Important Tax Alert

The United States House of Representatives recently passed a corporate tax relief bill, which the U.S. Senate is likely to pass this weekend and send to the President, who is expected to sign it.  The bill, the American Jobs Creation Act of 2004, includes many provisions that apply to a broad variety of businesses.  Because it is important for CPAs to be aware of these provisions we thought you'd like to have the summary of the bill that was prepared for the AICPA Tax Section members. The effective dates, in particular, could present traps for the unwary.

Lawmakers did not include in the final version of the bill tax shelter language that the AICPA has fought long and hard against that would have codified the economic substance doctrine.  The bill also does not raise the standard for tax return positions to "more likely than not"  -- an idea that we oppose.  We strongly believe that both provisions would have long-term, negative effects on both taxpayers and the government.

Tax Section E-ALERT

October 8, 2004

American Jobs Creation Act of 2004

Despite its title, the moving force behind the American Jobs Creation Act of 2004 is repealing the extraterritorial income exclusion (known as ETI), which ran afoul of world trade agreements and subjected U.S. exporters to trade sanctions by the European Union.  A wide variety of tax incentives and revenue offsets are included in the bill which was passed by the House on October 7, and which the Senate is expected to pass before adjourning this weekend.

The following highlights are far from comprehensive.  In addition to its centerpiece - tax relief for manufacturers - the bill contains numerous provisions that apply to specialized industries and taxpayers, including agriculture, RICs, REITs, tobacco producers, tax-motivated expatriates, fuel tax evaders, NASCAR tracks, and Alaskan Native subsistence whalers, to name only a few.

We strongly recommend that you check the legislative text for planning opportunities and potential pitfalls that may affect your clients and your practice.  Also, check the effective dates of each provision carefully.  Although most incentive provisions are effective beginning after December 31, 2004, and most revenue offsets are effective as of the date of enactment, a number of provisions are retroactive, effective for 2004, or do not institute changes for several years.

The AICPA Tax Section staff will be reviewing this bill in depth once it is passed and will make any resulting analysis or practice guidance available to Tax Section members.

Good News:  Economic Substance, " More Likely Than Not" Not in Bill

The AICPA is pleased to announce that provisions calling for the codification of the economic substance doctrine were eliminated in the final bill.  Over the last several years, we have worked to educate Congress about how codification and its companion increased "more likely than not" standard for return positions would negatively affect taxpayers and tax practitioners. [Read the AICPA's most recent comments.] Instead of being a useful means of identifying and preventing abusive tax shelters, the "more likely than not" standard would have increased the filing burden and cost for almost every tax return, flooding the IRS with additional paper rather than improving tax administration.

Fixing ETI - Manufacturing Deduction 'Replacement'

The ETI regime is repealed for transactions after December 31, 2004.  Transition relief allows (1) the ETI exclusion to remain in effect for transactions in the ordinary course of business that are pursuant to a binding contract in effect by September 17, 2003, and at all times thereafter; and (2) gives taxpayers 80-percent of their otherwise-applicable ETI benefits in 2005 and 60-percent in 2006.

In place of ETI, the bill would create a 9-percent deduction on all "qualified production activities income" from "domestic production gross receipts" and may be available to C and S corporations, partnerships, sole proprietorships, cooperatives, estates and trusts.  Taxpayers not subject to ETI will be eligible for the new manufacturing deduction.  The deduction is allowable for computing AMT income.

"Domestic production gross receipts" are derived from "any sale, exchange or other disposition, or any lease, rental or license, of qualifying production property that was manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the United States" - including film, electricity, natural gas, or potable water produced in the United States; and construction activities and engineering or architectural services performed in the United States for construction projects located in the United States.  Slightly different rules apply to passthroughs and cooperatives.

This bill also contains a assortment of foreign tax related items, including provisions refining the foreign tax credit (FTC), repealing the 90-percent limitation on using FTCs against AMT, and temporarily lowering tax rates on repatriating foreign earnings.  Again we urge you to become familiar with the scope of the legislation.

Business Tax Incentives, Tax 'Simplifications' and Sundry Tax Relief

179 Extension

The increased section 179 amount of $100,000 is extended for property placed in service before 2008, and would include off-the-shelf computer software as qualifying property.  Also, taxpayers may revoke expensing elections on amended returns without the consent of the Commissioner for tax years beginning before 2008.

Deducting State and Local Sales Taxes in Lieu of Deducting State Income Taxes

For 2004 and 2005, instead of deducting state and local income taxes, taxpayers would be able to choose to deduct state and local sales taxes by either (1) accumulating receipts; or (2) using IRS sales tax tables and adding actual sales taxes paid for major items, such as vehicles.

Reduced Recovery Periods for Leasehold/Restaurant Improvements

Reduced 15-year recovery periods (down from 39 years) would apply to improvements to qualified leasehold or restaurant property put into service between the date of enactment and January 1, 2006.

S Corporation Simplifications

S corporation simplifications include:  (1) All members of a family (up to six generations) are treated as one shareholder; (2) the number of shareholders permitted increases from 75 to 100; (3) IRAs may be shareholders of bank S corporations; (4) unexercised powers of appointment will be disregarded for determining the potential current beneficiaries of ESBTs; and the IRS may waive inadvertent invalid qualified subchapter S subsidiary elections and terminations.  Also, suspended losses or deductions with respect to stock transferred incident to divorce are treated as incurred by the corporation with respect to the transferee in the subsequent tax year.  A beneficiary of a qualified subchapter S trust (QSST) may deduct suspended losses under the at-risk rules and the passive loss rules when the trust disposes of the S corp stock.

S Corporations and ESOPs

ESOPs maintained by S corporations would not be treated as violating qualification requirements or as engaging in prohibited transaction merely because, under plan provisions, a distribution of qualifying employer securities held by the ESOP is used to make payments on a loan used to acquire the securities, whether or not allocated to participants, with some limitations. Effective for distributions made after December 31, 1997.

Exclusion of Incentive Stock Options and Employee Stock Purchase Plan Options from Wages

FICA and FUTA taxes would not apply on exercising a statutory stock option.  Federal income tax withholding would not be required on disqualifying dispositions, nor when compensation is recognized in connection with an employee stock purchase plan discount.  Also, remuneration for stock transferred pursuant to exercising an incentive stock option, under an employee stock purchase plan, or any disposition of such stock will not be taken into account for determining Social Security benefits.  Effective for stock acquired pursuant to options exercised after the date of enactment.

Farmer and Fisherman Income Averaging and AMT

Effective for 2004 and 2005, farmers and fisherman may use income averaging and may use their unaveraged income to compute their regular tax liability when computing AMT.

Revenue Offsets

Reduced Depreciation for Luxury SUVs

The limits on depreciating certain luxury sports utility vehicles would be reduced for vehicles placed in service after the date of enactment.

Increased Charitable Reporting Requirements

C corporations must obtain and attach a qualified appraisal for deductions exceeding $5,000.  Effective for contributions made after June 3, 2004.

Deduction Limits for Charitable Contributions of Vehicles

The charitable deductible may not exceed the gross proceeds from vehicle re-sale effective for contributions made after December 31, 2004.  This provision includes penalties for donee organizations who "knowingly furnishing a false or fraudulent acknowledgement."

Significant New Requirements for Nonqualified Deferred Compensation Plans

Deferred compensation plans (including salary reduction plans, 401(k) wrap-arounds, and supplemental executive retirement plans) executed after December 31, 2004, must meet the following requirements or the compensation would be taxed immediately.

• Require the election of a deferral date before the services being compensated occur;
• limit the available types of permitted investment alternatives;
• prohibit assets from being held outside the United States;
• abolish deferrals related to the employer's financial health to stop executives from receiving payouts preceding their company's financial failure; and
• restrict distributions to specific dates or events, such as employee disability, separation from service, or change in the company's ownership or control.

These rules, which contain transitional rules, would affect all deferred plans effective after December 31, 2004, and those undergoing "material modification" after October 3, 2004.

Private Sector Collection of Tax Debts

Effective on the date of enactment, the IRS would be permitted to use private debt collection companies to locate and contact outstanding assessed tax liabilities of any type and to arrange payment by the taxpayers.  The IRS may pay the private agencies up to 25 percent of amounts collected.

Limitation on Transfer and Importation of Built-in Losses

The basis of built-in loss assets acquired from foreign parties in tax-free transactions must be marked to market, thus negating the regular carryover basis rule.  Effective for transactions after the date of enactment.

Affirmation of IRS's Consolidated Return Regulation Authority

This Anti-Rite Aid provision is fully retroactive and applies to all tax years.   It confirms that the IRS is permitted to promulgate rules for consolidated returns that are not consistent with the treatment for companies filing separately.

Reform of tax treatment of certain leasing arrangements - LILO and SILO

Deductions from property leased to a tax-exempt entity are limited to the taxpayer's gross income from the lease for the tax year effective, generally, for leases entered into after March 12, 2004.

Consistent 15-Year Amortization Period for Intangibles

Conforms the amortization period for both organizational and start-up expenditures to 15-year period amortization period applicable to intangibles (section 197)  Effective for expenditures after the date of enactment.

Changes With the Potential to Affect Your Practice

Tax Shelter Exception to Confidentiality

Taxpayer communications with tax practitioners regarding all tax shelters - whether entered into by corporations, individuals, partnerships, exempt organizations, or any other entity - are no longer protected by the Code's confidentiality provision effective for communications made on or after the date of enactment.

"Material Advisor" Disclosure of Reportable Transactions

Each "material advisor" involved with any reportable or listed transaction must timely file an information return or incur a $50,000 or greater penalty which cannot be waived except for rare circumstances for reportable but not listed transactions.  "Material advisor" includes any person who provides material aid, assistance, or advice with respect to insuring any reportable transaction and who derives gross income for such assistance or advice in excess of $250,000 ($50,000 for advice to individuals).  Penalties will apply to transactions for which material aid, assistance or advice is provided after the date of enactment.

Expanded Sanctions for Practitioners before IRS

Censure and monetary penalties have been added as sanctions that may be imposed on practitioners for actions taken after the date of enactment.  Monetary penalties may be imposed separately on both practitioners and their employers in addition to, or in lieu of, any suspension, disbarment, or censure of an individual.

Reminder:  Check for special provisions that will affect your clients.

Get more detailed information about the American Jobs Creation Act of 2004 .