San Jose CPA - Tax Planning

2010 Small Business Jobs Act

The recently enacted 2010 Small Business Jobs Act includes a wide-ranging assortment of tax breaks and incentives for small business, paid for with various revenue raisers. Here's a brief overview of the tax changes in the new law.

Tax breaks and incentives

Enhanced small business expensing (Section 179 expensing). In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Jobs Act law, taxpayers could expense up to $250,000 of qualifying property—generally, machinery, equipment and certain software—placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling). Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000.

The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).

100% exclusion of gain from the sale of small business stock for qualifying stock acquired after date of enactment, September 27, 2010, and before Jan. 1, 2011. Before the 2009 Recovery Act, individuals could exclude 50% of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60% for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don't exceed $50 million, and the corporation must meet active business requirements). Under the 2009 Recovery Act, the percentage exclusion for gain on QSBS sold by an individual was increased to 75% for stock acquired after Feb. 17, 2009 and before Jan. 1, 2011. Under the new law, the amount of the exclusion is temporarily increased yet again, to 100% of the gain from the sale of qualifying small business stock that is acquired in 2010 after date of enactment and held for more than five years. In addition, the new law eliminates the alternative minimum tax (AMT) preference item attributable for that sale.

General business credits of eligible small businesses for 2010 allowed to be carried back five years. Generally, a business's unused general business credits can be carried back to offset taxes paid in the previous year, and the remaining amount can be carried forward for 20 years to offset future tax liabilities. Under the new law, for the first tax year of the taxpayer beginning in 2010, eligible small businesses can carry back unused general business credits for five years. Eligible small businesses consist of sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.

General business credits of eligible small businesses in 2010 aren't subject to AMT. Under the AMT, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.

S corporation holding period. Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built-in gain at the highest corporate rate of 35%. This holding period is reduced where the 7th tax year in the holding period preceded the tax year beginning in 2009 or 2010. The 2010 Small Business Jobs Act temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th tax year in the holding period precedes the tax year beginning in 2011.

Extension of 50% bonus first-year depreciation. Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009 (2010 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).

Special rule for long-term contract accounting. The new law provides that in determining the percentage of completion under the percentage of completion method of accounting, bonus depreciation is not taken into account as a cost. This prevents the bonus depreciation from having the effect of accelerating income.

Boosted deduction for start-up expenditures. The new law allows taxpayers to deduct up to $10,000 in trade or business start-up expenditures for 2010. The amount that a business can deduct is reduced by the amount by which startup expenditures exceed $60,000. Previously, the limit of these deductions was capped at $5,000, subject to a $50,000 phase-out threshold.

Limitation on penalty for failure to disclose certain reportable transactions (including listed transactions) on a return. The new law limits the penalty to 75% of the decrease in tax resulting from the transaction. The minimum penalty is $10,000 for corporations and $5,000 for individuals (for failure to report a listed transaction, the maximum penalty is $200,000 and $100,000, respectively). These changes are retroactively effective to penalties assessed after Dec. 31, 2006.

Deductibility of health insurance for the purpose of calculating self-employment tax. The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.

Cell phones removed from listed property category. This means that cell phones can be deducted or depreciated like other business property, without onerous recordkeeping requirements.

My employer granted me incentive stock options as part of my compensation package. I was considering exercising some of my options this year. So what are the tax implications?
When you are granted Incentive Stock Options (ISOs), there is no tax effect for you. When you exercise the options there is no addition to your regular taxable income. HOWEVER (the big caveat), there is an addition to your alternative minimum taxable income. Alternative minimum taxable income is a separate income tax calculation that includes certain items that the regular income tax calculation does not include. One of those items which is included in alternative minimum taxable income and not in regular taxable income is the difference between the market price of stock and the option price of stock on the day the option is exercised. For example, today you exercised 3,000 options which were granted to you through the company's incentive stock option plan. The option price was $1.75 per share (and so you wrote the company a check for $5,250). The market price today was $31.75 per share. You have no additional taxable income for regular tax purposes. You DO however have $90,000 of additional taxable income for alternative minimum tax purposes. If you are considering exercising incentive stock options, it is probably wise to undertake some measure of tax planning in order to gauge the effect of the alternative minimum tax on your overall tax picture. Also be aware of the timing rules related to sale of stock acquired through the exercise of stock options.

What's the difference between Incentive Stock Options (ISOs) and non-qualified stock options?
The primary difference relates to taxation at the date of exercise. Whereas Incentive Stock Options are not subject to regular income tax when exercised, non-qualified stock options are. Note that regular income tax is mentioned. When exercising Incentive Stock Options, attention should be paid to the Alternative Minimum Tax (AMT).

I am considering accepting a new position in California. What will the tax consequences be?
California does have relatively high individual income tax rates (9.3% at the highest). California also has relatively high real estate prices (which leads to some of America's highest mortgage interest deductions). In order to assess the effect of these variables on your financial picture, and whether your new compensation package is adequate, a three to five year tax planning projection compared against your current situation can often be quite valuable. In fact, it may be possible to show from an after tax, cash flow perspective how a higher salary will be required from a prospective employer before a decision is made.

What approach is used in planning for multiple years at the same time?
Tax planning software that handles multiple years simultaneously is used. For example, your decision to sell stock in one year may affect your April 15 tax liability in the next year. That upcoming tax liability may cause you to have to sell stock next year. If you do sell stock, and pay tax, how will that affect your AMT in the following year? An example of a multi-year tax projection can be found by clicking here.

Tax planning is important as a part of your overall financial planning picture. We work with attorneys, CFPs, and other financial and investment advisors to guide our clients. In this economy, we can assist you to protect you and your family's future. .