For Small Businesses, Tax Law Has Become a Moving Target
By CONRAD DE AENLLE
Published: February 9, 2013
TAX planning can be difficult for a small business, all the more so when a lot of the work is left until the last minute — not by the owners or their accountants, but by Congress.
Businesses will have to make sense of a number of tax changes approved on New Year’s Day, along with some tax increases and other requirements approved earlier, notably in connection with health care programs.
The legislation, which averted the so-called fiscal cliff, set higher rates on several taxes that affect small-business owners, while giving new life to credits and deductions that they find particularly helpful. And if they still have to pay more to the Internal Revenue Service, it may not be their only extra expense, tax specialists warn. The cost — in time, money and worry — of preparing returns, tweaking payroll systems and complying with regulations will rise, too, they say.
“There were some big changes as we moved into the new year,” said Kate Barton, the Americas vice chairwoman for tax services at Ernst & Young. “We moved from the fiscal cliff to a fiscal minefield.”
Small-business owners may already be placing themselves on the casualty list. Eighty percent of the ones responding to a Gallup poll last month said that the tax situation was hurting them a little or a lot, versus 2 percent who said it was helping. In the health care realm, the spread of opinion was similar, at 73 percent to 2 percent.
Business owners had to start docking their employees’ pay, and their own, by an extra two percentage points on Jan. 1, when a two-year reduction in the payroll tax expired. They might also have had to increase withholding or estimated-tax payments to adjust for higher income and Medicare tax rates that went into effect that day for high earners.
Tax rates on dividends also increased for those with high incomes. That could affect owners of businesses set up as C corporations, who often extract money from their companies as dividends instead of salary, Ms. Barton said.
The higher rate on dividends could make a C corporation less tax efficient than a sole proprietorship or an entity like a partnership or a subchapter S corporation, in which income ultimately accrues to the owners as individuals. She noted, though, that this is just one of several considerations when deciding which structure is best.
“It might be better to have a lower corporate rate than a higher individual rate,” but with the changes made on Jan. 1, “the difference in rates could be only four percentage points,” she said. “You really need to think it through because there’s more flexibility with a partnership or some other flow-through entity. You’ve got to run the numbers to see what’s best.”
Several deductions and credits coveted by small businesses have been renewed, expanded or reinstated retroactively, said Carl J. Giardino, managing director of the tax group at theCBIZ MHM consulting firm. The amount of the Section 179 deduction, which allows expenditures on capital items like factory equipment to be written off immediately rather than depreciated gradually, has been raised to $500,000 from $125,000. The increase applies to 2012 and 2013 alike.
Bonus depreciation, which allows capital equipment to be written off at a faster rate beyond what the Section 179 deduction allows, has been extended and applies to the first $2 million spent, he said. Unlike the situation with the deduction, only new equipment — not used — qualifies for accelerated depreciation.
Two credits that expired in 2011 or were sharply curtailed, the Research Tax Credit and the Work Opportunities Tax Credit, have been brought back and made retroactive to 2012, Mr. Giardino said. The first credit is for 20 percent of research expenditure that exceeds a baseline amount or 14 percent using a different formulation. The second is for 40 percent of varying portions of wages for new employees in certain fields.
The Work Opportunities credit, which covers military veterans, workers coming off government assistance, and ex-felons, is useful for “almost any type of Main Street business,” he said. “If I hire 10 people and can put $25,000 to $40,000 back in my pocket, that’s significant” to a small business. “A lot of companies in the restaurant field were taking advantage of this. It really helped them stay afloat.”
That was until the credit was eliminated for all categories of workers except veterans last year, before the reinstatement. While he acknowledges the value of this and other credits to small businesses, Mr. Giardino finds the on-again, off-again situation unhelpful.
“We keep doing Band-Aids, extending credits a year or two,” he said. “We need some permanency with these provisions for them to become meaningful so that businesses can plan accordingly.”
Some intense planning could be in order as the Jan. 1, 2014, deadline approaches for important requirements of the Affordable Care Act. It could cost employers dearly if they fail to meet certain conditions, warned J. D. Piro, head of the legal group of the health and benefits practice at the Aon Hewitt consulting firm.
A business with 50 or more employees who each work at least 30 hours a week must offer them health insurance that meets certain criteria. If it does not and if any employees get subsidized coverage at a government insurance exchange, Mr. Piro said, the business is subject to hefty fines. The calculation is tedious, but it works out to a fine of $2,000, times the size of the total work force — not just the employees who obtain an exchange subsidy — minus $60,000.
Businesses also face a penalty when the premium for the employer’s plan exceeds 9.5 percent of an employee’s wages and the employee decides to take an exchange subsidy. This penalty is $3,000, but is assessed based on the number of employees who get the subsidy, not the entire staff.
Even if companies manage to escape the penalties, Mr. Piro said, headaches may be unavoidable.
“Small businesses are going to have to conduct tests to make sure their coverage is affordable and to make sure they’ve offered it to full-time employees,” he said. “There’s a lot of work involved to make sure they meet these rules.”
Ms. Barton at Ernst & Young agreed. “A lot of companies of all sizes are grappling with it and are very ill prepared,” she said. “I’m really worried about small companies. They should do a feasibility analysis to see if their existing benefit plan is adequate and their employees are educated.”