Leveraging Tax Code

LEVERAGING THE TAX CODE TO YOUR ADVANTAGE

By Donald A. Kruschke

Stopol Director of Thermoforming

Vice President of Stopol Business Services

There currently are several tax laws in existence that can be leveraged to your company’s advantage. However, two in particular can be considered very favorable to thermoformers and other plastics processors.

These two tax laws are:

1. Like-Kind Exchanges
2. Expense Election Under Section 179

LIKE-KIND EXCHANGES

If you have commercial property or an appreciated asset that you want to sell but are hesitant because of taxation concerns, you may want to consider the benefits of a like-kind exchange.

Rather than recognize a large taxable gain, IRS Code 1031 allows you defer the tax if you structure the deal as a like-kind exchange rather than as a sale. This enables you to apply all of the appreciation in your property, undiminished by the tax that would otherwise be payable, toward acquiring replacement property.

Essentially, IRS Code 1031 allows the seller to reinvest total sale proceeds. The amount not paid in capital gains tax to federal and state governments allows the investor to build equity. Therefore, tax deferment increases the availability of funds that can be invested and enhances value that is compounded with continuous re-investments.

To qualify for like-kind benefits, the following four conditions must be met:

1. The property traded and received must be used for business or investment purposes.
2. The property traded and received must not be held primarily for sale, such as inventory.
3. The properties must be of a like kind (i.e., real estate can only be exchanged for real estate).
4. The properties must be tangible (i.e., stocks, bonds, notes, securities, evidences of debt, or partnership interests do not qualify).

The most common types of exchanges are as follows:

• Simultaneous Exchange: One in which you trade your property for property that another party already owns (i.e., the transfers occur contemporaneously).
• Deferred Exchange: One in which you transfer property for the other party’s promise to acquire and transfer property of like-kind to you. Deferred exchanges must satisfy two timing rules. First, within 45 days of the transfer of your property, you must give the other party written identification of the property you want to receive. Second, you must receive that property within 180 days after transferring your property or within the due date of your tax return for the year of your transfer. It is recommended that you use an escrow account to handle a deferred exchange. The escrow holder or trustee cannot be a “disqualified” person such as your agent or someone who is “related” to you or your agent.
• Exchanges Handled by Intermediaries: The third and most common way to make a like-kind exchange is to use a qualified intermediary that is contracted to transfer (and acquire, if necessary) both properties. As with an escrow holder or trustee, the intermediary cannot be a disqualified person. Equipped with the appropriate expertise, forms and timelines, Stopol is a qualified intermediary.

The following are a few special rules about like-kind exchanges to keep in mind:

• The tax consequences to the other party do not affect your tax status.
• If the properties are not equal in value, one party can transfer cash or other non-like-kind property to equalize the exchange. Although non-like-kind property is taxable to the recipient, the transaction still qualifies as like-kind.
• If you transfer a liability in the exchange, the liability is treated as cash and is taxable to you.

Although structuring a like-kind exchange can be complex, the tax deferral is often worthwhile. You may want to consult with your tax attorney on how to take advantage of the like-kind exchange law.

Please see the scenario below for an example of how IRS Code 1031 can work for a plastics processor:

Stopol informs Company A of a piece of property that is available. Company A purchases the property for $300,000 and sells it a few years later for $500,000 - for a profit of $200,000. Under normal circumstances, Company A is required to pay capital gains taxes on that $200,000. However, Stopol informs Company A of another piece of property that is available, and Company A purchases it for $500,000. By structuring the deal as a like-kind exchange, Company A is exempt from capital gains taxes until it makes a profit off the new investment.

EXPENSE ELECTION UNDER SECTION 179

On May 5, 2003, Congress passed into law the “Jobs & Growth Tax Relief Reconciliation Act of 2003″. This Act provides substantial tax incentives to manufacturers because it allows them to aggressively depreciate deductions for new and used machine tool purchases.

A key and beneficial aspect of this law is the Expense Election under Section 179, which allows businesses to claim a deduction on capital equipment expenditures. The amount of the deduction has varied since the law was enacted.

On February 13, 2008, President Bush signed into law the “Recovery Rebates and Economic Stimulus for the American People Act of 2008.” This act provides business growth incentives by increasing Section 179 expensing and bringing back bonus depreciation.

What This Means for You

• Increased Section 179 Expensing. Prior to the Act, small businesses could expense up to $128,000 of the cost of new and used equipment placed in service during that year. The Act increases the maximum expense amount to $250,000.

• Return of Bonus Depreciation. The Act brings back the special rules of bonus depreciation by permitting a bonus first-year depreciation deduction equal to 50 percent of the cost of the new property placed in service during 2008.

Section 179 Basics

Please read the information below to see how you can use Section 179 to your advantage.

• Section 179 doesn’t discriminate between purchases of new and used assets.
• Section 179 requires taxpayers who place more than $500,000 worth of Section 179 property into service during a single taxable year to reduce, dollar for dollar, their 179 deduction by the amount exceeding the $500,000 threshold. For example, if a taxpayer put $550,000 worth of 179 property into service during 2006, then he or she would be required to reduce his or her 179 deduction by $50,000 ($550,000-$500,000=$50,000) so that his or her 179 deduction could be no greater than $75,000 ($125,000 - $50,000 = $75,000). Again, this limit is also set to revert after 2010 to $200,000.
• Section 179 provides that the 179 deduction in any given year may not exceed the taxpayer’s total taxable income in that year. If, for example, the taxpayer’s taxable income was $75,000 in 2006, then his or her 179 deduction could not exceed $75,000. However, the 179 deduction not taken can be carried over.
• Section 179 can only be taken in the year that the capital asset is acquired and ready for use in the business.
• Company vehicles may be expensed via Section 179 as long as they:

1. Have a gross weight of more than 14,000 pounds.
2. Can seat more than nine passengers behind the driver’s seat
3. Are equipped with an open cargo box of at least 6 feet.
4. Are equipped with a closed cargo box not accessible from the interior.
5. Have a fully enclosed driver compartment and load-carrying device, does not have seating rearward of the driver’s seat, and have no body section protruding more than 30 inches ahead of the leading edge of the windshield.

How This Could Work for You

The following example illustrates how current tax rules regarding depreciation can benefit those making capital equipment purchases in 2008:

Example:

A company purchases a $400,000 machine from Stopol. The company purchased no other capital equipment during 2008, so it may deduct $250,000 under Section 179. The remaining $150,000 is then depreciated, generating an estimated additional deduction of $21,500. The sum of these two deductions is then subtracted from the cost of the equipment, resulting in a total first-year deduction of $271,500 or 67.9 percent of the $400,000 investment. This deduction equals a real cash savings of $95,025, which means the customer essentially spent $304,975 on the machine.

Snapshot View

Cost of Equipment                                                                $400,000

Section 179 Expense                                                           $250,000

First Year Depreciation                                                        $21,500

Total First-year Deduction                                                   $271,500

Real Cash Savings on your Equipment Purchase            $95,025

(assuming a 35% tax bracket)

Cost of equipment after tax savings                                   $304,975

This example presumes that the mid-quarter convention does not apply.

Please note that your annual deduction cannot exceed your aggregate net taxable income for 2008.

CONCLUSION

Like-Kind Exchanges and the Expense Election Under Section 179 are just two ways in which Stopol can help you leverage the tax code to your advantage. The next time you are thinking about selling surplus assets or making a capital expenditure, you may want to consult with Stopol first to see if you can further maximize your transaction.

NOTE: This information is designed to serve as a guide/ illustration for our customers. The tax calculations for each individual and/or company are unique and your tax preparer should be consulted to determine your actual savings.