With the so-called “fiscal cliff” looming large on the horizon and the sunset of the Bush-era tax laws slated for 2013, there are a number of near-term tax considerations facing small businesses.
For example, after Dec. 31, there will be five tax brackets for individuals — 15 percent, 28 percent, 31 percent, 36 percent and 39.6 percent. In addition, the capital gains tax rate will generally return to 20 percent, and dividends will be subject to ordinary income tax rates. The maximum corporate tax rate will remain at 35 percent.
This presents an interesting reversal for income earners in the top individual tax rates (36 percent and 39.6 percent). For the first time in many years, the top individual tax rates will exceed the top corporate tax rate (35 percent) — and that doesn’t even consider the Medicare surtax of 3.8 percent on an individual’s net investment income.
It’s been decades since corporate tax rates were lower than marginal individual rates. Closely held corporations paying taxable dividends to high-earning owners may find it better to distribute dividends before year end 2012 (at favorable capital-gains equivalent rates), and perhaps retain corporate earnings or pay salaries up to the 31 percent rate beginning in 2013 rather than distributing earnings as dividends.
All of this assumes that Congress does not extend current tax rates, change corporate tax rates, or come up with something completely different either before or after year-end. And this uncertainty is much of the challenge facing business owners today.
Also beginning January 2013, the Affordable Care Act imposes a 3.8 percent Medicare contribution tax on net investment income for higher-income earners if modified adjusted gross income exceeds a threshold (e.g., $250,000 for married earners). Net investment income includes categories of income such as interest, dividends and royalties. But it also includes rents and certain passive income or gains from business interests in partnerships and S-corporations.
Starting in 2013, business owners should consider the pass-through nature of any investment income from partnerships, LLC’s or S-corporations. Business owners should also consider that a one-time sale of a business (or the sale of any asset, really) could inflate the seller’s modified adjusted gross income above the threshold level effectively subjecting the seller’s net investment income in the same year to the 3.8 percent surtax.
On the business-employer side, there is an additional 0.9 percent Medicare tax on wages paid to higher income employees. The new Medicare tax applies to earners in excess of $200,000 or married couples with incomes in excess of $250,000. The additional 0.9 percent tax must be withheld by employers for wage earners over the thresholds.
A number of changes are scheduled to take effect in 2013 that may affect your business or your personal situation. Consult an experienced tax adviser to develop a comprehensive strategy to minimize your tax burden in the New Year.
Frank S. Macgill is the managing partner at HunterMaclean in Savannah and the leader of the firm’s Taxation Practice Group. He can be reached at 912-236-0261 or firstname.lastname@example.org.