The Act, signed into law by President Obama on February 17, 2009 includes significant changes to various provisions of the Internal Revenue Code of 1986, as amended (the “Code”). This memorandum summarizes these changes, highlighting those provisions of relevance to investors and businesses. Except as otherwise noted, the tax provisions of the Act are retroactive to January 1, 2009. All references to sections (e.g., “§ 45”) are to sections of the Code.
Business Tax Provisions
- Delayed Recognition of Certain Cancellation of Debt Income. A taxpayer generally has income where the taxpayer cancels or repurchases its own debt for an amount less than the issue price (cancellation of debt income or “CODI”). Prior to the Act, the CODI realized on the repurchase of a debt instrument was recognized in the year of repurchase. Under the Act, a taxpayer can elect to have CODI from the repurchase of applicable debt deferred until 2014 and then report the income ratably over the 2014 through 2018 tax years.
- For example, if a taxpayer repurchases debt issued for $10 million at a discounted price of $5 million in 2009, such taxpayer has $5 million of CODI. If the relief provided under the Act is elected, instead of recognizing $5 million in 2009, the taxpayer recognizes $1 million in each of 2014-2018.
- This election is voluntary. Therefore, if a taxpayer has, for example, NOLs (see definition below) expiring in 2009, the taxpayer would generally not elect this deferral.
- A repurchase for this purpose includes the retirement of debt for cash, forgiveness of debt, conversion of debt into corporate stock or a partnership interest of the issuer, contribution of the debt to the capital of the issuer, or exchange of the debt for newly issued debt. Further, certain modifications of a debt obligation may cause a deemed debt-for-debt exchange.
- Applicable debt for purposes of this relief is either (1) a debt instrument issued by a C corporation, or (2) a debt instrument issued by any other person or legal entity in connection with the person’s or legal entity’s trade or business.
- CODI deferred under this rule is accelerated upon the taxpayer’s death, the liquidation or sale of substantially all the taxpayer’s assets, or cessation of business by the taxpayer (as applicable). It does not appear that the CODI deferred is accelerated in the case of a merger.
- Certain additional rules apply if the repurchased debt is exchanged for debt which is subject to the original issue discount (“imputed interest”) rules.
- The election is made with the return for the taxable year in which the debt is repurchased.
- This rule allows taxpayers to restructure or buy back debt at a significant discount, which may be possible in current market conditions, and defer the related taxes on such buy-backs and restructurings.
- 5-Year Carryback of Net Operating Losses (“NOLs”) for Small Businesses. Generally, NOLs may be carried back 2 years before the year that the loss arises (the “NOL Carryback Period”) and carried forward the 20 subsequent years. Under the Act, an eligible small business may elect a 3-, 4-, or 5-year carryback period for 2008 NOLs (defined below), instead of the general 2-year carryback period.
- Eligible “small businesses” are corporations, sole proprietorships, or partnerships whose average annual gross receipts are $15 million or less for the three-tax-year period ending with the tax year in which the loss arose.
- A “2008 NOL” is a NOL either for a tax year beginning in 2008 or ending in 2008.
- The election must be made by the due date for the taxpayer’s return for the year in which the NOL arose, with extensions.
- This provision may be useful to taxpayers in obtaining cash refunds in loss years. If, for example, a taxpayer paid taxes in 2004, and incurs a NOL in 2008, the taxpayer can carry back this NOL to create a current tax refund.
- Small Business Capital Gains. Prior to the Act, 50% of the gain from the sale of certain small business stock held for more than five years is excluded from income. The remaining 50% is taxed at a maximum rate of 28%. Under the Act, the 50% gain exclusion is increased to 75% for stock issued after February 17, 2009 and before January 1, 2011.
- To qualify, the stock must generally be purchased by a non-corporate taxpayer at original issue for cash, and, at the time the stock is issued, the corporation must be a domestic C corporation whose gross assets do not exceed $50 million and is primarily engaged in the active conduct of certain professional services.
- The amount of gain eligible for the exclusion is limited to the greater of 10 times the taxpayer’s basis in the stock, or $10 million.
- Extension of Bonus Depreciation and AMT Depreciation Relief. Generally, businesses recover the cost of capital expenditures over a period of years as prescribed in the relevant depreciation schedule. In 2008, businesses were temporarily allowed a 50% bonus first-year depreciation for certain qualified property placed in service in 2008. The Act extends the application of this rule to qualified property acquired in 2009 (2010 for certain aircraft, certain transportation property, and long-production-period property).
- The bonus first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes. The taxpayer may elect out of bonus first-year depreciation.
- Briefly, “qualified property” for purposes of this section includes (1) property to which § 168 applies and has a recovery period of 20 years or less (most machinery, equipment or other tangible personal property), (2) computer software depreciable under § 167(a), and (3) certain leasehold improvements. Also, as noted above, this section applies to certain aircraft, transportation property, and long-production-period property. The original use of the property must begin with the taxpayer.
- This provision incentivizes investments by granting taxpayers additional tax benefits for certain investments made in 2009.
- Extension of Expensing of § 179 Property. Under § 179, taxpayers can elect to treat the cost of certain property placed in service during the tax year as an expense allowed as a deduction for the tax year in which the § 179 property is placed in service. In 2008, the deductible § 179 expense cannot exceed $250,000, and the maximum deductible expense is phased out by the amount by which the cost of § 179 property placed in service during the tax year 2008 exceeds $800,000. The Act extends the $250,000 and $800,000 amounts to tax years beginning in 2009.
- Section 179 property is property which is acquired by purchase for use in the active conduct of a trade or business and is either: (1) tangible property subject to § 168; (2) computer software subject to § 167; or (3) § 1245 property (which includes certain real estate and leases thereof).
- This provision, like the bonus 50% depreciation mentioned above, incentivizes investments by granting taxpayers additional tax benefits for certain investments made in 2009.
- Small Business Estimated Tax Payment Relief for 2009. The bill reduces the 2009 required estimated tax payments for individuals who received 50% of their gross income in the prior year from a small trade or business and whose adjusted gross income from the prior year was less than $500,000 ($250,000 is married and filing separately). For purposes of this relief, a small trade or business means any trade or business that employed no more than 500 persons, on average, during the calendar year ending in or with the preceding taxable year.
- Election to Accelerate Recognition of Historic AMT/R&D Credits. In 2008, in lieu of the above-described bonus depreciation, businesses can elect to accelerate the recognition of a portion of their historic AMT or research and development (R&D) credits. The amount that taxpayers may accelerate is calculated based on the amount that the taxpayer invests in property that would otherwise qualify for bonus depreciation. The Act extends this acceleration rule through 2009.
- Temporary Reduction of S Corporation Built-In Gains Holding Period from 10 Years to 7 Years. Prior to the Act, if a taxable corporation converts into an S corporation, following such a conversion, an S corporation must hold its assets for 10 years in order to avoid a tax (35% at the corporate level) on any built-in gains that existed at the time of the conversion. The Act reduces this holding period from 10 years to 7 years for sales occurring in 2009 and 2010.
- For example, if the taxpayer made an S corporation election for 2002, the recognition period will end in 2009, instead of 2012. This temporary shortening of the recognition period may also be applicable to RICs and REITs.
- Work Opportunity Credit. The work opportunity credit is expanded to apply to unemployed veterans and disconnected youth who begin work in 2009 or 2010.
- New Markets Tax Credit. The new markets tax credit under § 45D provides tax benefits for investments in certain entities whose primary mission is serving or providing investment capital for low-income communities or low-income persons. The Act increases the maximum amount of qualified investments under § 45D by $1.5 billion to $5 billion per year for 2008 and 2009.
- Low-Income Housing Grant in Lieu of Credit. Under current law, the low-income housing credit under § 42 provides a credit to the owners of certain low-income housing (the “LIHC”). Under the Act, states have an option to receive and pay out grant money to owners of qualifying low-income housing, instead of the LIHC allocations for 2009.
- The current economic climate has reduced the attractiveness of LIHCs (due to the fact that many investors do not have taxable income to apply the LIHC against). Using grants instead of credits helps alleviate this problem.
- Suspension of AHYDO Rules. Generally, the issuer of a debt instrument with OID may deduct the portion of such original issue discount equal to the aggregate daily portions of the OID for days during the taxable year. However, in the case of certain high-yield discount obligation (an “AHYDO”) issued by a corporate issuer no deduction is allowed for a certain disqualified portion of the original issue discount on such obligation and the remainder of the OID on any such AHYDO is not allowable as a deduction until paid by the issuer. The Act generally suspends the AHYDO for debt issued in a debt-for-debt exchange occurring after August 31, 2008, and before January 1, 2010.
- This technical change is useful to taxpayers restructuring debt, allowing them to deduct certain interest that would not otherwise be deductible under the AHYDO rules.
Other Notable Tax Provisions.
- Changes to COBRA. The Act provides certain individuals involuntarily terminated during the period beginning September 1, 2008 and ending December 31, 2009 with a 65% subsidy for COBRA continuation premiums for up to 9 months from the Treasury. The premium subsidy is also applicable to COBRA continuation for the individuals’ families. The premium subsidy is excluded from gross income, but if the premium subsidy is provided during a taxable year in which the taxpayer’s modified adjusted gross income exceeds $145,000 (or $290,000 for joint filers), then the amount of the premium subsidy for all months during the taxable year must be repaid. For taxpayers with modified adjusted gross income between $125,000 and $145,000 (or $250,000 and $290,000 for joint filers), the amount which must be repaid is ratably reduced. Employers must provide qualifying terminated employees an additional notification (in addition to other pre-Act notice requirements) about the availability of the premium subsidy with respect to that COBRA coverage, and a description of the option to enroll in different coverage offered if so permitted by the employer. A violation of this additional notice is a violation of the underlying COBRA notice requirements.
- Qualified Transportation Fringe Benefits. Qualified transportation fringe benefits provided by an employer are excluded from an employee’s gross income for income tax purposes and from an employee’s wages for payroll tax purposes. Prior to the Act, up to $230 (for 2009) per month of employer-provided parking is excludable from income and up to $120 (for 2009) per month of employer-provided transit and vanpool benefits are excludable from gross income. The Act provides that $230 (indexed for inflation) per month will be excludable for both parking (remaining at $230) and transit and vanpool benefits (up from $120). This is effective beginning in March of 2009.
- Section 529 Plans. Expenses paid or incurred in 2009 or 2010 for the purchase of certain computer technology or equipment (as defined under Code Sec. 170(e)(6)(F)(i)) are “qualified higher education expenses” for purposes of qualified tuition programs under § 529.
The provisions of the Act are complex, and we have only attempted to provide a very brief overview of the Act. If you would like to discuss with an attorney from our firm how to best take advantage of tax benefits under the Act, please contact us at 415.981.1400.
PLEASE NOTE: This memorandum is published by Greene Radovsky Maloney Share & Hennigh LLP for informational purposes only and does not constitute legal advice. CIRCULAR 230 COMPLIANCE: To ensure compliance with revised Treasury Regulations under Circular 230, this is to advise you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding tax-related penalties that may be asserted against the taxpayer. A taxpayer may rely on professional advice to avoid federal tax penalties only if that advice is reflected in a comprehensive tax opinion that conforms to stringent requirements under federal law.