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February 28, 2013
Over the Fiscal Cliff for Tax Savings (Part 2)

ARDMORE, Pa. — Package renews more than 50 temporary tax breaks through 2013

ARDMORE, Pa. — The so-called “fiscal cliff” tax package recently signed into law renewed more than 50 temporary tax breaks through 2013, saving individuals and businesses an estimated $76 billion. For the owners and operators of small- and medium-sized laundry businesses, there is good news and bad news contained in the fiscal cliff tax laws.

First, the good news: greater certainty in taxes. The owners and operators of laundry businesses have grown used to many longstanding tax breaks but they also have had to get used to the uncertainty of whether they will be renewed each year.

On the downside, in addition to a 3.8% Net Investment Income (NII) tax and a 0.9% Additional Medicare tax that, thanks to the Health Care and Education Reconciliation Act of 2010, began in 2013, many laundry owners discovered they are subject to new taxes. Single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more in taxes in 2013.

TAXING IT ALONE

Single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more because of a higher 39.6% income tax rate and a 20% maximum capital gains tax. Of course, for other individuals, the alternative minimum tax (AMT) has finally been indexed for inflation.

Ironically, the AMT was created to ensure that wealthy individuals, not middle-income households, would pay some kind of income tax. The new law increases the 2012 exemption amounts to $50,600 for unmarried individuals and $78,750 for couples filing jointly. For 2013, the AMT exemption amounts are predicted to be $80,750 for married couples filing jointly and $51,900 for single individuals.

ESTATE TAXES NEVER DIE

Always of significant interest to family-owned businesses, the estate tax has long been a bit of a mixed bag. The $5 million-per-person exemption was kept in place (and indexed for inflation). The top rate was increased, however, to 40% effective Jan. 1, 2013. This change is expected to increase government revenues from 2012 levels by $19 billion. Other good news for estate planning: portability is kept in place and estate and gift taxes remain unified, i.e., the $5 million stays in place for gift-tax purposes as well as estates. And, best of all, it is all permanent.

PLANNING OPPORTUNITIES ABOUND

The majority of laundry businesses operate as pass-through entities, such as partnerships and S corporations. Profits are passed through to their individual owners and therefore are taxed at individual income tax rates. Some business owners might be considering switching to a regular C corporation with its top rate of 35% rather than doing business through an S corporation, LLC, etc., subject to a top rate of 39.6% on the pass-through income.

But it’s important to look much deeper than the tax rates. With a pass-through entity, the shareholders are taxed only once on the income. With a regular C corporation, distributions would first be taxed at the corporate level and once again at the shareholder’s level for an additional 15-20%, plus the 3.8% net investment income tax.

That double taxation becomes even more significant on the sale of the laundry business. Although there are provisions in the tax law that allow all or a portion of the gain on the sale of a business to be excluded or ignored, they are limited.

Another consideration, particularly for small businesses, is that any expenses disallowed by an IRS auditor will only result in increased income to the pass-through entity. When doing business as a regular corporation, disallowed personal expenses increase the income of the corporation and are taxed as constructive dividends to the shareholders. The same is true for unreasonable compensation of shareholder/officers.

Keep in mind that if a switch from an S corporation to a regular C corporation is made, a switch back to an S corporation can’t be made for five years—unless permission is received from the IRS. If an LLC or partnership is incorporated, there can be expenses and potential tax consequences.

The increase in the top tax rates, the AMT relief provided for the 2012 tax year, and the hidden taxes all combine to make it possible for many small- and medium-sized businesses ineligible for business credits thanks to AMT limitations in 2011 to potentially be able to take advantage of these dozens of credits. It is, in essence, a back-door opportunity for small businesses, similar to when Congress expanded eligibility for credits for 2010.

Although it is not the grand bargain as envisioned by lawmakers, many popular but temporary tax extenders relating to businesses were included in the American Taxpayer Relief Act: the Code Section 179 small-business expensing, bonus depreciation, and the Work Opportunity Tax Credit. Unfortunately, the new law is effectively a stopgap measure designed expressly to prevent the onus of the expiration of the Bush-era tax cuts from falling on middle-income taxpayers. Congress must still address spending cuts and may even tackle tax “reform.”

The time is now—before filing the laundry operation’s 2012 tax returns—for every laundry business owner to consult with their accountants and/or tax professionals to focus on the potential savings offered by these newly revised, extended and expanded business credits, deductions and tax write-offs.

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult a financial adviser for advice regarding your particular situation.

February 26, 2013
Over the Fiscal Cliff for Tax Savings (Part 1)

ARDMORE, Pa. — Package renews more than 50 temporary tax breaks through 2013

ARDMORE, Pa. — The so-called “fiscal cliff” tax package recently signed into law renewed more than 50 temporary tax breaks through 2013, saving individuals and businesses an estimated $76 billion. For the owners and operators of small- and medium-sized laundry businesses, there is good news and bad news contained in the fiscal cliff tax laws.

First, the good news: greater certainty in taxes. The owners and operators of laundry businesses have grown used to many longstanding tax breaks but they also have had to get used to the uncertainty of whether they will be renewed each year.

On the downside, in addition to a 3.8% Net Investment Income (NII) tax and a 0.9% Additional Medicare tax that, thanks to the Health Care and Education Reconciliation Act of 2010, began in 2013, many laundry owners discovered they are subject to new taxes. Single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more in taxes in 2013.

EQUIPMENT WRITE-OFFS FOR PROFITABLE OPERATIONS

The American Taxpayer Relief Act extended through 2013 the Tax Code’s Section 179 first-year expensing write-off for equipment and business property purchases. Now, the higher expensing limits in effect in 2011 have been reinstated for 2012 and extended for expenditures made before Dec. 31, 2013. Thus, a laundry business can expense or immediately deduct up to $500,000 of expenditures in 2012 and 2013, subject to a phase-out if total capital expenditures exceed $2 million.

The tax break that allows profitable laundry businesses to write off large capital expenditures immediately—rather than over time—has long been used as an economic stimulus by our lawmakers. While 100% “bonus” depreciation expired at the end of 2011, today the new law allows 50% bonus depreciation for property placed in service through 2013.

Some transportation and longer-lived property are even eligible for bonus depreciation through 2014. If bonus depreciation had not been extended, the 2012 tax year would have been the final year in which substantial first-year write-offs for buyers of business automobiles and light trucks were available.

To be eligible for bonus depreciation, property must be depreciable under the standard MACRS (Modified Accelerated Cost Recovery System) and have a recovery period of less than 20 years. Section 179 first-year expensing remains a viable alternative, especially for small businesses. Property qualifying for the Section 179 write-off may be either used or new, in contrast to the bonus depreciation requirement that the taxpayer be the “first to use.”

Leasehold improvements and building improvements generally must be depreciated over 39 years. The tax law provides a special 15-year, straight-line depreciation break for qualified leasehold improvements, restaurant property, and retail improvements. Naturally, there are quite a few restrictions, such as the lease must between unrelated parties.

Qualified leasehold improvements also qualify for the 50% bonus depreciation. In fact, qualified leasehold improvements, restaurant property, and retail improvements up to $250,000 may qualify for Section 179 expensing. And, best of all, these provisions have been extended for property placed in service before Jan. 1, 2014.

MORE, MORE AND MORE

The Work Opportunity Tax Credit (WOTC), which rewards employers that hire individuals from certain target groups, has extended to Dec. 31, 2013, and applies to individuals who begin work for the employer after Dec. 31, 2011. Under the revised WOTC, laundry businesses hiring an individual from within a target group are eligible for a credit generally equal to 40% of first-year wages up to $6,000.

An S corporation is a pass-through entity and not usually subject to income taxes. It is, however, liable for the tax imposed on built-in gains or capital gains. The tax on built-in gains is a corporate-level tax on S corporations that dispose of assets that appreciated in value during the years when the operation was a regular C corporation.

The new law extends a relaxed version of the provision limiting the “recognition period” to five years, but only for “built-in gains” recognized in 2012 and 2013. Thus, if a laundry business elected S corporation status beginning Jan. 1, 2007, it will be able to sell appreciated assets it held on that date without begin subject to a hefty tax bill.

Check back Thursday for the conclusion!

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult a financial adviser for advice regarding your particular situation.

June 19, 2012
Changes in Repair/Replace Tax Rules (Part 1 of 2)

ARDMORE, Pa. — Are certain expenditures currently deductible or must they be capitalized

ARDMORE, Pa. — In an effort to resolve the controversy over whether certain expenditures made by a laundry business are currently deductible as repair expenses, or whether they must be capitalized and deducted over the life of the underlying business asset, the Internal Revenue Service has finally released new regulations.

The IRS’s long-awaited expanded regulations for determining whether an expense must be capitalized because it betters or improves tangible business property or equipment, restores it, or adapts it to a new and different use, will have a significant impact on every laundry business that acquires, produces, or improves its tangible property. 

In addition to clarifying and expanding the current rules, the new regulations create “bright-line” tests for applying the repair-or-capitalize standards, provides guidance for accounting for—and disposing of—repaired property, as well as clarifying other aspects of the repair/capitalize dilemma.

The new regulations specify how repairs made simultaneously with improvements are to be treated, and provide a “safe harbor” for routine maintenance expenses such as materials and supplies. The new rules are also must reading for landlords and tenants that must capitalize expenses related to leased buildings. And, because the new rules were issued in “temporary” form, every plant owner and operator will feel the impact immediately.

CAPITALIZE-OR-REPAIR EXPENSE

Since the Reconstruction Era Income Tax Act of 1870, taxpayers have been prohibited from deducting amounts paid for new buildings, permanent improvements, or betterments made to increase the value of property. While this concept has been recognized as part of tax law almost from its inception, exactly what must be capitalized and what may be currently deducted as an expense has been at issue ever since.

According to the IRS, expenditures are currently deductible as a repair expense if they are incidental in nature and neither materially add to the value of the property nor appreciably prolong its useful life. Expenditures are also currently deductible if they are for materials and supplies consumed during the year.

On the other hand, expenses must be capitalized and written off over a number of years if they are for permanent improvements or betterments that increase the value of the property, restore its value or use, substantially prolong its useful life, or adapt it to a new or different use.

Unfortunately, the current rules don’t clearly address even the core issue of whether expenditures should be deducted currently (e.g., as repairs or as materials and supplies) or capitalized by the plant owner or operator.

REPAIR/REPLACE BASICS

Under the rules, the cost of work performed to return property to a former condition without extending its useful life is currently deductible as a repair expense, unlike capital improvements that extend its life or increase its usefulness or productivity and which must be depreciated.

Similarly, the cost of incidental repairs is typically deductible. The regulations state that the cost of incidental repairs that neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient condition, may be deducted as an expense.

Quite frequently, new additions are made to existing property. These additions are not replacement components nor are they repairs to property, but are instead newly installed components. These additions are required to be capitalized.

At other times, replacement parts or components are added. For example, a car’s engine is worn out and replaced. This replacement returns the car to its condition prior to the deterioration of the part. It would be logical to consider this replacement as an increase in the car’s value requiring capitalization. Conversely, it would also make sense to say that by returning the car to its prior condition, it had been repaired. Under this theory, all repairs would be deductible, no matter how substantial they might be.

The above interpretation renders meaningless any distinction between a deductible business expense and a capital expenditure. Thus, it is oftentimes insufficient to merely look at increased value as the determining factor for characterizing the replacement of a part or component. An increase in value is only one of many factors that must be considered to determine deductibility or capitalization.

Check back Wednesday for Part 2: Changes, We Have Changes

Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult a tax adviser for advice regarding your particular situation.