The end of 2012 saw the United States on the precipice of higher tax rates springing back to life, the elimination of favorable business tax provisions and significant cuts to federal spending. From the edge of the proverbial fiscal cliff, the United States leaped to the closest ledge at the beginning of 2013, with the politicians finally reaching an agreement to mostly preserve current tax rates and extend numerous favorable business tax provisions. With the president of the United States largely failing to lead the way to a policy solution, Vice President Joe Biden and Republican Sen. Mitch McConnell (Ky.) filled the vacuum by striking a deal addressing fiscal policy. The deal mostly averted the drastic consequences that may have otherwise resulted if the country had completely fallen over the fiscal cliff.
The agreement is embodied in legislation passed by Congress, entitled the American Taxpayer Relief Act (H.R. 8), which was swiftly signed by the president. The American Taxpayer Relief Act temporarily eliminates the risk of a shock to the economy, which may have resulted due to the mix of drastic tax increases and cuts in federal spending. Congress still faces an impending deadline to address federal spending, which has led to sizable budget deficits. For the gaming industry, the American Taxpayer Relief Act operates to extend a host of favorable business tax law programs. Thus, a closer examination of the tax extender provisions and the potential benefit to businesses operating within the gaming industry is in order.
Extension of Individual Tax Rates
The (then) looming Jan. 1, 2013, increases to individual tax rates received considerable attention in the mainstream United States media. Americans’ personal distaste for paying tax is well documented and intertwined within our cultural fabric. While the individual federal income tax rates are certainly not a business tax issue, the rate at which income is taxed can still have economic consequences to the business community, in particular, the gaming industry. As income tax rates rise, the prospect of consumers having diminished disposable income becomes likely.1 Consequently, less disposable income may mean a lower consumer spend on leisure activities, such as weekend excursions to the Las Vegas Strip, and curtailing gambling activities.
Under prior tax law, individual tax rates were set to spike on Jan. 1, 2013, upon the sunset of tax cuts enacted in 2001 and 2003. Even at the lower income levels, rate increases would have ranged from 3 to 5 percent. The American Taxpayer Act largely keeps the individual tax rates in effect as of 2012. An exception is for those taxpayers with incomes above $450,000 if filing a joint return, $400,000 if filing an individual return, $425,000 if filing as head of household, and $225,000 if a return is filed as married filing separately. The act increases the tax rate for these taxpayers from 35 percent to 39.6 percent.
Thus, not only can many individual employees of gaming businesses benefit by the preservation of the 2012 income tax rates, the American Taxpayer Relief Act avoids a rate spike and limits the corresponding impact on consumer spending on leisure activities.
Business Tax Provisions
The American Taxpayer Relief Act includes the extension of several business-friendly tax law provisions. Specific tax-extenders that may be of benefit to businesses operating within the gaming industry are highlighted below.
The research credit available under the Internal Revenue Code of 1986, as amended (Code or IRC), operates through a complex web of regulations issued under two Code sections, both of which use similar language.2 The research credit allows taxpayers to claim a credit under the IRC § 38 general business credit for “qualified research expenses.” Under prior law, the research credit did not apply to amounts paid or accrued after Dec. 31, 2011.
The American Taxpayer Relief Act extended the research credit for two years. Under the extender, qualified research expenses paid or accrued prior to Jan. 1, 2014 are eligible for the credit.
Gaming equipment manufacturers may be able to benefit from the extension of the research credit. Specifically, the research credit may benefit those manufacturers that are actively engaged in the development of new gaming devices. A Tax Court decision issued in 2009 may also offer planning opportunities for gaming equipment manufacturers to structure their research activities.3
Extension of Bonus Depreciation, Favorable Recovery Periods and Expensing
The federal tax law prohibits the immediate recovery via a deduction of the cost of property used for the production of income in a trade or business that has a useful life beyond one year. The Code instead requires that the costs of such property be capitalized and then recovered through depreciation deductions over a period of years. Under prior tax law, businesses could claim “bonus depreciation” for certain qualifying types of property. The bonus depreciation is equal to 50 percent of the cost of the property, which could potentially result in a substantial deduction. Property eligible for bonus depreciation includes certain property with a recovery period of 20 years or less, as well as certain computer software, qualified leasehold and qualified restaurant property.
The American Taxpayer Relief Act extends the bonus depreciation deduction for eligible property that is placed in service prior to Jan. 1, 2014. The extension of the bonus depreciation deduction may be particularly beneficial to casino operators and gaming equipment manufacturers. For example, purchases of new gaming devices or other equipment used at the casino property may qualify for bonus depreciation. Thus, there may be tax incentives to make capital expenditures in 2013.
The American Taxpayer Relief Act also extends the 15-year recovery period for qualified leasehold and retail improvements, and qualified restaurant property. The availability of a 15-year recovery period may be beneficial if new restaurants or retail space is added to casino properties in 2013.
Finally, the American Taxpayer Relief Act increases the ability to immediately expense up to $500,000 of qualifying IRC § 179 property. IRC § 179 allows certain taxpayers the option of electing to immediately expense the cost of new or used tangible personal property, rather than recovering the cost through depreciation deductions. Under the American Taxpayer Relief Act, the $500,000 maximum expensing amount is phased out at $2,000,000 of expenses for 2012 and 2013.
Extension of the Work Opportunity Credit
The Work Opportunity Credit grants a credit to employers that hire employees from certain targeted employee groups. The targeted groups include individuals receiving long-term family assistance and eligible military veterans. The American Taxpayer Relief Act extends the Work Opportunity Credit for qualifying employees hired before Jan. 1, 2014. The available credit is generally $6,000, but in some cases can be as high as $24,000. The extension of the Work Opportunity Credit is beneficial to those businesses which intend to hire new workers in 2013.
Enhanced Charitable Deduction for Food Inventory
The American Taxpayer Relief Act extended the charitable contribution deduction for “C corporations” that donate food inventory to eligible donees. Under the Act, a charitable contribution deduction is equal to the lesser of either (1) the cost of the food inventory plus half of the property’s appreciation, or (2) twice the cost of the food inventory. The enhanced charitable deduction for contributions of food inventory offers businesses a tax incentive when donating food inventory to charities.
Extension of Tax Benefits for Indian Country
The American Taxpayer Relief Act also extended two tax provisions directly applicable to federal Indian tribes: (1) the Indian Employment Credit; and (2) accelerated depreciation for property located on Indian reservations.
The Indian Employment Credit is a tax credit for employers based on the amount of qualifying wages and health insurance costs paid to enrolled members of Indian tribes and their spouses that meet certain requirements. The credit is equal to 20 percent of the qualifying compensation paid to the eligible employee. The credit, however, is capped at $20,000 per employee. The credit expired at the end of 2011. The American Taxpayer Relief Act extends the Indian Employment Credit retroactively for two years, covering qualifying payments made in 2012 and 2013.
IRC § 168(j) offers a shorter depreciation recovery period for certain depreciable property used in the active conduct of a trade or business located within an Indian reservation. The accelerated depreciation is not, however, available for property used for purposes of conducting or housing Class I, II or III gaming. Under prior law, the accelerated depreciation rules did not apply to property placed in service after Dec. 31, 2011. The American Taxpayer Relief Act extends the application of the benefits of IRC § 168(j) accelerated cost recovery to depreciable property placed in service by Dec. 31, 2013.
The White House and Congress had to first leap from the fiscal cliff before reaching an agreement on the extension of favorable tax provisions. The legislation—the American Taxpayer Relief Act—not only offers certainty, with respect to tax policy to the business community, but extends favorable business tax provisions for the next two years. As outlined, several of the business tax-extenders may be beneficial to gaming businesses.
1 For example, a report prepared by Ernst & Young LLP on behalf of several United States business trade associations found that the rate increases in the highest tax brackets (raising the top two rates to 35 percent and 39.6 percent, respectively) proposed by the president “will have significant adverse economic effects in the long-run: lowering output, employment, investment, capital stock, and real after-tax wages….” Robert Carroll & Gerald Prante, “Long-Run Macroeconomic Impact of Increasing Tax Rates on High-Income Taxpayers in 2013” (July 2012).
2 The research credit is authorized by IRC §§ 41 and 174. The Department of the Treasury has promulgated regulations under each Code section.
3 The United States Tax Court decision TG Missouri Corp. v. Commissioner, 133 T.C. 12 (Nov. 12, 2009) offers businesses, particularly businesses with extensive research and development activities, the ability to structure their activities in a tax efficient manner to maximize the availability of the research credit. TG Missouri, a case in which I and my colleagues, Will Elwood and Andrew MacLeod, represented TG Missouri in the Tax Court proceeding, was the first case to ever decide a long-standing dispute with the Internal Revenue Service over the meaning of the phrase “property of a character subject to the allowance for depreciation” as used in IRC §174(c) and Treasury Regulations § 1.174-2(b)(2) and (4). TG Missouri further clarified that certain third-party toolmaker costs could qualify for the research credit. As a result, those businesses that were reluctant, following the IRS’ more than decade-long assault on research credit claims with respect to this issue, to claim research credits on their property because it may have theoretically been depreciable in the hands of another person, now have clear guidance that the proper analysis focuses solely on whether the property is depreciable in that business’ hands.