By Michael D. Koppel, CPA, MST
Gray, Gray & Gray, LLP
December 2012
As the end of 2012 draws closer, many people start to think about enjoying the holidays. But as a business owner it is also time to plan for the all-important task of preparing to pay the tax bills your company will be responsible for in the new year. Always a complicated (and often frustrating) process, tax planning in 2012 presents a whole new set of challenges for companies in the petroleum and energy industry in New England and beyond.
The confluence of major tax legislation, the “maybe/maybe not” expiration of numerous tax provisions, and the rhetoric surrounding the Presidential and Congressional elections makes tax planning extremely difficult. We simply do not know all of the tax issues that will face businesses or individuals once the dust has settled. So the course of action we are recommending is to steer straight, prepare for what we do know to be certain, and remain flexible enough to adapt quickly if and when tax regulations shift suddenly.
Here, then, is an overview of what we know, what we expect to occur, and what might possibly happen that will impact your taxes for 2012.
A substantial number of taxpayer-friendly tax provisions expired at the end of 2011 and more are scheduled to expire at the end of 2012. While there has been a substantial amount of attention to the end of the “Bush Tax Rates” there are several provisions that directly affect the retail petroleum industry which demand attention.
Depreciation Woes
The first area of uncertainty concerns depreciation. In 2011 businesses had several powerful tools to maximize the amount of asset acquisitions, which they could advantageously expense immediately, rather than capitalize and depreciate over time.
Internal Revenue Code §179 (IRC 179) – This tax code section allows a business to immediately expense a stated amount of qualified property. In 2011 a business could expense up to $500,000 of qualified purchases. But for 2012 the immediately deductible amount is reduced to $139,000, and drops to only $25,000 in 2013. Then the news gets worse.
IRC 179 has a phase out, meaning that after a business purchases a certain amount of qualified assets the amount that can be written off decreases. In 2011 the phase out did not begin until $2,000,000 in assets were purchased. In 2012 the phase out limitation is reduced to $560,000 and in 2013 it will be only $200,000.
Reduction in the ability to immediately expense asset purchases does not end with IRC 179. In 2011 businesses enjoyed “bonus depreciation” which allowed them to immediately expense qualified new property. During 2011 a business could use bonus depreciation on 100% of their qualified purchases. However, for 2012 the bonus depreciation rate has been reduced to 50%, and it is completely eliminated in 2013. The reduction in the amount of bonus depreciation is particularly painful because the amount of new property that can be depreciated immediately is unlimited and the deduction can be applied to more types of assets.
Another issue that may affect some companies’ depreciation strategy is the loss of the 15-year depreciable life for qualified leasehold improvements for retail businesses. Effective for 2012, the depreciable life has been increased to 39 years, spreading the tax advantage out over a much longer period of time. This may especially affect c-stores and other businesses with retail divisions.
The issue of depreciation is even more important because of new regulations for 2012 that require most businesses to change their capitalization policies so that they will likely have to capitalize more expenditures. Both real and personal property are affected by the new rules. The details of these new rules are lengthy and complex. We suggest that you contact your tax advisor to determine how they affect you.
The bottom line is this: If you are considering purchasing significant assets, such as new trucks or equipment, you should plan for the changes that have occurred with regard to depreciation.
Disappearing Tax Credits
The bad news for businesses does not end with depreciation. Many businesses take advantage of hiring individuals from targeted groups in order to qualify for the work opportunity credit. The credit expired December 31, 2011. However, many people believe that the credit will be reinstated retroactively, so they continue to gather the information required. A special credit for unemployed veterans and veterans with service-connected disabilities is still available though 2012.
Health Care Bill Affects Individual Taxes
In discussing tax planning for closely held businesses we must also discuss tax increases on high-income individual taxpayers caused by the Patient Protection and Affordable Care Act (PPACA). High-income taxpayers are defined as individuals with adjusted gross income in excess of $200,000, or married filing jointly of $250,000. It is important to remember that while many of the provisions of PPACA , such as the individual and business health insurance mandates, are effective in 2014, many other tax increases are effective in 2013.
The first increase is a 3.8% Medicare Surtax on net investment income (NII). Net investment income is defined as income from interest, dividends, annuities, royalties and rents as long as it is not derived in the ordinary course of a trade or business. Additionally, the tax applies to income from a trade of business of a “passive” activity. The 3.8% tax also applies to capital gains unless the gain is derived from the sale of property used in a trade or business (including the sale of a partnership or S corporation ownership of a non-passive owner). Planning to avoid or minimize the Medicare Surtax requires careful planning and discussion with your tax or financial advisor. While we do not know if the “Bush Tax Rates” will stay or go, an increase of 3.8% on net investment income is substantial.
The second tax increase is on earned income. Taxpayers with earned income in excess of $200,000 single ($250,000 married filing jointly) will have an additional 0.9% tax on the excess. There are some important considerations with this new tax.
Shareholders of an S Corporation generally receive both wages and allocations of income. It is important to remember that allocations of income received by a shareholder on their schedule K-1 of an S corporation are not treated as earned income and thus not subject to this additional tax. (Remember, the courts have consistently ruled that employees/shareholders should receive reasonable compensation for their services.)
With regard to partnerships and limited liability companies (LLC) taxed as a partnership, the interests of limited partners and members treated as limited partners are not considered earned income. What is important to remember is that taxpayers can have more than one type of ownership. This is generally called “bifurcation” and can allow taxpayers to reduce the amount of their self-employment income, including the new 0.9% surtax.
Another individual tax situation that bears close attention is changes in the gift tax. Financial planning and tax experts agree that the gift tax situation in 2013 will most likely be less favorable than in 2012. If you are considering making a substantial gift for estate planning or succession planning for your business you should act quickly to take advantage of the current high exemption levels.
Nobody knows what Congress will do with regard to these and many other tax provisions during their lame duck session after the election or during early 2013. As business advisors we constantly impress on our clients the importance of understanding all conditions that could affect your business, including taxes. Unfortunately, an accurate survey of the 2012 tax “landscape” is impossible at this point. Therefore it is essential to be prepared for any eventuality.
Michael Koppel is a Tax Partner at Gray, Gray & Gray Certified Public Accountants, Westwood, MA (www.gggcpas.com). Gray, Gray & Gray has served the accounting, tax and business advisory needs of companies in the oilheat and energy industry for more than 67 years.