In some ways, the title of the Small Business Jobs Act of 2010 says it all. This new federal law aims to create jobs within the United States, with small companies acting as engines of growth. Among the multiple provisions of this act, several provide tax benefits for small businesses. The authors of the new law hope that lower taxes will make many small and thus more to add employees.

Equipment deductions

One provision of the new law expands Section 179 of the tax code, which allows small companies to buy business equipment and take a first-year tax deduction. Ordinarily, companies must depreciate the equipment they buy, thus spreading deductions over several years.

From 2008 through 2010, Congress passed a series of laws setting the maximum first-year “expensing” election at $250,000. Once annual equipment purchases topped $800,000, companies would lose the tax benefits of expensing, dollar for dollar. In the Small Business Jobs Act of 2010, the $250,000 expensing cap for 2010 was increased from $250,000 to $500,000, and the higher limit was set for 2011 as well (Up to $250,000 of the $500,000 cap can be deducted for lease hold improvements, such as renovating a store or a restaurant.) For each of those two years, the phase out is now $2 million.

Example 1: ABC Corp. spends $450,000 on business equipment in 2011. It can immediately deduct $450,000, which is under the $500,000 cap.

Example 2: DEF Corp. spends $1.1 million on business equipment in 2011. It can immediately deduct $500,000, the amount of the cap. The other $600,000 of equipment purchases will be depreciated under standard IRS rules.

Example 3: GHI Corp. spends $2.2 million on business equipment in 2011. The company’s expenditures are $200,000 over the $2 million phaseout threshold so its expensing election is reduced by $200,000, from $500,000 to $300,000. The company can depreciate the other $1.9 million of equipment purchases under standard IRS rules.

With the new law in place, if a company spends $2.5 million or more on equipment this year, no expensing will be permitted. As you can see, the increased deduction and phaseout levels greatly expand the number of companies that might save tax by deducting equipment expenses right away.

The Section 179 tax deduction is limited to the buyer’s taxable business income that year. If a company spends $100,000 on equipment in 2011, for example, it must have at least $100,000 of taxable income this year to take a full deduction.

Startup deductions

The new law also increases startup deductions allowed under Section 195 of the tax code. For 2010 and 2011, the ceiling is raised from $5,000 to $10,000, and the phaseout threshold rises from $50,000 to $60,000. With this arrangement, new companies can deduct the lesser of (1) the amount of the startup expenses or (2) $10,000, reduced by the amount by which the startup expenditures exceed $60,000.

Example 4: JKL Corp. has startup expenses of$10,000 in 2011. The company can deduct all $10,000 of its outlays.

Example 5: MNO Corp. has startup expenses of $63,000 in 2011. The company is $3,000 over the $60,000 threshold so it can deduct $7,000 of its outlays: $10,000 minus the excess $3,000.

You incur startup costs when you’re investigating or creating a new business but have not actually begun operations. (Money spent to buy capital equipment doesnt qualify.) Those costs might include market surveys, advertisements, travel to line up suppliers, consulting fees, and wages paid prior to opening the doors of a new business. Such outlays may be deductible in the year that you begin operations, under Section 195. Costs you cant deduct right away can be amortized over 180 months, beginning in the month operations begin.

Example 6: MNO Corp. takes a $7,000 deduction for startup costs, out of $63,000, as previously explained. The remaining $56,000 may be amortized over 180 months, providing MNO with a deduction of $311 a month for those 180 months.

Built-in gains

Standard C corporations face many tax hurdles. They could owe corporate income taxes on profits, for example. The IRS might determine that a business owner’s compensation is unreasonable and deny a deduction to a C corporation.

To avoid such tax traps, small companies may elect to be S corporations rather than C corporations. To qualify for this election, S corporations must meet certain criteria: they can have no more than 100 shareholders and only one class of stock, for example. After an S corporation election, business owners report company profits on their personal tax returns and the company owes no corporate tax.

Some C corporations elect S corporation status while holding appreciated assets. In the past, a 10–year rule had been in effect-if holdover assets with built–in gain were sold within 10 years of a switch to S corporation status, the company would owe tax on the built–in gain at the highest corporate tax rate, which is now 35%. The American Recovery and Reinvestment Act of 2009 shortened that 10–year holding period to seven years for 2009 and 2010. The new Small Business Jobs Act further reduces the holding period to five years for dispositions of assets with built–in gain in 2011.

With this new provision, companies that have made the C…to…S switch won’t owe corporate income tax in 2011 on the built…in gain of appreciated assets sold after five years from the conversion. The reduced tax bite may help small businesses sell off unneeded assets and raise capital.

Self-employment health insurance

For several years, self-employed individuals have been able to deduct 100% of the cost of health insurance for themselves and family members. However, that deduction does not reduce the amount of self-employment income subject to self-employment (Medicare and Social Security) tax. Under the new law, self-employed individuals can deduct health insurance premiums when calculating earned income subject to self-employment tax for tax years beginning in calendar year 2010.

Example 7: Joan Barnes is a self-employed Web designer. In 2009, she reported earned income of $90,000. Joan paid $8,000 in health insurance premiums in 2009, which she deducted from her gross income; nevertheless, she paid Social Security and Medicare tax on $90,000 of earnings.

Assume that Joan had the same earned income and health insurance premiums in 2010. Again, she will deduct that $8,000 deduction from her gross income on her tax return. For 2010, though, she will owe Medicare and Social Security tax only on $82,000 of earned income: $90,000 of earnings minus $8,000 in health insurance costs.

Cell phones

The tax code considers certain types of assets to be “listed property.” The list includes items such as cars, motorcycles, cameras, and computers—in essence, assets that a business might provide to employees but that also can provide a non-business personal benefit. Employees with listed property must keep records to show business use versus personal use. There may be limits on depreciation deductions and employees might have to report some taxable income from personal use of listed property. Your depreciation and related deductions are limited if listed property is not used more than 50% for business.

When cell phones were introduced, they were relatively expensive; employer-provided cell phones were often a perk to selected employees. Therefore, cell phones were classed as listed property. Now, of course, cell phones are priced for a mass market and may be a workplace necessity. Therefore, the new law removes cell phones and similar devices from the category of listed property, effective in 2010. If an employer-provided cell phone is used primarily for business, employees won’t have to report any taxable income for personal use.

Fed funding

Under the new law, the Small Business Administration (SBA) will create an online lending platform that lists all lenders offering SBA-guaranteed loans. This platform will display the interest rates each lender charges for SBA loans so that small business borrowers can compare rates.

Among other features of the Small Business Jobs Act are increased funding and lower fees for some SBA loans. The SBA also will conduct a three-year pilot program that offers grants to states with plans to increase small business exports. Beyond the SBA, federal contracting requirements are being amended to encourage bids from small companies and federal agencies have been told to solicit bids from small businesses.

2011 Q1 | Lower Taxes May Mean More Jobs