The American Taxpayer Relief Act of 2012 signed yesterday by President Barack Obama contains broad business tax provisions that will affect virtually every employer in Massachusetts. The so-called “fiscal cliff deal” extends 31 business tax breaks and 12 energy tax breaks while partially extending current tax brackets.

The bill does not, however, extend the temporary payroll-tax rate reduction, a policy sure to engender significant conversation between employees and their HR departments when the first paychecks of 2013 are issued.

Here is a summary of provisions of interest to business owners and managers:

Tax credit for research and experimentation expenses.  The bill extends for two years, through 2013, the research tax credit equal to 20 percent of the amount by which a taxpayer’s qualified research expenses for a taxable year exceed its base amount for that year and provides an alternative simplified credit of 14 percent.  The bill also modifies rules for taxpayers under common control and rules for computing the credit when a portion of a trade or business changes hands.

Work opportunity tax credit.  This bill extends for two years, through 2013, the provision that allows businesses to claim a work opportunity tax credit equal to 40 percent of the first $6,000 of wages paid to new hires of one of eight targeted groups.   These groups include members of families receiving benefits under the Temporary Assistance to Needy Families (TANF) program, qualified ex-felons, designated community residents, vocational rehabilitation referrals, qualified summer youth employees, qualified food and nutrition recipients, qualified SSI recipients, and long-term family assistance recipients.

15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.  The bill extends for two years, through 2013, the temporary 15-year cost recovery period for certain leasehold, restaurant, and retail improvements, and new restaurant buildings, which are placed in service before January 1, 2014. The extension is effective for qualified property placed in service after December 31, 2011.

Bonus depreciation.  Under current law, businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule.  For 2008 through 2010, Congress allowed businesses to take an additional depreciation deduction allowance equal to 50 percent of the cost of the depreciable property.  Federal law expanded this provision to allow 100 percent bonus depreciation for investments placed in service after September 8, 2010 and before 2012 and 50 percent bonus depreciation for investments placed in service during 2012.  This provision would extend the current 50 percent expensing provision for qualifying property purchased and placed in service before January 1, 2014 (before January 1, 2015 for certain longer-lived and transportation assets) and also allow taxpayers to elect to accelerate some AMT credits in lieu of bonus depreciation.  This provision also decouples bonus deprecation from allocation of contract costs under the percentage of completion accounting method rules for assets with a depreciable life of seven years or less that are placed in service in 2013. For regulated utilities, the provision clarifies that it is a violation of the normalization rules to assume a bonus depreciation benefit for ratemaking purposes when a utility has elected not to take bonus depreciation.

9% Credit Rate Freeze for the Low-Income Housing Tax Credit Program.  The low-income housing tax credit program provides a tax credit over a period of ten years after the housing facility is placed-in-service.  The credit provided each year is determined by present-value formula based on the federal cost of borrowing.  Over the past few years, as the federal cost of borrowing has declined, so has the amount of tax credits that can be used to build a LIHTC project.  To deal with this, in 2008, Congress adjusted the formula and set a minimum credit amount of 9%, which is based on the original credit rate when the program was created.  The provision is effective for facilities placed-in-service before December 31, 2013.  This proposal would extend the expiration date by changing the deadline to projects that have received an allocation before January 1, 2014.

New Markets Tax Credit.  Through the New Markets Tax Credit (NMTC) program, the federal government is able to leverage federal tax credits to encourage significant private investment in businesses in low-income communities. The program provides a 39 percent tax credit spread over seven years.  The bill extends for two years the new markets tax credit, permitting a maximum annual amount of qualified equity investments of $3.5 billion each year.

Employer wage credit for activated military reservists.  The bill extends for two years, through 2013, the provision that provides eligible small business employers with a credit against the employer’s income tax liability for a taxable year in an amount equal to 20 percent of the sum of differential wage payments to activated military reservists.

Returning Heroes and Wounded Warriors Work Opportunity Tax Credits. Currently businesses are allowed to claim a work opportunity tax credit (WOTC) for hiring qualified veterans in the following targeted groups and up to the following credit amounts:

• Veterans in a family receiving supplemental nutrition assistance:  $2,400
• Short-term unemployed veterans:  $2,400
• Service-related disabled veterans discharged from active duty within a year:  $4,800
• Long-term unemployed veterans:  $5,600
• Long-term unemployed service-related disabled veterans: $9,600

A credit against Social Security taxes is also available to tax-exempt employers. Transfers are made from general revenues to make the Social Security trust fund whole.  The provision expires on December 31, 2012.  The proposal would extend these credits for an additional year, though 2013.

Temporarily extend increase in the maximum amount and phase-out threshold under section 179. Under current law, a taxpayer with a sufficiently small amount of annual investment may elect to deduct the cost of certain property placed in service for the year rather than depreciate those costs over time.  The 2003 tax cuts temporarily increased the maximum dollar amount that may be deducted from $25,000 to $100,000.  The tax cuts also increased the phase-out amount from $200,000 to $400,000.  These amounts have been further modified and extended several times on a temporary basis, increasing up to a high of $500,000 and $2 million respectively for taxable years beginning in 2010 and 2011, and then to $125,000 and $500,000 respectively for taxable years beginning in 2012, before reverting to the permanent amounts of $25,000 and $200,000 respectively for taxable years beginning in 2013 and thereafter. The modified proposal would increase the maximum amount and phase-out threshold in 2012 and 2013 to the levels in effect in 2010 and 2011 ($500,000 and $2 million respectively). Within those thresholds, the proposal would also allow a taxpayer to expense up to $250,000 of the cost of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. This proposal expires at the end of 2013 and the amounts revert to $25,000 and $200,000, respectively.

Treatment of certain dividends of regulated investment companies (RIC’s).  The bill extends a provision allowing a RIC, under certain circumstances, to designate all or a portion of a dividend as an “interest-related dividend,” by written notice mailed to its shareholders not later than 60 days after the close of its taxable year. In addition, an interest-related dividend received by a foreign person generally is exempt from U.S. gross-basis tax under sections 871(a), 881, 1441 and 1442 of the Code. The proposal extends the treatment of interest-related dividends and short-term capital gain dividends received from a RIC to taxable years of the RIC beginning before January 1, 2014.

Look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company rules.  The bill allows deferral for certain payments (interest, dividends, rents and royalties) between commonly controlled foreign corporations (CFC).  This provision allows U.S. taxpayers to deploy capital from one CFC to another without triggering U.S. tax. The proposal extends present law to the end of 2013.  The proposal is effective for tax years beginning after December 31, 2011.

Special rules for qualified small business stock.  Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion is increased to 75 percent. For stock acquired after September 27, 2010 and before January 1, 2012, the exclusion is 100 percent and the AMT preference item attributable for the sale is eliminated. Qualifying small business stock is from a C corporation whose gross assets do not exceed $50 million (including the proceeds received from the issuance of the stock) and who meets a specific active business requirement. The amount of gain eligible for the exclusion is limited to the greater of ten times the taxpayer’s basis in the stock or $10 million of gain from stock in that corporation. The provision extends the 100 percent exclusion of the gain from the sale of qualifying small business stock that is acquired before January 1, 2014 and held for more than five years. The bill also clarifies that in the case of stock acquired after February 17, 2009, and before January 1, 2014, the date of acquisition for purposes of determining the percentage exclusion is the date the holding period for the stock begins.

Reduction in S corporation recognition period for built-in gains tax.  If a taxable corporation converts into an S corporation, the conversion is not a taxable event. However, following such a conversion, an S corporation must hold its assets for a certain period in order to avoid a tax on any built-in gains that existed at the time of the conversion. The American Recovery and Reinvestment Act reduced that period from 10 years to seven years for sales of assets in 2009 and 2010.  The Small Business Jobs Act reduced that period to five years for sales of assets in 2011.  The bill extends the reduced five-year holding period for sales occurring in 2012 and 2013.  In addition, this bill clarifies rules for carryforwards and installment sales.

Empowerment zone tax incentives.  The bill extends for two years the designation of certain economically depressed census tracts as Empowerment Zones. Businesses and individual residents within Empowerment Zones are eligible for special tax incentives.

Payroll Tax Increase

The end of the payroll tax reduction creates employee-relations challenges for companies.

Effective January 1, employers should withhold 6.2 percent for employee Federal Insurance Contribution Act (FICA) contributions.  The payroll tax has increased to its previous rate of 6.2%.  In recent years, employees experienced a lower rate of 4.2% and therefore greater take home pay as a result of the temporary 2% decrease in employee contributions to FICA.  The Congressional Budget Office reports that the payroll tax increase will raise $95 billion.

Important for employers & employees:

• Your next payroll and paycheck – Employers may want to consider communicating to employees that their next paycheck will be lower as a result of the payroll tax increase. The Tax Policy Center in Washington, D.C., reports that 80 percent of households with incomes between $50,000 and $200,000 will pay higher taxes.   Among the households facing higher taxes, the average increase would be $1,635.  Individuals can estimate how much more in FICA taxes they will pay in the new year by using this calculator.
• Payroll accuracy and treble damages – For Massachusetts employers especially, accurate payroll accounting is vital given that state law mandates treble damages for any violation of wage and hour violations, event for honest mistakes.