By Paul N. Gada, Toolkit Staff Writer
After months of political wrangling, Congress has passed a small business tax incentives bill coupled with an increase in the federal minimum wage. The Small Business and Work Opportunity Tax Act of 2007 (2007 Small Business Tax Act), signed into law on May 25, 2007, is part of a much larger and more controversial bill--U.S. Troop Readiness, Veterans' Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007.
The 2007 Small Business Tax Act targets nearly $5 billion in tax incentives, principally to small businesses. It also includes tax incentives to help taxpayers recovering from Hurricane Katrina, as well as an important package of S corporation reforms.
However, revenue-raising provisions totaling nearly $5 billion mean more taxes for certain taxpayers. One of the provisions, an expansion of the kiddie tax to apply to children who are under age 19 or who are full-time students up to age 24, will impact millions of families.
Small Business Tax Incentives
The small business tax incentives are designed to help businesses absorb the cost of a higher federal minimum wage. The new law gradually raises the minimum wage to $7.25 over two years. Highlights of the small business tax incentives are:
- an extended and enhanced small business Code Section 179 expensing election
- a FICA tip credit calculation that ignores the new hike in the minimum wage
- an extended and enhanced Work Opportunity Tax Credit
Small business expensing. Almost every new tax law over the past few years has tweaked the small business expensing election, and the 2007 Small Business Tax Act is no exception. The dollar and investment limitations have been increased again starting in 2007.
Under the new law, the base $100,000 limit ($112,000 as indexed for inflation for 2007) is increased to $125,000 for tax years beginning in 2007 through 2010 (indexed for inflation after 2007). The new law also retroactively raises the investment limitation to $500,000 (formerly $450,000) for tax years beginning in 2007 through 2010. The $500,000 amount is indexed for inflation in tax years beginning after 2007 and before 2011.
Because of the extension of enhanced expensing, small business owners now have more certainty when planning future business purchases. The significantly more generous tax break is not only extended through 2010, it is also indexed for inflation. If Congress had not acted, the dollar limitation would have plummeted to $25,000 and the investment limitation to $200,000 after 2009. But since the deduction is completely phased out under the new levels for qualifying purchases above $625,000, the deduction continues to be confined generally to the relatively small business.
FICA tip credit. Under the 2007 Small Business Tax Act, the FICA tip credit will continue to be based on the old minimum wage of $5.15 per hour, rather than the new minimum wage, which will reach $7.25 over the next two years. As a result, even though the minimum wage has increased, the amount of the tip credit will not be reduced. The provision applies with respect to tips received for services performed after December 31, 2006.
For the FICA tip credit, the new law in effect freezes the minimum wage level so that the scheduled increase in the hourly minimum wage will not lower the credit amount.
An employer may claim a credit for FICA tax paid on tips received by employees for serving or delivering food or beverages consumed on the employer's premises if tipping is customary. Employers may claim the FICA tip credit even if employees do not report the tips. The credit equals the employer's FICA obligation (7.65 percent) attributable to tips that exceed those tips treated as wages for purposes of the minimum wage requirements of the Fair Labor Standards Act (FLSA).
Work Opportunity Tax Credit. The 2007 Small Business Tax Act extends the Work Opportunity Tax Credit (WOTC) through August 31, 2011. It had been set to expire for employees hired after December 31, 2007. The new law also broadens the scope of the credit. The expanded WOTC is effective starting May 26, 2007.
The WOTC encourages employers to hire individuals from various economically challenged populations. Traditionally the credit, which is a percentage of qualified wages paid during each of the first two years of employment, targeted individuals receiving public assistance, high-risk youth, ex-felons, veterans, and others similarly situated.
The 2007 Small Business Tax Act expands the targeted veterans' community. It now includes veterans with service-connected disabilities who have been unemployed for six months or more during a one year period ending on the hire date (the six months does not have to be consecutive) and are hired within one year after having been discharged from the military or released from active duty. Additionally, the new law raises the qualified wage threshold for the expanded veterans' groups (from $6,000 to $12,000).
The high-risk youth and vocational rehabilitation referral targeted groups have also been expanded. The new law expands the high-risk youth target group to include individuals from rural renewal counties. These are counties outside of metropolitan areas that experienced population losses in the 1990s.
A major plus of the new law is that it adds some certainty to tax planning. The WOTC, like so many temporary tax incentives, has been renewed year after year but not always early enough for employers to make strategic tax plans.
Family Business Tax Simplification
Under the 2007 Small Business Tax Act, a married couple who jointly operates an unincorporated business and who files a joint return can elect not to be treated as a partnership for federal tax purposes. This treatment is available for tax years beginning after December 31, 2006.
Each spouse would take into account his or her share of income, gain, loss, and other items as a sole proprietor. They would not have to file a partnership return (Form 1065) and report two Schedule K-1s. Instead, couples would each report their share of income on Form 1040, Schedule C.
The husband and wife can be the only members of the joint venture. If there are other individuals in the enterprise, the provision does not apply. Additionally, both spouses must materially participate in the business.
Married couples who in the past attributed all of the income from a joint venture to one spouse need to carefully consider this new provision, especially as it impacts Social Security benefits. The new law aims to ensure that when a married couple jointly own and participate in a small business they both get credit for paying Social Security and Medicare taxes.
S Corporations
The 2007 Small Business Tax Act includes a package of S corporation reforms. The changes impact the treatment of passive investment income, partial sale of qualified subchapter S subsidiaries (QSubs), interest deduction by electing small business trusts (ESBT), reduction of earnings and profits (E&P), and banks operating as S corps.
The new S corp provisions are designed to make it easier for small businesses to retain S corporation status. In two cases, ESBT interest and E&P reduction, they also encourage use of the S corp business entity by effectively reducing the taxes owed by shareholders.
Katrina Recovery Tax Incentives
The 2007 Small Business Tax Act extends and enhances some of the tax incentives in the Gulf Opportunity Zone Act of 2005 and Katrina Emergency Tax Relief Act of 2005. These include the extension of special expensing for qualified property, an enhanced low-income housing credit, and flexible tax-exempt bond financing rules.
GO Zone expensing. The 2007 Small Business Tax Act extends the small business expensing election for "specified GO Zone property" (those continuing to rebuild and recover from Hurricane Katrina and other recent hurricanes) through 2008. The specified areas in the GO Zone include seven Louisiana parishes and five Mississippi counties. Under the new law, the 2007 annual dollar limitation is $225,000 ($100,000 plus the regular expensing election limit, which was raised elsewhere under the new law to $125,000). The increased limits apply to qualifying property placed in service after December 31, 2007, and before January 1, 2009.
The maximum deduction is reduced by the amount by which all qualifying property placed in service during the tax year exceeds an investment limitation. The inflation-adjusted investment limitation for property placed in service in tax years beginning in 2007 has been $1.05 million. The 2007 Small Business Tax Act raises the investment limitation to $1.1 million for 2007 and 2008 ($600,000 plus the investment limit for the regular expensing election).
Low-income housing credit. The 2007 Small Business Tax Act expands the scope of, and loosens the rules for, the low-income housing credit as applied to buildings in the GO Zones.
Extended placed-in-service dates. Under the Gulf Opportunity Act of 2005, the GO Zone, the Rita GO Zone, and Wilma GO Zone were all treated as high-cost areas for property placed into service during calendar years 2006, 2007 and 2008. Property placed in service in these areas during the applicable tax years qualified for the enhanced low-income housing credit. The placed-in-service date is now extended for the enhanced credit in these areas through 2010.
Carryover allocations. Previously, the owner of a qualified building could only claim a credit installment if the owner received a housing credit allocation from the state or local housing credit agency before the end of the year. An exception to this existed where a builder could carry over an allocation because:
- More than 10 percent of the taxpayer's reasonably expected basis was incurred as of the later of six months after the allocation from the government was made or the end of the calendar year in which the allocation was made; and
- The building was placed in service in the GO Zone before the end of the second calendar year following the calendar year of allocation.
The 2007 Small Business Tax Act repeals these two requirements, allowing owners of a qualified building to more easily carry over a credit installment for the 2006, 2007 and 2008 tax years. This removes all obstacles for taxpayers, who have not yet received low-income housing credit allocations from the state and local government, to carry over credits from the 2006 calendar year.
Community developments grants. The 2007 Small Business Tax Act modifies the definition of below-market federal loan for GO Zone buildings by excluding community development grants from the definition of a federal subsidy that would disqualify the building from an enhanced low-income housing credit.
Revenue Raisers
Unfortunately, not all provisions in the 2007 Small Business Tax Act are pro-taxpayer. Some of the revenue raisers will hit a lot of taxpayers' wallets. The measures are expected to raise almost $5 billion over 10 years, making the new law fully offset.
Major "kiddie tax" changes. The 2007 Small Business Tax Act extends the reach of the "kiddie tax" by raising the age limit to include all children under age 19 (previously under age 18) and students under age 24. Both changes are effective for tax years beginning after May 25, 2007.
The effective date for the new kiddie tax provision brings with it some good news and some bad news. For calendar-year taxpayers, the higher age limit starts in 2008. The last hike in the kiddie tax, from age 14 through age 17, was made retroactive to the beginning of 2006. This time, the change is not retroactive and, for most taxpayers, does not take effect until next year. Parents have the option to sell quickly in 2007, while the old rule is still in effect.
However, because this provision is effective for tax years beginning after May 25, 2007, there is also some bad news. It is not until 2008 that capital gain for those in the 15 percent or lower tax brackets fall to zero rather than 10 percent. That zero no-tax rate remains through 2010. Many lawmakers earlier this year called for preventing dependents under age 24 from using the zero percent rate. The new law covers this loophole and more by expanding the kiddie tax.
The actual computation of the kiddie tax remains the same. The net unearned income of the child (for 2007, generally unearned income over $1,700) is taxed at the parents' marginal tax rates, if the rates are higher than the child's tax rates. Only last year, TIPRA raised the reach of the kiddie tax from under age 14 to under age 18.
The main downside of the kiddie tax revenue raisers is that college age students will no longer be able to sell off their appreciated investment accounts set up by the parents to cover current tuition. At a minimum, taking out student loans with interest until the year the student turns 24 will be necessary now to carry forward such a plan. However, the maximum tax of capital gains imposed on any stock sales might rise from 15 to 20 percent after 2010, adding another price tag to postponing income recognition.
So, filling out a satisfaction survey on the 2007 Small Business Tax Act will really depend on who you are and your particular circumstances. If you are a small business owner located in a hurricane-damaged area with no employees or college-bound children who is looking to purchase some new business assets, the latest tax law changes are looking pretty good right now. Everyone else can draw their own conclusions.
- Related items:
- Prepare Now for Next Year's Tax Season
- Last-Minute Tax Filing Tips
- Congress Finalizes Katrina Tax Relief, Turns to Reconstruction Funding
Added to the news on June 4, 2007.
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