You are likely aware that various business and individual income tax provisions were enacted in 2001 and 2003 during President George W. Bush's administration, and that these tax provisions are referred to colloquially as the "Bush Tax Cuts." You also are likely aware that Congress passed legislation during 2010 ("2010 Legislation") to extend the Bush Tax Cuts through 2012 and implement several new tax provisions designed to stimulate the United States economy. However, you may not be very familiar with the details of these tax provisions and how they affect you and your business. This article is intended to provide you with insight into several significant tax planning opportunities for you and your business in 2011 and 2012. However, this article is not intended to provide a comprehensive analysis of all of the provisions of the 2010 Legislation. Therefore, it is important that you consult with your tax attorney, accountant, or financial advisor to ensure that your business and personal tax planning take full advantage of the opportunities provided by the 2010 Legislation.
Business Income Tax Planning
Accelerated Expensing and Bonus Depreciation: If your business purchases a piece of equipment or other item with a useful life of more than one year, it is generally required to depreciate the item over the term of the item's useful life. However, two provisions in the 2010 Legislation enable your business to take larger depreciation deductions with respect to property it purchased and placed in service in 2011 and 2012.
First, your business may choose to "expense" (that is, take a deduction equal to 100% of the cost of the item) up to $500,000 with respect to eligible property (e.g., machinery, equipment, furniture, etc.) it purchases and places in service during 2011. However, the $500,000 cap will be reduced if your business purchases and places in service more than $2,000,000 of eligible property in 2011. During 2012, your business may choose to expense up to $125,000 with respect to eligible property it purchases and places in service, with the expensing cap being reduced if your business purchases and places in service more than $500,000 of eligible property.
Second, your business may choose to take bonus depreciation deductions in excess of the amounts generally allowed with respect to eligible property (e.g., machinery, equipment, furniture, etc.) it purchases in 2011 and 2012. During 2011, your business may choose to accelerate 100% of the depreciation deductions into 2011 with respect to eligible items it purchases during 2011. During 2012, your business may choose to accelerate 50% of the depreciation deductions into 2012 with respect to eligible items it purchases during 2012 and take the remaining 50% of the depreciation deductions on the normal depreciation schedule for the item.
- Planning Tip: The 2010 Legislation's accelerated expensing and bonus depreciation provisions provide significant incentives for your business to purchase machinery and equipment in 2011 and 2012. However, it is important for you to talk with your tax attorney, accountant, or financial advisor to ensure that you make the proper elections to take advantage of these provisions and apply the provisions to your business in the most tax efficient manner.
Converting a C Corporation into an S Corporation or a Limited Liability Company: The combination of the current historically low federal corporate tax rates and depressed asset values makes 2011 a great time to convert a C corporation into an S corporation or a limited liability company ("LLC"). C corporations are subject to double taxation because corporate profits are taxed once at the corporate level and then taxed again when the profits are distributed to shareholders. S corporations and LLCs, however, are "pass-through" entities whose profits are subject to taxation only at the personal level, which can yield significant tax savings after the conversion.
- Planning Tip: Converting a C corporation into an S corporation or LLC requires an analysis of the tax attributes of the C corporation and, thus, you should consult with your tax attorney, accountant, or financial advisor before engaging in such a conversion. A conversion may produce the significant tax benefits you desire, but you need to be sure that the conversion will not result in unintended consequences.
Individual Income Tax Planning
Low Tax Rates Continue: Consistent with the Bush Tax Cuts, the lowest individual income tax bracket for 2011 and 2012 will be 10%, and the highest bracket will be 35%. These rates are historic lows. They were 15% and 39.6%, respectively, prior to the enactment of the Bush Tax Cuts.
The Bush Tax Cuts and the 2010 Legislation also provide for a historically low long-term capital gains tax rate (which applies to investments held for more than one year) of 15% for 2011 and 2012. Prior to the enactment of the Bush Tax Cuts, the long-term capital gains tax rate was 20%.
The Bush Tax Cuts and the 2010 Legislation also provide for favorable tax treatment of dividends at the rate of 15% for 2011 and 2012. Prior to the Bush Tax Cuts, dividends were taxed as ordinary income, making them subject to a maximum tax rate of 39.6%.
- Planning Tip: It is impossible to know today whether Congress will extend these historically low tax rates past 2012. Accordingly, you should consider (a) accelerating both non-capital gain and long-term capital gain income items into 2011 and 2012 to take advantage of the lower individual income and long-term capital gains rates (for example, sell excess inventory items owned by an S corporation or LLC and sell appreciated stocks), (b) deferring losses into 2013 and beyond to enable you to take deductions for them later in the event the tax rates increase in 2013 and beyond (for example, wait to sell loss items owned by an S corporation or LLC and wait to sell depreciated stocks), and (c) declaring dividends in 2011 and 2012 to take advantage of the preferable tax treatment of dividends. These simple techniques will enable you to mitigate the impact of possible increased tax rates in 2013 and beyond.
Education Funding Planning: Both the Bush Tax Cuts and the 2010 Legislation increase the maximum contribution that can be made to a Coverdell education savings account to $2,000 per child per year and provide that proceeds from a Coverdell account may be used to pay elementary, middle, and high school education expenses. A Coverdell account is similar to a state 529 college savings plan in that both investment vehicles provide for tax-free growth as long as the account proceeds are used on qualified education expenses. However, Coverdell accounts and 529 plans differ as follows:
- 529 plans have much higher maximum contribution limits than Coverdell accounts;
- Coverdell accounts are subject to income eligibility limits ($95,000 if single and $220,000 if married (but note that a non-qualified parent could gift money to a child to invest in the Coverdell account)), while 529 plans are not; and,
- Proceeds from 529 plans can be used to pay only college education expenses.
- Planning Tip: Establish and fully fund a Coverdell account if you have young children that you would like to send to private school. The Coverdell account will provide for tax-free growth that you can use to pay for your child's pre-college private education expenses. You can establish and fund both a Coverdell account and a 529 plan.
Conservation Easements: A conservation easement limits the future development of a parcel of real property and is created for the benefit of a qualified conservation agency, thereby making it a charitable contribution. The 2010 Legislation extends a tax provision originally enacted in 2006 that allows an individual donating a conservation easement to deduct an amount equal to 50% of the individual's adjusted gross income in the year of the donation. The donor then can continue to deduct an amount equal to 50% of the donor's adjusted gross income over the next 15 years until the remaining value of the conservation easement has been deducted.
- Planning Tip: You may want to consider donating a conservation easement in 2011 or 2012 in order to ensure that you can take advantage of the favorable 50% annual deduction. Conservation easements also provide estate tax benefits that are beyond the scope of this article.
Conservation easements and their valuation are complicated, so assistance from your attorney, accountant, or tax advisor is strongly recommended.
While tax planning may not be the most enjoyable aspect of your business and personal planning, effective proactive tax planning can save both you and your business substantial amounts of money.
© 2011, Ward and Smith, P.A.
For further information regarding the issues described above, please contact Lee C. Hodge.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.