Bonus Depreciation Allowance

The Act allows an additional first-year depreciation deduction equal to 30% of the adjusted basis of qualified property for both regular tax and alternative minimum tax (AMT) purposes for the tax year the property is placed in service. The basis of the property and the depreciation allowances in the year of purchase and later years are appropriately adjusted to reflect the additional deduction. However, taxpayers can elect out of the additional first-year depreciation for any class of property for any tax year.

An example in the report illustrates the ordering rules for applying this provision. On March 1, 2002, a calendar year taxpayer acquires and places in service qualified property that costs $50,000. The taxpayer is first allowed a $24,000 deduction under IRC Sec. 179, then an additional first-year depreciation deduction of $7,800 based on $26,000 ($50,000 original cost less $24,000) of adjusted basis. Finally, the remaining adjusted basis of $18,200 ($26,000 adjusted basis less $7,800 additional first-year depreciation) is recovered in 2002 and later years under the regular depreciation rules.

To qualify for the bonus first-year depreciation deduction, the general MACRS rules must apply to the property, which must (1) have an applicable recovery period of 20 years or less, (2) be water utility property, (3) be computer software other than software covered by IRC Sec. 197, or (4) be qualified leasehold improvement property.

Furthermore, (1) the original use of the property must commence with the taxpayer on or after September 11, 2001; (2) the property must be placed in service before January 1, 2005; and (3) the property must be purchased within the applicable time period. In general, the applicable time period for acquired property is (1) after September 10, 2001, and before September 11, 2004, if no binding written contract for the acquisition is in effect before September 11, 2001; or (2) pursuant to a binding written contract that was entered into after September 10, 2001, and before September 11, 2004.

In addition, the Section 280F limitation on the amount of depreciation allowed for certain passenger autos is increased in the first year by $4,600 for autos that qualify (and do not elect out of the increased first-year deduction).

Five-year Carryback of Net Operating Losses

The Act temporarily extends the general net operating loss (NOL) carryback period to five years (from two years) for NOLs arising in tax years ending in 2001 and 2002. In addition, the five-year carryback period applies to NOLs from these years that qualify for a three-year carryback period (i.e., NOLs arising from casualty or theft losses of individuals or attributable to certain presidentially declared disaster areas).

A taxpayer can elect to forgo the five-year carryback period, which must be made by the due date of the return (including extensions) for the year of the loss. The election is irrevocable. If a taxpayer elects to forgo the five-year carryback period, the losses are subject to the rules that otherwise would apply under IRC Sec. 172.

Finally, the Act allows an NOL deduction attributable to NOL carrybacks arising in tax years ending in 2001 and 2002, as well as NOL carryforwards to these taxable years, to offset 100% of the taxpayer's alternative minimum taxable income.

Discharge of an S Corporation’s Indebtedness

In the Gitlitz case [531 U.S. 206 (2001)], the Supreme Court held that income from the discharge of indebtedness of an S corporation that is excluded from income is treated as an item of income that increases the basis of a shareholder's stock in the S corporation and allows suspended corporate losses to pass through to a shareholder. According to the JCT report, under the decision, an S corporation shareholder is allowed to deduct a loss for tax purposes that was not economically incurred.

Under the Act, income from the discharge of indebtedness of an S corporation that is excluded from the S corporation's income is not taken into account as an item of income by any shareholder and so does not increase the basis of any shareholder's stock in the corporation. This provision applies to discharges of indebtedness after October 11, 2001, with an exception for discharges of indebtedness before March 1, 2002, pursuant to a plan of reorganization filed with a bankruptcy court on or before October 11, 2001.

Nonaccrual Experience Method of Accounting

Under the Act, the nonaccrual experience method of accounting is available only for amounts to be received for the performance of qualified services and for services provided by certain small businesses. Qualified services are services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. As under present law, the availability of this method is conditioned on the taxpayer not charging interest or a penalty for failure to timely pay the amount charged.

This provision is effective for tax years ending after the date of enactment. Any change in the taxpayer's method of accounting required as a result of the limitation on the use of the nonaccrual experience method is treated as a voluntary change initiated by the taxpayer with the IRS’s consent. Any resulting Section 481(a) adjustment is to be taken into account over the lesser of the number of years the taxpayer used the nonaccrual experience method of accounting or four years.

Deemed Sale of Assets

The Act clarifies the effects of the "deemed sale election" to recognize gain on assets held on January 1, 2001. First, consistent with Rev. Rul. 2001-57, the exclusion of gain on the sale of a principal residence under IRC Sec. 121 does not apply where the taxpayer makes an election for his or her residence.

Second, the Act clarifies that an election for an interest in a passive activity does not allow the deduction of suspended losses under IRC Sec. 469(g)(1)(A). (Under this provision, upon the taxable disposition of a passive activity, the excess of any current loss from the activity including suspended loss carryovers over any net income or gain for the year from all other passive activities, including their suspended loss carryovers, is treated as a fully deductible passive loss.) Instead, any gain is taken into account in determining the passive activity loss for the tax year as defined in IRC Sec. 469(d)(1). However, the JCT report says that IRC Sec. 469(g)(1)(A) may apply to a subsequent disposition of the interest in the activity by the taxpayer.

Extend Alternative Minimum Tax Relief for Individuals

For 2001, all nonrefundable personal credits are allowed to the extent of the full amount of the individual's regular tax and alternative minimum tax (AMT). But for tax years beginning after 2001, these credits (other than the adoption credit, child credit, and IRA credit) are allowed only to the extent that the individual's regular income tax liability exceeds his or her tentative minimum tax determined without regard to the minimum tax foreign tax credit. The adoption credit, child credit, and IRA credit are allowed to the full extent of the individual's regular tax and AMT.

Under the Act, an individual can offset his or her entire regular tax liability and AMT liability by the personal nonrefundable credits in 2002 and 2003.

Extend Work-related Credits