NEW YORK - “Self-employed business owners on the higher end of the income scale face two new taxes and higher maximum tax rates in 2013,” says Jim Keller, a senior tax analyst at Thomson Reuters.
The planning strategies summarized below can reduce or avoid exposure to the new, higher taxes. “Additionally, thanks to the enactment of the 2012 American Taxpayer Relief Act in early 2013 (referred to as the Relief Act), small businesses have several tax breaks available for 2013 they otherwise would not have had.”
Up-to-date analyses of legislation and regulations, authored by Keller and hundreds of other experts, are available to tax and accounting professionals on the industry-leading, award-winning Thomson Reuters Checkpoint research platform.
Avoiding Higher Tax Rates and New Taxes
Higher Maximum Tax Rates. Starting in 2013, the Relief Act imposes a new 39.6% tax rate for individuals (including self-employed business owners) with ordinary income above $400,000 for single filers, $450,000 for married couples filing jointly and $225,000 for married couples filing separately. Plus, those in the 39.6% tax bracket face a higher 20% tax rate on long-term capital gains and qualified dividends. To keep income below these thresholds, cash method businesses can delay sending year-end invoices and pay December bills by the end of the year. Cash and accrual businesses can claim bonus deprecation and/or a Section 179 deduction, prepay expenses to the extent allowed by the Code, or arrange an installment sale of qualifying property.
New 0.9% Tax on Earned Income. A 0.9% tax applies to wages and self-employment (SE) income earned in 2013 by individuals with income above $200,000 for single filers, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. The strategies noted in the preceding paragraph for lowering SE income also apply here. This new tax also provides another reason for S corporation shareholder/employees to reduce their salary in favor of distributions because distributions are not subject to the 0.9% tax. While salary must be reasonable for the services provided, in many cases the amount can be set at the low end of a range that is reasonable and supportable.
New 3.8% Net Investment Income Tax. Beginning in 2013, a 3.8% net investment income tax (NIIT) applies to individuals with modified adjusted gross income (MAGI) above the thresholds listed in the preceding paragraph. The NIIT Is imposed on interest, dividends, annuities, royalties, rent, and income from business in which you do not actively participate (referred to as passive activities). Since passive activity income is subject to the NIIT, you may want to reexamine your involvement in the business if you are subject to the passive activity rules. Increased involvement may create a better tax result.
Better Depreciation Breaks Available in 2013
If your business will be buying equipment or computer software, or making capital improvements in the near future, Keller recommends you consider doing so by the end of this year. Here is why . . .
Bigger Section 179 Deduction: Following changes by the Relief Act, businesses can immediately deduct up to $500,000 of qualified property purchases made in 2013. (This is referred to as the Section 179 deduction.) This limit is reduced dollar for dollar by the qualified property placed in service during the year over $2 million. Unless Congress makes further changes, the maximum Section 179 deduction next year will decrease to $25,000 and the phase-out threshold will be $200,000. By acting before the end of this year, businesses can get an extra $475,000 deduction for buying qualified property.
Real Property Section 179 Deduction: Historically, the Section 179 write-off could be claimed for the cost of purchasing tangible personal property but not real property. But once again, thanks to the Relief Act, businesses can claim the Section 179 deduction for up to $250,000 of qualified leasehold improvements, restaurant property, and retail improvements placed in service in 2013. In addition, a 15-year write-off is available for the remaining cost of this property. Keller adds that unless Congress acts, these three categories of property will be depreciated next year over a 39-year period.
Bonus Depreciation. The Relief Act extended 50% first-year bonus depreciation to eligible new (not used) assets placed in service in calendar-year 2013. To be eligible, the asset must be (1) qualified property (which includes most tangible personal property and purchased software costs plus certain leasehold improvement costs), (2) acquired by the end of 2013, and (3) placed in service by the end of 2013 (although the deadline is extended one year for certain assets with longer production periods).
Bonus depreciation also increases the maximum first-year depreciation deduction for 2013 by $8,000 for new passenger autos and light trucks that are subject to the luxury auto depreciation limits (which basically, includes autos and trucks with a gross vehicle weight rating of 6,000 pounds or less). The first year depreciation limits for passenger autos placed in service in 2013 are $3,160 or $11,160 with bonus depreciation, and $3,360 or $11,360 with bonus depreciation for light trucks and vans.
Unless Congress takes action, the bonus depreciation break will not be available after 2013.
Depreciation Rules for Heavy SUVs Still Good. Under the tax law, a “heavy SUV” is an SUV, truck, or van that has a gross vehicle weight rating above 6,000 pounds. Buying one of these vehicles can be a good tax move because a heavy SUV used over 50% for business can qualify for 1) the $25,000 heavy SUV Section 179 deduction; 2) 50% first-year bonus depreciation for vehicles acquired and placed in service in 2013; and 3) accelerated five-year depreciation for the rest of the vehicle's depreciable basis. In contrast, the 2013 first-year depreciation limits for light trucks with a gross vehicle weight rating of 6,000 pounds or less are $3,360 or $11,360 with bonus deprecation.
Benefits of Working from Home
Claiming a Home Office Deduction. There is a new safe harbor in 2013 you can use to determine your deductible home office expenses. The safe harbor is an alternative to deducting actual expenses and equals $5 × square feet of qualified home office used up to 300 square feet (or a maximum of $1,500). You still have to meet the basic requirements for claiming a home office deduction, such as using the space exclusively and regularly as the principal place of business or as a place to meet with clients or customers. However, you will get a deduction for the business use of your home without making the complex calculations, or meeting the substantiation rules, that are otherwise required.
Other Benefits of Home Office Deduction. Generally, the expenses you incur when driving between your home and regular place of business are nondeductible commuting expenses. But, if your home office qualifies as your principal place of business, you can deduct all transportation costs incurred in going between your residence and other work locations in the same trade or business—regardless of whether the other locations are a regular or temporary work location.
Taxpayers should consult with a personal tax advisor before applying these or other tax strategies.
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