The so-called “fiscal cliff” tax package recently signed into law renewed more than 50 temporary tax breaks through 2013, saving individuals and businesses an estimated $76 billion. On the downside, employees are already finding less in their paychecks because the American Taxpayer Relief Act did not extend the payroll tax holiday that had reduced Social Security payroll deductions from 6.2 percent to 4.2 percent on earned income up to the Social Security wage base ($113,700 for 2013). It is a similar story for the self-employed worker.
For the owners and operators of small- and medium-sized woodworking shops and businesses, there is good news and bad news contained in the fiscal cliff tax laws. First, the good news: Greater certainty in taxes. Woodworking professionals have grown used to many longstanding tax breaks, but they also have had to get used to the uncertainty of whether those breaks will be renewed each year. While many tax breaks expired at the end of 2011, the new tax law renews them retroactively allowing professional woodworkers to claim them on both their 2012 and 2013 tax returns.
The American Taxpayer Relief Act extended through 2013 Section 179 of the tax code, which includes the first-year expensing write-off. Now, the higher expensing limits in effect in 2011 have been reinstated for 2012 and extended for expenditures made before Dec. 31, 2013. Thus, a woodworking shop can expense or immediately deduct up to $500,000 of equipment expenditures in 2012 and 2013, subject to a phaseout if total capital expenditures exceed $2,000,000. The maximum amount that can be expensed in years beginning after 2013 will, without amendment, drop to $25,000.
The election to expense and write off the off-the-shelf computer software used by so many woodworking professionals under Section 179 is also extended and applies to expenditures made before Dec. 31, 2013.
The tax break that allows profitable woodworking shops and businesses to write off large capital expenditures immediately — rather than over time — has long been used as an economic stimulus. While 100 percent “bonus” depreciation expired at the end of 2011, today the new law allows 50 percent bonus depreciation for property placed in service through 2013. Some transportation and longer-lived property are even eligible for bonus depreciation through 2014.
To be eligible for bonus depreciation, property must be depreciable under the standard Modified Accelerated Cost Recovery System and have a recovery period of less than 20 years. Section 179 first-year expensing remains a viable alternative especially for small businesses. Property qualifying for the Section 179 write-off can be either used or new in contrast to the bonus depreciation requirement that the taxpayer be the “first to use.”
More, more and more
The Work Opportunity Tax Credit, a tax credit that rewards employers that hire individuals from targeted groups, was extended to Dec. 31, 2013, and applies to individuals who begin work for the employer after Dec. 31, 2011. Under the revised tax credit, woodworking businesses hiring an individual from within a targeted group are eligible for a credit generally equal to 40 percent of first-year wages up to $6,000.
Although an S corporation is a pass-through entity and not usually subject to income taxes, it is liable for the tax imposed on so-called “built-in” and capital gains. The tax on built-in gains is a corporate level tax on S corporations that dispose of assets that appreciated in value during the years when the operation was a regular C corporation.
The new law extends a relaxed version of the provision that limits the “recognition period” to five years, but only for “built-in gains” recognized in 2012 and 2013. Thus, if a woodworking business elected S corporation status beginning Jan. 1, 2007, it will be able to sell appreciated assets it held on that date without being subject to a hefty tax bill. Anyone in this situation might want to take advantage of this provision, but are advised to consult with a tax professional.
Taxing it alone
Thanks to the Health Care and Education Reconciliation Act that became law in 2010, beginning in 2013, many individuals discovered they are subject to a 3.8 percent net investment income tax and a 0.9 percent additional Medicare tax. The new taxes apply to single taxpayers with a modified adjusted gross income in excess of $200,000 and married taxpayers with a modified adjusted gross income in excess of $250,000 if filing a joint return or $125,000 if filing a separate return.
More recently, single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more in taxes in 2013 because of a higher 39.6 percent income tax rate and a 20 percent maximum capital gains tax. For others individuals, the alternative minimum tax has finally been indexed for inflation.
Ironically, the AMT was created to ensure that wealthy individuals would pay some kind of income tax, not middle-income households. The new law increases the 2012 exemption amounts to $50,600 for unmarried individuals and $78,750 for jointly-filing couples. For 2013, the AMT exemption amounts are predicted to be $80,750 for married couples filing jointly and $51,900 for single individuals.
Estate taxes never die
Always of significant interest to family-owned businesses, the estate tax has long been a bit of a mixed bag. The $5 million per person exemption was kept in place and indexed for inflation. The top rate was, however, increased to 40 percent (effective date Jan. 1, 2013). This change to 40 percent is expected to increase government revenues from 2012 levels by $19 billion. Other good news for estate planning — portability is kept in place and estate and gift taxes remain unified — i.e., the $5 million stays in place for gift tax purposes as well as estates. And it is all permanent.
Planning opportunities abound
The majority of woodworking businesses operate as pass-through entities, such as partnerships and S corporations. Profits are passed through to their individual owners and therefore are taxed at individual income tax rates. Some business owners might be considering switching to a regular C corporation with its top rate of 35 percent rather than doing business through an S corporation, LLC, etc., and be subjected to a top rate of 39.6 percent on the pass-through income.
It should also be kept in mind that if a switch is made from an S corporation or a regular C corporation, a switch back to an S corporation can’t be made for five years unless permission is received from the IRS. If an LLC or partnership is incorporated, there can be expenses and potential tax consequences.
Although it is not the grand bargain as envisioned by lawmakers, many popular but temporary business-related tax provisions were included in the American Taxpayer Relief Act. Remember though, despite the Section 179 small business expensing, bonus depreciation and the Work Opportunity Tax Credit, the new law is effectively a stop-gap measure. Congress must still address spending cuts and might even tackle tax reform.
The time is now — hopefully before filing the woodworking operation’s 2012 tax returns — for every woodworking professional to consult with their accountants and/or tax professionals to focus on the potential savings offered by these newly revised, extended and expanded business credits, deductions and tax write-offs.
Mark E. Battersby is a freelance tax and financial writer based in Ardmore, Pa.
This article originally appeared in the March 2013 issue.