Business Provisions of the American Taxpayer Relief Act

While a good majority of the tax changes in the 11th hour Fiscal Cliff bill (American Taxpayer Relief Act of 2012) concern individual taxes, there are a few changes for small business owners, which are mostly centered around the extension of and retroactive change to depreciation limits and rules.

Section 179 Depreciation Limit

In 2011, we had a $500k limit on the amount that could be taken as Section 179 depreciation expense (provided the business purchased less than $2 million in qualifying property in the year).  This limit was very generous and few small businesses had to worry about getting close to this limit.  However, in 2012 the limit was scheduled to be reduced to $139k (after inflation adjustments), and then even further reduction to $25k in 2013.  For small businesses that acquire a lot of equipment each year, such large limit reductions would have a big impact.

All of 2012, we were unsure if Congress would increase the Section 179 limit, and finally after the ball dropped in Times Square and many of us had resigned ourselves to the 139k limit, our bickering government representatives finally get it together and decided to make a retroactive change to the 2012 limit.  Now, it is as if the the treat of the $139k limit never existed, and we now have a $500k limit for 2012 and 2013.

Now, correct me if I am wrong, but I thought the purpose the Section 179 depreciation benefit was to encourage business owners to buy more business equipment and help spur economic growth?  How are we suppose buy equipment when our government does not decide on the depreciation limit until after the year is over?  I had several clients that typically buy more than $139k in equipment that were trying to make purchase decisions at year-end, and the delay caused by partisan politics in Washington on this limit was extremely frustrating.

Bonus Depreciation Kept Alive

Is bonus depreciation ever going to truly go away?  It seems it is always brought back by 11th hour legislation.  Unfortunately, this time around we only have 50% bonus depreciation that is extended through 2013.  While businesses with net taxable income will use Section 179 depreciation, bonus could be useful for those with losses.

In 2011, we were spoiled with 100% bonus depreciation, and we pretty much wrote off everything in the first year that qualified.  Now we are going to be a little more limited, but it is still a good benefit if you remember back to years before bonus was available.  At best, it provides a great first year deduction for those of you who purchased new vehicles weighing less than 6,000 GVW.  Even with 50% bonus depreciation, you are still going to get $11,160 in depreciation in the first year ($11,360 if a light van or truck) given that most new vehicles are well over $22,320 these days.  Remember, it has to be a brand new.  Certified new does not qualify.

Qualified Leasehold Improvement Retroactive Change

Even though this one will greatly benefit my calendar year filing businesses, it frustrates me to no end that Congress would make this change retroactive to 2012.  Not only did it make one paragraph from my book obsolete, but we are going to have to file several amendments for our fiscal year corporations that have already filed tax returns with qualified leasehold improvements put into use after 1/1/12.

To fully understand my frustration, you need the background history on this tax deduction:

  • In 2011 (and several years prior) you could depreciate qualifying leasehold improvements over 15 years and then use Section 179 or bonus depreciation on the improvements.
  • Before this rule, we had to depreciate them over 39 years, so this was a BIG benefit.
  • Due to the patchwork of tax code in the last few years, the special treatment expired as of 1/1/12, and qualified leasehold improvements could no longer be depreciated over 15 years.
  • Even worse, if you had any 179 carryover originating from qualified leasehold improvements at that point, you had to reclassify the amount (according to steps in Sec 179(f)(4)) and depreciate it under the 2012 rules over 39 years.  Reporting this adjustment was a bit complicated since the IRS did really anticipate the expiration of the tax rules, so not only was it a lost benefit, but it cost fiscal year small businesses more in tax prep fees.
  • Fortunately, there was some saving grace in that the qualifying improvements still qualified for bonus depreciation (since the availability of bonus treatment was not based on the 15 year life), so we were able to take 50% bonus depreciation, but the rest went over 39 years.

Now, fast forward a few months after these fiscal year returns have been filed to when we are all enjoying New Years and watching football (or soccer in my case).  Our government officials, in all their wisdom, decide to retroactively change the 2012 rules and make the 15 year special treatment available again.  In addition, they extend it to 2013 as well, so it is as if the rules we used during 2012 for fiscal year filers never existed.

Again, if you are a calender year filer and you made or are looking to make some leasehold improvements that qualify for the 15 year treatment, this is very welcome news.  However, if you are a fiscal year filing corporation, your CPA may need to file amendments for you once the tax preparation software companies update their software for all the Fiscal Cliff bill changes.

By the way, if you bought my book and would like more information on this change, please feel free to email me at pdxcpa@gmx.com.  Again, it only changes one paragraph in the Fixed Assets chapter, but I would be happy to provide additional details on this change for my readers.

Other Extenders

In addition to the depreciation changes and the retroactive change that has me all riled up (much like the Cascadian supporter groups are at Don Garber), there were also some minor extensions that will benefit a select group of small businesses.  The Research and Work Opportunity Tax Credits were both extended through 2013.  The enhanced charitable deduction for contributions of food inventory is also extend through 2013, as is the special treatment of qualified small business stock.

All in all, there was not much change for businesses; however, we will likely see more substantial changes later in the year.  You may say I am a dreamer, but I am thinking we may actually see some comprehensive tax reform this year.

Avoid Fiscal Cliff Panic

As you can imagine, I have heard a lot of panic from clients since the election results came in last month.  Some panic is warranted, as most acknowledge that the 2% payroll tax reduction will not be extended, capital gains will likely be increased to 20% or 25% at most, and that tax rates will likely be increased for married couples with AGI over $250k.  However, when it comes to capital gains, panic can actually be very detrimental and cost you much more in taxes than you would think.

Naturally, you would assume accelerating a large capital gains to take advantage of the 15% rate would result in large tax savings, but unfortunately the alternative minimum tax erodes the tax savings if you are a high-income taxpayer.  In fact, most of the time it results in an overall tax rate between 20% and 25%.  Why this happens is very complex and even CPAs get frustrated in fully understanding the alternative minimum tax, but here is the best explanation I could find.  Basically, if a large amount of your income is long-term capital gain income and you are a high-income taxpayer, the AMT tax can kick in and erase the benefit of the 15% rate.  We witnessed this quite a bit back in 2010 when financial advisers worried about the expiration of the 15% rate and advised their clients to sell off their low basis stock.  It sounded like a great idea at the time, but when preparing the tax returns in 2011, many were surprised at how AMT tax erased much of the benefit.  Well, the same thing can happen for tax year 2012 if you give in to panic.

Before you make any big moves on capital gains before year-end, talk to your CPA and and have them run a projection to see what the true impact would be.  It may just be that there is no need to panic.

Obama vs. Romney Tax Policy Outline

The first 2012 Presidential debate will take place on Wednesday, and this time it will be focused on domestic policy.  One of the most important domestic issues right now is the “Fiscal Cliff” and tax reform that is long overdue.  I highly recommend you read through CCH’s outline of the tax policies of each candidate before Wednesday’s big event.  It was released back on 9/11/12 and provides great analysis that is easy to follow even if you are not a tax professional.

While actual tax reform will likely require a lot of compromise from both parties, it is good to have an understanding of both platforms, as ideas from each could end of shaping eventual reform in 2013 and beyond.

My guess is that most small business owners are a bit apathetic this election cycle, as we all know that some form of tax increase is just around the corner regardless of who wins the election.  After all, it is very likely that the 2% payroll tax holiday will be left to expire at the end of the year, and many high income taxpayers will have to starting paying the additional Medicare taxes resulting from the Health Care reform that the Supreme Court upheld in June.

Personally, I am a bit of a skeptic, as politicians have avoided substantial tax reform for years.  In fact, right now I am more interested in what Caleb Porter will bring to the Portland Timbers in 2013.  Tax increases will be a little easier to take if we make it to the playoffs next year. #RCTID