As summer wanes and autumn arrives, businesses and their owners would like to plan now to save on their 2012 taxes as well as to get ready for the coming year. The problem: many of the tax rules for 2012 and 2013 are not yet known. More than 50 tax rules expired at the end of 2011. The Bush-era tax cuts, as well as the payroll tax reduction for workers, are set to expire at the end of 2012.
The House passed the Job Protection and Recession Prevention Act of 2012 to extend the Bush-era tax cuts through 2013 (H.R. 8). The Senate Finance Committee also approved the Family and Business Tax Cut Certainty Act of 2012 to extend various tax rules for 2012 (and in many cases for 2013 as well) that had expired at the end of 2011 (no bill number has been assigned). Congress is currently on its summer recess and, no doubt, upon its return in September will be focused on the November election. Here is a roundup of some planning that businesses can do now, as well as alerts to potential opportunities in the pending legislation that may be enacted in the lame duck session after the election.
Distribute profits as dividends
Corporations can make dividend distributions to shareholders. While the dividends are not deductible by the corporation, they are taxed at favorable rates for individuals. Through 2012, the maximum rate for qualified dividends received by individuals is 15% (zero for those in the 10% or 15% tax bracket). This special tax treatment for dividends is set to disappear after 2012 so that dividends would be taxed as ordinary income at rates up to 35% or possibly higher. The special tax treatment could be retained after 2012 through Congressional action.
Corporations sitting on profits for the year can take advantage of the certainty regarding the tax treatment of dividends made in 2012 by making dividend distributions before the end of the year. S corporations need to exercise special caution to avoid disproportionate distributions that have the effect of creating a second class of stock and terminating the S election.
For dividends made to owner-employees, there is an added advantage. These distributions are not subject to payroll taxes. If the same cash from corporate profits had been used to pay these individuals additional compensation, the payments would be deductible as compensation, but also subject to payroll taxes, both for the corporation and the owner-employee.
Take advantage of Section 1202 opportunities
Through the end of this year, certain C corporations can offer stock that enables investors to obtain tax-free treatment for gains as long as they hold the stock for more than five years (Code Sec. 1202). While this rule may be extended beyond 2012, companies seeking equity financing now can take advantage of the tax certainty for this year. It typically takes three to four months to close a deal, so action in this regard should be pursued now.
The 100% exclusion of gain on the sale of Sec. 1202 stock, called qualified small business stock, can only be used by a C corporation in certain industries, including technology, manufacturing, retail and wholesale. Also, the gross assets of the corporation at the time immediately before and after the issuance of the stock cannot exceed $50 million.
Sec. 1202 stock can be given as bonuses to employees. Qualifying businesses should explore this avenue of reward for purposes of year-end bonuses.
If this provision is not extended, the exclusion drops to 50% of gain on the sale of qualified small business stock. Whether this reduced exclusion will be meaningful depends on what the capital gains rates will be at the time such stock is sold (in 2018 or later years).
Find more guidance on Sec. 1202 stock in IRS Publication 550, Investment Income and Expenses, at www.irs.gov/pub/irs-pdf/p550.pdf.
Invest in machinery and equipment
The tax law provides incentives to businesses for buying computers, furniture, machines, and other equipment in two forms: a first-year expensing deduction (Sec. 179) and bonus depreciation (Sec. 168). Both of these tax breaks enable businesses to recover their outlays for these items more rapidly than by using regular depreciation. Both types of tax breaks apply for 2012. However, at this time, it is uncertain what the limitations on these breaks will be. Without any Congressional action, here are the applicable tax rules:
- The Sec. 179 deduction for 2012 is limited to $139,000 of new or used equipment placed in service this year, provided that the business is profitable.
- Bonus depreciation is limited to 50% of the cost for new (not used) property, regardless of the business’ profitability.
It is possible that these rules will yet be liberalized for 2012 (e.g., the Sec. 179 deduction may be increased to $500,000, which was the limit for 2011, and bonus depreciation could be increased to 100%, which was also the limit for 2011). Companies may want to review their spending budgets for the year in light of current and potential tax breaks.
Charitable contributions
Businesses that want to make donations of cash or property to charity can begin to plan their giving for 2012. Donations usually depend not only on what the businesses can afford, but also on tax incentives for giving. At present, only basic tax rules on giving apply because various enhanced deductions expired at the end of 2011. Here are the applicable rules:
- For C corporations, donations are capped at 10% of taxable income.
- For owners of S corporations, partnerships, and sole proprietorships, deductions are taken into account on the owners’ personal returns. The amount of their deductions depends on the owners’ adjusted gross income and the type of donations involved.
Stay alert to last-minute extensions of enhanced deductions for such donations as food inventory, computers to schools and libraries, and conservation easements.
Set up retirement plans for 2012
The contribution limits and other rules for qualified retirement plans are set for 2012; there is no uncertainty. The limits will be indexed for inflation in 2013. Businesses can opt to adopt a qualified retirement plan for 2012 if it does not have one. The deadlines for adoption:
- October 1, 2012, for SIMPLE plans for small businesses. Small businesses that are started up after this date have until it is practical to adopt a plan. A plan adopted after this date is not effective for the current year.
- December 31, 2012, for most qualified retirement plans, including profit-sharing plans (with or without 401(k) features) and defined benefit (pension) plans.
- April 16, 2013 (or October 15, 2013, for business returns on extension) for SEP plans for 2012.
If plans are set up by the required date, which means that the paperwork has been completed with the financial institution managing the plans, then employers have until the extended due date of their returns to make 2012 contributions.
Examine basis for owners of pass-through entities
If 2012 is shaping up to be a bad year for the business, owners of S corporations, partnerships, and limited liability companies can only deduct the portion of the loss passed through to them to the extent of their basis. Early planning for basis can ensure that there is a sufficient amount to enable the full loss to be taken on 2012 returns.
S corporation shareholders, for example, can loan money to their corporations to increase or establish basis in loans; they can then take passed-through losses to the extent of this basis. However, merely guaranteeing third-party loans to the corporation does not create basis. Basis in this case is created only when and to the extent shareholders are called upon to pay this corporate debt.
Revise FSAs for 2013
The Patient Protection and Affordable Care Act of 2010 placed a cap on the amount of salary that employees can contribute to their company’s flexible spending accounts (FSAs) starting in 2013. The cap is $2,500; it will be indexed for inflation after 2013. Until now, the cap was set by companies and averaged $5,000.
Companies technically have until the end of 2014 to revise their FSA documents to reflect the new cap. However, the plans must be operated in conformity with the new law starting in 2013.
Businesses should plan now to inform employees about the new limitations. They should also update payroll systems if they handle payroll internally; outside payroll companies will undoubtedly be prepared for this change.
Conclusion
CPAs should meet with their business clients to assess their current tax picture and to devise strategies for optimizing tax savings for the year. They should also pay attention to developments in Congress that could favorably impact tax-saving opportunities for 2012.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.
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