Tax-planning opportunities may have a limited timeframe
It is late summer 2013. The recovery from the great recession is progressing, albeit slowly when compared to prior recoveries. Business activity is increasing, the housing market is getting stronger, and the sentiment of consumers and business is improving.
There may be tax-planning opportunities for many businesses to consider as business activity strengthens. As the economy moves forward, the cost of capital may be impacted by the possibility of a change in Federal Reserve monetary policy in the future. Therefore, the timing to take advantage of tax planning and the low interest rate environment may be limited.
Tax rates for many businesses have increased in 2013 as the top individual marginal ordinary income tax rates have increased for the owners of S corporations, limited liability companies, partnership and sole proprietorships. Additionally, the payroll tax holidays, as well as Medicare tax increase, have added to the tax burden for these business owners.
For those businesses seeing growth in export activities, the use of the Interest Charge-Domestic International Sales Corp., or IC-DISC, is an often overlooked tax benefit that provides preferential tax rates for export profits. The U.S. has provided various tax incentives for export activities for over 40 years. A portion of the business profits are taxed at the qualified dividend rate which is tied to the long-term capital gains tax rate. The top federal long-term capital gains tax rate is currently 20 percent. State income taxes and the Medicare tax on investment income can boost this rate higher. The qualified dividend rate has been permanently placed into the tax code and does not need to be renewed in the future. This is a change from the past when the qualified dividend provision had to be extended on a periodic basis.
Many companies in West Michigan are taking advantage of this export incentive. There are also likely many businesses that have not taken advantage of this specific tax incentive. Michigan ranks highly among states for the volume of export transactions, in part the result of our shared border with Canada. Given the large amount of export transactions that Michigan generates, the IC-DISC export incentive can be utilized by many small and medium-sized businesses. Export transactions create additional manufacturing employment and employment that supports the manufacturing activity.
Capital expenditures for a plant expansion, a new piece of machinery or the purchase of computers are entitled to tax depreciation deductions. Significant accelerated depreciation incentives have been included in the tax code for most of the years since the tragic events of 9/11. Though some depreciation provisions are temporary, they have been extended several times over the past decade. The current provision for 50 percent first-year deprecation on qualified property for items placed into service expires after the current calendar year (Dec. 31, 2013). As a result of the scheduled expiration, this may mean that only five months remain before the provision expires, unless the accelerated depreciation provisions are extended again by Congress and the president.
There are also provisions such as the depreciation rates for certain leasehold improvements, restaurant improvements and retail store improvements. These items have a 15-year recovery period for improvements placed into service before Jan. 1, 2014. The deprecation rates will revert back to recovery periods as long as 39 years if the provisions are allowed to expire.
Additionally, full expensing of certain depreciable property also expires for property placed into service after Dec. 31, 2013. This expensing amount reverts to $25,000 for 2014 and beyond. Currently, the amount subject to expensing is capped at $500,000 and is phased out for businesses with $2 million in qualified property.
Certain property may also qualify for energy-related credits, grants and other incentives offered by various levels of government and utilities, which we have discussed recently in this column. A little research and advance planning may provide additional benefits in addition to any tax depreciation on fixed asset additions.
Businesses that expect to make significant investments in expanding their buildings or purchase a building should consider the benefits of a cost segregation study to properly classify the costs incurred as either real property or personal property for federal tax depreciation purposes. There is a difference in the depreciable life between real and personal property. Many components in and around the actual building may be eligible for some of the depreciation provisions described above if the property competent is classified as personal property.
As the economy begins to grow stronger, it is not a certainty that all or some of the depreciation provisions mentioned above will be renewed again. With the current political climate in Washington, no one can claim to have a crystal ball on what may or may not be accomplished with any tax provisions or tax reform. With the Federal Reserve still managing low interest rates (at least in the short term), the opportunity for making the decision for major fixed asset purchases in 2013 may be upon businesses.
Unfortunately, in recent years Congress and the president have renewed these provisions nearly a year after they actually sunset or expire. The depreciation provisions last expired at the end of 2011 and were not renewed until the fiscal cliff legislation was passed in early January 2013. Thus, there was no clarity on deprecation for 2012 additions until 2013. This may make some business decisions on planning for any major fixed asset purchases for 2014 difficult to forecast as we move through the latter half of 2013.
Given recent history, any decision on tax legislation including extension of any expiring provisions may not be known until after the 2014 midterm election cycle in late 2014. This will also be when many of the deferred Affordable Care Act health insurance mandates for employers will come into full effect. Businesses should consider all of this as they evaluate current and future business plans.
Bill Roth is a tax partner with the local office of BDO USA LLP. The views expressed are those of the author and not necessarily of BDO. The comments are general in nature and not to be considered specific tax or accounting advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult their professional advisers before acting on any items discussed herein.