New tax breaks for small businesses and their owners, and AMT update

Situation: Your client has a small business and is considering some capital expenditures this year but is wondering about the tax implications.

Solution: The American Recovery and Reinvestment Act contains several provisions designed to encourage small-business owners to invest in their companies. Some of these provisions are available only for a limited time.

Faster recovery of certain investments in business property: Small businesses that invest in new property or equipment will have the opportunity to increase the expensing or depreciation of the purchases in 2009. There are two options to increase deductions related to capital expenditures.

Increased limit on Section 179 expense: Businesses can elect to expense, rather than depreciate, the cost of machinery, equipment, vehicles and other tangible property placed in service in 2009. The maximum deduction is $250,000, and the cost of property in excess of this amount may be depreciated over the life of the property. In 2010, the Section 179 cap will drop to $133,000 (indexed for inflation). After 2010, the cap returns to the prior limit of $25,000.

The Section 179 deduction cannot exceed taxable income. If the deduction is limited, it may be carried over to future years. However, it phases out for capital expenditures above $800,000 and limits the tax break to smaller businesses. The phaseout level on capital expenditures also decreases after 2009.

Bonus depreciation allowed in 2009: A small business may deduct up to 50% of the cost of “qualified property” purchased and placed in service in 2009 (2010 for certain longer-lived property). Qualified property is almost any capital expenditure other than buildings.

The Section 179 expense and the bonus depreciation may be used together. However, the basis for depreciating the property must first be reduced by the Section 179 expense.

Extended NOL carry-back period: Normally, a net operating loss may be carried back two years and carried forward 20 years to offset taxable income. For NOLs created after Dec. 31, 2007, the act provides a five-year carry-back period. Therefore, if the business paid taxes in the prior five years, the NOL may be carried back to the fifth prior year and each succeeding year to offset income and refund taxes.

This provision applies to most types of businesses, as well as individuals, provided that gross income did not average more than $15 million in the three years leading up to the NOL. To claim the refund, eligible businesses must file Form 1139 by Sept. 15. Eligible individuals must file by Oct. 15 using Form 1045.

Shortened period for taxing S corporation built-in gains: Corporations which elect S corporation status are not taxed at the corporate level. Instead, the income, deductions and credits are reported by the shareholders.

If a C corporation elects S corporation status, any gain inherent in property owned by the corporation at the time of the election and sold within 10 years of the election will be taxed at the maximum corporate rate (currently 35%). A provision of the act reduces the 10-year period to seven years in 2009 and 2010. This provision will benefit corporations that became S corporations (or acquired property from a C corporation) between 1999 and 2003.

Breaks for individuals who own small businesses: An individual may exclude 75% of the gain from qualified small-business stock acquired after Feb. 17 of this year and before Jan. 1, 2011. To qualify, the stock must be held at least five years and acquired at the original issue date. This provision will benefit individuals after Feb. 17, 2014, upon satisfying the five-year holding period. Certain limitations apply to the exclusion, which is normally 50% of the gain.

A taxpayer who receives more than half of his or her income from a small business may reduce the required 2009 estimated tax payments. Normally, estimated tax payments must equal or exceed the smaller of 90% of the current year tax or 110% of the prior-year tax. In 2009, taxpayers who qualify only make estimated payments based on the lesser of 90% of the 2008 tax or 90% of the 2009 tax. This provision benefits taxpayers with 2009 income greater than 2008.

AMT motor vehicle credit update: The new legislation contains a provision that allows individuals to claim the alternative-fuel motor vehicle credit against alternative minimum tax, which updates the Tax Insight column “Are new car tax incentives worth it?” which appeared May 5.