Whole Ball of Tax 2003

JOB CREATION AND WORKER ASSISTANCE ACT OF 2002
KEY PROVISIONS

Tax Breaks—Some Retroactive—For Both Businesses, Individuals

(RIVERWOODS, ILL., January 2003) – The Job Creation and Worker Assistance Act signed into law by President Bush last year brought tax breaks to businesses and individuals with the goal of helping to stimulate the economy. With the economy still struggling along, it’s no surprise that the President acted quickly in 2003 to propose a new economic stimulus plan to create growth and jobs, and again provide assistance to unemployed workers, notes CCH INCORPORATED (CCH), a leading provider of tax law information and software.

While many of the changes proposed by the plan would accelerate tax reductions passed in 2001 law, the new plan does little to affect tax changes enacted in 2002, which brought retroactive tax breaks for both businesses and individuals. The following is an overview from CCH on the 2002 law.

Tax Breaks For Both Business And Individuals

The Job Creation and Worker Assistance Act contained many important provisions affecting both businesses and individuals. It brought one of the business community’s most sought after tax incentives, a 30-percent depreciation "bonus." It also made several tax breaks retroactive to the 2001 tax year.

Among the key incentives of the bill were:

• Temporary 30-percent depreciation "bonus;"
• Five-year carryback period for net operating losses;
• Special tax breaks for New York City reconstruction;
• Electronic filing of Forms 1099;
• Prospective reversal of the Supreme Court’s S Corporation decision in Gitlitz v Commr;
• Limitation on experience-based accounting method for service providers;
• Extension of many expiring tax credits and deductions.

Businesses received the lion’s share of the tax breaks under the bill. Two of the breaks – the temporary 30-percent depreciation "bonus" and the five-year carryback period for net operating losses — were applied retroactively.

Others, although buried in "Miscellaneous and Technical" or "Extenders" sections of the Act, significantly benefited certain businesses, transactions and industries. Businesses affected by the September 11 tragedy in New York City, were given a set of special tax breaks tailored to their circumstances.

Depreciation bonus: Taxpayers received an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property. The 30-percent "bonus" is allowable for regular and alternative minimum tax (AMT) purposes for the tax year in which the property is placed in service. To qualify for the "bonus," property must satisfy the general MACRS rules. Property eligible for this special treatment includes:

• Property with a recovery period of 20 years or less;
• Water utility property;
• Non-section 197 computer software; or
• Qualified leasehold improvements.

Generally, property must be acquired after September 10, 2001 and before September 11, 2004.

NOLs: Taxpayers generally can carry back net operating losses (NOLs) two years, unless they qualify for special treatment. The stimulus bill temporarily extended the general carryback period from two to five years. To be eligible for the extended carryback period, the losses must arise in tax years ending in 2001 and 2002.

Taxpayers were given one opportunity to elect this treatment. If they elect not to carry back NOLs for five years, their election is final. The law also allowed a taxpayer’s NOL deduction to reduce alternative minimum taxable income (AMTI) up to 100 percent.

Method of accounting: Taxpayers performing "qualified services," now have limited ability to use the non-accrual experience method of accounting under the law to get a more favorable treatment for bad debts. The Act limited the exclusion to amounts received in the performance of qualified services.

Electronic filing of Forms 1099: Previously, copies of some information returns had to be presented to the named individual either in person or in a statement sent by first-class mail in a specified format. The new law allowed information returns to be sent electronically, as long as the recipient agrees.

Contributions to retirement plans: In 2001, the Treasury discontinued the sale of 30-year bonds. Part of the fallout from this action was a negative effect on interest rates used to determine additional required contributions for defined benefit plans. A 30-year Treasury rate, which is artificially low, makes a plan look like it is under-funded since its funding liability is calculated with the use of an interest rate that has to fall within a permissible range (currently it is between 90 percent and 105 percent). The law, however, expanded the permissible range to between 90 percent and 120 percent for 2002 and 2003.

Extensions of expiring business tax credits. The law extended for two years, until December 31, 2003, many popular temporary tax credits and deductions:

• Work Opportunity Tax Credit;
• Welfare-to-Work Tax Credit;
• Credit for producing electricity from wind, biomass and poultry litter;
• Taxable income limit on percentage depreciation from marginal wells;
• Clean-fuel vehicle deduction;
• Qualified zone academy bonds;
• Cover over payments to Puerto Rico and the Virgin Islands;
• Tax on failure to comply with mental health parity requirements;
• Suspension of reduction of deductions for mutual life insurance companies;
• Tax incentives for investment in Native American reservations; and
• Other energy incentives.

The law gave New York City residents special tax breaks to help the city, its business community and individuals rebuild, with enhanced depreciation and expensing as well as other breaks. The scope of the tax incentives is limited by geography. Only taxpayers in a special "Liberty Zone" – southern Manhattan – can take advantage of the incentives.

Highlights of the Liberty Zone relief measures and benefits include:

Expensing: The maximum IRC §179 deduction amount for qualifying property used in the Liberty Zone was increased, by the lesser of (1) $35,000 or (2) cost of qualifying property put in service during the taxable year.

Depreciation: Added to normal first-year depreciation deductions was an amount equivalent to 30 percent of qualified Liberty Zone property’s adjusted basis, applicable for both regular and alternative minimum tax purposes.

Work Opportunity Tax Credit (WOTC): A new targeted group was added for Liberty Zone taxpayers. The new group consists of: (1) individuals substantially performing all their services in the recovery zone for a business in the Liberty Zone and (2) individuals substantially performing all their services in New York City for a business relocated from the Liberty Zone to someplace else within New York City due to the terrorist attacks.

Converted property: Instead of the usual two-year period, a five-year replacement period now applies to involuntarily converted property within the Liberty Zone due to the terrorist attacks, if replaced with property to be substantially used in New York City.

A significant number of individuals were affected by the introduction of two new tax breaks and the extension of two others under the Job Creation and Worker Assistance Act.

AMT relief: In 1998, Congress enacted some limited AMT relief when it allowed individual taxpayers to temporarily use the personal credits – the child tax, adoption, dependent care, elderly and disabled and higher education credits – against regular tax liability and AMT. The Economic Growth and Tax Relief Reconciliation Act made permanent use of the child tax and adoption credits. However, EGTRRA did not extend use of the other personal credits beyond their cut-off date of December 31, 2001. The Job Creation and Worker Assistance Act did. Under the Act, taxpayers can make full use of all the nonrefundable tax credits through December 31, 2003.

For the 2002 and 2003 tax years, AMT taxpayers will be able to continue, as they have done over the past three years, to use all the nonrefundable personal tax credits to their fullest. However, after December 31, 2003, only the child tax and adoption credits will be permitted to be used to their fullest extent.

Teachers: The new law provided an above-the-line deduction for teacher classroom expenses. Educators, in elementary and secondary schools, are able to deduct qualifying classroom expenses up to $250 annually for 2002 and 2003. Qualifying classroom expenses include supplies, books and equipment.

Archer Medical Savings Accounts: The Act extends MSAs through December 31, 2003.

Foster care: Payments to a qualified foster care provider by state or local governments or a tax-exempt placement agency generally are excluded from income. The bill expands the definition of qualified foster care payments and who is deemed a qualified foster care individual.

The Job Creation and Worker Assistance Act of 2002 also made more than 20 technical corrections to 2001’s big tax cut, EGTRRA and some earlier tax laws. Many are pension-related amendments that clarify the intent of EGTRRA. Many of the technical corrections create substantive changes, some of them to reflect the intent of Congress on original provisions that were inartfully drafted. These include:

Child tax credit: The refundable portion of the child tax credit will continue to be determined as it was pre-EGTRRA.

Adoption credit: The transition rule for the credit, the dollar amount for special needs children and employer-provided assistance for special needs adoptions are clarified.

HOPE credit: Taxpayers may claim the education IRA exclusion and the HOPE credit in the same year.

Benefit and contribution limits: The bill corrects the dollar amounts used for calculating and indexing future cost of living adjustments.

Top heavy rules: Distributions made after an individual’s severance from employment will be taken into account in determining top heavy status for only one year.

Deduction limits: EGTRRA increased the cap on annual deductible contributions to a SEP to 25 percent of an individual’s compensation. The new Act increases the tax-free contribution limit to 25 percent as well.

Credit for new retirement plans: EGTRRA also gave eligible small businesses a credit for new retirement plan expenses. Under the new bill, to take advantage of the credit, the plan must be first effective after December 31, 2001.

Catch-up contributions: One of EGTRRA’s most significant reforms was the allowance of catch-up contributions by qualifying taxpayers over age 49. The new bill clarifies that a person who reaches age 50 by the end of the tax year is eligible to make catch-up contributions as of the beginning of the year.

Retirement plan rollovers: The Act requires that plans must provide for the rollover of after-tax contributions only to a qualified defined contribution plan or a traditional IRA. With respect to spousal consent to cash-out of the benefit, the bill clarifies when rollover amounts may be disregarded.

Worth noting is that EGTRRA requires plan participants to receive notice of significant future reductions in benefits. The new bill clarifies that the notice requirement applies only to qualified defined benefit plans and, depending on the type of the reduction, if the benefit is significant.

Earlier laws: Among the more important clarifications to pre-EGTRRA tax laws are:

• Treatment of disposition of interest in passive activity (Taxpayer Relief Act of 1997);

• Wash sale rules inapplicable to any loss arising from section 1256 contracts (Technical and Miscellaneous Revenue Act of 1988).

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, legal, securities, insurance, human resources, health care and small business markets. CCH is a wholly owned subsidiary of Wolters Kluwer North America. The CCH web site can be accessed at cch.com. The CCH tax and accounting group destination site can be accessed at tax.cchgroup.com.

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