Arizona PROP 208 – Big Tax Increase Possible in Arizona

On the ballot in Arizona this November is Proposition 208 (the “Proposition”). Proponents assert it will benefit students in public schools. Critics warn it sends most of the increased income tax revenue it generates into the school bureaucracy, not to teachers, as it implies, and will dissuade some businesses and taxpayers from moving to or staying in Arizona. Regardless, some polls indicate at the moment proponents of the measure have the upper hand. For reasons discussed below, there may be greater tax savings to have more Arizona businesses taxed as corporations if this initiative is passed.

Section 5 of the Proposition provides for an income tax surcharge of 3.5% on individual taxpayer. The surcharge is on top of the existing 4.5% income tax and applies to taxable income of married taxpayers above $500,000, and to single and married filing separate individuals above $250,000.

If passed, the maximum income tax rate in Arizona will rise from a middling 4.5% to 8.0%, the eleventh highest state income tax in the country, and the highest in the western continental region, excluding California.

If passed, it will be effective for tax years beginning in 2021, and then the days of Arizona’s reputation as a relatively low state may be over, with some ramifications. There would no longer be as much incentive for higher income individuals to flee to Arizona solely for income tax benefits.

For tax professionals, it is interesting that the language of the Proposition creates a separate statutory income tax section to implement the surcharge. However, the estate and trust income tax rates refer only to the regular tax rate statute, which highest rate is 4.5%, and makes no reference to the new surcharge section. So it appears that the top Arizona estate and trust income tax rate would not change. The corporate tax rates are also not affected. Taxation of flow through entities, such as limited liability companies – not electing to be taxed as corporations, will have their income taxed to their owners, who, if individuals, would be subject to the surcharge rules.

Since the Tax Cuts and Jobs Act enacted in 2017, corporations now enjoy a relatively low federal income tax rate of 21% (reduced from 35% under prior law). Arizona corporations will not be subject to the 3.5% Arizona income tax surcharge. So the rate benefit (and tax savings) for Arizona “C” corporations could now be as high as 17.5% for certain businesses.

Please contact Les Raatz in our Phoenix office (602-285-5022) or any of the other tax attorneys at Dickinson Wright if you wish to further explore this important ballot initiative and plan accordingly.

PE Funds Are Not Part of Controlled Group; What About Your Company?

Earlier this month, the U.S. Supreme Court denied a request to review the First Circuit Court of Appeals decision in the Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund case, thereby confirming the Appeals Court’s decision that the two separate Sun Capital private equity funds were not under common control with a portfolio company and therefore were not a controlled group as defined in Code Section 414.  As a result of the decision, neither fund is liable to the multiemployer pension fund for $4.5 million of withdrawal liability owed by Scott Brass Inc.

While this decision is good news for private equity funds that follow a structure similar to that used by the Sun Capital Partners funds, it is a reminder of the high stakes involved when companies are found to be part of a controlled group.  At its heart, the controlled group rule requires that all employees of the controlled group members be treated as if they were employed by one employer when:

  • determining if members of the controlled group can offer separate 401(k) plans to their employees. Each such plan must pass the Code Section 410(b) coverage rules and the Code Section 401(a)(4) non-discrimination rules on a controlled group basis.
  • determining if a member is a large employer for purposes of the Affordable Care Act. Employees of non-US members do not count for ACA purposes.
  • determining if a member has 20 or more employees on a typical business day during the preceding calendar year and therefore must offer COBRA continuation coverage to terminated employees. Employees of non-US members count for COBRA purposes.
  • determining whether one member may make employer contributions to the Health Savings Accounts of its employees if other members do not make similar contributions.

A previous tax blog provides an overview of the ownership rules that can cause one legal entity to be part of a controlled group with another entity.  Companies that may be part of a controlled group should talk to experienced benefits counsel about these rules.

About the Author

Deborah L. Grace is a Member in Dickinson Wright’s Troy office where she advises HR professionals, CFOs, and private equity firms on all matters relating to employee benefits law, including designing and administering 401(k) retirement plans and welfare benefit plans.  Deb can be reached at 248-433-7217 or and you can visit her bio here.

Graduated GRATs

One traditional estate planning technique that has become increasingly popular in recent months is the Grantor Retained Annuity Trust (GRAT). Simply stated, a GRAT is an irrevocable trust where the grantor contributes property to the GRAT and retains the right to receive a percentage of the assets back over a designated period of years; any property remaining in the GRAT at the end of the designated term passes to the remainder beneficiaries of the GRAT. The percentage selected is often tied to actuarial calculations to approximately equal the value of the grantor’s original contribution to the GRAT. For gift tax purposes, the actuarial value received back is deducted from the value of the property originally contributed to the GRAT, often resulting in a nominal taxable gift to the remainder beneficiaries. This can be an effective transfer tax technique for a donor who has already used his or her lifetime gift tax exemption amount.

Where the remainder interest gift is “zeroed out”, the value transferred to the remainder beneficiaries is essentially the appreciation in the value of the property contributed to the GRAT during the GRAT term. Often, the payments back to the grantor are structured as level percentage payments over the GRAT term. However, IRS regulations permit the annuity percentages to be graduated, increasing by as much as 20% each year over the course of the GRAT term. This means that the percentage of the original contribution paid back to the donor in early years can be substantially lower, thereby allowing the assets remaining in the GRAT to more fully appreciate before the larger percentage payments are made in later years. This graduated GRAT structure can be particularly effective for an entity where exponential growth is expected and/or a liquidity event is anticipated since the percentage payments back to the donor are based on the initial value contributed to the GRAT (rather than the appreciating value over the course of the GRAT term). A graduated GRAT can also be an efficient transfer tax technique for an income-producing asset, where the income produced can be used to pay some or all of the annuity back to the grantor.

If you would like to discuss potential benefits of a graduated GRAT, please contact Jeff Gehring in the Lexington, Kentucky office (859-899-8713) or one of the estate planners in our other offices.

IRS Announces No Information Returns to be Filed for PPP Loan Forgiveness

Under the Paycheck Protection Program (“PPP”) established by the CARES Act, a borrower is eligible for forgiveness of all or a portion of the principal amount of a loan made in accordance with the PPP if certain conditions are satisfied (“qualifying forgiveness”). While the Internal Revenue Code generally requires a borrower to include the amount of any loan forgiveness in gross income, the amount of any such “qualifying forgiveness” is excluded from gross income pursuant to the provisions of the PPP.

Typically, a lender that discharges at least $600 of indebtedness of a borrower is required to file a Form 1099-C (Cancellation of Debt) with the IRS as well as furnish a payee statement to a borrower whose loan has been discharged.

However, the IRS recently announced that lenders should not file a Form 1099-C (Cancellation of Debt) nor furnish a payee statement to the borrower to report the amount of any “qualifying forgiveness” with respect to a loan made under the PPP (see Announcement 2020-12, 2020-41 IRB). The IRS was concerned that the filing of such information returns could result in the inadvertent issuance of IRS notices for underreporting to borrowers for amounts of “qualifying forgiveness”, and that the furnishing of such payee statements to a borrower “could cause confusion” (presumably in connection with whether such amounts should be included in the borrower’s gross income).

For more information, please contact Troy Terakedis in our Columbus, Ohio office at 614-619-2203 or any other attorney in our Tax Practice Group.