S Corporations Should Consider Incorporating Foreign Branch Operations in Light of Higher Tax Rates

Lowell Yoder, Contributor to Forbes and Head of McDermott Will & Emery’s U.S. & International Tax practice writes: As I pointed out in a blog in early 2012, there are 4.5 million S corporations in the U.S.  These businesses are operated in pass-through form, where only one level of income tax is imposed on earnings and it is paid by the owners—not the corporation.  Back in August of 2012, I suggested that S Corporations should start to plan for a possible tax rate increase in 2013 if the Bush tax cuts expired].  They expired.

Beginning in 2013, the top individual tax rate—with the new Medicare Tax—will increase from 35% to 43.4% (39.6% plus 3.8%; the 3.8% Medicare Tax generally does not apply to the S corporation income allocable to shareholders who are “active” in the business).  So, I am again suggesting that S corporations consider a change to their foreign operating structure, which could substantially reduce their tax costs.

S Corporation with Foreign Operations – A Case Study

To illustrate, let’s assume foreign operations deriving $10 million of income subject to a 20% foreign tax rate.

Income derived from conducting foreign operations in a branch is subject to U.S. tax with a credit for foreign income tax.  In 2012 the tax cost of such operations was $3.5 million—i.e., $2 million of foreign tax and $1.5 million of U.S. tax.  In 2013 the tax on the foreign branch’s income will be $4.34 million—i.e., $2 million of foreign tax and $2.34 million of U.S. tax.

Alternatively, conducting the operations in a foreign subsidiary generally would defer U.S. tax to the extent the earnings are reinvested in the foreign operations (which is an important assumption in this analysis).  This structure provides a current savings of $1.5 million in 2012.  With the higher rates, the tax deferral would be $2.34 million in 2013.

U.S. tax is imposed on the earnings of a foreign subsidiary when distributed to the S corporation.  In 2012, a dividend of the after-tax amount of $8 million paid by a corporation organized in a jurisdiction that has an income tax treaty with the U.S. would generally have been subject to a 15% tax rate (with no credit for foreign taxes), resulting in a total tax cost of $3.2 million ($2 million foreign and $1.2 million U.S.).

This cost of repatriation will go up in 2013 because the tax on qualified dividends increases from 15% to 23.8% (the Medicare Tax is imposed on this dividend regardless of a shareholder’s “active” or “passive” status).  Thus, an $8 million dividend received by the S corporation would bear a total tax cost of $3.9 million ($2 million foreign and $1.9 million U.S.).  But, the total tax on profits repatriated would still be less than if the profits were subject to direct U.S. taxation (i.e., $3.9 million vs. $4.34 million).

Should an S Corporation Operate in a Foreign Subsidiary or a Foreign Branch?

As general rule, the tax savings of operating in a foreign subsidiary rather than a foreign branch will be even greater in 2013, as illustrated by the comparison below (each S corporation would need to input its specific details to arrive at the relevant numerical analysis).

Comparison of Tax Consequences

	2012
		Foreign Subsidiary
	Branch	Reinvested	Repatriated
Income	$10m	$10m	$10m
Foreign Tax	$2m	$2m	$2m
U.S. Taxes	$1.5m	$0	$1.2m
Total Taxes	$3.5m	$2m	$3.2m
Available Cash	$6.5m	$8m	$6.8m

	2013
		Foreign Subsidiary
	Branch	Reinvested	Repatriated
Income	$10m	$10m	$10m
Foreign Tax	$2m	$2m	$2m
U.S. Taxes	$2.34m	$0	$1.9m
Total Taxes	$4.34m	$2m	$3.9m
Available Cash	$5.66m	$8m	$6.1m

Note that if the foreign income tax rate is 26% or higher, the total tax cost after repatriation would be greater than if the foreign operations were conducted in a branch (ignoring the time value of money for the period of time the U.S. income tax is deferred).

What Should an S Corporation Do Now?

An S corporation’s current foreign structure might not be optimal with the higher U.S. tax rates, and, if not, consideration should be given to changing it.  Incorporating foreign branch operations can save or defer substantial federal income taxes (and possibly state income taxes).

Where's My Refund?

"Where's My Refund?" will be available for use after the IRS starts processing tax returns on Jan. 30. Here are some tips for using "Where's My Refund?" after it's available on Jan. 30:

• Initial information will generally be available within 24 hours after the IRS receives the taxpayer’s e-filed return or four weeks after mailing a paper return.
• The system updates every 24 hours, usually overnight. There’s no need to check more than once a day.
• “Where’s My Refund?” provides the most accurate and complete information that the IRS has about the refund, so there is no need to call the IRS unless the web tool says to do so.
• To use the “Where’s My Refund?” tool, taxpayers need to have a copy of their tax return for reference. Taxpayers will need their social security number, filing status and the exact dollar amount of the refund they are expecting.

For the latest information about the Jan. 30 tax season opening, tax law changes and tax refunds, give us a call....and yes, ExactCPA is an authorized IRS electronic filing provider!

Multi-million dollar Intuit partnership will connect millions to Tradeshift platform (and end the banking industry as we know it?)

We've never heard of "Tradeshift" until today, however this new partnership with Intuit merits taking a look at this Danish company with an office in San Franciso that some say might disrupt the world banking industry.  Christian Lanng, Chief Executive Officer & Co-founder writes:   Tradeshift to become biggest platform for business interactions, reaching over 5m QuickBooks users  In just a couple of years, Tradeshift has connected over 150,000 businesses. Today, we’re announcing a new partnership with Intuit that will connect the five million businesses who use QuickBooks onto Tradeshift and create the largest network of companies on one platform that the world has ever seen.   

Why does this matter? Scale. The value of any communications network increases directly in proportion to number of users — and when it reaches a point where it includes most of the businesses you want to interact with, something amazing happens. Skype, Facebook, Linkedin; all these platforms are successful because they have critical mass.  Today is a giant leap toward Tradeshift joining that lineup.   The millions of companies who choose QuickBooks to give them confidence, insight and new opportunities from financial data will now enjoy the same experience around external business interactions using Tradeshift. They’ll be able to get paid faster via Tradeshift Instant Payments and add new business processes using Tradeshift Apps.  At such a scale (and with our commitment to open standards) Tradeshift becomes an even more appealing environment for developers and partners to create and sell Apps. And that opens the door to running any business process on the platform and, in time, feeding more data back into Quickbooks too.  

We built Tradeshift E-invoicing because it’s the one thing every single company needs but when it comes to business interactions, the sky’s the limit.  And finally, the global enterprises that have been desperate for years to embrace a more efficient electronic future can do so safe in the knowledge that companies they work with are already connected.  As Tradeshift becomes more and more ubiquitous as the platform for all business interactions, we may look back at this as the tipping point. But what’s really interesting is that this isn’t the biggest news we’ll have all year. It’s not even the biggest news we’ll be announcing in the next couple of months.  Buckle up 2013, there are very good reasons that companies like Intuit want to become strategic partners with Tradeshift    Well with hype this this we just had to take a closer look at Tradeshift, and  E.B. Boyd for Fast Company writes: how Tradeshift is using real-time data to change the way rates get set for small business loans and may do nothing less than disrupt the world banking industry.

A Danish startup has created a fairly straightforward web-based application that lets organizations invoice each other online. But humble though it may sound, in the long run, this Nordic venture could well end up disrupting not just the business software industry but the banking industry as well.

That's because the invoicing application is just the tip of a much larger iceberg that the company, Tradeshift, is envisioning--one that leverages big data to reinvent how credit ratings are set for small- and medium-sized businesses.

Its most potentially disruptive idea is Instant Payments, a service which allows suppliers to get paid immediately once a customer accepts an invoice on the Tradeshift system, instead of having to wait the usual 30, 60, or 90 days.

The money still comes with an interest rate, but the size of that rate gets determined based on the buyer's credit rating, not the supplier's. Which is good news for small- and medium-sized suppliers, which often get hit with higher rates because they are perceived to be riskier bets.

Large companies, however, often have better credit ratings. And when you combine that with the fact that Tradeshift can see that a buyer has accepted an invoice (thereby declaring that they do intend to pay the bill), the risk for Tradeshift (and its financing partners) plummets. 

"We can do real-time credit assessments," CEO and cofounder Christian Lanng tells Fast Company.

LANNG SAYS THAT FORTUNE 500S ARE SENDING "MILLIONS" OF INVOICES THROUGH THE SYSTEM ANNUALLY, AND THAT THE OVERALL VOLUME OF TRANSACTIONS HAS TRIPLED SINCE JANUARY.

Instant Payments is currently being beta tested in England and Denmark and is slated to be available in the U.S. in the fall. The long-term implications of the real-time visibility Tradeshift now has are powerful. "You cannot even begin to imagine what big data will do to finance," Lanng says. "As we get more data on transactions, that changes the whole credit picture."

Lanng and his cofounders, Mikkel Hippe Brun and Gert Sylvest, came up with the idea for the e-invoicing service while building a similar system system for the Danish government. The initial goal was simply to help businesses around the world become more productive. Invoices are still largely delivered in paper or PDF format, which means parties on the receiving end have to spend time retyping the details into their own systems. (The Danish government estimated that this costs 15 minutes of worker time per invoice.)

Since businesses of all sizes and shapes share the same challenge, Lanng, Brun, and Sylvest decided to tackle the problem on a global scale. Tradeshift launched in 2010, with Morten Lund, one of Skype's early investors, helping to arrange seed funding. (Lund is now chairman of Tradeshift's board.)

The company initially launched just in Scandinavia, Germany, and the U.K. But since companies frequently do business trans-nationally, the system rapidly swept across the globe.

Today 100,000 businesses in 190 countries use Tradeshift, including the U.K.'s National Health Service, the French government, and Kuehne+Nagel, one of the largest transportation and logistics companies in the world. About 2,000 new companies join every week, up from 1,000-1,500 a week six months ago.

With 20,000 companies on the system, the United States has the largest number of users (including Dell and Accenture). India and Malaysia are fast-growing countries, though, and CEO Lanng tells Fast Company India could soon overtake the U.S.

The company won't disclose the exact number of transactions processed, but Lanng says that Fortune 500s are sending "millions" of invoices through the system annually, and that the overall volume of transactions in the system has tripled since January.

The service is free to use. Tradeshift makes its money off its developer ecosystem. The company quickly saw that the main value they were creating wasn't solely in productivity. All of a sudden, its databases contained massive amounts of real-time data about economic activity that businesses would want to access and put to use beyond simply checking the status of invoices.

About 30 third-party apps have been built on top of Tradeshift so far (with 20 more on the way), Lanng says, including ones that create heat maps of your suppliers and customers and others that integrate with Google Docs and PayPal. In addition to public apps that anyone can use, individual companies can build proprietary apps to use just with their own supply chain. 

"This is what happens when you take the Facebook model and apply it to business," Lanng says. "You get some very powerful business possibilities."

Privacy is not an issue, Lanng says, because the apps don't give users access to all the data in the system, only to data relating to their own businesses. "A lot of this data is data they share with their business partners anyway," he explains. But instead of delivering it manually and partners having to re-key it into their own systems, they can now access it in real-time through the centralized system.

Tradeshift takes a percentage of the fees charged by paid public apps (30%, on average) and negotiates independent deals with companies that build proprietary apps.

If the developer ecosystem expands, the Tradeshift model could one day steal market share from business software stalwarts like Intuit's QuickBooks, as small and medium-sized businesses choose to work on Tradeshift and use its app ecosystem because of the convenience of connecting real-time with their business partners elsewhere.

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Tax Preparer Rules Vanish On Filing Eve After Court Loss

By Richard Rubin for Bloomberg writes: The U.S. Internal Revenue Service suspended its regulation of tax-return preparers after a federal court ruling said the agency lacked authority, removing a tax- compliance tool that was years in the making and raising concerns from the national taxpayer advocate.

With the tax-filing season starting Jan. 30, hundreds of thousands of return preparers won’t have to register with the federal government, pass a competency test or meet continuing- education requirements. The court decision undercuts work that persuaded the IRS to impose the rules to protect filers, said Nina Olson, the national taxpayer advocate whose office is an independent organization within the agency.

“Taxpayers are going to go into filing season without preparers who are prepared,” Olson said in an interview yesterday. “This is a consumer protection regulatory scheme.”  U.S. District Judge James Boasberg in Washington invalidated the regulations in a decision Jan. 18 and enjoined the IRS from enforcing them. Boasberg, picked for his post by PresidentBarack Obama, wrote that the IRS overstepped its authority by relying on an 1884 law that allowed it to regulate people presenting cases before the Treasury Department.

“Filing a tax return would never, in normal usage, be described as ‘presenting a case,’” he wrote. “At the time of filing, the taxpayer has no dispute with the IRS; there is no case to present.”

The IRS responded yesterday by suspending the program. The 15-hour annual continuing-education requirement started in 2012 and the testing requirement was taking effect this year.

‘Further Action’

“The Internal Revenue Service, working with the Department of Justice, continues to have confidence in the scope of its authority to administer this program,” the agency said in a statement on its website. “It is considering how best to address the court’s order and will take further action shortly.”

The rules were designed to impose standards on hundreds of thousands of return preparers who aren’t certified public accountants, attorneys or enrolled agents already licensed to practice before the IRS. The idea, promoted by former Commissioner Douglas Shulman, was to require minimum qualifications and help the agency combat tax fraud.

“What’s sad is a lot of taxpayer money has been spent on this thing and it was done without statutory bases,” said Allen Buckley, an Atlanta attorney who helped the plaintiffs with their briefs. “Fortunately, justice was done here and our system worked.”

Questioning Urged

Olson said she will be advising taxpayers to ask “vigorous questions” of their return preparers about their qualifications. Low-income households are particularly vulnerable to incompetent or unscrupulous tax preparers who offer the promise of large refunds, she said.

Supporters of IRS regulation of return preparers include Robert Kerr, senior director for government relations at the National Association of Enrolled Agents. He said the agency, which audits about 1 percent of individual returns, could improve compliance with tax laws through such regulation.

Accountants and tax-preparation companies such as H&R Block Inc. (HRB) and Intuit Inc. (INTU) supported the rules.  Intuit, which makes TurboTax, was “disappointed” by the ruling, Dan Maurer, senior vice president and general manager of the consumer tax group, said in a statement.  “We were all waiting for the result,” said John Ams, executive vice president of the National Society of Accountants in Alexandria, Virginia, and a member of an IRS advisory board. “We were all aware of it. I think even the IRS was surprised because there was no hearing.”

The suit challenging the regulations was filed by return preparers, who were assisted by the libertarian-leaning Institute for Justice.  The conventional wisdom would be that the IRS would appeal and seek to block the court order from taking effect during that process, Kerr said “It ain’t over ‘til it’s over,” he said. “I certainly don’t believe it’s over yet.”

The case is Loving v. Internal Revenue Service, 12-cv- 00385, U.S. District Court, District of Columbia (Washington).

New York: Multiple Taxes: Proposed Budget Includes Credits and Other Tax Provisions

New York Gov. Andrew M. Cuomo has released his 2013-2014 executive budget, which contains corporate and personal income, sales and use, property, motor fuels, and other tax provisions but no tax increases. Among other things, the proposed budget would:

• extend the MTA business tax surcharge for five years;
• extend the film production tax credit for five years, enhance the credit, and improve transparency;
• establish the New York Innovation Hot Spots Program;
• extend the high income charitable contribution deduction limitation for three years;
• close the royalty income "loophole";
• extend and enhance the historic commercial properties rehabilitation tax credit;
• establish the Charge NY electric vehicle recharging equipment tax credit;
• establish tax-free sales and the sale of alcoholic beverages at Taste-NY facilities;
• update criteria for refusal and revocation of a sales tax certificate of authority;
• expand the cigarette and tobacco retailer registration clearance process;
• increase the civil penalty for possessing unstamped cigarettes; and
• allow local governments to extend existing sales tax rates without state legislative approval.

IRS Increases Mileage Rates for 2013

We've received some questions on the new mileage deductions in operating a vehicle so allow us to further clarify.  If  you are a business owner that uses your personal vehicle for business purposes or are planning on moving in 2013 the IRS has issued the new 2013 standard mileage rates. These rates are used to calculate the deductible costs of operating an automobile for business, charitable, medical and moving purposes.

Starting on January1, 2013, the new standard mileage rates for the use of a car, van, pickup or panel trucks increased to the following rates:

• Business – The rate increased to 56.5 cents per mile driven for business purposes, a one cent increase over the 2012 mileage rates. This rate is based on an annual study of the fixed and variable costs of operating an automobile.
• Medical/Moving – The rate increased to 24 cents per mile driven for medical/moving purposes, a one cent increase over the 2012 mileage rates
• Charity – The rate increased to 14 cents per mile driven in service to charitable organizations, again a one cent increase over the 2012 mileage rates.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Limitations

It’s important to note there are limitations on how the standard mileage deduction rates may be used. A taxpayer is prohibited from using these rates on any vehicle that has been depreciated using the Modified Accelerated Cost Recovery System or after claiming a Section 179 deduction for a vehicle. Finally, the business standard mileage rate is not permitted to be used for more than four vehicles at the same time.

In addition to these limitations, there are several rules that need to be followed when using the standard mileage rate to calculate the amount of deductible business, moving, medical or charitable expenses. More specific information can be found in the IRS Rev. Procedure 2010-51. There are several variables to consider when determining if and how to use these standard mileage rates. We encourage you to speak with your tax advisor to determine the best option possible for your situation, you're always welcome to contact us to discuss.