Tax Increase Prevention and Reconciliation Act of 2005
Public Law 109-222
H.R. 4297: Signed
into law by the President on May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 contains $90
billion in tax cuts and $20 billion in revenue raisers. It is also expected to
keep 15 million taxpayers from being hit by the alternative minimum tax. However,
Congress failed to reach an agreement on extending the state and local sales
tax deduction, the teacher classroom expense deduction, certain employment tax
credits, 15-year straight-line depreciation for leasehold and restaurant
improvements, and other temporary incentives set to expire. It is expected that
some of these could be tacked onto the pending pension reform bill. The
following is our coverage
of the Tax Increase Prevention and
Reconciliation Act of 2005, which will be included in TheTaxBook™, 2006 tax year edition.
Capital Gain
and Qualified Dividends Maximum Tax Rates
Current law, TheTaxBook™ 2005 Edition, page 6-6: Long term capital gains and qualified
dividends are subject to a 15% maximum tax for taxpayers whose regular tax rate
is 25% or higher. The maximum rate is 5% for taxpayers in the 10% or 15% tax
brackets. Beginning in 2008, the 5% maximum rate is reduced to 0% for taxpayers
in the 10% or 15% tax brackets. [IRC §1(h)]
These
rules were scheduled to expire for tax years beginning in 2009, and revert back
to the rules in effect prior to 5/6/2003. Prior to tax years ending on or after
5/6/2003, the maximum long term capital gain rate was 20% for taxpayers whose
regular tax rate is 25% or higher, and 10% for taxpayers in the 10% or 15% tax
brackets. The 0% rate for taxpayers in the 10% and 15% tax brackets was not
scheduled to begin in 2008. Qualified dividends were subject to ordinary tax
rates.
New law, Section 102 of the Tax Increase Prevention and Reconciliation
Act of 2005: The 15%, 5% and 0% tax rates for long term capital gains and
qualified dividends is extended 2 years through December 31, 2010. The rates do
not revert to pre-5/6/2003 levels until the 2011 tax year.
Alternative
Minimum Tax Relief
Current law, TheTaxBook™ 2005 Edition, page 1-4: For
2005, the AMT Exemption amounts are:
- $58,000 for MFJ
- $40,250 for Single and HOH
- $29,000 for MFS
- $5,850 plus earned income for the Kiddie tax
exemption.
The
2006 AMT exemption amounts (other than the Kiddie tax exemption amounts) were
scheduled to drop back down to the 2000 tax year exemption amounts.
New law, IRC §55(d)(1): The new law increases
these amounts for 2006 as follows:
- $62,550 for MFJ
- $42,500 for Single and HOH
- $31,275 for MFS
The
2006 Kiddie tax exemption amount was not changed by the new law. The inflation
adjusted amount remains at $6,050 plus earned income.
Unless
a new law increases the AMT exemption amounts, the 2007 amounts will be:
- $45,000 for MFJ
- $33,750 for Single and HOH
- $22,500 for MFS
Current law, TheTaxBook™ 2005 edition, page 1-10: All
nonrefundable personal credits are allowed against regular tax and AMT [IRC §26(a)(2)]. Nonrefundable personal
credits include:
- Child and dependent care expense credit (TheTaxBook™, page 11-3),
- Credit for elderly or the disabled (TheTaxBook™, page 11-7),
- Adoption expense credit (TheTaxBook™, page 11-7),
- Child tax credit (TheTaxBook™, page 11-3),
- Mortgage interest credit (TheTaxBook™, page 11-8),
- Education credits (TheTaxBook™, page 12-2),
- Retirement savings contribution credit (TheTaxBook™, page 11-6),
- Nonbusiness energy property credit (TheTaxBook™, page 1-17), and
- Residential energy efficient property credit (TheTaxBook™, page 1-17).
Except
for the adoption expense credit, the child tax credit, and the retirement
savings contribution credit, the rule that allows nonrefundable personal
credits to be taken against AMT was scheduled to expire for tax year 2006. (The
rule allowing the adoption expense credit, child tax credit, and retirement
savings contribution credit against AMT is permanent.)
New law, IRC §26(a)(2): All nonrefundable
personal credits are allowed against regular tax and AMT for the 2006 tax year.
Except for the adoption expense credit, the child tax credit, and the
retirement savings contribution credit, nonrefundable personal credits will not
be allowed against AMT for the 2007 tax year.
Section 179
Expense
Current law, TheTaxBook™ 2005 Edition, page 9-15: The
maximum annual Section 179 deduction is $105,000 for 2005 and $108,000 for
2006. If the total cost of Section 179 property placed in service in 2005
exceeds $420,000, the available deduction is reduced dollar for dollar by the
excess. For 2006, the investment limit increases to $430,000.
The maximum
Section 179 deduction was scheduled to drop to $25,000 for tax year 2008 and
beyond with no inflation adjustment provision. The investment limit was
scheduled to drop to $200,000 for tax year 2008 with no inflation adjustment
provision.
If a
return is filed without claiming a Section 179 deduction, an election to claim
the deduction can be made on an amended return. This provision was scheduled to
expire for tax year 2008 and beyond, where the election must be made on a
timely-filed return, including extensions.
Off-the-shelf
computer software is eligible for a Section 179 deduction. This provision was
scheduled to expire for tax year 2008 and beyond.
New law, IRC §179: All of the above rules set to expire in 2008 have been
extended 2 years through December 31, 2009. They are now scheduled to expire
for tax year 2010 and beyond.
Kiddie Tax
Current law, TheTaxBook™ 2005 Edition, page 12-9: Children under age 14 with investment
income of more than $1,600 ($1,700 for 2006) are subject to tax at their parent’s
rate and must file Form 8615. An election is available to report interest
income, dividends, and capital gain distributions of a child under age 14 on
the parent’s return using Form 8814 if the child’s gross income is less than
$8,000 ($8,500 for 2006).
New law, IRC §1(g)(2): Beginning in 2006, the
kiddie tax rules apply to a child under age 18, unless the child files a MFJ
return for the year.
New law, IRC §1(g)(4)(C): Beginning in 2006, taxable income as a
beneficiary of a qualified disability trust is considered earned income for
purposes of the kiddie tax rules, and is thus not subject to tax at the
parent’s rate.
Roth IRA
Conversions
Current law, TheTaxBook™ 2005 Edition, page 13-14: Money in a traditional IRA, SEP-IRA, or
a SIMPLE IRA can be converted to a Roth IRA if, in the year of conversion, modified
AGI is $100,000 or less, and the filing status is not MFS. The conversion is
taxable to the extent money converted does not represent a return of
nondeductible basis. By paying tax on the conversion now, a taxpayer can plan
for future tax free withdrawals from the Roth IRA. Distributions are tax free
under the following:
- Distributions of nondeductible contributions
and conversion amounts are always tax free, regardless of how long they were
inside the Roth IRA.
- Distributions of conversion amounts are not
subject to the 10% early withdrawal penalty if they were held in the Roth IRA
for at least five years, or one of the early withdrawal penalty exceptions
apply.
- Distributions of earnings are tax free if the
participant is over age 59½, the participant is disabled or deceased, or the
participant uses the funds as a qualified first time home buyer. A taxpayer
must also have had a Roth IRA for five years to qualify for the tax free
distribution of earnings rule to apply.
New law, IRC §408A(c)(3): Beginning in 2010, the
$100,000 modified AGI limitation no longer applies. Taxpayers of any income
level qualify for a Roth IRA conversion. Taxpayers filing MFS will also qualify
for a Roth IRA conversion.
New law, IRC §408A(d)(3): For Roth IRA conversions in 2010, any amount
required to be included in gross income due to the conversion can be included
ratably over tax years 2011 and 2012, unless the taxpayer elects to pay the tax
on the conversion in 2010. The amount of tax reported over this two year period
will be accelerated if there is a distribution of any converted amounts prior
to 2012. The amount included in income in the year of the distribution is
increased by the amount distributed, and the amount included in income in 2012
(or 2011 and 2012 in the case of a distribution in 2010) is the lesser of:
1) half of the amount includible in income as a result of the
conversion; and
2) the remaining portion of such amount not already included in
income.
Capital Gains
Treatment for Self-Created Musical Works
Current law, TheTaxBook™ 2005 Edition, page 6-7: Gain on the sale of capital assets held
long term are subject to a maximum tax rate of 15%, with exceptions for
collectibles (28% maximum tax rate) and unrecaptured Section 1250 gain (25%
maximum tax rate). Capital assets that qualify for long term capital gain tax
rates are defined in Section 1221 as any property held by a taxpayer except for
the following:
- Stock in trade or other property included in
inventory or held mainly for sale to customers.
- Accounts or notes receivable for services
performed in the ordinary course of a trade or business or as an employee, or
from the sale of stock in trade or other property held mainly for sale to
customers.
- Depreciable property used in a trade or
business, even if it is fully depreciated.
- Real estate used in a trade or business.
- Copyrights, literary, musical, or artistic
compositions, letters or memoranda, or similar property created by the
taxpayer’s personal efforts.
-
- Certain commodities derivative financial
instruments held by a dealer.
- Certain hedging transactions entered into in
the normal course of a trade or business.
- Supplies regularly used in a trade or
business.
New law, IRC §1221(b)(3): For taxable years beginning after 5/17/2006, a taxpayer can elect to treat the sale or
exchange of a musical composition or copyright in musical works created by the
taxpayer’s personal efforts as a sale of a capital asset, subject to capital
gains treatment. This is true even if the musical composition or copyright in
musical works is otherwise considered inventory held
mainly for sale to customers. This election is scheduled to expire for sales or
exchanges after December 31, 2010.
Amortization of
Expenses Incurred in Creating or Acquiring Music or Music Copyrights
Current law, TheTaxBook™ 2005 Edition, page 9-20: The
income forecast method of depreciation may be used instead of straight-line
depreciation for the following intangible assets:
- Motion picture films or video tapes
- Sound recordings
- Copyrights
- Books
- Patents
Under
the income forecast method, each year’s depreciation is equal to the cost, less
salvage value, of the property, multiplied by a fraction. The numerator is the
current year’s net income from the property, and the denominator is the total
income anticipated from the property through the end of the 10th
taxable year following the taxable year the property is placed in service. [IRC
§167(g)]
New law, IRC §167(g)(8): In lieu of using the income forecast method, a
taxpayer may elect to amortize the cost of creating or acquiring musical
property placed in service during the year that otherwise would be chargeable
to a capital account. Expenses are amortized over a 5-year period beginning
with the month the property was placed in service. Musical property is defined
as any musical composition, including accompanying words, or any copyright with
respect to a musical composition. The amortization election under Section
167(g)(8) does not apply if expenses are treated as qualified creative expenses
under the uniform capitalization rules of Section 263A, or musical property
acquired as a Section 197 intangible asset. This election applies for taxable
years beginning after December 31, 2005 and before January 1, 2011.
Offer in
Compromise (OIC)
Current law, TheTaxBook™ 2005 Edition, page 15-9: An OIC
is an offer made by a taxpayer to settle a tax liability for less than the full
amount owed. The IRS will usually accept an OIC if it is unlikely that the tax
liability can be collected in full and the amount offered reasonably reflects
collection potential. The goal of the OIC program is to achieve collection of
what is potentially collectible at the earliest possible time and at the least
cost to the government.
In
general, a taxpayer can make an OIC if:
- There is doubt as to the existence of the tax
liability, or there is doubt as to the amount of the tax liability that the IRS
claims is owed.
- There is doubt as to the ability of the IRS to
collect the tax owed, such as when the taxpayer’s assets and income are less than
the full amount of the assessed liability.
- The OIC will promote effective tax
administration. For example, the taxpayer owes the tax and can pay the tax, but
due to a long-term illness, the taxpayer’s financial resources could be
exhausted leaving the taxpayer unable to meet basic living expenses.
New law, IRC §7122: The new law contains the following requirements for
submission of an OIC:
- The taxpayer must pay 20% of the OIC at the
time a lump-sum OIC application is submitted to the IRS for approval. The term
“lump-sum OIC” means any offer of payments made in five or fewer installments.
- The taxpayer must pay the first proposed
installment at the time a periodic payment OIC application is submitted to the
IRS for approval.
- The taxpayer must continue to make the
proposed installments of a periodic payment OIC during the time period the OIC
is being evaluated by the IRS for approval. Any failure to make an installment
during this period may be considered a withdrawal of the OIC.
- The application of any payment made under the
above rules with respect to the tax liability may be specified by the taxpayer.
- The tax liability which is the subject of the
OIC is reduced by any user fee imposed with respect to the OIC.
- The IRS may issue regulations waiving the
required payment rules above in a manner consistent with the practices
established under Section 7122(d)(3).
- Any OIC which does not meet these new
requirements may be returned to the taxpayer as unprocessable.
- Any OIC submitted will be deemed to be
accepted by the IRS if the OIC is not rejected by the IRS within 24 months
after the date the OIC was submitted.
These
new rules are effective for OICs submitted on and after July 16, 2006.
Domestic
Production Activities Deduction
Current law, TheTaxBook™ 2005 Edition, page 8-18: The
Section 199 deduction is 3% of the lesser of:
- The qualified production activities income
(QPAI) of the taxpayer for the year, or
- The taxable income for the taxable year
determined without regard to Section 199. In the case of an individual, taxable
income means AGI without regard to Section 199.
The
deduction is further limited to 50% of the W-2 wages paid by the taxpayer
during the year. The deduction is available for businesses engaged in
manufacturing, film production, electricity production, natural gas production,
potable water production, construction contractors (including home construction
contractors), engineering services, and architectural services.
If the
business is a pass-thru entity, such as a partnership or an S corporation, the
deduction is figured at the partner or shareholder level.
New law, IRC §199: For taxable years beginning after 5/17/2006, the 50% of
W-2 wage limitation applies to W-2 wages paid by the taxpayer that are properly
allocable to domestic production gross receipts. If the business is a
partnership or an S corporation, each partner or shareholder is treated as paying
W-2 wages for the taxable year in an amount equal to such person’s allocable
share of the W-2 wages of the partnership or S corporation that are allocable
to domestic production gross receipts.
Foreign Earned
Income Exclusion and Housing Exclusion
Current law, TheTaxBook™ 2005 Edition, page 14-9: A
taxpayer may be able to exclude from taxation up to $80,000 of foreign earned
income. A taxpayer may also be able to either deduct a portion of housing
expenses from income or treat a limited amount of income used for housing
expenses as not taxable by the United States [IRC §911]. To qualify for either the exclusion or deduction, the
taxpayer must have a tax home in a foreign country and earned income from
personal services performed in the foreign country. The exclusion or deduction
is reported on Form 2555, Foreign Earned
Income.
The
$80,000 is adjusted for inflation beginning in 2008 by using the cost-of-living
adjustment determined under Section 1(f)(3) for the calendar year in which the
taxable year begins, determined by substituting “2006” for “1992” in Section
1(f)(3)(B).
New law, IRC §911: The new law includes the following reforms:
- The $80,000 is adjusted for inflation
beginning in 2006 and the cost-of-living adjustment under Section 1(f)(3) is determined by substituting “2004” for “1992” in
Section 1(f)(3)(B). Thus, the $80,000 is adjusted to $82,400 for 2006.
- The employer-provided housing exclusion is
tied to the foreign earned income exclusion cap. The base housing amount used
in calculating the foreign housing cost exclusion in a taxable year is 16% of
the amount (computed on a daily basis) of the foreign earned income exclusion
limitation (instead of the present law 16% of the grade GS-14, step 1 amount),
multiplied by the number of days of foreign residence or presence in that year.
- An objective standard is applied in
determining the amount of reasonable housing expenses. The amount of the
exclusion is limited to 30% of the maximum amount of a taxpayer’s foreign
earned income exclusion. Thus, the maximum amount of the foreign housing cost
exclusion in 2006 is $11,536 [($82,400 X 30%) minus ($82,400 X 16%)].
- A stacking rule is applied to ensure that
citizens living and working abroad are subject to the same
These
new rules are effective for taxable years beginning after December 31, 2005.
Controlled
Corporation Distribution of Stock or Securities
Current law, TheTaxBook™ 2005 Edition, page 18-17:
Distributions of stock or securities of a controlled corporation under a
corporate reorganization plan may qualify for tax free exchange treatment
provided certain requirements are met [IRC §355].
Distributions generally fall into three categories: (1) a spin-off, (2) a
split-off, or (3) a split-up. Under a spin-off, a corporation can transfer
assets to another corporation that it controls, and then distribute the
controlled corporation’s stock to its shareholders. Under a split-off, a
corporation can transfer assets to another corporation that it controls, and
then the shareholders surrender some of their stock in the distributing
corporation for stock in the controlled corporation. Under a split-up, a
corporation can transfer all of its assets to two or more controlled
corporations. After distributing stock in the controlled corporations to its
shareholders, the distributing corporation dissolves.
In
general, the distribution of stock or securities of a controlled corporation
may qualify as a tax free exchange if:
- The corporation that transfers its assets to
another corporation is in control of the corporation that receives the assets
prior to the distribution.
- The transaction is not used primarily as a way
to distribute E&P.
- The assets transferred make up an active trade
or business.
- The transaction is not used primarily as a way
to avoid federal income tax.
Section
355(b) contains details on whether a corporation may be treated as engaged in
the active conduct of a trade or business.
New law, IRC §355(b): For distributions after 5/17/2006 and before
December 31, 2010, the new law modifies the definition of an active trade or
business. The new definition applies the active trade or business test on an
affiliated group basis, which apply the same set of standards regardless of
whether a business is owned by a holding company or owned directly. The law is
intended to help corporations avoid costly and inefficient internal
restructurings prior to engaging in certain corporate distributions to their
shareholders.
New law, IRC §355(g): For distributions after 5/17/2006, the new law also
adds a limitation that denies tax-free treatment to certain “cash rich”
spin-offs where either the distribution corporation or the controlled
corporation is a “disqualified investment corporation,” defined as having
investment assets that are two-thirds or more (75% or more under a first-year
transition rule) of the value of the corporation’s total assets.
Imputed
Interest on Below-Market Loans
Current law, TheTaxBook™ 2005 Edition, page 3-18 and
21-19: If interest is less than the applicable federal rate, the foregone
interest may be taxable interest income to the lender. Imputed interest rules
prevent taxpayers from using loans to shift income to taxpayers in lower brackets
or to shift income from ordinary income to capital gains by raising a purchase
price and charging less interest. [IRC §7872]
Imputed
interest rules do not apply if the total outstanding between the parties is
$10,000 or less in the case of:
- Loans that are compensation related loans
between an employer and an employee, or between an independent contractor and a
person for whom the contractor provides services.
- Loans between a corporation and its
shareholder.
If the
borrower and lender are both individuals and the outstanding amount of all
loans between them is $100,000 or less, the imputed interest rule will not
apply if the borrower’s investment income is $1,000 or less. If the borrower’s
investment income is more than $1,000, the interest taxable to the lender is
limited to the borrower’s net investment income.
New law, IRC §7872(h): A new exception to the imputed interest rules
applies to a loan to a Qualified Continuing Care Facility (other than nursing
homes) if the loan was made pursuant to a continuing care contract and the
lender (or lender’s spouse) attains age 62 before the close of the year.
A
continuing care contract is defined as a written contract between an individual
and a qualified continuing care facility under which:
- The individual (or spouse) may use the
qualified continuing care facility for life,
- The individual (or spouse) is provided housing
appropriate for his or her health in an independent living unit (with
additional facilities outside the living unit for meals and other personal care),
and (2) in an assisted living facility or nursing facility, as available in the
continuing care facility, and
- The individual (or spouse) is provided
assisted living or nursing care as the health of such person requires and is
available in the continuing care facility.
A
qualified continuing care facility is a facility designed to provide services
under continuing care contracts, which include an independent living unit, plus
an assisted living or nursing facility, or both. Substantially all of the
independent living unit residents must be covered by continuing care contracts.
A qualified continuing care facility does not include a facility which is of a
type traditionally considered to be a nursing home.
This
exception to the imputed interest rules applies for calendar years 2006 through
2010, with respect to loans made before, on, or after such calendar years.
Estimated Tax
for Corporations
Current law, TheTaxBook™ 2005 Edition, page 18-3: Corporations
with $500 or more in tax must make estimated tax installments by the 15th
day of the 4th, 6th, 9th, and 12th
months of the tax year (April 15, June 15, September 15, and December 15 for a
calendar year corporation). Under various methods of calculating installments,
the tax due through estimated tax payments is either based on 100% of the tax
that the corporation will show on the current year, or 100% of the tax shown on
the corporation’s return for the previous year.
New law, Section 401 of the Tax Increase Prevention and Reconciliation
Act of 2005: For all corporations, 20.5% of the required estimated tax
installment otherwise due in September of 2010 is not due until October 1,
2010, and 27.5% of the required estimated tax installment otherwise due in
September of 2011 is not due until October 1, 2011.
For
corporations with at least $1 billion in assets as of the end of the preceding
year:
- The required estimated tax installment
otherwise due in July, August, or September of 2006 shall be 105% of such
amount. The next required installment shall be appropriately reduced to reflect
the increase of the previous installment.
- The required estimated tax installment
otherwise due in July, August, or September of 2012 shall be 106.25% of such
amount. The next required installment shall be appropriately reduced to reflect
the increase of the previous installment.
- The required estimated tax installment
otherwise due in July, August, or September of 2013 shall be 100.75% of such
amount. The next required installment shall be appropriately reduced to reflect
the increase of the previous installment.
Author’s comment: These are timing issues and are
revenue-neutral. Congress will sometimes change the timing of tax collection
for budgeting purposes.
Tax-Exempt Bond
Interest Reporting
Current law, TheTaxBook™ 2005 Edition, page 6-2: The
payer of interest of $10 or more must report the interest payment to the
recipient and the IRS on a Form 1099-INT [IRC §6049(a)]. One exception to this
rule is the payment of interest on tax exempt municipal bonds.
New law, IRC §6049(b)(2): Effective for interest paid after December 31,
2005, the payment of tax exempt municipal bond interest of $10 or more must be
reported to the recipient and the IRS on a 1099.
Other
Provisions and Modifications
Withholding on Certain Payments
Made by Governmental Entities, IRC §3402(t): Beginning with payments
made in 2011, a 3% withholding requirement is imposed on payments for property
and services made by the Federal government and by all State and local
governments and their instrumentalities. This rule includes payments made in
connection with a government voucher or certificate program, such as payments
made under certain Department of Agriculture programs. Local governments with
less than $100 million of annual expenditures are not subject to these
withholding rules. Certain payments are excluded from the withholding rules
including payments related to certain public benefits programs such as food stamps
or welfare benefits.
Veteran’s Mortgage Bonds, IRC §143(l): Certain states have qualified veteran’s mortgage
bond programs that allow these states to finance affordable mortgages for
veterans. Under current law, veterans are eligible for these mortgages only if
they served prior to 1977 and apply for these mortgages within a 30-year
eligibility period after they leave active service. Under the new law, in the
case of the states of
Controlled Foreign Corporations, IRC §953 and §954: Foreign subsidiaries of
The new
law also adds a provision that provides a “CFC look-through” rule exception for
cross-border payments of dividends, interest, rents, and royalties that are
funded with active income that has not been repatriated. This “CFC
look-through” rule will be effective for taxable years beginning after December
31, 2005 and before January 1, 2009. [IRC §954(c)(6)]
Application of FIRPTA to
Regulated Investment Companies, IRC §897(h)(4):
The new law modifies the scope of the application of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) regime
by targeting those qualified investment entities with significant interest in
United States real property and modifies the application of FIRPTA for
investors that own not more than 5% of certain qualified investment entities.
This rule is effective as if it were included in the provisions of Section 411
of the American Jobs Creation Act of 2004 to which it relates.
Treatment of Distributions
Attributable to FIRPTA Gains, IRC §897(h)(1):
The new law modifies the ability of a foreign investor to avoid the FIRPTA
regime by investing in a tiered qualified investment entity. This rule
generally takes effect for taxable years of qualified investment entities
beginning after December 31, 2005 with some exceptions for the withholding
rules.
Prevention of Avoidance of Tax
on Investments of Foreign Persons in United States Real Property Through Wash
Sale Transactions, IRC §897(h)(5): The new law imposes a
FIRPTA obligation on foreign investors that engage in sale and repurchase
transactions (wash sale) in order to avoid capital gain distributions that
would otherwise subject the foreign investor to FIRPTA withholding. These rules
generally take effect for taxable years beginning after December 31, 2005.
Environmental Cleanup Funds, IRC §468B(g): Under current law, income earned by certain environmental cleanup funds is taxable to the company that contributed to the fund. This is true even though the taxpayer has permanently surrendered all control and dominion over the money in the fund.
Effective for accounts and funds established after 5/17/2006, environmental cleanup settlement funds are treated as governmentally owned and not subject to tax if certain standards and requirements are met. Congress hopes this provision will encourage more companies to establish settlement funds devoted to environmental cleanup. This exemption from tax is scheduled to expire for accounts and funds established after December 31, 2010.
Vessel Tonnage Limit,
IRC §1355(a)(4):
The tonnage tax is an alternative tax regime for
Qualified Small Issue Bonds, IRC §144(a): Qualified small issue bonds are tax-exempt state and
local bonds used to finance private business manufacturing facilities or the
acquisition of land and equipment by certain farmers. The bonds are subject to
limits on the amount of financing that may be provided. The new law accelerates
the application of the increased $20 million capital expenditure limitation
from bonds issued after September 20, 2009 to bonds issued after December 31,
2006.
Application of Earnings
Stripping Rules to Partners Which are Corporations, IRC §163(j)(8): Corporations are financed either through equity or
debt. When a corporation distributes dividends, the distributions are not
deductible. When a corporation repays debt, the portion of the repayment that
represents interest is deductible. The incentive is to structure corporate
financing where shareholders contribute only a nominal amount of equity, and
then use debt instruments for the rest of the financing. This allows the
corporation to claim an interest deduction for the portion of the distribution
that otherwise would be considered a nondeductible dividend distribution.
The tax
code has several ways to limit a corporation’s ability to reclassify dividends
as interest. One limitation is found in Section 163(j) which denies an interest
deduction for interest paid to a related party if the related party is not
subject to tax on the interest received. Any disallowed interest is carried
forward to the next taxable year. The limitation can also apply when
interest is paid to an unrelated party where a related party guarantees the
debt. A corporation is subject to these rules if it
has the following two characteristics:
- The corporation’s interest expense exceeds 50%
of the corporation’s adjusted taxable income, plus any disallowed interest
expense carried forward from prior years, and
- The corporation’s debt to equity ratio exceeds
1.5 to 1.
Special rules apply when interest is paid to a pass-thru entity, such as a partnership, as to whether the pass-thru entity is treated as a related party, and whether interest paid to the pass-thru entity is treated as subject to tax.
The new law codifies proposed Treasury regulations which state that when a corporation owns an interest in a partnership, the corporation's share of partnership liabilities is treated as liabilities of the corporation for purposes of applying the interest limits of Section 163(j). The corporation's distributive share of interest income from the partnership and interest expense from the partnership is treated as interest income or interest expense of the corporation. The new law also gives the IRS authority to reallocate shares of partnership debt, or distributive shares of the partnership's interest income or interest expense, as may be appropriate to carry out the purposes of Section 163(j). For example, it is not intended that the application of Section 163(j) to corporations with direct or indirect interests in partnerships be circumvented through the use of allocations of partnership interest income or expense (or partnership liabilities) to or away from partners.
The new rules under Section 163(j)(8)
apply to taxable years beginning on or after 5/17/2006.
Amortization
of Geological and Geophysical Expenditures, IRC §167(h): For
amounts paid or incurred after 5/17/2006, the new law replaces 2-year
amortization with 5-year amortization for certain expenditures made by major
integrated oil companies.
Loan
and Redemption Requirements on Pooled Financing Requirements, IRC
§148(f) and §149(f): For bonds issued after
5/17/2006, the new law imposes the following new requirements on pooled
financing bonds as a condition of tax-exemption.
1) The issuer must reasonably expect that at
least 30% of the net proceeds of the pooled bonds will be lent to borrowers one
year after the date of issue.
2) The new law imposes a 30% written loan
requirement to restrict the issuance of pooled bonds where potential borrowers
have not been identified. This rule does not apply to bonds issued by States
(or an integral part of a State) to provide loans to subordinate governmental
units or State entities created to provide financing for water-infrastructure
projects through the
3) The new law requires the redemption of
outstanding bonds with proceeds that are not loaned to borrowers within the
expected loan origination periods.
4) The new law eliminates the rule allowing an
issuer of pooled financing bonds to disregard the pooled bonds for purposes of
determining whether the issuer qualified for the small issuer exception rebated.
Repeal
of FSC/ETI Binding Contract Relief, Section 513 of the Tax
Increase Prevention and Reconciliation Act of 2005: For taxable years
beginning after 5/17/2006, the rules grandfathering certain binding contracts
under the foreign sales corporation/extraterritorial
income (FSC/ETI) regimes is repealed.
Tax Involvement of Accommodation
Parties in Tax Shelter Transactions, IRC §4965: For tax years ending after
5/17/2006, certain exempt entities are subject to penalties for participating
in prohibited tax shelter transactions as accommodation parties. A prohibited
tax shelter transaction is generally any transaction that the Secretary of the
Treasury determines is a listed transaction or a reportable transaction as
defined under current law.
Copyright 2006, Tax Materials, Inc.™
1-866-919-5277
www.thetaxbook.com