Monday, December 20, 2010

Select Tax Provisions in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”), signed into law by President Obama on December 17, 2010, extends generally for two years certain tax code provisions that expired or will expire at the end of 2010.

Select income tax provisions of the Act include:

1. Relating to U.S. citizens and resident aliens

a. The highest ordinary income tax rate remains at 35% for all individuals through 2012.
b. The highest income tax rate on long-term capital gains and qualified dividend income remains at 15% for all individuals through 2012.
c. Itemized deductions for all individuals through 2012 are not subject to an overall limitation which would otherwise reduce the itemized deductions by up to 80%.
d. Individuals may exclude all gains from the sale of certain small business stock acquired at original issue in 2011.
e. Taxpayers may deduct private mortgage insurance premiums paid or accrued in 2011 in connection with acquisition indebtedness on a qualified residence.
f. Taxpayers may elect to deduct state and local sales tax in lieu of state and local income tax through 2011.
g. Taxpayers may offset the entire regular and alternative minimum tax liability for 2010 and 2011 by certain nonrefundable personal credits (e.g. dependent care credits, child credits, etc.).
h. The tax rate of the individual portion of the social security tax for remuneration received in 2011 is reduced by 2%, from 6.2% to 4.2%. In the case of self-employment, the social security tax rate for taxable years of individuals that begin in 2011 is also reduced by 2%, from 12.4% to 10.4%.

2. Relating to foreign shareholders of a regulated investment company (“RIC”)

a. For 2010 and 2011, foreign shareholders of a RIC are generally not subject to U.S. federal income tax and withholding tax on dividends designated as arising from the RIC’s certain interest income that would not be subject to U.S. tax if earned by the foreign shareholders directly. Similar rules apply to certain short-term capital gain dividends.
b. Also for 2010 and 2011, an interest in a RIC can not be treated as U.S. real property interest, and any distribution from a publicly traded RIC that is attributable to the sale of a U.S. real property interest, is exempt from U.S. federal income tax if the distribution is to a foreign shareholder who holds no more than 5% of the publicly traded stock. However, withholding tax otherwise required for distributions made prior to December 17, 2010 is not affected.

3. Relating to controlled foreign corporations (“CFCs”)

a. For 2010 and 2011, U.S. shareholders of a CFC are not taxed currently on the CFC’s active financing income.
b. Also for 2010 and 2011, U.S. shareholders of a CFC are not required to include any dividend, interest, rent and royalty income received by the CFC from a related CFC, to the extent such income is attributable to the related CFC’s income that is not dividend, interest, rent, royalty, or other “subpart F income” or income effectively connected with a U.S. trade or business.

4. Relating to the 100-percent expensing for certain business assets (“Bonus Depreciation”)

a. The 100-percent Bonus Depreciation is extended to qualified property placed in service before January 1, 2012 (or before January 2013 for certain longer-lived and transportation property).
b. The Bonus Depreciation will be 50% for qualified property placed in service in 2012 (or in 2013 for certain longer-lived and transportation property).
c. A corporation generally may increase its minimum tax credit limitation by the Bonus Depreciation with respect to certain property placed in service in 2011 or 2012 (or through 2013 in the case of certain longer-lived and transportation property).

The key non-income tax provisions made by the Act are to modify the estate, generation-skipping and gift tax provisions in a number of significant respects, including:

1. Providing that for 2011 and 2012, there will be a $5 million estate, generation-skipping and gift tax exemption (which will be indexed for inflation beginning in 2012) per individual and a maximum estate, generation-skipping and gift tax rate of 35%. The new exemption and tax rate generally apply in 2010, except that the gift tax exemption for 2010 remains at $1 million and the generation-skipping tax rate for transfers made in 2010 is zero;

2. Allowing the estates of decedents who died in 2010 to elect to pay no estate tax but have a modified carry-over basis regime for their heirs;

3. Adopting a portability concept for the new $5 million exemption from estate and gift tax, but not generation-skipping tax; and

4. Providing an extension for certain tax filings and disclaimers for decedents dying in 2010 before enactment of the new law.

The Act also extends for 2 years the code provision that excludes from the estates of nonresident decedents the stock of a RIC to the extent the RIC’s assets are debt obligations, deposits or other property that would be treated as situated outside the U.S. if held directly by the estates.

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Tuesday, October 12, 2010

FATCA Guidance: Notice 2010-60

On August 27, 2010, the Internal Revenue Service (the “IRS”) published Notice 2010-60 (the “Notice”), which provides preliminary guidance concerning withholding and reporting obligations under the FATCA provisions of the Hiring Incentives to Restore Employment Act. For a discussion of the FATCA provisions, please see our blog post from March 23, 2010.

I. Grandfathered Obligations
The Notice excludes from FATCA withholding any payments on obligations outstanding on March 18, 2012. For these purposes, an obligation is any legal agreement that does not constitute equity and that has a definitive term or expiration date.

II. Definition of Financial Institution
The Notice clarifies the statutory definition of “financial institution.” Under the Notice, financial institutions include:

  • Entities that accept deposits in the ordinary course of a banking or similar business, such as savings banks, commercial banks, savings and loan associations, thrifts, building societies, and other cooperative banking institutions. The fact that an entity is subject to banking and credit laws is relevant but not determinative as to whether that entity is a financial institution.

  • Entities that, as a substantial portion of their business, hold financial assets for the account of others, such as broker-dealers, clearing organizations, trust companies, custodial banks, and entities that act as custodians with respect to the assets of employee benefit plans. The fact that an entity is subject to banking and credit laws or to broker-dealer regulations is relevant but not determinative as to whether that entity is a financial institution.

  • Entities that are engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, or commodities, such as mutual funds, funds of funds, exchange-traded funds, hedge funds, private equity and venture capital funds, commodity pools, and other investment vehicles. For these entities, “business” will likely have a broad meaning, with isolated transactions possibly constituting a “business.”

The Notice provides that the term “financial institution” does not include start-up companies that will operate a non-financial institution business, certain non-financial entities that are liquidating or emerging from bankruptcy, hedging or financing centers of a non-financial group, and certain holding companies with subsidiaries that are not engaged primarily in a financial institution business.

The Notice also excludes from the definition of financial institution certain foreign retirement plans and insurance companies that issue insurance or reinsurance contracts without cash value, such as property and casualty insurance or term life insurance contracts.

Finally, the Notice does not exclude from the definition of financial institution any foreign financial institutions that receive withholdable payments solely via their U.S. branches, nor any controlled foreign corporations that are also foreign financial institutions.

III. Foreign Financial Institutions and Their Collection of Account Information
The Notice describes procedures for how a foreign financial institution can fulfill its FATCA due diligence obligations for determining which, if any, of its accounts are U.S. accounts. A foreign financial institution must (i) determine whether its account holders that are individuals are to be treated as U.S. persons or as other persons, and (ii) determine whether its account holders that are entities are to be treated as U.S. persons, foreign financial institutions, or non-financial foreign entities.

The Notice provides procedures for how a foreign financial institution can make these determinations. Generally, a foreign financial institution must divide its accounts into four groups: individual account holders versus entity account holders, and pre-existing accounts versus new accounts. Within each of these four groups, the Notice then provides procedures for determining which accounts are presumptively U.S. accounts, which accounts are presumptively not U.S. accounts, and which accounts the foreign financial institution must request additional information from to determine if they are U.S. accounts.

IV. Reporting Requirements on U.S. Accounts
If a foreign financial institution has U.S. accounts, the Notice provides preliminary guidance on what information about such accounts the foreign financial institution must report to the IRS. Generally, the foreign financial institution must report the name, address, and taxpayer identification number of the account holder, along with the account balance or value, and gross receipts and withdrawals from the account.

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Monday, October 11, 2010

IRS Releases Proposed Regulations Covering Series LLCs

On September 13, 2010, the Internal Revenue Service (“IRS”) released proposed regulations that would treat an individual series of a domestic series LLC as a separate entity formed under local law regardless of whether that series is a juridical person for local law purposes. The proposed regulations generally do not apply to a series entity organized under the laws of a foreign jurisdiction unless the foreign series entity engages in an insurance business.

The proposed regulations define a series as a segregated group of assets and liabilities that is established pursuant to a “series statute” by agreement of a “series organization”. Thus, a series generally includes a cell, segregated account or segregated portfolio. A series organization is a juridical entity that establishes and maintain a series. A series statute is a statute of a state that provides for the organization of a series of a juridical person and permits: (1) members of a series organization to have rights with respect to the series; (2) a series to have separate rights, powers or duties with respect to specified property or obligations; and (3) the segregation of assets and liabilities of the series organization such that none of the debts and liabilities of the series organization or any other series of the series organization are enforceable against the assets of a particular series of the series organization.

The proposed regulations include a transition rule that would allow a series to continue to be treated together with the series organization as a single entity for federal tax purposes if, among other things, the series was established and conducted business or investment activity prior to September 14, 2010 and there was a reasonable basis for claiming single-entity classification.

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Wednesday, September 1, 2010

Update on U.S. Long-Term Capital Gain, Interest and Dividend Tax Rates

Long-term capital gains and qualified dividends are currently taxed at a maximum rate of 15 percent, and ordinary income (including interest and non-qualified dividends) is currently taxed at a maximum marginal rate of 35 percent. These rates (which were part of the so-called “Bush tax cuts”) are scheduled to expire on December 31, 2010. Various legislative proposals would extend the Bush tax cuts in whole or in part, but it is unclear whether Congress will act before year end and, if it does, what changes will result. Without Congressional action, in 2011 the highest rate on long-term capital gains will rise to 20 percent and the highest marginal rate on ordinary income, including interest and all dividends, will rise to 39.6 percent.

In addition, on March 30, 2010, President Obama signed into law the Health Care and Education Reconciliation Act of 2010 (the “HCERA”). The HCERA imposes a 3.8 percent surtax on unearned income (including capital gains, interest and dividends). The surtax is effective January 1, 2013.

The chart below illustrates the 2011-2013 highest marginal tax rates, assuming that the Bush tax cuts are not extended.

2010 2011 2012 2013
Ordinary Unearned Income (e.g., interest and non-qualified dividends)  35% 39.6% 39.6% 43.4%
Qualified Dividends 15% 39.6% 39.6% 43.4%
Long Term Capital Gains 15% 20% 20% 23.8%

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Tuesday, March 23, 2010

President Obama Signs HIRE Act

On March 18, 2010 President Obama signed into law the "Hiring Incentives to Restore Employment Act" (the "Bill"), which contains a revised version of the Foreign Account Tax Compliance Act of 2009 (“FATCA”) that was first introduced on October 27, 2009 (for a discussion of FATCA please see our November 9, 2009 post entitled "Foreign Account Tax Compliance Act of 2009"). The withholding provisions of the Bill will apply to payments made after December 31, 2012. However, a grandfather rule exempts payments made under any obligation outstanding on the date that is 2 years after the enactment of the Bill from its withholding provisions. The foreign-targeted obligations provisions of the Bill apply to obligations issued after the date which is 2 years after the date of the enactment of the Bill. Finally, provision requiring withholding on “dividend equivalent payments" will apply to payments made on or after the date that is 180 days of the enactment of the Bill.

The full text of the act can be found here.

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House Passes Health Care Act Imposing New Taxes on High Income Taxpayers

On March 21, the House of Representatives passed the Health Care and Education Affordability Reconciliation Act of 2010 (the "Reconciliation Act"). The Reconciliation Act is expected to be passed by the Senate and signed into law by the President. The Reconciliation Act will impose a tax of 3.8 percent on the "net investment income" of individual taxpayers earning more than the threshold amount ($200,000 per year for single taxpayers or $250,000 for married taxpayers filing jointly). The Act defines net investment income to include income from interest, dividends, annuities, royalties and rents other than such income derived in the ordinary course of a trade or business as well as capital gains and income derived from passive activities within the meaning section 469 of the Internal Revenue Code. The 3.8 percent tax will only apply to net investment income to the extent that the taxpayer's adjusted gross income for the taxable years exceeds the threshold amount. The tax will be imposed on investment income earned after December 31, 2012.

The full text of the Reconciliation Act can be found here.

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Wednesday, March 17, 2010

FinCEN and IRS Provide Further Guidance on Reporting Requirements for Foreign Financial Accounts

On February 26, 2010, two branches of the U.S. Treasury Department addressed aspects of reporting investments in foreign funds.

The Financial Crimes Enforcement Network (“FinCEN”) issued proposed regulations addressing the Form TD F 90-22.1 (“FBAR”) reporting obligations of U.S. persons who hold interests in certain foreign “financial accounts.” Under these proposed rules, a “financial account” would include an interest in a “mutual fund or similar pooled fund which issues shares to the general public that have a regular net asset value determination and regular redemptions.” The proposed regulations explicitly reserve decision on the issue of whether hedge funds and private equity funds will be considered “financial accounts” for FBAR filing purposes. The proposed regulations indicate that the Treasury Department remains concerned about the use of foreign investment funds to evade taxes and that FinCEN will continue to study this issue. The proposed regulations also address many other issues, including confirming that a U.S. single-member limited liability company treated as a disregarded entity for U.S. federal income tax purposes is considered a U.S. person who generally must file an FBAR if it has an interest in a foreign financial account. The proposed regulations do not address the effective date of the new regulations if they become final.

Simultaneously, the Internal Revenue Service (“IRS”) released Notice 2010-13 (the “Notice”) and Announcement 2010-16 (the “Announcement”) to provide relief with respect to certain FBAR filing obligations for 2009 and prior years. The Notice provides that the IRS will not require U.S. persons to report any investment in foreign hedge funds or private equity funds for 2009 and earlier years. The Notice also extends the filing deadline to June 30, 2011 for any U.S. person with signature authority over, but no financial interest in, a foreign financial account with respect to years prior to 2010. In the Announcement, the IRS suspended FBAR reporting obligations with respect to 2009 and prior years for any person who is not a U.S. person as defined in the 2000 version of the FBAR form and instructions. Under that definition, a U.S. person is (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust. However, other than the definition of U.S. persons, all requirements in the 2008 version of the FBAR form and instructions (as modified by the Notice) remain in effect unless changed by future guidance. As reported in our client alert last year, the IRS has stated that investments in foreign funds should be treated as foreign financial accounts subject to FBAR reporting. Thus, unless additional guidance provides otherwise, investments in foreign funds in 2010 and thereafter would presumably have to be reported.

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Wednesday, February 3, 2010

Proposed New York Legislation to Eliminate the Income Tax Exemption for Resident Trusts

On January 19, 2010, Bill A09710 was introduced in the New York State Assembly which would amend the definition of a “resident trust for tax years beginning on or after January 1, 2010. This Bill will affect persons who have changed the tax situs of a trust from New York to another jurisdiction through the use of nonresident trustees.

Section 601(c) of the New York Tax Law (“Tax Law”) imposes an income tax on the income of a “resident trust.” Section 605(b)(3) of the Tax Law defines a resident trust to include: (1) a trust created by a New York decedent; (2) an irrevocable trust created by a New York resident; or (3) a trust that become irrevocable while the creator was a New York resident.

Notwithstanding the general rule of Section 601(c), Section 605(b)(3)(D) of the Tax Law was introduced as a result of the 1964 New York Court of Appeals decision in Mercantile-Safe Deposit & Trust Co. v. Murphy. Section 605(b)(3)(D) provides that a resident trust will not be subject to tax if three conditions are met: (1) all trustees are domiciled in a state other than New York; (2) the entire corpus of the trust, including real and tangible property, is located outside New York; and (3) all income and gains of the trust are derived from or connected with sources outside of the f New York.

Bill A09710 would repeal Section 605(b)(3)(D), eliminating all three conditions for tax exemption. The Bill provides that a testamentary trust created under the will of a New York domiciled decedent would be deemed a New York resident trust and the income of such trust would be fully taxable in New York. A nontestamentary trust settled by a New York resident grantor would also be considered a New York resident trust. A resident nontestamentary trust with New York source income would be fully taxable, while a resident nontestamentary trust with no New York source income would be taxed based on the proportion of identifiable beneficiaries of the trust who are New York residents.

The purpose of A09710 is to prevent a trust settled by a New York resident from avoiding New York through the use of nonresident trustees.

A text of Bill A09710 is available here. Part G of the Bill addresses the taxation of resident trusts.

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Monday, January 25, 2010

Tax Relief for Charitable Contributions to Haiti

On January 22 President Obama signed a bill (H.R. 4462) that allows taxpayers to deduct on their 2009 tax returns charitable cash contributions made for the relief of victims affected by the earthquake in Haiti by treating these contributions as though they were made on December 31, 2009. The bill would apply to contributions made after January 11, 2010 and before March 1, 2010.

The bill could have significant implications for taxpayers' penalties for underpayments of estimated tax, as well as their state (and local) income tax liability.

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Wednesday, January 13, 2010

Trusts and Estates Tax Advisory

Congressional inaction in 2009 has led to a one year repeal of the federal estate and generation skipping transfer taxes effective January 1, 2010 and expiring December 31, 2010. If Congress fails to act in 2010, the federal estate tax will revert in 2011 to the 2000 rules and the exempt amount of $1 million.

Barring retroactive reenactment of these taxes, and at the risk of oversimplification, the primary effects of this change are as follows:

  1. Temporary elimination of the federal estate tax for individuals dying in 2010. Residents of certain states, including New York, New Jersey and Connecticut will still be subject to a state estate tax.

  2. Temporary reduction in the maximum federal gift tax rate to 35% for lifetime gifts made during 2010, with the $1 million exemption for lifetime gifts being retained.

  3. Temporary elimination of the generation skipping transfer tax with respect to outright transfers in 2010 by lifetime gift or by will to grandchildren or more remote descendants. Transfers in trust may be subject to the generation skipping tax in years after 2010, even though no tax is imposed on the creation of such a trust.

  4. The income tax basis of property that is included in the estate of an individual dying in 2010 will not be stepped-up to the date of death value. Inherited property will now be subject to complex carry-over basis rules (after an exemption of the $1.3 million in gains, with an additional $3 million exemption in gains for property inherited by a surviving spouse).
Congress may eliminate these changes, possibly with retroactive effect to January 1, 2010, by reenacting the federal estate and generation-skipping transfer taxes. This possibility results in any changes being perilous. Furthermore, existing estate plans may be adversely affected by the repeal of these taxes, especially if a will or trust instrument utilizes a tax related formula provision to determine the distribution of assets among beneficiaries.

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