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TAX NEWS - march 2010

Health care reconciliation package becomes law; economic substance, 'black liquor' provisions take effect immediately

President Barack Obama on March 30 signed into law a companion package of "fixes" to comprehensive health care legislation that was enacted last week. Taken together, the just-signed Reconciliation Act of 2010 and the Patient Protection and Affordable Care Act raise nearly $438 billion over 10 years in taxes targeted at high-income individuals, selected health care-related industries, and corporate taxpayers.

Two significant revenue raisers in the reconciliation bill - codification of the economic substance doctrine and a provision to make "black liquor" ineligible for the cellulosic biofuel producer credit under section 40(b) - became effective upon enactment.

The reconciliation bill's other major new revenue provision - a 3.8 percent unearned income Medicare contribution to be levied on individuals with adjusted gross income (AGI) over $200,000 and joint filers with AGI over $250,000 - becomes effective for taxable years beginning after December 31, 2012. This provision, combined with the provision from the Patient Protection and Affordable Care Act that increases Medicare taxes on wages and self-employment income by 0.9 percentage points for the same high-income individuals, raises $210.2 billion over 10 years, or 48 percent of the tax revenue needed to pay for health care reform.

Economic substance codification

The reconciliation agreement adds a revenue raiser not included in the Patient Protection and Affordable Care Act that codifies the economic substance doctrine. The provision requires a conjunctive analysis of economic substance under which taxpayers must show both that (1) a transaction changed their economic position in a meaningful way apart from the federal income tax effects, and (2) they had a substantial purpose apart from federal income tax effects for entering into the transaction.

A 40 percent strict liability penalty applies to tax understatements attributable to undisclosed noneconomic substance transactions. The penalty is 20 percent if a transaction is adequately disclosed. Provisions in health care reform legislation approved by the House last November that would have limited the ability of large corporations and publicly traded companies to obtain relief from accuracy-related penalties under the reasonable-cause exception are not included in this bill.

The provision is effective for transactions entered into after the date of enactment.

The Joint Committee on Taxation (JCT) staff estimates that this provision will raise $4.5 billion over 10 years.

Black liquor

Another new revenue offset added by the reconciliation bill modifies the cellulosic biofuel producer credit under section 40(b) to preclude black liquor - the wood pulp byproduct that paper companies use to power their mills - from eligibility.

This provision is intended to resolve a debate over the tax treatment of black liquor that has continued since 2007. When section 6426(d)(2)(G) was clarified in 2007 to apply to "liquid fuel derived from biomass," paper mills became eligible to claim the refundable alternative fuel mixture credit under section 6426(e) by adding a small amount of diesel fuel to their black liquor. The alternative fuel mixture credit expired on December 31, 2009. If Congress decides to extend the section 6426(e) credit, it is generally expected to add a provision that will make black liquor ineligible.

But a new issue in the debate emerged last year when the IRS held in an internal legal memorandum (ILM 200941011) that black liquor also may be eligible for the nonrefundable cellulosic biofuel producer credit under section 40(b)(6), which is not scheduled to expire until December 31, 2012.

To address this, the reconciliation bill modifies section 40(b)(6) (which allows taxpayers to claim a $1.01-per-gallon nonrefundable credit for certain liquid fuels produced) to provide that a fuel is ineligible for the cellulosic biofuel producer credit if:

- Its combined water-and-sediment content is greater than 4 percent (determined by weight) or
- Its ash content exceeds 1 percent (determined by weight).

The effect of this statutory change is that black liquor will not qualify for a nonrefundable credit under section 40(b)(6).

The provision is effective for fuels sold or used after December 31, 2009. The Joint Committee on Taxation (JCT) estimates that this provision will raise $23.6 billion over 10 years.

Changes to Patient Protection Act

The reconciliation bill also makes changes to a number of provisions in the Patient Protection and Affordable Care Act, including:

- The excise tax on "Cadillac" health plans;
- Annual fees on prescription drug manufacturers and importers, medical device manufacturers, and health insurance providers;
- The individual mandate and employer responsibility fee;
- Limits on flexible spending account contributions;
- The refundable health care premium tax credit; and
- The repeal of the deduction for Medicare Part D retiree drug subsidies.
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