On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010. In addition to provisions intended to improve access to capital by small businesses and to encourage exporting, the new law contains $12 billion in tax breaks to help businesses and purportedly inspire or make it easier for them to hire workers. The act does not contain any direct tax incentives for hiring. Here is a roundup of the provisions that may be helpful to certain businesses.
Write-Offs for Equipment and Other Capital Expenses
Businesses may be able to deduct entirely or at least substantially accelerate write-offs for the cost of certain equipment or some specific capital improvements rather than having to depreciate them over a number of years. These breaks apply regardless of how the purchase is financed; they can be claimed whether the equipment is paid for up front or financed in whole or in part.
First-year expensing (“Section 179 deduction”). The dollar limit on writing off the cost of equipment purchases for a business in 2010 and 2011 is increased to $500,000; it was previously at $250,000 in 2010 and $25,000 in 2011 (Code Sec. 179). The dollar limit would begin to phase out when total purchases exceed $2 million, instead of the former $800,000 threshold.
The expensing rule applies not only to equipment and machinery (whether new or pre-owned), but also to qualified leasehold improvements, restaurant improvements and retail improvements up to $250,000.
Normally, the cost of off-the-shelf software must be written off over 36 months. However, for purposes before 2012, the cost can be treated as qualified property for purposes of the first-year expensing deduction.
The opportunity to revoke or make an expensing election without IRS consent applies through 2011; this election option was previously set to apply only through 2010.
Bonus depreciation. The 50% bonus depreciation rule has been extended through 2010 (Code Sec. 168(k)). This allows half of the cost of qualified property to be deducted in the year of purchase. Bonus depreciation can be claimed in addition to first-year expensing.
Depreciation for the purchase of cars, light trucks and vans is limited each year to a dollar amount (Code Sec. 280F). However, new cars, light trucks and vans purchased in 2010 qualify for an additional $8,000 write-off in the first year because of bonus depreciation. For example, if a new business car is bought in 2010 and used 100% for business, a depreciation deduction of up to $11,060 can be claimed. (Dollar limits for cars, light trucks and vans can be found in Rev. Proc. 2010-18, IRB 2010-9, 427.)
Promoting Entrepreneurship
The new law contains several measures intended to encourage business formation.
Start-up costs. Businesses can elect to deduct start-up costs up to a set dollar limit in their first year of operation (Code Sec. 195). Start-up costs include certain expenses incurred before a business opens its doors, such as:
- Costs for an analysis or survey of potential markets, products, labor supply and transportation facilities.
- Advertisements of the business’ opening.
- Salary and wages paid to employees and their instructors for training.
- Travel costs for securing prospective distributors, suppliers and customers.
- Fees to consultants for professional services.
Start-up costs do not include deductible interest, taxes, or research costs.
For start-up costs incurred after October 22, 2004, the first-year deduction limit has been $5,000; the new law doubles it to $10,000 beginning in 2010. Excess amounts are amortized over 180 months.
The dollar limit is phased out when total start-up costs exceed a set amount. That threshold amount had been $50,000; it has been raised to $60,000. Thus, if start-up costs exceed $70,000, the entire amount must be amortized over 180 months.
Exclusion for gain from the sale of qualified small business stock. Investors who purchase stock in certain small corporations are rewarded by being allowed to exclude a certain percentage of their gain if they meet set requirements (Code Sec. 1202). Under the new law, investors who purchase qualified business stock that is issued after September 27, 2010, and before January 1, 2011, and hold it for at least five years, will not pay any capital gains on the sale of the stock (Code Sec. 1202); there is 100% exclusion. Qualified small business stock is stock in a C corporation (not an S corporation) that has gross assets when the stock is issued of not more than $50 million. The corporation must be an active trade or business.
For stock issued after February 17, 2009, and before September 28, 2010, the exclusion is 75% of the gain. Prior to this time, the exclusion had been set at 50% of the gain (or 60% of the gain for stock of businesses located within certain economically-distressed areas).
The exclusion applies not only for regular income tax purposes but also for purposes of the alternative minimum tax.
Reduction in the built-in gains period for S corporations. When a corporation that has been operating as a C corporation converts to S status, any appreciation within its assets will be taxed to the S corporation as built-in gains if sold within a set period. Usually, the built-in gains tax period is 10 years (Code Sec. 1374). For tax years beginning in 2009 and 2010, the period is reduced to seven years; for tax years beginning in 2011, the period is reduced to five years.
Other Helpful Changes
Self-employed health insurance deduction. Health insurance premiums paid by a self-employed person (or a more-than-2% S corporation shareholder) are deductible only as a personal deduction; it is subtracted from gross income. (It is not an itemized deduction.) However, for 2010 only, such premiums are deductible for self-employment tax purposes. This means that the premiums reduce net earnings from self-employment for purposes of self-employment tax.
For example, if a self-employed individual pays health insurance premiums in 2010 of $12,000 for herself and her family, she saves approximately $1,800 in self-employment tax.
Carryback of the general business credit. The general business credit is not a separate credit; it is the conglomeration of certain business credits into one unit, with a single carryback period and carryover period (Code Sec. 39). The general business credit may not exceed the taxpayer’s net income over the greater of the taxpayer’s tentative minimum tax or 25% of the regular tax in excess of $25,000. Usually, excess credit amounts can be carried back for one year and forward for up to 20 years. Under the new law, the carryback period is extended to five years for eligible small businesses.
Eligible small businesses mean a privately-held corporation, partnership or sole proprietorship with average annual gross receipts in the three prior years not exceeding $50 million.
This longer carryback period applies to credits in a business’ first taxable year beginning after December 31, 2009 (i.e., 2010 for calendar-year businesses).
Also, the general business credit of an eligible small business can be used to offset the alternative minimum tax (Code Sec. 38).
Cell phones. These are no longer considered “listed property,” which requires special recordkeeping and deductions which cannot be accelerated without business usage being more than 50% of total usage. This rule applies starting this year.
Revenue Raisers
To help pay for the tax cuts, the new law contains a number of revenue raisers. Some apply only to very large corporations or businesses engaged in specific industries. Two revenue raisers with more general application include:
Rollovers to Roth accounts. Amounts from qualified retirement plans can be rolled over to Roth 401(k) accounts, effective after September 27, 2010 (Code Sec. 402A). When these rollovers are made, plan participants must include the rollover amounts in income.
Reporting by rental property owners. To help pay for the tax cuts, as a revenue raiser, those in the business of rental real estate must issue Form 1099s to service providers starting in 2011 (Code Sec. 6041). Service providers include painters, plumbers, accountants and anyone else providing services to rental properties.
Excluded Provisions
During the legislative process, a number of revenue raisers had been discussed but were not included in the final bill. These include:
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Changes to carried interest rules. Currently, this type of compensation paid to equity fund managers is treated as capital gain; proposed changes would have treated a certain percentage of this compensation as ordinary income.
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Changes to grantor retained annuity trusts (GRATs). A GRAT is a trust that pays the grantor an annuity from the trust for a set period, after which the balance of the trust is payable to named beneficiaries at reduced gift tax cost. Proposed changes would have required that the retained annuity interest be for a term of not less than 10 years, that the annuity would not decline during this term and that the remainder interest passing to beneficiaries has a value greater than zero at the time of the transfer.
Note: Future legislation may include these revenue raisers.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.
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