This article originally appeared in the November 2012 issue of Smart Business Philadelphia magazine.
With year-end tax season in full swing, a cloud of uncertainty hovers over businesses. Forecasting what 2013 will bring in terms of tax rates and legislation is difficult because of the impending presidential election and the unknowns about whether the Bush-era tax cuts will be extended.
What will happen to tax rates in 2013? How could estate planning be affected? Is now the time for your business to buy equipment?
"This year, the traditional planning techniques of deferring income and accelerating deductions may not be appropriate, depending on what happens with tax rates," says Michael R. Viens, director, Tax Strategies, at Kreischer Miller, Horsham, Pa.
Viens recommends businesses plan early but hold off on executing any specific plan until the post-election dust settles and Congress gives some indication of its direction concerning late 2012 or early 2013 tax legislation.
Smart Business spoke with Viens about how businesses can best prepare and position their organizations to be flexible in light of the uncertain political and economic climate.
How is this year different in terms of tax planning?
A key concern is tax rates and whether they will increase in 2013. If nothing happens legislatively by year-end, tax rates are scheduled to increase, impacting a number of events. Traditional business tax strategy focuses on deferring income and accelerating deductions, keeping as much cash in the business as possible. But such a strategy, if employed this year, may create higher taxable income in 2013, with the potential for a higher tax bite that could more than offset 2012 tax savings. Once the election is over, we should have clearer indications as to the likely tax regime in 2013 and beyond and will be in a better position to make decisions regarding implementation of specific tax planning initiatives.
Start planning now. Work through the what-ifs with your advisers, but wait before pulling the trigger until after the election.
Is now a good time to purchase equipment?
The purchase of appropriate qualifying equipment is a common year-end activity for businesses that wish to take advantage of the value of bonus-depreciation opportunities that allow an immediate 50 percent write-off, and a Section 179 expense deduction that allows deduction of the full amount of the purchase price of the equipment, up to $139,000, in the year in which it was purchased and placed in service. Bonus-depreciation provisions expire Dec. 31, 2012, and the Section 179 deduction is scheduled to revert to $25,000 for tax years beginning in 2013, unless extended.
With equipment purchases, economics should drive the decision, with tax impact being secondary. If the equipment is important and acquiring it today means the business will be in a better position than it would be buying it in January, purchasing now likely should win the day. But all things being equal, a purchase in December versus January may be worth considering once it is understood what tax deductions and rates will apply in 2013.
How might an equipment purchase in 2012 be more beneficial than in 2013 if the current tax structure is not continued?
Say a business purchases qualifying equipment for $1 million and places it in service in December 2012. It immediately gets a $500,000 tax deduction in 2012 per the 50 percent bonus depreciation rule and may also receive normal first-year depreciation for another $100,000. That equals a $600,000 deduction in 2012. And with a 35 percent tax rate, the tax savings is $210,000, resulting in a net short-term cash outlay for the equipment at $790,000.
If this purchase is deferred until January 2013 with no bonus depreciation and a new 40 percent tax rate, the business may save in the short term only $80,000 in cash rather than $210,000. However, due to subsequent depreciation, the business would realize a total of $240,000 in tax savings on the same $600,000 deduction that would be otherwise accelerated into 2012.
The business should weigh the longer-term $30,000 tax savings from deferring the equipment purchase into 2013 against an earlier short-term tax savings. The choice involves tradeoffs — short-term cash flow versus the present value of longer-term higher tax savings. Without knowing what 2013 will bring, planning for both scenarios is key.
How should businesses proceed with succession planning given tax law uncertainty?
Estate taxes are of importance to business owners in transferring ownership to the next generation, and there is uncertainty regarding those provisions. There are currently opportunities to transfer significant family wealth without incurring gift tax due to historically high lifetime gift exemption levels. But this could go away if the estate/gift tax structure is not extended. Businesses transferring ownership should discuss opportunities now with an attorney and their tax adviser.
What traditional year-end tax planning techniques still apply, regardless of what the tax law brings?
Address safe harbors to avoid underpayment penalties. Because many businesses are seeing 2012 earnings that are more robust than in 2011, a prior year-based 100 or 110 percent (applicable for higher income taxpayers) safe harbor comprised of withholding and/or estimated tax payments may be an easy answer. A business with a tax liability of $100,000 in 2011 could use a $110,000 safe harbor and make up a shortfall when tax returns are due next April.
What planning strategy can business owners adopt to prepare for unknown 2013 outcomes?
Develop a Plan A and Plan B, working out how your business will react if tax law continues as is, and what decisions will be implemented if the current tax opportunities and tax rates change. Depending on the position of the business and owner circumstances, this year may require a more robust planning process than in the past, which is a good reason to enlist an experienced accountant and begin the tax-planning dialogue early. ●