The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for small business, paid for with various revenue raisers. Here’s a brief overview of the tax changes in the new law.
Enhanced Small Business Expensing (Section 179 Expensing) – To help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Jobs Act law, taxpayers could expense up to $250,000 of qualifying property-generally, machinery, equipment and certain software-placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000.
The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
100% Exclusion of Gain from the Sale of Small Business Stock for Qualifying Stock Acquired After Date of Enactment and Before January 1, 2011 – Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don’t exceed $50 million, and the corporation must meet active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011. Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after date of enactment and held for more than five years. In addition, the new law eliminates the alternative minimum tax (AMT) preference item attributable for that sale.
If you are considering investing in a small business, We would be happy to work with you to determine whether the new total exclusion for QSBS would work to your advantage. However, it should be noted that while the new provision for QSBS is ostensibly intended to encourage investment in small businesses, it may be less effective in that regard than desired, due to the restrictions on obtaining the total exclusion, specifically: (1) the narrow window within which the small business stock must be purchased (i.e., between date of enactment and the end of 2010); (2) the long holding period requirement for QSBS (the stock must he held for at least five years); and, most importantly, (3) the fact that the tax break only applies to investments in C corporations, a form of business organization that is not often used by small businesses.
General Business Credits of Eligible Small Businesses for 2010 Allowed to be Carried Back Five Years – Generally, a business’s unused general business credits can be carried back to offset taxes paid in the previous year, and the remaining amount can be carried forward for 20 years to offset future tax liabilities. Under the new law, for the first tax year of the taxpayer beginning in 2010, eligible small businesses can carry back unused general business credits for five years. Eligible small businesses consist of sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.
General Business Credits of Eligible Small Businesses in 2010 Not Subject to AMT – Under the AMT, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.
S Corporation Holding Period Temporarily Shortened – Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built-in gain at the highest corporate rate of 35%. This holding period is reduced where the 7th tax year in the holding period preceded the tax year beginning in 2009 or 2010. The 2010 Small Business Jobs Act temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th tax year in the holding period precedes the tax year beginning in 2011.
Extension of 50% Bonus First-Year Depreciation – Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).
Special Rule for Long-Term Contract Accounting – The new law provides that in determining the percentage of completion under the percentage of completion method of accounting, bonus depreciation is not taken into account as a cost. This prevents the bonus depreciation from having the effect of accelerating income.
If you’ve recently started a business, or if you’re in the process of starting one now, you should be aware of a recent tax law change that could make a big difference in your tax bill. The recently enacted 2010 Small Business Jobs Act doubles the amount of start-up expenses that someone starting a business in 2010 can write off this year. Here are the details.
Generally, expenses incurred before a business begins don’t generate any deductions or other current tax benefits. However, under pre-2010 Small Business Jobs Act law, taxpayers, whether they were individuals, corporations or partnerships, were permitted to elect to write off up to $5,000 of “start-up expenses” in the year business began, and the rest could be deducted over a period of 180 months. The $5,000 figure was reduced by the excess of total start-up costs over $50,000. You were deemed to have made this election unless you opted out.
The new law doubles the amount that can be written off for 2010 to $10,000 and increases the phase-out threshold from $50,000 to $60,000. It is important to note that this increased deduction is temporary, and only applies to tax years beginning in 2010.
Start-up expenses include, with a few exceptions, all expenses incurred to investigate the creation or acquisition of a business, to actually create the business, or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a startup expense is the cost of analyzing the potential market for a new product.
It is important to keep a record of these start-up expenses, and to make the appropriate decision regarding the write-off election. As mentioned above, if you opt out of the election, there is no current tax benefit derived for the eligible expenses covered by the election. Also, you should be aware that an election either to deduct or to amortize start-up expenditures, once made, is irrevocable.
Limitation on Penalty for Failure to Disclose Certain Reportable Transactions (including listed transactions) on a Return – The new law limits the penalty to 75% of the decrease in tax resulting from the transaction. The minimum penalty is $10,000 for corporations and $5,000 for individuals (for failure to report a listed transaction, the maximum penalty is $200,000 and $100,000, respectively). These changes are retroactively effective to penalties assessed after Dec. 31, 2006.
Deductibility of Health Insurance for the Purpose of Calculating Self-Employment Tax – The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
Generally, business owners can’t deduct the cost of health insurance for themselves and their family members for purposes of calculating self-employment tax. The new law allows business owners to deduct health insurance costs incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
At issue is the 15.3% tax that self-employed individuals pay on their net earnings, commonly referred to as self-employment tax. Since 2003, self-employed individuals have been allowed to deduct the cost of health insurance for income tax purposes. While this change enabled small-business owners to deduct the cost of health care from their income, that income already had been exposed to self-employment tax. Thus, the self-employed effectively paid self-employment tax on income used to purchase health care. The new legislation allows the self-employed to deduct their health insurance premiums on their self-employment tax as well as their income tax. For now, the change is limited only to the 2010 tax year.
Cell Phones Removed from Listed Property Category – This means that cell phones can be deducted or depreciated like other business property, without onerous recordkeeping requirements. Since 1989 (shortly after the first cell phones were introduced), employers and employees have been required to keep a detailed log of business and personal use on employer-provided cellular telephones and similar mobile communication devices to substantiate costs that were allowable as business expenses. In tax parlance, cell phones were included in the category of “listed property” (i.e., items obtained for use in a business but which lend themselves easily to personal use) and thus were subjected to strict substantiation rules. Employers who failed to meet the substantiation requirements couldn’t deduct the costs of the cell phones, and employees who failed to meet the substantiation rules saw the amount that represented personal use of the cell phone counted as taxable wages (instead of a tax-free working condition fringe benefit).
The new legislation removes cell phones and similar telecommunications equipment (including PDAs and Blackberry devices) from the “listed property” rules. This makes it easier for employers that provide cell phones to employees, as well as for employee who use their own cell phones. As with other business property, taxpayers must still be able to demonstrate the business use of the cell phone.
The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. To offset a portion of the cost of the various tax breaks and incentives in the Act, Congress beefed up certain reporting requirements and penalties, in the hope that the added requirements will generate revenue and lead to more effective tax collection. Here are the details of the new reporting requirements.
Information Reporting Required for Rental Property Expense Payments – For payments made after Dec. 31, 2010, the new law requires persons receiving rental income from real property to file information returns with IRS and service providers reporting payments of $600 or more during the tax year for rental property expenses. Exceptions are provided for individuals renting their principal residences on a temporary basis (including active members of the military), taxpayers whose rental income doesn’t exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under IRS regulations).
Increased Information Return Penalties (effective for information returns required to be filed after Dec. 31, 2010). For example, the first-tier penalty will be increased from $15 to $30, and the calendar year maximum will be increased from $75,000 to $250,000. For small filers, the calendar year maximum will be increased from $25,000 to $75,000 for the first-tier penalty. The minimum penalty for each failure due to intentional disregard will be increased from $100 to $250. The penalties for failure to file information returns to payees will be similarly increased.
Allow Participants in Governmental 457 Plans to Treat Elective Deferrals as Roth Contributions – For tax years beginning after December 31, 2010, the new law will allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include designated Roth accounts. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free. The changes are designed to give increased flexibility in retirement preparation while generating immediate revenue for the government.
Allow Rollovers from Elective Deferral Plans to Designated Roth Accounts – The new law allows 401(k), 403(b), and governmental 457(b) plans to permit participants to roll their pre-tax account balances into a designated Roth account. The amount of the rollover will be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans will be able to allow these rollovers immediately as of date of enactment.
Nonqualified Annuity Contracts – The new law permits holders of nonqualified annuities (annuity contracts held outside of a qualified retirement plan or IRA) to elect to receive part of the contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis.
Please keep in mind that we have described only the highlights of the most important changes in the new law. If you would like more details about any aspect of the new legislation, please do not hesitate to call.