Tax Update

by

John M. Murray, CPA

Member of the Firm

Last month, President Bush signed the Small Business and Work Opportunity Tax Act.  The new tax law will provide a number of tax breaks for small business, including general provisions affecting small businesses and some favorable changes to the rules governing S corporations. However, this new law may cause some individual taxpayers to find an increase in their tax bills due to the revenue raising portions of the law, such as new and enhanced penalties and broadening of the “kiddie tax”.

The tax relief provisions for small businesses include:

1. The limit for the Section 179 election to expense business equipment purchases is immediately increased from $112,000 to $125,000, with the investment-based expensing phase-out amount increased from $450,000 to $500,000.  The enhanced expensing provision is extended for another year through 2010.
2. The Work Opportunity Tax Credit for hiring certain disadvantaged workers was set to expire at the end of 2007. The new law extends the credit through August 31, 2011, and broadens the credit to include more veteran groups.
3. The FICA tip credit will continue to be based on the old $5.15 minimum wage even though the minimum wage increases to $7.25 an hour. 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.
4. Simplify Family Business Tax. Married couples who jointly operate an unincorporated business and who file a joint return may elect not to report their income as a partnership. Instead of filing a partnership return, they can each report their income on Schedule C of Form 1040. The new law also ensures that both spouses receive credit for paying Social Security and Medicare taxes.
5. Waive individual and corporate alternative minimum tax (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 the 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.
6. Liberalize several S corporation rules. The new law contains several provisions beneficial to S corporations, including measures that: 1) 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. 2) Exclude restricted bank director stock from treatment as S corporation stock.
7. Set forth a special accounting rule for banks that become S corporations and that change from the reserve method of accounting for bad debts.
8. Revise the tax treatment of sales of stock of wholly owned subsidiaries of S corporations.
9. 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 Dec. 31, 1996.
10. Permit an electing small business trust (ESBT) to deduct interest expense it incurs when it borrows funds to purchase S corporation stock.
11. The legislation pays for the above benefits by:
12. Raising the age limit for the "kiddie tax". The taxing of a child's unearned income above a certain amount at the parents' higher rate is increased from age 18 to 19.  For full-time students, the kiddie tax will apply until age 24. This change is effective for tax years beginning after May 25, 2007 - which for most taxpayers means the change will become effective in 2008.
13. Expanding preparer penalties to all types of tax returns including employment, excise, exempt organizations, and estate and gift tax and increasing the penalty amounts.
14. Creating a new penalty on claims for refunds that are filed without any reasonable basis.
15. Increasing the penalty for bad checks and money orders.
16. Modifying the rule that the IRS must stop charging interest and filing related penalties if it fails to notify the taxpayer about a deficiency within 18 months after the taxpayer filed the return. The time limit is extended to 36 months.
17. Eliminating the requirement that the IRS hold a collection due process hearing before issuing a levy on delinquent employment taxes.

Aside from the Small Business and Work Opportunity Tax Act, the IRS will launch a new National Research Program (NRP) reporting compliance study on 13,000 individuals this fall.  This Research Program will update the agency's audit selection tools.  Most individuals from this sample will have specific lines of their returns confirmed through in-person audits with an IRS examiner. However, some will not be contacted if the IRS can obtain matching and third-party data that confirms the accuracy of their return. The targeted research design of the new individual NRP avoids the need for IRS agents to routinely check all the lines of a taxpayer's return.

If you would like to review how these recent and upcoming changes might affect your business and/or personal tax planning, please contact your Witt Mares tax professional.