The American Recovery and Reinvestment Act of 2009 (“ARRA”) (Pub.L. 111-5, § 1 et seq., Feb. 17, 2009, 123 Stat. 115)) is a spending bill enacted by the 111th United States Congress and signed into law by President Barack Obama on February 17, 2009. The ARRA was based largely on proposals made by President Obama and is intended to provide a stimulus to the United States economy in the wake of the recent economic downturn. The total $787 billion cost of the ARRA includes nearly $300 billion in tax relief. The ARRA includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending provisions for education, health care, and infrastructure. The ARRA also includes a number of non-economic recovery related items that were either part of longer-term plans or desired by Congress.
The ARRA contains several provisions that directly affect small businesses, corporations, S corporations, and partnerships. Although there are numerous other relevant provisions, the following eight sections will have the greatest impact on these entities.
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Cancellation of Debt Income (IRC §108)
Summary: A taxpayer can elect to defer cancellation of indebtedness income arising from a qualified reacquisition of certain corporate or business debt instruments issued by the taxpayer or a related person.
Explanation: The cancellation of indebtedness generally results in the realization of income by the debtor. The debtor must report income equal to the amount of indebtedness that was forgiven. Cancellation of indebtedness income also occurs when a debtor repurchases his own debt at a discount. In debt repurchase transactions, the amount of income is generally equal to the difference between the adjusted issue price and the price paid for the debt instrument. If a debtor reacquires an applicable debt instrument in 2009 or 2010, the debtor can report the income ratably over a five-year period beginning in 2014. An applicable debt instrument is a debt instrument (as defined by statute) which was issued by a C corporation or any other person in connection with the conduct of a trade or business by such person.
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Code Section 179 Expense Election for 2009 (IRC §179)
Summary: The increased Internal Revenue Code (“Code”) Section 179 expensing allowance provided for the 2008 tax year is extended one additional year. Thus, for the years beginning in 2009, the Code Section 179 dollar limitation is $250,000, and the investment limitation is $800,000.
Explanation: Code Section 179 allows a taxpayer an election to expense, rather than capitalize and depreciate, its investment in Code Section 1245 tangible depreciable property (typically machines and equipment) and certain computer software that is purchased in the tax year. Code Section 179 property is depreciable tangible personal property that is purchased for use in the active conduct of a trade or business. Historically, the election was limited to $125,000 of investment tax each year. The limitation was reduced via a phase-out when total investment for the tax year exceeded $500,000. The Economic Stimulus Act of 2008 increased these amounts to $250,000 and $800,000, respectively, for the 2008 tax year. The ARRA extends these expensing limitation increases from 2008 for an additional year to include 2009. Thus, for tax years beginning in both 2008 and 2009, the investment tax dollar limitation is $250,000 and the total investment limitation is $800,000 before the phase-out takes place.
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Availability of Bonus Depreciation for 2009 (IRC §168)
Summary: The bonus depreciation deduction previously applied to property placed in service prior to January 1, 2009. The bonus depreciation deduction has been extended one year to apply to property placed in service before January 1, 2010.
Explanation: Code Section 168(k)’s fifty percent “bonus depreciation” deduction is extended for one year, so that it applies to qualified property placed in service in both 2008 and 2009. Taxpayers may take the fifty percent bonus depreciation in addition to the traditional depreciation. Code Sec. 168(k)(1) allows a deduction of fifty percent of the basis of qualified property in the tax year it is placed in service, prior to the determination of any other depreciation on the remaining basis. Qualified property includes: (i) new property (i.e., property whose original use begins with the taxpayer) that is depreciable under the Modified Accelerated Cost Recovery System (“MACRS”) and has a recovery period of twenty years or less (including, for example, special handling devices for food and beverage manufacture; special tools for the manufacture of finished plastic products; fabricated metal products; certain motor vehicles; certain aircraft; computers; petroleum drilling equipment; office furniture, fixtures, and equipment; and vessels and water transportation equipment); (ii) MACRS water utility property; (iii) off-the-shelf computer software depreciable over three years; and (iv) qualified leasehold improvement property. The taxpayer must be the original user of the property. The legislation extends the bonus depreciation rules by one year by allowing the deduction for otherwise qualified property placed in service before January 1, 2010.
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S Corporations and Built-In Gains (IRC §1347)
Summary: For tax years beginning in 2009 and 2010, no tax is imposed on an S corporation’s net unrecognized built-in gain if the seventh tax year in the corporation’s ten-year recognition period preceded its 2009 and 2010 tax year.
Explanation: A corporate-level tax is imposed on an S corporation’s net recognized built-in gains attributable to assets that it held at the time it converted from an C corporation to an S corporation, if the gain is recognized during the statutorily defined recognition period. The “net recognized built-in gain” is the lesser of (i) the amount that would be the taxable income of the S corporation if only recognized built-in gains and recognized built-in losses were taken into account or (ii) the corporation’s taxable income for the tax year. The recognition period is generally the ten-year period beginning the first day of the first taxable year for which the corporation was an S corporation. Under the new law, if the seventh taxable year in the recognition period precedes the taxable period beginning in 2009 or 2010, no tax will be imposed on the net recognized built-in gain.
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Maximum Five-Year Carryback Period for 2008 Net Operating Losses of Small Businesses (IRC §172)
Summary: Eligible small businesses can elect to use an extended three-, four-, or five-year carryback period for 2008 net operating losses (NOLs). An eligible small business is generally a business that meets a $15 million average annual gross receipts test.
Explanation: Eligible businesses that sustain an NOL for a tax year generally can take an NOL deduction to reduce income in another tax year. An NOL is the amount by which deductions exceed gross income, with modifications. Under the general rule, taxpayers can carry back an NOL to each of the two tax years preceding the loss year or carry over the NOL to each of the twenty tax years following the loss year. An “eligible business” is defined as a corporation, partnership or sole proprietorship that had average annual gross receipts of no more than $15 million for the tax year of the NOL and the two immediately preceding tax years. The ARRA benefits small businesses experiencing financial difficulty by expanding their ability to use NOLs attributable to 2008. Taxpayers can elect to carry back 2008 NOLs for three, four, and five years, instead of the normal two years. Also, eligible small businesses that have an “applicable 2008 NOL” and have elected to apply the special carryback rule can use a carryback period of three, four, or five years. An “applicable 2008 NOL” is a taxpayer’s NOL for any tax year ending in 2008.
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Estimated Tax Payments of Qualified Individuals (IRC §6654)
Summary: For certain individuals with qualified small business income, estimated tax payments (i.e., pay quarterly) for tax years beginning in 2009 may be based on ninety percent of the individual’s prior year’s tax liability. An individual is a qualified individual if the gross income shown on the individual’s return for the preceding tax year is less that $500,000 and more than fifty percent of the gross income shown on the return for the preceding tax year is from a business which employed less than 500 employees on average during the calendar year that ends with or within the preceding tax year of the individual.
Explanation: There are certain exceptions to the requirement that taxpayers pay 100 percent tax for a given tax year (for example, less than $1,000 income; no tax liability for preceding tax year; hardship; “against equity and good conscience”; newly retired; disability). Taxpayers who don’t qualify for the Code Sec. 6654(e) exceptions may avoid the penalty for failure to pay taxes by (i) paying at least ninety percent of the tax shown on the current year’s return; (ii) paying 100 percent of the tax shown on the prior year’s return; or (iii) paying installments on a current basis on an annualized income installment method. Under the ARRA, in the case of a tax year of a “qualified individual” that begins in 2009, the exception to the estimated tax penalty that is based on paying 100 percent of the tax shown on the prior year’s return will be satisfied if the qualified individual paid at least ninety percent of the tax shown on the prior year’s tax return. A qualified individual means any individual if (a) the adjusted gross income shown on the individual’s return for the preceding tax year is less than $500,000, and (b) the individual certifies that more than fifty percent of the gross income shown on the return for the preceding tax year was “income from a small business.” Income from a small business means income from a trade or business with an average number of employees of less than 500 persons for the calendar year ending with or within the preceding tax year of the individual.
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Qualified Small Business Stock (IRC §1202(a)(3))
Summary: The percentage exclusion for qualified small business stock sold by an individual is increased from fifty to seventy-five percent for stock acquired after February 17, 2009 and before January 1, 2011.
Explanation: To encourage investment in small business, individuals may exclude from gross income fifty percent of the gain from the sale of qualified small business stock held at least five years. The exclusion is increased to sixty percent in the case of the sale of certain empowerment zone stock. The taxable portion of the gain is taxed at the capital gains tax rate of twenty-eight percent and seven percent of the excluded gain is an alternative minimum tax preference. “Qualified small business stock” is stock of a C corporation that is owned by a noncorporate taxpayer and held by that taxpayer for more than five years. To be eligible for the exclusion, the small business stock must be acquired by the individual at its original issue, for money, for property other than stock, or as compensation for services. The amount of gain eligible for this exclusion with respect to any corporation is the greater of (i) ten times the taxpayer’s basis in the stock or (ii) $10 million. Under the ARRA, the percentage exclusion for qualified small business stock sold by an individual is increased from fifty percent to seventy-five percent for stock acquired after February 17, 2009 and before January 1, 2011.
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Work Opportunity Credit (IRC §51)
Summary: The work opportunity credit is designed to provide an incentive for employees to hire individuals from certain disadvantaged groups that have a particularly high unemployment rate. The credit is scheduled to expire for individuals who begin to work after August 31, 2011. The credit is expanded to include unemployed veterans and disconnected youth who begin work during 2009 and 2010.
Explanation: Generally, an employer who hires an individual from one of these targeted groups may claim a tax credit equal to forty percent of the first $6,000 of qualified wages paid to that individual during the first year of employment. However, the credit is reduced to twenty-five percent of the qualified first-year wages for an employee who works 400 hours or less during the first year of employment. The employer may not claim the credit for qualified wages paid to an employee who works less than 120 hours in the first year of employment. The targeted groups historically included (i) individuals who are members of families receiving assistance under the Temporary Assistance for Needy Families program for at least nine months during the eighteen-month period ending on the hiring date, (ii) ex-felons hired within one year after conviction or release from prison, (iii) individuals who have attained age eighteen, but not forty, on the hiring date and who live in an empowerment zone, enterprise community, renewal community, or rural renewal community, and (iv) certain physical or mentally disabled persons. For 2009 and 2010, the targeted groups will include “disconnected youth” and “unemployed veterans.” A disconnected youth is a person that is (a) at least sixteen years of age but no older than twenty-five on the date of hire, (b) not regularly attending school during the six-month period preceding the hiring date, (c) is not regularly employed during such six-month period, and (d) is not readily employable by reason of lacking a sufficient number of basic skills. An unemployed veteran is defined as a veteran that (A) was discharged or released from active duty in the Armed Forces at any time during the five-year period ending on the hiring date, and (B) received unemployment compensation under State or Federal law for not less than four weeks during the one-year period ending on the hiring date.
CONCLUSION
This Legal Update is merely a snapshot of the business incentives provided for in the ARRA. Please note that the ARRA also contains numerous provisions relevant to individuals and health insurance (for example, the first-time homebuyer credit and changes in COBRA premiums) that may affect your business. An analysis of your current and projected tax situation should be performed to determine how the ARRA, as well as other recent legislation, will specifically affect you and your business.
If you have any questions regarding the ARRA and how it may impact your business, please feel free to contact either the Chairperson of the Tallman, Hudders & Sorrentino, P.C. Business, Corporate and Transactional Practice Group, Dolores A. Laputka, Esq., or the Vice-Chairperson, Theodore J. Zeller, III, Esq., via telephone at (610) 391-1800, or by email at their respective addresses below.
Dolores A. Laputka
Theodore J. Zeller, III
Please note that the purpose of this Legal Update is to provide you with general information concerning the key provisions of the ARRA. It should not be considered or construed to be legal advice or opinion.
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