TAX NEWS - 2010

U.S. Tax: Extenders action delayed as Senate bill hits procedural wall

U.S. Senate adjourned June 18 without completing work on legislation to extend expired tax provisions, despite last-minute efforts by Finance Committee Chairman Max Baucus, D-Mont., to pare down the bill to garner the necessary support. The latest version of the American Jobs and Closing Tax Loopholes Act of 2010 stalled on June 17, when Senate lawmakers defeated a motion to end debate and move to final passage.

Baucus unveiled his scaled-back bill a day earlier, after withdrawing a more expansive package that also had failed to clear procedural hurdles. The revised bill made changes to earlier proposals to tighten the tax treatment of income from carried interests and subject certain S corporation income to self-employment taxes. It also made cuts to spending provisions in an effort to make the bill more palatable to deficit hawks.


Changes and more changes

Baucus said June 17 that the Senate will continue efforts to gain the support of moderates such as Ben Nelson, D-Neb., and Susan Collins, R-Maine, who both voted against the package. A further slimming down of the bill's spending provisions is likely when the Senate resumes work on the bill the week of June 21.

S corporations – On the tax side, some are still concerned with a provision in the bill that would require shareholderemployees of a personal service S corporation to pay employment tax on their full share of allocated earnings. Baucus narrowed the scope of his proposal so that it 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. (The earlier version would have applied to an S corporation engaged in a professional service business that is principally based on the reputation and skill of three or fewer individuals.) But that was not enough to satisfy Finance Committee member Olympia Snowe, R-Maine, who continues to push for her amendment to strike the provision from the measure altogether. It is unclear if Snowe's amendment will be allowed a floor vote.

Carried interests – Baucus's revised bill also modified his carried interest proposal, providing for more stringent treatment of carried interest from the sale of short-term assets but a more generous exception for long-term assets. Generally, the revised provision would tax income from carried interests as 75 percent ordinary income and 25 percent capital gain for taxable years ending after December 31, 2010. Carried interest allocable to the sale or exchange of any asset held at least five years would be treated as 50 percent ordinary income and 50 percent capital gain.

Baucus indicated on June 17 that he intends to offer a technical change that would clarify that enterprise value in the sale of an investment services partnership interest would be taxed as 50 percent capital gain and 50 percent ordinary income. Additional amendments possible – Further tax amendments are also expected to be offered, although they may not necessarily be brought up for a vote.


Revenue offsets

In addition to the carried interest and S corporation provisions, the revised bill includes revenue raisers 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 (estimated 10-year revenue gain: $14.5 billion).

- Treat distributions of debt securities in a tax-free spin-off transaction in the same manner as distributions of cash or other property (estimated 10-year revenue gain: $255 million).

- 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 (estimated 10-year revenue gain: $510 million).

- 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 (estimated revenue gain: $21.23 billion in 2015, revenue neutral over 10 years).

- 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 (estimated 10-year revenue gain: $18.7 billion). The rate undercurrent law is 8 cents per barrel.

- Ease pension funding requirements for certain cash-strapped companies offering defined benefit plans (estimated 10-year revenue gain: $2 billion).

The revised bill adds a provision that would deny deductions for punitive damages and provide that damage amounts paid by an insurer would be included in the taxpayer's gross income. This provision would raise an estimated $315 million over 10 years.


Incentives

On the incentive side, the Senate bill 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 extended under both bills 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.

The revised bill also adds provisions that would: make the first-time homebuyer credit available for homebuyers who made a binding contract to purchase a home before the expiration of the homebuyer tax credit (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 penalty proportional to underlying tax savings; and allow disaster low-income housing tax credits to be exchanged for grants or refundable credits.


House action

For its part, the House had taken steps to allow that chamber to consider the extenders package under expedited procedures pending Senate action. However, after seeing the bill had stalled in the Senate, the House adjourned for the week late June 17. Currently the House schedule indicates the package is "possible for next week's schedule."

The House version of extenders legislation, which was approved May 28, is substantially similar to the Senate package.