Technical Corrections Act of 2007
Includes Many Substantive Changes

H.R. 4839, the "Tax Technical Corrections Act of 2007" (TCA), was passed by Congress on Dec. 19, 2007, and awaits the President's sig­nature. Although many of the TCA's changes are strict­ly clerical in nature, a number of them make substantive changes to legislation that was enacted in recent years.

Following are highlights of some of the more wide­ly applicable provisions of the TCA. All changes are retroactively effective as if included in the legislation that enacted the provision being changed.

AMT Refundable Credit
Amount Liberalized

Under the Tax Relief and Health Care Act of 2006, for tax years beginning after Dec. 20, 2006, if an individual has a "long-term unused minimum tax credit" for any tax year beginning before Jan. l, 2013, the amount determined under the Code Sec. 53(c) limit on the min­imum tax credit for the tax year can't be less than "the AMT refundable credit" amount for that tax year. The credit is subject to a phaseout, and is refundable.

Under pre-TCA law, the "AMT refundable credit amount" is the greater of:

(1) the lesser of $5,000 or the long-term unused mini­mum tax credit; or

(2) 20% of the long-term unused minimum tax credit.

The long-term unused minimum tax credit (MTC) for any tax year is the portion of the minimum tax cred­it attributable to the adjusted net minimum tax for tax years before the 3rd taxable year immediately preced­ing the tax year (assuming the credits are used on a first-in, first-out basis).

A taxpayer whose AGI for a tax year exceeds an annually-adjusted threshold amount must reduce his AMT refundable credit amount by 2% for each $2,500 (or fraction thereof) by which his AGI exceeds the threshold amount. For example, for 2007, the threshold amount is $234,600 for married couples filing jointly and surviving spouses and $156,400 for singles.

New law. Under the TCA, the AMT refundable credit amount for a year beginning before 2013 (before any reduction by reason of adjusted gross income) is an amount (not in excess of the long-term unused MTC for that year) equal to the greater of:

(1) $5,000;

(2) 20% of the long-term unused minimum tax credit; or

(3) the AMT refundable credit amount (if any) for the prior tax year the preceding year's credit amount  before any reduction by reason of adjusted gross income.

Observation: By providing that an individual's AMT refundable credit amount for a tax year is the greatest of items (1), (2), and (3) listed above, the TCA gives the taxpayer an AMT refundable credit amount of at least $5,000 for a tax year, provided the individual's long-term unused MTC is at least $5,000.

Revised Tax Computation When Foreign Earned
Income Exclusion is Utilized

Under the Tax Increase Prevention Act of 2005 (TIPRA), for tax years beginning after 2005, where a taxpayer claimed a foreign earned income or foreign housing cost exclusion ("excluded amounts") the regu­lar tax was calculated under a stacking rule. Thus, the regular tax was equal to the excess (if any) of:

... the regular tax that would be imposed for the tax year if the taxpayer's taxable income were increased by the amount of these exclusions for the tax year, over

... the tax that would be imposed for the tax year if the taxpayer's taxable income were equal to the amount of these exclusions for the tax year.

Similarly, his tentative minimum tax for the tax year was equal to the excess (if any) of:

... the amount that would be the tentative minimum tax for the tax year (calculated after reduction for any AMT foreign tax credits) if the taxpayer's taxable excess were increased by the amount of these exclusions for the tax year, over

... the amount that would be the tentative minimum tax for the tax year (calculated after reduction for any AMT foreign tax credits) if the taxpayer's taxable excess were equal to the amount of these exclusions for the tax year.

New law. For tax years beginning after 2006, the TCA amends the regular tax computation and the AMT computation when an individual taxpayer excludes amounts under the foreign earned income or foreign housing cost exclusion.

Regular tax computation. The TCA amends the reg­ular tax computation to provide that where a taxpayer has excluded amounts and has taxable income for the tax year, the regular tax is equal to the excess (if any) of:

(1) the regular tax that would be imposed for the tax year if the taxpayer's taxable income were increased by the amount of these exclusions for the tax year; over

(2) the tax which would be imposed for the tax year if the taxpayer's taxable income were equal to the amount of these exclusions for the tax year. (Code Sec. 911 (f)(1)(A), as amended by TCA § 4(c))

However, if the taxpayer's net capital gain exceeds his taxable income for a tax year (i.e., there is a "capi­tal gain excess"):

... the taxpayer's net capital gain (determined without including any qualified dividend income in net capital gain) is reduced (but not below zero) by the net capital gain excess; (Code Sec. 911 (f)(2)(A)(i))

... the taxpayer's qualified dividend income is reduced by the portion of the capital gain excess that exceeds the taxpayer's net capital gain (determined without includ­ing any qualified dividend income in net capital gain) and the reduction under item (1), above (Code Sec. 911 (t)(2)(A)(ii);

... adjusted net capital gain, unrecaptured section 1250 gain, and 28% rate gain are each determined after increasing the amount in Code Sec. 1(h)(4)(B) that is treated as capital loss for purposes of calculating 28% rate gain and unrecaptured section 1250 gain by the cap­ital gain excess. (Code Sec. 911(f)(2)(A)(iii)) Thus, it is treated as a long-term capital loss carried to the tax year.

Illustration: In 2007, an unmarried individual has $80,000 of excluded income, a $30,000 gain from the sale of a capital asset, and $20,000 deductions. The taxpayer's taxable income is $10,000. The tax­payer's tax is the excess of the amount of tax com­puted on taxable income of $90,000 ($10,000 tax­able income plus $80,000 excluded income) of which $30,000 is adjusted net capital gain, over the tax computed on the $80,000. In determining the tax on the $90,000, the net capital gain and the adjusted net capital gain are each $10,000. This results in a tax of $1,500 (15% of $10,000 of adjusted net capi­tal gain). (JCX-119-07)

observation: Absent the provision, the tax on the $90,000 would have been calculated as if $30,000 were capital gain, while the tax on the $80,000 would have been calculated at ordinary income rates, with the result that the individual may have escaped tax entirely.

Illustration: In 2007, an unmarried individual has $90,000 of excluded income, a $5,000 gain on the sale of a capital asset held for more than a year, $25,000 unrecaptured section 1250 gain, and $20,000 deductions. The taxpayer's taxable income is $10,000. The taxpayer's tax is the excess of the amount of tax computed on taxable income of $100,000 ($10,000 taxable income plus $90,000 excluded income) over the amount of tax computed on taxable income of $90,000 (excluded income). In determining the tax on the $100,000, the net capital gain is $10,000, of which $5,000 is adjusted net cap­ital gain and $5,000 is unrecaptured section 1250 gain. This results in a tax of $2,000 (15% of $5,000 adjusted net capital gain plus 25% of $5,000 unre­captured section 1250 gain).

Alternative minimum tax computation. The TCA amends the alternative minimum tax computation to provide that where a taxpayer has excluded amounts and has a taxable excess, his tentative minimum tax before reduction by the AMT foreign tax credit is equal to the excess (if any) of:

(A) the amount that would be the tentative minimum tax (taking into account the special capital gains rates) for the tax year before reduction by the AMT foreign tax credit if the taxpayer's taxable excess (generally, the AMTI minus the exemption amount) were increased by the amount of these exclusions for the tax year (Code Sec. 911(f)(1)(B)(i)); over

(B) the amount that would be the tentative minimum tax (taking into account the special capital gains rates) for the tax year before reduction by the AMT foreign tax credit if the taxpayer's taxable excess were equal to the amount of these exclusions for the tax year. (Code Sec. 911(f)(1)(B)(ii)) 

Thus, in computing the tentative minimum tax on the remaining income, the tax computation is made before the reduction for the AMT foreign tax credit. This conforms the AMT computation to the regular tax computation, which is also made before the application of the foreign tax credit.

Where, without regard to this rule, a taxpayer's net capital gain would exceed his taxable excess for a tax year, the amount in items (A), using the Code Sec. 55(b)(3) alternative minimum tax capital gains cal­culation, is determined:

... by applying the regular tax rules described above in items (1), (2), and (3) under the "Regular tax computa­tion," but substituting the taxable excess for taxable income (Code Sec. 911(f)(2)(B)(i)) and

... the reference in the alternative minimum tax capital gains calculation to the net capital gain that is subject to a 5% rate under (Code Sec. 1(h)(1)(B)) is to be read as a reference to that amount determined :by applying the regular tax rules described in items (1), (2), and (3). (Code Sec. 911(f)(2)(B)(ii))

For this purpose, terms in the above rules that are also used in the Code Sec. 1(h) capital gains rules have the meanings used in the capital gains rules, except that in applying the above rules for minimum tax purposes, the minimum tax rules are taken into account.

Donee Use of Donated Personal Property
Must be Substantially Related to its Purpose or
Function to Avoid Problems for Donor

For contributions of "applicable property" where the donee disposes of the property within specified time periods following the contribution, the donor's deduc­tion is subject to reduction (if the disposition occurs in the same year as the contribution) or recapture (if the disposition occurs with specified time periods follow­ing the year of the contribution). "Applicable property" is charitable deduction property:

(A) that is tangible personal property whose use is iden­tified by the donee as related to the purpose or function that is the basis of the donee's exemption, and

(B) for which a deduction in excess of the donor's basis is allowed.

The reduction and/or recapture consequences can be avoided if the donee provides a certification. This certifi­cation consists of a written statement that satisfies one of two sets of requirements. Under pre-TCA law, the writ­ten statement under one of these sets of requirements:

(1) had to be signed under penalty of perjury by an offi­cer of the donee organization;

(2) had to certify that the donee's use of the property was related to the purpose or function that was the basis for its tax-exemption; and

(3) had to describe how the property was used and how that use furthered that purpose or function.

New law. Under the TCA, the written statement sat­isfies the requirement at (2) above only if, in addition to certifying that its use of the donated property was related to its exempt use or function, the donee organi­zation certifies that its use of the donated property was substantial. (Code Sec. 170(e)(7)(D)(i)(I), as amended by TCA § 3(c))

Observation: In other words, the donee must certi­fy not only that its use of the donated property was related to its exempt purpose or function, but also that its use of the property was substantial.

Note that the TCA also changes the definition of "applicable property." It provides that the definition of "applicable property" for purposes of the reduction required in the amount of the taxpayer's deduction if the donee disposes of the property before the end of the contribution year no longer includes the requirement described at (B), above. (Code Sec. 170(e)(1 )(13)(i) as amended by TCA § 11(a)(15))

Penalty for Substantial and Gross Valuation
Misstatements Attributable to Incorrect Appraisals

The 2006 Pension Protection Act (PPA) imposed a penalty on any person:

(A) who prepared a property appraisal and knew, or rea­sonably should have known, that the appraisal would be used in connection with a return or a refund claim, and

(B) the claimed property value on the return or refund claim that was based on the appraisal resulted in a sub­stantial valuation misstatement under Code Sec. 6662(e) or a gross valuation misstatement under Code Sec. 6662(h) for the property.

The penalty equaled the lesser of:

(1) the greater of: (a) 10% of the underpayment (as defined in Code Sec. 6664(a)) attributable to the mis­statement described in (B) above, or (b) $1,000, or

(2) 125% of the gross income for preparing the appraisal received by the person who prepared it.

Under pre-TCA law, the period of limitations for the assessment of Code Sec. 6694(a) penalties (preparer penalties for understatements of taxpayer liability due to an unreasonable positions) and Code Sec. 6695 penalties (certain other preparer penalties) was three years from the date that the return or refund claim for which the penalty was assessed, was filed.

New law. The TCA provides that the valuation mis­statement penalty described above will also apply to any person who prepares an appraisal upon which a Code Sec. 6662(g) substantial estate or gift tax valua­tion understatement is based. (Code Sec. 6695A(a)(2), as amended by PPA § 3(e))

Observation: Thus, in addition to persons who are currently subject to the penalty for valuation mis­statements attributable to incorrect appraisals, that penalty will also apply to any person who:

(A) prepares a property appraisal and knows, or rea­sonably should have known, that the appraisal would be used in connection with a return or a refund claim, and 

(B) the claimed property value on the return or refund claim that is based on the appraisal results in a substantial estate or gift tax valuation understate­ment under Code Sec. 6662(g).

The TCA also provides that the Code Sec. 6695A penalty for valuation misstatements attributable to incor­rect appraisals is subject to a 3-year limitation period. (Code Sec. 6696(d)(1), as amended by PPA § 3(e)(2))

Observation: Thus, the period of limitations for the assessment of a Code Sec. 6695A penalty is three years from the date that the return or refund claim for which the penalty is assessed, is filed.

Observation: The above changes were necessary because Congress failed to add all the appropriate cross references when it added Code Sec. 6695A to the Code as part of the PPA.

Retroactive Repeal of Limits on Estate & Gift Tax Charitable Deductions for Series of Fractional Contributions of Tangible Personal Property

The 2006 Pension Protection Act (PPA) included a rule which provided that, if a taxpayer made a lifetime gift of an undivided portion of his entire interest in any tangible personal property, for which an income tax charitable deduction was allowed (an "initial fractional contribution"), and then, on his death, the taxpayer made an additional bequest, legacy, devise, or transfer of an interest in the same property (an "additional con­tribution"), there was a limit on the amount of the estate tax charitable deduction allowable for the additional

contribution. For estate tax charitable deduction pur­poses, the fair market value of the additional contribu­tion was determined by using the lesser of:

... the fair market value of the property at the time of the initial fractional contribution, or

... the fair market value of the property at the time of the additional contribution.

Observation: Thus, under PPA, any post-gift appre­ciation in the value of the tangible personal proper­ty was not taken into account in determining the amount of the estate tax charitable deduction. If, however, the property declined in value after the date of the lifetime gift, the reduction in value was taken into account for purposes of determining the estate tax charitable deduction.

The PPA also provided a similar rule (and a similar "valuation whipsaw") for gift tax charitable deduction purposes.

The PPA also imposes similar limits on the income tax charitable deduction allowable for "additional con­tributions" of fractional interests in tangible personal property.

Observation: The limits on the income tax charita­ble deduction for additional contributions of frac­tional interests in tangible personal property do not result in the kind of "valuation whipsaw" that was caused by the limits on the estate and gift tax chari­table deductions.

New law. Congress realized that the limits imposed by the PPA on the estate and gift tax charitable deduc­tions allowable for "additional contributions" of tangible personal property had unintended consequences (i.e., the valuation whipsaws described above). (Committee Report) Thus, the TCA retroactively repeals these rules. (Code Sec. 2055(g) as amended by TCA § 3(d)(1)), Code Sec. 2522(e)(2) as amended by TCA § (d)(2)(A))

Observation: Thus, the 2007 TCA eliminates the valuation whipsaws that would have resulted from the limits imposed by the PPA on the estate and gift tax charitable deductions allowable for "additional contributions" of fractional interests in tangible per­sonal property.

Observation: The TCA does not repeal Code Sec. 170(0)(2), which imposes limits on the income tax charitable deduction allowable for "additional con­tributions" of fractional interests in tangible person­al property. Those limits do not result in the kind of "valuation whipsaw" that would have been caused by the repealed limits on the estate and gift tax char­itable deductions. However, the limits on the income tax charitable deduction still provide a dis­incentive to making charitable contributions of frac­tional interests in tangible personal property because, even if the property appreciates in value after the initial fractional contribution, the income tax charitable deduction must nevertheless be based on the value of the property at the time of the initial fractional contribution.

How Special Elective Deferral Limit Applies to

Designated Roth Contributions

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), a special rule allows certain employees to make additional elective deferrals to a tax-sheltered Code Sec. 403(b) annuity, sub­ject to (1) an annual limit of $3,000, and (2) a cumulative limit of $15,000 minus the amount of additional elective deferrals made in previous years under the special rule.

Pre-TCA law provides a rule to coordinate the cumulative limit with the ability to make designated Roth contributions, but inadvertently reduces the $15,000 amount by all designated Roth contributions made in previous years.

New law. The TCA clarifies that the $15,000 amount is reduced only by additional designated Roth contributions made under the special rule. ((Code Sec. 402(g)(7), as amended by TCA § 8(a)(1))

Designated Roth Contributions Are Subject to FICA

Under pre-TCA law, elective deferrals are included in wages for purposes of social security and Medicare taxes. (Code Sec. 3121(v)(1)(A))

New law. The TCA clarifies that wage treatment applies also to elective deferrals that are designated as Roth contributions. (Code Sec. 3121(v)(1)(A), as amended by TCA § (8)(a)(2))

Revised Rules for Contributions of Appreciated

Property by S Corporations

The 2006 Pension Protection Act (PPA) amended the S corporation rules so that the decrease in a shareholder's basis in his S corporation stock by reason of a charitable contribution made by the S corporation equals the share­holder's pro rata share of the adjusted basis of the con­tributed property. This rule applies for contributions made in tax years beginning after 2005 and before 2008.

Observation: Under the pre-2006 Pension Protec­tion Act rules, when an S corporation made a chari­table contribution of appreciated property, the share­holder's basis was reduced by the fair market value of the property. When the shareholder sold his stock, the basis reduction caused him to recognize more gain. This result differed from that of a direct charitable contribution of appreciated property, which didn't result in any gain recognition by the contributor.

New law. The TCA provides that where the above rule applies to limit the decrease in the basis resulting from the charitable contribution, the rule that limits the aggregate amount of losses and deductions that may be taken by the S corporation shareholder to his basis in the S corporation's stock and debt does not apply to the extent of the excess (if any) of:

... the shareholder's pro rata share of the charitable contribution, over

... the shareholder's pro rata share of the adjusted basis of such property. (Code Sec. 1366(d)(4), as amended by PPA § 3(b))

Illustration: A 100% shareholder in an S corpora­tion has a $300 basis in his S corporation stock. The S corporation contributes property with a basis of $200 and a fair market value of $500 to a charity. Under pre-TCA law, the shareholder could only take a $300 deduction for the contribution, since his basis in the stock was $300. The TCA allows the shareholder to take a full $500 deduction. The share­holder reduces his basis in his S corporation stock from $300 to $100.

Look-through Rule Clarified for Related CFCs

Under subpart F, U.S. persons who are 10% share­holders of a controlled foreign corporation (CFC) are required to include in income their pro rata share of the CFC's subpart F income whether or not this income is distributed to the shareholders. Subpart F income includes foreign base company income (FBCI), which in turn includes foreign personal holding company income (FPHCI). For subpart F purposes, FPHCI includes dividends, interest, income equivalent to inter­est, rents and royalties.

A look-through rule provides that a FPHCI doesn't include dividends, interest, rent, and royalties received or accrued from a CFC which is a related person to the extent attributable or properly allocable to income of the related person which is neither subpart F income nor income effectively connected to a trade or business. Under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), the look-through rule applies for tax years of foreign corporations beginning after Dec. 31, 2005 and before Jan. 1, 2009, and tax years of U.S. shareholders with or within which such tax years of foreign corporations end.

In Notice 2007-9, 2007-5 IRB 401, IRS concluded that the look-through rule didn't apply to interest, rent or royalties if deductions for those amounts created (or increased) a deficit which reduced the subpart F income of the related CFC payor or another CFC.

New law. The TCA provides that the look-through rule doesn't apply to any interest, rent, or royalty to the extent it creates (or increases) a deficit which under Code Sec. 952(c) may reduce the subpart F income of the payor or another CFC. (Code Sec. 954(c)(6)(B), as amended by TCA § 4(a)) Thus, interest, rents, and roy­alties will be treated as subpart F income, notwith­standing the general look-through rule, if the payment creates or increases a deficit of the payor corporation and that deficit is from an activity that could reduce the payor's subpart F income under Code Sec. 952(c)(1)(B) (the accumulated deficit rule) or could reduce the income of a qualified chain member under Code Sec. 952(c)(I)(C) (the chain deficit rule).