Weekly Report

By the Tax Management Editorial Staff
Washington, D.C.

On December 16, 2005, the House and Senate approved by unanimous consent a long-negotiated package (H.R. 4440) of business and individual tax breaks meant to help the Gulf Coast recover from the fall's spate of hurricanes. The Act also contains a host of technical corrections to previously enacted legislation. The Tax Technical Corrections Act of 2005 was originally introduced in the House as H.R. 3376 and in the Senate as S. 1447. The Act includes significant corrections pertaining to the §199 deduction for domestic production activities, the repatriation of foreign dividends and §965 dividends received deduction, and nonqualified deferred compensation plans under §409A. President Bush signed the Act into law December 21.

The following is a discussion of the technical corrections sections of the Act.

TITLE IV--TECHNICALS

Public Holding Company Act. The Act repeals §§1081-1083 (relating to exchanges in obedience to SEC orders) to conform to the repeal of the Public Utility Holding Company Act of 1935. The repeal does not apply to any exchange, expenditure, investment, distribution, or sale made in obedience to an order of the Securities and Exchange Commission. The Act removes §§1245(b)(5) and 1250(d)(5) (providing special rules for gain from dispositions of certain depreciable property in obedience to SEC orders under §1081). These amendments do not apply with respect to any transaction ordered in compliance with the Public Utility Holding Company Act of 1935 before its repeal. [Act §402(a)]

Credit for electricity produced from renewable sources. The Act amends §45(c)(3)(A)(ii) to change the wording of the reference to "nonhazardous lignin waste material" to "lignin material" so as not to infer that lignin is hazardous or waste. [Act §402(b)]

Clean renewable energy bonds. The Act repeals §54(l)(5), as it may provide a double benefit when computing the estimated tax penalty in the manner prescribed under §§6654(f) and 6655(g). The Act also amends the effective date of conforming amendments associated with the enactment of §54 to be effective for taxable years beginning after 2005. [Act §402(c)]

Advanced nuclear power credit. The Act clarifies the production credit for advanced nuclear power (§45J) to carry out the intent that the phase-out is indexed for inflation but the credit rate is not indexed for inflation. Specifically, the Act provides that it is not intended that the inflation adjustment rule referred to in §45J(e) be interpreted to apply to the credit rate in §45J(a)(1) as well as the phase-out referred to in §45J(c)(2). Effective as if included in the 2005 Energy Policy Act. [Act §402(d)]

Pollution control facilities. The Act clarifies that the 84-month amortization period (applicable to certain atmospheric pollution control facilities under §169(d)(5)) only applies to facilities used in connection with a plant or other property placed in service after December 31, 1975. Effective as if included in the 2005 Energy Policy Act. [Act §402(e)]

Net operating losses. The Act makes minor clerical changes to net operating loss carryover rules for transmission property and pollution control investments. [Act §402(f)]

Nonconventional source fuels credit. The Act clarifies that the credit is allowable without the requirement to make an election. [Act §402(g)]

Energy efficient commercial buildings deduction. The Act repeals as deadwood certain language in §1250. [Act §402(h)]

Residential energy efficient property credit. The Act clarifies that the dollar limitations for the residential energy efficient property credit (§25D) are applied without regard to carryovers of the credit from prior taxable years. The Act redrafts the joint occupancy rule to apply to expenditures with respect to a dwelling unit rather than the credit allowed with respect to the unit. The Act also redrafts the rules relating to the carryover of unused personal credits (including the new credit for residential energy efficient property) so as to include in the Code rules for both the taxable years in which the credits are allowed against the alternative minimum tax (AMT), and the taxable years in which the credits are not so allowed. Effective as if included in the 2005 Energy Policy Act, except for the rules relating to the coordination of personal credits, which apply to taxable years beginning after December 31, 2005. [Act §402(i)]

Alternative motor vehicle credit and credit for alternative fuel vehicle refueling property. The Act provides that the credits for property sold to a tax-exempt entity are subject to the business credit limitations, rather than the personal credit limitations, as the property is subject to the allowance for depreciation. [Act §402(j), (k)]

Research credit. The Act clarifies that the rule preventing amounts from being taken into account more than once also applies to the provisions of the research credit relating to energy research consortia. The Act also clarifies that qualified research with respect to energy research consortia must be conducted in the United States or Puerto Rico. [Act §403(l)]

Domestic Production Activities Deduction. The Act makes significant corrections to the §199 deduction for domestic production activities. The Act clarifies the definition of W-2 wages and provides that wages do not include amounts not in a return filed with the Social Security Administration on or before the 60th day after the due date of such return. The Act removes the distinction between direct and indirect expenses and substitutes a "properly allocable" term. The Act adds an active conduct and ordinary course of business requirement for construction, engineering and architecture projects of real property. The Act clarifies that the lease, rental, license, sale or exchange or other disposition of land does not qualify. The Act adds that for purposes of federal government contracts, items manufactured or produced for the federal government under a federal government contract qualify if the federal acquisition regulations provide that the risk of loss is transferred to the federal government before manufacturing or production is completed. The Act provides that a patron of a cooperative who receives certain payments from an agricultural or horticultural cooperative that are attributable to qualified production activities income is allowed a deduction equal to the portion of the deduction allowed to the cooperative that is attributable to such income. The Act amends the definition of an expanded affiliated group by adopting a "more than 50%" and "at least 80%" test for qualification. The Act provides that the §199 deduction is the same for alternative minimum tax purposes, except that, in the case of a corporation, the taxable income limitation is the corporation's AMTI. The Act also provides that a §199 deduction is not allowed in determining a taxpayer's appropriate NOL or NOL carrybacks and carryforwards. The Act also gives the government authority to issue regulations limiting the deduction to one taxpayer with respect to the same economic activity. [Act §403(a)]

S corporation shareholder rules. The Act repeals the §1361(c) requirement that a family must elect to be treated as one shareholder for purposes of determining the number of shareholders for purposes of subchapter S. The Act also provides that the determination of whether a common ancestor is more that six generations removed from the youngest generation of shareholders is made at the latest of (1) the date the subchapter S election is made; (2) the date a family member first holds stock in the S corporation; or (3) October 22, 2004. The Act provides that the estate of a family member is treated as a member of the family for purposes of determining the number of shareholders. The Act also conforms the provision relating to certain adopted individuals and foster children with the amendments made by title II of the 2004 Working Families Tax Relief Act. Effective as if included in the 2004 American Jobs Creation Act. [Act §403(b)]

Suspension of suspended built-in losses incident to a divorce. The effective date of §235 of the American Jobs Creation Act is corrected to provide that it is effective for transfers after December 31, 2004. [Act §403(c)]

REITs. The Act clarifies that a real estate investment trust (REIT) may cure de minimis failures of asset requirements (other than the requirement that the REIT may not hold more than 10% (five percent for certain prior years) of the value of securities of a single issuer, for which failure-specific procedures are provided) by using the same procedures as the REIT may use for larger failures of asset tests. The Act also clarifies that the new rules that permit the curing of certain REIT failures apply to failures with respect to which the requirements of the new rules are satisfied in taxable years of the REIT beginning after the date of enactment. Similarly, the Act clarifies that the new rules governing deficiency dividends that allow the taxpayer to make a determination by filing a statement with the IRS apply to statements filed in taxable years of the REIT beginning after the date of enactment.

According to the Joint Committee on Taxation Technical Explanation of the Act, it is intended that the provisions of the AJCA that allow a REIT to correct failures of REIT qualification without losing its REIT status apply to corrections of failures for which the requirements for correction are satisfied after the date of enactment, regardless of whether such failures occurred in taxable years beginning on, before, or after the date of enactment. Similarly, according to the Joint Committee Explanation, it is intended that the provisions of the AJCA that allow deficiency dividends under §860 to correct distribution failures, provided the deficiency is identified in a statement filed after the date of enactment in accordance with the provisions of the AJCA, apply to failures occurring in taxable years beginning on, before, or after the date of enactment.

The Act clarifies that the new hedging rules apply to transactions entered into in taxable years beginning after the date of enactment. The Act also clarifies that securities of a partnership held by a REIT before the October 22, 2004 date of enactment of the AJCA, that would have qualified as straight debt securities if the AJCA had never been enacted by virtue of the prior law requirement that the REIT hold at least 20% of the partnership equity, will continue to qualify (regardless of whether they were disposed of before the date of enactment or whether the REIT has disposed of its interest in the partnership equity to the one-percent-or-less interest required by the AJCA) while held by the REIT (or its successor) until the earlier of the disposition or the original maturity date of such securities. [Act §403(d)]

Film and television production costs. The Act clarifies that the $15 million production cost limitation and the 75% qualified compensation requirement are determined on an episode-by-episode basis (not an aggregate basis). The Act adds rules for recapture as ordinary income of the deduction for expensing of certain films and television production costs in a manner similar to the recapture rules applicable to expensing under §179. [Act §403(e)]

Railroad track maintenance credit. For purposes of the rule that prevents the claiming of the credit by more than one eligible taxpayer with respect to the same mile of track, the Act clarifies that Class II and Class III railroads that operate track under a lease are not required to obtain assignment from the track owner in order to use or assign the credit. Under the Act, the credit is limited in respect of the total number of miles of track (1) owned or leased by the Class II or Class III railroad, and (2) assigned by the Class II or Class III railroad for purposes of the credit. The Act clarifies that a Class I railroad is not treated as a Class II or III railroad for purposes of the credit (and it is not eligible to claim the credit with respect to track it owns) by reason of performing track maintenance services (on the same or different track) for a Class II or III railroad. The Act also clarifies the rules governing the assignment of track by Class II or III railroads. Under the Act, a track mile may be assigned only once per tax year, effective at the close of the tax year, and any track mile assigned may not also be taken into account by the assignor taxpayer for the tax year. The Act provides that an assigned track mile is taken into account by the assignee in the tax year that includes the effective date of the assignment. [Act §403(f)]

International shipping activities. The Act strikes as deadwood the rule added by the AJCA regarding the operation of a qualifying vessel by a nonelecting corporation that is a member of an electing group. The Act clarifies §1354(b) to provide that an election to determine income tax on certain international shipping activities using a per ton rate is timely if made on or before the due date (including extensions) for filing the tax return for the relevant taxable year.

The Act clarifies the treatment of operating agreements under the tonnage tax rules. Under the Act, an operating agreement is not a charter but is instead an agreement with an owner or charterer of a qualifying vessel to provide operating or management services in respect of a qualifying vessel, for example, crew, technical, or commercial services. The Act clarifies that a person providing services for a vessel under an operating agreement is treated as operating the vessel and may elect tonnage tax treatment, assuming the other requirements for such treatment are met, but a subcontractor to a person providing services under an operating agreement is neither treated as providing services under an operating agreement nor as operating a vessel for purposes of the tonnage tax. Under the Act, the provision of equipment, tools, provisions, or supplies would not be considered an operating agreement or part of an operating agreement unless such equipment, tools, provisions, or supplies are provided by the person providing the services under the operating agreement and are provided in connection with such services.

According to the Joint Committee on Taxation Technical Explanation of the Act, present law provides that in order to elect tonnage tax treatment, a person must meet a shipping activity requirement as well as "operate" a qualifying vessel, and it is intended that a person providing services under an operating agreement is deemed to be "using" tonnage of qualifying vessels, and the appropriate amount of such tonnage is taken into account for purposes of this test.

The Act clarifies that interests in operating agreements are taken into account for purposes of allocating the notional shipping income from the operation of qualifying vessels among respective ownership, charter, and operating agreement interests. In addition, the Act provides that in the case of a partnership operating a vessel, the extent of a partner's ownership, charter, or operating agreement interest is determined on the basis of the partner's interest in the partnership. [Act §403(g)]

AMT for farmers and fishermen using income averaging. The Act clarifies that in computing the regular tax for purposes of determining the alternative minimum tax of a farmer or fisherman using income averaging, the foreign tax credit does not need to be recomputed. [Act §403(h)]

Reforestation expenses.The Act clarifies that the reforestation expensing recapture rule applies to trusts and estates, but the deduction only applies to estates. The Act also expands §1245(a)(2) to include the recapture rules for reforestation expensing.

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(i)]

First-year additional depreciation. The Act clarifies that either noncommercial aircraft or property having a longer production period can qualify. [Act §403(j)]

Foreign tax credit. The Act clarifies that, in a case in which an overall domestic loss is used as a carryback, the requirement in §904(g)(2) that the taxpayer have elected the benefits of the foreign tax credit applies to the taxable year in which the loss is used. [Act §403(k)]

Look-through rules to apply to dividends from noncontrolled §902 corporations. The Act adds a transition rule under which a taxpayer may elect not to apply the 2004 American Job Creation Act's look-through rules to taxable years beginning before January 1, 2005. [Act §403(l)]

Look-through treatment for sales of partnership interests. The Act clarifies that constructive ownership is taken into account in determining whether a controlled foreign corporation is a 25% owner of a partnership for purposes of the rule treating a sale of a partnership interest as a sale of a proportionate share of the assets of the partnership. [Act §403(m)]

Repeal of foreign personal holding company rules and foreign investment company rules. The Act repeals as deadwood §532(b)(2), which coordinated the foreign personal holding company and accumulated earnings tax regimes, and instead provides that in computing a corporation's accumulated taxable income, a deduction is allowed in the amount of any income of the corporation that resulted in an inclusion for a U.S. shareholder under §951(a). In the case of a corporation that is otherwise subject to the accumulated earnings tax on a gross basis (under Regs. §1.535-1(b)), the Act provides that appropriate adjustments are made to this deductible amount to take into account deductions that may have reduced the inclusion under §951(a), but which would not otherwise have been allowable in computing accumulated taxable income. The Act also repeals as deadwood §6683, which addresses the failure of a foreign corporation to file a required personal holding company return, a rule that is no longer needed in light of the provision of the Act exempting foreign corporations from the personal holding company rules. Effective as if included in the 2004 American Jobs Creation Act. [Act §403(n)]

Aircraft leasing and shipping. The Act clarifies that, for purposes of the foreign tax credit limitation as in effect for taxable years beginning before January 1, 2007, shipping income was defined to include income that meets the definition of foreign base company shipping income as in effect before the definition was repealed under §415 of the American Jobs Creation Act of 2004. The repeal is effective for taxable years of foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end. [Act §403(o)]

REIT look-through distributions. The Act clarifies that the rules providing an exception from the Foreign Investment in Real Property Tax Act (FIRPTA) only apply to real estate investment trusts (REITs) and not to regulated investment companies (RICs). The Act also clarifies that the period of time during which a foreign shareholder may not have held more than 5% of the class of stock with respect to which the distribution is made is the one-year period ending on the date of the distribution. The rules apply to any distribution of a REIT that is treated as a deduction for a taxable year of the REIT beginning after the October 22, 2004 enactment date of the American Jobs Creation Act of 2004. The rules also apply to deficiency dividends under §860 that are paid after October 22, 2004, and are treated as deductible in taxable years beginning prior to October 22, 2004. Such dividends qualify for the exclusion from FIRPTA treatment if the other requirements of the American Jobs Creation Act of 2004 are met.

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(p)]

Incentives to reinvest foreign earnings in the United States. The Act amends §965(a)(2)(B) to clarify that distributions made indirectly through tiers of controlled foreign corporations are eligible for the benefits of §965 only if they originate with a dividend received by one controlled foreign corporation from another controlled foreign corporation in the same chain of ownership described in §958(a). The Act also provides that for purposes of determining the amount of excess dividends eligible for the deduction, only cash dividends received during the elected taxable year are taken into account under §965(b)(2)(A). The provision also provides the Treasury Secretary with explicit regulatory authority to prevent the avoidance of the purposes of §965(b)(3). The provision also clarifies the definition of "applicable financial statement" under §965(c)(1). The Act also clarifies that the expense disallowance rule of §965(d)(2) applies only to deductions for expenses that are directly allocable to the deductible portion of the dividend, instead of "properly allocated and apportioned." In addition, the provision clarifies that foreign taxes that are not allowed as foreign tax credits by reason of §965(d) do not give rise to income inclusions under §78. The provision also clarifies §965(f) to provide that an election to apply §965 is timely if made on or before the due date (including extensions) for filing the tax return for the relevant taxable year. [Act §403(q)]

State and local sales taxes. The Act clarifies that the itemized deduction for state and local sales tax does not apply in calculating alternative minimum taxable income.

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(r)]

Naval shipbuilders. The Act provides that the five-taxable year period for use of the 40/60 percentage-of-completion/capitalized cost method is determined with respect to the construction commencement date, not the contract commencement date. The Act further provides that any change of accounting method required by the provision is not subject to §481. Effective as if included in the 2004 American Jobs Creation Act. [Act §403(s)]

Credit for electricity produced from renewable sources. The Act deletes the word "synthetic" from the definition of refined coal to carry out the intent that qualifying solid fuels produced from coal meet two primary standards, and also not be subject to a chemical change test for certain fuels from coal to qualify for a tax credit.

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(t)]

Expatriated entities. The Act clarifies that the inversion gain rule of §7874(a)(1) does not apply to an entity that is an expatriated entity with respect to an entity that is treated as a domestic corporation under §7874(b). Effective as if included in the 2004 American Job Creation Act. [Act §403(u)]

Expatriation of individuals. The Act clarifies that the exception to the requirement of minimal prior physical presence in the United States is both for (i) teachers, students, athletes, and foreign government individuals, and (ii) individuals receiving medical attention. The Act clarifies that taxpayers who lose citizenship or terminate long-term resident status will continue to be treated for federal tax purposes as citizens or long-term residents until they meet the notice and information reporting requirements of §7701(n). [Act §403(v)]

Penalty for failure to disclose reportable transactions. The Act clarifies that the penalty for failing to disclose participation in a reportable transaction applies to returns and statements that are filed after October 22, 2004 the date of enactment, without regard to the original or extended due date for such return or statement. [Act §403(w)]

Accuracy-related penalties for listed transactions. The Act clarifies that underpayments attributable to an understatement resulting from participation in a listed transaction or a reportable transaction with a significant tax avoidance purpose are not subject to accuracy-related penalties under §6662 to the extent that an accuracy-related penalty under §6662A is imposed upon such underpayment. The Act clarifies that accuracy-related penalties under §6662A do not apply to underpayments to which a fraud penalty under §6663 is applied. The Act also clarifies that, with respect to disqualified opinions, the strengthened reasonable cause exception to §6662A penalties does not apply to the opinion of a tax advisor if (1) the opinion was provided to the taxpayer before October 22, 2004, (2) the opinion relates to a transaction entered into before October 22, 2004, and (3) the tax treatment of items relating to the transaction was included on a return or statement filed by the taxpayer before October 22, 2004. [Act §403(x)]

Statute of limitations for unreported listed transactions. The Act provides that the statute of limitations with respect to an undisclosed listed transaction does not expire until one year after the earlier of (1) the date on which the Secretary is furnished the required information, or (2) the date on which a material advisor satisfies the list maintenance requirements with respect to a request by the Secretary. [Act §403(y)]

Material advisor list maintenance requirement. The Act provides that the penalty under §6708 for failing to comply with the §6112 list maintenance requirements applies to both (1) material advisors with respect to reportable transactions under present-law §6112, and (2) organizers and sellers of potentially abusive tax shelters under prior-law §6112. [Act §403(z)]

Minimum holding period for withholding taxes on gain and income other than dividends. The Act provides that the exception from the minimum holding period for certain withholding taxes paid by registered or licensed brokers and dealers on income and gain from securities also apply to gain from the sale of stock. [Act §403(aa)]

Disallowance on partnership loss transfers. The Act redrafts the wording of the provision relating to basis adjustments to undistributed partnership property in §734(b) to clarify that it applies in the case of a distribution of property to a partner by a partnership with respect to which there is a substantial basis reduction. [Act §403(bb)]

REMICs. The Act clarifies that, if more than 50% of the obligations transferred to, or purchased by, a real estate mortgage investment conduit (REMIC) are originated by a government entity and are principally secured by an interest in real property, then each obligation originated by a government entity and transferred to, or purposed by, the REMIC is treated as principally secured by an interest in real property. The Act closely aligns this rule with the principally secured standard that generally is provided by the definition of a qualified mortgage, and clarifies that the treatment of obligations as principally secured by an interest in real property under this rule does not extend to obligations that are not originated by a government entity.

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(cc)]

Corporate liquidations. The Act provides that on the tax-free liquidation of a corporation, the fair market value basis rule applies only to property described in §362(e)(1)(B), i.e., property that became subject to U.S. income tax on the liquidation. The Act drafted such provision to conform the scope of the liquidation rule to the rule applicable to transfers of property by shareholders to corporations. The Act provides that the election under §362(e)(2)(C) to apply the basis limitation to the transferor's stock basis is made at such time and in such form and manner as the Secretary may prescribe, and, once made, is irrevocable. Effective as if included in the 2004 American Jobs Creation Act. [Act §403(dd)]

Exclusion of gain on sale of principal residence. The Act amends the rule under §121(d), governing the exclusion from gross income of gain from the sale of a principal residence for property acquired in a like-kind exchange. The Act clarifies that the exclusion does not apply to property acquired in an exchange in which gain is not recognized under §1031(a) or (b). The Act also clarifies that the exclusion does not apply to exchanges by the taxpayer or by any person whose basis in the property is determined by reference to the basis in the hands of the taxpayer. In addition, the Act corrects duplicate numbering of paragraphs within §121(d).

Effective as if included in the American Jobs Creation Act of 2004, i.e., for sales or exchanges after October 22, 2004. [Act §403(ee)]

Leases of tax-exempt property. The Act clarifies rules that limit deductions that are allocable to tax-exempt use property by amending the general effective date of the leasing provision amendments under the American Jobs Creation Act of 2004, §§847 and 848, to specify that the AJCA amendments also apply to property acquired after March 12, 2004, that is treated as tax-exempt use property other than by reason of a lease (e.g., because the property is owned by a partnership that has a tax-exempt partner and provides for certain special allocations).

Effective as if included in the American Jobs Creation Act of 2004. [Act §403(ff)]

Substantiation of charitable contributions. The Act adds to the substantiation requirement applicable to deductions taken for contributions of used motor vehicles, boats, and airplanes with a claimed value of over $500. The Act specifies that the written acknowledgement also must indicate whether the donee organization provided goods or services as consideration for the vehicle and must describe and provide a good faith estimate of the value of such goods and services or, if the goods or services consist solely of intangible religious benefits, provide a statement to that effect.

Effective as if included in the American Jobs Creation Act of 2004, i.e., for contributions made after December 31, 2004. [Act §403(gg)]

Nonqualified deferred compensation plans. The Act clarifies that: (1) the additional tax and interest under Code §409A are not treated as payments of regular tax for alternative minimum tax purposes; (2) the application of the rule providing that certain additional deferrals must be for a period of not less than five years is not limited to the first payment for which deferral is made; (3) Treasury Department guidance providing a limited period during which plans can conform to the requirements applies to plans adopted before January 1, 2005; and (4) the effective date of the funding provisions relating to offshore trusts and financial triggers is January 1, 2005. Under the Act, not later than 90 days after the date of enactment of this provision, the Secretary of the Treasury must issue guidance under which a nonqualified deferred compensation plan that is in violation of the requirements of the funding provisions relating to offshore trusts and financial triggers will be treated as not violating such requirements if the plan comes into conformance with such requirements during a limited period as specified by the Secretary in guidance. [Act §403(hh)]

Straddles. The Act clarifies that taxpayers are permitted to identify a straddle as an identified straddle under §1092(a)(2)(B) (by making a clear and unambiguous identification on their books and records) without regard to whether the Secretary has prescribed regulations under the mandate in that section. The Act provides that the Secretary's mandate under the provision is to issue guidance in the form of regulations or in another form. Effective as if included in the 2004 American Jobs Creation Act. [Act §403(ii)]

Divisive reorganizations. The Act clarifies that the adjusted basis of property taken into account for purposes of §361(b)(3) is reduced by the liabilities assumed (within the meaning of §357(c)). Section 361(b)(3) provides generally that, if a corporation receives money or property other than stock or securities in a tax-free reorganization and transfers the money or other property to its creditors in connection with the reorganization, the transfer to creditors is treated a "distribution in pursuance of the plan of reorganization" and, thus, tax free. The 2004 AJCA added a sentence to §361(b)(3) stating that this nonrecognition rule only applies in a divisive "D" reorganization to the extent that the sum of money and fair market value of the other property transferred to creditors does not exceed the adjusted bases of the assets transferred. The Act adds a parenthetical clarifying that the adjusted bases of those assets are reduced by the amount of liabilities assumed (within the meaning of §357(c)). The Act also amends §357(d)(1) to clarify that the §357(d) rules on determining when a liability is assumed apply to §361(b)(3). [Act §403(jj)]

Preferred stock. The Act extends the "real and meaningful likelihood" test (added by AJCA) to the "limited and preferred as to dividends" part of the §351(g)(3)(A) definition of "preferred stock." Section §351(g) states generally that the nonrecognition rule of §351(a) does not apply to transfers to controlled corporations if the transferor receives "nonqualified preferred stock." Section §351(g)(2)(A) defines "nonqualified preferred stock," and §§351(g)(3)(A) defines "preferred stock." Preferred stock is stock that is (i) limited and preferred as to dividends and (ii) does not participate in corporate growth to any significant extent. The 2004 AJCA added a sentence to §351(g)(3)(A) stating that stock does not participate in corporate growth to any significant extent (part (ii) of the definition) "unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation." The Act adds another sentence that similarly clarifies part (i) of the definition: stock is not limited and preferred as to dividends unless there is a "real and meaningful likelihood that dividends beyond any limitation or preference will actually be paid." [Act §403(kk)]

Partnership organizational expenditures. The Act corrects the reference to "taxpayers" to refer to "partnerships" in the rules relating to deduction or amortization of partnership organizational expenses (Code §709). [Act §403(ll)]

Deduction for entertainment expenses. The Act further limits the deduction for a taxpayer's entertainment expenses that are treated as compensation to an employee when the recipient of the entertainment is a "specified individual." The Act amends the definition of a "specified individual"--generally a director, officer, or principal stockholder of the taxpayer--to reference a related party of the taxpayer, as described in §267(b) or §707(b), as well as the taxpayer.

Effective as if included in the American Jobs Creation Act, i.e., for expenses incurred after October 22, 2004. [Act §403(mm)]

Uniform definition of child. The Act amends §152(e) to permit a divorced or legally separated custodial parent to waive, by written declaration, the right to claim a child as a dependent for purposes of the dependency exemption and child credit, but not for other child-related tax benefits. The waiver would grant the noncustodial parent the right to claim the child as a dependent for these purposes. The provision clarifies that the waiver rules under the uniform definition of qualifying child operate as under prior law. Conforming amendments are made for purposes of health savings accounts (§223), the dependent care credit (§21), and dependent care assistance programs (§129) that an individual may qualify as a dependent for these purposes without regard to whether the individual has gross income that exceeds the exemption amount (§152(d)(1)(B)) or is married and files a joint return (§152(b)(2)). In addition, an individual treated as a dependent under the conforming amendments is not subject to the rule in §152(b)(1) that a dependent is treated as having no dependents for the applicable taxable year. Effective as if included in the provisions of the Working Families Tax Relief Act of 2004 to which they relate.

Bonus depreciation. The Act clarifies that property acquired and placed in service during 2005 pursuant to a written binding contract entered into after May 5, 2003, and before January 1, 2005, is eligible for the 50% additional first-year depreciation deduction. The provision corrects a date in the rules applicable to qualified New York Liberty Zone property so that it refers to the January 1, 2005, date in the corresponding rule for additional first-year depreciation in §168(k). Effective as if included in §201 of the Jobs and Growth Tax Relief Reconciliation Act of 2003 to which it relates.

Disclosure. The Act corrects cross references within the disclosure rules (§6103) relating to disclosure to the National Archives and Records Administration.

Qualified plans. A special rule under §402(g)(7)(A) allows employees with at least 15 years of service with certain organizations to make additional elective deferrals to a tax-deferred annuity, subject to an annual and cumulative limit. The cumulative limit is $15,000, reduced by any additional pretax elective deferrals made for preceding years. For taxable years beginning after 2005, plans may allow employees to designate pretax elective deferrals as Roth contributions. The Act reduces the $15,000 cumulative limit by designated Roth contributions made for preceding years.

Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), §415(c)(7)(C) applied a special limit to contributions to tax-sheltered annuities for foreign missionaries with adjusted gross income not exceeding $17,000. This special limit was mistakenly dropped from EGTRRA. The Act revises the special limit to reflect the pre-EGTRRA rule.

Effective as if included in EGTRRA.

Summonses. The 1998 IRS Reform Act provides that the special procedures for third-party summons (§7609) do not apply to a John Doe summons and certain emergency summonses. The Act corrects this reference, so as to make only the notice procedures of §7609(a) inapplicable to a John Doe summons or an emergency summons, rather than making the entire §7609 inapplicable. Effective as if included in the 1998 IRS Reform Act §3415.

Basis of stock in controlled foreign corporations. The Act clarifies that the basis adjustments of §961(c) apply not only with respect to the stock of the controlled foreign corporation that earns the subpart F income that gives rise to the basis adjustments, but also with respect to the stock of higher-tier controlled foreign corporations in the same chain of ownership.

Depreciation of certain solar- or wind-powered equipment. The Act amends §168 to provide that 5-year property includes certain heating, cooling, and other equipment using solar or wind (rather than solar and wind) energy. Effective as if included in §11813 of the Omnibus Budget Reconciliation Act of 1990.

Clarification of earnings and profits and stock basis where LIFO recapture tax applies. In general, under §1363(d), the LIFO recapture amount is included in the income of a C corporation that becomes an S corporation for the last taxable year of the C corporation. Any increase in tax due to this inclusion is payable in four equal annual installments. The Act provides that the rules relating to the prohibition on adjustments of earnings and profits of an S corporation and the requirement to reduce the basis of stock of the S corporation for nondeductible expenses do not apply to any corporate tax imposed under §1363(d). Effective as if included in §10227 of the Omnibus Budget Reconciliation Act of 1987.

Expansion of bank S corporation eligible shareholders to include IRAs. The Act expands the provision in the American Jobs Creation Act of 2004 (§233) allowing certain bank stock to be held by an IRA (or to be sold by an IRA to the beneficiary) to include stock in a depository holding company (as defined in §3(w)(1) of the Federal Deposit Insurance Act). A depository holding company includes a bank holding company and a thrift holding company. Effective as if included in the provision of the American Jobs Creation Act of 2004 to which it relates. [Act §413(a)]

Exclusion of investment securities income from passive income test for bank S corporations. The Act expands the rule in the American Jobs Creation Act of 2004 (§237) which provides that, in the case of a bank, bank holding company, or financial holding company, certain interest and dividend income is not treated as passive under the S corporation passive investment income rules. Under the provision, this rule applies to a bank and to a depository holding company (as defined in §3(w)(1) of the Federal Deposit Insurance Act). A depository holding company includes a bank holding company and a thrift holding company. Effective as if included in the provision of the American Jobs Creation Act of 2004 to which it relates. [Act §413(b)]

Information returns for qualified subchapter S subsidiaries. The Act provides that an S corporation and a qualified subchapter S subsidiary are recognized as a separate entities for purposes of making information returns, except as otherwise provided by regulations. Effective as if included in the provision of the American Jobs Creation Act of 2004 to which it relates. [Act §413(c)]