By Mitchell R. Kops, Sanford J. Davis, and William J. Kambas
President Obama recently signed into law the Small Business Jobs Act of 2010 (the "Act"). After stalling in Congress earlier this year, the Act progressed rapidly in the month of September as the Senate and House approved it on September 16 and 23, respectively. It was signed into law on September 27, 2010. The Act seeks to stimulate entrepreneurial growth in three ways:
- 1) Increasing entrepreneurs' access to capital by facilitating certain lending programs;
- 2) Encouraging expansion into new markets; and
- 3) Creating tax incentives to promote access to capital, new investment, entrepreneurship, and business operations.
While increasing access to capital and encouraging overseas expansion are welcomed developments, it is the tax provisions of which business owners and entrepreneurs immediately should be aware. These tax incentives offer targeted relief for small business owners and also benefit certain larger enterprises. However, they are either temporary or apply only to specific tax years. Additionally, the Act contains "revenue raisers" that could create new tax risk.
This alert will first address the tax incentives and will close with a brief discussion of the provisions relating to increased financing and export incentives.
1) Tax incentives to simulate business and entrepreneurial development
- a) Exclusion on Sale/Exchange of Qualified Small Business Stock
The Act amends Internal Revenue Code (the "IRC" or "Code") Section 1202, which excludes from taxable income gains from the sale of certain small business stock, by providing for a 100% exclusion of gain from the sale or exchange of qualified small business stock acquired after the enactment date of the Act and before January 1, 2011. To qualify for the exclusion, the sale or exchange cannot occur until the taxpayer has held the stock for more than five years. For further discussion of this provision, please see our tax alert.
- b) Business Credits Available to Eligible Small Businesses
The Act added a number of new provisions relating to business credits.
AMT Offset. Eligible small businesses ("ESBs," which are businesses that have average annual gross receipts over the three prior tax years of no more than $50 million) can offset their regular and, now, the
alternative minimum tax ("AMT") for tax years that begin in 2010 with ESB credits (which include but are not limited to the investment credit, the work opportunity credit, the alcohol fuels credit, the research credit, and the renewable electricity production credit, among others). The Act now treats the "tentative minimum tax" calculated by businesses as being zero for purposes of the ESB credits, which therefore offsets both regular and AMT liability. This change applies for credits determined in tax years beginning in 2010 and to carrybacks of such credits.
Increased Deduction for Start-up Expenses. The Act doubles the deduction allowed for start-up expenditures. The deduction can now be an amount up to $10,000 and the phase out threshold is increased to $60,000. A business must reduce the amount it deducts to the extent start-up expenditures exceed $60,000. Typical start-up expenditures include advertising costs, employee training expenses, professional consulting fees, and the cost of analyzing potential markets. This deduction is available for tax years beginning after 2009 but before 2011.
Extended Carryback. The Act extends the carryback period for unused general business credits. For credits determined in a taxpayer's first year beginning in tax year 2010, ESBs can carry back unused general business credits for up to 5 years. This begins with credits earned in 2010.
- a) Temporary Reduction in S Corporation Recognition Period
The Act offers tax relief to S corporations by reducing the built-in gains tax recognition period. The Code imposes a 35% tax on built-in gains recognized within a specified number of years after a C corporation elects to become an S corporation or when an S corporation receives property from a C corporation in a nontaxable carryover basis transfer to the extent that gains are recognized during a "recognition period." Under the Act, the recognition period is reduced to 7 years for tax years beginning in 2009 or 2010 if the seventh year precedes such tax year and 5 years for tax years starting in 2011 if the fifth year precedes such tax year. This provision only applies for the 2009, 2010, and 2011 tax years.
- b) Liberalized Expensing Rules for Tax Years 2010 and 2011
The Act increases the amount taxpayers may expense under IRC Section 179 and extends benefits to real estate assets for the 2010 and 2011 tax years. Specifically, entrepreneurs and business owners should be aware of the following:
- 1. With Regard to Tangible Personal Property
The Act increases the maximum expensing limit under IRC Section 179 applicable to computer software and depreciable trade or business property to $500,000 and raises the phase out threshold amount to $2 million. For example, if a taxpayer places Section 179 property into service in 2010 with a cost of $2.1 million, the taxpayer can elect to expense $400,000, an amount equal to $500,000 (the maximum expense amount for 2010) less $100,000 (the amount by which the cost of the Section 179 property, $2.1 million, exceeds the 2010 phase out amount, $2 million). The provision also allows taxpayers who have already placed Section 179 property into service to benefit from these new rules. This applies to tax years beginning in 2010 and 2011. The Act also allows taxpayers to revoke Section 179 elections without IRS consent for any tax year beginning after 2002 but before 2012.
•2. With Regard to Real Property
Section 179 expensing previously was limited to tangible personal property. The Act authorizes taxpayers to treat up to $250,000 of the cost of qualified real property (which includes leasehold improvements, restaurants, and retail property) as property eligible to be expensed. As such, the Act marks the first time that taxpayers can apply Section 179 expensing rules to real property. As above, this applies to tax years beginning in 2010 and 2011.
- c) Extension of First-Year Bonus Depreciation
The Act extends for an additional year the temporary 50% depreciation bonus that allows a taxpayer to depreciate 50% of the basis of qualified property in the year the property is placed into service and then amortize the remaining 50% of cost using normal depreciation rules. The additional depreciation applies to purchases of eligible property any time in 2010 (even before the enactment of the Act). The bonus first-year depreciation provisions of the Act apply to both large and small businesses. Certain "long-lived" property also would qualify if placed into service in 2011.
Additionally, the Act provides beneficial rules for certain 7-year property (which includes computer software, water utility property, and qualified leasehold improvement property). Specifically, the Act decouples bonus depreciation from allocation of contract costs under the percentage of completion accounting method rules for assets with depreciable lives of 7 years or less. Contractors who do not complete contracts within the same year in which they are entered may benefit from these provisions and may still be able to capitalize on the bonus depreciation rules. Generally speaking, these rules apply to qualifying property placed in service in 2010 and 2011.
- e) Promoting Entrepreneurship and Small Business Fairness
The Act contains other tax incentives aimed specifically at small business owners and entrepreneurs in order to promote entrepreneurship and small business fairness. For example, it allows a self-employed taxpayer to deduct health insurance costs when calculating self-employment taxes for the 2010 tax year.
The Act also removes cell phones and similar communications equipment from the listed property category of Section 280F, which limits deductions for business property also used for personal purposes, for tax years starting after December 31, 2009.
- f) Limitation on Penalties for Failure to Disclose Reportable Transactions
The Act relaxes the penalty for failure to disclose reportable transaction information with a tax return. Reportable transactions are those identified by the IRS as listed tax shelters or those with similar characteristics (i.e. large losses or confidentiality agreements). The penalty is now limited to 75% of the tax benefit received and establishes penalty ranges of $10,000-$200,000 for corporations and $5,000-$100,000 for individuals. For reportable transactions that do not qualify as listed transactions, the Act establishes maximum penalties of $10,000 and $50,000 for individuals and corporations, respectively. The relaxed penalty provisions apply retroactively to penalties assessed after December 31, 2006.
2) "Revenue Raisers": a counterpart to the tax incentives
The Act contains multiple provisions expected to raise the revenue lost by granting the incentives above. These "revenue raisers" include, but are not limited to, the following:
- a) Rental Income Information Reporting
Taxpayers who engage in real estate rentals must now report payments of $600 or more for rental property expenses. There are three exceptions to this new reporting requirement: (i) for those who only temporarily rent their principal residences (which would include members of the military); (ii) for those whose rental income is less than an IRS-determined amount; and (iii) for those for who the reporting requirement would create a hardship, as determined by the IRS. This new reporting applies to rental income generated after December 31, 2010.
- b) Penalties for Failure to Timely File Information Returns
The Act increases penalties for failure to timely file information returns (which generally includes Forms 1099 and W-2) with the IRS. The IRS employs a "tiered" system that specifies penalty amounts based on levels of violation (i.e., the delay in filing and whether it was corrected in a timely manner). The first-tier penalty moves from $15 to $30 with an increase in the yearly maximum penalty from $75,000 to $250,000. The Act also raises the second-tier penalty from $30 to $60 and the calendar year maximum penalty from $150,000 to $500,000. The third-tier penalty increases from $50 to $100 with an increase in the calendar year maximum from $25,000 to $1.5 million.
Small businesses (those with gross receipts of not more than $5 million) are not exempt from increased penalties. They face increased annual maximum penalty amounts for each of the three respective tier. The first-tier maximum penalty increases from $25,000 to $75,000. The second-tier maximum increases from $50,000 to $200,000. The Act raises the third-tier maximum penalty from $100,000 to $500,000. Under the Act, the minimum penalty for each failure to report because of intentional disregard increases from $100 to $250.
The Act also amends the current rules for failure to furnish payee statements by imposing a tier and cap regime similar to the penalty scheme for failure to timely file information returns. These rules apply to information returns required to be filed after December 31, 2010.
- c) New Source Rules on Guarantees Affecting International Business Operations
Under the Act, guarantee fees will be sourced like interest. That is, guarantee fees will be sourced to the residence of the payor and will be subject to withholding tax. Therefore, guarantee fees paid by a US entity to a non-US entity will now be characterized as a US source payment subject to US withholding tax (30% of the gross amount) as if it were an interest payment. This applies to guarantees issued anytime immediately after enactment of the Act on September 27, 2010.
- d) Corporate Estimated Tax Payment
Though not taking effect for a few years, the Act increases the estimated tax payments due for large corporations (those with assets of $1 billion or more) in 2015. Specifically, each installment of estimated tax (typically due in July, August, and September) in 2015 is increased by 36%. Estimated taxes were last adjusted through the Hiring Incentives to Restore Employment (HIRE) Act, which was enacted in March 2010, and are now again being adjusted. Following the Act, the required payment due at each installment goes from 123.25% to 159.25% (123.25% + 36% = 159.25%).
3) Lending Programs
The Act attempts to increase the capital available to small businesses by granting greater access to certain governmental lending programs. First, it increases the ability of the Small Business Administration (the "SBA") to fund businesses by increasing the SBA's ability to provide guarantees. Second, it increases the SBA's potential loan participation to 90% of the balance of the financing outstanding for most loans. Finally, the Act also increases the maximum loan amount under the 7(a) Loan Program from $2 million to $5 million.
The Act also establishes a $200,000 Treasury-supported lending facility for eligible intermediaries that make certain small business loans for the purpose of funding start-up, newly created, and growing small businesses in order to provide working capital and other capital needed for real estate, materials, supplies, fixtures, and equipment.
4) Export Incentives and Assistance
The Act attempts to increase export activity. It does so by tasking the Office of International Trade to maintain a distribution network for programs related to trade promotion, finance, adjustment assistance, remedy assistance, and data collection. The goal of this mandate is to enhance the ability of small businesses to compete in foreign markets.
Additionally, the Act creates a 3-year trade and export promotion pilot program that provides grants to states for export programs that assist eligible businesses. To qualify for the pilot program, a small business must:
- (1) be in operation for at least 1 year;
- (2) operate profitably based on U.S. operations;
- (3) demonstrate an understanding of exporting costs and operating in foreign markets; and
- (4) have a strategic exporting plan in effect.
The information in this article is provided for the purposes of general information only and does not constitute legal advice. Users should take appropriate legal advice based on their individual circumstances. Withers accepts no responsibility or liability for any loss which may result from reliance on any of the information contained in this article.
© Withers LLP. This article is republished with the permission of Withers LLP. Further duplication without the permission of Withers LLP is prohibited. All rights reserved.
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