Recent Federal Income Tax Incentives Targeted at Small Businesses (2012)

1. Business Law Institute
May 2012
Recent Federal Income Tax Incentives
Targeted at Small Businesses
Presented by:
Kevin W. Kaiser
Lindquist & Vennum PLLP
Kevin D. Whitaker
Moquist Thorvilson Kaufmann &
Pieper LLC

2. Recent Federal Income Tax Incentives Targeted
at Small Businesses
ANY TAX ADVICE CONTAINED IN THIS COMMUNICATION IS NOT
INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED FOR
THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE
IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS
ADDRESSED HEREIN.
The information contained herein is general in nature and based on
authorities that are subject to change. Applicability to specific situations is
to be determined through consultation with your tax adviser.
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3. Small Business Tax
Policy Considerations
Policy considerations
Reward for investment in research and innovation
o Small Businesses regarded as engines of
innovation
Financial markets deny small businesses adequate
credit
o Small businesses are at the mercy of bankers and
non-bank lenders
Small business bear disproportionate compliance
burdens
o Simplification
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4. Small Business
Choice of Entity
Pass-through entities (generally suited for closely held
businesses)
− Sole proprietorship
− Partnership/LLC
− S-corporation
o Self-employment tax considerations
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5. Small Business
Choice of Entity
Sole proprietorship
Administrative convenience
o No formation, license or registration fees
o No federal tax identification number (TIN) required
unless the business hires employees or other special
circumstances
o Business activity reported on individual tax return
o Income taxed at individual rates, plus self-
employment taxes
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6. Small Business
Choice of Entity
Partnership/LLC
Partnerships are generally treated as pass-through
entities, not subject to tax at the entity level
Partnerships provide partners with a significant amount
of flexibility to vary their respective shares of
partnership income
o Allocations are permitted to the extent the partner to
which the allocation is made received the economic
benefit or bears the economic burden of such
allocation, and the allocation substantially affects the
dollar amounts to be received by the partners from
the partnership independent of tax consequences
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7. Small Business
Choice of Entity
Partnership/LLC
Many partnerships are organized as limited liability companies (LLCs)
o “Check-the-Box” rules govern the classification of legal entities
o Generally, LLC with two or more members is classified as partnerships
for federal income tax purposes
 Tax rules – default: two or more LLC members will be a partnership
o “Check the Box” default rules for tax:
 1-member LLC = Sole proprietorship (LLC disregarded)
 2 or more members = Partnership
 => Check-the-box option for LLC to be classified as a corporation
 => S-corporation election available to LLC/Corporation
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8. Small Business
Choice of Entity
S-Corporation
Generally, organized as a state law corporation (or, LLC)
Corporate law filings and administrative requirements, including:
o Tax identification number
o Secretary of state filings
o Separate bank account
Limitations on the number and type of shareholders
o 100 shareholder limit (family members treated as 1 shareholder)
o Only individual shareholders and selected trusts
Self Employment Tax
o Earnings from salary subject to self employment tax
o Pass-through share of income, after deduction for shareholder salary
not subject to self-employment tax
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9. Small Business
Choice of Entity
Taxable Entities
C-corporation
o Subject to entity level tax
o Corporate law filings and administrative requirements
o Dividends payable to shareholders are taxable to
recipients and not deductible to the corporation.
(Corporate double tax)
o Generally, C-corporate form of business required to
access public capital markets. Best suited if entity will
be publicly traded.
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10. Small Business
Choice of Entity
Taxable entities
C-corporation
− Founders’ stock tax incentives
o Qualified small business stock (section 1202)
o Small business stock (section 1244)
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11. Small Business
Choice of Entity
Qualified small business stock (QSBS) gain exclusion (section 1202)
The tax rules provide a special tax incentive to encourage investments in
C-corporations that qualify as “small business corporations.”
Noncorporate taxpayers can exclude from gross income 100 percent of the
gain on the sale or exchange of QSBS acquired after September 27, 2010
and before January 1, 2012, and held more than 5 years. Generally, the
gain on the sale or exchange of QSBS before September 27, 2010 and
after January 1, 2012 is eligible for a 50 percent exclusion.
QSBS defined:
o Issuer must be a C corporation
o Aggregate gross assets must not exceed $50 million immediately
before the QSBS issued
o Corporation must engaged in an active trade or business
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12. Small Business
Choice of Entity
Ordinary Loss Treatment for Section 1244 Small Business Stock
An individual may take an ordinary loss deduction for a loss sustained on the
sale, exchange, or worthlessness of certain “small business stock” (referred to
as Section 1244 stock), rather than recognize a capital loss
Section 1244 Deduction Limits
o Unmarried individuals:
 Up to $50,000 of the loss on Section 1244 stock may be claimed by
unmarried individuals as an ordinary loss
 Any excess loss over $50,000 is treated as a capital loss and must
comply with the rules for capital losses
o Married individuals:
 Up to $100,000 of the loss on Section 1244 stock may be claimed as
an ordinary loss by married individuals filing a joint return even if only
one spouse owns the stock
 Any excess loss over $100,000 is treated as a capital loss and must
comply with the rules for capital losses
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13. Small Business
Choice of Entity
Ordinary Loss Treatment for Section 1244 Small Business Stock
Section 1244 Defined
o The corporation can have equity (total assets minus total liabilities) up to
$1 million at the time the stock is issued
o The stock must be issued for cash or property not stock and securities
o More than half the corporation's income for the preceding five years before
the loss must have come from business operations, not from passive
income (rents, royalties, dividends, interest. annuities, or gains from the
sale of stocks or securities)
o If the corporation was not in existence for five years before your loss, then
the years it was in existence will be considered for the gross receipts test
o Stock must be acquired by purchase (not by-gift, inheritance, or by
purchasing the stock from someone else)
o Taxpayer claiming the Section 1244 loss must be the original purchaser of
the stock
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14. Employment Related Tax Incentives
Federal Unemployment Tax (FUTA)
− Employers pay tax on first $7,000 of each employee’s
wages
− 6.2% tax rate through June 30, 2011
− Reduced to 6.0% tax rate starting July 1, 2011
− Credit for state unemployment taxes against federal
limited to 5.4% of wages, producing effective FUTA tax
rate of 0.6% in 2011
− The wage base remains at $7,000 for 2012. Effective
tax rate for 2012 will be 0.6%
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15. Employment Related Tax Incentives
Deduction for Health Insurance
Self-employment tax rate reduced by 2% to 13.3% in 2011, and
continued to 2012
Self-employed may continue to deduct health insurance costs from
business income when determining their income tax liability
Deduction is allowed for business owner, spouse and dependents
(children under 27 in certain circumstances)
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16. Employment Related Tax Incentives
Returning Heroes Tax Credit, and Wounded Warriors Tax Credit
Component of Work Opportunity Credit
Hired after 11/11/2011 and before 1/1/2013
Up to $5,600 for hiring a long-term unemployed veteran
Up to $2.400 for hiring a short-term unemployed veteran
Up to $9,600 for hiring an unemployed veteran with a service
related disability
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17. Equipment Expensing Provisions
Section 179 Deduction (Immediate write-offs)
Expensing provision for certain business property
Maximum first-year write-off in 2011 is $500,000; $139,000 in 2012
Most tangible personal property eligible
Includes qualified restaurant, leasehold and retail properties in
2011
Section 179 was expanded to also cover 15-year qualified real
estate/leasehold improvements in 2011
Phase out begins at $2.0 million in 2011; $560,000 in 2012
Limits and exceptions
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18. Equipment Expensing Provisions
Section 179D Deduction for Energy Efficient Commercial Building
Taxpayers may deduct all or a part of the cost of energy efficient
commercial building property place in service after December 31,
2005, and before January 1, 2014
"Energy efficient commercial building property" is defined as property:
o For which depreciation or amortization is allowable
o Which is installed on or in a building located in the U.S.
o Within the scope of Standard 90.1-2001 of the American Society of
Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating
Engineering Society of North America
o Installed as part of the interior lighting systems, heating and cooling
ventilation
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19. Equipment Expensing Provisions
Bonus Depreciation (More immediate write-offs)
First-year bonus depreciation allowance for eligible property
100% deduction for property placed in service in 2011; 50% in
2012
Property eligibility requirements
Benefits of using bonus depreciation:
o Immediate tax relief
o Improved cash flow
o Additional reinvestment capital
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20. Equipment Expensing Provisions
Qualified Leasehold Improvements
Qualified leasehold improvement property is generally any
improvement to a building that meets all of the following
requirements:
o The building is non-residential real property
o The improvement is to an interior portion of the building
o The improvement was made pursuant to a lease by the tenant
or sub-tenant
o The improvement was placed in service more than three years
after the date the building was first placed in service by any
taxpayer
For 2011 Section 179 was available for qualified leasehold
improvements but not for 2012
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21. Start-up and Organizational Costs
Expensing
Start-up Costs Organizational Costs
Deduction in year business Deduction for certain costs in
starts/succeeding years creating C or S corporation
or partnership
Can include full range of
business investigatory costs Certain legal and accounting
fees
First $5,000 in expenses
deducted; the remaining is First $5,000 in expenses
amortized over 180 months deducted; the remaining is
(15 years) amortized over 180 months
(15 years)
$5,000 first year maximum
$5,000 first year maximum
$50,000+ dollar-for-dollar
phase-out $50,000+ dollar-for-dollar
phase-out
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22. Research and Experimentation
Tax Credit
Federal Research and Experimentation Tax Credit
Section 41 governs the calculation and definition of credit eligible
research expenses
Credit Eligible Expenses 4-Part Test
Permitted Purpose
Technological in Nature
Process of Experimentation
Elimination of Uncertainty
Creditable Expenses
Wages
Supplies
Contract labor
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23. Research and Experimentation
Tax Credit
Minnesota Research and Experimentation Tax Credit
Minnesota generally follows the federal rules for determining
qualified R&D activities with the exception that the qualifying
activity must be done in Minnesota
In 2010 the law was changed to make the Minnesota credit
refundable
For those early stage/loss companies this new law creates a
significant benefit and positive cash-flow impact
The credit also applies and is passed through to owners of S-
corporations, partnerships/LLC’s as well as sole proprietors
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24. Minnesota Angel
Tax Credit
Minnesota Angel Tax Credit
Minnesota's Angel Tax Credit provides incentives to investors or
investment funds that put money into startup and emerging
companies focused on high technology or new proprietary
technology. The Angel Tax Credit :
o Provides a 25-percent individual income tax credit for qualified
investors
o Is refundable. Non-Minnesota residents, including residents of
foreign countries, are eligible for the credit
o Allows a maximum credit of $125,000 per year per individual
o Allows a maximum credit of $250,000 for those married and
filing jointly
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25. Minnesota Angel
Tax Credit
Minnesota Angel Tax Credit
The Minnesota's Angel Tax Credit has numerous requirements and
requires an application process and state regulatory approval by
Department of Employment and Economic Development ("DEED").
Key definitions:
o Qualified Investment – Generally, only equity investments
(convertible debt in limited circumstances)
o Qualified Investor or Angel – Must be certified by DEED. Must
be individual or Qualified Fund with natural persons as owners
o Qualified Small Business – Must be certified by DEED.
Generally, QSB must be involved in innovation or research or
technological activity
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26. Cash vs. Accrual Method of Accounting
Cash vs Accrual Method of Accounting
Under the cash method income is reported when constructive
receipt occurs (money is available without restriction). Expenses
are deducted when actual payment occurs. In general, the cash
method cannot be used to account for inventory purchases and
sales. However an exception applies to taxpayers with average
annual gross receipts of $1 million or less. Also taxpayers with
average annual gross receipts of $10 million or less can continue
to use the cash method if the business is primarily a service-type
business.
Generally cash basis allows the taxpayer more flexibility in
controlling taxable income in a given year
One exception however, is for taxpayers who receive advance
payments in which there may be income deferral opportunities if
using the accrual method
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27. Financially Distressed Businesses
Partnership Debt for Equity Rules
The IRS released final regulations on partnership debt for equity
exchanges
Generally, extinguishing debt with equity is a taxable exchange
When a debtor partnership issues a capital or profits interest to a
creditor in satisfaction of a debt, the partnership is treated as
having satisfied the debt for an amount of money equal to the FMV
of the partnership interest being issues to the creditor
To the extent the principal amount of the debt exceeds the FMV of
the equity being issued, the partnership recognizes cancellation of
debt (COD) income
Such COD income must be included in the distributive shares of
the partners (subject to any exclusions at the partner level)
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28. Financially Distressed Businesses
Net Operating Losses
Planning for Net Operating Losses (NOLs)
NOL deduction available when current year’s income is less than
current year’s deductions
NOLs can be carried back 2 years and forward 20
Planning required to maximize deduction
NOL versus Section 179 deduction
NOL versus bonus depreciation
Many businesses have large NOLs generated during economic
downturn
Proper planning will insure best tax result so that NOL benefits are
not allowed to expire
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29. Tax Planning Considerations
Tax myths and recent audit results
Tax avoidance vs. tax evasion
Aggressive tax planning to avoid
o Independent contractor vs. Employee
 Taxes cannot be saved by treating (true) employees as
independent contractors
o Convoluted entity structuring
o Claiming tax losses that do not correspond to a true economic
loss (e.g., abusive tax shelters)
o Mixing personal and business expenses
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30. Tax Planning Considerations
Business tax planning adds value
Every major corporation has tax professionals employed on a full
time basis to do tax planning and to comply with the tax rules,
regulations, and deadlines
Maximizing deductions will lower a businesses taxable income and
taxes paid, and increase cash-flow
Strict adherence to tax rules, with appropriate documentation, is
required to ensure that the expenses are legitimate deductions
that can be supported in the event of an IRS exam
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31. Q&A
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32. Contact Information
Kevin W. Kaiser
Lindquist & Vennum PLLP
Phone: (612) 371-2467
E-mail: kkaiser@lindquist.com
Kevin D. Whitaker
Moquist Thorvilson Kaufmann & Pieper LLC
Phone: (763) 557-2583
E-mail: Kevin.Whitaker@mtkcpa.com
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