October 2010
President Obama has signed the Small Business Jobs Act of 2010 (the "Act") into law. The Act includes a number of tax changes, including provisions intended to encourage investments in and by businesses. Taxpayers must act within limited time periods, however, to take advantage of a number of the new provisions.
Section 179 of the Internal Revenue Code provides a limited exception to the general rule that the cost of property acquired for use in a business must be capitalized and recovered in the form of depreciation over a prescribed recovery period that extends beyond the year of acquisition. Instead, Section 179 permits a taxpayer to expense a portion of the cost of qualifying property placed in service in any year, subject to a cap that is reduced on a dollar-for-dollar basis by the cost to the taxpayer of qualifying property placed in service during the year to the extent in excess of a phase-out amount. In general, qualifying property is tangible, depreciable property acquired by purchase for use in the active conduct of a trade or business. Qualifying property need not be new. For a limited period of time, qualifying property also includes certain “off-the-shelf” software that is readily available for purchase by the general public subject to a non-exclusive license without modification.
Before the enactment of the Act, the cap on the amount that could be expensed was $250,000 for tax years beginning in 2010 and $25,000 for tax years beginning in 2011 or thereafter. The phase-out amount was $800,000 for tax years beginning in 2010 and $200,000 for tax years beginning in 2011 or thereafter. Thus, a taxpayer placing $225,000 or more of qualifying property into service in 2011 would not have been able to expense any portion of the cost of the qualifying property under Section 179.
Under the Act, but only for tax years beginning in 2010 and 2011:
After 2011, the cap and phase-amount amounts are scheduled to revert to $25,000 and $200,000, respectively, and qualifying property will cease to include off-the-shelf software and qualified real property.
The post-9/11 stimulus provisions that Congress added to the Internal Revenue Code included Section 168(k). In general, Section 168(k) allowed a taxpayer acquiring and placing certain qualifying property in service by a deadline date to claim a percentage of the cost of the property as “bonus” depreciation for the year in which the property was placed in service. Most recently, the percentage of the cost that was allowed as bonus depreciation was 50%. Qualifying property, for purposes of Section 168(k), was generally new, depreciable, tangible personal (i.e., not real estate) property with a recovery period of 20 years or less. Qualifying property also included computer software not subject to 15-year amortization under Section 197 of the Internal Revenue Code, certain “water utility property” and certain “qualified leasehold improvement property.” Before the enactment of the Act, the deadline date by which qualifying property had to be acquired and placed in service was December 31, 2009 (or December 31, 2010 for certain transportation property, aircraft or property with a recovery period of at least 10 years).
The Act has extended the deadline date by which qualifying property must be acquired and placed in service to December 31, 2010 (or December 31, 2011 for certain transportation property, aircraft or property with a recovery period of at least 10 years).
Section 1202 of the Internal Revenue Code allows a non-corporate taxpayer who has held “qualified small business stock” (or “QSBS”) for more than five years to exclude a portion of the gain recognized on a sale of the stock. For stock to be QSBS, it must have been acquired upon original issuance (or by inheritance, gift or, under certain circumstances, distribution from another who acquired the stock upon original issuance) from a C corporation that, among other things, satisfies certain “qualified small business” and “active business” requirements. The “qualified small business” requirement limits the applicability of Section 1202 to stock issued by corporations with aggregate gross assets of $50 million or less. The “active business” requirement limits the applicability of Section 1202 to corporations most of whose assets are used in one or more “qualified trades or businesses” (which exclude, among other things, providing professional services such as law, engineering, accounting and actuarial science). In addition, the corporation may not have redeemed more than de minimis amounts of its outstanding stock within specified periods of time before or after the issuance of the stock in question. “Look-through” rules can allow an S corporation or partnership to pass the benefits of Section 1202 through to its owners.
From the enactment of Section 1202 in 1993, the maximum excludible portion was 50%. Unfortunately, the non-excluded portion has generally been taxed since 2001 at a 28% rate. In addition, a portion of any excluded gain has generally been a preference item under the alternative minimum tax. Given the rate at which the unexcluded portion is taxed, Section 1202 lost much of its luster in 2003 when the maximum rate generally applicable to long-term capital gains from stock sales was reduced to 15%. The American Recovery and Reinvestment Tax Act of 2009 breathed some new life into Section 1202 by increasing the maximum excludible portion to 75% for QSBS acquired after February 17, 2009 and before January 1, 2011.
Under the Act, the maximum excludible portion of the gain on the sale of QSBS acquired by December 31, 2010 (and after the date of enactment of the Act) and held for more than five years has been increased to 100%. In addition, no portion of the excluded gain is a preference item under the alternative minimum tax. Thus, gains of eligible taxpayers on sales of QSBS acquired by December 31, 2010 (and after the date of enactment of the Act) and held for more than five years will not be subject to tax under the regular federal income tax or under the federal alternative minimum tax.
S Corporation Built-in Gains Period Shortened. Generally, Section 1374(d) provides that an S corporation must hold onto any appreciated assets for 10 years following its conversion from a C corporation or face a business-level tax imposed on the built-in gain at the highest corporate rate. Under the 2009 Recovery Act, this holding period was reduced where the 7th tax year in the holding period preceded the tax years beginning in 2009 or 2010. The Act again 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.
Deduction of Start-up Expenditures Temporarily Expanded. Section 195(b)(3) permits a taxpayer to elect to deduct start-up expenses of a trade or business. Under prior law, the limit of these deductions was capped at $5,000, subject to a $50,000 phase-out threshold. As amended by the Act, for tax years beginning in 2010 only, Section 195(b)(3) allows taxpayers to deduct up to $10,000 in trade or business start-up expenditures. The deductible amount is reduced by the amount by which start-up expenditures exceed $60,000. For tax years beginning in 2011 and thereafter, the $5,000 and $50,000 amounts will again apply.
2010 Health Insurance Costs Deductible for Self-Employment Tax Purposes. In general, Section 162(l)(4) disallows a deduction for health insurance costs in determining self-employment tax liability of self-employed persons. For tax years beginning in 2010 only, the Act permits self-employed persons to deduct the costs of health insurance for themselves and their family members in calculating their self-employment tax.
Cell Phones No Longer “Listed Property.” To qualify for certain deductions and exclusions with regard to “listed property” (including cell phones), taxpayers have to meet various onerous substantiation and use requirements. Under the Act, cell phones are removed from the listed property category for tax years beginning in 2010 and thereafter. This means that cell phones may be deducted or depreciated like other business property, without onerous recordkeeping requirements. In addition, it may now be easier for an employee to claim a cell phone provided by her employer as an excludible working condition fringe benefits.
For information on the Small Business Jobs Act, please contact one of this article's tax law authors: Chip Wry, Bob Finkel or Diana Española.
This article is not intended to constitute legal or tax advice and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending any transaction or matter addressed herein.
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