The Small Business Jobs and Credit Act of 2010

On Sept. 27, 2010, President Obama signed into law the Small Business Jobs and Credit Act of 2010 (H.R.5297) (“the Act”). The Act contains significant tax provisions in addition to other provisions intended to stimulate investment in small business and facilitate the access of small business owners to capital. This article briefly summarizes those tax provisions that the author believes will be of most interest to law firms and certain individuals. Although the Act is labeled a small business bill, it also affects larger businesses.

Temporary Increase to Amount of Depreciable Property That Can Be Expensed

Section 179 allows a business to write off the cost of furniture, computers, machinery and equipment acquisitions (tangible personal property) in the year of acquisition instead of taking depreciation deductions over a number of years. The current law allows a Section 179 deduction of $250,000 in 2010 but only a $25,000 deduction in 2011. The amount of the deduction is decreased dollar-for-dollar, if acquisitions exceed a threshold ' $800,000 in 2010 and $200,000 in 2011.

The new law increases the Section 179 limit to $500,000 in 2010 and 2011. The limit begins to decrease if acquisitions exceed $2 million and is reduced to zero if acquisitions exceed $2.5 million.

Not only is this increased limit a boon to firms looking to acquire property in 2011, it is, dare I say, a gift to those who have already made substantial acquisitions in 2010.

Deduction for Qualified Real Property

The new law allows a $250,000 deduction for acquisitions of certain qualified improvements to real property placed in service in 2010 and 2011. This $250,000 is part of the overall Section 179 deduction available; a taxpayer cannot claim $500,000 for personal property acquisitions and an additional $250,000 for qualified real property ' the overall maximum is $500,000 of which $250,000 can be for qualified real property.

For most law firms, qualified leasehold improvements fall under these rules for what improvements meet the “qualified” standard:

1. The building must have been placed in service at least three years before the leasehold improvement;
2. The improvements must be made subject to a lease;
3. The improvements must be to tenant space, not common areas, not an expansion of the building and not escalators or elevators; and
4. The tenant and landlord cannot be related ( i.e., common ownership).

Bonus Depreciation

Perhaps the most expensive cost of the Act is for bonus depreciation, which is the option to write off 50% of the cost of new property acquired and placed in service. This was available in 2008 and 2009 and has now been extended for property acquired and placed in service by Dec. 31, 2010. The Act also extends through 2011 bonus depreciation for property with a recovery period of 10 years or longer. It is important to note that bonus depreciation only applies to new property.

When combining bonus depreciation and Section 179, Section 179 is taken first and bonus depreciation is applied to the remaining basis. For example, if in 2010 the firm acquired and placed in service new espresso machines with a cost of $800,000, it could take a Section 179 deduction for $500,000 and bonus depreciation of $150,000 [50% ' ($800,000 ' $500,000)].

Bonus Depreciation for Autos and Light Trucks

An additional $8,000 deduction is available for autos and light trucks acquired in 2010 that are subject to the “luxury auto” limit on depreciation. Since any such vehicle is one with a cost of more than $15,300 and a gross vehicle weight of less than 6,000 pounds, it applies to most vehicles a business may acquire for general transportation needs.

Amount of Deductible Startup Expenses Increased for 2010

Under prior legislation, lawyers who have or are looking to start their own firms could deduct expenses incurred in starting the new venture, but only up to the first $5,000 of such expenses. Expenses in excess of that amount had to be capitalized and recovered through amortization deductions over 15 years. The deductible amount is phased out if the startup expenses exceed $50,000. However, for expenses incurred during 2010 in starting a new firm, the deduction limit is increased from $5,000 to $10,000. The threshold at which the deduction phase-out begins is increased from $50,000 to $60,000.

Deduction of Cost of Health Insurance in Computing Self-Employment Tax

For the tax year 2010 only, a self-employed individual may deduct the cost of health insurance for his or her family when computing his net earnings from self-employment for purposes of determining his self-employment tax as well as his income tax. Before, self-employed taxpayers could deduct the cost of this health insurance for income tax purposes but not for self-employment tax purposes. Self-employed taxpayers include partners in partnerships.

For 2010, the rate is 12.4% of the first $106,800 of net earnings from self-employment for the Old Age, Survivors and Disability Insurance and 2.9% of all net earnings from self-employment for the Medicare hospital insurance tax. Accordingly, for earnings in excess of $106,800, the amount of tax savings will be 2.9% of health insurance premiums paid. If earnings are less than $106,800 (unrealistic as this may sound) the tax savings would be 15.3% of premiums paid.

New Rules for Employer Provided Cell Phones (Including Smart Phones)

The Act emancipated such equipment from the definition of “listed property” under the Internal Revenue Code. The amendment applies to taxable years beginning after Dec. 31, 2009. For law firms, it is a welcome first step. The “de-listing” of cell phones eliminates the heightened substantiation requirements and special depreciation rules that apply to listed property. So now, lawyers can devote more of their time to submitting hours in a timely fashion and to the collection of outstanding client receivables.

But ' not so fast. Until such time that the Internal Revenue Service (“IRS”) and the Treasury Department (“Treasury”) issue guidance to the contrary, this change does not eliminate all substantiation requirements for employer-provided cell phones. Guidance issued in 2009 indicates that the IRS generally considers personal use of an employer-provided cell phone taxable to the employee and will require at least some substantiation to ascertain the value of such personal usage. The Act does not appear to override this general treatment. However, legislative history to the Act suggests that Treasury and the IRS have the ability to treat personal cell phone usage as a nontaxable de minimis fringe benefit. While we all hope Treasury adopts this suggestion, many expect that Treasury will not provide a blanket rule that all personal cell phone usage automatically qualifies as a nontaxable de minimis fringe. It appears that some level of substantiation will be required as a condition for nontaxable de minimis fringe treatment.

Information Reporting Required for Certain Expenses in Connection with Rental Property

In order to strive for revenue neutrality, the Act needed to contain provisions designed to increase revenue, since the provisions described above will reduce the tax revenue flowing to Uncle Sam. One of the revenue raisers is a new reporting rule that is likely to apply to numerous individuals and much to the angst of many lawyers owning rental property.

Taxpayers who are engaged in a “trade or business” are required to report payments they make to others for goods and services if payments to the provider are $600 or more during the tax year. These payments are reported using a 1099 form. Until now, these reporting requirements have not been applicable to investors who owned rental real estate, because these investors were not considered to be engaged in a trade or business.

Under the Act, recipients of rental income from rental real estate will be required to provide forms 1099 to providers of goods and services, even though the recipient of the rental income is not considered to be engaged in a trade or business. This would include payments to a variety of service providers such as plumbers, painters, electricians and gardeners whom you pay $600 or more during the year. There is an exception for individuals who receive only minimal amounts of rent, as provided in regulations. These new reporting rules apply starting in 2011.

Allow Roth Rollovers from Certain Elective Deferral Plans

Another revenue raiser expands the circumstances in which a taxpayer can roll tax deferred retirement funds into a Roth retirement account. Generally, when a taxpayer makes such a rollover he or she must pay tax currently on the amount transferred, but then subsequent earnings on the account and future withdrawals from the account are not taxed. Roth conversions raise revenue for the government now, but will reduce revenue in future years.

The Act added a provision to the Roth account rules which permits amounts in 401k plans to be rolled over to the plan's Roth account, provided that the plans have a Roth feature. For rollovers made during 2010, the amount rolled over is subject to tax in equal parts in 2011 and 2012.

Last Words

After reading many of the Act's provisions, it is difficult to ascertain where the new jobs will come from. In addition, I do not expect any further significant tax legislation until after the November elections because of possible adverse consequences affecting the polls. The fate of the “Bush tax cuts” expiring at the end of this year remains uncertain until the lame ducks are back in session.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson (http://www.maxfieldpeterson.com/) and a member of this newsletter's Board of Editors.

On Sept. 27, 2010, President Obama signed into law the Small Business Jobs and Credit Act of 2010 (H.R.5297) (“the Act”). The Act contains significant tax provisions in addition to other provisions intended to stimulate investment in small business and facilitate the access of small business owners to capital. This article briefly summarizes those tax provisions that the author believes will be of most interest to law firms and certain individuals. Although the Act is labeled a small business bill, it also affects larger businesses.

Temporary Increase to Amount of Depreciable Property That Can Be Expensed

Section 179 allows a business to write off the cost of furniture, computers, machinery and equipment acquisitions (tangible personal property) in the year of acquisition instead of taking depreciation deductions over a number of years. The current law allows a Section 179 deduction of $250,000 in 2010 but only a $25,000 deduction in 2011. The amount of the deduction is decreased dollar-for-dollar, if acquisitions exceed a threshold ' $800,000 in 2010 and $200,000 in 2011.

The new law increases the Section 179 limit to $500,000 in 2010 and 2011. The limit begins to decrease if acquisitions exceed $2 million and is reduced to zero if acquisitions exceed $2.5 million.

Not only is this increased limit a boon to firms looking to acquire property in 2011, it is, dare I say, a gift to those who have already made substantial acquisitions in 2010.

Deduction for Qualified Real Property

The new law allows a $250,000 deduction for acquisitions of certain qualified improvements to real property placed in service in 2010 and 2011. This $250,000 is part of the overall Section 179 deduction available; a taxpayer cannot claim $500,000 for personal property acquisitions and an additional $250,000 for qualified real property ' the overall maximum is $500,000 of which $250,000 can be for qualified real property.

For most law firms, qualified leasehold improvements fall under these rules for what improvements meet the “qualified” standard:

1. The building must have been placed in service at least three years before the leasehold improvement;
2. The improvements must be made subject to a lease;
3. The improvements must be to tenant space, not common areas, not an expansion of the building and not escalators or elevators; and
4. The tenant and landlord cannot be related ( i.e., common ownership).

Bonus Depreciation

Perhaps the most expensive cost of the Act is for bonus depreciation, which is the option to write off 50% of the cost of new property acquired and placed in service. This was available in 2008 and 2009 and has now been extended for property acquired and placed in service by Dec. 31, 2010. The Act also extends through 2011 bonus depreciation for property with a recovery period of 10 years or longer. It is important to note that bonus depreciation only applies to new property.

When combining bonus depreciation and Section 179, Section 179 is taken first and bonus depreciation is applied to the remaining basis. For example, if in 2010 the firm acquired and placed in service new espresso machines with a cost of $800,000, it could take a Section 179 deduction for $500,000 and bonus depreciation of $150,000 [50% ' ($800,000 ' $500,000)].

Bonus Depreciation for Autos and Light Trucks

An additional $8,000 deduction is available for autos and light trucks acquired in 2010 that are subject to the “luxury auto” limit on depreciation. Since any such vehicle is one with a cost of more than $15,300 and a gross vehicle weight of less than 6,000 pounds, it applies to most vehicles a business may acquire for general transportation needs.

Amount of Deductible Startup Expenses Increased for 2010

Under prior legislation, lawyers who have or are looking to start their own firms could deduct expenses incurred in starting the new venture, but only up to the first $5,000 of such expenses. Expenses in excess of that amount had to be capitalized and recovered through amortization deductions over 15 years. The deductible amount is phased out if the startup expenses exceed $50,000. However, for expenses incurred during 2010 in starting a new firm, the deduction limit is increased from $5,000 to $10,000. The threshold at which the deduction phase-out begins is increased from $50,000 to $60,000.

Deduction of Cost of Health Insurance in Computing Self-Employment Tax

For the tax year 2010 only, a self-employed individual may deduct the cost of health insurance for his or her family when computing his net earnings from self-employment for purposes of determining his self-employment tax as well as his income tax. Before, self-employed taxpayers could deduct the cost of this health insurance for income tax purposes but not for self-employment tax purposes. Self-employed taxpayers include partners in partnerships.

For 2010, the rate is 12.4% of the first $106,800 of net earnings from self-employment for the Old Age, Survivors and Disability Insurance and 2.9% of all net earnings from self-employment for the Medicare hospital insurance tax. Accordingly, for earnings in excess of $106,800, the amount of tax savings will be 2.9% of health insurance premiums paid. If earnings are less than $106,800 (unrealistic as this may sound) the tax savings would be 15.3% of premiums paid.

New Rules for Employer Provided Cell Phones (Including Smart Phones)

The Act emancipated such equipment from the definition of “listed property” under the Internal Revenue Code. The amendment applies to taxable years beginning after Dec. 31, 2009. For law firms, it is a welcome first step. The “de-listing” of cell phones eliminates the heightened substantiation requirements and special depreciation rules that apply to listed property. So now, lawyers can devote more of their time to submitting hours in a timely fashion and to the collection of outstanding client receivables.

But ' not so fast. Until such time that the Internal Revenue Service (“IRS”) and the Treasury Department (“Treasury”) issue guidance to the contrary, this change does not eliminate all substantiation requirements for employer-provided cell phones. Guidance issued in 2009 indicates that the IRS generally considers personal use of an employer-provided cell phone taxable to the employee and will require at least some substantiation to ascertain the value of such personal usage. The Act does not appear to override this general treatment. However, legislative history to the Act suggests that Treasury and the IRS have the ability to treat personal cell phone usage as a nontaxable de minimis fringe benefit. While we all hope Treasury adopts this suggestion, many expect that Treasury will not provide a blanket rule that all personal cell phone usage automatically qualifies as a nontaxable de minimis fringe. It appears that some level of substantiation will be required as a condition for nontaxable de minimis fringe treatment.

Information Reporting Required for Certain Expenses in Connection with Rental Property

In order to strive for revenue neutrality, the Act needed to contain provisions designed to increase revenue, since the provisions described above will reduce the tax revenue flowing to Uncle Sam. One of the revenue raisers is a new reporting rule that is likely to apply to numerous individuals and much to the angst of many lawyers owning rental property.

Taxpayers who are engaged in a “trade or business” are required to report payments they make to others for goods and services if payments to the provider are $600 or more during the tax year. These payments are reported using a 1099 form. Until now, these reporting requirements have not been applicable to investors who owned rental real estate, because these investors were not considered to be engaged in a trade or business.

Under the Act, recipients of rental income from rental real estate will be required to provide forms 1099 to providers of goods and services, even though the recipient of the rental income is not considered to be engaged in a trade or business. This would include payments to a variety of service providers such as plumbers, painters, electricians and gardeners whom you pay $600 or more during the year. There is an exception for individuals who receive only minimal amounts of rent, as provided in regulations. These new reporting rules apply starting in 2011.

Allow Roth Rollovers from Certain Elective Deferral Plans

Another revenue raiser expands the circumstances in which a taxpayer can roll tax deferred retirement funds into a Roth retirement account. Generally, when a taxpayer makes such a rollover he or she must pay tax currently on the amount transferred, but then subsequent earnings on the account and future withdrawals from the account are not taxed. Roth conversions raise revenue for the government now, but will reduce revenue in future years.

The Act added a provision to the Roth account rules which permits amounts in 401k plans to be rolled over to the plan's Roth account, provided that the plans have a Roth feature. For rollovers made during 2010, the amount rolled over is subject to tax in equal parts in 2011 and 2012.

Last Words

After reading many of the Act's provisions, it is difficult to ascertain where the new jobs will come from. In addition, I do not expect any further significant tax legislation until after the November elections because of possible adverse consequences affecting the polls. The fate of the “Bush tax cuts” expiring at the end of this year remains uncertain until the lame ducks are back in session.

Stephen M. (Pete) Peterson is the CEO of the accounting and business advisory firm, Maxfield Peterson (http://www.maxfieldpeterson.com/) and a member of this newsletter's Board of Editors.