Tax Tips

Tax relief for small businesses

Earlier this year, the Small Business and Work Opportunity Tax Act of 2007 (SBWOTA) was signed into law. As part of your year end tax planning, consider these new provisions:

• SBWOTA increases the small business expensing election from $100,000 to $125,000, retroactive to the beginning of 2007 and extending through 2010 (indexed for inflation). Expensing is phased out when a company’s investment in qualifying property exceeds $500,000 for the year (up from $400,000). Review your purchases for the year and, if you haven’t used up the election, consider accelerating planned purchases into this year to generate additional tax deductions.

• The act extends the Work Opportunity tax credit, which would have expired at the end of 2007, through Aug. 31, 2011. As you review your workforce needs, keep in mind this tax-savings opportunity.

• The act made several S corporation reforms that make it easier to retain S status and ease the tax burden on shareholders. In light of these changes, consider whether you would benefit by electing S status for next year.

• The act allows family businesses owned and operated by married couples to elect not to be treated as partnerships for federal tax purposes. If the spouses are the only participants in the company and certain requirements are met, they can report their shares of business income on Form 1040, Schedule C, eliminating the need to file a partnership tax return and two Schedule K-1 forms. If you fall into this category, you may want to make the election on your 2007 tax return. •

Defining your terms

If you give a loved one an interest in a family business, a family limited partnership, real estate or another asset, your gift tax liability is based on the fair market value of the transferred interest. If the IRS challenges the amount reported on your gift tax return and assigns a higher value, you could end up with an unexpected tax liability.

One way to avoid this unpleasant surprise is to give a “defined-value” gift. Instead of transferring a percentage interest in an asset, you transfer a fixed dollar amount. Once the value of your gift is determined (by negotiation or litigation with the IRS, or expiration of the statute of limitations), you calculate the shares needed to transfer the desired value. Any remaining amounts go to an “excess beneficiary,” such as a charity. Take care because this strategy’s validity hasn’t been settled by the courts yet. •

Is it too late for you to shift income to your kids?

Earlier this year, lawmakers closed a loophole that many parents of college-age children were poised to take advantage of. The new law doesn’t take effect until 2008, so there’s still a brief window of opportunity.

Currently, long-term capital gains are taxed at 15%, but the rate is only 5% for taxpayers in the two lowest tax brackets. In 2008, the lower rate is scheduled to drop to zero, lasting through 2010. Until recently, many parents planned to take advantage of these rates by transferring appreciated assets to children who would be age 18 (previously age 14) or older in these years and then selling the assets tax-free to help pay college expenses.

The reason for waiting until age 18 is the “kiddie tax,” which requires unearned income in excess of $1,700 received by a child under age 18 to be taxed at the parents’ marginal rate. But starting in 2008, the kiddie tax will apply to children under 19, with the threshold increased to 24 for full-time students unless they provide more than half of their own support. This change will virtually eliminate the benefits of the asset-shifting strategy described above.

You may still be able to enjoy significant tax savings if you act before the higher age limit kicks in. If you transfer appreciated assets to a child who is 18 (or will turn 18 by the end of the year) and the child sells the assets by Dec. 31, 2007, he or she can take advantage of the 5% capital gains rate (assuming the child is in one of the lowest two tax brackets). •