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.
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.
• 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
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
- Dependent care FSAs are not impacted and still have a $5,000 annual maximum
- 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
- 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.