Small Business Tax Breaks Enacted with Minimum Wage Legislation

A $4.84 billion package of tax incentives for small businesses and a long-delayed increase in the federal minimum wage were folded into the Iraq war supplemental spending bill (H.R. 2206) signed into law by President Bush on May 25.

Under the newly enacted legislation, the minimum hourly wage of $5.15 is set to rise in three stages: to $5.85 on July 23, 2008, to $6.55 one year later, and finally to $7.25 starting July 23, 2009. Among the provisions affecting small businesses are an extension and an expansion of the Work Opportunity Tax Credit (WOTC), an extension of the Section 179 expensing provision, and a simplification of S corporation rules. The law also allows employers to continue to receive the current level of tip tax credit even as the minimum wage rises.

To help soften the impact of a higher minimum wage on small businesses, Republicans in Congress have long called for tax relief for small businesses to be included in any legislation raising the minimum wage. In February of this year, the Senate approved a package of tax breaks for small businesses worth $8.3 billion, while the House passed a minimum wage bill that included tax incentives amounting to $1.3 billion. Shortly before the supplemental spending bill came to a vote on May 24, the tax-writing committees of the House and Senate finally settled upon a small business tax relief package worth $4.84 billion over 10 years.

Under Section 179, small businesses are permitted to write off qualifying capital purchases that would otherwise be depreciated. The new legislation raises the Section 179 expensing limit to $125,000 and the phase-out to $500,000 for taxable years beginning in 2008 through 2010. These limits are indexed for inflation for tax years 2008, 2009, and 2010. For businesses in the Gulf Opportunity Zone (GO Zone), enhanced Section 179 expensing of up to $225,000 is extended through 2008.
The WOTC, which benefits businesses that hire members of certain economically disadvantaged groups, such as welfare recipients and high-risk youth, is extended through August 31, 2011. The law also expands WOTC eligibility for employers hiring disabled veterans and people in areas suffering from population loss. Additionally, employers paying the alternative minimum tax (AMT), which excludes most deductions, will nonetheless be permitted to claim the WOTC and the tip credit.
The legislation further allows an unincorporated business owned jointly by a married couple to file as a sole proprietorship instead of a partnership, thus ensuring that both spouses receive credit for paying Social Security and Medicare taxes. Modifications to the S Corporation rules include changes to the tax treatment of certain types of stock transactions.

The cost of these tax breaks is offset in a number of ways, including enhanced penalties for violations of tax filing rules. Congress also anticipates a reduction in the amount of credits taxpayers will claim under the FICA/tip tax credit as a result of the increase in the minimum wage.

Among the largest revenue generators is an increase in the “kiddie tax” age—currently 17 and under—to 18 and under, or up to age 24 if the child is a student. Under the kiddie tax, children’s investment income in excess of $1,700 is taxed at the parents’ top rate. Lawmakers said this change in the kiddie tax rules discourages the practice of transferring assets to children to avoid paying higher taxes.

Commenting on the passage of the legislation, Senate Finance Committee Chairman Max Baucus (D-MT), said, “Thanks to this bill, America’s minimum wage workers are finally going to get their pay raise, and small businesses will get needed tax cuts.”

Baucus added, “There’s more the Finance Committee can do for American families and businesses this year, from education and health tax incentives to additional small business tax relief. But I’m satisfied that we’ve made a good start, and extremely pleased to finally get these provisions done.”

Despite the inclusion of small business tax breaks in the minimum wage legislation, Dan Danner, executive vice president of the National Federation of Independent Business (NFIB) said the tax relief fell short of meeting the needs of small businesses.

“Small business owners have always opposed mandated wage levels because it leaves them with fewer choices in how they compensate their employees,” said Danner. “But in the face of an inevitable wage hike, the small-business community was pleased to hear that Congress was planning to offer a tax package aimed at helping small businesses cope with additional labor costs.”

However, Danner continued, “while small businesses appreciate the increased and extended expensing limit included in the bill, the tax package as a whole simply does not offer enough growth-oriented tax relief to allow small businesses to invest and stay competitive. NFIB is disappointed to see that the reduced tax package falls short of truly offsetting the costs small businesses will be forced to absorb as a result of a minimum wage increase.”