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Faster Than You Can Say Recovery, Congress Passes Economic Stimulus Plan

(RIVERWOODS, ILL., March 8, 2002) – With signs that the economy is regaining strength, Congress moved with uncharacteristic speed to pass an economic stimulus package: the Job Creation and Worker Assistance Act of 2002, a scaled-down version of the economic stimulus packages that stymied Congress last year. The now popular plan costing $42 billion over ten years links an extension of unemployment benefits with numerous tax measures from prior stimulus bills, according to CCH INCORPORATED (CCH), a leading provider of tax law information and software. (For additional information on the tax bill and related resources, visit cch.com/taxbill2002.)

While the bill is narrower than President Bush wanted, he is soon expected to sign the measure into law. The new law will bring retroactive tax breaks for both businesses and individuals. Amended 2001 tax returns may have to be filed.

"The plan does include several proposals that are important to the president – including accelerated depreciation and the Liberty Zone tax incentives to help New York City recover," noted CCH Principal Tax Analyst Mark Luscombe, JD, CPA.

The new tax bill contains many important provisions affecting both businesses and individuals. It brings one of the business community’s most sought after tax incentives, a 30-percent depreciation "bonus." It also makes several tax breaks retroactive to the 2001 tax year – affecting tax returns that have already been filed or are about to be filed this tax season.

Among the key incentives of the bill are:

• 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.

Compromises were made to get the bill through Congress so quickly. To garner bipartisan support, the package was stripped of the most controversial provisions – including a healthcare tax credit proposal – and the size and scope of business cuts were trimmed.

Businesses receive 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 — apply retroactively to affect 2001 tax returns.

Others, although buried in "Miscellaneous and Technical" or "Extenders" sections of the Act, significantly benefit certain businesses, transactions and industries. Finally, nearly six months after the September 11 tragedy in New York City, those businesses affected have a set of special tax breaks tailored to their circumstances.

Depreciation bonus: Taxpayers will get 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 will temporarily extend 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 would be given one opportunity to elect this treatment. If they elect not to carry back NOLs for five years, their election is final. The new law also allows a taxpayer’s NOL deduction to reduce its alternative minimum taxable income (AMTI) up to 100 percent.

"Although the provision is applicable to any business that has experienced significant losses lately, airlines are among the big winners with respect to this provision," noted Luscombe.

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

Electronic filing of Forms 1099: Currently, copies of some information returns must 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 now allows information returns to be sent electronically, as long as the recipient agrees.

Contributions to retirement plans: Last year, the Treasury discontinued the sale of 30-year bonds. Part of the fallout from this action was a negative affect 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 new law, however, expands the permissible range to between 90 percent and 120 percent for 2002 and 2003.

Extensions of expiring business tax credits: Many popular temporary tax credits and deductions expired December 31, 2001. The new law extends for two years, until December 31, 2003, the:

• 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.

President Bush promised New York City residents special tax breaks to help the city, its business community and individuals rebuild and the bill gives taxpayers enhanced depreciation and expensing as well as other breaks. However, the scope of the tax incentives is limited by geography.

Only taxpayers in a special "Liberty Zone" – southern Manhattan – will be able to 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 is 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 is 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 is 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 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 are affected by the introduction of two new tax breaks and the extension of two others.

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. EGTRRA 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 new bill does. 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," Luscombe explained. However, after December 31, 2003, only the child tax and adoption credits will be permitted to be used to their fullest extent.

Luscombe also noted that extending use of the nonrefundable personal tax credits gives Congress a little more time to tackle true AMT reform. However, with the cost of the war on terrorism and protecting the homeland, Congress will be reluctant to reduce the revenues generated by the AMT.

Teachers: The bill includes one of the President’s favorite incentives, an above-the-line deduction for teacher classroom expenses. Educators, in elementary and secondary schools, will be 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: Although Archer Medical Savings Accounts (MSAs) have failed to meet initial expectations of popularity, continuing them past their initial cut-off date enjoyed significant bipartisan support. Generally, contributions to MSAs by employees of qualifying small businesses and self-employed taxpayers are deductible and interest and other earnings on contributions accrue tax-free. To be eligible for tax-free treatment, contributions must be used for qualifying medical expenses. 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.

Technical Corrections to EGTRRA

The Job Creation and Worker Assistance Act of 2002 also makes 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.

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 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).

"Although the bill’s tax provisions are scored to carry a net revenue cost of $42 billion over the next ten years, that grand total does not do justice to its impact over the next three years," Luscombe said. It actually gives out $123 billion in tax breaks over the next three years, he noted, before it starts to return a positive net revenue flow to the Treasury to make up part of the difference.

And there may be more to come. There’s talk on Capitol Hill of another tax bill this year that would address some of the issues that were included in the previous failed stimulus packages, including reduced payroll taxes for small businesses, a phased-in repeal of the corporate AMT, a $300 rebate for certain low-income individuals and an immediate reduction in the individual 27-percent income tax rate to 25 percent.

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 web site can be accessed at tax.cchgroup.com.

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