By Rollin J. Groseclose, JPS Shareholder
Year-end planning is often challenging, and 2013 will prove to be no exception, because there are higher top income tax rates for ordinary income, capital gains and dividends; there is uncertainty surrounding the extension of dozens of individual and business tax provisions set to expire at December 31; and there are two new taxes facing higher-income individuals: a 0.9% payroll tax on wages and self-employment income and a complicated 3.8% surtax on net investment income.
Coupled with other provisions of the Patient Protection and Affordable Care Act of 2010 (Affordable Care Act) taking effect, changes made to North Carolina tax laws and the prospect of comprehensive tax reform being batted around in Congress, year-end planning may require considerably more thought and time this year.
This article focuses on tax planning for businesses. Keep in mind that most closely-held businesses are pass-through entities (S corporations or partnerships), where items of income and expense flow through to the owners’ personal tax returns, along with the associated tax implications.
Aside from the traditional timing techniques used to defer income or accelerate expenses, following are a number of items that businesses may want to consider.
We’ve gotten rather accustomed to this form of accelerated depreciation, where a percentage of the underlying cost of an asset can be written off in the first year it is placed in service, with any balance eligible for regular depreciation, creating a considerable deduction in Year 1. For 2013, 50% of the cost of most new machinery, equipment and software is eligible for this one-time expense. In addition, qualified leasehold improvements, restaurant property and retail improvements qualify. There is no cap on the amount of the investment in these assets or the resulting tax benefit.
This bonus deduction generally won’t be available next year unless Congress acts to extend it. Thus, businesses planning to purchase new depreciable property in the near future should consider the merits of accelerating their purchasing plans. Recall that the asset must be new, meaning it has not previously been used by any other taxpayer or business.
Note that many states, including North Carolina, do not allow the full benefit of bonus depreciation, requiring an adjustment to minimize the immediate state benefit. This adjustment is reversed over time, eventually allowing the same depreciation as for Federal purposes.
SECTION 179 EXPENSE
The Section 179 expense has been in existence for many years, but only in the past few years has it been as high as it is now. Businesses should consider making expenditures that qualify for this additional one-time expensing option. For tax years beginning in 2013, qualifying investments of up to $2 million are eligible for expensing of up to $500,000. Once the $2 million cap is exceeded, the expensing limit is reduced dollar for dollar, fully eliminating it at $2.5 million.
Generally qualifying assets are limited to personal property such as equipment, computers and furnishings, although certain software and qualified real property also qualify. Unlike bonus depreciation, these assets do not have to be new.
Unless Congress changes the rules, for tax years beginning in 2014, the expense limit will drop to
$25,000, with the associated investment limit dropping to $200,000. In addition, expensing won’t be available for qualified real property. The generous dollar ceilings that apply this year mean that many small and medium-sized businesses that make timely purchases will be able to currently deduct most, if not all, their outlays for qualifying assets. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.
Note that as with bonus depreciation, North Carolina and many other states limit the first year benefit provided with the Federal deduction, forcing taxpayers to instead spread the benefit over several years.
RESEARCH AND DEVELOPMENT (R&D) CREDITS
Businesses may wish to make qualified research expenses before the end of 2013 to claim both Federal and state tax credits. Currently the Federal credit is set to expire at the end of 2013 unless Congress extends it as it has in years past. North Carolina recently extended their version of the credit through 2015.
There are common misconceptions about what activities and expenditures qualify for the R&D credits, resulting in many businesses not taking advantage of them. It’s worth taking a look to see if funds already expended during the year may qualify, which can considerably reduce current year and possibly prior year tax outlays.
OTHER OPPORTUNITIES AND CONSIDERATIONS
Following are a variety of additional opportunities and changes for businesses to consider:
- Consider investing in qualified leasehold improvements, qualified restaurant buildings and
improvements and qualified retail improvements. The American Taxpayer Relief Act of 2012 (ATRA) extended the ability to write these items off over 15 years, whereas normally they would be written off over 39 years.
- The Internal Revenue Service recently finalized repair and capitalization regulations, which could necessitate businesses solidifying or changing their internal policies by December 31 in order to maximize tax benefits.
- North Carolina corporate income tax rates are set to drop from 6.9% to 6.0% in 2014 and drop to
5.0% effective January 1, 2015. Corporations subject to North Carolina income with the ability to defer income beyond 2013 may wish to consider this to reduce their state tax.
- Restaurants and other establishments with food inventory will continue to receive an enhanced deduction for charitable donations of food made through December 31, 2013. Beginning in 2014, the enhance deduction is eliminated.
- Some long-standing North Carolina tax credits are set to expire at the end of 2013. These include Article 3J credits such as investing in real estate, investing in machinery and equipment and creating jobs. Businesses that can increase qualifying expenditures or activity in 2013 to qualify will have the ability to carry forward installments of these credits to benefit future years.
- Businesses may wish to secure or increase a work opportunity tax credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2013. Under current law, the WOTC won’t be available for workers hired after this year.
- Investments in qualified small business stock made before January 1, 2014 may qualify for 100% exclusion of any future gains realized on the sale of that stock.
- For business owners with an interest in a partnership (often organized as an LLC) or S corporation, ensure you have adequate basis in the entity to deduct any anticipated loss that will pass through to you.