Business Provisions of the Small Business Jobs Act of 2010
In an effort to provide financial assistance to small businesses, Congress has passed the Small Business Jobs Act of 2010 (H.R. 5297 or “the Act”) which was signed into law by the President on September 27, 2010. The Act is intended to encourage investment and job creation in part by establishing a $30 billion small business fund and by providing limited tax relief primarily to small businesses.
Below is a brief summary of several of the more significant tax provisions of the Act which may affect our business clients. We will also separately summarize certain tax provisions affecting retirement plans, individual clients and tax penalties.
1. Exclusion of Gain from Sale or Exchange of Qualified Small Business Stock
Under prior law non-corporate taxpayers excluded from gross income 75% of the gain from the sale or exchange of qualified small business stock acquired between February 18, 2009, and the end of 2010, but the exclusion returned to 50% for qualified small business stock acquired after 2010. Qualified small business stock is stock acquired upon its first issuance from a C corporation which then has adjusted gross assets of $50 million or less, at least 80% of which are used in the active conduct of a trade or business, and held for at least 5 years.
Under the Act, the exclusion from gross income increases to 100% for qualified small business stock acquired after the day of enactment – September 27, 2010 – through the end of 2010. The exclusion also applies in computing the individual Alternative Minimum Tax (AMT). (Under prior law, 3.5% of the gain from the sale of qualified stock was treated as a preference item and added back for AMT calculations.)
Observation: The window for acquisition of qualified stock entitled to the expanded exclusion is narrow – from late September 2010 through the end of this year.
2. Carry-Back of Unused Credits and Relief from AMT for Small Businesses
Under prior law unused general business credits could be carried back only to the previous tax year. Under the Act, unused general business credits generated in the tax year beginning in 2010 may be carried back up to five years for businesses with average annual gross receipts of $50 million or less in the past three tax years. Also, such businesses may use all general business credits they claim to lower any AMT liability for the tax year beginning in 2010.
Observation: A partnership’s or S corporation’s credits are not eligible small business credits unless the partners or shareholder(s) also meet the gross receipts test. Moreover, the business cannot be a publicly traded company.
General business credits include credits such as the Work Opportunity Tax Credit, Low Income Housing Credit, Disabled Access Credit, Empowerment Zone Hiring Credit, and the Employer Provided Child Care Credit.
Observation: One popular general business credit – the Research & Development Credit – is not currently available in 2010 for this beneficial treatment. It expired at the end of 2009 and it’s unclear whether it will be reinstated in 2010 and, if it is, whether it will be retroactive for all of 2010.
3. Reduced Application of Built-In Gains Tax for S Corporations
Generally an S corporation is not subject to corporate level tax, but the individual shareholders are taxed on its profits. However, under prior law, a C corporation that converted to an S corporation was subject to the highest rate of corporate level tax on gain that arose prior to the conversion, where the gain is recognized by the S corporation within ten years after its conversion (seven years for property sold in 2010 or 2011). Under the Act, an S corporation that previously converted from C corporation to S corporation status and that sells property at a gain in 2011, where the gain arose prior to conversion, is subject to corporate-level tax only if the property is sold within five years after becoming an S corporation.
Observation: This provision will free-up capital for an S corporation by allowing divestment during 2011 of assets no longer needed by the business, but held more than five years after conversion from C corporation to S corporation status, with no corporate-level tax.
4. Expensing of Depreciable Business Assets
Under prior law, eligible taxpayers could elect to deduct the costs of certain depreciable business assets or so-called qualified Section 179 property. Up to $250,000 of these costs could be deducted immediately for tax years beginning in 2010, with a phase-out occurring when the costs of such property exceed $800,000 during the year.
Under the Act, the maximum deduction is increased to $500,000 and the phase-out threshold is increased to $2 million for property placed in service in tax years commencing in 2010 and 2011.
- The Act expands the definition of Section 179 property to include qualified real property, encompassing qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. However, taxpayers are limited to expensing up to $250,000 of the total cost of these properties. In addition, since the amount of Section 179 property costs which can be expensed in a given year generally cannot exceed taxable income derived from an active trade or business in the year, it should be noted that under the Act Section 179 deductions attributable to qualified real property which are disallowed under the trade or business income limitation can only be carried over to tax years in which the definition of eligible Section 179 property also includes qualified real property.
- The Act also extends treatment of computer software as Section 179 property through 2012.
- Taxpayers should carefully analyze their fixed asset procurement budgets to determine if they should accelerate or defer purchases to take full advantage of the Section 179 deduction. For example, a taxpayer may elect to exclude real property from the definition of Section 179 property, if it is close to reaching the $2 million cap beyond which the deduction phases out.
5. Extension of Bonus Depreciation
Under previous legislation that expired at the end of 2009, taxpayers were permitted to depreciate 50% of the cost of certain qualified property in the first year it was placed in service. The new Act extends first-year bonus depreciation to qualified property placed in service through the end of 2010, retroactive to January 1, 2010. Further, the Act extends first-year bonus depreciation to qualified property placed in service through 2011, if it has a recovery period of 10 years or more or is transportation property.
- Bonus depreciation is available to businesses of all sizes – not just small businesses.
- However, this window of opportunity expires for most property placed in service after 2010, and after 2011 for property with a recovery period of ten years or more and transportation property.
- Notably, the new law decouples depreciation from allocation of contract costs under the percentage-of-completion method for assets with depreciable lives of seven years or less which are placed in service after 2009. This decoupling permits taxpayers using the percentage-of-completion method to utilize bonus depreciation in the year such property is placed in service.
6. Increased Deduction for Start-Up Expenses
Under prior law, a taxpayer could elect to deduct start-up expenditures in the year in which its active trade or business begins, to the extent that such expenditures did not exceed $5,000, reduced by the amount that such start-up expenditures exceeded $50,000. Under the Act, the amount of deductible start-up expenditures for 2010 and later years that may be deducted in the year an active trade or business begins rises from $5,000 to $10,000 and the phase-out threshold is increased from $50,000 to $60,000.
- Start-up expenditures not deducted in the year in which the active trade or business begins remain deductible ratably over 180 months beginning with the month in which the active trade or business begins.
- Start-up expenditures are amounts paid or incurred in connection with investigating the creation or acquisition of an active trade or business, creating an active trade or business, or any activity engaged in for profit and for the production of income, before the day on which the active trade or business begins.
7. Reporting of Rental Property Expenses
The Act requires taxpayers who receive rental income from leasing real property to file information returns (typically Forms 1099) with the Internal Revenue Service (IRS) and with service providers to report payments of $600 or more to a service provider in any tax year – beginning with 2011 – in the course of earning rental income.
Observation: Exemptions from the general reporting requirements are allowed for members of the military or employees of the intelligence community who rent their primary residences, individuals receiving minimal amounts of rental income (to be determined under IRS regulations), and individuals for whom the requirements would impose hardship (also to be determined under IRS regulations).
8. Sourcing of Income from Guarantees
The Act amends the sourcing rules for income from the guarantee of indebtedness. U.S. source income includes amounts received directly or indirectly from a domestic corporation or a non-corporate U.S. person for the provision of a guarantee of indebtedness of such person made after the Act’s enactment date of September 27, 2010.
- An indirect (as opposed to direct) payment can include payment by a foreign bank to a foreign corporation, for the foreign corporation’s guarantee of its U.S. subsidiary’s debt to the foreign bank, where the foreign bank charges additional interest to the U.S. subsidiary to compensate for the fee it pays to the foreign guarantor corporation. In this situation, the foreign guarantor’s payment from the foreign bank will be U.S. source income.
- Congress intends to overturn the U.S. Tax Court’s decision in Container Corp., 134 TC No. 5 (2010), which held that a guarantee is analogous to services and therefore the fee paid is sourced to the country where the services are performed, i.e., the guarantor’s country. The Act treats the payments as interest and sources them generally to the country of the guaranteed party.
- In addition, fees received for providing a foreign person with a guarantee of indebtedness are U.S. source income, if such amount is connected with income which is effectively connected with the conduct of a U.S. trade or business.
For further information on any of these provisions, or other tax or financial provisions of the Act, please consult Aninda Dhar, Lorin Luchs, Gerry O’Beirne, Murray Solomon or another EisnerAmper LLP professional.
This publication is intended to provide general information to our friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.