Year-End Tax-Planning Strategies for Businesses

With the passing of the last major filing deadline of the calendar year on October 15, 2013, tax practitioners can now concentrate on planning for their clients for the coming year. Year-end 2013 brings many new planning opportunities, along with the traditional year-end tax planning strategies. It also brings challenges—for both individuals and businesses.

There is much for taxpayers and their tax advisors to consider in taking action before 2013 ends, including the important changes made by: the American Taxpayer Relief Act of 2012, P.L. 112-240, some of which officially sunset this year; the provisions in the Patient Protection and Affordable Care Act, P.L. 111-148, scheduled to take effect this year, next year, or later; the U.S. Supreme Court’s decision on same-sex marriage; and the release of significant new IRS rules on many pressing issues, with additional guidance expected when the IRS returns from the federal government shutdown. There is also the prospect of comprehensive tax reform in 2014, which will require some "crystal ball" forecasting of what Congress may or may not do in the coming year.

Business incentives scheduled to officially end with 2013 include bonus depreciation, enhanced Code Sec. 179 expensing, the work opportunity credit, and a handful of other significant tax benefits. Although Congress has routinely renewed these tax extenders in the past, current politics over budget concerns, and the impression that the economy may no longer need extraordinary stimulus measures, may point to the 2013 year-end as being the last occasion for businesses to take advantage of one or more of these special benefits.

New for Business Owners

Businesses should also be aware of certain tax rules that are new for 2013. In particular, increased tax rates on higher-income individuals effective for 2013 may impact business strategies directed toward minimizing taxes for business owners with either pass-through or dividend income. Also important for year-end 2013 are tax strategies in connection with new final "repair" regulations.

Code Sec. 179 Expensing

An enhanced Code Sec. 179 expense deduction is available through 2013 to businesses (other than estates, trusts or certain non-corporate lessors) that elect to treat the cost of qualifying property (Code Sec. 179 property) as an expense rather than a capital expenditure. The annual dollar limitation on Code Sec. 179 expensing for 2013 is $500,000. An annual $2 million overall investment limitation applies before the maximum $500,000 deduction must be reduced, dollar for dollar, for excess amounts.

Comment

Comment: For tax years beginning after 2013, that dollar limit is scheduled to plummet under current law to $25,000, unless otherwise extended by Congress. The phase-out ceiling is also scheduled to drop to $200,000.

Carryforward. The Code Sec. 179 deduction is also limited to the taxpayer’s taxable income derived from the active conduct of any trade or business during the tax year, computed without taking into account any Code Sec. 179 deduction, deduction for self-employment taxes, net operating loss carryback or carryover, or deductions suspended under any provision. Any amount disallowed by this limitation may be carried forward and deducted in subsequent tax years, subject to the maximum dollar and investment limitations, or, if lower, the taxable income limitation in effect for the carryover year.

Planning Note

Since the maximum dollar limit for 2014 is scheduled to fall to $25,000 (unless extended by Congress), businesses should not assume that a carryover will be fully absorbed immediately in 2014. Therefore, monitoring taxable income in 2013 for this purpose is important within an overall Code Sec. 179 strategy.

Planning Note

Under current law, off-the-shelf computer software and certain real property will not qualify for Code Sec. 179 expensing after 2013, even at the lower $25,000 ceiling. This makes it particularly crucial for affected taxpayers to avail themselves of year-end strategies in 2013.

Bonus Depreciation

The 2012 Taxpayer Relief Act generally allows for 50-percent bonus depreciation during 2013. After 2013, bonus depreciation is scheduled to expire (except for certain non-commercial aircraft and longer production period property, which may be eligible for 50-percent bonus depreciation through 2014).

Planning Note

Unlike regular depreciation, under which half- or quarter-year conventions may be required, a taxpayer is entitled to the full, 50-percent bonus depreciation irrespective of when during the year the asset is purchased. Year-end placed-in-service strategies, therefore, can provide an almost immediate "cash discount" for qualifying purchases, even when factoring in the cost of business loans to finance a portion of those purchases.

Luxury car depreciation caps. Along with the sunset of bonus depreciation, the additional $8,000 first-year depreciation cap for passenger automobiles under Code Sec. 280F to account for bonus depreciation is scheduled to expire after 2013. The scheduled sunsetting of the additional $8,000 first-year depreciation amount may give businesses an additional incentive to purchase (and place into service) a vehicle before year-end 2013.

Special 15-Year Recovery Property

The 2012 Taxpayer Relief Act extended through 2013 the 15-year recovery period for qualified leasehold improvements, qualified retail improvements, and qualified restaurant property. To qualify for this accelerated recovery period, the qualifying property must be placed in service before January 1, 2014.

Final Repair/Capitalization Regulations

In September 2013, the IRS released much-anticipated final "repair" regulations that explain when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing, and replacing tangible property. The final regulations are considered to challenge virtually every business because of their broad application.

Compliance timetable. The final regulations apply to tax years beginning on or after January 1, 2014, but provide taxpayers with the option to apply either the final or temporary regulations to tax years beginning after 2011 and before 2014. The IRS has promised critical "transition guidance" later this year to help taxpayers deal with implementation regarding how to apply the regulations for years prior to 2014, as well as what change-of-accounting procedures should be followed.

De minimis expensing alternative. The final regulations also include a new de minimis expensing rule that allows taxpayers to deduct certain amounts paid or incurred to acquire or produce a unit of tangible property. To take advantage of this $5,000 de minimis rule, however, taxpayers must have written book policies in place at the start of the tax year that specify a per-item or invoice-threshold dollar amount (up to $5,000) that will be expensed for financial accounting purposes. Calendar-year taxpayers, therefore, should have a policy in place by year-end 2013 to qualify for 2014.

Comment

For smaller businesses, the final regulations added a safe harbor for taxpayers without an applicable financial statement. The per-item or invoice-threshold amount in that case is $500.

Work Opportunity Credit

Eligibility for the work opportunity credit ends on December 31, 2013. Among other requirements, an employer must hire members of certain targeted groups and have those individuals start work before January 1, 2014.

In addition, on or before the day the employee begins work, the employer must receive a written certificate from the designated local agency indicating that the employee is a member of a specific targeted group. Employers can use Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, to obtain the certification.

Additional Sunsetting Tax Breaks

Other provisions in danger of expiring or being significantly cut back after 2013 currently include, among others: the research and experimentation credit, 100-percent gain exclusion for small business stock, reduced five-year recognition period for S built-in gains, and more.

Affordable Care Act

When Congress passed the Affordable Care Act in 2010, it delayed the effective date of several key provisions until 2014. In July 2013, the Obama Administration announced a further delay in the Affordable Care Act’s employer shared responsibility payment provision (also known as the employer mandate) until 2015. The individual shared responsibility provision (known as the individual mandate) has not been delayed, and starting in 2014, individuals must carry health insurance or otherwise pay a penalty, unless exempt.

Employer reporting. The Affordable Care Act generally requires applicable large employers to file an information return (known as a Code Sec. 6056 return) that reports the terms and conditions of the health care coverage provided to the employer’s full-time employees for the year. Following the White House’s announcement of the delay in employer (and insurer) reporting, the IRS issued transition relief and proposed regulations.

Comment

The IRS has encouraged voluntary compliance with the employer information reporting requirements for 2014 and is expected to issue additional guidance before January 1, 2014.

W-2 reporting. The Affordable Care Act requires employers that provide applicable employer-sponsored coverage to report the cost of that coverage on the employee’s Form W-2, Wage and Tax Statement. Small employers—generally employers filing fewer than 250 Forms W-2 for the previous calendar year—are temporarily exempt from reporting. Other entities, such as multi-employer plans, are also eligible for the temporary relief.

Individual mandate. Beginning January 1, 2014, the Affordable Care Act generally requires individuals to carry minimum essential coverage for each month, qualify for an exemption, or make a payment when filing his or her return. Certain individuals may be exempt, including individuals whose income is below the minimum threshold for filing a return, members of a health care sharing ministry, individuals unlawfully present in the U.S., and others.

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A Closer Look at the New Final “Repair” Regulations on Materials and Supplies

In September 2013, the IRS released much-anticipated final "repair" regulations that explain when taxpayers must capitalize costs and when they can deduct expenses for acquiring, maintaining, repairing, and replacing tangible property. This article is part of a series discussing important features of the regulations; it focuses on the rules for materials and supplies.

The final repair regulations retain the general structure for materials and supplies provided in the temporary regulations. However, it also refines the definition of materials and supplies and limits the election to capitalize to only rotable, temporary, and standby emergency spare parts. In addition, the final regulations clarify application of the optional method of accounting for rotable and temporary spare parts to provide consistency with the taxpayer’s book treatment.

Comment

The rules for materials and supplies in the final regulations do not affect the treatment provided under any provision of the Code or regulations. Thus, a material or supply that is acquired and used to improve a unit of tangible property must be capitalized unless it can be properly deducted under the general de minimis capitalization rule. Similarly, the uniform capitalization rules of Code Sec. 263A require a taxpayer to capitalize the direct and allocable indirect costs, including the cost of materials and supplies, of property produced or to property acquired for resale. Where the uniform capitalization rules apply, the cost of materials and supplies is considered an indirect material cost subject to capitalization.

Materials and Supplies

The cost of non-incidental materials and supplies are generally deducted in the tax year first used or consumed. The final and temporary regulations define “materials and supplies” to mean tangible property used or consumed in the taxpayer’s business operations that is not inventory and that:

• is a component that is acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer, but is not acquired as part of any single unit of tangible property;
• consists of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less, beginning when used in a taxpayer’s operations;
• is a unit of property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations;
• is a unit of property with an acquisition or production cost (as determined under the UNICAP rules) of $200 or less (the threshold is $100 or less under the temporary regulations); or
• is identified by the IRS in published guidance.

Comment

Listening to critics, the IRS expanded the definition of materials and supplies that may be expensed to include property with an acquisition or production cost of up to $200 in the final regulations. The IRS reasoned that this higher threshold amount will “capture many common supplies such as calculators and coffee makers.” The IRS rejected a call for a $500 threshold as too high, but the final regulations retain language that would permit the IRS the flexibility to change the amount in the future without actually having to amend the regulations.

Rotable and Temporary Spare Parts

The final regulations retain the general rule that rotable and temporary spare parts are materials and supplies that are deducted in the year used or consumed. Alternatively, a taxpayer may use an optional method of accounting for rotable or temporary spare parts that allows the taxpayer to deduct the amount paid to acquire or produce the part in the tax year that the part is first installed on a unit of property for use in the taxpayer's operations.

Comment

The IRS declined to make the optional method the default method as it would create an overly burdensome recordkeeping requirement for many taxpayers.

For this purpose, a rotable spare part is a material or supply that is installed on a unit of property, removed from the property, repaired or improved, and either reinstalled on the same or other property or stored for later installation. Temporary spare parts are components used temporarily until a new or repaired part can be installed and then are removed and stored for later installation.

Comment

The IRS rejected a recommendation to expand the definition of rotable and temporary spare parts to include rotable spare parts that the taxpayer leases to customers in the ordinary course of a leasing business. The IRS concluded that such parts are outside the scope of regulations governing materials and supplies.

Recognizing that taxpayers may have pools of rotable or temporary parts that are treated differently for financial statement purposes, the final regulations remove the requirement that an electing taxpayer use the optional method for all pools used in the same trade or business. However, if a taxpayer chooses to use the optional method for a pool for tax purposes, but does not use the optional method for that pool in its books and records for the trade or business, the taxpayer must use the optional method for all of its pools in that trade or business.

Election to Capitalize Materials and Supplies

The temporary regulations issued in 2011 provide that a taxpayer can elect to capitalize and depreciate, as a separate asset, amounts paid for any materials and supplies used to repair or improve a unit of property. Under the final regulations, however, only rotable, temporary, or standby emergency spare parts qualify for the election. The IRS noted in the preamble to the final regulations that, without this limitation, different recovery periods could apply to a capitalized material or supply and the property it improves or repairs. The limitation is also consistent with previous IRS rulings.

Standby emergency spare parts are parts acquired for a particular machine and set aside to avoid substantial operational time loss. Standby spare parts are usually expensive, and they are not subject to periodic replacement, acquired in quantity, repaired or reused. The optional accounting method does not apply to standby emergency parts.

Comment

The procedure to revoke an election to capitalize and depreciate materials and supplies has been clarified in the final regulations. The taxpayer must file a request for a private letter ruling to obtain IRS consent, which the IRS may grant if the taxpayer acted reasonably and in good faith and the revocation will not prejudice the government. The IRS can modify these procedures through published guidance.

Other Published Guidance

The IRS clarified that prior published guidance that permits certain property to be treated as materials and supplies remains in effect, regardless of the final regulations, including smallwares or certain inventoriable items used by small businesses.