The economic downturn has resulted in a significant decrease in profits for many businesses. This sudden financial strain has made it increasingly difficult for businesses to deduct interest expenses due to the limitations imposed by Section 163(j) of the Internal Revenue Code. In this challenging environment, businesses must explore strategic measures to optimize their tax positions and maintain financial stability. One such measure is adopting an accounting method change to capitalize interest expenditures into inventory costs. This approach can effectively convert interest expenses, which are subject to Section 163(j) limitations, into costs of goods sold (COGS), which are not subject to these limitations.

Section 163(j) limits the deduction of business interest expenses to the sum of business interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest. Due to the economic downturn, many businesses are experiencing lower ATI, which in turn reduces the allowable interest deduction. Consequently, a significant portion of interest expenses may become disallowed, further exacerbating financial challenges.

Capitalizing interest expenditures involves adding the interest costs incurred during the production of inventory to the cost basis of that inventory. This process aligns with the Uniform Capitalization (UNICAP) rules under Section 263A of the Internal Revenue Code, read in combination with Sections 263(a) and 266. By capitalizing interest costs, businesses can transform interest expenses subject to Section 163(j) limitations into COGS, which are deductible when the inventory is sold and are not subject to the same limitations.

Capitalized interest is not considered interest for Section 163(j) purposes and thus avoids disallowance. This enables businesses to fully utilize their interest expenses as part of COGS. Aligning interest costs with the period in which inventory is sold can smooth taxable income, potentially lowering tax liabilities during periods of reduced profitability. Furthermore, capitalizing interest can help increase the foreign-derived intangible income (FDII) deduction.

Businesses should evaluate their eligibility to capitalize interest under Section 263A. Conducting financial modeling to assess the impact of capitalizing interest on taxable income and overall tax position is essential. Consulting with tax advisors to understand the regulatory requirements and implications of changing the accounting method is crucial. The formal change can be implemented by filing Form 3115 (Application for Change in Accounting Method) with the IRS and obtaining their approval.

In the face of an economic downturn, businesses must proactively explore strategies to navigate the challenges posed by Section 163(j) limitations. Capitalizing interest expenditures into inventory costs offers a viable solution to convert interest expenses subject to disallowance into deductible COGS. By adopting this accounting method change, businesses can optimize their tax positions and improve cash flow. Given the complexities involved, it is crucial to conduct thorough financial modeling and consult with tax advisors to ensure a smooth and compliant transition. Businesses interested in exploring this strategy should consult with their tax advisors.

The U.S. Treasury Department on May 11, 2024, released the “Green Book,” which is the Treasury’s “General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals.” This 256-page document details the tax proposals in the Biden Administration’s FY 2025 budget, also released and transmitted to Congress.

These proposals, as explained in the Green Book, aim to increase and reform corporate taxation and raise individual taxes to “reduce the deficit by cracking down on fraud, cutting wasteful spending, and making the wealthy and corporations pay their fair share.” Here are some key proposals included in the Green Book:

• Increase the corporate rate to 28% from the current 21%
• Increase the CAMT rate to 21% from the current 15%
• Increase the global intangible low-taxed income (GILTI) rate to 21% from the current 10.5%
• Repeal the foreign-derived intangible income (FDII) deduction, which was enacted by Trump to provide a tax break for businesses in export and effectively reduced the corporate tax rate to 13.125% for qualifying taxpayers
• Quadruple the stock buyback tax from the current 1%
• Deny the deduction for all compensation over $1 million for all C corporations
• Eliminate tax-free treatment of like-kind exchanges
• Strengthen the limitation on losses for noncorporate taxpayers
• Increase the top individual income tax rate from the current 37% to 39.6%
• Increase the Medicare rate and net investment income tax rate to 5% from the current 3.8%
• Apply the net investment income tax to pass-through business income
• Impose a 25% minimum tax on those with wealth exceeding $100 million
• Tax capital gains at ordinary rates for households with over $1 million in earnings
• Tax unrealized gains at death

The Biden administration proposes these tax hikes to control the current inflation crisis and promote “equality” and “equity.” In theory, raising taxes can potentially ease inflation and reallocate wealth to those in need, but it can also slow down the economy, resulting in higher unemployment and reduced economic growth, and decrease everyday people’s buying power—a situation known as “stagflation.”

We expect strong pushback from Republicans on the proposal, and it is likely that the proposal will face significant challenges in Congress. Therefore, enactment of these proposals is unlikely. However, taxpayers should keep an eye on developments.

임금의 일부를 스톡 옵션으로 지급 받는 개인들은 소득세가 없는 주로 이주할 경우의 관련 세금 영향을 고민한다. 이는 캘리포니아 주민에게 특히 중요한데, 이 뉴스레터는 캘리포니아 주민이 다른 주로 이주하였을 때 스톡 옵션에 대한 소득세를 피할 수 있는지에 대해 탐구한다.

핵심은 캘리포니아 주민이었을 때 받은 스톡 옵션을 소득세가 없는 주로 이주한 후 행사하였을 때에 소득세 회피 가능 여부이다.

캘리포니아 세무 규정은 거주자에겐 전 세계 소득에 대해 과세하는 반면 비거주자에겐 캘리포니아에서 발생한 소득에만 과세를 한다. 스톡 옵션에 경우, 캘리포니아는 스톡 옵션을 얻기 위한 서비스 또는 노동을 행한 장소를 기준으로 소득을 배분하는 “source rule”을 사용한다.

Gene and Joann Clark 의 항소 사례(2001-SBE-006)에서 the California State Board of Equalization (이하 캘리포니아 주세위원회) 는 조세를 위한 스톡 옵션 소득 분배를 다루었다. Gene Clark 은 캘리포니아에서 고용 되었을 때 스톡 옵션을 받았고, 다른 주로 이주한 후 해당 옵션을 행사하였다.

위원회는 스톡 옵션의 귀속 기간 동안 캘리포니아에서 근무한 시간의 비율에 따라 관련 소득을 과세키로 결정하였다. 판결은 구체적으로 스톡 옵션 부여일부터 귀속 또는 행사일까지의 기간 중 근무한 시간을 기준으로 소득이 배분되어야 함을 확정하였다. 이는 캘리포니아에서 근무한 시간에 해당하는 스톡 옵션 소득에 대해서만 과세함을 의미한다.

캘리포니아 주민이었을 때 받은 스톡 옵션은 해당 주에서 행한 서비스에 대한 보상으로 간주한다. 즉, 소득세가 없는 주로 이주하여 캘리포니아 비거주자로 변경이 되더라도 해당 스톡 옵션 행사에 대한 소득은 캘리포니아 소득세에 대상이 되며, 이는 부여일부터 귀속 또는 행사일까지의 기간 중 캘리포니아에서 근무한 시간의 비율을 기준으로 계산된다.

소득세가 없는 주로 이주하는 것은 캘리포니아 주민이었을 때 부여받은 스톡 옵션에 대한 캘리포니아 소득세를 면제시키지 못한다. 캘리포니아는 주에서 행한 서비스에 따라 소득을 과세한다. 핵심 결정 요인은 행사 시점의 거주지가 아닌 소득의 출처지이다.

Many individuals who receive stock options as part of their compensation package ponder the tax implications if they relocate to a state with no income tax. This issue is particularly relevant for those who were California residents when they received their stock options. This newsletter explores whether moving out of California can help you avoid California income tax on these stock options.

The core question is: Can a former California resident avoid California state income tax on stock options received while a resident but exercised after moving to a state with no income tax? 

California's tax regulations stipulate that residents are taxed on worldwide income, while non-residents are taxed on income derived from California sources. For stock options, California uses a source rule, which allocates income based on where the services that earned the options were performed.

In the case of the Appeal of Gene and Joann Clark (2001-SBE-006), the California State Board of Equalization addressed the issue of how to apportion income from stock options for tax purposes. Gene Clark received stock options while he was employed in California. He later exercised these options after moving out of state.

The Board determined that the income from the stock options was subject to California tax based on the proportion of time Clark had worked in California during the vesting period of the options. Specifically, the ruling confirmed that the income should be apportioned according to the period of service performed in California relative to the total period from the grant date to the vesting or exercise date. This meant that only the portion of the stock option income attributable to the time he worked in California would be subject to California income tax.

If you received stock options while a resident of California, these options are considered compensation for services rendered during your employment in the state. Upon moving to a no-income-tax state, you change your residency status to non-resident. However, the income from exercising these stock options will still be subject to California tax based on the proportion of time you were employed in California relative to the total time from the grant date to the vesting or exercise date.

Relocating to a no-income-tax state does not exempt you from California income tax on stock options received while you were a California resident. California will tax the portion of the stock option income that corresponds to services performed in the state. The key determinant is the source of the income, not your residency at the time of exercise.