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Recently Congress passed the Small Business Jobs Act of 2010. The Act's purpose is to provide tax incentives for small businesses during these tough economic times. Some of these provisions may be useful to you and may present planning opportunities for the remainder of the year. Here are some of the highlights that we may want to discuss.
Temporary Exclusion of 100% of Gain on Qualified Small Business Stock
Section 1202 permits a taxpayer, other than a corporation, to exclude in general 50% of the gain realized on the sale of “qualified small business stock” if the taxpayer holds the stock for more than five years before the sale. “Qualified small business stock,” subject to a few exceptions, is stock in a domestic corporation if: (1) the corporation is a “qualified small business” when the stock is issued; and (2) the taxpayer acquires the stock at its original issue in exchange for money, other property (not including stock), or as compensation for services provided to the corporation. A “qualified small business” is generally a domestic C corporation, the gross assets of which do not exceed $50 million (without regard to liabilities). The corporation must be an “active business,” rather than simply an investment company. The amount of gain that may be excluded under §1202 is limited to the greater of $10 million or 10 times the taxpayer's basis in the stock. A portion of the gain excluded generally must be added back as a preference for alternative minimum tax purposes. If the stock represents an interest in a qualified business entity (under empowerment zone rules), as well as meeting all the requirements to qualify for the general 50% exclusion, a 60% exclusion applies. Seventy-five percent of the gain may be excluded if the qualified small business stock is acquired after February 17, 2009, and before September 28, 2010, and held for more than five years (but the alternative minimum tax preference applies).
The 2010 SBJA has amended §1202(a) to provide a very temporary 100% exclusion of the gain from the sale of qualified small business stock. All of the gain from qualified small business stock acquired after the date of enactment—September 27, 2010—and before January 1, 2011, is excluded. Moreover, the minimum tax preference does not apply to such stock. In other words, no regular tax or alternative minimum tax is imposed on the sale of this stock if it is held for at least five years.
Business Credit Carrybacks
Currently, small businesses are allowed to offset their income tax by a number of credits. Many of these credits are lumped together and form what is called the general business credit. The amount of the general business credit allowed for any tax year is limited to any excess of the taxpayer's net income tax over the taxpayer's unoffsetable income tax. The unoffsettable income tax equals the greater of two amounts. The first is the taxpayer's tentative minimum tax for the tax year. The second is 25% of the taxpayer's excess net regular tax liability, which is the excess, if any, of the taxpayer's net regular tax liability over $25,000. Currently, general business credits in excess of this limitation may be carried back one year and forward up to 20 years.
For a business's first tax year beginning in 2010, Congress has extended the one-year carryback to 5 years for an eligible small business. Additionally, Congress has provided that this eligible small business credit may offset both regular and alternative minimum tax liability.
For these purposes, an eligible small business is a non-publicly traded corporation, or a partnership, if the average annual gross receipts of the entity for the three-tax-year period ending with the prior tax year does not exceed $50 million. For sole proprietors, this $50 million test is applied as if it were a corporation.
This provision will allow some eligible small businesses to take advantage of the general business credit at an accelerated rate, rather than possibly having to carry over the credits forward up to 20 years.
Additional §179 Expensing
For the last few years, Congress has increased the amount taxpayers are allowed to deduct in the year a depreciable asset is placed in service (the §179 deduction), in an attempt to spur economic activity. As 2010 began, the §179 deduction was limited to $250,000. This amount, however is reduced by the amount by which the cost of §179 property placed in service during the year exceeds a certain threshold amount. For 2010, the threshold amount was set at $800,000.
Congress has increased both the §179 amount and the corresponding threshold amount for both 2010 and 2011. For 2010 and 2011, the §179 amount is increased to $500,000, and the phase-out, or threshold amount is increased to $2 million. This may provide you with some planning opportunities.
Congress has also temporarily expanded the definition of property qualifying for §179 to include certain real property - specifically, qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. The maximum amount that may be expensed for such real property is $250,000. If it's advantageous to your particular situation, however, you can elect to exclude real property from the definition of §179 property.
Additional First Year Depreciation
In addition to allowing a greater §179 deduction, Congress is also extending the additional 50% first-year bonus depreciation deduction into 2010. The extension applies for qualified property acquired and placed in service during 2010 (or placed in service during 2011 for certain long-lived property and transportation property). With this change, first-year depreciation limitations on automobiles is increased by $8,000. Therefore, for 2010, the first-year depreciation deduction for business cars placed in service in 2010 is $11,060.
Additional $5,000 for Start-Up Expenditures
Generally, you can elect to deduct up to $5,000 of start-up expenditures in the taxable year in which an active trade or business begins. However, the $5,000 amount is reduced (but not below zero) by the amount by which the cumulative cost of start-up expenditures exceeds $50,000. Start-up expenditures are amounts that would have been deductible as trade or business expenses, had they not been paid or incurred before a business began.
For tax years beginning in 2010, Congress has increased the amount of start-up expenditures a taxpayer can elect to deduct from $5,000 to $10,000 and increases the deduction phase-out threshold such that the $10,000 is reduced (but not below zero) by the amount by which the cumulative cost of start-up expenditures exceeds $60,000.
Cell Phones No Longer Considered Listed Property
As you may know, in the last few years, the IRS has taken a keen interest in the business use of cell phones (and other similar telecommunications equipment). Both employers and sole proprietors have been subject to heightened substantiation requirements. Additionally, if the use of a cell phone is less than 50% business, then the taxpayer may receive less of a depreciation deduction in the earlier years of the phones use.
Congress has lessened the burden on taxpayers by removing cell phones (and other similar telecommunications equipment) from the definition of “listed” property.
Thus, for tax years beginning after December 31, 2009, the heightened substantiation requirements and special deprecation rules no longer apply to this equipment. If this is of particular concern to you, you may want to schedule an appointment so that we can discuss the new rules and the current substantiation requirements.
Temporary Reduction in Recognition Period for S Corporation Built-in Gains Tax
S corporations are generally exempt from all federal income taxes. However, a “built-in gains tax” is imposed on an S corporation's “net recognized built-in gain” for any year during a “recognition period” beginning with its first day as an S corporation. The recognition period is generally 10 years. The net recognized built-in gain for any year is the lesser of (a) the corporation's recognized built-in gains (i.e., all items of income or gain recognized during the recognition period that are attributable to prior C corporation years) over recognized built-in losses for the year, or (b) the corporation's taxable income for the year (generally computed as if the corporation were still a C corporation). Recognized built-in gain subject to tax is generally presumed to include any gain recognized by the S corporation on the disposition of any asset during the recognition period, although this presumption may be rebutted by establishing that either the asset was not held by the corporation on the conversion date or that some or all of the gain exceeded the unrealized gain in the asset on the conversion date. If the corporation's net recognized built-in gain (once it is computed) is less than taxable income, the net recognized built-in gain amount is subject to tax at a flat 35% rate. In contrast, if taxable income is less, only that amount is subject to tax. For any taxable year beginning in 2009 or 2010, the recognition period is temporarily shortened from 10 years to seven years.
The 2010 SBJA shortens the recognition period even further, to five years, for taxable years beginning in 2011. In other words, a calendar-year corporation that used to be a C corporation but has been an S corporation beginning with its 2006 tax year can sell its built-in gain assets in 2011 without incurring the built-in gains tax.
Disregard of Bonus Depreciation in Computing Percentage Completion
The taxable income from a “long-term contract” is generally determined under the “percentage-of-completion method.” A “long-term contract” is a building, installation, construction, or manufacturing contract that is not completed in the same taxable year in which it is entered into. Under the “percentage-of-completion method,” a taxpayer determines the amount of income to be recognized in a taxable year by using a two-step process. First, the taxpayer multiplies the total amount of revenue that the taxpayer expects to receive from the contract by the cumulative percentage of the contract that has been completed by year end. Second, the taxpayer subtracts from this result the amount of contract revenue included in income in all preceding years. The cumulative percentage of the contract that has been completed is equal to the ratio of (a) the cumulative costs allocable to the contract incurred in the current, and all preceding, taxable years to (b) the total expected costs allocable to the contract. Costs allocable to the contract are deductible in the year incurred, regardless of the taxpayer's overall method of accounting.
As discussed above, the 2010 SBJA extends the additional 50% first-year bonus depreciation deduction into 2010. The 2010 SBJA also adds a subsection to §460(c), providing that—solely for purposes of determining the percentage of completion—the cost of “qualified property” is taken into account as a cost allocated to the contract as if bonus depreciation had not been enacted. “Qualified property” for this purpose is property otherwise eligible for bonus depreciation that has a MACRS recovery period of seven years or less and that is placed in service during 2010 (or, in the case of §168(k)(2)(B) longer-production-period property, during 2010 or 2011).
Modification of Penalty for Failure to Disclose Certain Information
The reporting requirements regarding tax shelters create interlocking disclosure obligations for both taxpayers and advisors, and parallel penalty provisions. Under §6707A, a harsh, strict liability penalty applies to a failure to disclose a “listed transaction” or an otherwise “reportable” transaction. For listed transactions, the maximum penalty is $100,000 for natural persons ($200,000 for all other persons (e.g., corporations). For reportable transactions other than listed transactions, the maximum penalty is $10,000 for natural persons ($50,000 for all other persons). Unlike other penalties, the IRS Commissioner (or his delegate) can rescind (or abate) the penalty only if rescinding the penalty would promote compliance with the tax laws and effective tax administration, and such determinations are not subject to judicial review.
The 2010 SBJA changes the general rule for determining the amount of the applicable penalty to better achieve proportionality between the penalty and the tax savings that were the object of the transaction, retains the current penalty amounts as the maximum penalty that may be imposed, and establishes a minimum penalty. Accordingly, under a new general rule, a participant in a reportable transaction who fails to disclose as required under §6011 is subject to a penalty equal to 75% of the reduction in tax reported on the participant's income tax return as a result of participation in the transaction, or that would result if the transaction were respected for federal tax purposes. The maximum annual penalty that a taxpayer may incur for failing to disclose a particular reportable transaction (other than a listed transaction) is $10,000 in the case of a natural person ($50,000 for all other persons). The maximum annual penalty that a taxpayer may incur for failing to disclose a listed transaction is $100,000 in the case of a natural person ($200,000, for all other persons). The 2010 SBJA also establishes a minimum penalty — $5,000 for natural persons ($10,000 for all other persons).
The changes made by the 2010 SBJA apply to all penalties assessed under §6707A after December 31, 2006; thus, refund opportunities may arise for penalties already assessed.
Information Reporting for Rental Property Expense Payments
Under the 2010 SBJA, recipients of rental income from real estate generally will be subject to the same information reporting requirements as taxpayers engaged in a trade or business. Effective for payments made after December 31, 2010, rental income recipients making payments of $600 or more to a service provider (e.g., a plumber, painter, or accountant) in the course of earning rental income now will have to provide a Form 1099-MISC to the IRS and to the service provider. The IRS will issue regulations providing exceptions to the reporting requirement for (1) members of the military or employees of the intelligence community who rent their principal residence on a temporary basis; (2) individuals receiving only minimal amounts of rental income; and (3) individuals for whom the requirements would cause a hardship.
Increase in Information Return Penalties
Effective with respect to information returns that must be filed on or after January 1, 2011 (i.e., 2010 information returns), the 2010 SBJA revises the §6721 penalty for failure to file a correct information return by:
• increasing the first-tier penalty from $15 to $30 per return, and increasing the calendar year maximum from $75,000 to $250,000;
• increasing the second-tier penalty from $30 to $60 per return, and increasing the calendar year maximum from $150,000 to $500,000;
• increasing the third-tier penalty from $50 to $100 per return, and increasing the calendar year maximum from $250,000 to $1,500,000; and
• Increasing the minimum penalty for each failure due to intentional disregard from $100 to $250 per return.
For small business filers, the 2010 SBJA also increases the calendar year maximum from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The 2010 SBJA also revises the §6722 penalty for failure to furnish a payee statement to provide tiers and caps similar to those applicable to the §6721 — i.e., a first-tier penalty of $30 per statement, subject to a calendar year maximum of $250,000; a second-tier penalty of $60 per statement, subject to a calendar year maximum of $500,000, and a third-tier penalty of $100 per statement, subject to a calendar year maximum of $1,500,000. The §6721 penalty is also revised to provide limitations on penalties for small businesses and increased penalties for intentional disregard that parallel the §6721 penalty for failure to furnish information returns.
Continuous Levy Extended to Employment Tax Liability of Certain Federal Contractors
Under the IRS's Federal Payment Levy Program (FPLP), the IRS can continuously levy up to 15% of government payments to federal contractors that are delinquent on their tax obligations. The levy generally continues in effect until the liability is paid or the IRS releases the levy. Before levying, the IRS provides the delinquent taxpayer with notice and opportunity for a collection due process (CDP) hearing. Effective for levies issued after September 27, 2010, the 2010 SBJA will now allow the IRS to impose the levy before a CDP hearing occurs.
Adjustment to 2015 Estimated Tax Payment by Corporations with at Least $1 Billion in Assets
In the case of a corporation with assets of at least $1 billion (determined as of the end of the preceding taxable year), the estimated tax payments due in July, August or September, 2015, currently are increased to 123.25% of the payment otherwise due (with the next required payment reduced accordingly). The 2010 SBJA has now increased the required payment percentage for 2015 payments by 36 percentage points to 159.25% of the payment otherwise due (with the next required payment reduced accordingly).
We would be happy to discuss your particular situation with regards to any of the legislative changes discussed above.