Thomson Reuters Tax Analyst offers U.S. business tax tips to consider-while there's still time
NEW YORK, Nov. 12, 2012-A "perfect storm" (of the tax kind) awaits small businesses on January 1, 2013," said Jim Keller, a senior tax analyst for Thomson Reuters.
That day, the maximum ordinary income tax rate for individuals increases from 35 percent to 39.6 percent, the maximum tax rate on long-term capital gains increases from 15 percent to 20 percent, and the maximum tax rate for qualified dividends skyrockets from 15 percent to the 39.6 percent top ordinary income tax rate. Several tax breaks expire on December 31, 2012 as well, including 50 percent bonus depreciation and the increased Section 179 deduction amount. Additionally, the $5.12 million basic exclusion amount for lifetime gifts and testamentary transfers by a decedent will fall to $1 million on January 1, 2013.
Why are individual tax rates important in the taxation of businesses? Because most small businesses are taxed as single-owner sole proprietorships or S corporations, or as multi-owner pass-through entities-either partnerships, LLCs taxed as partnerships, or S corporations-where the results of operations are passed through and taxed to the individual partners, members, or shareholders.
Also as part of the perfect storm, two new Medicare taxes will take effect on January 1, 2013. Individuals earning more than $200,000 ($250,000 if married filing jointly, $125,000 if married filing separately) will pay an additional 0.9 percent Medicare tax on wages exceeding those base amounts. Self-employed persons earning more than the threshold amounts will pay the additional tax on amounts above the thresholds. In addition, a new 3.8 percent Medicare tax will apply to some or all of the net investment income of persons with an adjusted gross income (AGI) above $200,000 ($250,000 for married filing jointly, $125,000 for married filing separately).
As shown by the following table, business owners will face a new tax world on January 1, 2013:
Tax Rate on|
December 31, 2012
Tax Rate on|
January 1, 2013
|Top Individual Income Tax Rate||35%||39.6%|
|Additional Medicare Tax on Wages||N/A||.9%|
|Medicare Contribution Tax on Investments||N/A||3.8%|
|Maximum Rate on Long-Term Capital Gains||15%*||20%|
|Maximum Rate on Qualified Dividends||15%*||39.6%|
|Top Marginal Rate on Long-Term Capital Gains||15%*||23.8% (20% + 3.8%)|
|Highest Marginal Rate on Wages||35%||40.5% (39.6% + .9%)|
|Top Marginal Rate on Qualified Dividends||15%*||43.4% (39.6% + 3.8%)|
|* 0% for Persons with Marginal Tax Rate < 25%|
Congress may take action before year-end, such as by extending the status quo for another year. However, "given the certainty in tax rates through December 31, 2012, and the uncertainty in tax rates thereafter, businesses and their practitioners should consider taking action by year-end to cut their tax bill," said Keller.
Following are the top ten small business tax-saving ideas to consider-while there's still time.
1. Sell Corporate Stock, Partnership Interests, and LLC Interests. Gain or loss from the sale of a business interest is generally treated as capital gain or loss. Therefore, stock, and partnership and LLC interests, should be sold by December 31, 2012 to take advantage of the 15 percent or 0 percent long-term capital gain rate. If a prior year sale qualified as an installment sale, the taxpayer can accelerate note collections into 2012. For sales occurring in 2012, the taxpayer can elect out of the installment method, which will pull the proceeds into 2012 to be taxed at 2012's lower tax rates.
2. Give Business Interests to Family Members. The applicable exclusion amount for 2012 offsets tax on cumulative lifetime gifts and testamentary transfers of $5.12 million; however, this amount falls to $1 million in 2013. Similar tax benefits can result from transferring stock to a family limited partnership (FLP) and gifting FLP interests to family members-gift tax is avoided or reduced by the increased applicable exclusion amount. Plus, appropriate valuation discounts, such as the minority interest discount, can be claimed for the transfer. This provides a unique giving opportunity for the rest of 2012.
3. Purchase Property Eligible for Section 179 Deduction. The maximum Section 179 deduction is $139,000 for eligible property placed in service in tax years beginning in 2012. This amount is reduced dollar for dollar by the excess of qualified property placed in service during the tax year over $560,000. Unless Congress takes further action, the maximum Section 179 deduction for tax years beginning in 2013 will be $25,000, and the phase-out threshold will be $200,000. However, watch out if the business is expected to have (or is close to) a tax loss for the tax year, advised Keller. There is an income limitation too, so Section 179 deductions that create or increase a business tax loss are disallowed, with the excess carried over to the following tax year.
4. Purchase Property Eligible for Bonus Depreciation. The Tax Relief Act of 2010 authorized 50 percent bonus depreciation for qualified property acquired and placed in service by December 31, 2012 (which is extended one year for certain longer-lived assets). For new passenger autos or light trucks used 100 percent for business and subject to the luxury auto depreciation limitations, the bonus depreciation break increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service in 2012. Under current law, there is no bonus depreciation or extra $8,000 auto or light truck depreciation limitation after December 31, 2012.
5. Redeem a Shareholder's Stock. A shareholder who wants the corporation to redeem some or all of his or her stock should complete the redemption by the end of 2012. Whether the redemption is treated as a sale or exchange (capital gain) or a nonliquidating corporate distribution (dividend to the extent of the corporation's earnings and profits, and possible capital gain thereafter), the 2013 long-term capital gain and dividend tax rates are scheduled to be higher than the 2012 rates.
6. Liquidate the Business. Owners planning on liquidating the business should do so by the end of 2012 to use the 15 percent long-term capital gain and dividend tax rates. The 2013 rates for these taxes are scheduled to be 20 percent for long-term capital gains, and ordinary income tax rates for dividends. While an installment sale is normally a good idea because it defers tax until later years when the payments are received, deferral is undesirable when future payments are taxed at a higher rate. To tax the gain in 2012, the owner can elect out of the installment method for the liquidation gain on his or her 2012 Form 1040 (the tax return for the year the liquidating distribution is received).
7. Distribute C Corporation Earnings and Profits. Shareholders recognize a taxable dividend to the extent the distribution is paid out of corporate earnings and profits (E&P). If the distribution exceeds E&P, the excess reduces the shareholder's stock basis, with any amount in excess of the shareholder's stock basis treated as capital gain. Once again, with shareholders facing a major increase in the tax rate on dividends in 2013, the rest of 2012 presents a great opportunity to clear out some or all of the corporation's E&P at a low (and in some cases zero) tax rate.
8. Distribute S Corporation Earnings and Profits. S corporations sometimes have a substantial amount of accumulated earnings and profits (AE&P) because they formerly were a C corporation or acquired the assets of another corporation that had AE&P. AE&P can subject the S corporation to a tax on net passive income and can terminate the S election if the corporation has AE&P and passive investment income in excess of 25 percent of gross receipts for three consecutive years. In addition, AE&P can cause distributions to be taxed as dividends. "The solution to these problems is to distribute AE&P now by taking advantage of the maximum 15 percent dividend tax rate through the end of 2012," advised Keller.
9. Make an S Corporation Deemed Dividend. An S corporation that has a significant amount of AE&P but little or no cash or other property to make distributions can make a deemed dividend to one or more shareholders. A deemed dividend is a hypothetical distribution of AE&P to the shareholders on the last day of the corporation's tax year, and is useful to corporations that lack assets to make a distribution because no actual distribution of cash or property is required. In the right situation, a deemed dividend can be a great way to clear out AE&P before the dividend tax rate increases on January 1, 2013.
10. Minimize Self-employment (SE) Taxation. Partnership business income allocable to general partners and guaranteed payments to limited or general partners for services are subject to the SE tax. LLC members are subject to SE tax on their earnings from business activities unless they are classified as limited partners. Next year, a new 0.9 percent Medicare surtax will be imposed on SE income in excess of specified threshold amounts. It may be possible to lower the SE tax impact by using a corporation to hold the partnership or LLC interest (e.g., to limit liability), leasing property to the business (assuming that leasing is not a trade or business), structuring retirement payments to meet a special SE tax exception, or employing family members and paying them deductible wages to cover their living expenses.
Next Step. Business owners should consult with a professional advisor before applying these tax saving tips. And as noted, subsequent action by Congress may affect one or more of these strategies.
Up-to-date analyses of legislation and regulations affecting taxpayers are available on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.
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