American Jobs Creation Act of 2004

On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 ("Act"). This memorandum describes some of the important provisions of the Act.

"S" Corporation Reform

The Act relaxes the rules governing eligibility to elect "S" corporation status, including increasing the number of eligible shareholders from seventy-five (75) to one hundred (100) and treating lineal descendants of the same family for six (6) generations as one (1) shareholder. The Act also provides relief from inadvertent terminations and invalid elections of "S" corporation status.

Nonqualified Deferred Compensation Plans

The Act makes significant changes to the rules affecting taxation of nonqualified deferred compensation plans effective 2005 and thereafter. The new rules apply very broadly to any nonqualified plans, agreements or arrangements that provide for deferral of income, including supplemental retirement plans, stock option plans and bonus arrangements. Certain "grandfather" rules might apply to amounts that are treated as deferred prior to January 1, 2005.

Generally, taxpayers must meet specific requirements to avoid constructive receipt of income under plans that provide for deferral of income. Failure to comply with the new rules results in immediate taxation of deferred amounts, interest and an additional tax equal to 20% of deferred amounts. We recommend that employers immediately determine if they have any plans or arrangement that are covered under the new law and make any changes that are required to comply with its requirements.

Election to Deduct State and Local Sales Taxes

For 2003 through 2005, taxpayers may elect to deduct either state and local income taxes or state and local sales taxes as an itemized deduction on their federal income tax returns. The deduction is subject to the phase-out limitations for taxpayers with incomes over specified amounts.

Repeal of the Extraterritorial Income Exclusion

The Extraterritorial Income Exclusion which provides an exclusion from gross income for certain exporting activities is gradually phased-out from 2004 through 2006 and completely repealed in 2007 and thereafter. The exclusion remains in effect for taxpayers that had binding contracts in effect on September 17, 2003.

Deduction for Manufacturing Activities

Starting in 2005, the Act provides a new deduction against income for certain U.S. manufacturing activities. Manufacturing activities that qualify for the deduction include: (1) the sale, lease or license of property manufactured or produced in the United States, (2) construction activities performed in the United States (including engineering or architectural services), (3) processing of agricultural products, (4) the sale of electricity, natural gas and water, and (5) the production of certain motion pictures and videotapes.

For 2005 and 2006, the deduction is 3% of the lesser of: (i) net income from the qualifying activity for the taxable year or (ii) taxable income (determined without regard to the new deduction). The deduction is increased to 6% for years 2007 through 2009 and again increased to 9% for 2010 and thereafter. The deduction is further limited for any taxable year to 50% of the wages paid by the taxpayer during such year.

When fully phased-in, the deduction could reduce by as much as three (3%) percent the U.S. effective income tax rate on manufacturers. For partnerships and "S" corporations, the deductions is determined at the partner or shareholder level by taking into account each owner's allocable share of income from manufacturing activities.

Foreign Tax Provisions

A. Incentive to Repatriate Foreign Earnings - Deduction for Dividends from Controlled Foreign Corporations

The Act allows U.S. corporations to elect to deduct 85% of certain cash dividends received from controlled foreign corporations in which they are shareholders. The amount of deductible dividends is limited to $500,000.00 or the taxpayer's earnings shown as permanently invested outside the United States on its financial statements. Also, the shareholder must reinvest the dividends pursuant to a domestic reinvestment plan approved by senior management and the Board of Directors.

B. Foreign Tax Credit Provisions

Effective for 2005, the Act repeals the ninety (90%) percent limit on the use of the foreign tax credit against alternative minimum tax ("AMT") liability. Although other limitations still apply, taxpayers may now use their entire foreign tax credit in determining their AMT. The Act also extends the carryover period for foreign tax credits from five (5) to ten (10) years and reduces the carryback period from two (2) to one (1) year.

C. Repeal of Subpart F Shipping Income Treatment

Starting in 2005, the Act repeals the provisions characterizing certain income of non-U.S. corporations from vessel operations as Subpart F shipping income. This may permit U.S. taxpayers to defer U.S. taxation on income from certain international shipping and transportation activity.

Alternative Tax Regime for International Shipping Corporations

The Act allows corporations involved in U.S. foreign trade using qualified vessels (not less than 10,000 deadweight tonnage) to elect to be subject to an alternative "tonnage tax" as opposed to the normal U.S. corporate tax system. Further, the Act provides for tax deferral on the sale of qualified vessels provided the proceeds are reinvested in a new vessel.

Conclusion

There are numerous other special provisions in the Act that may provide you or your business with a tax savings opportunity. Please contact us if you have any questions concerning the new legislation or if you would like us to review the effect the Act has on your unique tax situation or business.