The American Recovery and Reinvestment Act of 2009 (ARRA), signed into law yesterday by President Obama, contains numerous business and investment tax provisions. It includes tax-credit incentives for renewable-energy use by businesses and individuals, investment in low-income communities, and job creation for the unemployed. The legislation also includes tax-relief provisions for certain types of workout transactions and for small businesses (including rules that raise current limits on the expensing of depreciable property and rules that permit the filing of expedited tax refund claims for the carryback of net operating losses to up to five prior tax years), as well as other business and investment incentives.

A summary of these tax provisions follows below.

For more information on the provisions or other tax matters, please contact Wayne R. Strasbaugh at 215.864.8328 or strasbaugh@ballardspahr.com, Wendi L. Kotzen at 215.864.8305 or kotzenw@ballardspahr.com, Jeffrey R. Davine at 303.299.7312 or davine@ballardspahr.com, or another member of our Tax Group.

Business Renewal Energy Incentives   

Extension of Renewable Electricity Production Credit. ARRA extends the Section 45 production tax credit (PTC) for three years, through December 31, 2012, for wind projects and through December 31, 2013, for closed-loop biomass, open-loop biomass, geothermal, landfill gas, waste-to-energy, hydropower, and marine renewable projects.

Election of Investment Credit in Lieu of Production Credit. The Section 48 investment tax credit (ITC) is 30 percent of the basis of qualifying property and is claimed in the year the property is placed in service. By contrast, the Section 45 PTC is claimed over a 10-year period, based on a price-adjusted credit for the amount of electricity produced and sold. ARRA allows certain Section 45 PTC-type facilities (wind, closed-loop biomass, open-loop biomass, landfill gas, waste-to-energy, hydropower, and marine facilities) to elect to claim the Section 48 ITC in lieu of the PTC. The election can be made for wind facilities that are placed in service between 2009 and 2012 and other PTC-qualifying facilities that are placed in service between 2009 and 2013.

Elimination of Subsidized Financing Reduction for Section 48 Investment Tax Credit. Previously, the Section 48 ITC had to be reduced if the property qualifying for the credit was financed with tax-exempt private activity bonds, or through any other federal-, state-, or local-subsidized financing program. ARRA eliminates this limitation.

Repeal of Limitation on Section 48 Investment Tax Credit for Qualified Small Wind Energy Property. The 30 percent Section 48 ITC for qualified small wind-energy property was capped at $4,000. ARRA removes the cap limitation.

Treasury Department Grants in Lieu of Section 48 Investment Tax Credits and Section 45 Production Tax Credits. Taxpayers can apply for a Treasury Department grant in lieu of Section 48 ITCs or Section 45 PTCs to defray the costs of qualifying renewable-energy property. To qualify for a grant, the energy property must either be (1) placed in service in 2009 and 2010, or (2) placed in service after 2010 and before the credit-termination date applicable to the property, but only if construction of the property begins in 2009 or 2010. The grant amount is equal to 30 percent of the cost basis of the following types of property that qualify for Section 48 ITCs: qualified fuel cell property, solar equipment, and qualified small wind-energy property. In addition, the grant amount is equal to 30 percent of the cost basis of the following technologies that qualify for the Section 45 PTC: wind, closed-loop biomass, open-loop biomass, landfill gas, waste-to-energy, hydropower, and marine facilities. Certain organizations, including nonprofits, clean renewable-energy bond lenders, and electric cooperatives, are ineligible for the grants.

Advanced Energy Project Credits. ARRA provides for a new investment tax credit that is part of the Section 46 investment credit. Like the Section 48 ITC, the new Section 48C Advanced Energy Project Credit is equal to 30 percent on the cost basis of qualifying advanced energy projects. A qualifying advanced energy project is defined as one which re-equips, expands, or establishes a manufacturing facility to produce equipment related to solar, wind, geothermal, fuel cells, microturbines or electric car/hybrid batteries, renewable grids, carbon capture and sequestration, renewable-fuels refining or blending (not fossil fuels), or energy-conservation technologies, including energy-conserving lighting and smart-grid technologies

Modification of Credit for Carbon Dioxide Sequestration . ARRA modifies the credit for carbon dioxide sequestration under Section 45Q to require that any taxpayer claiming the $10 credit per ton for carbon dioxide captured and transported for use in enhanced oil recovery or natural gas recovery must demonstrate that the carbon dioxide is permanently stored in certain types of geologic formations. It also expands the types of secure geologic storage formations to include oil and gas reservoirs.

Temporary Increase in Tax Credits for Alternative Vehicle Refueling Property . Section 30C provides a tax credit to businesses that install fuel pumps for alternative fuel vehicles, including pumps dispensing ethanol, natural gas, hydrogen, and biodiesel. The credit is equal to 30 percent of the cost basis of the equipment, capped at $30,000. For ethanol, natural gas, and biodiesel refueling equipment placed in service in 2009 or 2010, ARRA increases the credit to 50 percent of the cost basis of the equipment, capped at $50,000. With respect to hydrogen refueling equipment placed in service during 2009 or 2010, the credit remains at 30 percent of the cost basis of the equipment, but ARRA raises the cap on the amount of the credit to $200,000.

Individual Energy Incentives

Credit for Energy Efficiency Improvements on Existing Homes and AMT Offset. For 2009 and 2010, ARRA increases the amount of the Section 25C credit for installation of qualifying energy-efficiency improvements to existing homes from 10 percent to 30 percent. In addition, ARRA modifies standards for energy-efficiency improvements that qualify for the Section 25C credit and increases the limit on the amount of the credit to $1,500. Under Section 26(a)(2), nonrefundable personal tax credits, including the Section 25C credit, are allowed against alternative minimum tax (AMT). ARRA extends Section 26(a)(2) through 2009 so that the Section 25C credit will continue to be allowed against AMT.

Credits for Residential Energy Property and AMT Offset. Under Section 25D, tax credits for residential installation of solar water-heating equipment were capped at $2,000; qualified small wind-energy projects were capped at $500 per kilowatt hour of capacity, up to $4,000; and geothermal heat pumps were capped at $2,000. ARRA removes the dollar limitations on the amount of tax credits for installation of the foregoing energy properties. Under Section 26(a)(2), nonrefundable personal tax credits, including the Section 25D credit, are allowed against AMT. ARRA extends Section 26(a)(2) through 2009 so that the Section 25D credit will continue to be allowed against AMT.

Credit for Plug-in Electric Vehicles and AMT Offset. ARRA modifies the tax credit under Section 30D for qualified plug-in, electric drive motor vehicles placed in service during a tax year. The base amount of the credit is $2,500. If the electric vehicle draws propulsion from a battery with at least 5 kilowatt hours of battery capacity, the credit is increased by $417, plus $417 for each kilowatt hour of battery capacity in excess of 5 kilowatt hours (capped at $5,000). The credit is allowed against AMT and is phased out for vehicles produced by a manufacturer once the manufacturer sells 200,000 plug-in electric drive motor vehicles in the United States.

Credit for Plug-in Electric Vehicle Conversions and AMT Offset. Section 30B provides a tax credit for the placement in service of alternative motor vehicles, including hybrid vehicles and vehicles with qualified fuel cells. ARRA modifies Section 30B to add a new credit for any motor vehicle that is converted to a plug-in electric drive motor vehicle (as defined in Section 30D) during 2009 and 2010. The credit is 10 percent of the cost of converting the vehicle capped at $40,000 of conversion costs. Under ARRA, the credit allowed for alternative motor vehicles under Section 30B, including the new credit for plug-in electric motor conversions, is allowed against AMT.

Investment in Low-Income Communities

Increase in New Markets Tax Credit. ARRA increases the Section 45D New Markets Tax Credit allocation cap from $3.5 billion to $5 billion for calendar years 2008 and 2009.

"Trade-in" of Low Income Housing Credits. ARRA authorizes state housing credit agencies to elect to trade in Section 42 Low Income Housing Tax Credits (LIHTC) for federal grants. The grants are limited to 85 percent of 10 times (1) the state's unused or returned 2008 housing credit ceiling, plus (2) 40 percent of the state's 2009 credit ceiling and 2009 pool allocation. The multiplication factor of 10 in the grant formula adjusts for the fact that grants are paid in a lump sum, whereas credits would have been allowable each year for 10 years. A state housing credit agency receiving a grant must use the grant to make "subawards" to finance the construction or acquisition and rehabilitation of qualified low-income buildings.

Job Creation for the Unemployed

Incentives to Hire Unemployed Veterans and Disaffected Youth . Under Section 51, businesses are allowed to claim a work opportunity credit for equal to 40 percent of the first $6,000 of wages paid to employees in certain targeted groups. Unemployed veterans and disconnected youth are two new target groups created by ARRA that qualify for the credit. To obtain the credit, qualifying unemployed veterans and disconnected youths must begin work for the employer in 2009 or 2010.

Workout-Related Provisions

Deferral and Spread of Cancellation of Indebtedness Income

Current Law. Under current law, if a solvent taxpayer satisfies its own debt for less than the amount of that debt, subject to certain exclusions, the taxpayer recognizes cancellation of indebtedness income (COD). COD can result from a variety of transactions, including (a) satisfaction of debt at a discount, (b) acquisition by the taxpayer or a related person of the taxpayer's debt at a discount, (c) modification of the taxpayer's debt in a transaction that results in a deemed exchange of that debt, and (d) an exchange of the taxpayer's debt for equity in the taxpayer.

If a taxpayer is insolvent, COD is recognized only to the extent that the discharge of debt renders the taxpayer solvent, and COD is not recognized by a taxpayer whose debt is discharged in a bankruptcy. The cost to a taxpayer of not recognizing COD is a reduction of its tax attributes, such as NOLs, and the basis for its depreciable assets. 

If a taxpayer is solvent and not in a bankruptcy proceeding, it must recognize COD unless certain exceptions apply. Applicable exceptions include COD that results from a reduction of qualified real property business indebtedness (QRPBI), reductions in purchase money debt, and an exchange of debt for equity of the debtor to the extent of the fair market value of the equity.

COD Deferral and Spread. ARRA allows taxpayers to elect to defer recognition of COD occurring in 2009 and 2010 and then, after the deferral period, to spread out the recognition of the COD over five years (COD Deferral and Spread). For COD occurring in 2009, the deferral period is five years; for COD occurring in 2010, the deferral period is four years. If the COD results from an actual or deemed exchange of debt instruments, OID deductions also are deferred until the COD is recognized. 

If a taxpayer makes this election to avail itself of the COD Deferral and Spread, the other COD exclusion rules do not apply. As a result, if a taxpayer makes this election, it is not permitted to take advantage of the bankruptcy, insolvency, or QRPBI exclusions.

The COD Deferral and Spread is accelerated and recognized in the year that a taxpayer (1) dies, (2) liquidates or sells substantially all of its assets, (3) ceases to do business, or (4) similar circumstances. If a partnership or S corporation is the issuer of the debt, COD Deferral and Spread also ceases upon a holder's disposition of its interest in the entity, be it through sale, exchange, or redemption.

When COD Deferral and Spread Election May Be Made. The COD Deferral and Spread election is available for COD resulting from a "reacquisition" of any "applicable debt instrument" in 2009 and 2010. An applicable debt instrument is a debt issued by any person in connection with the conduct of a trade or business by that person and any debt instrument issued by a C corporation. The issuer, a person who otherwise is the obligor or a person related to the issuer or obligor, must be the person who reacquires the debt instrument. And, the reacquisition must be accomplished by virtue of (1) the acquisition of the debt instrument for cash; (2) an exchange of the debt instrument for another debt instrument, or a deemed exchange of the debt instrument for another debt instrument as the result of the debt instrument being modified; (3) an exchange of a debt instrument for stock or a partnership interest of the issuer; (4) a contribution of a debt instrument to the capital of a corporation or partnership; (5) the holder's complete forgiveness of a debt instrument; or (6) a similar transaction.

Special Rules for Partnerships. Under current law, when a partnership's debt is discharged, recognition of COD is determined at the partner level. As a result, for example, absent an applicable exclusion, solvent partners must recognize COD income resulting from the discharge of a partnership debt whereas insolvent partners do not recognize such income. However, this new election for COD Deferral and Spread is made and applies at the partnership level. A partnership considering this election may have partners with conflicting interests and, as a result, the sponsor of the partnership must carefully consider the consequences of this election before making it.

Partnership tax rules treat a reduction in a partnership's debt as a distribution of cash to the partners. If that deemed distribution exceeds a partner's basis for its partnership interest, the partner recognizes gain. If a partnership elects COD Deferral and Spread, the deemed distribution to a partner that occurs upon the discharge of the partnership's debt is suspended (in part) to prevent current recognition of gain by a partner from such discharge.

Election Mechanics. The COD Deferral and Spread election may be made by a taxpayer for any debt instrument to which it wants the election to apply. The election must (i) be attached to the taxpayer's tax return for the tax year of the reacquisition, (ii) clearly identify the debt instrument or instruments to which it applies, (iii) set forth the amount of the deferral, and (iv) include any other information required by the IRS.

Temporary Suspension of Limitations on Excessive Interest Deductions (AHYDO Limitations). ARRA suspends the application of the Code provisions limiting interest deductions on certain applicable high-yield discount obligations (AHYDO) to obligations that are issued after August 31, 2008, and before 2010 in exchange for non-AHYDO, including deemed issuances that might result from modifications of existing debt in workout situations. By suspending the AHYDO limitations, ARRA will permit borrowers under such newly issued obligations to deduct interest attributable to original issue discount on obligations with yields that exceed IRS formula-determined applicable federal rates by more than 5 percentage points. The suspension does not apply to obligations paying certain types of contingent interest or to obligations issued to persons related to the borrower. ARRA further authorizes the IRS to extend the suspension period or to use a higher base rate than the applicable federal rate for all debt issuances (not merely issuances in exchange for non-AHYDO) in applying the AHYDO limitations, if the IRS determines either (or both) of such actions to be appropriate in light of distressed conditions in the debt capital markets.

Other Business and Investment Incentives

Temporary Election to Carry Back Small Corporation NOLs. ARRA permits certain small corporations to elect to carry back net operating losses from taxable years beginning or ending in 2008 (but not both years) to the third, fourth, or fifth taxable year preceding the loss year. To be eligible to make this election, a corporation must have average annual gross receipts of $15 million or less for the three taxable years preceding the loss year. This provision cannot be utilized by businesses that do not pay corporate income tax, such as subchapter S corporations. With respect to filing dates already passed, elections made to forego a carryback may be revoked, and elections to increase a carryback period or to obtain a quick tax refund by means of a tentative carryback adjustment may still be made, if filed within 60 days after ARRA's enactment.

Suspension of S Corporation Built-in Gain. If a C corporation becomes an S corporation, for the 10-year period beginning on the first day it is an S corporation (recognition period), the corporation must pay corporate-level tax on any of its recognized built-in gain. Built-in gain is the excess of (i) the fair market value of the corporation's assets on the first day it is an S corporation over (ii) the corporation's tax basis for those assets on the same day. The corporation's assets include good will developed by the corporation itself, which would have a tax basis of zero. 

An S corporation must recognize built-in gain upon a taxable disposition of any asset, with inherent built-in gain, that it owned on the first day it was an S corporation. The built-in gain the S corporation must pay corporate level lax on is the lesser of (x) the gain recognized on the sale of the asset or (y) the built-in gain.

ARRA allows an S corporation to sell built-in gain assets in 2009 or 2010 without recognition of corporate-level gain if the S corporation is at least in the eighth year of the recognition period.

For example, assume a C corporation became an S corporation on January 1, 2002, and had a built-in gain of $10 million. In 2008, the corporation sells all of its assets, recognizing all $10 million of its built-in gain and an additional gain of $5 million, all of which is long-term capital gain. The corporation and its shareholders would owe approximately $5.2 million of federal and state income taxes on the $10 million built-in gain and approximately $1 million on the rest of the gain. 

If the sale occurred in 2009, instead of 2008, the corporation and the shareholders would owe only approximately $2 million of federal and state income taxes on the built-in gain and approximately $1 million on the rest of the gain. The savings are approximately 32 percent of the built-in gain.

Extension of Additional First-Year Depreciation. The additional 50 percent first-year depreciation allowable for qualifying property placed in service during 2008 (and for certain property placed in service during 2009) has been extended for another year. Under this provision, it is possible for more than one half of the cost of qualifying property to be taken as a deduction when it is placed in service. Qualifying property includes qualified leasehold improvement property, certain software, and most tangible personal property.

A contract for the acquisition of the property cannot have been in effect before January 1, 2008. Property that is manufactured, constructed, or produced by or for the taxpayer must meet certain additional requirements regarding the date of commencement of manufacture, construction, or production. Additional rules are designed to prevent avoidance of the time limitations.

The limitation on the amount of depreciation allowed for certain qualifying automobiles is increased in the first year by $8,000. Corporations can elect to claim research or minimum tax credits in lieu of claiming the additional first-year depreciation for "eligible qualified property."

Extension of Expensing of Certain Depreciable Business Assets. Up to a limit, taxpayers may generally expense tangible personal property and off-the-shelf computer software purchased for use in the active conduct of a business. The $250,000 limit that may be expensed in 2008 has been extended to 2009 (before the change, the limit was scheduled to decrease to $125,000 in 2009). As in 2008, the $250,000 is reduced by the amount by which the cost of qualifying property placed in service during the year exceeds $800,000.

Reduction of Effective Tax Rate for Qualified Small Business Stock Issued in 2009 and 2010. ARRA reduces the effective tax rate on capital gains realized from sales of qualified small business stock that has been held for at least five years from the date of its original issuance where the stock has been issued in either 2009 or 2010. The effective tax rates for capital gains realized from sale of such stock will be 7 percent for regular tax purposes and 12.88 percent for alternative minimum tax purposes. ARRA does not expand the types or sizes of business eligible to issue qualified small-business stock, however.

Nullification of IRS Built-in Loss Notice for Bad Bank Loans. ARRA prospectively nullifies the effect of an IRS Notice issued by the Bush administration (IRS Notice 2008-83) that permits acquired banking corporations to utilize losses realized from bad loans in post-acquisition transactions without regard to the change of ownership limitations imposed under Section 382 of the Code. Bank acquisitions made on or before January 16, 2009, and those occurring pursuant to binding contracts in effect on that date may still obtain relief from the change of ownership limitations under IRS Notice 2008-83.

Exemption of Certain Ownership Changes Occasioned by EESA. ARRA exempts from the loss utilization limitation rules of Section 382 of the Code any corporate ownership change required under a loan agreement or a commitment for a line of credit entered into by a corporation with the Treasury Department under the Emergency Economic Stabilization Act of 2008 (EESA). However, this exemption is unavailable to corporations under the control of a single person or a group of related persons. Moreover, any corporation exempted from an ownership change by reason of this provision will remain subject to the Section 382 loss limitation rules with respect to any future ownership change.

Pass-Through of Certain Tax Credits by Mutual Funds. ARRA provides procedures for mutual funds to elect to pass through to their shareholders credits from certain qualified tax credit bonds that they hold as portfolio investments (including qualified forestry conservation bonds, new clean renewable energy bonds, qualified energy conservation bonds, Qualified Zone Academy Bonds, and Build America Bonds). Shareholders include in income their proportionate share of the interest income attributable to the credits passed through and are allowed a proportionate share of the credits. Funds make the pass-through election by mailing a written notice to shareholders within 60 days after the end of the fund's fiscal year and complying with any additional procedures prescribed by the IRS.  

Withholding by United States, States, and Their Subdivisions and Instrumentalities . The Tax Increase Prevention and Reconciliation Act of 2005 added Section 3402(t) to the Internal Revenue Code to require the United States and every state and their subdivisions and instrumentalities to withhold 3 percent of all payments of $10,000 or more they make to persons providing services or property (other than real property, including payments for leasing real property and leasehold improvements), beginning with all payments made by the government entities after December 31, 2010. This withholding requirement does not apply to payments made by a government entity that makes less than $100 million of such payments annually, wages paid to a government employee, interest, and certain other enumerated exceptions.

Withholding is required from payments under government programs to provide health care or other services that are not based on the needs or income of the recipients, including programs where eligibility is based on the age of the beneficiary. When a government entity required to withhold enters into a contract with a prime contractor that, in turn, enters into contracts with subcontractors, withholding is required only from the payments to the prime contractor. Government payments for construction of buildings or public works are subject to withholding. 

A taxpayer from whom tax is withheld may claim a credit against its income tax and estimated taxes for the amounts withheld. A government entity that is obligated to withhold, but fails to do so, is liable for the tax unless it can prove that the payee paid its income tax liability.

ARRA defers application of this withholding requirement for one year to payments made by government entities, beginning in 2012. 

 


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This newsletter is a periodic publication of Ballard Spahr LLP and is intended to alert the recipients to new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and specific legal questions you have.