In Dec. 2010, as most businesses and their individual owners were focused on year-end planning, the uncertainty of the passing of the tax relief bill complicated the process. If Congress did nothing, the capital and individual tax rates would have increased and various credits and incentives would have been lost.
But when Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), the provisions of the act came as a pleasant surprise to many taxpayers, according to Mark Ulishney, CPA, a partner with Crowe Horwath LLP.
“When President Obama signed the act into law on December 17, many of the current rates that were already in place were extended,” said Ulishney. “Capital gains rates were extended at 15 percent through Dec. 31, 2012. In addition, the highest individual tax rate remained at 35 percent instead of increasing to 39.6 percent, as many expected. While many taxpayers expected rates to go up, Congress decided to keep them status quo to help stimulate the economy.”
Smart Business spoke with Ulishney about how the new tax law will benefit businesses and their individual owners.
What impact do the changes have on the year-end planning that was done before the act was passed?
The uncertainty that existed at the end of last year made planning challenging. As businesses and their individual owners were working with their tax advisers in early December, they were contemplating whether the capital gain and ordinary rates would increase. Individuals needed to decide whether to hold investments or sell to take advantage of the expiring lower capital gain rates. Businesses (especially flow-through entities) that paid taxes at the individual level needed to determine whether to accelerate income or deductions in order to achieve the greatest tax benefit between 2010 and 2011, if individual rates were to increase. When the act passed right before the holidays, some decisions already planned may not have been the most effective.
The individual tax rate also has an impact on business enterprises that are flow-though entities. For C corporations, the tax rate, in many cases, is 35 percent. But for S corporations, partnerships, and LLCs — common flow-through entities — the income or loss is passed through to the individual’s tax return. As a result, if the individual rate increased to 39.6 percent, entrepreneurs would need to reconsider from a tax perspective if remaining a flow-through entity would be the most beneficial form of entity given that the expected highest individual tax rate of 39.6 percent would exceed the maximum corporate tax rate by 4.6 percent.
How has bonus depreciation changed under the new law?
Prior to the passage of the 2010 Tax Relief Act, certain qualified assets that were acquired and placed in service in 2010 could take advantage of the 50 percent bonus depreciation as enacted in the Small Business Jobs Act of 2010. Under the new law, for qualified assets that are acquired and placed in service after Sept. 8, 2010, and before Jan. 1, 2012, bonus depreciation increased from 50 percent to 100 percent. There are no limits on the investment amount, but the qualified asset must be purchased new (‘original use’) and must be placed in service on or before Dec. 31, 2011. For qualifying assets placed in service from Jan. 1, 2010, to Sept. 8, 2010, assets remained eligible for 50 percent bonus depreciation. Some taxpayers may find themselves in a possible refund position for 2010 if they paid estimated taxes based on 50 percent bonus depreciation and made significant capital investments in the fall of 2010.
Because the act was passed so late in 2010, many companies did not have much time to purchase qualifying assets and take advantage of the increase in bonus depreciation. Taxpayers that really benefit are the ones that made plans to purchase qualified assets in the fall of 2010 as part of their normal tax planning, but surprisingly got the boost to 100 percent. The favorable deduction continues through 2011 and is scheduled to revert to 50 percent for 2012.
What are some of the important points to consider when deciding whether to elect Section 179 or to take bonus depreciation?
The Small Business Jobs Act of 2010 increased the Section 179 expensing election, providing a $500,000 dollar limit and a $2 million investment limit for tax years beginning in 2010 and 2011. Businesses can expense up to $500,000 in cost basis as long as their capital expenditures do not exceed $2 million. The maximum annual deduction is generally reduced dollar for dollar by the amount of Section 179 property placed in service during the tax year in excess of the investment limit. The 2010 Tax Relief Act sets the 2012 expense limit at $125,000 with an investment limit of $500,000. These limits are further reduced after 2012. Although the thresholds were reduced after 2011, Section 179 remains a favorable benefit to many taxpayers.
During tax planning, taxpayers should consider whether they will get a greater benefit from using Section 179 or bonus depreciation or a combination of both. A few notable differences between bonus depreciation and Section 179 include:
• Bonus depreciation only applies to ‘new’ qualifying assets, whereas Section 179 also applies to ‘used’ qualifying assets.
• Bonus depreciation is not an election and is mandatory, whereas Section 179 is elective for specific qualifying assets and can be applied to pre-Sept. 9, 2010 acquisitions to potentially achieve a greater benefit. Taxpayers can elect out of bonus depreciation.
• Bonus depreciation can place a taxpayer in a net operating loss position, whereas Section 179 is limited to the taxpayer’s business taxable income. Any Section 179 expense that is limited due to the taxable income limitation can be carried over indefinitely until utilized.
For tax years 2010 through 2012, taxpayers should consider these differences in order to achieve the most favorable tax results.
Mark Ulishney, CPA, is a partner at Crowe Horwath LLP. Reach him at (954) 202-8579 or [email protected]