Changes in the American Jobs Creation Act of 2004
Mark H. Levin
AUGUST 2005 - On October 22, 2004, President
Bush signed the American Jobs Creation Act of 2004 (AJCA)
in response to the World Trade Organization’s (WTO)
rulings that the benefits available to foreign sales corporations
(FSC) and the Extraterritorial Income Exclusion Act of 2000
(ETI) constituted illegal export subsidies. The ETI repealed
the FSC provisions and replaced them with an exclusion for
extraterritorial income. The AJCA also made some other significant
changes affecting both businesses and personal income taxes.
Repeal of the ETI Provisions
The AJCA repealed the ETI provisions [including
subpart E of Part III of subchapter N and IRC sections 54(g)(4)(B)(i),
275(a), 864(e), 903, and 999(c)(1)], and replaced them with
a percentage deduction available to manufacturing activities
[IRC section 199(a)].
The repeal is phased out over three years.
For transactions that occurred in 2004, taxpayers retained
100% of their ETI benefits. For transactions occurring in
2005, taxpayers will retain 80% of their ETI benefits. For
transactions occurring in 2006, taxpayers retain 60% of
their ETI benefits. For transactions occurring after 2006,
taxpayers cannot take any of their previously permitted
The AJCA provides that the ETI exclusion
provisions remain in effect for transactions in the ordinary
course of a trade or business if such transactions are pursuant
to a binding contract between the taxpayer and an unrelated
party, provided that such a contract was in effect on September
17, 2003, and thereafter.
THE AJCA enacted an income deduction based
on a percentage of the lesser of “qualified production
activities income” (QPAI, defined below) or taxable
income (modified AGI for individuals) to be phased in over
five years (see IRC section 199) as follows:
||Percent of QPAI
The deduction is effective for taxable years
beginning after December 31, 2004. The deduction is limited
to 50% of the W-2 wages of the employer for the taxable
The deduction is available to all business
entities: C corporations, S corporations, partnerships,
sole proprietorships, cooperatives, estates, and trusts.
All members of an expanded affiliated group will be treated
as a single taxpayer for the computation of this deduction.
An expanded affiliated group is an affiliated group, as
defined in IRC section 1504(a), except that 50% is substituted
for 80% and without regard to IRC section 1504(b) [see also
IRC sections 199, 54(g)(4)(B)(i), and 864(e)].
In the case of S corporations, partnerships,
sole proprietorships, cooperatives, estates and trusts,
or any other pass-through entity, this deduction shall be
applied at the shareholder, partner, or similar level [IRC
section 199 (d)(1)].
The deduction will be allowed for the purposes
of computing the alternative minimum taxable income (including
adjusted current income). According to IRC section 56 (g)(4)(C)(v),
the deduction is determined by reference to the lesser of
the qualified production activities income (QPAI) (defined
below), as determined for the regular tax, or the alternative
minimum taxable income (in the case of an individual, adjusted
gross income is determined for the regular tax) without
regard to this deduction.
Qualified Production Activities
QPAI is an amount equal to the excess, if
any, of the taxpayer’s domestic production gross receipts
for the taxable year, under IRC section 199(c)(1), over
the sum of:
- the cost of goods sold that are allocable
to such receipts;
- other deductions, expenses, and losses
that are directly allocable to such receipts; and
- a ratable portion of other deductions,
expenses, and losses that are not directly allocable to
Domestic production gross receipts are defined
as the gross receipts of the taxpayer that are derived from
- any sale, exchange, or other disposition,
or any lease, rental, or license, of qualifying production
property that was manufactured, produced, grown, or extracted
by the taxpayer in whole or in significant part within
the United States;
- any sale or other disposition, or any
lease, rental, or license, of a qualified film produced
by the taxpayer;
- any sale, exchange, or other disposition
of electricity, natural gas, or potable water produced
by the taxpayer in the United States;
- construction activities performed in
the United States; and
- engineering or architectural services
performed in the United States for construction projects
located in the United States.
The definition of “manufactured”
property in the legislation is not clear and has caused
considerable confusion among commentators.
A film is qualified, as described in IRC
section 168(f)(3), if not less than 50% of the total compensation
relating to the production is for services performed in
the United States by actors, production personnel, directors,
and producers [IRC section 199(c)(6)]. Films of a sexually
explicit nature generally do not qualify.
Under IRC section 199(c)(5), qualifying
production property is defined as tangible personal property,
any computer software, and any sound recordings described
in IRC section 168(f)(4).
AJCA extended the $100,000 maximum deduction allowed under
IRC section 179 through 2007 (it was scheduled to lapse
after 2005). The AJCA also extended the $400,000 phase-out
provisions of IRC section 179 through 2007 (also formerly
scheduled to lapse after 2005). The section 179 deduction
for sport utility vehicles rated at not more than 14,000
pounds gross vehicle weight is limited to $25,000, effective
for vehicles placed in service after October 22, 2004.
The AJCA provides that qualified leasehold
improvements, as defined in IRC section 168(k), placed in
service before January 1, 2006, are entitled to be depreciated
under a 15-year recovery period [under IRC section 168(e)(3)(E)],
and continue to be eligible for the “bonus”
first-year depreciation under IRC section168(k).
The AJCA provides that qualified restaurant
property placed in service before January 1, 2006, may be
depreciated under a 15-year recovery period [IRC section
168(e)(7)]. The allowance of a 15-year recovery period also
permits qualified restaurant property to utilize “bonus”
first-year depreciation under IRC section 168(k).
S Corporation Changes
The AJCA included three provisions that
make it more difficult for an S corporation to be disqualified
by exceeding the maximum number of eligible shareholders
(see IRC section 1361).
First, for taxable years beginning after
December 31, 2004, S corporations may have as many as 100
eligible shareholders (formerly limited to 75).
Second, for taxable years beginning after
December 31, 2004, family members that are shareholders
of an S corporation may elect to be treated as one shareholder.
Family members are defined as those with a common ancestor,
lineal descendants of a common ancestor, and the spouses
(or former spouses) of such lineal descendants or common
ancestors. A family may not consist of more than six contiguous
Third, for taxable years beginning after
December 31, 2004, powers of appointment are disregarded,
to the extent they are unexercised, in determining the potential
current beneficiaries of an electing small business trust
(ESBT). In addition, also for taxable years beginning after
December 31, 2004, the AJCA increases the period during
which an ESBT can dispose of S corporation shares after
an ineligible shareholder becomes a potential current beneficiary
to one year.
The AJCA provides that, for transfers occurring
after December 31, 2004, if a shareholder’s S corporation
stock is transferred to a spouse (or former spouse, incident
to a divorce), any suspended losses due to insufficient
basis [under IRC section 1366(d)(1)] are also transferred
to the spouse (or former spouse). While the AJCA addresses
suspended losses due to lack of basis, it does not address
losses suspended under the at-risk or passive-loss rules
when transferred incident to a divorce.
For transfers made after December 2004,
when a qualified subchapter S corporation trust (QSST) disposes
of its shares in an S corporation, it is treated as a disposition
by such income beneficiaries, allowing the beneficiaries
to deduct losses suspended under the passive-loss or at-risk
rules (see IRC section 1361).
In addition, the AJCA permits the IRS to
waive inadvertent qualified subchapter S elections and terminations
starting in taxable years beginning after December 31, 2004.
Deduction of state and local
sales taxes. For taxable years 2004 and 2005,
taxpayers that itemize deductions may elect to deduct state
and local general sales taxes instead of state and local
income taxes [IRC section 164(b)(5)]. Taxpayers electing
to deduct state and local general sales taxes can either
save all of their receipts and deduct the exact amount paid,
or use a table (based on adjusted gross income, provided
by the IRS) plus the actual tax on certain “big-ticket”
Foreign tax credits. Starting
in taxable years beginning after December 31, 2006, the
number of foreign tax credit baskets will be reduced to
two (currently nine). The two baskets will be passive category
income and general category income (see IRC section 904).
Passive category income is defined as passive
income as well as the following:
- Dividends from a DISC or former DISC
[as defined in IRC section 992(a)] to the extent that
such dividends are treated as income from sources not
including the United States;
- Taxable income attributable to foreign
trade income [within the meaning of IRC section 923 (b)];
- Distributions from an FSC or former FSC
out of earnings and profits attributable to foreign trade
income or interest, or carrying charges [as defined in
IRC section 927 (d)(1)] derived from a transaction which
results in foreign trade income.
General category income is defined as income
other than passive category income and includes financial
Effective for excess credits that can be
carried to years ending after October 22, 2004, any excess
foreign tax credit may be carried forward for 10 years (formerly
five) [IRC section 904 (c)]. The carryback period is reduced
from two years to one.
The AJCA repealed the 90% limitation on
the foreign tax credit in computing the alternative minimum
tax for taxable years beginning after December 31, 2004,
thus allowing 100% of the foreign tax credit against the
alternative minimum tax (IRC section 59).
Mark H. Levin, CPA, is
manager, state and local taxes, at H.J. Behrman & Company,
LLP, New York, N.Y.