On January 2nd President Obama signed into law the American Tax Payers Relief Act (ATRA 2012) designed to yank the nation back from fiscal disaster. The effects of the fiscal cliff deal are far reaching and have left many small business owners with a wide range of emotions including relief, frustration and confusion. So what does the fiscal cliff mean for small business in 2013? Below is a look at some of the key elements of the fiscal cliff deal and the possible effects they may have on small business.
The ATRA did not extend the 4.2% Bush-era rate for employee social security tax, and it has gone back up to 6.2%. While the increase in social security tax effects employees by taking an additional 2% in social security tax, many fear an indirect impact on small business. Chiefly, by taking money out of the hands of consumers they will not spend as they normally do. Instead, many small business owners fear consumers will only spend on necessities such as food and postpone optional purchases.
One positive from the ATRA for small business is the increased immediate deduction businesses can take for capital purchases (new and used, financed or leased equipment, and off-the-shelf software). The amount has been drastically increased from 2012’s limit of $139,000 to $560,000 for 2013. In addition, the limit on equipment purchases for 2013 is $2,000,000 — this is the maximum amount that can be spent on equipment before the Section 179 Deduction available to your company begins to be reduced. Further, the Fiscal Cliff deal renewed bonus depreciation for one year:
Section 179 of the Tax Code allows a taxpayer to elect to deduct the cost of certain types of property on their income taxes as an expense, rather than requiring the cost of the property to be capitalized and depreciated. Section 179 was designed to spur capital investment by allowing an extra write-off when an asset is purchased. So for example, if a farmer buys a tractor for $50,000, they can expense 100% of that up to a certain dollar amount. Section 179 was designed specifically for small businesses, however, unless extended in 2014, the deduction amount will fall drastically to $25,000 and the bonus depreciation will also expire.
The research and development (or experimentation) tax credit was extended through 2013. It allows businesses to deduct capital expenditures on R&D as business expenses, either taken in the year they are incurred or amortized for no more than 60 months. In 2010 the General Accountability Office concluded that the credit reduced “business’s costs of new qualified research by 6.4% to 7.3%,” representing a $5.6 billion federal subsidy for R&D in 2009. The R&D tax credit can result in a company’s taxes being reduced by as much as 3%. In addition, if the R&D tax credit had not been extended many companies would have invested less in R&D in 2013.
Capital Gains Tax
Capital gains are an increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. A capital gain may be short term (one year or less) or long term (more than one year) and must be claimed on income taxes.
Capital gains and dividends will now be taxed at a 20% rate for individuals earning above the top income-tax bracket (400,000 for individuals and $450,000 for couples). Many experts have noted the 20% capital gains tax is really an effective rate of 23.8% when the cost of financing the Affordable Care Act is accounted for. The rate remains 15% for those making under $400,000. However, with the cap being set at $400,000 and above after the fiscal cliff deal, the capital gains tax increase will not affect most small business.
Estate and Gift Tax
The fiscal cliff deal kept the estate and gift-tax exclusion at $5 million, indexed for inflation, increasing the top tax rate from 35% to 40%. This calmed the fears among many small and family owned businesses that the exemption could fall back to its pre-2010 level of $3.5 million, or even further to the $1 million level of 2002. The deal was great news for family owned businesses because it maintains business continuity. Essentially, illiquid businesses might have been forced to sell off assets to pay estate taxes effectively destroying the business before it could be passed on to heirs.
So what does this all mean for small business owners? While there are some positives such as deduction limits, R&D and estate taxes, there are some negatives such as the social security tax and uncertainties such as what will be extended for 2014. In addition, the pending debt ceiling debate will play a significant role in the outcome of 2013 for small businesses. For the moment at least, the positives of the ATRA outweigh the negatives for small businesses in 2013.
Ryan A. Hintzen
The Hintzen Law Firm, PLLC