CONGRESS RECENTLY EXTENDED IRC §179 TO INCLUDE DEDUCTIONS FOR REAL PROPERTY BUT ONLY FOR 2010 AND 2011

Usually when you think of §179 of the Internal Revenue Code, you think of deductions available to businesses for depreciable, tangible “personal” property such as equipment, vehicles and computers. However, Congress has given a gift in the Small Business Jobs Act, signed September 27, 2010, by extending the deductions to include up to $250,000 of Qualified Real Property.

What kind of real property will qualify for this favorable tax treatment?

· First: Qualified Leasehold Improvements—typically capital improvements made to an interior portion of a commercial non-residential building.

· Second: Qualified Retail Property Improvements—typically capital improvements to buildings which are open to the general public for the sale of tangible personal property.

· Third: Qualified Restaurant Property—typically, capital expenditures for the improvement, purchase or construction of any building (new or used), if more than 50% of the building’s square footage is devoted to the preparation of, and seating for, the on-premises consumption of prepared meals.

In order to receive the benefit of this deduction for Qualified Real Property, you must place the building or capital improvement in service by the end of your 2011 tax year, so it may take some quick footwork to be able to elect §179 treatment.

Whether you can take advantage of this deduction depends on your individual circumstances and (big disclaimer coming here) you cannot consider the foregoing to be tax advice of any sort. As with anything connected with the Internal Revenue Code, there are tricky issues, so you should consult with your tax planner to guide you as to how best to take advantage of this opportunity. That said, this link will take you to a good first step in understanding the process.

Small Business Resources

As President of the Women Business Owners of Montgomery County, I have the opportunity to learn about various resources and programs aimed at women-owned and small businesses here in Montgomery County. Earlier this month, I attended the launch of the new Rockville Women’s Business Center. RWBC began as an initiative of the non-profit Rockville Economic Development, Inc. (REDI). The Center is located within the REDI offices at 95 Monroe Street in downtown Rockville, and offers tailored training, counseling and technical assistance to help entrepreneurs start and build successful business enterprises that are positioned for long-term growth. The Center is open to all and promises to be a great resource for both start-ups and companies looking to grow and expand.

I also recently attended a briefing by Robert Carpenter of the U.S. Small Business Administration on the new Small Business Jobs Act, and how this legislation affects our small business community.

One change that caught my attention is a provision that will allow some small businesses to refinance their owner-occupied commercial real estate mortgages into the SBA 504 loan program. Regulations implementing this provision should be issued during the first quarter of 2011. The law also sets higher loan limits for the 7(a) and 504 programs ($2 million to $5 million) and expands the number of small businesses eligible for SBA loans by increasing the alternate size standard to those with less than $15 million in net worth and $5 million in average net income.

The briefing, hosted by the Montgomery County Department of Economic Development (“DED”), also included information on the Small Business Revolving Loan Program, administered by DED, which provides “micro” loans of between $5,000 and $100,000 to small businesses which are looking to expand in Montgomery County and may not qualify for traditional private banking financing.

The Small Business Revolving Loan Program recently received a $2 million infusion to provide loans to small businesses whose expansion includes the creation of new jobs or the relocation of existing jobs into the County. Eligible businesses must have gross revenues of less than $5 million annually and fewer than 75 employees. To learn more, go to http://www.montgomerycountymd.gov/dedtmpl.asp?url=/content/ded/financing/small-business-revolving-loan-program.asp.

Choosing a Business Entity: Common Legal Entities

In my last post, I talked about the benefits of forming a separate legal entity for your business. Once you’ve decided to set up a separate entity, you’ll need to figure out which type of entity makes the most sense. While not exhaustive, the following are some of the most common forms of business entities. Each type varies in terms of its ease in creation and maintenance and the tax consequences to the owners.

Corporation:
The corporation has, until recently, been the most traditional form of business entity. A corporation is owned by one or more stockholders who are issued shares of stock in return for their investment. Although in small businesses and family-run corporations, the stockholders may have a role in running the business, their role as stockholders is strictly economic. Absent extreme circumstances, such as fraud, a stockholder of a corporation is not personally liable for the acts or obligations of the corporation.

The corporation is managed by a Board of Directors, which is elected annually by the stockholders. The Board appoints the corporation’s officers, including a President, Treasurer and Secretary, who are responsible for the day-to-day business affairs of the corporation.

A corporation is taxed as a separate entity, meaning that it files its own tax return and pays taxes without regard to the tax status of the individual shareholders. However, if the corporation distributes a portion of its after-tax income to its shareholders in the form of dividends, each shareholder will pay a separate tax on the dividend received. This “double taxation” can be avoided if the corporation makes an election under subchapter S of the Internal Revenue Code. It is critical to consult with a tax professional for the rules and requirements relating to corporate taxation.

Corporations must comply with many formalities (which, to the detriment of many shareholders, are often overlooked), including annual meetings of the stockholders, election of directors, keeping of minutes and a stock transfer ledger, all of which are typically set forth in the corporation’s bylaws. Some of the corporate formalities may be dispensed with if the corporation is set up as a “close corporation” pursuant to the provisions of Title 4 of the Maryland Corporations and Associations Act.

Limited Liability Company:
In recent years, an increasingly-popular alternative to the corporation is the limited liability company (“LLC”). An LLC is an unincorporated business organization with at least one “member.” Members may be individuals, corporations, partnerships, or other LLCs. LLCs have gained favor, especially among small businesses, because they offer the limited liability of a corporation but with fewer record keeping requirements and other formalities and, like a corporation, can be managed by non-member employees.

An LLC offers the same liability protection for its members as a corporation does for its stockholders. This means that, absent fraud, self-dealing and the like, a member is not responsible for the debts, liabilities and obligations of the LLC.

An LLC can consist of only one member. However, where there are multiple members, it is critical for the members to enter into an “Operating Agreement” which sets forth the relative rights and obligations of the members regarding contributions, distributions, allocations of profits and management of the business.

LLCs are also favored because they offer the streamlined “pass-through” tax benefits of a partnership. This means that the entity is not taxed separately but rather passes through its income, deductions, credits, as well as other items, to its members. Your tax advisor can provide you with more information on the tax implications of operating as an LLC.

Limited Partnership:
A limited partnership is a partnership which includes one or more general partners, who are responsible for the management of the business, and limited partners, who have an economic interest in the partnership, but take no part in the management of the business. Limited partnerships are most commonly used in real estate ventures (although, in recent years, LLC’s are becoming favored alternative entities). Limited partnerships must comply strictly with the provisions of the Maryland Limited Partnership Act, Md. Code Sec. 10-101, et seq.

General partners are personally liable for the obligations of the partnership. Limited partners, like corporate shareholders, are not liable for partnership obligations beyond their financial contributions. Unlike shareholders, however, except in unique circumstances, limited partners may not participate in the management of the partnership’s business –- another reason why LLC’s are becoming favored alternatives. There is no legal prohibition on the role of members in the management of the LLC’s business –- even if those members are merely passive investors.

Limited partnerships are treated the same as partnerships for tax purposes.

Again, this list is not exhaustive. There are other entities, such as professional corporations, limited liability partnerships and others, that may be more suitable for your business activities. A business attorney, working together with your tax advisor, can help you decide which form is most appropriate for your business.

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Choosing a Business Entity

Whether you are just starting a business enterprise or you’ve been running your existing business as a sole proprietor or as a partnership, you should consider whether it makes sense to form a separate legal entity for the business. This is important for accounting purposes, as well as insulating your personal assets from the liabilities, debts and obligations of the business.

If you are operating your business as a sole proprietor, then from a legal and tax perspective, you, as the owner, are inseparable from the business. Since a sole proprietorship and its owner are considered one and the same, taxes on a sole proprietorship are determined at the personal income tax rate of the owner. In fact, a sole proprietor simply reports all business income or losses on an individual income tax return.

Similarly, because they are the same entity, a sole proprietor is personally responsible for any liabilities, obligations and debts of the business.

If you have a partner, then you have formed a general partnership, which is defined under the Maryland Code as “an association of two or more persons to carry on as co-owners a business for profit.”

Each partner is personally liable to third parties for all the liabilities, obligations and debts of the partnership, as well as the other partners. In this context, the only difference between a sole proprietorship and a partnership is that a partner could find him/herself liable for liabilities, obligations or debts created by another partner in the business. The partnership is not taxed as a separate entity. Instead, taxable income, losses, deductions, and credits are passed through on a pro-rated basis to each of the partners. Each partner is taxed directly on his/her share of the partnership’s net income, whether that income is distributed or not.

Why Form a Separate Entity?

Most of us carry casualty insurance, which protects our business from the loss of assets in the event of a casualty (e.g., a fire) and liability insurance (which, by the way, should always include contractual liability coverage), which protects your business from liabilities asserted by third parties for acts such as negligence (e.g., a fire caused by your -- or your employee’s -- negligence in your leased space which damages or destroys the landlord’s premises). But there could be situations where the insurance proceeds either don’t cover the claim being asserted or where the limits of coverage are insufficient to cover the entire amount of the claim being asserted. Also, business and economic cycles could create financial pressures on your business operations, making it necessary to negotiate with lenders, landlords and other creditors.

Unless your business is a separate legal entity, your home and other personal assets could be at risk. Establishing a separate legal entity, maintaining its separate existence and using the entity’s name on your marketing materials, invoices, etc. will help protect your personal assets.

There are also tax and accounting benefits associated with establishing a separate legal entity. Each type of entity has different tax and legal implications so it is critical that you consult with your attorney and a tax advisor before forming a separate legal business entity.

Next week I will discuss the various types of common legal entities.

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