Small Business Taxes & Management^TM--Copyright 2013, A/N Group, Inc.

Energy Tax Extenders

Credit for Energy-Efficient Existing Homes. This credit, which expired at the end of 2011, has been extended for expenditures made through December 31, 2013. The credit applies to energy efficient windows, furnaces, and similar items for residential use.

Cellulosic Biofuel Producer Credit. This credit has been extended through December 31, 2013. Amendments have been made to the original law.

Biodiesel and Renewable Diesel. In addition to extending this provision to December 31, 2013, amendments have been made to the rules.

Energy from Renewable Resources. Credits for expenditures to produce energy from renewable resources have been extended through 2013 and amendments made to the law.

Energy Efficient New Homes. The credit for energy-efficient new homes has been extended through December 31, 2013.

Cellulosic Biofuel Plant Property. This credit has been extended through 2013 with amendments.

Other Provisions

There are a number of other provisions in the bill, many of which deal with healthcare and the new healthcare law. Here are selected provisions of particular interest:

Transfers from Retirement Plans to Roth Accounts. The law amends Section 402A to allow certain retirement plans to transfer funds to a participant's Roth account without the plan violating the provisions of Sections 401(k)(2)(B)(i), 403(b)(7)(A)(i), 403(b)(11) or 457(d)(1)(A) as a result of the transfer. The amendment is effective for transfers after December 31, 2012.

Extension of Emergency Unemployment Compensation Program.

Extension of Funding for Reemployment Services.

Medicare Physician Payment Update.

Payment for Outpatient Therapy Services.

1-Year Extension of Agricultural Programs.

Supplemental Agricultural Disaster Assistance.

Implications of the New Law--Individuals

In General. The bulk of the provisions are extensions of existing law, although some have minor changes. There's not a lot of planning for many of these provisions. For example, the law once again provides a benefit for those who ride a bicycle to work. While it could put some money in your pocket, it's unlikely you'll take up biking just to secure the benefit. Same is true about the renewal of the education credits. It may make it easier to send your son or daughter to college, but it's unlikely to be the deciding factor. On the other hand, there are some important points to consider in the new law. We've tried to mention the important ones below.

Net Investment Income Tax. This isn't a provision of the new law, but will affect many tax planning techniques, so a review here is important. The 3.8% tax applies to the net investment income of taxpayers with modified adjusted gross income above the threshold. The thresholds are:

Married, filing joint--$250,000
Single and head of household--$200,000
Surviving spouse--$200,000
Married, filing separate--$125,000

For example, Fred and Sue have adjusted gross income of $300,000 and taxable income of $275,000. For 2013 they're subject to the net investment income tax and they're in the 33% bracket for regular income tax. Their qualified dividends will be taxed at 18.8% (15% plus 3.8%). Their regular dividends (subject to full taxation) will be taxed at 36.8% (33% plus 3.8%).

Additional Medicare Tax. Again, not part of the new law, but a 0.9% additional tax applies to earned income (salaries, self-employment income) above a threshold amount beginning in 2013. While a medicare tax, it only applies to the individual and is paid on Form 1040 (though amounts are withheld from pay). (There is no employer portion.) The dollar amounts of the thresholds are the same as for the net investment income tax discussed, but apply to wages and self-employment income. This tax does not apply to investment, passive, etc. income. You could avoid the additional tax by reducing a salary you take from a corporation, but you must take a reasonable salary from your S corporation.

Tax Rates. For taxpayers below the new 39.6% bracket, there's no change in the rates or brackets. The 39.6% threshold starts at:

Married, filing joint--$450,000
Single--$400,000
Head of household--$425,000
Surviving spouse--$450,000
Married, filing separate--$225,000

There's another incentive to avoid the top bracket--that's where qualified dividends and long-term capital gains are taxed at 20%, rather than 15%.

The old approaches work here. If you can, put more money into retirement savings (assuming you'll be in a lower bracket), try to level your income by deferring or accelerating income or deductions to avoid the 39.6% bracket. Your options will depend heavily on how your personal finances and business interests are structured.

The best use of net operating losses either as a carryback or electing to only carry them forward, becomes more important because of the higher top rate of 39.6% and the potential for having dividends or other investment income subject to the net investment income tax. There's no rule of thumb here. The first step may be to think it through, then run the numbers.

Dividends. For taxpayers with taxable income below the threshold for the net investment income tax, (see table above) there's no change in the rules until your taxable income is high enough to put you in the 39.6% bracket. Qualified dividends are taxed at 0% or 15%, depending on your tax bracket. If you're subject to the net investment income tax both qualified and nonqualified dividends will be taxed at an additional 3.8%. For example, if, because of your tax bracket, your qualified dividends are taxed 15%, but you're above the threshold in the table above, the final tax rate on the dividends will be 18.8%. If you're in the top tax bracket, 39.6%, qualified dividends will be subject to the income tax of 20%. That's a result of the American Taxpayer Relief Act of 2012. To that 20% you'll have to add the net investment income tax of 3.8%, so the final tax will be 23.8%.

While dividends may be taxed at a higher rate because of the net investment income tax, so will other investment income. So there's generally no advantage to switching from stocks that yield qualified dividends to another investment that produces interest. Because both are saddled with the same net investment income tax, the relative advantages of qualified dividends (and long-term capital gains) remains the same. As always, investment considerations are important.

Capital Gains. The story for long-term capital gains is pretty much the same as for dividends. For taxpayers in the lower brackets, the 10% and 15% rate applies as before. For those in the 39.6% bracket, the rate on long-term capital gains is now 20%. And, as above, the 3.8% net investment income tax applies if you're above the AGI threshold. Thus, the top tax rate on capital gains is 23.8%. The relative advantage of long-term capital gains over short-term gains or ordinary income remains pretty much the same. Thus, if you're near the 12-month holding threshold, consider holding on to put you over the top.

The higher rates mean it's more important than ever to make use of unrealized capital losses. Using your capital losses to offset capital gains accomplishes two things. First, it reduces your gains and, as a result, your taxes. But it also reduces your AGI which could keep you below a threshold, possibly the one for net investment income. If your income fluctuates from year to year, you might want to time taking capital gains to a year when you won't be subject to the net investment income. As always, investment considerations are paramount.

Charitable contributions of capital gain property could deliver more benefits than in the past. Now, if you sell the property and then contribute the proceeds the tax on the gain could be higher than in the past and the benefits reduced. And selling the property will increase your AGI which could result in losing some or your deductions, exemptions, and subject you to the net investment income tax. Gains from installment sales are taxed based on the rules in effect when the payments are received, not when the deal was signed.

State and Local Sales Tax. Continues to be deductible. It's no longer an unpredictable item on Schedule A. If you tend to spend more than the tables allow or you expect big expenditures in a year, it makes sense to save your receipts and total them up at the end of the year.

Personal Exemption and Itemized Deduction Phaseout. They're back. The phaseouts for both start at AGI of:

Married joint; surviving spouses--$300,000
Heads of household--$275,000
Single--$250,000
Married, filing separate--$150,000

Discharge of Qualified Principal Residence Debt. Debt forgiveness generally results in income to the debtor. There several exceptions. The law extends through December 31, 2013 the exception for up to $2 million in debt incurred in acquiring or improving the principal residence of the taxpayer. The discharge of the debt must either be related to the financial condition of the taxpayer or a decline in the value of the property. The taxpayer's basis in the residence is reduced by the about of debt forgiven. If you qualify, this could be a major benefit that should be discussed with your tax and financial advisor. Since it could take some time to come to an agreement with your lender, you should start the process as soon as possible.

Estate Taxes. The good news here is that the $5/10 million exemption amount is now permanent. The tax rate has gone up to 40%, but most taxpayers will have little trouble staying below the exemption level. The basis step-up and unified estate and gift credit are also permanent.

But that doesn't mean you can ignore the estate tax, even if you're far below the exemption limit. A number of states still impose some sort of estate tax with exemption amounts as low as $1 million and, in some cases, with rates of 15%. On a $3 million taxable estate, the estate tax could be $450,000.

So while the concern is less, if the size of your estate approaches the federal threshold, you live or have property in a state where there's an estate or inheritance tax, you should talk to your tax advisor.

Implications of the New Law--Businesses

Bonus Depreciation Extended Through 2013. This is one of the biggest tax benefits in the bill. Bonus depreciation generally allows taxpayers to write off 50% of the cost, plus first-year depreciation, in the year the asset is placed in service. It also allows faster depreciation of autos and light trucks based on a more generous first-year writeoff. Only certain assets qualify and the asset must be purchased new. There was a question whether or not Congress would extend this benefit. Now scheduled to expire at the end of 2013, it may not be extended again.

Higher Sec. 179 Expensing. The new law extends the $500,000 limit on expensing and $2 million limit on the phaseout of the benefit for property placed in service through the end of 2013 (the provision retroactively applies to property placed in service in 2012 also). The fast writeoff can improve a taxpayer's cash flow and avoid depreciation hassles. (Remember, you still must keep records of the asset, however.) That can be particularly important in light of the new regulations tightening the rules on capitalization of asset purchases.

Qualified Leasehold Improvements, Restaurant Buildings, Retail Improvements. Leasehold improvements and building improvements generally must be depreciated over 39 years. Section 168 has provided a special 15-year straight-line depreciation for qualified leasehold improvements, restaurant property, and retail improvements. A number of rules apply for the property to meet the qualified definition, such as the lease has to be between unrelated parties. Qualified leasehold improvements also qualify for the 50%-bonus depreciation. Qualified leasehold improvement, restaurant, and retail improvement property up to $250,000 may qualify for Section 179 expensing. These provisions have been extended for property placed in before January 1, 2013. The benefits here are substantial and if you can qualify you should take advantage of them. It's not to late to start planning for such construction work. Check the rules carefully before proceeding.

Work Opportunity Tax Credit. The credit is equal to 40% of the first $6,000 of wages paid ($3,000 for summer youths) for newly hired employees who are a member of a targeted group. Targeted group members include food stamp recipients, qualified supplemental security income (SSI) recipient, long-term family assistance recipients, etc. The provision expired at the end of 2011, but has been retroactively extended for individuals who begin work after December 31, 2011 and before January 1, 2014. The credit of a maximum of $2,400 per employee directly reduces the business's taxes by that amount.

C vs. S Corporation. Some business owners might be considering switching to a C corporation with its top tax rate of 35% rather than doing business through an S corporation, LLC, etc. and be subject to a top rate of 39.6% on the passthrough income. You've got to look much deeper than the tax rates. With a passthrough entity (e.g., S corporation) you're only taxed once on the income. With a C corporation distributions would first be taxed at the corporate level and once again at the shareholder's level for an additional 15% or 20%, plus the 3.8% net investment income tax.

The double taxation could be even more significant on the sale of the business. There have been provisions in the law that provided for the exclusion of all or a portion of the gain, but they have been limited.

Another consideration, particularly for small businesses is the fact that any expenses the IRS disallows as personal will only result in increased income to the passthrough entity. If you're doing business as a C corporation and are audited, the personal expenses will be disallowed, increasing the income of the corporation and be taxed as constructive dividends to the shareholders. The same is true for unreasonable compensation of shareholder/officers.

You should also keep in mind that if you switch from an S to a C corporation you can't switch back to an S corporation for five years unless you receive permission from the IRS. If you incorporate an LLC or partnership there can be expenses and potential tax consequences.

On the other hand, it may make sense to set up a C corporation to operate a portion of the business. That's particularly true if the income from the separate business will be taxed at a lower rate and/or it's unlikely that the business will be sold but will be passed on to your heirs. This is tricky area and dependent on your type of business, the assets involved, etc. Talk to your tax advisor before taking any action.

Built-In Gains Tax. A C corporation that elects S corporation status can have a built-in gain that's subject to a separate tax. The tax is based on the increase in the value of an asset while it was owned by the C corporation. For example, Madison Inc., a C corporation, purchased land in 1990 for $10,000. In 2008 Madison elected S status when the land was worth $200,000. At the time of the conversion to S status, Madison had a $190,000 built-in gain that's subject to a separate tax if sold by the S corporation. This "taint" used to apply for 10 years. The new law extends a relaxed version of the provision that limits the taint to 5 years, but only for 2012 and 2013. If Madison waits 5 years it escapes this "double tax". Taxpayers in such situations may wait to take advantage of this provision. Again, talk to your tax advisor.

--Last Update 01/16/13