Decoding the Stimulus Act

The American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”) became law this February and includes new tax breaks and extends several existing tax breaks for small businesses. Although some provisions are not as generous as some people originally hoped, there are still some opportunities for small businesses. The following provisions may benefit your small business in 2009 and when filing its 2008 tax returns.

Bonus Depreciation

Tax legislation enacted last year allowed businesses to accelerate the normal cost recovery schedules for depreciable property by allowing a first year write off of half the cost of qualified depreciable property (e.g., computers, equipment, and certain land and tenant space improvements) purchased and placed into service in 2008. The other 50% of a qualified item would be depreciated according to its normal depreciation schedule, resulting in well over half the cost being written off for tax purposes in the year of purchase.

How the Stimulus Can Affect You

The Stimulus Act extends the 50% bonus depreciation to property purchased and placed into service in 2009.

Small Business Expensing

Prior to 2008, businesses could expense (or write off) up to $125,000 in eligible equipment each year until 2010. This amount was reduced by the cost of capital expenditures for eligible equipment in excess of $500,000, ultimately phasing out to zero if a business spent $625,000 or more on eligible equipment. In 2008, businesses were allowed to expense up to $250,000 of equipment. This amount was reduced to the extent that total capital expenditures for eligible equipment exceeded $800,000, phasing out to zero if such expenditures reached $1,050,000.

If a taxpayer elected small business expensing (section 179), the business could expense what it could first, and then apply bonus depreciation to amounts that were not covered by the expensing provision. For example, a business owner elected to apply small business expensing to a number of different purchases, covering 30% of the cost of property X. If the purchase of property X also was eligible for bonus depreciation, then half of the remaining 70% could be depreciated in the first year. The other half would be depreciated according to its normal depreciation schedule.

How the Stimulus Can Affect You

The 2008 thresholds have been extended through 2009. Note that the small business expensing and bonus depreciation provisions are not mutually exclusive. A taxpayer eligible for small business expensing also may take advantage of bonus depreciation with respect to amounts not expensed under the small business expensing provision.

Five-Year Carryback of 2008 Net Operating Losses

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 the losses can be “carried back” against income taxed in previous years (or carried forward to future tax years). Generally, a net operating loss may be carried back only two years.

How the Stimulus Can Affect You

The Stimulus Act allows small businesses with annual gross receipts of $15 million or less to extend the carryback period for 2008 losses up to five years. Eligible taxpayers may make the net operating loss carryback election for any year beginning or ending in 2008.

Deferral of Cancellation of Debt Income

Under current law, when a business has debt cancelled or reduced, it will generally have cancellation of debt (COD) income equal to the difference between the old debt’s adjusted issue price and the amount (if any) paid or deemed paid by the business. In the simplest case, any reduction in the amount of principal owed is treated as ordinary taxable income. There are exceptions (for example, in the case of bankruptcy, insolvency, and qualified real estate business indebtedness) under which COD income may be excluded from a taxpayer’s gross income.

How the Stimulus Can Affect You

The Stimulus Act allows taxpayers to defer recognition of COD income arising from the reacquisition of debt instruments (such as bonds, notes, debentures, and certain other contractual arrangements constituting indebtedness) in 2009 or 2010. Reacquisitions include the acquisition of the old debt instrument for cash; exchange of the old debt instrument for a new debt instrument (including a renegotiation or modification of the old debt instrument); the issuance of corporate stock or a partnership interest in exchange for the old debt instrument; certain contributions of a debt instrument to the capital of a corporate issuer; and the partial or complete forgiveness of a debt instrument by its holder. COD income that otherwise would be recognized in 2009 or 2010 is deferred outright for five or four years respectively, then spread out ratably. The COD income will be taken into income in 20% installments over the following five years.