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AJCA: comng to a tax return near you
Any practice that modifies, adapts or adds to the business premises will qualify for a write-off period.
The American Jobs Creation Act (AJCA) of 2004, the fifth major tax cut signed into law in the last four years, has ballooned into a 145-billion tax break that will benefit veterinarians—and their veterinary practices.
More than 630 pages long with upwards of 270 provisions, that new tax bill limits the popular write-off that allowed many veterinarians to write-off the entire cost of a large sport-utility vehicle (SUV) in the year it was acquired. These new limits, along with the closing of a number of loopholes and the addition of several so-called revenue raisers, are expected to completely offset the cost of this law.
Unfortunately, despite our lawmakers' extremely broad definition of "manufacturers" that includes professionals, such as architects and engineering firms, the centerpiece tax cut of this new legislation, a 3-percent tax-rate reduction, will not apply to many veterinary practices. It is unlikely that the Internal Revenue Service (IRS) will expand the definition to include veterinarians or their practices.
As defined in the law, manufacturers and "domestic producers" in the areas of construction, engineering, energy production, computer software and film and videotapes, as well as the processing of agricultural products, will benefit from a tax-rate cut that is not really a tax cut, but a deduction.
The new deduction is available to manufacturers and domestic producers operating as regular C-corporations, S-corporations, partnerships, sole proprietorships, cooperatives and others. While it was created to help cushion the blow of repealing an almost $50 billion tax break for U.S. exporters, this bill is also about jobs. Thus, lawmakers limited the total tax-rate deduction to an amount equal to 50 percent of the W-2 wages paid during the tax year.
Faster write-offs, lower tax bills
Although few veterinary practices are expected to benefit from the new lower tax rate for manufacturers, lawmakers extended the 2002 rules that raised the threshold for Section 179 write-offs from $25,000 to $100,000. This special, first-year expensing write-off for equipment costs is reduced by the amount by which the cost of qualifying property placed in service by the veterinary practice exceeds $400,000.
Originally designed as a temporary measure to stimulate the economy, the write-off was scheduled to drop back to $26,000 in 2006. Not only have the higher caps been extended through 2007, the threshold has been indexed for inflation. In 2004, it is $102,000 with a $410,000 cap. This change carries the indexing through 2007, too.
On the depreciation front, lawmakers created a 15-year recovery period for qualified leasehold improvements. Thus, any veterinary practice that modifies, adapts or adds to the practice's business premises between now and Jan. 1, 2006, will qualify for a 15-year write-off period for the cost of those improvements.
The old rules required that leasehold improvements or additions be depreciated using straight-line depreciation over the same 39-year period as business property. A qualified leasehold improvement is defined as an improvement to the interior of a building made by either the landlord or the lessee and placed in service more than three years after the building was first placed in service.
Despite the popularity of limited liability companies (LLCs) and other partnership-type entities, S-corporations remain the fastest-growing type of business entity. A veterinary practice operating as an S-corporation passes through income and loss to its principals or shareholders. The principal or shareholder then reports their shares of these items on their individual tax returns.
In order to encourage the continued growth of S-corporations, the new law attempts to reform and simplify tax treatment for that structure, hopefully helping the entity continue as the nation's leading job-creating force. The new law, for example, allows family members to opt to be treated as one shareholder for purposes of determining the number of shareholders of an S-corporation. It also increases the maximum number of S-corporation shareholders from 75 to 100.
Under current law, most family members are treated as separate shareholders, which limits the veterinary practice's ability to diversify its investors and therefore better withstand business fluctuations. But where permitted by professional licensing authorities, a husband and wife can include a child or children as S-corporation shareholders. They can treat all of them as one shareholder in the veterinary practice.
The new law also allows both traditional and Roth IRAs to hold S-corporation bank stock that the IRA with the IRA owner treated as the shareholder. It also allows that stock to be sold by the beneficiary for fair-market value upon the corporation making an "S" election. Also, in cases such as divorce or stock transfers, an S-corporation's suspended losses or deductions can now be transferred to a spouse.
Obviously, those veterinarians reorganizing an existing practice or business—or starting a new practice—will need to look long and hard at the new S-corporation rules, particularly the many new benefits.
Devil in the details
As already mentioned, the cost of this new law to the U.S. Treasury will be offset by closing a number of tax loopholes, as well as with other revenue-raising measures. Among the loopholes closed under the new law is one that allowed some small-business owners to deduct up to $100,000 of the cost of a luxury SUV on their income tax returns. Because the vehicle caps on depreciation do not apply to cars or trucks weighing more than 6,000 pounds, veterinarians could deduct up to the full cost of the SUV immediately as a Section 179 expense. But under the new law, the deduction for vehicles weighing not more than 14,000 pounds is capped at $25,000, effective for SUVs placed in service after the date of enactment.
The law takes aim at companies conducting "corporate inversions," which involve a company switching its headquarters in name only to an overseas tax haven to lower or eliminate U.S. taxes. Somewhat closer to home, the new law will make charitable donations slightly more difficult for many incorporated practices.
The reporting of non-cash charitable contributions has been extended to incorporated veterinary practices and businesses; the requirement that a donor obtain a qualified appraisal of the donated property if the amount of the claimed deduction is more than $5,000. Similarly, if the amount of that contributed property, other than cash, inventory or publicly-traded securities, exceeds $500,000, then the appraisal must be attached to the annual tax return.
As for those tax schemes used by so many veterinarians to shelter profits and proceeds from the sale of their practices and businesses from the tax collector's grasp, the new law contains 21 provisions that crack down on tax shelters.
The bill also requires both veterinarians and their practices to disclose to the IRS details about any, and all, tax shelters they participate in or benefit from, as well as boosting penalties for failing to do so.
Applying to all tax returns and statements filed today, the law adds a new penalty for failing to disclose so-called "reportable" transactions regardless of whether the transaction ultimately results in an understatement of tax or not. The penalty for failing to inform the IRS is $10,000 for an individual ($50,000 for practices and businesses). If the shelter is a "listed transaction," which is required to be registered with the IRS, the penalty skyrockets to $200,000 ($100,000 for individuals).
For those veterinarians who might be less than truthful on their practice or personal tax returns, the new law also creates a new accuracy-related penalty for reportable and listed transactions. Because lawmakers granted the IRS discretion in applying the penalties, the IRS is likely to continue its carrot-and-stick approach with taxpayers suspected of participating or promoting abusive shelters.
Deductions for life
The American Jobs Creation Act of 2004 will save veterinarians and other taxpayers an estimated $145 billion in taxes during the next 10 years. The law's 276 provisions benefit restaurant owners and Hollywood producers, makers of bows, arrows, tackle boxes and sonar fish finders, NASCAR track owners, native Alaskan whalers and even importers of Chinese ceiling fans. The question is, will it benefit veterinarians and their practices?
The much-touted centerpiece of this new law will lower the tax rate on the profits of incorporated manufacturers and other so-called domestic producers from 35 percent to 32 percent. Unfortunately, those tax-rate cuts are unlikely to help many veterinarians or their practices.
Also on a down note, many of these revenue-raising provisions are, for the most part, permanent, while the majority of tax cuts have only a temporary life.
Fortunately, the benefits and tax-savings from this new tax law far outweigh the downside. Keep in mind that effective dates vary from provision to provision. What's more, many of the provisions in the new law will require immediate action to maximize benefits and avoid problems.
Mr. Battersby is a financial consultant in Ardmore, Pa.