Critical Business Provisions of the Protecting Americans from Tax Hikes Act of 2015
Corporate & Finance Alert
January 6, 2016
On December 18, 2015, the Senate passed, and President Obama signed, the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act” or “Act”). The Act reflects a broad agreement among the House, the Senate and the President to retroactively extend a broad mix of business, individual, energy, and other tax breaks. The Act does considerably more than the typical tax extenders legislation seen in recent years, in that it makes over twenty key tax provisions permanent, including the Research Tax Credit, enhanced IRC Section 179 expensing, relaxation of the S corporation Built-in Gains Tax, and the American Opportunity Tax Credit. The PATH Act also adopts a number of changes relating to REITs, FIRPTA, Bonus Depreciation, “family tax relief,” tax reporting, administration, and procedural provisions.
After listing some of the more important tax extender items, this summary provides a few comments on some of the most critical business extenders, as well as some other provisions of interest to mid-sized businesses. The items listed below that are described in more detail are identified with an asterisk.
Note that items were either extended (i) permanently, (ii) for five (5) years, from 2015 through 2019, or (iii) for two (2) years, from 2015 through 2016.
I. Permanently Extended Items
- 15-year straight-line cost recovery for qualified leasehold improvements (IRC Section 168)*
- Increase and modifications to expense limitations for IRC Section 179 deductions*
- Reduction in S corporation built-in gain recognition period (IRC Section 1374)*
- American Opportunity Tax Credit (Code Section 25A)
- Research tax credit (IRC Sections 38 and 41)
- RIC qualified investment entity treatment under FIRPTA, and other FIRPTA changes (IRC Sections 897 and 1445)
- Subpart F exception for active financing income (IRC Sections 953 and 954)
- 100-percent gain exclusion on qualified small business stock (IRC Section 1202)*
- Tax-free distributions from individual retirement plans for charitable purposes
- Deduction for state and local sales taxes (IRC Section 164)
II. Items Extended for Five (5) Years through 2019
- Extension and modification of bonus depreciation (IRC Section 168(k))*
- New Markets Tax Credit (IRC Section 45D)*
- Work Opportunity Tax Credit (IRC Sections 51 and 52)
- Look-through treatment of payments between related CFCs under Subpart F foreign personal holding company rules (IRC Section 954(c)(6))
III. Items Extended for Two (2) Years through 2016
- Above-the-line deduction for qualified tuition and related expenses (IRC Section 222)
- Exclusion from gross income of discharges of acquisition indebtedness on principal residences (IRC Section 108)
- Mortgage insurance premiums treated as qualified residence interest (IRC Section 163)
- Suspension of medical device excise tax (IRC Section 4191)*
- Extension and modification of empowerment zone tax incentives (IRC Sections 1391 and 1394)
- Extension and modification of credit for nonbusiness energy property (IRC Section 25C)
- Credit for energy-efficient new homes (IRC Section 45L)
- Biodiesel and renewable diesel incentives (IRC Section 40A)
IV. Brief Summary of Certain More Critical Extenders
A. 15-year Straight-Line Cost Recovery for Qualified Improvements. The PATH Act retroactively and permanently extends the availability of 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. Normally, nonresidential real property is depreciated on a straight-line basis over 39 years. Qualified leasehold improvements are improvements to an interior portion of a building that is nonresidential real property, provided certain other requirements are met. Qualified restaurant property is any IRC Section 1250 property (typically improvements to real estate) that is a building or an improvement to a building, if more than 50% of the building is devoted to the preparation of, and seating for on-premises consumption of prepared meals. Qualified retail improvement property is any improvement to an interior portion of a building which is nonresidential real property if such portion is open to the general public and is use in the retail trade or business of selling tangible personal property to the general public.
B. Increase and Modifications to Expense Limitations for IRC Section 179 Deductions. Pre-Act, the dollar limit for IRC Section 179 expensing for 2015 had reverted to $25,000 with an investment limit of $200,000. The Act favorably and permanently extends and modifies increased expensing limitations, and treats certain real property as IRC Section 179 property. Taxpayers can elect under IRC Section 179 to expense or deduct the cost of qualifying property, rather than to recover those costs through depreciation. The PATH Act provides that the maximum amount that a taxpayer may expense, for taxable years beginning after 2014, is $500,000 (instead of prior law’s amount of $25,000). The $500,000 amount is reduced by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,000,000 (instead of prior law’s amount of $200,000). The Act also permanently allows (i) off-the-shelf computer software to qualify as IRC Section 179 property, and (ii) qualified real property (i.e., qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) to qualify as IRC Section 179 property (and removes the $250,000 cap related to this category of expenditure beginning in 2016), as a result of which some business may want to postpone larger purchases of such property until 2016. Finally, the Act allows air conditioning and heating units to qualify as IRC Section 179 property, for taxable years beginning after 2015.
C. Reduction of S Corporation Recognition Period for Built-in Gains Tax. In general, under IRC Section 1374, a corporate level built-in gains tax applies at a rate of 35% on an S corporation’s net recognized built-in gain which economically accrued prior to the effective date of the S election and which is recognized during the 10-year recognition period beginning as of the effective date of the corporation’s S election. The PATH Act permanently shortens the recognition period to five years from the S corporation’s conversion date, consistent with law that was in place in 2012, 2013, and 2014. This provision reduces the likelihood of triggering the IRC Section 1374 built-in gain tax, which is one drawback to a C corporation’s conversion to an S corporation.
D. Exclusion of 100% of Gain on Certain Small Business Stock. Under IRC Section 1202, a taxpayer other than a corporation may exclude a fixed percentage of the gain from the sale of certain small business stock acquired at original issue and held for at least five years. The amount of gain eligible for the exclusion is the greater of (i) ten times the taxpayer’s basis in the stock, or (ii) $10 million applied cumulatively. To qualify as a small business, the aggregate gross assets held by the corporation may not exceed $50 million when the stock is issued, the corporation must meet certain active trade or business requirements, and the corporation must be a C corporation. Under the PATH Act, the percentage exclusion is permanently fixed at 100%.
E. Extension and Modification of Bonus Depreciation. As previously in effect, bonus depreciation allowed a first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property. The PATH Act extends and modifies bonus depreciation for five years, generally through 2019. The percentage allowed is 50 percent for the years 2015 through 2017, with a gradual phase down by 10 percent per calendar year beginning in 2018. Thus, generally, the percentage for property placed in service in 2018 is 40 percent, and for 2019 is 30 percent. The PATH Act also allows bonus depreciation for qualified improvement property (described above in subsection IV A) without regard to whether the improvements are property subject to a lease, and also removes the requirement that the improvement must be placed in service more than three years after the date the building was first placed in service. In addition, the Act also continues the election to accelerate the use of AMT credits in lieu of bonus depreciation and increases the amount of unused AMT credits that may be claimed in lieu of bonus depreciation. It should be noted that, unlike IRC Section 179 expensing (above), only new property is eligible for bonus depreciation.
F. Extension of New Markets Tax Credit. IRC Section 45D provides a new markets tax credit (NMTC) for qualified equity investments in corporations or partnerships which satisfy the definition of a qualified community development entity (CDE). The NMTC amounts to 39% of the investment in the CDE, with 5% earned in each of the first three years, and 6% earned in each of the next four years. Substantially all of the investment proceeds must be used by the CDE to make qualified low-income community investments. The new Act extends the NMTC for five years (2015 – 2019), permitting up to $3.5 billion in qualified equity investments in each of those years.
G. Suspension of Medical Device Excise Tax. Since January 1, 2013, IRC Section 4191 imposed a 2.3% excise tax on the sales of taxable medical devices by manufacturers, producers, or importers of such devices. Generally, a taxable medical device is any device intended for humans and regulated by the FDA under the Federal Food, Drug, and Cosmetic Act. Eyeglasses, contact lenses, hearing aids and a number of other items are exempt under a “retail exemption.” The PATH Act suspends the imposition of the tax on medical devices for 2016 and 2017. The health care industry had heavily lobbied for this change because of its potential negative impact on the medical device industry.
V. Other Provisions of the PATH Act
The PATH Act includes dozens of additional miscellaneous provisions, most of which are favorable to taxpayers. A few of the more interesting or significant provisions are outlined as follows.
A. Increase in FIRPTA Withholding Tax Rate under IRC Section 1445. Although foreign persons are generally not subject to U.S. tax on gain from the disposition of U.S. investment property, such as stock of a U.S. operating corporation, they are subject to tax under FIRPTA (Foreign Investment in Real Property Tax Act of 1980) on the gain from a disposition of a United States Real Property Interest (USRPI), including a corporation that qualifies as a United States Real Property Holding Corporation (USRPHC). A buyer of a USRPI from a foreign person must withhold tax from the purchase price, historically at a rate of 10% of the gross purchase price. A number of exceptions apply, but only if the buyer obtains the proper withholding certificates or affidavits. The PATH Act increases the withholding tax rate on dispositions and certain distributions of USRPIs from 10 percent to 15 percent. The 10 percent rate continues to apply for sales of residences when the buyer intends to use the property for personal use, if the purchase price does not exceed $1,000,000. The new rate is effective for dispositions that occur 60 days after the effective date of the PATH Act.
B. Exception from FIRPTA Tax for Interests Held by Foreign Retirement and Pension Funds. A foreign person subject to tax on FIRPTA gain is required to file a U.S. tax return like that of any foreign taxpayer who earns income effectively connected with a U.S. trade or business. The new Act creates a new exemption for qualified foreign pension funds, or foreign entities wholly owned by a qualified foreign pension fund, with respect to either (i) a disposition of any USRPI held directly (or indirectly through one or more partnerships), or (ii) any distribution received from a real estate investment trust. Among other requirements, a qualified foreign pension fund means any trust, corporation, or other organization or arrangement (i) which is created or organized under the law of a country other than the United States; (ii) which is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees; (iii) which does not have a single participant or beneficiary with a right to more than five percent of its assets or income; and (iv) which is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates. This new exemption is effective to dispositions and distributions after the date of enactment.
C. A Mix of REIT Provisions. The PATH Act adopts a number of provisions with respect to REITS, some of which are designed to curb the aggressive use of REIT-rules as a corporate tax-reduction strategy. These provisions include:
- The Act prevents REITS from participating in a IRC Section 355 spin-off as either a distributing or a controlled corporation. Two exceptions are available. First, Section 355 is available if both the distributing and the controlled corporations are each REITs. Second, a REIT may spin off a taxable REIT subsidiary as long as the REIT has controlled the subsidiary for at least three years during which time the REIT fully qualified as a REIT. Following a tax-free spin-off by a non-REIT entity, neither a distributing nor controlled corporation will be allowed to elect to be treated as a REIT for ten (10) years.
- Historically, no more than 25 percent of the value of total REIT assets could consist of securities of one or more taxable REIT subsidiaries. Under the PATH Act, this percentage is reduced to 20 percent. This provision takes effect for taxable years beginning after December 31, 2017.
- The Act expands the definition of real estate assets that can be held by REITS for purposes of meeting the 75 percent qualified assets test to include debt instruments issued by publicly offered REITS and interests in mortgages on real property.
- The Act places limits on designations of dividends by REITs. The aggregate amount of dividends designated by a REIT as qualified dividends or capital gains dividends may not exceed the dividends actually paid by the REIT. In addition, the Act repeals the preferential dividend rule for publicly offered REITs.
D. Acceleration of Filing Dates for Forms W-2 and 1099-MISC. The PATH Act accelerates the date by which Forms W-2, W-3, and Forms 1099-MISC must be filed with either the Social Security Administration or the IRS, as appropriate, to January 31 of the year following the year of payment. Payors will continue to be required to issue employee and payee statements to employees and payees as of that same date, i.e., January 31. This provision of the Act is effective for returns with respect to payments made in 2016.