General business provisions.

Sec. 179 Expense Deduction

The Small Business and Work Opportunity Tax Act of 2007 (SBWOTA) (1) and the Economic Stimulus Act of 2008 (2) have increased the amount that businesses can deduct under Sec. 179.

In tax years 2003-2009 taxpayers could elect to expense the cost of up to $100,000 (adjusted for inflation) of qualifying tangible property and off-the-shelf computer software (Sec. 179 property) instead of capitalizing and depreciating the property. However, the amount of property that a taxpayer could expense in a tax year was reduced by the amount of the cost of Sec. 179 property the taxpayer placed into service in the tax year in excess of $400,000 (adjusted for inflation). The maximum expense amount and the phaseout threshold amount as adjusted for inflation for 2007 were $112,000 and $450,000, respectively.

SBWOTA

Under SBWOTA, the maximum Sec. 179 expense election amounts were increased beginning in 2007. The first-year deduction allowed was increased to $125,000 and the phaseout threshold was increased to $500,000. (These limits are adjusted for inflation beginning in 2008.) The increased expense amount and phaseout threshold amount are applicable in years beginning after 2006 through tax years ending before 2011. (3)

SBWOTA also extended the inclusion of off-the-shelf computer software as qualifying Sec. 179 property and a taxpayer's ability to revoke the Sec. 179 election or to change which assets are covered by the election in years after the year of the election until the end of 2010. Previously, both of these provisions were scheduled to expire at the end of 2009.

Economic Stimulus Act

Under the SBWOTA rules, as adjusted for inflation, the maximum Sec. 179 expense amount for 2008 was $128,000 and the phaseout threshold was $510,000. However, for tax years beginning in 2008 (only), the Economic Stimulus Act raises the Sec. 179 expense amount to $250,000 and the phaseout threshold to $800,000. (4)

Note: Although the increased Sec. 179 expense and phaseout threshold amounts provided in both laws are of great benefit to small business taxpayers, the potential reversion of the amounts to their pre-2003 levels after 2010 remains a problem. If this occurs, the maximum Sec. 179 expense amount will be $25,000 and the phaseout threshold will be $200,000.

Bonus Depreciation

The Economic Stimulus Act amended Sec. 168(k) to allow taxpayers to take an additional 50% first-year "bonus depreciation" deduction for qualifying property acquired in calendar year 2008. Qualifying property includes property that has a recovery period of 20 years or less or is classified as off-the-shelf computer software not covered under Sec. 197, water utility property, or leasehold improvement property. The deduction applies to the regular tax and the alternative minimum tax (AMT).

The qualifying property's original use must begin after December 31, 2007, the acquisition (including contract dates) must occur during 2008, and the asset must be placed in service during 2008. Similarly, the taxpayer must place self-constructed assets and sale-leaseback property in service during 2008. However, the act extended the placed-in-service date through December 31,2009, for assets with longer production periods and for certain aircraft.

The taxpayer must reduce the qualifying property's adjusted basis by the bonus depreciation before computing the customary depreciation for the appropriate cost recovery period. The IRS intends to issue guidance allowing taxpayers generally to rely on Regs. Sec. 1.168(k)-1 for purposes of the bonus depreciation provision of the Economic Stimulus Act. (5)

Note: As was the case with previous bonus depreciation provisions, if a taxpayer elects to take a Sec. 179 expense deduction for an item of property and the cost of that item of property is greater than the amount of the deduction taken, the taxpayer may also take a bonus depreciation deduction for the item of property based on the cost of the property reduced by the amount of the Sec. 179 expense deduction.

Depreciation Limits on Passenger Automobiles

The allowable depreciation deduction for a passenger automobile is generally limited under Sec. 280F(a)(1) (A)(i) to $2,560 for the first year. To allow taxpayers to take advantage of the bonus depreciation provisions described above for these automobiles, the Economic Stimulus Act increases the depreciation limit by $8,000 for passenger automobiles that are also qualified property for bonus depreciation purposes. (6)

Sec. 179 Deduction for GO Zone Property

The Gulf Opportunity Zone Act of 2005 (7) increased the maximum Sec. 179 expense amount and the phaseout threshold for the deduction for qualified GO Zone property placed in service after August 27, 2005, and on or before December 1, 2007. The maximum Sec. 179(b)(1) expense amount is increased by the lesser of $100,000 or the cost of the qualified Sec. 179 GO Zone property placed in service; under Sec. 179 (b)(2), the phaseout threshold is increased by the lesser of $600,000 or the cost of the qualified Sec. 179 GO Zone property placed in service. (8)

SBWOTA extended the placed-in-service deadline for the increased Sec. 179 expense amount and the phaseout threshold for the areas hardest hit by Hurricane Katrina from December 31, 2007, to December 31, 2008. The extended placed-in-service deadline applies to qualified GO Zone property substantially all the use of which is in the Louisiana parishes of Calcasieu, Cameron, Orleans, Plaquemines, St. Bernard, St. Tammany, and Washington and the Mississippi counties of Hancock, Harrison, Jackson, Pearl River, and Stone.

Work Opportunity Credit

Sec. 51 provides a credit to an employer equal to 40% of the first-year wages paid or incurred by the employer during the tax year to individuals who are members of certain targeted groups. SBWOTA extends the Sec. 51 work opportunity tax credit for 44 months for qualified individuals who begin work for an employer after 2007 and before September 1,2011. (9) The credit was scheduled to expire for individuals who began work for an employer after 2007.

SBWOTA also increases qualified first-year wages from $6,000 to $12,000 for individuals who are qualified veterans. (10) In addition, it expands the definitions of qualified veterans, targeted high-risk youths, and targeted vocational rehabilitation referrals for purposes of the work opportunity tax credit. (11)

FICA Tip Credit

Employers in the food and beverage industries may take a credit for the excess employer Social Security tax paid on employee cash tips (the FICA tip credit). (12) The term "excess employer Social Security tax" refers to the FICA tax paid by an employer on tips received by an employee during any month, to the extent such tips are deemed to have been paid by the employer to the employee and exceed the amount by which the wages (excluding tips) paid by the employer to the employee during such month are less than the total amount that would be payable (with respect to such employment) at the applicable minimum wage rate.

SBWOTA provides that the FICA tip credit will continue to be determined on the basis of a minimum wage of $5.15 an hour (the federal minimum wage on January 1, 2007), insulating the tip credit from future increases in the minimum wage, which would have reduced the amount of credit available to employers. (13)

Capitalization of Cost to Acquire, Produce, or Improve Tangible Property

In August 2006, the IRS issued proposed regulations under Sec. 263(a) relating to the treatment of amounts paid to acquire, produce, or improve tangible property. The regulations were highly controversial, particularly with respect to the proposed miles regarding the capitalization of costs that were "improvements" to property and the determination of what is a unit of property for purposes of determining whether costs must be capitalized. The Service has withdrawn these regulations and issued new proposed regulations, (14) which will be effective when published as final regulations.

Definition of Improvement

The prior proposed regulations defined a unit of property as "improved" if the costs paid (1) materially increased the value of the unit of property or (2) restored the unit of property. This treatment was criticized for not drawing enough of a bright line.

The new proposed regulations replace the material increase in value standard for determining whether property is improved with a "betterment" standard. (15) Under this new standard, taxpayers must capitalize amounts spent that

1. Result in a betterment to a unit of property;

2. Restore a unit of property; or

3. Adapt a unit of property to a new or different use.

Unit of Property

In determining whether a cost was a capitalizable improvement, the 2006 proposed regulations began with an initial unit of property determination of all components that are functionally interdependent to define the largest unit of property as a starting point for the analysis. A taxpayer was to make a unit of property determination using a facts-and-circumstances test that applied four exclusive factors.

The new proposed regulations include revised rules for determining a unit of property that are generally based on a "functional interdependence" standard, similar to that used for depredation and Sec. 263A purposes. (16) Under these rules, in general, all the components that are functionally interdependent comprise a single unit of property. Components of property are considered functionally interdependent if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer. Special rules apply to buildings, plant property, and network assets.

Routine Maintenance Safe Harbor 

In response to requests from practitioners, the IRS has included a routine maintenance safe harbor in the new proposed regulations' improvement rules. Under this safe harbor, an amount paid for routine maintenance performed on a unit of property is deemed to not improve that unit of property, and the amount paid can be expensed. Routine maintenance is defined as the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the unit of property to keep the property in its ordinarily efficient operating condition. It includes, for example, the inspection, cleaning, and testing of the unit of property and the replacement of parts of the unit of property with comparable, commercially available, and reasonable replacement parts. (17)

De Minimis Expensing Rule

Under the new proposed regulations, a taxpayer would not be required to capitalize an amount paid for the acquisition or production of a unit of property (as defined in Regs. Sec. 1.263 (a)-3(d)(2)) if the following requirements are met: (18)

* The taxpayer has an applicable financial statement (AFS);

* At the beginning of the tax year, the taxpayer has written accounting procedures that treat an item as an expense for nontax purposes to the extent the item costs less than a specified dollar amount;

* The taxpayer treats the amount paid during the tax year as an expense on its AFS in accordance with its written accounting procedure; and

* The total aggregate of such amounts paid and not capitalized does not distort taxable income.

In concert with this rule, the 2008 regulations also provide a safe harbor under which the amount deducted by a taxpayer in accordance with its AFS de minimis standard will be considered not to distort taxable income. A taxpayer will satisfy the safe harbor if the amount deducted trader its AFS de minimis standard, when added to the amount deducted for materials and supplies in accordance with Prop. Kegs. Sec. 1.162-3(d) (1)(iii) (relating to property costing $100 or less), does not exceed the lesser of: 1. 0.1% of the taxpayer's gross receipts for the tax year, or 2. 2% of the taxpayer's total depreciation and amortization expense for the tax year as determined in its AFS. (19)

(1) Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28.

(2) Economic Stimulus Act of 2008, P.L. 100-185.

(3) Sec. 179(b).

(4) Sec. 179(b)(7).

(5) IR-2008-58 (4/11/2008).

(6) Sec. 168(k)(2)(F).

(7) Gulf Opportunity Zone Act of 2005, P.L. 109-135.

(8) Sec. 1400N(e)(1)(B)(i).

(9) Sec. 51(c)(4).

(10) Sec. 51(b)(3).

(11) Sec. 51(d).

(12) Sec. 45B.

(13) Sec. 45B(b)(1)(B).

(14) REG-168745-03.

(15) Prop. Regs. Sec. 1.263(a)-3(d)(1).

(16) Prop. Regs. Sec. 1.263(a)-3(d)(2).

(17) Prop. Regs. Sec. 1.263(a)-2(e).

(18) Prop. Regs. Sec. 1.263(a)-2(d)(4)(i).

(19) prop. Kegs. Sec. 1.263(a)-2(d)(4)(iii).