Section 179 Expanded Depreciation
Liberalized Jobs Tax Credit
Spousal Joint Ventures

In late May of 2007, Congress passed the Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28, enacted 5/25/2007). This legislation contained several changes that will be welcome news for businesses, in the form of better depreciation, an improved tax credit for hiring certain workers, and a new structure for a husband-wife owned business. In addition, there is a major adverse change regarding the infamous kiddie tax (see Individual Tax Developments below).

Section 179 Expanded Depreciation

One of the more important tax provisions for small businesses has been the ability to claim a first year Section 179 depreciation deduction of up to $100,000 of equipment additions per year. This provision has been inflation indexed annually, and recently had reached $108,000.

The new legislation increases the Section 179 annual dollar limit to $125,000, effective for tax years beginning in 2007. And, in an important corollary adjustment, the asset addition phase-out threshold has been increased to $500,000. For the small business owner, understanding this phase-out threshold may be the more important development. As eligible equipment additions within any year exceed this phase-out threshold, there is a dollar-for-dollar reduction in the eligible Section 179 amount.

For those businesses reporting on fiscal years, the old limits apply for tax years beginning in 2006 and ending in 2007. Here is a chart summarizing these amounts:

Example. Ajax Construction, a calendar year S corporation, is enjoying a profitable year and acquires a number of items of equipment in 2007 to improve its depreciation deductions. The sum of those asset additions is $600,000. Ajax must reduce its $125,000 Section 179 limit for 2007 by $100,000, the amount by which its qualifying property acquisitions exceed $500,000. Accordingly, Ajax may only claim $25,000 of Section 179 deductions for 2007. Had Ajax limited its current year equipment additions to $500,000, it would have qualified for a full $125,000 first year Section 179 deduction.

Small business owners who are able to budget their annual equipment additions to stay beneath the asset addition phase-out threshold may actually have greater first year depreciation deductions than those who exceed that threshold!

Liberalized Jobs Tax Credit

For years, the tax law has incented employers to hire disadvantaged workers by providing tax credits. An employer who hires an individual from one of nine various targeted groups qualifies for a tax credit. At a minimum, the credit is $2,400 for each eligible hire (40% of the first $6,000 of wages).  Individuals from some groups qualify for greater credits, and those credits extend into the second year of employment of that individual. The targeted groups included individuals employed from families receiving welfare benefits, disabled veterans, rehabilitation referrals, food stamp recipients, and the like.

The recent Small Business Act has expanded one of these targeted categories in a very significant manner, in a change that has not been well-publicized to the business community.

The new category of eligible workers is labeled “designated community residents.” It must be an individual who has attained age 18 but not age 40 on the hiring date, and has his or her principal residence within an empowerment zone, enterprise zone, renewal community or rural renewal county. Assuming that an individual meeting these criteria is employed and earns at least $6,000, the employer will qualify for a potential $2,400 Work Opportunity Tax Credit. The individual must have been engaged to begin work after May 25, 2007, and must be certified at the time of hire by the state workforce agency for the applicable location. Employers have only 28 days after the job applicant begins work to submit a certification request to their state workforce agency. IRS Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, is used for this purpose.

Any business that may have hired a “designated community ” resident within the last 28 days should submit this paperwork to the state employment agency, so that they may investigate and complete the certification that will allow this tax credit. A key aspect is that the worker does not need to be a low-income individual or in any other disadvantaged category. This could, in fact, be a highly paid professional worker who happens to reside in one of these designated areas. You can obtain information regarding whether your new employee lives in the designated areas on the United States Department of Housing and Urban Development website (www.hud.gov). Please let us know if we can assist in establishing procedures that assure that this and other jobs credit opportunities are not overlooked.

As a further benefit, any Work Opportunity Tax Credit now has a greater likelihood of producing immediate tax savings. In the past, this and other business credits have only been allowed to reduce regular tax and not alternative minimum tax (AMT). This meant that many business owners could only utilize small amounts of these credits annually, even though their business may have qualified for large tax credits.

But for tax years beginning after 2006, the Work Opportunity Tax Credit will offset any tax, whether it is regular tax or AMT. This will make these jobs credits even more lucrative than in the past.

Spousal Joint Ventures

In general, if an entity has two or more owners, it must either report as a partnership or a corporation. In theory, it has not been possible for two individuals to simply split a business, and each report their respective share of the income and deductions as a proprietorship within their respective Form 1040s.

Beginning in 2007, the new legislation provides a special election for a husband and wife, allowing them to treat a “qualified joint venture” as two proprietorships rather than a more formal partnership. A qualified joint venture is available if the only members are a husband and wife who file a joint Form 1040. Further, both spouses must materially participate in the business activity, to the extent of at least 500 hours per year. Finally, this is an elective provision to which both spouses must consent.

When this election is made, the spouses can avoid the formality of filing an actual partnership return. Rather, each spouse simply reports the respective share of the joint venture as a sole proprietorship. Each proprietorship share is subject to the self-employment social security tax.

Observation: While this new rule provides welcome simplicity, it does not produce any direct tax savings. Further, until the IRS provides guidance on making the election and operating guidelines for these spousal joint ventures, it would be premature to take action.

If you have any questions concerning the tax issues discussed here, please contact us at info@marg.com.