On February 17, 2009 U.S. President Barack Obama signed into law the “American Recovery and Reinvestment Act of 2009” – a package of spending provisions and tax incentives with an estimated cost of US$787 billion. While many of the provisions are targeted to relieving the tax burden on individuals and small businesses and providing incentives for renewable energy, infrastructure and state and municipal bonds, the legislation includes several significant changes to the U.S. tax regime generally applicable to U.S. businesses.
Tax Incentives for Business
Elective deferral of income from cancellation of indebtedness
The legislation permits taxpayers to elect to defer income from cancellation of indebtedness (COD) recognized as a result of a repurchase (or deemed repurchase) of the taxpayer's indebtedness by the taxpayer or a related person. The taxpayer electing deferral will generally be able to defer tax on the COD income until 2014 and recognize the COD income rateably over the following five taxable years. The provision applies only to repurchases of debt that occur in 2009 or 2010. Unlike some earlier drafts of the provision, there is no requirement that the debt repurchase be made with cash; the provision explicitly applies to COD income arising from debt-for-debt or debt-for-equity exchanges, as well as deemed repurchases resulting from a “significant modification” of debt.
The election can be made by taxpayers on a debt-by-debt basis. Electing taxpayers are required to forego any future exclusion of COD income that would potentially be available under certain other provisions (for example, the exclusion of COD income for insolvent debtors). Any deferred COD income is accelerated in certain circumstances, including on a liquidation of the taxpayer or the sale of substantially all of its assets. Each eligible taxpayer with COD income will need to carefully consider the advisability of electing deferral based on its particular circumstances.
Suspending the application of the applicable high yield debt obligation rules to certain debt exchanges
The applicable high yield debt obligation (AHYDO) rules generally limit the deductibility of original issue discount on high-yield debt instruments maturing in more than five years that are issued at a significant discount. The legislation suspends the application of these rules to debt issued (or deemed issued) in exchange for debt that was not previously subject to the AHYDO rules, if the exchange occurred or will occur between September 1, 2008 and December 31, 2009. The suspension does not apply to debt obligations issued to a related person. This provision provides needed relief for taxpayers who had COD income following a debt restructuring but had been denied current interest deductions under the AHYDO rules.
Limiting IRS Notice 2008-83, which exempted U.S. banks from certain Section 382 limitations
Generally, when a target corporation is acquired or otherwise undergoes an “ownership change,” the use of built-in losses of the target corporation are subject to limitations under Section 382. In September of 2008, the IRS issued Notice 2008-83, which effectively exempted U.S. banks from the limitations under Section 382 for built-in losses of target corporations attributable to loans or bad debts. The legislation limits this favourable exemption provided to U.S. banks to transactions completed or subject to a binding contract before January 16, 2009.
Miscellaneous Tax Provisions
The package also includes, among other provisions, a one-year extension of the expiring bonus depreciation provision (allowing businesses to depreciate up to 50 percent of the cost of new equipment in the year of purchase) and a temporary reduction in the recognition period for S corporation built-in gains from ten to seven years. The extension of the current two-year limitation on carrying back net operating losses contained in both the House and Senate versions of the legislation was significantly scaled back as part of the conference committee negotiations. While the extension still exists in the final legislation, it is limited to small businesses with US$15 million or less in annual gross receipts.