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Year End Tax Planning Opportunities

Later this month, the lame-duck Congress will reconvene, and it appears that some form of tax legislation is likely. This client alert will cover tax planning ideas that are guaranteed, absent any eleventh-hour tax legislation in 2010. In the Small Business Jobs Act of 2010, taxpayers received a small boost when Congress extended some valuable and well-publicized business tax incentives, such as bonus depreciation and Code Sec. 179 small business expensing. At the same time, other tax incentives, some of which are new for 2010, may require quick action.

Bonus depreciation

Bonus depreciation is valuable because there is no limit on the total amount of bonus depreciation that may be claimed in any given tax year. However, the asset must be placed in service qualified property before January 1, 2011, or the opportunity closes for this year.

The 2010 Small Business Act extends 50 percent bonus depreciation for qualified property placed in service before January 1, 2011. The property has to be new (property whose original use begins with the taxpayer), and only certain accelerated depreciation conventions are allowed.

Consider the following example:

  • Client X acquires new qualifying property that costs $50,000 and is five-year property subject to a half-year convention. X can take 50 percent bonus depreciation of $25,000 in the first year, thereby reducing the property’s basis to $25,000. X can also take one-half of a full year’s depreciation in the first year. For 2010, X can deduct depreciation of $30,000. The remaining $20,000 is deducted throughout the subsequent years’ normal depreciation convention.

Qualifying cars and light trucks/vans also have the opportunity for additional bonus depreciation of $8,000, making 2010’s total deductible amount $11,060 for passenger cars and $11,160 for trucks. Generally, these amounts are reduced proportionately if use of the automobile or truck is less than 100 percent business-related. However, these higher amounts will not be available after December 31, 2010.

Code Sec. 179 expensing

The Code Sec. 179 election to expense certain capital assets has been expanded to enable many businesses to deduct the entire cost of their depreciable property during the year it is purchased and placed in service. Qualified property for the Code Sec. 179 expensing deduction must be originally purchased for use in a trade or business.

In an effort to encourage capital expenditures, beginning in 2010 and 2011 with regards to certain improvements, taxpayers can gain additional deductions. A taxpayer can elect up to $250,000 of the $500,000 Code Sec. 179 deduction limit (subject to the investment limitation) for qualified real property. There are three types of qualified real property: (1) qualified leasehold improvement property; (2) qualified restaurant property; and (3) qualified retail improvement property.

Payroll tax exemption

Employers that qualify individuals between February 4, 2010, and January 1, 2011, may qualify for a 6.2 percent payroll tax incentive. The incentive exempts businesses from paying the employer’s share of Social Security taxes on wages paid to qualified new hires after March 18, 2010, and before January 1, 2011. Some employers mistakenly believe that they have to lay-off employees to qualify. This is incorrect. The payroll tax exemption can apply to wages paid to any qualified employee.

In addition, based upon a 2010 federal court case, employers who have recently gone through a reduction in force or plant closing may qualify for a refund of FICA taxes paid for severance compensation!

There is also a Worker Retention Credit available. The credit may be claimed for a retained worker for the first taxable year ending after March 18, 2010, for which the retained worker satisfies the specific statutory requirements.

Code Sec. 199 deduction

Often overlooked is the Code Sec. 199 domestic production activities deduction. For purposes of the deduction, the definition of manufacturing is broad; however, its under-utilization may be due to the complexity surrounding the deduction.

Generally, the maximum Code Sec. 199 deduction is equal to a percentage of the lesser of either the taxpayer’s qualified production activities income (QPAI) or taxable income. The maximum deduction for 2010 is, for most taxpayers, nine percent. However, the deduction is limited to 50 percent of the W-2 wages actually paid to employees and reported by the employer.

Code Sec. 45R tax credit

Small employers offering qualified health insurance coverage to their employees may be eligible for a new tax credit. The Code Sec. 45R credit is generally available to employers that pay at least half the cost of qualified coverage. For the 2010 tax year, the maximum credit is 35 percent of premiums paid by eligible employers (non-profit employers may be eligible for a reduced credit of 25 percent). The maximum credit goes to employers with 10 or fewer full-time equivalent (FTE) employees paying average annual wages of $25,000 or less.

Energy tax incentives

Numerous tax incentives are designed to motivate businesses to invest in energy conservation, energy efficiency and the production of alternative energy. Taxpayers generally have through December 31, 2013, to place in service biomass, marine and other types of renewable energy property to claim the renewable energy production tax credit.

Accelerating taxable income

Although most profitable businesses use year-end planning strategies to accelerate deductions and defer income, not all businesses profit from these techniques. Quite to the contrary, some businesses should do just the opposite to come out ahead. For example, proper management of Net Operating Losses (NOLs) is critical. If NOLs are about to expire, a business may want to accelerate income and defer deductions as much as possible to use those expiring NOLs now and benefit from deferred deductions in the future. Those otherwise counter-intuitive techniques might include an election out of bonus depreciation, termination of “LIFO” depreciation and changing accounting methods.

These are just some of the certain straight-forward business and tax planning opportunities as 2010 comes to a close. There is a possibility the lame-duck Congress might pass tax legislation in 2010. However, until that happens, be sure to meet with your Davis & Kuelthau business advisor to take advantage of these opportunities before the end of the year.

If you have any questions or would like more information, please contact your Davis & Kuelthau attorney.