Not Much Help From The New Tax Law

This time of year a person’s thoughts turn to taxes, and the latest tax act is euphemistically called “The Small Business and Work Opportunity Tax Act of 2007.” This new tax act does not have a lot of good news, but it does provide a few special benefits to the franchise owner.

I recently asked one of the young tax lawyers in our office, Rod Mauszycki, about his thoughts on this new tax law. He provided a great discussion, but his comments did boil down to a few advantageous key provisions you may find helpful.

The increase in Section 179 expense deduction for capital improvements. The expense deduction was increased to $125,000 and the phase-out threshold increased each year to $500,000. In 2008 through 2010 the amounts of the deduction and investment limitation will be adjusted for inflation. This increase is a great thing for the franchise industry as a group, since it is always investing in furniture, fixtures and equipment that should qualify for the Section 179 deduction. A couple of key elements are necessary to take this deduction: (a) you have to make a profit; and (b) this is a limitation on an individual basis. If an individual owns a number of different flow-through entities, he or she can only take the deduction one time for all of the entities owned. Again, this deduction should be utilized. Please note that the capital expenditures used for this Section 179 deduction needed to be placed in service by the end of 2007.

New Qualified Joint Venture. A provision that will cost franchise owners some additional accounting fees concerns husbands and wives who have set up a partnership (LLC). In the past husbands and wives had to file a partnership return, which, in many cases, did not allow for both spouses to maximize the credit for payment of Social Security and Medicare taxes. Although there were some drawbacks, one benefit is that business returns (such as partnerships) are not audited as frequently as individual returns. However, it has been a nuisance for a husband and wife to file both a joint return and then a partnership return because each person owned an interest in the partnership. The new tax law creates something called a Qualified Joint Venture (QJV). A QJV is an unincorporated business that is wholly owned by a married couple and both spouses materially participate in the business. Each spouse will now file a separate Schedule C (which is for sole proprietorship) and a separate Self Employment Schedule called an SE. All income, gain, loss, deduction and credits are divided between the spouses according to their respective interests in the venture. What’s neat about this provision is that you may be able to adjust self employment tax if one of the spouses is employed and maxes out his or her FICA through a shift in ownership.

This new QJV eliminates the need for extra tax filings but still provides the legal protection of a limited liability company (LLC).

The changes made are beneficial but highly technical in nature, so please consult your tax advisor. In the past, capital gains from the sale or exchange of stock or securities in an S corporation were treated as passive investment income and subject to tax. This rule has been liberalized so that gains from the sale of stock or securities are no longer treated as passive income. Therefore, S corporations (if you sell a business and re-invest the money at the S level) may be a beneficial entity to utilize. There are certain changes in the sale of an interest in a qualified subsidiary of an S corporation, which allows the S corporation to only recognize gain proportionate to the percentage of stock sold. The new tax law also eliminates some of the issues regarding pre-1982 earnings and profits and deductibility of interest expenses by an electing small business trust. These are all things that may be of help to you.

4. Alternative Minimum Tax. The alternative minimum tax (“AMT”) has been a big issue. Congress is the process of providing a one year patch for the AMT exemption amount. Although it is not a permanent solution, the patch will provide AMT relief for an estimated 25,000,000 individuals. One benefit resulting from the tax act is that the Social Security Tip Credit can now be applied to offset AMT liability. There are several pitfalls with Tip Credits; therefore, you should consult with your tax advisor before electing to take the Tip Credit.

5. Non-Beneficial Provisions. There are a couple of provisions in the new tax act that may not be beneficial to the franchise owner.

A. Kiddy Tax. This is a tax parents had to pay for the unearned income received by their children. Now the tax has been extended to age 19 or until age 24 if the child is a full time student and his or her earned income is less than half of his or her support.

B. Minimum Wage. The minimum wage will be increased from $5.15 to $7.25 within the next two years. This increase is probably long overdue but, as usual, the franchise world is probably hit more by this raise than most industries.

Always keep in mind that there is still a number of good tax planning ideas. One idea I love is charitable contributions from an IRA. If you have an IRA and are over 70-1/2, you should look at this opportunity to avoid tax on IRA withdrawals. It may be a lot of help to you.