Each year, on December 31, a collection of "temporary" tax breaks, credits and deductions expires. Congress usually plans on extending those tax items, but doesn’t always do so in time. It’s an odd annual tradition, really. On 12/31/13, Congress let about 55 tax breaks expire. The full array includes everything from energy tax breaks to tax relief for underwater homeowners. Below are three changes we believe will impact your business the most.
Section 179 of the IRS Tax Code allows a business to deduct, for the current tax year, the full purchase price of financed or leased equipment and off-the-shelf software that qualifies for the deduction. The equipment purchased, financed, or leased must be within the specified dollar limits of Section 179, and the equipment must be placed into service in the same tax year that the deduction is being taken (for tax year 2013, this means the equipment must have been put into service between 01/01/2013 and 12/31/2013). The stimulus acts over the past several years have generously increased the limits of the Section 179 deduction and also added a one-time "Bonus Depreciation" (see below) on equipment that exceeded the deduction limit. That’s the whole purpose behind Section 179 -- to motivate the American economy (and your business) to move in a positive direction.
For tax year 2013, business owners can immediately deduct up to $500,000 of qualifying assets they need to buy to run their businesses (office and medical equipment, machinery, software, etc.). But for 2014, Section 179 has been restored to its original limits -- plunging to just $25,000. This reduction is a whopper for small and mid-size business owners.
While both new and used equipment qualify for Section 179 deduction, Bonus Depreciation covers new equipment only. Bonus Depreciation is useful to very large businesses spending more than $560,000 on new capital equipment in 2013; also businesses with a net loss in 2013 qualify to carry-forward the Bonus Depreciation to a future year. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation -- unless the business has no taxable profit in 2013. In this case, that business can elect to use 50% Bonus Depreciation and carry-forward to a year when the business is profitable.
The Bonus Depreciation tax credit expired on December 31, 2013.
Research and Development (R&D)
Known also as the Research & Experimentation Tax Credit, the R&D Tax Credit is a general business tax credit for companies that are incurring R&D expenses. The legislative intent for the R&D Tax Credit is to increase R&D spending in the United States. The credit allows companies that perform certain types of research to write off some of their expenses, such as scientists' wages and various equipment. The credit calculation is complicated, involving floating numbers and multiple worksheets, but it can be quite substantial.
The R&D credit expired on December 31, 2013, as Congress failed to agree to an annual renewal of temporary tax provisions within the tax code. But this isn’t the first time the credit has expired. In fact, it’s happened more than a dozen times, and each time Congress has eventually renewed it (most recently in January 2013 as part of the fiscal cliff deal). Will Congress do so again? Maybe so, but the uncertainty around the timing and length of renewal could pose challenges. If a company anticipates that the expiring provisions are going to be retroactively reinstated, but is incorrect, it can prove to be a very costly decision, particularly for a small or medium-sized business.
So, what now? Somewhat expectedly, Congress is currently working to resurrect the dead provisions. Senator Harry Reid (D-NV), recently introduced Senate Bill 1859, which would extend the overwhelming majority of the expired provisions (Section 179, Bonus Depreciation, and R&D credits included). But the bill’s future looks grim. Govtrack.us gives it a slim 20% chance of being enacted. Senate Republicans objected when the bill came up in December; Sen. Orrin Hatch wanted the bill to go through the Finance Committee first, while Minority Leader Mitch McConnell suggested that the GOP would take up the bill only if Democrats withdrew some of their nominations. Those kinds of demands will not easily be met by Democrats, making gridlock an almost certain reality. What’s more, according to the Center on Budget and Policy Priorities, extending these tax breaks would cost about $55 billion a year unless they are offset with spending cuts or tax hikes elsewhere. I highly doubt Washington is prepared to make such concessions. Also, keep in mind the partisan divide over the underlying goals of tax reform: Democrats want to raise revenue and Republicans want it to be revenue neutral. And both sides of the aisle, I believe, will be cautious about extending tax breaks that appear to be a sort of “corporate welfare” (and all three provisions discussed here could be viewed that way).
Bottom line? I wouldn’t expect any sweeping, meaningful tax reform in 2014. Keep yourself abreast of the changes and make plans to do business as if all current tax policies will remain in place.