Tax Week in Review

Monday, April 2, 2001

Deloitte & Touche OnLine

• House OKs Budget Resolution

• Ways & Means Snuffs the 'Death Tax'

• Democrats Push Tax Rebates

• Finance Committee Considers Small Business, Farm Tax Issues

• Marriage Penalty Relief Heads Down the Aisle

• High Court Hears Consolidated Return Case

• Washington Date Book

House Passes Budget Resolution, Blesses $1.6 Trillion Tax Cut

The House March 28 passed a budget resolution (H. Con. Res. 83) on a 222-205 party-line vote that provides for President George W. Bush's proposed 10-year, $1.6 trillion tax cut.  The resolution adopted by the full House was not substantively changed from the version the House Budget Committee reported March 23. (For prior coverage, see Tax News & Views, Mar. 26, 2001.)

Headaches in the Senate? -- With the House having completed action on a budget resolution and well on its way toward approving $1.6 trillion in tax cuts, the focus now shifts to the Senate, where the prospect for tax reductions is uncertain.

Senate Budget Committee Chairman Pete Domenici, R-N.M., is set to unveil the Senate's version of the budget resolution, which, like the House's, is expected to call for $1.6 trillion in tax relief.  Because they lack the votes to bring the resolution through the Budget Committee, Republicans plan to bring it directly to the floor April 2, although it is unclear if the GOP will be able win approval in a floor vote.

At press time, Senate Minority Leader Tom Daschle was trying to get Republicans to postpone consideration until after the Easter recess -- scheduled for April 7-22 -- to give lawmakers a chance to consider the president's detailed budget proposal, which is due to be released April 9.

The Senate plans to complete work on the resolution before departing for the Easter recess.  When the two chambers return, they will have to reconcile their differences and pass identical versions of the resolution.  At that point, the Senate Finance Committee may begin to draft tax legislation, which the full Senate could consider in May.

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Estate Tax Repeal Clears Ways and Means

The House Ways and Means Committee on March 29 voted 24-14 to gradually repeal the estate tax (H.R. 8) by 2011.  Although the vote was largely along party lines, Rep. Amo Houghton, R-N.Y., broke ranks to vote against the measure, while Rep. John Tanner, D-Tenn., voted for it.

Following repeal, an heir's basis in inherited assets would generally equal the donor's basis (carryover basis) in those assets at the time of death.  A decedent's estate would, however, be allowed to increase the basis of assets transferred by up to $1.3 million. The basis of property transferred to a surviving spouse could be increased by an additional $3 million, for a total of $4.3 million. The House is scheduled to vote on the measure April 4. 

Anti-abuse Provisions -- Importantly, to prevent possible abuses resulting from the repeal, the legislation precludes certain property from being eligible for a basis increase, including -- 

• property that was acquired by the decedent by gift (other than from his or her spouse) during the three-year period ending on the date of the decedent's death;

• property constituting a right to receive income in respect of a decedent;

• stock or securities of a foreign personal holding company;

• stock of a domestic international sales corporation (or former domestic   international sales corporation);

• stock of a foreign investment company; and

• stock of a passive foreign investment company (except for which a decedent shareholder had made a qualified electing fund election).

The bill also allows the Treasury Secretary to promulgate anti-abuse rules that would treat a transfer that claims to be a gift as never having been transferred if the donor received anything, either directly or indirectly, in exchange at the time of transfer or later.  It further directs the Treasury

Secretary to issue a study concerning any tax-avoidance schemes the legislation could spawn, as well any increase in income tax revenues it could bring about.

Reporting Requirements -- As approved by the Ways and Means Committee, the bill also includes several reporting provisions for transfers made by gift or at death.

Gifts -- Individuals receiving non-cash property worth more than $25,000 would be required to report to the IRS the basis and character of that gift. Similarly, donors would need to provide information to the IRS concerning the adjusted basis of the property in the hands of the donor at the time of the gift, the donor's holding period for such property, and sufficient information to determine whether any gain on the sale of the property would be treated as ordinary income. The legislation also requires donors to furnish any other information the Treasury Secretary may prescribe.

Transfers at Death -- Estate executors also would be subject to reporting requirements similar to those prescribed for gifts. The executor would be required to report information to the IRS on transfers of non-cash assets in excess of $1.3 million made at death and transfers of appreciated property worth more than $25,000 received by a decedent within three years of death. That information would include -- 

•  the adjusted basis of the property in the hands of the decedent and its fair market value at the time of death;

•  the decedent's holding period for the property;

• sufficient information to determine whether any gain on the sale of the property would be treated as ordinary income; and

• the amount of basis increase allocated to the property.

As with donors of gifts, the executor must furnish any other information the Treasury Secretary may request.

Penalties for Non-Compliance -- The legislation imposes penalties for failure to report required information.

• Individuals failing to report to the IRS transfers of non-cash assets in excess of $1.3 million would face the most stringent fine -- a penalty of $10,000.

• Those failing to report required information to the IRS on transfers of non-cash property valued over $25,000, could be fined up to $500. Failure to provide required information to the beneficiary of such transfers could result in a $50 fine.

• Individuals who fail to report required information because of intentional disregard of the rules could be fined 5 percent of the fair market value of the property in question at the time it was transferred either by gift or death.

Tax Recapture Provisions Remain Intact -- Many existing estates have claimed certain tax benefits that may, in certain instances, trigger a recapture tax. Because the repeal of the estate tax, under the Ways and Means proposal, would be effective for decedents dying after December 31, 2010, the following recapture provisions, the legislation says, will continue to apply: qualified conservation easements, special-use valuations, qualified family-owned business deductions, and installment payments of estate tax for closely-held businesses.  Finally, the bill extends the income tax exclusion of up to $250,000 of gain on the sale of a principal residence to estates and heirs.

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Democrats Propose Tax Rebate as Economic Stimulant

Senate Minority Leader Tom Daschle, D-S.D., joined Sen. Joseph Lieberman, D-Conn., March 27 to introduce an economic stimulus plan that would provide each taxpayer with a tax rebate this year. The plan would be paid for with $60 billion of the $96 billion budget surplus forecast for the current fiscal year.

Under the Democratic plan, individual taxpayers would get a $300 rebate -- $600 for couples -- which would be distributed to taxpayers in the form of an IRS check, probably cut within two months after the plan is signed into law. The plan also would cut the 15 percent income tax rate to 10 percent on the first $6,000 of income for individuals, and on $12,000 for couples who file jointly. That would mean a $150 tax cut in the second half of this year for individuals -- $300 for couples -- in the form of smaller withholdings from their paychecks.

Congressional Republicans also back a $60 billion rebate, but insist that it be linked to the $958 billion marginal income tax rate cut the House passed March 8. Bush administration officials also insist that any such rebate must be done as part of the president's broad-based tax cut package.

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Senate Finance Committee Ponders Tax Relief for Small Businesses and Farms

Small businesses and family farms need targeted tax relief to remain competitive and handle downturns in the economy, according to lawmakers and private-sector witnesses who spoke at a March 28 Senate Finance Committee hearing.

"Family farms and fisheries and small businesses have special tax needs and tax burdens far different from those of large corporations," said Finance Committee Chairman Charles Grassley, R-Iowa. "Rate cuts like the ones suggested by President Bush will help, but they don't go far enough. This much-needed tax relief is a key ingredient in any recipe for an economic stimulus."

Ranking Democrat Max Baucus of Montana agreed. "It's getting to be time for the rubber to meet the road and time is short. We're going to have to decide what's actually going to be in this tax bill," Baucus said. Considering the government has some hard choices to make and a limited number of dollars to spend, targeted tax cuts might help small business and farms more than Bush's broad-based tax plan, which favors upper-income taxpayers, he added.

Alexander Urges S-Corp Reforms -- Former IRS Commissioner Don Alexander urged lawmakers to reform "the restrictive rules, largely enacted over 40 years ago, that still shackle the more than 2.5 million subchapter S corporations in the United States."

Specifically, Alexander suggested allowing S corporations access to the issuance of preferred stock and bank directors' qualifying shares, as well as boosting the level of eligible shareholders from 75 to 150. He also suggested eliminating the rule that terminates S corporation status for corporations that have both subchapter C earnings and profits that derive more than 25 percent of gross receipts from passive sources for three consecutive years.

"Typically, subchapter S corporations are family-owned-and-operated businesses or otherwise closely held organizations that have been reliable engines of job growth and productivity for the domestic economy," said Alexander. "We're not asking for partnership treatment to create a level playing field, we just want basic reform of some of the restrictions that just don't make much sense," he explained.

In response to a question from Finance Committee member Blanche Lincoln, D-Ark., on limited liability companies (LLC) such as those enjoying much success in her home state, Alexander said "it makes no sense to continue to have old regulations for old businesses when new corporations organizing under LLC status have almost none."

On improving depreciation schedules, Alexander told Lincoln, "I don't know what the revenue impact of that would be. But section 179 expensing would be a good example of a place where the Code could be simplified," Alexander said, referring to the provision in tax law allowing businesses to treat up to $24,000 of certain property as an expense rather than a captial expenditure. "We should follow up on Treasury's recent depreciation study and make it more simple rather than more difficult," he added.

Other witnesses said a full deduction for health care costs, meals and expenses, and full repeal of the estate tax would be of more help than a reduction in marginal income tax rates.

Business Community Plans for the Future -- Most of the major players in the small business community, including the National Federation of Independent Businesses, did not testify at the March 28 hearing. President Bush has asked his business allies not to load up current legislation with tax breaks that benefit them. Publicly, they are supporting the president's efforts to cut individual tax rates and repeal the estate tax. Behind the scenes, however, they continue to push their agenda on the Hill, congressional tax aides tell Deloitte & Touche.

That agenda includes international tax matters like worldwide interest allocation, extending the exemption from subpart F international provisons for active financing income, and foreign sales corporation issues. Corporate AMT reform, corporate rate reductions, and capital gains relief are also frequent topics of conversation. Readjustment of depreciation schedules is popular with high tech, cellular telecommunications, franchise owners, and real estate firms. Pension reform legislation such as the Comprehensive Retirement Security and Pension Reform Act (H.R. 10), which was recently introduced in the House by Ways and Means members Rob Portman, R-Ohio, and Ben Cardin, D-Md., is being pushed by investment groups among others.  Also, industry-specific measures such as energy incentives, broadband/telecommunications, and a repeal of the federal telecommunications excise tax are getting some play in the halls of Congress.

Even though experienced business lobbyists understand that not all of these provisions can make their way into this year's tax bill, they know that they must lay the groundwork for passage of these provisions in future legislation.

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House Says 'I Do' to Marriage Penalty Relief

Continuing its march toward complete passage of President Bush's 10-year, $1.6 trillion tax cut plan, the House on March 29 voted 282-144 to approve legislation to cut income taxes for married couples and double the annual per-child tax credit. Sixty-four Democrats left their party leaders at the altar to join a unanimous Republican contingent in voting for the Marriage Penalty and Family Tax Relief Act of 2001 (H.R. 6). The bill would reduce revenue by $399 billion over 10 years.

Thomas: $1.6 Trillion May Not Be Enough -- So far this session, the House Ways and Means Committee has approved proposals that allocate all but $70 billion of the president's $1.6 trillion tax relief target. If the president's target holds, certain GOP tax priorities may have to be modified.

Faced with that reality, Ways and Means Chairman Bill Thomas, R-Calif., told reporters on March 29 that while $1.6 trillion dollars is the appropriate price tag for President Bush's tax package, Congress may have other tax priorities that could go beyond that amount.

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Supreme Court Hears Consolidated Return Case

The U.S. Supreme Court on March 26 heard oral arguments in United Dominion Industries Inc. v. United States. 

At issue is whether, for a consolidated group, product liability losses (PLLs) are determined on a consolidated basis or on a member-by-member basis.  PLLs, which are the lesser of a taxpayer's net operating loss (NOL) or the total of allowable product liability expenses, may be carried back 10 years instead of the usual 3 years.  Congress's reason for allowing the longer carryback period was to recognize that product liabilities often take a number of years to arise.

Background -- The Fourth Circuit had held in United Dominion Industries Inc. v. United States, 208 F.3d 452 (4th Cir. 2000), that the product liability expenses of each member corporation must be compared to that member's separate net operating loss (SNOL) -- if there is no SNOL, there can be no PLL. Thus, the Fourth Circuit adopted the government's "separate entity" approach while rejecting the government's position that a member's product liability expenses must be compared to the member's separate taxable income (STI). The Fourth Circuit reasoned that a member's STI is not the equivalent of an NOL.

The High Court agreed to hear the case because of a split among the circuits.  In Intermet Corp. v. Commissioner, 209 F.3d 901 (2000), the Sixth Circuit agreed with the taxpayer that all the members' product liability expenses, combined, must be compared to the group's consolidated net operating loss.

Taxpayer's Position -- Counsel for United Dominion argued that the consolidated approach is correct because product liability expenses are part of the calculation of consolidated income or loss.  Therefore, United Dominion asserted, there is no need for the consolidated return regulations to specify that the PLL be determined on a consolidated basis.  (The Fourth Circuit had held that the lack of a reference to PLLs in the regulations mandated the conclusion that PLLs be determined on a separate-entity basis.)

Justice David H. Souter asked whether the deduction of PLLs by an affiliated group would result in a double deduction.  "No," replied United Dominion's counsel, explaining that because product liability expenses are included in a consolidated NOL, they would be carried back three years by the group.  In other words, the question is whether they are carried back 3 years or 10 years.

Justice Stephen G. Breyer asked whether adopting the taxpayer's position -- allowing a consolidated group to benefit from product liability expenses incurred by a members in years before the member was part of the group -- would encourage "trafficking" in PLLs.  United Dominion's counsel responded that buying PLLs was an unlikely scenario and that there are other statutory mechanisms the IRS can use in cases involving tax-avoidance motives.

Government's Position -- The government's attorney faced stiffer questioning, and was interrupted after speaking barely more than a minute.  In response to a question by Justice John Paul Stevens, the government stated that each group member is a "taxpayer" because each member is severally liable for the consolidated tax liability; but Justice Ruth Bader Ginsburg later caught the government's attorney referring to the "consolidated taxpayer." 

The government pressed its position that a member's product liability expenses must be compared to the member's STI, but Justice Ginsburg reminded counsel that the Fourth Circuit had rejected that argument.  Justice Ginsburg focused on the inconsistencies in the government's position: the IRS had originally allowed the 10-year carryback, following the taxpayer's consolidated approach, but the Joint Committee on Taxation reversed that position.  Government counsel tried to back out of that corner by stating that the government's "litigation" position has been consistent. 

Returning to an issue that arose in questioning the taxpayer's counsel, Justice Anthony M. Kennedy asked the government's counsel whether the IRS could rely on section 269 when the Service finds that a corporation has acquired another for the purpose of avoiding income tax.  The attorney answered affirmatively, but pointed out that such an approach would require more litigation, because the issue would involve a question of fact.  (Section 269 allows the IRS to disallow any deduction or credit secured by means of a corporate acquisition, if the Service finds that the principal purpose of the acquisition was tax avoidance.)

Although the Court is not required to issue its opinion in this case before the current term ends in June, practitioners anticipate a decision by then.

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