Indeed, the revenue raising portion of the bill is
expected to equal the $145 billion needed to make the bill revenue
neutral.
As we stated, this is a wide-ranging
bill and in the interest of brevity, we will go right into the
analysis of its impact:
Foreign Sales Corporation /
Extraterritorial Income (FSC/ETI)
The European Union (EU) currently has a 12%
penalty sanction on US exports that is growing at the rate of 1% per month
due to the World Trade Organization (WTO) declaring America's FSC/ETI
rules - which qualify US exporters as eligible for income exclusions
for qualifying extraterritorial income - an illegal trade
subsidy. The AJC Act begins repealing the FSC/ETI rules
starting in 2005. Taxpayers will be able to claim 100% of their FSC/ETI
benefits for the current year, but that drops to 80% in 2005, 60% in 2006
and is completely repealed thereafter. The full exclusion remains in
effect for companies that had entered into binding contracts in effect on
September 17, 2003.
Manufacturers
In order to replace the FSC/ETI rules, the
AJC Act creates a new deduction for manufacturers that reduces the
corporate income tax rate for domestic manufacturing 3 percentage points
from 35% to 32% in 2005. "Manufacturers" is now a bit of a
misnomer because for the purpose of this new rate, it has been defined in
very broad terms as the following:
- Traditional manufacturing
- Construction
- Engineering
- Energy production
- Computer software
- Films and videotape
- Processing of agricultural products
This new deduction will remain at 3% in
2006, but will rise to 6% in 2007 through 2009 and jump to 9% in 2010 when
it is fully phased in. The deduction however, is limited 50% of the
W-2 wages paid by the taxpayer during the tax year and to the lesser of:
1) qualified production activities income
for the year, or
2) taxable income for the year.
The new deduction is available to
corporations, S corporations, individuals, partnerships, estates, trusts
and cooperatives. The deduction is also available for alternative
minimum tax (AMT) purposes. All taxpayers now identified as
"manufacturers" as noted above will be eligible for the
deduction regardless of whether or not they export.
As of this writing, the IRS has not
regulations describing what business activities qualify as manufacturing
for purposes of this new deduction. This is obviously going to be a
critical issue for many of our clients so we will follow up with a new
article as soon as we have that information. With any luck, we may
have more answers within the next few weeks and in time for year-end
planning.
Small Business Expenses
The AJC Act extends through 2007, the
expensing of qualifying property up to $100,000. The special
treatment is reduced when the cost of qualifying property placed in
service exceeds $400,000. However, in addition to extending the
$100,000 expense option, the AJC Act also indexed the amount for inflation
beginning in 2004. For the current year, the expense amount has been
increased to $102,000 with a $410,000 property cap. The inflation
index will continue to cause adjustments at least through 2007.
SUV Writeoffs
Most vehicles acquired for business use
have a depreciation cap of $2,960 for the first year unless the vehicle's
weight exceeds 6,000 pounds. For the past few years, consumer
advocates have complained about loopholes in the law that allowed certain
taxpayers to acquire heavy SUVs and immediately take a Section 179
deduction up to the full cost of the vehicle. Congress addressed
that concern with this bill and reduced the maximum deduction to $25,000
for heavy vehicles weighing no more than 14,000 pounds. This
provision takes effect for any vehicles acquired after October 22, 2004.
Leasehold Improvements
The AJC Act sets up a new 15 year recovery
period for qualified leasehold improvements made to nonresidential real
property placed in service after October 22nd and before January 1,
2006. The new 15 year recovery period uses straight-line
depreciation and cannot be transferred to subsequent owners. A
qualified leasehold improvement is an improvement to the interior of a
building, made by either the lessor or lessee and placed in service more
than 3 years after the building is placed in service. The 15 year
recovery period replaces the prior 39 year recovery period under prior
law.
Restaurant Property
The Act also establishes a 15 year recovery
period and straight line depreciation for qualified restaurant property
placed in service after October 22nd and before January 1, 2006 and also
makes the property eligible for first-year bonus depreciation. The
restaurant must use more than half of the building's square footage and
any qualified restaurant property is an improvement placed in service more
than 3 years after the building is placed in service.
S Corporations
In a move intended to boost S corporations,
they are now permitted to have as many as 100 shareholders instead of the
previous 75 and all members of a family are now considered one
shareholder. The Act defines family members as "the common
ancestor, lineal descendants of the common ancestor, and the spouses (or
former spouses) of lineal descendants or common ancestor." To
qualify as a common ancestor, the person must be no more than 6
generations removed from the youngest generation of shareholders who
otherwise would be members of the family.
Other AJC Act provisions affecting S
corporations included:
-
Permits traditional and
Roth IRAs to hold shares in a bank that is an S corp;
-
Allows suspended losses or
deductions to be transferred in the case of transfers of stock to a
spouse incident to divorce.
-
Eases the rules for
determining potential current beneficiaries of an electing small
business trust.
-
Relaxes some passive
activity loss rules as they relate to qualified subchapter S trusts.
-
Gives relief from
inadvertent invalid subchapter S subsidiary elections and
terminations.
-
Provides for qualified
subchapter S subsidiaries to file information returns.
-
Permits distributions from
an ESOP maintained by an S corp to repay certain loans.
State And Local Sales Tax
Deduction
Since many states do not have
an income tax, the AJC Act now allows individuals to elect to deduct state
sales taxes instead of state and local income taxes for tax years
beginning after 2003 and before 2006. If you elect to deduct state
and local sales taxes paid, you will either have to keep receipts for your
sales taxes paid or use tabled provided by the Secretary of the Treasury
based on average consumption and other factors.
This particular provision not
only helps residents of states that have no state income tax, but it can
also prove to be beneficial to our clients who make large purchases during
the year and find that their sales tax expenditures exceed their state and
local income tax payments. It is not anticipated that the sales tax
deduction tables will be prepared in time for this year's filing season so
we can only presume that the IRS will allow some type of estimate to be
made for 2004. We will obviously keep you posted on developments in
this area.
Farmers
Farmers fared well under the AJC Act with
several new tax breaks. In addition to a $10 billion buyout of the
tobacco price support program, the processing of agricultural products was
also treated as "manufacturing" and made eligible for the tax
rate deduction discussed above. The Act also gave farmers some AMT
relief since it now allows the special income averaging that farmers and
fishermen are permitted to be used for comparative AMT calculations.
Under prior law, farmers often lost the benefits they were supposed to
gain from income averaging because of AMT. The Act also extends the
time that farmers are allowed to reinvest the proceeds from sales of
livestock due to weather-related conditions into similar livestock from 2
years to 4 years.
Vehicle Donations
The AJC Act now limits the deduction for
automobiles donated to charity depending upon how the charity uses the
vehicle. In most cases of course, the charity simply sells the
vehicle and it is now required to report the proceeds of that sale to the
donor to be used as the donor's charitable deduction. If the charity
uses the vehicle for its own purposes, it is still required to report the
value of that vehicle to the donor and the IRS. Vehicle donation is
a growing "industry" with many charitable groups and Congress is
allowing the IRS to crack down on the major abuses that are occurring.
Company Aircraft
Officers, directors and owners (10% or
greater) of companies will no longer be allowed to deduct the expenses for
the use of a facility (such as an airplane) in connection with a
nonbusiness activity to the extent that the expenses exceed the amount
treated as compensation or includible income for that individual.
Donation of Intellectual Property
Contributions of patents or other
intellectual property (other than certain copyrights or inventory) to
charitable organizations after June 3, 2004 will be limited to a
charitable deduction of the taxpayer's basis in the contributed property
or its fair market value, whichever is less. The donor is allowed to
take an additional charitable deduction based on a specified percentage of
the income the donee receives with respect to the donated property.
The amount of the additional deduction is calculated on a sliding scale
and can be taken either in the contribution year or the subsequent tax
years.
Non-Disclosure Penalties
The AJC Act increases penalties for
promoters and investors who fail to disclose their participation in
abusive transactions to $10,000 for individuals and $50,000 for
non-individual taxpayers. If the tax shelter is a "listed
transaction," the penalty is increased to $100,000 for individuals
and $200,000 for non-individual taxpayers. In addition to the tough
new penalties, the Act also creates an accuracy-related penalty for
reportable and listed transactions as well as a penalty equal to 50% of
the gross income derived from the abusive transaction.
Tax Shelters
The AJC Act has relaxed the confidentiality
rules for communications between taxpayers and practitioners about
shelters. It also extends the statute of limitations to capture more
abusive transactions and exposes promoters and others doing business with
them to more strict sanctions. "Material advisors" will be
sanctioned for failing to file information returns about reportable
transactions as well as not maintaining lists of investors in abusive
transactions. These tough new provision are all effective as of
October 22, 2004.
Repatriation of Foreign Earnings
Certain cash dividends (with a few
exceptions for non-cash) received by a US corporation from a controlled
foreign corporation are eligible for an 85% dividends received
deduction. Taxpayers must elect whether to take the deduction for
dividends received either during the first tax year before enactment of
the new law or during the last tax year before enactment. The new
law does require taxpayers to identify how they plan to reinvest the
dividends in the United States.
Expatriation
United States citizens who relinquish their
citizenship for tax avoidance purposes (determined by objective rules)
will be treated as citizens for federal tax purposes and taxed on their
worldwide income if they return to the United States for more than 30
days.
International Tax
The AJC Act reduces the number
of foreign tax credit baskets from nine to just two consisting of passive
category income and general category income. The new law also
delineates some financial services income as general category income and
allows taxpayers to make a temporary election about certain creditable
foreign taxes. Congress also approved changes to the interest expense
allocation rules for the foreign tax credit limitation.
Other international and
foreign tax credit changes include:
-
Application of a
re-sourcing rule to U.S. source income when a taxpayer’s foreign tax
credit is reduced because of an overall domestic loss.
-
Application of
look-through treatment under subpart F for sales of partnership
interests.
-
Clarification of certain
deem-paid foreign tax credits.
-
Creation of new exceptions
from the definition of U.S. property for certain shareholders in
controlled foreign corporations.
-
An election for taxpayers
required to translate foreign income taxes at the average exchange
rate to use exchange rates at the time the taxes are paid.
-
Elimination of secondary
withholding tax on dividends paid by some foreign corporations.
-
Similar treatment of
interest paid by foreign partnerships and foreign corporations.
-
Taxpayer-friendly
treatment of certain regulated investment company (RIC) income where
dividends are received by foreign persons and their estates.
-
Repeal of foreign personal
holding company and foreign investment company rules.
-
Modification of temporary
exceptions from subpart F personal holding company income for banking,
finance and similar business activity.
-
Relaxation of the rules
requiring foreign investors receiving REIT distributions to file U.S.
returns.
-
Reduction in the
withholding tax rate on U.S. source dividends paid to a Puerto Rico
corporation.
As you can see, the American Jobs Creation
Act of 2004 was a fairly wide-ranging bill which addressed many issues and
left some loose ends still dangling. Over the next few months, we
will try to close some of those loose ends as new information is released
and as always, please do not hesitate to contact our office if you see
something of concern and need further clarification.
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