It’s Time for Mid-Year Tax Planning
Early this year, the American Taxpayer Relief Act (ATRA) triggered a flurry of activity as taxpayers scrambled to assess the new law’s impact on their 2012 tax bills. Now that the dust has settled, it’s a good time to embark on some mid-year tax planning. Businesses, in particular, have many tax-saving opportunities, some of which might not be available next year. ATRA provides other opportunities, as well.
Invest in Equipment and Other Depreciable Assets
If your business needs new equipment or other depreciable property, consider acquiring it this year to take advantage of enhanced deductions before they expire.
Internal Revenue Code Section 179 allows a business to immediately “expense” the full cost of equipment, machinery, furniture, vehicles and other qualifying assets. Before ATRA, the limit on Sec. 179 deductions had been scheduled to drop to $25,000 for 2013. And the investment phaseout threshold (above which the Sec. 179 deduction is reduced dollar-for-dollar) was to fall to $200,000. But ATRA extended previous limits of $500,000 and $2 million, respectively, through Dec. 31, 2013.
Be aware that Sec. 179 expensing can’t reduce taxable income below zero to create a net operating loss. And, because of the phaseout, businesses that invest $2.5 million or more won’t benefit, because their deduction will be completely phased out.
Fortunately, this doesn’t mean that businesses making larger investments can’t enjoy enhanced depreciation-related breaks under ATRA. The act also extended 50% bonus depreciation through the end of 2013 (2014 for certain transportation and longer-period production property). This provision allows you to immediately write off 50% of the cost of certain capital expenditures, including tangible property with a recovery period of 20 years or less, purchased computer software, water utility property and qualified leasehold improvement property.
Unlike Sec. 179 expensing, which is available for new or used property, bonus depreciation is available only for “original use” property. Generally, this means new property, but in some cases bonus depreciation is available for property a taxpayer converts from personal to business use.
The new law also extends 15-year accelerated depreciation for qualified leasehold and retail improvements and qualified restaurant property placed in service by the end of 2013. And it allows up to $250,000 of the Sec. 179 deduction to be applied to such property. Finally, it allows 50% bonus depreciation to be applied to qualified leasehold improvement property.
Claim Research Credits
The tax credit for increased research expenditures expired at the end of 2011, but ATRA revived it through Dec. 31, 2013. This valuable credit is complex and widely misunderstood and, as a result, is often overlooked.
If your business conducts research in connection with developing new or improved products, technologies or processes, consult your tax advisor to determine whether you qualify for the credit. It’s available to businesses in a wide range of industries, including manufacturing, technology, health care, construction, agriculture, and even retail and finance.
Set Up a Deferred Compensation Plan
If you haven’t done so already, consider setting up a nonqualified deferred compensation plan for your highly compensated employees. Significant tax increases this year for high earners make these plans an attractive employee recruitment and retention tool.
A nonqualified deferred compensation plan enables highly compensated employees to defer a portion of their salaries on a pretax basis, reducing the impact of higher tax rates or even moving employees into a lower bracket. It also allows them to set aside funds for retirement well in excess of contribution limits for 401(k) and other qualified plans. This year, the maximum employee deferral to a 401(k) plan is $17,500 ($23,000 for employees 50 or older by the end of the year).
As you consider the benefits of nonqualified deferred compensation, keep in mind that your contributions won’t be deductible until your employees actually receive them. Also, familiarize yourself with Internal Revenue Code Sec. 409A, which imposes strict requirements on the timing of deferred compensation. (See the sidebar “Deferred comp: Timing is everything.”)
These are only some of the opportunities to consider in light of ATRA. You may benefit from other extended breaks as well, such as the Work Opportunity credit for hiring veterans and people from certain disadvantaged groups, or a wide variety of energy-related breaks. As you consider your tax-planning options for 2013 and beyond, also keep an eye on Congress. New legislation may require you to alter your tax strategies.
Sidebar: Deferred Comp: Timing is Everything
A nonqualified deferred compensation plan offers valuable benefits for highly compensated employees. To avoid losing these benefits, it’s critical for employers and employees to comply with Internal Revenue Code Section 409A. Among that section’s requirements:
- Employees must make deferral elections before the beginning of the year in which they earn the compensation being deferred (except for certain performance-based compensation).
- Benefits must be paid on a specified date, according to a fixed payment schedule or on the occurrence of a specified event (such as death, disability or termination of employment).
- Once compensation is deferred, payments can be delayed (by five years or more) but not accelerated. Elections to delay benefits must be made at least 12 months in advance.
What if employees want to defer a portion of this year’s compensation to soften the blow of higher taxes? Ordinarily, they’d be required to have made the deferral election in 2012, but there’s an exception for newly established plans and new participants in existing plans: Employees can defer 2013 compensation, provided they make the election within 30 days after they become eligible.
Charitable Deductions: Form Over Substance
To support a charitable deduction, you need to comply with IRS substantiation requirements. This generally includes obtaining a contemporaneous written acknowledgment from the charity stating the amount of the donation, whether you received any goods or services in consideration for the donation, and the value of any such goods or services. “Contemporaneous” means the earlier of 1) the date you file your tax return, or 2) the extended due date of your return.
A recent U.S. Tax Court case (Durden) demonstrates the importance of obtaining proper acknowledgment on a timely basis. In that case, the taxpayers claimed deductions for donations to their church, substantiating them with canceled checks and a written acknowledgment from the church.
The IRS denied the deduction, however, because the acknowledgment failed to state whether the taxpayers received goods or services in consideration of their donations. The taxpayers obtained a second acknowledgment from the church that contained the required statement, but the IRS — and the Tax Court — refused to accept it because it wasn’t “contemporaneous.”
Home office deduction simplified
Earlier this year, the IRS announced an optional “safe harbor” method for claiming the home office deduction. Beginning with their 2013 tax returns, taxpayers can use this method in lieu of calculating, allocating and substantiating their actual expenses. Other rules — such as the requirement that the office be used regularly and exclusively for business — still apply.
The safe harbor deduction is capped at $1,500 per year, based on $5 per square foot up to a maximum of 300 square feet. Homeowners who take advantage of the safe harbor can’t depreciate the business portion of their homes, but they can claim allowable mortgage interest, property taxes and casualty losses on the home as itemized deductions — without allocating between personal and business use.
The safe harbor doesn’t limit deductions for business expenses unrelated to the home.
Now may be the time to buy QSBS
The American Taxpayer Relief Act extended the 100% exclusion for gain on sales of qualified small business stock (QSBS) to QSBS acquired through 2013. If you invest in QSBS by the end of this year and hold the stock for more than five years, you’ll be able to sell it tax-free. The requirements for a stock to qualify as QSBS are complicated, but your tax advisor can help determine whether a particular stock is eligible for this tax break.