Senate Finance releases summary of changes to tax extenders

Reduce Medicare physician payment update from 19 to 6 months.  Medicare physician 

payment rates are scheduled to be reduced by more than 20 percent in June.  This provision 

would reverse that reduction and provide a 2.2 percent update to physician payment rates 

through November 30, 2010. This change will reduce the cost of the bill by $16.4 billion over 10 

years. 

Eliminate the Extension of Federal Additional Compensation (FAC).  Federal Additional 

Compensation, which increases unemployment benefits by $25 a week, was phased-out at the 

end of May 2010.  The original Baucus substitute would have extended FAC through November 

2010.  This modification eliminates that extension of FAC. Under this bill, individuals that are 

currently receiving FAC will continue to receive FAC until the exhaustion of all benefit 

programs, but no later than the end of the week beginning December 7, 2010.  The non-reduction 

rule for FAC also continues to apply through the end of the week beginning December 7, 2010.  

In addition, the “non-reduction rule” has been attached to the Emergency Unemployment 

Compensation (EUC) provision.  This change will reduce the cost of the bill by $5.8 billion over 

10 years. 

Changes to the taxation of carried interest.  The bill would prevent investment fund managers 

from paying taxes entirely at capital gains rates on investment management services income 

received as carried interest in an investment fund. To the extent that carried interest reflects a 

return on invested capital, the bill would continue to tax carried interest at capital gain tax rates. 

However, to the extent that carried interest does not reflect a return on invested capital, this 

amendment would require investment fund managers to treat seventy-five percent (75%) of the 

remaining carried interest as ordinary income beginning on January 1, 2011. The amount that 

will be treated as ordinary income is reduced to fifty percent (50%) for carried interest that does 

not reflect a return on invested capital but which is attributable to the sale of assets which are 

held for 5 or more years.  This amendment provides that the lower recharacterization percentage 

also applies to the gain or loss attributable to the underlying assets held for 5 or more years when 

a partnership interest is sold as well as to gain attributable to section 197 intangibles of a 

partnership whose principal activity is providing specific investment management services with 

respect to the assets of the partnership when the partnership interest has been held for 5 or more 

years.  This amendment also provides that, on selling an interest in any publicly traded 

partnership, a person who is not an investment service provider will be exempt from the rule that 

recharacterizes as ordinary income under Internal Revenue Code section 751(a) that portion of 

the gain or loss attributable to an investment services partnership interest. This proposal, as 

amended, is estimated to raise $13.905 billion over 10 years. 

Changes to Employment Taxes on Earning of Certain Service Professionals.  Social Security 

taxes are imposed on compensation and self-employment income up to the Social Security Wage 

Base (currently $106,800) and the Medicare tax is imposed on all self-employment and 

compensation income. Some service professionals have been avoiding Medicare and Social 

Security taxes by routing their self-employment income through an S corporation. These 

taxpayers then pay themselves a nominal salary and take the position that the remaining earnings 

are exempt from employment taxes. A provision passed by the House and included in the 

original Baucus substitute would address this abuse in situations where (1) an S corporation is a 

partner in a professional service business or (2) an S corporation is engaged in a professional 

service business that is principally based on the reputation and skill of 3 or fewer individuals.   

This provision does not change the ability of S corporations to use some income to make 

business investments or deduct those small business investments.  To make the second 

alternative more administrable and more targeted, this amendment changes the language so that 

the policy applies only if 80 percent or more of the professional service income of the 

corporation is attributable to the services of 3 or fewer owners of the corporation.  This proposal, 

as amended, is estimated to raise $9.15 billion over 10 years.  

 

Increase Oil Spill Liability Trust Fund solvency. The Oil Spill Liability Trust fund is financed 

by an 8-cent-per-barrel tax on the oil industry. There is approximately $1.5 billion available in 

this trust fund. The nonpartisan Congressional Research Service has stated, “a major spill, 

particularly one in a sensitive environment, could threaten the viability of the fund.” To ensure 

the continued solvency of the Oil Spill Liability Trust Fund, the bill would increase the per- 

barrel amount that oil companies are required to pay into the fund to 49 cents.  This proposal, as 

amended, is estimated to raise $18.3 billion over 10 years.  

 

Addition of the Modification to the Section 6707A Penalty.  The bill revises section 6707A of 

the Internal Revenue Code to make the penalty for failing to disclose a reportable transaction 

proportionate to the underlying tax savings.  The purpose of this change is to prevent small 

businesses from paying a penalty significantly greater than the benefit they would receive from 

their investment.    The penalty for failure to disclose reportable transactions to the IRS would be 

set at 75 percent of the tax benefit received.  Reportable transactions are defined as investments 

in transactions that the IRS has identified as listed tax shelters or that have characteristics of tax 

shelters, including large losses or confidentiality agreements. The minimum penalty under this 

bill is $10,000 for corporations and $5,000 for individuals, and the maximum penalty is 

$200,000 for corporations and $100,000 for individuals.  The bill also requires the IRS to 

provide an annual report to the Senate Finance Committee and to the House Ways and Means 

Committee giving an account of certain tax-shelter related penalties asserted during the year.  

This proposal, which passed the Senate by unanimous consent in December of 2009, is estimated 

to cost $176 million over ten years. 

 

Addition of Clarification for Affiliated Hospitals for Distribution of Residency Positions.  

The bill would make a technical correction to clarify that residency positions being used as part 

of an affiliation agreement between teaching hospitals would not be considered unused residency 

positions, for the purpose of the redistribution of GME slots under current law. This provision is 

estimated to save approximately $50 million over 10 years.  

Addition of Disaster Low-Income Housing Tax Credits.  Under current law, every year states 

receive allocations of low-income housing tax credits (LIHTC) based on population or a small 

state set-aside.  In response to Hurricane Katrina in 2005, as well as the floods in the Midwest in 

2007, the LIHTC was expanded to allow for additional credits, called “disaster credits”, to help 

affected states rebuild.  This amount is on top of what States receive under current law.  As part 

of the American Recovery and Reinvestment Act of 2009, LIHTCs are eligible to be exchanged 

for grants.  This exchange program only applies to LIHTCs allocated based on population – it 

did not apply to disaster credits.  In the underlying bill, LITHCs allocated in 2010 are eligible to 

be refundable credits.  This provision also allows disaster credits from the Katrina and 

Midwestern flood disasters to be exchanged for either grants or refundable credits.  The 

provision is estimated to cost $91 million over 10 years.  

Addition of Extension of Closing Date for Homebuyer Tax Credit.  As part of the Worker, 

Homeownership, and Business Assistance Act of 2009, the homebuyer tax credit was expanded 

and extended to allow homebuyers to receive a tax credit for the purchase of a qualifying home 

through April 30, 2010.  Homebuyers can benefit from the tax credit up to July 1, 2010 if they 

entered into a binding contract by April 30, 2010 and close on the home within 60 days.  This 

provision extends the closing date for homebuyers who entered into a binding contract by April 

30, 2010, allowing them to be eligible for the tax credit if they close on the home before October 

1, 2010.  The provision is estimated to cost $140 million over 10 years.  

 

Addition of Denial of Deductions for Punitive Damages.  Under current law, a deduction is 

allowed for damages paid or incurred as ordinary and necessary expense in the course of a trade 

or business.  However, no deduction is allowed for a fine or penalty paid to a government for the 

violation of any law.   If a taxpayer is convicted in violation of antitrust laws, no deduction is 

allowed for two-thirds of any amount paid or incurred on a judgment or settlement.  This 

provision denies a tax deduction for payments made for punitive damages in connection with any 

legal judgment or settlement.  Additionally, in the case that a taxpayer’s punitive damages are 

paid by an insurer, the amounts paid on behalf of the taxpayer are included in the taxpayer’s 

gross income. This provision applies to damages paid or incurred after December 31, 2011.   The 

provision is estimated to raise $315 million over 10 years. 

 

Foreign tax loophole closer clarification regarding the source rules for income on 

guarantees.  The provision would reverse a recent Tax Court decision to provide that guarantee 

payments made to foreign persons are treated like interest, rather than services, and therefore 

subject to U.S. withholding tax when paid by a U.S. person to a foreign person.  The 

modification would clarify that the provision only applies to guarantees of indebtedness (rather 

than to guarantees of obligations).  The clarification has no revenue effect. 

Foreign tax loophole closer clarification regarding the provision that would terminate the 

special rules for interest and dividends received from “80/20 companies”.  The provision 

would eliminate the withholding and foreign tax credit benefit for 80/20 companies 

prospectively, subject to a “grandfather” rule that would continue to provide favorable 

withholding tax treatment to payments made by existing legitimate 80/20 companies.  The 

modification would clarify that for purposes of applying the grandfather provision for periods 

prior to January 1, 2011, the 80/20 rules then in effect shall apply.  The clarification has no 

revenue effect.