Tax Planning Strategies for 2012

By Kelli Franco
Moss Adams LLP

When it comes to taxes, the results of the coming election and the ultimate fate of the 2001 and 2003 tax cuts are going to be the most important issues in the near term. And the uncertainty of what will happen makes tax planning very difficult. If the 2001 and 2003 tax cuts expire, the highest individual rate will increase from 35 percent to 39.6 percent, and with the Medicare surtax on investment income, this rate will further increase to 43.4 percent. So what to do?

1. Consider Plan A and Plan B
Plan A assumes that the president and Congress allow some of the 2001 and 2003 tax cuts to expire and the health care reform provisions to kick in. This means taxes on most small businesses (assuming most are pass-through entities) and individuals making more than $250,000 will increase. As a result, consider doing the opposite of what you'd normally do. Instead of deferring income and accelerating expenses, you may want to accelerate income and defer expenses. For your construction company, Plan A may include slowing the depreciation on purchased equipment, ceasing some of the deferral strategies you've used, and delaying bonus payments.

Plan B would be a situation where the 2001 and 2003 tax cuts are extended in their entirety and portions of the Affordable Care Act are repealed. You should take advantage of the tax methods of accounting favorable to contractors, such as using Section 179 and the 50 percent bonus depreciation on equipment purchases. You should also consider other opportunities to defer income and accelerate expenses, where possible.

2. Consider Your Accounting Methods and Deferral Strategies
As contractors, you're allowed a variety of different tax accounting methods depending on whether you're a small contractor (under $10 million in revenue) or a large contractor. These can also vary depending on the type of contractor you are and the type of projects you work on. As tax professionals we look at your job schedules and determine what tax (cash) saving strategies are available to you. It's important to understand what method you're currently using and how it works. This may allow you to further control the amount of income you will have to recognize in 2012 and 2013, depending on what plan (A or B) you implement.

3. Depreciation Methods
Two provisions of deducting fixed-asset expenses are scheduled to change in 2013.

• Section 179
For 2012, Section 179 allows a 100 percent first-year write off of qualifying purchases (equipment, computers, non-passenger vehicles) of up to $139,000, which is phased out if you have yearly purchases over $560,000. You can purchase new or used equipment to take advantage of this provision. However, you must have taxable income in your company to use it. In 2013, Section 179 limitations are scheduled to decrease to $25,000.

• Bonus Depreciation
In 2012, contractors can write off 50 percent of new qualifying purchases as long as they have a tax life of 20 years or less and are for original use. If a contractor rents or leases a new piece of equipment and purchases it within 90 days, the contractor is deemed to be the original user. Contractors do not need to be profitable to take the bonus depreciation. In 2013, there will be no bonus depreciation.

4. Transactional Planning
If the Plan A scenario occurs, tax rates will go up. So, what else should you consider?

• Dividend Planning
By far the biggest potential increase in tax rates involves the tax on qualified dividends, which have been taxed at the same 15 percent rate as long-term capital gains for many years now. These rates are set to increase to 43.8 percent in 2013.

If your company is an S corporation that has prior C corporation earnings, consider paying a dividend from your C corporation earnings. However, in this economy most contractors need to watch their cash and may not be able to afford to pay out dividends plus amounts to cover the taxes in 2012. Instead, they may be able to trigger a "deemed dividend," which would allow the dividend to be taxed to the shareholders, and the only cash outlay will be the taxes on the dividend. It will be important to consult with your tax professional to evaluate the benefits of this type of planning.

• Installment Sales
If you've entered into a transaction where you have sold some investment property or stock and you hold the note, you have some decisions to make. Normally with this type of transaction, you would be able to defer the gain of the sale and recognize the income as the principal payments are made on the note. This is a tax favorable method most of the time. The problem is that the tax rate you pay depends on the tax rate that's in place at the time of the payment—not when the contract is signed. With tax rates scheduled to rise in a Plan A scenario, you could "elect-out" of this method and recognize the gain on the transaction in 2012.

• Capital Gains Harvesting
Normally, tax professionals advise their clients that if they have "loser stocks" and capital gains, they should consider selling the loser stocks to offset the capital gains. If you are anticipating that tax rates are going up with Plan A, consider selling some of your capital gain stocks to lock in the 15 percent rates. However, there are some limitations regarding repurchasing those same stocks within 31 days. You should review the specific rules with your tax advisor.

5. Estate Planning
Considering today's favorable estate and gift tax rates and exemptions and low property valuations and interest rates, 2012 may be an opportune time for estate planning. Through the end of this year, taxpayers can transfer up to $5.12 million of their estate without incurring federal transfer taxes and lower their future tax burden.

Federal Rates and Exemptions Estate, Gift and GST Tax
2012 Rates 35%
Exemptions $5.12 million
2013 Rates 55%
(scheduled) Exemptions $1 million

The Bottom Line
With looming legislative changes scheduled for Jan. 1, it’s important to take the time to explore your options and determine the best course of action—and the sooner the better. Your tax professional and legal counsel can help you develop the best plan for your needs and suggest an appropriate timeline for implementation. If you'd like to get started, contact a Moss Adams LLP professional today.

Associated General Contractors of America