PLANNING FOR BUSINESSES [Part 5/7]
Businesses seeking to maximize tax benefits through 2013 year-end tax planning may want to consider two general strategies:
- Use of traditional timing techniques for income and deductions; and
- Special consideration of significant tax incentives (known as tax extenders) scheduled to expire at the end of 2013.
Business incentives scheduled to end with 2013 include bonus depreciation, enhanced Code Sec. 179 expensing, the Work Opportunity Tax Credit, and many other business-friendly provisions. Although Congress has routinely renewed these tax extenders in the past, current politics over budget concerns, and the impression that the economy may no longer need extraordinary stimulus measures, may point to 2013 year-end as the last occasion for businesses to take advantage of one or more of these special benefits.
Ultimately, the fate of many of the tax extenders may be decided when Congress takes up comprehensive tax reform. However, as partisan politics continue in Washington, prospects steadily diminish for a “grand bargain” in which the extenders would carry a January 1, 2014 effective date.
New for business owners:
Businesses should also be aware of those tax rules that are new-for-2013. In particular, increased tax rates on higher-income individuals effective for 2013 may impact business strategies directed toward minimizing taxes for business owners with either pass-through or dividend income. Also important for year-end 2013, are tax strategies in connection with recently-issued final “repair” regulations.
Code Section 179 Expensing
An enhanced Code Sec. 179 expense deduction is available through 2013 to taxpayers (other than estates, trusts or certain noncorporate lessors) that elect to treat the cost of qualifying property (Code Sec. 179 property) as an expense rather than a capital expenditure. The annual dollar limitation on Code Sec. 179 expensing for tax years beginning in 2012 and 2013, as increased by ATRA, is $500,000. Similarly, for tax years beginning in 2012 and 2013, an annual $2 million overall investment limitation applies before the maximum $500,000 deduction must be reduced, dollar-for-dollar, for amounts above that $2 million amount.
The Code Sec. 179 deduction phases out completely in a tax year beginning in 2013 if the taxpayer places more than $2.5 million of Code Sec. 179 property in service. In contrast, for tax years beginning after 2013, that dollar limit is scheduled to plummet under current law to $25,000 unless otherwise extended by Congress. The phase-out ceiling is also scheduled to drop to $200,000 in 2014 unless otherwise extended by Congress. As a result, purchases of otherwise qualifying property in excess of only $225,000 in 2014 will reduce the Code Sec. 179 deduction to $0.
A business could maximize its benefits under Code Sec. 179 by expensing property that does not qualify for bonus depreciation (such as used property) and property with a long modified accelerated cost recovery system (MACRS) depreciation period. For example, given the choice between expensing an item of MACRS five-year property and an item of MACRS 15-year property, the 15-year property should generally be expensed since it takes 10 additional tax years to recover its cost through annual depreciation deductions as opposed to recovery of the cost of the five-year property.
The Code Sec. 179 deduction is also limited to the taxpayer’s taxable income derived from the active conduct of any trade or business during the tax year, computed without taking into account any Code Sec. 179 deduction, deduction for selfemployment taxes, net operating loss carryback or carryover, or deductions suspended under any provision. Any amount disallowed by this limitation may be carried forward and deducted in subsequent tax years, subject to the maximum dollar and investment limitations, or, if lower, the taxable income limitation in effect for the carryover year.
Since the maximum dollar limit for 2014 is scheduled to fall to $25,000 (unless the $500,000 amount is extended to at least the same degree by Congress), business should not assume that a carryover will be fully absorbed immediately in 2014. Monitoring 2013 taxable income in 2013 for this purpose therefore is important within an overall Code Sec. 179 strategy.
Code Sec. 179 property is generally defined as new or used depreciable tangible Code Sec. 1245 property that is purchased for use in the active conduct of a trade or business. Off-the-shelf computer software is also included for 2013 in the definition of qualifying property as is some real property (discussed below).
Under current law, off-the-shelf computer software and certain real property will not qualify for Code Sec. 179 expensing after 2013, even at the lower $25,000 ceiling. This makes year-end strategies that take advantage of them in 2013 particularly critical.
Qualified real property:
The Code Sec. 179 expensing allowance for qualified real property, is scheduled to expire for property placed in service after 2013. Qualified real property for expensing purposes includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
Code Sec. 179 expensing versus bonus depreciation:
Unlike Code Sec. 179 expensing, there is no dollar cap on the amount of bonus depreciation that a business may claim (Bonus depreciation is discussed below). Additionally, Code Sec. 179 property encompasses used property, while bonus depreciation is limited to first-use by the taxpayer.
Bonus depreciation is keyed to a calendar year and generally ends after December 31, 2013. Rules for 2013 Code Sec. 179 expensing, on the other hand, apply for tax years beginning in 2013.
ATRA generally allows for 50 percent bonus depreciation during 2012 and 2013. After 2013, bonus depreciation is scheduled to expire (except for certain noncommercial aircraft and longer production period property which may be eligible for 50 percent bonus depreciation through 2014).
Qualified property for bonus depreciation purposes must be depreciable under the Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. These requirements encompass a wide variety of assets. The property must be new and placed in service (as well as acquired) before January 1, 2014 (placed in service before January 1, 2015 for certain noncommercial aircraft and longer production period property).
Unlike regular depreciation, under which half or quarter year conventions may be required, a taxpayer is entitled to the full, 50-percent bonus depreciation irrespective of when during the year the asset is purchased. Year-end placed-in-service strategies therefore can provide an almost immediate “cash discount” for qualifying purchases, even when factoring in the cost of business loans to finance a portion of those purchases.
Although a bonus-depreciation election should be factored into a year-end strategy, a final decision on making it is not required until a return is filed. Further, bonus depreciation is not mandatory. Certain taxpayers should consider electing out of bonus depreciation to spread depreciation deductions more evenly over future years.
Bonus depreciation’s placed-in-service deadline for certain noncommercial aircraft and property with a longer production period was extended by ATRA for an additional year, but its acquisition date remains at before January 1, 2014, as under the general rule. Property acquired pursuant to a written binding contract entered into before January 1, 2014, is deemed acquired before January 1, 2014.
Luxury car depreciation caps:
Along with the sunset of bonus depreciation, the additional $8,000 first-year depreciation cap for passenger automobiles under Code Sec. 280F to account for bonus depreciation is scheduled to expire after 2013.
The scheduled sunsetting of the additional $8,000 first-year depreciation amount may give businesses an additional incentive to purchase (and place into service) a vehicle before year-end 2013. The additional $8,000 amount could be extended by Congress as in the past but there is no guarantee that it will do so again.
Final Repair/Capitalization Regulations
In September 2013, the IRS released much-anticipated final “repair” regulations that explain when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing and replacing tangible property. The final regulations make many significant taxpayer-friendly changes to temporary regulations issued in 2011. The final regulations are considered to challenge virtually every business because of their broad application.
The final regulations apply to tax years beginning on or after January 1, 2014, but provide taxpayers with the option to apply either the final or temporary regulations to tax years beginning after 2011 and before 2014. The IRS has promised critical “transition guidance” later this year to help taxpayers deal with implementation regarding how to apply the regulations for years prior to 2014 as well as what change-of-accounting procedures should be followed.
As a result of the final regulation’s optional retroactive effective date, some taxpayers may be better off putting certain procedures into place before the start of 2014 to maximize benefits; other taxpayers may consider filing amended returns for 2012 and 2013 to take advantage of certain elections provided in the final regulations. Under all circumstances, taxpayers must use only permissible procedures in their tax years beginning in 2014. Because of all these immediate options and requirements, taxpayers should work on integrating a response to the final regulations as part of their 2013 year-end planning, and have a definite plan in place before mandatory rules become effective on January 1, 2014.
De minimis expensing alternative:
The final regulations also include a new de minimis expensing rule that allows taxpayers to deduct certain amounts paid or incurred to acquire or produce a unit of tangible property. If the taxpayer has an Applicable Financial Statement (AFS), written accounting procedures for expensing amounts paid or incurred for such property under certain dollar amounts, and treats such amounts as expenses on its AFS in accordance with its written accounting procedures, the final regulations allow up to $5,000 to be deducted per invoice.
To take advantage of the $5,000 de minimis rule, taxpayers must have written book policies in place at the start of the tax year that specify a per-item dollar amount (up to $5,000) that will be expensed for financial accounting purposes. Calendar-year taxpayers, therefore, should have a policy in place by year-end 2013 to qualify for 2014.
For smaller businesses, the final regulations added a safe harbor for taxpayers without an AFS. The per-item or invoice threshold amount in that case is $500.
JDKatz, P.C. is a full-service law firm focused on tax law, business and transactional law, estate planning and elder law. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys, or visit http://www.jdkatz.com.