posted on March 18, 2013 12:43
The chairman of the U.S. House of Representatives Ways and Means Committee, David Camp (R-Mich.), has released a discussion draft of his vision for reform of several key tax code provisions of interest to small business. The below analysis is provided courtesy of the Small Business Legislative Council.
The positive change that will affect the greatest number of small businesses lies in accounting. The draft replaces the current tax accounting rules (such as sections 447 and 448 of the tax code) that apply to small businesses and farms with a uniform rule under which all businesses with gross receipts of $10 million or less may use the cash method of accounting.
Sole proprietors would continue to be able to use the cash method regardless of the level of gross receipts. The draft also coordinates the new cash accounting rules with the uniform capitalization rules generally to exempt small businesses from the complex capitalization rules that require the allocation to their inventory of certain direct costs (e.g., materials and labor) associated with the production of the inventory as well as indirect costs (e.g., overhead and administrative expenses).
The issue is how this change to permit more use of cash accounting will affect businesses that are typically forced to keep inventories by other sections of the tax code.
Section 179 of the tax code allows businesses to write off the amount of equipment and asset purchases in the year of purchase up to a certain amount as long as the business does not spend more than a specific total amount on such purchases in a year. The “direct expensing allowance” is often referred to as a small business provision but it is the amounts that make it a small business-friendly provision since larger businesses bump up against the cap.
The draft increases permanently the amounts for new equipment and property up to $250,000, with the deduction phased out for investments exceeding $800,000 (both amounts indexed for inflation). It should be noted that, without action, these current temporary levels of $500,000 and $2,000,000 will revert to $25,000 and $200,000 respectively in 2014. Therefore, if tax reform does not make it happen, a new temporary increase in the allowance will be needed by the end of the year.
S Corporations and Partnerships and C Corporation Migration
The chairman’s proposal attempts to take a small step towards a unified business tax system. The draft includes two options for aligning treatment of Subchapter S corporations and partnerships.
The draft provides an incentive for some C corporations to migrate to S corporation status (the incentive is a shortened built-in gain period). The last great migration was after the 1986 tax reform effort. The trade-off will remain the double taxation of C corporations (entity level and dividends), albeit at lower levels, versus single layer taxation at higher personal rates.
Unified Deduction for Start-up and Organizational Expenses
For new businesses, the draft combines three existing provisions for start-up and organizational expenses into a single provision applicable to all businesses. The draft increases the threshold for start-up expenses to $10,000 (up from $5,000), with a phase-out beginning at $60,000 of such expenses (up from $50,000) and expands the deduction to cover organizational expenses. The draft repeals the separate special rules relating to the organizational costs of corporations and partnerships. Expenses above the new limit continue to be deductible over the 15-year period following the start of the business.