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									                  Small Business & Work Opportunity Tax Act

On May 25, 2007, the President signed an                purchase in the year the qualified assets are
emergency war spending law that includes                placed in service, within certain limits.
the Small Business and Work Opportunity
Tax Act (the Act). Following is a summary               Pre-Act law provides the maximum amount
of its more notable tax provisions. Please              a small business taxpayer may expense for
contact your BKD advisor for more                       taxable years beginning in 2003 through
information.                                            2009 is $100,000 of the cost of the
                                                        qualifying property. The $100,000 amount
Small Business Tax Provisions                           is reduced (but not below zero) by the
The Work Opportunity Tax Credit                         amount by which the cost of qualifying
(WOTC). The WOTC allows employers                       property placed in service during the year
credits against wages for hiring individuals            exceeds $400,000. The $100,000 and
from one or more of nine target groups,                 $400,000 amounts are indexed for inflation.
such as recipients of public assistance,                Under pre-Act law, in 2007, small business
qualified veterans on assistance and “high-             taxpayers are allowed to expense $112,000,
risk youth.” The Act extends WOTC                       and the phase-out threshold is $450,000.
through August 31, 2011.                                The Act extends Section 179 small business
For individuals who begin work for an em-               expensing for one year (through December
ployer after May 25, 2007 the Act also:                 31, 2010) and provides an increase in the
                                                        expensing level to $125,000 and the phase-
   •   Expands the qualified veterans                   out to $500,000 starting in taxable years
       target group to include individuals              beginning after December 31, 2006.
       certified as entitled to compensation
       for service-connected disabilities               Extension of GO Zone Small Business
       and increases the amount of quali-               Expensing. The Act extends for one year
       fied first-year wages subject to the             (through December 31, 2008) increased
       credit from $6,000 to $12,000 for                expensing for qualified Section 179 Gulf
       these individuals                                Opportunity Zone (GO Zone) property in
                                                        specified portions of the GO Zone.
   •   Expands the definition of “high-risk
       youth” to include otherwise qualify-             Extension and Expansion of Low-income
       ing individuals who are age 18 but               Housing Credit Rules for Buildings in the
       not yet age 40 on the hiring date                GO Zones. The Act extends through De-
                                                        cember 31, 2010, the placed-in-service dead-
   •   Modifies the WOTC to allow the                   line for properties located in the GO Zone,
       credit for employers who hire indi-              Rita Zone and Wilma Zone allocated a Low-
       viduals in counties that have suffered           income Housing Tax Credit (LIHTC) in
       significant population losses                    2006, 2007 or 2008. In addition, the act ex-
                                                        tends the GO Zone, Rita Zone and Wilma
                                                        Zone “difficult to develop area” designations
Section 179 Small Business Expensing. In                until December 31, 2010. The Act also al-
lieu of depreciation, small business taxpay-            lows GO Zone, Rita Zone and Wilma Zone
ers may elect to deduct (or “expense”) the              properties placed in service by January 1,
cost of qualified assets (or property) they             2011, to use enhanced 9% credits with “dis-

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                   Small Business & Work Opportunity Tax Act

aster relief” Community Development Block                  Waiver of Individual and Corporate
Grant (CDBG) funds loaned at below-market                  Alternative Minimum Tax (AMT) Limita-
rates, effective May 25, 2007.                             tions on WOTC and Tip Credits. Pre-Act
                                                           law limits a small business’s ability to claim
Enhancement of the Tip Credit for
                                                           WOTC and the tip credit by imposing a limi-
Certain Small Businesses. Tips received
                                                           tation that such credits cannot be used to off-
by restaurant employees are treated as wages
                                                           set the alternative minimum tax (the AMT).
for purposes of Social Security taxes. As
                                                           The Act provides a permanent waiver of the
such, employers must pay Social Security
                                                           individual and corporate AMT limitations for
taxes on tips received by their employees.
                                                           WOTC and the tip credit. This provision is ef-
These employers receive a business tax
                                                           fective for credits determined in taxable years
credit for taxes paid on tip income exceeding
                                                           beginning December 31, 2006.
the federal minimum-wage rate.
The Act allows businesses to continue
claiming the full tip credit despite an in-
crease in the federal minimum wage. The                    S Corporation Changes
Act achieves this by freezing the federal
minimum-wage level for purposes of                         Capital Gain Not Treated as Passive
calculating the credit. This provision                     Investment Income. An S corporation is
applies to tips received for services                      subject to corporate-level tax at the highest
performed after December 31, 2006.                         corporate tax rate on its excessive net pas-
                                                           sive income if the corporation (1) has accu-
Family Business Tax Simplification.                        mulated earnings and profits at the close of
Under pre-Act law, if an unincorporated                    the taxable year and (2) has gross receipts for
business that is jointly owned by a married                which more than 25% are passive investment
couple files as a sole proprietorship (as op-              income. In addition, an S corporation election
posed to a partnership), only the filing                   is terminated whenever the S corporation
spouse will receive credit for paying Social               (1) has accumulated earnings and profits at
Security and Medicare taxes. Furthermore,                  the close of each of three consecutive taxable
unless the married couple is located in a                  years and (2) has gross receipts for each of
community property state, both the married                 those years, more than 25% of which are
couple and the business will be subject to                 passive investment income. The Act elimi-
penalties for failing to file as a partnership.            nates gains from sales or exchanges of stock
The Act allows an unincorporated business                  or securities as an item of passive investment
that is jointly owned by a married couple in               income. This provision applies to taxable
a common-law state to elect to file as a sole              years beginning after May 25, 2007.
proprietorship without penalty as long as each             Treatment of Bank Director Shares. An S
spouse materially participates and they file a             corporation may have no more than 100
joint return. Each spouse will be required to              shareholders and may have only one out-
file separate Schedules C (or E or F, as the               standing class of stock. An S corporation
case may be) rather than a single, combined                has one class of stock if all outstanding
schedule in order to preserve proper credits               shares of stock confer identical rights to dis-
under the Social Security system. This pro-                tribution and liquidation proceeds. National
vision is effective for taxable years beginning            and state banking laws require bank directors
after December 31, 2006.                                   to own stock. In some cases, a bank enters
                                                           into an agreement under which the bank (or

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                   Small Business & Work Opportunity Tax Act

holding company) re-acquire the stock of                 the recognition of gain on underlying assets
a director who no longer holds the office,               only to the extent of the proportionate per-
at the price the director paid for the stock.            centage of stock sold. This provision ap-
The Act clarifies a qualifying director's                plies to taxable years beginning after De-
shares are not treated as a second class of              cember 31, 2006.
stock for purposes of subchapter S. This
                                                         Elimination of Earnings and Profits
provision applies to taxable years begin-                Attributable to Pre-1983 Years. The Act
ning after December 31, 2006.                            provides that, in the case of any corporation
Treatment of Banks Changing from the                     that was not an S corporation for its first
Reserve Method of Accounting. A finan-                   taxable year beginning after December 31,
cial institution that uses the reserve method            1996, the accumulated earnings and profits
of accounting for bad debts may not elect                of the corporation are reduced by the ac-
to be an S corporation. If a financial insti-            cumulated earnings and profits (if any)
tution changes from the reserve method of                accumulated in a taxable year beginning be-
accounting, adjustments to taxable income                fore January 1, 1983, for which the corpora-
are taken into account for the taxable year              tion was an electing small business corpora-
of the change, which is necessary to prevent             tion under subchapter S. This provision ap-
amounts from being duplicated or omitted                 plies to taxable years beginning after May
by reason of the change. These adjustments               25, 2007.
are subject to two levels of taxation. The
                                                         Deductibility of Interest Expense on
Act allows a bank which changes from the
                                                         Indebtedness Incurred by an Acquiring
reserve method of accounting for bad debts
                                                         Business Trust to Acquire S Corporation
to elect to take into account all adjustments            Stock. The Act enables an electing small
the year before it changes to an S corpora-              business trust (ESBT) to deduct interest
tion.                                                    expenses it incurs when it borrows funds to
Adjustments taken into account the year be-              purchase S corporation stock. All other
fore the corporation changes to an S corpo-              taxpayers and qualified S corporation trusts
ration are only subject to corporate-level               are currently entitled to deduct interest
taxation. This provision applies to taxable              incurred to acquire S corporation stock. The
years beginning after December 31, 2006.                 current disallowance of the deduction for
                                                         such interest by an ESBT is reversed and
Treatment of Disposition of an Interest in
                                                         given consistent treatment with other S cor-
Qualified Subchapter S Subsidiary. If a
                                                         poration shareholders. This provision
subsidiary of an S corporation ceases to be a
                                                         applies to taxable years beginning after
qualified subchapter S subsidiary (QSub) the
                                                         December 31, 2006.
subsidiary is treated as a new corporation
acquiring all its assets immediately before
such cessation from the parent S corporation
in a fully taxable transaction. The Act                  Offsets
provides that, where the disposition of stock            Increase in Age of Minor Children Whose
of a QSub results in the termination of the              Unearned Income is Taxed as Parents’
QSub election, the disposition is treated as a           Income. The Act raises the age to 19 (24 if
disposition of an undivided interest in the              a student) under which the unearned income
assets of the QSub (based on the percentage              of minors who provide less than half their
of the stock disposed of) followed by a                  support with earned income is taxed at their
deemed transfer to the QSub. This results in             parents’ tax rate. This provision applies to

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                  Small Business & Work Opportunity Tax Act

all unearned income (not just dividends and           It increases the amount of the penalty for the
capital gains) and allows the lower divi-             understatement of a taxpayer’s liability by a
dends and capital gains rates to apply if the         tax return preparer to the greater of $1,000
parents are eligible for the lower rates.             or 50% of the income derived by the tax
Some individuals were transferring large              return preparer with respect to the return or
amounts of unearned income, including                 claim.
dividend and capital gains proceeds, to their         It establishes an “unreasonable position”
children’s accounts so it would be taxed at           standard—if the preparer knew, or
their children’s lower tax rates. In 1986,            reasonably should have known, of the
Congress shut down this strategy for                  position; there was not a reasonable belief
children under age 14. The Tax Increase               the position would more likely than not be
Prevention and Reconciliation Act of 2005             sustained on its merits; and the position was
(TIPRA) expanded this treatment to chil-              not disclosed or there was not reasonable
dren ages 14 to under 18. This provision is           basis for the position. An exception applies
effective for taxable years beginning after           if there was reasonable cause for the
May 25, 2007. Thus, for most taxpayers, it            understatement and the tax return preparer
does not apply until 2008.                            acted in good faith. The penalty for an
Modify Interest Suspension Rules. In gen-             understatement due to willful or reckless
eral, the IRS may charge interest and certain         conduct is increased to $5,000 or 50% of the
penalties on tax deficiencies that are deter-         income derived. This provision applies to
mined after a tax return is filed, e.g., as the       returns prepared after May 25, 2007; how-
result of an audit. The IRS must stop                 ever, the IRS has granted transitional relief
charging interest and certain penalties if a          under which the substantive portions of this
taxpayer is not notified of the deficiency            new provision are effective for income tax
within 18 months of filing. Only after the            returns due after December 31, 2007.
taxpayer is notified of the deficiency do the
interest charges start up again. This                 Erroneous Refund Claim Penalty. The
provision was enacted in the IRS                      Act creates a 20% penalty on claims for
Restructuring and Reform Act of 1998 in               refund that are filed without any reasonable
response to complaints the IRS acted too              basis. The penalty is applied to the “exces-
slowly, causing unnecessary interest charges          sive amount” of the claim, the amount by
to build up on taxpayers. The Act modifies            which the claim exceeds the amount allow-
the 18-month rule by extending the period to          able. Under current law, penalties apply to
36 months. This provision is effective for            understatements but not to claims for refund.
IRS notices issued after November 25, 2007.           Claims for the earned income tax credit are
Permanent Extension of IRS User Fees.                 excluded from this provision. This provision
The Act makes permanent the fees the IRS              does not apply to any portion of the exces-
is authorized to charge for private letter            sive amount of the claim to which other pen-
rulings and other forms of guidance.                  alties apply. This provision applies to claims
                                                      filed or submitted after May 25, 2007.
Understatement of Taxpayer Liability by
Return Preparers. The Act expands the
application of preparer penalties to all types
of tax returns, including employment, ex-
cise, exempt organizations, estate and gift.

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