Another May—another tax law change

by Julie A. Welch

The Small Business and Work Opportunity Tax Act of 2007 signed into law on May 25, 2007, is good news for many small businesses since it includes tax incentives.

Some of these incentives include the ability to write off an even higher amount of equipment in the year of purchase and an extension of the Work Opportunity Tax Credit. However, offsetting the cost of the tax incentive provisions, the law again increases the age of children subject to the “Kiddie Tax” which taxes children’s unearned income of more than $1,700 at their parent’s tax rate which generally results in a higher tax.

If you are like most business owners, you want to know what in the new tax law that might affect you. Here are some of the key items:

Without this law, the maximum amount that could be expensed (depreciated under Section 179) for equipment, furniture, and off-the-shelf computer software purchases during 2007 was $112,000. Now the amount that can be expensed increases to $125,000 for tax years beginning after 2006. Additionally, the phase-out threshold for total purchases which begins reducing the maximum avail-able expense amount increases from $450,000 to $500,000. This expansion of section 179 will last through 2010 (tax years beginning before Jan. 1, 2011).

The Work Opportunity Tax Credit provides

a credit to employers who hire “targeted” groups of workers. Generally individuals in these groups have a particularly high unemployment rate. The credit, which is generally up to $2,400 per eligible worker, is a percentage of the wages paid to the worker during the first year. This credit was set to expire at the end of 2007. This law extends the credit for roughly 3-and-a-half years through August 31, 2011 for most of the targeted groups. So, employers who hire eligible workers on or before August 31, 2011 will be eligible for the credit. As with the prior rules, workers must be certified by a state employment security agency that they are in a targeted group.

For married couples operating unincorporated businesses, such as limited liability companies, who file joint returns, there is some simplification. They may elect not to be treated as a partnership thereby eliminating the need to file a partnership tax return. This simplification is effective for years beginning after December 31, 2006. It affects new businesses as well as businesses that have filed partnership tax returns in prior years. If both individuals are working in the business, separate Schedule Cs would generally need to be included on the individual tax return.

There were several changes impacting S corporations that earn too much passive investment income are penalized under the Internal Revenue Code. Specifically if an S corporation that has accumulated Earnings and Profits (one that was not always an S corporation and has not distributed its previous accumulated earnings) has too much passive investment income, that income can be taxed at the highest corporate tax rate, and if the situation applies for 3 consecutive years, then the S election is terminated altogether. Gains from sales of stock will now be excluded from passive investment income for purposes of the passive investment income test. This new law applies to taxable years beginning after the date of enactment (after May 25, 2007). Companies still subject to the excess passive investment income tax might consider distributing a “dividend” which is taxable to the shareholders but will reduce the previously accumulated Earnings and Profits and could eliminate the excess passive investment income situation.

One of the revenue raisers in the new tax law increases the age of children subject to the Kiddie Tax. The Kiddie Tax taxes a child’s investment income over a certain dollar amount (currently $1,700) at the parent’s tax rate thus reducing the income tax benefit of splitting income with a child. When the Kiddie Tax was initially enacted, it applied to children under the age of 14. Last year, the law was changed retroactive for all of 2006 to increase that age to children under the age of 18. This law now raises the age to children under the age of 19 and also includes full-time students under the age of 24 if they don’t earn more than half of their own support. This new age change is applicable to years beginning after 2007.

 

Julie A. Welch, CPA, CFP® is a partner at Meara, King & Co. and co-author of 101 Tax Saving Ideas
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