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This year’s tax law extends certain breaks, credits for optometrists
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The so-called “fiscal cliff” tax package signed into law early this year renewed more than 50 temporary tax breaks through 2013, saving optometrists, businesses and optometric practices an estimated $76 billion. On the downside, employees are already finding less in their paychecks because the American Taxpayer Relief Act did not extend the payroll tax holiday that had reduced Social Security payroll deductions from 6.2% to 4.2% on earned income up to the Social Security wage base ($113,700 for 2013). It is a similar story for the self-employed optometrists.
There is good news and bad news for optometrists in the fiscal cliff tax laws. Included in the new law was a 1-year delay in the 26.5% Medicare physician payment cuts that had been scheduled to take effect Jan. 1, 2013. Unfortunately, the 1-year Medicare physician payment patch was partially offset with $22 billion in payment reductions to other Medicare providers, including hospitals, pharmacies and dialysis clinics.
Like the sustainable growth rate, the key factor in annual Medicare payment updates designed to limit spending, optometrists and principals in optometry practices have grown accustomed to many longstanding tax breaks. However, they also have had to get accustomed to the uncertainty of whether they will be renewed each year. While many key tax breaks were allowed to expire at the end of 2011, the new tax law renews them retroactively, allowing optometrists to claim them on both their 2012 and 2013 tax returns.
For example, an often overlooked, neglected and misunderstood tax credit – the research and development tax credit – has been extended through 2013 and made retroactive for 2012. While only for research in the clinical sense, many of the small practices and businesses it was designed to help have in the past shied away from the complex rules. Perhaps the potential of reaping a share of the $14.3 billion in tax savings may entice more optometrists to investigate the research tax credit.
Equipment write-offs
The American Taxpayer Relief Act extended the tax code’s Section 179 first-year expensing write-off. Now, the higher expensing limits in effect in 2011 have been reinstated for 2012 and extended for expenditures made before Dec. 31, 2013. Thus, an optometry practice can expense or immediately deduct up to $500,000 of the cost of equipment and business property in 2012 and 2013, subject to a phase-out if total capital expenditures exceed $2 million. The maximum amount that can be expensed in years beginning after 2013 will, without amendment, drop to $25,000.
The election to expense the off-the-shelf computer software used in so many optometry practices under Section 179 has also been extended and applies to expenditures made before Dec. 31, 2013.
The tax break that allows profitable optometry practices to write off large capital expenditures immediately, rather than over time, has long been used by our lawmakers as an economic stimulus. Today, the new law allows 50% bonus depreciation for property placed in service through 2013.
To be eligible for bonus depreciation, property must be depreciable under the standard Modified Accelerated Cost Recovery System and have a recovery period of less than 20 years. Section 179 first-year expensing remains a viable alternative, especially for small practices and businesses. Property qualifying for the Section 179 write-off may be either used or new in contrast to the bonus depreciation requirement that the taxpayer be the “first to use.”
Tax credits for hiring
The Work Opportunity Tax Credit (WOTC), a tax credit that rewards employers that hire individuals from targeted groups, has been extended to Dec. 31, 2013, and applies to individuals who began work for the employer after Dec. 31, 2011. Under the revised WOTC, optometry practices and businesses hiring an individual from within a targeted group are eligible for a credit generally equal to 40% of first-year wages up to $6,000.
The new tax law has permanently extended the exclusion from income and employment taxes of employer-provided education assistance up to $5,250. The optometry practice may also deduct up to $5,250 annually for qualified education assistance paid on behalf of an employee.
Change to S corporation
Although an S corporation is a pass-through entity and not usually subject to income taxes, it is liable for the tax imposed on built-in gains or capital gains. The tax on built-in gains is a corporate level tax on S corporations that dispose of assets that appreciated in value during the years when the practice was a regular “C” corporation.
The new law extends a relaxed version of the provision limiting the recognition period to 5 years, but only for “built-in” gains recognized in 2012 and 2013. Thus, an optometry practice that elected S corporation status for the tax year beginning Jan. 1, 2007, will be able to see appreciated assets it held on that date without being subject to a hefty tax bill.
Additional Medicare tax
Thanks to the Health Care and Education Reconciliation Act of 2010, beginning in 2013, many individuals suddenly discovered they were subject to a 3.8% net investment income tax and a 0.9% additional Medicare tax (AMT). The new taxes apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with a MAGI in excess of $250,000 if filing a joint return, or $125,000 if filing separately.
More recently, single individuals with incomes above the $400,000 level and married couples with income higher than $450,000 will pay more income tax in 2013 because of a higher 39.6% income tax rate and a 20% maximum capital gains tax. For other individuals, the alternative minimum tax has finally been indexed for inflation.
Ironically, the AMT was created to ensure that wealthy individuals would pay some kind of income tax, not middle-income households. The new law increases the 2012 exemption amounts to $50,600 for unmarried individuals and $78,750 for jointly filing couples. For 2013, the AMT exemption amounts are predicted to be $80,750 for married couples filing jointly and $51,900 for single individuals.
Good news for estate taxes
Always of significant interest to the owners of small businesses and principals in so many professional practices, the estate tax has long been a bit of a mixed bag. On one hand, the $5 million per person exemption has been kept in place (and indexed for inflation). However, the top rate has increased to 40% – effective as of Jan. 1, 2013.
Other good news for estate planning: portability is kept in place and estate and gift taxes remain unified; that is, the $5 million stays in place for gift tax purposes as well as estates. Best of all, it is permanent.
Lower tax rate for C corporations
The majority of optometry practices are pass-through entities, such as S corporations, limited liability companies and even partnerships. Profits are passed through to the practice’s principals and are taxed at individual income tax rates. With a regular C corporation’s top tax rate of 35%, some optometrists may want to consider switching from an S corporation or LLC, where they will be subject to a top rate of 39.6% on the pass-through income.
Looking much deeper than the tax rates, keep in mind that the profits of a pass-through entity are taxed only once, usually on the returns of the practice’s principals. With a regular C corporation, distributions would first be taxed at the corporate level and, once again, at the shareholder’s level for an additional 15% or 20%.
That double taxation becomes even more significant on the sale of the optometry practice. Although there are provisions in the tax law that allow all or a portion of the gain on the sale of a practice or business to be excluded or ignored, they are limited.
Another consideration, particularly for small professional practices or businesses, is that any expenses that are disallowed by an IRS auditor will only result in increased income to the pass-through entity. Doing business as a regular corporation, disallowed personal expenses increase the income of the corporation and are taxed as “constructive dividends” to the shareholders. The same is true for the so-called “unreasonable compensation” of shareholders/officers/principals.
Tax breaks may be short-lived
Although it is not the grand bargain envisioned by lawmakers, many popular but temporary tax extenders relating to optometrists and their practices were included in the American Taxpayer Relief Act. However, despite tax breaks such as the Section 179 small business expensing, bonus depreciation and the Work Opportunity Tax Credit, the new law is effectively a stop-gap measure designed expressly to prevent the onus of the expiration of the Bush-era tax cuts from falling on middle-income taxpayers. Congress must still address spending cuts and may even tackle tax “reform.”
The time is now for every optometrist and principal in an optometry practice to consult with their accountants and/or tax professionals to focus on the potential savings offered by these newly revised, extended and expanded business credits, deductions and tax write-offs.
The uncertainty remains whether they will be renewed from year to year.