Some wealthy families will help finance tax breaks for small business under the recently enacted Small Business and Work Opportunity Tax Act of 2007, according to CCH, a Wolters Kluwer business and leading provider of tax and accounting information, software and services (CCHGroup.com). For CCH's Special Tax Briefing on the new law, go to CCHGroup.com and access CCH Tax Briefings under News & Commentary, Tax Legislation Coverage.
The tax provisions were part of larger legislation that also increased the minimum wage and provided funding for the Iraq war, signed into law on May 25. An expansion of the "kiddie tax" to cover children up to age 19 -- up to 24 if they are college students -- is one of the principal ways that the Act funds tax incentives to businesses, mainly small ones, as well as S corporation reforms.
Under the kiddie tax, a child's unearned income in excess of $1,700 -- income in the form of interest, capital gains and so on -- is taxed at the parents' top rate. This rule used to apply to children 13 years and younger. This allowed wealthy families to transfer assets to older teenagers and pay less tax as a family unit. Last year, though, Congress expanded the tax to cover children 17 years and younger, and this year's change, effective for the 2008 tax year, limits the tax savings opportunities still further.
"There are still some opportunities for family tax savings, but they're quite limited," said Mark Luscombe, JD, LLM, CPA and CCH principal federal tax analyst.
This is the first tax law to emerge under the new Democratic leadership of both houses of Congress, and its provisions reflect their "pay-as-you-go" approach to tax cuts.
"Having to pay for tax cuts with offsetting tax increases will probably limit the amount of tax legislation that will make it through Congress, and may endanger extension of some existing tax breaks beyond their expiration dates," Luscombe noted.
Businesses, especially small ones, will benefit under the new law. It extends and expands the Section 179 enhanced expensing provisions through 2010. Under Section 179, businesses are permitted to deduct in one year outlays for equipment that would otherwise have to be depreciated over several years.
The law provides for an immediate 2007 increase in the expensing limit from $112,000 to $125,000, with the phase-out level increasing from $450,000 to $500,000, still limiting its benefits to relatively small enterprises.
The law will also extend Section 179 expensing for Go Zone businesses (those devastated by Katrina and other recent hurricanes) through 2008. Under the new law, the limit is increased to $125,000 for tax years beginning in 2007 through 2011. The amount is also indexed for inflation for tax years beginning after 2007 and before 2011. This means that qualifying Go Zone businesses can take up to $250,000 in Section 179 expense deductions by combining the special Go Zone expensing with regular expensing.
The Work Opportunity Tax Credit (WOTC), which benefits businesses that hire members of certain "target groups" such as welfare recipients, is extended through September 30, 2011. The law also expands the WOTC to allow credit to employers who hire veterans and individuals in counties that have suffered population loss.
In a move to help many small businesses offset the costs of dealing with the higher minimum wage required in the new law, the tax portion allows employers to receive full tip credit despite increase in Federal minimum wage. The tip credit will be based on a minimum wage of $5.15 per hour rather than the new minimum wage, which will reach $7.25 over the next two years. Even though the minimum wage has increased, the amount of the tip credit will not be reduced.
Partners But No Partnership
The new law also helps married couples who operate a joint venture and who file a joint return. Each spouse can take into account his or her share of income, gain, loss and other items as a sole proprietor. They do not have to file a partnership return (Form 1065) and report two Schedule K-1s. Instead, couples would each report their share of income on Form 1040, Schedule C. This treatment is available for tax years beginning after December 31, 2006.
"This means that both spouses can get credit for Social Security benefits without having to file a complicated partnership return," Luscombe noted. "Before, they either had to formally become a partnership or else all the economic activity of the business, including Social Security taxes and credits, was attributed to only one spouse."
S Corp Package
Several modifications to the S corporation rules will help small businesses keep the tax benefits of being an S Corporation. The legislation's Subchapter S provisions facilitate the use of S corps by closing some of the traps that could trigger termination of S corporation status and by reducing the taxes owed by the shareholders of an S corp.
"Congress meant to encourage businesses to operate as S corporations, but several provisions in previous legislation were drafted in such a way that they could turn into traps for the unwary. This Act tries to remove the traps and preserve the benefits of this kind of business entity," Luscombe observed.
Paying For Benefits
In addition to expanding the kiddie tax, the new law enhances revenues through a variety of technical changes that swell IRS coffers to offset the tax benefits doled out elsewhere in the legislation. For example, it eliminates the requirement that the IRS hold a collection due process hearing before issuing a levy on delinquent employment taxes. The $750 threshold for bad check penalties is increased to $1,250 and the $15 fee is increased to $25 for bounced checks payable to the IRS.
The new law also expands preparer penalties to all types of tax returns, such as employment, excise, exempt organizations, estate and gift tax. It also raises the amounts of the penalties and expands the standard of conduct subject to penalty.
"Congress hopes to close the 'tax gap' between what is owed and what is collected in part by cracking down on unscrupulous preparers," Luscombe said. "Whether this can best be accomplished through new legislation or by more rigorous enforcement is an open question."
About CCH, a Wolters Kluwer business
CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, audit and accounting information, software and services. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company.
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