Business leaders here and nationwide are bracing for the “fiscal cliff,” an unprecedented slate of tax hikes and spending cuts set to take effect next January. That uncertainty is putting a damper on business investment and acquisitions.
Patti Spencer, an estate tax lawyer and head of Spencer Law Firm in Lancaster, said she's advising businesses to "hunker down."
"I wouldn't encourage a business to expand or make new investments. There are just too many uncertainties," she said.
Companies appear to be taking that advice.
"If I can't plan, I can't invest," said John Steffee, a partner in the West Shore firm of Pfister and Rompalo. "Business is just sitting tight right now."
Nationally, a slew of business owners and top executives have expressed their concerns about the fiscal cliff and revised earnings forecasts downward. According to a Wall Street Journal poll, 47 percent of business executives doubt the cliff will be avoided.
Steffee and Jeffrey Berdahl of Allentown-based RLB Accountants briefed reporters on the fiscal cliff earlier this month at a presentation co-sponsored by the Pennsylvania Institute of Certified Public Accountants and the Pennsylvania Newspaper Association.
For all businesses, the fiscal cliff's challenges include not only the prospect of higher taxes but also the months of uncertainty as policy decisions are put off.
Many small businesses are pass-through entities, said Jim Ostrowski, the partner in charge of the small-business group at Lancaster-area accounting firm Reinsel Kuntz Lesher.
Their owners will have to calculate how changes in personal income tax rates affect their companies' finances, he said. But, "It's hard to plan if you don't know," he said.
Capital gains and estate taxes are set to change, too, Steffee and Berdahl said.
Income, estate and capital gains taxes all will revert to pre-Bush era rates and rules. Another change: Dividends will be taxed as ordinary income, making dividend-paying stocks dramatically less attractive to investors.
"If I'm high-income, I'm looking at tax-exempt municipal bonds," Steffee said. "They will look more attractive."
Even depreciation is part of the fiscal cliff.
Bonus depreciation, a measure designed to encourage capital purchases, expires this year, and other depreciation rules become stricter, Ostrowski said. Businesses will no longer be able to front-load write-offs the way they can this year.
Local accountants and tax law experts offered a number of recommendations to individuals and business owners looking to deal with the fiscal cliff.
Accelerate revenue: Taxes are more likely to go up than down next year, said Jim Ostrowski, the partner in charge of the small-business group at Lancaster-based accounting firm Reinsel Kuntz Lesher. That means you'll pay less on revenue recognized this year. Try to get clients to pay you early, and if you have a choice between assigning income to 2012 or 2013, choose 2012, he said.
Defer deductions: Deductions will do you more good when tax rates are higher, Ostrowski said. For example, if you wait until January to pay your state taxes for the fourth quarter of 2012, you can deduct them from your 2013 federal taxes. If federal tax rates go up, you'll reduce your tax liability correspondingly.
Realize capital gains: If you're thinking of selling your business, you will need to complete the deal by Dec. 31 to lock in the current capital gains tax rate of 15 percent, said John Steffee of Wormleysburg-based accounting firm Pfister and Rompalo. Steffee said he expects a "tremendous flurry" of mergers and acquisitions by the end of the year.
Review estate plans: Because the Bush estate tax cuts are scheduled to expire, family business owners may benefit from transferring ownership to their heirs this year, said Patti Spencer of Spencer Law Firm, based in Lancaster. If at least $2 million to $3 million is at stake, the tax advantages likely are worth it, she said.
Review investments: Now is the time to convert traditional IRAs to Roth IRAs, Spencer said. You will have to pay capital gains taxes now, but when you retire, the distributions from the Roth will be tax-free. Given that today "the tax rates are as low as they probably ever will be," the trade-off makes sense, Spencer said.
Speak to a professional: Tax law is complicated, and planning for the fiscal cliff involves many unknowns. "Sit down with an adviser before Dec. 31," Steffee and Jeffrey Berdahl of RLB Accountants recommended.
Republicans and Democrats both say they want to avert the fiscal cliff, but they disagree on how to do so.
Unless Congress acts to change existing law, tax hikes and cuts will total nearly $500 billion in 2013, according to the Congressional Budget Office. They will combine with about $100 billion from "other provisions of law" to create a net impact of more than $600 billion, or about 4 percent of GDP, the CBO said.
The federal deficit would shrink dramatically — about $560 billion in 2013 after economic feedback effects are accounted for, the CBO calculated — but at the cost of throwing the fragile national economy back into recession, the agency said.
The cliff's tax and spending components are both substantial. On the tax side, the Bush cuts of 2001 and 2003 are set to expire, as is the payroll tax cut from 6.2 percent to 4.2 percent enacted in 2010 and extended this year. Those and other changes could result in Americans' tax bills rising by nearly $400 billion in 2013.
Accompanying that are more than $100 billion in federal spending cuts. About $65 billion of that will come from sequestration, the sharp automatic cuts in military and domestic spending set to take effect in the wake of Congress' deficit reduction "super" committee's inability to reach a deal. Another $26 billion comes from the expiration of extended unemployment insurance.
President Barack Obama has called for preserving most of the Bush income tax cuts, but would raise the marginal rate on high earners — from 35 to 39.6 percent on incomes in the top bracket. He would set the estate tax at 2009 levels, raise the capital gains tax to 20 percent and tax dividends as ordinary income for high earners.
Republican presidential contender Mitt Romney has called for reducing the Bush tax rates by a further 20 percent for all income levels. He has said he would limit deductions, but has not said how. He has called for repealing the estate tax and exempting capital gains, dividends and interest from taxes for individuals making up to $100,000 and couples making up to $200,000.
Obama would permanently adjust the alternative minimum tax for inflation; Romney would abolish it.
Some observers expect Congress to hammer out a deal this year after the Nov. 6 election. Others think the debate could extend well into next year. In 2010, a similar impasse dragged on for months, and some of the final deal applied retroactively.