In the spring of 1996, Democrats began identifying legislative issues that they thought could define the differences between Democrats and Republicans in fall elections.
One initiative was a proposal to increase the minimum wage from $4.25 to $5.15 an hour. The House Republican leadership’s initial reaction was that the proposal would not even be considered.
Many Republicans, however, especially those from states with their own higher minimum wage laws, began to feel pressure from voters to support the minimum wage increase.
The House Republican leadership decided to couple the minimum wage increase with a series of small business tax proposals that they could say addressed the “real” job issue — encouraging small businesses to create more jobs. While many other items were eventually added to the legislation, it retains its small business orientation.
Small Business Job Protection Act of 1996
Small Business Expensing
The Act gradually raises the current-law small business expensing limitation from the $17,500 level set in 1993 to $25,000 in the following increments:
| For tax years beginning in |
Expensing allowance |
| 1997 | $18,000 |
| 1998 | $18,500 |
| 1999 | $19,000 |
| 2000 | $20,000 |
| 2001 | $24,000 |
| 2002 | $24,000 |
| 2003 and later | $25,000 |
Effective date: The provision is effective for taxable years beginning after 1996.
Treatment of Product Storage in Home Offices
The Act clarifies that the exception to the home office deduction limitations for expenses related to space used to store inventory also applies to space used to store product samples. The taxpayer must be in the trade or business of selling products at retail or wholesale, and the home must be the sole fixed location of such trade or business.
Interestingly, the most widely discussed home office deduction controversy of the past few years remains unaddressed. In the Soliman decision, the Supreme Court denied home office deductions for a doctor who used his home office for billing and scheduling matters since he had no such office at the hospital where he practiced. The court though ruled that he was not eligible for the deduction because the home office was not his “principal place of business.”
Effective date: The provision applies to taxable years beginning after 1995.
Independent Contractor
Significant federal tax consequences depend on whether a worker is classified as an employee or an independent contractor. Worker classification status affects withholding and employment tax requirements, participation in benefit plans, the ability to take tax deductions for certain expenses, and the ability to exclude from income certain compensation. The Revenue Act of 1978 imposed a moratorium on IRS examinations of an individual’s employment tax classification under specific circumstances.
Congress believed that the IRS had unduly attempted to narrow the scope of section 530 protection in its administrative guidance and practice. To strengthen the protection offered by section 530, the Act:
- Clarifies that section 530 applies without regard to a worker’s classification under the 20-factor common law test.
- Requires the IRS to inform taxpayers of their potential section 530 protection.
- Creates an absolute safe harbor for any industry practice shared by one-fourth of the relevant industry for at least 10 years.
- Places the burden of proof in these cases on the IRS once the taxpayer establishes a prima facie case for its classification.
- Provides that changes in worker classification do not affect the application of section 530.
The Act also provides that section 530 protection is not available on the grounds that a prior audit failed to raise the employment tax issue if the audit upon which the taxpayer seeks to rely commenced after 1996 and was not explicitly an employment tax audit.
Effective date: The provisions generally apply to periods after 1996.
Leasehold Improvements
The Act treats lessors and lessees similarly with respect to leasehold improvements disposed of at the end of a lease term. Under the provision, a lessor that disposes of a leasehold improvement at the end of the term of a lease would be allowed to recover the adjusted basis of the improvement at that time.
Effective date: The provision is effective for leasehold improvements disposed of after June 12, 1996. (No inference is intended as to the proper treatment of such dispositions before June 13, 1996.)
Tax-Exempt Bonds for First-Time Farmers
The Act doubles the amount of farm land that an individual could own and still be considered a first-time farmer eligible for land acquisition loans financed by tax-exempt bonds. The Act also allows the bonds to be used to purchase land from related parties provided that:
- The price reflects the fair market value of the property, and
- The related seller is not treated as having a continuing interest in the property.
Effective date: The proposal is effective for financing provided with bonds issued after the date of enactment.
15-Year Depreciation For Gas Stations/Convenience Stores
The Act provides that the 15-year recovery period (rather than the 39-year recovery period for real estate) applies to any building and depreciable real property used to market petroleum products or in the retail gasoline trade (whether or not food or other convenience items are sold at the outlet) but not including any facility related to petroleum and natural gas trunk pipelines.
Effective date: The provisions are effective for property placed in service on, or after, the date of enactment, but a taxpayer may elect to apply the provision for any property subject to the tax code’s modified accelerated cost recovery system that was placed in service prior to the date of enactment.
The Health Coverage Availability
and Affordability Act of 1996
Self-Employed Health Insurance Deduction
The Act gradually increases the 30% self-employed health insurance deduction to 80% as follows:
| For taxable years beginning in |
Deduction |
| 1997 | 40% |
| 1998 – 2002 | 45% |
| 2003 | 50% |
| 2004 | 60% |
| 2005 | 70% |
| 2006 and thereafter | 80% |
The Act also extends the exclusion for accident and health insurance benefits to benefits received under uninsured plans that function effectively like insurance.
Effective date: The provision is effective for taxable years beginning after 1996.
Medical Savings Accounts
One of the most hotly contested issues of 1996 was the proposal by Republicans to try to contain spiraling health care costs by creating Medical Savings Accounts (MSAs). MSAs, in effect, would resemble limited purpose IRAs that would cover routine medical expenses of people who have only catastrophic health insurance protection. Opponents claimed MSAs would benefit only a narrow slice of healthy, high-income taxpayers and would encourage employers to move away from more traditional insurance coverage. The stalemate over MSAs was resolved with a compromise to adopt a pilot MSA program for small businesses only.
The Act permits businesses with fewer than 50 workers to offer employee health benefits through a high-deductible health insurance plan to cover major medical expenses and an MSA for routine expenses. Both the employer and employee could contribute to the MSA. Employer contributions would not be included in the employee’s income. Similarly, self-employed workers could buy a high-deductible plan and make tax-favored contributions to their MSAs. Earnings on an MSA would not be taxable unless withdrawn for non-medical purposes.
Annual MSA contributions would be limited to a percentage of the deductible on a high-deductible insurance plan. That percentage would be 65% for individuals and 75% for families.
High-deductible plans must have a minimum deductible of $1,500 for an individual and $3,000 for a family policy. The maximum deductible would be $2,250 for an individual and $4,500 for a family. The maximum out-of-pocket cap under a plan would be $3,000 for an individual and $5,500 for families.
The contribution limits and the deductible caps place the maximum annual tax-favored contribution to an MSA at $3,375 for a family covered by an MSA plan. Individuals would have a maximum annual contribution of $1,463.
Tax- and penalty-free withdrawals from an MSA can be made for medical expenses. Penalty-free withdrawals for any purpose can also be made after age 65.
MSAs will not be exempt from the estate tax unless:
- The MSA becomes the MSA of the surviving spouse.
- The penalty for nonmedical withdrawals would be 15%.
- And MSAs could only be used to cover medical expenses of family members also covered by high-deductible health insurance.
Effective date: MSAs will become effective Jan. 1, 1997.