Selected Recently Expired Business Tax
Provisions (“Tax Extenders”)
Jane G. Gravelle
Senior Specialist in Economic Policy
Donald J. Marples
Specialist in Public Finance
Molly F. Sherlock
Specialist in Public Finance
April 30, 2014
Congressional Research Service
7-5700
www.crs.gov
R43510
Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Summary
On April 3, 2014, the Senate Finance Committee voted to report the Expiring Provisions
Improvement Reform and Efficiency (EXPIRE) Act (S. 2260), which would extend a set of
expired tax provisions through the end of 2015. These and other temporary tax provisions that are
regularly extended for one or two years are often referred to as “tax extenders.” Permanent
extension of certain expiring provisions has also been discussed in the context of tax reform.
House Ways and Means Committee Chairman Dave Camp’s tax reform discussion draft, the Tax
Reform Act of 2014, would make permanent several provisions that are currently part of the “tax
extenders.” This report briefly summarizes and discusses the economic impact of selected
business-related tax provisions that expired at the end of 2013 and that are being considered for
extension.
The provisions discussed in this report include three employer-related benefits:
• Work Opportunity Tax Credit
• Indian Employment Tax Credit
• Employer Wage Credit for Activated Military Reservists
Two international provisions that provide exceptions from the Subpart F rules are discussed:
• Look-Through Treatment of Payments between Related Controlled Foreign
Corporations under the Foreign Personal Holding Company Rules
• Exceptions under Subpart F for Active Financing Income
Seven special business cost recovery provisions are discussed:
• Bonus Depreciation
• Increase in Expensing to $500,000/$2,000,000 and Expansion of Definition of
Section 179 Property
• Special Expensing Rules for Certain Film and Television Productions
• 15-Year Straight-Line Depreciation Provisions
• 7-Year Recovery Period for Motorsports Entertainment Complexes
• 3-Year Depreciation for Race Horses Two Years Old or Younger
• Accelerated Depreciation for Business Property on an Indian Reservation
Two provisions related to regulated investment companies (RICs) are discussed:
• Treatment of Certain Dividends of RICs
• RIC Qualified Investment Entity Treatment under the Foreign Investment in Real
Property Act (FIRPTA)
And eight other business-related provisions are also discussed:
• Tax Credit for Research and Experimentation Expenses
• Credit for Certain Expenditures for Maintaining Railroad Tracks
Congressional Research Service
Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
• Reduction in S-Corporation Recognition Period for Built-In Gains
• Election to Accelerate AMT Credits in Lieu of Additional First-Year Depreciation
• Temporary Increase in Limit on Cover Over of Rum Excise Tax Revenues to
Puerto Rico and the Virgin Islands
• 100% Exclusion for Qualified Small Business Stock
• Deduction Allowable with Respect to Income Attributable to Domestic
Production Activities in Puerto Rico
• Modification of Tax Treatment of Certain Payments to Controlling Exempt
Organizations
This report does not include provisions that in the past have been classified as charitable,
community development, or energy-related provisions. The report also does not include housing-
related provisions, which are discussed in CRS Report R43449, Recently Expired Housing
Related Tax Provisions (“Tax Extenders”): In Brief, by Mark P. Keightley.
Congressional Research Service
Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Contents
Introduction ...................................................................................................................................... 1
Employment-Related Provisions ..................................................................................................... 4
Work Opportunity Tax Credit .................................................................................................... 5
Indian Employment Tax Credit ................................................................................................. 6
Employer Wage Credit for Activated Military Reservists ......................................................... 6
International Provisions ................................................................................................................... 7
Look-Through Treatment of Payments between Related Controlled Foreign
Corporations under the Foreign Personal Holding Company Rules ...................................... 8
Exceptions under Subpart F for Active Financing Income ........................................................ 9
Cost Recovery Provisions .............................................................................................................. 10
Bonus Depreciation ................................................................................................................. 10
Increase in Expensing to $500,000/$2,000,000 and Expansion of Definition of
Section 179 Property ............................................................................................................ 11
Special Expensing Rules for Certain Film and Television Productions .................................. 13
15-Year Straight Line Depreciation Provisions ....................................................................... 13
Seven-Year Recovery Period for Motorsports Entertainment Complexes .............................. 14
Three-Year Depreciation for Race Horses Two Years or Younger .......................................... 15
Accelerated Depreciation for Business Property on an Indian Reservation ............................ 15
Regulated Investment Company Provisions .................................................................................. 16
Treatment of Certain Dividends of Regulated Investment Companies (RICs) ....................... 16
RIC Qualified Investment Entity Treatment under FIRPTA ................................................... 16
Other Provisions ............................................................................................................................ 17
Tax Credit for Research and Experimentation Expenses......................................................... 17
Credit for Certain Expenditures for Maintaining Railroad Tracks .......................................... 18
Reduction in S-Corporation Recognition Period for Built-In Gains ....................................... 19
Election to Accelerate AMT Credits in Lieu of Additional First-Year Depreciation ............... 20
Temporary Increase in Limit on Cover Over of Rum Excise Tax Revenues to Puerto
Rico and the Virgin Islands .................................................................................................. 21
100% Exclusion for Qualified Small Business Stock .............................................................. 22
Deduction Allowable with Respect to Income Attributable to Domestic Production
Activities in Puerto Rico ...................................................................................................... 22
Modification of Tax Treatment of Certain Payments to Controlling Exempt
Organizations ........................................................................................................................ 24
Tables
Table 1. Cost of Extending Certain Expired Provisions .................................................................. 2
Contacts
Author Contact Information........................................................................................................... 24
Congressional Research Service
Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Introduction
On April 3, 2014, the Senate Finance Committee voted to report the Expiring Provisions
Improvement Reform and Efficiency (EXPIRE) Act (S. 2260), which would extend a set of
expired tax provisions through the end of 2015. These and other temporary tax provisions that are
regularly extended for one or two years are often referred to as “tax extenders.”1 This report
briefly summarizes and discusses the economic impact of selected business-related tax provisions
that expired at the end of 2013 and that are being considered for extension.
The provisions discussed in this report include several employer-related benefits, international
provisions that provide exceptions to the Subpart F rules, special cost recovery provisions,
provisions related to regulated investment companies (RICs), as well as several other business-
related provisions. A complete list of the provisions discussed in this report can be found in Table
1.
This report does not include provisions that in the past have been classified as charitable,
community development, or energy-related provisions. The report also does not include housing-
related provisions, which are discussed in CRS Report R43449, Recently Expired Housing
Related Tax Provisions (“Tax Extenders”): In Brief, by Mark P. Keightley.
It would cost an estimated $85.3 billion to extend expired and expiring provisions through 2015,
as proposed in the Chairman’s Modification to the EXPIRE Act.2 More than half of this cost
($46.9 billion) is from the extension of business-related provisions discussed in this report.
Extending the tax credit for research and experimentation expenditures for two years, through
2015, would reduce revenues by an estimated $15.4 billion between 2014 and 2024. The revenue
cost of extending the exception under Subpart F for active financing income through 2015 is
estimated to be $10.4 billion between 2014 and 2024. Table 1 provides information on the
revenue cost of extending the business-related tax provisions discussed in this report through the
end of 2015, as proposed in the EXPIRE Act.
1 For general background, see CRS Report R43124, Expired and Expiring Temporary Tax Provisions (“Tax
Extenders”), by Molly F. Sherlock.
2 This is the cost over the budget window, which includes FY2014 through FY2024.
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Table 1. Cost of Extending Certain Expired Provisions
billions of dollars
Permanent
10-Year Cost
Extension
of Extension
Cost of
Approved by
through
Permanent
House
2015 in
Extension:
Committee
EXPIRE Act
2014 - 2024
on Ways and
Provision
Means
Employment-Related Provisions
Work Opportunity Tax Credit
$3.2a $16.4
Indian Employment Tax Credit
$0.1
$0.7
Employer Wage Credit for Activated Military Reservists
$0.3b -i-
International Provisions
Look-Through Treatment of Payments between Related Control ed Foreign Corporations under
$2.5 $20.3c YES
the Foreign Personal Holding Company Rules
Exceptions under Subpart F for Active Financing Income
$10.4
$58.8c YES
Cost Recovery Provisions
Bonus Depreciation
$2.9 $296.4
Increase in Expensing to $500,000/$2,000,000 and Expansion of Definition of Section 179
$3.1 $73.1c YES
Property
Special Expensing Rules for Certain Film and Television Productions
-i-d $1.3
15-Year Straight-Line Depreciation Provisions
$4.8
$16.2
7-Year Recovery Period for Motorsports Entertainment Complexes
$0.1
$0.6
3-Year Depreciation for Race Horses Two Years Old or Younger
-i-
$0.5
e
Accelerated Depreciation for Business Property on an Indian Reservation
$0.2
$1.4
Regulated Investment Company Provisions
Treatment of Certain Dividends of Regulated Investment Companies (RICs)
$0.2
$1.3
RIC Qualified Investment Entity Treatment under FIRPTA
$0.1
$0.7
CRS-2
Permanent
10-Year Cost
Extension
of Extension
Cost of
Approved by
through
Permanent
House
2015 in
Extension:
Committee
EXPIRE Act
2014 - 2024
on Ways and
Provision
Means
Other Provisions
Tax Credit for Research and Experimentation Expenses
$15.4
$155.5c YES
Credit for Certain Expenditures for Maintaining Railroad Tracks
$0.4
$2.1
Reduction in S-Corporation Recognition Period for Built-In Gains
$0.2
$1.5c YES
Election to Accelerate AMT Credits in Lieu of Additional First-Year Depreciation
$0.6
$0.7
Temporary Increase in Limit on Cover Over of Rum Excise Tax Revenues to Puerto Rico and
$0.3 n.a.
the Virgin Islands
100% Exclusion for Qualified Small Business Stock
$1.9
$9.2
Deduction Allowable with Respect to Income Attributable to Domestic Production Activities in
$0.2 $2.1
Puerto Rico
Modification of Tax Treatment of Certain Payments to Controlling Exempt Organizations
-i-
$0.2
Source: Joint Committee on Taxation, Estimated Revenue Effects Of The Chairman’s Modification To The “Expiring Provisions Improvement Reform And Efficiency Act
Of 2014,” Scheduled For Markup By The Committee On Finance On April 3, 2014, https://www.jct.gov/publications.html?func=startdown&id=4577; Congressional
Budget Office, The Budget and Economic Outlook: 2014 to 2024, Washington, DC, February 4, 2014, http://www.cbo.gov/publication/45010; and the Tax Reform Act of
2014, available at http://tax.house.gov/.
Notes: An -i- indicates a revenue cost of less than $50 million. An entry of “n.a.” indicates that the estimate was not available.
a. The EXPIRE Act would expand the WOTC to include the long-term unemployed.
b. The EXPIRE Act would expand this credit to be available for employers of any size, and increase the credit rate to 100%.
c. This revenue estimate was prepared by the JCT in advance of the April 29, 2014, markup considering permanent extension of this provision. JCT’s revenue
estimates are available at https://www.jct.gov/publications.html.
d. The EXPIRE Act would expand this provision to include live theatrical productions.
e. This provision would be made permanent in House Ways and Means Committee Chairman Dave Camp’s Tax Reform Act of 2014, but was not considered during
the April 29, 2014, markup related to permanent extension of expired provisions.
CRS-3
Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
On April 29, 2014, the House Committee on Ways and Means voted to report legislation that
would make permanent six provisions that are currently part of the extenders.3 The following
legislative proposals were included in the markup:
• H.R. 4429, to amend the Internal Revenue Code of 1986 to permanently extend
the subpart F exemption for active financing income;
• H.R. 4438, the American Research and Competitiveness Act of 2014;
• H.R. 4453, to amend the Internal Revenue Code of 1986 to make permanent the
reduced recognition period for built-in gains of S corporations;
• H.R. 4454, to amend the Internal Revenue Code of 1986 to make permanent
certain rules regarding basis adjustments to stock of S corporations making
charitable contributions of property;
• H.R. 4457, America’s Small Business Tax Relief Act; and
• H.R. 4464, to amend the Internal Revenue Code of 1986 to make permanent the
look-through treatment of payments between related controlled foreign
corporations.
Five of these provisions are discussed in this report (see Table 1).4 The permanent extension of
the research tax credit as proposed in the American Research and Competitiveness Act of 2014,
would significantly change the provision by eliminating the general credit and allowing only an
alternative credit (with a rate increased to the rate of the current credit). The alternative credit, as
discussed in the section “Tax Credit for Research and Experimentation Expenses,” is less
effective at the margin.5
For certain cost recovery provisions, the 10-year revenue cost of a permanent extension is
substantially greater than the cost of temporarily extending the provision through 2015, as
proposed in the EXPIRE Act. For example, the revenue cost of temporarily extending bonus
depreciation, through 2015 is $2.9 billion. Making bonus depreciation permanent would cost
$296.4 billion. With a temporary extension, tax liability is deferred, with much of the cost
recovered in the later years in the budget window. A similar pattern is observed for the proposed
increase in the Section 179 expensing allowances, with a temporary extension having an
estimated cost of $3.1 billion. A permanent extension, however, would cost $73.1 billion between
2014 and 2024.
Employment-Related Provisions
Tax incentives have been used at the federal level to encourage employers to hire employees from
certain groups or to encourage employers to provide certain forms of compensation or benefits.
The first two credits discussed below, the work opportunity tax credit (WOTC) and the Indian
3 For more information, see http://waysandmeans.house.gov/calendar/eventsingle.aspx?EventID=377547.
4 This report does not include a discussion of the temporary rules regarding basis adjustments to stock of S corporations
making charitable contributions of property.
5 For more information, see CRS Report RL31181, Research Tax Credit: Current Law and Policy Issues for the 113th
Congress, by Gary Guenther.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
employment tax credit, encourage employers to hire selected types of employees. The third
provision, the employer wage credit for employees on active military duty, encourages employers
to provide “differential pay” to employees whose military pay is less than their civilian salary.
Work Opportunity Tax Credit6
The work opportunity tax credit (WOTC) is a non-refundable wage credit intended to increase job
opportunities for certain categories of disadvantaged individuals. The WOTC reduces the cost of
hiring specified groups of disadvantaged individuals. WOTC-eligible hires include members of
families receiving Temporary Assistance to Needy Families (TANF) benefits, certain members of
families receiving food stamp benefits, ex-felons, and certain veterans.
For most eligible hires that remain on a firm’s payroll at least 400 hours, an employer can claim
an income tax credit equal to 40% of wages paid during the worker’s first year of employment, up
to a statutory maximum. For most WOTC-eligible hires, the wage maximum is $6,000, for a
maximum credit of $2,400. For eligible veterans, the maximum eligible wage varies between
$6,000 and $24,000, depending on the veteran’s characteristics and work history. Eligible summer
youth hires’ maximum wage to which the credit can be applied is $3,000. A credit equal to 25%
of a qualified worker’s wages is available for eligible hires that remain employed for at least 120
hours, but fewer than 400 hours.
The WOTC was created as part of the Small Business Job Protection Act of 1996 (P.L. 104-188).
The WOTC evolved from an earlier tax credit designed to increase employment among targeted
groups, the Targeted Jobs Tax Credit (TJTC), which was available from 1978 through 1994.
When first enacted, the WOTC was scheduled to expire on October 1, 1997. Since 1997, the
WOTC has been expanded, modified, and regularly extended. In several instances, the WOTC
was allowed to lapse before being retroactively reinstated.
The WOTC is designed to encourage employers to hire more disadvantaged individuals by
compensating for potential higher costs of training and possible lower productivity. Since the
credit is focused on hiring from targeted groups, and not net job creation, the credit is not
necessarily intended to create new jobs or promote recovery in labor markets.7 Studies evaluating
the credit have looked at whether the credit increases job opportunities for targeted disadvantaged
individuals, and whether the WOTC is a cost-effective policy measure for achieving this
objective.
Early evidence on the WOTC suggested that while the credit did offset part of the cost of
recruiting, hiring, and training WOTC-eligible employees, it had a limited effect on companies’
hiring decisions.8 More recent studies have found that the WOTC provided benefits to certain
groups: increasing the wage income of disabled veterans and increasing employment among long-
term welfare recipients, for example. Researchers have also explored whether the credit causes
6 Internal Revenue Code (IRC) Section 51(c)(4).
7 Kenneth A. Couch, Douglas J. Besharov, and David Neumark, “Spurring Job Creation in Response to Severe
Recessions: Reconsidering Hiring Credits,” Journal of Policy Analysis and Management, vol. 32, no. 1 (Winter 2013),
pp. 142-171.
8 For an overview of the empirical literature on the WOTC, see U.S. Congress, Senate Committee on the Budget, Tax
Expenditures: Compendium of Background Material on Individual Provisions, committee print, prepared by
Congressional Research Service, 112th Cong., December 2012, S. Prt. 112-45, pp. 759-771.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
employers to “churn” their workforce in order to take advantage of the credit, replacing currently
credit-ineligible workers with credit-certified workers. Evidence of this behavior has not been
found.
For more information on the WOTC, see CRS Report RL30089, The Work Opportunity Tax
Credit (WOTC), by Christine Scott.
Indian Employment Tax Credit
The Indian employment tax credit is an incremental credit claimed by employers for qualified
wages and health insurance costs. Similar to the WOTC, the Indian employment credit is
designed to encourage hiring of certain individuals—enrolled members of an Indian tribe and
their spouses. There are also restrictions limiting the benefit to services performed within an
Indian reservation for individuals living on or near the reservation.
The Indian employment credit is 20% of the excess of qualified wages and health insurance costs
over base year expenses, paid by an employer. The credit is allowed for the first $20,000 in
qualified wages and health insurance costs. The base year is 1993, such that the incentive is
incremental to 1993 wages and health insurance costs (the base year has not been changed since
the credit was enacted). The credit is not available for wages paid to an employee whose total
wages exceed $30,000, as adjusted for inflation ($45,000 in 2013). The employer must reduce
their deduction for wages by the amount of the credit.
The Indian employment credit was first enacted in 1993, as part of the Omnibus Reconciliation
Act of 1993 (P.L. 103-66). It was initially scheduled to expire at the end of 2003, but has been
regularly extended, often retroactively. Past extensions of the Indian employment credit have
extended the termination date without updating the base year. Some have proposed updating the
base year, in an effort to (1) eliminate the need for taxpayers to maintain tax records dating back
to 1993, and (2) restore the incremental design of the credit.9
Extending the Indian employment credit might encourage additional hiring of Indian tribe
members and their spouses. Similar to the WOTC, while the Indian employment credit may not
increase overall employment on or near Indian reservations, it might increase employment among
tribe members.
Employer Wage Credit for Activated Military Reservists10
Members of the National Guard or Reserves who are called up to active duty receive military pay.
Some National Guard or Reserves members may have civilian salaries higher than their military
pay. Civilian employers might choose to compensate employees for the reduction in salary that
results from being called up to active duty. This form of compensation is often called differential
pay. Certain small businesses may qualify for a tax credit to offset some of the costs associated
with providing these military pay differentials.
9 See, for example, Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2015
Revenue Proposals, Washington, DC, March 2014, pp. 13-15, http://www.treasury.gov/resource-center/tax-policy/
Documents/General-Explanations-FY2015.pdf.
10 IRC Section 45P.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Under this provision, eligible small businesses can claim a 20% tax credit for differential wage
payments made to National Guard or Reserves members who are on active duty for more than 30
days. Eligible small businesses are those with fewer than 50 employees that provide differential
wage payments to every qualified employee under a written plan. Eligible differential wage
payments cannot exceed $20,000 per year, meaning the maximum value for the tax credit is
$4,000 (20% of $20,000) per employee.
The employer wage credit for employees on active military duty was added to the code as part of
the Heroes Earnings Assistance and Relief Tax Act of 2008 (P.L. 110-245). The provision, which
was set to expire at the end of 2009, has been extended twice as part of past “tax extenders”
legislation.
Employers that offer differential pay do so voluntarily. Reasons employers may choose to offer
differential pay include a show of patriotism or support for troops, or an effort to retain
employees after their military duty ends. There is a perception that small businesses may be less
able to offer differential pay than larger firms. This provision, by reducing the net cost of
providing differential pay for small businesses, should increase the total amount of differential
pay being provided by small businesses. If the goal of the provision is to provide income support
to National Guard or Reserve members called up to active duty, one might question why the
incentive is limited to employers with fewer than 50 employees.
Not all employees called up to active duty will necessarily be eligible to receive differential pay.
Since differential pay is the difference between an individual’s civilian salary and military salary,
many middle-income individuals will not receive differential pay, as their military salaries are at
least equal to their civilian salary. Lower-income individuals usually receive a higher military
than civilian salary. Thus, the tax benefit tends to favor employers of middle- to higher-wage
earners employed by qualified small businesses. Businesses employing middle- to lower-income
wage earners may not have the opportunity to provide differential pay (if their employee’s
military pay is equal to or greater than their civilian pay), but may face other burdens when
employees are called up to active duty (e.g., workforce disruptions).
International Provisions
In general, income earned abroad by foreign incorporated subsidiaries is not taxed until it is
repatriated (paid to the U.S. parent as a dividend).11 Foreign subsidiaries are not allowed to
circumvent this tax by making other payments to the parent such as loans. The tax due on
repatriated income is offset by credits for foreign income taxes paid. For passive income (such as
interest income) and certain types of payments which can be easily manipulated to reduce foreign
taxes, tax rules require this income to be taxed currently (referred to as Subpart F income to
indicate where in the code its tax treatment is specified). The two international provisions in the
extenders package provide exceptions from the Subpart F rules.
11 For general background on international tax issues, see CRS Report RL34115, Reform of U.S. International
Taxation: Alternatives, by Jane G. Gravelle and CRS Report R42624, Moving to a Territorial Income Tax: Options and
Challenges, by Jane G. Gravelle.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Look-Through Treatment of Payments between Related Controlled
Foreign Corporations under the Foreign Personal Holding
Company Rules12
Unless an exception applies, Subpart F income includes dividends, interest, rent, and royalty
payments between related firms. These items of income are subject to Subpart F because
affiliated firms can use them to shift income and avoid tax. For example, without Subpart F a
U.S. parent’s subsidiary (1st tier subsidiary) in a country without taxes (e.g., the Cayman Islands)
could lend money to its own subsidiary (2nd tier subsidiary) in a high tax country. The interest
payments would be deductible in the high tax country, but no tax would be due in the no-tax
country. Thus, an essentially paper transaction shifts income out of the high tax country. A similar
effect might occur if an intangible asset is transferred to the no-tax subsidiary, and then licensed
in exchange for a royalty payment by the high tax subsidiary.
In some cases, a U.S.-based multinational firm might be able to avoid having the earnings of a
foreign subsidiary classified as Subpart F income if the high tax (2nd tier) subsidiary could be
treated as an unincorporated entity for U.S. tax purposes. This is not feasible for some businesses
that are required, by foreign law, to operate as what are for U.S. tax purposes per se corporations,
or those that would face complex challenges and costs in changing their structure.
Methods of avoiding Subpart F taxation were made easier in 1997, when U.S. entity classification
rules (to be a corporate or non-corporate entity) were simplified by simply checking a box on a
form. These “check-the-box” regulations provided a way to avoid treatment of payments as
Subpart F income under certain circumstances by allowing firms to elect treatment as an
unincorporated entity. They were originally intended to simplify classification issues for domestic
firms and the IRS, but their usefulness in international tax planning quickly became evident. The
Treasury issued regulations in 1998 to disallow their use to avoid Subpart F,13 but, after protests
from firms and from Congress, withdrew them.
In the example above, if the high-tax subsidiary is not a direct subsidiary of the U.S. parent but is
a subsidiary of the Cayman Islands subsidiary (i.e., a 2nd tier subsidiary), the Cayman Islands (1st
tier) subsidiary can elect to treat the high-tax subsidiary as if it were a pass through entity. This
treatment would effectively combine the two subsidiaries into a single firm. This outcome can be
achieved simply by checking a box, making the high tax subsidiary a disregarded entity under
U.S. law. Because there are no separate firms, no income is recognized by the Cayman Islands
firm although the high tax subsidiary (2nd tier) is still a corporation from the point of view of the
foreign jurisdiction in which it operates and can deduct interest in the high tax jurisdiction.
The check-the-box rules did not work in every circumstance. For example, if the related firms did
not have the same 1st tier parent, check-the-box did not apply. In some cases, because of foreign
countries’ rules about corporate and non-corporate forms, the check-the-box regulations’
classification of some entities as per se corporations made this planning unavailable. In addition,
other undesirable tax consequences (from the firm’s point of view) could occur as a side effect of
check-the-box.
12 IRC Section 954(c)(6).
13 Notice 98-11, January16, 1998, http://www.irs.gov/pub/irs-drop/n-98-11.pdf.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
The look-through rule effectively puts this check-the-box type of planning into the tax code,
rather than as a regulation (which could be altered without legislation), but disconnects it from the
regulations’ creation of a disregarded entity. Related firms do not have to have the parent-child
relationship; they can be otherwise related as long as they are under common control.
The look-through rules were originally enacted in the Tax Increase Prevention and Reconciliation
Act of 2005 (P.L. 109-222), for 2006 through 2008, and subsequently extended.
The main argument against the look-through rules (and check-the-box as well) is that it
undermines the purpose of Subpart F, which is to prevent firms from using passive and easily
shifted income to avoid tax. The rules also provide a way to shift and reinvest excess foreign
earnings among distantly related operations, or to shift earnings to a tax haven, without first
repatriating them to the U.S. parent. This is done by paying dividends directly to related foreign
subsidiaries of their parent. Thus, it increases the disincentive to repatriate earnings.
The main argument for the provision is to allow firms the flexibility to redeploy earnings from
one location to another without having U.S. tax consequences (foreign tax rules are unchanged).
Firms could, for example, accomplish much of the treatment of look-through rules (even in the
absence of check-the-box), but that may involve complex planning and inconvenience. An
argument can also be made that in some cases (for example, with the payment of interest), the
profit shifting is not harming the U.S. Treasury, but rather reducing taxes collected by foreign
governments. If profits are shifted to low-tax countries and then eventually repatriated, foreign
tax credits will be smaller, and the U.S. tax collected higher (although deferred). At the same
time, this planning achieves lower effective foreign taxes in countries with relatively high
nominal tax rates and, as a result, encourages investment in those countries compared to the
United States.
Exceptions under Subpart F for Active Financing Income14
The Taxpayer Relief Act of 1997 (P.L. 105-34) contained a temporary exception from subpart F
income tax rules for active financing income. Active financing income applies to some of the
income earned by American corporations from the active conduct of a banking, financing, or
insurance business abroad. This income—which includes dividends and capital gains—would
otherwise be taxed under Subpart F as passive income. The tax expenditure is therefore the
allowance of deferral for this income. Since being enacted in 1997, the temporary provision
providing an exception under Subpart F for active financing income has regularly been extended.
The original enactment of Subpart F in 1962 had an exception for banking and insurance. The
rationale for this exception was that such income (e.g., interest and dividends) was not passive
income in the hands of banking and insurance firms. The Tax Reform Act of 1986 (P.L. 105-34)
eliminated the exception, because firms could locate profits in tax havens that have little
economic substance. President Clinton applied a line-item veto to this provision when enacted in
1997, but the line-item veto was subsequently found unconstitutional.
Industry advocates argue that the purpose of the active financing exception may be to place U.S.
financial services businesses on similar footing to their competitors from other countries.
14 IRC Sections 953(e), 954(h)(9), and 954(i).
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Conversely, passive income could be viewed as passive regardless of the underlying businesses.
The provision does provide an incentive for U.S. financial service businesses to invest in low-tax
countries (as high foreign taxes generally negate the tax benefit provided by deferral). Today,
some U.S. corporations not traditionally thought of as providing financial services may, in fact,
have significant financial service operations through their subsidiaries.
Cost Recovery Provisions
The cost of assets that provide services over a period of time, such as machines or buildings, is
deducted over a period of years as depreciation. The schedule of depreciation deductions depends
on the life of the asset and the distribution of deductions over that life. Straight-line depreciation
is used for structures, where equal amounts are deducted in each year. For equipment, deductions
are accelerated with larger amounts deducted in earlier years. Equipment is most commonly
depreciated over 5 or 7 years, but some short-lived assets are depreciated over 3 years and some
longer-lived assets are depreciated over 10, 15, or 20 years. Non-residential structures are
depreciated over 39 years. Aside from the desire for economic stimulus, traditional economic
theories suggest that tax depreciation should match as closely as possible economic (physical)
depreciation of assets.
The depreciation provisions discussed below all allow earlier deductions for depreciation, which
are valuable because of the time value of money. Expensing provisions allow a firm to deduct the
cost of an asset the year it is placed in service.
Bonus Depreciation15
Bonus depreciation has allowed firms to deduct part of the cost of equipment (most recently,
50%) in the year it was placed into service, rather than recover the cost over a period of time.
Bonus depreciation was intended for a specific, short-term purpose: to provide an economic
stimulus during a recession. Most economic stimulus provisions enacted in response to the recent
economic slowdown have been allowed to expire.
Bonus depreciation was introduced on two occasions: in 2002 (The Job Creation and Worker
Assistance Act of 2002, P.L. 107-147) and 2008 (the Economic Stimulus Act of 2008, P.L. 110-
185). The 2002 stimulus was allowed to expire as planned. Thus, bonus depreciation, unlike most
other expiring provisions, has not been continuously extended (and therefore might not be
regarded as a traditional “extender”). Regardless, the bonus depreciation introduced in 2008 was
in place for six years (through 2013), although its size varied over that period.
The analysis of bonus depreciation differs for a temporary stimulus provision, compared to a
permanent provision that can affect the size and allocation of the capital stock. A temporary
investment subsidy is expected to be more effective than a permanent one for the purpose of
short-term stimulus, encouraging firms to invest while the benefit was in place. Its temporary
nature is critical to its effectiveness. Yet, research suggests that bonus depreciation was not very
15 IRC Section 168(k).
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effective, and probably less effective than the other tax cuts or spending increases that have now
lapsed.16
As a permanent provision, bonus depreciation benefits equipment investments which already are
favored over structures, contributing to lower effective tax rates and, in some cases, negative tax
rates. Compared to a statutory corporate tax rate of 35%, bonus depreciation lowers the effective
tax rate for equipment from an estimated 26% rate to a 15% rate. Buildings are taxed
approximately at the statutory rate. Total effective tax rates for corporate assets would be slightly
higher because of stockholder taxes. Because interest payments are deducted, effective tax rates
with debt financing can be negative. For assets that would be taxed at the firm’s effective rate of
35% if they were equity assets (such as buildings), the effective tax rate on debt financed
investment is negative 5%. The rate on equipment without bonus depreciation is negative 19%,
but with bonus depreciation it is negative 37%.17 If bonus depreciation were made permanent,
U.S. effective tax rates on equipment would be significantly lower than the OECD average.18
The usual extenders cost a fraction of the cost of permanent provisions in a ten-year budget
window, but bonus depreciation is a smaller fraction because it is a timing provision. For
example, a two year extension costs $2.9 billion between 2014 and 2024, less than 1% of the cost
of $296.4 billion for a permanent provision.
For more information, see CRS Report R43432, Bonus Depreciation: Economic and Budgetary
Issues, by Jane G. Gravelle and CRS Report RL31852, Section 179 and Bonus Depreciation
Expensing Allowances: Current Law, Legislative Proposals in the 113th Congress, and Economic
Effects, by Gary Guenther.
Increase in Expensing to $500,000/$2,000,000 and Expansion of
Definition of Section 179 Property19
This provision allows firms to expense (deduct immediately), with dollar limits, the cost of
investment in equipment. In 2013, this amount was $500,000. Once a firm’s investment reached
at least $2,000,000, the amount eligible is reduced one dollar for each dollar of investment in
excess of $2,000,000. Thus once a firm’s investment reached $2,500,000, no deduction is
allowed. Without extension the exemption will revert to its permanent level of $25,000, with a
phase-out beginning at $200,000. No deduction would be allowed when investment is $225,000.
Off-the-shelf computer software will also no longer be eligible and a $250,000 expensing
provision for leasehold property, which was eligible for expensing in 2013, will no longer be
allowed.
16 See Congressional Budget Office, Policies for Increasing Economic Growth and Employment in 2012 and 2013,
Washington, DC, November 15, 2011, http://www.cbo.gov/publication/42717. A review of the evidence is provided in
CRS Report R43432, Bonus Depreciation: Economic and Budgetary Issues, by Jane G. Gravelle..
17 Ibid. When an investment is debt financed, the tax savings from the interest deductions more than offset tax due (in
present value terms) on the earnings from the investment, and if the offset is large enough, it also offsets the tax on
interest receive by the creditor. For a large share of investments the creditor is tax exempt (e.g., a pension fund or an
IRA account).
18 For calculations and comparisons, see CRS Report R43432, Bonus Depreciation: Economic and Budgetary Issues,
by Jane G. Gravelle.
19 IRC Section 179.
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The first expensing provision was relatively small when adopted as a permanent provision in the
Small Business Tax Revision Act of 1958 (P.L. 85-866). It allowed a deduction of 20% of the first
$20,000 ($10,000 for a single return). The provision was first revised in the Economic Recovery
Tax Act of 1981 (P.L. 97-34) to allow a deduction for all costs with limits of $10,000. The limits
were revised over time, but the limits were small and the changes were permanent.
The temporary increases since 2002 occurred in two distinct parts. The first increase occurred
when the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27) increased the
maximum allowance to $100,000, and the beginning of the phase-out to $400,000, effective from
2003-2005. This bill also added the off-the-shelf software to eligible property. The U.S. Troop
Readiness, Veterans’ Care, Katrina Recovery, and Iraq Appropriations Act of 2007 (P.L. 110-28),
increased the limit to $125,000, and the phase-out point to $500,000, through 2010. All of the so-
called Bush tax cuts were due to expire at the end of 2010, but they were extended near the end of
December that year.
The second set of temporary increases was part of the stimulus bills to address the 2007-2009
recession. The Economic Stimulus Act of 2008 (P.L. 110-185) increased the limit to $250,000 and
the phase-out point to $800,000; this provision was extended by subsequent legislation through
2010. In the Small Business Jobs Act of 2010 (P.L. 111-240) the limit was increased to $500,000
with a phase-out at $2,000,000, through 2011, and the leasehold property provision was added.
These provisions were subsequently extended.
Because one set of extensions might be considered part of the Bush-era tax cuts, which might be
made permanent along with other provisions, while another part is associated with a temporary
stimulus along with the option to extend all of the limits, one option might be to extend or make
the Bush-era tax provisions permanent and allow the higher limits added in 2008 and 2010 to
expire.
The original expensing provision in 1958 was justified as a simplification of depreciation rules
for small firms and a way to provide them an incentive to invest more. This argument is more
difficult to make with the higher spending caps from recent years. Later expansions, as in the case
of bonus depreciation, were justified to stimulate investment.
Extending the temporary provisions of Section 179 is likely to be relatively ineffective as a
stimulus. It has no incentive effect after the maximum cap is reached, and it increases the cost of
capital in the phaseout range. As noted earlier, bonus depreciation, which had no limits or phase-
outs, did not appear to be an effective stimulus.
For more information, see Section 179 and Bonus Depreciation Expensing Allowances: Current
Law, Legislative Proposals in the 113th Congress, and Economic Effects, by Gary Guenther.
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Special Expensing Rules for Certain Film and Television
Productions20
Investments in film and television productions are generally recovered using the income forecast
method. Under this method, depreciation deductions are based on the pattern of expected
earnings.
The American Jobs Creation Act of 2004 (P.L. 108-357) included special rules to allow expensing
for certain film and television production costs. The main purpose of the provision was to
discourage “runaway” productions, or the production of films and television shows in other
countries, where tax and other incentives are often offered. Initially, the provision was set to
expire at the end of 2008. However, since 2008, the provision has regularly been extended as part
of “tax extender” packages.
Under the special expensing rules for film and television production, taxpayers may elect to
deduct immediately up to $15 million of production costs ($20 million for productions produced
in certain low-income and distressed communities) in the tax year incurred. Eligible productions
are limited to those in which at least 75% of the compensation paid is for services performed in
the United States. For productions that started before 2008, the expensing deduction is not
allowed if the aggregate production cost exceeds $15 million ($20 million for productions in
designated low-income and distressed communities).
The ability to expense (deduct immediately) certain film and television production costs provides
a benefit by allowing deductions to be taken earlier, thus deferring tax liability. The magnitude of
the benefit depends on the average lag time from production to earning income. For many films,
production costs would be deductible in the year the film is released. If the film is released one
year after the production costs are incurred, which may be the case for independent and smaller
productions, the provision accelerates cost recovery by one year. The benefit conferred by
accelerating cost recovery deductions by one year is limited. Furthermore, taxpayers with limited
or no tax liability may derive little or no benefit from the expensing allowance.
The primary policy objective of providing special tax incentives for film and television producers
is to deter productions from moving overseas, lured by lower production costs as well as tax and
other subsidies offered by foreign governments. In evaluating this incentive, one consideration is
the economic value of domestic film and television production relative to the cost of the targeted
tax benefits.
15-Year Straight Line Depreciation Provisions21
Three types of non-residential structure investments that would otherwise be depreciated over 39
years could be depreciated over 15 years under this provision. These categories include certain
leasehold improvements (improvements that are made pursuant to leasing use to a tenant),
restaurant property, and retail improvements. Qualified leasehold improvements are those done
pursuant to a lease at least three years after a building is constructed. They cannot involve any
enlargement of the building, elevator, escalator, structural components benefitting a common
20 IRC Section 181(f).
21 IRC Sections 168(e)(3)(E)(iv), (v), (ix).
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area, or the internal framework of the building. Restaurant property improvements can qualify for
a new or existing building as long as more than 50% of the space is devoted to the preparation
and serving of meals. Retail property improvements must be made at least three years after the
building was constructed and apply to the sale of goods, not services.
Leasehold improvements were also eligible for bonus depreciation and a Section 179 deduction
up to $250,000 (see discussions above) in 2013.
The leasehold improvement and restaurant provisions were originally enacted in the American
Jobs Creation Act of 2004 (P.L. 108-357). Under this act, investments made after October 22,
2004, through 2007 were eligible for the 15-year depreciation. At that time both leasehold and
restaurant improvements had to have been undertaken at least three years after the building was
constructed. The Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (P.L. 110-343)
extended these provisions through 2009, eliminated the three-year rule for restaurant property,
and added the retail provision. It excluded all but leasehold improvements from bonus
depreciation.
The main argument against these provisions is that buildings, since 1981, have been depreciated
as a composite investment with the aim of averaging out the treatment of different components to
reflect the overall value of depreciation. Prior to this change, taxpayers were engaging in
component depreciation, separating out various short-lived components (such as a roof) for
shorter lives. Under the current composite treatment, if a taxpayer puts a roof on a building that
roof is depreciated on the standard useful life, because the overall life allows for the slower
depreciation of some components and the quicker depreciation of others (such as the building
shell). Component depreciation, where different parts of the building were depreciated separately,
was eliminated in the Economic Recovery Tax Act of 1981. By allowing the separation of
specific components for shorter lives without increasing them for longer-lived components, this
provision undermines composite depreciation.
The argument for faster depreciation for leasehold improvements is that these are made based on
the preferences of the leaseholder and may become obsolete with another leaseholder. The
argument for retail and restaurant property is that they actually depreciate faster than other
buildings, although this is not the position taken by the Bureau of Economic Analysis in their
estimates of economic depreciation.22
Seven-Year Recovery Period for Motorsports Entertainment
Complexes23
An exception from the 39 year depreciation life for nonresidential structures exists for the theme
and amusement park industry. Assets in this industry are assigned a recovery period of seven
years. Historically, motorsports racing facilities have been included in this industry and also
allowed a seven-year recovery period. However, ambiguities in the law led to questions about
whether motorsports racing facilities were correctly categorized. When the Treasury reconsidered
the appropriateness of this classification in 2004, Congress made the seven-year treatment
22 Depreciation rates are at http://www.bea.gov/national/pdf/BEA_depreciation_rates.pdf. Commercial buildings have
depreciation rates that are slower than industrial buildings.
23 IRC Sections 168(i)(15) and 168(e)(3)(C)(ii).
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mandatory through 2007 with the American Jobs Creation Act of 2004 (P.L. 108-357). Since
2004, the provision has been extended as part of “tax extenders” legislation. Without this
provision, motorsports racing facilities would be depreciated over the standard 39-year life.
The tax authorities presumably estimated motorsports racing facilities to have slower depreciation
rates than the seven-year life that applies to amusement park facilities. If so, this provision
constitutes a subsidy to the auto racing industry that does not appear to have an obvious
justification. Supporters argued that the provision preserves historical treatment and provides a
stimulus to business. They also argued that the benefit helps make them more competitive with
sports facilities that are often subsidized by state and local governments.
Three-Year Depreciation for Race Horses Two Years or Younger24
The cost recovery period for horses is seven-years, although race horses that begin training after
age two have a three-year recovery period. Under the temporary provision, this three-year
recovery period is extended to all race horses. In particular, all race horses placed in service after
December 31, 2008, and before January 1, 2014, have a three-year recovery period as a result of
the Food, Conservation, and Energy Act of 2008 (P.L. 110-246).25 The industry claims that
reducing the recovery period to three years more closely aligns the recovery period with the
racing life of a horse. The IRS cost recovery period suggests a longer view. Some race horses
continue in productive activity after their racing career through breeding, as well has having a
residual value for resale. A Treasury study estimated, taking those uses into account, an overall
economic life of nine years.26
This provision does not affect breeders who race their own horses, since they deduct the cost of
breeding and thus have no basis in the horses. The provision generally benefits investors who
purchase horses.
Accelerated Depreciation for Business Property on an Indian
Reservation 27
The Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) contained a provision allowing
businesses on Indian reservations to be eligible for accelerated depreciation (through a reduction
in the applicable recovery periods), as part of an effort to increase investment in Indian
Reservations. Since its initial temporary enactment, this provision has regularly been extended as
part of “tax extenders” legislation.
Extending the provision might encourage additional investment on Indian Reservations.
However, if the main target of these provisions is an improvement in the economic status of
individuals currently living on Indian Reservations, it is not clear to what extent this tax subsidy
will succeed in that objective, as these subsidies are not given directly to workers but instead are
24 IRC Section 168(e)(3)(A).
25 This provision expired for the first time at the end of 2013. Thus, the provision has not previously been extended.
26 U.S. Department of Treasury, Report to Congress on the Depreciation of Horses, March 1990,
http://www.treasury.gov/resource-center/tax-policy/Documents/depreci8study_horses.pdf.
27 IRC Section 168(j)(8).
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received by businesses. Capital subsidies may not ultimately benefit workers. It is possible that
capital equipment subsidies may encourage more capital intensive businesses and make workers
relatively worse off. In addition, workers would not benefit from higher wages resulting from an
employer subsidy if the wage is determined by regulation (the minimum wage) that is set higher
than the prevailing market wage.
Regulated Investment Company Provisions
A regulated investment company (RIC) is an entity that meets the following conditions: (1) its
income is generally earned from passive investments; (2) it distributes at least 90% of its income;
and (3) it elects to be taxed as an RIC. Mutual funds are examples of RICs.
Treatment of Certain Dividends of Regulated Investment
Companies (RICs)28
A key feature of the RIC tax regime is the ability to deduct income distributed to its shareholders
as dividends—effectively passing the tax forward to its shareholders who generally treat this
income as ordinary income. However, certain dividends are subject to a gross-basis tax and
withholding, with an exception.
The American Jobs Creation Act of 2004 (P.L. 108-357) contained a provision that exempts
interest-related and short-term capital gains dividends from the U.S. income tax (and
withholding) if they are paid to a foreign person and the income wouldn’t have been subject to
the tax if it had been earned directly by a foreign person. The provision has subsequently been
extended and modified multiple times.
The provision was enacted as part of a broader effort to reform and simplify the tax code for
businesses. The provision mitigates a disparity between the tax treatment of direct and indirect
investment of foreign persons.
RIC Qualified Investment Entity Treatment under FIRPTA29
In general, a foreign person or corporation is not taxed on U.S. source capital gains income unless
certain conditions are met. However, if the income is from selling U.S. real property, the
distribution is taxed at the same rates as a U.S. person under the Foreign Investment in Real
Property Tax Act (FIRPTA). The FIRPTA rules, adopted in 1980, considered investment in real
property to be income effectively connected to business which is generally subject to U.S. taxes.
There is an exception if (1) the investment is made through a qualified investment entity; (2) the
U.S. real property is regularly traded on an established U.S. securities market; and (3) the
recipient foreign person or corporation did not hold more than 5% of that class of stock or
beneficial interest within the one-year period ending on the date of distribution. The temporary
exception was enacted in the American Jobs Creation Act of 2004 (P.L. 108-357) and has since
been extended several times as part of various “tax extenders” legislation.
28 IRC Sections 871(k)(1)(C) and (2)(C), and 881(e)(1)(A) and (2).
29 IRC Section 897(h)(4).
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Most passive income of foreigners is generally not taxed by the United States because of
exceptions in law or tax treaties, just as most passive income earned by U.S. citizens abroad is not
taxed by foreign governments. Thus, the provision mitigates a disparity between the tax treatment
of direct and indirect investment of foreign persons. The provision encourages investment in real
property in the United States through eligible entities.
Other Provisions
Tax Credit for Research and Experimentation Expenses30
The research and experimentation credit (or the research credit) is 20% of the amount by which
qualified research expenses exceed a base amount, with a minimum of 50% of current research
expenses. The base amount is a past fixed amount of spending that increases over time with the
increase in gross receipts. There is also an alternative credit of 14% for research in excess of 50%
of the average qualified research over the past three years. Because this alternative credit has a
base that increases with research expenditures of the firm, an additional dollar of spending in year
one increases the base for future spending, which reduces the incentive to an estimated 7.9%.31
The incentive in the regular credit is also reduced from 20% to 10% through this mechanism if
the credit’s base is limited by the 50% of total spending minimum. The credit also has a basis
adjustment so that credit amounts cannot also be deducted. For a corporation expensing these
costs and at the top tax rate, the credit is reduced by 35%, so the effective credit rate is 13%
(6.5% if the 50% minimum rule applies, and 5.1% if the alternative credit is used).
There are two additional credits: 20% (in excess of a base) for university basic research that is not
directed at commercial objectives and 20% (without a base) for contract energy research.
Qualified research expenditures must be experimental, for the purpose of discovering information
that is technological in nature and used in the development of a new or improved product,
process, computer software technique, formula or invention that is to be leased, licensed, or used
by the firm. These expenses include wages and salaries of researchers, supplies, costs of using
computers, and from 65% to 100% of contract research. Equipment and structures are not
eligible. Research must be conducted in the United States.
The original research credit was adopted in the Economic Recovery Act of 1981 (P.L. 97-34), at a
25% rate and without a basis adjustment. It was in excess of a base equal to the average of the
past three years of research spending. As in the case of the current alternative credit, an additional
dollar increased the base in the future but had a more powerful effect, reducing the effective
credit to about 3%.
The credit has been extended numerous times, lapsed for one year, and has been extended
retroactively. It was also revised in a variety of ways, some of which remain and some which
30 IRC Section 41(h)(1)(B).
31 An additional dollar today causes the base to increase in the future. For example, in the following year the base will
be higher by $1, multiplied by 0.5, divided by 3 and divided by (1+r) where r is the discount rate. The current
expenditure will also increase the base in the same way in the second year out (except that the discount factor is (1+r)2)
and in the third year out (with a discount factor of (1+r)3). Using a discount rate of 7%, the value will fall from 14% to
7.9%.
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were overtaken by other changes. Among significant changes the Tax Reform Act of 1986 (P.L.
99-514) reduced the rate to 25%. The Technical and Miscellaneous Revenue Act of 1988 (P.L.
100-647) added a partial (half) basis adjustment. A major change was made in the Omnibus
Budget Reconciliation Act of 1989 (P.L. 101-239), which created a three-year fixed base for the
credit that was then adjusted by the growth in gross receipts, significantly increasing the effective
credit. That legislation also added the full basis adjustment. A different alternative credit was
added in the Small Business Job Protection Act of 1996 (P.L. 104-188), but the current form of
the alternative credit was added in Tax Relief and Health Care Act of 2006 (P.L. 109-432), so that
for a time there were two alternatives. The earlier alternative credit was repealed in the Tax
Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312).
Many economists agree that there is an economic justification for subsidizing research and
development (R&D) because private firms are not able to capture the full return from an
innovation, so that the total amount they invest is likely to fall short of the level of investment
warranted by the social returns. This outcome is called a market failure because value of the
benefits is greater than the cost for the last dollars spent and additional spending could yield
benefits above the additional costs. Despite patents and secrecy, an innovation may provide
information to others that can be exploited. Evidence suggests that the social return (the return to
other firms and customers as well as to the original firm) is higher than the private return.
The research credit, however, arguably is a blunt instrument to address this market failure since it
does not vary based on the size of the spillover effect. Targeted grants are an alternative method
of subsidizing research. Others suggest that some types of research (such as creating computer
games) should not be subsidized. Additionally, the uncertainty over whether the credit will be
extended likely reduces its effectiveness.
For more information, see CRS Report RL31181, Research Tax Credit: Current Law and Policy
Issues for the 113th Congress, by Gary Guenther.
Credit for Certain Expenditures for Maintaining Railroad Tracks32
Qualified railroad track maintenance expenditures paid or incurred in a taxable year by eligible
taxpayers qualify for a 50% business tax credit. The credit is limited to $3,500 times the number
of miles of railroad track owned or leased by an eligible taxpayer. Qualified railroad track
maintenance expenditures are amounts, which may be either repairs or capitalized costs, spent to
maintain railroad track (including roadbed, bridges, and related track structures) owned or leased
as of January 1, 2005, by a Class II or Class III (regional or local) railroad. Eligible taxpayers are
smaller (Class II or Class III) railroads and any person who transports property using these rail
facilities or furnishes property or services to such a person.
The taxpayer’s basis in railroad track is reduced by the amount of the credit allowed (so that any
deduction of cost or depreciation is only on the cost net of the credit). The credit cannot be
carried back to years before 2005. The credit is allowed against the alternative minimum tax. The
amount eligible is the gross expenditures, not taking into account reductions such as discounts or
loan forgiveness.
32 IRC Section 45G(f).
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The provision was enacted in the American Jobs Creation Act of 2004 (P.L. 108-357). The
provision relating to discounts was added by the Tax Relief and Health Care Act (P.L. 109-432).
The credit was allowed against the alternative minimum tax by the Emergency Economic
Stabilization Act of 2008 (P.L. 110-343).
This provision substantially lowers the cost of track maintenance for the qualifying short line
(regional and local) railroads, with tax credits covering half the costs for those firms and
individuals with sufficient tax liability. Class II and III railroads account for 31% of the nation’s
rail miles.33 These regional railroads are particularly important in providing transportation of
agricultural products.
While no rationale was provided when the credit was introduced, sponsors of earlier free-standing
legislation and industry advocates indicated that the purpose was to encourage the rehabilitation,
rather than the abandonment, of short-line railroads. These railroads were spun off in the
deregulation of railroads in the early 1980s. Advocates also indicated that this service is
threatened by heavier 286,000-pound cars that must be used to connect with longer rail lines.
They also suggested that preserving these local lines will reduce local truck traffic. There was
also some indication that a tax credit was thought to be more likely to be achieved than grants.
The arguments stated by industry advocates and sponsors of the legislation are also echoed in
assessments by the Federal Railroad Administration (FRA), which indicated the need for
rehabilitation and improvement, especially to deal with heavier cars. The FRA also suggested that
these firms have limited access to bank loans.
In general, special subsidies to industries and activities tend to lead to inefficient investment
allocation, since in a competitive economy businesses should earn enough to maintain their
capital. Nevertheless it may be judged or considered desirable to subsidize rail transportation to
reduce the congestion and pollution of highway traffic. At the same time, a tax credit may be less
suited to remedy the problem than a direct grant since firms without sufficient tax liability cannot
use the credit.
Reduction in S-Corporation Recognition Period for Built-In Gains34
Closely held corporations (100 or fewer shareholders) can elect to be taxed as S corporations,
where income flows through to the individual owners as is the case with a partnership. Firms that
first operate as a corporation (a C corporation), and switch to an S corporation, are taxed
separately at the top corporate rate of 35% on gain that is attributable to the years when the
corporation was a C corporation. This treatment applies for the first 10 years the firm is an S
corporation. An individual income tax also applies to the gain, net of the corporate level tax. The
extender provision reduces that period to five years.
If a C corporation converts to a partnership or other non-corporate entity, the conversion triggers
both a corporate-level and an individual-level tax on gains. Without the built-in gains
requirement, C corporations converting to S corporations (where a taxable event is not triggered)
could sell assets after conversion with a single level of tax on gains at a relatively low rate. This
33 Railroad Facts American Association of Railroads, 2012.
34 IRC Section 1374(d)(7).
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provision requires gains recognized over a period of years that are gains from the C corporation
period to be taxed at a higher rate.
The 10-year period was reduced to seven years by the American Recovery and Reinvestment Tax
Act of 2009 (P.L. 111-5). It was further reduced to five years by The Small Business Jobs Act of
2010 (P.L. 111-240).
The reduction to five years allows more gains to avoid this tax. It also increases the incentive to
convert to S corporation status rather than partnership form. S corporations are limited to 100
shareholders. Therefore, this benefit accrues to businesses that are likely to be closely held. No
specific rationale has been given for including this provision in a stimulus bill (ARRA).
Election to Accelerate AMT Credits in Lieu of Additional First-Year
Depreciation35
Firms are potentially subject to an alternative minimum tax (AMT) applied to a broader base, but
with a lower rate for large corporations and high income business owners. Since the higher AMT
tax may arise from timing shifts (because of the longer depreciation period under the AMT base)
a credit is allowed for the excess of the AMT over regular tax if the regular tax exceeds the AMT
tax in future years, up to the amount of the excess regular tax.
Under the provision, firms may elect to forgo bonus depreciation as well as regular accelerated
depreciation for purposes of calculating both AMT and regular income tax liability. In turn, firms
can increase the amount of AMT credits by 20% of bonus depreciation. These credits are
refundable, but are limited to the lesser of $30 million, or 6% of credit forwards generated before
January 1, 2006, whichever is smaller.
This election can provide firms that would not use bonus depreciation because of lack of tax
liability some tax reductions.
This provision was first enacted for both research and experimentation credits and AMT credits in
the Housing and Economic Recovery Act of 2008 (P.L. 110-289), shortly after bonus depreciation
was enacted in mid-2008. It was subsequently extended, but the extension in the Tax Relief,
Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312) limited
the provision to the AMT credit. It continued to be extended through 2013.
This provision was part of the stimulus proposals enacted to combat the 2007-2009 recession.
The provision does not directly affect marginal investment, but it does affect cash flow. Most
forecasters believe this type of cash flow benefit has to have a minimal effect on economic
stimulus.36 For firms that are in distress, however, cash flow may be more likely to contribute to
spending.
35 IRC Section 168(k).
36 For recent estimates of output multipliers associated with tax provisions affecting cash flow, see Congressional
Budget Office, Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic
Output from January 2012 Through March 2012, May 2012, available at http://www.cbo.gov/sites/default/files/
cbofiles/attachments/ARRA_One-Col.pdf.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Temporary Increase in Limit on Cover Over of Rum Excise Tax
Revenues to Puerto Rico and the Virgin Islands37
Most federal excise taxes do not apply in the United States Virgin Islands (USVI) and Puerto Rico
(PR) or the other possessions. An exception, however, is a special excise tax on items produced in
PR or the USVI and shipped to the United States. The tax was first imposed to ensure that
producers in the possessions would not have a tax advantage over producers in the United States
that are subject to excise taxes. In the case of rum that is produced in either the USVI or PR and
sold in the U.S., most of the revenue from the so-called equalization tax is returned (“covered
over”) by the federal government to the treasuries of PR and the USVI.
The cover-over provisions for rum extend as far back as 1917 for PR and 1954 for the USVI. The
scope of the cover-over was expanded by the Caribbean Basin Economic Recovery Act of 1983
(P.L. 98-67) which provides that all revenue from federal excise taxes on rum imported into the
United States from any source—including any foreign country—is remitted to the treasuries of
PR and the USVI by a formula that is roughly based upon the shares of rum produced by the two
possessions. The Deficit Reduction Act of 1984 (P.L. 98-369) placed a cap on the rebate of excise
taxes on rum and other distilled spirits based upon a $10.50 rate even as the federal tax rate on
spirits rose to $12.50 and later $13.50 per proof-gallon. Subsequently, temporary increases in this
limit have routinely been enacted.
The justification for the return of the revenues was to provide for the welfare of the territories and
return revenue generated from their products, since the territories could not participate in federal
provisions benefitting the states. Controversy about the provision arose from the use of funds in
the USVI to subsidize the maker of Captain Morgan, which then led to increased subsidies by PR,
which had previously had a limit on the share of the cover-over that could subsidize the rum
industry. From the federal government’s perspective, state and local incentives for industrial
development are a redistribution of tax dollars from state and local governments to manufacturing
firms without a net gain in national GDP. From this perspective, the incentives shift economic
activity from one location in the United States to another. The intended improvement of social
welfare (i.e., helping economically disadvantaged areas) is usually the justification for such
policies in light of what many economists identify as the “zero-sum” nature of the incentives.
The recent recession and related budget situation have elevated the interest in the rum cover-over
program. From the perspective of U.S. taxpayers, some may question the efficacy of the rum
cover-over, regardless of the historical precedent. Further, proponents of restrictions on the use of
covered-over revenue have alluded to the possibility that Congress may reconsider the cover-over
principle generally, possibly ending the program, if the recipients use the revenue for
“unreasonable” subsidies.
For more information, see CRS Report R41028, The Rum Excise Tax Cover-Over: Legislative
History and Current Issues, by Steven Maguire.
37 IRC Section 7652(f).
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
100% Exclusion for Qualified Small Business Stock38
Under current law, gains on the sale of capital assets held longer than one year generally are taxed
at rates lower than the rates for ordinary income. Individual taxpayers in the 10% and 15% tax
brackets pay no tax on long-term capital gains, whereas long-term gains reported by most
taxpayers in higher brackets are taxed at a fixed rate of 15%. For taxpayers in the 39.6% tax
bracket, capital gains are taxed at a fixed rate of 20%.
The Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) contained a provision that allowed
an exclusion from gross income of 50% of any gain from the sale or exchange of qualified small
business stock (QSBS) issued after August 10, 1993. This provision is permanent. In the
American Recovery and Reinvestment Act of 2009 (P.L. 111-5), an exclusion of 75% was
allowed. The Small Business Jobs Act of 2010 (P.L. 111-240) increased the exclusion to 100%.
Subsequent extensions and modifications of the provision allow for a full exclusion of any gain
for stock acquired after September 27, 2010, and before January 1, 2014.
To be eligible, the taxpayer must acquire the stock at its original issue and hold it for a minimum
of five years. There is an annual limit on the exclusion for gains on the sale of QSBS issued by
the same firm: the exclusion cannot exceed the greater of $10 million, less any cumulative gain
excluded by the taxpayer in previous tax years, or ten times a taxpayer’s adjusted basis in the
stock.
The original provision was adopted when capital gains were taxed as ordinary income. Part of the
reason for adopting the increased exclusion was that the benefit was lessened or disappeared with
the lower tax rates on capital gains.
The special benefit for this small business stock appears to have been intended to facilitate the
formation and growth of small firms organized as C corporations involved in developing new
manufacturing technologies. The provision provides investors an incentive to acquire a sizable
equity stake in small firms.
An exclusion of part (or all) of the gain from small business stock allows for investors in firms of
different sizes to face different effective tax rates. Along with the effect on equity, the provision
may also reduce economic efficiency through its distortionary effect on the allocation of capital.
The provision could, however, increase economic efficiency if it were to correct for capital
market imperfections and allow for optimal small business formation and growth.
Deduction Allowable with Respect to Income Attributable to
Domestic Production Activities in Puerto Rico39
The Section 199 domestic production activities deduction reduces tax rates on certain types of
economic activity, primarily domestic manufacturing activities. Qualified domestic
manufacturing activities qualify for a deduction equal to 9% of the lesser of taxable income
derived from qualified production activities or taxable income. The effect of the deduction is to
reduce the effective tax rate on income from qualified activities by 3.15 percentage points, from
38 IRC Section 1202(a)(4).
39 IRC Section 199(d)(8).
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
35% to 31.85%. The Section 199 domestic production activities deduction is a permanent part of
the Internal Revenue Code (IRC).
When the Section 199 deduction was enacted as part of the American Jobs Creation Act of 2004
(AJCA; P.L. 108-357), the term “United States,” as used for the purposes of determining eligible
domestic activities, included the 50 states and the District of Columbia, but not U.S. possessions
or territories. In 2006, as part of the Tax Relief and Healthcare Act (P.L. 109-432), special rules
that allowed Puerto Rico to be considered a part of the United States for the purposes of the
Section 199 domestic production activities deduction were temporarily enacted. This temporary
provision has recently been extended as part of “tax extenders” legislation.
The U.S. tax code generally treats U.S. possessions as foreign countries, and Puerto Rico
maintains an independent tax system. There are, however, many special rules interconnecting the
Puerto Rican and U.S. tax systems. Before 1996, domestic corporations with business operations
in the U.S. possessions could generally eliminate their U.S. tax liability on foreign-source income
from operations in the possessions using the possessions tax credit. From 1996 through 2005, the
Puerto Rico economic activity credit was available for domestic corporations with activities in
Puerto Rico. Following the expiration of the possessions tax credit and Puerto Rico economic
activity credit, companies with operations in Puerto Rico may find it more advantageous to
structure as a controlled foreign corporation (CFC), thus benefitting from the option to defer U.S.
tax on active income from those operations.
Allowing the Section 199 production activities deduction to be claimed on manufacturing
activities in Puerto Rico can be viewed as an effort to provide similar tax treatment to income
from manufacturing activities taking place in Puerto Rico and from the rest of the United States.40
Absent this provision, U.S.-based manufacturers with operations in Puerto Rico, operating in
flow-through form (e.g., a branch or partnership), would face a higher effective tax rate on
manufacturing activities in Puerto Rico than other domestic manufacturing activities.
Allowing the Section 199 deduction for activities in Puerto Rico essentially extends a tax benefit
designed for domestic corporations to a possession that is generally treated as a foreign country
for tax purposes. This raises the question of why this tax benefit has been provided to Puerto Rico
but no other U.S. possessions. Concerns have also been raised that extending Section 199 to
Puerto Rico would create an incentive for U.S. companies operating in Puerto Rico to adopt a
bifurcated structure, with certain activities being undertaken by a CFC with other activities,
specifically those that qualify for Section 199, being undertaken in a flow-through structure.41
Since other domestic businesses do not have this organizational flexibility, this would provide
greater potential benefits to manufacturers with operations in Puerto Rico. This could be the
intent of the policy, if extending Section 199 to businesses in Puerto Rico is intended, in part, to
encourage additional manufacturing activity in Puerto Rico.
For general information on the Section 199 deduction, see CRS Report R41988, The Section 199
Production Activities Deduction: Background and Analysis, by Molly F. Sherlock.
40 See U.S. Congress, Joint Committee on Taxation, An Overview Of The Special Tax Rules Related To Puerto Rico
And An Analysis Of The Tax And Economic Policy Implications Of Recent Legislative Options, 109th Cong., June 23,
2006, JCX-24-06, available at https://www.jct.gov/publications.html?func=startdown&id=1496.
41 Ibid., pp. 90-93.
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Selected Recently Expired Business Tax Provisions (“Tax Extenders”)
Modification of Tax Treatment of Certain Payments to Controlling
Exempt Organizations42
Tax-exempt organizations are required to pay taxes on unrelated business taxable income (UBTI),
which is defined as income resulting from business activities that are unrelated to their charitable
or tax-exempt purpose. Rents, royalties, interest, and annuities (passive income) are generally not
considered business taxable income, except when such payments are received from a “controlled
entity.”43
The Pension Protection Act of 2006 (P.L. 109-280) included special rules temporarily providing
that certain payments, including rents and royalties received by a tax-exempt entity from a
controlled entity or subsidiary, are not considered unrelated business income. Payments that are in
excess of an arms-length price cannot be excluded from UBTI. Since being enacted, these rules
have regularly been extended as part of “tax extenders” legislation.
The purpose of including payments received from controlled entities in business taxable income
is to prevent tax-exempt organizations from using separate but controlled entities to avoid
unrelated business income taxes. For example, one concern is that a 501(c)(3) charitable
organization could set up a controlled subsidiary to engage in a profitable activity (e.g., selling
merchandise). If the charity had sold the merchandise itself, the income would be subject to the
unrelated business income tax. To avoid the tax, the charity could set up a controlled subsidiary to
sell the merchandise, which would pay royalties to the charity (lease the charity’s logo, for
example). The controlled subsidiary would deduct the royalty payments as a cost of doing
business, and the charity would receive royalty income, which would not be considered unrelated
business income. In this scenario, the charity would avoid paying tax on business activities.
Treating rent, royalty, interest, and annuity payments from controlled organizations as UBTI
while similar types of payments from third parties are not taxed may raise questions related to
fairness. Tax-exempt entities could claim that as long as tax-exempt parents’ dealings with
controlled subsidiaries are done at arm’s length, the scope for abuse should be limited. It is this
logic that led to the enactment of the provision modifying the tax treatment of certain payments to
controlling exempt organizations.
Author Contact Information
Jane G. Gravelle
Molly F. Sherlock
Senior Specialist in Economic Policy
Specialist in Public Finance
jgravelle@crs.loc.gov, 7-7829
msherlock@crs.loc.gov, 7-7797
Donald J. Marples
Specialist in Public Finance
dmarples@crs.loc.gov, 7-3739
42 IRC Section 512(b)(13)(E).
43 A controlled entity is one that is more than 50% owned (or otherwise controlled) by the parent organization.
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