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On May 25, 2007, the President signed into law the “Fair Minimum Wage Act of 2007,” and the “Small Business and Work Opportunity Tax Act of 2007.”
Here are some of the highlights of the new tax laws.
Minimum Wage
Current Law. Prior to July 24, 2007, the federal minimum wage is as follows:
Nonexempt employees must be paid at least a minimum wage of not less than $5.15 an hour.
Youths under 20 years of age may be paid a minimum wage of not less than $4.25 an hour during the first 90 consecutive calendar days of employment with an employer.
Tipped employees are considered to have their tips count towards the employer meeting the minimum wage standard, but employers must pay a direct wage on top of tips of at least $2.13 per hour if they claim a tip credit. New Law. The federal minimum wage has been increased as follows:
Effective on July 24, 2007, nonexempt employees must be paid at least a minimum wage of not less than $5.85 an hour.
Effective on July 24, 2008, nonexempt employees must be paid at least a minimum wage of not less than $6.55 an hour.
Effective on July 24, 2009, nonexempt employees must be paid at least a minimum wage of not less than $7.25 an hour.
Credit for Employer FICA Taxes Paid on Tips
Current Law, The federal minimum wage under the Fair Labor Standards Act (FLSA) is $5.15 per hour. Income received in the form of tips may count towards meeting the federal minimum wage.
New Law. The tip credit is based on the amount of tips in excess of those treated as wages for purposes of the FLSA as in effect on January 1, 2007. Thus, the tip credit is determined based on a minimum wage of $5.15 per hour, even though the new federal minimum wage will be $7.25 per hour effective July 24, 2009.
Section 179 Expense
Current Law. The following provisions concerning the Section 179 deduction was scheduled to expire starting in the year 2010:
The Section 179 deduction limit increase from $25,000 to $100,000, indexed annually for inflation. The 2007 inflation adjusted amount was scheduled to be $112,000.
Investment in Section 179 property limit increase from $200,000 to $400,000, indexed annually for inflation. The 2007 inflation adjusted amount was schedule to be $450,000.
The ability to revoke the Section 179 deduction election by the taxpayer without IRS consent.
The cost of off-the-shelf computer software may be expensed under Section 179 rather than amortized over a 36-month period. Thus, for example, starting in the year 2010, the Section 179 deduction limit would be $25,000 with no indexing annually for inflation.
New Law. Each of the above Section 179 provisions has been extended 1 year and is scheduled to expire starting in the year 2011. In addition, the following changes apply for tax years 2007 through 2010:
The Section 179 deduction limit is increased from $100,000 to $125,000, indexed annually for inflation.
The investment in Section 179 property limit increases from $400,000 to $500,000, indexed annually for inflation.
Qualified Section 179 Gulf Opportunity Zone (Go Zone) Property
Current Law. The maximum section 179 deduction is increased by the lesser of $100,000 or the cost of qualified Section 179 Gulf Opportunity Zone property placed in service during the year. The investment limit in Section 179 is increase by the lesser of $600,000, or the cost of qualified Section 179 Gulf Opportunity Zone property placed in service during the year. The $100,000 and $600,000 additional amounts are not indexed annually for inflation. This rule applies with respect to qualified Section 179 Gulf Opportunity Zone property acquired on or after August 28, 2005, and placed in service on or before December 31, 2007.Thus, for property placed in service during 2006, the maximum Section 179 deduction for qualified property placed in service in the GO Zone is $208,000 ($108,000 indexed amount for the regular Section 179 deduction + $100,000).
New Law. The increased Section 179 deduction for GO Zone property is extended to include property placed in service on or before December 31, 2008.
Husband and Wife Business
Current Law. If a husband and wife operate a jointly owned business and share in the profits and losses, they should file Form 1065 as a partnership, not Schedule C. An exception applies for a husband and wife that wholly own an unincorporated business as community property under the community property laws of a state. In community property situations, the husband and wife can treat the business either as a sole proprietorship, or as a partnership.
New Law. Beginning in 2007, a qualified joint venture whose only members are a husband and wife may elect not to be treated as a partnership for federal tax purposes. A qualified joint venture is one where:
The only members of the joint venture are a husband and wife,
Both spouses materially participate in the trade or business, and
Both spouses elect to have the provision apply. All items of income, gain, loss, deduction and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, each spouse would account for his or her respective share on the appropriate form (such as Schedule C). The new law is not intended to change the determination under present law of whether an entity is a partnership for Federal tax purposes (without regard to this election).
For purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a qualified joint venture is taken into account just as it is for Federal income tax purposes (i.e., in accordance with their respective interests in the venture). A corresponding change is made to the definition of net earnings from self-employment under the Social Security Act. The new law is not intended to prevent allocations or reallocations, to the extent permitted under present law, by courts or by the Social Security Administration of net earnings from self-employment for purposes of determining Social Security benefits of an individual.
Kiddie Tax
Current Law. For 2006 in general, a child under age 18 must pay tax at his or her parent’s tax rate on unearned income of more than $1,700. The remaining earned income plus up to $1,700 of unearned income minus the child’s standard deduction is taxed at the child’s rate, regardless of whether the Kiddie tax applies to the child. An exception to the Kiddie tax applies if the unearned income of the child is reported on the parent’s return using Form 8814, Parents’ Election To Report Child’s Interest and Dividends. Exceptions also apply if the child’s top tax rate is more than the parent’s tax rate, or the child files a joint return.
The Kiddie tax applies regardless of whether the child may be claimed as a dependent by either or both parents.
New Law. Effective for taxable years beginning after May 25, 2007, the Kiddie tax rules apply to children who are 18 years old, or who are full-time students over age 18 but under age 24. The Kiddie tax rules do not apply to children age 18 or older whose earned income exceeds one-half of the amount of their total support.
Planning Tip. The expanded Kiddie tax rules will not affect calendar year taxpayers until 2008. This may allow some taxpayers to accelerate plans and recognize income within the remainder of 2007 before the new limits kick-in.
Taxpayer Penalties – Accuracy Related Penalty
Current Law. A taxpayer may be subject to a penalty under Section 6662 equal to 20% of the underpayment if an undisclosed position taken on a return causes an underpayment which is attributable to 1 or more of the following:
Negligence, including failure to make a reasonable attempt to comply with the rules, or intentional disregard of the rules.
Substantial understatement of income tax, which is defined as more than the greater of 10% of the actual amount due or $5,000.
Substantial valuation misstatement.
Substantial overstatement of pension liabilities.
Substantial estate or gift tax valuation understatement. New Law. For claims for refund or credit filed after May 25, 2007, a penalty is imposed on any taxpayer filing an erroneous claim for refund or credit. The penalty is equal to 20% of the disallowed portion of the claim for refund or credit for which there is no reasonable basis for the claimed tax treatment. The penalty does not apply to any portion of the disallowed portion of the claim for refund or credit relating to the earned income credit, or any portion of the disallowed portion of the claim for refund or credit that is subject to accuracy-related or fraud penalties.
S Corporation Taxes
Current Law. An S Corporation generally does not pay tax at the corporate level. Items of income and loss flow through to the individual shareholders, who in turn, pay tax on their individual returns. An exception applies for the Excess Net Passive Income Tax under Section 1375. If an S corporation has accumulated earnings and profits (such as from when it was a C corporation), has passive investment income in excess of 25% of gross receipts, and has taxable income for the year, then a flat 35% tax on the excess net passive income applies at the S corporation level.
For purposes of this rule, passive investment income includes gross receipts derived from royalties, rents, dividends, interest, annuities, and gains from the sale or exchange of stock or securities. Gross receipts include amounts received for the sale of property, investments, and gain (but not losses) from the sale of stock or securities.
In addition, an S corporation election is terminated whenever the S corporation has accumulated earnings and profits at the close of each of three consecutive taxable years and has gross receipts for each of those years more than 25 percent of which are passive investment income.
New Law. For taxable years beginning after May 25, 2007, gain from the sale or exchange of stock or securities is not an item of passive investment income.
S Corporations – Bank Director Stock
Current Law, TheTaxBook™ 2006 Edition, page 19-3: Among other rules, an S corporation:
May have no more than 100 shareholders.
May have only one outstanding class of stock. An S corporation has one class of stock if all outstanding shares of stock have identical rights to distribution and liquidation proceeds. Differences in voting rights are disregarded.
National banking law requires that a director of a national bank own stock in the bank and that a bank have at least five directors. In some cases, a bank director enters into an agreement under which the bank (or a holding company) will reacquire the stock upon the director’s ceasing to hold the office of director, at the price paid by the director for the stock.
New Law. For taxable years beginning after December 31, 2006, restricted bank director stock is not taken into account as outstanding stock in applying any of the S corporation rules. Thus, the stock is not treated as a second class of stock, a bank director is not treated as a shareholder of the S corporation by reason of the stock, the stock is disregarded in allocating items of income, loss, etc. among the shareholders, and the stock is not treated as outstanding for purposes of determining whether an S corporation holds 100% of the stock of a qualified subchapter S subsidiary.
Restricted bank director stock is stock in a bank, or a depository institution holding company, if the stock is required to be held by an individual under applicable Federal or State law in order to permit the individual to serve as a director of the bank or holding company and which is subject to an agreement with the bank or holding company pursuant to which the holder is required to sell the stock back upon ceasing to be a director at the same price the individual acquired the stock.
A distribution (other than a payment in exchange for the stock) with respect to the restricted stock is includible in the gross income of the director and is deductible by the S corporation for the taxable year that includes the last day of the director’s taxable year in which the distribution is included in income.
The new law also says restricted bank director stock is not treated as a second class of stock for taxable years beginning after December 31, 1996.
S Corporations – Qualified Subchapter S Subsidiary (QSub)
Current Law. A QSub is an S corporation (or a corporation that is eligible to be an S corporation) that is owned 100% by another S Corporation. A QSub is disregarded for tax purposes and does not file a separate return.
If the QSub ever fails to be 100% owned by another S Corporation, the QSub is treated as a new corporation acquiring all its assets and assuming all of its liabilities. The tax treatment of the termination of the QSub election is determined under general principals of tax law, including the step transaction doctrine. Example (1) of Treasury Reg. §1.1361-5(b)(3) provides an example in which an S corporation sells 21% of the stock of a QSub to an unrelated party. In the example, the deemed transfer of all the assets to the QSub is treated as a taxable sale because the S corporation was not in control of the QSub immediately after the transfer by reason of the sale, and thus the transfer did not qualify for non-recognition treatment under section 351.
New Law. For taxable years beginning in 2007, the new law provides that where the sale of stock of a QSub results in the termination of the QSub election, the sale is treated as a sale of an undivided interest in the assets of the QSub, based on the percentage of the stock sold, followed by a deemed transfer to the QSub under Section 351 (tax-free transfer). Thus, in the Treasury regulation example, the S corporation is treated as selling a 21% interest in all the assets of the QSub to the unrelated party, followed by a transfer of all the assets to a new corporation in a transaction to which section 351 applies. Thus, the S corporation will recognize 21% of the gain or loss in the assets of the QSub.
The new law is not intended to change the present-law treatment of the disposition of stock of a QSub by an S corporation in connection with an otherwise non-taxable transaction.
Work Opportunity Tax Credit
Current Law. The Work opportunity credit was scheduled to expire after 2007. The credit equals 40% of first year wages (25% for employment of 120 to 400 hours, 0% for employment of less than 120 hours). Qualified first year wages are wages attributable to services rendered by certified employees hired that are members of a targeted group of eligible individuals during the one-year period beginning with the day the individual began work for the employer. The maximum credit per employee is:
$2,400 (40% of the first $6,000 of wages), or
$1,200 (40% of the first $3,000 of wages) with respect to qualified summer youth employees, or
$9,000 (40% of the first $10,000 of first year wages and 50% of the first $10,000 of second year wages) with respect to long-term family assistance recipients. The employer’s deduction for wages paid is reduced by the amount of the credit. A targeted group of eligible individuals includes:
Families receiving benefits under the Temporary Assistance for Needy Families Program (TANF),
A qualified veteran,
A qualified ex-felon,
A high-risk youth,
A vocational rehabilitation referral individual who has a physical or mental disability that constitutes a substantial handicap to employment,
A qualified summer youth employee,
A qualified food stamp recipient,
A qualified SSI recipient, and
A long-term family assistance recipient. The work opportunity tax credit is not allowed for wages paid to a relative or dependent of the taxpayer. No credit is allowed for wages paid to an individual who is a more than 50% owner of the entity. Similarly, wages paid to replacement workers during a strike are not eligible for the work opportunity tax credit. Wages paid to any employee during any period for which the employer received on-the-job training program payments with respect to that employee are not eligible for the work opportunity tax credit. The work opportunity tax credit generally is not allowed for wages paid to individuals who had previously been employed by the employer. Certain rules apply with respect to obtaining certification that an individual qualifies as a member of a targeted group of employees.
New Law. The credit is extended 44 months for qualified individuals who begin work for an employer after December 31, 2007, and before September 1, 2011.
Qualified veterans targeted group. The new law expands the qualified veterans’ targeted group to include service related disabled individuals:
Having a hiring date not more than one year after being discharged from active duty, or
Having been unemployed for six months or more during the one-year period ending on the date of hiring. Qualified first-year wages. The new law expands the definition of qualified first-year wages from $6,000 to $12,000 for individuals in the qualified veterans’ targeted group. The increased wage definition does not apply to veterans qualified with reference to a food stamp program, as defined under current law.
High-risk youth targeted group. The definition of high-risk youths is expanded to include otherwise qualifying individuals age 18 but not yet age 40 on the hiring date. Individuals from rural renewal counties may also be included in this category. The name of this category has been changed to the “designated community residents” targeted group.
Vocational rehabilitation referral targeted group. The new law expands the definition of vocational rehabilitation referral to include any individual certified as an individual with a physical or mental disability that constitutes a substantial handicap to employment and who has been referred to the employer while receiving, or after completing, an individual work plan developed and implemented by an employment network pursuant to subsection (g) of section 1148 of the Social Security Act.
Low Income Housing Credit
Current Law. The low-income housing credit is allowed for each new qualified low income building placed in service after 1986. The credit is taken over a 10-year period. The owner of a qualified building must receive Form 8609, Low-Income Housing Credit Allocation Certificate, from a state or local housing credit agency in order to claim the credit. Certain housing credit ceiling amounts apply to the various States. Under the Golf Opportunity Zone Act of 2005, these housing credit ceiling amounts were increased for each of the States within the Gulf Opportunity Zone for calendar year 2006.
An enhanced credit is also available for buildings located in high cost areas. Under the Gulf Opportunity Zone Act of 2005, the Gulf Opportunity Zone, the Rita GO Zone, and the Wilma GO Zone are treated as high-cost areas for purposes of the low income housing credit for property placed-in-service in calendar years 2006, 2007, and 2008.
New Law. The new law extends and expands the low-income housing credit rules for buildings located in one of the GO Zones. The new law:
Repeals some of the requirements under the carryover allocation rules.
Extends 2 years the placed in service dates for buildings eligible for the enhanced credit.
Modifies the definition of below market Federal loans.
Treats rehabilitation expenditures as a separate new building.
Alternative Minimum Tax
Current Law. To the extent the tentative minimum tax exceeds the regular tax, a taxpayer is subject to the alternative minimum tax. In general, business tax credits reduce regular tax, but do not reduce the tentative minimum tax. Thus, a business tax credit generally cannot offset AMT.
New Law. Beginning in 2007, the work opportunity tax credit and the credit for employer FICA taxes paid on tips may be used to offset the alternative minimum tax liability.
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