Burying your head in the sand won’t make the new federal repair regulations go away. In fact, avoidance will only make things worse.
With that in mind, here’s the lowdown on what your business needs to know about — to remain in the good graces of the Internal Revenue Service.
Effective Jan. 1, these tangible property regulations, commonly known as “repair” regulations, affect anybody with fixed assets — from a beginning investor with only one rental house to owners of multi-million-dollar corporations, said Dave Mason, CPA and partner at BKD.
They cover how and when a business owner can deduct expenses for purchasing or repairing tangible assets, and whether these assets must be capitalized — recorded as a long-term asset to delay tax recognition of the expense.
There are several key changes in the final regulations that differ from the 2011 temporary regulations.
The de minimis rule for tangible property expenditures changed to a $5,000 threshold per item, rather than in sum. If business owners have a written policy regarding capital items, they’re allowed to follow their own book minimum capitalization policy for tangible property, as long as the policy doesn’t exceed $5,000 per invoice or item. The overall ceiling has been eliminated, replaced by a per-invoice or per-item limit.
Without an “applicable” financial statement (at a minimum, financials that are audited), that threshold is reduced to $500 per invoice or item.
“Most small business would fall under this standard, since the majority of taxpayers don’t have reviews or audited financials,” said Jordan Empey, tax manager at Stockman Kast Ryan & Co. “They still need a written policy in place, though.”
There are some exceptions to these safe harbor rules, but only careful analysis will reveal what applies to each small business owner.
In order to use the safe harbor provision, a company’s capitalization policy must be in writing at the beginning of the year and the expenditure deducted on the financial statement.
Safe harbor has also been expanded regarding routine maintenance of buildings and tangible personal property, sometimes even after the class life of the item has expired.
“You have to have interplay between tax professionals and auditors.”
– Dave Mason, BKD partner
In the past, the way a company capitalized or depreciated an item on its financial statement used to be disconnected from the tax return, Mason said.
For instance, if repair expenses are treated as deductible items on a financial statement, then the repair may have to be capitalized on the tax return. Beginning Jan. 1, a company’s position on its financial statement impacts its options on tax returns.
In other words, if you don’t want to analyze the fact-based tests in the regulations, then you can elect annually to follow your book minimum capitalization policy.
If that sounds intricate — it is. To navigate these changes, “You have to have interplay between tax professionals and auditors,” Mason said.
In other words, this isn’t something one can calculate in between meeting with clients and managing employees.
“The repair regulations will impact almost all business owners. Anybody who’s buying property will have to determine whether they have to capitalize the costs or expense it,” Empey said. “They’ll have to make one or more accounting method changes, and these are pretty detailed, actually.”
A large number of small business owners in Colorado Springs use a flow-through tax structure for S-corporations, LLCs, LLPs, sole proprietorships and partnerships, etc. Therefore, several other tax changes will also affect them.
Also new for 2013, the personal exemption phaseout begins when the adjusted gross income for a single person exceeds $250,000 annually, or $300,000 for married couples filing jointly. For each $2,500 that exceeds the AGI limit, 2 percent of the per-person standard $3,900 exemption is lost.
Such “stealth” taxes don’t affect tax rates, but they erode deductions, Mason said.
The so-called Pease limitation simultaneously chips away at deductions, taking 3 percent of the excess over the same AGI thresholds.
For instance, a single person with an AGI of $300,000, or $50,000 over the threshold, loses 3 percent, or $1,500 of itemized deductions.
“You get a haircut on that, but you can’t lose more than 80 percent of your otherwise allowable itemized deductions,” Mason said.
Of course, this 3.8 percent Medicare Investment Income Tax affects portfolio income, including interest, dividends, capital gains and royalties. Not only that, but it has the potential to impact passive investors via their flow-through entities.
Individuals with modified AGI higher than $200,000 for singles, or $250,000 for married, will see their investment income subject to this additional rate — including passive income received on a Schedule K-1 from businesses they own.
Not that anyone could forget, but in a list of tax increases, the 4.6 percent tax bracket increase still deserves a mention. When calculating Uncle Sam’s share for the year, remember that for the highest bracket ($400,000 for single, $450,000 for married joint filers), marginal tax increased from 35 percent to 39.6 percent.
“There are significant tax increases coming into effect for 2013,” Mason said. “With the 3.8 percent additional Medicare tax, the 4.6 (percent) in the tax bracket and the PEP and PEASE stealth taxes, you’re potentially pushing 10 percent.”
If you need to buy a capital asset, then go ahead and buy it in 2013 to decrease your tax liability. Most of these federal changes, however, require complicated tax strategies for business owners.
“It’s going to be even more complex because PEP, Pease and Medicare all have different threshold amounts, and that means more computations,” Empey said.
This isn’t something to ignore or try to deal with at the last minute. The time is ripe to consult with your tax adviser and devise the best solution for keeping the lion’s share of your profit and income.