Daily Tax Update - June 17, 2010

NEWEST EXTENDERS SUBSTITUTE CONTAINS CHANGES TO CARRIED INTEREST AND S CORP PROVISIONS: The latest version of the extenders package was introduced yesterday by Senate Finance Chairman Max Baucus. However, even the latest modifications appear to be insufficient to break the impasse in the Senate. Today, Republican Senators Olympia Snowe and Susan Collins said that they would still oppose the newest version. Collins said, "It’s moving in the right direction. It’s not there yet.” Snowe wants the S corporation provision removed from the bill. A Republican substitute was defeated on a 57-41 vote earlier today. The Republican alternative needed 60 votes to pass.

  • The modifications include:
    • Changes to the taxation of carried interest: The bill would prevent investment fund managers from paying taxes entirely at capital gains rates on investment management services income received as carried interest in an investment fund. To the extent that carried interest reflects a return on invested capital, the bill would continue to tax carried interest at capital gain tax rates. However, to the extent that carried interest does not reflect a return on invested capital, this amendment would require investment fund managers to treat 75% of the remaining carried interest as ordinary income beginning on January 1, 2011. If an amount is attributable to the sale of assets held for 5 or more years, however, the amount that will be treated as ordinary income is reduced to 50%. Unlike the prior Senate and House versions, the new Senate amendment does not contain a phase-in period in which a lower percentage (50%) of amounts received from January 1, 2011 through December 31, 2012 would be treated as ordinary income.
    • Changes to employment taxes on earning of certain service professionals: Social Security taxes are imposed on compensation and self-employment income up to the Social Security Wage Base (currently $106,800) and the Medicare tax is imposed on all self-employment and compensation income. Congress is concerned that some service professionals have been avoiding Medicare and Social Security taxes by routing their self-employment income through an S corporation. A provision passed by the House and included in the original Baucus substitute would include S corporation income in self-employment earnings where (1) an S corporation is a partner in a professional service business or (2) an S corporation is engaged in a professional service business that is principally based on the reputation and skill of 3 or fewer individuals. To make the second alternative more administrable and more targeted, this amendment changes the language so that the policy applies only if 80% or more of the professional service income of the corporation is attributable to the services of 3 or fewer owners of the corporation.
    • Addition of the modification to the section 6707A penalty: The bill revises section 6707A of the Internal Revenue Code to make the penalty for failing to disclose a reportable transaction proportionate to the underlying tax savings. The purpose of this change is to prevent small businesses from paying a penalty significantly greater than the benefit they would receive from their investment. The penalty for failure to disclose reportable transactions to the IRS would be set at 75% of the tax benefit received. The minimum penalty under this bill is $10,000 for corporations and $5,000 for individuals, and the maximum penalty is $200,000 for corporations and $100,000 for individuals.
    • Foreign tax loophole closer clarification regarding the source rules for income on guarantees: The House provision would reverse a recent Tax Court decision to provide that guarantee payments made to foreign persons are treated like interest, rather than services, and therefore subject to US withholding tax when paid by a US person to a foreign person. The modification would clarify that the provision only applies to guarantees of indebtedness (rather than to guarantees of obligations). Presumably, the reference to obligations is a reference to performance guarantees as opposed to financial guarantees.
    • Foreign tax loophole closer clarification regarding the provision that would terminate the special rules for interest and dividends received from “80/20 companies”: The House provision would eliminate the withholding and foreign tax credit benefit for 80/20 companies prospectively, subject to a “grandfather” rule that would continue to provide favorable withholding tax treatment to payments made by existing legitimate 80/20 companies. The modification would clarify that for purposes of applying the grandfather provision for periods prior to January 1, 2011, the 80/20 rules then in effect shall apply.
    • Increase Oil Spill Liability Trust Fund solvency: To ensure the continued solvency of the Oil Spill Liability Trust Fund, the bill would increase the per-barrel amount that oil companies are required to pay into the fund to 49 cents.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com or Philip R. West - pwest@steptoe.com.
  • The summary and bill text can be accessed here.

Revenue Ruling 2010-18 provides various prescribed rates for federal income tax purposes including the applicable federal interest rates, the adjusted applicable federal interest rates, the adjusted federal long-term rate, the adjusted federal long-term tax-exempt rate. These rates are determined as prescribed by § 1274. The rates are published monthly for purposes of sections 42, 382, 412, 1288, 1274, 7520, 7872, and various other sections of the Internal Revenue Code.

H.R.5536: To amend the Internal Revenue Code of 1986 to allow individuals to designate that up to 10 percent of their income tax liability be used to reduce the national debt, and to require spending reductions equal to the amounts so designated.
Sponsor: Rep Flake, Jeff [AZ-6] (introduced 6/16/2010) Cosponsors (None)

H.R.5537: To amend the Internal Revenue Code of 1986 to clarify the treatment of emergency service volunteers as independent contractors.
Sponsor: Rep Wu, David [OR-1] (introduced 6/16/2010) Cosponsors (None)

S.3496: A bill to amend the Internal Revenue Code of 1986 to allow individuals to designate that up to 10 percent of their income tax liability be used to reduce the national debt, and to require spending reductions equal to the amounts so designated.
Sponsor: Sen McCain, John [AZ] (introduced 6/16/2010) Cosponsors (None)

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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