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Closely Held Businesses

Multi-State Taxation

By Closely Held BusinessesNo Comments

Most large corporations do business in more than one state and, as a result, are typically subject to the corporate income tax in multiple states. However, each state faces two important limits on how much of these corporations’ profits it can tax.

  1. If a corporation does not conduct a minimal amount of business in a specific state, that state is not allowed to tax the corporation at all. Corporations that have sufficient contact in a state to be taxable are said to have “nexus” with that state.
  2. Each state in which a corporation has nexus must develop rules for dividing the corporation’s profits into an in-state portion and an out-of-state portion.  Then, the state can only tax the in-state portion.  This process is referred to as “apportionment” which is explained in further detail below.

Apportionment & Allocation

According to the Uniform Division of Income for Tax Purposes Act (R&TC §§25120–25141), all taxpayer income is divided into business income — which is apportioned among the states where the business operates — or nonbusiness income — which is allocated to a particular source state.

Apportionment

The Uniform Division of Income for Tax Purposes Act (UDITPA) recommends an apportionment rule that equally depends on three different factors in determining the portion of a corporation’s business income (i.e. sales, rent & royalties, income arising from regular course of trade or business) that can be taxed by a state. These factors include the following:

  1. The percentage of a corporation’s nationwide payroll that is paid to the residents of a state.
  2. The percentage of a corporation’s nationwide sales that are made to the residents of a state.
  3. The percentage of a corporation’s nationwide property that is located within a state.

The UDITPA’s recommendation was to assign each of the three factors an equal weight in allocating a company’s business income among the states in which it operates.

However, over the past two decades, many states have chosen to increase the importance of the sales factor and decrease the importance of the payroll and property factors.  Therefore, the majority of states currently use apportionment formulas that give “double-weight” or more to the sales factor, meaning that a corporation’s in-state sales are at least twice as important as each of the other factors. At the extreme side of the spectrum, more than a dozen states rely entirely on the sales factor in determining at least some corporations’ tax liabilities. This approach is referred to as the “single sales factor” (SSF).

The following is an overview of the various apportionment formulas:

Formula Description
3-Factor Formula Average the 3 factors (payroll, sales, property)

 

Double Weighted Sales Factor

 

4-factor formula with the sales factor being doubled

 

Single Sales Factor

 

Only uses the sales factor

(California uses this)*

 

Other Many states use unique formulas

 

 Allocation

Allocation generally refers to the assignment of non-business income to the particular state in which it is earned.  Non-business income arises from activities outside a corporation’s regular course of business, which can include items such as:

  • Rent & Royalties
  • Capital Gains
  • Interest
  • Dividends

Composite Returns

Many states allow a pass-through entity to file a composite return on behalf of its nonresident individual owners in lieu of each owner filing his or her own nonresident return.  This saves the owners from having to report and pay tax on their share of state income from the entity.  Thus, nonresident owners do not have to file a tax return in any state a composite return was filed.

Multi-state taxation is a complex topic.  If your business is thinking about operating in multiple states, please contact us at 858-558-9200 so that we can further discuss the issues you may face.

Repair and Capitalization Rules Update

By Closely Held BusinessesNo Comments

The IRS has come out with additional guidance on how to comply with the final regulations for repairs, capitalization, and MACRS in Rev. Proc. 2015-20.  In Rev. Proc. 2015-20 the IRS appears to provide an easing of the requirement for small businesses (defined as having less than $10 million of gross receipts or less than $10 million of assets) to file Form 3115 for a change in accounting method.

However, a closer look at this Rev. Proc. reveals that it may be in most taxpayers’ best interest to file Form 3115 in order to provide audit protection for earlier years.  In addition, there may be opportunities to take a current year deduction related to these changes.  The following article attempts to answer the most common questions regarding these new regulations.

http://www.forbes.com/sites/anthonynitti/2015/02/14/repair-regulation-relief-what-does-it-really-mean-not-as-much-as-you-think/

Finalized IRS Repair and Capitalization Rules

By Closely Held BusinessesNo Comments

Final regulations on materials and supplies:

  • $200 per item threshold for materials and supplies.
  • Standby emergency spare parts are now included in the definition of material and supplies.
  • Election to capitalize materials and supplies now limited to rotable, temporary, and standby emergency parts; and
  • Materials and supplies are subject to de minims safe harbor.
  • Gain on the disposition of a material or supply is ordinary income.

De Minims Safe Harbor Election

  • If individual items purchased are less than $500 (or $5,000 with applicable financial statement (AFS)), item can be expensed and not capitalized.
  • Must make annual election Reg. §1.263(a)-1(f)(1) and attach to tax return when filing. The election is irrevocable.
  • A taxpayer with an AFS must have a written accounting procedure for non-tax purposes effective at the beginning of the tax year describing their expense.
  • A taxpayer without AFS must also have an accounting procedure in place; however it does not need to be written.

Safe Harbor for Small Taxpayers with Buildings

  • For taxpayers that have $10 million or less in annual gross receipts and make improvements on a building owned or lease that has an unadjusted basis no greater than $1 million, a new safe harbor is available.
  • Under the safe harbor, taxpayers are not required to capitalize building improvements if the total amount does not exceed the lesser of $10,000 or 2% of the unadjusted basis of the building
  • This election must be made annually and attached to a timely filed return and is irrevocable.

Above is a summary of some of the new IRS regulations for repairs and capitalization, but there are many other changes not mentioned here. For more detail, or if you have any questions regarding these changes and would like to talk to a professional, please call Lindsay and Brownell at (858) 558-9200.

If you would like more information regarding these regulations, here is a link to an article that goes into more detail: https://drive.google.com/viewerng/viewer?url=http://www.cchgroup.com/media/WK/TAA/PDFs/news-and-insights/federal-tax-legislation/Finalrepair-Capitalization-MACRS-Regulations-Update2014.pdf

Extenders Bill

By Closely Held BusinessesNo Comments

With the end of the 2014 calendar year quickly approaching, President Obama signed a bill that approves a one-year retroactive extension of a large number of temporary tax deductions, credits, and incentives that expired at the end of 2013. Many of the tax breaks in the bill relate to businesses, but a handful of them will pertain to individuals. Below are some of the major tax provisions that have been renewed and will remain in effect for the 2014 tax year:

General Business Credits & Incentives

  • Tax credit for research and experimentation expenses
  • Additional first-year depreciation for 50 percent of basis of qualified property
  • Election to accelerate AMT credits in lieu of additional first-year depreciation
  • 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
  • Increased expensing limits ($500,000/$2 million) and expanded definition of section 179 property
  • Employer wage credit for activated members of the military reserve force
  • Treatment of certain dividends of regulated investment companies (RICs)
  • Special rules for qualified small business stock
  • Reduction in recognition period for S corporation built-in gains tax
  • Determination of low-income housing credit rate for credit allocations with respect to non-federally subsidized buildings
  • Treatment of military basic housing allowance under low-income housing tax credit

Energy Tax Incentives

  • Credit for construction of new energy-efficient homes
  •     Deduction for energy-efficient commercial buildings
  •     Credit for energy-efficiency improvements to existing homes
  •     Alternative fuel vehicle refueling property (non-hydrogen refueling property)
  •     Incentives for biodiesel and renewable diesel
  •     Incentives for alternative fuel and alternative fuel mixtures
  •     Second generation biofuel producer credit
  •     Special depreciation allowance for second generation biofuel plant property

Infrastructure, Economic Development & Community Assistance Provisions

  • New markets tax credit
    • Work opportunity taxcredit
    • Qualified zone academy bonds: allocation of bond limitation
    • Empowerment zone tax incentives:

o   Designation of an empowerment zone and of additional empowerment zones

o   Increased exclusion of gain (attributable to periods through 12/31/18) on the sale of qualified business stock of an empowerment zone business

o   Empowerment zone tax-exempt bonds

o   Empowerment zone employment credit

o   Increased expensing under section 179

o   Non-recognition of gain on rollover of empowerment zone investments

Individual Tax Incentives

  • Deduction for state and local general sales taxes
  • Above-the-line deduction for qualified tuition and related expenses
  • Parity for exclusion from income for employer-provided mass transit and parking benefits
  • Deduction for certain expenses of elementary and secondary school teachers
  • Discharge of indebtedness on principal residence excluded from gross income of individuals
  • Premiums for mortgage insurance deductible as interest that is qualified residence interest

Provisions Governing Charitable Giving, Tax-Exempt Entities

  • Tax-free distributions from individual retirement plans by individuals age 70.5 and older for charitable purposes
  • Special rules for contributions of capital gain real property made for conservation purposes
  • Enhanced charitable deduction for contributions of food inventory
  • Modification of tax treatment of certain payments to controlling exempt organizations
  • Basis adjustment to stock of S corporations making charitable contributions of property

If you have any questions regarding how these tax extenders may affect you, please call Lindsay & Brownell at (858) 558-9200 and we will help you take advantage before the end of the year! Don’t miss this potential tax saving opportunity!

Details of the extender bill can be found on the legislative website by following this link:

http://www.cchgroup.com/media/WK/TAA/PDFs/news-and-insights/federal-tax-legislation/Extenders-Bill-ABLE-Act.pdf

Closely Held Business Year-End Planning and Tax Issues

By Closely Held BusinessesNo Comments

The following information provides a look at important information related to Closely Held Businesses regarding year-end planning.

3.8% Medicare Contribution Tax:

Once again the Medicare surtax will be assessed on taxpayers with Net Investment Income above certain thresholds. The Medicare surtax does not apply to income derived from an active trade or business, or from the sale of property used in an active trade or business. The Medicare surtax is based on the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (MAGI) (AGI with foreign income added back) above a specified threshold.

The MAGI thresholds for 2014 are:

  • $250,000 for married taxpayers filing jointly or a surviving spouse;
  • $125,000 for married taxpayers filing separately;
  • $200,000 for single and head of household taxpayers; and
  • $12,150 in 2014 for estates and trusts (indexed for inflation).

NII includes:

  • Gross income from interest, dividends, annuities, royalties, and rents, provided this income is not derived in the ordinary course of an active trade or business;
  • Gross income from a trade or business that is a passive activity;
  • Gross income from a trade or business of trading in financial instruments or commodities; and
  • Net gain from the disposition of property, other than property held in an active trade or business.

Additional 0.9% Medicare Tax on Earned Income:

The 0.9% will still be in effect for wages and self-employment income received in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately) for a total Medicare tax of 2.35% for those individuals.

An employer is required to collect additional Medicare tax on any employee who is in excess of $200,000 for the calendar year, regardless of employee’s filing status or other wages/compensation.

De Minimis Expensing Rule (repairs vs. cap regulations):

Purchases of multiple inexpensive tangible items are not required to be capitalized.  The aggregate amount of these items can be expensed.  “Inexpensive” varies from client to client and should be defined in a written policy.  The amount that can be expensed is subject to certain limitations. Larger companies with Applicable Financial Statements may deduct up to $5,000 per invoice. For smaller companies without Applicable Financial Statements there is a $500 safe harbor.

Corporate Inversions:

The IRS has issued final, temporary, and proposed regulations to implement certain restrictions on corporate inversion as set forth by Code Section 7874.  These Regulations identify specific stocks that are disregarded when determining whether the issuer is a surrogate foreign corp.

Year-end considerations:

Year-end considerations regarding income and expenses not mentioned above have remained relatively the same; consider accelerating or deferring income into years in which you will receive higher expenses or a lower tax bracket. Additional suggestions are as follows:

Zero-out income

  • C-Corp – Calculate wages and/or bonuses by zero-ing out income to avoid double taxation.

Reasonable Compensation

  • S-Corp income is not subject to employment taxes or self-employment income
  • S-Corp owners must take reasonable compensation (subject to employment taxes) for services performed for the S-Corp

Withholding & Estimated tax payments

  • Consider whether sufficient withholding has been made throughout the year
  • If not consider making an estimated tax payment or, if possible, a year-end bonus with extra withholding

Home Office Safe-Harbor Deduction

  • Allowed a deduction of $5 per square foot up to 300 square feet
  • Deduction is limited to the gross income derived from the business

Pending Provisions:

The following provisions are presented as the current tax law. Negotiations are ongoing regarding an extender bill that would reinstate provisions that are currently expired. Please check back for updates, as we will keep you informed as changes occur. *NOTE* These Provisions have been superseded. Please refer to the article “Extenders Bill” for an update – Click Here

  • Bonus Depreciation has expired and is no longer available.
  • Section 179 expense: $25,000 deduction limitation with phase-out beginning at $200,000.
  • Research Tax Credit has expired and is no longer available
  • Small Business Stock: 50% gain exclusion (60% for empowerment zone stock) for stock purchased after December 31, 2013.

Basis and At-Risk for Partnerships and S Corporations

By Closely Held BusinessesNo Comments

The ability to take losses in a closely held business that you are invested in is dependent on three things:

  • Your basis in the entity,
  • The amount that you have at-risk, and
  • Whether you fall under passive activity loss limitations.

These calculations also may differ depending on the type of entity that you are invested in.

To calculate your tax basis in an S corporation:

                     +     Initial Capital Contribution or Amount Invested

                     +     Additional Paid in Capital

                     +     Separately Stated Income Items from K-1

                     +     Tax Exempt Income from K-1

–            Distributions

–             Nondeductible expenses and losses

+     Debt you are personally liable for

       Tax Basis

  • If any of the expense or loss items cause your basis to go below zero, those losses must be suspended and carried forward to the next tax year.

Tax basis in a partnership is calculated similarly to basis in an S corporation. The adjusted basis of property that you contributed to the partnership plus any additional contributions, increased share of partnership liabilities and income less any distributions, decreased share of partnership liabilities and losses will equal your basis in the partnership.

  • Like an S corporation, partnership basis can’t go below zero, and any losses that cause the partnership to go below zero should be suspended and carried forward to the next tax year.
  • Unlike an S corporation, partnerships can add both recourse and qualified non-recourse liabilities to their basis.
  •  A recourse liability is one in which the partner has the economic risk of loss for the liability. A qualified non-recourse liability is a liability that is obtained by the partnership that has real property as collateral for the loan.

If you have basis in a business that you are invested in, you must determine if you are at-risk for that investment before determining if you are eligible to deduct losses. For an S corporation, the amount that you are at-risk is equal to your total basis in the S corporation. With a partnership on the other hand, you can have a different amount at-risk than your basis. This depends on the specific type of partnership that the business operates under.

Finally, if you determine that you have basis and are at-risk for your investment in a closely held business, you must determine if the passive activity loss limitation rules apply to you.

Basis, at-risk, and passive activity loss limitations are all very complex issues, so please contact us directly for further information or clarification.

Patient Protection and Affordable Care Act: Employer Notification of Exchanges

By Closely Held BusinessesNo Comments

Although recent legislation postponed elements of the Patient Protection and Affordable Care Act, employers need to be aware of upcoming deadlines. The Act requires employers covered by the Fair Labor Standards Act to provide a notice to employees about the existence of the health benefits Exchange by October 1, 2013.

The following link provides a discussion of the Exchange and details of the required notification;
if you have additional questions on how the Act will affect you, please contact us.

Patient Protection and Affordable Care Act

By Closely Held BusinessesNo Comments

NOTE: ON JULY 2, 2013, THE GOVERNMENT ANNOUNCED A ONE-YEAR POSTPONEMENT ON THE LARGE EMPLOYER HEALTH CARE MANDATE DISCUSSED BELOW. FOR MORE DETAILS ON THIS POSTPONEMENT, PLEASE SEE THE ARTICLE HERE.

Patient Protection and Affordable Care Act:

With the “Obamacare” act fast approaching its fruition in 2014, we need to become more aware of how this will affect us as individuals and as businesses. Understanding this complicated bill is paramount for a successful transition into the New Year.

The California Exchange: It states in the passage of the bill that every state must have an “exchange” that can help individuals and employers pick the right type insurance that fits their needs. The exchange offers four levels of coverage: Platinum, Gold, Silver and Bronze. You can learn more information about the exchange and the different levels of coverage at http://www.coveredca.com.

Individual: Individuals must have insurance or face a penalty. The penalty phases in over the next three years. For 2014 the penalty is the greater of 1% of the individual’s income or $95 dollars. In 2015 the penalty is the greater of 2% of income or $325 dollars. Lastly, in 2016 the penalty is 2.5% of income or $695 dollars.

Several groups are exempt from the requirement to obtain coverage or pay the penalty, including:

  • People who would have to pay more than 8 percent of their income for health insurance
  • People with incomes below the threshold required for filing taxes (in 2012, $9,750 for a single person and $27,100 for a married couple with two children)
  • People who qualify for religious exemptions
  • Undocumented immigrants
  • People who are incarcerated
  • Members of Native American tribes

Tax credits are available to help pay for coverage for employees who are between 100% and 400% of the federal poverty level and enroll in coverage through an Affordable Insurance Exchange.


Businesses: 
Businesses will be broken into two groups, large businesses and small businesses. Small businesses do not have to offer health care to their employees but can get a credit if they have no more than 25 employees and meet certain requirements.

To calculate if you are a large business you must divide the sum of the total number of full-time (FT) and full-time equivalent employees for each calendar month in the preceding calendar year by 12 and if the result is not a whole number, round down to the next lowest whole number. If the result is greater than or equals 50 the employer is a large employer.
A large employer is not technically responsible for offering their employees’ health care, but they must make a shared responsibility payment if they do not or possibly even if they do. There are two situations where a large employer is subject to shared responsibility payments:

  • Failure to offer coverage, or offers coverage to less than 95% of its employees (and after 2014, their dependents). Payment = $2,000/12 x (# of FT employees for that month – 30)
  • Employer offers minimum essential health coverage to at least 95% of its FT employees (and after 2014, their dependents), but at least one FT employee receives a tax credit.
  • Individuals can receive a tax credit if:
  • They are not offered coverage
  • The coverage is unaffordable
  • Coverage does not provide minimum value.
  • Payment = $3,000/12 x (# of FT Employees for that month enrolled in a qualified health plan for which a premium tax credit or cost-sharing reduction is paid or allowed.)
Eligibility for the small business group must have the following:
  • No more than 25 full-time equivalent employees.
  • Average annual wages of these employees is less than or equal to $50,000 (for 2013).
  • Employer has a qualified health care contribution arrangement. A qualifying arrangement includes:
  • Employer makes non-elective contributions
  • Non-elective contribution of at least 50% of the premium cost made on behalf of each employee enrolled in the plan.
  • Contribution is considered non-elective as long as it is not part of a salary reduction arrangement.
  • For tax years beginning in 2013 employer needs to make non-elective contributions towards healthcare. After 2013, must participate in an insurance exchange to claim the credit.

For a more thorough understanding of these changes that are fast approaching, please do not hesitate to call our offices.

Changes with Recent Legislation

By Closely Held BusinessesNo Comments

Closely Held Business Issues:

Recent legislation has brought change for closely held businesses and their owners. Increases to the Medicare tax, the new tax on net investment income, and compliance with healthcare reform are all issues that are new in 2013. Following is a summary of some of the many changes that go into effect this year. Please contact us if we can help you in understanding how these changes will impact you for 2013 and beyond.

Major Changes:

3.8% Medicare Contribution Tax: Taking effect on January 1, 2013 the Medicare surtax is imposed on a taxpayer’s “net investment income” (NII). However, the Medicare surtax does not apply to income derived from an active trade or business, or from the sale of property used in an active trade or business. The Medicare surtax is based on the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (MAGI) (AGI with foreign income added back) above a specified threshold. The MAGI thresholds and the components of NII are detailed in the 12/13/12 Closely Held Business posting.

Additional 0.9% Medicare Tax on Earned Income: Effective January 1, 2103, higher income individuals are subject to an additional 0.9% Medicare tax. The additional Medicare tax means that the portion of wages and self-employment income received in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately) is subject to a 2.35% Medicare tax rate. The additional Medicare tax is imposed on individuals and does not apply to corporations, estates, or trusts.

Proposition 30 Rate Increases: The passage of Proposition 30, which is aimed primarily at funding education, will have tax implications for the following:

  • California composite returns: Tax imposed on nonresident individuals participating in composite returns filed by corporations and pass-through entities is imposed at the highest marginal tax rate, which is now 12.3% for the 2012—2018 tax years.
  • Sale of real property: Withholding on the sale of California real property can now be calculated based on the reportable gain from the sale rather than on a percentage of the total sales price. The applicable withholding rate is the highest marginal tax rate of 12.3%.

Updates on Limitations:

Bonus Depreciation (Extended): Bonus depreciation is 50% for 2013. Bonus depreciation is for new capital assets only, with a recovery period of 20 years or less.

  • California: No bonus depreciation.

Section 179 Deduction (Extended): The deduction limitation is $500,000 for 2013. These deductions are phased-out if property is purchased in excess of $2,000,000. Section 179 is for newly purchased new or used capital assets.

  • California: Deduction is limited to $25,000 and is phased-out for property purchases in excess of $200,000.

Retirement Contributions: Below are the limitations for retiremment plans:

  • Traditional and Roth IRA maximum contribution (due April 15, 2014)
    $5,500 with $1,000 catch-up for 50+ years (not to exceed taxable income, subject to AGI limitations)
  • SEP IRA maximum contribution (due by extended due date)
    Lower of $51,000 or 25% of employee’s salary
  • Simple IRA maximum contribution (due by extended due date)
    $12,000 with $2,500 catch-up for 50+ years
  • 401(k) maximum contribution (due by extended due date)
    $17,500 with $5,500 catch-up for 50+ years

Other Planning Ideas:

  • Business owners might consider setting up their business entity as an S-Corp, rather than as a partnership, so that the entity’s income allocable to owners is not treated as earned income.
    • If an entity is operating as a partnership, LLC, or single member LLC, the owners could convert it to an S-Corp when the tax first takes effect. (If the shareholder materially participates in the business, income from an S corporation is also not subject to the 3.8 percent Medicare contribution tax on investment income, which also starts to apply in 2013.)
    • Another consideration would be to move an S-Corp to a C-Corp if you have many passive shareholders to avoid the Medicare tax.
    • If business owners activtely participate in the management or provide services to a S-Corp they must take “reasonable compensation” for services rendered. Determing “reasonable compensation” is a facts and circumstances determination based on the services performed, the owner’s training and expereience, among other factors.
      • While the income passed through the S-Corp is not considered earned income, the compensation for services performed for the S-Corp is considered earned income.
  • Extended Business tax incentives:
    • Research tax credit
    • Work opportunity tax credit
    • 15-year recovery period for leasehold, restaurant & retail improvement property
      • California: 39-year recovery period
  • Small employer health insurance credit (Updated):
    • Employers with 25 or fewer full-time employees paying average annual wages of not more than $25,000 may be eligible for a maximum tax credit of 35 percent on health insurance premiums paid
    • A full-time employee is defined as 32 hours or more per week.
    • Applicable for tax years beginning in 2010 through 2013
    • Reporting of employer sponsored healthcare coverage on W-2 (Updated)
    • Mandatory starting in 2012
    • Starting in 2014 all small businesses with more than 50 full-time employees will be subject to a $100 per day per employee penalty for not offering health insurance
    • $2,500 minimum tax if there are one or more penalties not corrected by the date a notice of examination is sent.

California Tax Credits

New Jobs Credit: Nonrefundable credit for qualified small business hiring new qualified full time employees.

  • Qualified Small Business: no more than 20 employees on the last day of the prior tax year.
  • $3,300 for each net increase in qualified full-time employees hired during the tax year.

Enterprise Zone Credit:

  • Credit for hiring a qualified employee in a designated Enterprise Zone.
  • Credit amount: 50% of qualified wages (cannot exceed 150% of the minimum wage) paid to a qualified employee in the employee’s first year of employment and 40%, 30%, 20% and 10% of qualified wages in the second through fifth years, respectively.
  • Qualified Employee:
    • Hired after area designated an enterprise zone.
    • At least 90% of the employee’s services in an enterprise zone related to the conduct of the taxpayer’s trade or business.
    • At lease 50% of the employee’s services are performed in an enterprise zone.
    • Employee meets the criteria of certain targeted groups.

Closely Held Business Planning

By Closely Held BusinessesNo Comments

Recently, end of year tax planning for businesses has been complicated by uncertainty over the future availability of many tax incentives. Many business incentives extended by Congress in 2010 are about to expire. In addition, many of the “Bush-era” tax cuts are scheduled to sunset at the end of 2012. It is unclear if Congress will provide further extensions as they debate across-the-board spending cuts scheduled to take effect in 2013. In addition, businesses must prepare to comply with healthcare reform. This combination of events provides tax planning considerations unique to 2012 that requires a multi-year strategy taking into account a variety of scenarios and outcomes.

The most effective way to prepare for 2012 and beyond is to become familiar with the issues and planning strategies below. Please contact us if we can help you with the following techniques.

Major Changes:

3.8% Medicare Contribution Tax: Taking effect immediately on January 1, 2013, the Medicare surtax will be imposed on a taxpayer’s “net investment income” (NII). However, the Medicare surtax will not apply to income derived from an active trade or business, or from the sale of property used in an active trade or business. The Medicare surtax is based on the lesser of the taxpayer’s NII or the amount of “modified” adjusted gross income (MAGI) (AGI with foreign income added back) above a specified threshold.

The MAGI thresholds are:
• $250,000 for married taxpayers filing jointly or a surviving spouse;
• $125,000 for married taxpayers filing separately;
• $200,000 for single and head of household taxpayers; and
• $11,650 for estates and trusts.

NII includes:
• Gross income from interest, dividends, annuities, royalties, and rents, provided this income is
not derived in the ordinary course of an active trade or business;
• Gross income from a trade or business that is a passive activity;
• Gross income from a trade or business of trading in financial instruments or commodities; and
• Net gain from the disposition of property, other than property held in an active trade or
business.

Additional 0.9% Medicare Tax on Earned Income: Effective January 1, 2103, higher income individuals will be subject to an additional 0.9% Medicare tax. The additional Medicare tax means that the portion of wages and self-employment income received in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately) will be subject to a 2.35% Medicare tax rate, as opposed to the current 1.45%. The additional Medicare tax is imposed on individuals and does not apply to corporations, estates, or trusts.

Proposition 30 Rate Increases: The passage of Proposition 30, which is aimed primarily at funding education, will have tax implications for the following:
• California composite returns: Tax imposed on nonresident individuals participating in
composite returns filed by corporations and pass-through entities is imposed at the highest
marginal tax rate, which is now 12.3% for the 2012—2018 tax years.
• Sale of real property: Withholding on the sale of California real property can now be calculated
based on the reportable gain from the sale rather than on a percentage of the total sales price.
The applicable withholding rate is the highest marginal tax rate of 12.3%.

De Minimis Expensing Rule (New repairs vs. cap regulations): Purchases of multiple inexpensive tangible items are not required to be capitalized. The aggregate amount of these items can be expensed. “Inexpensive” varies from client to client and should be defined in a written policy. The amount that can be expensed is subject to certain limitations.

Updates on Limitations:

Bonus Depreciation: Bonus depreciation is 50% for 2012, and not eligible in 2013 (based on current law. Bonus depreciation is for new capital assets only, with a recovery period of 20 years or less.

Section 179 Deduction: The deduction limitation is $139,000 for 2012 and will decrease to $25,000 in 2013 (based on current law). These deductions are phased-out if property is purchased in excess of $560,000 in 2012 and $200,000 in 2013. Section 179 is for newly purchased new or used capital assets.

Retirement Contributions: Below are the limitations for retirement plans:

  •  Traditional and Roth IRA maximum contribution (due April 15, 2013 & 2014)
    • 2012: $5,000 with $1,000 catch-up for 50+ years (not to exceed taxable income,
      subject to AGI limitations)
  •  2013: $5,500 with $1,000 catch-up for 50+ years (not to exceed taxable income,
    subject to AGI limitations)
    • SEP IRA maximum contribution (due by extended due date)

    •  2012: lower of $50,000 or 25% of employee’s salary
    • 2013: lower of $51,000 or 25% of employee’s salarySimple IRA maximum contribution (due by extended due date)
    •  2012: $11,500 with $2,500 catch-up for 50+ years
    • 2013: $12,000 with $2,500 catch-up for 50+ years
  • 401(k) maximum contribution (due by extended due date)
    • 2012: $17,000 with $5,500 catch-up for 50+ years
    • 2013: $17,500 with $5,500 catch-up for 50+ years

Other Planning Ideas and Year-End Considerations:

  • Business owners might consider setting up their business entity as an S-Corp, rather than as a
    partnership, so that the entity’s income allocable to owners is not treated as earned income.

    • If an entity is operating as a partnership, LLC, or single member LLC, the owners
      could convert it to an S-Corp, ideally at the beginning of 2013, when the tax first
      takes effect. (If the shareholder materially participates in the business, income from
      an S corporation is also not subject to the 3.8 percent Medicare contribution tax on
      investment income, which also starts to apply in 2013.)
    • Another consideration would be to move an S-Corp to a C-Corp if you have many
      passive shareholders to avoid the Medicare tax
  • Business tax incentives likely to be extended:
    • Research tax credit
    • Work opportunity tax credit
    • 15-year recovery period for leasehold, restaurant & retail improvement property
  • Small employer health insurance credit :
    • Employers with 10 or fewer full-time employees paying average annual wages of
      not more than $25,000 may be eligible for a maximum tax credit of 35 percent on
      health insurance premiums paid
    • A full-time employee is defined as 32 hours or more per week.
    • Applicable for tax years beginning in 2010 through 2013
  • Reporting of employer sponsored healthcare coverage on W-2
    • Optional in 2011, mandatory in 2012
    • Starting in 2014 all small businesses with more than 25 full-time employees will be
      subject to a $2,000/employee penalty for not offering health insurance
  • Flex spending accounts
    • The health FSA limit for 2013 is $2,500
    • If spouses are eligible to contribute to an FSA, each spouse may contribute up to
      $2,500.
    • Dependent care FSAs are not impacted and still have a $5,000 annual maximum
      per household.
  • S-Corps – Fringe Benefit Reporting
    • Must report health insurance premiums in W-2’s for more than 2% shareholders
    • Must have all personal use auto expense included in W-2’s
    • Must report all other fringe benefits in W-2’sTiming of income and deductions
    • Due to tax rate increases, it can be beneficial to accelerate income into 2012 and
      defer deductions to 2013
    • Please refer to our individual tax planning guide for specific rates as well as
      techniques for income acceleration and deduction/credit deferrals.
  • Zero-out income
    • C-Corp – Calculate wages and/or bonuses by zero-ing out income to avoid double
      taxation.
  • Consider paying dividends out of Earnings & Profit in 2012
    • We lose the preferential rate for qualified dividends after 2012. In 2013, dividends
      will be taxed at the marginal rate, which may be as high as 39.6%
    •  The 3.8% Medicare surtax on investment income starts in 2013 as well, so clients
      subject to the surtax will have to pay that on top of the marginal rate.
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