23 March 2018
On February 17, President Obama signed into law the “American Recovery and Reinvestment Tax Act of 2009,” an economic stimulus package that contains both tax relief and incentive provisions (the “Act”). The principal thrust of the Act’s tax provisions affecting businesses is to:
(1) add several new tax relief measures including deferred taxation of income from cancellation of debt in restructuring transactions, liberalized rules on recognition of S corporation “built-in gain,” and expanded net operating loss (“NOL”) carryback periods for eligible small businesses;
(2) renew or modify tax stimulus provisions including bonus depreciation, R&D and Alternative Minimum Tax (“AMT”) credit monetization, expensing of new business property, and reduced taxation of gain on certain stock investments in regular C corporations;
(3) enact several energy-related tax measures including a 30 percent credit for Treasury qualified advanced energy projects investments, business tax credits for new “target group” employee hiring, and expanded categories of tax-exempt financing; and
(4) codify one Internal Revenue Service (“IRS”) position announced in late 2008 that eases the burden of the capital markets credit crunch on corporate debt obligation issuers, prospectively repeal another IRS position that impacts utility of certain tax losses of acquired financial institutions, and add further tax-based limitations on executive (salary and golden parachute) compensation for recipients of funds under the Troubled Asset Relief Program (“TARP”).
Our analysis of the more salient aspects of these provisions of the Act as they affect businesses follows.
Use of Net Operating Losses
The Act includes three provisions affecting the use of NOLs.
First, the Act generally eases the NOL carryback limitation for small businesses (that satisfy a $15 million gross-receipts test) in a tax year that ends or begins in 2008 by extending the carryback period from 2 to 5 taxable years. Eligible small businesses must have average gross receipts of $15 million or less over a 3-year period ending with the year the NOL arose. The new carryback rule thus enables qualifying businesses with newly incurred NOLs to amend prior year returns and seek a tax refund(s) for tax years as far back as 2003. Taxpayers can elect to either forgo the 5-year carryback or elect to use a carryback period of either 3 or 4 years. This extended carryback period also applies for AMT purposes. The carryback provision under the original bill of the House of Representatives adopted on January 28, 2009 was more beneficial to business as it would have extended the new carryback period to any business with an NOL, applied to NOLs arising in both 2008 or 2009, and suspended the 90 percent limitation on use of NOLs for AMT purposes (though it would have reduced the NOL by 10 percent for regular tax purposes), features rejected in the bill reconciliation process.
Second, the Act repeals with prospective effect IRS Notice 2008-83, issued just prior to TARP’s enactment in early October 2008, which provides favorable treatment of bank loan losses “built-in” as of, but realized after, an ownership change—i.e., a more than 50 percentage point increase in stock ownership of one or more 5 percent shareholders. The IRS Notice continues to exempt banks with respect to ownership changes that occurred on or before January 16, 2009 (or pursuant to agreements then in effect) from the restriction on the use of an NOL with regard to a “built-in” loan loss on the ownership change date. This exemption received much negative publicity with news that TARP-financed acquisitions of banks were also tax-advantaged. The exemption was also criticized as outside Congress’ delegation to Treasury of regulatory authority, which did not authorize rules benefiting particular industries or classes of taxpayers.
Third, the Act clarifies with respect to recipients of TARP bailout funds under the Emergency Economic Stabilization Act of 2008 the regular limitation on use of pre-acquisition NOLs does not apply to ownership changes occurring as a result of a restructuring plan that is required under a loan agreement or a commitment for a line of credit with the Treasury Department (where the restructuring is intended to produce a rationalization of costs, capitalization and capacity with regard to the manufacturing workforce of, and suppliers to, the taxpayer and its subsidiaries).
Debt Restructuring and Forgiveness-Ratable Recognition of Income from Cancellation of Indebtedness
To address the increasing number of debt restructuring transactions and their correlative tax cost on distressed borrowers, the Act permits C corporations and any other taxpayers that conduct a trade or business to delay recognition of cancellation of indebtedness (“COD”) income in connection with their reacquisition during 2009 and 2010 of specified types of debt instruments (e.g., bonds, debentures, notes, certificates). Recognition of COD income is deferred for either 4 or 5 years for reacquisitions during 2010 or 2009, respectively, until 2014. COD income is then reported in gross income ratably over a 5-year period. Deferral of COD income requires an election by the debtor filed with its income tax return for the tax year of the reacquisition that identifies the instrument and amount of deferred income. Debt reacquisitions eligible for the deferral election are broadly defined and include direct purchases by the taxpayer and related parties and refinancings in which new debt is exchanged for old debt. The COD provisions also include special matching rules that insure partners will not realize phantom gain as the result of a decrease in a partner’s share of partnership liabilities. Lastly, in the case of COD transactions that retire old debt using new debt instruments that contain original issue discount (“OID,” meaning discount arising by reason of an excess of stated redemption price over issue price), OID generated interest expense deductions will be deferred until after the first year of ratable COD inclusion and disallowed to the extent the amount of OID does not exceed the amount of COD income to be recognized on the reacquired instrument (i.e., OID in excess of the COD amount would be deductible).
Increased Gain Exclusion on Sale of Qualified Small Business Stock
For investments after February 17, 2009 and before January 1, 2011, the Act increases the portion of eligible gain an individual taxpayer can exclude from gross income on the sale or exchange of qualified small business stock (“QSBS”) held (directly and through pass-through entities) for more than 5 years from 50 percent to 75 percent (from 60 percent to 75 percent for investments in certain empowerment zone businesses). To qualify for the exclusion from income for QSBS gain, a taxpayer must acquire the stock at original issue from a C corporation that meets certain active trade or business requirements and has gross assets that do not exceed $50 million. A taxpayer’s qualifying gain may not exceed the greater of (i) ten times the adjusted basis in the QSBS stock, or (ii) $10 million. This provision will be beneficial to founders of new businesses and venture capital investors as qualifying gains are subject to a 28 percent tax rate for regular tax purposes but an effective 7 percent rate after the QSBS exclusion. However, a portion of QSBS gain recognized after the 5-year holding period will be included in Alternative Minimum Tax (AMT) income and taxed at 28 percent which generally will reduce the overall tax benefit.
Reduction in Recognition Period for S-Corporation Built-In Gains Tax
An S corporation subject to the “built-in gains” tax generally would incur a 35 percent corporate level tax on the amount of “built-in asset gain” (present on the effective date when it converted from regular C to S corporation status) to the extent such gain is recognized during the 10-year recognition period that begins on the S election effective date. The Act reduces the S corporation “built-in gains” recognition period from 10 to 7 years for “built-in gain” assets if the 7th taxable year of the corporation’s “built-in gain” recognition period precedes either 2009 or 2010. The rule thus benefits S corporations for which the applicable “built-in gain” recognition period would ordinarily expire at the end of 2009, 2010, 2011, or 2012 (i.e., under the generally applicable 10-year recognition period). With respect to the same eligible S corporations, the shortened “built-in gain” recognition period will also apply to “built-in gain” assets acquired from a C corporation in a carryover basis transaction (in which gain was not recognized by the transferor corporation). This provision is designed to encourage asset sale transactions by S corporations that are nearing the end of the regular 10-year recognition period but ordinarily would be motivated to defer sale until the end of year 10. .
Suspension of Limitation of Deduction on Corporate-Issued High-Yield Debt
The Act temporarily suspends the limitation on the tax deductibility of interest on applicable high-yield OID debt obligations of corporations (“AHYDOs”)—i.e., corporate debt issued at a discount from the stated redemption price generally resulting in “substantial OID” relative to required interest payments over a 5-year accrual period—exchanged for outstanding obligations of the same issuer that are not subject to the AHYDO deduction limitations. The suspension applies to any AHYDO issued in an exchange during the period starting on September 1, 2008 and ending on December 31, 2009. If the IRS determines that continued distressed conditions in the debt capital markets necessitate applying the suspension after 2009, it has been delegated legislative authority to continue the AHYDO rule suspension. This provision mitigates the hardship arising under current credit capital market conditions where many debt instruments are inadvertently falling into AHYDO status under the technical requirements of the OID rules.
Businesses will be entitled to an initial year “bonus” depreciation of 50 percent of their cost for qualifying assets purchased for “original” use and placed in service in 2009 (or 2010 for certain longer-lived and transportation property). Bonus depreciation is allowed for both regular tax and AMT purposes. Bonus depreciation was adopted during the first term of the Bush administration as a stimulus measure that was renewed in 2008 for one year.
Under bonus depreciation, both the bonus amount and regular depreciation are reported in the first year of service. The tax basis of the purchased property is first adjusted downward to reflect the bonus depreciation amount. Then, the remaining basis is eligible for regular depreciation starting with the first year. Bonus depreciation is not prorated by either the length of time the property is placed in service or a short tax year, i.e. less than 12 months such as the case of the first year of a new company. A taxpayer may elect out of bonus depreciation, but its use does not require a special election.
Property that qualifies for bonus depreciation generally is depreciable property with a recovery period of 20 years or less for tax purposes, certain computer software, qualified leasehold improvement property and water utility property. In the case of certain aircraft or certain depreciable property with a recovery period of at least 10 years for tax purposes, bonus depreciation also applies to property purchased and placed in service in 2010.
Corporations May Elect To Forgo Bonus Depreciation And Instead Realize Benefits for Deferred Research & Development and AMT Credits
Corporations otherwise eligible for first-year bonus depreciation with respect to acquired property may elect to claim, as refundable credits, deferred research credits and alternative minimum tax credits attributable to prior tax years. The election, however, requires the corporation to forego the bonus depreciation amount otherwise allowable with respect to qualified bonus depreciation property. The provision in effect allows a corporate taxpayer to accelerate realization of the benefits of the R&D and AMT credits and defer depreciation deductions when the latter has low current utility.
Section 179 Expensing
The Act extends through 2009 the expensing of up to $250,000 of the cost of depreciable personal property used in an active trade or business. However, this expense deduction is reduced dollar-for-dollar to the extent that the purchase price exceeds $800,000. The amount expensed may not exceed taxable income that is derived from the active conduct of a trade or business; in other words, the expense cannot by itself generate an NOL.
Corporate Tax Rates and Dividends-Received Deduction
The Act makes no change to present corporate income tax rates under which the highest marginal rate is 35 percent. The Act also does not include a temporary 85-percent dividends-received deduction for repatriations made by foreign subsidiaries, although it had considerable support in the Senate before the bill reconciliation process.
Executive Compensation Limits for TARP Recipients
The Act provides that any entity that has received or will receive TARP funds is subject to a $500,000 compensation deduction limit while any obligations arising from financial assistance under TARP remain outstanding. Furthermore, the $500,000 compensation deduction limit will remain in effect until no obligations arising from TARP financial assistance remain outstanding (other than warrants to purchase common stock). This provision represents an expansion of the TARP provisions enacted in October 2008 that apply only to financial institutions which sell more than $300 million of troubled assets under TARP.
The Act also expands the prohibition on golden parachutes payments to include, in addition to the senior executive officers, the next five most highly compensated employees of a TARP recipient and critically expands the term “golden parachute payment” to any payment for “departure” from a company for any reason, thus expanding the reach of the golden parachute payment tax rules denying deductibility and imposing the 20 percent excise tax. The Act also prohibits a TARP recipient from paying or accruing any bonus, retention award or incentive compensation to at least the 25 most highly compensated employees, and expands the requirement to recover bonuses, retention awards, or incentive compensation paid to senior executive officers based on statements of earnings, revenues, gains and other criteria that are found to be materially inaccurate to the next 20 most highly compensated employees of a TARP recipient.
The Act finally provides corporate governance rules relating to a TARP recipient’s compensation committee and requires TARP recipients to adopt policies regarding luxury expenditures.
Business Tax Credits for Hiring
The Act adds two new categories of employees to the targeted groups eligible for the work opportunity credit: (i) “unemployed veterans” (veterans discharged or released from military service during the 5-year period ending on the hiring date, who have received 4 weeks or more of unemployment compensation in the year hired), and (ii) “disconnected youths” (youths between the ages of 16 and 24 who have not been regularly employed or attended school in the 6 months preceding their hiring date and who are not “readily employable by reason of lacking a sufficient number of basic skills”). If an unemployed veteran or disconnected youth is hired during 2009 or 2010, the business would receive an income tax credit equal to 40 percent of the individual’s qualified first-year wages. However, the amount of qualified first-year wages eligible for credit for any single individual cannot exceed $6,000 per year ($12,000 in the case of certain disabled veterans).
New Categories of Tax-Exempt Financings
The Act enacts an array of measures designed to enhance the marketability of state and local government bonds, as well as reduce the financing costs of such bonds. The Act provides for more financing and other tax benefits to areas with significant poverty, unemployment, home foreclosures or general economic distress, and enact a new bond-financing program for school construction and repair.
The Act provides for a wide range of tax incentives related to energy including the addition of a 30 percent qualifying energy project credit to the investment tax credit. The new credit is equal to 30 percent of the qualifying investment in certain depreciable tangible property (not including a building or its structural components) placed in service at manufacturing facilities that are designated a “qualified advanced energy project.” The project must re-equip, expand, or establish a manufacturing facility for the production of certain types of energy (e.g., solar, wind, geothermal, electric or hybrid). To receive the 30 percent energy project credit, the investment must be in a project certified by the Secretary of Treasury (who may allocate not more than $2 billion in such energy credits). Developers will have three years from the date the Secretary certifies their project to place it in service.