Tax Legislation Update: Small Business Jobs Act of 2010
By Nancy Faussett, CPA
Publication Date: 11/15/2010
The Small Business Jobs Act of 2010 (H.R. 5297) was signed into law on September 27, 2010. With the understanding that for small businesses to expand, they need both tax cuts and greater access to loans, the Act creates new and expanded tax incentives and a $30 billion loan fund. The provisions of this Act affect small businesses as well as individual taxpayers. There are both tax incentives and revenue raisers to pay for them. This article describes the most significant of these provisions.
Provisions Targeted to Small Businesses
Most of the tax provisions of the Act are targeted specifically for small businesses:
General Business Credit
Normally, the General Business Credit cannot exceed the taxpayer’s net income tax over the greater of a) the tentative minimum tax for the tax year or b) 25% of the taxpayer's net regular tax liability exceeding $25,000. Generally, any excess amounts may be carried back one year or carried forward for up to 20 years. The Act extends the carryback period of eligible small business credits from one to five years, effective for the taxpayer’s first tax year beginning after 2009.
Furthermore, also effective for the first tax year beginning after 2009, eligible small businesses may use their General Business Credits to offset their Alternative Minimum Tax (AMT).
"Eligible small businesses" are sole proprietorships, partnerships, and non-publicly traded corporations, any of which that have $50 million or less in average gross receipts for the prior three years.
Small Business Stock
The Act provides for a temporary 100% exclusion for capital gains under IRS Section 1202 from the sale of certain small business stock if held for more than five years. The stock must be acquired after the September 27, 2010 date of enactment and before 2011. The minimum tax preference does not apply to the excluded amount. This, therefore, greatly enhances the benefits for investing in Section 1202 stock.
Section 6707A Penalty
The Act revises the penalty under IRS Section 6707A for failure to disclose a reportable transaction to the IRS. A "reportable transaction" is one that the IRS has determined as having potential for tax evasion (such as tax shelters). The penalty is now revised so that it will be commensurate with the tax benefit received from the transaction in question. The provision should ease the impact of the penalty on small businesses who have complained that often the penalty amount exceeded any tax benefit resulting from the transaction.
The Section 6707A penalty for any reportable transaction will be 75% of the decrease in tax as a result of the transaction. There is a minimum penalty of $10,000 for corporations and $5,000 for individuals. The maximum penalty amount for failure to disclose listed transactions is $200,000 for corporations and $100,000 for individuals, while for other reportable transactions it is $50,000 for corporations and $10,000 for individuals.
The revised Section 6707A penalty will be applied retroactively to such penalties assessed after December 31, 2006.
Health Insurance Deduction for Self-Employed Taxpayers
The Act temporarily allows business owners a deduction for the cost of health insurance when calculating their 2010 self-employment taxes.
Provisions Affecting Fixed Assets
The following provisions in the Act affect businesses and their fixed assets:
Section 179 Expensing:
a. For years starting in 2010 and 2011, the maximum Section 179 expense amount is increased to $500,000 (up from $250,000 in 2010) and the investment ceiling increases to $2,000,000 (up from $800,000 in 2010).
Unless these amounts are changed or extended, for tax years beginning in 2012, the maximum Section 179 expense amount will be reduced to $25,000 and the investment ceiling threshold will be $200,000 (both of these amounts to be indexed for inflation).
b. For years starting in 2010 and 2011, the Act expands the definition of Section 179 property to include qualifying real property (certain leasehold improvements, restaurant property and retail improvement property) and allows businesses to claim $250,000 of Section 179 expense on it. Note that for purposes of the $500,000 limitation mentioned above, no more than $250,000 can be claimed on qualifying real property.
"Qualifying real property" for this purpose is the following:
1) Qualifying leasehold improvements are:
- Interior improvements made to leased nonresidential real property,
- Occupied exclusively by the lessee or sublessee,
- Placed in service more than three years after the building was first placed in service, and
- Cannot constitute an enlargement of the building, nor can it be an elevator, escalator, a structural component benefitting a common area, nor an interior structural component.
2) Qualifying restaurant property is:
- Section 1250 property,
- An improvement to a building (or a building), and
- Where more than 50% of the square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals.
3) Qualifying retail improvement property is:
- An improvement made to the interior of nonresidential real property,
- Has a portion open to the general public and used in retail sales,
- Placed in service more than three years after the building was first placed in service, and
- Cannot constitute an enlargement of the building, nor can it be an elevator, escalator, a structural component benefitting a common area, nor an interior structural component.
No amount of any claimed but unused Section 179 expense attributed to qualifying real property may be carried over to a tax year beginning after 2011. Furthermore, if Section 179 expense amount is claimed on both qualifying personal and real property and, due to the taxable income limitation, a carryover amount results, such carryover must be prorated between both types of property.
c. The provision qualifying off-the-shelf computer software as Section 179 property is extended for one year. Therefore such software qualifies as Section 179 property if placed in service in tax years beginning after 2002 and before 2012.
d. A taxpayer’s ability to revoke a Section 179 election without the consent of the IRS is extended for one year. Therefore, a taxpayer may now revoke a Section 179 election with respect to any tax year beginning after 2002 and before 2012.
50% Bonus Depreciation:
a. Bonus depreciation is extended for one year, for property placed in service in 2010 (and certain long production period property and transportation property placed in service in 2011).
b. Bonus depreciation on assets with a recovery period of seven years or less is to be disregarded when computing the percentage-of-completion for long-term contracts. In other words, the cost of qualified property taken into account as a cost allocated to the contract is to be done as if bonus depreciation had not been claimed but rather MACRS had been applied to its entire depreciable basis. This applies to such property placed in service after 2009 and before 2011 (before 2012 for longer-production period property). This will allow contractors to benefit from bonus depreciation even if they do not finish a contract within the same year.
c. The allowable amount of depreciation on a luxury vehicle (defined in Section 280F(d)(5)) on which bonus depreciation is claimed is increased if the vehicle is placed in service in 2010. This additional depreciation, up to $8,000, is only for the year in which the vehicle is placed in service. This provision extends, for one more year, the additional $8,000 already allowed for qualifying vehicles placed in service in 2008 and 2009. Therefore, qualifying luxury automobiles placed in service in 2010 may claim a maximum depreciation deduction of $11,060 and qualifying trucks and vans placed in service in 2010 may claim a maximum depreciation deduction of $11,160.
Start-up Expenses
For tax years beginning in 2010, the amount allowed as a deduction for start-up expenses under IRS Section 195 is increased. A taxpayer may now deduct up to $10,000 (up from $5,000) of start-up expenses for years beginning in 2010. The phaseout threshold for the cumulative cost of start-up expenses (that is, the point at which the amount of allowable expenses is reduced), is increased to $60,000 (up from $50,000). The remaining Section 195 amount is amortized over 180 months.
Cell Phones
For years beginning after 2009, cell phones are removed from the definition of listed property under IRS Section 280F. This means that the substantiation requirements and special depreciation rules that apply to listed property no longer apply to cell phones.
S Corporation Provision
For clients who are shareholders in an S corporation, the following provision has potential ramifications affecting the amount of income passed through to them:
When a C corporation elects to become an S corporation, the S corporation may be subject to a built-in gains tax on any appreciated assets held by the C corporation on the day it converts to S corporation status. The built-in gains tax is calculated at the highest corporate rate (currently 35%). To avoid this, the S corporation must hold the appreciated assets generally for ten years. However, the American Recovery and Reinvestment Act of 2009 temporarily shortened the usual 10-year holding period to seven years for dispositions in tax years beginning in 2009 and 2010 (that is, if the seventh tax year in the recognition period preceded the 2009 and 2010 tax years). Now, this latest Act shortens the holding period to five years for any tax year beginning in 2011, if the fifth tax year in the recognition period precedes the tax year beginning in 2011.
Provisions for Individual Taxpayers – Revenue Raisers
There are several provisions in the Act to promote retirement savings by individual taxpayers. The following provisions are considered to be revenue raisers as they encourage distributions that are taxable:
Roth IRAs
There are two provisions that affect Roth IRA accounts:
a. The Act allows individuals in government Section 457 retirement plans to contribute deferred amounts to Roth IRA accounts. Since contributions to Roth IRAs are made with after-tax dollars, this is a revenue raiser. This provision is effective for tax years beginning after 2010.
b. The Act authorizes 401(k), 403(b), and 457(b) plans to allow their participants to rollover pre-tax account amounts into a Roth IRA. Only plans that have a designated Roth IRA contribution plan qualify and the distribution to be rolled over must otherwise be allowed under the plan. Except for any after-tax contributions, such distributions are taxable. Since this provision is effective on enactment, any rollovers made in 2010 can take advantage of the rule that allows deferment of the income recognition until 2011 and then can include it ratably in income over a two-year period. This is effective for distributions made after September 27, 2010.
Nonqualified Annuity Contracts
The Act allows partial annuitization of nonqualified annuity contracts (i.e., annuity contracts that are held outside of a qualified retirement plan or IRA). A portion of an annuity, endowment, or life insurance contract may be annuitized (either for at least 10 years or for the lives of one or more individuals) while the balance remains as is, accumulating income on a tax-deferred basis. This provision is effective for amounts received in taxable years beginning after 2010.
Other Revenue Raisers
The following are other revenue raisers included in the Act:
Information Reporting of Rental Income
The Act requires information reporting for those earning rental income and who make payments of $600 or more to service providers (such payments that constitute rental property expenses). Generally, such reporting will constitute providing a Form 1099-MISC to both the IRS and the service provider. This provision applies to payments made after 2010. It makes real estate renters subject to the same information reporting requirements as taxpayers engaged in a trade or business.
The Act provides for exceptions to the reporting requirement for the following: a) members of either the military or the intelligence community who rent their principal residence on a temporary basis, b) individuals who receive only minimal amounts of rental income, and c) individuals for whom the reporting would cause a hardship.
Levies for Unpaid Federal Taxes on Federal Contractors
The Act allows the IRS to issue levies for unpaid federal taxes on federal contractors prior to any collection due process (CDP) hearing. This provision applies to levies issued after September 27, 2010.
Increased Penalties on Information Returns
The Act increases Section 6721 and Section 6722 penalties for information returns required to be filed after 2010:
- First-tier penalties (for late filing an information return within 30 days after the due date) will increase from $15 to $30. The calendar year maximum will increase from $75,000 to $250,000.
- Second-tier penalties (for late filing an information return more than 30 days after the due date, but before August 1) will increase from $30 to $60. The calendar year maximum will increase from $150,000 to $500,000.
- Third-tier penalties (for failing to file before August 1) will increase from $50 to $100. The calendar year maximum will increase from $250,000 to $1.5 million.
For qualifying small businesses (i.e., those with average gross receipts for the last three years of $5 million or less), 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 intentional failure-to-file will increase from $100 to $250.
Guaranteed Fees Earned by U.S. Subsidiaries of Foreign Businesses
The Act changes the tax treatment of guarantee fees under source rules for income earned by U.S. subsidiaries of foreign businesses. Amounts received for guarantees of indebtedness, after September 27, 2010, will be considered U.S. source income if paid by either:
- A noncorporate resident (per Section 861(a)(1) except that foreign partnerships are not included) or a domestic corporation for the provision of a guarantee of indebtedness of such person, or
- A foreign person who has indebtedness that is effectively connected to the conduct of a trade or business within the U.S.
Cellulosic Biofuel Producer Credit
The Act makes crude tall oil, a waste byproduct of the paper manufacturing process, ineligible for the cellulosic biofuel producer credit. This provision is effective for fuels sold or used after December 31, 2009.
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