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President Obama Signs Small Business Jobs Act Containing $12 Billion in Short-Lived Tax Incentives

Tax

By Ron Kramer

On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010, (H.R. 5297). In addition to $12 billion in tax incentives (some of which impact both small and large businesses) designed to provide capital and create jobs, the 2010 Jobs Act (The Act) creates the $30 billion Small Business Lending Fund Program to spur and encourage small banks to lend money to small businesses. The Act also increases the permitted size of Small Business Administration (SBA) loans from $2,000,000 to $5,000,000 and continues the 90% federal government guarantee of such loans through 2010 to provide capital to small business.

Many of the Act’s $12 billion of tax incentives are short-lived, most expiring at the end of 2010, but a few extending through 2011. For instance, the availability of bonus depreciation extends only through 2010, but the enhanced Section 179 expensing provisions are effective for taxable years beginning in 2010 and 2011.

Although dubbed the “Small Business” Jobs Act primarily because of the small business lending provisions, the scope of the Act’s tax incentives and revenue raisers impact businesses of all sizes, include retirement tax provisions affecting individual taxpayers and contain measures affecting international business transactions.

Will the business tax incentives have sufficient time to generate substantial economic activity and create jobs prior to their expiration? Can new machinery and equipment orders be completed and placed in service by the December 31, 2010 bonus depreciation expiration date? Is there sufficient demand to warrant new machinery and equipment orders at this time? Major uncertainties facing U.S businesses today, arising from current economic and social policies, could cause businesses to stay on the sidelines, with the result that the $12 billion of tax incentives goes underutilized and few jobs are created.

The tax incentives and revenue raisers contained in the new legislation are summarized below.

 

General Business Provisions

Bonus depreciation. The new law retroactively extends the business tax incentive for bonus depreciation for all of 2010. An additional first-year depreciation deduction equal to 50% of the adjusted basis of qualified property is available for property acquired and placed in service during all of 2010 (or placed in service during 2011 for certain longer-lived property and transportation property).

The new law also includes a special rule for the allocation of bonus depreciation for long-term contract purposes under Section 460(c) of the Internal Revenue Code. The 50% bonus depreciation on 2010 equipment purchases is not taken into account as a cost in applying the percentage of completion method. Thus, bonus depreciation will not have the effect of accelerating the reporting of income under the percentage of completion method for 2010.
Note: The bonus depreciation rule will apply to corporate aircraft ordered anytime after December 31, 2007 and before January 1, 2011 and placed in service before January 1, 2012.  Due to the short time remaining for 2010 bonus depreciation, new equipment has to be ordered and placed in service by December 31, 2010. Accordingly, you must act quickly to take advantage of the bonus depreciation extension for 2010.

Code Sec. 179 expensing. The new law increases the maximum amount a taxpayer may expense under Code Sec. 179 to $500,000 and raises the phase-out threshold to $2 million. The Enhanced Code Sec. 179 expensing is available for tax years beginning in 2010 and 2011. For 2011, the expensing limit and the phase-out threshold had been scheduled to return to $25,000 and $200,000, respectively; the enactment of this law supersedes that previously expected timeline.

The new law also allows taxpayers to expense qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. The maximum amount with respect to real property that may be expensed, however, is limited to $250,000 of the total $500,000 limitation, and certain limitations on carryovers apply.

Business autos. For 2010, first-year depreciation for business autos and light trucks is increased by $8,000 to $11,060 and $11,160, respectively.

Start-up expenditures. To encourage entrepreneurship, the new law increases the amount of start-up expenditures that a taxpayer may elect to deduct from $5,000 to $10,000 for tax years beginning in 2010 (i.e., for one year only). The new law also increases the deduction phase-out threshold so that the $10,000 is reduced, but not below zero, by the amount by which the cumulative cost of qualified start-up expenses exceeds $60,000.
Author’s Comment: The increased deduction for start-up costs is intended to provide after-tax cash flow for start-up businesses to hire more workers, but not many more.

S corporation built-in gains tax. A C corporation that converts to an S corporation generally must hold any appreciated assets for 10 years following the conversion or, if disposed of earlier, pay tax on the appreciation at the highest corporate tax rate (currently 35 percent). Previously, the American Recovery and Reinvestment Act of 2009 (ARRA) temporarily shortened the usual 10-year holding period to seven years for dispositions in tax years beginning in 2009 and 2010. The new law further shortens the holding period to five years in the case of any tax year beginning in 2011, if the fifth year in the recognition period precedes the tax year beginning in 2011.
Author’s Comment: This new provision will allow some S corporations to access capital tied up in appreciated assets without triggering the onerous double-tax effects of the built-in gains tax.

Cell phones. The new law removes cell phones from the definition of “listed property” for tax years beginning after December 31, 2009. Thus, the strict substantiation requirements for business use of the cell phone are gone.
Author’s Comment: The new law did not contain any guidance as to whether employer-provided cell phones could be treated as a working condition fringe benefit under Internal Revenue Code (IRC) Section 132(d), or that an employee’s personal use of a cell phone could be treated as a de minimis fringe benefit under IRC Section 132(e).

 

Small Business Provisions

Small business stock. IRC Section 1202 provides for a partial exclusion for gain from certain small business stock. To encourage investment in small businesses, the American Recovery and Reinvestment Act of 2009 (ARRA) had already temporarily increased the percentage exclusion for qualified small business stock acquired after February 17, 2009 and before January 1, 2011 to 75%. The new law raises the exclusion to 100% for qualified stock issued after the date of enactment and before January 1, 2011. The stock must be acquired at original issue from a qualified small business and held for at least five years. Also, the exclusion is not treated as a preference item for Alternative Minimum Tax (AMT) purposes.
Author’s Comment: Will this provision result in much benefit? The stock of an S corporation cannot qualify as “small business stock,” so many small businesses cannot take advantage of the exclusion for new shareholders. In addition, the provision is not likely to create jobs in the short term and will expire before many can take advantage of it.

General business credits. The new law extends the carryback period for eligible small business credits from one to five years. Eligible small business credits are defined for purposes of the new law as the sum of the general business credits determined for the tax year with respect to an eligible small business. An eligible small business is a corporation whose stock is not publicly traded; a partnership; or a sole proprietorship. Additionally, the average annual gross receipts of the corporation, partnership, or sole proprietorship for the prior three tax-year periods cannot exceed $50 million (Partners and S corporation shareholders must meet the same gross receipts test). The extended carryback provision is effective for credits determined in the taxpayer’s first tax year beginning after December 31, 2009.

Bonus: The new law also provides that general business credits of eligible small businesses in 2010 are not subject to the Alternative Minimum Tax (AMT). Thus, 2010 general business credits (such as R & D Tax Credit) can be used against both the regular tax and the AMT tax liability. A significant number of taxpayers are barred from taking advantage of the general tax credits because of AMT. Thus, use of 2010 tax credits can mean cash in your pocket. You should also note that carrybacks of 2010 credits can be applied against the regular tax and AMT tax liability for the carryback year.

Code Sec. 6707A penalty relief. The new law retroactively reforms the Code Sec. 6707A penalty regime for taxpayers failing to disclose participation in reportable and listed transactions. Generally, the penalty would equal 75% of the reduction in tax reported on the participant’s return as a result of the transaction, or that would result if the transaction was respected for federal tax purposes. Under the new law, the maximum penalty for an individual for failing to disclose a reportable transaction is $10,000 ($100,000 in the case of a listed transaction). The maximum penalty for all other taxpayers for failing to disclose a reportable transaction is $50,000, and $200,000 in the case of the listed transaction.

 

 

Provisions for Individuals 

Health insurance and self-employment tax. For computing self-employment taxes, a self-employed individual cannot deduct health insurance costs. For 2010 only, the new law allows the deduction for the cost of health insurance in calculating net earnings from self-employment for purposes of self-employment (FICA) taxes.

 

Retirement Savings Provisions

Designated Rollovers to Roth Accounts. Starting after the date of enactment, the new law permits 401(k), 403(b), and governmental 457(b) plans to permit certain participants to roll their pre-tax account balances into a Roth account. The rollover amount is subject to tax; however, for 2010, the participant can pay the tax on any amount rolled-over in equal installments in 2011 and 2012, unless the participant elects to pay all the tax in 2010.
Author’s Comments: For taxpayers who opt to pay the tax on a 2010 rollover in 2011 and 2012, a distribution of such rollover amounts or the death of the participant before 2012, results in acceleration of income. Also, unlike a rollover to a Roth IRA account, a designated Roth account is subject to the minimum distribution requirements.

Partial annuitization of annuity contracts. The new law allows for partial annuitization of a nonqualified annuity, endowment or life insurance contract. Holders of nonqualified contracts (annuity contracts held outside of a tax-qualified retirement plan or IRA) may elect to receive a portion 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. The annuity is considered a separate contract under IRC Section 72. The annuitization period must be for 10 years or more, or for the lives of one or more individuals. The annuitization provision in the new law is effective for amounts received in tax years beginning after December 31, 2010.
Author’s Comment: Under prior law, a taxpayer that wished to annuitize only a portion of an existing annuity contract and avoid the “income first” taxation rules would have to exchange a portion of an existing contract for a second smaller contract. Congress decided to eliminate the need for such exchange to allow taxpayers to access existing annuity, endowment and life insurance contracts for retirement payments. Check with your financial advisor or the providers of such contracts to determine how the new tax provisions will be administered for your contracts.

Roth designated contribution programs for government retirement savings plans. Beginning in 2011, retirement savings plans sponsored by state and local governments (457 plans) may allow participants to designate elective deferrals as Roth contributions. Tax-exempt employers that qualify as eligible employers for Code Sec. 457 purposes were not included in this expansion of designated Roth contribution programs.

 

 

Revenue Raisers

Rental property expense payments. The new law imposes information reporting requirements on certain recipients of rental income from real estate. These recipients are now considered to be engaged in the trade or business of renting property. Rental income recipients making payments of $600 or more to a service provider must file an information return with the IRS and the service provider. The new law permits the IRS to exclude by regulation individuals for whom reporting would be a hardship and individuals who receive only minimal amounts of rental income from the requirement. Certain members of the military and intelligence services are also excluded. The reporting provision applies to payments made after December 31, 2010.
Author’s Comment: Congress has passed a number of new information reporting (Form 1099) requirements in recent months aimed at closing the “Tax Gap.” Congress has the perception that third-party reporting increases tax compliance. New 1099 reporting for payments made to corporations and vendors enacted in the Health Care legislation is also scheduled to go into effect for 2011.

Increase in information return penalties. The following information return penalties are increased under the new law: (1) the first-, second- and third-tier penalties for failure to file a correct return in a timely manner; (2) the reduced three-tier penalties for failure by a small business to file a correct return in a timely manner; and (3) the enhanced penalty for intentional disregard of a filing requirement. In addition, penalties for failure to furnish a correct payee statement in a timely manner are increased, and the structure of the penalty has been changed to resemble that of the penalty for failure to file a correct return in a timely manner. Also, for both penalties, the penalty amounts will be subject to inflation adjustments every five years. The new penalties apply for information returns required to be filed on or after January 1, 2011.

1.   Failure to file correct information return by August 1 of any year:

 

Old

New

Per return

$50

$100

Maximum aggregate penalty

$250,000

$1,500,000

Small business aggregate penalty

$100,000

$500,000

2.   Correction within 30 days of filing date:

 

Old

New

Per return

$15

$30

Maximum aggregate penalty

$75,000

$250,000

Small business aggregate penalty

$25,000

$75,000



3.   Correction after filing date but on/or before August 1 of any year:

 

Old

New

Per return

$30

$60

Maximum aggregate penalty

$150,000

$500,000

Small business aggregate penalty

$50,000

$200,000



The minimum penalty for failure to file a correct information return that is due to intentional disregard of a filing requirement is increased from $100 to $250.

Failure to furnish correct payee statement. The structure of the penalties for failure to furnish a correct payee statement in a timely manner has been changed to resemble that of the three-tier penalties for failure to file a correct information return in a timely manner, including reduced maximum penalties for “small businesses.” The penalty amounts are the same. The enhanced penalty for failure to furnish a correct payee statement that is due to intentional disregard of the rules increases from $100 to $250.

The definition of “small businesses” for purposes of the revised penalties is firms with gross receipts of not more than $5 million.

Federal contractors. The new law allows the IRS to issue continuous levies for a federal contractor’s unpaid federal tax liabilities before a collection due process (CDP) hearing. The provision is effective for levies issued after the date of enactment. A post-levy notice must be sent to the contractor, which will allow the contractor to appeal the levy.
Author’s Comment: This process ensures that when the federal government is the customer, payments are not being made to contractors with outstanding tax liabilities. The IRS can levy the payments and apply them to the contractor’s IRS account.

International tax – sourcing rules for income on guarantees. The U.S. Tax Court, in Container Corp v. Commissioner, recently rejected IRS arguments that fees paid by a domestic corporation to its foreign parent with respect to guarantees issued by the parent for the debts of the domestic corporation were analogous to interest. The Tax Court held that the payments were more closely analogous to compensation for services, and determined that the source of the fees should be determined by reference to the residence of the foreign parent-guarantor. As a result, the income was treated as income from foreign sources.

The new law, in effect, provides a legislative override of the opinion in Container Corp. v. Commissioner, supra, by amending the source rules of IRC Sections 861 and 862 to address income from guarantees issued after the date of enactment. Under new section 861(a)(9), income from sources within the United States includes amounts received, whether directly or indirectly, from a non-corporate resident or a domestic corporation for the provision of a guarantee for indebtedness of such person.
Author’s Comment: This provision is another in a series of tax provisions attacking perceived abuses by U.S. corporations conducting business abroad.

Cellulosic biofuel producer credit. The new law makes crude tall oil and certain other substances, which are largely generated as byproducts of paper manufacturing, ineligible for the cellulosic biofuel producer credit. The new limitations on the cellulosic biofuel producer credit are effective for fuels sold or used on or after January 1, 2010.

Corporate estimated tax payments. The new law increases the required payment of estimated tax by large corporations (with assets of at least $1 billion) by 36 percentage points for July, August, or September 2015. The next required installment is proportionately reduced to reflect the increase. Thus, the estimated tax payment required to be made by certain large corporations in July, August, or September of 2015 has been increased to 159.25% of the amount otherwise due.
Author’s Comment: Congress uses this avenue to shift revenues from one fiscal year to another (the federal government’s fiscal year begins October 1) in order to meet Federal budget requirements.


Summary and Conclusions

It remains to be seen if the tax incentives contained in the Small Business Jobs Act of 2010 will have a significant impact on economic activity and job creation. The combination of the late enactment of the legislation, the short lifespan of the tax incentives, and Congress’ decision not to consider extending the Bush tax cuts before the mid-term election, could cause the Act to fall far short of the Administration’s expectations for aiding economic recovery.

 

 

Schneider Downs provides accountingtax, wealth management and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh, PA and Columbus, OH. 

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

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