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September 2007 Latest tax legislation brings mostly good news The Small Business and Work Opportunity Tax Act is meant to help offset scheduled increases in the federal minimum wage In late May, Congress passed another major tax law, the Small Business and Work Opportunity Tax Act of 2007, to which we will refer in this article as “the Act.” The stated purpose of the new legislation, which President Bush signed into law on May 25, was to provide small business owners with tax relief to help offset scheduled increases in the federal minimum wage. Consistent with that intent, the Act contains several changes that will be welcome news for businesses, in the form of better depreciation, an improved tax credit for hiring certain workers, and a new structure for businesses co-owned by a husband and wife. Section 179 Expanded Depreciation One of the more important tax provisions for small businesses has been the ability to claim a first-year Section 179 depreciation deduction of up to $100,000 in equipment additions. This provision has been inflation-indexed annually and recently reached $108,000. The Act increases the Section 179 annual dollar limit to $125,000, effective for tax years beginning in 2007. And, in an important corollary adjustment, the asset addition phase-out threshold has been increased to $500,000. For the small business owner, understanding this phase-out threshold may be the more important development. As eligible equipment additions within any year exceed this phase-out threshold, there is a dollar-for-dollar reduction in the eligible Section 179 amount. For businesses reporting on fiscal years, the old limits apply for tax years beginning in 2006 and ending in 2007. Here is a summary of those amounts:
Small business owners who are able to budget their annual equipment additions to stay beneath the asset addition phase-out threshold may actually have greater first-year depreciation deductions than those who exceed that threshold! Spousal Joint Ventures In general, if an entity has two or more owners, it must report as either a partnership or a corporation. In theory, it has not been possible for two individuals to simply split a business and each report their respective share of the income and deductions as a proprietorship within their respective Form 1040s. Beginning in 2007, the new legislation provides a special election for a husband and wife, allowing them to treat a “qualified joint venture” as two proprietorships rather than a more formal partnership. A qualified joint venture is available if the only members are a husband and wife who file a joint Form 1040. Further, both spouses must materially participate in the business activity, to the extent of at least 500 hours per year. Finally, this is an elective provision to which both spouses must consent. When this election is made, the spouses can avoid the formality of filing an actual partnership return. Rather, each spouse simply reports the respective share of the joint venture as a sole proprietorship. Each proprietorship share is subject to the self-employment Social Security tax.
Liberalized Rules for S Corporations The Act makes the following favorable changes (among others) to the S corporation tax rules. S Corp Stock and Securities Gains Not Treated as Passive Income. When an S corporation has earnings and profits (E&P) from prior C corporation years, it can be exposed to a corporate-level tax on excess net passive income. In addition, the corporation’s S status can be revoked if more than 25% of gross receipts are from passive investment income for three consecutive years. Effective for tax years beginning after May 25, 2007, gains from an S corporation’s sales of stock and securities will not count as passive investment income for purposes of these unfavorable rules. Pre-1983 E&P Eliminated for Certain S Corps. If a corporation was an S corporation for any tax year that began before 1983 and was not an S corporation for its first tax year that began after December 31, 1996, any earnings and profits (E&P) accumulated during pre-1983 S corporation years are eliminated from the corporation’s accumulated E&P balance. For an affected S corporation, this favorable provision can reduce the amount of distributions that will be treated as taxable dividends. The change takes effect at the start of the first S corporation tax year that begins after May 25, 2007. Liberalized Jobs Tax Credit For years, the tax law has provided tax credits to encourage employers to hire disadvantaged workers from one of nine targeted groups. At a minimum, the credit is $2,400 for each eligible hire (40% of the first $6,000 of wages). Individuals from some groups qualify for greater credits, and those credits extend into the second year of employment of that individual. The targeted groups have included disabled veterans, rehabilitation referrals, food stamp recipients, and members of families receiving welfare benefits. The Act has expanded one of the targeted categories in a very significant manner, in a change that has not been well-publicized to the business community. The new category of eligible workers is labeled “designated community residents.” It must be an individual who, on the date of hire, is in the 18-39 age group and whose principal residence is within a “rural renewal” county. A rural renewal county is any county that (a) is outside of a metropolitan statistical area and (b) has had a population loss from 1990 through 1994, and again from 1995 through 1999. The IRS instructions for Form 8850 identifies the counties within each state that qualify as rural renewal counties. (Form 8850 instructions are available at www.irs.gov, under Forms and Instructions.) Assuming that an individual meeting these criteria is employed and earns at least $6,000, the employer will qualify for a potential $2,400 Work Opportunity Tax Credit. The individual must have been engaged to begin work after May 25, 2007, and must be certified at the time of hire by the state workforce agency for the applicable location. Employers have only 28 days after the job applicant begins work to submit a certification request to their state workforce agency. IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, is used for this purpose. Any business that may have hired a “rural renewal” county resident within the last 28 days should submit this paperwork to the state employment agency, so that the agency can investigate and complete the certification that will allow this tax credit. A key aspect is that the worker does not need to be a low-income individual or in any other disadvantaged category. This could, in fact, be a highly paid professional worker who happens to reside in a county that has experienced population losses during the prior decade. As a further benefit, any Work Opportunity Tax Credit now has a greater likelihood of producing immediate tax savings. In the past, this and other business credits have been allowed to reduce regular tax but not alternative minimum tax (AMT). Consequently, many business owners could utilize only small amounts of these credits annually, even though their business may have qualified for large tax credits. But for tax years beginning after 2006, the Work Opportunity Tax Credit will offset any tax, whether it is regular tax or AMT. This will make these jobs credits even more lucrative than in the past. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |