TAX NEWS - 
2010
US Tax: Baucus revises carried interest, S corp offsets in new extenders package
The move came after the extenders package Baucus introduced on June 8 failed to overcome a procedural point of order and was withdrawn.
Carried interests
Baucus's original bill would have taxed carried interest as 65 percent ordinary income and 35 percent capital gain beginning in 2013, with a temporary transition ratio of 50-50 for 2011 and 2012. The revised bill raises the ratio to 75 percent ordinary and 25 percent capital gain, and eliminates the transition relief. The 75-25 split would apply for tax years ending after December 31, 2010.
The revised bill also changes the ratio for carried interest income allocable to the sale or exchange of long-held assets. In the previous version, the split was 55 percent ordinary and 45 percent capital treatment for assets held seven years or more. The new provision lowers the ratio to 50-50, and applies it to assets held for at least five years.
For sales of investment services partnership interests (ISPIs), the revised bill adds a lookthrough rule to apply the 50-50 ratio to the gain or loss attributable to underlying assets held for five years or more. The 50-50 treatment also would apply to gains attributable to section 197 intangibles when an ISPI is held for five or more years in a "management entity" – a partnership whose principal activity is providing specific management services with respect to the assets of the partnership.
Under Baucus's original bill, there was an exception to the ordinary income treatment of the disposition of an ISPI for certain energy-related publicly traded partnerships (PTPs) by widely held regulated investment companies, real estate investment trusts, or nonservice individual partners. The revised bill eliminates that carve-out.
Partners who are not investment service providers and dispose of a PTP interest would be exempted under the revised bill from treating an ISPI as an inventory item for purposes of section 751.
The revised carried interest provisions are estimated to raise $13.9 billion over 10 years (down from $14.45 billion in Baucus's original proposal).
Application of employment taxes to service professionals
Baucus's revised bill retains a provision that would require shareholder-employees of a personal service S corporation to pay employment tax on their full share of allocated earnings, but applies it to a more targeted universe of taxpayers.
As proposed in Baucus's original bill – and in the extenders legislation approved by the House last month – the provision would apply to (1) an S corporation that is a partner in a professional services business and (2) 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 proposal was criticized by Senate taxwriters Mike Enzi, R-Wyo., and Olympia Snowe, R-Maine, among others, as unduly burdensome on small businesses.
Under the revised bill, the provision would apply to:
- An S corporation that is a partner in a professional services business and
- An S corporation that is 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.
According to a summary provided by the Senate Finance Committee staff, the new 80-percent-of-gross-income standard should make the provision more administrable.
The revised provision is estimated to raise $9.15 billion over 10 years (down from $11.25 billion in the original Baucus bill and the House-passed bill). It would be effective for taxable years beginning after December 31, 2010.
Other tax changes
The revised bill also changes other revenue provisions in the earlier extenders legislation to:
- Increase the Oil Spill Liability Trust Fund tax to 49 cents per barrel (from 41 cents in the original Baucus bill and 8 cents under current law). The increase would bring the estimated 10-year revenue gain to $18.3 billion (from $15 billion). The House bill would raise the tax to 34 cents per barrel, for an estimated 10-year revenue gain of $11.79 billion.
- Clarify that an international revenue offset in the original bill that would source guarantees like interest applies only to guarantees of indebtedness rather than guarantees of obligations. This change has no revenue effect.
- Clarify the proposed repeal of the so-called "80/20 company" rules to provide that for purposes of applying the grandfather provision for periods prior to January 1, 2011, the 80/20 rules then in effect shall apply. This change has no revenue effect.
In addition, the bill includes a new offset 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.
On the incentive side, the revised bill will incorporate an amendment approved on the Senate floor June 16 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. Under current law, taxpayers must close on a home by June 30 to take advantage of the credit. (The provision is estimated to cost $140 million over 10 years.)
The revised bill also adds a provision that would allow disaster low-income housing tax credits to be exchanged for grants or refundable credits (10-year cost: $91 million).
What's next?
The Senate is scheduled to continue voting on amendments – including a Republican substitute offered by John Thune, RS. D., – on June 17, and a vote to end debate and move to final passage could come as early as June 18. But given on-going concerns over spending issues and the struggles that Democratic leaders have faced to corral the 60 votes needed to clear procedural hurdles, consideration of extenders legislation in the Senate may roll into next week.
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