Business Year-End Tax Planning
Year-end tax planning for businesses received a welcome boost recently when Congress passed the Small Business Jobs Act of 2010. The new law extended some valuable and well-publicized business tax incentives, such as bonus depreciation and Code Sec. 179 small business expensing. At the same time, businesses can benefit from many other tax incentives, some of which are new for 2010 and require quick action. This newsletter explores some year-end planning activities that may be valuable for your business.
Bonus depreciation is valuable because there is no limit on the total amount of bonus depreciation that may be claimed in any given tax year. However, the window to take advantage of bonus depreciation under the 2010 Small Business Act is small. Taxpayers generally must place in service qualified property before January 1, 2011.
Before Congress passed the 2010 Small Business Act, 50 percent bonus depreciation applied to property acquired after December 31, 2007, and placed in service before January 1, 2010. Certain property with a longer production period was eligible for an extended placed-in-service deadline before January 1, 2011.
The 2010 Small Business Act extends 50 percent bonus depreciation for qualified property placed in service before January 1, 2011. Bonus depreciation applies to new property (property whose original use begins with the taxpayer) that is depreciable under MACRS and has a recovery period of 20 years or less, is off-the shelf computer software, or is qualified leasehold improvement property. There is also an extended place-in-service date through December 31, 2011 for property with a longer production period.
Let’s look at an example. ABC Co. purchases qualifying property before January 1, 2011. The property costs $100,000 and is five-year property. ABC Co. can take 50 percent bonus depreciation of $50,000 in the first year. This reduces the property’s basis to $50,000. The taxpayer can also take one-half of a full year’s depreciation in the first year. For 2010, ABC can deduct depreciation of $60,000. The remaining $40,000 is deducted throughout the subsequent four years of the property’s term.
Taxpayers may also claim additional bonus depreciation of $8,000 for the purchase of cars and light trucks/vans, making the total deductible amount for 2010 $11,060 for passenger cars and $11,160 for trucks. Generally, these amounts are reduced proportionately if use of the automobile or truck is less than 100 percent business-related. However, these higher amounts will not be available after December 31, 2010.
Code Sec. 179 expensing. Under Code Sec. 179, taxpayers can elect to recover part or all of the cost of qualified property, up to a limit, by deducting it in the year it is placed in service. Code Sec. 179 expensing is often called small business expensing but recent increases have significantly expanded its scope. The Code Sec. 179 dollar and phase out investment limits are $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The Code Sec. 179 expensing deduction enables many businesses to deduct the entire cost of their depreciable property during the year it is purchased and placed in service.
Businesses have enhanced planning opportunities for Code Sec. 179 expensing in tax years beginning in 2010 and 2011 with regards to certain improvements. A taxpayer can elect up to $250,000 of the $500,000 Code Sec. 179 deduction limit (subject to the investment limitation) for qualified real property. There are three types of qualified real property: (1) qualified leasehold improvement property; (2) qualified restaurant property and (3) qualified retail improvement property.
Payroll Tax Exemption
Employers that hire certain unemployed individuals after February 3, 2010, and before January 1, 2011 may qualify for a 6.2-percent payroll tax incentive. The incentive exempts businesses from paying the employer’s share of Social Security taxes on wages paid to qualified new hires after March 18, 2010 and before January 1, 2011. Some employers mistakenly believe that they cannot claim the incentive unless they had previously laid off employees. This is incorrect. The payroll tax exemption can apply to wages paid to any qualified employee.
Not every new hire may qualify for the incentive. Generally, a qualified employee is an individual who was unemployed or who was employed but worked 40 hours or less during the 60-day period ending on the date of new employment. The individual also must not have been hired to replace another employee of that employer, unless the other employee separated from employment voluntarily or was terminated for cause. Certain family members of the employer or employees who are related in other ways to the employer are not qualified employees for purposes of the payroll tax exemption.
Worker Retention Credit
Related to the payroll tax exemption is a new but temporary worker retention credit. An eligible employer may claim the credit for each new hire who meets certain retention requirements. A retained worker is a qualified employee (as defined for purposes of the payroll tax exemption) who remains an employee for at least 52 consecutive weeks, and whose wages (as defined for income tax withholding purposes) for the last 26 weeks equal at least 80 percent of the wages for the first 26 weeks. The amount of the credit is the lesser of $1,000 or 6.2% of wages (as defined for income tax withholding purposes) paid by the employer to the retained worker during the 52 consecutive week period. The credit may be claimed for a retained worker for the first taxable year ending after March 18, 2010 for which the retained worker satisfies the 52 consecutive week requirement.
Code Sec. 199 deduction. Often overlooked is the Code Sec. 199 domestic production activities deduction. The deduction is targeted to U.S. taxpayers engaged in manufacturing activities. The definition of manufacturing is broad for purposes of the deduction but its under-utilization may be due to the complexity surrounding the deduction.
Generally, the maximum Code Sec. 199 deduction is equal to a percentage of the lesser of either the taxpayer’s qualified production activities income (QPAI) or taxable income. The maximum deduction for 2010 is, for most taxpayers, nine percent. The deduction is, however, limited to 50 percent of the W-2 wages actually paid to employees and reported by the employer.
Code Sec. 45R tax credit. Small employers offering qualified health insurance coverage to their employees may be eligible for a new tax credit. The Code Sec. 45 R credit is generally available to small employers that pay at least half the cost of qualified coverage. For the 2010 tax year, the maximum credit is 35 percent of premiums paid by eligible employers (non-profit employers may be eligible for a reduced credit of 25 percent). The maximum credit goes to employers with 10 or fewer full-time equivalent (FTE) employees paying average annual wages of $25,000 or less. The credit is completely phased out for employers with more than 25 FTEs or with average annual wages of more than $50,000.
The Code Sec. 45R credit has many restrictions. For example, many small businesses may employ family members of the owner(s). Certain family members are excluded from the definition of employee for purposes of the Code Sec. 45R credit. A sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses also are not considered employees for purposes of the credit.
Business Credit Changes
The 2010 Small Business Act made some taxpayer-friendly changes to the Code Sec. 38 general business credit. The eligible small business credits of an eligible small business (ESB) determined in the first tax year of the business that begins in 2010 may be carried back five years and forward for 20 years. An ESB is a corporation the stock of which is not publicly traded; a partnership; or a sole proprietorship (Code Sec. 38(c)(5)(C), as added by the 2010 Jobs Act). Additionally, the ESB must have average annual gross receipts for the three-tax-year period before the tax year of $50 million or less. The provision is intended to encourage ESBs to accelerate their business expenditures to 2010.
Energy Tax Incentives
A variety of tax incentives are available to encourage businesses to invest in energy conservation, energy efficiency and the production of alternative energy. Taxpayers generally have through December 31, 2013 to place in service biomass, marine and other types of renewable energy property to claim the renewable energy production tax credit (although the placed in service date for wind facilities is through December 31, 2012). Additionally, taxpayers that place in service qualified renewable energy property may elect to claim the investment tax credit in lieu of the production tax credit. Taxpayers may also be eligible to apply for a grant instead of claiming the investment tax credit or the renewable energy production tax credit for property placed in service in 2010.
This letter has examined just some of the year-end planning opportunities and challenges for businesses, with special emphasis on incentives that are temporary. As always, please contact our office if you have any questions. We can design a year-end strategy that maximizes your tax savings.
Guy L. Haffley, CPA
Haffley, Taylor & Company, LLC