My objective with this article is to share with you the elements of current U.S. tax laws and the potential future changes that could affect you and your business. I intend to cover the Tax Increase Prevention Act of 2014. Then, I will examine the proposals from Republicans and Democrats that may become the law of the land in future years.
The Tax Increase Prevention Act of 2014 (“TIPA”) — During 2014, politicians delayed any change to tax legislation until late November. Then, through a flurry of activities in the House and Senate during the first few weeks of December, they agreed to a piece of legislation known as HR 5771 (TIPA), which was then sent to President Obama and signed into law on Dec. 19, 2014.
Overview: The new law retroactively provides an extension to many “tax extenders” from Dec. 31, 2013 to Dec. 31, 2014. Yes, you read that correctly. The tax extender that I will cover only extends through Dec. 31, 2014. Due to brevity, we cannot cover all the tax extenders, but we will cover the ones that might affect most Americans. In addition, this article scratches the surface of specific tax laws and does not delve into the depth of each section, which is subject to exceptions, conditions and definitions based on specific facts and circumstance. Therefore, while my article serves as an alert to various tax issues, you must consult with a competent tax adviser regarding your specific situation.
Some of the Individual Tax Extenders through Dec. 31, 2014 are:
- State and Local Sales Tax Deduction is the ability to claim a deduction for state and local sales tax instead of a state and local income tax deduction.
- Mortgage Debt Exclusion allows taxpayers to exclude any cancellation of debt income of up to $2 million that originate from a foreclosure of their primary residence.
- Charitable Distribution of IRAs allows Americans age 70½ or older to make tax-free distributions from their traditional IRAs to charitable organizations instead of receiving a Required Minimum Distribution (RMD) that is subject to federal personal income tax. This tax-free distribution is limited to $100,000 per year.
- Transit Benefits Parity allows an exclusion of income up to $250 per month for employer-provided mass transit or parking.
- Teachers’ classroom expense deduction of $250 as an adjustment to their Adjusted Gross Income (AGI).
Some of the Business Tax Extenders through Dec. 31, 2014 are:
- Section 179 allows taxpayers to deduct the payment made for the purchase of an asset as an immediate expense as opposed to a long-term depreciation schedule. Thus, under Section 179, a taxpayer would have less taxable income in the year when placing the asset in service. The 2014 Act, TIPA, increased the Section 179 dollar limit from $25,000 to $500,000. In addition, it increased the phase-out limit from $200,000 to $2 million.
- 50 percent Bonus Depreciation is extended and helps many taxpayers, including, but not limited to, those who purchased vehicles in 2014. Namely, for applicable vehicles, there is potentially an additional $8,000 of expensing in 2014. Furthermore, for luxury automobiles, this extender can allow up to $11,160 of expensing in 2014.
- Research Tax Credit allows a 20 percent credit for qualified research expense or a 14 percent alternative simplified credit.
- 100 percent Exclusion of Gain on Qualified Small Business Stock is extended on the sale of such stocks held for more than five years by noncorporate taxpayers. Stocks which you acquire after 2014 will have a 50 percent exclusion of income.
- TIPA extends the 5-year recognition period (i.e., instead of 10-year) for “Built-In-Gain” (BIG) tax when an S-Corporation that was originally a C-Corporation sold its assets in 2014. Without this exclusion, the asset sale and the distribution of gain will be subject to double taxation as if the old C-corporation was still in existence.
- Work Opportunity Tax Credit extends the credit for employers who have hired qualified employees in 2014. For most “qualified employees,” the credit is limited to 40 percent of the first-year compensation and up to $6,000, whichever is less.
Proposals from Republicans and Democrats
Beyond the rhetoric heard from each side of the aisle, there are common themes among their proposals even when the sound bites do not clearly state the facts.
Some of the Proposals issued by Republicans are as follows:
Many pundits believe that Republicans will increase taxes on higher income Americans. This strategy is primarily to increase their appeal to the general population for the next presidential election. Their tax proposals support such views.
Although the Republicans’ proposed tax rates will be lower on paper, their plan for excluding many of the itemized deductions and expanding phase-out limitations will in effect increase taxes on Americans.
- Exclusion of gain from the sale of a principal residence will have a phase out when a taxpayer’s modified adjusted gross income (MAGI) exceeds $500,000 as married filing jointly or $250,000 for other tax filers. The requirement to own and use a primary residence also increases to five out of eight years instead of two out of five years.
- Mortgage interest deduction for the acquisition and capital improvement of a primary residence would be reduced to $500,000 as opposed to $1 million as it stands now.
At present under specific guidelines, an employee can deduct business expenses that his employer does not reimburse, but which employer policy and industry standards require.
- Such deductions are part of the taxpayer’s itemized deductions. Under the Republican proposals, such employee business expenses would no longer be deductible.
Some of the Proposals issued by Democrats are as follows:
They are very clear that they will tax the rich and allow middle and lower class income Americans to have tax breaks.
- The exclusion for the cancellation of debt income for a primary residence under a foreclosure will be extended to Dec. 31, 2017.
- Student loans that are forgiven will be excluded from income instead of being categorized as cancellation of debt income.
- In response to Mr. Buffett’s statement that his secretary pays more income tax than he, the Democrats have designed a new tax. It is called Fair Share Tax (FST). This new income tax targets very wealthy taxpayers whose adjusted gross income (AGI) is more than $1 million. The tax rate is at 30 percent for taxable income, which the government defines as the taxpayer’s AGI less his charitable deductions with specific limitations.
- All employers who have been in business for more than two years and have 10 or more employees must offer an automatic IRA through a payroll deduction. The employer has no contribution expense but becomes a facilitator for an automatic payroll deduction.
- Their proposal permanently extends the Section 179 deduction to $500,000 and a phase-out limit of $2 million.
- The estate and generation skipping lifetime exclusion will be $3.5 million instead of $5.43 million and the lifetime gift exclusion limit will be $1 million instead of $5.43 million. The top tax rate will be 45 percent.
Similar Taxation Proposed by both Republicans and Democrats:
- The structure of the present tax laws is such that when an S-Corporation shareholder receives a profit payout, such profit payout is not subject to self-employment tax even when the shareholder materially participates in the business. This is correct as long as he receives reasonable compensation as the shareholder of the S-Corporation based on facts and circumstances. Both Democrats and Republicans have proposals to change this. The Democrats’ proposal will go after only S-Corporations that are considered personal service corporations (PSC), such as attorneys, accountants, doctors and architects. The Republicans’ proposal would mandate self-employment tax on all S-Corporations’ profit payout regardless of the nature of the business.
Republicans want to repeal the bonus depreciation. The Democrats have no written proposal. However, the perception is that bonus depreciation might not continue unless there is a significant lobbying effort by business groups.
Although no one can predict the future through a murky crystal ball that politicians have mishandled because their modus operandi is to maintain the status quo and self-interest, I hope this article has cleared up some of the obscurity of this subject. Make sure that you consult with a competent tax adviser who understands your specific facts and circumstances as well as current tax laws and potential changes in the future. It is the best possible way to protect yourself and your business from potential tax problems.