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2. Biodiesel income tax credit (sec. 862 of the bill and new
sec. 40A of the Code)
Present
Law
No income tax credit or excise tax rate reduction is
provided for biodiesel fuels under present law.
However, a 52-cents-per-gallon income tax credit
(the "alcohol fuels credit") is allowed
for ethanol and methanol (derived from renewable
sources) when the alcohol is used as a highway motor
fuel. Registered blenders may forgo the full income
tax credit and instead pay reduced rates of excise
tax on gasoline that they purchase for blending with
alcohol. These present law provisions are scheduled
to expire in 2007.
House
Bill
No provision.
Senate
Amendment
In general
The Senate amendment provides a new income tax
credit for biodiesel and qualified biodiesel
mixtures, the biodiesel fuels credit. The biodiesel
fuels credit is the sum of the biodiesel mixture
credit plus the biodiesel credit and is treated as a
general business credit. The amount of the biodiesel
fuels credit is includable in gross income. The
biodiesel fuels credit is coordinated to take into
account benefits from the biodiesel excise tax
credit and payment provisions discussed above. The
credit may not be carried back to a taxable year
ending before or on September 30, 2004. The
provision does not apply to fuel sold or used after
December 31, 2006.
Biodiesel is monoalkyl esters of long chain fatty
acids derived from plant or animal matter that meet
(1) the registration requirements established by the
Environmental Protection Agency under section 211 of
the Clean Air Act and (2) the requirements of the
American Society of Testing and Materials D6751.
Agri-biodiesel is biodiesel derived solely from
virgin oils including oils from corn, soybeans,
sunflower seeds, cottonseeds, canola, crambe,
rapeseeds, safflowers, flaxseeds, rice bran, mustard
seeds, or animal fats.
Biodiesel may be taken into account for purposes of
the credit only if the taxpayer obtains a
certification (in such form and manner as prescribed
by the Secretary) from the producer or importer of
the biodiesel which identifies the product produced
and the percentage of the biodiesel and
agri-biodiesel in the product.
Biodiesel mixture credit
The biodiesel mixture credit is 50 cents for each
gallon of biodiesel used by the taxpayer in the
production of a qualified biodiesel mixture. For
agri-biodiesel, the credit is $1.00 per gallon. A
qualified biodiesel mixture is a mixture of
biodiesel and diesel fuel that is (1) sold by the
taxpayer producing such mixture to any person for
use as a fuel, or (2) is used as a fuel by the
taxpayer producing such mixture. The sale or use
must be in the trade or business of the taxpayer and
is to be taken into account for the taxable year in
which such sale or use occurs. No credit is allowed
with respect to any casual off-farm production of a
qualified biodiesel mixture.
Biodiesel credit
The biodiesel credit is 50 cents for each gallon of
100 percent biodiesel which is not in a mixture with
diesel fuel and which during the taxable year is (1)
used by the taxpayer as a fuel in a trade or
business or (2) sold by the taxpayer at retail to a
person and placed in the fuel tank of such person's
vehicle. For agri-biodiesel, the credit is $1.00 per
gallon.
Later separation or failure to use as fuel
In a manner similar to the treatment of alcohol
fuels, a tax is imposed if a biodiesel fuels credit
is claimed with respect to biodiesel that is
subsequently used for a purpose for which the credit
is not allowed or that is changed into a substance
that does not qualify for the credit.
Effective date
The biodiesel fuel income tax credit provision is
effective for fuel produced, and sold or used after
September 30, 2004, in taxable years ending after
such date.
Conference
Agreement
The conference agreement generally follows the
Senate amendment, except for the effective date.
Effective date. --The provision is effective
for fuel produced, and sold or used after
December 31, 2004
, in taxable years ending after such date
F.
Exclusion of Incentive Stock Options and Employee
Stock Purchase Plan Stock Options from Wages (sec.
261 of the House bill and secs. 421(b), 423(c),
3121(a), 3231, and 3306(b) of the Code)
Present
Law
Generally, when an employee exercises a compensatory
option on employer stock, the difference between the
option price and the fair market value of the stock
(i.e., the "spread") is includible in
income as compensation. In the case of an incentive
stock option or an option to purchase stock under an
employee stock purchase plan (collectively referred
to as "statutory stock options"), the
spread is not included in income at the time of
exercise.98
If the statutory holding period requirements are
satisfied with respect to stock acquired through the
exercise of a statutory stock option, the spread,
and any additional appreciation, will be taxed as
capital gain upon disposition of such stock.
Compensation income is recognized, however, if there
is a disqualifying disposition (i.e., if the
statutory holding period is not satisfied) of stock
acquired pursuant to the exercise of a statutory
stock option.
Federal Insurance Contribution Act
("FICA") and Federal Unemployment Tax Act
("FUTA") taxes (collectively referred to
as "employment taxes") are generally
imposed in an amount equal to a percentage of wages
paid by the employer with respect to employment.99
The applicable Code provisions100
do not provide an exception from FICA and FUTA taxes
for wages paid to an employee arising from the
exercise of a statutory stock option. There has been
uncertainty in the past as to employer withholding
obligations upon the exercise of statutory stock
options. On June 25, 2002, the
IRS
announced that until further guidance is issued, it
would not assess FICA or FUTA taxes, or impose
Federal income tax withholding obligations, upon
either the exercise of a statutory stock option or
the disposition of stock acquired pursuant to the
exercise of a statutory stock option.101
House
Bill
The House bill provides specific exclusions from
FICA and FUTA wages for remuneration on account of
the transfer of stock pursuant to the exercise of an
incentive stock option or under an employee stock
purchase plan, or any disposition of such stock.
Thus, under the House bill, FICA and FUTA taxes do
not apply upon the exercise of a statutory stock
option.102
The House bill also provides that such remuneration
is not taken into account for purposes of
determining Social Security benefits.
Additionally, the House bill provides that Federal
income tax withholding is not required on a
disqualifying disposition, nor when compensation is
recognized in connection with an employee stock
purchase plan discount. Present law reporting
requirements continue to apply.
Effective date. --The House bill is effective
for stock acquired pursuant to options exercised
after the date of enactment.
Senate
Amendment
No provision.
Conference
Agreement
The conference agreement follows the House bill.
G.
Incentives to Reinvest Foreign Earnings in the
United States
(sec. 271 of the House bill, sec. 231 of the Senate
amendment, and new sec. 965 of the Code)
Present
Law
The
United States
employs a "worldwide" tax system, under
which domestic corporations generally are taxed on
all income, whether derived in the
United States
or abroad. Income earned by a domestic parent
corporation from foreign operations conducted by
foreign corporate subsidiaries generally is subject
to
U.S.
tax when the income is distributed as a dividend to
the domestic corporation. Until such repatriation,
the
U.S.
tax on such income generally is deferred, and
U.S.
tax is imposed on such income when repatriated.
However, under anti-deferral rules, the domestic
parent corporation may be taxed on a current basis
in the
United States
with respect to certain categories of passive or
highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has
been distributed as a dividend to the domestic
parent corporation. The main anti-deferral
provisions in this context are the controlled
foreign corporation rules of subpart F103
and the passive foreign investment company rules.104
A foreign tax credit generally is available to
offset, in whole or in part, the U.S. tax owed on
foreign-source income, whether earned directly by
the domestic corporation, repatriated as a dividend
from a foreign subsidiary, or included in income
under the anti-deferral rules.105
House
Bill
Under the provision, certain dividends received by a
U.S.
corporation from a controlled foreign corporation
are eligible for an 85-percent dividends-received
deduction. At the taxpayer's election, this
deduction is available for dividends received
either: (1) during the first six months of the
taxpayer's first taxable year beginning on or after
the date of enactment of the bill; or (2) during any
six-month or shorter period after the date of
enactment of the bill, during the taxpayer's last
taxable year beginning before such date. Dividends
received after the election period will be taxed in
the normal manner under present law.
The deduction applies only to dividends and other
amounts included in gross income as dividends (e.g.,
amounts described in section 1248(a)). The deduction
does not apply to items that are not included in
gross income as dividends, such as subpart F
inclusions or deemed repatriations under section
956. Similarly, the deduction does not apply to
distributions of earnings previously taxed under
subpart F, except to the extent that the subpart F
inclusions result from the payment of a dividend by
one controlled foreign corporation to another
controlled foreign corporation within a certain
chain of ownership during the election period. This
exception enables multinational corporate groups to
qualify for the deduction in connection with the
repatriation of earnings from lower-tier controlled
foreign corporations.
The deduction is subject to a number of limitations.
First, it applies only to repatriations in excess of
the taxpayer's average repatriation level over three
of the five most recent taxable years ending on or
before March 31, 2003, determined by disregarding
the highest-repatriation year and the
lowest-repatriation year among such five years (the
"base-period average"). In addition to
actual dividends, deemed repatriations under section
956 and distributions of earnings previously taxed
under subpart F are included in the base-period
average.
Second, the amount of dividends eligible for the
deduction is limited to the greatest of: (1) $500
million; (2) the amount of earnings shown as
permanently invested outside the United States on
the taxpayer's most recent audited financial
statement which is certified on or before March 31,
2003; or (3) in the case of an applicable financial
statement that fails to show a specific amount of
such earnings, but that does show a specific amount
of tax liability attributable to such earnings, the
amount of such earnings determined in such manner as
the Treasury Secretary may prescribe.
Third, dividends qualifying for the deduction must
be invested in the United States pursuant to a plan
approved by the senior management and board of
directors of the corporation claiming the deduction.
No foreign tax credit (or deduction) is allowed for
foreign taxes attributable to the deductible portion
of any dividend received during the taxable year for
which an election under the provision is in effect.
For this purpose, the taxpayer may specifically
identify which dividends are treated as carrying the
deduction and which are not; in the absence of such
identification, a pro rata amount of foreign tax
credits will be disallowed with respect to every
dividend received during the taxable year.
In addition, the income attributable to the
nondeductible portion of a qualifying dividend may
not be offset by net operating losses, and the tax
attributable to such income generally may not be
offset by credits (other than foreign tax credits
and
AMT
credits) and may not reduce the alternative minimum
tax otherwise owed by the taxpayer. No deduction
under sections 243 or 245 is allowed for any
dividend for which a deduction is allowed under the
provision.
Effective date. --The House bill provision is
effective for a taxpayer's first taxable year
beginning on or after the date of enactment of the
bill, or the taxpayer's last taxable year beginning
before such date, at the taxpayer's election.
Senate
Amendment
Under the provision, certain actual and deemed
dividends received by a U.S. corporation from a
controlled foreign corporation are subject to tax at
a reduced rate of 5.25 percent. For corporations
taxed at the top corporate income tax rate of 35
percent, this rate reduction is equivalent to an
85-percent dividends-received deduction. This rate
reduction is available only for the first taxable
year of an electing taxpayer ending 120 days or more
after the date of enactment of the provision.
The reduced rate applies only to repatriations in
excess of the taxpayer's average repatriation level
over 3 of the 5 most recent taxable years ending on
or before December 31, 2002, determined by
disregarding the highest-repatriation year and the
lowest-repatriation year among such 5 years.106
The taxpayer may designate which of its dividends
are treated as meeting the base-period average level
and which of its dividends are treated as comprising
the excess.
In order to qualify for the reduced rate, dividends
must be described in a "domestic reinvestment
plan" approved by the taxpayer's senior
management and board of directors. This plan must
provide for the reinvestment of the repatriated
dividends in the United States, "including as a
source for the funding of worker hiring and
training; infrastructure; research and development;
capital investments; or the financial stabilization
of the corporation for the purposes of job retention
or creation."
The provision disallows 85 percent of the foreign
tax credits attributable to dividends subject to the
reduced rate and removes 85 percent of the
underlying income from the taxpayer's foreign tax
credit limitation fraction under section 904. In
addition, any expenses, losses, or deductions of the
taxpayer may not be used to reduce the tax on
dividends qualifying for the benefits of the
provision.
In the case of an affiliated group, an election
under the provision is made by the common parent on
a group-wide basis, and all members of the group are
treated as a single taxpayer. The election applies
to all controlled foreign corporations with respect
to which an electing taxpayer is a United States
shareholder.
Effective date. --The Senate amendment
provision is effective for the first taxable year of
an electing taxpayer ending 120 days or more after
the provision's date of enactment.
Conference
Agreement
The conference agreement follows the House bill,
with modifications.
Under the conference agreement, certain dividends
received by a U.S. corporation from controlled
foreign corporations are eligible for an 85-percent
dividends-received deduction. At the taxpayer's
election, this deduction is available for dividends
received either during the taxpayer's first taxable
year beginning on or after the date of enactment of
the bill, or during the taxpayer's last taxable year
beginning before such date.107
Dividends received after the election period will be
taxed in the normal manner under present law. The
conferees emphasize that this is a temporary
economic stimulus measure, and that there is no
intent to make this measure permanent, or to
"extend" or enact it again in the future.
The deduction applies only to cash dividends and
other cash amounts included in gross income as
dividends, such as cash amounts treated as dividends
under sections 302 or 304 (but not to amounts
treated as dividends under Code sections 78, 367, or
1248).108
The deduction does not apply to items that are not
included in gross income as dividends, such as
subpart F inclusions or deemed repatriations under
section 956. Similarly, the deduction does not apply
to distributions of earnings previously taxed under
subpart F, except to the extent that the subpart F
inclusions result from the payment of a dividend by
one controlled foreign corporation to another
controlled foreign corporation within a certain
chain of ownership during the election period, with
the result that cash travels through a chain of
controlled foreign corporations to the taxpayer
within the election period. The amount of dividends
eligible for the deduction is reduced by any
increase in related-party indebtedness on the part
of a controlled foreign corporation between October
3, 2004 and the close of the taxable year for which
the deduction is being claimed, determined by
treating all controlled foreign corporations with
respect to which the taxpayer is a U.S. shareholder
as one controlled foreign corporation.109
This rule is intended to prevent a deduction from
being claimed in cases in which the U.S. shareholder
directly or indirectly (e.g., through a related
party) finances the payment of a dividend from a
controlled foreign corporation. In such a case,
there may be no net repatriation of funds, and thus
it would be inappropriate to provide the deduction.
The deduction is subject to a number of general
limitations. First, it applies only to repatriations
in excess of the taxpayer's average repatriation
level over three of the five most recent taxable
years ending on or before June 30, 2003, determined
by disregarding the highest-repatriation year and
the lowest-repatriation year among such five years
(the "base-period average"). If the
taxpayer has fewer than five such years, then all
taxable years ending on or before June 30, 2003 are
included in the base period.110
Repatriation levels are determined by reference to
base-period tax returns as filed, including any
amended returns that were filed on or before June
30, 2003. U.S. shareholders that file a consolidated
tax return are treated as one U.S. shareholder for
all purposes of this dividends-received deduction
provision. Thus, all such shareholders are
aggregated in determining the base-period average
(as are all controlled foreign corporations). In
addition to cash dividends, dividends of property,
deemed repatriations under section 956, and
distributions of earnings previously taxed under
subpart F are included in the base-period average.
Second, the amount of dividends eligible for the
deduction is limited to the greatest of: (1) $500
million; (2) the amount of earnings shown as
permanently invested outside the United States on
the taxpayer's most recent audited financial
statement which is certified on or before June 30,
2003;111
or (3) in the case of an applicable financial
statement that does not show a specific amount of
such earnings, but that does show a specific amount
of tax liability attributable to such earnings, the
amount of such earnings determined by grossing up
the tax liability at a 35-percent rate. If there is
no applicable financial statement, or if such
statement does not show a specific earnings or tax
liability amount, then the $500 million limit
applies. This $500 million amount is divided among
corporations that are members of a controlled group,
using a 50-percent standard of common control. The
two financial statement amounts described above are
divided among the U.S. shareholders that are
included on such statements.
Third, in order to qualify for the deduction,
dividends must be described in a domestic
reinvestment plan approved by the taxpayer's senior
management and board of directors. This plan must
provide for the reinvestment of the repatriated
dividends in the United States, including as a
source for the funding of worker hiring and
training, infrastructure, research and development,
capital investments, and the financial stabilization
of the corporation for the purposes of job retention
or creation. The conferees note that this list of
permitted uses is not exclusive. The reinvestment
plan cannot, however, designate repatriated funds
for use as payment for executive compensation.
Dividends with respect to which the deduction is not
being claimed are not required to be included in any
domestic reinvestment plan.
No foreign tax credit (or deduction) is allowed for
foreign taxes attributable to the deductible portion
of any dividend. For this purpose, the taxpayer may
specifically identify which dividends are treated as
carrying the deduction and which dividends are not.112
In other words, the taxpayer is allowed to choose
which of its dividends are treated as meeting the
base-period repatriation level (and thus carry
foreign tax credits, to the extent otherwise
allowable), and which of its dividends are treated
as comprising the excess eligible for the deduction
(and thus entail proportional disallowance of any
associated foreign tax credits). The deduction
itself will have the effect of appropriately
reducing the taxpayer's foreign tax credit
limitation.
Deductions are disallowed for expenses that are
properly allocated and apportioned to the deductible
portion of any dividend.
The income attributable to the nondeductible portion
of a qualifying dividend may not be offset by
expenses, losses, or deductions, and the tax
attributable to such income generally may not be
offset by credits (other than foreign tax credits
and
AMT
credits).113
The tax on this amount also cannot reduce the
alternative minimum tax that otherwise would be owed
by the taxpayer. However, the deduction available
under this provision is not treated as a preference
item for purposes of computing the
AMT
. Thus, the deduction is allowed in computing
alternative minimum taxable income notwithstanding
the fact that it may not be deductible in computing
earnings and profits. No deduction under sections
243 or 245 is allowed for any dividend for which a
deduction is allowed under the provision.
Effective date. --The provision is effective
only for a taxpayer's first taxable year beginning
on or after the date of enactment of the bill, or
the taxpayer's last taxable year beginning before
such date, at the taxpayer's election. The deduction
available under the provision is not allowed for
dividends received in any taxable year beginning one
year or more after the date of enactment.
H.
Other Incentive Provisions
1. Special rules for livestock sold on account of
weather-related conditions (sec. 281 of the House
bill, sec. 649 of the Senate amendment, and secs.
1033 and 451 of the Code)
Present
Law
Generally, a taxpayer realizes gain to the extent
the sales price (and any other consideration
received) exceeds the taxpayer's basis in the
property. The realized gain is subject to current
income tax unless the gain is deferred or not
recognized under a special tax provision.
Under section 1033, gain realized by a taxpayer from
an involuntary conversion of property is deferred to
the extent the taxpayer purchases property similar
or related in service or use to the converted
property within the applicable period. The
taxpayer's basis in the replacement property
generally is the cost of such property reduced by
the amount of gain not recognized.
The applicable period for the taxpayer to replace
the converted property begins with the date of the
disposition of the converted property (or if
earlier, the earliest date of the threat or
imminence of requisition or condemnation of the
converted property) and ends two years after the
close of the first taxable year in which any part of
the gain upon conversion is realized (the
"replacement period"). Special rules
extend the replacement period for certain real
property and principal residences damaged by a
Presidentially declared disaster to three years and
four years, respectively, after the close of the
first taxable year in which gain is realized.
Section 1033(e) provides that the sale of livestock
(other than poultry) that is held for draft,
breeding, or dairy purposes in excess of the number
of livestock that would have been sold but for
drought, flood, or other weather-related conditions
is treated as an involuntary conversion.
Consequently, gain from the sale of such livestock
could be deferred by reinvesting the proceeds of the
sale in similar property within a two-year period.
In general, cash-method taxpayers report income in
the year it is actually or constructively received.
However, section 451(e) provides that a cash-method
taxpayer whose principal trade or business is
farming who is forced to sell livestock due to
drought, flood, or other weather-related conditions
may elect to include income from the sale of the
livestock in the taxable year following the taxable
year of the sale. This elective deferral of income
is available only if the taxpayer establishes that,
under the taxpayer's usual business practices, the
sale would not have occurred but for drought, flood,
or weather-related conditions that resulted in the
area being designated as eligible for Federal
assistance. This exception is generally intended to
put taxpayers who receive an unusually high amount
of income in one year in the position they would
have been in absent the weather-related condition.
House
Bill
The House bill extends the applicable period for a
taxpayer to replace livestock sold on account of
drought, flood, or other weather-related conditions
from two years to four years after the close of the
first taxable year in which any part of the gain on
conversion is realized. The extension is only
available if the taxpayer establishes that, under
the taxpayer's usual business practices, the sale
would not have occurred but for drought, flood, or
weather-related conditions that resulted in the area
being designated as eligible for Federal assistance.
In addition, the Secretary of the Treasury is
granted authority to further extend the replacement
period on a regional basis should the
weather-related conditions continue longer than
three years. Also, for property eligible for the
provision's extended replacement period, the
provision provides that the taxpayer can make an
election under section 451(e) until the period for
reinvestment of such property under section 1033
expires.
Effective date. --The House bill provision is
effective for any taxable year with respect to which
the due date (without regard to extensions) for the
return is after
December 31, 2002
.
Senate
Amendment
The Senate amendment is the same as the House bill,
except that it also permits the taxpayer to replace
compulsorily or involuntarily converted livestock
with other farm property if, due to drought, flood,
or other weather-related conditions, it is not
feasible for the taxpayer to reinvest the proceeds
in property similar or related in use to the
livestock so converted.
Effective date. --The Senate amendment
provision is effective for taxable years beginning
after
December 31, 2001
.
Conference
Agreement
The conference agreement follows the Senate
amendment, except for the effective date.
Effective date. --The conference agreement
provision is effective for any taxable year with
respect to which the due date (without regard to
extensions) for the return is after
December 31, 2002
.
2. Payment of dividends on stock of cooperatives
without reducing patronage dividends (sec. 282 of
the House bill, sec. 648 of the Senate amendment,
and sec. 1388 of the Code)
Present
Law
Under present law, cooperatives generally are
entitled to deduct or exclude amounts distributed as
patronage dividends in accordance with Subchapter T
of the Code. In general, patronage dividends are
comprised of amounts that are paid to patrons (1) on
the basis of the quantity or value of business done
with or for patrons, (2) under a valid and
enforceable obligation to pay such amounts that was
in existence before the cooperative received the
amounts paid, and (3) which are determined by
reference to the net earnings of the cooperative
from business done with or for patrons.
Treasury Regulations provide that net earnings are
reduced by dividends paid on capital stock or other
proprietary capital interests (referred to as the
"dividend allocation rule").114
The dividend allocation rule has been interpreted to
require that such dividends be allocated between a
cooperative's patronage and nonpatronage operations,
with the amount allocated to the patronage
operations reducing the net earnings available for
the payment of patronage dividends.
House
Bill
The House bill provides a special rule for dividends
on capital stock of a cooperative. To the extent
provided in organizational documents of the
cooperative, dividends on capital stock do not
reduce patronage income and do not prevent the
cooperative from being treated as operating on a
cooperative basis.
Effective date. --The House bill provision is
effective for distributions made in taxable years
ending after the date of enactment.
Senate
Amendment
The Senate amendment is the same as the House bill.
Effective date. --The Senate amendment
provision is effective for distributions made in
taxable years ending after the date of enactment.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
3. Manufacturing relating to timber
a. Capital gains treatment to apply to outright
sales of timber by landowner (sec. 283 of the House
bill, sec. 333 of the Senate amendment, and sec.
631(b) of the Code)
Present
Law
Under present law, a taxpayer disposing of timber
held for more than one year is eligible for capital
gains treatment in three situations. First, if the
taxpayer sells or exchanges timber that is a capital
asset (sec. 1221) or property used in the trade or
business (sec. 1231), the gain generally is
long-term capital gain; however, if the timber is
held for sale to customers in the taxpayer's
business, the gain will be ordinary income. Second,
if the taxpayer disposes of the timber with a
retained economic interest, the gain is eligible for
capital gain treatment (sec. 631(b)). Third, if the
taxpayer cuts standing timber, the taxpayer may
elect to treat the cutting as a sale or exchange
eligible for capital gains treatment (sec. 631(a)).
House
Bill
Under the House bill, in the case of a sale of
timber by the owner of the land from which the
timber is cut, the requirement that a taxpayer
retain an economic interest in the timber in order
to treat gains as capital gain under section 631(b)
does not apply. Outright sales of timber by the
landowner will qualify for capital gains treatment
in the same manner as sales with a retained economic
interest qualify under present law, except that the
usual tax rules relating to the timing of the income
from the sale of the timber will apply (rather than
the special rule of section 631(b) treating the
disposal as occurring on the date the timber is
cut).
Effective date. --The provision is effective
for sales of timber after
December 31, 2004
.
Senate
Amendment
The provision in the Senate amendment is the same as
House bill.
Effective date. --The provision is effective
for sales of timber after the date of enactment.
Conference
Agreement
The conference agreement includes the provision in
the House bill and Senate amendment.
Effective date. --The provision is effective
for sales of timber after
December 31, 2004
.
b. Expensing of reforestation expenditures (sec.
331 of the Senate amendment and secs. 48 and 194 of
the Code)
Present
Law
Section 194 provides for an 84-month amortization
period for up to $10,000 of qualified reforestation
expenditures. Section 48(b) provides a 10-percent
credit on up to $10,000 of qualified amortizable
basis in timber property. The amount amortized under
section 194 is reduced by one half of the amount of
credit claimed under section 48(b).
House
Bill
No provision.
Senate
Amendment
The Senate amendment permits up to $10,000 of
qualified reforestation expenditures to be deducted
in the year paid or incurred (i.e., expensed). The
Senate amendment permits qualified reforestation
expenditures above $10,000 to be amortized over 84
months. The Senate amendment also repeals the
reforestation tax credit.
Effective date. --Expenditures paid or
incurred after the date of enactment.
Conference
Agreement
The conference agreement follows the Senate
amendment provision.
c. Election to treat cutting of timber as a sale
or exchange (sec. 102(b) of the House bill, sec. 332
of the Senate amendment, and sec. 631(a) of the
Code)
Present
Law
Under present law, a taxpayer may elect to treat the
cutting of timber as a sale or exchange of the
timber. If an election is made, the gain or loss is
recognized in an amount equal to the difference
between the fair market value of the timber and the
basis of the timber. An election, once made, is
effective for the taxable year and all subsequent
taxable years, unless the
IRS
, upon a showing of undue hardship by the taxpayer,
permits the revocation of the election. If an
election is revoked, a new election may be made only
with the consent of the
IRS
.
House
Bill
Under the House bill, an election made by a
corporation for a taxable year ending on or before
the date of enactment, to treat the cutting of
timber as a sale or exchange, may be revoked by the
taxpayer without the consent of the
IRS
for any taxable year ending after that date. The
prior election (and revocation) is disregarded for
purposes of making a subsequent election.
Effective date. --The provision applies to
taxable years ending after the date of enactment.
Senate
Amendment
The provision is the same as the House bill, except
the provision applies to all taxpayers.
Effective date. --The provision applies to
taxable years ending after the date of enactment.
Conference
Agreement
The conference agreement includes the provision in
the Senate amendment.
d. Modified safe harbor rules for timber REITs
(sec. 334 of the Senate amendment and sec. 857 of
the Code)
Present
Law
In general
Under present law, real estate investment trusts
("REITs") are subject to a special
taxation regime. Under this regime, a REIT is
allowed a deduction for dividends paid to its
shareholders. As a result, REITs generally do not
pay tax on distributed income. REITs are generally
restricted to earning certain types of passive
income, primarily rents from real property and
interests on mortgages secured by real property.
To qualify as a REIT, a corporation must satisfy a
number of requirements, among which are four tests:
organizational structure, source of income, nature
of assets, and distribution of income.
Income or loss from prohibited transactions
A 100-percent tax is imposed on the net income of a
REIT from "prohibited transactions". A
prohibited transaction is the sale or other
disposition of property held for sale in the
ordinary course of a trade or business,115
other than foreclosure property.116
A safe harbor is provided for certain sales of
rent-producing real property. To qualify for the
safe harbor, three criteria generally must be met.
First, the REIT must have held the property for at
least four years for rental purposes. Second, the
aggregate expenditures made by the REIT during the
four-year period prior to the date of the sale must
not exceed 30 percent of the net selling price of
the property. Third, either (i) the REIT must make
seven or fewer sales of property during the taxable
year or (ii) the aggregate adjusted basis of the
property sold must not exceed 10 percent of the
aggregate bases of all the REIT's assets at the
beginning of the REIT's taxable year. In the latter
case, substantially all of the marketing and
development expenditures with respect to the
property must be made through an independent
contractor.
Certain timber income
Some REITs have been formed to hold land on which
trees are grown. Upon maturity of the trees, the
standing trees are sold by the REIT. The Internal
Revenue Service has issued private letter rulings in
particular instances stating that the income from
the sale of the trees can qualify as REIT real
property income because the uncut timber and the
timberland on which the timber grew is considered
real property and the sale of uncut trees can
qualify as capital gain derived from the sale of
real property.117
Limitation on investment in other entities
A REIT is limited in the amount that it can own in
other corporations. Specifically, a REIT cannot own
securities (other than Government securities and
certain real estate assets) in an amount greater
than 25 percent of the value of REIT assets. In
addition, it cannot own such securities of any one
issuer representing more than five percent of the
total value of REIT assets or more than 10 percent
of the voting securities or 10 percent of the value
of the outstanding securities of any one issuer.
Securities for purposes of these rules are defined
by reference to the Investment Company Act of 1940.118
Special rules for taxable REIT subsidiaries
Under an exception to the general rule limiting REIT
securities ownership of other entities, a REIT can
own stock of a taxable REIT subsidiary ("TRS"),
generally, a corporation other than a REIT119
with which the REIT makes a joint election to be
subject to special rules. A TRS can engage in active
business operations that would produce income that
would not be qualified income for purposes of the
95-percent or 75-percent income tests for a REIT,
and that income is not attributed to the REIT.
Transactions between a TRS and a REIT are subject to
a number of specified rules that are intended to
prevent the TRS (taxable as a separate corporate
entity) from shifting taxable income from its
activities to the pass-through entity REIT or from
absorbing more than its share of expenses. Under one
rule, a 100-percent excise tax is imposed on rents,
deductions, or interest paid by the TRS to the REIT
to the extent such items would exceed an arm's
length amount as determined under section 482.120
House
Bill
No provision.
Senate
Amendment
Under the provision, a sale of a real estate asset
by a REIT will not be a prohibited transaction if
the following six requirements are met:
(1) The asset must have been held for at least four
years in the trade or business of producing timber;
(2) The aggregate expenditures made by the REIT (or
a partner of the REIT) during the four-year period
preceding the date of sale that are includible in
the basis of the property (other than timberland
acquisition expenditures121
) and that are directly related to the operation of
the property for the production of timber or for the
preservation of the property for use as timberland
must not exceed 30 percent of the net selling price
of the property;
(3) The aggregate expenditures made by the REIT (or
a partner of the REIT) during the four-year period
preceding the date of sale that are includible in
the basis of the property and that are not directly
related to the operation of the property for the
production of timber or the preservation of the
property for use as timberland must not exceed five
percent of the net selling price of the property;
(4) The REIT either (a) does not make more than
seven sales of property (other than sales of
foreclosure property or sales to which 1033 applies)
or (b) the aggregate adjusted bases (as determined
for purposes of computing earnings and profits) of
property sold during the year (other than sales of
foreclosure property or sales to which 1033 applies)
does not exceed 10 percent of the aggregate bases
(as determined for purposes of computing earnings
and profits) of property of all assets of the REIT
as of the beginning of the year;
(5) Substantially all of the marketing expenditures
with respect to the property are made by persons who
are independent contractors (as defined by section
856(d)(3)) with respect to the REIT and from whom
the REIT does not derive any income; and
(6) The sales price on the sale of the property
cannot be based in whole or in part on income or
profits of any person, including income or profits
derived from the sale of such properties.
Capital expenditures counted towards the 30-percent
limit are those expenditures that are includible in
the basis of the property (other than timberland
acquisition expenditures), and that are directly
related to operation of the property for the
production of timber, or for the preservation of the
property for use as timberland. These capital
expenditures are those incurred directly in the
operation of raising timber (i.e., silviculture), as
opposed to capital expenditures incurred in the
ownership of undeveloped land. In general, these
capital expenditures incurred directly in the
operation of raising timber include capital
expenditures incurred by the REIT to create an
established stand of growing trees. A stand of trees
is considered established when a target stand
exhibits the expected growing rate and is free of
non-target competition (e.g., hardwoods, grasses,
brush, etc.) that may significantly inhibit or
threaten the target stand survival. The costs
commonly incurred during stand establishment are:
(1) site preparation including manual or mechanical
scarification, manual or mechanical cutting,
disking, bedding, shearing, raking, piling,
broadcast and windrow/pile burning (including slash
disposal costs as required for stand establishment);
(2) site regeneration including manual or mechanical
hardwood coppice; (3) chemical application via
aerial or ground to eliminate or reduce vegetation;
(4) nursery operating costs including personnel
salaries and benefits, facilities costs, cone
collection and seed extraction, and other costs
directly attributable to the nursery operations (to
the extent such costs are allocable to seedlings
used by the REIT); (5) seedlings including storage,
transportation and handling equipment; (6) direct
planting of seedlings; and (7) initial stand
fertilization, up through stand establishment. Other
examples of capital expenditures incurred directly
in the operation of raising timber include
construction cost of road to be used for managing
the timber land (including for removal of logs or
fire protection), environmental costs (i.e., habitat
conservation plans), and any other post stand
establishment capital costs (e.g., "mid-term
fertilization costs)."
Capital expenditures counted towards the
five-percent limit are those capital expenditures
incurred in the ownership of undeveloped land that
are not incurred in the direct operation of raising
timber (i.e., silviculture). This category of
capital expenditures includes: (1) expenditures to
separate the REIT's holdings of land into separate
parcels; (2) costs of granting leases or easements
to cable, cellular or similar companies; (3) costs
in determining the presence or quality of minerals
located on the land; (4) costs incurred to defend
changes in law that would limit future use of the
land by the REIT or a purchaser from the REIT; (5)
costs incurred to determine alternative uses of the
land (e.g., recreational use); and (6) development
costs of the property incurred by the REIT (e.g.,
engineering, surveying, legal, permit, consulting,
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