By David P. Webb
and D. Nathan Smith
President Obama signed into law the Small Business Jobs Act of 2010 on Sept. 27, 2010 (the “Act”). The Act extended or introduced provisions designed to lessen the tax burden of small businesses. Many of these tax-saving provisions will be available to assist in the farming business. The two biggest ones will be the increased Section 179 expense deduction and the extension of bonus depreciation.
Increased Section 179 Expensing
Section 179 of the Internal Revenue Code (the “Code”) allows businesses a one-time deduction for qualified property that is purchased and placed in service in the trade or business. Qualified property generally includes personal property that is used in the trade or business. In the case of farmers, it will include property such as farm machinery and equipment.
The Section 179 expense deduction typically available to businesses is $250,000. However, the Act increases the deduction to $500,000 for qualified property purchased and placed in service in 2010 and 2011.
Note that the Section 179 expense deduction begins a dollar-for-dollar phase out when qualifying property of $2,000,000 or greater is placed in service. If qualifying property exceeding $2,500,000 is placed in service, the expense deduction will be completely phased out. The Act also extends the definition to include “qualified real property.” Importantly for farmers, qualified real property includes leasehold improvement property used in the trade or business. Up to half of the $500,000 expense deduction may be qualified leasehold improvement property.
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Example Of The Interaction Of Two Combined Deductions
• Assume a farming business purchases a new farming implement for $1,000,000. The implement is placed in service during 2010. The cost basis for the implement is $1,000,000.
$1,000,000 Cost Basis
• Thus, a $500,000 Section 179 expense deduction and a $250,000 bonus depreciation deduction will be available, for a total deduction of $750,000 in the year of purchase.
• The remaining $250,000 of cost basis will be depreciated under the typical modified accelerated cost recovery (“MACRS”) depreciation tables. Note that the typical MACRS deduction will be taken in 2010 in addition to the Section 179 and bonus depreciation deductions, so that the actual deduction available in 2010 will exceed $750,000.
Extension Of Bonus Depreciation
The Act extends the availability of bonus depreciation for qualified property placed in service in 2010. Qualified property for purposes of bonus depreciation is generally coterminous with the definition of qualified property for Section 179 expensing purposes. The bonus depreciation deduction is equal to 50 percent of the cost basis of property placed in service during the taxable year. Bonus depreciation is only available for new property. Purchases of used equipment do not qualify. Certain long-lived property (such as fixed machinery) and transportation property are entitled to an extended placed in service deadline, which extends to the end of 2011.
Because property that qualifies for Section 179 expensing also typically qualifies for bonus depreciation, the two deductions may be combined for qualifying property. The interaction of the two deductions is demonstrated in an example shown in the yellow box.
In addition to the heavy hitter Section 179 and bonus depreciation deductions, the Act contained a number of lesser provisions, which may provide tax savings to farmers.
Five-Year Carryback Of General Business Credits
A number of general business credits are available for businesses, such as the agricultural chemicals security credit and the low sulfur diesel fuel production credit. Code Section 39 provides the general rule that any unused credits may be carried back one year. The Act amends the general rule and provides a five-year carryback for credits acquired following Dec. 31, 2009. Note that the extended five-year carryback is only available for eligible small businesses, which generally includes sole proprietorships, partnerships and private corporations that have averaged less than $50 million in gross receipts over the previous three years.
Removal Of Cellular Phones As Listed Property
Current Code Section 280F provides that cellular phones are “listed property,” meaning that their use for business purposes must be substantiated in order to sustain a deduction. The Act removes cellular phones from the definition of listed property.
Deduction For Health Insurance Costs In Computing Self-Employment Tax
The Act provides a temporary deduction for 2010 for self-employed individuals. In computing self-employment taxes, such individuals may deduct the cost of health insurance for themselves, their spouses and their children who have not attained the age of 27 as of the end of the taxable year.
Relaxed Penalty For Failure To Disclose Reportable Transactions
The Act amends Code Section 6707A that contains the much-criticized penalty for failure to disclose a reportable transaction. Reportable transactions are those transactions that the Treasury Secretary has determined must be disclosed to IRS because of a potential for tax avoidance. A listed transaction is a reportable transaction that has been described in an IRS publication.
Currently the mandatory penalty for failing to disclose a reportable transaction is $10,000 for individuals and $50,000 for all others. Listed transactions carry a mandatory penalty of $100,000 in the case of individuals and $200,000 for all others.
Under the Act, the penalty is made proportional to the actual tax savings that were the object of the transaction. Failure to disclose a reportable transaction now results in a penalty equal to 75 percent of the reduction in tax reported on the taxpayer’s return as a result of participation in the transaction. A minimum penalty of $5,000 for individuals and $10,000 for all others is established, and the maximum level for all penalties is capped at the levels of the mandatory penalties prior to passage of the Act. The revised penalty structure is effective for all Section 6707A penalties assessed after Dec. 31, 2006.
In conclusion, the Act creates the opportunity for substantial tax savings for farmers who have been contemplating purchases of equipment or other property for the trade or business. Bonus depreciation will only be available for property that is purchased in 2010, but the increased Section 179 expense deduction will be available for property purchased in 2010-2011. Farmers also should consider if other tax-saving provisions of the Act may be applicable to their business.
David P. Webb and D. Nathan Smith are tax attorneys with Baker, Donelson, Bearman, Caldwell & Berkowitz, PC in its Jackson, Miss., office.