July 9, 2007
Dear Client,
As you probably know, Congress recently passed the 2007 Small Business Act. This new legislation was designed ostensibly to soothe the burden on small business of the increase in the minimum wage from $5.15 to $7.25 per hour over two years. There are an assortment of tax relief and revenue raising provisions. Here are the main tax provisions under the new law as well as a couple of law changes effective last year.
Recent tax breaks:
Recent tax relief provisions:
- Extend and enhance Section 179 small business expensing. The Code Sec. 179 expensing limit is increased to $125,000 and the investment-based expensing phase-out is increased to $500,000, effective for tax years beginning after 2006, and the enhanced expensing provision is extended for another year (through 2010).
- Renewed deduction for state and local sales taxes through 2007 (actually from the Tax Relief and Health Care Act of 2006).
- The up to $4,000 above the line deduction for higher education expenses is extended through 2007. (Also from the 2006 Act.)
- Extend and liberalize the work opportunity tax credit. The credit is extended for 3.5 years with liberalized rules for hiring disabled veterans and workers in rural renewal counties.
- Extend and enhance certain GO Zone tax incentives. The small business expensing rules allowed for GO Zone businesses (i.e., $100,000 higher expensing limit and $600,000 higher phase-out point) are extended for one year (through 2008) for small businesses in the hardest hit area of the GO Zone. Also, the low-income housing credit rules for buildings in the GO Zones are extended and expanded, and the bond financing rules for repairs and reconstructions of residences in the GO Zones are modified.
- Enhance the tip credit for certain small businesses. The Federal minimum wage level for purposes of calculating the tip credit is frozen, thereby allowing restaurants to continue claiming the full tip credit despite an increase in the Federal minimum wage.
- Simplify family business tax. An unincorporated business that is jointly owned by a married couple in a common law state is permitted to file as a sole proprietorship (under prior law, unless the married couple was located in a community property state, both the married couple and the business were subject to penalties for failing to file as a partnership). The new law also ensures that both spouses receive credit for paying Social Security and Medicare taxes.
- Waive individual and corporate AMT limitations on work opportunity tax credits and tip credits. Prior law limited a small business' ability to claim the work opportunity tax credit and the tip credit by imposing a limitation that such credits could not be used to offset taxes that would be imposed under the alternative minimum tax (AMT). The new law provides a permanent waiver of the individual and corporate AMT limitations for the work opportunity tax credit and the tip credit.
- Liberalize several S corporation rules. The new law also contains several provisions beneficial to S corporations, including measures that:
- Redefine "passive investment income" for purposes of S corporation revocation rules to exclude gains from the sale or exchange of stock or securities as an item of passive investment income.
- Exclude restricted bank director stock from treatment as S corporation stock.
- Set forth a special accounting rule for banks that become S corporations and that change from the reserve method of accounting for bad debts.
- Revise the tax treatment of sales of stock of wholly-owned subsidiaries of S corporations.
- Eliminate pre-1983 earnings and profits arising during an S corporation year, regardless of whether the corporation was an S corporation in its first taxable year beginning after December 31, 1996.
- Permit an electing small business trust (ESBT) to deduct interest expense it incurs when it borrows funds to purchase S corporation stock.
Revenue provisions (offsets).
The 2007 Small Business Act pays for the above benefits by:
Raising the kiddie tax age from under-18 to under-19 (under-24 if a student). The kiddie tax curtails the ability of parents to significantly lower their family's tax bill by transferring investment assets to low-taxed minor children. For 2007, a child under age 18 pays tax at his or her parent's highest marginal rate on the child's unearned (investment) income in excess of $1,700. However, the kiddie tax does not apply to a child who is married and files a joint return for the tax year. Unearned income within reach of the kiddie tax includes interest, dividends and capital gains.
The new law did not change the kiddie tax rules for children under age 18. But it did expand the kiddie tax to apply (starting next year) where:
- a child turns age 18, or turns age 19-23 if a full-time student, before the close of the tax year;
- the child's earned income for the tax year doesn't exceed one-half of his or her support;
- the child has more than $1,700 of unearned income (but the $1,700 may be higher after an inflation adjustment is released later this year for 2008);
- the child has at least one living parent at the close of the tax year; and
- the child doesn't file a joint return for the tax year.
This expansion of the kiddie tax rules attempts to curtail a strategy some wealthy (and some moderate-income) parents were advised to use to take advantage of a beneficial feature of the long-term capital gains rate.
Please keep in mind that we have described only the highlights of the most important changes in the new law. Give us a call at your earliest convenience for more details on how you may be affected by this important tax legislation.
Barto, Hoss & Company
If you would like to schedule a planning meeting or have questions please contact us.