On February 17, 2009, as part of a comprehensive economic stimulus plan, President Barack H. Obama signed into law the $787 billion American Recovery and Reinvestment Act of 2009 (ARRA). The administration and lawmakers hope the ARRA will aid in the country's recovery from the current recession. Approximately one-third of the $787 billion is allocated to tax cuts that affect both businesses and individuals. This alert provides a general summary of some of the more important business tax provisions, energy tax provisions and Small Business Administration provisions of the ARRA.
The ARRA includes $13.5 billion in business tax incentives, including but not limited to the following:
Extension of Bonus Depreciation. Last year, Congress temporarily allowed businesses to recover the costs of capital expenditures made in 2008 faster than the ordinary depreciation schedule would allow by permitting these businesses to immediately write-off 50 percent of the depreciable basis of qualifying property acquired in 2008 (after any Section 179 deduction and before figuring out the regular depreciation deduction). Qualifying property includes, among other categories, tangible property depreciated under the modified accelerated cost recovery system (MACRS) with a recovery period of 20 years or less. Among other requirements, the original use of the property must have begun with the taxpayer in 2008. The ARRA extends this temporary benefit for capital expenditures in 2009 (and 2010 for certain longer-lived and transportation property).
Extension of Election to Accelerate Historic Alternative Minimum Tax (AMT) and Research and Development Credits. The ARRA generally permits corporations to increase the research credit or minimum tax credit limitation by the bonus depreciation amount with respect to certain property placed into service in 2009 (2010 in the case of certain longer-lived and transportation property).
Five-Year Carryback of Net Operating Losses (NOL). An NOL is the excess of business deductions (computed with certain modifications) over gross income in a particular tax year. An NOL from one tax year can be deducted, through an NOL carryback or carryforward, in another tax year in which gross income exceeds business deductions. In general, NOLs may be carried back two years and forward 20 years. The NOL is first carried back to the earliest tax year for which it is allowable as a carryback and is then carried to the next earliest tax year. Any NOL remaining after application in the two-year carry-back period can be used prospectively to offset income in future years. However, a taxpayer may elect to take the NOL as a carryforward without first using any as a carryback.
The ARRA allows "eligible small businesses" to elect to carryback NOLs for taxable years ending in 2008 (or if the small business elects, for taxable years beginning in 2008) for a period of up to five years. Therefore, an eligible small business taxpayer can choose a three-, four-, or five-year carryback period for its 2008 NOL, rather than being limited to the otherwise applicable two-year carryback period. The key factor in deciding whether to elect to carry an NOL back three, four, or five tax years should be which election will result in the largest tax savings. Other than compliance issues and the possibility that the taxpayer was taxable at a low rate in an early year (and could benefit from not reducing lightly taxed income in favor of reducing income taxed at a higher rate in a later year), there does not appear to be any reason why an eligible small business taxpayer would not elect the longest carryback period. The carryfoward period remains 20 years.
Unlike the special five-year carryback for 2001 and 2002 for NOLs included in the Job Creation and Worker Assistance Act of 2002 that automatically applied, a taxpayer must affirmatively elect the increased carryback under the ARRA. The ARRA does not affect a taxpayer's ability to elect to forego the entire carryback for the NOL and instead carries it forward.
An applicable eligible small business is a taxpayer whose average annual gross receipts for the three-tax-year period (or shorter period of existence) ending with the tax year before the year in which the loss arose are $15 million or less. In other words, a taxpayer's average annual gross receipts for 2005 – 2007 must not have exceeded $15 million. If a taxpayer's average annual gross receipts exceed $15 million, it can carryback the NOL only two years under the general rule.
Extension of Enhanced Section 179 Expensing of Certain Depreciable Business Assets. The ARRA extends the capital expenditure write-off election of $250,000 with the phase-out threshold of $800,000 that was in effect for 2008 – 2009. Under current law (prior to the ARRA), in lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment in depreciable assets can elect to deduct (or expense) such costs under Section 179. The maximum amount a taxpayer can expense for taxable years beginning in 2008 is $250,000 of the cost of qualifying property placed in service for the taxable year. For taxable years beginning in 2009 and 2010, the limitation is $125,000. For taxable years beginning in 2008, the $250,000 is reduced (but not below zero) by the amount by which the cost of qualifying property placed into service during the taxable year exceeds $800,000 (for taxable years beginning in 2009 and 2010, $500,000). The ARRA extends the $250,000 and $800,000 amounts to taxable years beginning in 2009.
Deferred Recognition of Cancellation of Indebtedness Income (COD). Generally, absent the taxpayer qualifying for one of five exceptions, the discharge or cancellation of a debt results in the debtor recognizing COD income, taxed at ordinary income rates. The five exceptions to the recognition of income from a discharge of indebtedness are:
- Bankruptcy
- Insolvency
- Discharge of "qualified farm indebtedness"
- Discharge of "qualified real property business indebtedness"
- Discharge of up to $2 million of mortgage debt on the taxpayer's principal residence
Generally, an issuer of a debt instrument that later repurchases the instrument for less than its adjusted issue price must recognize income equal to the excess of the adjusted issue price over the repurchase price. A repurchase can be for cash or in exchange for a new obligation or security. Prior to the passage of the ARRA, COD income was required to be recognized in the year of repurchase. The ARRA provides that COD income from the reacquisition of an "applicable debt instrument" after December 31, 2008 and before January 1, 2011, is includible in gross income ratably over a period of five tax years beginning with: (1) for reacquisitions occurring in 2009, the fifth tax year following the tax year in which the reacquisition occurs; and (2) for reacquisitions occurring in 2010, the fourth tax year following the tax year in which the reacquisition occurs. For example, if in 2009 a taxpayer reacquires notes that it issued with an adjusted issue price of $4 million for a purchase price of $3 million, the taxpayer has COD income equal to $1 million. If the taxpayer elects to include the income over a five-year period, it will recognize $200,000 in each of the five tax years from 2014 to 2018.
A taxpayer may determine that it is best to not make the deferral election if it has an NOL carryover that it could use to offset the COD income and the NOL is expiring. Further, if the taxpayer qualifies for one of the five exceptions discussed above, the deferral election is not necessary.
An applicable debt instrument is any debt instrument issued by (1) a C corporation or (2) any other person in connection with the conduct of a trade or business by such person. For the purposes of the provision, a "debt instrument" is broadly defined to include any bond, debenture, note, certificate, or any other instrument or contractual arrangement constituting indebtedness (within the meaning of Section 1275(a)(1)).
A "reacquisition" is any "acquisition" of an applicable debt instrument by (1) the debtor that issued (or is otherwise the obligor under) such debt instrument or (2) any person related to the debtor within the meaning of Section 108(e)(4). For purposes of the provision, an acquisition includes, without limitation:
- An acquisition of a debt instrument for cash
- The exchange of a debt instrument for another debt instrument (including an exchange resulting from a modification of a debt instrument)
- The exchange of corporate stock or a partnership interest for a debt instrument
- The contribution of a debt instrument to the capital of the issuer
- The complete forgiveness of a debt instrument by a holder of such instrument
The ARRA includes special rules for debt-for-debt exchanges, acceleration of deferred items, and partnerships.
Increased Exclusion on Gain From Sale of Qualified Small Business Stock. Prior to the ARRA, noncorporate taxpayers can exclude 50 percent of any gain realized on the sale or exchange of "qualified small business stock" (QSBS), as defined under Section 1202(c) of the Internal Revenue Code, held for more than five years. Further, for QSBS in a corporation that is a "qualified business entity" (QBE) during substantially all of the taxpayer's holding period, noncorporate taxpayers can exclude 60 percent of the gain realized on the sale or exchange of that QSBS, if held for more than five years.
The portion of the gain includible in taxable income is taxed at a maximum rate of 28 percent under the regular tax. A percentage of the excluded gain is an AMT preference. The portion of the gain includible in alternative minimum taxable income (AMTI) is taxed at a maximum rate of 28 percent under the AMT. Thus, under pre-ARRA law, gain from the sale of QSBS is taxed at effective rates of:
- 14 percent under the regular tax
- 14.98 percent under the AMT for dispositions before Jan. 1, 2011
- 19.98 percent under the AMT for dispositions after Dec. 31, 2010 for stock acquired before Jan. 1, 2001
- 17.92 percent under the AMT for dispositions after Dec. 31, 2010 for stock acquired after Dec. 31, 2000
The ARRA provides that, for QSBS acquired after February 19, 2009, and before January 1, 2011: (a) the 50-percent gain exclusion is increased to 75 percent, and (b) none of the 60-percent gain exclusion rules for QBE QSBS apply. As a result of the increased exclusion, gain from the sale of qualified small business stock to which Section 1241 applies is taxed at effective rates of seven percent under the regular tax and 12.88 percent under the AMT.
Reduction in Holding Period for S Corporation Assets Subject to Built-In Gains Tax. An S corporation is generally not subject to tax, but passes through its items to its shareholders, who pay tax on their pro rata shares of the S corporation's income. An S corporation that was previously taxed as a C corporation (or where an S corporation receives property from a C corporation in a nontaxable carryover basis transfer), is taxed at the highest corporate rate on all gains that were "built-in" at the time the S corporation election is made, if the S corporation disposes of any asset with a built-in gain during the recognition period. Generally, the recognition period begins on the date the S corporation election is made (or the date the S corporation received the property) and runs for 10 years.
The ARRA provides that no tax is imposed on the net unrecognized built-in gain of an S corporation if the seventh tax year in the recognition period preceded the 2009 and 2010 tax years. Essentially, the ARRA reduces the recognition period to seven years for the 2009 and 2010 tax years. For example, the recognition period will end at the beginning of the 2009 tax year if the S corporation election was made for the 2002 tax year, and the recognition period will end at the beginning of the 2010 tax year if the S corporation election was made for the 2003 tax year. For property acquired from C corporation in carryover basis transactions, the recognition period is reduced to seven years from the date the property is acquired.
Removal of Special Financial Institution NOL Limitation Exception. Under Section 382, the ability of a loss company to use its NOL is limited where there has been a change of ownership in excess of 50 percent. Section 382 is designed to prevent companies from trafficking in losses. On September 30, 2008, the Treasury issued Notice 2008-83, which allows unlimited use of losses when a financial institution is acquired. The ARRA repeals Notice 2008-83 prospectively, as of January 16, 2009.
Addition of Special NOL Limitation Exception. Under Section 382, the ability of a loss company to use its NOL is limited where there has been a change of ownership in excess of 50 percent. The ARRA provides that no such limitation will be imposed when the ownership change is (1) the result of a taxpayer restructuring required under a loan agreement or commitment entered into with the Treasury pursuant to the Emergency Economic Stabilization Act of 2008 and (2) intended to result in a rationalization of the costs, capitalization, and capacity with regard to the manufacturing workforce of, and suppliers to, the taxpayer and its subsidiaries. This rule, however, does not apply to a later ownership change, unless that ownership change also is described above. In addition, this rule does not apply to an ownership change if, immediately after the ownership change, any person (other than a voluntary employees' beneficiary association (VEBA)) owns stock possessing 50 percent or more of the vote or stock value of the company.
Renewable Energy Tax Incentives
The ARRA includes $20 billion in energy tax incentives, including but not limited to the following:
Temporary Election to Claim the Investment Tax Credit in Lieu of Production Tax Credit. Generally, an income tax credit for producing electricity from certain renewable resources, known as the production tax credit, is available for electricity produced from qualified energy resources and refined coal and Indian coal produced at a qualified facility. The production tax credit is generally available for a 10-year period beginning on the placed-in-service date of the qualifying facility for electricity produced during that period.
In addition, a nonrefundable business energy credit (i.e., an investment tax credit) is available for any tax year in which energy property is placed in service. The tax credit is based on 30 percent of the cost of:
- Qualified fuel cell property
- Solar energy producing property
- Fiber optic solar energy property
- Qualified small wind energy property
A 10-percent business energy credit applies to certain other types of property.
The ARRA provides that, for qualifying wind, geothermal, biomass, and certain other projects, the developers can elect to claim the 30-percent investment tax credit in lieu of the production tax credit. Under the ARRA, this election allows taxpayers that place qualified investment facilities (other than wind facilities) in service in 2009, 2010, 2011, 2012, or 2013 to elect irrevocably to take the 30-percent investment tax credit in the year the facility is placed in service, instead of the electricity production tax credit, which is taken for 10 years. Taxpayers have to place qualified investment facilities that are wind facilities in service in 2009, 2010, 2011, or 2012 to be able to elect irrevocably the 30-percent investment tax credit instead of the production tax credit.
Extensions
Prior to the passage of the ARRA, a facility using wind to produce electricity had to be originally placed in service before January 1, 2010 in order to be a qualified facility for purposes of the production tax credit. The ARRA extends this date to January 1, 2013.
Prior to the passage of the ARRA, a facility using closed-loop biomass, open-loop biomass, geothermal energy, landfill gas, trash, or qualified hydropower had to be originally placed in service before January 1, 2011 in order to be a qualified facility for purposes of the production tax credit. The ARRA extends this date to January 1, 2014.
Prior to the passage of the ARRA, a facility using marine and hydrokinetic renewable energy to produce electricity had to be originally placed in service before Jan. 1, 2012 in order to be a qualified facility for purposes of the electricity production credit. The ARRA extends this date to January 1, 2014.
Grants in Lieu of Energy Credits. The ARRA allows taxpayers to apply for a grant when they place specified energy property in service in lieu of claiming investment tax credits. The grant will reimburse the taxpayer for part of the expense of the facility. The ARRA authorizes the Treasury Secretary to provide a grant to any taxpayer that either: (1) places the property in service during 2009 or 2010, or (2) places the property in service after 2010, but only if the construction of the property began during 2009 or 2010 and is completed before the credit termination date with respect to that property.
New Credit for Investment in Advanced Energy Property. The ARRA creates a new 30 percent investment tax credit for facilities that manufacture "advanced energy property," including facilities for the manufacture of renewable energy, energy storage, energy conservation, and carbon capture and sequestration. The ARRA provides for $2.3 billion of manufacturing credits to be made available through a competitive bidding process.
U.S. Small Business Administration (SBA) Provisions
Surety Bond Guarantees. The ARRA provides $15 million for the Surety Bond Guarantees Revolving Fund.
Business Loans Program Account. The ARRA provides $363 million for the business loans program account. Of this amount, $6 million is for the cost of direct loans provided under the Microloan program. The remaining $630 million will implement the fee reductions and new loan guarantee authorities under Sections 501 and 506 of the ARRA.
Temporary Fee Reductions or Eliminations. The ARRA authorizes temporary fee reductions (until September 30, 2010) under the 7(a) loan guarantee program and temporary fee eliminations under the CDC/504 loan program.
SBA Guarantee of 90 Percent on 7(a) Loans. The ARRA authorizes the SBA to guarantee up to 90 percent of "qualifying small business loans" made by eligible lenders. A qualifying small business loan is a loan to a small business concern pursuant to Section 7(a) of the Small Business Act. Loan guarantees may not be issued after 12 months following the date of enactment.
SBA Secondary Market Guarantee Authority. The ARRA authorizes the establishment of the SBA Secondary Market Guarantee Authority to provide a federal guarantee for pools of first lien 504 loans (i.e., the first mortgage position, nonfederally guaranteed loans made by private sector lenders under Title V of the Small Business Investment Act of 1958) that are to be sold to third-party investors.
Refinancing of Community Development Loans. The ARRA authorizes the SBA to refinance community development loans under its 504 program and revises the job creation goals of the program.
Simplification of Maximum Leverage Limits and Aggregate Investment Limits. The ARRA simplifies the maximum leverage limits and aggregate investment limits required of Small Business Investment Company program. Note that the ARRA does not include a provision, proposed by the Senate, regarding the maximum 7(a) loan amount.
Deferred Loans to Existing Debtors With Immediate Financial Hardship. The ARRA authorizes the SBA to carry out a program to provide loans on a deferred basis to viable small business concerns that have a qualifying small business loan and are experiencing immediate financial hardship.
Reporting. The ARRA requires the Government Accountability Office to report to Congress on the implementation of SBA provisions.
Increase in Surety Bond Maximum Amount. The ARRA provides an increase in the surety bond maximum amount and modifies the size standards.
Secondary Market Lending Authority. The ARRA establishes a secondary market lending authority within the SBA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.