Daily Tax Update - June 30, 2010

SUBSTITUTE SMALL BUSINESS TAX INCENTIVES BILL INTRODUCED IN SENATE: Yesterday, Senate Finance Committee Chairman Max Baucus and Small Business and Entrepreneurship Committee Chair Mary Landrieu released a substitute amendment to the House-passed small business bill.

  • The bill includes:
    • 100% Exclusion of Small Business Capital Gains. Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and before January 1, 2011, the exclusion is increased to 75 percent. At the time of sale, however, 28% of the excluded gain will be treated as a tax preference item subject to the alternative minimum tax (AMT). This bill would temporarily increase the amount of the exclusion to 100 percent of the gain from the sale of qualifying small business stock that is acquired after the date of enactment in 2010 and held for more than five years. Additionally, the bill eliminates the AMT preference item attributable for that sale. This provision is estimated to cost $517 million over ten years.
    • General Business Credit Relief For Certain Small Businesses. Under current law, a business’ unused general business credit may generally be carried back to offset taxes paid in the previous year, and the remaining amount may be carried forward for 20 years to offset future tax liabilities. However, under the Alternative Minimum Tax (AMT), taxpayers may generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits may be used to offset AMT liability, such as the credit for small business employee health insurance expense. This bill allows certain small businesses to use all types of general business credits against their AMT. This bill also extends the one year carryback for general business credits to five years for certain small businesses. These provisions apply to general business credits for those sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years. These provisions are estimated to cost $977 million over ten years for the AMT relief and $107 million over ten years for the carryback relief.
    • S Corp Holding Period. Generally, a C corporation converting to an S corporation must hold onto any appreciated assets for 10 years following its conversion or face a business-level tax imposed on the built-in gain at the highest corporate rate of 35 percent. This holding period is reduced where the 7th taxable year in the holding period preceded the taxable year beginning in 2009 or 2010. This bill temporarily shortens the holding period of assets subject to the built-in gains tax to 5 years if the 5th taxable year in the holding period precedes the taxable year beginning in 2011. This provision is estimated to cost $70 million over ten years.
    • Increase of Section 179 Expensing and Expansion to Certain Real Property. Under current law, taxpayers may elect to write-off the costs of certain tangible personal property that is purchased for use in the active conduct of a trade or business in the year of acquisition in lieu of recovering these costs over time through depreciation. For the taxable year beginning in 2010, taxpayers may write-off up to $250,000 of these capital expenditures subject to a phase-out once these capital expenditures exceed $800,000. After 2010, the thresholds revert to $25,000 and $200,000, respectively. This bill would increase the thresholds to $500,000 and $2,000,000 for the taxable years beginning in 2010 and 2011. Within those thresholds, this bill would allow taxpayers to expense up to $250,000 of the cost of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. This provision is estimated to cost $2.2 billion over ten years.
    • Extension of Bonus Depreciation. Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule. Congress temporarily allowed businesses to recover the costs of certain capital expenditures made in 2008 and 2009 more quickly than under ordinary depreciation schedules by permitting those businesses to immediately write-off 50 percent of the cost of depreciable property placed in service in those years. This bill extends the additional, first-year 50 percent depreciation for qualifying property purchased and placed in service in 2010. This provision is estimated to cost $5.5 billion over ten years.
    • Modify 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 penalty would be set at 75 percent of the tax benefit received. Reportable transactions are defined as investments in transactions that the IRS has identified as listed tax shelters or that have characteristics of tax shelters, including large losses or confidentiality agreements. 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. The bill also requires the IRS to provide an annual report to the Senate Finance Committee and to the House Ways and Means Committee giving an account of certain tax-shelter related penalties asserted during the year. This provision is estimated to cost $176 million over ten years.
  • The offsets include:
    • Require Information Reporting for Rental Property Expense Payments. The bill requires persons receiving rental income from real property to file information returns to the IRS and to service providers reporting payments of $600 or more during the year for rental property expenses. In general, there is an exception for individuals renting their principal residences, including active members of the military, from the reporting requirements. This provision is estimated to raise $2.5 billion over ten years.
    • Increase Penalties for Failure to File Information Returns. The bill increases penalties for failure to timely file information returns to the IRS. The first-tier penalty is increased from $15 to $30, and the calendar year maximum is increased from $75,000 to $250,000. The second-tier penalty is increased from $30 to $60, and the calendar year maximum is increased from $150,000 to $500,000. The third-tier penalty is increased from $50 to $100, and the calendar year maximum is increased from $250,000 to $1.5 million. For small filers, the calendar year maximum is increased from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The minimum penalty for each failure due to intentional disregard is increased from $100 to $250. The penalty amounts are adjusted every five years for inflation. Penalties for failure to file information returns to payees are similarly increased. This provision is estimated to raise $421 million over ten years.
    • Allow Participants in Governmental 457 Plans to Treat Elective Deferrals as Roth Contributions. Beginning in 2011, the bill would allow retirement savings plans sponsored by state and local governments (governmental 457(b) plans) to include Roth accounts, which are currently available only in 401(k) and 403(b) plans and will be available in the federal Thrift Savings Plan in 2011. Contributions to Roth accounts are made on an after-tax basis, but distributions of both principal and earnings are generally tax-free. This provision is estimated to raise $506 million over ten years.
    • Allow Rollovers from Elective Deferral Plans to Roth Designated Accounts. The bill would allow 401(k), 403(b), and governmental 457(b) plans to permit participants to roll their pre-tax account balances into a Roth account. The amount of the rollover would be includible in taxable income except to the extent it is the return of after-tax contributions. If the rollover is made in 2010, the participant can elect to pay the tax in 2011 and 2012. Plans would be able to allow these rollovers immediately upon enactment. This provision is estimated to raise $5.1 billion over ten years.
    • Crude Tall Oil Ineligible for Cellulosic Biofuel Producer Credit. In 2008, Congress enacted a $1.01 per gallon tax credit for the production of biofuel from cellulosic feedstocks in order to encourage the development of new production capacity for biofuels that are not derived from food source materials. Some taxpayers are seeking to claim the cellulosic biofuel tax credit for processed fuels that are highly corrosive, such as crude tall oil (another waste by-product of the paper manufacturing process). The bill limits eligibility for the tax credit to fuels that are not highly corrosive (i.e., fuels that could be used in a car engine or in a home heating application). This provision is estimated to raise $1.8 billion over ten years.
  • The substitute does not include a provision in the House-passed bill that would raise $5.3 billion by setting a 10-year minimum term for grantor retained annuity trusts. The substitute would allow rollovers from elective deferral plans to Roth accounts and treat section 457 elective deferrals as Roth contributions. It is unclear when the Senate will act on the bill.
  • Additional information can be accessed here.

WALL STREET REFORM BILL CONTAINS DERIVATIVES PROVISION: The “Wall Street Reform and Consumer Protection Act” conference report contains a provision to address the recharacterization of income as a result of increased exchange-trading of derivatives contracts by clarifying that section 1256 does not apply to certain derivatives contracts transacted on exchanges.

  • As discussed in yesterday’s Daily Tax Update, the controversial bank tax pay-for provision was removed from the conference report. The new pay-fors would raise the FDIC premium ratios from 1.15 to 1.35 and make changes to the Troubled Asset Relief Program (ensuring that no future commitments would be made from that fund).
  • Meanwhile, Republican Senator Scott Brown along with Democratic Senator Maria Cantwell continue to withhold their support for the bill. Today, Brown said that while he does “appreciate the conference committee revisiting the Wall Street reform bill” and removing the bank tax provision, he wanted to review it further. Brown added, “Over the July recess, I will continue to review this important bill. I remain committed to putting in place safeguards to prevent another financial meltdown, ensure that consumers are protected, and that this bill is paid for without new taxes.”
  • The House is expected to pass the conference report later today. As far as timing for Senate consideration of the conference report, Senate Financial Services Chairman Chris Dodd said, “[If] people want a few more days to digest it, we'll come back and the leaders certainly told me that this would be the first priority on the return from the July 4 break.”
  • A summary of the bill can be accessed here
  • For additional information, contact Philip R. West - pwest@steptoe.com.

TAX BILLS INTRODUCED JUNE 29TH:
H.R.5622: To amend the Internal Revenue Code of 1986 to provide for the identification of corporate tax haven countries and increased penalties for tax evasion practices in haven countries that ship United States jobs overseas, and for other purposes.
Sponsor: Rep McNerney, Jerry [CA-11] (introduced 6/29/2010) Cosponsors (2)

H.R.5623: To amend the Internal Revenue Code of 1986 to extend the homebuyer tax credit for the purchase of a principal residence before October 1, 2010, in the case of a written binding contract entered into with respect to such principal residence before May 1, 2010, and for other purposes.
Sponsor: Rep Dahlkemper, Kathleen A. [PA-3] (introduced 6/29/2010) Cosponsors (7)

H.R.5638: To amend the Internal Revenue Code of 1986 to extend the qualifying advanced energy project credit.
Sponsor: Rep Sestak, Joe [PA-7] (introduced 6/29/2010) Cosponsors (None)

H.R.5639: To amend the Internal Revenue Code of 1986 to exclude executive branch officers and employees from nonrecognition rules relating to the sale of property to comply with conflict-of-interest requirements.
Sponsor: Rep Stearns, Cliff [FL-6] (introduced 6/29/2010) Cosponsors (None)

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
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.

STEPTOE & JOHNSON LLP - TAX PRACTICE
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