This is Part 3 of the 3-part series describing several rulings that were made in the last year that affect S corporations.
Small Business Jobs Act of 2010
The Small Business Jobs Act of 2010 expanded the dollar amount of new or used tangible personal property that may be expensed in the year placed in service under Sec. 179 to $500,000 for 2011. The phaseout of this tax benefit starts at $2 million and would be fully phased out for property acquired in the tax year that exceeded $2.5 million. For 2012, the maximum amount is $139,000 and the phaseout starts at $560,000.
Under the act, in an expansion of the Sec. 179 provision, for tax years beginning in 2010 and 2011, $250,000 of the $500,000 limit for the Sec. 179 deduction may be applied to qualified leasehold, retail, and restaurant improvements. This category of assets has a 15-year life, so it is likely that taxpayers that place these assets into service in these years will choose to apply Sec. 179 to them. If the Sec. 179 income limitation applies to a taxpayer for 2011, this category of asset carryover cannot be deducted under Sec. 179 in 2012. Instead, the remaining carryover amount is depreciated as property placed in service on the first day of 2011.
Patient Protection and Affordable Care Act of 2010
The Patient Protection and Affordable Care Act of 2010 imposed an excise tax on amounts paid for indoor tanning services. Under new regulations, QSubs and other disregarded entities will be treated as separate entities for purposes of the excise tax on indoor tanning services.
Zero Capital Gains Rate in 2011 and 2012
The zero capital gains rate for individual taxpayers in the lower two tax brackets was extended in 2011 and 2012, so taxpayers should consider gifting appreciated S corporation stock to their children, grandchildren, or parents. In 2008, the tax law extended the “kiddie tax” to income (including capital gains and dividends) of 18-year-olds who do not provide more than half of their support, and to 19- to 23-year-olds who are full-time students and do not provide more than half of their own support. Thus, the 0% tax rate generally will be unavailable to students through age 23 unless they have significant earned income or possibly trust fund income that contributes to their own support. Parents may hire a child to legitimately work for them and pay him or her enough to meet the 50% self-support test, but not so much that they exceed the first two bracket limits.
IC-DISC Tax Rate Arbitrage
Interest charge domestic international sales corporation (IC-DISC) status can be used to to play the tax rate differential for companies that produce products in the United States but sell them overseas. Essentially the IC-DISC receives a commission based on the greater of 50% of net export income or 4% of gross revenue. Dividends to shareholders are qualified for the Sec. 1(h) 15% tax rate, and the producing entity corporation gets a deduction at 35%. The producing entity can also use Sec. 199.
Upcoming Net Investment Income Taxes
The Health Care and Education Reconciliation Act of 2010 imposes a net investment income tax of 3.8% of the lower of net investment income or modified AGI over a base amount for tax years beginning in 2013. If the passthrough entity has investment income such as interest income, dividend income, certain royalties and rents, as well as capital gains, that will be part of net investment income. If the investor is considered not materially participating under the rules of Sec. 469, then the income reported on line 1 of Schedule K-1 will be considered net investment income. The S shareholder should note that estimated taxes are required for this Sec. 1411 tax. In addition, there is also a hospital insurance tax scheduled to apply beginning in 2013 that would impose a 0.9% tax on wages and self-employment income above the thresholds described in Sec. 1411.
Employee Stock Ownership Plans
Shareholders should be aware of a few complicated provisions designed to prevent abuses of Employee Stock Ownership Plan rules. These provisions include the normal fiduciary rules that apply to trusts as well as the Sec. 409(p) disqualified person rules when dealing with S corporations.
If you have any questions about any of these rulings or changes, or if you think you may be affected by any of them, I encourage you to contact me.