The American Job Creations Act:
Tax Relief and Incentives for Small Business Owners
On October 22, 2004, President Bush signed into law the 600-plus page, and $137 billion, corporate tax bill known as the American Jobs Creation Act. While the Act’s original purpose was to repeal the Foreign Sales Corporation/Extraterritorial Income (ETI) provisions that the World Trade Organization (WTO) ruled illegal, the Act focuses on tax relief for a variety of special interest groups; including manufacturers, small business owners, farmers, and community banks. The Act seemingly has “something for everyone” with tax reform ranging from the elimination of tariffs imposed on U.S. products recently imposed by European members of the WTO to a 4.7% duty on imported ceiling fans.
Repeal of ETI for Manufacturers. The Act provides a 9% deduction (equaling 3% tax rate cut) on all manufacturing and certain other domestic production activity undertaken in the U.S. regardless of whether the products are exported or not. C corporations, S corporations, partnerships, sole proprietorships, cooperatives, estates, and trusts may tax the deduction. The deduction commences in tax years after 2004, and is phased in over 5 years: 3% in 2005-06; 6% for 2007-09; 9% after 2009.
Small Business Relief through Subchapter S Reform. The Subchapter S reform allows more small businesses to qualify for Subchapter S treatment. This allows the businesses to avoid double taxation by allowing them to pay income tax only once at the individual shareholder level, and decreases the regulatory burden on S corporations. Such tax reform allows the three million Subchapter S small businesses to be more competitive in the marketplace, and allows greater ownership among family and community members.
The S corporation reform and simplification provisions go into effect for tax years beginning after December 31, 2004. Key changes include:
- Allowing family members to elect to be treated as a single shareholder
- Increasing the number of eligible S corporation shareholders from 75 to 100
- Attributing suspended losses to be transferred with S corporation stock to the transferee spouse in a divorce
- Permitting S corporation shares to be held in IRAs
- Expanding eligible bank shareholders to include IRAs (effective October 22, 2004)
- Easing restrictive passive income rules
- Allowing the IRS to waive inadvertent S elections
- Permitting S corporations to use distributions on stock held by its ESOP to repay loans if the S stock of at least equal value is allocated to participant accounts
Other Business Tax Incentives and Simplification. The Act excludes certain stock options and stock purchase plans from employee wages for payroll tax and income tax withholding purposes and extends the amount of deductions that a taxpayer can expense under Section 179 of the Internal Revenue Code (which is $100,000 as indexed for inflation) for another 2 years, until 2007. Other business incentives and tax simplification measures include:
- Treating qualified leasehold improvements and restaurant property placed in service after the enactment date of the Act as 15-year recovery property for depreciation purposes
- Reducing double taxation of U.S.-based companies
- Reducing foreign tax credits (FTCs)
- Allowing FTCs to be carried forward for 10 years instead of 5 years
- Repealing the 90% limitation on the use of FTCs against AMT
Closing Loopholes and Miscellaneous Provisions. The Act also includes a number of provisions designed to close tax shelters and other loopholes that frequently involve the non-disclosure of reportable transactions.
Provisions designed to close tax loopholes in the Act include:
- Allowing an above-the-line deduction for attorneys’ fees and court costs associated with an unlawful discrimination claim for judgments and settlements
- Allowing tax credits for alcohol fuels and the production of electricity to be applied against AMT
- Making it more difficult to defer tax on nonqualified deferred compensation for amounts deferred after 2004
- Limiting the deduction of an SUV that can be expensed in a single year under Section 179 to $25,000 (compared to $102,000 in 2004)
- Requiring more specific reporting rules for noncash charitable contributions and motor vehicles, boats, and airplanes
Key anti-tax shelter provisions include:
- Imposing civil penalties for failing to file reports when a person doing business in the U.S. makes a transaction or maintains an account with a foreign financial entity
- Adding a penalty for failing to disclose reportable transactions, including substantial understatements of tax
- Requiring disclosure of the identity of material advisors who have assisted a corporate taxpayer with reportable transactions
- Allowing the IRS to seek an injunction against material advisors to enjoin the advisors from failing to file an information return for reportable transactions, or requiring a timely list of investors upon the IRS’ written request
- Deeming communications between a taxpayer and federally authorized tax practitioner regarding tax shelters as a non-confidential communication
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