American Jobs Creation Act of 2004
On October 22, 2004, President George W. Bush signed into law the American Jobs Creation Act of 2004. The centerpiece of this legislation is the repeal of the Foreign Sales Corporation-Extraterritorial Income (“FSC-ETI”) regime and the implementation of a new domestic production activities deduction. In addition, there were significant changes in areas related to S corporations, incentive stock options, and individual taxation. The Tax Flash Focus is intended to highlight certain key provisions of the Act.
The Act repealed the FSC-ETI regime. This repeal was primarily in response to a 2002 decision by the World Trade Organization that the FSC-ETI regime was a prohibited export subsidy. As a result of the WTO determination, the European Union began imposing sanctions against a wide range of US exports.
The Act generally repeals the FSC-ETI regime for transactions occurring after December 31, 2004. However, the Act contains various transitional and grandfather rules that soften the impact of the repeal on US businesses.
Despite some initial posturing suggesting they might do otherwise, the European Commission has indicated that it would end the sanctions against US exports beginning on January 1, 2005. However, the European Commission also indicated that it plans to file an appeal with the WTO regarding the language under the Act that grandfathers FSC-ETI benefits for certain existing contracts. These grandfather provisions principally benefit US manufactures of goods that have a long delivery time (such as airplanes, computers and heavy equipment).
New Domestic Production Activities Deduction
The Act contains a new manufacturing deduction that is designed to partially replace the FSC-ETI regime. The manufacturing deduction will be phased-in over the next six years, and the deduction is generally equal to: ·
- three percent of the taxpayer’s “qualified production activities income” for tax years beginning in 2005 and 2006;
- six percent of such income for tax years beginning in 2007-2009; and
- nine percent of such income for tax years beginning in 2010 and years thereafter.
The deduction is limited to 50 percent of the W-2 wages paid by the taxpayer for the year. For corporate taxpayers that are members of certain affiliated groups, the deduction is calculated by treating all members of the group as one taxpayer and then allocating the deduction among the members in proportion to each member’s share of the qualified production activities income. The deduction is allowable for purposes of calculating alternative minimum taxable income (including adjusted current earnings), and special rules apply to the income of partnerships, S corporations, and farm cooperatives.
S Corporation Reforms
The Act contains a variety of S corporation reforms that will increase the flexibility of using an S corporation for tax years beginning after December 31, 2004. For example, the Act increases the number of eligible S corporation shareholders from 75 to 100.
In addition, the Act provides an election to allow all members of a family to be treated as one shareholder in determining the number of S corporation shareholders. A family is generally defined as the common ancestor and all lineal descendants of the common ancestor as well as the spouses and former spouses of such individuals. The provision also applies if the family member holds stock indirectly as a beneficiary of an electing small business trust or a qualified subchapter S trust.
Under current law, a qualified subchapter S subsidiary is treated as a disregarded entity. As a disregarded entity, all operations of the entity are reported by the S corporation that owns the subsidiary’s stock, and the subsidiary does not have a separate tax reporting requirement. The Act provides authority to require information returns from qualified subchapter S subsidiaries, which may cause new tax reporting obligations for such subsidiaries.
Exclusion of Incentive Stock Options from Certain Withholding Obligations
In the past, there was some uncertainty with respect to employer withholding obligations on the exercise of statutory stock options. The Act provides specific exclusions from FICA and FUTA wages for compensation on account of a transfer of stock acquired pursuant to the exercise of an incentive stock option. The Act also provides that federal income tax withholding is not required on a disqualifying disposition of such stock.
New Sales Tax Deduction for Certain Individual Taxpayers
Taxpayers are entitled to an itemized deduction on their individual tax returns for the payment of certain state and local income taxes. This was a perceived injustice to taxpayers who live in states that do not have an income tax and that use a sales tax to fill the state coffers.
Under the Act, for tax years beginning after December 31, 2003, and prior to January 1, 2006, taxpayers will be entitled to elect to take an itemized deduction for state and local sales taxes in lieu of the current deduction for state and local income taxes. The allowable deduction will be determined by either using the taxpayer’s actual sales taxes paid based on retained receipts or by using tables that take into account the average consumption by taxpayers based on filing status, number of dependents, adjusted gross income, and the state and local rates.