Tax Incentives and Revenue Raisers in the Small Business Jobs Act of 2010
On September 27, the “Small Business Jobs Act of 2010” (the “Jobs Act”) was signed into law by President Obama. No further tax legislation is expected from Congress until after the Fall election, if at all. Hence, action on the expiration of the Bush-era tax cuts, important corporate tax credits and relief from the Alternative Minimum Tax remain in flux. Importantly, estate tax rates will go up and the estate tax exemption (technically called the “applicable exclusion amount”) will go down dramatically if Congress fails to act during the lame duck session. Congressional deadlock during the lame duck session is a distinct possibility.
The Jobs Act extends bonus depreciation; extends, expands and doubles expensing under Code § 179; provides for a 100% gain exclusion for “small business stock”; liberalizes the S corporation built-in gain rules; extends the carryback period for eligible small business credits to five years; removes cell phones from “listed property”; enhances the deduction for startup expenses; and allows a self-employment tax deduction for 2010 health insurance costs. Revenue raisers include allowing active participants in 401(k) and other plans to rollover existing balances to a designated Roth account under the plan; increasing failure-to-file penalties on information returns; new 1099 reporting for rental property expenses; streamlined tax levies on delinquent federal contractors; and accelerated estimated tax payments for certain large corporations. Notably, the Jobs Act does not include any tightening of rules governing grantor retained annuity trusts (“GRATs”); hence GRATs established by high net worth individuals remain attractive options for gift tax-free shifting of wealth, at least for the time being.
Here are highlights of the Jobs Act’s incentives:
Dollar amounts for expensing under § 179 liberalized. For tax years beginning in 2010, the Jobs Act increases the maximum Code § 179 expensing amount from $250,000 to $500,000 and the beginning-of-phaseout amount from $800,000 to $2,000,000. For tax years beginning in 2011, the same $500,000 maximum expensing amount and $2,000,000 beginning-of-phaseout amount will apply even though, under pre-2010 Jobs Act law, those amounts had been scheduled to revert to $25,000 and $200,000, respectively.
Qualified real property expensing under § 179. For any tax year beginning in 2010 or 2011, for the first time under federal tax law, a taxpayer also can elect to treat up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) as expensing-eligible property. (Certain types of property, such as that used for lodging, would not be eligible). The dollar cap applies to the aggregate cost of qualified real property. This change applies to property placed in service after December 31, 2009, in tax years beginning after that date.
However, no amount attributable to qualified real property can be carried over to a tax year beginning after 2011, but to the extent that any amount cannot be carried over to a tax year beginning after 2011, the Code will be applied as if no Code § 179 expensing election had been made for that amount.
Other expensing changes. The Jobs Act also provides that a taxpayer’s ability to revoke a Code § 179 election without IRS consent applies to any tax year beginning after 2002 and before 2012 (instead of before 2011, as under pre-Jobs Act law). Additionally, computer software is qualifying property for purposes of the Code § 179 election if it is placed in service in a tax year beginning after 2002 and before 2012 (instead of before 2011, as under pre-Jobs Act law).
Planning Pointer. A taxpayer may also elect to exclude otherwise qualified real property from the definition of Code § 179 property. That election may allow a taxpayer to avoid the phaseout or elimination of expensing if the regular $2,000,000 eligible property cap is otherwise close to being reached.
Bonus depreciation. The Jobs Act extends, through December 31, 2010, 50% first-year bonus depreciation, which otherwise expired on December 31, 2009. The extension is retroactive to January 1, 2010. The Jobs Act also extends, through 2011, the additional year of bonus depreciation allowed for property with a recovery period of 10 years or longer, and for transportation property (tangible personal property used to transport people or property). Bonus depreciation is not limited by the size of the business, unlike practical access to Code § 179 “small business” expensing. The bonus depreciation provision is by far the most expensive single tax break in the Jobs Act, weighing in at $5.4 billion over 10 years, but carrying an initial cost of $29.5 billion in its first two years because of accelerated depreciation that would otherwise be deducted in later years.
Planning Pointer. Bonus deprecation under the Jobs Act carries a very short window of opportunity — qualifying equipment must be purchased and placed into service on or before December 31, 2010.
Long-term contracts. The Jobs Act also decouples bonus depreciation from allocation of contract costs under the percentage of completion accounting method rules for assets with a depreciable life of seven years or less. This change allows contractors to benefit from bonus depreciation even if they do not complete their contracts within the same year.
First year dollar cap for auto depreciation increased by $8,000. The limitation under the Code on the amount of depreciation deductions allowed with respect to certain passenger automobiles is increased in the first year by $8,000 for automobiles that qualify and for which the taxpayer does not elect out of the additional first-year deduction. For 2010, therefore, maximum first-year depreciation for passenger automobiles used for business is $11,060.
Deduction for startup expenses increases. For tax years beginning in 2010, the deduction for startup expenses under Code § 195 is increased from $5,000 to $10,000 and the phaseout threshold is increased from $50,000 to $60,000.
Cell phones no longer listed property. The Jobs Act removes cell phones and similar personal communication devices from their current classification as listed property under Code § 280F, thereby lifting the strict substantiation requirements of use and the additional limits placed on depreciation deductions. In addition, the provision enables the fair market value of personal use of a cell phone or other similar device provided to an employee predominantly for business purposes to be excluded from the employee’s gross income.
Planning Pointer. “Listed property” designation was imposed on cell phones when they were novel, expensive, and not widely owned. Today, not only are cell phones widely available and used, but also necessary for doing business.The IRS Commissioner announced in January 2010 that the IRS would call a temporary halt to enforcing strict substantiation on cell phone use until Congress makes good on its leadership’s promise to pass remedial legislation. The Jobs Act’s relief provision applies to tax years beginning after December 31, 2009.
Five-year carryback of small business unused general business credits. The general business credit (GBC) generally can’t exceed: (1) the excess of a taxpayer’s net income tax over the greater of the taxpayer’s tentative minimum tax; or (2) 25% of so much of the taxpayer’s net regular tax liability as exceeds $25,000. Credits in excess of this limitation may be carried back one year and forward up to 20 years. The Jobs Act extends the carryback period from one to five years for eligible small business (ESB) credits determined in tax years beginning on or after January 1, 2010.
ESB credits, for a tax year beginning in 2010, include all of the component credits of the GBC, but only as determined with respect to eligible small businesses (ESBs). ESBs are businesses that (1) are corporations, the stock of which isn’t publicly traded, partnerships or sole proprietorships and (2) have average annual gross receipts, for the three-tax-year period preceding the tax year, of no more than $50 million.
ESB credits not subject to AMT. For ESB credits determined in tax years beginning in 2010, ESBs, as defined above for purposes of the longer credit carryback, may use all types of general business credits to offset their Alternative Minimum Tax (AMT). Hence, an ESB credit can offset both regular tax and AMT liability.
100% exclusion for gain from qualified small business stock. The 2009 Recovery Act temporarily increased the Code § 1202 percentage exclusion for “qualified small business stock” sold by an individual from 50% to 75% for stock acquired after February 17, 2009 and before January 1, 2011, and held for more than five years. The Jobs Act raises the exclusion to 100% for gain on stock acquired after September 27, 2010 and before January 1, 2011. Under the Jobs Act, the excluded gain will not count as an AMT preference item but the five-year holding period continues to apply.
Planning Pointer. To be eligible for the exclusion both prior to and under the Jobs Act, an individual must generally acquire the small business stock at its original issue (directly or through an underwriter) for money, for property other than stock, or as compensation for services. When the stock is issued, the aggregate gross assets of the issuing corporation may not exceed $50 million. In addition, the corporation also must use at least 80% of the value of its assets in the active conduct of one or more qualified trades or businesses. The stock or eligible replacement must be held for at least five years. Under limitations already in effect, the amount of gain eligible for the 100% exclusion by an individual with respect to any corporation is capped at the greater of (1) 10 times the taxpayer’s basis in the stock or (2) $10 million.
Reduced recognition period for S corp built-in gains tax. Where a regular or C corporation elects to become an S corporation (or where an S corporation receives property from a C corporation in a nontaxable carryover basis transaction), the S corporation is taxed at 35% on all gains that were built-in at the time of the election if the gains are recognized during a 10 year period generally following the S election (“recognition period”) or transfer date from a C corporation. For tax years beginning in 2009 and 2010, no tax is imposed on the net unrecognized built-in gain of an S corporation if the seventh tax year in the recognition period preceded the 2009 and 2010 tax years.
For any tax year beginning in 2011, the Jobs Act shortens the holding period of assets subject to the built-in gains tax to only five years if the fifth tax year in the recognition period precedes the tax year beginning in 2011.
One year self-employment tax break. For tax years beginning after December 31, 2009, but before January 1, 2011, when calculating self-employment taxes, the deduction for health insurance costs of a self-employed taxpayer can be deducted in computing net earnings from self-employment.
Penalty relief for failure to include reportable transaction information with return. Retroactively effective to penalties assessed after December 31, 2006, the controversial Code § 6707A penalty is revised so that the penalty for failure to disclose a reportable transaction (i.e., a transaction the IRS has identified as a listed tax shelter or as having the characteristics of a tax shelter) to the IRS is commensurate with the tax benefit received from the transaction. Thus, under the Jobs Act, the penalty is 75% of the tax benefit received, with a minimum penalty of $10,000 for corporations and $5,000 for individuals. For listed transactions, the maximum penalty is increased to $200,000 for corporations and $100,000 for individuals, while for other reportable transactions, the maximum penalty is $50,000 for corporations and $10,000 for individuals.
Here are highlights of the Jobs Act’s revenue raisers:
Information reporting for rental income. For payments made after December 31, 2010, persons receiving rental income from real property will have to file information returns (Form 1099s) with the IRS and service providers reporting payments of $600 or more during the year for real property expenses. Exceptions are provided for individuals temporarily renting their principal residences (including active members of the military), taxpayers whose rental income doesn’t exceed an IRS-determined minimal amount, and those for whom the reporting requirements would create a hardship under IRS regulations.
Increased penalty for failure to timely file information returns. For information returns required to be filed after December 31, 2010, the Jobs Act increases the Code’s penalties for failure to timely file information returns with the IRS. The first-tier penalty increases from $15 to $30, and the calendar year maximum increases from $75,000 to $250,000. The second-tier penalty increases from $30 to $60, and the calendar year maximum increases from $150,000 to $500,000. The third-tier penalty increases from $50 to $100, and the calendar year maximum increases from $250,000 to $1,500,000. For small business filers, the calendar year maximum increases 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 minimum penalty for each failure due to intentional disregard increases from $100 to $250.
Increased penalty for failure to furnish a payee statement. The Code’s penalty for failure to furnish a payee statement is revised to provide tiers and caps similar to those applicable to the penalty for failure to file information returns. A first-tier penalty will be $30, subject to a maximum of $250,000; the second-tier penalty will be $60 per statement, up to $500,000, and the third-tier penalty will be $100, up to a maximum of $1,500,000. Limitations will apply on penalties for small businesses and increased penalties for intentional disregard that parallel the penalty for failure to furnish information returns.
Exception to pre-levy CDP hearing rule for federal contractors. For levies issued after September 27, 2010, the IRS may issue levies before a CDP hearing with respect to federal tax liabilities of delinquent federal contractors identified under the Federal Payment Levy Program. When a levy is issued before a CDP hearing, the taxpayer will have an opportunity for a CDP hearing within a reasonable time after the levy.
Code § 457(b) plans could include Roth accounts. For tax years beginning after December 31, 2010, retirement savings plans sponsored by state and local governments (i.e., governmental Code § 457(b) plans) will be able to include Roth accounts.
Certain retirement plans can rollover distributions into Roth accounts. For distributions after September 27, 2010, 401(k), 403(b), and governmental 457(b) plans will be able to permit participants to roll their pre-tax account balances into a designated Roth account. If the rollover is made in 2010, the participant may elect to apply the tax in 2011 and 2012.
Accelerated estimated tax payment for large corporations. Estimated taxes for large corporations (those with assets of not less than $1 billion) otherwise due for July, August, or September of 2015, will be increased by 36%.
This article is a brief summary highlighting some of the major provisions of particular interest to taxpayers in the Midwest. If you have a question regarding the impact of the Jobs Act on you, your clients or your business, don’t hesitate to contact a member of our Tax and Estate Planning Practice Group.
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