Withers Worldwide

The Emergency Economic Stabilization Act ("EESA" or the "Act") contains multiple tax provisions.  Certain provisions are associated with the TARP, the federal government's financial rescue program.  They include three tax provisions: (i) an allowance for ordinary losses on preferred stock in Fannie Mae and Freddie Mac; (ii) a prohibition on certain types of executive compensation; and (iii) an extension of the temporary exclusion from gross income for mortgage debt cancellation income.  More details can be found here.  The EESA also contains a series of tax raisers, tax extenders, energy incentives, and an individual Alternative Minimum Tax (AMT) patch for 2008, described  below.

A.       Offshore Deferred Compensation

The Act creates new Code section 457A which provides that any compensation for services rendered after December 31, 2008 to certain offshore entities that is deferred under a nonqualified plan is includible in gross income when it is no longer subject to a substantial risk of forfeiture.  Prior to new section 457A, the manager was not taxed until the compensation was ultimately paid and the deferred amounts could be grown on a pre-tax basis through employer investment.  This provision would apply to deferred compensation owed by an offshore entity that is not subject to either U.S. tax or to a comprehensive non-U.S. tax and to any partnership, including a domestic partnership, unless substantially all of the partnership's income is allocated to taxable investors, including foreign investors subject to a comprehensive foreign income tax.  Qualified employer plans or other common employer benefits (such as vacation or sick leave or disability or death benefits) as well as certain equity-based compensation grants are not included in the definition of nonqualified deferred compensation plan. 

The principal targets of this provision appears are U.S. managers of offshore investment funds (such as hedge funds, private equity funds, and other pooled investment vehicles and characterized as "tax indifferent parties" in the Act) that have deferred compensation arrangements whereby the U.S. manager defers receipt of management fees which then also can further grow tax-free.  Under the new law, such compensation will be taxable at the time it vests instead of the time it is physically paid.  Any existing deferral arrangements attributable to services performed prior to December 31, 2008 are grandfathered in under this new provision, however the amounts deferred must be are taken into income no later than 2017.

B.      Return Preparer Penalties

The Act equalizes the penalty standard for tax return preparers and taxpayers.  Effective for returns filed after May 25, 2007return preparers had to satisfy the "more likely than not" standard to avoid penalties on undisclosed return positions (i.e., those that are not disclosed in accordance with IRS disclosure rules).  Now, both return preparers and taxpayers can avoid penalty if they have substantial authority for taking undisclosed return positions (other than tax shelter and reportable transactions).  For disclosed positions, the Act requires that preparers and taxpayers have a "reasonable basis" for taking such position.  This provision is effective for returns prepared after May 25, 2007, except changes related to tax shelters and reportable transactions are effective as of October 3, 2008.

C.      Broker Reporting of Tax Basis in Public Securities Sold

The Act imposes a basis reporting obligation for brokers with regard to publicly-traded stock, including whether gain or loss is short or long-term.   For corporate stock, the provision would apply beginning 2011 and for other types of public securities beginning either 2012 or 2013.

D.      Expensing of Qualified Film Production Activity Costs

U.S. film and television production costs in 2008 and 2009 may be expensed (rather than capitalized) up to $15 million ($20 million if a significant amount of the production expenses are incurred in certain low-income or distressed areas).  Eligibility is not lost if the cost threshold is exceeded, as was the case under the prior provision.

RENEWABLE ENERGY INCENTIVES

The energy tax package contains new, modified, and extended credits relating to (i) renewable energy such as wind, water, and geothermal energy producing technology, (ii) carbon mitigation and assistance to the coal industry, (iii) transportation and domestic fuel security from biofuels, diesels, and electric fuels, and (iv) energy conservation and efficiency programs from energy efficient buildings and recycling.

TAX EXTENDERS

A full explanation of all the tax extenders is beyond the scope of this briefing note.  However, a number of key tax extenders are highlighted below. 

1.       Taxpayers now have until December 31, 2009 to make tax-free contributions to qualified charitable organizations directly from their IRA plans without triggering U.S. income tax.  Therefore, distributions (up to $100,000 per year) donated to a charitable organization from an IRA may continue tax-free through 2009.

2.       Tax-exempt organizations are allowed to exclude from unrelated business taxable income ("UBTI") any payments that are less than fair market value made to it by a controlled entity until December 31, 2009.  Previously, tax-exempt organizations were required to include in UBTI 100% of "specified payment" (interest, annuities, royalties, or rents) received from a controlled entity to the extent that the payment reduces the "net unrelated income" (or increases the "net unrelated loss") of the controlled entity. 

3.       Shareholders of an S corporation that makes charitable contributions of property will be eligible until December 31, 2009 to make a basis reduction in their S corporation stock equal to the shareholders' pro rata share of the adjusted basis of the contributed property.

4.       C corporations have until December 31, 2009 to take an enhanced charitable deduction for (i) donations of computer equipment and software to schools and (ii) for donations of books to schools, public libraries, and literacy programs.

5.       Foreign persons who invest in U.S. mutual funds will not be subject to U.S. withholding tax on all or a portion of dividends characterized as "interest-related dividends" received through the mutual fund for mutual fund tax years beginning before January 1, 2010.  In order for foreign persons to receive the benefit of this extension, mutual funds must designate and identify applicable amounts in a written notice to shareholders not later than 60 days after the close of its taxable year.  This extension addresses a disparity that existed between foreign persons who invested directly in interest-bearing and other securities and foreign persons who invested in the same securities indirectly through U.S. mutual fund.

6.       The sale of stock in a domestically controlled mutual fund is not subject to tax under the Foreign Investment in Real Property Tax Act ("FIRPTA") rules through December 31, 2009.  This exclusion from FIRPTA is extended to U.S. mutual funds by characterizing U.S. mutual funds "qualified investment entities" under the FIRPTA rules through December 31, 2009. 

7.       The estate of a nonresident alien decedent ("NRA") dying before January 1, 2010 will be able to take advantage of the "estate tax look-through rule for mutual fund stock."  Stock of a mutual fund that was owned by a nonresident alien is not deemed U.S. source property in the proportion that, at the end of the quarter of the mutual fund's taxable year immediately before the alien's date of death, the assets held by the mutual fund are property that would be treated as situated outside the United States if held directly by the estate.

8.       U.S. parent corporations with foreign subsidiaries that are "controlled foreign corporations" ("CFCs") engaged in banking, financing, or a similar business are eligible until December 31, 2009 for a deferral of tax on such subsidiary's undistributed earnings, provided the subsidiary is predominately engaged in the same banking-related business.  For this provision to apply the subsidiary must pass an entity level income test to show that the income is active, and not passive, income.

9.       CFCs are eligible through December 31, 2009 for a tax deferral on payments of interest, dividends, rents, and royalties to related CFCs.  Therefore, the U.S. parent of multiple CFCs will be able to deploy capital from one CFC to another without triggering U.S. tax.

10.   Taxpayers now have until December 31, 2009 to elect to take an itemized deduction for state and local general sales taxes in lieu of the itemized income tax deduction.

11.   Taxpayers now have until December 31, 2009 to take a qualified tuition deduction of $4,000 for taxpayers with an annual adjusted gross income ("AGI") of $65,000 or less ($130,000 for joint returns) and $2,000, for those taxpayers with an annual AGI of $80,000 or less ($160,000 for joint returns).

12.   Taxpayers now have until December 31, 2009 to take a "new markets" tax credit.  This is a credit for investments in a domestic corporation or partnership, the primary mission of which is to serve low-income communities or low-income persons.

13.   Taxpayer's now have until December 31, 2009 to take the section 41 research tax credit.  In addition, the proposal would increase the alternative simplified credit from 12% to 14% and repeal the alternative incremental research credit (relating to an election for a three-tiered fixed base percentage) for the 2009 tax year.  The research tax credit is a nonrefundable credit for a percentage of expenses involving original investigation for the advancement of scientific knowledge not having a specific commercial objective.

14.   Qualified leasehold improvement property, qualified restaurant improvement property and qualified retail improvement property placed in service during 2009 must be depreciated over 15 years under the Modified Accelerated Cost Recovery System (MACRS). 

AMT RELIEF

The Act raises the AMT exemption for individual taxpayers beginning 2008 to the following amounts:  $69,950 for couples filing jointly or surviving spouses and $46,200 for single persons.  The Act also extends the AMT "patch" that permits allowable nonrefundable personal credits to offset AMT.  Lastly, it increases the AMT refundable credit for long-term unused credits by accelerating refunds for up to 50% of the long-term unused minimum tax credit to be refunded over each of two years instead of 20% over five years.