Signed by the President on September 27, 2010, the Small Business Jobs Act of 2010 provides a number of tax benefits for small and medium-sized businesses, but also contains some significant changes as to information reporting (1099s) and the penalties for failure to report. The following is a discussion of the major tax changes included in the Act that may be of interest to those in the nonprofit community with for-profit affiliates:
Section (§) 179 allows a business to write off the cost of furniture, computers, machinery and equipment acquisitions (tangible personal property) in the year of acquisition instead of taking depreciation deductions over a number of years. The current law allows a §179 deduction of $250,000 in 2010 but only a $25,000 deduction in 2011. The amount of the deduction is decreased dollar-for-dollar, if acquisitions exceed a threshold – $800,000 in 2010 and $200,000 in 2011.
The new law increases the §179 limit to $500,000 in 2010 and 2011. The limit begins to decrease if acquisitions exceed $2,000,000 and is reduced to zero if acquisitions exceed $2,500,000.
Not only is this increased limit a boon to companies looking to acquire property in 2011, it is a gift to those that have already made substantial acquisitions in 2010.
Section 179 for Qualified Real Property
As discussed above, the §179 deduction has previously applied only to acquisitions of tangible personal property. The new law allows a $250,000 deduction for acquisitions of certain qualified improvements to real property placed in service in 2010 and 2011. This $250,000 is part of the overall §179 deduction available; a taxpayer cannot claim $500,000 for personal property acquisitions and an additional $250,000 for qualified real property – the overall maximum is $500,000 of which $250,000 can be for qualified real property.
Qualified real property is either qualified leasehold improvements (QLHI), qualified restaurant property (QRP) or qualified retail improvement property (QRIP). The rules for what improvements meet the “qualified” standard are different for each of the three types of improvements.
QLHI must meet the following tests:
The building must have been placed in service at least three years before the leasehold improvement;
The improvements must be made subject to a lease;
The improvements must be to tenant space, not common areas, not an expansion of the building and not escalators or elevators; and
The tenant and landlord cannot be related (i.e. common ownership).
QRP is a building or an improvement if more than 50% of the building’s square footage is devoted to the preparation of, and seating for on-premise consumption of, prepared meals. Unlike QLHI and QRIP, QRP can be a brand new building or improvements in a recently constructed building.
QRIP is improvements to an interior portion of a building where such portion is open to the general public and used in the trade or business of selling tangible personal property to the general public. Also, as with QLHI, the improvements must have been made more than three years after the building was placed in service and not to common areas, enlargements or escalators and elevators.
Bonus depreciation is the option to write off 50% of the cost of new property acquired and placed in service. This was the law in 2008 and 2009 and has now been extended for property acquired and placed in service by December 31, 2010. Note that bonus depreciation only applies to new property whereas §179 is available for both new and used property.
When combining bonus depreciation and §179, §179 is taken first and bonus is applied to the remaining basis. For example, if in 2010 the company acquired and placed in service new machinery with a cost of $800,000, it could take a §179 deduction for $500,000 and bonus depreciation of $150,000 (50% x ($800,000 – $500,000).
Bonus Depreciation for Autos and Light Trucks
An additional $8,000 deduction is available for autos and light trucks acquired in 2010 that are subject to the “luxury auto” limit on depreciation. Since any such vehicle is one with a cost of more than $15,300 and a gross vehicle weight of less than 6,000 pounds, it applies to most vehicles a business may acquire for general transportation needs.
Note to the above four changes – neither Maryland nor Virginia accepts bonus depreciation or the increased §179 write-off. DC follows federal law.
S Corporation Built-in Gains
When a C corporation elects to become an S corporation, 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 the recognition period. The recognition period generally is the first ten S corporation years. A “built-in gain” exists if, at the time of the S corporation election, the fair market value of a corporate asset exceeds its tax basis. The most common built-in gains are (1) real estate, (2) goodwill (going-concern value) and (3) for cash-basis taxpayers, the excess of accounts receivable over accounts payable plus accrued expenses.
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. Under the new law, the recognition period is shortened to five years for gains recognized in 2011 (only in 2011) and would apply to any such S corporation that made the election effective for years beginning in 2006 or earlier.
This is a major planning opportunity for affected corporations and must be considered in any 2010 and 2011 tax planning.
1099 Reporting by Owners of Schedule E Properties
For payments made after Dec. 31, 2010, persons receiving rental income from real property would have to file information returns (Forms 1099) to the IRS and to service providers reporting payments of $600 or more during the year for rental property expenses. Exceptions would be provided for individuals temporarily renting their principal residences (including active members of the military), taxpayers whose rental income does not exceed an IRS-determined minimal amount (not yet announced), and those for whom the reporting requirement would create a hardship (under IRS regulations to be issued).
Note that this takes effect in a few months. Affected taxpayers will have to begin the process of obtaining tax identification numbers from service providers immediately. Do not plan to rely on the latter two exceptions noted above.
Significantly Increased Penalties for Failure to File Information Returns
For information returns required to be filed after Dec. 31, 2010, the penalties for failure to timely file information returns to the IRS would be increased. The first-tier penalty would go from $15 to $30 per unreported form, and the calendar year maximum from $75,000 to $250,000. The second-tier penalty would be increased from $30 to $60, and the calendar year maximum from $150,000 to $500,000. The third-tier penalty would be increased from $50 to $100, and the calendar year maximum from $250,000 to $1,500,000. For small business filers, the calendar year maximum would go 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 would be increased from $100 to $250.
First tier penalties are for self-corrected forms filed within 30 days of the due date of the form. Second tier penalties are for self-corrected forms filed by August 1st. Third tier penalties are for any other unreported or underreported payments.
Self-Employed Health Insurance Deduction for S-E Tax
For 2010, and 2010 only, a taxpayer can deduct from self-employment income the cost of health insurance in computing his/her self-employment tax.
The income tax cuts that were enacted in 2001 and 2003 under President Bush expire on December 31, 2010. Unless Congress acts now, which means the Democrats and Republicans have to agree on what should be extended and what can expire, everything resets to the tax law in effect as of January 1, 2001. The following is a summary of some of those changes and actions you may want to take to avoid the changes; any actions should be discussed with your tax advisor. Note that both sides want some or all of these expiring provisions extended but no one knows what the future (of tax) holds.
Higher tax rates: Highest tax brackets increase with a maximum rate of 39.6% instead of current 35%. Planning – If you think you will be affected by the return of higher rates, consider accelerating income into 2010 or deferring deductions.
The Marriage Penalty returns: Tax brackets change, affecting married returns with taxable income around $125,000. The reason for this change is that the current brackets eliminate the Marriage Penalty by making them 200% of a single person’s tax bracket. The old law was approximately a 67% increase.
Capital gains tax increases: The current 15% rate for long-term gains increases to 20% – a 1/3rd increase in the tax rate. Planning – Now may be a good time to recognize some of those gains in stocks you have been holding. If you want to maintain your investments, you can sell for a gain and repurchase the same stock; the “wash sale” rule only applies to losses.
Dividends: Most dividends on stock have been taxed at capital gains rates (15%) since 2003 but will be taxed as ordinary income in 2011 – with a maximum rate of 39.6%. Planning – If you own a privately-held taxable corporation (not an S corporation), consider paying a dividend by year end. If the company still needs those funds, you can lend back the net-of-tax dividend.
Alternative Minimum Tax (AMT): Every year for the past number of years, Congress has passed a one-year patch so that AMT does not affect a large number of “middle-class” taxpayers. This will have to be addressed in 2010 and again in 2011 or millions of taxpayers will find they are subject to additional taxes.
“When will we know the answers so that we can plan efficiently for income taxes?” That is an excellent question. Some pundits believe that the lame-duck Congress will address this after the November elections. Others believe that it won’t be addressed until a new Congress
IRS has announced that under a one-time relief program small tax-exempt organizations that failed to file returns for 2007, 2008 and 2009 can avoid losing their tax-exempt status by filing a return by Oct. 15, 2010. Two types of relief are available: (1) a filing extension for the smallest organizations (eligible to file Form 990-N); and (2) a voluntary compliance program for small organizations (eligible to file Form 990-EZ). IR 2010-87
See http://www.irs.gov/charities/article/0,,id=225702,00.html for more information.
The health care legislation that was enacted in two parts earlier this year impose on businesses a number of reporting requirements and potential tax penalties. The legislation will also impose significant new taxes on higher income individuals. The following chart summarizes the major tax provisions and the year in which each is effective:
|Reporting of health insurance premiums paid by employer on employees’ W-2s||2011|
|1099 reporting for payments to corporations (currently exempt from such reporting)||2012|
|0.9% HI Tax on wages and/or self-employment earnings (see below)||2013|
|3.8% Unearned Income Medicare Contribution (see below)||2013|
|Limit on contributions to medical reimbursement cafeteria plans, etc., to $2,500||2013|
|Penalties imposed on employers who do not provide adequate employer-paid health insurance||2014|
|Annual fee imposed on health insurance providers||2014|
|40% excise tax on “Cadillac” health insurance plans||2018|