Key 2014 Tax Benefits Finally Passed By Congress

With 14 days to spare, Congress just this week got around to looking at the US tax code for 2014. In particular, the subject of the discussion are tax incentives that generally everybody thinks are good ideas that expired on December 31st, 2013.

To be very clear: the people we elect to oversee the tax code just finished approving items that should have gone into effect 12 months ago. Granted, this is a slight improvement on the timeline of the tax reforms of 2012 (signed January 2nd, 2013), yet remains an embarrassing failure of governance that has wide and sweeping effects for those of us who help people make important business and financial decisions.

I consider complaining about Congress America's fifth professional sport, and a great way to win new friends and impress people. According to Gallup a full 79% of our nation currently disapproves how Congress handles its job. The point of this post isn't to add fuel to that nation-sized tire fire, but rather to point out the actual effect that this has on those of us who have to give business owners advice based on the US tax code.

The bill, H.R. 5771, extends certain tax breaks to individuals and small businesses until next week (December 31st, 2014). Here's a quick rundown of a few of the provisions (more detail here):

  • $250 above-the-line deduction for teachers 
  • Exclusion of income for debt discharge due to loss of primary residence (foreclosure)
  • Commuter transit benefits (TransitChek in NYC)
  • Tax deduction of qualified tuition & fees (in lieu of education credits) 
  • Exemption of income for IRA distributions to charities 
  • Bonus / accelerated depreciation for certain business property
  • Exclusion of gain from small business stock
  • Energy efficiency tax credits

Most agree that these are all generally good things. I think that we can all get behind a (very small) tax deduction for teachers, for college education, for charitable contributions from an IRA, etc.

The business deductions are a little trickier. The way that most deductions work for larger items that have a usable life is not as straightforward as items that are "consumed" during the operating year. If a business buys property that is expected to last more than a year - for example, computer, desk, telephone, car, larger equipment - the tax code requires that these items spread the deduction over the usable life of the item (e.g., for five-year property, the first year deduction is close to 1/5th the total cost in year one, another 1/5th in year two, etc.). The rules are somewhat more complicated than that - the IRS mandates use of a bizarre formula called Modified Adjusted Cost Recovery System (MACRS - more here) which is difficult to explain in plain English.

The sixth bullet above outlines a way to accelerate the deduction with a purchase of (new) business property. The bonus depreciation rules apply to most classes of property, allowing a 50% deduction in the first year, while Section 179 (a more restrictive class of property) allow for 100% deduction (treating it like an expense).

The effect that these provisions have is that many businesses with surplus income might purchase additional equipment towards the end of the year to take advantage of the accelerated deduction. This effectively nudges the business owner to spend funds in the broader economy. While these expenses are generally taxed to the recipient, because one company's expense is another company's income, generally economic activity is a good thing worthy of an incentive.

It should be noted that this accelerated expensing isn't "free" - it doesn't create deductions out of thin air. Not only must the company actually purchase the item (and spend the money, unless they borrow it, such as with an auto loan) - but they also have a lower deduction going forward. In fact, in the case of a Section 179 deduction, all of the expense is "used up" in the year of purchase, meaning zero deduction going forward. This is generally in the business owner's interest, since they can pay less income tax now, thus enjoying the economic benefit of that untaxed income while also enjoying the use of the property.

This comes up often in the year-end strategy meetings that I am currently having with clients. For example, an additional Medicare surcharge tax applies to any investment income once a married couple exceeds $250,000 in modified gross income. A business owner who hypothetically is looking at $260,000 in net business income in 2014 might choose to spend $10,000 or so on a piece of equipment next week, and if that transaction is Section 179 eligible, they can then deduct the $10,000 expense and only pay tax on the remaining $250,000 of net income (possibly staying below the surcharge tax threshold). Without Section 179, or a bonus deprecation, much less of this expense can be deducted in the current year, meaning that even though the owner spends $10,000 on this hypothetical expense, they can only deduct $1,400 or so, subjecting the remaining income to that higher tax rate.

Another case arrives with business owners who are relying on health insurance plans whose incomes must remain below a certain level to qualify. For these owners, who are usually self-employed, small businesspersons, the year-end accelerated deprecation or Section 179 expensing is a very valuable tool to use in their overall financial arsenal.

It is very frustrating to be well into December of the current tax year before Congress begins to look at these provisions. For all of 2014, I was advising clients not to count on this bill being passed, simply because Congress has been extremely unreliable.

Regardless of what side of the aisle you may or may not support, millions of American small business owners are being hurt every year by our legislature's refusal to work together, even when they generally agree on 90% of the issues (such as with H.R. 5771).

I would ask you to consider supporting candidates for Congress who are willing to work with their fellow elected leaders. I'm Bill Sweet and I approved this message.