As part of the intense horse-trading that led up to the reluctant compromise between the Congress and President Bush on funding for the Iraq War, the parties also hammered out an agreement to raise the national minimum wage for the first time in nearly a decade, and to put in place a set of small business tax changes that are designed to help smaller employers offset some of the costs of a wage increase. The benefits include enhancement and extension of the Section 179 expensing allowance, extension of the Work Opportunity Tax Credit, and a tweaking of the rules governing S corporation Excess Net Passive Income. The agreement also contains some "revenue raisers" to fund the benefits granted, including an extension of the "Kiddie Tax" to children over the age of 18 in some circumstances, and increased and extended tax return preparer penalties. The legislation, called the Small Business and Work Opportunity Tax Act of 2007 (SBWOTA) was signed into law by the President on May 25, 2007.
Under separate legislation providing $120 billion to fund military operations in Iraq, the national minimum wage has been increased by 70 cents an hour to $5.85 effective July 24, 2007. The measure contains two additional 70 cent increases to $6.55 in July, 2008, and to $7.25 in July, 2009. SBWOTA was coupled with the war funding and minimum wage bill to provide some relief for the segment of the economy expected to bear the greatest part of the cost of increases in the minimum wage.
A popular tax strategy for wealthier families has been to shift taxable income to children by putting investment assets such as stocks or certificates of deposit in the children's names. Since the children usually have lower marginal tax rates than their parents, the family group pays less income tax. Congress sought to put limits on this tactic by passing the so-called "kiddie tax" rules in the 90's. In their original form, if the child was under the age of 14, all of her investment income in excess of a designated threshold (initially $700) was taxed at her parents' marginal rate rather than hers. In 2006, the rules were modified to cover children under the age of 19, and the threshold would have been $1,700, adjusted annually for inflation, for 2007 returns.
Now, in a search for additional revenue to balance the costs of the new benefits for small businesses, Congress is re-visiting the Kiddie Tax. The new law will cause investment income of children as old as 23 to be taxed at their parents' marginal rate. The parents' rate applies to all of the child's investment income in excess of the inflation adjusted threshold if
Children who do not have a living parent are excluded from the provision, as are those who file a joint return for the year.
- The child has not had her 19th birthday by the end of the tax year, or
- If she is a full-time student, has not had her 24th birthday, and her earned income from wages, etc. is not greater than 50% of her support.
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Under pre-SBWOTA law, a paid preparer of an income tax return was liable for a $250 penalty if
- The return contained an understatement of tax that was due to a position that had no realistic possibility of being sustained,
- The paid preparer knew of the position, or had reason to know of it, and
- The position was not adequately disclosed on the face of the return.
Effective for returns prepared after May 25, 2007, Congress has extended the preparer penalties to preparers of estate, gift, excise and employment tax returns, in addition to preparers of income tax returns. Preparers of such returns that contain an understatement due to an "unreasonable position" will now be subject to a penalty equal to the greater of $1,000 or 50% of the income they receive for the preparation of the return. A position is "unreasonable" if
- The preparer knew, or should have known, of the position,
- There was not a reasonable belief that the position was more likely than not to be sustained on its merits, and
- Either the position was not disclosed on the return as provided in Code Section 6662(d)(2)(b)(ii), or there was not a reasonable basis for the position as defined in §6694(a)(3).
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In the aftermath of Hurricane Katrina, Congress had increased the amount of new business property that a taxpayer could expense in a year to $100,000, indexed for inflation using 2002 as the base year. The inflation-adjusted amount for 2007 would have been $112,000 but for the passage of SBWOTA. The otherwise-available amount is reduced, but not below zero, by the amount that the total investment in new business property for the year exceeds a threshold amount. Under old law, the threshold amount was $400,000, indexed for inflation; and the amount that would have been in effect for 2007 was $450,000. Congress had made the increases in the two amounts temporary, and for tax years beginning after 12/31/09, the annual expense limit was scheduled to be reduced to $25,000, and the phase-out threshold was slated to go to $200,000.
The new law sets the annual expense limit at $125,000, and the phase-out threshold at $500,000. Both of these amounts are adjusted for inflation, and both are now in effect for all tax years beginning before January 1, 2011. Comment: It is not likely that the Section 179 amounts will ever revert to their pre-Katrina levels. Lawmakers apparently build in these cutoff dates in order to reduce the calculated budget impact of a particular piece of legislation.
The new law also extends through 12/31/08 previously enacted Section 179 benefits for Gulf Opportunity Zone (GoZone) taxpayers. These temporary tax benefits were scheduled to run out at 12/31/07. In general, the Alabama counties of Baldwin, Mobile and Washington are affected by these provisions, along with all the counties on the Mississippi and Louisiana Gulf Coast.
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The WOTC permits employers to claim a credit equal to a percentage of the wages they pay to employees who fall into certain "targeted groups" such as welfare recipients. The credit was scheduled to expire on 12/31/07. SBWOTA expands the definition of targeted groups for wages paid after May 25, 2007 to include certain disabled veterans, as well as residents of rural counties that had net population declines during the five-year periods from 1990 - 1994 and 1995 - 1999. The availability of the credit is extended through August 31, 2011.
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Ever since Congress completely re-wrote Subchapter S of the Code in 1982, nearly every major piece of tax legislation has included some sort of tinkering with the rules governing S corporations, and the 2007 Act is no exception. SBWOTA includes at least one relatively obscure provision that will benefit S corporations that have been a C corporation at some point in their history.
S corporations that have C corporation earnings and profits on their balance sheet are subject to a corporate level tax under Code §1375 if their gross receipts from "passive investment income" are greater than 25% of their total gross receipts. Furthermore, if the greater-than-25% relationship holds for three consecutive years, the S corporation would have a forced termination of its S election. Under old law, gains from the sale of stocks and securities held for investment, to the extent of any gain recognized, were treated as gross receipts derived from passive investment income, causing the ratio of passive gross receipts to be higher. Effective for tax years beginning after May 25, 2007, such gains will no longer be treated a passive for purposes of the §1375 computation.