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2012 Taxpayer Relief Act: Business and Investments

Date: January 2013

After weeks of negotiation, Congress has passed the American Taxpayer Relief Act to avert the tax side of the "Fiscal Cliff" and bring some certainty to the Tax Code. Almost all taxpayers are affected by the numerous extensions and modifications. Many popular but temporary tax extenders relating to businesses are included in the American Taxpayer Relief Act. Among them is Code Sec. 179 small business expensing, bonus depreciation, the research tax credit, and the Work Opportunity Tax Credit. This letter provides some highlights of the American Taxpayer Relief Act as it applies to investments and business taxpayers.


INVESTMENTS


CAPITAL GAINS/DIVIDENDS SUNSETS

The American Taxpayer Relief Act raises the top rate for capital gains and dividends to 20 percent, up from the Bush-era maximum 15 percent rate. That top rate applies to the extent that a taxpayer's income exceeds the thresholds set for the 39.6 percent rate ($400,000 for single filers; $450,000 for joint filers and $425,000 for heads of households).

All other taxpayers will continue to enjoy a capital gains and dividends tax at a maximum rate of 15 percent. A zero percent rate will also continue to apply to capital gains and dividends to the extent income falls below the top of the 15 percent income tax bracket—projected for 2013 to be $72,500 for joint filers and $36,250 for singles. Qualified dividends for all taxpayers continue to be taxed at capital gains rates, rather than ordinary income tax rates as they were prior to 2003.

The 28 and 25 percent tax rates for collectibles and recaptured Code Sec. 1250 gain, respectively, continue unchanged after 2012. Also unchanged is the application of ordinary income rates to short-term capital gains; only long-term capital gains, those realized on the sale or disposition of assets held for more than one year, can benefit from the reduced net capital gain rate.

Generally, dividends received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121-day period, are qualified dividends for purposes of the reduced tax rate. Certain dividends do not qualify for the reduced tax rates and are taxed as ordinary income. Those include (not an exhaustive list) dividends paid by credit unions, mutual insurance companies, and farmers' cooperatives.

Installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later is now taxed at the 20 percent rate for higher-income taxpayers.

It should be noted that starting in 2013, under the Patient Protection and Affordable Care Act (PPACA), higher income taxpayers must also start paying a 3.8 percent additional tax on Net Investment Income (NII) to the extent certain threshold amounts of income are exceeded ($200,000 for single filers, $250,000 for joint returns and surviving spouses, $125,000 for married taxpayers filing separately). Those threshold amounts stand, despite higher thresholds now set for the 20 percent capital gain rate that previously had been proposed by President Obama to start at the same levels. The NII surtax thresholds are not affected by the American Taxpayer Relief Act. Starting in 2013, therefore, taxpayers within the NII surtax range must pay the additional 3.8 percent on capital gain, whether long-term or short-term. The effective top rate for net capital gains for many "higher-income" taxpayers thus becomes 23.8 percent for long term gain and 43.4 percent for short-term capital gains starting in 2013.


BUSINESS PROVISIONS


Code Sec. 179 Small Business Expensing
The American Taxpayer Relief Act extends through 2013 enhanced Code Sec. 179 small business expensing. The Code Sec. 179 dollar limit for tax years 2012 and 2013 is $500,000 with a $2 million investment limit. The rule allowing off the shelf computer software is also extended. Without the American Taxpayer Relief Act, the Code Sec. 179 dollar limit for tax years beginning in 2012 would have been $125,000 (subject to inflation adjustment) with a $500,000 investment limit (again, subject to inflation adjustment). In tax years after 2012, the dollar limit would have reverted to $25,000 with a $200,000 investment limit. This significant decrease in the value of the incentive has now been postponed to tax years after 2013.

Bonus Depreciation
The American Taxpayer Relief Act extends 50 percent bonus depreciation through 2013. Some transportation and longer period production property is eligible for 50 percent bonus depreciation through 2014. Bonus depreciation has been used as an economic stimulus in many tax bills in recent years. One hundred percent bonus depreciation generally expired at the end of 2011 (with certain transportation and longer period production property eligible for 100 percent bonus depreciation through 2012).

Bonus depreciation also relates to the dollar limitations on the depreciation deduction for the year in which a taxpayer places a passenger automobile in service within a business, and for each succeeding year. If bonus depreciation had not been extended, 2012 would have been the final year in which substantial first-year writeoffs for the purchase of a business automobile may be available.

To be eligible for bonus depreciation, qualified property must be depreciable under the Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. These requirements encompass a wide-variety of assets. The property must be new and placed in service before January 1, 2014 (January 1, 2015 for certain longer production period property and certain transportation property). Subject to the investment limitations, Code Sec. 179 expensing remains a viable alternative, especially for small businesses. Property qualifying under Code Sec. 179 expensing may be used or new, in contrast to bonus depreciation's "first-use" requirement.

Research Tax Credit
The American Taxpayer Relief Act extends through 2013 the incremental research tax credit, which expired after 2011. Commonly called the research or research and development credit, the incremental research credit may be claimed for increases in business-related qualified research expenditures and for increases in payments to universities and other qualified organizations for basic research. The credit applies to excess of qualified research expenditures for the tax year over the average annual qualified research expenditures measured over the four preceding years.

Work Opportunity Tax Credit
The American Taxpayer Relief Act extends through 2013 the Work Opportunity Tax Credit (WOTC), which rewards employers that hire individuals from targeted groups with a tax credit. Under the revived WOTC, employers hiring an individual within a targeted group (generally, otherwise hard-to-employ workers) are eligible for a credit generally equal to 40 percent of first-year wages up to $6,000. The WOTC is part of the general business credit.

The Vow to Hire Heroes Act of 2011 (Heroes Act) extended the WOTC for unemployed veterans and unemployed veterans with service connected disabilities through 2012. The WOTC for qualified veterans can be as high as $9,600. The Heroes Act did not extend the non-veteran WOTC provisions. The American Taxpayer Relief Act extends the WOTC for qualified veterans as well as for those within prior targeted groups.

Employer-Provided Child-Care Facilities and Services
The income tax credit for qualified expenses incurred by an employer in providing child care for employees has been made permanent for tax years beginning after December 31, 2012. The amount of the credit for a given tax year is the sum of 25 percent of the qualified child care expenditures and 10 percent of the qualified child care resource and referral expenditures incurred by the taxpayer for the tax year. The maximum amount of the credit allowable in any given tax year is $150,000Qualified Leasehold/Retail Improvements, Restaurant Property
The American Taxpayer Relief Act extends through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements and qualified restaurant property.


CORPORATIONS

  • Accumulated Earnings Tax. The 15-percent accumulated earnings tax rate is increased to 20 percent, for tax years beginning after December 31, 2012. The rate is now permanent.
  • Personal holding company tax rate. The 15-percent rate on personal holding companies is increased to 20 percent, for tax years beginning after December 31, 2012. The rate is now permanent.
  • Repeal of collapsible corporation rules. The collapsible corporation rules of Code Sec. 341 are permanently repealed in tax years beginning after December 31, 2012. Thus, for post-2012 tax years, a shareholder of what would have been defined as a collapsible corporation will not be required to report as ordinary income, any gain realized on sales or exchanges of their stock or on certain distributions that would normally result in capital gain treatment.
Planning Opportunity
The majority of U.S. businesses are pass-through entities, such as partnerships and S corporations. This means that profits are passed through to their individual owners and therefore are taxed at individual income tax rates. A "C" corporation, with its current corporate level tax rate of 35 percent (which may drop if recent corporate tax reform proposals are adopted), may become more attractive with rates rising to 39.6 percent for some individuals.

MORE BUSINESS TAX EXTENDERS
A number of other business tax extenders expired after 2011 and they are extended through 2013 under the American Taxpayer Relief Act. They include, among others:
  • New Markets Tax Credit
  • Employer wage credit for activated military reservists
  • Subpart F exceptions for active financing income
  • Look through rule for related controlled foreign corporation payments
  • 100 percent exclusion for gain on sale of qualified small business stock
  • Reduced recognition period for S corporation built-in gains tax
  • Enhanced deduction for charitable contributions of food inventory
  • Tax incentives for empowerment zones
  • Treatment of dividends of regulated investment companies (RICs)
  • Treatment of RICs as qualified investment entities
  • S corporations making charitable donations of property
Not extended. Certain business provisions not extended by the American Taxpayer Relief Act include:
  • Enhanced deduction for corporate charitable contributions of book inventory;
  • Enhanced deduction for corporate charitable contributions of computers;
  • Tax incentives for the District of Columbia; and
  • Expensing of brownfields remediation costs
The American Taxpayer Relief Act has a significant impact on all taxpayers. If you have any questions about the new law or how it affects you, please call our office for an appointment. We will be happy to assist you.