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Senate Panel Codifies Economic Substance In Agricultural Tax Package

by Leroy Baker,, New York

11 October 2007

The Senate Finance Committee has approved a number of amendments to an agricultural tax incentive package that will codify the economic substance doctrine and tighten up existing tax laws to generate the revenues needed to pay for the package.

The offsets, written mainly by panel Chairman Max Baucus (D-Mont.), were contained in the 'Heartland, Habitat, Harvest, and Horticulture Act of 2007', which was recently approved by the committee in a 17-4 vote.

More than $10 billion of the $15 billion in agricultural tax breaks will be offset by a clarification of the economic substance doctrine, and the introduction of a 30% penalty for understatements attributable to transactions lacking economic substance. This penalty is reduced to 20% if the transaction was disclosed. While the proposal clarifies the application of the doctrine, it does not change current-law standards used by courts in determining when to utilize an economic substance analysis.

Under the proposal, in any case in which a court determines that the economic substance doctrine is relevant to a transaction, the economic substance doctrine would be satisfied only if the transaction changes in a meaningful way (apart from federal income tax consequences) the taxpayer’s economic position, and the taxpayer has a substantial non-Federal tax purpose for entering into such transaction. The proposal would become effective for transactions entered into after the date of enactment.

The Baucus amendment also proposes that any deduction for interest on unpaid taxes attributable to any non-economic substance transaction understatement be denied, raising $43 million over ten years if enacted.

Additional offsets include:

Sale-In/Sale-Out (SILO)—Foreign: This proposal disallows future losses on foreign tax exempt use property for leases entered into on or before March 12, 2004. This will provide $3.235 billion over ten years.

Limitation on Schedule F Loss: The amount of Schedule F (agricultural) loss that a taxpayer may use to reduce income is generally not limited. The proposal would limit the amount of Schedule F loss that a taxpayer may use to offset income to $200,000 if the taxpayer receives Agriculture Program Payments or CCC loans. Losses that are limited in a particular year may be carried forward to subsequent years. This provision will provide $456 million over ten years.

Optional Self-Employment Tax: Qualifying for Social Security benefits can be difficult for self-employed farmers and ranchers, because they do not always have a steady income stream. When there are no earnings, no Social Security taxes are paid and no quarters are accrued. Through farm optional methods, farmers and ranchers may voluntarily pay Social Security taxes in order to earn quarters so that they can receive Social Security benefits. However, the payment thresholds are outdated and no longer allow farmers and ranchers to earn four quarters of credit per year. The proposal modifies the farm optional method so that electing taxpayers may be eligible to secure four credits of Social Security benefit coverage each taxable year. The proposal makes a similar modification to the non-farm optional method. This provision will provide $110 million over ten years.

Information Reporting for Commodity Credit Corporation Transactions: The Commodity Credit Corporation (“CCC”) may make market assistance loans to farmers of eligible commodities. A farmer receiving a CCC loan can use cash to repay such a loan, purchase CCC certificates for use in repayment of the loan, or deliver the pledged collateral as full payment for the loan at maturity. In IRS Notice 2007-63, the IRS held that the CCC must use Form 1099-G to report market gain associated with the repayment of a CCC loan whether the taxpayer repays the loan with cash or uses CCC certificates in repayment of the loan. This codifies that notice with no revenue effect.

Modification of Section 1031 Treatment for Certain Real Estate: An exchange of property, like a sale, generally is a taxable event. However, no gain or loss is recognized if property held for productive use in a trade or business is exchanged for property of a “like kind”. For purposes of section 1031, the determination of “like kind” relates to the nature or character of the property and not grade or quality. Therefore, improved real estate and unimproved real estate are generally considered to be property of a “like kind” as this relates to the grade or quality of the real estate. The proposal modifies section 1031 to disallow non-recognition treatment for exchanges of unimproved real estate for which the owner has received Agriculture Program Payments or CCC loans for improved real estate. This will provide $27 million over ten years.

Additional energy-related offsets include a 5-cent reduction in the ethanol credit, an extension of the tariff on ethanol, the elimination of certain refunds of duty imposed on ethanol, an exclusion of denaturant from alcohol fuels credit, and reclassification of alcohol and biodiesel as taxable fuel.

These revenue raising measures are designed to offset the cost of the $15.05 billion '4-H' bill, which will create a trust fund to help ranchers and farmers hurt by crop and livestock losses, convert a number of conservation payment programs into fully-offset tax credit programs, and offer additional incentives for rural economic development and energy-related tax relief to aid agricultural producers.

“This disaster assistance, tax relief, and timely energy incentives will provide a much needed boost to American agriculture and greater security to our hardworking agricultural producers,” stated Baucus. “Whether it’s getting a few more dollars in their pockets, rewarding their conservation of American lands, or making sure that one disaster won’t force them to sell the family farm, this package is good for producers in my home state of Montana and across the country.”

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