As tax deadlines loom for the 2013 tax year, taxpayers, especially small-business owners, may notice that their tax bills are going up. That’s a trend that’s likely to continue as changes related to the Affordable Care Act and the American Taxpayer Relief Act of 2012 take shape. What do you need to know for 2014, so you can start planning now?
Your Tax Bracket
Business owners who report their federal income taxes as a pass through entity (generally, partnerships, S corporations and limited liability companies) or as a sole proprietor likely saw an increase in the amount of tax in 2013. This is because of dramatic changes in the federal income tax brackets for individuals: For 2013, the top rate increased to 39.6 percent for 2013 and the remaining tax brackets shifted, as well. Those weren’t temporary changes, and you’ll see them again in 2014. There is some relief, however: Cost of living adjustments to the brackets in 2014, as reported by the IRS, mean that most taxpayers will save a few dollars.
Medicare and the Net Investment Income Tax
Other changes to taxes on business-related income from 2013 that are sticking around in 2014? The Medicare tax surcharge and the Net Investment Income Tax (NIIT) are here to stay. Taxpayers who earn over $200,000 ($250,000 for married taxpayers) will be subject to the Medicare surtax: The Medicare surtax of .9 percent will be added to your wages, compensation or self-employment income over that amount. The Net Investment Income Tax (NIIT) is imposed on net investment income (which includes certain income from businesses) for taxpayers with modified adjusted gross income (MAGI) of at $200,000 ($250,000 for married taxpayers).
The limitation for itemized deductions and the personal exemption phaseout (PEP) claimed on individual returns for tax year 2014 will begin for taxpayers with incomes of $254,200 or more ($305,050 for married couples filing jointly). The limitation reduces itemized deductions as your income increases while the personal exemption phaseout reduces your ability to claim exemptions for you and your dependents.
It’s also more difficult to qualify to claim itemized deductions for some taxpayers. The threshold for claiming medical expenses as a deduction is now 10 percent of adjusted gross income (AGI) as compared to 7.5 percent of AGI in 2012. That means that, in addition to the requirement that you itemize your deductions, your qualifying medical expenses (which include the cost of health insurance premiums) must exceed 10 percent of your AGI before you can claim the first dollar of expenses—the more money you make, the higher the threshold.
The medical expense deduction dovetails nicely with other changes related to the Affordable Care Act. For individuals, if you do not have health insurance in 2014 and you are not otherwise exempt, you will be subject to a “shared responsibility payment.” For 2014, the penalty is either 1 percent of your taxable income or a flat fee of $95 per uninsured adult and $47.50 per child (up to $285 for a family), whichever amount is higher. For businesses, employers with a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees equivalent to 50 full-time employees) must offer affordable health coverage that provides a minimum level of coverage to their full-time employees and their dependents or be subject to a penalty. Unlike the shared responsibility payment, the so-called “employer mandate” doesn’t kick in until 2015.
Big Ticket Purchases
Perhaps the most significant change to small businesses is the reduction of the section 179 expense deduction. Under section 179 of the Tax Code, business owners can immediately deduct dollars spent on qualifying equipment rather than depreciating those dollars over a number of tax years. For the last several years, business owners could deduct up to $500,000 in qualifying assets. In 2014, the limit drops to a mere $25,000. If you plan to buy big ticket items, it may make sense to consider structuring the purchase over time.
A Silver Lining
It's not all bad news. Small-business owners and the self-employed do have the option to claim a simplified tax deduction for a home office in 2014. The deduction, which makes record-keeping and calculations a lot easier, is figured based on a flat rate of $5/square foot of home office space up to a maximum of 300 square feet. If your home office is bigger than 300 square feet—or if your expenses are significant—you still have the option to use the traditional method (generally calculating your home expenses and pro-rating them according to the size of your office). The simplified home office deduction was introduced in 2013 and applies to the 2014 tax year.
Expect more changes in 2014 as Congress attempts to tackle corporate tax reform. Many of the changes that are being considered focus squarely on pass-through entities. The proposals run the gamut from changes in accounting method for certain companies providing personal services (including consultants, lawyers, doctors and architects) to adjustments in calculation of basis to eliminating the traditional “draw” in lieu of salaried wages. You’ll want to watch carefully.
Finally, while most taxpayers focus on federal tax laws, you’ll also want to watch for changes in state tax laws, especially as discussions heat up on Internet sales tax laws. If you sell a taxable product or service, especially across state laws, you should pay close attention.
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