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December 2011 Archives
If you have been considering purchasing new computers, equipment, vehicles, or other assets for your business, it might be a good idea to make the purchase before ringing in the new year. This is because the Internal Revenue Code currently contains two provisions which allow immediate write-offs for certain qualified purchases (as opposed to gradual cost recovery over time in the form of depreciation deductions).
Section 179 Deduction. The maximum deduction allowed has been increased to $500,000 (instead of reverting to $25,000 as scheduled), and the maximum purchase price has been increased to $2 million. This includes new and used capital equipment. In addition, it includes software.
However, in order to qualify for the Section 179 deduction, the property must be acquired for use in your trade or business. For mixed use property (i.e. property used for both business and non-business purposes), the Section 179 deduction is still available if the property is used more than 50% of the time for business. In that case, the cost of the property should be multiplied by the percentage of business use, and the resultant business cost will be the basis for your Section 179 deduction. For the types of property that qualify for the Section 179 deduction, see the IRS website.
Section 168(k) Bonus Depreciation. Under Section168(k), a taxpayer is permitted to write off the entire purchase price immediately (as opposed to gradually recovering the cost through depreciation deductions over time). This is a big deal because the costs of these types of capital investments are typically recovered over a 7- to 15-year period. In some cases, the recovery period may even be 20 years. Significantly, Section 168(k) applies after the application of Section 179. This means that in cases where Section 179 does not allow immediate expensing of the full cost, the entire cost may, nevertheless, be deductible after application of Section 168(k). Note, however, that unlike Section 179, Section 168(k) only applies to new property. For more information regarding the types of property that qualify for the Section 168(k) deduction, see the IRS website.
Option to Opt Out of Bonus Depreciation. The IRS recently ruled that taxpayers may forego bonus depreciation at their option. It may seem illogical to forgo this kind of tax benefit. However, such abstinence is worth considering in cases where a business has expiring net operating losses or capital loss carryovers. In those cases, the loss carryovers should be used currently, and cost recovery deductions should be saved for later.
401(k). As a general rule, a taxpayer can contribute up to $16,500 tax-free to a 401(k) plan. In addition, taxpayers who are older than 50 years old may contribute an additional $5,500 for a maximum tax-free contribution of $22,000. Significantly, the amount contributed lowers taxable income.
IRA. Taxpayers who do not have a 401(k) may make a deductible contribution to a traditional IRA. However, the contribution limits are lower. For taxpayers 50 years or younger, the contribution limit for 2011 is $5,000. For taxpayers older than 50 years old, the contribution limit for 2011 is $6,000. out of your taxable income. Nonetheless, taxpayers are generally well-advised to contribute pre-tax income into a retirement account where it can grow tax-free rather than paying taxes on that money.
Gifts. The gift-tax exemption is currently at an all-time high of $5 million ($10 million for married taxpayers). Consequently, high-wealth individuals may be well-advised to consider making gifts this year before the gift-tax exemption reverts to $1 million after 2012.
Charitable Giving. Consider donating appreciated stock or other assets to charitable organizations that accept such donations. Such a donation will result in a charitable deduction equal to the fair market value of the donated asset. This means that taxpayers can deduct the full value of the donated property without incurring a tax liability on the appreciation.
Charitable Contributions Directly from IRA. This is the last year in which taxpayers aged 70½ and older will be permitted to make charitable contributions straight out of their IRAs. This method of charitable giving could be advantageous for taxpayers with IRAs that have appreciated substantially over time or for taxpayers who do not need the required minimum distributions for living expenses for three reasons. One: tax is avoided on appreciation. Two: the taxpayer is entitled to a charitable deduction. Three: the required minimum distribution is not included in the taxpayer's income for the year.
An allowance for costs of corporate equity financing has been proposed in the United Kingdom as a means of eliminating the distortions created by the debt-equity distinction in the corporate tax context. See Institute for Fiscal Studies, Tax By Design: The Mirrlees Review.This proposal comes after a comprehensive review of the British tax system (the "Mirrlees Review") by a prominent group of international tax experts. The study identified traits of a desirable modern tax system and assessed the U.K.'s tax system to determine the extent to which it conforms to these principles. Belgium enacted a similar allowance in 2005 which has substantially enhanced the efficiency of its corporate tax system.
Like the British tax system, the U.S. tax system encourages debt financing by permitting tax deductions for interest paid but not for dividends paid. A tax deduction for costs of equity financing would deincentivize extensive corporate leveraging and neutralize debt-to-equity ratios. In essence, tax considerations would be eliminated (as they should be) from the decision of whether to employ debt or equity financing. As a result, corporations would become more efficiently structured from a capital perspective and resources which are currently being allocated to tax planning could be reallocated to more value-added activities.
For instance, under current U.S. tax law, the determination of whether an instrument should be treated as debt or equity involves a balancing test, which is quite costly in terms of both time and money, to determine whether the instrument is more like debt or equity. See I.R.C. § 385(b). Under this balancing test, the following factors are considered:
- Whether there is a written unconditional promise to pay, on demand or on a fixed date, a sum certain in money in return for an adequate consideration, and to pay a fixed rate of interest;
- Whether there is subordination to or preference over any corporate indebtedness;
- The ratio of debt to equity;
- Whether there is convertibility into common stock; and
- The relationship between the holdings of stock in the corp and the holdings of the interest in question