Thursday, April 22, 2010

IRS releases new Form 3115 for tax accounting method changes

The IRS issued today an advance copy of Announcement 2010-32 (which will be published in Internal Revenue Bulletin 2010-19 on May 10, 2010) discussing the new December 2009 revision of Form 3115, which is required for both automatic tax accounting method changes as well as non-automatic tax accounting method change requests.

In short, the IRS will generally accept either the new or the old (December 2003) version through May 30, 2010, after which it will only accept the December 2009 version.  Nevertheless, taxpayers are urged to use the new version before the deadline.

All links are to Adobe Acrobat (PDF) files.

I hope to get a chance soon to review the specific changes between the old and new versions and will update when I'm done.

Monday, April 19, 2010

IRS Announcement 2010-30 re disclosure of Uncertain Tax Positions (UTPs)

Just received the following advance release of Announcement 2010-30:

Announcement 2010-30 releases the draft schedule, Schedule UTP, accompanied by draft instructions that provide a further explanation of the Service’s proposal requiring reporting of uncertain tax positions, and invites public comment on the draft schedule and instructions.

Announcement 2010-30 will be in IRB 2010-19, dated May 10, 2010.

The advance is available at but does not include a copy of proposed "Schedule UTP."

EDIT 4/20/10:

The IRS has now uploaded Schedule UTP and the instructions

Income tax treatment of foreign currency option gains

Here's an article I wrote (with minor edits to add endnotes) for the November 2009 edition of the AICPA Tax Section's The Tax Adviser (specifically, the Tax Clinic).  I hope you find it useful.

As many practitioners already know, Sec. 988 treats most (but not all) gains and losses from foreign currency transactions as ordinary in character. 

Depending on the taxpayer’s circumstances, this treatment can be favorable or otherwise.

While the full range of exceptions to this rule are beyond the scope of this article, there is one in particular that may be of particular interest to investors.

For this example, let’s say that individual U.S. “Investor” holds substantial foreign stocks (e.g., on the London Stock Exchange) denominated in foreign currency (e.g., UK pounds or “GBP”).  Further, let’s say that Investor is concerned about possible fluctuations in the USD/GBP exchange rate, and so decides to manage that risk by purchasing a foreign currency option as follows directly from a U.S. investment bank:
  • European[i]-style GBP put/USD call, with “non-deliverable” settlement[ii]
  • Not exchange-traded (or subject to the rules of an exchange)[iii]
  • Call currency amount:   USD 650,000
  • Put currency amount:    GBP 345,000
  • Strike price:           1.8841 USD/GBP
  • Reference currency:     GBP
  • Settlement currency:    USD
  • Trade date:             January 2, 200X
  • Valuation date:         December 1, 200X
  • Premium:                USD 15,000
In this example, this means that Investor pays USD 15,000 for the right to receive (in cash) the net value of the excess of the USD amount over the GBP amount on the valuation date.  If there is no net positive excess, no additional money changes hands.
More specifically, if on the valuation date the spot exchange rate is 1.6 USD/GBP (i.e., the value of the USD has increased compared to the GBP), then Investor would be entitled to receive USD 650,000 - (GBP 345,000 x 1.6 USD/GBP) = USD 98,000.  After consideration of the option premium, Investor’s net profit would be USD 83,000.  Query:  Should this profit be characterized as ordinary income, or capital gain?  And if the latter, what is the holding period?  While the answer might seem clear at the outset, getting there is somewhat circuitous and may also require specific action on Investor’s part in the form of an election by the end of the trade date.
1)      Section 988
a)      In general
In general, Sec. 988 treats foreign currency gains/losses attributable to a “section 988 transaction” as ordinary income/loss.  Moreover, by its express terms, Sec. 988 overrides any other contrary provisions under Chapter 1 of the Internal Revenue Code (sections 1 through 1400U-3, dealing with Normal Taxes and Surtaxes).  However, exceptions do apply.
In determining whether a particular arrangement is covered by this rule, Sec. 988(c)(1) treats as a “section 988 transaction” any specified transaction (e.g., any forward contract, futures contract, option, or similar financial instrument) if the amount which the taxpayer is entitled to receive (or is required to pay) by reason of such transaction is determined by reference to the value of 1 or more nonfunctional currencies.  Since the option in this example meets those criteria, it would appear (so far) to constitute a “section 988 transaction” and presumably give rise to ordinary income.
b)     Interplay with Sec. 1256
Next, we need to consider Sec. 988(c)(1)(D), which provides that the acquisition of any forward contract, futures contract, option, or similar financial instrument is not a “section 988 transaction” if it represents a regulated futures contract or nonequity option which would be marked to market under Sec. 1256  if held on the last day of the taxable year.
Under Sec. 1256(g)(1), a “regulated futures contract” is a contract with respect to which the amount required to be deposited and the amount which may be withdrawn depends on a system of marking to market, and which is traded on or subject to the rules of a qualified board or exchange.  In our example, the option is clearly not a “regulated futures contract” since there were no amounts required to be deposited or able to be withdrawn.
Under Sec. 1256(g)(3), a “nonequity option” includes any listed option which is not an equity option.  Sec. 1256(g)(5), in turn, provides that a “listed option” is one which is traded on (or subject to the rules of) a qualified board or exchange.  Sec. 1256(g)(7) further provides that the term “qualified board or exchange” means (1) an SEC-registered national securities exchange, (2) a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, or (3) any other exchange, board of trade, or other market which the Secretary determines has rules adequate to carry out the purposes of Sec. 1256. 
While this statutory language is less definitive than some might like, the IRS has provided guidance in identifying certain entities as qualified boards of exchange for purposes of Sec. 1256.[iv]  Nevertheless, in our example, the foreign currency option was not traded on (or subject to the rules of) an exchange of any sort.  Consequently, the option should not constitute a nonequity option.
As a result, the option should not be excluded from consideration as a “section 988 transaction” by Sec. 988(c)(1)(D).  Therefore, it would continue to appear (so far) to constitute a “section 988 transaction” and presumably give rise to ordinary income/loss.
c)      Election to treat as capital gain/loss
Having established the option as a “section 988 transaction,” one of the exceptions to ordinary income/loss treatment is found in Sec. 988(a)(1)(B), which permits taxpayers to elect to treat gains/losses on certain foreign currency arrangements as capital in nature.
This exception provides that (unless prohibited in the regulations), inter alia, a taxpayer may elect to treat any foreign currency gain or loss attributable to an option which is a capital asset in the hands of the taxpayer and which is not a part of a straddle as capital gain or loss if the taxpayer makes an election and identifies the transaction before the close of the day on which such transaction is entered into (or earlier as the Secretary may prescribe).
i)        Capital asset characterization
In relevant part, Sec. 1221(a) provides the definition of a “capital asset” as property held by a taxpayer, but excludes:
  • Any commodities derivative financial instrument held by a commodities derivatives dealer,
  • Any hedging transaction which is clearly identified as such before the close of the day on which it was entered into (or such other time as the Secretary may by regulations prescribe).
With respect to the first item, Investor is not a “commodities derivatives dealer” because he is not a person that regularly offers to enter into, assume, offset, assign, or terminate positions in commodities derivative financial instruments with customers in the ordinary course of a trade or business.  Sec. 1221(b)(1)(A).
As for the second item, the option is not a “hedging transaction” because it was not a transaction entered into by the taxpayer in the normal course of the taxpayer's trade or business primarily (i) to manage risk of price changes or currency fluctuations with respect to ordinary property which is held or to be held by the taxpayer, (ii) to manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, by the taxpayer, or (iii) to manage such other risks as the Secretary may prescribe in regulations.  Sec. 1221(b)(2).
Accordingly, since the option does not meet any of the exceptions in Sec. 1221(a), it is a capital asset and eligible for the aforementioned election.
ii)      Mechanics of election
Regs. Sec. 1.988-3(b) addresses the requirements of making the Sec. 988(a)(1)(B) capital gain/loss election.  The requirements for that election are as follows:
  • The taxpayer makes the election by clearly identifying such transaction on his books and records on the date the transaction is entered into. While no specific language or account is necessary for identifying a transaction referred to in the preceding sentence, the method of identification must be consistently applied and must clearly identify the particular transaction subject to the election.
  • The taxpayer must provide verification of the election by attaching a statement to his income tax return that set forth: (i) a description and the date of each election made by the taxpayer during the taxable year; (ii) a statement that each election made during the taxable year was made before the close of the date the transaction was entered into; (iii) a description of any contract for which an election was in effect and the date such contract expired or was otherwise sold or exchanged during the taxable year; (iv) a statement that the contract was never part of a straddle as defined in Sec. 1092; and (v) a statement that all transactions subject to the election are included on the statement attached to the taxpayer's income tax return.
Note:  Taxpayers that do not comply with these requirements run the risk of the IRS invalidating the election.  However, if the failure was due to reasonable cause or bona fide mistake, taxpayers may be able to obtain relief regarding that failure, but the burden of proving it would be on them.  Fortunately, Regs. Sec. 1.988-3(b)(5) provides a way for most taxpayers to obtain a presumption of having met the statement and verification requirements by getting “independent verification.”  Taxpayers may get this independent verification by (1) establishing a separate account (or accounts) with an unrelated broker or dealer through which all transactions to be independently verified pursuant to this paragraph are conducted and reported, (2) having only those transactions entered into on or after the date the taxpayer establishes such account be recorded in the account, (3) having transactions subject to the election entered into such account on the date such transactions are entered into, and (4) obtaining from the broker or dealer a statement detailing the transactions conducted through such account and that includes on such statement the following: “Each transaction identified in this account is subject to the election set forth in section 988(a)(1)(B).”
In this example, it is assumed that Investor fulfilled their obligations with respect to the election under Sec. 988(a)(1)(B), thereby resulting in the treatment of the gain as capital in character.
2)      Section 1256
Pursuant to Sec. 1256(a), certain contracts are generally required to be “marked to market” if held by the taxpayer at the close of the taxable year, and are further characterized as generating gain or loss that is 40% short-term capital gain or loss and 60% long-term capital gain or loss.  Moreover, Sec. 1256(c) generally provides that Sec. 1256(a) applies even if the contract is not held at year end (e.g., a transfer, lapse, or other disposal during the year).
Sec. 1256(b), by its terms, covers the following types of contracts (and are defined under Sec.  1256(g): (1)  any regulated futures contract, (2)  any foreign currency contract, (3)  any nonequity option, (4)  any dealer equity option, and (5)  any dealer securities futures contract.  Having already addressed regulated futures contracts and nonequity options above, and noting that the option is not a dealer equity option or a dealer securities futures contract (since Investor is not a “dealer”), that leaves the question of whether the option is a “foreign currency contract.”
Pursuant to Sec. 1256(g)(2)(A), a “foreign currency contract” is defined as a contract which (i)  requires delivery of, or the settlement of which depends on the value of, a foreign currency which is a currency in which positions are also traded through regulated futures contracts, (ii) is traded in the interbank market, and (iii) is entered into at arm's length at a price determined by reference to the price in the interbank market.
In a nutshell, the option is not a “foreign currency contract” even though a casual reading might suggest otherwise.  The rationale for this conclusion is as follows:
  • In Notice 2007-71, the IRS and Treasury state that foreign currency options, whether or not the underlying currency is one in which positions are traded through regulated futures contracts, are not “foreign currency contracts” as defined in Sec. 1256(g)(2).  Apart from their resistance to what they view as an abuse (not relevant to our example), the Notice explains that a “foreign currency contract […is] a contract that requires delivery of, or the settlement of which depends on the value of, certain foreign currencies. The original statutory definition, however, did not allow for cash settlement and required actual delivery of the underlying foreign currency in all circumstances. Options, by their nature, only require delivery if the option is exercised. Section 102 of [TRA 1984] added the clause “or the settlement of which depends on the value of.” There is no indication, however, that Congress intended by this addition to extend the definition of “foreign currency contract” to foreign currency options. That conclusion is confirmed by the legislative history to  §988(c)(1)(E), enacted by [TAMRA 1988], which indicates that a foreign currency option is not a foreign currency contract as defined in §1256(g)(2).
  • Moreover, FSA 200025020 (which was issued prior to Notice 2003-81, which was modified and supplemented by Notice 2007-71) provided the following reasoning (internal citations omitted):
“Although the definition of a foreign currency contract provided in section 1256(g)(2) may be read to include a foreign currency option contract, the legislative history of [TCA 1982], which amended section 1256 to include foreign currency contracts, indicates that the Congress intended to extend section 1256 treatment only to foreign currency forward contracts that are traded on the interbank market. There is no indication that foreign currency option contracts were contemplated for inclusion in the statutory definition of a forward currency contract in section 1256(g)(2)(A).
Sections 1256(g)(3) and (4) deal comprehensively with options listed on a qualified board or exchange. These provisions were added to the Code by section 102(a)(3) of [TRA 1984].  They provide that only dealer equity options (i.e., listed stock options) and listed options (other options listed on exchanges) are section 1256 contracts. The legislative history to these provisions is silent regarding whether the failure to separately include a provision address in the treatment of foreign currency options was due to their having been included within section 1256(g)(2)(A).”
Further, commentators have seemed to accept (or at least not dispute) that foreign currency options are not “foreign currency contracts.” [v]  Consequently, the option should not be treated as a “foreign currency contract” and thus does not fall under Sec. 1256.
3)      Holding Period
Having established that the option is a capital asset, and not subject to Sec. 1256, the final step in our analysis is determining whether the gain on its disposition is long-term or short-term.
Sec. 1222 generally controls the holding period of property in determining the long-term vs. short-term character of the gain (or loss) on the disposition of a capital asset.  In short, that section provides that capital gains are long-term if held for not more than 1 year, and short-term otherwise.
Without going into great detail on this issue (since it should be fairly apparent from the trade and termination dates being less than 12 months), it is clear that the gain is short-term in nature.
As the reader can see from the above, reaching the ultimate answer to the initial query was not exactly a straightforward proposition, and highlights the need for additional clarity in situations like these.  After all, even in this relatively simple example, the conclusion was dependent on a close and critical reading of the legislative history given several easily-misinterpreted terms in the statute itself.

[i] A “European” option may be exercised only at the expiry date of the option, i.e., at a single pre-defined point in time.  An “American” option may be exercised at any time on or before the expiry date.
[ii] “Non-deliverable” settlement means that settlement is made on a net value basis and that currencies do not change hands.
[iii] I.e., not traded on (or subject to the rules of) an SEC-registered national securities exchange, a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, or any other exchange, board of trade, or other market which the Secretary determines has rules adequate to carry out the purposes of section 1256.
[iv] See, e.g., Rev. Rul. 85-72 (the International Futures Exchange (Bermuda) Ltd.); Rev. Rul. 86-7 (the Mercantile Division of the Montreal Exchange , effective April 18, 1985); Rev. Rul. 2007-26 (ICE Futures, a U.K. Recognised Investment Exchange, effective for ICE Futures Contracts (commodity futures contracts and futures contract options) entered into on or after April 1, 2007); Rev. Rul. 2009-4 (the Dubai Mercantile Exchange, effective for Dubai Mercantile Exchange Contracts (commodity futures contracts and futures contract options) entered into on or after February 1, 2009); PLR 200726006 (an unnamed United Kingdom Recognized Investment Exchange that was a wholly-owned subsidiary of a U.S. corporation and overseen by the United Kingdom's Financial Services Authority, provided that the exchange continued to comply with certain specified conditions).
[v] Mulroney, 921-2nd T.M., Tax Aspects of Foreign Currency, section VII.B.4.:  “Comment: Nonlisted foreign currency options should not fall within the definition of a ‘foreign currency contract,’ even if the denomination currency is a currency in which positions are traded on a qualified board or exchange. This is because §1256(g)(3), which sets forth the definition of a nonequity option, should be viewed as preemptive in terms of the types of options covered under §1256.

Thursday, April 15, 2010

House passes "Taxpayer Assistance Act of 2010" (HR 4994)

This Bill passed the House by a large margin (399-9), and now goes to the Senate. I haven't yet seen any public comments on its chances for eventual enactment, but (1) its strong bipartisan support, (2) fairly limited scope, and (3) lack of highly controversial provisions suggests smooth sailing.

It isn't as massive as the recent Health Care legislation, which you can see from the following outline. If you want to see the full text, see

  • Sec. 101. Removal of cellular telephones and similar telecommunications equipment from listed property.
  • Sec. 102. Electronic filing exemption for religious reasons.
  • Sec. 103. Accelerate interest on refunds for returns filed electronically.

  • Sec. 201. Study on the effectiveness of collection alternatives.
  • Sec. 202. Repeal of partial payment requirement on submissions of offers-in-compromise.

  • Sec. 301. Referrals to Low-Income Taxpayer Clinics permitted.
  • Sec. 302. Programs for the benefit of low-income taxpayers.
  • Sec. 303. EITC outreach.
  • Sec. 304. Taxpayer notification of suspected identity theft.
  • Sec. 305. Clarification of IRS unclaimed refund authority.
  • Sec. 306. Study on delivery of tax refunds.
  • Sec. 307. Study on timely processing and use of information returns.
  • Sec. 308. Study on easing the burden of in-person tax payments.

  • Sec. 401. Expansion of bad check penalty to electronic payments.
  • Sec. 402. Increase in information return penalties.
  • Sec. 403. Budget compliance.

More to come...

Friday, April 9, 2010

State Research Tax Credits - You May Be Entitled To More Than You Thought

Despite the sad fact that the federal research credit under section 41 has expired for amounts paid or incurred after December 31, 2009 (and which will hopefully be extended again), certain states still provide credits for qualified expenditures. However, many states impose additional requirements on the computation of the state credits (e.g., activities having been conducted in the state, computations of base amounts, etc.) that are easily overlooked, but can have substantial impact. Accordingly, it makes sense to revisit how these state rules might affect your clients.

Note: At the time of this writing more than half of the states provide some sort of tax credit for expenses paid or incurred with respect to a taxpayer’s qualified research activities. Since a review of each state’s provisions is beyond the scope of this article, we’ll focus on some of the more interesting California provisions under Cal. Revenue & Taxation Code section 23609. In addition, the federal and California research credit provisions also provide benefits for amounts paid for “basic research,” but those are also outside the scope of this article.


The federal research credit was originally enacted in 1981 and was intended in large part to spur domestic innovation. It took the form of a nonrefundable credit against income tax available to taxpayers for certain qualified expenditures that exceeded a defined “base amount.” Even though it expired as of the end of 2009, many commentators believe that it will return (although possibly with additional changes), as it has many times before.

In computing the credit for both federal and California purposes, it is important to remember that there are various methods to consider, depending on whether the company had sufficient activity in the 1984 – 1988 time period, whether the taxpayer wants to elect an alternative computation method, whether the taxpayer is a member of a group of businesses that must aggregate their activities, and so on. However, for the sake of this discussion, the standard method of computing the credit is as follows (for both federal and California) for businesses that are not “start-ups.”
  • Take the total of the taxpayer’s qualified research expenditures for tax years beginning after December 31, 1983, and before January 1, 1989.
  • Divide that total by total gross receipts for those same years.
  • The resulting percentage is the “fixed base percentage,” which, per section 41(c)(3)(C), cannot be greater than 16%.
  • Take the average gross receipts for the 4 years preceding the current year and multiply that amount by the fixed base percentage. The result is the “tentative base amount.”
  • Compare the tentative base amount against the current year qualified expenditures.
  • If the current year qualified expenditures are less than the tentative base amount, no research credit is available.
  • If the current year qualified expenditures are greater than the tentative base amount, then the “increment” is the lesser of (1) the difference between the total current year qualified expenditures and the tentative base amount, or (2) one-half of the current year qualified expenditures.
  • The credit is then determined by multiplying the credit rate (20% for federal, 15% for California) by the above increment.
  • Finally, the taxpayer needs to decide if they prefer to follow section 280C(c) and reduce their otherwise deductible/capitalizable research expenditures or instead elect a reduced credit that reflects an impact similar to that of section 280C(c).

Note: In this context, a start-up company is one that had both qualified research expenses and gross receipts either (1) for the first time in a taxable year beginning after December 31, 1983; or (2) for fewer than three taxable years beginning after December 31, 1983, and before January 1, 1989.

California R&TC section 23609

The California research credit (effective as of 1987), while based on the federal credit, does contain some notable differences. In the right circumstances, those differences sometimes provide substantial (and unexpected) benefits to those who read the California rules carefully.

The first key difference in the California rules restricts the credit by the location of the qualifying activity. Specifically, Cal. Revenue & Taxation Code (“R&TC”) section 23609(c)(2) provides that qualified research includes only research conducted in California. While this makes sense in that California doesn’t want to provide incentives outside of the state, it places the responsibility on the taxpayer to not only ensure its in-house expenses (e.g., wages, supplies) are for California activities, but contract research expenses are as well. This means that the taxpayer would have to be able to establish that its subcontractors performed their work in California as well to qualify those expenses for the California research credit.

The second key difference is one with which many California practitioners seem unfamiliar. In fact, I have encountered at least two relatively recent cases in which this difference in California law has provided the taxpayers with additional California research credits in excess of six figures that they otherwise might have missed! That provision is the one under R&TC section 23609(h)(3) which reads as follows:
“Section 41(c)(6) of the Internal Revenue Code, relating to gross receipts, is modified to take into account only those gross receipts from the sale of property held primarily for sale to customers in the ordinary course of the taxpayer's trade or business that is delivered or shipped to a purchaser within this state, regardless of f.o.b. point or any other condition of the sale.”

In addition, California Publication 1082 (“Research & Development Credit: Frequently Asked Questions”), section 8 provides the following (in relevant part):
“Excluded receipts are items such as California “throwback” sales for apportionment purposes, as well as, receipts from services, rents, operating leases and interest. In addition, royalties and license payments are generally excluded from the definition of gross receipts for research credit purposes…This California definition of gross receipts applies to both the average annual gross receipts for the prior four years and the base years (1984-1988).”

Note: While the Publication does not have the weight of statutory authority, it is seemingly consistent with the statutory language noted above, and does represent the Franchise Tax Board’s official stance, so ignore it at your peril.

As innocuous as this second item may appear, it represents a fundamental conceptual difference in the computation of the California credit. In short, it redefines “gross receipts” for California purposes as basically only including inventory sales to California purchasers. So what does this really mean? It means that not only should practitioners expect the fixed base percentage to usually differ between federal and California, it also means that average gross receipts for the preceding 4 years will usually differ as well. Moreover, this can (in the right circumstances) provide a large (often beneficial) difference to the taxpayer.

For the sake of illustration, please consider the following simple example:
  • QREs = Qualified research expenditures
  • GR = Gross receipts

  • Taxpayer develops new/improved products for sale to customers
  • All qualified activities are conducted in California
  • Current tax year is 2009

What this example demonstrates is the fact that a taxpayer blindly using the federal rules in this case would have erroneously forgone $840,000 of California research credits to which it was entitled. Fortunately, the taxpayer in this case should be able to file an amended return and claim those credits, but having to go through that process isn’t the ideal way to claim that benefit.


In discussions with other practitioners, relatively few seem to be well-versed in the intricacies of the California research credit. Fortunately however, it’s not that complicated to take the time to read carefully through what amounts to the roughly two and a half pages of Cal. R&TC 23609.

Similarly, for those with clients conducting qualified research in other states, there could be some hidden gems there as well.

Thursday, April 8, 2010

IRS Posts Employer Q&A re Tax Benefits for Certain Employers

Following the recent enactment of the HIRE Act, the IRS has posted on its website [] a set of questions and answers for employers that stand to benefit from some of the Act's new provisions by hiring certain qualified employees. The introductory text reads as follows, and is accompanied by links to IRS Q&As, News releases related to the HIRE Act, and References/Related Topics.
"Under the Hiring Incentives to Restore Employment (HIRE) Act, enacted March 18, 2010, two new tax benefits are available to employers who hire certain previously unemployed workers (“qualified employees”).

The first, referred to as the payroll tax exemption, provides employers with an exemption from the employer’s 6.2 percent share of social security tax on wages paid to qualifying employees, effective for wages paid from March 19, 2010 through December 31, 2010.

In addition, for each qualified employee retained for at least 52 consecutive weeks, businesses will also be eligible for a general business tax credit, referred to as the new hire retention credit, of 6.2 percent of wages paid to the qualified employee over the 52 week period, up to a maximum credit of $1,000."
Well worth a visit.

Monday, April 5, 2010

The New Health Care Law - How Does it Affect You?

As if the entire process and components of the Health Care legislation weren’t confusing enough, the first part (H.R.3590) not only modified itself in certain areas, but the second part (H.R.4872) partially modified the first just one week later!

If you do feel compelled to read through the actual legislation yourself, it’s probably a good idea to first review the Joint Committee’s explanation, which you can find at (released on 3/21/10 as document JCX-18-10 and entitled Technical Explanation Of The Revenue Provisions Of The “Reconciliation Act Of 2010,” As Amended, In Combination With The “Patient Protection And Affordable Care Act”).

In an attempt to clarify the overall impact, this overview incorporates the following two Acts that recently became law and addresses the law as it stands after their combined passage. They are as follows:

While the thousands of pages of text in the new law address a host of issues relating to health care related items, including taxes (as well as seemingly unrelated items such as student loans), the key tax issues fall into a handful of categories that affect individuals and businesses:
  • New and/or Increased Taxes and Fees
  • New and/or Expanded Credits and Incentives
  • Deduction/Exclusion Limitations and/or Restrictions
  • Information Reporting and Disclosure
  • New and/or Expanded Administrative Requirements

Without further ado, here is a brief discussion of the more widely-applicable tax related provisions.


    • Imposes a new nondeductible 40% excise tax on “coverage providers” of employer-sponsored health insurance if the aggregate value of such coverage for an employee exceeds a specified threshold. Depending on the type of coverage, “coverage providers” are generally employers, and/or plan administrators.
    • The threshold for 2018 for individuals is $10,200 and for families it is $27,500, but will be subject to adjustment for differences in increases in health care costs between 2010 and 2018 compared to projections. In addition, adjustments will be made based on differences in age, gender, and high-risk profession rates.
    • Effective for taxable years beginning after 12/31/17.
    • Imposes an annual nondeductible fee on entities that manufacture and/or import branded prescription drugs for sale to (or attributable to) certain government programs. The multi-billion dollar fees are to be apportioned amongst the covered businesses based on their relative shares of branded prescription drug sales for the prior year (more heavily weighted for businesses with higher sales).
    • Effective for calendar years beginning after 12/31/10.
    • Imposes an annual nondeductible fee on certain entities that provide health insurance coverage of United States health risks as part of their business.
    • The multi-billion dollar fees are to be apportioned amongst the covered businesses based on their relative shares of their health insurance net written premiums for the prior year (more heavily weighted for businesses with higher sales).
    • Effective for calendar years beginning after 12/31/13.
    • Requires certain “large” employers (generally those with an average of at least 50 full time employees during the prior calendar year) to offer minimum essential health care coverage. Those failing to do so are generally subject to a nondeductible excise tax of $166.67 per employee per month (in excess of a 30-employee threshold).
    • Also imposes a nondeductible excise tax on large employers that do offer employees the opportunity to sign up for minimal essential coverage, but one or more instead purchase coverage through an exchange that allows or pays a premium tax credit or cost-sharing reduction. The penalty for this situation is $250 per employee per month, and is limited to the amount of the first penalty noted above (which also serves as an overall limitation).
    • Each of the dollar amounts above will be adjusted for inflation after 2014.
    • Effective starting after 12/31/13.
    • Imposes a 2.3% excise tax on the sale of certain medical devices, to be borne by manufacturers, producers, or importers of covered devices. Taxable medical devices are those defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act (21 U.S.C. 321) that are intended for humans. This generally means the following:
      • An instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part, or accessory, which is (1) recognized in the official National Formulary, or the United States Pharmacopeia, or any supplement to them, (2) intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals, or (3) intended to affect the structure or any function of the body of man or other animals, and which does not achieve its primary intended purposes through chemical action within or on the body of man or other animals and which is not dependent upon being metabolized for the achievement of its primary intended purposes. (One example might be an Ultrasonic air embolism monitor used as a monitoring device in the area of Anesthesiology.)
    • However, the following items are generally excluded:
      • Eyeglasses, contact lenses, hearing aids, and any other items determined to be typically purchased at retail by the general public for their own personal use.
    • Effective for sales after 12/31/12.

    • Imposes an additional 0.9% tax on wages (and self-employment income) of those earning more than a threshold amount. That threshold is $250,000 for joint (or surviving spouse) returns, $125,000 of married-filing-separate returns, and $200,000 for other returns.
    • Effective for compensation received in tax years beginning after 12/31/12.
    • Imposes (on the individual using the services) a 10% tax on the amount paid for the indoor tanning services.
    • Effective for services performed on or after 7/1/10.
    • Increases from 10% to 20% the additional tax imposed on disqualifying distributions from an HSA or Archer MSA.
    • Effective for disqualifying distributions made during tax years starting after 12/31/10.
    • Requires most U.S. citizens and legal residents, as well as their dependents, to maintain a minimum level of health care coverage. Those who do not will generally be subject to a penalty. This penalty is based on household income, with a maximum penalty (per month, per person) of $95 for 2014, $325 for 2015, $695 for 2016, and indexed for inflation thereafter. Penalty amounts for minors (under 18) are 50% of the adult amounts, and the maximum family penalty is 300% of the individual adult penalty (but further limited to certain national averages).
    • Effective for tax years starting after 12/31/13.
    • Imposes 3.8% Medicare tax on individuals, trusts, and estates with unearned income and that have modified adjusted gross income in excess of certain thresholds.
    • For individuals, that tax is based on the lesser of (1) net investment income or (2) modified AGI over $250,000 (for joint or surviving spouse returns; $125,000 for married filing separate; all other individuals have a threshold of $200,000).
    • For trusts and estates, the tax is based on the lesser of (1) undistributed net investment income or (2) the excess of AGI over the dollar amount where the highest income tax bracket starts. Caveat: For trusts and estates, the threshold (for 2010) starts at only $11,200, far below the those applicable to individuals.
    • Note that tax-free investments (e.g., certain bonds) are exempt from this tax.
    • Effective for tax years beginning after 12/31/12.


    • Provides eligible small employers with a safe harbor exemption from some of the nondiscrimination rules that otherwise apply to cafeteria plans. Eligible employers are generally those that (1) allow all employees to participate and elect any available benefit under the plan, (2) provide a minimum contribution for all non-highly-compensated employees, and (3) have no more than 100 employees (as an average for the 2 prior years).
    • Effective for tax years beginning after 12/31/10.
    • This provision is a real sleeper and has had surprisingly little press despite its generous provisions. It provides a 50% nonrefundable investment tax credit to certain small businesses (with no more than 250 employees) that invest in qualifying “therapeutic discovery” projects in years beginning in 2009 or 2010. Covered projects are those designed to:
      • Treat or prevent diseases or conditions via pre-clinical activities, clinical trials, and clinical studies, or carrying out research protocols, for the purpose of obtaining approval of a product under specific sections of the Federal Food, Drug, and Cosmetic Act or the Public Health Service Act;
      • Diagnose diseases or conditions or to determine molecular factors related to diseases or conditions by developing molecular diagnostics to guide therapeutic decisions; or
      • Develop a product, process or technology to further the delivery or administration of therapeutics.
    • Qualified investments are the aggregate amount of costs paid or incurred for the tax year for expenses necessary for and directly related to the conduct of a qualifying therapeutic discovery project, but exclude (1) compensation paid to the CEO and the four highest paid officers other than the CEO, (2) interest expense, (3) facility maintenance expenses, (4) service costs as determined under the uniform capitalization rules, and (5) any other expense determined by the Secretary to be appropriate under the circumstances.
    • Alternatively, qualifying taxpayers may generally elect to receive a grant instead of a credit with respect to their qualifying investment.
    • Note: This provision is not automatic for potentially qualifying small businesses. It requires potential recipients to apply to the program which is to be established by the Secretary (in consultation with the Department of Health and Human Services) within 60 days after 3/23/10. Following the submission of an application, the Secretary will have 30 days to approve or reject the application. Selection criteria will take into consideration only those projects
      • That show reasonable potential to result in new therapies to treat areas of unmet medical need, or to prevent, detect, or treat chronic or acute diseases and conditions, to reduce long-term health care costs in the United States, or to significantly advance the goal of curing cancer within 30 years, and
      • That have the greatest potential to create and sustain high quality, high-paying jobs in the United States, and to advance U.S. competitiveness in the fields of life, biological, and medical sciences.
    • Effective for amounts paid or incurred in tax years beginning after 12/31/08.

    • Excludes from income amounts received by individuals under the National Health Service Corps loan repayment program (as well as certain state programs) intended to provide for increased health care availability in underserved areas.
    • Effective for amounts received in tax years starting after 12/31/08.
    • Raises the maximum adoption credit (as well as the income exclusion for employer-provided adoption assistance) to $13,170 for 2010, with additional changes to the inflation adjustment and income limitation threshold for post-2010 years. Also makes the credit refundable starting in 2010.
    • The sunset of these provisions (which reduces the amounts to prior, lower amounts) is also delayed by 1 year (i.e., for tax years beginning after 12/31/11).
    • Provides a refundable tax credit for individuals and families to help subsidize the purchase of health insurance through an exchange. The amount of the credit is based on the insured person’s income and is generally available for those with household incomes between 100% and 400% of the federal poverty level and who do not receive (or are not offered) health insurance through an employer.
    • Effective for tax years ending after 12/31/13.
    • Establishes a subsidy to help lower-income individuals and families (household incomes between 1 and 4 times the poverty level) afford health care coverage.
    • Effective from 3/31/10.


    • Increases the lower limit for taking an itemized deduction for unreimbursed medical expenses from 7.5% to 10% of Adjusted Gross Income (for regular tax purposes, but leaves the threshold for AMT purposes unchanged). If taxpayer (or their spouse) reaches age 65 during any of the tax years 2013 through 2016, this increase does not apply to such years.
    • Effective for taxable years beginning after 12/31/12.
    • Denies a deduction for executive compensation in excess of $500,000 to certain health insurance providers. This generally excludes employers with self-insured plans. In addition, performance-based compensation does not escape this limitation.
    • Effective for compensation for tax years beginning after 12/31/12 that are attributable to services performed during years beginning after 12/31/09.
    • Reduces the deduction for expenses attributable to retiree prescription drug expenses by the amount of the subsidy (to the extent the subsidy is excluded from income).
    • Effective for tax years beginning after 12/31/12.
    • Restricts certain special insurance company tax benefits to those entities satisfying a minimum medical loss ratio of 85% for the year (i.e., the percentage of its total premium revenue expended on reimbursement for clinical services provided to enrollees during the year).
    • These rules generally allow Blue Cross, Blue Shield, and similar organizations a deduction of 25% of the year’s claims and liabilities under cost-plus contracts as well as administrative expenses related to such claims and contracts (minus the prior year’s surplus for regular tax), as well as other tax benefits.
    • Effective for tax years beginning after 12/31/09.
    • Changes the cellulosic biofuel producer credit so that it no longer applies to unprocessed fuels with specified percentages of water, sediment, or ash content, such as “black liquor.”
    • Effective for fuels sold or used after 1/1/10.
    • Restricts allowable distributions from Health FSAs, HSAs, HRAs, and Archer MSAs to (1) prescribed drugs, including over-the-counter medicines if prescribed by a doctor and (2) insulin.
    • Effective for expenses incurred after 12/31/10.
    • Imposes an upper limit on Health FSAs under cafeteria plans of $2,500 per year (indexed for future inflation).
    • Effective for taxable year beginning after 12/31/12.


    • Requires employers to disclose the value of health insurance coverage on each employee’s W-2.
    • Effective for tax years beginning after 12/31/10.
    • Requires businesses to file information returns for all payments totaling $600 or more, even if the recipient is a corporation (but not including tax-exempt corporations).
    • Also expands the scope of the type of payments for which reporting is required to include all payments in consideration for property, and other gross proceeds for both property and services.
    • Effective for payments made after 12/31/11.
    • Having been discussed for quite some time, places the Economic Substance doctrine into the Code. The Economic Substance doctrine generally stands for the proposition that there should be no tax benefits to the extent that there was no real financial motive aside from saving federal taxes.
    • Also establishes an increase in the penalty where the transaction(s) at issue did not have economic substance (i.e., 40% instead of 20%).
    • Effective from 3/31/10.


    • Sets new requirements for charitable hospitals, in addition to those previously established. These include (1) performance of a community health needs assessment once every 3 years, (2) creation/implementation of a written financial assistance policy, (3) limitation on charges billed for emergency or other medically necessary care for those qualifying for financial assistance, and (4) limitation on extraordinary collection efforts without first trying to determine if the responsible persons are eligible for financial assistance.
    • Also imposes a penalty of up to $50,000 for failures to conduct the community health needs assessment.
    • Generally effective for tax years beginning after 3/23/10, except for the community health needs assessment (effective for tax years beginning after 3/23/12) and the penalty for failure to perform the assessment (effective for failures after 3/23/10).
    • Increases the amount of the required federal estimated tax due in the 3rd quarter 2014 by 15.75 percentage points.
    • Effective from 3/31/10.

As always, I look forward to your questions and comments.