How to plan for expiring tax provisions in an election year

Gregory C. Brown, Tax Partner, Sensiba San Filippo

With several tax provisions set to expire this year, and tax rates set to increase, business owners need to start planning now for the impact on their businesses.

“Business owners need to be collaborating with their tax advisers on a level they may not be accustomed to in the past,” says Gregory C. Brown, tax partner at Sensiba San Filippo LLP. “Discuss your plans with your tax adviser and look at the tax implications in light of the expected changes. This will require more time, energy and communication than in the past with respect to tax planning for 2012 and beyond.”

Smart Business spoke with Brown about expiring tax provisions and how they could potentially impact businesses and their owners.

What could happen with tax legislation in 2012, in light of it being an election year?

It’s difficult to say. Congress is challenged with many difficult issues and a very limited number of days that they will be in session to address these issues. A few possible Congressional outcomes for tax provisions could be a complete tax reform overhaul or a simple extension of provisions that have expired or are set to expire. Or Congress could let things expire and the set changes take hold. If something does happen this year, it’s probably going to be later in the year, after the election.

What provisions set to expire this year would have the biggest impact on business owners?

For small business owners, cash is vital. A few of the more prominent tax provisions that will impact operating cash flow stem from equipment purchases and the cost recovery through bonus depreciation. Currently, if you purchase certain capital assets, under bonus depreciation, you can expense a large amount of the purchase costs right off the top in the year that asset is placed in service. This means the recovery of the purchase cost is realized sooner than later, saving tax dollars and making more cash available. These provisions are being reduced and eliminated.

Another significant tax provision is IRC (Internal Revenue Code) Section 179, which is expense electing for equipment and other capital purchases. If you purchase certain qualified equipment, you can expense 100 percent of the cost with certain limitations. In 2011, the maximum amount that could be expensed is $500,000, with an overall purchase limitation of $2 million before the expense amount is reduced. In 2012, the expense election is reduced to a maximum of $125,000, with a purchase limitation of $500,000. As these expensing limits are scaled back, and barring a change by Congress, the cost recovery time is increased and may impact the business’s ability to make these purchases.

If you, as a business owner, are considering purchasing capital equipment, these provisions need to be considered.

What will the impact be of expiring tax provisions on business owners personally?

Without Congress acting, several provisions will expire at the end of 2012. Business owners, along with all individual taxpayers, will be subject to increased capital gain, dividend, and ordinary income tax rates. The long term capital gain, for capital assets held at least 12 months, are taxed currently at a max rate of 15 percent. This rate is slated to go up to 20 percent starting in 2013. In addition, dividends are currently taxed at the 15 percent capital gain rate. Starting in 2013, dividend income will be taxed at increased 2013 ordinary income rates, with a top rate of 39.6 percent.

Also in 2013, as part the health care overhaul of 2010, there will be a new Medicare tax of 3.8 percent on unearned income, which includes interest, dividend and capital gains. This will impact taxpayers with income of more than $200,000 for individuals and $250,000 for a married couple. This is a new add-on surtax, on top of all other income taxes.

What should business owners be doing now in respect to the current tax environment?

Look at your business plan and determine what you are planning to do. On the individual side, gain an understanding of what you are doing now and what you are planning to do, and superimpose those plans on top of what is potentially going to happen with tax provisions. That means looking at different scenarios with respect to the plans you have with your business — with hiring, with capital equipment purchases, etc. — to see if there are things you want to do imminently, or if there are things you want to delay. Questions you should ask include, ‘What is the tax impact of what I am thinking, and is this the right time?’

In 2011, everything was relatively static with respect to expiring provisions. 2012 is going to be a real wild card and tax planning is going to be daunting because there is not a lot of clarity about which way business owners should go.

The most critical advice I can give is to not delay in approaching professional advisers. If you are thinking about a significant transaction for 2012, you need to start talking to your business advisers now, versus later. Your CPA, attorney, investment adviser and other professionals can help you get your arms around your situation and things will go much more smoothly if it’s not the 11th hour.

It can be a tough situation when a business owner does not talk to his or her tax adviser to later find out, when it is too late, that there was a more tax efficient route to take. Good tax professionals are experts at boiling down complicated tax code and regulations and working with business owners to get to the right answer. Putting business owners in the best possible tax position is the primary job of the tax adviser.

Gregory C. Brown is a tax partner at Sensiba San Filippo LLP. Reach him at (925) 271-8700 or [email protected]