Businesses seeking to maximize tax benefits through 2013 year-end tax planning may want to take special consideration of significant tax incentives (known as tax extenders) scheduled to expire at the end of 2013.
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.
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 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 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.
- STRATEGY: The Sec. 179 deduction phases out completely in a tax year beginning in 2013, if the taxpayer places more than $2.5 million of 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 Sec. 179 deduction to $0.
- STRATEGY: A business could maximize its benefits under 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.
Carry forward. The 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 Sec. 179 deduction, deduction for self-employment 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.
- STRATEGY: 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 Sec. 179 strategy.
Qualifying property. Sec. 179 property is generally defined as new or used depreciable tangible 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.
- STRATEGY: Under current law, off-the-shelf computer software and certain real property will not qualify for 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 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.
Sec. 179 Expensing vs. Bonus Depreciation
Unlike Sec. 179 expensing, there is no dollar cap on the amount of bonus depreciation that a business may claim. Additionally, 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 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).
Qualifying property. 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).
- STRATEGY: 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.
- STRATEGY: 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.
- A word of caution: 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 Sec. 280F to account for bonus depreciation is scheduled to expire after 2013.
- STRATEGY: 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.
Compliance timetable. 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.
- STRATEGY: 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.
- STRATEGY: 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.
- STRATEGY: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.
15-Year Recovery For Leasehold/Retail Improvements, Restaurant Property
ATRA extended through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements and qualified restaurant property. To qualify for this accelerated recovery period, the qualifying property must be placed in service before January 1, 2014.
- Qualified restaurant property is any Sec. 1250 property that is a building or an improvement to a building. More than 50 percent of the building’s square footage must be devoted to preparation of meals and seating for on-premise consumption of prepared meals.
- Qualified leasehold improvement property is any improvement made by the lessor or lessee under or pursuant to the terms of a lease to an interior part of a building that is nonresidential real property that is more than three years old.
- Qualified retail improvement property is any improvement to an interior portion of nonresidential real property that has been in service for more than three years. The improved interior portion must be open to the general public and used in the retail trade or business of selling tangible personal property.
Work Opportunity Tax Credit
Eligibility for the Work Opportunity Tax Credit (WOTC) ends on December 31, 2013. Among other requirements, an employer must hire members of certain targeted groups and have those individuals start work before January 1, 2014.
- Targeted groups. Targeted groups include qualified individuals in families receiving certain government benefits, individuals who receive supplemental Social Security Income or long-term family assistance, and veterans.
- Amount. The credit is generally equal to 40 percent of the qualified worker’s first-year wages up to $6,000 ($3,000 for summer youths and $12,000, $14,000, or $24,000 for certain qualified veterans). For long-term family aid recipients, the credit is equal to 40 percent of the first $10,000 in qualified first year wages and 50 percent of the first $10,000 of qualified second-year wages.
- Advanced certification required. On or before the day the employee begins work, the employer must receive a written certificate from the designated local agency (DLA) indicating that the employee is a member of a specific targeted group. Employers can use Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, to obtain the certification.
Research Tax Credit
ATRA extended the Sec. 41 research tax credit through 2013. The research credit may be claimed for increases in business-related qualified research expenditures and for increases in payments to universities and other qualified organizations for basic research. The credit applies to excess of qualified research expenditures for the tax year over the average annual qualified research expenditures measured over the four preceding years.
- Although the research tax credit enjoys significant bipartisan support in Congress, the Obama Administration, and the business community, its estimated $14.3 billion 10-year revenue cost for making it permanent will likely persuade Congress once again to enact a one- or two-year extension of the credit, and perhaps waiting to do so retroactively sometime in 2014.
Small Business Stock
To encourage investment in small businesses and specialized small business investment companies (SSBICs), Sec. 1202(a) allows a non-corporate taxpayer to exclude from gross income a specified percent of the gain realized from the sale or exchange of qualified small business stock held for more than five years. As extended by ATRA, a full 100-percent exclusion applies to qualified small business stock that is acquired after September 27, 2010, and before January 1, 2014, and held for more than five years. Under current law, the percentage that is excluded reverts to 50-percent (60-percent for empowerment zone stock) for qualifying stock acquired after December 31, 2013.
Eligible gain from the disposition of qualified stock of any single issuer is subject to a cumulative limit for any given tax year is equal to the greater of: (1) $10 million ($5 million for married taxpayers filing separately), reduced by the total amount of eligible gain taken in prior tax years; or (2) 10 times the taxpayer’s adjusted basis in all qualified stock of a corporation disposed of during the tax year.
- STRATEGY: Year-end planning for 2013 that takes advantage of the sunsetting 100 percent exclusion requires attention to two dates: (1) The Sec. 1202 stock must be acquired before January 1, 2014, which in turns requires steps taken by the corporation under state law or otherwise to issue such stock; and (2) taxpayers who hold such shares need to wait five-years before disposition; even being a single day short of the five-year period – measured from the acquisition date – eliminates any benefit, with no proration allowed. Certain exchanges of similar stock before the five year period however are permitted.
Recognition Period for S Built-in Gains
A corporate-level tax, at the highest marginal rate applicable to corporations, is imposed on an S corporation’s net recognized built-in gain (for example, gain that arose prior to the conversion of a C corporation to an S corporation that is recognized by the S corporation during the recognition period). That recognition period, specified under Sec. 1374, is generally the 10-year period beginning with the first day of the first taxable year for which the corporation becomes an S corporation. ATRA extended a reduced recognition period of five years through 2013.
- STRATEGY: The disposition of property with built-in gain before the end of 2013 should be considered for property already held for five years, or more. After December 31, 2013, that property must be held for 10 years unless Congress again changes the rule.
Other Provisions Sunsetting at Year End
Many more valuable business tax extenders are scheduled to expire after 2013. These tax benefits include:
- New Markets Tax Credit
- Employer wage credit for activated military reservists
- Subpart F exceptions for active financing income
- Look through rule for related controlled foreign corporation payments
- Enhanced deduction for charitable contributions of food inventory
- Tax incentives for empowerment zones
- Indian employment credit
- Low-income tax credits for non-federally subsidized new buildings
- Low-income housing tax credit treatment of military housing allowances
- Treatment of dividends of regulated investment companies (RICs)
- Treatment of RICs as qualified investment entities
- Adjusted-basis reduction of stock after S corp. charitable donation of property
Some extenders were not extended by ATRA and have thus expired. Their supporters are likely to fight for renewal in 2014. These include brownfields remediation expensing and tax incentives for the District of Columbia.