Business just got less taxing

Nation's Business, Oct, 1997 by Joan Pryde

The way Michele Dyson figures it, the new tax law enacted in August is going to make it easier for her to keep her Silver Spring, Md., company, CIS Global, on the cutting edge of computer technology.

Dyson needs to buy state-of-the-art equipment early in 1998 for her company, a systems integrator and Internet-access provider, so it can continue to provide the best service possible for its customers.

Dyson was considering selling investment property to raise the $200,000 or more she would need. Selling the property makes even more sense now because the law, enacted Aug. 5, lowered capital-gains rates and will let her keep more of any profit from the sale.

"Without some sort of tax benefit, it's hard to plow thousands of dollars into new equipment," Dyson says. Any time the company can save money with a particular type of investment, that's where the money will be spent, she says.

The capital-gains cut, which applies to individuals and small firms whose income shows up on the owners' personal income-tax forms, is one of a host of provisions in the new law expected to benefit small businesses.

Other such changes include a reduction in the estate tax, a new exemption from the alternative minimum tax, expansion of the home-office deduction, restoration of deductibility for employee educational expenses, and a variety of changes in pension laws.

"These tax cuts are grease for the wheels of the American economy," says Bruce Josten, the U.S. Chamber of Commerce's executive vice president for government relations.

Though some benefits will be seen immediately, small businesses won't feel the full effect of the most important tax changes until after 2002. That's when the federal budget deficit is projected to be wiped out as a result of the new balanced-budget law, which contains the tax-cut package.

The estate-tax and health-deductibility provisions, as well as part of the capital-gains reduction, are all "back, loaded" -- meaning that most of their benefits will arrive late in their phase-in periods.

Capital-Gains Cuts

The new law cuts the top tax rate for individuals on long-term capital gains to 20 percent from 28 percent, although the holding period has risen to 18 months from 12 months. (Profits on assets held 12 to 18 months are taxed at the former 28 percent rate; assets held less than 12 months are taxed at the individuals personal rate.) Taxpayers in the 15 percent income-tax bracket get a lower rate of just 10 percent on assets held at least 18 months, down from 15 percent.

The new rates are effective for sales after July 28, 1997.

Because no changes were made to the corporate capital-gains tax, with its top rate of 35 percent, the only businesses that benefit from the new rates are partnerships, S corporations, and sole proprietorships.

The new law contains an even bigger individual capital-gains break that is on the horizon, though how quickly you become eligible for the break depends on your tax bracket.

Beginning Jan. 1, 2001, taxpayers in the 15 percent income-tax bracket will have an 8 percent capital-gains rate for assets they have held for at least five years. Taxpayers in higher income-tax brackets will get an 18 percent rate on assets held at least five years, but only for assets acquired after Jan. 1, 2001. Thus, those taxpayers won't actually get the benefit of the 18 percent rate until at least 2006.

Delaying the lower rates on assets held five years is one of the instances of back loading in the tax law

The full benefits of the new capital-gains rates are not granted to investments in business real estate, however. If you sell property that you depreciated, any capital gain attributable to that depreciation is taxed at 25 percent. Only gains above the amount depreciated am eligible for the 20 percent and 10 percent rates.

Boost For Small-Business Stock

Another provision enhances a tax statute on the books since 1993 that gives a special capital-gains break to investors in small-business stocks. The 1993 law allows a 50 percent exclusion on gains from stock held at least five years if the company issuing the stock is deemed a qualified small business. A business must meet a host of requirements to qualify, the most important of which is that its assets total no more than $50 million.

The new tax law gives you a way out if you decide to sell your stock within the five-year window: You can avoid paying taxes on your gain as long as you roll over the proceeds into the stock of another qualified small business. And you can still qualify for the 50 percent exclusion after the initial five years.

Tom Ochsenschlager, a partner in the Washington, D.C., office of accounting firm Grant Thornton LLP, says the new "rollover" provision is a significant improvement to the earlier statute because the five-year holding period has been a major deterrent to investors who may have wanted to cash in on the 50 percent exclusion. "When we talk to people about this provision, their reaction is they never met a stock they wanted to hold for five years," he says.