The American Taxpayer Relief Act of 2012 that became law in January famously rescued the nation – at least temporarily – from the dreaded fiscal cliff. Although a potential economic nightmare may have been averted for a while, the new law also brought a new look to the 2013 tax policy landscape.
Many of the changes impacting all of us as individual taxpayers have been written about extensively in the press. But others directly linked to business activities have received less attention. I will address one of the most potent of these – the Section 179 deduction – from a construction-industry perspective so that perhaps you’ll be able to use it to your advantage.
Many tax breaks made permanent – for now
As it stands now, U.S. tax policy will continue to help those near the bottom of the taxable income ladder most by partially subsidizing certain family costs such as mortgage interest, daycare, tuition, student loan interest deductions and so forth.
As household income climbs, some of these tax breaks get phased-out. Note: a potential phase-out of the mortgage interest deduction for upper income households has been floated recently by lawmakers in Washington – a move that would wreak havoc with real estate values and the pace of new residential construction. But this is a topic for another day.
At incomes above where these breaks help most of us, tax planning becomes simple (and estate planning becomes all the rage). For those with little change in taxable income from year to year, short-range planning is relatively easy. But tax planning gets trickier for those whose incomes rise or fall from year to year based on their business results.
Planning becomes even more difficult if you can’t quite decipher what the rules are. Well, you are not alone on this score. According to a new survey by the National Federation of Independent Businesses, 85 percent of business owners say that the U.S. Tax Code is too complex and should be overhauled. Over 90 percent say they have given up trying to comply with its provisions and instead pay outside professionals to prepare their filings.
As of this writing, talks are underway in Congress to simplify tax rules for small businesses as part of comprehensive tax reform. But while Congress dithers, business owners still need to make decisions every day based on the tools and information they have at their disposal.
Section 179 makes a comeback
For the construction industry, improvements to the Section 179 depreciation rules may be the most relevant and potentially valuable change to come out of the fiscal cliff deal. Limits on qualifying assets and write-offs that were set to drop dramatically in 2012 were restored by the new law to the more favorable limits available in 2011.
This gives you even more incentive this year to plan the timing of equipment and machinery purchases as well as the scheduling of depreciation to attain maximum tax benefits. The key will be your ability to reasonably estimate what your taxable income will look like over the next few years.
To illustrate, let’s assume you and your spouse will have steady annual household income of $300,000 for the next few years. But let’s say you are worried that future federal tax changes might increase your tax rate by, say, seven points, from a marginal rate of 35 to 42 percent. That would represent a tax increase of 20 percent (7 percent divided by 35 percent).
History suggests that rates would not take that dramatic a jump, as you would likely retain much of the break in rates on your first, say, $150,000 of income to temper such an increase. But marginal rates for incomes above that would likely bear more of the burden.
Under these assumptions, you would not want to take the Section 179 deduction immediately, because although you might save $50,000 in taxes in 2013, you might instead save a total of $100,000 if spread out over the next few years.