Pending Tax Legislation: Sewage, Kids, Surfing and Deferred Compensation
Our Congress is quietly working to enhance our society. On May 11, the Senate passed the 1007-page Jumpstart Our Business Strength (JOBS) Act, which was followed on June 22 by the more modest House of Representatives 411-page Working Families Assistance Act. Of course, these bills contain a huge number of provisions having nothing to do with the cutesy names.
Indeed, their primary purposes are to replace foreign trade-related tax provisions (necessary to end a European Union embargo that began in March) and eliminate a burgeoning tax shelter that threatens to flush our corporate tax system down the drain. The latter involves U.S. corporations purchasing and leasing back foreign cities sewage systems and other infrastructure to generate massive depreciation deductions. I kid you not.
Significant parts of the two bills target many of the major Enron and other tax shelter abuses that have permeated the press over the past few years. However, they then diverge rather significantly.
So, the Joint Conference Committee expects to reconcile the different provisions by sometime in August. I anticipate that will culminate in a 1418-page masterpiece entitled the Revive Our Trade, Timber and Energy Companies and Ravage Avoiders, Promoters, Officers, Lawyers and Accountants (ROTTEn-CRAPOLA) Act of 2004.
Teenagers, who obviously are in the same league as Enron and other scammers, are the subject of a Senate launched salvo. The beloved Kiddie Tax forces youngsters under 14 to pay tax at their parents top rate. The Senate proposes to change that to age 18 beginning this year. This is okay with me since my youngest recently turned 18, but I fear that next year those yahoos in Washington will shoot for 21.
The House proposes to increase the number of permissible S corporation shareholders to 100 from its current 75. Perhaps even more significantly, members of a family (defined as up to three generations of descendants of a common ancestor, plus spouses) may elect to be treated as one person. If accepted by the Senate, these provisions could make S status available to large families and to corporations owned by up to 100 unrelated families.
Does this seem a bit schizophrenic? The Senate wants to punish kids under 18, while the House wants to benefit large families. There's more. The House wants to continue to encourage you to buy an SUV to lug all those kids around (only on business trips, of course). It would extend for two years (through 2008) the provision that allows small businesses to expense the first $100,000 of new depreciable property.
On the other hand, the Senate apparently prefers for you to keep the kids at home surfing the internet. Its bill contains a provision allowing individuals to expense broadband internet equipment and connection costs. There must be a catch because the provision is 19 pages long and I don’t understand most of the terminology. However, it is clear that you cannot deduct any costs incurred in launching a satellite.
There are some real gems here for family members not active in your business, such as the repeal of excise taxes on fishing tackle boxes and sonar devices suitable for finding fish. Feuding families will appreciate the proposed simplification of the excise tax imposed on bows and arrows. Again, I kid you not.
Current law generally taxes compensation only when it is received. That concept has spawned a variety of deferred compensation plans, which allow you to earn income but delay the tax until it is paid to you (or you can access the money). The employer can even segregate cash into an IRS-approved rabbi trust to secure payment, as long as the company’s creditors can grab the dough if the firm goes bankrupt.
Both the Senate and the House believe that people have been abusing the system. Using similar approaches, the legislation will accelerate taxation of deferred compensation unless payment is conditioned on the future performance of substantial services or
The plan prohibits distribution prior to the employee’s death or disability, a specified time, a substantial change of corporate ownership, the employee’s separation from service or the occurrence of an unforeseen emergency;
The plan prohibits acceleration of payment;
The employee elects to defer the compensation prior to the year in which it is earned;
The funds are not placed in an offshore trust; and
In the Senate bill, the plan’s investment options are comparable to those available under the employer’s defined benefit plan (or other options to be specified by the Treasury).
If deferred compensation is caught by the provision, both bills will tax the compensation and charge interest for the length of any prior tax deferral, plus the Senate adds a penalty of 10 percent of the compensation.
This provision apparently can apply to phantom stock plans, as well as to the approaches commonly used by family businesses to provide retirement income for senior family members. If enacted, it would apply to compensation deferred in taxable years beginning after 2004, so major plan changes may be required to avoid accelerating taxation.
Check with your tax advisor to see what else of interest is buried in this legislation. You might find a desire to encourage our legislators to travel to Europe for a first-hand look at some of the infrastructure being purchased by major American corporations.