Taxing QuestionsPosted on Sunday, November 2nd, 2003 by Doug Bartholomew
No sooner had the ink dried on President Bush’s signature on the Jobs and Growth Tax Relief Reconciliation Act of 2003 on May 28 than small-business owners began scratching their heads, wondering just what the new tax package held in store for them. To find out, we tracked down four national experts to learn exactly how the new tax measure affects small businesses.
This year’s tax law changes are—surprise!—numerous and complex. You would be wise to huddle with a tax pro to understand how specific aspects of the new tax cut may affect you. As one member of our expert panel, author and lawyer Fred Daily puts it, “There is a flip side to most things, and it’s not always apparent with changes in the tax law. For some tax changes, it may be that left-handed sheep farmers in Montana are the only ones that can benefit.”
Sharing their informed views on the new tax measure are small-business tax veterans:
Sandy Botkin, CPA, former IRS attorney and author of Lower Your Taxes Big Time (McGraw-Hill, 2003).
Frederick W. Daily, lawyer and author of Tax Savvy for Small Business (Nolo Press, 2003).
Michael Gray, a San Jose, Calif.–based CPA who maintains a tax-smart Web site called profit
Barbara Weltman, a Millwood, N.Y. tax lawyer and publisher of the newsletter, Barbara Weltman’s Big Ideas for Small Business.
What are the broad implications of the new tax law for the economy and for small businesses?
WELTMAN: The idea is for business to spend more to help the economy, and that will help create more jobs. This is a marvelous federal tax cut, but a couple of things—the alternative minimum tax, and the fact that state taxes might not follow these rules—might diminish the gains taxpayers and small-business owners get from it.
GRAY: This is the second-biggest tax cut in history. A lot of tax professionals are kind of nervous, because we’ve seen our tax laws change before. There’s always the possibility Congress could change their minds on this stuff, especially when they see big deficits occurring. For small-business owners, the new depreciation rules are some of the most important aspects of the new tax laws. Also, I think this is a huge opportunity for people who are planning to sell their business to have relatively modest tax rates apply.
DAILY: There isn’t anything in the new tax act that’s necessarily going to affect all small businesses. It depends on the person’s tax bracket and other factors. The key Bush tax-cut change that will affect small businesses is a new provision allowing accelerated write-offs of vehicles and equipment used for business.
How does that provision work?
BOTKIN: Small-business owners now can deduct up to $100,000 of equipment per tax return in the year they bought it—whether they pay cash or finance it, and whether it’s new or used equipment. It’s certainly not a bad deal for small businesses. And it’s effective for any purchases of equipment made starting January 1, 2003.
GRAY: This new expense allowance is up from $25,000. Small-business people should keep in mind, though, that it’s effective only for the 2003–2005 tax years. Also, it’s important to note that estates and trusts don’t qualify. So if you have a family partnership business that’s owned by a trust, you can’t take advantage of this higher expense allowance. But in general, the expense allowance is a big incentive for small business to purchase equipment.
WELTMAN: Being able to write off the entire cost of equipment the first year—rather than depreciate it over several years—can be a way for small businesses to increase cash flow. Of course, you can only claim equipment expenses if you’re profitable. Also, most small-business owners lease vehicles rather than buy, so they’re not going to get any of the benefit.
I should add that the favorable interest rates that are available now make financing these purchases extremely attractive.
DAILY: There’s nothing wrong with taking a loan to get this write-off. The business just has to acquire the equipment—vehicles, furniture, computers or software—and start using it before the end of the year. But they don’t have to pay a dime on it to get the deduction. They can buy the whole thing on credit.
But you may be better off depreciating equipment you purchase this year over the long-term anyway. If your business isn’t doing so well this year, and you think you will do better in future years, you’re wiser not taking the faster write-off.
What is this I hear about small-business owners and sole proprietors buying Hummers and other SUVs to take advantage of the new law?
GRAY: I get a lot of questions from clients who are focused on this issue. They’re interested in getting this big write-off from their vehicle.
BOTKIN: Every tax lawyer I know is going out and buying an SUV to take advantage of this.
GRAY: If you buy a huge vehicle with a gross-vehicle-weight rating [the maximum safe weight of the vehicle with a full load] of more than 6,000 pounds, you can take the entire purchase price up to $100,000 as a current-year deduction. The manufacturers have awakened to the fact that these vehicles can qualify for this tax benefit, so they are intentionally making them heavier. Ecologically speaking, it’s a disaster.
By contrast, for ordinary vehicles purchased by the business, you can claim the 50 percent bonus depreciation, allowing for a $10,710 first-year write-off.
For the vehicle to qualify, it has to be used more than 50 percent for business, and only that portion of the vehicle used for business qualifies. Remember, commuting doesn’t qualify as a business use—you can only count visits to clients or business meetings.
What about electric vehicles and hybrid cars? Do businesses that buy these more environmentally friendly vehicles get a break too?
GRAY: They sure do. Businesses that purchase all-electric vehicles can deduct up to $26,050 of the purchase price the first year. Some hybrid vehicles, including those made by Toyota and Honda, also qualify.
How do the expense rules affect the purchase of business such as software packages for accounting or human resources management?
DAILY: Business software now can be fully expensed in the first year, instead of being depreciated over three years as in the past. As a practical matter, I think a lot of people were writing off commercial off-the-shelf software as a business expense in the first year anyway.
GRAY: Software always should have qualified to be expensed, instead of depreciated. It didn’t make sense that you could expense a computer but not the software. The new law gives an incentive to buy business software, which now can be expensed up to $100,000. It also avoids an argument with the IRS over whether you have to keep using the same software program for two to three years to fully depreciate it.
Are the changes in the tax law significant enough for owners to change their business’s structure from, say, a limited partnership to a corporation?
GRAY: Most people structure their business based on tax considerations. There are some things in the new law that favor regular corporations more than before. For instance, dividends you pay out are taxed at a lower rate than before.
DAILY: But most small businesses are not C corporations, so they can’t take advantage of this.
GRAY: And owners should keep in mind that these tax-law changes are temporary—they expire in a few years. Of course, if you were already planning to change to a regular corporation within a short period of time, then go ahead and make that change.
It’s good to remember back to 1986, when people invested heavily in tax shelters and then had the rug pulled out from under them when those tax benefits were eliminated. Instead of making a radical change in the business structure, I think people should temper their decisions.
The alternative minimum tax [AMT], originally established to catch higher-income taxpayers with excessive deductions, seems to be ensnaring more middle-income people. Does the new tax law accelerate this trend?
|Tax Tips from the Experts
Our tax-savvy panelists recommend that small-business owners act now before the end of the year to begin planning for the impact of the new tax law:
BOTKIN: No question, substantially more people will be hit by the AMT. Many middle-income people, including small-business owners, will probably be subject to the AMT— especially if they have capital gains and dividends. Many of these people are going to be affected by the AMT. Or if you have a lot of unreimbursed employee business expenses. That will do it. But while the AMT prohibits itemized deductions for most people, small-business people can deduct all business expenses, whether under regular income tax or AMT.
WELTMAN: This is the flip side of the tax act. By pushing your regular tax rate down, you’re more likely to be subject to the AMT, which means you’ll be taxed at a 26 to 28 percent rate.
What about someone who’s considering selling a business? Would he or she be affected by the new tax provisions?
WELTMAN: Absolutely. If you’re thinking of selling your business, now is the time to do it. The reason is that under the new law, you pay on capital gains at a rate of only 15 percent—the lowest the capital-gains tax rate has been in 40 years. And it applies even if you’re selling your interest in the company to your
GRAY: This is a huge opportunity for people to sell their business and have relatively modest tax rates apply. Even if you do an installment sale of your business whereby you expect to be paid off by the end of 2008, you can still get this advantageous tax rate. This is a big reason to be thinking of selling a business over the next couple of years.
What’s more, if you sell the asset and give a piece of it to your children, they can sell their interest and pay an even lower rate. Also, if you have excess accumulated earnings in the business, now is the time to pay a dividend. It really makes sense to take dividends now.
How does the new law affect retirement planning?
GRAY: For some people, retirement plans are not as good a deal as before. If you’re pretty close to retirement, with the new long-term capital-gains rates, you may be better off investing your assets outside the plan. The reason is that retirement plan payouts are taxed as ordinary income at a much higher rate. Remember, though, that these special tax rates are effective only to 2008, and for retirement planning you generally think of a longer time frame.
How will state income taxes play with the federal changes?
WELTMAN: Your capital gains may be treated differently when it comes to your state taxes.
GRAY: The big mess out of all this is that most states are not conforming.
WELTMAN: This is one of the factors—the other being the triggering of the AMT for many people—that may diminish the gains from this otherwise marvelous federal tax cut. I would certainly advise people to talk to their tax advisors to see exactly how a deduction will affect these other tax issues.