As the economy continues to improve, many companies have implemented or are considering implementing a compensatory stock option plan for executives and other key employees. Such a plan may consist of incentive stock options (ISOs) or nonqualified stock options (NSOs). Which type of plan will produce the best tax results in a given case will depend on a number of factors, such as the size and tax bracket of the issuing corporation, the employee’s tax bracket, whether the employee is subject to the alternative minimum tax (AMT), and whether the employee will hold the option shares for the long haul.

The evaluation is difficult even when tax rates are stable. It is more much difficult with the possibility that ordinary income and capital gain rates may rise in 2013 if the so-called Bush tax cuts are allowed to expire as currently scheduled. In addition, starting in 2013, some high-income taxpayers may face a 3.8% medicare surtax on capital gains (and other forms of investment income) under a provision that was part of the 2010 health reform legislation. It could be eliminated if the Supreme Court declares the entire legislation unconstitutional (or, possibly, if the Republicans win the White House and Congress in the November elections).

On May 7, Congress returned from a one-week recess to face a variety of bills carrying tax changes.

Highway bill. The first formal conference meeting on the Highway bill is scheduled to take place on May 8. The vehicle for the conference will be H.R. 4348, the Surface Transportation Extension Act of 2012, Part II, as amended with the text of S. 1813, the “Moving Ahead for Progress in the 21st Century Act” or MAP-21.
H.R. 4348 was approved by the House on April 18 (see ¶ 2062). The bill would provide for a second short-term extension of various highway-related excise tax provisions, including excise taxes on fuel used by certain buses, certain alcohol fuels, gasoline (other than aviation gasoline) and diesel fuel or kerosene, certain heavy trucks and trailers, and tires. Also included in the bill is a controversial provision permitting construction of the Keystone XL oil pipeline from Canada. The Administration has threatened to veto the final bill if it contains the Keystone provision.
S. 1813 was approved by the Senate back on March 14. The Senate’s version authorizes various highway and transportation funding for two years and also provides a number of important tax changes, including pension funding relief, a higher exclusion amount for employer-provided transit and vanpooling benefits, and revised rules for certain corporate reorganizations. See Weekly Alert ¶ 103/22/2012 for details.
Student loan interest bill. The Senate was scheduled to vote on May 7, on the motion to invoke cloture on the motion to proceed to S. 2343, the “Stop Student Loan Interest Rate Hike Act of 2012.” The bill aims to keep the interest rate on college students’ loans from doubling on July 1, 2012, and would pay for the cost of keeping the current 3.4% loan rate in place by closing what’s seen as an S Corporation employment tax “loophole.” According to a summary of the legislation, the loophole would be closed by requiring those with incomes over $250,000 to include, for purposes of employment taxes, income received from a S Corporation or limited partnership interest in a professional services business. The change would target only those S Corporations that derive 75% or more of their gross revenues from the services of three or fewer shareholders or where the S Corporation is a partner in a professional service business.

On April 27, the House of Representatives by a vote of 215 to 195 passed its version of the student loan bill, H.R.4628, the “Interest Rate Reduction Act.” The bill would pay for keeping student loan interest at current levels by eliminating funding designated for prevention and public health programs by the 2010 health care reform law. The White House has said if the President is presented with H.R. 4628, as passed by the House, his senior advisors would recommend that he veto the bill.

Small business tax bill. During the current three-week work period, Congress will grapple with competing versions of a bill to provide tax breaks to small businesses.
On April 18, the House of Representatives passed H.R. 9, the “Small Business Tax Act,” by a vote of 235 to 173. H.R. 9, a Republican-backed bill, would allow qualified small businesses (those with fewer than 500 employees) to claim a new 20% deduction. In general, the deduction, which would be similar to the Code Sec. 199 domestic production activities deduction (and would be coordinated with that deduction), would be equal to 20% of the lesser of:

(1) qualified domestic business income (generally, domestic business gross receipts less cost of goods sold allocable to such receipts, less other expenses, losses or deductions allocable to such receipts); or
(2) taxable income (without regard to the new deduction) for the tax year.

The new small business deduction couldn’t exceed 50% of the greater of: (a) W-2 wages paid to non-owners of the business; or (2) W-2 wages paid to non-owner family members of direct owners, plus W-2 wages paid to 10%-or-less direct owners. Certain partners’ distributive shares of partnership items could be treated as W-2 wages for purposes of the new deduction.

The bill, which would apply for the first tax year of the taxpayer beginning after Dec. 31, 2011, does not carry any offsets to pay for the small business deduction. The White House has previously said that the President would veto the measure if it passes Congress because the Administration believes that “this bill is not an effective way to incentivize small business investment and job creation.” (See ¶ 2057)

The Senate, for its part, will consider S. 2237, the “Small Business Jobs and Tax Relief Act of 2012.” This bill, favored by the Democrats, would create a tax credit for new payroll added in 2012 through hiring or by increasing wages. The credit would equal 10% of the excess of wages and compensation paid during calendar year 2012 over what was paid during 2011. There would be a $5 million maximum increase in eligible wages taken into account for the credit, thereby capping the amount of the credit at $500,000. S. 2237 also would retroactively extend 100% bonus first-year depreciation to apply to qualifying new property bought and placed in service before 2013 (before 2014, for certain aircraft and long-production-period property). Current law’s option to claim 50% bonus first-year depreciation for qualifying new property bought and placed in service before Jan. 1, 2013 (before Jan. 1, 2014 for certain aircraft and long-production-period property) would be kept in place. Finally, the bill would expand the election to accelerate AMT credits in lieu of bonus depreciation.

Sequester bill. This week, the House of Representatives will consider the “Sequester Replacement Reconciliation Act of 2012.” The bill, which deals with automatic spending cuts, carries two tax provisions. The first would amend Code Sec. 36B(f), to provide for full recapture of overpayments resulting from certain federally subsidized health insurance. This change would apply to tax years ending after 2013. The second change would amend Code Sec. 24, to require taxpayers to provide social security numbers to claim the refundable portion of the child care credit. This change would be effective for tax years beginning after the enactment date.

There are unique provisions in India’s Finance Bill for 2012, and speculation exists on whether the stern positions that India is taking in the Bill, as well as its formal declaration that it will not follow the OECD transfer pricing guidelines, are indications that the BRICS could embark on developing a new “source country” treaty model. These developments suggest that the Indian government believes that (1) India can attract foreign investment regardless of its taxation policies and practices, and (2) the OECD is losing relevance in a changing global economy. Not surprisingly, the U.S., U.K., and other OECD countries, for the most part, resisted this suggestion.

An IRS official advised that review of the first round of Schedules UTP (Statement of Uncertain Tax Position) indicates that, for the most part, taxpayers have done a sound job of reporting. Where the descriptions were not well stated, the Service will make “soft” contacts advising how the statements should be upgraded for the second round of filings.

On April 26, the House Ways & Means Select Revenue Measures Subcommittee will hold a hearing on tax extenders. Ahead of the hearing, the Joint Committee on Taxation released a report titled “Legislative Background of Selected Federal Tax Provisions Scheduled to Expire in 2011 or 2012.”

On April 24, the Senate sent the surface transportation bill to a joint Senate-House conference committee. H.R.4348, the Surface Transportation Extension Act of 2012, Part II, as amended with the text of S.1813, the “Moving Ahead for Progress in the 21st Century Act” or MAP-21, is the vehicle for the conference. The committee is charged with reconciling the two versions of the bill, which contain significant differences.

H.R. 4348 was approved by the House on April 18 (see ¶ 2062). The bill would provide for a second short-term extension of various highway-related excise tax provisions, including excise taxes on fuel used by certain buses, certain alcohol fuels, gasoline (other than aviation gasoline) and diesel fuel or kerosene, certain heavy trucks and trailers, and tires. Also included in the bill is a controversial provision permitting the Keystone XL oil pipeline from Canada. The Administration has threatened to veto the final bill if it contains the Keystone provision.

S.1813 was approved by the Senate back on March 14. The Senate’s version authorizes various highway and transportation funding for two years and also provides a number of important tax changes, including pension funding relief, a higher exclusion amount for employer-provided transit and vanpooling benefits, and revised rules for certain corporate reorganizations. See Weekly Alert ¶ 103/22/2012 for details.

The following senators were appointed as conferees: Barbara Boxer (D-CA), Max Baucus (D-MT), John D. Rockefeller (D-WV), Richard Durbin (D-IL), Tim Johnson (D-SD), Charles Schumer (D-NY), Bill Nelson (D-FL), Robert Menendez (D-NJ), James Inhofe (R-OK), David Vitter (R-LA), Orrin Hatch (R-UT), Richard Shelby (R-AL), Kay Bailey Hutchison (R-TX), and John Hoeven (R-ND).

On April 18, the House of Representatives passed H.R.9, the “Small Business Tax Act” by a vote of 235 to 173, sending the bill to the Senate for consideration. H.R. 9, which was introduced by House Majority Leader Eric Cantor (R-VA), would allow qualified small businesses (those with fewer than 500 employees) to claim a new 20% deduction. In general, the deduction, which would be similar to the Code Sec. 199 domestic production activities deduction (and would be coordinated with that deduction), would be equal to 20% of the lesser of:

(1) qualified domestic business income (generally, domestic business gross receipts less cost of goods sold allocable to such receipts, less other expenses, losses or deductions allocable to such receipts); or
(2) taxable income (without regard to the new deduction) for the tax year.

The new small business deduction couldn’t exceed 50% of the greater of: (a) W-2 wages paid to non-owners of the business; or (2) W-2 wages paid to non-owner family members of direct owners, plus W-2 wages paid to 10%-or-less direct owners. Certain partners’ distributive shares of partnership items could be treated as W-2 wages for purposes of the new deduction.

For a qualified small business that is a partnership and that so elects, the portion of the entity’s qualified domestic business taxable income for the tax year that is allocable to each qualified service-providing partner would be treated as W-2 wages paid during that tax year to an employee who is a 10%-or-less direct owner. The domestic business gross receipts of the partnership for the tax year would have to be reduced by any amount treated as W-2 wages under this rule. Under an amendment in the nature of a substitute to H.R. 9, a qualified service-providing partner would be any partner who is a 10%-or-less direct owner and who materially participates in the trade or business to which the income relates.

Gross receipts and W-2 wages taken into account under the new deduction could not be taken into account for Code Sec. 199 purposes.

The bill, which would apply for the first tax year of the taxpayer beginning after Dec. 31, 2011, does not carry any offsets to pay for the small business deduction.

The White House has previously said that the President would veto the measure if it passes Congress because the Administration believes that “this bill is not an effective way to incentivize small business investment and job creation.”

On April 18, the House by a vote of 293 to 127 approved H.R. 4348, the Surface Transportation Extension Act of 2012, Part II. Among other things, the bill would provide for a second short-term extension (see ¶ 2056) of various highway-related excise tax provisions. For example, the bill would extend through September 30, 2012, excise taxes on: (1) fuel used by certain buses, (2) certain alcohol fuels, (3) gasoline (other than aviation gasoline) and diesel fuel or kerosene, (4) certain heavy trucks and trailers, and (5) tires. These taxes were previously scheduled to expire at the end of June. Also included in the bill is a provision permitting the Keystone XL oil pipeline from Canada.

H.R. 4348 will have to be reconciled with the Senate’s version of the bill. The transportation bill approved by the Senate back on March 14 (S. 1813, the “Moving Ahead for Progress in the 21st Century Act” or MAP-21) includes a number of important tax changes including pension funding relief, a higher exclusion amount for employer-provided transit and vanpooling benefits, and revised rules for certain corporate reorganizations.

A new Congressional Research Service (CRS) report examines the tax provisions currently set to expire at the end of the year and the budgetary costs and policy considerations associated with extending them. These include the so-called Bush tax cuts, the alternative minimum tax (AMT) patch, the payroll tax cut, and a host of other miscellaneous provisions and “tax extenders.”