The most radical revision of business taxes since 1986 - the American Jobs Creation Act of 2004 - has passed both the House and the Senate by wide margins.
At press time, President Bush, despite expressing some misgivings over the voluminous special interest provisions, had indicated that he would sign the bill.
While the original intent of the bill was simply to repeal the foreign sales corporation/extraterritorial income provisions that the World Trade Organization had ruled illegal - which had led to the imposition of sanctions by the European Union - the end result is "something for everyone," according to Martin B. Tittle, an Ann Arbor, Mich.-based international tax attorney.
"It's over 600 pages long, and in order to get it passed everyone wanted a piece of the pie," he said. "Just about any special interest that didn't get something into the bill should fire their lobbyist. It has a plethora of special interest provisions to make it impossible for some people to vote against it. My personal favorite is the suspension of the 4.7 percent duty on imported ceiling fans."
Since the benefits are aimed at manufacturers, he noted, "It will encourage every business to shoehorn itself into the definition of a manufacturer."
The act repeals the FSC/ETI regime, and replaces it with a 9 percent deduction (equivalent to a 3 percent rate cut) on all domestic manufacturing activity. The deduction is available to C corporations, S corporations, partnerships, sole proprietorships, cooperatives, and estates and trusts.
It extends enhanced Section 179 expensing from $25,000 to $100,000 through 2007, reduces the depreciation period for restaurants and leasehold improvements from 39 years to 15 years, and provides a number of provisions simplifying the tax treatment of S corporations.
On the reform and simplification side, the new act includes provisions to reduce double taxation of U.S.-based companies, such as reducing the foreign tax credit baskets from nine to two, and allowing FTCs to be carried forward for 10 years instead of five.
It repeals the 90 percent limitation on the use of FTCs against the alternative minimum tax, and encourages companies to reinvest foreign earnings in the United States by temporarily taxing repatriated income at 5.25 percent.
It also includes numerous other tax relief provisions, such as the repeal of the 4.3 cent fuel excise tax, temporary suspension of the special occupational tax on small businesses, an elective tonnage tax system for international shipping income, and a 50 percent tax credit for railroad track maintenance.
The principal provision for individuals will allow them to deduct state and local sales taxes instead of state income taxes for 2004 and 2005. Taxpayers will have the option of deducting their actual sales taxes or using Internal Revenue Service-published tables.
"There has been some grumbling about how much the bill grew beyond the simple repeal of FSC/ETI," said Senate Finance Committee chairman Chuck Grassley, R-Iowa. "Well, one of the reasons it grew is because the Finance Committee found sufficient offsets, most of the loophole closers, to allow members to get their particular interests into the bill."
The act's costs are offset by reducing tax avoidance through corporate inversions and individual expatriation, shutting down abusive tax shelters, closing corporate tax loopholes, combating fuel tax evasion, clarifying the tax treatment of executive deferred compensation plans, extending IRS user fees, and extending customs user fees.
Although the bill has been discussed and worked on in Congress for over a year, the sudden legislative action has come as a surprise to many observers.
"At the beginning of the year, we thought it was certain to get passed because of the escalating sanctions," said Mark Luscombe, principal analyst for Riverwoods, Ill.-based CCH and a contributor to Accounting Today. "Then, when nothing happened by summer, it didn't look as if anything would get passed until after the elections or even next year."
"It's possible they thought they might lose one of the houses of Congress and wanted to get something passed before elections," observed Luscombe. "It also might be the case that the sanctions were beginning to hurt some industries, and there was pressure to get something done now. If they waited until next year, the sanctions would be starting to really cause some pain."
The repealed FSC/ETI provisions had their origin in domestic international sales corporations, which were conceived in the early 1970s. Since European companies pay tax solely on income earned in Europe, U.S. companies, which are taxed on total income from domestic and foreign sales, are at a disadvantage. The DISCs were allowed to defer tax on a percent of export profits, placing U.S. companies on a more equal footing.
The European Commission found fault with the DISC provisions, and brought an action under the General Agreement on Tariffs and Trade, the predecessor of the World Trade Organization, in 1976. Even though the U.S. replaced the DISC with the foreign sales corporation provisions pursuant to a 1981 GATT Council Understanding, more than a decade later the European Union obtained a WTO ruling that the FSC provided an illegal export subsidy.
To comply with the WTO, the U.S. repealed the FSC provisions and enacted the Extraterritorial Income Exclusion Act in 2000.
"Although the basic exclusion rules under ETI functioned differently from the FSC regime, many of the concepts in ETI were the same," said Selva Ozelli, an international tax attorney and CPA with New York-based RIA, a Thomson business. "So the EU challenged them, and in January 2002 the WTO held that ETI also constituted a prohibited export subsidy."
In a WTO arbitration proceeding, the EU was permitted to impose sanctions on U.S. exports. The sanctions began with a 5 percent tariff on many U.S. products on March 1, 2004, and have escalated by 1 percent a month to the 12 percent currently in effect. Without the repeal of the FSC/ETI provisions, the tariffs would continue to escalate to 17 percent.
"The new act repeals the FSC and ETI provisions, and in their place it allows a limited-time, tax-favored repatriation of offshore earnings, numerous changes to the foreign tax credit rules that will allow multinationals to take enhanced tax credits to reduce the multinationals' effective tax rates, enhanced foreign source income deferral rules, and enhanced interest deduction rules," said Ozelli.
Although the impetus for the legislation was the repeal of the FSC/ETI provisions that the European Union found objectionable, the EU has said that it will study the legislation, including its transition periods and grandfather clauses, before lifting the sanctions now in effect.
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