Tax Law Alert: Tax Increase Prevention and Reconciliation Act
President Bush yesterday signed into law the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) that Congress passed last week. TIPRA extends certain business and individual tax incentives that were set to expire and also contains various revenue raising provisions.
A second "trailer" bill to extend additional expiring tax incentives, including the research and development credit, the state and local sales tax deduction, the college tuition deduction, and the deduction for teachers buying classroom supplies, is expected to follow. In addition, Congressional leaders reportedly are advocating for a number of changes to the rules relating to charitable contributions, including allowing a limited above-the-line deduction for charitable contributions and modifying various rules affecting charitable organizations. A number of other business and individual changes that were included in earlier versions of the TIPRA bill also may resurface in future legislation.
Following is a brief summary of some of the changes made by TIPRA, most of which are effective as of the date of enactment.
- The current capital gain and qualified dividend income tax rates (generally at a maximum 15 percent rate) are extended for two additional years. Under prior law the rates were scheduled to revert to pre-2003 rates for taxable years beginning after 2008. Under TIPRA the current favorable rates are extended through 2010.
- Timing changes are made with regard to certain corporate estimated tax payments. Corporations with assets of $1 billion or more must increase their estimated tax payments due in July, August or September of taxable years 2006, 2012 and 2013 by a specified percentage, and must reduce their succeeding payment for each of those years accordingly. In addition, a portion of the corporate estimated tax payments otherwise due on September 15 of 2010 and 2011 are not due until October 1 of those years.
- The Section 179 election to expense up to $100,000 of the cost of certain depreciable assets placed in service during the year (subject to phase-out if the cost of qualifying property exceeds $400,000) is extended through 2010. Prior to TIPRA, the maximum deductible amount was scheduled to revert to $25,000 (subject to a $200,000 phase-out amount) beginning in 2008.
- TIPRA codifies proposed Treasury regulations that attribute certain partnership items to direct or indirect corporate partners for purposes of the so-called "earnings stripping" rules. The new rules provide that liabilities of a partnership are treated as liabilities incurred by the corporate partner, and that interest paid or accrued to the partnership is treated as paid or accrued to a partner in proportion to the corporate partner’s distributive share of income for the taxable year.
- The rules applicable to tax-free corporate spin-offs are modified. If a person that did not hold 50 percent or more of the voting power or value of stock of the distributing or controlled corporation immediately before a transaction does hold 50 percent or more immediately after the transaction, distributions made during the one-year period after the date of enactment generally will not qualify for tax-free treatment if investment assets represent 75 percent or more of the value of either the distributing or controlled corporation’s total assets. Distributions made on or after the one-year anniversary of the date of enactment generally will not qualify if investment assets represent two-thirds or more of the value of either the distributing or controlled corporation’s total assets. These new rules will not apply to certain grandfathered transactions. The new law also includes revisions to the definition of "active business," which generally are effective for distributions made after the date of enactment and before 2011, subject to limited exceptions.
- The Section 199 domestic manufacturing deduction rules are modified so that only wages allocable to domestic production are includible for purposes of calculating the deduction. In addition, the deduction is limited to 50 percent of such wages paid during the calendar year that ends in the applicable taxable year. These provisions are effective for taxable years beginning after the date of enactment.
- Environmental cleanup settlement funds that are created for the sole purpose of resolving Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) claims are treated as beneficially owned by the United States and are therefore exempt from entity-level taxation. To qualify, a fund must be established after the date of enactment and before 2011 pursuant to a consent decree entered by a judge of a U.S. District Court and must meet certain other conditions.
- TIPRA includes several provisions applicable to tax-exempt bonds. A previously scheduled increase in the capital expenditure limitation from $10 million to $20 million for qualified small issue bonds is accelerated so that the increase now applies to bonds issued after 2006. New conditions are imposed on the tax-exempt treatment of qualifying pooled financing bonds. An existing IRS exception related to the application of tax-exempt bond arbitrage rules to the Texas Permanent University Fund is codified and extended until August 31, 2009.
- Certain tax-exempt entities, including Section 501(c) organizations and pension plans, are subject to new penalties and disclosure obligations in connection with participation in prohibited tax shelter transactions (i.e., listed transactions and reportable transactions). The penalty amount generally is the greater of 100 percent of the entity’s after-tax net income attributable to the transaction or 75 percent of the proceeds received by the entity for the year that are attributable to the transaction. If the entity participates in a prohibited transaction without knowing or having reason to know the transaction is prohibited, or if the transaction becomes prohibited after the entity participates in the transaction, the penalty generally is equal to the foregoing amount multiplied by the highest unrelated business taxable income rate (currently 35 percent). A "manager" of a tax-exempt entity who causes the entity to participate in a prohibited transaction also may be personally subject to a $20,000 penalty.
- Information reporting on Form 1099 is now required by payors of interest on tax-exempt state or local bonds. This provision applies to interest payments made after 2005.
- Payments made after 2010 by federal, state and local governmental entities to persons providing property or services generally are subject to a new three percent withholding tax. The withholding requirement is subject to several exceptions, including an exception for payments made pursuant to certain public benefits programs for which eligibility is determined by a needs or income test.
- A taxpayer who sells or exchanges musical compositions or copyrights in musical works created by the taxpayer may elect to treat the sale or exchange as a capital gain or loss. This rule applies to sales or exchanges occurring in taxable years beginning after the date of enactment, but only if the sale occurs before 2011. In addition, taxpayers may elect to amortize over five years certain costs paid or incurred to create or acquire musical compositions or copyrights. This provision applies to expenses paid or incurred in taxable years beginning after 2005 and before 2011.
- The amortization period for geological and geophysical expenditures by certain major integrated gas and oil companies is extended from two to five years.
- A taxpayer requesting an offer-in-compromise that would be paid in five or fewer installments must make a "good faith" payment at the time of the request equal to 20 percent of the amount of the offer and must continue to make payments under the taxpayer’s proposed payment schedule while the offer is under consideration. The IRS must make a decision with respect to an offer within two years of submission or the offer will be deemed accepted. This provision is effective for offers that are submitted beginning 60 days after the date of enactment.
- Subpart F makes 10-percent U.S. shareholders of a controlled foreign corporation (CFC) subject to current U.S. tax on certain income earned by the CFC, whether or not such income is distributed. TIPRA extends for two years a subpart F exception, previously scheduled to expire in 2007, for certain income derived in the active conduct of a banking, financing or similar business, or in the conduct of an insurance business. In addition, TIPRA creates a limited subpart F exception, effective for taxable years beginning after 2005 and before 2009, for dividends, interest, rents and royalties received by a CFC from a related CFC to the extent attributable to non-subpart F income of the payor.
- TIPRA modifies provisions of the Foreign Investment in Real Property Tax Act (FIRPTA), which generally treats gains and losses from dispositions of U.S. real property by a nonresident alien or foreign corporation as effectively connected with a U.S. trade or business and therefore subject to U.S. tax at rates applicable to U.S. persons. The new provisions revise and expand special rules applicable to U.S. real property interests held by or through a regulated investment company (RIC) or real estate investment trust (REIT).
- Certain foreign earned income and foreign employer-provided housing benefits are excludable by U.S. citizens working abroad. The maximum exclusion amount for compensation, previously $80,000 per year through 2007, is now adjusted for inflation beginning in 2006, for which the maximum exclusion amount is set at $82,400. The excludable amount for housing costs is capped at 30 percent of the maximum exclusion amount for compensation. The regular and AMT tax rates on income in excess of the maximum exclusion amount are the rates that would have applied if the foreign income were not excluded. These provisions apply to taxable years beginning after 2005.
- TIPRA repeals certain relief for pre-existing binding contracts that was allowed in connection with the 2000 repeal of the foreign sales corporation tax rules and the 2004 repeal of the extraterritorial income tax regime. The binding contract relief repeal provision is in response to a recent World Trade Organization ruling and is effective for taxable years beginning after the date of enactment.
- The minimum number of deadweight tons required to qualify for the tonnage tax method, an alternative method of tax computation available to U.S. vessels used in foreign trade, is reduced from 10,000 to 6,000 for taxable years beginning after 2005 and ending before 2011.
Changes Affecting Individuals
- Alternative minimum tax (AMT) relief for individuals is extended for one additional year, at higher exemption amounts than in 2005. For taxable years beginning in 2006 only, the exemption amounts are $62,550 for married individuals filing jointly and for surviving spouses, $42,500 for unmarried individuals other than surviving spouses, and $31,275 for married individuals filing separately. Absent additional legislation, the exemption amounts will be substantially reduced for 2007 and later years.
- The ability to apply nonrefundable personal credits against AMT liability is extended for one additional year, by providing that the AMT offset will be allowed for taxable years beginning in 2006.
- TIPRA broadens the application of the so-called "kiddie tax," which generally taxes a child’s unearned income above a certain amount ($1,700 for 2006) at his or her parent’s rate if the parent’s tax rate is higher. The kiddie tax now will apply to children under age 18, rather than age 14 as provided by prior law. New exceptions apply for children who are married and file joint returns and for distributions from certain qualified disability trusts. These provisions are effective for taxable years beginning after 2005.
- Modified adjusted gross income limitations applicable to a conversion from a traditional IRA to a Roth IRA are eliminated for taxable years beginning after 2009. In addition, unless a taxpayer elects otherwise, the amount includible in gross income as a result of a conversion to a Roth IRA in 2010 generally is not included in that year; instead, one-half of the income is included in 2011 and one-half is included in 2012.
- Modifications are made to the provisions that exempt from the below-market imputed interest rules certain loans to qualified continuing care facilities pursuant to continuing care contracts. The changes include elimination of the dollar cap on the amount of outstanding loans and a reduction in the minimum age of a qualifying lender or lender’s spouse from 65 to 62.
- The eligibility requirements for state veterans’ mortgage loan programs in Alaska, Oregon and Wisconsin are modified. In addition, the volume limitations for those states are changed, and will increase annually until 2010, and then be reduced to zero beginning in 2011.
If you have any questions about this update or need assistance with any federal income tax matter, please contact your Stoel Rives lawyer or any of the following tax lawyers:
IRS Circular 230 notice: Any tax advice contained herein was not intended or written to be used, and cannot be used, by you or any other person (i) in promoting, marketing or recommending any transaction, plan or arrangement or (ii) for the purpose of avoiding penalties that may be imposed under federal tax law.