With the individual tax rate increases starting in 2013, now is a good time take advantage of the many deductions and credits available. In addition to the tax rate increases in the American Taxpayer Relief Act of 2012 (ATRA) there are also two new taxes arising out of the 2010 healthcare reform legislation known as the Patients Protection and Affordable Care Act (PPACA) that also become effective in 2013.
Tax Rate Increases under ATRA
A big relief was that there was not an across the board rate increase as was feared if the Bush Tax Cuts were allowed to expire, however, a 39.6% rate will now apply to individuals with income over $400,000 for single taxpayers or $450,000 for married couples. The top rate on capital gains and qualified dividends was kept at 15% for taxpayers with income below the $400,000/$450,000 levels, but for taxpayers with income above those levels the rate on capital gains and qualified dividends will be 20%.
New Medicare Taxes
Under the PPACA there are two new Medicare taxes starting in 2013. The first one is a .9%
increase to the current Medicare tax on wages and self employment income from 1.45% to
2.35% on earned income above $200,000 for single taxpayers or $250,000 for married
The other new Medicare tax is the 3.8% surtax on net investment Income (NII). This tax
applies to the lesser of the taxpayer’s net investment income or adjusted gross income over
$200,000 for single taxpayers or $250,000 for married couples. A taxpayer must have both NII and gross income over the applicable thresholds in order to be subject to the 3.8% surtax. NII is defined as investment income less otherwise allowable deductions properly allocable to such income. Under the proposed reliance regulations issued by the IRS, NII can come from one of following three categories:
-Gross income from interest, dividends, annuities, rents and royalties (other than
such income derived in the ordinary course of an active trade or business)
-Gross income from any passive trade or business or business in the trading of
financial instruments or commodities
-Net gains attributable to the disposition of property (other than property held in an
active trade or business)
The inclusion of passive activities in the definition of NII represents a huge shift in
traditional tax planning. More emphasis will be placed on treating profitable activities as
active instead of passive to avoid the 3.8% surtax. However it is important to watch that
passive losses do not go unused and be aware that net income from an active trade or
business may be subject to self employment tax.
Taxpayers should review their current structure to see if any passive activities can be
grouped with non passive activities to avoid passive income. The proposed regulations
allow taxpayers a “fresh start” regrouping election to replace any previous grouping
When you combine the new top rate of 39.6% with the new surtax, taxpayers whose
income is above the applicable thresholds will see ordinary rates go from 35% to 43.4%
(39.6% plus 3.8%). Likewise, the tax on capital gains and qualified dividends will go from
15% to 23.8% (20% plus 3.8%).
The $500,000 section 179 expensing provision was also extended by ATRA through
2013. The deduction begins to phase out when total qualified purchases for the year
exceeds $2 million.
The 50% bonus depreciation was also extended for 2013. Under the bonus depreciation
provisions the original use of the property must begin with the taxpayer, therefore used
equipment will not qualify. Qualified property must also have a recovery period of 20 years or less. The IRS clarified that unlike regular tax depreciation; bonus depreciation is not required to be allocated to long-term contracts for those contractors that use the
percentage of completion method of accounting. This provision allows contractors to
benefit from bonus depreciation even when a contract is not completed in the same year
in which it began.
Domestic Production Activities Deduction
The Domestic Production Activities Deduction (DPAD) continues to be a popular
deduction for the construction industry. The DPAD generally is equal to 9% of the lesser
of the taxpayers “qualified” production activities for the year or taxable income (adjusted
gross income for individual taxpayers).
In order to qualify for the deduction, taxpayers must have Domestic Production Gross
Receipts (DPGR). The definition of DPGR is very broad, but includes gross receipts from
the lease, rental, license, sale, exchange or other disposition from a broad list of
activities, including construction or substantial renovation of real property in the U.S.,
including residential and commercial buildings and infrastructure such as roads, power
lines, water systems and communication facilities. Revenue from civil engineering and
architectural services performed in the U.S. for U.S. construction projects also qualify as
This deduction is often overlooked but could be beneficial for subcontractors who are
involved in the design of energy efficient government-owned commercial buildings. The
deduction could be as high as $1.80 per square foot. Generally the owner of a
commercial building would get the deduction but if the building is owned by a federal,
state, or local government, such as a school or municipal building the IRS allows the
deduction to be allocated to the person primarily responsible for creating the technical
specifications of the building. This would include, for example, an architect, engineer,
contractor, environmental consultant or energy services provider. The governmental
entity is also allowed to allocate the deduction among firms if there is more than one
Other Provisions Beneficial to the Construction Industry
Many provisions that were set to expire at the end of 2011 or 2012 were extended under
ATRA through 2013, including but not limited to the following.
-15 year straight-line cost recovery for qualified leasehold improvements – this
also applies to qualified restaurant property and qualified retail improvement property
(Note, this type of property also qualifies for section 179 expensing up to $250,000
and the 50% bonus depreciation).
- Work Opportunity tax credit (WOTC) – for hiring persons who fall into one of the
designated target groups, including qualified veterans.
-Empowerment Zone credit – available to contractors hiring individuals who live
and work within an empowerment zone.
-Research and Experimentation credit (R&E) – examples of R&E credits claimed
by subcontractors include expenditures for design-build, fabrication, architectural and
engineering projects or activities.
-Railroad Track Maintenance credit – the railroad is allowed to assign this credit
to taxpayers that provide railroad related services to the railroad, including railroad
-Energy efficient new homes credit – for contractors that cut energy use for
heating and cooling in constructed homes by 50% compared to the 2006
International Energy Conservation Code (IECC).
-Credit for alternative fuel vehicle refueling property – for the development and
installation of the infrastructure needed to deliver alternative fuels to clean-fuel
-Credit for biodiesel and renewable diesel used as fuel – if used by the taxpayer
as a fuel in a trade or business.
Tax planning is increasingly important for 2013. Subcontractors should review their
current structures with their tax advisors and project their income for the year to see if
they will be affected by the rate increases. Also, check that they are claiming all
applicable deductions and credits in order to minimize their tax liabilities.