that Form 1099 reporting is now required for most payments of $600 or more, including purchases of property, to payees (now including corporations). As a result, taxpayers will need to provide Forms 1099 to the IRS and to each corporate provider of property or services of $600 or more. Further, this vast expansion of information reporting responsibilities also increases the potential liability for backup withholding if TINs are not properly collected prior to the time of payment from payees who were previously exempt from information reporting. Although there are legislative proposals to repeal or modify the expanded Form 1099 reporting and the proposal does not take effect until 2012, it is important for corporate tax executives to evaluate and modify their internal systems, procedures and processes so that they can timely comply with the new law if necessary.
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