Tax Strategy: Military and farm tax legislation clear Congress

So far, 2008 has not been a year for major tax legislation.Nor, being an election year, are the remaining six months likely to offer major legislation. Two bills that did make it through Congress prior to Memorial Day included tax provisions focused on farmers and alternative energy and on military personnel and veterans. The farm legislation required the override of a presidential veto and included a procedural snafu where one of the non-tax titles of the legislation was not forwarded to President Bush along with the rest of the legislation. Barring any litigation over that issue, the enactment date of the legislation is May 22, 2008.

The military legislation passed both houses of Congress unanimously, and, as of this writing, the president was expected to sign it.

In this column a month ago, we covered some of the likely tax provisions to be included in the farm bill. In this column, we will focus on some provisions in both pieces of legislation that are likely to have an impact beyond the farm, alternative energy and military areas that are the obvious focus of the legislation.

MORE STIMULUS

One of the key elements of qualifying for the rebate checks that were the central focus of the Economic Stimulus Act of 2008 was the requirement that there would be no rebate checks if there were no Social Security numbers. The goal of the legislation was to keep illegal aliens from qualifying for the checks. A number of groups have argued that they were unintentionally overlooked in the economic stimulus legislation, including SSI recipients and persons with tax identification numbers who are not illegal aliens.

However, the group that got the ear of Congress in the Heroes Earnings Assistance and Relief Tax Act of 2008 is military personnel who file a joint return with spouses who do not have a Social Security number. The legislation relaxes the Social Security number requirement for military families. It remains to be seen whether other overlooked groups will get the ear of Congress before it is too late to issue the checks this year.

RESERVE EMPLOYERS

Employers of military personnel have long had to deal with certain provisions in the law designed to protect “citizen soldiers” from being penalized in their civilian jobs for their obligations to their country. Some employers try to punish these employees, while others go out of their way to reward them. This military legislation addresses both situations.

In order to be qualified, a plan must provide that the survivors of a participant who dies while performing qualified military service are entitled to any additional benefits that would have been provided under the plan had the participant returned and then terminated employment on account of death. This could impact life insurance benefits and annuities.

Further, an employer who sponsors a retirement plan may treat a participant in the plan who dies or becomes disabled while performing qualified military service as if the individual had resumed employment on the day preceding death or disability and terminated employment on the actual date of death or disability. This would permit the participant to qualify for any benefit accrual restoration provisions required under the plan. Both changes are effective for deaths and disabilities occurring on or after Jan. 1, 2007.

Small business employers with fewer than 50 employees are also encouraged to make differential wage payments to employees called to active duty. That encouragement comes by way of a new tax credit equal to 20 percent of the differential wages paid. This provision will apply to amounts paid starting the date after President Bush signs the legislation.

TAXATION OF EXPATRIATES

In an ever-tightening noose around individuals who seek to escape their U.S. tax obligations by renouncing their citizenship, the new military legislation pays for some of the military tax breaks by imposing an immediate mark-to-market tax regime to treat expatriating individuals as if they had sold all of their property for its fair market value on the day before the expatriation date or the residency termination date for long-term U.S. residents. The tax will be imposed to the extent that the net unrealized gain exceeds $600,000. Some are already arguing that the legislation may go too far and impose double taxation in certain situations, particularly for dual citizens or long-term residents.

Another new wrinkle in the legislation imposes a transfer tax on the receipt of property by gift, bequest or inheritance from an expatriate. The tax would be imposed at the highest gift tax rate, unless the property was included in a timely filed gift tax return or timely filed estate tax return, or was eligible for a charitable or marital deduction.

The mark-to-market provision actually simplifies current law, which required a 10-year waiting period, and it is not clear whether it will reduce or encourage expatriation. The government certainly expects the provision to raise extra revenue. The taxation of recipients will impose a perhaps difficult burden on the recipients to know how the donor treated the property for tax purposes.

THE ‘HALLIBURTON PROVISION’

In what some are referring to as the Halliburton provision, another revenue raiser in the military legislation treats a foreign person who is a member of a domestically controlled group of entities as a U.S. employer for FICA tax purposes with respect to services performed by its employees in connection with a contract entered into between the U.S. government and any member of the group.

The result can be overcome where a totalization agreement is in effect that subjects the employee’s wages exclusively to a foreign country’s social security system or other evidence of such an obligation to a foreign country. The change applies to services performed in calendar months beginning more than 30 days after President Bush signs the legislation.

KANSAS DISASTER AREA

The Food, Conservation and Energy Act of 2008 included extensions of a number of provisions of the Internal Revenue Code that provided relief to the Gulf Coast as a result of Hurricanes Katrina, Wilma and Rita, and to areas of Kansas declared federal disaster areas as a result of storms and tornados in the spring of 2007. As with the hurricanes, there were a number of disaster declarations adding additional areas and specifying different levels of assistance based on the evaluation of the level of damage. The legislation itself did not define the disaster area except by reference to the presidential disaster declarations.

Perhaps the most significant legacy of these provisions will be that the Katrina relief provisions will never be allowed to die. As violent tornadoes sweep the country in 2008, one can easily imagine that, as has been done in Kansas, these tax relief provisions will continually be extended to apply to the current disaster of the year.

LIKE-KIND STOCK EXCHANGES

One of the tenets of Code Sec. 1031 has long been that you cannot have like-kind exchanges of stock. However, in what appears to be a provision designed for a particular group of taxpayers, the farm legislation authorizes like-kind exchange treatment for exchanges of stock in irrigation, reservoir or ditch companies where the highest court of the state or a state statute treats the stock as real property. The provision has been associated with Colorado, although no specific state or states are mentioned in the legislative language.

While this provision is obviously of very narrow application, it is an opening of the gates for other worthy or not-so-worthy claims of entitlement to like-kind exchange treatment for exchanges of stock.

SUMMARY

As is usually the case even with relatively small pieces of tax legislation, there are taxpayers affected other than the obvious targets of the legislation. Certainly this is true of the military and farm bills. Tax practitioners who do not count military personnel, veterans, farmers or the alternative energy industry among their clients will still want to review the details of the new legislation to find that hidden provision with an impact on their client.

In addition to the provisions specifically highlighted here, there are other provisions in the two pieces of legislation affecting charitable donors of real property, race horse owners, volunteer firefighters, Peace Corps volunteers, members of the U.S. intelligence community, timber owners and timber REITs, and bond issuers. Followers of tax legislation have learned long ago never to judge a piece of tax legislation solely by its title.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.