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A Wilmington NC CPA tax preparer discusses President Obama’s tax propositions

Beleaguered President Obama is proposing three tax changes for 2010, according to today’s headlines. 

 Permanent extension of the research and development tax credit

The Research and Experimentation Tax Credit, as it is officially known, was enacted as part of the Economic Recovery Tax Act (ERTA) of 1981.  It provided a 25% tax credit for research and development capital expenses to help America stay on the cutting edge of technology.  It has since been dropped and reinstated 13 times.  The current credit is 20%.  The credit deals with capital investments.  Actual research and development expenses have been tax deductible by companies since the 1950s. 

Let’s look at this by again using the perspective of the CPA for our example company, Wilmington NC Widgets.  If WNW had genuine research expense, like salaries and supplies, the CPA can just deduct these as expenses on the tax return.  No credit here.  But if Wilmington NC Widgets invested in a piece of equipment specifically for research and development, it could qualify for the Credit.  The credit is structured so that it must stay in force for Wilmington NC Widgets to reap the full value.  So the CPA and management may not be inclined to invest in that piece of equipment, especially in a recession, if the Credit wasn’t made permanent.

Writing off all equipment this year

This wording is a little vague, but I’ll demonstrate the possibilities, again from the perspective of the CPA for Wilmington NC Widgets.  There are already multiple similar incentives for a company the size of WNW.  Let’s say WNW bought a $70,000 piece of equipment on January 1st, 2010.  By default, the CPA would depreciate that off over 7 years on the tax returns, probably using the Double Declining Balance technique.  So, say, $14,000 could be deducted in 2010.

President Obama’s proposition, as I understand it, would allow the CPA for Wilmington NC Widgets to deduct the entire $70,000 in 2010.  Much nicer than the $14,000 allowed above, right?  But Section 179 already allows any company to immediately expense up to $250,000 in 2010.  Subject to limitations of course.  Special 50% depreciation allowances are already in place, such that WNW could deduct $35,000 of the equipment in 2010 under these current provisions.

So this new incentive doesn’t seem to be a small business incentive except under the following scenario.  The CPA for Wilmington NC Widgets arranges the purchase of $300,000 of equipment under great financing provisions; let’s say no money down in 2010.  WNW has $300,000 of profit in 2010 (unlikely in this economy) and the CPA elects to deduct the entire amount during 2010 tax preparation.  No tax due in 2010 and everyone is happy.

But in 2011, Wilmington NC Widgets has to pay interest and principal on the financing, let’s say $70,000.  Now there is no remaining tax deduction left for the $300,000 piece of equipment.  If the CPA for Wilmington NC Widgets didn’t carefully consider future cash flow, the company could easily slip into a cash flow pitfall: a double whammy of increased taxes and financing.  While immediate tax relief is generally better than eventual tax relief, it takes discipline and strong cash flow management later.

Increased taxes for the rich

The decrease in marginal income tax rates instigated by Bush expired this year.  It sounds like President Obama may allow the two highest categories to be reinstated.  

If you need a free initial consult from a Wilmington NC CPA and tax accountant, please call us at (910) 399-2705.