U.S. Tax: House approves tax treaty benefit limitations, other significant offsets for small-business jobs package

The House of Representatives voted 246-178 on March 24 to approve a $16.8 billion small-business jobs bill that would be paid for through limitations on treaty benefits, changes to the rules governing "divisive D" reorganizations, repeal of the 80/20 company rules, and other significant revenue raisers.

The Small Business and Infrastructure Jobs Tax Act of 2010 (H.R. 4849) was reported out by the House Ways and Means Committee on March 17.


Limitation on tax treaty benefits

The bill would prevent foreign multinationals from "treaty shopping" to avoid tax on income earned in the United States by having a U.S. subsidiary make a deductible payment to a country with which the United States has a tax treaty with reduced withholding rates before repatriating the earnings in the parent's country.

The provision would limit treaty benefits on payments that are:

- Deductible for U.S. federal income tax purposes;
- Made by a U.S. corporation that is controlled by a foreign parent; and
- Made to a recipient that is also controlled by the same foreign parent.

A reduced withholding rate would not be available for those payments unless the foreign parent would have qualified for a reduced rate on a direct payment.

The provision would be effective for payments made after the date of enactment. The Joint Committee on Taxation (JCT) staff estimates this provision would raise $7.7 billion over 10 years. It is identical to a provision in an earlier version of health care reform legislation (H.R. 3962) that passed the House last November.


Divisive 'D' reorgs

Current law generally allows for the tax-free exchange of property for stock or securities between corporations that are parties to a divisive spin-off, split-off, or split-up reorganization pursuant to sections 368(a)(1)(D) and 355 (a "divisive D" reorg).

The bill would amend section 361 to provide that debt securities or nonqualified preferred stock would be treated as taxable "other property" (boot). The transferor corporation would recognize gain to the extent that boot exceeds the adjusted basis of the assets transferred (net of liabilities). In its explanation of the provision, the Joint Committee on Taxation (JCT) notes as an example that "under the proposal, in a divisive D reorganization, the exchange of the controlled corporation's securities for the distributing corporation's securities would be treated in the same manner as (1) the assumption of the distributing corporation's debt by the controlled corporation or (2) the use of a cash distribution from the controlled corporation to retire debt of the distributing corporation."

The proposal would be effective for transactions occurring after the date of enactment, but certain transactions would be grandfathered if they are made pursuant to a binding agreement in effect on March 15, 2010, and described in an IRS ruling request and Securities and Exchange Commission filings. The provision is expected to raise $260 million by 2020.


'80/20 company' rules

Dividends and interest paid by a domestic corporation are generally considered U.S.-source income and subject to withholding tax if paid to a foreign person. An exception to this rule applies when a domestic corporation derives at least 80 percent of its gross income from an active foreign business (an "80/20 company"). In that context, the dividends and interest paid by the 80/20 company are treated as foreign-source, and not subject to U.S. withholding tax.

The bill, taking up a proposal from President Obama's fiscal 2011 budget blueprint, would repeal these provisions.

The proposal would be effective for taxable years beginning after December 31, 2010. The Joint Committee on Taxation (JCT) estimates this provision would raise $950 million over 10 years.


Information reporting for rental property expenses

The bill adopts another budget proposal that would require information reporting for rental property expenses. Recipients of real estate rental income that make payments of $600 or more to a service provider (such as a plumber or accountant) in the course of earning rental income would be required to send an information return (generally, Form 1099-MISC) to the IRS and to the service provider.

This provision would apply to payments made after December 31, 2010, and would raise almost $2.5 billion over 10 years.


Levies on payments to federal vendors or contractors

The bill would give the IRS greater levy authority over federal vendors or contractors:

- Vendors – The bill would allow the IRS to levy 100 percent of any payment due a federal vendor for the sale or lease of real or other property that is not included in the current levy authority on payments for goods and services. This provision would be effective for levies approved after the date of enactment and would raise $147 million over 10 years.

- Contractors – The bill would allow the IRS to issue levies before a collection due process hearing on federal contractors who owe federal taxes. This provision would be effective for levies issued after December 31, 2010. It is estimated to raise just over $1 billion in 10 years.


GRATs

The bill adopts another Obama budget proposal that would require a grantor retained annuity trust (GRAT) to have a minimum term of ten years, instead of a more typical term of two years. The longer life would increase the chance that the grantor's death occurs during the annuity period, resulting in the grantor retained annuity trust (GRAT) assets being included in the grantor's estate rather than being transferred to the beneficiaries of the grantor retained annuity trust (GRAT) if the grantor dies after the term. The change would have a significant impact on the ability to use GRATs for generation-skipping transfer tax planning.

This provision would apply to transfers made after the date of enactment, and would raise $4.4 billion over 10 years.


Information return penalties

The bill would increase several penalties for failure to file correct information returns under section 6721. Generally, it would raise the penalty for single failures from $50 to $100 and the annual aggregate limit from $250,000 to $1.5 million.

Penalties for corrected failures would also rise, as would the lower limitations for taxpayers with gross receipts of under $5 million. The bill also proposes to adjust the section 6721 penalties for inflation every five years.

These provisions would apply to information returns required to be filed after January 1, 2011, and would raise about $420 million by 2020.


Cellulosic biofuel producer credit

The legislation would raise $1.9 billion by excluding from the cellulosic biofuel producer credit under section 40(b)(6) certain processed fuels with an acid number exceeding 25. Effectively, this revenue offset would exclude the highly corrosive fuel known as "crude tall oil." This oil is another byproduct of the paper manufacturing process from which "black liquor" is derived. Lawmakers have sought numerous times to exclude black liquor from the section 40(b)(6) credit but are just now targeting crude tall oil.

This provision would be effective for fuels sold or used on or after January 1, 2010, and would raise nearly $1.9 billion over 10 years.


Corporate estimated tax payments

H.R. 4849 also would increase required corporate estimated tax payments by 4.5 percentage points for payments due in July, August, and September of 2014, by 3.5 percentage points for the same period in 2015, and by 1.25 percentage points for the same period in 2019.


Small-business tax incentives

The bill also proposes a number of tax incentives targeted at small businesses including:

- 100 percent exclusion of small-business capital gains – The bill would increase the amount of the section 1202 exclusion to 100 percent for qualifying stock acquired after March 15, 2010, and before January 1, 2012. The American Recovery and Reinvestment Act (P.L. 111-5) temporarily increased the exclusion to 75 percent for qualifying stock acquired in 2009 and 2010.

- Interaction of New Markets Tax Credits and alternative minimum tax – The bill would allow the New Markets Tax Credit to be claimed against the alternative minimum tax for qualified investments made between March 15, 2010, and January 1, 2012.

- Reportable transaction penalty relief – The bill generally would make the penalty for failing to disclose reportable transactions proportionate to the underlying tax savings that were the object of the transaction.

Other incentives in the legislation include provisions that would permit owners of certain buildings financed with taxexempt bonds to elect to receive direct payments in lieu of low-income housing credits, increase the deduction for start-up expenditures, and extend the Build America Bond and the Recovery Zone bond programs.


Next steps

The legislation now moves to the Senate where its consideration is expected to be delayed until after the upcoming twoweek spring recess that begins on March 29. For his part, Senate Finance Committee Chairman Max Baucus, D-Mont., may introduce his own small-business incentives bill in the near future.