Dissecting the Tax Act: How changes made in the American Taxpayer Relief Act could play out for business owners
Taxpayers, investors and the stock market anxiously awaited the changes promised in the American Taxpayer Relief Act of 2012 (the Act) only to find that most passed provisions in the Act generally create more questions and concerns for the 2013 tax year and beyond.
To help unravel the changes made to the current tax laws that impact business owners, Smart Business spoke with Cathy Goldsticker and Robin Bell, tax partners at Brown Smith Wallace LLC. They outlined the Act’s relevant changes and the ways business owners can take advantage of many of its provisions and identify areas for tax planning opportunities.
What Effect Did the Extension of Many Tax Provisions Have on Business Tax?
One key business provision is the ‘Section 179’ expensing election for first year tax write-offs of furniture and equipment, which has been retroactively increased to what it had been in 2011. For 2012, there is a $500,000 immediate write-off available on up to a $2 million investment in equipment and furniture. Without this change, it would have been $139,000.
This means, if you bought more than $2 million in qualifying business assets, you would lose the ability to write off the $500,000 in year one. Conversely, if you bought qualifying assets in 2012 that totaled less than $2 million, you can write off $500,000 in 2012 immediately and depreciate the remaining purchase price over the prescribed IRS life.
The change ultimately results in added choices for business owners because, for some businesses, writing off $500,000 in 2012 is not such a good idea. For an S Corp. or a partnership, for example, it may be better to take the write-off over several years because the rates for higher-income individuals, which will be a marginal rate of 39.6 percent instead of 35 percent, makes waiting generally the better option. However, if you have a high income this year, but next year, you anticipate it will be lower, it might make more sense to take it in 2012.
On the other side, since the tax rates of C Corps. remain at 35 percent and it’s unclear whether rates will change, it would probably behoove that type of company to take the immediate expensing.
Additionally, the 50 percent bonus depreciation for the purchase of new business assets was retroactively reinstated to the beginning of 2012. But faster depreciation might not be the best choice if you expect a bigger benefit from a future deduction, similar to the Section 179 consideration. Also, the research and development credit was made retroactively available for 2012.
Were Any Permanent Tax Law Changes Made?
The one permanent tax law change that receives attention year after year relates to the alternative minimum tax and is referred to as ‘the AMT patch.’ It’s mostly applicable to middle-income and lower earners and has become permanent at $78,750 (married amount), with annual inflation adjustments. AMT affects business owners because many operate as S Corps. and partnerships, which means the tax is paid by the owner(s), not the business.
Another permanent tax law change is the estate and gift tax exclusion that’s now $5.12 million. It was widely believed that after 2012, the exclusion would decrease significantly by reverting back to the pre-2001 tax law amount. When it was believed it would expire, many undertook gifting and other estate planning measures before the end of 2012. Freezing it at the higher level enables many more people to take advantage of this provision.
What Are the Tax Benefits For C Corps That Elect To Become S Corps?
There was a reduction in the S Corp. recognition period for built-in gains tax. If you’re currently a C Corp., you can make an election to be treated as an S Corp. for income tax purposes. When you make the election, you may have a double tax (built in gain tax) on certain asset dispositions during a 10-year period. Historically, the rule has been that from the day of conversion for 10 years, certain assets sold had additional income tax due on the difference between your basis in them at that time and their fair-market value. The 10-year period became five years for 2011 and that will continue for 2012 and 2013 under the Act. This provision is making it easier to avoid double taxation on certain assets or selling your business, but it’s also accelerating some collection by the IRS because in the first year there may be revenue to collect on certain transactions.
There are many reasons to change from a C Corp. to an S Corp., but the driver of avoiding double taxation could be part of a sound tax strategy. The Tax Act has raised the individual tax bracket up to 39.6 percent for higher-income taxpayers, so it’s possible a C Corp. structure, which utilizes a 35 percent maximum tax rate, is better.
How Were Individual Tax Laws Affected?
Although tax rates for lower-income taxpayers remain the same, higher income ($450,000 or higher) will now have a marginal tax rate of 39.6 percent (married taxpayers). Also, the capital gains and dividends tax rate is now 20 percent for higherincome taxpayers instead of 15 percent. These are just the basic income tax rates stemming from the 2012 Tax Act, but there is also a 3.8 percent Medicare tax coming with the implementation of health care reform on much of the same income. Another Tax Act provision reduces the tax benefits of personal exemptions and itemized deductions. Individual taxpayers are going to lose some itemized deductions and some or all of their personal exemption deductions as their income grows (phase-outs). This was the case when the Bush tax laws were in effect a few years back and didn’t get changed, modified or removed with the 2012 Tax Act. For the 2010 and 2011 tax years, these itemized deductions and personal exemption phase-outs disappeared. Because Congress didn’t do anything permanent to change the law, the phase-outs are in effect again, so the tax benefits for these two items are reduced.
What Changes Were Made to Estate and Gift Taxes?
The tax rate increased from 35 percent to 40 percent on taxable estates or deceased individuals with assets in excess of $5.12 million, indexed for inflation.
If you haven’t given away roughly $5 million from your estate in 2012, you have another chance because the larger exclusion remains in the law.
Another important aspect of the estate and gift tax is the portability feature of the exclusion. Historically, one person was entitled to an exclusion when they died. The Act made permanent a provision that allows one spouse to pass their unused estate exemption to their living spouse, doubling the amount the surviving spouse can gift during their lifetime without incurring a tax.
There are effects on this portability provision should the surviving spouse remarry, so make sure tax advice is obtained.
Which Energy Credits and Provisions Were Extended?
Many credits for energy-efficient home improvements, appliances, new construction, two- and three-wheeled plug-in electric vehicles and alternative fuel sources were extended. However, while the credits have been preserved, there are still limitations on the applicability and amounts of the credits.
From a general perspective, the energy incentives should be here to stay and more should be in the pipeline. Those who are interested in understanding them should do a careful cost/benefit analysis on your purchase or construction.
That’s not to minimize the environmental impact of these purchases, but sometimes it is very expensive to try to be energy-efficient. And sometimes, the benefit from the credit perspective side does not offset the cost of trying to be green.
Ultimately, if you’re inclined to be green, that’s wonderful, but proceed with caution because the tax benefit may not outweigh the costs.●
CATHY GOLDSTICKER, CPA
Partner, Tax Services
ROBIN BELL, CPA
Partner, Tax Services
For more information regarding the American Taxpayer Relief Act, visit www.bswllc.com/fiscal-cliff-averted.
Insights Accounting is brought to you by Brown Smith Wallace LLC
© 2013 Smart Business Network Inc. Reprinted from the February 2013 issue of Smart Business St. Louis.