Just as the Memorial Day holiday was about to begin, as lawmakers prepared to flee Washington, D.C., for vacation, agreement was reached to continue funding the war in Iraq. That funding bill also raised the minimum wage. Not a big deal, many metal center operators would say, because half the states already require minimum wages in excess of the federal level. However, there are all those tax breaks—almost $5 billion worth—tacked onto the bill to consider.

The Small Business and Work Opportunity Tax Act of 2007, part of the much larger and more controversial U.S. Troops Readiness, Veterans’ Health and Iraq Accountability Act of 2007, targets nearly $5 billion in tax incentives for small business. The bill also includes tax incentives to help taxpayers still recovering from Hurricane Katrina, as well as an important package of S corporation reforms.

Unlike tax bills in the past, the so-called “revenue raisers,” which mean more taxes for certain taxpayers, are unusually limited. The small-business tax incentives, on the other hand, were designed to help businesses absorb the cost of a higher minimum wage, which will rise to $7.25 from $5.15 an hour in three steps over two years.

Work Opportunity Tax Credit
Those who employ large numbers of workers have long been aware of the Work Opportunity Tax Credit. The WOTC was created in 1996 to provide employers with a unique tax incentive to hire individuals from among groups that have a particularly high unemployment rate or other special employment needs.

Many employers in rural areas may now be able to take advantage of the WOTC. The new law expands the high-risk youth target groups to include individuals from rural renewal counties. These are defined as counties outside of metropolitan areas that experienced population losses in the 1990s.

Combined with the Welfare-to-Work tax incentives for 2007, the WOTC enlists state employment security agencies to find and certify individuals who are members of a targeted group. Set to expire for employees hired after Dec. 31, 2007, the WOTC was extended through Aug. 31, 2011.

Small business expensing
In lieu of depreciation deductions, a metal center operation with sufficiently small investments in equipment or other business property can choose to deduct (or “expense”) such cost under Tax Code Section 179. The new law extends and expands the Section 179 enhanced first-year expensing provisions through 2010. It provides for an immediate 2007 increase in the expensing limit from $112,000 to $125,000, while the new law retroactively raises the investment limitation from $450,000 to $500,000 for tax years beginning in 2007 through 2010.

If Congress had not acted, the dollar limitation would have plummeted to $25,000 and the investment limitation to $200,000 after 2009. Because the deduction is completely phased out under the new levels for qualifying purchases above $625,000, the deduction continues to be confined generally to relatively small metal centers and other businesses.

Naturally, no first-year expensing allowance is allowed if the metal center did not have taxable income in the year in which the property is placed in service. However, the amount of the deduction disallowed for this reason may be carried forward to a non-loss year. And, notably, computer software placed in service in taxable years beginning before 2010 is treated as property qualifying for Section 179 write-offs.

In addition, the 2007 Small Business Tax Act extends and expands some of the tax incentives in the Gulf Opportunity Zone Act of 2005 and Katrina Emergency Tax Relief Act of 2005. These include extension of special expensing for qualified property, an enhanced low-income housing credit and flexible tax-exempt bond financing rules.

S corporation business entity
Several modifications to the S corporation rules will help small businesses retain the benefits of being an S corporation. In fact, the new S corporation provisions were designed specifically to make it easier for small businesses to retain their S corporation status, a status often inadvertently jeopardized thanks to the complexity of the rules in this area.

Two of the new rules, “electing small business trust” (ESBT) interest and “earnings and profits” (E&P) reduction encourage the use of the S corporation business entity by effectively reducing the taxes owed by S corporation shareholders.

Among the S corporation reforms are those involving passive investment income. The passive investment income test has long been a trap for many S corporations that have converted from regular or C corporation status. An S corporation is not subject to corporate level income tax on its income, usually passing through income (and losses) to its shareholders—except when it comes to passive investment income. The new tax law eliminates some of that worry by switching treatments and no longer characterizing capital gain from the sale of stock or securities as passive investment income.

Ordinarily, a metal center or business operating as an S corporation has to pay corporate level tax at the highest rate on its excess net passive income if the corporation has accumulated earnings and profits from its C corporation years and has gross receipts that are more than 25 percent of passive investment income. Worse yet, if more than 25 percent of the S corporation’s gross receipts are passive investment income for three consecutive years, it loses its S corporation status.

A qualified Subchapter S corporation (QSub) is a wholly owned subsidiary that an S corporation has chosen to treat as a “QSub.” These entities are frequently employed by businesses in joint ventures, as well as for liability protection when spinning off a new venture. Unfor­ tunately, once the QSub is no longer wholly owned by the S corporation, it ceases to qualify as a QSub and is treated as a new corporation that acquired all of its assets from the parent S corporation in exchange for stock. In other words, it is a taxpaying business entity.

The new law favorably alters the treatment of a sale of qualified Sub­ chapter S subsidiary (QSub) stock that terminates the QSub election. Under the new rules, the sale will be treated as a sale of an undivided interest in the assets of the QSub. This provision eliminates the danger of an avalanche of gain being recognized—and taxed—on the sale of only a partial (but substantial, more than 20 percent) interest in the subsidiary. Now, for example, if an S corporation sells 25 percent of its QSub stock, it would recognize only 25 percent of the gain. Obviously, this would save the metal center operating as an S corporation substantial tax on the deemed sale.

While Congress recently handed a victory to low-income workers by passing the first increase in the federal minimum wage in a decade, small businesses have not been ignored. Many of the $4.84 billion in business-related tax cuts designed to ease the pain of the increased minimum wage are retroactive to Jan. 1, 2007. Metal center businesses should plan to take advantage of these tax breaks.

Mark E. Battersby is a freelance writer and consultant on tax and financial issues based in Ardmore, Pa. He can be reached at 610-789-2480.