The Job Creation and Worker Assistance Act of 2002

By Mark H. Levin

In Brief

Order Out of Chaos

The Job Creation and Worker Assistance Act of 2002 provides a wide range of tax relief benefits for businesses and individuals affected by the terrorist attacks of September 11, 2001. Many of the provisions focus on the area of lower Manhattan designated the Liberty Zone. The act will provide welcome and much-needed relief for many, but the specifics are necessarily complex and require careful reading. For example, many relief provisions are complicated because they were structured to prevent abuses, such as individuals or businesses doubling their benefits in ways the act does not intend.

President Bush signed the Job Creation and Worker Assistance Act of 2002 into law on March 9, 2002. It contains tax relief for businesses both in lower Manhattan and nationwide that have been affected by the terrorist attacks of September 11, 2001, and many provisions are retroactive to that date. The act also contains various provisions affecting pensions, other employee benefits, and portions of current law that would otherwise expire. A number of controversial proposed measures were removed from the final legislation, including those dealing with health insurance and payroll taxes.

Significant Changes Affect Many Businesses

The following provisions apply to taxpayers nationwide:

The changes described above affecting returns already filed for 2001 may require amended returns. Businesses with substantial capital expenditures on or after the 2001 effective dates or unused NOL carrybacks may be particularly interested in the amended return procedures.

Liberty Zone Major Business-Related Provisions

The more significant provisions of the act apply to businesses located in lower Manhattan. They include all of the above provisions, plus the following:

Extender Provisions

In addition to the new provisions above, the following existing tax provisions were extended for two additional years:

Discussion and Analysis

The following provisions of the act apply to all businesses nationwide:

Depreciation: Bonus first-year depreciation. The act provides an additional first-year “bonus” 30% depreciation deduction under IRC section 168(k)(1), provided that the property was—

For many taxpayers, this capital spending incentive may be the act’s most significant change. Capital expenditures must be carefully analyzed and action taken to ensure the full benefit of the retroactive provision.

Under this provision, a business may take an additional 30% depreciation deduction on qualified property. Qualified property is defined as original-use property to which the general rules of the modified accelerated cost recovery system (MACRS) apply and which the taxpayer placed into service on or after September 11, 2001. (Original use means the first use to which the property is put, regardless of whether such use corresponds to the use of such property by the taxpayer.) The additional 30% bonus depreciation does not apply to any property that has been previously used.

Qualified property is defined as—

The taxpayer must purchase the property within the applicable time period; the property may not be subject to a binding written contract in effect prior to September 11, 2001, and must be placed in service before January 1, 2005.

Qualified leasehold improvement property is defined as any improvement to the interior of a building that is nonresidential real property that meets the following requirements:

Qualified leasehold improvement property does not include expenditures attributable to any of the following:

For purposes of this provision, a binding commitment to enter into a lease would be treated as such and the parties would be treated as lessor and lessee. A lease between related parties would not be treated as a lease for this purpose.

The 30% bonus depreciation is not available to property that must be depreciated under ADS. Otherwise qualified property for which the taxpayer has elected to use ADS is still qualified property with respect to the additional first-year 30% bonus depreciation. The additional first-year 30% bonus depreciation is automatic. Taxpayers that do not want to use the 30% bonus depreciation must elect out. Failure to do so will mandate a 30% basis reduction in the asset before depreciation computation. Using the additional first-year 30% bonus depreciation is also considered depreciation for AMT purposes and will not produce any AMT adjustment.

Any taxpayers who acquired qualified property after September 11, 2001, and filed their return prior to the enactment of the act must file an amended return to use the additional first-year 30% bonus depreciation.

The 30% first-year bonus depreciation is in addition to the regular MACRS allowance otherwise allowed. Taxpayers that utilize the 30% first-year bonus depreciation must reduce the basis of the asset before computing the regular MACRS depreciation.

The additional first-year 30% bonus depreciation is in addition to, and does not replace, the first-year expensing provisions of IRC section 179. Eligible taxpayers may take advantage of both, but must first use the IRC section 179 deduction before taking the 30% first-year bonus depreciation.

For example, a taxpayer who purchases a qualifying asset (eligible for seven-year MACRS) on October 1, 2001, for $100,000 may depreciate the asset as follows:

Depreciation: Luxury automobiles. The act provides for an additional $4,600 deduction in the year that a luxury passenger automobile [as defined in IRC section 280F(d)(5)] is acquired. Unlike the basic deduction allowed under IRC section 280F, the additional $4,600 deduction will not be indexed. The additional amount is applicable to luxury automobiles acquired after September 10, 2001, but before September 11, 2004. With this additional amount the maximum deduction allowed under IRC section 280F in the year of acquisition is temporarily increased to $7,660. The allowable deduction for subsequent years remains unchanged.

IRS Revenue Procedure 2002-33 provides detailed guidance on how the bonus depreciation and other deductions are claimed for qualified property not claimed in 2001 tax returns. In addition, the revenue procedure explains how to expense Liberty Zone property additions under IRC section 179, its interrelationship with bonus depreciation, and the treatment of Liberty Zone leasehold improvements.

The state tax law implications of these federal law changes must be carefully considered as well. Some states have already acted to conform to the federal changes. A number of states have decoupled from the federal changes due to budgetary pressures. State governments’ websites are a reliable source of updated information, as are the websites for some software vendors and legal publishing houses. As of this writing, New York City has legislation pending to decouple from the federal changes for businesses outside the Liberty Zone.

Repeal of Gitlitz v. Comm’r. The new act effectively reverses the U.S. Supreme Court decision in Gitlitz v. Comm’r, which held that an S corporation shareholder’s basis was increased by cancellation of debt income excluded under IRC section 108. This provision is effective for cancellation of debt income for tax years ending after October 11, 2001. However, the amendment does not apply to any discharge of indebtedness before March 1, 2002, in connection with a reorganization plan filed with a bankruptcy court on or before October 11, 2001.

Five-year NOL carryback. The act temporarily extends the general NOL carryback period to five years for NOLs arising in taxable years ending in 2001 and 2002. The five-year carryback also applies to NOLs from taxable years ending in 2001; 2002 NOLs arising from casualty or theft losses of individuals or attributable to certain presidentally declared disaster areas qualify for a three-year carryback period. A taxpayer may elect to forego the entire five-year carryback period and carry the NOL forward, or forego only the additional three years and carry the NOL back for two years. For taxpayers in lower tax brackets, an election to waive the extended carryback would be beneficial. The extended carryback would be effected in the same manner as under prior law (i.e., corporate taxpayers would use either Form 1139 or Form 1120X, and individual taxpayers would use either Form 1045 or Form 1040X).

New York is among the states that incorporate the extended carryback period. In evaluating whether to use the extended carryback, the effect of the limitation imposed by New York on the amount that may be carried back should be determined as well.

IRS Revenue Procedure 2002-40 provides detailed guidance on how to use or waive both the entire five-year carryback period and the basic two-year carryback period for taxpayers that filed their returns for tax years 2001 or 2002 before the law was passed, and could have been barred from taking advantage of the new extended NOL carryback period. The Revenue Procedure gives affected taxpayers until October 31, 2002, to make any election to waive the carryback period made on the return as filed.

Limitation of AMT NOL deduction. The act temporarily suspends the 90% of AMT income limitation for taxable years ending in 2001 and 2002 in deducting AMT NOLs in computing the AMT. Therefore, for taxable years ending in 2001 and 2002, a taxpayer may deduct an AMT NOL to the extent of 100% of AMT income.

Liberty Zone Business Provisions

The act designates the area damaged in the September 11, 2001, terrorist attacks as the New York Liberty Zone, defined as the “area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with East Broadway), in the Borough of Manhattan in the City of New York.” Businesses that are or were located in the zone are eligible for additional tax relief above that afforded to businesses nationwide.

If a business qualifies for such benefits, the Liberty Zone provisions take precedence; the business cannot avail itself of both the Liberty Zone benefits and benefits available nationwide.

Expansion of the WOTC. The act creates the Liberty Zone business employee credit (LZBEC) as part of the WOTC and directed toward Liberty Zone business employees.

Liberty Zone business employees consist of individuals that work for a Liberty Zone business that employs an average of less than 201 employees on business days during the taxable year, and that perform substantially all of their services for a business located in the zone. This group also includes employees that perform substantially all of their services in New York City for a business that was forced to relocate from the zone because of the destruction or damage of their workplace. Unlike the other eight targeted groups, members of this new group will not require certification of their wages to qualify for the WOTC.

The credit for this new group is based on 40% of the first $6,000 of qualified wages, to a maximum credit of $2,400 per employee in each taxable year. Qualified wages are defined as “wages paid or incurred by the employer to individuals who are New York Liberty Zone business employees of such employer for work performed during the calendar year 2002 and 2003.”

Unlike the other targeted groups, the credit for the new targeted group is available for wages paid for both new hires and existing employees. For each qualified business that relocated from the zone to elsewhere in New York City due to the physical destruction or damage of their workplaces, the number of that employer’s employees whose wages are eligible under the new targeted category may not exceed the number of employees employed in the zone on September 11, 2001. Qualified businesses that operated in the zone both on and after September 11 and businesses that move into the zone after September 11, 2001, are not subject to this limitation.

The carryback and carryforward rules that apply to the general business credit are applied separately with respect to any unused LZBEC. The unused credit may be carried back one year and carried forward for 20 years. The LZBEC portion of the WOTC is allowed as a credit against the AMT.

Depreciation: Bonus first-year depreciation. In addition to the new nationwide provisions for businesses located in the zone, the act also permits the 30% bonus depreciation to be used on qualified Liberty Zone property. For property to qualify for the 30% first-year bonus depreciation as qualified Liberty Zone property, it must meet the following requirements:

The 30% first-year bonus depreciation is in addition to the deduction allowed under IRC section 179 and is computed after reducing the property’s basis by the deduction taken. The basis of any property for which the 30% first-year bonus depreciation was taken must be reduced by that amount before depreciating the property under MACRS.

The 30% bonus depreciation is not available to property that must be depreciated under the alternative depreciation system (ADS). Otherwise, qualified property for which the taxpayer has elected to use ADS is still qualified property with respect to the additional first-year 30% bonus depreciation. The use of the additional first-year 30% bonus depreciation is considered depreciation for AMT purposes and will not produce any AMT adjustment.

Unlike the IRC section 179 deduction, the additional first-year 30% bonus depreciation is automatic; taxpayers who do not want to use it must elect out.

Special rules for qualified leasehold improvement property. Qualified Liberty Zone leasehold improvement property is eligible for the additional first-year 30% bonus depreciation or it may be included as MACRS five-year property (nine-year property under the ADS) using the straight line method. If the taxpayer elects to treat qualified Liberty Zone leasehold improvement property as MACRS five-year property, it may not also use the additional first-year 30% bonus depreciation. Qualified Liberty Zone leasehold improvement property is defined as qualified leasehold improvement property if—

Increased IRC section 179 deduction. The act provides for an increase in the maximum amount a taxpayer can deduct under IRC section 179 for qualifying property used in the Liberty Zone by the lesser of $35,000 or the cost of section 179 property that is qualified Liberty Zone property placed in service during the taxable year

This increase is in addition to the deduction permitted by section 179 and applies to qualified Liberty Zone property that was acquired after September 10, 2001, and placed in service before January 1, 2007 (January 1, 2009, for qualifying nonresidential real property and residential rental property).

This increased limitation is phased out similar to the regular section 179 deduction but takes into consideration only 50% of the cost of the qualified Liberty Zone property.

Recapture rules similar to those under IRC section 179(d)(10) shall apply to any qualified Liberty Zone property that ceases to be used in the New York Liberty Zone.

For example, a taxpayer who purchases a qualifying asset (eligible for seven-year MACRS) on October 1, 2001, for $100,000 may depreciate the asset as follows:

Extension for certain property involuntarily converted. The act extends to five years the replacement period for a taxpayer to purchase property to replace property that was involuntarily converted within the zone as a result of the September 11 terrorist attack, but only if substantially all of the use of the replacement property is in New York City.

Individual Provisions

Accelerated marriage penalty phase-out. The act accelerates the phase-in of the elimination of the marriage penalty in the standard deduction to 2005. Under the act the standard deduction for married filing separately will be 50% of the amount allowed for married filing jointly. This had not been scheduled to occur until 2009.

Personal nonrefundable credits to offset AMT through 2003. The act allows individuals to offset both their regular tax liability and their AMT liability by the personal nonrefundable credits in 2002 and 2003. (These are the dependent care credit in IRC section 21; the credit for the elderly and disabled in IRC section 22; the adoption credit in IRC section 23; the child tax credit in IRC section 24; the credit for interest on certain home mortgages in IRC section 25, the Hope scholarship and lifetime learning credits in IRC section 25A; the D.C. first-time homebuyer credit in IRC section 1400C; and the credit for elective deferrals and IRA contributions, also known as the saver’s credit, in IRC section 25B.)

Previously, nonrefundable personal credits could offset the AMT liability in only 2000 and 2001. Limitations on the use of the aforementioned nonrefundable credits (except for the adoption credit, the child tax credit, and the saver’s credit) against the AMT liability have been postponed until after 2003.

Foreign tax credit. The act extends the time during which an individual’s foreign tax credit is not reduced by the nonrefundable personal credits until after 2003 (previously 2001).

Rate reduction credit treated as a nonrefundable personal credit. The act provides that the 2001 rate reduction credit is to be treated as a nonrefundable personal credit for all income tax provisions in the IRC. Previously the 2001 rate reduction credit was considered as a nonrefundable personal credit only for the purposes of computing a taxpayer’s 2001 estimated tax.

Elementary and secondary school teachers’ expenses. The act allows elementary or secondary school teachers to receive an above-the-line deduction of up to $250 for otherwise eligible IRC section 162 trade or business expenses. These eligible expenses are limited to amounts paid or incurred in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services), and other equipment and supplementary material used in the classroom by the eligible educator.

An eligible educator is defined as a kindergarten through grade 12 teacher, instructor, counselor, or principal in a school for at least 900 hours during a school year. A school is defined as any school that provides elementary or secondary education, as determined under state law.

Adoption expenses. The act permits a taxpayer who pays or incurs expenses to adopt a special-needs child to claim a credit for those expenses as they are paid or incurred starting in 2003. Previously, these expenses had been aggregated and the taxpayer was allowed a credit based on the aggregate expenses in the year when the adoption of the special-needs child became final. Under the act, the allowed credit is equal to the expenses paid or incurred by the taxpayer in the year they are paid or incurred. In addition, in the year the adoption of the special-needs child becomes final, the taxpayer is allowed a credit equal to the amount paid or incurred in that year plus the excess of $10,000 over the amounts paid or incurred in the year the adoption becomes final and all prior years.

©2002 CPA Journal. Legal Notices