By Kenneth H. Bridges, CPA, PFS May 2007
On May 25, 2007, President Bush signed into law the Small Business and Work Opportunity Tax Act of 2007 (the “Act”). Highlights of the Act include:
Increase in minimum wage – The minimum wage will increase from $5.15 per hour to $7.25 per hour in three $0.70 increments over the next two years. It will increase to $5.85 per hour 60 days after the bill’s enactment, to $6.55 one year after enactment, and to $7.25 two years after enactment.
Code section 179 expensing enhanced and extended – Most small businesses can elect to immediately expense up to $100,000 each year ($112,000 for 2007, as adjusted for inflation) of the cost of furniture and equipment purchased for use in the business. For tax years beginning after 2009, this amount was scheduled to revert to the old $25,000 per year limit. The Act increases the amount which can be expensed to $125,000 and extends the favorable higher amount through the end of 2010. Further, the Act increases to $500,000 the amount of furniture and equipment which can be purchased during the year before the deduction amount begins to be phased out.
GO Zone tax incentives extended – Businesses in the “Gulf Opportunity Zone” (areas impacted by Hurricane Katrina) can have the amount of their section 179 expensing limit increased by up to an additional $100,000. This additional benefit was scheduled to expire at the end of 2007. For businesses in the hardest hit areas, the benefit is extended through 2008.
Work opportunity tax credit extended – Employers who hire members of certain target groups are permitted a tax credit of up to 40% of the first $6,000 of wages paid to each member of a targeted group (such as recipients of public assistance, qualified veterans on assistance, high risk youth, qualified ex-felons, etc.). This tax credit was scheduled to expire at the end of this year, but has now been extended through August 31, 2011. The Act also expands the definitions of the qualifying individuals.
Alternative minimum tax can be offset by WOTC and tip credit – Many tax credits can offset “regular tax”, but not the AMT. The Act provides that the work opportunity tax credit and the FICA tip credit can now offset AMT.
Spouses may elect out of partnership rules – An unincorporated business carried on by two or more persons generally is treated for income tax purposes as a partnership. The Act provides that an unincorporated business carried on jointly by spouses is permitted to file as a sole proprietorship, with each spouse reporting their respective share of the business income.
ESBTs can deduct interest on S-corp stock acquisition debt – Electing small business trusts (ESBTs) will now be permitted a tax deduction for interest expense on debt incurred to purchase S corporation stock.
S corporation capital gains – An S corporation which was previously a C corporation and has “C-corp earnings and profits” can be subject to a corporate level tax if its “passive investment income” exceeds 25% of its gross receipts for the year. The Act removes capital gains from stock sales from the definition of passive investment income making it less likely that an S-corp will inadvertently trigger this very punitive tax.
Kiddie tax age increased (again) – Since the Tax Reform Act of 1986, children under the age of 14 have had their unearned income (e.g. interest and dividends) over a minimal amount ($1,700 for 2006) taxed at their parents’ marginal tax rate. This provision was designed to prevent parents from shifting income to their children’s typically lower tax rate bracket. 2006 tax legislation increased the age to children under 18, and now the 2007 legislation increases the age to include children who are 18 and full-time students up to the age of 23.
FICA tip credit enhanced – 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.
Late 2007 Tax Legislation
In late 2007, several acts were passed which contained tax provisions, including The Tax Increase Prevention Act of 2007 and The Mortgage Forgiveness Debt Relief Act of 2007. Highlights of the legislation include:
Alternative minimum tax relief – The alternative minimum tax (“AMT”) is a separate but parallel system to the regular income tax. You must compute your tax under both systems, and pay the greater of the two. If the AMT is higher than the regular tax then this excess shows up on your return as an additional tax. For 2006, married individuals filing jointly were permitted a maximum exemption in computing the AMT of $62,550 and singles were permitted a maximum exemption of $42,500. For 2007, these maximum exemption amounts (which are subject to phase-out for higher income taxpayers), were scheduled to be reduced to $45,000 and $33,750, respectively. This would have meant millions more taxpayers being subject to the AMT for 2007. To avoid this, Congress has increased the exemptions for 2007 to $66,250 and $44,350, respectively. This represents a tax savings of up to $5,950 for those directly affected.
Relief from tax on mortgage debt forgiveness – In general, a discharge of indebtedness results in taxable income for the debtor, unless an exception is met. Prior to the recent legislation, there was no exception for a discharge of personal mortgage debt, unless the debtor was in bankruptcy or insolvent. The recent legislation provides that taxable income will not include any discharge (in whole or part) of qualified residence indebtedness during 2007 – 2009. The relief applies only to the original purchase price plus improvements of the taxpayer’s principal residence. It does not apply to discharges of second mortgages or home equity loans unless the proceeds were used to acquire, construct or substantially improve the residence, or to refinance debt used for that purpose. The relief does not apply to second homes, vacation homes or investment properties, and the amount of relief is limited to $2,000,000.
Deduction for mortgage insurance extended – The deduction for mortgage insurance premiums, which was scheduled to expire at the end of 2007, has been extended for three more years.
Increase in penalty for late filing of partnership and S-corp returns – Historically, the penalty for late filing of a partnership or LLC return has been $50 per month per partner, up to a maximum of 5 months (i.e. $250 per partner). For a large partnership, this can be a significant penalty. The recent legislation makes it even worse. Under the new law, the penalty will be $85 per partner per month for a maximum of 12 months (i.e. up to $1,020 per partner). Also, the penalty will now apply to S-corps as well, whereas in the past there has generally been no penalty for late filing of an S-corp return unless it had tax due (which is unusual) or the IRS determined the failure to file was willful.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.