Business Taxation under RRA '93
Green, Gary L., Jr., The National Public Accountant
The Revenue Reconciliation Act of 1993 has made substantial changes to the tax landscape of many businesses. For business, especially small business, the new law has created unique opportunities for competitive growth. To assist you in understanding the new burdens businesses face in complying with RRA '93, this comprehensive summary of the business provisions will reduce the new law to its simplest elements.
Tax Savings or Short-Term Return
Prior to RRA '93, businesses could elect to deduct as an expense, rather than to depreciate, up to $10,000 of the purchase cost for tangible personal property placed into service during the taxable year (the exception was noncorporate lessors). The 1993 Act raises the ceiling for the annual expense election to $17,500. If the purchase of depreciable equipment exceeds $200,000, the $17,500 expensing allowance is reduced (but not below zero) at a rate of $1 for each dollar in excess of $200,000. Accordingly, no section 179 is available if total purchases exceed $217,500. This higher ceiling is retroactive to January 1, 1993.
This change has created the possibility of a short-term return on capital. Expensing $10,000 of equipment in the remaining part of 1993 will give a business owner a tax savings of $2,800 (assuming 28% marginal rate), but expensing $17,500 can give this same business owner $4,900 (an additional $2,100) six to eight weeks after the business tax return is filed. For businesses short on capital for equipment or in sudden need of a new piece of equipment, this change could help retain the competitive edge. The tax refund, received five to seven months later (assuming an October or November purchase and a February filing date), can be used to either invest in new capital equipment or pay-off the short-term note created to offset the immediate capital deficit. Either of these options provides more productive equipment for the business than would have been available under pre-'93 provisions.
Small Business Investment
With prior tax law changes, business investors lost important tax breaks: the capital gain deduction, the alternative tax rate on net capital gains for corporations and the ability to offset earned income (e.g., salary and wage income) by losses from passive investments. Since 1986, capital gain is subject to tax at the same rate as ordinary income, except for individuals and sole proprietorships, who pay a maximum effective tax rate of 28%. For corporations, such gain likewise is taxed as ordinary income, subject to a maximum effective corporate tax rate of 39%.
Although most of the capital gain advantages have been lost, restrictions on capital loss deductions continue in force. For individuals, net capital losses (whether short-term or long-term) can only be used to offset up to $3,000 of income per year. One benefit is that long-term capital losses (including carryovers from pre- 1988 tax years) can offset other income on a one-for-one basis rather than a two-for-one basis. For corporations, capital losses remain deductible only against capital gains. Moreover, unlike individuals who may carry over unused capital losses until fully absorbed, corporations may carry over such losses for only five years; however, a corporation may chose to carry back such losses for three years. Now, there is an additional alternative.
Under RRA '93, classification of income as capital gain has regained some of its importance. The '93 Act provides that a noncorporate taxpayer who holds qualified small business stock (QSBS) purchased after August 10, 1993, for more than five years can exclude from gross income 50% of any gain realized from the sale or exchange of that stock. The exclusion is limited; however, to either: (1) 10 times the taxpayer's basis in the stock; or (2) $10 million in gain from all the taxpayer's transactions in that stock (all must to be held at least five years).
Assume Mr. White purchases 10,000 shares of newly-issued ABC Corporation's QSBS for $7 million at the beginning September, 1993. …