December 11, 2006

Section 44 Small Business Disabled Access Credit Considerations

Houston Tax Attorney Blog

Houston Tax Attorney

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A lot of small business overlook the IRC Section 44 small business disabled access credit.

Essentially Section 44 provides a credit for up to one half of the costs to comply with the Americans with Disabilities Act (ADA). The maximum annual credit cannot exceed $5,000 and the costs must exceed $250. Businesses that have revenues of under $1 million or under 30 full time employees qualify for this tax credit. Most costs to purchase equipment or devices and to create or modify personal or real property are eligible for this credit if (1) they are reasonably necessary to comply with the ADA and (2) the primary purpose of complying with the ADA.

The Fifth Circuit Court of Appeals recently addressed Section 44 in Arevalo v. Commissioner. The Arevalo case provides an example of when taxpayers should not try to qualify for the Section 44 tax credit and it shows how the IRS approaches these tax credits.

Arevalo was yet another individual taxpayer who “invested” payphones with Alpha Telecom. Alpha Telecom purports to “sell” payphones as “business opportunities” and at the same time, if the “business owner” agrees, Alpha Telecom essentially manages and operates the payphones for the “business owner.” The courts have held that these transactions are “investments,” and not “businesses.”

Arevalo had claimed a Section 44 tax credit on his personal 2001 tax return because, apparently, the Alpha Telecom payphones were modified to be ADA compliant. The US Tax Court and the Fifth Circuit (just like the Sixth Circuit did with a different taxpayer) held that Arevalo was not entitled to the Section 44 tax credit.

In reaching this determination, the court held that (1) Arevalo could not show how funds were expended to make the payphones ADA compliant, because Alpha Telecom, apparently, did not disclose to Arevalo how the payphones were ADA compliant and (2) that the Section 44 tax credit is only available to the party that is subject to the ADA, which in this case was Alpha Telecom (and not Arevalo).

The court also denied Arevalo’s Section 167 depreciation deduction with regard to the payphones. In doing so, the court used the old “substance over form” analysis to show that Arevalo did not acquire enough of the ownership in the payphones for it to count as a business. If Arevalo were operating the payphones he would have been able to explain how the phones were modified to comply with the ADA and he would have been the individual that was subject to the ADA.

The problem for taxpayers is that many common transactions could fall prey to this analysis, such as leasing/sales arrangements and even sales/consignment arrangements.

Perhaps the lesson learned from the Arevalo case is that taxpayers should only claim the Section 44 tax credit (or even the Section 190 architectural and transportation barrier removal expense tax credit) if they document the underlying transactions prior to filing the Form 8826.

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