Overview of Tax Changes in the
American Jobs Creation Act of 2004

As you probably know, Congress recently passed the American Jobs Creation Act of 2004 (“the Act”), which replaces the U.S. export tax regime with broad based tax relief for domestic manufacturing, U.S. multinationals, and a wide variety of other businesses and industries.  Here is what you need to know right now about this important new legislation:

Deduction of State and Local General Sales Taxes. In a move that will primarily benefit individuals in states with sales taxes but with no or limited individual income taxes (i.e., Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming), taxpayers, who itemize, will be able to deduct on their federal tax returns for 2004 and 2005 either what they pay in state and local income taxes or what they pay in sales taxes. Previously, only state and local income tax payments were deductible. Taxpayers who itemize may deduct their actual sales taxes or use IRS published tables.

Repeal of Exclusion for Extraterritorial Income (ETI).  At the heart of the Act is the repeal of the exclusion for extraterritorial income (ETI), an export break that the World Trade Organization ruled to be an illegal subsidy.  Specifically, the Act repeals the ETI system of tax benefits for transactions after 2004, with transition relief for 2005 and 2006 and grandfather rules for contracts entered into before September 18, 2003.

New Deduction for U.S. Production Activities. The Act replaces ETI with a new tax break for domestic production activities. The deduction is a percentage of the net income from those activities   3% in 2005 2006, 6% for 2007 2009, 9% after 2009. (The 9% deduction percentage is intended to be equivalent to a 3% rate cut.)

The U.S. production activities deduction is allowed with respect to a taxpayer's qualified production activities income, which is the taxpayer's domestic production gross receipts net of expenses. "Domestic production gross receipts" are receipts derived from any of the following:

• Any lease, rental, license, sale, exchange, or other disposition of
• qualifying production property (i.e., tangible personal property, any computer software, and certain sound recordings) that was manufactured, produced, grown, or extracted in whole or in significant part by the taxpayer within the U.S.
• any qualified film produced by the taxpayer
• electricity, natural gas, and potable water produced by the taxpayer in the U.S.
• Construction performed in the U.S.
• Engineering and architectural services performed in the U.S. for construction projects in the U.S.

The deduction is available to all taxpayers with qualified production activities income. For pass thru entities (such as S corporations, partnerships, estates and trusts), the deduction generally is determined at the shareholder, partner or similar level by taking into account at that level the proportional share of the qualified production activities income of the entity. The deduction is allowed for AMT purposes.
 
 Business Tax Incentives. In addition to the new deduction for U.S. production activities, the Act spreads billions of dollars of tax breaks throughout the business world. These include:

• An extension of ethanol subsidies through 2010 and the creation of new biodiesel tax subsidies through 2006.
• An expansion of the provision permitting ranchers to defer gain on livestock sold as a result of weather related conditions to cover gain reinvested in other ranch equipment or property (formerly, the reinvestment had to be in livestock) and to lengthen the reinvestment period from two years to four
• A provision ensuring that dividends on capital stock won't reduce patronage income or prevent the cooperative from being treated as operating on a cooperative basis.
• A provision ensuring that the small producers tax credit will flow through to  cooperative members
• An extension of the income averaging option (which previously was available to farmers) to individuals engaged in the trade or business of fishing, and coordination with AMT so that the use of averaging won't increase AMT
• Several tax relief provisions for timber including: (1) capital gains treatment for outright sales of timber, (2) safe harbor rules for timber REITs, (3) expensing of reforestation costs, and (4) an election to treat timber as a sale or exchange.

Tax Reform and Simplification for U.S. Businesses. The Act includes several provisions to reduce double taxation of U.S. based companies, including reducing the foreign tax credit (“FTC”) baskets from nine to two and allowing FTCs to be carried forward for 10 years instead of five.

The Act repeals the 90 percent limitation on the use of FTCs against AMT. The Act encourages companies to reinvest foreign earnings in the U.S. by temporarily allowing an 85% dividends received deduction on distributions from controlled foreign corporations (“CFCs”).

Miscellaneous Provisions. The Act also:

• 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
• Allows an above the line deduction for attorney's fees and court costs incurred in connection with an unlawful discrimination claim
• 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
• Allows the tax credits for alcohol fuels and the production of electricity to be applied against AMT
• Excludes certain stock options from employee wages for FICA/FUTA withholding purposes.

Revenue Provisions. To pay for the benefits, the Act imposes scores of new costs on taxpayers. Among other items, these include:

• Reducing tax avoidance through corporate inversions and individual expatriation
• Shutting down abusive tax shelters
• Closing various loopholes
• Combating fuel tax evasion
• Tightening the rules for charitable contributions of patents, motor vehicles, boats and airplanes
• Making it more difficult to defer tax on nonqualified deferred compensation for amounts deferred in tax years beginning after 2004
• Extending IRS user fees
• Limiting the amount of the cost of an SUV that may be expensed in a single year to $25,000, effective for vehicles placed in service after the enactment date of the Act.

Please keep in mind that we have described only the highlights of the most important changes in the new law. Please do not hesitate to call a member of our Taxation & Estate Preservation Group for details on how you may be affected by this important tax legislation