Remember the fiscal cliff? As last year drew to a close, we appeared to be hurtling toward the edge. January 1marked the expiration of the Bush tax cuts, and mandatory defificit-reduction measures were due tokick in the same day. Experts feared the one-two punch of higher taxes and reduced government spending would, at the very least, slow our economic recovery.
At the eleventh hour, President Obama and Congressional Republicans reached a compromise. The result was the Taxpayer Relief Act of 2012. It was enacted on Jan. 2, 2013, but many of its provisions are retroactive for the 2012 tax year. Let’s review three provisions that are likely to affect your dealership and your personal tax returns.
1. BUSINESS PROVISIONS
Like most business owners, dealers have to spend money to make money. The Taxpayer Relief Act extended a 50 percent bonus depreciation for new equipment through Dec. 31, 2013. Bonus depreciation allows for a 50 percent write-off of new equipment; the extension does not apply to used equipment, however. It also includes most purchased software costs. It increases first-year depreciation to $11,160 for new cars and $11,360 for new trucks.
Additionally, section 179 of the Taxpayer Relief Act allows for immediate expensing of up to $500,000 of equipment and qualifying real estate in 2013. That fig- ure was scheduled to be reduced to $139,000 for 2013. The section 179 deduction phases out as pur- chases exceed $2 million. Unlike 50 percent bonus depreciation, the deduction applies to both new and used assets and is a limited deduc- tion based on taxable income.
This provision applies to “qualifying real property.” That would include leasehold improve- ments for third-party tenants but not a related dealership or related finance company (RFC). Retail improvements do qualify, including, for example, the interior portion of nonresidential property used in the retail trade of selling personal property. It also applies to qualifying restaurant property.
The 15-year depreciation for leasehold improvements and retail space improvements was also extended through the end of this year.
2. INDIVIDUAL PROVISIONS
The act included several provisions that affect every taxpayer and several more that affect the highest earners. Effective Jan. 1, 2013, the 2 percent payroll-tax reduction which had been in existence for two years was eliminated. This means your potential customer’s take-home pay has been reduced by 2 percent for 2013 and beyond.
Tax rates at the highest income levels have been increased as well. The 2012 tax rates were 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent for any income from $388,300 and above. The new rates for 2013 are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent for any income from $400,000 and above for singles and $450,000 for married couples filing jointly. While many dealers may not expect to reach that level, your income can vary greatly from year to year. So it may make sense to plan for fluctuations, if possible, and reduce income to below the top brackets. Leveling out the spikes into higher brackets will ensure that more of your income is taxed at a lower rate.
Some possible options for dealers may be to review inventory market-value adjustments, plan the timing of fixed-asset purchases with bonus and Section 179 deductions, plan the timing of employee bonuses between years and to look for possible receivable charge-offs at year’s end.
Also note that the alternative minimum exemption tax patch has been made permanent.
The personal and dependent exemption phase-out is back permanently for 2013. The exemption may be completely eliminated for some higher income taxpayers. The phase-out starts at $250,000 for singles and $300,000 for married couples filing jointly.
The itemized deductions phase-out is back permanently for 2013 as well. You may lose up to 80 percent of your itemized deductions for 2013, as the phase-out starts at $250,000 for singles and $300,000 for married couples filing jointly.
3. THE OBAMACARE EFFECT
Thanks to the Patient Protection and Affordable Care Act, there’s Section 1402, which covers the Medicare Investment Income Tax. It took effect Jan. 1, 2013, and includes a 3.8 percent tax that will be charged on investment income over the modified adjusted gross income (MAGI) thresholds of $200,000 for singles, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately.
The effective top marginal federal tax rate — including the tax rate changes from the Tax Reform Act of 2012 — is 43.6 percent of investment income. In some states with high income tax rates, the total income tax rates on some high income investment earnings can be greater than 50 percent.
Income subject to this Medicare Investment Income Tax consists of interest income, dividend income, capital gains, annuities, net rental income, royalties and passive income.
Income not subject to this ad- ditional income tax is active trade or business income such as your dealership or RFC, distributions from IRAs or other qualified re- tirement plans, other income treated as self-employment and a gain on the sale of an active trade of business, such as an S corpora- tion, partnership or sole proprietorship. Although this income is not subject to the additional Investment Income Tax, it does raise the total income and therefore may move investment income to the threshold at which it does become taxable. Possible timing of this income can help reduce the amount of investment income subject to the Medicare Investment Income Tax.
To help reduce this possible investment income tax, you may consider reducing rent paid to related parties. Reducing rent paid by the dealership and your RFC, for example, will increase dealership income and decrease rental income subject to the tax.
You can also reduce interest rates on officer notes payable in your dealership and your RFC. Generally, interest rates on related party debt can be set between 1 and 1.5 percent interest rates for up to a nine-year note. Also be sure to treat interest paid on intercompany debts as operating income. Do not classify it as interest income on S corporation and partnership tax returns.
Try to recognize investment income when possible in lower income years and time any possible dividends from reinsurance companies, capital gains and other income subject to this tax.
The Medicare tax increases 0.9 percent to 2.35 percent as of Jan. 1, 2013, for singles with earned income of more than $200,000 and married couples filing jointly whose income exceeds $250,000. The tax is assessed on the employee share only, but the employer withholds it. Many taxpayers may have paid themselves large bonuses at year-end to pay in required tax withholdings and avoid penalties, but this will cost you the additional increase if you are over the previously stated limits. You may want to consider starting to pay quarterly estimated tax payments instead to meet your required tax withholdings.
We have covered some of the main changes which may affect most dealers and their dealer- ships. You still have time to plan and institute your income changes before year-end. Not doing so may increase your income tax needlessly.