Congress and President Bush Finally Agree on Tax Legislation

Scott E. Vincent
Vincent & Fontg LLC
Kansas City
As this article went to press, President Bush was expected to sign a $70 billion tax reconciliation package (H.R. 4297 – “Tax Increase Prevention and Reconciliation Act of 2005”) that the administration and Congress have been negotiating for several months. The package, which passed both the House and Senate in early May, has both business and investor tax breaks. There are also provisions to protect middle-class families from AMT exposure. The investment tax breaks are generally extended through 2010, when all of the tax cuts enacted under the Bush administration will expire.

Key Provisions of the Bill

As noted, the legislation has a variety of provisions for business, investors and individuals. Some of the key provisions include the following:

• Two-year extension of the 15% top tax rates on capital gains and dividend income;

• An increase from “under 14” to “under 18” as the age of minor children whose unearned income is taxed as if it were their parent’s income;

• An AMT hold harmless provision extending exemption levels though the end of 2006 at a higher level: $62,550 (married) and $42,500 (other);

• Provisions allowing more taxpayers to convert to Roth individual retirement accounts by removing the modified adjusted gross income limitations on rollovers from a traditional IRA to a Roth IRA, with some payment relief provisions for rollovers in future years;

• Requirements that interest paid on tax-exempt bonds be subject to information reporting in a manner similar to that for interest paid on taxable obligations;

• New requirements for partial payments with offers-in-compromise submissions;

• A small business expensing provision extending the 2003 enhanced provisions through the end of 2009;

• Two-year extension of the active financing exception under small business expensing provisions;

• Provisions denying tax-free treatment for certain spin-offs where either the distributing corporation or the controlled corporation is a “disqualified investment corporation”;

• Extending from two years to five years the period during which oil companies have to write off geological and geophysical expenses;

• Provisions applying earnings stripping rules to partners that are C corporations;

• Changes to corporate estimated tax payments that raise revenue by increasing certain payments for corporations with assets of more than $1 billion;

• Another provision to raise revenue by requiring withholding on certain payments (after 2010) to those providing services to the government in an attempt to improve compliance through withholding;

• Penalties on certain tax-exempt entities for participating in prohibited tax shelter transactions as accommodation parties; and

• Provisions regarding the controlled foreign corporation look-through exception for cross-border payments of dividends, interest, rents, and royalties that are funded with active income that has not been repatriated.

Foreign Sales Corporation Provisions

The domestic manufacturing deduction for a foreign sales corporation (FSC) is to be limited to 50% of the wages paid by the taxpayer during the calendar year that ends in such taxable year. Only wages allocable to domestic production gross receipts are included for purposes of this limitation. The reconciliation bill also repeals all of the FSC grandfathering provisions, including grandfathering of leasing contracts which typically involve goods that have already been exported.

These provisions are significant revenue raisers in the package. Congress also indicated that the FSC provisions were included in the bill in an effort to eliminate the whole FSC structure over which the EU and other countries have threatened to retaliate against the United States.

Foreign Earned Income Exclusion

Another revenue raiser changes certain provisions of the foreign earned income exclusion and housing allowance for U.S. citizens working abroad, including:

• indexing the income exclusion for inflation starting in 2006 (rather than 2008 under current law);

• making the base housing amount used in calculating the foreign housing cost exclusion in a taxable year 16% of the amount of the foreign earned income exclusion limitation (instead of the present law 16% of the grade GS-14, Step 1 amount); and

• including income that is excluded as either foreign earned income or as a housing allowance in determining marginal applicable tax rates.

Plans for Additional Tax Extenders

Congress is considering an additional package of tax extenders that were pushed out of the reconciliation bill by revenue limitations. This “follow-on” package is expected to include the following:

• Expanded R&D credit;

• Two-year extension of state and local sales tax deductibility; and

• Deductions for college tuition and out-of-pocket teacher expenses.

There is pressure in Congress to complete the pension measure before Memorial Day, so watch for these extenders as part of that package in early summer.