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Blue Skies?

The new minimum wage law could mean sunny skies--or clouds on the horizon.

When president Clinton signed the minimum wage bill (officially dubbed the Small Business Job Protection Act of 1996, H.R. 3448) into law just before the Democratic National Convention, the sun came out and things looked brighter for small businesses all over the nation. Besides the minimum wage increase itself, the law includes a number of provisions designed to provide tax relief for small businesses.

But don't put away those umbrellas just yet: Upon closer inspection, a few clouds still loom on the horizon--clouds that, in the view of Michael J. Knight, a CPA and former chairman of the American Institute of Certified Public Accountants' Small Business Taxation Committee, might bring some showers into your life.

According to Knight, the law includes a number of measures that should simplify life for small businesses. He highlights the following categories:


  • equipment purchases


  • independent contractors


  • S corporations


  • simplified pension plans, retirement plans and spousal IRAs

What's the good, the bad and the ugly in each case? Read on.

1. Equipment purchases. The law increases the amount of the deduction allowed for new equipment from the current $17,500 for the year the equipment is placed in service to $25,000. "This is good news," says Knight. "It should open doors to existing businesses planning to expand or update their equipment and to start-ups that still have their equipment purchases ahead of them."

What's not so good, he says, is that the increase doesn't happen immediately. It ratchets up--$18,000 for 1997, $18,500 for 1998, $19,000 for 1999, $20,000 for 2000, $24,000 for 2001, $24,000 again for 2002--and finally reaches $25,000 in 2003.

2. Independent contractors. "Relief is here for independent contractors," Knight says. Misclassifying someone as an employee when they're really an independent contractor has long been fraught with the peril of an audit and, worse, the possibility of owing back taxes. Now if employers can prove they're following an industry standard by classifying an employee as an independent contractor, the burden of proving the person is an employee shifts to the IRS.

The downside: Until now, business owners could rely on their previous IRS audits as a reasonable basis for classifying workers as independent contractors. In fact, this was one of the strongest measures the business community had to shield itself from IRS attack. "The thing to be wary of now," says Knight, "is that no longer will you have that safe harbor." Now business owners can base their classifications on past audits only if that audit specifically examined whether the worker or job should have been classified as an employee.

3. S corporations. The new law opens the door a little wider for businesses considering formation as an S corporation. For one thing, says Knight, it expands the number of shareholders you can have from 35 to 75. It also allows S corporations to have wholly owned subsidiaries. But the really good news is that the law makes it easier to get into and out of S corporations, primarily by simplifying the rules and making them easier to comply with.

"[Previously,] the tedium involved in getting your S corp election reinstated if you had inadvertently terminated it was unbelievable," Knight says. "These reforms should make
S corps more attractive because the rules are easier to follow."

4. Pension plans, retirement plans and spousal IRAs. A large segment of the taxation part of the law is devoted to simplifying pension plans for small businesses. "The rules for setting up pension plans were so onerous, many business owners said, `Why bother?' " explains Knight. "The new law is appealing to small businesses and, certainly, provides incentive to at least consider a pension plan if you haven't before because of the burdensome rules." Specifically, there are three main changes:


  • SIMPLE: The law creates a new pension plan called SIMPLE (Savings Incentive Match Plan for Employees). As its name suggests, the concept is to simplify the rules so that not only are pension plans easier to set up and administer, but more employees can participate if they choose. SIMPLE is designed to eventually replace SAR/SEP pension plans (but not SEP-only plans) and can be set up either as an IRA or a 401(k).

One key change for small-business owners, says Knight, is that the rules requiring that employees have to be part of the plan are relaxed. In other words, what's good for the goose is no longer necessarily good for the gander.


  • Family involvement: Another significant change for retirement plans is that family members working in a family business can now participate fully. The IRS was worried that business owners hired family members as "sham" employees so they could put away more tax-free money for retirement. To prevent this, under the old rules, family members working for the business were required to "aggregate" their incomes and be treated as one employee, limiting how much they could contribute to the retirement plan. The new law permits family members to be treated as regular employees for purposes of contributing to the plan.


  • Spousal IRA: The third major change in the retirement arena is the creation of a spousal IRA. "This is a big plus for homemakers," says Knight. Previously, the IRA contribution was limited to a total of $2,250 a year for a household where only one spouse works outside the home. "Now a married couple can put away $4,000 a year tax-free," Knight says.

At first blush at least, all the pension reforms seem to be aimed in the right direction. However, while setting up a pension plan may be easier, it still isn't what most of us would call simple. There's a lot of stuff here you can trip over, cautions Knight, who says actuaries and pension plan administrators are having a field day dissecting the matching requirements and percentage tests for SIMPLE.

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This article was originally published in the November 1996 print edition of Entrepreneur with the headline: Blue Skies?.

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