“Does the walker choose the path, or the path the walker?”
In December, Congress passed the Protecting Americans from Tax Hikes Act of 2015 (PATH) which was combined with other legislation and signed in to law by President Obama. This $622 billion tax package extends expired or expiring tax breaks for businesses and individuals. It was easy to miss with all the excitement of the holiday season and its lack of mainstream media coverage.
It’s always good for business owners and CFOs to be kept abreast of these developments. They can present ways to save or spend wisely.
Unfortunately for many tax lawyers and accountants, these extensions typically occur at the tail-end of the year (Read: Every year ever since 1917). But rather than bait us all along again in 2016, there are some choice updates that will enable you to plan for your business for next year and beyond.
“Built in Gain” (BIG) tax for S corporations (Section 1374)
In general, C corporations are subject to a “double tax” regime whereby (i) the corporation is taxed on its income and gain, and (ii) profits distributed to shareholders are taxed a second time (to the shareholders) as dividend income.
In contrast, S corporations are, in general, not subject to an entity-level tax. Rather, the entity’s income and gain “flow through” and are taxed to the shareholders, regardless of distributions.
If a corporation was a C corporation and then converted to an S corporation, there is a special rule that in effect keeps the appreciation of the C corporation’s assets (i.e., the built-in gain) in existence at the time of conversion subject to that second, entity-level of taxation for a certain period of time.
Under the originally enacted statute, that period was 10 years after the conversion to an S corporation. That period has been adjusted frequently in recent years, and was shortened to 5 years for tax years beginning in 2012, 2013 and 2014. The time period was scheduled to revert to the original 10 years in 2015. PATH continued this 5-year provision for 2015 and permanently extends it for future years.
By shortening the provision in half, it will free up a lot of money if you want to sell a property. This is money to be reinvested into the business, a new endeavor, or savings. Time is such a valuable commodity — many argue the most precious. With a rule like this, you can see why.
Itemized deduction for sales tax (Section 164(b)(5))
Generally, if you itemize deductions, for federal income tax purposes you can deduct state income taxes. Under a special rule first enacted in 2004 and extended several times since, instead of deducting state income taxes you could elect to deduct state sales tax paid. If you chose to deduct state sales tax paid, you could choose either: (i) your actual sales tax paid or (ii) an amount allowed under IRS tables.
Because you had to choose between deducting sales tax or state income tax, this sales tax deduction was most beneficial for those who live in states without an income tax.
This deduction for sales tax expired at the end of 2014. PATH renewed this provision for 2015 and permanently extends it for future years.
Now it’s in the law that if you choose to use your sales tax deduction. Keep your records so you can get the bigger deduction of option 1.
Extension through 2019
Bonus depreciation (Section 168(k))
If you purchase property for use in a trade or business, generally you cannot deduct that amount; you must capitalize the cost and take depreciation deductions over several years.
Under a special rule (and subject to numerous requirements), the depreciation deduction for the first year that certain qualified property was placed in service was 50% of the cost of the asset. This was known as “bonus depreciation.”
The 50% bonus depreciation allowance expired at the end of 2014. PATH continues bonus depreciation allowance for qualified property placed in service during 2015 through 2019. The bonus depreciation percentage is 50% for property placed in service during 2015, 2016 and 2017 and phases down, with 40% in 2018, and 30% in 2019.
This accelerates the writeoff of the capital asset purchased, which reduces the income tax burden and keeps more money in the business owners’ hands.
There are other extenders in PATH that are also a positive step impacting businesses, like the sale of qualified business stock, which we may explore in future installments.
It would’ve been nicer if our elected officials would pass these extensions at the beginning of a year so you and I can plan better.
But we’ll take what we can get!
Contact Brinen & Associates if you’d like to discuss how these and other extenders may apply to your business.