’Tis the season for tax-planning opportunities and decisions
The presidential candidate debates have been running on the cable business news channels, covering tax and economic policy views of the candidates. At times, the statements have been both provoking and entertaining. In some respects, I prefer the daytime programing on the business channels, which has included a fair share of merger and acquisition activity in recent months.
The flurry of merger and acquisition activity in 2015 has been assisted by the strengthening of economic conditions since the dark days of 2008 and 2009. The memories of the Great Recession are slowly fading away. Many of us have seen a rebound in the value of our retirement accounts.
The merger activity is enhanced by the tax planning some parties to the transactions have used for either the target company or the acquiring company and their respective shareholders. The recently announced Weyerhaeuser–Plum Creek merger is one of them. Both companies operate as real estate investment trusts. Plum Creek converted to REIT status in the late 1990s and Weyerhaeuser more recently.
Both of these companies hold significant amounts of timber properties as well as some manufacturing or processing facilities. The timberland and standing timber generally qualify as real estate under the REIT rules.
The advantage of the structure is that REITS generally don’t pay federal corporate income tax if their earnings are distributed to shareholders. Certain timber-related gains can also qualify for long-term capital gain taxation for the REIT shareholders.
Weyerhaeuser and Plum Creek aren’t the only companies that have converted into a REIT structure and minimized their corporate income taxes. Many other companies have made a REIT conversion. This includes billboard companies, communications tower companies, as well as other companies where real estate is a significant asset. A number of technical requirements for REIT status must be met, including having qualifying assets and qualifying income.
We have seen a similar trend for one level of taxation in the natural resources area over the years. Many pipeline and other natural resource-related companies have operated as publicly traded partnerships. Once again, the qualifying public partnerships generally incur no entity level federal income tax. The partners owning units in the partnership may tax on their share of the partnership earnings.
A number of technical requirements must be met to achieve public partnership status under Internal Revenue Service regulations. Earlier in 2015, the IRS announced it was going to adjust its ruling practices on what activities may qualify for public partnership tax status. This may limit some businesses from taking advantage of the structure in future years.
REITS and public partnerships aren’t the only tax entity planning that is used by businesses and their owners. Many businesses have been structured as S corporations, partnerships, limited liability companies or sole proprietorships to avoid the detriment of double taxation by operating as a C corporation. These structures are often referred to as flow-through entities. Owners of flow-through entities pay one level of federal tax. The tax status of the entities likely played some role in determining the structure to use.
Many merger transactions among corporations are structured to be tax-free (in reality, tax-deferred) for the corporation’s shareholders. This allows shareholders to continue to hold their investment without incurring taxes at the time of the merger.
It is not only federal income tax planning that businesses have utilized. For many years states and localities have offered tax credits, grants, property tax abatements and other incentives to entice businesses to locate in their city or state.
State and local taxes also impact individual tax planning. Recall that in the 1980s and early 1990s, many Michigan retirees moved to Florida in an attempt to avoid the Michigan individual income tax and the intangibles tax. Michigan made changes to the tax system in the 1990s that reduced the tax burden for many retirees.
The tax planning discussed above doesn’t necessarily grab the business headlines we have seen for other tax planning over the past two years. Inversions monopolized tax headlines in 2014 and are obtaining more press coverage again as we close out 2015. The discussion of the inversion topic has resurfaced as a result of two major drug companies entering into merger discussions.
Some inversions are permissible under the Internal Revenue Code and its regulations. There are a number of technical rules that impact the ability to enter into an inversion and the U.S. tax consequences of an inversion to the corporation and its shareholders. Undoubtedly, if a mega inversion transaction occurs in the near future, we will hear a lot of political discourse on the topic again.
All of us likely engage in some tax planning, whether we realize it or not. We can and do make decisions that may better our income tax position. Many individuals often make year-end donations to charitable organizations to obtain a tax deduction for that tax year. Others may have purchased energy-efficient furnaces or an electric vehicle to obtain the tax credit. Some individuals decide to own a home versus renting a home to take advantage of mortgage interest deductions and property tax deductions.
We only have a few weeks before the New Year arrives. This is a good time to review one’s tax position for any planning opportunities that may exist for one’s individual tax situation. Businesses can also make some decisions that may impact tax bills of either the business or the business owners.
Many variables play into any tax-planning analysis, so some time and effort may be required. The proper planning can reap financial rewards. The use of professional advisers can assist in this process to review the advantages and disadvantages of any tax planning decision. .
In the end, appropriate tax planning isn’t a four-letter word. The benefits of tax planning in what remains of 2015 may help cover the cost of some of those upcoming holiday gift purchases.
Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and not necessarily those of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult their professional advisers before acting on any items discussed.