The Impact of the Tax Legislation on my Agency The Impact of - - PDF document

The Impact of the Tax Legislation on my Agency

The Impact of Federal Tax Reform on Big “I” Members

October 2018

Disclaimer

This presentation includes only general information and should not be relied upon as legal or compliance

• advice. This document is not intended to provide

specific advice about individual legal, business, or

• ther questions. If specific legal or other expert advice

is required or desired, the services of an appropriate, competent professional should be sought.

What is in the new law?

• The centerpiece of the tax reform law is a new flat tax of 21% on all C-corps. Approximately one-

third of Big “I” member agencies are C-Corps.

• The law also makes changes related to the taxation of pass-through businesses including a new

20% deduction for

• wners/shareholders
• f

most insurance agencies and brokerages. Approximately two-thirds of Big “I” member agencies are organized as pass-through entities. As a result, Big “I” advocacy efforts focused heavily on these provisions.

• On the individual side, the law puts in place new tax brackets, and nearly doubles the standard

deduction, but makes changes to or eliminates many popular deductions for those who itemize on their tax returns.

• The changes on the business side are mostly permanent, while most of the changes to the

individual side, including those related to pass-through businesses, are scheduled to expire at the end of 2025.

Impact on C-Corps

• Previously C-Corps faced a graduated tax with a top base rate of 35%,

because the majority of C-crops were taxed at this top base rate, the most C-Corps should see a tax deduction since Section 13001 of the law imposes a permanent 21% flat federal tax on C-Corps and fully repeals the corporate AMT.

• However, some deductions have been removed or limited, which will

impact C-corps differently based on the business’ specific circumstances. For example:

– The new law amends section 163(j) of the tax code to limit the deduction of net interest to 30% of EBITA (previously was limited to 50%). – No deduction is permitted for entertainment expenses, business meals are still deductible at 50%.

Impact on Individual Rates

• The law lowers tax brackets at nearly every

income level, but these lower rates will expire at the end of 2025.

• The law does not make any changes to the long

term capital gains tax rate but does adjust the income brackets.

• The AMT for individuals was not eliminated,

but it was amended so it will impact less taxpayers.

• A number of changes that limit or eliminate

popular deductions were also made (see next slide).

• Overall, the impact will depend on the specific

circumstances of each taxpayer.

Impact on Individual Rates Cont’d

Standard Deduction/ Personal Exemption Standard deduction is $12,000 (single); $18,000 (HOH); $24,000 (joint). The personal exemption for every taxpayer and most dependents is repealed. Alternative Minimum Tax (AMT) The AMT, which imposes an alternative tax of 26% and 28% on some filers, was retained but the amount of income exempted from the AMT is increased. Less taxpayers are expected to be impacted by the AMT. Charitable Deduction May be deducted up to 60% of Adjusted Gross Income (AGI) rather than 50%. Child Tax Credit Increased from $1,000 to $2,000 and joint filers with AGI of up to $400,000, and all other filers with AGI of up to $200,000 annually can take the full credit. Phased out above those amounts. Disaster Costs Deductible only for uninsured losses incurred from a federally declared disaster. Estate Tax Doubles this exemption for 2018 to $11.2m (individual) and $22.4 (joint). The threshold is indexed for inflation. Medical Expenses Can deduct medical expenses above 7.5% of AGI through 2019 then reverts to 10%.

• Misc. Expenses

Previously certain items (i.e. unreimbursed business expenses) were deductible if they exceeded 2% of AGI, but the new law eliminates this deduction. Mortgage Interest Permitted for new mortgages up to $750,000, but no deduction permitted for home equity loans. State & Local Taxes Caps deduction at $10,000. Cap does not apply to state and local taxes imposed in carrying on a trade or business.

A new 20% deduction for pass-through entities is a BIG WIN for insurance agencies and brokerages!

Tax Rates for Pass Throughs

• Income from pass-through businesses will be taxed at the new relevant individual rates. However, in

addition to the reductions in the individual tax rates, the new law creates a 20% deduction that will be available to the vast majority of insurance agency owners and shareholders. The deduction is available whether or not your itemize your taxes.

– All pass-through business owners/shareholders receive the full 20% deduction when annual taxable income does not exceed $315,000 (joint) / $157,500 (single) in 2018 – these levels are indexed for inflation. – For owners/shareholders when annual taxable income exceeds $315,000 (joint) / $157,500 (single) in 2018 the total deduction cannot exceed 50% of employee W-2 wages, or 25% of W-2 wages plus 2.5% of capital assets (e.g. tangible property purchased for the business), whichever is greater. – Finally, the deduction is phased out for an owner/shareholder of a “specified service trade or business” (specified service) between $315,000 (joint)/ $157,500 (single) and $415,000 (joint) / $207,500 (single). An

• wner or shareholder of a specified service with annual taxable income above $415,000 (joint) and

$207,500 (single) cannot utilize the deduction.

What is a Specified Service?

The tax law defines a “specified service trade or business” as any trade or business involving the performance of services in the fields

• f health, law, accounting, actuarial science, performing arts,

consulting, athletics, financial services, brokerage services, the performance of services that consist of investing and investment management, trading, or dealing in securities, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.

Specified Service: Brokerage Services

“Proposed §1.199A-5(b)(2)(x) uses the

• rdinary

meaning

• f

“brokerage services” and provides that the field of brokerage services includes services in which a person arranges transactions between a buyer and a seller with respect to securities (as defined in section 475(c)(2)) for a commission or fee. This includes services provided by stock brokers and other similar professionals, but does not include services provided by real estate agents and brokers, or insurance agents and brokers.”

Specified Service: Consulting

Finally, traditional insurance activities should also not be considered “consulting” under the draft regulation:

“[T]he performance of services in the field of consulting means the provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems….The performance of services in the field of consulting does not include the performance of services other than advice and counsel, such as sales or economically similar services or the provision of training and educational

• courses. For purposes of the preceding sentence, the determination of whether a person’s services are

sales or economically similar services will be based on all the facts and circumstances of that person’s

• business. Such facts and circumstances include, for example, the manner in which the taxpayer is

compensated for the services provided. Performance of services in the field of consulting does not include the performance of consulting services embedded in, or ancillary to, the sale of goods or performance of services on behalf of a trade or business that is otherwise not an SSTB (such as typical services provided by a building contractor) if there is no separate payment for the consultingservices.”

Examples: Consulting

• Allen is in the business of providing services that assist unrelated entities in making their

personnel structures more efficient. Allen studies its client’s organization and structure and compares it to peers in its industry. Allen then makes recommendations and provides advice to its client regarding possible changes in the client's personnel structure, including the use

• f temporary workers. Allen is engaged in the performance of services in an specified

service business in the field of consulting.

• Don is in the business of licensing software to customers. Don discusses and evaluates the

customer’s software needs with the customer. The taxpayer advises the customer on the particular software products it licenses. Don is paid a flat price for the software license. After the customer licenses the software, Don helps to implement the software. Don is engaged in the trade or business of licensing software and not engaged in an specified service business in the field of consulting.

Is Insurance a Specified Service?

Insurance is NOT a Specified Service!!!!

• Based on this draft regulation, those insurance agencies and brokerages that only

participate in traditional insurance activities should not be considered a Specified Service.

• Insurance agencies and brokerages that also derive income from non-traditional

insurance activities such as consulting related to any type of insurance, retirement planning, investing, or wealth management, are not a Specified Services if only a small amount of income is draw from these activities.

– De minimis rule: A trade or business is not a Specified Service if it has gross receipts of $25m or less (in a taxable year) and less than 10% of the gross receipts are attributable to the Specified

• Service. If gross receipts are above $25m, the relevant percentage is 5%. This means an insurance

agency that has predominantly a P&C book of business, but also has a small consulting, retirement planning, or financials services component would not be considered a specified service trade or business under the draft regulation.

What if my insurance agency has gross receipts above the di minimis threshold?

If, for example, you are the owner of a pass-through business (and your income is above the threshold amount), and the business derives 50% of its gross receipts from the sale of insurance and 50% of its gross receipts from retirement planning there is nothing in the draft tax regulation that would prevent you from splitting your business into two separate entities, etc. and being able to benefit from the deduction on the non- specified service portion of the business.

Guardrails

• “Crack & Pack”: This rule prevents you from organizing your business in a way to expressly take

advantage of the tax law when you otherwise wouldn’t be able to. For example, a doctor’s office that is currently one LLC cannot split into two LLCs under common ownership in which one LLC provides medical services and takes in revenue from patients and one LLC includes all the employees who earn wages and “leases” its services to the medical LLC for a fee. The “crack & pack” rule prevents the employee LLC from being able to take the deduction. However, if the employee LLC also sold products to clients (such as medical devices, or skin care products) then they could potentially take the deduction.

• Performing Services as an Employee: There is a rebuttable presumption that a former employee is

still an employee. For example, if an insurance producer works for an insurance agency and makes $100,000 a year in wages then forms her own business solely to benefit from the deduction, there is a presumption that the deduction cannot be taken. However, the presumption can be rebutted, if for example the producer becomes an owner of the insurance agency.

Calculating the Deduction: Taxable income that does not exceed the threshold

In general, the section 199A deduction is determined for individuals with taxable income for the taxable year that does not exceed the threshold amount (e.g. $157,500 individual/ $315,000 joint in 2018) by determining 20% to the total QBI amount. That sum is then compared to 20% of the amount by which the individual’s taxable income exceeds net capital

• gain. The lesser of these two amounts is the individual’s section 199A deduction.
• Example: John, an unmarried individual, owns and operates a business as a sole
• proprietorship. The business generated $100,000 in net taxable income from operations in
• 2018. John has no capital gains or losses. After allowable deductions not relating to the

business, John’s total taxable income for 2018 is $81,000. The business’s QBI is $100,000. John’s Sec. 199A deduction for 2018 is equal to $16,200, the lesser of 20% of John’s QBI from the business ($100,000 x 20% = $20,000) and 20% of John’s total taxable income for the taxable year ($81,000 x 20% = $16,200).

Calculating the Deduction: Taxable income that exceeds the threshold

In general, the Sec. 199A deduction is determined for individuals with taxable income for the taxable year that exceeds the threshold amount (e.g. $207,500 individual/ $415,000 joint in 2018) and who are not deriving income from a Specified Service as the lesser of:

• 1. 20% of the QBI for the business; or
• 2. 50% of W-2 wages with respect to the business, or the sum of 25% of W-

2 wages with respect to the business plus 2.5% of capital assets (e.g. tangible property purchased for the business), whichever is greater.

Here's the 5 things you should talk to your accountant about for 2018 ASAP:

• If your agency is a C Corp, review your debt interest relative to your agency’s projected EBITA;
• Review your marginal income tax rates (including your QBI deduction) to gauge whether your current

tax bracket will be higher or lower in retirement. If there is a realistic chance it will be higher in retirement, change some or all of your 401(k) deduction from pre-tax to Roth ASAP;

• If you are a pass-through entity, estimate what your taxable income will be for 2018 (using the QBI

definition of taxable) to ascertain if it curtails the full amount of your QBI deduction and adjust accordingly;

• If you are a pass-through entity and have non-insurance revenues like retirement or health

consulting and they exceed 10% (or if revenues are in excess of $25 million, 5%) gauge whether it makes sense to consider separating those activities into two entities so that the insurance component entity can take advantage of the SSTB categorization; and

• If you have ownership of a pass-through entity that is a SSTB, you should ascertain whether you can

lower your income below the thresholds perhaps by maximizing retirement plan contributions, or

• ther income lowering strategies.

Massachusetts Association

• f Insurance Agents

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