February 17, 2009
The American Recovery and Reinvestment Act of 2009 (the "Stimulus Act") is expected to be signed into law by President Obama today. The approximately 11oo pages of the Stimulus Act include a number of tax provisions. We have summarized below some of the most important tax provisions, and we invite your questions about specific tax-related topics within the Stimulus Act.
The update will cover the following topics:
Deferral of Cancellation of Debt Income
General Deferral Rules
The Stimulus Act will amend Internal Revenue Code (“IRC”) § 108 by adding paragraph (i), which will allow taxpayers to elect to defer cancellation of debt (“COD”) income arising from the repurchase of debt in 2009 and 2010. The election will defer COD income resulting from debt buybacks in 2009 for five years and from buybacks in 2010 for four years and then spread the COD income over the next five years, starting in 2014. The election is irrevocable, and in cases of pass-through entities, must be made by the entity rather than its members.
The COD deferral provision covers all types of repurchased debt, including bonds, debentures, notes, certificates, and any other instrument or contractual arrangement constituting indebtedness for tax purposes. The provision can apply in a variety of situations, including:
1. satisfying debt at a discount with cash;
2. debt-for-debt exchanges (including deemed exchanges resulting from debt modifications);
3. equity-for-debt exchanges (including exchanges of partnership interests for debt);
4. contributions of debt for capital; and
5. the complete forgiveness of debt by the creditor.
Generally, either the debt issuer or a related party within the meaning of IRC § 108(e)(4) may effect the debt restructuring.
Deferral of Original Issue Discount Deduction
In the case of a debt-for-debt exchange, any original issue discount (“OID”) deduction that would otherwise arise from the new debt will likewise be deferred until the five-year period in which the taxpayer recognizes the COD income. This rule also applies in a cash-for-debt exchange to the extent that the taxpayer issues a debt instrument and uses the proceeds of that debt instrument to reacquire debt. If only a portion of the new debt instrument is used to repay debt, then the deferral rule applies to the portion of the proceeds used to repay debt.
Certain Technical Rules
In the case of a partnership, any income deferred under new IRC §108(i) will be allocated to the partners who were in the partnership immediately before the debt discharge, in the manner that it would have been included in the distributive shares of each partner under IRC § 704. Any decrease in the partner’s share of partnership liabilities as a result of the debt discharge will not be taken into account under IRC § 752 if it would require the partner to recognize gain under IRC § 731. Instead, the decrease in partnership liabilities will be taken into account when the deferred COD income is recognized.
Any COD income deferred under the new provision will be accelerated and taken into account in the year in which the taxpayer (1) dies, (2) liquidates or sells substantially all of its assets (including in a Title 11 case), (3) ceases to do business, or (4) is in other similar circumstances. For pass-through entities, the acceleration will also apply to a member of the entity if the member sells, exchanges or redeems its interest in the entity.
If a taxpayer elects to defer COD income, it will not benefit from the other exceptions to COD income recognition in IRC § 108(a)(1)(A)-(D). For example, a taxpayer who makes an election to defer COD income under IRC § 108(i) will not be able later to exclude that deferred COD income because the taxpayer falls within the Title 11 or insolvency exceptions in IRC §§ 108(a)(1)(A)-(B). Furthermore, since the election is made at the entity level, an insolvent or bankrupt partner in a partnership that elects to defer COD income under the new provision would not appear to have the opportunity to exclude its COD income by virtue of its insolvency or bankruptcy.
Suspension of Limitation on High Yield Original Issue Discount (AHYDO) Deductions
In general, the issuer of a debt instrument with OID may deduct the OID accrued during a particular taxable year. However, under the rules governing “applicable high yield discount obligations” (“AHYDOs”), certain OID on high yield debt is not deductible under IRC § 163(e)(5). The Stimulus Act will temporarily suspend the limitations for issuances of AHYDOs in exchange for obligations that are not AHYDOs in 2009. Issuances of AHYDOs resulting from the significant modification of obligations that are not AHYDOs during 2009 will also be exempted from the IRC § 163(e)(5) limitations.
The suspension does not apply to issuances of contingent debt obligations described in IRC § 871(h)(4), nor does it apply to issuances to persons related to the issuer.
Net Operating Losses and Built-in Losses
Net Operating Loss Carryback Period Extended for Small Businesses
The Stimulus Act will add a new provision to allow small businesses with less than $15 million in revenues to elect to carry back net operating losses for up to five years rather than two under IRC § 172. The taxpayer may elect to have the provision apply to net operating losses incurred either (i) in its tax year ending in 2008 or (i) in its tax year beginning in 2008.
Exception to Built-In Loss Limitation for Banks Clarified
Internal Revenue Service Notice 2008-83, released on October 1, 2008, provides that certain post-ownership change deductions related to bad bank debt will not be considered a built-in loss or deduction for purposes of the limitation on the deductibility of losses after a change of control under IRC § 382(h). Lawmakers questioned the Treasury’s authority to exempt a particular industry from a tax law and found Notice 2008-83 inconsistent with the congressional intent in enacting IRC § 382. Consequently, the Stimulus Act repeals Notice 2008‑83 as of January 16, 2009. Agreements resulting in a change of control that are in effect before that date will benefit from Notice 2008‑83, but the agreement must either be a written binding agreement, or an agreement described in a public announcement or SEC filing.
Ownership Changes Exempted from IRC § 382
Though the Stimulus Act repeals Notice 2008-83, it simultaneously creates a separate exception to the § 382 limitations by adding paragraph (n) to IRC § 382. New IRC § 382(n) provides that § 382 will not apply to ownership changes pursuant to a restructuring plan required under a loan agreement or commitment for a line of credit with the government under the Emergency Economic Stabilization Act of 2008. This provision is intended to protect companies that received government funds to aid their restructuring from facing § 382 limitations on certain losses.
To qualify for the exception, the restructuring plan generally must be “intended to result in a rationalization of costs, capitalization, and capacity with respect to the manufacturing workforce of, and suppliers to, the taxpayer and its subsidiaries.” Moreover, the ownership change cannot result in any person or group of related persons (other than a voluntary employees’ association under IRC § 501(c)(9)) owning more than 50% of the total combined voting power of all classes of voting stock or the total value of the stock.
Business Tax Incentives
The business tax incentives in the Stimulus Act generally consist of special depreciation benefits, tax credits, and special rules for qualified small businesses and S corporations.
- Extends through 2009 the bonus depreciation rules of IRC § 168(k), which permit taxpayers to take a deduction equal to 50% of the adjusted basis of certain depreciable property in the year in which such property is placed into service.
- Extends through 2009 the increased limits on the expensing of certain depreciable assets under IRC § 179 currently in place for 2008.
- The Stimulus Act expands the applicability of the work opportunity credit provided under IRC § 51(a), which permits employers to take a credit against tax liability of 40% of the first $6,000 of wages paid to individuals who are members of a “targeted group.” The definition of “targeted group” is expanded to include certain unemployed veterans and certain unemployed 16-24 year-olds who begin work for the employer in 2009 or 2010.
- The new markets tax credit for qualified equity investments made in qualified community development entities (IRC § 45D) is expanded with the authorization of an additional $1.5 billion of investments for each of 2008 and 2009.
- The low-income housing credits available to each state under IRC § 42 are reduced by the amount of any grants awarded to such state under § 1602 of the Stimulus Act. Taken together, these tax credits and housing grants permit states to convert low-income housing credits into grants for low-income housing projects.
Small Businesses and S Corporations
- The 50% exclusion under IRC § 1202 of gain on the sale of stock of a “qualified small business” held for more than 5 years is increased to 75% for stock acquired between now and the end of 2010. In general, a qualified small business is a domestic C corporation with gross assets of $50,000,000 or less at all times since 1993.
- The Stimulus Act reduces the recognition period of built-in gains of S corporation assets. IRC § 1374 generally provides that an S corporation will be taxed upon the recognition of any gain that existed at the time the S election became effective, provided such recognition occurs with a specified recognition period. The recognition period is reduced by the Stimulus Act from ten years to seven years following the S election for any built-in gains recognized in tax years beginning in 2009 or 2010.
The Stimulus Act contains a variety of energy-related provisions targeting the production of renewable energy facilities, energy conservation measures, and electric vehicles.
Renewable Energy Production:
- The deadline by which qualifying facilities must be placed in service to qualify for the renewable electricity production credit (IRC § 45) is extended (generally through 2013, but only 2012 for wind facilities).
- The 10% business energy credit (IRC § 48) component of the general business credit (IRC § 38) is modified to eliminate the $4,000 per year credit cap for wind facilities and eliminate the basis reduction rule for property financed subsidized energy financing or private activity bond proceeds.
- Taxpayers are given the option to irrevocably elect to have certain tangible, depreciable property that is eligible for the renewable electricity production credit (IRC § 45) instead be treated as property eligible for the 10% business energy credit (IRC § 48).
- As an alternative to claiming the renewable electricity production credit (IRC § 45) or the 10% business energy credit (IRC § 48), the Stimulus Act provides for the Secretary of Energy to provide grants to person who place qualifying property in service. Such grants are intended to mimic the operation of those credits and are subject to recapture where the property is disposed of within 5 years of receipt of the grant.
- The new clean renewable energy bond (“New CREBs”) program (IRC § 54C) is expanded with the authorization of an additional $1.6 billion of New CREBs.
- The Stimulus Act establishes a new 30% credit under IRC § 48C as part of the general business credit (IRC § 38) for investment in qualifying advanced energy manufacturing projects certified by the Secretary of the Treasury in consultation with the Secretary of Energy. Up to $2.3 billion of credits may be allocated. Qualifying projects generally include projects that re-quip, expand or establish a manufacturing facility for the production of (1) property used to produce energy from renewable sources, (2) certain energy storage systems and components for electric and hybrid vehicles, (3) qualified plug-in electric drive motor vehicles and components, (4) electric grids to support the storage and transmission of intermittent renewable energy sources, (5) carbon dioxide capturing and sequestration equipment, (6) property designed to refine or blend renewable fuels, (7) energy conservation technologies, and (8) other advanced energy property designed to reduce greenhouse gas emissions, as may be determined by the Secretary of the Treasury.
- The 10% credit for the purchase of qualified energy efficiency improvements for existing homes (IRC § 25C) is increased to 30% and extended through 2010, and existing fixed-amount credits for specified equipment are conformed to the 30% credit. An increased $1,500 cap is implemented for property placed in service in 2009 and 2010. In addition, efficiency standards for qualifying properties have been updated.
- The Stimulus Act eliminates the credit caps for qualified solar hot water, geothermal, and wind property under the residential energy efficient property credit (IRC § 25D) and eliminates the reduction in credits for property subsidized with government funding.
- The 30% qualified clean-fuel vehicle refueling property credit (IRC § 30C) component of the general business credit (IRC § 38) is increased to 50% for qualifying property other that hydrogen refueling property. In addition, the maximum credit for business property is increased to $200,000 for qualified hydrogen refueling property and $50,000 for other qualified property. For nonbusiness property, the maximum credit is increased to $2,000.
- The qualified energy conservation bonds program (IRC § 54D) is expanded with the authorization of an additional $2.4 billion of such bonds. The Stimulus Act also clarifies that grants, loans and other repayment mechanisms can be used to implement green community programs.
- Additional requirements are imposed under the Stimulus Act for qualifying for the carbon dioxide sequestration credit (IRC § 45Q) for captured carbon dioxide used as a tertiary injectant.
- The existing plug-in electric drive motor vehicle credit (IRC § 30D) component of the general business credit (IRC § 38) is significantly modified, limiting the credit to $7,500 for all weight classes, eliminating the credit for low-speed vehicles and vehicles weighing 14,000 pounds or more, and replacing the aggregate 250,000 vehicle limit with a 200,000 vehicle-per-manufacturer limit. The changes are effective for vehicles acquired beginning in 2010.
- The Stimulus Act provides a new 10% credit, up to $2,500 per vehicle, under IRC § 30 as part of the general business credit (IRC § 38) for low-speed vehicles and vehicles with less than 4 wheels sold in 2010 and 2011 that are qualified plug-in electric drive motor vehicles. The maximum credit is $2,500 per vehicle.
- The Stimulus Act provides a new 10% credit, up to $4,000 per vehicle, under IRC § 30B(i) as part of the general business credit (IRC § 38) for the cost of converting a motor vehicle into a qualified plug-in electric drive motor and placed in service after the enactment of the Stimulus Act and before 2012.
- The Stimulus Act also provides that the personal credit portion of the alternative motor vehicle credit (IRC § 30B) may be used as a credit against the alternative minimum tax.
Tax-Advantaged Bond Provisions
The Stimulus Act creates new classes of tax-advantaged bonds, expands the definition of certain existing classes of tax-advantaged bonds, amends certain provisions dealing with interest on such bonds, and provides new rules governing certain types of bonds.
New Tax-Advantaged Bonds
- The Stimulus Act adds qualified school construction bonds under IRC § 54F as a new category of qualified tax credit bonds (IRC § 54A). Qualifying bonds must be issued by a State or local government and designated as such, and all of the proceeds of the bonds must be used for construction or repair of a public school.
- Build America Bonds
- Build America Bonds are added as a new category of tax-advantaged bonds under IRC § 54AA. Qualifying bonds are obligations other than private activity bonds if: (i) the interest would otherwise be excludable under IRC § 103; (ii) the obligations are issued before 2011; and (iii)the obligations are irrevocably designated as such by the issuer. Holders of Build America Bonds earn tax credits of 35% of the amount of interest payable on each payment date. The tax credits are subject to tax and these bonds are subject to some of the same rules as qualified tax credit bonds.
- The Stimulus Act adds new IRC § 6431, which allows issuers of Build America Bonds to elect a credit for 35% of any interest payments made on the bonds if the entire excess of available project proceeds over a reasonably required reserve are used for capital expenditures. The credit to the issuer would be in lieu of the credit to the holder of the bonds and would be paid to the issuer contemporaneously with the payment of the related interest.
- The Stimulus Act also adds new IRC § 1400U‑2, which allows an issuer of Build America Bonds to designate the bonds as recovery zone economic development bonds if the entire excess of available project proceeds over the amounts in a reasonably required reserve are used to promote economic activity in an area of substantial poverty, high unemployment, or other general distress. In the case of Build America Bonds designated as recovery zone economic development bonds, the issuer receives a credit of 45% of any interest payments made on the bonds. The credit to the issuer would be in lieu of the credit to the holder of the bonds and would be paid to the issuer contemporaneously with the payment of the related interest.
- The Stimulus Act adds to the list of exempt facility bonds a new class known as recovery zone facility bonds (IRC § 1400U‑3) for 2009 and 2010. To qualify, the bonds must direct almost all proceeds toward property used in a trade or business that is constructed, purchased, or renovated after the location of the property is classified as a recovery zone (i.e., an area of substantial poverty, high unemployment, or other general distress).
- The Stimulus Act adds new IRC § 7871(f), which allows for tax exempt bonds issued by Indian tribal governments, known as “tribal economic development bonds.” Tribal economic development bonds are generally subject to the same rules as tax exempt bonds issued by State or local governments.
Amendments to Existing Tax-Advantaged Bonds
- The qualified zone academy bond program (IRC § 54E), a class of qualified tax credit bonds, is expanded by authorizing an additional $1 billion of bonds and authorizing issuances through the end of 2010.
- The Stimulus Act expands the tax exempt qualified small issue bonds program (IRC § 144(a)) by allowing the bonds issued between now and the end of 2012 to finance private business facilities that manufacture certain intangible property. In addition, during that period, the amendment allows for the financing of certain functionally related and subordinate facilities and eliminates the 25% of net proceeds cap.
- Refer to the Energy Provisions discussion, above, for the amendments made by the Stimulus Act to the qualified energy conservation bonds program (IRC § 54D) and the new clean renewable energy bond (“New CREBs”) program (IRC § 54C).
Tax Exempt Bonds Held by Financial Institutions
- In certain circumstances, IRC § 265 disallows deductions for certain interest paid on amounts borrowed to purchase or carry tax exempt obligations. The Stimulus Act amends that section to provide that in the case of financial institutions, tax exempt obligations held by the institution that are issued in 2009 or 2010 generally will not be taken into account in calculating this deduction disallowance to the extent the amount of the bonds do not exceed 2% of the adjusted basis of the institution’s assets. However, such amounts excluded from the calculation will constitute financial institution preference items subject to a 20% interest deduction disallowance under IRC § 291(e).
- The Stimulus Act also expands the qualified small issuer category of qualified tax exempt obligations that qualify for the decreased 20% interest deduction disallowance for financial institutions under IRC § 291(e). As amended, the amount of tax exempt bonds that may be issued annually by a qualified small issuer is increased from $10 million to $30 million for tax-exempt obligations issued during 2009 or 2010. In addition, for the purposes of applying this limit, qualified 501(c)(3) bonds issued in 2009 or 2010 are treated as having been issued by the 501(c)(3) organization for whose benefit they were issued.
Tax Credit Bonds Held by RICs and REITs
- The Stimulus Act allows certain regulated investment companies ("RICs") to elect under new IRC § 853A to (i) forego tax credits on any tax credit bonds that a RIC holds during any year in which an election is in effect, (ii) include in income as interest the amount of income it would have included with respect to such credits if no election were in effect, and (iii) increase its dividends paid deduction by the amount of such income. If the election is made, each shareholder of the RIC is required to include in gross income the shareholder’s proportionate share of the interest income attributable to the credits and is allowed to take such proportionate share as a credit against the shareholder’s income. For purposes of new IRC § 853A, tax credit bonds include qualified tax credit bonds under IRC § 54A, Build America Bonds under IRC § 54AA, and any other bond for which a credit is allowable under subpart H.
- Conforming amendments also allow shareholders of real estate investment trusts (“REITs”) to obtain similar benefits of qualified tax benefit credits of bonds owned by REITs.
Certain Operating Rules
- For the purposes of the new rules listed above, refunding bonds, the proceeds from the issuance of which are used to purchase old bonds, are generally treated as issued on the date of issuance of the refunded bond (or, in the case of a series of refundings, the original bond).
- The Stimulus Act also applies certain prevailing wage rules for government contracts to projects financed with proceeds from new clean renewable energy bonds (IRC § 54C), qualified energy conservation bonds (IRC § 54D), qualified zone academy bonds (IRC § 54E), qualified school construction bonds (IRC § 54F), and recovery zone economic development bonds (IRC § 1400U‑2).
- IRC § 57 is amended such that tax exempt interest on private activity bonds issued in 2009 and 2010 will not be treated as tax preference items for AMT purposes. Additionally, the tax exempt interest on private activity bonds issued during 2009 and 2010 will not be included in gross income for the purposes of computing the alternative minimum taxable income under IRC § 56.
TARP – IRC § 162(m)(5)
The Stimulus Act subjects entities that have received or will receive financial assistance under the TARP to the provisions of IRC § 162(m)(5). In general, IRC § 162(m)(5) limits the amount employers may deduct for compensation paid or accrued with respect to executives to no more than $500,000 per year.
The Stimulus Act extends the existing homebuyers credit (IRC § 36) to qualifying home purchases before December 1, 2009, and increases the maximum credit amount from $7,500 ($3,750 each for a married couple filing separately) to $8,000 (4,000 each for a married couple filing separately). Additionally, the Act waives the recapture of the credit for qualifying home purchases after December 31, 2008 and before December 1, 2009 (even if the taxpayer elects to treat the purchase in 2009 as occurring on December 31, 2008), provided that the home is not sold or ceases to be the principle residence of the taxpayer within 3 years of purchase.
Auto Tax Credit
The Stimulus Act provides a new above-the-line deduction for sales tax paid on qualified motor vehicles purchased between now and the end of 2009 (IRC §§ 63, 164). A qualified motor vehicle generally includes passenger automobiles, light trucks, and motorcycles weighing no more than 8,500 pounds, and certain motor homes. In each case, the original use of the vehicle must commence with the taxpayer. In general, the deduction is limited to the portion of sales tax attributable to a maximum purchase price of $49,500. The deduction is phased out for taxpayers with modified adjusted gross income between $125,000 and $135,000 ($250,000 and $260,000 in the case of a joint return).
- The Stimulus Act increases the AMT exemption amount (IRC § 55) for taxable years beginning in 2009 to $70,950 in the case of married individuals filing a joint return and surviving spouses, $46,700 in the case of unmarried individuals, and $35,475 in the case of married individuals filing separate returns.
- In addition, the Stimulus Act extends the provision (IRC § 26) allowing an individual to offset entire regular tax liability and alternative minimum tax liability by certain nonrefundable personal tax credits to taxable years beginning in 2009.
- Refer to the Tax-Advantaged Bonds Provisions discussion, above, for the AMT modifications relating to tax-advantaged bonds.
The Stimulus Act increases the monthly exclusion from an employee’s gross income and wages for employer-provided transit passes and vanpool benefits (IRC § 132(f)) for March 2009 through December 2010. The exclusion is raised to match the exclusion for employer-provided parking, which is $230 per month in 2009.
Making Work Pay Credit
The Stimulus Act creates a new refundable tax credit under IRC § 36A . Qualifying individuals generally receive a credit of the lesser of 6.2% of the individual’s earned income or $400 in each of 2009 and 2010. The credit is phased out for individuals with modified adjusted gross income in excess if $75,000 ($150,000 in the case of a joint return).
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In addition, the Stimulus Act includes other provisions dealing with such items as the earned income tax credit, the refundable child credit, the American Opportunity Tax credit for certain educational expenses, computer expenses as qualified expenses for Section 529 accounts, and the effective date of the withholding tax rules for government contractors.
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To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein.
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