Several significant tax law changes will come about as a result of legislation passed in September of this year and legislation passed in previous years that is set to expire at the end of this year.
One of the most significant is the Small Business Jobs Act of 2010. This law, signed by President Barack Obama in September, extends or increases several cost recovery incentives regarding the acquisition of new depreciable property used in a trade or business.
The law extends a 50 percent first-year bonus depreciation that had been set to expire at the end of 2009 until the end of this year. Under bonus depreciation, a company can accelerate depreciation that would otherwise be deducted in later years.
Qualifying equipment must be purchased and placed into service on or before Dec. 31.
“Even the depreciation deductions allowed with respect to passenger automobiles are increased under bonus depreciation,” says Walter M. McGrail, JD, CPA, a senior manager at Cendrowski Selecky PC. “Absent bonus depreciation, passenger automobiles are typically subject to a maximum depreciation deduction in the first year of approximately $3,000. For 2010, maximum first-year depreciation for passenger automobiles is $11,060 ($11,160 for light trucks).”
Unlike Section 179 expensing of the cost of newly acquired depreciable business property, adds McGrail, bonus depreciation is not limited by the size of the business or the dollar value of investment in new depreciable property.
Smart Business spoke with McGrail about the Small Business Jobs Act of 2010 and the key areas that businesses need to pay attention to in the coming months.
What is changing in regard to Section 179 expensing?
The new law increases the maximum deduction for newly acquired depreciable property to $500,000. Qualifying taxpayers may deduct up to $500,000 in the cost of qualifying depreciable property in the year of purchase in lieu of recovering the cost of such property in annual depreciation charges.
A taxpayer’s ability to obtain this deduction is limited by the overall investment in depreciable property for the year. However, the new law increases this overall limit from $800,000 to $2 million for tax years beginning in 2010 and 2011.
How do the qualified small business stock provisions work?
The qualified small business stock provisions have a short fuse and limited applicability, but there are significant advantages for investment in small business stock. The new law increases the benefits of investing in qualified small business stock.
For investments in qualified small business stock post September 2010 and before January 1, 2011, 100 percent of any resulting gain on such stock is excluded from taxation if held for five years. Under the new law, the excluded gain will not generate AMT tax.
Acquired shares must be newly issued shares of a C corporation, not an S corporation, and held until at least 2015.
To be eligible for the exclusion, the individual must generally acquire the small business stock at its original issue (directly or through an underwriter) for money, for property other than stock, or as compensation for services. When the stock is issued, the aggregate gross assets of the issuing corporation may not exceed $50 million. In addition, the corporation also must use at least 80 percent of the value of its assets in the active conduct of one or more qualified trades or businesses.
The amount of gain eligible for the 100 percent exclusion by an individual with respect to any corporation is capped at the greater of 10 times the taxpayer’s basis in the stock, or $10 million.
Are there any other provisions to watch out for?
A C corporation that converts to an S corporation will generally incur federal income taxes on sales of its appreciated assets held at the date of conversion for a period extending 10 years following the conversion. Previous legislation had reduced this holding period to seven years for dispositions during 2009 and 2010.
The new law further shortens the holding period to five years beginning in 2011.
The new law raises the deduction limit for startup expense from $5,000 to $10,000 and increases the phaseout threshold to $60,000 for one year, 2010. Startup expenses are costs related to creating an active trade or business, or investigating the creation or acquisition of an active trade or business.
The increase is viewed as an incentive to investigate and create new businesses.
What tax provisions are expiring at the end of the year?
Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the individual marginal income tax rates were 15, 28, 31, 36 and 39.6 percent. EGTRRA gradually reduced the individual marginal income tax to 15, 25, 28, 33 and 35 percent, with a phase-in of rates at 10 percent.
Absent intervening legislation, effective for tax years beginning after Dec. 31, 2010, marginal tax rates will revert to 15, 28, 31, 36 and 39.6 percent. These rate hikes are in addition to the 0.9 percent Medicare tax on earned income above $200,000 ($250,000 for married couples filing a joint return) and a 3.8 percent Medicare tax on the lesser of the individual’s net investment income for the tax year or modified AGI in excess of $200,000 ($250,000 for married couples filing a joint return).
In addition to the increase in tax rates, the phaseout limitations for personal exemptions (both AMT and regular tax) and itemized deductions will return to previous limitation amounts, effectively reducing the benefit of such deductions.