The AJCA's domestic business provisions: the American Jobs Creation Act of 2004 (AJCA) is an expansive piece of legislation touching many types of taxpayers. This article discusses the AJCA provisions that primarily affect U.S. domestic businesses.

• Author: Karlinsky, Stewart S.

The American Jobs Creation Act of 2004 (1) (AJCA), enacted on Oct. 22, 2004, probably contains the most far-reaching set of tax law changes since the Tax Reform Act of 1986. Its cost is revenue scored at $139 billion.

This article focuses on the AJCA changes that affect domestic businesses in five main categories: cost recovery, domestic production activities, sleeper provisions, alternative minimum tax (AMT) and S corporations.

Cost Recovery

Bonus Depreciation and Sec. 179

Surprisingly, the AJCA did not extend the 30% or 50% bonus cost recovery regime, thus subjecting assets placed in service after 2004 to normal modified accelerated cost recovery system depreciation and AMT adjustments.

However, AJCA Section 201 did extend the enhanced Sec. 179 first-year expense election to 2006 and 2007. Thus, if new or used tangible personal property (or certain computer software) is acquired, $100,000 ($105,000, as indexed for 2005) of these capital costs can be expensed in the year placed in service, assuming that the total of qualified property acquired that year does not exceed $400,000 ($420,000 as indexed for 2005). For example, if the amount of qualified property acquired in 2005 equals or exceeds $525,000 ($105,000 + $420,000), no Sec. 179 expense would be allowed. (2)

Sport utility vehicles: Under Sec. 280F, taxpayers are prohibited from using the flail benefit of Sec. 179 for "luxury automobiles." However, there is a fairly longstanding exception for heavy trucks (i.e., gross vehicle weight (GVW) greater than 6,000 lbs.). In an environmentally conscious world, in which certain vehicles are venerated for their gas conservation, it made little sense to reward conspicuous gas guzzlers whose weight met the heavy truck weight limit. Thus, Sec. 179(b)(6), added by AJCA Section 910(a) for purchases after Oct. 22, 2004, does not allow the full Sec. 179 deduction, but instead caps it at the old Sec. 179 limit of $25,000 (not indexed). There are exceptions for vehicles with GVW greater than 14,000 lbs. and for certain pick-up trucks, delivery vans and passenger vans (carrying more than nine passengers behind the driver), which would be eligible for the $100,000 (indexed) expensing limit.

Leasehold/Restaurant Improvements

AJCA Section 211 contains a short window of which nonresidential real estate property owners need to be aware. Basically, for qualified leasehold improvement property placed in service between Oct. 23, 2004 and Dec. 31, 2005, it authorizes a 15-year recovery period, rather than 39 years, using the straight-line method. To qualify, improvements must not be attributable to (1) a building less than three years old, (2) an enlargement of the building, (3) the building's internal structural framework, (4) a structural component benefiting common areas or (5) an elevator or escalator.

Similar rules and effective date apply to "qualified restaurant property." This term is new and denotes an improvement to a building more than three years old, for which more than half of its square footage is devoted to the restaurant business. This would seem to favor stand-alone restaurants, rather than those in a commercial building. The AJCA makes such improvements eligible for 50% bonus depreciation through the end of 2004.

Film Production

AJCA Section 244 offers a significant tax incentive to movie and TV film producers. It allows them to deduct $15 million (in some cases, $20 million) in the year that the cost of a qualified film or television production is expended, provided (among other things) that at least 75% of total production compensation is for services performed in the U.S. and the film is not sexually explicit. This "super" Sec. 179 expensing rule is effective for productions starting after Oct. 22, 2004 and before 2009, but only applies to aggregate production costs that do not exceed $15 million ($20 million if filming occurs in certain designated zones).

Organization and Start-Up Costs

AJCA Section 902 allows taxpayers to elect to deduct up to $5,000 of organization costs and $5,000 of start-up costs in the year in which business begins, rather than amortizing them over 60 months, as under pre-AJCA Secs. 248, 709 and 195. However, $1 of the $5,000 expensing limit is lost for every such dollar spent above $50,000. Any nonexpensed start-up or organization costs have to be amortized over 15 years. This rule is effective for expenditures paid or incurred after Oct. 22, 2004. Total cumulative expenditures include expenditures that occur before and after the enactment date for purposes of the $50,000 test.

Domestic Production Activities Deduction

The World Trade Organization had imposed substantial tariffs on certain U.S.-produced goods, because it deemed that the U.S. was violating international tariffs and trade agreements, by enacting rules on domestic international sales corporations, foreign services corporations and, most recently, extraterritorial income (ETI). To avoid these tariffs, AJCA Section 102 phased out the ETI provisions and added Sec. 199, which allows a phased-in 9% U.S. production activities deduction for all domestic producers. For tax years beginning in 2005 and 2006, the deduction percentage is 3%; for tax years beginning in 2007-2009, it is 6%; and for 2010 and thereafter, it is 9% of the smaller of the taxpayer's qualified production activities income or taxable income.

Applicability

Although Sec. 199 applies to all taxpayers (as is discussed below), the usefulness for partnerships, limited liability companies (LLCs) and sole proprietors may be reduced by the requirement that the business have W-2 wages and positive qualified production activities income.

The deduction is a percentage of the taxpayer's "qualified production activities income" for the tax year (or taxable income, if smaller). Qualified activities are broadly defined to include gross receipts derived from any sale, exchange, disposition, lease, rental or license of qualifying production property manufactured, produced, grown or extracted by the taxpayer, in whole or in significant part, within the U.S.; certain films produced by the taxpayer; and electricity/natural gas/potable water produced by the taxpayer in the U.S. Domestic production gross receipts also include gross receipts derived from U.S. construction and engineering and architectural services related to domestic real estate. The only explicitly excluded categories are retail sales of food or beverages prepared by the taxpayer; transmission of electricity/natural gas/potable water; or a lease, license or rental of property to a related party.

"Qualified Production Activities Income"

This term is defined as domestic production gross receipts, less the cost of goods sold properly allocable to those receipts, less directly and indirectly related expenses, deductions and losses allocable to such receipts. The allocation of indirectly related expenses requires significant guidance from Treasury. (3)

Limits

Two main limits apply to Sec. 199. First, a taxpayer's qualified production activities income and taxable income (without regard to the Sec. 199 deduction) must both be positive. If either reflects a loss, no Sec. 199 deduction or carryover is permitted. Second, the deduction may not exceed one-half of the W-2 wages (not necessarily from the production activity) reported in the calendar year that ends in the tax year of the deduction.

Example 1: X Corp. has (1) a Sept. 30, 2006 year-end that reflects $400,000 in net profit from a manufacturing activity, (2) W-2 wages of $10,000 from production salaries in 2005 and (3) $100,000 from nonproduction salaries in 2005. X's Sec. 199 deduction is $12,000 ($400,000 x 0.03), which does not exceed $55,000 ($110,000W-2 wages in 2005 x 0.50).

This limit may be problematic for partnerships, LLCs and sole proprietors, because guaranteed payments are not deemed W-2 wages, partners/ members are...