President Obama signed into law the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" (the Act) on Dec. 17, 2010. The legislation represents an $858 billion tax deal negotiated by the president and Republican leaders. The heart of the Act is a two-year extension of certain tax cuts enacted when George W. Bush served as president and temporary estate tax relief. The Act ultimately defers decisions on expiring tax cuts and sets the table for the possibility of major tax reform during the next few years to broaden the tax base and reduce tax rates. Certain provisions of the Act are summarized below.
Reduced rate on capital gains. Since 2008, the tax rate on long-term capital gains has been zero percent for individuals in the 10 percent and 15 percent income tax brackets and 15 percent for everyone else. However, those rates were scheduled to expire at the end of 2010, with the result that in 2011 the long-term capital gains tax rate would have risen to 20 percent (10 percent for taxpayers in the 15 percent tax bracket) if Congress had not acted. The Act extends, for two additional years (through 2012), the zero percent and 15 percent long-term capital gains tax rates.
Reduced rate on dividends. Since 2003, "qualified dividends" have been taxed at the same rates that apply to long-term capital gains. Qualified dividend income generally includes dividends received from domestic corporations and qualified foreign corporations. The rates of tax on qualified dividends were also scheduled to expire at the end of 2010, so that beginning in 2011, taxes on qualified dividends would have returned to the rates that were in effect before 2001, and all dividend income received in 2011 would have been taxed as ordinary income. The Act extends, for two additional years (through 2012), the tax regime in effect since 2003 for qualified dividends.
Temporary extension of increased small business expensing. For taxable years beginning in 2012, the maximum amount a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year (the maximum amount had been scheduled to revert to $25,000 in 2012). The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000. The $125,000 and $500,000 amounts are indexed for inflation. In addition, the treatment of off-the-shelf computer software as qualifying property is extended, as is the provision permitting a taxpayer to amend or irrevocably revoke an election for a taxable year under section 179 without the consent of the commissioner for one year (through 2012).
Temporary employee payroll tax cut. The Act reduces the employee old age, survivors and disability insurance (OASDI) tax rate under the Federal Insurance Contributions Act by two percentage points to 4.2 percent for one year (2011). Similarly, the provision reduces the OASDI tax rate for self-employed individuals by two percentage points to 10.4 percent for taxable years that begin in 2011. A similar reduction applies to the railroad retirement tax. The rate reduction is not taken into account in determining the deduction allowed to self-employed individuals for the full amount of the employer portion of Self-Employment Contributions Act taxes. Thus, the deduction for 2011 remains at 7.65 percent of self-employment income (determined without regard to the deduction).
Tax-free distributions from individual retirement plans for charitable purposes. The Pension Protection Act of 2006 amended the individual retirement account (IRA) distribution rules to allow tax-free treatment of distributions from IRAs in which the distributions are donated to charity. Under pre-Act law, the tax-free qualified charitable distribution rules applied only to distributions made in tax years beginning in 2006 through 2009. The Act extends the exclusion for qualified charitable distributions to distributions made in tax years beginning after Dec. 31, 2009, and before Jan. 1, 2012. Under a special rule, for purposes of both: (i) the tax-free qualified charitable distribution rules; and (ii) the required minimum distribution rules as they apply to IRAs and individual retirement annuities, any qualified charitable distribution made after Dec. 31, 2010, and before Feb. 1, 2011, will be deemed to have been made on Dec. 31, 2010, if the IRA owner so elects at such time and in such manner as the IRS will prescribe.
Therefore, a qualified charitable distribution made in January 2011 is permitted to be: (i) treated as made in the taxpayer's 2010 tax year, and is thus permitted to count against the 2010 $100,000 limitation on the exclusion; and (ii) treated as made in the 2010 calendar year, and is thus permitted to be used to satisfy the taxpayer's required minimum distribution for 2010.
New markets tax credit. The Act extends the new markets tax credit for two years, through 2011, subject to a $3.5 billion maximum annual amount. Therefore, for each of the 2010 and 2011 calendar years, up to $3.5 billion in qualified equity investments is permitted. In addition, the Act extends the carry-over period for unused new markets tax credits for two years, through 2016.
Research credit. The Act retroactively extends the research credit to apply to amounts paid or incurred before Jan. 1, 2012. Under pre-Act law, a taxpayer was entitled to a research credit for qualifying amounts paid or incurred before Jan. 1, 2010. The credit generally was equal to 20 percent of the amount by which the taxpayer's qualified research expenses exceeded a specific base. Because the extension of the research credit is retroactive to include amounts paid or incurred after Dec. 31, 2009, taxpayers such as fiscal-year corporations that paid or incurred amounts for research credits in 2010 and already filed returns for a fiscal year that includes part of 2010 might consider filing an amended return to claim a refund for the amount of the additional tax paid because of not claiming amounts now eligible for the credit.
Fifteen-year straight-line cost recovery. The Act extends the rules that provide for straight-line depreciation over a 15-year recovery period for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property, for two years, to apply to property placed in service on or before Dec. 31, 2011.
Enhanced charitable deduction for corporate contributions of computer inventory. The Act extends the rule that allows C corporations that make a qualified contribution of computer technology or equipment to certain exempt organizations and libraries to claim an above-basis deduction to contributions made before Jan. 1, 2012.
Expensing of environmental remediation costs. The Act extends the provision permitting the expensing of qualified environmental remediation expenditures (i.e., expenditures that would otherwise be chargeable to capital account and were incurred in connection with the abatement or control of "hazardous substances" at a "qualified contaminated site") for two years, to include expenditures paid or incurred before Jan. 1, 2012.
Deduction relating to domestic production activities in Puerto Rico. The Act extends the provisions that allow the special domestic production activities rules to apply to gross receipts from Puerto Rico for two years, to the first six taxable years of a taxpayer beginning after Dec. 31, 2005, and before Jan. 1, 2012. Generally, trade or business activities must be conducted in the U.S. to be eligible for the domestic production activities deduction. However, under a special rule, the U.S. includes Puerto Rico for any taxpayer with gross receipts from sources within Puerto Rico, but only if all of the taxpayer's Puerto Rico-sourced gross receipts are taxable under the federal income tax for individuals or corporations.
Exceptions for active financing income. The Act extends for two years (for taxable years beginning before 2012) the present-law temporary exceptions from subpart F foreign personal holding company income; foreign base company services income; and insurance income for certain income that is derived in the active conduct of a banking, financing or similar business, or in the conduct of an insurance business.
Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules. Under the "look-through rule," dividends, interest (including factoring income that is treated as equivalent to interest), rents and royalties received by one controlled foreign corporation (CFC) from a related CFC are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the payor that is neither subpart F income, nor treated as effectively connected income. The look-through rule is effective for taxable years of foreign corporations beginning before Jan. 1, 2010, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end. The Act extends for two years the application of the look-through rule to taxable years of foreign corporations beginning before Jan. 1, 2012, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.
Basis adjustment to stock of S corporations making charitable contributions of property. If an S corporation contributes money or other property to a charity, each shareholder takes into account the shareholder's pro rata share of the contribution in determining its own income tax liability and reduces the basis in the stock of the S corporation by the amount of the charitable contribution that flows through to the shareholder. The Act extends the rule that the decrease in a shareholder's basis in his S corporation stock, by reason of a charitable contribution made by the S corporation, equals the shareholder's pro rata share of the adjusted basis of the contributed property rather than the fair market value of such property for contributions in tax years beginning before Jan. 1, 2012.
Empowerment zone tax incentives. The Act extends for two years, through Dec. 31, 2011, the period for which the designation of an empowerment zone is in effect, thus extending for two years the empowerment zone tax incentives, including the wage credit, accelerated depreciation deductions on qualifying equipment, tax-exempt bond financing, and deferral of capital gains tax on the sale of qualified assets sold and replaced. In the case of a designation of an empowerment zone - the nomination for which included a termination date that is Dec. 31, 2009 - termination will not apply with respect to such designation, if the entity that made such nomination amends the nomination to provide for a new termination date in such manner as the Secretary of the Treasury may provide. The Act also extends for two years, through Dec. 31, 2016, the period for which the percentage exclusion for qualified small business stock (of a corporation that is a qualified business entity) acquired on or before Feb. 17, 2009, is 60 percent. Gain attributable to periods after Dec. 31, 2016, for qualified small business stock acquired on or before Feb. 17, 2009, or after Dec. 31, 2011, is subject to the general rule, which provides for a percentage exclusion of 50 percent.
Work opportunity credit. The Act extends the work opportunity tax credit (available on an elective basis for employers hiring individuals from one or more of nine targeted groups) for four months (for individuals who begin work for an employer after Aug. 31, 2011, and before Jan. 1, 2012). The amount of the credit available to an employer is determined by the amount of qualified wages paid by the employer. Generally, qualified wages consist of wages attributable to service rendered by a member of a targeted group during the one-year period beginning on the day the individual begins work for the employer (two years in the case of an individual in the long-term family assistance recipient category).
Qualified zone academy bonds. The Act extends the qualified zone academy bond program for one year and authorizes issuance of up to $400 million of qualified zone academy bonds for 2011. The issuer election to receive a payment in lieu of providing a tax credit to the holder of the qualified zone academy bond is not available for bonds issued with the 2011 national limitation. The provision has no effect on bonds issued with limitation carried forward from 2009 or 2010.
Temporary exclusion of 100 percent of gain on small business stock. The Act extends the 100 percent exclusion of the gain from the sale of certain small business stock acquired at original issue and held for at least five years, as well as the exception from minimum tax preference treatment, for one year (for stock acquired before Jan. 1, 2012).
Christopher C. Scarpa is a Partner in Stradley Ronon's tax department and a member of the firm's nonprofit and religious organizations and public finance practice groups. Zachary P. Alexander is a Partner in Stradley Ronon's tax practice group. David J. Karasko is a Member of Stradley Ronon's business and tax practice groups. Justin H. Brown is an associate in Stradley Ronon's trusts, estates & personal planning practice group.