TAX NEWS - 2010

US Tax: Baucus unveils carried interest changes, spending cuts in 'Extenders 3.0'

U.S. Senate Finance Committee Chairman Max Baucus, D-Mont., on June 23 introduced his third version of legislation to extend expired tax provisions, which further hones a revenue offset that would change the treatment of income from carried interests and, in an effort to appease deficit hawks, whittles down unpaid-for spending provisions.

The latest iteration of the American Jobs and Closing Tax Loopholes Act of 2010 comes after earlier versions fizzled in the past two weeks due to concerns over their cost and size. Although revenue estimates were not available at press time, the new bill is expected to add less to the deficit than either of its predecessors, and Majority Leader Harry Reid, D-Nev., hopes it will garner the 60 votes needed to clear procedural hurdles and win final passage. Reid indicated that he plans to file a motion to end debate on the measure late on June 23. According to Senate procedure, a vote to end debate and approve the measure could occur on June 25, although the process may be expedited with the consent of Senate Republican leadership.


Carried interest changes

Baucus's latest bill modifies a handful of the carried interest provisions from the version he unveiled on June 16. The most substantial change is a reworking of the provisions allowing a reduced rate of ordinary income treatment for gains or losses allocable to long-term assets, including section 197 intangibles.

The June 16 version of the legislation provided for 50 percent ordinary, 50 percent passthrough treatment for income from the disposition of assets held at least five years. The new bill keeps that ratio and, although the provisions have been rewritten, the effect appears to be the same as under the prior version. The 50-50 ratio would apply to income or loss allocable to the gain or loss from the disposition of any asset held by an investment services partnership for at least five years.

For the disposition of investment services partnership interests (ISPIs), the new bill would apply the 50-50 ratio to income or loss allocable to an interest that has been held at least five years, but only to the extent that the gain or loss is attributable to assets held by the partnership for at least five years. A proportionate share rule would apply in the case of tiered partnership structures.

The new language also includes a substantial reworking of the provisions applying the 50-50 ratio to section 197 intangibles. The prior requirement for an ISPI to be held in a management entity to receive this treatment has been removed. Under the new bill, intangibles would be eligible for the preferred rate as long as the holding period for the intangibles is not longer than the ISPI's holding period and the value of the intangible is determined according to regulations which are to be issued by the Treasury Secretary. The new bill further clarifies that this treatment for an entity's intangibles is available if the investment management services are provided directly or indirectly.

The new bill adds an exception to the definition of an ISPI to exclude some partnerships. To qualify for the exception, the partnership must make all partnership distributions and allocations pro rata on the basis of each partner's capital contributions, which must constitute qualified capital interests under new section 710(d).

The legislation generally would not treat an ISPI as a qualified capital interest to the extent that the interest is acquired with the proceeds of a loan or advance that is made or directly or indirectly guaranteed by the partnership or another partner. It also adds an exception that would not apply this disqualification to the extent the loan or advance is repaid before the date of enactment.

Finally, the new bill clarifies an exception that was added last week. The bill says an ISPI would be treated as an inventory item for section 751 purposes, but partners who dispose of a publicly traded partnership (PTP) interest that is not an ISPI would be exempt from this treatment. It clarifies that the exception would apply to the direct or indirect disposition of a PTP interest and that it would not be available to persons who hold an ISPI indirectly.


Other offsets

The new bill retains revenue provisions from previous versions that would:

- Tighten foreign tax credit rules and close perceived foreign tax loopholes. Several of these provisions – related to foreign tax credit splitting, covered asset acquisitions, use of section 956 for foreign tax credit planning, and redemptions by foreign subsidiaries – would be effective retroactively.

- Require shareholder-employees of a personal service S corporation to pay employment tax on their full share of allocated earnings. As modified in the June 16 version, the provision would apply to an S corporation engaged in a professional service business if 80 percent or more of its gross income is attributable to the service of three or fewer shareholders of the corporation.

- Treat distributions of debt securities in a tax-free spin-off transaction in the same manner as distributions of cash or other property.

- Repeal the boot-within-gain limitation in the case of any reorganization transaction if the exchange has the effect of the distribution of a dividend, and ensure that an appropriate amount of earnings is taken into account in determining the amount of the dividend.

- Increase the required corporate estimated tax payments factor for corporations with assets of $1 billion or more by 36 percentage points for payments due in July, August, and September of 2015, with an offsetting reduction in 2016.

- Increase the Oil Spill Liability Trust Fund tax to 49 cents per barrel (sunset December 31, 2020), and increase the single-incident expenditure caps for the trust fund. The rate under current law is 8 cents per barrel.

- Deny deductions for punitive damages and provide that damage amounts paid by an insurer would be included in the taxpayer's gross income.

- Ease pension funding requirements for certain cash-strapped companies offering defined benefit plans.

Baucus also added an offset that would eliminate advance refundability of the earned income tax credit effective for taxable years beginning after December 31, 2010.


Incentives

On the incentive side, the new Senate bill, like prior versions, would extend business provisions such as the research and experimentation tax credit, the New Markets Tax Credit, 15-year straight-line cost recovery for qualified leasehold improvements, the exception for active financing income under subpart F, and lookthrough treatment of payments between related controlled foreign corporations.

Among the individual incentives that would be extended are the itemized deduction for state and local general sales taxes, the additional standard deduction for state and local real property taxes, and the above-the-line deduction for qualified tuition and related expenses.

The bill also would extend an array of charitable-giving provisions and infrastructure and economic development tax incentives, make the first-time homebuyer credit available for homebuyers who made a binding contract to purchase a home before the credit expired (on April 30, 2010) and officially close on the home by September 30, 2010, revise the section 6707A penalty for failure to disclose reportable transactions to make it proportional to underlying tax savings, and allow disaster low-income housing tax credits to be exchanged for grants or refundable credits.


And in the House...

For its part, the House, which approved its own extenders bill in May, has largely waited in the wings for the Senate to act. Although Ways and Means Committee Chairman Sander Levin, D-Mich., has reportedly been participating in discussions with Baucus during the drafting of the latest Senate bill, it is unclear whether or not the House will approve this bill in its current form or seek additional changes.