Senate Finance Committee Chairman Max Baucus, D-Mont., has scaled back the carried interest and S corporation tax provisions, in addition to several others, after the tax extenders and unemployment legislation hit a speed bump in the Senate.
The bill, known as the American Jobs and Closing Tax Loopholes Act of 2010, failed to clear a 60-vote threshold on Wednesday during a vote on waiving the budget rules (see Tax Extender and Unemployment Bill Stalls in Senate).
Baucus introduced a substitute amendment to try to allay concerns about the bill, which would extend a variety of expired tax breaks through the end of the year, as well as extend unemployment benefits through the end of November. Some legislators have complained about the $140 billion cost of the bill, as well as several provisions designed to raise revenue to offset that cost, including ones that would raise carried interest taxes on hedge fund managers, private equity firm partners, venture capitalists, and real estate investment partnerships, as well as provisions affecting the foreign tax credits claimed by multinational companies, and the tax treatment of some professional services firms organized as S corporations. Among the changes are some to the carried interest tax provision, which was already scaled back earlier this month (see Senate Modifies Carried Interest Tax Provision).
Several senators had some concerns about the earlier substitute and this amendment shows that we all listened, said Baucus in a statement. We heard what those senators were saying and adjusted the amendment accordingly.
The bill would prevent investment fund managers from paying taxes entirely at capital gains rates on investment management services income received as carried interest in an investment fund. To the extent that carried interest reflects a return on invested capital, the bill would continue to tax carried interest at capital gain tax rates. However, to the extent that carried interest does not reflect a return on invested capital, this amendment would require investment fund managers to treat 75 percent of the remaining carried interest as ordinary income beginning on Jan. 1, 2011. The amount that would be treated as ordinary income would be reduced to 50 percent for carried interest that does not reflect a return on invested capital but which is attributable to the sale of assets which are held for five or more years.
The amendment provides that the lower recharacterization percentage also would apply to the gain or loss attributable to the underlying assets held for five or more years when a partnership interest is sold, as well as to a gain attributable to Section 197 intangibles of a partnership whose principal activity is providing specific investment management services with respect to the assets of the partnership when the partnership interest has been held for five or more years.
The amendment also provides that, on selling an interest in any publicly traded partnership, a person who is not an investment service provider would be exempt from the rule that recharacterizes as ordinary income under Section 751(a) of the Tax Code that portion of the gain or loss attributable to an investment services partnership interest.
In the area of S corporation employment taxes, Social Security taxes are imposed on compensation and self-employment income up to the Social Security wage base (currently $106,800) and the Medicare tax is imposed on all self-employment and compensation income. Some service professionals have been avoiding Medicare and Social Security taxes by routing their self-employment income through an S corporation. These taxpayers then pay themselves a nominal salary and take the position that the remaining earnings are exempt from employment taxes. A provision passed by the House and included in the original Baucus substitute would address this in situations where an S corporation is a partner in a professional service business, or where an S corporation is engaged in a professional service business that is principally based on the reputation and skill of three or fewer individuals. This provision does not change the ability of S corporations to use some income to make business investments or deduct those small-business investments.
To make the second alternative more administrable and more targeted, the new amendment changes the language so that the policy applies only if 80 percent or more of the professional service income of the corporation is attributable to the services of three or fewer owners of the corporation.
Another of the changes in the latest version of the bill would reduce Medicare physician payment updates from 19 to six months. Medicare physician payment rates are scheduled to be reduced by more than 20 percent in June. The provision would reverse that reduction and provide a 2.2 percent update to physician payment rates through Nov. 30, 2010.
Another change in the bill would eliminate a $25 hike in weekly unemployment benefits. Federal Additional Compensation, which increases unemployment benefits by $25 a week, was phased out at the end of May 2010. The original Baucus substitute amendment would have extended the FAC through November 2010. The latest modification of the bill would eliminate that extension of the FAC. Under this bill, individuals who are currently receiving the FAC will continue to receive the extra $25 until the exhaustion of all benefit programs, but no later than the end of the week beginning Dec. 7, 2010. The non-reduction rule for FAC also continues to apply through the end of the week beginning Dec. 7, 2010. In addition, the non-reduction rule has been attached to the Emergency Unemployment Compensation provision.
Another change in the bill would increase the Oil Spill Liability Trust Fund Tax. The Oil Spill Liability Trust Fund is financed by an 8-cent-per-barrel tax on the oil industry. There is approximately $1.5 billion available in this trust fund. The nonpartisan Congressional Research Service has stated, A major spill, particularly one in a sensitive environment, could threaten the viability of the fund. To ensure the continued solvency of the fund, the bill would increase the per-barrel amount that oil companies are required to pay into the fund to 49 cents.
The new amendment also would revise Section 6707A of the Tax Code to make the penalty for failing to disclose a reportable transaction proportionate to the underlying tax savings. The purpose of this change is to prevent small businesses from paying a penalty significantly greater than the benefit they would receive from their investment. The penalty for failure to disclose reportable transactions to the IRS would be set at 75 percent of the tax benefit received. Reportable transactions are defined as investments in transactions that the IRS has identified as listed tax shelters or that have characteristics of tax shelters, including large losses or confidentiality agreements. The minimum penalty under this bill is $10,000 for corporations and $5,000 for individuals, and the maximum penalty is $200,000 for corporations and $100,000 for individuals. The bill also requires the IRS to provide an annual report to the Senate Finance Committee and to the House Ways and Means Committee giving an account of certain tax-shelter related penalties asserted during the year.
Other parts of the substitute amendment include an extension in the closing date for the First-Time Homebuyer Tax Credit (see Senate Passes Homebuyer Credit Extension). The tax credit was expanded and extended to allow homebuyers to receive a tax credit for the purchase of a qualifying home through April 30, 2010. Homebuyers can benefit from the credit up to July 1, 2010 if they entered into a binding contract by April 30, 2010, and close on the home within 60 days. This provision extends the closing date for homebuyers who entered into a binding contract by April 30, 2010, allowing them to be eligible for the tax credit if they close on the home before Oct. 1, 2010.
Other provisions clarify some of the provisions regarding foreign tax credits for multinational companies. One provision would reverse a recent Tax Court decision to provide that guarantee payments made to foreign persons are treated like interest, rather than services, and therefore subject to U.S. withholding tax when paid by a U.S. person to a foreign person. The modification would clarify that the provision only applies to guarantees of indebtedness, rather than to guarantees of obligations.
Another provision would eliminate the withholding and foreign tax credit benefit for 80/20 companies prospectively, subject to a grandfather rule that would continue to provide favorable withholding tax treatment to payments made by existing legitimate 80/20 companies. The modification would clarify that for purposes of applying the grandfather provision for periods prior to Jan. 1, 2011, the 80/20 rules then in effect would apply.
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