Many small businesses ignore the IRC Section 44 small business disability access credit.
Basically Section 44 provides credit for up to half the cost of complying with the Americans with Disabilities Act (ADA). The maximum annual credit must not exceed $5,000 and the fee must exceed $250. Businesses with under $1 million in income or under 30 full-time employees are eligible for this tax credit. Most costs to purchase equipment or devices and to create or modify personal or tangible property qualify 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 a Section 44 tax credit and it shows how the IRS approaches this tax credit.
Arevalo is another individual taxpayer who “invested” in payphones with Alpha Telecom. Alpha Telecom intends to “sell” payphones as a “business opportunity” and at the same time, if the “business owner” agrees, Alpha Telecom essentially manages and operates payphones for the “business owner”. The court ruled that this transaction was an “investment”, and not a “business”.
Arevalo had claimed a Section 44 tax credit on his 2001 personal tax return because, apparently, Alpha Telecom’s payphones were modified to conform to the ADA. The US Tax Court and Fifth Circuit (as the Sixth Circuit did with different taxpayers) held that Arevalo was not entitled to a Section 44 tax credit.
In reaching this decision, the court ruled that (1) Arevalo could not demonstrate how funds were spent to make payphones ADA-compliant, because Alpha Telecom, apparently, did not disclose to Arevalo how payphones complied with the ADA and (2) that the Section 44 tax credit only available to ADA-compliant parties, which in this case is Alpha Telecom (and not Arevalo).
The court also rejected Arevalo’s Section 167 depreciation reduction in respect of payphones. In doing so, the court used an old “substance over form” analysis to show that Arevalo did not acquire enough holdings in payphones to count as a business. If Arevalo operates a payphone, he will be able to explain how the phone was modified to comply with the ADA and he will be an ADA-compliant individual.
The problem for taxpayers is that many common transactions can fall prey to this analysis, such as lease/sale agreements and even sale/consignment agreements.
Perhaps the lesson learned from the Arevalo case is that taxpayers should only claim a Section 44 tax credit (or even a Section 190 architectural and transportation barrier removal tax deduction) if they document the underlying transaction prior to filing Form 8826. An experienced tax attorney can assist taxpayers. tax in this case.