The “American Jobs Creation Act of 2004” was signed into law on October 22, 2004, after months of debate on how to proceed with this legislation to repeal the exclusion for extraterritorial income, which the World Trade Organization had ruled amounted to an illegal export subsidy. The Act goes well beyond addressing the illegal subsidy and creates billions of dollars of new tax breaks for a broad spectrum of taxpayers. However, it is fully offset by a number of revenue provisions. Below is a brief outline of key provisions of the Act, which is over 600 pages long. Below is a brief outline of key provisions of the Act.

Repeal of Exclusion for Extraterritorial Income (ETI)

• For transactions after 2004, the Act repeals the ETI system of tax benefits subject to transition relief for 2005 and 2006 and grandfather rules for contracts entered into before Sept. 18, 2003. (Act Sec. 101)
  
• For tax years beginning after 2004, the Act provides a 9% deduction (equal to a 3% rate cut) on all manufacturing (and certain other domestic production) activity undertaken in the U.S., whether it is exported or not. The deduction is available to C corporations, S corporations, partnerships, sole proprietorships, cooperatives, and estates and trusts, and is allowed for AMT purposes. The deduction is phased in over five years: 3% in 2005-2006, 6% for 2007-2009, and 9% after 2009. (Act Sec. 102)

Business Tax Incentives

• The Act extends for an additional two years the increased amounts that a taxpayer may expense under Code Sec. 179 ($100,000 indexed for inflation) and other expensing enhancements so that they continue through 2007 tax years. (Act Sec. 201)
  
• The Act treats qualified leasehold improvements and restaurant property placed in service after October 22, 2004 and before 2006 as 15-year recovery property depreciated on a straight-line basis.
  
• The Act directs IRS to issue new regs for the designation of targeted areas for the new markets tax credit. (Act Sec. 221)
  
• For tax years beginning after 2004, the Act allows family members to elect to be treated as one shareholder for purposes of determining the number of shareholders of an S corporation (Act Sec. 231) and increases the maximum number of S shareholders from 75 to 100. (Act Sec. 232)
  
• The Act allows an IRA to hold S corporation bank stock that the IRA held on the enactment date with the IRA owner treated as the shareholder and allows the stock to be sold to the beneficiary for fair market value upon the corporation making an S election. (Act Sec. 233)
  
• For tax years beginning after 2004, the Act disregards unexercised powers of appointment in determining the potential current beneficiaries of a special type of trust for holding S stock known as an electing small business trust (ESBT), and increases the period during which a trust can dispose of stock after an ineligible shareholder becomes a potential current beneficiary from 60 days to one year. (Act Sec. 234)
  
• For tax years beginning after 2004, the Act allows suspended losses to be transferred with transfers of S stock to a spouse or former spouse incident to divorce. (Act Sec. 235)
  
• For tax years beginning after 2004, the Act permits a beneficiary of a qualified Subchapter S trust (QSST) to deduct suspended losses under the at-risk and passive loss rules when the trust disposes of S stock. (Act Sec. 236)
  
• For elections and terminations after 2004, the Act provides relief from inadvertently invalid qualified Subchapter S subsidiary (QSub) elections and terminations (Act Sec. 238) and allows QSubs to file information returns. (Act Sec. 239)
  
• For distributions after '97, the Act permits an S corporation to use distributions on stock held by its ESOP to repay loans, provided that stock of at least equal value is allocated to participant accounts. (Act Sec. 240)
  
• For Small Business Investment Companies (SBICs) formed after October 22, 2004, the Act excludes from the debt-financed property rules debt incurred by an SBIC that is evidenced by a debenture issued by it under section 303(a) of the Small Business Investment Act of 1958 and that is held or guaranteed by the Small Business Administration. (Act Sec. 247)
  
• For tax years beginning after October 22, 2004, the Act generally allows corporations to elect a "tonnage tax" on their taxable income from certain shipping activities in lieu of the U.S. corporate income tax. (Act Sec. 248)
  
• For options exercised after October 22, 2004, the Act excludes certain stock options and stock purchase plans from employee wages for payroll tax and income tax withholding purposes. (Act Sec. 251)

Agricultural Tax Relief and Incentives

• The Act repeals the reduced rates of excise tax for most alcohol-blended fuels and instead creates two new excise tax credits: the alcohol fuel mixture credit (Act Sec. 301) and the biodiesel mixture credit. (Act Sec. 302).
  
• For any tax year for which the due date (without regard for extensions) for the return is after 2002, if a rancher is forced to sell livestock as a result of drought he must pay tax on any gain unless he reinvests in livestock or, as added by the Act, in other ranch equipment or property, within 4 years (increased from 2-years under pre-Act law). (Act Sec. 311)
  
• Effective after October 22, 2004, the Act provides that, to the extent provided in organizational documents of the cooperative, dividends on capital stock won't reduce patronage income or prevent the cooperative from being treated as operating on a cooperative basis. (Act Sec. 312)
  
• For tax years after October 22, 2004, the Act provides that the small producer tax credit flows through to cooperative members. (Act Sec. 313)
  
• For tax years beginning after 2003, the Act extends the option of income averaging, which under pre-Act law is available to farmers, to individuals engaged in the trade or business of fishing and it coordinates income averaging with the AMT so that use of averaging won't increase AMT. (Act Sec. 314)
  
• The Act provides capital gains treatment on the outright sale of timber by a landowner after 2004. (Act Sec. 315)
  
• The Act extends the 50% bonus depreciation for small aircraft by one year so that it applies through 2005. (Act Sec. 336)

Tax Reform and Simplification for U.S. Businesses

• The Act includes several provisions to reduce double taxation of U.S.-based companies, such as reducing the foreign tax credit (FTC) baskets from nine to two for tax years beginning after 2006 (Act Sec. 404) and allowing FTCs to be carried forward for 10 years instead of five for excess foreign tax credits that may be carried to any tax years ending after October 22, 2004. (Act Sec. 417).
  
• For tax years beginning after 2004, the Act repeals the 90-percent limitation on the use of FTCs against AMT. (Act Sec. 421)
  
• The Act encourages companies to reinvest foreign earnings in the U.S. by temporarily making certain dividends received by a U.S. corporation from controlled foreign corporations eligible for an 85% dividends-received deduction. At the taxpayer's election, this deduction is available for dividends received either during (i) the taxpayer's first tax year beginning on or after October 22, 2004, or (ii) the taxpayer's last tax year beginning before such date. (Act Sec. 422)

Deduction of State and Local General Sales Taxes

• For 2004 and 2005, the Act allows taxpayers to deduct state and local sales taxes instead of state income taxes. Taxpayers may deduct their actual sales taxes or use IRS-published tables. (Act Sec. 501)

Miscellaneous Provisions

• For property acquired after 2004 and before 2010, the Act excludes from unrelated taxable income of tax-exempt investors gain or loss from the sale or exchange of a qualifying brownfield property and excepts such property from the debt-financed property rules. (Act Sec. 702)
  
• For a judgment or settlement occurring after October 22, 2004, the Act allows an above-the-line deduction for attorney's fees and court costs incurred in connection with an unlawful discrimination claim. (Act Sec. 703)
  
• Generally for electricity sold and produced after October 22, 2004, the Act expands the credit for electricity produced from renewable resources to include open-loop biomass, geothermal and solar energy, small irrigation power, landfill gas, trash combustion and refined coal production facilities. (Act Sec. 710)
  
• For tax years ending after October 22, 2004, the Act allows the tax credits for alcohol fuels and for the production of electricity to be applied against AMT. (Act Sec. 711)

Anti-Tax Shelter Provisions

The Act contains a number of revenue offsetting provisions that are designed to shut down abusive tax shelters, including the following:

• For returns and statements due after October 22, 2004, the Act adds a new penalty for failing to disclose reportable transactions which applies without regard to whether the transaction ultimately results in an understatement of tax. The penalty is $10,000 for a natural person ($50,000 in any other case). These amounts are increased to $100,000 and $200,000 respectively for listed transactions. (Act Sec. 811)
  
• For tax years ending after October 22, 2004, the Act modifies the accuracy related penalty by replacing the rules for tax shelters with a new accuracy-related penalty that applies to listed transactions and reportable transactions with a significant tax avoidance purpose. The penalty rate and defenses available to avoid the penalty vary depending on whether the transaction was adequately disclosed. In general, a 20% penalty is imposed on any understatement attributable to an adequately disclosed listed transaction or reportable avoidance transaction. If the taxpayer does not adequately disclose the transaction, the reasonable cause exception (as strengthened by the Act) is not available (i.e., a strict-liability penalty applies), and the taxpayer is subject to an increased penalty equal to 30% of the understatement. (Act Sec. 812)
  
• Communications made after October 22, 2004 with respect to tax shelters are not subject to the confidentiality provision that otherwise applies to a communication between a taxpayer and a federally authorized tax practitioner. (Act Sec. 813)
  
• For tax years with respect to which the period for assessing a deficiency did not expire before the enactment date, the Act extends the statute of limitations (SOL) with respect to a listed transaction if a taxpayer fails to include on any return or statement for any tax year any information with respect to a listed transaction which is required to be included with the return or statement. For such a transaction, the SOL won't expire before the date that's one year after the earlier of (1) the date on which IRS is furnished the required information, or (2) the date that a material advisor satisfies the list maintenance requirements with respect to a request by IRS. (Act Sec. 814)
  
• For transactions with respect to which material aid, assistance or advice is provided after October 22, 2004, the Act repeals the pre-Act law rules for registration of tax shelters and instead requires each material advisor with respect to any reportable transaction (including any listed transaction) to timely file an information return with IRS. (Act Sec. 815)
  
• For returns due after October 22, 2004, the Act repeals the pre-Act law penalty for failure to register tax shelters and instead imposes a penalty on any material advisor who fails to file an information return, or who files a false or incomplete information return, with respect to a reportable transaction (including a listed transaction). The amount of the penalty is $50,000 except that for a listed transaction, the amount of the penalty is increased to the greater of (1) $200,000, or (2) 50% of the gross income of such person related to aid, assistance, or advice which is provided with respect to the transaction before the date the information return that includes the transaction is filed. (Act Sec. 816)
  
• For transactions for which material aid, assistance or advice is provided after October 22, 2004, each material advisor with respect to a reportable transaction (including a listed transaction) must maintain a list that (1) identifies each person with respect to whom the advisor acted as a material advisor for the reportable transaction, and (2) contains other information as may be required by IRS. (Act Sec. 815)
  
• For requests made after October 22, 2004, the Act modifies the penalty for failing to maintain the required list (covered in the preceding item) by making it a time-sensitive penalty. Thus, a material advisor who is required to maintain an investor list and who fails to make the list available upon written request by IRS within 20 business days after the request will be subject to a $10,000 per day penalty. (Act Sec. 817)
  
• For activities occurring after enactment date, the Act modifies the penalty on promoters of tax shelters to be 50% of the gross income derived by the person from the activity for which the penalty is imposed. The new penalty rate applies to any activity that involves a statement regarding the tax benefits of participating in a plan or arrangement if the person knows or has reason to know that such statement is false or fraudulent as to any material matter. (Act Sec. 818)
  
• For tax years beginning after October 22, 2004, the Act modifies the definition of "substantial" for corporate taxpayers for purposes of the accuracy-related penalty for substantial understatements so that a corporate taxpayer has a substantial understatement if the amount of the understatement for the tax year exceeds the lesser of (1) 10% of the tax required to be shown on the return for the tax year (or, if greater, $10,000), or (2) $10 million. (Act Sec. 819)
• Effective the day after October 22, 2004, IRS may seek an injunction against a material advisor to enjoin the advisor from (1) failing to file an information return for a reportable transaction, or (2) failing to maintain, or to timely furnish upon written request by IRS, a list of investors with respect to each reportable transaction. Also, IRS may seek injunctions for violations of the rules under Circular 230. (Act Sec. 820)
  
• For failures to report occurring on or after October 22, 2004, the Act adds an additional civil penalty of up to $10,000 for violating the requirement that citizens, residents, or persons doing business in the U.S. must file reports when they make a transaction or maintain an account with a foreign financial entity. (Act Sec. 821)
  
• For actions taken after October 22, 2004, those violating the Circular 230 rules of practice before IRS may be censured or hit with monetary penalties. (Act Sec. 822)
  
• For underpayments attributable to transactions entered into in tax years beginning after October 22, 2004, the Act disallows any deduction for interest paid or accrued within a tax year that is attributable to an understatement arising from an undisclosed listed transaction or from an undisclosed reportable avoidance transaction (other than a listed transaction). (Act Sec. 838)

Other Offsetting Revenue Provisions:

The Act further offsets costs by, among other items,

• Reducing tax avoidance through corporate inversions and individual expatriation. (Act Secs. 801 - 806)
  
• Closing various loopholes. (various Act Secs.)
  
• Combating fuel tax evasion. (Act Sec. 851 - 871)
  
• Tightening (a) the reporting rules for noncash charitable contributions (Act Sec. 883) and (b) the rules for deducting contributions charitable contributions of (i) patents and similar property made after June 3, 2004 (Act Sec. 882), and (ii) motor vehicles, boats and airplanes made after 2004. (Act Sec. 884)
  
• Making it more difficult to defer tax on nonqualified deferred compensation for amounts deferred in tax years beginning after 2004. (Act Sec. 885)
  
• Extending IRS user fees. (Act Sec. 891)
  
• Limiting the amount of the cost of an SUV that may be expensed in a single year to $25,000 for property placed in service after October 22, 2004. (Act Sec. 910)