From higher income and investment taxes for the well off to an expiration of lucrative tax deductions off equipment, there’s not a lot for small business owners to be happy about in the tax code as they file with the IRS this spring.
“A lot of people are going to owe money," says Gail Rosen, a Martinsville, N.J.-based CPA. “People are going to fill out their tax return and get disgusted.”
Rosen suspects sticker shock may be unavoidable in many cases. But there are plenty of strategies to employ going forward that can lessen the sting in coming years. Here are five tax code changes that you should be reacting to for both yourself and your business.
1. Higher income tax rates. This is the first tax-filing season that the top tax rate has been raised to 39.6 percent for an individual who made more than $400,000 or a jointly filing couple making more than $450,000 in the previous year. Starting in 2013, the Affordable Care Act also kicked in with an additional 0.9 percent Medicare tax on wages and self-employment income; the Medicare tax applies to people making more than $200,000 or jointly filing couples earning more than $250,000 annually. Rosen and other experts agree that the hike gives you another reason to sit down with a tax professional and hash out how this changes your financial picture and whether there are any extra deductions or tax shelters such as IRAs that might lessen the burden going forward.
2. Higher investment taxes. Federal health reform, starting in the 2013 tax year, also sought to better fund Medicare by tacking on a 3.8 percent Net Investment Income Tax for people making more than $200,000 or jointly filing couples earning more than $250,000 a year. Given the extra tax, make sure that your investments are being held in a tax efficient manner, says Eric Levenhagen, CPA at ProWise Tax & Accounting in Mason City, Iowa.
That means stocks or mutual funds that are consistently high yield should go into tax sheltered accounts, while investments that have not been yielding as much go into the taxable accounts. Any individual should consider this if they are subject to the extra 3.8 percent tax. This strategy works best if the person is not dependent on investment income.
It might also be fruitful to consult with a tax professional on what investments truly are personal investments to the IRS, says Miguel Farra, principal in charge of the tax and accounting department at Morrison, Brown, Argiz & Farra’s Miami office. That’s especially true with real estate investments. For instance, he says that real estate professionals with multiple holdings might not be subject to the new 3.8 percent tax. Same goes for business owners who personally own their enterprise’s location for liability reasons and are renting it to the business.
3. A final farewell for equipment purchase breaks? The party is ending when it comes to economically stimulative tax breaks on equipment purchases. The 2013 tax year was the last tax year for bonus depreciation, a deduction involving half the value of new equipment purchased. It remains to be seen whether Congress will retroactively restore the more generous first-year depreciation tax break under section 179 of the tax code. As it stands, if no action is taken, the maximum section 179 deduction on property put into service for tax year 2014 is $25,000 a year, versus $500,000 for the 2013 tax year. Levenhagen cautions that business owners should not decide on important capital purchases based on changes in the tax code. “I always tell people not to make financial decisions based on the tax ramifications.” That said, he adds, “If your business could survive for a little while without it, you might hold off for a little bit,” Levenhagen says.
4. Plenty of smaller changes. It is also worth noting that there are plenty of other deductions that could be going away this tax-filing season. For example, 2013 is the first tax year in which people earning more than $250,000 or couples earning more than $300,000 a year might see a reduction in personal exemptions and itemized deductions. (On a brighter note, certain types of dividends will continue to be taxed at preferential capital gains rates.) It’s another reason to make that appointment with a financial planner and a tax professional to reevaluate tax-sheltering strategies to see if what you’ve been doing is still your best bet moving forward.
5. Take advantage of the home office deduction. On a positive note, new changes make it easier than ever to claim a home office on a tax form. This is the first tax-filing season in which the IRS will allow a simplified home office deduction of $5 per square foot, with a limit of $1,500 for 300 square feet of home office space. (Note that we’ve said “office space” not “kid’s playroom” or “table in the kitchen.”) Still, Rosen says that the traditional calculation might yield more tax savings. That route involves a more complicated equation, measuring the home office’s square footage, dividing it by the home’s total square footage, and then applying the percentage to a host of home-related expenses from mortgage interest to utility bills to home value depreciation. Calculate both approaches and talk with your tax preparer about which is best for your particular situation.