2010 New Tax Laws
Tax breaks and incentives
Enhanced small business expensing (Section 179 expensing). In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Jobs Act law, taxpayers could expense up to $250,000 of qualifying property—generally, machinery, equipment and certain software—placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000.
The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
100% exclusion of gain from the sale of small business stock for qualifying stock acquired after Sept. 27, 2010 and before Jan. 1, 2011. Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don't exceed $50 million, and the corporation must meet active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011. Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after Sept. 27, 2010 and held for more than five years. In addition, the new law eliminates the alternative minimum tax (AMT) preference item attributable for that sale.
General business credits of eligible small businesses for 2010 allowed to be carried back five years. Generally, a business's unused general business credits can be carried back to offset taxes paid in the previous year, and the remaining amount can be carried forward for 20 years to offset future tax liabilities. Under the new law, for the first tax year of the taxpayer beginning in 2010, eligible small businesses can carry back unused general business credits for five years. Eligible small businesses consist of sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.
General business credits of eligible small businesses in 2010 aren't subject to AMT. Under the AMT, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.
S corporation holding period. Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built-in gain at the highest corporate rate of 35%. This holding period is reduced where the 7th tax year in the holding period preceded the tax year beginning in 2009 or 2010. The 2010 Small Business Jobs Act 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.
Extension of 50% bonus first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).
Special rule for long-term contract accounting. The new law provides that in determining the percentage of completion under the percentage of completion method of accounting, bonus depreciation is not taken into account as a cost. This prevents the bonus depreciation from having the effect of accelerating income.
Boosted deduction for start-up expenditures. The new law allows taxpayers to deduct up to $10,000 in trade or business start-up expenditures for 2010. The amount that a business can deduct is reduced by the amount by which startup expenditures exceed $60,000. Previously, the limit of these deductions was capped at $5,000, subject to a $50,000 phase-out threshold.
Limitation on penalty for failure to disclose certain reportable transactions (including listed transactions) on a return. The new law limits the penalty to 75% of the decrease in tax resulting from the transaction. The minimum penalty is $10,000 for corporations and $5,000 for individuals (for failure to report a listed transaction, the maximum penalty is $200,000 and $100,000, respectively). These changes are retroactively effective to penalties assessed after Dec. 31, 2006.
Deductibility of health insurance for the purpose of calculating self-employment tax. The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
Cell phones removed from listed property category. This means that cell phones can be deducted or depreciated like other business property, without onerous recordkeeping requirements.
Offsets (revenue raisers)
Information reporting required for rental property expense payments. For payments made after Dec. 31, 2010, the new law requires persons receiving rental income from real property to file information returns with IRS and service providers reporting payments of $600 or more during the tax year for rental property expenses. Exceptions are provided for individuals renting their principal residences on a temporary basis (including active members of the military), taxpayers whose rental income doesn't exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under IRS regs).
Increased information return penalties (effective for information returns required to be filed after Dec. 31, 2010).
Application of continuous levy to tax liabilities of certain federal contractors. For levies issued after Sept. 27, 2010, the new law allows IRS to issue levies before a collection due process (CDP) hearing on Federal tax liabilities of Federal contractors (taxpayers would have an opportunity for a CDP hearing within a reasonable time after a levy is issued).
Allow participants in governmental 457 plans to treat elective deferrals as Roth contributions. For tax years beginning after Dec. 31, 2010, the new law will allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include designated Roth accounts. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free.
Allow rollovers from elective deferral plans to designated Roth accounts. The new law allows 401(k), 403(b), and governmental 457(b) plans to permit participants to roll their pre-tax account balances into a designated Roth account. The amount of the rollover will be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans will be able to allow these rollovers immediately as of Sept. 27, 2010.
Crude tall oil (a waste by-product of the paper manufacturing process) is excluded from eligibility for the cellulosic biofuel producer credit. The new law limits eligibility for the tax credit to fuels that are not highly corrosive (i.e., with an acid number of 25 or less), effective for fuels sold or used after Dec. 31, 2009.
Nonqualified annuity contracts. The new law permits holders of nonqualified annuities (annuity contracts held outside of a qualified retirement plan or IRA) to elect to receive part of the contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis.
Guarantee fees. Amounts received directly or indirectly for guarantees of indebtedness of a U.S. payor issued after Sept. 27, 2010 are sourced, like interest, in the U.S. As a result, amounts paid by U.S. taxpayers to foreign persons will generally be subject to U.S. withholding tax.
Expensing and bonus depreciation provisions in the 2010 Small Business Jobs Act
The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting business. Two of the most significant changes allow for faster cost recovery of business property. Here are the details.
Enhanced small business expensing (Section 179 expensing). In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Act law, taxpayers could expense up to $250,000 for qualifying property—generally, machinery, equipment and certain software—placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000.
The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property that can be expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
Extension of 50% bonus first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).
Increased deduction for start-up expenditures in the 2010 Small Business Jobs
If you've recently started a business, or if you're in the process of starting one now, you should be aware of a recent tax law change that could make a big difference in your tax bill. The recently enacted 2010 Small Business Jobs Act doubles the amount of start-up expenses that someone starting a business in 2010 can write off this year. Here are the details.
Generally, expenses incurred before a business begins don't generate any deductions or other current tax benefits. However, under pre-2010 Small Business Jobs Act law, taxpayers, whether they were individuals, corporations or partnerships, were permitted to elect to write off up to $5,000 of “start-up expenses” in the year business began, and the rest could be deducted over a period of 180 months. The $5,000 figure was reduced by the excess of total start-up costs over $50,000. You were deemed to have made this election unless you opted out.
The new law doubles the amount that can be written off for 2010 to $10,000 and increases the phaseout threshold from $50,000 to $60,000. It is important to note that this increased deduction is temporary, and only applies to tax years beginning in 2010.
Start-up expenses include, with a few exceptions, all expenses incurred to investigate the creation or acquisition of a business, to actually create the business, or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a startup expense is the cost of analyzing the potential market for a new product.
As you can see, it's important to keep a record of these start-up expenses, and to make the appropriate decision regarding the write-off election. As mentioned above, if you opt out of the election, there is no current tax benefit derived for the eligible expenses covered by the election. Also, you should be aware that an election either to deduct or to amortize start-up expenditures, once made, is irrevocable.
100% exclusion of gain from the sale of certain small business stock in the 2010 Small Business Jobs Act
The recently enacted 2010 Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. One of the changes could help those who are starting a business this year. It provides a 100% exclusion of gain from the sale of small business stock, with certain limitations. Here are the details.
Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don't exceed $50 million and that meets active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011.
Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after Sept. 27, 2010 and held for more than five years. In addition, the new law eliminates the AMT preference item attributable for that sale.
If you are considering investing in a small business, I would be happy to work with you to determine whether the new total exclusion for QSBS would work to your advantage. However, it should be noted that while the new provision for QSBS is ostensibly intended to encourage investment in small businesses, it may be less effective in that regard than desired, due to the restrictions on obtaining the total exclusion, specifically: (1) the narrow window within which the small business stock must be purchased (i.e., between Sept. 27, 2010 and the end of 2010); (2) the long holding period requirement for QSBS (the stock must he held for at least five years); and, most importantly, (3) the fact that the tax break only applies to investments in C corporations, a form of business organization that is not often used by small businesses, which, for tax purposes, are typically operated as S corporations, partnerships, limited liability companies or sole proprietorships.
Simplified business cell phone deduction rules in the 2010 Small Business Jobs Act
For an example of genuine tax simplification, it would be hard to beat a provision in the recently enacted 2010 Small Business Jobs Act. For the last several years, just about everyone, it seems, even the IRS, has complained about the archaic rules governing the tax treatment of employer-provided cell phones. Since 1989 (shortly after the first cell phones were introduced), employers and employees have been required to keep a detailed log of business and personal use on employer-provided cellular telephones and similar mobile communication devices to substantiate costs that were allowable as business expenses. In tax parlance, cell phones were included in the category of “listed property” (i.e., items obtained for use in a business but which lend themselves easily to personal use) and thus were subjected to strict substantiation rules. Employers who failed to meet the substantiation requirements couldn't deduct the costs of the cell phones, and employees who failed to meet the substantiation rules saw the amount that represented personal use of the cell phone counted as taxable wages (instead of a tax-free working condition fringe). Why the strict rules for cell phones? Back in 1989, cell phones were considered an expensive luxury item only used by executives, and Congress believed that an employee's use of an employer-provided cell phone to make personal calls should be treated as a taxable fringe benefit, similar to an employee's personal use of an employer-provided automobile.
Needless to say, times have changed. No longer considered a luxury item, cell phones and other mobile communication devices are now part of daily business practices at all levels, and the deduction limitations and documentation requirements no longer make sense. Today, cell phones are more akin to a land line phone which for years an employee may have occasionally used to make a personal call without tax consequence. Detailed documentation is not required for use by an employee of his office phone, and there is no reason that cell phones should be subject to stricter substantiation requirements. You may have read in the news that the IRS Commissioner and Treasury Secretary joined in a statement urging Congress to repeal the law. “The passage of time, advances in technology and the nature of communication in the modern workplace,” the Commissioner said, “have rendered this law obsolete. [We] ask that Congress act to make clear that there will be no tax consequence to employers or employees for personal use of work-related devices such as cell phones provided by employers.”
And lo and behold, that is precisely what Congress has done. The new legislation removes cell phones and similar telecommunications equipment (including PDAs and Blackberry devices) from the “listed property” rules. This makes it easier for employers that provide cell phones to employees, as well as for employee who use their own cell phones. As with other business property, taxpayers must still be able to demonstrate the business use of the cell phone.
Deductibility of health insurance for purposes of calculating self-employment tax in the 2010 Small Business Jobs Act
The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. One provision that could be valuable to business owners this year concerns the calculation of self-employment tax.
Generally, business owners can't deduct the cost of health insurance for themselves and their family members for purposes of calculating self-employment tax. The new law allows business owners to deduct health insurance costs incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
At issue is the 15.3% tax that self-employed individuals pay on their net earnings, commonly referred to as self-employment tax. The self-employment tax rate is the sum of 12.4% for Social Security (old age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). The Social Security tax applies to the first $106,800 of net earnings in 2010; there is no ceiling on the Medicare tax.
Back in 2003, small-business advocates won the first battle in this area by achieving legislation allowing self-employed individuals to deduct the cost of health insurance for income tax purposes. While this change enabled small-business owners to deduct the cost of health care from their income, that income already had been exposed to self-employment tax. Thus, the self-employed effectively paid self-employment tax on income used to purchase health care.
According to a report by the Kaiser Family Foundation, employers paid an average health insurance premium of $13,770 for family coverage in 2010. The 15.3% self-employment tax on earnings used to pay this average premium would be $2,107.
Arguing that this was money that could be used to reinvest in and grow the business, small-business advocates have pushed for legislation that would allow the self-employed to deduct their health insurance premiums on their self-employment tax as well as their income tax.
The new legislation does precisely that. For now, however, the change is limited to the 2010 tax year.
Retirement plan and annuity changes in the 2010 Small Business Jobs Act
The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for small business. Paying for the tax breaks, in large part, are new provisions allowing taxpayers to convert 401(k) and government retirement accounts into Roth accounts, in which they pay taxes up front on the money they contribute, enabling them to withdraw it tax-free after they retire. Advocates of the new provisions argued that the changes would increase flexibility in retirement preparation, while generating immediate revenue for the government. There is also a provision permitting partial annuitization of nonqualified annuity contracts. Here are the details.
Participants in governmental 457 plans allowed to treat elective deferrals as designated Roth contributions. For tax years beginning after Dec. 31, 2010, the new law will allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include designated Roth accounts. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free.
Distributions from elective deferral plans may be rolled over to designated Roth accounts. The new law allows 401(k), 403(b), and governmental 457(b) plans to permit participants to roll over their pre-tax account balances into a designated Roth account. The amount of the rollover will be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans will be able to allow these rollovers immediately upon the Act's enactment.
Nonqualified annuity contracts. The new law permits holders of nonqualified annuities (annuity contracts held outside of a qualified retirement plan or IRA) to elect to receive part of the contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis. The annuity payments must be for a period of 10 years or more, or during one or more lives.
Information reporting changes in the 2010 Small Business Jobs Act
The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. To offset a portion of the cost of the various tax breaks and incentives in the Act, Congress beefed up certain reporting requirements and penalties, in the hope that the added requirements will generate revenue and lead to more effective tax collection. Here are the details of the new reporting requirements.
Information reporting required for rental property expense payments. For payments made after Dec. 31, 2010, the new law requires persons receiving rental income from real property to file information returns with IRS and service providers reporting payments of $600 or more during the year for rental property expenses. Exceptions are provided for individuals 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 requirement would create a hardship (under IRS regs).
Increased information return penalties. For information returns required to be filed after December 31, 2010, the penalties in the tax code for failure to timely file information returns to IRS will be increased. For example, the first-tier penalty will be increased from $15 to $30, and the calendar year maximum will be increased from $75,000 to $250,000. For small filers, the calendar year maximum will be increased from $25,000 to $75,000 for the first-tier penalty. The minimum penalty for each failure due to intentional disregard will be increased from $100 to $250. The penalties for failure to file information returns to payees will be similarly increased.
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