BUSINESS YEAR-END PLANNING

This year-end provides unique opportunities for virtually every business to reassess their business plan with an eye toward maximizing tax savings in 2013 and, even, for 2014 and beyond. This year, shareholders and other business owners face a new landscape of tax rates for “higher income” individuals including  a 39.6 percent maximum income tax rate, a 20 percent maximum tax rate on capital gains and dividends, a 3.8 percent net investment income tax, and a 0.9 percent Medicare compensation surtax. New as well are requirements and opportunities surrounding the tax treatment of repairs, improvements, acquisition costs and other common business expenses.

Further, some of the usual tax breaks for businesses are coming to an end in 2013, if Congress does not renew them. 2013 may provide the last chance for businesses to take advantage of bonus depreciation, enhanced “section 179” expensing, and the work opportunity credit. Finally, although the “employer mandate” under the new health care reform law was recently postponed from 2014 to 2015, now is not too early to start planning to comply with rules that will be based on the number of employees on January 1, 2014.

Bonus depreciation

Bonus depreciation is scheduled to end in 2013. Bonus depreciation is for new property (i.e., property whose original use begins with the taxpayer) and includes tangible personal property, purchased computer software and qualifying leasehold improvement property. A taxpayer is entitled to the full, 50-percent bonus depreciation irrespective of when during the year the asset is purchased.

Code Section 179 Expensing

Until the end of the year, taxpayers can elect to expense up to $500,000 of qualifying property additions. Next year, that limit plunges to just $25,000.  So, if you know you will buying such property in 2014, consider doing it before the end of the 2013 year.

Section 179 property is generally defined as new or used depreciable tangible property that is purchased for use in the active conduct of a trade or business. Off-the-shelf computer software is also included for 2013, as is qualified real property (up to $250,000). Both of these latter types of property will no longer qualify for section 179 expensing at all after 2013.

Tax Credits

The 2012 Taxpayer Relief Act extends the Research Credit to apply to any amounts paid or incurred for qualified research and experimentation before January 1, 2014.

The Work Opportunity Credit for all targeted groups is extended through December 31, 2013. Therefore, the credit applies with respect to wages paid to persons who begin work for the employer before January 1, 2014.

Revised Repair/Capitalization Rules

The IRS recently issued long-awaited comprehensive final rules on the treatment of payments to acquire, produce or improve tangible property. In 2014, businesses must use these new rules in determining whether they can deduct their costs as repairs instead of  capitalizing the costs.  Businesses will benefit if certain procedures for treating expenses are put into place by January 1, 2014. Some businesses will be better off if they start applying the new rules retroactively to the 2012 and 2013 tax years. Many of these decisions require advance planning.

Pass-through Issues

Many business operations are not taxed at the entity level as corporations but, instead, pass through taxable profits and losses to their unincorporated owners or to their S corporation shareholders. Starting in 2013, these owners face new year-end planning challenges in the form of a higher individual tax rates and additional surtaxes on passive income by way of the net investment income surtax of 3.8 percent and the Additional Medicare Tax of 0.9 percent on compensation, both aimed at the “higher-income” taxpayers. Deferring some of this income, or harvesting losses to offset some of the income, are traditional year-end planning techniques that take on added value for the 2013 year-end tax year.

Based on all that is new and all that may be expiring in 2013, many businesses can benefit from a fresh assessment of how year-end tax planning can help reduce their overall tax liability for both 2013 and 2014.

PERSONAL YEAR-END PLANNING

As the end of the year gets closer, there is still time to think about  year-end tax planning to minimize your 2013 tax liability. New tax legislation has brought greater certainty to year-end planning, but has also created new challenges. The number of changes made to the tax rules and the opportunities these changes bring may seem overwhelming. This letter is intended to be a mile-high view of some key year-end tax planning strategies.

Expiring Tax Incentives

Some tax incentives are set to expire at the end of this year, unless extended by Congress. So, you might want to take advantage of them this year. For example, there are only a few weeks left to make a tax-free distribution by those age 70-1/2 or older from IRAs for charitable purposes. And, now is the time to take advantage of a tax credit for making certain energy efficient home improvements. Finally, you might want to accelerate into 2013 the purchase of big ticket items that you were going to make in 2014 to take advantage of the deductibility of the sales tax.

New Taxes and Rates

Not surprisingly, some individuals may be surprised that they owe additional taxes in 2013. Three new taxes are in effect for 2013: the Additional Medicare Tax, a revived 39.6 percent tax bracket for higher income individuals, and the 3.8-percent Net Investment Income surtax.

The Additional Medicare Tax of .9% applies to wages and self-employment income above $250,000 for married couples filing joint returns and $200,000 for single individuals.

The starting points for the 39.6 percent bracket for 2013 are $450,000 for married couples filing jointly and  $400,000 for single filers. Also revived for 2013 are the personal exemption phase outs and the limitation on itemized deductions for higher income individuals. Capital gains rates for individuals in this highest tax bracket increase to 20%, starting in 2013.

The new Net Investment Income surtax applies to individuals, estates and trusts that have certain investment income above $250,000 threshold for married couples filing jointly and $200,000 for single filers. However, qualified dividends received from domestic corporations and qualified foreign corporations continue to be taxed at the same rates that apply to capital gains.

A summary of the new 2013 rates in comparison to the 2012 rates is as follows:

	Wages	Long-term capital gains	Qualified dividends	Passive income	Active income from general partnership	Active income from S corp
2012 highest tax bracket	35%	15%	15%	35%	35%	35%
Medicare tax on earned income	1.45%	0%	0%	0%	2.90%	0%
2012 highest marginal tax rate	36.45%	15%	15%	35%	37.90%	35%
Expiration of tax cuts in 2013	4.60%	5%	5%	4.60%	4.60%	4.60%
2013 highest marginal income tax rate	41.05%	20%	20%	39.60%	42.50%	39.60%
Net investment income tax effective in 2013	0.90%	3.80%	3.80%	3.80%	0.90%	0%
2013 top total tax rate	41.95%	23.80%	23.80%	43.40%	43.40%	39.60%
Increase from 2012 to 2013	5.50%	8.80%	8.80%	8.40%	5.50%	4.60%

Planning for gifts

Gift-giving is often overlooked as a year-end planning strategy. For 2013, individuals can make tax-free gifts (no tax consequences for the giver or the recipient) of up to $14,000 to any individual. Married couples may “split” their gifts to each recipient, which effectively raises the tax-free gift to $28,000.

There are special rules for gifts made for medical care and education that can be a valuable component of a year-end tax strategy, especially for individuals who want to help a family member or friend. Monetary gifts given directly to a college to pay tuition or to a medical service provider have no tax consequences to the person making the gift and the person benefiting from education or medical care.

Traditional Tax Planning

Traditional year-end planning techniques nevertheless remain important for 2013. As always, tax planning requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. The deferral of income and the acceleration of deductions and credits  may be used to reduce an individual taxpayer’s income tax liability:

Income Deferral:

• Defer billings and collections
• Receive bonuses earned for 2013 in 2014
• Sell appreciated assets in 2014
• Offset tax losses against current gains (loss harvesting)
• Postpone the redemption of U.S. Savings Bonds
• Delay Roth conversions to 2014
• Defer debt forgiveness income if possible
• Minimize retirement distributions
• Execute like-kind exchange transactions

Deductions/Credit Acceleration:

• Bunch itemized deductions into 2013 in order to use the standard deduction into 2014
• Accelerate deductible bill payments into 2013
• Pay last state estimated tax installment in 2013 instead of 2014
• Minimize the effect of  AGI limitations on deductions and credits
• Maximize net investment interest deductions
• Match passive activity income and losses

Every tax situation is different and requires a careful and comprehensive plan. We can assist you in aligning traditional year-end techniques with strategies for dealing with any unconventional issues that you may have. Please call your tax professional at our office for an appointment.

Congress took the nation to the very edge of the fiscal cliff before passing a few critically important measures. To refresh your memory, the fiscal cliff was created in 2011 by Congress as a way to kick down the road (to New Year’s Eve in 2012) a can full of certain politically contentious issues.

It was set up so that a lot of bad things would happen if Congress did nothing, such as automatic tax increases and automatic spending cuts. Unfortunately, the political climate did not improve in those 18 months, and compromise became increasingly difficult.

Changes to Tax Rules

At the last minute, perhaps to avoid being responsible for tax increases, Congress eliminated the automatic expiration of the Bush era tax cuts except for those individuals making more than $400,000 or couples making more than $450,000. Congress addressed the spending cuts part of the problem by kicking that can down the road into March 2013. So, it seems we will be blessed by many of the same arguments in a few months.

In 2013, the top income rate will increase to 39.6% (from 35%) on ordinary income and to 20% (from 15%) on capital gains and qualified dividends. Moreover, the Affordable Healthcare Act implemented a new surtax of 3.8% that will be imposed on investment type income and gains for the same high-income taxpayers, increasing the tax on investment income to a maximum of 23.8%. In addition, there will be new limits on the deductions for personal exemptions and itemized deductions. Finally, the 2% reduction in payroll taxes temporarily enacted in 2008 was not extended.

Several individual provisions were extended into 2013, including qualified tuition expenses and education credits, mortgage insurance premiums treated as qualified residence interest, distributions from IRA’s for charitable purposes, sales tax deduction in lieu of state income taxes, and an inflation adjustment fix to the Alternative Minimum Tax (AMT) liability.

Business income tax rates are not changing. There were a few provisions that were extended or modified. They include research tax credits and production tax credits, certain energy credits and more generous expensing of property and equipment extended through 2013.

We would be happy to help you apply the new rules to your estimated 2013 tax liability for calculating withholding and estimated payments.

Business owners and individuals across the country are watching (perhaps anxiously) to see if Congressional lawmakers are able to get down to business and prevent going head first over the “fiscal cliff”, the potential effect of the expiration of many tax provisions and required spending cuts to begin in 2013. Here are some of the more important changes that will go into effect this coming January if Congress does nothing.

New Taxes and Changes in Rates

Many individuals, estates, and trusts will pay an additional 3.8% tax on net investment income. Net investment income includes dividends, interest (except from municipal bonds), net capital gains, rents, royalties, and investment annuities. The additional tax kicks in for most joint filers with modified adjusted gross income of $250,000 or more. Dividends will be taxed at ordinary rates (versus 15% currently) and the capital gains rate will increase to 20% (from 15% currently). The potential additional tax should be considered when you are managing 2012 gains and losses.

Estate Taxes and Exemptions

The current $5 million exemption from gift taxes expires at the end of the year. It might be a good opportunity to consider additional gifts this year if you have not utilized the full $5 million exemption as the tax impact of gifts could be more expensive beginning next year. Absent Congressional action, the top rate will go to 55% after only a $1 million exemption. The current House approved bill extends the current 35% rate and $5 million exemption while the Obama budget proposes a top rate of 45% and only a $3.5 million exemption.

Repair and Maintenance Expense Changes

Last February we described the new depreciation regulations involving tangible property. Recognizing the complexity of the new rules, the IRS has issued Notice 2012-73 alerting taxpayers that changes will be made to the regulations to revise the de minimis provision, the treatment of dispositions, and safe harbor rule for routine maintenance. The final regulations for these topics will be effective for years beginning after December 31, 2013. The other provisions of the new regulations can be applied to tax years beginning after December 31, 2011. The changes will allow taxpayers to consider which portions of the new regulations (originally enacted or the subsequent changes) are most favorable to each taxpayer. Moreover, it will allow for additional time to evaluate the impact of the new regulations so that everyone can develop an implementation plan.

Reimbursable Expense Plans

IRS Revenue Ruling 2012-25 clarified the tax treatment for employers and employees of expense reimbursement programs by considering four fact patterns. The first three illustrate how an employer incorrectly characterizes wages as nontaxable reimbursements when the employer pays the same amount regardless of whether the employee actually incurs or submits documentation of expenses related to the employer’s business. The fourth fact pattern supports the treatment as a reimbursement only when an employee provides proper substantiation for deductible mileage and other expenses that were actually incurred by the employee.

Other Matters

The reimbursement rate for standard mileage for 2013 is increased to 56.6 cents per mile for business travel.

The IRS is contacting more taxpayers for field or correspondence audits. Between the 2010 and 2011 fiscal year the number of IRS examinations increased 12.3% for Partnership and S corporation returns. That trend is expected to continue.

For several years the IRS has been matching more information on individual returns to the amounts on information returns (Forms 1099, 1098, W-2 and Schedule K-1). Beginning in 2013, the IRS will begin the same sort of matching program for partnerships and corporations. With similar increases in matching programs at the state level, everyone can expect the correspondence notices to increase substantially in the coming years.

As always, if you have questions please call your BKM Sowan Horan tax professionals. Due to the uncertainty of what Congress might actually do, we encourage you to contact us soon in order to discuss the possibilities regarding your specific situation.