Tax planning strategies for family businesses

Planning for relief

As approved in the House last November, the roughly $1.75 trillion Build Back Better Act calls for significant tax increases impacting large corporations and high-income individuals to pay for lower- and middle-class tax relief and fund new spending for White House priorities such as expanded access to pre-kindergarten education, child care and elder care, affordable housing, and programs to mitigate climate change. (Among the more notable revenue-raising proposals are a surcharge on certain upper-income taxpayers, expansion of income subject to the 3.8% Net Investment Income Tax, reduction in the capital gains exclusion for certain small business stock, and extension of excess business loss rules. A detailed summary of the tax provisions in the House-passed legislation is available from Deloitte Tax LLP.)

Plan pushback

Senate action on the legislation came to a halt shortly before Christmas when West Virginia Democrat Joe Manchin announced that he would not support it in its current form and thus would not provide the crucial 50th vote needed to get it through the chamber.

Since he announced his opposition to the bill, Manchin has been relatively tight-lipped about his specific objections and only recently began offering some details about the types of provisions he might be open to supporting. He also has suggested that any social spending proposals should be vetted through the congressional committee process under regular order—that is, outside of budget reconciliation.

The vision Manchin is beginning to lay out is far different than that of Democrats in the progressive wing of the party, who began this Congress with far more ambitious fiscal policy goals. But even if those members were to resign themselves to accepting the significantly narrower bill Manchin envisions, such a measure likely still would face resistance from centrist Democratic Sen. Kyrsten Sinema of Arizona, given her stated opposition to increasing tax rates. As those watching this process play out for nearly a year have said, finding the Venn diagram overlap of provisions that can win the support of both Manchin and Sinema is proving to be nearly impossible—and in this 50-50 Senate, that bodes poorly for success.

Income tax and legacy planning considerations

Considering that the likelihood of tax reform passing does not seem to be on the immediate horizon, family businesses are choosing to focus on new issues.

• Excess business losses
  The limitation on an excess business loss (EBL) was enacted by the 2017 Tax Act (P.L. 115-97, known as the Tax Cuts and Jobs Act, or TCJA). This provision means that an EBL is not allowed in the current year and is only permitted to be carried forward and treated as a net operating loss (NOL) in subsequent years. An EBL for the taxable year exists when a taxpayer’s aggregate trade or business deductions exceed the sum of the taxpayer’s aggregate trade or business gross income or gain that is attributable to such trades or businesses, plus a threshold amount, indexed annually for inflation. For tax year 2021, the threshold amount is $262,000, or 200% of that amount in the case of a joint return.
  
  Therefore, taxpayers owning pass-through entities that are generating a loss are questioning how the first year for which the limitation on EBLs applies may affect them and their owners.
• Pass-through entity tax
  In 2017, the TCJA limited the state and local tax (SALT) deduction for individuals to not more than $10,000 annually ($5,000 if married filing separately) for taxable years 2018 through 2025, after which the SALT cap deduction will be repealed unless Congress extends it. Thus, in response, certain jurisdictions have enacted, or are contemplating the enactment of, tax laws that impose taxes on the income of partnerships and S corporations (pass-through entities) that is otherwise taxable in the jurisdiction at the owner level based on the source of the income or the residency of one or more owners. These taxes are called “pass-through entity taxes” or “PETs” and are imposed at the election of the pass-through entity (and, in some cases, its owners). In most cases, the jurisdiction’s tax law provides a corresponding or offsetting owner-level tax benefit, such as a full or partial credit, deduction, or exclusion. Thus, through the pass-through entity, owners receive a deduction for federal purposes that would have been limited if the SALT been paid by the owner directly.
• Estate planning
  Concurrently with their income tax issues, family business owners should not lose sight of legacy planning for their family and the business. Family enterprises should work with their advisers to clearly define their goals, identify any that may require a lengthy realization period, and identify any tax planning considerations that may be subject to legislative change.
  

Tax planning moving forward

Whatever the driving motivations are for business enterprises, it is important to remember that the decisions at the entity level will affect all owners, both financially and personally. If future generations do not share a common vision for growth, then other succession planning discussions will be necessary. Whatever leaders decide to do as their business evolves, and whatever comes of any potential legislative or regulatory changes, the most pertinent considerations will bubble to the top of the planning agenda for both the partnership and its owners. Continued consultation with advisers to discuss how decisions made by the entity will affect all of those involved will be a key factor to navigate changes to come.