Business Tax Provisions of the American Taxpayer Relief Act of 2012

The ATRA was passed by Congress on January 1, 2013 and signed by Pres. Obama on January 2, 2013.  ATRA retroactively reinstated for 2012 certain expired business tax provisions and extended others including the following:

1.     The Section 179 expensing limit is increased to $500,000 for tax years beginning in 2012 (up from $139,000) and 2013 (up from $25,000).  The Section 179 deduction phases-out dollar for dollar as total eligible Section 179 property purchases during the year exceed $2 million for tax years beginning in 2012 (up from $560,000) and 2013 (up from $200,000).  In addition, up to $250,000 of the $500,000 expense amount can be for the cost of qualified leasehold improvements, qualified restaurant improvements, new restaurant buildings, and qualified retail improvements.  Finally, the special rule permitting off-the-shelf computer software to be expensed under Section 179 is extended to tax years beginning in 2012 and 2013.

2.     The 50% bonus depreciation for “new” property (and for qualified leasehold improvements) placed in service in 2012 is extended to property placed in service in 2013.

3.     The research and experimental tax credit expired December 31, 2011.  It is reinstated for expenditures made in 2012 and extended through 2013.

4.     The 100% exclusion of gain on the sale of certain small business stock held for more than five years is retroactively reinstated so that stock acquired from September 28, 2010 through December 31, 2013 is eligible for the 100% exclusion instead of the regular 50% exclusion.

5.     The shorter depreciation period (15 years instead of 39 years) for qualified leasehold improvements, qualified restaurant improvements, new restaurant buildings, and qualified retail improvements expired December 31, 2011.  It is reinstated for property placed in service during 2012 and 2013.

6.     The special rule limiting the reduction of S corporation stock basis to the tax basis of appreciated property donated to charity (instead of a higher reduction for fair market value) is reinstated for donations made in tax years beginning in 2012 and 2013.

7.     The reduction in the S corporation built-in gain recognition period (e.g. for C corporations electing S status) from 10 years to 5 years is extended to sales of assets in 2012 and 2013.

8.     The penalty tax rate on C corporations that are subject to the accumulated earnings tax or to the personal holding company tax rises from 15% for tax years beginning in 2012 to 20% for tax years beginning in 2013.

9.     The prior, temporary repeal of the collapsible corporation tax rules is now made permanent.

Most businesses are now organized as “pass-through” entities (PTE), meaning that business net income is allocated to the owners for purposes of paying income tax.  A regular or “C” corporation is not a PTE and pays its own income tax.  The top C corporation tax rate remains 35%, although some proposals have been made to lower the rate.  With the ATRA tax rate increases on individuals, the top PTE tax rate is 39.6%.  In addition, new Obamacare taxes begin in 2013 and will add to the top income tax rate of PTE owners, adding as much as 3.8% for a total of 43.4%.  Obamacare taxes do not apply to C corporations so its top rate remains 35%.  Nevertheless, a PTE will often remain the entity of choice for small business owners due to the potential for double taxation that can apply to C corporation shareholders (e.g. dividends, sale of assets and liquidation) resulting in an effective combined top federal tax rate of 50.5%.  The gap in between a PTE's single tax rate and a C corporation's double tax rate has been significantly narrowed in 2013.  Therefore, the decision of whether to select a C corporation as your business entity warrants a closer inspection, particularly when certain other C corporation tax advantages (e.g. nontaxable fringe benefits) are considered.