Signed by the President on September 27, 2010, the Small Business Jobs Act of 2010 provides a number of tax benefits for small and medium-sized businesses, but also contains some significant changes as to information reporting (1099s) and the penalties for failure to report. The following is a discussion of the major tax changes included in the Act that may be of interest to those in the nonprofit community with for-profit affiliates:
Section (§) 179 allows a business to write off the cost of furniture, computers, machinery and equipment acquisitions (tangible personal property) in the year of acquisition instead of taking depreciation deductions over a number of years. The current law allows a §179 deduction of $250,000 in 2010 but only a $25,000 deduction in 2011. The amount of the deduction is decreased dollar-for-dollar, if acquisitions exceed a threshold – $800,000 in 2010 and $200,000 in 2011.
The new law increases the §179 limit to $500,000 in 2010 and 2011. The limit begins to decrease if acquisitions exceed $2,000,000 and is reduced to zero if acquisitions exceed $2,500,000.
Not only is this increased limit a boon to companies looking to acquire property in 2011, it is a gift to those that have already made substantial acquisitions in 2010.
Section 179 for Qualified Real Property
As discussed above, the §179 deduction has previously applied only to acquisitions of tangible personal property. The new law allows a $250,000 deduction for acquisitions of certain qualified improvements to real property placed in service in 2010 and 2011. This $250,000 is part of the overall §179 deduction available; a taxpayer cannot claim $500,000 for personal property acquisitions and an additional $250,000 for qualified real property – the overall maximum is $500,000 of which $250,000 can be for qualified real property.
Qualified real property is either qualified leasehold improvements (QLHI), qualified restaurant property (QRP) or qualified retail improvement property (QRIP). The rules for what improvements meet the “qualified” standard are different for each of the three types of improvements.
QLHI must meet the following tests:
The building must have been placed in service at least three years before the leasehold improvement;
The improvements must be made subject to a lease;
The improvements must be to tenant space, not common areas, not an expansion of the building and not escalators or elevators; and
The tenant and landlord cannot be related (i.e. common ownership).
QRP is a building or an improvement if more than 50% of the building’s square footage is devoted to the preparation of, and seating for on-premise consumption of, prepared meals. Unlike QLHI and QRIP, QRP can be a brand new building or improvements in a recently constructed building.
QRIP is improvements to an interior portion of a building where such portion is open to the general public and used in the trade or business of selling tangible personal property to the general public. Also, as with QLHI, the improvements must have been made more than three years after the building was placed in service and not to common areas, enlargements or escalators and elevators.
Bonus depreciation is the option to write off 50% of the cost of new property acquired and placed in service. This was the law in 2008 and 2009 and has now been extended for property acquired and placed in service by December 31, 2010. Note that bonus depreciation only applies to new property whereas §179 is available for both new and used property.
When combining bonus depreciation and §179, §179 is taken first and bonus is applied to the remaining basis. For example, if in 2010 the company acquired and placed in service new machinery with a cost of $800,000, it could take a §179 deduction for $500,000 and bonus depreciation of $150,000 (50% x ($800,000 – $500,000).
Bonus Depreciation for Autos and Light Trucks
An additional $8,000 deduction is available for autos and light trucks acquired in 2010 that are subject to the “luxury auto” limit on depreciation. Since any such vehicle is one with a cost of more than $15,300 and a gross vehicle weight of less than 6,000 pounds, it applies to most vehicles a business may acquire for general transportation needs.
Note to the above four changes – neither Maryland nor Virginia accepts bonus depreciation or the increased §179 write-off. DC follows federal law.
S Corporation Built-in Gains
When a C corporation elects to become an S corporation, the S corporation is taxed at 35% on all gains that were “built-in” at the time of the election if the gains are recognized during the recognition period. The recognition period generally is the first ten S corporation years. A “built-in gain” exists if, at the time of the S corporation election, the fair market value of a corporate asset exceeds its tax basis. The most common built-in gains are (1) real estate, (2) goodwill (going-concern value) and (3) for cash-basis taxpayers, the excess of accounts receivable over accounts payable plus accrued expenses.
For tax years beginning in 2009 and 2010, no tax is imposed on the net unrecognized built-in gain of an S corporation if the seventh tax year in the recognition period preceded the 2009 and 2010 tax years. Under the new law, the recognition period is shortened to five years for gains recognized in 2011 (only in 2011) and would apply to any such S corporation that made the election effective for years beginning in 2006 or earlier.
This is a major planning opportunity for affected corporations and must be considered in any 2010 and 2011 tax planning.
1099 Reporting by Owners of Schedule E Properties
For payments made after Dec. 31, 2010, persons receiving rental income from real property would have to file information returns (Forms 1099) to the IRS and to service providers reporting payments of $600 or more during the year for rental property expenses. Exceptions would be provided for individuals temporarily renting their principal residences (including active members of the military), taxpayers whose rental income does not exceed an IRS-determined minimal amount (not yet announced), and those for whom the reporting requirement would create a hardship (under IRS regulations to be issued).
Note that this takes effect in a few months. Affected taxpayers will have to begin the process of obtaining tax identification numbers from service providers immediately. Do not plan to rely on the latter two exceptions noted above.
Significantly Increased Penalties for Failure to File Information Returns
For information returns required to be filed after Dec. 31, 2010, the penalties for failure to timely file information returns to the IRS would be increased. The first-tier penalty would go from $15 to $30 per unreported form, and the calendar year maximum from $75,000 to $250,000. The second-tier penalty would be increased from $30 to $60, and the calendar year maximum from $150,000 to $500,000. The third-tier penalty would be increased from $50 to $100, and the calendar year maximum from $250,000 to $1,500,000. For small business filers, the calendar year maximum would go from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The minimum penalty for each failure due to intentional disregard would be increased from $100 to $250.
First tier penalties are for self-corrected forms filed within 30 days of the due date of the form. Second tier penalties are for self-corrected forms filed by August 1st. Third tier penalties are for any other unreported or underreported payments.
Self-Employed Health Insurance Deduction for S-E Tax
For 2010, and 2010 only, a taxpayer can deduct from self-employment income the cost of health insurance in computing his/her self-employment tax.
Taxation of Political Organization Taxable Income
A political organization is subject to tax on its “political organization taxable income”. I.R.C. Section 527(c) defines this amount as the gross income of the organization, other than exempt function income, less deductions modified under I.R.C. Section 527(c)(2) directly connected with the production of the taxable income including a $100 specific deduction.
IRS Tax Filing Requirements
Political parties, campaign committees for candidates for federal, state or local office and political action committees are all political organizations subject to tax under I.R.C. Section 527. Unless a specific exemption applies, organizations subject to I.R.C. Section 527 generally are required to file (1) an initial notice with the IRS on Form 8871, (2) a periodic report regarding contributions and expenditures on Form 8872, (3) annual income tax returns on Form 1120-POL and (4) annual information returns on Form 990. Organizations required to report to the Federal Election Commission as political committees are not required to file notices and reports with the IRS in order to be tax-exempt under I.R.C. Section 527. However, they are subject to other tax compliance requirements applicable to political organizations which generally may include filing the Form 1120-POL if the organization has taxable income. Political committees that may be exempt from the IRS initial notice and periodic report filing requirements include any committee, club, association or other group of persons which receives contributions aggregating in excess of $1,000 during a calendar year or which makes expenditures aggregating in excess of $1,000 during a calendar year and any separate segregated fund established under the provisions of Section 441(b) of the Federal Election Campaign Act. Please consult your tax advisor to confirm whether an exemption from the IRS filing requirements will apply. A political organization even if it is exempt from IRS filing requirements still may be required to file reports with the Federal Election Commission.
I.R.C. Section 527 Exemption
I.R.C. Section 527 provides an income tax exemption for exempt function income of certain political organizations. If a PAC qualifies under I.R.C. Section 527, it receives an exemption with respect to its exempt function income and is taxable only on political organization taxable income.
Definition of Political Organization
I.R.C. Section 527(e)(1) and Treas. Reg. Sec. 1.527-2(a) define “political organization” as a party, committee, association, fund or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function activity. A political organization may include a committee or other group which accepts contributions or makes expenditures for the purpose of promoting the nomination of an individual for an elective public office in a primary election or in a meeting or caucus of a political party. A segregated fund established and maintained by an individual may qualify as a political organization.
Organizational and Operational Tests
The regulations under Treas. Reg. Sec. 1.527-2(a)(2) and (3) set forth the organizational test and the operational test to determine if something qualifies as a political organization under I.R.C. Section 527. A political organization meets the organizational test if its articles of organization provide that the primary purpose of the organization is to carry on one or more exempt functions. A political organization is not required to be formally chartered or established as a corporation, trust or an association. If an organization has no formal articles of organization, consideration is given to statements of the members of the organization at the time the organization is formed that they intend to operate the organization primarily to carry on one or more exemption functions. An appropriate written statement of purpose should be prepared by the founders of the organization at the time of its formation in order to make sure that an informally established political organization satisfies the organizational test. To qualify under I.R.C. Section 527, an organization must also meet the operational test. The exempt function activities are not required to constitute the organization’s only activities. Treas. Reg. Sec. 1.527-2(a)(3) specifically provides that an organization may engage in activities that do not qualify as exempt function activities as long as they are not the organization’s primary activities. Therefore, a political organization can satisfy the operational test even if it engages in a certain amount of incidental social or nonpartisan political activities. For example, it is permissible for a political organization to (1) sponsor nonpartisan educational workshops which are not intended to influence or attempt to influence the selection, nomination, election or appointment of any individual for public office, (2) pay an incumbent’s office expenses or (3) carry on social activities which are unrelated to its exempt function. However, expenditures for these purposes are not considered to be for an exempt function for purposes of the exemption and calculating any potential taxable income. Also, it is not necessary that a political organization operate in accordance with normal corporate formalities as ordinarily established in bylaws or under state law.
The income tax exemption provided to political organizations applies only to the “exempt function income” of the organization as defined in I.R.C. Section 527(c)(3). Income of a political organization qualifies under I.R.C. Section 527(c)(3) only if it is one of the types of political organization income enumerated in the statute and it is segregated for use solely in the organization’s exempt function. Exempt function income consists solely of amounts received as (1) contributions of money or other property, (2) membership dues, fees or assessments from a member of a political organization or (3) proceeds from a political fund raising or entertainment event or proceeds from the sale of political campaign materials which are not received in the ordinary course of any trade or business. Income will be considered segregated for use only for an exempt function only if it is received into and disbursed from a segregated fund as defined in Treas. Reg. Sec. 1.527-2(b). A “segregated fund” is a fund which is established and maintained by a political organization or an individual separate from the assets of the organization or the personal assets of the individual. The purpose of the fund must be to receive and segregate exempt function income (and earnings on such income) for use only for an exempt function or for an activity necessary to fulfill an exempt function. Accordingly, the amounts in the fund must be dedicated for use only for an exempt function. The fund must be clearly identified and established for the purposes intended.
Types of Political Action Committees
There are several different types of political action committees (“PACs”) which include (1) corporate or labor separate segregated funds (“SSFs”), (2) nonconnected committees and
(3) leadership PACs.
A nonconnected committee is a political committee that is not a party committee, an authorized committee of a candidate or a separate segregated fund established by a corporation or labor organization. Certain features distinguish a nonconnected committee from an SSF. A nonconnected committee does not have a connected organization. No corporation or labor organization establishes, administers or raises money for a nonconnected committee. An SSF always has a sponsoring corporation or labor organization. A nonconnected committee may receive limited financial and administrative support from a sponsoring organization that is not a corporation or labor organization, such as a partnership or an unincorporated association. All forms of support including money and other items of value received by a nonconnected committee from a sponsoring organization are considered contributions which are subject to annual limits, prohibitions and disclosure requirements under the Federal Election Campaign Act. By contrast, an SSF generally may receive unlimited administrative support from its connected organization and such support is usually not subject to federal disclosure requirements. Unlike an SSF, a nonconnected committee may solicit contributions from anyone in the general public who may lawfully make a contribution in connection with a federal election. By contrast, an SSF may solicit only a limited class of individuals who have specific relationships with the connected organization (i.e., stockholders or members and certain employees of the connected organization and their families).
Members of Congress and other political leaders often establish nonconnected committees, generally known as “leadership PACs”, to support candidates for various federal and nonfederal offices. A leadership PAC is defined as a political committee that is directly or indirectly established, financed, maintained or controlled by a candidate or an individual holding federal office. A leadership PAC is not an authorized committee of the candidate or officeholder and is not affiliated with an authorized committee of a candidate or officeholder. Leadership PACs do not include political party committees. While leadership PACs may be associated with a candidate for federal office, they remain legally unaffiliated with the candidate’s principal campaign committee (also known as the candidate’s authorized committee) and they operate under the same rules as other nonconnected committees. Any financial support to the leadership PAC from a candidate’s authorized committee is a contribution to the leadership PAC. Any support from the leadership PAC that could be paid by the candidate’s authorized committee is a contribution from the leadership PAC to the candidate. Additional requirements apply to leadership PACs that do not apply to other nonconnected committees. Due to restrictions on the types of funds that federal candidates may raise and spend, any PAC that is directly or indirectly established, financed, maintained or controlled by a federal candidate may not solicit, receive, direct, transfer, spend or disburse funds in connection with an election for federal office, including certain federal election activity. Such a PAC may solicit, receive, direct, transfer, spend or disburse funds in connection with a nonfederal election only if the amounts and sources are consistent with state law and the Federal Election Campaign Act’s contribution limits and source prohibitions are observed.
I.R.C. Section 527(e)(2) defines “exempt function” as the function of influencing or attempting to influence the selection, nomination, election or appointment of any individual to any Federal, State or local public office or office in a political organization, or the election of Presidential or Vice-Presidential electors, whether or not such individual or electors are selected, nominated, elected or appointed. The definition of “exempt function” includes the making of expenditures relating to an office described in the preceding sentence which, if incurred by the individual, would be allowable as a deduction under I.R.C. Section 162(a). Treas. Reg. Sec. 1.527-2(c)(1) provides that whether an expenditure is for an exempt function depends on all of the facts and circumstances. Generally, where an organization supports an individual’s campaign for public office, the organization’s activities and expenditures in furtherance of the individual’s election or appointment to that office are for an exempt function of the organization. The individual is not required to be an announced candidate for the office. Furthermore, the fact that an individual never becomes a candidate is not crucial in determining whether an organization is engaging in engaging in an exempt function. An activity engaged in between elections which is directly related to and supports the process of selection, nomination or election of an individual in the next applicable political campaign is an exempt function activity. Expenditures that are not directly related to influencing or attempting to influence the selection process also may be an expenditure for an exempt function by a political organization. These are expenses which are necessary to support the directly related activities of the political organization. Activities which support the directly related activities are those which must be engaged in to allow the political organization to carry out the activity of influencing or attempting to influence the selection process. For example, expenses for overhead and record keeping are necessary to allow the political organization to be established and to engage in political activities. Similarly, expenses incurred in soliciting contributions to the political organization are necessary to support the activities of the political organization.
Federal Election Law
Federal election law generally provides regulations on the way American political campaigns for Congress and the presidency raise money and disclose the amount and sources of contributions. The Federal Election Campaign Act of 1971 (“FECA”) and its subsequent amendments govern nearly all aspects of federal campaign finance activity including (1) the size of contributions to political campaigns, (2) the source of such contributions, (3) public disclosure of campaign financial information and (4) public financing of presidential campaigns. FECA requires every candidate or committee active in a federal campaign to establish a central committee through which all contributions and expenditures must be reported. Among other requirements, such committees must file with the Federal Election Commission (“FEC”) a quarterly report of receipts and expenditures which must list any contribution or expenditure of $100 or more and must include extensive information about donors. The FEC makes this information available for public inspection. FECA continues the ban on contributions by corporations and labor unions. That is, FECA prohibits corporations and labor unions from using their general treasury funds to make contributions or expenditures in connection with federal elections. The law also provides for contribution limits on all other sources of funding sharply limiting the amount any individual, committee or group can contribute to candidates or political committees in any election. See the FEC Campaign Guide for Corporations and Labor Organizations regarding the scope of permissible activities in federal elections. These prohibitions could change as a result of the Citizens United case decided in January, 2010 and this area will need to be monitored .
Types of Political Action Committees
There are several different types of political action committees (“PACs”) which include (1) corporate or labor separate segregated funds (“SSFs”), (2) nonconnected committees and
(3) leadership PACs.
Separate Segregated Funds
Corporations and labor organizations generally are prohibited from making contributions or expenditures in connection with federal elections. The Federal Election Campaign Act and the Federal Election Commission regulations permit corporations and labor organizations to set up political committees which may make contributions to and expenditures on behalf of federal candidates and other committees. Federal election law refers to a corporate or labor political committee as a “separate segregated fund” or SSF which is more commonly referred to as a “political action committee” or PAC. Money contributed to a separate segregated fund is held in a separate bank account from the general corporate or union treasury. A corporation or union that sponsors an SSF is called the connected organization. The connected organization may use its general treasury funds to pay for the costs of operating and raising money for the SSF. The connected organization may also exercise control over its committee. Corporations and unions often adopt bylaws to govern their SSFs. However, bylaws are not required under the law and they do not have to be filed with the FEC except when requested.
S corporations are subject to their own unique charitable contribution rules. Exempt organizations should favor receiving contributions of property from S corporations over receiving S corporation stock. Contributed property can potentially be held, invested, or sold by the exempt organization without being subject to unrelated business income tax (UBIT), but in every case holding or selling S corporation stock will generate unrelated business taxable income. Shareholders should favor making charitable contributions of property at the S corporation level, avoiding the adverse tax consequences of nonliquidating distributions or constructive distributions. Structuring S corporation contributions to exempts using a disregarded single-member limited liability company is an innovative technique that offers benefits to both the donor and done. (A.F. Dana, 23 Taxation of Exempts, No. 2, 37 (September/October 2010).)
Senator Bill Nelson, Democrat of Florida, has proposed that businesses with 25 or fewer employees would be exempt from the new 1099 filing requirement. In addition, for businesses with more than 25 employees, the reporting threshold would be set at $5,000, rather than $600. For more details, read Robert Pear’s article titled “Many Push for Repeal of Tax Provision in Health Law”.
The 2010 Patient Protection and Affordable Health Care Act dramatically changes the Form 1099 reporting requirements for businesses.
Current Law: Businesses are required to file Form 1099-MISC to report payments to service providers to whom they paid more than $600 during the year. Payments to corporations are exempt from that requirement. Penalties for failure to file required Forms 1099 are $50 per occurrence with a maximum penalty of $250,000 per calendar year. Continue reading »
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