Friday, March 16, 2012

The surface transportation bill OK'd by the Senate on March 14 is primarily legislation that would overhaul a number of federal highway-related programs. However, the 1500-plus page bill—formally known as S. 1813, the “Moving Ahead for Progress in the 21st Century Act” or MAP-21—also includes a number of important tax changes. These include “parity” for employer-provided mass transit and parking benefits, changes for “reverse Morris Trust” corporate transactions, significant pension funding relief, and AMT changes for private activity bonds. A summary released March 15 indicates that the bill includes new reporting rules for certain sales of life insurance policies and a one-year delay in the worldwide interest expense allocation method.

Here are highlights of the tax changes in the Senate-passed surface transportation bill.

Parity for employer provided mass transit and parking benefits. For 2011, there was parity for exclusion from income for employer-provided mass transit and parking benefits under Code Sec. 132(f). The exclusion was $230 per month for each of these breaks in 2011. However under current law, for 2012, the exclusion under current law is $240 for qualified parking (due to an inflation adjustment) but only $125 for employer-provided transit and vanpooling benefits.

Under the bill, effective for months after Dec. 31, 2011, the 2012 exclusion amount for employer-provided transit and vanpooling benefits would be increased from $125 to $240. According to an early summary of the provision, in order for the extension to be effective retroactive to Jan. 1, 2012, expenses incurred before the enactment date by employees for vanpool and transit benefits could be reimbursed by employers on a tax-free basis to the extent they exceed $125 per month and are less than $240.

Reverse Morris Trust transactions. Under current law, in certain corporate reorganizations involving a spin-off of a subsidiary, the subsidiary can issue its stock or debt securities in the transaction without triggering gain to the parent corporation on the transaction. This includes transactions commonly referred to as “Reverse Morris Trust” transactions. Gain is recognized to the extent of the value of money or other property distributed by the subsidiary in the reorganization. Thus, if the subsidiary borrows and distributes cash, or assumes debt of the parent, gain will be recognized. But if the subsidiary distributes its own debt securities in the transaction, no gain is recognized even though the economic result is equivalent to the subsidiary's direct assumption of the parent's debt.

S. 1813 would treat distributions of debt securities to the parent in reorganization transactions involving a spin-off in the same way as distributions of cash or other property in the reorganization. The change would generally apply to exchanges after the enactment date, but under a transition rule the following transactions would be exempt: those made pursuant to a written agreement which was binding on Feb. 6, 2012, and at all times thereafter; those described in a ruling request submitted to IRS on or before Feb. 6, 2012; or those that are transactions described on or before Feb. 6, 2012, in a public announcement or in a filing with the Securities and Exchange Commission.

Funding break for employers maintaining pension plans. For pension minimum funding purposes, plan liabilities are calculated by discounting future payments to a present value by using required interest rates based on corporate bonds. In particular, plans must discount future liabilities using three different interest rates (segment rates), depending on the length of time until the liabilities must be paid. These rates are derived from a “yield curve” of investment-grade corporate bonds averaged over the most recent 24 months. Present value is inversely related to the interest rate used to arrive at present value, and, as a result, the lower the corporate bond rates used to calculate plan liabilities, the greater the funding liability.

As a result of the current, low interest rate climate, pension plan contributions have been very high, and there is concern this will lead to company layoffs or pension plan freezes.

Under the bill, plan liabilities would continue to be determined based on corporate bond segment rates, which are based on the average interest rates over the preceding two years. However, for plan years beginning in calendar year 2012, for purposes of the minimum funding rules, the segment rates would be adjusted up or down, as necessary, to an amount equal to either 90% or 110% of the 25-year historic average of interest rates, whichever is closest. In today's low-rate environment, the immediate effect of the change would be to raise interest rates for funding purposes and thereby lower the minimum required pension contribution.

For plan years beginning in calendar year 2013, the interest rate “corridor” would expand in 5% increments each year until it reaches 30% above and 30% below the 25-year historic average of interest rates. Thus, for plan years beginning in a calendar year after 2015, the segment rates would be adjusted to an amount equal to 130% or 70% of the 25-year average, whichever is closest.

Extension for using excess pension assets for future retiree health benefits; expansion for transfers to retiree life insurance. Certain “excess assets” may be transferred from an ongoing defined benefit plan to a health account (within the defined benefit plan) to be used for health costs for retirees covered by the plan. Under current law, such transfers are only permitted to be made through Dec. 31, 2013.

S. 1813 would  permit such transfers to be made through Dec. 31, 2021. In addition, for transfers made after the enactment date, transfers of excess pension assets could be made to an applicable life insurance account (in very broad terms, a separate account established and maintained for amounts transferred under Code Sec. 420 for qualified current retiree liabilities based on premiums for applicable life insurance benefits).

Reporting of life settlement transactions. The bill would require information reporting upon the sale of an existing life insurance policy. It's designed to “aid the seller” in determining the amount of taxable profit from the sale of the policy by providing the seller with information about the purchase price and basis in the policy. The change would not apply to the initial sale of a life insurance policy by a life insurance company to an individual, but if the policy owner sells the policy to a third party the reporting provisions would apply. In general, the change would apply to reportable policy sales after Dec. 31, 2012. For transactions entered into after Aug. 25, '99, the bill also would repeal a controversial basis calculation rule for certain life insurance policies.

Delay of worldwide interest expense allocation method. A summary of the surface transportation bill says S. 1830 would delay the use of the worldwide interest expense allocation method by one year. Under this method, taxpayers may elect to use an alternative method for allocating interest expense between U.S. and foreign sources for purposes of determining a taxpayer's foreign tax credit limitation. The worldwide method is generally preferred by U.S. corporations with foreign subsidiaries, because using the worldwide method typically results in less of a restriction on the use of the foreign tax credit. That's because, under the worldwide method, foreign financing costs are taken into account, which means that U.S. financing costs are allocated fully against U.S.-source income instead of being partly allocated to foreign-source income. This election was to have been available for tax years beginning after 2008, but in 2008, the phase-in of this rule was delayed for two years (for tax years beginning after 2010). Additionally, in November of 2009, the phase-in of this rule was delayed for an additional seven years (for tax years beginning after 2017), and in March of 2010, the phase-in was further delayed to tax years beginning after 2020.

The bill would delay implementation by one additional year, to tax years beginning after 2021.

AMT relief for private activity bonds. Tax-exempt interest on private activity bonds issued after the enactment date and before Jan. 1, 2013, wouldn't be an item of tax preference for purposes of the alternative minimum tax (AMT). Additionally, tax-exempt interest on private activity bonds issued after the enactment date and before Jan. 1, 2013, wouldn't be included in the corporate adjusted current earnings adjustment.

Longer writeoffs for leased highway property. States or their political subdivisions may contract with a private entity to lease an existing highway or build a new one, and then operate the highway for a number of years. Although these transactions generally are structured as a lease (plus grant of a franchise permitting the private entity to collect tolls), the private entity is treated as the owner because it has the burdens and benefits of ownership.

Under the bill, for leases entered into after the enactment date, the highway property would have to be depreciated over 45 years (instead of 15), and the cost of the grant of the franchise to collect tolls would have to be amortized over a period that's not less than the term of the applicable lease (instead of 15 years under Code Sec. 197). For bonds issued after the enactment date, the bill also would bar private activity bond financing of applicable leased highway property.

Revocation or denial of passport of individuals owing more than $50,000 in back taxes. Effective on Jan. 1, 2013, the bill would authorize the government to deny the application for a new passport or renewal of an existing passport when the individual has more than $50,000 (indexed for inflation) of “seriously delinquent tax debt.” The government also could revoke a passport upon reentry into the U.S. for such individuals.

Other changes. The bill would clarify that funds on federal employees' thrift savings accounts are subject to legal process by IRS for payments of delinquent taxes. It also would permit IRS to impose a levy of up to 100% (up from current law's 15%) against Medicare service providers with tax delinquencies. S. 1813 also would extend various highway-related excise taxes through Sept. 30, 2015, and extend the highway trust fund expenditure authority through Sept. 30, 2013.

Summary of the Senate Finance Committee Title to S.1813, MAP21
Extension of Highway Trust Fund Expenditure Authority
Under present law, revenues from the highway excise taxes, as imposed through March 31, 2012, generally are
dedicated to the Highway Trust Fund. Dedication of excise tax revenues to the Highway Trust Fund are
governed by the Internal Revenue Code (IRC). The IRC authorizes expenditures (subject to appropriations) from
the Highway Trust Fund through March 31, 2012. This provision would extend the expenditure authority for the
Highway Trust Fund through September 30, 2013.
Extension of HighwayRelated
Six separate excise taxes are imposed to finance the Federal Highway Trust Fund program. Three of these taxes
are imposed on highway motor fuels. The remaining three are a retail sales tax on heavy highway vehicles, a
manufacturers’ excise tax on heavy vehicle tires, and an annual use tax on heavy vehicles. The annual use tax on
heavy vehicles expires October 1, 2012. Except for 4.3 cents per gallon of the Highway Trust Fund fuels tax rates
(which is permanent), the remaining taxes are scheduled to expire after March 31, 2012. This provision would
extend the motor fuel taxes, and all three non‐fuel excise taxes at their current rates through September 30,
2015. (212) 588-1113
Alvin S. Brown, Esq.
Tax attorney

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