Tax tips for the fiscal cliff -- and beyond
If there is anything that history has taught us, it is that it’s impossible to predict the future. And this year, even making an educated guess about what 2013 will hold for Colorado businesses is difficult, thanks to the rancorous political environment and the looming fiscal cliff. But that shouldn’t be an excuse to put off preparation and planning.
There is a distinct possibility that taxes will increase. If the current standoff between the President and Congress continues and no actions are taken, we could see taxes increase to as much as 39.6 percent on ordinary income and 23.8 percent on capital gains.
It can be extraordinarily difficult to plan for such uncertainty—paralyzing in some cases. But planning and preparation will be crucial for businesses, even though the temptation may be to take a wait-and-see approach. There are actions organizations can take now to reach a more advantageous tax position while officials are working to come to an agreement on how to manage the fiscal cliff.
- Understand new reporting requirements. For the first time this year, employers will be required to provide the IRS and employees with the total cost of annual group health coverage. This information must be reported on the W-2 form, which is used to report employee wages and withholding and is due Jan. 31, 2013.
- Consider the timing of business investments. The rules for deducting investments in your business have changed. Last year, 100 percent bonus depreciation allowed businesses to fully deduct the cost of eligible equipment placed in service. Property placed in service in 2012 is only eligible for 50 percent bonus depreciation—meaning you can deduct half the cost of eligible equipment placed in service this year, while the other half will be depreciated using normal rules. Property placed in service in 2013 will not be eligible for bonus depreciation at all.
- Consider S status. Even if individual tax rates increase, the single level of taxation available for S corporations is such a significant benefit over the long run that any privately held company should at least consider the advantages of converting or organizing as such. A conversion is made with a simple election for tax purposes and doesn’t affect the liability protection of a corporation. There are a number of requirements you must satisfy to qualify for S corporation status, but it’s worth looking into.
- Prepare for possible tax increases in 2013. If Congress does not act to prevent it, the new Medicare tax and the scheduled expiration of the 2001 and 2003 tax cuts will raise tax rates for individuals with many types of income. There are strategies for deferring deductions and recognizing income, but the key is to be flexible. It may not make sense to accelerate tax. We don’t know what will happen legislatively yet. You want to prepare your strategies, but delay executing them until the situation in Congress becomes clearer. For example, pass-through businesses in which profits are taxed at the individual level may want to consider reversing normal tax strategy and accelerating income into 2012 (or deferring deductions into 2013) to avoid higher taxes due to rate increases.
- Help your employees prepare for possible tax increases. Corporate employers can help their employees prepare for possible tax increases by facilitating flexibility with respect to the payment of bonuses and deferred compensation. If it appears Congress will not act and rates will increase in 2013, it may benefit the employees for employers to pay bonuses at the end of December, allowing them to be taxed under the current rates. But make sure this will not force employees into a higher bracket, and do not give employees the option of when to receive the bonus. The IRS will treat this as constructive receipt and require employees to include the bonus in 2012 income, whether the option is accepted or not. For example, many accrual-basis corporations declare bonuses before the end of the year, but pay them shortly after the new year. The corporation deducts the bonuses in the year paid, but employees do not have to include the bonus as income until the year it is paid.
The fiscal cliff has the potential to significantly change the cost of doing business. It’s important for organizations to work with their tax professionals to take into account the possibility of expiring tax cuts and rate increases when planning for next year and beyond.