Business Tax Provisions of the American Taxpayer Relief Act of 2012

White and Williams Tax and Estates Alert | January 24, 2013
by: John Eagan

Many of the business provisions contained in the American Taxpayer Relief Act of 2012 (ATRA) apply retroactively to January 1, 2012.  The impact of the retroactive application should be considered carefully for fiscal year taxpayers who have already filed their 2011 tax returns that covered part of 2012.  These taxpayers should consider amending their tax returns to add amounts paid or incurred after December 31, 2011 to the calculation of the applicable deductions or tax credits that are now available under ATRA.

S Corporations.  As a general rule, S corporations that converted from a C corporation are taxed if assets that were appreciated at the time of the S election (“built-in gain”) are sold within the 10-year period after the effective date of the S election.  For the 2008-2010 tax years, the 10-year period was reduced to seven years and for the 2011 tax year the seven-year period was further reduced to five years.  ATRA extends the reduced five-year built-in gain recognition period to include the 2012 and 2013 tax years.  ATRA also provides that if a built-in gain asset is sold on an installment method, the tax treatment of all income associated with the payments is determined by the tax year in which the sale occurred, not by the tax year in which the payments are received.

In addition, the rules that reduce a shareholder’s basis in S corporation stock for the pro rata share of the basis of S corporation property that is contributed to charity is extended for the 2012 and 2013 tax years.

Depreciation and Increased Expensing.  ATRA extends the 50% “bonus” first-year depreciation for qualified property for an additional year through December 31, 2013 (and through December 31, 2014 for longer-lived and transportation property).  In a companion provision, ATRA allows corporations to forgo the bonus depreciation and increase the alternative minimum tax credit limitation.

ATRA extends until December 31, 2013, special depreciation rules for certain types of property.  Qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements continue to be able to be depreciated over 15 years; motorsports entertainment complexes continue to be able to be depreciated over seven years; and certain production costs of qualified film and television production in the U.S. are eligible for the expensing election.  In addition, the first-year depreciation limit for luxury auto and certain trucks is increased by $8,000 for 2013.

ATRA extends the increased expensing limitations of Code Section 179, which allows certain taxpayers to expense, rather than capitalize, certain depreciable business assets.  For the 2012 tax year, ATRA retroactively increases the Code Section 179 maximum expensing amount from $139,000 to $500,000.  Effective for tax years beginning in 2013, ATRA increases the maximum expensing amount from $25,000 to $500,000.  However, for tax years beginning after 2013, the maximum expensing amount is scheduled to return to $25,000. 

A two-year extension was adopted for Code Section 179 expensing of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) and a one-year extension was adopted for the expensing of off-the-shelf computer software.

Tax Credits.  The research credit is now available until December 31, 2013, which is an extension of two years from the December 31, 2011 expiration date under prior law.  ATRA also makes a conforming change to reflect the December 31, 2013 date for the “orphan drug credit” that is available to promote the development and marketing of drugs to be used for the treatment of rare diseases or conditions.

ATRA liberalizes the research credit in several respects.  In the case of an acquisition of a trade or business from another person, the acquirer is able to include certain qualified research expenses paid or incurred by the predecessor business as well as certain of the gross receipts of the predecessor business.  ATRA also revises the rules on how the research credit is allocated among the members of a controlled group.

Several other tax credits were retroactively extended under ATRA through December 31, 2013, including the work opportunity tax credit, temporary minimum low-income tax credit for non-federally subsidized new buildings, and the new markets tax credit.  The employer-provided child care credit was extended permanently.

International

Under the controlled foreign corporation (CFC) rules, U.S. persons who are 10% (or greater) shareholders of a CFC are required to report their pro rata share of “Subpart F income” of the CFC whether or not the CFC income is distributed to the shareholders.  Under prior law, certain income derived from the active conduct of banking, financing or similar businesses, or from the conduct of an insurance business, was excluded from Subpart F income.  ATRA extends this exclusion for two years (for tax years beginning before January 1, 2014).

The CFC rules also contained a provision that excluded from Subpart F income certain payments (generally, dividends, interest, rents and royalties) between related CFCs, although this provision expired for tax years before January 1, 2012.  ATRA extends this “look-through” exclusion for two years (for tax years of foreign corporations beginning before January 1, 2014).

Under the withholding provisions of the Foreign Investment in Real Property Tax Act (FIRPTA), a U.S. partnership, a trustee of a U.S. trust, or an executor of a U.S. estate is required to withhold income tax on the income attributable to the disposition of a U.S. real property interest to the extent the income is allocable to a foreign person.  The withholding tax rate is 35% of the allocable gain, although the rate could be reduced to 15% if the IRS issued regulations authorizing the lower 15% rate. 

The authority of the IRS to issue such regulations for a reduced FIRPTA withholding rate was scheduled to expire for tax years beginning after December 31, 2012.  ATRA eliminates the December 31, 2012 sunset date and allows the IRS, by regulation, to use a reduced rate of 20% (which conforms to the increase under ATRA from a 15% rate to a 20% rate for many other types of income).

ATRA also extends the withholding exemption for interest-related dividends and short-term capital gain dividends of a regulated investment company (RIC) for dividends paid for tax years beginning before January 1, 2014.  RICs are also included within the definition of a qualified investment entity through December 31, 2013 for withholding purposes on FIRPTA gain on distributions to foreign persons.  However, there is an exception from the withholding obligation for payments made on or before January 2, 2013.

Preferential Tax Rates.  ATRA contains several provisions that allow preferential income tax rates for taxpayers.  These rates, while higher than the tax rates under prior law, are still substantially lower than the top ordinary income tax rates.

Subject to certain limits, non-corporate taxpayers can exclude 100% of the gain realized on the sale of qualified small business stock that was acquired during a “temporary period,” and was held for more than five years.  Prior to ATRA, the “temporary period” began on September 28, 2010 and ended on December 31, 2011.  ATRA extends the temporary period for two years through December 31, 2013.  In addition, the excluded gain is not subject to the alternative minimum tax.

Under ATRA, the highest rate on capital gains and qualified dividends is now 20% instead of 15% as was the case under prior law.  A 20% tax rate now applies to the following types of income:

  • The tax rate for both the accumulated earnings tax and the undistributed personal holding tax is increased under ATRA from 15% to 20%.  This rate is effective for tax years beginning after December 31, 2012.
  • The provision of prior law that would have allowed the character of qualified dividend income when received by a partnership to pass through to partners was due to expire for tax years beginning after December 31, 2012.  ATRA made the pass-through treatment permanent, which means qualified dividend income received by a partnership will pass through to the partners and will be taxed at the new 20% rate.  A similar provision was enacted for common trust funds maintained by a bank, regulated investment companies, and real estate investment trusts that have qualified dividend income.
  • The provision of prior law that treated the dividend portion of the gain on the sale (other than a redemption) of Code Section 306 stock by non-corporate shareholders as qualified dividend income was due to expire for tax years beginning after December 31, 2012.  ATRA made the qualified dividend treatment permanent, which means that the dividend portion is now taxed at a maximum rate of 20%.
  • The pass through of qualified dividend income (taxed at a maximum  rate of 20%) by a regulated investment company or a real estate investment trust was set to expire December 31, 2012.  ATRA has made this pass-through treatment permanent.

As always, the Tax and Estates Practice Group at White and Williams is committed to keeping our clients and friends up to date with important tax developments.  For current information, please refer to the Tax and Estates page on our website, www.whiteandwilliams.com.

IRS Circular 230 Notice: To ensure compliance with certain regulations promulgated by the U.S. Internal Revenue Service, we inform you that any federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code, or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein, unless expressly stated otherwise. 

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation with any specific legal question you may have.