Many small business owners exhaled a collective sigh of relief after the 11th-hour passage of the American Taxpayer Relief Act of 2012. While most of the Bush era tax cuts have been extended or made permanent, uncertainty lingers around the potential impact of higher payroll taxes and surtaxes related to the Affordable Care Act (often referred to as ObamaCare). Small businesses owners are now scrambling to adjust their returns for 2012 to take advantage of retroactive deductions and implement tax strategies for 2013. And those that fall into the new higher income marginal rate will likely see their taxes rise this year and beyond.
While some provisions were made permanent, like marginal tax rates and alternative minimum tax (AMT) exemption amounts, estate and gift tax exemption levels, other deductions and credits have only been extended through this year. “I have a greater sense of certainty when it comes to tax planning for 2013,” notes Andrew Schrage, co-owner of Money Crashers Personal Finance. “I no longer have to guess, which makes for a more streamlined roadmap as I plan my finances throughout the year.”
Kent Reed, owner of franchised brokerage services company Murphy Business & Financial Corp. in Atlanta, Georgia, was disappointed with the final deal. He had hoped for more comprehensive tax reform, as Reed and the small and medium-sized businesses he consults regard the tax code as an obstacle when it comes to strategizing. “Before we can even adjust, they change it,” notes Reed. “It makes it very difficult to plan long term.” Reed decided to postpone filing for 2012 to see if there are any deductions he can take.
“For small business owners looking to put new assets into service or build out their space, it’s a good year to do it,” notes Claudia Lazzarato, tax manager at Pleasanton, California-based tax and accounting firm Sensiba San Filippo. Deductions set to expire or be reduced significantly were extended for 2013. Scheduled to drop to $25,000 before the fiscal cliff deal, limits for Section 179, which allows small businesses to deduct qualified equipment purchases, were increased from $125,000 in 2012 to $500,000 for companies with less than $2 million in qualified capital expenditures for 2013 and 2012, retroactively. Set to expire at the end of 2012, the deduction for 50-percent bonus depreciation was extended through the end of 2013 (2014 for certain types of property).
Alternative minimum tax exemption amounts have been permanently increased from $33,750 to $50,600 for single filers and from $45,000 to $78,750 for married couples filing jointly. “Now that these amounts are set, we know how hard our clients will be hit by AMT and whether there’s a way to avoid it,” Lazzarato points out.
Certain tax credits also remain in place through this year. The research and development (R&D) credit, which expired at the end of 2011, was extended through 2013 and made retroactive through 2012, as was the work opportunity credit for employers that hire veterans or those from groups that have faced barriers to employment.
Among the Bush era tax provisions made permanent are the six federal income tax brackets (10-35 percent), with the addition of a top bracket (39.6 percent) for higher income taxpayers ($400,000 individuals/$450,000 married couples filing jointly), and the 15-percent tax on capital gains and dividends (increased to 20 percent for income at or above that top bracket). “As most small businesses are structured so revenues flow through to their personal income, it’s an especially important planning point to try to stay below that higher income threshold,” explains Lazzarato. Scheduled to drop to $1 million, the estate and gift tax exemption has been made permanent at $5 million (indexed for inflation), along with the exclusion amount "portable" between spouses. “This is good news for family-owned businesses and small business owners gifting business stock,” notes Lazzarato.
Even those small business owners that remain below the higher income threshold, their taxes will rise to some extent, as Social Security payroll taxes have returned to their pre-2011 rate of 6.2 percent (up from 4.2 percent). “It makes it all the more important for small business owners to decide how to invest money coming in as a means of managing their taxable income,” explains Lazzarato. And the fiscal cliff deal did not postpone the implementation of the Affordable Care Act surtax of 0.9 percent on earned income above certain threshold ($200,000 for single filers; $250,000 married) and 3.8 percent on the lesser of net investment income or modified gross income over these amounts. For this reason, Reed has postponed adding new staff through at least the first quarter until the effects of these higher taxes can be measured.
To complicate matters, personal and dependency exemptions have been phased out for those in the higher income brackets (adjusted gross income $300,000 married filing jointly; $250,000 single), who may also be subject to limits on itemized deductions. Schrage has decided to hire an accountant for the first time. “Up until now, I’ve always used Turbo Tax,” notes Schrage. “But I just don’t feel comfortable filing my own returns this year.”
Reed expects to pay $4,000-$6,000 in additional taxes this year, depending on where the AMT hits. His accountant has recommended changing the structure of his business from an LLC to an S Corp, allowing profits to be split between salary and S corporation distributions. “Rather than being on a cash basis from year to year, we’d accrue and have some stock,” explains Reed. While his salary would be subject to payroll taxes, dividend distributions are not. “You want to put more money into goodwill and capital gains because you’re taxed at a lower rate.”
Another tax benefit for S Corps is the retroactive restoration of the shareholder basis rule for stock in S corporations that make charitable donations of appreciated assets for 2012 and 2013. “Under the temporary incentive, shareholders reduce their basis (or value) in the stock of the S corporation by their pro rata share of the adjusted basis (typically the smaller amount) of the contributed property, rather than by the fair market value (typically the larger amount) of the charitable contribution,” explains Lazzarato. “The lower basis reduction for charitable gifts benefits the shareholders because their value (basis) in the stock remains higher while reducing taxable income by the higher amount (fair market value).”
“You don’t want to base all your business decisions on taxes,” cautions Lazzarato. “But you should at least calculate them beforehand so you know what to expect at the end of the year.” While there seems to be less uncertainty now, many small business owners have a wait-and-see attitude about how the deal will affect their bottom line. Schrage would like to see all deductions/credits for small business made permanent, though he’s not holding his breath. “That would take a lot of the guesswork out of hiring.”