TAX NEWS - may 2010
Levin announces one-year extenders package offset by foreign tax credit restrictions, carried interest tax hike
The legislation would raise additional revenue through provisions that would modify the tax treatment of certain corporate transactions and ease pension funding requirements for certain cash-strapped companies that offer defined benefit plans.
The package of tax incentives and revenue offsets reflects discussions between Levin and Senate Finance Committee Chairman Max Baucus, D-Mont. The broader bill also includes a number of unpaid-for nontax provisions.
Although the House of Representatives had been expected to vote on the legislation on May 21, that deadline has now slipped to the week of May 24. Sources on and off Capitol Hill attribute the delay to disagreements over nontax provisions related to Medicare physician reimbursements and fee disclosures in retirement plans. It is unclear whether the delay will prevent Congress from completing work on the bill and sending it to President Obama before the Memorial Day recess, which begins May 31.
Business, individual extenders
Notable business provisions that would be extended under the bill include, among others, 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.
The bill also includes a new provision that would permit companies to apply a portion of their unused alternative minimum tax credits toward new investments in qualified property - such as equipment purchases or factory construction - in 2010. In addition to extending a variety of energy-related tax incentives for one year, the bill also would allow manufacturers of energy-efficient appliances such as dishwashers and clothes washers to elect to receive a direct payment in lieu of the section 45M energy-efficient appliance tax credit. The amount of the payment would be 85 percent of the tax credit that would otherwise have been allowed under section 45M.
Among the individual incentives extended under the bill 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.
Foreign tax credit provisions & international 'loophole closers'
To help offset the cost of the extenders, the bill includes provisions intended tighten the foreign tax credit rules and close perceived foreign tax loopholes that the Joint Committee on Taxation (JCT) staff estimates would raise $14.5 billion over 10 years.
Foreign tax credit splitting - In its last two budgets, the Obama administration has claimed that current law allows taxpayers to inappropriately separate creditable foreign taxes from associated income. In response, the administration proposed the adoption of matching rules that would prevent the splitting of foreign taxes. This bill adopts the proposal in the administration's FY 2011 budget package released this February, but with an accelerated (date-of-introduction) effective date.
According to the summary, the bill would suspend the recognition of foreign tax credits until the related foreign income is taken into account for U.S. tax purposes. The summary says the bill targets "abusive techniques" and will not affect timing differences that "result from normal tax accounting differences between foreign and U.S. tax rules."
The provision would be effective for foreign taxes claimed after the date of the bill's introduction and would raise an estimated $6.33 billion over 10 years.
Covered asset acquisitions - The bill also would change the foreign tax credit rules for acquisitions treated as asset acquisitions for U.S. tax purposes but as stock acquisitions for foreign tax purposes. These covered asset acquisitions result in a step-up in U.S. (but not foreign) tax basis of the acquired entity's assets to the fair market value of the stock or interest in the acquired entity. The summary says these transactions allow the depreciation of the assets for U.S. purposes to exceed the depreciation for foreign tax purposes, reducing the U.S. taxable base relative to the foreign taxable base, causing the entity's foreign income taxes to exceed the amount necessary to prevent double taxation of the U.S. taxable base. The excess can then be used to reduce U.S. taxes on unrelated foreign income.
In response, the bill would prevent taxpayers from claiming a "foreign tax credit with respect to foreign income that is never subject to U.S. taxation because of a covered asset acquisition."
The provision would apply to related-party transactions occurring after the date of introduction and unrelated-party transactions occurring after the date of enactment. According to the summary, this provision will raise $4.03 billion over 10 years.
Deemed-paid taxes from lower-tier foreign corporations affirmatively using section 956 - In the case of a U.S. corporation that owns multiple tiers of controlled foreign corporations (CFCs), the bill would limit the amount of foreign tax credits that may be claimed with respect to an income inclusion under section 956 from a lower-tier CFC. The limit would be the amount that would have been allowed if the CFC had paid an actual dividend. Under the "pooling" regime for deemed-paid foreign tax credits, the effect of an actual dividend is to "blend" the pools of the dividend payor and dividend recipient, and thus could significantly reduce the deemed paid taxes otherwise available under present law on an unblended section 956 income inclusion directly from the lower-tier CFC.
The provision would apply to the affirmative use of section 956 after the date of enactment and would raise a little more than $1 billion over 10 years.
Modification of affiliation rules for purposes of rules allocating interest expense - For purposes of computing the foreign tax credit limitation, foreign-source taxable income is determined by allocating and apportioning interest expense of each member of an affiliated group (generally, domestic corporations) as if all members of such group were a single corporation. Existing regulations contain anti-abuse rules that, according to the summary, prevent taxpayers from excluding interest expense from the affiliated group apportionment rules by placing the interest in a foreign subsidiary. The regulations achieve this result by including certain foreign subsidiaries in the U.S. affiliated group.
According to the summary, the bill would "modify the affiliation rules to strengthen the anti-abuse rules."
The provision, which would apply to taxable years beginning after the date of enactment, is estimated to raise $405 million over 10 years.
Separate application of foreign tax credit limitation to items resourced under tax treaties - Similar to the approach of Code section 904(h)(10), which applies to income of a foreign corporation that is U.S. source under internal U.S. law, but is sourced foreign under a treaty source rule, the bill would impose a separate foreign tax credit limitation "basket" on income that is U.S. source under internal U.S. law, is sourced foreign under a treaty source rule, and is earned by a U.S. taxpayer through a branch or a disregarded entity.
The summary indicates that the provision is intended to prevent taxpayers from artificially inflating foreign-source income and using treaties as the basis for claiming "foreign tax credits that have nothing to do with double taxation."
The provision would apply to taxable years beginning after the date of enactment. It is estimated to raise $253 million over 10 years.
Redemptions by foreign subsidiaries - The summary says that foreign-based multinational companies have devised a technique, using section 304, for avoiding U.S. taxation of foreign subsidiary earnings where the foreign subsidiary is owned by a U.S. subsidiary of a foreign parent corporation.
The bill would prevent the technique from causing a foreign subsidiary's earnings to be reduced under section 304. Thus, these earnings would be preserved for potential U.S. taxation in the hands of the U.S. subsidiary (if distributed by the foreign subsidiary), and, ultimately, in the hands of the foreign parent when repatriated to it. This provision would be effective for acquisitions after the date of introduction and would raise $255 million over 10 years.
Source rules on guarantees - In the recently decided case of Container Corp. v. Commissioner, the IRS argued that guarantee fees received by a foreign parent corporation from a U.S. subsidiary should be sourced like interest, but the Tax Court held that they should be sourced like compensation for services (i.e., based on where the services are performed). The government has not yet appealed this decision.
The summary argues that sourcing guarantee fees in a manner similar to services would permit U.S. subsidiaries of foreign corporations to engage in earning-stripping transactions by making deductible payments to foreign affiliates (thereby reducing their U.S. income tax liability) without the imposition of U.S. withholding tax on the payment. Under the bill, fees for guarantees issued after the date of enactment will be sourced like interest and, as a result, if paid by U.S. taxpayers to foreign persons, would generally be subject to U.S. withholding tax. No inference is intended with respect to the treatment of guarantees issued before the date of enactment.
The proposal is estimated to raise $2.03 billion over 10 years.
80/20 rules - Dividends and interest paid by a domestic corporation or noncorporate resident are generally considered U.S.-source income, and are subject to U.S. withholding tax if paid to a foreign person. An exception to these rules applies when at least 80 percent of the gross income of the domestic corporate or individual resident alien payor during a testing period (generally, the prior three years) was active foreign business income. Interest paid by corporation meeting this test (an "80/20 company"), or by an individual meeting this test, is at least 80 percent foreign source. Dividends paid by an 80/20 company are at least 80 percent exempt from U.S. withholding tax.
The summary indicates that the Treasury Department is aware that some companies "have abused the 80/20 company rules." The bill would adopt the Obama administration proposal to repeal the 80/20 rules, but would provide relief for "existing 80/20 companies that meet specific requirements and are not abusing the 80/20 company rules." The provision would be effective for tax years beginning after December 31, 2010, and is estimated to raise $153 million over 10 years.
Technical correction to statute of limitations provision in the HIRE Act - The bill would make a technical correction to the amendment to Internal Revenue Code section 6501(c)(8) in the Hiring Incentives to Restore Employment (HIRE) Act, to clarify the circumstances under which the statute of limitations will be tolled for corporations that fail to provide certain information on cross-border transactions or foreign assets. Under the technical correction, the statute of limitations period will not be tolled if the failure to provide such information is shown to be due to reasonable cause and not willful neglect. The proposal is estimated to not have any revenue effect over 10 years.
Tax treatment of carried interest income
As expected, the bill would alter the taxation of income from carried interests. The summary gives few details, but says that the provision would continue to tax carried interest income at the capital gains rate to the extent the carried interest reflects a return on invested capital. To the extent the carried interest does not reflect a return on invested capital, the provision would require investment fund managers to treat 75 percent of that carried interest as ordinary income with the remaining 25 percent as capital gain - effectively creating a blended rate of approximately 35 percent. From the summary, it appears that the bill does not include any exemptions for specific industries.
According to the summary, the bill would provide transition relief until January 1, 2013, but the summary does not give details of that relief.
The JCT staff is still analyzing the provision and has not yet provided a revenue estimate.
Service professionals and employment taxes
The legislation would tighten rules with respect to service professionals who have avoided employment taxes on earned income by use of passthrough entities. In a typical arrangement, shareholders of an S corporation pay themselves a nominal salary subject to Social Security and Medicare taxes and avoid self-employment taxes on the remaining allocable share of earnings.
The proposal would close this opportunity for:
- S corporations engaged in a professional service business that is principally based on the reputation and skill of three or fewer individuals or
- An S corporation that is a partner in a professional services business.
The proposal also would clarify that individuals who are engaged in professional service business cannot avoid employment taxes by passing their earnings through a limited liability company or a limited partnership. The proposal is estimated to raise $9.6 billion over 10 years.
Corporate tax offsets
Gain recognition in certain spin-off transactions - Under current law, a parent corporation will recognize gain to the extent it receives from a subsidiary, as part of a tax-free spin-off transaction, cash or other property that exceeds the parent's basis in the subsidiary. The same treatment applies if the subsidiary assumes parent debt in excess of the parent's basis. However, the parent will not recognize gain if the subsidiary distributes its own debt securities to the parent before the spin-off.
The bill would treat distributions of debt securities in a tax-free spin-off transaction the same as a distribution of cash or other property - that is, taxable boot. The provision would be effective for exchanges after the date of enactment, but the bill includes a transition rule. This provision, which appears to be the same as one included in a small-business bill that cleared the House in March, would raise $260 million over 10 years.
Dividends received in reorganizations - In certain reorganization transactions, if an exchanging shareholder receives in exchange for its stock of the target corporation both stock and property (boot) that cannot be received without the recognition of gain, the exchanging shareholder is required to recognize gain equal to the lesser of the gain realized in the exchange or the amount of boot received (the "boot-within-gain" limitation).
In its fiscal 2011 budget, the Obama administration proposed scrapping the boot-within-gain limitation because Treasury said there was no significant policy reason to vary the treatment of a distribution that otherwise qualifies as a dividend by reference to whether it is received in the normal course of a corporation's operations or as part of a reorganization exchange.
The bill would repeal the limitation in the case of any reorganization transaction if the exchange has the effect of the distribution of a dividend. The provision would apply to exchanges after the date of enactment and would raise $460 million over 10 years.
Oil Spill Liability Trust Fund
The extenders bill would increase the current 8-cents-per-barrel oil industry tax used to fund the Oil Spill Liability Trust Fund by an as yet unspecified amount. The tax would be imposed on crude oil received at a U.S. refinery and on each barrel of imported petroleum products. Citing concerns about the continued solvency of the $1.5 billion fund if there is a major oil spill, the taxwriters propose to increase the tax. The White House submitted a similar proposal to Congress as part of its May 12 supplemental budget request in response to the oil spill in the Gulf of Mexico. The administration proposed increasing the tax to 9 cents per barrel.
Pension funding relief
The legislation would give companies sponsoring defined benefit pension plans temporary relief from existing statutory pension funding obligations that, in many cases, are exacerbating financial pressures already created by the recession. This funding relief is estimated to raise about $2 billion over 10 years.
Amortization options for single-employer plans - Companies sponsoring single-employer defined benefit plans would elect one of two options to spread out the timing of their pension funding obligations:
- 9-year amortization schedule - Plan sponsors would amortize pension funding shortfalls over nine years, but during the first two years would be required to pay only the interest on the pension funding shortfall.
- 15-year rule - Alternatively, the plan sponsor would amortize the shortfall over 15 years.
In either case, the relief would be available for up to two plan years during the four-plan-year period beginning in 2008, 2009, 2010, or 2011. Under the proposal, the annual funding obligation would be increased if the sponsoring employer makes excessive employee or shareholder payments.
Multiemployer plans - Multiemployer plans would be permitted to elect a 30-year amortization period for certain losses incurred in either or both of the first two plans years ending on or after June 30, 2008. This election would not be available unless the plan is projected not to have a decrease in its funded percentage in 15 years. If the sponsor elects to use the amortization relief, benefit increases would be restricted for a two-year period unless increases were funded with additional contributions and certain funding levels were met. The provision also extends the maximum smoothing period for determining plan asset values from five years to 10 years for the either or both of the first two plan years ending on or after June 30, 2008.
The legislation would permit multiemployer plans in "endangered" or "critical" status to extend the longer recovery periods available under the Worker, Retiree, and Employer Recovery Act of 2008 by up to two years. Plans meeting certain conditions could also elect to use an alternative default contribution schedule.
Plans subject to prior-law funding rules - For single-employer plans not subject to rules under the Pension Protection Act of 2006 (PPA 2006), the plan sponsor may elect to determine its funding contribution without regard to the deficit reduction contribution rules for up to two plan years. The plan may alternatively elect to amortize its funding liability under a 15-year payment schedule for one plan year. Plan sponsors could elect relief for plan years beginning during the threeplan-year period from 2009 to 2011. Certain charity plans can elect to be temporarily covered by the prior-law funding rules.
The legislation also would modify certain amortization extensions provided to multiemployer plans before the PPA 2006. For demonstrating that funding improvements have been met, plans may treat the return on plan assets for plan years that include any of the period from June 30, 2008, to October 31, 2008, as the interest rate used for charges and credits to the plan's funding standard account.
Additional provisions - Other changes for single-employer plans would: (1) provide greater flexibility for using pre-financial crisis funded percentages in applying the accrual restriction rule, essentially allowing plans to use their funded percentage for the last plan year beginning before September 30, 2009; (2) permit the payment of benefits in the form of a Social Security leveling payment for 2010 and 2011; (3) temporarily permit employers to make a contribution to the plan in the amount of plant shutdown benefits in lieu of waiving credit balances; and (4) temporarily permit plans to apply credit balances against minimum required contributions for the period of 2009-2011 if the plan was at least 80 percent funded before the financial crisis.
Qualified airline employees who receive bankruptcy settlement amounts will be able to roll over these proceeds to a traditional IRA, and to recharacterize a prior contribution of a settlement amount to a Roth IRA as a contribution to a traditional IRA.
For multiemployer plans, the legislation provides transition rules for certifications of a plan's funded status. The rules would apply in cases in which a plan's certification is due after the date of enactment and for certain plans whose most recent certification does not take into account an election to take funding relief for a plan year beginning on or after October 1, 2009.
Reporting requirement - The legislation would require single-employer plan sponsors that have aggregate unfunded vested benefits exceeding $75 million to provide additional reporting to the Pension Benefit Guaranty Corporation.