On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010.  The legislation includes a number a taxpayer-friendly changes (most of which are temporary), as well as some unfavorable changes (most of which are permanent).  This letter summarizes the most important changes.

SECTION 179 FIRST-YEAR DEPRECIATION DEDUCTIONS DOUBLED FOR 2010 AND 2011

The Section 179 deduction allows many small and medium-sized businesses to immediately write off most or all of the cost of qualifying new and used assets in the first year instead of having to depreciate the cost over a number of years.  The new law doubles the maximum annual Section 179 deduction to $500,000 for eligible assets placed in service in tax years beginning in 2010 and 2011 (up from the $250,000 maximum that applied for tax years beginning in 2009).  Most types of depreciable personal property used in a business qualify.  For the first time, some types of real estate improvement costs also qualify (see below).

However, larger businesses can lose all or part of the Section 179 deduction allowance due to a phase-out rule.  Under that rule, the allowance is reduced dollar for dollar by the cost of qualifying assets placed in service during the year (those that would otherwise be eligible for Section 179) in excess of the applicable threshold.  For tax years beginning in 2010 and 2011, the new law increases the phase-out threshold to $2,000,000 (up from the $800,000 threshold for tax years beginning in 2009).

Note:  Before considering any Section 179 deduction, determine if your business has a tax loss for the year.  You can't claim a Section 179 write-off that would create or increase a business tax loss for the year. 

SOME REAL PROPERTY IMPROVEMENT COSTS QUALIFY FOR SECTION 179 DEPRECIATION DEDUCTIONS

Until now, real property improvement costs were ineligible for the Section 179 deduction.  For tax years beginning in 2010 and 2011, up to $250,000 of improvement costs for certain qualified leasehold improvement property, restaurant property, and retail property can be immediately deducted under the Section 179 deduction provisions.
 
The $250,000 Section 179 allowance for qualifying real estate improvements is part of the overall $500,000 allowance.  Again, if your business already has a tax loss for the year, you can't claim a Section 179 write-off that would create or increase a business tax loss for the year.

50% FIRST-YEAR BONUS DEPRECIATION RETROACTIVELY REINSTATED FOR 2010

The new law retroactively reinstates the 50% first-year bonus depreciation deduction to cover qualifying new (not used) personal property assets and purchased software placed in service by December 31, 2010.  Before this retroactive change, the bonus depreciation provision had expired as of December 31, 2009.  It's now back for eligible assets placed in service by the end of 2010.

Unlike the Section 179 deduction, bonus depreciation is available to even the largest businesses.  However, small and medium-sized businesses that can take advantage of both the Section 179 deduction and bonus depreciation are the biggest winners.

BIGGER FIRST-YEAR DEPRECIATION DEDUCTIONS FOR NEW AUTOS AND LIGHT TRUCKS FOR 2010

If your business buys a new (not used) passenger auto or light truck during 2010 that is subject to the luxury auto depreciation limitations (most passenger vehicles are subject to these rules except for big SUV's, pickups, and vans), the reinstated 50% bonus depreciation write-off increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service by December 31, 2010.

•  For new cars, bonus depreciation raises the first-year depreciation write-off for 2010 to $11,060 (assuming 100% business use).
•  For new light trucks, the maximum first-year depreciation deduction is $11,160 (assuming 100% business use).

START-UP COST DEDUCTION RULE LIBERALIZED FOR 2010

For tax years beginning in 2010, the new law increases the maximum deduction that can be claimed for start-up costs to $10,000 (up from $5,000) in the year when a new business commences operations.  However, the $10,000 deduction allowance starts to phase out once cumulative start-up costs exceed $60,000.  Start-up costs that cannot be deducted in the year when business commences under the $10,000 allowance can be amortized over 180 months, starting with the month when business commences.

QSBC STOCK SALE RULES LIBERALIZED FOR SHARES ISSUED IN NARROW THREE-MONTH WINDOW

Before the new law, non-C corporation sellers of Qualified Small Business Corporation (QSBC) shares generally paid a 28% capital gains tax on only 50% to 75% of the gain on the sale of these shares (depending on when the QSBC shares were purchased).  However, a percentage of the excluded gain was potentially subject to the Alternative Minimum Tax (AMT).  To encourage
 
new investments in QSBC stock, the new law exempts 100% of the gain realized on qualifying sales of QSBC shares that are issued between September 28, 2010 and December 31, 2010.  This 100% exclusion applies for both the 28% capital gains tax and the AMT.

Note:  The QSBC shares must be held for over five years to qualify for any of these gain exclusion breaks.  Therefore, for the 100% exclusion to apply, the sale must occur in 2015 and beyond.  Also, there is only a three-month window of opportunity to acquire QSBC shares that qualify for the 100% exclusion.  If you are interested in taking advantage of this, you will need to close the deal by December 31, 2010.  Also, there are numerous rules that must be met for the stock to qualify as QSBC shares.

BREAK FOR S CORPORATION BUILT-IN GAINS RECOGNIZED IN 2011

When a C corporation converts to S corporation status, the corporate-level built-in gains tax generally applies when built-in gain assets (including receivables and inventories) are turned into cash or sold within the recognition period.  The recognition period is normally the 10-year period (reduced to 7 years for 2009 and 2010 dispositions) that begins on the conversion date.  For tax years beginning in 2011, the new law exempts gains from the built-in gains tax if the fifth year of the recognition period has gone by before the start of the 2011 tax year.  Therefore, deferring asset sales that would generate built-in gains until 2011 is something to consider.

ELIGIBLE SMALL BUSINESSES GET SPECIAL TREATMENT FOR 2010 GENERAL BUSINESS CREDITS

Before the new law, most general business credits could be used to offset regular income tax but not AMT.  General business credits generated in the current year that could not be used in that year (unused credits) could be carried back one year or forward 20 years.  The new law creates an exception that allows general business credits that arise in tax years beginning in 2010 to offset AMT for 2010.  Also, unused general business credits from 2010 can be carried back five years or forward 20 years.  However, these exceptions are only available to Eligible Small Businesses (ESBs) with average annual gross receipts for the preceding three tax years of $50 million or less.

CELL PHONES USED FOR BUSINESS ARE NO LONGER LISTED PROPERTY

Effective for tax years beginning after 2009, cell phones and similar telecommunication devices used for business are no longer subject to the ultra-strict recordkeeping requirements that formerly applied.  This retroactive change has some taxpayer-friendly consequences.  For instance, a self-employed individual is no longer required to keep detailed records to prove that a cell phone is used for business.  However, if the individual has only one cell phone that is used for both personal and business purposes, some sort of recordkeeping will still be necessary to determine allowable business deductions.  An employee who uses a personal cell phone for his or her employer's business can claim the related costs as a miscellaneous itemized deduction without having to prove the phone usage was for the employer's convenience.

Note:  There is some speculation that the Internal Revenue Service might soon issue rules that would allow employers to provide cell phones to employees as a tax-free fringe benefit.

 
HEALTH INSURANCE PREMIUMS CAN BE DEDUCTED IN CALCULATING 2010 SELF-EMPLOYMENT TAXES

Until now, a self-employed individual's federal income tax deduction for health insurance premiums could not be deducted as an expense when calculating his or her self-employment tax liability on Schedule SE.  For 2010, the health insurance premium deduction is allowed as an expense on Schedule SE. 

RENTAL PROPERTY OWNERS MUST ISSUE 1099s TO SERVICE PROVIDERS

Starting in 2012, owning a rental property will generally be considered a business for purposes of the Form 1099 information return reporting requirements.  Therefore, in early 2012 rental property owners will generally be required to file a 2011 Form 1099 for any service provider that is paid $600 or more during 2011 (for things like yard care, painting, and accounting).  Also, a copy of the Form 1099 must be provided to each payee.

Note:  Starting in 2012, another tax-law change included in the healthcare reform legislation will impose additional Form 1099 reporting requirements for payments by businesses. 

HARSHER PENALTIES FOR FAILURE TO COMPLY WITH FORM 1099 REPORTING RULES

Starting next year, the Internal Revenue Service can assess higher penalties for failing to file Form 1099 information returns with the Internal Revenue Service and failing to send copies to payees.  In many cases, the penalties will be doubled.  The new rules will apply to 1099 forms and payee statements due in 2011 and beyond.

CONCLUSION

This letter only covers what we think are the most important tax changes in the Small Business Jobs Act of 2010.  Please contact us if you have questions about issues discussed in this letter or want information about provisions that we have not addressed here.

Sincerely,

SMITH & GESTELAND, LLP

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