Schiff Hardin Tax Alert
Tax Implications of the Emergency Economic Stabilization Act of 2008

On October 3, 2008, the House of Representatives joined the Senate in passing the Emergency Economic Stabilization Act of 2008 (the "Act"), and the President signed the Act into law on the same day. While most discussions of the Act focus on its authorization of the purchase of up to $700 billion in impaired assets directly from financial institutions by the Secretary of the Treasury, the Act also includes many tax provisions, including a host of tax relief measures for both individuals and businesses. A summary of some of the more relevant of the 116 tax provisions follows.

Alternative Minimum Tax ("AMT") Provisions

The AMT disallows many deductions and exemptions available to taxpayers when calculating their ordinary tax liability. The AMT has been criticized both for its complexity and for its impact on taxpayers other than the high-income households for which it was originally intended. Because of this, Congress has passed annual patches designed to minimize the overall impact of the AMT through taxpayer exemptions. The Act increases the 2008 exemptions from $33,750 to $46,200 for individuals and from $45,000 to $69,950 for married joint filers. Additionally, the Act accelerates the taxpayer's use of personal credits, such as the education tax credits and the dependent care credit, against the AMT.

The AMT also requires recipients of incentive stock options to pay tax on the spread between the purchase price and the grant price of the option. The Act contains provisions abating the tax, penalties and interest for underpayments related to the receipt of incentive stock options and increasing the AMT refundable credit amount for penalties and interest that were paid prior to the Act's passage. The Act also allows individuals, even those who paid their incentive stock option AMT liabilities, to accelerate the refund of the minimum tax credit that has not been used.

Individual Extender Provisions

The Act extended the expiration dates of a number of benefits for individual taxpayers that had either already expired or were scheduled to expire at the end of 2008.

• Under the American Jobs Creation Act of 2004, taxpayers were allowed to elect an itemized deduction for state and local sales taxes instead of a deduction for state and local income taxes. However, this provision expired on December 31, 2007. The Act extends the provision to the end of 2009 and is effective for all of 2008.
• The Act also extends the above-the-line tax deduction for certain qualified higher education expenses to the end of 2009.
• The Housing and Economic Recovery Act of 2008 added a real property tax deduction to the standard deduction for taxpayers who do not file itemized returns and therefore do not receive a deduction for their property taxes. The Act extends this provision, which originally applied only to tax year 2008, to the end of 2009.
• The Pension Protection Act of 2006 allowed taxpayers to make tax-free contributions to qualified charitable organizations from Individual Retirement Accounts. This benefit expired on December 31, 2007. The Act extends the benefit to the end of 2009 and is effective for contributions made during 2008.
• The Mortgage Forgiveness Debt Relief Act of 2007 excluded from taxable income debt forgiven before the end of 2009 in a foreclosure or write-down of principal on a mortgage on a principal residence. The Act extends for an additional three years the exclusion from taxable income, but does not extend the exclusion to home equity loans used for purposes other than improvements or additions to the principal residence.

Business Extender Provisions

The Act also extended the expiration dates of several tax benefits available to businesses that either had already expired or were scheduled to expire at the end of 2008.

• The Act extends the availability of tax credits that cover up to 20% of qualified research and development spending to the end of 2009.
• U.S. companies with foreign subsidiaries engaged in the business of banking or finance may defer tax on the subsidiaries' earnings if those earnings qualify as active rather than passive income. Earnings are considered active if a subsidiary conducts substantial activity with respect to the business of banking or finance. The Act extends the deferral provision, which was originally scheduled to expire at the end of 2008, to the end of 2009.
• Businesses are currently allowed to defer taxes for interest payments, dividends, rents and royalties exchanged between controlled foreign corporations ("CFCs"). This benefit, which was scheduled to expire at the end of 2008, is designed to allow businesses to move capital between multiple CFCs without generating tax liability. The Act extends the benefit to the end of 2009.
• The Act also extends through 2009 provisions allowing enhanced deductions to businesses for qualified food inventory donations, computer contributions, and donations of books to schools and literacy programs.
• The Pension Protection Act of 2006 provided that with respect to charitable contributions of property by an S corporation prior to December 31, 2007, the shareholder's basis in the stock of the S corporation would be reduced by the shareholder's pro rata share of the adjusted basis of the contributed property. The Act extends this provision until the end of 2009.
• The American Jobs Creation Act shortened the cost recovery period to 15 years from 39 years for certain leasehold improvements and restaurant property placed in service prior to 2008. The Act extended this provision to the end of 2009 and included retail owners and new restaurants for the shortened recovery period for property placed in service during 2009 only.

Modification of Standard for Tax Return Preparer Penalty

Tax return preparers are subject to penalties when they prepare returns that misstate taxpayers' income tax liabilities. For undisclosed taxpayer positions, the Act reduces the standard that must be met by preparers from "more likely than not" to the easier to meet "substantial authority." This measure is intended to ensure that taxpayers and tax return preparers are subject to the same reporting standards.

Limits on Tax Benefits for Executive Compensation

Companies that participate under the Act may be subject to reduced deduction allowances for executive compensation. Section 162(m) of the Internal Revenue Code generally limits the annual deduction allowed for compensation (other than performance-based compensation) of a company's five most highly paid employees to $1 million per employee. That annual deduction limit will be reduced to $500,000 for any company selling at least $300 million of assets to the Treasury Department and selling at least some of those assets through the Act's troubled asset auctions. However, this reduction does not apply to companies who only sell their assets directly to the Treasury.

Modification of Child Tax Credit

Certain taxpayers receive a $1,000 tax credit for each qualifying child under the age of 17 that can be used to reduce their income tax liability. If this tax credit exceeds the taxpayer's income tax liability, the taxpayer is eligible for a refund if he meets an income threshold. The Act lowers the threshold from $12,050 to $8,500 for 2008.

Basis Reporting by Brokers on Sales of Stock

The Act creates mandatory basis reporting to the IRS by brokers for transactions with respect to publicly traded securities, such as stock, bonds, commodities, derivatives and other securities as designated by the Treasury.

Current Inclusion of Deferred Compensation Paid by "Tax Indifferent Parties"

With respect to services performed after 2008, the Act changes the tax treatment of deferred compensation that is payable by a tax indifferent entity, e.g. foreign corporations and partnerships having foreign partners located in jurisdictions with no, or low-income tax rates. Prior to the Act, employees and other service providers could defer paying tax on compensation until the compensation was paid. Under the Act, compensation deferred by a tax indifferent tax entity under a nonqualified deferred compensation plan is taxable to the service provider when the amount is no longer subject to a substantial risk of forfeiture or is not determinable, whichever is later. In addition, if taxation is deferred because the amount is not determinable, then the income tax on the deferred compensation is subject to an interest charge and also to a surcharge equal to 20% of the deferred compensation when the amount of the compensation is determinable.

Conclusion

The enactment of the Emergency Economic Stabilization Act of 2008 would not have been possible without the inclusion of multiple tax provisions benefiting individuals and businesses. Because many of these provisions expire at the end of 2009, taxpayers may have to act fast to take advantage of them. Schiff Hardin's Tax Department is closely monitoring these provisions, as well as the implementation of the Troubled Asset Relief Program provisions.

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Schiff Hardin LLP Tax attorneys advise clients on the tax aspects of the formation, financing, operation and termination of their business activities. Working in conjunction with the firm's corporate attorneys, clients are advised on the structuring of sophisticated business transactions involving mergers and acquisitions, reorganizations, liquidations and spin-offs in order to achieve optimal income tax results. Tax considerations also must be taken into account in connection with debt restructurings and financing transactions, including leveraged leases and sale-leasebacks. Our tax attorneys also represent taxpayers involved in federal, state and local tax controversies.

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