On Feb. 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the "Act"). Tax incentives for businesses, individuals and the development of alternative energy comprise close to $300 billion of the nearly $800 billion in stimulus spending contained in the Act. This alert summarizes some of the Act's more significant tax provisions.
Cancellation of Debt Income
Deferral and Ratable Inclusion of Cancellation of Debt Income. A taxpayer must generally recognize income from the cancellation of indebtedness in the year of cancellation unless an exception applies. The Act allows a taxpayer to elect to defer recognizing cancellation of indebtedness income if such income arises from the reacquisition of any debt instrument issued by either a C corporation or any person in connection with such person's trade or business. A "reacquisition" includes (i) a debt repurchase by the debtor or a person related to the debtor, (ii) a debt-for-debt exchange, (iii) an equity-for-debt exchange, (iv) a contribution to capital, or (v) the cancellation of the debt. The reacquisition must occur after Dec. 31, 2008, but before Jan.1, 2011. Income deferred under the election must be included in the taxpayer's gross income ratably over a five-year period beginning in 2014. This provision allows a taxpayer experiencing financial difficulties to defer income recognition as well as the payment of income taxes associated with such income for several years and, thus, on a present value basis, lowers the tax cost associated with the cancellation of indebtedness considerably.
Section 382 Loss Limitation Changes
Loss Limitation Relief. Section 382 of the Code limits the amount of net operating losses that a corporation may use annually to reduce its taxable income after undergoing a change of ownership. The Act provides an exemption from these loss limitation rules for any corporation that has undergone an ownership change as a result of a restructuring that was required to enable the corporation to borrow money from the Department of Treasury under the Economic Stabilization Act of 2008.
Repeal of Notice 2008-83. In late 2008, the IRS issued Notice 2008-83, which provided in effect an exemption from the loss limitation rules of Section 382 for banks that undergo an ownership charge and have losses due to bad debts and loans. The Act repeals Notice 2008-83 for any ownership change occurring after Jan. 16, 2009, unless the ownership change is pursuant to either a written binding contract entered into on or before that date or a written agreement described in a public announcement or a Securities and Exchange Commission filing on or before that date.
Applicable High Yield Discount Obligation (AHYDO)
AHYDO Relief. A corporate issuer is permitted to deduct as interest the amount of original issue discount with respect to debt instruments it issued prior to the date of payment to the extent such interest economically accrued during the taxable year. However, if the debt instrument is an AHYDO (1) no deduction is allowed for the "disqualified portion" of the original issue discount and (2) the remainder of the original issue discount on such obligation is not allowed as a deduction until paid. The corporate holder of an AHYDO treats the disqualified portion as a corporate distribution that can be treated as a dividend. An AHYDO is any corporate debt instrument if (1) the maturity date on such instrument is more than five years from the date of issue, (2) the yield to maturity on such instrument exceeds the sum of (a) the applicable Federal rate in effect under section 1274(d) for the calendar month in which the obligation is issued and (b) five percentage points, and (3) as of the end of the first accrual period ending five years after the date of issue, the instrument has a significant amount of original discount interest that has not been paid by the issuer.
The Act suspends the application of the AHYDO rules for obligations issued in a debt-for-debt exchange (including an exchange resulting from a significant modification) that occurs in or after Sept. 1, 2008, and before Jan. 1, 2010. The suspension applies to a new instrument if (i) the new instrument is not issued for an old instrument which is an AHYDO; (ii) the new instrument is not issued to a related party to the issuer and (iii) the new instrument does not bear contingent interest.
Temporary Investment Incentives
Extension of Bonus Depreciation. The Act provides businesses of all sizes with tax incentives to make capital expenditures in 2009. During 2008, Congress temporarily allowed businesses to recover the costs of capital expenditures made in 2008 faster than depreciation schedules would normally have allowed by permitting these businesses to write-off immediately 50 percent of the cost of the following types of depreciable property if such property was acquired in 2008 for use in the United States: (1) property to which the modified accelerated cost recovery system applies that has an applicable recovery period of 20 years or less, (2) water utility property, (3) non-custom-made computer software, and (4) qualified leasehold improvement property. The Act extends this temporary benefit to similar capital expenditures incurred in 2009.
Extension of Enhanced Small Business Expensing. In general, businesses with a modest amount of capital expenditures during a taxable year may elect to write-off immediately the cost of certain capital expenses (e.g., off-the-shelf computer software placed in service in taxable years before 2011 and depreciable tangible personal property purchased for use in the business) in lieu of recovering these costs over time through depreciation. The Act provides these businesses with an additional incentive to make capital expenditures in 2009. Under the Act, they may write-off up to $250,000 of capital expenditures, subject to a phase-out once capital expenditures exceed $800,000. Under prior law, these amounts were $125,000 (indexed for inflation) and $500,000 (indexed for inflation), respectively.
Temporary Reduction in Recognition Period for Built-In Gains Tax. When a C corporation converts to an S corporation, the S corporation is subject to tax at the highest corporate tax rate on the recognition of any built-in gain in its assets that existed at the time of the conversion if such gain is recognized during the ten-year period after conversion. The Act provides that this ten-year period is shortened to seven years for 2009 and 2010.
Qualified Small Business Stock
Small Business Capital Gains. The Act creates additional incentives for individual taxpayers to purchase stock in qualified small businesses (generally C corporations with gross assets of less than $50 million that meet active business requirements) after Feb. 17, 2009, and before Jan. 1, 2011. Under the new law an individual may, subject to certain limitations, exclude 75 percent of the gain from the sale of the stock from gross income if he or she holds the stock for more than five years prior to selling it. Only 50 percent of this gain would have been excluded under prior law. This means that under the new law gain from the sale of the qualified small business stock will generally be taxed at effective rates of 7 percent under the regular federal income tax rules and 12.88 percent under the federal alternative minimum tax rules. This is a reduction from the effective rates of 14 percent and 17.92 percent, respectively, that would have been applicable under prior law.
Small Business Provisions
Five-year Carryback of Net Operating Losses for Small Businesses. Businesses with gross receipts of $15 million or less that have a net operating loss in 2008 may elect under the Act to carry the loss back and offset it against net income from its 2003 or later tax year. Under prior law, the small business was not permitted to carry the loss back to a tax year earlier than 2006. Any small business currently operating at a loss that had net income in any of its 2003, 2004 or 2005 tax years will be able to receive a refund of income taxes paid in those years by carrying back 2008 net operating losses.
Temporary Small Business Estimated Tax Payment Relief. Individuals operating small businesses may be permitted to make lower quarterly estimated tax payments to the Internal Revenue Service in 2009. Under the new law, if an individual earned more than 50 percent of his or her gross income in 2008 from a business that employed fewer than 500 employees, then his or her quarterly estimated tax payments for 2009 will not exceed 90 percent of the tax liability shown on his or her 2008 tax return. For individuals operating small businesses, this could reduce the amount of their quarterly estimated tax payments by up to 10 percent (and possibly 20 percent if his or her 2008 adjusted gross income exceeded $150,000) of the amount of quarterly estimated tax payments that would have been required to be paid under prior law.
Election to Substitute Grants for Low-Income Housing Tax Credits
The authority to take low-income housing tax credits is allocated by a housing credit agency in each State out of each State's pool of housing credit authority. The total housing credit authority for a state is based on the state's population. Because of the slowdown in the real estate sector in 2008, many states may have unused housing credit authority.
The Act permits states to surrender their unused 2008 housing credit authority in exchange for grants equal to 10 times the surrendered authority amount. The state may also elect to surrender up to 40 percent of its 2009 housing credit ceiling (including its share of any national pool) in exchange for grants. The grants must be utilized by the State to finance qualified low-income housing projects, whether or not the recipient project also has an award of tax credits. Before awarding funds to a project, however, the state must determine that the award will increase the total funds available to the project and that the project developer has made good faith efforts to obtain investment commitments.
Extension and Modification of New Markets Tax Credit
The new markets tax credit is allowed with respect to a qualified equity investment in a community development entity that has been allocated credit authority by the Community Development Reinvestment Fund of the U.S. Treasury ("CDFI Fund"). The Act increases the CDFI Fund's new markets allocation authority for 2008 and 2009 by $1.5 billion for each year, for a total of $5 billion for each year. Because the 2008 authority had already been allocated pursuant to a competitive application process, the Act provides that the CDFI Fund will allocate the new 2008 amount to applicants that applied for, but did not receive, a 2008 allocation, or who received less allocation authority than their application requested, without a new application process.
Extension of Renewable Electricity Production Credit
Section 45 of the Code provides for a tax credit for the sale to an unrelated party of electricity produced at a qualified facility from certain qualified renewable resources, including wind, biomass, geothermal energy, solar energy, small irrigation power, solid municipal waste and hydropower. Generally, the credit was due to expire for facilities placed in service after 2009, with respect to wind, and after 2010 with respect to most other resources. The Act extends the provision to facilities placed in service through 2012, in the case of wind, and through 2013 in the case of other facilities.
Election of Investment Credit in Lieu of Production Credit
Section 45 of the Code provides for a production tax credit for the sale to an unrelated party of electricity produced at a qualified facility from certain qualified renewable resources, including wind, biomass, geothermal energy, solar energy, small irrigation power, solid municipal waste and hydropower. The production tax credit is taken over ten years based on a credit rate per dollar of revenue from electricity sold to an unrelated party for each year during the ten-year period. Section 48 of the Code provides for an energy credit for certain energy property (including solar equipment, geothermal power equipment, small wind energy property, and certain fuel cell property) placed in service by the taxpayer. The energy credit, unlike the production credit, is taken entirely in the year the property is placed in service and is based on a percentage (generally 30 percent for solar and fuel cell property) of the cost of the energy property.
The Act allows a taxpayer to make an irrevocable election to treat qualified production credit facilities (other than certain coal and solar facilities) placed in service in 2009 or 2010 as eligible for the immediate 30 percent energy credit, rather than the production tax credit. The purpose in allowing the election is to attract investors to these facilities that might not be willing, in this economic environment, to take the risk of a long-term, credit-based return.
Elimination of Subsidized Energy Financing Limitation
Prior to the Act, the tax basis for the purpose of calculating the energy credit under Section 48 was reduced if the project received subsidized energy financing. The basis was reduced in the same proportion that the subsidized energy financing bore to the entire cost of the project. The term "subsidized energy financing" meant any financing provided under a federal, state or local program a principal purpose of which was to provide subsidized financing for projects designed to conserve or produce energy, thereby reducing the amount of available energy credits. The Act eliminates the reduction for subsidized energy financing.
Grants in Lieu of Energy or Production Credits
A taxpayer that might not have the capacity to utilize tax credits can still obtain the benefit of investing in renewable energy facilities placed in service in 2009 or 2010. The Act authorizes the Treasury Department to issue a grant to each owner of a qualified facility or energy property placed in service during those two years in an amount equal to 30 percent of the basis of the property placed in service that would be eligible for either the energy credit under Section 48 or the production credit under Section 45 (10 percent for property that would be eligible for only a 10 percent energy credit).
The grants are intended to mimic the energy tax credit, thus: (1) the grant is not income, (2) the taxpayer must reduce the tax basis in the energy property by the amount of the grant, (3) a portion of the grant is subject to recapture in the event the property is disposed of by the recipient within 5 years, (4) only the basis of depreciable or amortizable property that would be eligible for a tax credit may be taken into account in determining the amount of the grant, and (5) no grant may be awarded to a federal, state or local governmental authority or a tax-exempt entity. The grants may also be claimed with respect to property not placed in service in 2009 or 2010 if construction begins in either of those years and is completed by certain outside dates.
Credit for Investment in Advanced Energy Property
Despite the numerous credits available for the production or construction of renewable energy production facilities or the use of energy saving property, no existing tax credit was intended to encourage the development of a domestic manufacturing base to produce the equipment used in such facilities. However, the Act adds such a credit.
The Act creates a tax credit equal to 30 percent of the cost of depreciable (or amortizable) property used in a project that equips, expands, or establishes a manufacturing facility for the production of:
- Property designed to produce energy from the sun, wind or geothermal deposits or other renewable sources;
- Fuel cells, microturbins or an energy storage system for electric or hybrid vehicles;
- Electric grids to support the transmission or storage of renewable energy;
- Property designed to capture and sequester carbon dioxide;
- Property designed to refine or blend renewable fuels or produce energy conservation technology;
- Other advanced energy property designed to reduce greenhouse gas emissions as determined by the Secretary of Treasury
To be eligible for credits, the particular project must be certified by the Secretary of Treasury, in consultation with the Secretary of Energy. A program for certification must be created by Treasury within 180 days of enactment of the Act. In certifying a project, the Secretary must give weight to commercially viable projects with the greatest potential for: (1) domestic job creation, (2) pollutant reduction, (3) commercial employment in the United States, (4) low cost of electricity generation or measured reduction of energy consumption, (5) the shortest time from certification to completion.
Expand New Clean Renewable Energy Bonds
New clean renewable energy bonds ("New CREBs") may be issued by qualified issuers to finance qualified renewable energy facilities. A qualified issuer generally includes governmental bodies and public power providers, and qualified renewable energy facilities generally include wind, biomass, geothermal, solar and hydropower facilities. New CREBs are a type of tax credit bond, which means that a taxpayer holding New CREBs on a certain date is entitled to a tax credit based on a credit rate set by the Treasury. There is a national limitation for New CREBs of $800 million. The Act expands the New CREBs program to authorize issuance of up to an additional $1.6 billion of New CREBs.
Expand Qualified Energy Conservation Bonds
Energy conservation bonds may be issued by state and local governments to finance qualified conservation purposes. A qualified conservation purpose includes expenditures incurred for purposes of reducing energy consumption, implementing green community programs, development involving the production of renewable energy and mass commuting facilities and expenditures to support research in energy efficiency projects. Energy conservation bonds are a type of tax credit bond, which means that a taxpayer holding energy conservation bonds on a certain date is entitled to a tax credit based on a credit rate set by the Treasury. There is a national limitation for energy conservation bonds of $800 million. The Act expands the energy conservation bond program to authorize issuance of up to an additional $2.4 billion of energy conservation bonds.
Credit for Nonbusiness Energy Property
There is currently a 10 percent credit for the purchase of qualified energy efficiency improvements to existing homes, such as insulation materials, windows and doors and other heating or cooling efficiency improvements. Additionally, there is a specified dollar amount credit for the purchase of specific energy efficient property such as fans, furnaces and boilers. The Act raises the credit rate to 30 percent and provides that all energy property otherwise eligible for the specified dollar credit is instead eligible for the 30 percent credit on expenditures for such property. The credit is also extended for one additional year, through Dec. 31, 2010. The amendments apply to taxable years beginning in 2009.
Plug-In Vehicle Incentives
Current law provides for a tax credit for new qualified fuel cell and hybrid vehicles. The credit amount varies based on technology, weight, fuel efficiency and other factors, and is generally available for vehicles purchased after 2005. The credit terminates after 2009, 2010 or 2014, depending on the type of vehicle. A credit is also available for qualified plug-in electric drive vehicles that are equipped with a grid-chargeable battery pack. Once a total of 200,000 credit-eligible vehicles have been sold by a manufacturer for use in the U.S., the credit phases out.
The Act expands the type of vehicles qualifying for a credit to include vehicles with leased batteries, as well as two- and three-wheel vehicles and some "neighborhood" electric vehicles, it adds a credit for conversions of conventional vehicles to plug-in hybrids, and doubles the 250,000 vehicle limitation to 500,000.
Extension of First-Time Homebuyer Credit
The Act extends this credit for an additional five months, now for purchases made prior to Dec. 1, 2009, and increases the amount of the credit from $7,500 to $8,000. The Act also eliminates the repayment obligation that had been in the law, so long as the home is not sold within three years after the purchase. A first-time homebuyer that purchases a principal residence in 2009 may elect to treat such purchase as made on Dec. 31, 2008, and can thus claim this credit against 2008 tax liabilities.
Qualified Small-Issue Bonds
The Act permits the proceeds of qualified small-issue bonds which are issued during 2009 or 2010 to be applied to pay for a facility which is used for the creation or production of intangible property (patents, copyrights, formulas, designs, patterns, know-how and formats, and similar property).
National Recovery Zone Bonds
The Act creates two new categories of bonds, national recovery zone economic development bonds and national recovery zone facility bonds, and permits $10 billion of the national recovery zone economic development bonds and $15 billion of the national recovery zone facility bonds to be issued each year for 2009 and 2010. The authorized amount is to be allocated among the states based upon employment decline in that state, and then further allocated among counties and municipalities in each state based upon similar criterion. The proceeds of the bonds are to be applied:
- to pay for construction of public infrastructure, job training and educational programs, and capital expenditures of property;
- within a recovery zone, which includes an area which has significant poverty, unemployment or home foreclosures; and
- for recovery zone property, which applies to construction or rehabilitation of property acquired by purchase after the date that the recovery zone has been designated where substantially all of the use of the property takes place in the active conduct of a qualified business within that recovery zone.
All trades or businesses qualify except for rental of residential real property, golf courses, country clubs, massage parlors, hot tub or suntan facilities, racetrack or other gambling facilities, or liquor stores.
Qualified School Construction Bonds
The Act permits $11 billion of bonds to be issued each year for 2009 and 2010, the proceeds of which are to be applied to construct (including land acquisition), repair or rehabilitate a public school facility. The authorized amount is to be allocated among the states based on criteria specified in the Elementary and Secondary Education Act of 1965.
Alternative Minimum Tax Treatment of Interest
Under the Act, interest on a private activity bond which is issued during 2009 or 2010 is not treated as an item of tax preference in calculating the alternative minimum tax. Moreover, for corporations, in calculating earnings and profits under Section 56(g)(4)(B), interest on tax-exempt bonds issued during 2009 and 2010 is not included. These rules also apply to any refunding bonds issued during those years which refund an obligation issued from 2004 through 2008.
Credit for Interest on Build America Bonds
Pursuant to the Act, with respect to any tax-exempt obligation issued prior to 2011 (which includes national recovery zone bonds and qualified school construction bonds), the issuer may make an irrevocable election to have the interest included in the holder's income. Then the issuer can further elect to either (i) receive a cash subsidy or (ii) have the holder receive a tax credit, in either case equal to 35 percent of the interest payable during that year. The credit allowable to the holder in any year cannot exceed the holder's tax liability for the taxable year (including alternative minimum tax) over the amounts of tax credits otherwise allowed (other than refundable credits and credits with respect to clean renewable energy bonds). Any unused credits granted to the holder may be carried over to future taxable years. The credit is not available for interest payable on private activity bonds.
De Minimis Safe Harbor Exception for Tax-Exempt Interest Expense Limitation For Financial Institutions
Current law does not allow a financial institution to take an interest deduction for the portion of its interest expense that is allocable to its holdings of tax-exempt bonds. The Act excludes from this interest deduction calculation investments in tax-exempt bonds issued during 2009 and 2010 to the extent those bond holdings constitute less than 2 percent of the total assets of the financial institution .
Small Issuer Exception to Tax-Exempt Interest Expense Allocation Rules for Financial Institutions
Tax-exempt bonds issued by a "qualified small issuer" are excluded from a financial institution's interest deduction limitation calculation. The Act increases the dollar threshold from $10 million to $30 million for tax-exempt bonds issued in 2009 and 2010 in determining whether an issuer will be classified as a qualified small issuer. Moreover, in determining that limitation, qualified 501(c)(3) bonds are treated as issued by the 501(c)(3) organization for whose benefit the borrowing was made, not by the actual issuer.