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Over the Fiscal Cliff for Tax Savings
| Mark E. Battersby
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>> Published Date: 2/27/2013
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The “Fiscal Cliff” tax package recently signed into law renewed more than 50 temporary tax breaks through 2013, saving individuals and businesses an estimated $76 billion. On the downside, employees are already finding less in their paychecks because the American Taxpayer Relief Act didn’t extend the payroll tax holiday that had reduced Social Security payroll deductions from 6.2% to 4.2% on earned income up to the Social Security wage base ($113,700 for 2013). It’s a similar story for self-employed growers.
For those of you who own and operate small and medium-sized greenhouse and retail garden center businesses, there’s good news and bad news contained in the fiscal cliff tax laws. First, the good news: Greater certainty in taxes. Many of you have gotten used to having a number of longstanding tax breaks. Unfortunately, you’ve also had to get used to the uncertainty of whether those provisions would be renewed each year. While many popular tax breaks expired at the end of 2011, the new tax law renews them retroactively, allowing you to claim them on both your 2012 and 2013 tax returns.
Admittedly, the American Taxpayer Relief Act didn’t specifically favor commercial greenhouse growers like it did when granting $59 million in tax credits for algae growers to encourage production of “cellulosic biofuel” at up to $1.01 per gallon. However, among the business provisions in the new law that growers should be aware of are:
Research and Development Tax Credits: The new law extended the often overlooked, neglected or difficult-to-understand research credit, which expired at the end of 2011, through December 31, 2013. The research credit, or research and development credit, as it’s often labeled, may be claimed for increases in business-related research expenditures. While only for research in the clinical sense, many of the small businesses it was designed to help have in the past shied away from the complex rules. Perhaps the potential of reaping a share of the $14.3 billion in tax savings may entice more growers to investigate the research tax credit.
Equipment Write-Offs for Profitable Operations: The American Taxpayer Relief Act extended through 2013 the Tax Code’s Section 179, first-year expensing write-off for equipment and other business property acquisitions. Now, the higher expensing limits in effect in 2011 have been reinstated for 2012 and extended for expenditures made before December 31, 2013. Thus, a grower can expense or immediately deduct up to $500,000 of expenditures in 2012 and 2013, subject to a phase-out if total capital expenditures exceed $2,000,000. The maximum amount that can be expensed in years beginning after 2013 will, without amendment, drop to $25,000.
Bonus Write-Offs: The tax break that allows profitable greenhouse businesses to write-off large capital expenditures immediately—rather than over time—has long been used as an economic stimulus. One hundred percent “bonus” depreciation expired at the end of 2011. Today, the new law allows 50% bonus depreciation for property placed in service through 2013. Some transportation and longer-lived property are even eligible for bonus depreciation through 2014.
To be eligible for bonus depreciation, property must be depreciable under the standard MACRS system and have a recovery period of less than 20 years. Code Section 179 first-year expensing remains a viable alternative, especially for small businesses. Property qualifying for the Section 179 write-off may be either used or new in contrast to the bonus depreciation requirement that the grower or retailer be the “first to use.”
More, more and more
The Work Opportunity Tax Credit (WOTC), a tax credit that rewards employers that hire individuals from targeted groups, has been extended to December 31, 2013, and applies to individuals who begin work for the employer after December 31, 2011. Under the revised WOTC, growers or retailers hiring individuals from within a targeted group are eligible for a credit that’s generally equal to 40% of first-year wages up to $6,000.
In another area, although an “S” corporation is a pass-through entity and not usually subject to income taxes, it’s liable for the tax imposed on built-in gains or capital gains. The tax on built-in gains is a corporate level tax on S corporations that dispose of assets that appreciated in value during the years when the operation was a regular “C” corporation. The new law extends a relaxed version of the provision that limits the taint to five years, but only for 2012 and 2013. Thus, if a greenhouse or retail business waits five years, it escapes the “double tax.” Anyone in this situation may wait to take advantage of this provision, but is advised to consult with a tax professional.
Taxing it alone
Thanks to the Health Care and Education Reconciliation Act of 2010, beginning in 2013, many individuals discovered they will be subject to a 3.8% Net Investment Income (NII) tax and a 0.9% percent Additional Medicare tax. The new taxes apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with a MAGI in excess of $250,000 if filing a joint return, or $125,000 if filing a separate return.
More recently, single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more in taxes in 2013 because of a higher 39.6% income tax rate and a 20% maximum capital gains tax on the “wealthy.” For others, the Alternative Minimum Tax (AMT) has finally been indexed for inflation.
Ironically, the AMT was created to ensure that wealthy individuals would pay some kind of income tax, not middle-income households. The new law increases the 2012 exemption amounts to $50,600 for unmarried individuals and $78,750 for jointly filing couples. For 2013, the AMT exemption amounts are predicted to be $80,750 for married couples filing jointly and $51,900 for single individuals.
Estate taxes never die
Always of significant interest to family-owned businesses, the estate tax has long been a bit of a mixed bag. Under the new law, the $5 million-per-person exemption was kept in place (and indexed for inflation). The top rate was, however, increased to 40%—effective date January 1, 2013. This change to 40% is expected to increase government revenues from 2012 levels by $19 billion. Other good news for estate planning: portability is kept in place and estate and gift taxes remain unified—meaning the $5 million stays in place for gift tax purposes as well as estates. And it’s all permanent.
Planning opportunities abound
The majority of greenhouse businesses operate as pass-through entities, such as partnerships and S corporations. Profits are passed through to their individual owners and therefore are taxed at individual income tax rates. Some business owners might be considering switching to a regular C corporation with its top rate of 35% rather than doing business through an S corporation, LLC, etc. and subject to a top rate of 39.6% on the pass-through income.
Looking much deeper than the tax rates is important, however. With a pass-through entity, the shareholders are taxed only once on the income. With a regular 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.
That double taxation becomes even more significant on the sale of the business. Although there are provisions in the tax law that allow all or a portion of the gain on the sale of a business to be excluded or ignored, they’re limited.
Another consideration, particularly for small businesses, is that any expenses disallowed by an IRS auditor will only result in increased income to the pass-through entity. Doing business as a regular corporation, disallowed personal expenses increase the income of the corporation and are taxed as constructive dividends to the shareholders. The same is true for unreasonable compensation of shareholder/officers.
It should also be kept in mind that if a switch is made from an S corporation to a regular C corporation, a switch back to an S corporation can’t be made for five years—unless permission is received from the IRS. If an LLC or partnership is incorporated, there can be expenses and potential tax
consequences.
Although it’s not the grand bargain as envisioned by lawmakers, many popular, but temporary, tax extenders relating to businesses were included in the American Taxpayer Relief Act. Despite the Code Section 179 small business expensing, bonus depreciation and the Work Opportunity Tax Credit, the new law is effectively a stop-gap measure designed expressly to prevent the onus of the expiration of the Bush-era tax cuts from falling on middle-income taxpayers. Congress must still address spending cuts and may even tackle tax “reform.”
The time is now—hopefully, before filing your 2012 tax returns—for every greenhouse and garden center owner to consult with their accountants and/or tax professionals to focus on the potential savings offered by these newly revised, extended and expanded business credits, deductions and tax write-offs. GT
Mark E. Battersby is a freelance business reporter from Ardmore, Pennsylvania, who regularly reports on the news and developments within the tax and financial arenas. He can be reached at (610) 789-2480 or
MEBatt12@earthlink.net.
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