As the year draws to a close, it’s important that we calculate the expected taxable income or loss of your business and determine if there is anything we can do before the end of the year to mitigate any potential tax liability for 2012.
While there is still a lot of uncertainty as to which way tax rates will go in 2013, there are several tax provisions and credits that can help reduce your business income this year, many of which either expire at the end of this year or are significantly reduced next year. We should evaluate whether your business can take advantage of any of these. However, the focus should not be entirely on tax savings, but rather on whether or not an action otherwise makes good financial sense. The following are some tax-savings initiatives that you may want to consider before the close of the year.
New 3.8 Percent Medicare Tax
Beginning in 2013, a Medicare contribution tax of 3.8 percent applies to the lesser of (1) net investment income; or (2) the excess of modified adjusted gross income over a threshold amount.
The threshold amount is $250,000 in the case of individuals filing a joint return or a surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. Modified adjusted gross income is adjusted gross income increased by the amount excluded from income as foreign earned income (net of the deductions and exclusions disallowed with respect to the foreign earned income).
In the case of an estate or trust, the tax is 3.8 percent of the lesser of:
(1) undistributed net investment income or
(2) the excess of adjusted gross income over the dollar amount at which the highest income tax bracket applicable to an estate or trust begins.
Certain interests in a trade or business are subject to the tax. Specifically, investment income for purposes of the tax is the sum of (1) gross income from interest, dividends, annuities, royalties, and rents (other than income derived in the ordinary course of any trade or business to which the tax does not apply); (2) other gross income derived from any trade or business to which the tax applies; and (3) net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property other than property held in a trade or business to which the tax does not apply.
In the case of a trade or business, the tax applies if (1) the trade or business is a passive activity with respect to the taxpayer; or (2) the trade or business consists of trading financial instruments or commodities.
The tax does not apply to other trades or businesses.
In the case of the disposition of a partnership interest or stock in an S corporation, gain or loss is taken into account only to the extent gain or loss would be taken into account by the partner or shareholder if the entity had sold all its properties for fair market value immediately before the disposition. Thus, only net gain or loss attributable to property held by the entity that is not property attributable to an active trade or business is taken into account. No guidance has been issued yet on the mechanics of actually applying this rule.
However, if you are contemplating the disposition of an interest in a partnership or S corporation in the near future and the disposition will generate gain, we should explore whether or not disposing of the interest this year, as opposed to next year, would produce any tax savings. Alternatively, we may want to explore ways to shelter such gain next year. Such strategies might include planning to keep your net investment income or modified adjusted gross income beneath the applicable threshold.
Tax Rates, Capital Gains and Losses, and Dividends
Probably the biggest unknown for 2013 is the direction that tax rates will go for ordinary income as well as capital gains. Currently, capital gains are generally taxed at a rate of (1) 15 percent, if the regular tax rate that would apply to the taxpayer is 25 percent or higher; and (2) 0 percent, if the regular tax rate that would apply to the taxpayer is lower than 25 percent. Higher tax rates apply to gain from collectibles, qualified small business stock, and unrecaptured Section 1250 gain. The maximum capital gains rate that applies to sales or exchanges of capital assets other than collectibles, qualified small business stock, and unrecaptured Section 1250 gain is scheduled to increase to 20 percent (10 percent if the taxpayer is in the 15 percent income tax bracket).
Also, special rule allows “qualified dividends” to be taxed at the capital gains rates. However, this special rule is scheduled to terminate at the end of 2012. After that, the distinction between qualified dividends and other ordinary dividends disappears, and all ordinary dividends will be taxed at ordinary income rates.
Thus, if you control a C corporation and want to take cash out of the corporation, you should consider paying a dividend to yourself in 2012 to the extent it otherwise makes financial sense to do so.
If you have a corporation you’ve been thinking of liquidating, doing so before year end would be preferable if the liquidation will result in a gain. You not only get the reduced capital gains rates on the gain, but you’ll avoid the 3.8 percent Medicare tax on the amounts over the applicable threshold.
Section 179 Expenses Deduction
In 2012, your business can deduct up to $139,000 of Section 179 property placed in service during the tax year, subject to certain limitations. If the cost of Section 179 property placed in service during 2012 is more than $560,000, the Section 179 deduction is limited. Section 179 property is generally tangible personal property placed in service in your trade or business. It does not include buildings or land.
For 2013, the Section 179 deduction will be limited to $25,000, subject to certain limitations. If the cost of Section 179 property placed in service during 2013 is $200,000 or more, no Section 179 deduction is allowed.
Thus, if you are anticipating any large purchases in the next several months, it may be advantageous to accelerate such purchases into the current year to take advantage of this deduction. In the past, this deduction has been extended by tax legislation late in the year. While that may happen again, it is not something we can count on.
In addition, special limitations apply to sport utility vehicles (SUVs). Generally, any Code Sec. 179 deduction is limited to $25,000 for SUVs.
A 50-percent additional first-year depreciation deduction is available for qualified property placed in service before 2013. So if you are planning on purchasing depreciable property in early 2013, you may want to move the purchase up to December to take advantage of this tax benefit.
Although the additional first year depreciation deduction is generally scheduled to disappear after 2012, the placed-in-service date is extended through 2013 for certain long-lived property and transportation property.
Health Insurance Tax Credit for Covering Employees
If you are not already doing so, and if your small business qualifies, you might be eligible for a fairly significant tax credit for providing health insurance coverage to your employees. The credit can be as much as 35 percent of your insurance premium payments.
Work Opportunity Credit
A business is allowed a 40 percent credit for qualified first-year wages paid or incurred during the tax year to individuals who are members of a targeted group of employees. While this credit generally expired in 2011, it’s still in effect for 2012, but not beyond that, in the case of qualified veterans that your business hires.
Adoption Assistance Programs
If your business currently has an adoption assistance program in place, the tax-free benefits of the program are scheduled to end this year. Thus, any amounts paid under the program in 2013 will be taxable to the employee and, thus, subject to income tax withholding.
Educational Assistance Program
If your business currently has an educational assistance program in place, the tax-free benefits of the program are scheduled to end this year. Thus, any amounts paid under the program in 2013 will be taxable to the employee and, thus, subject to income tax withholding, except to the extent the payments meet the requirements for a qualified scholarship or the payments are for job-related education that qualifies as a working condition fringe benefit.
Please call me at your convenience so we can set up an appointment and estimate your business’s tax liability for the year and discuss any questions you may have.
Murray Tax Services
*CIRCULAR 230 DISCLOSURE: Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained herein is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.