On November 2, 2017, the House Ways and Means Committee released a draft of the Tax Cuts and Jobs Act (the House proposal). On November 9, Senate Finance Committee (SFC) Chairman Orrin Hatch (R-UT) released a summary of the Chairman’s Mark of its proposed version of the Tax Cuts and Jobs Act (the Senate proposal). Together, these two versions of the Tax Cuts and Jobs Act are referred to as the Act.
The Senate began marking up its proposed legislation on November 13, 2017. By November 14, 2017, the SFC released a description of the Chairman’s Modification to the Chairman’s Mark (the Modified Mark). After evaluating a number of individual amendments from his colleagues in the Senate, Senator Hatch, as manager of the bill, offered a Manager’s Amendment to the Modified Mark (the Manager’s Amendment).
On November 16, 2017, the House of Representatives passed the House proposal, and the SFC passed the updated Senate proposal, which included the changes made by the Modified Mark and the Manager’s Amendment. On November 21, 2017, the SFC released the legislative text of the resulting tax reform bill.
While this legislative language is similar to the provisions outlined in the initial Senate proposal, it contains a number of modifications and additions. Some are nuanced tweaks; others are brand new. This alert compares the tax accounting and accounting method provisions of the initial Senate proposal that differ from the final legislative language passed by the SFC. With certain provisions, this alert addresses distinctions between the Senate proposal and the House proposal. (The tax accounting and accounting method provisions not affected by the Modified Mark or the Manager’s Amendment are discussed in our previous Legal Alerts: Take One and Take Two.)
Due to the current wide-ranging availability of business tax deductions and credits, and the negotiability of such limited taxpayer-favorable items, it is likely that as the Act continues to be debated and marked up, certain deductions and credits will be repealed or further modified, and if not, left intact. To the extent deductions and credits play a significant part in a business’s tax planning, it will be important to monitor applicable deductions and credits and take note of the ultimate position of the deductions and credits as tax reform ends.
Corporate Tax Rate Reduction
The modifications to the Senate proposal did not alter the provision reducing the corporate tax rates to a flat rate of 20%, effective for the tax years beginning after December 31, 2018. After 2018, the Senate proposal would reduce the 80% dividends received deduction (DRD) to 65% and the 70% DRD to 50% and would repeal the maximum corporate tax rate on net capital gains.
To pay for this tax benefit, the Senate proposal would repeal or modify a number of existing provisions, including: repeal of section 199 beginning in 2019; limiting business interest expense deductibility; limiting the carryover and carryback of net operating losses (NOLs); and requiring certain research or experimental (R&E) expenditures under section 174 to be capitalized.
Eversheds Sutherland Perspective: The delay in its effective date provides companies with time to plan for changes to the Tax Code, which may include filing amended returns or even filing for relief under section 9100. The delay gives corporate taxpayers time to take advantage of provisions that may be changed or repealed. Taxpayers will also have additional time to make annual elections and to take other actions in anticipation of the corporate tax rate reduction.
Taxpayers should consider whether to file particular accounting method changes in anticipation of the rate change, including taxpayer-favorable accounting method changes that accelerate deductions or defer income. To the extent that requests must be filed with the IRS National Office on or before the last day of the tax year for which the change is effective, such non-automatic changes must be filed by December 31, 2017, for calendar year taxpayers. In this regard, taxpayers may want to consider filing the following changes: certain revenue recognition method changes such as percentage of completion method changes under section 460, ASC 606 method changes, and advance payments in connection with the sale of goods under Treas. Reg. § 1.451-5; deduction method changes such as acceleration of payment liabilities under a recurring item exception; and, inventory method changes such as changing from a method of allocating expenses to ending inventory as a part of the taxpayer’s book method or UNICAP method to a method of currently expensing these costs.
To the extent that the change is available automatically, such accounting method changes can be filed as of the extended due date for the taxpayer’s 2017 federal income tax return. Many taxpayer-favorable accounting method changes are available automatically, including, for example, tangible property/depreciation, customer rebates and allowances, accrued compensation, deducting prepaid payment liabilities (e.g., insurance, licenses, fees), and changing to defer revenue using advance payment provisions. Additionally, companies should consider items that relate to changes in facts, for which no accounting method change is required (e.g., amending a return to capture missed deductions (section 199 deductions, missed section 174 costs, etc.); filing carryback claims to take advantage of the current NOL provisions; and prepayment at year-end for certain goods and services, making prepayments, etc.).
Repeal of Alternative Minimum Tax (AMT) for Corporations
The modifications to the Senate proposal did not alter its repeal of the AMT. If there is currently a carryforward AMT credit available, a taxpayer would be able to claim a refund of 50% of the remaining credits in tax years beginning in 2019, 2020, and 2021. Taxpayers would be able to claim a refund of all remaining credits in the tax year beginning in 2022.
Eversheds Sutherland Perspective: Because the AMT is being repealed and because the Senate proposal envisions a 50% limitation on refundable credits beginning after 2017 and defers deduction of all remaining credits until 2022, companies with AMT credits should ensure that these amounts have been properly carried back prior to repeal. To the extent that credits remain subsequent to repeal, usage will be available on a more limited basis under the transition rules.
Limitation on Deduction for Interest
The Senate proposal limits deductions for net interest expenses to 30% of the adjusted taxable income. This limitation applies at the taxpayer level (or at the consolidated tax return level for affiliated companies). Any disallowed interest expense may be carried forward indefinitely. The Senate proposal excludes small businesses meeting its gross receipts test as well as certain regulated public utilities.
The Modified Mark allows farming businesses (as defined in section 263A(e)(4)) to elect not to be subject to the limitation, but those electing businesses must use the alternative depreciation system to depreciate any property used in the farming business with a recovery period of 10 years or more. The Manager’s Amendment adds certain electric cooperatives to the entities already excluded from this limitation provision.
Eversheds Sutherland Perspective: The limitations on deductible interest will have significant economic consequences for certain businesses. The Manager’s Amendment softens the economic effects for farming businesses although this change includes a trade-off of longer recovery for depreciable assets. Further, the modification treats electric cooperatives similar to other utilities.
Expanded Bonus Depreciation and Other Cost Recovery Provisions
The House proposal provides a five-year period for taxpayers to expense 100% of the cost of “qualified property” acquired and placed in service after September 27, 2017, and before January 1, 2023. The proposal expands the definition of qualified property eligible for additional depreciation, allowing the provision to apply to both new and used property. It repeals the taxpayer election to use alternative minimum tax (AMT) credits in lieu of additional depreciation, and it explicitly excludes from classifying as qualified property any property used by a regulated public utility company and any property used in a real property trade or business.
Like the House proposal, the Senate proposal expands bonus depreciation to allow full expensing of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The Senate proposal makes fewer modifications to the existing definition of qualified property for bonus depreciation. Under section 168, qualified property includes (1) MACRS property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; and (4) qualified improvement property. In addition, the original use of qualified property must begin with the taxpayer, and the property must be acquired and placed in service within certain parameters.
The Senate proposal extends additional first-year depreciation through 2022 (2023 for longer production period property and aircraft). Like the House proposal, the 50% allowance is increased to 100%. The Senate proposal excludes certain public utility property from the scope of qualified property and makes a conforming amendment to the repeal of the AMT—repealing the election to accelerate AMT credits in lieu of additional depreciation.
Unlike the House proposal, which excludes real property used in a trade or business from the full expensing provisions, the Senate proposal does not exclude such property. Rather, the Senate proposal shortens the recovery period from 39 years for non-residential real property and 27.5 years for residential real property to 25 years for both non-residential real property and residential rental property. The Senate proposal also eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, consolidating them under section 179(f) as “qualified improvement property.” The Senate proposal provides a general recovery period of 10 years for this property and a special recovery period of 20 years for property that falls under the alternative depreciation system (ADS). There is also a proposed conforming amendment to section 467 changing the statutory recovery period for purposes of determining whether a rental agreement is a long-term agreement. The Senate proposal further requires a real property trade or business electing out of the limitation on interest deduction to use ADS for non-residential real property, residential real property and qualified improvement property. Finally, the Senate proposal would restore a provision, which expired at the end of 2009, that permitted farmers and ranchers to depreciate most farm machinery and equipment over five years rather than seven years. The provision also would repeal the rule under current law that requires property used in a farm business to be depreciated more slowly than in other industries. The Modified Mark expands the definition of qualified property eligible for the additional first-year depreciation allowance to include qualified film, television and live theatrical productions, effective for productions placed in service after September 27, 2017, and before January 1, 2023. For this purpose, a production is considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).
The Modified Mark also shortens the alternative depreciation system recovery period for residential real property from 40 years to 30 years, effective for property placed in service after December 31, 2017.
Eversheds Sutherland Perspective: Although the final language expands upon the Senate’s initial proposal, it is still less generous than the House proposal. The House proposal expands the current definition of qualified property by repealing the original use requirement, making full expensing available to both new and used property. However, the Senate Proposal retains the original use requirement. Further, the modifications made through the Modified Mark and the Manager’s Amendment did not make any changes to the depreciation for luxury automobiles and personal use property or the farm equipment recovery provision.
For luxury automobiles placed in service in 2017 and for which the additional first-year depreciation deduction under section 168(k) is not claimed, the maximum amount of allowable depreciation deduction is increased significantly – from $3,160 in the first year; $5,100 in the second year; $3,050 in the third year; and $1,875 in the fourth and later years to $10,000; $16,000; $9,600; and $5,760, respectively. The Senate bill restores a provision that expired in 2009 that permitted farmers and ranchers to depreciate most farm machinery and equipment over five years rather than seven years. It would also repeal the rule that requires property used in a farm business to be depreciated more slowly than in other industries.
The Senate proposal strays from the House proposal in several interesting ways. The most significant distinction is the difference between the respective definitions of qualified property provided in section 168(k). For the Senate proposal, the temporary full expensing provision will be limited to new property. The House proposal is more generous because it allows additional bonus depreciation for used property. Furthermore, the Senate proposal failed to exclude property used in a real property trade or business.
Nonetheless, the Senate proposal shortens the recovery period to determine depreciation deductions from 39 years to 25 years; reduces compliance complexities by eliminating the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property; and provides a general 10-year recovery period for qualified improvement property. In addition to this focus on real property, the Senate proposal provides more favorable treatment for luxury automobiles and certain farm property.
Like-Kind Exchanges of Real Property
The modifications did not change the Senate proposal limiting the non-recognition of gain in the case of like-kind exchanges of real property. Generally, this provision would apply to exchanges occurring after December 31, 2017, but it does provide an exception for any exchange if either the property being exchanged or received is exchanged or received before January 1, 2018.
Eversheds Sutherland Perspective: Due to the generous transition period, there remains a planning opportunity for taxpayers intending to make such an exchange. Although the new rule would eliminate deferral under section 1031 for exchanges of tangible personal property and intangible property, there is a window period during the transition period to complete any final exchanges under the historic provisions. Additionally, for tangible personal property, the proposed allowance for full expensing may offset the negative impact of eliminating the gain deferral under section 1031. However, for personal property not subject to full expensing and intangible property, the proposed limitation to section 1031 would likely have an adverse impact.
Expansion of Section 179 Expensing
The modifications did not change the Senate proposal expanding section 179 expensing. The Senate proposal increases to $1 million the amount a taxpayer may deduct under section 179, with the phase-out amount raised to $2.5 million, effective for tax years beginning after December 31, 2017.
Eversheds Sutherland Perspective: As described, the $1 million limitation is reduced, but not below zero, by the amount by which the cost of qualifying property placed in service during the taxable years exceeds $2.5 million. The limitation reduction provides a planning opportunity for taxpayers investing more than $3.5 million in qualifying property because there would be no limitation on the possible total amount written off by the taxpayer. For companies considering an investment in qualifying property, it is important to consider the opportunity that exists between the effective date of this provision—tax years beginning after December 31, 2017—and the effective date of the corporate tax rate reduction—tax years beginning after December 31, 2018. Investments made during this period will receive the benefit of this provision at the currently high corporate tax rates.
Repeal of the Domestic Production Manufacturing Deduction under Section 199
The modification left in place the original Senate proposal repealing the domestic production activities deduction under section 199. The provision is delayed until tax years beginning after December 31, 2018.
Eversheds Sutherland Perspective: The original intent of the section 199 deduction was to provide a targeted corporate rate reduction that would allow US companies to compete against international tax systems, while also drawing international companies to the United States and its tax structure. Because this provision encourages domestic production, repeal seems at odds with the overall focus of the Act, US economic development. Nonetheless, it is suggested that the overall corporate rate reduction provides a larger benefit and repeal of section 199 is required to meet revenue targets. Coupled with the delay in the corporate tax rate reduction, the timing of this repeal creates an opportunity for companies to take advantage of this deduction at the current, higher corporate tax rates. But such potential planning must be balanced against the benefits of more traditional planning (deferral of income and acceleration of deductions) in the context of tax rate reform.
Reduction in Amount of NOLs and Repeal of Most NOL Carrybacks
The House proposal reduces the potential amount of a taxpayer’s net operating loss (NOL) deductions to 90% of the taxpayer’s taxable income. This proposal eliminates all NOL carrybacks except for a special one-year carryback for small businesses and farms in the case of certain casualty and disaster losses.
Similarly, the Senate proposal reduces the NOL deduction to 90% of the taxpayer’s taxable income and eliminates most NOL carrybacks. This proposal, however, allows a two-year carryback for certain losses incurred in a farming business.
The Modified Mark reduces the Senate proposal’s 90% deduction to 80% for taxable years beginning after December 31, 2023. (The Manager’s Amendment provides the effective date for this change to be for taxable years beginning after December 31, 2022.) The Modified Mark preserves present law for the NOLs of property and casualty insurance companies. Under this modification, the NOLs of property and casualty insurance companies may be carried back two years and carried forward 20 years to offset 100% of taxable income in such years.
The Senate proposal further specifies that the 80% limitation on NOLs would be repealed if the Treasury Secretary determines that aggregate on-budget federal revenues for all sources for fiscal years 2018 through 2026 exceed a certain dollar threshold.
Eversheds Sutherland Perspective: The modified Senate provision seems to marry the two proposals and pay for the marriage with a 10% reduction in the deduction for taxable years after December 31, 2023. When evaluating how to assess the impact of this change, it will be important for taxpayers to pay attention to the timing of such losses because the changes vary depending on the type and timing of the NOL. Taxpayers should fully evaluate any NOLs currently captured on their balance sheets as deferred tax assets to ensure that they are taking full advantage of the NOL carryback provisions before the provisions are repealed.
Special Rules for Tax Year of Income Inclusion
The modifications did not affect the original Senate proposal to revise the rules associated with the recognition of income. It specifically requires taxpayers to recognize income no later than the tax year in which such income is taken into account for book purposes. This proposal codifies the Deferral Method in Rev. Proc. 2004-34, 2004-22 I.R.B. 991. The Senate proposal suggests that the proper time for recognizing income for tax purposes should be matched with when it is recognized for financial accounting purposes. The proposal would apply to income instead of the original issue discount (OID) rules. As a result, items such as late-payment fees, cash-advance fees, and interchange fees would be included in taxable income upon receipt and treated as income for financial accounting purposes. Currently, the OID provisions allow income deferral for these items. Importantly, this proposal would be effected as a change in method of accounting requiring a section 481 adjustment.
Eversheds Sutherland Perspective: Because of the distinctive goals of financial accounting (conservatism) and income tax accounting (clear reflection of income), it seems improper to designate when a taxpayer must recognize income based on when that income is recognized for financial accounting purposes. Nonetheless, the codification of the one-year deferral for advance payments from Rev. Proc. 2004-34 will be a welcome change because that treatment had previously only been available administratively, which meant that it could be subject to revision or even repeal. Codification will give taxpayers confidence that it cannot be easily eliminated. However, codification means that the IRS may reconsider other administrative deferral provisions under section 451, such as those for goods or for coupon redemption. Although taxpayers will appreciate the Senate’s codification of an administrative provision that many companies use to defer income attributable to advance payments with respect to goods and services, the proposal may result in a narrowing of the other administrative deferral provisions by the IRS. With respect to taxpayers that would see an acceleration of income (for example, due to the changes to OID), taxpayers would be required to effect the change immediately. Further, the change is effected through an accounting method change, which for these taxpayers means a positive section 481(a) adjustment that will be required when the tax rate is 35%.
Research and Experimental Expenditures
Under the Modified Mark, amounts defined as specified R&E expenditures are required to be capitalized and amortized ratably over a five-year period, beginning with the midpoint of the taxable year in which the specified R&E expenditures were paid or incurred. Specified R&E expenditures, which are attributable to research that is conducted outside of the United States, are required to be capitalized and amortized ratably over a period of 15 years, beginning with the midpoint of the taxable year in which such expenditures were paid or incurred. Specified R&E expenditures subject to capitalization include expenditures for software development.
Specified R&E expenditures do not include expenditures for land or for depreciable or depletable property used in connection with the R&E, but do include the depreciation and depletion allowances of such property. Also excluded are exploration expenditures incurred for ore or other minerals (including oil and gas).
In the case of retired, abandoned, or disposed property with respect to which specified R&E expenditures are paid or incurred, under the proposal, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period.
The application of this rule is treated as a change in the taxpayer’s method of accounting for purposes of section 481, initiated by the taxpayer, and made with the consent of the Secretary. This rule is applied on a cutoff basis to R&E expenditures paid or incurred in taxable years beginning after December 31, 2025 (hence there is no adjustment under section 481(a) for R&E expenditures paid or incurred in taxable years beginning before January 1, 2026).
The proposal applies to amounts paid or incurred in taxable years beginning after December 31, 2025.
The Manager’s Amendment could add reporting requirements for R&E expenditures in tax years beginning after December 31, 2024. Failure to report would result in a fine of $1,000 per day (up to a maximum of $250,000).
Eversheds Sutherland Perspective: This new Senate provision is substantively similar to the House provision. The Senate provision applies to expenditures paid or incurred in tax years beginning after December 31, 2025—three years later than the House provision. It requires the capitalization and amortization of domestic R&E expenses over five years (15 years for expenses related to research outside of the U.S.).
The Senate proposal reflects a significant change in the treatment of R&E expenditures subject to section 174. Currently, these amounts are deductible immediately, or an election can be made to treat them as deferred expenses and recovered ratably over a period of not less than 60 months. Further, an election is available under section 59(e) to recover R&E expenditures over 10 years, which would be repealed as part of the AMT repeal. Once in force, the impact of this change in the short term will be a higher tax bill, which is likely to have a negative impact on research activities. Companies are currently incented to invest in research through immediate expensing. Companies that cannot take advantage of the deduction are allowed to elect slower recovery for R&E expenditures.
Unfortunately, the accelerated recovery of R&E costs will be reduced under the current proposal. Moreover, the Senate proposal also requires that companies continue to amortize R&E expenditures even after the activities have been abandoned or retired. The Senate proposal also makes an important change in the treatment of software development costs, which are currently deductible under section 174 as provided in administrative guidance with Rev. Proc. 2000-50, 2000-2 C.B. 601 (December 4, 2000). The Senate proposal would require capitalization of these otherwise deductible expenses, which can be quite significant.
The Senate proposal may further be used by the IRS to clarify that changes in the treatment of R&E expenditures under section 174 should be treated as an accounting method change. Currently, there is a question on whether such changes should be effected with an accounting method change or an amended return. See FAA 20170501F (finding that under Rev. Rul. 58-74, a taxpayer may amend returns for open years to deduct certain costs resulting in depreciable property being treated as section 174 expenditures). Because this provision is implemented with an accounting method change, the IRS may take the position that other changes involving section 174 cannot be implemented with an amended return.
Zero-Percent Dividends Paid Deduction and Reporting Penalty
The Manager's Amendment would continue forbidding a corporation to be able to deduct dividends paid when computing taxable income for purposes of computing taxable income subject to section 11. However, the amendment would require corporations that pay dividends to shareholders to report the total dividends paid during the tax year and during the first 2-1/2 months of the next tax year. Failure to file such information return would be subject to a daily penalty of $1,000 not to exceed $250,000.
Eversheds Sutherland Perspective: Courts assume that every word written into law by Congress has meaning. This assumption makes a zero percent tax rate all the more interesting to consider. It is very likely that this provision is a placeholder for a future dividends paid deduction, which is part of anticipated corporate integration. This concept would help reduce the double taxation of corporations, which pay taxes on their income and on the dividends they distribute to investors.
Qualified Opportunity Zones
The Code contains many tax incentives to aid economically distressed areas. Many of these incentives seek to attract the investment of capital into distressed communities. These investments may be used to start new businesses, develop abandoned property, or provide low-income housing.
The Modified Mark adds two tax incentives for investments in qualified opportunity zones. The first tax incentive in the plan would provide for the deferral of income for capital gains if the gains are reinvested in a qualified opportunity fund. The plan would define a qualified opportunity fund as an investment vehicle organized as a qualified opportunity zone that holds at least 90% of its assets in qualified opportunity zone property. It would also provide that the certification process for a qualified opportunity fund be done by the Department of Treasury's Community Development Financial Institutions Fund and mirror the process for allocating the new markets tax credit.
The plan would define a qualified opportunity zone property as any qualified opportunity zone stock, any qualified opportunity zone partnership interest, or any qualified opportunity zone business property. The plan would further limit the maximum amount of gain that may be deferred to be equal to the amount invested in a qualified opportunity fund by the taxpayer during the 180-day period beginning on the date of the sale of the asset to which the deferral pertains. The plan would require that amounts exceeding the maximum deferral amount be recognized as capital gains and, thus, be includible in gross income.
The plan would also provide basis adjustments if an investment in a qualified opportunity zone fund is held for a certain period of time. The plan would provide the basis on the original gain increase by 10% of the original gain if the taxpayer holds the investment in the qualified opportunity zone fund for at least five years. The plan would provide that if the taxpayer holds the asset or investment for seven years, the basis will increase an additional 5% of the original gain. The plan would provide that the deferred gain be recognized on the earlier of the date on which the qualified opportunity zone investment is disposed of or December 31, 2026. Only taxpayers that rollover capital gains of non-zone assets before December 31, 2026, would be able to take advantage of the special treatment of capital gains for non-zone and zone realizations.
The plan would provide that the basis of an investment in a qualified opportunity zone fund immediately after its acquisition is zero. However, if the taxpayer held the investment for at least five years, the basis on the investment would be increased by 10% of the deferred gain. The plan would further provide that if the investment is held by the taxpayer for at least seven years, the basis on the investment would be further increased by an additional 5% of the deferred gain. If the taxpayer holds the investment until at least December 31, 2026, then the basis in the investment would increase by the remaining 85% of the deferred gain.
The second tax incentive in the plan would allow any post-acquisition capital gains on investments in opportunity zone funds that are held for at least 10 years to be excluded from gross income. The plan would provide the taxpayer with an election, in the case of the sale of exchange of an investment in a qualified opportunity zone fund held for more than 10 years, to have the basis of such investment be equal to the fair market value of the investment at the date of such sale of exchange. The bill would not prohibit taxpayers from recognizing losses associated with investments in qualified opportunity zone funds as under current law.
Eversheds Sutherland Perspective: Following the designation of qualified opportunity zones, the creation of a qualified opportunity fund might be a good planning tool for purposes of tax deferral and developing goodwill in local communities.
Orphan Drug Credits
The Senate proposal limits the orphan drug credit to 50% of qualified testing expenses for the taxable year as exceeds 50% of the average qualified clinical testing expenses for the three taxable years preceding the taxable year for which the credit is being determined. In the event that one of the three preceding years has no qualified clinical expenses, the credit is equal to 25% of the qualified expenses. Similar to the research credit under section 280C, the proposal allows taxpayers to elect a reduced credit in lieu of reducing otherwise allowable deductions. The proposal also limits qualified clinical testing expenses to the extent that the testing giving rise to such expenses is related to the use of a drug that has previously been approved in the treatment of any other disease or condition, if all such diseases taken together affect more than 200,000 persons in the United States.
The Manager’s Amendment puts the Orphan Drug Credit rate at 27.5% (instead of the current law’s 50% rate), and would have reporting requirements similar to those required in sections 48C and 48D. The Manager’s Amendment would further modify the mark by striking any base amount calculation and by striking the limitation regarding qualified clinical testing expenses to the extent such testing relates to a drug which has previously been approved under section 505 of the Federal Food, Drug, and Cosmetic Act.
Eversheds Sutherland Perspective: The reforms proposed by the Senate would result in a significant cut to the current opportunities available to companies that take advantage of the credit. Due to the recent attention paid to pharmaceutical drug prices and the heat that Congress has placed on the industry, it is important for taxpayers that use such credits to closely monitor this provision to fully understand the impact its repeal or reduction could have on ongoing operations.
The Senate proposal modified the rehabilitation credit, repealing the 10% rehabilitation credit for pre-1936 buildings and reducing the credit to 10% for qualified rehabilitation expenditures with respect to certain historic structures.
The Manager’s Amendment provides: (1) a 20% credit for qualified rehabilitation expenditures with respect to a certified historic structure; and (2) that the 20% credit be claimed ratably over a five-year period beginning in the taxable year in which a qualified rehabilitated structure is placed in service.
Eversheds Sutherland Perspective: Any taxpayer engaged in—or considering engaging in—any rehabilitation projects should take time to evaluate the project timeline. It will be important to take advantage of the transition period. For projects with timelines extending past the transition period, it will be important to reevaluate contracts to understand what protections are provided.
Employer Credit for Paid Family and Medical Leave
The Senate plan would allow eligible employers (employers that allow all qualifying full-time employees at least two weeks annual paid family and medical leave and allow part-time employees a commensurate amount of leave on a pro rata basis, without regard to leave paid for by a state or local government) to claim a business credit equal to 12.5% of the wages paid to qualifying employees during any period during which such employees are on family and medical leave (FMLA leave) if the payment rate under the program is 50% of the wages normally paid to an employee. The credit would be increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.
A qualifying employee would be any employee, as defined in section 3(e) of the Fair Labor Standards Act of 1938, whom the employer has employed for at least one year, and whose compensation for the preceding year was less than or equal to 60% of the compensation threshold for highly compensated employees. If an employer provides paid leave as vacation leave, personal leave, or other medical or sick leave, this paid leave would not be considered family and medical leave.
These changes would be effective for wages paid in taxable years beginning after December 31, 2017, but the credit would not apply to wages paid in taxable years beginning after December 31, 2019.
Eversheds Sutherland Perspective: The addition of this credit provides a tax benefit to companies that are already compensating their employees who are using leave under the FMLA. This credit opportunity provides a planning opportunity and an opportunity to reexamine the current employee benefits offered.
Citrus Farmer Relief
The Manager’s Amendment seeks to aid citrus growers as they replant in the wake of the recent hurricanes. The amendment modifies the special rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage due to casualty. Significantly, the proposal allows recovery for parties other than the taxpayer provided that certain equity requirements are met.
Under the proposal, with respect to replanting costs paid or incurred after the date of enactment, but no later than a date which is 10 years after such date of enactment, for citrus plants lost or damaged due to casualty, such costs may be deducted by a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50% in the replanted citrus plants at all times during the taxable year in which the replanting costs are paid or incurred and such other person holds any part of the remaining equity interest, or (2) such other person acquires all of the taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land.
Eversheds Sutherland Perspective: For those taxpayers that now fall within the equity requirements laid out in the Manager’s Amendment, it will be important to review the provisions, ensure they fall within the requirements, and properly take advantage of this new available opportunity.
Relief for Craft Brewers and Wine and Spirits Producers
The Modified Mark excludes the aging periods of beer, wine, and distilled spirits from the calculation of the production period for purposes of the UNICAP interest capitalization rules. This “CRAFT beverage modernization” provision, introduced by Senator Rob Portman of Ohio, would lower the tax rate on beer produced in the United States, particularly for small breweries. The amendment will lower the tax on beer to $16 per barrel on the first six million barrels brewed, and lower it to $3.50 per barrel for small brewers on the first 60,000 barrels produced domestically.
Eversheds Sutherland Perspective: The UNICAP provisions of section 263A require certain direct and indirect costs allocable to real or tangible personal property produced to be capitalized into the cost basis of the property produced. Interest costs that must be capitalized are generally limited to certain types of property: real property with a 20-year depreciable life; personal property with a production period estimated to exceed two years; and personal property with a production period estimated to exceed one year with estimated costs of more than $1 million. For property that is aged (such as beer, wine, and distilled spirits) the aging time is generally included in the production period, which means that these producers are generally required to capitalize interest expenses. However, the Senate proposal would exclude such producers from the interest capitalization provisions, making interest expense otherwise deductible, a benefit appreciated by these taxpayers.
Aircraft Management Services
The Modified Mark would exempt certain payments related to the management of private aircraft from the excise taxes imposed on taxable air transportation. Exempt payments would include amounts paid by an aircraft owner for management services related to maintenance and support of the owner’s aircraft or flights on the owner’s aircraft.
Eversheds Sutherland Perspective: This proposal would provide certainty on the issue of whether amounts paid to aircraft management service companies are taxable. In March 2012, the IRS issued a Chief Counsel Advice concluding that amounts paid to aircraft management companies were generally subject to tax and the management company must collect the tax and pay it over to the government. The IRS began auditing aircraft management companies for this tax; however, it suspended assessments in May 2013 to develop further guidance. In 2017, the IRS decided not to pursue examination of this issue and conceded it in ongoing audits. No further guidance has been issued to date; therefore, this provision in the Modified Mark would serve as a welcome piece of guidance to assist those taxpayers that incur such costs.