New Legislation Extends and Expands Tax Breaks for Small Businesses, Their Investors and More
Posted 9-24-2010 | By Gloria McDonnell | Download Article
On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010 (SBJA), creating a $30 billion fund to provide capital to community banks to encourage lending to small businesses. The legislation also includes $12 billion in tax relief for small businesses and incentives to encourage investment in them. There also are some benefits for larger businesses, the self-employed and individual taxpayers. Following is an overview of the most relevant and potentially lucrative tax provisions which must be considered as they may impact your tax liability for 2010 and 2011:
Increased exclusion on small business stock gains
To make investing in certain small businesses more attractive, SBJA temporarily increases the qualified small business (QSB) stock gain exclusion. The exclusion will be 100% for stock acquired after SBJA’s enactment date (that is, the date the president signs it into law) and before Jan. 1, 2011. It must be held for at least five years. Additionally, the act eliminates the alternative minimum tax (AMT) preference item on such gains, making it tax free for AMT purposes.
How does the exclusion work? You generally can exclude a portion of gains on the sale of QSB stock you’ve held at least five years. To be a QSB, the company can’t hold gross assets exceeding $50 million at the time the stock is issued and must be engaged in an active trade or business. The exclusion, based on the old long-term capital gains rate of 28%, generally is 50% (resulting in a 14% effective rate), but last year it was increased to 75% for stock acquired after Feb. 17, 2009, and before Jan. 1, 2011 (resulting in a 7% effective rate).
QSB stock also can help diversify your portfolio while providing additional potential tax benefits. Therefore, purchasing it this year may be worth considering.
Increased and expanded Sec. 179 expensing
SBJA also helps small-business owners invest in their own businesses by increasing the Internal Revenue Code Section 179 expensing election limit. For tax years beginning in 2010 and 2011, the limit will now be $500,000, with a dollar-for-dollar phaseout starting when purchases for the year exceed $2 million. Thus, no Sec. 179 expensing is allowed if acquisitions equal $2.5 million or more.
Under Sec. 179, you may elect to expense the cost of certain tangible personal property — such as equipment, furniture and off-the-shelf computer software — in the year of acquisition, instead of recovering the costs more slowly through depreciation deductions. A business can claim the expensing election only to offset its net income, not to reduce net income below zero.
Before SBJA, the 2010 expensing limit was $250,000, subject to an $800,000 acquisition limit, and the 2011 expensing limit was scheduled to drop to $25,000, with a $200,000 acquisition limit.
SBJA also temporarily expands the definition of eligible property to include qualified leasehold-improvement, restaurant and retail-improvement property. The maximum amount of such property that can be expensed is $250,000.
Extended bonus depreciation
Another depreciation-related provision extends the special allowance for certain property, generally if acquired in calendar year 2010. Businesses can recover the costs of qualifying depreciable property more quickly by immediately deducting 50% of the cost.
The following types of property qualify for this special bonus depreciation:
- Tangible property with a recovery period of 20 years or less,
- Computer software purchased by the business,
- Water utility property, and
- Qualified leasehold improvement property.
Bonus depreciation isn’t subject to any asset purchase limits, so businesses ineligible for Sec. 179 expensing can take advantage of it. And businesses that qualify for Sec. 179 expensing can take bonus depreciation on asset purchases in excess of the $500,000 Sec. 179 limit. Of course, they’ll still want to keep in mind the $2 million Sec. 179 phaseout threshold, because Sec. 179 expensing is more beneficial than bonus depreciation.
Extended carryback of general business credit
SBJA extends the maximum carryback period for the general business credit to five years for most privately held businesses. Eligible businesses include sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the previous three years. The extended carryback period applies to credits for the tax year beginning in 2010.
The general business credit (the total of various credits including the R&D credit) can’t exceed certain limits. Normally, any credit in excess of the limits can be carried back only one year to offset taxes paid in the previous year, with any remainder carried forward up to 20 years to offset future tax liabilities.
SBJA also allows the general business credit to offset 2010 AMT liability.
Reduced recognition period for S corporation built-in gains tax
SBJA temporarily reduces the asset holding period that S corporations which have converted from C corporations must meet to avoid built-in gains tax. For assets sold in the tax year beginning in 2011, the holding period will be five years.
Built-in gains tax is a corporate-level tax of 35% that’s generally imposed on an S corporation’s gain that 1) is the result of a sale of assets acquired before the business converted to an S corporation, and 2) is recognized by the S corporation during the holding period. Normally, this is the 10-year period that begins on the first day of the first taxable year for which the S election is in effect. So to avoid the 35% tax, the S corporation generally must hold any appreciated assets for 10 years after the conversion.
In 2009, the holding period for assets subject to the built-in gains tax was reduced to seven years for assets sold in tax years beginning in 2009 and 2010. So S corporations that have been holding on to assets because they didn’t meet the seven-year holding period should see if they’ll qualify for the five-year holding period next year and, if so, consider whether it would be beneficial to sell the assets.
New breaks for the self-employed and individuals
As mentioned, the law doesn’t benefit just businesses and their investors; it also provides new tax saving opportunities for the self-employed and other individuals:
- If you’re self-employed, SBJA permits you to deduct for 2010 self-employment tax purposes any costs incurred in 2010 for health insurance for you and your spouse, dependents and children age 26 or under. (You already could deduct these expenses for income tax purposes.)
- If you’re a government employee who participates in a 457(b) plan, be aware that SBJA may allow your employer to start providing you the option to designate some or all of your contributions as Roth contributions. The contributions won’t reduce your taxable income, but you won’t have to pay any tax on qualified distributions.
- Under SBJA, your 401(k), 403(b) or 457(b) plan may allow (but isn’t required to allow) you to roll any portion of your pretax account balance into a Roth account. The amount of the rollover would be includible in your taxable gross income — except to the extent it’s the return of any after-tax contributions. If the rollover is made in 2010, you can elect to pay the tax over a two-year period in 2011 and 2012.
Other Provisions
Under the new law, cell phones are no longer considered listed property, therefore are not subject to the rules requiring substantiation of business use. In addition, the fair value of the personal use of employer provided cell phones can be excluded from an employee’s income.
Generally, taxpayers can deduct $5,000 of business start-up expenses and start-up expenses in excess of this amount must be capitalized and amortized. The new law increases the amount that can be deducted to $10,000.
Catch the breaks
Any number of the tax relief provisions discussed here could apply to your situation. To learn more about how SBJA may affect you or your business, please contact Gloria McDonnell, CPA, at 651-407-5829 or gmcdonnell@hlbtr.com.