Last night we finally made our way through the 2014 mid-term elections. It was a very successful election for the Republican Party which will soon be in control of both houses of the US Congress. Last night’s victory speeches and today’s interviews have taken a relatively positive tone. Political pundit and former Republican US Representative Joe Scarborough recently said “most Republicans I talk to understand if all they do is obstruct in 2015, they will lose the big election, the big prize, in 2016.”
So, what does all this mean for tax policy?
First Things First: In a previous posting we discussed the “Tax Extenders”. To briefly summarize – the tax extenders are 55 temporary tax provisions that are generally extended every couple years. These provisions expired at the end of 2013 leaving a lot of unknowns for many businesses and individuals. The Republican controlled House of Representatives had been favoring a targeted approach to the extenders with the intent to make certain provisions permanent. Conversely the Democrat controlled Senate had sought a blanketed 2 year extension of all the expired tax provisions. We’ve seen inaction on these extenders because of election year politics and not necessarily because of the provisions themselves. The provisions have generally received support from both sides. These extensions are overdue by a year and need immediate attention. While some skepticism has set in about whether or not we’ll see an extension of the provisions for 2014, it is still my opinion that we will see a retroactive short-term package that will cover the majority of the provisions for 2014 and 2015. The upcoming lame duck legislative session has only 14 days in it and the IRS has to finalize tax forms and calculations. I think they’ll get it done.
Beyond 2014: Unfortunately we’ve seen this song and dance before and by the time you read this we will be full-throttled into the 2016 presidential election. However I believe there is a real possibility that comprehensive tax reform will be put back on the table. The effective tax rate of this country’s economic engine, the middle class, is still too high and the corporate tax rate is not competitive with the rest of world. Both Republicans and Democrats understand this and want to change it. The White House will want some “loopholes” closed to increase the tax base but I also believe the White House will concede on lowering the tax rates. There is real common ground in this area and with some compromise it can get done. Furthermore if the Republicans can deal on immigration and/or infrastructure there should be even more momentum for tax reform.
We should know where we stand by Friday when the Congressional leadership meets with President Obama. If you see John Boehner and Mitch McConnell dejected and sounding off outside on the White House driveway, I’d say things didn’t go well and tax reform along with everything else is dead…….again.
One of the main elements of negotiating a leased space is the cost associated with the build out of the space. Tenants generally require some level of customization of the space for their business purpose. The construction allowance seems to be a straightforward mechanism that allows a landlord to improve their property by simply reimbursing the new lessee with a pre-negotiated amount. In exchange the lessee generally has significant control in matching the finishes to their needs while also limiting the size of their investment in their temporary home.
Under the most basic read of the Internal Revenue Code the payment from the landlord is taxable income to the lessee. This creates an obvious dilemma for the lessee. Internal Revenue Code Section 110 was created to address this inequity. The provision establishes the parameters of a tax-free construction allowance.
- The lease is limited to 15 years or less.
- The improvements are for nonresidential real property.
- The improvements must be part of a retail space (includes services to the public).
- The landlord owns the improvements.
- The provision will not apply to Section 1245 property (tangible personal property).
If the construction allowance violates any of these provisions then the payment will likely be taxable income at least in some portion. There are some planning steps that can help solidify favorable treatment under this provision and it all starts with adding the correct language in the lease agreement and following proper procedures for payment. From there proper documentation of the expenditures should be maintained and the tax return should have the proper disclosures. If some portion of the construction allowance will still be used for personal property then the terms of the lease should be adjusted to ensure that the tax consequences match the intended results.
With the Summer of 2014 closing out, it is finally time for us to start talking about what everyone has been waiting for all year long – Football.
Well, no, but equally exciting we can start talking about the Tax Extenders. “Tax Extenders” is a package of temporary Federal tax breaks (over 50) that expire and extend every couple years. These provisions expired at the end of 2013.
Since 2014 is a mid-term election year there has been little political courage to see the extension through to completion. Both the US House of Representatives and the US Senate have taken up differing versions of the legislation. The House version attempts to make some key provisions permanent and the Senate version, referred to as the EXPIRE Act, attempts to give all provisions a two year extension. Both efforts were officially stalled several months ago in favor of waiting for the November election results.
Below are some key provisions that have widespread applicability that we should hope to see extended:
- Qualified Restaurant Buildings, Retail Improvements and Leasehold Improvements – $4.8 Billion (10 Year Cost) – Restaurant operators have the ability to recover their real estate investment over a 15 year depreciable period rather than the default period of 39 years. Other similar provisions would also benefit a retailer’s improvements to real estate and a lessee making qualifying leasehold improvements.
- Bonus Depreciation – $2.85 Billion (10 Year Cost) – Bonus depreciation allows for a 50% immediate write-off of qualifying property. When coupled with a cost segregation study this provision can be a major incentive for companies to not only purchase new equipment but perhaps expand their facilities.
- Increased Limit to IRC Section 179 Expensing Election – The expensing election for qualifying equipment reverted back to its $25,000 limit on January 1, 2014. Increasing this limit has become part of the Tax Extenders. The extenders version raises the limit to $500,000.
- Research & Experimentation Tax Credit (R&D Tax Credit) – $16 Billion (10 Year Cost) – This has wide-spread applicability to businesses that are willing to invest in the betterment of the science of their product. Qualifying start-ups may benefit from a payroll tax credit.
- Work Opportunity Tax Credit (WOTC) – $3.16 Billion (10 Year Cost) – Employers are incentivized through this tax credit to hire qualifying individuals that are on living assistance, unemployed or disabled veterans or ex-felons.
- Energy Efficient Commercial Building Deduction (179D) – $304 Million (10 Year Cost) – Real estate owners willing to invest in energy efficient systems (lighting, HVAC, etc.) that increase the efficiency by at least 50% can benefit from a deduction of up to $1.80 per square foot. This extended version of the law does increase the efficiency requirements from prior years.
- New Market Tax Credit – $1.8 Billion (10 Year Cost) – This is a major tool in the development of targeted markets that incentivizes private investment through the award of tax credits. When these tax credits are administered through a non-profit development corporation that has a large scale (multi-year) strategic plan of development they can really make an impact on a city and its economy.
This is just a sample of the provisions covered in the Tax Extenders. Most of these provisions have had support from both sides of the aisle. So while these provisions become a politically charged topic in an election year, we’re nearly certain to see an extension in some form regardless of the election results. In the past when we’ve seen expired provisions extended it has been applied retroactively to eliminate the gap. We’ll be following these developments closely but the variables should be factored into your year-end plan currently. You may need to add a few if/then statements to your formula….
In June Ohio passed a biennial budget bill which tinkered with the state’s tax laws. While the initial version of the law was very concerning for businesses and the Ohio economy, the final version is much more palatable. The following is a summary of the key provisions:
• Small Business Investor Income Deduction – If there was a “Great” category this would be in it. This is a 50% deduction on an individual’s Ohio business income up to the first $250,000. This ultimately nets to over $6,000 of tax savings for owners maximizing the deduction. While this amount won’t turn around a company, it is a tremendous help to all the small businesses working hard in Ohio.
• Commercial Activity Tax Increase – Businesses grossing less than $1M in taxable receipts will not see an increase in their Ohio CAT. However businesses grossing between $1M and $2M will pay $650 more; $2M and $4M will pay $1,950 more; And greater than $4M will pay $2,450 more. We did not see an increase in the stated rate or an increase in the taxable base so while this isn’t horrible news it’s still a tax increase on businesses. Bad.
• Gambling Loss Deduction: Repealed – Federal law allows for a deduction of gambling losses as an itemized deduction up to the point of gambling winnings. Ohio’s taxable income starts with Federal Adjusted Gross Income which is before the itemized deductions. Since Ohio started profiting from the newly built casinos throughout the state it matched the Federal policy on allowing gambling losses to offset gambling winning. Unfortunately this new law never saw the light of day. It’s been repealed. While this will not be an issue for me as I never walk out until I’m thoroughly in the red (do as I say and not as I do), this is bad not only for the taxpayer but bad for the Ohio economy. This could be a meaningful edge for Ohioans to visit their Ohio casinos rather than the casinos in the neighboring states. Bad.
• Sales Tax Increase – In September the state sales tax rate will increase from 5.5% to 5.75%. This is separate from local sales tax which still applies. Bad.
• All Ohioans will benefit from a slight reduction in the individual income tax rates. The Ohio individual tax rates will be reduced by 10% over the next three years. This will take the highest marginal rate in Ohio down to 5.33% from 5.925%. This is still high compared to its neighbors: Michigan at 4.35%, Indiana at 3.4% and Pennsylvania at 3.07%. The rate is just slightly better than Kentucky’s highest rate of 6%. Furthermore Ohio is freezing the inflation adjustments on its tax brackets and it is taking away the $20 personal exemption credit for taxpayers making more than $30,000. While Ohio should do more on this front we can’t label a tax cut as bad. So it’s OK for now.
There are a few other provisions dealing with individual income tax, sales tax, excise tax and property tax. The version of the bill that passed is significantly better than what was initially proposed. Considering where this effort started Ohio businesses and residents are in a better spot. However there is more work for the state to do. Perhaps this is the first step.