Federal tax law changes sure to have wide impact
We have commented in recent months that some tax legislation has been in the queue that may be favorable to both individual and business taxpayers. Some recent proposals by the Obama administration have received some press and the attention of both political parties in Congress. In addition, there has been continued debate about extending various tax provisions, including the research tax credit and some or all of the Bush tax cuts.
On Sept. 23, Congressional approval moved one set of tax legislation forward. President Obama signed the Small Business Jobs Act of 2010 Sept. 27. In addition to certain tax relief, which we will discuss below, the SBJA establishes a $30 billion fund to be lent to small businesses. It also provides for some changes to the Small Business Administration loan program to help small businesses gain access to credit. The tax deduction provisions provide approximately $12 billion in tax benefits to affected taxpayers.
Most of the tax incentives are centered on capital expenditures in plant and equipment. The premise being that capital purchases will create or retain jobs in the construction and manufacture of the plant and equipment and in the businesses that put the equipment into service. The SBJA extends bonus depreciation for one year for qualified property acquired and placed into service during 2010. Certain long-lived property and transportation equipment, including private aircraft, can be placed into service in 2011. This is, in effect, a one-year extension of the provision that has been available for property placed into service in 2001 and 2011.
The bonus depreciation is 50 percent of the adjusted basis of the qualified property. The bonus depreciation is allowed for both regular and alternative minimum tax purposes. The president earlier in September announced a proposal for 100 percent bonus depreciation. With a potentially more beneficial depreciation provision on the horizon, it may be interesting what happens with capital expenditures in the final months of 2010 with the certainty of 50 percent bonus depreciation, contrasted with a potential benefit of 100 percent bonus deprecation if the Obama proposal is, in fact, enacted.
Bonus depreciation has been effective several times in recent years. A 30 percent bonus depreciation was in effect for a three-year period (Sept. 10, 2001, to Sept. 11, 2004), and 50 percent bonus depreciation for the investments made from May 5, 2003, to Dec. 31, 2004, and for 2008 and 2009. Thus, for a good part of the past nine years, some form of bonus deprecation has been available.
A bigger concern for many small businesses is not the tax benefits but the ability to borrow to make such a purchase of property. The $30 billion fund is meant to assist on that issue, as many have noted since the recession started that credit has been more difficult for many small businesses to obtain. Also, some of the SBA loan changes are intended to help with the financing issue.
The SBJA also provides for an increase in the amount a taxpayer can expense (at 100 percent) under Code Section 179. The SBJA provides that the maximum amount that can be expensed by qualifying taxpayers is increased to $500,000 for investment in 2010 and 2011. There is a phase-out of the $500,000 amount for investments that exceed $2 million in a given tax year. This provision also applies to certain computer software if placed into service before 2012.
The section 179 provision also has application on a temporary period for certain real property including qualified leasehold improvements, qualified restaurant property and qualified retail improvement property. The limitation under these rules for the 100 percent expensing of these types of real property is $250,000.
The differences in the treatment of real and personal property under the various provisions place an importance in determining the proper tax classification for depreciation purposes of the assets that are acquired or constructed. A cost segregation study may assist in situations where projects include elements of both real and personal property. In addition, the federal bonus depreciation and expensing rules have specific requirements that need to be met, and any taxpayers considering taking advantage of the provisions should consult with their tax advisers on how the rules may impact their depreciation, taxable income and tax liability. Many states do not necessarily follow the federal tax changes for bonus depreciation, and adjustments for state income tax reporting may be required.
The SBJA has many other provisions. We will note a couple of others that may impact West Michigan businesses. The SBJA extends by an additional year for carryback of certain eligible small business credits from one to five years. General business credits continue to be eligible for a 20-year carryover period. This provision applies for credits in the taxpayer’s first tax year beginning after 2009.
The SBJA also provides that general business credits of eligible small businesses reduce both regular and AMT tax liabilities. This is beneficial, as often many taxpayers find that the credits aren’t fully realized since they don’t reduce AMT tax liability. This provision provides the ability to utilize such credits against a taxpayer’s AMT liability.
The SBJA also increases the amount of start-up expenditures that are deductible in the year of starting a new trade or business. Under current law, only $5,000 is allowed as a current year deduction with the remainder amortized ratably over 180 months, starting in the month the business begins. The current amount allowed as an expense is increased to $10,000 with a phase-out of the additional amount if the total start-up expenditures exceed $60,000. This may be of benefit for many that try to start a new business rather than seeking work as an employee, given the lackluster job market in many regions of the country.
The real work of tax legislation may still lie ahead, whether it is considered before the recess for the mid-term elections or during a lame duck session of Congress, or after a new Congress is seated in January. Several expired tax provisions such as the research tax credit still await whether they will again be available for taxpayers to make use of the credit for 2010 and future tax years.
The estate tax also expired in 2010 and will be reset at 2000 levels when it comes back to life in 2011, unless action is taken to adjust the lifetime exemptions and estate tax rate schedule. It appears there is some agreement that the estate tax should resemble the levels of exemptions and tax rates that were in place for 2009, though it not certain in the current political environment in Washington what may actually be agreed to and enacted, if any legislation occurs on the matter. This legislation will have impact on the ability for small businesses to transition from one generation to another within a family.
The Bush income tax cuts with regard to ordinary income tax rates, capital gain tax rates and dividend tax rates are also set to sunset at the end of the year. Marginal tax rates for nearly all taxpayers will increase and the child tax credit will be reduced from $1,000 to $600 per child if no action is taken. Thus, nearly all taxpayers will have an increased tax bill for 2011 if no action is taken. Some action on this is likely as there has been much discussion by both parties on what provisions should be retained and for what levels of income. Some of the debate centers on whether the highest earning taxpayers should receive any benefit of extending many of the Bush tax initiatives. This may not be resolved until a lame duck session of Congress or when the new Congress is seated in January.
The current uncertain status makes it difficult for many taxpayers who have some discretion in their income and deduction situations to make a decision on what to do in the remaining days of 2010 with respect to any year-end tax planning. Many taxpayers are hoping that any outstanding tax legislation is completed by Dec.31, 2010, and not sometime in 2011 with retroactive application to 2010.
William F. Roth III is a tax partner with BDO USA LLP. The views expressed are those of the author and not necessarily those of BDO.