With the largest voter turnout in our nation's history, Americans and American businesses were fixated on the 2004 presidential election. Now that the ballots have been cast, U.S. corporations should take a hard look at an important new tax act that was passed just a few days before the election.
On October 22, 2004, President Bush signed the American Jobs Creation Act of 2004 (2004 Jobs Act), the first major corporate tax act since the 1986 Tax Act. Although the scope and impact of this new tax legislation are largely unknown, some speculate the 2004 Jobs Act will provide nearly $137 billion in tax relief over the next 10 years.
The tax relief provisions include new S corporation reforms, a new domestic manufacturing deduction, a temporary incentive for U.S. multinationals to repatriate foreign earnings, and international tax reforms designed to improve the global competitiveness of U.S. businesses.
Far from securing tax simplification, the 2004 Jobs Act continues the practice of adding new layers to the tax code serving social objectives. These provisions stack upon each other like layers on a multi-layer cake. The 2004 Jobs Act simply adds new layers.
In addition to its impressive tax relief provisions, the 2004 Jobs Act enacts new tax increases and restrictions. It contains important new restrictions on deferred compensation, new tax shelter penalties, and many other narrow, targeted provisions.
This article highlights the new domestic manufacturing deduction, the new provision limiting deferred compensation, and the new reporting requirements for taxable mergers and acquisitions. Other important provisions are discussed in other articles of this issue. The 2004 Jobs Act also includes many narrow, targeted provisions that are important on a case-specific basis.
Domestic Manufacturing
The 2004 Jobs Act enacts a new incentive to manufacture in the United States by providing a new 9% tax deduction for income from domestic production activities. The deduction is available to all corporations, partnerships, sole proprietorships, cooperatives, and estates and trusts with qualifying production activities income. The deduction is calculated on the lesser of income from domestic production activities or a taxpayer's taxable income.
Amount of Deduction for Domestic Production
Activities Income
Year
|
Deduction |
| 2005-2006 |
3% |
| 2007-2009 |
6% |
| 2010 and thereafter |
9% |
Qualifying Activities
The 2004 Jobs Act provides a broad definition of what qualifies as production activities eligible for this new deduction. Qualified production activities include income from the license, lease, rental, sale, exchange, or other disposition of:
-
any tangible personal property, computer software, or sound recording that is manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part within the United States;
-
motion pictures and television productions if more than 50% of the total compensation for services is performed in the United States;
-
electricity, natural gas, or potable water produced in the United States;
-
construction performed in the United States; and
-
engineering or architectural services performed in the United States for construction projects in the United States.
Computation of Allowable Deduction
In general, the allowable deduction is equal to 3% (6% and 9% in subsequent years) of a taxpayer's gross receipts from qualifying activities reduced by the allocable cost of goods sold, deductions that are directly allocable to those receipts (for example, marketing and advertising expenses), and a ratable share of other deductions not related to another category of income (for example, corporate general and administrative expenses relating to advertising).
Deferred Compensation
In an important new provision, the 2004 Jobs Act broadly targets deferred compensation arrangements. It enacts new requirements for "nonqualified deferred compensation" plans, including new reporting requirements, restrictions on the timing and form of elections to defer income, the timing of distributions, and certain other technical requirements. If these requirements are not met, the participant is subject to an accelerated tax liability, enhanced underpayment interest, and an additional 20% tax.
Nonqualified Deferred Compensation Plans
The new rules broadly define a nonqualified deferred compensation plan to include any plan providing for the deferral of compensation other than a qualified employer plan or any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. General stock option arrangements in which the exercise price is at least equal to the fair market value of the underlying stock on the date of grant are not considered to be nonqualified deferred compensation plans. But if the stock option arrangement includes a deferral feature other than the feature that the option holder may exercise the option in the future, the stock option plan will fall under the new rule. Incentive stock options and employee stock purchase plans are also not subject to new rule provisions. However, any discounted stock options or stock appreciation rights are subject to the new rules.
Deferral Elections and Distributions
The new rules place limits on deferral dates. An election to defer compensation must be made no later than the close of the tax year preceding the year in which the compensation will be earned. In the case of performance-based compensation based on services performed over a period of at least 12 months, the election may be made up to six months before the end of the 12-month service period.
Distributions may be made only on separation from service, at death, at a specified time (or pursuant to a fixed schedule), upon a change in control of a corporation, upon an unforeseeable emergency, or upon the participant's disability. If a plan allows participants to receive a distribution at a specified time or pursuant to a schedule, the participant's initial election must specify the distribution date and the form of the payment (for example, a lump-sum distribution or payments over a 10-year term).
Distributions may not be accelerated, with some limited exceptions, and subsequent elections to further defer an amount are permitted only if the election is made 12 months in advance and the payment is deferred another five years.
Effective Date and Transition Rules
The new deferred compensation provision generally applies to amounts deferred after December 31, 2004. Plans that were in effect before October 3, 2004, and that are not materially modified may still be operated in accordance with their old terms for amounts deferred before January 1, 2005.
Taxable M&A Reporting
Congress created a new reporting rule for taxable mergers. The 2004 Jobs Act requires a corporation acquiring the stock or assets of a target corporation to disclose specified information to the IRS and the target shareholders. The reporting requirement applies only to the acquiring corporation (or a stock transfer agent in the alternative). However, new tax regulations could require disclosure by the acquired corporation as well. Also, the 2004 Jobs Act extends existing information reporting penalties to failures to comply with the requirements under this provision.
Many Other Narrow Provisions
The 2004 Jobs Act includes many very technical, targeted provisions that are beyond the scope of this article. For example, Congress enacted new tax shelter penalties and other revenue-raising provisions aimed at isolated abuses.
Several of these anti-abuse provisions are an outgrowth of congressional hearings and investigations during the past few years on some tax shelters, executive compensation, and corporate governance issues. That congressional scrutiny was triggered, in part, by the Enron bankruptcy and increased media attention regarding some business practices.
Rothgerber Johnson & Lyons LLP advises many corporations on tax planning and structuring. If you or others within your company have questions as to the application of this new tax law, please call Jim Walker in our Denver office.
Jim Walker is RJ&L's senior tax partner. His practice focuses on providing innovative tax planning and structuring advice. He regularly represents corporate taxpayers before federal and state administrative agencies. Mr. Walker is a Fellow of the American College of Tax Counsel and the American College of Trust and Estate Counsel. He can be reached at 303-628-9510 or by e-mail at jwalker@rothgerber.com.