The Education, Jobs, and Medicaid Assistance Act of 2010.

• Author: Weber, Neal A.

PL. 111-226, informally known as the Education, Jobs, and Medicaid Assistance Act of 2010, was signed into law by President Barack Obama on August 10, 2010, effective for tax years beginning after December 31, 2010. The act made significant changes to foreign tax credits under the Code. The changes include:

* New Sec. 909, which creates a "matching rule" to prevent the splitting of foreign tax credits from associated foreign income;

* Amendment of Sec. 901, adding subsection (m) to deny foreign tax credits in covered acquisition transactions where the foreign income is not subject to U.S. tax; and

* Amendment of Sec. 960 to limit the amount of foreign taxes deemed paid as a means of preventing affirmative use of the "hopscotch" rule as a foreign tax credit planning device under Sec. 956.

Many business organizations have voiced opposition to the new law, pointing out that the new provisions impose de facto tax increases to the marginal tax rate of U.S. enterprises operating outside the United States.

U.S. Foreign Tax Credit System

In the United States, citizens, residents, and businesses are taxed on worldwide income, regardless of whether the income was generated from within the United States. To mitigate double taxation of income, the U.S. taxpayer can offset foreign taxes paid with a credit against its U.S. tax liability. Thus, the U.S. taxpayer may elect a credit for foreign taxes paid or accrued dollar for dollar against its U.S. tax liability. The U.S. tax system allows a credit for direct tax payments (i.e., foreign taxes paid directly by a U.S. company). In addition, the system also allows credit for taxes paid at the subsidiary level when income is repatriated to the United States. Specific ownership requirements must be met to be eligible for indirect credits.

If the taxpayer does not elect the foreign tax credit, it may deduct the foreign taxes paid against its taxable income. Taxpayer circumstances dictate whether the credit or the deduction produces a greater benefit. The purpose behind the foreign tax credit is to ensure that U.S.-based businesses are not harmed by the worldwide tax system. Checks and balances, as well as limitations, are built into the statutory regime to guard against abuse and maintain functional consistency across U.S. taxpayers.

There are several inherent limitations used to avoid abuse:

* The foreign tax credit is limited to the amount of U.S. tax that would be imposed on the foreign-sourced income were the tax credit not available. This limitation is calculated by multiplying the taxpayer's foreign-source income by the U.S. tax rate.

* Sec. 904(c) limits the amount of credit utilized against the U.S. tax liability to the amount determined in the above computation. Taxpayers may carry back the excess to the previous year and carry forward the remaining excess to the subsequent 10 tax years.

* Cross-crediting of taxes generated by different types of income is prohibited.

The...