[WPRT 108-10]
[From the U.S. Government Publishing Office]
108th Congress
2nd Session COMMITTEE PRINT WMCP:
108-10
_______________________________________________________________________
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
__________
WRITTEN COMMENTS
on
H.R. 3654, THE ``TECHNICAL CORRECTIONS ACT OF 2003''
[GRAPHIC] [TIFF OMITTED] CONGRESS.#13
JANUARY 23, 2004
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM MCCRERY, Louisiana JIM MCDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHIL ENGLISH, Pennsylvania LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona EARL POMEROY, North Dakota
JERRY WELLER, Illinois MAX SANDLIN, Texas
KENNY C. HULSHOF, Missouri STEPHANIE TUBBS JONES, Ohio
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
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unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of Tuesday, December 9, 2003, announcing request for
written comments on H.R. 3654, the ``Technical Corrections Act
of 2003''...................................................... 1
______
BDO Seidman, LLP, National Tax Office, Donald A. Barnes, letter.. 2
Burlington Northern Santa Fe Corporation, Fort Worth, TX, Thomas
N. Hund, letter................................................ 4
Iacopi, Lenz & Company Accountancy Corporation, Stockton, CA,
Constance Logan, statement..................................... 5
Investment Company Institute, statement and attachment........... 11
Jackson & Campbell, PC, Michael J. Grace, letter................. 14
National Association of Real Estate Investment Trusts, Tony M.
Edwards, letter................................................ 17
Perkins & Company, PC, Portland, OR, Christopher J. Loughran,
letter......................................................... 18
Vinson & Elkins, LLP, Christine L. Vaughn, and Thomas Crichton,
IV, letter..................................................... 20
Vitter, Hon. David, a Representative in Congress from the State
of Louisiana, letter........................................... 23
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
December 9, 2003
No. FC-10
Thomas Announces Request for
Written Comments on H.R. 3654, the
``Technical Corrections Act of 2003''
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee is requesting written
public comments for the record from all parties interested in H.R.
3654, the ``Technical Corrections Act of 2003.''
BACKGROUND:
Yesterday, Chairman Bill Thomas, along with Ranking Member Charles
Rangel (D-NY), introduced H.R. 3654, the ``Technical Corrections Act of
2003.''
H.R. 3654 includes provisions that technically correct and clarify
the intent of previous tax laws.
``We hope the public will review the proposed changes and provide
comments during the coming months so we can send appropriate
legislation to the President as soon as possible,'' said Thomas.
The bill includes technical corrections to the provisions relating
to dividends taxed at capital gains rates that were enacted in the Jobs
and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-26). The
bill also includes technical corrections to the rules relating to bonus
depreciation, carryback of net operating losses and other provisions
that were enacted in the Job Creation and Worker Assistance Act of 2002
(P.L. 107-147).
Technical corrections and clerical amendments to other enacted tax
legislation, including the Economic Growth and Tax Relief
Reconciliation Act of 2001 (P.L. 107-16), the Victims of Terrorism Tax
Relief Act of 2001 (P.L. 107-134), the Community Renewal Act of 2000
(P.L. 106-554), the Taxpayer Relief Act of 1997 (P.L. 105-34) and the
Small Business Job Protection Act of 1996 (P.L. 104-188) are also
included in the bill.
Senate Finance Chairman Charles Grassley (R-IA) and Ranking Member
Max Baucus (D-MT) have introduced companion legislation in the Senate.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit written comments for
the record should send it electronically to
[email protected], along with a fax copy to
(202) 225-2610, by close of business Friday, January 23, 2004. Please
note that in the immediate future, the Committee website will allow for
electronic submissions to be included in the printed record. Before
submitting your comments, check to see if this function is available.
Finally, due to the change in House mail policy, the U.S. Capitol
Police will refuse sealed-packaged deliveries to all House Office
Buildings.
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1. Due to the change in House mail policy, all statements and any
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Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov.
BDO Seidman, LLP, National Tax Office
Washington, DC 20036
January 23, 2004
Chairman William M. Thomas
House Ways and Means Committee
U.S. House of Representatives
Washington, DC 20515
Dear Chairman Thomas,
In response to your request for comments regarding additional
technical corrections that may be needed to the Job Creation and Worker
Assistance Act of 2002, we respectfully submit the following comments.
We ask that the taxwriting Committees consider a minor addition to
section 3(b) of the Tax Technical Corrections Act of 2003 to rectify
the problem described below.
I. Applicable Statutory Provisions
IRC Sec. 172(b)(1)(H) provides that ``[i]n the case of a taxpayer
which has a net operating loss for any taxable year ending during 2001
or 2002, subparagraph (A)(i) shall be applied by substituting `5' for
`2' and subparagraph (F) shall not apply.''
IRC Sec. 172(b)(3) provides that ``[a]ny taxpayer entitled to a
carryback period under paragraph (1) may elect to relinquish the entire
carryback period with respect to a net operating loss for any taxable
year.''
IRC Sec. 172(j) provides that ``[a]ny taxpayer entitled to a 5-year
carryback under subsection (b)(1)(H) from any loss year may elect to
have the carryback period with respect to such loss year determined
without regard to subsection (b)(1)(H).''
II. Problem
The 2002 tax legislation was enacted in March 2002, after some
taxpayers had filed their tax returns for 2001. In May 2002, the
Internal Revenue Service issued Rev. Proc. 2002-40, 2002-1 C.B. 1096,
the purpose of which was to provide administrative relief for taxpayers
that filed tax returns for 2001 or 2002 without taking advantage of the
new 5-year NOL carryback period provided by IRC Sec. 172(b)(1)(H). The
administrative guidance provided by Rev. Proc. 2002-40 is applicable
whether the taxpayer filed its 2001 or 2002 tax returns before or after
enactment of the 2002 tax legislation.
Section 5 of Rev. Proc. 2002-40 addressed taxpayers that previously
filed a NOL carryback claim from tax years ending in 2001 or 2002 using
a 2-year carryback period. Section 5 is subdivided in two parts--
Sec. 5.01 is directed to those taxpayers that filed a 2-year carryback
claim but want to use a 5-year carryback period, and Sec. 5.02 is
directed to those taxpayers that filed a 2-year carryback claim and
want to use a 2-year carryback period.
The factual situation we are concerned about involves corporate
taxpayers that had net operating losses in their taxable years ending
during 2001, did not make an election under IRC Sec. 172(b)(3), filed a
2-year carryback claim before enactment of the 2002 tax legislation,
want to use a 5-year carryback period, but did not file a carryback
claim using a 5-year period by October 31, 2002 as required by Rev.
Proc. 2002-40, Sec. 5.01. Some taxpayers in this category had
significant financial or operational problems and were unable to obtain
professional tax advice regarding the somewhat unusual filing
requirement imposed by Rev. Proc. 2002-40, Sec. 5.01.
For the reasons discussed below, we think these taxpayers should be
provided relief in the Technical Corrections Act.
III. Reasons Why Relief Should Be Provided in the Tax Technical
Corrections Act of 2003
For several reasons, we believe taxpayers that filed their 2001 tax
returns prior to enactment of the 2002 tax legislation should be
entitled to a 5-year carryback of those NOLs even if they did not meet
the filing requirement imposed by Rev. Proc. 2002-40, Sec. 5.01, and
that the carryback should be available as long as the statute of
limitations is open for the year in which the NOL was incurred.
A. LRev. Proc. 2002-40, Sec. 5.01 imposes an extra-statutory
requirement.
The Job Creation and Worker Assistance Act of 2002 permits
taxpayers to carry back NOLs incurred in taxable years ending during
2001 or 2002 5 years and does not address the situation of taxpayers
that had filed tax returns and carryback claims for 2001 or 2002 prior
to enactment of the statute.
In pertinent part, Rev. Proc. 2002-40, Sec. 5.01 reads as follows:
L ``If a taxpayer that previously filed an application for a
tentative carryback adjustment (whether or not the Service has acted
upon such application) or an amended return using a 2-year carryback
period for an NOL incurred in a taxable year ending in 2001 or 2002,
and that did not elect to forgo the 5-year carryback period under
172(j), wants to use the 5-year carryback period provided under
172(b)(1)(H), the taxpayer may do so by following the procedures of
section 7 of this revenue procedure on or before October 31, 2002.''
Rev. Proc. 2002-40, Sec. 7.01 requires a corporate taxpayer to file
a Form 1139 or Form 1120X using a 5-year carryback period by October
31, 2002.
The general rule in IRC Sec. 172 is that taxpayers must carry back
NOLs 5 years, unless they elect not to carry back the NOL at all, or
elect to forego the 5-year carryback period in favor of the 2-year
carryback period. Thus, the general rule is that taxpayers are entitled
to a 5-year carryback of NOLs incurred in tax years ending in 2001 or
2002 if they do nothing and make no elections. Rev. Proc. 2002-40,
Sec. 5.01 reverses this statutory presumption and imposes an
affirmative election and filing obligation on taxpayers that want to
carry back their NOLs 5 years.
Furthermore, the October 31, 2002 filing deadline imposed by Rev.
Proc. 2002-40, Sec. 5.01 has no basis in the statute. We understand the
October 31, 2002 deadline was an arbitrary date selected by the Service
to provide taxpayers with additional time to revoke an IRC
Sec. 172(b)(3) election, to make an IRC Sec. 172(j) election, or to
file a Form 1139. While providing taxpayers additional time to meet
these statutory deadlines is appropriate, it is not appropriate to
impose an arbitrary deadline for the filing of 5-year carryback claims.
If taxpayers that filed their 2001 tax returns prior to enactment
of the Job Creation and Worker Assistance Act of 2002 did not make an
election under IRC Sec. 172(b)(3), they should be entitled to carry
back their 2001 NOLs 5 years, assuming their carryback claims are
timely filed within the applicable statute of limitations.
B. LTaxpayers that filed a 2-year carryback claim are at a disadvantage
compared to similarly situated taxpayers that did not file any
carryback claim.
Rev. Proc. 2002-40 distinguishes between taxpayers depending upon
whether the taxpayer has filed a 2-year carryback claim. Rev. Proc.
2002-40, Sec. 5 is applicable to taxpayers with NOLs that filed a 2-
year carryback claim, whereas Rev. Proc. 2002-40, Sec. 6 is applicable
to taxpayers with NOLs that had not filed a 2-year carryback claim.
If a taxpayer filed a 2-year carryback claim, Rev. Proc. 2002-40,
Sec. 5.01 requires the taxpayer to file a carryback claim using a 5-
year period by October 31, 2002. In contrast, if a similar taxpayer
with a NOL had not filed a 2-year carryback claim, Rev. Proc. 2002-40,
Sec. 6.02 provides that the taxpayer need do nothing and will be
entitled to the 5-year carryback period ``by operation of law.''
The foregoing distinction drawn by Rev. Proc. 2002-40 is not
reasonable. It imposes an affirmative obligation on taxpayers that
filed 2-year carryback claims before enactment of the 2002 tax
legislation, but no obligation on taxpayers that did not file 2-year
carryback claims. The same rule should apply to both. Under the general
statutory rules, taxpayers may file amended tax returns carrying back
NOLs any time before expiration of the statute of limitations under IRC
Sec. 6511 for the taxable year in which the NOL was incurred. Taxpayers
that filed 2-year carryback claims before enactment of the 2002 tax
legislation were not required to file those claims. Taxpayers can amend
carryback claims any time before expiration of the statute of
limitations.
IV. Proposal for Tax Technical Corrections Act of 2003
To provide relief for taxpayers described above, we would suggest
that a new subsection (D) be added to Sec. 3(b) of the Tax Technical
Corrections Act of 2003, as follows:
L``(2) In the case of a net operating loss for a taxable year
ending during 2001 or 2002----
* * *
L(D) if no election was made under section 172(b)(3) on a tax
return filed before enactment of the Job Creation and Worker Assistance
Act of 2002, the carryback period under section 172(b)(1)(H) shall
apply if a 5-year carryback claim is timely filed within the applicable
period of limitations.''
This proposed provision would permit taxpayers that filed their
2001 tax returns before enactment of the 2002 tax legislation an option
to carry back their 2001 NOLs either 2 years or 5 years. This
flexibility seems appropriate in light of all the circumstances.
Offering these taxpayers the flexibility of carrying back their NOLs 5
years, even though they failed to meet the October 31, 2002 deadline
imposed by Rev. Proc. 2002-40, Sec. 5.01, would be consistent with the
objectives of the legislation.
We appreciate your attention to this matter. If you need any
additional information, please feel free to contact me.
Very truly yours,
Donald A. Barnes
Burlington Northern Santa Fe Corporation
Fort Worth, Texas 76131
January 21, 2004
The Honorable William M. Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, D.C. 20515
Dear Mr. Chairman:
Pursuant to your request for written comments on H.R. 3654, the
``Technical Corrections Act of 2003,'' (``Introduced Act''). We
appreciate the opportunity you have provided for receiving our comments
on this legislation.
I would like to bring to your attention our concerns with the
retroactive application of the ``binding contract rule'' included in
the bonus depreciation provision of the Introduced Act, which we
believe represents a substantive change to the bonus depreciation
provision of the Job Creation and Worker Assistance Act of 2002 (``Job
Creation Act'') and not a mere technical correction. Taxpayers who made
business decisions on the basis of the existing law not only relied on
those provisions in making investment decisions but have already filed
tax returns for 2001 and 2002 on the basis of these rules. We request
your assistance in modifying it to limit its application to the time
period beginning December 8, 2003, which is the date the bill was first
introduced in the House of Representatives.
As you know, the Job Creation Act provides a bonus depreciation
deduction equal to 30% of the basis of qualified property in the year
the property is placed in service. To be qualified property, (i) the
property must have been acquired by the taxpayer after September 10,
2001, (ii) the original use of the property must commence with the
taxpayer on or after September 11, 2001 and (iii) the taxpayer could
not have entered into a written binding contract for the acquisition of
the property before September 11, 2001. The Job Creation Act also
provides that self-constructed property will be considered to be
acquired by the taxpayer after September 10, 2001, if manufacture,
construction, or production began after that date even if the taxpayer
had a binding contract before September 11, 2001.
The Introduced Act would substantially alter the property
qualifying for bonus depreciation. One result of these changes would be
to deny bonus depreciation where there was a commitment in place before
September 11, 2001 to acquire property or if construction commenced
before September 11, 2001, even if the person that eventually acquires
the property after the commitment date is not a direct party to those
plans or a person related to a party to those plans. Therefore, a
taxpayer who was unrelated to the earlier transaction and who qualified
for bonus depreciation under the previous rules will now in 2003 be
disqualified from such benefit. The existing rules accomplished their
goals by bringing new investors and capital to market in situations the
``technical corrections'' will retroactively deem not eligible for
these incentives.
The provisions of the Introduced Act are unduly burdensome on both
taxpayers and the government and their application cannot be reasonably
made in every instance. The retroactive application of the Introduced
Act, which clearly changes the existing law, would especially harm
capital intensive taxpayers that have made a series of investment
decisions subsequent to the enactment of the Job Creation Act and prior
to December 8, 2003 assuming an investment qualifies for bonus
depreciation, which will be incorrect if the Introduced Act becomes
law.
I would like to again request your support to modify the proposed
``binding contract rule'' by limiting its application to transactions
entered into on or after December 8, 2003, which is the date this
change in law first came to the general attention of taxpayers.
Taxpayers that in reliance on the existing law entered into contracts
after September 11, 2001 and placed the relevant property in service on
or before December 8, 2003 can be assured that the property qualifies
for bonus depreciation based on the rules in effect when they entered
into their agreements.
Please contact Ms. Shelley Venick, Vice President and Tax Counsel,
at 817-352-3400 should you have any questions or comments concerning
the above. We appreciate your consideration of this matter and look
forward to working with you on this issue.
Respectfully submitted,
Thomas N. Hund
Executive Vice President
Chief Financial Officer
Statement of Constance Logan, Iacopi, Lenz & Company Accountancy
Corporation, Stockton, California
I. Introduction
The purpose of this comment is to suggest that section 168(k) be
amended to clarify whether certain farmers who have elected out of the
provisions of IRC 263A under section 263A(d)(3) and are therefore
committed under section 263A(e)(2) to using the Alternative
Depreciation (ADS Farmers) qualify for the special 50% 168(k) Bonus
Depreciation. The Code is ambiguous regarding this issue, and both the
Committee reports and the legislative Blue Book are silent about the
application to these farmers. However, the Treasury Department issued
pronouncements interpreting this section to exclude the ADS farmers
from the benefits of Bonus Depreciation.
Impact: The farmers targeted by the Treasury rulings are
essentially cash-basis small- to mid-sized farmers that have incurred
pre-production or development costs (i.e. planting, fertilizer,
irrigation, and so forth) for orchards and vineyards and have elected
to expense rather than capitalize these costs. Farmers who are required
to use the accrual method of accounting under sections 447 or 483 may
not make this election. This 263A(d) election is irrevocable (except
with the permission of the Secretary of the Treasury) and the
263A(e)(2) ADS requirement applies to the year that the development
costs are incurred and to all subsequent years. It applies not just to
development costs but to all depreciable property acquired by the
farmers for use in their farming business (i.e. harvesting equipment,
sprinkler systems, new trees and vines, and so forth) in all the
subsequent years. A farmer may have made an election 10 years ago to
expense development costs and because of this will not qualify for the
50% Bonus Depreciation on new harvesting equipment that he purchases in
2003. While these farmers may only comprise a minority of farmers,
their economic contributions are substantial, and if the Treasury
Department's interpretation is correct, the farming industry as a whole
will be adversely affected.
II. Ambiguous Code Language
Section 168(k) allows an additional first year depreciation
deduction of 50% \1\ of the cost of a qualified asset. The remaining
balance of the cost of the asset is depreciated using the normal MACRS
rates. To be a qualified asset, it must be new (the original use begins
with the taxpayer) and have a cost recovery period (depreciable life)
of 20 years or less. Further, it must be MACRS property, which is
tangible property used in a trade or business or for the production of
income and subject to an allowance for depreciation.\2\ Unlike section
179, there is no dollar limit to the amount of Bonus Depreciation that
may be claimed and no limit on the cost of property that qualifies.\3\
The Bonus Depreciation provisions are temporary and are scheduled to
expire December 31, 2004.\4\ Farmers could potentially reap huge
benefits if they are allowed to claim the Bonus Depreciation. Typical
farm assets that would qualify if they were purchased new for the farm
business are planting and harvesting equipment (5 year property), farm
vehicles (5 year property), special purpose agricultural or
horticultural buildings (10 year property), barns and silos (20 year
property), irrigation systems (15 year property), and trees and vines
\5\ (10 year property).
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\1\ This was originally 30% for assets acquired after Sept. 10,
2001 but was increased to 50% by the Jobs and Growth Tax Relief
Reconciliation Act of 2003 for assets acquired after May 5, 2003.
\2\ 2002 Tax Legislation, Law, Explanation and Analysis Job
Creation and Worker Assistance Act of 2002 Sec. 305.
\3\ See IRC Sec. 179 (restricting additional first year
depreciation under that section to $100,000 and eliminating the
deduction if qualified property purchases exceed $400,000 during the
tax period).
\4\ Job Creation and Worker Assistance Act of 2002, P.L. 107-147,
Act Sec. 101(a) (March 9, 2002). This date is extended to December 31,
2004 by the 2003 Tax Act.
\5\ To qualify as ``new'' for bonus depreciation, trees and vines
must be planted after Sept. 11, 2001 and produce a marketable crop
before Jan. 1, 2006.
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It is the complex interrelationship between the depreciation rules
of Section 168(g) and (k) and the uniform capitalization rules of
Section 263A(d) and (e) that provides the ambiguity that needs to be
resolved.
IRC Section 168: Bonus Depreciation under section 168(k) is not
applicable to businesses required to use the Alternative Depreciation
System (ADS) under Section 168(g).\6\ The ADS is basically a straight-
line depreciation system with longer depreciable lives unlike the MACRS
accelerated system that uses shorter lives and higher rates (i.e.
double the straight line rate). Section 168(k)(2)(C) specifically
identifies 2 categories of property that are excluded from ``qualified
property'' for Bonus Depreciation: (1) property to which the
alternative depreciation applies under Section 168(g), and (2) Section
280F(b) (listed property with predominant personal use).\7\ Section
168(g) provides that the ``depreciation deduction provided . . . shall
be determined under the alternative depreciation system'' for four
specific categories of property: (1) Foreign use property, (2) Tax-
exempt use property, (3) Tax-exempt bond financed property, and (4)
Property identified by Executive Order.\8\ Use of the ADS method is
also required if the taxpayer makes an election to use ADS under
Section 168(g)(7).\9\ This section provides for a separate election to
use the alternative depreciation system and does not identify any
particular type of property. Pursuant to Section 168(k)(2)(C)(i)(I)
this election will not eliminate the bonus depreciation on property for
which this election is made.
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\6\ IRC Sec. 168(k)(1)(C).
\7\ ``(i) Alternative depreciation property. The term ``qualified
property'' shall not include any property to which the alternative
depreciation system under subsection (g) applies, determined:
(I) without regard to paragraph (7) of subsection (g) (relating to
election to have system apply), and
(II) after application of Section 280F(b) (relating to listed
property with limited business use).''
\8\ IRC 168(g)(1)(A)-(D).
\9\ IRC 168(g)(1)(E).
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In addition to those assets specifically identified in Section
168(g), two other code sections specify assets for which the use of the
ADS is required under certain circumstances. One is referenced in
Section 168(k)(2)(C)(i)(II), Section 280F(b) \10\ (relating to
``listed'' property) \11\ and one is not referenced, Section 263A(e)
(relating to certain farmers). Section 280F(d) was specifically
identified in Section 168(k)(1)(C)(i)(II) as being excluded from Bonus
Depreciation. However, the language in Section 168(g) or 168(k) does
notably not exclude farmers either by reference to farmers or to
Section 263A(e)(2).\12\ Certain farmers may be excluded under the broad
phrase ``property to which the alternative depreciation system under
[168(g)] applies'' \13\ depending on how this section and Section
263A(e) are interpreted. If the phrase ``property to which 168(g)
applies'' encompasses Section 263A(e) and 280F(b) property, then it is
redundant to add 280F(b) as another exception in Section
168(k)(2)(C)(i)(II).
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\10\ Relating to Listed Property which is certain dual use property
used more for personal than for business.
\11\ See CCH Federal Tax Service Sec. G:16.262 (including as listed
property as any passenger automobile, transportation equipment, or
computers).
\12\ Reference to Code Section 263A(e)(2) was how the IRS and
Treasury excluded certain farmers from the Bonus Depreciation rules.
\13\ IRC 168(k)(2)(C).
Section 263A: Section 263A(d) Farmers' election out of the Uniform
Capitalization rules allows farmers to expense pre-production costs for
orchards and vineyards rather than to capitalize these costs and
postpone recovery until the trees or vines start producing. As a
condition of making this election, the farmer must (1) use the ADS
depreciation method and (2) recapture any capital outlay expended
through 263A(d) as ordinary income rather than capital gain income upon
the sale of the orchard or vineyard.
The provisions of 263A(d) and (e) apply to any farm crop with a
pre-production period of 2 years or more but generally would apply only
to trees \14\ and vines. The election is irrevocable (without the
consent of the Secretary of the Treasury Department) and the ADS
straight-line method applies prospectively to all assets purchased for
farm use (not just the trees and vines or assets purchased during the
pre-productive period).
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\14\ Other than citrus or almond trees.
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If farm property of farmers who have elected out of the Uniform
Capitalization Rules is ``any property to which the alternative
depreciation system under subsection (g) applies'' then farmers would
not be able to claim the Bonus Depreciation. This is precisely the
phrase that is ambiguous and subject to differing interpretations. The
key to resolving this ambiguity is an analysis of Legislative Intent
regarding the application of 168(k) to ADS Farmers.
III. Analysis of Legislative Intent
When a statute is not clear on its face, legislative intent may be
inferred from many extrinsic sources including the avowed purpose of
the statute, the committee reports and other reference materials
referred to by the lawmakers in making their decision, and the
statute's relationship to the whole legislative scheme currently and
historically.
A. Purpose: The expressed legislative intent of the Job Creation and
Worker Assistance Act of 2002 was to create jobs and assist
workers and to help the country recover from the economic effects
of the September 11th tragedy. One way they intended to do this
was by providing tax incentives to businesses, in the form of
Bonus Depreciation in order to encourage purchases of new
equipment and other assets. Encouraging capital investments in
new assets would stimulate the demand for new assets and
ultimately the increased manufacturing and supply of these assets
thus creating more jobs. The investment in capital assets and the
additional funds from tax savings would also stimulate the
expansion of businesses with increased production and sales that
also would require the hiring of new employees.
L It is understandable why Congress would not allow the Bonus
Depreciation for property that would be used outside of the United
States,\15\ because this would stimulate foreign markets not the U.S.
economy. It is also understandable why they would exclude listed
property under Section 280F(b),\16\ because this property is only
excluded if the personal use is 50% or more. So these would essentially
be personal, not business assets. Also, it was the tax incentives that
would provide the stimulus so it is equally understandable why Congress
would exclude tax-exempt use property. It is not, however,
understandable why Congress would intend to exclude ADS Farmers'
property. Farms are businesses that could hire new employees if they
had tax incentives to help them expand by buying new assets. Also, a
demand for new farm equipment would spur the economy by supporting
increased manufacture of farm equipment. Further, farmers tend to hire
unskilled labor, the group with the highest unemployment rate.
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\15\ See IRC 168(k)(2)(C) (referring to the excluded taxpayers in
IRC 168(g)(1)).
\16\ IRC 168(k)(2)(C).
B. Committee Reports and Legislative Blue Book: When Congress'
intent is not clear from the actual language of a statute or the
surrounding text, the intent may often be discerned from the
congressional committee reports and if that is not conclusive,
from the language or intent of other legislative publications.
The staff of the Joint Committee prepared a legislative summary
on March 22, 2002.\17\ The document lists four basic requirements
for Bonus Depreciation but there is no mention of 263A(e)(2) or
farmers in this entire document. Therefore, it is certainly not
clear from this document that the legislators intended to exclude
the 263A(2)(e) farmers.
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\17\ Joint Committee on Taxation, Summary of P.L. 107-147, the
``Job Creation and Worker Assistance Act of 2002'' (JCX-22-02), March
22, 2002.
---------------------------------------------------------------------------
L The Jobs Growth and Tax Relief Reconciliation Act of 2003
(2003 Act) increased the bonus depreciation rate from 30%-50% and
extended the applicable period. The committee reports for this Act do
not address the 263A(e)(2) farmer issue or any of the specifically
excluded types of property. This Act became law on May 28, 2003 which
was after the publication of the IRS Revenue Procedure \18\ excluding
ADS Farmers and after the legislative analysis contained in the ``Blue
Book,'' \19\ but before the Treasury Department Temporary Regulation
excluding ADS Farmers.\20\ Does the failure to specifically exclude
263A(e)(2) from Section 168(k) bonus depreciation in the amendment to
Section 168(k) mean that Congress was ratifying the position taken in
the IRS Revenue Procedure or that Congress was not aware of the IRS
position? It is here postulated that based on the totality of the
information available to the legislatures at the time of the enactment,
including committee reports and the Blue Book Explanation, they were
unaware of either the Treasury position or the impact of 168(k) on the
ADS farmers. No mention was made of either in any of the documents. The
Blue Book specifically listed the four excluded categories of taxpayers
in Section 168(g) \21\ and Section 280F(b) but did not mention
263A(e)(2) or farmers.
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\18\ I.R.B. 2002-20, 963, April 29, 2002.
\19\ Joint Committee on Taxation's General Explanation of Tax
Legislation Enacted in the 107th Congress (Blue Book), (JCS-1-03,
January 24, 2003).
\20\ I.T. Reg. 1.168(k)-1T.
\21\ Foreign use property, tax-exempt use property, tax-exempt bond
financed property, and Executive Order property.
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L It is interesting to note that in June 2002 the Joint
Committee staff prepared a summary for S. 312, the ``Tax Empowerment
and Relief for Farmers and Fisherman Act,'' \22\ which proposed tax law
changes that would help farmers. This summary included an overview of
current law but did not mention the Section 263A(e)(2) farmers Bonus
Depreciation dilemma. A logical inference is that the drafters were not
aware of the adverse impact of the Treasury interpretation on certain
farmers.
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\22\ Joint Committee on Taxation, Overview of Present Law and
Selected Proposals Regarding the Federal Income Taxation of Small
Business and Agriculture (JCX-45-02), May 31, 2002.
C. Legislative Scheme: The staff of the Joint Committee on Taxation
\23\ explaining the 2002 Act indicated that the ``present law''
that was the starting point for the recommended Bonus
Depreciation provision was Section 179 that allows an additional
first year depreciation expensing option for certain property.
There are many restrictions on the application of Section 179
most of which were minimized by the 2002 Act.\24\ ADS Farmers are
qualified to claim the benefits of Section 179. However, neither
foreign use property nor tax-exempt use property are qualified
Section 179 property,\25\ and neither is Section 280F(d)
property.\26\ No effort was made to restrict ADS Farmers' use of
Section 179. And, as was mentioned above, the Committee Reports
are silent on the issue of farmer's depreciation.
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\23\ Technical Explanation of the ``Job Creation and Worker
Assistance Act of 2002.''
\24\ Notably the amount that can be expensed was increased from
$24,000 to $100,000 per year and the maximum dollar amount of Section
179 placed in service during the taxable year was raised from $200,000
to $400,000 thus qualifying more taxpayers for the deduction.
\25\ IRC 179(d)(1); IRC 50(b).
\26\ IRC 280F(d)(1) Coordination with Section 179.
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L Section 280F, which restricts depreciation on Luxury Autos
and certain personal use property (listed property), was modified by
the 2002 Act in two ways. The dollar limitation for deductions was
increased and Section 280F(b) property that is used more than 50% for
personal use was specifically excluded from the benefits of Section
168(k). The fact that this section, which is the only other section
that requires the use of the ADS method, was specifically addressed by
legislation whereas Section 263A(e)(2) was not addressed indicates that
the impact of Section 168(k) on farmers may not have been brought to
the attention of the legislators.
D. Legislative History: There are numerous code sections that
manifest the legislator's intent to provide tax benefits to
farmers. A Congressional intent to exclude farmers from Section
168(k) Bonus Depreciation would seem counter-intuitive to all
these other sections.
1. LSection 263A(d): Allows farmers to elect to expense pre-
productive costs rather than postponing cost recovery through delayed
depreciation deductions. This initially came at a cost to the farmer
but at the time of its enactment, it was considered beneficial for the
farmer. In retrospect, any election under this section would not have
been made if anyone realized Congress would pass a law with a
retroactive negative impact such as Section 168(k) as interpreted by
the IRS.
2. LFarmers' Income Averaging: This allows farmers to average
income over a three-year period to help even out fluctuations in income
and to take advantage of lower tax rates. When Congress realized that
the Alternative Minimum Tax (AMT) interfered with the benefits of
income averaging, they proposed a change to the AMT rules.\27\
---------------------------------------------------------------------------
\27\ Joint Committee on Taxation, Overview of Present Law and
Selected Proposals Regarding the Federal Income Taxation of Small
Business and Agriculture (JCX-45-02), May 31, 2002.
---------------------------------------------------------------------------
3. LEstimated Tax Payments: Farmers are not required to pay
estimated taxes if they file their tax returns by March 1 of the
following year and pay all taxes due at that time.
4. LCash Method of Accounting: Most farmers are allowed to use
the cash method of accounting which allows them to deduct expenses when
paid and report income when received. Other comparably situated
taxpayers generally must use the accrual method of accounting.\28\
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\28\ IRC Sec. 446; IRC 447; IRC 448(a)(3).
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5. LNet operating loss carryback: Before the 2002 Tax Act,
farmers were allowed to carry back net operating losses from the
farming business for 5 years.\29\ This was another mechanism to even
out fluctuating income and it provided for immediate refund of taxes
paid in past years. Other taxpayers were restricted to a 2-year carry
back period.
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\29\ IRC Sec. 172.
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IV. IRS and Treasury Department Interpretation of Section 168(k)
In April 2002 the Internal Revenue Service issued a Revenue
Procedure regarding the application of Section 168(k) Bonus
Depreciation and as part of their interpretation, summarily excluded
farmers who had made the 263A election and as a result were using ADS
to calculate depreciation.\30\ The Treasury Department incorporated the
IRS interpretation in a regulation issued on September 5, 2003.
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\30\ I.R.B. 2002-20, 963, April 29, 2002.
A.
LRevenue the IRS issued Procedure 2002-33 on April 29, 2002 to
provide ``procedures for a taxpayer to claim the additional 30%
depreciation . . . provided by Sec. 168(k).'' \31\ In Section 2
paragraph .04 the procedure states, ``The additional first year
depreciation must not be deducted for, among other things: (1) property
that is required to be depreciated under the alternative depreciation
system of Sec. 168(g) pursuant to Sec. 168(g)(1)(A) through (D) or
other provisions under the Code (for example, property described in
Sec. 263A(e)(2)(A) or Sec. 280F(b)(1).'' (Italics added for emphasis).
Throughout the six page Revenue Procedure this was the only reference
to the 263A(e)(2) ADS farmers. Although there were pages of
explanations for other provisions there was neither a reference to this
statement nor any analysis.\32\ A few words in one part of a
parenthetical phrase and the benefits of bonus deprecation are
abolished for the ADS farmers.
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\31\ I.R.B. 2002-20, 963, April 29, 2002. (Just 51 days after the
enactment of P.L. 107-147 on March 9, 2002).
\32\ There was no analysis for Section 280F(d) either, however this
code section was specifically identified in the Code.
---------------------------------------------------------------------------
L Immediately after Section 168(k) was passed, commentators
offered interpretations of how the 263A(d) election would affect
farmers and all considered Section 168(k)(C) ambiguous and open to
interpretation. After the IRS ruling there were no further comments in
the tax literature.
B.
LTemporary Treasury Regulation 1.168(k)-1T was issued September
5, 2003 \33\ to ``provide the requirements that must be met for
depreciable property to qualify for the additional first year
depreciation deduction provided by Section 168(k).'' \34\ Using wording
almost identical to the Revenue Procedure,\35\ the regulation at
1.168(k)-1T(b)(2)(ii) provides ``property will not meet the
requirements of [168(k)] if the property is . . . (2) required to be
depreciated under the alternative depreciation system of Section 168(g)
pursuant to Section 168(g)(1)(A) through (D) or other provisions of the
Internal Revenue Code (for example, property described in Section
263A(e)(2)(A) or Section 280F(b)(1)'' \36\ This was the only reference
to Section 263A(e)(2) ADS farmers, and, as with the revenue procedure,
there was no explanation or analysis. The IRS employee who authored
both pronouncements, explained his reasoning in a letter dated December
2, 2003: ``Because the alternative depreciation system of Section
168(g) applies to property the taxpayer made the election for under
Section 263A(d)(3), this property is not eligible for the additional
first year depreciation deduction. This result occurs because Section
168(k)(2)(C)(i) does not provide an exception for property the taxpayer
made the election for under Section 263A(d)(3).\37,38\ Based on this
reasoning, it could equally be argued that because Section
168(k)(2)(C)(i) does not specifically exclude Section 263A(e)(2) from
Bonus Depreciation (as it does Section 280F(b)), ADS farmers should be
eligible for the deduction. It should be noted that both the IRS and
the Treasury Department included 263A(e)(2) farmers in the same phrase
with Section 280F(b) listed property although the latter was
specifically excluded from 168(k) by the language of the code. The fact
that these sections were not both mentioned in the code (and the fact
that 263A(e)(2) was not mentioned in the code, Committee reports, or
the Blue Book) should have prompted some analysis by the IRS of the
intent of this section of the legislation. It is clear from the
language of the code that Congress intended to exclude Section 280F(b)
property. It is not clear that Congress intended to exclude Section
263A(2)(e) property. On the contrary, it is apparent that the issue of
the ADS farmers regarding Bonus Depreciation was not considered by the
legislature at all.
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\33\ T.D. 9091 (Sept. 5, 2003).
\34\ Preamble to I.T. Reg. 1.168(k)-1T.
\35\ Both the Revenue Procedure and the Temporary Regulations were
authored by Douglas Kim from the IRS.
\36\ I.T. Reg. 1.168-T.
\37\ Letter dated Dec. 2, 2003 from Douglas H. Kim, Id. at No. 50-
12306, Internal Revenue Service Department of the Treasury, Washington,
DC 20024.
\38\ The ``exceptions'' in Section 168(k)(2)(C) are the property
that does not qualify. Mr. Kim apparently meant to say ``exclusion from
the 168(g) exception.''
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V. Conclusion
Based on the forgoing, this commentator recommends that Section
168(k)(2)(C) be amended to read as follows:
L``168(k)(2)(C)(i)(I) without regard to paragraph (7) of
subSection (g) (relating to election to have system apply), or Section
263A(e)(2)(A) (relating to the effects of a Section 263A(d)(3)
election), and''
It is respectfully submitted that this amendment would clarify the
legislative intent of the original enactment and would eliminate the
uncertainty in the administration of IRC Sec. 168(k) while extending
the benefits of Bonus Depreciation to deserving farmers who have been
inadvertently excluded.
Statement of Investment Company Institute
The Investment Company Institute (the ``Institute'') \1\ strongly
supports the Tax Technical Corrections Act of 2003 (``TTCA'') \2\ and
urges its prompt enactment. In particular, we support the technical
corrections to the Jobs and Growth Tax Relief and Reconciliation Act of
2003 (``JGTRRA'') that clarify rules relating to qualified dividend
income (``QDI'') taxable at the new 15 percent maximum tax rate. The
approximately 25 million mutual fund shareholders who invest through
taxable accounts in funds holding equities would benefit from these
changes to Internal Revenue Code Section 854 \3\ (which provides the
rules pursuant to which QDI received by a mutual fund beginning January
1, 2003 retains its character when paid by the fund to its
shareholders).
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\1\ The Investment Company Institute is the national association of
the American investment company industry. Its membership includes 8,672
open-end investment companies (``mutual funds''), 605 closed-end
investment companies, 108 exchange-traded funds and 6 sponsors of unit
investment trusts. Its mutual fund members have assets of about $7.149
trillion. These assets account for more than 95% of assets of all U.S.
mutual funds. Individual owners represented by ICI member firms number
86.6 million as of mid 2003, representing 50.6 million households.
\2\ H.R. 3654, S. 1984.
\3\ All references to sections, unless otherwise indicated, are to
sections of the Internal Revenue Code.
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Transition Relief From 60-Day Designation Requirement
Section 854(b)(2), as amended by JGTRRA, provides that the amount
of any distribution by a fund that may be treated as QDI shall not
exceed the amount designated by the fund ``in a written notice to its
shareholders mailed not later than 60 days after the close of its
taxable year.'' For funds with taxable years that ended more than 60
days before JGTRRA was enacted (i.e., funds with January and February
year-ends), there was no opportunity to make this 60-day designation
for distributions made during the taxable year. Even for funds with
later taxable year-ends, the ability to make prompt designations has
been hampered by delays in the issuance of comprehensive Treasury
guidance (particularly before the recent release of guidance regarding
dividends from foreign corporations) and by the funds' need to review
2003 transaction histories.
The TTCA would provide transition relief for 2003 from the 60-day
designation requirement. Specifically, the TTCA would provide that,
with respect to the taxable year of a fund ending on or before November
30, 2003, the period for providing notice of the qualified dividend
amount, as required under Section 854(b)(2), does not expire prior to
the date by which the fund must provide IRS Form 1099 information to
shareholders in accordance with Section 6042(c) (i.e., January 31,
2004).
Flow Through of QDI From Qualified Foreign Corporations and REITs
Under Section 854(b)(1)(B), as enacted in JGTRRA, if the aggregate
dividends received by a fund are less than 95 percent of its gross
income for the year, then shareholders can treat as QDI only the
portion of the fund's dividends designated by the fund as such. Section
854(b)(1)(C) limits the amount of dividends that a fund may designate
as QDI to the amount of aggregate dividends received by the fund for
the taxable year.
The definition of aggregate dividends provided by Section 854(b)(3)
prior to enactment of JGTRRA excluded certain dividends that generally
are treated as QDI and also included other dividends that generally are
not treated as QDI. To address the under-inclusiveness of Section
854(b)(3), JGTRRA added new clauses (iii) and (iv) of Section
854(b)(1)(B) to expand the definition of aggregate dividends for
purposes of clause (i) of Section 854(b)(1)(B) to include dividends
received from qualified foreign corporations and certain dividends
received from a real estate investment trust (``REIT''). To address the
over-inclusiveness of the term ``aggregate dividends,'' JGTRRA added
new Section 854(b)(5) to limit the amount that a fund can include in
aggregate dividends, for purposes of Section 854(b)(1)(B), to the QDI
of the fund.
The JGTRRA provisions designed to address the under-inclusiveness
of Section 854(b)(3)--by expanding the definition of aggregate
dividends--apparently do not apply for purposes of Section
854(b)(1)(C), which limits the amount of QDI the fund can designate
under Section 854(b)(1)(B) to the amount of aggregate dividends
received by the fund. Likewise, the JGTRRA provisions designed to
address the over-inclusiveness of Section 854(b)(3)--by limiting the
amount that a fund can include in aggregate dividends--apparently do
not apply for purposes of the Section 854(b)(1)(C) limitation.
The effect of the JGTRRA changes not applying for purposes of
Section 854(b)(1)(C) would be to prevent funds that do not receive at
least 95 percent of their gross income from qualifying dividends from
treating any dividends received from qualified foreign corporations and
REITs as part of the aggregate dividends that may be designated as QDI.
To ensure that Section 854 operates as intended, the TTCA would
modify the limitation on the designation of QDI and thereby clarify
that dividends from qualified foreign corporations and eligible REIT
dividends may flow through a fund to its shareholders.
Effective Date for Partnerships in Master Feeder Structures
The 15 percent maximum tax rate on QDI provided by JGTRRA applies
to dividends received by individuals in taxable years beginning after
December 31, 2002. In the case of dividends received by funds, JGTRRA
applies to dividends received after December 31, 2002 (without regard
to the fund's taxable year).
A recently issued IRS Announcement interpreting the JGTRRA
effective date provisions (Announcement 2003-56) states that, in the
case of partnerships with fiscal years beginning in 2002 and ending in
2003, no dividends received by the partnership during that fiscal year
may be treated as qualified dividends, even if received during 2003. By
its terms, this announcement would appear to apply to funds that invest
in partnerships, including funds that are part of a master-feeder
structure.
The master-feeder structure, which is common in the mutual fund
industry,\4\ typically consists of one or more mutual funds, known as
``feeder funds,'' with substantially identical investment objectives
that pool their assets in a single investment pool, or ``master fund,''
that is classified as a partnership for Federal income tax purposes.
The feeder funds and the master fund typically have the same taxable
year. Feeder funds, as partners in a partnership, do not receive
dividends directly; instead, they take into income their distributive
shares of the dividend income received by the master fund partnership
pursuant to Section 702.
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\4\ Feeder funds have approximately $50 billion of assets in master
funds holding equities.
---------------------------------------------------------------------------
Under the effective date provision applicable to mutual funds, a
mutual fund with a taxable year ending on June 30, 2003 would treat the
new qualified dividend provisions as applying to dividends it received
during the period from January 1, 2003 through June 30, 2003. We
believe that this result was intended to apply without regard to
whether the mutual fund received the dividends directly from the
distributing corporation or through a master fund that held the stock
of the distributing corporation.
The TTCA would modify JGTRRA by essentially providing partnerships
with the same effective date that applies to funds. Under the TTCA,
partnerships, like funds, would be permitted to treat as QDI the
eligible dividends received after 2002, even if the partnership's
fiscal year began before January 2003.
Mutual Fund Distribution of Subchapter C Earnings and Profits
JGTRRA does not include any specific provision pursuant to which a
fund may treat as QDI a distribution of subchapter C earnings and
profits that it acquired in a tax-free acquisition of a C corporation's
assets or as a result of a C corporation converting to a mutual fund;
these amounts must be distributed by the fund to maintain its status as
a regulated investment company under subchapter M.
Subchapter C earnings and profits have been taxed at the entity
level and hence may be distributed to the C corporation's shareholders
as QDI. Shareholders in a fund that distributes Subchapter C earnings
and profits received in situations described above likewise should be
permitted to treat the distributed amounts as QDI. Treatment as QDI
should not be forfeited merely because the Subchapter C earnings and
profits are distributed by the fund rather than by the C corporation.
The TTCA would modify Section 854(b)(1)(C) to provide that the
amount that may be designated by a fund as QDI under Section
854(b)(1)(B) shall not exceed the sum of QDI and ``the amount of any
earnings and profits which were distributed by the company for such
taxable year in order to comply with the requirements of Section
852(a)(2)(B) and accumulated in a taxable year with respect to which
this part did not apply.''
Holding Period Requirement for Qualified Dividend Income
In order for a dividend on common stock to be treated as QDI under
JGTRRA, the taxpayer must hold the stock on which the dividend is paid
for at least 61 days. Sections 1(h)(11)(B)(iii) and 246(c). For this
purpose, only days during the 120-day period beginning on the date that
is 60 days before the ex-dividend date are taken into account. Also for
this purpose, the taxpayer's holding period begins the day after the
date on which the stock is acquired. Section 246(c)(3).
JGTRRA, as originally enacted, prevents a taxpayer who acquires
common stock the day before the ex-dividend date from meeting the 61-
day holding period requirement for that dividend. For example, if an
individual acquires stock on July 30 that goes ex-dividend on July 31,
the 120-day period begins on June 1 (60 days before the July 31 ex-
dividend date) and ends on September 28 (59 days after the July 31 ex-
dividend date). Because the taxpayer's holding period begins on July 31
(the day after the purchase date) and only 59 days remain (after July
31) in the 120-day period, the taxpayer can never meet the 61-day
holding period requirement for that first dividend. The 2003 Form 1040
Instructions, reflecting JGTRRA as enacted, contain a similar example
and indicate that such a dividend is not QDI.\5\
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\5\ See, 2003 Form 1040 Instructions, p. 23, Line 9b, ex. 2.
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The TTCA would allow an investor who acquires common stock the day
before it goes ex-dividend to meet the 61-day holding-period
requirement by extending the 120-day holding period to 121 days--
thereby providing a period that includes 60 days both before and after
the ex-dividend date.\6\
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\6\ The TTCA also extends the holding period with respect to
preferred stock from 180 to 181 days.
__________
SUMMARY POINTS
I. The Tax Technical Corrections Act of 2003 Should Be Enacted Promptly
The Investment Company Institute strongly supports the Tax
Technical Corrections Act of 2003 (``TTCA'') and urges its prompt
enactment. In particular, we support the technical corrections to the
Jobs and Growth Tax Relief and Reconciliation Act of 2003 (``JGTRRA'')
that clarify rules relating to qualified dividend income (``QDI'')
taxable at the new 15 percent maximum tax rate. These technical
corrections would provide the approximately 25 million mutual fund
shareholders who invest through taxable accounts in funds holding
equities with the tax benefits intended by Congress when JGTRRA was
enacted.
II. Effect of Technical Corrections on Mutual Fund Shareholders
A. Transition Relief From 60-Day Designation Requirement
The TTCA includes transition relief from the statutory requirements
for timely designating the character of dividends paid. QDI
designations for distributions made by funds for taxable years ending
during 2003 are being made, taking this transition relief into account,
by January 31, 2004 (the date by which the fund must provide IRS Form
1099 information to shareholders for payments made in 2003).
B. Flow Through of QDI From Qualified Foreign Corporations and
REITs
The TTCA clarifies that dividends received by a fund from qualified
foreign corporations and REITs that are eligible for QDI treatment do
not inadvertently lose that eligibility when they flow through a fund
to its shareholders.
C. Effective Date for Partnerships in Master Feeder Structures
The TTCA clarifies that JGTRRA provides investors in partnerships
with the same effective date for QDI benefits that JGTRRA expressly
provides to shareholders in mutual funds. Among other things, the
clarification will permit fund shareholders who invest in a feeder fund
that holds an interest in a master fund partnership (where the
portfolio management is performed) to receive the same benefits as
other fund shareholders.
D. Mutual Fund Distribution of Subchapter C Earnings and Profits
The TTCA clarifies that a fund shareholder will receive QDI
treatment for dividends attributable to amounts previously taxed to a
fund's predecessor.
E. Holding Period Requirement for Qualified Dividend Income
The TTCA clarifies that the period during which common stock must
be held for 61 days to receive QDI treatment is 121, rather than 120,
days (i.e., 60 days both before and after the ex-dividend date). This
clarification will permit an investor who acquires stock the day before
it goes ex-dividend to meet the holding-period requirement.
Jackson & Campbell, PC
Washington, DC 20036
January 23, 2004
Chairman William M. Thomas
Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515-6348
Dear Chairman Thomas,
We appreciate the opportunity to comment on H.R. 3654/S. 1984, the
``Tax Technical Corrections Bill of 2003.'' i The TCB would
correct a technical glitch involving dividends that individual
taxpayers receive through passthrough entities. We urge the Congress to
approve the correction promptly. We also urge the IRS quickly to
announce that it will follow the anticipated technical correction in
processing 2003 tax returns.
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\i\ H.R. 3654, introduced in the House of Representatives December
8, 2003, and referred to the Committee on Ways and Means; S. 1984,
introduced in the Senate December 9, 2003, and referred to the
Committee on Finance (the ``TCB''). On December 9, 2003, the Committees
requested written public comments for the record on the TCB. See
ADVISORY from the Committee on Ways and Means, ``Thomas Announces
Request for Written Comments on H.R. 3654, the Technical Corrections
Act of 2003'' (December 9, 2003), and U.S. Senate Committee on Finance,
``Senators Introduce Tax Technical Corrections Bill'' (December 9,
2003).
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Context
Jobs and Growth Tax Relief Reconciliation Act of 2003 ii
The 2003 Act taxes ``qualified dividend income'' of individuals at
a maximum tax rate of 15%.iii In general, this amendment
applied to ``taxable years beginning after December 31, 2002.''
iv The following special effective date rule was provided
for regulated investment companies (``RICs'') and real estate
investment trusts (``REITs''):
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\ii\ Public Law 108-27 [H.R. 2], May 28, 2003 (the ``2003 Act'').
\iii\ 2003 Act, Sec. 302(a), adding IRC Section 1(h)(11), which
treats ``qualified dividend income'' of individuals as net capital gain
for purposes of the maximum capital gain rate in IRC Sec. 1(h). See
also the Joint Explanatory Statement of the Committee of Conference,
May 22, 2003 (the ``Conference Report''), Section III B.
\iv\ 2003 Act, Sec. 302(f)(1).
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L(2) Regulated investment companies and real estate investment
trusts. In the case of a regulated investment company or a real estate
investment trust, the amendments made by this section shall apply to
taxable years ending after December 31, 2002; except that dividends
received by such a company or trust on or before such date shall not be
treated as qualified dividend income (as defined in Section 1(h)(11)(B)
of the Internal Revenue Code 1986, as added by this Act).v
[Emphasis supplied.]
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\v\ 2003 Act, Sec. 302(f)(2).
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IRS Position
Announcement 2003-56
As a result of the 2003 Act, the IRS announced in Announcement
2003-56 changes in the reporting requirements for certain 2002 tax
forms filed by entities with 2002-2003 fiscal years ending after May 5,
2003.vi Although the Announcement primarily addressed the
taxation of capital gains, it included the following note:
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\vi\ Announcement 2003-56, 2003-39 IRB 694 (September 29, 2003)
(the ``Announcement''). The Announcement referred to May 5, 2003 on
account of the transitional rules in 2003 Act Sec. 301(c) governing the
taxation of net capital gains for taxable years which include May 6,
2003.
LNote: Dividends received in a tax year beginning in 2002 and
ending in 2003 are not qualified dividends, even if the dividends are
received during 2003. Therefore, [i]ndividuals and estates with 2002-
2003 fiscal years cannot have any qualified dividends for that tax
year. Partnerships, S corporations, and estates with 2002-2003 fiscal
years have no qualified dividends to pass through to their partners,
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shareholders, or beneficiaries.
Example vii
Assume, for example, that a partnership owns stock in a domestic
corporation or a qualified foreign corporation.viii The
partnership uses as its taxable year a fiscal year ending September 30.
Assume also that all of the partners are individuals who use the
calendar year as their taxable years. After December 31, 2002 but on or
before September 30, 2003, the partnership received dividends from a
corporation in which the partnership owns stock. For its taxable year
ended September 30, 2003, the partnership reports to the partners their
respective distributive shares of these dividends.ix The
partners report their shares of the dividends on their individual tax
returns for their taxable years ended December 31, 2003. According to
Announcement 2003-56, the partners may not treat these passthrough
dividends as qualified dividends. The result would be the same,
according to the Announcement, in the case of an S corporation
receiving dividends the prorata shares of which the S shareholders take
into account on their individual tax returns for the taxable years in
this example.
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\vii\ Announcement 2003-56 does not contain this example. It is
provided here solely to illuminate the issue that this comment letter
addresses.
\viii\ Under IRC Sec. 1(h)(11), ``qualified dividend income''
generally means dividends received during the taxable year from
domestic corporations and qualified foreign corporations.
\ix\ See IRC Sec. 702(a). The 2003 Act conformed Sec. 702(a) to
reflect the possibility of a partnership reporting qualified dividends
to its partners. As amended by Sec. 302(e)(8) of the 2003 Act, IRC
702(a)(5) now requires each partner to take into account separately:
``(5) dividends with respect to which Section 1(h)(11) or Part XIII of
subchapter B applies.'' In this amended language, ``Section 1(h)(11)''
refers to the provision of the Code taxing individuals' qualified
dividend income as net capital gain. See also note 3.
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Proposed Technical Correction
The TCB would extend to additional passthrough entities the 2003
Act's special effective date rule applicable to REITs and RICs. Section
2(a)(5) of the Bill reads as follows:
L(5) Paragraph (2) of Section 302(f) of the Jobs and Growth Tax
Relief Reconciliation Act of 2003 x is amended to read as
follows:
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\x\ As previously explained, Sec. 302(f) of the 2003 Act states the
effective date of IRC Sec. 1(h)(11), which taxes qualified dividend
income of individual taxpayers at the same rates as net capital gain.
See notes 4 and 5.
L`(2) PASS-THRU ENTITIES--In the case of a pass-thru entity
described in subparagraph (A), (B), (C), (D), (E), or (F) of Section
1(h)(10) of the Internal Revenue Code 1986, as amended by this Act, the
amendments made by this section shall apply to taxable years ending
after December 31, 2002; except that dividends received by such an
entity on or before such date shall not be treated as qualified
dividend income (as defined in Section 1(h)(11)(B) of such Code, as
added by this Act).'. [Emphasis supplied.] xi
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\xi\ TCB Sec. 2(a)(5). The entities cross referenced in IRC
Sec. 1(h)(10) are: RICs, REITs, S corporations, partnerships, estates,
trusts, and common trust funds.
This amendment would take effect as if included in Section 302 of
the 2003 Act.xii
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\xii\ TCB Sec. 2(b).
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The Staff of the Joint Committee on Taxation has explained the
proposed technical correction as follows:
LThe provision provides that, in the case of partnerships, S
corporations, common trust funds, trusts, and estates, Section 302 of
the [2003] Act applies to taxable years ending after December 31, 2002,
except that dividends received by the entity prior to January 1, 2003,
are not treated as qualified dividend income. The [2003] Act provided a
similar rule in the case of RICs and REITs.xiii
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\xiii\ Staff of the Joint Committee on Taxation, Description of the
``Tax Technical Corrections Act of 2003,'' JCX-104-03 (December 9,
2003), page 2.
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Support for Proposed Technical Correction
The proposed amendment of the 2003 Act's effective date makes
perfect sense and should be enacted for various reasons.
1. LThe proposed technical correction merely clarifies the general
effective date. The 2003 Act provided that dividends received by
individual shareholders are subject to tax at a rate not exceeding 15%
if the dividends are received in taxable years of individuals beginning
after December 31, 2002.xiv Both the substantive rule and
its general effective date xv focus on the treatment of
dividends, not by any intervening passthrough entity but, rather, by
the person ultimately receiving and taxable on the dividends. The
proposed technical correction merely clarifies that dividends are
subject to the same treatment when received through a 2002-2003 fiscal
year of a passthrough entity.
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\xiv\ ``Under the House Bill, dividends received by an individual
shareholder from domestic corporations are taxed at the same rates that
apply to net capital gain.'' House Bill as summarized in the Conference
Report, Section III B. The 2003 Act's reduction of individual tax rates
on capital gains and dividends are scheduled to sunset for taxable
years beginning after December 21, 2008. 2003 Act, Sec. 303.
\xv\ 2003 Act, Sec. 302(f)(1).
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2. LPassthrough dividends should not be taxed differently than
directly received dividends. Dividends of individuals should qualify
for the preferential rate whether received directly or through a
passthrough entity, provided that (i) the individual receives the
dividends in a taxable year of the individual beginning after December
31, 2002 and (ii) the entity passing through the dividends receives
them after December 31, 2002.xvi The Legislative History of
the 2003 Act anticipated no different treatment of dividends received
through passthrough entities having 2002-2003 fiscal years.
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\xvi\ In some cases, an individual may receive dividends through
two or more vertical levels or ``tiers'' of passthrough entities.
Treasury regulations or other administrative guidance should provide
that such dividends qualify for the preferential rate only if no entity
in the tiered structured received the dividends before January 1, 2003.
When Congress in the 2003 Act wanted the character of income to be
determined at the level of a passthrough entity, Congress so provided.
The 2003 Act's reduction of individual tax rates on net capital gains
generally applied to taxable years ending on or after May 6,
2003.xvii Transitional rules were provided for taxable years
which include May 6, 2003.xviii In applying these
transitional rules to capital gains received through passthrough
entities, Congress directed that the determination of when gains and
losses are properly taken into account shall be made at the entity
level.xix Congress did not similarly require that the
character of dividends (as qualified dividend income) be determined at
the level of a passthrough entity. Consequently, whether or not
dividends received through passthrough entities qualify to be taxed at
the 2003 Act's reduced rates should be determined at the individual
recipient's level.
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\xvii\ 2003 Act, Sec. 301(d)(1).
\xviii\ 2003 Act, Sec. 301(c).
\xix\ 2003 Act, Sec. 301(c)(4).
3. LThe 2003 Act's special effective date for dividends received
through RICS and REITs makes even more sense for other types of
passthrough entities. REITs and RICs are hybrid entities. They
technically are subject to tax as entities separate from their owners.
They typically pay no tax provided that they distribute sufficient
income to their owners.xx The 2003 Act provided rules for
determining the extent to which REITs and RICs ``pass through''
qualified dividend income to their shareholders.xxi
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\xx\ IRC Sec. Sec. 852(b) and 857(b).
\xxi\ See IRC Sec. Sec. 854(b)(1)(B) and 854(b)(5) (RICs), as
amended by 2003 Act, Sec. 302(c), and IRC Sec. 857(a)(2) (REITs), as
amended by 2003 Act, Sec. 302(d).
Partnerships and S corporations are pure passthrough entities. They
generally are not subject to tax as entities separate from their
owners.xxii Partners and S corporation shareholders are
subject to tax on their respective shares of the entity's income
regardless of whether or when distributed. This flow through income has
the same character as if realized directly from the source from which
the partnership or S corporation realized it.xxiii
Therefore, dividends that a partnership or an S corporation receives
after December 31, 2002 should be taxable to the entities' owners
(partners and S shareholders, respectively) as though the owners
received the dividends directly.xxiv
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\xxii\ Under targeted exceptions to this construct, S corporations
are subject as entities to tax on their built-in gains and excess
passive investment income and to a LIFO recapture tax. See IRC sections
1374, 1375, and 1363(d).
\xxiii\ IRC Sec. Sec. 702(b) and 1366(b). Congress should consider
amending IRC Sec. 1366(a)(1) to clarify that qualified dividends are a
``separately computed'' item of S corporations. Compare IRC
Sec. 702(a)(5) as amended by the 2003 Act.
\xxiv\ Similarly, the 2003 Act's amendment of IRC Sec. 702(a)(5)
treating a partnership's qualified dividends as a ``separately stated
item'' should be interpreted consistently with the proposed technical
correction, i.e., by reference to the taxable years of the partners to
whom the partnership reports the dividends. See Letter from Richard M.
Hervey of November 25, 2003 to Michael S. Novey, Associate Tax
Legislative Counsel, U.S. Department of the Treasury, 2004 TNT 1-27
(January 12, 2004).
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Coordination With Internal Revenue Service
The issue of how to treat dividends received through fiscal year
2002-2003 passthrough entities arises in preparing entity and
individual tax returns for 2003. Returns of entities categorizing the
dividends must be filed (absent extensions) within either 2.5 months or
3.5 months after the end of the entity's fiscal year.xxv The
passthrough dividends must be correctly reported on the returns of
individual partners and shareholders. Calendar-year partners and S
shareholders generally must file their 2003 returns (absent extensions)
by April 15, 2004.xxvi
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\xxv\ S corporations must file their returns within 2.5 months
after the end of the tax year. Partnerships, trusts, and estates must
file their returns within 3.5 months after the end of the tax year. IRC
Sec. Sec. 6072 and 6037.
\xxvi\ IRC Sec. 6072.
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We urge the IRS quickly to announce that in processing returns for
2003 tax years it will follow the TCB's anticipated clarification as
though enacted. As previously explained, the proposed technical
correction merely clarifies the general effective date of the 2003
Act's taxation of qualified dividends. Announcement 2003-56 should be
modified accordingly.ixxvii
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\xxvii\ The proposed technical correction and the IRS' adopting it
would not prevent recipients of dividends from electing to treat them
as investment income under IRC Sec. 163(d) rather than as qualified
dividend income. See IRC Sec. Sec. 1(h)(11)(D)(i) and 163(d)(4)(B), as
amended by Sec. 302 of the 2003 Act.
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Thank you for carefully considering these comments. Should you want
to discuss them, please feel free to call me at 202-457-4278 (through
January 31, 2004) or 202-452-7965 (beginning February 1, 2004).
Sincerely,
Michael J. Grace
National Association of Real Estate Investment Trusts
Washington, DC 20006
January 22, 2004
The Honorable William M. Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, D.C. 20515
Dear Chairman Thomas:
Pursuant to the instructions contained in Ways and Means Committee
Press Release No. FC-10, this statement is made by the National
Association of Real Estate Investment Trusts' (``NAREIT'')
regarding H.R. 3654, the ``Tax Technical Corrections Act of 2003''
(``TTCA'').
NAREIT is the national trade association for real estate companies.
Members are REITs and other publicly-traded businesses that own,
operate and finance income-producing real estate, as well as those
firms and individuals who advise, study and service these businesses.
REITs are companies whose income and assets are mainly connected to
income-producing real estate. By law, REITs regularly distribute most
of their taxable income to shareholders as dividends. NAREIT represents
approximately 170 REITs or other publicly-traded real estate companies,
as well as over 1,300 investment bankers, analysts, accountants,
lawyers and other professionals who provide services to REITs.
NAREIT strongly supports the TTCA and urges its enactment. NAREIT
specifically would like to thank the Ways and Means Committee for the
helpful and appropriate changes relating to REIT dividends included in
the TTCA.
Among other items, the TTCA would provide technical corrections to
Public Law No. 108-27, the Jobs and Growth Tax Relief Reconciliation
Act of 2003 (``JGTRRA''). As you know, JGTRRA provides that the
``qualified dividend income'' (``QDI'') of non-corporate taxpayers is
taxed at the same rate as ``net capital gain,'' at a maximum rate of
15%. JGTRRA's policy goal in reducing the tax rate applicable to QDI
was to minimize the double taxation (at the corporate and shareholder
levels) otherwise applicable to income earned by corporations.
JGTRRA permits the following type of REIT dividends to qualify for
this lower rate:
(1) distributions by the REIT of income attributable to dividends
from a taxable REIT subsidiary (``TRS'') or other corporation; (2)
distributions attributable to income on which tax was payable in the
previous year due to distributing less than 100% of its REIT taxable
income; and (3) distributions of income on which tax was payable for
the previous taxable year due to the ``built in gains'' tax under the
Sec. 337(d) regulations, in both cases less the tax payable on such
income.
Although JGTRRA provides for these three items to qualify as QDI
when distributed by a REIT, there is some ambiguity in the JGTRRA's
statutory language. Specifically, there is ambiguity under JGTRRA as to
whether a REIT is ``treated as receiving'' QDI from a TRS and ambiguity
as to whether a mutual fund may distribute QDI attributable to REIT
distributions. Both individual taxpayers who invest in REITs directly
and through mutual funds, as well as the entire REIT industry, could
benefit from clarifications to this language.
Furthermore, consistent with the policy goal of minimizing double
taxation applicable to corporate-earned income, REIT distributions of
``earnings and profits'' earned by C corporations (and therefore
already subject to tax at the corporate level) should be permitted to
qualify as QDI. Accordingly, NAREIT welcomes the provisions in the TTCA
that would incorporate these changes.
I would be pleased to discuss NAREIT's comments with you in more
detail. Please contact me at (202) 739-9408 if you have any questions.
Thank you.
Sincerely,
Tony M. Edwards
Senior Vice President & General Counsel
Perkins & Company, PC
Portland, Oregon 97204
January 22, 2004
Chairman William M. Thomas
House Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas:
We are hereby requesting clarifying language (or Joint Committee
explanation with similar effect) with respect to the Tax Technical
Corrections Act of 2003, Section 3(b)(2)(C), and IRC Section 172(j) of
the Internal Revenue Code, as enacted by the Job Creation and Workers
Act of 2002 (2002 Act). The purpose of the clarifying language would be
to ensure that the five year net operating loss (NOL) carryback
provision from the 2002 Act would be implemented by the IRS consistent
with the plain language of the statute at IRC Section 172(j) and
Congressional intent. IRC Section 172(j) states that the five year
carryback is mandatory unless the taxpayer elects otherwise.
The clarifying language suggested would be as follows:
To provide the result intended by IRC Section 172(j) and IRC
Section 172(b)(1)(H) as further explained below, and to disadvantage no
taxpayer, new subsection ``(D)'' [new subsection 3(b)(2)(D)] could be
added to section 3(b) of the Tax Technical Corrections Act of 2003 as
follows:
L ``(D) if no election was made under section 172(b)(3) or
section 172(j) on a tax return filed before enactment of the Job
Creation and Worker Assistance Act of 2002, the carryback period under
section 172(b)(1)(H) shall apply if a 5-year carryback claim is timely
filed within the applicable period of limitations.''
Although the above would be the clearest method of ensuring the
proper result, if as a practical matter, merely providing clarifying
language via the Joint Committee explanation is the only realistic
approach, we would suggest as an alternative the following language be
incorporated in the Joint Committee's discussion of the ``five-year
carryback of net operating losses'' contained in its explanation with
respect to the Tax Technical Corrections Act of 2003:
L ``The filing of a two year net operating loss carryback for a
year ending in 2001 or 2002, where such two year loss carryback was
filed before the enactment of the Job Creation and Workers Act of 2002
on March 9, 2002, shall not be construed to be an election under
section 172(j) to elect out of the 5 year carryback period (i.e. no
deemed election will be forced upon a taxpayer), if the taxpayer timely
files, or has filed, an amended return or tentative carryback
adjustment for such year within the otherwise applicable period of
limitations under IRC section 6511 or 6411 reflecting the 5 year loss
carryback.''
Explanatory Support for Requested Clarification
The clarifying language does no harm to any taxpayer that relied on
the administrative guidance provided in section 5 of Revenue Procedure
2002-40. Any taxpayer who relied on that guidance desiring to elect out
of the 5 year carryback period by having a previously filed 2 year
carryback constitute such election, will obtain that result even with
the clarifying language (such taxpayer has to do nothing further to
obtain the desired result).
On the other hand, where a taxpayer relied on the plain language of
the statute in IRC section 172(j) [and the historical norm with respect
to such elections, that the taxpayer must make an affirmative election
to avoid the mandatory carryback period], and in good faith reliance on
the statute, took no affirmative action to elect out of the 5 year
carryback period (because it wanted a 5 year carryback to apply), such
taxpayer should not have a deemed election to forego the 5 year
carryback period forced upon it. A taxpayer relying on the plain
language of section 172(j) and the historical norm for such elections
(that the taxpayer must affirmatively elect out), had no reason to
anticipate that through administrative guidance (Revenue Procedure
2002-40, section 5.02) a deemed election would be forced on it at an
arbitrary date, such date being potentially years before the taxpayer
otherwise anticipated that the amended return was required to be filed
under pursuant to the normal period of limitations under IRC section
6511.
The fact that a taxpayer properly filed a 2 year NOL carryback
before section 172(j) was enacted (e.g. prior to March 9, 2002) could
not be properly construed to indicate the taxpayer desired to elect out
of the 5 year carryback period. Properly construed, it is merely
evidence that the taxpayer sought to use the NOL carryback to the
fullest extent possible, under the law that existed at the time, which
allowed only a 2 year carryback.
In an illustrative example we are familiar with, the taxpayer had a
fiscal year end 3/31/01 return which generated an NOL. The loss year
return (Form 1120) for FYE 3/31/01 was filed on October 11, 2001, and
the 2 year NOL carryback on Form 1139 (the only carryback allowed by
law at that point) was filed immediately after October 11, 2001 (during
October 2001). The 2002 Act was then passed 5 months later on March 9,
2002, containing section 172(b)(1)(H), which mandates a 5 year NOL
carryback for the loss for FYE 3/31/01, unless the taxpayer elects out
of the 5 year carryback period under section 172(j).
The taxpayer had no desire to elect out of the 5 year carryback
period, and understood that per the plain language of the statute at
section 172(b)(1)(H) a 5 year carryback was mandatory, but that the
statutory period of limitations allowed the amended return to report
the 5 year loss carryback to be filed as late as October 11, 2004.
The taxpayer filed a Chapter 11 bankruptcy petition on April 10,
2002, before the taxpayer was able to have a Form 1120X to claim the 5
year carryback prepared. As part of the bankruptcy proceeding the
taxpayer (which did not have in-house tax counsel or in-house cpas) was
not able to engage third party tax advisors, and had no such advisors
when Revenue Procedure 2002-40 was issued on 5/22/2002.
The taxpayer correctly understood the statute under section
6511(d)(2) allowed the 5 year NOL carryback claim (Form 1120X) to be
filed within 3 years of the date the loss year return was filed.
Therefore the taxpayer had until 10/11/2004 to file the 5 year
carryback claim under well known period of limitation rules. The
taxpayer remained in bankruptcy proceedings through 10/31/2002, and was
never aware of the administrative acceleration provision within Revenue
Procedure 2002-40, section 5, which purports to force a deemed election
under section 172(j) onto them (if the Form 1120X was not filed by 10/
31/2002). The taxpayer filed the 5 year carryback claim as soon as
possible after it became aware of the issue, filing Form 1120X to carry
the FYE 3/31/01 NOL back 5 years on 1/3/2003. The IRS Service Center
rejected the claim (relying on Rev. Proc. 2002-40, section 5), and
despite efforts of the Taxpayer Advocate Office, has thus far refused
to process the claim.
We have tried to resolve the matter administratively through
multiple channels at the IRS without success. We initially contacted
the author of Revenue Procedure 2002-40, Martin Scully. He indicated
agreement that the result was inequitable under the facts presented,
and indicated that the 10/31/02 required action date contained in
section 5 of Rev. Proc. 2002-40 was arbitrarily selected. However, he
said that he could not provide any relief, and suggested we file the
amended return reporting the 5 year carryback although he was not sure
if it would be accepted. We then contacted the Taxpayer Advocate
Office, and the representative there, Marron Dooney, agreed the claim
had merit and should be processed, but was unable to convince the IRS
Service Center. The taxpayer is pursuing its remaining administrative
appeal rights within the IRS, but the concern is that unless there is
language clarifying that the deemed election provision of Rev. Proc.
2002-40, section 5, is inappropriate and contrary to the statute, it
will be difficult to obtain an equitable and just appeals decision.
Note that a similarly situated taxpayer, with a FYE 3/31/01 loss
year, who has done nothing except file its loss return on 10/11/2001,
would still have until 10/11/2004 to file its 5 year loss carryback
return on Form 1120X. In the example above, it is only the fact the
taxpayer timely filed its 2 year carryback return (before the 5 year
carryback statute existed), that it is denied by Rev. Proc. 2002-40 its
statutory right to a 5 year carryback period.
There is no advantage being gained by the taxpayer(s) via the
requested clarification. There is no new information relating to the 2
or 5 year carryback period that is available to any taxpayer after 10/
31/02 that was not available to the taxpayer before that date. So
allowing the taxpayer to file its 5 year carryback under the normal (3
year) period of limitations rules does not create any advantage for the
taxpayer as compared to what the statute allowed. The clarifying
language also does not disadvantage any taxpayer that was aware Rev.
Proc. 2002-40 existed, and desired a 2 year carryback period, and
therefore intentionally let the 10/31/2002 date pass. If that was their
desire, they need not take any additional action and they have obtained
the result they desired.
Thank you for your assistance with this matter. You can reach the
undersigned at (503) 221-7565 or the address indicated above if you
have any questions or wish clarification.
Very truly yours,
Christopher J. Loughran
CPA & Shareholder
Vinson & Elkins, LLP
Washington, DC 20004
January 23, 2004
The Honorable William M. Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
In response to your request for comments on H.R. 3654, the Tax
Technical Corrections Act of 2003, we are hereby submitting an
additional provision for inclusion in the bill.
The need for the proposed technical correction arises because the
Internal Revenue Service has recently asserted a change in its position
regarding the treatment under the foreign tax credit rules of certain
business arrangements that have been excluded from partnership
treatment by virtue of having made an election under section 761(a) of
the Internal Revenue Code.\1\ These co-ownership arrangements are
referred to as ``Elect-Out Arrangements,'' and the election out is a
common fixture of oil and gas operating agreements.
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\1\ All section references are to the Internal Revenue Code of
1986, as amended, unless otherwise noted.
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The tax code has provided an election for co-owners to be excluded
from partnership treatment under certain circumstances since 1954, and
oil and gas joint venturers have relied on this feature in order to be
taxed as co-owners of oil and gas property rather than as partners in a
partnership.\2\ In the absence of an election, co-ownership of oil and
gas property would be treated for Federal income tax purposes (but not
for any other legal purpose) as a partnership among the co-owners.
Thus, an Elect-Out Arrangement generally is taxed as a direct, rather
than indirect, property investment by each co-owner.
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\2\ An Elect-Out Arrangement is generally characterized by (i) the
direct co-ownership of undivided interests in property rather than
ownership through a partnership or other legally recognizable entity,
(ii) the right of each co-owner separately to take in kind and dispose
of the property produced or extracted, and (iii) prohibitions on joint
marketing activity, whether directly or through the grant to any co-
owner of collective irrevocable representative capacity. See Treas.
Reg. Sec. 1.761-2(a)(3).
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Historically, the sale of an interest in a jointly-owned property
held through an Elect-Out Arrangement has been treated for tax purposes
as a sale of the co-owner's interest in the underlying assets.
Recently, however, the Internal Revenue Service has asserted that this
well-settled characterization should not apply for foreign tax credit
purposes, based on its interpretation of the combined effect of two
disparate statutory changes--one to the foreign personal holding
company rules made in 1988 and the other to the foreign tax credit
limitation rules of section 904(d) made in 1993. Section 1012(i)(18) of
the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) amended
section 954(c)(1)(B) of the Code to include gain on the sale of an
``interest in a . . . partnership'' in the definition of foreign
personal holding company income. Section 904(d)(2)(A)(i) cross
references section 954(c)(1)(B) to define passive income for purposes
of the foreign tax credit separate basket limitations. Section
13235(a)(2) of the Omnibus Reconciliation Act of 1993 (OBRA) amended
section 904(d)(2)(A)(iii) to remove foreign oil and gas extraction
income (FOGEI) from a list of specific exclusions from the definition
of passive income for section 904 purposes.
Asserted IRS Position. The IRS is asserting that (i) because
section 954(c)(1)(B), as amended by TAMRA, by its terms specifically
refers to a partnership interest, a section 761(a) election will not
preclude application of the provision, and (ii) because section
904(c)(2)(A)(iii), as amended by OBRA, no longer specifically excludes
FOGEI from passive income characterization, the fact that any gain on a
disposition of an interest held through an Elect-Out Arrangement
involving foreign oil and gas producing properties is FOGEI does not
prevent its treatment as ``passive income'' for purposes of section
904(d). The IRS refuses to undertake an analysis of the interdependence
of the foreign personal holding company and foreign tax credit rules
with the partnership rules of Subchapter K, ignoring judicial authority
and prior IRS interpretation. Under the IRS approach, foreign oil and
gas extraction taxes cannot be credited against U.S. tax liability with
respect to gain on the sale of an undivided interest in a foreign oil
and gas concession which has an Elect-Out Arrangement in effect. The
IRS is attempting to treat the sale as the sale of a partnership
interest rather than as the sale of the co-owned assets.
Proposed Technical Correction. A correct reading of the foreign
personal holding company rules would give effect to the section 761(a)
election. Section 954(c)(1)(B) should be amended to make clear that a
sale of an interest in a co-ownership arrangement that has in effect a
valid election under section 761(a) will not be treated as a sale of a
partnership interest but instead will be treated as a sale of the
underlying assets of such arrangement.
Reasons for Change. The proposed technical correction, which would
reflect current law, is consistent with Congressional intent, judicial
authority, and IRS interpretation contemporaneous with enactment of the
1988 statute. In addition, this technical correction would parallel the
technical correction to section 1031(a) Congress enacted in 1990, which
expressly provided that an interest in a co-ownership arrangement for
which a valid section 761(a) election is in effect shall not be treated
as a partnership interest for section 1031 purposes, but rather as an
interest in the underlying assets.\3\ Congress enacted this technical
correction in direct response to an indication that the IRS intended to
interpret the statute to the contrary, and related its effective date
back to the 1984 change to section 1031 that excluded exchanges of
interests in partnerships from favorable nonrecognition treatment.\4\
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\3\ Omnibus Budget Reconciliation Act of 1990, P.L. No. 101-508,
Sec. 11703(d)(1).
\4\ Deficit Reduction Act of 1984, P.L. No. 98-369, Sec. 77(a).
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Prior to 1988, it was well settled that the sale of an interest in
an Elect Out Arrangement was treated as the sale of the underlying
assets of the organization for purposes of determining the appropriate
section 904 foreign tax credit basket.\5\
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\5\ See Priv. Ltr. Rul. 87-26-061 (April 1, 1987).
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The TAMRA change relates to revisions to section 954 contained in
the Tax Reform Act of 1986. The legislative history accompanying the
1986 legislation makes clear that Congress intended to treat gain from
the sale of property which does not generate active trade or business
income as passive for purposes of the foreign personal holding company
rules. The legislative history for the TAMRA change does not indicate
any further reason for including gain from the sale of a partnership
interest in section 954(c)(1)(B), nor is any reference made to the
existence of Elect-Out Arrangements. It is reasonable to infer that the
treatment of sales of interests in Elect-Out Arrangements in the oil
and gas industry was not addressed at the time because (i) they were
not treated as sales of interests in partnerships, based upon judicial
authority, existing IRS position, and industry practice, (ii) they did
not give rise to passive income or gain from their operation or
disposition, and (iii) in any event the income from the sale of an
interest in an Elect-Out Arrangement with respect to an oil and gas
working interest constitutes FOGEI, which at the time was expressly
excluded from the term passive income in section 904(d).
The OBRA legislative history makes clear that the amendment to
section 904(d)(2)(A)(iii) some 5 years later was intended to subject
interest income earned on working capital in an oil and gas extraction
business to treatment as passive income under section 904,
notwithstanding its character as FOGEI. No reference to passive
treatment for any other type of FOGEI appears in the legislative
history. There simply is no evidence Congress intended to alter the
treatment of gain from the disposition of an undivided interest in an
oil and gas property held through an Elect-Out Arrangement under
section 904.
Under existing judicial authority, a section 761(a) election
applies to negate the applicability of all provisions within Subchapter
K and all provisions outside of Subchapter K that are interdependent
with Subchapter K. The determination of interdependence properly is
based on all the relevant facts and circumstances.
The first case to consider the scope of the section 761(a) election
was Bryant v. Commissioner.\6\ The Tax Court held that, despite the
existence of a section 761(a) election, a joint venture should be
treated as a partnership for purposes of section 48(c), and therefore,
a limitation on the investment tax credit in section 48(c) should be
applied both to the Elect-Out Arrangement as an entity and to the
participants therein. In explaining its reasoning, the Court noted
that, ``In our opinion, sections 761(a) and 48(c)(2)(D) are not
interdependent.'' \7\
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\6\ 46 T.C. 848 (1966), aff'd., 399 F.2d 800 (5th Cir. 1968).
\7\ Bryant, 46 T.C. at 864.
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An inflexible rule whereby a section 761(a) election does not apply
to any Code section outside of Subchapter K would be unworkable, and
there is universal agreement that there are clearly some sections
outside of Subchapter K to which a section 761(a) election applies.\8\
Non-Subchapter K Code provisions that require the filing of a
partnership return or the computation of partnership income are
numerous. Without the flexibility provided by an interdependence
analysis, virtually all co-ownership arrangements that have made a
valid section 761(a) election could be forced to adhere to the
provisions of Subchapter K, which in effect would nullify the elect-out
provision. Accordingly, subsequent court decisions and IRS rulings have
interpreted Bryant as holding that a section 761(a) election is
applicable to a Code section outside of Subchapter K only if the
section is ``interdependent'' with Subchapter K.\9\
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\8\ See Rev. Rul. 83-129, 1983-2 C.B. 105; Priv. Ltr. Rul. 79-26-
088; Priv. Ltr. Rul. 79-30-028; Priv. Ltr. Rul. 79-38-046.
\9\ See McMahon, The Availability and Effect of Election Out of
Partnership Status Under Section 761(a), 9 Va. Tax Rev. 1, 32 (1989).
The IRS, however, apparently based on dicta in Madison Gas & Electric
Co. v. Commissioner, 72 T.C. 521 (1979), aff'd. 633 F.2d 512 (7th Cir.
1980) and Cokes v. Commissioner, 91 T.C. 222 (1988), applies this rule
counter-intuitively, i.e., only if the non-Subchapter K Code provision
in question does not specifically refer to partnerships. Logically, it
would seem that a statutory reference to partnerships would increase
the likelihood of, rather than negate, an interdependency of the
provision with Subchapter K.
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In the most recent case dealing with the interdependence test,
Travelers Insurance Co. v. United States, the Court of Federal Claims
held that a special rule applicable to ``partnerships'' in former
section 907(c)(3)(D) (now section 907(c)(3)(C)) was interdependent with
Subchapter K and therefore inapplicable to an Elect-Out
Arrangement.\10\ The taxpayer in Travelers had argued that because
former section 907(c)(3)(D) expressly provided that FOGEI and FORI
includes a taxpayer's ``distributive share of partnership income,'' the
section 761(a) election had no effect on section 907(c)(3)(D), and
therefore the taxpayer should be treated as a partner of a partnership
for purposes of this section. The Government argued that section 907(c)
was inapplicable because the taxpayer elected under section 761(a) not
to be treated as a partner under Subchapter K of the Code.\11\ The
Court held that the Elect-Out Arrangement was not a partnership for
purposes of section 907(c) despite the fact that section 907(c)(3)(D)
specifically referred to partnerships. The Court explained that
``section 907(c) and Subchapter K are plainly interdependent as the
latter defines the terms of the former.'' \12\
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\10\ 28 Fed. C. 602 (Ct. Fed. Cl. 1993), rev'd on other grounds,
303 F.3d 1373 (Fed. Cir. 2002).
\11\ Ironically, the IRS is claiming with respect to section
954(c)(1)(B) that the inclusion of the term ``partnership'' in the
statute per se causes the section not to be interdependent with
Subchapter K. In Travelers, it was the taxpayer that was arguing the
inclusion of the term ``partnership'' in section 907(c) resulted in per
se non-interdependence, and the government was arguing for a facts and
circumstances application of interdependence.
\12\ Id. at 609.
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The IRS has itself concluded that the application of the section
761(a) election should not be strictly limited to Subchapter K. For
example, in Revenue Ruling 83-129, the Service held that section 761(a)
extended to section 616, and that as a result, two joint venturers who
had elected out of Subchapter K could make different individual
elections under sections 616(a) and 616(b). General Counsel Memorandum
39043, issued in 1983, supported this position, stating that, ``if the
limitation or rule outside of Subchapter K [cannot] be applied without
doing violence to the concept of electing out of Subchapter K and
computing income and deductions at the partner level,'' such limitation
or rule is ``interdependent'' with (and subject to) section 761(a).\13\
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\13\ GCM 39,043 (Aug. 5, 1983).
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So far as the foreign personal holding company rules in section
954(c)(1)(B)(ii) relate to partnership interests, they are clearly
interdependent with the partnership rules of Subchapter K--computation
of the amount of gain from the disposition of a partnership interest
under section 954(c)(1)(B)(ii) would require the calculation of its
basis through application of sections 705, 701, 702, and 752, all of
which are inapplicable to Elect-Out Arrangements. The results of the
interdependence analysis show that the section 761(a) election must be
given effect for purposes of section 954(b)(1)(C).
Finally, the IRS has consistently treated the sale of an interest
in a domestic Elect-Out Arrangement as the disposition of the seller's
proportionate share of the underlying assets, with the character of the
gain or loss determined by the nature of the underlying assets. Recent
technical advice and field service advice memoranda contain detailed
analysis supporting this approach.\14\ However, none of this analysis
supports treating the sale of a foreign Elect-Out Arrangement
differently from the sale of a domestic Elect-Out Arrangement.
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\14\ Tech. Adv. Mem. 92-14-011 (April 3, 1992); Tech. Adv. Mem. 95-
04-001 (January 27, 1995).
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Based on the foregoing, adoption of the proposed technical
correction to section 1012(i)(18) of TAMRA would properly reflect
Congressional intent and the appropriate scope of section 761(a).
Thank you for your consideration of this proposal. If you have any
further questions or need any additional information, please do not
hesitate to contact us.
Respectfully submitted,
Christine L. Vaughn and Thomas Crichton, IV
Washington, DC 20515
January 15, 2004
The Honorable Bill Thomas
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, D.C. 20515
Dear Mr. Chairman:
In response to your request for written comments on H.R. 3654, the
Tax Technical Corrections Act of 2003, I hereby submit the following
request.
With Reps. Crane and McCrery as original cosponsors, I introduced a
bill on April 11, 2003 that would amend the Internal Revenue Code of
1986, to allow certified U.S. legal tender coins to be acquired by
individual retirement accounts and other individually directed pension
plan accounts. That bill, H.R. 1820, was referred to Ways and Means
Committee.
I feel H.R. 3654 is an appropriate vehicle for H.R. 1820 because
H.R. 3654 contains technical corrections to the Taxpayer Relief Act of
1997, the last piece of legislation which addressed the issue of
certain coins being allowed in individual retirement accounts and other
individually directed pension plan accounts. In that instance, the menu
of coins available for inclusion in these plans was expanded to allow
platinum coins within the plans. As a result, today IRA investors can
choose from a range of investment options in physical precious metals,
in both coin and bar form.
As way of background, prior to 1981, all rare coins qualified as
investments for self-directed retirement accounts. The Economic
Recovery Tax Act of 1981 added section 408(m) to the U.S. Code, which
created a category of ``collectibles'' that were no longer eligible for
future investments in self-directed retirement accounts, such as
Individual Retirement Accounts (IRAs). This category of collectibles
included such things as wines, rugs, jewelry, antiques, and art.
Arbitrarily, two long-tested and respected investments, rare coins,
including investment grade U.S. legal tender coinage, and precious
metals, were inappropriately included in this category, limiting
investors' freedom of choice for investments.
The irony is that these coins are already allowed in corporate
pension plans. The American investing public should not be penalized
for not having access to corporate pension options. Because U.S. legal
tender coin investments can be included in defined contribution pension
and profit-sharing plans, it is only equitable to provide such
investment options for self-directed retirement plans. Removing current
restrictions would allow individual investors, whose total investment
program (or much of it) consists of their IRAs or other self-directed
accounts, to select from the same investment options currently
available to corporate investors.
Such legislation simply expands the menu of options for investors
and allows them to diversify and stabilize their retirement portfolios.
Some investors are understandably nervous having all their investment
``eggs'' in a volatile stock market basket. Allowing tangible assets in
an investment portfolio creates certain safeguards for the overall
investment portfolio ``basket.'' Indeed, as current stock portfolios
are losing value, the certified coin market has been extremely active
and coin values have been rising.
H.R. 1820 ensures that certified U.S. legal tender coins purchased
for self-directed retirement accounts must be in the control of a
qualified, third party trustee (as defined by the IRS), and not in the
control of the investor. Also, coins eligible for inclusion in a self-
directed retirement account must be certified by a recognized,
independent third-party grading service, i.e., graded and encapsulated
in a sealed plastic case. Each coin, therefore, has a unique
identification number, grade, and description. Further, liquidity is
assured by including as eligible only those coins that trade on
recognized national electronic coin exchanges, or that are listed by a
recognized wholesale reporting service.
The Joint Committee on Taxation has previously determined that the
proposal to restore certified legal tender coins, as qualified
investments will have negligible economic impact on federal revenues.
I am hopeful that H.R. 1820 can be included within H.R. 3654, and
if I can provide further information or answer any questions, please
feel free to call on me or contact Chris Stanley on my staff at 53015.
Sincerely,
The Honorable David Vitter
Member of Congress