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Tax Aspects of Complying with the Americans with Disabilities Act

By Ellen D. Cook, Anne K. Judice, and J David Lofton

The tax code can soften the financial blow.

Complying with the Americans with Disabilities Act can be costly. There are a number of sections in the IRC that can help relieve this financial burden. The author explains their use and how sometimes they can be used in tandem.

The financial burdens imposed by Titles I and III of the Americans with Disabilities Act (ADA) can be great. Although Title I itself offers employers relief only if its required accommodations would cause them "undue hardships," there is another source of comfort open to employers: five specific sections of the IRC--IRC Secs. 44, 51, 179, 190, and 1250(b)(3)--provide relief to employers who seek to adhere to the guidelines of Title I. IRC Sec. 51 deals with expenses of hiring individuals with disabilities; IRC Secs. 44 and 179 pertain to expenditures for tangible, personal property such as special equipment; and IRC Secs. 44, 190, and 1250(b)(3) relate to expenditures to make alterations to real property. The later sections also provide relief to business owners and landlords who alter existing facilities in compliance with Title III.

IRC Sec. 44 Disabled Access Credit

To encourage compliance with the ADA, specifically Titles I and III, the Omnibus Budget Reconciliation Act of 1990 added IRC Sec. 44. This section grants a nonrefundable credit, not to exceed the taxpayer's tax liability, for "eligible small businesses" that pay or incur expenses after November 5, 1990, to make improvements to provide access to the disabled. The disabled access credit is part of the general business credit, subject both to the general business credit's limitations and to the IRC Sec. 39 carryback and carryforward rules. The disabled access credit is fixed at an amount equal to 50% of so much of the "eligible access expenditures" for the taxable year as exceeds $250 but does not exceed $10,250. Therefore, the maximum allowable credit is $5,000 per year.

Under IRC Sec. 44(b), an eligible small business is defined as any person (i.e., sole proprietorship, partnership, regular or S corporation, or limited liability company) meeting either of two conditions: 1) the gross receipts of such person for the preceding taxable year did not exceed $1,000,000 or 2) such person employed not more than 30 full-time employees during the preceding taxable year. An employee is considered as being full-time if employed for at least 30 hours per week for 20 or more weeks that year. Further, eligible access expenditures are defined to include the reasonable and necessary amounts paid or incurred for the purpose of enabling a business to comply with the requirements of the ADA, including--

  • removing architectural, communications, physical, or transportation barriers that prevent a business from being accessible to, or usable by, individuals with disabilities;
  • providing interpreters or other effective means of delivering audio materials to individuals with hearing impairments;
  • providing readers, taped texts, and other methods of delivering visual materials to individuals with visual impairments;
  • acquiring or modifying equipment or devices for individuals with disabilities; and
  • providing other similar services, modifications, materials, or equipment.

Thus, IRC Sec. 44 could be applied to expenditures to make real property accessible--such as widening doors, constructing wheelchair ramps and the like for the purchase of personal property, such as equipment to convert text to Braille, and
to wages for
interpreters and readers otherwise deductible under IRC Sec. 162. To illustrate the use of the IRC Sec. 44 credit consider the following example:

A corporation in the 34% marginal tax bracket, meets the IRC Sec. 44 requirements to be an eligible small business. On January 1, 1995, $20,000 of expenses were incurred to comply with the ADA for each of the following purposes:

  • Improvements to a commercial building,
  • Purchase of equipment that converts text to Braille, and
  • Wages paid to an interpreter.

The effect on the first year of the use of the IRC Sec. 44 credit is shown in
Exhibit 1.

This example, as is true of all examples in this article, ignores both the time value of money and future changes in a taxpayer's marginal tax rate. Further, in subsequent years, the expenditures not qualifying for the IRC Sec. 44 credit would be capitalized and depreciated under MACRS for the applicable recovery period. Thus, subsequent year tax savings will differ according to what amounts were capitalized. Over the depreciable life, the tax savings would gradually reverse.

Generally, a taxpayer should take advantages of IRC Sec. 44 before pursuing the benefits of other IRC sections. Factors such as whether or not the entire credit is available because of tax liability limitations or general business credit limitations should be considered, as well as others discussed later. Finally, some or all of a taxpayer's expenditures for improvements may not be eligible for the disabled access credit.

IRC Sec. 51 Targeted Jobs Tax Credit

Employers who hire individuals with disabilities are entitled to a 40% credit on the first $6,000 in qualified first-year wages (i.e., those in a 12-month period) paid to such individuals. The credit, which is automatic unless the employer elects to forgo its provisions, is in lieu of a deduction for wages under IRC Sec. 162. The targeted jobs tax credit, which originally expired on June 30, 1992, was extended to December 31, 1994, by the Revenue Reconciliation Act (RRA) of 1993. As of the date of this writing, its status for 1995 is unknown. Like the disabled access credit, the targeted jobs tax credit is part of the general business credit, subject both to the general business credit's limitations and IRC Sec. 39 carryback and carryforward rules.

Computed on Form 5584, the credit is available to employers who hire individuals from one of the several targeted groups named in the IRC, including "a vocational rehabilitation referral." A vocational rehabilitation referral is defined as any individual who is certified by the designated local agency as a) having a physical or mental disability which, for such individual, constitutes or results in a substantial handicap to employment; and b) having been referred to the employer upon completion of (or while receiving) rehabilitative services pursuant to an individualized written rehabilitation plan. This latter plan must be under a state plan for vocational rehabilitation services approved under the Rehabilitation Act of 1973, or a program of vocational rehabilitation carried out under chapter 31 of title 38 of the U.S. code. Such employee must be employed for a minimum of 90 days or must complete 120 hours of service.

Because the credit was retroactively reinstated by the RRA, an employer may file an amended income tax return for 1992 and 1993 to claim the additional credit. While there is no question this may be done for employees who were certified prior to the original June 30, 1992 expiration date, the committee reports are silent as to how the retroactive reinstatement is applied to new qualified employees hired after June 30, 1992, and before August 1993, the date of enactment of the RRA. It is presumed the IRS will issue guidelines on the need, if any, for retroactive certification of employees.

IRC Sec. 179 Limited Expensing

Code IRC Sec. 179 may be used alone or in conjunction with IRC Sec. 44 to yield a tax benefit when new or used tangible, personal property (e.g., Braille readers or voice-activated computers) is placed in service during the tax year. This irrevocable election allows immediate expensing of up to $17,500 of the cost of "IRC Sec. 179 property" purchased and placed in service during the year. IRC Sec. 179 property includes any tangible property (to which the IRC Sec. 68 investment tax credit applies) that is considered to be IRC Sec. 1245 property and is acquired for use in the active conduct of a trade or business. Amounts in excess of the $17,500 limit are capitalized and depreciated using MACRS depreciation.

The $17,500 election is an annual one that can be used in any manner where a combination of qualifying assets are purchased. The $17,500 amount is subject to two limitations.

The amount of the deduction is reduced by the amount by which the cost of IRC Sec. 179 property placed in service during the taxable year exceeds $200,000. The disallowed amount is capitalized and depreciated. For example, if $210,000 of qualifying property is placed in service, the amount of the allowable immediate expensing is [$17,500($210,000 $200,000)] or $7,500. Thus, $7,500 of the cost could be immediately expensed and the remainder depreciated. There is no carryover of the disallowed amount.

The amount allowed as a deduction is limited to the aggregate amount of taxable income of the taxpayer for such taxable year that is derived from the active conduct by the taxpayer of any trade or business during such taxable year. The disallowed portion may be carried over to a subsequent year.

For example, assume that $17,500 in expenses qualify for the deduction after the first limitation is applied, but that taxable income is $10,000. In this case, $10,000 would currently be allowed as a deduction, with $7,500 being allowed as a carryover to the next tax year subject to the same limitations. The following example will further clarify the application of this section.

In compliance with the ADA, a corporate taxpayer in the 34% marginal tax bracket purchased and placed in service a specially designed computer for employees with disabilities at a cost of $25,000. The effect of various options including utilizing the IRC Sec. 179 option in the first year is shown in Exhibit 2.

IRC Sec. 190 Deduction for Removal of Barriers

If a taxpayer cannot use the IRC Sec. 44 disabled access credit on all expenditures related to real property (either for failing to meet its eligibility requirements or for having total qualified expenditures that exceed its $10,250 limit), IRC Sec. 190 could be utilized to yield a tax deduction. IRC Sec. 190, which was part of the tax code prior to enactment of the ADA, allows a taxpayer to elect to treat qualified architectural and transportation barrier removal expenses that are paid or incurred during the taxable year as expenses not chargeable to the basis of the asset. Such expenditures, up to a maximum of $15,000 a year, are allowable as a deduction that must be separately identified on the tax return. Amounts in excess of the $15,000 limit (and for which no IRC Sec. 44 credit was taken) must be capitalized and depreciated using the MACRS depreciation.

IRC Sec. 190 defines architectural and transportation barrier removal expenses to include any expenditures made for the purpose of making any facility or public transportation vehicle owned or leased by the taxpayer for use in connection with its trade or business more accessible to, and usable to or by, handicapped and elderly individuals. Further, a qualified architectural and transportation barrier removal expense is defined as an expense with respect to which the taxpayer establishes that the resulting removal of any such barrier meets the standards promulgated by the U.S. Secretary of the Treasury with the concurrence of the Architectural and Transportation Barriers Compliance Board.

The qualification standards for grading, walks, parking lots, ramps, entrances, doors and doorways, stairs, floors, toilet rooms, water fountains, public telephones, elevators, controls, identification, warning signals, hazards, the international accessibility symbol, and other barrier removals are found in Treas. Reg. Sec. 1.190-2(b). As a practical matter, such expenditures may include those costs incurred for installing ramps and grab bars, lowering telephones and water fountains, widening doorways, making minor modifications of restrooms, rearranging restaurant tables or display racks, adding raised letters or Braille to elevator control buttons, and constructing curb cuts at sidewalks and entrances.

The election to deduct expenses must be made on the return for the tax year for which the election is to apply. The return must be filed no later than the due date (including extensions) of the return. The election is irrevocable after the due date of the return and applies to all such expenses (up to the $15,000 limit) that were paid or incurred during the tax year. Both the IRC Sec. 190 deduction and IRC Sec. 44 credit may be used in the same tax year, although not on the same eligible expenses. The following example will illustrate this point.

On July 1, 1995, a regular corporation with a marginal tax rate of 34%, incurred $35,000 in total expenditures for the removal of certain barriers to its headquarters building (a "commercial facility" under the ADA) to bring the building into compliance with the ADA. The effect of using both the IRC Sec. 44 credit and the IRC Sec. 190 deduction on the first year's taxes is shown in Exhibit 3.

IRC Sec. 1250(b)(3) Exemption from Ordinary Income Recapture

Another item of tax relief for real property owners is found in IRC Sec. 1250(b)(3). Ordinarily, IRC Sec. 1250's recapture provisions would require that, upon the sale of a building, any deduction in excess of the allowable depreciation must be treated as a "depreciation adjustment" that will be recaptured as ordinary income, rather than as a more favorably treated long-term capital gain. IRC Sec. 1250(b)(3), however, specifically exempts the depreciation deduction taken for expenditures that qualify for IRC Sec. 190 treatment from being considered as a depreciation adjustment. Thus, depreciation deductions on qualified IRC Sec. 190 expenditures need not be recaptured as ordinary income; instead, they can be considered as long-term capital gains. Further, the IRC Sec. 190 deductions themselves are not subject to recapture as ordinary income.

IRC Sec. 1250 recapture of depreciation on residential rental property and nonresidential real property placed in service after December 31, 1986, and on substantial improvements thereto, is not required since that property must be depreciated under the straight-line method thus resulting in no excess depreciation.

Special Considerations for Pass-Through Entities

In the case of partnerships, limited liability companies classified as such for Federal tax purposes, and S corporations, the $17,500 limit on the IRC Sec. 179 deduction, the $15,000 limit on the IRC Sec. 190 deduction, and the $5,000 limit on the IRC Sec. 44 credit apply at both the entity and owner level. The entity must apply the appropriate limits to determine the amount of expenditures to pass on to its owners as qualified tax credits or tax deductions, and which to pass on as excess expenditures that must be added to the property's basis. The individual owners will share the entity's applicable IRC Secs. 44, 179, or 190 limits proportionately to their distributive shares in the entity's gains and losses. The entity's owners individually can elect how to allocate their IRC Secs. 179, 190, and 44 limits between the qualified expenditures that were received as their distributive shares and the qualified expenditures, if any, that they incurred on property they individually own.

There is a presumption that each partner's or shareholder's distributive share of expenses will be fully deductible under IRC Sec. 179 or 190 (or yield a tax credit under IRC Sec. 44). Therefore, the basis of the partnership's, LLC's, or S corporation's property will be increased only upon a showing that all or part of the partner's or shareholder's distributive share of such expenses will not be deductible by that partner or shareholder because it will be more than that individual's limit as allocated by that individual.

Tax Planning Opportunities

The IRC Sec. 44 tax credits and IRC Secs. 179 and 190 deductions are available annually. Consequently, taxpayers should use effective tax planning to maximize benefits of any expenditures incurred. Two critical considerations are the timing of the expenditures and the taxpayer's marginal tax rate. Of course, the expectations regarding future changes in tax rates and/or tax law should also enter into any successful tax planning.

Timing of Expenditures. A taxpayer must carefully plan the timing of qualified expenditures to maximize the tax benefit of the interaction between IRC Sec. 44 and IRC Sec. 190. For example, a corporate taxpayer in the 34% marginal tax bracket who will incur qualified expenditures of $20,500 or more would be wise to spread the cost over two tax years, if there is no expectation of changes in marginal tax rates. This is shown in Exhibit 4.

Marginal Tax Rates. A taxpayer's tax bracket will have an impact on the timing of qualified expenditures. Should the taxpayer anticipate a decrease to a lower rate in a subsequent year, the expenditure should be made in the earlier year. The same holds true for potential changes in corporate rates.

Other Tax Savings Suggestions. Some of the costs incurred in complying with the ADA can be deducted from gross income in the year paid or incurred as "ordinary and necessary" business expenses under IRC Sec. 162. Such costs include those to review all employment applications to eliminate questions about physical or mental disabilities and the costs of altering tests that screen out people with disabilities.

Finally, some tax planners have suggested an alternative to employers hiring readers for the visually impaired or sign-language interpreters for the hearing impaired. Although these wages are eligible for the IRC Sec. 44 disabled access credit, planners suggest employers should instead consider increasing the compensation to their workers with disabilities, enabling them to hire their own assistance providers as independent contractors. While this method is beneficial to the employers because it avoids costly fringe benefits, the employees with disabilities are also served because their reader or interpreter is directly responsible to them and a special tax provision of IRC Sec. 67(d) allows workers with disabilities to deduct "impairment-related work expenses" in full and avoid additional costs or tax consequences for either employers or employees.

Ellen D. Cook, MS, CPA, is an associate professor of accounting and Anne K. Judice, Esq., is an assistant professor of legal studies at the University of Southwestern Louisiana. J David Lofton, Esq., (now deceased) was a coordinator of real estate and insurance programs and associate professor of legal studies at the same institution.

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1997 New York State Society of Certified Public Accountants. Legal Notices.

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