Financial Planning Questions With Tax Cuts in Limbo
LOS ANGELES — With the Bush-era tax cuts set to expire unless Congress can reach an extension agreement before Jan. 1, tax-planning uncertainties are presenting distinct challenges for business owners such as installing security contractors.
As an example, business owners are often advised to defer fourth-quarter income into the following calendar year to delay tax liability. However, if tax rates rise in 2013, it might be better to recognize the income in 2012 and defer deductions to 2013 when they could have more impact.
“We have to be prepared for all alternatives, but the marching order really has to be control what you can control. What you can’t control, you have to take a wait-and-see approach. It doesn’t mean you sit on your hands. There are certain [preparations] that people should be doing all the time no matter what,” says Charles Schwager, a CPA and partner with Woodland Hills, Calif.-based Barkin, Perren, Schwager & Dolan who specializes in the alarm industry. “Everyone should maximize their retirement and be penalty proof. Make sure you are not going to incur unnecessary penalties for not paying your taxes adequately.”
A key provision of the Bush tax cuts of 2001 and 2003 is the 15% tax rate on long-term capital gains. For installing security contractors, when recurring monthly revenue (RMR) is sold by a sole proprietorship, S Corp., or partnership, it generally results in capital gains, explains Mitch Reitman, managing principal of Fort Worth, Texas-based Security Industry Capital (SIC) Consulting, which provides financial services to security alarm companies in 23 states and Canada.
“If the 15% rate is allowed to expire at the end of the year, the tax rate on capital gains is set to return to 20%. This could mean an increase in taxes of $50,000 on a $1 million gain,” he says.
Security dealers who are planning to sell their company in the near future, and are concerned about tax rates increasing, should “set things in motion now,” Reitman advises. “If it becomes evident that rates are going to increase there will be a rush to sell before the end of the year. This could create a buyers’ market in which a large amount of sellers want to sell to a small group of potential buyers. We may see a reduction on sales prices and it may be that some deals cannot be completed before the tax rates change.”
Following are just some of the other focuses business owners should also address with their tax professional:
Capital expenditures — In 2010 and 2011, businesses were allowed to expense up to a maximum of $500,000 in equipment and property on one year’s tax return, rather than the standard practice of depreciating such assets over time. The maximum Section 179 expense that can be claimed in 2012 is $139,000, will drop to $25,000 in 2013 if no changes are made.
Bonus depreciation — The tax compromise of 2010 allowed business owners to take 100% bonus depreciation, instead of standard depreciation, for purchases of tangible assets (such as furniture, vehicles and equipment) made in 2011. That meant the entire cost of a particular asset could be written off with no limit on its cost. In 2012, as it stands now, bonus depreciation is reduced to 50%; it disappears entirely in 2013, meaning that the cost can only be recovered by depreciating it over years.
Self-employment tax — Self-employed people, including sole proprietors, partnerships, and limited liability companies, paid self-employment tax on earned income at a rate of 13.3% in 2011 and 2012 under tax compromise legislation passed in 2010. In the new year, barring any congressional intervention, that figure goes back up to 15.3%. “If I have not reached the maximum Social Security or self-employment income level, then I may want to bring that in to 2012 to take advantage of that lower rate,” says Schwager. “If I wait till the next year it could cost me a couple percentage points in higher social security or self-employment tax. It is important to realize that if I am already over the threshold [$110,000], I can’t do anything about it.”
FICA — In 2012, the portion of FICA or Social Security taxes that are deducted from employee paychecks is 4.2%. The employee also pays 1.45% in Medicare taxes. The employer pays 6.2% for Social Security and 1.45% in Medicare taxes. Absent an extension, the 2% break to the employee is set to expire Dec. 31. Although this tax benefit has had no cost to employers, the money was paid to the employees as opposed to being remitted to the IRS, it has effectively given employees a 2% raise, says Reitman. “If the rate is restored to the full 6.2%, employees are going to see their paychecks shrink by more than 2%. If the rates do revert, make sure that you explain this to your employees before they receive their first January paycheck.”
Procrastination and insufficient tax planning can be damaging, Schwager says. Close attention to detail can stave off financial penalties or worse.
“If I am having a good year, I should expect to plan for either what I have to pay or take advantage to reduce that tax,” says Schwager. “If I am on top of my business and running it efficiently, that includes having good financial feedback on how I’m doing. Don’t get caught unprepared and miss planning opportunities.”
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