With the economy mired in the deepest recession in decades, a drop in economic activity that has been compounded by continuing mortgage defaults, a historic decline in housing prices, falling equity values, illiquid credit markets, declining consumer confidence, and enormous and rapid job losses, congress has shifted its attention to economic recovery. On February 17th President Obama signed the American Recovery and Reinvestment Act of 2009. Included in the $787B Tax Stimulus Bill, were $286.9B in tax provisions. Many of these provisions may impact your business! These provisions cover a number of areas including: enhanced expenses for small business, bonus depreciation, net operating loss carry-back, work opportunity tax credit, discharge of indebtedness, new markets tax credit, renewable energy incentives.
Extension of Enhanced Expenses for Small Businesses - Cost $.04B
In 2003, Congress increased the amount of Section 179 expensing to $100,000 and raised the start of the phase-out range to $400,000, through the end of tax year 2009. The economic stimulus package that Congress enacted in January 2008 raised these limits for tax year 2008 to $250,000 and $800,000. The proposal would extend the 2008 limits on the amount of investment that small businesses can expense, rather than depreciate through the end of 2009. Both the stimulus effect and revenue cost would be very modest. Although it would be easy to let the higher limits expire, past history suggests Congress often extends expiring tax benefits.
It is hard to know how much this proposal would boost the economy. There have been no studies on the effect of Section 179 expensing on the long-term level or timing of investment. Lower capital costs should encourage some additional investment, but much of the tax benefit would go to investments that would have been undertaken even if taxpayers had to depreciate them. A temporary tax incentive could accelerate some investment. However, since generous expensing rules have been in place for several years, some capital purchases that may otherwise have been accelerated already have occurred.
Extension of Bonus Depreciation - Cost $5.1B
To determine taxable income, businesses subtract expenses from their receipts. While some business expenses are for items that are entirely used up during the year (e.g., materials and labor), other business expenses are for durable goods that last for many years. The expense for investment in capital equipment (e.g., tractors, computers and wind turbines) occurs over many years as the value of the investment is used up or depreciated. Under current law, businesses calculate taxable income by deducting capital costs over time according to a fixed depreciation schedule.
The provision would speed up depreciation deductions by providing businesses with a "bonus" depreciation allowance equal to 50 percent of the cost of qualifying investments acquired in 2009. Businesses would deduct the remaining 50 percent of the investment's cost according to regular depreciation schedules. Accelerating depreciation deductions does not increase the total amount a company can write off for a given investment. Instead, it allows businesses to deduct more of the cost now and less in the future. That reduces their current tax liabilities at the cost of higher taxes later. Since deductions today are worth more to taxable businesses than deductions in the future, the provision lowers the effective tax rate on new investment making investment more attractive. Lower taxes also increase cash flow.
5 Year Carryback of Net Operating Losses - Cost $0.9B
Businesses calculate taxable income by subtracting expenses from revenues. While net income is taxed immediately, net operating losses do not qualify for immediate refunds on current tax returns. However, businesses may effectively receive a refund to the extent that they can be "carried back" against income taxed in previous years. Under current law, businesses may use current losses to offset only the past two years of profits. Losses that exceed the sum of the previous two years of positive income may be "carried forward" and used to offset taxable income earned in future years. Losses can currently be carried forward for twenty years.
The provision would increase the net operating loss (NOL) carry-back period from two years to five years in the case of an NOL for any taxable year either beginning or ending in 2008. The benefit would apply to small businesses only. For the purpose of the provision, a business qualifies as "small" if it's annual gross receipts are $15 million or less.
Businesses that are unable to absorb their current losses with past tax payments do not receive immediate benefits from investment tax incentives such as expensing or bonus depreciation. Unused deductions can't be used until future years. Because this blunts any stimulus provided by investment tax incentives, extending the carry-back period would enhance these incentives. The more generous carry-back period could allow a business to benefit immediately from temporary investment incentives.
The provision would also give an infusion of cash to some businesses that are running losses, which may promote investment. This might be especially important if those businesses have trouble borrowing because of financial market problems. The carry-back provision acts like an interest-free loan to these businesses. The Congressional Budget Office (2008) has concluded, however, that "effects of taxes on investment that stem from their impact on cash-flow are generally believed to be weaker, dollar for dollar, than those that stem from the direct effects of taxes on the cost of capital." But this relationship might be reversed when businesses are having difficulty obtaining external finance.
The provision would also help small businesses that were relatively healthy in the past but now have losses that are larger than recent profits. The provision would benefit old capital held by these businesses, but it is not clear whether it would induce them to undertake new investment. Large businesses, start-up businesses that have large losses relative to past gains, and small businesses whose owners can offset their losses from the business with other income would receive no benefit from the provision.
Incentives to Hire Unemployed Veterans and Disconnected Youth - Cost $0.2B
The Work Opportunity Tax Credit (WOTC) is available for employers hiring individuals from one or more of nine targeted groups including welfare recipients, food stamp recipients (age 18-39), poor and disabled veterans, youth from disadvantaged geographic areas, Supplemental Security Income recipients, and qualified ex-felons. An individual is not treated as a member of the target group unless she or he received a certification from a designated local agency before starting work or the employer completed a request for certification within four weeks of hiring the employee. The credit is determined by the amount of qualified wages paid by the employer. Certified employees must work a minimum of 120 hours. Generally, the subsidy level is 40 percent (25 percent for employment of 400 hours or less) of qualified first-year wages up to $6,000, resulting in a maximum subsidy of $2,400 per qualified worker. The credit applies only to qualified first-year wages except in the case of workers who have received Temporary Assistance for Needy Families (TANF) for an extended period of time. Employers who hire these individuals receive a larger credit that covers both first and second year wages
The proposal would expand the target group to include disconnected youth and unemployed, recently discharged veterans hired in 2009 or 2010. Individuals would qualify as unemployed veterans if they were discharged or released from active duty during the five years before being hired and received unemployment compensation for not less than four weeks during the year before being hired. Individuals would qualify as disconnected youths if they are between 16 and 25 when hired, have not been regularly employed or attending school in the past 6 months, and lack basic skills. The small literature on the WOTC credit suggests that the credit has been vastly underutilized and has had no meaningful impact on employment rates among the disadvantaged. Few businesses participate in the program. Only about one out of 790 corporations and one out of 3,450 individuals with a business affiliation claimed the credit. The relatively few workers whose employers have participated in the program did enjoy modestly higher earnings.
Deferral of Certain Income From Discharge of Indebtedness - Cost $1.6B
Under current law, if a borrower or related party buys back or exchanges its own debt at less than the issue price, it must pay tax on the difference between the original price and the debt's current value when purchased or exchanged. For example, consider a business that borrowed $100,000 three years ago. Today, due to the credit crunch, interest rates on corporate debt are far higher than they were. And, as a result of the recession, the firm's credit rating may be much lower. Consequently, that $100,000 bond may now be worth only $60,000. If the issuer buys back that debt at today's price (or exchanges it for other debt also worth $60,000), the $40,000 difference is considered income and is subject to tax.
The Internal Revenue Code has, in the past, allowed all businesses in these circumstances to defer income even if they repurchased their debt at a discount. However, today, debt forgiveness results in income except under limited circumstances such as bankruptcy. The proposal would permit any business to defer income if it buys back or exchanges its own debt at a discount in 2009 and 2010. Any income realized in 2009 due to a debt buyback must be included ratably in income in each of the five taxable years beginning five years after the year of realization. Any income realized in 2010 due to a debt buyback must be included ratably in income in each of the five taxable years beginning four years after the year of realization.
Supporters of this proposal argue that it would encourage firms to repurchase or exchange debt, which would make them more liquid and put them in a better position to withstand the economic downturn. However, because these transactions may both reduce leverage and boost earnings, they appear to already be occurring, despite the tax businesses must pay on the trades. Thus, in many cases the new tax benefit may subsidize debt repurchase or exchange that would occur anyway, resulting in a windfall and generating little new economic activity. This tax break would provide no additional cash flow to unprofitable companies that are paying no tax.
Increase in the New Markets Tax Credit - Cost - $0.8B
The New Markets Tax Credit (NMTC) was designed to stimulate the flow of capital into low-income and economically-distressed areas by providing investors with a tax incentive for investing in qualified Community Development Entities (CDEs). The CDEs, in turn, directly provide capital to low-income areas by investing in projects or organizations located or operating in qualified census tracts. Investors receive a tax credit equal to 5 percent of the investment amount in each of the first three years following the initial investment, and a credit equal to 6 percent of the investment amount in each of the following four years. In total, investors receive a credit equal to 39 percent of the initial investment amount. Investors are required to maintain their investment in the CDE for the entire seven-year period. CDEs are certified by a branch of the Treasury, the Community Development Financial Institutions Fund (CDFI). Through 2008, CDFI has authorized $19.5 billion in NMTC financing.
The stimulus proposal would increase the amount of allowable tax-preferred investment to $5 billion in calendar years 2008 and 2009, an increase of $1.5 billion in each year. Tax credits for investment in 2009, made after the date of enactment, could be claimed against the AMT. There are several reasons to doubt the ability of the Credit to act as an effective stimulus tool. For one, on net, the NMTC appears to have drawn capital away from other investments, without generating much new investment activity. The primary use of the allocations was to provide loans for the development of commercial real estate, while investment in business and entrepreneurs was less prevalent. Furthermore, a large proportion of census tracts, approximately 40 percent, are eligible as potential destinations for qualified investment, raising questions about the ability of the credit to help truly distressed areas. At the same time, there are several reasons to be optimistic about the credit's potential. Studies found that the NMTC is an effective stimulant for investment in low-income communities, estimating that each $1 in federal tax expenditure for the program resulted in $14 in investment in low-income communities and that the NMTC was an effective means of making borrowing more accessible to investors and developers, dropping the cost of borrowing by 250 to 500 basis points.
Renewable Energy Incentives - Cost - $20B
There are many tax incentives that promote energy conservation and renewable energy. Among these are business credits for electricity produced from renewable energy (wind power, geothermal etc.), investments in renewable energy property, and tax-exemption of bonds to finance certain renewable energy property. Individuals can receive credits for purchases of alternative fuel vehicles (electric cars, hybrid vehicles, plug-in hybrid electric vehicles, and fuel cell vehicles), and for a wide variety of energy-saving residential investments (such as solar and photovoltaic energy systems; high-efficiency water heaters, heating, and air conditioning systems; storm windows, storm doors, insulation, and other energy-saving property). The Energy Policy Act of 2005 added new and expanded tax subsidies for alternative energy production and conservation investments by businesses and households and for some traditional energy sources ("clean coal" and natural gas refining), at a revenue cost then estimated at $8 billion over 5 years and $14 billion over 10 years.
Many of these incentives are scheduled to expire after short periods. These sunset provisions limit revenue loss, but may also limit the credits' effectiveness. The proposal would extend and modify a number of existing tax incentives for renewable energy production and conservation and add some new ones. These include:
· Extending a credit for electricity produced from renewable resources through 2012 for wind energy and through 2013 for other qualifying renewable energy sources (The credit is now due to expire at the end of 2010).
· Allowing businesses to claim a 30 percent investment credit for property used to produce electricity from renewable sources (in addition to solar, which already receives the credit) in the year the property is installed through 2012 for wind energy property and through 2013 for other renewable energy property. Taxpayers could use this one-time credit if they find it more advantageous than the production credit (above) that is claimed over time as electricity is generated from the property.
Any investment subsidy provides some short-term stimulus, but "green" jobs do no more than other jobs to promote economic recovery and investments in new and alternative technologies may be slower in coming. Tax incentives for renewable energy and conservation reduce fossil fuel use, potentially slow global warming, reduce dependence on oil imports, and could spur the development of new technologies that can sustain themselves in the future without credits. However, the proposed credits are not large enough to have much impact on global warming or oil imports and are less cost-effective than policies that directly raise prices of fossil fuels, such as a carbon tax or tradable permits that limit total carbon emissions.
On February 17, President Obama signed the American Recovery and Reinvestment Act of 2009. Included in the $787B Tax Stimulus Bill, were $286.9B in tax provisions. These provisions cover a number of areas including: enhanced expenses for small business, bonus depreciation, net operating loss carry-back, work opportunity tax credit, discharge of indebtedness, new markets tax credit, and renewable energy incentives. Many of these provisions may impact your business in 2009 and the year to come by improving profits, lowering taxes, and increasing cash flow. A welcomed response in a challenging market!