On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010 (SBJA or “the Act”). Despite its title, the Act’s provisions impact businesses of many sizes. There are also implications for individual taxpayers in investor capacities and in retirement planning. Most of the provisions build upon existing law by extending, and in some cases expanding, current incentives.
Under prior law, a 50% bonus depreciation deduction was allowed for qualifying MACRS property, generally new property with a recovery period of 20 years or less. The provision expired at the end of 2009, but now has been extended to include property placed in service before January 1, 2011. Additionally, certain property with long production periods and transportation property, including certain aircraft, qualify if placed in service before January 1, 2012. Bonus depreciation also applies to qualified leasehold improvements. The property must not be predominantly used outside the U.S. in order to qualify. The deduction is allowed in full for AMT purposes.
To illustrate the benefits of bonus depreciation, assume that a taxpayer purchases and places in service computers (five year property) in 2010, costing $2,000,000. Absent bonus depreciation, the depreciation deduction would be $400,000. With the bonus, the deduction would increase to $1,200,000, or 60% of the cost of the property.
Unlike Code Section 179 expensing, bonus depreciation is not limited by a deduction cap or overall investment cap. This makes the extension of bonus depreciation one of the provisions of the Act that is applicable to businesses of all sizes. Over half of the cumulative tax relief in the Act comes from this single provision.
Section 179 Expense Election
Code Section 179 allows for an election to deduct the cost of certain property instead of capitalizing and depreciating it. Under prior law, the amount of annual expense was limited to $250,000 and was reduced dollar for dollar for the amount of Code Section 179 property placed in service in excess of $800,000. The allowed expense amount and the investment limitation of $250,000 and $800,000, respectively, were scheduled to revert to prior levels of $25,000 and $200,000 in 2011. The Act, however, increases the allowed expense amount and the investment limitation to $500,000 and $2,000,000, respectively, for years beginning in 2010 and 2011.
In addition to extending and increasing the Code Section 179 deduction, the Act temporarily expands the definition of Code Section 179 property to include certain qualified real property. While the deduction has traditionally been limited to tangible
personal property and computer software, the Act allows a deduction for qualified leasehold improvements, qualified restaurant property, and qualified retail improvements (collectively, qualified real property). The allowed Code Section 179 expense amount for qualified real property is $250,000, and any expense claimed with respect to qualified real property will be applied to the overall expense limitation of $500,000. If a taxpayer’s investment in qualified real property causes them to exceed the investment limitation of $2,000,000, the taxpayer may elect to exclude qualified real property from the definition of Code Section 179 property.
The expense election is calculated prior to, and in addition to, bonus depreciation. For example, the combined expense deduction, bonus deduction, and regular depreciation deduction amounts to 80% for a $1,000,000 eligible five-year asset placed in service in 2010.
Built-in Gains Tax Holding Period for S Corporations – Reduced
S corporations that converted from C corporations or acquired assets from C corporations in a nontaxable carryover basis transfer are generally subject to a corporate level tax (at a top rate of 35%) on the built-in gains when those assets are sold. This built-in gains tax generally applies for a recognition period of 10 years from the date the C corporation converted to S corporation status. Prior changes to the law temporarily reduced the recognition period to seven years for asset sales subject to the built-in gains tax in tax years beginning in 2009 and 2010. The Act further reduces the recognition period to five years for asset sales subject to the built-in gains tax in tax years beginning in 2011, but only if the fifth year in the recognition period has already occurred prior to 2011.
Extended Carry Back of General Business Credit and Removal of AMT Floor
For tax years beginning after December 31, 2009, the SBJA increases the carry back period from one year to five years for eligible small business credits generated by eligible small businesses. An eligible small business is defined as a non-publically traded corporation, a partnership or a sole proprietorship with average annual gross receipts of $50 million or less over the three year period immediately preceding the current tax year. The new legislation contains special rules for short tax years and companies less than three years old.
The credits eligible for the extended carry back period are listed in section 38 of the Internal Revenue Code and include the energy credit, the credit for increasing research activities, the work opportunity credit, and the small employer health insurance credit, among many others.
Perhaps the biggest change affecting small businesses from this provision is the removal of the AMT floor when determining credit utilization. For tax years ending before January 1, 2010, the credit was taken against a taxpayer’s regular tax liability only to the extent of alternative minimum tax. Under the new legislation the eligible business credits can be used to offset the entire tax liability.
Enhanced Start-up Expense Deduction
For tax years beginning in 2010 only, the Act has increased the current deduction attributed to start-up expenses from $5,000 to $10,000, subject to a dollar for dollar phase out. The dollar for dollar phase out has increased from $50,000 to $60,000. Accordingly, if start up expenses total $60,000 or less, a full $10,000 can be deducted in 2010. Any costs not deducted are currently capitalized and amortized ratably over 180 months.
Information Reporting for Rental Property Expense Payments
Subject to certain exceptions, any person receiving rental income from real estate that in turn makes payments totaling $600 or more to a service provider must file appropriate information returns reporting such payments. This provision applies to payments made after December 31, 2010.
Higher Failure to File Penalties on Information Returns
Failure to file penalties for information returns have increased both on a per occurrence basis and on the maximum allowable penalty. The late filing penalties are segregated into three tiers based upon how late the forms are.
First-tier penalties are assessed against those taxpayers filing information returns no more than 30 days after the due date of such returns. The penalty has been increased from $15 to $30 per form with the maximum penalty increased from $75,000 to $250,000.
Second-tier penalties apply to returns filed more then 30 days late but before August 1. Penalties for these returns increased from $30 to $60 per form with the maximum penalty increasing from $150,000 to $500,000.
Lastly, third-tier penalties apply to taxpayers filing information returns after August 1. Such penalties increase from $50 to $100 per form with the maximum penalty increasing from $250,000 to $ 1.5 million.
Source Rules for Income on Guarantees
The new legislation introduces new sourcing rules attributable to guarantees of debt. Amounts received either directly or indirectly from a U.S. or foreign person for the guarantee of a debt is treated as U.S. source income, but only if effectively connected to the conduct of a U.S. trade or business.
Exclusion for Qualified Small Business Stock (QSBS) Gain
To encourage certain investments in small businesses, Code Section 1202 allows a taxpayer to exclude some of the gain on the ultimate sale of the investment. Under prior law, individuals could exclude 50% (75% if acquired after February 17, 2009, and before January 1, 2011) of the gain of QSBS held at least five years. The gain is taxed at a maximum regular tax rate of 28% and 7% of the excluded gain is an AMT preference. The amount of gain eligible for the exclusion (per issuer) is limited to the greater of (1) 10 times basis or (2) $10 million ($5 million if married filing separately).
The Act increases the exclusion from 75% to 100% for stock acquired after September 27, 2010, and before January 1, 2011. The Act also eliminates excluded gain as an AMT preference.
In addition to the five year holding period requirement for QSBS, certain other requirements must be met:
- Must be a C corporation acquired at original issuance;
- Corporation’s assets cannot exceed $50 million at time of issuance; and
- Corporation is engaged in the active conduct of a qualified trade or business (generally
excludes services, financing, hotel and restaurant businesses).
However, we emphasize that the excluded gain is no longer a tax preference under the provisions of the new law.
Health Insurance Deduction from Self Employment Income
Self-employed individuals will be able to deduct the cost of health insurance incurred for the taxpayer, his or her spouse and dependents under the age of 27 when calculating self-employment income. Under the new law, this benefit applies to the self-employed individual’s first tax year beginning after December 31, 2009, and is only good for one year. For purposes of calculating the health insurance deduction, the definition of earned income has remained the same.
Taxable Rollovers from Pre-Tax Retirement Accounts to Designated Roth Accounts
Beginning on September 27, 2010, the SBJA permits rollovers from pre-tax 401(k), 403(b) and 457(b) plans into designated Roth accounts within their plans. The rollover amount is taxable to the applicable employee, however, if amounts are rolled
over before the end of 2010 the plan participant can pay the tax ratably in 2011 and 2012. The new benefit complements the existing Roth IRA conversion rules currently in effect