The first phase of the political tussle over the “fiscal cliff” primarily concerned deficit and stimulus measures. However, it resulted in some favorable tax law changes too. This article describes those changes that are most likely to be relevant to business taxpayers.
Tax Rates
Beginning in 2013, the top marginal income tax rate for individuals is 39.6%, applicable to taxable income over $400,000 for taxpayers filing singly and over $450,000 for taxpayers filing jointly. The top tax rate for capital gains and qualified dividends, applicable above the same threshold, is now 20%. However, taken together with the 3.8% tax on net investment income that has a lower threshold — over $200,000 for taxpayers filing singly and over $250,000 for taxpayers filing jointly — certain capital gains can be taxed at up to 23.8%.
Also for individuals, alternative minimum tax exemptions, which historically have had to be renewed each year, have been increased and made permanent. The maximum gift and estate tax rate is now 40%, with an exclusion of $5,120,000 (indexed for inflation).
The corporate tax rate did not rise for either ordinary income or capital gains. That means the relative disadvantage of carrying on business through taxable corporations has been diminished.
Thus, based solely on rate changes, the landscape has not changed much for most tax planning situations. Use of the C corporation has become somewhat less expensive compared to the alternatives, but the change should affect decisions only at the margin. It is still very much worthwhile to plan to generate capital gains and dividends instead of ordinary income. The estate and gift tax rate remains high enough to motivate planning and the exemption cap is low enough that many taxpayers will have to deal with it.
Incentives
The credit for research expenditures, perennially in danger of expiration, was extended through 2013 and some of its provisions made more liberal.
The Act makes changes to and extends several depreciation and expensing provisions:
- The Section 179 $500,000 limit on property purchases that can be deducted instead of capitalized is retroactively and through 2013 extended, with a phase-out that begins only when the taxpayer places more than $2,000,000 worth of such property in service during the year. The benefit of the provision is scheduled to be reduced again starting in 2014.
- The provision allowing 50% “bonus” depreciation is extended generally for property placed in service during 2013.
- There are provisions intended to provide incentives to purchase certain cars and trucks, leasehold and retail improvements, restaurant property and other items during 2013, as well as several other “targeted” provisions to provide incentives in other industries.
- Certain film and television production incentives are also extended.
The Act contains some benefits for businesses that operate outside the United States. The category of “Subpart F” income of controlled foreign corporations, which is taxed in the United States even if never distributed to the U.S. parent, is narrowed by the extension through 2013 of an exclusion for income from active foreign financing businesses and a provision allowing certain taxpayers to “look through” tiers of foreign corporations where the underlying source of income is non-Subpart F income.
For businesses in a position to take advantage of them, the suite of incentives provided for businesses within “empowerment zones” has been reinstated retroactively and extended through 2013, with some benefits remaining available through 2018.
Transactions
When a corporation makes an election to be taxed as an “S” corporation not subject to corporate tax, its “built-in gain” items from the pre-election period are still subject to corporate tax if disposed of within a 10-year recognition period. To encourage disposition transactions, the Act shortens the recognition period from 10 to 5 years for 2013 (an incentive) and retroactively to 2012 (a windfall for taxpayers that happened to sell in 2012). This is the third time an acceleration provision like this has been enacted in the past 5 years — continuing evidence of the fact that if you are resisting converting a C corporation to S corporation status because the 10-year recognition period seems too long for you to benefit from, you are missing out on the possibility that one of these acceleration provisions may shorten the window for you too.
Also for both 2012 and 2013, instead of the normal 50% exclusion from income of gain on the sale of qualified small business stock the exclusion has been increased to 100%. This is an incentive to invest in small business stock, as the exclusion percentage depends on the date of purchase, not the date of sale.
